Results of Operations for the Years Ended November 30, 1998, 1997 and 1996
The following is a discussion of the Company's results of operations and financial condition. This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and notes thereto presented under
XL Capital Ltd. ("XL" or the "Company") is a holding company organized under the laws of the Cayman Islands. XL was incorporated on March 16, 1998 as the successor to EXEL Limited, a Cayman Islands corporation organized in 1986 ("EXEL"), in connection with EXEL's merger with Mid Ocean Limited, a Cayman Islands corporation ("Mid Ocean"). In the merger, which was completed on August 7, 1998, all of the shares of EXEL and Mid Ocean were exchanged for shares in the Company pursuant to two schemes of arrangement approved by the Grand Court of the Cayman Islands in accordance with Section 85 of the Companies Law (1995 Revision) of the Cayman Islands. The Company operated under the name "EXEL Limited" from completion of the merger until February 1, 1999, when its current name was approved by the requisite vote of the Company's shareholders. References herein to "XL" or the "Company" also shall include EXEL unless the context otherwise requires. Through its subsidiaries, the Company is a leading provider of insurance and reinsurance, including coverages relating to certain financial risks, to industrial, commercial and professional service firms, insurance companies and other enterprises on a worldwide basis.
The Company's reinsurance operations are conducted primarily through XL Mid Ocean Reinsurance Ltd, an insurance company organized under the laws of Bermuda ("XLMORe"), and its subsidiaries. On August 7, 1998, XLMORe was formed through the merger of X.L. Global Reinsurance Company, Ltd. ("XLGRe") and Mid Ocean Reinsurance Company Ltd. ("MORe"). XLGRe was formed in November 1997 through the merger of X.L. Reinsurance Company, Ltd. ("XLRe") and Global Capital Reinsurance Company Limited ("GCRe") following EXEL's acquisition of GCR Holdings Limited, a Cayman Islands holding company, on June 12, 1997. XLRe commenced operations on December 1, 1995 to write specialty reinsurance business. MORe and GCRe were organized in 1992 and 1993, respectively, initially to write property catastrophe reinsurance following severe hurricanes which struck the southeastern United States in the late 1980's and early 1990's. Each of XLRe, MORe and GCRe was organized as an insurance company under the laws of Bermuda. XLMORe maintains branches in London, Singapore and a European contact office in Munich.
The Company participates in several joint ventures of strategic importance. In general, the Company has pursued a strategy of entering into joint ventures with organizations which possess expertise in lines of business that the Company wishes to enter. The Company's principal joint ventures are in the areas of financial guaranty insurance, life insurance for high net worth individuals, Latin American reinsurance, political risk insurance and currency overlay and related risk management.
In November 1998, the Company entered into a joint venture with Financial Security Assurance Holdings Ltd., a New York corporation ("FSA"), to write certain types of financial guaranty insurance and reinsurance. FSA, through its subsidiaries, is primarily engaged in the business of providing financial guaranty insurance on asset-backed and municipal obligations. Under the terms of the joint venture, each of the Company and FSA formed a Bermuda insurance company in which it was the majority shareholder and made a minority investment in the company formed by its co-venturer. The Company formed and maintains majority ownership of XL Financial Assurance Ltd. ("XLFA"). FSA formed and maintains a majority ownership of Financial Security Assurance International Ltd. ("FSAI"). Each of XLFA and FSAI has a capitalization of approximately $100 million. As part of the joint venture, the Company and FSA exchanged approximately $80 million of each other's stock, following which the Company owned approximately 6% of the issued and outstanding common stock of FSA.
In June 1998, the Company formed Reeve Court Insurance Ltd., an insurance company organized under the laws of Bermuda, as a joint venture with such company's management for the purpose of providing life insurance to high net worth individuals. Reeve Court has a total capitalization of approximately $100 million.
In October 1997, the Company and Risk Capital Holdings, Inc., a Delaware corporation ("RCHI") which holds all of the outstanding shares of Risk Capital Reinsurance Company, a Nebraska corporation ("RCRe"), organized LARC Holdings, Ltd., a Bermuda corporation ("LARC") which holds all of the shares of Latin American Reinsurance Company, Ltd., a Bermuda insurance company ("LARe"). LARe has approximately $100 million in shareholders' equity and provides multi-line reinsurance to the Latin American reinsurance market, concentrating on short- tail, multi-peril property reinsurance and, to a lesser extent, casualty, marine, aviation and other lines of reinsurance on both a treaty and facultative basis. XLMORe owns approximately 75% of the outstanding shares of LARC. The Company indirectly owns approximately 28% of RCHI.
In March 1997, XLI became a founding shareholder along with RCHI and another insurance company of Sovereign Risk Insurance Ltd. ("Sovereign"), a Bermuda- based managing general agency formed to write selected political risk insurance coverages. The Company owns 40.5% of Sovereign.
In 1996, the Company acquired approximately 28% of Pareto Partners ("Pareto"), a firm which specializes in foreign currency overlay management and related services. At December 31, 1998, Pareto had approximately $26 billion of assets under management. The Company works closely with Pareto to develop new products and ventures, including the F/XL foreign currency protection product offered by XLI.
The Company, through its subsidiaries XLI, XLE, XLIA and XLRS, is a leading insurer and provides third party general liability insurance, directors and officers liability insurance, professional liability insurance, employment practices liability insurance and other liability insurance including, property insurance, and other
insurance covers, including political risk insurance and financial products. The liability insurance is written on an excess basis and the loss experience is characterized as low frequency and high severity. Property is written on a pro rata as well as an excess basis. Policies written on a pro rata basis can attach at much lower levels. As a result, loss experience can be higher frequency and lower severity.
Sovereign issues subscription policies with XLI and the other insurance company each assuming 50% of each policy written. The Company reinsures 10% of all risks assumed through Sovereign to RCRe.
LARe provides multi-line reinsurance to the Latin American market, emphasizing short-tail, multi-peril property reinsurance and, to a limited extent, casualty, marine, aviation and other lines of reinsurance.
The Company's wholly owned subsidiary, Brockbank, is a leading Lloyd's managing agency which manages five syndicates, two of which are dedicated corporate syndicates whose capital is solely provided by the Company. These corporate syndicates write property, marine and energy, aviation and satellite, motor, professional indemnity and other specialty lines, primarily of insurance but also reinsurance.
The comparative consolidated financial statements are those of EXEL, the Company's predecessor, as previously discussed in note 1.
differences arising on such estimates are recorded in the period they are determined. Premiums are earned on a monthly pro-rata basis over the period the coverage is provided. Unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of policies in force. Premiums written under the multi-year alternate rating methodology may be subject to a mandatory reinstatement premium in the event of a loss. An asset is accrued to reflect the obligation of the insured's reinstatement premium and the premium is earned in accordance with the "with or without" method; that is, the pricing of the premium is evaluated in terms of a no loss situation and the resultant premium is earned over the remaining term of the policy. The balance of the reinstatement premium is earned to the extent of the loss reaching the full policy limit; that is, in the event of a full limit loss the balance of the reinstatement premium together with any unearned premium of the underlying cover would be fully earned. Premiums written and unearned premiums are presented after deductions for reinsurance ceded to other insurance companies.
In the normal course of business, the Company seeks to reduce the loss that may arise from events that could cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Reinsurance premiums ceded and the commissions recorded thereon are expensed and earned on a monthly pro-rata basis over the period the reinsurance coverage is provided. For those reinsurance policies that provide coverage to the Company over the term of the underlying business, the premiums ceded and commissions recorded thereon are expensed and earned on a monthly pro-rata basis over the estimated term of those policies. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy.
Investments are available for sale and are carried at fair value. The fair value of investments is based upon quoted market values where available or by reference to broker or underwriter bid indications. The net unrealized appreciation or depreciation on investments is included as a separate component of shareholders' equity.
date with the resulting foreign exchange gains and losses recognized in income, unless the foreign currency exposure is directly hedged as discussed in note 3 (d). Revenue and expense transactions are translated at the average exchange rates prevailing during the year.
The Company accounts for its investments in affiliates on the equity basis.
Management believes that the reserves for unpaid losses and loss expenses are sufficient to pay any claims that may penetrate the minimum attachment point. However, there can be no assurance that losses will not exceed the Company's total reserves. The methodology of estimating the reserve is periodically reviewed to ensure that the assumptions made continue to be appropriate and any adjustments resulting therefrom are reflected in income of the year in which the adjustments are made.
The Company has adopted Statement of Financial Accounting Standards ("SAFS") No. 128, "Earnings per Share". SFAS No. 128 replaced primary and fully diluted earnings per share with basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the weighted average number of ordinary shares outstanding for each period. Diluted earnings per share reflects the potential dilution that could occur if the securities to issue ordinary shares were exercised into ordinary shares. Prior years earnings per share amounts have been restated to reflect this.
The contractual maturities of fixed maturity securities as of November 30, 1998 and 1997 are shown below (U.S. dollars in thousands). Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company owned 27.9% of the issued shares of RCHI as at November 30, 1998 and 1997, respectively. Outstanding share warrants if exercised would dilute the Company's ownership to 22.1% as at November 30, 1998. RCHI commenced operations on November 6, 1995.
The Company owns 28% of Pareto Partners, a partnership engaged in the business of providing investment advisory and discretionary management services.
On November 3, 1998, XL and FSA formed Financial Security Assurance International Ltd. ("FSAI") under the laws of Bermuda. FSAI was capitalized with $100 million, of which FSA and XL contributed 80% and 20% respectively. FSAI will focus on financial guaranty insurance and reinsurance opportunities. As of November 30, 1998, no contracts were written.
Prior year incurred losses in 1998 were effected in part, by the release of insurance reserves established for the Company's professional lines. These reserves were reduced in accordance with actuarial estimates. In addition, reserves were released on specialty cover policies for the years 1995 through 1997 due to the absence of losses that would affect the Company's layers. These policies were for a three-year period, written on a claims-made basis and expired in 1998.
The 1997 losses were offset by the release of $260 million in reserves that related to prior years in accordance with actuarial estimates.
In February 1998, subsidiaries of the Company established a $500 million letter of credit facility with a syndicate of commercial banks led by Mellon Bank N.A. Letters of credit issued under this facility are collateralized by pledged securities in XLI's fixed maturity investment portfolio. Letters of credit totalling approximately $80.6 million and $155.8 million were outstanding as at November 30, 1998 and 1997, respectively.
Mid Ocean had a $325 million letter of credit facility with Citibank N.A., London Branch. Letters of credit issued under this facility are collateralized by pledged securities in Mid Ocean's investment portfolio. This
Derivative investments are also utilized to add value to the portfolio where market inefficiencies are believed to exist. At November 30, 1998, bond and stock index futures outstanding were $333.4 million, with underlying investments having a market value of $ 2.1 billion. All managers are prohibited by the Company's investment guidelines from leveraging their positions.
On June 27, 1996, the Company borrowed $11.0 million from the Bank of Bermuda (New York) Limited in order to fund its investment in Pareto Partners, Inc., an investment management company. The loan is repayable in four years. During the year the weighted average interest rate charged on the loan was 6.02%. Total interest expense amounted to $0.7 million and $0.7 million for the years ended November 30, 1998 and 1997 respectively.
The following table is a summary of shares issued and outstanding (in thousands):
The Board of Directors has authorized the repurchase of the Company's ordinary shares through several buy back programs. During 1998 the Company repurchased 3.2 million shares at an aggregate cost of $255.2
million. On March 13, 1998, the Board of Directors discontinued its existing share repurchase program and authorized a program for $500 million of the Company's ordinary shares. In August 1998, $300 million of share repurchases related to the merger with Mid Ocean. In addition, the Company had purchased a further 732,000 shares at a cost of $51.2 million during the year.
The Company's executive stock plan, the "1991 Performance Incentive Program", provides for grants of non qualified or incentive stock options, restricted stock awards and stock appreciation rights ("SARs"). The plan is administered by the Company and Compensation Committee of the Board of Directors. Stock options may be granted with or without SARs. Grant prices are established at the fair market value of the Company's common stock at the date of grant. Options and SARs have a life of 10 years and vest annually over three years from date of grant.
Restricted stock awards issued under the plan vest over a five year period from the date of grant. These shares contained certain restrictions, for said period, relating to among other things, forfeiture in the event of termination of employment and transferability. As the shares are issued, deferred compensation equivalent to the difference between the issue price and the estimated fair market value on the date of the grant is charged to shareholders' equity and subsequently amortized over the five-year restriction period. Restricted stock issued under the plan totaled 131,936 shares, 274,300 shares and 120,500 shares in 1998, 1997 and 1996, respectively.
The Company also has stock plans in place for its non-employee directors. The "Stock and Option Plan", issues non-qualified options to the directors-- 4,000 shares at the commencement of their directorship and 2,000 shares each year thereafter. On December 3, 1997, 5,000 options were granted to each director. All options vest immediately on grant date. Effective April 11, 1997, all options granted to Non-Employee Directors are granted under the 1991 Performance Incentive Program.
The fair value of options granted was $40.7 million, $9.9 million and $4.3 million for the years ended November 30, 1998, 1997 and 1996, respectively.
In 1998, four regular quarterly dividends were paid, three of $0.40 per share to shareholders of record at February 6, April 16 and July 15, and one of $0.44 per share to shareholders of record at September 28.
In 1997, four regular quarterly dividends were paid, three of $0.32 per share to shareholders of record at February 6, April 22 and July 11, and one of $0.40 per share to shareholders of record at September 25.
In 1996, four regular quarterly dividends were paid, one of $0.20 per share to shareholders of record at February 2, and three of $0.25 per share to shareholders of record at April 15, July 12 and October 11.
Under The Insurance Act, 1978, (as amended by the Insurance Act Amendment 1995) amendments thereto and related regulations of Bermuda (the "Act"), XLI and XLMORe are required to prepare statutory financial statements and to file in Bermuda a statutory financial return. The Act also requires these companies to maintain certain measures of solvency and liquidity during the year. Other subsidiaries of the Company based in Bermuda, including XLFA, LARe and Reeve Court, are also subject to regulation under the Act.
The primary difference between statutory net income and statutory capital and surplus for the Company's subsidiaries as shown above, and net income and shareholder's equity presented in accordance with generally accepted accounting principles are deferred acquisition costs.
XLE is permitted to cover risks throughout the European Community (subject to certain restrictions) pursuant to the "Third Directive" relating to non- life insurances. Its operations, however, are largely restricted to the Republic of Ireland and are subject to regulation under Irish regulatory authority. The principal legislation and regulations governing the insurance activities of Irish insurance companies are the Companies Act of 1963 to 1990 and a range of Irish Insurance Acts from 1909 through 1995 (the "Irish Acts"). In addition, there is a comprehensive network of regulations and statutory provisions empowering the making of regulations of which the most relevant are the European Communities (Non-Life Insurance) Framework Regulations, 1994, the European Communities (Insurance Undertakings Accounts) Regulations, 1996 and a range of other European Communities Regulations and administrative rules (the "Irish Regulations").
XLE's insurance activities are subject to extensive regulation in the Republic of Ireland, principally under the Irish Acts and Irish Regulations, which impose on insurers headquartered in the Republic of Ireland minimum solvency and reserve standards and auditing and reporting requirements and grant to the Minister for Enterprise, Trade and Employment (the "Irish Minister") wide powers to supervise, investigate and intervene in the affairs of such insurers. The Irish Minister's powers and functions are exercised through the Department of Enterprise, Trade and Employment.
The United Kingdom Financial Services Authority ("UK FSA") regulates reinsurance entities that are "effecting and carrying on" insurance business in the United Kingdom. XLMORe, through its London branch, "effects and carries on" business in the United Kingdom and is therefore regulated by the UK FSA.
A person would be viewed by Lloyd's as a "major shareholder" of the CCVs if such person owns 15% or more of the Company's outstanding capital stock and as a "controller" if it owns 30% or more of the Company's outstanding capital stock. Therefore, any person that becomes the owner of 15% or more of the Company's stock may be required to deliver a declaration and undertaking to Lloyd's, in the form prescribed by Lloyd's, unless Lloyd's exempts such person from this requirement.
As a "controller", the Company is required to give certain undertakings, directed principally towards ensuring that there is no direct interference in the conduct of the business of the relevant managing agency, but there are no provisions in The Lloyd's Act of 1982, the bye-laws or the regulations which provide for any liabilities of the CCVs or the Brockbank group as a whole to be met by the Company. In addition, a managing agency is required to comply with various capital and solvency requirements, and to submit to regular monitoring and compliance procedures. The CCVs, as corporate members of Lloyd's, are each required to commit a specified amount approximately equal to 50% of their underwriting capacity on the syndicates to support its underwriting on those syndicates.
FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits", effective for fiscal years beginning after December 15, 1997. This Statement revises employers' disclosures about pensions and other postretirement benefit plans. This standard is expected to have a minimal impact on the Company's consolidated financial disclosures.
SFAS No. 131 and No. 133 are not expected to have a significant impact on the Company's overall results but will affect the Company's financial statements and disclosures.
PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (U.S. dollars in thousands, except per share amounts)
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of shareholders' equity and comprehensive income and of cash flows present fairly, in all material respects, the financial position of XL Capital Ltd and its subsidiaries at November 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended November 30, 1998, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.