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 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, 1996 is derived from the audited financial statements of Chartwell. The following table also includes selected data from Statutory Annual Statements. 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.
(3) The GAAP loss ratio for the year ended December 31, 1992 was increased by approximately 36.8 percentage points due to losses related to Hurricanes Andrew and Iniki. In addition, in 1992 the Company's mix of assumed business consisted of more excess of loss coverages which generally have a higher loss ratio (but a lower expense ratio) than pro rata coverages. For the year ended December 31, 1992, the Company ceded more losses for statutory purposes than for GAAP purposes because certain reinsurance contracts did not meet the GAAP conditions for reinsurance accounting under SFAS No. 113. As a result, the GAAP basis loss ratio was higher than the SAP basis loss ratio for the year ended December 31, 1992.
(5) For statutory accounting purposes, the Company ceded a significant amount of premiums in 1992 due in part to premiums to reinstate coverages exhausted by losses related to Hurricanes Andrew and Iniki. The reduction in statutory net premiums written for 1992 results in an increase in the underwriting expense ratio in 1992 since operating expenses were relatively stable from the prior year.
(7) Total assets and loss and LAE reserves are stated gross of reinsurance recoverable in accordance with the requirements of Statement of Financial Accounting Standards 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.
Year Ended December 31, 1996 Compared With Year Ended December 31, 1995
Revenues: Total revenues for the year ended December 31, 1996 increased 83% to $264.5 million, compared to $144.5 million for the comparable period in 1995. The accompanying table summarizes gross and net premiums written and total revenues for the periods indicated:
Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written for the year ended December 31, 1996 were $263.8 million, an increase of 108% compared to the same period in 1995. The increase in gross premiums written was attributable to business acquired in the Merger and continued growth with existing and new clients in all client segments. Business emanating from the Merger consisted of: (i) a seasoned book of specialty insurance business which is the basis for the Controlled Source Insurance business, (ii) a marine pool (Navigators Marine Pool) which is included with Chartwell's other marine and aviation business in the Marine & Aviation Accounts client segment; (iii) certain of INSCORP's reinsurance contracts which met Chartwell's underwriting standards and which were renewed in Chartwell Reinsurance, primarily in the Regional and Specialty Accounts client segments; and (iv) certain of INSCORP's reinsurance contracts that were not renewed because they did not meet Chartwell's underwriting standards and which are classified below as "INSCORP Run-off." Specialty Accounts gross premiums written for the year ended December 31, 1996 increased 66.6% over the prior year due to expansion of existing clients and development of new clients, particularly in the workers compensation line, as a result of favorable legislative and economic developments in certain jurisdictions. Global Accounts continued to focus on expansion in the international marketplace rather than the large domestic insurance marketplace in response to market conditions. Growth in Regional Accounts and Marine & Aviation accounts was mainly attributable to the retention of INSCORP contracts and, to a lesser extent, expansion with new and current clients. Controlled Source Insurance Accounts grew as a result of the expansion of current programs in response to market opportunities. The distribution of the Company's gross premiums written among its underwriting client segments was as follows:
Net premiums written for the year ended December 31, 1996 increased 56% to $192.3 million, compared to $123.3 million for the same period in 1995. The increase in net premiums written was principally attributable to the reasons described above for the increase in gross premiums written. Net premiums earned for the year ended December 31, 1996 were $209.5 million, an increase of $89.2 million or 74% compared to the same period in 1995.
Net Investment Income and Net Realized Capital Gains (Losses). Consolidated net investment income, exclusive of realized and unrealized capital gains and losses, for 1996 was $44.1 million, an increase of $24.2 million, or 121%, over the same period in 1995. The improvement reflects the increase in invested assets principally from the net proceeds of Chartwell's public stock offering in the first half of 1996 and continued positive cash flow from operations of $12.2 million offset by a decline in the value of marked-to-market investments of $10.0 million. In addition, on June 28, 1996, the Company received $7.9 million in settlement of the Reserve Indemnification Agreement which further increased the Company's invested asset base. The average annual tax equivalent yield on invested assets before investment expenses increased to 6.7% for 1996 compared to 6.8% for the same period in 1995.
The Company realized net capital gains of $1.2 million for 1996 compared to $3.2 million for the same period in 1995. Both the 1996 and 1995 net capital gains were realized principally to reposition certain sectors of the portfolio and to modify the portfolio to improve credit quality without sacrificing yield.
Net Income Before Extraordinary Item. Net income before extraordinary item increased to $22.9 million for the year ended December 31, 1996 as compared to $6.2 million for the same period in 1995 and, on a per share basis, increased 52% to $2.52 from $1.66 reported a year ago. The largest components of this increase were increases in net investment income and income from service operations as described above. After-tax operating income per share (which excludes net realized capital gains on the sale of investments) for the year ended December 31, 1996 increased 121% to $2.43 from $1.10 reported for the same period in 1995.
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. Net income per share increased 39% to $2.31 for the year ended December 31, 1996 from $1.66 per share reported a year ago.
Revenues Year Ended December 31, -------------------------- (Dollars in Thousands) 1995 1994 --------- --------- Gross premiums written ........................ $ 126,968 $ 116,396 ========= ========= Net premiums written .......................... $ 123,314 $ 113,962 ========= ========= Premium earned ................................ $ 120,258 $ 102,698 Net investment income ......................... 19,907 14,726 Net realized capital gains (losses) ........... 3,199 (3,794) Service operations ............................ 1,095 1,679 --------- --------- Total ..................... $ 144,459 $ 115,309 ========= =========
Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written for the year ended December 31, 1995 were $127.0 million, an increase of 9.1% compared to the same period in 1994. The increase in gross premiums written was attributable to premium growth on the underlying reinsured business, increased participations on existing client treaties, and the establishment of new programs and client relationships in all of Chartwell's underwriting segments. Specialty Accounts volume increased over 1994 levels due to the expansion of relationships with existing clients and the addition of new programs in the fidelity, surety and accident and health lines. Global Accounts volume decreased from 1994 levels due to a decrease in general liability premiums because of continued competitive pressures on rates while property premiums continued to grow. Gross premiums written for automobile coverage decreased as a result of developing competition in the United Kingdom marketplace for United Kingdom motor business. Regional Accounts volume decreased from 1994 levels primarily due to non-renewal of a large account that experienced deteriorating underwriting results. Chartwell elected to non-renew such account at the expiring term since other reinsurers did not support a rate increase. Marine & Aviation Accounts volume increased from 1994 levels primarily due to expansion into the marine market, an increase in aviation premiums due to increased rate levels on certain programs and expansion of existing business relationships.
December 31, ----------------------- (Dollars in Thousands) 1995 1994 --------- --------- Specialty .......................................... $ 60,529 $ 53,807 Global: Domestic ........................................ 21,010 22,136 International ................................... 17,400 17,535 --------- --------- Subtotal Global .................................... 38,410 39,671 Regional ........................................... 16,738 19,541 Marine & Aviation .................................. 11,291 3,377 --------- --------- $ 126,968 $ 116,396 ========= =========
and the loss and LAE ratio increased by 5.4 percentage points for the same period as a result of the Northridge, California earthquake. Chartwell did not incur a significant loss from either domestic or international catastrophic activity occurring in 1995.
Income from service operations, primarily from Chartwell Advisers, decreased to $1.1 million for 1995 from $1.7 million in 1994. The service revenue for 1994 included certain one-time fees earned by Chartwell Advisers related to the start-up of New London Capital plc.
Interest and Amortization. Interest and amortization increased by 6.0% to $7.8 million in 1995 from $7.4 million in 1994. The 1995 expense amount includes $8.0 million of interest and amortization on the Senior Notes, $0.1 million of interest on bank debt and other amortization offset by $0.3 million of savings from an interest rate swap which was terminated during the second quarter of 1995. The 1994 expense amount includes $0.9 million of interest and amortization on a senior term loan and certain subordinated debentures which were outstanding prior to the Senior Notes issuance on March 17, 1994, $6.4 million of interest and amortization on Chartwell's Senior Notes and a one-time cash conversion incentive payment of $0.8 million associated with certain refinancing transactions completed concurrently with Chartwell's issuance of the Senior Notes, as discussed under "--Liquidity and Capital Resources" below (the Senior Notes issuance and the use of proceeds thereof and the foregoing transactions being herein collectively referred to as the "1994 refinancing"), offset by $0.7 million of savings from the interest rate swap.
Preferred Dividends and Accretion. Preferred dividends and accretion were $1.1 million for 1994. Such amount includes a 4% cash conversion incentive payment of $0.8 million made to preferred stockholders associated with Chartwell's 1994 refinancing. All of the preferred stock was converted to common stock as part of the 1994 refinancing.
For the years ended December 31, 1996, 1995 and 1994, Chartwell's consolidated cash flow provided by operations was $12.2 million, $23.0 million and $30.2 million, respectively. 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 (i.e., premiums received less paid losses and LAE and underwriting expenses) 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 $500.7 million, $330.6 million and $238.6 million for the years ended December 31, 1996, 1995 and 1994, respectively. Trading activity increased during the second and third quarters of 1995 primarily to modify the portfolio by sector and to capitalize on some opportunities to improve on credit quality without sacrificing yield. Much of the activity that occurred in 1994 was due to changes in Chartwell's investment guidelines which called for a repositioning of the portfolio into higher yielding securities as interest rates trended upward, particularly at the short-end of the yield-curve. During this period, Chartwell kept durations short and reduced its exposure to corporate bonds by selling longer maturity corporate bonds in favor of shorter maturity securities.
Financing activities have also been a source of liquidity for Chartwell and its subsidiaries. On March 17, 1994, Chartwell completed the offering of $75.0 million principal amount of the Senior Notes. Net proceeds of $71.9 million (after transaction expenses) were received by Chartwell and were used as follows:
o $23.4 million was used to retire the remaining amount outstanding under the senior term loan at par.
o $18.5 million, the remaining proceeds, was held by Chartwell for working capital.
Concurrently with the Senior Notes offering, as part of the 1994 refinancing, (i) all outstanding shares of two series of Chartwell's preferred stock were converted to Common Stock, (ii) all outstanding shares of the remaining series of preferred stock were redeemed for a nominal consideration and (iii) the holders of certain warrants issued in connection with Chartwell's subordinated debentures referred to above exercised their right to acquire Common Stock and in connection therewith, all the outstanding subordinated debentures were retired.
On May 17, 1995, Chartwell terminated an interest rate swap transaction it had entered into in April 1994 with a notional amount of $37.5 million to hedge the 10.25% fixed interest rate on the Senior Notes. The effect on the financial statements of this swap was a reduction of interest expense of $0.3 million for the year ended December 31, 1995 and $0.7 million in 1994.
In connection with the establishment prior to the Merger of Re Holdings as an intermediate-level holding company for Chartwell's operations, all of Chartwell's obligations under the Senior Notes were assumed by Re Holdings, and Chartwell was released from any further obligations under the Senior Notes.
In connection with the Merger, Re Holdings entered into the Fleet Loan and the Fleet Revolver. At the time of the Merger, Re Holdings borrowed the full amount under the Fleet Loan and used the proceeds to repay in full Piedmont's existing bank debt. The Fleet Loan had a seven year term (subject to two one-year extensions) and required equal annual repayments of principal after the first year. At December 31, 1996, there was no outstanding balance under this bank facility because it was replaced by the New Credit Facilities described below.
On November 14, 1996 Re Holdings borrowed the full amount under the Term A-1 loan and used the proceeds to repay the Fleet Loan in full. On November 25, 1996 Re Holdings borrowed the full amount under the Term A-2 loan, $11.6 million under the Term B loan, and $5.1 million under the First Union Revolver to acquire Archer Shares. In addition, on November 29, 1996 Re Holdings accessed an additional $10.3 million under the Term B loan to guarantee certain Loan Notes used to acquire Archer Shares. Subsequently, Re Holdings paid down $1.7 million of the First Union Revolver in order to provide capacity to issue certain letters of credit in connection with the capitalization of Oak Dedicated Limited, a corporate vehicle formed by Chartwell to provide capacity to selected syndicates managed by Archer. Letters of credit, denominated in Pounds Sterling, totaling $22.1 million were issued on November 29, 1996 and are currently outstanding. The amounts denominated in Pounds Sterling were converted to U.S. Dollars at the rate of 1.7125 per (pound)1, the rate in effect on December 31, 1996.
The First Union Loans have six-year terms and the First Union Revolver has a five-year term but may be extended for one year with the consent of First Union. Term Loans A-1 and A-2 require repayment of principal starting in year 3, $6.0 million; year 4, $7.5 million; year 5, $7.5 million and year 6, $9.0 million. Term Loan B requires repayment of principal starting in year 3, $4.5 million; year 4, $5.5 million; year 5, $5.5 million and year 6, $6.7 million. Borrowings under the First Union Revolver are available at any time prior to maturity, subject to minimum funding amounts. Both the First Union Loans and the First Union Revolver will bear interest at a rate selected by Re Holdings equal to either (1) the base rate (as defined below) or (2) London Interbank Offered Rate ("LIBOR") plus a margin (the "Margin"). The amount of the Margin will depend on the higher of Re Holdings' senior debt rating by Standard & Poor's or Moody's. The margin can range from 0.50% to 0.875%. Based on Re Holdings' current senior debt ratings, the Margin over LIBOR would be 0.75%, compared to the margin under Re Holdings' prior credit agreement with Fleet of 1.15%. The base rate is the higher of (1) First Union's prime commercial lending rate or (2) the federal funds rate plus 0.5%. Re Holdings will also pay (1) an unused commitment fee equal to 0.25% on the aggregate unused portion of the revolver, (2) utilization fees for the issuance of letters of credit and Loan Note guarantees at a rate per annum of 0.375% (if secured) or the Margin (if unsecured) on the outstanding amount of potential credit exposure, and (3) certain other fees customary in connection with syndicated loans of this nature.
Chartwell is largely dependent upon receipt of dividends and other statutorily permissible payments from Re Holdings to meet its obligations and to pay dividends on the Common Stock. Re Holdings is in turn largely dependent on interest, dividends and other payments from its subsidiaries to meet its obligations, including the obligation to pay interest and principal on the Senior Notes and under the New Credit Facilities. The agreements governing the foregoing debt obligations 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 following the declaration of dividends to stockholders, and upon at least ten days notice to the Commissioner prior to dividend payments, pay dividends to Re Holdings 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, 1996, Chartwell Reinsurance reported unassigned funds in the amount of $54.5 million. Up to $23.8 million is available under the foregoing formula for the payment of dividends by Chartwell Reinsurance without regulatory approval in 1997. Chartwell Reinsurance paid Chartwell no dividends in 1996, 1995 or 1994.
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 October 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based Compensation," which became effective for the Company beginning January 1, 1996. SFAS No. 123 requires expanded disclosures of stock-based compensation arrangements with employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instrument awarded. Companies are permitted, however, to continue to apply APB Opinion No. 25, which recognizes compensation cost based on the intrinsic value of the equity instrument awarded. The Company will continue to apply APB Opinion No. 25 to its stock based compensation awards to employees and will disclose the required pro forma effect on net income and earnings per share. (See Note 15).
In October 1994, the FASB issued SFAS No. 119, "Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments", which was effective for the financial statements of Chartwell for the year ended December 31, 1994. SFAS No. 119 requires more complete disclosure about the amounts, nature and terms of derivative financial instruments. For entities that hold derivative financial instruments for purposes other than trading, it requires disclosures about those purposes and about how the instruments are reported in the financial statements. If a purpose for holding the derivative financial instrument is to hedge anticipated transactions, SFAS No. 119 requires disclosure about the anticipated transactions, any hedging gain or loss deferred and the transactions or other events that result in the recognition of the deferred amounts.
The effects of inflation on Chartwell are considered in pricing and estimating reserves for unpaid losses and loss adjustment expenses. The actual effects of inflation on Chartwell's results cannot be accurately determined until ultimate losses are settled. However, based on the actual results reported to date, management believes that premium rates and loss reserves, including reserves for losses that have been incurred but not reported, adequately incorporate the effects of inflation. See Item 1, "Business--Reserves."