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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 1-10804
XL CAPITAL LTD
(Exact name of registrant as specified in its charter)
CAYMAN ISLANDS 98-0191089
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CUMBERLAND HOUSE, 1 VICTORIA STREET, HM 11
HAMILTON, BERMUDA (Zip Code)
(Address of principal executive offices)
(441) 292-8515
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Class A Ordinary Shares, Par New York Stock Exchange, Inc.
Value $0.01 per Share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the shares of all classes of voting stock of
the registrant held by non-affiliates of the registrant on March 17, 2000 was
approximately $6.5 billion computed upon the basis of the closing sales price of
the Ordinary Shares on that date. For purposes of this computation, shares held
by directors and officers of the registrant have been excluded. Such exclusion
is not intended, nor shall it be deemed, to be an admission that such persons
are affiliates of the registrant.
As of March 17, 2000 there were outstanding 121,350,631 Class A Ordinary
Shares, $0.01 par value per share, and 3,115,873 Class B Ordinary Shares, $ 0.01
par value per share, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION PURSUANT TO REGULATION 14A RELATING TO THE ANNUAL MEETING OF
SHAREHOLDERS TO BE HELD ON MAY 12, 2000 IS INCORPORATED BY REFERENCE IN
PART III OF THIS FORM 10-K.
XL CAPITAL LTD
TABLE OF CONTENTS
Page
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters......................................... 17
Item 6. Selected Financial Data..................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................. 19
Item 8. Financial Statements and Supplementary Data................. 30
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ................................... 73
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 74
Item 11. Executive Compensation...................................... 74
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 74
Item 13. Certain Relationships and Related Transactions.............. 74
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 74
THIS ANNUAL REPORT ON FORM 10-K CONTAINS "FORWARD-LOOKING STATEMENTS" AS
DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. A NON-EXCLUSIVE
LIST OF THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENTS IS SET FORTH HEREIN
UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION - CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS.
PART I
ITEM 1. BUSINESS
RECENT DEVELOPMENTS
On June 18, 1999, XL Capital Ltd (sometimes referred to as the "Company")
merged with NAC Re Corp., a Delaware corporation, in a stock merger.
Shareholders of NAC received 0.915 Company shares for each NAC share in a tax
free exchange. Approximately 16.9 million of the Company's Class A ordinary
shares were issued in this transaction.
The NAC merger was accounted for as a pooling of interests under U.S.
generally accepted accounting principles ("U.S. GAAP"). Accordingly, all prior
period information contained in this document includes the results of NAC as
though it had always been a part of the Company. Following the merger, the
Company changed its fiscal year end from November 30(th) to December 31(st) as a
conforming pooling adjustment. Consolidated financial information presented
herein is based upon the new fiscal year end for all years presented.
HISTORY
The Company was incorporated with limited liability under the Cayman
Islands Companies Act on March 16, 1998, as EXEL Merger Company. The Company was
formed as a result of the merger of EXEL Limited and Mid Ocean Limited on
August 7, 1998, and was renamed EXEL Limited on that date. The merger was
accounted for as a purchase business combination. EXEL and Mid Ocean are
companies that were incorporated in the Cayman Islands in 1986 and 1992,
respectively. At class meetings held in August 1998, the shareholders of EXEL
and Mid Ocean approved Schemes of Arrangement under Cayman Islands law pursuant
to which EXEL and Mid Ocean became wholly-owned subsidiaries of the Company.
Following the merger, Mid Ocean's two main operating subsidiaries, a reinsurance
company and a Lloyd's managing agency with two dedicated corporate syndicates,
were combined with the Company's liability insurance business. At a special
general meeting held on February 1, 1999, the shareholders of the Company
approved a resolution changing the name of the Company to XL Capital Ltd. The
Company, through its subsidiaries, is a leading provider of insurance and
reinsurance coverages and financial products to industrial, commercial, and
professional service firms, insurance companies and other enterprises on a
worldwide basis.
NAC was organized in 1985 and, through its subsidiaries, writes property
and casualty insurance and reinsurance in the U.S., Canada and Europe.
In 1999, the Company made the following investments:
(1) The Company further expanded into the United States by completing the
acquisition of both Intercargo Corporation and ECS, Inc. Intercargo is
headquartered in Schaumburg, Illinois, and through its subsidiaries, underwrites
specialty insurance products for companies engaged in international trade,
including U.S. Customs bonds and marine cargo insurance. ECS is an underwriting
manager headquartered in Exton, Pennsylvania, which specializes in environmental
insurance coverages and risk management services.
(2) The Company signed a joint venture agreement with Les Mutuelles du Mans
Assurances Group to form a new French reinsurance company, Le Mans Re. The
Company owns a 49% shareholding in the new company, which underwrites a
worldwide portfolio comprising all classes of non-life reinsurance business
together with a selective portfolio of life reinsurance business.
(3) The Company made strategic minority investments in two investment
management firms, Highfields Capital Management L.P., a global equity investment
firm, and MKP Capital Management, a New York-based fixed income investment
manager specializing in mortgage-backed securities.
1
In 1998, the Company made the following investments:
(1) The Company entered into a joint venture with FSA Holdings Ltd. to
write financial guaranty insurance and reinsurance. Under the terms of the joint
venture, each of the Company and FSA formed a Bermuda insurance company in which
it is the majority shareholder and made a minority investment in the company
formed by its co-venturer.
(2) The Company formed Reeve Court Insurance Ltd., a Bermuda company
organized as a joint venture with that company's management for the purpose of
providing life insurance to high net worth individuals.
(3) The Company formed two companies now known as XL Insurance Company of
New York and XL Capital Assurance. XL Insurance Company of New York is a
property and casualty insurance company, and XL Capital Assurance is a financial
guaranty insurance company.
In 1997, the Company made the following investments:
(1) The Company acquired GCR Holdings Limited, whose reinsurance subsidiary
was amalgamated with the Company's reinsurance operations.
(2) The Company acquired a 75% holding in Latin America Re, a Bermuda
reinsurance company.
(3) The Company formed Sovereign Risk Insurance, a Bermuda-based managing
general agency, as a joint venture to write political risk insurance on a
subscription basis on behalf of its shareholders.
In 1996, the Company acquired 30% of Pareto Partners, a firm which
specializes in foreign currency management and related services.
OPERATIONS
The Company is organized into four underwriting segments - insurance,
reinsurance, Lloyd's Syndicates and financial services - and a corporate
segment, which includes the investment operations of the Company. The
descriptions of policies and coverages which follow are summary in nature. Only
the terms and conditions of individual policies or contracts have legal effect,
and nothing in this report constitutes an admission of coverage or other
liability or interpretation of any particular policy provision.
INSURANCE OPERATIONS
The Company provides both excess and primary insurance globally through the
following subsidiaries: XL Insurance, XL Europe, XL Insurance Company of New
York, Greenwich Insurance, Indian Harbor Insurance, ECS and Intercargo.
The Company provides third party general liability insurance, directors and
officers liability insurance, professional liability insurance, employment
practices liability insurance and integrated liability insurance, property
insurance and other insurance covers including political risk insurance. The
liability insurance is written on an excess basis and the loss experience is
characterized as low frequency and high severity. The Company generally requires
that disputes arising under the policies be settled by arbitration in London.
General liability coverage is typically provided on an occurrence-reported
policy form, with up to a maximum limit of $200 million per occurrence and in
the annual aggregate. Policies typically cover occurrences causing unexpected
and unintended personal injury, or property damage to third parties arising from
events or conditions which commence at or subsequent to an inception date - or
retroactive date, if applicable, but not prior to January 1, 1986 - and prior to
the expiration of the policy, provided proper notice is given during the term of
the policy or the discovery period. Traditional occurrence coverage is also
available for restricted classes of risk and is generally written on a
follow-form basis, i.e. the policy generally adopts the terms, conditions and
exclusions of the underlying policy, currently up to a maximum of $50 million
per occurrence in excess of a minimum attachment point of $25 million.
2
Directors and Officers coverage is written on a follow-form claims-made
basis providing up to a maximum limit of $75 million on both a primary and
excess basis.
Professional liability risks are also generally written on a follow-form
basis. Coverage is provided for certain categories of risk up to a maximum of
$50 million with a minimum attachment of $20 million.
Employment practices liability risks are written on a claims-made and
reported policy. The policy covers claims brought by an employee against an
insured for certain employment practices, up to a maximum of $100 million annual
aggregate limit in excess of a minimum attachment point of $0.5 million.
Property insurance risks are written on a follow-form basis, which usually
provides coverage for all risks of physical damage and business interruption up
to a maximum limit of $100 million per occurrence, with a sub-limit of up to
$25 million for coverage in critical earthquake zones. Property insurance is
written on both a pro rata and excess basis. Policies written on a pro rata
basis can have losses attaching at lower levels, resulting in loss experiences
that can be higher frequency and lower severity.
The Company offers multi-year combined line coverages for traditional
casualty coverages including general, directors and officers liability,
professional liability and property coverage, in addition to a blended finite
coverage for risks which traditionally have been difficult to place through pure
risk transfer mechanisms.
Primary program insurance risks written include specialty insurance such as
auto warranty business, environmental insurance, U.S. Customs bonds and marine
cargo insurance.
REINSURANCE OPERATIONS
The Company, through NAC Re and XL Mid Ocean Re, provides a broad range of
property and casualty reinsurance products on a global basis. Business is
written on both a proportional and excess of loss basis.
The Company's casualty reinsurance is provided on a treaty and facultative
basis and includes general liability, professional liability, automobile and
workers' compensation, and commercial and personal property risks and specialty
risks, including fidelity and surety and ocean marine. Business is written on an
excess of loss basis, under which the Company indemnifies an insurer for a
portion of the losses on insurance policies in excess of a specified loss
amount, generally $1 million or more, and up to an amount per loss specified in
the contract. It is also written on a pro rata basis under which the Company
assumes from the primary insurer a percentage of loss specified in the treaty of
each risk in the reinsured class.
The Company's property business is primarily short-tail in nature and
includes property catastrophe, property excess of loss, property pro rata,
marine and energy, aviation and satellite and various other reinsurance to
insurers on a worldwide basis. A significant portion of business underwritten
consists of large aggregate exposures to man-made and natural disasters, and
generally, loss experience is characterized as low frequency and high severity.
This may result in volatility in the Company's financial results. The Company
endeavors to manage its exposures to catastrophic events by limiting the amount
of its exposure in each geographic zone worldwide and requiring that its
property catastrophe contracts provide for aggregate limits and varying
attachment points.
The Company's property catastrophe reinsurance account is generally "all
risk" in nature. It is therefore exposed to losses from sources as diverse as
windstorms, earthquakes, freezes, riots, floods, industrial explosions, fires or
any number of other potential disasters. In accordance with market practice, the
Company's policies generally exclude certain risks such as war, nuclear
contamination or radiation. The Company's predominant exposure under such
coverage is to property damage. Property catastrophe reinsurance provides
coverage on an excess of loss basis when aggregate losses and loss adjustment
expenses from a single occurrence of a covered peril exceed the attachment point
specified in the policy. Some of the Company's property catastrophe contracts
limit coverage to one occurrence in any one policy year, but most contracts
generally provide for one reinstatement.
The Company also writes property risk excess of loss reinsurance. Risk
excess of loss reinsurance responds to a loss of the reinsured on a single
"risk" of the type reinsured rather than to aggregate losses for all covered
risks as does catastrophe reinsurance.
3
The Company's property pro rata account includes proportional reinsurance
of direct property insurance. The Company considers this business to be related
to its catastrophe and other property exposures. In proportional reinsurance,
the Company assumes a specified proportion of the risk on the specified coverage
and receives an equal proportion of the premium. The ceding insurer receives a
commission, based upon the premiums ceded to the Company, and the ceding insurer
may also be entitled to receive a profit commission based upon the ratio of
losses, loss adjustment expense and the Company's expenses to premium ceded. The
Company is dependent upon the ceding insurer's underwriting, pricing and claims
administration to yield an underwriting profit. In some instances, the Company
may be entitled to the benefit of other reinsurance, known as common account
reinsurance, purchased by the ceding company on an account reinsured by the
Company on a proportional basis.
The aviation portfolio is written on both a proportional and excess of loss
basis. The exposures are mainly derived through proportional relationships on
defined segments of account following market leaders in the field. Due to the
highly technical nature of the satellite business, the exposures retained under
this portfolio are acquired mostly through proportional reinsurances of
specialist underwriters.
Other reinsurance written by the Company includes political risk, nuclear
accident, professional indemnity and life and annuity.
LLOYD'S OPERATIONS
The Company's Lloyd's operations are conducted by Brockbank and Denham.
Brockbank operates through two subsidiaries, which are Lloyd's managing general
agencies, Brockbank Syndicate Management and Brockbank Personal Lines. These
Brockbank subsidiaries manage five syndicates, two of which are dedicated
corporate syndicates whose capital is provided solely by the Company. During
1999, these dedicated corporate syndicates (syndicates 1209 and 2253) wrote a
range of specialty lines, primarily of insurance but also reinsurance, in
parallel with the other syndicates managed by Brockbank (syndicates 588, 861 and
253). Effective January 1, 2000, motor business is no longer written. Denham is
a Lloyd's managing agency which manages one Lloyd's syndicate (syndicate 990),
whose capital is partially provided by the Company and which writes casualty and
non-marine physical damage insurance. As managing agencies, Brockbank and Denham
receive fees and commissions in respect of the underwriting services they
provide to syndicates.
Corporate syndicate 1209 writes a wide range of classes across the
property, casualty and marine, aviation and transport sectors to a globally
diverse group of clients. Coverages range from global "all risks" programs for
multinationals to tailored facilities for agents with small and medium sized
businesses, with particular emphasis on North America and Europe. The
syndicate's specie account includes fine art, cash in transit, financial
institutions and jewelry. The syndicate's accident and health account is
worldwide and comprises personal accident insurance and reinsurance, medical
expenses and kidnap and ransom. The professional indemnity account includes
professional and directors and officers liability and fidelity, with particular
emphasis in the service sectors (financial institutions, lawyers, information
technology, architects and engineers) in North America. Other business written
by the Company's Lloyd's operations includes the bloodstock account and
contingency coverages.
Through the marine, hull and machinery account, syndicate 1209 has a
significant involvement with many of the world's largest fleets. The syndicate's
energy account comprises cover for all elements of the worldwide hydrocarbon
industry. The syndicate writes a space account and is involved at every stage of
major space launches and associated pre-launch operations. The marine liability
account embraces all the major types of cover available, including pollution
insurance, financiers' exposures and certificates of financial responsibility
reinsurance, as well as the more traditional liability cover, such as
charterers' liabilities. The syndicate writes a broad international cargo
account, specializing in the technology sector and in large plant and project
equipment. The syndicate also writes war and political risk cover for ships and
aircraft, and also covers most political risks, including expropriation,
confiscation, terrorism and trade disruption.
Syndicate 1209's treaty reinsurance account provides high excess or
catastrophe cover predominantly for direct insurers. This account is diverse and
consists of protections for companies ranging from the large worldwide
multi-line insurers to the small domestic industrial mutual insurers. Excess of
loss coverage is provided for most lines of insurance. Syndicate 1209 also
writes a book of non-proportional treaty reinsurance business.
4
Until December 1999, syndicate 2253 wrote an account of direct and broker
based motor insurance in the United Kingdom, an account which was also written
by syndicate 1209. This business was offered through two distribution channels:
Admiral Insurance, a direct response motor operation, and Zenith Insurance,
which offered motor insurance through a network of retail brokers. Admiral
concentrated on the private car market. Zenith operated across a broader range
of activities, covering areas such as taxis, motorcycles, agricultural vehicles
and commercial fleets, as well as private cars. In December 1999, Brockbank sold
Admiral and Zenith. The Company expects decreases in premiums, fee income and
certain costs as a result of the sale, however it does not expect the overall
profitability of its Lloyd's operations to be significantly affected by such
sales.
FINANCIAL SERVICES
The Company, through XL Capital Products, provides credit enhancement
coverages in the form of financial guaranty insurance and reinsurance and credit
default swaps on asset-backed, municipal and select corporate risk obligations.
Financial guaranty insurance generally guarantees payments of interest and
principal on an issuer's obligations when due. Credit default swaps provide
coverage for losses upon the occurrence of specified credit events set forth
therein. The Company's underwriting policy is to credit enhance obligations and
exposures that would otherwise be lower investment grades without the benefit of
the Company's enhancement, although on an exception basis, the Company will
consider underwriting high non-investment grade risks.
Asset-backed obligations insured or reinsured by the Company are generally
issued in structured transactions backed by pools of assets of specified types,
such as residential mortgages, auto loans and other consumer receivables,
equipment leases and corporate debt obligations, having an ascertainable cash
flow or market value. Municipal obligations insured or reinsured consist mainly
of general or special obligations of state and local governments, supported by
the issuer's ability to charge fees for specified services or projects.
Corporate risk-based obligations which the Company has underwritten include
essential infrastructure projects and obligations backed by receivables from the
future sales of commodities and other specified services. Obligations guaranteed
or enhanced by the Company range in duration from a few years to 15 or more
years, and premiums are either received on an installment basis or up front.
The Company has adopted written underwriting guidelines for the various
products and asset classes comprising the credit enhancement business, which
include single and aggregate risk limitations on specified exposures. A credit
committee including Bermuda-based executive officers of the Company provides
final underwriting approval for each transaction. Par insured and notional
amounts covered under the Company's guarantees and credit default swaps may be
up to $500 million or more for certain risks, and the underlying risks include
those of the Organization for Economic Cooperation and Development and emerging
market issuers and assets.
The Company has also underwritten two transactions whereby substantial loss
reserves were assumed. In addition to the underwriting risks assumed, the
Company also has embedded exposure in these transactions to investment
performance return and ceded reserves. These transactions are actuarially
expected to be of long duration.
PREMIUMS
See "Management's Discussion and Analysis of Results of Operations and
Financial Condition" and Note 3 in the Notes to the Consolidated Financial
Statements.
REINSURANCE CEDED
In many cases, the risks assumed by the Company are reinsured with other
reinsurers. The benefits of ceding risks to other reinsurers include reducing
exposure on individual risks, protecting against catastrophic risks and
maintaining acceptable capital ratios. Reinsurance ceded does not legally
discharge the Company from its liabilities in respect of the risk being
reinsured. The following is a discussion of the types of reinsurance ceded by
the Company.
5
INSURANCE OPERATIONS
The Company purchases a quota share and an excess of loss reinsurance
treaty to protect the general liability occurrence-notified business written.
Under the terms of the current quota share treaty, the Company cedes 20% of each
risk subject to a per risk maximum of $30 million. The aggregate maximum amount
recoverable under this treaty is 300% of the total premium ceded. Effective
April 1, 1999, the business covered by the treaty was extended to include
employment practices liability business. The treaty is placed with eight
reinsurers and no single reinsurer participates in excess of 20% of the program.
All reinsurers are rated by A.M. Best as A or better and all reinsurers, except
for one, are rated by S&P as BBB or better. The most significant reinsurers on
this program are Hannover Re, St. Paul Re and Cigna. These companies are rated
AA+, AA and BBB, respectively, by S&P, and have participations of 20%, 20% and
15%, respectively, on a reinsurance balance receivable and unpaid losses
recoverable balance of $192 million as of December 31, 1999.
Under the terms of the excess of loss reinsurance treaty, the Company is
reinsured for $112.5 million excess of various per risk, aggregate and
quota-share retentions. The maximum amount recoverable under this treaty is $250
million. The treaty is placed with eighteen reinsurers including four Lloyd's
syndicates. No single reinsurer participates in excess of 20% of the program.
All reinsurers are rated by S&P as A or better, and all reinsurers, except for
one, are rated by A.M. Best as A or better. The most significant reinsurers on
this program are American Re, ERC Frankona and PMA Re. These companies are rated
AAA, AAA and A, respectively, by S&P, and have participations of 20%, 12.5% and
10%, respectively, on a reinsurance balance receivable and unpaid losses
recoverable balance of $38 million as of December 31, 1999.
The Company also purchases a variable surplus treaty to protect the
property business written. Under the terms of the current treaty, the Company
can cede a maximum of 50% of each risk subject to a per risk maximum of $25
million. The maximum amount recoverable under this treaty is $50 million. The
treaty is placed with eight reinsurers and no single reinsurer participates in
excess of 20% of the program. All reinsurers are rated by A.M. Best as A or
better and by S&P as A- or better. The most significant reinsurers on this
program are ERC Frankona, PMA Re and St. Paul Re. These companies are rated AAA,
A and AA, respectively, by S&P, and have participations of 20%, 16% and 15%,
respectively, on a reinsurance balance receivable and unpaid losses recoverable
balance of $13 million as of December 31, 1999.
The Company also purchases a quota share reinsurance treaty to protect the
general liability occurrence business. At December 31, 1999, there were no
losses under this treaty.
REINSURANCE OPERATIONS
Traditionally, the Company has purchased limited retrocession reinsurance
on its property business with covers primarily originating from common account
reinsurance on assumed business. Specific excess of loss protection is purchased
for the London and Singapore branch operations, and a corporate multi-year
program is purchased for its global property exposures. This protection gives
total limits in various layers and excess of varying attachment points according
to territorial exposure. The Company has co-reinsurance retentions within this
program. In August 1998, the Company placed $200 million of retrocessional
property catastrophe cover in a combination reinsurance and capital market swap
transaction which covered hurricane and earthquake exposure in the U.S. and its
territories and in the Caribbean. This cover was not renewed in 1999 and was
replaced by a second event cover of $300 million excess of a retention of
$500 million.
The Company's casualty reinsurance program in 1999 covers multiple claims
arising from two or more risks in a single occurrence or event. Workers'
compensation business is reinsured at $195 million in excess of $5 million
retention for any one occurrence. An additional casualty contingency cover is
purchased for a total of $32 million excess of an initial retention of
$5 million, which gradually increases up to an additional $3 million should
gross losses exceed $30 million. In addition, the Company had coverage in 1999,
1998 and 1997 in the event that the accident year loss and loss expense ratio
exceeded a pre-determined amount. At December 31, 1999, the Company had a
reinsurance balance receivable and unpaid loss recoverable of $117 million due
from Hannover Re (Ireland) Ltd, which is rated A+ by A.M. Best.
6
The Company had an intercompany stop loss agreement in place in 1999 under
which a subsidiary in the reinsurance segment was covered by a subsidiary in the
insurance segment for losses exceeding a specified loss ratio up to $100
million. The purpose of this agreement is to efficiently manage statutory
surplus levels across the Company.
The 1998 casualty reinsurance program was similar to that of 1999. Workers'
compensation business is reinsured for $195 million in excess of $5 million
retention for any one occurrence. An additional casualty contingency cover is
purchased for a total of $25 million excess of an initial retention of
$5 million.
The Company's 1997 casualty reinsurance program was substantially similar
to the 1998 program.
The Company terminated two retrocessional programs effective January 1,
1997. Termination of these programs has resulted in an increase in net retention
levels for the years 1996 and prior. As the casualty book of business matures,
the increase in net retentions for these years may result in increased
volatility in future years to the extent the actual frequency and severity of
claims differs from management's current estimates. The Company believes its
exposure to such volatility is within acceptable levels.
LLOYD'S OPERATIONS
The Company's Lloyd's operations have historically purchased reinsurance to
protect the syndicates against extraordinary loss or loss involving one or more
underwriting classes. The amount purchased is determined with reference to the
syndicates' aggregate exposure and potential loss scenarios.
COMPETITION
The worldwide property and casualty insurance and reinsurance industry is
highly competitive. The markets for the Company's insurance and reinsurance
products are characterized by strong and, at times, intense price competition
driven largely by the substantial amount of excess capacity currently present in
the industry. The Company believes that such competitive forces will be present
in the industry over the short to medium term. Some of the Company's competitors
possess significantly greater financial and other resources than the Company.
The Company generally competes on the basis of financial strength, coverage
terms, claims paying rating and reputation, price and customer service.
See Industry Overview included in the "Management's Discussion of Financial
Condition and Results of Operations" for further discussion of current market
conditions.
UNDERWRITING AND MARKETING
UNDERWRITING
The insurance subsidiaries write liability and property coverage for a wide
array of industry groups, including chemical, industrial, pharmaceutical,
property owners, landlords and tenants, utilities, auto, consumer, rail, oil and
construction with respect to third-party general liability and first-party
property; industrial/manufacturing, utilities, chemical/pharmaceutical and
financial institutions with respect to directors and officers liability; and
lawyers, insurance brokers and insurance companies for professional liability.
Although rates are influenced by a number of factors, including competition, the
Company's rating methodology seeks to set rates individually for each insured in
accordance with claims potential as measured by past experience and future
expectations, the attachment point and amount of underlying insurance, the
nature and scope of insured operations (including the industry group in which
the insured operates), exposures to loss, and other specific risk factors
relevant in the judgment of the underwriters and insurance market conditions.
Underwriters separately evaluate each industry category and sub-groups within
each category and premiums are set and adjusted for an insured based in large
part on the industry group in which the insured is placed and the insured's risk
relative to the other risks in that group. Each industry group is reviewed
annually to take into account outstanding reported losses and new loss incident
reports within each group. Rates may vary significantly according to the
industry group of the insured as well as within the group.
The reinsurance subsidiaries employ an analytical approach to underwriting
designed to specify an adequate premium for a given exposure that is intended to
be commensurate with the amount of capital they anticipate
7
placing at risk. Underwriting opportunities presented are evaluated based upon a
number of factors including: the type and layer of risk to be assumed; actuarial
evaluation of premium adequacy; the cedent's underwriting and claims experience;
the cedent's financial condition and claims paying rating; exposure; and
experience with the cedent and the line of business to be underwritten. In
addition, the Company assesses a variety of other factors including: the
reputation of the proposed cedent and the likelihood of establishing a long-term
relationship with the cedent; the geographic area in which the cedent does
business and its market share; a detailed assessment of catastrophe and risk
exposures; historical loss data for the cedent and, where available, for the
industry as a whole in the relevant regions, in order to compare the cedent's
historical catastrophe loss experience to industry averages; and the perceived
financial strength of the cedent. On-site underwriting reviews are performed
where deemed necessary to determine the quality of a current or prospective
cedent's underwriting operation.
For the property catastrophe reinsurance business, the Company has
developed underwriting guidelines under which it generally limits the amount of
exposure it will directly underwrite for any one reinsured and the amount of the
aggregate exposure to catastrophic losses in any geographic zone. The Company
believes it has defined zones such that a single occurrence, such as an
earthquake or hurricane, generally should not affect more than one zone. The
definition of the Company's zones is subject to periodic review and change. The
Company also generally seeks an attachment point for its property catastrophe
reinsurance anticipated to be high enough to produce a low frequency of loss.
The Company seeks to limit its aggregate exposure in the retrocessional and pro
rata business because it is sometimes difficult to allocate risks associated
with such business to specific geographic areas.
The Company's Lloyd's operations underwrite a broad range of risks, and the
factors taken into consideration in the underwriting process vary between class
of business. An actuarial resource is available to underwriters to assist in the
review and rating of risks. Underwriters operate within agreed guidelines, which
establish maximum gross exposure by business area and geographic region. The
daily acceptance of risk is performed by the active underwriter, the class
underwriters and individuals with specific delegated authority. Underwriting
authority limits are agreed between the active underwriter, the class
underwriter and the managing agency's board of directors. Underwriters may
delegate underwriting authority on a contractual basis to individuals who are
approved and monitored. Brockbank Syndicates also participate on market
facilities where underwriting authority is delegated to the lead insurer.
For the financial services business, the Company has adopted written
underwriting guidelines for the various products and asset classes comprising
the credit enhancement business, which include single and aggregate risk
limitations on specified exposures. A credit committee including Bermuda-based
executive officers of the Company provides final underwriting approval for each
transaction.
As part of the underwriting process, all of the Company's insurance and
reinsurance underwriting operations evaluated potential exposures to claims,
losses and defense costs associated with Year 2000-related issues. Such claims,
losses and costs, to the extent that they materialize, could have a material
adverse affect on the Company's results of operations and financial condition.
No significant matters had been notified to the Company as of March 17, 2000.
For more information concerning the impact of Year 2000 issues on underwriting
results, see "Management's Discussion and Analysis of Results of Operations and
Financial Condition - Year 2000 Considerations" and " - Cautionary Note
regarding Forward-Looking Statements"
MARKETING
Clients are referred to the Company's subsidiaries through a large number
of brokers who receive from the insured or ceding company a brokerage commission
usually equal to a percentage of gross premiums. In general, subsidiaries of the
Company are not committed to accept business from any particular broker, and
brokers do not have the authority to bind any subsidiary of the Company, except
in the case where underwriting authority may be delegated to selected
administrators. These administrators are subject to a financial and operational
review prior to any delegation of authority and ongoing reviews are carried out
as necessary.
During 1999, 1998 and 1997, approximately 21%, 34% and 35% of the Company's
consolidated gross written premiums were generated from or placed by Marsh &
McLennan Companies. During 1999, 1998 and 1997, approximately 13%, 19% and 18%
of the Company's consolidated gross written premiums were generated from or
8
placed by AON Corporation and its subsidiaries. Concentration in the insurance
and reinsurance brokerage industry could have a material adverse effect on the
Company's business and results of operations in the future. See "Management's
Discussion and Analysis of Results of Operations and Financial
Condition - Cautionary Note Regarding Forward-Looking Statements." No other
broker accounted for more than 10% of gross premiums written in each of the
three years ended December 31, 1999, 1998 and 1997.
UNPAID LOSSES AND LOSS EXPENSES
Certain aspects of the Company's business have loss experience
characterized as low frequency and high severity. This may result in volatility
in both the Company's results and operational cash flows.
Loss reserves are established due to the significant periods of time that
may lapse between the occurrence, reporting and payment of a loss. To recognize
liabilities for unpaid losses, the Company estimates future amounts needed to
pay claims and related expenses with respect to insured events. The Company's
reserving practices and the establishment of any particular reserve reflect
management's judgement concerning sound financial practice and do not represent
any admission of liability with respect to any claim made against the Company's
subsidiaries.
The method of establishing case reserves for reported claims differs
between the Company's operations. For the insurance operations, claims personnel
determine whether to establish a "case reserve" for the estimated amount of the
ultimate settlement, if any. The estimate reflects the judgment of claims
personnel based on general corporate reserving practices, and on the experience
and knowledge of such personnel regarding the nature and value of the specific
type of claim and, where appropriate, advice of counsel. Reserves are also
established to provide for the estimated expense of settling claims, including
legal and other fees and the general expenses of administering the claims
adjustment process. A similar process is followed in the reinsurance and Lloyd's
operations when the Company is a lead underwriter. Other reinsurance and Lloyd's
business case reserves are established based upon reports received from insureds
and reinsureds, supplemented by the Company's case reserve estimates.
Periodically, adjustments to the case reserves may be made as additional
information regarding the claims becomes known or payments are made.
Most of the Company's incurred but not reported ("IBNR") loss reserves are
derived from casualty business. Casualty business generally has a longer tail
than the Company's other lines of business. IBNR is calculated in two steps.
First, case reserve development is estimated with the use of the loss
development factor method. Second, IBNR is estimated with a frequency and
severity approach. Since coverage is usually triggered when a notice is
submitted by the insured, IBNR losses exist only when claims with a loss notice
develop into the relevant layers of coverage. The method estimates the ultimate
number of claims (i.e., frequency) via the Bornhuetter-Ferguson technique. The
severity component (average claim size) is developed via a single parameter,
pareto loss distribution, adjusted for average attachment points and limits. The
Company believes the methods presently adopted provide a reasonably objective
result as it is based upon the Company's loss data rather than more theoretical
models often used in the low frequency high layer business the Company writes.
However, even such actuarially sound methods, when coupled with the nature of
the risks written, can lead to subsequent adjustments to reserves that are both
significant and irregular.
Several aspects of the Company's casualty insurance operations complicate
the actuarial reserving techniques for loss reserves as compared to other
insurance operations. Among these aspects are the differences in the policy
forms from more traditional forms, the lack of complete historical loss data for
losses of the same type intended to be covered by the policies, and the
expectation that losses in excess of the attachment level of the Company's
policies will be characterized by low frequency and high severity, limiting the
utility of claims experience of other insurers for similar claims. While
management believes it has made a reasonable estimate of ultimate losses, the
ultimate claims experience may not be as reliably predicted as may be the case
with other insurance operations, and there can be no assurance that losses and
loss expenses will not exceed the total reserves.
Claims relating to property catastrophe and property risk excess treaties
will generally become known within approximately 18 to 24 months from the date
of occurrence. Conversely, claims on the casualty business develop on average 5
to 8 years from the date of occurrence. Claims under a significant number of
Lloyd's syndicate policies, with the exception of motor, will generally become
known within 36 months of the date of the occurrence. Motor claims not involving
personal injury will generally be known and paid within 12 months of the
occurrence.
9
Losses and loss expenses are charged to income as incurred. The reserve for
unpaid losses and loss expenses represents the accumulation of case reserves,
loss expense reserves and IBNR. During the loss settlement period, additional
facts regarding individual claims and trends usually will become known. As these
become apparent, it often may become necessary to refine and adjust the reserves
upward or downward from time to time. The final liability nonetheless may be
significantly less than or greater than the prior estimates.
The table below presents the development of unpaid loss and loss expense
reserves for 1989 through 1999. The top line of the table shows the liability,
net of reinsurance recoveries at the balance sheet date for each of the
indicated years. This represents the estimated amounts of net loss and loss
expenses arising in all prior years that are unpaid at the balance sheet date,
including IBNR. The upper portion shows the re-estimated amount of the
previously recorded reserve liability based on experience as of the end of each
succeeding year. The estimate changes as more information becomes known about
the frequency and severity of claims for individual years. The "Cumulative
Redundancy (Deficiency)" line represents the aggregate change in the successive
years with respect to that liability. The lower portion of the table reflects
the cumulative paid losses relating to these reserves. Conditions and trends
that have affected development of liability in the past may not necessarily
occur in the future. Accordingly, it may not be appropriate to extrapolate
future redundancies or deficiencies based on the tables below. See "Management's
Discussion and Analysis of Results of Operations and Financial
Condition - Cautionary Note Regarding Forward-Looking Statements."
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
NET OF REINSURANCE RECOVERIES
(In Millions)
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
------------------------------------------------------------------------------------------------
ESTIMATED LIABILITY FOR UNPAID
LOSSES AND LOSS EXPENSES,
NET OF REINSURANCE
RECOVERIES.................. $1,005 $1,268 $1,486 $1,795 $2,057 $2,482 $2,899 $3,166 $3,609 $4,303 $4,537
LIABILITY RE-ESTIMATED AS OF:
One year later.............. 1,039 1,269 1,468 1,800 2,089 2,455 2,885 2,843 3,354 4,016
Two years later............. 1,030 1,128 1,388 1,830 2,089 2,383 2,546 2,704 3,038
Three years later........... 935 960 1,299 1,819 2,115 2,190 2,445 2,407
Four years later............ 783 910 1,303 1,891 1,972 2,085 2,214
Five years later............ 755 858 1,384 1,856 1,950 1,927
Six years later............. 775 871 1,384 1,820 1,752
Seven years later........... 789 884 1,392 1,644
Eight years later........... 811 945 1,245
Nine years later............ 867 795
Ten years later............. 724
CUMULATIVE REDUNDANCY (1)...... 281 473 241 151 305 555 685 759 571 287
CUMULATIVE PAID LOSSES, NET OF
REINSURANCE RECOVERIES, AS
OF:
One year later.............. $ 159 $ 223 $ 194 $ 267 $ 256 $ 317 $ 445 $ 234 $ 458 $ 812
Two years later............. 349 307 393 468 521 709 667 576 932
Three years later........... 404 403 499 689 865 921 934 932
Four years later............ 459 456 632 937 1,033 1,110 1,143
Five years later............ 481 486 831 1,102 1,198 1,199
Six years later............. 504 585 924 1,253 1,273
Seven years later........... 598 597 974 1,319
Eight years later........... 598 633 1,020
Nine years later............ 611 662
Ten years later............. 621
(1) See "Management's Discussion and Analysis of Results of Operations and
Financial Conditions" for further discussion.
10
The table below presents the claim development of the gross liability for
unpaid losses and loss expenses for the years 1992 through 1999:
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
GROSS OF REINSURANCE RECOVERABLES
(In Millions)
1992 1993 1994 1995 1996 1997 1998 1999
---------------------------------------------------------------------
ESTIMATED GROSS LIABILITY FOR UNPAID LOSSES AND
LOSS EXPENSES:.................................. $1,977 $2,269 $2,760 $3,238 $3,623 $3,972 $4,897 $5,369
LIABILITY RE-ESTIMATED AS OF:
One year later.................................. 1,996 2,309 2,764 3,244 3,221 3,763 4,735
Two years later................................. 2,037 2,323 2,721 2,872 3,164 3,496
Three years later............................... 2,043 2,373 2,494 2,793 2,902
Four years later................................ 2,134 2,198 2,414 2,572
Five years later................................ 2,067 2,208 2,268
Six years later................................. 2,065 2,022
Seven years later............................... 1,903
CUMULATIVE REDUNDANCY.............................. 74 247 492 666 721 476 162
The following table presents an analysis of paid and unpaid losses and loss
expenses and a reconciliation of beginning and ending unpaid losses and loss
expenses for the years indicated:
RECONCILIATION OF UNPAID LOSSES AND LOSS EXPENSES
(in thousands)
1999 1998 1997
------------------------------------
Unpaid losses and loss expenses at beginning of year........ $4,896,643 $3,972,376 $3,623,334
Unpaid losses and loss expenses recoverable................. (593,960) (363,716) (457,373)
------------------------------------
Net unpaid losses and loss expenses at beginning of year.... 4,302,683 3,608,660 3,165,961
Increase (decrease) in net losses and loss expenses incurred
in respect of losses occurring in:
Current year............................................. 1,591,414 1,085,161 1,056,228
Prior year............................................... (287,110) (243,644) (317,379)
------------------------------------
Total net incurred loss and loss expenses............. 1,304,304 841,517 738,849
Interest incurred on experience reserves.................... - 1,798 866
Exchange rate effects....................................... (5,950) 718 (658)
Net loss reserves acquired through purchase of
subsidiaries.............................................. 30,003 580,879 34,593
Net loss and loss expenses paid in respect of losses
occurring in:
Current year............................................. 281,806 272,456 97,296
Prior year............................................... 811,696 458,433 233,655
------------------------------------
Total net paid losses................................. 1,093,502 730,889 330,951
Net unpaid losses and loss expenses at end of year.......... 4,537,538 4,302,683 3,608,660
Unpaid losses and loss expenses recoverable................. 831,864 593,960 363,716
------------------------------------
Unpaid losses and loss expenses at end of year.............. $5,369,402 $4,896,643 $3,972,376
------------------------------------
11
Losses incurred in 1999 grew significantly over 1998 for a number of
reasons. The Company acquired Mid Ocean and Brockbank in August 1998 and as a
consequence only recognized the effect of their operations for five months in
1998. Incurred losses for these entities were approximately $475 million in 1999
compared to $260 million in 1998. The Company was also affected by a number of
catastrophes in 1999 compared to 1998. The fourth quarter of 1999 generated
approximately $135 million of catastrophic losses to the Company, of which the
European storms in December account for the major part. The Company also
experienced a number of smaller catastrophe losses in 1999 that totaled
approximately $50 million. These losses included the Turkey earthquakes, the
Sydney hailstorms and the Oklahoma tornadoes. By comparison, the Company
incurred approximately $60 million in catastrophe losses relating to Hurricane
Georges and the SwissAir disaster in 1998. These losses were incurred in the
reinsurance operations.
The Lloyd's operations experienced loss deterioration on the U.K. motor
business written by Brockbank, principally relating to its 1998 and 1999
underwriting years of approximately $20 million. The motor business was sold,
realizing a gain of approximately $40 million included in fee and other income
in 1999. The Company retains residual liability on this business.
1999 incurred losses also include an increase of reinsurance loss reserves
of $95 million for NAC Re when it merged with the Company in June 1999. In
addition, the acquisition of Intercargo in June 1999 added approximately
$30 million to total incurred losses.
The decrease in prior year incurred losses is driven primarily by the
Company's insurance liability excess of loss reserves. The basis for
establishing IBNR is unlike most insurance companies due to the lack of industry
data. Consequently, the Company estimates loss reserves through actuarial models
based upon its own experience. When the Company commenced writing this type of
business in 1986, limited data was available and the Company made its best
estimate of loss reserves at that time. Over time, the amount of data has
increased, providing a larger statistical base for estimating reserves.
Redundancies in prior year loss reserves have occurred where loss experience has
developed more favorably than expected.
The increase in paid losses in 1999 and 1998 reflects the acquisition of
Mid Ocean and Brockbank in 1998. In addition, the nature of the Company's high
excess of loss liability and catastrophe business can result in loss payments
that are both irregular and significant. Similarly, adjustments to reserves for
individual years can be irregular and significant. Such adjustments are part of
the normal course of business for the Company. Conditions and trends that have
affected development of liability in the past may not necessarily occur in the
future. Accordingly, it is inappropriate to extrapolate future redundancies
based upon historical experience. See generally "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Cautionary Note
Regarding Forward-looking Statements".
CLAIMS ADMINISTRATION
Claims management for the insurance operations includes the review of
initial loss reports, creation of claims files, administration of a claims
database, generation of appropriate responses to claims reports, identification
and handling of coverage issues, determination of whether further investigation
is required and, where appropriate, retention of claims counsel, establishment
of case reserves, payment of claims, and notification to reinsurers.
Claims management for the reinsurance operations includes the receipt of
loss notifications, the establishment of loss reserves and approval of loss
payments. Additionally, claims audits are conducted for both specific claims and
overall procedures at the offices of selected ceding companies.
Claims in respect of business written by the Lloyd's operations are
primarily notified by various central market bureaus. Where a syndicate is a
"leading" syndicate on a Lloyd's policy, its underwriters and claims adjusters
will deal with the broker or insured on behalf of itself and the following
market for any particular claim. This may involve appointing attorneys or loss
adjusters. The claims bureaus and the leading syndicate advise movement in loss
reserves to all syndicates participating on the risk. A claims department can,
at times, adjust the case reserves it records from those advised by the bureaus.
12
INVESTMENTS
Management oversees the Company's investment strategy, establishes
guidelines for the various external managers and implements investment decisions
with the assistance of such managers. The current investment strategy seeks to
maximize investment income through a high-quality, diversified portfolio whilst
focusing on preserving principal and maintaining liquidity. In this regard, at
December 31, 1999, the Company's fixed income investment portfolio includes U.S.
and non-U.S. sovereign government obligations, corporate bonds and other
securities, 60% of which were rated Aa or AA or better by a nationally
recognized rating agency. The Company also maintains a portfolio of equity
securities. Under current investment guidelines, up to 30% of the Company's
investment portfolio may be invested in equity securities. Insurance laws and
regulations impose restrictions on the Company's investments whereby certain
types of investments such as unquoted equity securities, investments in
affiliates, real estate and collateral loans may not qualify as admitted assets.
The Company did not have an aggregate investment in a single entity, other than
the U.S. government, in excess of 10% of shareholders' equity at December 31,
1999, 1998 or 1997.
For additional information concerning the Company's investments, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Investment Operations".
The following table reflects investment results for the Company for each of
the five years in the period ended December 31, 1999:
NET PRE-TAX PRE-TAX ANNUALIZED
AVERAGE INVESTMENT REALIZED EFFECTIVE
YEAR ENDED DECEMBER 31 INVESTMENTS (1) INCOME (2) GAINS YIELD
- ---------------------- ------------------------------------------------------
(U.S. DOLLARS IN THOUSANDS)
1999................................................ $8,981,833 $525,318 $ 94,356 5.85%
1998................................................ $7,762,931 $417,290 $211,204 5.38%
1997................................................ $6,274,946 $345,115 $410,658 5.50%
1996................................................ $5,813,455 $304,823 $174,593 5.24%
1995................................................ $5,203,710 $288,989 $131,840 5.55%
(1) Average of the beginning and ending amounts of investments and cash and cash
equivalents net of pending trades for the period. Investment securities are
carried at market value.
(2) After investment expenses, excluding realized gains.
RATINGS
The Company's principal insurance and reinsurance subsidiaries have a
claims paying rating of "AA" from S&P and "A+" from A.M. Best Company, Inc. An
insurer rated "AA" by S&P has very strong financial security characteristics,
differing only slightly from those rated higher. An insurer rated "A+" by A.M.
Best has superior financial strength, operating performance and market profile
when compared to standards established by A.M. Best, and have a very strong
ability to meet their ongoing obligations to policyholders.
REGULATION
See Note 18 to the Consolidated Financial Statements.
TAX MATTERS
See Note 17 to the Consolidated Financial Statements.
13
EMPLOYEES
At December 31, 1999, the Company and its subsidiaries employed
approximately 1,300 employees. None of these employees are represented by a
labor union, and the Company believes that its employee relations are excellent.
ITEM 2. PROPERTIES
The Company rents space for its principal executive offices under leases
which expire up to June 2009. Total rent expense for the years ended
December 31, 1999, 1998 and 1997 was approximately $13 million, $9 million and
$7 million, respectively. In 1997, the Company acquired commercial real estate
in Bermuda for the purpose of securing long-term office space to meet its
anticipated needs. The Company is in the process of developing this property and
constructing its worldwide headquarters. The total cost of this development,
including the land, is expected to be approximately $110 million, of which
$60 million has been spent through December 31, 1999. It is estimated that the
development will be completed sometime in 2001. See Note 11 to the Consolidated
Financial Statements for discussion of the Company's lease commitments.
ITEM 3. LEGAL PROCEEDINGS
The Company, through its subsidiaries, in common with the insurance and
reinsurance industry in general, is subject to litigation and arbitration in the
normal course of its business. As of December 31, 1999, the Company was not a
party to any material litigation or arbitration other than as routinely
encountered in claims activity, none of which is expected by management to have
a material adverse effect on the Company's financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth
quarter of the fiscal year covered by this report.
14
EXECUTIVE OFFICERS OF THE COMPANY
The table below sets forth the names, ages and titles of the persons who
were the executive officers of the Company for the year ended December 31, 1999.
NAME AGE POSITION
- ---------------------------------------------------------------------------------------------------------------
Brian M. O'Hara........................ 51 President, Chief Executive Officer and Director of the
Company
Robert R. Lusardi...................... 43 Executive Vice President and Chief Financial Officer of the
Company
Mark E. Brockbank...................... 47 Executive Vice President of the Company and Chief Executive
Officer of Brockbank
Nicholas M. Brown, Jr.................. 45 Executive Vice President of the Company and President and
Chief Executive Officer of XL America
K. Bruce Connell....................... 47 Executive Vice President of the Company and President and
Chief Executive Officer of XL Capital Products
Paul S. Giordano....................... 37 Executive Vice President, General Counsel and Secretary of
the Company
Christopher V. Greetham................ 55 Executive Vice President and Chief Investment Officer of
the Company
Henry C. V. Keeling.................... 44 Executive Vice President of the Company and President and
Chief Executive Officer of XL Mid Ocean Re
Fiona Luck............................. 42 Executive Vice President of the Company, Group Operations
Clive R. Tobin......................... 47 Executive Vice President of the Company and President and
Chief Executive Officer of XL Insurance
Brian M. O'Hara has been President and Chief Executive Officer of the
Company since 1994 and a Director of the Company since 1986, having previously
served as Vice Chairman of the Company from 1987. He is Chairman of XL Insurance
and XL Mid Ocean Re and was Chief Executive Officer of XL Insurance until 1998,
having previously served as Chairman, President and Chief Executive Officer from
1994, President and Chief Executive Officer from 1992, and as President and
Chief Operating Officer from 1986.
Robert R. Lusardi has been Executive Vice President and Chief Financial
Officer of the Company since February 1998. Prior to joining the Company,
Mr. Lusardi was Managing Director at Lehman Brothers from 1980 to 1998.
Mark E. Brockbank has been Executive Vice President of the Company since
August 1998. Mr. Brockbank has been employed at Lloyd's since 1974 when he
joined Willis Faber Dumas as a marine broker. He became underwriter of syndicate
861 in 1983. He was appointed a Director of Brockbank Syndicate Management Ltd
in 1983 and of The Brockbank Group plc in 1988.
Nicholas M. Brown, Jr. has been Executive Vice President of the Company
since July 1999. He was President and Chief Executive Officer of NAC Re Corp
from January 1999, having previously served as President and Chief Operating
Officer of NAC and President and Chief Executive Officer of NAC Re from 1996.
Prior to joining NAC, Mr. Brown served as Executive Vice President and Chief
Operating Officer of St. Paul Fire and Marine Insurance Company from 1994 to
1996, and as President of St. Paul Specialty from 1993 to 1994. From 1976 though
1993, he served in various positions at Aetna Life and Casualty Companies.
K. Bruce Connell has been Executive Vice President of the Company since
March 1998 and is President and Chief Executive Officer of XL Capital Products.
Mr. Connell previously served as President and Chief Operating
15
Officer of XL Global Re from November 1997 to August 1998, President of XL
Global Re since December 1995 and as Senior Vice President of XL Insurance from
1990 to 1995.
Paul S. Giordano has been Executive Vice President and General Counsel of
the Company since June 1999. Mr. Giordano served as Senior Vice President since
January 1997 and was appointed Secretary of the Company on December 31, 1997.
Mr. Giordano was associated with Cleary, Gottlieb, Steen and Hamilton and
Clifford Chance in New York and London prior to joining the Company.
Christopher V. Greetham has been Executive Vice President of the Company
since December 1998 and has served as Chief Investment Officer of the Company
since 1996. Prior to joining the Company, Mr. Greetham served as Senior Vice
President and Chief Financial Officer of OIL Insurance Ltd from 1982 to 1996 and
as Vice President of Bankers Trust Company from 1975 to 1982.
Henry C.V. Keeling has been Executive Vice President of the Company and
Chief Executive Officer of XL Mid Ocean Re since August 1998. Mr. Keeling was
President and Chief Operating and Underwriting Officer of Mid Ocean Re from 1992
to 1998. He previously served as a director of Taylor Clayton (Underwriting
Agencies) Ltd and deputy underwriter for syndicate 51 at Lloyd's from 1984
through 1992.
Fiona Luck has been Executive Vice President of Group Operations of the
Company since July 1999. Ms. Luck was previously employed at ACE Bermuda as
Executive Vice President from 1998, and Senior Vice President from 1997. From
1992 to 1997, Ms. Luck was the Managing Director of the Marsh & McLennan Global
Broking office in Bermuda.
Clive R. Tobin has been Executive Vice President of the Company and
President and Chief Executive Officer of XL Insurance since July 1999, having
previously served as Executive Vice President of XL Insurance from 1998, and as
a Senior Vice President of XL Capital Products from February 1999. Mr. Tobin
previously served as President of Rockefeller Insurance Company and Acadia Risk
Management Services, Inc from 1986 to 1995.
16
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) The Company's Class A ordinary shares, $0.01 par value, are listed on
the New York Stock Exchange under the symbol XL.
The following table sets forth the high and low closing sales prices per
share of the Company's Class A ordinary shares per fiscal quarter, as reported
on the New York Stock Exchange Composite Tape.
HIGH LOW
-----------------
1999:
1st Quarter............................................... $75.188 $56.750
2nd Quarter............................................... 66.500 56.750
3rd Quarter............................................... 57.688 42.188
4th Quarter............................................... 58.063 44.938
1998:
1st Quarter............................................... $77.500 $59.625
2nd Quarter............................................... 80.813 72.250
3rd Quarter............................................... 83.250 62.125
4th Quarter............................................... 77.688 63.938
Each Class A ordinary share has one vote, except that if, and so long as,
the Controlled Shares of any person constitute ten percent (10%) or more of the
issued Class A ordinary shares, the voting rights with respect to the Controlled
Shares owned by such person shall be limited, in the aggregate, to a voting
power of approximately 10%, pursuant to a formula specified in the Articles of
Association. "Controlled Shares" shall include, among other things, all Class A
ordinary shares for which such person is deemed to beneficially own directly,
indirectly or constructively (within the meaning of Section 13(d)(3) of the
Securities Exchange Act of 1934).
(b) The approximate number of record holders of Class A ordinary shares as
of December 31, 1999 was 700.
(c) In 1999, four regular quarterly dividends were paid at $0.44 per share
to all shareholders of record on February 5, April 23, July 12 and
September 24.
The Company paid four regular quarterly dividends in 1998, three of $0.40
per share to all shareholders of record on February 6, April 16, and July 15 and
one of $0.44 per share to all shareholders of record on September 28.
The declaration and payment of future dividends by the Company will be at
the discretion of the Board of Directors and will depend upon many factors,
including the Company's earnings, financial condition, business needs, capital
and surplus requirements of the Company's operating subsidiaries and regulatory
restrictions.
As a holding company, the Company's principal source of income is dividends
or other statutorily permissible payments from its subsidiaries. The ability to
pay such dividends is limited by the applicable laws and regulations of Bermuda,
the United States, and the United Kingdom, including those promulgated by the
Society of Lloyd's. See Note 18 to the Consolidated Financial Statements for
further discussion.
(d) Rights to purchase Class A Ordinary Shares were distributed as a
dividend at the rate of one Right for each Class A ordinary share held of record
as of the close of business on October 31, 1998. Each Right entitles holders of
XL Class A ordinary shares to buy one ordinary share at an exercise price of
$350. The Rights would be exercisable, and would detach from the Class A
ordinary shares, only if a person or group were to acquire 20% or more of XL's
outstanding Class A ordinary shares, or were to announce a tender or exchange
offer that, if consummated, would result in a person or group beneficially
owning 20% or more of XL's Class A ordinary shares. Upon a person or group
without prior approval of the Board acquiring 20% or more of XL's Class A
ordinary shares, each Right would entitle
17
the holder (other than such an acquiring person or group) to purchase XL
Class A ordinary shares (or, in certain circumstances, Class A ordinary shares
of the acquiring person) with a value of twice the Rights exercise price upon
payment of the Rights exercise price. XL will be entitled to redeem the Rights
at $0.01 per Right at any time until the close of business on the tenth day
after the Rights become exercisable. The Rights will expire at the close of
business on September 30, 2008, and do not initially have a fair value. The
Company has initially reserved 119,073,878 Class A ordinary shares being
authorized and unissued for issuance upon exercise of Rights.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data below includes the results of NAC
for all years presented and is based upon the Company's new fiscal year end of
December 31. The selected consolidated financial data should be read in
conjunction with the consolidated financial statements and the notes thereto
presented under Item 8.
1999 1998 1997 1996 1995
----------------------------------------------------------------
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
INCOME STATEMENT DATA:
Net premiums earned................ $ 1,750,006 $ 1,324,291 $1,114,758 $1,038,643 $1,053,748
Net investment income.............. 525,318 417,290 345,115 304,823 288,989
Net realized gains on
investments .................... 94,356 211,204 410,658 174,593 131,840
Equity in net income of
affiliates ..................... 40,907 50,292 64,959 59,084 51,074
Losses and loss expenses (1)....... 1,304,304 841,517 738,849 739,058 772,096
Acquisition costs and operating
expenses........................ 689,005 436,598 318,107 277,801 269,427
Interest expense................... 37,378 33,444 29,622 22,322 15,648
Amortization of intangible
assets ......................... 49,141 26,881 7,403 368 368
Income before minority interest and
income tax expense.............. 431,159 686,962 841,509 537,594 468,113
Net income......................... 470,509 656,330 809,029 516,471 450,080
PER SHARE DATA:
Net income per
share - basic(2)(3)............. $ 3.69 $ 5.86 $ 7.95 $ 4.81 $ 3.82
Net income per
share - diluted(2)(3)........... $ 3.62 $ 5.68 $ 7.74 $ 4.73 $ 3.76
Weighted average shares
Outstanding - basic (3)............ 127,601 112,034 101,708 107,339 117,833
Weighted average shares
Outstanding - diluted (3).......... 130,304 116,206 105,005 109,908 120,496
Cash dividends per share (3)....... $ 1.76 $ 1.64 $ 1.36 $ 0.95 $ 0.71
BALANCE SHEET DATA:
Total investments.................. $ 9,122,591 $ 9,057,892 $6,562,609 $5,647,589 $5,234,208
Cash and cash equivalents.......... 557,749 480,874 383,594 321,140 787,759
Investments in affiliates.......... 479,911 154,668 524,866 414,891 351,669
Total assets....................... 15,090,912 13,581,140 9,070,031 7,823,375 7,424,468
Unpaid losses and loss expenses ... 5,369,402 4,896,643 3,972,376 3,623,334 3,238,156
Notes payable and debt............. 410,726 613,873 453,866 323,858 299,927
Shareholders' equity............... 5,577,078 5,612,603 3,195,749 2,637,533 2,564,422
Book value per share (3)........... $ 43.64 $ 43.59 $ 31.55 $ 25.31 $ 22.85
Fully diluted book value per share
(3) . $ 43.13 $ 43.20 $ 31.42 $ 25.24 $ 22.79
OPERATING RATIOS:
Loss and loss expense ratio (1).... 69.1% 63.6% 66.3% 71.2% 73.3%
Underwriting expense ratio (4)..... 34.3% 30.2% 27.9% 26.2% 25.6%
Combined ratio (5)................. 103.4% 93.8% 94.2% 97.4% 98.9%
18
1) The loss and loss expense ratio is the calculated by dividing the losses and
loss expenses incurred by the net premiums earned. In 1999, the loss and
loss expense ratio excludes an increase to reserves of $95 million
associated with the merger with NAC.
2) Net income per share is based on the weighted average number of ordinary
shares and ordinary share equivalents outstanding for each period as
required by Statement of Financial Accounting Standard No. 128.
3) All share and per share information has been retroactively restated to give
effect to a one for one stock dividend paid to XL shareholders of record on
July 26, 1996. Cash dividends per share have not been adjusted for the
pooling effect of NAC.
4) The underwriting expense ratio is the sum of acquisition expenses and
operating expenses divided by net premiums earned. Operating expenses
relating to the corporate segment have not been included for purposes of
calculating the underwriting expense ratio.
5) The combined ratio is the sum of the loss and loss expense ratio and the
underwriting expense ratio. A combined ratio of under 100% indicates an
underwriting profit and over 100% indicates an underwriting loss.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
The following is a discussion of the Company's results of operations and
financial condition. Prior period information presented is the combination of
the results formerly presented by XL Capital and NAC, as required for a business
combination accounted for by the pooling of interests method, which assumes NAC
had always been a part of the Company. It is also based upon the Company's new
fiscal year end of December 31. See Note 6 "Business Combinations" of the
audited Consolidated Financial Statements for further details. The Company's
results of operations and financial condition for 1998 were significantly
impacted by the acquisition of Mid Ocean in August 1998, which was accounted for
as a purchase business combination.
This "Management's Discussion and Analysis of Results of Operations and
Financial Condition" contains forward-looking statements which involve inherent
risks and uncertainties. Statements that are not historical facts, including
statements about our beliefs and expectations, are forward looking-statements.
These statements are based upon current plans, estimates and expectations.
Actual results may differ materially from those projected in such
forward-looking statements, and therefore you should not place undue reliance on
them. See "--Cautionary Note Regarding Forward-Looking Statements" for a list of
factors that could cause actual results to differ materially from those
contained in any forward-looking statement.
This discussion and analysis should be read in conjunction with the audited
Consolidated Financial Statements and notes thereto presented under Item 8.
INDUSTRY OVERVIEW
Abundant capacity and significant price competition continued to
characterize the property and casualty insurance and reinsurance industry during
1999. Excess capital and limited opportunities for growth in traditional markets
continued to generate merger and acquisition activity as companies attempt to
maintain or improve market share and performance. Perhaps more than ever, the
Company, together with the industry, faces a difficult challenge in generating
profitable growth.
1999 was among the worst years for insured catastrophic losses. The
industry suffered losses from, amongst other events, the Sydney hailstorms, the
Oklahoma tornadoes, Hurricane Floyd and the European windstorms. Despite these
losses, premium rates in 1999 did not increase significantly.
19
RESULTS OF OPERATIONS
The following table presents an after tax analysis of the Company's net
income for the years ended December 31, 1999, 1998 and 1997 (U.S. dollars in
thousands except per share amounts):
1999 1998 1997
------------------------------
Net operating income
(excluding net realized gains on investments)........... $370,809 $457,402 $413,307
Net realized gains on investments......................... 99,700 198,928 395,722
------------------------------
Net income................................................ $470,509 $656,330 $809,029
------------------------------
Earnings per share - basic................................ $3.69 $5.86 $7.95
Earnings per share - diluted.............................. $3.62 $5.68 $7.74
Net income decreased in 1999 compared to 1998 as a result of a decrease in
both net operating income and net realized gains on investments. The decrease in
net operating income in 1999 from 1998 is due to a decrease in underwriting
income. The primary reason for this decrease is losses incurred by the Company
of $125 million after tax, or $0.97 per share, as a result of two major European
windstorms in December 1999. Net operating income increased in 1998 over 1997
due to the acquisition of Mid Ocean in 1998. Net income decreased in 1998
compared to 1997 as a result of a decrease in net realized gains on investments.
Basic and diluted earnings per share decreased in 1999 over 1998 and in
1998 over 1997 due to both a decrease in net income, and, following the
acquisition of Mid Ocean, a net increase in the weighted average number of
shares issued and outstanding.
SEGMENTS
The Company is organized into four underwriting segments - insurance,
reinsurance, Lloyd's syndicates and financial services - and a corporate
segment, which includes the investment operations of the Company. See Part 1 and
Item 8, Note 3 to the Consolidated Financial Statements for further details.
INSURANCE OPERATIONS
The insurance business is written primarily by the following subsidiaries
of the Company: XL Insurance, XL Europe, XL Insurance Company of New York,
Greenwich Insurance, Indian Harbor Insurance, ECS and Intercargo. Insurance
business written includes general liability, other liability (including
directors and officers, professional and employment practices liability),
program business, property, marine, aviation, satellite and other product lines
(including U.S. Customs bonds, surety, political risk and specialty lines).
The following table summarizes the underwriting profit (loss) for this
segment (U.S. dollars in thousands):
% CHANGE % CHANGE
1999 99 VS 98 1998 98 VS 97 1997
----------------------------------------------------
Net premiums earned............................ $463,069 12.9% $410,030 (4.4%) $428,774
Fee and other income........................... 7,584 (8.0%) 8,244 NM -
Losses and loss expenses....................... 309,079 15.4% 267,823 (24.0%) 352,203
Acquisition costs.............................. 65,318 37.0% 47,688 (13.6%) 55,199
Operating expenses............................. 70,929 42.7% 49,702 33.5% 37,232
----------------------------------------------------
Underwriting profit (loss)..................... $ 25,327 (52.3%) $ 53,061 NM $(15,860)
----------------------------------------------------
NM=Not Meaningful
The overall increase in net premiums earned in the insurance segment in
1999 over 1998 is primarily a result of an increase in gross premiums written in
the primary property, aviation and satellite, marine and other lines of business
by the Company's subsidiaries in the U.S. See Note 3 to the Consolidated
Financial Statements. Net
20
premiums earned in 1999 also reflect the purchase of Intercargo in May 1999, for
which approximately $33 million was earned from the date of purchase. Partially
offsetting this increase is a decrease in the general liability lines, where
there was a reduction in the amount of gross premiums written due to increased
competition. This decrease also accounts for the overall reduction in net
premiums earned in 1998 over 1997. High levels of competition continued,
particularly on a price basis and in coverage terms, although business retention
has remained in excess of 80% for the last three years. Generally, the Company's
response has been to move to higher attachment levels which result in lower
premiums as the Company moves further away from risk.
There was a small increase in the net premiums earned in 1999 over 1998 in
the other liability business, which comprises mostly professional lines, despite
a decrease in the amount of gross premiums written in 1999 compared to 1998. The
increase in net premiums earned is primarily as a result of several tailored
programs written in 1998, which are earned over a period greater than one year.
There were also increases in net premiums earned in 1998 over 1997 in the
property, marine, energy, aviation and satellite lines of business, mainly in
the U.S. where there were expanded opportunities on existing accounts, as well
as new business.
The source of fee and other income differs between 1999 and 1998. During
1998, the Company assisted in structuring a transaction that resulted in fee
income. These transactions tend to be irregular in nature and require an
investment of Company resources that are included in operating expenses. During
1999, the Company purchased ECS, which underwrites business on behalf of third
parties in exchange for commissions. This income will decline in the future as
ECS underwrites business on behalf of the Company.
The changes in the loss and loss expenses, acquisition costs and operating
expenses as shown above are discussed below as part of the analysis of the
Company's underwriting ratios.
The decrease in the underwriting profit in 1999 over 1998 in this segment
is due to higher loss and loss expense ratios in 1999 as reflected in the
underwriting expense ratios set forth below. The following table represents the
ratios for this segment for the three years ended December 31, 1999:
1999 1998 1997
----------------------
Loss and loss expense ratio................................. 66.7% 65.4% 82.1%
Underwriting expense ratio.................................. 29.4% 23.8% 21.6%
----------------------
Combined ratio.............................................. 96.1% 89.2% 103.7%
----------------------
The increase in the loss ratio in 1999 over 1998 is the result of two
factors. The Company had an intercompany stop loss agreement in place in 1999
under which a subsidiary in the reinsurance segment was covered for losses
exceeding a specified loss ratio up to $100 million. The purpose of this
agreement is to efficiently manage statutory surplus levels across the Company.
As a result of catastrophic losses which occurred in 1999, the full amount of
losses of $100 million were included in the insurance segment and excluded from
the reinsurance segment. The loss and loss expense ratio would have been 45.2%
and the underwriting profit would have been $125 million had this stop loss
agreement not been in place. Offsetting this loss in 1999 and also causing the
decrease in the loss ratio in 1998 from 1997 was a reduction of insurance loss
reserves established on the Company's liability lines due to updated actuarially
determined reserve estimates. Due to the lack of industry data available, the
Company estimates loss reserves based upon its own experience. Over time, the
amount of data available has increased, providing a larger statistical base for
estimating reserves and loss experience has developed more favorably than
expected. In addition, reserves were reduced on specialty cover policies for the
years 1995 through 1997, which expired in 1998 and for which there was an
absence of expected losses on these policies.
The increase in the expense ratio over each of the years presented is due
to both the changes in the product mix towards U.S. primary business which tends
to have higher acquisition costs, and the additional operating expenses incurred
by the Company in establishing its start up operations in the U.S. and new lines
of business.
21
REINSURANCE OPERATIONS
The reinsurance business is written by XL Mid Ocean Re, which writes
primarily property lines which are short-tail in nature, and NAC Re, which
primarily writes long-tail casualty business. Business written in this segment
includes casualty, property catastrophe, other property, marine, energy,
aviation and satellite and other lines, including political risk and specialty
lines.
The following table summarizes the underwriting profit (loss) for this
segment (U.S. dollars in thousands):
% CHANGE % CHANGE
1999 99 VS 98 1998 98 VS 97 1997
----------------------------------------------------
Net premiums earned............................ $909,915 19.7% $760,409 10.8% $685,984
Losses and loss expenses....................... 597,269 31.1% 455,583 17.8% 386,646
Acquisition costs.............................. 224,359 31.2% 171,039 19.8% 142,818
Operating expenses............................. 103,264 20.7% 85,541 12.8% 75,829
----------------------------------------------------
Underwriting (loss) profit..................... $(14,977) NM $ 48,246 (40.2%) $ 80,691
----------------------------------------------------
The increase in net premiums earned in 1999 over 1998 is due to two
factors: (i) the acquisition of Mid Ocean in August 1998 which results in only
five months of net premiums earned included in 1998 compared to twelve months in
1999, and (ii) increases in gross premiums written and earned in the casualty
reinsurance business in 1999 resulting primarily from a relatively small number
of large reinsurance transactions. The increase in net premiums earned in 1998
over 1997 is primarily due to the acquisition of Mid Ocean. This increase was
partially offset by declines in net premiums earned on the casualty business in
1998 over 1997 due to increased market competition and pricing and the Company's
decision not to renew accounts that were deemed not to meet the Company's
profitability standards.
Operating expenses increased in 1999 over 1998 and in 1998 over 1997 due to
the acquisition of Mid Ocean.
The changes in the underwriting result in the reinsurance segment for each
of the three years ended December 31 are due to changes in the underwriting
ratios as illustrated below.
1999 1998 1997
----------------------
Loss and loss expense ratio................................. 65.6% 60.0% 56.4%
Underwriting expense ratio.................................. 36.0% 33.8% 31.9%
----------------------
Combined ratio.............................................. 101.6% 93.8% 88.3%
----------------------
The increase in the loss ratio in this segment in 1999 over 1998 was due to
losses incurred by the Company from two major European windstorms which occurred
in December 1999, together with other insured catastrophes in Sydney and
Oklahoma, and from satellite losses earlier in the year. Property catastrophe
business has loss experience which is generally categorized as low frequency but
high severity in nature. This may result in volatility in the Company's
financial results for any fiscal year or quarter. Property catastrophe losses
generally are notified and paid within a short period of time from the covered
event. In addition, there was an increase in the loss ratio in 1999 over 1998 in
the casualty reinsurance business relating to reserve increases in accordance
with actuarial estimates, caused to a large extent by the deterioration in
premium rates. Actuarial assumptions are used to establish initial expected loss
ratios employed in the actuarial methodologies from which the reserve for loss
and loss expenses is derived. Such loss ratios are periodically adjusted to
reflect comparisons with actual claims development, inflation and other
considerations.
Net losses incurred in this segment in 1999 reflect a reduction of
$100 million relating to an intercompany reinsurance agreement with another of
the Company's subsidiaries in the insurance segment. The loss and loss expense
ratio would have been 76.6% and the underwriting loss would have been $115
million had this stop loss
22
agreement not been in place. Net losses incurred in 1999 also exclude an
adjustment to reserves of $95 million following the merger with NAC.
The increase in the loss ratio in 1998 over 1997 is due to losses relating
to Hurricane Georges and SwissAir for approximately $60 million.
The increase in the expense ratio in 1999 over 1998 is primarily due to an
increase in profit commission payable to cedents of proportional business
written by XL Mid Ocean Re. Profitability on some contracts written in earlier
underwriting years has increased relative to original estimates, with the
resulting increases in profit commissions payable.
The Company's casualty business includes an element of asbestos and
environmental claims on business written prior to 1986. The Company's reserving
process includes a supplemental evaluation of claims liabilities from exposure
to asbestos and environmental claims, including related loss adjustment
expenses. However, the Company's loss and loss expense reserves for such
exposures, net of reinsurance, as of December 31, 1999, 1998, and 1997 is less
than 1% of its total reserves. A reconciliation of the Company's gross and net
liabilities for such exposures for the three years ending December 31, 1999 is
set forth in Note 7 of the Notes to Consolidated Financial Statements.
LLOYD'S SYNDICATES
The Lloyd's operations comprise Brockbank and Denham, both of which were
acquired in 1998. Brockbank provides underwriting and other services to five
Lloyd's syndicates, two of which are dedicated corporate syndicates whose
capital is provided by the Company. During 1999, these dedicated corporate
syndicates wrote a range of specialty lines, primarily of insurance but also
reinsurance, in parallel with other syndicates managed by Brockbank. Denham
provides similar services to one corporate syndicate whose capital is partially
provided by the Company and which specializes in liability coverages.
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
1999 1998
-------------------
Net premiums earned......................................... $355,769 $153,852
Fee and other income........................................ 65,892 14,081
Losses and loss expenses.................................... 297,595 118,111
Acquisition costs........................................... 89,195 30,614
Operating expenses.......................................... 28,125 14,875
-------------------
Underwriting profit......................................... $ 6,746 $ 4,333
-------------------
The increase in 1999 over 1998 in this segment is a result of the Brockbank
acquisition in August 1998. In addition, results for Denham were not significant
in 1998.
In 1999, fee and other income primarily relates to the sale by Brockbank of
its two motor insurance businesses, Admiral and Zenith, resulting in a gain of
$40.2 million. The Company expects there to be decreases in net premiums earned,
fee income and certain costs next year as a result of this sale. However, the
Company does not expect the overall profitability of its Lloyd's operations to
be significantly affected by such sales. Excluding the gain on sale, fee and
other income primarily relates to fees received from the management of Lloyd's
syndicates and profit commissions which are earned based upon the estimated
results of syndicates managed.
23
The following table presents the underwriting ratios for this segment:
1999 1998
---------------
Loss and loss expense ratio................................. 83.6% 76.8%
Underwriting expense ratio.................................. 33.0% 29.6%
---------------
Combined ratio.............................................. 116.6% 106.4%
---------------
Losses incurred by the corporate syndicates of Brockbank attach at lower
levels and are therefore higher in frequency but lower in severity as compared
to the losses relating to the reinsurance and insurance segments of the Company.
The increase in the loss ratio in 1999 over 1998 is due to reserve increases
related to adverse development on the U.K. motor business prior to the sale for
which the Company still retains residual liability.
FINANCIAL SERVICES
The financial services business includes premiums received from credit
enhancement by financial guaranty insurance and reinsurance policies and credit
default swaps written in respect of asset-backed, municipal and corporate risk
obligations. Fee income included in this segment is comprised primarily of
income received from the two loss reserve transactions that were underwritten in
1999. Premiums received in respect of credit default swap transactions are also
included as fee income and earned over the life of the policies.
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
1999
-------
Net premiums earned......................................... $21,253
Fee and other income........................................ 26,924
Losses and loss expenses.................................... 5,361
Acquisition costs........................................... 2,108
Operating expenses.......................................... 16,670
-------
Underwriting profit......................................... $24,038
-------
Financial guaranty insurance premiums and credit default swap premiums are
earned over the life of the exposure and certain transactions such as
installment premiums are not recognized as premiums written until the premium is
received.
The following table presents the underwriting ratios for the financial
services segment:
1999
------
Loss and loss expense ratio................................. 25.2%
Underwriting expense ratio.................................. 88.4%
------
Combined ratio.............................................. 113.6%
------
This segment writes business with an expected loss ratio of approximately
25%. The high expense ratio reflects the start up nature of this segment.
24
INVESTMENT OPERATIONS
The following table illustrates the change in net investment income and net
realized gains and losses for the three years ended December 31, 1999 (U.S
dollars in thousands):
% CHANGE % CHANGE
1999 99 VS 98 1998 98 VS 97 1997
----------------------------------------------------
Net investment income.......................... $525,318 25.9% $417,290 20.9% $345,115
Net realized investment gains.................. $ 94,356 NM $211,204 NM $410,658
Annualized effective yield..................... 5.85% - 5.38% - 5.50%
External investment professionals manage the Company's portfolio under the
direction of management.
At December 31, 1999, total investments and cash, net of the payable for
investments purchased, were $9.1 billion, compared to $8.9 billion at
December 31, 1998. This increase includes the reinvestment of investment income
and realized gains, but is primarily due to the loss portfolio transfers
discussed further in "--Financial Condition and Liquidity". This increase was
net of any transfer of assets to limited investment partnerships, included in
investments in affiliates. As the Company's long-tail casualty business matures
over the next three to five years, it is possible that claims payments may
increase due to the additional exposure to events which occurred in prior years
but have not yet been paid. Funds available for investment may therefore be
reduced as compared to prior years due to such increased claims payments. The
Company's fixed income investments (including short-term investments and cash
equivalents) at December 31, 1999 represented approximately 88% of investments
available for sale and were managed by several independent investment managers
with different strategies. Of the fixed income securities, approximately 87% are
of investment grade, with 60% rated Aa or AA or better by a nationally
recognized rating agency.
The payable for investments purchased was $622.3 million at December 31,
1999 and $633.2 million at December 31, 1998. The payable balance at any one
time is the result of a timing difference as it is the Company's policy to
account for its investments on a trade basis.
The increase in investment income in 1999 over 1998 is primarily due to an
increase in the annualized effective yield on the portfolio. The increase in
investment income in 1998 over 1997 is due to an increase in the average asset
base, primarily due to the merger with Mid Ocean in August 1998 and the
Company's positive operational cash flow. The investment income from the asset
accumulation business assets transferred did not have a significant impact due
to the timing of the transfers to the Company which occurred in the third and
fourth quarters of 1999.
Net realized gains in 1999 and 1998 reflect the strong performance of the
equity market. In 1998, equity gains of $150.0 million were realized as some of
the Company's equity managers locked in gains where they felt valuations had
reached their targets. However, 1999 equity gains were offset by declining fixed
income markets, which had been strong throughout most of 1998. Due to declining
interest rates combined with widening spreads in the corporate and mortgage
markets, the fixed income sector allowed the Company opportunities to increase
the yield on its investment in 1999. As a result, the Company's investment
managers will continue to pursue a total return strategy to take advantage of
the higher yields. During 1997, both the fixed income and equity portfolios were
restructured, resulting in the above-normal turnover of the portfolio and
contributing to the significant gains realized during the year. Market
conditions were also very strong during 1997.
The Company also maintains a synthetic equity portfolio holding S&P 500
Index futures that realized net gains of $11.3 million and $23.2 million for the
years ended December 31, 1999 and 1998, respectively.
25
OTHER REVENUES AND EXPENSES
The following table sets forth other revenues and expenses of the Company
for the three years ended December 31, 1999 (U.S. dollars in thousands):
% CHANGE % CHANGE
1999 99 VS 98 1998 98 VS 97 1997
--------------------------------------------------
Equity in net income of affiliates................ $ 40,907 (18.7%) $50,292 (22.6%) $64,959
Amortization of intangible assets................. 49,141 NM 26,881 NM 7,403
Corporate operating expenses...................... 89,037 NM 37,139 NM 7,029
Interest expense.................................. 37,378 11.8% 33,444 12.9% 29,622
Minority interest................................. 220 NM 749 NM 308
Income tax (benefit) expense...................... (39,570) NM 29,883 (7.1%) 32,172
NM=Not Meaningful
The decrease in equity in net income of affiliates in 1999 over 1998 and
1998 over 1997 is due to Mid Ocean. Partially offsetting the decrease in 1999
are earnings from new investments made in limited investment partnerships by the
Company during 1999. In 1998, seven months of earnings from the Company's equity
position in Mid Ocean were recognized, which ended in August 1998 upon the
acquisition of the balance of the outstanding Mid Ocean shares. A full year's
equity earnings from Mid Ocean were included in 1997.
The increase in the amortization of intangible assets in 1999 over 1998 and
1998 over 1997 mainly relates to the goodwill arising from the Mid Ocean
acquisition in 1998. In 1999, there is also additional goodwill amortization of
approximately $4.0 million arising from acquisitions of ECS and Intercargo.
Operating expenses in 1999 include $45.3 million of one-time charges
related to the merger with NAC. In 1998, they include $17.5 million of one-time
charges associated with the merger with Mid Ocean. Other increases are due to
the increase in the corporate infrastructure necessary to support the growing
worldwide operations of the Company.
Increases in interest expense in 1999 over 1998 and 1998 over 1997 is due
to the increase in the average long-term debt outstanding during the each of the
years. In 1999, this was used to finance the acquisitions of ECS and Intercargo,
and in both 1999 and 1998, the repurchase of shares.
The changes in the income tax expense of the Company principally reflect
the decline in the profitability of the U.S. operations for each year. In 1999,
a deterioration of the casualty book for business underwritten prior to the
merger with NAC resulted in a pre-tax net loss for U.S. operations, generating
an income tax benefit for the year. See Note 17 to the Consolidated Financial
Statements.
FINANCIAL CONDITION AND LIQUIDITY
As a holding company, the Company's assets consist primarily of its
investments in subsidiaries and the Company's future cash flows depend on the
availability of dividends or other statutorily permissible payments from its
subsidiaries. The ability to pay such dividends is limited by the applicable
laws and regulations of Bermuda, the United States, Ireland and the United
Kingdom, including those promulgated by the Society of Lloyd's which are
described more fully in Note 18 to the Consolidated Financial Statements. No
assurance can be given that the Company or its subsidiaries will be permitted to
pay dividends in the future. The Company's shareholders' equity at December 31,
1999 was $5.6 billion, of which $3.1 billion was retained earnings.
Certain aspects of the Company's business are characterized as having low
frequency and high severity exposures. This may result in volatility in both the
Company's results and operational cash flows. However, the Company continues to
generate significant positive cash flow from operating activities.
26
In 1999, 1998 and 1997, the total amount of net losses paid by the Company
was $1,093.5 million, $730.9 million and $330.9 million, respectively. The
increase is primarily due to the acquisition of Mid Ocean in August 1998.
The Company establishes reserves to provide for estimated claims, the
general expenses of administering the claims adjustment process and for losses
incurred but not reported. These reserves are calculated by using actuarial and
other reserving techniques to project the estimated ultimate net liability for
losses and loss expenses. The Company's reserving practices and the
establishment of any particular reserve reflect management's judgement
concerning sound financial practice and does not represent any admission of
liability with respect to any claims made against the Company's subsidiaries. No
assurance can be given that actual claims made and payments related thereto will
not be in excess of the amounts reserved.
Inflation can have an effect on the Company in that inflationary factors
can increase damage awards and potentially result in larger claims. The
Company's underwriting philosophy is to adjust premiums in response to
inflation, although this may not always be possible due to competitive pressure.
Inflationary factors are considered in determining the premium level on any
multi-year policies at the time contracts are written.
In 1999, the Company completed the purchase of Intercargo and ECS for a
total of $222.8 million in cash. Both of these transactions are accounted for
under the purchase method of accounting, and resulted in goodwill of
$159.6 million. These transactions were financed in part through bank borrowings
and internal funds.
During 1999, the Company redistributed assets from investments available
for sale and cash for the following investments:
(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.
(2) The Company invested $97.0 million in a joint venture with Les
Mutuelles du Mans Assurances Group to form a new French reinsurance company, Le
Mans Re.
(3) The Company invested a further $91.0 million in limited partnerships
and other investments.
These above investments account for the increase in investments in
affiliates and other investments.
The Company assumed two loss portfolio transfers during the second half of
the year which are accounted for on a deposit basis. These reserves are included
in deposit liabilities and policy benefit reserves with the corresponding assets
held in investments available for sale.
The Company has had several stock repurchase programs as part of its
capital management. On January 22, 1999, the Board of Directors discontinued the
Company's existing program with $148.8 million remaining and replaced it with an
authorization to repurchase $500 million. During the first six months of 1999,
the Company purchased 2.1 million shares at a cost of $126.8 million. In
June 1999, the Board of Directors rescinded the Company's share repurchase
program. On January 9, 2000 the Board of Directors authorized the repurchase of
shares up to $500 million. The repurchase of shares was announced in conjunction
with a small dividend increase of $0.04 per share per annum as part of the
Company's capital management strategy. The Company has purchased 3.7 million
shares up to March 17, 2000 at a cost of $165.8 million or $44.76 per share.
As at December 31, 1999, the Company had bank and loan facilities available
from a variety of sources, including commercial banks, totaling $2.36 billion
comprising 364-day facilities, 5-year facilities, notes payable and other loans
and letter of credit facilities. Debt and notes outstanding at December 31, 1999
were $410.7 million and letters of credit outstanding were $891.6 million.
Letters of credit issued and outstanding, 66% of which were collateralized by
the Company's investment portfolio, primarily support U.S. non-admitted business
and the Company's Lloyd's capital requirements.
During 1999 and 1998, borrowings under these facilities were $329 million
and $655 million, respectively, and repayments under the facilities were
$340 million and $495 million, respectively. The borrowings in 1999
27
facilitated the repurchase of shares and the purchase of Intercargo and ECS. In
1998, borrowings include $300 million to fund the cash election available to
shareholders in connection with the Mid Ocean merger. Included in the 1998 notes
payable and debt was $100 million 5.25% Convertible Subordinate Debentures due
2002, which were converted in June 1999 by the issue of 1.8 million shares out
of treasury. Additional borrowings in 1998 were made to fund the Company's U.S.
operations. The total pre-tax interest expense on notes and debt outstanding
during the year ended December 31, 1999 and 1998 was $37.4 million and
$33.4 million, respectively. Associated with the Company's bank and loan
commitments are various loan covenants with which the Company was in compliance
throughout the period. See Note 10 to the Consolidated Financial Statements for
further details.
YEAR 2000 ISSUES
There was no significant impact of Year 2000 issues on the Company's
technology systems. Total costs incurred by the Company in ensuring its
technology systems were compliant through December 31, 1999 were not
significant. The Company did not experience any significant disruption due to
the impact of Year 2000 issues on its service providers.
The Company is exposed to risks associated with Year 2000 issues based upon
the underwriting exposures that it assumes. All insurance and reinsurance
subsidiaries of the Company examined the potential exposure to Year 2000-related
risks associated with the coverages that they provided. In some instances, Year
2000-related risks were expressly excluded from or included in certain
coverages, and in other instances, coverage in respect of such risks is neither
expressly excluded nor included. To the extent that Year 2000-related risks
materialize, participants in the property and casualty insurance and reinsurance
industry, including the Company, could pay or incur significant claims, losses
or defense costs which could have a material adverse effect on the Company's
results of operations and financial condition. In view of the apparent lack of
significant Year 2000-related losses, the Company does not expect to have a
material exposure to Year 2000-related coverage claims. See generally
"--Cautionary Note Regarding Forward-Looking Statements".
FINANCIAL RISK MANAGEMENT
The Company is exposed to various market risks, including changes in
interest rates and foreign currency exchange rates. Market risk is the potential
loss arising from adverse changes in interest rates and foreign currency
exchange rates. The Company manages its market risks based on guidelines
established by management. The Company enters into derivatives and other
financial instruments primarily for risk management purposes.
This risk management discussion and the estimated amounts generated from
the sensitivity analyses are forward-looking statements of market risk assuming
certain adverse market conditions occur. Actual results in the future may differ
materially from these projected results due to actual developments in the global
financial markets. The analysis methods used by the Company to assess and
mitigate risk should not be considered projections of future events of losses.
See generally "--Cautionary Note Regarding Forward-Looking Statements".
The Company's investment portfolio consists of fixed income and equity
securities, denominated in both U.S. and foreign currencies. Accordingly,
earnings will be affected by changes in interest rates, equity prices and
foreign currency exchange rates.
An immediate 100 basis point adverse shift in the treasury yield curve
would result in a decrease in total return of 5.8% or $438 million on the
Company's fixed income portfolio as of December 31, 1999.
In evaluating the impact of price changes of the equity portfolio, a 10%
change in equity prices would affect total return by approximately
$114 million.
The Company has short-term debt and long-term debt outstanding. Interest
rates on short-term debt are LIBOR based. Accordingly, any changes in interest
rates will affect interest expense.
28
FOREIGN CURRENCY RISK MANAGEMENT
The Company uses foreign exchange contracts to manage its exposure to the
effects of fluctuating foreign currencies on the value of its foreign currency
fixed maturities and equity investments. These contracts are not designated as
specific hedges for financial reporting purposes and therefore realized and
unrealized gains and losses on them are recorded in income in the period in
which they occur. These contracts generally have maturities of three months or
less. In addition, where the Company's investment managers are of the opinion
that potential gains exist in a particular currency, a forward contract may not
be entered into. At December 31, 1999, forward foreign exchange contracts with
notional principal amounts totaling $339.3 million were outstanding. The fair
value of these contracts as at December 31, 1999 was $341.1 million with
unrealized gains of $1.8 million. Losses of $2.7 million were realized during
the year. Based on this value, a 10% appreciation or depreciation of the U.S.
dollar as compared to the level of other currencies under contract at
December 31, 1999 would have resulted in approximately $34.6 million in
unrealized gains and $33.7 million in unrealized losses.
In addition, the Company also enters into foreign exchange contracts to buy
and sell foreign currencies in the course of trading its foreign currency
investments. These contracts are not designated as specific hedges, and
generally have maturities of two weeks or less. As such, any realized or
unrealized gains or losses are recorded in income in the period in which they
occur. At December 31, 1999, the value of such contracts outstanding was not
significant.
The Company attempts to hedge directly the foreign currency exposure of a
portion of its foreign currency fixed maturity investments using forward foreign
exchange contracts that generally have maturities of three months or less and
are rolled over to provide continuing coverage for as long as the investments
are held. Where an investment is sold, the related foreign exchange sale
contract is closed by entering into an offsetting purchase contract. At
December 31, 1999, the Company had, as hedges, foreign exchange contracts for
the sale of $94.0 million and the purchase of $7.5 million of foreign currencies
at fixed rates, primarily Euros (49% of net contract value), British pounds
(18%) and New Zealand Dollars (16%). The market value of fixed maturities
denominated in foreign currencies that were hedged and held by the Company as at
December 31, 1999 was $85.2 million.
Unrealized foreign exchange gains and losses on foreign exchange contracts
hedging foreign currency fixed maturity investments are deferred and included as
a component of shareholders' equity. As at December 31, 1999, unrealized
deferred losses amounted to $2.0 million and were offset by corresponding
increases in the dollar value of the investments. Realized gains and losses on
the maturity of these contracts are also deferred and included in shareholders'
equity until the corresponding investment is sold. As at December 31, 1999,
realized deferred losses amounted to $0.5 million.
FINANCIAL MARKET EXPOSURE
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, 1999, the portfolio held
$121.9 million in exposure to S&P 500 Index futures and underlying assets of
$122.0 million. Based on this value, a 10% increase or decrease in the price of
these futures would have resulted in exposure of $134.1 million and
$109.7 million, respectively. The value of the futures is updated daily with the
change recorded in income as a realized gain or loss. For the year ended
December 31, 1999, net realized gains from index futures totaled $11.3 million
as a result of the 19.5% increase in the S&P Index during the twelve-month
period.
Derivative investments are also utilized to add value to the portfolio
where market inefficiencies are believed to exist. At December 31, 1999, bond
and stock index futures outstanding were $241.1 million with underlying
investments having a market value of $2.5 billion (all managers are prohibited
by the Company's investment guidelines from leveraging their positions). A 10%
appreciation or depreciation of these derivative instruments at this time would
have resulted in unrealized gains and losses of $24.1 million, respectively.
29
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Consolidated Financial Statements for a discussion on
recent accounting pronouncements.
CURRENT OUTLOOK
The Company believes competition in the property casualty insurance and
reinsurance industry will continue to be strong in 2000, exerting pressure on
rates in general across many product lines. Although the Company believes some
opportunities will exist in 2000 for growth in selected product lines, no
assurances can be made that growth in these lines will be sufficient to offset
the competitive pressures affecting the majority of the Company's product lines.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 ("PSLRA") provides a
"safe harbor" for forward-looking statements. This Form 10-K, the Company's
Annual Report to Stockholders, any proxy statement, any Form 10-Q or Form 8-K of
the Company or any other written or oral statements made by or on behalf of the
Company may include forward-looking statements which reflect the Company's
current views with respect to future events and financial performance. Such
statements include forward-looking statements both with respect to the Company
and the insurance and reinsurance sectors in general (both as to underwriting
and investment matters). Statements which include the words "expect", "intend",
"plan", "believe", "project", "anticipate", "will", and similar statements of a
future or forward-looking nature identify forward-looking statements for
purposes of the PSLRA.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in such
statements. The Company believes that these factors include, but are not limited
to, the following: (i) ineffectiveness or obsolescence of the Company's business
strategy due to changes in current or future market conditions; (ii) increased
competition on the basis of pricing, capacity, coverage terms or other factors;
(iii) greater frequency or severity of claims and loss activity, including as a
result of natural or man-made catastrophic events, than the Company's
underwriting, reserving or investment practices anticipate based on historical
experience or industry data; (iv) developments in the world's financial and
capital markets which adversely affect the performance of the Company's
investments; (v) changes in regulation or tax laws applicable to the Company,
its subsidiaries, brokers or customers; (vi) acceptance of the Company's
products and services, including new products and services; (vii) changes in the
availability, cost or quality of reinsurance; (viii) changes in the distribution
or placement of risks due to increased consolidation of insurance and
reinsurance brokers; (ix) the impact of the Year 2000-related issues on the
Company's underwriting exposures; (x) loss of key personnel; (xi) the effects of
mergers, acquisitions and divestitures; (xii) changes in rating agency policies
or practices; (xiii) changes in accounting policies or practices; and
(xiv) changes in general economic conditions, including inflation, foreign
currency exchange rates and other factors. The foregoing review of important
factors should not be construed as exhaustive and should be read in conjunction
with the other cautionary statements that are included herein or elsewhere. The
Company undertakes no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future
developments or otherwise.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES PAGE
- ------------------------------------------------------------ --------
Consolidated Balance Sheets as at December 31, 1999 and
1998...................................................... 32
Consolidated Statements of Income and Comprehensive income
for the years ended December 31, 1999, 1998 and 1997...... 33
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 1999, 1998 and 1997 ............. 34
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.......................... 35
Notes to Consolidated Financial Statements for the years
ended December 31, 1999, 1998 and 1997.................... 36
30
XL CAPITAL LTD
CONSOLIDATED BALANCE SHEETS AS AT DECEMBER 31, 1999 AND 1998
(U.S. dollars in thousands, except share amounts)
1999 1998
-------------------------
A S S E T S
Investments:
Fixed maturities, available for sale at fair value
(amortized cost: 1999, $7,835,919; 1998, $7,433,724)... $ 7,581,151 $ 7,512,903
Equity securities, at fair value (cost: 1999, $863,020;
1998, $1,127,590)...................................... 1,136,180 1,299,098
Short-term investments, at fair value (amortized cost:
1999, $405,375; 1998, $246,085)........................ 405,260 245,891
-------------------------
Total investments................................... 9,122,591 9,057,892
Cash and cash equivalents................................... 557,749 480,874
Investments in affiliates (cost: 1999, $478,266; 1998,
$141,590)................................................. 479,911 154,668
Other investments........................................... 165,613 44,085
Accrued investment income................................... 111,590 95,910
Deferred acquisition costs.................................. 275,716 204,271
Prepaid reinsurance premiums................................ 217,314 215,466
Premiums receivable......................................... 1,126,397 904,203
Reinsurance balances receivable............................. 149,880 124,771
Unpaid losses and loss expenses recoverable................. 831,864 593,960
Intangible assets (accumulated amortization: 1999, $118,663;
1998, $70,190)............................................ 1,626,946 1,502,828
Deferred tax asset, net..................................... 97,928 37,481
Other assets................................................ 327,413 164,731
-------------------------
Total assets........................................ $15,090,912 $13,581,140
-------------------------
L I A B I L I T I E S A N D S H A R E H O L D E R S' E Q U I T Y
Liabilities:
Unpaid losses and loss expenses............................. $ 5,369,402 $ 4,896,643
Deposit liabilities and policy benefit reserves............. 837,893 -
Unearned premiums........................................... 1,497,376 1,337,277
Notes payable and debt...................................... 410,726 613,873
Reinsurance balances payable................................ 387,916 183,660
Net payable for investments purchased....................... 622,260 633,181
Other liabilities........................................... 345,738 256,862
Minority interest........................................... 42,523 47,041
-------------------------
Total liabilities................................... $ 9,513,834 $ 7,968,537
-------------------------
Commitments and Contingencies
Shareholders' Equity:
Authorized, 999,990,000 ordinary shares, par value $0.01
Issued and outstanding:
Class A ordinary shares (1999, 124,691,541; 1998,
125,629,257)........................................... 1,247 1,256
Class B ordinary shares (1999, 3,115,873; 1998,
3,115,873)............................................. 31 31
Contributed surplus......................................... 2,520,136 2,508,062
Accumulated other comprehensive income...................... 19,311 235,185
Deferred compensation....................................... (28,797) (22,954)
Retained earnings........................................... 3,065,150 2,891,023
-------------------------
Total shareholders' equity.......................... $ 5,577,078 $ 5,612,603
-------------------------
Total liabilities and shareholders' equity.......... $15,090,912 $13,581,140
-------------------------
See accompanying notes to Consolidated Financial Statements
31
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(U.S. dollars in thousands, except share and per share amounts)
1999 1998 1997
------------------------------------
Revenues:
Net premiums earned....................................... $1,750,006 $1,324,291 $1,114,758
Net investment income..................................... 525,318 417,290 345,115
Net realized gains on sales of investments................ 94,356 211,204 410,658
Equity in net income of affiliates........................ 40,907 50,292 64,959
Fee and other income...................................... 100,400 22,325 -
------------------------------------
Total revenues...................................... 2,510,987 2,025,402 1,935,490
------------------------------------
Expenses:
Losses and loss expenses.................................. 1,304,304 841,517 738,849
Acquisition costs......................................... 380,980 249,341 198,017
Operating expenses........................................ 308,025 187,257 120,090
Interest expense.......................................... 37,378 33,444 29,622
Amortization of intangible assets......................... 49,141 26,881 7,403
------------------------------------
Total expenses...................................... 2,079,828 1,338,440 1,093,981
------------------------------------
Income before minority interest and income tax expense...... 431,159 686,962 841,509
Minority interest in net income of subsidiary............. 220 749 308
Income tax (benefit) expense.............................. (39,570) 29,883 32,172
------------------------------------
Net income.................................................. $ 470,509 $ 656,330 $ 809,029
------------------------------------
Change in net unrealized appreciation of investments........ (211,842) (15,414) 6,233
Foreign currency translation adjustments.................... (4,032) (872) (2,388)
------------------------------------
Comprehensive Income........................................ $ 254,635 $ 640,044 $ 812,874
------------------------------------
Weighted average ordinary shares and ordinary share
equivalents outstanding - basic........................... 127,601 112,034 101,708
------------------------------------
Weighted average ordinary shares and ordinary share
equivalents outstanding - diluted......................... 130,304 116,206 105,005
------------------------------------
Earnings per ordinary share and ordinary share
equivalent - basic........................................ $ 3.69 $ 5.86 $ 7.95
------------------------------------
Earnings per ordinary share and ordinary share
equivalent - diluted...................................... $ 3.62 $ 5.68 $ 7.74
------------------------------------
See accompanying notes to Consolidated Financial Statements
32
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(U.S. dollars in thousands)
1999 1998 1997
------------------------------------
Ordinary Shares:
Balance-beginning of year................................. $ 1,287 $ 1,013 $ 1,039
Issue of shares........................................... 1 15 6
Issue of shares - Mid Ocean acquisition................... - 291 -
Exercise of stock options................................. 5 3 4
Repurchase of treasury shares............................. (15) (35) (36)
------------------------------------
Balance-end of year................................... 1,278 1,287 1,013
------------------------------------
Contributed Surplus:
Balance-beginning of year................................. 2,508,062 506,452 500,599
Issue of shares........................................... 15,951 101,502 18,917
Issue of shares Mid Ocean acquisition..................... - 2,093,426 -
Exercise of stock options................................. 11,711 9,147 6,277
Repurchase of treasury shares............................. (15,588) (202,465) (19,341)
------------------------------------
Balance-end of year................................... 2,520,136 2,508,062 506,452
------------------------------------
Accumulated other comprehensive income:
Balance-beginning of year................................. 235,185 251,471 247,626
Net change in unrealized gains on investment portfolio,
net of tax............................................. (213,482) (10,352) (8,302)
Net change in unrealized gains on investment portfolio of
affiliate.............................................. 1,640 (5,062) 14,535
Currency translation adjustments.......................... (4,032) (872) (2,388)
------------------------------------
Balance-end of year................................... 19,311 235,185 251,471
------------------------------------
Deferred Compensation:
Balance-beginning of year................................. (22,954) (18,263) (9,825)
Issue of restricted shares................................ (13,603) (10,506) (13,675)
Amortization.............................................. 7,760 5,815 5,237
------------------------------------
Balance-end of year................................... (28,797) (22,954) (18,263)
------------------------------------
Retained Earnings:
Balance-beginning of year................................. 2,891,023 2,455,076 1,898,094
Net income................................................ 470,509 656,330 809,029
Cash dividends paid....................................... (212,659) (156,482) (120,607)
Repurchase of treasury shares............................. (83,723) (63,901) (131,440)
------------------------------------
Balance-end of year................................... 3,065,150 2,891,023 2,455,076
------------------------------------
Total shareholders' equity.................................. $5,577,078 $5,612,603 $3,195,749
------------------------------------
See accompanying notes to Consolidated Financial Statements
33
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(U.S. dollars in thousands)
1999 1998 1997
---------------------------------------
Cash flows provided by operating activities:
Net income............................................... $ 470,509 $ 656,330 $ 809,029
Adjustments to reconcile net income to net cash provided by
operating activities:
Net realized gains on sales of investments............... (94,356) (211,204) (410,658)
Amortization of (discounts) premium on fixed
maturities............................................ (14,429) (14,718) (2,170)
Equity in net income of affiliates, net of cash
received.............................................. (34,506) (24,973) (34,395)
Amortization of deferred compensation.................... 7,657 5,815 5,237
Amortization of intangible assets........................ 49,141 26,881 7,403
Unpaid losses and loss expenses.......................... 411,396 323,857 314,449
Unearned premiums........................................ 131,767 52,161 (193,018)
Premiums receivable...................................... (166,027) 4,245 151,203
Unpaid losses and loss expenses recoverable.............. (212,928) (221,177) 94,349
Prepaid reinsurance premiums............................. (1,848) (45,961) (49,328)
Reinsurance balances receivable.......................... (25,109) (31,103) 16,419
Other.................................................... (25,632) 39,783 25,424
---------------------------------------
Total adjustments..................................... 25,126 (96,394) (75,085)
---------------------------------------
Net cash provided by operating activities................ 495,635 559,936 733,944
Cash flows used in investing activities:
Proceeds from sale of fixed maturities and short-term
investments........................................... 15,664,591 15,765,103 12,385,521
Proceeds from redemption of fixed maturities and
short-term investments................................ 134,565 516,418 187,441
Proceeds from sale of equity securities.................. 1,017,177 918,501 1,381,465
Purchases of fixed maturities and short-term
investments........................................... (16,075,719) (16,460,877) (12,615,821)
Purchases of equity securities........................... (803,728) (1,020,032) (1,147,601)
Deferred (gains) losses on forward contracts............. (509) (12,163) 8,247
Investments in affiliates................................ (348,543) (1,126) (43,184)
Acquisition of subsidiaries, net of cash acquired........ (173,206) 41,483 (660,137)
Other investments........................................ (120,717) 4,411 (6,016)
Deposit liabilities and policy benefit reserve........... 837,893 - -
Other assets............................................. (35,133) 13,430 (54,353)
---------------------------------------
Net cash provided (used) in investing activities............ 96,671 (234,852) (564,438)
Cash flows used in financing activities:
Issue of restricted shares............................... 69 514 387
Proceeds from exercise of stock options.................. 14,014 15,092 12,284
Repurchase of treasury shares............................ (99,344) (266,401) (154,720)
Dividends paid........................................... (212,659) (156,481) (120,607)
Proceeds from loans...................................... 328,700 655,000 530,000
Repayment of notes....................................... (100,000) - -
Repayment of loans....................................... (339,735) (495,000) (400,000)
Repayment of debentures.................................. (101,737) - -
Minority interest........................................ (4,900) 19,988 26,226
---------------------------------------
Net cash used in financing activities....................... (515,592) (227,288) (106,430)
Effects of exchange rate changes on cash on foreign currency
cash balances............................................. 161 (516) (622)
Increase in cash and cash equivalents....................... 76,875 97,280 62,454
Cash and cash equivalents-beginning of year................. $ 480,874 $ 383,594 $ 321,140
---------------------------------------
Cash and cash equivalents - end of year..................... $ 557,749 $ 480,874 $ 383,594
---------------------------------------
Taxes paid.................................................. $ 30,246 $ 31,200 $ 37,600
---------------------------------------
Interest paid............................................... $ 28,268 $ 32,800 $ 27,100
---------------------------------------
See accompanying notes to Consolidated Financial Statements
34
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31 1999, 1998 and 1997
(U.S. dollars in thousands)
1. HISTORY
XL Capital Ltd (sometimes referred to as 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, in connection with EXEL's merger with Mid Ocean Limited, a
Cayman Islands corporation. The merger was accounted for as a purchase under
U.S. generally accepted accounting principles ("GAAP") and as such, results of
operations of Mid Ocean are included from August 1, 1998, the effective date of
the merger. In the merger, all of the shares of EXEL and Mid Ocean were
exchanged for shares in the Company according to two schemes of arrangement
under Cayman Islands law. 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 Capital 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.
In 1999, XL Capital merged with NAC Re Corp, a Delaware corporation. The
merger has been accounted for as a "pooling of interests" under U.S. GAAP. Under
pooling of interests accounting, it is assumed that XL Capital and NAC have been
merged from the date of incorporation of the Company, and accordingly, all prior
period information contained in this document includes the results of NAC. NAC
was organized in 1985 and, through its subsidiaries, writes property and
casualty insurance and reinsurance in the U.S., Canada and Europe. Subsequent to
the merger agreement, XL Capital amended its financial year from November 30 to
December 31 as a conforming pooling adjustment and to facilitate year end
reporting for its subsidiaries.
XL Insurance, a company organized under the laws of Bermuda, and its
subsidiaries are the Company's principal insurance subsidiaries. XL Insurance
was formed in 1986 in response to a shortage of high excess liability coverage
for Fortune 500 companies in the U.S. In 1990, XL Insurance formed XL Europe, an
insurance company organized under the laws of Ireland to serve European clients
and, in 1998, formed two companies now known as XL Insurance Company of New York
and XL Capital Assurance.
XL Mid Ocean Reinsurance 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. XL Global Re was formed in November 1997 through
the merger of XL Reinsurance and Global Capital Reinsurance following EXEL's
acquisition of GCR Holdings Limited, a Cayman Islands holding company, on
June 12, 1997. XL Reinsurance commenced operations on December 1, 1995 to write
specialty reinsurance business. Mid Ocean Re and Global Capital Re 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.
The Company further expanded into the U.S. in 1999 by completing the
acquisition of both Intercargo Corporation and ECS, Inc. Intercargo, through its
subsidiaries, underwrites specialty insurance products for companies engaged in
international trade, including U.S. Customs bonds and marine cargo insurance.
ECS is an underwriting manager, which specializes in environmental insurance
coverages and risk management services.
The Brockbank Group was acquired through the merger with Mid Ocean.
Brockbank is a company organized under the laws of the United Kingdom and is a
leading Lloyd's managing agency which provides underwriting and similar services
to five Lloyd's syndicates. Two of these syndicates are dedicated corporate
syndicates whose capital is provided solely by the Company and its subsidiaries.
Mid Ocean acquired 51% of Brockbank in December 1995 and the remaining 49% in
August 1997. The two corporate syndicates, which commenced operations on
January 1, 1996, underwrite property, marine and energy, aviation, satellite,
professional indemnity, U.K. motor and other specialty lines of insurance and
reinsurance to a global client base. As a managing agency, Brockbank receives
fees
35
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
1. HISTORY (CONTINUED)
and commissions in respect of underwriting services it provides to syndicates.
In the fourth quarter of 1999, Brockbank sold its two motor insurance
businesses, Admiral and Zenith. The Company expects there to be decreases in
premiums, fee income and certain costs, however it does not expect the overall
profitability of its Lloyd's operations to be materially affected by such sales.
Denham Syndicate Management Limited was acquired by NAC during 1998 and it
also provides underwriting and similar services to one corporate syndicate,
whose capital is partially provided by the Company. This syndicate writes a
specialized book of international business, concentrating on long-tail casualty
and non-marine physical damage.
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 that possess expertise in lines of business that the Company
wishes to write. 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 and related
risk management. In July 1999, the Company entered into a joint venture with Les
Mutuelles du Mans Assurances Group to form a new French reinsurance company, Le
Mans Re. The Company owns a 49% shareholding in the new company, which
underwrites a worldwide portfolio comprising all classes of non-life reinsurance
business together with a selective portfolio of life reinsurance business.
In 1999, the Company made strategic minority investments in two investment
management firms. The Company acquired minority investments in Highfields
Capital Management L.P., a global equity investment firm, and MKP Capital
Management, a New York-based fixed income investment manager specializing in
mortgage-backed securities.
In 1998, the Company entered into a joint venture with FSA Holdings Ltd to
write financial guaranty insurance and reinsurance. Under the terms of the joint
venture, each of the Company and FSA formed a Bermuda insurance company in which
it is the majority shareholder and made a minority investment in the company
formed by its co-venturer.
The Company formed Reeve Court Insurance, a Bermuda company organized as a
joint venture with such company's management for the purpose of providing life
insurance to high net worth individuals in 1998.
In 1997, the Company acquired a 75% holding in Latin America Re, a Bermuda
reinsurance company.
The Company formed Sovereign Risk Insurance as a joint venture in 1997.
Sovereign is a Bermuda-based managing general agency that writes political risk
insurance on a subscription basis on behalf of its shareholders.
In 1996, the Company acquired approximately 30% of Pareto Partners, a firm
that specializes in foreign currency management and related services.
36
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(U.S. dollars in thousands)
2. SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PREPARATION
These consolidated financial statements include the accounts of the Company
and all of its subsidiaries and have been prepared in accordance with U.S.
generally accepted accounting principles ("GAAP"). They include the merger with
NAC, which occurred in June 1999, and which has been accounted for as a "pooling
of interests" under U.S. GAAP. They are also based upon the Company's new fiscal
year end of December 31. Results of operations, statements of position and cash
flows include NAC as though it had always been a part of the Company. All
material intercompany accounts and transactions have been eliminated. The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
(B) PREMIUMS AND ACQUISITION COSTS
Premiums written are recorded in accordance with the terms of the
underlying policies. Reinsurance premiums assumed are estimated based upon
information received from ceding companies and any subsequent 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 and
unearned premiums are presented after deductions for reinsurance ceded to other
insurance companies.
Financial guaranty insurance premiums are earned over the life of the
exposure, and certain transactions such as installment premiums are not
recognized as premiums written until the premium is received.
Acquisition costs, which vary with and are primarily related to the
acquisition of policies, primarily commissions paid to brokers, are deferred and
amortized over the period the premiums are earned. Future earned premiums and
the anticipated losses, investment income and other costs related to those
premiums are also considered in determining the level of acquisition costs to be
deferred.
(C) REINSURANCE
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 are expensed and
the commissions recorded thereon are earned on a monthly pro-rata basis over the
period the reinsurance coverage is provided. Amounts recoverable from reinsurers
are estimated in a manner consistent with the claim liability associated with
the reinsured policy. Provision is made for estimated unrecoverable reinsurance.
(D) INVESTMENTS
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.
37
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Short-term investments comprise investments with a maturity equal to or
greater than 90 days but less than one year. Equity securities include
investments in open end mutual funds. All investment transactions are recorded
on a trade date basis. Realized gains and losses on sales of investments are
determined on the basis of average cost or amortized cost. Investment income is
recognized when earned and includes interest and dividend income together with
the amortization of premium and discount on fixed maturities and short-term
investments.
Financial futures and forward currency contracts are carried at fair value,
with the corresponding realized or unrealized gain or loss included in income,
except in the instance of forward foreign currency contracts that are used to
hedge currency risks on specific investments. Gains and losses from these
contracts are deferred and included in shareholders' equity until the
corresponding asset is sold.
(E) CASH EQUIVALENTS
Cash equivalents include fixed interest deposits placed with a maturity of
under 90 days when purchased.
(F) FOREIGN CURRENCY TRANSLATION
Assets and liabilities of foreign operations whose functional currency is
other than the U.S. dollar are translated at year end exchange rates. Revenue
and expenses of such foreign operations are translated at average exchange rates
during the year. The effect of the translation adjustments for foreign
operations is recorded, net of applicable deferred income taxes, as a separate
component of accumulated other comprehensive income in shareholders' equity.
Other monetary assets and liabilities denominated in foreign currencies are
translated at the exchange rate in effect at the balance sheet date with the
resulting foreign exchange gains and losses recognized in income, unless the
foreign currency exposure is directly hedged as discussed above. Revenue and
expense transactions are translated at the average exchange rates prevailing
during the year.
(G) INVESTMENTS IN AFFILIATES
Investments in which the Company has significant influence over the
operations of its affiliates are carried under the equity method of accounting.
Under this method, the Company records its proportionate share of income or loss
for such investments in its results of operations.
(H) OTHER INVESTMENTS
The Company accounts for its other investments on a cost basis as it has no
significant influence over these entities. Investments are written down to their
realizable value where management considers there is a permanent decrease in
value. Income is recorded when received.
(I) AMORTIZATION OF INTANGIBLE ASSETS
Intangible assets recorded in connection with the Company's business
combinations are amortized on a straight-line basis over the expected life of
the related operations acquired. The Company evaluates the recoverability of its
intangible assets whenever changes in circumstances warrant. If it is determined
that an impairment exists, the excess of the unamortized balance over the fair
value of the intangible asset will be charged to earnings at that time.
38
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(J) LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses includes reserves for unpaid reported
losses and loss expenses and for losses incurred but not reported. The reserve
for unpaid reported losses and loss expenses has been established by management
based on amounts reported from insured or ceding companies and consultation with
independent legal counsel, and represents the estimated ultimate cost of events
or conditions that have been reported to or specifically identified by the
Company. Certain workers' compensation case reserves are considered fixed and
determinable and are subject to tabular reserving. Such tabular reserves are
discounted using an interest rate of 7%.
The Company recognizes as a component of loss reserves, the loss experience
accounts of policyholders for policies written on a multi-year basis where
experience accounts are a percentage of premiums net of related losses paid.
Interest is earned on liable amounts and charged to investment income. In the
event the insured cancels the policy, the return of the experience account is
treated as a commutation if the Company was previously notified of a loss, or as
a return premium if there has been no loss notification.
The reserve for losses incurred but not reported has been estimated by
management in consultation with independent actuaries and is based on loss
development patterns determined by reference to the Company's underwriting
practices, the policy form and the experience of the relevant industries.
Management believes that the reserves for unpaid losses and loss expenses
are sufficient to pay any losses that fall within coverages assumed by the
Company. However, there can be no assurance that losses will not exceed the
Company's total reserves. The methodology of estimating loss reserves 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.
(K) DEPOSIT LIABILITIES AND POLICY BENEFIT RESERVES
Short duration contracts entered into by the Company which are not deemed
to transfer significant underwriting and/or timing risk are accounted for as
deposits, whereby liabilities are recorded for the same amount of premium
received. The Company will periodically re-assess the amount of the deposit
liabilities. Changes are recorded in the period they are determined as either
interest income where the contract does not transfer underwriting risk, or net
losses and loss expenses incurred where the contract does not transfer
significant timing risk.
Policy benefit reserves relate to long duration contracts written by the
Company which do not transfer significant mortality or morbidity risks, and are
accounted for as deposits, and liabilities for estimated future policy benefits
are established at the time such funds are received.
(L) INCOME TAXES
The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred income taxes reflect the net tax effect of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. A
valuation allowance is established for any portion of a deferred tax asset that
management believes will not be realized.
(M) STOCK PLANS
The Company accounts for stock compensation plans in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees". Accordingly, compensation expense for stock option
39
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
grants and stock appreciation rights is recognized to the extent that the fair
value of the stock exceeds the exercise price of the option at the measurement
date.
(N) PER SHARE DATA
Basic earnings per share is based on weighted average common shares
outstanding and excludes any dilutive effects of options and convertible
securities. Diluted earnings per share assumes the conversion of dilutive
convertible securities and the exercise of all dilutive stock options.
(O) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of certain assets and liabilities are based on published market
values, if available, or estimates of fair value of similar issues. Fair values
are reported in Notes 4 and 10.
(P) RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement ("SFAS")
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
is required to be adopted in years beginning after June 15, 2000. The Company
has not yet completed its assessment of the effect of the adoption of this
standard on results of operations, financial condition or liquidity, but
believes it will not be significant.
3. SEGMENT INFORMATION
The Company is organized into four underwriting segments - insurance,
reinsurance, Lloyd's syndicates and financial services - in addition to a
corporate segment that includes the investment operations of the Company.
Certain business written by the Company has loss experience characterized as low
frequency and high severity. This may result in volatility in both the Company's
results and operational cash flows.
INSURANCE OPERATIONS
The insurance business is written primarily by the following: XL Insurance,
XL Europe, XL Insurance Company of New York, Greenwich Insurance, Indian Harbor
Insurance, ECS and Intercargo. Business written includes general liability,
other liability including directors and officers, professional and employment
practices liability, property, program business, marine, aviation, satellite and
other product lines including U.S. Customs bonds, surety, political risk and
specialty lines.
REINSURANCE OPERATIONS
The Company's reinsurance business is primarily written by NAC Re and XL
Mid Ocean Re. Business written includes treaty and facultative reinsurance to
primary insurers of casualty risks, principally: general liability; professional
liability; automobile and workers' compensation; commercial and personal
property risks; specialty risks including fidelity and surety and ocean marine;
property catastrophe; property excess of loss; property pro rata; marine and
energy; aviation and satellite; and various other reinsurance to insurers on a
worldwide basis. The Company endeavors to manage its exposures to catastrophic
events by limiting the amount of its exposure in each geographic zone worldwide
and requires that its property catastrophe contracts provide for aggregate
limits and varying attachment points.
40
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
3. SEGMENT INFORMATION (CONTINUED)
LLOYD'S SYNDICATES
The Lloyd's operations are comprised of Brockbank and Denham. Corporate
syndicates write property, marine and energy, aviation and satellite, motor,
professional indemnity, liability coverage and other specialty lines, primarily
of insurance but also reinsurance. Effective January 1, 2000, the Company
discontinued writing direct motor business.
FINANCIAL SERVICES
Financial services premiums are written by XL Insurance through XL Capital
Products. Business written includes insurance and reinsurance solutions for
complex financial risks. These include financial insurance and reinsurance,
credit enhancement swaps and other collateralized transactions. While each of
these are unique and are tailored for the specific needs of the insured, they
are typically multi-year policies. Due to the nature of these types of policies,
premium volume as well as profit margin can vary significantly from period to
period. The Company has approached this market on a "net-line" basis, but may
cede a portion of some policies to third parties from time to time. In 1999, the
Company also commenced assuming large loss portfolios as part of its new asset
accumulation strategy.
The Company evaluates performance of each segment based on underwriting
profit or loss. Other items of revenue and expenditure of the Company are not
evaluated at the segment level. In addition, management does not consider the
allocation of assets by segment. The following is an analysis of the
underwriting profit or loss by segment together with a reconciliation of
underwriting profit or loss to net income:
LLOYD'S FINANCIAL
YEAR ENDED DECEMBER 31, 1999 INSURANCE REINSURANCE SYNDICATES SERVICES TOTAL
- ---------------------------- -------------------------------------------------------------
Net premiums earned.......................... $463,069 $909,915 $355,769 $21,253 $1,750,006
Fee and other income......................... 7,584 - 65,892 26,924 100,400
Net losses and loss expenses (1), (2)........ 309,079 597,269 297,595 5,361 1,209,304
Acquisition costs............................ 65,318 224,359 89,195 2,108 380,980
Operating expenses (3)....................... 70,929 103,264 28,125 16,670 218,988
-------------------------------------------------------------
Underwriting profit (loss)................... $ 25,327 $(14,977) $ 6,746 $24,038 $ 41,134
Net investment income........................ 525,318
Net realized gains on investments............ 94,356
Equity in net earnings of affiliates......... 40,907
Interest expense............................. 37,378
Amortization of intangible assets............ 49,141
Corporate operating expenses (3)............. 43,765
Loss reserve adjustment (1).................. 95,000
One time charges (3)......................... 45,272
Minority interest............................ 220
Income tax benefit........................... (39,570)
----------
Net income................................... $ 470,509
----------
Loss and loss expense ratio.................. 66.7% 65.6% 83.6% 25.2% 69.1%
Underwriting expense ratio................... 29.4% 36.0% 33.0% 88.4% 34.3%
-------------------------------------------------------------
Combined ratio............................... 96.1% 101.6% 116.6% 113.6% 103.4%
-------------------------------------------------------------
41
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
3. SEGMENT INFORMATION (CONTINUED)
(1) Net losses and loss expenses exclude an increase to loss reserves of
$95.0 million associated with the merger with NAC.
(2) Net losses and loss expenses for the insurance segment include, and the
reinsurance segment exclude, $100.0 million relating to an intercompany stop
loss agreement. Total results are not affected. The loss and loss expense
ratio would have been 45.2% and 76.6% and the underwriting profit (loss)
would have been $125 million and $(115) million in the insurance and
reinsurance segments, respectively, had this stop loss agreement not been in
place.
(3) Operating expenses exclude corporate operating expenses, shown separately,
and one time charges of $45.3 million associated with the merger with NAC.
LLOYD'S FINANCIAL
YEAR ENDED DECEMBER 31, 1998 INSURANCE REINSURANCE SYNDICATES SERVICES TOTAL
- ---------------------------- -------------------------------------------------------------
Net premiums earned........................... $410,030 $760,409 $153,852 $ - $1,324,291
Fee and other income.......................... 8,244 - 14,081 - 22,325
Net losses and loss expenses.................. 267,823 455,583 118,111 - 841,517
Acquisition costs............................. 47,688 171,039 30,614 - 249,341
Operating expenses (1)........................ 49,702 85,541 14,875 - 150,118
-------------------------------------------------------------
Underwriting profit........................... $ 53,061 $ 48,246 $ 4,333 $ - $ 105,640
Net investment income......................... 417,290
Net realized gains on investments............. 211,204
Equity in net earnings of affiliates.......... 50,292
Interest expense.............................. 33,444
Amortization of intangible assets............. 26,881
Corporate operating expenses (1).............. 19,679
One time charges (1).......................... 17,460
Minority interest............................. 749
Income tax expense............................ 29,883
----------
Net income.................................... $ 656,330
----------
Loss and loss expense ratio................... 65.4% 60.0% 76.8% N/A 63.6%
Underwriting expense ratio.................... 23.8% 33.8% 29.6% N/A 30.2%
-------------------------------------------------------------
Combined ratio................................ 89.2% 93.8% 106.4% N/A 93.8%
-------------------------------------------------------------
(1) Operating expenses exclude corporate operating expenses, shown separately,
and one time charges of $17.5 million associated with the merger with Mid
Ocean.
42
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
3. SEGMENT INFORMATION (CONTINUED)
LLOYD'S FINANCIAL
YEAR ENDED DECEMBER 31, 1997 INSURANCE REINSURANCE SYNDICATES SERVICES TOTAL
- ---------------------------- -------------------------------------------------------------
Net premiums earned........................... $428,774 $685,984 $ - $ - $1,114,758
Net losses and loss expenses.................. 352,203 386,646 - - 738,849
Acquisition costs............................. 55,199 142,818 - - 198,017
Operating expenses (1)........................ 37,232 75,829 - - 113,061
-------------------------------------------------------------
Underwriting profit (loss).................... $(15,860) $ 80,691 $ - $ - $ 64,831
Net investment income......................... 345,115
Net realized gains on investments............. 410,658
Equity in net earnings of affiliates.......... 64,959
Interest expense.............................. 29,622
Amortization of intangible assets............. 7,403
Corporate operating expenses (1).............. 7,029
Minority interest............................. 308
Income tax expense............................ 32,172
----------
Net income.................................... $ 809,029
----------
Loss and loss expense ratio................... 82.1% 56.4% N/A N/A 66.3%
Underwriting expense ratio.................... 21.6% 31.9% N/A N/A 27.9%
-------------------------------------------------------------
Combined ratio................................ 103.7% 88.3% N/A N/A 94.2%
-------------------------------------------------------------
(1) Operating expenses exclude corporate operating expenses, shown separately.
43
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
3. SEGMENT INFORMATION (CONTINUED)
SUPPLEMENTAL SEGMENT AND GEOGRAPHIC INFORMATION
The following table is an analysis of the Company's gross premiums written,
net premiums written and net premiums earned by line of business:
YEAR ENDED DECEMBER 31
------------------------------------
GROSS PREMIUM WRITTEN: 1999 1998 1997
------------------------------------
Casualty insurance.......................................... $ 297,899 $ 411,405 $ 376,837
Casualty reinsurance........................................ 481,392 311,057 348,402
Property catastrophe........................................ 147,372 80,420 (82,294)
Other property.............................................. 424,666 315,013 258,957
Marine, energy, aviation and satellite...................... 212,452 108,701 84,021
Lloyd's syndicates.......................................... 591,520 162,773 -
Other....................................................... 287,619 254,170 149,462
------------------------------------
Total....................................................... $2,442,920 $1,643,539 $1,135,385
------------------------------------
NET PREMIUM WRITTEN: 1998 1997
------------------------------------
Casualty insurance.......................................... $ 232,614 $ 301,362 $ 265,296
Casualty reinsurance........................................ 419,000 268,460 322,135
Property catastrophe........................................ 128,863 71,380 (82,902)
Other property.............................................. 311,312 231,690 191,026
Marine, energy, aviation and satellite...................... 152,783 82,484 68,111
Lloyd's syndicates.......................................... 423,880 145,691 -
Other....................................................... 233,431 223,197 116,779
------------------------------------
Total....................................................... $1,901,883 $1,324,264 $ 880,445
------------------------------------
NET PREMIUM EARNED: 1998 1997
------------------------------------
Casualty insurance.......................................... $ 272,677 $ 287,438 $ 363,967
Casualty reinsurance........................................ 331,778 282,245 321,394
Property catastrophe........................................ 133,420 122,583 43,519
Other property.............................................. 324,571 233,045 189,159
Marine, energy, aviation and satellite...................... 163,112 92,147 65,016
Lloyd's syndicates.......................................... 355,769 153,852 -
Other....................................................... 168,679 152,621 131,703
------------------------------------
Total....................................................... $1,750,006 $1,324,291 $1,114,758
------------------------------------
44
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
3. SEGMENT INFORMATION (CONTINUED)
The following table shows an analysis of the Company's net premiums written
by geographical location of subsidiary:
NET PREMIUMS WRITTEN: 1999 1998 1997
------------------------------------
Bermuda..................................................... $ 561,750 $ 534,092 $ 241,006
United States............................................... 684,468 497,364 541,362
Europe and other............................................ 655,665 292,808 98,077
------------------------------------
Total....................................................... $1,901,883 $1,324,264 $ 880,445
------------------------------------
MAJOR CUSTOMERS
During 1999, 1998 and 1997, approximately 21%, 34% and 35% of the Company's
consolidated gross written premiums were generated from or placed by Marsh &
McLennan Companies. During 1999, 1998 and 1997, approximately 13%, 19% and 18%
of the Company's consolidated gross written premiums were generated from or
placed by AON Corporation and its subsidiaries. No other broker accounted for
more than 10% of gross premiums written in each of the three years ended
December 31, 1999.
4. INVESTMENTS
Net investment income is derived from the following sources:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
------------------------------
Fixed maturities, short-term investments and cash
equivalents............................................... $538,169 $423,612 $346,373
Equity securities........................................... 11,835 19,596 21,046
------------------------------
Total investment income................................... 550,004 443,208 367,419
Investment expenses......................................... 24,686 25,918 22,304
------------------------------
Net investment income....................................... $525,318 $417,290 $345,115
------------------------------
45
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
4. INVESTMENTS (CONTINUED)
The following represents an analysis of realized and the change in
unrealized appreciation on investments:
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
---------------------------------
Net realized gains (losses):
Fixed maturities and short-term investments:
Gross realized gains...................................... $ 116,226 $ 445,086 $ 203,278
Gross realized losses..................................... (214,196) (398,046) (167,146)
---------------------------------
Net realized gains (losses)............................ (97,970) 47,040 36,132
Equity securities:
Gross realized gains...................................... 254,779 613,186 400,751
Gross realized losses..................................... (62,453) (463,159) (26,225)
---------------------------------
Net realized gains..................................... 192,326 150,027 374,526
Net realized gain on sale of investment in affiliate........ - 14,137 -
---------------------------------
Net realized gains on investments...................... 94,356 211,204 410,658
---------------------------------
Change in unrealized appreciation:
Fixed maturities and short-term investments............... (333,868) (37,741) 98,212
Equity securities......................................... 101,652 41,819 (102,152)
Deferred gains on forward contracts....................... 762 (13,708) 8,247
Investment portfolio of affiliates........................ (11,438) (5,062) 14,535
Change in deferred income tax liability................... 31,050 (722) (12,609)
---------------------------------
Net change in unrealized appreciation on investments........ (211,842) (15,414) 6,233
---------------------------------
Total net realized and change in unrealized
appreciation on investments......................... $(117,486) $ 195,790 $ 416,891
---------------------------------
46
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
4. INVESTMENTS (CONTINUED)
The cost (amortized cost for fixed maturities and short-term investments),
market value and related unrealized gains (losses) of investments are as
follows:
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1999 COST GAINS LOSSES VALUE
- ----------------- -------------------------------------------------
Fixed maturities:
U.S. Government and Government agency............... $ 560,628 $ 1,011 $ (12,532) $ 549,107
Corporate........................................... 4,610,613 31,407 (234,730) 4,407,290
Mortgage-backed securities.......................... 1,118,104 682 (23,602) 1,095,184
U.S. States and political subdivisions of the
States.............................................. 779,328 7,850 (17,402) 769,776
Non-U.S. Sovereign Government....................... 767,246 10,809 (18,261) 759,794
-------------------------------------------------
Total fixed maturities........................... $7,835,919 $ 51,759 $(306,527) $7,581,151
-------------------------------------------------
Short-term investments:
U.S. Government and Government agency............... $ 82,475 - $ (63) $ 82,412
Corporate........................................... 315,834 229 (270) 315,793
Non-U.S. Sovereign Government....................... 7,066 - (11) 7,055
-------------------------------------------------
Total short-term investments..................... $ 405,375 $ 229 $ (344) $ 405,260
-------------------------------------------------
Total equity securities............................... $ 863,020 $377,302 $(104,142) $1,136,180
-------------------------------------------------
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1998 COST GAINS LOSSES VALUE
- ----------------- -------------------------------------------------
Fixed maturities:
U.S. Government and Government agency............... $1,876,198 $ 19,878 $ (5,310) $1,890,766
Corporate........................................... 3,605,183 80,085 (83,383) 3,601,885
Mortgage-backed securities.......................... 1,027,383 13,353 (634) 1,040,102
U.S. States and political subdivisions of the
States.............................................. 237,864 46,926 (666) 284,125
Non-U.S. Sovereign Government....................... 687,096 27,229 (18,299) 696,026
-------------------------------------------------
Total fixed maturities........................... $7,433,724 $187,471 $(108,292) $7,512,903
-------------------------------------------------
Short-term investments:
U.S. Government and Government agency............... $ 27,816 $ 128 $ - $ 27,944
Corporate........................................... 200,204 69 (284) 199,989
Non-U.S. Sovereign Government....................... 18,065 - (107) 17,958
-------------------------------------------------
Total short-term investments..................... $ 246,085 $ 197 $ (391) $ 245,891
-------------------------------------------------
Total equity securities............................... $1,127,590 $242,798 $ (71,290) $1,299,098
-------------------------------------------------
47
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
4. INVESTMENTS (CONTINUED)
The contractual maturities of fixed maturity securities are shown below.
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.
DECEMBER 31, 1999 DECEMBER 31, 1998
----------------------- -----------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
-------------------------------------------------
Due after 1 through 5 years......................... $2,091,280 $2,025,736 $2,390,830 $2,397,734
Due after 5 through 10 years........................ 1,816,040 1,773,639 2,104,804 2,139,561
Due after 10 years.................................. 2,810,495 2,686,592 1,910,707 1,935,506
Mortgage-backed securities.......................... 1,118,104 1,095,184 1,027,383 1,040,102
-------------------------------------------------
$7,835,919 $7,581,151 $7,433,724 $7,512,903
-------------------------------------------------
At December 31, 1999 and 1998, approximately $89.4 million and
$92.0 million, respectively, of securities were on deposit with various U.S.
state or government insurance departments in order to comply with insurance
regulations.
Through its subsidiaries, the Company has two facilities available for the
issuance of letters of credit collateralized against the Company's investment
portfolio, which were up to a value of $791.4 million at December 31, 1999. At
December 31, 1999 and 1998, approximately $591.0 million and $348.9 million,
respectively, of letters of credit were issued and outstanding under these
facilities.
Included in cash and invested assets at December 31, 1999 and 1998 are
approximately $16.6 million and $22.4 million, respectively, of assets held in a
"holding company" escrow account arising from a tax allocation agreement between
certain of the Company's U.S. subsidiaries.
5. INVESTMENTS IN AFFILIATES
The following investments are accounted for on the equity basis:
In 1999, the Company acquired minority investments in Highfields Capital
Management L.P., a global equity investment firm, and MKP Capital Management, a
New York-based fixed income investment manager specializing in mortgage-backed
securities, and invested in the closed end funds they manage.
In 1999, the Company signed a joint venture agreement with Les Mutuelles du
Mans Assurances Group to form a new French reinsurance company, Le Mans Re. The
Company owns a 49% shareholding in the new company, which underwrites a
worldwide portfolio comprising all classes of non-life reinsurance business
together with a selective portfolio of life reinsurance business.
The Company owned 27.9% of the issued shares of Risk Capital Holdings as at
December 31, 1999 and 1998. Risk Capital provides reinsurance and other forms of
capital for insurance companies with capital needs that cannot be met by
reinsurance alone. Subsequent to year end, this investment was sold. See
Note 20 for further discussion.
The Company owns 30% of Pareto Partners, a partnership engaged in the
business of providing investment advisory and discretionary management services.
48
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
5. INVESTMENTS IN AFFILIATES (CONTINUED)
In 1998, the Company and FSA formed FSA International, a Bermuda company.
At December 31, 1999, the Company owned 20% of FSA International.
The Company owned approximately 25% of Mid Ocean until July 31, 1998.
Subsequent to this date, Mid Ocean was acquired by the Company and has been
consolidated.
6. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END
(A) NAC RE CORP.
On June 18, 1999, the Company merged with NAC in an all-stock transaction.
Shareholders of NAC received 0.915 Company shares for each NAC share in a tax
free exchange. Approximately 16.9 million of the Company's Class A ordinary
shares were issued in this transaction. The merger transaction has been
accounted for as a pooling of interests under U.S. GAAP.
Following the merger, the Company changed its fiscal year end from
November 30 to December 31 as a conforming pooling adjustment. No adjustments
were necessary to conform NAC's accounting policies, although certain
reclassifications were made to the NAC financial statements to conform to the
Company's presentation.
The following table presents a reconciliation of the total revenues, net
income, and earnings per share of the Company as previously reported as adjusted
for the change in fiscal year end, combined with the results of NAC:
CONSOLIDATED
CONSOLIDATED CONSOLIDATED SHAREHOLDERS'
DECEMBER 1998 TOTAL REVENUES NET INCOME EQUITY
- ------------------------------------------------------------ ---------------------------------------------
XL Capital - year end November 30, 1998 as previously
reported.................................................. $1,217,648 $587,663 $4,817,880
Less one month December 31, 1997............................ 93,835 57,168
Add one month December 31, 1998............................. 202,210 29,785 43,998
---------------------------------------------
XL Capital - year end December 31, 1998 as adjusted before
combination with NAC...................................... 1,326,023 560,280 4,861,878
NAC - year end December 31, 1998............................ 699,379 96,050 750,725
---------------------------------------------
Combined results - year end December 31, 1998............... $2,025,402 $656,330 $5,612,603
---------------------------------------------
BASIC EARNINGS DILUTED EARNINGS
PER SHARE PER SHARE
---------------------------------
XL Capital - year end November 30, 1998 as previously
reported.................................................. $6.32 $6.20
XL Capital - year end December 31, 1998 as adjusted before
combination with NAC...................................... $5.88 $5.77
NAC - year end December 31, 1998 (1)........................ $5.74 $5.22
Weighted average combined earnings per share as adjusted.... $5.86 $5.68
(1) After giving effect to the exchange of 0.915 Company shares for each NAC
Share
49
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
6. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END (CONTINUED)
CONSOLIDATED
CONSOLIDATED CONSOLIDATED SHAREHOLDERS'
DECEMBER 1997 TOTAL REVENUES NET INCOME EQUITY
- -------------- ---------------------------------------------
XL Capital - year end November 30, 1997 as previously
reported.................................................. $1,159,026 $676,961 $2,479,130
Less one month December 31, 1996............................ 57,743 20,777 -
Add one month December 31, 1997............................. 93,835 57,168 59,558
---------------------------------------------
XL Capital-year end December 31, 1997 as adjusted before
combination with NAC...................................... 1,195,118 713,352 2,538,688
NAC - year end December 31, 1997............................ 740,372 95,677 657,061
---------------------------------------------
Combined results - year end December 31, 1997............... $1,935,490 $809,029 $3,195,749
---------------------------------------------
BASIC EARNINGS DILUTED EARNINGS
PER SHARE PER SHARE
---------------------------------
XL Capital - year end November 30, 1997 as previously
reported.................................................. $7.95 $7.84
---------------------------------
XL Capital - year end December 31, 1997 as adjusted before
Combination with NAC...................................... $8.40 $8.30
NAC - year end December 31, 1997 (1)........................ $5.69 $5.21
Weighted average combined earnings per share, as adjusted... $7.95 $7.74
---------------------------------
(1) After giving effect to the exchange of 0.915 Company shares for each NAC
Share.
(B) ECS, INC AND INTERCARGO CORPORATION
In 1999, the Company acquired ECS, an underwriting manager which
specializes in environmental insurance coverages and risk management services.
Commencing January 2000, ECS will underwrite policies on behalf of the Company's
insurance and reinsurance subsidiaries.
In 1999, the Company acquired Intercargo, which through its subsidiaries,
underwrites specialty insurance products for companies engaged in international
trade, including U.S. Customs bonds and marine cargo insurance.
The Intercargo and ECS acquisitions have been accounted for under the
purchase method of accounting. The combined purchase price was $222.8 million
and the resulting goodwill of $159.6 million is being amortized over 20 years.
Cash acquired as a result of the acquisition was $49.6 million.
(C) MID OCEAN LIMITED
In August 1998, the Company merged with Mid Ocean. Shareholders of Mid
Ocean received 1.0215 Company shares for each Mid Ocean share subject to a cash
election option which was taken up of $96 million. The merger with Mid Ocean was
accounted for as a purchase under U.S. GAAP and results of operations of Mid
Ocean are included from August 1, 1998. The total purchase price was
$2.2 billion; the fair value of Mid Ocean's net assets not already owned by the
Company was $0.9 billion with the balance of $1.3 billion representing goodwill
which is
50
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
6. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END (CONTINUED)
being amortized over 40 years. On August 1, 1998, the consolidated balance sheet
of Mid Ocean included the following items at fair value:
Investments available for sale.............................. $1,668,224
Premiums receivable......................................... 445,540
Other assets................................................ 442,831
Total assets................................................ 2,556,595
Unpaid loss and loss expense reserves....................... 595,261
Unearned premium............................................ 458,994
Total liabilities........................................... 1,195,835
Shareholders' equity........................................ 1,360,760
Cash and cash equivalents totaling $137 million is included in other
assets. Cash acquired as a result of this merger was $41 million.
See Note 22 for further details.
(D) GCR HOLDINGS LIMITED
In June 1997, the Company acquired GCR Holdings Limited in an all-cash
transaction. The acquisition was accounted for as a purchase under U.S. GAAP.
The total purchase price was $667 million, the fair value of GCR's net assets
was $402 million, with the balance of $265 million representing goodwill which
is being amortized over 20 years. Cash and cash equivalents of approximately
$7 million were acquired.
7. LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses are comprised of:
YEAR ENDED DECEMBER 31
------------------------------------
1999 1998 1997
------------------------------------
Reserve for reported losses and loss expenses............... $2,175,688 $2,062,046 $1,416,745
Reserve for losses incurred but not reported................ 3,193,714 2,834,597 2,555,631
------------------------------------
Unpaid losses and loss expenses............................. $5,369,402 $4,896,643 $3,972,376
------------------------------------
Losses and loss expenses incurred comprise:
Loss and loss expense payments.............................. $1,392,024 $ 849,777 $ 560,542
Change in unpaid losses and loss expenses................... 303,140 285,775 344,580
Reinsurance recoveries...................................... (390,860) (294,035) (166,273)
------------------------------------
Losses and loss expenses incurred........................... $1,304,304 $ 841,517 $ 738,849
------------------------------------
51
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
The following table represents an analysis of paid and unpaid losses and
loss expenses and a reconciliation of the beginning and ending unpaid loss and
loss expenses for the years indicated:
1999 1998 1997
------------------------------------
Unpaid losses and loss expenses at beginning of year........ $4,896,643 $3,972,376 $3,623,334
Unpaid losses and loss expenses recoverable................. (593,960) (363,716) (457,373)
------------------------------------
Net unpaid losses and loss expenses at beginning of year.... 4,302,683 3,608,660 3,165,961
Increase (decrease) in net losses and loss expenses incurred
in respect of losses occurring in:
Current year.............................................. 1,591,414 1,085,161 1,056,228
Prior year................................................ (287,110) (243,644) (317,379)
------------------------------------
Total net incurred loss and loss expenses.............. 1,304,304 841,517 738,849
Interest incurred on experience reserves.................... - 1,798 866
Exchange rate effects....................................... (5,950) 718 (658)
Net loss reserves acquired through purchase of
subsidiaries.............................................. 30,003 580,879 34,593
Net loss and loss expenses paid in respect of losses
occurring in:
Current year.............................................. 281,806 272,456 97,296
Prior year................................................ 811,696 458,433 233,655
------------------------------------
Total net paid losses.................................. 1,093,502 730,889 330,951
Net unpaid losses and loss expenses at end of year.......... 4,537,538 4,302,683 3,608,660
Unpaid losses and loss expenses recoverable................. 831,864 593,960 363,716
------------------------------------
Unpaid losses and loss expenses at end of year.............. $5,369,402 $4,896,643 $3,972,376
------------------------------------
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.
Several aspects of the Company's casualty insurance operations complicate
the actuarial reserving techniques for loss reserves as compared to other
insurance operations. Among these aspects are the differences in the policy
forms from more traditional forms, the lack of complete historical loss data for
losses of the same type intended to be covered by the policies and the
expectation that losses in excess of the attachment level of the Company's
policies generally will be characterized by low frequency and high severity,
limiting the utility of claims experience of other insureds for similar claims.
While management believes it has made a reasonable estimate of ultimate losses,
the ultimate claims experience may not be as reliably predicted as may be the
case with other insurance operations, and there can be no assurance that losses
and loss expenses will not exceed the total reserves.
Losses incurred in 1999 grew significantly over 1998 for a number of
reasons. The Company acquired Mid Ocean and Brockbank in August 1998 and
consequently, only recognized the effect of their operations for five months in
1998. Incurred losses for these entities were approximately $475 million in 1999
compared to $260 million in 1998. The Company was also affected by a number of
catastrophes in 1999 compared to 1998. The fourth
52
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
quarter of 1999 generated approximately $135 million of catastrophic losses to
the Company, of which the European storms in December account for the major
part. The Company also experienced a number of smaller catastrophe losses in
1999 that totaled approximately $50 million. These losses included the Turkey
earthquakes, the Sydney hailstorms and the Oklahoma tornadoes. By comparison,
the Company incurred approximately $60 million in catastrophe losses relating to
Hurricane Georges and the SwissAir disaster in 1998. These losses were incurred
in the reinsurance operations.
The Lloyd's operations experienced loss deterioration on the U.K. motor
business written by Brockbank, principally relating to its 1999 and 1998
underwriting years of approximately $20 million. 1999 incurred losses also
include an increase to reinsurance loss reserves of $95 million for NAC when it
merged with the Company in June 1999. In addition, the acquisition of Intercargo
in June 1999 also added approximately $30 million to total incurred losses.
The decrease in prior year incurred losses is driven primarily by the
Company's insurance liability excess of loss reserves. The basis for
establishing IBNR is unlike most insurance companies due to the lack of industry
data. Consequently, the Company estimates loss reserves through actuarial models
based upon its own experience. When the Company commenced writing this type of
business in 1986, limited data was available and the Company made its best
estimate of loss reserves at that time. Over time, the amount of data has
increased, providing a larger statistical base for estimating reserves.
Redundancies in prior year loss reserves have occurred where loss experience has
developed more favorably than expected.
The increase in paid losses in 1999 and 1998 reflects the acquisition of
Mid Ocean and Brockbank in 1998. In addition, the source of the Company's high
excess of loss liability and catastrophe business can result in loss payments
that are both irregular and significant. Similarly, adjustments to reserves for
individual years can be irregular and significant. Such adjustments are part of
the normal course of business for the Company. Conditions and trends that have
affected development of liability in the past may not necessarily occur in the
future. Accordingly, it is inappropriate to extrapolate future redundancies or
deficiencies based upon historical experience. See generally "Management's
Discussion and Analysis of Results of Operations and Financial
Condition - Cautionary Note Regarding Forward-looking Statements".
The Company's net incurred losses and loss expenses includes a provision of
$10.6 million, $1.2 million and $3.7 million in 1999, 1998 and 1997,
respectively, for estimates of actual and potential non-recoveries from
reinsurers. Such charges for non-recoveries relate mainly to reinsurance ceded
for casualty business written prior to 1986. Included in unpaid losses and loss
expenses at December 31, 1999, 1998 and 1997 is a reserve for potential
non-recoveries from reinsurers of $25.8 million, $14.5 million and
$13.8 million, respectively.
Except for certain workers' compensation unpaid losses, the Company does
not discount its liabilities for unpaid losses and loss expenses. The Company
utilizes tabular reserving for workers' compensation unpaid losses that are
considered fixed and determinable and discounts such losses using an interest
rate of 7% for financial statements prepared in accordance with GAAP and a 5%
interest rate for U.S. statutory accounting purposes. The tabular reserving
methodology results in applying a uniform and consistent criteria for
establishing expected future indemnity and medical payments (including an
explicit factor for inflation) and the use of mortality tables to determine
expected payment periods. Tabular unpaid losses and loss expenses, net of
reinsurance, at December 31, 1999, 1998 and 1997 were $85.7 million,
$61.3 million and $42.4 million, respectively. The related discounted unpaid
losses and loss expenses were $28.1 million, $20.7 million and $16.1 million as
of December 31, 1999, 1998 and 1997, respectively.
53
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
ASBESTOS AND ENVIRONMENTAL RELATED CLAIMS
The Company's reserving process includes a continuing evaluation of the
potential impact on unpaid liabilities from exposure to asbestos and
environmental claims, including related loss adjustment expenses. Liabilities
are established to cover both known and incurred but not reported claims.
A reconciliation of the opening and closing unpaid losses and loss expenses
related to asbestos and environmental exposure claims for the years indicated is
as follows:
YEAR ENDED DECEMBER 31,
---------------------------
1999 1998 1997
---------------------------
Net unpaid losses and loss expenses at beginning of year.... $34,850 $32,767 $28,500
Net incurred loss and loss expenses......................... 4,416 5,541 8,067
Less net paid losses and loss expenses...................... 3,060 3,458 3,800
---------------------------
Net increase in unpaid losses and loss expenses............. 1,356 2,083 4,267
Net unpaid losses and loss expenses at end of year.......... 36,206 34,850 32,767
Unpaid losses and loss expenses recoverable at end of
year...................................................... 49,022 43,211 37,905
---------------------------
Gross unpaid losses and loss expenses at end of year........ $85,228 $78,061 $70,672
---------------------------
Incurred but not reported ("IBNR") losses, net of reinsurance, included in
the above table was $16.1 million in 1999, $17.0 million in 1998 and
$16.6 million in 1997. Unpaid losses recoverable are net of potential
uncollectable amounts.
As of December 31, 1999 and 1998, the Company had approximately 370 and 400
open claim files, respectively, for potential asbestos exposures and 245 and 760
open claim files, respectively, for potential environmental exposures.
Approximately 46% and 51% of the open claim files for 1999 and 1998,
respectively, are due to precautionary claim notices. Precautionary claim
notices are submitted by the ceding companies in order to preserve their right
to receive coverage under the reinsurance contract. Such notices do not contain
an incurred loss amount to the Company. The Company believes it has made
reasonable provision for its asbestos and environmental exposures and is unaware
of any specific issues that would materially affect its estimate for losses and
loss expenses. The estimation of loss and loss expense liabilities for asbestos
and environmental exposures is subject to much greater uncertainty than is
normally associated with the establishment of liabilities for certain other
exposures due to several factors, including: i) uncertain legal interpretation
and application of insurance and reinsurance coverage and liability; ii) the
lack of reliability of available historical claims data as an indicator of
future claims development; iii) an uncertain political climate which may impact,
among other areas, the nature and amount of costs for remediating waste sites;
and iv) the potential of insurers and reinsurers to reach agreements in order to
avoid further significant legal costs. Due to the potential significance of
these uncertainties, the Company believes that no meaningful range of loss and
loss expense liabilities beyond recorded reserves can be established. As these
uncertainties are resolved, additional reserve provisions, which could be
material in amount, may be necessary.
54
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
8. REINSURANCE
The Company utilizes reinsurance and retrocession agreements principally to
increase aggregate capacity and to reduce the risk of loss on business assumed.
The Company's reinsurance and retrocession agreements provide for recovery of a
portion of loss and loss expenses from reinsurers and reinsurance recoverables
are recorded as assets. The Company is liable if the reinsurers are unable to
satisfy their obligations under the agreements.
A 20% quota share reinsurance policy exists with several U.S. reinsurers
covering general liability insurance risks only. The maximum amount recoverable
from the reinsurers is the ceded percentage of the original policy limit on a
per occurrence basis, with an annual aggregate of 300% of the total premium
ceded.
There are a limited amount of retrocession agreements in place for the
Company's short tail reinsurance business assumed for common account reinsurance
on proportional contracts written and "high level" property catastrophe excess
of loss protection. For the long tail casualty reinsurance business written,
several reinsurance policies are in place to limit the Company's retention on
any one claim and also for multiple claims arising from two or more risks in a
single occurrence or event.
The Company's Lloyd's syndicates have traditionally purchased a significant
amount of reinsurance to protect against extraordinary loss or loss involving
one or more of the lines of business written. Reinsurance is purchased on an
excess of loss and quota share basis.
The effect of reinsurance and retrocessional activity on premiums written
and earned is shown below:
PREMIUMS WRITTEN PREMIUMS EARNED
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
----------------------------------- ------------------------------------
1999 1998 1997 1999 1998 1997
--------------------------------------------------------------------------
Direct...................... 1,088,028 779,551 517,773 994,339 672,871 537,070
Assumed..................... 1,354,892 863,988 617,612 1,259,632 926,730 783,116
Ceded....................... (541,037) (319,275) (254,940) (503,965) (275,310) (205,428)
--------------------------------------------------------------------------
Net......................... $1,901,883 $1,324,264 $ 880,445 $1,750,006 $1,324,291 $1,114,758
--------------------------------------------------------------------------
The Company recorded reinsurance recoveries on loss and loss expenses
incurred of $390.9 million, $294.0 million and $166.3 million for the years
ended December 31, 1999, 1998 and 1997, respectively. The Company is the
beneficiary of letters of credit, trust accounts and funds withheld in the
aggregate amount of $228.9 million at December 31, 1999, collateralizing
reinsurance recoverables with respect to certain retrocessionnaires.
Increases in all of the above balances in 1999 over 1998 and in 1998 over
1997 is primarily due to the acquisition of Mid Ocean in 1998.
9. DEPOSIT LIABILITIES AND POLICY BENEFIT RESERVE
During 1999, the Company entered into a contract that transfers
insufficient risk to be accounted for as reinsurance under SFAS No. 113. This
contract has been recorded as a deposit liability and is matched by an
equivalent amount of investments. At December 31, 1999, total deposit
liabilities are $310.4 million.
In December 1999, the Company entered into a contract reinsuring a
portfolio of life and annuity business that has been accounted for as an
investment contract under SFAS No. 97, with a corresponding liability for
estimated future policy benefits in the amount of $635.6 million. The Company
has contracted to transfer liabilities of $108.1 million to a third party for an
equivalent consideration
55
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
10. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS
As at December 31, 1999, the Company had bank and loan facilities available
from a variety of sources including commercial banks totaling $2.16 billion
(1998: $2.24 billion) of which $410.7 million (1998: $613.9 million) was
outstanding. In addition, $891.6 million (1998: $348.9 million) of letters of
credit were outstanding, 66% of which were collateralized by the Company's
investment portfolio, primarily supporting U.S. non-admitted business,
intercompany quota share agreements between affiliates and the Company's Lloyd's
capital requirements.
The financing structure at December 31, 1999 was as follows:
FACILITY COMMITMENT IN USE/OUTSTANDING
- ------ --------------------------------
DEBT:
Company term note......................................... $ 11,000 $ 11,000
2 facilities of 364 day Revolvers - total................. 650,000 -
2 facilities of 5 year Revolvers - total.................. 350,000 299,700
7.15% Senior Notes due 2005............................... 100,000 100,000
--------------------------------
$1,111,000 $410,700
--------------------------------
LETTERS OF CREDIT:
7 facilities - total...................................... $1,246,500 $891,600
--------------------------------
The financing structure at December 31, 1998 was as follows:
IN
FACILITY COMMITMENT USE/OUTSTANDING
- ------ ------------------------------
DEBT:
Company term note......................................... $ 11,000 $ 11,000
3 facilities of 364 day Revolvers - total................. 700,000 113,000
2 facilities of 5 year Revolvers - total.................. 350,000 190,000
7.15% Senior Notes due 2005............................... 100,000 99,900
8% Senior Notes due 1999.................................. 100,000 100,000
5.25% Convertible Subordinated Debentures due 2002........ 100,000 100,000
------------------------------
$1,361,000 $613,900
------------------------------
LETTERS OF CREDIT:
3 facilities - total...................................... $ 876,000 $348,900
------------------------------
The 364-day facilities are provided by a syndicate of banks where the
borrowings are unsecured, and by a U.S. bank where the borrowings are
collateralized and guaranteed. There were no borrowings outstanding at
December 31, 1999. The weighted average interest rate on the funds borrowed
during 1999 was approximately 5.41% and approximately 5.9% during 1998.
Two syndicates of banks provide the two five-year facilities and borrowings
are unsecured. The amounts of $299.7 million and $190.0 million outstanding at
December 31, 1999 and 1998, respectively, relate primarily to the
$300.0 million borrowed to finance the cash option election available to
shareholders in connection with the Mid Ocean acquisition in August 1998. The
1999 outstanding amount also relates to the $109.7 million borrowed to finance
the acquisition of ECS and Intercargo during 1999. The weighted average interest
rate on funds borrowed during 1999 was approximately 5.43% and 5.7% during 1998.
56
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
10. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS (CONTINUED)
In 1995, the Company issued $100.0 million of 7.15% Senior Notes due
November 15, 2005 through a public offering at a price of $99.9 million.
$100.0 million of 5.25% Convertible Subordinated Debentures due
December 15, 2002 were issued in December 1992 through a private offering. The
Debentures were called in June 1999 and converted to approximately 1.8 million
of the Company's shares.
$100.0 million of 8% Senior Notes due June 15, 1999 were issued in
June 1992 through a public offering. These Notes were repaid in June 1999
through additional borrowings and internal funds.
Total pre-tax interest expense on the borrowings described above was
$37.4 million, $33.4 million and $29.6 million for the years ended December 31,
1999, 1998 and 1997, respectively. Associated with the Company's bank and loan
commitments are various loan covenants with which the Company was in compliance
throughout the three year period.
The Company has seven letter of credit facilities available at
December 31, 1999, two from two syndicates of banks, three from U.K. banks and
two from U.S. banks. Two syndicates of banks and a U.K. bank provided the three
letter of credit facilities available at December 31, 1998. These facilities are
used to collateralize certain reinsureds' premium and unpaid loss reserves with
the Company and for Lloyd's capital requirements of the Company's corporate
syndicates. Of the letters of credit outstanding at December 31, 1999,
$591.0 million (1998: $348.9 million) were collateralized against the Company's
investment portfolio and $300.6 million (1998: Nil) were unsecured.
11. COMMITMENTS AND CONTINGENCIES
(A) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company invests in derivative instruments, such as foreign currency
forward contracts and futures for purposes other than trading. These derivative
instruments are used for foreign currency exposure management and to obtain
exposure to specific financial markets.
(I) FOREIGN CURRENCY EXPOSURE MANAGEMENT
The Company uses foreign exchange contracts to manage its exposure to the
effects of fluctuating foreign currencies on the value of its foreign currency
fixed maturities and equity investments. These contracts are not designated as
specific hedges for financial reporting purposes and therefore, realized and
unrealized gains and losses recognized on them are recorded in income in the
period in which they occur. These contracts generally have maturities of three
months or less. In addition, where the Company's investment managers are of the
opinion that potential gains exist in a particular currency, then a forward
contract will not be entered into. At December 31, 1999 and 1998, forward
foreign exchange contracts with notional principal amounts totaling
$339.3 million and $322.4 million, respectively, were outstanding. The fair
value of these contracts as at December 31, 1999 was $341.1 million (1998:
$316.2 million) with unrealized losses of $1.8 million (1998: $6.2 million).
Losses of $2.7 million and gains of $17.0 million were realized during 1999 and
1998, respectively.
In addition, the Company also enters into foreign exchange contracts to buy
and sell foreign currencies in the course of trading its foreign currency
investments. These contracts are not designated as specific hedges for financial
reporting purposes, and generally have maturities of two weeks or less. As such,
any realized or unrealized gains or losses are recorded in income in the period
in which they occur. At December 31, 1999 and 1998, the value of such contracts
outstanding was not significant.
57
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company attempts to hedge directly the foreign currency exposure of a
portion of its foreign currency fixed maturity investments using forward foreign
exchange contracts that generally have maturities of three months or less, and
which are rolled over to provide continuing coverage for as long as the
investments are held. Where an investment is sold, the related foreign exchange
sale contract is closed by entering into an offsetting purchase contract. At
December 31, 1999, the Company had, as hedges, foreign exchange contracts for
the sale of $94.0 million and the purchase of $7.5 million of foreign currencies
at fixed rates, primarily Euros (49% of net contract value), British pounds
(18%) and New Zealand dollars (16%). The market value of fixed maturities
denominated in foreign currencies that were hedged and held by the Company as at
December 31, 1999 was $85.2 million.
Unrealized foreign exchange gains or losses on foreign exchange contracts
hedging foreign currency fixed maturity investments are deferred and included in
shareholders' equity. As at December 31, 1999 and 1998, unrealized losses
amounted to $2.0 million and $1.3 million, respectively, and were offset by
corresponding increases in the U.S. dollar value of the investments. Realized
gains and losses on the maturity of these contracts are also deferred and
included in shareholders' equity until the corresponding investment is sold. As
at December 31, 1999 and 1998, realized losses amounted to $0.5 million and
$0.7 million, respectively.
The Company is exposed to credit risk in the event of non-performance by
the other parties to the forward contracts, however the Company does not
anticipate non-performance. The difference between the notional principal
amounts and the associated market value is the Company's maximum credit
exposure.
(II) FINANCIAL MARKET EXPOSURE
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, 1999, the portfolio held
$121.9 million (1998: $148.2 million) in exposure to S&P 500 Index futures and
underlying assets of $122.0 million (1998: $149.6 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, 1999 and 1998, net realized gains from
index futures totaled $11.3 million and $23.2 million, respectively.
Derivative investments are also utilized to add value to the portfolio
where market inefficiencies are believed to exist. At December 31, 1999, bond
and stock index futures outstanding were $241.1 million (1998: $235.6 million),
with underlying investments having a market value of $2.5 billion (1998:
$2.1 billion). All managers are prohibited by the Company's investment
guidelines from leveraging their positions.
(B) CONCENTRATIONS OF CREDIT RISK
The Company's investment portfolio is managed by external managers in
accordance with guidelines that have been tailored to meet specific investment
strategies, including standards of diversification which limit the allowable
holdings of any single issue. The Company did not have an aggregate investment
in a single entity, other than the U.S. government, in excess of 10% of
shareholders' equity at December 31, 1999 and 1998.
(C) OTHER INVESTMENTS
The Company has committed to invest in several limited partnerships as part
of its overall corporate strategy. The primary purpose of these partnerships is
to invest capital provided by the partners in various insurance and reinsurance
ventures. The Company had invested $99.7 million and $33.0 million as at
December 31, 1999 and 1998, respectively, with commitments to invest a further
$131.8 million over the next ten years. The Company
58
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
received income from its investments of $9.4 million and $3.6 million for the
years ended December 31 1999 and 1998, respectively. The Company continually
reviews the performance of the partnerships to ensure there is no decrease in
the values of its investments. The Company is a limited partner and, as such,
does not actively participate in the management of the partnerships.
(D) PROPERTIES
The Company rents space for its principal executive offices under leases
which expire up to 2009. Total rent expense for the years ended December 31,
1999, 1998 and 1997 was approximately $13 million, $9 million and $7 million,
respectively. Future minimum rental commitments under existing leases are
expected to be as follows:
Year ending December 31: 2000 $ 15,927
2001 14,888
2002 11,513
2003 10,806
2004 10,533
Later years 72,487
--------
Total minimum future rentals $136,154
========
In 1997, the Company acquired commercial real estate in Hamilton, Bermuda
for the purpose of securing long-term office space to meet its anticipated
needs. The Company is in the process of developing this property and
constructing its worldwide headquarters. The total cost of the development,
including the land, is expected to be approximately $110 million, of which
$60 million has been spent to December 31, 1999. It is estimated that the
development will be completed sometime in 2001. Upon completion of the
development, it is expected that the Company's rental commitments will be
reduced.
(E) TAX MATTERS
The Company is a Cayman Islands corporation and, except as described below,
neither it nor its non-U.S. subsidiaries have paid United States corporate
income taxes (other than withholding taxes on dividend income) on the basis that
they are not engaged in a trade or business in the United States; however,
because definitive identification of activities which constitute being engaged
in trade or business in the United States is not provided by the Internal
Revenue Code of 1986, regulations or court decisions, there can be no assurance
that the Internal Revenue Service will not contend that the Company or its
non-U.S. subsidiaries are engaged in trade or business in the United States. If
the Company or its non-U.S. subsidiaries were considered to be engaged in trade
or business in the United States (and, if the Company or such subsidiaries were
to qualify for the benefits under the income tax treaty between the United
States and Bermuda or Ireland, such businesses were attributable to a "permanent
establishment" in the United States), the Company or such subsidiaries could be
subject to U.S. tax at regular tax rates on its taxable income that is
effectively connected with its U.S. trade or business plus an additional 30%
"branch profits" tax on such income remaining after the regular tax, in which
case there could be a material adverse effect on the Company's shareholders'
equity and earnings.
59
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(F) FINANCIAL GUARANTIES
The Company insures and reinsures financial guaranties issued to support
public and private borrowing arrangements. Financial guaranties are conditional
commitments which guaranty the performance of a customer to a third party. The
Company's potential liabilities in the event of nonperformance by the issuer of
the insured obligation is represented by its proportionate share of the
aggregate outstanding principal and interest payable ("insurance in force") on
such insured obligation. At December 31, 1999, the Company's aggregate insurance
in force was $5.2 billion. The Company manages its exposure to credit risk
through a structured underwriting process which includes detailed credit
analysis, review of and adherence to underwriting guidelines, surveillance
policies and procedures and the use of reinsurance.
12. SHARE CAPITAL
(A) AUTHORIZED AND ISSUED
The authorized share capital is 999,990,000 ordinary shares of a par value
of $0.01 each. Holders of Class A shares are entitled to one vote for each share
held while Class B shares are not entitled to vote. In all other respects,
Class A and B shares rank PARI PASSU.
The following table is a summary of shares issued and outstanding:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
------------------------------
Balance - beginning of year................................. 128,745 101,282 104,192
Exercise of options......................................... 443 425 503
Issue of restricted shares.................................. 107 289 173
Repurchase of shares........................................ (1,488) (3,443) (3,586)
Issue of Class A shares..................................... - 27,076 -
Issue of Class B shares..................................... - 3,116 -
------------------------------
Balance - end of year....................................... 127,807 128,745 101,282
------------------------------
The issue of shares in 1998 was in exchange for Mid Ocean shares and FSA
shares.
(B) SHARE REPURCHASES
The Company has had several stock repurchase plans in the past as part of
its capital management. In June 1999, the Board of Directors rescinded the
Company's share repurchase plans. On January 9, 2000 the Board of Directors
authorized the repurchase of shares up to $500 million.
(C) STOCK PLANS
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 the 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.
60
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
12. SHARE CAPITAL (CONTINUED)
Restricted stock awards issued under the 1991 Performance Incentive Program
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 113,100
shares, 147,836 shares and 91,000 shares in 1999, 1998 and 1997, respectively.
Restricted stock awards granted by NAC prior to the merger amounted to 3,627
shares, 23,700 shares and 65,300 shares for the same respective periods. Vesting
for such shares generally occurs over a six year period.
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 the grant date. Effective
April 11, 1997, all options granted to non-employee directors are granted under
the 1991 Performance Incentive Program. Directors may also may make an
irrevocable election preceding the beginning of each fiscal year to defer cash
compensation that would otherwise be payable as his or her annual retainer in
increments of $5,000. The deferred payments are credited in the form of shares
calculated by dividing 110% of the deferred payment by the market value of the
Company's stock at the beginning of the fiscal year. Each anniversary
thereafter, 20% of these shares are distributed. Shares issued under the plan
totaled nil, 2,737 and 3,048 in 1999, 1998 and 1997, respectively.
A second stock plan, intended to replace the directors' "Retirement Plan
for Non-Employee Directors," provides for the issuance of share units equal to
the amount that would have been credited to the Retirement Plan, divided by the
market price of the Company's stock on December 1 of each year. These units
receive dividends in the form of additional units equal to the cash value
divided by the market price on the payment date. Stock units totaling 1,217,
5,531 and 6,716 were provided for in 1999, 1998 and 1997, respectively.
As a result of the merger with Mid Ocean during August 1998, 791,573 Mid
Ocean options were converted to options of XL Capital. These are 10 year options
that generally vest over 3 years.
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.
In 1999, the Company adopted the 1999 Performance Incentive Plan under
which 1,250,000 options were available and issued to employees who were not
directors or executive officers of the Company.
(D) FAS 123 PRO FORMA DISCLOSURE
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation." Had the Company adopted the accounting provisions of SFAS
No. 123, compensation costs would have been determined based on the fair value
of the stock option awards
61
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
12. SHARE CAPITAL (CONTINUED)
granted in 1999, 1998 and 1997, and net income and earnings per share would have
been reduced to the pro-forma amounts indicated below:
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
------------------------------
Net income - as reported.................................... $470,509 $656,330 $809,029
Net income - pro-forma...................................... $437,592 $635,239 $798,140
Basic earnings per share - as reported...................... $ 3.69 $ 5.86 $ 7.95
Basic earnings per share - pro-forma........................ $ 3.43 $ 5.67 $ 7.85
Diluted earnings per share - as reported.................... $ 3.62 $ 5.68 $ 7.74
Diluted earnings per share - pro-forma...................... $ 3.36 $ 5.47 $ 7.60
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
1999 1998 1997
---------------------------------
Dividend yield.............................................. 3.43% 1.81% 1.89%
Risk free interest rate..................................... 5.90% 4.76% 5.51%
Expected volatility......................................... 24.66% 24.72% 23.49%
Expected lives.............................................. 7.5 years 9.2 years 9.0 years
Total stock based compensation recognized in net income was $7.7 million in
1999, $5.8 million in 1998 and $5.2 million in 1997.
(E) OPTIONS
Following is a summary of stock options and related activity:
1999 1998 1997
--------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
-------------------------------------------------------------------
Outstanding - beginning of year............... 7,685,414 $50.61 5,744,063 $35.28 5,271,579 $29.27
Granted....................................... 3,207,492 $57.06 1,749,885 $68.27 1,036,305 $57.20
Granted - Mid Ocean conversion................ - - 791,573 $72.44 - $ -
Exercised..................................... (421,163) $27.57 (425,251) $30.06 (506,891) $19.99
Canceled...................................... (189,020) $55.25 (174,856) $40.12 (56,930) $40.97
-------------------------------------------------------------------
Outstanding - end of year..................... 10,282,723 $46.50 7,685,414 $46.79 5,744,063 $35.28
-------------------------------------------------------------------
Options exercisable........................... 5,287,657 4,288,434 3,043,676
-------------------------------------------------------------------
Options available for grant................... *1,028,853 * 2,455,190 * 4,082,135
-------------------------------------------------------------------
* Available for grant includes shares which may be granted on either stock
options or restricted stock.
62
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
12. SHARE CAPITAL (CONTINUED)
The following table summarizes information about the Company's stock
options (including stock appreciation rights) for options outstanding as of
December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------- ------------------------------------
AVERAGE
AVERAGE REMAINING AVERAGE
RANGE OF NUMBER OF EXERCISE CONTRACTUAL NUMBER OF EXERCISE
EXERCISE PRICES OPTIONS (000S) PRICE LIFE (YEARS) OPTIONS (000S) PRICE
- ----------------------- --------------------------------------------------------------------------------------------
$10.44 - $32.38........ 2,045 $22.30 3.7 2,023 $21.79
$32.92 - $50.00........ 4,548 $44.52 5.9 2,109 $39.40
$51.24 - $64.69........ 2,516 $56.58 7.6 776 $59.46
$73.00 - $79.25........ 1,231 $74.71 9.6 443 $74.74
--------------------------------------------------------------------------------------------
$10.44 - $79.25........ 10,340 $46.65 7.6 5,351 $38.58
--------------------------------------------------------------------------------------------
(F) VOTING
XL's Articles of Association restrict the voting power of any person to
less than 10% of total voting power.
(G) SHARE RIGHTS PLAN
Rights to purchase Ordinary Shares were distributed as a dividend at the
rate of one Right for each outstanding Ordinary Share held of record as of the
close of business on October 31, 1998. Each Right entitles holders of XL
Ordinary Shares to buy one ordinary share at an exercise price of $350. The
Rights would be exercisable, and would detach from the Ordinary Shares, only if
a person or group were to acquire 20% or more of XL's outstanding Ordinary
Shares, or were to announce a tender or exchange offer that, if consummated,
would result in a person or group beneficially owning 20% or more of XL's
Ordinary Shares. Upon a person or group without prior approval of the Board
acquiring 20% or more of XL's Ordinary Shares, each Right would entitle the
holder (other than such an acquiring person or group) to purchase XL Ordinary
Shares (or, in certain circumstances, Ordinary Shares of the acquiring person)
with a value of twice the Rights exercise price upon payment of the Rights
exercise price. XL will be entitled to redeem the Rights at $0.01 per Right at
any time until the close of business on the tenth day after the Rights become
exercisable. The Rights will expire at the close of business on September 30,
2008. The Company has initially reserved 119,073,878 Ordinary Shares being
authorized and unissued for issuance upon exercise of the Rights.
13. RETIREMENT PLANS
The Company maintains both defined contribution and defined benefit
retirement plans, which vary for each subsidiary. Plan assets are invested
principally in equity securities and fixed maturities.
The Company has a qualified defined contribution plan which is managed
externally and whereby employees and the Company contribute a certain percentage
of the employee's gross salary into the plan each month. The Company's
contribution generally vests over 5 years.
63
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
13. RETIREMENT PLANS (CONTINUED)
At NAC, a qualified non-contributory defined benefit pension plan exists to
cover substantially all its U.S. employees. Benefits are based on years of
service and compensation, as defined in the plan, during the highest consecutive
three years of the employee's last ten years of employment.
Under this plan, the Company's policy is to make annual contributions to
the plan that are deductible for federal income tax purposes and that meet the
minimum funding standards required by law. The contribution level is determined
by utilizing the entry age cost method and different actuarial assumptions than
those used for pension expense purposes. This plan also includes a non-qualified
supplemental defined benefit plan designed to compensate individuals to the
extent their benefits under the Company's qualified plan are curtailed due to
Internal Revenue Code limitations. The projected benefit obligation, accumulated
benefit obligation and fair value of the assets for this plan with accumulated
benefit obligations in excess of the plan assets were $4.6 million,
$2.5 million and Nil, respectively, as of December 31, 1999 and $5.0 million,
$2.5 million and Nil, respectively as of December 31, 1998. The discount rates
used in determining the actuarial present value of benefit obligations were 7.7%
and 6.5% for 1999 and 1998, respectively. The rate of increase for future
compensation levels was 6.5% for 1999 and 5.5% for 1998. The assumed rate of
return on plan assets was 9.0% for both 1999 and 1998.
NAC also maintains a qualified contributory defined contribution plan for
substantially all its U.S. employees and a qualified non-contributory defined
contribution plan for all its U.K. employees.
The Company's expenses for its retirement plans is not considered to be
significant.
14. OTHER COMPREHENSIVE INCOME
The balances of each classification, net of deferred taxes, within
accumulated other comprehensive income is as follows:
NET UNREALIZED FOREIGN CURRENCY
APPRECIATION ON TRANSLATION ACCUMULATED OTHER
INVESTMENTS ADJUSTMENTS COMPREHENSIVE INCOME
---------------------------------------------------------
YEAR ENDED DECEMBER 31, 1999
Beginning balance................................. $ 230,068 $ 5,117 $ 235,185
Current year change............................... (211,842) (4,032) (215,874)
---------------------------------------------------------
Ending balance.................................... $ 18,226 $ 1,085 $ 19,311
---------------------------------------------------------
YEAR ENDED DECEMBER 31, 1998
Beginning balance................................. $ 245,482 $ 5,989 $ 251,471
Current year change............................... (15,414) (872) (16,286)
---------------------------------------------------------
Ending balance.................................... $ 230,068 $ 5,117 $ 235,185
---------------------------------------------------------
YEAR ENDED DECEMBER 31, 1997
Beginning balance................................. $ 239,249 $ 8,377 $ 247,626
Current year change............................... 6,233 (2,388) 3,845
---------------------------------------------------------
Ending balance.................................... $ 245,482 $ 5,989 $ 251,471
---------------------------------------------------------
64
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
14. OTHER COMPREHENSIVE INCOME (CONTINUED)
The related tax effects allocated to each component of other comprehensive
income were as follows:
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
-------------------------------------
YEAR ENDED DECEMBER 31, 1999
Unrealized gains (losses) on investments:
Unrealized gains arising during year...................... $(148,536) $(36,394) $(112,142)
Less reclassification adjustment for gains realized in
income................................................. 94,356 (5,344) 99,700
-------------------------------------
Net unrealized losses....................................... (242,892) (31,050) (211,842)
Foreign currency translation adjustments.................... (6,308) (2,276) (4,032)
-------------------------------------
Other comprehensive income.................................. $(249,200) $(33,326) $(215,874)
-------------------------------------
YEAR ENDED DECEMBER 31, 1998
Unrealized gains (losses) on investments:
Unrealized gains arising during year...................... $ 196,512 $ 12,998 $ 183,514
Less reclassification adjustment for gains realized in
income................................................. 211,204 12,276 198,928
-------------------------------------
Net unrealized gains (losses)............................... (14,692) 722 (15,414)
Foreign currency translation adjustments.................... (1,342) (470) (872)
-------------------------------------
Other comprehensive income.................................. $ (16,034) $ 252 $ (16,286)
YEAR ENDED DECEMBER 31, 1997
Unrealized gains (losses) arising during year............. $ 429,246 $ 27,291 $ 401,955
Less reclassification adjustment for gains realized in
income................................................. 410,404 14,682 395,722
-------------------------------------
Net unrealized gains (losses)............................... 18,842 12,609 6,233
Foreign currency translation adjustments.................... (3,674) (1,286) (2,388)
-------------------------------------
Other comprehensive income.................................. $ 15,168 $ 11,323 $ 3,845
-------------------------------------
15. CONTRIBUTED SURPLUS
Under the laws of the Cayman Islands, the use of the Company's contributed
surplus is restricted to the issue of fully paid shares (i.e. stock dividend or
stock split) and the payment of any premium on the redemption of ordinary
shares.
16. DIVIDENDS
The following dividend information relates to the Company without inclusion
of the pooling effect with NAC:
In 1999, four regular quarterly dividends were paid at $0.44 per share to
shareholders of record at February 5, April 23, July 12 and September 24.
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.
65
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
17. TAXATION
Under current Cayman Islands law, the Company is not subject to any taxes
in the Cayman Islands on either income or capital gains. The Company has
received an undertaking that, in the event of any such taxes being imposed, the
Company will be exempted from Cayman Islands income or capital gains taxes until
June 2018.
The Company's U.S. subsidiaries are subject to federal, state and local
corporate income taxes and other taxes applicable to U.S. corporations. The
provision for federal income taxes has been determined on the basis of the
income of each of the Company's U.S. subsidiaries as if a tax return had been
prepared on an individual Company basis. Should the U.S. subsidiaries pay a
dividend to the Company, withholding taxes will apply.
Bermuda presently imposes no income, withholding or capital gains taxes and
the Bermuda subsidiaries are exempted until March 2016 from any such future
taxes pursuant to the Bermuda Exempted Undertakings Tax Protection Act 1966, and
Amended Act 1987.
XL Europe has been approved to carry on business in the International
Services Centre in Dublin. Under Section 39 of the Finance Act 1990, XL Europe
is entitled to benefit from a 10% tax rate on profits (including investment
income) until 2005.
Brockbank, NAC Re International and XL Mid Ocean Re's London branch office
are subject to United Kingdom corporation taxes. Other branches of the Company
are subject to relevant local taxes.
The income tax provision in the consolidated statement of income gives
effect to the permanent differences between financial and taxable income as
applied for each relevant subsidiary. Due to the fact that the Company and
certain subsidiaries are not subject to direct U.S. income taxes and that
certain U.S. subsidiaries have tax-exempt income, the Company's effective income
tax rate for its U.S. operation is less than the statutory U.S. Federal tax
rate.
The tax charge (benefit) in each of the three years ended December 31, 1999
is comprised of amounts from the various taxable jurisdictions in which the
Company operates. For all countries other than the U.S., there generally is no
significant difference between the effective tax rate and the statutory rate in
that jurisdiction. For U.S. operating income (loss), the effective rate differs
from the statutory rate of 35% due primarily to tax-exempt investment income in
all years and merger related costs in 1999.
Significant components of the provision for income taxes attributable to
operations were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
-----------------------------
CURRENT (BENEFIT) EXPENSE:
U.S....................................................... $(27,098) $10,490 $ 43,754
Non U.S................................................... 9,664 14,680 11,745
-----------------------------
Total current (benefit) expense............................. (17,434) 25,170 55,499
-----------------------------
DEFERRED (BENEFIT) EXPENSE:
U.S....................................................... (17,534) 4,729 (23,205)
Non U.S................................................... (4,602) (16) (122)
-----------------------------
Total Deferred (benefit) expense............................ (22,136) 4,713 (23,327)
-----------------------------
TOTAL TAX (BENEFIT) EXPENSE............................... $(39,570) $29,883 $ 32,172
-----------------------------
66
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
17. TAXATION (CONTINUED)
The U.S. subsidiaries current U.S. taxable income for the years ended
December 31, 1999 and 1997 is based on regular taxable income. The current U.S.
tax expense for the year ended December 31, 1998 is based on alternative minimum
taxable income.
U.S. and Non-U.S. taxes paid in the years ended December 31, 1999, 1998 and
1997 were approximately $30 million, $31 million and $38 million, respectively.
The Company's current tax liability is included in "other liabilities" in the
accompanying financial statements and amounted to $11 million in 1999 and
$26 million in 1998.
Significant components of the Company's deferred tax assets and
liabilities, which principally relate to U.S. subsidiaries, as of December 31,
1999 and 1998 were as follows:
YEAR ENDED
DECEMBER 31
-------------------
1999 1998
-------------------
DEFERRED TAX ASSET:
Net unpaid loss reserve discount.......................... $ 81,672 $ 84,008
Net unearned premiums..................................... 10,264 19,888
Unrealized depreciation on investments.................... 11,995 --
Compensation liabilities.................................. 8,960 6,978
Other..................................................... 12,516 3,331
-------------------
Deferred tax asset, gross of valuation allowance............ 125,407 114,205
Valuation allowance......................................... (11,995) -
-------------------
Deferred tax asset, net of valuation allowance.............. 113,412 114,205
-------------------
DEFERRED TAX LIABILITY:
Deferred policy acquisition costs......................... $ 6,850 $ 33,896
Unrealized appreciation on investments.................... - 31,050
Currency translation adjustments.......................... 566 2,755
Other..................................................... 8,068 9,023
-------------------
Deferred tax liability...................................... 15,484 76,724
-------------------
NET DEFERRED TAX ASSET...................................... $ 97,928 $ 37,481
-------------------
Shareholders' equity at December 31, 1999 and 1998 reflects tax benefits of
$1.5 million and $5.6 million, respectively, related to compensation expense
deductions for stock options exercised for one of the Company's U.S.
subsidiaries.
18. STATUTORY FINANCIAL DATA
The Company's ability to pay dividends is subject to certain regulatory
restrictions on the payment of dividends by its subsidiaries. The payment of
such dividends is restricted by applicable laws of Bermuda, Ireland, U.S. and
United Kingdom, including Lloyd's. The Company relies primarily on cash
dividends from XL Insurance and Mid Ocean.
67
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
18. STATUTORY FINANCIAL DATA (CONTINUED)
BERMUDA
Under The Insurance Act, 1978, (as amended by the Insurance Act Amendment
1995) amendments thereto and related regulations of Bermuda, XL Insurance and XL
Mid Ocean Re 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.
XL Insurance's and XL Mid Ocean Re's statutory capital and surplus,
statutory net income and the minimum statutory capital and surplus required by
the Act were as follows:
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------------
XL INSURANCE XL MID OCEAN RE
---------------------------------- ----------------------------------
1999 1998 1997 1999 1998 1997
-----------------------------------------------------------------------
Statutory net income.......... $ 83,019 $ 309,244 $189,281 $ 155,534 $ 108,290 $ 57,995
-----------------------------------------------------------------------
Statutory capital and
surplus..................... $1,381,299 $1,255,284 $882,366 $2,062,421 $1,966,200 $512,367
-----------------------------------------------------------------------
Minimum statutory capital and
surplus Required by the
Act......................... $ 338,609 $ 307,205 $310,240 $ 196,254 $ 100,000 $100,000
-----------------------------------------------------------------------
The primary difference between statutory net income and statutory capital
and surplus for the Company's subsidiaries, as shown above, and net income and
shareholders' equity presented in accordance with GAAP are deferred acquisition
costs.
Under the Act, XL Insurance and XL Mid Ocean 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 Mid Ocean Re have not been affected by this.
UNITED STATES
The Company's U.S. insurance and reinsurance subsidiaries are subject to
regulatory oversight under the insurance statutes and regulations of the
jurisdictions in which they conduct business.
Consolidated statutory net income and surplus of NAC Re, as reported to the
insurance regulatory authorities, differs in certain respects from the amounts
as prepared in accordance with GAAP. The main differences between statutory net
income and GAAP income relates to deferred acquisition costs and deferred income
taxes. The main differences between statutory surplus and shareholders' equity,
in addition to deferred acquisition costs and deferred income tax net assets,
are intangible assets, unrealized appreciation on investments, and any
unauthorized/authorized reinsurance charges.
68
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
18. STATUTORY FINANCIAL DATA (CONTINUED)
The following table shows statutory net income and GAAP net income (loss)
and consolidated statutory surplus and consolidated shareholders' equity of NAC
Re.
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
------------------------------
NET INCOME:
Statutory net income........................................ $ 8,948 $101,862 $ 70,292
------------------------------
GAAP net income (loss)...................................... $ (1,060) $ 98,586 $ 99,692
------------------------------
SHAREHOLDERS' EQUITY:
Consolidated statutory surplus.............................. $440,102 $737,114 $702,222
------------------------------
GAAP Consolidated shareholder's equity...................... $700,725 $750,725 $657,061
------------------------------
NAC Re is subject to New York insurance law, which imposes certain
restrictions on the payment of cash dividends and tax reimbursements. Generally,
NAC Re may pay cash dividends only out of statutory earned surplus. However, the
maximum amount of dividends that may be paid in any twelve month period without
the prior approval of the New York Insurance Department is the lesser of net
investment income or 10% of statutory surplus as such terms are defined in the
New York insurance law. Statutory earned surplus at December 31, 1999 is $(27.7)
million and consequently, NAC Re cannot make a dividend distribution. In
addition, the Company was required to make a commitment to New York State
insurance regulators not to pay dividends out of NAC Re for two years without
prior regulatory approval. Statutory earned surplus at December 31, 1998 was
$231.9 million and the maximum amount NAC Re was able to pay without such
regulatory approval, based on 10% of statutory surplus as of December 31, 1998
was approximately $73.7 million.
Brockbank, via Lloyd's, is a licensed insurer in the states of Illinois,
Kentucky and the U.S. Virgin Islands ("USVI"). It is also an eligible surplus
lines writer in all states other than Kentucky and USVI, and an accredited
reinsurer in every state other than Michigan, Kansas and Arizona. Brockbank
Insurance Services, Inc., is licensed in California as a fire and casualty
broker, surplus lines broker and special lines surplus lines broker.
The insurance laws of each state of the U.S. and of many foreign countries
regulate the sale of insurance within their jurisdiction by alien insurers, such
as XL Insurance and XL Mid Ocean Re. The Company believes it is not in violation
of the insurance laws of any state in the U.S. or any foreign country. From time
to time, various proposals for federal legislation within the United States have
been circulated which could require the Company to, amongst other things,
register as a surplus lines insurer. The Company believes that generally it
could meet and comply with the requirements to be registered as a surplus lines
insurer and such compliance would not have a material impact on the ability of
the Company to conduct its business. There can be no assurances, however, that
the activities of the Company will not be challenged in the future or that the
Company will be able to successfully defend against such challenges or that
legislation will not be enacted that will affect the Company's ability to
conduct its business.
IRELAND
XL Europe is permitted to cover risks throughout the European Community
(subject to certain restrictions) pursuant to the "Third Directive" relating to
non-life insurance. Its head office is in Ireland and it is subject to
regulation under Irish regulatory authority. The principal legislation and
regulations governing the insurance activities of Irish insurance companies are
the Insurance Acts 1909 to 1990 (the "Irish Acts") and a comprehensive network
of
69
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
18. STATUTORY FINANCIAL DATA (CONTINUED)
regulations and statutory provisions empowering the making of regulations of
which the most relevant are the European Communities (Non-Life Insurance)
Regulations, 1976, the European Communities (Non-Life Insurance Accounts)
Regulations, 1995, the European Communities (Non-Life Insurance) Framework
Regulations, 1994 and related administrative rules (the "Irish Regulations".)
XL Europe's insurance activities are subject to extensive regulation in
Ireland, principally under the Irish Acts and Irish Regulations, which impose on
insurers headquartered in Ireland minimum solvency and reserve standards and
auditing and reporting requirements and grant to the Minister of State for
Science, Technology and Commerce (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 medium of the Department of
Enterprise, Trade and Employment.
UNITED KINGDOM
The United Kingdom Financial Services Authority ("U.K. FSA") regulates
reinsurance entities that are "effecting and carrying on" insurance business in
the United Kingdom. Both XL Mid Ocean Re, through its London branch and NAC Re,
through its London subsidiary, "effect and carry on" business in the United
Kingdom and are therefore regulated by the U.K. FSA.
LLOYD'S
The Company, Brockbank and Denham are subject to the regulatory
jurisdiction of the Council of Lloyd's (the "Council"). Unlike other financial
markets in the U.K., Lloyd's is not subject to direct U.K. government regulation
through The Financial Services Act of 1986 but, instead, is self regulating by
virtue of the Lloyd's Act of 1982 through the bye-laws, regulations and codes of
conduct written by the Council, which governs the market. It is expected that
the new Financial Services Authority will take a supervisory regulatory role
during 2000. Under the Council, there are two boards, the Market Board and the
Regulatory Board. The former is led by a number of the working members of the
Council and is responsible for strategy and the provision of services such as
premium and claims handling, accounting and policy signing. The Regulatory Board
is responsible for the regulation of the market, compliance and the protection
of policyholders and capital providers. Under the regulations, the approval of
the Council has to be obtained before any person can be a "major shareholder" or
"controller" of a corporate Name or managing agency. The Company has been
approved as both a "major shareholder" and a "controller" of its corporate Names
(the "CCVs") and managing agencies.
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.
The Lloyd's Act of 1982 generally restricts certain direct or indirect
equity cross-ownership between a Lloyd's broker and a Lloyd's managing agent.
70
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
18. STATUTORY FINANCIAL DATA (CONTINUED)
OTHER REGULATION
The Company is subject to regulation in Australia, Singapore, Madrid, Latin
America and Germany as a result of its representative offices and branches in
such jurisdictions.
19. EARNINGS PER SHARE
The following table sets forth the computation of the basic and diluted
earnings per share:
YEAR ENDED DECEMBER 31:
------------------------------
1999 1998 1997
------------------------------
BASIC EARNINGS PER SHARE:
Net income.................................................. $470,509 $656,330 $809,029
Weighted average ordinary shares outstanding................ 127,601 112,034 101,708
Basic earnings per share.................................... $ 3.69 $ 5.86 $ 7.95
------------------------------
DILUTED EARNINGS PER SHARE:
Net income.................................................. $470,509 $656,330 $809,029
Add back after-tax interest on convertible debentures....... 1,752 3,504 3,504
------------------------------
Adjusted net income......................................... $472,261 $659,834 $812,533
------------------------------
Weighted average ordinary shares outstanding - basic........ 127,601 112,034 101,708
Average stock options outstanding (1)....................... 1,872 2,152 1,277
Conversion of convertible debentures (2).................... 831 2,020 2,020
------------------------------
Weighted average ordinary shares outstanding - diluted...... 130,304 116,206 105,005
------------------------------
Diluted earnings per share.................................. $ 3.62 $ 5.68 $ 7.74
------------------------------
(1) Net of shares repurchased under the treasury stock method.
(2) 1998 and 1997 reflect the assumed conversion of the NAC 5.25% Convertible
Subordinated Debentures due 2000. The Debentures were called in June 1999
and the actual conversion is reflected in 1999.
20. SUBSEQUENT EVENTS
On January 17, 2000, the Company entered into a stock repurchase agreement
with Risk Capital Holdings. Under this agreement, in exchange for its shares in
Risk Capital and $3.6 million in cash, the Company will receive the effective
remaining ownership in Latin America Re and 1.4 million shares and 100,000
warrants in Annuity & Life Re, in which the Company has an existing 7% position.
The total value of the transaction was $62.8 million.
71
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
21. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly financial data for
1999 and 1998 based upon the Company's amended year end of December 31 and the
pooling with NAC:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-----------------------------------------
1999
Net premiums earned..................................... $386,753 $414,386 $488,729 $460,138
Net investment income................................... 135,680 132,593 126,560 130,485
Net realized gains on interest.......................... 67,476 17,584 (12,671) 21,967
Equity in net income (loss) of affiliates............... (7,307) 16,642 15,372 16,200
Fee and other income.................................... 10,551 3,870 28,800 57,179
-----------------------------------------
Total revenues.......................................... $593,153 $585,075 $646,790 $685,968
-----------------------------------------
Income before income tax expense and minority interest.. $214,114 $ 28,886 $139,427 $ 48,732
-----------------------------------------
Net Income.............................................. $209,811 $ 62,708 $137,402 $ 60,588
-----------------------------------------
Net income per share and share equivalent - basic....... $ 1.63 $ 0.49 $ 1.08 $ 0.57
-----------------------------------------
Net income per share and share equivalent - diluted..... $ 1.58 $ 0.48 $ 1.07 $ 0.56
-----------------------------------------
1998
Net premiums earned..................................... $274,149 $264,568 $384,136 $401,438
Net investment income................................... 92,923 87,183 111,320 125,864
Realized gains on investments........................... 77,349 58,400 28,476 46,979
Equity in net income tax expense........................ 15,501 20,721 17,451 (3,381)
Fee and other income.................................... 4,172 1,437 8,567 8,149
-----------------------------------------
Total revenues.......................................... $464,094 $432,309 $549,950 $579,049
-----------------------------------------
Income before income tax expense and minority interest.. $193,833 $171,313 $148,882 $172,934
-----------------------------------------
Net income.............................................. $186,301 $165,422 $140,271 $164,336
-----------------------------------------
Net income per share and share equivalent - basic....... $ 1.84 $ 1.63 $ 1.20 $ 1.28
-----------------------------------------
Net income per share and share equivalent - diluted..... $ 1.78 $ 1.58 $ 1.17 $ 1.25
-----------------------------------------
72
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands)
22. UNAUDITED CONDENSED PRO FORMA FINANCIAL INFORMATION
Unaudited condensed pro forma financial information shown below relates to
the Company's acquisition of Mid Ocean in August 1998 and is based upon the
assumption that Mid Ocean had been a part of the Company's operations since
January 1, 1997.
PRO FORMA PRO FORMA
1998 1997
-----------------------
Net premiums earned......................................... $1,588,791 $1,607,768
Net investment income....................................... 494,389 443,031
Net realized gains on sale of investments................... 260,608 378,213
Equity in earnings (loss) of affiliates..................... (1,897) 3,748
Fee and other income........................................ 28,006 24,710
-----------------------
Total revenues............................................ 2,369,887 2,457,470
-----------------------
Losses and loss expenses.................................... 921,018 966,909
Acquisition costs and operating expenses.................... 514,877 450,893
Interest expense............................................ 44,839 46,311
Amortization of intangible assets........................... 45,464 37,560
-----------------------
Total expenses............................................ 1,526,198 1,501,673
-----------------------
Income before minority interest and income tax expense...... 843,689 955,797
Minority interest and income tax............................ 34,535 45,653
-----------------------
Net income................................................ $ 809,154 $ 910,144
-----------------------
Net income per share
Basic..................................................... $ 6.33 $ 7.08
Diluted................................................... $ 6.13 $ 6.89
Weighted average shares outstanding (000's)
Basic..................................................... 127,883 128,550
Diluted................................................... 132,036 132,173
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
There have been no changes in or any disagreements with accountants
regarding accounting and financial disclosure within the twenty-four months
ending December 31, 1999.
73
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This item is omitted because a definitive proxy statement which involves
the election of directors will be filed with the Securities and Exchange
Commission not later than 120 days after the close of the fiscal year pursuant
to Regulation 14A, which proxy statement is incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
This item is omitted because a definitive proxy statement which involves
the election of directors will be filed with the Securities and Exchange
Commission not later than 120 days after the close of the fiscal year pursuant
to Regulation 14A, which proxy statement is incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This item is omitted because a definitive proxy statement which involves
the election of directors will be filed with the Securities and Exchange
Commission not later than 120 days after the close of the fiscal year pursuant
to Regulation 14A, which proxy statement is incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is omitted because a definitive proxy statement which involves
the election of directors will be filed with the Securities and Exchange
Commission not later than 120 days after the close of the fiscal year pursuant
to Regulation 14A, which proxy statement is incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
PAGE
--------
(a) Financial Statements, Financial Statement Schedules
and Exhibits.
- Report of PricewaterhouseCoopers LLP on
Financial Statements and Financial Statement
Schedules....................................... 79
- Report of Ernst and Young LLP on Financial
Statements and Financial Statement Schedules.... 80
1. FINANCIAL STATEMENTS
Included in Part II--See Item 8 of this report.
2. FINANCIAL STATEMENT SCHEDULES
Included in Part IV of this report:
SCHEDULE
NUMBER PAGE
-------------------
- Consolidated Summary of Investments - Other than
Investments in Related Parties, as of December 31,
1999.................................................... I 81
- Condensed Financial Information of Registrant, as of
December 31, 1999 and 1998 and for the years ended
December 31, 1999, 1998, and 1997....................... II 82
- Reinsurance, for the years ended December 31, 1999, 1998
and 1997................................................ IV 85
- Supplementary Information Concerning Property/Casualty
Insurance Operations for the years ended December 31,
1999, 1998 and 1997..................................... VI 86
74
Other Schedules have been omitted as they are not applicable to the
Company.
3. EXHIBITS
3.1 Memorandum of Association, incorporated by reference to
Annex G to the Joint Proxy Statement of EXEL Limited and Mid
Ocean limited dated July 2, 1998.
3.2 Articles of Association, incorporated by reference to Annex
G to the Joint Proxy Statement of EXEL Limited and Mid Ocean
Limited dated July 2, 1998.
4.1 Rights Agreement, dated as of September 11, 1998 between the
Company and ChaseMellon Shareholder Services, L.L.C., as
Rights Agent, incorporated by reference to the Company's
Current Report on Form 8-K dated October 21, 1998.
10.1 Money Accumulation Savings Program, incorporated by
reference to Exhibit 10.15 to the Company's Registration
Statement on Form S-1 (No. 33-40533).
10.2 1991 Performance Incentive Program, incorporated by
reference to Exhibit 10.16 to the Company's Registration
Statement on Form S-1 (No. 33-40533).
10.3 1991 Management's incentive Plan, incorporated by reference
to Exhibit 10.17 to the Company's Registration Statement on
Form S-1 (No. 33-40533).
10.4 First Amendment to the 1991 Performance Incentive Program,
incorporated by reference to Exhibit 10.4 to the Company's
Annual Report on Form 10-K for the year ended November 30,
1996.
10.5 Retirement Plan for Non-employee Directors of XL Capital
Ltd, as amended, incorporated by reference Exhibit 10.5 to
the Company's Annual Report on Form 10-K for the year ended
November 30, 1996.
10.6.1 XL Capital Ltd Directors Stock and Option Plan, as amended,
incorporated by reference to Exhibit 10.6 to the Company's
Annual Report on Form 10-K for the year ended November 30,
1996.
10.6.2 Fourth Amendment to EXEL Limited Directors Stock and Option
Plan, incorporated by reference to Exhibit 10.6.2 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.7 XL Capital Ltd Stock Plan for Non-employee Directors,
incorporated by reference to Exhibit 10.6 to the Company's
Annual report on Form 10-K for the year ended November 30,
1996.
10.8 (Intentionally omitted)
10.9.1 Mid Ocean Limited 1993 Long Term Incentive and Share Award
Plan, incorporated by reference to Exhibit 10.9.1 to the
Company's Annual report on form 10-K (No. 1-10804) for the
year ended November 30, 1998
10.9.2 Amendment to Mid Ocean Limited 1993 Long Term Incentive and
Share Award Plan, incorporated by reference to Exhibit
10.9.2 to the Company's Annual Report on Form 10-K (No.
1-10804) for the year ended November 30, 1998.
10.10.1 Mid Ocean Ltd. Stock & Deferred Compensation Plan for
Non-employee Directors, incorporated by reference to Exhibit
10.10.1 to the Company's Annual Report on Form 10-K (No.
1-10804) for the year ended November 30, 1998.
10.10.2 Form of Severance Contract between NAC Re Corp. and the
executive officers of NAC Re incorporated herein by
reference to the Company's Annual Report on Form 10-K of NAC
Re for the year ended December 30, 1988.
10.10.3 1997 incentive and capital Accumulation Plan incorporated by
reference to Exhibit A to the NAC Re definitive Proxy
Statement filed with the Securities and Exchange Commission.
75
10.11.1 Mark E. Brockbank Employment Agreement, incorporated by
reference to Exhibit 10.11.1 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.11.2 Henry C.V. Keeling Employment Agreement, incorporated by
reference to Exhibit 10.11.2 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.11.4 Robert J. Newhouse, Jr. Employment Agreement, incorporated
by reference to Exhibit 1 to the Company's Annual Report on
Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.11.5 Michael A. Butt Employment Agreement, incorporated by
reference to Exhibit 10.11.5 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.1 Amendment to Brockbank Service Agreement, incorporated by
reference to Exhibit 10.12.1 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.2 Amendment to Keeling Service Agreement, incorporated by
reference to Exhibit 10.12.2 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.3 Amendment to Newhouse Service Agreement, incorporated by
reference to Exhibit 10.12.3 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.12.4 Amendment to Butt Service Agreement, incorporated by
reference to Exhibit 10.12.4 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.13.1 Robert J. Newhouse Consulting Agreement, incorporated by
reference to Exhibit 10.13.1 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.13.2 Ronald L. Bornheutter Consulting Agreement dated as of
July 1, 1999.
10.13.3 Ronald L. Bornheutter Settlement Agreement dated as of
June 30, 1999.
10.13.4 Employment Contract with Nicholas M. Brown, Jr. dated as of
June 30, 1998, incorporated herein by reference to NAC Re's
quarterly report on Form 10Q for June 30, 1998.
10.13.5 Amended and Restated Employment Agreement with Nicholas M.
Brown, Jr., dated as of June 18, 1999.
10.14.1 Credit Agreement (5-Year) between Mid Ocean Limited and The
Chase Manhattan Bank, incorporated by reference to Exhibit
10.14.1 to the Company's Annual Report on Form 10-K (No.
1-10804) for the year ended November 30, 1998.
10.14.2 Amendment No. 1 to Credit Agreement (5-Year) between Mid
Ocean Limited and The Chase Manhattan Bank, incorporated by
reference to Exhibit 10.14.2 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.14.3 Amendment No. 2 to Credit Agreement (5-Year) between Mid
Ocean Limited and The Chase Manhattan Bank.
10.14.4 Amendment No. 3 to Credit Agreement (5-Year) between Mid
Ocean Limited and The Chase Manhattan Bank.
10.14.5 Credit Agreement (364-Day) between Mid Ocean Limited and The
Chase Manhattan Bank, incorporated by reference to Exhibit
10.14.3 to the Company's Annual Report on Form 10-K (No.
1-10804) for the year ended November 30, 1998.
10.14.6 Amendment No. 1 to Credit Agreement (364-Day) between Mid
Ocean Limited and The Chase Manhattan Bank, incorporated by
reference to Exhibit 10.14.4 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November
30,1998.
10.14.7 Loan Agreement between XL America, Inc. and Three Rivers
Funding Corporation, incorporated by reference to Exhibit
10.14.5 to the Company's Annual Report on Form 10-K (No.
1-10804) for the year ended November 30,1998.
76
10.14.8 Letter of Credit Facility and Reimbursement Agreement by and
among XL Insurance Company, Ltd. et al. and Mellon Bank,
N.A., incorporated by reference to Exhibit 10.14.6 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30,1998.
10.14.9 First Amendment to Letter of Credit Facility Reimbursement
Agreement by and among XL Insurance Company, Ltd. et al. and
Mellon Bank N.A., incorporated by reference to Exhibit
10.14.7 to the Company's Annual Report on Form 10-K (No.
1-10804) for the year ended November 30,1998.
10.14.10 Second Amendment to Letter of Credit Facility Reimbursement
Agreement by and among XL Insurance Company, Ltd. et al. and
Mellon Bank N.A., incorporated by reference to Exhibit
10.14.8 to the Company's Annual Report on Form 10-K (No.
1-10804) for the year ended November 30,1998.
10.14.11 Short Term Revolving Credit Agreement between XL Insurance
Company, Ltd. and Mellon Bank N.A., incorporated by
reference to Exhibit (b)(1) of Amendment No. 2 to the
Schedule 14D-1 (the "GCR Schedule 14D-1") of EXEL Limited
filed with respect to GCR Holdings Company Limited,
incorporated by reference to Exhibit 10.14.9 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.12 First Amendment to Short Term Revolving Credit Agreement
between XL Insurance Company, Ltd. and Mellon Bank N.A.,
incorporated by reference to Exhibit 10.14.10 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.13 Second Amendment to Short Term Revolving Credit Agreement
between XL Insurance Company, Ltd. and Mellon Bank N.A.,
incorporated by reference to Exhibit 10.14.11 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.14 Third Amendment to Short Term Revolving Credit Agreement
between XL Insurance company, Ltd. and Mellon Bank N.A.,
incorporated by reference to Exhibit 10.14.12 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.15 Fourth Amendment to Short Term Revolving Credit Agreement
between XL Insurance Company, Ltd. and Mellon Bank N.A.,
incorporated by reference to Exhibit 10.14.13 to the
Company's Annual Report on Form 10-K (No. 1-10804) for the
year ended November 30, 1998.
10.14.16 Revolving Credit Agreement Between XL Insurance Company,
Ltd. and Mellon Bank N.A., incorporated by reference to
Exhibit (b)(2) of the GCR Schedule 14D-1, incorporated by
reference to Exhibit 10.14.14 to the Company's Annual Report
on Form 10-K (No. 1-10804) for the year ended November 30,
1998.
10.14.17 First Amendment to Revolving Credit Agreement between XL
Insurance Company, Ltd. and Mellon Bank N.A., incorporated
by reference to Exhibit 10.14.15 to the Company's Annual
Report on Form 10-K for the year ended November 30, 1998.
10.14.18 Second Amendment to Revolving Credit Agreement between XL
Insurance Company, Ltd. and Mellon Bank N.A., incorporated
by reference to Exhibit 10.14.16 to the Company's Annual
Report on Form 10-K for the year ended November 30, 1998.
10.14.19 Third Amendment to Revolving Credit Agreement between XL
Insurance Company, Ltd. and Mellon Bank, N.A.
10.14.20 Fourth Amendment to Revolving Credit Agreement between XL
Insurance Company, Ltd. and Mellon Bank, N.A.
10.14.21 Fifth Amendment to Revolving Credit Agreement between XL
Insurance Company, Ltd. and Mellon Bank, N.A.
10.14.22 Short Term Revolving Credit Agreement between XL Capital Ltd
et al and Mellon Bank, N.A.
10.14.23 First Amendment to Short Term Revolving Credit Agreement
between XL Capital Ltd et al. and Mellon Bank, N.A.
77
10.14.24 Letter of Credit Facility and Reimbursement Agreement dated
as of June 30, 1999 by and among XL Insurance Ltd et al. and
Mellon Bank, N.A.
10.14.25 First Amendment to Letter of Credit Facility and
Reimbursement Agreement dated as of June 30, 1999 by and
among XL Insurance Ltd et al. and Mellon Bank, N.A.
10.14.26 Letter of Credit Facility and Reimbursement Agreement dated
as of December 30, 1999 by and among XL Insurance Ltd et al.
and Mellon Bank, N.A.
10.14.27 First Amendment to Letter of Credit Facility and
Reimbursement Agreement dated as of December 30, 1999 by and
among XL Insurance Ltd et al. and Mellon Bank, N.A.
10.14.28 Letter of Credit Agreement dated as of December 17, 1999 by
and among XL Insurance Ltd, XL Mid Ocean Reinsurance Ltd and
The Chase Manhattan Bank.
10.14.29 Letter of Credit Facility Agreement dated as of
December 17, 1999 by and among XL Capital Ltd et al. and ING
Bank, N.V. (London Branch)
10.14.30 Amendment No. 1 to Letter of Credit Facility Agreement dated
as of December 17, 1999 by and among XL Capital Ltd et al.
and ING Bank, N.V. (London Branch)
11.1 Statement regarding computation of per share earnings.
21.1 List of subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Ernst & Young LLP
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of 1999.
78
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of XL Capital Ltd.:
In our opinion, based upon our audits and the report of other auditors, the
accompanying consolidated balance sheets, the related consolidated statements of
income and comprehensive income, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of XL
Capital Ltd. and its subsidiaries at December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999, in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedules listed in Item 14(a) of this Form 10-K, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein. These financial statements and financial statement schedules
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements and financial statement
schedules based on our audits. We conducted our audits of these statements and
schedules in accordance with generally accepted auditing standards 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. We did not
audit the financial statements or financial statement schedules of NAC Re Corp.
as at December 31, 1998, which statements reflect total assets of $3.2 billion
as of December 31, 1998 and total revenues of $699.4 million and $740.4 million
for the years ended December 31, 1998 and 1997, respectively. Those statements
were audited by other auditors whose report thereon has been furnished to us,
and our opinion expressed herein, insofar as it relates to the amounts included
for NAC Re Corp. for those dates, is based solely on the report of the other
auditors.
We previously audited and reported on the consolidated balance sheets, the
related consolidated statements of income and comprehensive income, of
shareholders' equity and of cash flows and the supplemental schedules of XL
Capital Ltd. and its subsidiaries as at and for the two years ended
November 30, 1998 prior to their restatement for the 1999 pooling of interests
and change in fiscal year. We also audited the combination of the accompanying
consolidated balance sheet as of December 31, 1998 and the consolidated
statements of income and comprehensive income, of shareholders' equity and of
cash flows for the two years ended December 31, 1998, after restatement for the
1999 pooling of interest. In our opinion, such consolidated statements have been
properly combined on the basis described in Note 6 of the consolidated financial
statements.
PRICEWATERHOUSECOOPERS LLP
New York, New York
February 9, 2000
79
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
NAC Re Corporation:
We have audited the consolidated balance sheet of NAC Re Corporation and
subsidiaries as of December 31, 1998 and the related consolidated statements of
income, stockholders' equity and cash flows for each of the two years in the
period ended December 31, 1998 (not presented separately herein). Our audits
also included the financial statements schedules listed in the Index at Item 14
of the 1998 NAC Re Corporation annual report on Form 10-K (not presented
separately herein). These financial statements and schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
NAC Re Corporation and subsidiaries at December 31, 1998, and the consolidated
results of their operations and cash flows for each of the two years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedules,
when considered in relation to the basic financial statements taken as a whole,
present fairly in all respects, the information set forth therein.
Ernst & Young LLP
New York, New York
February 3, 1999
Except for Note 15, as to which the date is
February 15, 1999
80
XL CAPITAL LTD
SUPPLEMENTAL SCHEDULE I
CONSOLIDATED SUMMARY OF INVESTMENTS--OTHER THAN
INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1999
(U.S dollars in thousands)
AMOUNT AT
WHICH SHOWN
COST OR IN THE
AMORTIZED MARKET BALANCE
TYPE OF INVESTMENT COST (1) VALUE SHEET
- ----------------- -------------------------------------
Fixed Maturities:
Bonds and notes:
U.S. government and government agencies and
authorities......................................... $ 560,628 $ 558,202 $ 558,202
U.S states and political subdivisions of the States.... 779,328 769,776 769,776
Non-U.S. sovereign governments......................... 767,245 759,794 759,794
Mortgage-backed securities............................. 1,118,105 1,086,089 1,086,089
All other corporate.................................... 4,610,613 4,407,290 4,407,290
-------------------------------------
Total fixed maturities.............................. $7,835,919 $7,581,151 $7,581,151
-------------------------------------
Equity Securities:.......................................... $ 863,020 $1,136,180 $1,136,180
-------------------------------------
Short-term investments...................................... $ 405,375 $ 405,260 $ 405,260
-------------------------------------
Total investments........................................... $9,104,314 $9,122,591 $9,122,591
-------------------------------------
(1) Investments in fixed maturities and short-term investments are shown at
amortized cost.
81
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS--PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
(U.S. dollars in thousands)
1999 1998
-----------------------
A S S E T S
Portfolio Investments:
Fixed maturities at fair value (amortized cost: 1999,
$101,233; 1998, $244,713).............................. $ 99,816 $ 245,713
Short-term investments at fair value (amortized cost:
1999, $43,563; 1998, $5,569)........................... 43,499 5,698
-----------------------
Total portfolio investments............................ 143,315 251,411
Cash and cash equivalents................................... 125,619 148,681
Investments in subsidiaries on an equity basis.............. 6,296,880 5,983,598
Investments in limited partnership.......................... 39,352 20,378
Accrued investment income................................... 539 1,967
Other assets................................................ 9,026 3,888
-----------------------
Total assets........................................... $6,614,731 $6,409,923
-----------------------
L I A B I L I T I E S
Amount due to subsidiaries.................................. 909,610 $ 679,799
Accounts payable and accrued liabilities.................... 128,043 117,521
-----------------------
Total liabilities...................................... $1,037,653 $ 797,320
-----------------------
S H A R E H O L D E R S' E Q U I T Y
Ordinary shares............................................. $ 1,278 $ 1,287
Contributed surplus......................................... 2,520,136 2,508,062
Accumulated other comprehensive income...................... 19,311 235,185
Deferred compensation....................................... (28,797) (22,954)
Retained earnings........................................... 3,065,150 2,891,023
-----------------------
Total shareholders' equity............................. 5,577,078 $5,612,603
-----------------------
Total liabilities and shareholders' equity............. $6,614,731 $6,409,923
-----------------------
82
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF INCOME AND COMPREHENSIVE INCOME--PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(U.S. dollars in thousands)
1999 1998 1997
------------------------------
Net investment income....................................... $ 1,890 $ 2,738 $ 64
Net realized gains (losses)................................. (278) 458 -
Equity in net income of subsidiaries (Dividends were Nil,
$117,900 and $186,548 in 1999, 1998 and 1997,
respectively.............................................. 560,166 632,521 749,554
Equity in net income of affiliate........................... - 49,878 62,135
Income from limited partnership............................. 4,947 3,599 4,342
------------------------------
Total revenues.............................................. 566,725 689,194 816,095
Operating expenses.......................................... 96,216 32,864 7,066
------------------------------
Net income.................................................. 470,509 $656,330 $809,029
------------------------------
Change in net unrealized appreciation on investments........ (3,084) 1,603 -
------------------------------
Comprehensive income........................................ $467,425 $657,933 $809,029
------------------------------
83
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF CASH FLOWS - PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(U.S dollars in thousands)
1999 1998 1997
---------------------------------
Cash flows provided by operating activities:
Net income................................................ $ 470,509 $ 656,330 $ 809,029
Adjustments to reconcile net income to net cash provided
by operating activities:
Net realized gains from sale of shares in affiliate.... - (458) -
Equity in net income of subsidiaries net of
dividends........................................... (557,317) (503,838) (553,607)
Equity in net income of affiliate net of dividends..... - (31,410) (34,849)
Accrued investment income.............................. 1,428 (1,967) -
Amount due from subsidiaries........................... 229,811 651,753 37,151
Accounts payable and accrued liabilities............... 10,522 116,402 (444)
Amortization of intangible assets...................... 31,348 10,494 -
Amortization of deferred compensation.................. 7,657 5,815 5,237
Amortization of discounts on fixed maturities.......... 366 335 -
Other assets........................................... (5,138) (631) (64)
---------------------------------
Total adjustments................................... (281,323) 246,495 (546,576)
---------------------------------
Net cash provided by operating activities........... 189,186 902,825 262,453
---------------------------------
Cash flows provided by (used in) investing activities:
Proceeds from sale of fixed maturities and short-term
Investments............................................ 118,756 198,893 -
Proceeds from redemption of fixed maturities and
short-term investments................................. 107,885 53,325 -
Purchases of fixed maturities and short term
investments............................................ (121,995) (501,957) -
Investment in limited partnership......................... (18,974) (1,129) 203
---------------------------------
Net cash provided (used in) by investing activities.... 85,672 (250,868) 203
---------------------------------
Cash flows used in financing activities:
Issuance of restricted shares............................. 69 514 387
Proceeds from exercise of options......................... 14,014 15,092 12,284
Dividends paid............................................ (212,659) (156,481) (120,607)
Repurchase of treasury shares............................. (99,344) (362,401) (154,720)
---------------------------------
Net cash used in financing activities............... (297,920) (503,276) (262,656)
---------------------------------
Net change in cash and cash equivalents............. (23,062) $ 148,681 -
Cash and cash equivalents - beginning of year............... $ 148,681 - -
---------------------------------
Cash and cash equivalents - end of year..................... $ 125,619 $ 148,681 -
---------------------------------
84
XL CAPITAL LTD
SCHEDULE IV--REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(U.S dollars in thousands)
CEDED ASSUMED
GROSS TO OTHER FROM OTHER NET
AMOUNT COMPANIES COMPANIES AMOUNT
-------------------------------------------------
1999................................................ $1,088,028 $541,037 $1,354,892 $1,901,883
-------------------------------------------------
1998................................................ $ 779,551 $319,275 $ 863,988 $1,324,264
-------------------------------------------------
1997................................................ $ 517,773 $254,940 $ 617,612 $ 880,445
-------------------------------------------------
85
XL CAPITAL LTD
SCHEDULE VI
SUPPLEMENTARY INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(U.S dollars in thousands)
LOSSES AND LOSS EXPENSES
INCURRED RELATED TO
RESERVES ------------------------ PAID
DEFERRED FOR LOSSES RESERVES FOR NET LOSSES
ACQUISITION AND LOSS UNEARNED NET EARNED INVESTMENT CURRENT PRIOR AND LOSS
COSTS EXPENSES PREMIUMS PREMIUMS INCOME YEAR (1) YEAR (2) EXPENSES
---------------------------------------------------------------------------------------------------------
1999................. $275,716 $5,369,402 $1,497,376 $1,750,006 $525,318 $1,591,414 $(287,110) $1,093,502
---------------------------------------------------------------------------------------------------------
1998................. $204,271 $4,896,643 $1,337,277 $1,324,291 $417,290 $1,085,161 $(243,617) $ 730,889
---------------------------------------------------------------------------------------------------------
1997................. $113,566 $3,972,376 $ 824,369 $1,114,758 $345,115 $1,056,228 $(317,379) $ 330,951
---------------------------------------------------------------------------------------------------------
AMORTIZATION
OF DEFERRED NET
ACQUISITION PREMIUMS
COSTS WRITTEN
-------------------------
1999................. $380,980 $1,901,883
-------------------------
1998................. $249,341 $1,324,264
-------------------------
1997................. $198,017 $ 880,445
-------------------------
86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
XL CAPITAL LTD
By /s/ BRIAN M. O'HARA
---------------------------------------------
Brian M. O'Hara
PRESIDENT AND CHIEF EXECUTIVE OFFICER
March 17,2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ BRIAN M. O'HARA President, Chief Executive
------------------------------------------------ Officer and Director March 17, 2000
Brian M. O'Hara (Principal Executive Officer)
Executive Vice President and
Chief
/s/ ROBERT R. LUSARDI Financial Officer (Principal
------------------------------------------------ Financial March 17, 2000
Robert R. Lusardi Officer and Principal
Accounting
Officer)
/s/ MICHAEL ESPOSITO JR.
------------------------------------------------ Director and Chairman of the March 17, 2000
Michael Esposito, Jr. Board of Directors
/s/ RONALD L. BORNHUETTER
------------------------------------------------ Director March 17, 2000
Ronald L. Bornhuetter
/s/ MICHAEL A. BUTT
------------------------------------------------ Director March 17, 2000
Michael A. Butt
/s/ ROBERT CLEMENTS
------------------------------------------------ Director March 17, 2000
Robert Clements
/s/ SIR BRIAN CORBY
------------------------------------------------ Director March 17, 2000
Sir Brian Corby
/s/ ROBERT R. GLAUBER
------------------------------------------------ Director March 17, 2000
Robert R. Glauber
87
SIGNATURES TITLE DATE
---------- ----- ----
/s/ ROBERT V. HATCHER, JR.
------------------------------------------------ Director March 17, 2000
Robert V. Hatcher, Jr.
/s/ IAN R. HEAP
------------------------------------------------ Director March 17, 2000
Ian R. Heap
/s/ PAUL JEANBART
------------------------------------------------ Director March 17, 2000
Paul Jeanbart
/s/ JOHN LOUDON
------------------------------------------------ Director March 17, 2000
John Loudon
/s/ DANIEL MCNAMARA
------------------------------------------------ Director March 17, 2000
Daniel McNamara
/s/ ROBERT J. NEWHOUSE, JR.
------------------------------------------------ Director March 17, 2000
Robert J. Newhouse, Jr.
/s/ ROBERT S. PARKER
------------------------------------------------ Director March 17, 2000
Robert S. Parker
/s/ CYRIL RANCE
------------------------------------------------ Director March 17, 2000
Cyril Rance
/s/ ALAN Z. SENTER
------------------------------------------------ Director March 17, 2000
Alan Z. Senter
/s/ JOHN T. THORNTON
------------------------------------------------ Director March 17, 2000
John T. Thornton
/s/ ELLEN E. THROWER
------------------------------------------------ Director March 17, 2000
Ellen E. Thrower
/s/ JOHN WEISER
------------------------------------------------ Director March 17, 2000
John Weiser
88