New York - 37,000 square feet Chicago - 3,500 square feet San Francisco - 2,000 square feet
The Company's results of operations are derived from participation in pools of insurance covering ocean marine, inland marine, aircraft and other liability insurance managed by MMO and affiliates. Effective January 1, 1997 and subsequent, the Company's participation in the pools increased to 100%. The Company has ceased writing any new policies covering aircraft insurance for periods subsequent to March 31, 2002.
The Company records premiums written in the year policies are issued and earns such premiums on a monthly pro rata basis over the terms of the respective policies. The following tables present the Company's premiums written and premiums earned on a net basis after ceded reinsurance for each of the past three years.
The Company estimates reserves each year based upon, and in conformity with, the factors discussed under "Business-Reserves". Changes in estimates of reserves are reflected in operating results in the year in which the change occurs.
Net premiums earned for the year ended December 31, 2002 grew by 34%, when compared to the same period of the prior year. Excluding the exited lines of business of aircraft and MMO London, net premiums earned for the year ended December 31, 2002 would have grown by 69% when compared to the same period of 2001. The increases were achieved primarily as a result of rate increases across all lines of business and new production opportunities.
Other liability - net premiums earned rose by 140% during 2002 when compared to 2001 due to new production opportunities arising from policies covering errors and omissions/professional liability risks, additional production in existing classes and larger premium rates on policy renewals. Net premiums in the other liability line are expected to increase in 2003 as premium rates are firm within this line of business, but premium increases are expected to be substantially lower in 2003 than they were in 2002.
Inland marine/fire - net premiums earned increased 268% for the year ended December 31, 2002 when compared to the same period last year, largely due to an underwriting program insuring excess and surplus lines property risks and improved pricing. The underwriting program commenced in July of 2001.
Aircraft - premiums earned grew 35% for the year ended December 31, 2002 when compared to the same period of 2001, despite a reduction in policy count, primarily as a result of rate increases. Contributing to the overall increase were premium surcharges for terrorism coverage written after September 11, 2001. The Company recorded approximately $28 million in gross premiums written from such premium surcharges in 2002. The prior year net premiums were adversely affected by reinstatement reinsurance costs of $5.0 million incurred as a result of the WTC attack. Net premiums written and earned are expected to decline significantly in 2003 in the aircraft segment as the Company has ceased writing new aircraft policies subsequent to March 31, 2002.
MMO London - premiums earned for the year ended December 31, 2002 were down by 71% to $4.2 million from $14.1 million in the prior year's comparable period and reflected reduced capacity for premium writings at Lloyd's. Premiums earned are expected to further decrease as the Company has completed its withdrawal from its U.K. operations in 2002 and the Company will not provide capacity (the ability to write premiums) to any Lloyd's syndicate for the 2002 and subsequent underwriting years.
Net losses and loss adjustment expenses incurred as a percentage of net premiums earned (the loss ratio) were 64.7% for the year ended December 31, 2002 as compared to 103.9% for the same period of 2001. The Company reported higher loss ratios in 2001 as a result of losses sustained from the WTC attack and larger severity losses arising from higher net loss retentions in the aircraft segment of business. Underwriting losses from MMO London also contributed to higher overall loss ratios in the prior year. In addition, the prior year loss ratio reflected larger charges for insolvent or financially impaired reinsurers of $10.8 million as compared to $5.1 million in calendar year 2002. A significant portion of such charges pertained to the 1998 to 2001 accident years in the aircraft segment of business and contributed to the adverse re-estimation of net loss reserves.
The Company reported lower overall loss ratios in 2002 as a result of a decrease in the frequency and severity of losses in the aircraft line when compared to the prior year. However, the number of large severity losses increased in the ocean marine line, which adversely affected the ocean marine line in 2002. The Company also reported adverse net loss development in its umbrella (other liability) losses of approximately $2.2 million in 2002 as a result of the additional development of asbestos losses with respect to a few insureds. This compared to $.6 million in adverse development for umbrella losses in 2001.
Policy acquisition costs as a percentage of net premiums earned for the year ended December 31, 2002 were 16.7% as compared with 19.0% for the same period of the prior year. The decrease in the percentage was primarily attributable to the aircraft expense ratio, which reflected a lower ratio as premium surcharges were recorded with a nominal processing charge. The Company expects a higher ratio in 2003 since writings in the aircraft line are expected to be significantly less than in 2002.
The Company's combined ratio (the loss ratio plus the ratio of policy acquisition costs and general and administrative expenses divided by premiums earned) improved to 97.5% for the 2002 year compared with 142.9% for 2001. Excluding losses from the WTC attack, the combined ratio would have been 127.6% in 2001.
Commission and other income, collectively, decreased to $1.7 million for the year ended December 31, 2002 from $3.6 million for the same period in the prior year. In 2001, larger profit commissions were earned based upon the ceded results of aircraft reinsurance treaties.
General and administrative expenses increased by 8% to $18.4 million for the year ended December 31, 2002 when compared to $17.0 million for the same period in 2001. The increase is principally attributable to $1.5 million in charges resulting from the reorganization of the Company's management structure in 2002.
Prepaid reinsurance premiums of $6.4 million and reserve of unearned premiums of $45.4 million as of December 31, 2002 each recorded decreases from the prior year end balances primarily due to reductions in the amount of inforce premiums from the aircraft and MMO London segments.
Inland marine - net premiums earned in the inland marine line rose in 2001 due to additional premium volume through expansion opportunities and firmer pricing. The increase in premium volume was achieved by writing a new program insuring excess and surplus lines property risks.
Aircraft - net premiums earned in the aircraft line increased in 2001, primarily due to higher net retention levels and rate increases; however, they were offset by ceded reinstatement premiums incurred of $5.0 million from the WTC attack. The increase in net premiums earned was achieved despite reductions in policy count and more expensive reinsurance costs resulting from a tighter reinsurance market. Part of this increase was attributable to premium surcharges received after the WTC attack. The Company recorded approximately $12 million in net premiums written from premium surcharges, of which $6.5 million was earned, in 2001.
MMO London - net premiums earned decreased in 2001 by 46%. Excluding a prior year transaction, which involved a one-time assumption of ocean marine and casualty premiums, net premiums earned in MMO London during 2001 would have decreased by 25% which reflected a reduction in capacity for premium writings at Lloyd's. Net premiums written and earned for the 2001 year include approximately $7.8 million and $4.9 million, respectively, resulting from the Company's interest in Lloyd's Syndicate 2010 which, effective January 1, 2001, primarily wrote assumed reinsurance of aircraft and property risks.
Policy acquisition costs as a percentage of net premiums earned was 19.0% for the year ended December 31, 2001 as compared with 24.1% for the same period in 2000. The decrease was attributable to a lower aircraft expense ratio, as much of the premium surcharges enacted after September 11, 2001 were recorded with a nominal processing charge. The prior year ratio also reflected a higher ratio for MMO London resulting from the recognition of larger premium deficiencies.
Net investment income was down 4% to $17.4 million for the year ended December 31, 2001 from $18.1 million for the same period of the prior year. The decrease generally reflected a lower interest rate environment and a reduction in overall invested assets during the year.
Realized investment gains were $2.9 million and $5.2 million for the years ended December 31, 2001 and 2000, respectively. The 2001 year reflected larger write-downs from other than temporary declines in the fair value of equity securities. The 2000 year amount reflected larger gains from the sale of equity securities.
Other liabilities as of December 31, 2001 increased to $23.2 million from $9.8 million as of the 2000 year end as a result of increases in funds held from reinsurers in order to collateralize their obligations to the Company as required by provisions of various reinsurance treaties. Funds obtained from reinsurers are invested for the benefit of the Company in the insurance pools managed by MMO.
Unpaid losses and loss adjustment expenses and reinsurance receivables as of December 31, 2001 increased to $534.2 million and $361.7 million, respectively, primarily as a result of gross losses of $154.9 million and reinsurance receivables of $146.9 million, respectively, incurred from the WTC attack.
Accumulated other comprehensive income decreased to $7.9 million as of December 31, 2001 from $10.9 million as of December 31, 2000. The change principally reflects decreases in the fair value of equity securities brought about by declines in the U.S. stock markets during 2001. Partially offsetting this decrease was the favorable impact of lower interest rates on the fair value of fixed maturity investments.
Cash flows from operating activities in 2002 and 2001 amounted to $65.4 million and $1.8 million, respectively, resulting primarily from increases in premiums. A commutation of ceded loss reserves contributed approximately $19.3 million in cash flows during 2002. Cash flows of $15.1 million were used in operating activities during 2000 as declines in premium rates, increases in ceded reinsurance premium costs and increases in severity claim payments on a gross basis negatively affected cash flows from operations. The Company's loss payments on Asbestos/Environmental business also adversely affected cash flows during the past three years.
The cash flows used in operating activities during 2000 were made available by investing activities and, in particular, through the sale or maturity of fixed income securities and short-term investments. Cash flows are expected to be favorable in the foreseeable future as a result of the strong underwriting climate in the Company's lines of business. However, they are expected to be less than the levels of cash recorded from operations in 2002 as a result of expected declines in premiums in the aircraft and MMO London lines of business.
Financing activities occurred, in prior years, as a result of borrowings under the Company's revolving credit agreement and unsecured credit facility. Repayments under the Company's prior loan facility were made at $1,250,000 per quarter over the past three years through June 30, 2002. The Company borrowed approximately $5.5 million in 2001 to assist in the payment of gross losses of the Company. The loan amount resulted from draw downs during 2001 on letters of credit provided to support the Company's U.K. operations.
The following table outlines the major contractual obligations of the Company as of December 31, 2002 and the years in which they become due.
On December 30, 2002, the Company signed a sublease, for which it received landlord's consent dated January 31, 2003, for 28,195 square feet for its principal offices in New York. The lease commenced on March 1, 2003 and expires on July 30, 2016. The minimum monthly rental payments of $102,794 will commence in 2004 and end in 2016 and amount to $15.3 million of total rental payments over the term of the sublease. The new offices will be located at 919 Third Avenue, New York, New York 10022.
There were no related party transactions which had a material effect on the Company's financial position, cash flows, liquidity or results of operations. Specific related party transactions are disclosed in Note 16 of the Company's financial statements.
The Company discloses significant accounting policies in the footnotes of its financial statements. Management considers certain accounting policies to be critical for the understanding of the Company's financial statements. Such policies require significant management judgment and the resulting estimates have a material effect on reported results and will vary to the extent that future events affect such estimates and cause them to differ from the estimates provided currently. These critical accounting policies include unpaid losses and loss adjustment expenses, allowance for doubtful accounts and impairment of investments.
Periods of inflation have prompted the pools, and consequently the Company, to react quickly to actual or potential imbalances between costs, including claim expenses, and premium rates. These imbalances have been corrected mainly through improved underwriting controls, responsive management information systems and frequent review of premium rates and loss experience.
The consolidated financial statements required in response to this item are included as part of Item 15(a) of this report.