Properties. Chartwell leases approximately 53,000 square feet of space for its principal executive offices in Stamford, Connecticut. Chartwell also leases approximately 68,000 square feet of space in London, England for the operations of Archer. INSCORP is located in Jericho, New York, occupying approximately 1,150 square feet of office space. Management believes Chartwell's current office space is adequate for its needs.
Recent Industry Performance The property and casualty insurance and reinsurance industry has historically been highly cyclical. Demand for reinsurance is influenced significantly by prevailing market conditions, including the underwriting results of primary insurers. The supply of reinsurance is primarily related to levels of underwriting capacity in the reinsurance industry and the relative cost and terms of reinsurance coverage. The industry's profitability and the cyclical trends in the industry can be affected significantly by volatile and unpredictable developments, including the occurrence of natural disasters, other catastrophic events, competitive pressures on pricing (premium rates), fluctuations in interest rates, other variations in the investment environment, changes in the judicial system regarding tort law, general economic conditions and trends, such as inflationary pressures, that may tend to affect the size of profits and losses experienced by ceding primary insurers and other factors such as changes in tax laws and regulations. Many sectors of the industry are currently in a cyclical downturn and it cannot be predicted if or when market conditions will improve or when other sectors may experience a deterioration in pricing and terms. Commencing in the late part of the 1980s, primary property and casualty insurers began to retain more of their business. This reduction in the amount of business ceded to reinsurers, combined with the growth in reinsurance capacity, resulted in renewed price competition and less attractive pricing for reinsurers. This caused a downturn for the reinsurance industry, resulting in increased underwriting losses which have continued to the present.
___________________________ (1) Beginning in 1996, the combined ratio includes both Chartwell Reinsurance and INSCORP. (2 Source: RAA Underwriting Report for the year ended December 31, 1997.
Revenues Year Ended December 31, --------------------------- (Dollars in thousands) 1997 1996 --------- --------- Gross premiums written.................. $ 362,770 $ 263,838 ========= ========= Net premiums written.................... $ 268,260 $ 192,251 ========= ========= Premiums earned......................... $ 245,700 $ 209,503 Net investment income................... 43,575 44,089 Net realized capital gains (losses)..... (3) 1,157 Service and other revenue............... 28,322 6,167 Equity in net earnings of investees 4,794 3,559 --------- --------- Total........... $ 322,388 $ 264,475 ========= =========
Underwriting Operations Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written for the year ended December 31, 1997 were $362.8 million, an increase of 37.5% compared to the same period in 1996. The increase in gross premiums written reflects new programs and products developed during the year with ceding companies in the Specialty and Controlled Source Insurance Accounts client segments and the addition of gross premiums written through Archer's two Dedicated CCV's. Gross premiums written by the Global Accounts, Regional Accounts and Marine & Aviation Accounts client segments either declined or remained constant as a result of continued competitive pressures. Net premiums written for the year ended December 31, 1997 increased 39.5% to $268.3 million, compared to $192.3 million for the same period in 1996. The increase in net premiums written was principally attributable to the reasons described above for the increase in gross premiums written. Net premiums earned for the year ended December 31, 1997 were $245.7 million, an increase of 17.3% compared to the same period in 1996.
Net Underwriting Results. The Company incurred an underwriting loss (net premiums earned minus losses, LAE and underwriting expenses) of $4.3 million for the year ended December 31, 1997 as compared to an underwriting loss of $8.9 million for the same period in 1996. The combined ratio computed in accordance with GAAP for the year ended December 31, 1997 decreased to 101.9% from 104.2% for 1996. Although the loss ratio component improved to 65.5 % for the year ended December 31, 1997 from 71.9 % recorded for the same period in 1996, the expense ratio increased to 36.4% for the year ended December 31, 1997 from the 32.3 % recorded for the same period in 1996, for the reasons noted above.
Service Operations Revenue from service operations, exclusive of net investment income, increased to $33.1 million for the year ended December 31, 1997 compared to $9.7 million for the same period in 1996. The improvement reflects increases in advisory fee revenues, equity in the earnings of investee companies and the inclusion, for the first time, of profit commissions and fees from Archer operations. The 1996 amount includes a gain of $2.8 million on a foreign exchange option entered into to protect the Company from the increasing value of the Pound Sterling for the period from inception of the Acquisition until completion. In March 1998, New London Capital plc ("NLC") notified Chartwell Advisers Limited ("Chartwell Advisers") that it chose not to renew the Advisory Agreement between NLC and Chartwell Advisers (the "Advisory Agreement") after its contractual expiration on December 31, 1998. In 1997, the Advisory Agreement produced base fees of $1.7 million and a profit commission of $0.7 million for Chartwell Advisers. Following the expiration of the Advisory Agreement, Chartwell Advisers will continue to earn profit commissions on the open years of account (1996, 1997 and 1998) to the extent such years are profitable.
Corporate Interest and Amortization. Interest and amortization expenses were $12.3 million for the year ended December 31, 1997 compared to $10.1 million for the same period in 1996. Interest and amortization on Re Holdings' 10.25% Senior Notes due 2004 (the "Senior Notes") was $5.2 million for the year ended December 31, 1997 and $6.0 million for the comparable period in 1996. Interest and amortization on the Company's CI Notes was $2.5 million and $2.2 million for the years ended December 31, 1997 and 1996, respectively. Also included in interest and amortization expense for the year ended December 31, 1997 is $3.4 million related to a credit facility with First Union National Bank, N. A. ("First Union") established to fund the Acquisition and replace an existing $20 million credit facility.
Consolidated Net Investment Income and Net Realized Capital Gains (Losses). Consolidated net investment income, exclusive of realized and unrealized capital gains and losses, for 1997 was $43.6 million, a decrease of 1.2% compared to the same period in 1996. This decrease is primarily due to a repositioning of the investment portfolio by increasing the municipal sector. This repositioning occurred late in 1996, and the full effect was realized in 1997. The average annual tax equivalent yield on invested assets before investment expenses for 1997 and 1996 was 6.7%. The Company realized net capital losses of $0.3 million for 1997 compared net capital gains of $1.2 million in 1996. The 1996 net capital gains were realized principally to reposition certain sectors of the portfolio and to modify the portfolio to improve credit quality without sacrificing yield.
Income Tax Expense. The provision for Federal income taxes for the year ended December 31, 1997 increased to $10.6 million compared with $9.7 million for the same period in 1996. The effective tax rate was 28.0% and 29.7% for the years ended December 31, 1997 and 1996, respectively. The principal factor in the decline below the statutory rate of 35.0% for both periods was the benefit of an increase during late 1996 and early 1997 of investments in tax-advantaged securities.
Year Ended December 31, 1996 Compared With Year Ended December 31, 1995 Revenues: Total revenues for the year ended December 31, 1996 increased 83% to $264.5 million, compared to $144.5 million for the comparable period in 1995. The accompanying table summarizes gross and net premiums written and total revenues for the periods indicated:
amount of proportional business written by the Company which generally has a lower loss and LAE ratio than excess of loss business but modestly higher commissions. Policy Acquisition Costs. Policy acquisition costs, consisting primarily of commissions paid to ceding companies and brokerage fees paid to intermediaries, less commissions received on business ceded to other reinsurers, were $52.0 million for the year ended December 31, 1996, compared to $28.8 million for the same period in 1995. Policy acquisition costs expressed as a percentage of net earned premiums (the acquisition expense ratio) increased to 24.8% from 23.9% in 1995. The increase is due both to the run-off of INSCORP's reinsurance portfolio and to a modestly higher commission structure, as noted above, for proportional business.
Service Operations Income from service operations increased to $9.7 million for the year ended December 31, 1996 compared to $1.1 million for the same period in 1995. The improvement reflects increases in advisory fee revenues, equity in the earnings of investee companies acquired in the Merger and development of new fee-based revenue sources during the year. Also included is a gain of $2.8 million on a foreign exchange option entered into to protect the Company from the increasing value of the Pound Sterling during the period commencing from the initialization of the Acquisition to the closing of the transaction. During that period, the Pound Sterling appreciated by approximately 6% relative to the U.S. Dollar.
increased the Company's invested asset base. The average annual tax equivalent yield on invested assets before investment expenses decreased to 6.7% for 1996 from 6.8% for 1995. The Company realized net capital gains of $1.2 million for 1996 compared to $3.2 million for the same period in 1995. Both the 1996 and 1995 net capital gains were realized principally to reposition certain sectors of the portfolio and to modify the portfolio to improve credit quality without sacrificing yield.
Income Before Income Taxes and Extraordinary Item. Net income before income taxes and extraordinary items increased to $32.5 million for the year ended December 31, 1996 compared to $8.9 million for the same period in 1995. The increase resulted primarily from the increase in earned premiums, the favorable results in both loss and loss adjustment expense and in other expenses, and from the increases in net investment income and service and other revenue.
portfolio by sector and to capitalize on some opportunities to improve on credit quality without sacrificing yield. There was no unusual trading activity during 1997. At December 31, 1997, the carrying value of total investments, including cash and cash equivalents, increased 5.5%, to $764.3 million compared to $724.7 million at December 31, 1996. The primary reasons for the increase were positive cash flow from operations of $28.3 million and the increase in the market value of the investment portfolio of $15.8 million. Financing activities have also been a source of liquidity for Chartwell and its subsidiaries. On March 17, 1994, Chartwell completed the offering of $75.0 million principal amount of the Senior Notes. The net proceeds to the Company after transaction expenses were $71.9 million. As of December 31, 1997, $48.8 million in principal amount of the Senior Notes were outstanding. The Senior Notes bear interest at a rate of 10 1/4% per annum and are due on March 1, 2004 In the first half of 1996, the Company completed a public offering of 2,725,000 shares of common stock at $23.00 per share. The net proceeds to the Company were $58.5 million after deduction of underwriting discount and expenses. Of the net proceeds, $48.5 million was contributed to Re Holdings of which $20.0 million was contributed to the statutory surplus of Chartwell Reinsurance and $28.5 million was used to retire 35% of the Senior Notes plus accrued interest. The remaining funds were retained for general corporate purposes. This redemption reduced Chartwell's annual expense for interest and amortization of debt issuance costs under the Senior Notes by $2.8 million per year. In connection with the Acquisition, stockholders of Archer Holdings could elect to receive Loan Notes in the amount of one Pound Sterling for each Pound Sterling of cash consideration. The aggregate amount of Loan Notes issued in connection with the consummation of the Acquisition was $9.4 million (denominated in Pounds Sterling). The Loan Notes, which are guaranteed by First Union as described below, pay interest semi-annually at the rate per annum calculated as one percent below the Sterling London Interbank Offered Rate ("LIBOR") and will mature in June, 2002 unless redeemed at an earlier date. Also in connection with the Acquisition, Re Holdings entered into a new credit facility with First Union, as agent (the "Credit Facility"). The Credit Facility provides for (i) a Tranche A-1 $20.0 million loan, (ii) a Tranche A-2 $10.0 million loan, (iii) a Tranche B $22.0 million loan (denominated in Pounds Sterling) (Tranche A-1, Tranche A-2 and Tranche B collectively, the "First Union Loans"), and (iv) a $25.0 million revolving credit facility (subsequently increased to $60.0 million) (the "First Union Revolver"). The First Union Loans have six-year terms and the First Union Revolver has a five-year term but may be extended for one year with the consent of First Union. Tranche A-1 and A-2 require repayment of principal starting in year 3, $6.0 million; year 4, $7.5 million; year 5, $7.5 million and year 6, $9.0 million. Tranche B requires repayment of principal starting in year 3, $4.2 million; year 4, $5.3 million; year 5, $5.3 million and year 6, $6.4 million. Borrowings under the First Union Revolver are available at any time prior to maturity, subject to minimum funding amounts. Both the First Union Loans and the First Union Revolver will bear interest at a rate selected by Re Holdings equal to either (1) the Base Rate (as defined below) or (2) U.S. dollar or Sterling LIBOR plus a margin (the "Margin"), as applicable. The amount of the Margin will depend on the higher of Re Holdings' senior debt rating by Standard & Poor's or Moody's and can range from 0.50% to 0.875%. Based on Re Holdings' current senior debt ratings, the Margin over LIBOR is currently at 0.75%. The U.S. dollar Base Rate is the higher of (1) First Union's prime commercial lending rate or (2) the federal funds rate plus 0.5%. The Sterling Base Rate is the rate per annum announced by Midland Bank plc plus the Margin. Re Holdings will also pay (1) an unused commitment fee equal to 0.25% on the aggregate unused portion of the revolver, (2) utilization fees for the issuance of letters of credit and guarantees of Loan Notes, issued in connection with the Acquisition, at a rate per annum of 0.375% (if secured) or the Margin plus a 0.075% facing fee, currently totaling 0.825% (if unsecured) on the outstanding amount of potential credit exposure, and (3) certain other fees customary in connection with syndicated loans of this nature. All payments of interest and fees with respect to each of the First Union Loans shall be made in the same currency in which the principal of such loan is required. During 1997, Re Holdings maintained the full balance on the Tranche A-1 and A-2 loans. The Tranche B loan increased by $2.0 million ((pound)1.2 million) to fund the redemption of certain Loan Notes for the same amount. The First Union Revolver was paid off during 1997. At December 31, 1997, $20.0 million, $10.0 million and $14.0 million were outstanding under the Tranche A-1, Tranche A-2 and Tranche B loans, respectively. In addition, at December 31, 1997, $7.2 million was used under the Tranche B loan to guarantee the Loan Notes and a total of $53.0 million of letters of credit were extended under the First Union Revolver. All amounts denominated in Pounds Sterling were converted to U.S. dollars at the rate of $1.6496 per (pound)1, the rate in effect at December 31, 1997.
CI Notes in cash rather than common stock. There can be no assurance that sufficient funds for any of the foregoing purposes would be available to the Company at such time.
Earnings Per Share - SFAS No. 128 In February, 1997, the FASB issued SFAS No. 128, "Earnings Per Share," which became effective for interim and annual periods ending after December 15, 1997. SFAS No. 128 supersedes Accounting Principles Board Opinion ("APB") No. 15 and replaces the presentation of primary earnings per share ("EPS") with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and provides guidance on other computational issues. At December 31, 1997, all prior period EPS data presented have been restated to conform with the provisions of SFAS No. 128. (See Note 1).
Accounting for Stock-Based Compensation - SFAS No. 123 In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation," which became effective for the Company beginning January 1, 1996. SFAS No. 123 requires expanded disclosures of