The following selected financial data should be read in connection with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes that are included in this Form 10-K. Financial information in the table reflects the results of operations and financial position of OdysseyRe. The results for the year ended December 31, 1999 reflect the results of Odyssey America from April 13, 1999, the date on which it was acquired by Fairfax.
equity and cash flows for each of the three years in the period ended December 31, 2003, and related notes, appear in this Form 10-K beginning at page [52].
Throughout 2002 and continuing into 2003, we experienced growth opportunities in a number of areas, evidenced by our increase in gross premiums written of $663.7 million, or 35.0%, to $2.6 billion for the year ended December 31, 2003 from $1.9 billion for the year ended December 31, 2002. Improved pricing, industry consolidations and a series of catastrophic events, both in the United States and globally, have all contributed to our growth. We have opportunistically expanded in certain classes of business and in each of our geographic business segments. Our non-United States operations, including Newline, accounted for 41.5% of our premium volume for 2003. For the years ended December 31, 2003 and 2002, our net premiums written were $2.2 billion and $1.6 billion, respectively, and our net income was $249.2 million and $208.2 million (which included a cumulative effect of a change in accounting principle of $36.9 million for 2002), respectively. As of December 31, 2003, we had total assets of $6.5 billion and total stockholders’ equity of $1.4 billion.
The property and casualty reinsurance and insurance industries use the combined ratio as a measure of underwriting profitability. The GAAP combined ratio is the sum of losses and loss adjustment expenses incurred as a percentage of net premiums earned plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include income from investments. Underwriting profitability is subject to significant fluctuations due to competition, catastrophic events, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 96.8% for the year ended December 31, 2003, a decrease of 2.3 percentage points from the 99.1% combined ratio for the year ended December 31, 2002. This continued underwriting profitability is a direct result of our underwriting actions, including improvements
The Americas division is our largest division and writes casualty, surety and property treaty, and facultative casualty reinsurance in the United States and Canada, and primarily treaty and facultative property reinsurance in Central and South America. The Americas division is comprised of three units, the United States, Canada, and Latin America, with two offices in New York City, and offices located in Stamford, Mexico City, Miami, Santiago and Toronto.
The EuroAsia division operates out of four offices, with principal offices in Paris and Singapore. The EuroAsia business consists of international reinsurance business which is geographically dispersed, mainly throughout the European Union, followed by Japan, Eastern Europe, the Pacific Rim, and the Middle East. The EuroAsia division has been successful in taking advantage of the rate increases throughout its international scope of operations and in creating new market opportunities by leveraging its long-term ceding company and broker relationships. The business underwritten by First Capital is also included in the EuroAsia division.
Premium estimates, the corresponding acquisition expenses and unearned premium reserves are established on a contract level for any significant accounts due but not rendered by the ceding company at the end of each accounting period. The estimated ultimate premium for the contract, actual accounts rendered by the ceding company, and our own experience on the contract are considered in establishing the estimate at the end of each accounting period.
The change in these estimates is reflected in the revenue account at the end of each accounting period. These estimates are considered “critical accounting estimates”, because changes in these estimates can materially affect net income.
We determine our reserve for unpaid losses and loss adjustment expenses based on the evaluation of our in-house claims department of the reports and individual case estimates received from ceding companies for reinsurance business or the estimates advised by our outside claims adjusters for insurance business. We use generally accepted actuarial methodologies to determine a reserve for losses incurred but not reported (“IBNR”) on the basis of our historical experience and other estimates. We review the reserves continually and changes in estimates are reflected in the operating results of the period in which they become known. Accordingly, losses and loss adjustment expenses are charged to income in the calendar year they are incurred.
We also establish reserves to provide for incurred but unreported claims and the estimated expenses of settling claims, including legal and other fees, and the general expenses of administering the claims adjustment process, known as loss adjustment expenses. We calculate incurred but not reported loss and loss adjustment expense reserves by using generally accepted actuarial reserving techniques to project the ultimate liability for losses and loss adjustment expenses. We periodically revise such reserves to adjust for changes in the expected loss development pattern over time.
Other underwriting expenses consist of cost of operations associated with our underwriting activities. These expenses include compensation, rent, and all other general expenses allocated to our underwriting activity and exclude any investment or claims related expenses.
The Americas division accounted for $1,421.4 million, or 54.7%, of our gross premiums written for the year ended December 31, 2003, an increase of $232.4 million, or 19.5%, compared to $1,189.0 million, or 61.6%, of our gross premiums written for the year ended December 31, 2002. Gross premiums written by the United States unit for the year ended December 31, 2003 were $1,188.0 million, an increase of $163.9 million, or 16.0%, compared to $1,024.1 million for the year ended December 31, 2002. Gross premiums written by the Latin America unit for the year ended December 31, 2003 were $149.7 million, an increase of $32.9 million, or 28.2%, compared to $116.8 million for the year ended December 31, 2002. The Canadian unit had gross premiums written of $79.6 million for the year ended December 31, 2003, an increase of $38.8 million, or 95.1%, compared to $40.8 million for the year ended December 31, 2002.
The increase in the EuroAsia division gross premiums written for the year ended December 31, 2003 compared to 2002, is comprised of increases in treaty property business of $89.0 million (55.4%), treaty casualty business of $19.5 million (45.9%) and all other treaty lines, principally marine, aerospace and credit, of $42.6 million (153.8%). Property facultative business decreased to $8.6 million for the year ended December 31, 2003 from $24.6 million for the year ended December 31, 2002 as we discontinued this line of business in Europe in 2003.
The U.S. Insurance division accounted for $333.8 million, or 12.8%, of our gross premiums written for the year ended December 31, 2003, an increase of $165.2 million, compared to $168.6 million, or 8.7%, of our gross premiums written for the year ended December 31, 2002. For the year ended December 31, 2003, Hudson had gross premiums written of $223.2 million, an increase of $54.6 million, or 32.4%, compared to $168.6 million for the year ended December 31, 2002. The new Healthcare unit established on January 1, 2003, contributed $110.6 million of premiums written for the year ended December 31, 2003.
Ceded Premiums Written. Ceded premiums written for the year ended December 31, 2003 increased by $141.3 million, or 53.7%, to $404.6 million from $263.3 million for the year ended December 31, 2002. The increase in ceded premiums written is attributable to an increase in cessions to the whole account aggregate excess of loss covers associated with prior underwriting years in the amount of $49.3 million, the addition of the Healthcare unit in 2003 which accounted for $37.1 million of the increase, and the increase in cessions attributable to the Hudson business of $22.2 million. The remaining increase in ceded premiums written is attributable to the increase in the gross premiums written.
Net Premiums Earned. Net premiums earned for the year ended December 31, 2003 increased by $532.5 million, or 37.2%, to $2.0 billion from $1.4 billion for the year ended December 31, 2002. This increase is consistent with the increase in net premiums written as described above.
Included in net realized investment gains for the years ended December 31, 2003 and 2002, respectively, are $58.8 and $13.0 million of realized losses on the other than temporary write-down of certain fixed income and equity securities.
Other Expenses (Income), Net. Other expenses (income), net for the year ended December 31, 2003 was a net expense of $7.9 million compared to $5.0 million of net income for the year ended December 31, 2002. The other expense (income), net for the years ended December 31, 2003 and 2002, is primarily comprised of the operating expenses of the holding company.
Interest Expense. We incurred interest expense related to debt obligations of $12.7 million for the year ended December 31, 2003, compared to $8.7 million for the year ended December 31, 2002. The 2003 expense includes a full year’s interest on our 4.375% convertible senior debentures due 2022, which were issued in June 2002, while only six months of expense is reflected in 2002. During the fourth quarter of 2003, we issued $225.0 million of our senior notes due November 1, 2013 (and prepaid $50.0 million of our senior notes due November 30, 2006) which contributed an additional $2.6 million of interest expense during 2003.
The Americas division accounted for $1,189.0 million, or 61.6%, of our gross premiums written for the year ended December 31, 2002, an increase of $357.6 million, or 43.0%, compared to $831.4 million, or 72.1%, of our gross premiums written for the year ended December 31, 2001. Gross premiums written by the United States unit for the year ended December 31, 2002 were $1,024.1 million, an increase of $305.8 million, or 42.6%, compared to $718.3 million for the year ended December 31, 2001. Gross premiums written by the Latin America unit for the year ended December 31, 2002 were $116.8 million, an increase of $44.5 million, or 61.5%, compared to $72.3 million for the year ended December 31, 2001. The Canadian unit had gross premiums written of $40.8 million for the year ended December 31, 2002, an increase of $24.4 million, or 148.8%, compared to $16.4 million for the year ended December 31, 2001.
The increase in the Americas division is comprised of increases in treaty property excess of loss of $31.4 million, proportional property of $52.5 million, casualty excess of loss of $58.9 million, proportional casualty of $128.8 million, marine and aerospace, surety and credit and miscellaneous lines of $42.4 million and facultative reinsurance of $43.6 million.
For the year ended December 31, 2002, the EuroAsia division had gross premiums written of $258.6 million, or 13.4%, of our gross premiums written, an increase of $112.1 million, or 76.5%, compared to
The increase in the EuroAsia division is comprised of increases in treaty property excess of loss of $31.5 million, proportional property of $52.9 million, casualty excess of loss of $10.9 million, marine and aerospace of $9.7 million, surety and credit of $3.9 million, facultative of $2.9 million and First Capital of $3.2 million. These increases were offset by a decrease in casualty proportional of $2.8 million.
The London Market division generated $315.3 million, or 16.3%, of our gross premiums written for the year ended December 31, 2002 as compared to $165.9 million, or 14.4%, of our gross premiums written for the year ended December 31, 2001. Gross premiums written by the London branch for the year ended December 31, 2002 were $117.5 million, an increase of $83.5 million, or 245.6%, compared to $34.0 million for the year ended December 31, 2001. Our Lloyd’s syndicate had gross premiums written of $197.8 million for the year ended December 31, 2002, an increase of $65.9 million or 50.0%, compared to $131.9 million for the year ended December 31, 2001. During 2002 there was a shift in writing certain treaty business between the branch and the syndicate. On an overall basis gross premiums written for treaty business increased in 2002 to $151.6 million or a 35.4% increase compared to 2001 of $112 million. Liability lines written by the syndicate was $163.7 million an increase of over 200% compared to 2001 of $53.9 million.
Net Realized Investment Gains. Net realized investment gains for the year ended December 31, 2002 increased by $122.5 million, to $135.8 million from a gain of $13.3 million for the year ended December 31, 2001. The increase in net realized gains in 2002 was primarily related to the sale of fixed income securities,
which generated gains as we realized the benefits of the appreciation in the portfolio due to the decline in interest rates, which hit levels not experienced in 40 years.
Other Expenses (Income), Net. Other expenses (income), net for the year ended December 31, 2002 was a net expense of $5.0 million compared to $0.8 million of net income for the year ended December 31, 2001.
Interest Expense. We incurred interest expense related to debt obligations of $8.7 million for the year ended December 31, 2002, as opposed to $5.9 million for the year ended December 31, 2001. We entered into our debt obligations in the latter part of June 2001, and therefore the 2001 period reflects a lower interest expense.
Federal and Foreign Income Tax Provision. Our federal and foreign income tax provision for the year ended December 31, 2002 increased by $94.5 million to a tax provision of $86.8 million as a result of the increase in operating income. We recognized a tax benefit of $7.7 million for the year ended December 31, 2001 due to the effects of the event of September 11th and Enron.
Our stockholders’ equity increased by $334.2 million, or 31.6%, to $1.4 billion as of December 31, 2003 from $1.1 billion as of December 31, 2002. The increase was mainly attributable to net income of $249.2 million, an increase in accumulated other comprehensive income, net of deferred taxes, of $90.7 million, the amortization of restricted stock of $1.1 million offset by dividends paid to stockholders of $6.9 million for the year ended December 31, 2003.
An additional source of funds for OdysseyRe is the dividend capacity of its subsidiary, Odyssey America. During 2004, Odyssey America can pay dividends to us of $178.7 million, without prior regulatory approval.
During the fourth quarter of 2003, we issued $225.0 million aggregate principal amount of senior notes due November 1, 2013. The issue was sold at a discount of $0.4 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 7.65%, which is due semi-annually on May 1st and November 1st. The senior notes are redeemable at a premium, prior to maturity, at our discretion. We used the proceeds from this offering to prepay $50.0 million aggregate principal amount of the 7.49% senior notes due November 30, 2006 and to contribute $165.0 million of additional capital to Odyssey America. The remainder will be used for general corporate purposes.
In June 2002, we issued $110.0 million aggregate principal amount of 4.375% convertible senior debentures (“Convertible Debt”) due 2022. The Convertible Debt is redeemable at our option beginning on June 22, 2005. Each holder of Convertible Debt may, at its option, require us to repurchase all or a portion of its Convertible Debt on June 22, 2005, 2007, 2009, 2012 and 2017. Under certain circumstances, each Convertible Debt holder can convert its Convertible Debt, into 46.9925 shares of OdysseyRe common stock for every $1,000 principal amount of the Convertible Debt; however, as of December 31, 2003, the Convertible Debt was not convertible, in accordance with the terms of the indenture under which the Convertible Debt was issued. The Convertible Debt is reflected on our balance sheet at a value of $110.0 million, the aggregate principal amount of Convertible Debt outstanding.
In December 2001, we issued $100.0 million aggregate principal amount of senior notes, pursuant to a private placement, due November 30, 2006. Interest accrues on the 7.49% senior notes at a fixed interest rate of 7.49%, which is due semi-annually on May 31st and November 30th. The 7.49% senior notes are
The table below displays the potential impact of market value fluctuations on the fixed income securities portfolio as of December 31, 2003 and December 31, 2002, based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. This analysis was performed on each security individually.
The preceding table indicates an asymmetric market value response to equivalent basis point shifts, up and down in interest rates. This partly reflects exposure to fixed income securities containing a put feature. In total these securities represent approximately 5% and 23% of the fair market value of the total fixed income portfolio as of December 31, 2003 and December 31, 2002, respectively. The asymmetric market value response reflects our ability to put these bonds back to the issuer for early maturity in a rising interest rate environment (thereby limiting market value loss) but to hold these bonds to their much longer full maturity dates in a falling interest rate environment (thereby maximizing the full benefit of higher market values in that environment).
As of December 31, 2003, we had gross unrealized appreciation on our entire investment portfolio of $169.6 million, which is offset by gross unrealized depreciation of $56.1 million.
Certain shortcomings are inherent in the method of analysis presented in the computation of the fair value of fixed rate instruments. Actual values may differ from those projections presented should market conditions vary from assumptions used in the calculation of the fair value of individual securities, including non-parallel shifts in the term structure of interest rates and a change in individual issuer credit spreads.
We have certain business arrangements with affiliated companies that have financial implications. A description of these arrangements are provided in note 12 of our consolidated financial statements included in this Form 10-K.
The following table provides a payment schedule of present and future obligations (in thousands):
Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2003, 2002 and 2001
Condensed Financial Information of Registrant as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001
The Company maintains an internal control structure intended to provide, among other things, reasonable assurance that its records include the transactions of its operations in all material respects and to provide protection against significant misuse or loss of Company assets. Management believes that the internal control structure meets these objectives. The internal control structure is supported by careful selection and training of qualified personnel, written policies and procedures that communicate details of the internal control structure to the Company’s worldwide activities, and by a staff of internal auditors who employ thorough auditing programs.
The Company’s financial statements have been audited by PricewaterhouseCoopers LLP, independent certified public accountants. Their audit was conducted in accordance with generally accepted auditing standards, which included consideration of the Company’s internal control structure. The Report of Independent Auditors appears on page 51.
To the Board of Directors and Stockholders of Odyssey Re Holdings Corp.:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Odyssey Re Holdings Corp. and its subsidiaries at December, 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management, our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in note 3 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standard 142, “Goodwill and Other Intangible Assets”.
(b) Premiums are earned (net of reinsurance ceded) over the terms of the related insurance policies and reinsurance contracts or certificates. Unearned premium reserves are established for the unexpired portion of insurance policies and reinsurance contracts or certificates. Such unearned premium reserves are computed by pro rata methods based on statistical data or reports received from ceding companies. Premium estimates are based on statistical and other data with subsequent adjustments recorded in the period they become known. Premium adjustments on deposit contracts and audit premiums are accrued on an estimated basis throughout the contract or policy term. Prepaid reinsurance premiums are reported as assets.
The reserves for losses and loss adjustment expenses are estimates of amounts needed to pay reported and unreported claims and related loss adjustment expenses. The estimates are based on assumptions related to the ultimate cost to settle such claims. The Company’s reserves for losses and loss adjustment expenses are determined in accordance with sound actuarial practices and management believes that such reserves are adequate. The inherent uncertainties of estimating reserves are greater for reinsurers than for primary insurers, due to the diversity of development patterns among different types of reinsurance contracts and the necessary reliance on ceding companies for information regarding reported claims. As a result, there can be no assurance that the ultimate liability will not exceed amounts reserved with a resulting adverse effect on the Company.
(f) On March 4, 2003, Fairfax increased its ownership interest in the Company to 80.6%. As a result, OdysseyRe and its United States subsidiaries are included in Fairfax Inc.’s, an affiliate, United States tax group. Inclusion of the Company into the Fairfax, Inc.’s tax group did not have an effect on the Company’s tax position. Effective June 19, 2001, the date of the Company’s initial public offering, through March 3, 2003, the Company, and its United States subsidiaries, filed a separate consolidated tax return. Prior to the offering, the Company and its United States subsidiaries were included in Fairfax Inc.’s consolidated federal income tax return. The federal income tax provision is allocated to each of the companies in the consolidated group, pursuant to a written agreement, on the basis of each company’s separate return taxable income.
(g) All derivative instruments are recognized as either assets or liabilities on the balance sheet and measured at their fair value. Gains or losses from changes in the derivative values are accounted for based on how the derivative is used and whether it qualifies for hedge accounting.
Effective January 1, 2003, the Company adopted the expense recognition provisions of SFAS 123, on a prospective basis, in accordance with SFAS 148, “Accounting for Stock-Based Compensation-Transaction and Disclosure.” The prospective method requires the application of the fair value based method to compensation awards granted, modified, or settled on or after the date of adoption. Accordingly, net income for the year ended December 31, 2003 reflects stock-based compensation expense related to stock options granted in 2003. The impact of adopting the recognition of SFAS 123 was not material to net income, financial condition or cash flows. Pursuant to APB 25, no stock-based compensation expense was recognized for the year ended December 2002. Had compensation cost been
charged to earnings in accordance with the fair value based method as prescribed in SFAS 123 for all outstanding stock-based compensation awards (occurring both before and after adoption of the recognition provisions of SFAS 123), the Company’s net income and net income per common share (on a pro forma basis) would have been as follows (in thousands, except per share amounts):
Effective January 1, 2002, the Company in accordance with the provisions of SFAS 141, “Business Combinations” and SFAS 142, “Goodwill and Other Intangible Assets”, fully amortized its negative goodwill of $36.9 million related to the 1996 acquisition of Clearwater and reflected the amortization as a cumulative effect of a change in accounting principle in its statement of operations for the year ended December 31, 2002. SFAS 142 requires that an entity determine if goodwill or other intangible assets has an indefinite or finite useful life. Goodwill and intangible assets with indefinite useful lives will not be subject to amortization and must be tested at least annually for impairment. Management has determined that the goodwill and intangible assets of $23.2 million and $19.1 million reflected in other assets as of December 31, 2003 and December 31, 2002 respectively, were not impaired. There is no effect on the Company’s federal and foreign income taxes resulting from the implementation of these accounting pronouncements.
The Company did not amortize goodwill or negative goodwill during the years ended December 31, 2003 and 2002. The retroactive effect of the implementation of SFAS Nos. 141 and 142 on net loss and basic and diluted loss per share for the year ended December 31, 2001 would be as follows (in thousands):
On October 28, 2003, Odyssey America purchased General Security Indemnity Company (“General Security”), an excess and surplus lines shell company domiciled in New York. The purchase price was comprised of investment assets of $33.7 million held by General Security at the purchase date and intangible assets of $3.9 million, which as of December 31, 2003 were not impaired and have an indefinite life. Prior to the completion of the sale, General Security entered into an Assumption Reinsurance, Indemnification and Administration agreement with General Security Indemnity Company of Arizona (“General Security-AZ”), pursuant to which all of the liabilities of General Security for all business written prior to the purchase date were transferred to General Security-AZ. General Security’s name has been changed to Hudson Specialty Insurance Company (“Hudson Specialty”). Odyssey America also purchased the rights to new and renewal medical malpractice and hospital professional liability business (“Healthcare business”) underwritten by TIG Insurance Company, a subsidiary of Fairfax. Hudson Specialty will serve as the main platform for the Healthcare business. The purchase price of the Healthcare business was $7.5 million and was recorded as an
intangible asset that will be amortized over a ten year life. On December 18, 2003, Hudson Specialty and the Healthcare business were contributed to Clearwater. Clearwater subsequently contributed $18.0 million to Hudson Specialty.
The composition of the fixed income securities, unaffiliated common stocks and short-term investments, which are carried at fair value, as of December 31, 2003 follows (in thousands):
The components of net investment income for the years ended December 31, 2003, 2002 and 2001 follows (in thousands):
The proceeds from the sales of investments were $4.9 billion, $2.5 billion and $0.4 billion for the years ended December 31, 2003, 2002 and 2001.
The components of gross and net realized investment gains (losses) for the years ended December 31, 2003, 2002 and 2001 follows (in thousands):
The fixed income securities’ unrealized depreciation principally relates to U.S. government securities and results from the current interest rate environment. The decline in the value of equity securities relates to three equity holdings and is due to current market conditions and does not result from the financial condition of the underlying entities.
The Company has entered into warrants, which replicate the investment characteristics of investment grade investments. Warrants are contracts that grant the holder the right to purchase an underlying financial instrument at a given price and time or at a series of prices and times. Warrants are marked to market with the related changes in market value recognized in net investment income. On disposition, any gain or loss is
recognized in income. At December 31, 2003, the notional amount and statement value of the warrants were $180.6 million and $5.3 million, respectively.
Counter-parties to the warrants and the credit default swaps expose the Company to credit related losses in the event of non-performance. The Company believes this risk is low given the counter-parties high credit ratings. The credit risk exposure is represented by the fair value of the warrants at the statement date and the floating rate payment amount for the credit default swaps.
Fixed income securities carried at $498.2 million as of December 31, 2003 were on deposit with various regulatory authorities to comply with insurance laws.
Common stocks, at equity as of December 31, 2003, include the Company’s investments in TRG Holding Corporation (27.5% owned by Fairfax and its affiliates, including 13.0% owned by the Company), Advent Capital (Holdings) PLC (46.8% owned by Fairfax and its affiliates, including 15.0% owned by the Company), MFXchange Ireland Ltd. (“MFX”) (100.0% owned by Fairfax and its subsidiaries, including 7.4% owned by the Company) and Hub International Limited (26.2% owned by Fairfax and its affiliates, including 13.6% owned by the Company). Zenith National Insurance Corporation (“Zenith”) (42.1% owned by Fairfax and its affiliates, including 6.5% owned by the Company) is included in common stocks and carried at fair value because Fairfax entered into agreements which eliminates any voting or other direct or indirect control by Fairfax and its affiliates over the operations of Zenith.
The Company has established a reserve for potentially uncollectible reinsurance recoverables. The reserve is based upon an evaluation of each retrocessionaire and estimates related to collectibility of individual balances. The reserve as of December 31, 2003 and 2002 was $28.5 million and $27.0 million, respectively, and has been netted against reinsurance recoverables on loss payments. The Company has also established a reserve for potentially uncollectible assumed reinsurance balances of $5.8 million as of December 31, 2003 and 2002, which has been netted against reinsurance balances receivable.
Clearwater is the beneficiary of a stop loss reinsurance agreement with nSpire Re Limited (“nSpire”), a wholly owned subsidiary of Fairfax (the “1995 Stop Loss Agreement”). Pursuant to the agreement, Clearwater ceded premium of $60.5 million for an aggregate limit of $175.0 million in excess of its December 31, 1995 reserves for unpaid losses and allocated loss adjustment expenses and potentially uncollectible reinsurance recoverables. Ceded losses and loss adjustment expenses incurred for the years ended December 31, 2003, 2002 and 2001 of $17.5 million, $17.5 million and $19.0 million, respectively, related to the stop loss agreement are included in the accompanying statements of operations and note 6. Reinsurance recoverables on paid and unpaid losses related to this agreement of $140.0 million and $122.5 million as of December 31, 2003 and 2002, respectively, are reflected in the accompanying balance sheets and are secured by letters of credit or cash.
Odyssey America has purchased whole account stop loss retrocessional protection related to its 1994 and 1996 through 2003 results. The contracts provide loss recovery in excess of a contractual ratio of incurred losses and acquisition costs as a percentage of earned premiums.
Investment management agreements with Hamblin Watsa Investment Counsel Ltd. (“Hamblin Watsa”), a wholly owned subsidiary of Fairfax, and administrative agreements with Fairfax have been entered into between the Company and its subsidiaries with respect to their investment portfolios. Pursuant to the agreements, basic, administrative and incentive fees, based upon total invested assets and realized gains, are paid to Hamblin Watsa and Fairfax. For the years ended December 31, 2003, 2002 and 2001, $13.3 million, $6.3 million and $5.9 million, respectively, of such fees are included in the consolidated statements of operations. In addition, for the year ended December 31, 2003, the Company paid $1.0 million of intranet fees to MFX.
Included in the consolidated balance sheets are amounts receivable related to expense sharing arrangements with affiliates of $1.1 million and $0.7 million as of December 31, 2003 and 2002, respectively, and payable to affiliates of $1.3 million and $5.3 million as of December 31, 2003 and 2002 respectively.
The 2003 and 2002 diluted earnings per common share assumes that 10,000 and 446,750, respectively of the Company’s stock options granted under the Odyssey Re Holdings Corp. 2002 Stock Incentive Plan would not be exercised as of December 31, 2003 and 2002, respectively. The 2003 and 2002 diluted earnings per share does not reflect the conversion of the Company’s convertible debentures into common stock of the Company because, under the terms of the indenture under which the convertible debentures were issued, the convertible debentures were not convertible as of December 31, 2003 and 2002.
The accumulated benefit obligation for the Plan is $29,038 and $24,510, as of December 31, 2003 and 2002, respectively.
The Company also maintains non-qualified excess benefit plans that provide officers and certain employees with defined retirement benefits in excess of qualified plan limits imposed by federal tax law. The following tables set forth the amounts recognized in the Company’s consolidated financial statements as of December 31, 2003 and 2002 (in thousands):
The Company also maintains a defined contribution profit sharing plan for all eligible employees. Each year, the Board of Directors may authorize payment of an amount equal to a percentage of each participant’s basic annual earnings based on the experience of the Company for that year. These amounts are credited to the employee’s account maintained by a third party, which has contracted to provide benefits under the plan. No contributions were made in 2003 and 2002.
The weighted average fair value of each option granted is estimated on the date of grant using the Black Scholes Price Model with the following weighted average assumptions used for grants: expected volatility of 31.0% and 30.0% for the years ended December 31, 2003 and 2002, respectively; risk-free interest rates ranging from 2.4% to 5.1%; annual dividend yield of 0.6%; and expected lives of five years for each grant for each of the years ended December 31, 2003 and 2002.
The following table summarizes the options outstanding and options exercisable as of December 31, 2003 (dollars in thousands):
OdysseyRe provides a compensatory employee stock purchase plan through which all employees who meet the eligibility requirements of the plan have the option to purchase OdysseyRe common stock in an amount up to 10% of their annual base salary. The Company purchases, on the employee’s behalf, OdysseyRe common stock equal to 30% of each employee’s contribution. In the event that OdysseyRe meets certain financial objectives, additional shares are purchased for the employee’s benefit. The expense related to this plan for the year ended December 31, 2003, 2002 and 2001 was $0.3 million, $0.2 million and $0.1 million, respectively.
During 2001, the Company adopted the Odyssey Re Holdings Corp. Stock Option Plan which provides for the grant of stock options to directors and key employees of the Company. Under the plan, such options will generally vest and become exercisable in two equal installments beginning on the fifth and tenth anniversary of the date of grant. As of December 31, 2003 and 2002, respectively, 52,654 and 56,531 options were issued with an exercise price of zero. The Company has reflected $0.2 million and $0.4 million of expense for the years ended December 31, 2003 and 2002, respectively, which represents the vested portion of the stock options.
OdysseyRe and its United States subsidiaries filed a consolidated federal income tax return from June 20, 2001 through March 3, 2003. For periods prior to June 20, 2001 and subsequent to March 3, 2003, OdysseyRe and its subsidiaries filed consolidated federal income tax returns with Fairfax, Inc. and its subsidiaries. For financial statement purposes, taxes are determined on a separate company basis. As of December 31, 2001, the Company had a net operating loss carryforward of $186.3 million, which was fully utilized during 2002.
and $142.7 million in a deposit trust account in London. The letter of credit and deposit trust account effectively secure the future contingent obligations of UK Holdings should the Lloyd’s underwriting syndicate in which Odyssey America participates incur net losses. Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the letter of credit and the deposit trust account.
Odyssey America provided quota share reinsurance to Gulf Insurance Company (“Gulf”) from January 1, 1996 to December 31, 2002, on a book of automobile residual value business. In March 2003, Gulf requested a payment of approximately $30 million, including a “special payment” of $26 million, due on April 28, 2003, representing Odyssey America’s purported share of a settlement (“Settlement”) between Gulf and one of the insureds whose policies, Gulf contends, were reinsured under the Residual Value Quota Share Reinsurance Agreements (the “Treaties”).
In May 2003, Gulf initiated litigation against two other reinsurers that participated with Odyssey America on the Treaties, demanding payment relating to the Settlement. In late July, Gulf added Odyssey America to its complaint against the other reinsurers. Odyssey and the other reinsurers have answered the complaint and discovery has commenced. Among other things, Odyssey America contends that, (i) Gulf breached its duty to Odyssey America of utmost good faith when it placed the Treaties by failing to disclose material information
Odyssey America intends to vigorously assert its claims and defend itself against any claims asserted by Gulf. At this early stage, it is not possible to make any determination regarding the likely outcome of this matter.
In January 2004, two retrocessionaires under common control of London Reinsurance Group Inc. (each, a “retrocessionaire”; together, “London Life”) filed a demand for arbitration seeking to resolve a dispute arising under a series of aggregate stop-loss retrocession agreements covering the years 1994 and 1996 to 2001 pursuant to which they participated and provided a layer of retrocession protection for Odyssey America in excess of a predetermined loss ratio and subject to a limit.
Among other things, London Life seeks a determination of its liability under the retrocession agreements. Odyssey America will seek enforcement of the retrocession agreements and confirmation of the liability of London Life pursuant to such agreements. As of this date, the arbitration panel has not yet been duly constituted.
Odyssey America finds London Life’s claims to be without merit and intends to vigorously pursue the arbitration. Odyssey America expects the arbitration panel to enforce the contracts in Odyssey America’s favor.
The following is the consolidated statutory basis net income (loss) and policyholders’ surplus of Odyssey America and its subsidiaries, for the years ended and as of December 31, 2003, 2002 and 2001 (in thousands):
The Company’s assumed financial guarantee reinsurance exposure to loss, in the event of nonperformance by the underlying insured and assuming underlying collateral proved to be of no value, was $74.7 million and $107.0 million as of December 31, 2003 and 2002, respectively. It is the responsibility of the ceding insurer to collect and maintain collateral under financial guarantee reinsurance.
As of December 31, 2003, such reinsurance inforce had a remaining maturity term of 1 to 33 years. The approximate distribution of the estimated debt service (principal and interest) of bonds, by type and unearned premiums, for 2003 and 2002 follows (in millions):
The prior years’ changes in loss estimates recognized in calendar years 2003, 2002 and 2001 are $116.9 million, $66.0 million, and $23.1 million, respectively. Higher loss estimates on United States casualty business for accident years 1997 through 2000 are principally causing the increase on prior years’ loss estimates in each of the calendar years. The classes of business contributing most to the change in loss estimates include directors and officers, errors and omissions and medical malpractice liability. The casualty insurance loss development patterns for these years were not consistent with prior periods due to the very competitive environment impacting coverage terms and conditions. This led to the cumulative deficiencies noted.
The Company uses tabular reserving for workers’ compensation indemnity reserves and discounts such reserves using an interest rate of 3.5%. Losses have been discounted using the Life Table for Total Population: United States, 1979 - 1981. Reserves reported at present value were approximately $78.0 million and $73.5 million as of December 31, 2003 and 2002, respectively. The amount of case reserve discount was $48.3 million and $37.7 million as of December 31, 2003 and 2002, respectively. The amount of incurred but not reported reserve discount was $18.4 million and $23.7 million as of December 31, 2003 and 2002, respectively.
The Company has exposure to asbestos and environmental pollution claims. Exposure arises from reinsurance contracts under which the Company has assumed liabilities, on an indemnity or assumption basis, from ceding companies primarily in connection with general liability insurance policies issued by such cedants. The Company’s estimate of its ultimate liability for such exposures includes case basis reserves and a provision for liabilities incurred but not reported. Case basis reserves are a combination of reserves reported to the Company by ceding companies and additional case reserves determined by the Company’s dedicated asbestos and environmental claims unit based on claims audits of cedants. The provision for liabilities incurred but not reported is established based on various methods such as loss development, market share and frequency and severity.
OdysseyRe’s 7.49% senior notes are subject to certain covenants, none of which significantly restricts the Company’s operating activities or dividend-paying ability. As of December 31, 2003, the Company was in compliance with all covenants.
division operates through two distribution channels, Newline at Lloyd’s, where the business focus is casualty insurance, and our London branch, where the business focus is worldwide property and casualty reinsurance.
The financial results of these divisions for the years ended December 31, 2003, 2002 and 2001 are as follows (in thousands):
A portion of the gross premiums written by the U.S. Insurance division has been ceded to, and is also included in, the Americas division’s gross premiums written. Accordingly, the total gross premiums written as shown in the table above does not agree to the gross premiums written of $2,558.2 million,
$1,894.5 million and $1,153.6 million for the years ended December 31, 2003, 2002 and 2001, respectively, reflected in the consolidated statements of operations.