Growth in net premiums earned in 2000 over 1999 is mainly due to new business, primarily environmental liability, written by ECS. ECS contributed approximately $260.0 million in gross premiums written and $110.0 million in net premiums earned in 2000. No premiums were written or earned by ECS in 1999 as ECS only commenced writing business on behalf of the Company with effect from January 1, 2000. Prior to this date, ECS had agency agreements in place with other companies. In addition, XL Aerospace wrote aviation and satellite business totaling $160.0 million in gross premiums written and $60.0 million in net premiums earned. In 1999, this agency wrote this business on behalf of the Lloyd's syndicates, of which the Company's share was approximately $20.0 million in gross premium written and $11.5 million in net premium earned. 2000 also includes approximately $60.0 million in gross premiums written and $25.0 million in net premiums earned of new professional liability business written. Generally, in 2000, premium rates have continued to be negatively affected by increased competition. Some price increases were experienced in 2000 in property lines, which have also contributed to the increase in net premiums earned. However, pricing has remained relatively unchanged on the liability lines of business. Contracts were not renewed where premium rates were not deemed by the Company to be sufficient to cover the risks underwritten.
In 1999, fee income and other primarily relates to the sale by XL Brockbank of its two motor insurance businesses, Admiral and Zenith, resulting in a gain of $40.2 million. In addition, 1999 also included $42.1 million of fees generated from the motor business prior to the sale. No such income was earned in 2000. XL Brockbank's managing agencies may also earn profit commissions and fees from syndicates they manage in order to offset their operating expenses. 1999 included $2.9 million in profit commissions. Due to the loss deterioration in the Lloyd's market, no commissions were earned in 2000, resulting in expenses in excess of fee income in 2000.
The increase in equity earnings of affiliates in 2000 compared to 1999 is primarily attributable to increased returns on the Company's holdings in investment management companies and the funds managed by those companies, in addition to new affiliate investments made in 2000. 1999 included a loss of $3.6 million relating to Arch Capital (formerly Risk Capital), which was sold in 2000. This loss, together with the inclusion of only seven months of equity earnings from the Company's equity position in Mid Ocean in 1998, contributed to the decrease in equity in net income of affiliates in 1999 compared to 1998.
Foreign exchange gains in 2000 related to the revaluation of a deposit liability denominated in U.K. Sterling. The exchange rate movement on the assets matching this deposit liability is included in accumulated other comprehensive income as those assets are designated as available for sale, and in net realized gains on sale of investments. Effective January 1, 2001, the Company has reorganized its corporate and operational structure for U.K. Sterling asset accumulation business such that future exchange translation adjustments of this nature will be matched against corresponding investment portfolio movements with minimal effect on earnings.
The increase in the amortization of intangible assets in 2000 compared to 1999 primarily related to a full year's charge for ECS and XL Specialty, acquired in the second quarter of 1999. The increase in 1999 over 1998 related to the acquisition of Mid Ocean in 1998, where a full year's goodwill charge was included in 1999.
(1) The Company made minority investments in Highfields Capital Management LP and MKP Capital Management LP and into the funds they manage totaling $281.2 million.
XL Re, formerly XL Mid Ocean Re, is organized under the laws of Bermuda. On August 7, 1998, XL Mid Ocean Re was formed through the merger of XL Global Reinsurance and Mid Ocean Re. Mid Ocean Re and Global Capital Re were organized in 1992 and 1993, respectively, initially to write property catastrophe reinsurance following a reduction in market capacity due to the effects of severe hurricanes that struck the southeastern United States in the late 1980's and early 1990's.
Investments are considered 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, net of tax, is included in accumulated other comprehensive income. Any unrealized depreciation in value considered by management to be other than temporary is charged to income in the period that it is determined.
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) interest and dividend income together with the amortization of premium and discount on fixed maturities and short-term investments.
The Company has established a committee and completed an implementation plan to identify all derivatives, evaluate risk management hedging strategies and determine appropriate valuation methodologies in order to assess the impact that adoption of this statement will have on its financial position and results of operation. Based on the Company's current accounting treatment for derivatives and as a result of its review, the Company has estimated that FAS 133, as amended, will not have a significant impact on the results of operations, financial condition or liquidity in future periods.
(1) Ratios are based on net premiums earned, excluding fee income and other. The underwriting expense ratio excludes exchange gains and losses
There were no significant non-income producing investments as at December 31, 2000, 1999 and 1998.
At December 31, 2000 and 1999, approximately $113.1 million and $89.4 million, respectively, of securities were on deposit with various U.S. state or government insurance departments in order to comply with relevant insurance regulations.
Business written by the Company has loss experience characterized as low frequency but high severity in nature. This may result in volatility in the Company's financial results. Actuarial assumptions used to establish the liability for losses and loss expenses are periodically adjusted to reflect comparisons to actual loss and loss expense development, inflation and other considerations.
Net losses incurred in 2000 increased over 1999, principally due to current year development. Current year development reflects both the growth in business assumed and an increase in loss ratios applied. The increase in the loss ratio is due to the effect of competition which has depressed premium rates, particularly on certain casualty lines. Current year losses also reflect the early development of certain losses on the Company's large account business within its insurance operations. Historically, the Company does not experience the reporting of such losses at an early stage and the Company's reserving methodology for these lines of business extrapolates these losses into the projections of future development. If future development is eventually determined to be less than the estimated
The Company also invests in a synthetic equity portfolio of S&P Index futures with an exposure approximately equal in amount to the market value of underlying assets held in this fund. As at December 31, 2000, the portfolio held $43.7 million (1999: $121.9 million) in exposure to S&P 500 Index futures and underlying assets of $43.2 million (1999: $122.0 million). The value of the futures is updated daily with the change recorded in income as a realized gain or loss. For the years ended December 31, 2000 and 1999, results from index futures totaled net realized losses of $0.2 million and net realized gains of $11.3 million, respectively.
Following the merger with NAC, new option plans were created in the Company to adopt the NAC plans. Options generally have a five or six year vesting schedule, with the majority expiring 10 years from the date of grant; the remainder having no expiration. A stock plan is also maintained for non-employee directors. Options expire 10 years from the date of grant and are fully exercisable six months after their grant date.
Under the Act, XL Insurance and XL Re are classified as a Class 4 insurer and reinsurer, respectively. Therefore, they are restricted to the payment of dividends in any one financial year of 25% of the prior year's statutory capital and surplus, unless their directors attest that such dividends will not cause the company to fail to meet its relevant statutory requirements. XL Insurance and XL Re have not been prevented from paying dividends by this restriction.
The United Kingdom Financial Services Authority ("U.K. FSA") regulates reinsurance entities that are "effecting and carrying on" insurance business in the United Kingdom. Through its branches and subsidiaries in London, the Company is deemed to "effect and carry on" business in the United Kingdom and certain of its subsidiaries are therefore regulated by the U.K. FSA.
The Company is subject to regulation in Australia, Singapore, Spain, Latin America and Germany as a result of its representative offices and branches in such jurisdictions.
(2) 1998 reflects the assumed conversion of the 5.25% Convertible Subordinated Debentures due 2000. The Debentures were called in June 1999 and the actual conversion is reflected in 1999.
The following is a summary of the unaudited quarterly financial data for 2000 and 1999: