Life Re's principal operations are conducted from approximately 51,000 square feet of leased office space located at 969 High Ridge Road, Stamford, Connecticut 06905. The lease with respect to such space expires on September 30, 2004. The rental expense paid by Life Re under the lease during 1998 was $1.0 million.
With the exception of historical information, the matters contained in the following analysis are "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but are not limited to, projections of earnings, revenues, income or loss, capital expenditures, plans for future operations and financing needs or plans, as well as assumptions relating to the foregoing. The words "expect", "project", "estimate", "predict", "anticipate", "believes" and similar expressions are also intended to identify forward-looking statements. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results, performance and achievements could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. Such factors include, but are not limited to, the uncertainties relating to general economic and business conditions which may impact the reinsurance marketplace; changes in laws and government regulations applicable to Life Re, the ability of Life Re to implement its operating strategies successfully, the ability of Life Re to execute Administrative Reinsurance transactions and the amount, timing and returns therefrom; material fluctuations in interest rate levels; material changes in mortality and morbidity experience; material changes in persistency; material changes in the level of operating expenses; and the success or failure of certain of Life Re's clients in premium writing, and other risks and uncertainties. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.
Life Re retrocedes portions of certain risks in excess of a predetermined retention amount for which it has accepted liability. From time to time, Life Re also has entered into quota share retrocessional agreements, and maintained catastrophe reinsurance to protect against catastrophic event risks. Failure of a retrocessionaire to honor its obligations could result in material losses to Life Re; to date, no such losses have occurred. No amounts due Life Re from its retrocessionaires were deemed uncollectible at December 31, 1998.
Group life reinsurance accounted for approximately 3% of policy revenues in 1998. Group life reinsurance is written on a direct basis and generally is excess of loss and often includes experience rating provisions.
Approximately 24% of 1998 policy revenues were derived from Administrative Reinsurance. This line of business involves the acquisition and administration of blocks of primary insurance policies (both interest sensitive and traditional) and annuity contracts and is expected to become an increasingly significant component of policy revenues in the future. This line of business also includes Life Re's reinsurance of automobile credit life and disability.
On December 1, 1998, Swiss Reinsurance Company ("Swiss Re") acquired in a merger transaction (the "Merger") all of the outstanding common shares of Life Re Corporation for $95.00 per share. Additionally, consideration equal to $95.00 less the exercise price was paid in exchange for the cancellation of all outstanding common stock options. The total cash purchase price was $1,801.2 million. Pursuant to the Merger, Life Re became a wholly owned indirect subsidiary of Swiss Re. Concurrently with the Merger, Life Re received a capital contribution of $207.6 million from Swiss Re and repaid all outstanding bank loans.
1998 and 1997, the Transactions contributed policy revenues totaling $94.0 million and $26.0 million, respectively, and approximately $65.3 million and $32.7 million, respectively, of investment income. Policy revenues and investment income related to the Transactions exclude the effects of the acquisition of REALIC and the reinsurance of automobile credit life and disability.
POLICY REVENUES by segment for the three year period are as follows:
POLICY BENEFITS increased by 50% in 1998 and 3% in 1997. The increase in 1998 was due to the Transactions and higher volumes of ordinary life reinsurance business. The increase in 1997 was due to an increase in accident and health and special risk pool participations, the 1996 Transactions and the purchase of REALIC in July 1995. As a percentage of policy revenues, policy benefits were 72% in 1998 and 70% in 1997 and 74% in 1996. The increase in 1998 is largely attributable to higher morbidity in the group accident and health and special risk reinsurance lines of business. Contributing to the lower percentage in 1997 was a shift in the mix of ordinary life reinsurance business from excess to first dollar quota share reinsurance; under first dollar quota share reinsurance, typically a higher portion of the reinsurance premium funds acquisition costs and a lesser portion funds mortality costs. Partially offsetting the shift in the mix of ordinary reinsurance business in 1997 was a deterioration in group accident and health and special risk morbidity experience. The higher percentage in 1996 primarily was due to an increase in revenues generated under reinsurance treaties with no acquisition costs, coinsurance involving paid-up insurance and Administrative Reinsurance, which generally produces no new business and, therefore, generally has a higher ratio of benefits to policy revenues.
ACQUISITION COSTS increased by 33% in 1998 and 27% in 1997. The increase in 1998 largely is due to the higher volumes of ordinary life business and the Transactions. The increase in 1997 reflects the higher volumes of ordinary life and group accident and health reinsurance business and the Transactions and, in addition, the aforementioned shift in the mix of ordinary reinsurance business from excess reinsurance to first dollar quota share reinsurance. As a percentage of policy revenues, policy acquisition costs were 27% in 1998, 29% in 1997 and 25% in 1996.
DISTRIBUTIONS ON CAPITAL SECURITIES of $15.2 million were incurred from the issuance in June 1997 of $100.0 million of 8.72% capital securities by a subsidiary trust and the issuance of 2,070,000 6.0% Adjustable Conversion-rate Equity Security Units in March 1998 by a subsidiary trust as further described in the Financial Condition and Liquidity section (also see Note 9 of the "Notes to Consolidated Financial Statements").
OTHER OPERATING EXPENSES increased in 1998 and 1997 mainly due to i) administrative fees of third party administrators ("TPAs") incurred within Administrative Reinsurance due to the Transactions and ii) higher compensation costs. Administrative Reinsurance utilizes the services of TPAs to administer all of its business; accordingly, to the extent Life Re is successful in expanding Administrative Reinsurance, its operating expenses will continue to increase.
The effective FEDERAL INCOME TAX rate was in excess of the statutory rate primarily due to the non-deductibility of certain compensation payments triggered by the sale of the Life Re.
invested assets totaled $102.9 million and $101.5 million at year end 1998 and 1997, respectively, and generally reflect the lower interest rate environment.
Life Re's fixed maturity securities, which constituted 91%, or $3,417.7 million, of the total fair value of its invested assets as of December 31 1998, are predominantly investment grade, liquid securities with varying maturity dates. The fair value of such investments may vary depending on economic and market conditions, the level of interest rates and the perceived creditworthiness of the issuer.
At December 31, 1998, collateralized mortgage obligations and mortgage-backed pass-through securities represented approximately 14% of Life Re's invested assets. Certain of such investments may be subject to prepayment risk and, therefore, are susceptible to fluctuations in the level of interest rates. Prepayments of these investments did not have a material impact on Life Re's 1998 results of operations.
Real estate and mortgages (at cost) totaled $30.7 million at December 31, 1998 and were acquired as part of the Transactions. Mortgage loans comprise the majority of this amount.
life insurance policies, account values under interest sensitive life and annuity contracts, group accident and health claim reserves, life claims payable and other miscellaneous liabilities. Through the Transactions, the relative proportion of interest sensitive and annuity policy benefit liabilities to the total has increased significantly and, at December 31, 1998, totaled approximately 60% of the policy benefits under life insurance contracts.
Asset/liability management techniques are utilized by Life Re to minimize the risks associated with interest rate fluctuations. For interest sensitive policy benefits, Life Re seeks to invest in assets with equal durations while attaining a targeted rate of return. Life Re currently does not engage in hedging transactions to mitigate the effects of interest rate fluctuations.
On December 1, 1998, as part of the acquisition of the Company by Swiss Re, the bank loans of $125.0 million were repaid.
On March 17, 1998 Life Re completed two separate public offerings in which it sold 3,500,000 shares of common stock, and 2,070,000 6.0% Adjustable Conversion-rate Equity Security Units issued through Life Re Capital Trust II ("Trust II") (the "Units"), (together, the "Offerings"). Life Re realized net proceeds of approximately $352 million from the Offerings. The Units consist of a stock purchase contract (the "Contract") and Quarterly Income Preferred Securities ("QUIPS"). Distributions on the QUIPS are cumulative, accrue from the first date of issuance of the QUIPS and are payable at a stipulated annual rate on a quarterly basis in arrears on a predetermined payment date. The QUIPS have a maturity of March 15, 2003 and are subject to a put option exercisable by the QUIPS holder on either March 15, 2001 or June 15, 2001. As a result of the Merger, the aggregate payment to Unit holders (net of the amount paid by Unit holders to the Company under the Contracts) will be approximately $24.6 million.
The primary sources of funds for Life Re Corporation (the "Parent") consist of dividends and surplus debenture interest payments from TexasRe, which are further funded by dividends from LRCA to TexasRe. The ability of the Parent to make distributions on capital securities is ultimately dependent on the statutory
The unpaid principal amount of the surplus debentures at December 31, 1998 was $160.5 million. The interest rate payable under the terms of the surplus debentures is 5.42%.
Currently, no prior approval of the Texas Insurance Commissioner is required to prepay or pay scheduled interest or principal on the surplus debentures provided that, after giving effect to any such payment, the statutory surplus of TexasRe is $125.0 million. TexasRe relies primarily on dividends from LRCA to meet its obligations under the surplus debentures as well as to pay dividends to Life Re Corporation.
Purchases and sales of fixed maturities increased substantially in 1998 and 1997 due primarily to restructuring of portfolios related to the Transactions. The completion of these types of transactions generally produces a cash outlay for acquisitions and a net cash inflow upon reinsurance of insurance in force. Financing cash flows include debt prepayments of $15.0 million in 1996. Withdrawals from annuity and interest sensitive life insurance contracts totaled $174.4 million in 1998 compared to $108.6 million in 1997 due to increased volumes of business resulting from the Transactions and an increase in the related rate of lapsation.
Life Re has completed its comprehensive review of its computer systems which could be affected by year 2000 processing issues. All of Life Re's core, or mission-critical, systems were year 2000 compliant at December 1998. Other non-core systems are planned to be compliant by June 1999. The costs associated with these efforts is not expected to exceed $1.0 million.
The computer systems of Life Re's third party administrators are or are in the process of becoming year 2000 compliant. Life Re is in the process of reviewing the third party administrators systems to ensure such compliance. Generally, the costs associated with these efforts are being borne by the third party administrators and the costs associated with this review are anticipated to be immaterial.
that data. However, Life Re believes its own systems and processes mitigate the risk that ceding companies year 2000 noncompliance would have a material adverse effect on its operations.
Life Re currently has no formal contingency plans in place in the event it does not complete all phases of Year 2000 compliance due to its expectation of completing all phases. However, should Life Re not complete all associated compliance work, Life Re would use estimating techniques based on available historical data to bill reinsurance premiums and record policy benefits and acquisition costs on business affected by this noncompliance. However, there can be no assurance that noncompliance would not have a material adverse impact on Life Re's operations.
On December 1, 1998, the Company was acquired by Swiss Reinsurance Company ("Swiss Re") in a merger transaction (the "Merger") (Note 3). As is permitted in certain circumstances, the cost of the Merger was not "pushed down" to establish a new accounting basis for the Company. Accordingly, the accompanying financial statements reflect the Company's historical cost basis.
Group accident and health and special risk reinsurance, involving the reinsurance of medical expenses, disability income, accidental death and catastrophic loss coverage, is conducted primarily through participation in reinsurance pools. In 1997, the Company decided to withdraw from the group accident and health and special risk reinsurance business and, since October 1997, has ceased to renew or accept new pool participations and has also ceased direct marketing activity.
Fixed maturities in these notes include fixed maturity securities which are part of assets held by ceding company under reinsurance treaty and those included in the caption fixed maturities in the accompanying consolidated balance sheets.
Mortgage loans are carried at amortized unpaid balances, net of provisions for estimated losses. Real estate is carried at cost.
Policy loans: The carrying value of policy loans approximates fair value, as the average loan interest rate approximates interest rates currently offered for similar loans.
Cash and short-term investments: The carrying amounts reported for these instruments approximate their fair values, due to their short maturity.
Insurance contracts: Fair values of insurance contracts are not required to be disclosed. The fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk, which minimizes exposure to changing interest rates by seeking to match investment cash flows with amounts due under insurance contracts.
Revenues for annuities and interest sensitive life insurance contracts consist of policy fees and charges for the cost of insurance, policy administration and surrenders that have been assessed against policyholder account balances during the period. Policy claims and benefits in excess of related policyholder account balances are charged to expense.
The costs of acquiring new business are deferred as acquisition costs and amortized. For acquisitions of in force blocks of business and stock acquisitions accounted for as purchases, such costs represent the excess of the liabilities assumed over the net assets received. For new reinsurance, such costs are those which vary with and are directly related to the production of new business, principally commissions. Costs deferred in connection with traditional life insurance products are amortized over the premium paying period of the related policies using assumptions consistent with those used to compute future policy benefits. For annuities and interest sensitive life insurance products, acquisition costs are amortized generally in proportion to the present value of expected gross profits from such products. Amortization is adjusted when current estimates of future gross profits are revised.
Future policy benefits under traditional long-term and group life insurance contracts have been computed based upon expected investment yields, mortality, persistency and other assumptions. These assumptions include a margin for adverse deviation and vary with the characteristics of the plan of insurance, year of issue, age of insured and other appropriate factors. Mortality and persistency assumptions are based on the Company's experience as well as industry experience and standards.
Prior to their cancellation (Note 3), the Company accounted for its stock options under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations. Under APB 25, the Company did not incur any expense from the issuance of stock options because the exercise price of the option equaled the market price of the underlying stock on the date of grant.
Effective February 28, 1998, the Company acquired, for a purchase price of $61,596, 100% of the common stock of Mission Life Insurance Company ("Mission"). The fair values of assets acquired and liabilities assumed were $258,982 and $199,586, respectively. Effective December 22, 1998, Mission acquired, for a purchase price of $17,552, 100% of the common stock of First Capital Life Insurance Company of Louisiana with assets at fair value of $85,364 and liabilities of $67,812. The primary business of these companies is insurance for final expenses. The Company also acquired a 20% interest in Mission Life Insurance Company of America which writes this type of business, substantially all of which is reinsured by the Company.
On September 30, 1997, the Company acquired a 79% interest in AML through the purchase of 79% of the common stock of AML's parent company, AML Acquisition Company, for a purchase price of $13,034. In conjunction with the purchase, the Company repaid $9,800 of long-term debt of AML Acquisition Company. The assets acquired had a fair value of $145,268 and the liabilities assumed aggregated $132,234.
Effective April 1, 1998, the Company acquired, for a purchase price of $46,600, 100% of the common stock of Lincoln Liberty Life Insurance Company and First Delaware Life Insurance Company from First Lincoln Holdings, Inc. and merged them into AML. The combined fair values of the assets acquired and the liabilities assumed were $242,196 and $195,472, respectively.
During 1996, the Company acquired and merged into REALIC three life insurance companies with assets at fair value of $302,409 and liabilities of $263,267. The total purchase price was $39,142.
During 1998, the Company entered into several indemnity reinsurance agreements pursuant to which the Company acquired existing blocks of in force business with liabilities for future policy benefits amounting to $50,199.
In December 1998, the Company entered into an agreement, subject to regulatory approval, to acquire 100% of LSL Financial Corporation, parent of Lone Star Life Insurance Company ("Lone Star Life"), for approximately $49,000. As of December 31, 1998, Lone Star Life had statutory assets of approximately $528,000 and capital and surplus of approximately $35,000. Its business consists principally of individual disability income and individual life insurance contracts. This transaction is expected to close in the first quarter of 1999.
Deferred acquisition costs are amortized with interest at rates ranging from 5.3% to 8.7% except for the amount attributable to the acquisition of LRCA which is amortized with interest at 15%. The percentage of deferred acquisition costs which is expected to be amortized in each of the next five years is 14.2%, 13.0%, 11.8%, 10.8%,and 10.2% and the percentage expected to be amortized in each of the next five years, net of interest accretion, is 7.9%, 7.2%, 6.5%, 6.0%, and 5.7%.
The Company's accident and health insurance business is of short duration and generally claims are reported within a short period of time after incurral. There have been no material favorable or adverse developments affecting accident and health insurance claims reserves in 1998, 1997 or 1996.
Through the date of the Merger, LRCA and LRCA's parent, TexasRe Life Insurance Company ("TexasRe"), filed a consolidated federal income tax return with Life Re Corporation and REALIC and AML filed separate federal income tax returns. Effective with the Merger, TexasRe files a consolidated federal life insurance return with its direct and indirect wholly owned subsidiaries, AML files a separate federal income tax return and Life Re Corporation files a consolidated federal income tax return with certain Swiss Re subsidiaries.
On March 17, 1998, the Company, through Life Re Capital Trust II ("Trust II"), completed a public offering of 2,070,000 6% Adjustable Conversion-rate Equity Security Units ("Units") (the "Units Offering"). The Units consist of Quarterly Income Preferred Securities ("QUIPS") and a forward purchase contract (the "Contract") for the Company's common stock. The QUIPS have a maturity of March 15, 2003 and are subject to a put option by the QUIPS holder on either March 15, 2001 or June 15, 2001 and the Contract matures on March 15, 2001. Because of the Merger, the Contract redemption rate became fixed at $95.00 and the Units ceased to trade publicly. Payments on the Units are fully and unconditionally guaranteed by the Company. As a result of the Merger, the aggregate payment to Unit holders (net of the amount paid by Unit holders to the Company under the Contracts) will be approximately $24,600 million.
The assets of Trust I and Trust II consist of junior subordinated debentures issued by Life Re Corporation which have terms that parallel the terms of the capital securities. The Trusts are accounted for as wholly owned subsidiaries of the Company.
Concurrently with the Units Offering (Note 9), on March 17, 1998, the Company completed a public offering in which it sold 3,500,000 shares of common stock (the "Common Stock Offering"). The net proceeds of the Common Stock Offering and the Units Offering totaled $352,297 of which $207,000 was contributed to the insurance subsidiaries.
In January 1999, pursuant to its Restated Certificate of Incorporation, the Company issued 10,000 shares of preferred stock with a par value of $.01 to its parent in exchange for a promissory note in the amount of $615,000 which bears interest at 5% payable annually in arrears beginning December 31, 1999. The note may be prepaid at any time and is due on December 31, 2008.
As of the Merger date, all outstanding common stock options vested and were cancelled in exchange for consideration equal to the excess of $95.00 over the exercise price of each option. During 1998, prior to the Merger, 582,000 options were granted at a weighted average exercise price of $64.98 and 166,650 options were exercised.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options had characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models did not necessarily provide a reliable single measure of the fair value of its employee stock options.
Pro forma net income (loss) including the effects of amortization of the estimated fair values of stock options granted after December 15, 1994 is $(36,496), $47,256 and $53,116 for 1998, 1997 and 1996, respectively.
Combined statutory basis net loss for TexasRe and subsidiaries was $159,319 and $54,121 in 1998 and 1997. In 1996, TexasRe and subsidiaries had combined statutory basis net income of $16,315.
Substantially all full time employees are covered by a noncontributory defined benefit pension plan. Benefits are determined by a formula which relates the pension payable to years of service at retirement, final five year average salary and wages covered by Social Security. Annual contributions to the plan are sufficient to satisfy legal funding requirements. In addition, the Company has an unfunded Supplemental Executive Retirement Plan which is a nonqualified plan that provides certain officers defined pension benefits in excess of limits imposed by federal tax law. The Company also sponsors a defined contribution savings plan covering substantially all employees with at least six months of service. The Company contributes 50% of the first 6% of salary contributed by employees. Participants vest in Company contributions over a four year period. The combined expense associated with employee benefit plans was $761, $1,438 and $1,151 in 1998, 1997 and 1996, respectively.
In the normal course of business, the Company seeks to limit its exposure to loss by ceding reinsurance to retrocessionaires. In general, the Company retains a maximum of $1,000 on any one life for ordinary life insurance business with certain limited exceptions depending upon age and classification of the risk. Amounts in excess of the retention are ceded to a pool of retrocessionaires. From time to time, the Company has also entered into quota share retrocessional agreements. In general, the Company's policy in regard to group insurance business is to retain not more than $250 of liability on any one life insurance risk, $300 on any one accident or health insurance risk or, for special risk insurance, $1,000 on any one risk. The Company has agreements with group retrocessionaires primarily on an excess basis. Contracts for reinsurance ceded do not relieve the Company from its obligations under contracts for reinsurance assumed. Failure of retrocessionaires to honor their obligations could result in losses to the Company; however, no amounts are deemed uncollectible at December 31, 1998.
Policy benefits recovered on reinsurance ceded for the years ended December 31, 1998, 1997 and 1996 were $306,393, $107,309 and $75,971, respectively.
The following table presents summarized data for the Company's business segments. One client within traditional reinsurance comprised over 10% of policy revenues in 1998.