RESTRUCTURING Everest Re Group, Ltd. ("Group"), a Bermuda company with its principal executive office in Barbados, was established in 1999 as a wholly-owned subsidiary of Everest Reinsurance Holdings, Inc. ("Holdings"). On February 24, 2000, a corporate restructuring was completed and Group became the new parent holding company of Holdings. Holders of shares of common stock of Holdings automatically became holders of the same number of common shares of Group. Prior to the restructuring, Group had no significant assets or capitalization and had not engaged in any business or prior activities other than in connection with the restructuring. See ITEM 1 - "Business - The Company" for a further discussion.
ACQUISITIONS On September 19, 2000, Holdings completed the acquisition of all of the issued and outstanding capital stock of Gibraltar Casualty Company ("Gibraltar") from The Prudential Insurance Company of America ("The Prudential") for $51.8 million, which approximated book value. As a result of the acquisition, Gibraltar became a wholly owned subsidiary of Holdings and, immediately following the acquisition, its name was changed to Mt. McKinley Insurance Company ("Mt. McKinley"). In connection with the acquisition of Mt. McKinley, which has significant exposure to asbestos and environmental claims, Prudential Property and Casualty Insurance Company ("Prupac"), a subsidiary of The Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinley's reserves as of September 19, 2000 and The Prudential guaranteed Prupac's obligation to Mt. McKinley.
On December 20, 2000, Everest Reinsurance (Bermuda), Ltd. ("Bermuda Re") completed the acquisition of all of the issued and outstanding capital stock of AFC Re Ltd. ("AFC Re"), a Bermuda-based annuity and life reinsurer, from AFC Holdings Ltd for $16.6 million, which approximated book value. Subsequent to the acquisition, AFC Re's reinsurance obligations were assumed by Bermuda Re.
SEGMENT INFORMATION During the quarter ended December 31, 2000, the Company's management realigned its operating segments to better reflect the way that management monitors and evaluates the Company's financial performance. The Company has restated all information for prior years to conform to the new segment structure. The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance on both a treaty and facultative basis through reinsurance brokers as well as directly with ceding companies within the United States. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the United States. The Specialty Underwriting operation writes accident and health ("A&H"), marine, aviation and surety business within the United States and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance through the Company's branches in Belgium, London, Canada, and Singapore, in addition to foreign "home-office" business. The Bermuda operation writes property, casualty, life and annuity business through brokers and directly with ceding companies.
EXPENSES. Incurred loss and loss adjustment expenses ("LAE") increased by 14.7% to $884.6 million in 2000 from $771.6 million in 1999. The increase in incurred losses and LAE was principally attributable to the increase in net premiums written together with modest strengthening of prior period reserves in select areas, including on a multi-year reinsurance treaty where such losses within the current experience band were accompanied by correspondingly lower commissions. The increase was partially offset by losses ceded under the Company's corporate retrocessional program and also reflects changes in the Company's mix of business. Incurred losses and LAE include catastrophe losses, which reflect the impact of both current period events and favorable and unfavorable development on prior period events and are net of reinsurance. Catastrophe losses, net of contract specific cessions but before cessions under the corporate retrocessional program in 2000, were $13.9 million, mainly reflecting modest net adverse development on 1999 catastrophe events, compared to $45.9 million in 1999. Net incurred losses and LAE in 2000 reflected ceded losses and LAE of $161.6 million, including $70.0 million ceded under the 1999 accident year aggregate excess of loss component of the Company's corporate retrocessional program. Ceded losses and LAE in 1999 were $7.4 million with no cessions under the accident year aggregate excess of loss component of the Company's corporate retrocessional program.
Contributing to the increase in incurred losses and LAE in 2000 from 1999 were a 71.1% ($29.2 million) increase in the U.S. Insurance operation principally reflecting increased premium volume, a 37.0% ($68.7 million) increase in the Specialty Underwriting operation principally attributable to increased premium volume in A&H business together with modest reserve strengthening for prior period marine, aviation and surety exposures, a 3.3% ($7.5 million) increase in the International operation, which included modest reserve strengthening for exposures produced through its London and Canadian branches, a 0.4% ($1.2 million) increase in the U.S. Reinsurance operation and $6.4 million of losses from the Bermuda operation as the Company began writing business in this operation during the quarter ended December 31, 2000. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing incurred losses and LAE by premiums earned, increased by 3.3 percentage points
to 75.3% in 2000 from 72.0% in 1999 reflecting the incurred losses and LAE discussed above. The following table shows the loss ratios for each of the Company's operating segments for 2000 and 1999. The loss ratios for all operations were impacted by the factors noted above.
Underwriting expenses decreased by 3.8% to $324.1 million in 2000 from $337.0 million in 1999. Commission, brokerage, taxes and fees decreased by $13.5 million, principally reflecting the Company's reassessment of the expected losses on the multi-year reinsurance treaty noted above that led to a $33.8 million decrease in contingent commissions with a corresponding increase to losses, partially offset by increases in premiums written and also reflecting changes in the mix of business. Other underwriting expenses increased by $0.6 million. Contributing to the underwriting expense decrease were a 26.5% ($34.5 million) decrease in the U.S. Reinsurance operation, which included the impact of the contingent commission adjustment noted above and a 2.0% ($1.9 million) decrease in the International operation. These decreases were partially offset by $5.9 million of expenses from the Bermuda operation, principally reflecting Federal excise tax paid on a loss portfolio transfer with an affiliate, and 52.8% ($12.8 million) and 9.1% ($7.3 million) increases in the U.S. Insurance operation and the Specialty Underwriting operation, respectively, principally related to production volume increases. Except as noted, the changes for each operation's expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, the underwriting performance of the underlying business. The Company's expense ratio, which is calculated by dividing underwriting expenses by premiums earned, decreased by 3.9 percentage points to 27.6% in 2000 compared to 31.5% in 1999.
OPERATING SEGMENT COMBINED RATIOS - --------------------------------------------------------------- SEGMENT 2000 1999 - --------------------------------------------------------------- U.S. Reinsurance 87.8% 97.9% U.S. Insurance 105.8% 113.1% Specialty Underwriting 113.1% 100.4% International 115.4% 111.5% Bermuda 106.0% N/A
of senior notes and $8.5 million relating to Holdings' borrowing under its revolving credit facility. Interest expense for 1999 reflects $1.5 million relating to Holdings' borrowing under its credit facility.
Net realized capital gains were $0.8 million in 2000, reflecting realized capital gains on the Company's investments of $30.9 million, partially offset by $30.1 million of realized capital losses, compared to realized capital losses of $16.8 million in 1999. The net realized capital losses in 1999 reflected realized capital losses of $33.9 million, which were partially offset by $17.1 million of realized capital gains. The realized capital gains in 2000 and 1999 arose mainly from activity in the Company's equity portfolio. The realized capital losses in 2000 and 1999 arose mainly from activity in the Company's fixed maturity portfolios.
Net premiums written increased by 7.8% to $1,095.6 million in 1999 from $1,016.6 million in 1998, reflecting the growth in gross premiums written and ceded premiums.
Contributing to the decrease in incurred losses and LAE in 1999 from 1998 were a 15.7% ($42.5 million) decrease in the International operation, which experienced unusual catastrophe losses in 1998 relating to hurricanes Georges and Mitch and Canadian ice storms, a 14.0% ($6.7 million) decrease in the U.S. Insurance operation and an 11.0% ($39.0 million) decrease in the U.S. Reinsurance operation despite the impacts of the Rouge Steel Plant Fire and Oklahoma tornados in 1999. These decreases were partially offset by a 78.1% ($81.4 million) increase in the Specialty Underwriting operation, principally attributable to the growth in A&H business. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
The Company's loss ratio decreased by 0.9 percentage points to 72.0% in 1999 from 72.9% in 1998 reflecting the incurred losses and LAE discussed above. The following table shows the loss ratios for each of the Company's operating segments for 1999 and 1998. The loss ratios for all operations were impacted by the factors noted above.
The Company's combined ratio increased by 0.3 percentage points to 103.5% in 1999 compared to 103.2% in 1998. The following table shows the combined ratios for each of the Company's operating segments for 1999 and 1998. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above.
Other loss for 1999 was $1.0 million compared to other income of $3.0 million in 1998. Other loss and income for the respective years were principally attributable to the impact of fluctuations in foreign currency exchange rates.
INCOME TAXES. The Company had income tax expense of $38.5 million in 1999 compared to $47.5 million in 1998, with the decrease resulting primarily from the increase in realized capital losses.
The Company maintains reserves to cover its estimated ultimate liability for losses and LAE with respect to reported and unreported claims. Because reserves are estimates of ultimate losses and LAE, management monitors reserve adequacy over time, evaluating new information as it becomes known and adjusting reserves, as necessary. Management considers many factors when setting reserves, including: (1) current legal interpretations of coverage and liability; (2) economic conditions; (3) internal actuarial methodologies which analyze the Company's experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments, pending levels of unpaid claims and product mix; and (4) the uncertainties discussed below regarding reserve requirements for asbestos and environmental claims. Based on these considerations, management believes that adequate provision has been made for the Company's loss and LAE reserves. Actual losses and LAE ultimately paid may deviate, perhaps substantially, from such reserves, impacting income in the period in which the change is made.
SHAREHOLDERS' EQUITY. The Company's shareholders' equity increased to $1,583.4 million as of December 31, 2000 from $1,327.5 million as of December 31, 1999 principally reflecting an increase of $175.4 million in retained earnings and an increase of $90.0 million in net unrealized appreciation of investments, partially offset by $16.4 million in treasury shares acquired during the year. Shareholders' equity decreased to $1,327.5 million as of December 31, 1999 from $1,479.2 million as of December 31, 1998 principally reflecting an increase of $207.3 million in net unrealized depreciation of investments and $96.4 million in share repurchases relating to the Company's stock repurchase plan, partially offset by an increase of $146.4 million in retained earnings for the year. Dividends of $11.0 million, $11.6 million and $10.1 million were declared and paid by the Company in 2000, 1999 and 1998, respectively. During the year ended December 31, 2000, the Company repurchased 0.650 million of its common shares at an average price of $25.24 per share with all such repurchases occurring in the three months ended March 31, 2000, raising the total repurchases under the Company's authorized repurchase program to 4.720 million shares at an average price of $27.60 per share with a total repurchase expenditure to date of $130.4 million. At December 31, 2000, 2.180 million shares remained under the existing repurchase authorization. As part of the Company's restructuring, the treasury shares held by the Company prior to February 24, 2000 were retired, resulting in a reduction to treasury shares with a corresponding reduction of paid-in capital and common shares.
LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY. The Company's liquidity requirements are met on a short-term and long-term basis by funds provided by premiums collected, investment income and collected reinsurance receivables balances, and from the sale and maturity of investments together with the availability of funds under the Company's revolving credit facility. The Company's net cash flows from operating activities were $90.0 million, $203.4 million and $183.3 million in 2000, 1999 and 1998, respectively. These cash flows were impacted by recoveries under the Company's Stop Loss Agreement with Mt. McKinley, which, prior to the Mt. McKinley acquisition, contributed $9.5 million, $79.0 million and $31.9 million in 2000, 1999 and 1998, respectively. These cash flows were also impacted by net catastrophe loss payments of $44.1 million, $28.3 million and $30.6 million in 2000, 1999 and 1998, respectively, and by net income taxes paid of $63.7 million, $59.6 million and $65.7 million in 2000, 1999 and 1998, respectively. Management believes that net cash flows from operating activities, after
Proceeds from sales, calls and maturities and investment asset acquisitions were $1,006.5 million and $2,024.6 million, respectively, in 2000 compared to $941.1 million and $1,068.4 million, respectively, in 1999 and $634.2 million and $755.3 million, respectively, in 1998. Additionally, the cash flow activity in 2000 included $340.1 million of new cash resulting from the acquisitions of Mt. McKinley and AFC Re and $450.0 million in proceeds from Holdings' offering of senior notes. The Company's current investment strategy seeks to maximize after-tax income through a high quality, diversified, duration sensitive, taxable bond and tax-preferenced municipal bond portfolio, while maintaining an adequate level of liquidity.
The Company maintains a corporate-level retrocessional protection program, above and beyond retrocessions purchased with respect to specific assumed business, to mitigate the potential impact of catastrophe losses. The principal components of the Company's corporate retrocessional protection program as it relates to catastrophes are an accident year aggregate excess of loss treaty and the retrocesssional excess of loss coverage of international exposures. For both 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage, which provides up to $175.0 million of recoveries if Everest Re's consolidated statutory basis accident year loss ratio exceeds a loss ratio attachment point provided in the contract for the respective accident years. Each arrangement provides for an adjustment premium, which reduces the net benefit by approximately 50%, in the event that the coverage is used. The Company's corporate retrocessional protection program includes a two-layer property catastrophe excess of loss program for losses incurred outside of the United States, which provide coverage of 58.25% of $17.5 million of losses in excess of $15 million of losses per occurrence and 70% of $20 million of losses in excess of $32.5 million of losses per occurrence. This coverage relates to a
If a single catastrophe were to occur in the United States that resulted in $203 million of gross losses and allocated loss adjustment expenses ("ALAE") in 2001 (an amount equivalent to the Company's PML), management estimates that the effect (including additional premiums and retained losses and ALAE) on the Company's income before and after taxes would be approximately $98 million and $63 million, respectively. These pre-tax and after-tax net loss estimates assume that the Company's aggregate losses and ALAE for 2001 would exceed the threshold loss ratio requirement in the aggregate excess of loss cover by at least $175.0 million.
GROUP. Under Bermuda law, Group is prohibited from declaring or paying a dividend if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities and its issued share capital and share premium (additional paid-in capital) accounts. Group's ability to pay dividends and its operating expenses is partially dependent upon dividends from its subsidiaries. The payment of dividends by insurer subsidiaries is limited under Bermuda law and the laws of the various U.S. states in which Group's insurance and reinsurance subsidiaries are licensed to transact business. The limitations are generally based upon net income and compliance with applicable policyholders' surplus or minimum solvency margin and liquidity ratio requirements as determined in accordance with the relevant statutory accounting practices.
BERMUDA RE. Under Bermuda law, Bermuda Re is unable to declare or pay a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio, or if after payment of the dividend, it fails to meet its minimum solvency margin or minimum liquidity ratio. As a long-term insurer, Bermuda Re will also be unable to declare or pay a dividend to anyone who is not a policyholder unless, after payment of the dividend, the value of the assets in its long-term business fund, as certified by its approved actuary, will exceed its liabilities for long-term business by at least the $250,000 minimum solvency margin. Prior approval of the Bermuda Minister of Finance is required if Bermuda Re's dividend payments would reduce its prior year-end total statutory capital by 15.0% or more.
The Company's current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. The Company's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with its current and projected operating results, market conditions, and tax
The overall strategy considers the scope of present and anticipated Company operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with the Company's capital structure and other factors, are used to develop a net liability analysis. This analysis includes estimated payout characteristics for which the investments of the Company provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration, and credit quality. The change in overall market sensitive risk exposure principally reflects the asset changes that took place during the year with no material change in the underlying risk characteristics.
The $5.5 billion investment portfolio is comprised of fixed maturity securities that are subject to interest rate risk and foreign currency rate risk, and equity securities that are subject to equity price risk. The impact of these risks in the investment portfolio is generally mitigated by changes in the value of operating assets and liabilities and their associated income statement impact.
The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on the fixed maturity portfolio as of December 31, 2000 and 1999 based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments are taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios. All amounts are in U.S. dollars and are presented in millions.
Foreign currency rate risk is the potential change in value, income, and cash flow arising from adverse changes in foreign currency exchange rates. The Company's foreign operations each maintain capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Generally, the Company prefers to maintain the capital of its foreign operations in U.S. dollar assets although this varies by regulatory jurisdiction in accordance with market needs. Each foreign operation may conduct business in its local currency as well as the currency of other countries in which it operates. The primary foreign currency exposures are the Canadian Dollar, the British Pound Sterling and the Euro for these foreign operations. The Company mitigates foreign exchange exposure by a general matching of the currency and duration of its assets to its corresponding operating liabilities. In accordance with Financial Accounting Standards Board Statement No. 52, the Company translates the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income. The primary functional foreign currency exposures are the Canadian Dollar, the Belgian Franc and the British Pound Sterling for these foreign operations.
The tables below display the impact on market value and after-tax unrealized appreciation of a 20% change in equity prices up and down in 10% increments as of December 31, 2000 and 1999. All amounts are in U.S. dollars and are presented in millions.
factors contained in this report which could cause the Company's actual results to differ materially from those which might be projected, forecasted or estimated in its forward-looking statements.
1) Changes in the level of competition in the United States, Bermuda and international reinsurance or insurance markets that adversely affect the volume or profitability of the Company's reinsurance or insurance business. These changes include, but are not limited to, the intensification of price and contract terms competition, the entry of new competitors, consolidation in the reinsurance and insurance industry and the development of new products by new and existing competitors;
5) Adverse development on claim and claim expense liabilities related to business written in prior years, including, but not limited to, evolving case law and its effect on environmental and other latent injury claims, changing government regulations, newly identified toxins, newly reported claims, new theories of liability, or new insurance and reinsurance contract interpretations;
11) Changes in interest rates, increases in which cause a reduction in the market value of the Company's fixed income investment portfolio, and its common shareholders' equity, and decreases in which cause a reduction of income earned on new cash flow from operations as well as on the reinvestment of the proceeds from sales, calls or maturities of existing investments;
13) Adverse results in litigation matters, including, but not limited to, litigation related to environmental, asbestos and other potential mass tort claims;