PROPERTIES Everest Re's corporate offices are located in approximately 115,000 square feet of leased office space in Liberty Corner, New Jersey. Bermuda Re's corporate offices are located in approximately 3,600 total square feet of leased office
space in Hamilton, Bermuda. The Company's other twelve locations occupy a total of approximately 64,000 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs.
The following is a discussion of the results of operations and financial condition of Everest Re Group, Ltd. and its subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto presented under ITEM 8.
ACQUISITIONS On September 19, 2000, Holdings completed the acquisition of all of the issued and outstanding capital stock of Gibraltar Casualty Company ("Gibraltar") from The Prudential Insurance Company of America ("The Prudential") for $51.8 million, which approximated book value. As a result of the acquisition, Gibraltar became a wholly owned subsidiary of Holdings and, immediately following the acquisition, its name was changed to Mt. McKinley Insurance Company ("Mt. McKinley"). In connection with the acquisition of Mt. McKinley, which has significant exposure to asbestos and environmental claims, Prudential Property and Casualty Insurance Company ("Prupac"), a subsidiary of The Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinley's reserves as of September 19, 2000. In addition, The Prudential guaranteed Prupac's obligation to Mt. McKinley. There were $78.9 million of cessions under this reinsurance at December 31, 2002, reducing the limit available under this contract to $81.1 million.
In connection with the Mt. McKinley acquisition, Prupac also provided excess of loss reinsurance for 100% of the first $8.5 million of loss with respect to certain of Mt. McKinley's retrocessions and potentially uncollectible reinsurance coverage. There were $0.0 million and $3.6 million of cessions under this reinsurance during the periods ending December 31, 2002 and 2001, respectively, reducing the limit available under the contract to $2.4 million.
Mt. McKinley, a run-off property and casualty insurer in the United States, has had a long relationship with Holdings and its principal operating company, Everest Reinsurance Company ("Everest Re"). Mt. McKinley was formed in 1978 by Everest Re and wrote insurance until 1985, when it was placed in run-off. In 1991, Mt. McKinley became a subsidiary of The Prudential. Mt. McKinley is also a reinsurer of Everest Re. Under a series of transactions dating to 1986, Mt. McKinley reinsured several components of Everest Re's business. In particular, Mt. McKinley provided stop-loss reinsurance protection, in connection with the Company's October 5, 1995 initial public offering, for any adverse loss development on Everest Re's June 30, 1995 (December 31, 1994 for catastrophe losses) reserves, with $375.0 million in limits, of which $103.9 million remains available (the "Stop Loss Agreement"). The Stop Loss Agreement and other reinsurance contracts between Mt. McKinley and Everest Re remain in effect following the acquisition. However, these contracts became transactions with affiliates effective on the date of the Mt. McKinley acquisition, and their financial impact is thereafter eliminated in consolidation. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for what management believes to be arm's-length consideration, all of its net insurance exposures and reserves to Bermuda Re.
During 2000, the Company completed two additional acquisitions, Everest Security Insurance Company ("Everest Security"), formerly known as Southeastern Security Insurance Company, a United States property and casualty company whose primary business is non-standard automobile insurance, and Everest International Reinsurance, Ltd. ("Everest International"), formerly known as AFC Re, Ltd., a Bermuda based life and annuity reinsurer.
INDUSTRY CONDITIONS The worldwide reinsurance and insurance businesses are highly competitive, yet cyclical by product and market. The terrorist attacks on September 11, 2001 (the "September 11 attacks") resulted in losses which reduced industry capacity and were of sufficient magnitude to cause most companies to reassess their capital position, tolerance for risk, exposure control mechanisms and the pricing terms and conditions at which they are willing to take on risk. The gradual and variable improving trend that had been apparent through 2000 and earlier in 2001 firmed significantly after the September 11 attacks. This firming generally took the form of immediate and significant upward pressure on prices, more restrictive terms and conditions and a reduction of coverage limits and capacity availability. Such pressures were widespread, with variability depending on the product and markets involved, but mainly depending on the characteristics of the underlying risk exposures. The magnitude of the changes was sufficient to create temporary disequilibrium in some markets as individual buyers and sellers adapted to changes in both their internal and market dynamics.
SEGMENT INFORMATION The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance on both a treaty and facultative basis through reinsurance brokers as well as directly with ceding companies within the United States. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the United States. The Specialty Underwriting operation writes accident and health ("A&H"), marine, aviation and surety business within the United States and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance through the Company's branches in London, Canada, and Singapore, in addition to foreign business written through the Company's New Jersey headquarters and Miami office. The Bermuda operation writes property, casualty, life and annuity business through brokers and directly with ceding companies.
Net premiums written increased by 69.1% to $2,637.6 million in 2002 from $1,560.1 million in 2001. This increase was a result of the increase in gross premiums written and the decrease in ceded premiums.
retrocessional program, respectively, with the 2001 accident year cessions relating principally to losses incurred as the result of the September 11 attacks.
Contributing to the increase in incurred losses and LAE in 2002 from 2001 were a 242.3% ($36.7 million) increase in the Bermuda operation, principally reflecting reserve strengthening with respect to Mt. McKinley asbestos exposures and increased premium volume, a 104.9% ($221.6 million) increase in the U.S. Insurance operation, principally reflecting increased premium volume coupled with changes in this segment's specific reinsurance programs, a 45.8% ($92.8 million) increase in the International operation, principally reflecting increased premium volume and a 19.2% ($86.3 million) increase in the U.S. Reinsurance operation, principally due to increased premium volume, partially offset by decreased catastrophe losses. These increases were partially offset by a 5.3% ($17.5 million) decrease in the Specialty Underwriting operation, principally attributable to decreased catastrophe losses. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
Net realized capital losses were $50.0 million in 2002, reflecting realized capital losses on the Company's investments of $142.8 million, which includes $101.3 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, of which $33.0 million were for WorldCom, partially offset by $92.8 million of realized capital gains, compared to net realized capital losses of $22.3 million in 2001. The net realized capital losses in 2001 reflected realized capital losses of $55.1 million, which included $22.6 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, which were partially offset by $32.8 million of realized capital gains.
Other expense was $2.1 million in 2002 compared to other income of $28.2 million in 2001. Significant contributors to other expense in 2002 were foreign exchange losses, normal provision for uncollectible audit premium in the U.S. Insurance
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 Premiums. Gross premiums written increased 35.3% to $1,874.6 million in 2001 from $1,385.6 million in 2000, as the Company took advantage of selected growth opportunities, while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 115.9% ($13.4 million) increase in the Bermuda operation, a 100.6% ($251.9 million) increase in the U.S. Insurance operation, principally attributable to growth in worker's compensation insurance, a 30.1% ($95.7 million) increase in the Specialty Underwriting operation, mainly attributable to growth in A&H medical stop loss writings, and a 26.7% ($128.8 million) increase in the U.S. Reinsurance operation, primarily reflecting improved market conditions. These increases were partially offset by a 0.2% ($0.8 million) decrease in the International operation. The Company continued to decline business that did not meet its objectives regarding underwriting profitability.
EXPENSES. Incurred loss and LAE increased by 36.7% to $1,209.5 million in 2001 from $884.6 million in 2000. The increase in incurred losses and LAE was principally attributable to an increase in business volume as reflected by the increase in net premiums earned, the impact of incurred losses relating to the September 11 attacks and the Enron bankruptcy and modest reserve strengthening in select areas, together with the impact of changes in the Company's mix of business. The Enron bankruptcy contributed $34.0 million of unusual losses in 2001 before cessions under the corporate retrocessional program. Incurred losses and LAE include catastrophe losses, which reflect the impact of both current period events and favorable and unfavorable development on prior period events and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss on property exposures of at least $5.0 million and has an event date of January 1, 1988 or later. Catastrophe losses, net of contract specific cessions but before cessions under the corporate retrocessional program in 2001, were $222.6 million, relating principally to the September 11 attacks, tropical storm Alison, the Petrobras Oil Rig loss and the El Salvador earthquake, compared to $13.9 million in 2000. Incurred losses and LAE in 2001 reflected ceded losses and LAE of $486.3 million compared to ceded losses and LAE in 2000 of $161.6 million, with the increase principally attributable to cessions relating to the September 11 attack losses and the Enron bankruptcy, together with the increased cessions under specific reinsurance arrangements in the U.S. Insurance operation. The ceded losses and LAE for 2001 reflect $164.0 million of losses ceded under the 2001 accident year aggregate excess of loss component of the Company's corporate retrocessional program. The ceded losses and LAE for 2001 and 2000 reflect $105.0 million and $70.0 million, respectively, of losses ceded under the 1999 accident year aggregate excess of loss component of the Company's corporate retrocessional program, with the amounts in both periods reflecting reserve strengthening in select lines, including with respect to 1999 accident year catastrophes.
Contributing to the increase in incurred losses and LAE in 2001 from 2000 were a 200.7% ($141.0 million) increase in the U.S. Insurance operation, principally reflecting increased premium volume, a 137.5% ($8.8 million) increase in the Bermuda operation, principally reflecting increased premium volume, a 41.5% ($131.9 million) increase in the U.S. Reinsurance operation, principally
INVESTMENTS. Net investment income increased by 12.9% to $340.4 million in 2001 from $301.5 million in 2000, principally reflecting the effect of investing the $406.0 million of cash flow from operations in 2001, partially offset by the lower interest rate environment and increased interest expense on funds held relating to the utilization of the 1999 and 2001 accident year aggregate excess of loss elements of the corporate retrocessional program. The following table shows a comparison of various investment yields as of December 31, 2001 and 2000, respectively, and for the periods then ended.
Net realized capital losses were $22.3 million in 2001, reflecting realized capital losses on the Company's investments of $55.1 million, which includes $22.6 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, partially offset by $32.8 million of realized capital gains, compared to realized capital gains of $0.8 million in 2000. The net realized capital gains in 2000 reflected realized capital gains of $30.9 million, which were partially offset by $30.1 million of realized capital losses. The net realized capital losses for 2001 allowed the Company to recapture taxes paid on net realized capital gains in prior periods. The realized capital gains in 2001 and 2000 arose mainly from activity in the Company's equity portfolio. The realized capital losses in 2001 and 2000 arose mainly from activity in the Company's fixed maturity portfolios.
Interest expense was $46.0 million for 2001 compared to $39.4 million in 2000. Interest expense for 2001 reflects $38.9 million relating to Holdings' senior notes and $7.1 million relating to Holdings' borrowing under its revolving credit facility. Interest expense for 2000 reflects $30.9 million relating to Holdings' senior notes and $8.5 million relating to Holdings' borrowing under its revolving credit facility.
Other income was $28.2 million in 2001 compared to $3.3 million in 2000. Other income for 2001 includes $25.9 million arising from a non-recurring receipt of shares in connection with the demutualization of a former insurance company client that had issued annuities to the Company in connection with certain claim settlement transactions. In addition, other income for 2001 includes foreign exchange gains as well as financing fees from Everest Security, offset by the amortization of deferred expenses relating to Holdings' issuance of senior notes. Significant contributors to other income for 2000 were foreign exchange
gains as well as financing fees from Everest Security, partially offset by net derivative expense and the amortization of deferred expenses relating to Holdings' issuance of senior notes. The foreign exchange gains and losses are attributable to fluctuations in foreign currency exchange rates.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. The Company continues to receive claims under expired contracts which assert alleged injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. The Company's asbestos claims typically involve potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. The Company's environmental claims typically involve potential liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damage caused by the release of hazardous substances into the land, air or water.
The Company's reserves include an estimate of the Company's ultimate liability for asbestos and environmental ("A&E") claims for which ultimate value cannot be estimated using traditional reserving techniques. There are significant
receivables, the Company has a reinsurance credit security committee that generally evaluates the financial strength of a reinsurer prior to entering into a reinsurance arrangement. Additionally, creditworthy foreign reinsurers of business written in the United States are generally required to secure their obligations. Management believes that adequate provision has been made for the Company's uncollectible balances. Actual uncollectible amounts may vary, perhaps substantially, from such reserves, impacting income in the period in which the change is made. See also Footnote 1 to Notes to the Consolidated Financial Statements.
INVESTMENT VALUATION. The Company's investment portfolio consists of investments available for sale and accordingly these securities are marked to market on a quarterly basis. Most securities are traded on national exchanges where market values are readily available. The Company holds some privately placed securities that are either valued by an investment advisor or by the Company using cash flow projections. Unrealized gains and losses from market fluctuations are reflected as comprehensive income, while market value declines that are considered other than temporary are reflected in the income statement as realized capital losses. The Company considerers many factors when determining whether a market value decline is other than temporary, including: (1) the length of time the market value has been below book value, (2) the credit strength of the issuer, (3) the issuer's market sector and (4) the length of time to maturity. Due to the uncertainty of these factors, investment losses may arise and could have a material adverse effect on the Company's future financial condition, results of operations and cash flows. See also Footnote 1 to Notes to the Consolidated Financial Statements.
FINANCIAL CONDITION CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and short-term investments, were $7,259.1 million at December 31, 2002, $5,783.5 million at December 31, 2001 and $5,493.0 million at December 31, 2000. The increase in cash and invested assets from 2001 to 2002 resulted primarily from $736.1 million in cash flows from operations generated in 2002, $346.3 million of net proceeds from the offering of common shares in February 2002, $203.4 million of net proceeds from Capital Trust's issuance of trust preferred securities in November 2002 and $135.9 million in net unrealized appreciation of the Company's investments. These increases were partially offset by $35.0 million in net payments on Holdings' credit facility and $22.9 million in share repurchases. The increase in cash and invested assets from 2000 to 2001 resulted primarily from $406.0 million in cash flows from operations generated in 2001 and $57.3 million in net unrealized appreciation of the Company's investments. These increases were partially offset by $130.0 million in net payments on Holdings' credit facility.
LOSS AND LAE RESERVES. Gross loss and LAE reserves totaled $4,905.6 million at December 31, 2002, $4,278.3 million at December 31, 2001 and $3,786.2 million at December 31, 2000. The increase in 2002 was primarily attributable to increased premiums earned, modest reserve strengthening in select areas and normal
variability in claim settlements. The increase in 2001 was primarily attributable to increased catastrophe losses resulting from the September 11 attacks, together with increased earned premiums and normal variability in claim settlements. Reinsurance receivables totaled $1,116.4 million at December 31, 2002, $895.1 million at December 31, 2001 and $509.0 million at December 31, 2000, with the changes in 2002 principally reflecting losses ceded under the accident year aggregate excess of loss element of the Company's corporate retrocessional program and losses ceded as part of a reinsurance agreement between Mt. McKinley and Prupac. At December 31, 2002, $440.0 million, or 39.4%, was receivable from subsidiaries of London Reinsurance Group ("London Life"). These receivables are effectively secured by a combination of letters of credit and funds held arrangements under which the Company has retained the premium payments due the retrocessionaires, recognized liabilities for such amounts and reduced such liabilities as payments are due from the retrocessionaire. In addition, $145.0 million, or 13.0%, was receivable from Continental Insurance Company ("Continental), which is partially secured by funds held arrangements, and $78.9 million or 7.1%, was receivable from Prupac, whose obligations are guaranteed by The Prudential. No other retrocessionaire accounted for more than 5% of the Company's receivables.
The Company generally has exposure to A&E losses through its Mt. McKinley operation with respect to insurance policies and through Everest Re with respect to reinsurance contracts. In each case, the Company's management and analysis of its exposures takes into account a number of features of its business that differentiate the Company's exposures from many other insurers and reinsurers that have significant A&E exposures.
The vast majority of Mt. McKinley's A&E exposed insurance policies are excess casualty policies, with aggregate coverage limits, which by definition also have protection afforded by underlying coverage. Mt. McKinley's attachment points vary but usually are protected by millions, often tens of millions, of dollars of underlying coverage. The excess nature of most of Mt. McKinley's policies also offers protection against non-product claims (for example, claims arising under general liability coverage). Although under some circumstances an excess policy could be exposed to non-product claims, such claims generally pose more of a risk to primary policies because non-product claims are generally less likely to aggregate. In addition, environmental claims arise under general liability coverage, and generally do not aggregate. Thus, these claims tend to create exposure for primary policies to a greater extent than excess policies.
Everest Re was formed in 1973 but was not fully engaged in underwriting casualty business under which A&E exposures generally arise until 1974, and it effectively eliminated A&E exposures through contract exclusions effected in 1984. Therefore, Everest Re has an approximate 11-year window of A&E exposure,
- -------------------------------------------------------------------------------- 1) Reported losses and paid losses for 2000 are net of ($311.3) million and $311.3 million, respectively, reflecting the establishment of Mt. McKinley's reserves at the acquisition date. Net paid losses, excluding the impact of the Mt. McKinley acquisition transaction, were ($42.3) million.
The gross reserves for asbestos and environmental exposures increased in 2002, principally due to an increase in management's estimate of the ultimate asbestos and environmental exposures, the effect of which was partially offset by paid losses. The net reserves for asbestos and environmental exposures decreased in 2002, principally due to an increase in losses ceded as part of a reinsurance agreement between Mt. McKinley and Prupac, the effect of which was partially offset by paid losses. The gross and net reserves for asbestos and environmental exposures in 2000 include Holdings' acquisition of Mt. McKinley.
not of absolute reserve adequacy, the Company considers, but does not rely on, the survival ratio when evaluating its reserves.
As noted earlier, there were developments in 2002 affecting asbestos exposures in general and the Company's asbestos exposures in particular. These developments together with enhancements in the Company's claim management and analytical processes resulted in the reserve strengthening noted earlier. These developments and actions have increased the emphasis on asbestos exposures as a separate component of the Company's A&E exposures. Despite the Company's approach of handling A&E exposures on a combined basis, management believes additional disclosure of the asbestos element of its A&E exposures is appropriate.
(1) Some totals may not reconcile due to rounding. (2) Under CIP agreements, payments depend upon the insured's actual claims experience and may be subject to annual caps or other controls on the rate of payment. (3) Actively Managed means that Mt. McKinley is managing the defense of claims against the insured. (4) Includes ($114.8) million of paid loss impact arising from the Mt. McKinley acquisition in 2000.
The Company's net three year survival ratio on its asbestos exposures was 9.7 years for the period ended December 31, 2002. This three year survival ratio when adjusted to exclude the CIP and actively managed reserves was 11.9 years, and when adjusted to exclude the CIP and actively managed reserves and to include stop loss protection from The Prudential was 14.8 years.
SHAREHOLDERS' EQUITY. The Company's shareholders' equity increased to $2,368.6 million as of December 31, 2002 from $1,720.5 million as of December 31, 2001, principally reflecting $346.3 million in net proceeds from the Company's offering of 5.0 million common shares in February 2002, $231.3 million of net income in 2002 and an increase of $104.2 million in net unrealized appreciation of investments, partially offset by $22.9 million in share repurchases and $16.3 million in shareholder dividends. Shareholders' equity increased to $1,720.5 million as of December 31, 2001 from $1,583.4 million as of December 31, 2000, principally reflecting an increase of $86.1 million in retained earnings, an increase of $44.8 million in net unrealized appreciation of investments and $10.0 million in common shares issued during the year in connection with the exercise of stock options. Dividends of $16.3 million, $12.9 million and $11.0 million were declared and paid by the Company in 2002, 2001 and 2000, respectively. During the year ended December 31, 2002, the Company repurchased 0.450 million of its common shares at an average price of $50.86 per share with all such repurchases occurring in the three months ended September 30, 2002. At December 31, 2002, 1.730 million shares remained under the existing repurchase authorization. As part of the Company's restructuring, the treasury shares held by the Company prior to February 24, 2000 were retired, resulting in a reduction to treasury shares with a corresponding reduction of paid-in capital and common shares.
On July 30, 2002, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission, providing for the issuance of up to $475.0 million of securities. Generally, under this shelf registration statement, Group may issue common shares, preferred shares, debt, warrants and hybrid securities, Holdings may issue debt securities and warrants and Capital Trust may issue trust preferred securities.
In November 2002, pursuant to a trust agreement between Holdings and JPMorgan Chase Bank, the property trustee, and Chase Manhattan Bank USA, the Delaware trustee, Capital Trust completed a public offering of $210.0 million of 7.85% trust preferred securities, resulting in net proceeds of $203.4 million. The proceeds of the issuance were used to purchase $210 million of 7.85% junior subordinated debt securities of Holdings that will be held in trust by the property trustee for the benefit of the holders of the preferred securities. Holdings used the proceeds from the sale of the junior subordinated debt for general corporate purposes and made capital contributions to its operating subsidiaries.
Capital Trust will redeem all of the outstanding trust preferred securities when the junior subordinated debt securities are paid at maturity on November 15, 2032. Holdings may elect to redeem the junior subordinated debt securities, in whole or in part, at any time after November 14, 2007. If such an early redemption occurs, the outstanding trust preferred securities will also be proportionately redeemed.
On March 14, 2000, Holdings completed public offerings of $200.0 million principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million principal amount of 8.5% senior notes due March 15, 2005. During 2000, the net proceeds of these offerings and additional funds were distributed by Holdings to Group. Interest expense incurred in connection with these senior notes was $38.9 million, $38.9 million and $30.9 million for the years ended December 31, 2002, 2001 and 2000, respectively.
LIQUIDITY. The Company's liquidity requirements are met on a short-term and long-term basis by funds provided by premiums collected, investment income and collected reinsurance receivables balances, and by the sale and maturity of investments, together with the availability of funds under the Company's revolving credit facility. The Company's net cash flows from operating
(1) Recoveries under the Stop Loss Agreement with Mt. McKinley prior to the acquisition of Mt. McKinley. (2) Net tax payments for 2001 include a $35.0 million payment to the Internal Revenue Service in connection with the Company's 1997 tax year liabilities. This one-time payment effectively settled a deferred tax liability relating to the tax basis losses incurred in the 1997 tax year. This payment, which related to a timing item, had no impact on the Company's results of operations for the period. (3) Non-recurring receipt of shares in a demutualized insurer.
The Company's current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable bond and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. The Company's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with the Company's current and projected operating results, market conditions and the Company's tax position. Proceeds from sales, calls and maturities and investment asset acquisitions were $2,822.1 million and $3,929.7 million, respectively, in 2002 compared to $1,492.2 million and $1,767.4 million, respectively, in 2001 and $1,006.5 million and $2,024.6 million, respectively, in 2000.
During the years ended December 31, 2002, 2001 and 2000, Holdings made payments on the Credit Facility of $80.0 million, $152.0 million and $0.0 million, respectively. During the years ended December 31, 2002, 2001 and 2000, Holdings had new Credit Facility borrowings of $45.0 million, $22.0 million and $176.0 million, respectively. As of December 31, 2002 and 2001, Holdings had outstanding Credit Facility borrowings of $70.0 million and $105.0 million, respectively. Interest expense incurred in connection with these borrowings was $3.5 million, $7.1 million and $8.5 million for the years ended December 31, 2002, 2001 and 2000, respectively.
The Company employs various techniques, including licensed software modeling, to assess its accumulated exposure. Such techniques are inherently more difficult to apply to non-property exposures. Accumulated exposures with respect to catastrophe losses are generally summarized in terms of the probable maximum loss ("PML"). The Company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years.
Management believes that the Company's greatest catastrophe exposure worldwide from any single event is to an earthquake affecting the west coast of the United States where the Company estimates it has a PML exposure of $338 million, including workers' compensation exposures. The Company further estimates that its PML exposure with respect to its greatest windstorm exposure, which relates to a hurricane affecting the east coast of the United States, is $264 million and that its single event International PML exposure is $197 million. There can be no assurance that the Company will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML.
For 2002 and initially in 2003, the Company has chosen not to purchase corporate retrocessional protection and to generally de-emphasize the purchase of specific reinsurance by its underwriters reflecting the Company's view that its exposures in the context of its capital and financial position do not warrant reinsurance purchases at current price levels. For both 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage, which provides up to $175.0 million of recoveries if Everest Re's consolidated statutory basis accident year loss ratio exceeds a loss ratio attachment point provided in the contract for the respective accident years. Each arrangement provides for an adjustment premium, which reduces the net benefit by approximately 50%, in the event that the coverage is used. The remaining limit available under these coverages is $85.0 million and $0.0 million, respectively. See ITEM 1 - "Risk Management and Retrocession Arrangements" for further details.
DIVIDENDS During 2002, 2001 and 2000, the Company declared and paid shareholder dividends of $16.3 million, $12.9 million and $11.0 million, respectively. As an insurance holding company, the Company is partially dependent on dividends and other permitted payments from its subsidiaries to pay cash dividends to its shareholders. The payment of dividends to Group by Holdings and to Holdings by Everest Re is subject to Delaware regulatory restrictions and the payment of dividends to Group by Bermuda Re is subject to Bermuda insurance regulatory restrictions. Management expects that, absent significant catastrophe losses, such restrictions should not affect Everest Re's ability to declare and pay dividends sufficient to support Holdings' general corporate needs and Holdings' and Bermuda Re's ability to declare and pay dividends sufficient to support Group's general corporate needs. See ITEM 1, "Business - Regulatory Matters - Dividends" and Note 13A of Notes to Consolidated Financial Statements.
portfolio, while maintaining an adequate level of liquidity. The Company's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with its current and projected operating results, market conditions, and the Company's tax position. The fixed maturities in the investment portfolio are comprised of non-trading available for sale securities. Additionally, the Company invests in equity securities, which it believes will enhance the risk-adjusted total return of the investment portfolio. The Company has also engaged in a small number of credit default swaps and specialized equity options, the market sensitivity of which is believed not to be material.
The Company's $7.3 billion investment portfolio is principally comprised of fixed maturity securities that are subject to interest rate risk and foreign currency rate risk, and equity securities that are subject to equity price risk. The impact of these risks on the investment portfolio is generally mitigated by changes in the value of operating assets and liabilities and their associated income statement impact.
Interest rate risk is the potential change in value of the fixed maturity portfolio, including short-term investments, due to change in market interest rates. In a declining interest rate environment, it includes prepayment risk on the $881.4 million of mortgage-backed securities in the $6.9 billion fixed maturity portfolio. Prepayment risk results from potential accelerated principal payments that shorten the average life and thus the expected yield of the security.
Foreign currency rate risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Each of the Company's foreign operations maintains capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Generally, the Company prefers to maintain the capital of its foreign operations in U.S. dollar assets, although this varies by regulatory jurisdiction in accordance with market needs. Each foreign operation may conduct business in its local currency as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the British Pound Sterling and the Euro. The Company mitigates foreign exchange exposure by a general matching of the currency and duration of its assets to its corresponding operating liabilities. In accordance with Financial Accounting Standards Board Statement No. 52, the Company translates the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income. The primary functional foreign currency exposures for these foreign operations are the Canadian Dollar, the Euro and the British Pound Sterling.
Although not considered material in the context of the Company's aggregate exposure to market sensitive instruments, the Company has issued five specialized equity put options based on the Standard & Poor's 500 ("S&P 500") index that are market sensitive and sufficiently unique to warrant supplemental disclosure.
RISK FACTORS The following risk factors, in addition to the other information provided in this report, should be considered when evaluating the Company. If any of the following risks actually occur, the Company's business, financial condition or results of operations could be materially and adversely affected and the trading price of the Company's common shares could decline significantly.
THE COMPANY'S RESULTS MAY FLUCTUATE AS A RESULT OF FACTORS GENERALLY AFFECTING THE INSURANCE AND REINSURANCE INDUSTRY.
affect the industry in general could also cause the Company's results to fluctuate. The industry's profitability can be affected significantly by:
The Company attempts to limit its risk of loss by purchasing reinsurance to transfer a portion of the risks it assumes. The availability and cost of reinsurance is subject to market conditions, which are outside of the Company's control. As a result, the Company may not be able to successfully purchase reinsurance and transfer risk through reinsurance arrangements. A lack of available reinsurance might adversely affect the marketing of the Company's business and/or force the Company to retain all or a part of the risk that cannot be reinsured. If the Company were required to retain these risks and ultimately pay claims with respect to these risks, the Company's net income could be reduced or the Company could incur a loss.
FAILURE TO COMPLY WITH INSURANCE LAWS AND REGULATIONS COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY'S BUSINESS.
IF U.S. TAX LAW CHANGES, THE COMPANY'S NET INCOME MAY BE REDUCED.
o Bermuda Re has gross RPII equal to 20% or more of its gross insurance income.
Company's allocable untaxed earnings and profits should be taxed as a dividend. If the IRS successfully contended that those provisions apply to the Company, shareholders would be taxed on that amount of gain at the rates applicable to ordinary income rather than the lower rates applicable to long-term capital gains. Assuming that none of the Company's non- U.S. subsidiaries have any RPII, the Company believes that these provisions of the Code should not apply to the disposition of any common shares by a U.S. shareholder who holds less than 10% of the outstanding common shares.
A number of multinational organizations, including the Organization for Economic Cooperation and Development ("OECD"), the European Union, the Financial Action Task Force and the Financial Stability Forum have all recently identified some countries as not participating in adequate information exchange, engaging in harmful tax practices or maintaining adequate controls to prevent corruption, such as money laundering activities. The OECD has threatened non-member jurisdictions that do not agree to cooperate with the OECD with punitive sanctions by OECD member countries, though specific sanctions have yet to be adopted by OECD member countries. It is as yet unclear as to what these sanctions will be, who will adopt them and when or if they will be imposed. On April 18, 2002, the OECD published a list of "uncooperative tax havens," which are those jurisdictions from whom the OECD has not received commitments to the OECD's principles of regulatory and tax transparency and effective exchange information. The governments of both Bermuda and Barbados have made these commitments. As a result, neither Bermuda nor Barbados was listed as an uncooperative tax haven.
guarantee in accordance with Section 27 of the International Business Companies Act with respect to its continued eligibility for this preferred status. This guarantee is applicable until 2014 and is subject to negative resolution, which means that this guarantee can be revoked at any time. In addition, there are currently no procedures for extending this guarantee. As a result, Group could be ineligible for these benefits after that period, which could reduce the Company's net income.
Bermuda Re is subject to an excise tax on reinsurance and insurance premiums it collects with respect to risks located in the United States. In addition, Bermuda Re may be subject to withholding tax on dividend income from United States sources. These taxes could increase and other taxes could be imposed in the future on Bermuda Re's business, which could reduce the Company's net income.
BERMUDA RE MAY NEED TO BE LICENSED OR ADMITTED IN ADDITIONAL JURISDICTIONS TO DEVELOP ITS BUSINESS.
As Bermuda Re's business develops, it will monitor the need to obtain licenses in jurisdictions other than Bermuda in order to comply with applicable law or to be able to engage in additional insurance-related activities. In addition, Bermuda Re may be at a competitive disadvantage in jurisdictions where it is not licensed or does not enjoy an exemption from licensing relative to competitors that are so licensed or exempted from licensing. Bermuda Re may not be able to obtain any additional licenses that it determines are necessary or desirable. Furthermore, the process of obtaining those licenses is often costly and may take a long time.
BERMUDA RE'S ABILITY TO WRITE REINSURANCE MAY BE SEVERELY LIMITED IF IT IS UNABLE TO ARRANGE FOR SECURITY TO BACK ITS REINSURANCE.
Many jurisdictions do not permit insurance companies to take credit for reinsurance obtained from unlicensed or non-admitted insurers on their statutory financial statements without appropriate security. Bermuda Re's reinsurance clients generally require it to post a letter of credit or enter into other security arrangements. If Bermuda Re is unable to obtain or maintain a letter of credit facility on commercially acceptable terms or unable to arrange for other types of security, its ability to operate its business may be severely limited. If Bermuda Re defaults on any letter of credit that it obtains, it may be required to prematurely liquidate a substantial portion of its investment portfolio and other assets pledged as collateral.