Chartwell leases approximately 53,000 square feet of space for its principal executive offices in Stamford, Connecticut. Chartwell also leases approximately 68,000 square feet of space in London, England for the operations of Archer. INSCORP is located in Jericho, New York, occupying approximately 1,150 square feet of office space. Management believes Chartwell's current office space is adequate for its needs.
(4) Statutory data have been derived from the Annual Statements of Chartwell Reinsurance and INSCORP as filed with insurance regulatory authorities and prepared in accordance with SAP.
The property and casualty insurance and reinsurance industry has historically been highly cyclical. Demand for reinsurance is influenced significantly by prevailing market conditions, including the underwriting results of primary insurers. The supply of reinsurance is primarily related to levels of underwriting capacity in the reinsurance industry and the relative cost and terms of reinsurance coverage. The industry's profitability and the cyclical trends in the industry can be affected significantly by volatile and unpredictable developments, including the occurrence of natural disasters, other catastrophic events, competitive pressures on pricing (premium rates), fluctuations in interest rates, other variations in the investment environment, changes in the judicial system regarding tort law, general economic conditions and trends, such as inflationary pressures, that may tend to affect the size of profits and losses experienced by ceding primary insurers and other factors such as changes in tax laws and regulations. Many sectors of the industry are currently in a cyclical downturn and it cannot be predicted if or when market conditions will improve or when other sectors may experience a deterioration in pricing and terms.
Inadequate pricing during the latter 1970s and early 1980s led to increased underwriting losses and a decline in underwriting capacity. Reinsurance rates and terms improved substantially during the mid-1980s as primary insurers, which had been adversely affected by the soft market of the previous several years, increased their demand for reinsurance. Reinsurers achieved improved underwriting results and, consequently, the supply of reinsurance capacity increased, both from existing companies and new entrants.
Commencing in the latter part of the 1980s, primary property and casualty insurers began to retain more of their business. This reduction in the amount of business ceded to reinsurers, combined with the growth in reinsurance capacity, resulted in renewed price competition and less attractive pricing for reinsurers. This caused a downturn for the reinsurance industry, resulting in increased underwriting losses which have continued to the present.
(2) Source: RAA Underwriting Report for the year ended December 31, 1996.
Revenues Year Ended December 31, ----------------------- (Dollars in thousands) 1996 1995 --------- --------- Gross premiums written ............................. $ 263,838 $ 126,968 --------- --------- Net premiums written ............................... $ 192,251 $ 123,314 --------- --------- Premiums earned .................................... $ 209,503 $ 120,258 Net investment income .............................. 44,089 19,907 Net realized capital gains ......................... 1,157 3,199 Service operations ................................. 9,726 1,095 --------- --------- Total ...................... $ 264,475 $ 144,459 ========= =========
December 31, ----------------------- (Dollars in thousands) 1996 1995 --------- --------- Specialty .......................................... $ 100,817 $ 60,529 Global: Domestic ........................................ 19,818 21,010 International ................................... 24,120 17,400 --------- --------- Subtotal Global .................................... 43,938 38,410 Regional ........................................... 25,967 16,738 Marine & Aviation .................................. 27,780 11,291 --------- --------- Total Reinsurance ................................ 198,502 $ 126,968 --------- =========
Net Underwriting Results. The Company incurred an underwriting loss (net premiums earned minus losses, LAE and underwriting expenses) of $8.9 million for the year ended December 31, 1996 as compared to an underwriting loss of $5.2 million
for the same period in 1995. The combined ratio for the years ended December 31, 1996 and 1995 computed in accordance with GAAP was 104.2% for both years. Although the loss ratio component improved to 71.9% for the year ended December 31, 1996 from 72.3% recorded for the same period in 1995, the expense ratio increased to 32.3% for the year ended December 31, 1996 from the 31.9% recorded for the same period in 1995, for the reasons noted above. On a pro forma basis, as if the Merger occurred on January 1, 1995, the expense ratio decreased to 32.3% for the year ended December 31, 1996 compared to 34.9% for the same period in 1995, and the combined ratio decreased to 104.2% for the year ended December 31, 1996 compared to 120.8% for the same period in 1995. The pro forma loss and LAE ratio for the year ended December 31, 1995 includes a strengthening of INSCORP's net loss reserves of $25.0 million for losses incurred but not reported with respect to INSCORP's business written in prior years. This reserve strengthening, which was undertaken by Piedmont prior to the Merger, increased the Company's pro forma loss and LAE ratio by 10.1 percentage points for the year.
Income from service operations increased to $9.7 million for the year ended December 31, 1996 compared to $1.1 million for the same period in 1995. The improvement reflects increases in advisory fee revenues, equity in the earnings of investee companies acquired in the Merger and development of new fee-based revenue sources during the year. Also included is a gain of $2,802,000 on a foreign exchange option entered into to protect the Company from the increasing value of the Pound Sterling during the period commencing from the initialization of the Acquisition to the closing of the transaction. During that period, the Pound Sterling appreciated by approximately 6% relative to the U.S. Dollar.
The distribution of Chartwell's gross premiums written among its underwriting client segments was as follows (in millions):
Loss and Loss Adjustment Expenses. Losses and loss adjustment expenses ("LAE") incurred increased 10.7% to $86.9 million for 1995 from $78.6 million in 1994. This increase was primarily attributable to the increase in loss reserves established as a result of the growth in earned premiums. Net losses and LAE expressed as a percentage of net earned premiums (the loss and LAE ratio) decreased to 72.3% for 1995 from 76.5% for the 1994 period. Net losses and LAE for 1994 were increased by $5.5 million,
Income Tax Expense (Benefit). The provision for Federal income taxes in 1995 increased to a $2.7 million expense compared with a $1.7 million benefit in 1994. The primary reason for the increase in 1995 compared with the same period in 1994 was the increase in income before taxes discussed above. The effective Federal tax rate was 30.2% for 1995 and 32.9% in 1994.
Net Income (Loss). Chartwell realized a $6.2 million net profit in 1995 compared with a net loss of $3.9 million in 1994 because of the factors discussed above.
As a holding company, Chartwell's assets consist primarily of the stock of its direct and indirect subsidiaries, Chartwell Reinsurance, INSCORP, Archer, and Chartwell Advisers. Chartwell's cash flow, therefore, depends largely on dividends and other payments from Re Holdings, and in turn Re Holdings' cash flow depends largely on interest, dividends and tax sharing payments from Chartwell Reinsurance. Chartwell Reinsurance's sources of funds consist primarily of net premiums, reinsurance recoveries, investment income and proceeds from sales and redemptions of investments. Funds are applied primarily to payments of claims, operating expenses and income taxes and to the purchase of investments, largely fixed income securities. Cash and short-term investments are maintained for the payment of claims and expenses. Chartwell Reinsurance's ability to pay cash dividends to the Company is restricted by law or subject to approval of the insurance regulatory authority of Minnesota, Chartwell Reinsurance's state of domicile. The Minnesota authority recognizes only statutory accounting practices for the ability of an insurer to pay dividends to its stockholders.
At December 31, 1996, the carrying value of total investments, including cash and cash equivalents, increased by $19.3 million, or 2.7%, to $724.7 million compared to $705.4 million at December 31, 1995. The primary reasons for the increase were (i) the net cash proceeds from the public offering and subsequent exercise of the underwriters' over-allotment option of $58.5 million, (ii) positive cash flow from operations of $12.2 million, (iii) assets relating to the Archer Acquisition of $9.6 million, and (iv) $2.7 million of miscellaneous sources of cash offset by (i) $28.3 million for the retirement of 35% of the Senior Notes plus accrued interest, (ii) the decline in the market value of the investment portfolio of $10.2 million pre-tax and (iii) $25.2 million for the cost of purchasing Archer shares.
At December 31, 1996, 88.7% of Chartwell's total investments (including cash and cash equivalents) consisted of fixed income securities, of which 96.1% were rated "A" or better (or "A-1" for commercial paper) by Moody's. While uncertainties exist regarding interest rates and inflation, Chartwell attempts to minimize such risks and exposures by balancing the duration of reinsurance liabilities with the duration of assets in its investment portfolio. The current market value of Chartwell's fixed maturity investments is not necessarily indicative of their future valuation. Chartwell does not have any investments in real estate or high-yield bonds and does not have any non-income producing fixed income investments. The Company's fixed income securities portfolio at December 31, 1996 was comprised primarily of U.S. Treasury and government agency, mortgage pass-through securities, and corporate and municipal bonds.
o $30.0 million was contributed to the statutory surplus of Chartwell Reinsurance.
In the first half of 1996, the Company completed a public offering of 2,725,000 shares of common stock at $23.00 per share. The net proceeds to the Company were $58.5 million after deduction of underwriting discount and expenses. Of the net proceeds, $48.5 million was contributed to Re Holdings of which $20.0 million was contributed to the statutory surplus of Chartwell Reinsurance and $28.5 million was used to retire 35% of the Senior Notes plus accrued interest. The remaining funds were retained for general corporate purposes. This redemption reduced Chartwell's annual expense for interest and amortization of debt issuance costs under the Senior Notes by $2.8 million per year. As a result of the offering, Standard & Poor's improved its rating with respect to the Senior Notes to BBB- from BB and Moody's improved its rating to Ba1 from Ba2.
In connection with the Acquisition, Re Holdings entered into the New Credit Facilities. The New Credit Facilities provide for (i) a Term A-1 $20.0 million loan, (ii) a Term A-2 $10.0 million loan, (iii) a Term B $22.0 million loan (denominated in Pounds Sterling), and (iv) a $25.0 million revolving credit facility (subsequently increased to $35.0 million).
At December 31, 1996, $20.0 million, $10.0 million, $11.6 million and $3.3 million was outstanding under the Term A-1, Term A-2, Term B loans and the First Union Revolver, respectively. In addition, at December 31, 1996, $10.3 million was used under the Term B loan to guarantee the Loan Notes and $21.7 million of letters of credit were extended under the First Union Revolver.
Upon consummation of the Merger, Chartwell became the successor to Piedmont under the CI Notes. The CI Notes do not require any interest payments until maturity or earlier redemption or repurchase. Under certain circumstances, the CI Notes may be settled by delivery of shares of common stock.
Chartwell and its subsidiaries may incur additional indebtedness in the future, subject to the limitations contained in the Senior Notes indenture, the agreements governing the New Credit Facilities and the CI Notes indenture.
In addition to the foregoing limitation, the New York Insurance Department, as is its practice in any change of control situation, has required Chartwell to commit to preclude the acquired New York-domiciled insurer, INSCORP, from paying any dividends for two years after the change of control without prior regulatory approval.
The maximum dividend permitted by law is not indicative of an insurer's actual ability to pay dividends, which may be constrained by business and regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends. Furthermore, beyond the limits described in the preceding paragraph, the Commissioner and Superintendent have discretion to limit the payment of dividends by insurance companies domiciled in Minnesota and New York, respectively.
Management believes that current levels of cash flow from operations and assets held at the holding company level provide the Company with sufficient liquidity to meet its operating needs in the short term (over the next 12 months), including the payment of interest on the Senior Notes and the New Credit Facilities. Management expects Chartwell to be able to continue to meet its operating needs after the next 12 months from internally generated funds. Since the ability of Chartwell to meet its obligations in the long term (beyond such 12-month period) is dependent upon such factors as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet its operating needs. The Company expects that, in order to repay the principal amount of the Senior Notes on maturity or otherwise, it will be required to seek additional financing or engage in asset sales or similar transactions, and would be required to take similar actions in order to repay the CI Notes on maturity or otherwise, in the event it chose or was required to settle the CI Notes in cash rather than common stock. There can be no assurance that sufficient funds for any of the foregoing purposes would be available to the Company at such time.
In March 1995, the FASB issued SFAS No. 121, "Accounting For the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," which is effective for the financial statements of Chartwell for the year ended December 31, 1996. SFAS No. 121 requires impairment of property, plant and equipment, identifiable intangibles and goodwill to be considered whenever evidence suggests a lack of recoverability. The implementation of SFAS No. 121 did not have a material effect on the financial condition or results of operations of Chartwell.
Management does not believe that current accounting changes being contemplated by regulatory authorities, if implemented, would have a significant effect on the operations or liquidity of Chartwell.
The NAIC's Insurance Regulatory Information System ("IRIS") was developed by a committee of state insurance regulators and is primarily intended to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies 11 industry ratios and specifies "usual values" for each ratio. Departure by an insurer from the usual values on four or more of the ratios generally leads to inquiries from individual state insurance commissioners as to certain aspects of such insurer's business. Departure from a usual value does not necessarily indicate an adverse condition, but rather a deviation from the norm.
For the year ended December 31, 1996, Chartwell Reinsurance fell outside the range of usual IRIS values with respect to the Change in Writings ratio. This unusual value resulted from continued growth with existing and new clients in all client segments.