The Company leases office space in Bermuda where the Company's principal executive offices are located, and in Edison, New Jersey, where PXRE Reinsurance's principal offices are located. We also lease office space in Brussels, Belgium, Norwalk, Connecticut and Richmond, Virginia.
(2) In the fourth quarter of 1999, the Company changed the reporting period for its U.K. operations from a fiscal year ending September 30 to a calendar year ending December 31. The results of operations for the period from October 1, 1998 to December 31, 1998, amounted to a loss of approximately $140,000. This loss was charged to retained earnings during 1999 in order to report only twelve months operating results. The U.K. operations of PXRE Limited and PXRE Managing Agency are included in the consolidated results on a one-quarter lag basis from 1997 through the third quarter of 1999.
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 1999, and also 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 vary materially from the results described or implied by these forward-looking statements.
We also provide our clients with finite reinsurance products. Unlike traditional reinsurance products that are primarily focused on transferring risk from the client to the reinsurer, finite products combine elements of risk transfer and the management of the impact of such risk by our clients. Finite reinsurance contracts are highly customized for each transaction. Under a typical finite contract, a portion of the expected losses are ultimately borne by our client and are funded through the payment of premium and the income we earn on that premium. If the loss experience with respect to the risks assumed by us is as expected or better than expected, our finite clients will share in the profitability of the underlying business through premium adjustments or profit commissions. If the loss experience is worse is than expected, our finite clients participate in this negative outcome. In addition, we offer finite reinsurance products where investment returns on the funds transferred to us over a period of years affect the profitability of the contract and the magnitude of any premium and commission adjustments.
Following a diversification effort into Lloyd's and the casualty sectors during the soft reinsurance market of the late 1990s, we decided to exit these businesses during 2000 and 2001, and are today fully focused on our traditional core property reinsurance operations. While our core businesses are volatile due to significant potential loss severity, we have been a highly successful underwriting organization over the long term. This proven expertise in some of the most dynamic areas of the reinsurance sector represents an opportunity to achieve particularly strong financial results in the current hardening phase of the underwriting cycle.
PXRE Bermuda is a quota share reinsurer of PXRE Reinsurance and PXRE Reinsurance provides aggregate excess of loss reinsurance protection for PXRE Bermuda. PXRE Bermuda, with approximately $34.3 million of statutory capital and surplus, also provides finite reinsurance coverages. PXRE Bermuda is not licensed nor admitted as an insurer in any jurisdiction other than Bermuda.
PXRE Barbados was licensed as an insurance company under Barbados' Insurance Act, 1996 and its name was changed from PXRE (Barbados) Ltd. to PXRE Reinsurance (Barbados) Ltd. It is not licensed nor admitted in any jurisdiction other than Barbados. PXRE Barbados is expected to provide finite reinsurance coverages to clients and to provide reinsurance coverage to other PXRE entities.
PXRE Solutions performs certain limited reinsurance intermediary activities on behalf of PXRE Reinsurance, PXRE Bermuda and PXRE Barbados.
The Company and its non-U.S. subsidiaries intend to operate their business in a manner that will not cause them to be treated as engaged in a trade or business in the United States and, thus, will not require them to pay U.S. federal corporate income taxes (other than withholding taxes on certain U.S. source investment income, dividends from PXRE Delaware to PXRE Barbados and excise taxes on reinsurance premiums). However, because there is uncertainty as to the activities which constitute being engaged in a trade or business within the United States, there can be no assurances that the U.S. Internal Revenue Service will not contend successfully that the Company or a non-U.S. subsidiary is engaged in a trade or business in the United States. In early March, 2002, two bills were proposed in the U.S. House of Representatives that seek to prevent so-called "corporate inversion" transactions. Under these bills, a foreign corporation would be taxed as a U.S. domestic corporation under the Internal Revenue Code if it became a foreign corporation as a result of an "inversion transaction" under the bill proposed by Representative McInnis or "corporate expatriation transaction" under the bill proposed by Representative Neal. As currently drafted, the McInnis bill would only apply to transactions completed after December 31, 2001. Commencing with the 2004 tax year, the Neal bill would apply to "corporate expatriation transactions" that occurred prior to September 11, 2001. It is unclear whether our 1999 reorganization would be treated as a "corporate expatriation transaction" under the Neal bill as currently drafted. At this point, we are unable to predict whether such a legislative effort would be successful, what form any such legislation could ultimately take and what impact any such legislation would have on us. If the Company or any of its non-U.S. subsidiaries were subject to U.S. income tax, the Company's shareholders' equity and earnings could be materially adversely effected.
Our invested assets consist primarily of fixed maturities and a diversified portfolio of hedge funds, but also include mezzanine bond and equity limited partnerships, and short-term investments. Our investments are subject to market-wide risks and fluctuations, as well as to risk inherent in particular securities. Although we seek to preserve our capital by investing in a portfolio of hedge funds and other privately held securities designed to provide diversification of risk, such investments entail substantial risks. Portfolio performance may be adversely impacted by equity and credit market conditions. There can be no assurance that our investment objectives will be achieved, and results may vary substantially over time. In addition, although we seek to employ investment strategies that are not correlated with our reinsurance exposures, losses in our investment portfolio may occur at the same time as underwriting losses and, therefore, exacerbate such losses' adverse effect on us. To our knowledge, very few other publicly traded reinsurers follow our strategy of investing a significant portion of our invested assets in hedge funds and other privately held securities. See "Investments."
As a catastrophe reinsurer, our estimations of losses are inherently less reliable than for reinsurers of risks that have an established historical pattern of losses. In addition, insured events which occur near the end of a reporting period, as well as with respect to our retrocessional book of business, the significant delay in losses being reported to insurance carriers, reinsurers and finally retrocessionaires require us to make estimates of losses based on limited information from our clients, industry loss estimates and our own underwriting data. Because of the uncertainty in the process of estimating our losses from insured events, there is a risk that our liabilities for losses and loss expenses could prove to be inadequate, with a consequent adverse impact on our future earnings and stockholders' equity. Additionally, as a consequence of our emphasis on property reinsurance, we may forgo potential investment income because property losses are typically settled within a shorter period of time than casualty losses.
Concerning catastrophe losses, our estimates are initially influenced to a significant degree by industry catastrophe models and underwriting information provided by our clients. This can cause significant development for an accident year when events occur late in the year, as happened in 1999. As an event matures, we rely more and more on our company development patterns by type of event as well as contract information to project ultimate losses for the event. This process can cause our ultimate estimates to differ significantly from initial projections. As an extreme example of these potential uncertainties, the European Wind Storm Martin occurred on December 27, 1999. We based our reserves to a significant degree on the average estimate of the cost of this storm by two major catastrophe modelers, which was approximately $1.0 billion. In 2001, the cost was estimated to be $2.5 billion by SIGMA. Our gross reserve at December 31, 1999 for this event was $31.3 million. Our gross estimate at December 31, 2001 for this event was $68.8 million. Thus, the original industry loss estimate increased by 150%, and our loss estimate has increased by 120%.
Excluding the extraordinary development of European Wind Storms Martin and Lothar in 2000, during the last 10 years, reserve development in any single year from prior year losses, expressed as a percentage of shareholders' equity, ranged from 15% adverse development in 1993 (primarily arising from Hurricane Andrew) to 4% favorable development in 1996.
Fair values for our investments in hedge funds and other privately held securities generally are established on the basis of the valuations provided monthly or quarterly by the managers of such investments. These valuations are determined based upon the valuation criteria established by the governing documents of such investments. Such valuations may differ significantly from the values that would have been used had ready markets existed and the differences could be material.
The most significant factor affecting our results in 2001 was the losses arising from the terrorist attacks on September 11, 2001. Our estimated net loss after tax arising from the September 11th terrorist attacks was $32.6 million or $2.82 per diluted share for the 2001 year. This loss estimate was developed through a contract-by-contract review of our entire book of business and assumed full-limit losses on all reinsurance contracts deemed affected except where credibly advised to the contrary by our clients. The following table more fully details the impact of the September 11th terrorist attacks on the year ended December 31, 2001:
Gross losses and loss expenses arising from the September 11th terrorist attacks totaled $181.7 million. This gross loss was reduced by specific and corporate retrocessional recoverables of $155.6 million. Approximately 93% of our September 11th related reinsurance recoverables are either fully collateralized or reside with entities rated "A" or higher. In this regard, proportional and specific excess coverages provided recoveries of $65.3 million and our general corporate excess of loss coverages provided a further benefit of $90.3 million. The net result of these covers reduced our gross loss from $181.7 million to $26.1 million. Many of these retrocessional covers on both an assumed and ceded basis have either reinstatement or additional premiums, resulting in a net premium reduction of $26.3 million. These additional costs are partially reduced by approximately $11.4 million of lower commission and brokerage expense and increased management fees, bringing the net impact to $41 million before tax.
Finite contracts that do not meet certain accounting requirements of The Financial Accounting Standard Board's Statement of Financial Accounting Standard ("SFAS") No. 113 and other accounting literature, that generally define a reinsurance transaction, are not booked as premiums, but rather are treated as deposits. During the second quarter of 2001, we entered into contracts that have expected deposits of $35.9 million from ceding companies on this deposit accounting basis. We also have two finite retrocessional agreements in place with Select Re that are accounted for as deposits pursuant to SFAS No. 113, totaling $19.9 million. We believe these retrocessional agreements will enhance the long-term profitability of the finite contracts to which they relate.
Catastrophe coverage, surplus and other ceded premiums written increased in 2001 from 2000 primarily due to additional premiums on retrocessional protection following the September 11th terrorist attacks.
Management fee income from all sources for the year ended December 31, 2001 increased 5.5% to $5.8 million from $5.5 million for 2000, reflecting the increase in business ceded to our managed business participants, including the effects of the September 11th terrorist attacks.
The provision for losses and loss expenses and the loss ratio includes the effect of foreign exchange movements on our liability for losses and loss expenses, resulting in foreign currency exchange gains of $1 million for 2001 compared to losses of $1.2 million for 2000.
The underwriting expense ratio was 33.4% for 2001 compared with 40.5% for 2000. Excluding the September 11th terrorist attacks, the expense ratio was 34.8%. The commission and brokerage ratio, net of management fee income, was 15.2% for 2001, compared with 18.4% in 2000. Excluding the September 11th terrorist attacks, the commission and brokerage ratio, net of management fee income, was 19.1% for 2001, compared with 18.4% for 2000. The operating expense ratio was 18.3% for 2001 (15.7% excluding the September 11th terrorist attacks) compared with 22.1% for 2000. The decrease largely reflected the expense savings associated with the termination of our Lloyd's operations. As a result of the above, our combined ratio was 127.0% for 2001 (101.5% excluding the September 11th terrorist attacks) compared with a combined ratio of 126.5% for 2000.
Underwriting operations as described in Note 10 to the Consolidated Financial Statements include premiums earned, losses incurred and commission and brokerage net of management fees, but do not include investment income, realized gains or losses, interest expense, operating expenses, unrealized foreign exchange gains or losses on losses incurred on weather contracts or management fees for Lloyd's syndicate agency management.
Gross premiums written for 2000 increased 21.5% to $269.0 million from $221.3 million for 1999. Net premiums written for the year ended December 31, 2000 increased 24.4% to $172.7 million from $138.8 million for 1999. Net premiums earned for the year ended December 31, 2000, increased 24.7% to $160.2 million from $128.5 million in 1999. Gross written, net written and net earned premium for 2000 increased from prior-year levels reflecting growth in our Structured/Finite Business segment, Casualty segment and the Catastrophe and Risk Excess segment, including one retroactive finite reinsurance contract written amounting to $20 million gross premiums written, ceded premiums written of $10 million and net premiums written and earned of $10 million. Gross and net premiums written increased in 2000 as compared to 1999 in all segments except "Other Lines," as we curtailed the underwriting activities of PXRE Lloyd's Syndicate during 2000. Our decision to buy additional retrocessional coverage reduced growth in net written and net earned premium from 1999 to 2000. Reinstatement premiums were lower in 2000 on retrocessional coverage since the level of loss activity was lower than in 1999.
The premiums ceded to our managed business participants decreased 14.8% to $36.2 million for 2000 compared with $42.5 million for 1999. The decrease in premiums ceded to these programs was due primarily to decreases in gross premiums written primarily on fronted business. In addition, we ceded premiums of $26.8 million from the Structured/Finite Business segment to a managed business participant, Select Re, commencing in 2000.
A summary of our 2000 and 1999 net premiums written and earned by business segment is included in Note 10 to the Consolidated Financial Statements.
Significant catastrophe and risk losses affecting the year ended December 31, 1999 loss incurred are as follows:
The catastrophe and risk excess underwriting portfolio can be characterized on a longer term basis as being comprised of coverages involving higher margins and greater volatility than other coverages written by PXRE.
Other operating expenses increased to $35.4 million for the year ended December 31, 2000 from $30.1 million in 1999. The increase was primarily related to a full year of our London agency operations as well as amortization of negative goodwill in 1999 that did not continue in 2000. Included in other operating expenses were foreign currency exchange losses of $0.6 million for 2000 compared to losses of $0.8 million for 1999.
During 2000, interest expense increased to $4.8 million compared to $3.9 million in 1999. The increase in interest expense relates to a draw down of $25 million under a credit facility in the fourth quarter of 1999, partially offset by a repayment of $10 million of the credit facility at March 31, 2000. The variable interest rate on this portion was 7.66% at December 31, 2000. This is part of PXRE Delaware's Credit Agreement with a syndicate of lenders (as described under "Liquidity and Capital Resources"). In addition, during 2000, we incurred minority interest expense amounting to $8.9 million related to our $100 million of TRUPS (as described below under "Liquidity and Capital Resources") compared to $8.8 million in 1999.
The net effect of foreign currency exchange fluctuations was a loss of $1.8 million in 2000 compared to a loss of $0.4 million in 1999.
Under Bermuda law, PXRE Bermuda is prohibited from declaring or paying any dividends during any financial year it is in breach of its minimum solvency margin or minimum liquidity ratio or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio. If it fails to meet its minimum solvency margin or minimum liquidity ratio on the last day of any financial year, the insurer will be prohibited, without the approval of the Supervisor of Insurance, from declaring or paying any dividends during the next financial year.
As a Class 3 insurer, PXRE Bermuda also is prohibited, without the approval of the Supervisor of Insurance, from reducing by 15% or more its total statutory capital, as set out in its previous year's financial statements, and if it appears to the Supervisor of Insurance that there is a risk of the insurer becoming insolvent or that it is in breach of the Act or any conditions imposed upon its registration, the Supervisor may, in addition to the restrictions specified above, direct the insurer not to declare or pay any dividends or any other distributions or may restrict it from making such payments to such extent as the Supervisor of Insurance may think fit. As at December 31, 2001, the statutory capital and surplus of PXRE Bermuda was estimated to be $34.3 million and the amount required to be maintained was estimated to be $9.4 million.
In the event the amount of dividends available, together with other sources of funds, are not sufficient to permit us to meet our debt service and other obligations and to pay cash dividends, it would be necessary to obtain the approval of the Connecticut Insurance Commissioner prior to the payment of additional dividends by PXRE Reinsurance or the approval of the Bermuda Supervisor of Insurance prior to the payment of additional dividends by PXRE Bermuda. If such approval were not obtained, we would have to adopt one or more alternatives, such as refinancing or restructuring our indebtedness or seeking additional equity. There can be no assurance that any of these strategies could be effected on satisfactory terms, if at all. In the event that we were unable to generate sufficient cash flow and were otherwise unable to obtain funds necessary to meet required payments of principal and interest on our indebtedness, we could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all of the funds borrowed thereunder to be due and payable together with accrued and unpaid interest.
On December 10, 2001, the Company entered into a Share Purchase Agreement with certain investors, Capital Z Financial Services Fund II, L.P., Capital Z Financial Services Private Fund II, L.P. (together with Capital Z Financial Services Fund II, L.P., "Capital Z"), Reservoir Capital Master Fund, L.P., Reservoir Capital Partners, L.P. (together with Reservoir Capital Master Fund, L.P., "Reservoir") and Richard E. Rainwater ("Rainwater") (each of Capital Z, Reservoir and Rainwater, a "Purchaser", and together, the "Purchasers"). The Share Purchase Agreement provides for the purchase of 7,500 shares of Series A Preferred Shares, allocated to two sub-series of shares, 5,000 shares allocated to sub-series A1 (A1 Preferred Shares) and 2,500 shares allocated to sub-series A2 (A2 Preferred Shares); the purchase of 5,000 shares of Series B Preferred Shares, allocated to two sub-series of shares, 3,333.333 shares allocated to Series B1 (B1 Preferred Shares) and 1,666.667 shares allocated to Series B2 (B2 Preferred Shares); and 2,500 shares of Series C Preferred Shares, allocated to two sub-series of shares, 1,666.667 shares allocated to Series C1 (C1 Preferred Shares) and 833.333 shares allocated to Series C2 (C2 Preferred Shares).
In connection with the Credit Agreement, PXRE Delaware and First Union entered into a cash flow hedge interest rate swap which, effective December 31, 1998, has the intended effect of converting the initial $36.7 million borrowings by PXRE Delaware into a fixed rate borrowing at an annual interest rate of 6.34%. The remaining $18.3 million outstanding on December 31, 2001, after paying down $10 million on March 31, 2001 and March 31, 2000, incurred an interest rate of 3.59% at December 31, 2001. Commitments under the Credit Agreement terminate on March 31, 2005 and are subject to annual reductions of $10 million commencing March 31, 2000 and $25 million on March 31, 2005, and, unless due or paid sooner, the aggregate principal of the loans are due and payable in full on March 31, 2005. Under the Amended Credit Agreement, the reduction of the outstanding commitments under the Credit Agreement has been accelerated. As amended, the outstanding commitment is reduced by $20 million on March 31, 2002, $5 million on July 1, 2002, $20 million on March 31, 2003 and by the remaining $10 million on March 31, 2004. In addition, commencing on June 30, 2003, 50% of Excess Cash Flow (as defined in the Second Amendment) shall be used to reduce the outstanding commitment. The variable interest rate under the Amended Credit Agreement has been increased by 100 basis points.
As of December 31, 2001, PXRE Reinsurance held an investment whose value exceeded the applicable limit under the Credit Agreement, which absent a waiver, would have resulted in an Event of Default under the Credit Agreement. In the Second Amendment, the Lenders agreed to waive this violation until May 1, 2002 in order to allow PXRE Reinsurance an opportunity to cure this violation. In this regard, PXRE Reinsurance owns certain fixed rate secured notes, due September 10, 2010, issued by FSL Funding Ltd. As of December 31, 2001, the value of these notes was $22 million. Under 7.5(viii)(c) of the Credit Agreement, the aggregate investment in any single non-U.S. Government guaranteed investment that may be held by PXRE Reinsurance is limited to 5% of its Average Combined Invested Assets (as defined in the Credit Agreement), which was $21.1 million at December 31, 2001.
The Credit Agreement enumerates various Events of Default, including but not limited to, if: (1) any Person or group becomes the "beneficial owner" of securities of the Company representing 20% or more of the combined voting power of the then outstanding securities of the Company ordinarily having the right to vote in the election of directors; or (2) the Board of Directors of the Company ceases to consist of a majority of the individuals who constituted the Board as of the date of the Credit Agreement or who subsequently become members after having been nominated, or otherwise approved in writing, by at least a majority of individuals who constituted the Board as of the date of the Credit Agreement (or their approved replacements).
On January 29, 1997, PXRE Capital Trust I ("PXRE Capital Trust"), a Delaware statutory business trust and a wholly-owned subsidiary of PXRE Delaware, issued $100 million principal amount of its 8.85% TRUPS 'sm' due February 1, 2027 in an institutional private placement. Proceeds from the sale of these securities were used to purchase PXRE Delaware's 8.85% Junior Subordinated Deferrable Interest Debentures due February 1, 2027 (the "Subordinated Debt Securities"). On April 23, 1997, PXRE Delaware and PXRE Capital Trust completed the registration with the Securities and Exchange Commission of an exchange offer for these securities and the securities were exchanged for substantially similar securities (the "Capital Securities"). Distributions on the Capital Securities (and interest on the related Subordinated Debt Securities) are payable semi-annually, in arrears, on February 1 and August 1 of each year, commencing August 1, 1997. Minority interest expense, including amortization of debt offering costs, for 2001 in respect of the Capital Securities (and related Subordinated Debt Securities) amounted to $8.9 million. On or after February 1, 2007, PXRE Delaware has the right to redeem the Subordinated Debt Securities, in whole at any time or in part from time to time, subject to certain conditions, at call prices of 104.180% at February 1, 2007, declining to 100.418% at February 1, 2016, and 100% thereafter. PXRE Delaware has the right, at any time, subject to certain conditions, to defer payments of interest on the Subordinated Debt Securities for Extension Periods (as defined in the applicable indenture), each not exceeding 10 consecutive semi-annual periods; provided that no Extension Period may extend beyond the maturity date of the Subordinated Debt Securities. As a consequence of PXRE Delaware's extension of any interest payment period on the Subordinated Debt Securities, distributions on the Capital Securities would be deferred (though such distributions would continue to accrue interest at a rate of 8.85% per annum compounded semi-annually). In the event that PXRE Delaware exercises its right to extend an interest payment period, then during any Extension Period, subject to certain exceptions, (i) PXRE Delaware may not declare or pay any dividend on, make any distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or rights to acquire such capital stock or make any guarantee payments (subject to specified exceptions) with respect to the foregoing, and (ii) PXRE Delaware may not make any payment of interest on, or principal of (or premium, if any, on), or repay, repurchase or redeem, any debt securities issued by PXRE Delaware which rank pari passu with or junior to the Subordinated Debt Securities. Upon the termination of any Extension Period and the payment of all amounts then due, PXRE Delaware may commence a new Extension Period, subject to certain requirements.
We believe that the TRUPS are currently trading at an attractive price. In order to take advantage of this opportunity, we may cause one or more of our subsidiaries to purchase some of the outstanding TRUPS and to hold them for investment purposes. If consummated, such a purchase is not expected to be treated as a redemption.
Fixed maturity and equity investments are reported at fair value, with the net unrealized gain or loss, net of tax, reported as a separate component of shareholders' equity. At December 31, 2001, an after-tax unrealized gain of $0.5 million ($0.04 book value per share) was included in shareholders' equity.
A principal component of our investment strategy is investing a significant portion of our invested assets in a diversified portfolio of hedge funds. At December 31, 2001, total hedge fund investments amounted to $115.6 million (including $16.7 million in short-term investments mentioned above), representing 11.5% of December 31, 2001 total assets. As at December 31, 2001, hedge fund investments with fair values ranging from $0.8 to $16.7 million were administered by nineteen managers. Four of the managers are affiliated with Mariner Investment Group ("Mariner").
Through our hedge fund managers, we may invest or trade in any securities or instruments including, but not limited to, U.S. and non-U.S. equities and equity-related instruments, currencies, commodities and fixed-income and other debt-related instruments and derivative instruments. Hedge fund managers may use both over-the-counter and exchange traded instruments (including derivative instruments such as swaps, futures and forward agreements), trade on margin and engage in short sales. Substantially all strategies hedge fund managers are expected to adopt employ leverage, to varying degrees, which magnifies both the potential for gain and the exposure to loss, which may be substantial. Leverage may be obtained through margin arrangements, as well as repurchase, reverse repurchase, securities lending and other techniques. Trades may be on or off exchanges and may be in thinly traded securities or instruments, which creates the risk that attempted purchases or sales may adversely affect the price of a particular investment or its liquidation and may increase the difficulty of valuing particular positions.
Hedge funds and other limited partnership investments are accounted for under the equity method or as part of a trading portfolio. Total investment income for the twelve months ended December 31, 2001, included $10.6 million attributable to hedge funds and other limited partnership investments.
In 2001, we entered into a joint venture agreement, dated June 2001 (the "JV Agreement"), with BF&M Properties Limited to form a Bermuda corporation, Barr's Bay Properties Limited ("Barr's Bay"). Barr's Bay was formed to construct an office building in Hamilton, Bermuda, in which we will have the option to lease office space for 3 consecutive five-year terms. We own 40% of the outstanding shares of Barr's Bay. Pursuant to the JV Agreement, we have agreed to lend up to $7 million to Barr's Bay to finance the construction of the subject office building. Such loans will be secured by a first mortgage on the property.
All amounts classified as reinsurance recoverable at December 31, 2001 are considered by our management to be collectible in all material respects.
Our risk management strategy is to accept certain levels of market risks, principally through our investment activities, in order to offset our insurance exposures that may be considered actuarial rather than financial. The objectives of our investment activities are to generate the required return from selected market sectors, that do not correlate with underwriting risk, and limit our exposures to market risks that may prevent us from servicing our insurance obligations. Our Board of Directors approves investment guidelines and the selection of external investment advisers who manage our portfolios. The investment managers make tactical investment decisions within the established guidelines. Management monitors the external advisers through written reports that are reviewed and approved by the Board of Directors or committee thereof. Management also manages diversification strategies across the portfolios in order to limit our potential loss from any single market risk. The performance and risk profiles of the portfolio are reported in various forms throughout the fiscal year to management, the Board of Directors, rating agencies, regulators, and to stockholders.
Our investment portfolio is summarized in Item 14, Notes to the Financial Statements, Item 7, Management's Discussion and Analysis and Item 1, Business.
The estimated potential loss is net of prepayment risk associated with the mortgage-related securities. The mortgage sector represents 6% of the portfolio at year-end. The estimate assumes a similar change in fair value across security sectors with no adjustment for change in value due to credit risk. The interest rate risk related to the short-term investments is not material. The average maturity of these investments is under one year.
As of December 31, 2001, 73.4% of our investment portfolio, at fair value, consisted of fixed maturities and short-term investments with fixed maturities. At December 31, 2001, 90.0% of the fair value of our long-term fixed maturities portfolio was in obligations rated "A1" or "A" or better by Moody's or S&P, respectively. The average value of our fixed maturity investments decreased 17.6% from $3.1 million at year end 2000 to $2.6 million at year end 2001. Non-agency mortgage and asset-backed securities accounted for 4.1% of fixed maturities based on fair value at December 31, 2001. We significantly reduced our investments in emerging market securities in 1999 and 2000, and have limited fixed income investment holdings not traded on a recognized exchange.
Our exposure to foreign exchange risk from our foreign denominated securities is not material. Only a small portion of our investment portfolio is denominated in currencies other than U.S. dollars. Additionally, the carrying value of certain receivables and payables denominated in foreign currencies are carried at fair value. For these reasons, these items have been excluded from the market risk disclosure. We may, however, be exposed to material foreign exchange risk in the event that a significant non-U.S. catastrophe event occurs.
Our risk management strategy includes investments that are expected to reflect offsetting changes in fair value in response to various changes in market risks.
In May 1999, PXRE Delaware entered into weather option agreements with two counterparties. In April 2000, these counterparties submitted invoices to PXRE Delaware in the aggregate sum of $8.3 million seeking payment under the weather option agreements, which invoices have been paid. PXRE Delaware insured its obligations under these weather option agreements through two Commercial Inland Marine Weather Insurance Policies issued by Terra Nova Insurance Company Limited ("Terra Nova"). PXRE Delaware submitted claims under these policies to Terra Nova in April 2000. Terra Nova has denied coverage, contending that its Managing General Agent had no authority to issue these policies. PXRE Delaware disagrees with Terra Nova's denial and has filed suite against Terra Nova in the United States District Court for the District of New Jersey. Both parties submitted motions of summary judgment, and the court denied both motions in an order dated as of January 18, 2002. The trial of this matter is expected to occur during the third quarter of 2002. The aggregate sum of $8.3 million is included in Other Assets; management has concluded that it is realizable and that no valuation allowance is necessary.
Report of Independent Accountants for the years ended December 31, 2000 and 1999