Selected Financial Data. Information required by Item 6 has been omitted because the Registrant meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K and is therefore filing this Form 10-K with the reduced disclosure format.
Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of the financial condition and results of operations of Chartwell should be read in conjunction with the consolidated financial statements and notes thereto of Chartwell included elsewhere herein. The following discussion does not include any information relating to Archer's historical results of operations prior to November 19, 1996 or INSCORP's historical results of operations prior to December 13, 1995. Archer's results of operations for the period from November 19, 1996 to December 31, 1996 were immaterial to Chartwell and, therefore, have not been included. INSCORP's results of operations for the period from December 13, 1995 to December 31, 1995 were immaterial to Chartwell; Chartwell Re has accounted for the Merger as though it had occurred on December 31, 1995. The financial information contained in this section for the year ended December 31, 1995 represents the results of Chartwell Re, the parent and predecessor company of Chartwell.
Recent Industry Performance The property and casualty insurance and reinsurance industry has historically been highly cyclical. Demand for reinsurance is influenced significantly by prevailing market conditions, including the underwriting results of primary insurers. The supply of reinsurance is primarily related to levels of underwriting capacity in the reinsurance industry and the relative cost and terms of reinsurance coverage. The industry's profitability and the cyclical trends in the industry can be affected significantly by volatile and unpredictable developments, including the occurrence of natural disasters, other catastrophic events, competitive pressures on pricing (premium rates), fluctuations in interest rates, other variations in the investment environment, changes in the judicial system regarding tort law, general economic conditions and trends, such as inflationary pressures, that may tend to affect the size of profits and losses experienced by ceding primary insurers and other factors such as changes in tax laws and regulations. Many sectors of the industry are currently in a cyclical downturn and it cannot be predicted if or when market conditions will improve or when other sectors may experience a deterioration in pricing and terms. Commencing in the late part of the 1980s, primary property and casualty insurers began to retain more of their business. This reduction in the amount of business ceded to reinsurers, combined with the growth in reinsurance capacity, resulted in renewed price competition and less attractive pricing for reinsurers. This caused a downturn for the reinsurance industry, resulting in increased underwriting losses which have continued to the present. The following table presents the statutory combined ratios of Chartwell, the property and casualty reinsurance industry during the 1993 to 1997 years. The combined ratio is the sum of the loss ratio (incurred losses and loss adjustment expenses divided by net premiums earned) and the underwriting expense ratio (underwriting expenses divided by net premiums written). A combined ratio of over 100% indicates unprofitable underwriting. Although an insurance company's underwriting may be unprofitable, the company may be profitable after including investment income.
Revenues Year Ended December 31, --------------------------- (Dollars in thousands) 1997 1996 --------- --------- Gross premiums written.................. $ 362,770 $ 263,838 ========= ========= Net premiums written.................... $ 268,260 $ 192,251 ========= ========= Premiums earned......................... $ 245,700 $ 209,503 Net investment income................... 43,457 43,598 Net realized capital gains (losses)..... (3) 1,157 Service and other revenue............... 28,322 3,367 Equity in net earnings of investees 4,794 3,559 --------- --------- Total........... $ 322,270 $ 261,184 ========= =========
Loss and Loss Adjustment Expenses. The Company's principal expense, loss and LAE related to the settlement of claims, was $160.8 million for the year ended December 31, 1997, a 6.8% increase compared to $150.6 million for the comparable period in 1996. The increase is principally attributable to the increase in net premiums written as noted above. Net losses and LAE expressed as a percentage of net earned premiums (the loss and LAE ratio) decreased to 65.5% for the year ended December 31, 1997 from 71.9% recorded for the same period in 1996. The improvement of 6.4 percentage points in the loss and LAE ratio for the year ended December 31, 1997 was a result of a change in the mix of business as well as the benefits of new reinsurance programs, including aggregate excess of loss reinsurance treaties, and the enhancement of existing reinsurance programs. In addition, the 1997 results were not materially affected by the run-off of reinsurance programs written by The Insurance Corporation of New York prior to December 1995, a factor which impacted the 1996 results.
Service Operations Revenue from service operations, exclusive of net investment income, increased to $33.1 million for the year ended December 31, 1997 compared to $6.9 million for the same period in 1996. The improvement reflects increases in advisory fee revenues, equity in the earnings of investee companies and the inclusion, for the first time, of profit commissions and fees from Archer operations. In March 1998, New London Capital plc ("NLC") notified Chartwell Advisers Limited ("Chartwell Advisers") that it chose not to renew the Advisory Agreement between NLC and Chartwell Advisers (the "Advisory Agreement") after its contractual expiration on December 31, 1998. In 1997, the Advisory Agreement produced base fees of $1.7 million and a profit commission of $0.7 million for Chartwell Advisers. Following the expiration of the Advisory Agreement, Chartwell Advisers will continue to earn profit commissions on the open years of account (1996, 1997 and 1998) to the extent such years are profitable.
Consolidated Net Investment Income and Net Realized Capital Gains (Losses). Consolidated net investment income, exclusive of realized and unrealized capital gains and losses for 1997 was $43.5 million, virtually the same level as the same period in 1996. The average annual tax equivalent yield on invested assets before investment expenses for 1997 and 1996 was 6.7%.
Income Tax Expense. The provision for Federal income taxes for the year ended December 31, 1997 increased to $12.2 million compared with $9.3 million for the same period in 1996. The effective tax rate was 30.1% and 29.4% for the years ended December 31, 1997 and 1996, respectively. The principal factor in the decline below the statutory rate of 35.0% for both periods was the benefit of an increase during late 1996 and early 1997 of investments in tax-advantaged securities.
Minority Interest. The Company recognized $525,000 of minority interest during the year ended December 31, 1997, representing Chartwell Re's ownership interest in the net income of Holdings Limited.
Extraordinary Item. Net of Income Tax. The Company recognized a net after-tax extraordinary expense of $1.9 million for the year ended December 31, 1996 for the write-off of unamortized debt issuance costs and a redemption premium associated with the redemption of 35% of the Senior Notes.
Year Ended December 31, 1996 Compared With Year Ended December 31, 1995 Revenues: Total revenues for the year ended December 31, 1996 increased 80.8% to $261.2 million, compared to $144.5 million for the comparable period in 1995. The accompanying table summarizes gross and net premiums written and total revenues for the periods indicated:
Revenues Year Ended December 31, ---------------------------- 1996 1995 ------------- ------------ (Dollars in thousands) Gross premiums written...................... $ 263,838 $ 126,968 ========= ========= Net premiums written........................ $ 192,251 $ 123,314 ========= ========= Premiums earned............................. 209,503 120,258 Net investment income....................... 43,598 19,907 Net realized capital gains.................. 1,157 3,199 Service and other revenue................... 3,367 1,095 Equity in net earnings of investees......... 3,559 -- --------- -------- Total............................. $ 261,184 $ 144,459 ========= =========
Underwriting Operations Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written for the year ended December 31, 1996 were $263.8 million, an increase of 108% compared to the same period in 1995. The increase in gross premiums written was attributable to business acquired in the Merger and continued growth with existing and new clients in all client segments. Net premiums written for the year ended December 31, 1996 increased 56% to $192.3 million, compared to $123.3 million for the same period in 1995. The increase in net premiums written was principally attributable to the reasons described above for the increase in gross premiums written. Net premiums earned for the year ended December 31, 1996 were $209.5 million, an increase of $89.2 million or 74.2% compared to the same period in 1995.
Loss and Loss Adjustment Expenses. The Company's principal expense, loss and LAE related to the settlement of claims, was $150.6 million for the year ended December 31, 1996 a 73.3% increase compared to $86.9 million for the comparable period in 1995. The increase is principally attributable to the increase in net premiums written as noted above. Net losses and LAE expressed as a percentage of net earned premiums (the loss and LAE ratio) improved to 71.9% for the year ended December 31, 1996, from 72.3% recorded for the same period in 1995. The improvement of 0.4 percentage points in the loss and LAE ratio for the year ended December 31, 1996 was due to an increase in the
Other Expenses. Other expenses related to underwriting operations, which include underwriting and administrative expenses, were $15.8 million for the year ended December 31, 1996 compared to $9.7 million for the same period in 1995. Other expenses expressed as a percentage of net earned premiums decreased to 7.5% for the year ended December 31, 1996 compared to 8.0% for the same period in 1995.
Income Tax Expense. The provision for Federal income taxes for the year ended December 31, 1996 increased to $9.3 million compared with $2.7 million for the same period in 1995. The effective tax rate was 29.4% and 30.2% for the years ended December 31, 1996 and 1995, respectively. The principal factor in the decline below the statutory rate of 35% for both periods was the benefit of investments in tax-advantaged securities which increased in the 1996 period.
Net Income Before Extraordinary Item. Net income before extraordinary item increased to $22.4 million for the year ended December 31, 1996 as compared to $6.2 million for the same period in 1995. The largest components of this increase were the increases in net investment income and income from service operations as described above.
Liquidity and Capital Resources Chartwell is a wholly-owned subsidiary of Chartwell Re. As a holding company, Chartwell's assets consist primarily of the stock of its direct and indirect operating subsidiaries, Chartwell Reinsurance, INSCORP, Archer, and Chartwell Advisers. Chartwell's cash flow, therefore, depends largely on dividends and other statutorily permissible payments from its operating subsidiaries. Chartwell's sources of funds consist primarily of net premiums, reinsurance recoveries, investment income and proceeds from sales and redemptions of investments. Funds are applied primarily to payments of claims, operating expenses and income taxes and to the purchase of investments, largely fixed income securities. Cash and short-term investments are maintained for the payment of claims and expenses. For the years ended December 31, 1997, 1996 and 1995, Chartwell's consolidated cash flow provided by operations was $25.5 million, $14.7 million and $23.0 million, respectively. The cash flow from operations in 1997 was greater than that in 1996 due to improved underwriting cash flows comprising premiums received less paid losses and LAE and underwriting expenses. The 1996 cash flow from operations was reduced as a result of the run-off of INSCORP's reinsurance reserves. The primary contributors to the positive cash flow for the 1995 period were underwriting cash flow and investment income received. The 1995 cash flow provided by operations was reduced by $10.9 million due to the payment of three unusually large claims from business written prior to 1985 and the commutation of a group of assumed contracts. Sales of available for sale investments were $200.8 million, $500.7 million and $330.6 million for the years ended December 31, 1997, 1996 and 1995, respectively. Trading activity increased during 1996 primarily to modify the
Year 2000 Compliance The Company believes that it has identified certain significant computer hardware and software applications that may require modification to ensure their continued proper operation, notwithstanding the change in century on January 1, 2000 ("Year 2000 Compliance"). The Company is using both internal and external resources to test such significant computer systems and applications and to make the modifications necessary for Year 2000 Compliance. The testing and modification process, which is proceeding on schedule, is expected to be completed by June 30, 1999. In addition, the Company has contacted certain of its significant business partners and service vendors to determine their Year 2000 Compliance readiness as well as the extent to which the Company is vulnerable to any third party Year 2000 Compliance issues. However, there can be no guarantee that the systems of other companies on which the Company's systems rely will become Year 2000 Compliant in a timely manner, or that the failure by a third party to become Year 2000 Compliant would not have a material adverse effect on the Company. The total cost to the Company to test and modify all systems to be Year 2000 Compliant has not been, and is not expected to be, material to its financial position or results of operations in any given year. These estimates of cost and the anticipated completion date for Year 2000 Compliance are based on management's best estimates utilizing current data regarding available resources, coordination with third parties and other relevant factors and information about systems conversion. However, there can be no assurance that these estimates will be achieved, and actual results could differ from the current plan.
Reporting Comprehensive Income - SFAS No. 130 In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which became effective for the Company beginning January 1, 1998. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. It does not require a specific format for that financial statement but requires that an enterprise display an amount representing total comprehensive income for the period in that financial statement.