Selected Financial Data. Information required by Item 6 has been omitted because the Registrant meets the conditions set forth in General Instruction I (1) (a) and (b) of Form 10-K and is therefore filing this Annual Report on Form 10-K in the reduced disclosure format.
- ----------------------------------------- (1) Beginning in 1996, the combined ratio includes both Chartwell Reinsurance and INSCORP. (2) Source: RAA Underwriting Report for the year ended December 31, 1998.
Year Ended December 31, 1998 Compared With Year Ended December 31, 1997
Revenues: Total revenues for the year ended December 31, 1998 decreased 7.5% to $298.0 million, compared to $322.3 million for the comparable period in 1997. The following table summarizes gross and net premiums written and total revenues for the periods indicated:
Income Before Income Taxes, Minority Interest and Extraordinary Item. Net income before income taxes increased to $48.6 million for the year ended December 31, 1998 compared to $40.5 million for the same period in 1997. The increase resulted primarily from the favorable results in both loss and loss adjustment expense and from the increase in net investment income.
Net Income Before Minority Interest. Net income before minority interest increased to $33.2 million for the year ended December 31, 1998 as compared to $28.3 million for the same period in 1997.
Minority Interest. The Company recognized $1.9 million of minority interest during the year ended December 31, 1998 and $(0.5) million during the year ended December 31, 1997, in each case representing Chartwell Re's ownership interest in the net income of Holdings Limited.
Net Income. The Company realized a net profit of $35.2 million for the year ended December 31, 1998 compared with a net profit of $27.8 million for the comparable 1997 period because of the factors discussed above.
Other Expenses. Other expenses related to underwriting operations, which include underwriting and administrative expenses, were $16.5 million for the year ended December 31, 1997 compared to $15.8 million for the same period in 1996. Other expenses expressed as a percentage of net earned premiums decreased to 6.7% for the year ended December 31, 1997 compared to 7.5% for the same period in 1996.
Consolidated Net Investment Income and Net Realized Capital Gains (Losses). Consolidated net investment income, exclusive of realized and unrealized capital gains and losses, for 1997 was $43.5 million, compared to $43.6 million in 1996. The average annual tax equivalent yield on invested assets before investment expenses for 1997 and 1996 was 6.7%.
The Company realized net capital losses of $3,000 for 1997 compared to net capital gains of $1.2 million in 1996. The 1996 net capital gains were realized principally to reposition certain sectors of the portfolio and to modify the portfolio to improve credit quality without sacrificing yield.
Income Before Income Taxes, Minority Interest and Extraordinary Item. Net income before income taxes and extraordinary items increased to $40.5 million for the year ended December 31, 1997 compared to $31.7 million for the same period in 1996. The increase resulted primarily from the increase in earned premiums, the favorable results in both loss and loss adjustment expense and other expenses, and the contributions from CMA to income from service operations.
Liquidity and Capital Resources Chartwell is a wholly-owned subsidiary of Chartwell Re. As a holding company, Chartwell's assets consist primarily of the stock of its direct and indirect operating subsidiaries, Chartwell Reinsurance, INSCORP and CMA. Chartwell's cash flow, therefore, depends largely on dividends and other statutorily permissible payments from its operating subsidiaries. Chartwell's sources of funds consist primarily of net premiums, reinsurance recoveries, investment income and proceeds from sales and redemptions of investments. Funds are applied primarily to payments of claims, operating expenses and income taxes and to the purchase of investments, largely fixed income securities. Cash and short-term investments are maintained for the payment of claims and expenses. For the years ended December 31, 1998, 1997 and 1996, Chartwell's consolidated cash flow provided by operations was $33.8 million, $25.5 million and $14.7 million, respectively. The increase in 1998 is due to the inclusion of Chartwell's share of the operating cash flow of syndicates managed by CMA, offset by a decline in cash provided by the reinsurance segment due to a reduction in premiums written and the collection of premiums on a monthly installment basis on certain accounts in the Controlled Source Insurance segment. The cash flow from operations in 1997 was greater than that in 1996 due to improved underwriting cash flows comprising premiums received less paid losses and LAE and underwriting expenses. The 1996 cash flow from operations was reduced as a result of the run-off of INSCORP's reinsurance reserves. Sales of available for sale investments were $158.4 million, $200.8 million and $500.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. Trading activity increased during 1996 primarily to modify the portfolio by sector and to capitalize on some opportunities to improve on credit quality without sacrificing yield. There was no unusual trading activity during 1997 and 1998. At December 31, 1998, the carrying value of total investments, including cash and cash equivalents, increased 15.0%, to $876.2 million compared to $762.2 million at December 31, 1997. The primary reasons for the increase were cash and investments acquired through the purchase of Oak Dedicated Two Limited and the remainder of Archer Dedicated plc (the holding company for ADIT One Limited), positive cash flow from operations and an increase in the market value of the investment portfolio. Financing activities have also been a source of liquidity for Chartwell and its subsidiaries. On March 17, 1994, Chartwell Re completed the offering of $75.0 million principal amount of the Senior Notes. The net proceeds to Chartwell Re after transaction expenses were $71.9 million. As of December 31, 1998, $48.8 million in principal amount of the Senior Notes were outstanding. The Senior Notes bear interest at a rate of 10 1/4% per annum and are due on March 1, 2004. In conjunction with the Piedmont Merger, the Company assumed all of Chartwell Re's obligations with respect to the Senior Notes. In the first half of 1996, Chartwell Re completed a public offering of 2,725,000 shares of common stock at $23.00 per share. The net proceeds to Chartwell Re were $58.5 million after deduction of underwriting discount and expenses. Of the net proceeds, $48.5 million was contributed by Chartwell Re to the Company of which $20.0 million was contributed to the statutory surplus of Chartwell Reinsurance and $28.5 million was used to retire 35% of the Senior Notes plus accrued interest. The remaining funds were retained for general corporate purposes. This redemption reduced Chartwell's annual expense for interest and amortization of debt issuance costs under the Senior Notes by $2.8 million per year.
Interest Rate Risk: Chartwell's fixed maturity investments and indebtedness are subject to interest rate risk. Increases and decreases in prevailing interest rates generally translate into decreases and increases in the fair value of fixed maturity investments and the interest payable on Chartwell's outstanding variable rate debt. On occasion, Chartwell utilizes stand-alone derivatives to manage and mitigate the volatility of interest rates on certain of its interest rate sensitive instruments. Additionally, the fair value of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment option, relative values of alternative investments, liquidity of the investment and other general market conditions. The table below summarizes the estimated effects of hypothetical increases and decreases in interest rates. It is assumed that the changes occur immediately and uniformly to each category of instrument containing interest rate risks. The hypothetical changes in market interest rates reflect what could be deemed best or worst case scenarios. Significant variations in market interest rates could produce changes in the timing of repayments due to prepayment options available. The fair value of such instruments could be affected and therefore actual results might differ from those reflected in the table, which follows:
Chartwell's common equity portfolio of $36.4 million primarily consists of long term strategic minority positions in illiquid equity securities of managing general agents of Controlled Source Insurance. A 10% immediate decrease in the market prices of all equity securities held by Chartwell at December 31, 1998, would result in an approximate 1.2% decrease in Chartwell's stockholders' equity.
In addition, the Company may also have material exposure in its property and casualty operations to claims related to the Year 2000 issue. It is not yet possible to determine whether such claims might be made against insurance or reinsurance contracts in which the Company participates or if such claims will be held to have merit. Readers are cautioned that forward-looking statements contained in this description of the Company's treatment of the Year 2000 issue should be read in conjunction with the Company's disclosures under the heading "Cautionary Note Regarding Forward-Looking Statements" below.
Cautionary Note Regarding Forward-Looking Statements This Annual Report on Form 10-K contains statements that may be considered to be "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, without limitation, insofar as they may be considered to be forward-looking statements, certain statements in (i) "Management's Discussion and Analysis of Financial Condition and Results of Operations--Consolidated Results of Operations - Year Ended December 31, 1998 Compared With Year Ended December 31, 1997" and "--Consolidated Results of Operations - Year Ended December 31, 1997 Compared With Year Ended December 31, 1996" concerning (A) certain relationships among gross premiums written, net premiums written and net premiums earned and (B) the development of reserves in respect of all or a portion of the Company's insurance and reinsurance business; (ii) "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" concerning the potential effects of certain events on the Company's indebtedness and portfolios of fixed income and equity instruments, foreign currency exposure, derivatives positions and certain other types of instruments; (iii) "Management's Discussion and Analysis of Financial Condition and Results of Operations--Market Risk Disclosures" concerning the potential effects of changes in the equity markets, interest rates and currency exchange rates; (iv) "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000 Compliance" concerning the costs and effects of Year 2000 compliance; (v) such other statements contained in this Annual Report that may be considered to be forward-looking statements; and (vi) variations of the foregoing statements wherever they appear in this Annual Report. All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. The Company believes that these include the following non-exclusive factors:
The facts set forth above should be considered in connection with any forward-looking statement contained in this Annual Report. The important factors that could affect such forward-looking statements are subject to change, and the Company does not intend to update any forward-looking statement or the foregoing list of important factors. By this cautionary note, the Company intends to avail itself of the safe harbor from liability with respect of forward-looking statements provided by Section 27A and Section 21E referred to above.