We lease office space in Bermuda, where our executive offices are located. In addition, Stonington leases office space in Dallas, Texas, and our other U.S. based subsidiaries lease space in Richmond, Virginia and in Tampa Bay and Tallahassee, Florida. We believe our facilities are adequate for our current and anticipated needs.
The following table sets forth our selected financial data and other financial information at and for each of the years in the five year period ended December 31, 2001. The historical financial information was prepared in accordance with U.S. generally accepted accounting principles. The statement of income data for the years ended December 31, 2001, 2000, 1999, 1998 and 1997 and the balance sheet data at December 31, 2001, 2000, 1999, 1998 and 1997 were derived from our audited consolidated financial statements, which have been audited by Ernst & Young, our independent auditors. You should read the selected financial data in conjunction with our consolidated financial statements and related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this filing and all other information appearing elsewhere or incorporated into this filing by reference.
(1) Operating income excludes net realized gains or losses on investments.
(4) The item "Company obligated mandatorily redeemable capital securities of a subsidiary trust holding solely junior subordinated debentures of RenaissanceRe" reflects $87.6 million aggregate liquidation amount of the capital securities issued by a subsidiary trust. The sole assets of the trust are $87.6 million aggregate principal amount of 8.54% junior subordinated debentures due March 1, 2027 issued by RenaissanceRe.
We are a leader in utilizing sophisticated computer models to construct a superior portfolio of these property catastrophe coverages. We believe that a combination of several factors - our disciplined underwriting approach, the experience of our underwriters, as well as our sophisticated risk models - have enabled us to significantly outperform the majority of our competitors. This was especially evident during 2001 when we achieved an 18% operating return on equity even though industry insurance losses were at an all time high.
Our principal subsidiary is Renaissance Reinsurance, a Bermuda domiciled company. In 2001, Renaissance Reinsurance wrote $451.4 million of gross written premiums, compared to $382.8 million in 2000. Of these premiums, $373.9 million were derived from property catastrophe reinsurance coverage, compared to $345.0 million in 2000.
In recent years, we have formed certain joint ventures whereby we write property catastrophe reinsurance for the joint ventures in return for management fees and a profit participation. o In January 1999, we formed Top Layer Re with State Farm to provide high layer coverage for non-U.S. risks. Renaissance Reinsurance and State Farm each own 50% of Top Layer Re. o In October 2001, we formed DaVinci Reinsurance Ltd. with State Farm and other private investors. DaVinci writes property catastrophe reinsurance side-by-side with Renaissance Reinsurance and is consolidated in our financial statements. o In 1999, we were also appointed underwriting managers of OP Cat, a wholly owned subsidiary of Overseas Partners Limited ("Overseas Partners"). OPCat, like DaVinci, was formed to write property catastrophe reinsurance side-by-side with Renaissance Reinsurance. In February 2002, Overseas Partners decided to exit the reinsurance business. In conjunction with this decision, Renaissance Reinsurance has agreed to assume OP Cat's business.
DeSoto and DeSoto Prime are active in the Florida homeowners market. During 2001, DeSoto and DeSoto Prime wrote $11.2 million of primary homeowners insurance coverage, compared to $12.7 million in 2000.
In addition to the reinsurance and insurance coverages discussed above, from time to time, we may consider opportunistic diversification into new ventures, either through organic growth or the acquisition of other companies or books of business. In evaluating such new ventures, we seek an attractive return on equity, the ability to develop or capitalize on a competitive advantage, and opportunities that will not detract from our core reinsurance operations. Accordingly, we regularly review strategic opportunities and periodically engage in discussions regarding possible transactions, although there can be no assurance that we will complete any such transactions or that any such transaction would contribute materially to our results of operations or financial condition.
In estimating impairments to our deferred tax asset, we analyze the businesses which generated the deferred tax asset, and the businesses that will potentially utilize the deferred tax asset. Our deferred tax asset relates primarily to net operating loss carryforwards that are available to offset future taxes payable of our U.S. operating subsidiaries. However, due to the limited opportunities in the U.S. primary insurance market, the U.S. insurance operations have not generated taxable income in the last few years. This calls into question the recoverability of the deferred tax asset. Although we retain the benefit of this asset through 2020, during 2001 and 2000 we recorded valuation allowances of $14.0 million and $8.2 million, respectively. As of December 31, 2001, the net balance of the deferred tax asset was $4.2 million.
A summary of the significant components of our revenues and expenses are as follows:
The $11.9 million increase in operating income in 2001, compared to 2000, was primarily the result of the following items: o a $15.1 million increase in underwriting income from our reinsurance operations due primarily to an increase in net premiums earned of $64.1 million, in part offset by a $ 46.8 million increase in claims, plus o an increase in fee income from our joint ventures of $8.2 million, primarily as a result of fees earned in 2001 on premiums written on behalf of our joint ventures in 2000, plus o a reduction in interest and fixed charges of $8.6 million resulting primarily from the repayment of $200 million of outstanding bank loans in the fourth quarter of 2000, less o an increase in tax expense during 2001 as a result of a $14.0 million increase to our valuation allowance on our deferred tax asset as a result of further reductions of our U.S. based insurance operations (after this adjustment the net deferred tax asset on our balance sheet is $4.2 million), less o an increase in corporate expenses of $3.5 million primarily due to costs related to research and development initiatives conducted by us in 2001, less o a decrease in investment income of $2.7 million primarily as a result of declining interest rates.
The $14.4 million increase in operating income in 2000, compared to 1999, was primarily the result of the following items: o a $17.5 million increase in investment income primarily due to an increase in interest rates and an increase in the level of assets held during the majority of 2000, plus o an increase in fee income from our joint ventures of $7.9 million as a result of an increase in premiums written on behalf of our joint ventures to $80.2 million in 2000 compared with $4.3 million in 1999, less o an increase of $7.2 million in interest expense as a result of an increase in outstanding bank loans during the majority of 2000, less o a $6.2 million increase in tax expense during the year, primarily as a result of an $8.2 million increase to our valuation allowance on our deferred tax asset, as a result of a decrease in our U.S. based insurance operations.
Because of improving market conditions, we have increased our premiums in the Specialty Reinsurance market, which we define as reinsurance coverages that are not specifically property catastrophe coverages. In evaluating specialty reinsurance opportunities, we focus on those coverages which, like property catastrophe reinsurance, produce losses that are infrequent in nature, but could be severe if they occur. Examples include aviation, satellite, finite and catastrophe exposed workers compensation coverages.
- -------------------------------------------------------------------------------- Ceded Premiums Year ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- (In thousands)
Although we would remain liable to the extent that any of our reinsurers fails to pay our claims, before placing reinsurance we evaluate the financial condition of our reinsurers. We believe that our process is effective and, to date, we have not written off any significant reinsurance recoveries. As of December 31, 2001, the majority of the $217.6 million of losses recoverable relates to outstanding claims reserves on our books, and accordingly they cannot be collected by us until we first pay our losses. We expect to fully collect on all of this recorded reinsurance balance recoverable.
(1) The category "Worldwide (excluding U.S.)" consists of contracts that cover more than one geographic region (other than the U.S.). The exposure in this category for gross premiums written to date is predominantly from Europe and Japan.
(2) The category "Specialty Reinsurance" includes coverages related to non-catastrophe reinsurance risks assumed by us. These coverages primarily include exposure to claims from accident and health, aviation, finite and satellite risks assumed by us.
The underwriting results of an insurance or reinsurance company are discussed frequently by reference to its loss ratio, expense ratio, and combined ratio. The loss ratio is the result of dividing claims and claim expenses incurred by net premiums earned. The expense ratio is the result of dividing underwriting expenses (acquisition and operational expenses) by net premiums earned. The combined ratio is the sum of the loss ratio and the expense ratio.
The table below sets forth our net premiums earned, claims and claim expenses and underwriting expenses by segment and their corresponding loss, expense and combined ratios:
In the normal course of business, we also purchase reinsurance protection (see discussion of Ceded Reinsurance Premiums above). Our underwriting results benefited from our purchase of reinsurance protection as we recorded reinsurance recoveries of $160.4 million, $52.0 million and $255.3 million during fiscal years 2001, 2000 and 1999, respectively. Although there can be no assurance that our underwriting results will continue to benefit from the purchase of reinsurance, we will continue to purchase reinsurance protection to the extent that appropriately priced coverage is available.
Our underwriting expenses consist of operational expenses and acquisition costs. Operational expenses consist of salaries and other general and administrative expenses. Acquisition costs consist of costs to acquire premiums and are principally made up of broker commissions and excise taxes. Our reinsurance business operates with a limited number of employees and we are able to grow our book of business without substantially increasing our operating costs. Acquisition costs are driven by contract terms and are normally a set percentage of premiums. Therefore, as our premiums increase, we expect that our operating costs will tend to remain relatively stable. Since our acquisition costs are based on a percentage of the premiums written, these costs will fluctuate in line with the fluctuation in premiums. Therefore, in total, as our premiums increase, we would expect that our expense ratio would decrease, as was the case in 2001. Other factors may also affect the expense ratios, including business mix, the receipt of ceding commissions or similar payments that may offset expenses.
Acquisition costs and operational expenses for the year ended December 31, 2001 were $84.0 million, or 25.2%, compared to $76.5 million, or 28.5% of net premiums earned for the year ended December 31, 2000. As discussed above, the primary reason for the decrease in the underwriting expense ratio was the increase in net premiums earned and the limited growth in the operational expenses of our reinsurance business.
Acquisition costs and operational expenses for the year ended December 31, 2000 were $76.5 million, or 28.5% of net premiums earned, compared to $62.3 million, or 28.1% of net premiums earned, for the year ended December 31, 1999. The primary contributor to the increase in the underwriting expense ratio was the increase in gross premiums earned by Renaissance Reinsurance with respect to noncatastrophe reinsurance products, which typically produce a higher underwriting expense ratio than our principal product, property catastrophe reinsurance.
For our primary operations, the majority of the premiums written are currently ceded to other reinsurers and as a result, net earned premiums from the primary operations were relatively minor during 2001, 2000 and 1999. Based on this reduced level of net earned premiums, relatively modest one-time adjustments to net written premiums, claims and claim expenses incurred, acquisition expenses or operating expenses can cause, and did cause, unusual fluctuations in the claims and claim expense ratio and the underwriting expense ratio of the primary operations. Because of its small scale, our primary insurance business does not materially affect the ratios of our consolidated operations. As can be seen by the net underwriting losses of the primary operations during 2001 and 2000, the primary operations are not a significant contributor to our consolidated operations. Subsequent to the September 11th tragedy, and the resulting insurance market turmoil, we currently expect that Glencoe, our Bermuda primary operation, will experience considerable growth in 2002. We also expect that the U.S. primary operations of DeSoto, DeSoto Prime and Stonington will continue to be limited, and therefore we do not expect these entities to contribute significantly to our consolidated operations during 2002, although these operations may grow if market conditions allow.
- -------------------------------------------------------------------------------- Year ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- (in thousands) $ 75,156 $ 77,868 $ 60,334 - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- Year ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- (in thousands) $ 16,244 $ 10,959 $ 4,915 - --------------------------------------------------------------------------------
During 2001, we formed a third joint venture, DaVinci, in which we own 25% of the equity. Due to the voting and governance structures of DaVinci, our income from this joint venture is not reflected in other income, but is instead consolidated in our financial statements. Our profit participation and equity participation in DaVinci will therefore be reflected primarily through underwriting income and investment income, partially offset by an increase in minority interest for the 75% of DaVinci owned by third parties.
Also, as discussed previously, since OP Cat has decided to cease its operations, and since we have decided to assume this book of business, our portion of the earnings from this book of business will, in the future, be reflected in our consolidated underwriting results and investment income instead of other income.
- -------------------------------------------------------------------------------- Year ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- (in thousands) $ 11,485 $ 8,022 $ 9,888 - --------------------------------------------------------------------------------
Due to our financial strength, we have had the ability to access the capital markets for various forms of capital. It is advantageous to have access to various forms of capital, as we therefore do not become dependant on any one source of capital. Furthermore, the cost and flexibility of each form of capital can help us to improve our return to common shareholders and at the same time, maintain a level of capital that allows us to grow our operations.
- -------------------------------------------------------------------------------- Year ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- (in thousands) $ 14,262 $ 4,648 ($1,525) - --------------------------------------------------------------------------------
Should our current U.S. operations begin to generate taxable income, or should additional opportunities arise to conduct business in the U.S., the valuation allowance could be eliminated as profits are recorded, and we could possibly earn profits without a corresponding reduction for taxes.
- -------------------------------------------------------------------------------- Year ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- (in thousands) $ 18,096 ($ 7,151) ($ 15,720) - --------------------------------------------------------------------------------
As a holding company, we rely on dividends from our subsidiaries and investment income to make principal and interest payments on our debt and capital securities, and to make dividend payments to our preference shareholders and common shareholders.
The payment of dividends by our subsidiaries is, under certain circumstances, limited under U.S. statutory regulations and Bermuda insurance law. U.S. statutory regulations and The Bermuda Insurance Act 1978, amendments thereto and related regulations of Bermuda, require our Bermuda insurance subsidiaries to maintain certain measures of solvency and liquidity. At December 31, 2001, the statutory capital and surplus of our Bermuda insurance subsidiaries was $1,490.3 million, and the amount required to be maintained by the Act was $259.7 million. Our U.S. subsidiaries are also required to maintain certain measures of solvency and liquidity. At December 31, 2001, the statutory capital and surplus of our U.S. subsidiaries was $32.6 million and the amount required to be maintained was $24.3 million. During 2001, Renaissance Reinsurance declared aggregate cash dividends of $147.1 million, compared with $95.6 million in 2000.
Cash flows from operating activities for 2001 were $326.5 million, which principally consisted of net income of $166 million, plus $119 million for losses incurred but not paid as of December 31, 2001, plus $58 million of collections on losses recoverable. The 2001 cash flows from operations were primarily utilized to reinvest in fixed income securities.
Our principal business is property catastrophe reinsurance, which subjects us to potential losses that are generally infrequent, but can be significant, such as losses from hurricanes and earthquakes. Because the loss events to which we are exposed are generally characterized by low frequency but high severity, our claims and claim expense reserves will normally fluctuate, sometimes materially, based upon the occurrence of a significant natural or man-made catastrophic loss for which we provide reinsurance. Our reserves will also fluctuate based on the payments we make for these large loss events. As we pay losses related to these large events, if no other events have occurred, our loss reserves would normally tend to decrease.
1994 $63.3 $63.3 $265.2 23.9% 23.9% 1995 100.4 100.4 486.3 20.6 20.6 1996 105.4 105.4 546.2 19.3 19.3 1997 110.0 110.0 598.7 18.4 18.4 1998 298.8 197.5 612.2 48.8 32.3 1999 478.6 174.9 600.3 79.7 29.1 2000 403.6 237.0 700.8 57.6 33.8 2001 572.9 355.3 1,225.0 46.8 29.0
Gross Ceded Net 1999 Accident Year Reserves Reserves Reserves - ------------------ -------- -------- -------- Incurred reserves $282.7 $185.0 $97.7 Claim payments in 1999 (26.8) -- (26.8) ------ ------ ----- Reserve as of December 31, 1999 255.9 185.0 70.9 Claim payments in 2000 (110.5) (124.8) 14.3 Reserve additions in 2000 6.1 (0.6) 6.7 ------ ------ ----- Reserves as of December 31, 2000 151.5 59.6 91.9 Claim payments in 2001 (37.8) (54.1) 16.3 Reserve additions in 2001 10.4 29.4 (19.0) ------ ------ ----- Reserves as of December 31, 2001 $124.1 $ 34.9 $89.2 ====== ====== =====
At December 31, 2001, 2000 and 1999, the claims and claim expense reserves of the Reinsurance segment were $500.1 million, $296.4 million and $361.9 million, respectively, of the total reserves of the Company. Also, As of December 31, 2001, 2000 and 1999, of the total reserves of the Reinsurance segment, 86%, 88% and 91% of the reserves, respectively, related to claims and claim expense reserves of the three most recent accident years. As of December 31, 2001, 2000 and 1999, included in our claims and claim expense reserves were reserves for incurred but not reported claims ("IBNR") of $286.7 million, $228.8 million, and $293.2 million, respectively.
Our total capital resources at December 31, 2001 and 2000 were as follows:
With these increased opportunities to grow our businesses, we also decided to materially increase our capital resources through the following activities: 1. In October 2001, we issued 2.5 million of Common Shares for net proceeds of $233 million. 2. In November 2001, we raised $145 million in net proceeds through the issuance of 6,000,000 $1.00 par value Series A Preference Shares at $25.00 per share. The shares are non-convertible and may be redeemed at $25.00 per share on or after November 19, 2006. Dividends are cumulative from the date of original issuance and are payable quarterly in arrears at 8.10% when, if, and as, declared by our Board of Directors. Under certain circumstances, such as amalgamations and changes to Bermuda law requiring approval of the holders of our preference shares to vote as a single class, we may redeem the shares prior to November 19, 2006 at $26.00 per share. The preference shares have no stated maturity and are not convertible into any of our other securities. 3. In July we issued $150 million of 7% Senior Notes due July 2008. We used a portion of the proceeds to repay $16.5 million of outstanding amounts under our $310 million revolving credit and term loan agreement. We can redeem the notes prior to maturity subject to payment of a "make-whole" premium; however, we currently have no intentions of calling the notes. The notes, which are senior obligations, pay interest semi-annually and contain various covenants, including limitations on mergers and consolidations, restriction as to the disposition of stock of designated subsidiaries and limitations on liens on the stock of designated subsidiaries.
We also formed DaVinci, our third joint venture, in October 2001. To form DaVinci, we raised $300 million of outside capital ($275 million as of December 31, 2001) and we utilized $200 million of our capital when we contributed $100 million as equity and provided $100 million as bridge financing. In the first half of 2002, we expect DaVinci to replace our $100 million of bridge financing with bank debt which, because we are consolidating DaVinci, will increase the outstanding debt on our consolidated balance sheet.
Our subsidiary, RenaissanceRe Capital Trust has issued capital securities which pay cumulative cash distributions at an annual rate of 8.54%, payable semi-annually. During 2000, we purchased $2.0 million of these capital securities recognizing a gain of $0.5 million which has been reflected in shareholders' equity. No securities were purchased during 2001. The sole asset of the Trust consists of our junior subordinated debentures in an amount equal to the outstanding capital securities. The Indenture relating to these junior subordinated debentures contains certain covenants, including a covenant prohibiting us from the payment of dividends if we are in default under the Indenture. We were in compliance with all of the covenants of the Indenture at December 31, 2001. The capital trust securities mature on March 1, 2027. Generally Accepted Accounting Principles do not allow these securities to be classified as a component of shareholders equity, therefore, they are reflected as minority interest.
During 2001, shareholders' equity increased by $524.2 million, from $700.8 million at December 31, 2000 to $1.2 billion at December 31, 2001. The significant components of the change in shareholders' equity included net income from continuing operations of $164.4 million, $145 million received from the issuance of 6 million Series A Preference Shares, and $233 million received from the issuance of 2.5 million common shares, offset by the payment of dividends of $32.8 million. At December 31, 2001, shareholders' equity attributable to common shareholders was $1.075 billion.
Our current investment guidelines call for the invested asset portfolio, including cash and cash equivalents, to have at least an average AA rating as measured by Standard & Poor's Ratings Group. At December 31, 2001, our invested asset portfolio had a dollar weighted average rating of AA, an average duration of 1.9 years and an average yield to maturity of 3.8%.
We have assumed risk through catastrophe and derivative instruments under which losses could be triggered by an industry loss index or geological or physical variables. During 2001, 2000 and 1999 we recorded recoveries on non-indemnity catastrophe index transactions of $2.7 million, nil, and $2.5 million, respectively. We report these recoveries in other income. We cannot provide any assurances that this performance will continue.
Our current foreign currency policy is to hold foreign currency assets, including cash and receivables, that approximate the net monetary foreign currency liabilities, including claims and claim expense reserves and reinsurance balances payable. All changes in the exchange rates are recognized currently in our statement of income. When necessary we will seek to hedge our exposure to foreign currency transactions through the use of options, swaps and/or forward contracts. As of December 31, 2001, we did not have any outstanding options, swaps or forward contracts related to foreign currency exposure.
As of December 31, 2001, we have not entered into any guarantees, or guaranteed the liabilities of any non-consolidated affiliates or subsidiaries or other non-related parties.
The September 11th tragedy has caused significant changes to the market environment. Many insurance and reinsurance companies are seeking and receiving higher prices for the risks that they assume and have substantially reduced their exposures, including various exclusions for acts of terrorism and acts of war. These actions are being taken as a result of an increased perception of risk for the industry in general, as well as an improved understanding of the correlation between, and within, various classes of business that were previously believed to be independent by other companies. In addition, there is a heightened sensitivity to credit quality as a number of other insurance companies have experienced downgrades in their credit ratings.
Because RenaissanceRe experienced relatively limited losses from the World Trade Center tragedy, and continues to have stable, high credit ratings, we believe we are well positioned to significantly increase our managed catastrophe premiums.
As a result of the World Trade Center tragedy, we expect the cost of reinsurance protection to increase during 2002. If prices rise to levels whereby we believe the purchase of reinsurance protection would become uneconomical, we may retain a greater level of net risk in certain geographic regions. In order to obtain longer-term retrocessional capacity, we have entered into multi-year contracts with respect to a portion of our portfolio.
The World Trade Center tragedy has caused insurers and reinsurers to seek to limit their potential exposures to losses from terrorism attacks. We often exlcude terrorism in the reinsurance and insurance that we write, but do have potential exposures to this risk. We are monitoring our aggregate exposures to terrorist attacks.