Information for this Item 6 is not required pursuant to General Instruction I(2) of Form 10-K.
Unless otherwise indicated, all financial data in this document have been prepared using generally accepted accounting principles (“GAAP”) in the United States of America. As used in this document, “Holdings” means Everest Reinsurance Holdings, Inc.; “Group” means Everest Re Group, Ltd. (formerly Everest Reinsurance Group, Ltd.); “Everest Re” means Everest Reinsurance Company and its subsidiaries (unless the context otherwise requires); and the “Company” means Everest Reinsurance Holdings, Inc. and its subsidiaries.
On February 24, 2000, a corporate restructuring was completed and Group became the new parent holding company of the Company, which remains the holding company for Group’s U.S. operations. Holders of the Company’s common stock automatically became holders of the same number of Group’s common shares. See ITEM 1, “Business - The Company” for a further discussion.
The worldwide reinsurance and insurance businesses are highly competitive yet cyclical by product and market. Competition with respect to the types of reinsurance and insurance business in which the Company is engaged is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best and/or Standard & Poor’s, underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written. These factors operate at the individual market participant level to varying degrees as applicable to the specific participant’s circumstances. They also operate in aggregate across the reinsurance industry more generally contributing, in combination with background, economic conditions and variations in the reinsurance buying practices of insurance companies, by participant and in the aggregate, to cyclical movements in reinsurance rates, terms and conditions and ultimately reinsurance industry aggregate financial results.
Through 2003, reinsurance and insurance markets had generally continued to firm, reflecting the continuing, although diminishing, implications of losses arising from the terrorist attacks of September 11, 2001, and more broadly, the impact of aggregate company reactions to broad and growing recognition that competition in the late 1990s reached extremes in many classes and markets, which ultimately led to inadequate pricing and overly broad terms, conditions and coverages. The effect of these extremes, which became apparent through excessive loss emergence, varied widely by company depending on product offerings, markets accessed, underwriting and
The following tables reflect the reconciliation from reported to proforma for the periods indicated:
The following table reflects the reconciliation from reported to proforma segment underwriting results for the period indicated:
As indicated in the preceding “Industry Conditions” section, the reinsurance and insurance industry generally experienced favorable market conditions from 2001 through 2003. These favorable market conditions, coupled with the Company’s financial strength, strategic positioning and market and underwriting expertise, enabled the Company to increase its volume of business significantly over this period. With the change in competitive trend throughout 2004 and with little clarity regarding the impact of property catastrophe losses on prospective market conditions, the Company continued to adapt its operations to slow its rate of growth and even decrease writings for some classes of business and reemphasize its focus on profitability as opposed to volume.
Gross written premiums were $3.8 billion for the year ended December 31, 2004, a decrease of 0.8% as compared with $3.9 billion for the year ended December 31, 2003, which had increased 49.9% compared with the year ended December 31, 2002. Gross written premiums were $2.6 billion for the year ended December 31, 2002, an increase of 46.2% compared with the year ended December 31, 2001.
Net written premiums, comprised of gross written premiums less ceded premiums, were $2.8 billion for the years ended December 31, 2004 and 2003. The year ended December 31, 2003 had increased 35.8% compared with the year ended December 31, 2002. Net written premiums for the year ended December 31, 2002 were $2.0 billion, an increase of 52.9% compared with the year ended December 31, 2001. The majority of cessions in both periods continue to relate to the quota share reinsurance between Everest Re and Bermuda Re and Everest International Reinsurance, Ltd. (“Everest International”).
Premiums earned were $2.7 billion for the year ended December 31, 2004, an increase of 9.8% compared with $2.5 billion for the year ended December 31, 2003, which had increased 35.3% compared with the year ended December 31, 2002. Premiums earned for the year ended December 31, 2002 were $1.8 billion, an increase of 46.1% compared with the year ended December 31, 2001. These increases reflect period to period changes in net written premiums and business mix together with normal variability in earning patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets, but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. Changes in estimates related to unreported reinsurance activity may also affect premiums earned.
relating to net adverse prior period reserve strengthening of $184.8 million, $201.5 million and $82.7 million for years ended December 31, 2004, 2003 and 2002, respectively, principally related to the Company’s treaty casualty business, particularly professional liability classes, and workers’ compensation business, partially offset in 2004 by a $32.7 million reduction in reserves related to the World Trade Center events.
The Company’s reserving methodologies continuously monitor the emergence of loss and loss development trends, seeking on a timely basis, to both adjust reserves for the impact of trend shifts and to factor the impact of such shifts into its underwriting and pricing on a prospective basis.
Net realized capital gains of $56.7 million for the year ended December 31, 2004 were primarily the result of gains on the sale of the Company’s interest only strips investment portfolio. Net realized capital losses of $22.9
million and $53.1 million for the years ended December 31, 2003 and 2002, respectively, were primarily the result of valuation adjustments on the interest only strip portfolio in accordance with Emerging Issues Task Force No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITF 99-20”) and write-downs in the value of securities deemed to be impaired on an other than temporary basis, partially offset by realized gains.
Other expense was $73.4 million, $14.0 million and $21.8 million in 2004, 2003 and 2002, respectively. This change was primarily due to increased deferrals of the retroactive reinsurance agreements with affiliates for asbestos reserve strengthening.
Net income for the years ended December 31, 2004, 2003 and 2002 was $175.5 million, $206.5 million and $115.1 million, respectively, generally reflecting a decrease in operating results due to the catastrophe losses, partially offset by improved investment results and realized capital gains.
These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting gain (loss) or underwriting results. Underwriting results include earned premium less losses and LAE incurred, commission and brokerage expenses and other underwriting expenses and are analyzed using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. For selected financial information regarding these segments, see Note 16 of Notes to Consolidated Financial Statements.
$443.5 million, $325.9 million, $290.3 million $202.7 million, and $68.3 million, respectively. As a result of a similar adjustment for the year ended December 31, 2002, gross written premiums, net written premiums, premiums earned, incurred losses and LAE and other expenses decreased by $186.5 million, $155.8 million, $133.6 million $97.4 million, and $28.3 million, respectively. Effectively, these adjustments remove the UK branch from the 2003 and 2002 International segment making period over period results comparable.
The following tables present the relevant operating results for the operating segments for the three years ended December 31, 2004, 2003 and 2002:
All the comparative analysis in this Segment Information section relates to the proforma information in the above table except where indicated otherwise.
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
$193.8 million increase in program business other than workers’ compensation, partially offset by a $95.5 million decrease in workers’ compensation business.
Incurred losses and LAE in 2004 reflected ceded losses and LAE of $789.6 million compared to ceded losses and LAE in 2003 of $688.8 million. Ceded losses and LAE in 2004 included $480.2 of ceded losses relating to the quota share reinsurance transactions noted earlier between Everest Re and Bermuda Re and Everest International as compared with ceded losses of $422.9 million for 2003. The ceded losses and LAE for 2003 included $85.0 million of losses ceded under the 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program and $81.1 million under an aggregate excess of loss reinsurance agreement provided by Prudential Property and Casualty Insurance Company of Indiana (“Prupac”), a wholly-owned subsidiary of The Prudential. On October 31, 2003, LM Property & Casualty Insurance Company (“LM”) completed its purchase of Prupac and its obligations from The Prudential. The Prudential continues to guarantee LM’s obligation under this agreement. Cessions under this reinsurance agreement exhausted the limit available under the contract at December 31, 2003.
Net adverse prior period reserve adjustments for the year ended December 31, 2004 were $184.9 million compared to $201.5 million in 2003. For the year ended December 31, 2004, the adverse reserve adjustments included net adverse asbestos and environmental (“A&E”) adjustments of $10.3 million and net adverse non-A&E adjustments of approximately $207.3 million relating primarily to casualty reinsurance, in particular, workers’ compensation, partially offset by favorable development of $32.7 million relating to the reduction of reserves for the World Trade Center events. For the year ended December 31, 2003, net adverse prior period reserve adjustments for A&E exposures were $16.8 million and net adverse non-A&E adjustments were $184.7 million, which were net of a cession of $85 million under the 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program. It is important to note that adverse non-A&E accident year reserve development arises from the reevaluation of accident year results, that such reevaluations
The U.S. Insurance segment reflected $54.0 million and $58.7 million of net adverse prior period reserve adjustments for the years ended December 31, 2004 and 2003, respectively. The adverse prior period reserve adjustments were principally due to accident years 2000 through 2002, where the Company strengthened its reserves for California workers’ compensation insurance. This was a relatively new book of business and was written in a challenging political and economic environment. While management believes that cumulative results through 2004 remain quite positive, there has been some deteriorating in claim frequency and severity related to accident years 2001 and 2002.
The Specialty Underwriting segment had $17.5 million of net adverse prior period reserve adjustments for the year ended December 31, 2004, principally related to net adverse prior period reserve adjustments in the surety and A&H business lines partially offset by favorable development from marine and aviation. The net favorable prior period reserve adjustments for the year ended December 31, 2003 were $23.9 million, primarily related to A&H business.
The International segment had $10.0 million and $15.8 million of net adverse prior period reserve adjustments for the years ended December 31, 2004 and 2003, respectively. The adverse prior period reserve adjustments in 2004 related primarily to 2003 Canadian property catastrophe, international and Asia business. The prior period reserve development for 2003 related primarily to general casualty business written on both a quota share and excess basis for accident years 1996 through 2002.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by net premiums earned, increased by 3.0 percentage points to 75.8% in 2004 from 72.8% in 2003, reflecting the impact of the changes in premiums earned and incurred losses and LAE discussed above, as well as favorable changes in the underlying business mix and aggregate rates, terms and conditions.
The following table shows the expense ratios for each of the Company’s operating segments in 2004 and 2003.
The Company’s combined ratio, which is the sum of the loss and expense ratios, increased by 1.4 percentage points to 99.1% in 2004 compared to 97.7% in 2003.
Imbedded pre-tax yield of cash and invested assets at December 31, 2004 and 2003
Imbedded after-tax yield of cash and invested assets at December 31, 2004 and 2003 .6%
Net realized capital gains were $56.7 million in 2004, reflecting realized capital gains on the Company’s investments of $107.4 million, including $77.6 million on the sale of interest only strip investments. This was partially offset by $50.7 million of realized capital losses, which included $43.9 million related to the write-downs in the value of interest only strips deemed to be impaired on an other than temporary basis in accordance
Other expense was $73.4 million and $14.0 million in 2004 and 2003, respectively. This change was primarily due to increased deferrals of the retroactive reinsurance agreements with affiliates for asbestos reserve strengthening.
Interest expense in 2004 was $75.5 million compared to $57.3 million in 2003. Interest expense in 2004 included $42.0 million relating to the senior notes, $32.4 million relating to the junior subordinated debt securities and $1.2 million relating to borrowings under the Company’s revolving credit facility. Interest expense in 2003 reflected $38.9 million relating to the issuance of the senior notes, $17.0 million relating to the junior subordinated debt securities and $1.4 million relating to borrowings under the Company’s revolving credit facility. The increase in interest expense was due to the additional issuance of $320 million of junior subordinated debt securities in March 2004 and the issuance of $250 million of senior notes in October 2004.
Income Taxes. The Company’s income tax expense is primarily a function of the U.S. statutory tax rate and the impact from tax preferenced investment income. Additionally, in conjunction with the transfer of the Company’s UK Branch to Bermuda Re, there were various tax issues giving rise to net tax expenses. The Company recognized income tax expense of $56.1 million in 2004 compared to $61.0 million in 2003.
Premiums. Gross written premiums increased 49.9% to $3,850.1 million in 2003 from $2,568.9 million in 2002, as the Company took advantage of the general firming of rates, terms and conditions and selected growth opportunities, while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 95.9% ($857.7 million) increase in the U.S. Reinsurance operation, principally related to a $519.4 million increase in treaty casualty business, a $253.9 million increase in treaty property business and a $62.8 million increase in facultative business. The International operation increased 44.2% ($161.1 million) primarily due to a $79.6 million increase in international business written through the home office representing primarily Latin American business and a $67.4 million increase to Canadian business. The U.S. Insurance operation grew 30.2% ($248.1 million) principally as a result of a $73.2 million increase in excess and surplus lines insurance and an $89.5 million increase in workers’ compensation. The Specialty Underwriting operation increased 2.9% ($14.3 million) resulting primarily from a $38.0 million increase in A&H business and a $19.0 million decrease in marine and aviation.
Expenses. Incurred loss and LAE increased by 38.1% to $1,796.9 million in 2003 from $1,301.5 million in 2002. The increase in incurred losses and LAE was principally attributable to the increase in net premiums earned, the impact of changes in the Company’s mix of business and reserve adjustments for prior period losses.
Incurred losses and LAE for 2003 reflected ceded losses and LAE of $688.8 million compared to ceded losses and LAE in 2002 of $457.0 million. Ceded losses and LAE in 2003 include $422.9 million of ceded losses relating to the quota share reinsurance transactions noted earlier between Everest Re and Bermuda Re as compared with ceded losses of $149.5 million for 2002. The ceded losses and LAE for 2003 also included $85.0 million of losses ceded under the 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program. The ceded losses and LAE for 2002 included $11.0 million and $90.0 million of losses ceded under the 2001 and 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program, respectively.
Incurred losses and LAE include catastrophe losses, which include the impact of both current period events and favorable and unfavorable development on prior period events, and are net of reinsurance. A catastrophe is an event with expected reported losses of at least $5.0 million before corporate level reinsurance and taxes. Catastrophe losses, net of contract specific cessions and the inter-affiliate quota share reinsurance described above, were $22.3 million in 2003, relating principally to May 2003 tornado and hailstorm events and hurricanes Fabian and Isabel, compared to $21.0 million in 2002.
Net prior period reserve adjustments for non-A&E exposures for the year ended December 31, 2003 were $184.7 million, which amount is net of a 2000 accident year cession of $85.0 million, and were comprised of an $134.1 million increase relating principally to the casualty exposures (including D&O liability exposures) in the U.S. Reinsurance operation, a $23.9 million decrease relating to the surety exposures in the Specialty Underwriting operation, a $15.8 million increase relating mainly to the casualty exposures of the Canadian branch elements in the International operation and a $58.7 million increase relating to the workers’ compensation exposures in the U.S. Insurance operation. The increase for the U.S. Insurance operation relates to the 2001 and 2002 accident exposure years and all other reserve adjustments relate to the 1996-2000 accident exposure years.
The following table shows the net prior period reserve adjustments for each of the Company’s operating segments for 2003 and 2002.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by net premiums earned, increased by 1.4 percentage points to 72.8% in 2003 from 71.4% in 2002, reflecting the combined impact of premiums earned and incurred losses and LAE discussed above.
The following table shows the expense ratios for each of the Company’s operating segments in 2003 and 2002.
Investment. Net investment income increased 10.4% to $284.8 million in 2003 from $258.0 million in 2002, principally reflecting the effects of investing the $1,051.0 million of cash flow from operations in 2003 and $209.9 million of net proceeds from Holdings’ issuance of junior subordinated debt securities in November 2002, all partially offset by the effect of the lower interest rate environment.
Imbedded pre-tax yield of cash and invested assets at December 31, 2003 and 2002
Annualized after-tax yield on average cash and invested assets for the twelve months
Net realized capital losses were $22.9 million in 2003, reflecting realized capital losses on the Company’s investments of $51.5 million, which included $16.4 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis and $25.2 million related to the impairment on interest only strips in accordance with EITF 99-20, partially offset by $28.6 million of realized capital gains, which included $12.5 million of realized capital gains on the interest only strips (see Note 1N of Notes to Consolidated Financial Statements), compared to net realized capital losses of $53.1 million in 2002. The net realized capital loss in 2002 reflected realized capital losses of $108.9 million, which included $79.7 million relating to write-downs in the value of securities, of which $25.7 million was for WorldCom, Inc., deemed to be impaired on an other than temporary basis, partially offset by $55.8 million of realized capital gains. The Company owned no interest only strips during 2002.
Other expense for 2003 was $14.0 million compared to other expense of $21.8 million for 2002. This change was primarily due to less deferrals of the retroactive reinsurance agreements with affiliates.
Interest expense was $57.3 million in 2003 compared to $44.6 million for 2002. Interest expense in 2003 reflected $38.9 million relating to the senior notes, $17.0 million relating to the junior subordinated debt securities and $1.4 million relating to borrowings under the revolving credit facility. Interest expense for 2002 reflected $38.9 million relating to the senior notes, $2.2 million relating to the junior subordinated debt securities and $3.5 million relating to borrowings under the revolving credit facility.
Like all insurance and reinsurance companies, the Company is exposed to unpredictable catastrophic events, including weather-related and other natural catastrophes, as well as acts of terrorism. Any material reduction in the Company’s operating results caused by the occurrence of one or more catastrophes could inhibit its ability to pay dividends or to meet its interest and principal payment obligations. The Company defines a catastrophe as an event that causes a pre-tax loss on property exposures before reinsurance of at least $5.0 million, before corporate level reinsurance and taxes. By way of illustration, during the past five calendar years, pre-tax catastrophe losses, net of contract specific reinsurance but before cessions under corporate reinsurance programs, were as follows:
If the Company’s loss reserves are inadequate to meet its actual losses, net income would be reduced or it could incur a loss.
The Company is required to maintain reserves to cover its estimated ultimate liability of losses and loss adjustment expenses for both reported and unreported claims incurred. These reserves are only estimates of what the Company believes the settlement and administration of claims will cost based on facts and
Decreases in pricing for property and casualty reinsurance and insurance could reduce the Company’s net income.
In 2004, the favorable market conditions, which had developed during 2000 through 2003, generally began to weaken. There were signs that pricing for most property classes declined modestly and that pricing for most casualty classes softened. Competition increased in part due to the relative profitability achieved by many
If rating agencies downgrade their ratings of the Company’s insurance subsidiaries, future prospects for growth and profitability could be significantly and adversely affected.
The Company’s insurance company subsidiaries, other than Mt. McKinley, which is in runoff, currently hold an “A+ (“Superior”)” financial strength rating from A.M. Best. Everest Re and Everest National hold an “AA- (“Very Strong”)" financial strength rating from Standard & Poor’s. Everest Re holds an “Aa3 (“Excellent”)” financial strength rating from Moody’s. Financial strength ratings are used by insurers and reinsurance and insurance intermediaries as an important means of assessing the financial strength and quality of reinsurers. In addition, an unfavorable rating or the lack of a rating of its reinsurers may adversely affect the rating of a company purchasing reinsurance. A downgrade or withdrawal of any of these ratings might adversely affect the Company’s ability to market its insurance products and could have a material and adverse effect on future prospects for growth and profitability. During the last five years, no active subsidiary of the Company has experienced financial strength rating downgrade. However, the Company cannot assure that a downgrade will not occur in the future. Consistent with market practice, many of the Company’s treaty reinsurance business allows the ceding company to terminate the contract or seek collateralization of the Company’s obligations in the event of a rating downgrade below a certain threshold. The termination provision would generally be triggered only if a rating fell below A.M. Best’s A- rating level, which is three levels below Everest Re’s current rating of A+. Everest Re also has more modest exposure to reinsurance contracts that contain provisions for obligatory funding of outstanding liabilities in the event of a rating agency downgrade. That provision would also generally be triggered only if Everest Re’s rating fell below A.M. Best’s A- rating level.
Changes in the availability and cost of reinsurance, which are subject to market conditions that are outside of the Company’s control, have thus reduced to some extent its ability to use reinsurance to tailor the risks it assumes on a contract or program basis or to mitigate or balance exposures across its reinsurance operations. Because the Company has reduced its level of reinsurance purchases, its net income could be reduced in the event of a large unreinsured event or adverse overall experience.
The Company’s industry is highly competitive and subject to pricing cycles that can be particularly pronounced. The ease of entry for well-capitalized competitors further exacerbates this market cycle. The Company competes on a global basis in the U.S. and international markets. According to Standard & Poor’s, the Company ranks among the top ten global reinsurance groups where 80% of the market share is concentrated. The top twenty groups in the Company’s industry represent 95% of the market’s revenues. The leaders in this market are Munich Re, Swiss Re, Berkshire Hathaway, Hannover Re and Employers Re. Relative to Group, some of these competitors may have greater financial resources, longer operating histories, and extensive business relationships that transcend the industry, any of which can be a significant competitive advantage. Forces outside the industry can also impact the Company’s market, including such factors as economic, regulatory, legal, and geophysical. The Company may not be able to compete successfully in the future should there be a significant change to the competitive landscape of its market.
The Company’s success has been, and will continue to be, dependent on the ability to retain the services of existing key executive officers and to attract and retain additional qualified personnel in the future. The loss of the services of any key executive officer or the inability to hire and retain other highly qualified personnel in the future could adversely affect the ability of the Company to conduct business. Generally, the Company considers key executive officers to be those individuals who have the greatest influence in setting overall policy and controlling operations: Chairman and Chief Executive Officer, Joseph V. Taranto (age 56), President and Chief Operating Officer, Thomas J. Gallagher (age 56), and Executive Vice President and Chief Financial Officer, Stephen L. Limauro (age 53). Of those three officers, the Company only has an employment contract with Mr. Taranto. That contract has been previously filed with the SEC and was most recently amended on April 18, 2003 to extend Mr. Taranto’s term of employment from March 31, 2004 until March 31, 2006. The Company is not aware that any of the above three officers are planning to leave the Company or retire in the near future. The Company does not maintain any key employee insurance on any of its employees.
Because of the Company’s holding company structure, its ability to pay dividends, interest and principal is dependent on its receipt of dividends, loan payments and other funds from its subsidiaries.