The following selected financial information should be read in conjunction with OPL’s consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” which follow this section. The decision to put the Company into liquidation will materially affect future results. The February 2002 decision to discontinue writing new reinsurance business and begin an orderly runoff of both the reinsurance and real estate & leasing operations also materially affected the comparability of the information.
a. Historic operations and sources of revenue, income and cash flow
Prior to the decision to begin an orderly runoff, the Company participated in a number of lines of reinsurance business including finite risk, accident & health, aviation & satellite, property, property catastrophe, auto liability, marine and workers’ compensation business primarily through OPRe in Bermuda and working layer casualty in the United States through OPUS Re.
The primary sources of reinsurance revenues were premiums from the Company’s reinsurance contracts and investment income earned from investing the premiums received and the capital allocated to the reinsurance segment. The expenses incurred by the reinsurance segment were primarily: (i) costs associated with the acquisition of the underlying business, including fees paid to reinsurance agents and brokers that introduce the business to the Company, and commissions paid to the reinsured (referred to as “ceding companies”) to reimburse them for a portion of their own acquisition costs; (ii) losses and loss adjustment expenses associated with underlying claims on the reinsured policies; and (iii) internal general and administrative expenses associated with the reinsurance runoff.
In addition, the Company earned real estate & leasing revenues by renting or leasing the hotel, office, retail and other properties that were acquired over time. The Company also expected to generate additional income from the appreciation in value of the properties during the period of ownership. Commencing in 2000, the Company started to dispose of its real estate properties on an opportunistic basis with a view to redeploying the capital to the reinsurance segment or providing liquidity to shareowners.
The primary risk management initiative was to negotiate the accelerated settlement of the accrued losses and loss expense liabilities of OPL and its wholly-owned subsidiaries, OPRe and OPUS Re. The negotiated settlements took the form of commutation or novation agreements and eliminated the risk of adverse claim experience on the reinsured policies and therefore released capital for distribution to shareowners. A commutation involves paying a single amount to the ceding company as a full and final settlement of the
However some ceding companies were not willing to agree to commutation or novations and in some cases were unable to agree on a mutually acceptable settlement price. As such the Company determined that the most effective way of releasing the remaining capital from OPRe and OPUS Re was through the sale of the subsidiary itself. The sale of OPUS Re was completed on November 15, 2004 and the sale of OPRe was completed on September 22, 2005. In accordance with SFAS No. 144, the results of operations and cash flows of OPRe and OPUS Re have been presented as discontinued operations for all periods presented in the Management’s Discussion and Analysis.
Following the sales of OPRe and OPUS Re and the commutation and novation of all of OPL’s own reinsurance obligations, the Company no longer has any reinsurance operations and OPL’s reinsurance license was cancelled upon application of the Company to the Bermuda Monetary Authority in October 2005. Similarly, all of the Company’s real estate assets have now been sold, the last one in 2003, and the former operating subsidiaries have also been sold or liquidated. As such, the Company no longer has any real estate operations.
The consolidated financial statements include amounts that, due to their nature, are inherently subjective, as their reported values are based on estimates that require complex assumptions and significant management judgment. The most critical accounting policies are discussed below:
Investments are reviewed periodically to determine if they have sustained any impairment in value that is considered to be other than temporary. If available-for-sale investments are determined to be impaired, the cost basis of the investment is written down to fair value at the balance sheet date and a corresponding realized loss is charged to the income statement in the period in which it is determined. If unquoted investments held at cost are determined to be impaired, the carrying value of the investment is written down to estimated fair value at the balance sheet date and a corresponding impairment expense is charged to the income statement in the period in which it is determined. The identification of potentially impaired investments, the assessment of whether any decline in value is other than temporary, and, for the unquoted investment in particular, the estimation of fair value involves significant management judgment. These judgments impact the carrying value of the investments in the consolidated balance sheets and the results from continuing operations.
The Company recorded an impairment charge of $2.5 million during the year ended December 31, 2005 in connection with its 16% ownership interest in an unquoted, Barbados-based reinsurance company. The assessment of other than temporary impairment reflects recent operational difficulties experienced by the investee which may impact its ability to operate profitably and continue to pay dividends for the foreseeable future. The assessment also takes into account the plans to liquidate OPL on a timely basis and the resulting inability to hold the investment until such time as it recovers in value. The estimate of net realizable value takes into account the following:
Following the sales of OPRe and OPUS Re there are no critical accounting policies associated with the Company’s former reinsurance activities. However the accounting policy for the estimation of reserves for accrued losses and loss expenses involved the most highly subjective and complex estimates and would have impacted reported net income from discontinued operations for the years ended December 31, 2005, 2004 and 2003.
There are other significant accounting policies that are important to an understanding of the Company’s Consolidated Financial Statements. See Note 2 of the Notes to the Consolidated Financial Statements included in “Item 8 - Financial Statements and Supplementary Data”.
7.2 Results of Operations - Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Disposed of all of its shares in a Bermuda based life reinsurer, effective September 14, 2005. The sale generated proceeds of $1.5 million and a realized gain of $0.7 million; and
Sold OPRe, effective September 22, 2005, for a total cash consideration of $170.5 million. As discussed further below, the sale represents a significant step towards the goal of returning capital to shareowners and, ultimately, liquidating OPL.
Although the sale of OPRe generated a loss of $26.9 million compared to the carrying value of OPRe’s net assets, the transaction resulted in the following benefits:
Eliminated the risk of adverse claims experience on OPRe’s remaining accrued losses and loss expense reserves of approximately $140 million. In particular, there were significant uncertainties associated with the estimated ultimate losses on a residual value reinsurance program on which OPRe had up to $180 million of claims exposure arising from potential lease income shortfalls on a portfolio of aircraft through 2013;
Obviated the need to hold significant capital and reserves for a further ten years or more in respect of OPRe’s remaining reinsurance obligations. It was becoming increasingly difficult to reach agreement with OPRe’s remaining cedants to commute or novate the remaining reinsurance liabilities on acceptable terms;
Better positioned OPL for a timely liquidation. As noted earlier, a Special General Meeting of Shareowners has been scheduled for January 31, 2006 to initiate the formal process to wind up the affairs of OPL. It is too early to accurately determine the date of final dissolution at this time, although the Company believes that the winding-up process will be substantially completed, if not completed, by the end of 2006 if events unfold according to plan.
An increase in the average amount of assets invested and an improvement in the U.S. fixed income markets meant that the Company’s debt securities generated a return of $3.8 million for the year ended December 31, 2005 compared to a return of $2.0 million for the year ended December 31, 2004;
On September 14, 2005, the Company disposed of all of its shares in a Bermuda based life reinsurer. The sale generated a gain of $0.7 million, although $0.6 million of this gain had already been recorded as other comprehensive income, whereas during the year ended December 31, 2004 the Company recorded a write-down in the cost basis of this investment of $0.4 million as the decline in value was considered other than temporary; and
Basic and diluted net loss per share was $0.42 for the year ended December 31, 2005 consisting of $0.01 loss per share from continuing operations and $0.41 loss per share from the discontinued operations of OPRe. For the year ended December 31, 2004 basic and diluted net income per share was $0.51 consisting of $0.03 loss per share from continuing operations offset by income of $0.55 per share from the discontinued operations of OPRe and OPUS Re.
The results for the year ended December 31, 2004 reflect a number of significant transactions that were effected in accordance with the Company’s runoff goals and objectives. In particular, the Company:
For the year ended December 31, 2004 the net loss from continuing operations of $4.1 million reflected the following:
A small underwriting loss due to the cost of commuting one of OPL’s reinsurance contracts, partially offset by a favorable change in the estimate of ultimate losses on remaining contracts;
The Company sold its final remaining leased asset during the fourth quarter of 2003 and therefore did not earn any real estate or leasing revenue in 2004;
The net income from discontinued operations for the year ended December 31, 2004 of $65.1 million comprised the following:
A net loss of $23.2 million from OPUS Re, including operating income of $4.9 million, a tax charge of $2.2 million (primarily due to a valuation allowance against deferred tax assets), and the loss on sale of $25.9 million.
Basic and diluted net income per share was $0.51 for the year ended December 31, 2004 consisting of a loss of $0.03 per share from continuing operations offset by income of $0.55 per share from the discontinued operations of OPRe and OPUS Re.
For the year ended December 31, 2003 the net loss from continuing operations of $21.5 million reflected the following results:
The investment portfolio generated income of $12.3 million, net of the write-down in the cost basis of the Company’s investment in a Bermuda based life reinsurer of $6.4 million as the decline in value was considered other than temporary;
A net underwriting loss of $8.9 million due primarily to an increase in estimated ultimate losses on a workers’ compensation program. The change in estimates followed an independent actuarial evaluation completed in the third quarter of 2003 and reflected adverse trending of medical expenses associated with workers’ compensation claims in California;
A loss of $25.4 million associated with the termination of the Company’s real estate and leasing operations, including (i) a pre-tax loss of $10.8 million from the sale of a distribution facility to Kmart Corporation for net cash proceeds of $6.8 million, (ii) the repurchase and cancellation of $75.0 million of long-term debt for a total premium of $35.9 million and (iii) a $20.9 million gain on sale of zero-coupon securities that were previously held as security for the aforementioned long-term debt but were released in connection with the repurchase and cancellation;
For the year ended December 31, 2003 basic and diluted net income per share was $0.39 consisting of a loss of $0.18 per share from continuing operations offset by income of $0.57 per share from the discontinued operations of OPRe and OPUS Re.
Following the decision to go into runoff, the Company’s investment objective has been to focus on capital preservation and short- to medium-term liquidity, as opposed to long-term return. Consequently, the Company has steadily reduced the duration of its investment portfolio and increased its short-term investment positions to ensure that it will have cash available to distribute to shareowners and to mitigate the exposure to investment losses in the event of interest rate increases. Following the sale of OPRe, the Company invested a significant portion of its funds in cash equivalents as it prepared for the liquidation of the Company. During January 2006 the Company sold all of its remaining marketable securities and is holding the proceeds as cash.
As a result of the decision to restructure OPL and cause its operations to begin an orderly runoff, the Company amended its dividend policy. It is unlikely that the Company will pay ordinary dividends in the future. It is expected that all future returns of capital to shareowners will be in the form of liquidating distributions, giving due consideration to the Company’s required capital levels to support its contingent liabilities and the availability of liquid assets.
Liquidating distributions of $296.9 million, $237.5 million, $237.5 million and $166.3 million were paid on January 5, 2004, August 31, 2004, May 18, 2005, and January 4, 2006, respectively.
Credit risk represents the loss that would occur if a counterparty or issuer failed to perform its contractual obligations. Certain policies and procedures have been established to protect the Company against such losses from its investments. Controlling duration of the investment portfolio by limiting tracking error to known benchmarks, placing limits on exposure to any one counterparty and mandating minimum credit ratings all serve to manage the credit exposure associated with the Company’s financial instruments.