Year Ended September 30, 1998 Compared with Year Ended September 30, 1997
Net premiums earned decreased 5.7% to $154.6 million for the year ended September 30, 1998 from $163.9 million for the year ended September 30, 1997. This decrease was the result of reduced premiums earned on the Company's core property catastrophe business that was partially offset by increased earned premiums on those premiums written by LaSalle Re Capital. Premiums written by LaSalle Re Capital are earned over a period of 18-24 months from the inception date of the underlying contracts. Premiums on property catastrophe excess of loss contracts are earned over the period coverage is provided, which is generally 12 months. Under proportional property catastrophe contracts, with the risks underlying the contracts incepting throughout the contract period, premiums are generally earned over 18 months. Premiums on other lines of business are earned over the period for which coverage is provided, which generally ranges between 12 months and 60 months.
Net realized gains on investments were $5.6 million for the year ended September 30, 1998 compared to $0.6 million for the year ended September 30, 1997. During the year ended September 30, 1998 the Company realized gains on investments as part of an exercise undertaken to increase the credit quality of the portfolio. In addition, during the last quarter of the year ended September 30, 1998, the Company took advantage of market conditions by realizing some of the large unrealized gains in the portfolio. The proceeds from this exercise were reinvested in securities with marginally lower yields.
Losses and loss expenses incurred increased 206.2% from $31.2 million for the year ended September 30, 1997 to $95.5 million for the year ended September 30, 1998. This was due to an increase in the number of worldwide catastrophic events that affected the Company during the year ended September 30, 1998. The largest loss event to affect the Company was Hurricane Georges, which occurred in September 1998. The Company established a $25 million loss provision for this event that represented 26% of the losses incurred for the year ended September 30, 1998. In addition, throughout the year ended September 30, 1998, the Company incurred losses in respect of various weather- related events, notably U.K. Midland floods ($7.0 million), Canadian winter freeze ($4.3 million) and various U.S. storms ($2.4 million). The Company sustained a number of claims relating to aggregate stop loss and excess of loss contracts, which accounted for approximately $16.8 million or 18% of losses incurred. A large percentage of these aggregate losses incurred in the year ended September 30, 1998 related to losses that had occurred in prior years. This was due to the extended loss reporting periods on these contracts, a number of which had a period of 24 months after the expiry of the contract within which to report losses. Also, as a result of increasing other lines of business the Company incurred losses relating to LaSalle Re Capital ($5.0 million), satellite coverages ($3.0 million), various risk excess coverages ($3.0 million) and political risks coverages ($1.7 million). As a result of the current year loss activity, the Company has increased the level of incurred but not reported reserves. Losses and loss expenses incurred during the year ended September 30, 1997 primarily included $12.0 million for floods in Eastern Europe, $6.1 million in respect of various international windstorms and winter storm activity in the United States and $4.6 million adverse development on Hurricane Fran (which occurred in September 1996).
Operational expenses decreased 29.4% from $12.7 million for the year ended September 30, 1997 to $8.9 million for the year ended September 30, 1998. As a percentage of net premiums earned, operational expenses were 5.7% during the year ended September 30, 1998 compared to 7.7% for the year ended September 30, 1997. Effective October 1, 1997, the Administrative Services Agreement with ARC was terminated and all of the personnel assigned to the Company by ARC became employees of the Company, with the Company assuming the functions previously performed by ARC. This generated a reduction in operational expenses of approximately $2.3 million, as the fees paid to ARC were in excess of the additional costs assumed by the Company. In addition, the Company experienced a reduction in executive compensation of approximately $2.4 million, due partly to a decline in the fair value of stock appreciation rights and partly to reduced bonus provisions. These decreases were offset by increased costs of $1.0 million relating to LaSalle Re Capital and fees paid to directors.
Corporate expenses decreased 72.2% from $1.8 million for the year ended September 30, 1997 to $0.5 million for the year ended September 30, 1998. The costs incurred in the year ended September 30, 1998 related to costs associated with the Company's investigation of potential merger and acquisition transactions. Corporate expenses for the year ended September 30, 1997 included costs associated with the Secondary Offering, the Preferred Offering, the Tender Offer, the formation costs of LaSalle Re Capital, the Company's move to the New York Stock Exchange and fees incurred with respect to the CatEPut. Corporate expenses do not include the underwriting discounts associated with the various offerings. These costs were borne by the selling shareholders in the Secondary Offering. In respect of the Preferred Offering, the underwriting discount was charged to additional paid in capital.
Interest expense increased 11.8% from $1.7 million in the year ended September 30, 1997 to $1.9 million for the year ended September 30, 1998. The increase was due to additional financing charges associated with the deposit portion of LaSalle Re's ceded reinsurance contract in the year ended September 30, 1998. As the contract incepted January 1, 1997, only three quarters of the annual charge was included in the year ended September 30, 1997. Other interest expenses related to the annual administration fee and the ongoing commitment fees payable on the Company's credit facility. As at September 30, 1998, there were no borrowings under this facility.
Year Ended September 30, 1997 Compared with Year Ended September 30, 1996
Net investment income increased 23.5% to $33.1 million for the year ended September 30, 1997 from $26.8 million for the year ended September 30, 1996. This increase was principally attributable to an increase in yields during the year ended September 30, 1997, together with a larger average investment base compared to the year ended September 30, 1996. Annualized investment income as a percentage of the average market value of invested assets was 6.07% for the year ended September 30, 1997 compared to 5.44% for the year ended September 30, 1996.
Interest expense was $1.7 million during the year ended September 30, 1997 compared to $0.2 million in the year ended September 30, 1996. This increase was due to financing charges associated with the deposit portion of LaSalle Re's ceded reinsurance contract. Other interest expenses related to the annual administration fee and the ongoing commitment fees payable on the Company's credit facility. As at September 30, 1997, there were no borrowings under this facility.
As a holding company, the Company's assets consist primarily of all of the outstanding voting stock of LaSalle Re. The Company's cash flows depend primarily on dividends and other permitted payments from LaSalle Re.
At September 30, 1998, 86.5% of the securities held in the Company's investment portfolio were fixed-income securities rated "AA" or better and 97.9% were fixed-income securities rated "A" or better by S&P or Moody's. No single investment comprised more than 5% of the overall portfolio. As at September 30, 1998, issuers from the Far East and Asia represented 5.7% of the investment portfolio. These securities had a market value of $33.6 million and an aggregate unrealized gain of $0.4 million. All of these securities had an average credit rating of AAA as assigned by S&P or Moody's, as at September 30, 1998.
Reinsurance balances receivable were $86.8 million at September 30, 1998 compared to $80.0 million at September 30, 1997. This increase was due to the inclusion of receivable balances relating to the business underwritten by LaSalle Re Capital. At September 30, 1998, these receivable balances were $31.2 million compared to $11.3 million as at September 30, 1997. Given the three-year accounting methodology utilized by Lloyd's, these balances will not be received until after the year 2000.
Other assets increased from $22.6 million at September 30, 1997 to $31.7 million as at September 30, 1998. This was primarily due to the deposit portion of the ceded reinsurance contract, which is accounted for in accordance with SFAS No 113 and the no claims bonus provision of the contract. In addition, following the termination of the Administrative Services Agreement the Company paid $1.5 million to purchase the existing fixed assets. The Company has also purchased additional fixed assets during the year ended September 30, 1998.
Other liabilities increased from $22.8 million as at September 30, 1997 to $29.2 million as at September 30, 1998. The increase of $6.4 million was primarily due to liabilities established for the purchased reinsurance protections for both the Company and LaSalle Re Capital and operating expenses of LaSalle Re Capital. This was offset partially by a reduction in the fees accrued pursuant to the Underwriting Services Agreement with CNA Bermuda which was terminated October 1, 1998 and the Administrative Services Agreement with ARC which was terminated October 1, 1997.
The Company has in place a $100 million committed line of credit from a syndicate of banks. The proceeds from the credit facility may only be used to buy preferred shares of LaSalle Re that, in turn, may use the proceeds of such purchase to meet current cash requirements. The facility matures December 1, 2000, and is secured by a pledge ("legal mortgage") of all the capital stock of LaSalle Re held by the Company, including any preferred shares that may be issued by LaSalle Re to the Company. The line of credit contains various covenants, including limitations on incurring additional indebtedness; restrictions on the sale or lease of assets not in the ordinary course of business; maintenance of a ratio of consolidated total debt to consolidated tangible net worth of no more than 0.40 to 1.00; maintenance of tangible net worth at the end of each fiscal year of the greater of $300 million or 70% of net premiums written; maintenance of statutory capital of LaSalle Re of at least $300 million, increasing to $350 million at the end of calendar year 1998 and $400 million at the end of calendar year 1999 and thereafter; and maintenance of a ratio of net premiums written to statutory capital at the end of any fiscal quarter for the four fiscal quarters then ended of no more than 1.00 to 1.00 in each case. The Company may pay dividends and make other restricted payments so long as, after giving effect to such restricted payments, no event of default has occurred. Dividends and restricted payments are limited to 50% of consolidated net income for its immediately preceding fiscal year less amounts paid on the Series A preferred shares. In order for the Company to pay dividends in excess of 50% of consolidated net income, the Company would have to renegotiate certain terms of its credit facility. As of September 30, 1998, the credit facility had not been utilized.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information." This statement is effective for financial statements issued for periods beginning after December 15, 1997 and requires the Company to report financial and descriptive information about its reportable operating segments. This standard will require additional disclosure and will be adopted by the Company for the year ended September 30, 1999.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Given the limited number of transactions currently entered into by the Company that are covered by the statement, the Company does not anticipate any significant changes to its current financial reporting.
The Company engaged International Business Machines Corporation ("IBM") to prepare an assessment and strategy report outlining the steps needed to make the Company's computer systems Year 2000 compliant. IBM's report indicated that certain of the Company's systems, applications and business interfaces have Year 2000 date problems which will require an estimated 359 person-days to correct. The Company has set a target date of March 31, 1999 for the completion of the necessary conversions to the following systems: (i) the Senator underwriting management system, (ii) the RSG reinsurance system, (iii) other software and hardware components and infrastructure, (iv) enterprise- wide spreadsheet and database files, (v) broker compliance and (vi) supplier compliance. The Company has budgeted $0.3 million for the overall Year 2000 compliance effort and has expensed $0.06 million to date for the IBM assessment and strategy report. Given the current level of estimated costs, it is not anticipated that the costs of Year 2000 compliance will have a material impact on the Company's future results.
A number of risk factors, including but not limited to the following, could affect the Company's plans to achieve Year 2000 compliance by March 31, 1999 within the current budget:
. As the Company is currently completing its installation of the Senator underwriting management system, any delay in completing that installation could delay the Year 2000 conversion of components of that system. To provide for that contingency, the Company has contracted with outside service providers to ensure that the Company's current RSG reinsurance system is Year 2000 compliant by January 31, 1999.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of LaSalle Re Holdings Limited and subsidiaries as of September 30, 1998 and 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1998 in conformity with generally accepted accounting principles.
YEARS ENDED SEPTEMBER 30, 1998 AND 1997 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
In November 1995, the Company and LaSalle Re consummated an offer (the "Exchange Offer") pursuant to which, among other things, the founding shareholders of LaSalle Re (the "Founding Shareholders") exchanged their capital stock of LaSalle Re for common shares of the Company (the "Common Shares") and, in certain circumstances, exchangeable non-voting shares of LaSalle Re (the "Exchangeable Non-Voting Shares"). The Exchange Offer was accounted for as if it were a pooling of interests of combining enterprises under common control.
Liabilities are recorded without consideration of potential salvage or subrogation recoveries that are estimated to be immaterial. Such recoveries, when realized, are reflected as a reduction of losses incurred.
The U.S. 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. Unearned premiums and deferred acquisition costs are translated at historic exchange rates. Foreign currency revenues and expenses are translated at the exchange rates in effect at the date of the transaction. Exchange gains and losses are included in the determination of net income, as they arise.
In June 1998, the Financial Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities". This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Given the limited number of transactions currently entered into by the Company that are covered by the Statement, the Company does not anticipate any significant changes to its current financial reporting.
The unrealized gain on investments as shown on the consolidated balance sheet of $13,838 (1997: $2,035) is net of the minority's interest of $4,107 (1997: $542).
In the normal course of reinsurance operations, the Company's bankers have issued letters of credit totaling $8,303 (1997: $8,673) in favor of ceding insurance companies to secure the Company's obligations under various reinsurance contracts. In connection with LaSalle Re Corporate Capital Ltd.'s support of three Lloyd's syndicates, the Company has posted letters of credit in the amount of $16,616 (1997: $15,974). In addition, in connection with a swap agreement, the Company has posted a letter of credit of $3,000. At September 30, 1998, $32,107 (1997: $28,344) of fixed interest securities have been pledged as collateral for these letters of credit.
Net investment income for the years ended September 30, 1998, 1997 and 1996 was derived from the following sources:
Included in gross investment income for the year ended September 30, 1998 was a charge of $863 (1997: $1,725; 1996: $3,280) relating to the amortization of investment premium.
Net realized gains (losses) comprise $6,085 realized gains and $510 realized losses (1997: $1,881 and $1,326; 1996: $1,242 and $1,660, respectively).
Coverage for the first loss is substantially funded by way of annual and reinstatement premium obligations. Accordingly, this portion of the coverage has been recorded as a financing arrangement whereby the consideration paid, net of associated financing charges, is recorded as a deposit and included as part of other assets in the consolidated balance sheet. The deposit asset is adjusted at the balance sheet date to reflect the net present value of expected future cash flows under that portion of the contract. Interest expense includes finance charges of $1,666 (1997: $1,470), which are being amortized over the period of the contract using the interest method.
The reinsurance agreement is secured by a company which currently holds a rating of "A+" (Superior) from A.M. Best Company, Inc. and a claims-paying rating of "AAA" (Excellent) from Standard & Poor's Ratings Services.
There were no premiums ceded for the year ended September 30, 1996.
The following earnings per Common Share amounts have been disclosed in accordance with the requirements of SFAS No. 128:
During the year ended September 30, 1997, 95,679 options were exercised at a price of $9.74. In addition, 136,350 options to purchase Exchangeable Non- Voting Shares were bought by the Company at a price of $24.97 and subsequently canceled. As at September 30, 1997, the Company and LaSalle Re had 136,350 options to purchase Common Shares and 1,967,751 options to purchase Exchangeable Non-Voting Shares outstanding respectively.
The original exercise price of the options was $16.67 per share, (which was equal to the fair value of the Company's shares at the grant date), minus dividend adjustments. The current exercise price is $6.78. As the options were granted to certain of the Founding Shareholders and their affiliates as an inducement to purchase stock in LaSalle Re, no compensation expense has been recorded in connection with the options.
The number of SARs which can be exercised is dependent upon the internal rate of return achieved during the period from November 22, 1993 through to the date of exercise and ending on March 30, 2004 or, if earlier, two years after the Chief Executive Officer's termination of employment. SARs will not be exercisable unless a targeted internal rate of return of at least 18% per annum is achieved during the entire measurement period. The internal rate of return is based upon the financial performance of LaSalle Re from inception to November 27, 1995 and LaSalle Re Holdings Limited's consolidated performance from that date forward. As at September 30, 1998, the number of SARs vested is 92,035, of which 68,174 became exercisable on January 1, 1997 and 23,861 on January 1, 1998. The remaining balance of SARs may become exercisable on January 1, 1999 if the Company's internal rate of return exceeds 18% through to December 31, 1998. At September 30, 1998, the Company's internal rate of return has exceeded 18%. During the fiscal year ended September 30, 1998, the fair value of the SARs has decreased and therefore the Company has recorded a reduction in the total liability relating to the SARs of $548 (1997: charge $1,611; 1996: charge $909).
Under the Incentive Plan, the options granted vest ratably in five annual installments over 5 years from the grant date, except for 85,218 options granted in 1997 which vest ratably in three annual installments over 3 years from the date of grant. The options can be exercised over a 10-year period, commencing on the vesting date. The Plan has an anti-dilution provision, which awards the option holder a number of shares of restricted stock in the event that a dividend, when added to the value of all cash dividends previously paid within the same fiscal year, exceeds 5% of the average book value per share for the prior four quarters. During the year ended September 30, 1998, 26,995 shares of restricted stock (1997: 19,362) were awarded. The restricted stock vests when the underlying options are exercised and is forfeited if the options expire unexercised. The Company has charged an expense of $374 (1997: $264; 1996: $268) relating to compensation on these options. The following table is a summary of the options granted and outstanding during 1998, 1997 and 1996.
agreement, LaSalle Re granted CNA Bermuda the authority to provide underwriting services and to underwrite all classes of insurance and reinsurance as agents for LaSalle Re. LaSalle Re agreed to pay fees, during this period, to CNA Bermuda as follows:
(ii) An underwriting profit commission equal to 1.67% of the aggregate net underwriting profits of LaSalle Re, where certain conditions are met.
The agreement provides for additional fees to be payable if services provided exceed the retainer. Fees in excess of the retainer are calculated at competitive commercial daily or hourly rates to be agreed between the parties.
The Company has incurred $850 (1997: $1,057; 1996: $1,028) for services provided for the year ended September 30, 1998, of which $215 (1997: $215) was payable at September 30, 1998.
LaSalle Re was party to an agreement with Integrated Runoff Insurance Services Corporation ("IRISC") whereby IRISC performed certain claims handling services for LaSalle Re. The contract expired December 31, 1996.
The Company has incurred $Nil (1997: $16; 1996: $92) for services provided for the year ended September 30, 1998. No balance was payable at September 30, 1998 (1997: Nil).
Effective January 1, 1997, LaSalle Re was party to a fronting agreement with Hedge Financial Products, an affiliate of CNA. CNA reinsured LaSalle Re 100% for the business fronted. LaSalle Re received an administration fee of $63 (1997: $250) for the services provided. The agreement was not renewed on January 1, 1998.
As at September 30, 1998, no fees were due to the Company (1997: $60).
The Company has investment guidelines which restrict investments in securities below an "AA" grade rating to 20% of the total portfolio and only 10% of the total portfolio can be invested in "BBB" grade rating. The Company is allowed to invest up to $10,000 in risk based investments and these bonds may carry a rating below "BBB". In addition, the guidelines restrict investments in a single issuer to no greater than 5% of the market value of the portfolio (except for U.S. and U.K. Government issues) and, with respect to country of issue, to no greater than 25% of the market value of the portfolio, except for U.S. and supernational borrowers.
The prior year development in 1998 was primarily due to a loss reported during the year on a 1996 aggregate stop loss contract. This contract had a period of 24 months after the expiry of the contract within which to report losses. Following this notification the Company also established reserves for the 1997 renewal of this contract. The prior year development in 1997 relates primarily to an additional liability on Hurricane Fran, which occurred in September 1996. The amounts incurred in respect of prior year losses in 1996 relate primarily to Hurricanes Luis and Marilyn, which occurred in September 1995. Additional information reported by ceding companies in the months following the losses necessitated the provision of additional liabilities. This impact was mitigated by the collection of additional reinstatement premiums. As at September 30, 1998 the Company's total reserve for incurred but not reported losses was $52,200 compared to $19,648 at September 30, 1997.
The Company may also enter into foreign exchange contracts to manage the exposures relating to known reinsurance losses denominated in foreign currencies. However, no such contracts had been entered into at September 30, 1998.
The Company has rented space for its principal executive offices under lease agreements, which expire up to 2001. Total rent expense for the year ended September 30, 1998 was approximately $365 (1997: $Nil; 1996: $Nil). Future minimum rental payments under the leases are expected to be as follows:
The following table sets forth the Company's gross premiums written and the percentage thereof allocated to the zone of exposure for the years ended September 30, 1998, 1997 and 1996: