The following selected consolidated GAAP financial data of the Company as of and for the years ended December 31, 1996, 1995, 1994, 1993 and 1992 were derived from consolidated financial statements of the Company which were audited by Coopers and Lybrand L.L.P. (1996) and Deloitte and Touche LLP (1992 - 1995), independent auditors. The statutory data have been derived from statutory financial statements filed with the Delaware Insurance Department. Such statutory financial statements are prepared in accordance with SAP, which differ from GAAP. The statutory financial statements are unconsolidated and reflect the results of operations of Everest Re's subsidiaries, Everest Ltd. and Everest National on the equity method. The following financial data should be read in conjunction with the Consolidated Financial Statements and accompanying notes. The supplemental information for 1995 excludes the effects of an IPO-related premium charge of $140.0 million ($91.0 million after taxes) for the Stop Loss Agreement and an IPO-related compensation expense charge of $13.3 million ($8.7 million after taxes) principally for stock awards to the Company's Chief Executive Officer. Such supplemental information is presented to facilitate an understanding of the impact on the Company's results of operations of
- - ------------ (1) After-tax operating income (loss), before after-tax net realized capital gains or losses, was $108.3 million (or $2.14 per share), ($21.2) million (or ($0.42)per share), $17.5 million (or $0.35 per share), $75.2 million (or $1.50 per share) and ($119.4) million (or ($2.39) per share) for the years ended December 31, 1996, 1995, 1994, 1993 and 1992, respectively. Supplemental after-tax operating income, before net realized capital gains and excluding IPO-related charges, was $78.4 million (or $1.56 per share) for the year ended December 31, 1995.
(7) GAAP losses and LAE incurred as a percentage of GAAP net premiums earned.
(12) Statutory underwriting expenses as a percentage of SAP net premiums written.
RESULTS OF OPERATIONS INDUSTRY CONDITIONS. Since 1987, a number of factors, including global competition, the emergence of significant reinsurance capacity from the Bermuda and rejuvenated Lloyds' markets, higher retentions by primary insurance companies and consolidation in the insurance industry, have caused increasingly competitive market conditions across most lines of business and have influenced the softening of prices and contract terms in the current market place. The Company cannot predict with any reasonable certainty, if, when or to what extent market conditions as a whole will change. See "Business-Competition" for a further discussion.
INITIAL PUBLIC OFFERING. On October 6, 1995 the Company's former ultimate parent, The Prudential Insurance Company of America, ("The Prudential"), completed an initial public offering ("IPO") of 100% of the outstanding stock of the Company. In connection with the IPO, the company incurred a non-recurring premium charge of $140.0 million ($91.0 million after-tax) for aggregate excess of loss reinsurance coverage (THE "STOP LOSS AGREEMENT") provided by Gibraltar Casualty Company ("Gibraltar") an affiliate of the former parent. This coverage protects the Company's consolidated earnings against up to $375.0 million of the first $400.0 million of adverse development, if any, on the Company's consolidated reserves for losses, allocated loss adjustment expenses and uncollectible reinsurance at June 30, 1995 (December 31, 1994 for catastrophe losses). At the same time, The Prudential paid $140.0 million to the Company, of which amount $91.0 million was a contribution to capital and $49.0 million was a payment in respect of the tax benefit of the premium paid for the Stop Loss Agreement. In addition, the Company incurred $13.3 million ($8.7 million after-tax) of non-recurring compensation expense, including $12.5 million in connection with IPO-related stock awards to the Chief Executive Officer. All of these IPO-related transactions had the effect of reducing cash flow for 1995 by $0.8 million and increasing stockholders' equity by $3.8 million. The following table shows the Company's 1995 results of operations as reported in the accompanying statement of operations and as adjusted to exclude these IPO-related charges:
PREMIUMS. Gross premiums written increased 10.0% to $1,044.0 million in 1996 from $949.5 million in 1995. Factors contributing to this increase included a 21.8% ($55.0 million) increase in U.S. broker treaty premiums, principally from increased writings in specialty casualty, workers compensation and substandard automobile lines, a 21.6% ($26.4 million) increase in U.S. direct treaty reinsurance and insurance due to the growth in primary
insurance written through Everest National, a subsidiary of the Company, and a 28.9% ($19.9 million) increase in U.S. facultative premiums, reflecting growth in casualty and specialty casualty lines, as the unit completed its first full year after its major restructuring and took advantage of significant dislocation in the market. These increases were partially offset by a 3.5% ($5.8 million) decrease in marine, aviation and surety premiums and a 0.3% ($0.9 million) decrease in international premiums.
Net premiums written, as adjusted, increased by 11.6% to $1,030.5 million in 1996 from $923.2 million in 1995, reflecting the growth in U.S. broker, U.S. direct treaty reinsurance and insurance and facultative gross written premiums coupled with decreased retrocessional costs.
Net realized capital gains decreased 83.1% to $5.7 million in 1996 from $33.8 million in 1995, principally reflecting the sale in 1995 of one half of the Company's investment in the common stock of Corporacion MAPFRE S.A. ("MAPFRE"), an insurance group in Spain. Realized capital gains on the sale of equity securities totalled $17.4 million, as generally favorable conditions continued in the U.S. equity securities market, and were partially offset by $11.7 million in realized capital losses on the sale of fixed maturities.
EXPENSES. Incurred losses and loss adjustment expenses ("LAE") increased by 6.1% to $716.0 million in 1996 from $674.7 million in 1995. Catastrophe losses on events with ultimate gross losses estimated at $5.0 million or greater ("CATASTROPHE LOSSES") in 1996 were $7.1 million, which included $10.0 million estimated for Hurricane Fran and $2.9 million of net favorable development on prior year occurrences, compared with $31.4 million in 1995, which included $30.9 million estimated for the Kobe, Japan earthquake and Hurricanes Marilyn and Opal and $0.5 million of net adverse development on prior year occurrences. The Company's loss and LAE ratio, as adjusted, decreased by 2.0 percentage points to 73.5% in 1996 from 75.5% in 1995. This improvement was attributable principally to the lower catastrophe losses and changes in the Company's business mix in line with the new underwriting strategy. Net incurred losses and LAE for 1996 reflected ceded losses and LAE of $206.0 million, including $116.5 million ceded under the Stop Loss Agreement, compared to ceded losses and LAE of $119.1 million in 1995.
The Company's combined ratio, as adjusted, decreased by 2.4 points to 105.3% in 1996 from 107.7% in 1995, reflecting the lower loss ratio and increased premiums.
Ceded premiums, as adjusted, decreased by 70.8% to $26.3 million in 1995 from $90.0 million in 1994 as a result of the lower premiums ceded under the Company's significantly restructured corporate-level retrocessional protection.
EXPENSES. Incurred losses and LAE decreased by 6.4% to $674.7 million in 1995 from $720.8 million in 1994. Catastrophe losses in 1995 were $31.4 million, including $30.9 million estimated for the Kobe, Japan earthquake and Hurricanes Marilyn and Opal and $0.5 million of net adverse development on prior year occurrences. These losses compared to the $81.9 million of catastrophe losses in 1994, including $70.9 million estimated for the Northridge earthquake and $11.0 million of net adverse development on prior year occurrences. The Company's loss and LAE ratio, as adjusted, decreased by 9.0 percentage points to 75.5% in 1995 from 84.5% in 1994. This improvement was attributable principally to the lower catastrophe losses, the absence of adverse development on net asbestos and environmental reserves, the lower premiums ceded under the Company's 1995 corporate-level retrocession program and changes in the Company's business mix in line with the new underwriting strategy. Net incurred losses and LAE for 1995 reflected ceded losses and LAE of $119.1 million, including $23.7 million ceded under the Stop Loss Agreement, compared to ceded losses and LAE of $119.7 million in 1994.
Underwriting expenses, as adjusted, increased by 8.0% to $287.4 million in 1995 from $266.2 million in 1994. Commission and brokerage expenses increased by $29.0 million, which was partly attributable to the $14.5 million of profit commission income in 1994 on the 1994 corporate-level retrocession program; (the adjustable features of the 1995 corporate-level retrocession program provide for the return of premiums rather than profit commissions). The balance was attributable primarily to changes in the Company's business mix. Other underwriting expenses decreased by $7.7 million, as the impact of the significant reduction in employees over the course of 1994 and 1995 more than offset the impact of salary and other expense increases that were generally in line with inflation. The
INCOME TAXES. The Company had income tax expense, as adjusted, of $26.4 million in 1995 compared to an income tax benefit of $22.6 million in 1994, with the difference substantially attributable to the improvement in pre-tax income, as adjusted, to $126.8 million in 1995 from a $12.0 million pre-tax loss in 1994.
FINANCIAL CONDITION CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and short-term investments, were $3,624.6 million at December 31, 1996, $3,238.3 million at December 31, 1995 and $2,573.2 million at December 31, 1994. The change in invested assets resulted primarily from cash flows from operations generated during the period together with net realized and unrealized gains (losses) on investments.
LOSS AND LAE RESERVES GENERAL. Gross loss and LAE reserves totaled $3,246.9 million at December 31, 1996, $2,969.3 million at December 31, 1995 and $2,706.4 million at December 31, 1994. These increases were consistent with the continued growth in the Company's book of business and, in 1994, adverse development of gross loss reserves principally related to asbestos and environmental exposures, most of which was ceded. In addition, the steady decline in paid losses that the Company has experienced since 1992 continued with paid losses in 1996 $31.2 million lower than in 1995, which were $108.8 million lower than in 1994.
Everest Re maintains reserves to cover its estimated ultimate liability for losses and LAE with respect to reported and unreported claims. Because reserves are estimates of ultimate losses and LAE, management monitors reserve adequacy over time, evaluating new information as it becomes known and adjusting reserves, as necessary. Management considers many factors when setting reserves, including: (i) current legal interpretations of coverage and liability; (ii) economic conditions; (iii) internal methodologies which analyze Everest Re's experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments, pending levels of unpaid claims and product mix; and (iv) the uncertainties discussed below regarding reserve requirements for asbestos and environmental claims. Based on these considerations, management believes that adequate provision has been made for Everest Re's loss and LAE reserves, which were $3,246.9 million as of December 31, 1996. Actual losses and LAE paid may deviate, perhaps substantially, from such reserves.
are not likely to be resolved in the near future. Everest Re establishes reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for Everest Re or its ceding company. Due to the uncertainties discussed above, the ultimate losses may vary materially from current loss reserves and, if coverage under the Stop Loss Agreement were exhausted, could have a material adverse effect on the Company's future financial condition, results of operations and cash flows.
The $222.3 million of reinsurance receivables as of December 31, 1996 was attributable principally to two retrocessional arrangements: (i) $116.4 million was due from various insurance and reinsurance companies, including Gibraltar, in connection with their participation in Everest Re's management underwriting facility ("MUF"), a reinsurance arrangement begun in 1977 pursuant to which Everest Re ceded certain reinsurance and direct excess insurance business; and (ii) $105.9 million was due as a result of the Company's former direct excess insurance operations, which ceased writing business in 1985 and which has been 100% ceded to Gibraltar since 1986. Paid losses for 1994 reflects the settlement of all asbestos-related claims from one ceding company, which management believes represents a settlement of Everest Re's largest asbestos-related exposure to any one ceding company.
STOP LOSS AGREEMENT AND PRUDENTIAL GUARANTEES. To the extent reserves as of June 30, 1995 (December 31, 1994 for catastrophe losses) for losses, allocated LAE and uncollectible reinsurance experience adverse development ("Adverse Development"), Everest Re is entitled, at the time reserves are increased, to payments under the Stop Loss Agreement, subject to the limit and other terms thereof. Gibraltar's obligations to make payments to Everest Re under the Stop Loss Agreement are guaranteed by The Prudential. Management expects that the general effect of the Stop Loss Agreement will be to protect the Company's consolidated earnings against up to $375.0 million of the first $400.0 million of Adverse Development. There can be no assurance, however, that the Company's net liability for such Adverse Development will be limited to $25.0 million. With respect to liquidity, the incurred loss reimbursement features of these agreements provide the Company with cash on or prior to the time it is required to
STOCKHOLDER'S EQUITY. Holdings' stockholder's equity increased to $1,086.0 million as of December 31, 1996 from $983.6 million as of December 31, 1995 principally reflecting $106.0 million in retained earnings for the year. Stockholder's equity as of December 31, 1995 increased to $983.6 million from $741.0 million as of December 31, 1994, principally reflecting the addition to paid in capital that offset the impact of non-recurring IPO related charges and an increase of $141.9 million in unrealized appreciation (depreciation) on investments, net of deferred taxes. Dividends of $6.1 million, $7.0 million and $7.5 million were declared and paid by Holdings in 1996, 1995 and 1994, respectively.
Holdings' stockholder's equity exceeded Everest Re's statutory-basis surplus by $313.3 million at December 31, 1996. The primary differences between GAAP and SAP as they relate to the Company are: (i) the deferral of acquisition costs under GAAP, which are immediately expensed under SAP; (ii) the provision for deferred taxes on temporary tax differences under GAAP, which are excluded under SAP; and (iii) the carrying at market value of fixed maturities available for sale under GAAP, as compared to at amortized cost under SAP.
LIQUIDITY AND CAPITAL RESOURCES EVEREST RE. Everest Re's liquidity requirements are met on both a short- and long-term basis by funds provided by premiums collected, investment income and collected reinsurance receivables balances, and from the sale and maturity of investments. Everest Re's net cash flows from operating activities were $414.0 million, $397.9 million, as adjusted, and $192.9 million in 1996, 1995 and 1994, respectively. The increases over 1994 in cash provided by operating activities were principally a result of decreases in net paid losses, including recoveries under the Stop Loss Agreement, and improved profitability. Recoveries under the Company's Stop Loss Agreement with Gibraltar contributed $53.4 million and $12.0 million of such net cash flows in 1996 and 1995, respectively.
Proceeds and applications from sales and acquisitions of investment assets were $1,632.9 million and $2,034.8 million, respectively, in 1996, compared to $1,113.4 million and $1,494.7 million, respectively, in 1995 and $1,362.5 million and $1,572.7 million, respectively, in 1994. Everest Re's current investment strategy seeks to maximize after-tax income through a high quality, diversified, duration sensitive, taxable bond and tax-exempt municipal bond portfolio, while maintaining an adequate level of liquidity.
HOLDINGS. Holdings is a holding company whose only material asset is the capital stock of Everest Re. Holdings' cash flow will consist primarily of dividends and other permissible payments from Everest Re. Holdings depends upon such payments for funds for general corporate purposes and for the payment of any dividends on its common stock. Holdings expects to finalize a $50.0 million bank line of credit as a means of expanding the liquidity options of the Company's operating subsidiaries.
The payment of dividends to Holdings by Everest Re is subject to limitations imposed by the Delaware Code. Based upon these restrictions, the maximum amount that will be available for payment of dividends to Holdings by Everest Re in 1997 without the prior approval of regulatory authorities is $84.4 million. Everest Re's future cash flow available to Holdings may be influenced by a variety of factors, including cyclical changes in the property and casualty reinsurance market, Everest Re's financial results, insurance regulatory changes and changes in general