We conduct our operations from leased office space located at Cumberland House, 1 Victoria Street, Hamilton, HM 11, Bermuda. Annuity and Life Re America conducts its operations from leased space located at 280 Trumbull Street, Hartford, Connecticut, USA. We believe our space is adequate to meet our current and expected needs.
The following table sets forth selected financial data and other operating information. The selected financial data have been derived from our consolidated financial statements and should be read in conjunction with our consolidated financial statements and accompanying notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this report.
With the exception of historical information, the matters contained in the following analysis are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act. Such statements may include, but are not limited to, projections of earnings, revenues, income or loss, capital expenditures, plans for future operations and financing needs or plans, as well as assumptions relating to the foregoing. The words "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.
Factors that could cause our actual results of operations or financial condition to differ from those described in this report include, but are not necessarily limited to, the following:
- We face significant competition from major U.S. and non-U.S. reinsurers, many of which are well established and have substantially greater financial, marketing and management resources than we do. Competition in the reinsurance business is based on many factors, including premium charges, reputation, financial strength, terms and conditions of products offered, financial ratings, claims adjudication philosophy and general industry experience. If we are unable to maintain or increase our position in the market our business could be adversely affected. Furthermore, because we rely on a small number of clients, our business is more susceptible to the adverse effects of competition from other reinsurers.
- Management of our underwriting risk is critical to the success of our business. In particular, we structure our investments to match our anticipated liabilities under reinsurance policies. If our calculations with respect to our reinsurance liabilities are incorrect, or if we improperly structure our investments to match such liabilities, we could have unexpected losses, including losses resulting from forced liquidation of investments prior to their maturity.
- Our success is dependent on our ability to manage our investment risks. The success of our investment strategy may be affected by general economic conditions, which can adversely affect the markets for
interest-rate-sensitive securities and equity securities, including the level and volatility of interest rates and the extent and timing of investor participation in these markets. Unexpected volatility or illiquidity in the markets in which we directly or indirectly hold positions could adversely affect our business. Our investment guidelines permit us to make some investments in below investment grade fixed income securities. While any investment carries some risk, the risks associated with lower-rated securities generally are greater than the risks associated with investment grade securities. We may also seek to hedge the equity related investment risk associated with our products. If we fail to match the equity related asset risk accurately with the equity related liabilities we could be exposed to the volatility of the equity markets. This could result in losses, which, in turn could adversely affect our business.
- All of our funds withheld assets related to our annuity reinsurance agreements are held and managed by our cedents or by investment managers appointed by our cedents. The performance of these assets, therefore, depends to a great extent on the ability of our cedents, or our cedents' investment managers, to make appropriate investments. If these assets do not accumulate at rates sufficient to meet minimum guarantees on the underlying policies before the policyholder surrenders the policy, we could be forced to fund these minimum guarantees. This could result in significant losses which, in turn could adversely affect our business.
- Some of the products offered by our cedents allow policyholders to withdraw their funds under certain circumstances. We seek to manage our investment portfolios so as to provide and maintain sufficient liquidity to support anticipated withdrawal demands. Unanticipated withdrawal or surrender activity may, under some circumstances, require us to dispose of assets on unfavorable terms, which could have an adverse affect on our business.
- Terrorist attacks may negatively affect our operations. There can be no assurance that there will not be further terrorist attacks against the United States or United States businesses. As a result of terrorism, the United States has entered into an armed conflict which could have a further impact on our business. Political and economic instability in some regions of the world may also result and could negatively impact our business. The consequences of further terrorist attacks and these armed conflicts are unpredictable, and we may not be able to foresee events that could have an adverse affect on our business.
- Our success is dependent upon our ability to attract and retain key executive officers. The loss of the services of key individuals, our inability to hire and retain other talented personnel, or our inability to secure appropriate work permits could adversely affect our business.
- We are subject to the laws and regulations of the jurisdictions in which we conduct business. These laws and regulations cover many aspects of our business, including licensure, premium rates, marketing practices and capital adequacy. Recently, the insurance and reinsurance regulatory framework has become subject to increased scrutiny in many jurisdictions and regulators have started to reexamine existing laws and regulations. Changes in these laws and regulations could have an adverse affect on our operations.
- The market for annuities and many life insurance products in the United States is based in part on the favorable tax treatment such products receive relative to certain other investment alternatives. Any material change in such tax treatment would have an adverse affect on the market for such products. In addition, many life insurance products are used to reduce federal estate tax obligations. The United States Congress has recently adopted legislation that eliminates federal estate tax over a ten-year period. Under this legislation, the demand for life insurance products could be reduced, which in turn could adversely affect our business.
- As a holding company, we have no significant operations or assets other than our ownership of the capital stock of our subsidiaries. Dividends and other permitted payments from our subsidiaries are our sole source of funds to pay expenses and dividends. The payment of dividends to us by our subsidiaries is subject to and limited by regulatory restrictions. Accordingly, there is no assurance that we will declare and pay dividends in the future.
Our two major business lines are life reinsurance and annuity reinsurance. Reinsurance agreements typically remain in force for the life of the underlying policies reinsured which range from ten to thirty years. Each year, a portion of the business under an existing treaty terminates due to, among other things, surrenders and/or lapses of underlying policies, deaths of underlying insureds and the exercise of recapture options.
Our primary annuity products are reinsurance of fixed deferred annuities and payout annuities structures. Profitability of the annuity reinsurance line is primarily dependent on earning a spread between the interest rate earned on the assets under management and the interest rate credited to the policyholder. This product line is market and interest rate sensitive. Fluctuations in the general level of interest rates, fixed income markets, and equity markets from period to period may cause fluctuations in the results of operations. This product line can be adversely impacted by the combined effects of poor market performance and excessive surrender rates, which occurred in 2001. At December 31, 2001 and 2000, our liability for annuity contracts amounted to approximately $1.5 billion.
We report our fixed maturity investments at fair value (our securities are classified as available for sale) with any change in their fair value reported as a change in accumulated comprehensive income. If we
Reinsurance premium revenues from life products with mortality risk are recognized when due from the policyholders. For those policies with premium paying periods that are significantly shorter than the total period over which benefits are expected to be provided, profits are deferred and recognized as income in a constant relationship to the insurance in force or, for annuities, in relation to the amount of expected future benefit payments. Premiums from universal life and investment-type contracts are reported in the balance sheet as interest sensitive contracts liability. Revenues from these investment type contracts consist of income earned on the assets and amounts assessed during the period against policyholders' account balances for mortality charges, policy administration charges and surrender charges. Deposit accounting procedures are applied to considerations received or paid relating to reinsurance contracts that do not qualify for reinsurance accounting. Policy benefits and claims that are charged to expense include benefit claims incurred in the period in excess of related policyholders' account balances.
Net Loss. For the year ended December 31, 2001, we had a consolidated net loss of $(38,710,000), $(1.51) per primary and fully diluted common share, compared to net income of $39,987,000, $1.57 per primary common share and $1.46 per fully diluted common share, for the year ended December 31, 2000. As more fully discussed below, our results for 2001 were adversely affected by poor performance on a major annuity reinsurance contract, adverse mortality experience on two major life reinsurance contracts, and the September 11th tragedy.
Our net operating loss for the year ended December 31, 2001 was $(39,940,000), compared with net operating income of $44,804,000 for the year ended December 31, 2000. The net operating loss was the result of a $33,000,000 charge related to minimum interest guarantees, a $24,700,000 charge for non-recoverable deferred acquisition costs, a $16,000,000 loss from adverse mortality experience on two of our inforce life reinsurance contracts underwritten in 1998, and a $12,000,000 charge for the September 11 tragedy. The first two charges both relate to our largest annuity reinsurance contract, and result from the combined impact of excessive surrenders and poor investment performance. As discussed elsewhere in this report we are seeking relief from our ceding reinsurers with respect to the two life reinsurance contracts mentioned above. If we are unable to rescind, recapture, reprice, or otherwise restructure these agreements, we may incur additional losses on these contracts in future periods.
Net Premiums. Net premium revenue for the year ended December 31, 2001 was $251,793,000, an increase of 50% over the year ended December 31, 2000. The majority of premium revenue was derived from traditional ordinary life reinsurance developed directly and through the use of intermediaries. The growth reflects the level of new business written and the increase in the face amount of insurance in force. At December 31, 2001 the total face amount of life insurance in force was approximately $117 billion compared with approximately $77 billion at December 31, 2000, an increase of 52%. New business writings and premium
Claims and Policy Benefits. Claims and Policy Benefits includes both life and annuity benefits. Life Insurance Claims and Policy Benefits for the year ended December 31, 2001 were $200,866,000 or 85% of net premium as compared with $115,953,000 or 77% of net premium for the year ended December 31, 2000. Aggregate mortality experience has been negatively impacted by $16,000,000 of adverse mortality experience on two of the Company's inforce life reinsurance contracts underwritten in 1998 and a $12,000,000 charge for the World Trade Center tragedy. As discussed elsewhere in this report we are seeking relief from our ceding reinsurers with respect to these two life reinsurance contracts. If we are unable to rescind, recapture, reprice, or otherwise restructure these agreements, we may incur additional losses on these contracts in future periods. The mortality experience of our book, excluding the two early life reinsurance contracts, is within pricing parameters. Although we expect mortality to be fairly constant over long periods of time, it will fluctuate from period to period. Reserves for future policy benefits are in part determined by claims reported from ceding companies, our aggregate experience and overall mortality trends.
Realized Investment Gains (Losses). Realized investment losses were approximately $(4,817,000) for the year ended December 31, 2000 compared with realized losses of $(1,285,000) for the year ended December 31, 1999. These gains and losses result from normal active management of our investment portfolio intended to improve performance and increase operating income.
During the year ended December 31, 2000 we had unrealized gains of approximately $13,334,000, as compared with unrealized losses of $14,992,000 during the year ended December 31, 1999 which were included in Accumulated Other Comprehensive Income. The change in unrealized gains and losses is principally related to movements in the general level of interest rates.
Claims and Policy Benefits. Life Insurance Claims and Policy Benefits for the year ended December 31, 2000 were $115,953,000 or 77% of net premium as compared with $79,953,000 or 79% of net premium for the
year ended December 31, 1999. Aggregate mortality experience has been favorable, falling within pricing parameters. Although we expect mortality to be fairly constant over long periods of time, it will fluctuate from period to period. Reserves for future policy benefits are in part determined by claims reported from ceding companies, our aggregate experience and overall mortality trends.
of invested assets (2.0% of Stockholders Equity) at December 31, 2000. We limit our exposure to below investment grade securities to 10% of the amount by which invested assets exceed the related insurance liabilities, as these investments are subject to a higher degree of credit risk than investment grade securities. We monitor these 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. At December 31, 2001 there were two impaired securities, which were written down by $600,000. At December 31, 2000 there was one impaired security, which was written down by $1,000,000.
(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, including assets on deposit with reinsurers) at the end of each calendar quarter included in the indicated period.
At December 31, 2001, mortgage backed securities represented approximately 11% of invested assets, as compared with 30% at December 31, 2000. Investors in these securities are compensated primarily for reinvestment risk rather than credit quality risk. Investments in mortgage backed securities include collateralized mortgage obligations ("CMO's") and mortgage backed pass-through securities. Mortgage backed securities generally are collateralized by mortgages issued by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"), all of which are agencies of the U.S. government. Of these, only GNMA mortgages are backed by the full faith and credit of the U.S. government. Credit risk generally is not a
consideration when investing in agency mortgage backed securities. Our mortgage backed securities portfolio had a weighted average investment quality rating of "AAA" at both December 31, 2001 and 2000.
Our liquidity and capital resources are a measure of our overall financial strength and our ability to generate cash flows from our operations to meet operating and growth needs. Our principal sources of funds are premiums received, net investment income, proceeds from investments called, redeemed or sold, funds drawn from our collateral funding facility (described below), and cash and short term investments. The principal obligations and uses of the funds are the payment of policy benefits, acquisition and operating expenses and the purchase of investments.
This reinsurance agreement does not qualify for reinsurance accounting under U.S. GAAP. As a result, funds received under this contract are recorded as a deposit liability. As part of this contract we deposited $41 million with the reinsurer, which is included in Deposits and other reinsurance receivables. We receive the benefit of investment income from the funds received and pay the third party reinsurer certain fees associated with the contract. For the year 2001, the fees were $1.2 million and are included in other insurance expenses.
Net cash used by operating activities was $(40,690,000) for the year ended December 31, 2001, as compared with cash provided by operations of $16,260,000 for the year ended December 31, 2000. The use of cash by our operating activities is primarily related to the net loss incurred for the year and its' related payments.
used to fund collateral requirements of our cedents. In the future, we may issue additional debt or other forms of capital to assist in meeting the collateralization needs of our cedents. During 2001 our Board of Directors approved a share repurchase program of up to $25,000,000 of our common stock. While our Board has given us the flexibility to repurchase our common stock in the future if market conditions so dictate, at the present time we anticipate utilizing this capital in the future to support our business growth.
During the year 2001 the Board of Directors declared and paid quarterly shareholder dividends of $.05 per share. 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 no assurance can be given that dividends will be declared or paid in the future.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE ANNUITY AND LIFE RE (HOLDINGS), LTD. AND SUBSIDIARIES
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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.
The consolidated financial statements include the accounts of Holdings and its subsidiaries, Annuity and Life Reassurance, Annuity and Life Re America and Annuity and Life Reassurance America. All significant inter-company accounts and transactions have been eliminated upon consolidation.
Premiums from universal life and investment-type contracts are reported in the balance sheet as interest sensitive contracts liability. Revenues from these investment type contracts consist of income earned on the assets and 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 costs of acquiring new business, principally allowances, which vary with and are primarily related to the production of new business, are deferred. Deferred policy acquisition costs are subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each accounting period.
(e) Reserves for future policy benefits and interest sensitive contracts liability
Premiums from universal life and investment-type contracts and benefit liabilities for traditional annuities (during the accumulation period) are reported in the balance sheet as interest sensitive contracts liability. Universal life and investment type contracts are recorded at their accumulated policyholder values (without reduction for potential surrender or withdrawal charges) plus any guaranteed minimum account value expected to be paid to the policyholder. Revenues from these investment type contracts consist of income earned on the assets and 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. Interest credited to policyholder account balances includes any interest cost associated with minimum guarantees expected to be paid in future periods.
Funds withheld at interest represents assets held by and managed by ceding companies in segmented portfolios under annuity reinsurance agreements. Under the terms of the reinsurance agreements investment income, which accrues to the Company, is based on the performance of the underlying portfolios. Assets in the underlying portfolios are managed by investment managers appointed by the cedent.
The Company accounts for stock option grants in accordance with APB opinion No. 25, "Accounting for Stock Issued to Employees" and FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB No. 25". Compensation expense for stock option grants is recognized to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is recorded over the shorter of the vesting or service period.
(b) The following table sets forth certain information regarding the investment ratings of the Company's fixed interest securities portfolio at December 31, 2001 and 2000.
(c) At December 31, 2001 and 2000 letters of credit totaling $197 million and $184 million, respectively, issued in the ordinary course of the Company's business had been issued by the Company's bankers in favor of certain ceding insurance companies. At December 31, 2001 and 2000 cash and investments of $112 million and $161 million, respectively, were pledged as collateral for these letters of credit.
(d) The maturity distribution of fixed income securities held as of December 31, 2001 and 2000 is shown below. Actual maturity dates may differ from contractual maturity dates because certain borrowers have the ability to prepay their obligations without penalty.
The exercise price of the Warrants, which is subject to adjustment, is $15.00, which was equal to the initial public offering price per share of the Company's common shares. The Class A Warrants are all currently exercisable. The Class A Warrants will expire on January 15, 2008. No Class A Warrants have been exercised at December 31, 2001.
The following table sets forth the computation of basic and diluted (loss) earnings per share.
As of December 31, 2001, 2000 and 1999 the Company had 1,860,536, 1,903,365, and 1,497,865 options outstanding, respectively. There were Class A and Class B warrants outstanding representing the right to acquire 3,457,490 shares in each of the above years. Inclusion of the incremental shares from assumed exercise of options and warrants is anti-dilutive in 2001. Consequently, they are not included in diluted EPS.
At December 31, 2001 and 2000 loans outstanding from management for such stock purchases were $1,000,000 and $1,150,000, respectively. Accrued interest on the notes was $317,259 and $217,241, respectively. Interest income of $100,018, $80,500, and $70,673 has been recognized for the years December 31, 2001, 2000 and 1999, respectively, on these loans.
The term of the options granted under the plan will not be more than ten years from the date of grant. Unless otherwise provided in the option agreement related to a specific grant, options granted under the Plan will be exercisable in three equal annual installments, commencing on the first anniversary of the grant date.
Each person who becomes an eligible non-employee Director, as defined in the plan, is automatically granted an option to purchase 15,000 common shares on the date he or she becomes an eligible non-employee Director. These options have an exercise price equal to the fair market value of the optioned common shares on the date the options are granted and are exercisable in three equal installments commencing with the first anniversary of the grant date. In addition, subject to certain conditions, each non-employee Director is automatically granted an option to purchase 2,500 common shares at each successive annual general meeting. These options have an exercise price equal to the fair market value of the optioned common shares on the date the options are granted and are immediately exercisable if granted after April 8, 1999.
At December 31, 2001, options to acquire 1,446,855 common shares were exercisable. The weighted average remaining contractual life of these exercisable options was 6.6 years.
The Company applies APB Opinion No. 25 and FASB Interpretation No. 44 in accounting for the Plan. Accordingly, no compensation cost has been recognized as the intrinsic value of the options was $nil at the measurement date. The net income and earnings per common share would have been reduced to the pro forma
The Company has entered into a retrocession agreement, which enables it to limit the amount of life reinsurance it retains to $1,000,000 per single life. The contract is automatic and effective for risks assumed and in force since from January 1, 1997. The limit of cover is $50 million and covers all single and joint life reinsurance assumed by the Company. At December 31, 2001 and 2000 the Company ceded approximately $493 million and $193 million of in force insurance coverage for a premium of $1,449,000 and $1,146,000, respectively. At December 31, 2001, $1,150,000 was recoverable from our reinsurers. There was no recoverable at December 31, 2000.
It should be noted that retrocession agreements do not relieve the Company from its obligations to its reinsureds and failure of the Company's reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors any concentrations of credit risk that may develop to minimize its exposure. The parties to the retrocession agreement described above have current credit rating of A+ or better, as assigned by A. M. Best.
9. RESERVES FOR FUTURE POLICY BENEFITS, INTEREST SENSITIVE CONTRACT LIABILITIES, AND CONTINGENCIES
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 contracts. The underlying parties to these contracts are large insurance companies based in the United States and Canada.
are the result of excessive surrenders by policyholders coupled with poor investment performance on the assets managed by the cedent. The total amount of Funds withheld at interest and the Interest sensitive contracts liability for this contract are $962 million and $1,007 million, respectively. While management has made what it believes to be adequate provision for future costs based upon reasonable assumptions about future investment performance and surrenders, the provision is an estimate. Actual amounts paid may be significantly higher or lower than the current reserve. XL Capital, an affiliated party, has agreed to provide additional protection for up to $10 million against further deterioration in this contract.
The Company plans to invoke the arbitration provisions of our reinsurance agreement in connection with our largest life reinsurance contract. The claim is based upon our contention that the cedent failed to disclose material facts, known to the cedent, about the block of business being reinsured when it was underwritten.
The following discussion outlines the methodologies and assumptions used to determine the estimated fair value of the Company's financial instruments. Considerable judgment is required to develop these fair values. Accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of the Company's financial instruments.
Fair value disclosures are not required for reinsurance balances recoverable, deferred policy acquisition costs, or liabilities arising from insurance contracts. As a result, they have not been determined by the
The Company writes a number of ordinary life reinsurance and annuity reinsurance contracts. The Company views life and annuity reinsurance as one business segment and accumulates financial data for this segment when assessing performance and allocating resources.
The acquisition has been accounted for as a purchase and the operating results of Annuity and Life Reassurance America have been included in the Company's financial statements since the date of acquisition. Prior to closing, the inforce insurance business of Annuity and Life Reassurance America was 100% reinsured by Annuity and Life Reassurance America with its former owner, a subsidiary of Swiss Re, who will continue to administer the business reinsured. Accordingly, there will be no earnings from the in-force business at the acquisition date accruing to the Company currently or in the future.
During 2001, the Company entered into a reinsurance agreement with a third party reinsurer to cede excess U.S. Statutory reserves (the amount by which the cedents U.S. Statutory reserves exceeds our U.S. GAAP reserves for certain life insurance contracts subject to certain state statutory regulations known as Triple-X) to the reinsurer. Under the agreement, the reinsurer is obligated to fund the collateral requirements associated with these excess U.S. Statutory reserves by making cash deposits with the Company. As of December 31, 2001, we had received deposits of $137 million from the reinsurer. We expect to cede additional excess U.S. Statutory reserves to, and receive additional deposits from, the reinsurer in the future.
The effective tax rate provided for in the financial statements is computed at a rate of zero. Substantially all income is exempt from taxation.
Under current Bermuda law neither Holdings nor Annuity and Life Reassurance is required to pay any taxes in Bermuda on either income or capital gains. Holdings and Annuity and Life Reassurance have each received an assurance from the Minister of Finance in Bermuda that in the event of any such taxes being imposed the Company will be exempted from taxation until the year 2016. Annuity and Life Reassurance 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.
Annuity and Life Reassurance America is subject to statutory regulations of the state of Connecticut of the United States that restrict the payment of dividends. It may not pay dividends in any 12-month period in excess of the greater of the prior year's statutory operating income or 10% of capital and surplus at the end of the preceding year, without regulatory approval. At December 31, 2001 the statutory capital and surplus of Annuity and Life Reassurance America is $19,749,000.