OdysseyRe’s corporate offices are located in approximately 2,117 square feet of leased office space in 140 Broadway, New York. Odyssey America’s corporate offices are located in approximately 98,358 total square feet of leased space in Stamford, Connecticut. Our other locations occupy a total of approximately 101,615 square feet, all of which are leased. The Americas division operates out of offices in New York, Stamford, Mexico City, Miami, Santiago and Toronto, the EuroAsia division operates out of offices in Paris, Singapore, Stockholm and Tokyo, the London Market division operates out of offices in London and Bristol, and the U.S. Insurance division operates out of offices in New York, California, Illinois, Michigan, and Minnesota.
The following GAAP statement of operations and balance sheet data relating to each of the years 1999 through 2003 has been derived from our annual consolidated financial statements audited by PricewaterhouseCoopers LLP, our independent accountants. Consolidated balance sheets as of December 31, 2003 and 2002, and the related consolidated statements of operations and comprehensive income, stockholders’
We encourage you to read the consolidated financial statements included in this Form 10-K because they contain our complete financial statements for the years ended December 31, 2003, 2002 and 2001. The results of operations for the year ended December 31, 2003 are not necessarily indicative of future results.
Assumes retroactive implementation of SFAS Nos. 141 and 142, which relates to goodwill and negative goodwill. These statements were adopted by us on January 1, 2002.
Inclusion of the unvested portion of restricted common stock granted under the Odyssey Re Holdings Corp. Restricted Share Plan would have an anti-dilutive effect on the 2001 diluted earnings per share (i.e., the diluted earnings per share would be greater than the basic earnings per share); accordingly, such shares were excluded from the calculation of the 2001 earnings per share.
Based on our common stock outstanding of 64,996,166 shares as of December 31, 2003, 65,003,963 shares as of December 31, 2002, 65,142,857 shares as of December 31, 2001 and 48,000,000 shares as of December 31, 2000 and 1999.
Odyssey Re Holdings Corp. is a Delaware domiciled company which was incorporated on March 21, 2001 to serve as the holding company for Odyssey America and its subsidiaries, Clearwater Insurance Company (formerly Odyssey Reinsurance Corporation), Hudson, Hudson Specialty, UK Holdings and Newline. On June 19, 2001, OdysseyRe sold 17,142,857 shares of its common stock in an initial public offering. In connection with this offering, we acquired all of the outstanding shares of Odyssey America from subsidiaries of Fairfax, our ultimate majority stockholder, for an aggregate consideration of $988.8 million, consisting of $233.6 million in cash, a $200.0 million term note and 48 million shares of our common stock. The acquisition has been accounted for at historical cost in a manner similar to a pooling of interests. Accordingly, the consolidated financial statements of Odyssey America and its subsidiaries have become our historical financial information. On September 10, 2002, we acquired 56.0% of the common stock of First Capital Insurance Ltd., a Singapore insurance company, and subsequently contributed First Capital to Odyssey America. During the second quarter of 2003, Odyssey America increased its ownership in First Capital to 97.7%. On January 1, 2004, Odyssey America contributed all of its shares of First Capital to Fairfax Asia (2003) Limited (“Fairfax Asia”) in exchange for Class B non-voting shares of Fairfax Asia, representing an approximate 45%, $32.0 million, ownership interest in Fairfax Asia. Fairfax Financial Holdings Limited, a Canadian financial services company, our majority stockholder, owns the controlling interest in Fairfax Asia.
in pricing as well as terms and conditions, and our opportunistic expansion into better performing lines of business.
We operate our business through four divisions, the Americas, EuroAsia, London Market, and U.S. Insurance, which are based principally on geographic regions.
The London Market division is comprised of our Lloyd’s of London business, in which we participate through our 100% ownership of Newline which in turn owns and manages Syndicate 1218, and our London branch office. Our Lloyd’s membership provides strong brand recognition, extensive broker and direct distribution channels and worldwide licensing, including the ability to write primary business on an excess and surplus lines basis in the United States. The London Market division in general, and Newline in particular, has experienced a resurgence of opportunities from domestic and international business. The London Market division writes insurance and reinsurance business worldwide principally through brokers.
The U.S. Insurance division is comprised of specialty program insurance business underwritten by Hudson and Hudson Specialty. Effective January 1, 2003, we commenced, on a new and renewal basis, underwriting medical malpractice and hospital professional liability business through the Healthcare unit located principally in Napa, California. In 2003, we reinsured this business through a 100% quota share agreement with an affiliate, and will underwrite this business directly through Hudson Specialty in 2004.
We derive our revenues from two principal sources: premiums from insurance and reinsurance assumed, net of premiums ceded (net premiums written); and income from investments. Net premiums written are earned (net premiums earned) as they are credited to revenue over the terms of the underlying contracts or certificates inforce. The relationship between net premiums written and net premiums earned will, therefore, vary depending generally on the volume and inception dates of the business assumed and ceded and the mix of such business between proportional and excess of loss reinsurance.
Consistent with our significant accounting policies, we utilize estimates in establishing premiums written, the corresponding acquisition expenses and unearned premium reserves for our reinsurance business. These estimates are required to reflect differences in the timing of the receipt of accounts from the ceding company and the actual due dates of the accounts at the close of each accounting period.
Losses and loss adjustment expenses, net of related reinsurance recoverables, are charged to income as incurred. Unpaid losses and loss adjustment expenses comprise the accumulation of case reserves and incurred but not reported reserves. Provisions for inflation and “social inflation” (e.g., awards by judges and juries which progressively increase in size at a rate exceeding that of general inflation) are implicitly considered in the overall reserve setting process as an element of the numerous judgments which are made as to expected trends in average claim severity. Legislative changes may also affect our liabilities, and evaluation of the impact of such changes is made in the reserve setting process.
Our reserves for losses and loss adjustment expenses are estimates of amounts required to pay reported and unreported claims and related loss adjustment expenses. We believe the estimate of these reserves is a “critical accounting estimate” because changes in these reserves can materially affect net income. The estimates are based on assumptions related to the ultimate cost to settle these claims. Our reserves for losses and loss adjustment expenses are determined in accordance with sound actuarial practices. However, the inherent uncertainties of estimating reserves are greater for reinsurers than for primary insurers, due to the diversity of development patterns among different types of reinsurance contracts and the necessary reliance on ceding companies for information regarding reported claims. As a result, we cannot be sure that our ultimate liability will not exceed amounts we have reserved. As of December 31, 2003, our estimate of these liabilities net of reinsurance recoverables was $2,341.7 million, and as of December 31, 2002 was $1,844.6 million.
Gross Premiums Written. Gross premiums written for the year ended December 31, 2003 increased by $663.7 million, or 35.0%, to $2.6 billion from $1.9 billion for the year ended December 31, 2002. Insurance and reinsurance market conditions improved substantially on a global basis the past two years, providing the key factor for growth. The increase in premium volume is attributable to increases in the Americas division of $232.4 million, or 19.5%, the EuroAsia division of $149.5 million, or 57.8%, the London Market division of $122.6 million, or 38.9% and the U.S. Insurance division of $165.2 million, or 98.0%.
The increase in the Americas division gross premiums written for the year ended December 31, 2003 compared to 2002, is comprised of increases in treaty property business of $67.1 million (22.0%), treaty casualty business of $122.0 million (17.4%), other treaty business of $10.8 million (15.4%) and facultative reinsurance of $32.5 million (28.9%).
The London Market division generated $437.9 million, or 16.8%, of our gross premiums written for the year ended December 31, 2003 as compared to $315.3 million, or 16.3%, of our gross premiums written for the year ended December 31, 2002. Gross premiums written by the London branch for the year ended December 31, 2003 were $154.4 million, an increase of $36.9 million, or 31.4%, compared to $117.5 million for the year ended December 31, 2002. Our Lloyd’s syndicate had gross premiums written of $283.5 million for
the year ended December 31, 2003, an increase of $85.7 million or 43.3%, compared to $197.8 million for the year ended December 31, 2002.
The increase in the London Branch gross premiums written for the year ended December 31, 2003, compared to 2002, is comprised of increases in treaty property business of $5.4 million (9.4%), treaty casualty business of $17.5 million (104.2%) and treaty, marine and aerospace business of $14.0 million (32.2%). The Lloyd’s syndicate business is principally comprised of liability insurance business.
Net Realized Investment Gains. Net realized investment gains for the year ended December 31, 2003 increased by $66.9 million, or 49.3%, to $202.7 million from a gain of $135.8 million for the year ended December 31, 2002. The increase in net realized gains in 2003 was primarily related to the sale of fixed income securities, which had appreciated in value.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses for the year ended December 31, 2003 increased by $338.6 million, or 34.6%, to $1,325.8 million from $987.2 million for the year ended December 31, 2002. The increase in losses is a direct result of the increase in net premiums earned and increases in net loss reserves of $116.8 million primarily associated with accident years 1997 to 2000 for U.S. casualty business. The losses and loss adjustment expense ratio for the year ended December 31, 2003 was 67.5% compared to 68.9% for the year ended December 31, 2002. The improved losses and loss adjustment expense ratio reflects the general improvements in primary and reinsurance pricing.
Acquisition Costs. Acquisition costs for the year ended December 31, 2003 increased by $113.7 million, or 31.4%, to $476.0 million from $362.3 million for the year ended December 31, 2002, with the increase due
to premium growth offset by a slight decrease in our acquisition cost ratio. The resulting acquisition cost ratio, i.e., acquisition expenses expressed as a percent of earned premium, was 24.2% for the year ended December 31, 2003 compared to 25.3% for the year ended December 31, 2002. The decrease in the acquisition expense ratio is attributable to the negotiation of lower commission and brokerage costs across the portfolio and mix of business, combined with the increased primary insurance underwritten during 2003, which has a lower acquisition cost ratio.
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2003 were $101.3 million compared to $70.3 million for the year ended December 31, 2002. The other underwriting expense ratio, expressed as a percent of premiums earned, was 5.2% for the year ended December 31, 2003, compared to 4.9% for the year ended December 31, 2002. This increase in other underwriting expenses and the related expense ratio is principally attributable to increased headcount from domestic and international expansion, increased premium taxes resulting from an increase in primary insurance premiums, and expenses associated with our Healthcare business and First Capital.
Federal and Foreign Income Tax Provision. Our federal and foreign income tax provision for the year ended December 31, 2003 increased by $42.3 million to $129.1 million, from $86.8 million for the year ended December 31, 2002, as a result of the increase in operating income.
$146.5 million, or 12.7%, of our gross premiums written for the year ended December 31, 2001. Opportunities in our EuroAsia division have increased due to catastrophe losses, competitor withdrawals and asset impairments, particularly in Europe. For the years ended December 31, 2002 and 2001, our Paris office had gross premiums written of $186.7 million and $109.6 million, respectively, an increase of $77.1 million, or 70.3%. For the years ended December 31, 2002 and 2001, our Singapore office had gross premiums written of $68.8 million and $36.9 million, respectively, an increase of $31.9 million, or 86.4%. For the year ended December 31, 2002, First Capital had $3.2 million of direct premiums written. First Capital was acquired on September 10, 2002, thus there was only one quarter’s worth of results in 2002.
The U.S. Insurance division which is comprised of Hudson specialty program business accounted for $168.6 million, or 8.7% of our gross premiums written for the year ended December 31, 2002, an increase of $111.8 million, compared to $56.8 million, or 4.9%, of our gross premiums written for the year ended December 31, 2001. The increase in the U.S. Insurance division’s gross premiums written is attributable to increases in property of $13.8 million, casualty of $28.6 million, and automobile lines of $39.4 million.
Ceded Premiums Written. Ceded premiums written for the year ended December 31, 2002 increased by $94.3 million, or 55.8%, to $263.3 million from $169.0 million for the year ended December 31, 2001. The increase in ceded premiums written is primarily attributable to the increase in gross premium volume and an increase in cessions related to our Hudson business of $61.2 million. Included in the results for the year ended December 31, 2001 were ceded premiums written of $28.8 million related to the event of September 11th.
Included in net realized investment gains for the year ended December 31, 2002 is $13.0 million of realized losses on the other than temporary write-down of certain fixed income and equity securities.
The other expense (income), net for the year ended December 31, 2002 is primarily comprised of the operating expenses of the holding company, since goodwill is no longer amortized. The major component of other expense (income), net, in 2001 was the amortization of goodwill, which consists of the negative goodwill associated with the purchase of Clearwater amortized over a ten-year period at $8.3 million per year, and the amortization of positive goodwill associated with the purchase of Odyssey America amortized over a ten-year period at $2.5 million per year.
Total cash provided by investing activities for the year ended December 31, 2003 was $359.1 million compared to cash used by investing activities of $93.3 million for the year ended December 31, 2002. The increase in cash proceeds from investing activities is mainly due to a change in the mix of short-term investments and cash and cash equivalents. Cash and cash equivalents were $1,588.7 million and $484.7 million, as of December 31, 2003 and 2002, respectively. The increase in cash and cash equivalents resulted from us selling longer term securities to realize capital gains during 2003 and the second half of 2002. A significant portion of the proceeds from these sales have been invested in shorter term securities. It is anticipated that our cash and cash equivalents will remain at high levels over the near term, pending re-investment on a basis consistent with our long-term value oriented investment philosophy. Cash and short-term investments are maintained for liquidity purposes and represented 42.6% and 21.9% as of December 31, 2003 and December 31, 2002, respectively, of total financial statement investments and cash on such dates. Total fixed income securities were $1.6 billion as of December 31, 2003. Total investments and cash amounted to $4.2 billion as of December 31, 2003, an increase of $1.2 billion compared to December 31, 2002. The fixed income securities portfolio has a weighted average of AA security rating as measured by Standard and Poor’s.
redeemable at a premium, prior to maturity, at our option. In November 2003 and June 2002, we prepaid $50.0 million and $10.0 million, respectively, aggregate principal amount of 7.49% senior notes. Immediately following the issuance of the 7.49% senior notes, we entered into an interest rate swap agreement, with Bank of America N.A., that effectively converted the fixed 7.49% interest rate into a variable interest rate of London Interbank Offered Rate (“LIBOR”) plus 263 basis points. In May 2003, we sold the variable interest rate instrument for a gain of $6.4 million. The gain has been capitalized and is being amortized over the remaining life of the 7.49% senior notes. In conjunction with the early extinguishment of $50.0 million of 7.49% senior notes, $3.0 million of the capitalized gain was immediately realized. As of December 31, 2003, the aggregate principal amount of 7.49% senior notes outstanding was $40.0 million and the remaining capitalized gain is $2.3 million.
Through Odyssey UK Holdings Corp., Odyssey America became a limited liability participant in the Lloyd’s market in 1997. In order to continue underwriting at Lloyd’s, Odyssey America has established a clean irrevocable letter of credit and a deposit trust account in favor of the Society and Council of Lloyd’s. As of December 31, 2003, Odyssey America had pledged U.S. Treasuries in the amount of $120.7 million in support of a letter of credit and $142.7 million in a deposit trust account in London. The letter of credit and deposit trust account effectively secure the future contingent obligations of Odyssey UK Holding Corp. should the Lloyd’s underwriting syndicate in which Odyssey America participates incur net losses. Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the letter of credit and the deposit trust account.
Rating agencies assess the claims-paying ability of reinsurers and their ratings represent independent opinions of financial strength and ability to meet policyholder obligations. These ratings are used by insurers and reinsurance and insurance intermediaries as an important means of assessing the financial strength and quality of reinsurers. In addition, the rating of a company purchasing reinsurance may be adversely affected by an unfavorable rating of its reinsurer. A reduction in our financial strength ratings could limit or prevent us from writing new reinsurance or insurance policies. Our financial strength ratings as of December 31, 2003 were: A.M. Best Company: “A” (Excellent); and Standard & Poor’s rating services: “A-” (Strong).
All market sensitive instruments discussed here relate to our investment assets which are classified as available for sale. As of December 31, 2003, our $4.2 billion investment portfolio is comprised of $1.6 billion of fixed income securities that are subject primarily to interest rate risk and credit risk.
Computations of the prospective effects of hypothetical interest rate changes are based on numerous assumptions, including the maintenance of the existing level and composition of fixed income security assets, and should not be relied on as indicative of future results.
As of December 31, 2003 and December 31, 2002, 83.6% and 88.6%, respectively, of our fixed income securities portfolio consisted of securities rated investment grade, with 16.4% and 11.4%, respectively, rated below investment grade.
As of December 31, 2003 and December 31, 2002, 13.3% and 8.2%, respectively, of our investment and cash portfolio, was in common stocks (unaffiliated and affiliated). Marketable equity securities, which represented approximately 12.2% and 7.2% on December 31, 2003 and 2002, respectively, of our investment and cash portfolio, are exposed to equity price risk, defined as the potential for loss in market value owing to a
decline in equity prices. A 10% decline in the price of each of these marketable equity securities would result in a decline of $51.5 million and $22.2 million as of December 31, 2003 and 2002, respectively in the fair value of the total investment portfolio.
Through investment in securities denominated in foreign currencies, we are exposed to foreign (non-U.S.) currency risk. Foreign currency exchange rate risk is the potential for loss in market value owing to a decline in the U.S. dollar value of these investments due to a decline in the exchange rate of the foreign currency in which these assets are denominated. As of December 31, 2003 and December 31, 2002, our total exposure to foreign denominated securities in U.S. dollar terms was approximately $816.4 million and $541.5 million, respectively, or 18.9% and 17.6%, respectively, of our investment portfolio, including cash and cash equivalents. The primary foreign currency exposure was in Canadian dollar denominated securities, which represented 5.4% and 7.6% as of December 31, 2003 and December 31, 2002, respectively, of our investment portfolio, including cash and cash equivalents. As of December 31, 2003, the potential impact of a 10% decline in each of the foreign exchange rates on the valuation of investment assets denominated in those respective foreign currencies would result in a total $81.6 million dollar decline in the fair value of the total investment portfolio.
Financial accounting standards and the related pronouncements that have been issued but are not yet effective will not have a material impact on our financial position, operations or cash flows.
For further detail on our long term debt principal and interest payments, see note 17 of our consolidated financial statements included in this Form 10-K.
Summary of Investments - Other than Investments in Related Parties as of
Supplementary Insurance Information as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001
Supplementary Information Concerning Property/ Casualty Insurance Operations as of December 31, 2003, 2002 and 2001 and years ended December 31, 2003, 2002 and 2001
Management is responsible for the preparation of the Company’s financial statements and the other financial information in this report. This responsibility includes maintaining the integrity and objectivity of financial records and the presentation of the Company’s financial statements in conformity with generally accepted accounting principles.
The Board of Directors, acting through its Audit Committee composed solely of directors who are not employees of the Company, is responsible for determining that management fulfills its responsibilities in the financial control of operations and the preparation of financial statements. The Audit Committee appoints the independent accountants. It meets regularly with management, internal auditors, and the independent accountants. The independent accountants and internal auditors have full and free access to the Audit Committee and meet with it to discuss their audit work, the Company’s internal controls, and financial reporting matters.
On June 19, 2001, the Company issued 17,142,857 shares of its common stock (26% of the total shares of common stock outstanding) in an initial public offering (the “offering”). In connection with the offering, all the outstanding shares of Odyssey America were acquired by the Company from subsidiaries of Fairfax, for aggregate consideration of $988.8 million, consisting of $233.6 million in cash, $200.0 million in a term note and 48 million shares of the Company’s common stock. This acquisition has been accounted for at historical cost in a manner similar to a pooling of interests. Accordingly, the consolidated financial statements of Odyssey America and its subsidiaries have become the Company’s historical financial information. The Company retained $51.3 million of the net proceeds from the offering. In connection with the offering, the Company granted restricted shares of its stock to various executives and employees, as further described in note 10.
For the years ended December 31, 2003, 2002 and 2001, the Company paid dividends of $6.9 million, $6.5 million and $1.6 million, respectively.
(a) All of the Company’s fixed income securities, which include bonds, notes and redeemable preferred stocks, and equity securities, which include common stocks, are categorized as “available for sale”, and are recorded at their fair value based on quoted market prices. Unrealized appreciation or depreciation of the Company’s fixed income and equity securities, net of applicable deferred income taxes, is included in accumulated other comprehensive income. Unrealized losses that are deemed other than temporary are charged to operations. Short-term investments are carried at cost, which approximates fair value.
(d) A purchase price in excess of net assets (“goodwill”), arising from a business combination, is tested for impairment at least annually. Goodwill is not subject to amortization. Unamortized deferred credits related to net assets acquired in excess of purchase price (“negative goodwill”) arising from a prior business combination is written-off as an extraordinary item (see note 3).
Deferred federal income taxes are provided for temporary differences between the financial statement and tax bases of assets and liabilities. Such differences relate principally to deferred acquisition costs, unearned premiums and unpaid losses and loss adjustment expenses.
(h) The Company has identified its operating segments to reflect the way that management monitors and evaluates the Company’s financial performance. The Company operates in four segments: Americas, EuroAsia, London Market, and U.S. Insurance. The presentation of segments for the years ended December 31, 2003, 2002 and 2001 is reflected in note 18.
(i) The Company translates the financial statements of its foreign subsidiaries to United States dollars by translating balance sheet accounts at the balance sheet date exchange rate and income statement accounts at the average exchange rate for the year. Translation gains or losses are recorded, net of deferred income taxes, as a component of comprehensive income. Foreign currency transaction gains or losses are reflected in the statement of operations in the period they are realized.
(j) Basic earnings per share are calculated by dividing net income (loss) by the weighted average number of common shares outstanding, excluding those non-vested shares granted under the OdysseyRe Restricted Share Plan. Diluted earnings per share are calculated by dividing net income (loss) by the weighted average number of common shares outstanding, inclusive of those vested and non-vested shares granted under the OdysseyRe Restricted Share Plan and stock options that would be assumed to be exercised on the balance sheet date. Such restricted shares and stock options are not included in the calculation of diluted earnings per share, if the effect would be anti-dilutive.
(k) In April 2002, the Company’s stockholders approved the Odyssey Re Holdings Corp. 2002 Stock Incentive Plan (the “2002 Plan”). During 2002, the Company accounted for stock-based compensation based on the intrinsic-value method prescribed in Accounting Principles Board Opinion (“APB”) 25, “Accounting for Stock Issued to Employees” and related Interpretations, as permitted under Statement of Financial Accounting Standards (“SFAS”) 123, “Accounting for Stock-Based Compensation.” The Company disclosed the pro forma impact on net income had all stock compensation cost been charged to earnings in accordance with the fair value based method prescribed in SFAS 123.
The gross unrealized appreciation of $119.5 million and the gross unrealized depreciation of $55.7 million results principally from the current interest rate environment.
The composition of the fixed income securities, redeemable preferred stock, unaffiliated common stocks and short-term investments, which are carried at fair value, as of December 31, 2002, follows (in thousands):
The fair value of fixed income securities, redeemable preferred stock and equity securities are based on the quoted market prices of the investments as of the close of business on December 31 of the respective years.
The amortized cost and fair value (both in thousands) of fixed income securities as of December 31, 2003, by contractual maturity, are shown below. Actual maturities may differ from the contractual maturities shown below due to the existence of call features or put features. In the case of securities containing call features, the actual maturity will be the same as the contractual maturity used below if the issuer elects not to exercise its call feature. Total securities subject to call represent approximately 3% of the total fair value. In the case of securities containing put features, the actual maturity will be the same as the contractual maturity used below if the investor elects not to exercise its put feature. Total securities containing the put feature represent approximately 5% of the total fair value.
Included in gross losses for the years ended December 31, 2003 and 2002 are $58.8 million and $13.0 million, respectively, related to realized losses on the other than temporary write-down of certain fixed income and equity securities.
Changes in unrealized net appreciation (depreciation) of investments, and the related tax effect, reflected in stockholders’ equity for the years ended December 31, 2003, 2002 and 2001 follows (in thousands):
The Company frequently reviews its investment portfolio for declines in value, and focuses its attention on securities whose market value is less than 80% of their amortized cost at the time of review. Generally a change in the market or interest rate environment does not constitute an impairment of an investment but rather a temporary decline. Temporary declines in investments will be recorded as an unrealized loss in accumulated other comprehensive income. If the Company determines that the decline is “other than temporary,” the carrying value of the investment will be written down to the fair value and a realized loss will be recorded in the Company’s consolidated statements of operations. The Company’s assessments are based on current evaluations of the financial position and future projections of the entity that issued the investment security. Prior assessments can change depending on current pertinent information.
In determining possible impairment of debt securities the Company reviews market and industry shifts, debt payment schedules that report how current and timely the issuer is with interest and principal payments, the issuers current financial position, and relevant analysis by rating agencies, investment advisors and analysts. In determining possible impairment of equity securities, the Company reviews market and industry shifts, historical price earnings ratio, recent financial statements, independent auditor’s report on the issuer’s financial statements and any significant recommendations by investment advisors or rating agencies. Additional relevant information is also considered in determining the valuation of an investment.
The following table reflects the Company’s investment’s fair value and gross unrealized depreciation, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2003 (in thousands):
The Company has purchased credit default swaps, which provide a hedge against adverse movements in fair value of investments and other corporate assets as a result of credit default risk associated with Federal Home Loan Mortgage Corporation, Federal National Mortgage Corporation and other related U.S. housing finance businesses. Under a credit default swap, the Company agrees with other parties to pay at specified periods fixed or floating rate interest amounts calculated by reference to an agreed notional principal amount in exchange for the credit default risk of a specified asset. Credit default swaps are marked to market at each statement date, with the related changes in market value recognized in net investment income. On disposition, any gain or loss is recognized in income. As of December 31, 2003, the fair value of the credit default swaps was $2.2 million.
The Company utilizes retrocessional agreements principally to increase aggregate premium capacity, to reduce and spread the risk of loss on insurance and reinsurance underwritten and to limit its exposure with respect to multiple claims arising from a single occurrence. There is a contingent liability with respect to reinsurance which would become an ultimate liability of the Company in the event that such reinsuring companies are unable, at some later date, to meet their obligations under the reinsurance agreements inforce. Reinsurance recoverables are recorded as assets, based on the Company’s evaluation of the retrocessionaires’ ability to meet their obligations under the retrocession agreement. Premiums written and earned are stated net of reinsurance ceded in the consolidated statements of operations. Direct, assumed, ceded and net amounts (in thousands and inclusive of amounts in note 6) for these items follows:
The Company markets its reinsurance products worldwide primarily through reinsurance brokers as well as directly to its customers. The Company’s five largest reinsurance brokerage firms accounted for an aggregate of approximately 60% of reinsurance gross premiums written for the year ended December 31, 2003. Loss of all or a substantial portion of the business provided by these brokers could have a material adverse effect on us.
In addition to the amounts in the table above, the Company has a receivable from nSpire of $17.0 million and $28.5 million as of December 31, 2003 and 2002, respectively, which represents transactions for certain reinsurance agreements.
The components of comprehensive income (loss) for the years ending December 31, 2003, 2002 and 2001 are shown in the following table (in thousands):
The following tables set forth the Plan’s funded status and amounts recognized in the Company’s consolidated financial statements as of December 31, 2003 and 2002.
The investment policy for the defined benefit plan seeks to invest in highly rated, lower risk, securities which preserve the investment asset value of the Plan while seeking to maximize the return on those invested assets. The Plan assets as of December 31, 2003 and 2002, are invested in highly rated fixed income securities. Although the liabilities of the Plan exceed the assets by $7.9 million, the Company believes the Plan is financially sound. The long term rate of return assumption is selected based on the fixed income securities portfolio. The actual return on assets has historically been close to our assumptions of expected returns, however, this year’s returns were lower. During 2003, the Company contributed $2.2 million to the Plan. Based on the Company’s current expectations, the 2004 contribution should approximate this amount.
The Company established a trust fund, included in other invested assets, which has assets of $5.9 million and $5.9 million as of December 31, 2003 and 2002, respectively, related to the non-qualified plans. Plan benefits are paid by the Company as they are incurred by the participants, accordingly, there are no assets held directly by the non-qualified excess benefit plans.
The Company also maintains a deferred compensation plan pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute up to 10% of annual compensation on a pre-tax basis. The Company contributes an amount equal to two-thirds of each employee’s pre-tax contribution up to the first 6% of pay. The maximum matching contribution is 4% of pay with certain government mandated restrictions on contributions to highly compensated employees. The Company contributed $1.1 million, $1.5 million and $0.8 million to this plan in 2003, 2002 and 2001, respectively.
The Company provides certain health care and life insurance (“postretirement”) benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company. The Company’s cost for providing postretirement benefits other than pensions is accounted for in accordance with SFAS 106 “Employers’ Accounting for Postretirement Benefits Other Than Pensions”. The following tables set forth the amounts recognized in the Company’s consolidated financial statements as of December 31, 2003 and 2002 (in thousands):
The accumulated benefit obligation for the postretirement benefit plan was $8,304 and $5,485, as of December 31, 2003 and 2002, respectively.
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is assumed to be 9% in 2002 and decreasing to 5% in 2010 and remaining constant thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point would increase the accumulated postretirement benefit obligation by $1.5 million and the service and interest cost components of net periodic postretirement benefit costs by $0.2 million for 2003. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation and the service and interest cost components of net periodic postretirement benefit cost for 2003 by $1.3 million and $0.2 million, respectively. The Company has elected to postpone and defer the recognition of the Medicare reform legislation until 2004.
During 2001, the Company adopted the Odyssey Re Holdings Corp. Restricted Share Plan which provides for the grant of restricted shares to directors and key employees of the Company. Shares granted under this plan generally vest in two equal installments beginning on the fifth and tenth anniversary of the date of grant. As of December 31, 2003 and 2002, respectively, 439,474 and 552,885 shares of restricted stock were granted. At the time of grant, the market value of the shares awarded under this plan is recorded as unearned compensation and is presented as a separate component of stockholders’ equity. The unearned compensation is charged to operations over the vesting period. In respect to the above grants, the amount of compensation expense incurred for each of the years ended December 31, 2003 and 2002 was approximately $1.1 million.
Certain employees of the Company have been granted shares of restricted common stock under the Fairfax Financial Holdings Ltd. Restricted Share Plan. The Fairfax restricted stock, which was granted from 1996 to 2000, vests over a three to ten year period. The Company has reflected $0.3 million of expense for each of the years ended December 31, 2003 and 2002, which represents the vested portion of the restricted stock. The Company no longer participates in this plan.
Pre-tax operating income, before cumulative effect of a change in accounting principle, from domestic companies, was $286.1 million, $252.9 million and $25.0 million for the years ended December 31, 2003, 2002 and 2001, respectively. Pre-tax operating income (loss) from foreign operations was $92.2 million, $5.2 million and ($40.6) million for the years ended December 31, 2003, 2002 and 2001, respectively.
During 2002, the Company reduced its current tax expense through the utilization of the net operating loss carryforward. During 2001, the Company has reflected a current tax expense related to taxable income for the period prior to the offering.
The components of the federal and foreign income tax provision (benefit) follow (in thousands):
Deferred federal and foreign income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Components of federal and foreign income tax assets and liabilities follow (in thousands):
The amounts above are reduced by an aggregate minimum rental recovery of $0.6 million resulting from the sublease of space to other companies.
Rental expense, before sublease income, under these operating leases were $8.4 million, $7.8 million and $7.8 million in 2003, 2002 and 2001, respectively. The Company recovered $0.7 million, $1.9 million and $2.8 million in 2003, 2002 and 2001, respectively, from subleases.
Clearwater has agreed to allow Ranger Insurance Company (“Ranger”), a subsidiary of Fairfax, to attach an assumption of liability endorsement to its policies where required. The agreement applies to endorsements issued from July 1, 1999 to March 31, 2004. The agreement may also terminate earlier upon Ranger receiving an A.M. Best rating of A- or better, Ranger ceasing to be under the control of Fairfax, or either party giving the other party 30 days notice. Following termination of the agreement, Clearwater will remain liable for any losses occurring prior to the effective date of the termination, pursuant to the terms of the endorsements. While Clearwater’s potential exposure in connection with these endorsements is not reasonably quantifiable at this time, we deem it to be immaterial, as Fairfax has agreed to indemnify Clearwater for any obligation under this agreement. The Company anticipates that Ranger will meet all of its obligations in the normal course of business, and Clearwater does not anticipate making any payments under this guarantee that would require Clearwater to utilize the indemnification from Fairfax. Clearwater has decided to terminate the agreement effective March 31, 2004.
Through UK Holdings, Odyssey America became a limited liability participant in the Lloyd’s market in 1997. In order to continue underwriting at Lloyd’s, Odyssey America has established a clean irrevocable letter of credit and a deposit trust account in favor of the Society and Council of Lloyd’s. As of December 31, 2003, Odyssey America had pledged U.S. treasuries in the amount of $120.7 million in support of a letter of credit
Odyssey America agreed, as of April 1, 2002, to guarantee the prompt payment of all of the insurance contract obligations (the “Subject Contracts”), whether incurred before or after the agreement, of Falcon Insurance Company (Hong Kong) Limited (“Falcon”), an affiliate, in the event Falcon becomes insolvent. While Odyssey America’s potential exposure in connection with this agreement is not reasonably quantifiable at this time, we deem it to be immaterial, as Fairfax has agreed to indemnify Odyssey America for any obligation under this agreement. Falcon has agreed to pay Odyssey America one percent of all gross earned premium associated with the subject business on a quarterly basis. During 2003, Falcon has paid $0.5 million to Odyssey America related to this agreement. Odyssey America anticipates that Falcon will meet all of its obligations in the normal course of business and does not anticipate making any payments under this guarantee that will require Odyssey America to utilize the indemnification from Fairfax.
In December 2002 Odyssey America and a retrocessionaire each demanded arbitration to resolve a dispute arising from an excess of loss retrocessional contract, effective January 1, 1998, pursuant to which the retrocessionaire reinsured Odyssey America for 50% of certain accident and health exposures assumed by Odyssey America from a third-party insurer. The dispute arose in October 2002 when the retrocessionaire asserted that the third-party insurer violated the reinsurance agreement with Odyssey America such that no further payments under the agreement should be made.
In August 2003, Odyssey America and the retrocessionaire executed an Assignment of Rights, Limited Indemnification and Cooperation Agreement, (the “Agreement”), pursuant to which the parties agreed to withdraw their respective demands for arbitration with prejudice. The Agreement enables the retrocessionaire, with the cooperation of Odyssey America, to assert its defenses directly against the insurer, and indemnifies Odyssey America for expenses it incurs resulting from Odyssey America’s cooperation or the retrocessionaire’s assertion of its defenses. Subsequently, Odyssey America entered into a substantially identical agreement (also, an “Agreement”) with the retrocessionaire that reinsured the remaining 50% of the business it had assumed. Odyssey America believes the Agreements make remote the likelihood that Odyssey America will incur any material liability in connection with the reinsurance agreement or retrocession contract.
As of December 31, 2003 and 2002, $7.3 million of funds held under reinsurance contracts related to cash collateral has been provided in regard to the above mentioned indemnification agreements. The Company has also provided a $20.5 million LOC to Clearwater and a $0.5 million LOC to Hudson as of December 31, 2003, of which approximately $20.1 million has been used as collateral in regard to the indemnification agreements. The indemnification agreements do not affect the reinsurance recoverable balances as reported in the accompanying consolidated financial statements.
Activity in the liability for unpaid losses and loss adjustment expenses for the years ended December 31, 2003, 2002 and 2001 are as follows (in thousands):
The Company’s reserves for asbestos and environmental related liabilities displayed below is from business written for accident years 1985 and prior. There is minimal exposure and no specific reported reserves in the more recent accident years. The Company’s asbestos and environmental reserve development, gross and net of reinsurance, for the years ended December 31, 2003, 2002 and 2001 is set forth in the table below (in thousands):
Our survival ratio for environmental and asbestos related liabilities as of December 31, 2003 is eleven years, reflecting full utilization of remaining indemnifications. Our underlying survival ratio for environmental related liabilities is five years and for asbestos related liabilities is fourteen years. The survival ratio represents the environmental impairment and asbestos related illness reserves, net of reinsurance, on December 31, 2003, plus indemnifications, divided by the average paid environmental and asbestos claims, net of reinsurance, for the last three years. Our survival ratio is nine years for environmental and asbestos related liabilities as of December 31, 2003, prior to the reflection of indemnifications. Our survival ratio compares favorably with the United States Property and Casualty Industry average survival ratio of nine years as published by A.M. Best in its special report on Asbestos and Environmental claims dated October 6, 2003.
During the fourth quarter of 2003, OdysseyRe issued $225.0 million aggregate principal amount of senior notes due November 1, 2013. The issue was sold at a discount of $0.4 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 7.65%, which is due semi-annually on May 1st and November 1st. The senior notes are redeemable at a premium, prior to maturity, at the discretion of OdysseyRe. The Company used the net proceeds from this offering to prepay $50.0 million aggregate principal amount of the 7.49% senior notes and to contribute $165.0 million of additional capital to Odyssey America. The remainder will be used for general corporate purposes.
In June 2002, OdysseyRe issued $110.0 million aggregate principal amount of 4.375% convertible senior debentures (“Convertible Debt”) due 2022. The Convertible Debt is redeemable at the Company’s option beginning on June 22, 2005. Each holder of Convertible Debt may, at its option, require OdysseyRe to
repurchase all or a portion of its Convertible Debt on June 22, 2005, 2007, 2009, 2012 and 2017. Under certain circumstances, each Convertible Debt holder can convert its Convertible Debt, into 46.9925 shares of OdysseyRe common stock for every $1,000 principal amount of the Convertible Debt, however, as of December 31, 2003, in accordance with the terms of the indenture under which the Convertible Debt was issued, the Convertible Debt was not convertible. The Convertible Debt is reflected on OdysseyRe’s balance sheet at a value of $110.0 million, the aggregate principal amount of Convertible Debt outstanding.
In December 2001, OdysseyRe issued $100.0 million aggregate principal amount of senior notes, pursuant to a private placement, due November 30, 2006. Interest accrues on the senior notes at a fixed interest rate of 7.49%, which is due semi-annually on May 31st and November 30th. The senior notes are redeemable at a premium, prior to maturity, at OdysseyRe’s option. In November 2003 and June 2002, OdysseyRe prepaid $50.0 million and $10.0 million, respectively, aggregate principal amount of senior notes. Immediately following the issuance of the senior notes, OdysseyRe entered into an interest rate swap agreement, with Bank of America N.A., that effectively converted the fixed 7.49% interest rate into a variable interest rate of London Interbank Offered Rate (“LIBOR”) plus 263 basis points. In May 2003, the Company sold the variable interest rate instrument for a gain of $6.4 million. The gain has been capitalized and is being amortized over the remaining life of the senior notes. In conjunction with the early extinguishment of $50.0 million of senior notes, $3.0 million of the capitalized gain was immediately realized. As of December 31, 2003, the aggregate principal amount of 7.49% senior notes outstanding was $40.0 million and the remaining capitalized gain is $2.3 million.
The Company’s operations are managed through four distinct divisions, Americas, EuroAsia, London Market and U.S. Insurance which are established principally based on geographic regions. The Americas division is comprised of the Company’s United States reinsurance operations and its Canadian and Latin America branch offices. The United States operations write treaty property, general casualty, specialty casualty, surety, and facultative casualty reinsurance business primarily through professional reinsurance brokers. Treaty business is written through its Canadian branch, while the Latin America branches write both treaty and facultative business. Effective January 1, 2003, insurance business underwritten by Hudson, which was previously included with the Americas division, and the 2003 new and renewal medical malpractice and hospital professional liability business (“Healthcare”), have been combined into a new division, the U.S. Insurance division. For comparative purposes, the segment information presented below for the years ended December 31, 2002 and 2001 has been restated to reflect the Hudson business in the U.S. Insurance division. The EuroAsia division is comprised of offices in Paris, Stockholm, Singapore and Tokyo. The EuroAsia division writes primarily treaty and facultative property business. The Company’s London Market
A summary of selected quarterly financial information follows (in thousands, except per share amounts):
Due to changes in the number of weighted average common shares outstanding during 2002, quarterly earnings per share amounts do not add to the total for the year.
OdysseyRe’s investment in Odyssey America is reflected on the equity method.