The Company rents space for its principal executive offices under leases which expire up to June 2009. Total rents expense for the years ended December 31 1998, 1997 and 1996 were approximately $9 million, $7 million and $6 million, respectively. In 1997 the Company acquired commercial real estate in Bermuda for the purpose of securing long-term office space to meet its anticipated needs. The Company is in the process of developing this property and constructing its worldwide headquarters. The total cost of this development, including the land, is expected to be approximately $110.0 million, of which approximately $25 million has been spent through December 31, 1998. It is estimated that the development will be completed sometime in 2001.
(1) Net income per share is based on the weighted average number of ordinary shares and ordinary share equivalents outstanding for each period as required by Statement of Financial Accounting Standard No. 128.
(2) All share and per share information has been retroactively restated to give effect to a one for one stock dividend paid to XL shareholders of record on July 26, 1996. Cash dividends per share have not been adjusted for the pooling effect of NAC Re.
(5) Combined ratio is the sum of the loss and loss expense ratio and the underwriting expense ratio. A combined ratio of under 100% indicates an underwriting profit and over 100% indicates an underwriting loss.
The following is a discussion of the Company's results of operations and financial condition. Information presented is the combination of the results formerly presented by XL and NAC Re, as required for a business combination accounted for by the pooling of interests method, which assumes NAC Re had always been a part of the Company. It is also based upon the Company's new fiscal year end of December 31. See note 6 "Business combinations" of the audited Consolidated Financial Statements for further details. The Company's results of operations and financial condition for 1998 are significantly impacted by the acquisition of Mid Ocean in August 1998.
This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and notes thereto presented under
In June 1999, XL received regulatory approval to merge with NAC Re Corp. ("NAC Re"). The merger has been accounted for as a "pooling-of-interests" under U.S. GAAP. Under the pooling of interests accounting it is assumed that XL and NAC Re have been merged from the date of incorporation of XL. Subsequent to the merger agreement, XL amended its financial year from November 30 to December 31 to be the same as NAC Re as a conforming pooling adjustment and to facilitate year end reporting for its subsidiaries. NAC Re is a Delaware corporation that was organized in June 1985 for the purpose of holding all the outstanding shares of common stock of NAC Reinsurance Corporation ("NAC"). NAC is a property and casualty reinsurance company incorporated in New York in 1929. NAC has two primary insurance subsidiaries, Greenwich Insurance Company ("Greenwich") and Indian Harbor Insurance Company ("Indian Harbor"). These companies are licensed to write in all 50 states, the District of Columbia, Puerto Rico and all provinces of Canada. NAC has a reinsurance subsidiary, NAC Reinsurance International Limited ("NAC Re International") based in London, England, which has a branch in Sydney, Australia and a contact office in Madrid, Spain. NAC Re International writes non-U.S. international property and casualty treaty and facultative reinsurance business.
XL Mid Ocean Reinsurance ("XLMORe") is organized under the laws of Bermuda. On August 7, 1998, XLMORe was formed through the merger of X.L Global Reinsurance Company, Ltd ("XLGRe") and Mid Ocean Reinsurance Company Ltd. ("MORe"). XLGRe was formed in November 1997 through the merger of X.L Reinsurance Company, Ltd. ("XLRe") and Global Capital Reinsurance Company Limited ("GCRe") following EXEL's acquisition of GCR Holdings Limited, a Cayman Islands holding company, on June 12, 1997. XLRe commenced operations on December 1, 1995 to write specialty
reinsurance business. MORe and GCRe were organized in 1992 and 1993, respectively, initially to write property catastrophe reinsurance following severe hurricanes which struck the southeastern United States in the late 1980's and early 1990's. XLMORe maintains branches in London, Singapore and a European contact office in Munich.
Denham Syndicate Management Limited was acquired by NAC Re during 1998 and it also provides underwriting and similar services to one corporate syndicate, whose capital is provided by the Company. This syndicate writes a specialized book of international business, concentrating on long-tail casualty and non-marine physical damage.
The Company participates in several joint ventures of strategic importance. In general, the Company has pursued a strategy of entering into joint ventures with organizations which possess expertise in lines of business that the Company wishes to write. The Company's principal joint ventures are in the areas of financial guaranty insurance, life insurance for high net worth individuals, Latin American reinsurance, political risk insurance and currency overlay and related risk management.
In 1996, the Company acquired approximately 30% of Pareto Partners ("Pareto"), a firm which specializes in foreign currency overlay management and related services. At December 31, 1998, Pareto had approximately $26 billion of assets under management. The Company works closely with Pareto to develop new products and ventures.
Premiums written are recorded in accordance with the terms of the underlying policies. Reinsurance premiums assumed are estimated based upon information received from ceding companies and any subsequent differences arising on such estimates are recorded in the period they are determined. Premiums are earned on a monthly pro-rata basis over the period the coverage is provided. Unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of policies in force. Premiums written and unearned premiums are presented after deductions for reinsurance ceded to other insurance companies.
Short-term investments comprise investments with a maturity equal to or greater than 90 days but less than one year.
All investment transactions are recorded on a trade date basis. Realized gains and losses on sales of investments are determined on the basis of average cost or amortized cost. Investment income is recognized when earned and includes interest and dividend income together with the amortization of premium and discount on fixed maturities and short-term investments.
The Company accounts for its other investments on a cost basis as it has no significant influence over these entities. Investments are written down to their realizable value where management considers there is a permanent decrease in value. Income is recorded when received.
Intangible assets recorded in connection with the Company's business combinations are amortized on a straight-line basis over the expected life of the related operations acquired. The Company evaluates the recoverability of its intangible assets whenever changes in circumstances warrant. If it is determined that an impairment exists, the excess of the unamortized balance over the fair value of the intangible asset will be charged to earnings at that time.
Unpaid losses and loss expenses includes reserves for unpaid reported losses and loss expenses and for losses incurred but not reported. The reserve for unpaid reported losses and loss expenses has been established by management in consultation with independent legal counsel and ceding companies, and represents the estimated ultimate cost of events or conditions that have been reported to or specifically identified by the Company. Certain workers' compensation case reserves are considered fixed and determinable and are subject to tabular reserving. Such tabular reserves are discounted using an interest rate of 7%.
The Company recognizes as a component of loss reserves, the loss experience accounts of insurers for policies written on a multi year basis where experience accounts are a percentage of premiums net of related losses paid. Interest is earned on liable amounts and charged to investment income. In the event the insured cancels the policy, the return of the experience account is treated as a commutation if the Company was previously notified of a loss, or as a return premium if there has been no loss notification.
FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Post-retirement Benefits," which is effective for fiscal years beginning after December 15, 1997. This Statement does not change the recognition or measurement of pensions or post-retirement benefit plans, but standardizes disclosure requirements for pensions and other post-retirement benefits. See Note 12 with respect to the Company's retirement plans.
The Company is organized into three main operating segments--insurance, reinsurance, Lloyd's syndicates--and a corporate segment that includes the investment operations of the Company.
Through Greenwich and Indian Harbor, the Company also writes primary program insurance business. The principal lines of business written include certain specialty classes such as auto warranty business and is written primarily through managing general agents and general agents.
LARe, a subsidiary of XLMORe, provides multi-line reinsurance to the Latin American market, emphasizing short-tail, multi-peril property reinsurance and, to a limited extent, casualty, marine, aviation and other lines of reinsurance.
At December 31, 1998, approximately $92 million of securities were on deposit with various U.S. state or government insurance departments in order to comply with insurance regulations.
Through its subsidiaries, the Company has two facilities available for the issuance of letters of credit, which were up to a value of $825 million at December 31, 1998. These facilities are collateralized against the Company's investment portfolio. At December 31, 1998, approximately $348.9 million of letters of credit were issued and outstanding under these facilities.
On November 3, 1998 XL and FSA formed Financial Security Assurance International Ltd. ("FSAI") under the laws of Bermuda. FSAI was capitalized with $100 million, of which FSA and XL contributed 80% and 20% respectively. FSAI will focus on financial guaranty insurance and reinsurance opportunities. As of December 31, 1998 no contracts had been written.
Following the merger, the Company changed its fiscal year end from November 30 to December 31 as a conforming pooling adjustment. No adjustments were necessary to conform NAC Re's accounting policies and certain reclassifications have been made to the NAC Re financial statements to conform to the Company's presentation.
In August 1998, the Company merged with Mid Ocean Limited ("Mid Ocean"). Shareholders of Mid Ocean received 1.0215 Company share for each Mid Ocean share subject to a cash election option which was taken up of $96 million. The merger with Mid Ocean was accounted for as a purchase under U.S. GAAP and as such, results of operations of Mid Ocean are included from August 1, 1998 which was deemed the closing date of the transaction. The total purchase price was $2.2 billion, the fair value of Mid Ocean's net assets not already owned by the Company was $0.9 billion with the balance of $1.3 billion representing goodwill which is being amortized over 40 years. On August 1, 1998 the following items were in the consolidated balance sheet of Mid Ocean:
Cash and cash equivalents totaling $137 million is included in other assets. The net cash acquired as a result of this merger was $41 million.
In June 1997, the Company acquired GCR Holdings Limited ("GCR") in an all cash transaction. The acquisition was accounted for as a purchase under US GAAP, accordingly results of operations of GCR are included from the closing date of the transaction. The total purchase price was $667 million, the fair value of GCR's net assets was $402 million, with the balance of $265 million representing goodwill which is being amortized over 20 years.
Business written by the Company is primarily characterized as low frequency but high severity in nature. This may result in significant volatility in the Company's financial results.
Prior year incurred losses in 1998 were effected mainly by the release of insurance reserves established for the Company's professional lines. These reserves were reduced in accordance with updated actuarially determined reserves. In addition, reserves were released on specialty cover insurance policies for the years 1995 through 1997 due to the absence of losses that would affect the Company's layers. The Company also experienced, in 1998, favorable development of its casualty reinsurance business written in 1996 and 1997. Actuarial assumptions used to establish the liability for losses and loss expenses are periodically adjusted to reflect comparisons to actual loss and loss expense development, inflation and other considerations.
The high level of the 1997 current year incurred losses was primarily due to three new major 1997 casualty indemnity reserves established. Historically, such losses have not emerged this quickly. Should actual loss activity prove to be different these reserves will be adjusted accordingly. The reduction in 1997 prior year losses was due to a release of $317.4 million in reserves that related to prior years in accordance with updated actuarial estimates across all insurance lines.
The Company's net incurred losses and loss expenses includes a provision of $1.2 million, $3.7 million and $1.2 million in 1998, 1997 and 1996 respectively, for estimates of actual and potential non-recoveries from reinsurers. Such charges for non-recoveries relate mainly to reinsurance ceded for casualty business written prior to 1986. Included in unpaid losses and loss expenses at December 31, 1998, 1997 and 1996 is a reserve for potential non-recoveries from reinsurers of $14.5 million, $13.8 million and $12.7 million, respectively.
There are a limited amount of retrocession agreements in place for the Company's short tail reinsurance business assumed. Coverages in place have related to common account reinsurance on proportional contracts written and "high level" property catastrophe excess of loss protection. For the long tail casualty reinsurance business written, several reinsurance policies are in place to limit the Company's retention on any one claim and also for multiple claims arising from two or more risks in a single occurrence or event.
The Company has the following reinsurance balances recorded at December 31, 1998 and 1997:
In late 1995, NAC Re issued $100 million of 7.15% Senior Notes due November 15, 2005 through a public offering at a price of $99.9 million.
NAC Re's $100 million of 5.25% Convertible Subordinated Debentures due December 15, 2002, were issued in December 1992 through a private offering. The Debentures were called in June 1999 and converted to approximately 1.8 million of the Company's shares.
Total pre tax interest expense on the borrowings described above was $33.4 million, $29.6 million and $22.3 million for the years ended December 31, 1998, 1997 and 1996 respectively. Associated with the Company's bank and loan commitments are various loan covenants with which the Company was in compliance.
The Company uses foreign exchange contracts to manage its exposure to the effects of fluctuating foreign currencies on the value of its foreign currency fixed maturities and equity investments on an overlay basis. The fair value of the Company's foreign currency denominated investments as at December 31, 1998 was $36.3 million. These contracts are not designated as specific hedges for financial reporting purposes and, therefore, realized and unrealized gains and losses recognized on them are recorded as a component of net realized gains and losses in the period in which they occur. These contracts generally have maturities of three months or less. In addition, where the Company's investment managers are of the opinion that potential gains exist in a particular currency, then a forward contract will not be entered into. At December 31, 1998, forward foreign exchange contracts with notional principal amounts totaling $322.4 million were outstanding. The fair value of these contracts as at December 31,1998, was $316.2 million with unrealized losses of $6.2 million. Gains of $17.0 million were realized during the year.
The Company attempts to hedge directly the foreign currency exposure of a portion of its foreign currency fixed maturity investments using forward foreign exchange contracts that generally have maturities of three months or less, and which are rolled over to provide continuing coverage for as long as the investments are held. Where an investment is sold, the related foreign exchange sale contract is closed by entering into an offsetting purchase contract. At December 31, 1998, the Company had, as hedges, foreign contracts for the sale of $37.5 million and the purchase of $0.1 million of foreign currencies at fixed rates, primarily New Zealand dollars (42% of net contract value), Norwegian Kroner (34%) and British pounds (11%). The market value of foreign currency fixed maturities held by the Company as at December 31, 1998 was $36.3 million.
the notional principal amounts and the associated market value is the Company's maximum credit exposure.
The Company has committed to invest in several limited partnerships as part of its overall corporate strategy. The primary purpose of these partnerships is to invest capital provided by the partners in various insurance and reinsurance ventures. The Company had invested $33.3 million and $27.2 million as at December 31, 1998 and 1997, respectively, with commitments to invest a further $138.7 million over the next ten years. The Company received income from its investments of $3.6 million and $4.3 million for the years ended December 31, 1998 and 1997, respectively. The Company continually reviews the performance of the partnerships to ensure there is no decrease in the values of its investments. The Company is a limited partner and, as such, does not actively participate in the management of the partnerships.
The Company rents space for its principal executive offices under leases which expire up to 2016. Total rent expense for the years ended December 31, 1998, 1997 and 1996 was approximately $9 million, $7 million and $6 million, respectively. Future minimum rental commitments under existing leases are expected to be approximately $9 million annually. In 1997 the Company acquired commercial real estate in Hamilton, Bermuda for the purpose of securing long-term office space to meet its anticipated needs. The Company is in the process of developing this property and constructing its worldwide headquarters. The total cost of the development, including the land, is expected to be approximately $110 million, of which $25 million has been spent to December 31, 1998. It is estimated that the development will be completed
The authorized share capital is 999,990,000 ordinary shares of a par value of $0.01 each. Holders of Class A shares are entitled to one vote for each share held while class B shares are not entitled to vote. In all other respects, Class A and B shares rank PARI PASSU.
The issuance of Class A shares was in exchange for Mid Ocean Limited shares and Financial Security Assurance Holdings Ltd. shares. The issuance of Class B shares was in exchange for the Mid Ocean Limited Class B and Class C shares.
over the five-year restriction period. Restricted stock issued under the plan totaled 147,836 shares, 91,000 shares and 286,300 shares in 1998, 1997 and 1996, respectively. Restricted stock awards granted by NAC Re prior to the merger amounted to 23,700, 65,300 and 52,700 for the same respective periods. Vesting for such shares generally occur over a six year period.
A second stock plan, intended to replace the directors' "Retirement Plan for Non-Employee Directors", provides for the issuance of share units equal to the amount that would have been credited to the Retirement Plan, divided by the market price of the Company's stock on December 1 of each year. These units receive dividends in the form of additional units equal to the cash value divided by the market price on the payment date. During 1996 the directors could elect to convert to this plan. Stock units totaling 5,531, 6,716 and 14,960 were provided for in 1998, 1997 and 1996 respectively.
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation". Had the Company adopted the accounting provisions of SFAS No. 123, compensation costs would have been determined based on the fair value of
the stock option awards granted in 1998, 1997 and 1996, and net income and earnings per share would have been reduced to the pro-forma amounts indicated below:
* Available for grant includes shares which may be granted on either stock options or restricted stock.
Through XLI and XLMORe in Bermuda, a qualified defined contribution plan exists which is managed externally and whereby employees and the Company contribute a certain percentage of the employee's gross salary into the plan each month. The Company's contribution generally vests over 5 years.
At NAC Re, a qualified non-contributory defined benefit pension plan exists to cover substantially all its U.S. employees, the "NAC Re defined benefit plan". Benefits are based on years of service and compensation, as defined in the plan, during the highest consecutive three years of the employee's last ten years of employment.
NAC Re also maintain a qualified contributory defined contribution plan for substantially all its U.S. employees and a qualified non contributory defined contribution plan for all its U.K. employees.
The balances of each classification, net of deferred taxes, within accumulated other comprehensive income is as follows:
Under the laws of the Cayman Islands, the use of XL's contributed surplus is restricted to the issuance of fully paid shares (i.e. stock dividend or stock split) and the payment of any premium on the redemption of ordinary shares.
The following dividend information relates to the Company without inclusion of the pooling effect with NAC Re:
Brockbank, NAC Re International and XLMORe's London branch office are subject to United Kingdom corporation taxes. Profits of XLMORe's Singapore branch office are subject to Singapore corporation taxes. The German subsidiary of XLMORe is subject to taxation in Germany.
The income tax provision in the consolidated statement of income gives effect to the permanent differences between financial and taxable income as applied for each relevant subsidiary. Due to the fact that the Company and certain subsidiaries are not subject to direct U.S. income taxes and that certain U.S. subsidiaries have tax-exempt income, the Company's effective income tax rate for its U.S. operations is less than the statutory U.S. tax rate.
An analysis of the Company's effective tax rate is as follows:
Significant components of the Company's deferred tax assets and liabilities, which principally relate to US subsidiaries, as of December 31, 1998 and 1997 were as follows:
XLI's and XLMORe's statutory capital and surplus, statutory net income and the minimum statutory capital and surplus required by the Act were as follows:
The primary difference between statutory net income and statutory capital and surplus for the Company's subsidiaries, as shown above, and net income and shareholder's equity presented in accordance with generally accepted accounting principles are deferred acquisition costs.
XLE is permitted to cover risks throughout the European Community (subject to certain restrictions) pursuant to the "Third Directive" relating to non-life insurance. Its head office is in the Republic of Ireland and it is subject to regulation under Irish regulatory authority. The principal legislation and regulations governing the insurance activities of Irish insurance companies are the Insurance Acts 1909 to 1990 (the "Irish Acts") and a comprehensive network of regulations and statutory provisions empowering the making of regulations of which the most relevant are the European Communities (Non-Life Insurance) Regulations, 1976, the European Communities (Non-Life Insurance Accounts) Regulations, 1995, the European Communities (Non-Life Insurance) Framework Regulations, 1994 and related administrative rules (the "Irish Regulations".)
XLE's insurance activities are subject to extensive regulation in the Republic of Ireland, principally under the Irish Acts and Irish Regulations, which impose on insurers headquartered in the Republic of Ireland minimum solvency and reserve standards and auditing and reporting requirements and grant to the Minister for Enterprise and Employment (the"Irish Minister") wide powers to supervise, investigate and intervene in the affairs of such insurers. The Irish Minister's powers and functions are exercised through the medium of the Department of Enterprise and Employment.
Consolidated statutory net income and surplus of NAC Reinsurance Corporation ("NAC"), as reported to the insurance regulatory authorities, differs in certain respects from the amounts as prepared in accordance with GAAP. The main differences between domestic statutory net income and GAAP income relates to deferred acquisition costs and deferred income taxes. The main differences between statutory surplus and shareholders' equity, in addition to deferred acquisition costs and deferred income tax net assets, are intangible assets, unrealized appreciation on investments, and any unauthorized/ authorized reinsurance charges. The following table shows domestic statutory net income and domestic GAAP net income and consolidated statutory surplus and consolidated shareholders' equity of NAC.
Brockbank, via Lloyd's, is a licensed insurer in the states of Illinois, Kentucky and the U.S Virgin Islands ("USVI"). It is also an eligible surplus lines writer in all states other than Kentucky and USVI, and an accredited reinsurer in every state other than Michigan. Brockbank Insurance Services, Inc., is a California licensed surplus and specialty lines broker.
The United Kingdom Financial Services Authority ("UK FSA") regulates reinsurance entities that are "effecting and carrying on" insurance business in the United Kingdom. Both XLMORe, through its London branch and NAC Re through its London subsidiary, "effect and carry on" business in the United Kingdom and are therefore regulated by the UK FSA.
A person would be viewed by Lloyd's as a "major shareholder" of the CCVs if such person owns 15% or more of the Company's outstanding capital stock and as a "controller" if it owns 30% of more of the Company's outstanding capital stock. Therefore, any person that becomes the owner of 15% or more of the Company's stock may be required to deliver a declaration and undertaking to Lloyd's, in the form prescribed by Lloyd's, unless Lloyd's exempts such person from this requirement.
In June 1999, the Company completed the acquisition of Intercargo Corporation ("Intercargo"). Intercargo is headquartered in Schaumburg, Illinois and through its subsidiaries underwrites specialty insurance products for Companies engaged in international trade, including U.S. Customs bonds and marine cargo insurance.
Unaudited condensed pro forma financial information shown below relates to the Company's acquisition of Mid Ocean Limited in August 1998 and is based upon the assumption that Mid Ocean Limited had always been a part of the Company's operations.