Net income per diluted share (4) $ 8.71 $ 7.74 $ 4.52 $ 2.10 $ 4.02
(1) Catastrophe losses are net of reinsurance. A catastrophe is defined, for purposes of the Selected Consolidated Financial Data, as an
event that causes a pre-tax loss on property exposures before reinsurance of at least $5.0 million before corporate level reinsurance
(3) Based on weighted average basic shares outstanding of 55.9 million, 54.0 million, 50.3 million, 46.2 million and 45.9 million for
(4) Based on weighted average diluted shares outstanding of 56.8 million, 55.0 million, 51.1 million, 47.1 million and 46.4 million for
GAAP commissions, brokerage, taxes, fees and general expenses as a percentage of GAAP net premiums earned. Combined ratio is
On February 24, 2000, a corporate restructuring was completed and Group became the new parent holding company of Holdings, which remains the holding company for Group’s U.S. operations. Effective January 1, 2005 the principal executive offices of Group were relocated from Barbados to Bermuda.
In 2004, the favorable market conditions, which had developed during 2000 through 2003, generally began to weaken. There were signs that pricing for most property classes declined modestly and that pricing for most casualty classes softened. Competition increased, in part due to the relative profitability achieved by many reinsurers over 2002 and 2003 and the attendant buildup of capital in these participants. However, this profitability and capital buildup varied significantly by market participant, reflecting the fact that the industry generally still remained exposed to fundamental issues that had negatively impacted its aggregate capacity in 2002 and 2003, including weak investment market conditions and adverse loss emergence. Both of these had tended to depress the industry’s aggregate financial performance and perceptions of financial strength of
Net written premiums, comprised of gross written premiums less ceded premiums, were $4.5 billion for the year ended December 31, 2004, an increase of 5.0% compared with $4.3 billion for the year ended December 31, 2003, which had increased 63.6% compared with the year ended December 31, 2002. Net written premiums for the year ended December 31, 2002 were $2.6 billion, an increase of 69.1% compared with the year ended December 31, 2001. The increases in net written premium are in line with the increases in gross written premium, as ceded written premium over the period was relatively stable at $172.6 million, $258.4 million and $208.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. Ceded premiums relate primarily to specific reinsurance purchased by the U.S. Insurance operation and, to a lesser extent, adjustment premiums in 2003 and 2002 on loss cessions made to the Company’s corporate level aggregate reinsurance coverages.
Incurred losses and LAE for the year ended December 31, 2004 were $3.3 billion, an increase of 26.6% compared with $2.6 billion for the year ended December 31, 2003, which had increased 59.6% compared with the year ended December 31, 2002. Incurred losses and LAE for the year ended December 31, 2002 were $1.6 billion, an increase of 34.7% compared with the year ended December 31, 2001. The major contributing factor for the increases in 2004 was the increase in incurred losses and LAE due to property catastrophe net event losses of $403 million, arising principally from hurricanes Charley, Frances, Ivan and Jeanne, Pacific typhoons, Edmonton hailstorms and the Asian tsunami. Other factors, including the level of incurred losses and LAE related to changes in volume as measured by earned premium, changes in rates, and terms and the effect of changes in prior period loss reserve estimates, also contributed. The increase in incurred losses and LAE relating to net adverse prior period reserve strengthening of $312.0 million, $256.9 million and $140.1 million for years ended December 31, 2004, 2003 and 2002, respectively, principally related to the Company’s asbestos exposures, treaty casualty and workers’ compensation, partially offset in 2004 by a $33.4 million reduction in
reserves related to the World Trade Center events. See ITEM 1, “Business - Changes in Historical Reserves” for additional details and explanation.
Net investment income was $495.9 million for the year ended December 31, 2004, an increase of 23.2% compared with $402.6 million for the year ended December 31, 2003, which had increased 14.8% compared with the year ended December 31, 2002. Net investment income for the year ended December 31, 2002 was $350.7 million, an increase of 3.0% compared with the year ended December 31, 2001. The year ended December 31, 2004 included a $32.7 million increase arising from an atypical increase in the value of one of the Company’s limited partnership investments. Excluding this increase, the net investment income increase generally reflected growth in the Company’s cash and invested assets. Premiums are generally collected over the first 12 to 15 months of the Company’s reinsurance and insurance contract, while related losses are typically paid out over numerous years. This tends to increase cash flow from operations when premiums are increasing. The Company’s cash flow from operations was $1,487.6 million, $1,653.8 million and $742.7 million for the years ended December 31, 2004, 2003 and 2002, respectively. Cash flow from operations was impacted in particular by increased loss payments relating to catastrophe losses and asbestos claim settlements in 2004. Coupled with common stock offerings and the issuance of junior subordinated debt securities, this contributed to the growth in the Company’s total investments and cash to $11,530.2 million.
Net realized capital gains of $89.6 million for the year ended December 31, 2004 were primarily the result of gains on the sale of the Company’s interest only strips investment portfolio. Net realized capital losses of $38.0 million and $50.0 million for the years ended December 31, 2003 and 2002, respectively, were primarily the result of valuation adjustments on the interest only strip portfolio in accordance with Emerging Issues Task Force No. 99-20, “Recognition of Interest Income and Impairment on Purchases and Beneficial Interests in Securitized Financial Assets” (“EITF 99-20”) and write-downs in the value of securities deemed to be impaired on an other than temporary basis, partially offset by realized gains.
The Company’s income tax expense is primarily a function of the statutory tax rates and corresponding net income in the jurisdictions where the Company operates, coupled with the impact from tax preferenced investment income. Variations between years generally reflect changes in the relative levels of pre-tax income between jurisdictions with different tax rates. Additionally, in conjunction with the transfer of the Company’s UK Branch to Bermuda Re, there were various tax issues giving rise to incremental net tax expenses in 2004. The Company incurred income tax expenses of $64.9 million, $65.2 million and $30.7 million for the years ended December 31, 2004, 2003 and 2002, respectively. The slight decrease in tax expense primarily reflected the impact of the catastrophe losses on 2004 underwriting results, which were partially offset by additional taxable net investment income, taxable realized capital gains and the expense associated with the transfer of the UK branch.
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 Everest Re’s branches in Canada and Singapore, in addition to foreign business written through Everest Re’s Miami and New Jersey offices. The Bermuda operation provides reinsurance and insurance to worldwide property and casualty markets and reinsurance to life insurers through brokers and directly with ceding companies from its Bermuda office and property and casualty reinsurance to the United Kingdom and European markets through its UK branch.
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 generally monitors and evaluates the financial performance of these operating segments based upon their underwriting gain (loss) or underwriting results. Underwriting results include earned premium less losses and LAE incurred, commission and brokerage expenses and other underwriting expenses and are analyzed using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. The Company utilizes inter-affiliate reinsurance but such reinsurance generally does not impact segment results, as business is generally reported within the segment in which the business was first produced. For selected financial information regarding these segments, see Note 18 of Notes to Consolidated Financial Statements.
Effective January 1, 2004, Everest Re sold its United Kingdom branch to Bermuda Re. Business for this branch was previously included in the International segment and is now included in the Bermuda segment. Due to the sale and in accordance with FAS 131, the Company restated the International and Bermuda segments for the years ended December 31, 2003 and 2002 to conform to December 31, 2004 segment reporting.
In 2003, Everest National, another subsidiary of the Company, opened a regional office in California to better serve its western U.S. insurance business. The business produced through this additional office is included in the U.S. Insurance operation.
Underwriting loss $ (91,989 ) $ (7,557 ) $ (11,032 )
Premiums. Gross written premiums increased 2.8% to $4,704.1 million in 2004 from $4,573.8 million in 2003, as the Company took advantage of selected growth opportunities, while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 32.0% ($166.9 million) increase in the International operations, primarily due to a $97.7 million increase in international business written through the Miami and New Jersey offices, representing primarily Latin American business, and a $67.2 million increase in Asian business. The Bermuda operation grew 21.3% ($155.2 million) reflecting an emphasis on traditional business classes in Bermuda and the UK. The U.S. Insurance operation grew 9.2% ($98.3 million), principally as a result of a $193.8 million increase in program business other than workers’ compensation, partially offset by a $95.5 million decrease in workers’ compensation business. The Specialty Underwriting operation decreased 3.1% ($15.8 million), resulting primarily from a $70.4 million decrease in A&H business, partially offset by an increase in surety business of $29.6 million and an increase in marine and aviation business of $25.0 million. The U.S. Reinsurance operation decreased 15.6% ($274.1 million), principally relating to an $142.5 million decrease in treaty casualty business, a $74.9 million decrease in facultative business, a $32.6 million decrease in treaty property business and a $19.8 million decrease in treaty non-property business.
Premium Revenues. Net premiums earned increased by 18.4% to $4,425.1 million in 2004 from $3,737.9 million in 2003. Contributing to this increase was a 60.6% ($339.1 million) increase in the Bermuda operation, a 42.0% ($194.1 million) increase in the International operation, a 13.8% ($114.0 million) increase in the U.S. Insurance operation and a 3.5% ($49.7 million) increase in the U.S. Reinsurance operation, partially offset by a 2.1% ($9.6 million) decrease in the Specialty Underwriting operation. All of these changes reflect period to period changes in net written premiums and business mix, together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets, but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. As premium reporting, earnings, loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, can and does introduce appreciable background variability in various underwriting line items. Changes in estimates related to unreported reinsurance activity also contribute.
Expenses. Incurred loss and LAE increased by 26.6% to $3,291.1 million in 2004 from $2,600.2 million in 2003. The increase in incurred losses and LAE was principally attributable to the provision for estimated catastrophe losses from hurricanes Charley, Frances, Ivan and Jeanne, Pacific typhoons, the Asian tsunami and reserve adjustments for prior period losses, together with the mitigating effects of the increase in net premiums earned and the impact of favorable changes in the Company’s underlying business mix and aggregate rates, terms and conditions.
Incurred losses and LAE in 2004 reflected ceded losses and LAE of $141.0 million compared to ceded losses and LAE in 2003 of $278.4 million. The decrease in ceded losses is primarily the result of the absence in 2004 of cessions under the corporate level aggregate reinsurance covers. The ceded losses and LAE in 2003 included $85.0 million of losses ceded under the 2000 accident year aggregate excess of loss component of the Company’s corporate retrocessional program and $81.1 million under the LM/Mt. McKinley reinsurance agreement.
Incurred losses and LAE include catastrophe losses, which include the impact of both current period events and favorable and adverse development on prior period events and are net of reinsurance. Individual catastrophe losses are reported net of specific reinsurance, but before recoveries under corporate level reinsurance and potential IBNR reserve offsets. The Company defines a catastrophe as a property event with expected reported losses of at least $5.0 million before corporate level reinsurance and taxes. Catastrophe losses, net of contract specific cessions, were $403.0 million in 2004, relating principally to aggregate estimated losses of $428.8 million from hurricanes Charley, Frances, Ivan and Jeanne, Pacific typhoons, Edmonton hailstorms and the Asian tsunami, which were partially offset by $33.4 million of reserve reductions related to the World Trade Center events. Catastrophe losses, net of contract specific cessions, were $36.8 million in 2003, relating principally to the May 2003 tornado and hailstorm events and hurricanes Fabian and Isabel.
The U.S. Reinsurance segment accounted for $77.7 million of net adverse prior period reserve adjustments for the year ended December 31, 2004, which included $34.2 million of favorable development due to the reserve reduction related to the catastrophe losses from the World Trade Center events, as compared to net adverse prior period reserve adjustments of $150.9 million for the year ended December 31, 2003. Asbestos exposures accounted for $10.3 million and $16.8 million of adverse reserve adjustments for the years ended December 31, 2004 and 2003, respectively, with the remainder principally attributable to professional liability and casualty business classes. During the late 1990s and early 2000s, there had been a proliferation of claims relating to bankruptcies and other financial management improprieties. This increased number of claims, combined with larger claims, has significantly increased incurred losses on the professional liability policies. In the general casualty area, the Company continues to experience losses greater than historical trends for accident years 1998 through 2001. These losses are being driven by adverse trends in litigation and economic variability. In both the professional liability and general casualty reinsurance areas, the Company relies upon loss reports from ceding companies. Although the Company may record reserves at higher levels than those reported by ceding companies, actual reported results have exceeded the initial loss indications.
The International segment had $4.4 million of favorable net prior period reserve adjustments for the year ended December 31, 2004 and net adverse prior period reserve adjustments of $15.8 million for the year ended December 31, 2003. The favorable development in 2004 related primarily to 2003 Canadian property catastrophe, international and Asia business. The prior period reserve development for 2003 related primarily to general casualty business written in the U.S. and Canada on both a quota share and excess basis for accident years 1996 through 2002.
The Bermuda segment reflected $190.3 million of net adverse prior period reserve adjustments for the year ended December 31, 2004 and $55.4 million of net adverse prior reserve adjustments for the year ended December 31, 2003. The development in the year ended December 31, 2004 was primarily the result of $149.1 million of A&E reserve development. For the year ended December 31, 2003, reserve adjustments included $33.5 million related to A&E exposures. All of the development related to asbestos exposures that were assumed through the September 19, 2000 loss portfolio transfer from Mt. McKinley in 2000.
In all cases, the prior period development, sometimes referred to as reserve strengthening, reflects management’s judgment as to the implications of losses and claim information reported during the period on the Company’s reserve balances.
Insurance operation and a 2.2% ($6.6 million) increase in the Specialty Underwriting operation. These changes reflect variability in premiums earned and changes in the loss expectation assumptions for business written, as well as the net prior period reserve development and catastrophe losses discussed above. Incurred losses and LAE for each operation were also impacted by generally improved pricing of the underlying business, as well as variability relating to changes in the mix of business by class and type, which in general reflected a more favorable mix.
The Company’s combined ratio, which is the sum of the loss and expense ratios, increased by 3.6 percentage points to 98.8% in 2004 compared to 95.2% in 2003.
Imbedded after-tax yield of cash and invested assets at December 31, 2004 and 2003 .1%
Net realized capital gains were $89.6 million in 2004, which reflected realized capital gains on the Company’s investments of $164.3 million, including $118.2 million on the sale of interest only strip investments, partially offset by $74.7 million of realized capital losses, which included $65.0 million related to the write-downs in the value of interest only strips deemed to be impaired on an other than temporary basis in accordance with EITF 99-20, prior to liquidation of the interest only strip portfolio during the second quarter of 2004. Net realized capital losses of $38.0 million in 2003 reflected realized capital losses on the Company’s investments of $88.7 million, which included $25.7 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis and $46.2 million related to the impairment on interest only strips,
Other income in 2004 was $0.7 million compared to other expense of $1.0 million in 2003. The decrease in net expense for 2004 was primarily due to variability in the impact of foreign exchange, partially offset by other miscellaneous expenses.
Premiums. Gross written premiums increased 60.7% to $4,573.8 million in 2003 from $2,846.5 million in 2002, as the Company took advantage of the general firming of rates, terms and conditions and selected growth opportunities, while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 95.9% ($857.7 million) increase in the U.S. Reinsurance operation, principally related to a $519.4 million increase in treaty casualty business, a $253.9 million increase in treaty property business and a $62.8 million increase in facultative business. The International operation increased 42.9% ($156.3 million), primarily due to a $79.6 million increase in international business written through the Miami and New Jersey offices representing primarily Latin American business and a $67.4 million increase to Canadian business. The U.S. Insurance operation grew 30.2% ($248.1 million), principally as a result of an $89.5 million increase in workers’ compensation and a $73.2 million increase in excess and surplus lines insurance. The Bermuda operation increased $450.8 million, reflecting a $256.9 million increase in premiums from the UK branch, and a shift toward more traditional business resulting from the rollout of treaty, facultative and individual risk capabilities in Bermuda. The Specialty Underwriting operation increased 2.9% ($14.3 million), resulting primarily from a $38.0 million increase in A&H business and a $19.0 million decrease in marine and aviation.
Premium Revenues. Net premiums earned increased by 64.4% to $3,737.9 million in 2003 from $2,273.7 million in 2002. Contributing to this increase was a 96.0% ($697.5 million) increase in the U.S. Reinsurance operation, a 45.1% ($143.4 million) increase in the International operation, a 43.7% ($250.5 million) increase in the U.S. Insurance operation, a $363.8 million increase in the Bermuda operation and a 1.9% ($9.0 million) increase in the Specialty Underwriting operation. All of these changes reflect period to period changes in net written premiums and business mix together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. As premium reporting and earnings and loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, can and does introduce appreciable background variability in various underwriting line items.
The U.S. Reinsurance segment accounted for $134.2 million and $96.7 million of the non-A&E net prior period reserve adjustments for the years ended December 31, 2003 and 2002, respectively. The two principal underwriting areas responsible for these deficiencies are professional liability and general casualty. During the late 1990s and early 2000s, there had been a proliferation of claims relating to bankruptcies and other financial management improprieties. This increased number of claims combined with larger claims has significantly increased incurred losses on the professional liability policies. In the general casualty area, the Company continues to experience losses greater than historical trends for accident years 1998 through 2003. These losses are being driven by adverse trends in litigation and economic variability. In both the professional liability and general casualty reinsurance areas, the Company relies upon loss reports from ceding companies. Although the Company generally records reserves at higher levels than those reported by ceding companies, actual reported results have exceeded the initial loss indications. The reserve adjustments in these areas were partially offset by favorable reserve development relating to property reinsurance for the 2002 accident year.
The International segment had an unfavorable net prior period reserve adjustment of $15.8 million and a favorable net prior period reserve adjustment of $6.2 million for the years ended December 31, 2003 and 2002, respectively. These reserve adjustments relate primarily to general casualty business written in the U.S. and Canada on both a quota share and excess basis for accident years 1996 through 2002, with the larger development on the 1998 through 2000 years.
The Bermuda segment reflected $21.9 million of unfavorable non-A&E net prior period reserve adjustments for the year ended December 31, 2003 and $11.7 million of development for the year ended December 31, 2002.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by net premiums earned, decreased by 2.1 percentage points to 69.6% in 2003 from 71.7% in 2002, reflecting the premiums earned and incurred losses and LAE discussed above, as well as the general firming of rates, terms and conditions and changes in business mix.
The Company, because of its income orientation, considers total return, the combination of income yield and capital appreciation/depreciation, to be less relevant as a measure of performance than may be the case for investment portfolios managed with alternate strategies. The following table provides a comparison of the Company’s total return by asset class to broadly accepted industry benchmarks for 2003 and 2002.
The Company has a small number of credit default swaps, which it no longer writes, and specialized equity put options in its product portfolio. These products meet the definition of a derivative under FAS 133. Net derivative income from these derivative transactions in 2003, was $5.9 million, which principally reflects changes in fair value of the specialized equity put options, compared to net derivative expenses of $14.5 million in 2002, which principally related to the specialized equity put options. See also Note 2 of Notes to the Consolidated Financial Statements.
expense in 2002 reflected $38.9 million relating to the issuance of the senior notes, $2.2 million relating to the junior subordinated debt securities and $3.5 million relating to borrowings under the Company’s revolving credit facility.
The Company acknowledges that there is more uncertainty in establishing loss reserves on assumed business as compared to direct business. At December 31, 2004 the Company had assumed loss reserves of $5,939.1 million, of which $313.0 million were loss reserves on A&E business.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. The Company continues to receive claims under expired contracts, both insurance and reinsurance, asserting alleged injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. The Company’s asbestos claims typically involve potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. The Company’s environmental claims typically involve potential liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damages caused by the release of hazardous substances into the land, air or water.
The Company’s reserves include an estimate of the Company’s ultimate liability for A&E claims. This estimate is made based on judgmental assessment of the underlying exposures as the result of (1) long and variable reporting delays, both from insureds to insurance companies and from ceding companies to reinsurers; (2) historical data, which is more limited and variable on A&E losses than historical information on other types of casualty claims; and (3) unique aspects of A&E exposures for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of the Company’s potential losses from A&E claims. Among the uncertainties are: (a) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (b) difficulty in identifying sources of asbestos or environmental contamination; (c) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (d) changes in underlying laws and judicial interpretation of those laws; (e) the potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (f) questions concerning interpretation and application of insurance and reinsurance coverage; and (g) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure.
remainder of the unexpired contract period. Such reserves are established based upon reports received from ceding companies or computed using pro rata methods based on statistical data. Premiums earned, and the related costs, which have not yet been reported to the Company, are estimated and accrued. Standard accepted actuarial methodologies are used to estimate earned but not reported premium at each financial reporting date.
The following table displays the estimated earned premiums before reduction for related expenses for the periods indicated at December 31:
CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and short-term investments, were $11,530.2 million at December 31, 2004, $9,321.3 million at December 31, 2003 and $7,265.6 million at December 31, 2002. The increase in cash and invested assets in 2004 from 2003 resulted primarily from $1,487.6 million in cash flows from operations generated during 2004, $320.0 million from net proceeds of the issuance of junior subordinated debt securities, $250 million from net proceeds of the issuance of senior notes and $40.1 million in net pre-tax unrealized appreciation of the Company’s investments, partially offset by a $70 million repayment on the revolving credit agreement. The increase in cash and invested assets in 2003 from 2002 resulted primarily from $1,653.8 million in cash flows from operations generated during 2003, $316.8
Commencing with the second quarter of 2003 and through the second quarter of 2004, the Company had investments in interest only strips. These investments were aimed at mitigating potential decreases in unrealized appreciation on the Company’s fixed income portfolio during a period where management judged that there was extraordinary potential for an increase in general interest rates. These fixed maturity securities give the holder the right to receive interest payments at a stated coupon rate on an underlying pool of mortgages. The interest payments on the outstanding mortgages are guaranteed by entities generally rated AAA. The ultimate cash flow from these investments is primarily dependent upon the average life of the mortgage pool. Generally, as market interest rates and, more specifically, market mortgage rates decline, mortgagees tend to refinance which will decrease the average life of a mortgage pool and decrease expected cash flows. Conversely, as market interest rates and, more specifically, market mortgage rates rise, repayments will slow and the ultimate cash flows will tend to rise. Accordingly, the market value of these investments tends to increase as general interest rates rise and decline as general interest rates fall. These movements are generally counter to the impact of interest rate movements on the Company’s other fixed income investments. The Company liquidated its interest only strip investment portfolio in the second quarter of 2004, at which point management concluded the extraordinary potential for increases in general interest rates had subsided to a more normal level.
The following table provides a comparison of the Company’s total return by asset class to broadly accepted industry benchmarks for the periods indicated:
There can be no assurance that reserves for, and losses from, claim obligations will not increase in the future. However, management believes that the Company’s existing reserves and reserving methodologies lessen the probability that any such increase would have a material adverse effect on the Company’s financial condition, results of operations or cash flows. In this context, the Company notes that over the past 10 years, its past calendar year operations have been affected variably by effects from prior period reserve re-estimates, with such effects ranging from a favorable $35.4 million, representing 1.2% of the net prior period reserves for the year in which the adjustment was made, to an unfavorable $312.0 million, representing 6.0% of the net prior period reserves for the year in which the adjustment was made. The Company has noted that variability has increased over the past three years and has taken actions to attempt to reduce this year to year variability prospectively.
The following table represents the reserve levels and ranges as of December 31, 2004 for each of the Company’s business segments.
(2) Although totals are displayed for both the low range and high range amounts, it should be noted that statistically the range of the
total is not equal to the sum of the ranges of the segments.
As a result, which relate principally to the U.S. Reinsurance and Bermuda segments, have been segregated from reserves for which a
Depending on the specific segment, the range derived for the loss reserves, excluding reserves for A&E exposures, ranges from minus 5.0% to minus 8.3% for the low range and from plus 5.0% to plus 8.3% for the high range. Both the higher and lower ranges are associated with the Specialty Underwriting segment. Within each range, management’s best estimate of loss reserves is based on the point estimate derived by the Company’s actuaries in detailed reserve studies. Such ranges are necessarily subjective due to the lack of generally accepted actuarial standards with respect to their development. In particular, the Company notes that the width of the range is dependent on the level of confidence associated with the outcome. For the above presentation, management has assumed what it believes is a reasonable confidence level but notes that there can be no assurance that the Company’s claim obligations will not vary within and potentially outside of these ranges, requiring incurred loss adjustments in the period the variability is recognized. The Company is not able to establish a meaningful range for A&E reserves.
Additional losses, including those relating to latent injuries, and other exposures, which are as yet unrecognized, the type or magnitude of which cannot be foreseen by the Company or the reinsurance and insurance industry generally, may emerge in the future. Such future emergence, to the extent not covered by existing retrocessional
Virtually all of the Mt. McKinley policies that are still potentially exposed to claims have policy language providing that expenses were paid within limits rather than in addition to limits. This is a substantial difference from primary coverage, which would most often cover expenses in addition to limits.
facilities have generally paid their exposures more quickly than non-signatory insurers, the Company believes that this has generally meant that it has paid its reinsurance exposure more quickly than it likely would have if it had not been subject to Wellington/CCR payments.
Beginning of period reserves $ 765 .3 $ 667 .9 $ 644 .4
The gross incurred losses for A&E exposures increased by $171.7 million and $172.6 million for the years ended December 31, 2004 and 2003, respectively. These increases are the result of reevaluations by management reflecting additional information received from insureds and ceding companies, ongoing litigation, additional claims received and settlement activity. Management closely monitors this additional information and adjusts reserves accordingly. The net incurred losses primarily reflect the impact of the reinsurance agreement between Mt. McKinley and LM.
Industry analysts have developed a measurement, known as the survival ratio, to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company’s current net reserves by the three year average of paid losses, and therefore measures the number of years that it would take to exhaust the current reserves based on historical payment patterns. Using this measurement, the Company’s net three year A&E survival ratio was 5.2 years at December 31, 2004. Adjusting for the effect of the reinsurance ceded under the reinsurance agreement with LM, this ratio rises to the equivalent of 6.8 years at December 31, 2004. The cession of $160.0 million to the stop loss reinsurance provided by LM in connection with the acquisition of Mt. McKinley results in unpaid proceeds that are not reflected in past net payments and effectively extend the funding available for future net payments.
Because the survival ratio was developed as a comparative measure of reserve strength and not of absolute reserve adequacy, the Company considers, but does not rely on, the survival ratio when evaluating its reserves.
Developments in 2004 and 2003 affecting asbestos exposures in general and the Company’s asbestos exposures in particular, together with enhancements in the Company’s claim management and analytical processes, resulted in the reserve strengthening noted earlier. These developments and actions have increased the emphasis on asbestos exposures as a separate component of the Company’s A&E exposures. Despite the Company’s approach of handling A&E exposures on a combined basis, management believes additional disclosure of the asbestos element of its A&E exposures is appropriate.
(2) Under SIP agreements, payments depend upon the insured's actual claims experience and may be subject to annual caps or other
3 Year Survival Ratio excluding SIP, actively managed & stop loss 22.3
CAPITAL. The Company’s business operations are in part dependent on the Company’s financial strength, and the market’s perception thereof, as measured by shareholders’ equity, which was $3,712.5 million and $3,164.9 million at December 31, 2004 and 2003, respectively. The Company has flexibility with respect to capitalization as a result of its perceived financial strength, including its financial strength ratings as assigned by independent rating agencies, and its access to the debt and equity markets. The Company continuously monitors its capital and financial position, as well as investment and security market conditions, both in general and with respect to the Company’s securities, and responds accordingly.
o On October 6, 2004, Holdings completed a public offering of $250.0 million principal amount of 5.40% senior notes due October 15, 2014. The net proceeds will be utilized to retire existing debt at Holdings, which is coming due in March 2005, and for other general corporate purposes.
On July 30, 2002, the Company filed a shelf registration statement on Form S-3 with the SEC, providing for the issuance of up to $475.0 million of securities. Generally, under this shelf registration statement, Group was authorized to issue common shares, preferred shares, debt securities, warrants and hybrid securities, Holdings was authorized to issue debt securities and Capital Trust was authorized to issue trust preferred securities. This shelf registration statement became effective on September 26, 2002 and was effectively exhausted with the April 23, 2003 transaction described below. The following securities were issued pursuant to that registration statement.
o On November 14, 2002, pursuant to a trust agreement between Holdings and JPMorgan Chase Bank, the property trustee, and Chase Manhattan Bank USA, the Delaware trustee, Capital Trust, an unconsolidated affiliate, completed a public offering of $210.0 million of 7.85% trust preferred securities, resulting in net proceeds of $203.4 million. The proceeds of the issuance were used to purchase $210 million of 7.85% junior subordinated debt securities of Holdings that will be held in trust by the property trustee for the benefit of the holders of the trust preferred securities. In conjunction with the issuance of Capital Trust’s trust preferred securities, Holdings issued $216.5 million of 7.85% junior subordinated debt securities due November 15, 2032 to Capital Trust. The proceeds from the junior subordinated debt securities issuance were primarily used for capital contributions to Holdings’ operating subsidiaries.
In periods for which disbursements for claims and benefits, policy acquisition costs and other operating expenses exceed premium inflows, cash flow from insurance operations would be negative. The effect on cash flow from operations would be partially offset by cash flow from investment income. Additionally, cash flow from investment maturities, both short term investments and longer term maturities, would further mitigate the impact on total cash flow.
As the exact timing of the payment of claims and benefits cannot be predicted with certainty, the Company maintains portfolios of long term invested assets with varying maturities, along with short-term investments that are intended to provide adequate cash for payment of claims. At December 31, 2004 and December 31, 2003 the Company held cash and short-term investments of $770.8 million and $336.7 million, respectively. Part of the short-term cash position at December 31, 2004 will be used to pay the $250 million of senior notes that come due on March 15, 2005. In addition to these cash and short-term investments at December 31, 2004, the Company had $0.3 billion, at fair value, of available for sale fixed maturity securities maturing within one year, $1.9 billion maturing within two to five years and $7.7 billion maturing after five years. These securities, in conjunction with the short-term investments and positive cash flow from operations, provide adequate sources of liquidity for the expected payment of losses in the near future. The Company does not anticipate selling securities or using available credit facilities to pay losses and LAE but has the ability to do so. Management expects the trend of positive cash flow from operations, which in general reflects the strength of overall pricing over the 2003 and 2004 years, to persist over the near term. However, in the intermediate and long term, the trend continuation will be impacted by the extent to which competitive pressures weaken overall pricing available in the Company’s markets and the extent to which the Company successfully implements its strategy of emphasizing profitability over volume should persist.
Effective December 8, 2004, Group, Bermuda Re, and Everest International entered into a new three year, $750 million group credit facility with a syndicate of lenders (“Group Credit Facility”). Wachovia Bank is the administrative agent for the Group Credit Facility. The Group Credit Facility consists of two tranches. Tranche one provides up to $250 million of revolving credit for liquidity and general corporate purposes, and for the issuance of standby letters of credit. The interest on the revolving loans shall, at the option of each of the borrowers, be either (1) Base Rate Loans (as defined below) or (2) an adjusted London Interbank Offered Rate (“LIBOR”) plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate, in each case plus 0.5% per annum. The amount of margin and the fees payable for the Group Credit Facility depend on Group’s senior unsecured debt rating.
Tranche two exclusively provides up to $500 million for the issuance of standby letters of credit on a collateralized basis.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth amount. Minimum net worth is an amount equal to the sum of (i) $2,373 million plus (ii) (A) 25% of consolidated net income for each of Group’s fiscal quarters and (B) 50% of any increase in consolidated net worth attributable to the issuance of ordinary and preferred shares. The base amount is reset at the end of each fiscal year to be the greater of 70% of Group’s consolidated net worth as of the last day of the fiscal year and the calculated minimum amount of net worth prior to the last day of the fiscal year. As of December 31, 2004, the Company was in compliance with these covenants.
Effective October 10, 2003, Holdings entered into a new three year, $150.0 million senior revolving credit facility with a syndicate of lenders, replacing the December 21, 1999, three year senior revolving credit facility, which expired on December 19, 2003. Both the October 10, 2003 and December 21, 1999 senior revolving credit agreements, which have similar terms, are referred to as the “Holdings Credit Facility”. Wachovia Bank is the administrative agent for the Holdings Credit Facility. The Holdings Credit Facility is used for liquidity and general corporate purposes. The Holdings Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either, (1) the Base Rate (as defined below) or (2) an adjusted LIBOR plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate, in each case plus 0.5% per annum. The amount of margin and the fees payable for the Holdings Credit Facility depends upon Holdings’ senior unsecured debt rating.
The Holdings Credit Facility requires Holdings to maintain a debt to capital ratio of not greater than 0.35 to 1, Holdings to maintain a minimum interest coverage ratio of 2.5 to 1 and Everest Re to maintain its statutory surplus at $1.0 billion plus 25% of future aggregate net income and 25% of future aggregate capital contributions. As of December 31, 2004, the Company was in compliance with these covenants.
EXPOSURE TO CATASTROPHES. As with other reinsurers, the Company’s operating results and financial condition can be adversely affected by volatile and unpredictable natural and other disasters, such as hurricanes, windstorms, earthquakes, floods, fires and explosions. Any such catastrophic event could generate insured losses in one or many of the Company’s treaties or lines of business, including property and/or casualty exposures. Although the Company attempts to limit its exposure to acceptable levels, including through the purchase of reinsurance when considered to be cost effective, it is possible that an actual catastrophic event or multiple catastrophic events could have a material adverse effect on the financial condition, results of operations and cash flows of the Company.
The Company employs various techniques, including licensed modeling software, to assess its accumulated exposure. Such techniques are inherently more difficult to apply to non-property exposures. Accumulated exposures with respect to catastrophe losses are generally summarized in terms of the PML. The Company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years.
Management believes that the Company’s greatest catastrophe exposure world wide from any single event is to a U.S. earthquake affecting the west coast including workers’ compensation exposure where the Company estimates it has a pre-tax PML exposure of $427 million. The Company further estimates that its second largest exposure relates to a hurricane affecting the U.S. east coast with a pre-tax PML of $390 million. There can be no assurance that the Company will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML.
If a single catastrophe were to occur that resulted in $427 million of gross loss and LAE in 2005 (an amount equivalent to the Company’s PML including its property and workers’ compensation exposures), management estimates that the effect on the Company’s income before and after taxes would be approximately $427 million and $341 million, respectively. Such impact represents approximately 9.2% of the Company’s beginning of year capital. Such estimates involve multiple variables, including which Everest entity would experience the loss, and as a result there can be no assurance that this amount would not be exceeded.
$175.0 million of recoveries per accident year if Everest Re’s consolidated statutory basis accident year loss ratio exceeded a loss ratio attachment point provided in the contract for the respective accident years. Each arrangement provided for an adjustment premium, which reduces the net benefit by approximately 50%, in the event that the coverage is used. There are no remaining limits available under these coverages. See ITEM 1, “Business - Risk Management and Retrocession Arrangements” for further details.
CONTRACTUAL OBLIGATIONS. The following table shows the Company’s contractual obligations for the year ended December 31, 2004:
(1) Loss and LAE reserves represent our best estimate of losses from claims and related settlement costs. Both the amounts and timing of such payments are estimates, and the inherent variability of resolving claims as well as changes in market conditions make the timing of cash outflows uncertain. Therefore, the ultimate amount and timing of Loss and LAE payments could differ from our estimates.
During 2004, 2003 and 2002, the Company declared and paid shareholder dividends of $22.4 million, $19.6 million and $16.3 million, respectively. As an insurance holding company, the Company is partially dependent on dividends and other permitted payments from its subsidiaries to pay cash dividends to its shareholders. The payment of dividends to Group by Holdings and to Holdings by Everest Re is subject to Delaware regulatory restrictions and the payment of dividends to Group by Bermuda Re is subject to Bermuda insurance regulatory restrictions. Management expects that, absent extraordinary catastrophe losses, such restrictions should not affect Everest Re’s ability to declare and pay dividends sufficient to support Holdings’ general corporate needs and Holdings’ and Bermuda Re’s ability to declare and pay dividends sufficient to support Group’s general corporate needs. For the years ended December 31, 2004, 2003 and 2002, Everest Re paid dividends to Holdings of $70 million, $45 million and $85 million, respectively. Bermuda Re paid dividends to Group of $15 million in 2004. See ITEM 1, “Business - Regulatory Matters - Dividends” and Note 14A of Notes to Consolidated Financial Statements.
In January 2003, FASB issued Financial Interpretation No. 46, “Consolidation of Variable Interest Entities”(“FIN 46”). FIN 46 addresses whether certain types of entities, referred to as variable interest entities (“VIEs”), should be consolidated or deconsolidated in a company’s financial statements. During October 2003, the FASB deferred the effective date of FIN 46 provisions for VIEs created prior to February 1, 2003 to the first reporting period ending after December 15, 2003. During December 2003, the FASB issued FIN 46R, replacing FIN 46. FIN 46R is effective, for entities that had not adopted FIN 46 as of December 24, 2003, no later than the end of the first reporting period that ends on or after March 15, 2004. The Company adopted FIN 46R in the first quarter of 2004, resulting in the deconsolidation of Everest Re Capital Trust (“Capital Trust”) and Everest Re Capital Trust II (“Capital Trust II”). For 2003 and 2002, where applicable, the financial statements have been restated to reflect the deconsolidation.
In March 2004, the Emerging Issue Task Force (“EITF”) reached a final consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. This issue establishes guidance for determining whether to record impairment losses associated with investments in certain equity and debt securities. The application of this issue was required for reporting periods beginning after June 15, 2004. On September 30, 2004, the FASB issued a FASB Staff Position EITF Issue 03-1-1, which delayed the effective date for the measurement and recognition guidance included in paragraphs 10 through 20 of EITF Issue 03-1. The Company is unable to predict the impact on other-than-temporary impairments until the guidance is finalized. Currently, the Company continues to apply Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”), and the Securities and Exchange Commission (“SEC”)‘s Staff Accounting Bulletin Topic 5:M, “Other Than Temporary Impairment Of Certain Investments In Debt And Equity Securities” and believes that unrealized losses in its investment portfolio are temporary in nature.
In December 2004, the Financial accounting Standards Board (“FASB”) issued FASB Statement 123(R) “Share-Based Payment” (“FAS 123(R)”). FAS 123(R) requires all share-based compensation awards granted, modified or settled after December 15, 1994 to be accounted for using the fair value method of accounting. Under the modified prospective application, compensation cost is recognized for the outstanding, non-vested awards based on the grant date fair value of those awards as calculated under FAS 123. The Company does not expect the adoption of the statement to have a material impact on the Company’s financial condition or results of operation. The application of this issue will become effective for interim or annual periods beginning after June 15, 2005.
The SEC’s Financial Reporting Release #48 requires registrants to clarify and expand upon the existing financial statement disclosure requirements for derivative financial instruments, derivative commodity instruments and other financial instruments (collectively, “market sensitive instruments”). The Company does not generally enter into market sensitive instruments for trading purposes.
The overall investment strategy considers the scope of present and anticipated Company operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with the Company’s capital structure and other factors, are used to develop a net liability analysis. This
The Company’s $11.5 billion investment portfolio at December 31, 2004 is principally comprised of fixed maturity securities, which are subject to interest rate risk and foreign currency rate risk, and equity securities, which are subject to equity price risk. The impact of these risks on the investment portfolio is generally mitigated by changes in the value of operating assets and liabilities and their associated income statement impact.
The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on the Company’s fixed maturity portfolio as of December 31, 2004 and 2003 based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments were taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios. All amounts are in U.S. dollars and are presented in millions. In general, for 2003, the lower volatility was attributable to the Company’s investments in interest only strips, the effect of which was to reduce overall portfolio duration and therefore sensitivity to interest rate moves.
Market Value Change from Base (%) 12.0 % 6.1 % 0.0 % (6.2 )% (12.1 )%
The Company had $7,836.3 million and $6,361.2 million of reserves for losses and LAE as of December 31, 2004 and December 31, 2003. These amounts are recorded at their nominal or estimated ultimate payment amount, as opposed to fair value, which would reflect a discount adjustment to reflect the time value of money. Since losses are paid out over a period of time, the fair value of the reserves is less than the nominal value. As interest rates rise, the fair value of the reserves decreases and conversely, if interest rates decline, the fair value will increase. These movements are the opposite of the interest rate impacts on the fair value of investments since reserves are future obligations. While the difference between fair value and nominal value is not reflected in the Company’s financial statements, the Company’ financial results will include investment income over time from the investment portfolio until the claims are paid. The Company’s loss and loss reserve obligations have an expected duration of approximately 4.5 years, which is reasonably consistent with the Company’s fixed income portfolio. If the company were to discount its loss and LAE reserves, net of reinsurance receivable on unpaid losses, the discount would be approximately $1.5 billion resulting in a discounted reserve balance of approximately $5.2 billion, representing approximately 50% of the fixed maturity market value. The existence of such obligations, and the variable differential between ultimate and fair value, which in theory applies equally to invested assets and insurance liability, provides substantial mitigation of the economic effects of interest rate variability even though such mitigation is not reflected in the Company’s financial statements.
varies by regulatory jurisdiction in accordance with market needs. Each foreign operation may conduct business in its local currency, as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the British Pound Sterling and the Euro. The Company mitigates foreign exchange exposure by a general matching of the currency and duration of its assets to its corresponding operating liabilities. In accordance with Financial Accounting Standards Board Statement No. 52, the Company translates the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income. As of December 31, 2004, there has been no material change in exposure to foreign exchange rates as compared to December 31, 2003.
The tables below display the potential impact of a parallel 20% increase and decrease in foreign exchange rates on the valuation of invested assets subject to foreign currency exposure in 10% increments as of December 31, 2004 and 2003. This analysis includes the after-tax impact of translation from transactional currency to functional currency as well as the after-tax impact of translation from functional currency to the U.S. dollar reporting currency. The growth in exposure between 2004 and 2003 principally arises from increases in the level of foreign currency investments, which are generally commensurate with changes in the Company’s mix of business. All amounts are in U.S. dollars and are presented in millions.
Equity risk is the potential change in market value of the common stock and preferred stock portfolios arising from changing equity prices. The Company invests in exchange traded and mutual funds, which invest principally in high quality common and preferred stocks that are traded on the major exchanges in the U.S.. The primary objective in managing the equity portfolio is to provide long-term capital growth through market appreciation and income.
During 2001, the Company sold five specialized equity put options based on the S&P 500 index for total consideration, net of commissions, of $16.9 million. These contracts each have a single exercise date, with maturities ranging from 18 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. No amounts will be payable under these contracts if the S&P 500 index is at or above the strike price on the exercise dates. If the S&P 500 index is lower than the strike price on the applicable exercise date, the amount due will vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the December 31, 2004 index value, the Company estimates the probability for each contract of the S&P 500 index being below the strike price on the exercise date to be less than 6.4%. The theoretical maximum payouts under the contracts would occur if on each of the exercise dates the S&P 500 index value were zero.
The tables below estimate the impact of potential movements in interest rates and the S&P 500 index, which are the principal factors affecting fair value of these instruments, looking forward from the fair value at December 31, 2004 and 2003. These are estimates and there can be no assurance regarding future market performance. The asymmetrical results of the interest rate and S&P 500 index shifts reflect that the liability cannot fall below zero whereas it can increase to its theoretical maximum.
Market Value Change from Base (%) (32.5 )% (14.8 )% 0.0 % 12.5 % 23.0 %
Market Value Change from Base (%) (99.6 )% (42.2 )% 0.0 % 30.6 % 52.5 %
Market Value Change from Base (%) (61.8 )% (27.6 )% 0.0 % 22.1 % 39.7 %
and the settlement costs of the Company’s specialized equity put options. 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 events or results to be materially different from the Company’s expectations include 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.
The Company’s success depends on its ability to accurately assess the risks associated with the businesses on which the risk is retained. If the Company fails to accurately assess the risks it retains, it may fail to establish adequate premium rates to cover its losses and LAE. This could reduce the Company’s net income and even result in a net loss. Losses may arise from events or exposures that are not anticipated when the coverage is priced. An example of an unanticipated event is the terrorist attacks on September 11, 2001. Neither the magnitude of loss on a single line of business nor the combined impact on several lines of business from an act of terrorism on such a large scale was contemplated when the Company priced its coverages. In addition to unanticipated events, the Company also faces the unanticipated expansion of its exposures, particularly in long-tail liability lines. An example of this is the ongoing expansion of the scope of insurers’ legal liability for A&E exposures discussed above.
In 2004, the favorable market conditions, which had developed during 2000 through 2003, generally began to weaken. There were signs that pricing for most property classes declined modestly and that pricing for most casualty classes softened. Competition increased in part due to the relative profitability achieved by many reinsurers over 2002 and 2003 and the attendant buildup of capital in these market participants. However, this profitability and capital buildup varied significantly by participant reflecting the fact that the industry generally still remained exposed to fundamental issues that had negatively impacted its aggregate capacity in 2002 and 2003, including weak investment market conditions and adverse loss emergence. Both of these had tended to depress the industry’s aggregate financial performance and perceptions of financial strength of industry participants over this period albeit with significant variation by individual market participant. The industry experienced a record level of catastrophe losses during 2004, particularly in the second half of the year, and it remains unclear whether the aggregate catastrophe losses experienced by the industry will reverse, stop or even moderate the trends toward market softening, particularly as respects property classes. Further discussion of competitive issues can be found in ITEM 1, “Business - Competition”.
The Company’s insurance company subsidiaries, other than Mt. McKinley, which is in runoff, currently hold an “A+ (“Superior”)” financial strength rating from A.M. Best. Everest Re, Bermuda Re and Everest National hold an “AA- (“Very Strong”)” financial strength rating from Standard & Poor’s. Everest Re and Bermuda Re hold an “Aa3 (“Excellent”)" financial strength rating from Moody’s. Financial strength ratings are used by insurers and reinsurance and insurance intermediaries as an important means of assessing the financial strength and quality of reinsurers. In addition, an unfavorable rating or the lack of a rating of its reinsurers may adversely affect the rating of a company purchasing reinsurance. A downgrade or withdrawal of any of these ratings might adversely affect the Company’s ability to market its insurance products and could have a material and adverse effect on future prospects for growth and profitability. During the last five years, no active subsidiary of the Company had experienced financial strength rating downgrade. However, the Company cannot assure that a downgrade will not occur in the future. Consistent with market practice, many of the Company’s treaty reinsurance business allows the ceding company to terminate the contract or seek collateralization of the Company’s obligations in the event of a rating downgrade below a certain threshold. The termination provision would generally be triggered only if a rating fell below A.M. Best’s A- rating level, which is three levels below Everest Re’s current rating of A+. Everest Re also has more modest exposure to reinsurance contracts that contain provisions for obligatory funding of outstanding liabilities in the event of a rating agency downgrade. That provision would also generally be triggered only if Everest Re’s rating fell below A.M. Best’s A- rating level.
If the Company is unable or chooses not to purchase reinsurance and transfer risk to reinsurers, its net income could be reduced or it could incur a net loss in the event of unusual loss experience.
The Company’s success has been, and will continue to be, dependent on the ability to retain the services of existing key executive officers and to attract and retain additional qualified personnel in the future. The loss of the services of any key executive officer or the inability to hire and retain other highly qualified personnel in the future could adversely affect the ability of the Company to conduct business. Generally, the Company considers key executive officers to be those individuals who have the greatest influence in setting overall policy and controlling operations: Chairman and Chief Executive Officer, Joseph V. Taranto (age 56), President and Chief Operating Officer, Thomas J. Gallagher (age 56), and Executive Vice President and Chief Financial Officer, Stephen L. Limauro (age 53). Of those three officers, the Company only has an employment contract with Mr. Taranto. That contract has been previously filed with the SEC and was most recently amended on April 18, 2003 to extend Mr. Taranto’s term of employment from March 31, 2004 until March 31, 2006. The Company is
Special considerations apply to the Company’s Bermuda operations. Under Bermuda law, non-Bermudians, other than spouses of Bermudians and individuals holding permanent resident certificates, are not permitted to engage in any gainful occupation in Bermuda without a work permit issued by the Bermuda government. A work permit is only granted or extended if the employer can show that, after a proper public advertisement, no Bermudian, spouse of a Bermudian or individual holding a permanent resident certificate is available who meets the minimum standards for the position. The Bermuda government has announced a policy that places a six-year term limit on individuals with work permits, subject to specified exemptions for persons deemed to be key employees. Currently, all six of the Company’s Bermuda-based professional employees who require work permits have been granted permits by the Bermuda government that expire at various times between March 2006 and February 2008. This includes Mark de Saram, the chief executive officer of the Company’s Bermuda reinsurance operation. In the event his work permit were not renewed, the Company could lose his services, thereby adversely affecting its ability to conduct its business in Bermuda until it was able to replace him with an individual in Bermuda who did not require a work permit or who was granted the permit.
The value of the Company’s investment portfolio and the investment income it receives from that portfolio could decline as a result of market fluctuations and economic conditions.
Further discussion of market-sensitive instruments can be found in ITEM 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Sensitive Instruments”.
“Management’s Discussion and Analysis of Financial Condition and Results of Operations - Market Sensitive Instruments”.
Bermuda Re does not intend to be licensed or admitted as an insurer or reinsurer in any U.S. jurisdiction. Under current law, Bermuda Re generally will be permitted to reinsure U.S. risks from its office in Bermuda without obtaining those licenses. However, the insurance and reinsurance regulatory framework has become subject to increased scrutiny. In the past, there have been congressional and other initiatives in the U.S. regarding increased supervision and regulation of the insurance industry, including proposals to supervise and regulate reinsurers domiciled outside the U.S. If Bermuda Re were to become subject to any insurance laws of the U.S. or any U.S. state at any time in the future, it might be required to post deposits or maintain minimum surplus levels and might be prohibited from engaging in lines of business or from writing some types of policies. Complying with those laws could have a material adverse effect on the Company’s ability to conduct business in Bermuda and international markets.
o election of directors is staggered, meaning that the members of only one of three classes of directors are selected each year;
o the total voting power of any shareholder owning more than 9.9% of the common shares will be reduced to 9.9% of the total voting power of the common shares;
o the board of directors may decline to register any transfer of common shares if it has reason to believe that the transfer would result in:
o the Company also has the option to redeem or purchase all or part of a shareholder’s common shares to the extent the board of directors determines it is necessary or advisable to avoid or cure any adverse or potential adverse consequences if:
The Board of Directors has indicated that it will apply these bye-law provisions in such manner that “passive institutional investors” will be treated similarly to investment companies. For this purpose, “passive institutional investors” include all persons who are eligible, pursuant to Rule 13d-1(b)(1) under the U.S. Securities Exchange Act of 1934, to file a short-form statement on Schedule 13G, but excluding any insurance company or any parent holding company or control person of an insurance company.
Before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance commissioner of the state where that insurance company is domiciled. Prior to granting approval of an application to acquire control of a domestic insurance company, a state insurance commissioner will consider such factors as the financial strength of the applicant, the integrity and competence of the applicant’s board of directors and executive officers, the acquiror’s plans for changes to the insurance company’s board of directors and executive officers, the acquiror’s plans for the future operations of the insurance company and any anti-competitive results that may arise from the consummation of the acquisition of control. Because any person who acquired control of the Company would thereby acquire indirect control of its insurance company subsidiaries in the U.S., the insurance change of control laws of Delaware, Arizona, California and Georgia would apply to such a transaction. This could have the effect of delaying or even preventing such a change of control.
The Companies Act 1981 of Bermuda (the “Companies Act”), differs in material respects from the laws applicable to U.S. corporations and their shareholders. The following is a summary of material differences between the Companies Act, as modified in some instances by provisions of the Company’s bye-laws, and Delaware corporate law that could make it more difficult for investors in the Company to protect their interests than investors in a U.S. corporation. Because the following statements are summaries, they do not address all aspects of Bermuda law that may be relevant to the Company and its shareholders.
o the material facts are disclosed or are known to the shareholders entitled to vote on the transaction and the transaction is specifically approved in good faith by the holders of a majority of the voting shares or
o the transaction is fair to the corporation as of the time it is authorized, approved or ratified.
Transactions with Significant Shareholders. As a Bermuda company, the Company may enter into business transactions with its significant shareholders, including asset sales, in which a significant shareholder receives, or could receive, a financial benefit that is greater than that received, or to be received, by other shareholders with prior approval from the Company’s board of directors but without obtaining prior approval from the shareholders. In the case of an amalgamation, in which two or more companies join together and continue as a single company, a resolution of shareholders approved by a majority of at least 75% of the votes cast is required in addition to the approval of the board of directors, except in the case of an amalgamation with and between wholly-owned subsidiaries. If the Company were a Delaware corporation, any business combination with an interested shareholder (which, for this purpose, would include mergers and asset sales of greater than 10% of the Company’s assets that would otherwise be considered transactions in the ordinary course of business) within a period of three years from the time the person became an interested shareholder would require prior approval from shareholders holding at least 66 2/3% of the Company’s outstanding common shares not owned by the interested shareholder, unless the transaction qualified for one of the exemptions in the relevant Delaware statute or the Company opted out of the statute. For purposes of the Delaware statute, an “interested shareholder” is generally defined as a person who together with that person’s affiliates and associates owns, or within the previous three years did own, 15% or more of a corporation’s outstanding voting shares.
Takeovers. Under Bermuda law, if an acquiror makes an offer for shares of a company and, within four months of the offer, the holders of not less than 90% of the shares that are the subject of the offer tender their shares, the acquiror may give the nontendering shareholders notice requiring them to transfer their shares on the terms of
Inspection of Corporate Records. Members of the general public have the right to inspect the public documents of the Company available at the office of the Registrar of Companies and the Company’s registered office, both in Bermuda. These documents include the memorandum of association, which describes the Company’s permitted purposes and powers, any amendments to the memorandum of association and documents relating to any increase or reduction in the Company’s authorized share capital. Shareholders of the Company have the additional right to inspect the Company’s bye-laws, minutes of general meetings of shareholders and audited financial statements that must be presented to the annual general meeting of shareholders. The register of shareholders of the Company also is open to inspection by shareholders without charge, and to members of the public for a fee. The Company is required to maintain its share register at its registered office in Bermuda. The Company also maintains a branch register in the offices of its transfer agent in the U.S., which is open for public inspection as required under the Companies Act. The Company is required to keep at its registered office a register of its directors and officers that is open for inspection by members of the public without charge. However, Bermuda law does not provide a general right for shareholders to inspect or obtain copies of any other corporate records. Under Delaware law, any shareholder may inspect or obtain copies of a corporation’s shareholder list and its other books and records for any purpose reasonably related to that person’s interest as a shareholder.
In the last few years, some members of Congress have expressed concern about U.S. corporations that move their place of incorporation to low-tax jurisdictions. Also, some members of Congress have expressed concern over a competitive advantage that foreign-controlled insurers and reinsurers may have over U.S. controlled insurers and reinsurers due to the purchase of reinsurance by U.S. insurers from affiliates operating in some foreign jurisdictions, including Bermuda. Although the recently enacted legislation, which increases the U.S. tax burden on so-called “inverting” companies, does not apply to the Company, the Company does not know whether any similar legislation disadvantageous to the Company’s Bermuda insurance subsidiaries will ever be
The Company and/or Bermuda Re may be subject to U.S. corporate income tax, which would reduce the Company’s net income.
The income of Bermuda Re is a significant portion of the Company’s worldwide income from operations. The Company has established guidelines for the conduct of its Bermuda operations that are designed to ensure that Bermuda Re is not engaged in the conduct of a trade or business in the U.S. Based on its compliance with those guidelines, the Company believes that Bermuda Re should not be required to pay U.S. corporate income tax, other than withholding tax on U.S. source dividend income. However, if the Internal Revenue Service (“IRS”) successfully contended that Bermuda Re was engaged in a trade or business in the U.S., Bermuda Re would be required to pay U.S. corporate income tax on any income that is subject to the taxing jurisdiction of the U.S., and possibly the U.S. branch profits tax. Even if the IRS successfully contended that Bermuda Re was engaged in a U.S. trade or business, the U.S.-Bermuda tax treaty would preclude the IRS from taxing Bermuda Re’s income except to the extent that its income were attributable to a permanent establishment maintained by that subsidiary. The Company does not believe that Bermuda Re has a permanent establishment in the U.S. If the IRS successfully contended that Bermuda Re did have income attributable to a permanent establishment in the U.S., Bermuda Re would be subject to U.S. tax on that income.
Based on its compliance with guidelines designed to ensure that it generates only immaterial amounts, if any, of income that is subject to the taxing jurisdiction of the U.S., the Company believes that it should be required to pay only immaterial amounts, if any, of U.S. corporate income tax, other than withholding tax on U.S. source dividend income. However, if the IRS successfully contended that the Company had material amounts of income that is subject to the taxing jurisdiction of the U.S., it would be required to pay U.S. corporate income tax on that income, and possibly the U.S. branch profits tax. Prior to the current year, even if the IRS had successfully contended that the Company had material amounts of income that was subject to the taxing jurisdiction of the U.S., the U.S.-Barbados tax treaty would have precluded the IRS from taxing its income, except to the extent that its income was attributable to a permanent establishment maintained by it in the U.S. Since the Company moved its principal executive offices out of Barbados as of December 31, 2004 and since the United States and Barbados recently made effective a protocol to the U.S.-Barbados tax treaty, which strengthens the limitation of benefits provisions of that treaty, the U.S.-Barbados tax treaty will no longer provide any protection to the Company. Nevertheless, the Company does not believe that it has material amounts of income subject to the taxing jurisdiction of the U.S. If the IRS successfully contended, however, that the Company did have income subject to tax in the U.S. the imposition of tax on that income would reduce the Company’s net income.
corruption, such as money laundering activities. The OECD has threatened non-member jurisdictions that do not agree to cooperate with the OECD with punitive sanctions by OECD member countries, though specific sanctions have yet to be adopted by OECD member countries. It is as yet unclear as to what these sanctions will be, who will adopt them and when or if they will be imposed. The OECD published a list of “uncooperative tax havens,” which are those jurisdictions from whom the OECD has not received commitments to the OECD’s principles of regulatory and tax transparency and effective exchange of information. The government of Bermuda has made these commitments. As a result, Bermuda is not currently listed as an uncooperative tax haven. However, it is possible that the OECD could change its view in the future and decide to list Bermuda as an uncooperative tax haven, or that one of the other multinational organizations could take a different view from the OECD and decide to recommend sanctions against Bermuda. Any sanctions imposed on Bermuda could increase the Company’s taxes and reduce its net income. In addition, the Company is not able to predict what changes will arise from the commitments given to the OECD by the government of Bermuda or whether those changes will subject it to additional taxes.