We conduct our operations from leased office space located at Cumberland House, 1 Victoria Street, Hamilton, and HM 11, Bermuda. Annuity and Life Re America conducts its operations from leased space located at 280 Trumbull Street, Hartford, Connecticut, USA. We believe our space is adequate to meet our current and expected needs.
With the exception of historical information, the matters contained in the following analysis are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act. Such statements may include, but are not limited to, projections of earnings, revenues, income or loss, capital expenditures, plans for future operations and financing needs or plans, as well as assumptions relating to the foregoing. The words "expect", "project", "estimate", "predict", "anticipate", "believes", and similar expressions are also intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results, performance and achievements could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. We assume no obligation to update any forward-looking statement to reflect actual results or changes in or additions to the factors affecting such forward-looking statements.
Our two major product lines are traditional ordinary life reinsurance and annuity reinsurance. The reinsurance agreements typically remain in force for the life of the underlying policies reinsured, which on average range from ten to thirty years. Each year, a portion of the business under an existing treaty terminates due to among other things, surrenders and/or lapses of underlying policies, deaths of underlying insureds and the exercise of recapture options.
At December 31, 2000 and 1999, our life insurance in force amounted to approximately $77.0 billion and $45.4 billion, respectively. We retrocede portions of certain risks in excess of a predetermined retention amount for which we have accepted liability. At December 31, 2000 and 1999, we ceded approximately $192.6 million and $34.9 million of life insurance coverage, respectively, or 0.25% and 0.08 % of our life insurance in force, respectively.
Net Income. For the year ended December 31, 2000, we had consolidated net income of $39,987,000, which is $1.57 per common share, or $1.46 per common share on a fully diluted basis, compared with $1.40 per common share, $1.31 per common share on a fully diluted basis for the year ended December 31, 1999.
For the year ended December 31, 2000 net operating income increased 21% over the prior year. Net operating income for the year ending December 31, 2000 was $44,804,000 or $1.76 per common share, $1.63 per common share on a fully diluted basis, compared with $36,988,000 or $1.45 per common share, $1.36 per common share on a fully diluted basis for the year ended December 31, 1999. The increase in net operating income was due to the growth and development of our reinsurance operations and favorable underwriting and investment results.
Net Premiums. Net premium revenue for the year ended December 31, 2000 was $168,404,000, an increase of 67% over the year ended December 31, 1999. The majority of premium revenue was derived from traditional ordinary life reinsurance developed directly and through the use of intermediaries. The growth reflects the level of new business written and the increase in the face amount of insurance in force. At December 31, 2000 the total face amount of life insurance in force was approximately $77.0 billion compared with approximately $45.4 billion at December 31, 1999, an increase of 70%. New business writings and premium revenue levels are significantly influenced by the seasonal nature of the life reinsurance marketplace and by large transactions and therefore can fluctuate from period to period.
Realized Investment Gains (Losses). Realized investment losses were approximately $4,817,000 for the year ended December 31, 2000 compared with realized losses of $1,285,000 for the year ended December 31, 1999. These gains and losses result from normal active management of our investment portfolio intended to improve performance and increase operating income.
period to period. Reserves for future policy benefits are in part determined by claims reported from ceding companies, our aggregate experience and overall mortality trends.
Policy Acquisition Costs and Other Insurance Expenses. Policy Acquisition Costs and Other Insurance Expenses, consisting primarily of allowances and amortization of deferred policy acquisition costs, were approximately $60,900,000 for the year ended December 31, 2000, as compared with $42,201,000 for the year ended December 31, 1999. Generally, policy acquisition costs and other insurance expenses fluctuate with business volume and changes in product mix. The increase in these costs reflects the growth and development of our reinsurance business.
Other Operating Expenses. Operating expenses were approximately $10,411,000 or 3.4% of total revenue for the year ended December 31, 2000, as compared with $7,686,000 or 4.1% of total revenue for the year ended December 31, 1999. The decrease in the ratio of operating expenses to total revenue is due to the growth and development of our reinsurance operations and our revenue base. We consider the operating expense level to be low by industry standards and is in line with our plan to be a low cost provider.
Year Ended December 31, 1999 Compared to the Eight and One Half Month Period Ended December 31, 1998
Net Income. For the year ended December 31, 1999, we had consolidated net income of approximately $35,703,000, which is $1.40 per common share, or $1.31 per common share on a fully diluted basis, compared with $0.81 per common share, $0.76 per common share on a fully diluted basis for the initial operating period of approximately eight and one-half months ended December 31, 1998. We began our insurance operations on April 17,1998 following the completion of our initial public offering and direct sales of our common shares. Earnings per share for the year ended December 31, 1998 has been calculated using earnings and the number of shares outstanding since the beginning of the second fiscal quarter. A loss of approximately $449,000 was incurred during the three month period ended March 31, 1998 relating to expenses and costs incurred in the formation and organization of the company.
Net Operating Income. In addition to net income, we report net operating income. This is not a substitute for net income computed in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP), but is an important measure used by management, equity analysts and investors to measure our results. We define net operating income as net income excluding realized gains and losses from the sale of investments. Our definition of net operating income may differ from that used by other public life and annuity companies.
For the year ended December 31, 1999 net operating income increased 120% over the prior year. Net operating income for the year ending December 31, 1999 was approximately $36,988,000 or $1.45 per common share, $1.36 per common share on a fully diluted basis, compared with $16,338,000 or $0.70 per common share, $0.66 per common share on a fully diluted basis for the initial operating period of approximately eight and one-half months ended December 31, 1998. The increase in net operating income is due to the growth and development of our insurance operations and favorable underwriting and investment results.
Net Premiums. Net premium revenue for the year ended December 31, 1999 was approximately $100,835,000, an increase of 261% over the initial operating period of approximately eight and one-half months ended December 31, 1998. All premium revenue was derived from traditional ordinary life reinsurance developed directly by the company and through the use of intermediaries. The growth reflects the level of new business written and the increase in the face amount of insurance in force. At December 31, 1999 the total
Net Investment Income. Total net investment income for the year ended December 31, 1999 was approximately $85,090,000, an increase of 253% over the initial operating period of eight and one half months ended December 31,1998. The growth in the investment income is primarily due to the income earned on Funds Withheld under modified coinsurance agreements related to our Interest Sensitive Contracts Liabilities. The income earned on the Funds Withheld was approximately $64,606,000 for the year ended December 31, 1999 compared with $8,927,000 for the initial operating of eight and one-half months ended December 31, 1998. The average yield rate earned on an annualized basis on the invested assets, excluding Funds Withheld, was approximately 6.29% for the year ended December 31, 1999 compared with 6.32% for the period ending December 31, 1998.
We do not consider realized gains and losses to be recurring components of earnings. We make decisions concerning the sales of invested assets based on a variety of market, business and other factors.
During the year ended December 31, 1999 we incurred unrealized losses of approximately $14,992,000, as compared with unrealized gains of approximately $3,723,000 incurred during the period ended December 31,1998 which were included in Other Comprehensive Income (Loss). The change in unrealized gains and losses is principally related to the increase in the general level of interest rates during 1999.
Interest Credited to Interest Sensitive Contract Liabilities. Interest credited to interest sensitive contract liabilities was approximately $22,313,000 for the year ended December 31, 1999, as compared with approximately $1,989,000 for the initial operating period of eight and one-half months ended December 31, 1998. This increase reflects the growth in the Interest Sensitive Contracts Liabilities and is directly related to income earned on the related Funds Withheld at Interest. The income earned on Funds Withheld was approximately $64,606,000 for the year ended December 31, 1999, as compared with $8,927,000 for the initial operating period of eight and one-half months ended December 31, 1998.
Policy Acquisition Costs and Other Insurance Expenses. Policy Acquisition Costs and Other Insurance Expenses, consisting primarily of allowances and amortization of deferred policy acquisition costs, were approximately $42,201,000 for the year ended December 31, 1999, as compared with $6,542,000 for the initial operating period of eight and one-half months ended December 31, 1998. Generally, policy acquisition costs and other insurance expenses fluctuate with business volume and changes in product mix. The increase in these costs reflects the growth and development of our life insurance and annuity business.
Other Operating Expenses. Operating expenses were approximately $7,686,000 or 4.1% of total revenue for the year ended December 31, 1999, as compared with $3,770,000 or 6.8% of total revenue for the initial operating period of eight and one-half months ended December 31, 1998. The decrease in the ratio of operating expenses to total revenue is due to the growth and development of our insurance operations and our revenue base. We consider the operating expense level to be low by industry standards and is in line with our plan to be a low cost provider.
Our results of operations and our financial condition are significantly affected by the performance of our investments and by changes in interest rates. During a period of declining interest rates, if our investments are prematurely sold, called, prepaid or redeemed, we may be unable to reinvest the proceeds in securities of equivalent risk with comparable rates of return. During a period of rising interest rates, the fair value of our invested assets could decline. In addition, rising interest rates could also cause disintermediation, which in turn could cause us to sell investments at prices and times when the fair values of such investments are less than their amortized cost. We believe that our traditional life insurance liabilities are not highly interest rate sensitive and, therefore, the effects of fluctuating interest rates on these liability cash flows are not significant. For interest sensitive liabilities, the cedent utilizes asset/liability matching to minimize the impact of changes in interest rates. We have not engaged in hedging activities to mitigate the effects of interest rate changes on our invested assets and related liabilities, although we may do so in the future.
The following table summarizes certain of our investment results, excluding interest earned on funds withheld under modified coinsurance agreements, for the periods ended December 31, 2000 and 1999.
Funds Withheld at Interest -- Interest Sensitive Liabilities Contracts. At December 31, 2000 and 1999 assets with a carrying value of $1,530,110,000 and $1,532,653,000, respectively, related to annuity reinsurance agreements are held by and managed by the ceding companies in segmented portfolios. The liability for the annuity reinsurance is included on our Balance Sheet as Interest Sensitive Contracts Liabilities. Under the terms of the reinsurance agreements, the investment income, which accrues to us, is based on the underlying portfolios. The assets in the underlying segmented portfolios are managed by investment managers appointed by the cedent.
Our liquidity and capital resources are a measure of our overall financial strength and our ability to generate cash flows from our operations to meet operating and growth needs. Our principal sources of funds are premiums received, net investment income, proceeds from investments called, redeemed or sold, cash and short term investments. The principal obligations and uses of the funds are the payment of policy benefits, acquisition and operating expenses and the purchase of investments.
Net cash provided by operating activities was $16,260,000 for the year ended December 31, 2000, as compared with cash used by operations of $18,920,000 for the year ended December 31, 1999. The increase in the cash provided by operating activities is primarily related to the growth and development of our insurance operations offset by the initial costs associated with writing new life reinsurance and annuity reinsurance business.
Our capital structure currently consists entirely of equity. At December 31, 2000 our total capitalization after deducting certain loans to management and including retained earnings and accumulated other comprehensive income (loss) amounted to approximately $441,216,000, as compared with $392,055,000 at December 31, 1999. We believe this level of capital is sufficient to support our insurance writings and growth for the near future.
At December 31, 2000 and 1999 we had no outstanding debt. At December 31, 2000 and 1999, letters of credit totaling $183,687,000 and $121,475,000, respectively, issued in the ordinary course of our business had been issued by our bankers in favor of certain ceding insurance companies to provide security and to meet regulatory requirements. At December 31, 2000 and 1999 letters of credit totaling $138,000,000 and $121,475,000, respectively, were fully collateralized by our investments. We may incur indebtedness in the future in connection with possible acquisitions of, investments in, joint ventures with or other strategic alliances with companies whose businesses complement the company's business.
On June 1, 2000 the Company, through Annuity and Life Re America, completed the acquisition of Annuity and Life Reassurance America, Inc., formerly Capitol Bankers Life Insurance Company. Annuity and Life Reassurance America is a life insurance company domiciled in the United States which is authorized to conduct its life insurance business in 43 states of the United States, and will focus its operations on the United States life reinsurance markets. The Company contributed additional capital to Annuity and Life Reassurance America during the fiscal year of $19,550,000 to bring the total capital and surplus of Annuity and Life Reassurance America to $25,000,000. The acquisition price and capital contribution was funded from available cash balances and proceeds from the sales of fixed maturity securities held by the Company.
For contracts with a single premium or a limited number of premium payments due over a significantly shorter period than the total period over which benefits are provided ("limited payment contracts"), reinsurance premiums are recorded as income when due with any excess profit deferred and recognized in income in a constant relationship to the insurance in force or, for annuities, in relation to the amount of expected future benefit payments.
For traditional life policies, future policy benefits and dividend liabilities are estimated using a net level premium method on the basis of actuarial assumptions as to mortality, persistency and interest established at policy issue. Assumptions established at policy issue as to mortality and persistency are based on anticipated experience, which, together with interest and expense assumptions, provide a margin for adverse deviation. When the liabilities for future policy benefits plus the present value of expected future gross premiums for a product are insufficient to provide for expected future benefits and expenses for that product, deferred policy acquisition costs are written off and thereafter, if required, a premium deficiency reserve is established by a charge to income. Benefit liabilities for traditional annuities during the accumulation period are equal to the accumulated present value of expected future benefit payments.
The Company classifies its investments in fixed income securities as available for sale and, accordingly, such securities are carried at fair value. The cost of fixed income securities is adjusted for amortization of premiums and discounts. The cost of fixed income securities is adjusted for declines in value that are considered other than temporary and is considered a realized loss.
The Company's functional currency is the United States dollar. Premiums written and receivable in foreign currencies are recorded at exchange rates prevailing on the date the contract attaches and liabilities for future benefits payable in foreign currencies at the time such liabilities are first recorded. Exchange gains or losses resulting from the periodic revaluation and settlement of such assets and liabilities are recorded in the Company's statement of operations.
In September 2000, the Financial Accounting Standards Board (FASB) issued Statement No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. However, most of the provisions of SFAS No. 125 have been carried over without change. The Statement is effective for transactions occurring after March 31, 2001 and is effective for recognition, reclassification and disclosures of transactions and collateral for fiscal years ending after December 15, 2000. This Statement is to be applied prospectively, with certain exceptions. Management has reviewed this statement and has concluded that it is not likely to significantly affect the Company's current financial reporting.
At December 31, 2000 investments of $66,435,000 were held in trust for the benefit of certain ceding companies (December 31, 1999: $nil).
In the event of a liquidation, dissolution or winding up of the Company, the holders of the common shares are able to share equally in the assets of the Company, if any remain after payment of all liabilities and the liquidation preference of any outstanding preference shares. Certain restrictions exist with respect to the transfer of shares, should such a transfer cause the number of shares held by one person to be 10% or more of the Company's outstanding common shares.
The exercise price of the Warrants is $15.00, which was equal to the initial public offering price per share of the Company's common shares. The Class A Warrants become exercisable over three years commencing on the first anniversary of the consummation of the Company's initial public offering. The Class A Warrants will expire on January 15, 2008. No Class A Warrants have been exercised at December 31, 2000.
In connection with the Direct Sales of equity securities to the "Strategic Investors," the Company issued Class B Warrants that enable the holders to purchase an aggregate of 397,500 common shares of the Company. The exercise price of the Warrants is $15.00 per share, which was equal to the price of the common shares in the initial public offering. The Class B Warrants become exercisable in three equal annual installments commencing on the first anniversary of the date of the Direct Sales. The Class B Warrants expire on the tenth anniversary of the consummation of the Direct Sales. No Class B Warrants have been exercised at December 31, 2000.
One of the Company's major shareholders is affiliated with The Prudential Investment Corporation, which serves as one of the Company's investment managers. The Company has agreed to pay a fee for investment management services to The Prudential Investment Corporation based upon the amount of funds managed. The fee is based upon a sliding scale and has been determined on an arms-length basis. The Company has entered into a life reinsurance agreement with the Prudential Insurance Company of America and an annuity reinsurance agreement with XL Mid Ocean Reinsurance, Ltd., a subsidiary of XL Capital, Ltd., one of the Company's major shareholders. These contracts have been negotiated under normal commercial terms.
At December 31, 2000, 1,007,406 options outstanding are presently exercisable with a weighted average remaining contractual life of 7.5 years.
The weighted average fair value of options granted during 1999 is $9.85 per share. The fair values of the options granted in 1999 are estimated on the date of the grant using the Black-Scholes option pricing model with the following assumptions; dividend yield of 0.8% per annum; expected volatility of 25%; expected life of 10 years and a risk free interest rate of 5.6%.
At December 31, 2000 and 1999, the Company did not have a material concentration of investments in fixed income securities in a single issuer, industry or geographic location.
SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information" requires public companies to report financial and descriptive information about their reportable operating segments. Operating segments, as defined, are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance.
On June 1, 2000 the Company, through Annuity and Life Re America, completed the acquisition of Annuity and Life Reassurance America, Inc., formerly Capitol Bankers Life Insurance Company. Annuity and Life Reassurance America is a life insurance company domiciled in the United States which is authorized to conduct its life insurance business in 43 states of the United States, and will focus its operations on the United States life reinsurance markets. The Company contributed additional capital to Annuity and Life Reassurance America during the fiscal year of $19,550,000 to bring the total capital and surplus of Annuity and Life Reassurance America to $25,000,000. The acquisition price and capital contribution was funded from available cash balances and proceeds from the sales of fixed interest securities held by the Company.
Under current Bermuda law neither Holdings nor Annuity and Life Reassurance is required to pay any taxes in Bermuda on either income or capital gains. Holdings and Annuity and Life Reassurance have each
Annuity and Life Re America and Annuity and Life Reassurance America, Inc. are subject to all applicable Federal and State taxes of the United States. The tax effect related to the current year's operating result is not material to the consolidated financial statements and, therefore, no separate item appears on the income statement or balance sheet. Temporary differences give rise to a net deferred tax asset of $252,000 against which a valuation allowance of $354,000 was established with respect to the utilization of the net operating loss carryforward. Temporary differences primarily related to net operating losses give rise to a gross deferred tax asset of $1,000,000 which is offset by temporary differences relating to deferred acquisition costs and unrealized gains on securities give rise to a gross tax liability. The net operating loss of $945,000 and $219,000 incurred in 2000 and 1999, respectively, are due to expire beginning in 2019.
Annuity and Life Reassurance America is subject to statutory regulations of the state of Connecticut of the United States that restrict the payment of dividends. It may not pay dividends in any 12-month period in excess of the greater of the prior year's statutory operating income or 10% of capital and surplus at the end of the preceding year, without regulatory approval. At December 31, 2000 the statutory capital and surplus of Annuity and life Reassurance America is $22,104,000.
The unaudited quarterly financial data for the years ended December 31, 2000 and 1999 are as follows: