The Company's principal executive offices are located in Hamilton, Bermuda. This facility currently serves as the headquarters for senior management, the financial and administrative departments and the Company's Bermuda subsidiaries. The following table sets forth additional information concerning the Company's facilities:
The selected consolidated financial data below should be read in conjunction with the Consolidated Financial Statements and the notes thereto presented under Item 8.
We conducted our audits in accordance with United States generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
DECEMBER 31, 1996 AND 1997 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)
DECEMBER 31, 1995, 1996 AND 1997 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE DATA)
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 Insurance Company ("Realm National") which, together with the Company's Bermuda based reinsurance company, writes insurance and reinsurance business. The Company specializes in the North American occupational accident and workers' compensation alternative risk transfer markets.
Marketable securities comprise investments in debt and equity securities and short term investments. All investments are classified as available for sale and are carried at fair value. The difference between fair value and cost is included as a separate component of shareholders' equity, net of applicable deferred income taxes.
Reserves are established for losses and loss expenses relating to claims which have been reported. In addition, reserves are established, in consultation with the Company's independent actuaries, for losses which have occurred but have not yet been reported to the Company and for adverse development of reserves on reported losses. Management believes that the resulting provision for outstanding losses and loss expenses is adequate to cover the ultimate net cost of losses and loss expenses incurred, however, such a provision is necessarily an estimate and may ultimately be settled for a significantly greater or lesser amount. The Company has limited historical loss experience available to serve as a reliable basis for the estimation of ultimate losses. It is at least reasonably possible that management will revise the estimate of outstanding losses and loss expenses significantly in the near term. Any subsequent differences arising are recorded in the period in which they are determined.
The components of the Company's risk management fees are as follows:
(iv) Program and captive management fees are initially recorded as of the effective date of the insurance policy or, in the case of installment premiums, when the installment is billed and are recognized in income over the period of the underlying policy (which is typically one year) in proportion to the level of services provided in accordance with the Company's contractual obligations. Any subsequent adjustments are recognized in income 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.
(v) Loss control and audit fees 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 the Company's claims handling experience over recent years. The proportion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
The Company's investments in affiliated companies which are not majority owned or controlled are accounted for using the equity method if the Company is able to exert significant influence upon such affiliated
companies. Other investments in affiliates are carried at cost. Investments in affiliates of $526 and $1,350 for the years ended December 31, 1996 and 1997, respectively, are recorded in other assets. The Company's equity share in the net income of affiliates, for the years ended December 31, 1995, 1996 and 1997 of $0, $282 and $1,266, respectively, is included in other income. Dividends received from affiliated companies of $0, $0 and $593 during 1995, 1996 and 1997, respectively, are recorded as a reduction in the carrying value of the investment.
Goodwill in the amount of $8,124 and $8,613 at December 31, 1996, and 1997, respectively, represents the excess of purchase price over fair value of net assets acquired. Goodwill is amortized on a straight-line basis over the expected periods to be benefited, generally 5 to 20 years. Accumulated amortization at December 31, 1996 and 1997 is $423 and $1,130, respectively. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. The amount of goodwill impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds. The assessment of the recoverability of goodwill will be impacted if estimated future operating cash flows are not achieved.
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 the
exchange rates in effect at the date of the transaction. Net exchange gains of $0, $559 and $311 are included in other income for the years ended December 31, 1995, 1996 and 1997, respectively.
The Company adopted FASB Statement No. 123, "Accounting for Stock-Based Compensation", on January 1, 1996. As permitted by the statement, the Company has elected to continue to account for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees", and, accordingly, recognizes compensation expense for stock option grants to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is recorded over the shorter of the vesting or service period.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130 "Reporting Comprehensive Income" and SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information." These statements will be effective for financial statements issued for periods beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components within a set of financial statements. This standard will be adopted in respect of the quarter ended March 31, 1998. Adoption of the standard will have no material effect on the earnings of the Company. SFAS No. 131 requires the Company to report financial and descriptive information about its reportable operating segments. The Company is currently reviewing the impact of this standard on its financial reporting.
In January 1996, the Company acquired all of the outstanding ordinary shares of Realm Investments Ltd. in exchange for 1,999,980 newly issued ordinary shares of the Company. The fair value assigned to the shares issued was $12,819. Realm Investments Ltd. was incorporated in Bermuda on September 1, 1993 and acted as the holding company for a number of Bermuda and United States subsidiaries involved in the insurance industry. Realm Investments Ltd. was affiliated with the Company through common ownership and directors.
The acquisitions have been accounted for by the purchase method of accounting and, accordingly, the purchase prices have been allocated to the assets acquired and the liabilities assumed based on the estimated fair values at the dates of acquisition. The excess of purchase price over the estimated fair values of the net assets acquired has been recorded as goodwill, which is being amortized on a straight line basis over 20 years, 15 years and 5 years for Realm Investments Ltd., Realm National and NAR, respectively.
Operating results of Realm Investments Ltd., Realm National, and NAR are included in the Company's consolidated results of operations from the effective dates of the acquisitions which were January 1, 1996, September 5, 1996, and July 1, 1996, respectively.
These amounts were derived from the financial statements of the Lloyds Broker. The lien had no impact on the Broker's operating statements or cash flows during the periods.
a) The cost/amortized cost and estimated fair value of marketable securities held as available for sale are as follows:
A deferred tax liability of $75 and $39 at December 31, 1996 and 1997, respectively, has been provided against unrealized gains on marketable securities held as "available for sale" which has been presented net as a separate component of shareholders' equity.
c) Proceeds from sales of investments in debt securities during 1996 and 1997 were $2,273 and $4,190, respectively. Proceeds from sales of investments in equity securities during 1996 and 1997 were $15 and $7,262, respectively. There were no realized gains or losses on the sale of marketable securities during 1996. There was $5 of realized losses and $443 of realized gains during 1997.
d) At December 31, 1996 and 1997, debt securities having an amortized cost of $2,563 and $2,925, respectively, were on deposit with government authorities as required by law.
In addition, deposit liabilities and related assets include $2,216 and $2,459 of deposits received from customers as security for the timely payment of premiums for workers' compensation insurance at December 31, 1996 and 1997, respectively. The deposit is restricted from use by the Company, and is the property of the
The Company, in the ordinary course of business, reinsures certain risks with other companies. Such arrangements serve to enhance the Company's capacity to write business and limit the Company's maximum loss on large or unusually hazardous risks.
At December 31, 1996 and December 31, 1997, there were no amounts due from any individual reinsurer in excess of 10% of the Company's shareholders' equity.
Since its acquisition Realm National has written property and workers compensation business. Realm National's workers' compensation business is subject to quota share reinsurance whereby it retains 25% of the first $1,000. Realm National's retention under the quota share treaty is further protected by common account excess coverage in excess of $3. Realm National purchases excess loss coverage on an occurrence basis up to $200,000.
Outstanding losses and loss expenses relate to the insurance activities of CIRCL and Realm National, which were acquired in January 1996 and September 1996, respectively.
The adverse development during 1997 on prior years primarily represents an increase in claims frequency on one particular program that covers bodily injury and property risks in the construction industry.
As discussed in Notes 1 and 3 to the consolidated financial statements, during 1996, the Company issued 1,999,980 shares in exchange for 100% of the share capital of Realm Investments Ltd. The fair value assigned to the shares issued was $12,819. The excess of the fair value of the shares issued over par value was recorded in additional paid in capital. This represents a non-cash financing and investing activity for the purpose of the statements of cash flows. The Company also issued 2,000,000 ordinary shares and 25 Class "A" non- voting shares to a private investor group. Contemporaneously, the private investor group also acquired additional ordinary shares from existing shareholders on a pro-rata basis, such that the private investor group's total ownership represented 32.5% of the total number of issued ordinary share capital at that time.
The options had an exercise price of $2.71 per share, which reflected the estimated fair value of the shares at the original grant date as updated for the exchange factor. The options were fully vested at the grant date and were able to be exercised at any time prior to January 23, 2003.
On November 25, 1997 the Company granted 300,000 options to certain employees.
The options have an exercise price of $22.00 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.
All of these options were outstanding at December 31, 1997 and none had vested at December 31, 1997.
The fair value of the options granted during 1997 was $6.59 per share (1995--$0.43 per share, 1996--$0)
Total income tax expense for the years ended December 31, 1995, 1996 and 1997 was allocated as follows:
Income tax expense attributable to income from continuing operations was $2,560, $2,281 and $2,925 for the years ended December 31, 1995, 1996 and 1997 respectively, and differed from the amounts computed by applying the U.S. federal income tax rate of 34% to income before taxation as a result of the following:
Cash and cash equivalents and fiduciary funds: The fair values for these instruments approximate their carrying amounts because of the short maturity of such instruments.
To manage the Company's exposure to these risks, the Company enters into forward foreign exchange contracts in the currencies to which the Company is exposed. These contracts generally involve the exchange of one currency for another at some future date. The Company had a notional principal amount outstanding of (Pounds)2,000 and (Pounds)1,000, at December 31, 1996 and 1997, respectively, relating to contracts to buy British Pounds Sterling in the future. There were no significant unrealized gains or losses on forward exchange contracts for the year ended December 31, 1995. Net unrealized gains on the forward exchange contracts for the year ended December 31, 1996 and 1997 amounted to $170 and $83, respectively and have been accrued in other income and included in other assets in the consolidated balance sheets. A net realized gain (loss) of $0, $465 and $(22) is included in other income in the consolidated statements of income in respect of such contracts during the years ended December 31, 1995, 1996 and 1997, respectively.
a) The Company's two business segments are risk management companies, which comprise those companies that do not retain any underwriting risk, and underwriting companies, which comprise those companies that do retain a degree of risk. Underwriting companies include revenues from net premiums earned and risk management fees earned in the form of policy issuance fees. Investment income has been allocated to the appropriate segment.
- -------- (i) Includes amortization of goodwill and depreciation of capital assets. (ii) Underwriting includes all of the revenues and assets of the Company's risk taking subsidiaries including policy issuance fees.
b) Summarized financial information by geographic location of subsidiary for the years ended December 31, 1995, 1996 and 1997 is as follows:
Identifiable assets by geographic segment are those assets that are used in the Company's operations in each segment.
Future minimum lease payments under non-cancelable operating leases as at December 31, 1997 are as follows:
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, 1996 and 1997 exceeded the amount calculated using the RBC requirements.
e) The Company's Bermuda insurance subsidiary, CIRCL, is required by its license to maintain capital and surplus greater than a minimum statutory amount determined as the greater of a percentage of outstanding losses and loss expenses (net of reinsurance recoverable) or a given fraction of net written
premiums. At December 31, 1996 and 1997, respectively, CIRCL was required to maintain a minimum statutory capital and surplus of $1,520 and $1,680. Accordingly, approximately $680 of contributed surplus and retained earnings is restricted from distribution.
CIRCL's total surplus and net income (loss) determined on a Bermuda statutory basis is as follows:
a) As set out in Note 3, in January 1996 the Company acquired Realm Investments Ltd. Prior to the acquisition, the Company earned brokerage fees from its business dealings with Realm Investments Ltd.
While any proceeding contains an element of uncertainty, management presently believes the outcome of currently pending proceedings will not have a material adverse effect on the Company.
(i) Total revenues and net income includes $478 net gain on the sale of subsidiaries during the fourth quarter of 1997.