Years Ended December 31, Period from -------------------------- June 23, 1995 to 1997 1996 December 31, 1995 ------------- ---------- ----------------- (In thousands, except share data) Income Statement Data Net premiums earned ............ $107,372 $35,761 Net investment income .......... 14,360 13,151 $4,578 Net realized investment gains (losses) ............. (760) 1,259 397 Total revenues ................. 120,972 50,171 4,975 Net income ..................... 2,039 4,112 1,019 Average shares outstanding Basic ...................... 17,032,601 16,981,724 16,747,084 Diluted .................... 17,085,788 16,983,909 16,990,425 Net income per share Basic ...................... $0.12 $0.24 $0.06 Diluted .................... 0.12 0.24 0.06
At January 1, 1998, the Company had approximately 200 renewable reinsurance treaties that are in force, with approximately $170 million of estimated annualized net premiums written, compared to $128 million at January 1, 1997. Such in-force premiums at January 1, 1998 represent estimated annualized premiums from treaties entered into during 1997 and the January 1, 1998 renewal period that are expected to generate net premiums written during 1998. Such renewable treaties at January 1, 1998 are estimated to generate approximately $113 million of net premiums written over the 12-month period ending December 31, 1998 without taking into account certain factors, including the possibility that (i) several treaties entered into in 1997 that are scheduled to expire during the remainder of 1998 may be renewed and (ii) additional treaties may be bound during 1998.
For the years ended December 31, 1997 and 1996 and for the period June 23, 1995 (date of inception) to December 31, 1995, the Company had consolidated net income of approximately $2.0 million, or $0.12 per share, $4.1 million, or $0.24 per share, and $1.0 million, or $0.06 per share, respectively. After-tax realized investment gains (losses) of ($0.5 million), or ($0.03) per share, $0.8 million, or $0.05 per share, and $0.3 million, or $0.02 per share, were also included in net income for the 1997, 1996 and 1995 periods, respectively. Net income for each of the years ended 1997 and 1996 included losses of $0.2 million, or $0.01 per share, representing the Company's equity in the net loss of investee companies accounted for under the equity method of accounting.
Net premiums written for the year ended December 31, 1997 compared to 1996 was as follows:
Approximately 28.5% and 5.2% of net premiums written in 1997 and 1996, respectively, were generated from companies in which the Company has invested or committed to invest funds. Approximately 28% and 30% of net premiums written in 1997 and 1996, respectively, were from non-United States clients, which are Lloyd's syndicates or are located in the United Kingdom and Continental Europe.
Set forth below are the Company's statutory composite ratios for the years ended December 31, 1997 and 1996 and the estimated aggregate statutory composite ratio for domestic reinsurers based on data reported by the RAA as of such dates:
Years Ended December 31, -------------------------------- 1997 1996 -------------- -------------- Claims and claims expenses......... 68.4% 67.3% Commissions and brokerage.......... 28.8 23.7 -------------- -------------- 97.2 91.0 Other operating expenses........... 9.1 15.3 ============== ============== Statutory composite ratio.......... 106.3% 106.3% ============== ==============
Claims and claims expenses generally represent the Company's most significant and uncertain costs. Reserves for these expenses are estimates involving actuarial and statistical projections at a given time of what the Company expects the ultimate settlement and administration of claims to cost based on facts and circumstances then known. The reserves are based on estimates of claims and claims expenses incurred and, therefore, the amount ultimately paid may be more or less than such estimates. The inherent uncertainties of estimating claim reserves are exacerbated for reinsurers by the significant periods of time (the "tail") that often elapse between the occurrence of an insured loss, the reporting of the loss to the primary insurer and, ultimately, to the reinsurer, and the primary insurer's payment of that loss and subsequent indemnification by the reinsurer. As a consequence, actual claims and claims expenses paid may deviate, perhaps substantially, from estimates reflected in the Company's reserves reported in its financial statements. The estimation of reserves by new reinsurers, such as the Company, may be less reliable than the reserve estimations of a reinsurer with an established volume of business and claims history. To the extent reserves prove to be inadequate, the Company may have to augment such reserves and incur a charge to earnings. Such a development, while not anticipated, could occur and result in a material charge to earnings or stockholders' equity in future periods. Subject to the foregoing, the Company believes that the reserves for claims and claims expenses are adequate to cover the ultimate cost of claims and claims expenses incurred through December 31, 1997.
Included in 1997 other operating expenses is a pre-tax foreign exchange loss of $682,000. Such loss is principally related to assets and premiums receivable of approximately $5.8 million denominated in European Currency Units, which is recorded separately from statutory underwriting results and therefore excluded from the statutory composite ratio. Unhedged monetary assets and liabilities are translated at the exchange rate in effect at the balance sheet date, with the resulting foreign exchange gains or losses recognized in income. Such future gains or losses are unpredictable, and could be material.
Given the Company's current level of surplus, under its current underwriting guidelines, the maximum net retention per risk for property treaties and per occurrence for casualty treaties is generally $10.0 million.
As a significant portion of the Company's investment portfolio will generally consist of equity securities issued by insurance and reinsurance companies and companies providing services to the insurance industry, the equity portfolio will lack industry diversification and will be particularly subject to the performance of the insurance industry. Unlike fixed income securities, equity securities such as common stocks, including the equity securities in which the Company may invest, generally are not and will not be rated by any nationally recognized rating service. The values of equity securities generally are more dependent on the financial condition of the issuer and less dependent on fluctuations in interest rates than are the values of fixed income securities. The market value of equity securities generally is regarded as more volatile than the market value of fixed income securities. The effects of such volatility on the Company's equity portfolio could be exacerbated to the extent that such portfolio is concentrated in the insurance industry and in relatively few issuers.
At December 31, 1997, substantially all of the Company's fixed maturity and short-term investments were rated investment grade by Moody's or Standard & Poor's and had an average quality rating of AA and an average duration of approximately 2.9 years.
At December 31, 1997, the Company is obligated under letters of credit approximating $46.5 million, which secure certain reinsurance obligations and investment commitments in amounts of approximately $30.8 million and $15.7 million, respectively. Securities with a carrying value of approximately $38.2 million have been pledged as collateral for a portion of these letters of credit.
The Company has not invested in derivative financial instruments such as futures, forward contracts, swaps, or options or other financial instruments with similar characteristics such as interest rate caps or floors and fixed-rate loan commitments. The Company's portfolio includes market sensitive instruments, such as mortgage-backed securities, which are subject to prepayment risk and changes in market value in connection with changes in interest rates. The Company's investments in mortgage-backed securities, which amounted to approximately $30.5 million at December 31, 1997, or 6% of cash and invested assets, are classified as available for sale and are not held for trading purposes.
The Nebraska insurance laws provide that, without prior approval of the Nebraska Director, Risk Capital Reinsurance cannot pay a dividend or make a distribution (together with other dividends or distributions paid during the preceding 12 months) that exceeds the greater of (i) 10% of statutory surplus as of the preceding December 31 or (ii) statutory net income from operations from the preceding calendar year not including realized capital gains. Net income (exclusive of realized capital gains) not previously distributed or paid as dividends from the preceding two calendar years may be carried forward for dividends and distribution purposes. Any proposed dividend or distribution in excess of such amount is called an "extraordinary" dividend or distribution and may not be paid until either it has been approved, or a 30-day waiting period has passed during which it has not been disapproved, by the Nebraska Director. Notwithstanding the foregoing, the Nebraska insurance laws provide that any distribution that is a dividend may be paid by Risk Capital Reinsurance only out of earned surplus arising from its business, which is defined as unassigned funds (surplus) as reported in the statutory financial statement filed by Risk Capital Reinsurance with the Nebraska Insurance Department for the most recent year. In addition, the Nebraska insurance laws also provide that any distribution that is a dividend and that is in excess of Risk Capital Reinsurance's unassigned funds, exclusive of any surplus arising from unrealized capital gains or revaluation of assets, will be deemed an "extraordinary" dividend subject to the foregoing requirements. See "Business--Insurance Regulation--Regulation of Dividends and Other Payments from Insurance Subsidiaries" and Note 10 of the accompanying Notes to the Consolidated Financial Statements of the Company.
At December 31, 1997, the Company's consolidated stockholders' equity totaled $401.0 million, or $23.51 per share based on issued and outstanding shares and $22.79 per share on a diluted basis which includes outstanding dilutive warrants and options. At such date, statutory surplus of Risk Capital Reinsurance was approximately $385 million. Based on data available as of December 31, 1997 from the RAA, Risk Capital Reinsurance is the eleventh largest domestic broker market oriented reinsurer as measured by statutory surplus.
Earnings per share are computed in accordance with Financial Accounting Standards Board ("FASB") Statement No. 128 "Earnings Per Share," which was retroactively adopted in the 1997 fourth quarter. All earnings per share amounts for all periods have been presented, and where appropriate, restated to conform to the new accounting requirements. (See Notes 2, 12 and 14 of the accompanying Notes to the Consolidated Financial Statements of the Company.)
Set forth below is pro forma information regarding net income and earnings per share, assuming the Company had accounted for its employee stock options under FASB No. 123 using a Black-Scholes option valuation model:
Years Ended December 31, June 23, 1995 -------------------------- (date of inception) to 1997 1996 December 31, 1995 ------------ ------------- ----------------------
Net income, as reported.. $2,039 $4,112 $1,019 Pro forma net income..... 994 3,569 911 Earnings per share, as reported Basic and diluted.... 0.12 0.24 0.06 Pro forma earnings per share Basic and diluted.... 0.06 0.21 0.05
The effect on net income and earnings per share after applying FASB No. 123's fair valuation method to stock issued under the Company's employee stock purchase plan does not materially differ from the pro forma information set forth above with respect to the Company's employee stock options. (See Note 8 of the accompanying Notes to the Consolidated Financial Statements of the Company.)
Many companies must undertake major projects to address the year 2000 issue. Each company's potential costs and uncertainties will depend on a number of factors, including its software and hardware and the nature of its industry. Companies also must coordinate with other entities with which they electronically interact, both domestically and globally, including suppliers, customers, creditors, borrowers and financial service organizations. If a company does not successfully address its year 2000 issues, it may face material adverse consequences.
In addition, property and casualty reinsurance companies may have underwriting exposure related to the year 2000. While the Company continues to review these potential exposures, the Company is unable to determine at this time whether the adverse impact, if any, in connection with the foregoing would be material to the Company.
Risk Capital Reinsurance, in common with other insurers, is subject to extensive governmental regulation and supervision in the various states and jurisdictions in which it transacts business. The laws and regulations of the State of Nebraska, the domicile of Risk Capital Reinsurance, have the most significant impact on its operations.
The effects of inflation on the Company will be implicitly considered in pricing and estimating reserves for unpaid claims and claims expenses. The actual effects of inflation on the results of the Company cannot be accurately known until claims are ultimately settled.
See the Consolidated Financial Statements and Notes thereto and required financial statement schedules on pages through and S-1 through S-7 below.