Properties. Chartwell leases approximately 53,000 square feet of space for its principal executive offices in Stamford, Connecticut. Chartwell also leases approximately 39,000 square feet of space in London, England for the operations of CMA. INSCORP is located in Jericho, New York, occupying approximately 1,150 square feet of office space. Management believes Chartwell's current office space is adequate for its needs.
Selected Financial Data. The following table sets forth selected consolidated financial data of Chartwell as of and for the periods indicated. This table does not include any historical operating financial data relating to CMA prior to December 31, 1996 or Piedmont prior to December 31, 1995 because the results of operations subsequent to the acquisition of CMA and the Piedmont Merger through the end of the years indicated were immaterial to Chartwell. The financial data for each of the five years in the period ended December 31, 1998 is derived from the audited consolidated financial statements of Chartwell. The following table also includes selected data from the Statutory Annual Statements of Chartwell Reinsurance and INSCORP. The selected consolidated financial data should be read in conjunction with the consolidated financial statements of Chartwell and notes thereto and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," included elsewhere herein.
(1) The net loss for the year ended December 31, 1994 includes after-tax expenses of $3.6 million for losses incurred related to the Northridge, California earthquake and $1.2 million of recapitalization expenses. (2) All per share amounts have been calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 requires dual presentation of basic and diluted earnings per share data presented. (3) Statutory data has been derived from the Statutory Annual Statements of Chartwell Reinsurance, INSCORP, Dakota and ReCor Insurance Company Inc. as filed with insurance regulatory authorities and prepared in accordance with SAP. (4) The statutory surplus of Chartwell Reinsurance was increased by $20.0 million in 1996 from the proceeds of a common stock offering, by $67.1 million in 1995 as a result of the Piedmont Merger and by $30.0 million in 1994 from the proceeds of the Senior Notes offering. The ratio of net premiums written to surplus ratio for 1995 includes only the premiums of Chartwell Reinsurance and excludes the increase in surplus that resulted from the Piedmont Merger. (5) Total assets and loss and LAE reserves are stated gross of reinsurance recoverable in accordance with the requirements of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." The balance sheet data at December 31, 1996 reflects the Acquisition of CMA and at December 31, 1995 reflects the Piedmont Merger. (6) Includes Chartwell's share of cash and investments held by CMA managed syndicates, totaling $100.2 million for 1998.
- - ------------------------------------------ (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.
Consolidated Results of Operations Year Ended December 31, 1998 Compared With Year Ended December 31, 1997 Revenues: Total revenues for the year ended December 31, 1998 decreased 7.6% to $298.0 million, compared to $322.4 million for the comparable period in 1997. The following table summarizes gross and net premiums written and total revenues for the periods indicated: Revenues Year Ended December 31, ---------------------------- 1998 1997 ------------- ------------ (Dollars in thousands) Gross premiums written............................ $ 342,951 $ 362,770 ========== ========== Net premiums written.............................. $ 217,054 $ 268,260 ========== ========== Premiums earned................................... 229,504 245,700 Net investment income............................. 48,869 43,575 Net realized capital gains (losses)............... 29 (3) Service and other revenue......................... 14,289 28,322 Equity in net earnings of investees............... 5,327 4,794 ---------- ---------- Total...................................... $ 298,018 $ 322,388 ========== ==========
Underwriting Operations Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written for the year ended December 31, 1998 were $343.0 million, a decrease of 5.5% compared to the same period in 1997. The decrease in gross premiums written was principally attributable to the opportunistic underwriting of certain reinsurance accounts in 1997, which did not renew for 1998, as well as Chartwell's response to the persistence of intense price competition in the reinsurance industry. On a consolidated basis, pro forma for the elimination of the opportunistic accounts underwritten in 1997, gross premiums written grew by approximately 16.2% in 1998 compared to 1997. Net premiums written for the year ended December 31, 1998 decreased 19.1% to $217.1 million, compared to $268.3 million for the same period in 1997. The decrease in net premiums written was principally attributable to the reasons described above for the decrease in gross premiums written. Net premiums earned for the year ended December 31, 1998 were $229.5 million, a decrease of 6.6% compared to the same period in 1997.
Other Expenses. Other expenses related to underwriting operations, which include underwriting and administrative expenses, were $24.0 million for the year ended December 31, 1998 compared to $16.5 million for the same period in 1997. Other expenses expressed as a percentage of net earned premiums increased to 10.5% for the year ended December 31, 1998 compared to 6.7% for the same period in 1997. The increase reflects the reduced level of premium volume and an increased share of expenses related to Chartwell's underwriting participation on syndicates managed by CMA.
Consolidated Net Investment Income and Net Realized Capital Gains (Losses). Consolidated net investment income, exclusive of realized and unrealized capital gains and losses, for 1998 was $48.9 million, an increase of $5.3 million, or 12.1%, over 1997. The improvement principally reflects the positive cash flow from operations of $33.3 million. The average annual tax equivalent yield on invested assets (excluding investment income from the Dedicated CCV's) before investment expenses was 6.5% for 1998, as compared to 6.7% for 1997. The Company realized net capital gains of $29,000 for 1998 compared to net capital losses of $3,000 for the same period in 1997.
Income Before Income Taxes. Net income before income taxes increased to $45.5 million for the year ended December 31, 1998 compared to $37.9 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.
Income Tax Expense. The provision for Federal income taxes for the year ended December 31, 1998 increased to $15.7 million compared with $10.6 million for the same period in 1997. The effective tax rate was 34.5% and 28.0% for the years ended December 31, 1998 and 1997, respectively. The principal factor in the decline below the statutory rate of 35% for both periods results from the benefit recognized on investments in tax-exempt securities. During the 1998 period, the tax benefit was largely offset by a provision for the repatriation of earnings of non-U.S. subsidiaries as well as the establishment of a valuation allowance of $1.4 million related to certain foreign tax credits generated during 1998.
Net Income. The Company realized a net profit of $29.8 million for the year ended December 31, 1998 compared with a net profit of $27.3 million for the comparable 1997 period because of the factors discussed above. Basic net income per share increased 9.2% to $3.10 per share for the year ended December 31, 1998 from $2.84 per share for the year ended December 31, 1997. Diluted net income per share increased 9.5% to $3.00 per share from $2.74 per share for the year ended December 31, 1997.
Year Ended December 31, 1997 Compared With Year Ended December 31, 1996 Revenues: Total revenues for the year ended December 31, 1997 increased 21.9% to $322.4 million, compared to $264.5 million for the comparable period in 1996. The following table summarizes gross and net premiums written and total revenues for the periods indicated:
Revenues Year Ended December 31, -------------------------------- 1997 1996 ------------- -------------- (Dollars in thousands) Gross premiums written.................... $ 362,770 $ 263,838 ============= ============= Net premiums written...................... 268,260 192,251 ============= ============= Premiums earned........................... 245,700 209,503 Net investment income..................... 43,575 44,089 Net realized capital gains (losses)....... (3) 1,157 Service and other revenue................. 28,322 6,167 Equity in net earnings of investees....... 4,794 3,559 ------------- ------------- Total............................ $ 322,388 $ 264,475 ============= =============
Service Operations Revenue from service operations, exclusive of net investment income, increased to $33.1 million for the year ended December 31, 1997 compared to $9.7 million for the same period in 1996. The improvement reflects increases in advisory fee revenues, equity in the earnings of investee companies and the inclusion, for the first time, of profit commissions and fees from CMA operations. The 1996 amount includes a gain of $2.8 million on a foreign exchange option entered into to protect the Company from the increasing value of the Pound Sterling for the period from inception of the acquisition of CMA until completion. In March 1998, NLC notified Chartwell Advisers that it chose not to renew the Advisory Agreement after its contractual expiration on December 31, 1998. In 1997, the Advisory Agreement produced base fees of $1.7 million and a profit commission of $0.7 million for Chartwell Advisers. Following expiration of the Advisory Agreement, Chartwell Advisers will continue to earn profit commissions on the open years of account (1996, 1997 and 1998) to the extent such years are profitable.
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 $43.6 million, a decrease of 1.2% compared to the same period in 1996. This decrease is primarily due to a repositioning of the investment portfolio by increasing the municipal sector. This repositioning occurred late in 1996, and the full effect was realized in 1997. 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.
Liquidity and Capital Resources 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 $33.3 million, $28.3 million and $12.2 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 14.7%, to $876.5 million compared to $764.3 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 completed the offering of $75.0 million principal amount of the Senior Notes. The net proceeds to the Company 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 the first half of 1996, the Company completed a public offering of 2,725,000 shares of common stock at $23.00 per share. The net proceeds to the Company were $58.5 million after deduction of underwriting discount and expenses. Of the net proceeds, $48.5 million was contributed to Re Holdings 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. In connection with the acquisition of CMA, stockholders of Chartwell UK could elect to receive Loan Notes in the amount of one Pound Sterling for each Pound Sterling of cash consideration. The aggregate amount of Loan Notes issued in connection with the consummation of the acquisition of CMA was $9.4 million (denominated in Pounds Sterling). The Loan Notes, which are guaranteed by First Union as described below, pay interest semi-annually at the rate per annum calculated as one percent below the Sterling London Interbank Offered Rate ("LIBOR") and will mature in June, 2002 unless redeemed at an earlier date. As of December 31, 1998, $3.8 million of the Loan Notes have been redeemed.
Market Risk Disclosures Chartwell's primary market risk exposures are: foreign currency exchange risk, in particular the U.S. dollar to the British pound sterling; interest rate risk on fixed and variable rate U.S. dollar and British pound sterling denominated short and long-term instruments; and equity price risk.
Accounting Standards Accounting for Derivative Instruments and Hedging Activities - SFAS No. 133 In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which becomes effective for the Company January 1, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company will be required to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for a change in the fair value of a derivative in earnings or other comprehensive income will depend on the intended use of the derivative and the resulting designation. Derivatives can be designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or a firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in foreign operations, an unrecognized firm commitment, an available-for-sale security, or a foreign currency denominated forecasted transaction. The difference between a derivative's previous carrying amount and its fair value at the date of implementation of SFAS No. 133 shall be reported as a transition adjustment. Such adjustment shall be reported in net income or other comprehensive income as the effect of a change in accounting principle and presented in a manner similar to the cumulative effect of a change in accounting principle in accordance with APB Opinion No. 20, "Accounting Changes." The Company is currently reviewing the impact of the implementation of SFAS No. 133 on its financial statements.