PXRE leases a total of approximately 28,400 square feet of office space in Edison, New Jersey (PXRE's corporate headquarters), New York, New York (a satellite office), London, England and Brussels, Belgium. The Edison, New Jersey lease, which covers approximately 24,000 square feet of office space, was signed in 1994 and is for a term of 15 years at a fixed annual rent of approximately $370,000 (inclusive of basic electricity) and additional rents on account of PXRE's proportionate share of increases in building operating expenses and property taxes over calendar year 1994.
(1) On December 11, 1996, PXRE merged with TREX. The Merger has been accounted for as a purchase. Accordingly, TREX has been included in PXRE's consolidated results of operations from the date of acquisition, which resulted in incremental earnings of $1,253,000 in 1996. For the period from January 1, 1996 until December 11, 1996, PXRE
(2) Until the fourth quarter of 1993, Transnational Reinsurance was a wholly-owned subsidiary of PXRE Reinsurance. On November 1, 1993, a registration statement relating to an initial public offering (the 'Offering') by TREX was declared effective. In conjunction with the formation of TREX, all of the outstanding capital stock of Transnational Reinsurance was contributed by PXRE Reinsurance to TREX in exchange for the issuance of 1,535,848 shares of TREX's Class B common stock which caused PXRE Reinsurance's holdings of TREX's Class B common stock to constitute approximately 21% of all of the outstanding common stock of TREX immediately after the Offering. As a result of this transaction, PXRE recorded a gain on sale in the fourth quarter of 1993 amounting to $10,564,000 on a pre-tax basis, representing the difference between PXRE Reinsurance's interest in the net assets of Transnational Reinsurance immediately after the Offering and the historical book value of its investment in Transnational Reinsurance. Subsequent to the Offering until December 11, 1996, PXRE accounted for its investment in TREX on the equity method as described in Note 1.
(4) During 1995, all of the outstanding shares of Series A Preferred Stock were converted into shares of PXRE's common stock. To 1995, these convertible preferred shares were the principal reason for the difference between basic and diluted earnings per share.
PXRE exercises discipline in committing and withholding its underwriting capacity and altering its mix of business to concentrate its underwriting capacity at any given point in time on those types of business where management believes that above average underwriting results can be achieved. PXRE has been pursuing a strategy of focusing on catastrophe-related coverages in both the national and international markets.
At December 31, 1997, PXRE was a party to three such retrocessional arrangements. One such arrangement is with a group of insurers and reinsurers referred to as the AMA; another is with Trenwick Group; and a third arrangement is with Select Re. Under these arrangements, PXRE cedes some of its underwritten risks to the participants, subject to maximum aggregate liabilities per reinsurance program. PXRE receives a management fee or commission of 5% of premiums ceded (4.2% for Select Re prior to 1998) and a percentage of any ultimate underwriting profits in connection with the reinsurance ceded. Under the arrangements with these participants, such percentage of ultimate underwriting profits is subject to adjustment based on cumulative experience. Future management fee income is dependent upon the amount of business ceded to the participants and the profitability of that business.
PXRE also purchases catastrophe retrocessional coverage for its own protection, depending on market conditions. PXRE has increased its purchases of such coverage in light of the continued general deterioration in catastrophe reinsurance pricing and the opportunity to buy protection at more favorable terms than in recent years.
In November 1993, PXRE sponsored the initial public offering of TREX to raise capital and take advantage of favorable conditions in the worldwide retrocessional reinsurance market. PXRE, through PXRE Reinsurance, retained a 21% ownership position in TREX and had responsibility for the day-to-day operations of TREX, including all the reinsurance operations of its subsidiary, Transnational Reinsurance, under the TREX Management Agreement. TREX and Transnational Reinsurance had no paid employees.
Under the terms of the TREX Management Agreement, Transnational Reinsurance shared in certain specified business of PXRE classified as property retrocessional reinsurance business, marine and aerospace retrocessional reinsurance or marine and aerospace reinsurance and facultative reinsurance.
In November 1997, PXRE announced the formation of an excess and surplus lines operation which will specialize in short-tail property type risks to be written as insurance in Transnational Insurance Company ('Transnational Insurance'), formerly Transnational Reinsurance. Its operations are expected to commence during the first quarter of 1998.
The estimation of losses for catastrophe reinsurers is inherently less reliable than for reinsurers of risks which have an established historical pattern of losses. In addition, insured events which occur near the end of a reporting period, as well as with respect to PXRE's retrocessional book of business, the significant delay in losses being reported to insurance carriers, reinsurers and finally retrocessionaires require PXRE to make estimates of losses based on limited information from ceding companies and based on its own underwriting data. Because of the uncertainty in the process of estimating its losses from insured events, there is a risk that PXRE's liabilities for losses and loss expenses could prove to be inadequate, with a consequent adverse impact on future earnings and stockholders' equity. Additionally, as a consequence of its emphasis on property reinsurance, PXRE may forgo potential investment income because property losses are typically settled within a shorter period of time than casualty losses.
Although PXRE's investment guidelines stress conservation of principal, diversification of risk and liquidity, PXRE's invested assets include equities and investments in limited partnerships, and PXRE's investments are subject to market-wide risks and fluctuations, as well as to risk inherent in particular securities. Accordingly, the estimated fair value of PXRE's investments does not necessarily represent the amount which could be realized upon future sale particularly if PXRE were required to liquidate a substantial portion of its portfolio to fund catastrophic losses.
excluding TREX. For comparative purposes, certain selected pro forma results are also presented for 1996 as if PXRE and TREX had merged at January 1, 1996.
response to this increasingly competitive environment by withdrawing capacity from areas of coverage not offering appropriate compensation for the exposure. Management anticipates that this trend will continue during 1998, although business written by PXRE's newly-established Lloyd's syndicate (PG Butler Syndicate 1224) has partially cushioned reductions elsewhere in PXRE's business. Underwriting premium volume and loss experience related to Syndicate 1224 is included in the consolidated results on a one quarter lag basis, commencing in the second quarter of 1997.
The provision for losses and loss expenses and the loss ratio includes the effect of foreign exchange movements on PXRE's liability for losses and loss expenses, resulting in a foreign currency exchange gain of $627,000 for 1997 compared to a loss of $41,000 for 1996 as reported, and a loss of $56,000 for the corresponding period of 1996 on a pro forma basis.
During 1997, PXRE experienced savings of $3,917,000 net for prior-year loss and loss expenses primarily related to the Eurotunnel fire and Hurricane Fran where redundant reserves were recognized in 1997 of approximately $1,644,000 and $1,440,000, respectively. In addition, included in the savings of $3,917,000 were prior-year losses originally thought to have triggered market loss coverage thresholds which have proven to be redundant by approximately $1,800,000, offset in part by development on prior year facultative losses. The loss ratio for 1996 was unfavorably affected by increases to reserves of $3,249,000 net for prior-year losses and loss expenses, as reported, and $8,986,000 net for prior-year losses and loss expenses on a pro forma basis, related principally to Hurricanes Marilyn and Luis.
The underwriting expense ratio was 34.8% for 1997 compared with 26.2% for the comparable period of 1996 as reported, and 27.6% for the corresponding period of 1996 on a pro forma basis. As a result of the above, the combined ratio was 48.5% for 1997 compared with 51.7% for the corresponding period of 1996 as reported, and 56.4% for the corresponding period of 1996 on a pro forma basis. The increase in underwriting expense ratio was substantially due to the Lloyd's syndicate operations, the decline in premiums earned on a pro forma basis, the decline in management fee income and the foreign exchange losses discussed below.
During 1997, interest expense decreased to $3,325,000 as compared to $6,957,000 in the corresponding period in the prior-year as reported due to the effect of the repurchase of $43.3 million of PXRE's 9.75% Senior Notes in open market purchases through the end of the third quarter of 1997. In addition in 1997, PXRE incurred minority interest expense amounting to $8,184,000 related to the $100 million of newly-issued 8.85% Capital Trust Pass-through Securities'sm' (TRUPS'sm') (as described below under 'Liquidity and Capital Resources').
affected by a $3,798,000 reduction in reinstatement premiums resulting from a reduced level of loss activity in 1996, as well as by $2,522,000 of cessions related to a retrocessional arrangement with the predecessor of Select Re.
Premiums ceded by PXRE to its managed business participants decreased 20.7% to $21,238,000 for 1996 compared with $26,774,000 for 1995. The decrease in premiums ceded to these programs was due to the decrease in the amount of premiums written by PXRE. During 1996, prior to the Merger, PXRE ceded $19,965,000 of premiums, compared to $24,790,000 during the twelve months of 1995, to Transnational Reinsurance in lieu of direct reinsurance writings by Transnational Reinsurance. Ceded premiums for catastrophe programs for 1996 decreased 12.2% to $5,427,000 from $6,180,000 for the comparable period of 1995 primarily because of the lower cost of coverage purchased.
Management fee income from all sources for 1996 decreased to $6,032,000 from $6,417,000 in 1995. The decrease reflected lower premium volume, offset, in part, by an improvement in the profitability of business ceded to managed business participants. Included in management fee income was $2,512,000 earned from TREX in 1996 prior to the Merger and $3,526,000 in 1995.
The loss ratio was 25.5% for 1996 compared with 35.7% for 1995. Catastrophe losses were $18,487,000 gross and $9,166,000 net for 1996 and prior accident years as compared with $28,439,000 gross and $20,073,000 net for 1995 and prior accident years.
The provision for losses and loss expenses includes the effect of foreign exchange movements on PXRE's liability for losses and loss expenses, resulting in a foreign currency exchange loss of $41,000 for 1996 compared to a gain of $39,000 for 1995.
The underwriting expense ratio was 26.2% for 1996 compared with 18.6% for 1995. The increase was substantially due to the increased operating expenses discussed below and the decline in premiums earned. As a result of the above, the combined ratio was 51.7% for 1996 compared with 54.3% for 1995.
Other operating expenses increased to $12,262,000 for 1996 from $11,237,000 in 1995. The operating expense increase for 1996 primarily reflected an increase of $301,000 related to changes in benefit plans, additional staff salaries, increased incentive compensation and other related benefits. Included in other operating expenses were foreign currency exchange gains of $143,000 for 1996 compared to gains of $196,000 for 1995.
Net investment income for 1996 increased 13.9% to $16,782,000 from $14,730,000 for 1995. The increase in net investment income was caused by an increase in average investments for 1996 compared with the previous year, as well as an increase in PXRE's pre-tax investment yield to 6.4% for 1996 compared to 5.9% for 1995, both calculated using amortized cost and investment
income before investment expenses. The increase in pre-tax investment yield primarily reflected the redeployment of PXRE's tax-exempt investment portfolio into taxable securities, including some higher yielding mortgage and asset-backed securities, in the fourth quarter of 1995 and throughout 1996. Net realized investment gains for 1996 were $94,000 compared with net realized gains of $85,000 for 1995. PXRE recorded directly to equity a $3,214,000 after-tax unrealized decrease in the value of its investment portfolio during 1996, reflecting the effect of an increase in interest rates during the first half of 1996.
Net income for the year ended December 31, 1996 included $3,898,000 which represented PXRE's approximately 22.1% equity share of TREX's net earnings through December 11, 1996 as compared with $5,948,000 representing PXRE's approximately 21.9% share of TREX's net earnings in 1995. Net income for 1996 also reflected $1,253,000 attributable to 100% of incremental earnings following the Merger on December 11, 1996 through the end of the year.
For the reasons discussed above, net income was $33,301,000 for the year ended December 31, 1996 compared to $39,786,000 for the year ended December 31, 1995. Basic net income per common share was $3.73 for 1996 compared to $4.81 for 1995 (after provision for cumulative dividends of $598,900 on the Series A Preferred Stock) based on average shares outstanding of 8,922,000 in 1996 and 8,150,000 in 1995. The change in the number of basic shares outstanding relates to the conversion of the preferred shares outstanding to common shares in the second quarter of 1995. Diluted net income per common share was $3.69 for 1996 compared to $4.52 for 1995 based on average shares outstanding of 9,020,000 in 1996 and 8,812,000 in 1995. The change in the number of diluted shares outstanding relates to the 1.0575 shares of PXRE common stock exchanged for each share of common stock of TREX in connection with the Merger.
PXRE relies primarily on cash dividends and net tax allocation payments from its subsidiaries PXRE Reinsurance and Transnational Insurance to pay its operating expenses and income taxes, to meet its debt service obligations and to pay dividends to PXRE stockholders. The payment of dividends by PXRE Reinsurance to PXRE and by Transnational Insurance to PXRE Reinsurance is subject to limits imposed under the insurance laws and regulations of Connecticut, the state of incorporation and domicile of PXRE Reinsurance and Transnational Insurance, as well as certain restrictions arising in connection with PXRE indebtedness discussed below. Under the Connecticut insurance law, the maximum amount of dividends or other distributions that PXRE Reinsurance may declare or pay to PXRE, and that Transnational Insurance may declare or pay to PXRE Reinsurance, within any twelve-month period, without regulatory approval, is limited to the lesser of (a) earned surplus or (b) the greater of 10% of policyholders' surplus at December 31 of the preceding year or 100% of net income for the twelve-month period ending December 31 of the
preceding year, all determined in accordance with SAP. Accordingly, the Connecticut insurance laws could limit the amount of dividends available for distribution by PXRE Reinsurance or Transnational Insurance without prior regulatory approval, depending upon a variety of factors outside the control of PXRE, including the frequency and severity of catastrophe and other loss events and changes in the reinsurance market, in the insurance regulatory environment and in general economic conditions. The maximum amount of dividends or distributions that PXRE Reinsurance may declare and pay during 1998, without regulatory approval, is $57,388,000. During 1997, no dividends were paid by PXRE Reinsurance to PXRE. During 1997, $58,877,000, including an extraordinary dividend approved by the Insurance Department of the State of Connecticut, was paid by Transnational Reinsurance to PXRE Reinsurance with the objective that Transnational Insurance commence 1998 with approximately $100 million of surplus.
Other sources of funds available to PXRE include proceeds of financings not contributed to PXRE Reinsurance and not otherwise utilized and net tax allocation payments by PXRE Reinsurance and Transnational Insurance.
On January 29, 1997, PXRE Capital Trust I, a Delaware statutory business trust and a wholly-owned subsidiary of PXRE ('PXRE Capital Trust') issued $100,000,000 principal amount of its 8.85% TRUPS'sm' due February 1, 2027 in an institutional private placement. Proceeds from the sale of these securities were used to purchase PXRE's 8.85% Junior Subordinated Deferrable Interest Debentures due February 1, 2027 (the 'Subordinated Debt Securities'). On April 23, 1997, PXRE and PXRE Capital Trust completed the registration with the Securities and Exchange Commission of an exchange offer for these securities and the securities were exchanged for substantially similar securities (the 'Capital Securities'). Distributions on the Capital Securities (and interest on the related Subordinated Debt Securities) are payable semi-annually, in arrears, on February 1 and August 1 of each year, commencing August 1, 1997. Minority interest expense, including amortization of debt offering costs, for 1997 in respect of the Capital Securities (and related Subordinated Debt Securities) amounted to approximately $8,184,000. On or after February 1, 2007, PXRE has the right to redeem the Subordinated Debt Securities, in whole at any time or in part from time to time, subject to certain conditions, at call prices of 104.180% at February 1, 2007,
time of such Restricted Payment the Consolidated Fixed Charge Coverage Ratio is greater than 2.0, and (y) in addition to permitted Restricted Payments referred to in clause (x), the payment of cash dividends on Qualified Capital Stock after August 31, 1993 of up to an aggregate of $6,000,000, provided, that such dividends on common stock do not exceed $0.25 per share in any year); (c) to sell or permit the issuance of any stock of PXRE Reinsurance or any other Principal Insurance Subsidiary; (d) to sell or transfer other assets (other than for at least Fair Market Value and generally for not less than 75% in cash or Cash Equivalents); (e) to create liens upon the properties or assets of PXRE or its Restricted Subsidiaries; or (f) to engage in any business other than the insurance and reinsurance businesses and other businesses incidental and related thereto. The Indenture also provides that within 30 days after a Change of Control (as defined) of PXRE, PXRE will offer to purchase all the Senior Notes then outstanding at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of such purchase. The consent of holders of PXRE's Senior Notes to certain amendments to the Indenture governing the Senior Notes was obtained in connection with the issuances of the Capital Securities.
PXRE's Board of Directors has authorized the purchase of Senior Notes in negotiated or open market transactions. During 1997, PXRE or PXRE Reinsurance purchased $43.3 million principal amount of Senior Notes at an average price of 107.4%. The principal amount of Senior Notes outstanding at December 31, 1997 was $21,414,000.
PXRE files federal income tax returns for itself and all of its direct or indirect subsidiaries that satisfy the stock ownership requirements for consolidation for federal income tax purposes (collectively, the 'Subsidiaries'). PXRE is party to an Agreement Concerning Filing of Consolidated Federal Income Tax Returns (the 'Tax Allocation Agreement') pursuant to which each domestic Subsidiary makes tax payments to PXRE in an amount equal to the federal income tax payment that would have been payable by such Subsidiary for such year if it had filed a separate income tax return for such year. PXRE is required to provide for payment of the consolidated federal income tax liability for the entire group. If the aggregate amount of tax payments made in any tax year by a domestic Subsidiary is less than (or greater than) the annual tax liability for such Subsidiary on a stand-alone basis for such year, such Subsidiary will be required to make up such deficiency (or receive a credit if payments exceed the separate return tax liability) to PXRE.
Of PXRE's fixed maturities portfolio at December 31, 1997, 91.1% of the fair value was in obligations rated 'A1' or 'A' or better by Moody's or S&P's, respectively. Mortgage and asset-backed securities accounted for 23.9% of fixed maturities based on fair value at December 31, 1997. PXRE has no investments in real estate or commercial mortgage loans. The average market yield to maturity of PXRE's fixed maturities portfolio at December 31, 1997 and 1996, as reported, was 6.1% and 5.7%, respectively. During the first quarter of 1997, PXRE repositioned a portion of its portfolio out of Treasury, GNMA and short-term investments into new sectors including asset and corporate mortgage-backed securities, emerging markets securities, tax-free municipals and investment grade Yankee bonds. During the second and third quarters of 1997, PXRE further repositioned the portfolio into a number of limited partnership investments and to a lesser extent equity investments.
TREX. The expected annual dividend based on shares outstanding at December 31, 1997 will be approximately $13,764,000 reflecting a dividend increase to $0.25 per quarter commencing in the fourth quarter of 1997.
Book value per common share was $28.10 at December 31, 1997.
PXRE's effective tax rate for 1997, 1996, and 1995 was 32.1%, 32.0%, and 31.4%, respectively, which differs from the statutory rate principally due to negative goodwill amortization, state and local taxes and tax-exempt income and in 1996 and 1995 tax on undistributed earnings of unconsolidated affiliates.
This report on Form 10-K contains various forward-looking statements and includes assumptions concerning PXRE's operations, future results and prospects. Statements included herein which are not historical in nature are intended to be, and are hereby identified as, 'forward-looking statements' for purposes of the safe harbor provided by Section 21E of the Exchange Act. These forward-looking statements are based on current expectations and are subject to risk and uncertainties. PXRE cautions the reader that actual results or events could differ materially from those set forth or implied by the forward-looking statements and related assumptions, depending on the outcome of certain important factors including the following: (i) significant catastrophe losses, the timing and extent of which are difficult to predict; (ii) changes in the level of competition in the reinsurance or primary insurance markets that impact the volume or profitability of the property-casualty reinsurance business (these changes include, but are not limited to, the intensification of price competition, the entry of new competitors, existing competitors exiting the market and the development of new products by new and existing competitors); (iii) changes in the demand for reinsurance, including changes in the amount of ceding companies' retentions; (iv) adverse development on loss reserves related to business written in prior years; (v) lower than estimated retrocessional recoveries on unpaid losses, including the effects of losses due to a decline in the creditworthiness of PXRE's retrocessionaires; (vi) increases in interest rates, which cause a reduction in the market value of PXRE's interest rate sensitive investments, including its fixed income investment portfolio; (vii) decreases in interest rates causing a reduction of income earned on net cash flow from operations and the reinvestment of the proceeds from sales, calls or maturities of existing investments; (viii) market fluctuations in equity securities and securities underlying limited partnership investments; and (ix) changes in management's evaluation of the impact of the Year 2000 problem on its operations.