On August 28, 2003, we changed our name to Scottish Re Group Limited from Scottish Annuity & Life Holdings, Ltd. In addition, our wholly owned subsidiaries World-Wide Holdings Limited and World-Wide Reassurance Company Limited changed their names to Scottish Re Holdings Limited and Scottish Re Limited, respectively.
We are a holding company organized under the laws of the Cayman Islands with our principal executive office in Bermuda. We are a reinsurer of 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, as well as around the world. We refer to this
portion of our business as Life Reinsurance North America. Scottish Re Holdings Limited and its subsidiary, Scottish Re Limited, specialize in niche markets in developed countries and broader life insurance markets in the developing world. We refer to this portion of our business as Life Reinsurance International. Life Reinsurance North America and Life Reinsurance International together are a reporting operating segment. To a lesser extent, we directly issue variable life insurance and variable annuities and similar products to high net worth individuals and families for insurance, investment and estate planning purposes. We refer to this portion of our business as Wealth Management, which is another reportable operating segment. Other revenues and expenses not related to Life Reinsurance or Wealth Management are reported in the "Other" segment.
o fee income from our variable life insurance and variable annuity products and from financial reinsurance transactions;
In our Wealth Management business, when we sell a variable life insurance policy or a variable annuity contract, we charge mortality, expense and distribution risk fees that are based on total assets in each policyholder's separate account. In the case of variable life insurance policies, we also charge a cost of insurance fee based on the amount necessary to cover the death benefit under the policy.
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.
During the year ended December 31, 2003, total revenues increased by 82% to $557.4 million. Total revenues include premiums earned in our Life Reinsurance operations, investment income on our invested assets, fee income on our Life Reinsurance and Wealth Management operations, realized losses on our investment portfolio and the change in the value of embedded derivatives. The increase in premiums earned is primarily due to continued growth in our Life Reinsurance North America and Life Reinsurance International segments. The increase in investment income is due to growth in our invested assets, which arises from business growth, our equity offering in July 2003 and our debt offerings in November and December 2002. The change in value of the embedded derivatives arises from the application of DIGB36.
income primarily due to the growth in our invested assets. The growth in our invested assets is due to the new business and the equity offering in April 2002.
During the year ended December 31, 2003 we implemented the requirements of DIG B36 which addresses whether SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" requires bifurcation of a debt instrument into a debt host contract and an embedded derivative if the debt instrument incorporates both interest rate risk and credit risk exposures that are unrelated or only partially related to the creditworthiness of the issuer of that instrument. Under DIG B36 modified coinsurance and coinsurance funds withheld reinsurance agreements where interest is determined by reference to a pool of fixed maturity assets, are arrangements containing embedded derivatives requiring bifurcation. In addition, reinsurance contacts with experience refunds are also considered to be arrangements containing embedded derivatives requiring bifurcation. DIG B36 was effective for fiscal quarters beginning October 1, 2003. We reviewed all contracts at October 1, 2003 and determined that the value of this derivative, net of related deferred acquisition costs, after taxation was a loss of $19.5 million. This is shown in the consolidated statements of income as a cumulative effect of change in accounting principle for the year ended December 31, 2003. The change in value of the derivative, net of related deferred amortization costs, during the quarter ended December 31, 2003 amounted to a gain of $13.9 million.
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 year ended December 31, 2003 and 2002 amounted to $2.0 million and $0.7 million, respectively.
During the year ended December 31, 2001 we implemented the requirements of EITF 99-20. EITF 99-20 applies to all securities, which represent beneficial interests in securitized assets, unless they meet certain exception criteria. A decline in fair value below the amortized cost basis is considered to be an other than temporary impairment whenever there is an adverse change in the amount or timing of cash flows to be received, regardless of the resulting yield, unless the decrease is solely a result of changes in market rates. At June 30, 2001 we reviewed all applicable securities and identified a write down of $406,000. This is shown in the consolidated statements of income as a cumulative effect of change in accounting principle.
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 mainly due to the public offering of 9,200,000 ordinary shares in July 2003 as discussed in Note 17 to the Consolidated Financial Statements.
$3.9 million in the year ended December 31, 2001. The losses in our Wealth Management operations arose principally from increased commission costs and severance payments. The losses in our Other segment arose because of reductions in investment income as we deployed more capital in the Life Reinsurance North America segment and increased costs in the first full year of our operations in Bermuda. Diluted earnings per ordinary share from continuing operations before cumulative effect of change in accounting principle amounted to $1.25 for the year ended December 31, 2002 an increase of 19% from 2001.
Diluted earnings per ordinary share for the year ended December 31, 2002 increased 21% to $1.23 from $1.02 in 2001. Diluted earnings per share increased as a result of the growth in net income described above. This increase has occurred despite the increase in the number of ordinary shares outstanding. The increase in the number of ordinary shares outstanding is a result of shares issued in the acquisition of Scottish Re Holdings Limited and the equity offering in April 2002 discussed in Note 17 to the Consolidated Financial Statements.
Premiums earned during the year ended December 31, 2002 increased 196% to $202.5 million compared with the same period in 2001. Premiums earned in 2002 increased due to the acquisition of Scottish Re Holdings Limited and the growth in the number of clients in our Life Reinsurance North America operations. Scottish Re Holdings Limited's premiums earned during the year amounted to $79.7 million. Premiums earned on the Life Reinsurance North America segment during the year ended December 31, 2002 increased 80% to $122.8 million from the same period in 2001.
Both Life Reinsurance and Wealth Management operations generate fee income. We earn fees in Life Reinsurance on certain of our financial reinsurance treaties that do not qualify under risk transfer rules for reinsurance accounting.
Fee income in our Life Reinsurance North America segment increased by 29% to $4.1 million for the year ended December 31, 2003 in comparison with the prior year period. The increases are due to continued growth in fee generating business in our Life Reinsurance North America segment. Wealth Management fees increased by 12% to $3.8 million during the year ended December 31, 2003. The overall growth in fees is principally due to the growth in segregated account balances, which is due to improved investment performance. The number of clients has decreased from 164 at December 31, 2002 to 154 at December 31, 2003. Segregated assets amount to $743.1 million and $653.6 million at December 31, 2003 and 2002, respectively. Policy face amounts totaled $1.1 billion and $936.8 million at December 31, 2003 and 2002, respectively.
Net investment income increased by $56.2 million or 109% to $107.9 million during the year ended December 31, 2002 compared to $51.7 million in the same period in 2001. The increase was due to the growth in
our average invested assets offset in part by decreases in realized yields. Our total invested assets increased significantly because of growth in our Life Reinsurance North America segment, assets acquired through the acquisition of Scottish Re Holdings Limited, investment of the proceeds of our equity offering in April 2002 and our convertible debt and capital securities offerings in November and December 2002. Total invested assets increased from $1.3 billion at December 31, 2001 to $2.3 billion at December 31, 2002. Funds withheld at interest grew from $562.4 million to $1.1 billion during 2002.
During the year ended December 31, 2002, average book yields were lower than in 2001, particularly on floating rate assets and cash. On the $1.1 billion portfolio managed by our external investment managers the yields on fixed rate assets were 5.84% and 7.09% at December 31, 2002 and 2001, respectively. The reduction in yield was due primarily to the much lower market yields at which new cash flows were invested and proceeds of maturities and sales were reinvested. Yields on floating rate assets are indexed to LIBOR. The yield on our floating rate assets decreased to 3.11% from 4.43%, and the yield on our cash and cash equivalents decreased to 1.48% from 2.20%. The volume of floating rate assets increased in 2002 as a result of our investing the proceeds of a $100.0 million floating rate funding agreement to earn a spread over the cost of funds.
During the year ended December 31, 2003, we recognized $1.9 million in losses in respect of "other than temporary impairments" on investments, impairment losses of $4.4 million under EITF 99-20 and $2.9 million (net of related deferred acquisition costs) of "other than temporary impairment losses" notified by ceding companies on contracts written on a modified coinsurance basis. These losses were offset by realized exchange gains of $1.3 million and net gains and losses on disposals of investments amounting to $3.5 million.
During the year ended December 31, 2002, realized losses amounted to $10.8 million net of associated amortization of deferred acquisition costs. 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.
Management reviews securities with material unrealized losses and tests for "other than temporary impairments" on a quarterly basis. Factors involved in the determination of 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. We review all investments with fair values less than amortized cost, and pay particular attention to those that have traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months and other assets with material differences between amortized cost and fair value. Investments meeting those criteria are analyzed in detail for "other than 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.
Under EITF 99-20, a decline in fair value below "amortized cost" basis is considered to be an "other than temporary impairment" whenever there is an adverse change in the amount or timing of cash flow to be received, regardless of the resulting yield, unless the decrease is solely a result of changes in market interest rates.
Credit Concern: transaction initiated due to a concern based on financial condition of issuer or industry
During the year ended December 31, 2003, there were gains of $13.9 million in respect of the valuation of the embedded derivatives in our modified coinsurance and funds withheld coinsurance contracts. These gains have been calculated in accordance with DIG B36 and are stated net of related deferred acquisition costs.
Claims and other policy benefits increased by 94% to $275.9 million in the year ended December 31, 2003 from $142.2 million in the same period of 2002. Claims and other policy benefits in our Life Reinsurance North America segment increased by 87% to $171.7 million in the year ended December 31, 2003 from $91.8 million in 2002. The increase is as a result of the increased number of clients and the increase in our traditional solutions business from these clients as previously described. Death claims are reasonably predictable over a period of many years, but are less predictable over shorter periods and are subject to fluctuation from year to year.
Claims and other policy benefits increased by 177% to $142.2 million in the year ended December 31, 2002 from $51.2 million in the same period of 2001. The increase is a result of the acquisition of Scottish Re Holdings Limited, the increased number of clients and the increase in our traditional solutions business from these clients in our Life Reinsurance North America segment. Scottish Re Holdings Limited's claims and other policy benefits were $50.4 million for the year ended December 31, 2002.
For the year ended December 31, 2002 interest credited to interest sensitive contract liabilities increased by $30.5 million or 174% to $48.1 million from $17.6 million in 2001. Interest credited includes interest in respect of a funding agreement for $100.0 million that we wrote in mid-year. The increase was due to interest credited on new 2002 reinsurance treaties and the funding agreement and increases in interest credited on treaties which commenced in prior years due to increasing average liability balances.
During the year ended December 31, 2003 acquisition costs and other insurance expenses increased by $55.9 million or 93% to $116.0 million from $60.1 million in 2002. The increase was a result of the increased life and annuity business in our Life Reinsurance North America and International segments.
Acquisition costs also includes the amortization of the present value of in-force business. As a result of the novation of the unit linked contract liabilities (as described in "Claims and Other Policy Benefits") the present value of the in-force on this business was fully amortized during 2003 resulting in an additional charge of $1.9 million in the year ended December 31, 2003.
Commissions and excise taxes vary with premiums earned. Other insurance expenses include direct and indirect expenses of those departments involved in the marketing, underwriting and issuing of reinsurance treaties. Of these total expenses a portion is deferred and amortized over the life of the reinsurance treaty or, in the case of interest sensitive contracts, in relation to the estimated gross profit in respect of the contracts.
We incurred interest expense of $7.6 million during the year ended December 31, 2003 in comparison with $1.4 million during 2002. Interest expense in 2003 comprises principally of interest on the $115.0 million of convertible debt issued in November 2002 and the $17.5 million capital securities issued in December 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, 2003, the average Standard & Poor's rating of the portfolio was "AA-," the average effective duration was 3.94 years and the average book yield was 4.46% as compared with an average rating of "AA-," an average effective duration 3.03 years and an average book yield of 4.93% at December 31, 2002. At December 31, 2003 the unrealized appreciation on investments, net of tax, was $16.8 million as compared with $8.9 million at December 31, 2002. The unrealized appreciation on investments is included in our consolidated balance sheet as part of shareholders' equity.
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 $805,000. At December 31, 2002 our fixed income portfolio had 930 positions and $16.1 million of gross unrealized losses. No single position had an unrealized loss greater than $1.3 million. There were $28.8 million of unrealized gains on the remainder of the portfolio.
Unrealized losses on securities that have been in an unrealized loss position for periods greater than two years amounted to $2.0 million and $478,000 at December 31, 2003 and 2002, respectively.
The following tables illustrate the industry analysis of the unrealized losses at December 31, 2003 and 2002.
The expected maturity dates of our fixed maturity investments that have an unrealized loss at December 31, 2003 and 2002 are presented in the table below.
Funds withheld at interest arise on contracts written under modified coinsurance agreements and funds withheld coinsurance agreements. In each case, the business reinsured consists of fixed deferred annuities. In substance, these agreements are identical to coinsurance treaties except that the ceding company retains control of and title to the assets. The deposits paid to the ceding company by the underlying policyholders are held in a segregated portfolio and managed by the ceding company or by investment managers appointed by the ceding company. These treaties transfer a quota share of the risks. The funds withheld at interest represent our share of the ceding companies' statutory reserves. The cash flows exchanged with each monthly settlement are netted and include, among other items, our quota share of investment income on our proportionate share of the portfolio, realized losses, realized gains (amortized to reflect the statutory rules relating to interest maintenance reserve), interest credited and expense allowances.
At December 31, 2003, funds withheld at interest totaled $1.5 billion with an average rating of "A-", an average effective duration of 5.06 years and an average book yield of 6.32% as compared with an average rating of "A", an average effective duration of 5.4 years and an average book yield of 6.49% at December 31, 2002. These are fixed income investments and include marketable securities, commercial mortgages, private placements and cash. Funds withheld at interest at December 31, 2003 includes $204.3 million arising on the acquisition of ERC Life. The market value of the funds withheld amounted to $1.6 billion at December 31, 2003.
Our cash flow from operations may be positive or negative in any period depending on the amount of new life reinsurance business written, the level of ceding commissions paid in connection with writing that business and the level of renewal premiums earned in the period.
At December 31, 2003, total capitalization was $964.3 million compared to $623.6 million at December 31, 2002. Total capitalization is analyzed as follows:
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 the 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.
In April 2003, we filed and had declared effective a registration statement with the Securities and Exchange Commission utilizing a "shelf" registration process relating to a number of different types of debt and equity securities. This shelf enables us to sell securities described in the registration statement up to a total of $500.0 million. Subsequent to the equity and Hybrid Capital Units offerings described below we have $21.6 million remaining on the shelf capacity.
o if the average closing price of our ordinary shares over a 20 day trading period ending on the fourth trading day before February 15, 2007 exceeds $19.32, a number of ordinary shares, based on the 20 day average closing price, equal to $25.00; and
In February 2004, we filed a registration statement with the Securities and Exchange Commission utilizing a "shelf" registration process relating to a number of different types of debt and equity securities. When declared effective, this shelf will enable us to sell securities described in the registration statement up to a total of $750.0 million. This shelf will increase our registration statement capacity from our previous shelf registration.
During 2003 we paid quarterly dividends totaling $6.2 million or $0.20 per share. During 2002, we paid quarterly dividends totaling $5.0 million or $0.20 per share.
b) a secured credit facility totaling $50.0 million. This facility provides a combination of borrowings and letters of credit. Interest rates on amounts borrowed under this facility is LIBOR plus 45 basis points. This facility expires in September 2004 but is renewable upon the agreement of both parties.
We must have sufficient assets available for use as collateral to support borrowings, letters of credit, and certain reinsurance transactions. With these reinsurance transactions, the need for collateral or letters of credit arises in four ways:
o when Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re (Dublin) Limited or Scottish Re Limited enters into a reinsurance treaty with a U.S. customer, we must contribute assets into a reserve credit trust with a U.S. bank or issue a letter of credit in order that the ceding company may obtain reserve credit for the reinsurance transaction;
o ERC Life is licensed, accredited, approved or authorized to write reinsurance in 50 states, the District of Columbia, Guam and the Federated States of Micronesia. When ERC Life enters into a reinsurance transaction with a customer domiciled in a state in which it is not a licensed, accredited, authorized or approved reinsurer, it likewise must provide a reserve credit trust or letter of credit; and
In addition, 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.
Our long-term debt is described in Note 15 to the Consolidated Financial Statements. Long term debt includes $115.0 million 4.5% senior convertible notes which are due December 1, 2022. The notes are subject to repurchase by us at a holder's option at various dates, the earliest of which is December 6, 2006. Long term debt also includes capital securities with various maturities from 2032 onwards. They are however, redeemable at earlier dates. They have been included in the above table at the earliest redemption date.
Our mezzanine equity is described in Note 16 to the Consolidated Financial Statements and consists of 5,750,000 HyCUs. 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.
On December 22, 2003, we completed the acquisition of ERC Life for $151.0 million in cash, subject to certain post closing adjustments. The adjustments are dependant on the completion of the audit of the 2003 financial statements of ERC Life prepared in accordance with U.S. statutory accounting principles. These financial statements are due to be delivered to us on March 31, 2004. We have estimated the post closing adjustment at approximately $20.0 million on the basis of information currently available. GE ERC has agreed to administer the business of ERC Life for up to nine months from the date of acquisition for a fee of $2.4 million.
In May 2003, FASB issued SFAS No. 150 "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities". This SFAS establishes standards for classification of financial instruments with characteristics of both liabilities and equity. We have adopted the provisions of SFAS 150. There were no changes to our financial position or results of operations.
We adopted DIG B36 on October 1, 2003. The initial adoption has resulted in a loss, after tax and after related amortization of deferred acquisition costs of $19.5 million. This has been recorded as a cumulative effect of change in accounting principle in our consolidated statement of income for the year ended December 31, 2003. The change in fair value of the derivative between October 1, 2003 and December 31, 2003 was a gain of $13.9 million, net of related amortization of deferred acquisition costs.
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 with respect to our known and unknown risks, uncertainties and other factors, which may cause the actual results to differ materially from the forward-looking statements. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," "may," "will," "continue," "project" and similar expressions, as well as statements in the future tense, identify forward-looking statements.
The effects of these factors are difficult to predict. New factors emerge from time to time and we cannot assess the potential impact of any such factor on the business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statement speaks only as of the date of this report and we do not undertake any obligation, other than as may be required under the Federal securities laws, to update any forward-looking statement to reflect events or circumstances after the date of such statement or to reflect the occurrence of unanticipated events.