Everest Re’s corporate offices are located in approximately 129,700 square feet of leased office space in Liberty Corner, New Jersey. The Company’s other twelve locations occupy a total of approximately 70,800 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs.
The worldwide reinsurance and insurance businesses are highly competitive yet cyclical by product and market. Competition in the types of reinsurance and insurance business that the Company underwrites is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best and/or Standard & Poor’s, underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written. These factors operate at the individual market participant level to varying degrees, as applicable to the specific participant’s circumstances. They also operate in aggregate across the reinsurance industry more generally, contributing, in combination with background economic conditions and variations in the reinsurance buying practices of insurance companies (by participant and in the aggregate), to cyclical movements in reinsurance rates, terms and conditions and ultimately reinsurance industry aggregate financial results.
The Company competes in the U.S. and international reinsurance and insurance markets with numerous global competitors. The Company’s competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies and domestic and international underwriting operations, including underwriting syndicates at Lloyd’s. Some of these competitors have greater financial resources than the Company and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. In addition, the lack of strong barriers to entry into the reinsurance business and the potential for securitization of reinsurance and insurance risks through capital markets provides additional sources of potential reinsurance and insurance capacity and competition.
For the insurance industry, 2005 was a year of unprecedented catastrophe losses in terms of both frequency and severity, which negatively impacted the financial results of a broad number of (re)insurance market participants. The Company believes that the scope and scale of industry losses have helped to stabilize the weakening that was taking place in many sectors and will lead to generally improving market conditions during 2006 that are likely to vary by product and market. For the property catastrophe and retrocession lines, the Company expects that demand and pricing will increase the most as companies reassess their risk management approach and rating agencies raise the required capital levels for many industry participants. The Company believes that price increases for these two lines will be most pronounced in peak catastrophe zones, such as the southeastern U.S. For remaining property lines, there will likely be modest rate increases, while the casualty markets have generally steadied and are expected to stabilize at adequate pricing levels in 2006 for both insurance and reinsurance.
magnitude and character of catastrophe exposures, the level of required capital to support the Company’s businesses from both the Company’s and rating agencies’ perspectives and the actual and potential volatility and variability of results, by product, business class and business unit, including with respect to the reliability of underlying statistical and modeling techniques.
experience, the Company continues to re-examine and adjust its comprehensive framework of risk assessment, accumulation monitoring and risk mitigation seeking balance between risk versus reward in the context of changing market conditions.
UK Branch Sale. Effective January 1, 2004, Everest Re sold its UK branch to Bermuda Re (“UK Branch Sale”) and in conjunction with the sale, Everest Re provided a reserve indemnity agreement for adverse development on loss and loss adjustment expenses (“LAE”) reserve balances as of December 31, 2002, as well as made sale related adjustments for the 2003 and 2002 quota share cessions. In order to provide comparability of the financial results between the years, the 2003 results were adjusted to exclude the UK branch activity. For the year ended December 31, 2003, gross written premiums, net written premiums, premiums earned, incurred losses and LAE, commission, brokerage, taxes and fees and other underwriting expense would decrease by $443.5 million, $325.9 million, $290.3 million, $202.7 million, $61.2 million and $7.1 million, respectively. Effectively, these adjustments remove the UK branch from the operating results for the year ended December 31, 2003.
The following table reflect the reconciliation from reported to proforma for the periods indicated:
Net realized capital gains were $64.6 million in 2005, driven by gains on the sale of the Company’s interest only strips of mortgage-backed securities (“interest only strips”) investment portfolio and other portfolio management activities in response to interest rate and credit market movements.
The Company generated an income tax benefit of $70.2 million in 2005, equating to an effective tax rate of 107.2% applied to its pre-tax loss of $65.5 million for the year. This elevated effective tax rate reflected the impact of the year’s catastrophe losses on U.S. operations, producing a significant tax loss.
The Company’s stockholders’ equity increased modestly by $0.1 billion to $1.8 billion at year-end 2005, primarily due to break-even earnings and the sale of treasury shares.
ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. For selected financial information regarding these segments, see Note 16 of Notes to Consolidated Financial Statements.
Effective January 1, 2004, Everest Re sold its United Kingdom branch to Bermuda Re, a Bermuda insurance company and direct subsidiary of Group. Business for this branch was previously included in the International segment and is now included as an element of the Bermuda segment of Group. Due to the sale and in accordance with Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“FAS 131”), the Company restated the International segment for the year ended December 31, 2003 to conform to December 31, 2005 and 2004 segment reporting. For the year ended December 31, 2003 the International segment was adjusted to exclude the UK branch activity. As a result of that adjustment, gross written premiums, net written premiums, premiums earned, incurred losses and LAE, commission, brokerage, taxes and fees and other underwriting expenses decreased by $443.5 million, $325.9 million, $290.3 million, $202.7 million, $61.2 million and $7.1 million, respectively. Effectively, these adjustments remove the UK branch from the 2003 International segment, making period over period results comparable.
Ceded premiums decreased to $944.2 million in 2005 from $1,027.7 million in 2004, principally resulting from the decrease in gross written premiums in the U.S. Insurance operation. Ceded premiums relate primarily to quota share reinsurance agreements between Everest Re and Bermuda Re and Everest International. Under these agreements Everest Re ceded to Bermuda Re 22.5% and to Everest International 2.5% of its net retained liability on all new and renewal policies written for underwriting years 2005 and 2004, Everest Re ceded to Bermuda Re 25% of its net retained liability on all new and renewal policies written for underwriting year 2003, Everest Re ceded to Bermuda Re 20% of its net retained liability on all new and renewal polices written for underwriting year 2002, and Everest Re’s Canadian branch ceded to Bermuda Re 50% of its net retained liability on all new and renewal property polices written for the 2005, 2004 and 2003 underwriting years.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by net premiums earned, increased by 15.0 percentage points to 90.8% in 2005 from 75.8% in 2004. This 15.0 point year over year loss ratio deterioration was primarily the result of a 25.6 point increase due to catastrophe losses, partially offset by a 13.7 point improvement in non-catastrophe prior year reserve development.
The following table shows the net catastrophe losses for each of the Company’s operating segments for years ended December 31, 2005 and 2004:
The following table shows net prior period reserve adjustments for each of the Company’s operating segments for the years ended December 31, 2005 and 2004.
net unfavorable A&E adjustments of $11.5 million. For the year ended December 31, 2004, the unfavorable prior period reserve adjustments included net unfavorable non-A&E, non-catastrophe adjustments of $198.5 million relating primarily to casualty reinsurance and net unfavorable A&E adjustments of $10.3 million. Partially offsetting the 2004 unfavorable development was $34.6 million of favorable catastrophe development principally related to the reduction of reserves for the 2001 World Trade Center losses and other catastrophe events. It is important to note that non-A&E accident year reserve development arises from the re-evaluation of accident year results and that such re-evaluations may also impact premiums and commissions attributed by accident year, generally mitigating, in part, the impact of loss development and that such impacts are recorded as part of the overall reserve evaluation process.
The U.S. Insurance segment reflected $19.4 million of net favorable prior period reserve adjustments for the year ended December 31, 2005 and $54.0 million of net unfavorable prior period reserve adjustments for the year ended December 31, 2004. The 2005 favorable prior period reserve adjustments related principally to California workers’ compensation for the 2004 accident year as the results of benefit reform have become clearer and the 2004 unfavorable prior period reserve adjustments related principally to the casualty classes related to accident years 2000 through 2002, where the Company strengthened its reserves for California workers’ compensation insurance. While management believes the cumulative results through 2005 remain quite positive, there was some deterioration in claim frequency and severity related to accident years 2001 and 2002.
The Specialty Underwriting segment had $25.4 million of net favorable prior period reserve adjustments for the year ended December 31, 2005 and $17.5 million of net unfavorable prior period reserve adjustments for the year ended December 31, 2004. In 2005, net favorable prior period reserve adjustments reflected $38.6 million of non-A&E, non-catastrophe favorable development on the marine, aviation, surety and A&H classes of business, partially offset by unfavorable catastrophe development of $13.2 million. In 2004, net unfavorable prior period reserve adjustments related to the surety and A&H classes of business, partially offset by favorable development in the marine and aviation business lines.
The International segment had $47.2 million of favorable net prior period reserve adjustments for the year ended December 31, 2005 and $0.7 million of net favorable prior period reserve adjustments for the year ended December 31, 2004. The favorable development in 2005 related primarily to favorable non-asbestos, non-catastrophe reserve development on the Canadian, Asian, and international business of $57.3 million, partially offset by unfavorable property catastrophe loss development of $10.1 million on the same business. The favorable development in 2004 related primarily to 2003 Canadian property catastrophe, international and Asian business.
Aggregate reserve development related to A&E exposures was $11.5 million and $10.3 million for the years ended December 31, 2005 and 2004, respectively. The Company has A&E exposure related to contracts written by the Company prior to 1986 and to claim obligations acquired as part of the Mt. McKinley acquisition in September 2000. The reserve strengthening on business written by the Company, net of reinsurance, was $11.5 million. Substantially all of the Company’s A&E exposures relate to insurance and reinsurance contracts with coverage periods prior to 1986. Given the uncertainties surrounding the settlement of A&E losses, management is unable to establish a meaningful range for these obligations.
The following table shows the expense ratios for each of the Company’s operating segments for 2005 and 2004.
Investment Results. Net investment income decreased 1.2% to $325.2 million in 2005 from $329.2 million in 2004, primarily reflecting lower returns from equity investments in limited partnerships. Investable assets increased by $0.4 billion to $7.9 billion in 2005, principally reflecting the effects of investing cash flow from operations during the year, partially offset by the repayment of $250 million of senior debt. Investment income for the limited partnerships for the years ended December 31, 2005 and 2004 was $7.5 million and $36.3 million, respectively.
Imbedded after-tax yield of cash and invested assets at December 31 .6%
The Company’s net realized capital gains were $64.6 million in 2005, which reflected realized capital gains on the Company’s investments of $75.9 million, including $25.3 million on the sale of interest only strips investments, partially offset by $11.3 million of realized capital losses, which included $4.1 million related to the write-downs in the value of interest only strips deemed to be impaired on an other than temporary basis in accordance with Emerging Issues Task Force Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITF 99-20”). Net realized capital gains were $56.7 million in 2004, which reflected realized capital gains on the Company’s investments of $107.4 million, including $77.6 million on the sale of interest only strips investments, partially offset by $50.7 million of realized capital losses, which included $43.9 million related to the write-downs in the value of interest only strips deemed to be impaired on an other than temporary basis in accordance with EITF 99-20.
Other Income (Expense). Other income in 2005 was $8.1 million compared to other expense of $73.4 million in 2004. The change in net other income for 2005 from net other expense in 2004 was primarily due to decreased deferrals on retroactive reinsurance agreements with affiliates.
Interest expense and fees in 2005 were $73.2 million compared to $75.5 million in 2004. Interest expense and fees in 2005 included $35.5 million relating to the senior notes, $37.4 million relating to the junior subordinated debt securities and $0.2 million relating to the credit line under the Company’s revolving credit facility. Interest expense and fees in 2004 included $42.0 million relating to senior notes, $32.4 million relating to the junior subordinated debt securities and $1.2 million relating to borrowings under the Company’s revolving credit facility. The lower interest expense on senior notes was due to the retirement of the 8.5% senior notes due March 15, 2005, partially offset by the issuance of new 5.4% senior notes on October 12, 2004.
The following table shows the net catastrophe losses for each of the Company’s operating segments for the years ended December 31, 2004 and 2003.
The following table shows the net prior period reserve adjustments for each of the Company’s operating segments for the years ended December 31, 2004 and 2003.
Net unfavorable prior period reserve adjustments for the year ended December 31, 2004 were $174.2 million compared to $129.1 million in 2003. For the year ended December 31, 2004, the unfavorable prior period reserve adjustments included net unfavorable non-A&E, non-catastrophe adjustments of $198.5 million relating primarily to casualty reinsurance, in particular, workers’ compensation and net unfavorable A&E adjustments of $10.3 million, partially offset by favorable development of $34.6 million relating to the reduction of reserves for the 2001 World Trade Center events. For the year ended December 31, 2003, net unfavorable non-A&E, non-catastrophe prior period reserve adjustments were $114.6 million, which were net of a cession of $85 million under the 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program and net unfavorable A&E adjustments of $16.8 million partially offset by net favorable catastrophe prior period reserve adjustments of $2.3 million. It is important to note that adverse non-A&E accident year reserve development arises from the reevaluation of accident year results, that such reevaluations
The Specialty Underwriting segment had $17.5 million of net unfavorable prior period reserve adjustments for the year ended December 31, 2004, principally related to net unfavorable prior period reserve adjustments in the surety and A&H business lines, partially offset by favorable development from marine and aviation. The net favorable prior period reserve adjustments for the year ended December 31, 2003 were $23.9 million, primarily related to A&H business.
The International segment had $0.7 million and $56.6 million of net favorable prior period reserve adjustments for the years ended December 31, 2004 and 2003, respectively. The favorable prior period reserve adjustments in 2004 related primarily to 2003 Canadian property catastrophe, international and Asia business. The prior period reserve development for 2003 related primarily to general casualty business written on both a quota share and excess basis for accident years 1996 through 2002.
Underwriting Expenses.The Company’s expense ratio, which is calculated by dividing underwriting expenses by net premiums earned, was 23.3% in 2004 compared to 24.8% in 2003.
The Company’s combined ratio, which is the sum of the loss and expense ratios, increased by 1.4 percentage points to 99.1% for the year ended December 31, 2004 compared to 97.7% for the year ended December 31, 2003.
The following table shows the combined ratios for each of the Company’s operating segments for the year ended December 31, 2004 and 2003. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above.
Investments. Net investment income increased 15.6% to $329.2 million in 2004 from $284.8 million in 2003, principally reflecting the effects of investing $921.6 million of cash flow from operations for the twelve months ended December 31, 2004, as well as $320.0 million of net proceeds from the issuance of junior subordinated debt securities in March 2004 and $246.7 million of net proceeds from the issuance of senior notes in October 2004, all partially offset by the effects of the lower interest rate environment and a $6.0 million decrease from the impact of the UK Branch Sale. The increase also reflected $32.7 million representing an atypical increase in the carrying value of a limited partnership investment.
Corporate charges not allocated to segments were income of $2.0 million in 2004 as compared to corporate expense of $2.1 million in 2003.
Income Taxes. The Company’s income tax expense is primarily a function of the U.S. statutory tax rate and the impact from tax preferenced investment income. Additionally, in conjunction with the transfer of the Company’s UK branch to Bermuda Re, there were various tax issues giving rise to net tax expenses. The Company recognized income tax expense of $56.1 million in 2004 compared to $61.0 million in 2003.
This report contains forward-looking statements within the meaning of the U.S. federal securities laws. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “will”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report include information regarding the Company’s reserves for losses and LAE, the adequacy of the Company’s provision for uncollectible balances, estimates of the Company’s catastrophe exposure, the effects of catastrophic events including the most recent hurricanes, on the Company’s financial statements and the ability of the Company’s subsidiaries to pay dividends. Forward-looking statements only reflect the Company’s expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from the Company’s expectations. Important factors that could cause the Company’s actual events or results to be materially different from the Company’s expectations include those discussed below under the caption ITEM 1A, “Risk Factors”. The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.