We believe that these properties are adequate to meet our needs for the foreseeable future.
The following selected financial data should be read in conjunction with the Consolidated Financial Statements, including the related Notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations." Consolidated balance sheet data as of December 31, 2001 reflect the acquisition of World-Wide Holdings, but consolidated statements of income data for
the periods ended December 31, 2001, 2000, 1999 and 1998 do not reflect the results of World-Wide Holdings, as the transaction was completed at the close of business on December 31, 2001.
- fee income from our variable life insurance and variable annuity products and from financial reinsurance transactions;
We seek to generate profits from three principal sources. First, in our Life Reinsurance business, we seek to receive reinsurance premiums and financial reinsurance fees that, together with income from the assets in which those premiums are invested, exceed the amounts we ultimately pay as claims and policy benefits, acquisition costs and ceding commissions. Second, in our Wealth Management business, we seek to generate fee income that will exceed the expenses of maintaining and administering our variable life insurance and variable annuity products. Third, within our investment guidelines, we seek to maximize the return on our unallocated capital.
- the level of fees that we charge on our Wealth Management contracts; and
Financial Accounting Standard 97 applies to investment contracts, limited premium contracts, and universal life-type contracts. For investment and universal life-type contracts, future benefit liabilities are held using the retrospective deposit method, increased for amounts representing unearned revenue or refundable policy charges. Acquisition costs are deferred and recognized as expense as a constant percentage of gross margins using assumptions as to mortality, persistency, and expense established at policy issue without provision for adverse deviation and are revised periodically to reflect emerging actual experience and any material changes in expected future experience. Liabilities and the deferral of acquisition costs are established for limited premium policies under the same practices as used for traditional life policies with the exception that any gross premium in excess of the net premium is deferred and recognized into income as a constant percentage of insurance in force. Should the liabilities for future policy benefits plus the present value of expected future gross premiums for a product be insufficient to provide for expected future benefits and expenses for that product, deferred acquisition costs will be written off and thereafter, if required, a premium deficiency reserve will be established by a charge to income. Changes in the assumptions for mortality, persistency, maintenance expense and interest could result in material changes to the financial statements.
Goodwill is established upon the acquisition of a subsidiary. Goodwill is calculated as the difference between the price paid and the value of individual assets and liabilities on the date of acquisition. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets," effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with the Statement. We applied the new rules on accounting for goodwill during 2002. Goodwill recognized in the consolidated balance sheet was assigned to reporting units and tested for impairment. There was no impairment in goodwill recognized on initial adoption. During the year we finalized the goodwill arising on the acquisition of World-Wide Holdings. Goodwill arising on this acquisition amounts to $35.5 million in comparison with $30.6 million at December 31, 2001. The increase has arisen from additional legal, professional and other costs relating to the acquisition and finalization of the deferred tax balance existing at the date of the acquisition.
Fixed maturity investments are evaluated for other than temporary impairments in accordance with SFAS 115 and EITF 99-20 as described in Note 2 to the consolidated financial statements. Under these pronouncements, realized losses are recognized on securities if the securities are determined to be other than temporarily impaired. Factors involved in the determination of potential impairment include fair value as compared to cost, length of time the value has been below cost, credit worthiness of the issuer, forecasted financial performance of the issuer, position of the security in the issuer's capital structure, the presence and estimated value of collateral or other credit enhancement, length of time to maturity, interest rates and our intent and ability to hold the security until the market value recovers.
Our accounting policies addressing reserves, deferred acquisition costs, value of business acquired, goodwill and investment impairment involve significant assumptions, judgments and estimates. Changes in these assumptions, judgments and estimates could create material changes in our consolidated financial statements.
Net operating earnings is a non-GAAP measurement. We determine net operating earnings by adjusting GAAP net income for net realized capital gains and losses, as adjusted for the related effects upon the amortization of deferred acquisition costs, and non-recurring items that we believe are not indicative of overall operating trends. Non-recurring items in the year ended December 31, 2002 include a charge of $904,000 relating to severance arrangements with certain employees and in 2001 a charge of $406,000 due to the cumulative effect of a change in accounting principle. While these items may be significant components in understanding and assessing our consolidated financial performance, we believe the presentation of net operating earnings enhances the understanding of our results of operations by highlighting earnings attributable to the normal, recurring operations of our business. However, net operating earnings are not a substitute for net income determined in accordance with GAAP.
During the year ended December 31, 2002 revenues increased by $184.9 million or 153% to $305.9 million in comparison with the same period in 2001. The increase is primarily due to the acquisition of World-Wide Holdings, the growth in our Life Reinsurance North America operations and an increase in investment income primarily due to the growth in our invested assets. The growth in our invested assets is due to the new business and the equity and debt offerings discussed in "Liquidity and Capital Resources". Revenues increased by $37.1 million or 44% to $121.0 million in 2001 from $83.9 million in 2000. The increases are primarily due to growth in our Life Reinsurance North America operations and an increase in investment income due to the increase in our invested assets resulting from new business, offset in part by an increase in realized losses.
As of December 31, 2002, in our Life Reinsurance North America operations we reinsured approximately $66.8 billion of life coverage on 1.3 million lives. The average benefit coverage per life is $49,000 and our maximum corporate retention on any one life is $500,000. As of December 31, 2001, we reinsured approximately $34.9 billion of life coverage on 993,000 lives. The average benefit coverage per life was $35,000.
Life reinsurance fees increased by 87% to $3.1 million during the year ended December 31, 2002 compared to the same period in 2001. The increase is due to the growth in the number of clients. Wealth Management fees increased by 10% to $3.4 million during the year ended December 31, 2002 compared to 2001. The growth in fees is principally due to the growth in segregated account balances which is due to an increase in the number of clients offset in part by negative investment performance. Wealth Management fees increased in 2001 by 43% to $3.1 million from $2.2 million in 2000. The growth has been primarily due to increases in variable account balances on which we earn fees and the increase in the number of clients.
(1) Investment performance for the year is determined using actual asset valuations where available and estimates where actual data is not available.
During the year ended December 31, 2002, realized losses amounted to $11.2 million in comparison with $3.9 million in 2001. Realized losses are stated net of associated amortization of deferred acquisition costs. The losses in 2002 consist of realized investment losses on unit linked securities held by World-Wide Holdings of $5.6 million, impairment losses recognized under EITF 99-20 of $6.7 million "and other than temporary impairments" on fixed maturity investments of $3.3 million. The "other than temporary impairments" were recognized due to credit deterioration on various securities. These losses were partially offset by net realized gains on the sales of fixed maturity investments of $5.2 million. During the year ended December 31, 2001 realized losses included amounts recognized as "other than temporary impairments" on fixed maturity investments of $6.9 million. The "other than temporary impairments" were recognized due to credit deterioration on various securities. The realization of losses in 2001 was due to the sale and write down of carrying values of securities, predominately securities issued by Enron and its affiliate, Osprey. These losses were offset in part by gains realized primarily for tax purposes on bonds in the portfolio of Scottish Re (U.S.), Inc. and gains of $529,000 on assets sold to fund part of the recapture of a block of business by one client on April 30, 2001. During 2001, we also recognized in income
The proceeds on sale represent fair value at the sales date
Under EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Assets," a decline in fair value below "amortized cost" basis is considered to be an "other than temporary impairment" whenever there is an adverse change in the amount or timing of cash flow to be received, regardless of the resulting yield, unless the decrease is solely a result of changes in market interest rates.
Unit-linked securities are comprised of investments in a unit trust denominated in British pounds. These investments were acquired as part of the purchase of World-Wide Holdings and are recorded at quoted market value. Changes in market value are recorded as net realized gains or losses.
Claims and other policy benefits increased by 117% to $51.2 million in 2001 from $23.6 million in 2000, as a result of the increased number of clients and the increase in business from these clients in our Life Reinsurance North America operations. In 2001, we recorded net claims totaling $750,000 in relation to the World Trade Center and Pentagon attacks on September 11, 2001. Gross claims in relation to these attacks were $816,000 of which $66,000 was recoverable under our catastrophe insurance coverage.
Operating expenses decreased to $9.1 million in 2001 from $9.9 million in 2000 due to the inclusion in 2000 of $0.9 million of non-recurring employee expenses relating to four employees including severance, recruiting and relocation expenses.
Life Reinsurance North America operating costs have increased principally because of growth in personnel. Wealth Management operating costs have increased due to costs incurred in setting up our Luxembourg office. Other operating expenses include executive salaries, head office expenses, legal and professional fees and other expenses not related to either our Life Reinsurance or Wealth Management lines of business. Other operating expenses increased significantly in 2002 and 2001 due to the cost of setting up and running our principal executive office in Bermuda, an increase in the number of executive staff including a full year of the salaries of those staff who joined us in 2000 and 2001 and recruitment costs.
The 2002 income tax benefit includes taxes on the earnings of World-Wide Reassurance Company Limited and Scottish Re (Dublin) Limited offset by the tax benefits of net operating losses in Scottish Re (U.S.) Inc., and Scottish Annuity & Life International Insurance Company (Bermuda) Ltd.,. The 2001 income tax expense includes taxes on the earnings of Scottish Re (U.S.) Inc., Scottish Annuity & Life International Insurance Company (Bermuda) Ltd. and Scottish Re (Dublin) Limited, which are offset by a release of capital loss carry-forwards. The tax benefit in 2000 is related to the earnings of Scottish Re (U.S.), Inc. only, offset by a release of valuation allowances related to capital loss carry- forwards. An analysis of income taxes and movements in deferred taxes appears in Note 17 to the consolidated financial statements.
At December 31, 2002 the portfolio controlled by us consisted of $1.1 billion of traded fixed income securities and cash. Of this total $1.0 billion represented the fixed income portfolio managed by external investment managers and $131.0 million represented other cash balances. The average Standard & Poor's rating of that portfolio was "AA-," the average effective duration was 3.03 years and
the average book yield was 4.93% as compared with an average rating of "A+," an average effective duration 3.5 years and an average book yield of 6.14% at December 31, 2001. At December 31, 2002 the unrealized appreciation on investments, net of tax, was $8.9 million as compared with depreciation of $3.6 million at December 31, 2001. The unrealized appreciation on investments is included in our consolidated balance sheet as part of shareholders' equity.
At December 31, 2001, the portfolio controlled by us consisted of $678.5 million of traded fixed income securities and cash. Of this total, $581.1 million represented the fixed income portfolio managed by external investment managers, $93.4 million represented investments of World-Wide Holdings, and $4.0 million represented other cash balances. At December 31, 2001, the portion of the portfolio managed externally had an average Standard & Poor's rating of "A+," an average effective duration of 3.5 years, and an average book yield of 6.14%, as compared with an average rating of "AA-," an average effective duration of 2.6 years and an average book yield of 7.24% at December 31, 2000. At December 31, 2001, the portion of the investment portfolio managed by World-Wide Holdings had an average rating of "AA-," an average effective duration of 1.9 years and an average book yield of 5.22%. At December 31, 2001, the unrealized depreciation on investments, net of tax was $3.6 million as compared to $3.8 million at December 31, 2000.
In the table below are the total returns earned by our portfolio for the year ended December 31, 2002, compared to the returns earned by three indices: the Lehman Brothers Global Bond Index, the S&P 500, and a customized index that we developed with New England Asset Management ("NEAM"), an external investment manager, to take into account our investment guidelines. We believe that this customized index is a more relevant benchmark for our portfolio's performance.
At December 31, 2002 our fixed maturity portfolio had 930 positions and $16.1 million of gross unrealized losses. No single position had an unrealized loss greater than $1.3 million. There were $28.8 million of unrealized gains on the remainder of the portfolio. At December 31, 2001 there were 193 securities in an unrealized loss position which totaled $11.0 million. Two individual losses exceeded $1.0 million.
The following tables illustrate the industry analysis of the unrealized losses at December 31, 2002 and 2001.
The expected maturity dates of securities that have an unrealized loss at December 31, 2002 and 2001 are presented in the table below.
At December 31, 2002 there were 5 securities with fair values that traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months. The total unrealized loss on these securities amounted to $1.1 million and the largest unrealized loss position was $0.5 million.
At December 31, 2001, funds withheld at interest totaled $562.4 million with an average rating of "A-," an average effective duration of 6.0 years and an average book yield of 6.80%.
percentage of below investment grade securities is 10% and other guidelines limit risk, ensure issuer and industry diversification as well as maintain liquidity and overall portfolio credit quality.
The $292.3 million increase in capitalization is due primarily to the net proceeds of the equity offering of $114.3 million, the net proceeds of the convertible debt and capital securities offerings of $127.8 million and net income for the year of $32.5 million less dividends paid of $5.0 million and increases in comprehensive income. Other comprehensive income consists of the cumulative translation adjustment arising from the translation of World-Wide Holdings' balance sheet at exchange rates as of December 31, 2002 and a minimum pension liability adjustment.
On April 4, 2002 we completed a public offering of 6,750,000 ordinary shares (which included the over-allotment option of 750,000 ordinary shares) in which we raised aggregate net proceeds of approximately $114.3 million. We used the net proceeds of the offering to repay short-term borrowings of $40.0 million, which we had borrowed under a credit facility with a U.S. bank, and for general corporate purposes.
On November 22, 2002 we completed the private offering of $115.0 million of 4.5% Senior Convertible Notes due 2022 (which included the over allotment option of $15.0 million) in which we raised aggregate net proceeds of approximately $110.9 million. We used the net proceeds of the offering to repay short term borrowings of $23.5 million, under reverse repurchase agreements, and for general corporate purposes.
At December 31, 2001 we had borrowed $25.1 million under a reverse repurchase agreement with a major broker/dealer. In November 2002, borrowings of $23.5 million remained outstanding under this agreement and were repaid from the proceeds of the convertible debt offering.
- when Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re (Dublin) Limited or World-Wide Reassurance enters into a reinsurance treaty with a U.S. customer, we must contribute assets into a reserve credit trust with a U.S. bank or issue a letter of credit in order that the ceding company may obtain reserve credit for the reinsurance transaction;
In addition, Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Annuity & Life have agreed with World-Wide Reassurance that in the event World-Wide Reassurance is unable to meet its obligations under its insurance or reinsurance agreements, Scottish Annuity & Life Insurance Company (Cayman) Ltd. (or if Scottish Annuity & Life Insurance Company (Cayman) Ltd. cannot fulfill such obligations, then Scottish Annuity & Life) will assume all of World-Wide Reassurance's obligations under such agreements.
Scottish Annuity & Life and Scottish Annuity & Life Insurance Company (Cayman) Ltd. have executed similar agreements for Scottish Re (Dublin) Limited and World-Wide Life Assurance S.A. and may, from time to time, execute additional agreements guaranteeing the performance and/or obligations of their subsidiaries.
Our business is capital intensive. We expect that our cash and investments, together with cash generated from our businesses, will be sufficient to meet our current liquidity and letter of credit needs. However, if our business continues to grow significantly, we will need to raise additional capital.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets," effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized but will be subject to annual impairment tests in accordance with the Statement. Other intangible assets will continue to be amortized over their useful lives.
We applied the new rules on accounting for goodwill and other intangible assets during 2002. Goodwill of $35.8 million arose on the acquisition of World-Wide Holdings. We have performed the required impairment tests of goodwill and have determined that there is no impairment. Our reported earnings and financial position for 2001 do not reflect significant amounts of amortization of goodwill.
The Derivative Implementation Group has recently released Statement 133 Implementation Issue No. 36, "Embedded Derivatives: Bifurcation of a Debt Instrument that Incorporates Both Interest Rate Risk and Credit Rate Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the Issuer of that Instrument" ("DIG B36"). DIG B36 addresses whether Statement of Financial Accounting Standard No. 133 "Accounting for Derivative Instruments and Hedging Activities" requires bifurcation of a debt instrument into a debt host contract and an embedded derivative if the debt instrument incorporates both interest rate risk and credit risk exposures that are unrelated or only partially related to the creditworthiness of the issuer of that instrument. Under DIG B36 modified coinsurance reinsurance agreements where interest is determined by reference to a pool of fixed maturity assets are arrangements containing embedded derivatives requiring bifurcation. DIG B36 has been issued for comment by the Financial Accounting Standards Board. It is not expected to be finalized until the second quarter of 2003. If DIG B36 is finalized in its current form, we have determined that our funds withheld at interest which arise under modified coinsurance agreements will be considered to contain embedded derivatives requiring bifurcation. These funds withheld at interest have a carrying value of $1.1 billion at December 31, 2002. We have not yet determined the value of the related embedded derivatives in these products. The market value of funds withheld at interest was $1.2 billion at December 31, 2002.
- terrorist attacks on the United States and the impact of such attacks on the economy in general and on our business in particular;
The effects of these factors are difficult to predict. New factors emerge from time to time and we cannot assess the potential impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward- looking statement. Any forward-looking statement speaks only as of the date of this report and we do not undertake any obligation, other than as may be required under the Federal securities laws, to update any forward-looking statement to reflect events or circumstances after the date of such statement or to reflect the occurrence of unanticipated events.