The Company also rents office space totaling approximately 450,000 square feet in Atlanta, Boston, Burlington (VT), Chicago, Columbus, Dallas, Denver, Florham Park (NJ), Hartford, Honolulu, Kansas City (KS), Los Angeles, Minneapolis, New York, Philadelphia, San Francisco, Seattle, Woodland Hills (CA), Brussels, Beijing, Melbourne, Sydney, Bermuda, Montreal, Toronto, Tokyo, Singapore and London. As a result of the Merger, American Re-Insurance assumed the lease obligations of MARC. American Re-Insurance is in the process of determining its needs with respect to such space which may include terminating certain leases.
The Company has invested significant amounts in computer resources, including electronic data processing equipment and the development of proprietary software to support its business. The Company's mainframe computer system is linked by a network to its domestic and most international branch operations. The Company utilizes its proprietary and other software systems in its day-to-day operations to support its businesses. For facultative operations, the Company uses proprietary facultative risk clearance, risk processing, accounts receivable, pro rata loss, excess of loss and management information systems. On-line facilities are available for (a) maintaining retrocessional participant information for financial reporting purposes, (b) treasury and claims services and (c) managing and administering treaty reinsurance. As part of the Company's disaster control strategy, all key data is backed up regularly for off site storage.
(1) 1996 balance sheet data and statutory data for all years has been restated to reflect the July 1997 Merger. See "Management's Discussion and Analysis of the Company's Results of Operations and Financial Condition."
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE COMPANY'S RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The exchange of MARC shares for American Re shares by Allianz and Victoria (totaling 50% of MARC's ownership) was accounted for using the purchase method for business combinations. The exchange of MARC shares for the Company's shares by Munich Re and the U.S. Branch (the remaining 50% of MARC's ownership) was accounted for as an "as-if-pooling of interests" business combination between parties under common control of the same parent company, Munich Re. The exchange of the insurance assets and liabilities of the U.S. Branch for the Company's shares was also accounted for as an "as-if-pooling of interests" business combination between parties under common control. Common control for American Re, MARC and the U.S. Branch was considered effective at December 31, 1996. As such, the Company's December 31, 1996, balance sheet and related footnote disclosures as originally filed in its 1996 Form 10-K, have been restated to reflect a 50% ownership of MARC, a 50% minority interest in the ownership of MARC by Allianz and Victoria, and a 100% ownership of the U.S. Branch.
The pro forma consolidated data does not purport to represent what the Company's financial position or results would have been had the Merger in fact occurred on the dates indicated above, or to project the Company's financial position or results of operations for any future dates or periods. The pro forma adjustments are based upon available information and certain assumptions that the Company believes are reasonable in the circumstances.
For statutory financial data, all totals have been restated to reflect the combination of financial results of the insurance/reinsurance subsidiaries, MARC, and the U.S. Branch.
period, which were previously written through MARC and the U.S. Branch in the 1996 period, in addition to the effect of foreign exchange translations from other currencies into the strengthening U.S. dollar.
The Company realized net capital gains of $87.7 million for the year ended December 31, 1997, compared to net capital gains of $4.8 million in 1996. On a pro forma basis, the Company experienced net capital gains of $27.8 million in 1996. This increase was primarily due to net capital gains of $67.9 million realized on equity securities sold in 1997, as compared to net capital gains of $22.8 million realized for the same period of 1996, and net capital gains realized on bonds sold of $26.2 million as compared to net capital gains of $9.8 million realized in 1996. MARC and the U.S. Branch had combined realized capital losses of $5.0 million in futures contracts during the 1996 period.
Federal and foreign income tax benefits were $3.4 million for the year ended December 31, 1997, compared to tax expense of $73.8 million in 1996. The decrease in Federal and foreign taxes was primarily due to recognition of net operating losses by the U.S. Branch prior to the Merger, resulting in a tax benefit of $24.4 million, in addition to the reversal of a valuation allowance that reduced the deferred tax asset associated with the U.S. Branch's loss reserve discount. This reversal of the valuation allowance resulted in a tax benefit of $37.7 million; the valuation allowance was reversed as the Company believes that the recognition of the deferred tax asset is more likely than not, based on its consolidated tax position.
The Company recognized an after-tax charge of $13.1 million for each of the years ended December 31, 1997 and 1996, representing the Company's minority interest in the earnings of American Re Capital, a single-purpose wholly owned subsidiary trust. The charge is due to the distributions incurred by American Re Capital on the Cumulative Quarterly Income Preferred Securities ("QUIPS").
YEAR ENDED DECEMBER 31, 1996, COMPARED WITH YEAR ENDED DECEMBER 31, 1995
The Company's net premiums written increased 16.7% to $1,902.4 million for the year ended December 31, 1996, from $1,629.5 million in 1995. Total treaty net premiums written increased 20.4% to $1,358.7 million for the year ended December 31, 1996, from $1,128.2 million in 1995, with increases in DICO's and International Operations' treaty net premiums written, partially offset by a decline in ARMI's treaty net premiums written. Facultative net premiums written increased 8.5% to $543.7 million for the year ended December 31, 1996, from $501.3 million in 1995, primarily due to both new accounts and the expansion of existing accounts. International net premiums written, which are included in the treaty and facultative amounts stated above, were $442.6 million, or 23.3% of total net premiums written for the year ended December 31, 1996, compared to $380.5 million, or 23.4% of total net premiums written in 1995. The Company believes the increase in international premium writings were attributable to its continued success in implementing its direct whole account marketing approach, as well as increasing opportunities in Latin America and Australia.
The Company's interest expense decreased by 10.9% to $54.1 million for the year ended December 31, 1996, from $60.7 million in 1995. This decrease was primarily attributable to the lower level of senior bank debt outstanding during the year ended December 31, 1996, compared to the 1995 period, under the Company's revolving credit facility. See "Financial Condition."
The Company realized net capital gains of $4.8 million for the year ended December 31, 1996, comprised of net capital gains of $3.9 million realized on bond sales and $0.9 million realized on the sale of other miscellaneous investments. The Company realized net capital gains of $4.7 million for the year ended December 31, 1995, comprised of net capital gains of $4.3 million on bond sales and $0.4 million realized on the sale of other miscellaneous investments.
The Company recorded income before income taxes, distributions on preferred securities of subsidiary trust, and extraordinary loss of $232.6 million for the year ended December 31, 1996, compared to a loss of $159.5 million in 1995. Federal and foreign income tax expenses were $73.8 million for the year ended December 31, 1996, compared to income tax benefits of $76.6 million in 1995.
The Company is a holding company which includes its principal subsidiary, American Re-Insurance. Based on statutory net premiums written of $2,491.7 million in 1997, American Re-Insurance ranked as the second largest property and casualty reinsurer in the U.S., according to Reinsurance Association of America statistics. The Company had total assets of $13,288.8 million and stockholders' equity of $2,586.4 million at December 31, 1997.
Total consolidated assets increased by 9.4% to $13,288.8 million at December 31, 1997, from $12,143.0 million at December 31, 1996. This increase was primarily due to an increase in cash and investments of $666.1 million and premiums due and other receivables of $167.6 million and goodwill associated with the Merger, due to the purchase of the MARC minority interest from Allianz and Victoria, of $182.5 million.
The total financial statement value of investments and cash increased to $7,673.4 million at December 31, 1997, from $7,007.3 million at December 31, 1996, primarily due to operating cash flows, the cash capital contribution from the Merger of $85.0 million, and an increase in the fair value of investments held. The financial statement value of the investment portfolio at December 31, 1997, included a net increase from amortized cost to fair value of $181.5 million for debt and equity investments, compared to a net increase of $84.9 million at December 31, 1996. At December 31, 1997, the Company recognized a cumulative unrealized gain of $118.0 million due to the net adjustment to fair value on debt and equity investments, after applicable income tax effects, which was reflected as a separate component of stockholders' equity. This represents a net increase to stockholders' equity of $62.8 million from the cumulative unrealized gain on debt and equity securities of $55.2 million recognized at December 31, 1996.
The Company's insurance/reinsurance subsidiaries' statutory surplus increased to $2,323.4 million at December 31, 1997, from $2,178.1 million at December 31, 1996. Operating leverage, as measured by such subsidiaries' premiums-to-surplus ratio, on an annualized basis was 1.07 to 1 and 1.21 to 1 at December 31, 1997, and December 31, 1996, respectively.
The Company's cash flow from operations may be influenced by a variety of other factors, including cyclical changes in the property and casualty reinsurance market, insurance regulatory initiatives, and changes in general economic conditions. Liquidity requirements are met on both a short- and long-term basis by funds provided by operations and from the maturity and the sale of investments. Cash provided by operations primarily consists of premiums collected, investment income, and reinsurance recoverable balances collected, less paid claims, retrocession payments, underwriting and interest expenses, QUIPS distributions, and income tax payments. Cash flows provided by operations for the Company were $366.1 million for 1997, $365.9 million for 1996, and $325.7 million in 1995.
Total cash proceeds in 1997 from sales of investments were $4,268.5 million compared to $1,203.5 million in 1996 and $1,011.3 million in 1995. Much of the increased activity in 1997 was due to the Merger, as the investment portfolio was significantly larger than prior years, in addition to a portfolio restructure, based on new investment managers' decisions and a redeployment into tax-exempt securities. Much of the activity in 1996 was due to an increase in the modified duration of the portfolio to 4.65 years at December 31, 1996, from 4.32 years at December 31, 1995, in addition to an overall redeployment out of tax-advantaged securities. Much of the activity in 1995 occurred due to a repositioning of the Company's foreign currency-denominated investments into longer duration securities, in addition to an overall redeployment out of tax-advantaged securities. Cash and cash equivalents were $641.6 million, $553.1 million, and $294.2 million, at December 31, 1997, 1996, and 1995, respectively. Cash and short-term investments are maintained for liquidity purposes and represented 8.4%, 7.9%, and 7.4%, respectively, of total financial statement investments and cash on such dates.
American Re has a $150 million unsecured bank credit agreement with Bank of America, NA. At December 31, 1997, $75 million remained available under the bank credit agreement.
Additionally, the Company is in the process of evaluating its underwriting risk arising from potential losses associated with Year 2000 failures and will continue to monitor its exposure to such risk. Generally, standard insurance and reinsurance contracts neither explicitly include nor explicitly exclude coverage for Year 2000 failures. As a result, some Year 2000-related losses may be determined to be covered under standard insurance and reinsurance contracts, depending upon the specific contract language and the facts and circumstances of each loss. The extent of Year 2000 losses which the Company may incur cannot be determined at this time, because of the uncertainty in both the nature and scope of Year 2000 related failures that are likely to occur and whether insurance or reinsurance may apply to losses arising from such failures. Given the possible magnitude of the Year 2000 problem, the Company may incur a significant amount of Year 2000 related losses that may have a material adverse impact on the Company's business, operations or financial condition. However, the Company believes it is taking reasonable and appropriate measures in the course of its business operations and client relationships to avoid or mitigate such Year 2000 related liability exposure.