The Company owns approximately 424,000 square feet of space in four contiguous executive office properties in Princeton, New Jersey, on land owned by Princeton University and subject to long-term
ground leases. The Company also owns properties for its foreign subsidiaries and representative offices totaling 18,545 square feet in Mexico City, Cairo, Santiago, Bogota and Buenos Aires.
(3) GAAP loss and LAE ratio represents the sum of losses and LAE as a percentage of net premiums earned. GAAP underwriting expense ratio represents underwriting expenses as a percentage of net premiums earned. GAAP combined ratio represents the sum of the GAAP loss and LAE ratio and GAAP underwriting expense ratio. See "Management's Discussion and Analysis of the Company's Results of Operations and Financial Condition."
The Company is a subsidiary of Munchener Ruckversicherungs-Gesellschaft Aktiengesellschaft in Munchen ("Munich Re"), a company organized under the laws of Germany. Munich Re is the world's largest reinsurance company, based on 1996 net premiums written, according to BUSINESS INSURANCE.
On July 1, 1997, American Re and Munich Re completed the merger of MARC into American Re-Insurance. Prior to this transaction, MARC was owned 27.5% by Munich Re, 22.5% by the U.S. Branch, 40% by Allianz, and 10% by Victoria. This transaction was effected by exchanging 100% of the common shares of MARC for newly issued shares of the Company. On July 2, 1997, the U.S. Branch exchanged its newly acquired shares of the Company with Munich Re for cash in the amount of $85.0 million. This amount approximated the statutory accounting value of the U.S. Branch's ownership in MARC at the time of the Merger. On July 3, 1997, Munich Re contributed the insurance-related assets and liabilities of the U.S. Branch to American Re-Insurance in exchange for additional shares of the Company. As a result of these transactions (collectively, the "Merger"), the shares of common stock held by Allianz and Victoria represent minority interests in the Company's common stock equal to less than 9% on an aggregate basis. Munich Re continues to own over 91% of the outstanding common stock of the Company.
As common control was considered effective at December 31, 1996, the Company's consolidated statements of income and cash flows for the year ended December 31, 1996, have not been restated. The Company's consolidated statements of income and cash flows for the year ended December 31, 1997, represent the fully consolidated operations of American Re, MARC, and the U.S. Branch for the period then ended, with 50% of MARC's net loss for the six-month period ended June 30, 1997, accounted for as minority interest. As a result, significant variances exist when comparing the results of operations for the year ended December 31, 1997, with the same period in 1996. Accordingly, selected financial results have been presented below on a pro forma basis for the year ended December 31, 1996, as if the merger transactions which took place in July 1997 had occurred on January 1, 1996. Pro forma adjustments to reflect such transactions have been applied to the respective historical income statements of the Company.
The decrease in facultative premiums was attributable to decreases of $107.0 million or 18.0% in the Company's Domestic Insurance Company Operations ("DICO"), $11.2 million or 5.9% in the Company's alternative market operations, AM-RE Managers, Inc., ("ARMI"), and $10.8 million or 28.1% in the Company's International Operations. These decreases generally were the result of what the Company perceives to be deteriorating market conditions in the facultative market in the 1997 period, which include depressed reinsurance prices and premiums, lower renewal retention ratios on existing business, increased net retentions by primary companies, and new entrants into the facultative market.
The increase in treaty net premiums written for the year ended December 31, 1997, from the same period in 1996 on a pro forma basis, was primarily attributable to an increase in DICO of $46.4 million or 3.7%, offset by decreases in International Operations of $37.8 million or 8.5%, and ARMI of $3.1 million or 3.1%. The slight growth in treaty premiums also was attributable to what the Company perceives as deteriorating market conditions, which include decreased pricing on the primary insurance company level, primary companies increasing net retentions on excess of loss business as a result of surplus growth, and conversion of certain reinsurance programs from a pro rata to an excess of loss basis, which generally result in a reduction of reinsurance premiums. The decrease in International Operations' net premium written was primarily due to the assumption or renewal of certain aviation treaties by Munich Re in the 1997
The Company's net premiums earned increased 38.4% to $2,486.1 million for the year ended December 31, 1997, from $1,796.7 million in 1996. On a pro forma basis, 1996 net premiums earned were $2,494.1 million, resulting in a decrease of 0.3%. The pro forma decrease in premiums earned was primarily attributable to the pro forma decrease in net premiums written, offset by the timing of premiums earned on business in force.
The Company's interest expense decreased by 20.9% to $42.8 million for the year ended December 31, 1997, from $54.1 million in 1996. This decrease was primarily attributable to the lower interest rate on the senior notes outstanding during the 1997 period, as compared to that of the senior subordinated debt outstanding during the 1996 period. In December 1996, the Company issued $500.0 million principal amount of 7.45% Senior Notes, and in-substance defeased its existing issue of 10 7/8% Senior Subordinated Debentures in the principal amount of $450.0 million, which were redeemed in September 1997.
In 1996, the Company recognized an extraordinary loss of $34.0 million after-tax, resulting from the in-substance defeasance of the senior subordinated debentures. This amount represents the write-off of the remaining unamortized financing fees from the senior subordinated debentures, interest payable through the redemption date of September 19, 1997, and a call premium of 4.75% of the redemption price. There was no comparable charge for the Company in 1997.
Net losses and loss adjustment expenses ("LAE") incurred decreased 12.9% to $1,167.8 million for the year ended December 31, 1996, from $1,340.2 million in 1995. This decrease was primarily due to a decrease in losses due to adverse development from Latent Liability Exposures. The Company incurred a $347.4 million charge for loss reserve strengthening, primarily due to increases in reserves for Latent Liability Exposures, in the fourth quarter of 1995. (See "Reserves for Unpaid Losses and Loss Adjustment Expenses".) The Company had no adverse loss development for Latent Liability Exposures in 1996. The year ended December 31, 1996, also included $16.5 million of catastrophe losses, compared to $10.0 million of catastrophe losses incurred in 1995.
Underwriting expenses, consisting of commission expense plus operating expenses, increased 17.9% to $533.5 million for the year ended December 31, 1996, from $452.5 million in 1995. This increase was primarily due to an increase in commission expense of 21.0% to $390.1 million for the year ended December 31, 1996, from $322.4 million in 1995. This increase was primarily due to the increase in writings of pro rata treaty premiums. Operating expenses increased 10.3% to $143.4 million for the year ended December 31, 1996, from $130.1 million in 1995, due to an increase in overhead expenses.
The Company experienced an underwriting gain (net premiums earned minus losses and LAE incurred and underwriting expenses) of $95.4 million for the year ended December 31, 1996, compared to an underwriting loss of $261.7 million in 1995. The change in the underwriting result was primarily due to the charge for loss reserve strengthening recognized in 1995. On a GAAP basis, the Company's loss ratio decreased to 65.0% for the year ended December 31, 1996 (inclusive of 0.9 points due to catastrophe losses), from 87.5% in 1995 (inclusive of 20.4 points due to the charge for loss reserve strengthening and 0.6 points due to catastrophe losses). The underwriting expense ratio increased slightly to 29.7% for the year ended December 31, 1996, from 29.6% in 1995. As a result of the decrease in the loss ratio, the GAAP combined ratio for the year ended December 31, 1996, decreased to 94.7% from 117.1% in 1995.
Pre-tax net investment income increased 11.5% to $248.2 million for the year ended December 31, 1996, from $222.6 million in 1995. This increase was primarily due to the increase in invested assets. The Company's after-tax net investment income increased by 9.7% to $183.0 million for the year ended December 31, 1996, from $166.8 million in 1995. The after-tax net investment income increase was less than the pre-tax net investment income increase due to the Company's decision to continue to increase the percentage of taxable fixed maturity investments in its portfolio, based on the relative attractiveness of investment yields on highly rated taxable instruments, in addition to tax planning considerations.
Other income increased by 21.5% to $47.5 million for the year ended December 31, 1996, from $39.1 million in 1995. The increase in the 1996 period was primarily attributable to a $12.7 million increase in fee subsidiary revenue. Other expenses increased 5.6% to $109.2 million for the year ended December 31, 1996, from $103.4 million in 1995. The increase was primarily attributable to $36.1 million in acquisition-
related expenses incurred during 1996, and a $16.5 million increase in subsidiary expenses from $39.3 million in 1995, to $55.8 million in 1996. The 1995 period included a $36.5 million increase in the provision for the allowance for uncollectible reinsurance primarily related to the charge for loss reserve strengthening in 1995; there was no similar charge during the 1996 period.
The Company incurred an after-tax expense of $13.1 million for the year ended December 31, 1996, compared to $4.4 million in 1995, representing the Company's minority interest in the earnings of American Re Capital, a single-purpose, wholly owned subsidiary trust. The expense was due to the distributions paid by American Re Capital on the QUIPS, which were issued August 30, 1995.
In 1996, the Company recognized an extraordinary loss of $34.0 million after-tax, resulting from the in-substance defeasance of the senior subordinated debentures. This amount represents the write-off of the remaining unamortized financing fees from the senior subordinated debentures, interest payable through the redemption date of September 19, 1997, and a call premium of 4.75% of the redemption price. See "Financial Condition." In 1995, the Company recognized an extraordinary, non-cash after-tax loss of $0.3 million, representing the write-off of capitalized financing fees from the revolving bank credit agreement after the obligation was paid in full.
The Company realized net income to common stockholders of $111.7 million for the year ended December 31, 1996, compared to a net loss of $87.6 million in 1995.
The Company is a subsidiary of Munich Re, a company organized under the laws of Germany. Munich Re is the world's largest reinsurance company, based on 1996 net premiums written, according to Business Insurance.
Common stockholders' equity increased 44.3% to $2,586.4 million at December 31, 1997, from $1,792.5 million at December 31, 1996. This increase was primarily attributable to the Merger-related transactions, with the non-cash purchase of the MARC minority interest of $425.0 million, and the capital contribution to the U.S. Branch of $85.0 million. In addition, the Company realized net income of $221.4 million for the year ended December 31, 1997, and recognized net market appreciation of $62.8 million on debt and equity securities, after applicable income tax effect.
The Company is an insurance holding company whose only material investment is in the capital stock of American Re-Insurance. The Company is dependent on dividends and tax allocation payments, primarily from American Re-Insurance, to meet its short- and long-term liquidity requirements, including its debt service obligations. It is the Company's understanding that it is Munich Re's intention to further strengthen the capital position of the Company by allowing net income to be retained; therefore, at this time, no cash dividends on the Company's common stock are anticipated.
The Company is required to apply a portion of its operating cash flow to the servicing and repayment of its debt obligations. The payment of dividends to the Company by American Re-Insurance is subject to limitations imposed by the Delaware Insurance Code. Based upon these restrictions and 1997 operating results, the maximum amount available for payment of dividends to the Company by American Re-Insurance in 1998 without approval of regulatory authorities is estimated to be $230.1 million.
Much attention has been given to the Year 2000 problem, (i.e., the failure of computer software and embedded computer chips to properly recognize the Year 2000 and later because such dates are represented only by the last two digits of the year, resulting in errors during certain computer operations). The Company has been aware of the Year 2000 problem for several years and has been making modifications and replacements in its systems as problems have been identified. Some Year 2000 problems have been eliminated in the course of upgrading the Company's computer hardware and software as part of its ongoing technology initiative. However, recognizing that the Company still has some Year 2000 non- compliant systems, e.g., certain mainframe systems, old software applications, and some facilities equipment, management has initiated a formal Company-wide process to identify and correct any remaining Year 2000 problems. The Company has dedicated in-house information technology staff, retained consultants, and designated representatives from the major business areas of the Company to review all systems for Year 2000 compliance and to correct all problems identified. The Company expects to complete this process by the fourth quarter of 1998, at which time the Company plans to conduct enterprise-wide testing of its systems to confirm their Year 2000 compliance. As part of this process, the Company is communicating with its clients, retrocessionaires, vendors and other business relationships regarding their Year 2000 compliance and is requesting modifications to their systems that are not Year 2000 compliant, as appropriate. The Company presently believes that with these modifications and replacements, the Year 2000 problem can be adequately addressed. The Company anticipates that Year 2000 specific expenditures through 1998, not including in-house resources, will be approximately $5.8 million. While additional expenses in connection with the Company's Year 2000 compliance effort are likely, it is anticipated that the total Year 2000 compliance expenditures will not have a material adverse effect on the Company's business, operations or financial condition.
Reference is made to the items included in Item 14(a) of this report.