All of the Company's facilities are leased. Aggregate lease payments for 1998 were $2.2 million (1997 - $1.9 million). The Company anticipates that it will be able to extend these leases as they expire or, if necessary or desirable, locate substitute facilities on acceptable terms.
The Company did not conduct any business from the date of its incorporation until January 1996. In January 1996, under the terms of a share purchase agreement, the Company exchanged 4,000,020 of its newly issued ordinary shares for 100% of the outstanding share capital of Stirling Cooke Brown Holdings (UK) Limited. Stirling Cooke Brown Holdings (UK) Limited was incorporated in England on February 5, 1990 and formerly acted as the
ultimate holding company for a number of United Kingdom subsidiaries involved in the insurance brokering industry.
Stirling Cooke Brown Holdings (UK) Limited was the predecessor entity of the Company. Accordingly, the consolidated financial statements of the Company for the year ended December 31, 1996 are those of Stirling Cooke Brown Holdings (UK) Limited.
The Company's program business segment also grew in terms of both revenues and profits. Revenues of $27.1 million in 1998 represented an increase of $7.3 million or 36.9% from revenues of $19.8 million in 1997 which was in turn a $7.9 million or 66.0% increase from revenues of $11.9 million in 1996. Despite increasingly competitive market conditions particularly in the latter part of the year, the Company was able to increase the volume of premiums written through its program business segment during the year. The increasingly competitive workers compensation market in which the majority of the Company's programs compete has resulted in a change in the Company's fee arrangements with reinsurers which is expected to negatively impact earnings in 1999. The Company is trying to minimize the effect of these changes in fee structure but it is expected that while the workers compensation market remains so competitive, the Company's fees will continue to be under pressure.
Segment profit of $5.2 million in 1998 represented an increase of $1.2 million or 31.7% from segment profit of $3.9 million in 1997 which was in turn a $0.8 million or 27.4% increase from segment profit of $3.1 million in 1996.
Segment profit of $1.7 million in 1998 represented a decrease of $0.8 million or 32.2% from segment profit of $2.5 million in 1997 which was in turn a $0.3 million or 10.7% decrease from segment profit of $2.8 million in 1996.
Segment profit of $1.2 million in 1998 represented an increase of $0.7 million or 148.2% from segment profit of $0.5 million in 1997 which was in turn a $0.4 million or 823.5% increase from segment profit of $0.1 million in 1996.
The Company's reinsurance segment comprising CIRCL experienced limited growth in revenues in 1998 and 1997. Revenues of $10.9 million in 1998 represented an increase of $1.5 million or 16.2% from revenues of $9.4 million in 1997 which was in turn a $1.2 million or 14.6% increase from revenues of $8.2 million in 1996. Net premiums earned are the largest component of revenues in CIRCL. Net premiums earned of $10.1 million in 1998 represented an increase of $1.2 million or 13.4% from net premiums earned of $8.9 million in 1997 which was in turn a $1.0 million or 12.0% decrease from net premiums earned of $7.9 million in 1996.
Segment loss of $3.4 million in 1998 represented a decrease of $3.5 million from segment profit of $0.1 million in 1997 which was in turn a $0.1 million decrease from segment profit of $0.2 million in 1996. There were two main factors leading to the segment loss in 1998, adverse development on one program and a provision of $2.5 million against reinsurance recoveries. The adverse development during 1998 reflects primarily an increase in claims frequency on one particular program that covers bodily injury and property risks in the construction industry. This program was not renewed by CIRCL in 1999. At December 31, 1998, the Company was in dispute with certain of its reinsurers in respect of amounts due under retrocession coverages. The Company has provided $2.5 million against reinsurance contracts with total recoveries of $13.4 million of which $10.2 million has been reported to date. The provision represents management's best estimates at this time of a possible shortfall in recoveries. This provision is included in the balance sheet as a component of paid losses recoverable from reinsurers. The provision is necessarily an estimate and amounts not collectible from reinsurers may ultimately be significantly greater or lesser than the provision established. It is reasonably possible that management will revise this estimate significantly in the near term. Any subsequent differences arising will be recorded in the period in which they occur.
Other includes primarily the Company's holding companies and other operating subsidiaries, and income earned in investments in affiliates. Revenues, consisting primarily of interest earnings, of $5.8 million in 1998 represented an increase of $2.6 million or 81.3% from revenues of $3.2 million in 1997 which was in turn a $1.2 million or 60.0% increase from revenues of $2.0 million in 1996. The increase in revenues in 1998 as compared to 1997 is primarily due to interest earnings on proceeds received from the Company's initial public offering in December, 1997, as well as income earned in investments in affiliates.
Segment profit of $3.6 million in 1998 represented an increase of $3.2 million from $0.4 million in 1997 which was in turn a $0.3 million increase from of $0.1 million in 1996. As with revenues, the increase in net income in 1998 as compared to 1997 is primarily due to interest earnings on proceeds received from the Company's initial public offering in December, 1997, as well as income earned on equity investments.
(i) $26.8 million of net proceeds from the Initial Public Offering during the year;
In December 1997, the AICPA Accounting Standards Executive Committee issued Statement of Position (SOP) 97-3. Accounting by Insurance and Other Enterprises for Insurance-Related Assessments. The accounting guidance of this SOP focuses on the timing of recognition and measurement of liabilities for insurance- related assessments. Guidance is also provided on recording assets representing future recoveries of assessments through premium tax offsets or policy surcharges. The SOP is effective for fiscal years beginning after December 15, 1998. The Company does not anticipate the statement to have a significant impact on the Company's financial position or results of operations.
The Year 2000 Issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. Any of the Company's programs or non-information systems that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or in miscalculations.
In 1997, the Company appointed individuals in each of the Company's geographic regions to review and assess the Company's state of readiness and its ability to process transactions in the Year 2000. These individuals and the overall committee that they are a part of are providing guidance to the operating and support departments, and have and will continue to monitor the progress of efforts made to address the Year 2000 issue. The Company is currently implementing its plan and preparing its various computer systems and selected applications for the Year 2000. This process involves taking inventory, testing, evaluating and adjusting all known date-sensitive systems and equipment for Year 2000 compliance. In addition, the Company is reviewing its essential non-information technology systems for Year 2000 compliance. The Company has also consulted with various third parties, including, but not limited to, outside consultants, outside service providers and infrastructure providers to develop approaches to the Year 2000 issue, to gain insight to problems and to provide additional perspective on solutions. The Company expects that compliance work with respect to the internal systems will be substantially completed by the end of the first quarter of 1999. In 1999, all systems critical to the Company's core businesses will be retested.
Company's operating results. However, management believes that ongoing communication with and assessment of third parties will minimize these risks.
The Company's insurance and reinsurance subsidiaries may also have an underwriting exposure to the Year 2000 phenomenon. Although the subsidiaries have not received any claims of coverage from insureds based on losses resulting from Year 2000 issues, there can be no assurance that insureds will be free from losses of this type or that these subsidiaries will be free from claims made under their policies.
The total estimated cost of compliance is $0.8 million. Approximately $0.5 million of the cost is related to reprogramming or replacement of software, and approximately $0.3 million is related to acquisition of hardware. Costs related to non-information technology are expected to be immaterial. Approximately $0.5 million of the $0.8 million cost of compliance has been incurred as of the end of December 31, 1998. All of these costs are being funded through operating cash flows. Total costs have not had and are not expected to have a material impact on the Company's financial results.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Stirling Cooke Brown Holdings Limited and subsidiaries as at December 31, 1997 and 1998 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with United States generally accepted accounting principles.
DECEMBER 31, 1997 and 1998 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
Dividends per share were $0, $0 and $0.12 for the years ended December 31, 1996, 1997 and 1998, respectively.
The Company did not conduct any business from the date of its incorporation until January 1996. In January 1996, under the terms of a share purchase agreement, the Company exchanged 4,000,020 of its newly issued ordinary shares for 100% of the outstanding share capital of Stirling Cooke Brown Holdings (UK) Limited. Stirling Cooke Brown Holdings (UK) Limited was incorporated in England on February 5, 1990 and formerly acted as the ultimate holding company for a number of United Kingdom subsidiaries involved in the insurance brokering industry.
On December 2, 1997, the Company and certain Selling Shareholders consummated an initial public offering of 3,421,250 ordinary shares. Of these shares, 1,375,000 were sold by the Company and 2,046,250 were sold by Selling Shareholders. Net proceeds of $26,832 were received by the Company upon consummation of the initial public offering.
Marketable securities comprise investments in debt and equity securities and short term investments. All investments are classified as available for sale and are carried at fair value. The difference between fair value and amortized cost/cost is recorded as accumulated other comprehensive income as a separate component of shareholders' equity, net of applicable deferred income taxes. Bond discounts and premiums are amortized over the remaining term of the securities. Such amortization is included as a component of net investment income in the consolidated statements of income. Realized gains and losses are determined
Acquisition costs associated with the acquisition of new or renewal business, including commissions and brokerage, are deferred and amortized to income over the periods in which the premiums are earned. The method followed in determining the deferred acquisition expenses limits the amount of the deferral to its realizable value by giving consideration to losses and expenses expected to be incurred as premiums are earned. Future investment income is anticipated in determining whether a premium deficiency exists.
Reserves are established for losses and loss expenses relating to claims which have been reported. In addition, reserves are established, in consultation with the Company's independent actuaries, for losses which have occurred but have not yet been reported to the Company and for adverse development of reserves on reported losses. Management believes that the resulting provision for outstanding losses and loss expenses is adequate to cover the ultimate net cost of losses and loss expenses incurred; however, such a provision is necessarily an estimate and may ultimately be settled for a significantly greater or lesser amount. The Company has limited historical loss experience available to serve as a reliable basis for the estimation of ultimate losses. It is at least reasonably possible that management will revise the estimate of outstanding losses and loss expenses significantly in the near term. Any subsequent differences arising are recorded in the period in which they are determined.
(ii) Managing general agency fees are included within Program Business revenue, and are reported net of commission expense to agents and are initially recorded as of the effective date of the related insurance policy. Fee income on installment premiums is recognized periodically when the installment is billed. Such fees are recognized in income over the period that services are performed in accordance with the Company's contractual obligations, typically ranging up to five years, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon the Company's claims handling experience over recent years. Any subsequent adjustments, including adjustments due to policy cancellation and premium adjustments, are recorded when advised by the client or agent. The portion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(v) Loss control and audit fees are included within Program Business revenue, and comprise claims administration handling, loss and safety control fees and premium audit fees. Such fees are recorded as the fees are billed and are recognized in income over the period that services are performed in accordance with the Company's contractual obligations, typically ranging up to five years depending on the type of service provided, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon the Company's claims handling experience over recent years. The proportion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". This statement is effective for all quarters of fiscal years beginning after June 15, 1999. Given the limited number of transactions currently entered into by the
Company that are covered by the Statement, the Company does not anticipate any significant changes to its current financial reporting.
In November 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position (SOP) 98-7. "Deposit accounting: Accounting for Insurance and Reinsurance Contracts that do not transfer risk." This SOP provides accounting guidance for insurance and reinsurance contracts that do not transfer risk, as determined by the provisions of SFAS 113. The Company is currently reviewing the impact of this standard on its financial reporting.
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". SFAS 131 establishes standards for reporting information about operating segments and related disclosures about products and services, geographic areas and major customers. This disclosure is located within Note 15.
In the normal course of reinsurance operations the Company's bankers have issued letters of credit totalling $12,226 and $13,141 at December 31, 1997 and 1998, respectively in favor of ceding insurance companies. At December 31, 1997 and 1998, $12,226 and $13,141, respectively, of cash and cash equivalents were pledged as collateral for these letters of credit.
c) Proceeds from sales of investments in debt securities during 1997 and 1998 were $4,190 and $10,680, respectively. Proceeds from sales of investments in equity securities during 1997 and 1998 were $7,262 and $658, respectively. There was $5 of realized losses and $443 of realized gains during 1997. There was $0 of realized losses and $59 of realized gains during 1998.
Included within other assets are investments in affiliates. Summarized condensed financial information of a Bermuda based underwriting management company, a 39% owned affiliate, which is accounted for by the equity method, is as follows:
The Company received dividends from this affiliate of $0, $593 and $2,145 during 1996, 1997 and 1998, respectively.
In addition, deposit liabilities and related assets include $2,459 and $2,687 of deposits received from customers as security for the timely payment of premiums for workers' compensation insurance at December 31, 1997 and 1998, respectively. The deposit is restricted from use by the Company, and is the property of the customer. The deposit is refunded to the customer after the policy expires or is canceled and all claims related to the insurance policy have been settled. The interest income earned by these restricted deposit accounts is the property of the customer, and is therefore excluded from the Company's operating results.
The Company accounts for reinsurance assumed and ceded in accordance with SFAS 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long- Duration Contracts". Net premiums earned are the result of the following:
At December 31, 1998 there was an amount due from one reinsurer that totaled $17,276. This reinsurer is rated `Superior' by A.M. Best. At December 31, 1997 there were no amounts due from any individual reinsurer in excess of 10% of the Company's shareholders' equity.
Comp Indemnity Reinsurance Company Limited ("CIRCL"), a subsidiary of the Company, assumes various quota shares of workers' compensation, employers' liability on both a primary and excess basis, bodily injury, difference in conditions, general liability risks, and property written on a treaty basis. CIRCL's exposure under the reinsurance contracts assumed is limited in most instances to $25 and $1,000 per occurrence for workers' compensation and employers liability, respectively and is subject to an annual aggregate limit based on various percentages of original gross written premium income. CIRCL further limits its exposure through the purchase of reinsurance protection for certain risks covering losses in excess of $1 and $50 per occurrence for workers' compensation and employers' liability.
The Company's authorized share capital at December 31, 1997 and 1998 comprised 20,000,000 ordinary shares of par value $0.25 each of which 9,863,372 ordinary shares were issued and fully-paid at that date. The Company's authorized share capital at December 31, 1996 comprised 8,048,000 ordinary shares of par value $0.25 each and 25 Class "A" non-voting shares with a par value of $1 each, of which 8,000,000 ordinary shares and 25 Class "A" non-voting shares were issued and fully-paid at that date.
On June 30, 1997, the shareholders exercised their options to purchase 600,000 ordinary shares in the Company (see Note 11 to the consolidated financial statements) at an exercise price of $2.71 per share. Contemporaneously, 288,888 ordinary shares of par value of $0.25 each were issued to the holders of the Class "A" shares pursuant to certain anti- dilution rights, and the Class "A" shares were repurchased by the Company for nominal consideration. The $72 excess of the par value of the ordinary shares issued over the original par value of the Class "A" shares was recorded as a deduction from additional paid in capital. On the same date the Company loaned the shareholders $1,625, an amount equal to the aggregate exercise price of the options. Such loans were evidenced by promissory notes, bearing interest at 7% per annum until maturity in June 1998 or earlier in the event of early repayment. Included within notes receivable was $325, $866 and $109 due from Messrs. Cooke, Brown and Jones, respectively. The loans were repaid in full in December 1997 following the successful completion of the IPO of the Company's ordinary shares.
In December 1997, under a put and call option originally granted in April 1997, the Company purchased 40,000 ordinary shares for a total cost of $667. These shares were held as treasury stock at December 31, 1997 and 1998.
In October 1998, the Company purchased a further 47,000 of its ordinary shares on the open market for a total cost of $567. These shares were held as treasury stock at cost at December 31, 1998.
In accordance with the provisions of FASB Statement No. 123, the Company applies APB Opinion 25 and related interpretations in accounting for its stock option plans and accordingly, recognizes compensation cost based on the intrinsic value of the options at the grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date as prescribed by SFAS 123, net income and earnings per share would have been reduced to the pro forma amounts indicated in the table below:
These pro forma compensation costs may not be representative of those to be expected in future years. As the options were granted on November 25, 1997, only approximately one month's compensation cost was expensed within the pro-forma net income for the year ended December 31, 1997.
Total income tax expense for the years ended December 31, 1996, 1997 and 1998 was allocated as follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1997 and 1998, are presented below:
earnings to become taxable in the foreseeable future. A deferred tax liability will be recognized when the Company expects that it will recover those undistributed earnings in a taxable manner, such as the receipt of dividends. The deferred tax liability relating to these unremitted earnings which is not recognized by the Company is approximately $200, $542 and $986 at December 31, 1996, 1997, 1998, respectively.
Earnings per share have been calculated in accordance with SFAS 128:
Forward foreign exchange contracts: The fair values of such contracts are based on quoted forward rates available for the remaining duration of the contracts at the balance sheet dates.
Other assets and liabilities: The fair values of all other financial instruments, as defined by SFAS 107, approximate their carrying values due to their short-term nature.
(b) Summarized financial information by geographic location of subsidiary for the years ended December 31, 1996, 1997 and 1998 is as follows:
(c) The Company's Program Business companies market and manage insurance products and programs developed by the Company on behalf of independent insurance carriers. In addition, the Company, through its brokerage operations and managing general underwriters provide additional business and services to certain of these independent insurance carriers in respect of these products and other insurance and reinsurance policies. For the year ended December 31, 1996, 1997 and 1998 revenues received from one independent insurance carrier approximately accounted for the following percentage of total revenues.
Total rental expense for the years ended December 31, 1996, 1997 and 1998, was $1,319, $1,894, and $2,191, respectively.
Realm National's total capital and surplus and net income determined on a New York statutory basis are as follows:
By agreement with the Insurance Department of the State of New York, Realm National was restricted from declaring dividends for a two year period from September 5, 1996 the date upon which its acquisition by the Company was completed.
minimum statutory capital and surplus of $1,680 and $2,135. Accordingly, approximately $1,664 of contributed surplus and retained earnings is restricted from distribution.
b) Goldman, Sachs & Co. acted as a co-managing underwriter for the Company's IPO completed in December 1997, from which the underwriters received aggregate underwriting discounts of $5.3 million from the Company and selling shareholders.
During 1998 certain of the reinsurers and reinsureds filed a total of 7 writs in the English courts (which are the equivalent of a complaint in U.S. jurisdictions) against the Company or certain of subsidiaries to toll the statute of limitations. Some of these writs were issued pending the outcome of related arbitrations. None of these writs specified an amount of damages sought. In most cases, the Company or the relevent subsidiaries have negotiated standstill agreements with the reinsurer or reinsured to toll the statute of limitations.
The primary factual allegation by the reinsurers is that, although they believed they reinsured the subject risks only at high excess levels, the LMX spiral caused their high excess positions to not equate with their expectation of remoteness from the incidence of risk. As to the Company or its subsidiaries, the reinsurers and reinsureds have alleged in their writs that the Company or its subsidiary was negligent, misrepresented, or failed to disclose the potential effect of the spiral on the reinsurers' exposure to risk.
The Company does not yet have sufficient information to determine whether any claims ultimately will be prosecuted against the Company or its subsidiaries or whether any such claims ultimately will result in payment of any liability or settlement by the Company or its subsidiaries.
(b) The Company is subject to other litigation and arbitration in the ordinary course of its business. While any of these proceedings contains an element of uncertainty, management presently believes the outcome of these currently pending proceedings will not have a material adverse effect on the Company.
(ii) As discussed in Note 8, the Company recorded a provision of $2,500 against paid and outstanding losses recoverable from reinsurers during the fourth quarter of 1998.
(iii) Quarterly revenues have been reclassified to conform to the year end presentation.