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 a reinsurer for the years ended December 31, 1999 and 1998, as a reinsurer and
The Company declared a dividend on February 25, 2000 of $0.08 per common share to be paid March 30, 2000 to the shareholders of record on March 15, 2000.
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"). THIS DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES.
In June 1998, the Company incorporated Accent Europe Insurance Company Ltd. ("Accent"), a direct insurance company in Ireland. With current capitalization of $15 million, Accent offers health and accident products on a pan-European basis to its insured parties.
In November 1998, the Company established a global support center (the "Shared Services Center") in Dublin, Ireland. Corporate functions operating from the Shared Services Center include operating and administrative functions such as underwriting, claims management, systems and technology, finance and accounting, human resources and policy administration.
In December 1998, the Company initiated the creation of a non profit healthcare service association, COMED, in the German market. Member services include physician referrals, a medical information hotline, second opinion services and access to disease management advisors. ESG has supported the formation and development of COMED by extending a credit facility of $12 million to fund start-up operations. As of December 31, 1999, $3.2 million has been advanced to COMED under this facility and were fully provided for. The ability of COMED to repay the loan is dependent on its ability to generate sufficient revenues from members. The initial marketing strategy of COMED was to carry out direct marketing programs to the general public, which failed to develop significant members. In recent months, the approach has been to attract members through direct contact with public and private sick funds, the German equivalent of HMO's. This has not yet led to any formal agreement with sick funds to offer COMED services to its members. Under the terms of the loan agreement, the Company has the right to refuse any further disbursements where the ability of COMED to repay the loan is in doubt.
In December 1998, the Company incorporated Vermittlungs-Beratungs-und-Beteiligungs GmbH ("VBB") as a founding member of COMED and Institut fur Praeventivmedizin & Techologie GmbH ("IPT") as a technology and service provider to COMED.
In June 1999, the Company acquired majority ownership of Health Benefit Consultants Ltd., a third party administrator of medical and personal accident insurance products in Thailand and PT International Health Benefits, a third party administrator of medical and personal accident insurance products and an insurer of limited managed care insurance products in Indonesia. The cost of these companies was not material. These two companies have established and manage extensive provider networks in their countries of operation and will provide ESG with a solid platform to promote medical insurance products throughout South East Asia.
The Company initiated a stock repurchase program in May 1999 to actively manage its capital base. As of March 23, 2000, the Company has repurchased 2,612,800 shares of its common stock, equivalent to 18.0% of the outstanding shares of ESG Re Limited under its Common Stock Repurchase Program. The average purchase price was $6.82. The Company can buy a further 83,391 shares of its common stock under the existing program.
Consolidated results of operations reflect the combined results of operations of the Company's reinsurance and health care divisions. Consolidated results of operations for the years ended December 31, 1999, 1998 and 1997 were as follows:
The Company reported net loss of $30.4 million for 1999 from its reinsurance division, compared to a net profit of $14.5 million for 1998. The Company's health care division established in 1999 had
1. Management Changes--On September 10, 1999, John C Head III was appointed Chief Executive Officer of the Company, effective October 1, 1999, following the resignation of Wolfgang Wand effective September 30, 1999; Edward Tilly, a non-executive director of the Company was appointed Deputy Chairman; and Steven Debrovner was appointed Chief Executive Officer of the Reinsurance division, having previously been Chief Marketing and Underwriting Officer of the Company. Dr. Gerald Moeller was appointed Chief Executive Officer of the Health Care Division on July 1, 1999. In October 1999, the Company appointed Antony Jeffery as Chief Actuary reporting to Joan Dillard. The Company announced the departure of Renate Nellich, President and CEO of ES North America, ESG's marketing and underwriting manager in Toronto, Canada, effective November 5, 1999. Marty Hatfield, Senior Vice President, Marketing, Underwriting and Claims, was appointed as Regional Executive for North America. In January 2000, the Company appointed Alasdair Davis as Chief Underwriting Officer of the Company reporting to Steven Debrovner. See "Current Developments" included in this filing.
- A medical quota share contract in Maine covering both 1998 and 1999 underwriting years has developed into a 126% loss and acquisition ratio, resulting in a loss of $4.8 million on the account. This loss was identified in the third quarter of 1999 and the Company has initiated a forensic audit on the account to determine whether the Company has any legal recourse against third parties to recover losses incurred. This account generated $18.9 million in net written premiums to the Company.
- A large 1999 medical group health account producing $65 million in gross written premium developed at a 99% loss and acquisition ratio, higher than anticipated at the inception of the risk. The negative development resulted in a deterioration of $2.1 million being reported in the third quarter.
- During the third quarter, the Company added $1.4 million to reserves relating to adverse development in several smaller accounts in North America, written through the Toronto office. No further deterioration in the performance of the business written through the Toronto office occurred during the fourth quarter.
On March 8, 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 to double-B-plus from triple-B. Standard & Poor's again cited the Company's continued weak earnings performance, concerns over internal control mechanisms and the Company's early departure from its original business development strategy. In addition, the reduced capitalization resulting from the loss in the fourth quarter was also raised as a concern.
4. Anticipated Withdrawal from a Line of Business--The Health Care division recognized $1.6 million in expenses associated with the unsuccessful launch of heart-monitoring technology services. The Company exited this business in the fourth quarter of 1999.
The results of operations of the Reinsurance Division of the Company for the years ended December 31, 1999, 1998 and 1997 were as follows:
For the year ended December 31, 1999, the Company managed, on behalf of itself and its co-reinsurers, total premiums of $348.3 million, of which it placed $14.9 million with co-reinsurers and retroceded $19.8 million, resulting in $313.6 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.
Net premiums earned increased by 152% over 1998 due to the Company now being in its second full year of operation, leading to a higher earned to written percentage on normal business. In addition, the Company wrote two accounts during the year with total premium of $76.5 million that had accelerated earnings patterns resulting in all such premium being earned during 1999. Gross and net premiums written and net premiums earned for the 12 months ended December 31, 1999 and 1998 were as follows:
The operating ratios for the 12 months ended December 31, 1999 and 1998, by line of business and in total, were as follows:
The Company experienced rapid growth in 1999 in its medical portfolio, particularly in the North American market. The Company's London market office established in July 1998 had a full year of production and exceeded premium targets set by management. The Toronto office wrote one large medical contract for $65 million that led to a dramatic growth in written and earned premium for the medical line. The North American medical rates are increasing and more rigorous terms of trade are being accepted by ceding companies. The Company will maintain its presence in the North American market on a selective basis whilst taking every opportunity to diversify the product range.
Special Risk business has declined by 50%, with one 1998 contract incurring a reduction in premium of $0.9 million in 1999.
Gross premium written from Credit business has declined by 85% in 1999. One three year contract in Latin America written in 1998 at $8 million was cancelled by the ceding company after twelve months with a resultant decrease in written premium of $5.3 million in 1999. Excluding the impact of this account on both underwriting years, the Credit portfolio has grown by 64%. The Company expects to develop this line of business further in 2000.
Management fee revenue in 1998 includes an upward revision in management fees on pool underwriting years prior to 1998 in the amount of $144 thousand.
The Company continued to incur significant expenses for professional services and for travel expenses in the development of its business. Personnel costs increased by $5.0 million from $4.4 million in 1998 to $9.4 million in 1999. The number of employees has increased from 76 at December 31, 1998 to 121 at December 31, 1999, excluding the Company's operations in Tbilisi, Georgia.
Taxes decreased by $0.5 million from $1.3 million in 1998 to $0.8 million in 1999. The reduction in taxes reflects the loss reported by the Company during 1999. The deferred tax asset of $0.8 million held by the Company at December 1998 has been written off as the Company considers recovery of the asset unlikely.
Through its newly formed health care division, ESG Health, the Company offers medical referral, second opinion and disease management services to the German market. The new division includes the costs associated with funding COMED, a non-profit German healthcare association that the Company helped to establish and IPT (Institut fuer Praeventivmedizin & Technologie GmbH), a provider of doctor's referral and second opinion services.
Expenses of $11.9 million were incurred primarily to establish ESG Health and to position its health care products. A provision of $6.0 million was established for an outstanding loan to and receivables from COMED incurred since its formation, of which $3.2 million related to loans provided under the $12 million loan facility provided by ESG in December 1998. COMED's ability to repay is dependent on its ability to generate sufficient revenues from members. Under the terms of the loan
agreement, the Company has the right to refuse any further disbursements where the ability of COMED to repay the loan is in doubt. The initial marketing strategy of COMED was to carry out direct marketing programs to the general public, which failed to develop significant members. In recent months, the approach has been to attract members through direct contact with public and private sick funds, the German equivalent of HMO's. The Company continues to market the concept of COMED directly to the public and private sick funds in Germany and remains confident that the services provided by COMED will develop into significant business opportunities in the German health care market as it moves to greater privatization.
The company expects to divest a portion of the health care division in 2000 through raising external capital to fund the venture. Extensive review by outside consultants and the senior management recruited by the Company from the pharmaceutical/disease management industry indicates substantial growth opportunities for the division in the European and North American markets. The Company is in negotiation with outside parties to take an initial equity stake in the division as the first step in reducing the Company's equity interest to a significant non-controlling equity investment in the venture.
The Company reported net income of $14.5 million for 1998, compared to a net loss of $5.1 million for 1997. The year ended December 31, 1998 represents the first full year of the Company's operation as a reinsurance company. The net loss incurred in 1997 includes a one-time, non-cash charge for compensation expense of $3.6 million related to Class B Warrants issued in connection with the Offerings, and approximately $1.5 million of other Offerings related costs.
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 for the period. In December 1997, the Company assumed a portion of the pool business it previously managed on behalf of reinsurance clients, retroactive to January 1, 1997. For the year ended December 31, 1997, the Company managed approximately $100 million of gross premiums written, of which it assumed approximately $26 million. Gross and net premiums written and net premiums earned for the 12 months ended December 31, 1998 and 1997 were as follows:
- New Business--approximately $186.2 million, or 83.0%, of total premiums managed was generated from new business. The Company's new representative office in Toronto underwrote $85.9 million of gross premiums. Two significant contracts for European medical, personal accident and life business were underwritten in the first quarter, including one for quota share treaty reinsurance incepting January 1, 1997. These contracts contributed $22.5 million to total premiums managed for the 12 months ended December 31, 1998. Additionally, one significant North American medical contract was underwritten in the third quarter, contributing $21.6 million to total premiums managed.
The operating ratios for the 12 months ended December 31, 1998 and 1997, by line of business and in total, were as follows:
The 12 months ended December 31, 1998 constituted the first full 12-month period that the Company operated as a reinsurer writing for its own account. Accordingly, a combined ratio is presented inclusive of an administrative expense component to provide a meaningful indication of the underwriting results of the business. The administrative expense ratio of 8.9% for the 12 months ended December 31, 1998, was calculated by expressing total administrative expenses, net of management fee revenue and corporate office expenses, as a percentage of net premiums earned. In addition, during the year, the Company deferred $1.5 million 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 ratio by 1.5%.
The majority of management fee revenue in 1998 consists of fees earned on those premiums managed for the Company's co-reinsurers. Management fee revenue in 1998 includes an upward revision in management fees on pool underwriting years prior to 1998 in the amount of $144 thousand.
The following table reflects the investment results for the 12 months ended December 31, 1998:
For the year ended December 31, 1998, the Company incurred significant expenses on professional services, on initiatives for improving accounting and control systems, hiring key executives, and identifying strategic investments, and on travel expenses related to all of the above activities. Total administrative expenses, less tax, for the 12 months ended December 31, 1998, were $12.0 million, or 6.1% and 12.1%, respectively, of net premiums written and net premiums earned, compared to $7.7 million in 1997. The 1997 expenses include $1.5 million of travel expense and professional service fees associated with the Company's capital raising activities. Tax expense increased by $1.8 million to $1.3 million in 1998. In 1997, the Company had a tax benefit of $569 thousand.
As of December 31, 1999, total investments and cash were $221.5 million, compared to $235.2 million at December 31, 1998. All fixed maturity securities in the Company's investment portfolio are classified as available for sale and are carried at fair value. Additionally, the Company purchased $4.0 million in foreign currency equities matched to liabilities related to a long-term European medical account.
The fixed maturity investment portfolios as of December 31, 1999 and 1998 were as follows:
The Company's investment policy objective is to maximize long-term investment returns while maintaining a liquid, high-quality portfolio. To this end, the investment policy requires that the portfolio have an average credit quality rating of AA, with no more than 3% of the portfolio invested in the securities of a single issuer (other than issues of sovereign governments with a rating of AA or better), and a target duration of 2.75 years. The Company's investment portfolio as of December 31, 1999 and 1998 complies with the adopted investment policy and guidelines.
In December 1997, the Company was capitalized with gross proceeds of $257 million from the Offerings. The Company also incurred expenses of $25 million related to the Offering and repaid its outstanding debt, principally loans from shareholders and bank demand borrowings, of $3.5 million. The proceeds of the Offering were used to capitalize ES Bermuda, ES Ireland and ES Germany with $55 million, $50 million and $12 million, respectively.
In 1998, the Company increased the capital of ES Bermuda by $35 million, and ES Ireland by $50 million. Accent Europe Insurance Company, the direct writer formed in 1998, is capitalized at $15 million.
At December 31, 1999, unearned premium reserves were $181.1 million compared to $111.9 million at December 31, 1998. Unearned premium reserves are established to cover the unexpired period of contracts of reinsurance underwritten by the Company. The increase was due to the growth in gross reinsurance premiums written by the Company. In the year ended December 31, 1999, the Company wrote two large contracts of reinsurance at a total premium of $75.9 million which had an accelerated earnings pattern compared to the normal contracts written by the Company.
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, but may consider acquiring additional funding as attractive market opportunities emerge.
As of December 31, 1999, the Company had the following material commitments for operating leases and employment contracts:
In support of its business, the Company enters into Letters of Credit arrangements with ceding companies. As at December 31, 1999, the Company had outstanding Letters of Credit of $65.8 million of which $39.1 million were secured against its fixed maturity investment portfolio. As at December 31, 1998, the Company had $23.6 million unsecured Letters of Credit issued in favor of ceding companies. In addition, certain ceding companies require the Company to maintain funds on deposit with them pursuant to reinsurance contract provisions. At December 31, 1999, the Company had $15.5 million funds retained on deposit by ceding companies compared to $3.6 million as at December 31, 1998.
The Company manages its underwriting risk exposures primarily through an excess of loss reinsurance program. This program generally provides limits up to a maximum of $30 million per occurrence, with a minimum attachment point generally of $100 thousand.
Following large losses on two underwriting accounts in North America in the third quarter, the Company initiated audits of both accounts to determine whether the Company has any legal recourse against third parties to recover losses incurred. This audit work is expected to be completed during the second quarter of 2000. These two accounts, one of which covered both the 1998 and 1999 business, generated premium to the Company of $85 million.
As of March 23, 2000, the Company has repurchased 2,612,800 shares of its common stock, equivalent to 18.0% of the outstanding shares of ESG Re Limited under its Common Stock Repurchase Program. The average purchase price was $6.82. The Company can buy a further 83,391 shares of its common stock under the existing program.
On November 11, 1999, 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 single-A-minus to triple-B. Standard & Poor's cited (i) weak earnings in the North American market; (ii) concerns over internal control mechanism and wide-scale changes in the management team, and (iii) a departure from its original business development strategy, as the motivating factors behind its decision. However, the rating agency listed the Company's extremely strong capitalization as a mitigating factor behind its decision. On March 8, 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 to double-B-plus from triple-B. Standard & Poor's again cited the Company's continued weak earnings performance, concerns over internal control mechanisms and the Company's early departure from its original business development strategy. In addition, the reduced capitalization resulting from the loss in the fourth quarter was also raised as a concern. The Company expects to return to its original business development strategy by refocusing its underwriting efforts on certain markets other than the North American market in the future. The Company has no plans to exit the North American medical market as premium rates are increasing and the Company expects to generate moderate underwriting profits from business written by its Toronto office. As noted above, as part of the refocus of the group, the Company has ceased writing North American medical business through its London market operation. The impact, if any, of the rating changes on the Company's ability to secure new and renewal business is not known at this time.
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. The Company believes that it does not currently enter into any transactions that are covered by this statement and therefore, the Company does not anticipate any significant change to its current financial reporting.
The AICPA issued Statement of Position 98-7, "Deposit Accounting" which is effective for financial statements with fiscal years beginning after June 15, 1999. The Company does not expect that this standard will have a significant impact on the current financial reporting.
The Year 2000 Issue relates to the ability of computer systems to properly interpret date information for the year 2000 and beyond. In January 1998, the Company initiated an enterprise-wide project to address Year 2000 issues with respect to the Company's computer software and information technology systems. The initiative had as its focus two distinct areas that include Year 2000 compliance of the Company's software, systems and technology platforms and the evaluation of the Year 2000 preparedness of significant third parties with whom the Company conducts business, including vendors and customers. The Company has completed this initiative at no material cost.
ESG Re Limited ("the Company") was incorporated under the laws of Bermuda on August 21, 1997. Its principal activities conducted through its subsidiaries, are to provide accident, health, credit, life and special risk reinsurance and to provide underwriting management services for these lines. During 1999, the Company established a health care division to offer medical referral, second opinion and disease management services to the German market.
Prior to the incorporation, the Company's operations were conducted through its subsidiary, European Specialty Group Holding AG ("ESG Germany"). On December 2, 1997, the shareholders of ESG Germany entered into agreements to receive 900,000 common shares, par value $1 per share, of the Company in exchange for all of their interests in ESG Germany (the "Formation"). ESG Germany thereby became a subsidiary of the Company.
In December 1997, in an Initial Public Offering (the "IPO"), the Company issued 10,350,000 common shares for proceeds of $207 million. Costs including discounts and commissions associated with the Formation, Direct Sales and IPO were approximately $25.8 million, of which $21.3 million were reflected as a reduction of additional paid-in capital. The Formation, Direct Sales and IPO were accounted for as a recapitalization.
The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The Company's significant accounting policies include the following:
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, which means that 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 Company and its subsidiaries file income tax returns as required by the laws of each country in which it has operations. 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.
Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per common share reflect the maximum dilution that would have resulted from the exercise of stock options and warrants to purchase common shares. Diluted earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding and the dilutive potential common shares during the period of calculation.
For purposes of the consolidated statement of cash flows, the Company considers all time deposits and commercial paper with original maturity dates of 90 days or less to be cash equivalents.
The Company's investment portfolio at December 31, 1999 and 1998 is comprised of the following:
The amortized cost, fair value and gross unrealized gains and losses of fixed maturity investments and equity investments as of December 31, 1999 and 1998 are presented in the tables below:
Proceeds from the sales of investments available for sale for the years ended December 31, 1999 and 1998 were $325.1 million and $445.3 million respectively. Realized investment gains and losses for the years ended December 31, 1999 and 1998 were as follows:
Management fees receivable represents management fee and related revenues that are primarily due from co-reinsurers and quota share retrocessionnaires to whom a portion of the Company's gross managed premium is allocated. At December 31, 1998, the Company had significant fees due from the
5. MANAGEMENT FEES RECEIVABLE (CONTINUED) reinsurers participating in the reinsurance pools in 1997 and prior years. Management fees receivable at December 31, 1999 and 1998 consist of the following:
Activity in deferred acquisition costs for the years ended December 31, 1999 and 1998 is summarized as follows:
8. INCOME TAXES (CONTINUED) The actual income tax expense attributable to income for the three years in the period ended December 31, 1999 is based on the statutory tax rates in the Company's taxable jurisdictions, which range from 0% to approximately 50%.
The Company utilizes retrocessional agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from retrocessionaires of a portion of the losses and loss expenses under certain circumstances. They do not discharge the primary liability of the Company. In the event retrocessionaires were unable to meet their obligations under the retrocession agreements, the Company would be liable for such defaulted amounts. The Company
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations for income from continuing operations:
The Company has entered into various employment contracts with terms of up to five years that have total minimum commitments of $7.9 million, excluding any performance bonuses that are
The Company and its subsidiaries have various lease obligations. Rental expenses are amortized on the straight-line basis over the term of the lease. Total rental expense was approximately $931 thousand, $398 thousand and $286 thousand for the years ended December 31, 1999, 1998 and 1997, respectively. During the year, the Company leased new premises in Ireland, Hong Kong, Australia, Indonesia, Toronto, Thailand, Taiwan, United States and Singapore to support the growth of the Company's operations.
Secured Letters of Credit in the amount of $39.1 million have been issued in favor of ceding companies. The letters of credit are secured by a lien on the Company's fixed maturities investment portfolio equal to 110% of the amount of the outstanding letters of credit. Unsecured Letters of Credit in the amount of $26.7 million have been issued in favor of ceding companies. As of December 31, 1998, unsecured Letters of Credit in the amount of $23.6 million have been issued in favor of ceding companies.
In connection with the Direct Sales, the Company issued Class A Warrants to purchase up to 1,381,200 common shares and Class B Warrants to purchase up to 1,381,200 common shares if certain performance criteria are satisfied. The Class A Warrants are vested and are exercisable at $20 per share at any time prior to December 2007.
Twenty percent of the Class B Warrants are available for vesting during each of the first five years following the closing date of the IPO, and will vest only if, for any 20 consecutive trading days during the one-year vesting period, the percentage change in the market price of the common shares since the closing date of the IPO exceeds the percentage change in the Wilshire 5000 Stock Price Index by at least 500 basis points. The Class B Warrants are exercisable for a period of 10 years from the date of vesting. The exercise price per Common Share is $20 and will be reduced by $1.50 on September 1, 2001. As of December 31, 1999 and 1998, 276,240 of the Class B Warrants are vested and are exercisable.
For the year ended December 31, 1997, in accordance with the Emerging Issues Task Force Consensus 96-18, "Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services," the Company recorded compensation
As of December 31, 1999, options to purchase a total of 980,075 shares of common stock were granted, net of forfeitures, to officers and employees of the Company (1998: 609,000). Options granted under the Employee Stock Option Plan generally vest at 25% at the date of grant and at 25% on each of the second, third and fourth anniversaries of the date of grant. All options are exercisable at the fair market value of the stock at the date of the grant and expire 10 years after the date of the grant.
On December 12, 1997, the Company adopted the ESG Re Limited Non-management Directors' Compensation and Option Plan (the "Directors' Plan"), under which non-management directors are compensated for their service on the Board. Non-management directors who were on the Board at the time of the closing of the offering, or who joined the Board within one year of the closing were granted stock options to purchase up to 10,000 common shares. Options granted on December 12, 1997, the date of the IPO, were granted at the IPO price of $20 per share. Each non-management director receives fees for services as a member of the Board of Directors and its committees, in amounts determined by the Board of Directors, to be paid in a combination of cash and common shares, as determined by the Board. A Director may elect to receive all or a portion of such fees in the form of options to purchase common shares equal to two times the fees that would otherwise be payable. A director may also elect to defer receipt of the fees, and if so deferred, will receive deferred compensation indexed to the greater of (i) the total return on the common shares; or (ii) the one-year U.S. Treasury bill rate. If a director does not elect the payment in options or deferred compensation alternatives, the fees will be paid in a combination of cash and shares as determined by the Board. Shares granted under the Directors' Plan will not be transferable for six months after receipt. The Company has reserved 1,000,000 common shares for issuance under the Directors' Plan.
The fair value of each option grant was estimated using the Black/Scholes option pricing model with the following assumptions: (i) dividend yield of 8.0%; (ii) expected volatility of 65.6%; (iii) risk-free rate of 6.3%; and (iv) expected life of 8 years.
14. STOCK-BASED COMPENSATION (CONTINUED) The weighted average remaining contractual life of options outstanding at December 31, 1999, is presented below:
In 1997, the Company entered into an agreement with Head Asset Management L.L.C. ("Head Asset Management"), an affiliate of Head & Company L.L.C. ("Head Company"), relating to the provision of investment management services. The Chairman of the Board of Directors and Chief Executive Officer is a Managing Member of Head Company. Pursuant to this agreement, which is subject to the Company's investment guidelines and other restrictions, the Company will pay Head Asset Management a fee equal to the sum of (i) 0.25% per annum of the first $200 million of assets under management; and (ii) 0.15% per annum of assets under management in excess of $200 million. The Company incurred expenses of $495 thousand and $549 thousand under this agreement for the years ended December 31, 1999 and 1998, respectively.
Under the Bermuda Insurance Act, 1978, amendments thereto and Related Regulations, ES Bermuda is required to maintain certain measures of solvency and liquidity. For the years ended December 31, 1999 and 1998, these requirements have been met. The statutory capital and surplus of ES Bermuda was $131.0 million and $137.1 million and the minimum required statutory capital and surplus was $13.2 million and $8.7 million as of December 31, 1999 and 1998, respectively. The minimum required level of liquid assets was $81.4 million and $55.2 million with actual liquid assets of $138.5 million and $109.7 million as of December 31, 1999 and 1998, respectively.