All of the Company's facilities are leased. Aggregate lease payments for 2000 were $1.9 million (1999 - $2.8 million). The Company anticipates that it will be able to extend these leases as they expire or, if necessary or desirable, locate substitute facilities on acceptable terms.
The Company's brokerage segment consists of subsidiaries that receive a fee or commission for brokering insurance and reinsurance contracts. Brokerage segment revenues of $11.2 million in 2000 represented a decrease of $13.7 million from brokerage segment revenues of $24.9 million in 1999, which had decreased $2.2 million from brokerage segment revenues of $27.1 million in 1998. This decrease in brokerage segment revenues was primarily the result of reduced business being brokered due to significantly diminished reinsurance capacity for workers' compensation business.
The brokerage segment's loss before tax of $4.8 million in 2000 represented a decrease of $7.5 million from income before tax of $2.7 million in 1999, which had decreased $8.8 million from income before tax of $11.5 million in 1998. The 2000 net loss reflects the decrease in revenues which was partially offset by a decrease in brokerage segment expenses. Expenses for the segment continued to be impacted by significant costs and provisions associated with widespread reinsurance disputes involving the Company or its clients including certain litigation.
The Company's program business segment consists of subsidiaries that market insurance products and administer programs developed by the Company. Program business revenues of $15.3 million in 2000 represented a decrease of $7.1 million from program business revenues of $22.4 million in 1999, which had decreased $4.7 million from program business revenues of $27.1 million in 1998. This decrease was due to reduced fee margins on programs and a reduction in program business volume due to management's decision to impose more selective underwriting conditions on continuing programs.
Loss before tax for the insurance segment of $5.0 million in 2000 represented an increase of $2.9 million from loss before tax of $2.1 million in 1999, which in turn had decreased $3.3 million from income before tax of $1.2 million in 1998. The increased loss before tax resulted from a strengthening of reserves against losses incurred on business written, primarily in respect of programs which are being discontinued.
Following a review of its operations, the Company decided to discontinue its loss-making reinsurance and underwriting management segments. In light of this decision, the Company took a charge against income of $5.2 million to write off goodwill in respect of these operations.
Underwriting management segment loss before tax of $4.9 million in 2000 represented a decrease of $6.7 million from income before tax of $1.8 million in 1999, which in turn reflected a $0.3 million decrease from income before tax of $2.1 million in 1998. In view of the reduction in underwriting management revenues, the resulting net loss, and the ongoing business prospects for the segment, the Company decided to discontinue the underwriting management segment. The net loss for the year reflects the decreased revenues, together with a write-off of associated goodwill following the decision to discontinue these operations.
The increase of $137.8 million in insurance and reinsurance balances receivable, and the corresponding increase of $135.5 million in insurance and reinsurance balances payable, primarily reflects the growth in clients' claims balances recorded in the Company's broking subsidiaries. As a result of various disputes between insurers and reinsurers on various reinsurance contracts, a number of the reinsurers have suspended paying claims due under the contracts. The Company's brokerage and underwriting management segment subsidiaries experienced a significant growth in client balances receivable and payable recorded at the end of the year, reflecting this accumulation of claims due from one party to another. These balances are reflected as an asset or liability, as the case may be, on the Company's balance sheet.
We have also audited the adjustments described in Note 3 that were applied to restate the 1998 financial statements. In our opinion, such adjustments are appropriate and have been properly applied.
Marketable securities comprise investments in debt and equity securities and short term investments. All investments are classified as available for sale in accordance with SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities". Accordingly, these securities are carried at fair value, with the difference between fair value and cost or amortized cost being recorded as accumulated other comprehensive income as a separate component of shareholders' equity, net of applicable deferred income taxes. Bond discounts and premiums are amortized over the remaining term of the securities. Such amortization is included as a component of net investment income in the consolidated statements of income. Realized gains and losses are determined on the basis of specific identification. Investment income is recorded as earned and accrued to the balance sheet date.
g) Recognition of risk management fees FOR THE YEARS ENDED ------------------- DECEMBER 31, ------------ 1998 1999 2000 --------- --------- ------- Brokerage fees and commissions.............. $ 26,968 $24,577 $ 8,920 Managing general agency fees................ 14,743 10,164 8,974 Program and captive management fees......... 3,908 2,298 483 Loss control and audit fees................. 4,508 7,577 5,358 Policy issuance fees........................ 2,095 2,495 3,230 -------- ------- -------- Total risk management fees... $ 52,222 $47,111 $ 26,965 ======== ======= ========
Underwriting management fees from discontinued segment................ $ 3,357 $ 3,900 $ 1,281 ======== ======= ========
(iv) Loss control and audit fees are included within program business segment revenue, and comprise claims administration handling, loss and safety control fees and premium audit fees. Such fees are recorded as the fees are billed and are recognized in income over the period that services are performed in accordance with the Company's contractual obligations, typically ranging up to five years depending on the type of service provided, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon industry standards. The proportion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(v) Policy issuance fees are recorded as the premium is written and earned over the applicable policy period (which is typically one year). The unearned portion is included in deferred income in the consolidated balance sheet.
Capital assets are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over four to five years, which are the estimated useful lives of the related assets.
Earnings per share have been calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share". Net income per share is calculated by dividing income available to ordinary shareholders by the weighted average number of ordinary shares outstanding. Shares held in treasury are not considered outstanding for purposes of the computation. Net income per share assuming dilution is computed by dividing income available to ordinary shareholders by the weighted average number of ordinary shares and potentially dilutive securities such as stock options. The dilutive effect of options is reflected in the computation by application of the treasury stock method.
Under the asset and liability method used by the Company as outlined in SFAS No. 109, "Accounting for Income Taxes", deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the consolidated financial statements' carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is provided for a portion or all of the deferred tax assets when it is more likely than not that such portion or all such deferred assets will not be realized.
The United States Dollar is the Company's functional currency. Foreign currency monetary assets and liabilities are translated at exchange rates in effect at the balance sheet date. Fixed assets and deferred income are translated at their historical exchange rates. Foreign currency revenues and expenses are translated at exchange rates in effect at the date of the transaction. Net exchange gains (losses) of $223, ($117) and ($392) were recorded for the years ended December 31, 1998, 1999 and 2000, respectively.
Certain amounts in 1999 and 1998 have been reclassified to conform to the current year presentation. These reclassifications had no impact on net income or shareholders' equity.
The Company's reinsurance segment consists of its reinsurance subsidiary, Comp Indemnity Reinsurance Company Limited ("CIRCL"). CIRCL primarily reinsured workers' compensation and property and general liability risks. Management had determined in early 1999 to cease underwriting new programs in the reinsurance segment due to unfavourable results, and for this reason, a number of exisiting contracts were not renewed for the 1999 year. During 2000, further losses were realized in this segment, primarily due to a strengthening of reserves on discontinued programs together with an increase in provisions against reinsurance recoveries. Due to the history of operating losses for the segment, together with the cessation of writing new programs, the Company decided to completely discontinue the segment and place the operation into run-off. At year end, reinsurance segment assets were primarily cash and cash equivalents, insurance and reinsurance balances receivable and paid and outstanding losses recoverable from reinsurers. Segment liabilities were primarily insurance and reinsurance balances payable, and outstanding losses and loss expenses.
In the normal course of insurance and reinsurance operations the Company's bankers have issued letters of credit totalling $18,604 and $13,360 at December 31, 1999 and 2000, respectively in favor of ceding insurance companies. At December 31, 1999 and 2000, $18,604 and $13,360, respectively, of cash and cash equivalents were pledged as collateral for these letters of credit.
One of the Company's subsidiaries was registered with the Society of Lloyd's as a registered Lloyd's Broker. Until July 3, 2000,as required by Lloyd's Brokers Byelaw (No. 5 of 1988), the subsidiary entered into a trust deed under which all insurance broking account assets were subject to a floating lien held in trust for the Society of Lloyd's for the benefit of the insurance creditors. With effect from July 3, 2000, in common with all Lloyd's Brokers, the security held under the trust deed was released as a result of changes to Lloyd's Distribution Policy enacted by Lloyd's Regulatory Bulletin dated May 31, 2000.
In its various capacities as an insurance intermediary, the Company acts as a conduit for insurance and reinsurance premiums from insureds and other intermediaries, and after deducting its risk management fee and, where appropriate, surplus lines taxes and stamping fees, remits the premium to the respective insurance company or underwriter. Additionally, the Company acts as a conduit for loss payments. Pending the remittance of such funds to the insurance company or underwriter in accordance with the applicable insurance contract, the Company holds collected funds in its own segregated bank accounts and is entitled to any accrued interest on such funds. The obligation to remit these funds is recorded as insurance and reinsurance balances payable on the Company's balance sheet. The period for which the Company holds such funds is dependent upon the date the insured remits the payment of the premium to the Company and the date the Company is required to forward such payment to the insurer.
Insurance balances receivable of $872,666 (1999 -- $734,868) and payable of $910,437 (1999 -- $774,888) primarily consist of clients' claims and premiums balances recorded by the Company in its capacity as an intermediary. As a result of various disputes between insurers and reinsurers on various reinsurance contracts, a number of the reinsurers have suspended paying claims due under the contracts. The Company's brokerage and discontinued underwriting management segment subsidiaries have experienced a significant growth in claims due from one party to another. These balances are reflected as an asset and liability of the Company in its role as an intermediary.
Deferred tax liabilities of $169 and $24 at December 31, 1999 and 2000, respectively, have been provided against unrealized gains on marketable securities held as "available for sale", which have been presented net as accumulated other comprehensive income within shareholders' equity.
December 31, 2000 ------------------------ AMORTIZED ESTIMATED --------- --------- COST FAIR VALUE ---- ---------- Due in one year or less.................. $ 4,208 $ 4,209 Due after one year through five years.... 19,990 19,894 Due after five years through ten years... 1,011 1,030 Due after ten years through twenty years. 957 958 ------- ------- $26,166 $ 26,091
c) Proceeds from sales of investments in debt securities during 1999 and 2000 were $11,469 and $3,319, respectively. Proceeds from sales of investments in equity securities during 1999 and 2000 were $2,349 and $3,659, respectively. There was $587 of realized losses and $232 of realized gains during 1999. There was $27 of realized losses and $784 of realized gains during 2000.
Certain of the Company's reinsurance contracts, referred to as rent-a-captive programs, do not satisfy the conditions for reinsurance accounting as the maximum exposure to loss is fully funded by premium, cash and other collateral and indemnity agreements. Accordingly, these contracts are accounted for as deposit liabilities. The assets related to these programs represent funds under management as the insured retains the risks and rewards of ownership. Such assets are recorded as assets related to deposit liabilities in the consolidated balance sheets. These assets comprised cash and short-term deposits at December 31, 1999 and 2000. The Company receives a fee based on a percentage of premiums written and investment income earned for structuring and providing ongoing management of the programs.
At December 31, 1999 there were amounts due from three reinsurers that totaled $52,039, each in excess of 10% of the Company's shareholders' equity. At December 31, 2000 there were amounts due from seven reinsurers that totaled $82,383, each in excess of 10% of the Company's shareholders' equity. These reinsurers are rated `Superior' by A.M. Best.
Realm National writes property, general liability and workers compensation business. Workers Compensation comprises the largest portion of the Realm National's written premium, which is produced mainly through two separate programs.
Realm National writes property business risk and purchased a property reinsurance program related to 2000 and prior years where it retained 25% of the first $1,000 on any one risk and purchased facultative reinsurance for limits above $1,000. In addition, Realm National's net retention was further protected with excess catastrophe limits to $10,000.
With respect to its general liability risks prior to 2000, Realm National purchased a reinsurance program whereby it retained 25% of the first $300 on any one risk and purchased facultative per-risk excess reinsurance for limits above $300. In 2000, Realm National retained the first $300 for any one loss and purchased an excess-of-loss treaty providing limits of $700 excess of $300.
Management decided in early 1999 to cease underwriting any new programs in CIRCL due to unfavourable results, and a number of existing contracts were not renewed for the 1999 year. In early 2001, following a review of its operations, the Company decided to completely discontinue its loss-making reinsurance segment, as discussed in Note 3.
The adverse development during 1998, 1999 and 2000 on prior years in discontinued operations primarily reflects the increase in provisions for doubtful reinsurance recoveries of $2.5 million in 1998, $2.1 million in 1999 and $2.4 million in 2000, as discussed in Note 9, as well as an increase in claims frequency on one particular program that covers bodily injury and property risks in the construction industry.
The Company's authorized share capital at December 31, 1999 and 2000 comprised 20,000,000 ordinary shares of par value $0.25 each, of which 9,863,372 ordinary shares were issued and fully paid at December 31, 1999 and 9,963,372 ordinary shares were issued and paid at December 31, 2000. Outstanding shares at December 31, 1999 and 2000 were 9,419,972 and 9,519,972, respectively, which were net of 443,400 treasury shares at each date.
In December 1997, under a put and call option originally granted in April 1997, the Company purchased 40,000 ordinary shares for a total cost of $667. These shares were held as treasury stock at December 31, 1999 and 2000.
Employees and directors have been granted options to purchase Ordinary Shares in the Company. These options have been issued as follows:
On November 25, 1997 the Company granted 300,000 options to certain employees. The options have an exercise price of $22 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to November 25, 2007. At December 31, 1999 and 2000, 186,750 and 140,850 of these options remained outstanding. The balance of the options were forfeited.
On October 26, 1999 the Company granted 285,000 options to certain officers and directors. The options have an exercise price of $2.31 per share, which reflected the market price of the shares on that date. The options vest ratably over a three-year period and may be exercised at any time prior to October 26, 2009. All of these options were outstanding at December 31, 2000.
On August 8, 2000, the Company granted 357,500 options to certain employees. The options have an exercise price of $2.0625 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to August 8, 2010. At December 31, 2000, 337,500 of these options remained outstanding. The balance of the options were forfeited.
The weighted average fair value of each option grant is estimated on the date of the grant using the Black-Scholes option pricing model with the following assumptions used:
The weighted average fair value of options granted during 2000 was $1.09 per share. The fair value of options granted during 1999 was $1.25 per share. There were no options granted during 1998. The fair value of options granted during 1997 was $6.59 per share.
CURRENT DEFERRED TOTAL ------- -------- ----- Year ended December 31, 1998 U.S. Federal and State.............. $ 1,324 $ (753) $ 571 Foreign (U.K.)...................... 3,219 -- 3,219 ------- --------- ------- $ 4,543 $ (753) $ 3,790 ======= ========= ======= Year ended December 31, 1999 U.S. Federal and State.............. $(1,377) $ (1,432) $(2,621) Foreign (U.K.)...................... 38 -- 38 ------- --------- ------- $(1,339) $ (1,432) $(2,583) ======== ========= ======= Year ended December 31, 2000 U.S. Federal and State.............. $ (327) $ (2,318) $(2,645) Foreign (U.K.)...................... 122 -- 122 -------- --------- ------- $ (205) $ (2,318) $(2,523) ======== ========= =======
Income tax expense (benefit) attributable to income from continuing operations and change in accounting method was $3,790, ($2,771) and ($2,523) for the years ended December 31, 1998, 1999 and 2000 respectively, and differed from the amounts computed by applying the U.S. federal income tax rate of 34% and U.S. state tax at an effective rate of 1.74% to income before taxation as a result of the following:
A valuation allowance of $1,800 has been recorded in 2000 ($Nil in 1999) against the tax effect of losses in connection with the Company's U.K. operations. With respect to U.S. taxation, there was no valuation allowance for deferred tax assets as of December 31, 1999 or 2000, as management believes that it is more likely than not that the deferred tax assets will be realized. However, the amount of deferred tax assets could be reduced in the near term if estimates of taxable income are reduced. U.S. federal and state tax loss carryforwards in the amount of approximately $6,400 are available to offset future U.S. federal and state taxable income.
Potential shares that are issued during a year are normally considered as outstanding throughout the year for purposes of calculating net income (loss) per share assuming dilution unless a net loss is incurred, in which case the shares are considered anti-dilutive and are therefore excluded from the calculation. Due to losses in both continuing operations and total operations during 2000, the anti-dilutive effect of the restricted share issuance described in Note 11 is excluded from the calculation of net income (loss) per share assuming dilution.
Deposit liabilities and related assets: Underlying assets are comprised mainly of cash and deposits. The carrying values for deposit liabilities and related assets approximated fair market values due to the short-term maturities of these instruments.
Concentrations of credit risk with respect to other financial instruments are to some extent limited due to the number of reinsurers, agents and customers comprising the Company's receivable base. At December 31, 1999 there were amounts due from three reinsurers that totaled $52,039, and at December 31, 2000 there were amounts due from seven reinsurers that totaled $82,383, as discussed in Note 9. At December 31, 1999 and 2000, management believes that approximately $6,742 and $9,342 of paid and outstanding losses recoverable from reinsurers may prove uncollectible and has established a provision for doubtful accounts accordingly, as discussed in Note 9.
(a) The Company has three continuing business segments; Brokerage, Program Business, and Insurance. The brokerage segment comprises subsidiaries that receive a fee or commission for brokering insurance and reinsurance contracts. The program business segment comprises subsidiaries that market insurance products and manage programs developed by the Company. The insurance segment represents a company that underwrites and retains, subject to its own reinsurance, certain insurance and reinsurance risks, and its revenues include premiums earned on insurance polices, investment income and policy issuance fees. Other includes the Company's holding companies, group services companies, and income earned from investments in affiliated companies (1998 - $2,631, 1999 - $ Nil, 2000 - $Nil). In early 2001, following a review of its operations, the Company decided to discontinue its loss-making reinsurance and underwriting management segments, as discussed in Note 3. Intercompany transactions are recorded under normal terms of trade. Adjustments and eliminations to revenue are in respect of intersegmental revenues that are eliminated at the consolidated level. Adjustments and eliminations to assets are primarily in respect of intersegmental insurance balances receivable that are eliminated at the consolidated level.
(b) Summarized financial information by geographic location of subsidiary for the years ended December 31, 1998, 1999 and 2000 is as follows:
(c) The Company's Program Business companies market and manage insurance products and programs developed by the Company on behalf of independent insurance carriers. In addition, the Company, through its brokerage operations, provides additional business and services to certain of these independent insurance carriers in respect of these products and other insurance and reinsurance policies. For the years ended December 31, 1998, 1999 and 2000 revenues received from one independent insurance carrier approximately accounted for the following percentage of total revenues.
b) Under New York law, Realm National may pay cash dividends only from earned surplus determined on a statutory basis. Further, Realm National is restricted (on the basis of the lower of 10% of statutory surplus at the end of the preceding twelve-month period or 100% of the adjusted net investment income for the preceding twelve-month period) as to the amount of dividends it may declare or pay in any twelve month period without the approval of the Insurance Department of the State of New York.
c) The NAIC has a model law which establishes certain minimum risk-based capital ("RBC") requirements for property-casualty insurance companies. The RBC calculation serves as a benchmark for the regulation of insurance companies by state insurance regulators. The calculation specifies various formulas and weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk and are set forth in the RBC requirements. The capital of Realm National as of December 31, 1999 and 2000 exceeded the amount calculated using the RBC requirements.
1999 2000 ---- ---- Total surplus at December 31......................$ 2,857 $ 752 Net loss for year ended December 31...............$(5,227) $(5,641)
CIRCL is also required to maintain a minimum liquidity ratio whereby the value of its relevant assets are not less than 75% of the amount of its relevant liabilities. Certain categories of assets do not qualify as relevant assets under the statute. At December 31, 1999 and 2000, respectively, CIRCL was required to maintain relevant assets of at least $23,000 and $17,234. At that date relevant assets were approximately $33,500 and $23,718 and the minimum liquidity ratio was therefore met.
The Company, together with one of its London subsidiaries and a former employee of that subsidiary, were named in a third-party complaint filed on or about February 20, 2001 in federal district court in California by defendant AXA Corporate Solutions (U.K.) Ltd. (allegedly misnamed in plaintiff's complaint as AXA RE UK). The third-party complaint alleges fraudulent and/or wrongful inducement to contract allegedly resulting in exposure to liability for claims under another Film Finance Cover brokered by the Company's London subsidiary. The Company, its London subsidiary and the former employee are in the process of evaluating their response to the third-party complaint, including the possibility of moving to dismiss the complaint.
Two of the Company's London subsidiaries, together with other unrelated parties, have been named in: (i) a complaint in federal district court in California; and, (ii) a third-party complaint in an existing action in the New York State Supreme Court, each filed on March 16, 2001 by New Hampshire Insurance Company. Each pleading alleges identical claims of fraudulent inducement and negligent misrepresentation in connection with another Film Finance Cover. The London subsidiaries are in the process of evaluating their responses to these complaints, including the possibility of filing motions to dismiss.
The Company understands that awards already have been made in favor of the reinsurer in two arbitrations. However, based on the Company's understanding of the reasons given by the arbitration panels for their awards in favor of the reinsurer in those cases, the Company does not believe there is any valid basis for its ceding insurer clients in those cases to assert a claim against the Company or its broker subsidiaries.
(d) Beginning in late 1998 and 1999, the reinsurance markets in which the Company historically has been involved experienced considerable disruption for a variety of reasons, including but not limited to the LMX market disputes described above and other disputes involving the North American workers' compensation reinsurance market. The effects of this disruption have continued up to the present time.
One result of this market disruption has been that certain reinsurers with whom the Company's broker subsidiaries placed business on behalf of ceding insurer clients suspended claims payments to those clients, as well as to the Company's insurance and reinsurance subsidiaries, in certain instances also claiming a right to rescind the reinsurance contracts. As a result, a number of arbitrations were commenced between Company clients and their reinsurers. The Company has endeavoured consistently to provide support to its clients in connection with these proceedings. In one ongoing arbitration involving Realm National, that company has succeeded in obtaining $4.8 million in interim relief from a reinsurer by order of the arbitration panel pending a final determination of the matters in issue.
In some instances, disputes or potential disputes have arisen concerning whether reinsurance was properly placed by the Company's broker subsidiaries. In other instances, the Company's ceding insurer clients have demanded indemnification by the Company if the client's reinsurance contracts ultimately are avoided by its reinsurers.