The following is a discussion of the Company's results of operations and financial condition. This discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto presented under ITEM 8.
Industry Conditions. Since 1987, a number of factors, including the emergence of significant reinsurance capacity from the Bermuda and rejuvenated Lloyds' markets, higher retentions by primary insurance companies and consolidation and increased capital levels in the insurance industry, have caused increasingly competitive global market conditions across most lines of business and have influenced the softening of prices and contract terms in the current market place. The Company cannot predict with any reasonable certainty, if, when or to what extent market conditions as a whole will change. See ITEM 1 - "Business-Competition" for a further discussion.
The Company, through its subsidiaries, operates in five operating segments: U.S. Broker Treaty, U.S. Direct Treaty Reinsurance and Insurance, U.S. Facultative, Marine, Aviation and Surety and International. These segments are generally referred to as operations in this document. The U.S. Broker Treaty operation writes property, accident and health and casualty reinsurance through reinsurance brokers within the United States. The U.S. Direct Treaty Reinsurance and Insurance operation writes property, accident and health and casualty reinsurance directly with ceding companies and primary property and casualty insurance, through agency relationships and program administrators within the United States. The U.S. Facultative operation writes property, casualty and specialty business through brokers and directly with ceding companies within the United States. The Marine, Aviation and Surety operation writes marine, aviation and surety business within the United States and worldwide. The International operation writes reinsurance through the Company's branches in Belgium, London, Canada, Hong Kong and Singapore, in addition to foreign "home-office" business. The U.S. Facultative, Marine, Aviation and Surety and International operations write business through brokers and directly with ceding companies.
These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management monitors and evaluates the financial performance of these operating segments based upon their underwriting gain or loss ("underwriting results").
PREMIUM REVENUES. Net premiums earned increased by 0.3% to $1,071.5 million in 1999 from $1,068.0 million in 1998 consistent with the growth in premiums written. Contributing to this increase was an 11.3% ($12.5 million) increase in the Marine, Aviation and Surety operation, a 9.7% ($35.9 million) increase in the U.S. Broker Treaty operation and a 5.4% ($9.4 million) increase in the U.S. Direct Treaty Reinsurance and Insurance operation. These increases were partially offset by a 14.6% ($49.8 million) decrease in the International operation and a 6.2% ($4.5 million) decrease in the U.S. Facultative operation. All of these changes reflect period to period changes in net written premiums together with normal variability in earnings patterns.
EXPENSES. Incurred losses and loss adjustment expenses ("LAE") decreased by 0.9% to $771.6 million in 1999 from $778.4 million in 1998. Incurred losses and LAE include catastrophe losses, which include the impact of both current period events and favorable and unfavorable development on prior period events and are net of reinsurance. Net catastrophe losses for 1999 were $45.9 million mainly arising from European storms ($19.5 million) and from the Rouge Steel Plant Fire ($13.0 million), together with lesser losses related to Hurricane Floyd, the Turkish Earthquakes and the Oklahoma Tornadoes compared to net catastrophe losses of $30.6 million for 1998. Net incurred losses and LAE for 1999 reflected ceded losses and LAE of $7.4 million, including $7.2 million ceded under the Stop Loss Agreement for 1999 offset by a $60.8 million reduction of the Company's previous cessions to the Stop Loss Agreement as a result of the Gibraltar dispute resolution, compared to ceded losses and LAE of $357.4 million in 1998, including $153.9 million ceded under the Stop Loss Agreement.
The Company's loss and LAE ratio ("loss ratio") decreased by 0.9 percentage points to 72.0% for 1999 from 72.9% in 1998. This decrease was attributable to changes in the Company's mix of business, including the absence in 1999 of the impact of certain reinsurance treaties with higher expected losses and lower ceding commissions which were reflected in 1998, partially offset by the increase in catastrophe losses in 1999. The Marine, Aviation and Surety operation's loss ratio decreased by 7.9 percentage points to 67.1% for 1999 from 75.0% in 1998 mainly due to changes in the marine business. The U.S. Direct Treaty Reinsurance and Insurance operation's loss ratio decreased by 6.1 percentage points to 68.5% for 1999 from 74.6% in 1998. This decrease was mainly due to the absence in 1999 of the impact of certain reinsurance
INCOME TAXES. The Company had income tax expense of $38.5 million in 1999 compared to $47.5 million in 1998, with the decrease resulting from the increase in realized capital losses.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 PREMIUMS. Gross premiums written decreased 2.7% to $1,045.9 million in 1998 from $1,075.0 million in 1997 as the Company maintained a disciplined underwriting approach in the face of increasingly competitive market conditions. Premium growth areas included a 10.8% ($35.2 million) increase in the U.S. Broker Treaty premiums, largely attributable to growth in non-standard auto, accident and health and workers compensation lines where the Company's relatively recent entry to these lines provided growth opportunities and a 6.8% ($10.8 million) increase in the U.S. Direct Treaty Reinsurance and Insurance premiums mainly due to portfolio reinsurance transactions. These increases were offset by a
Net premiums written decreased by 1.4% to $1,016.6 million in 1998 from $1,031.1 million in 1997, reflecting the decreases in the International, Marine, Aviation and Surety and U.S. Facultative gross written premiums, partially offset by growth in the U.S. Broker Treaty and U.S. Direct Treaty Reinsurance and Insurance premiums and the decrease in ceded premiums.
Contributing to the increase in incurred losses and LAE in 1998 from 1997 were a 13.3% ($29.5 million) increase in the U.S. Broker Treaty operation, a 9.6% ($23.6 million) increase in the International operation and a 6.0% ($7.3 million) increase in the U.S. Direct Treaty Reinsurance and Insurance operation. These increases were partially offset by a 31.3% ($20.3 million) decrease in the U.S. Facultative operation and a 24.6% ($27.1 million) decrease in the Marine, Aviation and Surety operation. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
The Company's combined ratio decreased by 0.8 percentage points to 103.2% in 1998 from 104.0% in 1997 reflecting the lower expense ratio, increased earned premium and loss ratio factors described above.
INVESTMENTS. Pre-tax investment income increased 7.2% to $244.9 million in 1998 from $228.5 million in 1997, principally reflecting the effect of investing the $183.3 million of cash flow from operating activities in 1998. The Company's pre-tax yield on average cash and invested assets decreased to 5.8% in 1998 from 5.9% in 1997 reflecting an increase in tax preferenced investments and a lower interest rate environment.
Net realized capital losses were $0.8 million in 1998 reflecting normal portfolio management activity compared to a net realized capital gain of $15.9 million in 1997, mainly arising from a $14.0 million gain on the sale of the Company's remaining investment in the common stock of Corporacion MAPFRE, a publicly traded Spanish insurer.
NET INCOME. Net income was $165.2 million in 1998 compared to $155.0 million in 1997. This improvement mainly reflects higher earned premium, higher investment income, and lower income taxes partially offset by a decrease in net capital gains and an increase in net incurred losses.
LOSS AND LAE RESERVES GENERAL. Gross loss and LAE reserves totaled $3,647.0 million at December 31, 1999, $3,800.0 million at December 31, 1998 and $3,437.8 million at December 31, 1997. The decrease in 1999 was primarily attributable to a reduction in reserves for 1995 and prior periods as a result of the Gibraltar dispute resolution together with normal variability in claim settlements and an unchanged level of earned premiums. The increase in 1998 was mainly due to reserve increases on pre-1986 accident years for asbestos and environmental exposures, most of which were ceded under various retrocessional arrangements resulting in an offsetting increase to reinsurance receivables. Reinsurance receivables totaled $742.5 million at December 31, 1999, $982.0 million at December 31, 1998 and $692.5 million at December 31, 1997. At December 31, 1999, $345.4 million, or 46.5%, of the total was receivable from Gibraltar, including $9.5 million which is contractually due in the first quarter of 2000, $255.5 million which is collateralized by funds held by the Company or offsetting liabilities and $80.4 million which is subject to the terms and conditions of The Prudential's guarantee of Gibraltar's payment obligations to the Company. Additionally, $145.0 million, or 19.5%, is receivable from Continental Insurance Company, which is secured by a funds held arrangement wherein the Company has retained the premium payments due the retrocessionaire, recognized a liability for such amounts and reduces such liability as payments are due from the retrocessionaire. No other retrocessionaire accounted for more than $25.0 million of the Company's receivable.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. Everest Re's asbestos claims typically involve liability or potential liability for bodily injury from exposure to asbestos or liability for property damage resulting from asbestos or asbestos containing materials. Everest Re's environmental claims typically involve potential liability for the mitigation or remediation of environmental contamination or bodily injury or property damages caused by the release of hazardous substances into the land, air or water. In addition to the previously described general uncertainties inherent in estimating reserves, there are significant additional uncertainties in estimating the amount of Everest Re's potential losses from asbestos and environmental
The Prudential has guaranteed all of Gibraltar's obligations under the Stop Loss Agreement and up to $400.0 million of Gibraltar's net obligations under all other reinsurance agreements between Gibraltar and Everest Re. At December 31, 1999, Gibraltar's net obligations under such other reinsurance agreements consisted of the following balances:
Reinsurance receivables from Gibraltar $ 345.4 Reserve for losses and loss adjustment expenses assumed from Gibraltar (151.0) Losses in the course of payment assumed from Gibraltar (4.1) Funds held by Everest Re under reinsurance treaties with Gibraltar (109.9) ---------- Net obligations of Gibraltar $ 80.4 ==========
On February 24, 2000, Holdings announced an agreement with The Prudential Insurance Company of America to acquire all of the issued and outstanding shares of Gibraltar Casualty Company for approximately $52.0 million. Closing of the acquisition will be subject to the satisfaction of customary closing conditions and the receipt of regulatory approvals.
o The PRUCO Indemnity will be terminated and PRUCO will be released from it obligations.
In connection with the acquisition, The Prudential will provide reinsurance to Gibraltar covering 80% of the first $200.0 million of any adverse development in Gibraltar's reserves. See also ITEM 1 - "Relationships with Gibraltar" for a further discussion.
STOCKHOLDERS' EQUITY. The Company's stockholders' equity decreased to $1,327.5 million as of December 31, 1999 from $1,479.2 million as of December 31, 1998 principally reflecting an increase of $207.3 million in unrealized depreciation of investments and $96.4 million in share repurchases relating to the Company's stock repurchase plan, partially offset by an increase of $146.4 million in retained earnings for the year. Stockholder's equity as of December 31, 1998 increased to $1,479.2 million from $1,307.5 million as of December 31, 1997 principally reflecting an increase of $155.1 million in retained earnings and an increase of $37.2 million in unrealized appreciation of investments. Dividends of $11.6 million, $10.1 million and $8.1 million were declared and paid by Holdings in 1999, 1998 and 1997, respectively.
The Company's stockholders' equity of $1,327.5 million exceeded Everest Re's statutory-basis surplus of $1,147.6 million by $179.9 million at December 31, 1999. The primary differences between GAAP and SAP as they relate to the Company are: (i) the deferral of acquisition costs under GAAP, which are immediately expensed under SAP; (ii) the provision for deferred taxes on temporary tax differences under GAAP, which are excluded under SAP; and (iii) the carrying at market value of fixed maturities available for sale under GAAP, as compared to at amortized cost under SAP.
LIQUIDITY AND CAPITAL RESOURCES EVEREST RE. Everest Re's liquidity requirements are met on both a short-term and long-term basis by funds provided by premiums collected, investment income and collected reinsurance receivables balances, and from the sale and maturity of investments. Everest Re's net cash flows from operating activities were $203.4 million, $183.3 million and $376.4 million, in 1999, 1998 and 1997, respectively. The decreases from 1997 in cash provided by operating activities were principally a result of increases in net paid losses reflecting maturation of the Company's loss reserves combined with the changes in the Company's mix of business and modest, if any, growth in gross written premium, all of which may affect growth in cash flow from operations in subsequent periods, offset by improved profitability. Recoveries under the Company's Stop Loss Agreement with Gibraltar contributed $79.0 million, $31.9 million and $99.8 million of such net cash flows in 1999, 1998 and 1997, respectively.
The Company maintains a corporate-level retrocessional protection program, above and beyond retrocessions purchased with respect to specific assumed coverage, to mitigate the potential impact of catastrophe losses. The principal components of the Company's retrocessional protection program as it relates to catastrophes are an accident year aggregate excess of loss treaty and the retrocessional excess of loss coverage of international exposures. During 1999, the Company purchased an accident year aggregate excess of loss protection which provides up to $175.0 million of coverage if Everest Re's statutory basis accident year loss ratio exceeds a loss ratio attachment point provided in the contract for the 1999 accident year. For 2000, the Company has purchased a new accident year aggregate excess of loss protection which provides up to $175.0 million of coverage if Everest Re's statutory basis accident year loss ratio exceeds a loss ratio attachment point provided in the contract for the 2000 accident year. The Company's retrocessional protection program, for the period from May 15, 1999 through May 15, 2000, includes a catastrophe retrocession which provides coverage of 70.0% of $20.0 million of losses per occurrence in excess of $10.0 million in losses incurred by the Company outside of the United States, provided that the Company's net loss per occurrence is $15.0 million. For the period from May 23, 1999 through May 23, 2000, the Company's catastrophe retrocession program provides coverage of 85% of $20.0 million of losses per occurrence in excess of $30.0 million in losses incurred by the Company outside of the United States. All aspects of the retrocession program have been structured to permit the program to be accounted for as reinsurance under SFAS No. 113. See ITEM 1 - "Risk Management and Retrocession Arrangements" for further details.
If a single catastrophe were to occur in the United States that resulted in $181.0 million of gross losses and allocated loss adjustment expenses ("ALAE") in 2000 (an amount equivalent to Everest Re's PML), management estimates that the effect (including additional premiums and retained losses and ALAE) on the Company's income before taxes would be $91.8 million. This pre-tax net loss estimate assumes that Everest Re's aggregate losses and ALAE for 2000 would exceed the threshold loss ratio requirement in the aggregate excess of loss cover by at least $175.0 million.
BERMUDA RE. Under Bermuda law, Bermuda Re is unable to declare or pay a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio, or if after payment of the dividend, it fails to meet its minimum solvency margin or minimum liquidity ratio. As a long-term insurer, Bermuda Re is also unable to declare or pay a dividend to anyone who is not a policyholder unless, after payment of the dividend, the value of the assets in its long-term business fund, as certified by its approved actuary, exceeds its liabilities for long-term business by at least the $250,000 minimum solvency margin. Prior approval of the Bermuda Minister of Finance is required if Bermuda Re's dividend payments would reduce its prior year end total statutory capital by 15.0% or more.
Holdings' prior credit facility, which has been terminated. The Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either (i) the Base Rate (as defined below) or (ii) an adjusted London InterBank Offered Rate ("LIBOR") plus a margin. The Base Rate is the higher of the rate of interest established by First Union National Bank from time to time as its prime rate or the Federal Funds rate plus 0.5% per annum. The amount of margin and the fees payable for the Credit Facility depend upon Holdings' senior unsecured debt rating or, if such is not available, on the financial strength rating of the Holdings' subsidiary, Everest Re. Group has guaranteed all of Holdings' obligations under the Credit Facility.
The Credit Facility agreement requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1, a minimum interest coverage ratio of 2.5 to 1 and to maintain Everest Re's statutory surplus at $850.0 million plus 25% of future aggregate net income and 25% of future aggregate capital contributions. Everest Re's statutory surplus was $1,147.6 million for the year ended December 31, 1999. Holdings' debt to capital ratio was 0.04 for the year ended December 31, 1999. Holdings' minimum interest coverage ratio was 3.5 for the year ended December 31, 1999. At December 31, 1999 and 1998, Holdings had outstanding borrowings of $59.0 million and $0.0 million, respectively. Interest expense incurred in connection with these borrowings was $1.5 million based on a weighted average interest rate of 5.8%, $0.0 million and $0.0 million for the periods ending December 31, 1999, December 31, 1998 and December 31, 1997, respectively.
On March 14, 2000, Holdings completed public offerings of $200 million principal amount of 8.75% senior notes due March 15, 2010 and $250 million principal amount of 8.50% senior notes due March 15, 2005. Holdings retained approximately $50 million of the net proceeds for general corporate purposes. Approximately $400 million of the net proceeds were distributed by Holdings to Group and approximately $250 million were used by Group to capitalize Bermuda Re. The remainder of the proceeds that were distributed to Group will be used for general corporate purposes. See Note 15B of Notes to Consolidated Financial Statements.
During 1999, 1998 and 1997, Holdings declared and paid dividends of $11.6 million, $10.1 million and $8.1 million, respectively.
On March 21, 1996, the Holdings' Board of Directors approved a stock repurchase plan authorizing the repurchase of an aggregate amount of 2,500,000 shares of common stock from time to time in open market transactions. During 1999, Holdings' Board of Directors extended this authorization by an additional 4,400,000 shares, bringing the total authorization to 6,900,000 shares. During 1999, 3,553,000 shares were repurchased at an average price of $27.14 per share compared with 516,900 shares at an average price of $33.68 per share in 1998. At December 31, 1999, 2,830,100 shares remain under the existing repurchase authorization. Group's Board of Directors has continued this stock repurchase plan.
The Company's current investment strategy does not provide for investments in derivative financial instruments or derivative commodity instruments. The Company's current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable and tax-exempt fixed maturity portfolio, while maintaining an adequate level of liquidity. The Company's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with its current and projected operating results, market conditions, and tax position. The fixed maturities in the investment portfolio are comprised of non-trading available for sale securities. Additionally, the Company invests in marketable equity securities, which it believes will enhance the risk-adjusted total return of the investment portfolio.
Equity risk is the potential change in market value of the common stock and preferred stock portfolios arising from changing equity prices. The Company invests in predominately high quality preferred and common stocks that are traded on the major exchanges in the United States. The primary objective in managing the $90.7 million equity portfolio is to provide long-term capital growth through market appreciation and income.
The tables below display the impact on market value and after-tax unrealized appreciation of a 20% change in equity prices up and down in 10% increments as of December 31, 1999 and 1998. During the year, there was no material change in the equity portfolio with respect to equity risk. All amounts are in millions of U.S.$.
READINESS. The Company has been actively engaged in a project to mitigate the potential effects of the year 2000 issue. For each segment of its internal computer processing environment (mainframe, midrange and PC equipment), the Company has a multi-phase plan that involves (a) the identification and assessment of year 2000 compliance, (b) the design and development of remedies (including the replacement of non-compliant systems if needed), (c) testing of year 2000 readiness (d) the implementation of fully integrated year 2000-compliant processing and (e) the development of appropriate contingency plans. The Company completed all year 2000 preparations on mission-critical systems prior to January 1, 2000. No material performance problems were detected in such systems on or after January 1, 2000, although the Company continues to monitor its technology environment for compliance.
RISKS. The Company does not rely on computer-dependent transactions to the same extent as many other businesses. However, in the event that the Company's internal processing environment could not be made year 2000-compliant, or in the event that significant business partners or service providers or other business entities experienced serious year 2000 problems, the Company could experience disruption in its business. This disruption could conceivably take several forms: (a) having to compile information and process transactions manually, (b) if compliance problems persisted, impairing the Company's ability to receive premiums from and make claim payments to its ceding companies, (c) impairing the Company's ability to obtain information about its investments or (d) impairing the value of the Company's fixed maturity and equity investments, if the entities underlying those investments themselves have substantial year 2000 costs, liabilities or disruptions. Any or all of the types of possible disruptions in such a "worst case scenario" could materially increase the cost of doing business, could impair the Company's ability to make required regulatory filings and could materially affect the Company's financial condition, results of operations or liquidity. However, based upon the absence of any material disruption having occurred on or after January 1, 2000 and current information, the Company does not expect such scenarios to occur and does not expect material disruption to its business.
CONTINGENCY PLANS. The Company has developed a contingency plan which addresses how each business unit in its corporate office would continue to perform its mission-critical functions in the event of a systems failure related to year 2000. The plan has been extended to its branch offices and will be reevaluated and updated as needed.
POTENTIAL CLAIMS EXPOSURE. Individuals or entities which experience business disruption, increased costs or other problems associated with the year 2000 issue may assert claims, which could be substantial, against their own insurance carrier to recover such costs or against other entities for damages. These carriers or entities may in turn assert that such potential damages are covered by insurance. Although some such claims have been made, it is not yet possible to determine the extent to which such claims will be made against insurers, whether such claims will be held to have merit or whether any such claims may be made against insurance or reinsurance contracts in which the Company participates.
4) Catastrophe losses in the Company's domestic or international reinsurance or insurance business;
20) The impact of current and future regulatory environments, generally, and on the ability of the Company's subsidiaries to enter and exit reinsurance or insurance markets;
21) Changes in the commission or brokerage levels that competitors are willing to offer to ceding companies, brokers or agents;
22) Adverse changes in tax treatment of the Company's business, including changes in tax treatment by the U.S., Bermuda or Barbados or other regulatory or political organizations with jurisdiction or potential jurisdiction over the Company or its affiliates;
23) Lack of success by Everest Bermuda in launching its start-up operation in Bermuda;
In addition to the factors outlined above that are directly related to the Company's businesses, the Company is also subject to general business risks, including, but not limited to, adverse state, federal or foreign legislation and regulation, adverse publicity or news coverage, changes in general economic factors, and the loss of key employees.