We currently lease, for a 6 month term expiring on July 1, 1999, a 740 square foot office space in George Town, Grand Cayman, Cayman Islands, British West Indies, where our principal offices are currently located. The rent for the six month term is $10,824. Effective May 1, 1999, we will lease approximately 3,600 square feet of office space in George Town, Grand Cayman where our executive and principal offices will be located. The base term of the lease is seven years. The annual rent will be $97,956 for the first three years and $102,854, $108,006, $113,412, and $119,108, for years four through seven, respectively. We also lease approximately 1,000 square feet of office space in George Town pursuant to a lease with Queensgate Bank and Trust Company Limited. This lease has a one year term which is automatically extended annually for an additional year unless either party gives written notice to the other at least 90 days prior to the end of the then current term. Our annual rent under this lease is $25,000, which is paid on a quarterly basis. We believe that these properties are adequate to meet our needs for the foreseeable future.
The following table summarizes our operating earnings for the period from May 12, 1998 to December 31,1998. Operating earnings, which excludes realized investment gains (losses) is a common measure used in the insurance industry.
Our business consists of three lines of business, variable life insurance, reinsurance and insurance administration. Our 1998 results only reflect one of these lines of business, our insurance administration business. The insurance administration business consists of a variety of insurance administration, accounting and other services on an annuity block of business originally written by Scottish Annuity.
We are currently reviewing a number of variable life and reinsurance transactions and expect to finalize some of them during the first half of 1999. Our variable life insurance product is targeted at high net worth individuals with liquidity in excess of $10 million. Our variable life insurance product offers an unusual feature, independent investment management, which we believe will differentiate us in the market. Our reinsurance focus is on the annuity business although we will consider life reinsurance.
On September 18, 1998, we executed a binder with a U.S. reinsurer to provide reinsurance, on a retrocession basis, for approximately 35,000 in force universal life insurance policies. We proposed a transaction structured on a monthly renewable term basis, whereby we would reinsure only the mortality risk on the policies. During the fourth quarter of 1998, we delayed closing on the transaction because of concerns about the mortality experience that arose as we completed our due diligence review prior to closing. We and the original reinsurer are presently engaged in negotiations with respect to the binder.
We completed our initial public offering of 16,750,000 Ordinary Shares on November 30,1998 for net proceeds after offering expenses and commissions paid to underwriters of $231,575,004. Simultaneously with this offering we raised $20,000,000 from direct sales to strategic investors of 1,418,440 of Ordinary Shares and Class A Warrants for 400,000 Ordinary Shares. We also raised $402,000 from the sale of other Class A Warrants and B Warrants. Substantially all of the net proceeds were used to capitalize Scottish Insurance.
Many existing computer programs use only two digits to identify a year in the date field. These programs, if not corrected, could fail or create erroneous results by or at the year 2000. This "Year 2000" issue is believed to affect virtually all companies and organizations, including us. Because most of our computer hardware and software is less than three years old, we believe that our exposure with respect to our own computer systems to Year 2000-related problems is not significant. In addition, we recently upgraded our principal accounting software from a DOS-based version which was not Year 2000 compliant to a Windows NT version which is certified Year 2000 compliant by the software vendor.
We rely significantly on a number of third party service providers, such as Westport, IRM Cayman, Milliman & Robertson, PIMCO, General Re and Prudential Investment, each of whom confirmed to us, or is in the process of confirming, is Year 2000 compliant. We also intend to require that any new investment managers or other third party service providers be or become Year 2000 compliant in a timely manner. There can be no assurance, however, that our operations will not experience disruptions due to the failure of third parties, including reinsurance counter parties, to become fully Year 2000 compliant in a timely manner or that a failure will not otherwise have an adverse effect on our business, results of operations or financial condition. In the event our plans with respect to Year 2000 readiness fail to protect our operations from disruptions or its business, results of operations or financial condition from adverse effect, we have no contingency plan other than the replacement of existing third party service providers which are not Year 2000 compliant with comparable third party service providers who are Year 2000 compliant. We may also have an exposure to Year 2000 issues from reinsurance business we write in the future. Since we have not written any reinsurance business we do not know what these exposures are or whether they will be material.
The Financial Accounting Standards Board's Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," was issued in June 1998 and requires adoption no later than fiscal quarters or fiscal years beginning after June 15, 1999. The new standard establishes accounting and reporting standards for derivative instruments. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. We have not yet completed our evaluation of the effect this standard will have on us.
Some of the statements contained in this report are not historical facts and are forward-looking within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results to differ materially from the forward-looking statements. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: our ability to execute the business plan; changes in the general economic conditions including the performance of the financial markets and interest rates; changes in insurance regulations or taxes; changes in rating agency policy; the loss of key executives; and Year 2000 issues. We assume no obligation to update any forward-looking statement to reflect actual results or changes in or additions to the factors affecting such forward-looking statements.
We will not be successful in our variable life insurance business if we cannot get clients from referrals by financial advisors, investment managers, private bankers, attorneys and other intermediaries in the United States. Since we are not licensed or registered to do business in the U.S., these referral sources cannot represent us and cannot be compensated by us for any activities in the U.S. As a result, we cannot assure you that we will be able to effectively implement our insurance and reinsurance plans.
We can, however, pay non-U.S. referral sources for activities undertaken outside the U.S. We expect to compensate referral sources based on a percentage of the revenue received from referrals. Subject to any regulatory limitations, we may provide referrals to persons or entities that provide referrals to us. We cannot assure you that we will receive a significant amount of referrals or, if so, that any referrals will result in actual sales of variable life insurance policies.
Our Ability to Develop Our Reinsurance Business is Dependent Upon Building Relationships.
these contracts or that want to lessen the reserve and capital requirements associated with these contracts. Since this market is largely unaddressed by other reinsurers, we consider it an attractive niche opportunity. Since this target business represents an unexploited market, however, we cannot be certain that it will meet our expectations.
In addition, certain past proposals would have eliminated transfers to trusts from the annual present interest exclusion from the gift tax. The enactment of these proposals into law would eliminate the primary and most tax- efficient method of making premium payments by insurance trusts. Because we expect that insurance trusts will purchase our variable life insurance (or our variable life insurance will be contributed to insurance trusts) to provide liquidity for estate taxes and to effect the tax-free transfer of the proceeds from one generation to another, adoption of these tax proposals would adversely affect sales of these policies and, as a consequence, would adversely affect our business, results of operations and financial condition. In addition, recent tax changes have adversely affected corporate owned life insurance products. Any
We are licensed as an unrestricted Class B insurer and are subject to regulation and supervision by the Cayman Islands Monetary Authority. We are not registered or licensed to do business in any jurisdiction in the United States or any other country. Generally, the sale of insurance within a jurisdiction where the insurer is not admitted to do business is prohibited. Under our operating guidelines, we do not operate in the United States or, to the extent prohibited, in any other country. We can give no assurance that inquiries or challenges to our insurance activities will not be raised in the future. Our variable life insurance products have customized features that are not typically available from a company subject to those laws. If we were to become subject to those laws, our business, results of operations and financial condition would likely be materially adversely affected.
Variable Life Insurance--Mortality Risk. The principal risk associated with our planned variable life insurance policies is mortality risk. Mortality risk typically is more stable when spread across large numbers of insureds. We expect to place our policies with a relatively small number of high net worth policyholders and to provide substantial death benefits with expected initial premiums of at least $1.0 million for single premium policies and $500,000 for multiple premium policies. As a result, our mortality risk exposure is likely to be larger, and our probability of loss is less predictable, than an insurer with a larger risk pool. As a result, we cannot assure you that our planned policy reserves will be adequate, that we will properly match our assets to meet anticipated liabilities, that we will not need to liquidate our assets at a substantial loss to meet our liabilities or that, to the extent we seek to reinsure mortality risk, this
Fixed Annuity Reinsurance--Investment Risk. The principal risk associated with our planned fixed annuity reinsurance activities is investment risk. Specifically, we will be subject to the following risks:
. the risk that interest rates will decline and funds reinvested will earn less than expected; and
Other Reinsurance Businesses--Mortality, Investment and Surrender Risk. We may also reinsure various forms of life insurance products, including universal life insurance, variable life insurance and traditional whole life insurance. The primary risk under life insurance policies is mortality risk. Our underwriting guidelines limit this risk to $500,000 per insured and we intend to reinsure, or retrocede, any liability for amounts in excess of $500,000 per insured to comply with these guidelines.
Reinsurance Business--Ceding Insurer Risk. An additional risk associated with our planned reinsurance business is the risk that the ceding insurer will be unable to pay to us amounts due because of its own financial difficulties. We can give no assurance that the ceding insurers will be able to pay amounts due to us, which could have a material adverse effect on our business, results of operations or financial condition. In addition, we can give no assurance that the ceding companies will maintain appropriate interest crediting rates with respect to fixed annuities or interest rate-sensitive life insurance policies.
We cannot assure you we will be able to effectively manage these risks. If we are unable to effectively manage these risks, our ability to support our planned variable life insurance and reinsurance businesses, and our results of operations and financial condition, will be adversely affected.
Our ability to match our anticipated reinsurance liabilities has not been tested. Therefore, we can not assure you that we will successfully structure our investments so as to match our anticipated reinsurance liabilities. If our calculations are incorrect, or if we improperly structure our investments to match these liabilities, we could be forced to sell investments before they mature at a significant loss with the result that our assets may not be adequate to meet our needed reserves, which could adversely affect our business, results of operations and financial condition.
As a Cayman Islands company, we plan to operate in a manner so that we are not subject to United States tax, other than withholding tax on certain investment income from United States sources. However, the Internal Revenue Service could contend that we are conducting business in the United States. If the Internal Revenue Service were to prevail in that contention, we would be subject to United States tax at regular corporate rates on taxable income that is effectively connected with United States business plus an additional 30% "branch profits" tax on the income remaining after the regular tax, which could adversely affect our results of operation.
Insurance and reinsurance premiums that will be paid to us will be subject to a U.S. excise tax for risks located in the United States. In addition, our investment income from United States sources could be subject to withholding tax. These taxes could be increased and other taxes could be imposed on our business, which could also adversely affect our results of operation.
Controlled Foreign Corporation Rules. Each "United States shareholder" of a "controlled foreign corporation" who owns shares in the controlled foreign corporation on the last day of its taxable year generally must include in his gross income for United States federal income tax purposes his pro-rata share of the controlled foreign corporation's "subpart F income," even if the subpart F income has not been distributed. For these purposes, any United States person who owns directly or indirectly 10% or more of our ordinary shares will be considered to be a "United States shareholder." In general, a foreign insurance company such as our subsidiary, Scottish Annuity & Life Insurance, is treated as a controlled foreign corporation only if such "United States shareholders" collectively own more than 25% of the total combined voting power or total value of our stock for an uninterrupted period of 30 days or more during any year. We believe that, because of the anticipated dispersion of our share ownership among holders and because of the restrictions in our Articles of Association on transfer, issuance or repurchase of our ordinary shares, our shareholders will not be subject to treatment as "United States shareholders" of a controlled foreign corporation. In addition, because under the Articles of Association no single shareholder will be permitted to exercise 10% or more of our total combined voting power, our shareholders should not be viewed as "United States shareholders' of a controlled foreign corporation for purposes of these rules. There can be no assurance, however, that these rules will not apply to our shareholders.
Related Person Insurance Income Risks. If our related person insurance income, determined on a gross basis, were to equal or exceed 20% of our gross insurance income in any taxable year, and direct or indirect insureds and persons related to such insureds were directly or indirectly to own more than 20% of the voting power or value of our capital stock, a United States person who directly or indirectly owns our Ordinary Shares on the last day of the taxable year may be required to include in his income for United States federal income tax purposes the shareholder's pro-rata share of our related person insurance income for the taxable year, determined as if this income were distributed proportionately to the United States person at that date. Related person insurance income is generally underwriting premium and related investment income attributable to insurance or reinsurance policies where the direct or indirect insureds are United States shareholders or are related to United States shareholders of the insurance company issuing the policies.
If we have related person insurance income, and all United States persons own 25% or more of the voting power or value of our shares, any shareholder who is a United States person who owns 10% or more of our shares and disposes of the shares would have any gain from the disposition generally treated as ordinary income to the extent of the shareholder's portion of our undistributed earnings and profits that were accumulated during the period that the shareholder owned the shares. The shareholder also will be required to follow certain reporting requirements, regardless of the amount of shares owned by the shareholder. These rules should not apply to sales of our shares because we, as Scottish Holdings, are not directly engaged in the insurance business and because proposed United States Treasury regulations applicable to this situation appear to apply only in the case of shares of corporations that are directly engaged in the insurance business. We can give no assurances however, that the IRS will interpret the proposed regulations in this manner or that the proposed regulations will not be promulgated in final form in a manner that would cause these rules to apply to dispositions of Ordinary Shares.
We are a holding company engaged in the variable life insurance and reinsurance business through our wholly owned subsidiary, Scottish Insurance. Our principal source of income is
Except as described below with respect to the purchase and sale of our shares on the Nasdaq National Market, our Articles of Association require our directors to decline to register any transfer of our shares if they believe that the transfer would result in a person (or any group of which such person is a member) beneficially owning, directly or indirectly, 10% or more of our outstanding shares. Similar restrictions apply to our issuance and repurchase of shares. The directors also may, in their absolute discretion, decline to register the transfer of any shares if they believe that the transfer may expose us, any subsidiary or shareholder or any person insured or reinsured or proposing to be insured or reinsured by us to adverse tax or regulatory treatment or if they believe that registration of the transfer under any federal or state securities law or under the laws of any other jurisdiction is required and the registration has not been done. A transferor of Ordinary Shares will be deemed to own the shares for dividend, voting and reporting purposes until a transfer of the shares has been registered on our Register of Members. We are authorized to request information from any holder or potential acquirer of our shares as necessary and may decline to register any transaction if we do not receive complete and accurate information.
In addition, the Articles of Association generally provide that any person (or any group) holding 10% or more of the total voting rights of all of our outstanding capital shares, will have the voting rights of to its voting shares reduced so that the person (or group) may not exercise more than approximately 9.9% of the total voting rights. Because of the attribution provisions of the U.S. tax code and the rules of the Securities and Exchange Commission regarding determination of beneficial ownership, this requirement may have the effect of reducing the voting rights of a shareholder whether or not the shareholder directly holds of record 10% or more of the voting shares. The directors also have the authority to request from any shareholder certain information for the purpose of determining whether such shareholder's voting rights are to be reduced. If the shareholder fails to respond to the notice, or submits incomplete or inaccurate information, the directors (or their designee) have the discretion to disregard all votes attached to the shareholder's Ordinary Shares.
Our Articles of Association contain provisions that make it more difficult to acquire control of us by means of a tender offer, open market purchase, a proxy fight or otherwise, including by reason of the limitation on transfers of Ordinary Shares and voting rights described above. While these provisions are designed to encourage persons seeking to acquire control to negotiate with our Board of Directors, they could have the effect of discouraging a potential purchaser from making a tender offer or otherwise attempting to obtain control. Cayman Islands law restricts disclosure of, among other things, shareholder lists. Accordingly, such laws may make the acquisition of control by means of a tender offer or proxy fight more difficult.