Everest Re’s corporate offices are located in approximately 115,000 square feet of leased office space in Liberty Corner, New Jersey. The Company’s other eleven locations occupy a total of approximately 56,000 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs.
On February 24, 2000, a corporate restructuring was completed and Group became the new parent holding company of the Company, which remains the holding company for Group’s U.S. based operations. Holders of the Company’s common stock automatically became holders of the same number of Group’s common shares. See ITEM 1, “Business - The Company” for a further discussion.
Mt. McKinley, a run-off property and casualty insurer in the U.S., had a long relationship with the Company and its principal operating company, Everest Re. Mt. McKinley was formed in 1978 by Everest Re and wrote insurance until 1985, when it was placed in run-off. In 1991, Mt. McKinley became a subsidiary of The Prudential. Mt. McKinley is also a reinsurer of Everest Re. Under a series of transactions dating to 1986, Mt. McKinley reinsured several components of Everest Re’s business. In particular, Mt. McKinley provided stop loss reinsurance protection, in connection with the Company’s October 5, 1995 initial public offering, for any adverse loss development on Everest Re’s June 30, 1995 (December 31, 1994 for catastrophe losses) reserves, with $375.0 million in limits, of which $103.9 million remains available (the “Stop Loss Agreement”). The Stop Loss Agreement and other reinsurance contracts between Mt. McKinley and Everest Re remain in effect following the acquisition. However, these contracts became transactions with affiliates effective on the date of the Mt. McKinley acquisition. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for what management believes to be arm’s-length consideration, all of its net insurance exposures and reserves to Bermuda Re.
Through 2002 reinsurance and insurance markets generally continued to firm, reflecting the continuing implications of losses arising from the September 11 attacks as well as aggregate company reactions to broad and growing recognition that competition in the late 1990s reached extremes in many classes and markets, which ultimately led to inadequate pricing and overly broad terms, conditions and coverages. The effect of these extremes, which had become apparent through excessive loss emergence, varied widely by company depending on product offerings, markets accessed, underwriting and operating practices, competitive strategies and business volumes. Across all market participants, however, the aggregate general effect was impaired financial results and erosion of the industry capital base. Coupled with deteriorating investment market conditions and results, and renewed concerns regarding longer term industry specific issues, including asbestos exposure and sub-par capital returns, these financial impacts introduced substantial, and in some cases extreme, pressure for the initiation and/or strengthening of corrective action by individual market participants. These pressures, aggregating across industry participants, resulted in firming prices, more restrictive terms and conditions, tightened coverage availability across most classes and markets and increasing concern with respect to the financial security of insurance and reinsurance providers, impacts which set the stage for the 2003 trends discussed above.
The Company's management monitors and evaluates overall Company performance based principally upon underwriting and financial results. The following is a three year summary of consolidated underwriting results and net income:
In the professional liability reinsurance class, the late 1990s and early 2000s saw a proliferation of claims relating to bankruptcies and other corporate, financial and/or management improprieties. This resulted in an increase in the frequency and severity of claims on the professional liability policies reinsured by the Company. In the general casualty area, the Company continues to experience claim frequency and severity greater than expected in the Company’s pricing and reserving assumptions, particularly for accident years 1998 through 2001. These losses reflect unfavorable trends in litigation and economic variability. With respect to both of these classes, another factor was the increasingly competitive conditions in insurance and reinsurance markets during this period. While the Company seeks to manage the impact of competitive condition changes on its results, it is generally unable to divorce itself entirely from the underlying industry cycles of its principal business.
The Company’s reserving methodologies continuously monitor the emergence of loss and loss development trends, seeking on a timely basis, to both adjust reserves, for the impact of trend shifts and to factor the impact of such shifts into its underwriting and pricing on a prospective basis.
The increase in net investment income to $284.3 million, $257.9 million and $265.9 million for the years ended December 31, 2003, 2002 and 2001, respectively, is also correlated to the increased premium volume. Premiums are generally collected over the first 12 to 15 months of the reinsurance contract while related losses are typically paid out over numerous years, resulting in an increase in cash flow when premiums are increasing. The Company’s cash flow from operations was $1,051.0 million, $425.2 million and $303.8 million for the years ended December 31, 2003, 2002 and 2001, respectively. Coupled with the issuance of trust preferred securities in November 2002, this facilitated the growth in the Company’s total investments and cash to $6,405.9 million, $5,142.7 million and $4,469.8 million as of December 31, 2003, 2002 and 2001, respectively. The impact on net investment income resulting from the growth in the investment portfolio was partially offset by an overall decline in interest rates during this same time period.
The Company’s stockholders’ equity increased to $1,546.9 million, $1,266.4 million and $1,111.4 million as of December 31, 2003, 2002 and 2001, respectively. This increase is due to increased net income and increased unrealized appreciation on the Company’s investments. Management believes that the Company generally has sufficient capital and resources to meet its known obligations.
The Company, through its subsidiaries, operates in four segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting and International. The U.S. Reinsurance operation writes property and casualty reinsurance on both a treaty and facultative basis through reinsurance brokers as well as directly with ceding companies within the U.S. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the U.S. The Specialty Underwriting operation writes A&H, marine, aviation and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance through the Company’s branches in London, Canada, and Singapore, in addition to foreign business written through the Company’s Miami and New Jersey offices.
These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management monitors and evaluates the financial performance of these operating segments principally based upon their underwriting results. For selected financial information regarding these segments, see Note 17 of Notes to Consolidated Financial Statements.
The following tables present the relevant underwriting results for the operating segments for the three years ended December 31, 2003, 2002 and 2001.
The Company has also recently announced that another subsidiary, Everest National, has opened a regional office in California to better serve its western U.S. Insurance business. The additional office will not affect segment reporting.
Expenses. Incurred loss and LAE increased by 42.9% to $1,999.7 million in 2003 from $1,399.0 million in 2002. The increase in incurred losses and LAE was principally attributable to the increase in net premiums earned, the impact of changes in the Company’s mix of business and reserve adjustments for prior period losses.
Net prior period reserve adjustments for non-A&E exposures for the year ended December 31, 2003 were $212.3 million, which amount is net of a 2000 accident year cession of $85.0 million, and were comprised of an $133.3 million increase relating principally to the casualty exposures (including D&O liability exposures) in the U.S. Reinsurance operation, a $24.3 million decrease relating to the surety exposures in the Specialty Underwriting operation, a $44.6 million increase relating mainly to the casualty exposures of the London and Canadian branch elements in the International operation and a $58.7 million increase relating to the workers’ compensation exposures in the U.S. Insurance operation. The increase for the U.S. Insurance operation relates to the 2001 and 2002 accident exposure years and all other reserve adjustments relate to the 1996-2000 accident exposure years.
Incurred losses and LAE include catastrophe losses, which include the impact of both current period events and favorable and unfavorable development on prior period events, and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss on property exposures of at least $5.0 million and has an event date of January 1, 1988 or later. Catastrophe losses, net of contract specific cessions, were $24.9 million in 2003, relating principally to May 2003 tornado and hailstorm events and hurricanes Fabian and Isabel, compared to $30.2 million in 2002.
Incurred losses and LAE for 2003 reflected ceded losses and LAE of $760.3 million compared to ceded losses and LAE in 2002 of $486.1 million. Ceded losses and LAE in 2003 include $494.4 million of ceded losses relating to the quota share reinsurance transactions noted earlier between Everest Re and Bermuda Re as compared with ceded losses of $178.6 million for 2002. The ceded losses and LAE for 2003 also included $85.0 million of losses ceded under the 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program. The ceded losses and LAE for 2002 included $11.0 million and $90.0 million of losses ceded under the 2001 and 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program, respectively.
The segment components of the increase in incurred losses and LAE in 2003 from 2002 were a 63.0% ($164.4 million) increase in the International operation, a 52.7% ($263.8 million) increase in the U.S. Reinsurance operation and a 50.7% ($175.0 million) increase in the U.S. Insurance operation. These increases were partially offset by a 0.9% ($2.5 million) decrease in the Specialty Underwriting operation. These fluctuations generally reflected the changes in premiums earned, changes in the current year loss expectation assumptions for business written (generally reflecting continued improvement in market conditions) and pricing and the net prior period reserve development discussed above. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by net premiums earned, increased by 1.0 percentage points to 72.5% in 2003 from 71.5% in 2002, reflecting the combined impact of premiums earned and incurred losses and LAE discussed above.
The Company’s combined ratio, which is the sum of the loss and expense ratios, decreased by 2.5 percentage points to 97.2% in 2003 compared to 99.7% in 2002. The following table shows the combined ratios for each of the Company’s operating segments for 2003 and 2002. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above.
Investment. Net investment income increased 10.2% to $284.3 million in 2003 from $257.9 million in 2002, principally reflecting the effects of investing the $1,051.0 million of cash flow from operations in 2003 and $203.4 million of net proceeds from Capital Trust’s issuance of trust preferred securities in November 2002, all partially offset by the effect of the lower interest rate environment.
The following table shows a comparison of various investment yields for the periods indicated:
The Company has in its product portfolio a credit default swap contract, which it no longer writes. This contract meets the definition of a derivative under Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”). There was no net derivative expense from this credit default transaction in 2003, compared to the $3.5 million derivative expense for 2002.
Other expense for 2003 was $14.0 million compared to other expense of $21.8 million for 2002. This change is primarily due to less deferrals of the retroactive reinsurance agreements with affiliates.
Income Taxes. The Company recognized income tax expense of $61.0 million in 2003 compared to an income tax expense of $24.8 million in 2002. The increase in taxes generally reflects the improved underwriting and investment income results. Net Income. Net income was $206.5 million in 2003 compared to a net income of $115.1 million in 2002, reflecting improved underwriting and investment income results partly offset by increased income taxes.
Ceded premiums increased to $565.9 million in 2002 from $432.9 million in 2001. This increase was principally attributable to $372.9 million of ceded premiums relating to a Quota Share Reinsurance Agreement between Everest Re and Bermuda Re, whereby Everest Re cedes 20% of its net retained liability on all new and renewal policies written during the term of this agreement, and an Excess of Loss Agreement between Everest Re, Everest National, Everest Security and Bermuda Re, whereby Bermuda Re assumes liability for primary insurance workers’ compensation losses exceeding $100,000 per occurrence, with its liability not to exceed $150,000 per occurrence. Ceded premiums in 2002 included $5.1 million and $49.4 million in adjustment premiums relating to claims made under the 2001 and 2000 accident year aggregate excess of loss elements of the Company’s corporate retrocessional program, respectively. Ceded premiums in 2001 included $81.3 million and $58.1 million in adjustment premiums relating to claims made under the 2001 and 1999 accident year aggregate excess of loss elements of the Company’s corporate retrocessional program, respectively, with the 2001 accident year cessions principally relating to losses incurred as a result of the September 11 attacks and the Enron bankruptcy.
Net written premiums increased by 54.5% to $2,189.5 million in 2002 from $1,416.9 million in 2001. This increase was a result of the increase in gross written premiums and ceded written premiums.
Incurred losses and LAE in 2002 reflected ceded losses and LAE of $486.1 million compared to ceded losses and LAE in 2001 of $619.4 million. Ceded losses and LAE in 2002 include $178.6 million of ceded losses relating to the reinsurance transactions noted earlier between the Company and Bermuda Re. The ceded losses and LAE in 2002 included $11.0 million and $90.0 million of losses ceded under the 2001 and 2000 accident year aggregate excess of loss components of the Company’s corporate retrocessional program, respectively. The ceded losses and LAE in 2001 included $164.0 million and $105.0 million of losses ceded under the 2001 and 1999 accident year aggregate excess of loss components of the Company’s corporate retrocessional program, respectively, with the 2001 accident year cessions relating principally to losses incurred as the result of the September 11 attacks.
Contributing to the increase in incurred losses and LAE in 2002 from 2001 was an 198.4% ($173.4 million) increase in the International operation, a 63.4% ($134.0 million) increase in the U.S. Insurance operation, principally reflecting increased premium volume coupled with changes in this segment’s specific reinsurance programs and an 11.4% ($51.4 million) increase in the U.S. Reinsurance operation, principally due to increased premium volume, partially offset by decreased catastrophe losses. These increases were partially offset by an 11.8% ($39.1 million) decrease in the Specialty Underwriting operation, principally attributable to decreased catastrophe losses. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by premiums earned, decreased by 9.4 percentage points to 71.5% in 2002 from 80.9% in 2001, reflecting the premiums earned and incurred losses and LAE discussed above. The following table shows the loss ratios for each of the Company’s operating segments for 2002 and 2001. The loss ratios for all operations were impacted by the expense factors noted above as well as by the impact on ceded premiums of the adjustment premiums under the Company’s corporate retrocessional program.
The Company’s combined ratio, which is the sum of the loss and expense ratios, decreased by 14.9 percentage points to 99.7% in 2002 compared to 114.6% in 2001. The following table shows the combined ratios for each of the Company’s operating segments for 2002 and 2001. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above as well as by the impact on ceded premiums of the adjustment premiums under the Company’s corporate retrocessional program.
Investments. Net investment income decreased by 3.0% to $257.9 million in 2002 from $265.9 million in 2001, principally reflecting the lower interest rate environment, partially offset by the effect of investing the $425.2 million of cash flow from operations in 2002 and $203.4 million of net proceeds from Capital Trust's issuance of trust preferred securities in November 2002. The following table shows a comparison of various investment yields as of December 31, 2002 and 2001, respectively, and for the periods then ended.
The Company has in its product portfolio a credit default swap, which it no longer writes. This product meets the definition of a derivative under FAS 133. Net derivative expense, essentially reflecting changes in fair value from this credit default transaction in 2002, was $3.5 million, compared to $7.0 million in 2001. See also Note 2 of Notes to the Consolidated Financial Statements.
Net Income. Net income was $115.1 million in 2002 compared to $38.3 million in 2001. This increase generally reflects the improved underwriting results, partially offset by increased tax expense, realized capital losses and a decrease in other income.
This report contains forward-looking statements within the meaning of the U.S. federal securities laws. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “will”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward looking statements contained in this report include information regarding the Company’s reserves for losses and LAE, the adequacy of the Company’s provision for uncollectible balances, estimates of the Company’s catastrophe exposure and the effects of catastrophe events on the Company’s financial statements and the ability of the Company’s subsidiaries to pay dividends. Forward-looking statements only reflect the Company’s expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from the Company’s expectations. Important factors that could cause the Company’s actual results to be materially different from its expectations include the uncertainties that surround the estimating of reserves for losses and LAE, those discussed in Note 3 of Notes to Consolidated Financial Statements included in this report and those discussed below under the caption “Risk Factors”. The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Like all insurance and reinsurance companies, the Company is exposed to unpredictable catastrophic events, including weather-related and other natural catastrophes, as well as acts of terrorism. Any material reduction in the Company’s operating results caused by the occurrence of one or more catastrophes could inhibit its ability to pay dividends or to meet its interest and principal payment obligations. The Company defines a catastrophe as an event that causes a pre-tax loss on property exposures of at least $5.0 million and has an event date of January 1, 1998 or later. By way of illustration, during the past five calendar years, pre-tax catastrophe losses, net of contract specific reinsurance but before cessions under corporate reinsurance programs, were as follows:
The Company has a quota share agreement with an affiliate, Bermuda Re whereby the Company cedes a percentage of its net retained liability on new and renewal policies, 25% and 20% for the years ended December 31, 2003 and 2002, respectively. This agreement enables the Company to write higher levels of gross premiums than it may be able to without the agreement. If this quota share arrangement became unavailable and could not be replaced at acceptable terms and conditions, the Company might need to reduce its premium volume, which could have a negative impact on net income. The Company generally evaluates, underwrites, selects and prices its products prior to consideration of the quota share reinsurance. Furthermore, the Company’s underwriters generally consider purchasing reinsurance with respect to specific insurance contracts or programs, and its senior management generally considers purchasing aggregate excess of loss reinsurance with respect to its overall operations, where reinsurance is deemed prudent from a risk mitigation perspective or is expected to have a positive cost/benefit relationship. The percentage of business that it has reinsured is indicated in the chart below.
The Company is a holding company, whose most significant assets consists of the stock of its operating subsidiaries. As a result, the Company’s ability to pay dividends, interest or other payments on its securities in the future will depend on the earnings and cash flows of the operating subsidiaries and the ability of the subsidiaries to pay dividends or to advance or repay funds to it. This ability is subject to general economic, financial, competitive, regulatory and other factors beyond the Company’s control. Payment of dividends and advances and repayments from some of the operating subsidiaries are regulated by U.S., state and foreign insurance laws and regulatory restrictions, including minimum solvency and liquidity thresholds. Accordingly, the operating subsidiaries may not be able to pay dividends or advance or repay funds to the Company in the future, which could prevent it from paying dividends, interest or other payments on its securities.