Capital Re Corporation (the "Corporation") was incorporated in the State of Delaware in December 1991, and is the successor by merger to a Maryland corporation incorporated in 1986. The Corporation is an insurance holding company and has five wholly owned operating subsidiaries. Capital Reinsurance Company ("Capital Reinsurance"), domiciled in the State of Maryland, commenced operations in January 1988. Capital Reinsurance is engaged in the business of financial guaranty reinsurance, primarily the reinsurance of municipal and non-municipal bond insurance obligations. Capital Reinsurance also sells municipal and non-municipal credit risk protection through credit default swap transactions. Capital Mortgage Reinsurance Company ("Capital Mortgage"), a New York domiciled company, commenced operations in February 1994. Capital Mortgage reinsures only residential mortgage guaranty insurance obligations, which are originated principally in the United States and the United Kingdom. KRE Reinsurance Ltd. ("KRE"), a Bermuda domiciled company, commenced operations in March 1994. KRE is engaged in the business of reinsuring financial guaranty, mortgage guaranty and trade credit insurance, both as a direct reinsurer of third party primary insurers and as a retrocessionaire of Capital Reinsurance, Capital Mortgage, Capital Credit Reinsurance Company Ltd. ("Capital Credit") and Capital Title Reinsurance Company ("Capital Title"). KRE also provides integrated financial solutions, in the form of structured reinsurance products, to accident and health insurers and specialty property and casualty insurers. Capital Credit, also a Bermuda domiciled insurance company, commenced operations in February 1990. Capital Credit reinsures trade credit and political risk insurance concentrated in Western Europe and the United States and is a retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title, a New York domiciled insurance company, commenced operations in March 1996. Capital Title is engaged in the business of reinsuring title insurance policies.
For marketing purposes, the Corporation aggregates its reinsurance lines of business into two divisions: financial guaranty and financial risks. The financial guaranty division is composed of municipal and non-municipal financial guaranty reinsurance and credit default swaps. The financial risks division is composed of mortgage guaranty reinsurance, trade credit reinsurance, title reinsurance and financial solutions.
In November 1996, the Corporation acquired 100% of the issued shares of Tower Street Holdings Limited (now known as RGB Holdings, Ltd.), the holding company for RGB Underwriting Agencies Ltd. ("RGB"). RGB is a managing agency and presently manages four syndicates operating in the Lloyd's of London ("Lloyd's") insurance market. In connection with its acquisition of RGB, the Corporation established a corporate name at Lloyd's. In 1998, the Corporation commenced a plan of divestiture of its Lloyd's operations, and those operations are presented as a discontinued operation. Pending divestiture, the Corporation will continue to support its commitments to Lloyd's. For comparative purposes, all prior period financial statements have been restated.
In December 1996, the Corporation entered into a joint venture with GCR Holdings Ltd. ("GCR") to form a Bermuda based insurer, Capital Global Underwriters Limited ("CGUL"), which specializes in financial lines reinsurance. In April 1997, EXEL Limited ("EXEL") acquired GCR. In March 1998, EXEL sold its share of CGUL to Bermuda based ACE Bermuda Insurance, Ltd., and CGUL was renamed ACE Capital Re Ltd. The Corporation, through KRE, owns a fifty-percent economic interest in ACE Capital Re Ltd. and controls 9.9% of its voting stock. The Corporation accounts for its investment in ACE Capital Re Ltd. under the equity method.
On June 30, 1998, the Corporation completed a two for one stock split of its outstanding common shares. Prior period financial results have been restated to reflect the stock split. Additionally, as mentioned above, the Corporation's investment in Lloyd's, which was previously consolidated, is reflected as a discontinued operation
Net income from continuing operations for the year ended December 31, 1998 decreased 37.6% to $44.2 million from $70.8 million for the same period of 1997. On a per share basis, basic and diluted net income from continuing operations decreased to $1.39 and $1.35, respectively, for the year ended December 31, 1998 from $2.23 and $2.18, respectively, for the same period of 1997, or 37.7% and 38.1%, respectively.
Net operating income from continuing operations (net income from continuing operations excluding realized gains and losses and foreign exchange gains and losses) decreased 31.5% to $45.1 million for the year ended December 31, 1998 from $65.9 million for the same period in 1997. On a per share basis, basic and diluted net operating income from continuing operations decreased to $1.42 and $1.38, respectively, for the year ended December 31, 1998 from $2.07 and $2.03, respectively, for the same period of 1997, or 31.4% and 32.0%, respectively.
mortgage guaranty reinsurance business to assuming structured excess of loss mortgage guaranty reinsurance business.
Gross Premiums Written Year Ended December 31, 1998 1997 ---- ---- (dollars in millions)
Financial Risks Division: Mortgage 66.7 70.5 Credit 35.1 23.0 Financial Solutions 11.0 0.1 Title 5.7 4.0 ------ ------
Net Premiums Earned Year Ended December 31, 1998 1997 ---- ---- (dollars in millions)
premiums earned and normal expected loss development from the credit, mortgage and financial lines businesses. The expense ratios for the years ended December 31, 1998 and 1997 were 47.8% and 47.6%, respectively. The combined ratio, excluding expenses associated with non-insurance operations, increased to 99.2% for the year ended December 31, 1998 from 61.2% for the comparable 1997 period. This increase is a result of the Allegheny and CFS losses as well as the Corporation's mix of business, which is producing more business from lines with relatively higher combined ratios than that of the financial guaranty reinsurance business. For the year ended December 31, 1998, the combined ratio excluding the Allegheny and CFS losses was 67.1%.
Year Ended December 31, 1997 versus Year Ended December 31, 1996
Financial Risks Division: Mortgage 70.8 53.7 Credit 23.0 15.1 Financial Solutions 2.7 0.0 Title 4.0 1.8 ------ ------
For the year ended December 31, 1997, net premiums earned increased 24.8% to $115.3 million from $92.4 million for the comparable 1996 period. This increase was primarily due to growth in net premiums earned across all product lines of business. For the year ended December 31, 1997, net refunded earned premium decreased to $4.8 from $5.8 million for the comparable period in 1996. Excluding the effects of net refunded earned premium, net premiums earned increased 27.6% to $110.5 million for the year ended December 31, 1997 from $86.6 million for the year ended December 31, 1996. A refunding extinguishes the Corporation's reinsurance liability for the refunded obligation and the Corporation then recognizes revenue equal to the remaining related deferred premium revenue. For the years ended December 31, 1997 and 1996, ceded earned premium was $17.7 million and $14.7
Net Premiums Earned Year Ended December 31, 1997 1996 ---- ---- (dollars in millions)
Financial Risks Division: Mortgage 53.2 43.9 Credit 17.2 12.2 Financial Solutions 0.1 0.0 Title 3.6 1.6 ------ -----
For the year ended December 31, 1997, net investment income increased 9.5% to $56.5 million from $51.6 million for the comparable period in 1996. Growth in investment income was primarily attributable to a larger investment portfolio caused by an increase in invested assets from positive operating cash flows during the twelve months ended December 31, 1997. In addition, the Corporation recognized net realized gains of $8.0 million for the year ended December 31, 1997 compared to $1.5 million for the same period in 1996.
In January 1994, the Corporation formed and capitalized, through the purchase of common shares, Capital Re LLC. Capital Re LLC exists solely for the purpose of issuing preferred and common shares and lending the proceeds of such issuance to the Corporation to fund its business operations. In January 1994, Capital Re LLC issued $75.0 million of company obligated mandatorily redeemable preferred securities, the proceeds of which were loaned to the Corporation. The Corporation has, among other undertakings, unconditionally guaranteed all legally declared and unpaid dividends of Capital Re LLC. The company obligated mandatorily redeemable preferred securities were issued at $25 par value per share and pay monthly dividends at a rate of 7.65% per annum.
"Capital Commitments") in CGA to the extent that such investment would be necessary in order for CGA's operating subsidiary, Commercial Guaranty Assurance, Ltd. ("CG Assurance") to maintain its triple-A rating from Duff & Phelps Credit Rating Company ("D&P"). Additionally, KRE has a $20 million outstanding excess of loss reinsurance agreement with CG Assurance which responds when CG Assurance's credit losses under Policies reach certain catastrophic levels (including Policies issued in favor of the funding banks described below). Also in June 1997, Capital Reinsurance invested $0.1 million in St. George Holdings Ltd. ("St. George"). In response to market value declines in the insured portfolios of CGA and the resulting potential stress on its triple A rating from Duff & Phelps, the Corporation performed an analysis to determine the appropriate valuation of its investment in CGA for the 1998 year-end reporting period. The Corporation determined the investment in CGA had suffered a permanent impairment as defined under the guidelines of Generally Accepted Accounting Principles ("GAAP"). Based on its analysis the Corporation recorded a $7.5 million write-down.
As part of its business plan, through its operating subsidiaries (the "St. George Investment Subsidiaries"), St. George purchases investment grade, asset-backed securities to be held to maturity, selectively resold, or repackaged with CG Assurance Policies and then resold (the "Managed Portfolios"). The securities purchases are funded by bank loans advanced to the St. George Investment Subsidiaries. CG Assurance issues Policies to secure repayment to the funding banks. Under certain of the bank loan agreements, the St. George Investment Subsidiaries are required to provide additional collateral to the extent the market values of the Managed Portfolios fall below certain thresholds. Failure to satisfy the collateral requirements may result in the liquidation of the Managed Portfolios and, to the extent that proceeds from liquidation are insufficient to repay the bank loans, the St. George Investment Subsidiaries must pay any shortfall. If the St. George Investment Subsidiaries cannot pay the amount then due, CG Assurance is obligated to pay such amounts under its Policies issued in favor of the funding banks.
Cash flows from operations for the years ended December 31, 1998 and 1997, consisting of reinsurance premiums collected net of expenses, investment income and income taxes, were $161.9 million and $143.4 million, respectively. The Corporation believes that current levels of cash flow from operations provide the Corporation with sufficient liquidity to meet its operating needs. The Corporation's non-operating cash outflows are primarily dedicated to (i) fixed-income investment activity, (ii) the payment of dividends on its common shares, (iii) payments of interest on long-term debt and (iv) the payment of its loan obligations to Capital Re LLC.
At December 31, 1998, cash and investments were approximately $1.18 billion, an increase of $162.9 million, or 15.9%, from $1.02 billion at December 31, 1997. In managing its investment portfolio, the Corporation places a high priority on quality and liquidity. As of December 31, 1998, the entire investment portfolio was invested in highly rated fixed income securities.
At December 31, 1998, approximately $193.6 million, or 16.5%, of the Corporation's investment portfolio was composed of mortgage-backed securities ("MBS"). Of the MBS portfolio, approximately $167.5 million, or 86.5%, is backed by agencies or entities sponsored by the U.S. government as to the full amount of principal and interest. As of December 31, 1998, the entire MBS portfolio was invested in triple A rated securities.
On December 16, 1998, Standard & Poor's ("S&P") affirmed the triple A financial strength rating of Capital Reinsurance. In addition, S&P placed on Credit Watch, with negative implications, the financial strength ratings of Capital Mortgage (double "A"), KRE (double "A"), Capital Title (double "A" minus) and Capital Credit (single "A" plus). S&P took this action as a result of its perceived uncertainty resulting from changes in management that occurred in December 1998. Should S&P ultimately decide to downgrade the subsidiaries' financial strength ratings, certain reinsurance contracts could become subject to cancellation. However, the Corporation does not believe that a downgrade, if any, would be of the magnitude that would result in such cancellations.
The following table provides information about the Corporation's fixed maturity investments at December 31, 1998 that are sensitive to changes in interest rates. The table presents cash flows of principal amounts and related weighted average interest rates by expected maturity dates. The cash flows are based on the earlier of the call date or the maturity date or, for mortgage-backed securities, expected payment patterns. Actual cash flows could differ from the expected amounts.
allocation of internal personnel, the overall testing and remediation will be less than $50,000 as originally anticipated. The costs are being funded through operating cash flows and will be expensed as incurred.
A Year 2000 bug issue may manifest itself as (i) a failure of the Corporation's software, systems and general technology, (ii) a failure of a client's or vendor's software or systems which would impact the Corporation, and (iii) insurance claims against the Corporation due to Year 2000 issues. Management believes that the likelihood that a failure of the Corporation's software and systems would have a material effect on the business of the Corporation is minimal. The information technology and other systems are not critical to the carrying-on of the Corporation's business. Additionally, all critical accounting, financial reporting and human resources functions can be maintained on a manual basis for a period of time without materially impeding the operations of the Corporation. Similarly, a failure of clients and vendors to properly provide data or services will also not materially affect the Corporation's ability to continue its operations. Such a failure would likely be temporary and could be compensated for in the short-term by using manual alternatives to tracking business with our clients or vendors. Reinsurance losses pose the most reasonably likely worst case scenario for the Corporation arising out of Year 2000 bugs. The issue would originate with a default on debt service obligations of bond issuers due to the issuer's own Year 2000 bug difficulties. In the event of such a default, the Corporation's clients, the ceding companies, will be required to make debt service payments on behalf of the defaulting issuers. The Corporation will have to make prompt payment to its clients for its agreed upon portion of such losses. Such defaults by bond issuers would generally be of a technical nature, arising out of temporary inabilities to process payments or calculate payment amounts. Additionally, the defaulted debt service obligations would generally not require our clients, the ceding insurers, to make debt service payments on behalf of the issuers for a prolonged period. Once issuers or payment agents have cured any errors, they would resume debt service payment and reimburse the insurers for all payments made. Hence, the reasonable worst case scenario for the Corporation under such circumstances would involve liquidity pressure which should ease quickly. There is no way to quantify the potential exposure under this scenario as there has never been any event similar to the Year 2000. Consequently, it is difficult to make assumptions based on the Corporation's business. However, as the Corporation's operating units affected by such an occurrence already meet the rating agency stress test requirements designed to simulate depression-era conditions, the Corporation believes it can withstand temporary defaults of that magnitude based on the Year 2000 bug.
Report of Independent Auditors............................................. 57 Consolidated Balance Sheets................................................ 58 Consolidated Statements of Income.......................................... 60 Consolidated Statements of Comprehensive Income............................ 61 Consolidated Statements of Stockholders' Equity............................ 62 Consolidated Statements of Cash Flows...................................... 63 Notes to Consolidated Financial Statements................................. 64
We have audited the accompanying consolidated balance sheets of Capital Re Corporation and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Capital Re Corporation and Subsidiaries at December 31, 1998 and 1997 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
Capital Re Corporation (the "Corporation") was incorporated in the State of Delaware in December 1991, and is the successor by merger to a Maryland corporation incorporated in 1986. The Corporation is an insurance holding company and has five wholly-owned operating subsidiaries. Capital Reinsurance Company ("Capital Reinsurance"), domiciled in the state of Maryland, commenced operations in January 1988. Capital Reinsurance is engaged in the business of financial guaranty reinsurance, primarily the reinsurance of municipal and nonmunicipal bond obligations. Capital Reinsurance also sells municipal and nonmunicipal credit risk protection through credit default swap transactions. Capital Mortgage Reinsurance Company ("Capital Mortgage"), a New York domiciled company, commenced operations in February 1994. Capital Mortgage reinsures only residential mortgage guaranty insurance obligations which are originated principally in the United States and the United Kingdom. KRE Reinsurance, Ltd. ("KRE"), a Bermuda domiciled company, commenced operations in March 1994. KRE is engaged in the business of reinsuring financial guaranty, mortgage guaranty, and trade credit insurance both as a direct reinsurer of third party primary insurers and as a retrocessionaire of Capital Reinsurance, Capital Mortgage, Capital Credit Reinsurance Company, Ltd. ("Capital Credit") and Capital Title Reinsurance Company ("Capital Title"). KRE also provides integrated financial solutions in the form of structured reinsurance products to accident and health insurers and specialty property and casualty insurers. Capital Credit, also a Bermuda domiciled insurance company, commenced operations in February 1990. Capital Credit reinsures trade credit and political risk insurance concentrated in Western Europe and the United States, and is also a retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title, a New York domiciled insurance company, commenced operations in March 1996. Capital Title is engaged in the business of reinsuring title insurance policies.
In June 1997, the Corporation invested approximately $10.9 million in CGA Group Ltd ("CGA"), a Bermuda domiciled insurance company formed to provide financial guaranty insurance of structured securities, including commercial real estate and asset-backed transactions. The Corporation's investment was in the form of common and preferred shares.
The 1997 and 1996 financial statements have been reclassified to conform with the 1998 presentation.
Discontinued Operations: During 1998, the Corporation commenced a plan of divestiture of it Lloyd's operations. As a result, the related subsidiaries of the Corporation have been classified as discontinued operations and prior period results have been restated for comparative purposes. Unless otherwise noted, all footnote disclosures reflect continuing operations only.
Investments in Securities: The Corporation accounts for its investments in fixed maturity securities in accordance with FASB Statement No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities". Management determines the appropriate classification of securities at the time of purchase. At December 31, 1998 and 1997 investments in fixed maturity securities were designated as available-for-sale.
Premium Revenue Recognition: All premiums are earned over the terms of the risks covered under the Corporation's reinsurance contracts. Generally, premiums are received either in full at contract inception or in installments over the life of the covered risk. Financial guaranty premiums are typically received entirely at contract inception. For purposes of earnings recognition, premiums are allocated to each year in the term of the guaranty and are earned pro-rata over the period of risk. Receipts of installment premiums for financial guaranty and all other lines of business are generally earned on monthly pro-rata basis over the installment period.
Losses and Loss Adjustment Expenses: The liability for loss and loss adjustment expenses is determined according to management's loss expectations which are based on historical loss development patterns as well as reports and individual case estimates received from ceding companies where applicable. An estimate is also provided for losses and loss adjustment expenses for incurred but not reported losses for the mortgage guaranty and trade credit lines of business. Incurred but not reported losses are not estimated for the financial guaranty and title reinsurance lines of business since they are underwritten to a zero loss standard. Financial guaranty loss and loss adjustment expenses were discounted using an average rate of 5.5% in 1998 and 6.4% in 1997.
Income Taxes: In accordance with FASB Statement No. 109, "Accounting for Income Taxes," deferred federal income taxes are provided on the temporary difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in deductible or taxable amounts in future years when the reported amount of the asset or liability is recovered or settled. Such temporary differences relate principally to premium revenue recognition, deferred acquisition costs, and contingency reserve. The Internal Revenue Code permits companies writing financial guaranty insurance and mortgage guaranty insurance to deduct from taxable income amounts added to the statutory contingency reserve, subject to certain limitations. The amounts deducted must be included in taxable income in the tenth or twentieth year following the year of deduction dependent on the type of business, or in the event that incurred losses exceed certain statutorily established levels and the contingency reserve is released to cover such excess losses. However, the tax benefits obtained from such deductions must be invested in noninterest-bearing U.S. Government tax and loss bonds. The Corporation records purchases of tax and loss bonds as payments of federal income taxes.
As mentioned in Note 1, the Corporation has commenced a plan of divestiture of its Lloyd's operations. The sale is expected to be completed during 1999. The Corporation's commitments to Lloyd's are described in Note 16.
Cash and Investments $ 20,689 Deferred Acquisition Costs 19,727 Reinsurance Balances 50,052 Other Assets 40,768 ---------- Total Assets $131,236
Net Assets $5,855 Payable to Capital Re Corp 5,840 ---------- Net Assets of Discontinued Operation $ 11,695
Purchases of tax and loss bonds are reflected as admitted assets, while under GAAP they are recorded as federal income tax payments;
Consolidated GAAP net income $ 41,542 $ 70,052 $ 56,524 Premium revenue recognition (14,168) (899) (14,851) Deferred acquisition costs (7,392) (16,273) (9,011) Deferral of income taxes 4,728 8,460 11,489 Tax and loss bonds 1,581 4,848 Interest expense and minority interest in Capital Re LLC 13,150 13,137 12,633 Other, including noninsurance subsidiaries (5,219) (5,876) (4,091) ================================= Consolidated statutory net income $ 32,641 $ 70,182 $ 57,541 =================================
Net financial guaranty par in force was approximately $57.0 billion at December 31, 1998. The composition at December 31, 1998, by type of issue and the range of final maturities, was as follows: Range of Final Type of Issue Net Par in Force Maturities ------------------------------------------------------------------------- (Dollars in Billions) Tax-backed $15.8 1-40 years Utility 15.0 1-40 years Nonmunicipal 13.0 1-35 years Special revenue 6.4 1-40 years Health care 6.1 1-40 years Housing .7 1-40 years ----- $57.0 =====
On December 16, 1998, Standard & Poor's ("S&P") affirmed the triple A financial strength rating of Capital Reinsurance. In addition, S&P placed on Credit Watch with negative implications, the financial strength ratings of Capital Mortgage (double `A'), KRE (double `A'), Capital Title (double `A'minus) and Capital Credit (single `A' plus). S&P took this action as a result of its perceived uncertainty resulting from changes in management that occurred in December 1998. Should S&P ultimately decide to downgrade the subsidiaries' financial strength ratings, certain reinsurance contracts could become subject to cancellation. However, the Corporation does not believe that a downgrade, if any, would be of the magnitude that would result in such cancellations.
The following summarizes the Corporation's aggregate investment portfolio at December 31, 1998:
Approximately 16.4% of the Corporation's total investment portfolio of $1.2 billion at December 31, 1998 is comprised of mortgage-backed securities ("MBS"), including collateralized mortgage obligations. Of the securities in the MBS portfolio, approximately 86.5% are backed by agencies or entities sponsored by the U.S. government. As of December 31, 1998, the weighted average credit quality of the Corporation's entire investment portfolio was AA+.
Year ended December 31, 1998 1997 1996 -------------------------------- (Dollars in Thousands)
Under agreements with its cedants and in accordance with statutory requirements, certain of the Corporation's subsidiaries maintain fixed maturity securities in trust accounts for the benefit of
The increase in incurred losses in 1998 were principally from two financial guaranty losses in the amounts of $10.0 million and $44.1 million, as well as expected losses in the mortgage guaranty, trade credit and financial solutions reinsurance lines of business. The financial guaranty losses incurred in 1998 related to two discrete reinsured bond issuances. The $10 million loss was for bonds issued by a now bankrupt hospital system while the $44.1 million was for losses expected on securities backed by charged off credit cards. During 1997, incurred losses were principally
from the mortgage guaranty and trade credit reinsurance lines of business. Incurred losses in 1996 were caused primarily by increases in reserves estimated for mortgage guaranty losses. The increases for 1997 and 1996 are consistent with the expected loss development patterns for the respective lines of business.
Financial guaranty insurance of municipal and nonmunicipal debt obligations, is a form of credit enhancement which, as a specialized class of surety, provides for the unconditional and irrevocable guarantee of the obligor's scheduled payment of principal and interest on investment grade municipal and non-municipal debt obligations. The premiums related to municipal bond reinsurance are generally paid in full at the time of policy issuance, credited to a deferred premium account and then recognized as revenues over the life of the reinsured obligation. As a result, only a small portion of annual premium revenue is derived from premiums written in any one year. Given the zero loss underwriting standard, this multi-year revenue translates into an annuity of earned premiums, which is itself supplemented by the investment income derived from the deferred premiums account. Non-municipal financial guaranty premiums are generally paid in installments over the life of the underlying obligation, also providing an annuity of earned premiums.
proportional treaty lines. These contracts are generally of a one year duration and premiums are typically received in installments throughout the coverage period.
For purposes of financial planning, resource allocation and performance evaluation, segments are measured based on net underwriting profits and other income directly attributable to the segments. For segment reporting purposes, investment income, net realized gains/losses, operating expenses (i.e., salaries, rent, etc.), interest expense and income taxes are allocated to the segments. The mortgage segment includes equity income from an investment in a subsidiary engaged in mortgage related products. Management does not allocate assets to the Corporation's segments. Rather, assets are managed as a consolidated pool.
The following tables summarize the operating results of the Corporation's segments:
The Corporation derives the majority of its gross written premiums from a small number of primary insurers. The primary insurers which accounted for 10% or more of gross written premiums are as follows:
MBIA 15.7 12.4 14.9% CMAC 14.6 15.8 15.9 FSA 12.0 11.5 * PMI * * 10.7 FGIC * * 11.9
Capital Reinsurance is party to a credit facility with Deutsche Bank AG pursuant to which Deutsche Bank AG provides up to $100 million specifically designed to provide rating agency qualified capital to further support Capital Reinsurance's claims-paying resources. This agreement expires January 27, 2006.
During 1998, 1997 and 1996, the Corporation paid total interest of approximately $7.4 million, $7.4 million and $6.9 million, respectively.
The Corporation and its subsidiaries file a consolidated federal income tax return. The Corporation's effective federal corporate tax rate for 1998, 1997 and 1996 was 19.4%, 27.3% and 26.7%, respectively.
Tax provision at statutory rate $ 19,199 $ 34,107 $ 27,274 Tax-exempt interest (8,436) (7,751) (6,710) Other (96) 277 349 ---------------------------------- Total federal income tax provision $ 10,667 $ 26,633 $ 20,913 ==================================
During 1993, Capital Reinsurance entered into a multi-year nonproportional reinsurance contract which provides for aggregate loss protection of $80.0 million in exchange for $19.5 million of premium. Additional premiums may become payable dependent upon the level of losses incurred. During 1993, Capital Credit entered into similar multi-year reinsurance contracts which provide for aggregate loss protection of $34.0 million in exchange for $4.25 million in premiums. Additional premiums may also become payable dependent upon the level of losses incurred.
During 1994, Capital Reinsurance entered into a portfolio excess of loss reinsurance contract which provides $100.0 million aggregate loss protection on specified municipal obligations in excess of $82.0 million of losses. Capital Mortgage entered into a similar portfolio excess of loss reinsurance contract which provides $30.0 million aggregate loss protection in excess of a specified loss ratio covering all reinsured obligations. Premiums due on both contracts are not dependent upon the level of losses incurred.
During 1995, Capital Mortgage entered into an assumption agreement whereby it provides excess of loss reinsurance on an existing portfolio of mortgage pool insurance. In connection with this assumed transaction, Capital Mortgage is required to cede a portion of the risks, thereby reducing its total net retention. Total ceded premiums under the contract were approximately $21.0 million. Total expected assumed premiums of $56.0 million are payable in seven annual installments of $8.0 million. As of December 31, 1998, the Corporation has received four of the seven installments. Contingent commissions will be payable on the assumed reinsurance and receivable on the ceded reinsurance, dependent upon the level of losses incurred under the contract.
The fair value for fixed maturity securities shown in Note 8 is based on quoted market prices.
The fair value of the Corporation's deferred premium revenue is based on entering into a cession of the entire portfolio with third party reinsurers under market conditions. This figure was determined by using the statutory basis unearned premium reserve, net of commissions, and the present value of the estimated future cash flow stream from installment premiums. At December 31, 1998, the fair value of the Corporation's net deferred premium revenue was estimated to be $361.5 million.
Reserve for Losses and Loss Adjustment Expenses, Net of Reinsurance Recoverable on Ceded Losses
The fair value of the Corporation's $75.0 million of outstanding Debentures is determined based on the projected cash flows discounted by the sum of the seven-year U.S. treasury yield at December 31, 1998 and the appropriate credit spread for similar debt instruments. At December 31, 1998, the fair value of the Corporation's Debentures was estimated to be $80.2 million. The carrying amount of the Corporation's bank note payable of $25 million approximates fair value due to its floating interest rate provision.
Under Maryland's insurance law, the amount of surplus available for distribution as dividends is subject to certain statutory provisions, which generally prohibit the payment of dividends in any
twelve-month period without prior approval of the Maryland Commissioner of Insurance in an amount exceeding 10% of policyholder's surplus at the preceding December 31. The amount available for distribution from Capital Reinsurance during 1998 with notice to, but without prior approval of, the Maryland Commissioner of Insurance under the Maryland insurance law is approximately $32.3 million. During 1998, Capital Reinsurance paid dividends in the amount of $8.0 million to the Corporation.
Under New York Insurance Law, as a mortgage guaranty insurance corporation, Capital Mortgage may not pay dividends except from earned surplus as defined by New York Insurance Law. Capital Mortgage is further restricted from paying dividends to the extent that any dividend paid to shareholders which, together with all dividends declared or distributed by it during the preceding twelve months, exceeds the lesser of 10% of its surplus to policyholders as shown by its last statement on file with the superintendent, or 100% of adjusted net investment income during such period unless specifically allowed by the superintendent. To date, Capital Mortgage has not declared or paid any dividends. The maximum dividend payable by Capital Mortgage during 1998 is $0 since its earned surplus was ($9.2) million as of December 31, 1998.
The Corporation participates in the Lloyd's of London insurance market through its corporate name, CRC Capital Ltd. At the Corporation's direction, a letter of credit has been provided to Lloyd's in satisfaction of CRC Capital's capital requirement. All corporate capital providers are required by Lloyd's to post funds at Lloyd's equal to a fixed percentage of the amount of committed insurance capacity. For the year ended December 31, 1998, the total amount of insurance capacity committed by CRC Capital was British Pound Sterling 88.2 million, and CRC Capital's Funds at Lloyd's requirement was 50% of that amount and was supported by a letter of credit for British Pound Sterling 44.1 million. For the 1999 year, the Corporation increased its insurance capacity commitment to British Pound Sterling 95.0 million which is supported by a letter of credit of British Pound Sterling 47.5 million.
as deferred compensation and was amortized ratably over the four-year vesting period. Upon completion of the initial public offering in 1992, these shares became vested and all restrictions lapsed.
On April 15, 1992, the Corporation adopted the 1992 Stock Option Plan (the "1992 Option Plan"). The 1992 Option Plan enables key employees to benefit from appreciation in the price of the common stock of the Corporation. The 1992 Option Plan provides for grants of incentive stock options ("ISO"), which are intended to qualify under Section 422 of the Internal Revenue Code and of options which are intended not to so qualify ("NQSO"). Under the 1992 Option Plan, options may be granted at a price not less than 100% of the fair market value as determined on the date granted. ISO's and NQSO's awarded, vest in four equal yearly installments commencing one year after the date of grant. Once vested, options may be exercised at any time and expire ten years from the date of grant. According to the terms of the 1992 Option Plan, the aggregate number of shares subject to option awards may not exceed 1,450,000. During 1997, the Corporation adopted the 1997 Stock Option Plan ("1997 Plan"). The terms of the 1997 Plan are similar to those of the 1992 Option Plan, however, the number of shares subject to option award shall not exceed 1,000,000.
Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Corporation had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of 5.5%, 6.3% and 5.4%; dividend yields of .53%,.67% and .80%; volatility factors of the expected market price of
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Corporation's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' expected lives. The Corporation's pro forma information follows (in thousands, except for per share information):
Pro forma net income $ 40,080 $ 69,052 $ 56,030 Pro forma basic earnings per common share $ 1.26 $ 2.18 $ 1.79 Pro forma diluted earnings per common share $ 1.23 $ 2.12 $ 1.76
1998 1997 1996 ----------------------------- Weighted-average fair value of options granted during the year $10.89 $8.50 $5.21 - --------------------------------------------------------------------------
In February 1999, ACE Bermuda Insurance Ltd., a subsidiary of ACE Limited, agreed to invest $75 million in the Corporation through a purchase of common stock. The proceeds will be used to augment the surplus of the Corporation's operating subsidiaries. Under the stock purchase agreement, as amended, the purchase price is determined as the lower of (i) fully diluted GAAP book value per share at December 31, 1998 (or $18.87 per share) and (ii) the average of the highest five consecutive market closing prices of the Corporation's common stock from March 12, 1999 through April 15, 1999. Closing is contingent on customary conditions and the affirmation of S&P's financial strength ratings of the Corporation's major subsidiaries.