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 reflects the acquisition of Scottish Re Holdings Limited, but consolidated statements of income data for the periods ended December 31, 2001 and 2000 and consolidated balance sheet data as of December 31, 2000 do not reflect the results of Scottish Re Holdings Limited, as the transaction was completed at the close of business on December 31, 2001. Consolidated balance sheet data as of December 31, 2003 and 2004 and consolidated statements of income data for the year ended December 31, 2004 reflect the acquisition of Scottish Re Life Corporation, but consolidated statement of income data for the years ended December 31, 2000 to December 31, 2002 and consolidated balance sheet data as of December 31, 2000 to 2002 do not reflect the results of Scottish Re Life Corporation as the transaction was completed on December 22, 2003. Consolidated statement of income data for the year ended December 31, 2003 includes net income of $1.2 million in respect of Scottish Re Life Corporation. Consolidated balance sheet data as of December 31, 2004 reflect the acquisition of the ING individual life reinsurance business, but consolidated statements of income data for the periods ended December 31, 2000 to 2004 do not reflect this data as the acquisition was completed at close of business on December 31, 2004.
: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
On December 31, 2004, we completed the acquisition of the individual life reinsurance business of ING. We have reinsured the liabilities of all of ING's individual life reinsurance business through a coinsurance transaction. ING transferred to us assets of approximately $1.9 billion. The assets transferred are subject to certain post closing adjustments. Certain of these assets will be held in trust to secure the reserve obligations of the business. Additionally, ING transferred certain operating assets associated with the business.
On December 22, 2003, we completed the acquisition of 95% of the outstanding capital stock of Scottish Re Life Corporation (formally ERC Life Reinsurance Corporation), for $169.9 million in cash. On February 19, 2004 ERC Life Corporation's name was changed to Scottish Re Life Corporation. Scottish Re Life Corporation was a subsidiary of General Electric's Employers Reinsurance Corporation, which we call GE ERC, and was one of the companies through which GE ERC conducted life reinsurance business in the United States. Scottish Re Life Corporation's business consists primarily of a closed block of traditional life reinsurance. No GE ERC employees were transferred to Scottish Re. GE ERC agreed to administer the business of Scottish Re Life Corporation for a fixed monthly fee for up to nine months from the date of acquisition and to assist with the transition of the business to Scottish Re's systems. This transition period has now been completed.
All amounts are reported in thousands of United States dollars, except per share amounts.
Premiums from reinsurance assumed on life business are included in revenues over the premium paying period of the underlying policies. When we acquire blocks of in-force business, we account for these transactions as purchases, and our results of operations include the net income from these blocks as of their respective dates of acquisition. Reinsurance assumed on annuity business does not generate premium income but generates investment income over time on the assets we receive from the ceding company. We also earn fees in our financial reinsurance transactions with U.S. insurance company clients. Because some of these transactions do not satisfy the risk transfer rules for reinsurance accounting, the premiums and benefits are not reported in the consolidated statements of income. A deposit received on a funding agreement also does not generate premium income but does create income to the extent we earn an investment return in excess of our interest payment obligations thereon.
o the mix of different types of business that we reinsure, because profits on some kinds of business emerge later than on other types;
SFAS No. 97 "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments" 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.
The development of policy reserves and amortization of deferred acquisition costs for our 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 monitors actual experience, and should circumstances warrant, will revise its assumptions and the related reserve estimates.
In the normal course of business, we acquire in-force blocks of business. The determination of the fair value of the assets acquired and the liabilities assumed require management to make estimates and assumptions regarding mortality, lapse rates and expenses. These estimates are based on historical experience, actuarial studies and information provided by the ceding companies. Actual results could differ materially from these estimates.
Fixed maturity investments are evaluated for other than temporary impairments in accordance with SFAS No. 115: "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115") and Emerging Issues Task Force 99-20: "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interest in Securitized Assets" ("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 amortized cost, length of time the value has been below amortized 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 funds withheld at interest arise on modified coinsurance and funds withheld coinsurance transactions. Derivatives Implementation Group Issue No. B36 "Embedded Derivatives: Bifurcation of a Debt Instrument that Incorporates Both Interest Rate and Credit Rate Risk Exposures that are Unrelated or Only Partially Related to the Creditworthiness of the Issuer of that Instrument" ("DIG B36") indicates that these transactions contain embedded derivatives. The embedded derivative feature in our funds withheld treaties is similar to a fixed-rate total return swap on the assets held by the ceding companies. The swap consists of two parts. The first is the market value of the underlying asset portfolio and the second is a hypothetical loan to the ceding company. The hypothetical loan is based on the expected cash flows of the underlying reinsurance liability. We have developed models to systematically estimate the value of the total return swap. The fair value of the embedded derivative is affected by changes in expected cash flows, credit spreads of the assets and changes in "risk-free" interest rates. The change in fair value is included in our calculation of estimated gross profits and, therefore, also affects the amortization of deferred acquisition costs. In addition to our quota share indemnity funds withheld contracts, we have entered into various financial reinsurance treaties that, although considered funds withheld, do not transfer significant insurance risk and are recorded on a deposit method of accounting. As a result of the experience refund provisions of these treaties the value of the embedded derivative is currently considered immaterial. Changes in our expectations of future cash flows could result in material changes to the financial statements.
Our accounting policies addressing premiums earned, reserves, deferred acquisition costs, value of business acquired, goodwill, investment impairment and embedded derivatives involve significant assumptions, judgments and estimates. Changes in these assumptions, judgments and estimates could create material changes in our consolidated financial statements.
Total revenues increased by 46% to $811.8 million in the year ended December 31, 2004 from $557.4 million in 2003. Total revenues include premiums earned in our Life Reinsurance Segments, investment income on our invested assets, fee income, realized losses and the change in the value of embedded derivatives. The increase in premiums earned is primarily due to the acquisition of Scottish Re Life Corporation and growth in the traditional solutions line of business in our Life Reinsurance North America Segment. The increase in fee income arises principally from our acquisition of Scottish Re Life Corporation. The increase in investment income is due to growth in our invested assets, which arises from business growth and acquisition, our offering of ordinary shares in July 2003 and our HyCU offering in the fourth quarter of 2003 and trust preferred debt offerings in the fourth quarter of 2003 and the second quarter of 2004. Growth in these areas has been offset by realized losses and a decrease in the change in value of embedded derivatives.
business, additional operating costs necessary to meet the requirements of the Sarbanes-Oxley Act of 2002, costs relating to due diligence activities and additional interest expense arising from the HyCU offering and trust preferred debt offerings in the fourth quarter of 2003 and the second quarter of 2004.
During 2003, we decided to discontinue our Wealth Management operations in Luxembourg. We have transferred our Luxembourg Wealth Management business to third parties, closed the Luxembourg office and are in the process of liquidating our Luxembourg subsidiary. We have reported the results of the Luxembourg wealth management activities as discontinued operations. Losses incurred in respect of these operations in the years ended December 31, 2004, 2003 and 2002 amounted to $0.2 million, $2.0 million and $0.7 million, respectively.
Income from continuing operations for the year ended December 31, 2004 increased 47% to $71.6 million from $48.8 million in the same period in 2003. Diluted earnings per share from continuing operations increased from $1.51 per ordinary share in 2003 to $1.91 in 2004. In the year ended December 31, 2003 we incurred a charge of $12.5 million to account for revised reporting by a ceding company client in connection with two fixed annuity reinsurance contracts. Income from continuing operations has increased primarily due to the acquisition of Scottish Re Life Corporation, continued growth in our Life Reinsurance North America Segment, and an increase in investment income primarily due to the increase in average invested assets. These increases were offset in part by increased operating costs, due diligence costs, and interest expense and realized losses.
Net income for the year ended December 31, 2004 increased 162% to $71.4 million from $27.3 million in the same period in 2003. In 2003 we implemented DIG B36 and incurred a charge of $19.5 million in respect of the cumulative effect of this change in accounting principle. In 2003 we also incurred a loss of $2.0 million in respect of costs relating to the closure of our Luxembourg Wealth Management Operations. Net income has also increased for the reasons discussed above related to income from continuing operations.
Diluted earnings per ordinary share amounted to $0.85 and $1.23 for the year ended December 31, 2003 and 2002, respectively. Diluted earnings per ordinary share for 2003 decreased due to the adoption of DIG B36 and the resultant cumulative effect of change in accounting principle. In addition, the number of weighted average shares outstanding increased from 26,505,611 to 32,228,001 mainly due to the public offering of 9,200,000 ordinary shares in July 2003.
In our Life Reinsurance North America Segment we reinsure life insurance, annuities and annuity-type products. These products are written by life insurance companies and other financial institutions located principally in the United States. The results of Scottish Re Life Corporation, which we acquired on December 22, 2003, are included in the results of this segment for the year ended December 31, 2004 and the period from December 22, 2003 to December 31, 2003.
Premiums earned in our Life Reinsurance North America Segment during the year ended December 31, 2004 increased 101% to $464.7 million in comparison with $230.7 million in 2003. A significant portion of the increase is due to the acquisition of Scottish Re Life Corporation, which contributed $122.2 million in earned premiums. The remaining increase is due to the increase in the number of client ceding companies and the increase in business from these clients in our Life Reinsurance North America Segment. As of December 31, 2004, we had approximately $1.0 trillion of life reinsurance in force covering approximately 14.2 million lives with an average benefit per life of $71,000 in our North American operations. Excluding the business acquired from ING, we had approximately $305.1 billion of life reinsurance in force covering 7.1 million lives with an average benefit per life of $43,000. As of December 31, 2003, we had approximately $275.0 billion of life insurance in-force on 6.2 million lives and our average benefit coverage per life was $43,000.
Net investment income increased by 52% to $206.0 million for the year ended December 31, 2004 from $135.7 million for the prior year. The increase is due to the growth in our average invested assets. Yields increased
marginally during 2004. At December 31, 2004, total invested assets in this segment, excluding those assets acquired in the purchase of ING, increased to $4.5 billion from $3.6 billion at December 31, 2003. On the portfolio managed by our external investment managers the yields on fixed rate assets less cash were 5.22% and 5.13% at December 31, 2004 and 2003, respectively. Yields on floating rate assets are indexed to LIBOR. The yield on our floating rate assets less cash increased to 3.44% as at December 31, 2004 from 3.43% as at December 31, 2003, and the yield on our cash and cash equivalents increased to 1.78% as at December 31, 2004 from 1.01% as at December 31, 2003. In 2004, the market value of floating-rate assets increased to $963.8 million, excluding those assets acquired in the purchase of ING, from $301.8 million in 2003 as a result of our increased floating rate liabilities.
Claims and other policy benefits increased by 101% to $344.3 million during the year ended December 31, 2004 from $171.7 million in the same period in 2003. The increase is a result of the acquisition of Scottish Re Life Corporation, the increased number of clients and the increase in business from these clients in our Life Reinsurance North America Segment as described above. Death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to fluctuation from period to period. Our targeted maximum retention in our Life Reinsurance operations is $1.0 million per life. For periods up to December 31, 2004 we ceded amounts in excess of $500,000. However, effective January 1, 2005, we have increased our retention to $1.0 million per life. Our retention on business acquired in the ING individual life reinsurance acquisition, effective December 31, 2004, is $2.0 million per life. In addition, we maintain catastrophe cover on our entire retained life reinsurance business, which effective January 1, 2005 provides reinsurance for losses of $50.0 million in excess of $10.0 million, and provides protection for terrorism, nuclear, biological and chemical risks.
For the year ended December 31, 2004, interest credited to interest sensitive contract liabilities increased by 19% to $106.5 million from $89.2 million in 2003. During the year ended December 31, 2003 we incurred $12.5 million due to revised reporting by a ceding company client in connection with two fixed annuity reinsurance contracts. Excluding this charge interest credited increased by 39% in comparison with the year ended December 31, 2003. Interest credited includes interest in respect of funding agreements. The amounts due on funding agreements are included in interest sensitive contract liabilities on our balance sheet and amount to $500.6 million at December 31, 2004 in comparison with $330.7 million at December 31, 2003. Interest credited on these agreements was $9.0 million in 2004 in comparison with $2.4 million in 2003. The remaining increase is due to interest credited on new reinsurance treaties and increases in interest credited on existing treaties due to increasing average liability balances. Interest sensitive contract liabilities amounted to $3.2 billion at December 31, 2004 in comparison with $2.6 billion at December 31, 2003.
Premiums earned in our Life Reinsurance North America Segment during the year ended December 31, 2003 increased 88% to $230.7 million from $122.8 million in 2002. The increase is due to increases in the amounts of life insurance in-force on existing traditional solutions treaties and on new business written during the year. As of December 31, 2003, the Company had reinsurance of approximately $275.0 billion of life insurance in-force on 6.2 million lives and our average benefit coverage per life was $43,000. As of December 31, 2002, we reinsured approximately $67.0 billion of life insurance in-force on 1.2 million lives and our average benefit coverage per life was $51,000.
Net investment income increased by $38.3 million or 39% to $135.7 million for the year ended December 31, 2003 from $97.4 million for the prior year. The increase was due to the growth in our average invested assets offset in part by decreases in realized yields during 2003. Our total invested assets increased because of growth in our Life Reinsurance North America financial solutions business and investment of the proceeds of the HyCU offering in December 2003, our equity offering in July 2003 and long-term debt offerings in October and November 2003. Total invested assets, in the segment, increased from $2.1 billion at December 31, 2002 to $3.6 billion at December 31, 2003.
Acquisition costs and other insurance expenses for our Life Reinsurance North America Segment increased to $83.6 million in 2003 from $48.4 million in 2002. The increase was a result of the growth of our business as described above. As discussed above, we incurred charges of $12.5 million this year due to revised reporting by a ceding company client in connection with two fixed annuity reinsurance contracts. In light of the impact of the revised reporting on the estimated gross profits of the two treaties in question, we revised the amortization of deferred acquisition costs on the two treaties, along with two other related treaties.
Premiums earned in our Life Reinsurance International Segment during the year ended December 31, 2004 decreased 24% to $122.2 million in comparison with $161.3 million in 2003. The majority of business in our Life Reinsurance International Segment is in respect of short duration contracts. We experience considerable reporting delays from some of our cedents on this business. In 2003, as part of the implementation of this segment's new administrative system, improved data was compiled to allow us to more accurately estimate our premium earned. As a result, premiums earned in 2003 included $23.4 million in respect of revisions in estimates of premiums earned.
Premiums earned from a portfolio acquired in 2002 were $11.5 million lower in 2004 compared to 2003 due to the run off nature of the portfolio. During 2004 we decided not to renew certain contracts, which did not meet our return thresholds. Earned premium for general reinsurance business, which consists of aircrew loss of license and related personal accident, decreased 5% from $35.8 million to $34.0 million. Premiums earned in 2004 include $4.2 million relating to a share of two Lloyd's of London life syndicates.
Operating expenses have increased by 63% to $18.8 million for the year ended December 31, 2004 from $11.5 million in the prior year. The increases are principally due to increased personnel costs as resources have been added as we continue to grow our business and include costs for recruitment expenses. Operating expenses have also increased due to implementation of the requirements of the Sarbanes Oxley Act of 2002 and United Kingdom regulatory changes. Other expense increases compared to 2003 include office costs due to the move to larger offices in the second quarter of 2003 and amortization of the costs of a new administration system. Operating expenses in this segment are incurred in pounds sterling. These expenses have increased as a result of the depreciation of the United States dollar in comparison with pounds sterling during 2004.
Premiums earned in our Life Reinsurance International Segment during the year ended December 31, 2003 increased by 102% to $161.3 million in comparison with $79.7 million in 2002. Our Life Reinsurance International Segment completed the acquisition of an in-force reinsurance transaction effective October 1, 2002. This transaction contributed $28.0 million to premiums earned during 2003 compared to $4.8 million of premiums earned in 2002. Premiums earned on other life business increased $48.4 million in the year ended December 31, 2003 in comparison with the prior year. The increase is due to an increase in the number of contracts to 2,115 in 2003 from 1,387 in 2002. Of the $48.4 million, $23.4 million resulted from revisions in estimates of premiums earned. The majority of business in our Life Reinsurance International Segment is in respect of short duration contracts. We have experienced considerable reporting delays from some of our cedents on this business. As part of the implementation of this segment's new administrative system, improved data was compiled which allowed us to more accurately estimate our premium earned. Premiums earned on aircrew loss of license insurance increased to $23.6 million during the current year in comparison with $16.5 million in the prior year due principally to new business. At December 31, 2003, there were 252 loss of license contracts in comparison with 186 at December 31, 2002.
The Other Segment comprises revenues and expenses not included elsewhere and includes corporate overhead. As previously discussed our Wealth Management operations, which were previously designated as a separate segment, are now included in the Other Segment.
We incurred interest expense of $6.4 million during the year ended December 31, 2003 in comparison with $1.4 million during 2002. Interest expense in 2003 comprises principally interest on the $115.0 million of convertible debt issued in November 2002. Interest expense in 2002 was in respect of borrowings under our credit facility and reverse repurchase arrangements. The credit facility borrowings were repaid in April 2002.
At December 31, 2002, we held unit-linked securities amounting to $16.5 million. These securities comprised investments in a unit trust denominated in British pounds. These securities were acquired as part of the purchase of Scottish Re Holdings Limited and were recorded at quoted market value. Changes in market value were recorded as net realized gains or losses. During 2003, we novated our liabilities on our unit-linked contracts as discussed in "Life Reinsurance International". The liabilities were settled by transferring a portion of the unit-linked securities to the original ceding company. The remaining unit-linked securities were sold realizing a gain of $0.3 million during the year. During the year ended December 31, 2003, changes in market value of those securities of $0.8 million were recognized as realized losses.
During the year ended December 31, 2002, realized losses amounted to $10.8 million. The losses in 2002 consist of realized investment losses on unit linked securities held by Scottish Re Holdings Limited 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. These losses were partially offset by net realized gains on the sales of fixed maturity investments of $4.8 million.
temporary impairment." When a decline is considered to be "other than temporary" a realized loss is incurred and the cost basis of the impaired asset is adjusted to its fair value.
the ING individual life business. In 2004, we established reserves of $3.3 million in respect of certain tax positions. The acquisition of the ING individual life reinsurance business is reflected under U.S. generally accepted accounting principles in accordance with purchase accounting requirements but for taxation is a currently taxable transaction. As a result, approximately $84.0 million of current tax expense and a corresponding $84.0 million of deferred tax benefit is not reflected in the income statement consistent with purchase accounting principles. At December 31, 2004 we believe that it is more likely than not that all gross deferred tax assets will reduce taxes payable in future years except for a valuation allowance of $21.6 million established in 2004.
The 2003 and 2002 income tax benefits are in respect of certain of our U.S. taxable entities and are offset by income tax expenses arising on our U.K., Irish and other U.S. entities. Included in the 2003 income tax benefit is $2.1 million in respect of state taxes.
At December 31, 2004, our fixed income portfolio had 1,773 positions and $12.0 million of gross unrealized losses. No single position had an unrealized loss greater than $0.9 million. There were $42.1 million of unrealized gains on the remainder of the portfolio. There were 44 private securities in an unrealized loss position totaling $0.7 million. At December 31, 2003 our fixed income portfolio had 1,375 positions and $14.6 million of gross unrealized losses. No single position had an unrealized loss greater than $1.6 million. There were $37.0 million of unrealized gains on the remainder of the portfolio. There were 34 private securities in an unrealized loss position totaling $0.8 million.
The following tables provide information on the length of time securities have been continuously in an unrealized loss position:
The expected maturity dates of our fixed maturity investments that have an unrealized loss at December 31, 2004 and 2003 are presented in the table below.
At December 31, 2004, total capitalization was $1.3 billion compared to $964.3 million and $623.6 million at December 31, 2003 and 2002, respectively. Total capitalization is analyzed as follows:
The $340.7 million increase in capitalization in 2003 is due primarily to the net proceeds of our 2003 equity offering of $180.1 million, the net proceeds of the offering of HyCUs which are included in mezzanine equity of $138.2 million, the trust preferred securities offerings of $30.0 million, net income for the year of $27.3 million and increases in other comprehensive income. These increases have been offset by dividends paid of $6.2 million. Other comprehensive income consists of the unrealized appreciation on investments, the cumulative translation adjustment arising from the translation of Scottish Re Holdings Limited's balance sheet at exchange rates as of December 31, 2003 and a minimum pension liability adjustment at December 31, 2002, only.
On November 22, 2002 we completed the private offering of $115.0 million of 4.5% Senior Convertible Notes due 2022 (which included an over allotment option of $15.0 million) in which we raised aggregate net proceeds of $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.
On May 12, 2004, we privately placed $32.0 million of trust preferred securities (the "2034 Trust Preferred Securities") which were issued by a trust subsidiary holding a thirty year $32.0 million aggregate principal amount subordinated note of Scottish Holdings, Inc. which is guaranteed by Scottish Annuity & Life Insurance Company (Cayman) Ltd. Net proceeds were $31.0 million. Scottish Holdings, Inc. provided $30.0 million capital infusion to its direct subsidiary Scottish Re (U.S.), Inc. and used the remainder of the net proceeds for general corporate purposes.
On December 18, 2004, Scottish Financial (Luxembourg) S.a.r.l., a subsidiary of Scottish Annuity & Life Insurance Company (Cayman) Ltd., privately placed $50.0 million of trust preferred securities (the "December 2034 Trust Preferred Securities") which were issued by a subsidiary trust holding a thirty year $51.5 million aggregate
principal amount subordinated note of Scottish Financial (Luxembourg) S.a.r.l. which is guaranteed by Scottish Annuity & Life Insurance Company (Cayman) Ltd. Net proceeds were $48.5 million, which was used for general corporate purposes.
The proceeds from the Cypress Entities net of a commitment fee and other expenses amounted to $168.3 million.
The ordinary shares, the Class C Warrants and the 7.00% Convertible Junior Subordinated Notes purchased by the Cypress Entities are collectively referred to as the "Purchased Securities." The effective purchase price was $19.375 per ordinary share (the "Purchase Price"). Upon exercise of the Class C Warrants and conversion of the 7.00% Convertible Junior Subordinated Notes (which is subject to certain conditions as described below), the Cypress Entities will become the largest shareholder group of Scottish Re.
The Class C Warrants are exercisable at an exercise price equal to $0.01 per share. The number of ordinary shares for which the Class C Warrants are exercisable will be subject to customary anti-dilution adjustments. The Class C Warrants do not have voting rights and are not exercisable until (i) our shareholders approve (A) certain amendments to our Articles of Association to allow the Cypress Entities to hold more than 9.9% of our issued and outstanding ordinary shares, and (B) the issuance of more than 20% of our ordinary shares to the Cypress Entities, as required by New York Stock Exchange rules (the "Shareholder Proposals"), and (ii) requisite regulatory approvals have been obtained from insurance regulators in Delaware and the United Kingdom. Notwithstanding the foregoing, the Class C Warrants will become exercisable (i) immediately upon their transfer to an unaffiliated third party provided that such transfer complies with the ownership limitations contained in our articles of association or (ii) to the extent the exercise thereof would not cause the Cypress Entities to own in the aggregate greater than 9.9% of the ordinary shares then outstanding. Upon approval of the Shareholder Proposals and the receipt of all requisite regulatory approvals, the Class C Warrants will automatically be exercised for the applicable number of ordinary shares. In the event that a change of control of Scottish Re occurs and the Class C Warrants cannot be exercised in full for ordinary shares by the terms of our articles of association or by applicable law, the holders of Class C Warrants may require us to repurchase the unexercised Class C Warrants pursuant to the terms specified in the Class C Warrants.
Upon the approval of our shareholders and the receipt of all requisite regulatory approvals, the 7.00% Convertible Junior Subordinated Notes will automatically be converted into our ordinary shares at an initial conversion price of $19.375 per ordinary share, subject to customary anti-dilution adjustments. If upon approval of the Shareholder Proposals the requisite regulatory approvals have not been obtained, the 7.00% Convertible Junior Subordinated Notes will automatically be exchanged for additional Class C Warrants to purchase the number of ordinary shares into which the 7.00% Convertible Junior Subordinated Notes (including any accrued and unpaid interest through the date of conversion) were convertible. If we have sought approval of the Shareholder Proposals unsuccessfully at least twice, after December 31, 2005, we may redeem all (but not less than all) of the then-outstanding 7.00% Convertible Junior Subordinated Notes for cash at a redemption price per share equal to the greater of (i) an amount equal to, (A) if prior to December 31, 2007, the initial Purchase Price paid by the Cypress Entities for the 7.00% Convertible Junior Subordinated Notes, plus an amount calculated based on an annual, compounded internal rate of return equal to the Penalty Rate (described below) on such investment for the period from December 31, 2004 through December 31, 2007(applying the 19% Penalty Rate to such period), or (B) if after December 31, 2007, the principal amount thereof plus accrued and unpaid interest thereon through the date of repurchase, and (ii) the market value at the time of such redemption of the number of ordinary shares into which the 7.00% Convertible Junior Subordinated Notes are then convertible. In the event of a change of control of Scottish Re, we will be required to repurchase the 7.00% Convertible Junior Subordinated Notes pursuant to the terms specified in the 7.00% Convertible Junior Subordinated Notes.
Subject to certain limited exceptions, the Cypress Entities have agreed not to divest the Purchased Securities for a period of 12 months from the Closing Date. We have granted the Cypress Entities demand and piggyback registration rights as well as, subject to certain exceptions, preemptive rights.
Scottish Re, Pacific Life, and certain of Scottish Re Group Limited's officers and directors have also entered into Voting Agreements with the Cypress Entities. Under these agreements, each of the signatories has agreed to vote any ordinary shares held by them in favor of the Shareholder Proposals.
o even when Scottish Re (U.S.), Inc. is licensed, accredited, approved or authorized to write reinsurance in a state, it may agree with a customer to provide a reserve credit trust or letter of credit voluntarily to mitigate the counter-party risk from the customer's perspective, thereby doing transactions that would be otherwise unavailable or would be available only on significantly less attractive terms.
The facility may be increased to an aggregate principal amount of $200.0 million. The interest rate on each loan made under the facility, as determined by the nature of the loan, will be at (i) the Federal Funds Rate plus 0.50%, (ii) the prime rate as announced by Bank of America, N.A., or (iii) the British Bankers Association LIBOR Rate plus an applicable margin.
The facility requires that Scottish Annuity & Life Insurance Company (Cayman) Ltd. maintain a minimum amount of shareholders' equity, a debt to capitalization ratio of less than 20% and uncollateralized assets of 1.2 times borrowings. In addition, the facility requires that Scottish Re maintain a minimum amount of shareholders' equity, and a debt to capitalization ratio of less than 30%. The facility also requires that Scottish Re (U.S.), Inc.
ING is obligated to maintain collateral for the Regulation XXX and AXXX reserve requirements of the business we acquired from them for the duration of such requirements (which relate to state insurance law reserve requirements applying to reserves for level premium term life insurance policies and universal life policies). We will pay ING a fee based on the face amount of the collateral provided until satisfactory alternative collateral arrangements are made. In the normal course of business and our capital planning we are always looking for opportunities to relieve capital strain relating to XXX reserve requirements for our existing business as well as the business acquired from ING. We anticipate implementing capital markets related solutions relating to these requirements as cost efficient opportunities arise.
The Pass-Through Trust expects to pay income distributions on the Pass-Through Certificates monthly, commencing February 14, 2005, at a rate per annum equal to 5.902%. The Pass-Through Trust expects to repay the stated amount of the Pass-Through Certificates on January 12, 2015. The Pass-Through Certificates are not subject to redemption prior to the scheduled maturity date other than as a result of certain tax events. The Investor Trust expects to pay income distributions on the Investor Certificates monthly, commencing February 14, 2005, at a rate per annum equal to 5.902%. The Investor Certificates are not subject to redemption prior to the scheduled maturity date other than as a result of certain tax events. The Investor Trust expects to repay the stated amount of the Investor Certificates on January 12, 2015. Scottish Annuity & Life Insurance Company (Cayman) Ltd. expects to pay interest on the Funding Agreements monthly, commencing February 11, 2005 (which is one business day immediately preceding each distribution date on the Pass-Through Certificates and the Investor Trust Certificates), at a rate equal to the 30-Day CP Index Rate for the related accrual period plus 1.477%. Scottish Annuity & Life Insurance Company (Cayman) Ltd. has the right to redeem the Funding Agreements on any payment date selected
Orkney Holdings, LLC will rely upon the receipt of dividend payments from its wholly-owned subsidiary, Orkney Re, Inc., a special purpose financial captive insurance company incorporated under the laws of the State of South Carolina, to make payments of interest and principal on the Orkney Notes. The ability of Orkney Re, Inc. to make dividend payments to Orkney Holdings, LLC is contingent upon meeting certain regulatory requirements and upon the performance of the block of business retroceded by Scottish Re (U.S.), Inc. to Orkney Re, Inc. This block of business consists of specified term life insurance policies with guaranteed level premiums issued by third party ceding insurers and reinsured with Scottish Re (U.S.), Inc.
o nonpayment of interest when due and payable in accordance with the terms of the Orkney Notes;
o Scottish Re (U.S.), Inc. fails to make a required payment under certain tax agreements, and such failure remains unremedied for a period of 30 days after receiving notice;
o breach or misrepresentation of any representation or warranty under the Indenture by either Orkney Holdings, LLC or Orkney Re, Inc., if unremedied for a period of 30 days after receiving notice; or
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has agreed with Scottish Re Life Corporation that it will (1) cause Scottish Re Life Corporation to maintain capital and surplus equal to at least 175% of Company Action Level RBC, as defined under the laws of the state of Delaware and (2) provide Scottish Re Life Corp. with enough liquidity to meet its obligations in a timely manner.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Re have agreed with Scottish Re Limited that in the event Scottish Re Limited 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 Re) will assume all of Scottish Re Limited's obligations under such agreements.
Scottish Re and Scottish Annuity & Life Insurance Company (Cayman) Ltd. have executed similar agreements for Scottish Re (Dublin) Limited and Scottish Re Life (Bermuda) Limited and may, from time to time, execute additional agreements guaranteeing the performance and/or obligations of their subsidiaries.
The following table shows our contractual obligations and commitments as of December 31, 2004 including our payments due by period:
Our mezzanine equity is described in Note 19 to the Consolidated Financial Statements and consists of 5,750,000 HyCU. On February 15, 2007, we shall receive proceeds from the sale of our ordinary shares of $143.8 million as required by the purchase contract forming part of each HyCU. The proceeds from this offering will be used by us to repay the convertible preferred shares of $143.8 million on May 21, 2007.
Effective December 31, 2003, we adopted the disclosure requirements EITF 03-1. This EITF provides guidance on disclosures for other than temporary impairments of debt and marketable equity investments that have been accounted for under SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities". During the quarter ended September 30, 2004, the effective date of the application of EITF 03-01 for debt securities that are impaired because of interest rate and/or sector spread increases was delayed pending issuance of further guidance.
Some of the statements contained in this report are not historical facts and are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Forward looking statements include information
The information called for by this item is set forth in "Item 15: Exhibits, Financial Statement Schedules and Reports on Form 8-K."