The Company previously operated two business segments, Reinsurance and Health Care. The Reinsurance division is a specialty reinsurance enterprise providing accident, medical, credit, life and other special risk reinsurance to insurers and selected reinsurers on a worldwide basis, and underwriting management services to co-reinsurers. Effective June 30, 2000, the Company discontinued the operations of its Health Care Division. Reference is made to Note 11 of Notes to Financial Statements for a description of the sale transaction and summary operating results.
The results for continuing operations have been disappointing. The nature of ESG Re's business has meant that the Company had continued exposure to underwriting decisions made in previous years. Initially, as the Company had relatively limited specific historical experience on a significant number of its programs on which to base its estimate of losses incurred but not reported, its reliance on ceding company expectations and industry experience was necessarily increased, which increased the uncertainty involved in the loss estimation process. In the second half of the year, the Company reviewed all major contracts with internal and external resources for adequacy of reserving and the related profitability. This resulted in a further strengthening of loss reserves.
The operations of the former Health Care division have entered into a strategic partnership with Bertelsmann/Springer for the marketing of its services to German health insurers. To date, sales proposals have been made to three of the largest insurers with decisions due back in April and May 2001. The expectation is that the group will be successful on at least one of the proposals. In the event none of the proposals are accepted, then the group would be in a position to revisit its business model and ESG Re would revalue its investment.
Since the third quarter of 2000, the Company has made significant progress in executing its business plan centered on select reinsurance writings and partnership enterprises. Reserves established appear to be adequate in the Company's efforts to ring fence the issues associated with the 1998 and 1999 underwriting years. While there can be no assurance that the reserves at any given date are adequate to meet the Company's obligations, the amounts reported in the Company's balance sheet are management's best estimate of that amount. The Company is continuing to take action to close out its liabilities on those underwriting years.
- New Business--approximately $130.5 million, or 51.1%, of total premiums managed was generated from new business.
The operating ratios for the 12 months ended December 31, 2000 and 1999, by line of business and in total, were as follows:
Gross written premiums on accident business declined 18.6% to $54.1 million for the year ended December 31, 2000, in line with the Company's selectivity on writing new and renewal business. Adverse claims development, particularly on the Company's Norwegian portfolio, contributed to the increase in the loss and acquisition expense ratio from 99.6% in 1999 to 122.0% in 2000.
Poor underwriting results across the two major lines of business contributed to the increase in the loss and acquisition ratio from 106.5% in 1999 to 112.3% in 2000. The 2000 results are comprised of three underwriting years, with the 2000 underwriting year contributing earned premium of $106.5 million, carrying a loss and acquisition ratio of 104.1%. The 1999 underwriting year contributed $117.8 million of earned premium with a loss and acquisition ratio of 105.4%. The 1998 underwriting
Net investment income decreased by $0.6 million from $13.5 million in 1999 to $12.9 million in 2000.
The Company's investment portfolio in 2000 was reduced, in part, as a result of the share buy back and investment results were negatively impacted by realized losses from the sale of bonds that fell outside the Company's investment guidelines following their respective rating downgrades.
(2) Other investments include $7.8 million of equity investment and loans provided to three companies that are expected to generate or secure profitable reinsurance business for the Company.
Professional service fees increased by $2.1 million from $8.2 million in 1999 to $10.3 million in 2000. Professional fees included $4.1 million in legal fees in respect of corporate compliance,
standardization of policy contracts and management agreements, acquisitions, forensic audits and legal disputes. Audit and accountancy costs of $2.0 million were incurred in audit, accounting, tax advisory and corporate reporting services. Consulting expenses of $4.1 million were incurred in actuarial support, computer systems improvements, recruitment, due diligence and corporate communications.
Reference is made to Note 11 of Notes to Financial Statements concerning the divestiture, effective June 30, 2000, of the Company's Health Care Division.
The Company reported a net loss of $42.0 million for 1999, compared to a net profit of $14.5 million for 1998. Included in the net loss for 1999 is $12.8 million of, primarily, expenses associated with the discontinued Health Care Division. As noted previously, the Health Care Division was divested, effective June 30, 2000 and amounts previously reported are now shown as part of discontinued operations.
The Company experienced rapid growth in 1999 in its medical portfolio, particularly in the North American market. The Company's London market office established in July 1998 had a full year of production and exceeded premium targets set by management. The Toronto office wrote one large medical contract for $65 million that led to a dramatic growth in written and earned premium for the medical line. The North American medical rates are increasing and more rigorous terms of trade are being accepted by ceding companies. The Company will maintain its presence in the North American market on a selective basis while taking every opportunity to diversify the product range.
Accident business grew by 27% in 1999, with strong growth in the London market reflective of 1999 being the first full year of operation. The London market is more competitive than the Continental Europe market and this has contributed to the increase in the loss and acquisition ratio in 1999. In addition, during the fourth quarter, the Company added $3.4 million to reserves relating to adverse development on a large Continental Europe contract, following the receipt of accounting information from the ceding company in February 2000.
this account on both underwriting years, the Credit portfolio has grown by 64%. The Company expects to develop this line of business further in 2000.
Gross premium from Life business declined by 37% in 1999 from $11.0 million to $6.9 million. Approximately $6.3 million of Life business written in Latin America in 1998 did not renew in 1999. Life business remains a core element of the ESG strategy. Additional underwriting and actuarial management has been recruited by the Company to enable expansion of this product line in 2000. Deterioration on two risks underwritten in Continental Europe has led to the loss on the account.
The Company has experienced significant growth in North America business in 1999 both through its Toronto underwriting office and its London market operations. The distribution of gross written premiums for years ended December 31, 1999 and 1998, is as follows:
The distribution of gross premiums written by line of business for the years ended December 31, 1999 and 1998 was as follows:
(1) Net investment income is net of investment-related expenses and income on premium receivable and funds held by ceding companies.
The Company's investment portfolio in 1999 was negatively impacted by a general decrease in prices in the U.S. bond markets, which resulted in net investment losses being realized on sales of fixed income securities during the year.
Total administrative expenses, which includes personnel costs, professional service fees, interest expense, other expenses and income taxes, increased by $12.5 million, or 95%, from $13.2 million in 1998 to $25.7 million in 1999.
The Company continued to incur significant expenses for professional services and for travel expenses in the development of its business. Personnel costs increased by $5.0 million from $4.0 million in 1998 to $9.0 million in 1999. The number of employees has increased from 76 at December 31, 1998 to 121 at December 31, 1999, excluding the Company's operations in Tbilisi, Georgia.
The Company's investment policy objective is to maximize long-term investment returns while maintaining a liquid, high-quality portfolio. To this end, the investment policy requires that the portfolio have an average credit quality rating of AA, with no more than 3% of the portfolio invested in the securities of a single issuer (other than issues of sovereign governments with a rating of AA or better), and a target duration of 2.75 years. The Company's investment portfolio as of December 31,2000 and 1999 complies with the adopted investment policy and guidelines.
Reinsurance funds recoverable on incurred losses increased from $11.5 million as at December 31, 1999 to $15.6 million as at December 31, 2000. The increase was due to additional losses being incurred above the Company's net retention levels that enable the Company to make recoveries from its excess of loss reinsurers, plus the additional quota share cessions to two of its retrocessionaires.
Deferred acquisition costs decreased from $57.8 million as at December 31, 1999 to $46.6 million as at December 31, 2000. Acquisition costs, consisting principally of commissions and brokerage expenses incurred at the time a contract or policy is issued, are deferred and amortized over the period in which the related premiums are earned. The decrease was a function of the decline in written premiums over the year.
As of December 31, 2000, the Company had the following material commitments for operating leases and employment contracts:
The Company manages its underwriting risk exposures primarily through an excess of loss reinsurance program. This program generally provides limits up to a maximum of $30 million per occurrence, with a minimum attachment point generally of $250 thousand.
The Company announced in a press release dated January 31, 2001, that Alasdair Davis will assume the role of Chief Executive Officer at the annual general meeting of shareholders in May 2001. John C Head III, the current Chief Executive Officer will remain as Chairman of the Board.
ESG Re Limited ("the Company") was incorporated under the laws of Bermuda on August 21, 1997. Its principal activities conducted through its subsidiaries, are to provide accident, health, credit, life and special risk reinsurance and to provide underwriting management services for these lines.
Fixed maturity securities are classified as available for sale and are reported at estimated fair value. Investments that are available for sale are expected to be held for an indefinite period but may be sold depending on interest rates and other considerations. Other investments over which the Company exercises significant influence are accounted for under the equity method. Otherwise these
investments are accounted for at cost. Unrealized investment gains and losses on investments available for sale, net of applicable deferred income tax, are reported as a separate component of "accumulated other comprehensive income". Realized gains or losses on sale of investments are determined on the basis of average cost. The carrying values of investments available for sale and other investments are adjusted for impairments in value that are considered to be other than temporary.
into U.S. dollars using weighted average exchange rates for the period. Gains and losses resulting from translating foreign currency financial statements, net of deferred income taxes, are excluded from income and included as a separate component of "accumulated other comprehensive income."
SFAS No. 123, "Accounting for Stock-Based Compensation" defines a fair value based method of accounting for stock-based employee compensation plans. Under SFAS No. 123, companies are encouraged, but are not required, to adopt the fair value method for all employee awards granted. Companies are permitted to account for such transactions under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," but must disclose in a note to the financial statements, pro forma net income and earnings per share as if SFAS No. 123 had been applied. The Company accounts for stock-based compensation under APB No. 25 and provides the fair value method disclosures required by SFAS No. 123.
Management fees receivable represents management fee and related revenues that are primarily due from co-reinsurers and quota share retrocessionnaires to whom a portion of the Company's gross
Activity in the reserve for unpaid losses and loss expenses for the years ended December 31, 2000 and 1999 is summarized as follows:
Realization of the deferred tax asset is dependent on generating sufficient taxable income in the future. During 2000, a valuation allowance of $11,444 to reduce the deferred tax asset was recorded in accordance with the provisions of SFAS109. The valuation allowance is necessary because sufficient uncertainty exists regarding the realizability of certain net operating loss carryforwards. The Company has a loss carryforwards of $65.0 million available to offset future foreign taxable income. Such tax loss carryforwards do not have an expiration date.
The Company utilizes retrocessional agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from retrocessionaires of a portion of the losses and loss expenses under certain circumstances. They do not discharge the primary liability of the Company. In the event retrocessionaires were unable to meet their obligations under the retrocession agreements, the Company would be liable for such defaulted amounts. The Company believes that it has minimized the credit risk with respect to its reinsurance by monitoring its retrocessionaires and avoiding concentrations with any single company.
Class A Warrants to purchase 1,381,200 common shares at $20 per share were outstanding as of December 31, 2000 and 1999. Options to purchase up to 1,680,328 common shares, issued at exercise prices between $2.01 and $26.00, were outstanding as of December 31, 2000. Options to purchase up to 1,440,503 common shares, issued at exercise prices between $5.44 and $26.50, were outstanding as of December 31, 1999. The incremental shares from assumed exercise of options and warrants have not been included in the above computations for 2000 and 1999 as they have an anti-dilutive effect on the net loss per common share.
The future minimum commitments under operating leases and employment contracts are as follows:
As of December 31, 2000, Secured Letters of Credit and Trust Accounts in the aggregate amount of $95.8 million have been issued in favor of ceding companies with $73.4 million related to Letters of Credit issued and $22.4 million related to Trust Accounts in force. The Letters of Credit and Trust Accounts are secured by a lien on the Company's fixed maturities investment portfolio, equal to 110% of the amount of the outstanding letters of credit, and 102% of the amount of the outstanding Trust Accounts. As of December 31, 1999 Secured Letters of Credit in the amount of $39.1 million were issued in favor of ceding companies.
Certain subsidiaries of the Company are obligated to make defined contributions to pension plans for their employees. As of December 31, 2000 and 1999, there were outstanding liabilities for pension contributions of $568 thousand and $448 thousand respectively. Pension contribution expenses were $732 thousand, $590 thousand, and $143 thousand, for the years ended December 31, 2000, 1999, and 1998, respectively.
In February 2000, Odyssey Re instituted an action in England against a broker, Stirling Cooke Brown, alleging fraud and conspiracy on the reinsurance placement of 1997 and 1998 Personal Accident and Workers Compensation "carve out" business with Odyssey Re. These proceedings mirror earlier proceedings commenced in New York which were dismissed on jurisdictional grounds. During 1998, ESG accepted a 25% quota share reinsurance treaty with Odyssey Re (UK) retroactive to January 1, 1998. This treaty covers various insurance companies involved in the litigation Odyssey Re instituted in New York over 1997 and 1998 business. This treaty terminated as of December 31, 1998 but ESG renewed its participation for 1999 directly to one of those ceding companies. In December 1999, the Company gave notice to rescind its contract with Odyssey Re (UK) for misrepresentation and failure to disclose material facts. On November 29, 2000 the Company filed suit in the High Court to seek a
As part of its prior underwriting pool management services, the Company collects premiums and pays claims on behalf of the pool participants. In addition to fees received for the underwriting services, the Company also earns interest income on funds it is authorized to hold in accordance with the underwriting management agreements between the Company and the pool participants. The Company is authorized to retain 25% of gross premiums as a claims fund held in bank accounts having trustee status.
The Company has adopted the 1997 Employees Stock Option Plan (the "Stock Option Plan") under which employees of the Company and its subsidiaries are eligible to participate. The Stock Option Plan is administered by the Compensation Committee of the Board. Subject to the provisions of the Stock Option Plan, the Board of Directors has sole discretionary authority to interpret the Stock Option Plan and to determine the terms and conditions of the awards.
The exercise price of the option are determined by the Board of Directors when the options are granted. Options granted under the Stock Option Plan are freely assignable subject to certain limitations. The Company has reserved 2,000,000 common shares for issuance under the Stock Option Plan.
As of December 31, 2000, options to purchase a total of 1,057,900 shares of common stock were granted, net of forfeitures, to officers and employees of the Company (1999:980,075). Options granted under the Employee Stock Option Plan generally vest at 25% at the date of grant and at 25% on each of the second, third and fourth anniversaries of the date of grant. All options are exercisable at the fair market value of the stock at the date of the grant and expire 10 years after the date of the grant.
The Company has adopted the ESG Re Limited Non-management Directors' Compensation and Option Plan (the "Directors' Plan"), under which non-management directors are compensated for their service on the Board. Each non-management director receives fees for services as a member of the Board of Directors and its committees, in amounts determined by the Board of Directors, to be paid in a combination of cash and common shares, as determined by the Board. A Director may elect to receive all or a portion of such fees in the form of options to purchase common shares equal to two times the fees that would otherwise be payable. A director may also elect to defer receipt of the fees, and if so deferred, will receive deferred compensation indexed to the greater of (i) the total return on the common shares; or (ii) the one-year U.S. Treasury bill rate. If a director does not elect the payment in options or deferred compensation alternatives, the fees will be paid in a combination of cash and shares as determined by the Board. Shares granted under the Directors' Plan will not be transferable for six months after receipt. The Company has reserved 1,000,000 common shares for issuance under the Directors' Plan.
To date all non-management directors have elected to receive their fees as options to purchase shares. As a result, a total of 622,428 shares of common stock have been granted, net of forfeitures, as stock options as of December 31, 2000 (1999: 460,428). Compensation expense related to these grants of $173 thousand and $232 thousand was recognized for the years ending December 31, 2000 and 1999, respectively.
The weighted average remaining contractual life of options outstanding at December 31, 2000, is presented below:
On February 25, 2000, a restricted stock plan "2000 Restricted Stock Plan" was approved by the Board of Directors. The purpose of the Plan is to provide an incentive to the officers and certain other key employees of the Company and its affiliates (as determined by the Compensation Committee of the Board of Directors) to contribute to the Company's future success and prosperity by making available to them an opportunity to acquire a proprietary interest or to increase their proprietary interest in the Company and to enhance the ability of the Company and its affiliates to attract and retain qualified individuals upon whom, in large measure, the progress, growth, and profitability of the Company depend. The Compensation Committee has discretionary authority to interpret the 2000 Restricted Stock Plan and to determine the terms of any awards, when, if and to whom awards are granted, and
In 1997, the Company entered into an agreement with Head Asset Management L.L.C. ("Head Asset Management"), an affiliate of Head & Company L.L.C. ("Head Company"), relating to the provision of investment management services. The Chairman of the Board of Directors and Chief Executive Officer is a Managing Member of Head Company. Pursuant to this agreement, which was revised July 1, 2000, and which is subject to the Company's investment guidelines and other restrictions, the Company will pay Head Asset Management a fee equal to the sum of (i) 0.20% per annum of the first $150 million of assets under management, and (ii) 0.15% per annum of assets under management in excess of $150 million. The Company incurred expenses of $397 thousand and $495 thousand under this agreement for the years ended December 31, 2000 and 1999 respectively.
For the year ended December 31, 2000, no client contributed more than 10% of total revenue. For the year ended December 31, 1999, one significant client relationship contributed $64.1 million to total revenue. For the year ended December 31,1998, one significant client contributed $25.1 million to total revenue.