The following table sets forth the selected consolidated financial data for ESG Re Limited and subsidiaries. The financial statements included herein represent the financial performance and results of the Company as an insurer and a reinsurer for the years ended December 31, 2000, 1999 and 1998, as a reinsurer and reinsurance management company for the year ended December 31, 1997 and as a reinsurance management company only for 1996.
THE FOLLOWING IS A DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITION, RESULTS OF OPERATIONS, LIQUIDITY AND CAPITAL RESOURCES OF ESG RE LIMITED AND ITS SUBSIDIARIES ("THE COMPANY" OR "ESG RE"). THIS DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES.
Effective June 30, 2000, the Company divested its Health Care Division. Net losses of $5.2 million in 2000 and $12.8 million in 1999, representing primarily the costs incurred to establish the division and to position the related health care products, are being reported as discontinued operations.
As part of the divestment, the Company retained 8,000,000 convertible preference shares, par value $1 per share, in this operation. The book value of $8.0 million for the Company's equity position is included in other investments.
For the year ended December 31, 2000, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $255.0 million, of which it placed $10.0 million with co-reinsurers and retroceded $33.1 million, resulting in $211.9 million net premiums written. For the year ended December 31, 1999, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $347.9 million, of which it placed $14.9 million with co-reinsurers and retroceded $19.8 million, resulting in $313.2 million net premiums written. The amount placed with co-reinsurers declined to 3.9% of total premiums managed in 2000 compared to 4.3% in 1999.
Gross and net premiums written and net premiums earned for the 12 months ended December 31, 2000 and 1999 were as follows:
Total premiums managed for the 12 months ended December 31, 2000 consisted of the following:
- Renewal Business--approximately $124.5 million, or 48.9%, of total premiums managed was generated from renewal business.
During 2000, the Company had reductions in total premiums managed on the 1999 and 1998 underwriting years of $37.1 million, equivalent to 6.6% of gross premium written in these years. This represents differences between estimates made at the time contracts were written and actual amounts reported by ceding companies. Such changes are recorded in the period in which the actual amounts are determined.
Underwriting results for the 12 months ended December 31, 2000 and 1999, by line of business and in total, were as follows:
After rapid growth in 1999 in its medical portfolio, the Company recognized in the second quarter of 2000 that much of this business was not profitable business. Actions taken at that time included the centralizing of underwriting, the cessation of writing North American medical business sourced from the London office, strengthening the Company's terms of trade, effecting rate increases and being more selective on business accepted. As a result, gross premiums written on medical business declined 31% during the year. The Company will maintain its presence in the North American and Latin American markets but on a much more selective basis. It will also continue to take every opportunity to diversify its product range.
year contributed $3.7 million to net earned premium with $17.1 million of loss and acquisition expense attached.
As a consequence of a reduction in premiums written, selectivity in business being written and growth in the partnership enterprise segment, more business was being sourced outside of the North American market in 2000 when compared to 1999. See Notes to the Consolidated Financial Statements.
The distribution of gross written premiums for years ended December 31, 2000 and 1999, is as follows:
The majority of management fee revenue in 2000 and 1999 consists of fees earned on those premiums managed for the Company's co-reinsurers.
The Company's investment portfolio in 1999 was negatively impacted by a general decrease in prices in the U.S. bond markets, which resulted in net investment losses being realized on sales of fixed income securities during the year
Total administrative expenses, which includes personnel costs, professional service fees, interest expense and other expenses, increased by $14.1 million, or 55%, from $25.7million in 1999 to $39.8million in 2000. The majority of the increase was due to the Company establishing a legal reserve of $8.4 million for costs associated with resolving disputes in respect of certain contracts and its investment in the Direct Response Marketing and Bancassurance lines of business.
The Company continued to incur significant expenses for professional services and for travel expenses in the development of its business. Personnel costs increased by $4.1 million from $9.0 million in 1999 to $13.1 million in 2000. The number of full time employees has increased from 121 at December 31, 1999 to 135 at December 31, 2000. The increase in employees was primarily in Direct Marketing, Bancassurance and in the centralized underwriting and claims operations.
Tax expense was nil for the year reflecting the losses reported.
For the year ended December 31, 1999, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $347.9 million, of which it placed $14.9 million with co-reinsurers and retroceded $19.8 million, resulting in $313.2 million net premiums written. For the year ended December 31, 1998, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $224.2 million, of which it placed $24.3 million with co-reinsurers and retroceded $4.3 million, resulting in $195.6 million net premiums written. The amount placed with co-reinsurers declined to 4.3% of total premiums managed in 1999 compared to 10.8% in 1998, as the Company amended two of its co-reinsurance agreements to enable business from certain markets to be retroceded to the reinsurers. In addition, the Company had one large medical account in North America, contributing $65 million in premium managed, which was retained 100% by ESG.
Underwriting results for the 12 months ended December 31, 1999 and 1998, by line of business and in total, were as follows:
Other business represents automobile warranty business ceded by a German company in which ESG made a 10% equity investment in 1998. In addition, property and casualty business written by the Company's subsidiary in Tbilisi, Georgia is included, on which the Company has a minimal risk retention.
As indicated previously, poor underwriting results on the medical line contributed to the increase in the loss and acquisition ratio from 89.1% in 1998 to 106.7% in 1999. The 1999 results are comprised of two underwriting years, with the 1998 underwriting year contributing earned premium of $78.8 million, carrying a loss and acquisition ratio of 118.4%. The 1999 underwriting year contributed $170.7 million, carrying a loss and acquisition ratio of 101.3%.
The operating expense ratios for the years ended December 31, 1999 and 1998, were calculated by expressing total administrative expenses net of corporate office expenses and health care division expenses, as a percentage of net premiums earned. For the year ended December 31, 1998, management fee revenue of $1.9 million was deducted from operating expenses due to the expense of administering the pool business of 1997 and prior underwriting years, which the Company previously managed as a reinsurance management services company. In addition, for the years ended December 31, 1999 and 1998, the Company deferred $1.3 million and $1.5 million respectively of expenses, which were identified by management as directly related to and, varying with, the volume of business generated. The deferral of such costs reflects a more appropriate matching of revenues with related expenses and improved the year-to-date combined ratios for years ended December 31, 1999 and 1998 by 0.5% and 1.5% respectively.
The majority of management fee revenue in 1999 and 1998 consists of fees earned on those premiums managed for the Company's co-reinsurers. During 1999, the Company adjusted downwards $1.0 million in estimated profit commissions due on pool underwriting years prior to 1998 following a re-evaluation of the pool results of those years.
Net investment income increased by $0.6 million from $12.9 million in 1998 to $13.5 million in 1999. The increase resulted from accelerated cash flows and more efficient management of short-term deposits. As of March 23, 2000, the Company's stock repurchase program has resulted in expenditure of $17.8 million of which $10.6 million was incurred in the fourth quarter of 1999. This will reduce investment income in 2000.
(2) In addition to the $3.2 million of loans provided to COMED, a further $7.8 million of equity investment and loans has been provided to three companies that are expected to generate or secure profitable reinsurance business for the Company.
The Company's investment portfolio in 1998 was positively affected by a general increase in prices in the U.S. bond markets, which allowed net investment gains to be realized on sales of fixed income securities during the year.
Professional service fees increased by $4.6 million from $3.6 million in 1998 to $8.2 million in 1999. Professional fees included $2.4 million in legal fees in respect of corporate compliance, standardization of policy contracts and management agreements, acquisitions and forensic audits. Audit and accountancy costs of $2.8 million were incurred in audit, accounting, tax advisory and corporate reporting services. Consulting expenses of $3.0 million were incurred in actuarial support, computer systems improvements, recruitment, due diligence and corporate communications.
Foreign exchange losses were $11 thousand in the 12 months ended December 31, 1999 compared to foreign exchange gains of $141 thousand for the 12 months ended December 31, 1998. These gains or losses are primarily unrealized and were incurred on the revaluation of assets and liabilities denominated in foreign currencies for reporting purposes. As the Company maintains a partial natural hedge, whereby foreign currency assets are held in the same currencies in which it must pay liabilities, the impact on cash flows from foreign exchange movements is reduced.
The fixed maturity investment portfolios as of December 31, 2000 and 1999 were as follows:
Operating activities provided net cash of $22.1 million for the year ended December 31, 1999 and used cash of $1.5 million for the year 2000. Cash flows from operations in future years may differ substantially from net income. As the Company only began to assume reinsurance risks for its own account in 1997, the Company has built up substantial loss reserves to meet future loss payments under reinsurance contracts. As reinsurance contracts mature, the Company will be required to pay out a higher percentage of incurred losses in loss payments, which affect cash flows.
The Company initiated a stock repurchase program in May 1999 to actively manage its capital base. As of March 15, 2001, the Company has repurchased 2,727,591 shares of its common stock, equivalent to 20.5% of the outstanding shares of the Company under its Common Stock Repurchase Program. The average purchase price was $6.74. The Company can buy a further 968,600 shares of its common stock under the existing program.
Reinsurance balances receivable decreased from $276.1 million as at December 31, 1999 to $241.6 million as at December 31, 2000. The decrease was due to the decline in gross reinsurance premiums written by the Company, which are recognized at the inception of the reinsurance contract, based upon information received from intermediaries and ceding companies. The Company compares estimated written premiums to actual premiums as reported by ceding companies on a monthly basis and differences are recorded in the period in which the actual amounts are determined.
Prepaid reinsurance premiums decreased from $9.1 million as at December 31, 1999 to $5.4 million as at December 31, 2000. During the year, the Company retroceded 13.6% of its gross written premiums to reinsurers compared to 6.3% in 1999, as the Company amended two of its co-reinsurance agreements to enable business from certain markets to be retroceded to the reinsurers. The Company has maintained the same levels of excess of loss protection in 2000 as was purchased in 1999.
At December 31, 2000, reserves for unpaid losses and loss expenses were $179.6 million compared to $136.9 million at December 31, 1999. This increase was directly the result of claims notifications received and reserve strengthening done in the later half of the year.
At December 31, 2000, unearned premium reserves were $148.1 million compared to $181.1 million at December 31, 1999. Unearned premium reserves are established to cover the unexpired period of contracts of reinsurance underwritten by the Company. At December 31, 2000, acquisition costs payable were $64.6 million compared to $73.1 million at December 31, 1999. The balance represents acquisition expenses due on gross reinsurance premiums written by the Company and is consistent with the decrease in written premiums.
The Company expects that its financial and operational needs for the foreseeable future will be met by funds generated from operations and the liquidity of its investment portfolio.
In support of its business, the Company enters into Letters of Credit and Trust Account arrangements with ceding companies. As at December 31, 2000, the Company had in total $95.8 million of outstanding Letters of Credit and Trust Accounts of which $73.4 million related to Letters of Credit issued and $22.4 million was issued in Trust Accounts. These arrangements were secured against the Company's fixed maturity investment portfolio. Effective January 1, 2001, the total Letters of Credit issued was decreased from $73.4 million to $50.1 million due to historical letters of credit expiring December 31, 2000. Further, in accordance with local regulatory requirements, the Company placed $20 million in a Trust Agreement in February, 2001.
On November 13, 2000, the Company was notified that Standard & Poor's lowered the long term counterparty credit and insurer financial strength ratings of the Company's reinsurance subsidiaries from BB+ to B+ citing concerns over poor operating results. An upward ratings adjustment will be a function of the Company's successful execution of its business strategy and the resultant improvement in operating earnings. To date, there has been no material impact from the rating change on the Company's ability to secure new and renewal business, but the Company cannot say with certainty that there will be no impact in the future.
Premiums written are estimated and recognized at the inception of the reinsurance contract, based upon information received from intermediaries and ceding companies. The Company compares estimated written premiums to actual premiums as reported by ceding companies on a periodic basis. The timeliness and frequency of ceding company reports vary considerably by ceding company, line of business and geographic area, therefore the actual ultimate premium written may not be known with certainty for prolonged periods. Differences between such estimates and actual amounts as reported by ceding companies are recorded in the period in which the actual amounts are determined.
The reserve for unpaid losses and loss adjustment expenses includes an estimate of reported case reserves and an estimate for losses incurred but not reported. Case reserves are estimated based on ceding company reports and other data considered relevant to the estimation process. The liability for losses incurred but not reported is based to a large extent on the expectations of ceding companies about ultimate loss ratios at the inception of the contracts, supplemented by industry experience and the Company's specific historical experience where available. As the Company has limited specific historical experience on a significant number of its programs on which to base its estimate of losses incurred but not reported, its reliance on ceding company expectations and industry experience is necessarily increased, which increases the uncertainty involved in the loss estimation process. The reserves as established by management are reviewed periodically, and adjustments are made in the periods in which they become known. Although management believes that an adequate provision has been made for the liability for losses and loss expenses, based on all available information, there can be no assurance that the ultimate losses will not differ significantly from the amounts provided.
Costs relating to the production of new business (primarily commissions and certain costs of marketing) are deferred and included in the deferred acquisition cost asset to the extent that such costs are recoverable from future related policy revenues. The deferred acquisition costs are being amortized over the periods in which the related premiums are earned. Such deferred costs are reviewed to determine if they are recoverable from future income, including investment income, and, if not considered recoverable, are charged to expense.
The Company and its subsidiaries file income tax returns as required by the laws of each country in which they operate. The Company accounts for income tax expenses and liabilities under the asset and liability method in accordance with Statement of Financial Accounting Standards Board ("SFAS") No. 109, "Accounting for Income Taxes." Deferred income taxes arise from the recognition of temporary differences between income reported for financial statement purposes and income for income tax purposes. These deferred taxes are measured by applying currently enacted tax rates. In addition, SFAS No. 109 requires the recognition of future benefits, such as for net operating loss carryforwards, to the extent that realization of such benefits is more likely than not.
The functional and reporting currency of the Company is U.S. dollars. Foreign currency receivables or payables that are denominated in a currency other than U.S. dollars are translated into U.S. dollars at the rates of exchange in effect at the balance sheet date. Revenues and expenses are translated into U.S. dollars using weighted average exchange rates for the period. The resulting exchange gains or losses are included in the results of operations. Exchange gains and losses related to the translation of investments available for sale are included in the net unrealized appreciation (depreciation) of investments, net of deferred income taxes, as a separate component of "accumulated other comprehensive income." Assets and liabilities related to foreign operations are translated into U.S. dollars at the exchange rate in effect at the balance sheet date; revenues and expenses are translated
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. As of December 31, 2000, the Company had no transactions that are covered by this statement.
The Company's investment portfolio at December 31, 2000 and 1999 is comprised of the following:
Proceeds from the sales of investments available for sale for the years ended December 31, 2000 and 1999 were $223.1 million and $325.1 million, respectively. Realized investment gains and losses for the years ended December 31, 2000, and 1999 were as follows:
Other investments represents equity investments in, and loans to, reinsurance- related enterprises, ceding companies or distribution channels that are expected to generate or secure additional profitable business for the Company. The loans bear interest at rates between 6% and 9% and are repayable between one and five years. Impairment reserves were provided against loans of $3.4 million advanced to COMED in 1999, under a $12 million loan commitment. The COMED loans were settled as part of the divestiture of the health care division.
managed premium is allocated. Management fees receivable at December 31, 2000, and 1999 consist of the following:
Activity in deferred acquisition costs for the years ended December 31, 2000, and 1999 is summarized as follows:
Under current Bermuda law, the Company is not required to pay taxes in Bermuda on either income or capital gains. Provision for income taxes consists of corporate and other applicable income taxes payable in the various jurisdictions in which the Company conducts its business including, but not limited to, Germany, Ireland, Canada and the United Kingdom. The components of income taxes for the years presented are as follows:
The actual income tax expense attributable to income for the three years in the period ended December 31, 2000 is based on the statutory tax rates in the Company's taxable jurisdictions, which range from 0% to approximately 44%.
The Company has entered into various employment contracts with terms of up to three years that have total minimum commitments of $3.1 million, excluding any performance bonuses that are determined by the Board of Directors of the Company. The contracts include various non-compete clauses following termination of employment. As of December 31, 1999, the minimum employee commitments were $7.9 million.
On August 10, 2000, the Board of Directors approved a plan for the divestiture of its Health Care Division. Implementation of that plan resulted in the divestiture of 4Sigma (formerly VVB Bermuda Limited) effective June 30, 2000, to affiliates of the Chief Executive Officer and senior management of the Health Care Division. The investors in 4Sigma include the Company, affiliates of the Chief Executive Officer of the Company ("CEO"), Dr. Gerald Moeller, previously a member of the board of ESG Re Limited and Chief Executive--Healthcare Division and former management of the Health Care Division. Terms comparable to those offered to the affiliates of the CEO were offered to non-related parties. The Company owns 8,000,000 convertible preference shares in 4Sigma. The book value of $8.0 million for the Company's equity position is included in other investments.
The operations of 4Sigma have entered into a strategic partnership with Bertelsmann/Springer for the marketing of its services to German health insurers. Currently, sales proposals have been made to three of the largest insurers with decisions due in April and May 2001. The expectation is that the group will be successful on at least one of the proposals. In the event none of the proposals are accepted, then the group will be in a position to revisit its business model and the Company would revalue its investment in 4Sigma.
Condensed summary operating results for the Health Care Division were as follows:
Additionally on August 10, 2000 the Board of Directors approved a plan to liquidate its majority-owned subsidiary in Indonesia. The Company does not expect to recover any debt or equity contributions advanced to and, expensed by, this subsidiary in previous periods. This operation reported a net loss of $1.1 million on revenues of $.6 million in 1999 and a net loss of $.2 million on revenues of $.4 million in 2000.
ESG Re and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. ESG Re does not believe that such litigation will have a material adverse effect on its financial condition, future operating results or liquidity.
judicial confirmation of its rescission. On February 5, 2001, Odyssey Re filed a response. On March 21, 2001, the Company filed a motion for summary judgment. The Company has also given notice to rescind the 1999 account. At this time, the Company is unable to determine the amount of its exposure and the possible effect upon the Company's business, financial condition or results of operation from these two contracts.
A summary of the status of the Company's outstanding stock options as of December 31, 2000, 1999 and 1998 is presented below:
The Company applies APB Opinion 25 and Related Interpretations in accounting for stock based compensation. Had the compensation expense for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those plans consistent with the method described in SFAS No. 123, the Company's net loss and earnings per share would have been adjusted to the proforma amounts indicated below:
the number of Common Shares covered by each award. An S-8 Registration Statement was filed and effective on March 13, 2000 covering this Plan.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," requires that an enterprise disclose information about its operating segments. The Company considers its reinsurance activities to constitute a single operating segment on the basis that such activities are monitored and evaluated primarily on a company wide basis. Investments are held in support of reinsurance activities and are considered to be a part of the reinsurance segment
The following table provides summary financial information by the Company's lines of business and geographic regions of the reinsurance segment. Revenues are allocated geographically on the basis of the location of the legal entity that retains the reinsurance risk.
Under Bermuda law, the Company 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, issued share capital (common share capital) and share premium (additional paid-in capital) accounts.