(1) 1996 balance sheet data and statutory data for all years prior have been restated to reflect the July 1997 Merger. See "Management's Discussion and Analysis of the Company's Results of Operations and Financial Condition."
The Company's net premiums earned decreased 2.7% to $2,418.9 million for the year ended December 31, 1998, from $2,486.1 million in 1997. The decrease in premiums earned was primarily attributable to the decrease in net premiums written, partially offset by the timing of premiums earned on business in force.
Pre-tax net investment income decreased 2.3% to $417.5 million for the year ended December 31, 1998, from $427.5 million in 1997. This decrease was primarily attributable to repositioning the Company's investment portfolio into tax-exempt securities, in addition to overall lower interest rates in the 1998 period, as compared to the 1997 period. The Company's after-tax net investment income increased 1.4% to $305.3 million for the year ended December 31, 1998, from $301.2 million in 1997.
Federal and foreign income tax expense was $82.4 million for the year ended December 31, 1998, compared to a tax benefit of $3.4 million in 1997. The increase in Federal and foreign taxes was primarily attributable to higher pre-tax income in the 1998 period, in addition to the recognition of $62.1 million of income tax benefits in 1997, representing net operating loss carry-forwards and the reversal of a deferred federal income tax asset valuation allowance associated with the U.S. Branch's reserve discount in the 1997 period, which reduced the corresponding federal income tax expense.
YEAR ENDED DECEMBER 31, 1997, COMPARED WITH YEAR ENDED DECEMBER 31, 1996
Net losses and LAE incurred increased 47.0% and $1,716.3 million for the year ended December 31, 1997, from $1,167.8 million in 1996. On a pro forma basis, 1996 net losses and LAE incurred were $1,675.1 million, resulting in an increase of 2.5%. This increase was primarily attributable to an overall increase in the proportion of treaty net premiums earned in the 1997 period, which carries a higher overall loss ratio than facultative business.
Net income to common stockholders was $221.4 million for the year ended December 31, 1997, compared to net income of $111.7 million in 1996.
The total financial statement value of investments and cash increased to $7,801.3 million at December 31, 1998, from $7,673.4 million at December 31, 1997, primarily due to cash flows from operating activities, and an increase in the fair value of investments held. The financial statement value of the investment portfolio at December 31, 1998, included a net increase from amortized cost to fair value of $244.5 million for debt and equity investments, compared to a net increase of $181.5 million at December 31, 1997. At December 31, 1998, the Company recognized a cumulative unrealized gain of $158.9 million due to the net adjustment to fair value on debt and equity investments, after applicable income tax effects, which was reflected as a separate component of accumulated other comprehensive income. This
The Company's reinsurance/insurance subsidiaries' statutory surplus increased to $2,631.1 million at December 31, 1998, from $2,323.4 million at December 31, 1997. Operating leverage, as measured by such subsidiaries' premiums-to-surplus ratio, on an annualized basis was 0.87 to 1 and 1.07 to 1 at December 31, 1998, and December 31, 1997, respectively.
As a holding company, the Company is dependent on dividends and tax allocation payments, primarily from American Re-Insurance, to meet its short- and long-term liquidity requirements, including its debt service obligations. It is the Company's understanding that it is Munich Re's intention to further strengthen the capital position of the Company by allowing net income to be retained; therefore, at this time, no cash dividends on the Company's common stock are anticipated.
respectively. Cash and short-term investments are maintained for liquidity purposes and represented 3.5%, 8.4% and 7.9%, respectively, of total financial statement investments and cash on such dates.
In October 1998, A.M. Best affirmed its rating of American Re-Insurance of "A++ (Superior)", the highest of A.M. Best's 15 qualitative ratings. "A++ (Superior)" is assigned by A.M. Best to those companies which, in its opinion, have demonstrated superior overall performance when compared to the standards established by A.M. Best and have demonstrated a very strong, ability to meet their policyholder and other contractual obligations over a long period of time. According to A.M. Best, the objectives of its rating system are to evaluate the factors affecting overall performance of an insurance or reinsurance company and to provide A.M. Best's opinion of the company's relative financial strength and ability to meet its obligation to policyholders currently and in the future.
In February 1999, Standard & Poor's Corporation ("S&P") affirmed American Re-Insurance's claims paying ability rating of "AAA," which is the highest of S&P's ratings. A rating of "AAA" is assigned by S&P to those companies which, in its opinion, have superior financial security on an absolute and relative basis and their capacity to meet policyholder obligations is overwhelming under a variety of economic and underwriting conditions.
In April 1998, Moody's Investors Service ("Moody's") affirmed American Re-Insurance's financial strength rating of "Aaa," which is the highest of Moody's 19 qualitative ratings. A rating of "Aaa" is assigned by Moody's to those companies which, in Moody's opinion, offer exceptional financial security.
IMPACT OF THE YEAR 2000 PROBLEM. The "Year 2000 problem" refers to the potential failure of computer software and embedded computer chips to properly recognize the year 2000 and later dates, because such dates are represented only by the last two digits of the year and may be interpreted during computer operations as preceded by 19 rather than 20. The Company has been aware of the Year 2000 problem for several years and has assigned a team of dedicated in-house information technology staff, working with retained consultants and designated representatives from each of the Company's major business areas, to review all critical systems for their Year 2000 compliance and to correct all problems identified.
THE COMPANY'S STATE OF READINESS. Some of the Company's Year 2000 problems have been eliminated in the ordinary course of ongoing upgrades to the Company's technology platforms. However, in order to address the remainder of the Company's Year 2000 non-compliant systems (e.g. certain mainframe systems, old software applications, and some facilities equipment), in 1997 management initiated a Year 2000 Compliance Program consisting of 5 phases: Phase 1--Planning, which consisted of defining the project scope, organizing a project team, developing a detailed project plan and obtaining management approval; Phase II--Inventory/Impact Analysis, which consisted of inventorying all of the Company's technology as well as non-technology-based systems and equipment containing embedded chips, determining whether there exists a potential Year 2000 problem, and analyzing the impact on the Company of such problem, and which resulted in the creation of a Year 2000 database including all products and services that need to be evaluated for Year 2000 compliance; Phase III--Renovation, which consists of repairing or replacing critical items that are not Year 2000 compliant; Phase IV--Vendor Compliance, pursuant to which, among other things, the Company is seeking representations from vendors that their products are
Year 2000 compliant or modifications to make such products Year 2000 compliant and has retained research consultants to independently verify vendors' Year 2000 compliance; and Phase V--Enterprise Wide Testing and Compliance Certification, which consists of performing a final integrated testing of the corrected business operations and underlying technical infrastructure in a controlled environment. The Company completed Phase I in January 1998 and Phase II in May 1998. The Company is currently in the final stages of Phases III, IV and V, which are expected to be completed by July 1999.
COSTS ASSOCIATED WITH YEAR 2000 ISSUES. Year 2000 specific expenditures for 1998, not including in-house resources, were approximately $5.1 million. These expenses were paid out of working capital and
The Company has exposure to movements in various currencies around the world, particularly the Belgian Franc and the Australian dollar. Changes in currency exchange rates primarily affect the international components of the Company's balance sheet, income statement, and statement of cash flows. This exposure is substantially mitigated because the Company's losses incurred and loss reserves are generally denominated in the same currency as premiums and invested amounts. At December 31, 1998, the Company had no material currency rate exposure.
In addition to interest rate and foreign exchange risk, the Company's common equity portfolio, aggregately $545.2 million at December 31, 1998, is subject to changes in value based on changes in equity prices. To hedge a portion of its exposure to movements in its equity prices, the Company entered into options contracts with a notional value of $18.5 million at December 31, 1998. A change in the fair value of the Company's equity portfolio would affect the calculation of the Company's other comprehensive income in its financial statements.
The Company has recently established American Re Capital Markets, Inc. to provide its clients with integrated solutions for mitigating risk in the financial markets. Currently, American Re Capital Markets is principally engaged in transactions in the weather derivative market, which exposes the Company to movement in weather related indexes. As of December 31, 1998, the Company was a party to 59 contracts with a notional value of $110.8 million. At December 31, 1998, the maximum payment amount of these contracts was $61.3 million, and the maximum receivable amount was $60.7 million.
Certain shortcomings are inherent in the method of analysis presented in the computation of the fair value of fixed rate instruments. Actual values may differ from those projections presented should market conditions vary from assumptions used in the calculation of the fair value. In the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in the calculation of fair value. Finally, the desire of many borrowers to repay their fixed-rate mortgage loans may decrease in the event of interest rate increases.