11, 1996, PXRE recorded equity in net earnings of TREX. Diluted average shares outstanding reflects the 5,680,256 weighted shares issued to holders of TREX common shares in connection with the Merger. Included in management fee was $2,512,000, $3,526,000 and $3,364,000 in 1996, 1995 and 1994, respectively, earned from TREX prior to the Merger. If the Merger had taken place at the beginning of 1996 and 1995, consolidated revenues would have been $153,410,000 and $193,972,000 for 1996 and 1995, respectively. Consolidated pro forma net income and diluted net income per share would have been $49,161,000 and $3.42 in 1996 and $60,755,000 and $4.19 in 1995. Such pro forma amounts are not necessarily indicative of what the actual consolidated results might have been if the Merger had been effected prior to December 11, 1996.
(5) The loss, underwriting expense and combined ratios included under "Other Operating Data" have been derived from the audited consolidated statements of income of PXRE prepared in accordance with GAAP.
The property and casualty reinsurance industry has been experiencing an extended period of soft market conditions. Competition has increased in recent years as a result of the ability of companies to raise additional capital and the use of both traditional and non-traditional reinsurance products. The level of excess capital has also been aided by favorable financial markets and the lower than normal number of major catastrophe losses in recent years. Consolidation has been, and continues to be, another dominant trend in the reinsurance industry. Companies are now larger, offer significantly more capacity to ceding companies and have greater access to capital through capital markets or their parent organizations. Further, Lloyd's has rebounded from a period of uncertainty and is now aggressively competitive. The result is an oversupply of capacity in the industry.
At December 31, 1998, PXRE was a party to retrocessional arrangements with a number of insurers and reinsurers. Under these arrangements, PXRE cedes some of its underwritten risks to the participants, subject to maximum aggregate liabilities per reinsurance program. PXRE receives a management fee or commission, initially based on premium volume, adjusted in some cases through contingent profit commissions related to underwriting results measured over a period of years. Future management fee income is dependent upon the amount of business ceded to the participants and the profitability of that business. Another arrangement with Select Re, a Bermuda reinsurer, formerly Investors Reinsurance Ltd, was renegotiated in 1998, and involves a five-year fee based undertaking to produce and underwrite business with Select Re. The Board of Directors of Select Re includes PXRE's Chief Executive Officer.
PXRE also purchases catastrophe retrocessional coverage for its own protection, depending on market conditions. PXRE has significantly increased its purchases of such coverage in 1998 in light of the continued general deterioration in catastrophe reinsurance pricing and the opportunity to buy protection at more favorable terms than in recent years.
As a reinsurer principally of property catastrophe-related coverages in both the national and international markets, PXRE's operating results in any given period depend to a large extent on the number and magnitude of natural and man-made catastrophes such as hurricanes, windstorms, floods, earthquakes, spells of severely cold weather, fires and explosions. While PXRE may, depending on market conditions, purchase catastrophe retrocessional coverage for its own protection, the occurrence of one or more major catastrophes in any given period could nevertheless have a material adverse impact on PXRE's results of operations and financial condition and result in substantial liquidation of investments and outflows of cash as losses are paid.
PXRE's invested assets include equities and investments in limited partnerships, real estate investment trusts, emerging market debt and other high yield bonds and are subject to market-wide risks and fluctuations, as well as to risk inherent in particular securities. Accordingly, the estimated fair value of PXRE's investments does not necessarily represent the amount which could be realized upon future sale particularly if PXRE were required to liquidate a substantial portion of its portfolio to fund catastrophic losses. PXRE's investment guidelines stress conservation of principal, diversification of risk and liquidity.
In the event the amount of dividends available, together with other sources of funds, are
not sufficient to permit PXRE to meet its debt service, its other obligations and to pay cash dividends, it would be necessary to obtain the approval of the Connecticut Insurance Commissioner prior to the payment of additional dividends by PXRE Reinsurance (or Transnational Insurance). If such approval were not obtained, PXRE would have to adopt one or more alternatives, such as refinancing or restructuring its indebtedness or seeking additional equity. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all.
The reinsurance business is increasingly competitive and is undergoing a variety of challenging developments. The industry has in recent years moved toward greater consolidation as ceding companies have placed increased importance on size and financial strength in the selection of reinsurers. Additionally, reinsurers are tapping new markets and complementing their range of traditional reinsurance products with innovative new products which bring together capital markets and reinsurance experience. PXRE competes with numerous major national and international reinsurance and insurance companies, many of which have substantially greater financial, marketing and management resources than PXRE.
Ceded premiums: - --------------- Managed business participants 21,542 16,534 30.3 Catastrophe coverage 25,979 9,643 169.4 -------- -------- Total reinsurance premiums ceded 47,521 26,177 81.5 -------- --------
Gross premiums written for 1998 increased 7.9% to $136,215,000 from $126,232,000 for 1997. Net premiums written for the year ended December 31, 1998 decreased 11.4% to $88,694,000 from $100,055,000 as PXRE increased the purchase of reinsurance and retrocessional coverage in 1998. Net premiums earned for the year ended December 31, 1998, increased 1.1% to $92,386,000 from $91,415,000 in 1997. The contribution of PXRE Lloyd's Syndicate operation, which commenced in the first quarter of 1997, together with PXRE's new business initiatives commenced in 1998, more than offset the continued impact of an intensely competitive market on PXRE's other business lines and helped PXRE increase its premium volume during the fourth quarter of 1998. New business expansion in 1998 included an international treaty underwriting team, excess and surplus lines written by Transnational Insurance, new international facultative business, and PXRE's new direct writing team.
Premiums ceded by PXRE to its managed business participants increased 30.3% to $21,542,000 for 1998 compared with $16,534,000 for 1997. The increase in premiums ceded to these programs was due primarily to an increased cession rate to Select Re and cessions from new operations offset in part by the effect of declines in gross premiums written in PXRE's traditional operations.
The underwriting results of a property and casualty insurer are discussed frequently by reference to its loss ratio, underwriting expense ratio and combined ratio. The loss ratio is the result of dividing losses and loss expenses incurred by net premiums earned. The underwriting expense ratio is the result of dividing underwriting expenses (reduced by management fees, if any) by net premiums written for purposes of SAP and net premiums earned for purposes of GAAP. The combined ratio is the sum of the loss ratio and the underwriting expense ratio. A combined ratio under 100% indicates underwriting profits and a combined ratio exceeding 100% indicates underwriting losses. The combined ratio does not reflect the effect of investment income on operating results. The ratios discussed below have been calculated on a GAAP basis.
Significant catastrophe and satellite losses affecting the year ended December 31, 1998 loss ratio are as follows:
Significant catastrophe and risk losses affecting the year ended December 31, 1997 loss ratio are as follows:
The underwriting expense ratio was 40.9% for 1998 compared with 34.8% for 1997. The increase in underwriting expense ratio was substantially due to higher acquisition expenses and contingent commissions on certain business. In addition, PXRE's diversification strategy announced in the second quarter of 1998, involving the addition of direct writing and international teams, and PXRE's strengthening of its Lloyd's and Brussel's units contributed a significant portion of the $3,597,000 of additional overhead expenses in 1998 in addition to expenses associated with the first year of underwriting operations for Transnational Insurance.
Net investment income for the year ended December 31, 1998 decreased 37.1% to $19,612,000 from $31,191,000 for 1997. The decrease in net investment income was largely due to the substantial turmoil witnessed in global securities markets during the third and fourth quarters of 1998 and the resulting decline in value of certain of PXRE's limited partnership investments. PXRE's pre-tax investment yield was 4.3% for 1998 compared with 6.3% for 1997, both calculated using amortized cost and investment income before investment expenses. The decline in yield was primarily due to returns on the limited partnership investments. Net realized investment losses for 1998 were $3,862,000 compared to gains of $2,467,000 for 1997, which includes trading in investment products having characteristics similar to the types of reinsurance PXRE traditionally assumes. In 1998, PXRE recorded the markdown of a Russian bond that is in technical default. This loss was recorded as realized which resulted in a pre-tax loss of $6,600,000.
The net effects of foreign currency exchange fluctuations were losses of $471,000 in 1998, as compared to losses of $594,000 for 1997.
The loss ratio was 13.7% for 1997 compared with 25.5% for 1996 as reported, and 28.8% for 1996 on a pro forma basis. The loss ratio for 1997 reflected a reversal of catastrophe losses of $1,457,000 gross and $964,000 net for 1997 and prior accident years, after taking into account, among other things, the German, Poland and Czech flood losses referred to below. In comparison, the loss ratio for 1996 reflected incurred catastrophe losses of $18,487,000 gross and $9,166,000 net for 1996 and prior accident years as reported, and $27,522,000 gross and $17,689,000 net for 1996 and prior accident years on a pro forma basis.
Amount of Losses ---------------- Loss Event Gross Net - ---------- ----- --- (in thousands)
Significant catastrophe and risk losses affecting the year ended December 31, 1996 loss ratio are as follows:
As Reported Pro Forma ----------- --------- Amount of Losses ---------------- Loss Event Gross Net Gross Net - ---------- ----- --- ----- --- (in thousands)
The underwriting expense ratio was 34.8% for 1997 compared with 26.2% for the comparable period of 1996 as reported, and 27.6% for the corresponding period of 1996 on a pro forma basis. As a result of the above, the combined ratio was 48.5% for 1997 compared with 51.7% for the corresponding period of 1996 as reported, and 56.4% for the corresponding period of 1996 on a pro forma basis. The increase in underwriting expense ratio was substantially due to the PXRE Lloyd's Syndicate operations, the decline in premiums earned on a pro forma basis, the decline in management fee income and the foreign exchange losses discussed below.
For the reasons discussed above, net income was $44,253,000 for 1997 compared to $33,301,000 for 1996 as reported, and $49,161,000 for 1996 on a pro forma basis. Diluted income per common share before extraordinary loss was $3.39 for 1997 compared to $3.69 for the prior comparable period as reported, and $3.42 on a pro forma basis. Diluted net income per common share was $3.19 for 1997 compared to $3.69 for 1996 as reported, and $3.42 for 1996 on a pro forma basis based on average shares outstanding of approximately 13,893,000 in 1997, 9,020,000 in 1996 as reported, and 14,389,000 in 1996 on a pro forma basis.
In December 1998 PXRE entered into a Credit Agreement dated as of December 30, 1998 (the "Credit Agreement") with First Union National Bank ("First Union") as Agent and as a Lender, pursuant to which First Union and additional Lenders which may become parties thereto agree to make available to PXRE a revolving credit facility. As at December 31, 1998, PXRE had outstanding borrowings under the Credit Agreement of $50,000,000, the net proceeds of which were contributed to the capital of PXRE Reinsurance. Loans under the Credit Agreement bear interest at an annual rate equal to First Union's base rate, as in effect from time to time, for
base rate loans or at a margin (.875% as of December 31, 1998) over First Union's Eurodollar rate for periods of 30, 60, 90 or 180 days for LIBOR loans. In connection with the Credit Agreement, PXRE and First Union entered into an interest rate swap which, effective December 31, 1998, has the intended effect of converting such $50 million borrowings by PXRE into a fixed rate borrowing at an annual interest of 6.215%. Commitments under the Credit Agreement terminate on March 31, 2005 and are subject to annual reductions of 13 1/3% commencing March 31, 2000 and 33 1/3% on March 31, 2005, and, unless due or paid sooner, the aggregate principal of the loans are due and payable in full on March 31, 2005.
Board as of December 30, 1998 (or their approved replacements). A copy of the Credit Agreement is filed as Exhibit 4.8 and is incorporated herein by reference.
In August 1993, PXRE completed a public offering of $75,000,000 principal amount of 9.75% Senior Notes due August 15, 2003. Interest expense, including amortization of debt offering costs, for 1998 in respect of the Senior Notes amounted to approximately $1,395,000. As previously announced, PXRE elected to redeem on August 15, 1998, all of the outstanding 9.75% Senior Notes due August 15, 2003, issued under the Indenture dated August 31, 1993.
The Notes were redeemed at a price of 103.656% of the principal amount, plus accrued interest thereon to August 15, 1998, and, as a result, PXRE recorded an extraordinary loss of $843,000, net of tax, in the third quarter of 1998, including the remaining unamortized offering costs.
PXRE's management has established general procedures and guidelines for its investment portfolio and oversees investment management carried out by Phoenix Investment Partners, Limited (formerly Phoenix Duff & Phelps Corporation), a public majority-owned subsidiary of Phoenix Home Life, and by selected other investment managers. PXRE's invested assets include equities and investments in limited partnerships, REITS, emerging market debt and other high yield bonds, and PXRE's investments are subject to market-wide risks and fluctuations, as well as to risk inherent in particular securities. At December 31, 1998, PXRE's investment portfolio consisted primarily of fixed maturities and short-term investments. As at December 31, 1998, 77.6% of PXRE's investment portfolio, at fair value, consisted of fixed maturities and short-term investments, while the balance was in equity securities including various mutual funds and other invested assets primarily in the form of limited partnerships. The investment policies stress conservation of principal, diversification of risk and liquidity and are approved by its Board of Directors.
Of PXRE's fixed maturities portfolio at December 31, 1998, 84.4% of the fair value
was in obligations rated "A2" or "A" or better by Moody's or S&P, respectively. Mortgage backed securities accounted for 14.7% of fixed maturities based on fair value at December 31, 1998. At December 31, 1998 PXRE had no investments in real estate or commercial mortgage loans; however, PXRE has invested in common and preferred shares of publicly traded REITS. The average market yield to maturity of PXRE's fixed maturities portfolio at December 31, 1998 and 1997, was 5.9% and 6.1%, respectively. Starting in the first quarter of 1997, PXRE has repositioned a portion of its portfolio out of U.S. Treasury, GNMA and short-term investments into new sectors including asset and corporate mortgage backed securities, emerging markets securities, tax-free municipals, investment grade Yankee bonds, a number of limited partnership investments and, to a lesser extent, equity investments and a diversified REIT portfolio.
Book value per common share was $27.13 at December 31, 1998.
During the fourth quarter of 1998, PXRE acquired 992,700 shares of common stock under its current authorized stock repurchase program and, subsequent to December 31, 1998 and through to March 19, 1999, PXRE has purchased an additional 651,800 shares of common stock. PXRE continues to have authorization under that plan to repurchase up to 648,200 shares. PXRE had 12,323,764 common shares outstanding as of December 31, 1998.
PXRE may be subject to gains and losses resulting from currency fluctuations because
The investment portfolio of PXRE is summarized in the Notes to the Financial Statements, Item 7, Management's Discussion and Analysis and Item 1, Business.
PXRE's principal market risk exposure is to changes in domestic interest rates. Changes in interest rates may affect the fair value of PXRE's fixed-income portfolio, borrowings (Bank Debt and Trust Preferred) and a related interest rate swap. PXRE's holdings subject it to exposures in the treasury, municipal, and various asset-backed sectors. These sectors consist primarily of investment grade securities whose fair value is subject to interest rate and prepayment risk. All investment positions are long with no 'short' or derivative positions.
PXRE's investment in foreign sovereign debt securities are subject to interest rate risk which is included in the sensitivity analysis below. However, the major risk factor with these sectors is credit risk. The fair values of these securities reflect their below investment grade credit ratings. During the third and fourth quarter of 1998, these sectors were subjected to substantial declines in fair value during the instabilities from the emerging market crisis. However, the value recovered substantially in the fourth quarter of 1998. The potential loss estimated in this sensitivity analysis does not include a separate estimate of losses from changes in credit spreads which, the Company has experienced in the last two fiscal quarters. The Company does not expect similar losses due to changes in credit spreads.
The estimated potential loss reflects the prepayment risk of the mortgage-related securities. The mortgage sector is a minor portion of the portfolio at year-end and was largely liquidated soon thereafter. The estimate assumes a similar change in fair value across security sectors with no adjustment for change in value due to credit risk. The interest rate risk related to the investments of the Lloyd's Syndicate is diminimus. The average maturity of these investments is under one year.
respect to the foreign sovereign securities holdings. The estimated potential loss in fair value due to changes in credit spreads was estimated at $5 million. This analysis excludes the impact of changes in credit spreads on other portfolio sectors and borrowings that may be offsetting.
PXRE is exposed to equity price risk in the form of a limited number of equity investments, including holdings in the common stock of domestic REIT's. Based on a 10% decrease in equity prices the potential loss in fair value is estimated to be $4 million.
PXRE's risk management strategy includes investments that are expected to reflect offsetting changes in fair value in response to various changes in market risks. PXRE's exposure to interest risk in its fixed income portfolio is expected to be offset in part by the change in value of its REIT's. PXRE also invests in REIT's to limit the potential loss due to exposures to changes in interest rates; this loss limit is based on the expected minimum value of the real estate holdings of the trusts.
PXRE also holds other investments that are excluded from this disclosure that are expected to provide positive returns under most market conditions representing adverse changes in interest rates and other market factors (See Note 5 to the Financial Statements).
PXRE recognized a tax benefit of $1,661,000 in 1998 compared to tax expense in 1997 and 1996 of $20,705,000 and $15,644,000, respectively. The tax benefit reported by PXRE for 1998 is attributable primarily to tax-exempt income and amortization of negative goodwill. Tax expense in 1997 and 1996 differed from the statutory rate principally due to the relative proportion of underwriting and taxable investments versus tax exempt investments, negative goodwill amortization and state and local taxes.
PXRE's Year 2000 Project is proceeding on schedule. The Project is addressing the issue of computer programs and embedded computer chips being unable to distinguish between the year 1900 and the year 2000. PXRE believes that the impact of Year 2000 issues on its internal computer systems will not be material. PXRE wrote and upgraded most of its software over the last four years in an Oracle based software environment that has been certified as Year 2000 compliant. It has been PXRE's internal standard to develop or, where necessary, redevelop internally based systems using 4 digit date fields for all calculations.
PXRE has been in contact with its other material business partners to determine their state of readiness with regard to the Year 2000 issue and the potential impact on PXRE. PXRE has identified the following categories of business partners as material to PXRE's ability to conduct its operations: banks and investment advisors, reinsurance intermediaries, major reinsurance clients, telecommunications providers and utilities.
In connection with reinsurance intermediaries and reinsurance clients, PXRE has the ability to verify their calculations of reinsurance transactions so that material errors brought on by a failure of their systems are capable of being detected.
PXRE has made the decision to evaluate the potential Year 2000 exposures emanating from its reinsurance business by conducting an analysis of each individual customer's risk exposures. Where appropriate, PXRE intends to require that an exclusion be added to the reinsurance contract or letter of intent be received. PXRE began adding exclusions to reinsurance contracts in early 1998. Additionally, it is PXRE's position, in common with others in the industry that Year 2000 exposures are not fortuitous losses and thus are not covered under reinsurance contracts even without specific exclusions. For these reasons, PXRE believes that its exposures to Year 2000 claims will not be material. However, as was the case with environmental exposures, changing social and legal trends may create unintended coverage for exposures by reinterpreting reinsurance contracts and related exclusions. It is impossible to predict what, if any, exposure reinsurance companies may ultimately have for Year 2000 claims whether coverage for the issue is specifically excluded or included.
PXRE is reviewing its disaster recovery procedures and testing its ability to redeploy its computer and staff operations to a remote hot site location in the event of failure on the part of public utilities to provide electrical power or communication links following a Year 2000 problem. Additional formal contingency plans will not be formulated until PXRE has identified specific areas where there is a substantial risk of Year 2000 problems occurring, and no such areas have been identified as of this date.
Readers are cautioned that forward-looking statements contained in this Year 2000 Update should be read in conjunction with the Company's disclosures under the heading: "CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS."
significant presence; (v) adverse development on loss reserves related to business written in prior years; (vi) lower than estimated retrocessional recoveries on unpaid losses, including the effects of losses due to a decline in the creditworthiness of PXRE's retrocessionaires; (vii) increases in interest rates, which cause a reduction in the market value of PXRE's interest rate sensitive investments, including its fixed income investment portfolio; (viii) decreases in interest rates causing a reduction of income earned on new cash flow from operations and the reinvestment of the proceeds from sales, calls or maturities of existing investments; (ix) market fluctuations in equity securities and securities underlying limited partnership investments, (x) changes in the composition of PXRE's investment portfolio; and (xi) changes in management's evaluation of the impact of the Year 2000 problem on its operations.
Consolidated Statements of Cash Flow for the years ended December 31, 1998, 1997 and 1996