- --------------- (1) Book value per share is calculated by dividing end of period stockholders' equity (excluding unrealized investment gains or losses) by the end of period common shares outstanding.
"expect", "project", "estimate", predict", "anticipate", "believes", and similar expressions are also intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results, performance and achievements could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. 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.
At December 31, 1999, our life insurance in force amounted to $45.4 billion. We assign to third parties, or "retrocede," portions of certain risks in excess of a predetermined retention amount for which we have accepted liability. At December 31, 1999, we had ceded $34.9 million, or 0.08%, of our in force life insurance coverage.
Our primary annuity product is reinsurance of a general account fixed deferred annuity. The profitability of the deferred annuity reinsurance product line depends on earning a targeted spread between the interest rate earned on the supporting asset base and the interest rate credited to the underlying annuity liability. This spread is interest rate sensitive, as fluctuations in the general level of interest rates from period to period may cause fluctuations in the results of operations. At December 31, 1999, our liability for deferred annuity contracts amounted to $1.6 billion. Additional information concerning the spread between the interest rate earned on the supporting asset base and the interest rate credited to the underlying annuity liability is presented elsewhere in this report under the headings "Funds Withheld at Interest -- Interest Sensitive Contract Liabilities" and "Quantitative and Qualitative Disclosures about Market Risk."
Net Operating Income. In addition to net income, we report net operating income. This is not a substitute for net income computed in accordance with generally accepted accounting principles (GAAP), but is an important measure used by management, investors and others to measure our results. We define net operating income as net income excluding realized gains and losses from the sale of investments. Our definition of net operating income may differ from that used by other public life and annuity companies.
For the year ended December 31, 1999 our net operating income increased 120% over the prior year. Net operating income for the year ending December 31, 1999 was $36,988,000 or $1.45 per common share, $1.36 per common share on a fully diluted basis, compared with $0.70 per common share, $0.66 per common share on a fully diluted basis for the initial operating period of approximately eight and one-half months ended December 31, 1998. The increase in net operating income is due to the growth and development of our insurance operations and favorable underwriting and investment results.
Net Investment Income. Total net investment income for the year ended December 31, 1999 was $85,090,000, an increase of 253% over the initial operating period of eight and one half months ended December 31,1998. The growth in the investment income is primarily due to the income earned on Funds Withheld under modified coinsurance agreements related to our Interest Sensitive Contracts Liabilities. The income earned on the Funds withheld was $64,606,000 for the year ended December 31, 1999 compared with $8,927,000 for the initial operating period of eight and one-half months ended December 31, 1998. The average yield rate earned on an annualized basis on the invested assets, excluding Funds Withheld, was 6.29% for the year ended December 31, 1999 compared with 6.32% for the period ending December 31, 1998.
Realized Investment Gains (Losses). Realized investment losses were $1,285,000 for the year ended December 31, 1999 compared with realized gains of $2,673,000 for the initial operating period of eight and one-half months ended December 31, 1998. These gains and losses result from normal activity in the management of our investment portfolio.
During the year ended December 31, 1999, we incurred unrealized losses of $14,992,000, as compared with unrealized gains of $3,723,000 incurred during the period ended December 31,1998 which were included in Other Comprehensive Income (Loss). The change in unrealized gains and losses is principally related to the increase in the general level of interest rates during 1999.
favorable, falling within pricing parameters. We expect mortality to be fairly constant over long periods of time, but it will fluctuate from period to period. Reserve levels are in part determined by claims reported from ceding companies, our aggregate experience and overall mortality trends.
Policy Acquisition Costs and Other Insurance Expenses. Policy Acquisition Costs and Other Insurance Expenses, consisting primarily of allowances and amortization of deferred policy acquisition costs, were $42,201,000 for the year ended December 31, 1999, as compared with $6,542,000 for the initial operating period of eight and one-half months ended December 31, 1998. Generally, policy acquisition costs and other insurance expenses fluctuate with business volume and changes in product mix. The increase in these costs reflects the growth and development of our life insurance and annuity business.
We do not engage in trading activities to recognize realized investment gains and, thus, do not have a trading portfolio. However, we evaluate the desirability of continuing to hold a security when market conditions, creditworthiness or other measurement factors change. These changes may relate to a change in the credit risk of an issuer and a decision to sell may be made to avoid further declines in realizable value. Securities also may be sold prior to maturity to provide liquidity. As a result our securities are classified as "available for sale".
At December 31, 1999, fixed maturity securities, which constituted all of our invested assets, were 88% investment grade, liquid securities with varying maturity dates, as compared with 83% at December 31, 1998. The fair value of these investments may vary depending on economic and market conditions, the level of interest rates and the perceived creditworthiness of the issuer. At December 31, 1999 and 1998, the weighted average duration of invested assets was 3.7 and 2.9 years, respectively, and the weighted average investment quality rating was "AA-" in both years.
At December 31, 1999, $34,500,000 at fair value or 12% of invested assets, consisted of below investment grade securities, as compared with $45,000,000 or 17% of invested assets at December 31, 1998. We limit our investments in fixed maturities that are rated below investment grade to not more than 25% of our total capital because these investments are subject to a higher degree of credit risk than investment grade securities. We
monitor our below investment grade securities as well as the creditworthiness of the portfolio as a whole. When fair market values decline for reasons other than changes in interest rates or other perceived temporary conditions, the security is written down to its net realizable value. We had no fixed maturities in default at December 31, 1999 or 1998, and no securities were written down during 1999 or 1998.
The following table summarizes our investment results, excluding interest earned on funds withheld under modified coinsurance agreements, for the periods ended December 31, 1999 and 1998.
- --------------- (1) Fair value at end of the indicated year.
(2) The effective yield rate equals (i) net investment income divided by (ii) the average of total adjusted invested assets (fixed maturities at amortized cost) at the end of each calendar quarter included in the indicated period.
At December 31, 1999, 19% of our mortgage backed investment portfolio consisted of planned amortization class, target amortization class and sequential instruments, as compared with 14% at December 31, 1998. These investments are designed to amortize in a more predictable manner by shifting the primary risk of prepayment of the underlying collateral to investors in other tranches ("support classes") of the collateralized mortgage obligation.
These reinsurance agreements are accounted for as investment type contracts because they do not bear significant insurance risk. Accordingly, premiums are reported as a deposit liability on the balance sheet and benefits such as policy surrenders are reported as withdrawals from the liability account.
For the year ended December 31, 1999 and the eight and a half month period ended December 31, 1998 the interest spread we earned was:
At December 31, 1999 and 1998, we had no outstanding debt. At December 31, 1999 and 1998, letters of credit totaling $121,475,000 and $46,425,000, respectively, issued in the ordinary course of our business had been issued by our bankers in favor of certain ceding insurance companies to provide security and to meet regulatory requirements. These letters of credit are fully collateralized by our investments. We may incur indebtedness in the future in connection with possible acquisitions of, investments in, joint ventures with or other strategic alliances with companies whose businesses complement our business.
At the February 11, 1999, April 29,1999, July 28, 1999 and October 27, 1999 Board of Directors meetings, shareholder dividends of $.04 per share were declared. The Board intends to continue to declare and pay out of earnings a quarterly dividend. The continued payment of dividends is dependent on the ability of our operating subsidiaries to achieve satisfactory underwriting and investment results, and we cannot assure you that dividends will be declared or paid in the future.
On September 7, 1999, we signed an agreement to acquire Capitol Bankers Life Insurance Company for $2,000,000 plus the capital and surplus of Capitol Bankers. Upon completion of the acquisition, we intend to contribute additional capital to Capitol Bankers of approximately $18 million. Completion of the acquisition, however, is subject to regulatory approval. We expect to fund the acquisition price and subsequent capital contribution from available cash balances and proceeds from the sale of fixed maturity securities. Prior to closing, the in force insurance business of Capitol Bankers will be 100% reinsured by Capitol Bankers to a third party reinsurer. This transaction will be accounted for as a purchase.
We conducted our audits in accordance with United States generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and its subsidiaries as at December 31, 1999 and 1998 and the results of their operations and cash flows for the years ended December 31, 1999 and 1998 in conformity with United States generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
The accompanying financial statements are prepared in accordance with United States generally accepted accounting principles which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The following are the significant accounting policies adopted by the Company:
Premiums from universal life and investment-type contracts are reported as deposits to policyholders' account balances. Revenues from these contracts consist of amounts assessed during the period against policyholders' account balances for mortality charges, policy administration charges and surrender charges. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policyholders' account balances.
The development of policy reserves for the Company's products requires management to make estimates and assumptions regarding mortality, lapse, expense and investment experience. Such estimates are primarily based on historical experience and information provided by ceding companies. Actual results could differ materially from those estimates. Management monitors actual experience, and where circumstances warrant, will revise its assumptions and the related reserve estimates.
Realized gains and losses on investments are recognized in net income, using the specific identification method. Changes in fair values of securities carried at fair value are reflected in other comprehensive income.
Organization expenses consist of legal, accounting and incorporation expenses incurred in connection with the formation and organization of the Company. Such costs were expensed as incurred.
The most significant items of comprehensive income are net income and the change in unrealized gains and losses on securities.
For the purposes of the statements of cash flows, the Company considers all time deposits and short term investments with an original maturity of 90 days or less as equivalent to cash.
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, and for hedging activities. It requires that entities recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at their fair value. The accounting for changes in the fair value of such instruments depends upon the intended use of the derivative and the resulting designation. This standard also establishes new rules for derivative instruments designated and used as part of a hedging activity.
(d) For fixed interest securities held on December 31, 1999 and 1998 the maturity distribution is as follows:
(e) Investment income earned during the year is comprised as follows:
Net realized investment gains (losses) comprise $1,104,026 gross realized gains and $2,388,795 gross realized losses for the year ended December 31, 1999 (1998: $3,492,358 and $819,077 respectively).
In April 1998, the Company completed an equity offering of its shares to the public and direct sales of its shares to certain "strategic investors", directors and members of management. The Company issued 25,499,999 common shares, raising total equity of approximately $354,000,000.
transfer of shares, should such a transfer cause the number of shares held by one person to be 10% or more of the Company's outstanding common shares.
In connection with the Direct Sales of equity securities to the "Strategic Investors," the Company issued Class B Warrants that enable the holders to purchase an aggregate of 397,500 common shares of the Company. The exercise price of the Warrants is $15.00 per share, which was equal to the price of the common shares in the initial public offering. The Class B Warrants become exercisable in three equal annual installments commencing on the first anniversary of the date of the Direct Sales. The Class B Warrants expire on the tenth anniversary of the consummation of the Direct Sales.
The following table sets forth the computation of basic and diluted earnings per share. The Company was nominally capitalized with 12,000 common shares of par value of $1.00 each during the period from its incorporation to the date of the initial public offering and did not commence operations until April 17, 1998. For this reason the calculation of earnings per share for the year ended December 31, 1998 is based upon the earnings and number of shares outstanding since the beginning of the second fiscal quarter; in the opinion of Management this is the most meaningful presentation.
In addition, in 1998 Inter-Atlantic agreed to provide financial advisory and other services to the Company for a term of five years in exchange for four annual payments of $600,000. Such services include, among other things, assistance in the development of products, financial planning, management of assets and liabilities, international marketing efforts and such other services as the Company may request. In 1999 the Company prepaid this fee at a discount of 10%.
During the 1998 certain of the Company's officers purchased 163,121 shares in the Company as part of the Direct Sales. The Company made loans to the officers totaling $1,325,000 to partially finance such purchases. The loans bear interest at 7% per annum and must be repaid within five years of the consummation of the Direct Sales, except that $175,000 of the loans must be repaid within 14 months of the consummation of the Direct Sales.
In 1998 the Board of Directors adopted a Stock Option Plan (the "Plan") under which it may grant, subject to certain restrictions, Incentive Stock Options ("ISOs") and Non-Qualified Stock Options ("NQSOs"). The aggregate number of common shares for which options may be granted under the initial plan is limited to 1,552,500 Common Shares. In 1999 the plan was amended such that options may be granted in any fiscal year equal to not more than 2% of the adjusted average of the outstanding common shares of the Company, as that number is determined by the Company to calculate fully diluted earnings per share. In 1999 no options were granted under this amendment. Only eligible employees of the Company are entitled to ISOs, while NQSOs may be granted to eligible employees, non-employee Directors and consultants.
The Plan is administered by the Compensation Committee of the Board of Directors.
The Company has entered into a retrocession agreement which enables it to limit the amount of life reinsurance it retains to $2,000,000 per single life. The contract is on an automatic basis and is effective for risks assumed and in force from January 1, 1997. The limit of cover is $50 million and covers all single and joint life reinsurance assumed by the Company on an automatic basis. At December 31,1999 the Company ceded approximately $34.9 million of in force insurance coverage for a premium of $396,000. No claims are recoverable.
The Company has entered into several significant life reinsurance contracts and one significant deferred annuity contract. Due to the size of certain of these contracts, there is a material concentration of net premiums, funds withheld at interest, deferred policy acquisition costs and balances related to interest-sensitive contract liabilities with the underlying parties to these significant contracts. The underlying parties to these contracts are large insurance companies based in the United States and Canada.
The balance sheet captions "Funds Withheld at Interest" and "Interest Sensitive Contracts Liabilities" relate to deferred annuity contracts reinsured on a modified coinsurance basis. The Funds Withheld at Interest is equivalent to the statutory reserve held by the ceding company. Taking into consideration the structure of the reinsurance agreement, the carrying value of the liabilities approximate their fair value.
Fair value disclosures are not required for deferred policy acquisition costs and liabilities arising from insurance contracts and, therefore, they have not been determined by the Company.
intends to operate in a manner such that it will not be liable to United States tax other than premium excise taxes and withholding taxes on certain investments.
Under The Bermuda Insurance Act, 1978, and related regulations, Annuity and Life Reassurance is required to maintain certain levels of solvency. This requirement was met at the balance sheet date.
The Company was incorporated on December 2, 1997 but did not commence operations until the successful completion of its initial public offering on April 17, 1998.