As a Bermuda reinsurer, we are required to post collateral for the statutory reserves ceded to us by U.S. based insurers and reinsurers. We do not have sufficient available cash and investments to satisfy the collateral requirements asserted by Connecticut General Life Insurance Company (“CIGNA”), the cedent under our only remaining guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) agreement. We are attempting to restructure the reinsurance agreement or otherwise meet or reduce CIGNA’s request for collateral. We also continue to attempt to raise additional capital, but we presently have no commitments to raise capital and have been unable to do so since beginning such efforts in early 2002. There can be no assurance that we will be able improve our operations or liquidity. If we cannot do so, or we are unable to raise capital, we will not be able to satisfy our obligations and will likely be required to liquidate our business if we cannot successfully pursue any other strategic alternative. If we are required to liquidate, we can give you no assurance that we will be able to realize the book value of our assets or that investors in our common shares will realize any value on those shares.
Under Bermuda law, a single creditor could make a statutory demand upon us for satisfaction of obligations owed to that creditor. If the statutory demand is held to be valid, and we are unable to satisfy our obligations to that creditor, the creditor may institute proceedings seeking the liquidation of our business. As of the date of this report, we have been served with three statutory demands under Bermuda law and have satisfied or otherwise eliminated our obligations to two of the parties making those demands. The third statutory demand related to amounts that Imagine Group Holdings Limited, a Bermuda based reinsurer, alleges we are obligated to reimburse it for expenses it incurred in connection with a December 2002 capital raising transaction that was not consummated. Imagine has withdrawn its statutory demand, but has instituted civil proceedings against us for the amounts it alleges we owe. If a creditor of ours successfully pursues this statutory process and we are unable to discharge our obligations, liquidation proceedings could be commenced against us.
Prior to requesting their withdrawal, the financial strength ratings of both our operating subsidiaries had been downgraded to a level that effectively precluded them from writing new business. We cannot assure you that we will be able to obtain sufficient financial strength ratings or increase our cash and liquidity positions to a level where we can resume writing new business. If we are able to position ourselves to write new business in the future, we cannot assure you that we will be able to attract or retain customers.
In preparing our financial statements, we use estimates and assumptions based upon the best information available and management’s best judgment at the time our financial statements are prepared. The most significant estimates relate to policyholder benefit reserves for both the life and annuity business, the recoverability of deferred acquisition costs and the fair value of the embedded derivatives related to one of our annuity reinsurance contracts. These estimates require us to make assumptions about, among other things, future mortality, persistency, lapses, expenses and investment performance based upon historical results and information provided to us by our cedents. While we believe these estimates to be reasonable, we cannot assure you that they will be accurate. If these estimates prove to be inaccurate, they could have a significant adverse impact on our financial condition and results of operations.
Our ability to satisfy our obligations under our reinsurance contracts is significantly affected by the performance of our investments and the invested assets held and managed by our ceding companies. For example, if the invested assets held and managed by our ceding companies or their investment managers in connection with our remaining annuity reinsurance contracts do not accumulate at rates sufficient to allow us to meet our obligations to make certain guaranteed payments, we could be forced to fund any shortfalls in these policy benefits, as we had to do in recent years with respect to our annuity reinsurance contract with Transamerica and a large guaranteed minimum death benefit contract which has since been recaptured. If we are required to fund similar shortfalls in the future, it would adversely affect our business.
The American Institute of Certified Public Accountants has issued Statement of Position (“SOP”) 03-1 that will set new standards for accounting for Certain Nontraditional Long-Duration Contracts and for Separate Accounts effective for fiscal periods beginning after December 15, 2003. We anticipate that this new standard may increase the volatility of our reserves for our reinsurance contracts covering guaranteed minimum benefits related to variable annuity contracts, and deferred acquisition costs and interest sensitive contracts liability related to our Transamerica agreement, each of which will affect our future results of operations. In addition, we expect the adoption of the SOP will negatively affect our tangible book value, which we define as GAAP book value excluding deferred acquisition costs.
Terrorist attacks may negatively affect our results of operations in that we may experience higher than expected death claims in a given period, such as occurred in 2001 with the attack on the World Trade Center. There can be no assurance that there will not be further terrorist attacks against the United States or United States businesses. In addition, the United States has entered into armed conflicts, which could have a further impact on our business in ways we cannot currently anticipate. Political and economic instability in some regions of the world may also result and could negatively impact our business.
We are subject to the laws and regulations of the jurisdictions in which we conduct business. These laws and regulations cover many aspects of our business, including licensure, premium rates, marketing practices and capital adequacy. Recently, the insurance and reinsurance regulatory framework has become subject to increased scrutiny in many jurisdictions and regulators have started to reexamine existing laws and regulations. Changes in these laws and regulations could have an adverse affect on our operations. Further deterioration in our financial condition could expose our operations in the United States and Bermuda to increased levels of regulatory scrutiny and possibly to the winding up of our operations.
As a holding company, we have no significant operations or assets other than our ownership of the capital stock of our subsidiaries. Dividends and other permitted payments from our subsidiaries are our
We, along with Annuity and Life Reassurance, are Bermuda corporations that we believe are not subject to United States income tax because neither engages in business in the United States. However, because there is no definitive guidance as to what constitutes being engaged in trade or business in the United States, there can be no assurance that in the future the Internal Revenue Service may not contend that we are engaged in trade or business in the United States. The United States Internal Revenue Service (“IRS”) is currently conducting an audit of our United States based subsidiaries. Those companies currently have a significant tax based net operating loss carryforward. In addition, the IRS has requested certain information and documents related to our Bermuda based operations. While our United States based subsidiaries have complied with the IRS’ requests for information, both our Bermuda holding company and our Bermuda operating subsidiary have declined to supply the IRS with the information it has requested based on the IRS’ lack of jurisdiction over those entities. If the IRS were to determine that our Bermuda based companies were engaged in business in the United States, we could be subject to United States tax at regular corporate rates on our taxable income that is attributable to the Bermuda companies’ permanent establishment, if any, in the United States plus an additional 30% “branch profits” tax on such income remaining after the regular tax. Such taxes, if levied, could have an adverse effect on our business.
Our company has encountered significant difficulties during the last three years. In addition to reporting significant operating losses for those years, we did not have sufficient available cash and investments at December 31, 2002 to post as collateral to satisfy all of our obligations under certain of our reinsurance agreements. During 2003, we negotiated the termination or recapture of most of our reinsurance agreements. As a result of those terminations and recaptures and other actions taken by management, as of December 31, 2003 we had met all the collateral obligations of our remaining ceding companies with the exception of those asserted by CIGNA, the cedent under our only remaining GMDB and GMIB agreement. As of December 31, 2002, CIGNA asserted that we were required to post $59 million of collateral in addition to the $11 million of collateral we had previously provided. As of December 31, 2003, CIGNA was seeking $49 million of collateral in addition to the $11 million of collateral we had previously provided. We do not agree that the aggregate $60 million collateral requirement currently asserted by CIGNA is required to be posted. As a result, we have not posted any additional collateral for this agreement. If CIGNA’s asserted collateral requirement is valid, we do not have sufficient available cash and investments to satisfy CIGNA’s request. We are attempting to restructure the reinsurance agreement or otherwise meet or reduce CIGNA’s request for collateral. If these negotiations are unsuccessful, CIGNA could initiate arbitration or litigation proceedings against us. The specific relief sought and the outcome of any proceedings that CIGNA could initiate cannot be determined at this time. If we do not prevail in any such arbitration or litigation proceedings, it would have a material adverse effect on our financial condition and we may be required to liquidate our operations.
As a result of the termination and recapture of several or our reinsurance agreements in 2003, our life insurance in force has declined from $117.5 billion at December 31, 2002 to $17.5 billion at December 31, 2003. In addition, we have terminated our annuity reinsurance agreements with The Ohio National Life Insurance Company, our then second largest annuity reinsurance agreement, and Hartford Life, our then largest GMDB reinsurance agreement. We are not currently seeking to negotiate the termination or recapture of any of our remaining reinsurance agreements except that, as noted above, we are seeking to restructure our agreement with CIGNA.
Also in 2003, we instituted substantial premium rate increases on all of our non-guaranteed premium yearly renewable term agreements. The Metropolitan Life Insurance Companies (“MetLife”), the cedent under our largest life reinsurance agreement, objected to the premium rate increase and demanded arbitration. On December 19, 2003, the panel in the arbitration proceeding ruled that our rate increase was valid effective as of May 5, 2003. As a result of the ruling, MetLife chose to recapture its reinsurance agreement. The impact of the ruling and MetLife’s recapture was to release funds we had previously posted as collateral under that agreement. We utilized a large portion of those funds to fully collateralize Citibank’s letter of credit facility with us and to pay Transamerica an amount that we believe was due to it as of October 31, 2003 after deducting $5.0 million for investment related expenses that we believe was
owed to us by Transamerica. Transamerica is currently pursuing arbitration with us, asserting that the $5.0 million offset is not justified and that we owe it that amount and interest on the amounts that Transamerica previously alleged were due.
In addition to the discussions with Transamerica related to the alleged amounts owed to it, we have been attempting to engage Transamerica, and ultimately IL Annuity and Insurance Company (“IL Annuity”), the primary insurance company under the Transamerica agreement, in discussions aimed at improving the investment returns on the assets supporting that agreement and potentially redesigning the VisionMark product to reduce our minimum interest guarantee exposure. If we are not successful in convincing Transamerica and IL Annuity to restructure the portfolio and/or to redesign the product, we may incur additional write downs of deferred acquisition costs in the future.
We plan to continue to receive premiums and pay claims under our remaining reinsurance treaties; however, we are not currently underwriting any new treaties or accepting any new business from our existing treaties. We are currently exploring whether we can, should or will begin selling new insurance and reinsurance products in the future, but we cannot assure you that we will be able to successfully develop, underwrite or market any products currently being considered.
In light of the foregoing, the discussion of our results of operations for the year ended December 31, 2003 presented in this report is not likely to be indicative of our future operating results.
Our remaining life reinsurance agreements continue to be reinsurance of ordinary life insurance, primarily for mortality risk. Profitability of our life reinsurance line depends in large part on the volume and amount of death claims incurred. While death claims are reasonably predictable over a long time horizon, they are less predictable over shorter periods and are subject to fluctuation from quarter to quarter and year to year. Significant fluctuations from period to period could adversely affect the results of our operations, as occurred in 2003 and 2002. At December 31, 2003 and 2002, the total face amount of our life insurance in force amounted to approximately $17.5 billion and $117.5 billion, respectively. At December 31, 2003 and 2002, we had retroceded approximately $0.38 billion and $1.26 billion, respectively, of our in force business under our life reinsurance agreements to other reinsurers, or 2.16% and 1.07% of our life insurance in force, respectively.
of expected gross profits for purposes of amortizing deferred acquisition costs associated with the contract. The application of this accounting policy has increased the volatility of our reported earnings. While we have made an estimate of the fair value of the embedded derivative using a model that we believe to be appropriate and based upon reasonable assumptions, the assumptions used are subjective and may require adjustment in the future. In addition, as industry standards for estimating the fair value of embedded derivatives develop, it is possible that we may modify our methodology. Changes in our assumptions and industry standards could have a significant impact on the fair value of the embedded derivative and our reported earnings. We do not bifurcate and separately account for the embedded derivatives contained in our Transamerica annuity reinsurance agreement or our GMDB/GMIB reinsurance agreement with CIGNA because we acquired those agreements prior to the transition date elected by us under FAS 133, as amended. Because of the nature of the assets underlying our Transamerica contract, which were roughly 64% convertible bonds at December 31, 2003, the bifurcation and separate accounting for the embedded derivatives contained in that contract could add significant volatility to our reported results. If we bifurcated and separately accounted for the embedded derivatives contained in our GMDB/GMIB reinsurance agreement with CIGNA, it also could add volatility to our reported results.
AICPA Statement of Position (SOP 03-1) In July 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of Position (SOP) 03-1, Accounting and Reporting by Insurance Enterprises for Certain Non-Traditional Long-Duration Contracts and for Separate Accounts. The SOP
provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts. The SOP will change the manner in which life insurance companies account for certain types of insurance and reinsurance contracts including those that cover risks such as guaranteed minimum death benefits and guaranteed minimum income benefits. Additionally, the SOP provides accounting guidance for sales inducements paid to contract holders and provides guidance for establishing liabilities for contracts with features that may result in more than one potential account balance. The SOP is effective for financial statements for fiscal years beginning after December 15, 2003. The SOP may not be applied retroactively to prior years’ financial statements, and initial application should be as of the beginning of an entity’s fiscal year.
Management of the Company has primary responsibility for preparing the accompanying consolidated financial statements and for their integrity and objectivity. The consolidated financial statements included in this report were prepared in accordance with accounting principles generally accepted in the United States of America applied on a consistent basis. The consolidated financial statements include amounts that are based on management’s best estimates and judgments. Management also prepared the other information presented in the annual report and is responsible for its accuracy and consistency with the consolidated financial statements.
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. However, the Company has incurred significant operating losses. Further, the financial strength ratings of the Company’s operating subsidiaries were downgraded in 2002 and 2003 by A.M. Best, Standard & Poor’s, and Fitch Ratings to C+, BB-, and C, respectively. At the Company’s request, all three financial ratings have been withdrawn.
Transamerica Occidental Life Insurance Company (“Transamerica”) has alleged that the Company, as of October 31, 2003, owed $17.6 million under its annuity reinsurance agreement with Transamerica. On February 3, 2004, the Company paid Transamerica $12.6 million representing the net amount the Company believed was due under the reinsurance agreement as of October 31, 2003 after deducting $5.0 million for investment related expenses that the Company believes was owed to it by Transamerica. Transamerica is currently pursuing arbitration with the Company, asserting that the $5.0 million offset is not justified and that the Company owes Transamerica that amount and interest on the amounts that Transamerica previously alleged were due.
In addition, the Company has been attempting to engage Transamerica, and ultimately IL Annuity and Insurance Company, the primary insurance company under the Transamerica agreement, in discussions aimed at improving investment returns from the convertible bond portfolio and potentially redesigning the VisionMark product to reduce the minimum guarantee exposures from the Transamerica agreement. If the
For universal life and investment-type contracts, deferred policy acquisition costs are amortized over the expected average life of the contracts as a constant percentage of the present value of estimated gross profits arising principally from investment results, mortality and expense margins and surrender charges based on historical and anticipated future experience, which is updated at the end of each accounting period. In computing amortization, interest accrues to the unamortized balance of capitalized policy acquisition costs at the rate used to discount expected gross profit. The effect on the amortization of deferred policy acquisition costs of revisions to estimated gross profits are reflected in earnings in the period such estimated gross profits are revised.
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 is adjusted for amortization of premiums and discounts. The carrying value of fixed income securities is adjusted for declines in value that are considered other than temporary and any such adjustment is considered a realized loss.
The Company calculates basic earnings per common share and earnings per common share assuming dilution. Basic earnings per common share is calculated by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during the period.
A portion of the Company’s funds withheld at interest receivable asset contains embedded derivatives, which require bifurcation and separate accounting under FAS 133 - Accounting for Derivative Instruments and Hedging Activities, which the Company adopted as of January 1, 2001. The net fair value of these embedded derivatives is classified as part of the Company’s funds withheld asset on its balance sheet. The change in the fair value of these embedded derivatives is recorded in the Company’s statement of operations as Net change in fair value of embedded derivatives, which is a non-cash item. The Company, with the assistance of outside advisors, has developed a cash flow model to arrive at an estimate of the fair value of these embedded derivatives that uses various assumptions regarding future cash flows under the affected annuity reinsurance contracts. While the Company has made an estimate of the fair value of these embedded derivatives using a model that it believes is appropriate and based upon reasonable assumptions, the assumptions used are subjective and may require adjustment in the future. In addition, as industry standards for estimating the fair value of embedded derivatives develop, it is possible that the Company may modify its methodology. The Company does not bifurcate and separately account for the embedded derivatives contained in its annuity reinsurance agreement with Transamerica and its guaranteed minimum income benefit reinsurance agreement with CIGNA, because the Company acquired those agreements prior to the transition date it elected under FAS 133, as amended.
The Company has a combined GMDB/GMIB contract with CIGNA and an annuity reinsurance agreement with Transamerica that will be affected by the adoption of this new SOP. The SOP provides guidance for reserving for contracts with guaranteed minimum death and income benefits. The methodology is based on projection of a wide number of future scenarios regarding the present value of premiums earned and claims incurred. Based on this future projection and actual past experience of premiums and claims, a Benefit Ratio percentage is determined. The reserve is then determined by applying the Benefit Ratio percentage to actual premiums received less actual claims, both with interest. Management does not expect the amount of reserves carried for its GMDB/GMIB reinsurance agreement to change significantly as a result of the adoption of the SOP. The SOP also provides guidance for reserving for annuity agreements with more than one potential account balance. Such reserves should be based upon the highest contractually determinable balance, without consideration of surrender fees. Upon adoption of the SOP, there is a one-time transition adjustment to the amount of carried deferred acquisition costs. Management is currently analyzing the impact of the adoption of the SOP on its accounting for the Transamerica annuity reinsurance agreement.
The following table sets forth certain information regarding the investment ratings of the Company’s fixed income securities portfolio at December 31, 2003 and 2002.
The maturity distribution of fixed income securities held as of December 31, 2003 and 2002 is shown below. Actual maturity dates may differ from contractual maturity dates because certain borrowers have the ability to prepay their obligations without penalty.
In connection with the initial capitalization of the Company, the Company issued Class A Warrants that initially entitled the holders to purchase up to 3,059,990 common shares of the Company. The initial exercise price of the Class A Warrants was $15.00, which was equal to the price of the Company’s common shares in the initial public offering. Due to the effect of anti-dilution adjustment provisions in the Class A Warrants, the number of shares issuable upon exercise of the Class A Warrants has increased to 3,155,331 common shares and the exercise price of the Class A Warrants has been adjusted to $14.55 as the result of our issuance of warrants to Hartford Life, discussed below. The Class A Warrants are all currently exercisable and will expire on January 15, 2008. No Class A Warrants have been exercised at December 31, 2003.
In connection with the direct sales of equity securities to certain “Strategic Investors” in connection with the Company’s initial public offering, the Company issued Class B Warrants that initially enabled the holders to purchase an aggregate of 397,500 common shares of the Company. The initial exercise price of
The following table sets forth the computation of basic and diluted (loss) per share:
During 2003, the Company and XL Life had been in discussions with respect to each party’s rights and obligations under the novation and retrocession agreements entered into at December 31, 2002, as well as a $10.0 million excess of loss reinsurance policy and a catastrophe excess of loss cover that were each purchased by the Company from XL Life in the first quarter of 2002 and two annuity reinsurance agreements ceded to the Company by an affiliate of XL Life. The $10.0 million excess of loss reinsurance policy was purchased to protect against lifetime minimum interest guarantee payments under the Company’s annuity reinsurance agreement with Transamerica, and full recovery under the policy had been anticipated in establishing the Company’s deferred acquisition cost asset. The catastrophe excess of loss cover expired by its terms on December 31, 2002, but the parties had continued to discuss with XL Life the remaining obligations asserted under the agreement. The two annuity reinsurance agreements had been in effect since December 17, 1999, and represented approximately $95.9 million (including a cumulative loss from embedded derivatives of approximately $2.8 million) of the Company’s Funds withheld at interest and approximately $95.6 million of the Company’s Interest sensitive contract and other liabilities on July 1, 2003, the effective date of recapture.
At December 31, 2003 and 2002, loans outstanding from officers for such stock purchases were $0 and $1,250,000, respectively. Accrued interest on the loans was $0 and $376,493, respectively. Interest income of $43,998, $97,854, and $100,018 has been recognized for the years ended December 31, 2003, 2002 and 2001, respectively, on these loans.
At December 31, 2003, options to acquire 529,869 common shares were exercisable. The weighted average remaining contractual life of these exercisable options was 7 years.
On January 1, 2003, the Company voluntarily adopted the fair value based method of accounting for stock-based employee compensation under the prospective method described in FASB Statement Number 148. Under this method, the Company applies fair value accounting to all grants of employee stock options subsequent to December 31, 2002. Accordingly, $351,700 has been recognized as the fair value of the options granted during the year ended December 31, 2003. Based on the vesting of the options granted in the year, approximately $111,500 was expensed in 2003. Approximately $240,000 is deferred and will be expensed over the remaining vesting period and is reflected as unamortized stock-based compensation at December 31, 2003. The fair value of stock options awarded to employees and new directors will be amortized into income over the three-year vesting period. The fair value of stock options awarded to all other directors will be expensed immediately as their options are exercisable on the day of grant and vest upon their award.
In 2002, the Board of Directors adopted a Restricted Stock Plan under which it may grant common shares to key employees. The aggregate number of common shares that may be granted under the Restricted Stock Plan is 1,200,000. The Compensation Committee of the Board of Directors administers the Restricted Stock Plan. During 2002, the Company made two awards to employees. Under the first award to employees, the Company issued 133,500 shares of restricted stock that vest on the third anniversary of the grant date. Under the second award, certain employees of the Company were irrevocably offered shares of restricted stock, conditioned upon the execution of a retention agreement with the Company. The Company issued an aggregate 267,500 shares to those employees who chose to execute retention agreements and such shares vest in three equal annual installments commencing on the first anniversary of the grant date.
During the first quarter of 2003, the Company issued 200,000 shares of restricted stock to the Company’s President and Chief Executive Officer. These shares vest in three equal annual installments commencing on the first anniversary of the grant date. In addition, during the second quarter of 2003, the Company issued an additional 375,000 shares of restricted stock in connection with retention grants to employees. These shares also vest in three equal annual installments commencing on the first anniversary of the grant date. During 2003, 227,133 shares of restricted stock were cancelled as a result of certain employees terminating their employment with the Company. The fair value as determined at the date of grant of the restricted stock awards that remain outstanding on December 31, 2003 was approximately $2,400,000 and is reflected in the Company’s balance sheet as common shares and additional paid-in-capital. The fair value of the outstanding restricted stock is being amortized on a straight-line basis over the three-year vesting period. Based on the vesting of the restricted stock, approximately $325,000 was expensed in 2003. The unamortized balance of outstanding restricted stock is reflected in the balance sheet as a component of unamortized stock-based compensation and was approximately $1,269,000 at December 31, 2003.
The Company has entered into a retrocession agreement that generally enables it to limit the amount of life reinsurance it retains to $1,000,000 per single life. The contract is automatic and effective for risks assumed and in force from January 1, 1997. At December 31, 2003 and 2002, the Company had ceded approximately $380 million and $1.26 billion of in force insurance coverage, respectively, to other reinsurers. Total amounts of $465,000 and $500,000 were recoverable from reinsurers at December 31, 2003 and 2002, respectively.
On and since December 4, 2002, certain of the Company’s shareholders filed purported shareholder class action lawsuits against the Company and certain of its present and former officers and directors in the United States District Court for the District of Connecticut seeking unspecified monetary damages. The plaintiffs claim that the defendants violated certain provisions of the United States securities laws by making various alleged material misstatements and omissions in public filings and press releases. The plaintiffs filed a single consolidated amended complaint in July 2003, adding as defendants XL Capital Ltd and two additional directors. On October 1, 2003, the Company answered the amended and consolidated complaint and denied liability on the claims the plaintiffs have asserted. In February 2004, the court denied certain individual defendants’ motions to dismiss the action. In March 2004, the court denied motions to dismiss filed by certain other individual defendants and XL Capital Ltd. The court has not yet ruled on one individual defendant’s motion to dismiss. No assurance can be given that the Company will not be required to pay monetary damages in connection with these lawsuits.
On October 8, 2003, the Company was served with a statutory demand for $640,000 from Imagine Group Holdings Limited (“Imagine”), a Bermuda based reinsurance company, which was subsequently withdrawn. Imagine has since instituted a civil proceeding in the Bermuda Supreme Court against the Company, alleging that the Company is obligated to reimburse it for $640,000 of expenses incurred by Imagine in connection with a proposed December 2002 capital raising transaction that was not consummated. The Company does not believe that Imagine is entitled to reimbursement of these expenses under the applicable agreement and intends to defend itself against Imagine’s claims. The Company has filed an amended defense with the court to which it is awaiting a response.
Transamerica has alleged that the Company, as of October 31, 2003, owed $17.6 million under its annuity reinsurance agreement with Transamerica. On February 3, 2004, the Company paid Transamerica $12.6 million representing the net amount the Company believed was due under the reinsurance agreement
The United States Internal Revenue Service (“IRS”) is currently conducting an audit of the Company’s United States based subsidiaries. Those companies currently have a significant tax based net operating loss carryforward. In addition, the IRS has requested certain information and documents related to the Company’s Bermuda based operations. While the Company’s United States based subsidiaries have complied with the IRS’ requests for information, both the Company and its Bermuda operating subsidiary have declined to supply the IRS with the information it has requested based on the IRS’ lack of jurisdiction over those entities. If the IRS were to determine that the Company or its Bermuda operating subsidiary were engaged in business in the United States, those entities could be subject to United States tax at regular corporate rates on their taxable income that is attributable to a permanent establishment, if any, in the United States plus an additional 30% “branch profits” tax on such income remaining after the regular tax. Such taxes, if levied, could have an adverse effect on the Company’s business.
During 2003, the Company recorded $16,120,000 of payments made under the contract for minimum interest guarantees to policyholders who surrendered their policies. During 2002, the Company recorded $54,174,000 of payments and charges related to the Transamerica reinsurance contract, made up of $26,760,000 of payments made under the contract for minimum interest guarantees to policyholders who surrendered their policies and a write-down of deferred acquisition costs of $27,474,000. The 2002 charges were the result of a high level of surrenders by policyholders coupled with poor investment performance on the premiums paid by the holders of policies underlying the reinsurance contract. In writing down the deferred acquisition costs to their estimated recoverable amount, management has estimated the future levels of surrenders of the underlying policies together with the estimated future level of investment return on the invested premiums. While management has written down deferred acquisition costs to what it believes to be an appropriate level based upon reasonable assumptions about future investment performance and surrenders, the write down is an estimate. Actual amounts of income earned and amounts payable upon future surrenders may be significantly higher or lower than the amounts currently estimated. If actual experience varies significantly from the assumptions used to write down the deferred acquisition costs, additional write downs may be needed in the future.
December 31, 2003, the Company recorded a loss of $2.7 million related to its remaining life reinsurance agreement with Fidelity & Guarantee Life. Premiums associated with this agreement for the year ended December 31, 2003, was approximately $13.3 million.
During the first quarter of 2002, the Company began to separately track financial results of the life and annuity operations in segments. Each segment is defined by a dominant risk characteristic inherent in all products in that segment. The life segment consists of all products where the dominant risk characteristic is
The effective tax rate provided for in the financial statements is computed at a rate of zero. A substantial portion of the Company’s operations is Bermuda based and as a result income is exempt from taxation.