The earnings per share amounts have been restated to comply with the newly adopted accounting standard, "Earnings Per Share."
Despite soft market conditions, Trenwick has taken advantage of both the availability of capital in the financial markets and new opportunities in the business. Trenwick has raised additional capital for its reinsurance operation to increase its capacity for underwriting risks and to position the Company to take advantage of market opportunities. Over the past several years, Trenwick has implemented several strategic initiatives which have enabled it to write new business during the current soft market. Until 1997, this has resulted in an overall increase in premium writings. These initiatives included increased participation in renewal business through increased marketing efforts as reinsurance buyers consolidated their business within a smaller number of higher quality reinsurers, such as Trenwick. Growth was further augmented by hiring a team of senior underwriters in 1995. Trenwick also initiated several strategic alliances as an entry into lines of business not then written by the Company. Partners in these alliances include PXRE Re, a leader in property catastrophe reinsurance, Transatlantic Re, a leading reinsurer in healthcare professional liability and Duncanson & Holt (a wholly-owned subsidiary of
In 1997, Trenwick reported net premiums written of $195.2 million, a 14% decrease compared to 1996. This compares to a 15% increase in premiums written in 1996 over 1995. The decline in premium volume is due to Trenwick's decision not to participate in the continuing downward spiral of rates in the U.S. property/casualty reinsurance market. This decline is magnified by Trenwick's decision to buy more reinsurance protection in 1997 in light of the continued general deterioration in reinsurance pricing and the opportunity to buy additional protection at more favorable terms than in prior years. Trenwick's net casualty premium writings declined 12% as a result of three principal causes. Competition among primary companies has caused cedants to reduce their own premium writings or restructure their reinsurance programs, reducing the amount of reinsurance they purchase. As a result of consolidation within the industry, many ceding companies are now larger and financially stronger, enabling them to retain more risk. In addition, increasingly intense competition in the reinsurance markets has driven reinsurance prices on a number of accounts below pricing levels which the Company will accept.
New casualty business on a gross basis increased 8% for the year ended December 31, 1997 over the same period in 1996 and represented approximately 35% of total premium writings during the period. Continuing casualty business on a gross basis increased 2% for the year ended December 31, 1997 over the same period in 1996 and represented 55% of the total premium writings during the period.
The combined ratio is one means of measuring the profitability of a property and casualty reinsurance company. The combined ratio reflects underwriting experience, but does not reflect income from investments or provisions for income taxes. A combined ratio below 100% indicates profitable underwriting, and a combined ratio exceeding 100% indicates unprofitable underwriting. Although a reinsurer may have unprofitable underwriting results, the reinsurer may still be profitable because of investment income earned on its accumulated invested assets. In 1997, 1996 and 1995, Trenwick recorded an underwriting profit of $6.6 million, $8.8 million and $7.7 million, respectively.
The most significant underwriting cost affecting a reinsurance company's underwriting result is represented by its claims and claims expense ratio, which is the ratio of incurred claims and claims adjustment expenses to net earned premiums. The claims and claims expense ratio is a function of estimates of claims associated with business written in the current period and changes in estimates of claims on business written in prior periods.
As indicated in the preceding table, Trenwick's claims and claims expense ratio has improved since 1995, reflecting the lack of any material adverse impact from property catastrophe claims and favorable development of prior year reserves for claims and claims expense. Trenwick's property premium writings, including catastrophe business associated with PXRE Re, amounted to $22.3 million, $29.8 million and $32.2 million in 1997, 1996 and 1995, respectively. In 1997, 1996 and 1995, estimates of prior accident year claims were reduced by approximately $5.4 million, $4.4 million and $2.1 million, respectively. The reduction in 1997 is primarily due to favorable development in accident years 1990 and prior, partially offset by unfavorable development in accident years 1991 through 1993.
Trenwick's expense ratio, which is the ratio of policy acquisition costs and underwriting expenses to net earned premiums as determined in accordance with GAAP, increased in 1997 to 38.9% as compared to 34.5% in 1996 and 31.9% in 1995. Policy acquisition costs, which include brokerage and ceding commissions, vary directly with premium volume and are subject to changes in the mix of business. Trenwick writes business on both an excess of loss and quota share basis. Quota share business generally carries higher ceding commissions than excess of loss business. In 1997, quota share business
Trenwick America Re's statutory combined ratios for 1997, 1996 and 1995, provided in the preceding table, were 6.8, 8.1 and 15.6 percentage points better, respectively, than the weighted average statutory combined ratios for all reinsurance companies which reported their results to the RAA in those periods. The statutory combined ratios for this group of reinsurance companies in 1997, 1996 and 1995 were 102.7%, 103.8% and 111.1%, respectively. The statutory combined ratios as reported to the RAA by those companies, including Trenwick America Re, which primarily accept business from brokers, for 1997, 1996 and 1995 were 104.6%, 107.6% and 106.9%, respectively.
Included in Trenwick's net income were after-tax realized investment gains of $1.5 million, or $.13 per share, $194,000 or $.02 per share and $239,000 or $.03 per share in 1997, 1996 and 1995, respectively.
Trenwick completed the modification of its internally developed software to be year 2000 compliant during 1996, and is currently in the process of monitoring the compliance of its outside vendors. The total cost of achieving such compliance is not anticipated to have a material impact on Trenwick's financial condition or results of operations.
The Company's investment policy requires that certain debt investments be maintained in an amount equal to the discounted present value of net reinsurance liabilities. The policy also requires that additional debt investments be maintained in an amount equal to approximately 10% of total reserve liabilities to ensure adequate liquidity in the event of a significant change in estimated payments. At December 31, 1997, the debt investments held under this policy had an average maturity of approximately 4.6 years, as compared to approximately 4.5 years estimated for such liabilities.
Cash provided by financing activities increased to $50.6 million compared to cash used for financing activities of $5.3 million in 1996. This increase primarily resulted from funds received from the aforementioned private offering partially offset by the debt redemption.
Under Connecticut insurance laws and regulations, the maximum amount of shareholder dividends or other distributions that Trenwick America Re may declare or pay to Trenwick within any twelve month period, without the permission of the Connecticut Insurance Commissioner, is limited to the greater of 10% of policyholder surplus at December 31 of the preceding year, or 100% of net income excluding realized capital gains, for the twelve month period ending December 31 of the preceding year, both determined in accordance with statutory accounting practices. For the purpose of computing the limitation, carryforward provisions apply with respect to net income realized in the two previous calendar years which has not already been paid out as dividends. The maximum amount of dividends which could be paid by Trenwick America Re in 1998 without regulatory approval would be $84.4 million.
On February 27, 1998, Trenwick completed the acquisition of SOREMA (UK) Limited (renamed Trenwick International Limited) from SOREMA S.A. for cash in the amount of $60.6 million, which approximated book value. Trenwick International Limited is based in London and underwrites specialty treaty and facultative insurance and reinsurance on a worldwide basis. For the year ended December 31, 1997, Trenwick International Limited had gross and net premiums written of approximately $102 million and $70 million, respectively. The acquisition will be accounted for as a purchase and its capital will be doubled to over $125 million. Trenwick believes that the acquisition is an excellent means of diversifying its current business. Trenwick International Limited's experienced team of underwriters specializes in shorter-tail classes of insurance and reinsurance of risks located outside the United States. Trenwick also believes that the acquisition of an established company in the London insurance market provides an opportune platform for further international expansion. Pierre Croizat (former Chief Executive Officer of SOREMA Group), who joined the Company last September to initiate an international expansion plan, will head Trenwick's international operations.
Consolidated Statement of Changes in Stockholders' Equity for the three years ended December 31, 1997................................31
Schedules other than those listed above are omitted since they are either not required or are not applicable or the information required is presented in the consolidated financial statements, including the notes thereto.
To the Board of Directors and Stockholders of Trenwick Group Inc.
The earnings per share amounts prior to 1997 have been restated to comply with the newly adopted accounting standard, "Earnings Per Share".
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements OF and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following is a summary of significant accounting policies.
The consolidated financial statements include the accounts of Trenwick Group Inc. (Trenwick) and its subsidiaries. Trenwick's principal subsidiary, Trenwick America Reinsurance Corporation (Trenwick America Re), underwrites reinsurance.
Trenwick has classified all of its debt and equity securities as "available for sale" and reported them at fair value with net unrealized gains and losses included in stockholders' equity, net of related deferred income taxes. The fair value of debt securities and equity securities is estimated using quoted market prices or broker dealer quotes. Cash equivalents represent investments with maturities at date of purchase of three months or less and are carried at cost which approximates fair value.
Insurance premiums are earned on a pro rata basis over the related contract period, which is generally one year. Unearned premium income represents the portion of premiums applicable to the unexpired portion of premium coverage with renewal dates later than year end. Premiums on contracts are accrued on an estimated basis throughout the term of such contracts. These estimates may change in the near term.
Claims are recorded as incurred so as to match such costs with premiums over the contract periods. The amount provided for unpaid claims consists of any unpaid reported claims and estimates for incurred but not reported claims, net of salvage and subrogation. The estimates for claims incurred but not reported were developed based on Trenwick's historical claims experience and an actuarial evaluation of expected claims experience. Insurance liabilities are based on estimates and the ultimate liability may vary from such estimates. Any adjustments to these estimates are reflected in income when known.
Trenwick grants stock options for a fixed number of common shares to employees and non-employee directors with an exercise price equal to the market value of the shares at the date of grant. The accounting standard, "Accounting for Stock-Based Compensation", supersedes the previous opinion and establishes a fair value based method of accounting for stock-based compensation plans. However, it permits an entity to continue to apply the accounting provisions of the previous opinion and make pro forma disclosures of net income and earnings per share, as if the fair market value based method had been applied. Trenwick continues to account for the stock option grants in accordance with the previous opinion and has included the pro forma disclosures required by the fair value based method in Note 7.
Premises and equipment, including leasehold improvements, are recorded at cost and are amortized or depreciated using the straight-line method over their useful lives, which range from three to ten years.
The issuance costs of the capital securities are being amortized over the term of the junior subordinated debentures.
Debt issuance costs associated with the issuance of convertible debentures were being amortized over the term of the related debt using the interest method. The unamortized costs applicable to debentures converted to common stock were charged to stockholders' equity at the time of conversion.
A new accounting standard, "Reporting Comprehensive Income", which is effective for Trenwick's interim and annual periods beginning after December 15, 1997, establishes standards for reporting and presentation of comprehensive income and its components. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources and includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Adoption of this standard will have no material effect on the earnings of Trenwick.
The fair value and amortized cost of debt securities at December 31 are as follows:
During the twelve months ended December 31, 1997, all investments were income producing. The sources of net investment income for the years ended December 31 are as follows:
The components of the net unrealized appreciation of investments available for sale at December 31 are as follows:
Trenwick's subsidiary, Trenwick America Re, primarily provides reinsurance to insurers of property and casualty risks in the United States. Trenwick America Re generally obtains all of its business through brokers and reinsurance intermediaries which seek its participation on reinsurance being placed for their customers. Trenwick America Re writes treaty and facultative reinsurance both on an excess of loss and quota share basis. In underwriting reinsurance, Trenwick America Re does not target types of clients, classes of business or types of reinsurance. Rather, it selects transactions based upon the quality of the reinsured, the attractiveness of the reinsured's insurance rates and policy conditions and the adequacy of the proposed reinsurance terms.
Trenwick America Re obtained approximately 65% of its gross written premiums from three brokers in 1997 and 62% from three brokers in 1996 and 1995. Trenwick America Re's concentration of business through a small number of sources is consistent with the concentration of the property and casualty broker reinsurance market, in which a majority of the business is written through the top ten largest brokers in the reinsurance industry. Loss of all or a substantial portion of the business provided by these brokers could have a material adverse effect on the business and operations of Trenwick America Re. Trenwick does not believe, however, that the loss of such business would have a long-term adverse effect because of Trenwick's competitive position within the broker reinsurance market and the availability of business from other brokers. In 1997, 1996 and 1995, Trenwick America Re obtained approximately 11%, 11% and 10%; 15%, 12% and 10%; 19%, 11% and 9%, respectively, of its gross written premiums from three ceding companies.
Included in receivables from ceding insurers at December 31, 1997 and 1996 are accrued premiums of approximately $77,115,000 and $59,070,000, respectively, which have estimated payment dates ranging from 1997 to 2002. Premium payment dates are estimated using the anticipated payout pattern of claims which result in the additional premium due from ceding companies. The fair value of the accrued premiums for 1997 and 1996 is approximately $74,739,000 and $57,300,000, respectively, which is estimated using cash flows discounted at an interest rate of 5%.
The effects of reinsurance on premiums written, premiums earned and claims and claims expenses incurred for the three years ended December 31 are as follows:
The following table presents an analysis of gross and net unpaid claims and claims expenses and a reconciliation of beginning and ending net unpaid claims and claims expense balances for 1997, 1996 and 1995. The gross unpaid claims and claims expense balances at December 31, 1997 and 1996 are reflected in Trenwick's consolidated balance sheet. The net unpaid claims and claims expense balances are stated on a net basis after deductions for reinsurance recoverable on unpaid claims and claims expenses from retrocessionaires.
In 1997, 1996 and 1995, Trenwick recorded decreases of $5,366,000, $4,439,000 and $2,065,000, respectively, in estimates for claims occurring in prior accident years. The reduction in 1997 is primarily due to favorable development in 1990 and prior years, partially offset by unfavorable development in 1991 through 1993.
In 1996, Trenwick commuted an aggregate excess of loss retrocessional agreement covering the years 1989 through 1993 for which Trenwick received a total consideration of $29,700,000 representing outstanding reserves of approximately the same amount. The commutation was recorded in 1996 as a paid loss recovery.
Inflation raises the cost of economic losses and non-economic damages covered by insurance contracts and therefore is a factor in determining effective rates of reinsurance. The methods used by Trenwick to estimate individual case reserves and reserves for claims incurred but not yet reported implicitly incorporate the effects of inflation in the projection of ultimate losses.
Under Trenwick's current interpretation of policy language, management does not believe that it has a material exposure to environmental claims that requires additional reserves beyond its current estimates.
The components of reinsurance recoverable balances, net on the balance sheet at December 31 are as follows:
On January 28, 1997, Trenwick completed a private offering of $110,000,000 in 8.82% Subordinated Capital Income Securities through Trenwick Capital Trust I, a Delaware statutory business trust. Trenwick owns all of the common securities of the trust. Concurrently with the issuance of the capital securities, the trust invested the proceeds of their sale, together with the consideration paid to the trust by Trenwick for the common securities, in Trenwick's junior subordinated debentures, whose terms are similar to those of the capital securities.
In accordance with their terms, the capital securities were subsequently exchanged for fully registered capital securities, which are not subject to restrictions on transfer.
On May 21, 1997, Trenwick's Board of Directors approved a stock repurchase program covering up to 1,000,000 shares of the Company's common stock; no shares have been repurchased to date.
Trenwick called for redemption all $103,500,000 aggregate principal amount of Trenwick's 6% convertible debentures due December 15, 1999, on February 20, 1997, at a redemption price of 102.57% principal amount plus accrued interest to the redemption date. Of the $103,500,000 principal amount of debentures outstanding on that date, $45,819,000 principal amount were redeemed and $57,681,000 principal amount were converted into an aggregate of 1,783,926 shares of Trenwick's common stock.
As a result of the redemption, Trenwick recorded an extraordinary loss of $1,037,000, net of a tax benefit of $558,000.
Trenwick has several plans through which it makes options in common stock available to Trenwick employees at the discretion of the Board of Directors. Non-employee directors receive automatic grants under a separate plan. Exercise prices are generally fixed at the market value at the date of grant. Options vest and are exercisable on various terms, usually either over a five year period or up to a ten year period. All options have an expiration date not exceeding ten years. Total authorized common stock reserved for issuance under all stock benefit plans at December 31, 1997 is 999,362. Transactions under the stock option plans are summarized as follows:
Included in the table on the preceding page are options granted to certain senior officers under the 1993 Stock Option Plan. The exercise and vesting of these options are accelerated if the price of Trenwick's common stock achieves certain specified levels, subject to certain conditions.
The Black-Scholes option valuation model was developed for use in estimating the fair value of options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because Trenwick's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options.
$327,000), which vest over five years. Shares awarded in 1996 and 1995 vest over three to seven years. Shares repurchased in 1997, 1996 and 1995 have been in connection with the satisfaction of employees' withholding taxes payable upon the vesting of previously awarded shares. Trenwick has recognized compensation expense of $543,000, $534,000 and $531,000 for 1997, 1996 and 1995, respectively, determined by the award value of the shares amortized over the applicable vesting period.
During 1997, Trenwick adopted a new stockholder rights plan, replacing the plan adopted in 1989, and redeemed the rights issued under the 1989 plan. Stockholders of record at the close of business on September 24, 1997 received $0.01 for each redeemed right (equivalent to $0.00667 per share) and received one new right for each share of common stock held. The rights are exercisable only if a person or group acquires beneficial ownership of 15% or more of Trenwick's common stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more of Trenwick's common stock. Each right entitles a stockholder to buy 1/200 of a share of Trenwick's Series B Junior Participating Preferred Stock at an exercise price of $125, subject to adjustment. Trenwick has reserved 200,000 shares of such preferred stock for possible issuance under the plan.
Trenwick entered into a new ten-year operating lease agreement for office space as its current operating lease agreement expires on July 15, 1998. Assuming the new operating lease commences on July 16, 1998, Trenwick's minimum non-cancellable office space lease commitments totalling $15,317,000 would be payable as follows: 1998 - $1,094,000; 1999 - $1,419,000; 2000 - $1,419,000; 2001 $1,419,000; 2002 - $1,419,000; thereafter - $8,547,000.
Accounting literature defines the fair value of a financial instrument as the amount at which the OF instrument could be exchanged in a current transaction between willing parties and requires disclosure of fair value information about financial instruments for which it is practicable to estimate that value. In the event that quoted market prices were not available, fair values were based on estimates using discounted cash flow or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of the amount and timing of future cash flows. These fair value estimates may vary in the near term. The following table presents in summary form the carrying amounts and estimated fair values of Trenwick's financial instruments at December 31:
All share and per share information reflects a 3-for-2 stock split, paid on April 15, 1997.
On February 27, 1998, Trenwick completed the acquisition of SOREMA (UK) Limited (renamed Trenwick International Limited) from SOREMA S.A. for cash in the amount of $60,619,000 which approximated book value. Trenwick International Limited is based in London and underwrites specialty treaty and facultative insurance and reinsurance on a worldwide basis. For the year ended December 31, 1997, Trenwick International Limited had gross and net premiums written of approximately $101,811,000 and $70,035,000, respectively. The acquisition will be accounted for as a purchase.