PROPERTIES Everest Re's corporate offices are located in Newark, New Jersey, and occupy approximately 130,000 square feet of office space under a sublease with The Prudential that expires on December 31, 2004, subject to Everest Re's option to terminate the sublease with no penalty under certain circumstances. On December 3, 1996, Everest Re entered into a new sublease with The Prudential for 112,000 square feet of office space in Liberty Corner, New Jersey. On or about May 1, 1997, Everest Re will move its corporate offices to this new location and will terminate its sublease of the Newark, New Jersey office on a date to coincide with the commencement of rent payments under the sublease for the Liberty Corner, New Jersey office, without any penalties. Everest Re's other eight office locations occupy a total of 57,500 square feet, all of which are leased. Management believes that the above described office space is adequate for its current and anticipated needs.
these non-recurring charges, but should not, however, be considered as an alternative to the respective amounts determined in accordance with GAAP as an indicator of the Company's operating performance.
(2) Catastrophe losses are net of reinsurance. A catastrophe is defined, for purposes of the Selected Consolidated Financial Data, as an event that causes a pre-tax loss before reinsurance of at least $5.0 million and has an event date of January 1, 1988 or later.
(3) Losses with respect to Hurricane Andrew are net of a $100.0 million aggregate excess of loss reinsurance recovery in 1992.
(8) GAAP underwriting expenses as a percentage of GAAP net premiums earned. Including restructuring and early retirement costs, incurred in the fourth quarter of 1994, the Company's GAAP underwriting expense ratio in 1994 was 32.1%.
(9) Statutory results are on a Everest Re legal entity basis; consequently, investments in subsidiary operations are accounted for on an equity basis.
(11) Statutory losses and LAE incurred as a percentage of SAP net premiums earned.
(13) Excluding net unrealized appreciation (depreciation) of investments, stockholder's equity was $1,008.3 million, $899.9 million, $799.1 million, $794.6 million and $675.0 million as of December 31, 1996, 1995, 1994, 1993 and 1992, respectively.
(14) Based on 50.5 million shares outstanding for December 31, 1996, 50.8 million shares outstanding for December 31, 1995 and 50.0 million shares outstanding for December 31, 1994, 1993 and 1992, respectively.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 The following discussion and analysis is focused on a comparison of 1996 results of operations to 1995 results of operations, as adjusted to exclude the IPO-related charges.
REVENUES. Net premiums earned, as adjusted, increased by 9.0% to $973.6 million in 1996 from $893.3 million in 1995, generally consistent with the change in net premiums written.
Underwriting expenses, as adjusted, increased by 7.7% to $309.5 million in 1996 from $287.4 million in 1995. Commission and brokerage expenses increased by $26.1 million attributable primarily to increases in written premium and changes in the Company's business mix. Other underwriting expenses decreased by $4.0 million, as the impact of the significant reduction in employees over the course of 1995 and 1996 and other cost reduction initiatives more than offset the impact of salary and other expense increases that were generally in line with inflation. The Company's expense ratio, as adjusted, decreased by 0.4 points to 31.8% in 1996 from 32.2% in 1995 as the increase of premiums earned more than offset the increases in underwriting expenses.
PREMIUMS. Gross premiums written decreased 0.4% to $949.5 million in 1995 from $953.2 million in 1994. Factors contributing to this decrease included a 12.5% decrease in U.S. direct treaty reinsurance and insurance, where the non-renewal of certain larger contracts, because the ceding companies did not agree to pricing terms that satisfied the Company's revised underwriting guidelines, more than offset the growth of the primary insurance written through Everest National, a subsidiary of the Company, and a 1.9% decrease in U.S. broker treaty premiums resulting from efforts to improve underwriting standards and better control catastrophe exposures. These decreases were partially offset by growth in international premiums (which increased by 3.4%), U.S. facultative premiums (which increased by 3.2%), marine and aviation premiums (which increased by 1.8%) and surety premiums (which increased by 6.0%).
Net premiums written, as adjusted, increased by 6.9% to $923.2 million in 1995 from $863.2 million in 1994, mainly as a result of decreased retrocessional costs.
Net investment income increased 15.6% to $166.0 million in 1995 from $143.6 million in 1994, reflecting both the effect of investing the $397.9 million of cash flow from operating activities, as adjusted, in 1995 and higher yields earned on the investment portfolio. In the fourth quarter of 1993, the Company sold $530.4 million in appreciated bonds to realize capital gains sufficient to offset the impact on statutory surplus of a $30.0 million increase to asbestos and environmental incurred but not reported ("IBNR") reserves in that year (the "1993 Bond Sale"). At year-end 1993 and through most of the first quarter of 1994, a significant portion of the proceeds from the 1993 Bond Sale was held in short-term investments in anticipation of rising interest rates. As a result of the higher than normal amount of short-term investments in 1994, the Company's pre-tax yield on average cash and invested assets improved to 5.7% in 1995 from 5.5% in 1994.
Net realized capital gains were $33.8 million in 1995, principally from the sale of one half of the Company's investment in the common stock of MAPFRE and generally favorable conditions in the U.S. equity securities market. Net realized capital losses were $10.5 million in the year ended December 31, 1994 as sales of securities were limited due to the then declining market value of the Company's fixed maturities.
Company's expense ratio, as adjusted, increased to 32.2% in 1995 from 31.2% in 1994 as the reduction of other underwriting expenses was more than offset by the increase in commission and brokerage expenses.
NET INCOME. Net income, as adjusted, was $100.4 million in 1995 compared to $10.7 million in 1994. This improvement mainly reflected lower catastrophe losses, the absence of adverse development on net asbestos and environmental reserves, lower premiums ceded under the 1995 corporate-level retrocession program, higher investment income, lower operating expenses and realized capital gains.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. Everest Re's asbestos claims typically involve liability or potential liability for bodily injury from exposure to asbestos or liability for property damage resulting from asbestos or asbestos containing materials. Everest Re's environmental claims typically involve potential liability for the mitigation or remediation of environmental contamination or bodily injury or property damages caused by the release of hazardous substances into the land, air or water. In addition to the previously described general uncertainties inherent in estimating reserves, there are significant uncertainties in estimating the amount of Everest Re's potential losses from asbestos and environmental claims. Among the complications are: (i) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (ii) difficulty in identifying sources of asbestos or environmental contamination; (iii) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (iv) changes in underlying laws and judicial interpretation of those laws; (v) potential for an asbestos or environmental claim to involve many insurance providers over many policy periods ; (vi) long reporting delays, both from insureds to insurance companies and ceding companies to reinsurers; (vii) limited historical data concerning asbestos and environmental losses; (viii) questions concerning interpretation and application of insurance and reinsurance coverage; and (ix) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure. Management believes that these issues
- - ---------- (1) Net of $24,196 in 1996 and $16,687 in 1995 ceded under the incurred loss reimbursement feature of the Stop Loss Agreement.
The Company maintains a corporate-level retrocessional protection program, above and beyond retrocessions purchased with respect to specific assumed coverages, to mitigate the potential impact of catastrophe losses. At December 31, the attachment point of this program was $25.0 million per catastrophe in the U.S. and $10.0 million per catastrophe outside the U.S. No losses were ceded under the corporate-level retrocession program during 1996 or 1995. All aspects of the retrocession program have been structured to permit the program to be accounted for as reinsurance under SFAS No. 113.
economic conditions. The availability of such cash flow to Holdings could also be influenced by, among other things, changes in the limitations imposed by the Delaware Code on the payment of dividends by Everest Re. Holdings expects that, absent significant catastrophe losses, such restrictions should not affect Everest Re's ability to declare and pay dividends sufficient to support Holdings' current dividend policy.
During 1996 and 1995, Holdings declared and paid dividends of $6.1 million and $7.0 million, respectively.
TAX CONSOLIDATION WITH THE PRUDENTIAL The Internal Revenue Service ("IRS") has completed its examinations of The Prudential's tax returns for all years through 1992. As those examinations relate to Everest Re, the IRS has disallowed that portion of the fresh start benefit which relates to 1986 reserve strengthening as defined by the IRS. Consistent with case law favorable to taxpayers on the issue, the Company believes that, because there were no changes in reserving assumptions or methodologies between 1985 and 1986, all increases to reserves in 1986 for which a fresh start benefit was taken are normal reserve additions and, therefore, pursuant to the case law, does not constitute reserve strengthening that is not eligible for the fresh start benefit. If the IRS position prevails, the Company will be required to reimburse The Prudential, thereby incurring an additional charge of approximately $8.8 million, including the after-tax cost of interest through December 31, 1996.