We are currently tenants-at-will in approximately 2,100 square feet of office space in Duluth, Georgia. Western Reserve is the landlord on the space that we occupy. As tenants-at-will our landlord is required by law to provide us 60-days notice to vacate. Our monthly rent is $3,482, plus our proportionate share of the taxes. We are currently in the process of obtaining a new lease for office space. We do not own or lease any other properties.
The following analysis of our consolidated financial condition and results of operations should be read in conjunction with "Selected Financial Data" and the consolidated financial statements and accompanying notes included elsewhere in this report. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions developed by our management. Any adjustments to reported bases of assets or liabilities resulting from changes in estimates are reflected in earnings in the period the estimates are revised. This report contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors.
Certain statements made in this report are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the safe harbor provisions of that Act. Additionally, any written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and financial performance. These statements may include, but are not limited to statements relating to reinsurance revenues, gross profits, cash flows and net income in future periods. Such statements often include the words "believes," "expects," "assumes," "predicts," "continue," "potential," "should," "could," "can," "may," "will," "proposes," "anticipates," "intends," "plans," "estimates," "projects," variations or negations of such expressions or similar expressions. When we make forward-looking statements, we are basing them on our management's beliefs and assumptions, using information currently available to us. Because such forward-looking statements involve risks, both known and unknown, and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements, including but not limited to: a decrease in the level of demand for our reinsurance business, or increased competition in the industry; extent to which we are able to develop new reinsurance programs;
adverse reinsurance experience; estimates of reserves; assumptions used in accounting for deferred acquisition costs; negotiation of reinsurance agreements; our cash requirements; availability of capital on acceptable terms; the passage of federal or state legislation subjecting our business to additional supervision or regulation, including additional tax regulation, in the United States or other jurisdictions in which we operate; and changes in economic conditions, including interest rate conditions, which could affect our investment portfolio.
Global Preferred, through Global Preferred Re, provides reinsurance for life insurance and annuity products. The strength of our reinsurance business is based on our strong relationship with the independent agents of World Financial Group, which is an independent marketing organization that markets the products we currently reinsure. World Financial Group is an indirect subsidiary of AEGON USA, Inc. and, as of December 31, 2001, had over 7,500 associated independent registered agents licensed to sell securities and insurance products.
Although our reinsurance business is directed to us through our IMO relationship, the variable universal life insurance and variable annuity policies that we currently reinsure are underwritten and issued by various ceding life companies.
Under a reinsurance agreement, the economic consequences of certain insurance risks are transferred from the ceding life company to the reinsurer. Depending upon the type of reinsurance agreement, these risks may include mortality, persistency, investment and expense. Key considerations in evaluating the risks include industry experience, the ceding life company's pricing and assumptions, the type of product, the ceding life company's underwriting practices and procedures, the type of distribution system, the ceding life company's recent experience and the market for the product.
The ceding life companies retain responsibility for the payment of all claims, surrender values, commissions and expenses involved in issuing and maintaining the policies we reinsure. In addition, the ceding life companies administer the reinsurance contracts and, on a monthly basis, provide us with information regarding premiums, reserves and benefits and the amounts we owe to the ceding life company for claims and settlement expenses on the policies we reinsure.
Reinsurance Revenues. For renewable term reinsurance, we record as "premiums" the amount of reinsurance premiums we receive over the paying periods of the reinsured policies. For policies reinsured on a coinsurance or modified coinsurance basis, we record as "reinsured policy revenues" a proportionate share of gross revenues received by the ceding life company over the paying periods of the reinsured policies. These revenues represent the policy mortality and expense charges, asset-based allowances and deferred sales charges that have been assessed against the reinsured policy account balances. As we elect to convert coverage on policies that we currently reinsure on a renewable term basis to a coinsurance or modified coinsurance basis, the associated premium revenues for those policies will discontinue, and our proportionate share of the associated mortality and expense charges, asset based allowances and deferred sales charges will be recorded as reinsured policy revenues.
Future Policy Benefits. Liabilities for future benefits on life insurance policies are established in an amount adequate to meet the estimated future obligations on the policies in effect. Policy and contract reserves are included in "future policy benefits" on the consolidated balance sheet.
Investment income is recognized as it accrues or becomes legally due. Realized gains or losses on sales of investments are included in income, as are write-downs of securities where declines in value are deemed to be other than temporary. The cost of investment securities sold is determined based upon the specific identification method.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Reinsured Policy Revenues. Reinsured policy revenues decreased $1.7 million, or 13%, from $12.9 million for the year ended December 31, 2000 to $11.2 million for the same period in 2001. This decrease was primarily attributable to revenues associated with our variable annuity coinsurance and modified coinsurance agreements, which declined from $6.7 million for the year ended December 31, 2000 to $5.5 million for the same period in 2001, a decrease of $1.2 million, or 18%. Decreasing revenues for both variable universal life and variable annuity business have resulted primarily from a decline in collected mortality and expense charges associated with lower account values, due to the decline in the equity markets. Further, the variable universal life coinsurance and modified coinsurance business is a "closed block," meaning that there are no new policies being issued in this block of business, resulting in a
Net Investment Income and Net Realized Gain on Investments. Net investment income increased $283,000, or 54%, from $528,000 for the year ended December 31, 2000 to $811,000 for the same period in 2001, primarily due to the increased size of our portfolio from new purchases of fixed maturity securities.
Benefits, Claims and Settlement Expenses. Benefits, claims and settlement expenses decreased $1.3 million, or 17%, from $7.6 million for the year ended December 31, 2000 to $6.3 million for the same period in 2001. The decrease was primarily associated with better mortality experience in the current period, which resulted in lower claims activity. We do not expect, nor have we been advised by the ceding life companies of, any material claims exposure related to the September 11, 2001 terrorist attacks. The aggregate face value of insurance underlying the policies we reinsured at December 31, 2000 was $9.4 billion compared to $9.1 billion at December 31, 2001.
Change in Future Policy Benefits. Change in future policy benefits increased $359,000, or 17%, from $2.1 million for the year ended December 31, 2000 to $2.4 million in the same period of 2001. $230,000 of the increase was tied to the $2.4 million growth in premiums collected under the Financial Freedom Builder Monthly Renewable Term Agreement. Additionally, during the third quarter of 2001, we refined our methodology for recognizing earned premiums under the Zurich Kemper monthly renewable term agreement, which resulted in an increase in future policy benefits of $152,000.
Amortization of Deferred Acquisition Costs. Amortization of deferred acquisition costs decreased $72,000, or 2%, from $4.0 million for the year ended December 31, 2000 to $3.9 million for the same period in 2001. A majority of the decrease in the amortization of deferred acquisition costs resulted from the refinement of our methodology of recognizing earned premiums under the Zurich Kemper monthly renewable term agreement, which caused a $122,000 decrease. Offsetting this decrease was a net increase of $50,000, which reflects amounts related to historical realized experience and unlocking of future experience assumptions.
Operating Expenses. Operating expenses increased $696,000, or 55%, from $1.3 million for the year ended December 31, 2000 to $2.0 million for the same period in 2001. These expenses include salaries and benefits, professional fees for legal, actuarial and accounting expenses and other operating expenses. The increase was associated with a $447,000 increase in salaries, benefits and recruiting expenses, due to the employment of additional staff, payment of a discretionary bonus for the year 2000 and accrual of discretionary bonuses for 2001. The remainder of the increase was primarily due to increases in directors' and officers' insurance expenses, outside director fees, legal fees and our franchise taxes for the State of Delaware.
Interest Expense. Interest expense decreased $287,000, or 43%, from $665,000 for the year ended December 31, 2000 to $378,000 for the comparable period in 2001. The decrease was due to the
repayment of a $5.3 million debt on a line of credit. The final payment of principal and interest in the amount of $283,566 was paid in February 2001.
Reinsured Policy Revenues. Reinsured policy revenues decreased $612,000, or 5%, from $13.5 million for the year ended December 31, 1999 to $12.9 million for the same period in 2000. The overall revenue decline was due to a $2.8 million decline in revenues associated with our variable universal life coinsurance and modified coinsurance agreement with Western Reserve, partially offset by a $2.2 million increase in revenues attributable to our variable annuity reinsurance agreements, which was reflective of an increase in the contract benefits from existing policies reinsured and new business reinsured under these agreements. The decline in revenues associated with the variable universal life business was caused by Western Reserve's October 1, 1999 recapture of certain policies previously ceded to us under our reinsurance agreements. This recapture was in conjunction with the execution of the monthly renewable term agreement discussed above in "Premiums."
The sale of fixed maturity securities for the year ended December 31, 1999 resulted in a net realized loss on investments of $66,000 compared to a net realized gain on investments of $3,000 for the same period in 2000. This shift was caused by a decline in market yields, which resulted in an increase in the fair value of invested securities.
Benefits, Claims and Settlement Expenses. Benefits, claims and settlement expenses increased $3.1 million, or 68%, from $4.5 million for the year ended December 31, 1999 to $7.6 million for the same period in 2000. The increase was the result of greater claims activity than otherwise expected, an increase in volume of policies reinsured and the increasing age of the policies reinsured. The aggregate face value of insurance underlying the policies we reinsure was $8.0 billion at December 31, 1999 compared to $9.4 billion at December 31, 2000, which represented a $1.4 billion, or 17% increase.
Change in Future Policy Benefits. Change in future policy benefits increased $1.7 million, or 554%, from $314,000 for the year ended December 31, 1999 to $2.0 million in the same period of 2000. This change was tied to an increase in the liability for future policy benefits under our monthly renewable term reinsurance agreements, which rose by $2.0 million, or 188%, from $1.1 million at December 31, 1999 to $3.1 million at December 31, 2000. The Financial Freedom Builder Monthly Renewable Term Agreement we entered into with Western Reserve in October 1999 was the primary cause of this increase.
Amortization of Deferred Acquisition Costs. Amortization of deferred acquisition costs increased $227,000, or 6%, from $3.8 million for the year ended December 31, 1999 to $4.0 million for the same period in 2000. The increase was attributable to a $1.3 million increase in amortization for business reinsured on a coinsurance and modified coinsurance basis, which was driven by increased gross profits during 2000 from existing policies reinsured and new policies reinsured. Offsetting this increase was (1) amortization of $976,000 in 1999 associated with the Western Reserve coinsurance and modified coinsurance business that was recaptured on October 1, 1999 and (2) a decrease in amortization of deferred acquisition costs for business reinsured on a monthly renewable term basis of $55,000, which was driven by a shift in the mix of business toward more Financial Freedom Builder variable universal life policies, which do not have associated deferred acquisition costs.
Operating Expenses. Operating expenses increased $273,000, or 28%, from $983,000 for the year ended December 31, 1999 to $1.3 million for the same period in 2000. These expenses include professional fees for legal, actuarial and accounting expenses, operating expenses and other miscellaneous expenses. The increase in expenses was primarily associated with an increase in salaries due to the employment of additional staff in 2000. The increase was also attributable to increases in legal, accounting and actuarial fees for general corporate activities, tax consulting and actuarial consulting services.
Income Taxes. Income taxes decreased $405,000, or 18%, from $2.2 million for the year ended December 31, 1999 to $1.8 million for the same period in 2000. We earned statutory taxable income during 2000, which was attributable to lower payments of policy acquisition costs due to a decline in new business reinsured under our coinsurance and modified coinsurance agreements. Our effective tax rate was
The following table presents certain unaudited quarterly consolidated statements of income data for the eight-quarter period ending December 31, 2001, as well as the percentage of total revenue represented by each item. The information has been derived from the unaudited consolidated financial statements. The unaudited consolidated financial statements have been prepared on substantially the same basis as the audited consolidated financial statements contained herein and all adjustments, consisting only of normal recurring adjustments, which we consider to be necessary to present fairly this information when read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future period.
Our second segment, reported as universal life-type, relates to all variable annuity contracts and those variable universal life policies that are reinsured on a coinsurance and modified coinsurance basis. The products reinsured on a coinsurance and modified coinsurance basis are accounted for under SFAS No. 97 accounting principles and, as such, revenues therefrom are classified as reinsured policy revenues.
(1) Benefits, claims and settlement expenses include change in future policy benefits.
Our principal sources of cash flow have been premiums received from the ceding life companies, investment income, proceeds from the sale of invested assets, issuance of common and preferred stock, and short- and long-term financing. In addition to cash flow to meet operating expenses, our liquidity requirements relate primarily to the payment of gross reinsurance allowances, investment purchases, debt service and reinsurance claims.
Under the coinsurance and modified coinsurance agreements, since we are reinsuring risks on essentially the same basis as that of the original policy, reinsurance premiums are materially greater than premiums received on the renewable term reinsurance. During the first year in which a policy is reinsured on a coinsurance basis, we are required to reimburse the ceding life company for our share of acquisition costs, including first year commissions and issuance expenses. Thereafter, we reimburse the ceding life company for our share of renewal commissions and maintenance expenses. Further, under modified coinsurance, we allow the ceding life company to retain assets related to reserves in support of reinsured policy benefits (e.g., cash values). Accordingly, because of the type of reinsurance and the basis reinsured, the net first year cash outlays could be as much as, or more than, that year's premiums paid for variable universal life insurance, and as much as 10% of variable annuity premiums. In year two and beyond, however, our cash outlays for reinsurance allowances are significantly lower than in the first year of a policy.
In the first quarter of 1999, we negotiated amendments to our coinsurance and modified coinsurance agreements with Western Reserve in contemplation of completing a private offering of our stock begun in 1998. The amendments provided that: (1) we could defer payment to Western Reserve of reinsurance expense allowances on new policies reinsured in 1999, until the earlier of the completion of our offering, or December 31, 1999; (2) a reinsurance fee at an effective rate of 9% per year accrued on the deferred payments; and (3) Western Reserve could recapture the reinsurance on the policies issued during 1999 if the expense allowances were not paid by December 31, 1999. As contemplated by the new amendments, payment by us to Western Reserve of a portion of the reinsurance expense allowances on policies issued in 1999 was deferred pending the completion of our capital raising efforts in 1999. When the funding had not been completed by September 30, 1999, the reinsurance of all variable universal life policies and riders and 75% of the variable annuity policies issued from January 1, 1999 through September 30, 1999 that had been entered into on a coinsurance and modified coinsurance basis was recaptured. These recapture rights exercised by Western Reserve in 1999 were created specifically to address the possibility that we would not complete our contemplated capital raising in 1999. Concurrent with the recapture, we began reinsuring, on a monthly renewable term basis, 20% of certain variable universal life policies and riders issued by Western Reserve on or after January 1, 1999. Additionally, we further amended our reinsurance agreements to reduce our quota share percentage on the reinsurance of the Western Reserve variable annuity business for 1999 and thereafter. However, we retained the right to convert our monthly renewable term reinsurance of the variable universal life business to a coinsurance and modified coinsurance basis for all policies issued from January 1999 through March 2003 and the right to increase our quota share percentage of the reinsurance of Western Reserve variable annuity business.
Our cash requirements for operating and investment expenses consist of: salaries and benefits; management service fees; investment management and custodial fees; accounting and consulting services fees; expenses related to regulatory issues and compliance with corporate and tax matters; and other incidental administrative expenses. We incurred no capital expenditures during 2001.
Net cash flows provided by (used in) operating activities were $(10.7) million, $6.6 million and $10.4 million for the years ended December 31, 1999, 2000 and 2001, respectively. Changes in cash provided by operating activities primarily relate to: amounts of reinsurance premiums and policy revenues received; claims, reinsurance expense allowances and operating expenses paid; and changes in working capital. The amount of cash provided by operations increased in 2000 and 2001 because we utilized less cash to acquire new reinsurance business in those years and due to the increasing age of the policies reimbursed. In addition, cash paid for acquisition costs decreased in 2000 and 2001 because the amount of policies reinsured on a coinsurance and modified coinsurance basis decreased. The $10.7 million used in operations in 1999 was to reimburse Western Reserve for the first year reinsurance expense allowances on policies issued and reinsured during 1998 on a coinsurance and modified coinsurance basis. Regarding acquisition costs, substantially more cash was used in 1999 than in 2000 because more policies were reinsured during 1999 and 1998.
On July 30, 1999, we issued a $5 million, five-year convertible term note to Money Services, Inc. due on July 29, 2004. Money Services is a subsidiary of AEGON USA, Inc. Proceeds of this note were used to reduce a portion of the outstanding principal balance on a line of credit with Money Services from $10 million to $5 million. Interest is payable on the note at 7.5% per annum (except in the event of redemption), on the 29th of each succeeding January and July through and including July 29, 2004. Money Services has the right to convert the outstanding principal balance of this note into common stock at any time. Upon conversion, Money Services will receive 6.25 shares of common stock for each $100 of the outstanding principal amount of the note, which reflects our three-for-two stock split in 2001. We have the option to redeem the note before maturity, in whole or in part, between July 29, 2002 and July 29, 2004. To redeem the note, we must pay all principal, plus interest accrued from the date of the note through the redemption date at a higher effective interest rate of 9% per annum. As of December 31, 2001, we had an outstanding principal balance on the term note of $5 million and accrued interest of $158,000.
In addition, we had a $5 million line of credit with Money Services that we paid in full, together with the related accrued interest, on February 15, 2001. Principal payments totaled $277,285 during 2001.
Net cash flows provided by (used in) financing activities were $304,000, $(2.1) million and $(557,000) for the years ended December 31, 1999, 2000 and 2001, respectively. Changes in cash used in financing activities primarily related to the principal payments on the Money Services line of credit and the dividends paid on our preferred stock, offset by the issuance of 266,047 shares of preferred stock to accredited investors, during 2000, which resulted in net proceeds of approximately $3.1 million. The $304,000 source of cash in 1999 was due to the issuance of a $5 million term note, the proceeds of which were applied to reduce the then outstanding principal balance of our short-term debt.
We are a holding company with no direct operations, and our principal assets are the capital stock of Global Preferred Re and $3.7 million of cash and invested assets, as of December 31, 2001. We rely primarily on funds retained at the holding company level, debt service on amounts loaned to Global Preferred Re and potential dividends from Global Preferred Re to meet ongoing cash requirements. The ability of Global Preferred Re to pay us dividends is subject to, among other things, regulatory restrictions under the insurance laws of Bermuda. During the year ended December 31, 2001, Global Preferred Re paid us no dividends.
On February 22, 2002, Global Preferred filed a registration statement with the Securities and Exchange Commission for an initial public offering of common stock at a proposed maximum aggregate offering price of $120,750,000.
In September 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities -- a replacement of FASB Statement No. 125. This statement revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, not previously required under SFAS No. 125. The provisions of SFAS No. 140 did not have a significant impact on Global Preferred's financial statements.
FASB issued four new accounting standards in 2001. SFAS No. 141, SFAS No. 142, SFAS No. 143 and SFAS No. 144 primarily address the accounting for goodwill, business combinations, and the impairment and disposition of long-lived assets. The adoption of these standards in 2002 is not expected to have a material impact on the Company's financial statements.
OUR BUSINESS IS CURRENTLY DEPENDENT UPON OUR RELATIONSHIPS WITH INDEPENDENT AGENTS ASSOCIATED WITH WORLD FINANCIAL GROUP AND THE LOSS OF BUSINESS PROVIDED BY THE INDEPENDENT AGENTS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR GROWTH STRATEGIES AND BUSINESS.
To date, all life insurance and annuity policies reinsured by us have been written through the agents associated with World Financial Group who, until June 2001, were associated with WMA Agency. In June 2001, World Financial Group acquired certain assets of WMA Agency. As a result of the acquisition, substantially all of the agents became associated with World Financial Group. World Financial Group is the independent marketing organization that markets the products we currently reinsure. An independent marketing organization is an organization of independent agents that contracts with one or more insurance companies to distribute and market securities and insurance products. We have been informed that World Group Securities, Inc., the broker-dealer affiliated with World Financial Group, is in the process of obtaining approval for the transfer of the securities licenses of agents from WMA Securities, Inc., the broker-dealer affiliated with WMA Agency. We understand that the formation of World Group Securities and its business plan have been approved by the National Association of Securities Dealers and World Group Securities is awaiting state regulatory approvals which they have indicated that they anticipate receiving in the near future.
We believe the ability of those agents to continue placing new business with the life insurance companies that use us for reinsurance could be affected by a number of factors, including:
- The occurrence of regulatory actions that could restrict or prohibit sales activities by the agents or the life insurance companies.
We do not direct or oversee the activities of these agents. We cannot assure you that World Financial Group will be able to attract new agents or retain key agents responsible for significant portions of
If the business of World Financial Group, or any other IMO with which we establish a relationship, is materially disrupted, it could have a material adverse effect on our growth strategies and business. The business of an IMO could be adversely affected by a change of control, loss of one or more key agents, operational problems, regulatory compliance problems or other factors.
WE FACE CERTAIN SPECIALIZED RISKS COMMON TO ALL LIFE REINSURANCE COMPANIES; HOWEVER, BECAUSE OF THE CONCENTRATION OF OUR BUSINESS WITH A SMALL NUMBER OF LIFE INSURANCE COMPANIES, WE MAY HAVE A GREATER EXPOSURE TO THESE RISKS.
We face certain specialized risks common to all life reinsurance companies. However, because Western Reserve, American Skandia, Pacific Life and Zurich Kemper issued all of the policies we currently reinsure, we may have a more concentrated exposure to these risks than other life reinsurance companies. For the year ended December 31, 2001, Western Reserve accounted for 89% of our reinsurance premiums and reinsured policy revenues, American Skandia 9%, Pacific Life 0% and Zurich Kemper 2%. These risks include the risk of mispricing by life insurance companies of the coverage provided by the underlying policies, adverse insurance experience risk, and risks relating to miscellaneous and external events. Adverse insurance experience risks relate to the risks insured, which may include excessive claims, poor persistency, inadequate investment results, and excessive expenses. However, as long as the life insurance companies that issue the policies we reinsure retain a proportionate share of the risk insured, they will have an incentive to underwrite and price appropriately.
- Mortality. Mortality is the relative incidence of death experienced by insured lives taken as a group. We are subject to the risk that the mortality on the lives reinsured by us may be above the mortality assumed in pricing our reinsurance.
- Persistency. Persistency is the extent to which insurance policies are maintained by the policyholder. Policyholders may not pay premiums, causing their policies to lapse, or they may choose to surrender their policies for the cash surrender value. Policy lapses and surrenders will result in lost future revenues and may result in diminished profitability associated with the business reinsured.
We also face risks resulting from miscellaneous and external events that are difficult to estimate prior to their occurrence, including litigation, governmental and regulatory changes, tax law changes, product acceptance, epidemics, catastrophic events, terrorist attacks, market trends, a significant drop in the U.S. securities markets, a general economic downturn or negative publicity related to IMOs with whom we have relationships, insurance companies whose products we reinsure or products we reinsure. Any such events could have a material adverse effect upon our business.
To date, we have derived all of our life reinsurance revenues from variable universal life policies issued by Western Reserve, Pacific Life and Zurich Kemper and all of our annuity reinsurance revenues from variable annuities issued by Western Reserve and American Skandia. For the year ended December 31, 2001, Western Reserve accounted for 89% of our reinsurance premiums and reinsured policy revenues, American Skandia 9%, Pacific Life 0% and Zurich Kemper 2%.
The termination, non-renewal or unfavorable renegotiation of the reinsurance of new policies under these agreements would have a material adverse effect on our growth; however, it would not affect our right to continue to reinsure the policies already reinsured.
Our growth strategy includes developing affiliations with new IMOs similar to the one we have with World Financial Group. We intend to use various financial incentives, which may include stock, warrants and other forms of equity participation in our company, to form relationships with new IMOs. We cannot assure you that we will be successful in our efforts to establish these relationships. Furthermore, our inability to develop these relationships could adversely affect our growth strategy and business.
IF WE LOSE OR ARE UNABLE TO OBTAIN KEY PERSONNEL, OUR ABILITY TO IMPLEMENT OUR BUSINESS STRATEGY COULD BE DELAYED OR HINDERED.
We are substantially dependent on a small number of key employees, in particular Edward F. McKernan, President and Chief Executive Officer, Bradley E. Barks, Chief Financial Officer and Senior Vice President -- Finance, Caryl P. Shepherd, Chief Accounting Officer, Controller, Treasurer and Secretary, and Thomas Bobowski, Vice President of Marketing, with whom we have employment agreements. Due to increasing complexities associated with growing our business, deploying our business strategies, the increasing duration of the reinsurance agreements and diversification of the business reinsured, we plan to hire additional employees. The loss of the services of any key employee, or the inability to hire additional employees, could adversely affect the quality and profitability of our business operations. We do not currently maintain key employee insurance with respect to any of our employees.
In addition to the anticipated growth of our business resulting from the exercise of expansion rights under our existing reinsurance agreements with Western Reserve, we expect to continue our growth by broadening our existing relationships and forming new relationships with additional IMOs. Any growth of our business would place additional demands on our management, operational capacity and financial resources. Our inability to manage growth effectively could have a material adverse effect on our business, financial condition and results of operations. Additionally, we anticipate that we will need to recruit qualified personnel in all areas of our operations, including management, actuarial support, sales and marketing, to effectively manage and control additional growth. If we are unable to attract and retain additional qualified personnel, expand our operational capacity or otherwise manage our growth, our business, financial condition and results of operations may be adversely affected.
WE RELY ON NUMEROUS THIRD PARTIES TO PROVIDE POLICY ADMINISTRATION, INVESTMENT MANAGEMENT AND ADMINISTRATIVE SUPPORT SERVICES. IF THESE THIRD PARTIES DO NOT PROVIDE SATISFACTORY SERVICE AND ACCURATE INFORMATION, OUR BUSINESS COULD BE ADVERSELY AFFECTED.
The policies we reinsure are administered by the life insurance companies issuing the policies. The life insurance companies provide us with the information necessary for managing our reinsurance business. We do not participate in the underwriting or any of the direct administration of the reinsured policies and have conducted only a limited review of the administrative practices of the life insurance companies for which we provide reinsurance. Therefore, management may not have sufficient or timely information to evaluate the quality or the administration of the business reinsured by us or the accuracy of the information provided by these life insurance companies, though our agreements may provide us some limited oversight in the form of audit rights.
IF THE LIFE AND ANNUITY PRODUCTS WE REINSURE DO NOT CONTINUE TO BE ACCEPTED IN THE MARKETPLACE OR IF TAX REGULATIONS CHANGE WITH REGARD TO THOSE PRODUCTS, OUR BUSINESS STRATEGY COULD BE SIGNIFICANTLY AND ADVERSELY AFFECTED.
We compete, and will continue to compete, with numerous national and international reinsurance companies, primary insurance companies, underwriting syndicates and other financial services providers, many of which are well established, have significant operating histories and substantially greater underwriting, marketing and administrative resources than we do. Our growth strategy includes the expansion of our relationships with IMOs and other distribution channels through the strategic use of financial incentives. Our ability to compete with other reinsurers in this market will depend upon our ability to successfully develop and maintain strong relationships with IMOs. Aside from our experience in
Direct insurance companies that are licensed to underwrite insurance are also licensed to underwrite reinsurance, making commercial entry into the reinsurance business relatively uncomplicated. In addition, over the last several years, capital markets participants, including exchanges and financial intermediaries, have developed financial products intended to compete with traditional reinsurance. We are unable to predict the extent to which new, proposed or potential initiatives may affect the demand for our products. Barriers to entry to the reinsurance industry for non-insurers are mainly the time, capital and talent necessary to attract, underwrite and manage the business. Increased competition could cause us and other reinsurance providers to charge lower premium rates and obtain less favorable contract terms, which could adversely affect our ability to generate revenue and grow our business. Our business may be more susceptible to competition because we have a relatively small number of clients.
CONSOLIDATION IN THE INSURANCE INDUSTRY COULD LEAD TO LOWER MARGINS FOR US AND LESS DEMAND FOR LIFE AND ANNUITY REINSURANCE PRODUCTS.
We believe that our existing sources of cash, together with the net proceeds from our initial public offering, will be sufficient to meet our business needs through the first quarter of 2003, including exercising our contractual rights under our reinsurance agreements to increase our reinsurance percentages and convert certain monthly renewable term reinsurance arrangements to coinsurance and modified coinsurance. Thereafter, or if the public offering is not completed for any reason, to continue to fully implement our growth strategies, we may need to raise additional funds through loans from financial institutions and the sale of equity securities in subsequent private or underwritten public offerings. We cannot assure you that such alternatives would be available to us at an acceptable cost, if at all.
DUE TO THE TRANSACTIONS WE HAVE ENTERED INTO WITH ENTITIES THAT HAVE A COMMON OWNERSHIP WITH WORLD FINANCIAL GROUP, CONFLICTS OF INTEREST MAY ARISE WITH RESPECT TO OUR BUSINESS DEALINGS WHICH MAY HAVE AN ADVERSE EFFECT ON OUR FUTURE BUSINESS OPERATIONS.
Due to the relationships among us, the independent agents associated with World Financial Group, Western Reserve, Money Services, World Financial Group and AEGON USA, conflicts of interest may arise with respect to existing and future business dealings, including:
- The terms of World Financial Group's selling agreements (including commission arrangements) and our reinsurance relationships with life insurance companies;
IF WE ARE UNABLE TO REALIZE OUR INVESTMENT OBJECTIVES, OUR FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED.
General economic conditions can adversely affect the markets for interest-rate-sensitive securities, including the extent and timing of investor participation in such markets, the level and volatility of interest rates and, consequently, the value of fixed income securities. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. General economic conditions, stock market conditions and many other factors can also adversely affect the equities market and, consequently, the value of any equity securities we may own. We may not be able to realize our investment objectives, which could reduce our net income significantly.
The state insurance laws in the United States restricting the investments of insurance companies are not directly applicable to Global Preferred Re. Unlike insurance regulations in the United States, Bermuda law does not limit or regulate investments of Global Preferred Re as a long-term insurer provided that such investments are made for its potential benefit and Global Preferred Re maintains the minimum solvency margin prescribed under the Bermuda Insurance Act 1978. We have developed specific investment guidelines that stress diversification of risk, conservation of principal and liquidity, which are reviewed periodically by the Investment Committee of the board of directors.
Because we are not required to be licensed or admitted as an insurer in any jurisdiction other than Bermuda and because many jurisdictions do not permit insurance companies to take credit for reinsurance obtained from unlicensed or non-admitted insurers on their statutory financial statements unless appropriate security measures are in place, the majority of our reinsurance customers typically require us to obtain a letter of credit or provide other collateral through funds withheld or trust arrangements. Our letters of credit are collateralized with fixed income securities. If we are unable to increase our letter of credit capacity or are unable to do so on commercially acceptable terms or are unable to arrange for other collateral through funds withheld or trust arrangements, our ability to implement our business strategy would be significantly and negatively affected.
Although we currently have three letters of credit issued by Comerica Bank for the benefit of Western Reserve, Pacific Life and Zurich Kemper, in the amounts of $8.5 million, $50,000 and $300,000, respectively, as we grow we will need additional letter of credit capacity, or other acceptable forms of security. If we are unable to increase our letter of credit capacity, or are unable to do so on commercially acceptable terms or are unable to arrange for other collateral through funds withheld or trust arrangements, our ability to implement our business strategy would be significantly and negatively affected.
DUE TO THE ABSENCE OF A FINANCIAL STRENGTH RATING, IT MAY BE MORE DIFFICULT FOR US TO ENTER NEW MARKETS.
We are not currently rated by any insurance company rating service and have not sought any rating because the absence of a financial rating has not, to date, interfered with the implementation of our business strategy. However, development of our future business may be affected by the absence of such a rating. Accordingly, we will seek a rating if we believe it will enhance our business opportunities. We cannot assure you that we would receive a favorable rating.
Our results of operations may fluctuate significantly from quarter to quarter. Fluctuations may result from a variety of factors, including the volume and mix of reinsurance products we write, claim experience, policy persistency, timing of expenses and the performance of our investment portfolio. In particular, we seek to underwrite products and make investments to achieve long-term results. Accordingly, our short-term results of operations may not be indicative of our long-term prospects.
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Accounts that we deem to be sensitive to changes in estimates include
WE HAVE NO SIGNIFICANT OPERATIONS OTHER THAN OUR OWNERSHIP OF GLOBAL PREFERRED RE, WHICH IS REGULATED WITH RESPECT TO DECLARING OR PAYING DIVIDENDS. RESTRICTIONS ON OUR SUBSIDIARY'S ABILITY TO DECLARE AND PAY DIVIDENDS MAY HAVE A MATERIAL ADVERSE AFFECT ON OUR OPERATIONS.
OUR BUSINESS IS GEOGRAPHICALLY CONCENTRATED; THEREFORE, OUR OPERATIONS MAY BE AFFECTED BY REGULATORY, ECONOMIC, DEMOGRAPHIC AND OTHER CONDITIONS SPECIFIC TO A SMALL NUMBER OF STATES.
We are exposed to credit risk with respect to the payments owed to us by the life insurance companies under our reinsurance agreements. Our operating cash flow is derived entirely from reinsurance premiums and revenues those companies pay to us. An adverse change in the financial condition of a life insurance company for which we provide reinsurance, especially Western Reserve, could impair our ability to collect these balances as a general creditor, which, in turn, could result in a material, adverse effect upon our financial condition.
Global Preferred Re, our wholly owned operating subsidiary, is registered in Bermuda as a long-term insurer. It is subject to regulation and supervision in Bermuda. These statutes and regulations may restrict our ability to write reinsurance policies, to distribute funds and to pursue our investment strategy. Bermuda insurance statutes, regulations and policies of the Bermuda Monetary Authority and the Minister of Finance require Global Preferred Re to, among other things:
- Maintain a principal office and appoint and maintain a Principal Representative in Bermuda; and
Generally, Bermuda insurance statutes and regulations applicable to Global Preferred Re are less restrictive than those that would be applicable if Global Preferred Re were subject to the insurance laws of any state in the United States. In the past, there have been congressional and other initiatives in the United States regarding proposals to supervise and regulate insurers domiciled outside the United States. If in the future we became subject to any insurance laws of the United States or any state thereof or of any other jurisdiction, we cannot assure you that we would be in compliance with those laws or that coming into compliance with those laws would not have a significant and negative effect on our business.
If we choose to attempt to become licensed in another jurisdiction other than Bermuda, we may not be able to become licensed as the process of obtaining licenses is very time consuming and costly. The modification of the conduct of our business resulting from our becoming licensed in certain jurisdictions could significantly and negatively affect our business. In addition, our inability to comply with insurance statutes and regulations could significantly and adversely affect our business by limiting our ability to conduct business as well as subjecting us to penalties and fines.
The Bermuda Minister of Finance, under The Exempted Undertakings Tax Protection Act 1966 of Bermuda, has given us assurance that if any legislation is enacted in Bermuda that would impose tax on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax will not be applicable to us or to any of our operations or our shares, debentures or other obligations until March 28, 2016. We cannot assure you that Global Preferred Re will not be subject to any Bermuda tax after that date.
- Consolidated Statements of Cash Flows for the years ended December 31, 1999, 2000, and 2001