RESTRUCTURING On February 24, 2000, a corporate restructuring was completed and Everest Re Group, Ltd. ("Group") became the new parent holding company of the Company, which remains the holding company for Group's U.S. based operations. Holders of the Company's common stock automatically became holders of the same number of Group common shares. The Company is filing this report as a result of its public issuance of senior notes on March 14, 2000. See ITEM 1 - "Business - The Company" for a further discussion.
McKinley reinsured several components of Everest Re's business. In particular, Mt. McKinley provided stop-loss reinsurance protection, in connection with the Company's October 5, 1995 IPO, for any adverse loss development on Everest Re's June 30, 1995 (December 31, 1994 for catastrophe losses) reserves, with $375.0 million in limits, of which $89.4 million remains available (the "Stop Loss Agreement"). The Stop Loss Agreement and other reinsurance contracts between Mt. McKinley and Everest Re remain in effect following the acquisition. However, these contracts have become transactions with affiliates with the financial impact eliminated in consolidation.
During 2000, the Company completed an additional acquisition, Everest Security Insurance Company ("Everest Security"), formerly known as Southeastern Security Insurance Company, a United States property and casualty company whose primary business is non-standard automobile insurance.
RESULTS OF OPERATIONS Unusual Loss Events. As a result of the terrorist attacks at the World Trade Center, the Pentagon and on various airlines on September 11, 2001 (collectively the "September 11 attacks"), the Company incurred pre-tax losses, based on an estimate of ultimate exposure developed through a review of its coverages, which totaled $213.2 million gross of reinsurance and $55.0 million net of reinsurance. Associated with this reinsurance were $60.0 million of pre-tax charges, predominantly from adjustment premiums, resulting in a total pre-tax loss from the September 11 attacks of $115.0 million. After tax recoveries relating specifically to this unusual loss event, the net loss from the September 11 attacks totaled $75.0 million. Over 90% of the losses ceded were to treaties where the reinsurers' obligations are secured, which in the Company's opinion eliminates material reinsurance collection risk.
INDUSTRY CONDITIONS. The worldwide reinsurance and insurance businesses are highly competitive. The September 11 attacks resulted in losses which reduced industry capacity and were of sufficient magnitude to cause most individual companies to reassess their capital position, tolerance for risk, exposure control mechanisms and the pricing terms and conditions at which they are willing to take on risk. The gradual and variable improving trend, which has been apparent through 2000 and earlier in 2001 firmed significantly. This firming generally took the form of immediate and significant upward pressure on prices, including more restrictive terms and conditions and a reduction of coverage limits and capacity availability. Such pressures were widespread with variability depending on the product and markets involved, but mainly depending on the characteristics of the underlying risk exposures. The magnitude of the changes was sufficient to create temporary disequilibrium in some markets as individual buyers and sellers adapted to changes in both their internal and market dynamics.
These changes reflect a reversal of the general trend from 1987 through 1999 toward increasingly competitive global market conditions across most lines of business as reflected by decreasing prices and broadening contract terms. The earlier trend resulted from a number of factors including the emergence of significant reinsurance capacity in Bermuda, changes in the Lloyds market,
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 PREMIUMS. Gross premiums written increased 34.6% to $1,849.8 million in 2001 from $1,374.0 million in 2000, as the Company took advantage of selected growth opportunities, while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 100.6% ($251.9 million) increase in the U.S. Insurance operation, principally attributable to growth in worker's compensation insurance, a 30.1% ($95.7 million) increase in the Specialty Underwriting operation, mainly attributable to growth in A&H medical stop loss writings and a 26.7% ($128.8 million) increase in the U.S. Reinsurance operation, primarily reflecting improved market conditions. These increases were partially offset by a 0.2% ($0.8 million) decrease in the International operation. The Company continued to decline business that did not meet its objectives regarding underwriting profitability.
Net premiums written increased by 17.4% to $1,416.9 million in 2001 from $1,207.3 million in 2000. This increase was consistent with the increase in gross premiums written and the increase in ceded premiums.
EXPENSES. Incurred loss and loss adjustment expenses ("LAE") increased by 22.9% to $1,079.2 million in 2001 from $878.2 million in 2000. The increase in incurred losses and LAE was principally attributable to an increase in business volume as reflected by the increase in net premiums earned, the impact of incurred losses relating to the September 11 attacks and the Enron bankruptcy and modest reserve strengthening in select areas, together with the impact of changes in the Company's mix of business. The Enron bankruptcy contributed $34.0 million of unusual losses in 2001, before cessions under the corporate retrocessional program. Incurred losses and LAE include catastrophe losses, which reflect the impact of both current period events and favorable and unfavorable development on prior period events and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss on property exposures of at least $5.0 million and has an event date of January 1, 1988 or later. Catastrophe losses, net of contract specific cessions but before cessions under the corporate retrocessional program in 2001, were $222.6 million, relating principally to the September 11 attacks, tropical storm Alison, the Petrobras Oil Rig loss and the El Salvador earthquake loss, compared to $13.9 million in 2000. Incurred losses and LAE in 2001 reflected ceded losses and LAE of $619.4 million compared to ceded losses and LAE in 2000 of $176.4 million, with the increase principally attributable to cessions relating to the September 11 attack losses and the Enron bankruptcy, together with increased cessions under specific reinsurance arrangements in the U.S. Insurance operation. The ceded losses and LAE for 2001 reflect $164.0 million of losses ceded under the 2001 accident year aggregate excess of loss component of the Company's corporate retrocessional program. The ceded losses and LAE for 2001 and 2000 reflect $105.0 million and $70.0 million, respectively, of losses ceded under the 1999 accident year aggregate excess of loss component of the Company's corporate retrocessional program, with the amounts in both periods reflecting reserve strengthening in select lines. In addition, ceded losses and LAE in 2001 also reflects $119.4 million relating to the reinsurance transaction between the Company and Bermuda Re noted earlier.
Other income was $26.6 million in 2001 compared to $3.3 million in 2000. Other income for 2001 includes $25.9 million arising from a non-recurring receipt of shares in connection with the demutualization of a former insurance company client, which issued annuities, owned by the Company, in connection with certain claim settlement transactions. In addition, other income for 2001 includes foreign exchange gains as well as financing fees from Everest Security, offset by the amortization of deferred expenses relating to the Company's issuance of
senior notes. Significant contributors to other income for 2000 were foreign exchange gains as well as financing fees from Everest Security, partially offset by net derivative expense and the amortization of deferred expenses relating to Holdings' issuance of senior notes. The foreign exchange gains and losses are attributable to fluctuations in foreign currency exchange rates.
During 2000, the Company added to its product portfolio a credit default swap, which it no longer offers, that has characteristics which allow this transaction to be analyzed using approaches consistent with those used in the Company's other operations. This product meets the definition of a derivative under Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). Net derivative expense from this transaction in 2001 was $7.0 million, principally attributable to credit default losses relating to the Enron bankruptcy.
o volatile and unpredictable developments, including weather-related and other natural catastrophes;
The Company attempts to limit its risk of loss by purchasing reinsurance to transfer a portion of the risks it assumes. The availability and cost of reinsurance is subject to market conditions, which are outside of the Company's control. As a result, the Company may not be able to successfully purchase reinsurance and transfer risk through reinsurance arrangements. A lack of available reinsurance might adversely affect the marketing of the Company's programs and/or force the Company to retain all or a part of the risk that cannot be reinsured. If the Company were required to retain these risks and ultimately pay claims with respect to these risks, the Company's net income could be reduced or the Company could incur a loss.
The Company's success has been, and will continue to be, dependent on its ability to retain the services of its existing key executive officers and to attract and retain additional qualified personnel in the future. The loss of the services of any of its key executive officers or the inability to hire and retain other highly qualified personnel in the future could adversely affect the Company's ability to conduct its business.
with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend the Company from carrying on some or all of its activities or monetarily penalize the Company. These types of actions could have a material adverse effect on the Company's business.