The following table sets forth selected financial data and other operating information. The selected financial data have been derived from the consolidated financial statements of Life Re Corporation and Subsidiaries ("Life Re") and should be read in conjunction with the consolidated financial statements and accompanying notes of Life Re and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein.
- --------------- (1) Capital invested in Administrative Reinsurance transactions represents the sum of the consideration paid for life insurance in force acquired and the related capital to support the business.
Mortality and morbidity experience, both significant factors in the determination of the results of operations of Life Re, generally are predictable over time but are subject to fluctuations from year to year and quarter to quarter. Significant fluctuations from period to period could adversely affect Life Re's results of operations.
Life Re's reinsurance agreements frequently provide for rights of recapture, which permit the ceding company to increase the amount of liability it retains on the reinsured policies after the policies have remained in force for a designated period of time (generally ten to twenty years). Accordingly, an increase in the amount of liability retained by the ceding company will decrease both Life Re's insurance in force and premiums to be received from the reinsured policies. To date, recaptures have not had a material impact on Life Re's results of operations.
In 1998, Life Re derived approximately 68% of its policy revenues from traditional life reinsurance, which includes ordinary and group life reinsurance. Ordinary life reinsurance policy revenues were derived under agreements with approximately 500 ceding companies and accounted for approximately 65% of total policy
revenues. The agreements cover primarily new business to be written by the client and/or existing blocks of in force business. This business is predominately marketed directly by Life Re without the use of intermediaries. In 1998, 64 ceding companies each accounted for at least $1.0 million of ordinary life reinsurance policy revenues and in the aggregate represented approximately 95% of Life Re's ordinary life reinsurance policy revenues.
During 1998 and 1997, Life Re completed several transactions through which it acquired blocks of insurance in force (collectively, the "Transactions"). The 1998 transactions were the acquisition of 100% of the common stock of Capitol Bankers Life Insurance Company, Mission Life Insurance Company, Lincoln Liberty Life Insurance Company, First Delaware Life Insurance Company, Atlas Life Insurance Company, Aristar Life Insurance Company and First Capital Life Insurance Company of Louisiana. In 1998, Life Re also entered into several indemnity reinsurance agreements and recaptured the 40% retroceded portion of a block of business assumed in 1997 in conjunction with Employers Reassurance Corporation from Allianz Life Insurance Company of North America ("Allianz"). The 1998 transactions represented assets acquired of approximately $850.0 million. The 1997 transactions, which were the 79% stock purchase of AML Acquisition Company, parent of American Merchants Life Insurance Company, a coinsurance agreement with UNUM Life Insurance Company of America and the coinsurance agreement with Employers Reassurance Corporation covering in force business of Allianz, together represented assets acquired of approximately $970.0 million. The assets received as a result of the Transactions consisted primarily of cash and high quality investments. The Transactions were accounted for under the purchase method of accounting, and therefore, results of operations include the effect of the Transactions only from their respective dates of acquisition. For
NET INCOME decreased by $81.9 million in 1998 to a loss of $32.4 million, compared with $49.5 million of income in 1997; in 1996, net income was $54.2 million. Included in the 1998 results were pretax costs related to the Merger of $107.4 million. Income taxes in excess of the statutory rate in 1998 resulted from the non-deductibility of certain of these costs. After-tax realized investment gains of $2.0 million and $2.9 million in 1998 and 1997, respectively, were also included in these results. In March 1996, Life Re realized a gain of $13.5 million from the sale of its equity investment in Nacolah Holding Corporation, parent of North American Company for Life and Health Insurance (see Note 6 of "Notes to Consolidated Financial Statements"). Life Re utilized existing tax net operating loss carryforwards to offset the taxes otherwise payable in connection with the gain and reversed an existing deferred tax valuation allowance, resulting in a tax benefit of $4.8 million.
EARNINGS EXCLUDING REALIZED INVESTMENT GAINS AND AFTER-TAX MERGER COSTS increased by $15.5 million, or 33%, to $62.1 million in 1998 compared with $46.6 million in 1997 and $38.3 million in 1996. The increase in earnings experienced in 1998 and 1997 was due to higher volumes of ordinary life reinsurance in force and the Transactions, partially offset by a deterioration in accident and health morbidity experience.
The growth in ordinary life reinsurance revenues largely was due to new reinsurance agreements entered into during the last three years. First year premiums totaled $77.8 million in 1998 and increased by 72% and 53% in 1998 and 1997, respectively. The ordinary life reinsurance in force lapse rate has ranged from 9-11% during the last three years.
The growth in Administrative Reinsurance policy revenues was due to the Transactions and an increase in automobile credit reinsurance premiums.
Group accident and health and special risk premiums decreased by $62.3 million in 1998 due to Life Re's aforementioned reduced participations and retrocession agreement. Due to Life Re's decision to exit the accident and health and special risk reinsurance business, it anticipates further declines in group accident and health and special risk premiums of 80% in 1999. Premiums are expected to be minimal beyond 2000. Growth in 1996 was due principally to increased participation in major medical and accident reinsurance pools and quota share arrangements.
INVESTMENT INCOME increased by 55% in 1998 to $233.9 million and by 21% in 1997 to $151.0 million. These increases largely were due to the growth in invested assets resulting from the Transactions and the proceeds received from the issuance of common stock and Adjustable Conversion-rate Equity Security Units (see Financial Condition and Liquidity section). This rate of growth is dependent on new Administrative Reinsurance transactions and, to a lesser extent, new ordinary life reinsurance business. The weighted average portfolio yield rate (amortized cost basis) was 7.1% in 1998, 7.4% in 1997 and 7.8% in 1996. The decrease in the yield rate primarily is due to the investment of assets acquired from the Transactions at current rates.
INTEREST CREDITED TO POLICYHOLDER ACCOUNTS increased by 86% in 1998 and by 17% in 1997. These increases are attributable to Transactions as the majority of the policy benefit liabilities acquired in these transactions are interest sensitive.
INTEREST EXPENSE decreased to $7.4 million in 1998 from $8.0 million in 1997 and $8.4 million in 1996. In 1998, interest expense decreased due to the repayment of bank loans on December 1, 1998. This decrease in 1997 was due to (i) a decrease in the weighted average variable rate charged on outstanding debt, which decreased to 6.0% in 1997 from 6.2% in 1996 and (ii) a decrease in the outstanding principal balance to $125.0 million resulting from a first quarter 1996 repayment of $15.0 million.
MERGER COSTS of $107.4 million related primarily to severance and other compensation triggered by the Merger.
Invested assets at fair value amounted to $3,775.5 million and $2,784.6 million at December 31, 1998 and 1997, respectively. The increase in invested assets in 1998 resulted from the Transactions and the issuance of common stock and Adjustable Conversion-rate Equity Security Units in March 1998. Net unrealized gains on
Life Re's investment policy is designed to maintain a high quality portfolio, maximize current income, maintain a high degree of liquidity and match the cash flows of the portfolio to the required cash flows of Life Re's liabilities.
At December 31, 1998, approximately $95.1 million (at fair value), or less than 3%, of Life Re's invested assets consisted of below investment grade securities. Life Re generally limits its investments in fixed maturities that are rated below investment grade, as these investments are subject to a higher degree of credit risk than investment grade securities. Life Re closely monitors its below investment grade securities as well as the creditworthiness of the portfolio as a whole. When fair 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. In 1998, 1997 and 1996, Life Re wrote down the value of certain securities by $5.9 million, $2.6 million and $0.5 million, respectively. Life Re had no fixed maturities in default at December 31, 1998.
During 1998, 1997 and 1996, proceeds from sales of fixed maturities amounted to $799.7 million, $301.0 million and $253.4 million, respectively. The net gains realized from such sales were $7.4 million, $7.3 million and $1.8 million for the respective periods. The majority of the 1998 and 1997 sales was attributable to the restructuring of portfolios acquired in connection with the Transactions.
Life Re's obligations for policy benefit liabilities increased by 30% and 45% during 1998 and 1997, respectively. These increases resulted from the Transactions and increased reinsurance of new and in force life insurance. Policy benefits consist of the present value of future benefits under traditional ordinary and group
On June 6, 1997, Life Re completed a private placement under Rule 144A of the Securities Act of 1933, as amended, of $100.0 million of 8.72% capital securities of Life Re Capital Trust I ("Trust I"), a subsidiary of Life Re. Distributions are cumulative and payable in arrears beginning December 15, 1997. The securities have a maturity date of June 15, 2027 and may be redeemed at any time on or after June 12, 2007. Payments on the securities are fully and unconditionally guaranteed by Life Re. The securities have an effective interest rate of 8.75%. The assets of the Trust I consist of junior subordinated debentures issued by Life Re which have terms that parallel the terms of the capital securities.
Shareholder's equity increased by $442.3 million to $816.1 million at December 31, 1998 from $373.8 million at December 31, 1997 primarily as a result of the issuance of common stock for $219.1 million, a capital contribution of $207.6 million and a tax benefit $56.4 million, partially offset by a net loss of $32.4 million, common shareholder dividends of $7.2 million, issuance costs of Trust II securities of $3.4 million and an unrealized loss of $1.3 million.
Dividends paid to common shareholders were $.45 per share in 1998, $.52 per share in 1997 and $.40 per share in 1996.
Sources of liquidity are available to Life Re in the form of cash and short-term investments and, if necessary, the sale of invested assets. Life Re may enter into reverse repurchase agreements to fund short-term cash needs. Additionally, Life Re believes that it has a significant source of capital and liquidity from its ultimate parent, Swiss Reinsurance Company. In addition to its capital securities distribution obligations, Life Re's financial obligations consist of policy benefit and acquisition costs, taxes and general operating expenses. During the next twelve months, management believes these obligations will be adequately provided for by policy revenues and investment income.
earnings and surplus of its subsidiaries. The following table shows surplus debenture interest payments and dividends received by the Parent for the last three years as well as dividends available for payment in that year without prior approval of state regulatory authorities, and dividends paid to TexasRe for the last three years as well as dividends available for payment to TexasRe in that year without prior approval of state regulatory authorities:
Life Re has sent questionnaires to its ceding company clients to determine the extent to which data received and utilized by Life Re is vulnerable to those third parties failure to remediate their own year 2000 issues. Life Re has received responses from a significant number of these clients and is in the process of evaluating the information. There is no guarantee that the systems of other companies on which Life Re may rely for data will be timely converted and would not have an adverse effect on analyses and reports that utilize
Management of the Company has established and maintains a system of internal control that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. In addition, the adequacy and effectiveness of the system of internal control is reviewed periodically by the Company's internal auditors.
The Company's financial statements have been audited by independent auditors. The independent auditors have unrestricted access to each member of management in conducting their audit. Management has made available to the independent auditors all of the Company's financial records and related data, as well as the minutes of shareholders' and directors' meetings. Furthermore, management believes that all representations made to the independent auditors during their audits were valid and appropriate.
We have audited the accompanying consolidated balance sheets of Life Re Corporation and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations and comprehensive income, changes in shareholder's equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
The accompanying consolidated financial statements of Life Re Corporation and Subsidiaries (the "Company") have been prepared in accordance with generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated. All dollar amounts are reported in thousands unless otherwise indicated.
The Company's business, which is conducted through its principal wholly owned life insurance subsidiaries, Life Reassurance Corporation of America ("LRCA") and Reassure America Life Insurance Company ("REALIC") and its 79% owned subsidiary, American Merchants Life Insurance Company ("AML"), consists of three segments: traditional life reinsurance, Administrative Reinsurance(SM) and group accident and health and special risk reinsurance. Traditional life reinsurance primarily involves the transfer to the Company of mortality risks on insurance products from primary (or ceding) insurers of ordinary and group life policies. Substantially all of the traditional life reinsurance business is marketed directly by the Company without the use of intermediaries. Administrative Reinsurance involves the acquisition of blocks of life insurance and/or annuity contracts in force. The Company obtains its Administrative Reinsurance business through purchases of life insurance companies and also through indemnity coinsurance and assumption reinsurance agreements with ceding insurers. The Company also assumes responsibility for policy administration of the business obtained from these transactions which it outsources to third party administrators.
Fixed maturities, consisting of bonds and redeemable preferred stocks, and equity securities, consisting of common and nonredeemable preferred stocks, are classified as available for sale and are reported at fair value. Unrealized gains and losses on available for sale securities are recorded as other comprehensive income. These amounts are net of deferred income taxes and a valuation adjustment which represents the change in amortization of deferred acquisition costs that would have been recorded as a charge or credit to operations had the relating unrealized gains or losses been realized.
The following methods and assumptions were used by the Company to estimate the fair value of financial instruments reported or disclosed in the financial statements.
Future policy benefits for annuities and interest sensitive life insurance contracts are recorded at accumulated policyholder account values.
Policy claims include amounts determined on an individual case basis for reported claims and estimates of incurred but not reported claims developed on the basis of past experience.
The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities calculated using the tax rate in effect at the measurement date.
Earnings per share are not required to be presented in the financial statements of wholly owned subsidiaries.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). The Company does not expect the implementation of SFAS 133 will have a significant impact on its financial statements.
On December 1, 1998, Swiss Re acquired all of the outstanding common shares of Life Re Corporation for $95.00 per share. Additionally, consideration equal to the excess of $95.00 over the exercise price of each option was paid in exchange for the cancellation of all outstanding common stock options. The total cash purchase price was $1,801,151. Pursuant to the Merger, the Company became a wholly owned indirect subsidiary of Swiss Re. Costs incurred by the Company related to the Merger, primarily severance payments to certain executives and employees and compensation arrangements triggered by the Merger, are separately stated in the consolidated statement of operations and comprehensive income. Concurrently with the Merger, the Company received a capital contribution of $207,600 from Swiss Re and repaid all outstanding bank loans.
The following table summarizes the acquisitions and in force reinsurance transactions completed by the Company during the three years ended December 31, 1998. These transactions were accounted for as purchases and therefore results of operations include their effects only from their respective dates of acquisition. Significant transactions are further discussed below.
Effective June 30, 1998, the Company acquired, for a purchase price of $70,834, 100% of the common stock of Capitol Bankers Life Insurance Company ("Capitol Bankers"), an indirect subsidiary of The Manufacturers Life Insurance Company. The fair values of the assets acquired and liabilities assumed were approximately $183,148 and $118,210, respectively.
During 1998, the Company acquired, and merged into REALIC, Atlas Life Insurance Company and Aristar Life Insurance Company. The purchase price of these companies was $29,338 and $22,890, respectively. Together they had assets at fair value of $240,200 and liabilities of $188,241.
Effective December 30, 1997, the Company entered into an indemnity reinsurance agreement to coinsure 60% of a block of life insurance policies and annuity contracts coinsured by Employers Reassurance Corporation ("ERAC") from Allianz Life Insurance Company of North America. The Company simultaneously retroceded to ERC Life Insurance Company ("ERC Life"), a subsidiary of ERAC, on a modified coinsurance basis, 67% of the business assumed. The Company recorded a liability for policy benefits aggregating $683,345 and received assets, primarily fixed maturities, with a fair value of $652,019. The Company is required to maintain assets in a trust at least equal to the statutory reserves reinsured. The trust assets are managed by the Company's primary investment manager and are included in total investments in the accompanying balance sheet. The Company administers the entire block using a third party administrator. During 1998, the Company recaptured the business retroceded to ERC Life.
On March 4, 1999, the Company announced that it has entered into an agreement to acquire 100% of the common stock of Royal Maccabees Life Insurance Company and its wholly owned subsidiary, Royal Life Insurance Company of New York (collectively "Royal"), from Royal Sun Alliance Group plc for approximately $380,000. Royal has statutory assets of approximately $2,600,000. Its business consists primarily of individual and group life, annuities and disability income contracts. The transaction, which is subject to regulatory and other approvals, is expected to close during the second or third quarter of 1999.
Securities with a fair value of $101,182 at December 31, 1998 are owned by a ceding company and held in a dedicated portfolio in conjunction with an indemnity reinsurance agreement. Under the terms of the agreement, investment income, realized gains and losses and all other risks and rewards of ownership of the assets in the portfolio inure to the benefit or detriment of the Company. Accordingly, these assets, consisting of $96,922 of fixed maturities and $1,018 of equity securities classified as available for sale and $3,242 of short-term investments at December 31, 1998, have been included as investments in the accompanying balance sheet. The portfolio is managed by the Company's primary investment advisor under guidelines approved by both parties to the reinsurance agreement, subject to the requirement that the statutory carrying value of the assets in the dedicated portfolio must be maintained by the Company in an amount at least equal to the statutory reserves on the reinsured business.
Securities with a fair value of $146,550 at December 31, 1998 were on deposit with various governmental insurance regulatory agencies to comply with applicable insurance laws.
At December 31, 1998, the contractual maturities of investments in fixed maturities are as follows:
Investments in any entity in excess of ten percent of shareholder's equity at December 31, 1998, other than investments issued or guaranteed by the U.S. government, are as follows:
On March 18, 1996, Life Re Corporation sold its equity investment in Nacolah Holding Corporation ("Nacolah"), the parent of North American Company for Life and Health Insurance, in connection with the acquisition of Nacolah by Sammons Enterprises, Inc. The Company received proceeds of $25,057 and recorded a realized investment gain of $13,540.
The deferred income tax balances, included in other liabilities, are as follows:
At December 31, 1998, income taxes recoverable of $29,419, included in other assets, reflect a refund anticipated from the carryback of tax operating losses generated in 1998 primarily from Merger related compensation and cancellation consideration for non qualified stock options as well as reinsurance ceding allowances. Life insurance company operating losses of approximately $205,000 are available for carryforward which generally expire after 15 years. The Company has performed an actuarial valuation which indicates that its existing business will generate income in the carryforward period sufficient to utilize the operating losses. Therefore no valuation allowance has been established. In 1998, the provision for federal income taxes of $24,003 differed from an expected tax benefit of $2,946 based on the statutory rate of 35% primarily due to certain non-deductible Merger compensation payments. In 1996, the realized gain on the sale of Nacolah (Note 6) and other income triggered the utilization of tax net operating loss carryforwards available to Life Re Corporation and a corresponding reversal of the previously established deferred tax valuation allowance, resulting in a tax benefit of $4,775. This reduced the effective income tax rate in 1996 to 29%.
9. LOANS PAYABLE AND CORPORATION-OBLIGATED, MANDATORILY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY PARENT DEBENTURES
On December 1, 1998 in conjunction with the Merger (Note 3), the Company repaid all outstanding bank loans. Interest paid on bank loans was $7,768, $8,083 and $8,774 in 1998, 1997 and 1996, respectively.
On June 6, 1997, the Company completed a private placement under Rule 144A of the Securities Act of 1933, as amended, of $100,000 of 8.72% capital securities of Life Re Capital Trust I ("Trust I"), a subsidiary of the Company. Distributions are cumulative and payable in arrears beginning December 15, 1997. The securities have a maturity date of June 15, 2027 and may be redeemed, at the option of the Company, at any time on or after June 15, 2007. Payments on the securities are fully and unconditionally guaranteed by the Company. The securities have an effective interest rate of 8.75%.
Pursuant to a stock repurchase program approved by the Company's Board of Directors, 2,150,400 shares of common stock out of a total authorization of 3,000,000 shares were acquired through December 31, 1997 for a total purchase price of $46,647. In conjunction with the Common Stock and Units Offerings, the Board of Directors elected to discontinue the stock repurchase program. The treasury stock was retired effective with the Merger.
The Merger was effected by the conversion of each outstanding common share into consideration of $95.00 and a concurrent recapitalization whereby Swiss Re, through its wholly owned subsidiaries, became the sole holder of the Company's preferred and common stock consisting of 1,000 and 100 shares, respectively. The preferred stock has no dividend rights and a liquidation preference at par value.
The availability of funds to meet obligations, including, capital security distributions is dependent, in part, on the ability of its subsidiaries to transfer funds to Life Re Corporation. The subsidiaries are subject to certain state laws and regulations which limit their ability to transfer funds and pay dividends. Generally, the
Life Re Corporation owns $160,500 of surplus debentures issued by TexasRe which provide funds to Life Re Corporation in the form of principal and interest payments. Under the terms of an amendment to TexasRe's surplus debentures, no prior approval of the Texas Department of Insurance is required to pay or prepay scheduled principal or interest on the surplus debentures provided that, after giving effect to any such payment, the statutory surplus of TexasRe exceeds $125,000. The amendment to TexasRe's surplus debentures was approved under the consideration that statutory surplus, as defined, in excess of $125,000 be reflected in liabilities to the extent of outstanding surplus debenture interest and principal. Payments of surplus debenture interest to Life Re Corporation by TexasRe totaled $9,237, $9,799 and $10,008 in 1998, 1997 and 1996, respectively.
The combined statutory basis financial position of TexasRe and subsidiaries as of December 31, 1998 and 1997 is as follows:
LIFE RE CORPORATION STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (PARENT COMPANY)