We are a holding company incorporated under the laws of the Cayman Islands with our principal executive office in Bermuda. We are a reinsurer of life insurance, annuities and annuity-type products. These products are written by life insurance companies and other financial institutions located principally in the United States. We refer to this portion of our business as Life Reinsurance North America. We also specialize in niche markets in developed countries and broader life insurance markets in the developing world. More recently, we have become actively engaged in the reinsurance of United Kingdom and Ireland traditional solutions business and annuity products. We refer to this portion of our business as Life Reinsurance International. Life Reinsurance North America and Life Reinsurance International are each a reporting operating segment. We directly issue variable life insurance and variable annuities and similar products to high net worth individuals and families for insurance, investment and estate planning purposes. In prior years, we referred to this portion of our business as Wealth Management, which was another reportable operating segment. As this business is no longer a material contributor to our results and we are no longer actively marketing this business, we have combined it with the Corporate and Other Segment for all periods presented. Other revenues and expenses not related to Life Reinsurance are reported in the Corporate and Other Segment. The segments are consistent with the way in which we use financial information to evaluate business performance and to determine the allocation of resources. We measure segment performance based on profit or loss from operations before income taxes.
On December 31, 2004, we completed the acquisition of the individual life reinsurance business of ING. We reinsured the liabilities of all of ING's individual life reinsurance business through a 100% coinsurance transaction. ING transferred to us assets of approximately $1.8 billion. Certain of these assets are held in trust to secure the reserve obligations of the business. Additionally, ING transferred to us certain operating assets associated with the business. During 2005, we fully integrated the ING acquisition with our existing U.S. traditional business and migrated our Charlotte based policy administration operations to Denver. We now administer our combined business with an enhanced version of the ING policy administration system, known as SAGE. With the acquisition of the ING life reinsurance business, we have grown to be one of the three largest life reinsurers serving the United States.
On December 22, 2003, we completed the acquisition of 95% of the outstanding capital stock of ERC Life Corporation (renamed Scottish Re Life Reinsurance Corporation), for $169.9 million in cash. Scottish Re Life Corporation's business consists primarily of a closed block of traditional life reinsurance.
In 2005, we established Scottish Re Capital Markets, Inc., which is a registered broker dealer, formed to leverage the experience and expertise we have gained through our own efforts to deal with Regulation XXX and other reserve requirements. We believe Scottish Re Capital Markets can successfully assist our clients, both large and small, to effectively and efficiently access the capital markets to meet their reserving needs.
o Operations: premiums, changes in the number of treaties and life insurance in force, investment results, claim frequency and severity trends, claims and benefit ratio and acquisition and expense ratios and operating earnings per share;
o Investments: credit quality/experience, stability of long-term returns, cash flows and asset and liability duration; and
o Financial condition: our financial strength ratings, financial leverage and growth in return on equity and book value per share.
o Net income was $130.2 million in 2005 compared to $71.4 million in 2004. Net income available to ordinary shareholders per diluted share was $2.64 in 2005 compared to $1.90 in 2004, an increase of 39%;
o Total revenues reached a record $2.3 billion, an increase of 182% compared to last year;
o On January 12, 2005, we completed a private offering of $325.0 million Collateral Facility Securities through Stingray Pass-Through Trust. This transaction allows us to use eligible assets as collateral in our reinsurance business and it will guarantee our ability and capacity to issue $325.0 million of funding agreements in the future, without any capital market or execution risk at the time of issuance;
o In July 2005, we completed a public offering of 5,000,000 non-cumulative perpetual preferred shares with net proceeds of $120.4 million;
o In December 2005, we completed two transactions that together provided approximately $2.0 billion in collateral to fund Regulation XXX reserve requirements that were assumed in connection with the acquisition of ING's individual life reinsurance business.
Our primary business is life reinsurance, which involves reinsuring life insurance policies, with premiums earned typically over a period of 10 to 30 years. Each year, however, a portion of the business under existing treaties
Our investment income includes interest earned on our fixed income investments and income from funds withheld at interest under modified coinsurance agreements or coinsurance funds withheld agreements. Under GAAP, because our fixed income investments are held as available for sale, these securities are carried at fair value, and unrealized appreciation/depreciation on these securities is not included in investment income on our statements of income, but is included in comprehensive income as a separate component of shareholders' equity. Realized gains and losses include gains and losses on investment securities that we sell during a period, write downs of securities deemed to be other than temporarily impaired and foreign currency exchange gains and losses.
We have six principal types of expenses: claims and policy benefits under our reinsurance contracts; interest credited to interest sensitive contract liabilities; acquisition costs and other insurance expenses; operating expenses; collateral finance facilities expense; and interest expense.
When we issue a life reinsurance contract, we establish reserves for claims and future policy benefits. These reserves are our estimates of what we expect to pay in claims and policy benefits and related expenses under the contract or policy. From time to time, we may change the reserves if our experience leads us to believe that benefit claims and expenses will ultimately be greater than the existing reserve. We report the change in these reserves as an expense during the period when the reserve or additional reserve is established.
Collateral finance facilities expense includes costs incurred on our Regulation XXX funding arrangements and other collateral finance facilities. See Note 8 to the Consolidated Financial Statements for additional information.
Interest expense consists of interest charges on our long-term debt and HyCU instruments.
In addition, our profits can be affected by a number of factors that are not within our control. For example, movements in interest rates can affect the volume of business that we write, the income earned from our investments, the interest we credit on interest sensitive contracts, the level of surrender activity on contracts that we reinsure and the rate at which we amortize deferred acquisition costs. Other external factors that can affect profitability include mortality experience that varies from our assumed mortality. In addition, while death claims are reasonably predictable over a period of many years claims become less predictable over shorter periods and are subject to significant fluctuation from quarter to quarter and year to year. Other factors include changes in regulation or tax laws which may affect the attractiveness of our products or the costs of doing business and changes in foreign currency exchange rates.
Given the nature of our business, our accounting policies require the use of judgments relating to a variety of assumptions and estimates. Because of the inherent uncertainty in the assumptions and estimates underlying these accounting policies under different conditions or assumptions, the amounts reported in our financial statements could be materially different. Our accounting policies are described in Note 2 to the Consolidated Financial Statements. We believe our most critical accounting policies include the establishment of reserves for future policy benefits, the capitalization and amortization of deferred acquisition costs, the valuation of present value of in-force business, the valuation of investment impairments, the valuation of embedded derivatives, estimates of premiums, the valuation of tax balances and the determination of whether we are the primary beneficiary of a variable interest entity.
and the long-term nature of the reinsurance contracts, the reserving process, while based on actuarial science, is inherently uncertain.
In the underwriting process, we perform procedures to evaluate the ceding company's process for compiling and reporting data. After entering into a reinsurance contract, we work closely with our ceding companies to help ensure information submitted by them is in accordance with the underlying reinsurance contracts. Additionally, we have a dedicated compliance team that performs extensive audits, including on-site audits and desk reviews, of the information provided by ceding companies. In addition to ceding company audits, we routinely perform analysis, at a treaty level, to compare the actual results of ceding companies against initial pricing and expected results. Generally, there have been few disputes or disagreements with ceding companies and most are resolved through normal administration procedures.
to historical trends in reported assumed premiums by treaty and other information and adjusted if appropriate. Actual results could differ from these estimates. The adjustments in a given period have generally not been significant to the overall premiums or results of operations.
Based on historical experience, the creditworthiness of ceding companies and our contractual right of offset, uncollectible assumed premium amounts have been infrequent and not material. Any provision for doubtful accounts would be recorded on a specific case-by-case basis.
Present value of in-force business is established upon the acquisition of a subsidiary and is amortized over the expected life of the business at the time of acquisition. The amortization each year will be a function of the gross profits or revenues each year in relation to the total gross profits or revenues expected over the life of the business, discounted at the assumed net credit rate. The determination of the initial value and the subsequent amortization require management to make estimates and assumptions regarding the future business results that could differ materially from actual results. Estimates and assumptions involved in the present value of in-force business and subsequent amortization are similar to those necessary in the establishment of reserves and amortization of deferred acquisition costs.
Our primary investments are in fixed maturity securities, including corporate and government bonds, asset and mortgage-backed securities. All our fixed maturity and preferred stock are classified as available-for-sale as defined in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115"). Available-for-sale securities are carried at fair value with the difference from amortized cost included in shareholders' equity as a component of accumulated other comprehensive income. The difference is net of related deferred acquisition costs and taxes. Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities that are not actively traded, fair values are estimated using values obtained from independent pricing services.
See "Accounting Pronouncements FSP FAS 115-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" for a discussion of potential changes to the requirements for other-than-temporary impairments in Note 2 to the Consolidated Financial Statements.
We utilize the asset and liability method of accounting for income taxes. Under this method, deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. At December 31, 2005, we have net operating tax losses of $615.5 million against which a valuation allowance of $18.5 million has been established. The deferral of benefits from tax losses is evaluated based upon management's estimates of the future profitability of our taxable entities based on current forecasts and the period for which losses may be carried forward. A valuation allowance may have to be established for any portion of a deferred tax asset that management believes will not be realized. Should the future income of these entities fall below expectations, a further valuation allowance would have to be established, which could be significant.
Our results of operations for the years ended December 31, 2003 and 2004 do not include the results of the acquisition of the ING individual life reinsurance business, which was completed on December 31, 2004. The results for the year ended December 31, 2003 include net income of $1.2 million in respect of the results of Scottish Re Life Corporation for the period from December 22, 2003 to December 31, 2003. All amounts are reported in thousands of United States dollars, except per share amounts.
Net realized gains were $12.0 million higher in 2005 than 2004. Improvements in the credit markets in 2005 resulted in less write downs for other than temporary impairments of available for sale securities - $2.4 million in 2005 as compared to $9.9 million in 2004. We also realized a gain of $2.2 million in 2005 compared to a loss of $2.2 million for the same period in 2004, resulting from the mark to market of an interest rate swap. This derivative
has not been designated as a hedge and, accordingly, changes in fair value are recorded in the determination of net income.
Included in the 2005 tax benefit is a $2.5 million expense related to a write-off of a deferred tax asset related to state income taxes. The 2005 income tax benefit is in respect of certain of our U.S. taxable entities and our U.K. entities, offset by income tax expenses arising on our Irish entity and other U.S. entities. At December 31, 2005, we believe that it is more likely than not that all gross deferred tax assets will reduce taxes payable in future years except for a valuation allowance of $18.5 million.
traditional solutions line of business in our Life Reinsurance North America Segment. The increase in fee income in 2004 arises principally from our acquisition of Scottish Re Life Corporation. The primary drivers of the increase in investment income in 2004 are the impact of the growth in our invested assets, which arises from business growth and acquisition, net proceeds on our offering of ordinary shares in July 2003, our HyCU offering in the fourth quarter of 2003 and trust preferred debt offerings in the fourth quarter of 2003 and the second quarter of 2004.
During 2003, we decided to discontinue our Wealth Management operations in Luxembourg. We have transferred our Luxembourg Wealth Management business to third parties, closed the Luxembourg office and are in the process of liquidating our Luxembourg subsidiary. We have reported the results of the Luxembourg wealth management activities as discontinued operations. Losses incurred in respect of these operations in 2004 and 2003 amounted to $0.2 million and $2.0 million, respectively.
The 2004 income tax benefit is in respect of certain of our U.S. taxable entities and our U.K. and Irish entities, offset by income tax expenses arising on our other U.S. entities. Included in the 2004 income tax benefit is $1.7 million in respect of U.S. state taxes and $10.0 million arising in our Irish entity relating to the acquisition of the ING individual life business. In 2004, we established reserves of $3.3 million in respect of certain tax positions.
Net investment income increased by $135.5 million, or 66% in 2005 compared to 2004. The increase is due to the growth in our average invested assets base because of the ING acquisition, Regulation XXX financing transactions, increased operating cash flows and additional trust preferred securities issued in December 2004.
On the portfolio managed by our external investment managers, the yields on fixed rate assets remained flat at 5.2% in, 2005 compared to 2004. Yields on floating rate assets which are indexed to LIBOR increased to 4.9% in 2005 from 3.4% in 2004, and the yield on our cash and cash equivalents increased to 3.9% in 2005 from 1.8% in 2004.
In 2005, interest credited to interest sensitive contract liabilities increased by 25% to $133.0 million from $106.5 million in 2004. The increase is due to interest credited on new reinsurance treaties and increases in interest credited on existing treaties due to increasing average liability balances. Interest sensitive contract liabilities were $3.9 billion at December 31, 2005 in comparison with $3.2 billion at December 31, 2004.
The collateral finance facility costs associated with the Regulation XXX financing transactions completed in 2005 contributed to the significant increase in the collateral finance facilities expense in 2005. These facilities are described in Note 8 to the Consolidated Financial Statements.
Net investment income increased $70.3 million, or 52% in 2004 as compared to 2003. The increase is due to the growth in our average invested assets base and the favorable impact of marginally increased yields during 2004. At December 31, 2004, total invested assets in this segment, excluding those assets acquired in the purchase of ING, increased to $4.5 billion from $3.6 billion at December 31, 2003. On the portfolio managed by our external investment managers the yields on fixed rate assets less cash were 5.2% and 5.1% for 2004 and 2003, respectively. Yields on floating rate assets are indexed to LIBOR. The yield on our floating rate assets less cash remained flat at 3.4% in 2004 compared to 2003, and the yield on our cash and cash equivalents increased to 1.8% in 2004 from 1.0% in 2003. In 2004, the market value of floating-rate assets increased to $963.8 million, excluding those assets acquired in the purchase of ING, from $301.8 million in 2003 as a result of our increased floating rate liabilities.
Interest credited to interest sensitive contract liabilities was $17.4 million higher in 2004 than 2003. During 2003, we incurred $12.5 million due to revised reporting by a ceding company client in connection with two fixed annuity reinsurance contracts. Excluding this charge, interest credited increased by 6% in comparison with the 2003. Interest credited includes interest in respect of funding agreements. The amounts due on funding agreements are included in interest sensitive contract liabilities on our balance sheet and amount to $500.6 million at December 31, 2004 in comparison with $330.7 million at December 31, 2003. Interest credited on these agreements was $9.0 million in 2004 in comparison with $2.4 million in 2003. Interest sensitive contract liabilities amounted to $3.2 billion at December 31, 2004 in comparison with $2.6 billion at December 31, 2003.
Operating expenses increased by 113% to $18.4 million in 2004 as compared to 2003. Operating expenses as a percentage of operating revenues increased in 2004 to 2.7% from 2.3% in 2003. The increase is primarily the result of the acquisition of Scottish Re Life Corporation, additional personnel costs incurred as we continue to grow our business and the costs necessary to meet the requirements of the Sarbanes Oxley Act of 2002. The costs of Scottish Re Life Corporation include the cost of the transition services agreement with GE ERC of $2.4 million. Total employees in this segment have grown from 64 at December 31, 2003 to 91 at December 31, 2004.
The interest and costs of the collateral finance facility described in Note 8 to the Consolidated Financial Statements are included in collateral finance facility expenses and amounted to $2.7 million in 2004.
Investment income in 2005 increased by $1.5 million, or 15% compared to 2004 due to the investment income earned on the proceeds of additional capital contributed to this segment in December 2004 and June 2005.
During 2005, acquisition costs and other insurance expenses increased by $3.1 million or 18% to $20.7 million from $17.6 million in 2004. Acquisition costs include the amortization of the present value of in-force business. Acquisition costs for 2005 included $4.3 million due to revised reporting received on our share of two Lloyd's of London life syndicates and the write-off of an uncollectible receivable of $1.2 million. In 2004, we recognized profit commission income of $1.8 million arising from a run off book of business and also included $2.4 million expense relating to our share of two Lloyd's of London life syndicates.
Operating expenses have increased by 34% to $25.3 million in 2005 as compared to 2004. The primary drivers of the increase is $3.0 million relating to consulting fees for the review, design and implementation of processes and controls required to assist us in the remediation of the material weakness in internal controls noted in 2004. The remaining increase is principally related to increased personnel costs as resources have been added as we continue to grow our business and include costs for recruitment expenses and professional expenses incurred in addressing implementation of the requirements of the Sarbanes Oxley Act of 2002 and United Kingdom regulatory changes. The number of employees in this segment has grown as we continue to strive to grow our business in existing and prospective markets.
Investment income arises in the Corporate and Other Segment on capital not specifically allocated to the Life Reinsurance North America or Life Reinsurance International Segments. Investment income will increase or decrease as we raise capital and deploy it in our operating segments. Fee income and acquisition expenses arise from our wealth management operations.
Operating expenses include the costs of running our principal office in Bermuda, compensation and other costs for our Board of Directors and legal and professional fees, including those in respect of corporate governance legislation. Operating expenses have increased by 137% to $41.4 million in 2005 from $17.5 million in 2004. The
The collateral finance facilities expense consists of a portion of the put premium and amortization of facility costs on the Stingray Investor Trust described in Note 8 to the Consolidated Financial Statements. Expenses related to the proportion of the Stingray Investor Trust utilized in 2005 have been allocated to the Life Reinsurance North America segment.
At December 31, 2005, the portfolio controlled by us consisted of $6.7 billion of fixed income securities, preferred stock and cash. The portfolio controlled by us excludes the assets held by ceding insurers under modified coinsurance and funds withheld coinsurance arrangements. The majority of these assets are traded, however, $452.9 million represent investments in private securities. Of the total portfolio controlled by us, $5.4 billion represented the fixed income and preferred stock portfolios managed by external investment managers and $1.3 billion represented other cash balances. At December 31, 2004, the portfolio controlled by us consisted of $4.3 billion of fixed income securities, preferred stock and cash. The majority of these assets are traded, however, $330.3 million represented investments in private securities. Of the total portfolio, $3.5 billion represented the fixed income and preferred stock portfolio managed by external investment managers and $752.5 million represented other cash balances. The data in the tables below exclude the assets held by ceding insurers under modified coinsurance and funds withheld coinsurance agreements.
The following tables present the estimated fair values and gross unrealized losses for the fixed maturity investments and preferred stock that have estimated fair values below amortized cost as of December 31, 2005 and 2004, respectively. These investments are presented by class and grade of security, as well as the length of time the related market value has remained below amortized cost.
At December 31, 2005, our fixed income portfolio had 2,493 positions and $59.2 million of gross unrealized losses. No single position had an unrealized loss greater than $0.5 million. There were $25.5 million of unrealized gains on the remainder of the portfolio. There were 127 private securities in an unrealized loss position totaling $4.3 million. At December 31, 2004, our fixed income portfolio had 1,773 positions and $12.0 million of gross unrealized losses. No single position had an unrealized loss greater than $0.9 million. There were $42.1 million of unrealized gains on the remainder of the portfolio. There were 44 private securities in an unrealized loss position totaling $0.7 million.
We believe that the analysis of each security whose price has been below market for greater than twelve months indicated that the financial strength, liquidity, leverage, future outlook, and our ability and intent to hold the security until recovery support the view that the security was not other-than-temporarily impaired as of December 31, 2005. The unrealized losses on fixed maturity securities are primarily a result of rising interest rates, changes in credit spreads and the long-dated maturities of the securities. Additionally, as at December 31, 2005, approximately 98% of the gross unrealized losses are associated with investment grade securities.
Unrealized losses on securities that have been in an unrealized loss position for periods greater than two years amounted to $1.1 million at December 31, 2005 and $2.1 million at December 31, 2004. Unrealized losses on non-investment grade securities amounted to $1.3 million and $2.1 million at December 31, 2005 and December 31, 2004, respectively. Of these amounts, non-investment grade securities with unrealized losses of $0.1 million at December 31, 2005 and $1.0 million at December 31, 2004 had been in an unrealized loss position for a period
greater than one year, of which there was none at December 31, 2005 and $1.0 million at December 31, 2004 had been in an unrealized loss position for periods greater than 2 years.
The following tables illustrate the industry analysis of the unrealized losses at December 31, 2005 and 2004:
The expected maturity dates of our fixed maturity investments that have an unrealized loss at December 31, 2005 and 2004 are presented in the table below.
At December 31, 2005, there were 1,698 securities with unrealized loss positions, with no security having an unrealized loss greater than $0.5 million. At December 31, 2004, there were 647 securities with unrealized loss positions with no securities having an unrealized loss greater than $0.9 million. The increase in the number of securities with unrealized losses is primarily attributable to increases in interest rates.
We use various sophisticated asset/liability management processes to provide adequate liquidity over the lives of the liabilities and to limit exposure to changes in interest rates, adverse credit default experience and currency risk.
Liquidity expectations and requirements vary with the type of liability. For liabilities with potentially greater liquidity demands, we select assets to make the corresponding portfolios more liquid and run more frequent simulations reflecting updated experience.
At December 31, 2005, funds withheld at interest were in respect of seven contracts with five ceding companies. At December 31, 2004, funds withheld at interest were in respect of seven contracts with four ceding
We believe cash flows from operations will be positive over time. However, they may be positive or negative in any one period depending on the amount of new life reinsurance business written, the level of ceding commissions paid in connection with writing that business, the level of renewal premiums earned in the period and the timing of receipt of reinsurance receivables and settlement of reinsurance payables. To address the risk that operating cash flows may not be sufficient in any given period we maintain a high quality, fixed maturity portfolio with positive liquidity characteristics. These securities are available for sale and can be sold to meet obligations if necessary.
Net cash used in investing activities was $1.9 billion and $479.9 million in 2005 and 2004, respectively. The increase in cash used in investing activities and, in particular, the purchases of fixed maturity securities, are primarily related to the investment of the proceeds of the ING acquisition, the collateral finance facilities and the excess cash generated by operating and financing activities. In 2004 we received $414.0 million in cash on the completion of the ING acquisition.
Net cash provided by financing activities was $2.1 billion in 2005 and $937.5 million in 2004. The increase was principally due to the receipt of proceeds on our collateral finance facilities and the issuance of ordinary shares and non-cumulative perpetual preferred shares during 2005.
We are a holding company whose primary uses of liquidity include, but are not limited to, the immediate capital needs of our operating companies, dividends paid to our shareholders and interest payments on our indebtedness. See Note 10, "Debt Obligations" in the Notes to the Consolidated Financial Statements. The primary sources of our liquidity include proceeds from our capital raising efforts, interest income on corporate investments and dividends from operating subsidiaries. As we continue our expansion efforts, we will continue to be dependent upon these sources of liquidity.
Historically, we have generated positive net cash flows from operations. However, in the event of significant unanticipated cash requirements beyond normal liquidity, we have multiple liquidity alternatives available based on market conditions and the amount and timing of the liquidity need. These options include borrowings under committed credit facilities, the ability to issue long-term debt, capital securities or common equity and, if necessary, the sale of invested assets subject to market conditions.
The increase in capitalization at December 31, 2005 compared to December 31, 2004 is principally due to net proceeds of $174.1 million on the issuance of 7,660,000 ordinary shares (including an over allotment option of 1,410,000 shares), net proceeds of $168.3 million on the issuance of 5,000,000 non-cumulative perpetual preferred shares, the conversion of the 7% Convertible Junior Subordinated Note to ordinary shares and net income for the year ended December 31, 2005 of $130.2 million. These increases were partially offset by the net costs of the variable equity sale forward contracts of $13.8 million, decrease in other comprehensive income of $41.6 million and increase in dividends declared of $6.6 million. Other comprehensive income consists of the unrealized appreciation/depreciation on investments and the cumulative translation adjustment arising from the translation of Scottish Re Holdings Limited's balance sheet at exchange rates as of December 31, 2005.
See Notes 9, 10, 11 and 12 of the Consolidated Financial Statements for additional details on the items noted in the table.
o when Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re (Dublin) Limited or Scottish Re Limited enters into a reinsurance treaty with a U.S. customer, we must contribute
We also have a reverse repurchase agreement with a major broker/dealer. Under this agreement, we have the ability to sell agency mortgage backed securities with the agreement to repurchase them at a fixed price, providing the dealer with a spread that equates to an effective borrowing cost linked to one-month LIBOR. This agreement is renewable monthly at the discretion of the broker/dealer. At December 31, 2005 and 2004, there were no borrowings under this agreement.
ING is obligated to maintain collateral for the Regulation XXX and AXXX reserve requirements of the business we acquired from them for the duration of such requirements (which relate to state insurance law reserve requirements applying to reserves for level premium term life insurance policies and universal life policies). We will pay ING a fee based on the face amount of the collateral provided until satisfactory alternative collateral arrangements are made. In the normal course of business and our capital planning we are always looking for opportunities to relieve capital strain relating to XXX reserve requirements for our existing business, as well as, the business acquired from ING. We completed two financing solutions relating to these requirements in December 2005 and received a $6.7 million rebate of fees incurred in 2005.
On February 11, 2005, Orkney Holdings, LLC, a Delaware limited liability company, issued and sold in a private offering an aggregate of $850.0 million Series A Floating Rate Insured Notes due February 11, 2035 (the "Orkney Notes"). Orkney Holdings, LLC is organized for the limited purpose of holding the stock of Orkney Re, Inc., a South Carolina special purpose captive insurance company, and issuing the Orkney Notes. All of the common shares of Orkney Holdings, LLC are owned by Scottish Re (U.S.), Inc. Proceeds from this offering were used to fund the Regulation XXX reserve requirements for a defined block of level premium term life insurance policies issued between January 1, 2000 and December 31, 2003 reinsured by Scottish Re (U.S.), Inc. to Orkney Re, Inc. Proceeds from the Orkney Notes have been deposited into a series of trusts that collateralize the notes.
Interest on the principal amount of the Orkney Notes is payable quarterly at a rate equivalent to three month LIBOR plus 0.53%. At December 31, 2005, the interest rate was 5.07%. Any payment of principal, including by redemption, or interest on the Orkney Notes is sourced from dividends from Orkney Re, Inc. and the balances available in a series of trust accounts. Dividends may only be made with the prior approval of the Director of Insurance of the State of South Carolina in accordance with the terms of its licensing orders and in accordance with applicable law. The Orkney Notes also contain a customary limitation on lien provisions and customary events of default provisions, which, if breached, could result in the accelerated maturity of the Orkney Notes. Orkney Holdings, LLC has the option to redeem all or a portion of the Orkney Notes prior to and on or after February 11, 2010, subject to certain call premiums.
Interest on the principal amount of the Orkney II Notes is payable quarterly at a rate equivalent to three month LIBOR plus 0.425% for the Series A-1 Notes, three month LIBOR plus 0.73% for the Series A-2 Notes, and three month LIBOR plus 3.0% for the Series B Notes. At December 31, 2005, the interest rate on the Series A-1 Notes was 4.96%, Series A-2 Notes was 5.27%, and Series B Notes was 7.50%. The Orkney II Notes also contain a customary limitation on lien provisions and customary events of default provisions, which, if breached, could result in the accelerated maturity of the Orkney II Notes. Orkney Re II plc has the option to redeem all or a portion of the Orkney II Notes prior to and on or after February 11, 2007, subject to certain call premiums.
cash equivalents. Our consolidated statements of income show the investment return of Orkney II Re plc as investment income and the cost of the facility is reflected in collateral finance facilities expense.
On December 22, 2005, we entered into a second collateral finance facility with HSBC Bank USA, N.A ("HSBC II"). This facility is a 20 year collateral finance facility that provides up to $1.0 billion of Regulation XXX collateral support for the business acquired from ING and can be used to collateralize reinsurance obligations under inter-company reinsurance agreements. Simultaneously, we entered into a total return swap with HSBC Bank USA, N.A. under which we are entitled to the total return of the investment portfolio of the trust established for this facility. In accordance with FIN 46R the trust is considered to be a variable interest entity and we are deemed to hold the primary beneficial interest in the trust. As a result, the trust has been consolidated in these financial statements. The assets of the trust have been recorded as fixed maturity investments and cash and cash equivalents. Our consolidated statements of income show the investment return of the trust as investment income and the cost of the facility is reflected in collateral finance facilities expense. The creditors of the trust have no recourse against our general assets.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has agreed with Scottish Re (U.S.), Inc. that it will (1) cause Scottish Re (U.S.), Inc. to maintain capital and surplus equal to the greater of $20.0 million or such amount necessary to prevent the occurrence of a Company Action Level Event under the risk-based capital laws of the state of Delaware and (2) provide Scottish Re (U.S.), Inc. with enough liquidity to meet its obligations in a timely manner.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has agreed with Scottish Re Life Corporation that it will (1) cause Scottish Re Life Corporation to maintain capital and surplus equal to at least 175% of Company Action Level RBC, as defined under the laws of the state of Delaware and (2) provide Scottish Re Life Corporation with enough liquidity to meet its obligations in a timely manner.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Re Group Limited have agreed with Scottish Re Limited that in the event Scottish Re Limited is unable to meet its obligations under its insurance or reinsurance agreements, Scottish Annuity & Life Insurance Company (Cayman) Ltd. (or if Scottish Annuity & Life Insurance Company (Cayman) Ltd. cannot fulfill such obligations, then Scottish Re Group Limited will assume all of Scottish Re Limited's obligations under such agreements.
The following table shows our contractual obligations and commitments as of December 31, 2005, other then those arising from our reinsurance business including our payments due by period:
Our mezzanine equity is described in Note 11 to the Consolidated Financial Statements and consists of 5,750,000 HyCUs. On February 15, 2007, we shall receive proceeds from the sale of our ordinary shares of $143.8 million as required by the purchase contract forming part of each HyCU. The proceeds from this offering will be used by us to repay the convertible preferred shares of $143.8 million on May 21, 2007. The table above includes contractual payments and dividends due on the convertible preferred shares.
Life claims payable are included in "Reserve for Future Policy Benefits" in the Consolidated Balance Sheet. Life claims payable include benefit and claim liabilities for which we believe the amount and timing of the payment is essentially fixed and determinable. Such amounts generally relate to incurred and reported death claims and amounted to $560.8 million at December 31, 2005. As of December 31, 2005, reserves for future policy benefits of approximately $3.5 billion related primarily to reinsurance of traditional life insurance and related policies and approximately $3.9 billion of interest sensitive contract liabilities, primarily deferred annuities, have been excluded from this table because these amounts are generally comprised of policies or contracts where (i) we are not currently making payments and will not make payments in the future until the occurrence of an insurable event, such as death
Statement of Financial Position 03-1"Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Insurance Contracts and for Separate Accounts" ("SOP 03-01")
In September 2004, EITF 04-8 was issued. EITF 04-8 requires that certain instruments with embedded conversion features that are contingent upon market price triggers be included in diluted earnings per share calculations regardless of whether the contingency has been met. Our 4.5% senior convertible notes are convertible on the basis of a market price trigger. On October 26, 2004, we amended the terms of these notes so that we are required to settle the principal amount of $115.0 million in cash on conversion or repurchase. As a result, we continue to apply the treasury stock method in calculating diluted earnings per share for amounts in excess of the principal of $115.0 million. Also see Note 10 in the Consolidated Financial Statements.
In December 2003, the FASB revised FIN 46, which was originally issued in January 2003. FIN 46R addresses whether certain types of entities, referred to as variable interest entities ("VIEs"), should be consolidated in a company's financial statements. A company must consolidate a VIE in which it has an ownership, contractual or other financial interest if it is determined to be the primary beneficiary. A primary beneficiary has a variable interest that will absorb a majority of the expected losses if they occur, receive a majority of the entity's expected returns, or both. We are the primary beneficiary of the collateral finance facilities discussed in Note 8 to the Consolidated Financial Statements, and have consolidated the variable interest entities in accordance with FIN 46R. The Investor Trust, discussed in Note 8 to the Consolidated Financial Statements, is a variable interest entity but we are not considered to be the primary beneficiary of interest in the Investor Trust. Accordingly, it is not consolidated in accordance with FIN 46R.
otherwise promulgated. SFAS No. 154 is effective for fiscal years beginning after December 15, 2005. SFAS No. 154, upon adoption, is not expected to have a material effect on our results of operations or financial position.
In February 2006, the FASB issued SFAS No. 155, which resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." SFAS No. 155, among other things, permits the fair value remeasurement of any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133; and establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation. SFAS No. 155 is effective for all financial instruments acquired or issued in a fiscal year beginning after September 15, 2006. We are currently assessing the impact of SFAS No. 155 on our results of operations and financial position.
o changes in the rate of policyholder withdrawals or recapture of reinsurance treaties;
o the risk that our retrocessionaires may not honor their obligations to us;