- -------- (1) Net operating earnings represents net income before discontinued operations, minority interests and realized gains on investments after tax.
(c) $17.9 million of premiums in respect of Terra Nova Capital's share of the closure of the 1995 year of account into the 1996 year of account of which it had an 11% share.
Net Investment Income. Net investment income increased 9.0%, to $85.1 million in 1997 from $78.1 million in 1996. The increase arose from an increase of 11.0% in average invested assets, primarily attributable to the higher operating cash flows in 1997 compared to 1996, $75 million debt issue in August 1997 and the acquisition of Corifrance in the following month partially offset by lower investment yields. The average investment yield before realized gains and losses was 6.2% and 6.3% in 1997 and 1996, respectively. The average duration of fixed maturity investments at December 31, 1997 and 1996 was 4.9 years and 4.2 years, respectively.
Acquisition Costs. Acquisition costs, which are comprised of commission expenses and other underwriting expenses, increased 40.1% to $115.4 million in 1997 from $82.4 million in 1996. Acquisition costs as a percentage of net premiums earned decreased to 27.5% in 1997 from 29.6% in 1996. The decrease was largely a result of the earned premiums from the orphaned syndicate and RITC business written during 1997, which have very low acquisition costs; excluding this business, acquisition costs would have been 31.3% of premiums earned.
Net Interest Expense. Net interest expense in 1997 relates to interest on the $100 million 10.75% Senior Notes issued on June 30, 1995 and interest on the $75 million 7.2% Senior Notes issued on August 26, 1997. The net interest expense in 1996 relates to interest on the $100 million 10.75% Senior Notes.
Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written increased 19.3% to $361.0 million in 1996 from $302.7 million in 1995. The overall increase in gross premiums written of $58.3 million was a consequence of the increase in current year gross premiums written of $50.2 million, together with an increase in prior year premiums of $8.1 million.
Losses and Loss Adjustment Expenses. Losses and LAE decreased 0.5%, to $178.3 million in 1996 from $179.1 million in 1995. As a percentage of net premiums earned, losses and LAE decreased 7.1 percentage points, to 64.0% in 1996 from 71.1% in 1995. The loss and LAE ratio for non-marine property business marginally decreased to 61.6% in 1996 from 62.5% in 1995, due to slightly more favorable loss experience in 1996 compared to 1995. The loss and LAE ratio for non-marine casualty business decreased to 82.0% in 1996 from 101.3% in 1995 as a result of stable results for prior years in 1996. The decrease in the marine loss and LAE ratio to 55.9% in 1996 from 63.9% in 1995 was a consequence of the lower reinsurance costs experienced in 1996 and a decrease in adverse development of the 1992 and prior years on the marine LMX business in 1996.
Pursuant to a decision by Terra Nova's directors in February 1992 to cease writing aviation business ("Aviation"), Aviation has been accounted for as a discontinued operation in the financial statements of Terra Nova, the Company's predecessor. Insurance cover provided under Aviation policies issued by Terra Nova ceased upon the expiration of the last policy on December 31, 1992. Accordingly, Terra Nova has not been subject to any new Aviation risks since that date. However, Terra Nova may continue to receive payments from policyholders pursuant to existing contracts and to make payments under ceded reinsurance contracts. In addition, Terra Nova will continue to settle claims and make recoveries from its reinsurers. These future receipts and payments, together with the costs of running off the Aviation business, have been considered as part of estimating the loss from abandonment of Aviation for periods up to December 31, 1994. However, estimates of ultimate liabilities for losses and loss adjustment expenses may vary as a result of subsequent development.
Following the Terra Nova Acquisition, charges or credits resulting from changes in estimates after December 31, 1994 are reflected in continuing operations of the Company. In 1997, 1996 and 1995, the aviation business in run-off produced a break-even result.
The Company's assets consist primarily of the capital stock of UK Holdings and Terra Nova (Bermuda), and UK Holdings' assets consist primarily of the capital stock of Terra Nova, Terra Nova Capital and Octavian. The ability of the Company to pay dividends on its capital stock and to pay its obligations depends primarily on dividends or other payments from Terra Nova, Terra Nova (Bermuda), Terra Nova Capital, Octavian and Corifrance. The payment of dividends and other payments by Terra Nova, Terra Nova Capital and Octavian are subject to restrictions under U.K. law, Terra Nova (Bermuda), Bermuda law and Corifrance, French law.
(a) Cashflows from Terra Nova Capital of $60.9 million in 1997 compared to $5.3 million in 1996 due to the Company's increased participation on syndicates managed by Octavian in 1997;
Total investments and cash were $1,475.6 million at December 31, 1997. At December 31, 1997, 85.5%, 7.1% and 7.4% of total investments and cash were held in fixed maturities, common stocks and cash and cash equivalents, respectively. At December 31, 1997, approximately 93.5% of the Company's fixed income investments were rated "A" or better by Moody's or S&P. The Company's investment portfolio earned interest and dividend income, net of investment management fees, of 6.2% and 6.3% in 1997 and 1996, respectively. The Company had realized investment gains of $15.3 million and $11.8 million in 1997 and 1996, respectively.
On May 5, 1997, the Company announced its plans to buy back up to $20 million of its common stock on the open market at prevailing market prices or in privately negotiated transactions.
On August 28, 1997, the Company filed a Form 8-K in respect of the issue of $75 million 7.2% Senior Notes due 2007, fully and unconditionally guaranteed by Bermuda Holdings.
The Company declared and paid dividends in accordance with the following table:
The management of Bermuda Holdings is responsible for the integrity and fair presentation of the consolidated financial statements, related notes thereto and all other financial information presented herein. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts based on the best estimates and judgments of management.
We have audited the accompanying consolidated balance sheets of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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.
The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America. All material intercompany transactions and balances have been eliminated.
(b) Cash and cash equivalents: Cash and cash equivalents are comprised of cash and various short-term investments which have maturities when purchased of 90 days or less. Cash equivalents are stated at fair value which approximates cost.
(f) Income taxes: Deferred income taxes are recorded with respect to temporary differences between financial reporting and tax bases of assets and liabilities in accordance with Statement of Financial Accounting Standard ("SFAS") No. 109.
(g) Foreign currency translation: The U.S. dollar is the functional and reporting currency as a majority of the policies written are denominated in U.S. dollars. Revenues and expenses in non-U.S. dollar currencies are translated at the average rates of exchange. Monetary assets and liabilities are translated at the rate of exchange in effect at the close of the period. Non-monetary assets and liabilities, primarily deferred revenue and expenses, are translated at historic rates of exchange. Gains or losses resulting from non-U.S. dollar transactions are included in net income. Certain other net translation adjustments are shown as a separate component of shareholders' equity.
(i) Accrued premium income: Accrued premium income represents the difference between the estimated cumulative ultimate written premiums and cumulative billed premiums.
(k) Stock-based compensation: The Company has adopted SFAS No. 123 "Accounting for Stock-Based Compensation". As allowed under this standard, the Company accounts for stock option grants in accordance with APB Opinion No. 25 "Accounting for Stock Issued to Employees".
Compensation expense for stock option grants is recognised to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is accrued over the shorter of the vesting or service period.
(l) Risks and Uncertainties: Information about risks and uncertainties existing at the balance sheet date related to the following areas:
These disclosures are included in Notes 1, 3, 5, 12, 13, 14, 15 and 17.
(m) Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating the fair value of the financial instruments presented:
In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128 "Earnings per Share" ("EPS") effective for financial statements issued for periods ending after December 15, 1997. SFAS No. 128 requires dual presentation of basic and diluted EPS on the face of the income statements for the current period and all comparative periods regardless of whether basic and diluted EPS are the same; it also requires a reconciliation of the numerator and denominator used in computing basic and diluted EPS. Full disclosure of EPS under SFAS No. 128 is provided in Note 9 to the consolidated financial statements.
In June 1997, FASB issued SFAS No. 130 "Reporting Comprehensive Income" and SFAS 131 "Disclosures about Segments of an Enterprise and Related Information". These statements are effective for financial statements issued for periods beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components within a set of financial statements.
SFAS No. 131 requires the Company to report financial and descriptive information about its reportable operating segments. The Company is currently reviewing the impact of SFAS No. 130 and SFAS No. 131 on its financial reporting.
In February 1998, FASB issued SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits". SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. This statement significantly changes current financial statement disclosure requirements from those that were required under FAS 87, "Employers' Accounting for Pensions", FAS 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits", and FAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". However, SFAS No. 132 does not change the existing measurement or recognition provisions of FASB Statement Nos. 87, 88, or 106. The Company is currently reviewing the impact of SFAS No. 132 on its financial reporting.
Cash and securities with a carrying value of $19,465,928 and $18,583,564 at December 31, 1997 and 1996 respectively, were held in trust for the benefit of the Company's U.S. surplus lines policyholders.
Proceeds from sales of investments in fixed maturity securities during 1997, 1996 and 1995, respectively, were $521,301,000, $291,803,000 and $207,581,000. Realized net capital gains on sale of fixed maturities for the years ended December 31, 1997, 1996 and 1995 included gross capital gains of $9,600,000, $6,802,000 and $2,947,000 and gross capital losses of $4,258,000, $5,293,000 and $2,014,000, respectively.
Proceeds from sales of investments in equity securities during 1997, 1996 and 1995, respectively, were $215,732,000, $163,173,000 and $118,340,000. Realized net capital gains on sale of equity securities for the years ended December 31, 1997, 1996 and 1995, included gross capital gains of $29,613,000, $22,512,000 and $13,209,000 and gross capital losses of $19,622,000, $12,271,000 and $4,758,000, respectively.
(e) At December 31, 1997, the Company's portfolio by rating category, determined by recognized rating agencies, was:
(f) At December 31, 1997, the fair value of the following investments exceeded 10% of shareholders' equity:
(a) The U.K. corporation tax rate applicable to ordinary income was 33% for 1995 and 1996. The tax rate was reduced to 31% from 33% on April 1, 1997. The corporation tax rate in France was 41.67% for 1997. The difference between the actual tax expense on income from continuing operations and the "expected" amount computed by applying the U.K. corporation tax rate is explained as follows:
(d) Under current Bermuda law, Terra Nova (Bermuda) and Bermuda Holdings are not required to pay any taxes in Bermuda on either income or capital gains. Terra Nova (Bermuda) and Bermuda Holdings have received
Terra Nova operates defined benefit pension plans ("Terra Nova Plan") which cover all employees (except those in Canada and Belgium) over 20 years old who meet the eligibility conditions set out in the plan document. The cost of providing pensions for employees is charged to earnings over the average working life of employees in accordance with the recommendations of qualified actuaries. Annual funding requirements are determined based on the projected unit credit cost method, which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service. Final benefits are based on the employee's years of credited service and the higher of pensionable compensation received in the calendar year preceding retirement or the best average pensionable compensation received in any three consecutive years in the ten years preceding retirement.
The discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation of the Terra Nova Plan at December 31, 1997 and 1996 were 7.5% and 5.0% respectively. These are considered appropriate given the U.K. interest rate environment. The expected long-term rate of return on plan assets was 10.0%. The fund assets are invested primarily in equity securities.
The following table sets out the funded status of all defined benefit plans and the amounts recognized in the accompanying consolidated balance sheets of the Company at December 31, 1997 and 1996:
Basic EPS are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS considers all dilutive potential common shares that were outstanding during the period.
In accordance with the SEC Staff Accounting Bulletin Topic 4-D, for the purposes of the earnings per share calculations for 1995, application of the topic resulted in an approximately 1,909,766 share increase in the number of shares outstanding utilized in the calculation of earnings per share as presented in the accompanying statement of operations.
During 1997, the Company issued 35,986 ordinary shares to satisfy options exercised under the Company's fixed stock option plan (see Note 11). A further 26,000 options were exercised during the year, all of which were satisfied by issuing shares from the trust as described above.
At December 31, 1997 the Company has three stock-based compensation plans, which are described below. The Company applies APB Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, compensation cost of $3,244,000 has been charged against income for 1997 (1996: $400,701). The compensation expense for 1997 and 1996 determined using the fair value methodology of SFAS No. 123 is not materially different from the expense calculated in accordance with APB No. 25 and therefore pro forma net income and earnings per share, as required by SFAS No. 123, are not shown.
A summary of the Company's performance-based stock option plan as of December 31, 1997 and changes during the two years then ended is presented below:
The Company cedes reinsurance to and assumes reinsurance from Lloyd's syndicates. As of December 31, 1997, the aggregate exposure in respect of reinsurance ceded to Lloyd's syndicates in respect of continuing operations, including estimated reinsurance recoveries in respect of losses incurred but not reported, was approximately $87,583,000, the majority of which was ceded into Equitas with effect from September 4, 1996. No specific bad debt provision has been established for amounts due from Lloyd's syndicates.
Management has considered environmental and latent injury claims and claims expenses in establishing the liability for unpaid losses and loss adjustment expenses. The Company continues to be advised of claims asserting injuries from hazardous materials and alleged damages to cover various clean-up costs relating to policies written in prior years. Coverage and claim settlement issues, such as the determination that coverage exists and the definition of an occurrence, may cause the actual loss development to show more variation than the remainder of the Company's book of business. Traditional reserving techniques cannot be used to estimate asbestos-related and environmental pollution claims and, accordingly, the uncertainty in respect of the ultimate cost of these types of claims is greater than the uncertainty relating to standard lines of business. The Company believes it has made reasonable provisions for claims, although the ultimate liability may be more or less than held reserves. The Company believes that future losses associated with these claims will not have a material
(a) The Company is regularly involved, directly or indirectly, in litigation in the ordinary course of conducting their insurance and reinsurance business. In a number of cases, plaintiffs seek to establish coverage for liability under environmental protection laws. While the nature and extent of insurance and reinsurance coverage for environmental liability has widened since 1980, there has been no final judgment which would result in the wholesale transfer of environmental liability from insureds to insurers and reinsurers. In the judgment of management, none of these cases, individually or collectively, is likely to result in judgments for amounts which, net of loss and loss adjustment expense liabilities previously established and reinsurance recoverables which management believes are probable of realization, would have a material effect on the financial position of the Company, although there is no assurance that such losses will not materially effect the Company's results of operations for any period.
The 10.75% Senior Notes due 2005 may be redeemed at the option of UK Holdings at any time on or after July 1, 2000, at a redemption price equal to 104.031%, 102.688%, 101.344% and 100.000%, for the years 2000, 2001, 2002 and 2003 and thereafter, respectively, of the aggregate principal amount thereof plus accrued and unpaid interest thereon to the date of redemption. Subject to certain limitations, UK Holdings may also redeem on or before the third anniversary of the issuance of the Senior Notes up to 35% of the aggregate principal amount of the Senior Notes originally issued with the net proceeds of one or more offerings of capital stock (other than redeemable capital stock) of Bermuda Holdings or UK Holdings at a redemption price of 109.75% of the principal amount thereof plus accrued and unpaid interest thereon to the date of redemption. In addition, the Senior Notes are subject to redemption at the option of the holder thereof upon certain events constituting a change of control of Bermuda Holdings or UK Holdings (provided that holders of 25% of Senior Notes outstanding have tendered their Senior Notes for redemption), at a redemption price equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest thereon to the date of redemption, and must be redeemed upon certain tax-related events at a redemption price of 100% of the principal amount thereof plus accrued and unpaid interest thereon to the date of redemption.
The indenture governing the Senior Notes contains various covenants that limit, under certain circumstances, among other things, mergers and asset sales, indebtedness, dividends on and redemption of capital stock, the use of proceeds from asset dispositions, liens, sales of capital stock of Bermuda Holdings' principal insurance subsidiaries, encumbrances on the payment of dividends and other payments by subsidiaries, transactions with affiliates, issuance of preferred stock by subsidiaries, issuance of guarantees, investments and certain business activities. The indenture also contains customary events of default, including payment defaults, covenant defaults, defaults in respect of other indebtedness, certain judgments and bankruptcy.
Reinsurance recoverable on paid and unpaid losses in relation to Aviation are stated after deduction of an allowance for doubtful accounts as of December 31, 1997, 1996 and 1995 of $4,715,000, $5,261,000 and $7,294,990, respectively.
In determining the net liabilities and net loss of Aviation, Terra Nova has identified to Aviation all assets, liabilities, revenues and expenses directly related to the Aviation operations. The net cumulative cash flow from Aviation has been negative since the year ended December 31, 1990, and Terra Nova has provided cash to Aviation out of corporate assets to enable Aviation to meet its obligation on a cash basis. Because Aviation has been operating on a negative cash flow basis and has not generated investment assets in the periods presented in these financial statements, no investment income has been allocated to Aviation. Income tax benefits have been
Fees of $487,500, $3,216,004 and $2,500,000 were paid to a related party in 1997, 1996 and 1995 respectively, relating to the Offerings, the issue of the Senior Notes, and the Acquisitions and the capitalization of the Company.
Substantially all of the revenues are derived from business within the London Market. Additional operations are conducted in Belgium, Bermuda, Canada and France.
The following table is a summary of the operations of the four segments for the years ended December 31, 1997, 1996 and 1995:
The Company's net income per share amounts are based on the weighted average number of shares outstanding during the periods (see Note 9). The quarterly 1997 and 1996 per share data shown above, do not agree to those previously reported on form 10Q due to the adoption of SFAS No. 128 "Earnings per Share" in the fourth quarter of 1997.