TRENWICK GROUP LTD. FIVE YEAR SUMMARY Years Ended December 31, 2002, 2001 and 2000 and Years Ended September 30, 1999 and 1998 (Amounts expressed in thousands, except share and per share data)
The following discussion highlights material factors affecting Trenwick Group Ltd.'s results of operations for the three years ended December 31, 2002, 2001 and 2000. This discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto of Trenwick Group Ltd. for the years ended December 31, 2002, 2001 and 2000 contained in this annual report on Form 10-K.
Trenwick Group Ltd. ("Trenwick") is a Bermuda-based specialty insurance and reinsurance holding company with two principal businesses operating through its subsidiaries located in the United States and the United Kingdom. Trenwick's United States treaty reinsurance business provides, through an underwriting facility with Chubb Re, Inc. and its affiliate Federal Insurance Company (together, "Chubb"), treaty reinsurance to insurers of property and casualty risks. Trenwick's operations at Lloyd's of London ("Lloyd's") underwrite specialty property and casualty insurance as well as treaty and facultative property and casualty reinsurance on a worldwide basis.
As a result of a significant deterioration in Trenwick's financial condition, more fully described in "Significant Developments" below, Trenwick hired Greenhill & Co., LLC as its financial advisor to assist in the evaluation and implementation of a possible restructuring of its outstanding indebtedness and preferred equity as well as other strategic alternatives.
Trenwick was formed as a Bermuda company in 1999 to acquire two publicly held companies, Trenwick Group Inc. and LaSalle Re Holdings Limited ("LaSalle Re Holdings"), and the minority interest in LaSalle Re, a subsidiary of LaSalle Re Holdings. That transaction, in which Trenwick issued common shares to acquire LaSalle Re Holdings, Trenwick Group Inc. and the minority interest in LaSalle Re, was completed on September 27, 2000 and was accounted for as a purchase by LaSalle Re Holdings. Accordingly, in the financial statements, the assets and liabilities, and the revenues and expenses of LaSalle Re Holdings were included for all periods presented; the minority interest in common shares and minority interest in net income of LaSalle Re were eliminated as of September 30, 2000 and from October 1, 2000, respectively, and the assets and liabilities, and the revenues and expenses of Trenwick Group Inc. were included as of September 30, 2000 and from October 1, 2000, respectively. Trenwick Group Inc. had earlier acquired another publicly held company, Chartwell Re Corporation, on October 27, 1999.
During 2002 and the first quarter of 2003, a number of developments have occurred that have significantly and negatively affected Trenwick's operations, capital structure and the financial resources required to conduct its businesses. Set forth below are brief descriptions of a number of these developments as well as certain material transactions entered into by Trenwick to enable it to continue to conduct business operations despite the adverse developments. Investors and shareholders are cautioned that Trenwick has had a number of significant adverse events which could make it extremely difficult to continue in its
Trenwick announced on October 25, 2002 that it had engaged independent actuaries to conduct a review of reserves for unpaid claims and claims expenses at each of Trenwick's operating subsidiaries. Trenwick increased its reserves for unpaid claims and claims expenses in the fourth quarter of 2002 by $107 million, or $2.90 per share, which followed reserve increases made by Trenwick earlier in 2002. The aggregate reserve increases for 2002 were $285.1 million, or $7.75 per share. Both the fourth quarter and year to date 2002 reserve increases are net of benefits related to reductions in the liability under the contingent interest notes. The fourth quarter increase in Trenwick's reserves was based upon the study conducted by independent actuarial consultants and additional work performed during the quarter by Trenwick's internal actuaries. The increases in reserves impact Trenwick's United States and Bermuda insurance subsidiaries and Trenwick International. Trenwick's reserves at its Lloyd's operation, while also analyzed, were not significantly affected by this reserve increase. The reserve increases reflect a reassessment of Trenwick's reserves for unpaid claims and claims expenses in light of recent reported loss activity trends across its major business groups and principally impacts the 1998 to 2001 accident years. Included in the fourth quarter 2002 reserve increase was $20 million relating to Trenwick's exposure to asbestos and environmental liabilities. Following this increase to Trenwick's asbestos and environmental reserves, Trenwick's three year survival ratio (i.e., number of years that existing reserves will last if the current level of average annual payments for the last three years repeats itself indefinitely) for this type of exposure will be approximately 13 years. See Item 1 - "Business--Unpaid Claims and Claims Expenses," below.
Trenwick's United States and United Kingdom operations incurred financial accounting losses in the years 1999 through 2002 and, in connection with such losses, recorded as an asset up to $119.6 million and $96.8 million, respectively, of net deferred income taxes (before application of a valuation allowance). The net deferred income tax asset represented the future tax benefit of the losses previously incurred by Trenwick's United States and United Kingdom operations. Because of Trenwick's cumulative financial accounting losses, in the absence of specific favorable factors, application of FASB Statement No. 109 required Trenwick to establish during 2002 a 100% valuation allowance against its deferred tax asset related to its United States and United Kingdom operations. The establishment of a 100% valuation allowance against Trenwick's deferred tax asset increased Trenwick's provision for income taxes and net loss by $150.2 million, or $4.08 per share for the year ended December 31, 2002. The maintenance of a full valuation allowance against Trenwick's net deferred tax asset through December 31, 2002 further increased Trenwick's provision for income taxes and net loss by $65.1 million, or $1.77 per share. Trenwick's management will continue to monitor its tax position and reassess the need for a full valuation allowance on its deferred tax asset on a periodic basis.
Pursuant to a guaranty agreement entered into concurrently with the credit agreement, Trenwick has guaranteed the obligations of Trenwick America and Trenwick Holdings under the credit agreement. In April of 2002, Trenwick pledged the capital stock of LaSalle Re Holdings, which was a guarantor of the obligations under the credit agreement, and LaSalle Re as collateral to the Banks. In December of 2002, Trenwick agreed to provide the Banks additional security interests as described below.
Pursuant to the December Amendments, Trenwick is required to collateralize with cash, cash equivalents and marketable securities 60% of the outstanding letters of credit by August 1, 2003. In addition, Trenwick is required to use its best efforts to terminate the letters of credit by December 31, 2003. In order to do so, the letters of credit would need to be replaced with other letters of credit or collateral acceptable to Lloyd's. In the event Trenwick has not terminated the letters of credit by December 31, 2003, it is required on such date to collateralize with cash, cash equivalents and marketable securities the full amount of the outstanding letters of credit. At this time, Trenwick does not have sufficient available liquidity to collateralize the letters of credit as required by the December Amendments. Additionally, Trenwick does not believe that it will be able to replace the letters of credit with other letters of credit or collateral acceptable to Lloyd's. See Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources."
Since December, Trenwick has entered into additional amendments and numerous waivers with the Banks providing for, among other things, waivers of potential covenant defaults, further reductions in certain financial covenants, additional financial reporting, approval of certain employee and other payments, and extension of numerous deadlines imposed under the December Amendments.
Included in Trenwick's indebtedness at December 31, 2002 are senior notes with an aggregate principal amount of $75 million which are due April 1, 2003. Trenwick is engaged in continuing discussions with holders of the senior notes with respect to a possible restructuring of these senior notes. Trenwick's agreements entered into in connection with the renewal of its letter of credit facility in December 2002 provided that Trenwick would replace, refinance or restructure these senior notes by March 1, 2003. The banks participating in Trenwick's letter of credit facility have provided to Trenwick a waiver of this March 1, 2003 deadline as discussions with the senior note holders continue. At this time, Trenwick does not have sufficient available liquidity to pay the amount due on April 1, 2003 and is uncertain whether it will be able to complete the restructuring by that date. If Trenwick is unable to restructure these senior notes by April 1, 2003 and either the banks under the credit facility or the senior noteholders determine to exercise the rights available to them or take other action with respect to the assets of Trenwick, Trenwick and/or one or more of its subsidiaries may be forced to seek protection from creditors through proceedings commenced in Bermuda and other jurisdictions including the United States. In addition, at any time, the insurance regulatory authorities having jurisdiction over Trenwick's insurance company operating subsidiaries may commence voluntary or involuntary proceedings for the formal supervision, rehabilitation or liquidation of such subsidiaries, or one or more of the creditors of Trenwick or its subsidiaries may commence proceedings against Trenwick or its unregulated subsidiaries seeking their liquidation.
Moody's Investors Service announced on January 31, 2003 that it had lowered the senior debt rating of Trenwick from "Caa3" to "Ca", and had lowered the ratings of the trust preferred securities of Trenwick America and the preferred stock of LaSalle Holdings from "Ca" to "C", following Trenwick's
Standard and Poor's Ratings Services announced on March 4, 2003 that it placed its "CCC-" counterparty credit ratings on Trenwick Group Ltd., LaSalle Re Holdings and Trenwick America on CreditWatch with negative implications because it believes that Trenwick's ability to restructure its senior debt to keep it out of default is remote. Standard & Poor's also announced on March 4, 2003 that it placed its "CCC" counterparty credit and financial strength ratings on Trenwick America Reinsurance Corporation ("Trenwick America Re") Dakota Specialty Insurance Company ("Dakota"), LaSalle Re, Trenwick International and The Insurance Corporation of New York ("Inscorp") on CreditWatch negative. In addition, Standard and Poor's withdrew its "CCC" counterparty credit and financial strength ratings on Chartwell Insurance Company due to its merger with Trenwick America Re.
On February 4, 2003, Fitch Ratings announced that it had lowered its long-term rating and senior debt ratings on Trenwick and its subsidiaries to "C" from "CC." Fitch reported that its ratings action followed Trenwick's announcement that it was taking a $107 million reserve charge, and that it believed that Trenwick's business prospects and financial flexibility are "very limited" and that it would be unable to refinance its senior debt. Fitch also reported its belief that Trenwick's ability to remain a going concern is heavily dependent on financing by the letter of credit facility and that senior debt holders may be forced to consider accepting some form of payment in kind arrangement.
With the exception of Trenwick America Re, which is rated "NR-4" (Rating Withdrawn at Company's Request), each of Trenwick's operating insurance company subsidiaries is classified "NR-3" (Rating Procedure Inapplicable) by A.M. Best Company. All of Trenwick Managing Agents' managed syndicates are able to write business utilizing the ratings of Lloyd's, which is rated "A-" (Excellent) by A.M. Best Company and has an "A" financial strength rating from Standard & Poor's. These ratings are based upon factors that may be of concern to policy or contract holders, agents and intermediaries, but may not reflect the considerations applicable to an equity investment in a reinsurance or insurance company. A change in any such rating is at the discretion of the respective rating agencies.
By letter dated March 24, 2003, the Bermuda Monetary Authority ("BMA") issued permission for the free transferability on an interim basis of the shares while they are quoted on the OTC Bulletin Board. This permission is contingent on the condition that the BMA is notified promptly of any instances in which Trenwick or LaSalle Re Holdings become aware that a new shareholder has obtained 5% or more of either company's shares, including background information on any such new 5% shareholder.
On December 3, 2002, Trenwick America Re entered into a "letter of understanding" with the Connecticut Insurance Department pursuant to which Trenwick America Re agreed that it would not take certain actions without the prior written approval of the Connecticut Insurance Commissioner, including disposing of any assets, settling any intercompany balances or paying any dividends. For further discussion of the Connecticut letter of understanding, see Item 1 - "Business-Regulation - United States Regulation."
For a description of the RBC requirements applicable to Trenwick's United States insurance company subsidiaries, see Item 1 - "Business--Regulation - Risk Based Capital."
The BMA and LaSalle Re, which is in runoff, have agreed that LaSalle Re's insurance license be restricted so that it is not permitted to enter into any new contracts of insurance or reinsurance without the prior written consent of the BMA, effective January 1, 2003.
During the fourth quarter of 2002, Trenwick's subsidiary Trenwick America Re entered into an underwriting facility with Chubb which permits Trenwick America Re to underwrite up to $400 million of United States reinsurance business on behalf of Chubb through the end of January 2004. The underwriting facility is subject to cancellation prospectively by either party at any time. Chubb will receive one-third and Trenwick America Re will receive two-thirds of any profits generated by the business, with the initial profit distribution from Chubb to Trenwick America Re scheduled to begin in 2006.
During the first quarter of 2002, Trenwick amended the basis in which operating segments are reported. The continuing Lloyd's syndicates managed by Trenwick and the International Specialty Insurance and Reinsurance operations were combined into one operating segment and the U.S. based property and casualty reinsurance and Bermuda based property catastrophe reinsurance operations were combined into one segment called Reinsurance. These changes were made to conform to changes in Trenwick's management and operational structure. For the years ended December 31, 2002, 2001 and 2000, Trenwick reported its specialty insurance and reinsurance business in the following three business segments which are described in further detail below:
Trenwick's United States specialty program insurance segment was written principally through its U.S. subsidiary, Canterbury Financial Group, Inc. and its operating subsidiaries, Inscorp, Dakota and Chartwell Insurance Company (merged with and into Trenwick America Re effective December 31, 2002). Trenwick ceased underwriting U.S. specialty program insurance effective October 30, 2002, therefore this segment will be substantially limited to run off activities in 2003.
Results of Operations - Years Ended December 31, 2002 and 2001
In addition to providing net income (loss) information, when comparing the results of operations for the years ended December 31, 2002 and 2001, Trenwick has also provided operating income (loss) and underwriting income (loss) as management believes they are both meaningful measures of Trenwick's results. Operating income (loss) differs from net income (loss) under accounting principles generally accepted in the United States of America, sometimes referred to as U.S. GAAP, and does not replace net income (loss) as the GAAP measure of our results of operations. In arriving at operating income (loss), we start with GAAP net income (loss) and exclude net realized investment gains and losses, as well as non-recurring charges because i) net realized investment gains and losses are unpredictable and not necessarily indicative of current or future results and ii) charges such as reorganization expenses and the cumulative effect of changes in accounting principles are non-recurring in nature and are also not necessarily indicative of future results of operations. Underwriting income (loss), also a non-GAAP financial measure, is net premiums earned less claims and claims expenses incurred, acquisition costs and underwriting expenses.
The operating loss of $342.5 million in 2002 represented a $184.4 million greater loss than the operating loss of $158.1 million recorded in 2001. The operating losses in 2002 and 2001 include an aggregate of $303.4 million and $110.9 million of loss reserve increases, respectively, as a result of adverse development of prior years' losses. In addition, the operating loss in 2001 includes an aggregate of $122.2 million in catastrophe losses. The establishment of deferred tax valuation allowances contributed $150.2 million to the operating loss in 2002. The $384.7 million net loss in 2002 compared to the $154.4 million net loss in 2001 was the result of the net operating losses combined with (i) an extraordinary item, the writedown of goodwill resulting from the Trenwick/LaSalle business combination, recorded as a cumulative effect of a change in accounting principles, (ii) the loss recorded on the sale of a portion of Trenwick's business and (iii) increased reorganization expenses recorded in 2002. These items were offset in part by realized investment gains. The non-operating items are discussed in further detail under the caption "Non-Operating Income and Expenses."
The decrease in the combined ratio in 2002 compared to 2001, is primarily a result of the increase in net premiums earned in 2002 over 2001 combined with the improved market conditions in 2002.
Gross premiums written for 2002 were $1.6 billion compared to $1.5 billion for 2001 an increase of $0.1 billion or 8.4%. Details of gross premiums written are provided below:
2002 2001 Change ----------- ----------- ----------- Gross premiums written $ 1,574,522 $ 1,452,255 $ 122,267 Change in gross unearned premiums (74,616) (130,260) 55,644 ----------- ----------- ----------- Gross premiums earned 1,499,906 1,321,995 177,911 ----------- ----------- -----------
Gross premiums ceded (583,021) (481,937) (101,084) Change in ceded unearned premiums 62,020 49,448 12,572 ----------- ----------- ----------- Ceded premiums earned (521,001) (432,489) (88,512) ----------- ----------- ----------- Net premiums earned $ 978,905 $ 889,506 $ 89,399 =========== =========== ===========
Net premiums earned for 2002 were $978.9 million compared to $889.5 million for 2001. The increase in net premiums earned is commensurate with the increase in net premiums written.
prior years that are unpaid as of the balance sheet date, including claims that have been incurred but not yet reported to Trenwick. Claims and claims expenses incurred during the year ended December 31, 2002 were $881.5 million, an increase of $54.1 million compared to claims and claims expenses of $827.4 million for the year ended December 31, 2001, which includes adverse development across all business units of $303.4 million and $120.8 million, respectively. The increase in claims and claims expenses incurred in 2002 resulted mainly from the $303.4 million of loss reserve strengthening recorded. Of this amount, approximately $27.4 million related to adverse development on losses stemming from the September 11, 2001 terrorist attacks. The remaining $276.0 million of loss reserve increases are a result of the reassessment of reserve levels, a culmination of work completed by both Trenwick's internal actuaries and independent actuarial consultants in all of Trenwick's businesses, described in detail below. Of the reserve increases recorded, approximately $169.4 million, or 61.4%, relates to Trenwick's U.S. treaty reinsurance operations and principally impacts the most recent accident years, 1999 to 2001, where deterioration has occurred across all lines of business, most significantly in the general liability and asbestos and environmental lines of business. Trenwick's U.S. specialty program insurance, now in runoff, contributed approximately $45.5 million, or 16.5% of the reserve increases recorded in 2002. This deterioration was concentrated in a small number of programs and related primarily to general liability business. Of the remaining reserve increases recorded, $51.6 million emanated from Trenwick's international liability business written through Trenwick International, now in runoff. The last significant component of the increases on prior years' reserves for unpaid claims and claims expenses was recorded by Trenwick Managing Agents, which contributed $30.8 million of the reserve increases. These increases related primarily to the financial institutions and professional indemnity lines of business written through Trenwick's Lloyd's syndicates. These reserve increases were off set in part by a decrease in reserves for prior years claims at LaSalle Re of $15.4 million.
Trenwick's unpaid claims and claims expense liability at December 31, 2002 and 2001 includes an estimate of Trenwick's ultimate liability for asbestos and environmental claims of $112.0 million and $91.0 million, respectively, comprising gross liabilities for unpaid claims and claims expenses of $145.0 million and $118.7 million, respectively, net of reinsurance recoverable on unpaid claims and claims expenses of $33.0 million and $27.6 million. The balance sheet prior to the Trenwick/LaSalle business combination did not include liabilities for asbestos and environmental reserves, as LaSalle Re Holdings' business did not provide for such coverage.
Trenwick's 2001 results also included other catastrophe losses totaling $24 million. The largest of these losses was tropical storm Allison and storms affecting the Midwest United States amounting to $10.5 million and the November 12, 2001 American Airlines crash in Queens, New York of $7.8 million.
Trenwick strengthened its prior year loss reserves in 2001 by $110.9 million. This reserve strengthening includes $15.7 million related to U.S. casualty treaty reinsurance business, which was underwritten prior to 2001 and $11.5 million related to prior participation in the ECRA Pool. In addition, $13.9 million of the loss reserve strengthening related to U.S. specialty program insurance segment. Also included in the reserve strengthening was $20.4 million relating principally to directors and officers liability business written by Trenwick's Lloyd'ssyndicates. Lastly, the reserve strengthening included $48.3 million stemming from deterioration in discontinued businesses and reviews of the property insurance and liability business lines of Trenwick International.
2002 2001 Change -------- -------- -------- Policy acquisition costs $267,913 $273,066 $ (5,153) Underwriting expenses 89,904 79,016 10,888 -------- -------- -------- Total acquisition costs and underwriting expenses $357,817 $352,082 $ 5,735 ======== ======== ========
Underwriting expenses for the year ended December 31, 2002 as a percentage of earned premium increased to 9.2%, as compared to 8.9% for the same period in 2001, a result of an increase in premium levies from Lloyd's in 2002.
Net realized gains on investments, net of applicable income taxes, were $35.8 million during 2002, compared to $8.5 million for 2001. The gains in both years were a result of actions taken to reposition the investment portfolio into higher quality, shorter duration fixed income securities.
During the year ended December 31, 2002, Trenwick recorded a loss on the sale of LaSalle Re's in-force property catastrophe reinsurance business to Endurance of $20.1 million. The loss includes non-recurring revenues of $8.0 million related to the sale of renewal rights, offset by $28.1 million of non-recurring expenses, which consists of accelerated amortization of reinsurance contracts not transferred in the sale, as well as legal expenses, investment banking fees and severance and related costs.
Reorganization expenses incurred in 2002 and 2001 were $16.2 million and $4.8 million, respectively. Both the 2002 and 2001 expenses include non-recurring severance costs; additionally the 2002 amount includes other non-recurring costs related to Trenwick's decision to cease underwriting U.S. specialty program insurance and U.K. specialty market insurance through Trenwick International Limited.
In addition to providing net income (loss) information, when comparing the results of operations for the years ended December 31, 2001 and 2000, Trenwick has also provided operating income (loss) and underwriting income (loss) as management believes they are both meaningful measures of Trenwick's results. Operating income (loss) differs from net income (loss) under accounting principles generally accepted in the United States of America, sometimes referred to as U.S. GAAP, and does not replace net income (loss) as the GAAP measure of our results of operations. In arriving at operating income (loss), we start with GAAP net income (loss) and exclude net realized investment gains and losses, as well as non-recurring charges because i) net realized investment gains and losses are unpredictable and not necessarily indicative of current or future results and ii) charges such as reorganization expenses and the cumulative effect of changes in accounting principles are non-recurring in nature and are also not necessarily indicative
LaSalle Re Holdings was the accounting acquiror in the Trenwick/LaSalle business combination, which was completed on September 27, 2000. Therefore, the results of operations for the 2000 year do not include the results of Trenwick Group Inc. prior to the date of the combination, and as such, the 2001 and 2000 results lack comparability.
The underwriting result for 2000 included the results of LaSalle Re Holdings alone for the first nine months of 2000 and the combined results of LaSalle Re Holdings and Trenwick Group Inc. for the fourth quarter of 2000.
The increase in the combined ratio in 2001 compared to 2000 resulted from the significant increase in the loss ratio due to the unusual level of catastrophic losses and reserve strengthening in 2001.
Gross premiums ceded (481,937) (126,012) (355,925) Change in ceded unearned premiums 49,448 10,123 39,325 ----------- ----------- ----------- Ceded premiums earned (432,489) (115,889) (316,600) ----------- ----------- ----------- Net premiums earned $ 889,506 $ 302,749 $ 586,757 =========== =========== ===========
Gross premiums ceded for 2001 were $481.9 million compared to $126.0 million for 2000. The increase in gross premiums ceded of $355.9 million was due primarily to cessions relating to business acquired in the Trenwick/LaSalle business combination and reinstatement premiums. Businesses acquired in the Trenwick/LaSalle business combination included Lloyd's syndicates, international specialty insurance and reinsurance and U.S. specialty program insurance, all of which have significantly larger reinsurance and retrocessional programs than LaSalle Re.
Claims and claims expenses for 2001 were $827.4 million, an increase of $599.7 million compared to claims and claims expenses of $227.7 million for 2000. The increase in claims and claims expenses in 2001 resulted from an increase in business acquired in the Trenwick/LaSalle business combination in September 2000, a significant increase in catastrophe losses, in particular losses stemming from the September 11, 2001 terrorist attacks and reserve strengthening.
Claims and claims expenses incurred during the year ended December 31, 2001 included $122.2 million of catastrophe losses, which includes losses resulting from the September 11, 2001 terrorist attacks of $98.2 million. The losses from the September 11, 2001 terrorist attacks recorded during 2001 included an estimated $366.3 million before reinsurance recoverable of approximately $268.1 million. The principal losses related to aviation risks underwritten by Trenwick's operations at Lloyd's and property and related risks, including business interruption, underwritten by LaSalle Re.
Trenwick's estimate of its losses from aviation risks from the September 11, 2001 terrorist attacks are based on two maximum losses and two partial losses. Estimates of its property and related losses is based on an assessment of individual policies which Trenwick has determined have exposure to the World Trade Center loss. This assessment included market share analysis, probable maximum loss analysis, independent risk modeling analysis and cedant loss estimates.
LaSalle Re's claims and claims expenses incurred in the 2000 year included $6.5 million of catastrophe losses relating to U.K. floods and an increase of $20.4 million in prior period occurrences, principally losses relating to two storms, Martin and Anatol, which hit Europe in late December 1999.
2001 2000 Year Year Change -------- -------- -------- Policy acquisition costs $273,066 $ 78,603 $194,463 Underwriting expenses 79,016 31,891 47,125 -------- -------- -------- Total acquisition costs and underwriting expenses $352,082 $110,494 $241,588 ======== ======== ========
Trenwick recorded foreign currency losses of $2.5 million for 2001, compared to $1.0 million for 2000 due to the decline in the value of European currencies in 2001 and 2000, principally the British pound sterling, against the US dollar.
Minority interest represents the minority interest in common shares of LaSalle Re held by third party investors prior to the Trenwick/LaSalle business combination on September 27, 2000. Net income attributed to the minority interest was calculated as 23.5% of net income in 2000 prior to the Trenwick/LaSalle business combination.
Gross Unrealized Fair Value Loss ----------- ----------- 0-6 months $ 128,803 $ (3,281) 7-12 months 45,442 (3,571) Greater than 12 months 39,323 (3,717) ----------- ----------- Total $ 213,568 $ (10,569) =========== ===========
None of these unrealized losses were determined to be other than temporarily impaired and therefore no impairment has been recognized at year end 2002. In the event that circumstances surrounding the potential impairment of these investments change and management concludes the losses are other than temporary, there could be a material impact on the earnings of Trenwick.
Trenwick has not invested in derivative financial instruments such as futures, forward contracts, swaps, options or other financial instruments with similar characteristics such as interest rate caps or floors and fixed-rate loan commitments. Trenwick's portfolio includes market sensitive instruments, such as mortgage-backed and asset-backed securities, which amounted to approximately $277.7 million at December 31, 2002 or 12.0% of cash and invested assets. There are various categories of mortgage-backed and asset-backed securities that are subject to different degrees of risk from changes in interest rates and, for those mortgage-backed and asset-backed securities that are not agency-backed, defaults. Approximately 58% of Trenwick's mortgage-backed securities holdings were backed by government agencies, such as GNMA, FNMA and FHLMC, at December 31, 2002, and approximately 97% of asset-backed securities holdings were AAA- rated at December 31, 2002. The principal risks inherent in holding mortgage-backed and asset-backed securities are prepayment and extension risks related to significant decreases and increases in interest rates, resulting in the repayment of principal from the underlying mortgages either earlier or later than originally anticipated.
Trenwick's U.S. and U.K. operations incurred financial accounting losses in 1999 through the end of 2002 and in connection with such losses, recorded as an asset up to $119.6 million and $96.8 million, respectively, of net deferred income taxes (before application of a valuation allowance). The net deferred income tax asset represented the future tax benefit of the losses previously incurred by Trenwick's U.S. and U.K. operations. Because of Trenwick's cumulative financial accounting losses, in the absence of specific favorable factors, application of FASB Statement No. 109 required Trenwick to establish a 100% valuation allowance against its deferred tax asset related to its U.S. and U.K. operations during 2002. The initial establishment of a 100% valuation allowance against Trenwick's deferred tax asset during 2002 increased Trenwick's provision for income taxes and net loss by $150.2 million or $4.08 per share. The maintenance of a full valuation allowance against Trenwick's net deferred tax asset through December 31, 2002 further increased Trenwick's provision for income taxes and net loss by $65.1 million. Trenwick management will continue to monitor its tax position and reassess the need for a valuation allowance on its deferred tax asset on a periodic basis.
Trenwick's total debt to capital ratio (indebtedness divided by the sum of indebtedness, minority interest, convertible preferred stock and shareholders' equity) was 22.7% on December 31, 2002 and 31.2% on December 31, 2001. The decrease is primarily due to the repayment of Trenwick's term loan facility in 2002, offset in part by the decrease in shareholders' equity.
On October 18, 2002, A.M. Best Company lowered the financial strength ratings of Trenwick's operating subsidiaries below A-. The lowered A.M. Best Company ratings constituted an event of default under Trenwick's credit agreement. In addition, increases in Trenwick's loss reserves and the establishment of a Trenwick deferred tax asset reserve in the third quarter of 2002 resulted in Trenwick violating the financial covenants in the credit agreement requiring Trenwick to maintain a minimum tangible net worth and minimum risk-based capital. On November 13, 2002, Trenwick, its subsidiaries and the Banks executed a forbearance agreement with respect to the events of default arising from Trenwick's lowered A.M. Best Company ratings and financial covenant violations.
Since December, Trenwick has entered into three additional amendments and numerous waivers with the Banks providing for, among other things, waivers of potential covenant defaults, further reductions in certain financial covenants, additional financial reporting, approval of certain employee and other payments, and extension of numerous deadlines imposed under the December Amendments.
Trenwick America also assumed, effective September 27, 2000, Trenwick Group Inc.'s $113.4 million 8.82% Junior Subordinated Deferrable Interest Debentures held by Trenwick Capital Trust I (the "Trust") in respect of the $110 million in 8.82% Subordinated Capital Income Securities issued by the Trust. Under the terms of the debentures, Trenwick America is not restricted from incurring indebtedness, but is subject to limits on its ability to incur secured indebtedness for borrowed money.
Upon consummation of the acquisition of Chartwell Re Corporation ("Chartwell Re") in 1999, Trenwick Group Inc. became the successor obligor under Chartwell Re's Contingent Interest Notes due June 30, 2006. Effective September 27, 2000, Trenwick America assumed Trenwick Group Inc.'s obligations under the contingent interest notes in connection with the Trenwick/LaSalle business combination. The contingent interest notes were issued in an aggregate principal amount of $1 million, which accrues interest at a rate of 8% per annum, compounded annually. The interest is not payable until the maturity or earlier redemption of the contingent interest notes. In addition, the contingent interest notes entitle their holders to receive at maturity, in proportion to the principal amount of the contingent interest notes held by them, an aggregate of from $0 up to $55 million in contingent interest. The amount of contingent interest payable under the contingent interest notes is dependent upon the level of unpaid claims and claims expenses related to business written by Trenwick's subsidiary, Inscorp, prior to 1996. The contingent interest notes mature on June 30, 2006.
During the years ended December 31, 2002 and 2001 Trenwick recorded $18.3 million and $9.9 million, respectively, of adverse development related to the subject business. As a result, the carrying value of the contingent interest notes at December 31, 2002 has been reduced to the minimum principal value of $1 million plus accrued interest, which is the present value of the amount expected to be paid at maturity. The
contingent interest notes will continue to accrue interest at a rate of 8% per year. The contingent interest notes contain covenants which relate to the maintenance of certain records and limitations on certain indebtedness. At December 31, 2002, Trenwick was in compliance with these covenants.
As a result of the terrorist attacks of September 11, 2001, LaSalle Re incurred in excess of $140 million in catastrophe losses as defined under the catastrophe equity put option agreement and Trenwick delivered notice of exercise of the catastrophe equity put on March 28, 2002. On July 1, 2002, Trenwick commenced an arbitration proceeding seeking $55 million in damages and other relief against European Re. The claims arose out of European Re's failure to meet its obligations under the catastrophe equity put. On September 6, 2002, the catastrophe equity put option was amended and restated and the pending arbitration proceedings were terminated. Under the terms of the second restated agreement, European Re purchased 550,000 of Trenwick's Series B Cumulative Perpetual Preferred Shares (the "Series B Shares") with a liquidation preference of $100 per share for an aggregate purchase price of $40 million. The Series B Shares bear cumulative dividends, payable quarterly in arrears, based upon the Series B Shares' Standard & Poor's rating at LIBOR plus a margin determined in accordance with the following schedule:
On December 3, 2002, Trenwick America Re entered into a "letter of understanding" with the Connecticut Department of Insurance pursuant to which, among other things, Trenwick America Re is prohibited from paying any dividends, ordinary or extraordinary, without the prior written approval of the Connecticut Insurance Commissioner or her designee. On November 29, 2002, Trenwick announced that it had elected to suspend, with immediate effect and for an indefinite period of time, dividends or distributions payable on its outstanding common and convertible preferred shares, preferred shares of LaSalle Re Holdings, and on the capital securities of Trenwick Capital Trust I. Since the ability of Trenwick to meet both its operating needs in the short term as well as its obligations in the long-term is dependent upon such factors as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet its operating needs.
America Re's maximum retention generally does not exceed $7.75 million per occurrence on property catastrophe business. From 1989 to 1999, Trenwick America Re purchased aggregate excess of loss ratio treaties from several reinsurers. These facilities provided Trenwick America Re with a layer of protection against adverse results from its domestic casualty business in excess of specified loss ratios on an accident year basis. Trenwick America Re did not purchase an aggregate excess of loss ratio treaty after 1999.
Reinsurance was purchased that was specifically tailored to each of the specialty programs underwritten by the insurance subsidiaries of Canterbury Financial Group Inc.
In connection with the acquisition of Chartwell Re Corporation ("Chartwell") by Trenwick in 1999, Chartwell's insurance company subsidiaries purchased an aggregate excess of loss reinsurance agreement providing up to $100 million in coverage against unanticipated increases in Chartwell's reserves for business written on or before October 27, 1999, the date of completion of the acquisition of Chartwell. Within the $100 million maximum, the protection was limited to $100 million for increased reserves attributable to Chartwell's Lloyd's operations, $25 million for increased reserves attributable to catastrophe and year 2000 losses and $50 million for increased reserves attributable to asbestos and environmental coverage losses. The aggregate excess of loss reinsurance agreement is not cancelable by the reinsurers, London Life and Scandinavian Re, and their obligations have been secured by a trust account. The premium paid for this aggregate excess of loss reinsurance agreement was $56 million, and the $100 million coverage limit was exhausted during the 2000 year.
Trenwick remains liable with respect to insurance and reinsurance ceded in the event that the reinsurer or retrocessionaire is unable to meet its obligations. All reinsurers and retrocessionaires must be formally approved by the operating company's security committee. The evaluation process involves financial analysis of current audited financial data and comparative analysis of such data in accordance with guidelines established by Trenwick. Business is not conducted with reinsurers or retrocessionaires who are not currently approved by the security committee.
nature, do not represent an exact calculation of the liability and, while Trenwick has established reserves equal to the current best estimate of ultimate losses, there remains a likelihood that further changes in such claim estimates, either upward or downward, will occur in the future. Adjustments to previously reported reserves for unpaid claims and claims expenses are considered changes in estimates for accounting purposes and are reflected in the income statement in the period in which the adjustment becomes known.
o September 11, 2001 related claims, particularly with respect to catastrophe coverage underwritten in LaSalle Re;
Trenwick's management continually evaluates the potential for changes in unpaid claims and claims expenses to adjust recorded reserves and to proactively modify underwriting criteria and product offerings. In recent periods and continuing throughout 2002, the level of reported claims activity related to prior year loss events, particularly for liability-related exposures underwritten in 1997 through 2001, has been significantly higher than anticipated. Full consideration of these trends was incorporated into a comprehensive reserve study completed in the fourth quarter of 2002. Insurance reserves, by their very nature, do not represent an exact calculation of liability and, while Trenwick has established reserves equal to the current best estimate of ultimate losses, there remains a likelihood that further changes in such loss estimates, either upward or downward, will occur in the future.
Management believes that Trenwick's claim and claim expense liabilities are adequate. However, the process of estimating claims and claim expense liabilities is inherently imprecise and involves an
evaluation of many variables, including potentially unpredictable social and economic conditions. Accordingly, there can be no assurance that Trenwick's ultimate liability will not vary significantly from amounts reserved. The uncertainties in and the risk factors associated with the claims reserves at December 31, 2002 are similar to the uncertainties at prior year ends. However, given Trenwick's current surplus levels, it is now less financially equipped to handle these uncertainties should there be adverse development in the loss reserves. Reserves for Trenwick's participation in Lloyd's syndicates through its Lloyd's corporate members are included in the year end reserves. Part of the reserve represents reinsurance to close balances brought forward to the open years of account (for example, 1996 reinsured into the 1997 open year. Favorable or unfavorable development of the prior year's reserves can influence the results of the open years of 1999, 2000 and 2001.
Trenwick purchases reinsurance to reduce its exposure on individual risks, catastrophic losses and other large losses. Trenwick estimates the amount of uncollectible receivables from its reinsurers each period and establishes an allowance for uncollectible amounts. The amount of the allowance is based on the age of unpaid amounts, information about the creditworthiness of Trenwick's reinsurers, and other relevant information. Estimates of uncollectible reinsurance amounts are reviewed quarterly, and changes are recorded in the period they become known. A significant change in the level of uncollectible reinsurance amounts would have a significant effect on Trenwick's results of operations and financial position. Also see Note 7 of Notes to the Consolidated Financial Statements.
Deferred income tax assets and liabilities are computed based on temporary differences between financial statement and income tax bases of assets and liabilities using enacted income tax rates in effect for the year in which the differences are expected to reverse. FASB Statement No. 109 requires a valuation allowance to be recorded when it is more likely than not that some or all of the deferred tax assets will not be realized. Due to Trenwick's cumulative losses generated in recent years and uncertainties as to the amount of taxable income to be generated in future years, as of December 31, 2002, Trenwick could not support the future realizability of its net deferred tax asset. The effects of this determination on Trenwick's results from
operations are significant. As of December 31, 2002, Trenwick had increased its valuation allowance by $215.3 million, so as to record a valuation allowance for the full amount of its net deferred tax asset. Trenwick's Bermuda operations are not subject to income tax. Also see Note 10 of Notes to be Consolidated Financial Statements.
With respect to Trenwick's investment portfolio, the risk management strategy is to place its investments with high credit quality issuers and to limit the amount of credit exposure with respect to particular ratings categories and any one issuer. Trenwick selects investments with characteristics such as duration, yield, currency and liquidity to reflect the underlying characteristics of related estimated claim liabilities.
The borrowings of Trenwick are summarized in Note 9 to the financial statements, and under the caption "Financings, Financing Capacity and Capitalization" in this Management's Discussion and Analysis of Financial Condition and Results of Operations.
The above analyses do not take into account any correlation among foreign currency exchange rates, or any correlation among various markets (i.e., the fixed income markets and foreign exchange and equity markets). Trenwick's actual experience may differ from the results noted above due to the correlation assumptions utilized, or if events occur that were not included in the methodology, such as significant liquidity or market events. The selection of the amount of increases or decreases in currency exchange rates, interest rates and equity values in the above analyses should not be construed as a prediction of future market events, but rather, to illustrate the potential impact of such events.
The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local
Effective January 1, 2002, Trenwick adopted a new Financial Accounting Standards Board statement which amended the accounting for goodwill and other intangible assets. This new statement suspended systematic goodwill amortization and required Trenwick's Bermuda holding company, LaSalle Re Holdings to credit the negative goodwill balance of $11.6 million to operations as of January 1, 2002 as a cumulative effect of an accounting change. The statement also required that the remaining goodwill balance be tested for impairment under either market value or cash flow tests. Trenwick conducted both market value and cash flow tests and, as a result, recorded a $53.2 million write off of all of Trenwick's remaining goodwill as a cumulative effect of an accounting change as of January 1, 2002.
The result of the foregoing is that the future operations of Trenwick, at least in the next several years, are likely to consist substantially of the sale or management in runoff of some or all of its existing insurance and reinsurance businesses including administration of claims, regulatory reporting, settlement of reinsurance agreements (including commutations thereof where appropriate), cash and investment management and related matters. The costs involved in such operations are likely to differ significantly from those of prior years, where a significant portion of the operating costs related to underwriting, marketing and securing reinsurance for new business. The reimbursement of costs as they relate directly to the insurance entities themselves will be subject to review by regulatory authorities which may challenge these costs or impose other restrictions with respect to the runoff including the provision of an acceptable runoff plan. Adverse loss developments or weakness in reinsurance recoveries, among other factors, could significantly and negatively impact the success of any runoff. It is unlikely that any amounts will be available to the creditors or equity holders of the direct and indirect parent companies of any regulated insurance subsidiary of Trenwick until such time as the regulator having jurisdiction over such subsidiary has been assured of the solvency of such entity, which may require several years if achievable at all. It is possible that one or more of Trenwick's insurance company subsidiaries may be placed under the control of the regulatory body with jurisdiction over such entity, voluntarily or involuntarily, through rehabilitation, liquidation or other proceedings.
We are engaged in continuing discussions with the holders of our senior notes regarding a restructuring of our senior notes. At this time we do not have sufficient liquidity to pay the principal amount of $75 million due on April 1, 2003, and we do not believe that we will be able to replace, refinance or restructure the notes by this date. If we are unable to secure a waiver or extension of this deadline, and either the banks under our credit facility or the senior noteholders determine to exercise the rights available to them upon this failure, we and/or one or more of our subsidiaries may be forced to seek protection from creditors through proceedings commenced in Bermuda and other jurisdictions including the United States.
As a result of the September 11, 2001 terrorist attacks, LaSalle Re incurred large catastrophe losses that enabled Trenwick to exercise its rights under a catastrophe equity put option with European Reinsurance Company of Zurich, a subsidiary of Swiss Reinsurance Company ("European Re"). In this transaction, we issued Series B Shares to European Re for a purchase price of $40 million. These Series B Shares are convertible into our common shares upon the occurrence of certain events, including our failure to maintain a net worth (as defined) under generally accepted accounting principles of $225 million. Our net worth is below $225 million, and in the event that it remains below that amount through April 19, 2003, European Re will be able to convert the Series B Shares into common shares upon not less than 60 days' notice to us, and substantial dilution to existing common shareholders will occur. In addition, depending on the conversion ratio of preferred shares to common shares, which is based upon the trading price of our common shares and the book value and number of shares converted, this conversion could result in European Re obtaining control of our company subject to compliance with applicable insurance regulation.
We are a holding company and substantially all of our assets are held in our insurance company subsidiaries. These assets are generally unavailable to pay the debts of the holding company and there is substantial uncertainty as to whether we will ultimately receive any value from our insurance company subsidiaries.
restrictions on our New York insurance company subsidiary that are at a minimum similar to those imposed by the Connecticut Insurance Department on our Connecticut subsidiary. Trenwick has also been notified by the NYID that, in the NYID's view, approximately $26 million in loans made to Trenwick America by Inscorp in 2002 were in contravention of New York regulatory requirements. As a result, Inscorp and Trenwick may be the subject of regulatory action brought by the NYID. In addition, the Bermuda Monetary Authority has restricted the license of our Bermuda insurance company subsidiary to prohibit it from writing any new business without its prior written approval. Each of these regulators, as well as regulators in the United Kingdom and the State of North Dakota, may act independently of one another with respect to the insurance company domiciled in its jurisdiction. Any action by an insurance regulator, such as the commencement of voluntary or involuntary supervision, rehabilitation, conservation or liquidation proceedings with respect to one of these companies, could precipitate additional actions by the other insurance regulators. In the event of any such proceedings, it is unlikely that the assets of the insurance companies will be available to satisfy each others' liabilities, or the liabilities of Trenwick.
We are writing substantially all of our United States business as agent for a highly rated unaffiliated insurance company under an arrangement that is terminable at will. If this arrangement is terminated, we may be unable to find a replacement carrier and would have no ongoing business in the United States.
Our senior debt and other ratings have been downgraded significantly by Standard & Poor's, Moody's Investor Services and Fitch, to "CCC-", "Ca" and "C", respectively. These ratings generally reflect the ratings services' views that our business prospects and financial flexibility are very limited and their substantial doubt as to our ability to restructure our senior debt. In addition, these downgrades significantly and negatively affect our ability to raise capital and to negotiate favorable terms in restructuring our debt.
Several of the business lines from which we historically derived a significant portion of our revenue have ceased to write new business and are in runoff.
significantly to our revenue or results of operations and there are significant uncertainties that could if realized adversely affect our ability to continue a solvent runoff of these operations.
Our ability to attract and retain key management personnel has been negatively affected.
Our business model relied to a large extent on reinsurance to reduce our underwriting risk. As of December 31, 2002, our reinsurance recoverable balance was approximately $1.8 billion. Our subsidiaries are subject to credit risk with respect to their reinsurers because the transfer of risk to a reinsurer does not relieve the insurers of their liability to the insureds. In addition, reinsurers may be unwilling to pay our insurance company subsidiaries even though they have the financial resources and are contractually obligated to do so. Unfavorable arbitration decisions or the failure of one or more of the reinsurers to honor their obligations or make timely payments would impact our subsidiaries' cash flow and could cause us to incur significant losses. In the event of the rehabilitation, supervision, conservation or liquidation of any of our insurance company subsidiaries, we may not be able to influence the outcome of the collectibility of reinsurance recoverables, in that it will be the responsibility of the regulators supervising such proceedings.
Our results of operations and financial condition depend upon our ability to assess accurately the potential losses associated with the risks that we insure and reinsure. To the extent actual claims continue to exceed our expectations, we will be required to immediately recognize the less favorable experience. This could cause a material increase in our liabilities and a reduction in our profitability, including an operating loss and reduction of capital.
The regulatory system under which we operate, and potential changes thereto, could have a material adverse effect on our business.
Our insurance and reinsurance subsidiaries may not be able to obtain or maintain necessary licenses, permits, authorizations or accreditations in locales where we currently engage in business, or may be able to do so only at significant cost. In addition, we may not be able to comply fully with, or obtain appropriate exemptions from, the wide variety of laws and regulations applicable to insurance or reinsurance companies or holding companies. As a result of the events of the past several months, we are presently in discussions with, or subject to orders issued by, insurance regulators in all of the jurisdictions in which we and our insurance company subsidiaries are domiciled. Our inability to comply with or to obtain appropriate authorizations and/or exemptions under any applicable laws, regulations or orders could result in further restrictions on our ability to do business and could subject us to fines and other sanctions including the ceasing of our ongoing operations.
o The material facts as to such interested director's relationship or interests were disclosed or were known to the board of directors and the board of directors in good faith authorized the transaction by the affirmative vote of a majority of the disinterested directors;
Trenwick Group Ltd. Consolidated Balance Sheet (Amounts expressed in thousands, except share and per share data)
TRENWICK GROUP LTD. Notes to Consolidated Financial Statements (Amounts expressed in thousands, except share and per share data) Years Ended December 31, 2002, 2001 and 2000,
Trenwick's principal subsidiaries underwrite specialty insurance and reinsurance. More details on business segments and geographic information are disclosed in Note 6.
These financial statements were prepared in conformity with accounting principles that are generally accepted in the United States of America, sometimes referred to as U.S. GAAP. In preparing these financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual amounts may differ from these estimates.
The accompanying financial statements have been prepared assuming Trenwick will continue as a going concern. As discussed in Note 9 to the financial statements, Trenwick is currently required to repay certain senior notes by April 1, 2003 and collateralize, with cash or cash equivalents, 60% of the outstanding letters of credit under its senior credit facility by August 1, 2003. At this time, Trenwick does not have sufficient available liquidity to collateralize the letters of credit or repay the senior notes. As discussed in Note 14 to the financial statements, certain insurance subsidiaries of Trenwick do not meet
The assets and liabilities of operations whose functional currency is other than the United States dollar are translated at the rates of exchange at the balance sheet dates. Revenues and expenses of these operations are translated at the average exchange rates during each period. The effects of these translation adjustments, net of applicable income taxes, are recorded as a cumulative translation adjustment within other comprehensive income. Transaction gains and losses on currencies other than the United States dollar are included in operations. Disclosures included in the Notes to the Consolidated Financial Statements denominated in United Kingdom pounds sterling (pound) have been converted to United States dollars at various rates based upon various factors, including in some cases the date of the transaction described.
Other significant accounting policies are presented in italics within the appropriate footnotes.
The Trenwick/LaSalle business combination was accounted for as a purchase by LaSalle Re Holdings of the minority interest in LaSalle Re and of Trenwick Group Inc. Under the purchase basis of accounting, the purchase price ($346,178) was allocated to the identifiable assets acquired and liabilities assumed, based on their estimated fair values at the date of acquisition; the unallocated excess was recorded as goodwill. Recent changes in accounting for goodwill and its amortization are described in Note 15.
Effective April 1, 2002, Trenwick sold the in-force property catastrophe reinsurance business of its subsidiary, LaSalle Re, to Endurance Specialty Insurance, Ltd. ("Endurance"). The sale was effected through a 100% quota share reinsurance agreement, with Endurance paying Trenwick a ceding commission of 25% of premiums ceded under the quota share agreement and additional profit sharing of 50% if the losses do not exceed a loss ratio of 45%. In addition, Endurance will have the right to renew LaSalle Re's in-force business as it expires in exchange for a 12.5% commission on the business renewed. Included in the results for the year ended December 31, 2002 are $11,523 in ceding commissions earned on the quota share with Endurance, as well as $6,012 in amortization of acquisition costs on the related assumed business.
In connection with this transaction, Trenwick recorded the following non-recurring revenues and expenses during the year ended December 31, 2002:
On November 4, 2002, Trenwick Managing Agents entered into a second agreement with NICO, which was amended on December 23, 2002, and which enabled Syndicate 839 to have an authorized premium capacity of (pound)328,100 ($ 528,241), before qualifying quota share, for the 2003 year of account. Under the terms of the amended December 2002 agreement, NICO has agreed to provide (pound)75,600 ($120,143) in premium capacity for the 2003 year of account, by increasing its additional funding to (pound)49,786 ($79,120). Of the premium capacity, (pound)62,500 ($99,325) is being applied to the aviation insurance line of Syndicate 839's business and
On October 25, 2002, Trenwick's subsidiary Trenwick America Reinsurance Corporation ("Trenwick America Re") entered into an underwriting facility with Chubb Re, Inc. and its affiliate Federal Insurance Company (together, "Chubb") under which Trenwick America Re will cause, subject to Chubb's approval, all of its new and renewing United States reinsurance business during the term of the underwriting facility to be underwritten by Trenwick America Re as agent on behalf of Chubb, which will issue the reinsurance. Chubb's approval will not be unreasonably withheld. The underwriting facility permits Trenwick America Re to underwrite up to $400,000 of United States reinsurance business as agent on behalf of Chubb through January 31, 2004. The underwriting facility does not preclude Chubb from writing any business outside of the facility. As further described below, the profit commission to Trenwick America Re, if any, will be paid by Chubb beginning in the first quarter of 2006.
Chubb will receive as a fronting fee either five percent of gross written premium on two-thirds of the business underwritten through the underwriting facility, or $15,000 whichever is greater. To date, Trenwick America Re has paid $10,000 of this amount to Chubb, and additional payments of $1,250 are due to be paid by Trenwick America Re at the end of each
Chubb will receive one-third and Trenwick America Re will receive two-thirds of any profits generated by the underwriting facility, including underwriting profits and investment income. The profit commission will equal two-thirds of the experience account, and will be paid on the following payment schedule:
September 30, 2006 50% of cumulative indicated profit commission, less prior profit commission paid
March 31, 2007 75% of cumulative indicated profit commission, less prior profit commission paid
An "event of default" by Trenwick America Re under the Chubb facility would occur if creditors attach or take possession of any material amount of Trenwick America Re's assets, or if Trenwick America Re voluntarily or involuntarily enters into rehabilitation, dissolution, winding-up, liquidation, administration or reorganization proceedings under applicable bankruptcy, insolvency or similar law. Upon the occurrence of an event of default by Trenwick America Re, no profit commission will be paid and no reductions in the amount of collateral will be made until the event of default ceases, or January 1, 2012, which ever is earlier. At that time, the profit commission payment schedule and collateral reduction schedules will recommence at the point at which the event of default occurred.
During the first quarter of 2002, Trenwick amended the basis in which operating segments are reported. The continuing Lloyd's syndicates managed by Trenwick and the International Specialty Insurance and Reinsurance operations were combined into one operating segment and the United States based property and casualty reinsurance and Bermuda based property catastrophe reinsurance operations were combined into one segment called Reinsurance. These changes were made to conform to changes in Trenwick's management and operational structure.
o United States specialty program insurance, which was written principally through its United States subsidiary, Canterbury Financial Group, Inc. and its operating subsidiaries, The Insurance Corporation of New York, Dakota Specialty Insurance Company and Chartwell Insurance Company (merged with and into Trenwick America Re effective December 31, 2002). Trenwick ceased underwriting substantially all United States specialty program insurance effective October 30, 2002.
The following tables present business segment and other financial information for Trenwick as of December 31, 2002 and 2001 and for the years ended December 31, 2002, 2001 and 2000:
Insurance and reinsurance premiums on contracts are accrued on an estimated basis throughout the term of such contracts. For retrospectively rated and other experience rated reinsurance contracts, premiums are estimated and accrued based on the difference between total unpaid claims and claims expenses before and after the experience under the contract (the with-and-without method). Premium estimates are made based on statistical and other data and record subsequent adjustments in the period in which they become known. Short-duration contracts are accounted for as reinsurance when they provide indemnification against loss or liability relating to insurance risk and as deposits when they do not.
Policy acquisition costs consist primarily of commissions and brokerage expenses that vary with and are primarily related to the acquisition of business. Policy acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred policy acquisition costs are reviewed on a quarterly basis to determine that they do not exceed recoverable amounts after allowing for anticipated investment income.
The following table presents a reconciliation of the beginning and ending balances of net liabilities for unpaid claims and claims expenses. The gross liabilities for unpaid claims and claims expenses at period ends are as reflected in the balance sheet. The net liabilities for unpaid claims and claims expenses reflect deductions for reinsurance recoverable on unpaid claims and claims expenses, also as reflected in the balance sheet.
With respect to the 2002 provision for claims incurred prior to the current period, approximately 87% related to claims occurring between 1998 and 2001 and was spread across multiple lines of business. The period from 1998 to 2001 represents a period of weak insurance and reinsurance pricing and the actual loss results for business written during that period have turned out to be significantly worse than originally estimated by Trenwick when it originally
In 2001, Trenwick recorded a net increase $110,880 (net of recoveries under the contingent interest note of $9,893) in estimates for claims occurring in prior accident years. The increase in 2001 is principally due to reserve strengthening recorded on business acquired in the Trenwick/LaSalle business combination. This reserve strengthening includes $15,654 related to U.S. casualty treaty reinsurance business, which was underwritten prior to 2001 and $11,530 related to prior participation in the ECRA Pool. In addition, $13,940 of the loss reserve strengthening related to U.S. specialty program insurance. Also included in the reserve strengthening was $20,463 relating principally to directors and officers liability business written through Trenwick's Lloyd's syndicates. Lastly, the reserve strengthening included $48,293 stemming from deterioration in discontinued businesses and reviews of the property insurance and liability business lines written through Trenwick International. The increase in 2000 is principally due to unfavorable development of prior year estimates for LaSalle Re and Trenwick America Re offset in part by favorable development of prior year reserves at the Lloyd's syndicates managed by Trenwick Managing Agents. The increase in 2000 reflects a deterioration in market conditions since 1997.
Inflation raises the cost of economic losses and non-economic damages covered by insurance contracts and therefore is a factor in determining effective rates of reinsurance and the appropriateness of reserves. The methods used to estimate individual case reserves and reserves for claims incurred but not yet reported implicitly incorporate the effects of inflation in the projection of ultimate losses. Due to the inherent uncertainties of estimating unpaid claims and claims expenses, actual claims and claims expenses may deviate, perhaps substantially, from estimates reflected in these financial statements. Management believes that its claim estimation methods are reasonable and prudent and that its unpaid claims and claims expenses at year end 2002 are adequate.
From 1989 to 1999, Trenwick America Re purchased aggregate excess of loss ratio treaties from several reinsurers. These facilities provided Trenwick America Re with a layer of protection against adverse results from its domestic casualty business in excess of specified loss ratios. Trenwick America Re did not purchase an aggregate excess of loss ratio treaty after 1999 when its reinsurance philosophy was modified and it began using specific retrocessional and property catastrophe protections to manage its underwriting results, and to eliminate the use of aggregate stop loss coverages to provide capital enhancement. Interest expense on funds held under these facilities is recorded as an investment expense, and is included in the funds held offset at year end 2002 and 2001.
In 2002, LaSalle Re purchased two excess of loss programs which provided coverage of $20,000 in excess of the first $30,000 of losses per occurrence and $5,000 in excess of the first $50,000 of losses per occurrence both of which, as of April 1, 2002, were retroceded to Endurance as part of the sale of LaSalle's in-force reinsurance business. A third excess of loss program which provided coverage of $25,000 in excess of the first $100,000 of losses per occurrence for a four year period with a yearly aggregate limit of $50,000 and a contract aggregate limit of $150,000 was commuted by LaSalle Re in December 2002.
In 2001, LaSalle Re purchased three excess of loss programs which provide coverage of $20,000 in excess of the first $30,000 of losses per occurrence, $5,000 in excess of the first $50,000 of losses per occurrence and $25,000 in excess of the first $75,000 of losses per occurrence.
Reinsurance recoverable balances at year end 2002 and 2001 are net of allowances for doubtful accounts of $80,369 and $54,580, respectively, which includes $37,194 and $22,896 for paid claims and $43,175 and $31,684 for unpaid claims and claims expenses, respectively.
Net realized gains (losses) on sales of investments and their effect on net income follow:
During the years ended December 31, 2002 and 2001, Trenwick wrote down the fair value of certain securities by $1,365 and $3,441, respectively and reflected the write-downs as realized losses on investments to recognize declines in value that were other than temporary. No securities were written down during the year ended December 31, 2000.
Unrealized investment gains and losses are calculated as the difference between recorded values (fair value) and amortized cost or cost. Net unrealized investment gains and losses, net of applicable deferred income taxes, are included in common shareholders' equity as accumulated other comprehensive income.
Debt securities net unrealized gains $ 12,621 $ 34,571 Equity securities net unrealized gains -- 6,754 -------- -------- Net unrealized gains before income taxes 12,621 41,325 Applicable deferred income taxes 10,359 12,479 -------- -------- Net unrealized investment gains $ 2,262 $ 28,846 ======== ========
Indebtedness and other mandatorily redeemable obligations are recorded at their fair value at the date of the Trenwick/LaSalle business combination or at principal amounts advanced subsequent thereto. Discount on these obligations is accreted utilizing the interest method. The principal amount of Trenwick's contingent interest note obligations is adjusted for any adverse development in the applicable liability for claims and claims expenses. The mandatorily redeemable preferred capital securities held as an investment by a subsidiary (face amount $18,712) are eliminated in consolidation.
2002 2001 -------- -------- Senior notes $ 74,777 $ 73,920 Senior credit facility -- 195,035 Contingent interest notes 1,721 19,923 Other debt -- 2,385 -------- -------- Total indebtedness 76,498 291,263 -------- -------- Mandatorily redeemable preferred capital securities of U.S. subsidiary 68,320 68,119 Preferred shares of Bermuda subsidiary 75,000 75,000 -------- -------- Total minority interest 143,320 143,119 Convertible preferred stock 40,000 -- -------- -------- Total indebtedness, minority interest and convertible preferred stock $259,818 $434,382 ======== ========
December 31, 2002, as defined, was less than $225,000. In the event that the GAAP net worth of Trenwick remains below $225,000 through April 19, 2003, a Net Worth Conversion Event will have occurred and the holders of the Series B Shares will thereafter be able to convert their shares on not less than sixty days notice to Trenwick. Management believes it is unlikely that the GAAP net worth of Trenwick will exceed $225,000 at such time. The conversion price per common share of the Series B shares is the greater of i) the liquidity factor times the average thirty day stock price preceding the conversion date, ii) the liquidity factor times Book Value Per Common Share (as defined) or iii) par value of a common share. The liquidity factor will be calculated as an amount equal to 0.8 if the conversion occurs within 60 days after a Change in Control Conversion Event or 1.0 if the conversion does not occur within 60 days after the occurrence of a Change in Control Conversion Event.
Average market value of common shares Book value per share -------------- ------------------------------------------------------- $0.10-$0.50 $0.51-$1.00 $1.01-$2.00 $2.01-$5.00 ----------- ----------- ----------- ----------- Range of shares issuable upon conversion (in millions) $0.10-$0.50 550 - 110 108 - 55 54 - 28 27 - 11 $0.51-$1.00 108 - 55 108 - 55 54 - 28 27 - 11 $1.01-$2.00 54 - 28 54 - 28 54 - 28 27 - 11 $2.01-$5.00 27 - 11 27 - 11 27 - 11 27 - 11
The senior notes, with a par value of $75,000, are due April 1, 2003, and are not subject to redemption prior to maturity. They are unsecured obligations and rank senior in right of payment to all existing and future subordinated indebtedness of Trenwick America Corporation ("Trenwick America"), Trenwick's U.S. holding company. Under the terms of the notes, Trenwick America is not restricted from incurring indebtedness, but may not incur secured indebtedness for borrowed money unless it provides an equivalent security interest to the holders of the senior notes. Interest on the notes is payable semi-annually at an annual rate of 6.7%. As permitted under the terms of the senior notes, effective November 29, 2002, Trenwick America suspended payment of interest on these obligations, however interest continues to be charged to operations at the imputed rate of 7.9%. Trenwick is engaged in continuing discussions with holders of the senior notes with respect to a possible restructuring of these senior notes. Trenwick's agreements entered into in connection with the renewal of its letter of credit facility in December 2002 provided that Trenwick would replace, refinance or restructure these senior notes by March 1, 2003. The banks participating in Trenwick's letter of credit facility have provided to Trenwick a waiver of this March 1, 2003 deadline as discussions with the senior note holders continue. At this time, Trenwick does not have sufficient available liquidity to pay the amount due on April 1, 2003 and is uncertain whether it will be able to complete the restructuring by that date. If Trenwick is unable to restructure these senior notes by April 1, 2003 and either the banks under the credit facility or the senior noteholders determine to exercise the rights available to them or take other action with respect to the assets of Trenwick, Trenwick and/or one or more of its subsidiaries may be forced to seek protection from creditors through proceedings commenced in Bermuda and other jurisdictions including the United States. In addition, at any time the insurance regulatory authorities having jurisdiction over Trenwick's insurance company operating subsidiaries may commence voluntary or involuntary proceedings for the formal supervision, rehabilitation or liquidation of such subsidiaries, or one or more of the creditors of Trenwick or its subsidiaries may commence proceedings against Trenwick or its non-regulated subsidiaries seeking their liquidation.
Pursuant to a guaranty agreement entered into concurrently with the credit agreement, Trenwick has guaranteed the obligations of Trenwick America and Trenwick Holdings under the credit agreement. In April of 2002, Trenwick pledged the capital stock of LaSalle Re Holdings, which was the guarantor of the obligations under the credit agreement, and LaSalle Re as collateral to the Banks. In December of 2002, Trenwick agreed to provide the Banks additional security interests as described below.
On October 18, 2002, A.M. Best Company lowered the financial strength ratings of Trenwick's operating subsidiaries below A-. The lowered A.M. Best Company ratings constituted an event of default under the credit agreement. In addition, Trenwick's increases in reserves for unpaid claims and claims expenses and the establishment of a Trenwick deferred tax asset valuation allowance in the third quarter of 2002 resulted in Trenwick violating the financial covenants in the credit agreement requiring Trenwick to maintain a minimum tangible net worth and minimum risk-based capital. On November 13, 2002, Trenwick, its subsidiaries and the Banks executed a forbearance agreement with respect to the events of default arising from Trenwick's lowered A.M. Best Company ratings and financial covenant violations.
Pursuant to the December Amendments, Trenwick is required to collateralize with cash, cash equivalents and marketable securities 60% of the outstanding letters of credit by August 1, 2003. In addition, Trenwick is required to use its best efforts to terminate the letters of credit by December 31, 2003. In order to do so, the letters of credit would need to be replaced with other letters of credit or collateral acceptable to Lloyd's. In the event Trenwick has not terminated the letters of credit by December 31, 2003, it is required on such date to collateralize with cash, cash equivalents and marketable securities the full amount of the outstanding letters of credit. At this time, Trenwick does not have sufficient available liquidity to collateralize the letters of credit as required by the December Amendment. Additionally, Trenwick does not believe that it will be able to replace the letters of credit with other letters of credit or collateral acceptable to Lloyd's.
Since December 2002, Trenwick has entered into additional amendments and numerous waivers with the Banks providing for, among other things, waivers of potential covenant defaults, further reductions in certain financial covenants, additional financial reporting, approval of certain employee and other payments, and extension of numerous deadlines imposed under the December Amendments.
If there is an event of default under the credit agreement, including as a result of Trenwick failing to collateralize the letters of credit as described above, or if there is an event of default under other outstanding indebtedness of Trenwick or its subsidiaries, including under the senior note facility, resulting in a cross default under the credit agreement, Trenwick may be required to fully and immediately collateralize the outstanding letters of credit under the terms of the guaranty agreement. No liability for any such amounts has been reflected in Trenwick's financial statements for any potential future event of default. If the potential future events of default are not waived, there is substantial doubt as to Trenwick's ability to continue as a going concern and Trenwick and/or one or more of its subsidiaries may be forced to seek protection from creditors through proceedings commenced in Bermuda and other jurisdictions including the United States. In addition, at any time one or more of the insurance regulatory authorities having jurisdiction over Trenwick's insurance company operating subsidiaries may commence voluntary or involuntary proceedings for the formal supervision, rehabilitation or liquidation of such subsidiaries, or one or more of the creditors of Trenwick or its subsidiaries may commence proceedings seeking their liquidation.
The contingent interest notes were issued immediately prior to Chartwell's acquisition of The Insurance Corporation of New York in 1995 to protect Chartwell against the possibility of adverse development of that insurer's liability for claims and claims expenses and long-tail casualty exposures, which are more fully described in Note 7. Trenwick Group Inc. assumed the obligations of Chartwell under the contingent interest notes in the 1999 Trenwick/Chartwell merger, and Trenwick America subsequently assumed the obligations of Trenwick Group Inc. under the contingent interest notes in the Trenwick/LaSalle business combination, described in Note 2. The contingent interest notes were issued in an aggregate principal amount of $1,000 with principal accruing interest at a rate of 8% per annum, compounded annually. The interest will not be payable until scheduled maturity on June 30,2006 or earlier redemption of the
Components of interest expense and subsidiary preferred share dividends for the years ended December 31, 2002, 2001 and 2000 follow:
At December 31, 2002, there were warrants outstanding for the purchase of 153,263 common shares at prices of $25.45 and $26.67 per share ($4,003 aggregate). This does not include the warrants that Trenwick has agreed to issue to the Banks under the December Amendments. Warrants for 69,545 shares at an exercise price of $25.45 per share and warrants for 83,718 shares having an average exercise price of $26.67 per share expired on January 29, 2003. Warrants for 580 common shares at a price of $25.45 per share were exercised in December 2000.
During the years ended December 31, 2002, 2001 and 2000, Trenwick paid dividends of $0.12, $0.16 and $0.04, respectively, per common share.
In September 2000, Trenwick adopted a new shareholder rights plan. Shareholders of record received one right for each common share held. The rights are exercisable only if a person or group acquires beneficial ownership of 15% or more of Trenwick's common shares or commences a tender or exchange offer for 15% or more of Trenwick's common shares. Each right entitles a common shareholder to buy 1/200th of a junior participating preferred share at an exercise price of $85.00.
In the event that an outside party acquires beneficial interest in 15% or more of Trenwick's common shares, all rights holders except the acquirer may purchase,
for the exercise price, in lieu of the preferred shares, Trenwick common shares having a market value of twice the exercise price of each right. If Trenwick is acquired in a merger or other business combination after the acquisition of 15% of Trenwick's common shares, all rights holders except the acquirer may purchase the acquirer's shares at a similar discount. Trenwick is entitled to redeem the rights at $0.01 per right, subject to certain restrictions. The rights will expire on September 27, 2010.
Income taxes are provided based upon amounts reported in the financial statements and the provisions of currently enacted tax laws. Income taxes are allocated to operations, other comprehensive income and shareholders' equity, as applicable.
Current income tax assets and liabilities are provided for estimated income taxes refundable or payable based on the current year's income tax return. Deferred income tax assets and liabilities are recognized for the estimated future income tax effects of temporary differences and carryforwards. Temporary differences are the differences between the financial statement carrying amounts of assets and liabilities and their tax bases, as well as the timing of income or expense recognition for financial reporting and tax purposes of items not related to assets and liabilities. Valuation allowances are established to reduce the carrying amount of deferred income tax assets, if necessary, to amounts that are more likely than not to be realized. Trenwick periodically reviews the adequacy of these valuation allowances and records any changes in allowances through earnings.
In evaluating the realizability of Trenwick's net deferred tax asset, during 2002, Trenwick established a full valuation allowance on its net deferred tax asset. In prior years, Trenwick had recorded a valuation allowance with respect to its foreign tax credits, however, as of year-end 2002, management concluded that Trenwick's current circumstances and its cumulative financial accounting losses do not support a position that it is more likely than not that Trenwick will be able to realize these future tax benefits. Trenwick will periodically review the sufficiency of its valuation allowance and record any future changes in allowances through earnings.
For the 2002, 2001 and 2000 years, the U.K. effective tax rate of 133.4%, 28.8% and 51.5% respectively differs from the statutory tax rate of 30% as follows:
At December 31, 2002, Trenwick has net operating loss carryforwards in the U.S. and the U.K. The U.S. subsidiaries have a U.S. net operating loss carryforward of $261,832 that will be available to offset regular taxable income during the carryforward periods, which expire in 2007 ($9,655) and between 2018 through 2022 ($252,177). As a result of the Trenwick/LaSalle business combination, an ownership change took place on September 27, 2000, and approximately $32,485 of the total U.S. net operating loss carryforward became limited to a cumulative annual utilization of $5,228. The remaining $229,347 in U.S. net operating loss carryforwards are not so limited.
U.S. discounting and other loss reserve adjustments $ 51,019 $ 37,950 U.K. disclaimed loss reserves 11,942 37,796 Unearned premium income 15,888 10,845 U.S. net operating losses 91,641 48,782 U.K. net operating losses 80,795 945 U.K. losses not yet realized for tax purposes 4,261 35,958 Contingent interest note -- 6,416 Tax basis difference on investment securities 2,736 1,309 Employee stock option and compensation plans 1,849 1,057 Foreign tax credits 575 410 Alternative minimum tax credits 804 5,859 Debt issuance costs 757 1,399 Tax on foreign currency translation loss 1,619 1,276 Acquisition of indebtedness income 1,851 1,851 Other U.S. and U.K. items 1,506 1,082 --------- --------- Deferred tax asset, gross of valuation allowance 267,243 192,935 Valuation allowance (217,039) (1,212) --------- --------- Deferred tax asset, net of valuation allowance 50,204 191,723 --------- ---------
Additionally, Trenwick maintains a 401(k) savings plan for substantially all United States full-time employees, through which employees contribute up to the maximum amount allowable by the Internal Revenue Service. Trenwick contributes up to 6% of a participating employee's compensation to the plan.
The scheduled vesting of the 188,169 restricted common shares outstanding at year end 2002 is as follows: 2003, 54,832 shares; 2004, 54,832 shares; 2005, 54,790 shares and 2006, 24,715 shares. Trenwick recognized $795, $1,394 and $597, respectively, of compensation expense with respect to restricted common shares for the 2002, 2001 and 2000 years.
LaSalle Re Holdings had a similar plan which it terminated in connection with the Trenwick/LaSalle business combination. Prior to termination, LaSalle Re Holdings issued 21,532, shares under the plan during the year ended December 31, 2000, and recognized $47 of compensation expense.
During the year ended December 31, 2002, 1,365,187 share options were cancelled pursuant to the employee stock option exchange program. This voluntary program offered all active employees with the exception of the Chief Executive Officer a one-time opportunity to exchange stock options for new options at a grant price equal to the fair market value of Trenwick common shares on December 16, 2002, which was $0.89.
All of the outstanding share options were issued at an exercise price equal to fair market value on the date of grant; therefore no compensation expense has been recognized for these grants. Had the fair value based method described above been applied, net income (loss) available to common shareholders and net income (loss) per common share would have been the pro forma amounts shown below:
Expected volatility 53.0% 38.0% 30.0% Risk-free interest rate 4.0% 4.9% 5.1% Common share dividend yield 1.2% 0.9% 0.6%
The Black-Scholes option valuation model was developed for use in estimating the fair value of options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected share price volatility. Because Trenwick's share options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in Trenwick's opinion the existing models do not necessarily provide a reliable measure of the fair value of its share options.
In consideration for entering into an employment agreement, LaSalle Re Holdings granted stock appreciation rights to its former chairman and chief executive officer. During the year ended December 31, 2001, Trenwick paid $1,451 in settlement of his exercisable rights. During the years ended December 31, 2001 and 2000, Trenwick recognized $(278) and $765, respectively, of compensation expense under this agreement. At year end 2002, there are no stock appreciation rights outstanding.
Other comprehensive income is recorded for the change in the net unrealized appreciation of investments and the change in foreign currency translation adjustments, both net of income taxes.
The components of accumulated other comprehensive income at December 31, 2002 and 2001 follow:
For the years ended December 31, 2002, 2001 and 2000, 1,476,763, 3,061,151 and 2,474,521, respectively, aggregate share options, stock appreciation rights, contingently issuable shares and warrants were excluded from the computation of diluted earnings per share because their effect would have been antidilutive on the calculation for the respective period.
Each of Trenwick's U.S. insurance subsidiaries is subject to restrictions on the payment of dividends without prior approval from the state insurance regulator in its
respective state of domicile. These restrictions are based upon certain measures of statutory surplus and net income. At year end 2002, based upon these restrictions, Dakota Specialty Insurance Company and ReCor Insurance Company had $3,091 and $21, respectively, available for the payment of dividends to their parent, The Insurance Corporation of New York, in 2003 without prior regulatory approval. Dakota Specialty Insurance Company has received regulatory approval from the State of North Dakota Department of Insurance to pay an extraordinary dividend of $20,000 to its parent, The Insurance Corporation New York. The remainder of Trenwick's U.S. insurance subsidiaries are precluded from paying dividends without prior regulatory approval based upon these restrictions. Additionally, on November 26, 2002, Trenwick America Re entered into a "letter of understanding" with the Connecticut Department of Insurance pursuant to which Trenwick America Re agreed, among other things, that it would not lend any of its funds or make any ordinary or extraordinary dividends without the prior written approval of the Connecticut Insurance Department.
The NAIC has adopted Risk-Based Capital, or RBC, requirements for property and casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy and other business factors. RBC is generally calculated and reported to the regulatory authorities with an insurance company's annual regulatory filings on or before March 1 of each year. The RBC calculation yields a ratio of the total adjusted statutory capital of an insurance company to the minimum level of statutory required capital as calculated under the provisions of the RBC model. The RBC calculation takes into account: (1) asset risk, (2) credit risk, (3) underwriting risk, and (4) all other relevant risks including the insurance company's current underwriting activities. The Model Act of the NAIC provides four levels of regulatory activity if the RBC ratio yielded by the calculation falls below specified minimums. At each of four successively lower RBC ratios specified by statute, increasing regulatory action may be required. The four levels are: (1) Company Action Level Event, (2) Regulatory Action Level Event, (3) Authorized Control Level Event, and (4) Mandatory Control Level Event.
Under the insurance laws of their respective states of domicile, Trenwick's United States insurance subsidiaries are required to maintain minimum levels of capital and surplus as regards policyholders. The failure of an insurer to maintain the required surplus level can result in the placing of the insurer by the insurer's domestic state's insurance department into supervision, rehabilitation or liquidation proceedings, for the benefit of policyholders and creditors of the insurer, and the general public.
o Withdraw any of its bank accounts except in the ordinary course of business;
o Enter into any unaffiliated insurance or reinsurance contracts that would constitute new or renewal business, or any unaffiliated commutation agreements or settlement agreements in excess of $1,000 not in the ordinary course of business; or
On January 29, 2003, Trenwick met with the New York Insurance Department (the "NYID") and had similar discussions to those with the State of Connecticut Insurance Department on January 24, 2003 described above. The Insurance Corporation of New York's reported RBC was at the "Mandatory Control Level Event" for the year ended December 31, 2002. New York Insurance Law requires that New York domiciled insurers report their risk-based capital based on a formula calculated by applying factors to various asset, premium and reserve items. The NYID uses the formula as an early warning regulatory tool for purposes of monitoring New York domiciled insurance companies to identify possibly inadequately capitalized insurers. The New York Superintendent of Insurance has explicit regulatory authority to require various actions with respect to New York domiciled insurers whose capital base or other operations are not satisfactory. The Insurance Corporation of New York has ceased underwriting new business and is in ongoing communication with the New York Insurance Department concerning its operations and continued permitted activities.
Trenwick received a letter from the NYID dated March 11, 2003 in which the NYID noted that the surplus to policyholders of The Insurance Corporation of New York, as of December 31, 2002 was $18,300 and therefore was impaired in the amount of $16,700, based on the statutory requirement that it maintain a minimum surplus to policyholders of $35,000. In the letter, the NYID notified The Insurance Corporation of New York that the surplus impairment must be corrected within 30 days, and directed it to advise the NYID within 30 days as to the steps management will take to remove the impairment and comply with the minimum surplus requirement. If the NYID is not satisfied that The Insurance Corporation of New York has eliminated the impairment by April 10, 2003, the Superintendent of the NYID may proceed against The Insurance Corporation of New York pursuant to the provisions of Article 74 of the New York Insurance Law, the statute authorizing supervision, rehabilitation, conservation, liquidation and dissolution of insurers, including domestic insurers. Management expects to file its plan to correct the capital impairment by April 10, 2003 .
To date, the State of Florida has suspended the underwriting authority of The Insurance Corporation of New York and Trenwick America Re to write any further business. In addition, the State of Colorado has recently suspended The Insurance Corporation of New York's underwriting authority. It is anticipated that other states will suspend the underwriting authority of the various insurance companies.
company is subject to the guaranty fund laws of the states in which it conducts insurance business; however, Trenwick's United States insurance subsidiaries that conduct business on a surplus lines basis in a particular state are generally exempt from that state's guaranty fund laws.
The State of Connecticut Insurance Department has permitted Trenwick America Re to account for the reinsurance agreement purchased in connection with the Trenwick/Chartwell business combination on a prospective basis in its statutory basis financial statements. This treatment is consistent with the U.S. GAAP accounting treatment of the contract. The New York State Insurance Department has required The Insurance Corporation of New York to account for that reinsurance agreement on a retroactive basis. The difference in these statutory accounting practices does not have an effect on the combined statutory surplus or net income of Trenwick's U.S. insurance subsidiaries. The terms of this reinsurance agreement are described in Note 7.
The National Association of Insurance Commissioners, or NAIC, is an organization which assists state insurance supervisory officials in the United States to achieve insurance regulatory objectives, including the maintenance and improvement of state regulation. From time to time various regulatory and legislative changes have been proposed in the insurance industry, some of which could have an effect on reinsurers. Among the proposals that have in the past been or are at present being considered are the possible introduction of federal regulation in addition to, or in lieu of, the current system of state regulation of insurers, and proposals in various state legislatures (some of which proposals have been enacted) to conform portions of their insurance laws and regulations to various model acts adopted by the NAIC. Trenwick is unable to predict what effect, if any, these developments may have on its operations and financial condition.
statutory surplus of $14,305 on January 1, 2001, primarily due to the recording of net deferred income tax assets. New York (domicile of The Insurance Corporation of New York and ReCor Insurance Company Inc.) adopted codification as well as certain prescribed accounting practices that differ from codification. Most significantly deferred tax assets and liabilities were not recorded under New York law. The effect of differences in accounting practices by the New York Insurance Department served to decrease surplus by $9,042. In 2002 the New York Insurance Department adopted regulations to allow deferred tax assets as admitted assets, although certain prescribed accounting practices still differ from those found in the codification. The cumulative effect of this change in accounting in 2002 ($1,663) was recorded as an adjustment to increase statutory surplus.
Debt securities and cash with a carrying value of $84,723 at December 31, 2002 were on deposit with various state or governmental insurance departments in order to comply with insurance laws. Trenwick is currently engaged in a process to reduce redundant statutory deposits resulting from the December 31, 2002 merger of Chartwell Insurance Company with and into Trenwick America Re.
Goodwill represents the unamortized excess of purchase price over the fair value of identifiable net assets of acquired entities.
The following table presents the pro forma effect on net loss and loss per common share for the years ended December 31, 2001 and 2000 had this accounting standard been effective January 1, 2000 as compared to net loss available to common shareholders and loss per common share for the year ended December 31, 2002.
The goodwill resulting from the Trenwick/LaSalle Re business combination was recorded by Trenwick, ($1,120, net of accumulated amortization of $73 at December 31, 2001) Trenwick America, ($52,119, net of accumulated amortization of $1,866 at December 31, 2001) and by LaSalle Re Holdings, ($(11,586) net of accumulated accretion of $610 at December 31, 2001). The net amount ($41,653 at December 31, 2001) is presented as goodwill in the December 31, 2001 balance sheet.
Premises and equipment, including leasehold improvements and capitalized software costs, are recorded at cost and amortized or depreciated using the straight-line method over their useful lives.
Other liabilities: Accounts payable and accrued expenses $ 67,724 $ 85,810 Security deposits for insureds 17,114 9,548 Contingent balances payable 12,349 11,503 Other 29,362 18,693 -------- -------- Total $126,549 $125,554 ======== ========
During the years ended December 31, 2002, 2001 and 2000, Trenwick recorded $5,763, $1,944, and $239, respectively, in equity income related to investments in managing general agencies. Depreciation and amortization on items included in other assets charged to operations for the years ended December 31, 2002, 2001 and 2000 years was $12,569, $7,158 and $1,229, respectively. In connection with Trenwick's decision to cease underwriting new U.S. specialty insurance business, in December 2002, Trenwick sold its investment in one of the managing general agencies.
Total office rent expense for the years ended December 31, 2002, 2001 and 2000 was $3,685, $4,963, and $2,113, respectively.
The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties. Fair values are estimated based upon quoted market prices or broker dealer quotes and may vary in the near term.
The carrying amounts and estimated fair values of financial instruments in summary form at year end 2002 and 2001 follow:
Because Trenwick's operations are conducted through its operating subsidiaries, Trenwick is dependent upon the ability of its operating subsidiaries to transfer funds, principally in the form of cash dividends, tax reimbursements and other statutorily permissible payments. In addition to general legal restrictions on payments of dividends and other distributions to shareholders applicable to all corporations, Trenwick's insurance subsidiaries are subject to further regulations that, among other things, restrict the amount of dividends and other distributions that may be paid to their parent corporations, as more fully described in Note 14.
Debt securities and cash with a carrying value of $230,514 at year end 2002 are being held in trust as collateral for certain reinsurance obligations of Trenwick's subsidiaries.
At December 31, 2002 Trenwick Managing Agents had funds held as collateral for sponsored names guarantees for 2000 yearly of account syndicates that have not yet closed of $161.
During the year ended December 31, 2002, Trenwick received 42.0% of its gross written premiums through five brokers of which Marsh and McLennan accounted for 15.2%, Aon Reinsurance Agency accounted for 15.1%, Heath Lambert accounted for 4.7%, WillisFaber accounted for 4.2%, and Reinsurance Alternatives accounted for 2.8%. During 2001, Aon Reinsurance Agency accounted for 19.4%, Marsh and McLennan accounted for 16.0%, Reinsurance Alternatives accounted for 7.5%, Heath Lambert accounted for 5.8%, and Benfield Blanch accounted for 1.9%. During 2000, Aon Reinsurance Agency accounted for 18.0%, Marsh and McLennan accounted for 13.0%, Heath Lambert accounted for 6.0%, Reinsurance Alternatives accounted for 5.0% and Benfield Blanch accounted for 3.0%.
Loss of all or a substantial portion of the business provided by these brokers could have a material adverse effect on Trenwick's continuing underwriting business.
At December 31, 2002, 24% of Trenwick's net reinsurance recoverable is recoverable from five principal retrocessionaires. The reinsurance recoverable balances, net of funds held liabilities, were from London Life and Casualty Reinsurance Corporation ($80,996), GE Frankona Ltd. ($110,305), Centre Re Ltd. ($70,164), Transatlantic Reinsurance Company ($84,707) and AIOI Insurance Company Ltd. ($81,808). All of these companies are rated A or better by A.M. Best Company, or S&P if an A.M. Best rating is not available.
Included in other assets are Trenwick's investments in managing general agencies through which it writes primary insurance business, as more fully described in Note 16. At year end 2002 and 2001, the carrying value of these investments totaled $1,719 and $9,010, respectively. During 2002 and 2001, Trenwick incurred $10,807 and $11,655 of acquisition costs to these managing general agencies, respectively. At year end 2002 and 2001, Trenwick's balance sheet includes $22,557 and $19,231, respectively, of agents' balances receivable from these managing general agencies including installment premiums deferred and not yet due. The current portion of balances due from these managing general agencies are settled on a monthly basis.
Two of LaSalle Re Holdings'founding shareholders were CNA Financial and Aon. CNA's ownership of LaSalle Re Holdings during the period prior to the Trenwick/LaSalle business combination was between 15.6% and 18.3%. Additionally, during the year ended December 31, 2000, LaSalle Re Holdings assumed $668 of premiums, ceded $6,556 of premiums, incurred $1,244 of override and profit commissions on premiums ceded and incurred $685 in underwriting support service fees to CNA. Aon's ownership of LaSalle Re Holdings prior to the Trenwick/LaSalle business combination was between 15.3% and 18.0%. During the year ended December 31, 2000, LaSalle Re Holdings assumed $30,340 of premiums through Aon, incurred $3,034 of brokerage costs on premiums assumed through Aon and incurred $821 of investment management service expenses to Aon.
Operating activities are presented in the consolidated statement of cash flows on a direct basis. The indirect basis reconciles net income (loss) to cash from (for) operating activities.
TRENWICK GROUP LTD. AND SUBSIDIARIES SCHEDULE II-CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TRENWICK GROUP LTD. (Parent Company Only) BALANCE SHEET (Amounts expressed in thousands of United States dollars) December 31, 2002 and 2001
TRENWICK GROUP LTD. (Parent Company Only) STATEMENT OF OPERATIONS (Amounts expressed in thousands of United States dollars) Years Ended December 31, 2002, 2001 and 2000
TRENWICK GROUP LTD. AND SUBSIDIARIES SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT-(continued)
TRENWICK GROUP LTD. AND SUBSIDIARIES SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
TRENWICK GROUP LTD. AND SUBSIDIARIES SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 2002, 2001 and 2000 (Amounts in thousands of United States dollars)
Year Ended December 31, 2000 Allowances for uncollectible reinsurance recoverable and premiums receivable $ -- $ 25,557