(2) For 1998, operating income, the claims/claim expense ratio, the underwriting ratio, the combined ratio and the operating return on average shareholders' equity, as presented, also exclude the impact of an after-tax charge of $40.1 million taken in the fourth quarter of 1998 related to our subsidiary, Stonington. Including the charge related to Stonington, operating income, the claims/claim expense ratio, the underwriting ratio, the combined ratio and the operating return on average shareholders' equity would have been $81.5 million, 55.0%, 29.8%, 84.8% and 12.9%, respectively. Also for 1998, the primary segment information of pre-tax income and the claims/claim expense ratio also excludes the impact of the Stonington charge. Including the charge relating to Stonington, primary segment pre-tax income would have been a loss of $51.4 million and the claims/claim expense ratio would have been 200.0%.
(3) Earnings per common share -- diluted was calculated by dividing net income available to common shareholders by the number of weighted average common shares and common share equivalents outstanding. Common share equivalents are calculated on the basis of the treasury stock method.
(5) Book value per common share was computed by dividing total shareholders' equity by the number of outstanding common shares at year end.
The following is a discussion and analysis of our results of operations for the year ended December 31, 2001 compared with the years ended December 31, 2000, and for the year ended December 31, 1999. The following also includes a discussion of our financial condition at December 31, 2001. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes included in this filing. This filing contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from the results described or implied by these forward-looking statements. See "Note on Forward Looking Statements" and "Risk Factors."
Founded in 1993, RenaissanceRe is one of the leading providers of property catastrophe reinsurance coverage in the world. We believe that we are a provider of first choice for many insurers and reinsurers due to our modeling and technical expertise and our industry-leading performance. We principally provide property catastrophe reinsurance to insurers and reinsurers, with exposures worldwide, on an excess of loss basis. Property catastrophe reinsurance generally provides protection from claims arising from large catastrophes, such as earthquakes, hurricanes, winter storms, freezes, floods, tornadoes, fires, explosions and other man-made or natural disasters. Accordingly, our results depend to a large extent on the frequency and severity of catastrophic events, and the coverage offered to clients impacted by these events.
For the years ended December 31, 2001 and December 31, 2000, our gross premiums written were $501.3 million and $433.0 million, respectively, our net premiums written were $339.5 million and $293.3 million, respectively, our operating income available to common shareholders, which excludes realised gains and losses on investments, was $146.3 million (or $7.03 per common share) and $134.4 million (or $6.86 per common share), respectively, and our net income available to common shareholders was $164.4 million (or $7.90 per common share) and $127.2 million (or $6.50 per common share), respectively. At December 31, 2001, we had total assets of $2.6 billion and total shareholders' equity of $1.2 billion. At December 31, 2001, total shareholders'equity attributable to common shareholders was $1.075 billion and our book value per common share was $47.50, compared with $700.8 million and $35.72 per share at December 31, 2000.
In November 1999, RenaissanceRe incorporated Renaissance Underwriting Managers to act as underwriting manager to these joint ventures. Together, these joint ventures wrote $98.9 million of premium in 2001, compared to $80.2 million in 2000. In total, Top Layer Re and DaVinci had access to approximately $4.3 billion of capital as of December 31, 2001.
In addition to catastrophe reinsurance, we also write certain other lines of reinsurance through Renaissance Reinsurance including aviation, finite, satellite and catastrophe exposed workers compensation coverages. We refer to this business as our "Specialty Reinsurance" business. In 2001, we wrote gross written premiums of $77.5 million of specialty reinsurance, compared with $37.7 million written in 2000.
We also write primary insurance through our four subsidiaries Glencoe Insurance Ltd., DeSoto Insurance Company, DeSoto Prime Insurance Company and Stonington Insurance Company, formerly known as Nobel Insurance Company.
Glencoe, the largest of these subsidiaries, primarily provides catastrophe exposed primary property coverage on an excess and surplus lines basis. During 2001, Glencoe's gross written premiums were $12.9 million, compared to $5.3 million in 2000.
Stonington, a Texas-domiciled insurance company, is licensed to operate in all 50 states of the U.S.
Because we focus on writing reinsurance and insurance which provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the coverage we offer to clients impacted by these events.
For most insurance and reinsurance companies, the most significant judgment made by management is the estimation of the claims and claim expense reserves. Because of the variability and uncertainty associated with loss estimation, it is possible that our individual case reserves for each catastrophic event are incorrect, possibly materially. The period of time from the reporting of a loss to us through the settlement of our liability may be several years. During this period, additional facts and trends will be revealed and as these factors become apparent, reserves will be adjusted. Therefore, changes to our prior year loss reserves can impact our current underwriting results by 1) improving our results if the prior year reserves prove to be redundant, or 2) reducing our results if the prior year reserves prove to be insufficient. The impact on net income from changes in prior years loss reserves was an increase of $16.0 million during 2001, a decrease of $8.4 million during 2000 and an increase of $34.6 million in 1999.
To reduce the potential impact from prior period reserve adjustments, we estimate our claims and claim expense reserves based on 1) claims reports from insureds, 2) our underwriters' experience in setting claims reserves, 3) the use of computer models where applicable and 4) historical industry claims experience. Where necessary we will also use statistical and actuarial methods to estimate ultimate expected claims and claim expenses. We review our reserves on a regular basis.
Other material judgments made by us are the estimates of potential impairments in asset valuations, particularly: 1) Potential uncollectable reinsurance recoverables; and 2) Impairments in our deferred tax asset.
The following is a discussion and analysis of our results of operations for the year ended December 31, 2001, compared to each of the years ended December 31, 2000, and 1999, and a discussion of our financial condition at December 31, 2001.
Year ended December 31, 2001 2000 1999 - -------------------------------------------------------------------------------- (In thousands)
Property Catastrophe Reinsurance $ 373,896 $ 345,086 $ 279,605 Specialty Reinsurance 77,468 37,730 2,740 - -------------------------------------------------------------------------------- Total Reinsurance $ 451,364 $ 382,816 $ 282,345 - -------------------------------------------------------------------------------- Insurance premiums Glencoe 12,858 5,273 4,986 Insurance premiums other 37,099 44,913 63,974 - -------------------------------------------------------------------------------- Total Insurance premiums 49,957 50,186 68,960 - -------------------------------------------------------------------------------- Total gross written premiums $ 501,321 $ 433,002 $ 351,305 - --------------------------------------------------------------------------------
The increase in our property catastrophe premiums over the past two years is primarily due to an improving market following the worldwide level of losses occurring in 1999. During 1999, insured losses from natural catastrophes and man-made disasters are estimated to be over $33 billion which, before the World Trade Center disaster in 2001, was the second-highest claims total ever for insurers. During 1999, nine significant worldwide catastrophic events occurred: the hail storms in Sydney, Australia in April; the Oklahoma tornados in May; Hurricane Floyd which struck in September; Typhoon Bart which struck Japan in September; Turkish and Taiwanese earthquakes in August and September, respectively; and the Danish windstorm, Anatol, and the French windstorms, Lothar and Martin, in December. Six of these events each resulted in over $1 billion of insured damages.
Because of these events, as with many large losses, two things occurred 1) many reinsurers recorded significant losses and were forced to, or chose to, withdraw their underwriting capacity from these regions, and 2) these losses raised the awareness of the severity of the losses which could impact these geographic locations. As a result of these factors, prices for reinsurance coverages in these and other geographic locations increased, in some cases significantly. Accordingly, our reinsurance premiums also increased, first from the increased prices on renewing policies and secondly by enabling us to write new business which was previously priced at an uneconomical rate of return.
Our property catastrophe premiums also increased as a result of reinstatement premiums we received relating to these large losses. Per contractual terms, we record reinstatement premiums after an insured notifies us of a claim. Reinstatement premiums allow an insured to purchase, or reinstate, the limit of their reinsurance policy for the remainder of the policy period. Because of the increased level of claims from the 1999 events, and more recently from the 2001 World Trade Center disaster, our reinstatement and adjustment premiums for the years ended December 31, 2001, 2000 and 1999 were $35.3 million, $20.3 million and $6.8 million, respectively.
Over the past couple of years, we have reduced the amount of insurance premiums written by our other primary insurance companies because of the limited profitable opportunities in the U.S. primary insurance markets. During 2001, Stonington accounted for the majority of the premiums written, $25.9 million, the substantial majority of which was reinsured.
Reinsurance $ 124,684 $ 94,875 $ 77,153 Primary 37,090 44,824 60,639 - -------------------------------------------------------------------------------- Total $ 161,774 $ 139,699 $ 137,792 - --------------------------------------------------------------------------------
Because of the potential volatility of the property catastrophe reinsurance business, we purchase reinsurance to reduce our exposure to large losses. We utilize our REMS(C) modeling system to evaluate how each purchase interacts with our portfolio of reinsurance contracts we write, and with the other ceded reinsurance contracts we purchase. During 2001 and 2000, we increased our purchases of reinsurance because we received a number of new opportunities to purchase reinsurance at economical rates of return.
Also, we have recently begun buying quota share protection of our property catastrophe reinsurance business. These policies are similar to our joint venture activities, where we receive an override and a profit commission on these cessions.
Our claims and claim expenses, claims and claim expenses ratio, and our combined ratio for the reinsurance operations have increased primarily as a result of an increase in our specialty reinsurance premiums, which normally will produce a higher claims and claim expense and combined ratio than our principal product, property catastrophe reinsurance. Our claims and claim expenses for 2001 also increased as a result of our claims and claim expenses from the World Trade Center tragedy.
Although industry wide insurance losses were the highest in history during 2001 and were the third highest in history in 1999, we recorded increases in net income, cash flows from operations, earnings per share and book value per share. We attribute this outstanding performance to our disciplined underwriting approach, the experience of our underwriters, as well as our sophisticated risk models.
Because we primarily provide reinsurance coverage for damages resulting from natural and man-made catastrophes, it is possible that we could become liable for a significant amount of losses on a short-term notice. Accordingly we have structured our investment portfolio to preserve capital and provide us with a high level of liquidity, which means that the large majority of our investment portfolio contains investments in fixed income securities, such as U.S. Government bonds, corporate bonds and mortgage backed and asset backed securities.
As a result of the declining interest rate environment during 2001, the average yield on our portfolio fell from 6.8% as of December 31, 2000 to 4.2% as of December 31, 2001. Accordingly, as yields on our portfolio decrease, our interest income will also decrease, as was the case during 2001. Partially offsetting this decrease was the significant growth in assets during the year, which was primarily due to our capital raising activities of issuing $150 million of Senior Notes in July 2001, issuing 2.5 million Common Shares for $233 million in net proceeds in October 2001 and issuing, $150 million of Series A Preference Shares in November 2001. At December 31, 2001, we had an unusually large allocation to cash, which resulted from our decision to wait to invest the proceeds of these capital transactions until we perceived more favorable market conditions. In the short term this large cash allocation has depressed our investment returns.
Corporate expenses are incurred by us in running our non-underwriting operations include expenses related to legal and certain consulting expenses, costs for research and development, and other miscellaneous costs associated with operating as a publicly traded company. The majority of the increase in corporate expenses during 2001 primarily related to costs related to research and development initiatives conducted by us in 2001.
During 2001, our total fixed charges decreased as a result of our repayment of $200 million of borrowings under our revolving credit and term loan agreement in the fourth quarter of 2000. Since the majority of these funds were borrowed in August 1999, and due to the rising interest rates during 1999 and 2000, this caused interest expense on our debt to increase in 2000 over interest expense in 1999.
As a result of our issuance during 2001 of the Senior Notes and the Preference Shares, we expect our fixed charges to increase in 2002 compared to 2001.
In 1998, in conjunction with charges we recorded relating to our purchase and subsequent decision to significantly reduce the operations of Stonington, we recorded a deferred tax asset of $22 million. This deferred tax asset relates primarily to net operating loss carryforwards that are available to offset future taxes payable of our U.S. operating subsidiaries. However, due to the limited opportunities in the U.S. primary insurance market, the U.S. insurance operations have not generated taxable income in the last few years. This calls into question the recoverability of the deferred tax asset. Although we retain the benefit of this asset through 2020, during 2001 and during 2000 we recorded increases in our valuation allowances of $14.0 million and $8.2 million, respectively. As of December 31, 2001, the net balance of the deferred tax asset was $4.2 million.
During 2001, net realized gains on sales of investments were $18.1 million, compared to net realized losses of $7.2 million in 2000. As noted above, because our portfolio is structured to preserve capital and provide us with a high level of liquidity, our gains and losses on investments will be highly correlated to fluctuations in interest rates. Accordingly as interest rates decline, we will tend to have realized gains from the turnover of our portfolio, and as interest rates increase, we will tend to have realized losses from the turnover of our portfolio.
We have generated cash flows from operations in 2001 and in 2000 significantly in excess of our operating commitments. To the extent that capital is not utilized in our reinsurance business, we will consider using such capital to invest in new opportunities.
The table below sets forth our gross and net claims and claim expense reserves for the previous eight years, compared with the balance of our shareholders' equity. Percentage Gross Net Shareholders' of Equity At December 31, Reserves Reserves Equity Gross Net - -------------- -------- -------- ------------- -------------
The above information further reflects how our gross reserves, as a percentage of equity, can fluctuate based on the occurrence of significant loss events. For instance in 1999, our gross reserves, and our gross reserves as a percentage of equity increased sharply, due to the nine significant loss events occurring in 1999, many of which occurred in the last four months of the year (see discussion of Premiums above for a discussion of these events). However, as also can be seen from the data above, because of our ability to purchase reasonably priced reinsurance, historically our net reserves as a percentage of equity have shown much less variation from year to year.
We generally expect that the majority of our losses from large catastrophic events will be paid in a two to four year time frame. However, the event causing the loss, the locations of the loss, and whether our losses are from policies with insurers or reinsurers, can affect the time period in which our claims will be paid. For instance, losses occurring in the U.S., tend to pay more quickly than those losses occurring in other parts of the world. This trend is reflected in the current balance of our reserves, whereby seven of the nine events occurring in 1999, occurred outside of the U.S., and accordingly, our claim payments on these losses have tended to pay slower than those on events occurring in the U.S. Also, the 1999 events impacted claims payments in 2000 and 2001 to a greater extent than normal because most of the 1999 events occurred late in the year, including the most severe events, which were the European storms in December.
For illustrative purposes, the table below sets forth our claim payments and claim developments for the 1999 Accident Year for our Reinsurance segment through December 31, 2001:
For our insurance and reinsurance operations, our estimates of claims reserves are based on 1) claims reports from insureds, 2) our underwriters' experience in setting claims reserves, 3) the use of computer models where applicable and 4) historical industry claims experience. Where necessary we will also use statistical and actuarial methods to estimate ultimate expected claims and claim expenses. We review our reserves on a regular basis.
Common shareholders' equity $ 1,075,024 $ 700,818 Series A preference shares 150,000 - -------------------------------------------------------------------------------- Total shareholders' equity 1,225,024 700,818
7.00% senior notes 150,000 - 8.54% capital securities 87,630 87,630 Revolving credit facility - unborrowed 310,000 302,000 Revolving credit facility - borrowed - 8,000 Term and revolving loan facility 33,500 42,000 - --------------------------------------------------------------------------------
As is customary in our industry, a portion of our reinsurance policies provide our clients with the right to cancel or not renew our policies in the event our claims paying ratings are downgraded. In some instances the downgrade must be to a rating several levels below our current rating; in others, the trigger level is somewhat higher; and in others it is only one or two levels below our current rating. Many of our policies do not contain a provision of this type. Moreover, we cannot precisely estimate the amount of premium that is at risk, as this amount depends on the particular facts and circumstances at the time, including the degree of the downgrade, the time elapsed on the impacted in-force policies, and the effects of any related catastrophic event on the industry generally. In the event any of these provisions are triggered, we will vigorously seek to retain our clients and do not anticipate that a material amount of premium would be cancelled or nonrenewed. However, we can not assure you that our premiums would not decline, perhaps materially, following a ratings downgrade.
During 2001, as a result of the World Trade Center disaster, two results occurred in the reinsurance market. First, reinsurers recorded significant losses and were forced to, or chose to, withdraw their underwriting capacity for certain lines of reinsurance. Second, these losses raised the awareness of the severity of the losses which could occur. These factors caused an imbalance in the supply of and demand for reinsurance and, as a result, prices escalated for many segments of the reinsurance market. These imbalances provided us with an opportunity to increase our penetration of the property catastrophe reinsurance market, as well as provided us with opportunities to grow other areas of our operations, specifically our Specialty Reinsurance operations and our commercial property insurance operations written through Glencoe Insurance.
Also, in conjunction with market opportunities following the September 11th tragedy, we contributed an additional $135 million of capital to Glencoe, thereby increasing its total capital to greater than $200 million.
We continue to maintain a revolving credit and term loan agreement with a syndicate of commercial banks. During the third quarter of 2001, we repaid borrowings of $16.5 million on this facility and as of December 31, 2001 no amounts were outstanding. In the fourth quarter of 2000 we repaid $200.0 million of the then outstanding balance. Interest rates on the facility are based on a spread above LIBOR and averaged 5.45% during 2001, compared to 7.03% in 2000. Our revolving credit agreement contains certain financial covenants including requirements that consolidated debt to capital does not exceed a ratio of 0.35:1; consolidated net worth must exceed the greater of $100.0 million or 125% of consolidated debt; and 80% of invested assets must be rated BBB- or better. We were in compliance with all the covenants of this revolving credit and term loan agreement at December 31, 2001.
Renaissance U.S. has a $18.5 million term loan and $15.0 million revolving loan facility with a syndicate of commercial banks, each of which is guaranteed by RenaissanceRe. Interest rates on the facility are based upon a spread above LIBOR, and averaged 4.71% during 2001, compared to 6.98% in 2000. The related agreements contain certain financial covenants, including a covenant that RenaissanceRe, as principal guarantor, maintain a ratio of liquid assets to debt service of 4:1. The term loan has mandatory repayment provisions approximating $9 million per year in each of years 2002 and 2003. The loan facility of $15 million is repayable in 2003. During 2001, Renaissance U.S. repaid approximately $8.5 million of this facility. We were in compliance with all the covenants of this term loan and revolving loan facility at December 31, 2001.
Under the terms of certain reinsurance contracts, we may be required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. Our letters of credit are secured by a lien on a portion of our investment portfolio. At December 31, 2001, we had outstanding letters of credit aggregating $125.8 million, compared to $44.9 million in 2000. This increase is primarily related to the losses emanating from the September 11th tragedy. Also, in connection with our Top Layer Re joint venture we have committed $37.5 million of collateral to support a letter of credit.
At December 31, 2001, we held cash and investments totaling $2.2 billion, compared to $1.1 billion in 2000, with net unrealized appreciation of $16.3 million, compared to unrealized appreciation of $6.8 million in 2000.
The table below shows the aggregate amounts of investments available for sale, other investments and cash and cash equivalents comprising our portfolio of invested assets:
The growth in our portfolio of invested assets for the year ended December 31, 2001 resulted primarily from net cash provided by operating activities of $326 million, $233 million raised from the issuance of 2.5 million common shares, $145 million received from the issuance of 6 million Series A Preference Shares, $150 million raised from the issuance of 7% senior notes and $275 million of third party investment in our most recent joint venture, DaVinci Reinsurance. At year end, we had an unusually large allocation to cash, which resulted from our decision to wait to invest the proceeds of these capital transactions until we perceived more favorable market conditions; in the short term, this large cash allocation has depressed our investment returns. Over time, we expect our cash position to return to historical levels.
Our investment portfolio includes investments which are subject to changes in market values with changes in interest rates. The aggregate hypothetical loss generated from an immediate adverse parallel shift in the treasury yield curve of 100 basis points would cause a decrease in total return of 1.9%, which equated to a decrease in market value of approximately $41.0 million on a portfolio valued at $2,156.1 million at December 31, 2001. At December 31, 2000, the decrease in total return would have been 2.7%, which equated to a decrease in market value of approximately $28.4 million on a portfolio valued at $1,052.4 million. The foregoing reflects the use of an immediate time horizon, since this presents the worst-case scenario. Credit spreads are assumed to remain constant in these hypothetical examples.
The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The anticipated effects on us are considered in our catastrophe loss models. The effects of inflation are also considered in pricing and in estimating reserves for unpaid claims and claim expenses. The actual effects of inflation on our results cannot be accurately known until claims are ultimately settled.
Effective January 1, 2002 we implemented SFAS No. 142, "Goodwill and Other Intangible Assets." In accordance with SFAS 133, goodwill and other intangible assets are no longer being amortized but are reviewed periodically for impairment. The adoption of SFAS 142 had no significant impact on our consolidated financial statements.
In addition, we are anticipating that we will expand our presence in the specialty reinsurance coverages, which by our definition are coverages that are not specifically property catastrophe reinsurance coverages. In evaluating opportunities in the specialty reinsurance market, we focus on those coverages which, like property catastrophe reinsurance, produce losses that are infrequent in nature, but could be severe if they occur. Examples include aviation, satellite, finite and catastrophe exposed workers compensation coverages.
We also anticipate that we will increase the premiums written by our Bermuda based primary insurance company, Glencoe. Glencoe, which primarily provides catastrophe exposed primary property coverage on an excess and surplus lines basis, wrote $12.9 million of gross written premiums in 2001.
Subsequent to the World Trade Center tragedy, a substantial amount of capital has entered the insurance and reinsurance markets both through investments in established companies and through start-up ventures. The addition of new capital in the marketplace may cause a reduction in prices of reinsurance contracts, or could shorten the time horizon of the price increases for reinsurance contracts. Currently, however, we do not believe that the new capital has resulted in adverse changes to the prevailing pricing structure in the property catastrophe reinsurance market. To the extent that the newly-formed companies or established companies were to reduce the pricing of their products, this could force us to reduce our future underwriting premiums.
Reference is made to Item 14(a) of this Report for the Consolidated Financial Statements of RenaissanceRe and the Notes thereto, as well as the Schedules to the Consolidated Financial Statements.