- -------- (1) Minority interest represents those shares in LaSalle Re Limited that were held as Exchangeable Non-Voting Shares. These shares were exchangeable, at the option of the holder, for Common Shares of the Company on a one-for-one basis. These shares were exchanged for Trenwick Common Shares on a one-for-one basis following the Trenwick/LaSalle business combination.
The following discussion highlights material factors affecting the Company's results of operations for the three years ended December 31, 2001, December 31, 2000 and September 30, 1999. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and notes thereto of the Company contained in Item 8 of this Form 10-K.
The operating loss of $19.2 million in 2001 represented a $45.1 million decrease over the operating income of $25.9 million recorded in 2000. This decrease was primarily due to the deterioration of underwriting results caused by losses incurred related to Tropical Storm Alison ($8.0 million) and the September 11th terrorist attacks ($141.8 million gross and $86.8 million net of reinsurance recoverable). The adverse effect of the underwriting performance primarily generated the decrease in net income of $34.5 million.
The underwriting loss of $58.1 million in 2001 represented a $51.0 million increase compared to the underwriting loss of $7.1 million in the 2000 year. The underwriting loss in 2001 included losses of $122.0 million on current year loss events and net additions to prior years' reserves of $1.0 million. Of this $123.0 million total loss incurred, $22.1 million relates to Lloyd's syndicates which are now in run-off. The underwriting loss in 2000 included both losses of $60.2 million on current year loss events and additions to prior years' reserves of $20.4 million.
The increase in worldwide property catastrophe reinsurance gross premium writings for 2001 compared to 2000 resulted primarily from reinstatement premiums of $14.4 million generated by reinstated coverages on assumed contracts impacted by losses from the September 11th terrorist attacks.
The decrease in Lloyd's sydicates gross written premiums for 2001 compared to 2000 is expected as all of the Lloyd's sydicates business underwritten by the Company prior to the combination with Trenwick has not been renewed in 2001 and has been classified as runoff.
Net premiums earned in 2001 were $97.5 million compared to $108.1 million for 2000. The decrease in net premiums earned is primarily due to the increase in ceded premiums.
Claims and claims expenses for 2001 were $123.0 million, a increase of $42.4 million compared to claims and claims expenses of $80.6 million for 2000. The increase is due to losses associated with the September 11th terrorist attacks. The Company's incurred losses related to the September 11th terrorist attacks are based upon estimates of its ultimate exposure derived from a manual assessment of its outstanding policies. The assessment included market share analysis, probable maximum loss analysis, independent risk modeling analysis and cedent loss estimates. The Company's primary exposure for this event relates to commercial property damage, which includes business interruption and incidental workers' compensation coverage, and catastrophe aviation coverage. The Company's estimated loss from the September 11th terrorist attacks is $141.8 million gross and $86.8 million net of reinsurance recoverable. The reinsurance recoverable of $55.0 million related to the terrorist attacks is from companies which have financial strength ratings from A.M. Best of "A" or better. In addition to losses incurred related to the September 11th terrorist attack, the Company incurred losses of $8.0 million associated with Tropical Storm Alison. Claims and claims expenses incurred in 2000 included $6.5 million of catastrophe losses relating to U.K. floods and an increase of $20.4 million in prior period occurrences, principally losses relating to two storms, Martin and Anatol, which hit Europe in late December 1999.
2001 Year 2000 Year Change --------- --------- ------ (in thousands) Policy acquisition costs $20,886 $21,270 $ (384) Underwriting expenses 11,790 13,342 (1,552) ------- ------- ------- Total underwriting expenses $32,676 $34,612 $(1,936) ======= ======= ======= Underwriting expense ratio 33.5% 31.9% 1.6% ======= ======= =======
Total underwriting expenses, comprising policy acquisition costs and underwriting expenses, for 2001 decreased by $1.9 million compared to total underwriting expenses for 2000. Policy acquisition costs as a percentage of net premiums earned were 21.4% for 2001 compared to 19.7% for 2000. The increase in the ratio occurred principally because of an increase in the amount of amortized ceded premiums. As a percentage of gross premiums earned, policy acquisition costs were 13.9% in 2001 compared to 15.2% in 2000. The decrease of 1.3% was primarily due to the Company deriving less premiums from LaSalle Re Capital which has a higher expense ratio than the rest of the business.
Underwriting expenses for 2001 were $11.8 million compared to $13.3 million for 2000, a decrease of $1.5 million. The decrease is primarily due to a reduction in overall salary costs.
Net investment income for 2001 was $38.9 million compared to $37.4 million for 2000. The increase in net investment income in 2001 was primarily due to changes in the allocation of investments to higher yielding debt securities following a change in investment managers.
Interest expense was $1.1 million in 2000. There were no interest expense charges in 2001. Interest expense in 2000 included financing charges associated with a ceded reinsurance contract and other interest expenses related to the commitment fees payable on the Company's credit facility which was canceled effective the end of September, 2000.
The Company did not record any corporate expenses for 2001. The expenses of $3.3 million for 2000 relate primarily to the Company's decision to cancel the implementation of new reinsurance software and costs related to the Trenwick/LaSalle business combination.
Net realized gains on investments were $7.6 million during 2001, compared to net realized losses of $1.7 million for 2000. The gains in 2001 resulted from a change in investment managers and a consequential re-positioning of the portfolio to reflect a new investment philosophy.
Operating income of $25.9 million in 2000 represented a $32.7 million increase over the operating loss of $6.8 million recorded in fiscal year 1999. This improvement was principally due to better underwriting results in 2000, which was due to a decrease in prior year reserve strengthening to both catastrophe and non-catastrophe business. The effect of the improved underwriting performance primarily generated the increase in net income of $26.1 million.
Gross premiums written for 2000 were $130.2 million compared to $139.0 million for the 1999 fiscal year, a decrease of $8.8 million or 6%. Details of gross premiums written are provided below.
The increase in Lloyd's gross written premiums for 2000 compared to the 1999 fiscal year primarily arose from new information concerning premium estimates for the 1999 and 1998 underwriting years of account. All of the Lloyd's business underwritten by the Company prior to the combination with Trenwick has not been renewed as of December 31, 2000 and has been classified as runoff.
Total underwriting expenses, comprising policy acquisition costs and underwriting expenses, for 2000 increased by $1.0 million compared to total underwriting expenses for the 1999 fiscal year. Policy acquisition costs as a percentage of net premiums earned were 19.7% for 2000 compared to 15.7% for the 1999 fiscal
year. The increase in the ratio occurred principally because of an increase in the amount of amortized ceded premiums. As a percentage of gross premiums earned policy acquisition costs were 15.2% compared to 13.7%. The remaining increase of 1.5% was primarily due to the Company deriving more premiums from LaSalle Re Capital which has a higher expense ratio than the rest of the business at 20%.
Underwriting expenses for the year 2000 and the 1999 fiscal year remained comparable at 9.5%.
Net realized losses on investments were $1.7 million during 2000, compared to net realized gains of $0.6 million for the 1999 fiscal year. Both the losses and gains were made as a result of security sales executed pursuant to an investment policy designed to protect the total returns on the portfolio.
Operating activities produced a net cash inflow of $51.9 million for the year ended December 31, 2001 compared to $10.7 million for the year ended December 31, 2000. The increase was partially from the collection of a deposit of approximately $27.4 million on the Company's multi year reinsurance contract which was cancelled effective December 31, 2000. Cash flows from operations in future years may differ substantially from net income. Cash flows are affected by loss payments, which, due to the nature of the reinsurance coverage provided by LaSalle Re, are generally expected to comprise large loss payments on a limited number of claims and can therefore fluctuate significantly from year to year. The irregular timing of these large loss payments can create significant variations in operating cash flows between periods. LaSalle Re funds these payments from cash flows from operations and sales of investments. Loss payments following the September 11th terrorist attack have not been significant in 2001. Loss payments from this event are expected to be significant in 2002 and 2003.
Other assets decreased from $30.3 million as at December 31, 2000 to $3.2 million at December 31, 2001. The decrease is related to collection of the deposit on the Company's multi-year reinsurance contract.
The reduction in unearned premium by $5.0 million from December 31, 2000 to December 31, 2001 was primarily caused by the change in the mix of business in the 2001 year.
The negative goodwill of $11.9 million as of December 31, 2001 relates to the Trenwick/LaSalle business combination. The Company has adopted the push-down basis of accounting for the purchase of the minority interest in LaSalle Re in its financial statements.
In July 2001, the Financial Accounting Standards Board issued a statement covering goodwill which is required to be adopted at the beginning of 2002. See Note 11 of Notes to the Consolidated Financial Statements for details.
The Company paid a quarterly dividend of $0.5469 per share to holders of record of Series A preferred shares in March, June, September and December of 2001. As of December 31, 2001, dividends due but not yet declared on the Series A preferred shares amounted to $0.5 million. In addition, the Company paid common dividends to Trenwick in 2001 totalling $7.5 million.
A portion or all of the term loan must be repaid in the event of equity issuances, asset sales or debt issuances by Trenwick or its subsidiaries. At year end 2001, $195.0 million of term loans were outstanding, and $230.0 million of letters of credit were outstanding under the credit facility.
The accounting policies described below are those the Company considers critical in preparing its consolidated financial statements. These policies include significant estimates made by management using information available at the time the estimates are made. However, as described below, these estimates could change materially if different information or assumptions were used. The descriptions below are summarized and have been simplified for clarity. A more detailed description of the significant accounting policies used by the Company in preparing its financial statements is included in the Notes to the Consolidated Financial Statements and the note references are included below.
Consolidated Financial Statements. An extensive degree of judgment is used in this estimation process. Because the future cannot be predicted with certainty, the actual future claims and claims expense payments are usually different from the previously recorded liability reserve estimates. Sometimes the differences are significant. Any adjustments to the Company's liability reserves for claims and claims expenses are included in the Company's results of operations in the period in which the need for the adjustment becomes known. Due to the considerable variability of the reinsurance business underwritten by the Company, adjustments to its liability reserves for claims and claims expenses may occur each quarter and are sometimes significant.
The Company purchases reinsurance to reduce its exposure on catastrophic losses. The Company estimates the amount of uncollectable receivables from its reinsurers each period and establishes an allowance for uncollectable amounts if necessary. The amount of the allowance is based on the age of unpaid amounts, information about the creditworthiness of the Company's reinsurers, and other relevant information. Estimates of uncollectable reinsurance amounts are revised each period, and changes are recorded in the period they become known. A significant change in the level of uncollectable reinsurance amounts would have a significant effect on the Company's results of operations. Also see Note 4 of Notes to the Consolidated Financial Statements.
Investments are classified as available for sale and recorded at fair value, and unrealized investment gains and losses are reflected in shareholders' equity. Investment income is recorded when earned, and capital gains and losses are recognized when investments are sold. Investments are reviewed periodically to determine if they have suffered an impairment of value that is considered other than temporary. If investments are determined to be impaired, a capital loss is recognized at the date of determination.
The Company seeks to match the maturities of invested assets with the payment of expected liabilities. By doing this, the Company attempts to make cash available as payments become due. If a significant mismatch of the maturities of assets and liabilities were to occur, the impact on the Company's results of operations could be significant. Also see Note 5 of Notes to the Consolidated Financial Statements.
The information called for by this item can be found in the Consolidated Financial Statements and Notes thereto on pages -.