We currently lease office space in Hamilton, Bermuda where our executive and principal offices are located, and in Dublin, Ireland; George Town, Grand Cayman; Singapore; Denver, Colorado; Charlotte, North Carolina; and Windsor, England. Our life reinsurance business operates out of the Bermuda, Grand Cayman, Charlotte, Denver and Windsor offices while our wealth management business operates out of the Grand Cayman office. The Bermuda, Dublin and Grand Cayman leases expire in 2006, the Singapore lease expires in 2008, the Denver lease expires in 2010, with an option to lease office space for an additional five year option, the Charlotte lease expires in 2016 and the Windsor lease expires in 2023.
The following selected financial data should be read in conjunction with the Consolidated Financial Statements, including the related Notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations".
- -------------- (1) Scottish Re Holdings Limited was acquired on December 31, 2001 and is included in balance sheet data for 2001-2005 and income statement data for years 2002-2005.
Scottish Re Life Corporation was acquired on December 22, 2003 and is included in balance sheet data and income statement data for years 2003-2005. Consolidated statement of income data for the year ended December 31, 2003 includes net income of $1.2 million in respect of Scottish Re Life Corporation.
The ING individual life reinsurance business was acquired on December 31, 2004 and is included in balance sheet data for years 2004 and 2005 and income statement data for 2005.
The following discussion highlights significant factors influencing our consolidated financial position and our results of operations. It should be read in conjunction with the summary of selected financial data, consolidated financial statements and related notes found under Part II, Item 6 and Item 15 contained herein. In addition, you should read our discussion of "Critical Accounting Policies" beginning on page 42 for an explanation of those accounting estimates that we believe are most important to the portrayal of our financial condition and results of operations and that require our most difficult, subjective and complex judgments.
o On February 11, 2005, we completed our first securitization of excess reserves arising from Regulation XXX through an offering by Orkney Holdings, LLC of $850.0 million aggregate principal amount of 30-year maturity securities;
o During the fourth quarter of 2005, we fully completed the integration of the ING acquisition with our existing United States traditional business and migrated our Charlotte based policy administration operations to Denver;
o On December 21, 2005, we completed our second securitization of excess reserves arising from Regulation XXX through an offering by an orphaned Irish special purpose reinsurance company of $450.0 million aggregate principal amount of 30-year maturity securities;
o In December 2005, we completed a public offering of 7,660,000 ordinary shares (which included an over allotment option of 1,410,000 shares) in which we raised aggregate net proceeds of $174.1 million. In connection with the offering, we entered into variable share forward sales agreements whereby the forward purchasers agree to pay us an aggregate of approximately $75.0 million on September 29, 2006 and an aggregate of approximately $75.0 million on December 29, 2006; and
terminates due to, among other things, lapses or surrenders of underlying policies, deaths of policyholders and the exercise of recapture options by ceding companies.
Operating expenses consist of salary and salary related expenses, legal and professional fees, rent and office expenses, travel and entertainment expenses, directors' expenses, insurance and other similar expenses, except to the extent capitalized in deferred acquisition costs.
o volume and amount of death claims incurred; o our ability to assess and price adequately for the risks we assume;
Claims payable for incurred but not reported losses are determined using case basis estimates and lag studies of past experience. The time lag from the date of the claim or death to when the ceding company reports the claim to us can vary significantly by ceding company, but generally averages around 2 months. We update our analysis of incurred but not reported losses, including lag studies, on a quarterly basis and adjust our claim liabilities accordingly. The adjustments in a given period have generally not been significant relative to the overall reserves for future policy benefits or our results of operations.
Occasionally, we experience processing backlogs and establish reserves for processing backlogs with a goal of clearing all backlogs as quickly as possible. There were no significant processing backlogs at December 31, 2005.
Reinsurance premiums from traditional life policies and annuity policies with life contingencies are generally recognized as revenue when due from policyholders and are reported net of amounts retroceded. Traditional life policies include those contracts with fixed and guaranteed premiums and benefits, and consist principally of whole life and term insurance policies. For our traditional life reinsurance business, we estimate assumed premiums using actuarial model projections at the treaty level. Consistent with reinsurance industry practices, these models use the most recent policy level data available from our ceding companies and our estimate of new business for treaties still open to new business. The estimated premiums from the models are then compared
Determining whether a decline in current fair values is other than a temporary decline in value for securities classified as available-for-sale can frequently involve a variety of assumptions and estimates, particularly for investments that are not actively traded on established markets. For instance, assessing the value of some investments requires an analysis of expected future cash flows.
As the discussion above indicates, there are risks and uncertainties associated with determining whether declines in the fair value of investments are other-than-temporary. These include subsequent significant changes in general overall economic conditions, as well as specific business conditions affecting particular issuers, future financial market effects such as interest rate spreads, future rating agency actions and significant accounting, fraud or corporate governance issues that may adversely affect certain investments. In addition, there are often significant estimates and assumptions that we use to estimate the fair values of securities, including projections of expected
future cash flows and pricing of private securities. We continually monitor developments and update underlying assumptions and financial models based upon new information.
Total revenues increased by 182% in 2005 to $2.3 billion compared to 2004. The increase in premiums earned is primarily due to the acquisition of the ING business on December 31, 2004 and growth in the traditional solutions line of business in our Life Reinsurance North America Segment. The key drivers of the 2005 increase in investment income were the growth in our invested assets which arises from business growth and the ING acquisition, net proceeds of $120.4 million from our offering of 5,000,000 non-cumulative perpetual preferred shares in July 2005 and investment income earned on the invested assets from our Regulation XXX initiatives completed during the year.
When analyzing the impact of net investment income on the results of the segment, it is important to understand that a portion of the investment income earned is credited to the policyholders of our fixed annuity products. The interest credited to policyholders is included in the segment's expenses. Annuity product interest rate margins represent the excess of the yield on earning assets over the average crediting rate.
The change in value of the embedded derivatives arises from the application of DIG B36. During the year ended December 31, 2003, we implemented the requirements of DIG B36 which addresses whether SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" requires bifurcation of a debt instrument into a debt host contract and an embedded derivative if the debt instrument incorporates both interest rate risk and credit risk exposures that are unrelated or only partially related to the creditworthiness of the issuer of that instrument. Under DIG B36 modified coinsurance and coinsurance funds withheld reinsurance agreements where interest is determined by reference to a pool of fixed maturity assets, are arrangements containing embedded derivatives requiring bifurcation. In addition, reinsurance contacts with experience refunds are also considered to be arrangements containing embedded derivatives requiring bifurcation. DIG B36 was effective for fiscal quarters beginning October 1, 2003. The change in the value of embedded derivatives decreased revenues by $8.5 million in 2005 compared to an increase of $4.6 million in 2004. This change in value arose principally because of the asset/liability mismatch on modified coinsurance contracts assumed in the ING acquisition, coupled with a decrease in risk free interest rates and widening of credit spreads.
Total benefits and expenses in 2005 increased significantly compared to 2004 from $759.0 million to $2.2 billion or an increase of 188%. The increase in claims and policy benefits, acquisition costs and operating expenses was primarily due to the acquisition of the ING business on December 31, 2004 and continued growth in our Life Reinsurance North America Segment. Growth in interest credited reflects an increase in account balances and crediting rates on these balances. Additional operating costs in 2005 resulted from increased resources to support the growth in our business and $7.0 million of additional costs necessary to meet the requirements of the Sarbanes-Oxley Act of 2002. Collateral finance facilities expense in 2005 is impacted by the increased Regulation XXX financing transactions completed during the year. Interest expense increased in 2005 due to full year of interest on the 2004 trust preferred offerings, interest on the Cypress Notes and increases in LIBOR rates during 2005.
Our effective tax rate in each reporting period is determined by dividing the net tax benefit (expense) by our pre-tax income or loss. The change in our effective tax rate is due primarily to the amount in any reporting period of pre-tax earnings attributable to different subsidiaries (which changes from time to time), each of which may have different tax rates. The change in our effective tax rate is due primarily to the relationship of pre-tax income or losses in different jurisdictions. See Note 13 of the Consolidated Financial Statements for additional details.
Net income increased by 82%, or $58.8 million in 2005 compared to 2004 due to the reasons outlined above.
DIG B36 was effective for fiscal quarters beginning October 1, 2003. We reviewed all contracts at October 1, 2003 and determined that the value of this derivative, net of related deferred acquisition costs, after taxation was a loss of $19.5 million. This is shown in the consolidated statements of income as a cumulative effect of change in accounting principle for 2003. The change in value of the derivative, net of related deferred amortization costs, for 2004 amounted to a gain of $4.6 million. In the quarter ended December 31, 2003, the change in value of this derivative amounted to a gain of $13.9 million. The change in value is primarily due to movements in risk free interest rates and exposure to changing credit spreads.
Net income increased by 162%, or $44.1 million in 2004 compared to 2003 due to the reasons outlined above.
In our Life Reinsurance North America Segment we reinsure life insurance, annuities and annuity-type products through yearly renewable term agreements, coinsurance and modified coinsurance agreements. These reinsurance arrangements are predominantly on an automatic basis. These products are written by life insurance companies and other financial institutions located principally in the United States. The results of the ING acquisition, which we completed on December 31, 2004, are included in the results of this segment for the year ended December 31, 2005.
Net premiums earned increased by $1.3 billion or 289% in 2005 compared to 2004 primarily as a result of the favorable impact of the ING acquisition. The remaining increase is due to the increases in the amounts of life insurance in-force on existing business and on new business written during the year. New business face amounts assumed was $131 billion in 2005 compared to $64 billion in 2004. As of December 31, 2005, we had approximately $1.02 trillion of life reinsurance in-force. As of December 31, 2004, we had just under $1.0 trillion of life insurance in-force.
The change in value of embedded derivatives, net of related deferred amortization costs and taxes, arises from the application of DIG B36. The change in the value of embedded derivatives decreased revenues by $8.5 million in 2005 compared to an increase of $4.6 million in 2004. This change in value arose principally because of the asset/liability mismatch on modified coinsurance contracts assumed in the ING acquisition, coupled with a decrease in risk free interest rates and widening of credit spreads.
Claims and policy benefits increased by 297% in 2005 compared to 2004. The increase is primarily due to the impact of the ING acquisition. Claims and other policy benefits, as a percentage of net premiums, were 75.2%, and 73.7% in 2005 and 2004, respectively. Death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to fluctuation from quarter to quarter. During the second quarter of 2005, we experienced higher than expected mortality which resulted in higher claims of approximately $14 million. This was due principally to a higher than expected number of large claims being incurred. Mortality was within expectations for the remainder of 2005 and thus overall mortality in 2005 was slightly higher than expected. Conversely, in 2004, mortality experience in this business was slightly better than anticipated.
Acquisition costs and other insurance expenses increased by 205% in 2005 compared to 2004. The increase was a result of the ING acquisition and the increased life and annuity business. Acquisition costs and other insurance expenses, as a percentage of operating revenues, were 18.5% and 19.3% in 2005 and 2004, respectively. Operating revenues are defined as total revenues excluding realized gains (losses) and changes in the fair value of embedded derivatives. Excluding the impact of the $6.7 million rebate received from ING related to fees paid on Regulation XXX reserves, acquisition costs and other insurance expenses as a percentage of operating revenues were 18.8% in 2005. Overall, these percentages will fluctuate due to varying allowance levels within coinsurance-type arrangements, the timing of amounts due to and from ceding companies, as well as the amortization pattern of previously capitalized amounts, which are based on the form of the reinsurance agreement and the underlying insurance policies. Additionally, the mix of first year coinsurance versus yearly renewable term can cause the percentage to fluctuate from period to period.
Operating expenses for 2005 compared to 2004 increased by $30.4 million, or 165%. The increase is primarily the result of the ING acquisition and additional personnel and consulting costs incurred as we expanded our infrastructure in response to our recent and anticipated growth. We increased our head count principally because of hiring additional employees in respect of the acquisition of the ING business and adding management bench strength in key functional areas across the segment. Total employees in this segment have grown from 91 at December 31, 2004 to 226 at December 31, 2005. Operating expenses as a percentage of operating revenues decreased from 2.7% in 2004 to 2.3% in 2005 reflecting the benefits of scale and a portion of the benefits of the integration of ING into our existing operations.
Interest expense in this segment arises on the trust preferred securities. The increase in interest expense to $10.8 million, results from the issuance of an additional $50.0 million of the trust preferred securities in December 2004 and an increase in the LIBOR interest rates during 2005.
The increase in premiums earned in 2004 as compared to 2003 was primarily due to the impact of the acquisition of Scottish Re Life Corporation, on December 22, 2003, which contributed $124.8 million in earned premiums. The remaining increase is due to the increase in the number of client ceding companies and the increase in business from these clients. Excluding the business acquired from ING, as of December 31, 2004, we had approximately $305.1 billion of life reinsurance in force compared to approximately $275.0 billion as of December 31, 2003.
Fee income in 2004 increased to $7.9 million from $4.1 million in 2003 principally due to the acquisition of Scottish Re Life Corporation.
Claims and other policy benefits increased by $172.6 milion, or 101% in 2004 as compared to 2003. The increase is a result of the acquisition of Scottish Re Life Corporation, the increased number of clients and the increase in business from these clients as described above. Claims and other policy benefits, as a percentage of net premiums earned, were 73.7%, and 74.7% in 2004 and 2003, respectively. The mortality experience in this segment has fluctuated. This is somewhat expected as death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to significant fluctuation.
During 2004, acquisition costs and other insurance expenses increased by 59% to $131.7 million from $82.7 million in 2003. The increase was a result of the acquisition of Scottish Re Life Corporation, including the amortization of the present value of in-force arising on this business, and the increased life and annuity business as discussed above.
Interest expense in this segment arises on the trust preferred securities. The increase in interest expense to $4.6 million in 2004 from $1.1 million in 2003 arises from the issuance of an additional $62.0 million of trust preferred securities in October 2003, November 2003 and May 2004. An additional $50.0 million were issued in December 2004.
Net premiums earned decreased $3.5 million, or 2.8% in 2005 in comparison with 2004. During 2004, we reviewed the pricing and profitability of all contracts written in this segment and as a result, decided not to renew treaties which did not meet our return hurdles. Accordingly, premiums earned decreased in 2005 as compared to 2004. In addition during 2005, there was a favorable movement of $9.0 million due to revised reporting received on our share of two Lloyd's of London life syndicates offset by revisions to premium accruals based on improved underlying data of $2.2 million. During 2004, premiums earned include $4.2 million relating to revised reporting received on a share of two Lloyd's of London life syndicates.
Claims and other policy benefits decreased to $76.9 million, or 6% in 2005 compared to 2004. During 2005, additional information was received from ceding companies that resulted in a review of policy benefits on certain lines of business and a decrease of $7.9 million in claims and other policy benefits. This was partially offset by an increase of $5.3 million due to revised reporting received on our share of two Lloyd's of London life
syndicates. In addition, claims and other policy benefits in 2005 were impacted by the lower levels of premiums written during 2005 and revisions to premium accruals noted in the revenues section above.
Premiums earned in our Life Reinsurance International Segment during 2004 decreased 24% to $122.5 million in comparison with $160.9 million in 2003. The majority of business in our Life Reinsurance International Segment is in respect of short duration contracts. We experience considerable reporting delays from some of our cedents on this business. In 2003, as part of the implementation of this Segment's new administrative system, improved data was compiled to allow us to more accurately estimate our premiums earned. As a result, premiums earned in 2003 included $23.4 million in respect of revisions in estimates of premiums earned for past years. Premiums earned from a specific portfolio acquired in 2002 were $11.5 million lower in 2004 compared to 2003 due to the run-off nature of the portfolio. During 2004 we decided not to renew certain contracts which did not meet our return thresholds. Earned premium for general reinsurance business, which consists of aircrew loss of license and related personal accident, decreased 5% from $35.8 million to $34.0 million. Premiums earned in 2004 include $4.2 million relating to a share of two Lloyd's of London life syndicates.
Investment income during 2004 increased to $10.0 million compared to $7.5 million in 2003. A portfolio of business was recaptured in 2004 and resulted in additional investment income of $1.1 million. The remainder of the increase is due to the increased level of invested assets arising principally from growth in business.
business. Acquisition costs in 2004 also include $2.4 million relating to our share of two Lloyd's of London life syndicates.
Operating expenses have increased by 63% to $18.8 million in 2004 from $11.5 million in 2003. The increase is principally due to increased personnel costs as resources have been added as we continue to grow our business and also due to implementation of the requirements of the Sarbanes Oxley Act of 2002 and United Kingdom regulatory changes. Other expense increases compared to 2003 include office costs due to the move to larger offices in the second quarter of 2003 and amortization of the costs of a new administration system. Operating expenses in this segment are incurred in pounds sterling. These expenses have increased as a result of the depreciation of the United States dollar in comparison with pounds sterling during 2004.
The Corporate and Other Segment is comprised of revenues and expenses that are not included in the Life Reinsurance segments and it includes corporate overhead.
increases are principally due to increased personnel costs, including recruitment and relocation costs, as we continue to grow our business, the costs of option and restricted stock unit awards granted under our equity incentive compensation plans and professional fees of approximately $7.0 million incurred in respect of the implementation of the requirements of the Sarbanes-Oxley Act of 2002.
Interest expense includes interest on the 4.5% senior convertible notes and the 1.0% dividend payable on the convertible preferred shares of our HyCU's. In addition, interest expense in 2005 included $0.8 million in interest expense on the Cypress Notes. These were converted into Class C Warrants on April 7, 2005.
Operating expenses have increased by 61% to $17.5 million in 2004 from $10.9 million in 2003. These increases relate primarily to increased personnel costs and the costs of corporate governance initiatives, including implementation of the requirements of the Sarbanes-Oxley Act of 2002. Due diligence costs of $4.6 million were incurred in respect of various proposed acquisitions which were not successful. During 2004, interest expense increased by 30% to $8.4 million from $6.4 million in 2003 as a result of the HyCU's issued in December 2003.
At December 31, 2005, the average Standard & Poor's rating of our portfolio was "AA", the average effective duration was 2.9 years and the average book yield was 4.9% as compared with an average rating of "AA-", an average effective duration of 3.8 years and an average book yield of 4.2% at December 31, 2004. At December 31, 2005, the unrealized depreciation on investments, net of tax and deferred acquisition costs, was $17.9 million as compared with unrealized appreciation on investments, net of tax and deferred acquisition costs, of $13.7 million at December 31, 2004. The unrealized appreciation/ depreciation on investments is included in our consolidated balance sheet as part of shareholders' equity.
The following table presents the fixed income investment portfolio (market value) credit exposure by category as assigned by Standard & Poor's.
The following table illustrates the fixed income investment portfolio (market value) sector exposure.
Management reviews securities with material unrealized losses and tests for other than temporary impairments on a quarterly basis. Factors involved in the determination of potential impairment include fair value as compared to cost, length of time the value has been below cost, credit worthiness of the issuer, forecasted financial performance of the issuer, position of the security in the issuer's capital structure, the presence and estimated value of collateral or other credit enhancement, length of time to maturity, interest rates and our intent and ability to hold the security until the market value recovers. When a decline is considered to be "other-than-temporary" the cost basis of the impaired asset is adjusted to its fair value and a corresponding realized investment loss is recognized in the consolidated statements of income. The actual value at which such financial instruments could actually be sold or settled with a willing buyer may differ from such estimated fair values.
*Other industries each represent less than 3% of estimated fair value
At December 31, 2005, there was one security with a fair value that traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months. The unrealized loss on this security amounted to $0.5 million. At December 31, 2004 there were two securities with fair values that traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months. The total unrealized loss on these securities amounted to $1.1 million and the largest unrealized loss position was $0.9 million.
The following tables provide details of the sales proceeds, realized loss, length of time the security had been in an unrealized loss position and reason for sale for securities sold with a realized loss during 2005, 2004 and 2003.
When we originate each new reinsurance transaction, the price and terms are based on results of simulation models in which projected investment cash flows will match liability cash flows within reasonable tolerances. The investment portfolio characteristics found to be most suitable for the liability are used to design the investment guidelines and target duration for the portfolio. We currently manage our asset/liability processes for over eighty individual portfolios.
We periodically perform analyses, update guidelines and take other corrective action to keep the assets at the portfolio and enterprise level suitable for the relevant liabilities. Techniques include simulation of in-force assets and liabilities in various interest rate scenarios, adjustment of duration targets for each portfolio, monitoring the gap between actual and target duration at the portfolio, legal entity and enterprise levels. Historically, variations between the maturity of our investment portfolio and our liabilities have been small.
At December 31, 2005, the funds withheld at interest totaled $2.6 billion with an average rating of "A+", an average effective duration of 5.1 years and an average book yield of 5.6% as compared to $2.0 billion with an average rating of "A+", an average effective duration of 3.9 years and an average book yield of 5.2% at December 31, 2004. These are fixed income investments and include marketable securities, commercial mortgages, private placements and cash. The market value of the funds withheld amounted to $2.6 billion and $2.1 billion at December 31, 2005 and December 31, 2004, respectively.
companies. At December 31, 2005, we had three contracts with Lincoln National Life Insurance Company that accounted for $1.2 billion or 48% of the funds withheld balances. Additionally we had one contract with Security Life of Denver International Limited that accounted for $0.7 billion or 27% of the funds withheld balances and one contract with Fidelity & Guaranty Life that accounted for $0.6 billion or 23% of the funds withheld balances. The remaining contracts were with Illinois Mutual Insurance Company and American Founders Life Insurance Company. Lincoln National Life Insurance Company has financial strength ratings of "A+" from A.M. Best, "AA-" from Standard & Poor's, "Aa3" from Moody's and "AA" from Fitch. In the event of insolvency of the ceding companies on these arrangements we would need to exert a claim on the assets supporting the contract liabilities. However, the risk of loss is mitigated by our ability to offset amounts owed to the ceding company with the amounts owed to us by the ceding company. Reserves for future policy benefits and interest sensitive contract liabilities relating to these contracts amounted to $2.4 billion and $1.7 billion at December 31, 2005 and 2004, respectively.
According to data provided by our ceding companies, the following table reflects the market value of assets including cash backing the funds withheld at interest portfolio using the lowest rating assigned by the three major rating agencies.
Cash provided by operating activities amounted to $365.7 million in 2005 in comparison with $38.9 million in 2004. Operating cash flow includes cash inflows from premiums, fees and investment income and cash outflows for benefits and expenses paid. In periods of growth of new business our operating cash flow may decrease due to first year commissions paid on new business generated. For income recognition purposes these commissions are deferred and amortized over the life of the business. The increase in cash flow from operating activities is principally due to the ING acquisition.
In 2004, the decrease in operating cash flow in comparison with 2003 is partly attributable to settlement of a tax liability of approximately $23.0 million. This liability resulted from actions taken by the former owner of Scottish Re Life Corporation immediately prior to its acquisition in December 2003. When adjusted for this payment, cash inflows from operations in 2004 were $61.9 million compared to inflows of $88.5 million in 2003. This decrease is due to the timing of receipt of reinsurance receivables and settlement of reinsurance payables.
The increase in capitalization at December 31, 2004 compared to December 31, 2003 is due to the net income for the year ended December 31, 2004 of $71.4 million, the issuance of ordinary shares and warrants and notes to the Cypress Entities, totaling $126.9 million, the issuance of trust preferred debt of $82.0 million, the issuance of share capital to employees on the exercise of options of $8.3 million and an increase in other comprehensive income of $2.6 million partially offset by an increase in dividends declared of $0.9 million. Other comprehensive income consists of the unrealized appreciation/depreciation on investments and the cumulative translation adjustment arising from the translation of Scottish Re Holdings Limited's balance sheet at exchange rates as of December 31, 2004.
Historically, we have paid quarterly dividends of $0.05 per ordinary share and have paid quarterly dividends on our non-cumulative perpetual preferred shares during 2005. All future payments of dividends are at the discretion of our Board of Directors and will depend on our income, capital requirements, insurance regulatory conditions, operating conditions and such other factors as the Board of Directors may deem relevant. The amount of dividends that we can pay will depend in part on the operations of our reinsurance subsidiaries.
We must have sufficient assets available for use as collateral to support borrowings, letters of credit and certain reinsurance transactions. With these reinsurance transactions, the need for collateral or letters of credit arises in five ways:
o when Scottish Re (U.S.), Inc. enters into a reinsurance transaction, it typically incurs a need for additional statutory capital. This need can be met by its own capital surplus, an infusion of cash or assets from us or an affiliate or by ceding a portion of the transaction to another company within the group or an unrelated reinsurance company, in which case that reinsurer must provide reserve credit by contributing assets in a reserve credit trust or a letter of credit;
On July 14, 2005, Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc. and Scottish Re Limited entered into a $200.0 million, three-year revolving unsecured senior credit facility with a syndicate of banks. This facility replaced a 364-day facility which was due to mature in October 2005. The facility may be increased, at our option, to an aggregate principal amount of $300.0 million. The facility provides capacity for borrowing and extending letters of credit. The facility is a direct financial obligation of each of the borrowers; however, Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed the payment of obligations of Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc. and Scottish Re Limited. There were no outstanding borrowings at December 31, 2005. Outstanding letters of credit under this facility amounted to $40.9 million at December 31, 2005.
On August 18, 2005, Scottish Re (Dublin) Limited entered into a $30.0 million three-year revolving, unsecured letter of credit facility with a syndicate of banks. The credit facility may be increased, at our option, to an aggregate principal amount of $50.0 million. The facility is a direct financial obligation of Scottish Re (Dublin) Limited, however, Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed the payment obligations of Scottish Re (Dublin) Limited. There were no outstanding borrowings or letters of credit at December 31, 2005.
The financial covenants of these facilities require that Scottish Annuity & Life Insurance Company (Cayman) Ltd. maintain a minimum amount of consolidated shareholders' equity and maintain the ratio of unencumbered assets to aggregate borrowings under the facilities of 1.2 times borrowings. In addition, these facilities also require us to maintain a minimum amount of consolidated shareholders' equity and a debt to capitalization ratio of less than 30%. There were no outstanding borrowings and letters of credit at December 31,
On January 12, 2005, we entered into a put agreement with Stingray Investor Trust ("Investor Trust") for an aggregate value of $325.0 million. Under the terms of the put agreement, we acquired an irrevocable put option to issue funding agreements to Investor Trust in return for the assets in a portfolio of 30-day commercial paper. This put option may be exercised at any time. In addition, we may be required to issue funding agreements to Investor Trust under certain circumstances, including, but not limited to, the non-payment of the put option premium and a non-payment of interest under any outstanding funding agreements under the put agreement. The facility matures on January 12, 2015. This transaction may also provide collateral for Scottish Re (U.S.), Inc. for reinsurance obligations under intercompany quota share reinsurance agreements and at December 31, 2005, $50.0 million was in use for this purpose. The put premium incurred during the year ended December 31, 2005 amounted to $4.7 million, and is included in collateral finance facilities expense in the consolidated statements of income. In accordance with FIN 46R, we are not considered to be the primary beneficiary of Investor Trust and as a result we are not required to consolidate Investor Trust.
The holders of the Orkney Notes cannot require repayment from us or any of our subsidiaries, other than Orkney Holdings, LLC. The timely payment of interest and ultimate payment of principal for the Orkney Notes are guaranteed by MBIA Insurance Corporation.
In accordance with FIN 46R, Orkney Holdings, LLC, is considered to be a variable interest entity and we are considered to hold the primary beneficial interest. As a result, Orkney Holdings, LLC has been consolidated in these financial statements. The assets of Orkney Holdings, LLC have been recorded as fixed maturity investments and cash and cash equivalents. Our consolidated statements of income show the investment return of Orkney Holdings, LLC as investment income and the cost of the facility is reflected in collateral finance facilities expense.
On December 21, 2005, Orkney Re II plc, an orphan special purpose vehicle incorporated under the laws of Ireland, whose issued ordinary shares are held by a share trustee and its nominees in trust for charitable purposes, issued in a private offering $450.0 million of debt to external investors. The debt consisted of $382.5 million Series A-1 Floating Rate Guaranteed Notes (the "Series A Notes"), $42.5 million in aggregate principal amount of Series A-2 Floating Rate Notes (the "Series B Notes"), and $25.0 million Series B Floating Rate Notes, all due December 31, 2035 (collectively, the "Orkney II Notes"). The Orkney II Notes are listed on the Irish Stock Exchange. Proceeds from this offering were used to fund the Regulation XXX reserve requirements for a defined block of level premium term life insurance policies issued between January 1, 2004 and December 31, 2004 reinsured by Scottish Re (U.S.), Inc. to Orkney Re II plc. Proceeds from the Orkney II Notes have been deposited into a series of trusts that collateralize the notes.
The holders of the Orkney II Notes cannot require repayment from us or any of our subsidiaries, only from Orkney Re II plc. Assured Guaranty (UK) Ltd has guaranteed the timely payment of the scheduled interest payments and the principal on the maturity date, December 21, 2035 of the Series A-1 Notes.
In accordance with FIN 46R, Orkney Re II plc is considered to be a variable interest entity and we are considered to hold the primary beneficial interest. As a result, Orkney Re II plc has been consolidated in these financial statements. The assets of Orkney Re II plc have been recorded as fixed maturity investments and cash and
On December 22, 2005, we entered into a long term reinsurance facility with a third party ("Reinsurance Facility"), Bermuda-domiciled reinsurer that provides up to $1.0 billion of Regulation XXX collateral support for the business acquired from ING. The Bermuda reinsurer provides security in the form of letters of credit in trust equal to the statutory reserves. All risks and returns arising out of the underlying book of business are retained by us.
At December 31, 2005, we had $1.986 billion of collateral finance facility obligations relating to the HSBC I, HSBC II, Orkney Re, Inc. and Orkney Re II plc transactions. In connection with these transactions, we have assets in trust of approximately $2.705 billion which represent assets supporting both the economic and excess reserves and surplus in the transactions. The assets in trust are managed in accordance with predefined investment guidelines as to permitted investments, portfolio quality, diversification and duration.
Our long-term debt is described in Note 10 to the Consolidated Financial Statements. Long-term debt includes the $115.0 million of 4.5% senior convertible notes which are due December 1, 2022. The notes are subject to repurchase by us at a holder's option at various dates, the earliest of which is December 6, 2006. Long-term debt also includes capital securities with various maturities from 2032 onward. They are however, redeemable at earlier dates. They have been included in the above table at the earliest redemption date.
Collateral finance facility liabilities include HSBC I and II, and securitization obligations with Orkney Re, Inc., and Orkney Re II plc. These transactions are described in the previous section. These obligations are fully secured by fixed maturity investments and cash and cash equivalents included in our Consolidated Balance Sheet. The liabilities have been included in the table above at the earliest redemption date.
or disability or (ii) the occurrence of a payment triggering event, such as a surrender of a policy or contract. The timing of payment on these liabilities is not reasonably fixed and determinable since the insurable event or payment triggering event has not yet occurred, and we have no control over the timing of such occurrence. In addition to timing of payments, significant uncertainties relating to these liabilities include mortality, morbidity and persistency.
In July 2003, the Accounting Standards Executive Committee issued SOP 03-01. This SOP provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts and is effective for financial statements for fiscal years beginning after December 15, 2003. In implementing the SOP, we have made various determinations, such as qualification for separate account treatment, classification of securities in separate account arrangements, significance of mortality and morbidity risk, adjustments to contract holder liabilities and adjustments to estimated gross profits as defined in SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments". Implementation of this SOP did not have a material effect on our financial statements.
EITF 04-8 "The Effect of Contingently Convertible Debt on Diluted Earnings Per Share"(EITF 04-8)
FASB Interpretation No. 46 and 46R, "Consolidation of Variable Interest Entities" ("FIN 46" and "FIN 46R")
SFAS No. 154 "Accounting Changes and Error Corrections" (`SFAS No. 154")
In May 2005, the FASB issued SFAS No. 154, which replaces APB Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 requires retrospective application to prior periods' financial statements for changes in accounting principle, unless determination of either the period specific effects or the cumulative effect of the change is impracticable or
EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments ("EITF 03-1") and FAS 115-1"The meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("FSP FAS 115-1")
In June 2005, the FASB completed its review of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-1 provides accounting guidance regarding the determination of when an impairment of debt and marketable equity securities and investments accounted for under the cost method should be considered other-than-temporary and recognized in income. EITF 03-1 also requires certain quantitative and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No.115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment but has issued in November 2005, FSP FAS 115, which nullifies the guidance in paragraphs 10-18 of EITF 03-1, and references existing other than temporary impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell the security has not been made, and also provides guidance on the subsequent accounting for an impaired debt security. We have provided the appropriate disclosures in accordance with EITF 03-1. FSP FAS 115-1 is effective for reporting periods beginning after December 15, 2005. The adoption of FSP FAS 115-1 will not have a material effect on our results of operations or financial position.
SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments--an amendment of FASB Statements No. 133 and 140" ("SFAS No. 155")
o uncertainties relating to the ratings accorded to our insurance subsidiaries;
o the impact of acquisitions, including the ability to successfully integrate acquired businesses, the competing demands for our capital and the risk of undisclosed liabilities;
o the competitive environment in which we operate and associated pricing pressures; and