ESG Re and its subsidiaries lease office space in Bermuda, Dublin, Hamburg, Toronto, Miami, Hong Kong, Singapore, Taiwan, Sydney, Bangkok, Jakarta and London and own an office located in the Soviet State of Georgia. The owned property is currently valued at $290,000. All of these properties are for the Company's reinsurance division. The Company believes its space is adequate to meet its current and expected needs. The Company's health care division is provided with office space at the Company's offices in Hamburg.
reinsurance management company for the year ended December 31, 1997 and as a reinsurance management company only for the years prior to 1997.
(1) 1997 stock prices are for the period from December 12, 1997, the date of the initial public offering, to December 31, 1997. The initial public offering price was $20.00 per share.
The Company is a specialty reinsurance enterprise providing accident, health, life and related special risk reinsurance to insurers and selected reinsurers on a worldwide basis and, underwriting management services to co-reinsurers.
In December 1997, the Company raised gross proceeds of $257 million in a private placement and an initial public offering (the "Offerings"). As a result of obtaining this capital, the Company is able to assume reinsurance risks for its own account. Prior to the Offerings, the Company operated solely as a reinsurance management services company.
company in Bermuda for the health care division. In addition, during March 2000, the Company completed the acquisition of Innovacare GmbH, a disease Management Company based in Munich, Germany. The purchase price was $5.9 million.
The company expects to divest a portion of the health care division in 2000 through raising external capital to fund the venture. Extensive review by outside consultants and the senior management recruited by the Company from the pharmaceutical/disease management industry indicates substantial growth opportunities for the division in the European and North American markets. The Company is in negotiation with outside parties to take an initial equity stake in the division as the first step in reducing the Company's equity interest to a significant non-controlling equity investment in the venture
The December 31, 1999 and 1998, financial statement results included herein reflect the Company's financial performance as a reinsurance company. The December 31, 1997 financial statement results reflect the Company's financial performance as a reinsurance company and as a reinsurance management services company.
2. Negative impact upon underwriting results due primarily to deterioration of several major North American and European Accounts:
- A large quota share contract covering six ceding companies written in 1998 developed into a 111% loss and acquisition ratio. The negative development was primarily recognized during 1999, as re-pricing of the account in September 1998 did not ultimately prove sufficient to reverse losses from the initial tranche of the account, which incepted in January 1998. The ultimate loss on the account is estimated to be $4.6 million on $42 million in gross written premiums in 1998. This account has been renewed in 1999 on significantly improved terms.
- A North American medical account written through the London market for the 1998 underwriting year has deteriorated significantly in the fourth quarter. The ultimate loss recognized on the account is $2.3 million of which $1.8 million was recognized in the fourth quarter.
- The significant adverse development on North American medical business in the fourth quarter has resulted in the company adding an additional $6 million to IBNR reserves in the quarter. The Company is confident that adequate reserves have been provided. As part of a realignment of product mix, the Company has ceased writing North American medical business through its London market operation.
- A medical account in Latin America produced a loss of $2 million in the fourth quarter. The account was immediately restructured on better terms and pricing.
- Uncertainties regarding collections raised by slow payments on two accounts in Europe resulted in the establishment of a reserve of $2.0 million in the third and fourth quarters.
- Reserves were increased by $3.4 million in the fourth quarter on a Personal Accident account in Continental Europe having written premium of $31.4 million for underwriting years 1997, 1998 and 1999 respectively, following receipt of an interim bordereau in February 2000.
3. On November 11, 1999, the Company was notified that Standard & Poor's lowered the long term counterparty credit and insurer financial strength ratings of the Company's reinsurance subsidiaries from single-A-minus to triple-B. Standard & Poor's cited (i) weak earnings in the North American market; (ii) concerns over internal control mechanism and wide-scale changes in the management team, and (iii) a departure from its original business development strategy, as the motivating factors behind its decision. However, the rating agency listed the Company's extremely strong capitalization as a mitigating factor behind its decision.
The Company expects to return to its original business development strategy by refocusing its underwriting efforts on certain markets other than the North American market. The Company has no plans to exit the North American medical market as premium rates are increasing and the Company expects to generate moderate underwriting profits from business written by its Toronto office. As noted above, as part of the refocus of the group, the Company has ceased writing North American medical business through its London market operation.
5. The Company recognized an impairment loss of $0.7 million in the fourth quarter in respect of the goodwill recognized by the Company on its investment in SportSecure, a company in which the Company took majority ownership of in 1998. Management changes and declining premium volumes from the special risks line of business contributed to this decision.
Total premiums managed for the 12 months ended December 31, 1999 consisted of the following:
- Renewal Business--approximately $141 million, or 40.0%, of total premiums managed was generated from renewal business. This represents a renewal rate of 63% of risks managed in 1998.
During 1999, the Company had reductions in gross premiums written on the 1998 underwriting year of $1.6 million, equivalent to 0.8% of gross premium written in 1998. This represents differences between estimates made at the time contracts are written and actual amounts as reported by ceding companies. Such changes are recorded in the period in which the actual amounts are determined.
The following table reflects the investment results for the year ended December 31, 1999:
Total administrative expenses, which includes personnel costs, professional service fees, interest expense, other expenses and income taxes, increased by $14.1 million, or 106%, from $13.2 million in 1998 to $27.3 million in 1999.
In February 2000, the Company incorporated VBB Bermuda Limited, a holding company in Bermuda. This company will be the holding company of the Company's health care division. In addition, during March 2000, the Company completed the acquisition of Innovacare GmbH, a disease Management Company based in Munich Germany. The purchase price was $5.9 million.
Total premiums managed for the 12 months ended December 31, 1998 consisted of the following:
Geographic diversification of the Company's business continues to be demonstrated by the distribution of gross written premiums for the years ended December 31, 1998 and 1997, as follows:
The distribution of gross premiums written by line of business for the years ended December 31, 1998 and 1997 was as follows:
Net investment income increased by $12.3 million from $598 thousand in 1997 to $12.9 million in 1998. In December 1997, the Company raised net proceeds from the Offerings of $232 million. These proceeds were invested for the full year in 1998.
The Company's investment portfolio was positively affected by a general increase in prices in the U.S. bond markets, which allowed net investment gains to be realized on sales of fixed income securities during the year.
Total administrative expenses, which includes personnel costs, professional service fees, interest expense, other expenses and income taxes, increased by $6.0 million, or 85%, from $7.2 million in 1997 to $13.2 million in 1998.
Personnel costs increased by $2.1 million from $2.3 million in 1997 to $4.4 million in 1998. This increase was a result of the significant investment in personnel made both prior to and since the Offerings and includes additions of executives and staff at the holding company and various representative offices. Professional service fees increased by $2.0 million from $1.6 million in 1997 to $3.6 million in 1998. These professional service fees incurred in 1998 relate to the Company's new public reporting requirements, staff recruiting efforts and computer systems improvements. Professional costs in 1997 include $1.2 million associated with the Company's capital-raising activities. Travel expenses decreased by $0.3 million to $1.0 million, compared to the corresponding prior year period. These travel expenses relate primarily to the Company's continuing identification and investigation of new business and underwriting opportunities.
Foreign exchange gains of $141 thousand were recognized for the 12 months ended December 31, 1998. These gains were primarily unrealized and were incurred on the revaluation of assets and liabilities denominated in foreign currencies for reporting purposes. As the Company maintains a partial natural hedge, whereby foreign currency assets are held in the same currencies in which it must pay liabilities, the impact on cash flows from foreign exchange movements is reduced.
In 2000, the Company will continue to follow its investment policy and guidelines while seeking to improve long-term value by continuing to invest in selected strategic investments in accordance with its current commitments. A strategic investment is defined as an investment in a reinsurance-related enterprise, ceding company or distribution channel that is expected to generate or secure additional profitable business for the Company. In the aggregate, the Company has allocated up to $25 million to strategic investments. To date, ESG has invested $2.0 million and acquired an 83% ownership interest in IMEDI L International, a provider of general insurance products, based in Tbilisi, Georgia. This Company is consolidated within the Company's operating results. Additionally, equity investments and loans totaling $15.7 million were extended primarily to five other companies or associations with whom ESG has operating relationships. As noted under "Health Care Division" the Company has provided an investment impairment reserve of $3.2 million representing loans outstanding to COMED included in this total. In March 2000, the Company completed the acquisition of Innovacare GmbH, a disease
management company based in Munich, Germany. The Company has outstanding loan commitments of $10.8 million as at December 31, 1999, of which $8.8 million was to COMED. The Company has approved a plan to divest itself of a majority interest in its health care division in 2000, which includes the activities of COMED. The Company intends therefore to limit further loan contributions to COMED to ensure that the Company does not exceed its $25 million fund for other investments.
Operating activities provided net cash of $22.1 million for the year ended December 31, 1999 and $1.0 million for the year ended December 31, 1998. Cash flows from operations in future years may differ substantially from net income. As the Company only began to assume reinsurance risks for its own account in 1997, the Company has built up substantial loss reserves to meet future loss payments under reinsurance contracts. As reinsurance contracts mature, the Company will be required pay out a higher percentage of incurred losses in loss payments, which affect cash flows.
The Company initiated a stock repurchase program in May 1999 to actively manage its capital base. As of March 23, 2000, the Company has repurchased 2,612,800 shares of its common stock, equivalent to 18.0% of the outstanding shares of the Company under its Common Stock Repurchase Program. The average purchase price was $6.82. The Company can buy a further 83,391 shares of its common stock under the existing program.
Reinsurance balances receivable increased from $168.3 million as at December 31, 1998 to $276.1 million as at December 31, 1999. The increase was due to the growth in gross reinsurance premiums written by the Company, which are recognized at the inception of the reinsurance contract, based upon information received from intermediaries and ceding companies. The Company compares estimated written premiums to actual premiums as reported by ceding companies on a monthly basis and differences are recorded in the period in which the actual amounts are determined.
Deferred acquisition costs increased from $37.6 million as at December 31, 1998 to $57.8 million as at December 31, 1999. Acquisition costs, consisting principally of commissions and brokerage expenses incurred at the time a contract or policy is issued, are deferred and amortized over the period in which the related premiums are earned. The increase is due to the growth in acquisition expenses in the twelve months ended December 31, 1999 and the growth in unearned premium.
At December 31, 1999, reserves for unpaid losses and loss expenses were $136.9 million compared to $44.4 million at December 31, 1998. The increase was due to a combination of growth in the
At December 31, 1999, acquisition costs payable were $73.1 million compared to $45.5 million at December 31, 1998. The balance represents acquisition expenses due on gross reinsurance premiums written by the Company and is consistent with the increase in reinsurance balances receivable.
Shareholders' equity as of December 31, 1999 was $176.8 million, compared to $244.8 million at December 31, 1998. The major factors influencing the reduction in shareholders' equity in the 12-month period included a net loss of $30.4 million from the reinsurance division, a net loss of $11.6 million from the health care division, repurchase of common shares at a cost of $16.5 million, net unrealized investment losses of $3.6 million and the declaration of four dividends, each of $0.08 per common share, aggregating to $4.1 million. Book value per common share declined to $15.24 as of December 31, 1999 from $17.58 as of December 31, 1998.
In addition to the above commitments, the Company has outstanding loan commitments of $10.8 million as at December 31, 1999 of which $8.8 million was to COMED. As at December 31, 1998, the Company had a loan commitment of $12 million to COMED.
In February 2000, the Company incorporated VBB Bermuda, a holding company in Bermuda. This company will be the holding company of the Company's health care division, which the company plans to partially divest during 2000 through raising external capital to fund the venture. The Company plans to retain a significant non-controlling equity interest in the venture. The Company expects to commence private placement funding during the second quarter of 2000. As part of the development of the health care division, the Company intends to acquire the assets and brand of COMED, the non-profit organization that the Company helped to establish in December 1998 and restructure it as a for-profit organization that can be synergised with the Company's own health care entities. In addition, during March 2000, the Company completed the acquisition of Innovacare GmbH, a disease Management Company based in Munich, Germany. The purchase price was $5.9 million.
As at December 31, 1999, the Company had extended loans to COMED of $3.2 million under the loan facility of $12 million provided in December 1998. These loans were fully provided for as of December 31, 1999. The ability of COMED to repay the loan is dependent on its ability to generate sufficient revenues from members. Under the terms of the loan agreement, the Company has the right to refuse any further disbursements where the ability of COMED to repay the loan is in doubt.
The Company's systems do not interface electronically with those of its customers or clients. As such, the Company's exposure to the Year 2000 issue with respect to customers and clients is limited to the possibility that information supplied by these companies could not be of sufficient quality or timeliness and therefore could indirectly affect the quality or timeliness of the Company's own data. The Company communicated with its significant clients and service providers to assess their vulnerability and readiness to comply with Year 2000 issues and addressed compliance risks with each new significant vendor as they arose.
Although the change in date has occurred, it is not possible to conclude that all aspects of the Year 2000 issue that may affect the entity including those related to customers, suppliers, or other third parties, have been fully resolved.
Since 1994, ESG Germany has provided underwriting management services by operating as a personal and special risk reinsurance underwriter on behalf of certain reinsurers. ESG Germany earned management fees from reinsurance companies for administering various underwriting pools and providing underwriting services to reinsurance companies outside of the pool structure without directly participating in the underwriting results.
Subsequent to the IPO, the Company assumed for its own account, through retrocession, risks that ESG Germany previously underwrote on behalf of its reinsurance clients. The Company exercised a contractual right provided in the pool agreements to retrocede from its reinsurance clients a 30% share of the existing pool business, retroactive to January 1, 1997, of the 1997 business it managed for its reinsurance clients. The Company also assumed additional quota share reinsurance from various pool clients. In December 1999, the Company outsourced the administration of the runoff of the reinsurance pools to AON Claims Consultancy.
The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.
The financial statements for the year ended December 31, 1997 represent the financial performance of the Company both as a reinsurer and as a reinsurance management company. Certain items in the 1998 and 1997 financial statements have been reclassified to conform to the presentation adopted in 1999.
Fixed maturity securities are classified as available for sale and are reported at estimated fair value. Investments that are available for sale are expected to be held for an indefinite period but may be sold depending on interest rates and other considerations. Other investments over which the Company exercises significant influence are accounted for under the equity method. Other investments are accounted for at the lower of cost or estimated realizable value. Unrealized investment gains and losses on investments available for sale, net of applicable deferred income tax, are reported as a separate component of "accumulated other comprehensive income". Realized gains or losses on sale of investments are determined on the basis of average cost. The carrying values of investments available for sale and other investments are adjusted for impairments in value that are considered to be other than temporary.
Acquisition costs, consisting principally of commissions and brokerage expenses incurred at the time a contract or policy is issued, are deferred and amortized over the period in which the related premiums are earned. Deferred policy acquisition costs are limited to their estimated realizable value based on the related unearned premiums, anticipated claims and claim expenses and anticipated investment income.
Management fee revenue consists primarily of fees earned as compensation for underwriting and managing the reinsurance portfolio on behalf of the Company's co-reinsurers. These fees are estimated and recognized at the inception of the contracts with the co-reinsurers and amortized over the life of the contracts. In addition, adjustments to management fees and profit commission arising from underwriting results for 1997 and prior years, when the Company operated as a reinsurance management company, are estimated and accrued.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (I) EARNINGS PER SHARE
The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period as well as the disclosure of such amounts. Actual results, particularly for premiums written, premiums earned and loss reserves could materially differ from those estimates and assumptions.
The carrying value of the of the Company's investments approximates their fair value and is based on quoted market prices. Due to the uncertainty with respect to both the timing and amount of the proceeds to be realized from the Company's other investments, it is not practicable to determine the fair value of these other investments. The carrying values of other financial instruments, including cash and cash equivalents, accrued investment income, and other receivables and payables approximate their estimated fair value due to the short term nature of the balances.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not currently enter into any transactions that are covered by this statement and therefore, the Company does not anticipate any significant change to its current financial reporting.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The AICPA issued Statement of Position 98-7, "Deposit Accounting" which is effective for financial statements with fiscal years beginning after June 15, 1999. The Company does not expect that this standard will have a significant impact on the current financial reporting.
3. INVESTMENTS (CONTINUED) The components of net investment income are presented in the table below:
Other investments represents equity investments in, and loans to, reinsurance-related enterprises, ceding companies or distribution channels that are expected to generate or secure additional profitable business for the Company. The loans bear interest at rates between 6% and 9% and are repayable between one and five years. Impairment reserves have been provided against loans of $3.2 million advanced to COMED, under a $12 million loan commitment and against a loan of $0.2 million advanced in 1998 to a North American health care organization.
Activity in the reserve for unpaid losses and loss expenses for the years ended December 31, 1999 and 1998 is summarized as follows:
Realization of deferred tax assets is dependent on generating sufficient taxable income in the future. During 1999 and 1998, the Company recorded a valuation allowance of $6.8 million and $1.0 million, respectively, to reduce its deferred tax asset to estimated realizable value. The Company has tax loss carryforwards included in the calculation of the deferred tax asset as of December 31, 1999 and 1998, of $20.3 million and $3.4 million respectively, available to offset future foreign taxable income. Such tax loss carryforwards do not have an expiration date.
9. RETROCESSIONS (CONTINUED) believes that it has minimized the credit risk with respect to its reinsurance by monitoring its retrocessionaires and avoiding concentrations with any single company.
Losses and loss expenses incurred and earned premiums as reported in the statement of operations are after deduction for retrocessions. Written and earned premiums and losses incurred for the years ended December 31, 1999, 1998 and 1997 are comprised of the following:
Class A Warrants to purchase 1,381,200 common shares at $20 per share were outstanding as of December 31, 1999 and 1998. Options to purchase up to 1,440,503 common shares, issued at exercise prices between $5.44 and $26.50, were outstanding as of December 31, 1999. Options to purchase up to 815,428 common shares, issued at exercise prices between $14.76 and $26.50, were outstanding as of December 31, 1998. The incremental shares from assumed exercise of options and warrants have not been included in the above computation for 1999 as they have an anti-dilutive effect on the net loss per common share.
11. COMMITMENTS AND CONTINGENCIES (CONTINUED) determined by the Board of Directors of the Company. The contracts include various non-compete clauses following termination of employment. As of December 31, 1998, the minimum employee commitments were $7 million.
Certain subsidiaries of the Company are obligated to make defined contributions to pension plans for their employees. As of December 31, 1999 and 1998, there were outstanding liabilities for pension contributions of $448 thousand and $207 thousand respectively. Pension contribution expenses were $590 thousand, $143 thousand and $29 thousand, for the years ended December 31, 1999, 1998 and 1997, respectively.
In February 2000, Odyssey Re instituted an action in England against a broker, Stirling Cooke Brown, alleging fraud and conspiracy on the reinsurance placement of 1997 and 1998 Personal Accident and Workers Compensation "carve out" business with Odyssey Re. These proceedings mirror earlier proceedings commenced in New York which were dismissed on jurisdictional grounds. During 1998, ESG accepted a 25% quota share reinsurance treaty with Odyssey Re (UK) retroactive to January 1, 1998. This treaty covers various reinsurance contracts underwritten by Odyssey Re (UK) and retroceded to ESG. Among these ceding companies are various insurance companies involved in the litigation Odyssey Re instituted in New York over 1997 and 1998 business. This treaty terminated as of December 31, 1998 but ESG renewed its participation for 1999 directly to one of those ceding companies. In December 1999, the Company gave notice to rescind its contract with Odyssey Re (UK) for misrepresentation and failure to disclose material facts. The Company continues to investigate its position regarding the 1999 account regarding possible misrepresentation and failure to disclose material facts. At this time, the Company is unable to determine the amount of its exposure and the possible effect upon the Company's business, financial condition or results of operation from these two contracts.
13. WARRANTS (CONTINUED) expense of $3.6 million paid to a related party. This expense was reflected as a charge to the statement of operations, and as an increase to additional paid-in capital.
To date all non-management directors have elected to receive their fees as options to purchase shares. As a result, a total of 460,428 shares of common stock have been granted, net of forfeitures, as stock options as of December 31, 1999 (1998:206,428). Compensation expense related to these grants of
14. STOCK-BASED COMPENSATION (CONTINUED) $232 thousand and $347 thousand was recognized for the years ending December 31, 1999 and 1998, respectively.
Options granted under the Directors' Plan vest 100% at the date of grant. All options are exercisable at fair market value of the stock at the date of grant and expire 10 years after the date of grant.
A summary of the status of the Company's outstanding stock options as of December 31, 1999 and 1998 is presented below:
The Company applies APB Opinion 25 and Related Interpretations in accounting for stock based compensation. Had the compensation expense for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method described in SFAS No. 123, the Company's net loss and earnings per share would have been adjusted to the proforma amounts indicated below:
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," requires that an enterprise disclose information about its operating segments. The Company considers its reinsurance activities to constitute a single operating segment on the basis that such activities are monitored and evaluated primarily on a company wide basis. Investments are held in support of reinsurance activities and are considered to be a part of the reinsurance segment. In 1999, the Company established a Health Care division, which management considers a separate segment under
16. SEGMENT INFORMATION (CONTINUED) SFAS No. 131. Assets and liabilities of the Health Care segment are immaterial, as the only significant asset, loans to COMED, has been fully reserved. The Company plans to divest the Health Care segment in 2000. The Company plans to retain a significant, non-controlling equity interest in the venture. Segment disclosures for years ended December 31, 1998 and 1997 have not been included as the Company previously operated solely through its reinsurance division, which management considered a single segment. Results for both segments in 1999 are detailed below:
For the year ended December 31, 1999, one client contributed $64.1 million to total revenue. For the year ended December 31, 1998, one significant client relationship contributed $25.1 million to total revenue. For the year ended December 31,1997, three significant client relationships contributed $3.6 million, $2.6 million and $2.4 million to total revenue.
The Year 2000 issue arises because many computerized systems use two digits rather than four to identify a year. Date-sensitive systems may recognize the year 2000 as 1900 or some other date, resulting in errors when information using year 2000 dates is processed. In addition, similar problems may arise in the same systems that use certain dates in 1999 to represent something other than a date.
Although the change in date has occurred, it is not possible to conclude that all aspects of the Year 2000 issue that may affect the entity, including those related to customers, suppliers, or other third parties, have been fully resolved.