(1) All information for 1999 and prior years includes the results of NAC as though it had always been a part of the Company.
This "Management's Discussion and Analysis of Results of Operations and Financial Condition" contains forward-looking statements which involve inherent risks and uncertainties. Statements that are not historical facts, including statements about the Company's beliefs and expectations, are forward looking-statements. These statements are based upon current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements, and therefore undue reliance should not be placed on them. See " - Cautionary Note Regarding Forward-Looking Statements" for a list of additional factors that could cause actual results to differ materially from those contained in any forward-looking statement.
The reserve for losses incurred but not reported has been estimated by management and reviewed by independent actuaries, based on loss development patterns determined by reference to the Company's underwriting practices, the policy form, type of insurance program and the experience of the relevant industries.
frequency and high severity, limiting the utility of claims experience of other insurers for similar claims. While management believes the reserves for unpaid losses and loss expenses are sufficient to cover losses that fall within coverages assumed by the Company, the ultimate claims experience may not be as reliably predicted as may be the case with other insurance operations, and there can be no assurance that ultimate losses and loss expenses will not exceed the total reserves.
The establishment of unpaid loss and loss expense reserves also includes reinsurance recoveries. Due to the size of the gross losses arising from the September 11 event and the related reinsurance recoveries and the magnitude of the September 11 event on the reinsurance industry, the Company, in addition to its normal review process, further analyzed the recoverability of these assets. Approximately 96% of the relevant reinsurers currently fall into Standard & Poor's financial strength rating categories or equivalent of A or better, with approximately 65% rated AA or better. Accordingly, the Company believes that substantially all insurance will be recoverable. An allowance has been established for estimated uncollectible recoverables.
The Financial Accounting Standards Board issued FAS 133, "Accounting for Derivative Instruments and Hedging Activities" in June 1998. FAS 133 establishes accounting and reporting standards for derivative instruments including those embedded in other contracts (collectively referred to as derivatives), and for hedging activity. It requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Non-exchange traded weather products are not covered by FAS 133, however are also recorded at fair value. The Company adopted FAS 133, as amended, as of January 1, 2001. The Company conducts activities in three main types of instruments: credit default swap derivatives, weather risk management products and investment related derivative instruments. There was no significant impact from the adoption of FAS 133. See Item 8, Note 14 for further information on these derivative instruments.
The Company considers credit default swaps to be, in substance, financial guaranty contracts as the Company intends to hold them to maturity. Fair value is determined using a model developed by the Company and is dependent upon a number of factors, including changes in interest rates, credit spreads, changes in credit quality and other market factors. The change in fair value in a period is split between premiums, net losses and loss expenses, and net realized and unrealized gains and losses on derivative instruments. The change resulting from movements in credit spreads is unrealized as the credit default swaps are not traded to realize this value and is included in net realized and unrealized gains and losses on derivative instruments. Other elements of the change in fair value are based upon pricing established at the inception of the contract. Prior to the adoption of FAS 133, the net premiums earned and loss and loss expenses were included in fee income and other.
Investments are reviewed periodically to determine if they have sustained an impairment of value that is considered to be other than temporary. The identification of potentially impaired investments involves significant management judgment, which includes the determination of their fair value and the assessment of whether any decline in value is other than temporary. If investments are determined to be impaired, a realized loss is recognized. The current economic environment and recent volatility of securities markets increase the difficulty in determining impairment. For other investments that are not quoted, fair value is determined using the financial information received and other economic and market knowledge as appropriate.
The following table presents an after-tax analysis of the Company's net income for the years ended December 31, 2001, 2000 and 1999 (U.S. dollars in thousands, except per share amounts):
(1) Net operating (loss) income excludes after-tax net realized gains and losses on investments and net realized and unrealized gains and losses on derivative instruments.
The Company issued 9.2 million common shares on November 7, 2001, which did not significantly dilute the weighted average shares outstanding for 2001. During 2002, the weighted average shares will increase significantly as the 9.2 million shares will be weighted for the full year.
The Company is organized into three underwriting segments - insurance, reinsurance, and financial products and services - and a corporate segment, which includes the investment operations of the Company. Lloyd's syndicates are included in the insurance segment but are shown separately. See Item 1 and Item 8, Note 3 to the Consolidated Financial Statements for further information.
Effective July 1, 2001, the insurance segment included the results of Winterthur International. Each of the above line items experienced growth primarily as a result of the inclusion of business written and earned by Winterthur International. Consequently, period to period comparisons may not be meaningful.
Growth in net premiums earned in 2000 over 1999 is mainly due to new business, primarily environmental business, written by ECS. ECS contributed approximately $110.0 million in net premiums earned in 2000. No premiums were earned by ECS in 1999 as ECS only commenced writing business on behalf of the Company with effect from January 1, 2000. Prior to this date, ECS had agency agreements in place with other companies. In addition, the Company wrote aviation and satellite business totaling $60.0 million in net premiums earned. In 1999, this business was written on behalf of the Lloyd's syndicates, of which the Company's share was approximately $11.5 million in net premiums earned. 2000 also included approximately $25.0 million in net premiums earned of new professional liability business written.
The loss ratio was higher in the year ended December 31, 2001 compared to 2000 due primarily to net losses of $102.0 million incurred related to the September 11 event. This loss was partially offset by favorable loss development from prior accident years. There were no significant catastrophic loss events for this segment in the year ended December 31, 2000. In addition, the 2001 loss ratio increased primarily as a result of the inclusion of losses related to the inclusion of Winterthur International effective July 1, 2001. Business in force at June 30, 2001 for Winterthur International carries a maximum exposure to a combined ratio of 105%. As described in Note 5 to the Consolidated Financial Statements, the accounting for the purchase of Winterthur International required the Company to fair value the acquired assets and liabilities on June 30, 2001. The fair value adjustment to the loss reserves resulted in an accretion of discount for the year ended December 31, 2001 of $1.4 million.
Net premiums earned for the year ended December 31, 2001 increased over 2000 primarily as a result of additional syndicate capacity provided by the Company, currently at 63% compared to 53% in the prior year. In addition, net premiums earned increased due to greater premiums written in the prior year than originally estimated. The increase in net premiums earned was partially offset by the net reinstatement premiums of $21.4 million as a result of losses incurred from the September 11 event.
In November 2001, the Company realigned its Lloyd's operations effective January 1, 2002 and from that time, provides 100% of the capacity for Syndicates 1209 and 990. The Company believes that the expected increase in premiums generated from higher ownership will be reduced by premiums on discontinued lines such as excess of loss treaty, accident and health and certain property accounts.
In 1999, fee income and other primarily related to the sale of the Company's two motor insurance businesses, resulting in a gain of $40.2 million. In addition, 1999 also included $42.1 million of fees generated from the motor business prior to the sale. No such income was earned in 2001 or 2000.
Loss and loss expense ratio ........... 126.9% 72.8% 83.6% Underwriting expense ratio ............ 37.0% 41.5% 33.3% ----------------------------- Combined ratio ........................ 163.9% 114.3% 116.9% =============================
The loss and loss expense ratio increased in the year ended December 31, 2001 compared to 2000 primarily due to net losses incurred for the September 11 event of approximately $215.8 million and other significant losses including the Toulouse petrochemical plant explosion and the airport loss event in Sri Lanka, totaling approximately $19.0 million. In addition, the Company experienced loss deterioration on business written in previous underwriting years of approximately $23.0 million. The underwriting expense ratio was lower in 2001 compared to 2000 primarily due to savings generated from merging the managing agency operations against a higher net premiums earned base.
The decrease in the loss ratio and increase in the expense ratio in 2000 over 1999 primarily reflected the effect of the sale of the motor business. In 1999, the motor business had a loss ratio of approximately 101.1% and an expense ratio of approximately 21.8%. Non-motor business written typically has lower loss ratios and higher commissions than the motor business. The increase in the expense ratio in 2000 was also principally due to additional reinsurance costs and a charge of $7.5 million for employee severance and other costs associated with the realignment of the Company's operations.
The following table summarizes the underwriting results for this segment (U.S. dollars in thousands):
Fee income and other in 2001 and 2000 related primarily to non-underwriting costs for an outward reinsurance contract that did not exist in 1999.
Loss and loss expense ratio .......... 138.8% 71.5% 76.1% Underwriting expense ratio ........... 36.8% 37.7% 35.9% ------------------------------- Combined ratio ....................... 175.6% 109.2% 112.0% ===============================
Property catastrophe business has loss experience that is generally categorized as low frequency but high severity in nature. This may result in volatility in the Company's financial results for any fiscal year or quarter. Property catastrophe losses generally are notified and paid within a short period of time from the covered event.
Net losses and loss expenses in 2001 included $442.1 million related to the September 11 event, primarily on the property and aviation reinsurance lines of business. The combined ratio also increased in 2001 over 2000 due to the effects of the reinstatement premium expense noted above. In addition, net losses and loss expenses in 2001 included losses incurred related to continued adverse development in the casualty book of approximately $180.0 million in the 1997 through 1999 accident years. Actuarial assumptions are used to establish initial expected loss ratios employed in the actuarial methodologies from which the reserve for losses and loss expenses is derived. Such loss ratios are periodically adjusted to reflect comparisons with actual claims development, inflation and other considerations.
In addition, other large losses in 2001 totaled approximately $93.0 million, including the Sri Lanka airport loss, Tropical Storm Allison, the Petrobras loss in Brazil and the Seattle earthquake. Loss events in 2000, which included an oil refinery loss in Kuwait, several satellite losses and the Singapore Airlines loss, totaled approximately $95.0 million. Barring any significant catastrophes, the Company expects the combined ratio to improve significantly in 2002 due to business anticipated to be written at higher rates and at improved terms and conditions.
In 2000 and 1999, net losses and loss expenses incurred in the segment reflected a recovery of $33.5 million and $100.0 million respectively, under an intercompany stop loss arrangement. The loss and loss expense ratio in 2000 and 1999 would have been 75.1% and 87.1% respectively, had this arrangement not been in place. Included in net losses incurred in 2000 are loss reserve adjustments as discussed previously. Excluding the effects of the inter-
company stop loss agreement, the loss ratio was higher in 1999 compared to 2000 due to a higher amount of catastrophe losses and a reserve adjustment of $95.0 million related to the merger with NAC. Catastrophe losses in 1999 included European windstorms, hailstorms in Sydney, tornadoes in Oklahoma and satellite losses totaling approximately $185.0 million. In addition, there was an increase in the loss ratio in 2000 and 1999 in the casualty reinsurance business related primarily to deterioration in premium rates as described above.
The underwriting expense ratio decreased in the year ended December 31, 2001 compared to the same period in 2000 primarily due to a reduction in operating expenses related to certain compensation expenses of approximately $7.0 million accrued in previous years.
The Company's casualty business included a minimal element of asbestos and environmental claims on business written prior to 1986. The Company's reserving process includes a supplemental evaluation of claims liabilities from exposure to asbestos and environmental claims, including related loss adjustment expenses. However, the Company's loss and loss expense reserves for such exposures, net of reinsurance, as of December 31, 2001, 2000 and 1999 is less than 1% of its total reserves. A reconciliation of the Company's gross and net liabilities for such exposures for the three years ending December 31, 2001 is set forth in Item 8, Note 9 to the Consolidated Financial Statements.
Net premiums earned in 2001 increased compared to 2000 due to significantly greater net premiums written in 2001 in the financial guaranty business. This translated into an increase in net premiums earned of approximately $8.8 million as such premiums are earned over a relatively long time period. In 2001, financial guaranty business included primary and secondary municipal portfolios, asset-backed securities, structured finance transactions and reinsurance assumed. In 2000, most of the business was treaty business assumed from one financial guaranty company. Net premiums earned in 2001 also included weather related risk management transactions. The increase in net premiums earned in 2001 also included approximately $9.8 million of installment premiums from credit default swaps
The increase in fee income for 2001 related to trading gains and the change in the fair value of weather risk management products, reflecting the continued growth in this business. An analysis of the Company's risk management, controls and methodologies is provided within Item 7A, "Quantitative and Qualitative Disclosure of Market Risk."
The Company's financial guaranty operations write business with an expected loss ratio of approximately 25%. The increase in the loss ratio in 2001 related to a loss on a weather related risk management contract. The corresponding hedge of this contract realized a weather related derivative gain that is recorded in fee income and other. In 2001, there were no credit events that resulted in incurred losses for credit default swaps in this segment.
The underwriting expense ratio decreased due to the increase in net premiums earned as a result of the change in presentation noted above. The high expense ratio reflects operating expenses incurred in the generation of fee income and other that is not included in the ratio calculation.
The following table illustrates the change in net investment income and net realized gains and losses for each of the three years ended December 31, 2001 (U.S. dollars in thousands):
Net investment income increased in the year ended December 31, 2001 compared to 2000 due primarily to a higher investment base in 2001. The investment base in 2001 included the receipt of net funds of $1.1 billion related to new debt issued by the Company during the second and third quarters of 2001. As previously noted, the
Net realized investment gains in 1999 reflected the strong performance of the equity market. However, 1999 equity gains were offset by declining fixed income markets.
Net realized and unrealized gains on investment derivatives result from the Company's investment strategy to economically hedge against interest and foreign exchange risk within the investment portfolio. See
A S S E T S 2001 2000 ------------------------ Investments: Fixed maturities at fair value (amortized cost: 2001, $10,945,568; 2000, $8,714,196) ........... $10,831,927 $8,605,081 Equity securities, at fair value (cost: 2001, $575,090; 2000, $515,440) ......... 547,805 557,460 Short-term investments, at fair value (amortized cost: 2001, $1,050,015; 2000, $347,147) ............................... 1,050,113 339,007 ------------------------ Total investments available for sale ....... 12,429,845 9,501,548 Investments in affiliates ......................... 1,037,344 792,723 Other investments ................................. 273,528 177,651 ------------------------ Total investments .......................... 13,740,717 10,471,922 Cash and cash equivalents ............................ 1,863,861 930,469 Accrued investment income ............................ 180,305 143,235 Deferred acquisition costs ........................... 394,258 309,268 Prepaid reinsurance premiums ......................... 846,081 391,789 Premiums receivable .................................. 2,182,348 1,119,723 Reinsurance balances receivable ...................... 1,246,106 196,002 Unpaid losses and loss expenses recoverable .......... 5,033,952 1,339,767 Intangible assets (accumulated amortization: 2001, $194,045; 2000, $135,476) ................... 1,616,943 1,591,108 Deferred tax asset, net .............................. 419,222 152,168 Other assets ......................................... 439,282 296,501 ------------ ----------- Total assets ............................... $27,963,075 $16,941,952 =========== =========== L I A B I L I T I E S A N D S H A R E H O L D E R S' E Q U I T Y Liabilities: Unpaid losses and loss expenses ...................... $11,825,680 $5,672,062 Deposit liabilities and policy benefit reserves ...... 2,374,164 1,209,926 Unearned premiums .................................... 2,682,089 1,741,393 Notes payable and debt ............................... 1,604,877 450,032 Reinsurance balances payable ......................... 1,672,122 441,900 Net payable for investments purchased ................ 1,247,027 1,372,476 Other liabilities .................................... 1,071,402 439,433 Minority interest .................................... 48,530 41,062 ------------ ----------- Total liabilities .......................... $22,525,891 $11,368,284 ============ =========== Commitments and Contingencies
XL CAPITAL LTD CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999 (U.S. dollars in thousands)
XL CAPITAL LTD NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31 2001, 2000 AND 1999 (U.S. dollars in thousands, except per share amounts)
XL Capital Ltd (the "Company") is a holding company organized under the laws of the Cayman Islands. The Company was incorporated on March 16, 1998, as the successor to EXEL Limited, a Cayman Islands corporation organized in 1986, in connection with EXEL Limited's merger with Mid Ocean Limited, a Cayman Islands corporation. The Company operated under the name EXEL Limited from completion of the merger until February 1, 1999, when its current name was approved by the requisite vote of the Company's shareholders. The Company is a leading provider of insurance and reinsurance coverages and financial products and services to industrial, commercial and professional service firms, insurance companies and other enterprises on a worldwide basis.
On July 25, 2001, the Company completed the acquisition of certain Winterthur International insurance operations ("Winterthur International") to extend its predominantly North American based large corporate business globally. Effective July 1, 2001, the Company's results include Winterthur International. See Note 5 for additional information.
In 1999, XL Capital Ltd merged with NAC Re Corp ("NAC"), a Delaware corporation. NAC was organized in 1985 and writes property and casualty insurance and reinsurance in the U.S., Canada and Europe. Subsequent to the merger, the Company amended its financial year from November 30 to December 31.
The Company further expanded into the U.S. in 1999 by completing the acquisition of both Intercargo Corporation and ECS, Inc. Intercargo, renamed XL Specialty, underwrites specialty insurance products for companies engaged in international trade, including customs bonds and marine cargo insurance. ECS is an underwriting manager, which specializes in environmental insurance coverages and risk management services.
In July 1999, the Company entered into a venture with Les Mutuelles du Mans Assurances Group to form a new French reinsurance company, Le Mans Re. Le Mans Re underwrites a worldwide portfolio comprising most classes of property and casualty reinsurance business together with a selective portfolio of life reinsurance business.
In 1999, the Company made strategic minority investments in two investment management firms. The Company acquired minority investments in Highfields Capital Management LP, a global equity investment firm, and MKP Capital Management, a New York based fixed income investment manager specializing in mortgage-backed securities.
Premiums from long duration contracts that transfer significant mortality or morbidity risks are recognized as revenue and earned when due from policyholders. Premiums from long duration contracts that do not subject the Company to risks arising from policyholder mortality or morbidity are accounted for as deposit liabilities, discussed further in Note 2(m).
Acquisition costs, which vary with and are related to the acquisition of policies, primarily commissions paid to brokers, are deferred and amortized over the period the premiums are earned. Future earned premiums, the anticipated losses and other costs, together with investment income related to those premiums are also considered in determining the level of acquisition costs to be deferred.
In the normal course of business, the Company seeks to reduce the loss that may arise from events that could cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurers or reinsurers. Reinsurance premiums ceded are expensed and any commissions recorded thereon are earned on a monthly pro-rata basis over the period the reinsurance coverage is provided. Prepaid reinsurance premiums
Investments in which the Company has significant influence over the operations are classified as affiliates and are carried under the equity method of accounting. Under this method, the Company records its proportionate share of income or loss from such investments in its results for the period. Significant influence is deemed to exist where the Company has an investment of 3% or greater in closed end funds or limited partnerships. Significant influence is considered for other strategic investments on a case-by-case basis. The equity in net income of affiliates is shown separately between equity in net income of strategic insurance affiliates and equity in net income of investment fund related affiliates.
Management believes that the reserves for unpaid losses and loss expenses are sufficient to cover losses that fall within coverages assumed by the Company. However, there can be no assurance that losses will not exceed the Company's total reserves. The methodology of estimating loss reserves is periodically reviewed to ensure that the assumptions made continue to be appropriate and any adjustments resulting therefrom are reflected in income of the year in which the adjustments are made.
Contracts entered into by the Company which are not deemed to transfer significant underwriting and/or timing risk are accounted for as deposits, whereby liabilities are initially recorded at the same amount as assets received. An initial accretion rate is established based on actuarial estimates whereby the deposit liability is increased to the estimated amount payable over the term of the contract. Accretion expense is recorded against investment income generated from the related invested assets. The Company periodically reassesses the estimated ultimate liability. Any changes to this liability are reflected as an adjustment to interest income to reflect the cumulative effect to date of the period the contract has been in force, and by an adjustment to the future accretion rate of the liability over the remaining estimated contract term.
Long duration contracts that do transfer significant mortality or morbidity risks to the Company are accounted for as insurance contracts and policy benefit reserves are established based on the present value of the estimated ultimate liability. An initial accretion rate is established based on actuarial estimates and the policy benefit reserve is increased to the estimated amounts payable over the term of the contract. This accretion charge is recorded in the period as life claims and policy benefit reserves. The Company periodically reassesses the estimated ultimate policy benefits. Any changes to this estimate will be reflected as an adjustment to life claims and policy benefit reserves to reflect the cumulative effect to date of the period the contract has been in force and by an adjustment to the future accretion rate of the liability over the remaining estimated contract term.
The Company accounts for stock compensation plans in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Accordingly, compensation expense for stock option grants and stock appreciation rights is recognized to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date.
Certain business written by the Company has loss experience characterized as low frequency and high severity. This may result in volatility in both the Company's results and operational cash flows. General operations and Life operations are disclosed separately within each segment. General operations include property and casualty lines of business and financial products and services.
The Lloyd's syndicates write property, marine and energy, aviation and satellite, professional indemnity, liability coverage and other specialty lines.
Reinsurance business written includes treaty and facultative reinsurance to primary insurers of casualty risks, principally: general liability; professional liability; automobile and workers compensation; commercial and personal property risks; specialty risks including fidelity and surety and ocean marine; property catastrophe; property excess of loss; property pro-rata; marine and energy; aviation and satellite; and various other reinsurance to insurers on a worldwide basis. The Company endeavors to manage its exposures to catastrophic events by limiting the amount of its exposure in each geographic zone worldwide and requires that its property catastrophe contracts provide for aggregate limits and varying attachment points.
Financial products and services business written includes insurance, reinsurance and derivative solutions for complex financial risks. These include financial guaranty insurance and reinsurance, credit enhancement swaps, other collateralized transactions and weather risk management products. While each of these is unique and is tailored for the specific needs of the insured or user, they are often multi-year contracts. Due to the nature of these types of contracts, premium volume as well as underwriting results can vary significantly from period to period.
(1) Ratios are based on net premiums earned from general operations, excluding fee income and other. The underwriting expense ratio excludes exchange gains and losses.
(3) Corporate operating expenses include charges of $14.0 million related to the acquisition of Winterthur International.
The following table is an analysis of the Company's gross premiums written, net premiums written and net premiums earned from general operations, by line of business for the years ended December 31:
(1) Lloyd's syndicates write a variety of coverages encompassing most of the above lines of business.
(2) Other premiums written and earned include political risk, surety, bonding and warranty.
The following table shows an analysis of the Company's net premiums written by geographical location of subsidiary for the years ended December 31:
The Company has performed a detailed analysis of contracts it believes are exposed to this event. The process varied between segments, due to the specific nature of each of their operations, and by line of business. For the property lines of business, which are the main areas affected, the Company was able to identify a limited number of relevant contracts soon after the event. The process included identification of possible claims using underwriting systems to determine potential exposures on a case-by-case basis. The exposures were then analyzed to determine the exact location and magnitude of the potential loss.
On July 25, 2001, the Company completed the acquisition of Winterthur International primarily to extend its predominantly North American based large corporate insurance business globally. This was an all-cash transaction. The preliminary purchase price of approximately $405.6 million was based on audited financial statements as at December 31, 2000 for the business being acquired, and is subject to final determination based on the audited financial statements of Winterthur International as at June 30, 2001. These audited financial statements are not expected to be completed until later in 2002, at which time any final adjustment payment will be made or receivable collected. Results of operations of Winterthur International have been included from July 1, 2001, the date from which the economic interest was transferred to the Company.
The Second Amended and Restated Agreement for the Sale and Purchase of Winterthur International ("the Sale and Purchase Agreement") provides the Company with significant post-closing protection with respect to adverse development of reserves with respect to Winterthur International business written prior to July 1, 2001. This protection is based upon actual net loss experience and development over a three year post closing seasoning period based on loss development experience, collectible reinsurance, reinsurance recoveries and certain other factors. Business in force at June 30, 2001 carries a maximum exposure to a combined ratio of 105%. The Company's exposure to a deficiency in the net reserves and the run-off of expiring business of the acquired Winterthur International operations, including by reason of uncollectible reinsurance, is limited to $61.0 million. Certain Winterthur International businesses and product lines were not purchased, primarily asbestos, certain insurance liabilities in respect of 1985 and prior years, certain captive management, alternative risk and life insurance business.
The acquisition has been accounted for under the purchase method of accounting and, therefore, the identifiable assets and liabilities of Winterthur International were recorded at their estimated fair value on June 30, 2001 based on the unaudited financial statements prepared by the seller and provided to the Company at that time. The process of determining the fair value of such assets and liabilities acquired, as required under purchase accounting, included management's estimates and independent valuations. The purchase price was preliminarily allocated to the acquired assets and liabilities based upon their estimated fair value at June 30, 2001. The excess of the purchase price over acquired tangible net assets was then applied to intangible assets with finite and indefinite lives. The remaining purchase price excess over fair value of net assets was allocated to goodwill. The Company's estimate of the fair value of loss reserves is approximately $5.0 million less than the carrying value recorded by the seller at July 1, 2001. This difference will be charged to income over the next six years. The Company has included the $61.0 million exposure in establishing its risk premium adjustment inherent in the fair value of loss reserves.
Fair value of assets acquired .......................... $4,791,338 Fair value of liabilites acquired ...................... 4,564,376 ---------- Fair value of tangible net assets acquired ............. $ 226,962 Fair value of intangible assets acquired ............... 29,800 Goodwill related to the acquisition .................... 40,476 ---------- $ 297,238 ---------- Adjusted preliminary purchase price .................... $ 274,738 Other costs of acquisition ............................. 22,500 ---------- $ 297,238 ----------
The following unaudited pro forma financial information for the year ended December 31, 2001 includes the unaudited financial information for Winterthur International for the year ended December 31, 2001 as if the acquisition occurred on January 1, 2001. The unaudited pro forma financial information for the year ended December 31, 2000 includes the audited financial information for Winterthur International for the year ended December 31, 2000 as if the acquisition occurred on January 1, 2000.
Winterthur International results of operations for the first six months of 2001 and the year ended December 31, 2000 included in the pro forma financial information have not been adjusted for the contractual protection that the Company has received from the seller with effect from July 1, 2001.
(UNAUDITED) (UNAUDITED) PRO FORMA PRO FORMA YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, 2001 2000 ------------------------- Net premiums earned - general operations ....... $ 3,119,977 $2,568,867 Net premiums earned - life operations .......... 695,595 -- Net investment income .......................... 587,676 612,486 Net realized (losses) gains on investments ..... (93,318) 56,107 Net realized and unrealized gains and losses on derivative instruments ............. (12,176) 5,481 Equity in net income of investment affiliates .................................... 80,580 70,032 Fee income and other ........................... 55,421 26,978 ------------------------- Total revenues ................................. $ 4,433,755 $3,339,951 ------------------------- Net losses and loss expenses incurred - general operations ........................... $ 3,294,452 $1,866,269 Claims and policy benefit reserves - life operations .............................. 698,675 -- Acquisition costs, operating expense and foreign currency gains and losses ............ 1,214,828 872,883 Interest expense ............................... 69,100 39,647 Amortization of intangible assets .............. 59,069 97,458 ------------------------- Total expenses ................................. $ 5,336,124 $2,876,257 ------------------------- Net (loss) income .............................. $ (729,129) $ 527,158 ========================= (Loss) earnings per ordinary share - Basic ..... $(5.76) $4.23 (Loss) earnings per ordinary share - Diluted ... $(5.76) $4.19
In the first quarter of 2001, the Company acquired The London Assurance Company of America, Inc., a shell company licensed in forty five U.S. states, for the purpose of obtaining licenses for the financial guaranty operations of the Company. The cost of the acquisition less cash acquired was $16.5 million. Goodwill arising from the acquisition was $11.2 million.
Gross realized losses included $66.4 million of provisions for declines in fair value considered to be other than temporary, for fixed maturities and equity securities in the year ended December 31, 2001. In addition to specific review by management, an other than temporary decline is considered to occur in investments where there has been a sustained reduction.
The transfer of U.K. sterling investments arose when the Company reorganized its corporate and operational structure for U.K. sterling asset accumulation business from a U.S. dollar denominated entity to a U.K. sterling denominated branch.
The cost (amortized cost for fixed maturities and short-term investments), market value and related unrealized gains (losses) of investments are as follows:
Due after 1 through 5 years ... $ 2,173,907 $ 2,164,112 $1,829,636 $1,791,752 Due after 5 through 10 years .. 2,415,964 2,331,334 1,906,291 1,873,982 Due after 10 years ............ 3,077,594 3,043,404 3,159,572 3,108,952 Mortgage-backed securities .... 3,278,103 3,293,077 1,818,697 1,830,395 ------------------------------------------------ $10,945,568 $10,831,927 $8,714,196 $8,605,081 ================================================
At December 31, 2001 and 2000, approximately $328.3 million and $113.1 million, respectively, of securities were on deposit with various U.S. state or government insurance departments in order to comply with relevant insurance regulations. The increase in 2001 from 2000 related primarily to deposits required for the Company's Lloyd's operations related to the September 11 event.
The Company has two facilities available for the issue of letters of credit collateralized against the Company's investment portfolio with a value of $169.0 million at December 31, 2001 and $483.0 million at December 31, 2000. At December 31, 2001 and 2000, approximately $120.0 million and $160.0 million, respectively, of letters of credit were issued and outstanding under these facilities.
YEAR ENDED DECEMBER 31 --------------------------------------- 2001 2000 1999 --------------------------------------- Reserve for reported losses and loss expenses ................. $ 7,313,253 $2,788,378 $2,175,688 Reserve for losses incurred but not reported .................. 4,512,427 2,883,684 3,193,714 --------------------------------------- Unpaid losses and loss expenses ..... $11,825,680 $5,672,062 $5,369,402 =======================================
YEAR ENDED DECEMBER 31 --------------------------------------- 2001 2000 1999 --------------------------------------- Loss and loss expense payments ...... $ 2,651,566 $1,910,624 $1,392,024 Change in unpaid losses and loss expenses ................. 3,263,049 625,043 303,140 Reinsurance recoveries .............. (2,995,717) (1,103,108) (390,860) --------------------------------------- Net losses and loss expenses incurred ................. $ 2,918,898 $1,432,559 $1,304,304 =======================================
Prior year loss development in 2001 related primarily to continued adverse loss development in the Company's casualty reinsurance business written for the 1997 to 1999 underwriting years. This deterioration occurred industry-wide primarily as a result of competitive pressures on pricing. The Company recorded adverse development for this business of approximately $180.0 million in the fourth quarter of 2001.
Net losses incurred for 2000 also reflected reserve adjustments to several unprofitable lines of business that the Company exited, including trucking, inland energy and certain classes of aviation. A net reserve charge of $114.0 million was recorded for these lines.
The decrease in prior year incurred losses in 2000 and 1999 was driven primarily by the Company's insurance liability excess of loss reserves. The basis for establishing IBNR for these lines is relatively judgmental due to the lack of industry data available. Consequently, the Company estimates loss reserves through actuarial models based upon its own experience. When the Company commenced writing this type of business in 1986, limited data was available and the Company has made its best estimate of loss reserves for each underwriting year since that time. Over time, the amount of data has increased, providing a larger statistical base for estimating reserves. Redundancies in prior year loss reserves have occurred where loss experience has developed more favorably than expected. This trend did not continue in 2001 where the competitive effect of pricing has necessitated an increase to prior year loss reserves, particularly in the casualty lines as discussed above. In 1999, the Lloyd's operations experienced loss deterioration on the U.K. motor business principally from the 1998 and 1999 underwriting years of approximately $20.0 million.
Partially offsetting the increase in net incurred losses in 2000 compared to 1999 was a reduction in the number and magnitude of catastrophe losses that occurred. Catastrophe losses in 2000 included an oil refinery loss in Kuwait, several satellite losses, and the Singapore Airlines loss, and totaled approximately $95.0 million. By comparison, 1999 generated approximately $185.0 million of catastrophe losses to the Company, including the European storms in December, hailstorms in Sydney, tornadoes in Oklahoma and satellite losses.
The amount of paid losses increased in 2001 over 2000 due mainly to an increase in current year loss events. However, the majority of net losses incurred related to the September 11 event and other loss events in the fourth quarter of 2001 had not been reported to the Company as paid losses by December 31, 2001. Consequently, the Company expects a higher level of paid losses in 2002 related to these 2001 loss events.
The Company's net incurred losses and loss expenses included a charge of $21.5 million, $2.8 million and $10.6 million in 2001, 2000 and 1999, respectively, for estimates of actual and potential non-recoveries from reinsurers. Such charges for non-recoveries relate mainly to the September 11 event and reinsurance ceded for casualty business written prior to 1986. As at December 31, 2001 and 2000, the reserve for potential non-recoveries from reinsurers was $49.7 million and $25.6 million, respectively.
Except for certain workers compensation liabilities, the Company does not discount its unpaid losses and loss expenses. The Company utilizes tabular reserving for workers compensation unpaid losses that are considered fixed and determinable and discounts such losses using an interest rate of 7%. The tabular reserving methodology results in applying uniform and consistent criteria for establishing expected future indemnity and medical payments (including an explicit factor for inflation) and the use of mortality tables to determine expected payment periods. Tabular unpaid losses and loss expenses, net of reinsurance, at December 31, 2001 and 2000 were $231.0 million and $168.8 million, respectively. The related discounted unpaid losses and loss expenses were $98.0 million and $63.4 million as of December 31, 2001 and 2000, respectively.
Incurred but not reported losses, net of reinsurance, included in the above table was $8.0 million in 2001, $14.0 million in 2000 and $16.1 million in 1999. Unpaid losses recoverable are net of potential uncollectible amounts.
As of December 31, 2001 and 2000, the Company had approximately 453 and 374 open claim files, respectively, for potential asbestos exposures and 543 and 613 open claim files, respectively, for potential environmental exposures on business written prior to 1986. Approximately 44% and 45% of the open claim files for 2001 and 2000, respectively, are due to precautionary claim notices. Precautionary claim notices are submitted by the ceding companies in order to preserve their right to receive coverage under the reinsurance contract. Such notices do not contain an incurred loss amount to the Company.
The Company believes it has made reasonable provision for its asbestos and environmental exposures and is unaware of any specific issues that would significantly affect its estimate for losses and loss expenses.
The estimation of loss and loss expense liabilities for asbestos and environmental exposures is subject to much greater uncertainty than is normally associated with the establishment of liabilities for certain other exposures due to several factors, including: i) uncertain legal interpretation and application of insurance and reinsurance coverage and liability; ii) the lack of reliability of available historical claims data as an indicator of future claims development; iii) an uncertain political climate which may impact, among other areas, the nature and amount of costs for remediating waste sites; and iv) the potential of insurers and reinsurers to reach agreements in order to avoid further significant legal costs. Due to the potential significance of these uncertainties, the Company believes that no meaningful range of loss and loss expense liabilities beyond recorded reserves can be established. As these uncertainties are resolved, additional reserve provisions, which could be material in amount, may be necessary.
The Company has investment risk related to its ability to generate sufficient investment income to enable the total invested assets to cover the payment of the estimated ultimate liability. The Company establishes an initial accretion rate at inception of the contract, which is reviewed and adjusted periodically based on claims activity and current investment yields.
During 2001, the Company entered into long duration contracts that subject the Company to mortality and morbidity risks and which were accounted for as life premiums earned. Policy benefit reserves were established using a net premium method and assumptions for investment yields, mortality, morbidity, terminations and expenses, applicable at the time the insurance contracts were made. The assumptions include provisions for the risk of adverse deviations. At December 31, 2001, policy benefit reserves related to these contracts were $625.1 million. The average rate of assumed investment yield for these contracts was 5.1% per annum.
As at December 31, 2001, the Company had bank, letter of credit and loan facilities available from a variety of sources, including commercial banks, totaling $4.4 billion (2000: $2.6 billion) of which $1.6 billion (2000: $450.0 million) of debt was outstanding. In addition, $2.0 billion (2000: $1.1 billion) of letters of credit were outstanding, 5% of which were collateralized by the Company's investment portfolio, supporting U.S. non-admitted business and the Company's Lloyd's capital requirements.
DEBT: 364-day Revolver ................................. $ 500,000 $ -- 2 facilities of 5-year Revolvers - total ......... 350,000 350,000 7.15% Senior Notes due 2005 ...................... 100,000 99,970 6.58% Guaranteed Senior Notes due 2011 ........... 255,000 255,000 Zero Coupon Convertible Debentures due 2021 ...... 609,692 609,692 Liquid Yield Option NotesTM due 2021 ............. 290,147 290,147 Other operating debt ............................. 68 68 ----------------------- $2,104,907 $1,604,877 ======================= LETTERS OF CREDIT: 6 facilities - total $2,274,000 $2,029,000 =======================
Two syndicates of banks provide the two five-year facilities and borrowings are unsecured. The amount of $350.0 million outstanding at both December 31, 2001 and 2000 related primarily to acquisitions of subsidiaries. The weighted average interest rate on funds borrowed during 2001 was approximately 5.3% and 6.6% during 2000.
In May 2001, the Company issued $1,010.8 million principal amount at maturity (subject to adjustment in the event there is an upward interest adjustment) of Zero Coupon Convertible Debentures ("CARZ") at $593.57 per bond and, unless converted or repaid before their due date of May 2021, they will be repaid in May 2021 at $1,000 per bond, at a total cost of $1.01 billion. The accretion rate is 2.625% per annum on a semi-annual basis or 2.6422% per annum on an annual basis.
Each of the CARZ and LYONs provide the bondholders the right to require the Company to repurchase the bonds on predetermined dates ("put" dates) at predetermined values as set forth in the relevant indenture. The put dates for the CARZ occur on May 23 of 2002, 2004, 2006, 2008, 2011 and 2016. The put dates for the LYONs occur on September 7 of 2002, 2003, 2004, 2006, 2008, 2011 and 2016. The Company may, at its option, pay the repurchase price in cash or Class A ordinary shares or a combination thereof.
In addition, each of the CARZ and LYONs provide for a contingent conversion feature that gives the bondholders the right to convert the bonds into the Company's shares at other times during the life of the bonds should the market price of the Company's shares trade at certain levels. Accordingly, if the Company's share price is at least 110% of the accreted conversion price for at least twenty of the thirty days during the relevant conversion period, the bondholders would have the right to convert the bonds into Class A Ordinary Shares. If converted for shares, each CARZ would be converted into 5.9467 shares and each holder of a LYONs would receive 5.277 shares. The accreted values would be determined by applying the accretion rate to the initial issue price. In the example of CARZ, the accreted price on May 23, 2002 will be $609.25 determined by adding one year's accretion of 2.6422% per annum on an annual basis to the original issue price of $593.57.
The holders of each of the CARZ and LYONs also have the right to convert the bonds for shares in the event that the trading price of the bonds for a predetermined period falls below 95% of the value of the equivalent number of shares, provided however, if the shares are trading at a predetermined premium to the accreted price of the bonds, holders may receive cash, shares or a combination thereof in lieu of shares upon conversion.
In addition, in the event that the credit ratings assigned to the bonds by Standard & Poor's fall below the specified level of BBB+, the bonds would be convertible into shares at 5.9467 shares per CARZ and 5.277 per LYON. The rating assigned to the bonds at the time of issue was A+. Some corporate transactions, such as a change of control of the Company, would give the bondholders the right to require the Company to repurchase the bonds at the accreted value of the bonds at that time.
The bonds are also callable as the Company has the right to redeem the bonds for cash, in full or in part, at their accreted value at any time after May 23, 2004, in the case of the CARZ, and September 7, 2004, in the case of the LYONs.
The puts and the interest rate adjustment features embedded in the CARZ and LYONs are considered derivatives and are subject to fair value. There is currently minimal value ascribed to the puts, as the contingent events of these features are considered unlikely to occur or to the interest rate adjustment feature due to the current trading value of the bonds. Due to the contingent nature of the conversion features of these debt securities, there is no impact on fully diluted earnings (loss) per share at this time.
Credit default swaps issued by the Company meet the definition of a derivative under FAS 133. Effective January 1, 2001, the Company has recorded these products at fair value, modeled on prevailing market conditions and certain other factors relating to the structure of the transaction. The Company considers credit default swaps to be, in substance, financial guaranty contracts as the Company has the intent to hold them to maturity. The change resulting from movement in credit spreads is unrealized as the credit default swaps are not traded to realize this value and is included in net unrealized gains and losses on derivatives. Other elements of the change in fair value are based on pricing established at the inception of the contract.
Credit default swaps generally enhance a synthetic portfolio of securities. The credit ratings of the underlying securities vary and a single rating is calculated for the portfolio at the inception of the transaction by an independent agency. In order to effectively price and market the transaction, different tranches are modeled for the purpose of assigning credit ratings based upon the level of subordination. Generally, a primary layer is created to enable the originator of the transaction to participate in the risks. The Company generally participates in senior or rated tranches of a risk, but may participate in the primary layer in selected instances.
Calculation of the fair value is based on historically realized weather results, including heating and cooling degree days. Historical data is then adjusted for any underlying weather trends and the expected potential payout is computed for each transaction. Actual weather results impacting each transaction are then compared to historical weather data and the fair value adjusted accordingly.
The change in fair value recorded for the weather risk management products as of December 31, 2001 was a loss of $1.1 million and the realized gains totaled $17.7 million. These amounts have both been included in fee income and other.
The Company has entered into other investment derivative instruments in 2001 and 2000. Results of these transactions are insignificant.
The Company also uses bond and stock index futures to add value to the portfolio where market inefficiencies are believed to exist, to equitize cash holdings of equity managers and to adjust the duration of a portfolio of fixed income securities to match the duration of related deposit liabilities. These instruments are marked to market on a daily basis and changes in fair values are recorded through net realized and unrealized gains and losses on derivative instruments. The Company measures potential losses in fair values using various statistical techniques, including VaR. The Company calculates VaR for investment related derivatives based on a 95% confidence interval with a one month horizon.
At December 31, 2001 and 2000, bond and stock index futures outstanding were $695.6 million (2000: $83.8 million) with underlying investments having a market value of $9.7 billion (2000: $2.5 billion). Losses of $1.0 million and $32.4 million on these contracts were realized during the years ended December 31, 2001 and 2000, respectively. The Company reduces its exposure to these futures through offsetting transactions, including options and forwards. The VaR of the total investment portfolio and of all investment related derivatives at December 31, 2001 was approximately $351.0 and $18.0 million, respectively.
The Company utilizes special purpose vehicles to a limited extent both indirectly and directly in the ordinary course of the Company's business. At the transactional level, the Company provides various forms of credit enhancement including financial guaranty insurance and reinsurance of structured transactions backed by pools of assets of specified types, municipal obligations supported by the issuers' ability to charge fees for specified services or projects, and corporate risk based obligations including essential infrastructure projects and obligations backed by receivables from future sales of commodities and other specified services. The obligations related to these transactions are often securitized through off-balance sheet vehicles. In synthetic transactions, the Company guarantees payment obligations of counterparties including special purpose vehicles under credit default swaps referencing asset portfolios. The Company only provides financial guaranty insurance, or indirectly reinsurance, of these vehicles for fixed premiums at market rates but does not hold any equity positions or subordinated debt in these off-balance sheet arrangements. Accordingly, these vehicles are not consolidated.
The Company has a 38% investment in an asset-backed commercial paper company that invests funds provided through a commercial paper and a Euro Medium Term Note program. The assets of this company are guaranteed by an unrelated third party. The Company has a further indirect investment that does not provide any additional control. The Company accounts for this investment on an equity basis. The Company has loaned a $30.0 million note to this investment vehicle. The investment company has assets and liabilities of $950.0 million at December 31, 2001 and generated income net of start-up costs totaling $1.2 million. The Company believes its investment in this company and note receivable are realizable.
The Company provides and reinsures financial guaranties issued to support public and private borrowing arrangements. Financial guaranties are conditional commitments that guaranty the performance of an obligor to a third party. The Company's potential liability in the event of non-payment by the issuer of the insured obligation is represented by its proportionate share of the aggregate outstanding principal and interest payable ("insurance in force") on such insured obligation. In synthetic transactions, the Company guaranties payment obligations of coun-
The creditworthiness of a counterparty is evaluated by the Company, taking into account credit ratings assigned by independent agencies. The credit approval process involves an assessment of factors including, among others, the counterparty, country and industry credit exposure limits. Collateral may be required, at the discretion of the Company, on certain transactions based on the creditworthiness of the counterparty.
The Company's available for sale investment portfolio is managed by external managers in accordance with guidelines that have been tailored to meet specific investment strategies, including standards of diversification, which limit the allowable holdings of any single issue. The Company did not have an aggregate investment in a single entity, other than the U.S. government, in excess of 10% of shareholders' equity at December 31, 2001 and 2000.
The Company rents space for its principal executive offices under leases that expire up to 2014. Total rent expense for the years ended December 31, 2001, 2000 and 1999 was approximately $18.9 million, $18.3 million and $13.0 million, respectively. Future minimum rental commitments under existing leases are expected to be as follows:
Year ending December 31: 2002 $ 16,643 2003 15,681 2004 14,080 2005 12,668 2006 10,126 Later years 48,590 -------- Total minimum future rentals $117,788 --------
In 1997, the Company acquired commercial real estate in Bermuda for the purpose of securing long-term office space for its worldwide headquarters. Development was completed in April 2001. The total cost of this development, including the land, was approximately $125.0 million.
The Company is a Cayman Islands corporation and, except as described below, neither it nor its non-U.S. subsidiaries have paid United States corporate income taxes (other than withholding taxes on dividend income) on the basis that they are not engaged in a trade or business or otherwise subject to taxation in the United States. However, because definitive identification of activities which constitute being engaged in trade or business in the United States is not provided by the Internal Revenue Code of 1986, regulations or court decisions, there can be no assurance that the Internal Revenue Service will not contend that the Company or its non-U.S. subsidiaries are engaged in trade or business or otherwise subject to taxation in the United States. If the Company or its non-U.S. subsidiaries were considered to be engaged in trade or business in the United States (and, if the Company or such subsidiaries were to qualify for the benefits under the income tax treaty between the United States and Bermuda or Ireland, such businesses were attributable to a "permanent establishment" in the United States), the Company or such subsidiaries could be subject to U.S. tax at regular tax rates on its taxable income that is effectively connected with its U.S. trade or business plus an additional 30% "branch profits" tax on such income remaining after the regular tax, in which case there could be a significant adverse effect on the Company's results of operations and financial condition.
The Company issued 9.2 million shares during 2001 at a price of $89.00 per share to support capital requirements subsequent to the September 11 event. Net proceeds received were $787.7 million.
The Company's executive stock plan, the 1991 Performance Incentive Program, as amended and restated effective March 17, 2000, provides for grants of non-qualified or incentive stock options, restricted stock awards and stock appreciation rights ("SARs"). The plan is administered by the Company and the Compensation Committee of the Board of Directors. Stock options may be granted with or without SARs. Grant prices are established at the fair market value of the Company's common stock at the date of grant. Options and SARs have a life of not longer than ten years and vest as set forth by the Compensation Committee at the time of grant. Options currently vest annually over three years from date of grant.
Restricted stock awards issued under the 1991 Performance Incentive Program plan vest over such periods as the Compensation Committee may approve. These shares contained certain restrictions, prior to vesting, relating to, among other things, forfeiture in the event of termination of employment and transferability. As the shares are issued, deferred compensation equivalent to the fair market value on the date of the grant is charged to shareholders' equity and subsequently amortized over the vesting period. Restricted stock issued under the plan totaled 227,795 shares, 77,472 shares and 113,100 shares in 2001, 2000 and 1999, respectively. Restricted stock awards granted by NAC prior to the merger amounted to 3,627 shares in 1999. Vesting for restricted stock awards generally occurs over a four to six year period.
All options granted to non-employee directors are granted under the 1991 Performance Incentive Program. All options vest immediately on the grant date. Directors may also make an irrevocable election preceding the beginning of each fiscal year to defer cash compensation that would otherwise be payable as his or her annual retainer in increments of $5,000. The deferred payments are credited in the form of shares calculated by dividing 110% of the deferred payment by the market value of the Company's stock at the beginning of the fiscal year. These shares are distributed under the terms of the plan. Shares issued under the plan totaled 4,240, 8,179 and nil in 2001, 2000 and 1999, respectively.
A second stock plan is provided for the directors that grants share units equal to their annual retainer divided by market price of the Company's stock on January 1 of each year. These units receive dividends in the form of additional units equal to the cash value divided by the market price on the payment date. Stock units totaling 7,318, 12,903 and 1,217 were issued in 2001, 2000 and 1999, respectively. Total units are granted as shares upon retirement.
YEAR ENDED DECEMBER 31 --------------------------------- 2001 2000 1999 --------------------------------- Net (loss) income - as reported ............ $(576,135) $506,352 $470,509 Net (loss) income - pro-forma .............. $(615,868) $481,560 $437,592 Basic (loss) earnings per share - as reported .............................. $(4.55) $4.07 $3.69 Basic (loss) earnings per share - pro-forma ................................ $(4.86) $3.87 $3.43 Diluted (loss) earnings per share - as reported .............................. $(4.55) $4.03 $3.62 Diluted (loss) earnings per share - pro-forma ................................ $(4.86) $3.83 $3.36
The following table summarizes information about the Company's stock options (including stock appreciation rights) for options outstanding as of December 31, 2001:
consummated, would result in a person or group beneficially owning 20% or more of Class A ordinary shares. Upon a person or group without prior approval of the Board acquiring 20% or more of Class A ordinary shares, each Right would entitle the holder (other than such an acquiring person or group) to purchase Class A ordinary shares (or, in certain circumstances, Class A ordinary shares of the acquiring person) with a value of twice the Rights exercise price upon payment of the Rights exercise price. The Company will be entitled to redeem the Rights at $0.01 per Right at any time until the close of business on the tenth day after the Rights become exercisable. The Rights will expire at the close of business on September 30, 2008, and do not initially have a fair value. The Company has initially reserved 119,073,878 Class A ordinary shares being authorized and unissued for issue upon exercise of Rights.
The Company has a qualified defined contribution plan which is managed externally and whereby employees and the Company contribute a certain percentage of the employee's gross salary into the plan each month. The Company's contribution generally vests over 5 years. The Company's expenses for its qualified contributory defined contribution retirement plans were $9.7 million, $7.4 million and $4.8 million in the years ended December 31, 2001, 2000 and 1999, respectively.
Winterthur International pension benefits and retirement plans are subject to transition provisions in the Sale and Purchase Agreement. Under these plans, employees accrue benefits based on years of credited service, average compensation and age. The pension obligation under these arrangements will continue with the seller until contractual terms are satisfied and the liability under a GAAP basis has been quantified and agreed between the Company and the seller, at which point all Winterthur International employees will be covered under a Company plan. Definition of various contractual rights and obligations and valuation of the plans are not expected to be completed until later in 2002. The seller will provide the assets to fund the pension liability. It is not believed that adoption of these plans will have a significant effect on the results of operations, financial position and liquidity of the Company.
BEFORE TAX NET OF TAX EXPENSE TAX AMOUNT (BENEFIT) AMOUNT --------------------------------
YEAR ENDED DECEMBER 31, 2001: Unrealized gains (losses) on investments: Unrealized losses arising during year .... $(160,201) $ 9,576 $(169,777) Less reclassification for gains (losses) realized in income ..................... (93,237) 5,536 (98,773) -------------------------------- Net unrealized losses on investments ........ (66,964) 4,040 (71,004) Foreign currency translation adjustments .... (31,882) 5,415 (37,297) -------------------------------- Change in accumulated other comprehensive loss ........................ $ (98,846) $ 9,455 $(108,301) ================================ YEAR ENDED DECEMBER 31, 2000: Unrealized gains (losses) on investments: Unrealized losses arising during year .... $ (82,362) $(21,980) $ (60,382) Less reclassification for gains (losses) realized in income ..................... 45,090 (12,849) 57,939 -------------------------------- Net unrealized losses on investments ........ (127,452) (9,131) (118,321) Foreign currency translation adjustments .... (5,600) 102 (5,702) -------------------------------- Change in accumulated other comprehensive loss ........................ $(133,052) $ (9,029) $(124,023) ================================ YEAR ENDED DECEMBER 31, 1999: Unrealized gains (losses) on investments: Unrealized gains arising during year ..... $(176,092) $(36,394) $(139,698) Less reclassification for gains realized in income .............................. 66,800 (5,344) 72,144 -------------------------------- Net unrealized losses on investments ........ (242,892) (31,050) (211,842) Foreign currency translation adjustments .... (6,308) (2,276) (4,032) -------------------------------- Change in accumulated other comprehensive loss ........................ $(249,200) $(33,326) $(215,874) ================================
In 2001, four regular quarterly dividends were paid at $0.46 per share to shareholders of record of February 15, May 25, August 15 and November 30.
In 2000, four regular quarterly dividends were paid at $0.45 per share to shareholders of record of February 15, May 25, August 15 and November 15.
In 1999, four regular quarterly dividends were paid at $0.44 per share to shareholders of record at February 5, April 23, July 12 and September 24. This relates to the Company without inclusion of the pooling effect with NAC.
The Company's Bermuda subsidiaries are not subject to any income, withholding or capital gains taxes under current Bermuda law. In the event that there is a change such that these taxes are imposed, the Bermuda subsidiaries would be exempted from any such tax until March 2016 pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966, and Amended Act of 1987.
The Company's U.S. subsidiaries are subject to federal, state and local corporate income taxes and other taxes applicable to U.S. corporations. The provision for federal income taxes has been determined under the principles of the consolidated tax provisions of the Internal Revenue Code and Regulations thereunder. Should the U.S. subsidiaries pay a dividend to the Company, withholding taxes will apply.
The Company has operations in subsidiary and branch form in various other jurisdictions around the world, including but not limited to the U.K., Switzerland, Ireland, Germany, France and Luxembourg that are subject to relevant taxes in those jurisdictions.
The income tax provisions for the years ended December 31, 2001, 2000 and 1999 are as follows:
CURRENT (BENEFIT) EXPENSE: U.S ....................................... $ 5,398 $ (3,175) $(27,098) Non U.S ................................... 16,506 8,612 9,664 ------------------------------- Total current expense (benefit) .............. 21,904 5,437 (17,434) ------------------------------- DEFERRED BENEFIT: U.S ....................................... (69,384) (53,338) (17,534) Non U.S ................................... (142,434) (8,455) (4,602) ------------------------------- Total deferred benefit ....................... (211,818) (61,793) (22,136) ------------------------------- TOTAL TAX BENEFIT ......................... $(189,914) $(56,356) $(39,570) ===============================
The weighted average expected tax provision has been calculated using the pre-tax accounting income (loss) in each jurisdiction multiplied by that jurisdiction's applicable statutory tax rate. Reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average tax rate for the years December 31, 2001 and 2000 is provided below:
Expected tax provision at weighted average rate ... $(178,371) $(61,625) Permanent differences: Tax-exempt interest ............................. (8,964) (12,184) Goodwill ........................................ 691 6,000 Other ........................................... (3,270) 11,453 Net withholding taxes ............................. -- -- --------------------- Total tax benefit ................................. $(189,914) $(56,356) ---------------------
Significant components of the Company's deferred tax assets and liabilities as of December 31, 2001 and 2000 were as follows:
2001 2000 -------------------- DEFERRED TAX ASSET: Net unpaid loss reserve discount .................... $112,646 $ 83,230 Net unearned premiums ............................... 12,224 13,929 Compensation liabilities ............................ 8,396 9,271 Net operating losses ................................ 241,235 53,563 Currency translation adjustments .................... 1,693 -- Other ............................................... 52,656 1,866 Deferred tax asset, gross of valuation allowance ....... 428,850 161,859 Valuation allowance - foreign tax credit ............... 2,508 -- -------------------- Deferred tax asset, net of valuation allowance ......... 426,342 161,859 -------------------- DEFERRED TAX LIABILITY: Net unrealized appreciation on investments .......... 2,686 7,553 Currency translation adjustments .................... -- 566 Other ............................................... 4,434 1,572 -------------------- Deferred tax liability ................................. 7,120 9,691 -------------------- NET DEFERRED TAX ASSET ................................. $419,222 $152,168 ====================
At December 31, 2001 and 2000, the Company's management concluded that all deferred tax assets are more likely than not to be realized. A valuation allowance was taken for the U.S. foreign tax credits due to expire in 2002. U.S. net operating loss carryforwards at December 31, 2001 were approximately $285.0 million and will expire in future years through 2019. As at December 31, 2001, net operating loss carryforwards in the U.K. were $447.0 million and have no expiration.
Shareholders' equity at December 31, 2001 and 2000 reflected tax benefits of $9.1 million and $3.3 million, respectively, related to compensation expense deductions for stock options exercised for one of the Company's U.S. subsidiaries.
BASIC (LOSS) EARNINGS PER SHARE: Net (loss) income .............................. $(576,135) $506,352 $470,509 Weighted average ordinary shares outstanding ... 126,676 124,503 127,601 Basic (loss) earnings per share ................ $ (4.55) $ 4.07 $ 3.69 ============================== DILUTED (LOSS) EARNINGS PER SHARE: Net (loss) income .............................. $(576,135) $506,352 $470,509 Add back after-tax interest on convertible debentures (3) ............................... -- -- 1,752 ------------------------------ Adjusted net (loss) income ..................... $(576,135) $506,352 $472,261 ------------------------------ Weighted average ordinary shares outstanding - basic ........................... 126,676 124,503 127,601 Average stock options outstanding (1) (2) ...... -- 1,194 1,872 Conversion of convertible debentures (3) ....... -- -- 831 ------------------------------ Weighted average ordinary shares outstanding - diluted ......................... 126,676 125,697 130,304 ------------------------------ Diluted (loss) earnings per share .............. $ (4.55) $ 4.03 $ 3.62 ==============================
In 2001, a limited partnership, XL Capital Principal Partners I, L.L.C. ("the Partnership"), was formed. The general partner of the Partnership is a newly-formed wholly-owned subsidiary of the Company. All of the limited partners of the Partnership are current or former senior officers or directors of the Company or its subsidiaries. The Company's investment in this partnership is included in other investments.
The stated purpose of the Partnership is to achieve long-term capital appreciation for its investors through a portfolio of investments including, without limitation: private equity, venture capital and hedge funds; equity and equity-related securities of all types; investments in debt securities, preferred shares and other financial instruments; and securities issued by companies providing financial guaranty, insurance and reinsurance contracts. Generally, the Partnership is expected to co-invest in investments made by the Company substantially on the same terms as the similar investments made by the Company.
The Company registered its Dividend Reinvestment and Share Purchase Plan effective January 2002. This plan is intended to provide registered holders of XL Capital Class A ordinary shares with a convenient and economical way to reinvest all or a portion of their cash dividends and to make additional cash investments, subject to minimum and maximum purchase limitations, in its Class A ordinary shares.
The following is a summary of the unaudited quarterly financial data for 2001 and 2000:
In the fourth quarter of 2001, the Company incurred adverse loss development of its casualty reinsurance business written prior to 1999 of approximately $140.0 million after-tax, and losses related to certain other events, including the bankruptcy of Enron Corp., American Airlines Flight 587 and several large European property losses.
In the fourth quarter of 2000, the Company incurred after-tax charges of $124.6 million, or $0.98 per share, which included certain reserve adjustments together with employee severance charges and other costs associated with the realignment of the Company's operations and the discontinuation of certain business lines.