All of the Company's facilities are leased. Aggregate lease payments for 1997 were $1.9 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.
- -------- (1) Includes the operations of Realm Investments Limited from its January 1996 acquisition by the Company. Realm National from its September 1996 acquisition by the Company and the operations of North American Risk, Inc. from its July 1996 acquisition by the Company. All of such acquisitions were accounted for as purchases. See "Management's Discussion and Analysis of Financial Condition and Results of Operations". (2) Net income per share is calculated by dividing income available to ordinary shareholders by the weighted average number of Ordinary Shares outstanding. The Ordinary Shares which were subject to redemption are included in the computation of the weighted average number of outstanding Ordinary Shares since they have identical rights. Shares held in treasury are not considered outstanding for purposes of the computation. Income per Ordinary 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 are reflected in the computation by application of the treasury stock method. (3) Total assets comprise corporate assets together with cash held and insurance balances receivable in a fiduciary capacity. See Note 5 to the Consolidated Financial Statements. (4) The Ordinary Shares subject to redemption were reclassified to shareholders' equity upon consummation of the Initial Public Offering since those shares were no longer redeemable.
Stirling Cooke Brown Holdings Limited (the "Company") was incorporated in Bermuda on December 12, 1995. The Company is a holding company engaged, through its subsidiaries, in providing insurance services primarily in the United States, Bermuda and Europe. The Company's activities include insurance and reinsurance brokering, underwriting management, risk management, claims control, loss and safety prevention, third party administration and managed care services. In January 1996, the Company acquired all the outstanding common shares of Realm Investments Ltd. in exchange for 1,999,980 of its newly issued ordinary shares. The Company also acquired in September 1996 its own United States domiciled insurance company (Realm National) which, together with the Company's Bermuda based reinsurance company (CIRCL), writes insurance and reinsurance business. Realm National also earns policy issuance fees. The Company specializes in the North American occupational accident and workers' compensation alternative risk transfer markets.
Stirling Cooke Brown Holdings (UK) Limited was the predecessor entity of the Company. Accordingly, the consolidated financial statements of the Company for the year ended December 31, 1995 are those of Stirling Cooke Brown Holdings (UK) Limited.
We have audited the consolidated financial statements of Stirling Cooke Brown Holdings Limited and subsidiaries as listed in the accompanying index. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Stirling Cooke Brown Holdings Limited and subsidiaries as at December 31, 1996 and 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with United States generally accepted accounting principles.
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT PER SHARE DATA)
Dividends per share were $0.53, $0 and $0 for the years ended December 31, 1995, 1996 and 1997, respectively.
On December 2, 1997, the Company and certain Selling Shareholders consummated an initial public offering of 3,421,250 ordinary shares. Of these shares, 1,375,000 were sold by the Company and 2,046,250 were sold by Selling Shareholders. The net proceeds received by the Company of $26,832 will be used primarily to provide additional capital to Realm National to facilitate that company's plans to expand its underwriting activities.
These consolidated financial statements include the financial statements of the Company and all of its majority owned subsidiaries (collectively referred to as the "Company"). All significant intercompany balances and transactions have been eliminated on consolidation. The results of a number of subsidiaries have been included from the dates of their acquisition.
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.
Losses and related loss adjustment expenses are charged to income as they are incurred and are net of losses recovered and recoverable of $0, $6,775 and $16,866 for the years ended December 31, 1995, 1996 and 1997 respectively. Amounts recoverable from reinsurers are estimated in a manner consistent with the underlying liability associated with the reinsured policy. Outstanding losses recoverable are shown separately on the consolidated balance sheets.
(ii) Managing general agency fees are reported net of commission expense to agents and are initially recorded as of the effective date of the related insurance policy. Fee income on installment premiums is recognized periodically when the installment is billed. Such fees 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, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon the Company's claims handling experience over recent years. Any subsequent adjustments, including adjustments due to policy cancellation and premium adjustments, are recorded when advised by the client or agent. The portion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(iii) Underwriting management fees are initially recorded when premium is billed in accordance with terms of trade. Fee income on installment premiums is recognized periodically when the installment is billed. Fees are recognized in income over the period that services are performed in accordance with the Company's contractual obligations. Such fees are recognized in income over the period that contractual services are performed, typically up to five years, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon the Company's claims handling experience over recent years. Any subsequent adjustments, including adjustments due to policy cancellations, and premium adjustments are recorded when advised by the client or agent. The portion of recorded management fees that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(vi) Policy issuance fees are recorded as the premium is written and earned over the applicable policy period. The unearned portion is included in deferred income in the consolidated balance sheet.
The Company considers time deposits with original maturity dates of three months or less to be equivalent to cash. Fiduciary funds are restricted from use and are not considered cash equivalents.
Capital assets are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over four to five years, which is the estimated useful lives of the related assets.
In December 1997, AICPA Accounting Standards Executive Committee issued Statement of Position (SOP) 97-3. Accounting by Insurance and Other Enterprises for Insurance-Related Assessments. The accounting guidance of this SOP focuses on the timing of recognition and measurement of liabilities for insurance-related assessments. Guidance is also provided on recording assets representing future recoveries of assessments through premium tax offsets or policy surcharges. The SOP was issued to reduce diversity in practice and to improve comparability and disclosure. The SOP is effective for fiscal years beginning after December 15, 1998. The Company is currently reviewing the impact of the adoption of this new SOP on its consolidated financial statements.
During 1996, the Company incorporated a new subsidiary, North American Risk, Inc., which effective July 1, 1996, acquired the assets and liabilities of North American Risk Limited (a limited partnership) ("NAR") for a total cash cost of $94.
The estimated fair values of assets acquired and liabilities assumed are summarized as follows:
In the normal course of reinsurance operations the Company's bankers have issued letters of credit totalling $7,015 and $12,226 at December 31, 1996 and 1997, respectively in favor of the ceding insurance companies. At December 31, 1996 and 1997, $7,015 and $12,226 of cash and cash equivalents were pledged as collateral for these letters of credit, respectively.
One of the Company's subsidiaries is registered with the Society of Lloyd's as a registered Lloyd's Broker. As required by Lloyd's Brokers Byelaw (No. 5 of 1988), the subsidiary has entered into a trust deed under which all insurance broking account assets are subject to a floating lien held in trust for the Society of Lloyd's for the benefit of the insurance creditors. Insurance and reinsurance balances payable covered by the floating lien at December 31, 1996 and 1997, amounted to $80,070 and $95,279, respectively, including relevant creditors of other subsidiaries. The purpose of the trust deed is to provide security to the Lloyds Broker's insurance creditors in the event of the Brokers insolvency by creating a charge over the Broker's insurance transaction assets. The lien becomes enforceable only in the event the Lloyds Broker becomes insolvent or breaches Lloyds solvency rules or regulations. The assets which were subject to this floating lien at December 31, 1996 and 1997 were:
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, 1996 and 1997. 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.
customer. The deposit is refunded to the customer after the policy expires or is canceled and all claims related to the insurance policy have been settled. The interest income earned by these restricted deposit accounts is the property of the customer, and is therefore excluded from the Company's operating results.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. At December 31, 1996 and 1997 there were no allowances for uncollectible amounts. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies.
Realm National has also purchased a standard property reinsurance program whereby Realm National retains 25% of the first $1,000 on any one risk and purchased facultative per risk reinsurance for limits above $1,000 to $200,000. In addition, Realm National's net retained line is further protected by a per risk excess of loss cover which reduces the maximum loss on any one risk to $125.
Comp Indemnity Reinsurance Company ("CIRCL"), a subsidiary of Realm Investments Ltd., assumes various quota shares of workers' compensation, employers' liability on both a primary and excess basis, bodily injury, difference in conditions, general liability risks, and property written on a treaty basis. CIRCL's exposure under the reinsurance contracts assumed is limited in most instances to $250 and $1,000 per occurrence for workers' compensation and employers liability, respectively and is subject to an annual aggregate limit based on
The changes in outstanding losses and loss expenses are summarized as follows:
The Company's authorized share capital at December 31, 1997 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 that date. The Company's authorized share capital at December 31, 1996 comprised 8,048,000 ordinary shares of par value $0.25 each and 25 Class "A" non-voting shares with a par value of $1 each, of which 8,000,000 ordinary shares and 25 Class "A" non-voting shares were issued and fully-paid at that date.
On June 30, 1997, the remaining 400,516 ordinary shares held in treasury at that date were cancelled. The excess cost of treasury shares over their par value was recorded as a deduction from retained earnings.
On June 30, 1997, the shareholders exercised their options to purchase 600,000 ordinary shares in the Company (see Note 12 to the consolidated financial statements) at an exercise price of $2.71 per share. Contemporaneously, 288,888 ordinary shares of par value of $0.25 each were issued to the holders of the Class "A" shares pursuant to certain anti- dilution rights, and the Class "A" shares were repurchased by the Company for nominal consideration. The $72 excess of the par value of the ordinary shares issued over the original par value of the Class "A" shares was recorded as a deduction from additional paid in capital. On the same date the Company loaned the shareholders $1,625, an amount equal to the aggregate exercise price of the options. Such loans were evidenced by promissory notes, bearing interest at 7% per annum until maturity in June 1998 or earlier in the event of early repayment. Included within notes receivable was $325, $866 and $109 due from Messrs. Cooke, Brown and Jones, respectively. The loans were repaid in full in December 1997 following the successful completion of the IPO of the Company's ordinary shares.
On December 2, 1997, the Company and certain Selling Shareholders consummated the IPO of 3,421,250 ordinary shares at $22 per share. Of these shares 1,375,000 were sold by the Company and 2,046,250 were sold by Selling Shareholders. The Company received net proceeds of $26,832 after deducting underwriting commissions of $2,117 and expenses of $1,301 relating to the issue.
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, 1997.
On June 29, 1995, the Company granted 600,000 options to certain employee shareholders. The terms of the options were subsequently amended in 1996 to reflect the share exchange factor in the Share Purchase Agreement between the Company and Stirling Cooke Brown Holdings (UK) Limited discussed in Note 1.
These pro forma compensation costs may not be representative of those to be expected in future years. As the options were granted on November 25, 1997, only approximately one month's compensation cost has been expensed within the pro-forma net income for the year ended December 31, 1997.
The 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 in 1997:
At December 31, 1996, the Company established a valuation allowance relating to acquired deferred tax benefits. The realization of the tax benefits attributable to these acquired temporary differences will be applied to reduce (i) goodwill related to the acquisition, (ii) other acquired intangibles and (iii) income from other continuing operations.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred liabilities at December 31, 1996 and 1997, are presented below:
Valuation allowances of $190 and $104 have been established against the deferred tax asset as of December 31, 1996 and 1997, respectively. The ultimate realization of this deferred tax asset depends on the ability of the Company and its subsidiaries to generate sufficient taxable income during the periods in which those temporary differences become deductible.
The Company has not recognized a deferred tax liability for the undistributed earnings of its United States subsidiaries. (A 30% tax is generally imposed in the United States on dividends paid by United States corporations to non-United States shareholders). The Company does not expect those unremitted earnings to become taxable in the foreseeable future. A deferred tax liability will be recognized when the Company expects that it will recover those undistributed earnings in a taxable manner, such as the receipt of dividends. The deferred tax liability relating to these unremitted earnings which is not recognized by the Company is approximately $0, $200 and $542 at December 31, 1995, 1996, 1997, respectively.
The estimates of fair values presented herein are subjective in nature and are not necessarily indicative of the amounts that the Company would actually realize in a current market exchange. Any differences would not be expected to be material. Certain instruments such as prepaid expenses, other assets, goodwill and deferred expenses, deferred fee income and outstanding losses and loss expenses are excluded from fair value disclosure. Thus the total fair value amounts cannot be aggregated to determine the underlying economic value of the Company.
The Company maintains a substantial portion of its cash and cash equivalents in two financial institutions which the Company considers of high credit quality.
Concentrations of credit risk with respect to other financial instruments are limited due to the large number of reinsurers, agents and customers comprising the Company's receivable base. Management does not anticipate significant credit losses from such financial instruments. As at December 31, 1996 and 1997, there were no significant allowances for doubtful accounts.
The Company's functional currency is the U.S. dollar; however, as the Company operates internationally, it has exposure to changes in foreign currency exchange rates. These exposures include net cash inflows on non-U.S. dollar denominated transactions.
The revenue of each industry segment is comprised of revenues from unaffiliated customers. Interest income is included in revenue if the asset on which the interest is earned is included among the segment's identifiable assets.
Total rental expense for the years ended December 31, 1995, 1996 and 1997, was $612, $1,319 and $1,894, respectively.
By agreement with the Insurance Department of the State of New York, Realm National is restricted from declaring dividends for a two year period from September 5, 1996 the date upon which its acquisition by the Company was completed.
d) Realm National is licensed by the Insurance Department of the State of New York (the "Department") to write Special Risk insurance. Special Risk business represents business that is sold at rates that are not subject to prior approval of the Department. The Department's rules and regulations limit the amount of Special Risk business that a company may write based on the aggregate writings of the company. In 1994, Realm National disposed of its agricultural and ocean marine books of business as a condition precedent to the sale of Realm National to a prospective buyer. As a result, Realm National was no longer in compliance with the Department's limitation on Special Risk premium writings. Realm National has received a waiver of such limitations from the Department through September 5, 1997. Realm National's license has been renewed through August of 1998.
b) Amounts due from/to affiliates are interest free and unsecured with no fixed terms of repayment.
c) Goldman, Sachs & Co. acted as a co-managing underwriter for the Company's IPO completed in December 1997, from which the underwriters received aggregate underwriting discounts of $5.3 million from the Company and selling shareholders.
Goldman, Sachs & Co. or certain of their affiliates maintain certain contractual relationships with the Company and have provided, and currently provide investment banking services to the Company. Goldman, Sachs & Co. also provide investment management services to Realm National pursuant to a Corporate Account Agreement dated December 24, 1996 and received customary fees and expenses of approximately $52 during 1997 for such services.