- --------------- (1) Book value per share is computed by dividing stockholders equity at the end of the period by the number of common shares then outstanding.
- A decline in our financial ratings would adversely affect our business. Insurers and reinsurance intermediaries use insurance ratings as an important means of assessing the financial strength and quality of reinsurers. A.M. Best has assigned an "A" rating to Annuity and Life Re (Holdings), Annuity and Life Reassurance and Annuity and Life Reassurance America. A.M. Best has announced that our rating is under review with negative implications. Our subsidiaries, Annuity and Life Reassurance and Annuity and Life Reassurance America have received an "A" rating from Standard & Poor's, which has placed both companies on CreditWatch with negative implications. Annuity and Life Reassurance has been rated "A" by Fitch Ratings, which also has a negative ratings outlook. A downgrade in any of our ratings would adversely affect our ability to sell products and retain existing business. In particular, it is a condition in some of our reinsurance treaties that we maintain certain minimum credit ratings of "A-."
- A prolonged general economic downturn or a prolonged downturn in the equity and other capital markets could adversely affect the market for many annuity and life insurance products. If the market for annuities or life insurance were adversely affected, it would likely depress the demand for reinsurance of annuities or life insurance, which would have an adverse affect on our business.
- Annuity and Life Re (Holdings) and Annuity and Life Reassurance are Bermuda corporations and do not file United States tax returns because we do not engage 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. If we were considered to be 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 effectively connected with our United States business plus an additional 30% "branch profits" tax on such income remaining after the regular tax. Such taxes would have an adverse affect on our business.
Profitability of the 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 operations.
At December 31, 2001 and 2000, our life insurance in force amounted to approximately $117 billion and $77 billion, respectively. We retrocede portions of certain risks in excess of our maximum per life retention of $1 million. At December 31, 2001 and 2000, we had ceded approximately $493 million and $193 million of life insurance coverage, respectively, or 0.42% and 0.25% of our life insurance in force, respectively.
Annuity and Life Re (Holdings), Ltd. is a Bermuda holding company with operating subsidiaries in Bermuda and the United States. Our principal business is reinsurance of life and annuity risks. We consolidate the operations of all our subsidiaries in this report in accordance with U.S. GAAP requirements.
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 life and annuity business and deferred acquisition costs. These valuation accounts are estimates requiring us to make assumptions about future mortality, lapses, expenses, and investment results. While these estimates are based upon historical results and information provided to us by our cedents, actual results could differ materially from our estimates.
Net Operating Income. In addition to net income, we report net operating income. This is not a substitute for net income computed in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), but is an important measure used by management, equity analysts and investors to measure our performance. We define net operating income as net income excluding realized gains and losses from the sale of investments. Our definition of net operating income may differ from that used by other public life and annuity companies.
revenue levels are significantly influenced by large transactions and therefore can fluctuate from period to period.
Net Investment Income. Total net investment income for the year ended December 31, 2001 was $91,129,000, a decrease of 33% from the year ended December 31, 2000. The decline was primarily due to the reduction in net investment income from our largest annuity reinsurance contract. As a result, income earned in 2001 on Funds Withheld declined to $70,963,000 from approximately $116,522,000 for the year ended December 31, 2000, reflecting a general decline in interest rates and poor investment performance on the assets managed by the cedent. The average yield rate earned on an annualized basis on the invested assets, excluding Funds Withheld, was approximately 5.74% for the year ended December 31, 2001 compared with 6.85% for the year ending December 31, 2000, reflecting an overall decline in interest rates.
At December 31, 2001 we had unrealized gains of approximately $6,418,000, as compared with unrealized gains of $2,064,000 at December 31, 2000. The change in unrealized gains and losses is principally related to movements in the general level of interest rates.
Interest Credited to Interest Sensitive Contract Liabilities. Interest credited to interest sensitive contract liabilities was approximately $68,758,000 for the year ended December 31, 2001, as compared with approximately $63,042,000 for the year ended December 31, 2000. The 2001 expense includes a $33,000,000 charge for minimum interest guarantees resulting from poor investment performance and excessive surrender rates on our largest annuity reinsurance contract. After adjusting for this charge interest credited for the year 2001 is $35,758,000, a reduction of $27,284,000 from last year reflecting the general decline in interest rates credited to policyholders.
Policy Acquisition Costs and Other Insurance Expenses. Policy acquisition costs and other insurance expenses, consisting primarily of allowances and amortization of deferred policy acquisition costs, were approximately $105,045,000 for the year ended December 31, 2001. This expense includes a $24,700,000 charge to write down deferred acquisition costs to a level that can be supported from our revised view of future surrender rates on our largest annuity reinsurance contract due to its poor persistency. While management has made what it believes to be adequate provision for future costs based upon reasonable assumptions about future investment performance and surrenders, the provision is an estimate. Actual amounts paid may be significantly higher or lower than the current reserve. After adjusting for the third quarter charge policy acquisition costs and other insurance costs were $80,345,000, as compared with $60,900,000 for the year ended December 31, 2000. Generally, policy acquisition costs and other insurance expenses fluctuate with business volume and changes in product mix. The increase in these costs, as adjusted, reflects the growth and development of our life reinsurance business.
Other Operating Expenses. Operating expenses were approximately $11,552,000 or 3.2% of total revenue for the year ended December 31, 2001, as compared with $10,411,000 or 3.4% of total revenue for the year ended December 31, 2000. The decrease in the ratio of operating expenses to total revenue is due to our premium growth. We consider the operating expense level to be low by industry standards and in line with our plan to be a low cost provider.
For the year ended December 31, 2000 net operating income increased 21% over the prior year. Net operating income for the year ending December 31, 2000 was $44,804,000, compared with $36,988,000 for the year ended December 31, 1999. The increase in net operating income was due to the growth and development of our reinsurance operations and favorable underwriting and investment results.
Net Investment Income. Total net investment income for the year ended December 31, 2000 was $136,648,000, an increase of 61% over the year ended December 31,1999. The growth in the investment income was primarily due to the income earned on Funds Withheld under modified coinsurance agreements related to our Interest Sensitive Contracts Liabilities. The income earned on the Funds Withheld was approximately $116,522,000 for the year ended December 31, 2000 compared with $64,606,000 for the year ended December 31, 1999. The average yield rate earned on an annualized basis on the invested assets, excluding Funds Withheld, was approximately 6.85% for the year ended December 31, 2000 compared with 6.29% for the year ending December 31, 1999.
Other Operating Expenses. Operating expenses were approximately $10,411,000 or 3.4% of total revenue for the year ended December 31, 2000, as compared with $7,686,000 or 4.1% of total revenue for the year ended December 31, 1999. The decrease in the ratio of operating expenses to total revenue is due to the growth and development of our reinsurance operations and our revenue base. We consider the operating expense level to be low by industry standards and in line with our plan to be a low cost provider.
We do not engage in trading activities to generate realized investment gains and, thus, do not have a trading portfolio. However, we evaluate the desirability of continuing to hold a security when market conditions, creditworthiness or other measurement factors change. These changes may relate to a change in the credit risk of an issuer and a decision to sell may be made to avoid further declines in realizable value. Securities also may be sold prior to maturity to provide liquidity. As a result our securities are classified as "available for sale".
At December 31, 2001, fixed maturity investments were 99% investment grade, as compared with 97% at December 31, 2000. The fair value of such investments may vary depending on economic and market conditions, the level of interest rates and the perceived creditworthiness of the issuer. At December 31, 2001 and 2000, the weighted average duration of invested assets was 3.2 years, and the weighted average investment quality rating was "AA+" and "AA", respectively.
Our results of operations and our financial condition are significantly affected by the performance of our investments and by changes in interest rates. During a period of declining interest rates, if our investments are prematurely sold, called, prepaid or redeemed, we may be unable to reinvest the proceeds in securities of equivalent risk with comparable rates of return. During a period of rising interest rates, the fair value of our invested assets could decline. In addition, rising interest rates could also cause disintermediation, which in turn could cause us to sell investments at prices and times when the fair values of such investments are less than their amortized cost. We believe that our traditional life insurance liabilities are not highly interest rate sensitive and, therefore, the effects of fluctuating interest rates on these liability cash flows are not significant. For interest sensitive liabilities, we are primarily dependent upon the ceding company to utilize asset/liability matching or other strategies to minimize the impact of changes in interest rates. If the ceding company does not appropriately match its asset management strategy to its obligation to its policyholders we could sustain losses, as happened with our largest annuity reinsurance contract. We have not engaged in hedging activities to mitigate the effects of asset/liability mismatches of our cedents, or interest rate changes on our invested assets and related liabilities, although we may do so in the future.
Our invested assets consist primarily of fixed maturity securities. These fixed maturity securities are invested primarily in U.S. government and U.S. corporate obligations.
At December 31, 2001, approximately 2% of our mortgage backed investment portfolio consisted of planned amortization class ("PAC"), target amortization class ("TAC") and sequential instruments, as compared with 25% at December 31, 2000. These investments are designed to amortize in a more predictable manner by shifting the primary risk of prepayment of the underlying collateral to investors in other tranches ("support classes") of the CMO.
Funds Withheld at Interest -- Interest Sensitive Liabilities Contracts. At December 31, 2001 and 2000 assets with a carrying value of $1,488,326,000 and $1,530,110,000, respectively, related to annuity reinsurance agreements were held by and managed by the ceding companies in segmented portfolios. These amounts are included in our Balance Sheet as Funds withheld at interest. Under the terms of the reinsurance agreements, the investment income, which accrues to us, is based on the performance of the underlying portfolios. Assets in the underlying portfolios are managed by investment managers appointed by the cedent. As a result we cannot directly influence the investment strategy or performance of the portfolio. The liability for the annuity reinsurance is included on our Balance Sheet as Interest Sensitive Contracts Liabilities, and includes a provision for minimum interest guarantees expected to be paid in the future. While management has made what it believes to be adequate provision for future costs based upon reasonable assumptions about future investment performance and surrenders, the provision is an estimate. Actual amounts paid may be significantly higher or lower than the current provision.
During 2001, we entered into a reinsurance agreement with a third party reinsurer to cede excess U.S. Statutory reserves (the amount by which the cedents U.S. Statutory reserves exceeds our U.S. GAAP reserves for certain life insurance contracts subject to certain state statutory regulations known as Triple-X) to the reinsurer. Under the agreement, the reinsurer is obligated to fund the collateral requirements associated with these excess U.S. Statutory reserves by making cash deposits with us. As of December 31, 2001, we had received deposits of $137 million from the reinsurer. We expect to cede additional excess U.S. Statutory reserves to, and receive additional deposits from, the reinsurer in the future.
At December 31, 2001 our total capitalization, which consists entirely of equity, was $404,946,000. We believe this level of capital is sufficient to support our insurance writings and growth for the near future. However, as a Bermuda reinsurer we are required to post collateral for the statutory reserves ceded to us by U.S. based insurers and reinsurers. On March 1, 2002 we filed a shelf registration statement on Form S-3 to register under the Securities Act of 1933 $200,000,000 of senior debt to be sold in one or more transactions on a delayed basis. We may issue some or all of this debt in the future. This debt, if and when issued, would be
At December 31, 2001 and 2000 we had no outstanding debt. At December 31, 2001 and 2000, letters of credit totaling $197 million and $184 million, respectively, issued in the ordinary course of our business had been issued by our bankers in favor of certain ceding insurance companies to provide security and meet regulatory requirements. At December 31, 2001 and 2000 letters of credit totaling $101 million and $138 million, respectively, were fully collateralized by our investments. We may incur indebtedness in the future for investment or operational purposes.
On June 1, 2000 the Company, through Annuity and Life Re America, completed the acquisition of Annuity and Life Reassurance America, Inc., formerly Capitol Bankers Life Insurance Company. Annuity and Life Reassurance America is a life insurance company domiciled in the United States which is authorized to conduct its life insurance business in 43 states of the United States, and will focus its operations on the United States life reinsurance markets. The Company contributed additional capital to Annuity and Life Reassurance America during 2000 of $19,550,000 to bring the total capital and surplus of Annuity and Life Reassurance America to $25,000,000. The acquisition price and capital contribution was funded from available cash balances and proceeds from the sales of fixed maturity securities held by the Company.
The amounts related to the reinsured business referred to above are included on the Company's Balance Sheet in the assets as Receivable for Reinsurance Ceded and in the liabilities as Reserves for Future Policy Benefits. At December 31, 2001 and 2000 these amounts were $97.8 million and $104.5 million, respectively.
The purchase price exceeded the fair value of the net assets acquired (the capital and surplus of Annuity and Life Reassurance America) by $2,301,000, which has been allocated to the value of the 43 insurance licenses of Annuity and Life Reassurance America. This is being amortized over 20 years. See Note 2(k) of the "Notes to Consolidated Financial Statements" for information regarding SFAS No. 142.
We have audited the consolidated financial statements of Annuity and Life Re (Holdings), Ltd. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and its subsidiaries as at December 31, 2001 and 2000 and the results of their operations and cash flows for the years ended December 31, 2001, 2000 and 1999 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
Annuity and Life Re (Holdings), Ltd. ("Holdings") was incorporated on December 2, 1997 under the laws of Bermuda. Holdings provides annuity and life reinsurance to insurers and reinsurers through its wholly-owned subsidiaries: Annuity and Life Reassurance, Ltd. (Annuity and Life Reassurance), licensed under the laws of Bermuda as a long term insurer; and Annuity and Life Re America, Inc. (Annuity and Life Re America), an insurance holding company based in the United States and Annuity and Life Reassurance America, Inc. ("Annuity and Life Reassurance America"), a life insurance company domiciled in the United States. Holdings, Annuity and Life Reassurance, Annuity and Life Re America and Annuity and Life Reassurance America are collectively referred to herein as the "Company". The Company completed an initial public offering of its equity securities and commenced operations on April 17, 1998.
Reinsurance premiums from traditional life and annuity policies with life contingencies, where premiums collected match the period over which benefits are provided, are recognized as revenue when due from policyholders. Traditional life policies include those contracts with fixed and guaranteed premiums and benefits, and consist principally of whole life and term insurance policies. Benefits and expenses are matched with such revenue so as to result in the recognition of profits over the life of the contracts. This is achieved by means of the provision for liabilities for future policy benefits and deferral and subsequent amortization of policy acquisition costs.
For traditional life and annuity policies with life contingencies, deferred policy acquisition costs are charged to expense using assumptions consistent with those used in computing policy reserves. Assumptions as to anticipated premiums are estimated at the date of the policy issuance and are consistently applied during the life of the contracts. Deviations from estimated experience are reflected in earnings in the period such deviations occur. For these contracts, the amortization periods are generally the estimated life of the policies.
For universal life and investment-type products, 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 has classified as insurance licenses the cost in excess of fair value of net assets acquired in a purchase transaction. This cost is being amortized on a straight-line basis over 20 years (see Note 2(k) below).
The development of policy reserves for the Company's products requires management to make estimates and assumptions regarding mortality, lapse, expense and investment experience. Such estimates are primarily based on historical experience and information provided by ceding companies. Actual results could differ materially from those estimates. Management considers all of the Company's reinsurance contracts to be long duration contracts. Management monitors actual experience, and where circumstances warrant, will revise its assumptions and the related reserve estimates.
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.
In July 2001, the FASB issued Statement Number 141 -- Business Combinations and Statement Number 142 -- Goodwill and Intangible Assets. These statements will change how the Company will account for business combinations and for purchased goodwill and other intangible assets that arise from these combinations. The Company adopted the new standards on January 1, 2002.
The Standards require that all business combinations be accounted for using the purchase method and establish specific criteria for the recognition of intangible assets separately from goodwill. Under the standards, goodwill will no longer be amortized but will be subject to an impairment test on at least an annual basis. At December 31, 2001 and 2000, the Company was carrying goodwill of $2.1 million and $2.2 million, respectively. Goodwill amortization for the years ended December 31, 2001 and 2000 was $116,000 and $58,000, respectively. When the Company adopts this new standard, goodwill will not be amortized, but instead will be analyzed for impairment at least annually. No impairment is expected.
(a) The amortized cost and fair values of investments in fixed income securities classified as available for sale at December 31, 2001 and 2000 are as follows:
A deferred tax liability of $313,910 and $94,641 has been provided against unrealized gains on fixed income securities as of December 31, 2001 and December 31, 2000, respectively.
At December 31, 2001 and December 31, 2000 cash and investments of $272 million and $66 million, respectively, were held in trust for the benefit of certain ceding companies.
Gross realized investment gains for December 31, 2001, 2000, and 1999 were $3,659,762, $1,376,373, and $1,104,026, respectively. Gross realized losses for the same periods were $2,429,724, $6,193,494, and $2,388,795, respectively.
In connection with the initial capitalization of the Company, the Company issued Class A Warrants which entitle the holders to purchase up to 3,059,990 common shares in the Company.
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 enable the holders to purchase an aggregate of 397,500 common shares of the Company. The exercise price of the Warrants, which is subject to adjustment, is $15.00 per share, which was equal to the price of the common shares in the initial public offering. The Class B Warrants are all currently exercisable and expire on April 15, 2008. No Class B Warrants have been exercised at December 31, 2001.
Certain directors of the Company are also owners, directors, or officers of Inter-Atlantic Capital Partners, Inc. ("Inter-Atlantic"). In 1998, Inter-Atlantic agreed to provide financial advisory and other services to the Company for a term of five years in exchange for four annual payments of $600,000. Such services include, among other things, assistance in the development of products, financial planning, management of assets and liabilities, international marketing efforts and such other services as the Company may request. In 1999, the Company prepaid this fee at a discount of 10%. The prepayment is being amortized over the period the services are provided with the unamortized amount included in other assets.
One of the Company's major shareholders is affiliated with The Prudential Investment Corporation, which serves as one of the Company's investment managers. The Company has agreed to pay a fee for investment management services to The Prudential Investment Corporation based upon the amount of funds managed. The fee is based upon a sliding scale and has been determined on an arms-length basis. The Company has entered into a life reinsurance agreement with the Prudential Insurance Company of America and an annuity reinsurance agreement with XL Mid Ocean Reinsurance, Ltd., a subsidiary of XL Capital, Ltd. Both Prudential and XL Capital are major shareholders of the Company. These contracts have been negotiated under normal commercial terms. As discussed further in Note 9, the Company has entered into an additional agreement with XL Capital.
In 1998 the Board of Directors adopted a Stock Option Plan (the "Plan") under which it may grant, subject to certain restrictions, Incentive Stock Options ("ISO's") and Non-Qualified Stock Options ("NQSO's"). The aggregate number of common shares for which options may be granted under the initial plan was limited to 1,552,500 Common Shares. In 1999 the plan was amended such that options may be granted in any fiscal year equal to not more than 2% of the adjusted average of the outstanding common shares of the Company, as that number is determined by the Company to calculate fully diluted earnings per share. Only eligible employees of the Company are entitled to ISO'S, while NQSO's may be granted to eligible employees, non-employee Directors and consultants. The Plan is administered by the Compensation Committee of the Board of Directors.
amounts indicated below, had compensation cost been determined based on the fair value of the options at the grant date, consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation."
The fair value of the options is estimated on the date of grant using the Black-Scholes option pricing model. The following table details the assumptions and fair values for all issued options.
Annuity and Life Reassurance America also purchased reinsurance as discussed in Note 12.
During 2001, the Company wrote off $24.7 million of deferred acquisition costs and established additional reserves of $20.0 million related to the significant deferred annuity contract mentioned above. These charges
On January 21, 2002, we served written notice of arbitration in connection with our largest annuity contract. We are seeking monetary damages and/or equitable relief from our ceding insurer. The claim is based upon certain actions and/or omissions by the cedent that we assert have, without limitation, deprived us of the benefit of this reinsurance transaction. The parties are in the process of selecting an arbitration panel. It is not feasible to determine the outcome of this arbitration at the current time.
The balance sheet captions "Funds Withheld at Interest" and "Interest Sensitive Contracts Liabilities" relate to deferred annuity contracts reinsured on a modified coinsurance basis. Taking into consideration the structure of the reinsurance agreement, the carrying value of the liabilities and related assets approximate their fair value.
Company. Fair values of other assets and liabilities approximate their carrying values due to their short-term nature.
The purchase price of $13,200,000 exceeded the fair value of the net assets acquired (the capital and surplus of Annuity and Life Reassurance America) by $2,301,000. The excess, which has been allocated to the value of the 43 insurance licenses of Annuity and Life Reassurance America, is being amortized over 20 years (see Note 2(k) above).
This reinsurance agreement does not qualify for reinsurance accounting under U.S. GAAP. As a result, funds received under this contract are recorded as a deposit liability. As part of this contract the Company deposited $41.0 million with the reinsurer, which is included in Deposits and other reinsurance receivables. The Company receives the benefit of investment income from the funds received and pays the third party reinsurer certain fees associated with the contract. For the year 2001, the fees were $1.2 million and are included in other insurance expenses.
Under the Bermuda Insurance Act, 1978, and related regulations, Annuity and Life Reassurance is required to maintain certain solvency levels. Annuity and Life Reassurance is prohibited from declaring or paying a dividend if such a payment would reduce its statutory surplus below the required minimum of $250,000. This requirement was met at the balance sheet date and, therefore, no such restriction currently exists.
The unaudited quarterly financial data for the years ended December 31, 2001, 2000, and 1999 are as follows: