(1) Minority interest represents those shares in LaSalle Re that were held as exchangeable non-voting shares. These shares were exchangeable, at the option of the holder, for common shares of the Company on a one-for-one basis. These shares were exchanged for Trenwick common shares on a one-for-one basis following the Trenwick/LaSalle business combination.
The following discussion highlights material factors affecting the results of operations of LaSalle Re Holdings Limited (the "Company") for each of the three years ended December 31, 2002, 2001 and 2000. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto of the Company for the years ended December 31, 2002, 2001 and 2000 contained in this annual report.
On September 27, 2000, the Company, LaSalle Re, Trenwick Group Ltd. ("Trenwick") and Trenwick Group Inc. completed a business combination (the "Trenwick/LaSalle business combination). Under the terms of the business combination, the common shareholders of the Company, LaSalle Re and Trenwick Group Inc. exchanged their shares on a one-for-one basis for shares in Trenwick. Following this transaction, the Company became a wholly owned subsidiary of Trenwick, and a guarantor of certain indebtedness owed by Trenwick and certain of its direct and indirect subsidiaries.
Trenwick is a Bermuda-based specialty insurance and reinsurance holding company with subsidiaries located in the United States and the United Kingdom, including four runoff operations. Trenwick's operations at Lloyd's of London ("Lloyd's") underwrite specialty property and casualty insurance as well as treaty and facultative property and casualty reinsurance on a worldwide basis.
In 2002, Trenwick conducted several strategic reviews of its operations in light of its capital constraints and determined that it was necessary for Trenwick to reduce its operating leverage by reducing premium volumes to a level more commensurate with its capital base and to concentrate its limited financial resources on its core franchises and businesses, its United States treaty reinsurance business and its Lloyd's operations, where it would be able to write insurance and reinsurance based on direct or indirect financial support. As a result, Trenwick voluntarily placed into runoff its United States specialty program business formerly operated through its subsidiary, Canterbury Financial Group, Inc. and its London-based specialty insurance and reinsurance company, Trenwick International Limited. Additionally, in light of the increasing capital requirements imposed by the market on catastrophe insurance providers, Trenwick sold the in-force property catastrophe reinsurance business of the Company. Little or no new insurance or reinsurance is presently being offered in these runoff operations, including the Company, with the exception of business written through the Oak Entities owned by the Company, described below.
LaSalle Re's other business consisted primarily of participations in certain Lloyd's syndicates through LaSalle Re Capital, which provided capital support to those syndicates. Effective for the 2001 underwriting year at Lloyd's, LaSalle Re Capital withdrew its capital support from all Lloyd's syndicates. LaSalle Re Capital, which was incorporated in Bermuda in November 1996, is currently inactive. On December 10, 2002, LaSalle Re, with the permission of the Bermuda Monetary Authority ("BMA"), again became a corporate capital provider at Lloyd's pursuant to an agreement between Trenwick, LaSalle Re and the Company whereby the Oak Entities were contributed by Trenwick to LaSalle Re. The Oak Entities (three separate subsidiaries), which are incorporated in the United Kingdom, participate in Lloyd's syndicates managed by Trenwick Managing Agents ("TMA"), a wholly owned subsidiary of Trenwick. The contribution of the Oak Entities by Trenwick to LaSalle Re, together with an additional investment by LaSalle Re of $81.6 million, was completed as part of Trenwick's underwriting capital at Lloyd's for the 2003 year of account. In return for its investment, LaSalle Re will receive 43% of the economic interest (prior to the deduction of the Banks' letter of credit fees and profit participation, discussed below in "Significant Developments -- Pledge by Trenwick of the Company's Stock participation)and Assets, Including the Stock of LaSalle Re") in the 2003 year of account of syndicates managed by TMA at Lloyd's and will also participate in the economic interest in the results of such syndicates for the 2002 and prior years of account.
LaSalle Re's other wholly owned subsidiaries include LaSalle Re Services (currently inactive), which acted as a representative office for the Company in the United Kingdom until the completion of the Trenwick/LaSalle business combination in September 2000, and LaSalle Re Barbados, which was incorporated in Barbados in 2001 and acts as an investment holding company.
During 2002 and the first quarter of 2003, a number of developments have occurred that have significantly and negatively affected Trenwick's operations, capital structure and the financial resources required to conduct its businesses, including the Company. Set forth below are brief descriptions of a number of these developments as well as certain material transactions entered into by Trenwick and the Company to enable them to continue to conduct business operations despite the adverse developments. Investors and shareholders are cautioned that Trenwick and the Company have had a number of significant adverse events
determined that the reduction in capital and surplus resulting from the special dividend would not cause LaSalle Re to fall below the minimum statutory capital and surplus of $100 million which is required of a Class 4 insurer in Bermuda. In connection with this request, the BMA and LaSalle Re agreed that LaSalle's Certificate of Registration be endorsed to restrict LaSalle Re's license so that it can no longer write any insurance without the prior written consent of the BMA.
The Company has accounted for this distribution as a dividend in the accompanying Consolidated Financial Statements.
During the years ended December 31, 2001 and 2000, the Company purchased $10.7 million and $13.0 million par value, respectively, of Trenwick Capital Trust I Preferred Stock for $8.5 million and $9.9 million, respectively, which are included in the Company's debt securities held for investment. The Trenwick Capital Trust I Preferred Stock matures in 2037 and provides preferential cumulative semi-annual cash distributions at an annual rate of 8.82% which are guaranteed by Trenwick America Corporation, within certain limits, as to distribution payments and liquidation or redemption payments. In November 2002, Trenwick suspended the dividend payment on these securities. The market value of these investments was $2.4 million at December 31, 2002. In accordance with the Company's investment accounting policy, the Company determined that this investment suffered an impairment of value that is considered to be other than temporary and therefore the difference between amortized cost and market value is included in the accompanying Consolidated Statement of Operations and Comprehensive Income Statement as a realized loss of $16.0 million. No interest has been accrued on these securities since August 1, 2002, the date of the last dividend payment.
On December 10, 2002, the capital stock of the Oak Entities was contributed by Trenwick to LaSalle Re, prior to which certain indebtedness owed to Trenwick by the Oak Entities was forgiven. The transaction was approved by the BMA. The Oak Entities, as corporate capital providers, participate in several Lloyd's syndicates managed by TMA. The Company, through its subsidiary LaSalle Re Capital, participated in one of these syndicates through the 2000 Lloyd's year of account.
Trenwick announced on October 25, 2002 that it had engaged independent actuaries to conduct a review of the reserves for unpaid claims and claims expenses at each of Trenwick's operating subsidiaries, including those of the Company. Based upon the study conducted by independent actuarial consultants and additional work performed during the quarter by Trenwick's internal actuaries, Trenwick increased its reserves for unpaid claims and claims expenses in the fourth quarter of 2002 by $107 million, which was net of a favorable adjustment of $6 million applicable to LaSalle Re. The fourth quarter 2002 increases in reserves impact Trenwick's United States insurance subsidiaries and Trenwick International. Trenwick's reserves at its Lloyd's operation, which includes the Oak Entities, while also analyzed, were not adversely affected by this reserve increase. The fourth quarter 2002 reserve increases followed reserve increases made by Trenwick earlier in 2002, for an aggregate reserve increase for 2002 of $303.4 million, of which $33.1 million applied to the Company. The reserve increases recorded during 2002 include $21.5 million related to LaSalle Re's exposure to the terrorist attacks of September 11, 2001 offset in part by reductions in LaSalle Re's other reserves of $19.0 million. The remainder of the reserve increase relates primarily to the Oak Entities and reflects a reassessment of reserves for unpaid claims and claims expenses in light of recent reported loss activity trends across its major business groups and principally impacts the 1998 to 2001 accident years.
Concurrently with the Trenwick/LaSalle business combination in September of 2000, Trenwick America Corporation ("Trenwick America") and Trenwick Holdings Limited ("Trenwick Holdings"), Trenwick's U.S. and U.K. holding companies, entered into an amended and restated $490 million credit agreement with various lending institutions (the "Banks"), which was guaranteed by the Company. The credit agreement consisted of both a $260 million revolving credit facility and a $230 million letter of credit facility. The revolving credit facility was subsequently converted into a four-year term loan and repaid in full on June 17, 2002. Additionally, on December 24, 2002, the credit agreement was amended to reduce the letter of credit facility, which is utilized by Trenwick to support its underwriting operations at Lloyd's, to the currently outstanding $182.5 million. The letter of credit facility is scheduled to terminate on December 31, 2003, although the letters of credit issued pursuant to the facility are not scheduled to expire until December 31, 2006.
The December Amendments also prohibit Trenwick and its subsidiaries from declaring or paying any dividends (including on Trenwick's common shares, the perpetual preferred shares of the Company and the capital securities issued by Trenwick Capital Trust I). The December Amendments and the other amendments and waivers entered into in the first quarter of 2003 waive certain other defaults, add covenants further restricting the operation of Trenwick's business, prohibit Trenwick from making certain payments without the Banks' approval, prohibit Trenwick and its subsidiaries (including the Company) from selling or otherwise disposing of any assets or property, require Trenwick to regularly report certain financial information to the Banks, and adjust downward certain of the financial covenants.
Pursuant to the December Amendments, Trenwick is required to collateralize with cash, cash equivalents and marketable securities 60% of the outstanding letters of credit by August 1, 2003. If it is unable to do so, Trenwick's insurance company subsidiaries will be prohibited from underwriting any insurance or reinsurance business without the Banks' prior approval. In addition, Trenwick is required to use its best efforts to terminate the letters of credit by December 31, 2003. In order to do so, the letters of credit would need to be replaced with other letters of credit or collateral acceptable to Lloyd's. In the event Trenwick has not terminated the letters of credit by December 31, 2003, it is required on such date to collateralize with cash, cash equivalents and marketable securities the full amount of the outstanding letters of credit. At this time, Trenwick does not have sufficient available liquidity to collateralize the letters of credit as required by the December Amendments. Additionally, Trenwick does not believe that it will be able to replace the letters of credit with other letters of credit or collateral acceptable to Lloyd's.
Since December 2002, Trenwick has entered into additional amendments and numerous waivers with the Banks providing for, among other things, waivers of potential covenant defaults, further reductions in certain financial covenants, additional financial reporting, approval of certain employee and other payments, approval of the extension of the maturity of Trenwick America's senior notes from April 1, 2003 to August 1, 2003, the payment of interest accrued through April 1, 2003 to the holders of the senior notes and extension of numerous deadlines imposed under the December Amendments.
as a going concern and Trenwick and/or one or more of its subsidiaries (including the Company) may be forced to seek protection from creditors through proceedings commenced in Bermuda and other jurisdictions including the United States. In addition, at any time one or more of the insurance regulatory authorities having jurisdiction over Trenwick's insurance company subsidiaries (including the Bermuda Monetary Authority with respect to Company and LaSalle Re, or the Financial Services Authority or Lloyd's in the United Kingdom with respect to Trenwick's Lloyd's operations) may commence voluntary or involuntary proceedings for the formal supervision, rehabilitation or liquidation of such subsidiaries, or one or more of the creditors of Trenwick or its subsidiaries (including the Company) may commence proceedings against Trenwick or its subsidiaries (including the Company) seeking their liquidation.
Standard and Poor's Ratings Services announced on April 2, 2003 that it had lowered the counter-party credit ratings on Trenwick, Trenwick America and the Company to "D" following the announced non-payment of principal and interest on the Senior Notes. Standard & Poor's also stated that despite the agreement in principal to extend the maturity of the Senior Notes, it believes that the prospect for significant recoveries to the senior note holders is very low. Standard & Poor's also announced on March 4, 2003 that it placed its "CCC" counterparty credit and financial strength ratings on Trenwick America's subsidiaries, Trenwick America Reinsurance Corporation ("Trenwick America Re"), Dakota Specialty Insurance Company ("Dakota") and The Insurance Corporation of New York ("INSCORP") on CreditWatch negative. In addition, Standard and Poor's withdrew its "CCC" counterparty credit and financial strength ratings on Chartwell Insurance Company due to its merger with Trenwick America Re.
On April 2, 2003, A.M. Best Company announced that it had withdrawn the financial strength rating of "C" (Weak) and assigned a "NR-4" rating (Rating Withdrawn at Company's Request) to Trenwick America Re. Concurrently, A.M. Best downgraded the debt rating of Trenwick America to "D" from "C" relating to its Senior Notes. These rating actions followed the announced non-payment of principal and interest on the Senior Notes. The financial strength rating of Trenwick America Re had previously been downgraded to "C" (Weak) from "B-" (Fair) on February 3, 2003.
On March 25, 2003, the Series A Preferred Shares of the Company and the common shares of Trenwick were suspended from trading, pending application to the Securities and Exchange Commission for delisting, by the New York Stock Exchange ("NYSE") as a result of failure to meet the NYSE's minimum continued listing criteria. On the same day, Trenwick was notified that its common shares and the Series A Perpetual Preferred Shares of the Company would be quoted on the Over The Counter Bulletin Board ("OTC").
The operating loss of $34.5 million in 2002 represented a $31.6 million improvement from the operating loss of $66.1 million recorded in 2001. This improvement was primarily a result of improved underwriting results reported by the Oak Entities and the absence of significant catastrophe losses in 2002 as compared to 2001. The results for the years ended December 31, 2002 and December 31, 2001 included $21.5 million and $114.1 million, respectively, of catastrophe losses, including losses related to the September 11, 2001 terrorist attacks. The improved underwriting results were offset in part by a decrease in net investment income and an increase in income taxes, which was a result of the establishment of a full valuation allowance on the deferred tax asset related to the Oak Entities.
Gross premiums written for 2002 were $536.9 million compared to $522.3 million for 2001, an increase of $14.6 million. Details of gross premiums written are provided below.
Gross premiums ceded for 2002 were $266.9 million compared to $202.7 million for 2001. This increase was a result of the sale of LaSalle's in-force reinsurance business as of April 1, 2002 which was accounted for as a 100% ceded quota share contract, combined with an increase of ceded premiums related to the Oaks Entities, which is commensurate with the increase in gross premiums written. These increases in 2002 were offset in part by the reduction in reinstatement premiums from 2001 of $31.8 million which were incurred as a result of the September 11, 2001 terrorist attacks.
Net premiums earned in 2002 were $291.3 million compared to $303.0 million for 2001. The decrease in net premiums earned is due to the sale of LaSalle Re's inforce reinsurance business and is offset in part by the reduction in earned premiums during 2001 of $22.7 million as a result of reinstatement premiums related to the September 11, 2001 terrorist attacks.
Claims and claims expenses for 2002 were $178.2 million, a decrease of $127.4 million compared to claims and claims expenses of $305.6 million for 2001. The decrease in 2002 is attributable to a reduction in catastrophe losses in the first quarter of 2002, the period in which the Company underwrote property catastrophe reinsurance through LaSalle Re, compared to $114.1 million of catastrophe losses in the 2001
results. Included in the $173.3 million of claim and claim expenses incurred during 2002 are additional reserves for the September 11, 2001 terrorist attacks of $21.5 million, and reserve increases of $30.6 million related to the Oak Entities, partially offset by net reductions in prior year reserves for unpaid claims and claims expenses of $19.0 million at LaSalle Re. The increases recorded by the Oak Entities reflect a reassessment of reserves for unpaid claims and claims expenses in light of recent reported loss activity trends and principally impact the 1998 to 2001 accident years.
Claims and claims expenses for 2001 included $114.1 million in catastrophe losses, of which $92.9 million related to the September 11, 2001 terrorist attacks. The Company's primary exposure to this event relates to LaSalle Re's commercial property damage coverage, which includes business interruption and incidental workers' compensation coverage, and the Oaks Entities' catastrophe aviation coverage. The Company's estimated gross loss from the September 11, 2001 terrorist attacks is $417.6 million and $254.3 million net of reinsurance recoverable. The Company's exposure to aviation losses was based upon two maximum losses and two partial losses. Additionally, for purposes of these loss estimates, the Company has assumed that the property loss on September 11, 2001 was one occurrence, however, the Company's loss estimates would not be materially different if the September 11, 2001 property loss was determined to be two occurrences. Estimates of its property and related losses are based upon an assessment of individual policies which the Company has determined have exposure to the event. This assessment included market share analysis, probable maximum loss analysis, independent risk modeling analysis and cedant loss estimates.
The Company's 2001 results also include other catastrophe losses totaling $22.1 million. Included in this amount are losses related to Tropical Storm Allison and storms affecting the midwest United States amounting to $10.5 million, and losses related to the November 12, 2001 American Airlines crash in Queens, New York of $6.5 million.
Total expenses, comprising policy acquisition costs and underwriting expenses, for 2002 decreased by $8.1 million compared to total underwriting expenses for 2001. The decrease is primarily the result of the sale of LaSalle Re's inforce reinsurance business to Endurance combined with $11.6 million of ceded commissions earned related to the quota share reinsurance contract associated with the transaction.
2002 2001 Change --------- --------- --------- (in thousands) Average invested assets $ 692,331 $ 707,189 $ (14,858) Average amortized yields 5.7% 6.2% (0.5)%
The Company recorded foreign currency losses in 2002 of $1.7 million compared to losses of $0.1 in 2001. The increase in the foreign currency losses is a result of the U.S. dollar weakening, primarily during the third and fourth quarters of 2002.
Net realized gains on investments were $0.8 million during 2002, compared to $8.7 million for 2001. In 2002, net gains are net of a loss of $16.0 million on the Company's investment in the Trenwick Capital Trust I securities relating to a decline in market value that was determined to be other than temporary. This loss was offset by realized gains recognized upon the sale of securities in connection with LaSalle Re's dividend of $258 million to Trenwick, and related to Lloyd's funding for the operations of the Oaks Entities. The gains in 2001 resulted from a change in investment managers and a consequential repositioning of the portfolio to reflect a new investment philosophy.
During the year ended December 31, 2002, Trenwick recorded a loss of $20.1 million on the sale of LaSalle Re's in-force property catastrophe reinsurance business to Endurance. The loss includes non-recurring revenues of $8.0 million related to the sale of renewal rights, offset by $28.1 million of non-recurring expenses which consists of accelerated amortization of reinsurance contracts not transferred in the sale, as well as legal expenses, investment banking fees and severance and related costs.
The Company adopted Statement of Financial Accounting Standards No. 142 effective January 1, 2002. As a result, the Company wrote off its negative goodwill as of January 1, 2002 as a cumulative effect of change in accounting principle, which increased net income for the year ended December 31, 2002 by $11.6 million.
In addition to providing net income (loss) information, when comparing the results of operations for the years ended December 31, 2002 and 2001, the Company has also provided operating income (loss) and underwriting income (loss), as management believes they are both meaningful measures of the Company's results. Operating income (loss) differs from net income (loss) under accounting principles generally accepted in the United States, sometimes referred to as U.S. GAAP, and does not replace net income (loss) as the GAAP measure of our results of operations. In arriving at operating income (loss), we start with GAAP net income (loss) and exclude net realized investment gains and losses, as well as non-recurring charges because i) net realized investment gains and losses are unpredictable and not necessarily indicative of current or future results and ii) charges such as reorganization expenses, the cumulative effect of changes in accounting principles and loss on sale of business are non-recurring in nature and are also not necessarily indicative of future results of operations. Underwriting income (loss), also a non-GAAP financial measure, is net premiums earned less claims and claims expenses incurred, acquisition costs and underwriting expenses.
The underwriting loss of $133.6 million in 2001 represented a $72.8 million increase compared to the underwriting loss of $60.8 million in the 2000 year. The increase in the underwriting loss in 2001 was due to an increase in catastrophe losses of $53.9 million; 2001 included catastrophe losses of $114.1 million, while 2000 included catastrophe losses of $60.2 million.
Gross premiums written for 2001 were $522.3 million compared to $412.2 million for 2000, an increase of $110.1 million, or 26.7%. Details of gross premiums written are provided below.
The increase in worldwide property catastrophe reinsurance gross premium writings for 2001 compared to 2000 resulted primarily from new property catastrophe business combined with reinstatement premiums of $14.4 million generated by reinstated coverage on assumed contracts impacted by losses from the September 11, 2001 terrorist attacks.
Premiums ceded (202,653) (118,508) (84,145) Change in premiums ceded 23,639 (402) 24,041 --------- --------- --------- Amortized ceded premiums (179,014) (118,910) (60,104) --------- --------- --------- Net premiums earned $ 302,989 $ 271,696 $ 31,293 ========= ========= =========
Gross premiums ceded for 2001 were $202.7 million compared to $118.5 million for 2000. This increase was primarily due to an increase in business written by the Oak Entities which purchase significantly more reinsurance than LaSalle Re to manage various risks, including aviation. Ceded premiums also increased as a result of $31.8 million in reinstatements resulting from losses from the September 11, 2001 terrorist attacks.
Net premiums earned in 2001 and 2000 were $303.0 million and $271.7 million, respectively. The increase is commensurate with the increase in gross premiums written.
Claims and claims expenses for 2001 were $305.6 million, an increase of $86.6 million compared to claims and claims expenses of $219.0 million for 2000. The increase is due to losses associated with the September 11, 2001 terrorist attacks. The Company's estimated loss from the September 11, 2001 terrorist attacks through December 31, 2001 was $396.1 million gross and $232.8 million net of reinsurance recoverable. The Company's incurred losses related to the September 11, 2001 terrorist attacks are based upon estimates of its ultimate exposure derived from a manual assessment of its outstanding policies. The assessment included market share analysis, probable maximum loss analysis, independent risk modeling analysis and cedent loss estimates. The Company's primary exposure for this event relates to commercial property damage, which includes business interruption and incidental workers' compensation coverage, and catastrophe aviation coverage. In addition, the Company incurred losses of $10.5 million associated with Tropical Storm Alison and storms affecting the midwest United States, and $6.5 million of losses on the November 12, 2001 American Airlines crash in Queens, New York. Claims and claims expenses incurred in 2000 included $6.5 million of catastrophe losses relating to U.K. floods and an increase of $20.4 million in prior period occurrences, principally losses relating to two storms, Martin and Anatol, which hit Europe in late December 1999.
2001 2000 Change --------- --------- --------- (in thousands) Policy acquisition costs $ 97,376 $ 76,058 $ 21,318 Underwriting expenses 33,640 37,429 (3,789) --------- --------- --------- Total expenses $ 131,016 $ 113,487 $ 17,529 ========= ========= =========
Interest expense was $2.8 million in 2001 as compared to interest expense of $1.2 million in 2000. The increase is mainly a result of increased letter of credit fees relating to the Company's Lloyd's operations. Interest expense in 2000 also included financing charges associated with a ceded reinsurance contract and other interest expenses related to the commitment fees payable on the Company's credit facility which was canceled effective at the end of September of 2000.
As a holding company, the Company's assets consist primarily of all of the outstanding voting stock of LaSalle Re. The Company's operating capital is derived from dividends and other permitted payments from LaSalle Re and its subsidiaries, including fees for services provided to LaSalle Re and its subsidiaries which are subject to review by the BMA. The Company's ability to generate operating capital is limited and its ability to meet its obligations is dependent upon funding from LaSalle Re. There is substantial uncertainty as to what amount of future funds it will receive from LaSalle Re.
As of December 31, 2002, 98.1% of the debt securities held in the Company's investment portfolio were rated "AA" or better and 99.6% were rated "A" or better by Standard and Poor's or Moody's.
Concurrently with the Trenwick/LaSalle business combination in September of 2000, Trenwick America Corporation ("Trenwick America") and Trenwick Holdings Limited ("Trenwick Holdings"), Trenwick's
Pursuant to a guaranty agreement entered into concurrently with the credit agreement, Trenwick has guaranteed the obligations of Trenwick America and Trenwick Holdings under the credit agreement. In April of 2002, Trenwick pledged the capital stock of the Company, which was a guarantor of the obligations under the credit agreement, and LaSalle Re as collateral to the Banks. In December of 2002, Trenwick agreed to provide the Banks additional security interests as described below.
On October 18, 2002, A.M. Best Company lowered the financial strength ratings of Trenwick's operating subsidiaries below "A-". The lowered A.M. Best Company ratings constituted an event of default under the credit agreement. In addition, increases in Trenwick's reserves for unpaid claims and claims expenses and the establishment of a deferred tax asset reserve related to Trenwick's United States Subsidiaries in the third quarter of 2002 resulted in Trenwick violating the financial covenants in the credit agreement requiring Trenwick to maintain a minimum tangible net worth and minimum risk-based capital. On November 13, 2002, Trenwick, its subsidiaries and the Banks executed a forbearance agreement with respect to the events of default arising from Trenwick's lowered A.M. Best Company ratings and financial covenant violations.
The December Amendments also prohibit Trenwick and its subsidiaries from declaring or paying any dividends (including on Trenwick's common shares, the Series A Preferred Shares of the Company and the capital securities issued by Trenwick Capital Trust I). The December Amendments and the other amendments and waivers entered into in the first quarter of 2003 waive certain other defaults, add covenants further restricting the operation of Trenwick's business (including that of the Company), prohibit Trenwick from making certain payments without the Banks' approval, prohibit Trenwick and its subsidiaries from selling or otherwise disposing of any assets or property (including the Company), require Trenwick to regularly report certain financial information to the Banks, and adjust downward certain of the financial covenants.
not terminated the letters of credit by December 31, 2003, it is required on such date to collateralize with cash, cash equivalents and marketable securities the full amount of the outstanding letters of credit. At this time, Trenwick does not have sufficient available liquidity to collateralize the letters of credit as required by the December Amendments. Additionally, Trenwick does not believe that it will be able to replace the letters of credit with other letters of credit or collateral acceptable to Lloyd's.
If there is an event of default under the credit agreement, including as a result of Trenwick failing to collateralize the letters of credit as described above, or if there is an event of default under other outstanding indebtedness of Trenwick or its subsidiaries, including under the senior notes, resulting in a cross default under the credit agreement, Trenwick may be required to fully and immediately collateralize the outstanding letters of credit under the terms of the guaranty agreement. No liability for any such amounts has been reflected in Trenwick's financial statements for any future event of default. If the potential future events of default occur and are not waived, there is substantial doubt as to Trenwick's ability to continue as a going concern and Trenwick and/or one or more of its subsidiaries may be forced to seek protection from creditors through proceedings commenced in Bermuda and other jurisdictions including the United States. In addition, at any time one or more of the insurance regulatory authorities having jurisdiction over Trenwick's insurance company subsidiaries (including the Bermuda Monetary Authority with respect to the Company and LaSalle Re, or the Financial Services Authority or Lloyd's in the United Kingdom, with respect to Trenwick's Lloyd's operations) may commence voluntary or involuntary proceedings for the formal supervision, rehabilitation or liquidation of Trenwick or its subsidiaries, including the Company, or one or more of the creditors of Trenwick or its subsidiaries, including the Company may commence proceedings against Trenwick or its subsidiaries seeking their liquidation.
preference of $100 per share for an aggregate purchase price of $40 million. The Series B Shares bear cumulative dividends, payable quarterly in arrears, based upon the Series B Shares' Standard & Poor's rating at LIBOR plus a margin determined in accordance with the following schedule:
Standard & Poor's Rating LIBOR Margin BBB- or above 3.75% BB+ 4.25% BB 4.50% BB- 4.75% Below BB- 6.00%
These factors adjust upward by 0.25% on the third anniversary if the securities are still unrated, and upward by 0.50% on the fifth anniversary if they are still unrated. Also, if the Standard & Poor's rating is below BBB- on the fifth anniversary, the factors adjust upward by an additional 0.50%. The maximum adjustment based upon these circumstances is 0.75%. At December 31, 2002, the Series B Shares were rated "D" by Standard & Poor's.
The Series B Shares are convertible into common shares of Trenwick after five years or upon the occurrence of certain "conversion events" or the failure of Trenwick to maintain certain levels of capital. As of December 31, 2002, the Series B Shares would be settled with approximately 12.2 million common shares of Trenwick upon conversion. On February 20, 2003, Trenwick delivered a notice to European Re that Trenwick's GAAP Net Worth (as defined in the Certificate of Designation, Preferences and Rights (the "Certificate of Designation") of the Series B Shares) had fallen below $225 million. Trenwick's GAAP Net Worth did not equal or exceed $225 million during the period from February 20, 2003 through April 21, 2003 (which is 60 days after the date of notice). As a result, a Net Worth Conversion Event (as defined in the Certificate of Designation) occurred on April 21, 2003, and the Series B Shares are now convertible at the option of European Re into Trenwick common shares upon 60 trading days advance notice to Trenwick. European Re has not delivered to Trenwick such a notice of conversion. Should European Re convert such Series B Shares, substantial dilution to existing common shares will occur. In addition, depending on the conversion ratio of Series B Shares to Trenwick common shares, which is based upon the trading price of Trenwick common shares and the book value and number of shares converted, this conversion could result in European Re obtaining control of Trenwick, and therefore the Company, subject to compliance with applicable insurance law and regulation. See Note 8 of the Notes to the Consolidated Financial Statements for further discussion of the Series B shares and the conversion events relating thereto.
calculation of the liability and, while the Company has established reserves equal to the current best estimate of ultimate losses, there remains a likelihood that further changes in such claim estimates, either upward or downward, will occur in the future. Adjustments to previously reported reserves for unpaid claims and claims expenses are considered changes in estimates for accounting purposes and are reflected in the income statement in the period in which the adjustment becomes known.
o Reinsurance collectibility -the Company reviews and monitors its reinsurance recoverables from its reinsurers and makes provision for uncollectible reinsurance as appropriate. However, given the magnitude of reinsurance recoverables, $913 million at December 31, 2002, the Company has a significant exposure to collectibility issues.
Management believes that the Company's claim and claim expense liabilities are adequate. However, the process of estimating claims and claim expense liabilities is inherently imprecise and involves an evaluation of many variables, including potentially unpredictable social and economic conditions. Accordingly, there can be no assurance that the Company's ultimate liability will not vary significantly from amounts reserved. The uncertainties in and the risk factors associated with the claims reserves at December 31, 2002 are similar to the uncertainties at prior year ends. However, given the Company's current surplus levels, it is now less financially equipped to handle these uncertainties should there be adverse development in the loss reserves. Reserves for the Company's participation in Lloyd's syndicates through its Lloyd's corporate members are included in the year end reserves. Part of the reserve represents reinsurance to close balances brought
forward to the open years of account (for example, 1996 reinsured into the 1997 open year. Favorable or unfavorable development of the prior year's reserves can influence the results of the open years of 2000, 2001 and 2002.
The Company purchases reinsurance to reduce its exposure on individual risks, catastrophic losses and other large losses. The Company estimates the amount of uncollectible receivables from its reinsurers each period and establishes an allowance for uncollectible amounts. The amount of the allowance is based on the age of unpaid amounts, information about the creditworthiness of the Company's reinsurers, and other relevant information. Estimates of uncollectible reinsurance amounts are reviewed quarterly, and changes are recorded in the period they become known. A significant change in the level of uncollectible reinsurance amounts would have a significant effect on the Company's results of operations and financial position. Also see Note 6 of the Notes to the Consolidated Financial Statements.
Testing for impairment of investments also requires significant management judgment. The identification of potentially impaired investments, the determination of their fair value and the assessment of whether any decline in value is other than temporary are the key judgment elements. The discovery of new information and the passage of time can significantly change these judgments. Revisions of impairment judgments are made when new information becomes known, and any resulting impairment adjustments are made at that time. The current economic environment and recent volatility of securities markets increase the difficulty of determining fair value and assessing investment impairment. The same influences tend to increase the risk of potentially impaired assets.
The Company seeks to match the maturities of invested assets with the payment of expected liabilities. By doing this, the Company attempts to make cash available as payments become due. If a significant mismatch of the maturities of assets and liabilities were to occur and the Company had to liquidate investments prior to their maturity, it may incur realized losses and the effect on the Company's results of operations could be significant. Also see Note 7 of the Notes to the Consolidated Financial Statements.
o interest rate risk on fixed and variable rate U.S. dollar and British pound sterling denominated short and long-term instruments.
The Company's fixed maturity investments and indebtedness are subject to interest rate risk. Increases and decreases in prevailing interest rates generally translate into decreases and increases in the fair value of fixed maturity investments and the interest payable on the Company's outstanding variable rate debt. Additionally, the fair value of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, a prepayment option, relative values of alternative investments, liquidity of the investment and other general market conditions.
The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The effects of inflation are considered in pricing and in estimating reserves for unpaid claims and claim expenses. The actual effects of inflation on the Company's results cannot be accurately known until claims are ultimately settled.
The result of the foregoing is that the future operations of the Company, at least in the next several years, are likely to consist substantially of the management in runoff of LaSalle Re, including administration of claims, regulatory reporting, settlement of reinsurance agreements (including commutations thereof where appropriate), cash and investment management and related matters, and the ongoing participation in Lloyd's syndicates through the Oak Entities as corporate capital providers. The costs involved in the runoff operations are likely to differ significantly from those of prior years, where a significant portion of the operating costs related to underwriting, marketing and securing reinsurance for new business. The reimbursement of costs as they relate directly to LaSalle Re's runoff will be subject to review by the Bermuda Monetary Authority (the "BMA") which may challenge these costs or impose other restrictions with respect to the runoff including the provision of an acceptable runoff plan. Adverse loss developments, weakness in reinsurance recoveries or the failure to realize the value of its investments including the intercompany receivables, among other factors, could significantly and negatively impact the success of any runoff. It is unlikely that any amounts will be available to the equity holders of the Company until such time as the BMA has been assured of the minimum capital and solvency of LaSalle Re. In addition, the BMA has recently notified the Company that it will not permit the granting of a security interest in LaSalle Re's assets to the Banks as collateral under Trenwick's credit agreement. In the event that the runoff is not successful, it is also possible that LaSalle Re may be placed under the control of the BMA, voluntarily or involuntarily, through rehabilitation, liquidation or other similar proceedings.
You should carefully consider the risks described below regarding us and our Series A Preferred Shares. The risks and uncertainties described below are not the only ones we face. There may be additional risks and uncertainties. If any of the following risks actually occur or continue to occur, our business, financial condition or results of operations could be materially and adversely affected and the trading price of our Series A Preferred Shares could decline further.
Our independent accountants, PricewaterhouseCoopers LLP, have stated, in their audit report with respect to our financial statements as at and for the twelve months ended December 31, 2002, that substantial doubt exists as to our ability to continue as a going concern. Trenwick's and our ability to operate continue to be adversely impacted by the deterioration in Trenwick's financial condition and its lack of available financial resources to meet its obligations including amounts owed to the Company and LaSalle Re.
Trading of our Series A Preferred Shares has been suspended by the New York Stock Exchange.
In the absence of the permission granted by the BMA discussed in the previous paragraph, as a consequence of the suspension of trading, all transfers of shares involving holders of Trenwick's or the Company's securities would be required to be approved by the BMA before they could be entered into Trenwick's or the Company's share register. This procedure would only apply to share transfers involving shareholders who hold shares in their own name on Trenwick's or the Company's share register (a "record holder"). Shareholders who hold through nominees, brokers, or banks, which in turn have accounts through other nominees, would not be affected by this approval procedure unless one of the parties to the transfer becomes a record holder on Trenwick's or the Company's share register or the number of shares held by an existing record holder is increased or decreased by the transfer. If the BMA's free transferability permission is rescinded, this pre-approval process will cause a delay in share transfers.
We have guaranteed the obligations of Trenwick and Trenwick Holdings under Trenwick's credit agreement, which guaranty is supported by a security interest in all of LaSalle Re's shares.
We are a holding company and substantially all of our assets are held in LaSalle Re and LaSalle Re's participation in Lloyd's. LaSalle Re's assets are generally unavailable to pay the debts of the holding company and there is substantial uncertainty as to whether we will ultimately receive any value from them.
We are a holding company with no material assets other than the stock of our operating subsidiaries, our intercompany receivables due from Trenwick (the collectability of which are in doubt), and LaSalle Re's participation in Lloyd's. Our ability to pay dividends to our shareholders will be dependent on the earnings and cash flows of LaSalle Re in runoff and our Lloyd's operations and their ability to pay dividends or to advance or repay funds to us. Payment of dividends and advances and repayments from LaSalle Re is regulated by the BMA and regulatory restrictions, including minimum solvency and liquidity thresholds. We do not expect LaSalle Re will be able to pay dividends or advance or repay any funds to us in the foreseeable future.
Our financial strength ratings have been downgraded significantly by Standard & Poor's, and Fitch, and have been withdrawn by Moody's Investor Services. These downgrades generally reflect the ratings services' views that our business prospects and financial flexibility are very limited.
LaSalle Re's catastrophe liability and other insurance business, from which we historically derived a majority of our revenue, has ceased to write new business and is in runoff.
Our business model relied to a large extent on reinsurance to reduce our underwriting risk. As of December 31, 2002, our reinsurance recoverable balance was approximately $913 million. LaSalle Re is subject to credit risk with respect to its reinsurers because the transfer of risk to a reinsurer does not relieve the LaSalle Re of its liability to the insureds. In addition, reinsurers may be unwilling to pay us even though they have the financial resources and are contractually obligated to do so. Unfavorable arbitration decisions or the failure of one or more of the reinsurers to honor their obligations or make timely payments would impact our cash flow and could cause us to incur significant losses. In the event of the rehabilitation, supervision, conservation or liquidation of LaSalle Re, we may not be able to influence the outcome of the collectibility of reinsurance recoverables, in that it will be the responsibility of the regulators supervising such proceedings.
If our loss reserves are determined to be inadequate, we will be required to increase loss reserves at the time of such determination with a corresponding reduction in our net income or increase our net loss in the period in which the deficiency is rectified. It is possible that claims in respect of events that have occurred could
exceed our loss reserves and have a material adverse effect on our results of operations or our financial condition in general.
The supply of insurance and reinsurance coverage has decreased due to withdrawal of capacity and substantial reductions in capital resulting from, among other things, the terrorist attacks of September 11, 2001. This tightening of supply may result in governmental intervention in the worldwide insurance and reinsurance markets. We are currently unable to predict the extent to which new political, regulatory and industry initiatives may affect the demand for our products or the risks which may be available for us to consider underwriting. At the same time, threats of further terrorist attacks and the military initiatives and political unrest in the Middle East and Asia have adversely affected general economic, market and political conditions, increasing many of the risks associated with the insurance markets worldwide.
We are a Bermuda company and it may be difficult for you to enforce judgments against us or our directors and executive officers.
securities laws because these laws have no extraterritorial jurisdiction under Bermuda law and do not have force of law in Bermuda. A Bermuda court may, however, impose civil liability on us or our directors and officers if the facts alleged in a complaint constitute or give rise to a cause of action under Bermuda law.
The information called for by this item can be found in the Consolidated Financial Statements and Notes thereto beginning on page.