The Company leases office space in Hamilton, Bermuda and Dublin, Ireland, the locations in which it operates. The Company leases office space on a long-term basis in Bermuda, which the Company believes will be adequate for anticipated future operations. The lease in Ireland is currently on a month-to-month basis. Although sufficient to conduct current operations, the Company is seeking to lease replacement space in Dublin, Ireland on a long-term basis to support future operations.
(1) Formerly shown as combined shareholders’ equity (shareholders’ equity and minority interest) and combined book value per share. On July 30, 2003, the holders of non-voting common shares of Max Re and warrants to acquire non-voting common shares of Max Re exchanged such shares and warrants for Common Shares of the Company and warrants to acquire Common Shares of the Company. The effect of this exchange resulted in the elimination of minority interest and an increase in shareholders’ equity of equal amounts as of the date of the exchange.
To manage reinsurance and insurance liability exposure, make investment decisions and assess overall enterprise risk, the Company models its underwriting and investing activities on an integrated basis. The
The Company achieved a key objective of shifting its property and casualty product mix toward traditional reinsurance and insurance business during the year ended December 31, 2003. The strategy resulted in improved underwriting performance, which, coupled with strong investment performance, enabled the Company to generate increased net income. Implementation of the shift in product mix was realized through the hiring of a seasoned team of insurance underwriting professionals with proven track records. The Company believes these professionals bring underwriting talent, experience, discipline and market presence, which allowed the Company’s insurance operations to grow to over 16% of total gross premium written volume for the year ended December 31, 2003.
The Company also realized a diversification of its reinsurance underwriting business. The shift in underwriting focus and hiring of additional traditional reinsurance underwriting professionals, coupled with the introduction of insurance operations, enabled the Company to develop its professional liability, general liability, aviation and property underwriting capability and to expand into additional lines of business. Consequently, the Company believes its underwriting portfolio is more balanced and diversified than in previous years.
The Company experienced growth in premium revenue during the year ended December 31, 2003 with gross premium written of $1,009.8 million compared to $647.4 million in 2002. The increase of 56.0% reflects the Company’s strategic decision to shift its product mix toward traditional reinsurance and insurance products during the year. These markets are presenting additional underwriting opportunities to the Company at favorable pricing terms. Traditional reinsurance operations represent 31.6% of total volume, up from 21.3% in the prior year. The Company recognizes the potential for increased volatility in its loss ratio arising from the shift in product mix to traditional reinsurance and insurance business. The Company plans to manage this risk by selecting appropriate line sizes and underlying exposures to diversify its existing underwriting portfolio and to continue to purchase reinsurance protection to manage its risk.
The Company’s shift in product mix has resulted in improved underwriting performance in 2003. Loss ratios (losses, benefits and experience refunds as a percentage of net premiums earned) for the property and casualty business have declined from 83.3% in 2002 to 74.5% in 2003 and the combined ratio (total losses and expenses as a percentage of net premiums earned) has similarly declined from 111.2% in 2002 to 99.8% in 2003. Traditional reinsurance and insurance products are expected to generate lower loss and combined ratios than structured risk transfer products. In 2004, the Company expects to continue to increase the percentage of its gross premium written volume represented by traditional reinsurance and insurance operations.
Losses, benefits and experience refunds represent the largest expense to the Company and account for over 50% of total liabilities at December 31, 2003. The Company establishes loss expenses and reserves using a
The Company continually assesses its liquidity needs by monitoring new business prospects and development of its existing operations. In 2003, the Company generated $451 million of cash from operations of which the Company invested $396 million in fixed maturities and alternative investments. The Company expects to continue to generate operating cash inflow in 2004 through profitable new business, which will be offset partially by paid losses on existing reinsurance and insurance obligations, as well as operating expenses.
Acquisition costs consist principally of ceding commissions paid to ceding clients and brokerage expenses, and typically represent a percentage of the premiums on reinsurance and insurance contracts written. These costs are generally deferred and amortized over the period in which the related premiums are earned.
The Company’s premiums are recorded at the inception of each contract, based upon contract terms and information received from ceding clients and their brokers. For excess of loss contracts, the amount of premium is usually contractually documented at inception, and no management judgment is necessary in accounting for this. For quota share or proportional contracts, gross premiums written are normally estimated at inception by the ceding client. The Company accounts for such premiums using the initial estimates, and then adjusts them as advised by its ceding clients. The Company also accrues for reinstatement and additional premiums resulting from losses. Such accruals are based upon contractual terms, and the only element of management judgment involved is with respect to the amount of losses, benefits and experience refunds, as described below. Premiums are earned on a pro rata basis over the coverage period.
Reinstatement and additional premiums are recognized and earned at the time losses are adjusted by the Company. Reinstatement premiums are the premiums charged for the restoration of the reinsurance limit of a contract to its full amount after payment by the reinsurer of losses as a result of an occurrence. Additional premiums are premiums charged based on loss experience during the policy term or coverage period.
Under GAAP, the Company is not permitted to establish loss reserves until the occurrence of an event that may give rise to a loss. Once such an event occurs, the Company establishes reserves based upon estimates of total losses incurred by the ceding client as a result of the event and the Company’s estimate of the portion of such loss it covers. As a result, only loss reserves applicable to losses incurred up to the reporting date may be recorded, with no allowance for the provision of a contingency reserve to account for expected future losses.
The Company’s reinsurance and insurance reserves are actuarial projections as of the balance sheet date of the ultimate unpaid losses and benefits associated with its reinsurance and insurance contracts. Considerable judgment is required to evaluate losses and benefits and establish liabilities for losses and benefits. The Company employs a variety of actuarial loss reserving techniques and several models to assist in the setting and reviewing of reserves. The actuarial loss reserves techniques and models employed are principally based on paid and incurred loss development methods. Further, the Company retains an independent actuarial firm to annually review the adequacy of the reserves as determined by management. Additional information regarding losses, benefits and experience refund amounts incurred will be revealed over time and the estimates of such amounts may need to be revised, resulting in gains and losses in the periods determined.
Gross premiums written. Gross premiums written for the year ended December 31, 2003 were $1,009.8 million compared to $647.4 million for the year ended December 31, 2002, an increase of 56.0%. Gross premiums written for property and casualty were $901.5 million for the year ended December 31, 2003 compared to $632.7 million for the year ended December 31, 2002. Gross premiums written for property and casualty increased principally due to increased production of traditional reinsurance business and the commencement of the Company’s traditional insurance operations in the first quarter of 2003. Gross premiums written for life and
Reinsurance premiums ceded. Premiums ceded for the year ended December 31, 2003 were $154.6 million compared to $54.7 million for the year ended December 31, 2002, an increase of 182.6%. Reinsurance premiums ceded were principally related to the Company’s quota-share retrocessional and aggregate stop loss agreements with Grand Central Re and the quota share retrocession of its traditional insurance business. In addition during 2003, the Company purchased specific reinsurance to manage the risks associated with certain lines of business and to manage the exposure retained by the Company on certain transactions. As the Company’s traditional reinsurance and insurance business grows, the Company is purchasing, and expects to continue to purchase, additional retrocessional coverage consistent with its risk management objectives.
employed by the Company was profitable during the year ended December 31, 2003. Alternative investment strategies principally contributing to income during the year ended December 31, 2003 were distressed securities, emerging markets, event driven arbitrage, global macro, long/short equity and fixed income arbitrage.
Losses, benefits and experience refunds. Losses, benefits and experience refunds were $592.3 million for the year ended December 31, 2003 compared to $361.0 million for the year ended December 31, 2002, an increase of 64.1%. Property and casualty losses were $477.3 million for the year ended December 31, 2003 compared to $313.0 million for the year ended December 31, 2002. The increase in property and casualty losses was related to the increase in property and casualty premiums written and earned during the year ended December 31, 2003 compared to the same period in 2002. The loss ratio for property and casualty business for the year ended December 31, 2003 was 74.5% compared to 83.3% for the year ended December 31, 2002. The decrease in loss ratio reflects the increased traditional reinsurance and insurance underwriting production which is currently producing lower loss ratios than the Company’s structured and alternative risk products.
During the year ended December 31, 2003, incurred losses related to prior year contracts amounted to $25.3 million, and included amortization of deferred charges on retrospective property and casualty reinsurance contracts of $4.0 million, and was net of $5.1 million in realized profits from contracts terminated during the current year that were written in prior years. The Company recognized additional premiums, net of acquisition costs, of $19.2 million relating to incurred losses on prior years, which offsets the increase in incurred losses related to prior year contracts. One reinsurance contract that provides whole account coverage accounted for $19.1 million of the prior year incurred losses amount. The contract is a multi year reinsurance contract under which additional premium was recorded for a prior year. The premium adjustment caused the Company to recognize additional losses for the prior year at a percentage rate consistent with the original loss ratio.
Acquisition costs. Acquisition costs were $149.5 million for the year ended December 31, 2003 compared to $97.7 million for the year ended December 31, 2002, an increase of 53.0%. The increase in acquisition costs results from an increase in property and casualty net premiums earned. The decline, in percentage terms, of acquisition costs to net premiums earned during the year ended December 31, 2003, from 25.2% to 20.6%, principally reflected lower acquisition costs on insurance business written and the life and annuity business. Acquisition costs during each of the years ended December 31, 2003 and 2002 consisted primarily of amortization of deferred policy acquisition costs incurred in connection with writing property and casualty business. Acquisition costs are customarily associated with the type of premium written by the Company. Generally, acquisition costs fluctuate with business volume and changes in product mix. A significant component of deferred policy acquisition costs are ceding commissions paid to the buyer of the Company’s reinsurance products.
Year ended December 31, 2002 compared to year ended December 31, 2001
Net premiums written. Net premiums written for the year ended December 31, 2002 were $592.7 million compared to $594.2 million for the year ended December 31, 2001, a decrease of 0.3%. Net premiums written for property and casualty products for the year ended December 31, 2002 were $580.2 million compared to $412.6 million for the year ended December 31, 2001. Net premiums written for life and annuity products for the year ended December 31, 2002 were $12.5 million compared to $181.6 million for the year ended December 31, 2001.
Net gains on alternative investments. Net gains on the alternative investment portfolio were $32.1 million, including $8.4 million from the Company’s private equity reinsurance investments, for the year ended December 31, 2002 compared to $29.8 million, net of $0.3 million loss from the Company’s private equity reinsurance investments for the year ended December 31, 2001, an increase of 7.7%. The alternative investment portfolio returned a 5.2% gain during the year ended December 31, 2002 compared to a 6.7% gain during the year ended December 31, 2001. The increase in net gains of $2.3 million resulted from the return from the Company’s private equity reinsurance investments and the larger size of the alternative investment portfolio, offset by the lower return earned on these investments in 2002 compared to 2001.
Losses, benefits and experience refunds. Losses, benefits and experience refunds were $361.0 million for the year ended December 31, 2002 compared to $514.3 million for the year ended December 31, 2001, a decrease of 29.8%. Property and casualty losses and experience refunds were $313.0 million for the year ended December 31, 2002 compared to $313.0 million for the year ended December 31, 2001. The increase in property and casualty losses and experience refunds was smaller than the increase in property and casualty net premiums written and net premiums earned as the Company’s product mix changed during the year 2002.
During the year ended December 31, 2002, incurred losses related to prior years contracts amounted to $49.9 million, and included amortization of deferred charges on retrospective property and casualty reinsurance contracts of $6.3 million. The Company recognized additional premiums and interest on those premiums, net of acquisition costs, of $37.8 million, substantially mitigating the losses incurred on prior year contracts. One contract written during calendar year 2000 accounted for $41.2 million of the prior year incurred losses amount. The contract was a whole account stop loss cover, with worker’s compensation as the principal underlying risk, providing reinsurance for calendar year 1999, where losses incurred and settled through December 31, 2002 by the underlying reinsured exceeded the Company’s estimates and consequently resulted in additional losses being recorded by the Company.
Life and annuity benefits and experience refunds were $48.0 million for the year ended December 31, 2002 compared to $201.4 million for the year ended December 31, 2001. The decrease was principally attributable to the lower volume of life and annuity premiums written and earned in 2002 compared to 2001. The Company recorded net adverse mortality and morbidity expense of $7.0 million during the year ended December 31, 2002 resulting principally from worse than expected claims experience on a coinsurance transaction involving group long term disability written during calendar year 2000.
1.4%. The increase reflected the costs associated with growing the Company’s operations and principally relates to staff additions, offset by decreased bonuses paid to management and employees in 2002 compared to 2001. The general and administrative expense ratio was 5.5% for the year ended December 31, 2002 compared to 4.2% for the year ended December 31, 2001.
Duration of liabilities. The average duration of the Company’s liabilities as of December 31, 2003 was approximately 4.2 years. This average duration was calculated using the actuarial estimates of cash flow of the contracts in force. The actuarial estimates of cash flow of the contracts include assumptions as to the size and timing of payments due from the Company under the contracts. Variations in the Company’s actual experience from its assumptions may cause the average duration of its liabilities to be shorter or longer.
As a holding company, Max Re Capital’s principal assets are its investments in the common shares of its principal subsidiary, Max Re, and the common shares of its other subsidiaries. The Company’s principal source of funds is from interest income on cash balances and cash dividends from its subsidiaries, including Max Re. The payment of dividends is limited under Bermuda insurance laws. In particular, Max Re may not declare or pay any dividends if it is in breach of its minimum solvency or liquidity levels under Bermuda law or if the declaration or payment of the dividends would cause it to fail to meet the minimum solvency or liquidity levels under Bermuda law. At December 31, 2003, Max Re, which is required to have $382.8 million in statutory capital and surplus in order to pay dividends, had $698.0 million in actual statutory capital and surplus.
Capital resources. At December 31, 2003, the Company’s capital structure consisted of equity. Total capitalization after deducting loans to employees and including retained earnings and accumulated other comprehensive income amounted to $805.2 million as compared with $710.7 million at December 31, 2002. The Company has flexibility with respect to capitalization as the result of its access to the debt and equity markets.
In the ordinary course of business, the Company is required to provide letters of credit or other regulatory approved security to certain of its ceding clients to meet contractual and regulatory requirements.
The Company has three letter of credit facilities as of December 31, 2003, totaling $470.0 million. The Company’s primary letter of credit facility is with a syndicate of commercial banks, one of which is affiliated with a director of Max Re Capital. In June 2003, the Company amended the terms of this facility principally to lower the cost of the facility and reduced the capacity of the facility from $375.0 million to $270.0 million. In accordance with the facility agreement, the syndicate will issue letters of credit that may total up to $243.0 million secured by fixed maturities and up to $27.0 million secured by alternative investments. The Company believes that the terms of this letter of credit facility are comparable to the terms that the Company would expect to negotiate with an unrelated party. At December 31, 2003 and December 31, 2002, letters of credit totaling $249.9 million and $284.6 million, respectively, were issued and outstanding under this facility. Fixed maturities and cash equivalents with a fair value of $285.9 million and Max Re Diversified shares with a fair value of $74.3 million at December 31, 2003 were pledged as collateral for these letters of credit.
Each of the letter of credit facilities requires that the Company, and/or certain of its subsidiaries, comply with certain covenants, including a minimum consolidated tangible net worth and restrictions on the payment of dividends. The Company was in compliance with all the covenants of each of its letter of credit facilities at December 31, 2003.
Information with respect to this item is set forth under Item 15.