APPROXIMATE PROPERTY SQUARE FEET LEASE EXPIRATION --------------------------- ----------- -------------------- Hamilton, Bermuda.......... 5,900 June 20, 2006 London, England............ 12,500 August 10, 2009 Dallas, Texas.............. 14,700 August 31, 2003 Dallas, Texas.............. 10,500 May 31, 2001 New York, New York......... 7,900 October 31, 2003 New York, New York......... 2,800 September 14, 2004 Bradenton, Florida......... 12,350 June 28, 2008 Boca Raton, Florida........ 13,750 January 15, 2005 Southington, Connecticut... 2,460 August 31, 2011
Results of Operations For the Years Ended December 31, 2000, 1999 and 1998.
Net loss from operations for 2000 was $27.0 million, compared to 1999 net loss from operations of $6.7 million and 1998 net income from operations of $16.0 million. Following a review of its operations, the Company decided to discontinue its loss-making reinsurance and underwriting management segments. In light of this decision and following a comprehensive review of the value of all of its intangible assets, the Company took a charge against income in respect of the write-off of a significant portion of its goodwill. The write-off of goodwill, together with the annual amortization, resulted in a total charge against income for the year of $6.7 million, the majority of which related to the write-off of goodwill in respect of discontinued segments. The write-off of goodwill, together with additional strengthening of reserves against losses arising from discontinued programs in the reinsurance segment, resulted in losses from discontinued operations of $11.0 million for the year, compared to losses of $1.6 million for 1999 and $1.3 million for 1998.
Net loss from continuing operations before discontinued segments for 2000 was $16.0 million compared to a net loss continuing operations before discontinued segments of $4.8 million in 1999 and net income from continuing operations before discontinued segments of $17.3 million in 1998. The results for the year for continuing operations were affected by a number of different factors. The U.S. workers' compensation market in which the Company conducts most of its business remained a difficult environment in which to operate. The Company's risk-taking insurance segment recorded increased underwriting losses for the year, primarily arising from programs which are being discontinued. The program business segment suffered increased losses for the year due to decreased revenues as a result of reduced fee margins on programs and a reduction in program business volume following management's decision to impose more selective underwriting conditions on continuing programs. The brokerage segment also recorded a loss for the period primarily due to a significant decrease in business being brokered following the substantially diminished reinsurance capacity for workers' compensation business. The Company also continued to suffer from continuing costs and provisions pertaining to reinsurance-related disputes in which the Company and others were involved during the year, including certain litigation.
Revenues from continuing operations of $50.9 million in 2000 represented a $9.7 million decrease versus 1999 revenues from continuing operations of $60.6 million, which were $10.0 million below 1998 revenues from continuing operations of $70.6 million. Net loss from operations of $27.0 million in 2000 compares to a net loss from operations of $6.7 million in 1999 and net income from operations of $16.0 million in 1998. The decline in revenues from continuing operations in 2000 reflected the difficult market conditions in the brokerage and program business segments, which were partially offset by increased premium volume written and earned in the insurance segment as the insurance segment wrote more business and reduced the amount of reinsurance purchased for its programs. Expenses from continuing operations including insurance costs of $69.4 million in 2000 represent a $1.4 million increase over 1999 expenses from continuing operations of $68.0 million, which increased $18.5 million over 1998 expenses from continuing operations of $49.5 million. Insurance costs for the year 2000 increased to $22.6 million compared to $10.1 million in 1999 and $6.8 million in 1998. The increase in insurance costs for the year was primarily due to the increase in net premiums earned but also reflects a significant strengthening of reserves in the Company's U.S.-based insurance carrier.
Expenses from continuing operations excluding insurance costs for the year 2000 were $46.8 million versus $57.9 million in 1999 and $42.7 million in 1998. This decrease in expenses from continuing operations reflects the benefits of the restructuring program begun in 1999 together with a general reduction in administrative costs as a result of reduced business volume. This decrease in expenses from continuing operations was partially offset by continued costs and provisions pertaining to reinsurance-related disputes in which the Company is involved including certain litigation.
The program business segment loss before tax of $5.1 million in 2000 represented an increase in loss before tax of $2.4 million from loss before tax of $2.7 million in 1999, which had decreased $7.9 million from income before tax of $5.2 million in 1998. The increase in segment losses reflects the decrease in program fee revenues which was only partially offset by a reduction in operating costs. The Company continued to restructure its program segment operations, which resulted in the consolidation and streamlining of its operations in order to reduce expenses and increase efficiencies.
The Company's insurance segment consists of its wholly owned U.S.-based insurance company, Realm National Insurance Company. Insurance segment revenues of $23.5 million in 2000 represented an increase of $10.9 million from insurance segment revenues of $12.6 million in 1999, which reflected a $1.5 million increase from insurance segment revenues of $11.1 million in 1998. Gross written premiums were $61.4 million in 2000, which represented a $14.2 million increase from $47.2 million in 1999, which in turn reflected a $1.4 million decrease from $48.6 million in 1998. Net premiums earned increased to $18.5 million in 2000, which represented a $9.0 million increase from $9.5 million in 1999, which was a $1.8 million increase from $7.7 million in 1998. The remainder of the growth in revenues was primarily due to an increase in policy issuance fees. Policy issuance fees were $3.2 million in 2000, which represented a $0.7 million increase from $2.5 million in 1999, which was a $0.4 million increase from $2.1 million in 1998. The increase in insurance segment revenues reflects an increase in premium volume written and earned as the company wrote more business and reduced the amount of reinsurance purchased for its programs.
The Company's discontinued underwriting management segment comprised companies that primarily underwrote and administered reinsurance business on behalf of independent reinsurance companies. Underwriting management revenues of $1.6 million in 2000 represented a decrease of $2.5 million from underwriting management revenues of $4.1 million in 1999, which had increased $0.5 million from underwriting management revenues of $3.6 million in 1998.
The Company's discontinued reinsurance segment consisted of its reinsurance subsidiary, CIRCL. CIRCL primarily reinsured workers' compensation and property and general liability risks. Reinsurance segment revenues of $1.7 million in 2000 represented a decrease of $1.4 million from reinsurance segment revenues of $3.1 million in 1999, which in turn had decreased $7.8 million from reinsurance segment revenues of $10.9 million in 1998. Net premiums earned were the largest component of revenues in CIRCL. Net premiums earned of $0.9 million in 2000 represented a decrease of $1.5 million from net premiums earned of $2.4 million in 1999, which in turn reflected a $7.7 decrease from net premiums earned of $10.1 million in 1998.
Reinsurance segment loss before tax of $6.1 million in 2000 represented an increase in loss before tax of $2.7 million from a loss before tax of $3.4 million in 1999, which in turn was equal to loss before tax of $3.4 million in 1998. The primary reason for the loss before tax during 2000 was a strengthening of reserves on discontinued programs together with an increase of $2.1 million in provisions against reinsurance recoveries. CIRCL has experienced substantial delays in collection of reinsurance recoverables from certain of its reinsurers. CIRCL therefore has established a provision in the amount of $7.0 million against reinsurance contracts with projected reinsurance recoverables of a total of $27.4 million. This provision has been included in the balance sheet as a component of paid losses recoverable from reinsurers. The segment loss for 2000 also reflects the write off of associated goodwill following the decision to discontinue this operation.
At December 31, 2000, the Company held cash and marketable securities of $76.0 million, compared to $84.8 million at December 31, 1999. In addition, the Company held cash in fiduciary accounts relating to insurance client premiums amounting to $39.0 million at December 31, 2000, compared to $56.8 million at December 31, 1999. These decreased cash balances reflect the slow-down in the Company's business activities for 2000, the impact of delays in receiving outstanding reinsurance recoveries and the net loss for the year. Of the $76.0 million of cash and marketable securities held by the Company, $49.3 million (1999--$54.3 million) were held by subsidiaries whose payment of dividends to the Company was subject to regulatory restrictions or possible tax liabilities. At December 31, 2000, the Company's investment portfolio (at fair market value) totalled $34.6 million (1999--$34.1 million). The portfolio consisted primarily of U.S. Treasury obligations, short-term cash and A-rated corporate debt securities.
During the year ended December 31, 2000, the Company's operating activities used $7.8 million of net cash, compared to using $4.1 million of net cash during 1999 and generating $28.7 million in 1998. The cash generated from (used by) operating activities varies according to the Company's net income (loss) and the timing of collections and payments of the Company's own insurance and reinsurance balances.
The Company used $4.4 million during the year ended December 31, 1999 to repurchase 356,400 of its own shares on the open market.
The Company had no outstanding debt at December 31, 1999 and 2000.
In November 1998, the AICPA Accounting Standards Executive Committee issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Risk". This statement is effective for all quarters of fiscal years beginning after June 15, 1999. This SOP provides accounting guidance for insurance and reinsurance contracts that do not transfer risk, as determined by the provisions of SFAS No. 113. The Company adopted this standard effective January 1, 1999 and it did not have a significant impact on the Company's financial position or results of operations.
We have audited the consolidated balance sheets of Stirling Cooke Brown Holdings Limited and subsidiaries as of December 31, 1999 and 2000, and the related consolidated statements of income and comprehensive income, changes in shareholders' equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The consolidated financial statements of Stirling Cooke Brown Holdings Limited and subsidiaries for the year ended December 31, 1998 were audited by other auditors whose report, dated March 5, 1999, expressed an unqualified opinion on those statements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Stirling Cooke Brown Holdings Limited and subsidiaries as of December 31, 1999 and 2000 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
We conducted our audit in accordance with United States generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements (before restatement) referred to above present fairly, in all material respects, the results of operations and cash flows of Stirling Cooke Brown Holdings Limited and subsidiaries for the year ended December 31, 1998, in conformity with United States generally accepted accounting principles.
STIRLING COOKE BROWN HOLDINGS LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1999 AND 2000 (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE DATA)
Stirling Cooke Brown Holdings Limited ("Stirling Cooke") was incorporated in Bermuda on December 12, 1995. Stirling Cooke is a holding company which, through its subsidiaries, provides insurance services and products. Stirling Cooke provides its range of services and products to insurance and reinsurance companies, insurance agents, and insureds. Stirling Cooke is active primarily in the workers compensation, occupational accident and health and property/casualty insurance markets through its subsidiaries based in London, Bermuda and the United States. In January 1996, Stirling Cooke acquired all the outstanding common shares of Realm Investments Ltd. in exchange for 1,999,980 of its newly issued ordinary shares. Stirling Cooke also acquired, in September 1996, its own United States domiciled insurance company Realm National Insurance Company ("Realm National") which writes insurance business in the workers compensation, occupational accident and health and property/casualty insurance markets.
In early 2001, following a review of its operations, the Company decided to discontinue its loss-making reinsurance and underwriting management segments, as discussed in Note 3.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions for those transactions that are not yet complete or for which the ultimate effects cannot be precisely determined. Such estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Premiums written and assumed are recorded on an accrual basis and included in income on a pro-rata basis over the life of the policies or reinsurance agreements to which they relate, with the unearned portion deferred in the consolidated balance sheets. Adjustment premiums arising from premium audits are recorded in the period in which they are determined. Reinsurance premiums ceded are similarly pro-rated over the terms of the reinsurance contract with the unearned portion being deferred in the consolidated balance sheets as deferred reinsurance premiums ceded.
Acquisition costs associated with the acquisition of new or renewal business, including commissions, premium taxes and brokerage, are deferred and amortized to expense over the periods in which the premiums are earned. The method followed in determining the deferred acquisition expenses limits the amount of the deferral to its realizable value by giving consideration to losses and expenses expected to be incurred as premiums are earned. Future investment income is also anticipated in determining whether a premium deficiency exists.
(ii) Managing general agency fees are included within program business segment revenue and are reported net of commission expense to agents and are initially recorded as of the effective date of the related insurance policy and are recognized in income over the period of the underlying policy (which is typically one year). Fees for claims handling services are recognized in income over the period that services are performed in accordance with the Company's contractual obligations, typically ranging up to five years, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon industry standards. Any subsequent adjustments, including adjustments due to policy cancellation and premium adjustments, are recorded when advised by the client or agent. The portion that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
(vi) Underwriting management fees are initially recorded and earned when the premium is billed in accordance with terms of trade. Fee income for claims handling services is recognized in income over the period that services are performed in accordance with the Company's contractual obligations. Such fees are recognized in income over the period that contractual services are performed, typically up to five years, based on the Company's estimation of expected claims handling requirements in each accounting period. Such estimation is based upon the Company's claims handling experience over recent years. Any subsequent adjustments, including adjustments due to policy cancellations and premium adjustments, are recorded when advised by the client or agent. The portion of recorded fees that will be earned in the future is deferred and reported as deferred income in the consolidated balance sheets.
The Company's investments in affiliated companies that are not majority owned or controlled are accounted for using the equity method if the Company is able to exert significant influence upon such companies. Other investments in affiliates are carried at cost. Investments in affiliates of $198 and $248 as of December 31, 1999 and 2000, respectively, are recorded in other assets. The Company's equity share in the net income of affiliates, for the years ended December 31, 1998, 1999 and 2000 of $2,631, $Nil and $Nil respectively. In addition, for 1999, the Company recorded a write-down of $2,018 in Other income (loss) to recognize a decrease in the value of several of their equity holdings. Dividends received from affiliated companies of $2,145, $ Nil and $Nil during 1998, 1999 and 2000, respectively, are recorded as a reduction in the carrying value of the investment.
Goodwill in the amounts of $8,664 and $1,969 at December 31, 1999, and 2000, respectively, represents the excess of purchase price over fair value of net assets acquired. Goodwill is amortized on a straight-line basis over the expected periods to be benefited, generally 5 to 20 years. Accumulated amortization at December 31, 1999 and 2000 was $2,717 and $9,399, respectively. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through undiscounted future operating cash flows of the acquired operation. The amount of goodwill impairment, if any, is measured based on projected discounted future operating cash flows using a discount rate reflecting the Company's average cost of funds. Following a review of its operations, the Company decided to discontinue its loss-making reinsurance and underwriting management segments. In light of this decision and following a comprehensive review of the value of all of its intangible assets, the Company took a charge against income in respect of the write-off of a significant portion of its goodwill. The write-off of goodwill, together with the annual amortization, resulted in a total charge against income for the year of $6,695 , the majority of which was related to the write-off of goodwill in respect of discontinued segments.
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation", the Company has elected to continue to account for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees", and, accordingly, recognizes compensation expense for stock option grants to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is recorded over the shorter of the vesting or service period.
In December 1997, the AICPA Accounting Standards Executive Committee issued Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments". The accounting guidance of this SOP focuses on the timing of recognition and measurement of liabilities for insurance-related assessments. Guidance is also provided on recording assets representing future recoveries of assessments through premium tax offsets or policy surcharges. The SOP is effective for fiscal years beginning after December 15, 1998. The Company adopted this standard effective January 1, 1999 and it did not have a significant impact on the Company's financial position or results of operations.
During 1998, the AICPA Accounting Standards Executive Committee issued SOP 98-5, "Reporting on the Costs of Start-up Activities". The accounting guidance of this SOP requires that the costs of start-up activities be expensed as incurred and any costs that are carried as an asset prior to adoption of SOP 98-5 would be written off by reporting a cumulative effect of a change in accounting principle in the statement of income as of January 1, 1999. The cumulative effect of a change in accounting principle that was recorded in the statement of income for the first quarter of 1999 was approximately $307 (net of tax of $188).
In June 1999, the Financial Accounting Standards Board issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133". This statement amends SFAS No. 133 to defer its effective date for one year, to fiscal years beginning after June 15, 2000. In June 2000, the Financial Accounting Standards Board issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." This statement is an amendment of SFAS No. 133 with respect to the accounting and reporting standards for certain derivative instruments and certain hedging activities. Initial application of SFAS No. 133, as amended, began on January 1, 2001, and it is not expected to have a significant impact on the Company's financial position or results of operations.
Following a review of its operations, on March 6, 2001 the Company decided to discontinue its loss-making reinsurance and underwriting management segments and put these segments into run-off.
The Company's underwriting management segment is comprised companies that primarily underwrote and administered reinsurance business on behalf of independent reinsurance companies. Since 1999, the underwriting management segment has experienced a significant reduction in business written, which has led to decreasing revenues over the period. In view of the reduction in revenues, the resulting loss, and the ongoing business prospects for the segment, the Company decided to discontinue the segment and place the operation into run-off. At year end, underwriting management segment assets were primarily cash and cash equivalents, and insurance and reinsurance balances receivable. Segment liabilities were primarily insurance and reinsurance balances payable.
As a result of the planned run-off of operations for the underwriting management and reinsurance segments the operating results of the underwriting management and reinsurance segments in the accompanying financial statements have been reported as discontinued operations for all periods presented, and, accordingly, the operating results for periods prior to 2000 have been restated.
a) The cost or amortized cost and estimated fair value of marketable securities held as `available for sale' are as follows:
d) At December 31, 1999 and 2000, debt securities having an amortized cost of $3,971 and $1,630, respectively, were on deposit with government authorities as required by law.
e) At December 31, 1999 and 2000, there were no individual investments, other than investments in U.S. Government securities, which exceeded 10% of shareholders' equity.
The Company accounts for reinsurance assumed and ceded in accordance with SFAS 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts". Net premiums earned are the result of the following:
The Company, in the ordinary course of business, reinsures certain risks with other companies. Such arrangements serve to enhance the Company's capacity to write business and limit the Company's maximum loss on large or more hazardous classes of risks.
Due to the lack of available cost-effective reinsurance during 2000, Realm National decreased the level of reinsurance it purchased on its programs, resulting in a greater retention of premium but also a greater exposure to the underwriting risk on those programs.
CIRCL also assumed bodily injury, difference in conditions, and property risks through a general liability treaty covering risks in the construction industry. CIRCL's exposure under the reinsurance contracts assumed is limited in most instances to $250 per occurrence. In most instances, CIRCL limited this exposure through the purchase of reinsurance covering losses in excess of $63 per occurrence. In addition, CIRCL purchased aggregate reinsurance with limits based on various percentages of original gross written premium income.
The adverse development during 2000 on prior years in continuing operations primarily reflects the strengthening of loss reserves at the Company's U.S.-based insurance carrier.
In October 1998, the Company purchased a further 47,000 of its ordinary shares on the open market for a total cost of $567. These shares were held as treasury stock at cost at December 31, 1999 and 2000.
Effective November, 2000, the Company issued 100,000 restricted shares to Mr. Stephen A. Crane. The shares issued are subject to certain transfer restrictions which lapsed with respect to 33 1/3% of these shares on the date of their issuance. Restrictions on the balance of the shares will lapse equally in each of November 2001 and November 2002, contingent on Mr. Crane's continued employment with the Company.
On May 25, 2000, the Company granted 30,000 options to certain non-executive directors. The options have an exercise price of $2.50 per share, which reflected the estimated fair value of the shares at the grant date. The options vest ratably over a three-year period and may be exercised at any time prior to August 8, 2010. All of these options remained outstanding at December 31, 2000.
In accordance with the provisions of FASB Statement No. 123, the Company applies APB Opinion 25 and related interpretations in accounting for its stock option plans and accordingly, recognizes compensation cost based on the intrinsic value of the options at the grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date as prescribed by SFAS 123, net income (loss) and earnings (loss) per share would have been adjusted to the pro forma amounts indicated in the table below:
1999 2000 -------- ---------- Expected dividend yield.......... 4.5% 3.7-5.8% Expected stock price volatility.. 87.46% 92% Risk-free interest rate.......... 6.72% 6.07-6.64% Expected life of options......... 10 years 10 years
Under current Bermuda law, the Company is not required to pay any taxes in Bermuda on either income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that in the event of any such taxes being imposed the Company will be exempted from taxation until the year 2016.
Total income tax expense (benefit) attributable to income from continuing operations for the years ended December 31, 1998, 1999 and 2000 was allocated as follows:
As of December 31, 1998 and 1999 the Company had not recognized a deferred tax liability for the undistributed earnings of its United States subsidiaries. (A 30% tax is generally imposed in the United States on dividends paid by United States corporations to non-United States shareholders). As of December 31, 2000 the Company had no undistributed earnings of its U.S. subsidiaries on a consolidated basis. The deferred tax liability relating to these unremitted earnings, which is not recognized by the Company, is approximately $986, $2,442 and $Nil at December 31, 1998, 1999, and 2000, respectively.
To manage the Company's exposure to these risks, the Company enters into forward foreign exchange contracts in the currencies to which the Company is exposed. These contracts generally involve the exchange of one currency for another at some future date. The Company had no notional principal amounts outstanding at December 31, 1999 relating to contracts to buy British Pounds Sterling in the future. The Company had one notional principal amount outstanding at December 31, 2000, relating to contracts to buy British Pounds Sterling in the future which had a cost of $2,305, a fair value of $2,230, and an unrealized net loss of $70. Net realized gains (losses) of $182, $Nil and ($132) have been recorded in the consolidated statements of income in respect of such contracts during the years ended December 31, 1998, 1999 and 2000, respectively.
Future minimum lease payments under non-cancelable operating property leases as at December 31, 2000 are as follows:
2001.................. $2,671 2002.................. 2,264 2003.................. 1,962 2004.................. 1,471 2005.................. 1,088 2006 and thereafter... 3,526 ----- $12,982 -------
Total rental expense for continuing operations for the years ended December 31, 1998, 1999 and 2000, was $2,065, $3,089, and $1,854, respectively. Total rental expense for discontinued operations for the years ended December 31, 1998, 1999 and 2000, was $126, $114, and $117, respectively.
Realm National did not have any earned surplus available for the payment of dividends in 1999 and 2000 due to its statutory-basis accumulated deficit.
1999 2000 ---- ---- Total capital and surplus at December 31,....... $ 17,177 $14,116 Net income (loss) for year ended December 31,... $ 219 $(4,167)
Goldman, Sachs & Co. or certain of its affiliates maintained certain contractual relationships with the Company and provided investment banking services to the Company. Goldman, Sachs & Co. also provided investment management services to Realm National pursuant to a Corporate Account Agreement dated December 24, 1996 and received customary fees and expenses of approximately $32 during 1999 and $35 during 2000 for such services.
(a) The proceedings which Sphere Drake Insurance Limited ("Sphere Drake") caused to be issued on February 29, 2000 in the London Commercial Court (equivalent to a civil complaint in U.S. jurisdictions) against two of the Company's U.K. subsidiaries, two former officers of those subsidiaries and others, remain pending. Sphere Drake alleges, in substance, that each and every contract placed with it through its underwriting agent by the Company's U.K. broker subsidiary was commercially unreasonable. Sphere Drake further alleges that this was obvious to the broker and that, accordingly, the London Commercial Court should infer a conspiracy between the broker and the underwriting agent to defraud Sphere Drake, thereby allowing it to treat as void from the outset all of the inwards reinsurance contracts placed through the underwriting agent by the Company's broker subsidiary. These proceedings currently are focused on preparation for the trial of the action, which is scheduled for October 2001.
(b) The Company, together with one of its London subsidiaries and a former employee of that subsidiary, filed a motion to dismiss the claims asserted against them in the amended complaint in an existing action in the New York State Supreme Court brought by AXA Reassurance S.A. ("AXA"), in which AXA seeks to void reinsurance contracts entered into in connection with certain "reinsurance-backed gap film financing" arrangements ("Film Finance Covers") brokered by the Company's London subsidiary. The Court ruled on March 8, 2001, that it would hold the motion in abeyance pending further discovery. The Company, its subsidiary and the former employee currently are engaged in ongoing discovery proceedings in the action.
In addition, the Company's reinsurance subsidiary is party to one of the LMX arbitrations. This particular arbitration has been dormant for some time, and the Company expects it to be terminated shortly.
The reinsurers generally have alleged that they sustained losses due to an "artificial" spiral in the LMX market, the existence of which, as well as other information, was not disclosed to them by the ceding insurers or their reinsurance brokers. As a consequence, these reinsurers have asserted that they are no longer obliged to honor their reinsurance agreements and have suspended payment of claims.
With the exception of: (a) one inactive proceeding which the subsidiaries have been informed will be withdrawn; and (b) two related proceedings pending against certain subsidiaries of the Company, and certain current and former officers of these subsidiaries, each of which is in a very early procedural stage, all judicial proceedings against the Company's subsidiaries relating to these matters have been stayed or held in abeyance pursuant to standstill agreements or court order.
One of the arbitration awards referenced above allowed a reinsurer to avoid its reinsurance contracts with a Lloyd's syndicate. According to reports in the London press, that award may have caused the syndicate's liabilities to increase beyond the financial resources available to it and its Names, requiring the syndicate to avail itself of the Lloyd's Central Fund. Thereafter, Lloyd's initiated an investigation of that syndicate and all "market participants," including the Company's U.K. subsidiaries. The Company is aware that the investigation is ongoing, but has no other information as to the progress of the investigation or when it will be completed.
The Company understands that substantial progress has been and continues to be made by various market participants in settling ongoing reinsurance disputes, including many of the market participants that are parties to the arbitrations and other proceedings described above. The Company understands that a settlement by certain market participants of reinsurance disputes arising in the 1994 year of account (the "1994 Year of Account Settlement") has been executed.
A subsidiary of the Company has been notified of a potential claim by one of the parties to the 1994 Year of Account Settlement for the recovery of costs arising out of the settlement as well as for the costs and expenses incurred by the party in connection with its overall involvement in the LMX market. The Company's subsidiary has denied any liability for this potential claim.
Although no assurances can be given as to the outcome of the pending U.K. arbitrations or pending or potential arbitration or judicial proceedings related to the LMX spiral reinsurance arbitrations and their effect on the Company, the Company believes, based on the information presently available to it, that any such effect should not have a material adverse effect on the Company's financial condition.