of TREX common shares in connection with the Merger. Included in management fee was $2,512,000, $3,526,000 and $3,364,000 in 1996, 1995 and 1994, respectively, earned from TREX prior to the Merger.
(4) Until the fourth quarter of 1993, Transnational Reinsurance was a wholly-owned subsidiary of PXRE Reinsurance. On November 1, 1993, a registration statement relating to an initial public offering (the "Offering") by TREX of 5,750,000 shares of Class A common stock at $20.00 per share was declared effective. In conjunction with the formation of TREX and registration of TREX's Class A common stock in the Offering, all of the outstanding capital stock of Transnational Reinsurance was contributed by PXRE Reinsurance to TREX in exchange for the issuance of 1,535,848 shares of TREX's Class B common stock which caused PXRE Reinsurance's holdings of TREX's Class B common stock (when combined with the 100 shares of Class B common stock contributed to PXRE Reinsurance by PXRE in connection with the closing of the Offering) to constitute approximately 21% of all of the outstanding common stock of TREX immediately after the Offering. Thereafter, TREX, through Transnational Reinsurance, specialized principally in providing brokered property retrocessional reinsurance and marine and aviation retrocessional reinsurance in the United States and international markets pursuant to a Management Agreement with PXRE Reinsurance. As a result of this transaction, PXRE recorded a gain on sale in the fourth quarter of 1993 amounting to $10,564,000 on a pre-tax basis, representing the difference between PXRE Reinsurance's interest in the net assets of Transnational Reinsurance immediately after the Offering and the historical book value of its investment in Transnational Reinsurance. Subsequent to the Offering until December 11, 1996, PXRE accounted for its investment in TREX on the equity method as described in Note 1.
(5) During the second quarter of 1992, PXRE completed an offering of 1,059,800 depository shares, each representing 1/100 of a share of PXRE's Series A Cumulative Convertible Preferred Stock. The net proceeds of $24,403,000 were contributed to PXRE Reinsurance's surplus. During the first quarter of 1993, PXRE completed an offering of 2,300,000 shares of common stock. The net proceeds of $46,942,000 (except for $5,000,000 which was retained by PXRE for general corporate purposes) were contributed to PXRE Reinsurance's surplus. During the third quarter of 1993, PXRE completed an offering of $75,000,000 principal amount of 9.75% Senior Notes due 2003. The net proceeds of $72,150,000 (except for approximately $3,938,000 which was used by PXRE to repay all amounts outstanding under and retire a term loan facility and $15,000,000 which was retained by PXRE to provide support for debt service on the Senior Notes) were contributed to PXRE Reinsurance's surplus.
(7) The historical ratios of earnings to fixed charges were determined by dividing consolidated earnings by total fixed charges. For purposes of these computations (i) earnings consist of consolidated income before considering income taxes, fixed charges and minority interest and (ii) fixed charges consist of interest on indebtedness and that portion of rentals which is deemed by PXRE's management to be an appropriate interest factor. Earnings were inadequate to cover fixed charges by $7,615,000 for the year ended December 31, 1992. The historical ratios of earnings to combined fixed charges and preferred dividends were determined by dividing consolidated earnings by total fixed charges and preferred dividends. Earnings were inadequate to cover fixed charges and preferred dividends by $9,034,000 for the year ended December 31, 1992.
PXRE exercises discipline in committing and withholding its underwriting capacity and altering its mix of business to concentrate its underwriting capacity at any given point in time on those types of businesses where management believes that above average underwriting results can be achieved. PXRE has been pursuing a strategy of focusing on catastrophe-related coverages in both the international and domestic markets.
At December 31, 1996, PXRE was a party to three such retrocessional arrangements. One such arrangement is with a group of insurers referred to as the AMA; another is with Trenwick Group; and a third arrangement is with Investors Re, a Barbados reinsurer. Under these arrangements, PXRE cedes some of its underwritten risks to the participants, subject to maximum aggregate liabilities per reinsurance program. PXRE receives a management fee or commission of 5% of premiums ceded (4.2% for Investors Re) and a percentage of any ultimate underwriting profits in connection with the reinsurance ceded. Under the arrangements with these participants, such percentage of ultimate underwriting profits is subject to adjustment based on cumulative experience. Future management fee income is dependent upon the amount of business ceded to the participants and the profitability of that business.
In the past, PXRE has entered into other retrocessional arrangements providing catastrophic protection. In recent years, PXRE has reduced, upon renewal, its own catastrophe retrocessional facilities and has borne the associated increase in net exposures. As the cost of catastrophe retrocessional facilities has declined since 1995, PXRE has again commenced selectively purchasing such coverage, although PXRE did not purchase any significant catastrophe retrocessional coverage in 1995 or 1996.
In November 1993, PXRE sponsored the initial public offering of TREX to raise capital and take advantage of favorable conditions in the worldwide retrocessional reinsurance market. PXRE, through PXRE Reinsurance, retained a 21% ownership position in TREX and had responsibility for the day-to-day operations of TREX, including all the reinsurance operations of its subsidiary,
Transnational Reinsurance under the Management Agreement. TREX and Transnational Reinsurance had no paid employees.
Under the terms of the Management Agreement, Transnational Reinsurance shared in certain specified business of PXRE that was classified as property retrocessional reinsurance business, marine and aviation retrocessional reinsurance or marine and aviation reinsurance and facultative reinsurance. Transnational Reinsurance was also entitled to share similarly in other property reinsurance business, if any, which PXRE, from time-to-time, proposed that Transnational Reinsurance underwrite and which Transnational Reinsurance's Board of Directors approved.
Transnational Reinsurance paid PXRE an annual basic management fee under the Management Agreement equal to 5% of gross premiums written (including reinstatement premiums less return premiums) of Transnational Reinsurance and its consolidated subsidiaries (if any) as reflected in Transnational Reinsurance's statutory quarterly and annual statements filed with state insurance authorities. TREX and Transnational Reinsurance also paid all expenses directly attributable to them, including a proportionate share of PXRE's rental expenses with respect to office space based on gross premiums written for the management year and time spent by officers and employees of PXRE in connection with the preparation of reports filed by TREX with the SEC and proxy materials and annual reports sent to TREX shareholders.
finally retrocessionaires, require PXRE to make estimates of losses based on limited information from ceding companies and based on its own underwriting data. Because of the uncertainty in the process of estimating its losses from insured events, there is a risk that PXRE's liabilities for losses and loss expenses could prove to be inadequate, with a consequent adverse impact on future earnings and stockholders' equity. Additionally, as a consequence of its emphasis on property reinsurance, PXRE may forgo potential investment income because property losses are typically settled within a shorter period of time than casualty losses.
PXRE relies primarily on cash dividends and net tax allocation payments from its subsidiaries PXRE Reinsurance and Transnational Reinsurance to pay its operating expenses, to meet its debt service obligations and to pay common stock dividends to PXRE's stockholders. The payment of dividends by PXRE Reinsurance to PXRE, and by Transnational Reinsurance to PXRE Reinsurance, is subject to limits imposed under the insurance laws and regulations of Connecticut, the state of incorporation and domicile of PXRE Reinsurance and Transnational Reinsurance, as well as certain restrictions arising in connection with PXRE's outstanding indebtedness.
Ceded premiums for catastrophe programs for 1996 decreased 12.2% to $5,427,000 from $6,180,000 for the comparable period of 1995 primarily because of the lower cost of coverage purchased.
Other operating expenses increased to $12,262,000 for 1996 from $11,237,000 in 1995. The operating expense increase for 1996 primarily reflects an increase of $301,000 related to changes in benefit plans, additional staff salaries, increased incentive compensation and other related benefits.
Interest expense decreased to $6,957,000 in 1996 from $7,143,000 in 1995 due to PXRE Reinsurance's purchase of $3,050,000 par value of its parent company's 9.75% Senior Notes during the second and third quarters of 1996 at an average price of 106.1%.
Net premiums written for the year ended December 31, 1995, decreased 10.0% to $97,636,000 from $108,518,000 for the corresponding period of 1994. Gross premiums written for 1995 decreased 13.5% to $155,380,000 from $179,684,000 for 1994. Net premiums earned for the year ended December 31, 1995, decreased 12.2% to $97,142,000 from $110,601,000 in the year-earlier period. Gross written, net written and net earned premium decreased in 1995 which reflected PXRE's planned response to the trend of increased competition in the property catastrophe reinsurance market experienced since the end of 1994 and to loss activity in the aviation business. In response to these pressures during 1995, PXRE continued to accept some price concessions when consistent with exposures, moved to layers of risk that were less affected by competitive pressures, or reduced commitments where warranted.
Premiums ceded by PXRE to its managed business participants decreased 10.3% to $26,774,000 for 1995 compared with $29,842,000 for 1994. The decrease in premiums ceded to these programs was due to the decrease in the amount and percentage of gross premiums written by PXRE on behalf of the managed business participants. During 1995, pursuant to the Management Agreement, PXRE also ceded $24,790,000 of premiums compared to $28,722,000 during the corresponding period of 1994 to Transnational Reinsurance in lieu of direct reinsurance writings by Transnational Reinsurance. Management fee income from all sources for 1995 decreased to $6,417,000 from $6,992,000 in 1994. The decrease reflected loss activity that resulted in decreased profitability of business managed for other companies.
Ceded premiums for catastrophe programs for 1995 decreased 47.8% from the comparable period of 1994 primarily because of the lower level of ceded reinstatement premiums resulting from the reduced level of loss activity in 1995 and management's decision to commute certain reinsurance coverages subsequent to the first quarter of 1994.
The loss ratio was 35.7% for 1995 compared with 47.6% for 1994. The loss ratio for 1995 reflected incurred catastrophe losses of $28,439,000 gross and $20,073,000 net for 1995 and prior accident years as compared with $69,833,000 gross and $37,213,000 net for 1994 and prior accident years.
Significant catastrophe losses affecting the year ended December 31, 1994 loss ratio are as follows:
The underwriting expense ratio was 18.6% for 1995 compared with 14.8% for 1994. The increase was substantially due to the effect of a provision for contingent commissions related to the low level of losses incurred. As a result of the above, the combined ratio was 54.3% for 1995 compared with 62.4% for 1994.
Other operating expenses increased to $11,237,000 for 1995 from $8,365,000 in 1994. The operating expense increase for 1995 primarily reflects an increase of $1,653,000 related to changes in benefit plans, additional staff salaries, increased incentive compensation and other related benefits. Also contributing to the increases were additional costs of $216,000 under a new lease in Edison, New Jersey, and an increase in depreciation expense from the capital expenditures of $3,200,000 for PXRE's new facilities including additions to electronic data processing equipment. Included in other operating expenses were foreign currency exchange gains of $196,000 for 1995 compared to gains of $1,156,000 for 1994.
Interest expense decreased to $7,143,000 in 1995 from $7,789,000 in 1994 due to repurchase of $5,300,000 par value of PXRE's 9.75% Senior Notes, at prices from 99.25 to 99.625 during the fourth
Net income for the year ended December 31, 1995 included $5,948,000 which represents PXRE's approximately 21.9% equity share of TREX's net earnings as compared with $4,141,000 representing PXRE's approximately 21.2% share of TREX's net earnings in 1994. The change in the equity in TREX's earnings reflects the higher level of TREX's net income and the change in PXRE's ownership. The change in PXRE's ownership of TREX resulted from the repurchase by TREX of 270,100 shares of its publicly owned Class A shares during 1995.
In the event the amount of dividends available, together with other sources of funds, are not sufficient to permit PXRE to meet its debt service and other obligations and to pay cash dividends, it would be necessary to obtain the approval of the Connecticut Insurance Commissioner prior to the payment of additional dividends by PXRE Reinsurance (or Transnational Reinsurance). If such approval were not obtained, PXRE would have to adopt one or more alternatives, such as refinancing or restructuring its indebtedness or seeking additional equity. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. In the event that PXRE were unable to generate sufficient cash flow and were otherwise unable to obtain funds necessary to meet required payments of principal and interest on its indebtedness, PXRE could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all of the funds borrowed thereunder to be due and payable together with accrued and unpaid interest.
Default or Event of Default exists and the Consolidated Fixed Charge Coverage Ratio of PXRE would be greater than 2:1 after giving effect to the incurrence) and, in the case of the Restricted Subsidiaries, to issue preferred stock; (b) to pay dividends, repurchase stock and to make certain other Restricted Payments (other than, among other things, if no Default or Event of Default exists (x) Restricted Payments after August 31, 1993, not exceeding in the aggregate the sum of $3,000,000 plus 50% of Consolidated Net Income (or minus 100% of any loss) from such date (with certain adjustments), plus the amounts of certain equity proceeds and certain reductions in Investments in Unrestricted Subsidiaries, provided, that at the time of such Restricted Payment the Consolidated Fixed Charge Coverage Ratio is greater than 2.0, and (y) in addition to permitted Restricted Payments referred to in clause (x), the payment of cash dividends on Qualified Capital Stock after August 31, 1993 of up to an aggregate of $6,000,000, provided, that such dividends on common stock do not exceed $0.25 per share in any year); (c) to sell or permit the issuance of any stock of PXRE Reinsurance or any other Principal Insurance Subsidiary; (d) to sell or transfer other assets (other than for at least Fair Market Value and generally for not less than 75% in cash or Cash Equivalents); (e) to create liens upon the properties or assets of PXRE or its Restricted Subsidiaries; or (f) to engage in any business other than the insurance and reinsurance businesses and other businesses incidental and related thereto. The Indenture also provides that within 30 days after a Change of Control of PXRE, PXRE will offer to purchase all the Senior Notes then outstanding at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of such purchase.
The primary sources of liquidity for PXRE Reinsurance are net cash flow from operating activities (including interest income from investments), the maturity or sale of investments, borrowings, capital contributions, advances from PXRE and, subsequent to the Merger, dividends from Transnational Reinsurance. Funds are applied primarily to the payment of claims, operating expenses and income taxes
and to the purchase of fixed maturity and short-term investments. Premiums are typically received in advance of related claim payments.
Net cash flow provided by operations was $28,033,000 during 1996 compared with net cash flow provided by operations of $32,412,000 and $30,988,000 during 1995 and 1994, respectively, due to the effects of timing of collection of receivables and reinsurance recoverables and payments of losses.
Fixed maturity investments are reported at fair value, with the net unrealized gain or loss, net of tax, reported as a separate component of stockholders' equity. PXRE recorded directly to equity a $3,214,000 after-tax unrealized decrease in the value of its investment portfolio during 1996 reflecting an increase in interest rates during the period. Short-term investments are carried at amortized cost which approximates fair value. PXRE's short-term investments, principally high-grade commercial paper, were $59,792,000 at December 31, 1996 compared to $41,722,000 at December 31, 1995. The increase at December 31, 1996 was principally due to short-term investments acquired in the Merger.
During the fourth quarter of 1996, PXRE raised the quarterly dividend on its common stock from $0.18 per share to $0.21 per share. The increase in the dividend will result in an annual additional outlay of approximately $993,000, based on the shares outstanding prior to the Merger. An additional annual outlay of $4,771,000 will result from the shares exchanged as a result of the Merger.
In April 1995, PXRE's Board of Directors authorized the purchase of up to 700,000 shares of its common stock from time to time in open market or private block purchase transactions. Since inception of this purchase plan through December 31, 1996, PXRE purchased 531,400 of the 700,000 shares at a cost of $12,538,000.
In December 1996, PXRE completed an investment in Lloyd's, forming a new syndicate (PG Butler Syndicate 1224) and a presence in London. The new syndicate will have an initial capacity to underwrite 'L'35 million in annual premiums ($60 million at December 31, 1996 exchange rates) commencing with the 1997 renewal season. In connection with the capitalization of the syndicate, PXRE has placed on deposit $42,975,000 of U.S. government securities as collateral for Lloyds. In addition, PXRE issued a letter of credit for the benefit of Lloyds in the amount of $15,355,000, which is collateralized by U.S. government securities in approximately the same amount.
In January 1997, PXRE completed a $100 million offering of 8.85% Capital Trust Pass-through Securities'sm' (TRUPS'sm') through PXRE Capital Trust I in an institutional private placement. Proceeds of the transaction will be used for general corporate purposes, which may include the redemption or the purchase, from time-to-time, in the open market or in privately negotiated transactions or otherwise, of outstanding indebtedness and common stock of PXRE. The consent of holders of PXRE's Senior Notes to certain amendments to the Indenture governing the Senior Notes was obtained in connection with this offering.