The following GAAP statement of operations and balance sheet data relating to each of the years 1998 through 2002 has been derived from our annual consolidated financial statements audited by PricewaterhouseCoopers LLP, our independent accountants. Consolidated balance sheets as of December 31, 2002 and 2001, and the related consolidated statements of operations and comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2002, and related notes, appear in this Form 10-K beginning at page 48.
We encourage you to read the consolidated financial statements included in this Form 10-K because they contain our complete financial statements for the years ended December 31, 2002, 2001 and 2000. The results of operations for the year ended December 31, 2002 are not necessarily indicative of future results.
ORC’s and Hudson’s full year results are included in the combined statutory results for 1998 through 2002. Odyssey America’s full year results are included in the combined statutory results for 1999 through 2002.
Odyssey Re Holdings Corp. is a Delaware domiciled company which was incorporated on March 21, 2001 to serve as the holding company for Odyssey America and its subsidiaries, ORC, Hudson, UK Holdings and Newline. On June 19, 2001, OdysseyRe sold 17,142,857 shares of its common stock in an initial public offering. In connection with this offering, we acquired all of the outstanding shares of Odyssey America from subsidiaries of Fairfax, our ultimate majority shareholder, for an aggregate consideration of $988.8 million, consisting of $233.6 million in cash, a $200.0 million term note and 48 million shares of our common stock. The acquisition has been accounted for at historical cost in a manner similar to a pooling of interests. Accordingly, the consolidated financial statements of Odyssey America and its subsidiaries have become our historical financial information. On September 10, 2002, we acquired 56% of the common stock of First Capital Insurance Ltd., a Singapore insurance company, for consideration of $17.8 million.
Due to the improved pricing environment and our continued focus on underwriting discipline, our underwriting results have significantly improved. Our combined ratio was 99.1% for the year ended December 31, 2002, a decrease of 16.3 percentage points from the 115.4% combined ratio for the year ended December 31, 2001, which includes the effects of the terrorist attack of September 11th (“event of September 11th”) and the bankruptcy filing of Enron Corporation (Enron). Excluding these events, our combined ratio for the year ended December 31, 2002 improved by 4.0 percentage points to 99.1% from the 103.1% reported for the year ended December 31, 2001. This improvement is a direct result of our underwriting actions, including improvements in pricing as well as terms and conditions, and our opportunistic expansion into better performing lines of business.
The Americas is our largest division, accounting for $1.3 billion, or 69.7%, of our gross premiums written for the year ended December 31, 2002, as compared to $841.2 million, or 72.9%, of our gross premiums written for the year ended December 31, 2001. The Americas division writes treaty, both casualty and
property, and facultative casualty reinsurance in the United States and Canada, and treaty and facultative reinsurance in Central and South America, as well as primary business in the United States through Hudson, our insurance subsidiary. The Americas division is comprised of three units, the United States, Canada, and Latin America, with seven offices, located in Stamford, two offices in New York City, Mexico City, Miami, Santiago and Toronto. Gross premiums written by the United States unit for the year ended December 31, 2002 were $1.2 billion, an increase of $427.6 million, or 58.7%, compared to $728.1 million for the year ended December 31, 2001. Gross premiums written by the Latin American unit for the year ended December 31, 2002 were $116.8 million, an increase of $44.5 million, or 61.5%, compared to $72.3 million for the year ended December 31, 2001. The Canadian unit had gross premiums written of $40.8 million for the year ended December 31, 2002, an increase of $24.4 million, or 148.8%, compared to $16.4 million for the year ended December 31, 2001. The increases are due mainly to increased pricing both at the insurance and reinsurance levels. The London branch unit (business underwritten prior to 2001) had gross premiums written of $7.3 million for the year ended December 31, 2002, a decrease of $17.1 million compared to $24.4 million for the year ended December 31, 2001. Business previously written by the London branch unit is being written through the London Market division.
The EuroAsia division was formed in 2000 as part of the realignment of our business across geographic regions. EuroAsia operates out of four offices, with principal offices in Paris and Singapore. For the year ended December 31, 2002, the EuroAsia division had gross premiums written of $258.6 million, or 13.7% of our gross premiums written, compared to $146.5 million, or 12.7%, of our gross premiums written for the year ended December 31, 2001. For the years ended December 31, 2002 and 2001, our Paris office had gross premiums written of $186.7 million and $109.6 million, respectively. For the years ended December 31, 2002 and 2001, our Singapore office had gross premiums written of $68.8 million and $36.9 million, respectively. During the last quarter of 2002, First Capital had $3.2 million of direct premiums written. The EuroAsia division premiums are geographically dispersed, mainly throughout the European Union, followed by Japan, Eastern Europe, the Pacific Rim, and the Middle East. The EuroAsia division has been successful in taking advantage of the rate increases throughout its international scope of operations and in creating new market opportunities by leveraging its long-term ceding company and broker relationships.
respectively. As of December 31, 2002, we had total assets of $5.3 billion and total stockholders’ equity of $1.1 billion.
We derive our revenues from two principal sources: premiums from reinsurance assumed and insurance, net of premiums ceded (net premiums written); and income from investments. Net premiums written are earned (net premiums earned) as they are credited to revenue over the terms of the underlying contracts or certificates inforce. The relationship between net premiums written and net premiums earned will, therefore, vary depending generally on the volume and inception dates of the business assumed and ceded and the mix of such business between proportional and excess of loss reinsurance.
Gross Premiums Written. Gross premiums written for the year ended December 31, 2002 increased by $740.9 million, or 64.2%, to $1.9 billion from $1.2 billion for the year ended December 31, 2001. Insurance and reinsurance market conditions improved substantially on a global basis the past two years, providing the key factor for growth. The increase in premium volume is attributable to increases in the Americas division of $479.4 million, or 57.0%, the London Market division of $149.4 million, or 90.1% and the EuroAsia division of $112.1 million or 76.5%.
The increase in the Americas division is comprised of increases in treaty property excess of loss of $19.4 million, proportional property of $67.4 million, casualty excess of loss of $52.7 million, proportional casualty of $122.2 million, miscellaneous lines of $28.8 million, facultative reinsurance of $77.1 million and primary insurance through our subsidiary, Hudson, of $111.8 million.
The London Market division premium increase of $149.4 million is comprised of an increase in Newline of $65.9 million, principally in the financial lines of business of $109.8 million, offset by decreases in treaty reinsurance lines of business of $43.9 million previously written through Newline. The remaining increase of $83.5 million is from our London branch which is comprised of increases in all lines, property excess of loss of $15.3 million, property proportional of $7.9 million, casualty excess of loss of $9.9 million, marine and aerospace excess of loss of $13.4 million, proportional marine and aerospace of $30.1 million and casualty proportional of $6.9 million. The London Market division in general, and Newline in particular, has experienced a resurgence of opportunities from domestic and international business.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses for the year ended December 31, 2002 increased by $261.4 million, or 36.0%, to $987.2 million from $725.8 million for the year ended December 31, 2001. The increase in losses is a direct result of the increase in net premiums earned. The losses and loss adjustment expense ratio for the year ended December 31, 2002 was 68.9% compared to 80.6% for the year ended December 31, 2001. The improved losses and loss adjustment expense ratio reflects the general improvements in primary and reinsurance pricing. Excluding the effects of the event of September 11th and Enron, the losses and loss adjustment expense ratio was 69.7% for the year ended December 31, 2001.
Acquisition Costs. Acquisition costs for the year ended December 31, 2002 were $362.3 million compared to $248.4 million for the year ended December 31, 2001 with the increase due to the premium growth. The resulting acquisition cost ratio, i.e., acquisition expenses expressed as a percent of earned premium, was 25.3% for the year ended December 31, 2002 compared to 27.6% for the year ended December 31, 2001. A decrease in acquisition expense ratio of 2.3 percentage points is attributable to the negotiation of lower commission and brokerage costs across the portfolio and mix of business. Excluding the event of September 11th, the acquisition costs for the year ended December 31, 2001 were $239.2 million and the resulting acquisition cost ratio was 26.3%.
increase in operating income. We recognized a tax benefit of $7.7 million for the year ended December 31, 2001 due to the effects of the event of September 11th and Enron.
The increase in premiums in the Americas division is comprised of an increase in treaty property business of $67.5 million, an increase in general casualty business of $9.0 million, an increase in the Latin American unit business of $31.7 million, an increase in primary insurance activities of $28.3 million and a decrease in facultative business of $10.8 million. These increases are attributable to improved pricing in general and specifically to certain classes of business that were substantially affected by poor industry fundamentals during the past few years. Premiums decreased in the London branch business by $58.4 million due to the transfer of business into Newline and treaty casualty business by $15.2 million in classes where pricing had not yet improved to a level of adequate profitability. Gross premiums written of $7.4 million related to the event of September 11th are included in the Americas division for the year ended December 31, 2001.
The London Market division’s premium increase of $58.1 million is comprised of increases in marine and aerospace business of $13.6 million and international casualty business of $14.9 million, property business of $34.0 million and financial lines of $17.1 million. These increases were partially offset by a decrease in the North American casualty business of $0.3 million and the North American Binding Authority and other lines of $21.2 million. Gross premiums written of $11.1 million related to the event of September 11th are included in the London Market division for the year ended December 31, 2001.
The EuroAsia division’s gross premiums written for the year ended December 31, 2001 were $146.5 million, compared to $0.4 million for the year ended December 31, 2000. This division was not active during the first nine months of 2000.
Net Premiums Written. Net premiums written for the year ended December 31, 2001 increased by $283.4 million, or 40.4%, to $984.7 million from $701.3 million for the year ended December 31, 2000. Net premiums written represents gross premiums written less ceded premiums written and is directly influenced by the items described in the preceding sections. Net premiums written for the year ended December 31, 2001 have been decreased by $10.3 million related to the event of September 11th.
The increase in other underwriting expenses for the year ended December 31, 2001 compared to the year ended December 31, 2000 is largely attributable to costs associated with the establishment of our EuroAsia division branches. In addition, we recognized $2.0 million of expenses for the year ended December 31, 2001 related to our restricted stock plan.
Other Expense (Income), Net. Other expense (income), net is comprised of amortization of positive and negative goodwill and other income or expense items. The total of these items for the year ended December 31, 2001 was $0.8 million income as compared to $3.8 million income for the year ended December 31, 2000.
Interest Expense. The Company incurred interest expense of $5.9 million for the year ended December 31, 2001 related to the debt obligations issued in 2001.
2001 from 110.8% for the year ended December 31, 2000. This improvement was due to the underwriting actions described above.
Our stockholders’ equity increased by $235.2 million, or 28.7%, to $1.1 billion as of December 31, 2002 from $820.9 million as of December 31, 2001. The increase was mainly attributable to net income of $208.2 million, and an increase in accumulated other comprehensive income, net of deferred taxes of $34.7 million offset by dividends paid to stockholders of $6.5 million for the year ended December 31, 2002. We have flexibility with respect to capitalization as the result of our access to the debt and equity markets. During August 2002, we filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission, which was declared effective by the Commission on December 2, 2002. The registration statement provides for the offer and sale by OdysseyRe of securities, including equity and debt securities, having a total initial offering price of up to $290.0 million.
An additional source of funds for OdysseyRe is the dividend capacity of its subsidiary, Odyssey America. During 2003, Odyssey America can pay dividends to us of $134.6 million, without prior regulatory approval. During 2002, Odyssey America paid $18.0 million in dividends to us.
In June 2002, we issued $110.0 million aggregate principal amount of 4.375% convertible senior debentures (“Convertible Debt”) due 2022. The Convertible Debt is redeemable at our option beginning on
June 22, 2005. Each holder of Convertible Debt may, at its option, require us to repurchase all or a portion of its Convertible Debt on June 22, 2005, 2007, 2009, 2012 and 2017. Under certain circumstances, each Convertible Debt holder can convert its Convertible Debt, in accordance with the terms of the indenture under which the Convertible Debt was issued, to 46.9925 shares of our common stock for every $1,000 principal amount of the Convertible Debt. The Convertible Debt is reflected on our balance sheet at a value of $110.0 million, the aggregate principal amount of Convertible Debt outstanding.
In December 2001, we issued $100.0 million aggregate principal amount of senior notes, pursuant to a private placement, due November 30, 2006. Interest accrues on the senior notes at a fixed interest rate of 7.49%, which is due semi-annually on May 31st and November 30th. The senior notes are redeemable prior to maturity at our option. Immediately following the issuance of the senior notes, we entered into an interest rate swap agreement, with Bank of America N.A., that effectively converted the fixed 7.49% interest rate into a variable interest rate of LIBOR plus 263 basis points, which was 4.1% as of December 31, 2002. The proceeds from the sale of the senior notes were used to prepay part of the principal amount outstanding under the $200.0 million term note. On June 26, 2002, we prepaid $10.0 million aggregate principal amount of senior notes. As of December 31, 2002, the aggregate principal amount of senior notes outstanding was $90.0 million.
In connection with the business of Newline, we executed a secured letter of credit and a trust account in favor of Lloyd’s, as is customary for operations in the Lloyd’s market. As of December 31, 2002, the letter of credit was valued at £69.5 million, or $111.9 million, and was secured by a pledge of $136.0 million of our investment securities. As of December 31, 2002, the trust account was valued at £31.2 million, or $48.8 million.
The term market risk refers to the risk of loss arising from adverse changes in market rates and prices.
We believe that we are principally exposed to four types of market risk related to our investment operations. These risks are interest rate risk, credit risk, equity price risk and foreign currency risk.
All market sensitive instruments discussed here relate to our investment assets which are classified as available for sale. As of December 31, 2002, our $3.1 billion investment portfolio is comprised of $2.0 billion of fixed income securities that are subject primarily to interest rate risk and credit risk.
The table below displays the potential impact of market value fluctuations on the fixed income securities portfolio as of December 31, 2002 and December 31, 2001, based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. This analysis was performed on each security individually.
As of December 31, 2002 and December 31, 2001, 8.9% and 6.8%, respectively, of our investment portfolio, including cash and cash equivalents, was in common stocks (unaffiliated and affiliated). Marketable equity securities, which represented approximately 7.2% and 4.9% on December 31, 2002 and 2001, respectively of our investment portfolio, including cash and cash equivalents, are exposed to equity price risk, defined as the potential for loss in market value owing to a decline in equity prices. A 10% decline in the price of each of these marketable equity securities would result in a decline of $22.2 million and $13.0 million as of December 31, 2002 and 2001, respectively in the fair value of the total investment portfolio.
Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2002, 2001 and 2000
Summary of Investments - Other than Investments in Related Parties as of December 31, 2002
Condensed Financial Information of Registrant as of December 31, 2002 and 2001 and for the years ended December 31, 2002 and 2001
Supplementary Insurance Information as of December 31, 2002 and 2001 and for the years ended December 31, 2002, 2001 and 2000
Supplementary Information Concerning Property/ Casualty Insurance Operations as of December 31, 2002, 2001 and 2000 and years ended December 31, 2002, 2001 and 2000
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Odyssey Re Holdings Corp. and its subsidiaries at December, 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management, our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 4 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standard 142, “Goodwill and Other Intangible Assets”.
The Company issued $200.0 million in debt obligations in June 2001 in connection with the offering (See note 18). During 2000, a tax liability was forgiven by Fairfax and has been reflected as a capital contribution (See note 12).
Odyssey Re Holdings Corp. (the “Company” or “OdysseyRe”) is a Delaware domiciled company which was incorporated on March 21, 2001, to serve as the holding company for its wholly owned subsidiary Odyssey America Reinsurance Corporation (“Odyssey America”) and Odyssey America’s subsidiaries, Odyssey Reinsurance Corporation (“ORC”), Odyssey UK Holdings Corporation (formerly known as TIG Re UK Holdings Corporation) (“UK Holdings”), Newline Underwriting Management Ltd. which owns and manages a syndicate at Lloyd’s, Newline Syndicate 1218 (collectively, “Newline”) and Hudson Insurance Company (“Hudson”). On September 10, 2002, OdysseyRe acquired 56% of First Capital Insurance Ltd. (“First Capital”), a Singapore insurance company. First Capital’s balance sheet is consolidated in the Company’s financial statements as of December 31, 2002, and its results of operations are consolidated from September 10, 2002, the date of acquisition.
The Company, through a review of its reinsurance contracts, has evaluated and estimated its exposure arising from the terrorist attack of September 11, 2001. The Company’s estimate is based on the most recent information available. The Company’s initial estimate, established in 2001, appears to be appropriate; accordingly, such estimate has not been revised during the year ended December 31, 2002. As additional information becomes available such estimate could be revised. Included in the Company’s consolidated statements of operations for the year ended December 31, 2001 is a net pre-tax loss of $95.0 million. The after tax loss, assuming a 35% tax rate, is $61.8 million. Considerable time may elapse before the adequacy of the Company’s estimates can be determined. With respect to the ceded underwriting loss, the reinsurance recoverable is with highly rated reinsurers and the Company does not foresee any potential credit risks.
(a) All of the Company’s fixed income securities, which include bonds and notes, redeemable preferred stocks, and equity securities, which include common stocks, are categorized as “available for sale”, and are recorded at their fair value based on quoted market prices. Unrealized appreciation or
Other invested assets include limited partnerships which are accounted for under the equity method. Other invested assets also include benefit plan trust accounts which are carried at fair value.
The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
(c) Acquisition costs (net of acquisition costs ceded), consisting principally of commissions and brokerage expenses incurred on business written under insurance policies and reinsurance contracts or certificates, are deferred and amortized over the period in which the related premiums are earned. Commission adjustments are accrued based on premiums and losses recorded by the Company. Deferred acquisition costs are limited to their estimated realizable value, which considers anticipated losses and loss adjustment expenses and estimated remaining costs of servicing the contracts or certificates, all based on historical experience. Realizability is determined without consideration of investment income.
(d) A purchase price in excess of net assets (“goodwill”), arising from a business combination, is tested for impairment at least annually. Goodwill is not subject to amortization. Unamortized deferred credits related to net assets acquired in excess of purchase price (“negative goodwill”) arising from a prior business combination is written-off as an extraordinary item. (See note 4).
(f) Effective June 19, 2001, the date of the offering, the Company, and its United States subsidiaries, filed a consolidated tax return. Prior to the offering, the Company, and its United States subsidiaries, were included in the federal income tax return as part of a consolidated tax group with Fairfax Inc., an affiliate, and its other eligible subsidiaries. The federal income tax provision was allocated to each of the companies in the consolidated group, pursuant to a written agreement, on the basis of each company’s separate return taxable income.
(h) The Company has identified its operating segments to reflect the way that management monitors and evaluates the Company’s financial performance. The Company operates in three segments: Americas, London Market and EuroAsia. The presentation of segments for the years ended December 31, 2002, 2001 and 2000 is reflected in note 19.
Company’s net income and net income per share (on a pro forma basis) for the year ended December 31, 2002 would have been as follows (in thousands, except for per share amounts):
(l) Payments of claims made by the Company as a reinsurer to the broker due to a reinsured company are recorded on the Company’s books as a paid loss at the time the cash is disbursed. The payment is treated as a paid claim to the reinsured. Premiums due the Company from the reinsured are recorded as receivables from the reinsured until the cash is received by the Company either directly from the reinsured or from the broker.
On May 31, 1996, Fairfax acquired all of the common stock of ORC and its wholly owned subsidiaries for $227.9 million. The acquisition was accounted for as a purchase, and on May 31, 1996, ORC had $2,168.9 million of assets and $1,857.4 million of liabilities resulting in negative goodwill of $83.6 million at the date of acquisition. On January 1, 2002, the Company, in accordance with the provisions of SFAS 141 and in conjunction with the adoption of SFAS 142, fully amortized its remaining negative goodwill of $36.9 million and reflected the amortization as a cumulative effect of a change in accounting principle in its statement of operations for the year ended December 31, 2002. The amortization of negative goodwill during each of the years ended December 31, 2001 and 2000 was $8.3 million and was reflected in other expense (income), net.
On April 13, 1999, Fairfax acquired all of the common stock of Odyssey America and its wholly owned subsidiaries, UK Holdings and Newline for $646.9 million. This acquisition was accounted for as a purchase. The purchase price has been allocated to assets acquired ($2,640.9 million) and liabilities assumed ($2,019.2 million) based on estimated fair market value at the date of acquisition with the balance of $25.2 million recorded as goodwill. SFAS 142 established new accounting and reporting standards for acquired goodwill. Goodwill is not subject to amortization and must be tested at least annually for impairment. Management has determined that the goodwill of $18.3 million, related to the acquisition of Odyssey America, reflected in other assets as of December 31, 2002 and December 31, 2001 has an indefinite life and is not
impaired; accordingly, the Company has not amortized its goodwill during the year ended December 31, 2002. For the years ended December 31, 2001 and 2000, the Company amortized $2.6 million of goodwill, which was reflected in other expense (income), net.
On September 10, 2002, OdysseyRe purchased 14 million common shares, which constitutes 56% of the issued and outstanding shares, of First Capital. Fairfax and its affiliates maintain the option to purchase the remaining shares in equal installments over the next two years. On December 23, 2002, OdysseyRe contributed its shares of First Capital to Odyssey America. First Capital is a public limited liability company incorporated under the laws of Singapore. Its principal activity is conducting general insurance business. The purchase price of $17.8 million has been allocated to assets acquired ($48.8 million) less liabilities assumed ($17.8 million) based on estimated fair market value at the date of acquisition with the balance of $0.7 million recognized as goodwill. The 44% minority interest ownership of $13.9 million has been reflected in other liabilities as of December 31, 2002.
The retroactive effect of the implementation of SFAS Nos. 141 and 142 on net (loss) income and basic and diluted (loss) income per share for the years ended December 31, 2001 and 2000 would be as follows (in thousands):
The composition of the fixed income securities, unaffiliated common stocks and short-term investments, which are carried at fair value, as of December 31, 2001, follows (in thousands):
The amortized cost and fair value (both in thousands) of fixed income securities as of December 31, 2002, by maturity, are shown below. Actual maturities may differ from maturities shown below due to the existence of call features or put features. In the case of securities containing call features, the actual maturity will be longer than the call date maturity used below if the issuer elects not to exercise its call feature. Total securities subject to call represent approximately 4% of the total fair value. In the case of securities containing put features, the actual maturity will be longer than the put date maturity used below if the investor elects not to exercise its put feature. Total securities containing the put feature represent approximately 23% of the total fair value.
The components of net investment income for the years ended December 31, 2002, 2001 and 2000 follows (in thousands):
The components of gross and net realized investment gains (losses) for the years ended December 31, 2002, 2001 and 2000 follows (in thousands):
Changes in unrealized net appreciation (depreciation) on investments, and the related tax effect, for the years ended December 31, 2002, 2001 and 2000 follows (in thousands):
Common stocks, at equity as of December 31, 2002, include the Company’s investments in TRG Holding Corporation (27.5% owned by Fairfax and its affiliates, including 13.0% owned by the Company), Advent Capital (Holdings) PLC (46.8% owned by Fairfax and its affiliates, including 15.0% owned by the Company) and Hub International Limited (27.9% owned by Fairfax and its affiliates, including 14.2% owned by the Company). Zenith National Insurance Corporation (“Zenith”) (42.0% owned by Fairfax and its affiliates, including 6.5% owned by the Company) is included in common stocks and carried at fair value. Fairfax entered into agreements which eliminates any voting or other direct or indirect control by Fairfax and its affiliates over the operations of Zenith.
of reinsurance ceded in the consolidated statements of operations. Direct, assumed, ceded and net amounts (in thousands and inclusive of amounts in note 7) for these items follows:
The Company has established a reserve for potentially uncollectible reinsurance recoverables. The reserve is based upon an evaluation of each retrocessionaire and estimates related to collectibility of individual balances. The reserve as of December 31, 2002 and 2001 was $31.1 million, and has been netted against reinsurance recoverable on loss payments. The Company has also established a reserve for potentially uncollectible assumed reinsurance balances of $5.8 million as of December 31, 2002 and 2001, which has been netted against reinsurance balances receivable.
ORC is the beneficiary of a stop loss reinsurance agreement with ORC Re Ltd., a wholly owned subsidiary of Fairfax (the “1995 Stop Loss Agreement”). Pursuant to the agreement, ORC ceded premium of $60.5 million for an aggregate limit of $175.0 million in excess of its December 31, 1995 reserves for unpaid losses and allocated loss adjustment expenses and potentially uncollectible reinsurance recoverables. Ceded losses and loss adjustment expenses incurred for the years ended December 31, 2002, 2001 and 2000 of $17.5 million, $19.0 million and $16.0 million, respectively, related to the stop loss agreement are included in the accompanying statements of operations and note 7. Reinsurance recoverable on paid and unpaid losses related to this agreement of $122.5 million and $105.0 million as of December 31, 2002 and 2001, respectively, are reflected in the accompanying balance sheets and is secured by letters of credit or cash.
Investment management agreements have been entered into between the Company and its subsidiaries and Hamblin Watsa Investment Counsel Ltd. (“Hamblin Watsa”), a wholly owned subsidiary of Fairfax. Pursuant to the agreements, basic and incentive fees, based upon total invested assets, are paid to Hamblin Watsa. For the years ended December 31, 2002, 2001 and 2000, $3.3 million, $3.6 million and $2.3 million, respectively, of such fees are included in the consolidated statements of operations.
Current federal and foreign income taxes were recoverable from Fairfax Inc. of $7.0 million as of December 31, 2001 (See note 12).
The components of comprehensive income for the years ending December 31, 2002, 2001 and 2000 are shown in the following table (in thousands):
Inclusion of the unvested portion of the restricted common stock granted under the Odyssey Re Holdings Corp. Restricted Share Plan would have an anti-dilutive effect on the 2001 diluted earnings per share (i.e., the diluted earnings per share would be greater than the basic earnings per share); accordingly, such shares were excluded from the calculation of the 2001 diluted earnings per share.
The following table summarizes the status of the Plan (in thousands):
following tables set forth the amounts recognized in the Company’s consolidated financial statements as of December 31, 2002 and 2001 (in thousands):
to the first 6% of pay. The maximum matching contribution is 4% of pay with certain government mandated restrictions on contributions to highly compensated employees. The Company contributed $1.5 million, $0.8 million and $0.8 million to this plan in 2002, 2001 and 2000, respectively.
The Company provides certain health care and life insurance (“postretirement”) benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company. The Company’s cost for providing postretirement benefits other than pensions is accounted for in accordance with SFAS 106 “Employers’ Accounting for Postretirement Benefits Other Than Pensions”. The following tables set forth the amounts recognized in the Company’s consolidated financial statements as of December 31, 2002 and 2001 (in thousands):
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is assumed to be 9% in 2002 and decreasing to 5% in 2010 and remaining constant thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point would increase the accumulated postretirement benefit obligation by $0.8 million for 2002 and the service and interest cost components of net periodic postretirement benefit costs by $0.1 million for 2002. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation and the service and interest cost components of net periodic postretirement benefit cost for 2002 by $0.6 million and $0.1 million, respectively.
The weighted average fair value of each option granted is estimated on the date of grant using the Black Scholes Price Model with the following weighted average assumptions used for grants: expected volatility of 30.0%; risk-free interest rates ranging from 2.7% to 5.1%; annual dividend yield of 0.6%; and expected lives of five years for each grant.
During 2001, the Company adopted the Odyssey Re Holdings Corp. Stock Option Plan which provides for the grant of stock options to directors and key employees of the Company. Under the plan, such options will generally vest and become exercisable in two equal installments beginning on the fifth and tenth anniversary of the date of grant. As of December 31, 2002, 56,531 options were issued with an exercise price of zero. The Company has reflected $0.4 million of expense for the year ended December 31, 2002, which represents the vested portion of the stock options.
As a result of the initial public offering, the Company and its subsidiaries file a consolidated tax return. Prior to the offering, Odyssey America and its United States subsidiaries were part of the Fairfax Inc. United States consolidated tax return. For financial statement purposes, taxes are computed for the Company on a separate company basis. Accordingly, for financial statement purposes, net operating loss carryovers and alternative minimum tax (“AMT”) credit carryovers are also determined and maintained on a separate company basis. Deconsolidation from the Fairfax Inc. United States consolidated tax group occurred upon completion of the offering, as the interest of Fairfax Inc. in the Company dropped below 80% (see note 22). As of December 31, 2001, the Company had a net operating loss carryforward of $186.3 million, which was fully utilized during 2002.
Pre-tax operating income, before cumulative effect of a change in accounting principle from domestic companies, was $252.9 million, $25.0 million and $98.8 million for the years ended December 31, 2002, 2001 and 2000, respectively. Pre-tax operating income (loss) from foreign operations was $5.2 million, ($40.6) million and ($18.2) million for the years ended December 31, 2002, 2001 and 2000, respectively.
During 2002, the Company reflected a current tax expense related to taxable income reduced by the utilization of the net operating loss carryforward. During 2001 and 2000, the Company has reflected a current tax expense related to taxable income for the period prior to the offering.
Management believes that it is more likely than not that the Company will realize the benefits of its net deferred tax assets and, accordingly, no valuation allowance has been recorded for the periods presented.
Odyssey America has agreed, as of July 14, 2000, to guarantee the performance of all of the insurance and reinsurance contract obligations, whether incurred before or after the agreement, of Compagnie Transcontinentale de Réassurance (“CTR”), an affiliate, in the event CTR becomes insolvent and CTR is not otherwise indemnified under its guarantee agreement with a Fairfax affiliate. This guarantee was entered into as part of the redeployment of CTR’s business to Odyssey America. While Odyssey America’s potential exposure in connection with this guarantee is not reasonably quantifiable at this time, we deem it to be immaterial, as Fairfax has agreed to indemnify Odyssey America for all obligations under this guarantee.
In December 2002, Odyssey America and a retrocessionaire each demanded arbitration to resolve a dispute arising from an excess of loss retrocessional contract, effective January 1, 1998, pursuant to which the retrocessionaire reinsured Odyssey America for 50% of certain accident and health exposures assumed by Odyssey America from a third-party insurer. The dispute arose in October 2002 when the retrocessionaire asserted that the third-party insurer violated the reinsurance agreement with Odyssey America such that no further payments under the agreement should be made. Odyssey America is continuing to make payments to the third-party insurer on submitted claims pursuant to the reinsurance agreement, subject to a full reservation of rights.
Odyssey America intends to vigorously pursue the arbitration, and, to that end, has engaged the services of outside counsel. Odyssey America believes that it has a strong case against the retrocessionaire for full reinsurance coverage in accordance with the retrocessional contract. Nevertheless, at this early stage of the proceedings it is not possible to make any determination regarding the potential arbitration outcome, or the magnitude of any possible liability in the event of a determination adverse to Odyssey America.
The following is the consolidated statutory basis net income (loss) and policyholders’ surplus of Odyssey America and its subsidiaries, for the years ended and as of December 31, 2002, 2001 and 2000 (in thousands):
As of December 31, 2002 and 2001, $7.3 million of funds held under reinsurance contracts related to cash collateral has been provided in regard to the above mentioned indemnification agreements. The Company has also provided a $20.5 million LOC to ORC and a $0.5 million LOC to Hudson as of December 31, 2002, of which approximately $20.7 million has been used as collateral in regard to the indemnification agreements. The indemnification agreements do not affect the reinsurance recoverable balances as reported in the accompanying consolidated financial statements.
Activity in the liability for unpaid losses and loss adjustment expenses for the years ended December 31, 2002, 2001 and 2000 are as follows (in thousands):
The Company uses tabular reserving for workers’ compensation indemnity reserves and discounts such reserves using an interest rate of 3.5%. Losses have been discounted using the Life Table for Total Population: United States, 1979 - 1981. Reserves reported at present value were approximately $73.5 million and $70.6 million as of December 31, 2002 and 2001, respectively. The amount of case reserve discount was $37.7 million and $43.9 million as of December 31, 2002 and 2001, respectively. The amount of incurred but not reported reserve discount was $23.7 million and $13.2 million as of December 31, 2002 and 2001, respectively.
The Company’s reserves for asbestos and environmental related liabilities displayed below is from business written for accident years 1985 and prior. There is minimal exposure and no specific reported reserves in the more recent accident years. The Company’s asbestos and environmental reserve development, gross and net of reinsurance, for the years ended December 31, 2002, 2001 and 2000 is set forth in the table below (in thousands):
Our survival ratio for environmental and asbestos related liabilities as of December 31, 2002 is eleven years, reflecting full utilization of remaining indemnifications. Our underlying survival ratio for environmental related liabilities is eight years and for asbestos related liabilities is twelve years. The survival ratio represents the environmental impairment and asbestos related illness reserves, net of reinsurance, on December 31, 2002, plus indemnifications, divided by the average paid environmental and asbestos claims, net of reinsurance, for the last four years. Our survival ratio is eight years, prior to the reflection of indemnifications. Our survival ratio compares favorably with the United States Property and Casualty Industry average survival ratio of nine
years as published by A.M. Best in its special report on Asbestos and Environmental claims dated October 28, 2002.
In connection with the acquisition of Odyssey America and its subsidiaries, OdysseyRe issued a $200.0 million term note to a subsidiary of Fairfax, which was due between 2002 and 2004. The term note accrued interest using the three-month London Interbank Offered Rate (LIBOR) plus 225 basis points, payable quarterly. This debt has been fully extinguished by the proceeds from the senior notes, credit agreement and Convertible Debt described herein.
OdysseyRe’s debt obligations are subject to certain covenants, none of which significantly restricts the Company’s operating activities or dividend-paying ability. As of December 31, 2002, the Company was in compliance with all debt covenants.
The financial results of these divisions for the years ended December 31, 2002, 2001 and 2000 are as follows (in thousands):
The Company does not maintain separate balance sheet data for each of its operating segments. The business written and the experience for the Americas division includes the activities of its United States, Latin American and Canadian branch offices. The London branch business for underwriting years 2000 and prior is included in the Americas division. The London Market division is the business written and experience of the Company’s Lloyd’s Syndicate, and includes the business written by the London branch for underwriting year 2001 and subsequent business. The EuroAsia division was formed in mid-2000 and includes business written from its Paris and Singapore branches. Accordingly, the Company does not review and evaluate the financial results of its operating segments based upon balance sheet data.
On December 16, 2002, the Company announced it had entered into an agreement in principle to acquire the Healthcare division of the Specialty Risk Operations of TIG Insurance Company (“TIG”), OdysseyRe’s immediate majority stockholder. The Healthcare division specializes in the medical malpractice and hospital professional liability field.
In a related transaction, OdysseyRe plans to acquire one of TIG’s excess and surplus lines subsidiaries. OdysseyRe does not plan to assume liabilities associated with business written prior to its acquisition of this subsidiary. Prior to the closing of the acquisition of the non-admitted company, OdysseyRe will assume this
Odyssey Re Holdings Corp. was incorporated on March 21, 2001; accordingly, financial statement information for the year ended December 31, 2000 is not presented.
The condensed financial information of the registrant should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere herein.