Everest Re's corporate offices are located in approximately 112,000 square feet of leased office space in Liberty Corner, New Jersey. Bermuda Re's corporate offices are located in approximately 3,600 total square feet of leased office space in Hamilton, Bermuda. The Company's other thirteen locations occupy a total of approximately 67,000 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs.
- ------------ (1) After-tax operating income, before after-tax net realized capital gains or losses, was $115.8 million (or $2.51 per basic share and $2.46 per diluted share), $185.9 million (or $4.05 per basic and $4.01 per diluted share), $169.0 million (or $3.48 per basic and $3.47 per diluted share), $165.7 million (or $3.29 per basic and $3.27 per diluted share) and $144.6 million (or $2.86 per basic and $2.85 per diluted share) for the years ended December 31, 2001, 2000, 1999, 1998 and 1997, respectively. (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 on property exposures before reinsurance of at least $5.0 million and has an event date of January 1, 1988 or later. (3) Some amounts may not reconcile due to rounding. (4) Based on weighted average basic shares outstanding of 46.2 million, 45.9 million, 48.5 million, 50.4 million and 50.5 million for 2001, 2000, 1999, 1998 and 1997, respectively. (5) Based on weighted average diluted shares outstanding of 47.1 million, 46.4 million, 48.7 million, 50.7 million and 50.8 million for 2001, 2000, 1999, 1998 and 1997, respectively. (6) Loss ratio is the GAAP losses and LAE incurred as a percentage of GAAP net premiums earned. Underwriting expense ratio is the GAAP commissions, brokerage, taxes, fees and general expenses as a percentage of GAAP net premiums earned. Combined ratio is the sum of the loss ratio and underwriting expense ratio. (7) Excluding net unrealized appreciation (depreciation) of investments, shareholders' equity was $1,594.5 million, $1,502.1 million, $1,337.2 million, $1,281.6 million and $1,147.1 million as of December 31, 2001, 2000, 1999, 1998 and 1997, respectively. (8) Based on 46.3 million shares outstanding for December 31, 2001, 46.0 million shares outstanding for December 31, 2000, 46.5 million shares outstanding for December 31, 1999, 50.0 million shares outstanding for December 31, 1998 and 50.5 million shares outstanding for December 31, 1997.
Mt. McKinley, a run-off property and casualty insurer in the United States, has had a long relationship with Holdings and its principal operating company, Everest Reinsurance Company ("Everest Re"). Mt. McKinley was formed in 1978 by Everest Re and wrote insurance until 1985, when it was placed in run-off. In 1991, Mt. McKinley became a subsidiary of The Prudential. Mt. McKinley is also a reinsurer of Everest Re. Under a series of transactions dating to 1986, Mt. McKinley reinsured several components of Everest Re's business. In particular, Mt. McKinley provided stop-loss reinsurance protection, in connection with the Company's October 5, 1995 Initial Public Offering, for any adverse loss development on Everest Re's June 30, 1995 (December 31, 1994 for catastrophe losses) reserves, with $375.0 million in limits, of which $89.4 million remains available (the "Stop Loss Agreement"). The Stop Loss Agreement and other reinsurance contracts between Mt. McKinley and Everest Re remain in effect following the acquisition. However, these contracts have become transactions with affiliates, with the financial impact eliminated in consolidation.
As a result of the Enron bankruptcy in 2001, the Company has incurred losses, after-tax and net of reinsurance, amounting to $25.0 million. This unusual loss reflects all of the Company's exposures to this event, including underwriting, credit and investment.
INDUSTRY CONDITIONS. The worldwide reinsurance and insurance businesses are highly competitive. The September 11 attacks resulted in losses which reduced industry capacity and were of sufficient magnitude to cause most individual companies to reassess their capital position, tolerance for risk, exposure control mechanisms and the pricing terms and conditions at which they are willing to take on risk. The gradual and variable improving trend that had been apparent through 2000 and earlier in 2001 firmed significantly. This firming generally took the form of immediate and significant upward pressure on prices, more restrictive terms and conditions and a reduction of coverage limits and capacity availability. Such pressures were widespread with variability depending on the product and markets involved, but mainly depending on the characteristics of the underlying risk exposures. The magnitude of the changes was sufficient to create temporary disequilibrium in some markets as individual buyers and sellers adapted to changes in both their internal and market dynamics.
These changes reflect a reversal of the general trend from 1987 through 1999 toward increasingly competitive global market conditions across most lines of business as reflected by decreasing prices and broadening contract terms. The earlier trend resulted from a number of factors, including the emergence of significant reinsurance capacity in Bermuda, changes in the Lloyds market, consolidation and increased capital levels in the insurance and reinsurance industries, as well as the emergence of new reinsurance and financial products addressing traditional exposures in alternative fashions. Many of these factors continue to exist. As a result, although the Company is encouraged by the recent improvements, and more generally, current market conditions, the Company cannot predict with any reasonable certainty whether and to what extent these improvements will persist.
from those of expiring contracts. As premium reporting and earnings and loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, can and does introduce appreciable background variability in various underwriting line items.
Contributing to the increase in incurred losses and LAE in 2001 from 2000 were a 200.7% ($141.0 million) increase in the U.S. Insurance operation principally reflecting increased premium volume, a 137.5% ($8.8 million) increase in the Bermuda operation principally reflecting increased premium volume, a 41.5% ($131.9 million) increase in the U.S. Reinsurance operation, principally reflecting losses in connection with the September 11 attacks and tropical storm Alison and a 30.1% ($76.5 million) increase in the Specialty Underwriting operation principally attributable to increased premium volume in A&H medical stop loss business together with marine, aviation and surety losses relating to the September 11 attacks, the Enron bankruptcy and the Petrobras Oil Rig loss event. These increases were partially offset by a 14.1% ($33.3 million) decrease in the International operation principally due to more favorable loss experience. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing incurred losses and LAE by premiums earned, increased by 7.1 percentage points to 82.4% in 2001 from 75.3% in 2000 reflecting the incurred losses and LAE discussed above. The following table shows the loss ratios for each of the Company's operating segments for 2001 and 2000. The loss ratios for all operations were impacted by the expense factors noted above as well as by the impact on ceded premiums of the adjustment premiums under the Company's corporate retrocessional program.
Underwriting expenses increased by 40.6% to $455.7 million in 2001 from $324.1 million in 2000. Commission, brokerage, taxes and fees increased by $124.4 million, principally reflecting increases in premium volume and changes in the mix of business. In addition, in 2000, the Company's reassessment of the expected losses on a multi-year reinsurance treaty led to a $33.8 million decrease in contingent commissions with a corresponding increase to losses. Other underwriting expenses increased by $7.3 million as the Company has expanded its business volume and operations. Contributing to the underwriting expense increase were a 122.7% ($45.6 million) increase in the U.S. Insurance operation, mainly relating to the increased premium volume, a 70.8% ($68.0 million) increase in the U.S. Reinsurance operation, which included the impact of the contingent commission adjustment noted above and a 22.5% ($19.8 million) increase in the Specialty operation. These increases were partially offset by a 29.0% ($1.7 million) decrease in the Bermuda operation and a 1.5% ($1.4 million) decrease in the International operation. Except as noted, the changes for each operation's expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, the underwriting performance of the underlying business. The Company's expense ratio, which is calculated by dividing underwriting expenses by premiums earned, increased by 3.4 percentage points to 31.0% in 2001 compared to 27.6% in 2000.
Net realized capital losses were $22.3 million in 2001, reflecting realized capital losses on the Company's investments of $55.1 million, which includes $9.0 million relating to write-downs in the value of securities deemed to be other than temporary, partially offset by $32.8 million of realized capital gains, compared to realized capital gains of $0.8 million in 2000. The net realized capital gains in 2000 reflected realized capital gains of $30.9 million, which were partially offset by $30.1 million of realized capital losses. The net realized capital losses for 2001 allowed the Company to recapture taxes paid on net realized capital gains in prior periods. The realized capital gains in 2001 and 2000 arose mainly from activity in the Company's equity portfolio. The realized capital losses in 2001 and 2000 arose mainly from activity in the Company's fixed maturity portfolios.
Interest expense was $46.0 million for 2001 compared to $39.4 million in 2000. Interest expense for 2001 reflects $38.9 million relating to Holdings' senior notes issued on March 14, 2000 and $7.1 million relating to Holdings' borrowing under its revolving credit facility. Interest expense for 2000 reflects $30.9 million relating to Holdings' issuance of senior notes and $8.5 million relating to Holdings' borrowing under its revolving credit facility.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999 PREMIUMS. Gross premiums written increased 21.4% to $1,385.6 million in 2000 from $1,141.8 million in 1999 as the Company took advantage of selected growth opportunities while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 255.9% ($180.1 million) increase in the U.S. Insurance operation, principally attributable to growth in worker's compensation insurance, an 18.5% ($49.7 million) increase in the Specialty Underwriting operation, attributable to growth in A&H medical stop loss writings, a 3.6% ($11.2 million) increase in the International operation, mainly attributable to growth in Latin America and the markets served from the Company's London branch, and $11.6 million of writings through the Bermuda operation, which produced its first business during the quarter ended December 31, 2000. These increases were partially offset by a 1.8% ($8.9 million) decrease in the U.S. Reinsurance operation where growth across property and casualty lines was offset by reductions in non-standard auto writings. The Company continued to decline business that did not meet its objectives regarding underwriting profitability.
EXPENSES. Incurred loss and LAE increased by 14.7% to $884.6 million in 2000 from $771.6 million in 1999. The increase in incurred losses and LAE was principally attributable to the increase in net premiums written together with
Contributing to the increase in incurred losses and LAE in 2000 from 1999 were a 71.1% ($29.2 million) increase in the U.S. Insurance operation, principally reflecting increased premium volume, a 37.0% ($68.7 million) increase in the Specialty Underwriting operation principally attributable to increased premium volume in A&H business together with modest reserve strengthening for prior period marine, aviation and surety exposures, a 3.3% ($7.5 million) increase in the International operation, which included modest reserve strengthening for exposures produced through its London and Canadian branches, a 0.4% ($1.2 million) increase in the U.S. Reinsurance operation and $6.4 million of losses from the Bermuda operation as the Company began writing business in this operation during the quarter ended December 31, 2000. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
by $5.9 million of expenses from the Bermuda operation, principally reflecting Federal excise tax paid on a loss portfolio transfer with an affiliate, and 52.8% ($12.8 million) and 9.1% ($7.3 million) increases in the U.S. Insurance operation and the Specialty Underwriting operation, respectively, principally related to production volume increases. Except as noted, the changes for each operation's expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, the underwriting performance of the underlying business. The Company's expense ratio, which is calculated by dividing underwriting expenses by premiums earned, decreased by 3.9 percentage points to 27.6% in 2000 compared to 31.5% in 1999.
INVESTMENTS. Net investment income increased by 19.2% to $301.5 million in 2000 from $253.0 million in 1999, principally reflecting the effect of investing the $90.0 million of cash flow from operations in 2000, the investment of the $450.0 million in proceeds from Holdings' issuance of senior notes and the investment of the approximately $554.5 million of additional net invested assets resulting from the acquisitions of Mt. McKinley and AFC Re. The following table shows a comparison of various investment yields as of December 31, 2000 and 1999, respectively, and for the periods then ended.
Interest expense was $39.4 million for 2000 compared to $1.5 million in 1999. Interest expense for 2000 reflects $30.9 million relating to Holdings' issuance of senior notes and $8.5 million relating to Holdings' borrowing under its revolving credit facility. Interest expense for 1999 reflects $1.5 million relating to Holdings' borrowing under its credit facility.
Other income was $3.3 million in 2000 compared to other expense of $1.0 million in 1999. Significant contributors to other income for 2000 were foreign exchange gains as well as financing fees from Everest Security, offset by net derivative income and fair value adjustments and expenses relating to Holdings' issuance of senior notes. Other expense for 1999 principally included foreign exchange losses. The foreign exchange gains and losses are attributable to fluctuations in foreign currency exchange rates.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. The Company'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. The Company'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 additional uncertainties in estimating the amount of the Company's potential losses from asbestos and environmental claims. Among the complications impacting the estimation of such losses are: (1) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (2) difficulty in identifying sources of asbestos or environmental contamination; (3) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (4) changes in underlying laws and judicial interpretation of those laws; (5) potential for an asbestos or
FINANCIAL CONDITION CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and short-term investments, were $5,783.5 million at December 31, 2001, $5,493.0 million at December 31, 2000 and $4,139.2 million at December 31, 1999. The increase in cash and invested assets from 2000 to 2001 resulted primarily from $406.0 million in cash flows from operations generated in 2001 and $70.5 million in net unrealized appreciation of the Company's fixed maturity investments. These increases were partially offset by $130.0 million in net payments on Holdings' credit facility and $13.2 million in net unrealized depreciation of the Company's equity investments. The increase in cash and invested assets from 1999 to 2000 resulted primarily from Holdings' issuance of senior notes totaling $450.0 million, the proceeds of which have been invested, $349.7 million of new cash from the acquisition of Mt. McKinley, $204.8 million of new invested assets from the acquisition of AFC Re, $176.0 million in credit facility borrowings, $158.0 million in net unrealized appreciation of the Company's fixed maturity investments and $90.0 million in cash flows from operations generated in 2000. These increases were partially offset by $26.6 million in net unrealized depreciation of the Company's equity investments and $16.4 million in share repurchases.
The table below summarizes reserves and claim activity for asbestos and environmental claims, on both a gross and net of ceded reinsurance basis, for the periods indicated:
- ---------- (1) Reported losses and paid losses for 2000 are net of ($311.3) million and $311.3 million, respectively, reflecting the establishment of Mt. McKinley's reserves at the acquisition date. Net paid losses, excluding the impact of the Mt. McKinley acquisition transaction, were ($42.3) million. (2) Net of $0.0 million in 2001, $0.0 million in 2000 and $118.8 million in 1999 ceded as paid losses under the Stop Loss Agreement.
The Company's liquidity requirements are met on a short-term and long-term basis by funds provided by premiums collected, investment income and collected reinsurance receivables balances, and from the sale and maturity of investments together with the availability of funds under the Company's revolving credit facility. The following table shows cash flows from operating activities, as well as the impacts of select transactions on those cash flows, for the years ended December 31, 2001, 2000 and 1999.
Management believes that net cash flows from operating activities are generally consistent with expectations given the Company's investment strategies, mix of business and the normal variability of premium collections and the payout of loss reserves.
The Company employs various techniques, including licensed software modeling, to assess its accumulated exposure. Such techniques are inherently more difficult to apply to non-property exposures. Accumulated exposures with respect to property catastrophe losses are summarized in terms of the probable maximum loss ("PML"). The Company defines PML as its anticipated maximum property loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years.
Management estimates that the Company's greatest catastrophe exposure worldwide from any single event is to hurricanes and earthquakes in the coastal regions of the United States, where the Company estimates it has a PML exposure, before reinsurance, of approximately $140 million in each such region based on its current book of business. Similarly, management estimates that the largest current PML exposure, before reinsurance, outside the United States is approximately $97 million. There can be no assurance that the Company will not
The Company employs a retrocessional approach where reinsurance may be purchased to cover specific business written or exposure accumulations or it may be purchased as a corporate level retrocessional program covering the potential accumulation or aggregation of exposures across some or all of the Company's operations. All reinsurance purchasing decisions consider both the potential coverage and market conditions with respect to the pricing, terms, conditions and availability of such coverage, with the aim of securing cost-effective protection. The level of reinsurance coverage varies over time, reflecting the underwriter's and/or Company's view of the changing dynamics of both the underlying exposure and the reinsurance markets.
The principal components of the Company's existing corporate retrocessional protection program as it relates to catastrophes are an accident year aggregate excess of loss treaty and the retrocesssional excess of loss coverage of international exposures. For both 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage, which provides up to $175.0 million of recoveries if Everest Re's consolidated statutory basis accident year loss ratio exceeds a loss ratio attachment point provided in the contract for the respective accident years. Each arrangement provides for an adjustment premium, which reduces the net benefit by approximately 50%, in the event that the coverage is used. The remaining limits available under these coverages is $175.0 million and $11.0 million, respectively. The Company's corporate retrocessional protection program includes a two-layer property catastrophe excess of loss program for losses incurred outside of the United States, which provide coverage of 58.25% of $17.5 million of losses in excess of $15 million of losses per occurrence and 70% of $20 million of losses in excess of $32.5 million of losses per occurrence. This coverage relates to a twelve-month period beginning June 7, 2001 and the continuation or replacement of such coverage in June 2002 cannot be assured. All aspects of the retrocession program have been structured to permit the program to be accounted for as reinsurance under SFAS No. 113. See ITEM 1 - "Risk Management and Retrocession Arrangements" for further details.
If a single catastrophe were to occur in the United States that resulted in $140 million of gross losses and allocated loss adjustment expenses ("ALAE") in 2002 (an amount equivalent to the Company's PML), management estimates that the effect (including additional premiums and retained losses and ALAE) on the Company's income before and after taxes would be approximately $140 million and $101 million, respectively.
DIVIDENDS During 2001, 2000 and 1999, the Company declared and paid shareholder dividends of $12.9 million, $11.0 million and $11.6 million, respectively.
GROUP. Under Bermuda law, Group is prohibited from declaring or paying a dividend if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities and its issued share capital and share premium (additional paid-in capital) accounts. Group's ability to pay dividends and its operating expenses is partially dependent upon dividends from its subsidiaries. The payment of dividends by insurer subsidiaries is limited under Bermuda law and the laws of the various U.S. states in which Group's insurance and reinsurance subsidiaries are licensed to transact business. The limitations are generally based upon net income and compliance with applicable policyholders' surplus or minimum solvency margin and
BERMUDA RE. Under Bermuda law, Bermuda Re is prohibited from declaring or paying a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio or, if after payment of the dividend, it fails to meet its minimum solvency margin or minimum liquidity ratio. As a long-term insurer, Bermuda Re is also unable to declare or pay a dividend to anyone who is not a policyholder unless, after payment of the dividend, the value of the assets in its long-term business fund, as certified by its approved actuary, will exceed its liabilities for long-term business by at least the $250,000 minimum solvency margin. Prior approval of the Bermuda Minister of Finance is required if Bermuda Re's dividend payments would reduce its prior year-end total statutory capital by 15.0% or more. At December 31, 2001, Bermuda Re has met all requirements by a significant amount.
On December 21, 1999, Holdings entered into a three-year senior revolving credit facility with a syndicate of lenders (the "Credit Facility"), which replaced its prior credit facility which had been extended in June 1999 and increased from $50.0 million to $75.0 million on November 9, 1999. First Union National Bank is the administrative agent for the Credit Facility. The Credit Facility is used for liquidity and general corporate purposes. The Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either (1) the Base Rate (as defined below) or (2) an adjusted London InterBank Offered Rate ("LIBOR") plus a margin. The Base Rate is the higher of the rate of interest established by First Union National Bank from time to time as its prime rate or the Federal Funds rate plus 0.5% per annum. On December 18, 2000, the Credit Facility was amended to extend the borrowing limit to $235.0 million for a period of 120 days. This 120-day period expired during the three months ended March 31, 2001 and the limit reverted to $150.0 million. The amount of margin and the fees payable for the Credit Facility depend upon Holding's senior unsecured debt rating. Group has guaranteed Holdings' obligations under the Credit Facility.
EVEREST RE. The payment of dividends to Holdings by Everest Re is subject to limitations imposed by the Delaware Insurance Code. Based upon these restrictions, the maximum amount that will be available for payment of dividends to Holdings by Everest Re in 2002 without the prior approval of regulatory authorities is $129.4 million. Everest Re's future cash flow available to Holdings may be influenced by a variety of factors, including changes in the property and casualty reinsurance market, Everest Re's financial results, insurance regulatory changes and changes in general 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 Insurance 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' general corporate needs.
The overall investment strategy considers the scope of present and anticipated Company operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with the Company's capital structure and other factors, are used to develop a net liability analysis. This analysis includes estimated payout characteristics for which the investments of the Company provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration and credit quality. The change in overall market sensitive risk exposure principally reflects the asset changes that took place during the year with no material change in the underlying risk characteristics.
The Company's $5.8 billion investment portfolio is comprised of fixed maturity securities that are subject to interest rate risk and foreign currency rate risk, and equity securities that are subject to equity price risk. The impact of these risks in the investment portfolio is generally mitigated by changes in the value of operating assets and liabilities and their associated income statement impact.
and down in 100 basis point increments. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments are taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios. All amounts are in U.S. dollars and are presented in millions.
Equity risk is the potential change in market value of the common stock and preferred stock portfolios arising from changing equity prices. The Company invests in index mutual funds and high quality common and preferred stocks that are traded on the major exchanges in the United States. The primary objective in managing the $67.3 million equity portfolio is to provide long-term capital growth through market appreciation and income.
The tables below display the impact on market value and after-tax unrealized appreciation of a 20% change in equity prices up and down in 10% increments as of December 31, 2001 and 2000. All amounts are in U.S. dollars and are presented in millions.
SAFE HARBOR DISCLOSURE This report contains forward-looking statements within the meaning of the U.S. federal securities laws. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as "may", "will", "should", "could", "anticipate", "estimate", "expect", "plan", "believe", "predict", "potential" and "intend". Forward-looking statements contained in this report include information regarding the Company's reserves for losses and LAE and estimates of the Company's catastrophe exposure. Forward-looking statements only reflect the Company's expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from the Company's expectations. Important factors that could cause actual events or results to be materially different from the Company's expectations include those discussed below under the caption "Risk Factors". The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
o the overall level of economic activity and the competitive environment in the industry.
economic, financial, competitive, regulatory and other factors beyond the Company's control. Payment of dividends and advances and repayments from some of the Company's operating subsidiaries are regulated by U.S., state and foreign insurance laws and regulatory restrictions, including minimum solvency and liquidity thresholds. Accordingly, the Company's operating subsidiaries may not be able to pay dividends or advance or repay funds to Group in the future, which could prevent the Company from paying dividends or making other payments or distributions on its securities.
In the last few years, some members of Congress have expressed concern over a competitive advantage that foreign-controlled insurers and reinsurers may have over U.S.-controlled insurers and reinsurers due to the purchase of reinsurance by U.S. insurers from affiliates operating in some foreign jurisdictions, including Bermuda. Legislation has been proposed in Congress that might increase the U.S. tax burden on some of these transactions. The Company does not know whether this legislation or any similar legislation will ever be enacted into law. If it were enacted, the U.S. tax burden on some business ceded from the Company's licensed U.S. insurance subsidiaries to some offshore reinsurers could be increased. This could reduce the Company's net income.
The Company conducts its Barbados operations in a manner designed to minimize the Company's U.S. tax exposure. Based on the Company's compliance with guidelines designed to ensure that it generates only immaterial amounts, if any, of income that is subject to the taxing jurisdiction of the United States, the Company believes that it should be required to pay only immaterial amounts, if any, of U.S. corporate income tax, other than withholding tax on U.S. source dividend income. However, if the IRS successfully contended that the Company had material amounts of income that is subject to the taxing jurisdiction of the United States, the Company would be required to pay U.S. corporate income tax on that income, and possibly the U.S. branch profits tax. Even if the IRS successfully contended that the Company had material amounts of income that is subject to the taxing jurisdiction of the United States, the U.S.-Barbados tax treaty would preclude the IRS from taxing the Company's income, except to the extent that its income were attributable to a permanent establishment maintained in the United States. The Company does not believe that it has material amounts of income attributable to a permanent establishment in the United States. If the IRS successfully contended, however, that the Company did have income attributable to a permanent establishment in the United States, the Company would be subject to U.S. tax on that income. If Bermuda Re became subject to U.S. income tax on its income or if the Company became subject to U.S. income tax on more than immaterial amounts of income, the Company's income could also be subject to the U.S. branch profits tax. In that event, Group and Bermuda Re would be subject to taxation at a higher combined effective rate than if they were organized as U.S. corporations. The combined effect of the 35% U.S. corporate income tax rate and the 30% branch profits tax rate is a net tax rate of 54.5%. The imposition of these taxes would reduce the Company's net income.
HOLDERS OF THE COMPANY'S COMMON SHARES COULD BE SUBJECT TO U.S. TAXES ON UNDISTRIBUTED INCOME OF GROUP AND/OR BERMUDA RE.
o any U.S. tax payer who directly or indirectly through foreign entities owns shares of a foreign insurance company; or
o 20% or more of the value or voting power of the share capital of Bermuda Re is owned directly, indirectly or by attribution by U.S. taxpayers, or persons related to U.S. taxpayers, who are insured or reinsured by Bermuda Re; and
Generally, a U.S. shareholder will realize capital gain or loss on the sale or exchange of the common shares. However, the IRS could contend that special provisions of the Code apply and that the amount of any gain equal to the Company's allocable untaxed earnings and profits should be taxed as a dividend. If the IRS successfully contended that those provisions apply to the Company, shareholders would be taxed on that amount of gain at the rates applicable to ordinary income rather than the lower rates applicable to long-term capital gains. Assuming that none of the Company's non- U.S. subsidiaries have any RPII, the Company believes that these provisions of the Code should not apply to the disposition of any common shares by a U.S. shareholder who holds less than 10% of the outstanding common shares.
The Organization for Economic Cooperation and Development and the European Union are considering measures to limit harmful tax competition. These measures are largely directed at counteracting the effects of tax havens and preferential tax regimes in countries around the world. If these measures are adopted by a substantial number of member countries and if either Bermuda or Barbados is considered to be engaged in harmful tax competition, the Company might be subject to additional taxes, which would reduce its net income. In May 2000, the government of Bermuda made commitments to the OECD that reduce the likelihood of
Group and Bermuda Re currently are not subject to income or capital gains taxes in Bermuda. Both companies have received an assurance from the Bermuda Minister of Finance under The Exempted Undertakings Tax Protection Act 1966 of Bermuda to the effect that if any legislation is enacted in Bermuda that imposes any tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then that tax will not apply to them or to any of their operations or their shares, debentures or other obligations until March 28, 2016. This assurance does not prevent the application of any of those taxes to persons ordinarily resident in Bermuda and does not prevent the imposition of any tax payable in accordance with the provisions of The Land Tax Act of 1967 of Bermuda or otherwise payable in relation to any property leased to the Company. There are currently no procedures for extending these assurances. As a result, Group and Bermuda Re could be subject to taxes in Bermuda after March 28, 2016, which could reduce the Company's net income.