Selected Financial Data. The following table sets forth selected consolidated financial data of Chartwell as of and for the periods indicated. This table does not include any historical operating financial data relating to Archer prior to December 31, 1996 or Piedmont prior to December 31, 1995 because the results of operations subsequent to the Acquisition and the Merger through the end of the years indicated were immaterial to Chartwell. The financial data for each of the five years in the period ended December 31, 1997 is derived from the audited financial statements of Chartwell. The following table also includes selected data from the Statutory Annual Statements of Chartwell Reinsurance and INSCORP. The selected consolidated financial data should be read in conjunction with the consolidated financial statements of Chartwell and notes thereto and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," included elsewhere herein.
- ----------------------------------------- (1) The net loss for the year ended December 31, 1994 includes after-tax expenses of $3.6 million for losses incurred related to the Northridge, California earthquake and $1.2 million of recapitalization expenses. (2) All per share amounts have been calculated in accordance with a new accounting standard, Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which became effective December 15, 1997. SFAS No. 128 requires dual presentation of basic and diluted earnings per share and the restatement of all prior-period earnings per share data presented. (3) Statutory data has been derived from the Statutory Annual Statements of Chartwell Reinsurance and INSCORP as filed with insurance regulatory authorities and prepared in accordance with SAP. (4) The statutory surplus of Chartwell Reinsurance was increased by $20.0 million in 1996 from the proceeds of a common stock offering, by $67.1 million in 1995 as a result of the Merger and by $30.0 million in 1994 from the proceeds of the Senior Notes offering. The ratio of net premiums written to surplus ratio for 1995 includes only the premiums of Chartwell Reinsurance and excludes the increase in surplus that resulted from the Merger. (5) Total assets and loss and LAE reserves are stated gross of reinsurance recoverable in accordance with the requirements of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." The balance sheet data at December 31, 1996 reflects the Acquisition of Archer and at December 31, 1995 reflects the Merger of Piedmont with Chartwell.
Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of the financial condition and results of operations of Chartwell should be read in conjunction with the consolidated financial statements and notes thereto of Chartwell included elsewhere herein. The following discussion does not include any information relating to Archer's historical results of operations prior to November 19, 1996 or INSCORP's historical results of operations prior to December 13, 1995. Archer's results of operations for the period from November 19, 1996 to December 31, 1996 were immaterial to Chartwell and, therefore, have not been included. INSCORP's results of operations for the period from December 13, 1995 to December 31, 1995 were immaterial to Chartwell; Chartwell has accounted for the Merger as though it had occurred on December 31, 1995.
The following table presents the statutory combined ratios of Chartwell, the property and casualty reinsurance industry and the property and casualty insurance industry during the 1993 to 1997 years. The combined ratio is the sum of the loss ratio (incurred losses and loss adjustment expenses divided by net premiums earned) and the underwriting expense ratio (underwriting expenses divided by net premiums written). A combined ratio of over 100% indicates unprofitable underwriting. Although an insurance company's underwriting may be unprofitable, the company may be profitable after including investment income.
Consolidated Results of Operations Year Ended December 31, 1997 Compared With Year Ended December 31, 1996 Revenues: Total revenues for the year ended December 31, 1997 increased 21.9% to $322.4 million, compared to $264.5 million for the comparable period in 1996. The accompanying table summarizes gross and net premiums written and total revenues for the periods indicated:
Policy Acquisition Costs. Policy acquisition costs, consisting primarily of commissions paid to ceding companies and brokerage fees paid to intermediaries, less commissions received on business ceded to other reinsurers, were $72.7 million for the year ended December 31, 1997, compared to $52.0 million for the same period in 1996. Policy acquisition costs expressed as a percentage of net earned premiums (the acquisition expense ratio) increased to 29.6% from 24.8% in 1996. The increase is primarily due to the effect of the aggregate excess of loss reinsurance treaties entered into in 1997 which reduced net earned premium for the year without providing any reduction in commission expenses. Also contributing to the increase is the modestly higher commission structure, as noted above, for proportional business.
Income Before Income Taxes and Extraordinary Item. Net income before income taxes and extraordinary items increased to $37.9 million for the year ended December 31, 1997 compared to $32.5 million for the same period in 1996. The increase resulted primarily from the increase in earned premiums, the favorable results in both loss and loss adjustment expense and other expenses, and the contributions from Archer to income from service operations.
Net Income Before Extraordinary Item. Net income before extraordinary item increased to $27.3 million for the year ended December 31, 1997 as compared to $22.9 million for the same period in 1996, and basic earnings per share before extraordinary item increased 12.7% to $2.84 from $2.52 for the year ended December 31, 1996. Diluted earnings per share before extraordinary item increased 10.0% to $2.74 from $2.49. Basic and diluted after-tax operating income per share (which excludes net realized capital gains on the sale of investments) for the year ended December 31, 1997 increased 16.9% and 13.7%, respectively to $2.84 and $2.74 from $2.43 and $2.41, respectively, for the same period in 1996.
Extraordinary Item, Net of Income Tax. The Company recognized a net after-tax extraordinary expense of $1.9 million for the year ended December 31, 1996 for the write-off of unamortized debt issuance costs and a redemption premium associated with the redemption of 35% of the Senior Notes.
Net Income. The Company realized a net profit of $27.3 million for the year ended December 31, 1997 compared with a net profit of $21.0 million for the comparable 1996 period because of the factors discussed above. Basic net income per share increased 22.9% to $2.84 for the year ended December 31, 1997 from $2.31 per share for the year ended December 31, 1996. Diluted net income per share increased 19.7% to $2.74 from $2.29 per share for the year ended December 31, 1996.
Revenues Year Ended December 31, ---------------------------- 1996 1995 ------------- ------------ (Dollars in thousands) Gross premiums written...................... $ 263,838 $ 126,968 ========= ========= Net premiums written........................ $ 192,251 $ 123,314 ========= ========= Premiums earned............................. 209,503 120,258 Net investment income....................... 44,089 19,907 Net realized capital gains.................. 1,157 3,199 Service and other revenue................... 6,167 1,095 Equity in net earnings of investees......... 3,559 -- --------- -------- Total............................. $ 264,475 $ 144,459 ========= =========
Income Tax Expense. The provision for Federal income taxes for the year ended December 31, 1996 increased to $9.7 million compared with $2.7 million for the same period in 1995. The effective tax rate was 29.7% and 30.2% for the years ended December 31, 1996 and 1995, respectively. The principal factor in the decline below the statutory rate of 35% for both periods was the benefit of investments in tax-advantaged securities which increased in the 1996 period.
Net Income. The Company realized a net profit of $21.0 million for the year ended December 31, 1996 compared with a net profit of $6.2 million for the comparable 1995 period because of the factors discussed above. Basic net income per share increased 39.2% to $2.31 for the year ended December 31, 1996 from $1.66 per share for the year ended December 31, 1995. Diluted net income per share increased 38.8% to $2.29 from $1.65 per share for the year ended December 31, 1995.
Liquidity and Capital Resources As a holding company, Chartwell's assets consist primarily of the stock of its direct and indirect operating subsidiaries, Chartwell Reinsurance, INSCORP, Archer, and Chartwell Advisers. Chartwell's cash flow, therefore, depends largely on dividends and other statutorily permissible payments from its operating subsidiaries. Chartwell's sources of funds consist primarily of net premiums, reinsurance recoveries, investment income and proceeds from sales and redemptions of investments. Funds are applied primarily to payments of claims, operating expenses and income taxes and to the purchase of investments, largely fixed income securities. Cash and short-term investments are maintained for the payment of claims and expenses. For the years ended December 31, 1997, 1996 and 1995, Chartwell's consolidated cash flow provided by operations was $28.3 million, $12.2 million and $23.0 million, respectively. The cash flow from operations in 1997 was greater than that in 1996 due to improved underwriting cash flows comprising premiums received less paid losses and LAE and underwriting expenses. The 1996 cash flow from operations was reduced as a result of the run-off of INSCORP's reinsurance reserves. The primary contributors to the positive cash flow for the 1995 period were underwriting cash flow and investment income received. The 1995 cash flow provided by operations was reduced by $10.9 million due to the payment of three unusually large claims from business written prior to 1985 and the commutation of a group of assumed contracts. Sales of available for sale investments were $200.8 million, $500.7 million and $330.6 million for the years ended December 31, 1997, 1996 and 1995, respectively. Trading activity increased during 1996 primarily to modify the
Upon consummation of the Merger, Chartwell became the successor to Piedmont under the CI Notes. The CI Notes were issued in an aggregate principal amount of $1 million, which principal amount will accrue interest at a rate of 8% per annum, compounded annually. Such interest will not be payable until maturity or earlier redemption of the CI Notes. In addition, the CI Notes will entitle the holders thereof to receive at maturity, in proportion to the principal amount of the CI Notes held by them, an aggregate of from $10 million up to $55 million in contingent interest. Settlement of the CI Notes may be made by payment of cash or, under certain specified conditions, by delivery of shares of the Company's common stock. The CI Notes mature on June 30, 2006. Chartwell and its subsidiaries may incur additional indebtedness in the future, subject to the limitations contained in the Senior Notes indenture, the agreements governing the Credit Facility and the CI Notes indenture. The agreements governing the Senior Notes, the CI Notes and the Credit Facility significantly restrict the ability of Re Holdings to make dividend and other payments to Chartwell. Further, dividend payments by Chartwell Reinsurance and INSCORP are subject to limits under the laws of the States of Minnesota and New York, respectively. Under the applicable provisions of the insurance holding company laws of the State of Minnesota, Chartwell Reinsurance may, upon five days notice to the Commissioner of Insurance of the State of Minnesota ("the Commissioner") following the declaration of dividends to stockholders, and upon at least ten days notice to the Commissioner prior to dividend payments, pay dividends without the approval of the Commissioner, unless such dividends, together with other dividends paid within the preceding twelve months, exceed the greater of (i) 10% of Chartwell Reinsurance's policyholders' surplus as of the end of the prior calendar year or (ii) Chartwell Reinsurance's statutory net income, excluding realized capital gains, for the prior calendar year. Any dividend in excess of the amount determined pursuant to the foregoing formula would be characterized as an "extraordinary dividend" requiring the prior approval of the Commissioner. In any case, the maximum amount of dividends Chartwell Reinsurance may pay is limited to its earned surplus, also known as unassigned funds. As of December 31, 1997, Chartwell Reinsurance reported unassigned funds, as defined, in the amount of $68.8 million. Up to $26.3 million is available under the foregoing formula for the payment of dividends by Chartwell Reinsurance without regulatory approval in 1998. On November 25, 1997, Chartwell Reinsurance paid a $3.0 million dividend to Re Holdings. Chartwell Reinsurance paid no dividends in 1996 or 1995. Under New York law, which is applicable to INSCORP, the maximum ordinary dividend payable in any twelve month period without the approval of the Superintendent may not exceed the lesser of (a) 10% of policyholders surplus as shown on the company's last annual statement or any more recent quarterly statement or (b) the company's adjusted net investment income. Adjusted net investment income is defined as net investment income for the twelve months preceding the declaration of the dividend plus the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months prior to the declaration or distribution of the current dividend and ending twelve months prior thereto. In any case, New York law permits the payment of an ordinary dividend by an insurer or reinsurer only out of earned surplus. Moreover, notwithstanding the receipt of any dividend from INSCORP, Chartwell Reinsurance may make dividend payments to Re Holdings only to the extent permitted under the Minnesota provisions described above. In addition to the foregoing limitation, the New York Insurance Department, as is its practice in any change of control situation, required Chartwell to commit to preclude the acquired New York-domiciled insurer, INSCORP, from paying any dividends for two years after the Merger without prior regulatory approval. The foregoing restriction expired on December 13, 1997. The maximum dividend permitted by law is not indicative of an insurer's actual ability to pay dividends, which may be constrained by business and regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends. Furthermore, beyond the limits described in the preceding paragraph, the Commissioner and Superintendent have discretion to limit the payment of dividends by insurance companies domiciled in Minnesota and New York, respectively. Management believes that current levels of cash flow from operations and assets held at the holding company level provide the Company with sufficient liquidity to meet its operating needs in the short term (over the next 12 months). Management expects Chartwell to be able to continue to meet its operating needs after the next 12 months from internally generated funds. Since the ability of Chartwell to meet its obligations in the long term (beyond such 12-month period) is dependent upon such factors as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet its operating needs. The Company expects that, in order to repay the principal amount of the Senior Notes on maturity or otherwise, it will be required to seek additional financing or engage in asset sales or similar transactions, and would be required to take similar actions in order to repay the CI Notes on maturity or otherwise, in the event it chose or was required to settle the
Regulatory Accounting Practices Management does not believe that current accounting changes being contemplated by regulatory authorities, if implemented, would have a significant effect on the operations or liquidity of Chartwell.