The following table sets forth selected financial data and other operating information. The selected financial data have been derived from the consolidated financial statements of the Company and should be read in conjunction with the consolidated financial statements and accompanying notes of the Company and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Annuity & Life Re's two major product lines are traditional ordinary life reinsurance and annuity reinsurance. The reinsurance agreements typically remain in force for the life of the underlying policies reinsured, which on average range from ten to thirty years. Each year, a portion of the business under an existing treaty terminates due to among other things, surrenders and/or lapses of underlying policies, deaths of underlying insureds and the exercise of recapture options.
At December 31, 1998, net insurance in force for the Company amounted to $22.5 billion. The Company retrocedes portions of certain risks in excess of a predetermined retention amount for which it has accepted liability. At December 31, 1998, the Company did not retrocede any business and was not aware of any business it has assumed which should have been retroceded.
The Company's primary annuity product is reinsurance of a general account fixed deferred annuity. The profitability of the deferred annuity reinsurance product line is dependent on earning a targeted spread between the interest rate earned on the supporting asset base and the interest rate credited to the underlying liabilities. This product line is interest sensitive, as fluctuations in the general level of interest rates from period to period may cause fluctuations in the results of operations.
During the initial operating period of less than nine months, management has focused its efforts on developing its underwriting and pricing systems and marketing the Company to the leading purchasers of annuity and life reinsurance. The Company executed a number of reinsurance contracts during the six month period ending December 31, 1998, including two significant contracts - a life contract with estimated annual premiums of $40 million and an annuity contract with over $1 billion of deposits.
Net Premiums. Net premium revenue was $27.9 million from contracts executed during the initial nine-month operating period ending December 31, 1998. All of such premium revenue was derived from traditional ordinary life reinsurance covering existing blocks of in force business, developed directly by the Company and through the use of intermediaries.
Net Investment Income. Net investment income during the nine-month operating period ending December 31, 1998 was $24.1 million. The Net Investment Income includes $8.9 million in income earned and credited to Funds Withheld under modified coinsurance agreements related to the Company's Interest Sensitive contracts liabilities. The average yield earned on an annualized basis for this period on invested assets was approximately 6.32%.
Realized gains and losses are not considered by the Company to be recurring components of earnings. The Company makes decisions concerning the sales of invested assets based on a variety of market, business and other factors.
Other Operating Expenses. Operating expenses for the period ending December 31, 1998 were approximately $4.2 million and are in line with the Company's plan to be a low cost provider. The operating costs consisted primarily of salary and related expenses amounting to $2,696,499 and legal, accounting, rating and other consulting expenses amounting to $372,281.
Annuity & Life Re's investment policy is designed to achieve above average risk adjusted total returns, maintain a high quality portfolio, maximize current income, maintain an adequate level of liquidity, and match the cash flows of the portfolio to the required cash flows of the related liabilities.
The results of operations and the financial condition of Annuity & Life Re are significantly affected by the performance of its investments and by changes in interest rates. During a period of declining interest rates, if Annuity & Life Re's investments are prematurely sold, called, prepaid or redeemed, Annuity & Life Re may be unable to reinvest the proceeds in securities of equivalent risk with comparable rates of return. During a period of rising interest rates, the fair value of Annuity & Life Re's invested assets could decline. In addition, rising interest rates could also cause disintermediation, which in turn could cause Annuity & Life Re to be required to sell investments at prices and times when the fair values of such investments are less than their amortized cost. Annuity & Life Re believes that its traditional life insurance liabilities are not highly interest sensitive and, therefore, the effects of fluctuating interest rates on these liability cash flows are not significant. For interest sensitive liabilities, Annuity & Life Re utilizes asset/liability matching to minimize the impact of changes in interest rates. Annuity & Life Re has not engaged in hedging activities to mitigate the effects of interest rate changes on its invested assets and related liabilities, although it may do so in the future.
- --------------- (1) Fair value at end of the indicated year
Mortgage backed securities represented approximately 33% of invested assets as of December 31, 1998. Investors in these securities are compensated primarily for reinvestment risk rather than credit quality risk. Investments in mortgage backed securities include collateralized mortgage obligations ("CMO's") and mortgage backed pass-through securities. Mortgage backed securities generally are collateralized by mortgages issued by the Government National Mortgage Association ("GNMA"), the Federal National Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"), all of which are agencies of the U.S. government. Of these, only GNMA mortgages are backed by the full faith and credit of the U.S. government. Credit risk generally is not a consideration when investing in agency mortgage backed securities. Annuity & Life Re's mortgage backed securities portfolio had a weighted average investment quality rating of "AAA" at December 31, 1998.
Assets with a carrying value of $1,200,101,268 related to an annuity reinsurance agreement with the Company are held by and managed by the ceding company in segmented portfolios. The liability for the annuity reinsurance is included on the Company's Balance Sheet as Interest Sensitive Contracts Liabilities. Under the terms of the reinsurance agreement, the investment income which accrues to the Company is dependent upon the performance of the underlying portfolios. The assets in the underlying segmented portfolios are managed by investment managers appointed by the cedent.
The Company's liquidity and capital resources are a measure of the overall financial strength of the Company and its ability to generate cash flows from its operations to meet operating and growth needs. The Company's principal sources of funds are premiums received, net investment income, proceeds from investments called, redeemed or sold, cash and short term investments. The principal obligations and uses of the funds are the payment of policy benefits, acquisition and operating expenses and the purchase of investments. During the next twelve months, Management believes the obligations will be adequately provided for by its principal sources of funds.
The Company's capital structure currently consists entirely of equity. At December 31, 1998 total capitalization of the Company after deducting certain loans to management and including retained earnings and accumulated other comprehensive income amounted to approximately $375.3 million. Management believes this level of capital is sufficient to support the Company's insurance writings and growth for the near future.
At December 31, 1998 the Company had no outstanding debt. At December 31, 1998, letters of credit totaling $46,425,000 issued in the ordinary course of the Company's business had been issued by the Company's bankers in favor of certain ceding insurance companies; these letters of credit are fully collaterized by investments of the Company. The Company may incur indebtedness in the future in connection with possible acquisitions of, investments in, joint ventures with or other strategic alliances with companies whose businesses complement the Company's business.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE ANNUITY AND LIFE RE (HOLDINGS), LTD. AND SUBSIDIARY
The Audit Committee of the Board of Directors is comprised of certain directors who are neither employees nor officers of the Company. The Audit Committee meets periodically with management and independent auditors regarding independent audit scope, timing, results and to discus other auditing and financial reporting matters. The independent auditors have direct access to and meet privately with the Audit Committee.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and subsidiary as at December 31, 1998 and 1997 and the results of their operations and cash flows for the year ended December 31, 1998 in conformity with United States generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
During the period from its inception date to December 31, 1997, the Company did not incur any income or expenses that are required to be reported in a statement of income or a statement of cash flows under United States generally accepted accounting principles. Therefore, consolidated statements of operations and cash flows have not been presented for that period.
For traditional life and annuity policies with life contingencies, deferred policy acquisition costs are charged to expense using assumptions consistent with those used in computing policy reserves. Assumptions as
The Company classifies its investments in fixed income securities as available for sale and, accordingly, such securities are carried at fair value. The cost of fixed income securities are adjusted for amortization of premiums and discounts. The cost of fixed income securities are adjusted for declines in value that are considered other than temporary.
Realized gains and losses on investments are recognized in net income, using the specific identification method. Changes in fair values of securities carried at fair value are reflected in other comprehensive income, after deductions for related adjustments for deferred acquisition expenses and amounts required to satisfy policyholder commitments that would have been recorded had these securities been sold at their fair value.
The Company calculates earnings per common share based upon the guidance provided in Financial Accounting Standards Board Statement No. 128 "Earnings per Share." This statement requires the presentation of two amounts of earnings per share when the company has a complex capital structure. These amounts are earnings per common share and earnings per common share-assuming dilution.
In June 1998, the Financial Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities." This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Given the limited number of transactions currently entered into by the Company that are covered by the Statement, the Company does not anticipate any significant changes to its current financial reporting.
(a) The amortized cost and fair values of investments in fixed interest securities classified as available for sale are as follows:
During the year ended December 31, 1998 there were sales of fixed interest securities amounting to $309,328,762.
The following table sets forth certain information regarding the investment ratings of the Company's fixed interest securities portfolio at December 31, 1998.
(b) In the normal course of reinsurance operations the Company's bankers have issued letters of credit totaling $46,425,000 in favor of certain ceding insurance companies. At December 31, 1998 investments of a similar amount were pledged as collateral for these letters of credit.
(d) Investment income earned during the year is comprised as follows:
The common shareholders have no pre-emptive, redemption, conversion or sinking fund rights. Subject to certain voting restrictions, which limit the voting power of any one person to less than 10% of the combined voting power of the issued voting shares of the Company, each holder is entitled to one vote per share.
In connection with the initial capitalization of the Company, the Company issued Class A Warrants to certain individuals employed by Inter-Atlantic Securities Corporation ("Inter-Atlantic"). These Warrants entitle the holders to purchase up to 3,059,990 common shares in the Company.
installments commencing on the first anniversary of the date of the Direct Sales. The Class B Warrants expire on the tenth anniversary of the consummation of the Direct Sales.
Certain directors of the Company are also owners, directors, or officers of Inter-Atlantic Capital Partners, Inc. and/or its subsidiary, Inter-Atlantic. The Company entered into an agreement with Inter-Atlantic, whereby Inter-Atlantic agreed to provide financial advisory services to the Company in connection with its organization and initial public offering. Such services included, among other things, assistance in recruiting senior management, obtaining necessary governmental permits, preparing a registration statement, retaining underwriters and other services.
In addition, Inter-Atlantic has agreed to provide financial advisory and other services to the Company for a term of five years in exchange for four annual payments of $600,000 beginning on the first anniversary of the consummation of the planned initial public offering. Such services include, among other things, assistance in the development of products, financial planning, management of assets and liabilities, international marketing efforts and such other services as the Company may request.
One of the strategic investors is affiliated with Prudential Securities Incorporated, one of the underwriters of the Company's initial public offering, and with The Prudential Investment Corporation, which serves as one of the Company's investment managers. The Company paid a fee of $1.0 million to Prudential Securities Incorporated for investment banking and financial advisory services in connection with the Company's initial public offering. The Company has agreed to pay a fee for investment management services to The Prudential Investment Corporation based upon the amount of funds managed. The fee is based upon a sliding scale and has been determined on an arms-length basis. The Company has entered into a reinsurance agreement with the Prudential Insurance Company of America to reinsure certain mortality risks. Premium of approximately $1,400,000 and policy benefits of approximately $1,030,000 were included in the statement of operations during the year ended December 31, 1998 with respect to this reinsurance agreement.
Similarly, certain directors of the Company purchased an aggregate of 58,000 Common Shares directly from the Company as part of the Direct Sales. Because such Common Shares were not sold through the Underwriters as part of the Offering, the purchase price per share was equal to the initial public offering price per share, less the per share underwriting discounts and commissions.
At December 31, 1998 there were loans outstanding from management for stock purchases of $1,325,000 and accrued interest thereon of $66,068. Interest income of $66,068 has been recognized during the year on these loans.
The Plan is administered by the Compensation Committee of the Board of Directors. The Compensation Committee has the authority to select the parties to be granted ISO's and NQSO'S, to set the date of grant and other terms of the options granted under the plan.
Each person who becomes an eligible non-employee Director, as defined in the plan, shall be granted an option to purchase 15,000 common shares on the later of (i) the date he or she becomes an eligible non-employee Director or (ii) April 8, 1998. The options shall have an exercise price equal to the fair market value of the optioned Common Shares on the date the options are granted and shall be exercisable in three equal installments commencing with the first anniversary of the grant date. In addition, subject to certain conditions,
The Company applies APB Opinion No. 25 and Related Interpretations in accounting for the Stock Option Plan. Accordingly, no compensation cost has been recognized as the intrinsic value of the options was $nil at the measurement date. The net income and earnings per Common Share would have been reduced to the pro forma amounts indicated below, had compensation cost been determined based on the fair value of the options at the grant date, consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation."
The Company has entered into a retrocession agreement which enables it to limit the amount of life reinsurance it retains to $2,000,000 per single life. The contract is on an automatic basis and is effective for risks assumed and in force from January 1, 1997. The limit of cover is $50 million and covers all single and joint life reinsurance assumed by the Company on a automatic basis. The Company is not aware of any business it has assumed which should be ceded to the reinsurer under this retrocession, therefore no amounts have been recorded in the financial statements.
At December 31, 1998, the Company did not have a material concentration of investments in fixed income securities in a single investee, industry or geographic location.
The underlying parties to these contracts are large insurance companies based in the United States.
The Company's ability to pay dividends depends on the ability of Annuity Reassurance to pay dividends to the Company. While the Company itself is not subject to any significant legal prohibitions on the payment of dividends, Annuity Reassurance is subject to Bermuda regulatory constraints which affect its ability to pay dividends to the Company. Annuity Reassurance is prohibited from declaring or paying a dividend if such a payment would reduce its statutory surplus below the required minimum of $250,000.
The unaudited quarterly financial data for the year ended December 31, 1998 is as follows:
The Company's Form 10-Q for the period ended September 30, 1998, reflected a determination by management that a reinsurance agreement would be written on a coinsurance basis. Subsequently, the agreement's terms were modified. The effect on the quarter's financial statements is to reclassify certain previously reported amounts for premiums and acquisition costs. This reclassification had no effect on amounts previously reported for net income or net income per common share.