(2) Return on shareholders' equity is calculated by dividing net income (excluding realized investment gains and extraordinary charge) by average shareholders' equity for the period (which is the simple average of beginning and end of period shareholders' equity excluding unrealized investment gains or losses).
(5) Same as the ratio of earnings to fixed charges, excluding interest on annuities and financial products, except fixed charges and earnings include interest on annuities and financial products.
(6) Capital invested in Administrative Reinsurance transactions represents the sum of the consideration paid for life insurance in force acquired and the related capital to support the business.
(7) Amounts have been derived from the Annual Statements of Life Reassurance, REALIC, AML and TexasRe, as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices. For purposes of this presentation, capital and surplus are defined as statutory capital and surplus of Life Reassurance only, as its capital and surplus materially reflect that of Life Reassurance, REALIC and TexasRe, plus the Asset Valuation Reserve ("AVR") and the Interest Maintenance Reserve ("IMR") of Life Reassurance and REALIC.
The following analysis of Life Re's consolidated financial condition and results of operations should be read in conjunction with "Selected Financial Data" and the consolidated financial statements and accompanying notes included elsewhere herein.
Life Re retrocedes portions of certain risks in excess of a predetermined retention amount for which it has accepted liability. From time to time, Life Re also has entered into quota share retrocessional agreements, and maintained catastrophe reinsurance to protect against catastrophic event risks. Failure of a retrocessionaire to honor its obligations could result in material losses to Life Re; to date, no such losses have occurred. No amounts due Life Re from its retrocessionaires were deemed uncollectible at December 31, 1997.
Approximately 10% of 1997 policy revenues were derived from Administrative Reinsurance. This line of business involves the acquisition and administration of blocks of primary insurance policies (both interest sensitive and traditional) and annuity contracts and is expected to become an increasingly significant component of policy revenues in the future. This line of business also includes Life Re's reinsurance of automobile credit life and disability.
Approximately 25% of Life Re's policy revenues were generated from group accident and health and special risk reinsurance in 1997. This business generally is written on an annual basis through reinsurance facilities which are managed by managing general underwriters. Generally the risks are shared by several reinsurers on a quota share basis. During 1997, Life Re withdrew from the group accident and health and special risk marketplace. Life Re previously had reduced or canceled certain pool participations, and effective January 1, 1997, retroceded 50% of its 1997 group accident and health and special risk reinsurance risks. For the year ended December 31, 1997, Life Re had $121.2 million of policy revenues related to group accident and health and special risk reinsurance, a reduction of 13% from the prior year. Life Re anticipates further declines of 50% in 1998 and 80% in 1999. Life Re expects no adverse financial impact from its withdrawal from this business.
Insurance (see Note 5 of "Notes to Consolidated Financial Statements"). Life Re utilized existing tax net operating loss carryforwards to offset the taxes otherwise payable in connection with the gain and reversed an existing deferred tax valuation allowance, resulting in a tax benefit of $4.8 million. Net income in 1995 included an extraordinary charge amounting to $1.0 million, which resulted from the write-off of unamortized loan costs associated with amending and restating the 1992 credit agreement (see Note 8 of "Notes to Consolidated Financial Statements").
EARNINGS EXCLUDING REALIZED INVESTMENT GAINS increased by $8.3 million, or 22%, to $46.6 million, or $3.28 per share, in 1997 compared with $38.3 million, or $2.75 per share, in 1996 and $33.2 million, or $2.22 per share, in 1995. The increase in earnings experienced in 1997 and 1996 was due to higher volumes of ordinary life reinsurance in force and the Transactions, partially offset by a deterioration in accident and health morbidity experience.
The growth in ordinary life reinsurance revenues was largely due to new reinsurance agreements entered into during the last three years. First year premiums totaled $58.1 million in 1997 and increased by 53% and 68% in 1997 and 1996, respectively. The ordinary life reinsurance in force lapse rate has ranged from 9-11% during the last three years. The growth in ordinary life reinsurance revenues was partially offset by a decline in group life reinsurance revenues. Group life reinsurance premiums declined by $8.0 million in 1997 due to treaty terminations.
Group accident and health and special risk premiums decreased by $18.4 million in 1997 due to Life Re's aforementioned reduced participations and retrocession agreement. Due to Life Re's decision to exit the accident and health and special risk reinsurance business, it anticipates further declines in group accident and health and special risk premiums of 50% in 1998 and 80% in 1999. Growth in 1996 was due principally to increased participation in major medical and accident reinsurance pools and quota share arrangements.
INVESTMENT INCOME increased by 21% in 1997 to $151.0 million and by 26% in 1996 to $124.3 million. These increases were largely due to the growth in invested assets resulting from the Transactions. This rate of growth is dependent on new Administrative Reinsurance transactions and, to a lesser extent, new ordinary life reinsurance business. The weighted average portfolio yield rate (amortized cost basis) was 7.4% in 1997, 7.8% in 1996 and 8.2% in 1995. The decrease in the yield rate is primarily due to the investment of assets acquired from the Transactions at current rates.
DISTRIBUTIONS ON CAPITAL SECURITIES of $5.0 million were incurred from the issuance in June 1997 of $100 million of 8.72% capital securities by a subsidiary trust as further described in the Financial Condition and Liquidity section (also see Note 9 of the "Notes to Consolidated Financial Statements").
The effective FEDERAL INCOME TAX rate was 35% in 1997. In 1996, the effective tax rate was 29% due to a $4.8 million federal tax benefit resulting from the reversal of a deferred tax valuation allowance in connection with the realized investment gain on the Nacolah transaction. In 1995, the effective tax rate was 35%.
Invested assets at fair value amounted to $2,784.6 million and $1,833.2 million at December 31, 1997 and 1996, respectively. The increase in invested assets in 1997 resulted from the Transactions. Net unrealized gains on invested assets totaled $101.5 million and $39.7 million at year end 1997 and 1996, respectively, and generally reflect the decrease in interest rates from period to period.
maturities that are rated below investment grade, as these investments are subject to a higher degree of credit risk than investment grade securities. Life Re closely monitors its below investment grade securities as well as the creditworthiness of the portfolio as a whole. When fair values decline for reasons other than changes in interest rates or other perceived temporary conditions, the security is written down to its net realizable value. In 1997, 1996 and 1995, Life Re wrote down the value of certain securities by $2.6 million, $0.5 million and $0.9 million, respectively. Life Re had no fixed maturities in default at December 31, 1997.
Life Re's obligations for policy benefit liabilities increased by 45% and 33% during 1997 and 1996, respectively. These increases resulted from the Transactions and increased reinsurance of new and in force life insurance. Policy benefits consist of the present value of future benefits under traditional ordinary and group life insurance policies, account values under interest sensitive life and annuity contracts, group accident and health claim reserves, life claims payable and other miscellaneous liabilities. Through the Transactions, the relative proportion of interest sensitive and annuity policy benefit liabilities to the total has increased significantly and, at December 31, 1997, totaled approximately 60% of the policy benefits under life insurance contracts.
In 1995, Life Re amended and restated the 1992 credit agreement to convert the facility to a senior secured revolving and term loan. The revolving loan has a commitment amount of $160.0 million and converts to a term loan in January 2000, with a final maturity date of January 4, 2004. The date of conversion to a term loan can be extended to January 2001, with bank consent (see Note 8 of "Notes to Consolidated Financial Statements"). At December 31, 1997, loans totaling $125.0 were outstanding.
The 1995 credit agreement contains certain covenants which, among other things, restrict under certain circumstances the payment of dividends and repurchase of treasury stock. Further, certain actions of Life Re are limited, including those related to mergers, acquisitions, indebtedness and investments. Life Re and its subsidiaries are required to meet certain financial ratios and maintain a minimum level of statutory surplus.
On June 6, 1997, Life Re completed a private placement under Rule 144A of the Securities Act of 1933, as amended, of $100 million of 8.72% capital securities of Life Re Capital Trust I ("Trust I"), a subsidiary of Life Re. Distributions are cumulative and payable in arrears beginning December 15, 1997. The securities have a maturity date of June 15, 2027 and may be redeemed at any time on or after June 12, 2007. Payments on the securities are fully and unconditionally guaranteed by Life Re. The securities have an effective interest rate of 8.75%. The assets of the Trust I consist of junior subordinated debentures issued by Life Re which have terms that parallel the terms of the capital securities.
On March 17, 1998 Life Re completed two separate public offerings in which it sold 3,500,000 shares of common stock, and 2,070,000 6.0% Adjustable Conversion-rate Equity Security Units issued through Life Re Capital Trust II ("Trust II") (the "Units"), (together, the "Offerings"). Life Re realized net proceeds of approximately $352 million from the Offerings. The Units consist of a stock purchase contract (the "Contract") and Quarterly Income Preferred Securities ("QUIPS"). Under the terms of the Contract, on March 15, 2001 the holder will purchase from Life Re between 0.81967 of a share and one share of common stock, depending on the then current market price, for a purchase price of $66.00. Distributions on the QUIPS are cumulative, accrue from the first date of issuance of the QUIPS and are payable at a stipulated annual rate on a quarterly basis in arrears on a predetermined payment date. The QUIPS have a maturity of March 15, 2003 and are subject to a put option exercisable by the QUIPS holder on either March 15, 2001 or June 15, 2001.
Under the stock repurchase program initially approved by Life Re's Board of Directors during 1995, 2.2 million shares have been purchased. Due to the Offerings, the Board of Directors elected to discontinue the stock repurchase program as of February 1998.
Debt to total capitalization (outstanding debt divided by the sum of outstanding debt, capital securities, and shareholders' equity) has decreased significantly during the last two years. As a percentage, these amounts were 21%, 30% and 33% at year-end 1997, 1996 and 1995, respectively. Management believes Life Re's prospective debt to total capitalization generally should not exceed 25%.
TexasRe relies primarily on dividends from LRCA to meet its obligations under the surplus debentures as well as to pay dividends to Life Re Corporation.
The payments of dividends by TexasRe and LRCA are subject to restrictions set forth in Texas and Connecticut insurance laws and regulations (see Note 10 of "Notes to Consolidated Financial Statements"). Under Connecticut law, no dividend in an amount exceeding LRCA's earned surplus may be paid without prior regulatory approval. Approval has been received from the Connecticut Department of Insurance to define earned surplus for this purpose to include amounts of paid in surplus in excess of $125.0 million.
The growth in ordinary life reinsurance new business was substantial in 1997 and 1996, with increases in first year reinsurance premiums totaling 58% and 68%, respectively. Although Life Re does not expect the rate of growth experienced in 1997 to continue, its objective is to increase ordinary life reinsurance first year premiums written by 15-20% during 1998. This growth could be constrained by (i) competition, which could dilute the profitability of this business and (ii) the success of ceding companies in writing primary business.
Life Re believes that consolidation within the insurance industry will continue as companies shed non-core businesses or exit the industry due to operating inefficiencies. Through Administrative Reinsurance, Life Re expects to participate in this consolidation as it has in place the infrastructure through primary licenses and multiple administrative capabilities with which to effect reinsurance or other acquisition transactions. However, this participation may be adversely affected by such factors as the availability of adequate capital, the types of business opportunities presented and the competition for such business.
Currently, blocks of insurance in force acquired through Administrative Reinsurance are administered by several third party administrators. Life Re believes its strategy of outsourcing administrative services for direct insurance in force allows it to efficiently integrate acquisitions and to retain the capacity to pursue multiple acquisition opportunities simultaneously.
Life Re plans to complete, by June 1998, a comprehensive review of its computer systems to identify systems that could be affected by the year 2000 issue. Life Re presently believes that, with modifications to
Life Re has initiated formal communications with its ceding companies to determine the extent to which data received and utilized by Life Re is vulnerable to those third parties' failure to remediate their own year 2000 issues. There is no guarantee that the systems of other companies on which Life Re may rely for data will be timely converted and would not have an adverse effect on analyses and reports that utilize that data. However, Life Re believes it own systems and processes mitigate the risk that ceding companies year 2000 noncompliance will have a material adverse effect on its operations.
/s/ Rodney A. Hawes, Jr. /s/ Jacques E. Dubois - ----------------------------------- ----------------------------------- Rodney A. Hawes, Jr. Jacques E. Dubois Chairman of the Board and President and Chief Executive Officer Chief Operating Officer
We have audited the accompanying consolidated balance sheets of Life Re Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in common shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedule listed in the Index as Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
The Company's business activities consist of traditional life reinsurance and Administrative Reinsurance(SM). Traditional life reinsurance primarily involves the transfer to the Company of mortality risks on insurance products from primary (or ceding) insurers of ordinary and group life policies. Substantially all of the traditional life reinsurance business is marketed directly by the Company without the use of intermediaries. Administrative Reinsurance, which was initiated in 1995 with the purchase of REALIC, involves the acquisition of blocks of life insurance and/or annuity contracts in force. The Company has obtained its Administrative Reinsurance business through purchases of life insurance companies and also through indemnity coinsurance or assumption reinsurance agreements with ceding insurers. The Company also assumes responsibility for policy administration for the business obtained from these transactions which it outsources to third party administrators.
During 1997, the Company made a strategic decision to withdraw from the group accident and health and special risk reinsurance business. This business was primarily conducted through participation in reinsurance pools. Since October 1997, the Company has ceased to renew or accept new pool participations and has also ceased direct marketing activity.
Mortality and morbidity experience, significant factors in the determination of the results of operations for the life insurance industry, generally are predictable over time but are subject to fluctuations from year to year and quarter to quarter. A significant fluctuation from period to period could adversely affect the Company's results of operations.
As of December 31, 1997, the Company had net assets of $23,745 related to reinsurance of Canadian risks. A deterioration in the exchange rate of Canadian currency could have an adverse effect on results of operations.
Realized gains or losses from sales of investments, determined on the specific identification basis, and declines in fair value determined to be other than temporary are included in net income.
Policy revenues consist of premiums under traditional life and accident and health and special risk insurance policies and fees and charges under interest sensitive life insurance policies and annuity contracts.
The Company accounts for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities calculated using the tax rate in effect at the measurement date. LIFE RE CORPORATION AND SUBSIDIARIES
Earnings per share have been calculated in accordance with Financial Accounting Standards Board Statement No. 128, "Earnings Per Share" ("SFAS 128").
Earnings per common share is computed using the weighted average number of common shares outstanding during the periods presented. Earnings per share assuming dilution reflects the dilution that could occur if options to purchase common stock granted under the Company's stock option plans were exercised. The adoption of SFAS 128 did not result in the restatement of previously reported earnings per share as the calculation of earnings per share assuming dilution in accordance with SFAS 128 results in the same per share amounts previously reported. The following table presents the effect of dilutive common stock options.
Also in June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), effective for years beginning after December 15, 1997. SFAS 131 requires that a public company report financial and descriptive information about its reportable operating segments pursuant to criteria that differ from current accounting practice. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The financial information to be reported includes segment profit or loss, certain revenue and expense items and segment assets and reconciliations to corresponding amounts in the general purpose financial statements. SFAS 131 also requires information about revenues from products or services, countries where the company has operations or assets and major customers. The implementation of SFAS 131 will not affect results of operations or financial position but will affect the disclosure of segment information.
The following table summarizes the acquisitions and in force reinsurance transactions completed by the Company during the three years ended December 31, 1997. These transactions were accounted for as purchases and therefore results of operations include their effects only from their respective dates of acquisition. Significant transactions are further discussed below.
As of June 30, 1996, REALIC acquired, for an adjusted purchase price of $16,828, 100% of the common stock of two subsidiaries of I.C.H. Corporation. The assets acquired and liabilities assumed were $166,948 and $150,120, respectively. By December 31, 1996, these companies had been merged with and into REALIC.
On October 31, 1996, REALIC acquired, for a purchase price of $22,314, 100% of the common stock of New American Life Insurance Company from a subsidiary of General Accident plc. At the purchase date, this company was merged with and into REALIC. The assets acquired and liabilities assumed were $135,461 and $113,147, respectively.
Effective July 1, 1996, the Company purchased 20% of the common stock of Resource Financial Corporation ("RFC") for $200 and on September 30, 1996, purchased $15,000 of preferred stock and $5,000 of long-term debt of a wholly owned subsidiary of RFC. RFC and its subsidiary, Resource Life Insurance Company, were organized for the purpose of acquiring certain assets and operations from subsidiaries of Aon Corporation ("Aon"). RFC provides insurance product distribution and administrative and financial services for the retail automobile industry throughout the United States.
Also effective July 1, 1996, the Company entered into agreements with affiliates of Aon and with Resource Life Insurance Company which provide for the Company to reinsure automobile credit insurance produced through RFC or its predecessor, a substantial portion of which is retroceded by the Company. The Company pays contingent consideration for a period of five years to a subsidiary of Aon based on premiums produced through RFC subsequent to June 30, 1996. The contingent consideration paid through December 31, 1997 is deferred and is being amortized over the life of the related agreement.
Securities with a fair value of $109,266 at December 31, 1997 are owned by a ceding company and held in a dedicated portfolio in conjunction with an indemnity reinsurance agreement. Under the terms of the agreement, investment income, realized gains and losses and all other risks and rewards of ownership of the assets in the portfolio inure to the benefit or detriment of the Company. Accordingly, these assets, consisting of $107,103 of fixed maturities and $1,037 of equity securities classified as available for sale and $1,126 of short-term investments at December 31, 1997, have been included as investments in the accompanying balance sheet. The portfolio is managed by the Company's primary investment advisor under guidelines approved by both parties to the reinsurance agreement, subject to the requirement that the statutory carrying value of the assets in the dedicated portfolio must be maintained by the Company in an amount at least equal to the statutory reserves on the reinsured business.
Securities with a fair value of $121,931 at December 31, 1997 were on deposit with various governmental insurance regulatory agencies to comply with applicable insurance laws.
At December 31, 1997, the contractual maturities of investments in fixed maturities are as follows:
Investments in any entity in excess of ten percent of common shareholders' equity at December 31, 1997, other than investments issued or guaranteed by the U.S. government, are as follows:
acquisition of Nacolah by Sammons Enterprises, Inc. The Company received proceeds of $25,057 and recorded a realized investment gain of $13,540.
The Company's accident and health insurance business is of short duration and generally claims are reported within a short period of time after incurral. There have been no material favorable or adverse developments affecting accident and health insurance claims reserves in 1997, 1996 or 1995.
At December 31, 1997, income taxes payable of $17,240 are included in other liabilities, and at December 31, 1996, federal income taxes recoverable of $7,937 are included in other assets. In 1997 and 1995, the effective income tax rate on income before federal income taxes and extraordinary charge did not vary materially from the statutory federal income tax rate. The realized gain on the sale of Nacolah in 1996 (Note 5) and other income triggered the utilization of tax net operating loss carryforwards available to Life Re Corporation and a corresponding reversal of the previously established deferred tax valuation allowance, resulting in a tax benefit of $4,775. This reduced the effective income tax rate in 1996 to 29%.
At December 31, 1997, the outstanding borrowings bear interest at an annual effective rate of 6.26%. Interest paid on outstanding loans was $8,083, $8,774 and $9,807 in 1997, 1996 and 1995, respectively.
On June 6, 1997, the Company completed a private placement under Rule 144A of the Securities Act of 1933, as amended, of $100,000 of 8.72% capital securities of Life Re Capital Trust I ("Trust I"), a subsidiary of the Company. Distributions are cumulative and payable in arrears beginning December 15, 1997. The securities have a maturity date of June 15, 2027 and may be redeemed, at the option of the Company, at any time on or after June 15, 2007. Payments on the securities are fully and unconditionally guaranteed by the Company. The securities have an effective interest rate of 8.75%. The assets of Trust I consist of junior subordinated debentures issued by Life Re Corporation which have terms that parallel the terms of the capital securities.
Under Life Re Corporation's Restated Certificate of Incorporation, 5,000,000 shares of preferred stock are available for future issuance without shareholder approval. The rights, terms and preferences of the preferred stock may be determined by the Company's Board of Directors.
Pursuant to a stock repurchase program approved by the Company's Board of Directors, 2,150,400 shares of common stock out of a total authorization of 3,000,000 shares were acquired through December 31, 1997 for a total purchase price of $46,647. In conjunction with the Common Stock and Units Offerings, the Board of Directors elected to discontinue the stock repurchase program. Treasury stock also reflects the repurchase of shares of stock from certain officers in accordance with the terms of their stock purchase agreements.
The availability of funds to meet obligations, including dividends, capital security distributions and debt service, is dependent, in part, on the ability of its subsidiaries to transfer funds to Life Re Corporation. The subsidiaries are subject to certain state laws and regulations which limit their ability to transfer funds and pay dividends. Generally, the subsidiaries may not, without prior regulatory approval, transfer cash dividends, loans or advances in any twelve month period in excess of the greater of the prior year's statutory operating income or 10% of capital and surplus at the preceding year end. Additionally, under Connecticut law, no dividend in an amount exceeding LRCA's earned surplus may be transferred to TexasRe without prior regulatory approval. Approval has been received from the Connecticut Department of Insurance to define earned surplus for this purpose to include amounts of paid in surplus in excess of $125,000. At December 31, 1997, net assets of TexasRe totaling $113,130 are not available for transfer to Life Re Corporation in 1998 except with prior approval of state regulatory authorities. Dividends paid to Life Re Corporation by TexasRe were $16,314 in 1997, $12,087 in 1996 and $15,000 in 1995.
Combined statutory basis net income of TexasRe and subsidiaries was $16,315 and $27,087 in 1996 and 1995. In 1997, TexasRe and subsidiaries had a statutory basis net loss of $54,121.
Exercise prices for options outstanding as of December 31, 1997 range from $16.63 to $42.38. The weighted-average remaining contractual life of those options is 7 years.
Substantially all full time employees are covered by a noncontributory defined benefit pension plan. Benefits are determined by a formula which relates the pension payable to years of service at retirement, final five year average salary and wages covered by Social Security. Annual contributions to the plan are sufficient to satisfy legal funding requirements. In addition, the Company has an unfunded Supplemental Executive Retirement Plan which is a nonqualified plan that provides certain officers defined pension benefits in excess of limits imposed by federal tax law. The Company also sponsors a defined contribution savings plan covering substantially all employees with at least six months of service. The Company contributes 50% of the first 6% of salary contributed by employees. Participants vest in Company contributions over a four year period. The combined expense associated with employee benefit plans was $1,438, $1,151 and $1,031 in 1997, 1996 and 1995, respectively.
In the normal course of business, the Company seeks to limit its exposure to loss by ceding reinsurance to retrocessionaires. In general, the Company retains a maximum of $1,000 on any one life for ordinary life insurance business with certain limited exceptions depending upon age and classification of the risk. Amounts in excess of the retention are ceded to a pool of retrocessionaires. From time to time, the Company has also entered into quota share retrocessional agreements. In general, the Company's policy in regard to group
Amounts receivable on reinsurance ceded includes approximately $60,000 representing ERC Life's 67% retrocessional share of the acquisition costs associated with the ERAC agreement (Note 3).
The adoption of SFAS 128 did not result in the restatement of previously reported earnings per share as the calculation of earnings per share assuming dilution in accordance with SFAS 128 results in the same per share amounts previously reported.
LIFE RE CORPORATION AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II -- CONTINUED