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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, 2000
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 20, 2001 was
approximately $9.4 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 20, 2001, there were outstanding 125,337,654 Class A 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 11, 2001 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........................................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 15
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 Results of
Operations and
Financial Condition....................................... 19
Item 7A. Quantitative and Qualitative Discussion of Market Risk...... 30
Item 8. Financial Statements and Supplementary Data................. 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure...................................... 77
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 78
Item 11. Executive Compensation...................................... 78
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 78
Item 13. Certain Relationships and Related Transactions.............. 78
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K....................................................... 78
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
HISTORY
XL Capital (sometimes referred to as the "Company") is a leading provider
of insurance and reinsurance coverages and financial products and services to
industrial, commercial, and professional service firms, insurance companies and
other enterprises on a worldwide basis.
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. EXEL and Mid Ocean
are companies that were incorporated in the Cayman Islands in 1986 and 1992,
respectively. 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 merger was accounted for as a purchase business
combination.
On June 18, 1999, XL Capital merged with NAC Re Corp, a Delaware
corporation that was organized in 1985, in a stock merger. 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 to December 31 as a conforming pooling adjustment.
In October 2000, the Company realigned management responsibilities within
its three main operating segments: insurance, reinsurance and financial products
and services. In connection with this realignment, the Company decided to exit
from certain unprofitable lines of business, including Illinois-based
transportation and marine cargo, onshore energy at Lloyd's, pooled aviation and
medical stop loss reinsurance. More than $200.0 million of annual gross premium
written is associated with all of the discontinued business and approximately
120 employees will or have been made redundant as a result of these actions. The
Company incurred after-tax charges of $124.6 million, or $0.98 per share, in the
fourth quarter of 2000 which includes certain reserve adjustments together with
employee severance charges and other costs associated with this realignment.
At the same time, the Company announced that it has renamed certain of its
business units into a common XL brand identity. XL Mid Ocean Re has been renamed
"XL Re" and NAC Re will be renamed "XL Reinsurance America". Brockbank has been
branded as "XL Brockbank" and Brockbank Insurance Services now operates as "XL
Aerospace".
In 2000, the Company exchanged its investment in Arch Capital (formerly
known as Risk Capital), an affiliate, and $3.6 million in cash for Arch
Capital's ownership in Latin American Re and 1.4 million shares and 100,000
warrants of Annuity & Life Re. Annuity & Life Re is a leading provider of
annuity and life reinsurance to insurance companies in North America. The
Company beneficially owned 11% of Annuity & Life Re at December 31, 2000. The
Company acquired the remaining shares of LA Re owned by that company's
management in December 2000.
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 most classes of property and casualty reinsurance
business together with a selective portfolio of life reinsurance business.
For further information, see Note 1 to the Consolidated Financial
Statements.
RECENT DEVELOPMENTS
XL Capital announced on February 15, 2001 that it has agreed to purchase
Winterthur International from Winterthur Swiss Insurance Company ("Winterthur"),
a subsidiary of the Credit Suisse Group ("CSG"). The Company will purchase a
combination of insurance companies and selected Winterthur International
insurance portfolios. The all-cash transaction is valued at approximately
$600.0 million and may be funded by the Company out of a
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combination of current resources and external financing. Winterthur
International is the international, large commercial account property and
casualty insurance business of Winterthur. Winterthur International operates in
27 countries, has more than 1,000 employees and in 2000 had gross premiums
written and net premiums earned of approximately $1.3 billion and
$600.0 million, respectively. In terms of premium volume, Winterthur
International's top five markets are the U.K., Switzerland, Germany, the U.S.
and France. As at September 30, 2000, Winterthur International (including
certain operations to be retained by CSG) had investment assets of approximately
$1.0 billion.
OPERATIONS
The Company is organized into three underwriting segments - insurance,
reinsurance, and financial products and services - and a corporate segment,
which includes the investment operations of the Company. The following
descriptions of policies and coverages 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. The Company's Lloyd's
syndicates are now included in the insurance segment. They are disclosed
separately within this report since the nature of the business written and the
market in which the syndicates underwrite are significantly different from the
Company's other insurance subsidiaries.
INSURANCE OPERATIONS - EXCLUDING LLOYD'S SYNDICATES
The Company provides third party general liability insurance, environmental
liability insurance, directors and officers liability insurance, professional
liability insurance, aviation and satellite insurance, employment practices
liability insurance and integrated liability insurance, property insurance and
other insurance covers including program business and political risk insurance.
Liability insurance is generally written on an excess basis and the loss
experience is characterized as low frequency and high severity. This may result
in volatility in the Company's results of operations and financial condition.
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 $100 million
per occurrence in excess of a minimum attachment point of $25 million.
Environmental liability is written with limits up to $100 million with a
$2 million per occurrence retention, both on single and multi-year contracts.
Directors and officers coverage is written on a follow-form claims-made
basis providing up to a maximum limit of $100 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 $100 million with a minimum attachment of $20 million.
Insurance for satellite risks is written on a proportional basis to provide
first party physical damage or loss. Coverage includes all phases of operation
and can be provided up to a maximum limit of $75 million, although average risks
range from $5 million to $35 million depending on the type of satellite insured.
Facultative reinsurance is utilized to reduce the Company's net retention.
Aviation insurance is underwritten on a proportional basis providing both
aviation liability and physical damage.
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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 $150 million per occurrence, with a sub-limit of up to
$20 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 generally have losses attaching at lower levels, resulting in loss
experiences that can be higher frequency and lower severity.
Political risk insurance written by the Company generally covers risks
arising from expropriation, currency inconvertibility, and war or political
violence. Such insurance is typically provided in connection with direct and
other types of investments in emerging market countries in Latin America, Asia
and Eastern Europe.
The Company offers multi-year combined line policies for traditional
liability 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
traditional risk transfer mechanisms.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
The Company's Lloyd's operations are conducted by XL Brockbank and Denham.
XL Brockbank is a Lloyd's managing agency that manages five syndicates, two of
which are dedicated corporate syndicates whose capital is provided solely by the
Company. These dedicated corporate syndicates (syndicates 1209 and 2253) write a
range of specialty lines, primarily insurance and to a lesser extent
reinsurance, in parallel with the other syndicates managed by XL Brockbank
(syndicates 588, 861 and 253). Effective January 1, 2000, motor business was no
longer written. Denham is also a Lloyd's managing agency that manages one
Lloyd's syndicate (syndicate 990), whose capital is substantially provided by
the Company and writes casualty and non-marine physical damage insurance. As
managing agencies, XL Brockbank and Denham may receive fees and commissions in
respect of the underwriting services they provide to syndicates.
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. Marine and energy business
written includes involvement with many of the world's largest fleets and for all
major types of liability cover available. The syndicate also writes a broad
international cargo account and war and political risk cover for ships and
aircraft. Aviation business written includes a space account with coverages for
every stage of major space launches and associated pre-launch operations.
Accident and health business written is worldwide and comprises accident
insurance and reinsurance, medical expenses and kidnap and ransom. Professional
indemnity written includes professional liability, directors and officers
liability and fidelity. Other business written includes property, bloodstock and
contingency coverages.
Syndicate 990 writes a large range of classes including property, general
liability, accident and health and motor to a globally diverse group of clients.
Until December 1999, syndicate 2253 wrote an account of direct and broker
based motor insurance in the United Kingdom. In December 1999, XL Brockbank sold
the motor business but retains the residual liability relating to the runoff.
REINSURANCE OPERATIONS
The Company provides property, casualty and life reinsurance products on a
global basis. Business is written on both a proportional and excess of loss
basis.
The Company's casualty reinsurance 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
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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 and reinsurers 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 results of
operations and financial condition. The Company endeavors to manage its
exposures to catastrophic events by limiting the amount of its exposure in each
geographic zone worldwide, requiring that its property catastrophe contracts
provide for aggregate limits and varying attachment points and purchasing
reinsurance.
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,
and many 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 event 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 covers a loss of the reinsured on a single "risk" of
the type reinsured rather than to aggregate losses for all covered risks as is
the case with catastrophe reinsurance.
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 expenses 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 reinsurance of
specialist underwriters.
Other reinsurance written by the Company includes political risk, nuclear
accident, professional indemnity and life and annuity.
FINANCIAL PRODUCTS AND SERVICES
The Company operates in the following financial areas: credit enhancements,
insurance and capital market products and asset accumulation business. The
Company provides credit enhancement coverages in the form of financial guaranty
insurance and reinsurance and credit default swaps on asset-backed, municipal
and select called 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 provide credit to enhance obligations and exposures
that would otherwise be lower investment grades, although on an exception basis,
the Company will consider underwriting high non-investment grade risks.
4
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 issuers' ability to charge fees for specified services or projects.
Corporate risk-based obligations underwritten by the Company 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 received either on an installment basis or up front.
The Company has 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 provides
final underwriting approval for each transaction. Par insured and notional
amounts covered under the Company's guaranties 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 as well as
emerging market issuers.
The Company has also assumed loss reserves within its asset accumulation
business. The Company's primary exposure is to investment performance return on
assets relative to the implicit discount on the related deposit liabilities
assumed. These transactions are actuarially expected to be of long duration and
consist of life and annuity obligations and property and casualty insurance and
reinsurance, including limited risk transactions. In late 2000, the Company
established operations to provide insurance form coverages that previously were
available primarily in capital markets. No premiums were written relating to
this business in 2000. The Company intends to hedge these risks as they are
assumed.
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 certain cases, the risks assumed by the Company are partially 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 summary of significant reinsurance ceded by the
Company.
INSURANCE OPERATIONS - EXCLUDING LLOYD'S SYNDICATES
The Company uses reinsurance to support the underwriting and retention
guidelines of each entity as well as to control the aggregate exposure of the
Company to a particular risk or class of risks. Reinsurance is purchased at
several levels ranging from reinsurance of risks assumed on individual contracts
to reinsurance covering the aggregate exposure of groups of companies. All
reinsurers are required to be rated A or better by A.M. Best or BBB or better by
Standard & Poor's ("S&P").
The Company purchases a quota share treaty to protect both the general
liability occurrence-notified and traditional occurrence business written. Under
the terms of the current quota share treaty, the Company cedes 50% of the first
$50 million of each risk, and 80% of the next $50 million of each risk. The
aggregate maximum amount recoverable under this treaty is 400% of the total
occurrence-notified premium ceded for the first $50 million layer. There is no
aggregate maximum recoverable for the traditional occurrence business ceded for
this layer. The second layer is subject to an aggregate maximum recoverable
amount of $300 million.
During 2000, the Company also purchased excess of loss reinsurance and a
quota share reinsurance treaty to protect the directors' and officers,
professional liability and employment practices liability business written.
Under
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the terms of the excess of loss reinsurance treaty, the Company is reinsured for
a total of $40 million excess of $10 million per risk subject to co-insurance
retentions. The maximum amount recoverable under this program is $80 million.
Excess of loss programs limit the Company's liability exposure for
pollution to $2 million per occurrence for each and every occurrence with total
limits up to $90 million. There is no aggregate amount recoverable for business
ceded to this program.
Excess of loss reinsurance programs limit the Company's liability exposure
for inland marine and property coverages to $250,000 per occurrence for each and
every occurrence with total limits up to $25 million and there is no aggregate
maximum recoverable under this program.
Excess of loss reinsurance programs limit the Company's exposure to
directors' and officers and employment practices liability written in the U.S.
to $2.5 million per occurrence for each and every loss with total limits up to
$25 million. An annual aggregate limit does apply for this cover.
A variety of programs reduce Company's net exposure to aviation and
satellite single loss events. In addition, a variable surplus treaty, excess of
loss reinsurance and catastrophe reinsurance is used to protect the property
business written with various layers and excess of varying attachment points.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
The Company's Lloyd's operations purchase 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. Each reinsurer has to be
approved by a reinsurance security committee. Several coverages are purchased,
the most significant of which is a whole account stop loss policy reinsured with
a reinsurer rated AA by S&P, which protects losses above a specified loss ratio.
This coverage has been significantly reduced for 2001. A whole account excess of
loss treaty provides coverage against single loss events from $1 million to
$300 million and is placed with several reinsurers, predominantly rated AA by
S&P. In addition, there are various class specific reinsurances and facultative
reinsurance covers purchased on specific risks assumed.
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. A corporate multi-year program is purchased for
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.
The Company's casualty reinsurance program in 2000 covers multiple claims
arising from two or more risks from 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 $29 million excess of an initial retention of
$7.5 million, which gradually increases up to an additional $3 million should
gross losses exceed $30 million. The 1999 casualty reinsurance program was
similar to that of 2000. In addition, the Company had coverage in 2000, 1999 and
1998 in the event that the accident year loss and loss expense ratio exceeded a
pre-determined amount, with up to $108 million recoverable on an annual basis.
At December 31, 2000, the Company had a reinsurance balance receivable and
unpaid loss recoverable of $210.0 million due from Hannover Re (Ireland) Ltd,
which is rated A+ by A.M. Best.
In July 2000, the Company entered into an eighteen-month agreement to
extend or supplement existing aggregate excess of loss protections for certain
U.S. subsidiaries. The first layer of this agreement provides $43.3 million of
cover for July 1 to December 31, 2000, and $86.5 million for 2001, excess of an
accident year loss ratio of 55%. The second layer limit available is
$10 million for the first period and $20 million for 2001.
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The Company had an intercompany stop loss arrangement in place in 2000 and
1999, under which a subsidiary in the reinsurance segment was covered by a
subsidiary in the insurance segment for losses up to $100 million. The purpose
of this arrangement is to manage statutory surplus levels across the Company.
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. Although most of the property and casualty markets in which the
Company operates have seen some improvements in pricing and policy terms and
conditions, the Company believes that competitive forces will continue to be
present in the industry. 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 and Analysis
of Results of Operations and Financial Condition" for further discussion of
current market conditions.
UNDERWRITING
As part of the underwriting process, the Company 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 significant adverse affect on the Company's results of operations
and financial condition. No significant Year 2000 related matters had been
notified to the Company as of March 23, 2001. 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".
INSURANCE OPERATIONS - EXCLUDING LLOYD'S SYNDICATES
The Company's rating methodology seeks to set premiums 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. Underwriters separately
evaluate each industry category and sub-groups within each category. Premiums
are then 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 the insured's risk relative to the group.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
The Lloyd's syndicates underwrite a broad range of risks, and the factors
taken into consideration in the underwriting process vary between class of
business. The underwriters may use actuaries to assist in the review and rating
of risks. Underwriters operate within agreed guidelines that 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. Syndicates
also participate on market facilities where underwriting authority is delegated
to the lead insurer.
REINSURANCE OPERATIONS
The Company employs 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 it anticipates placing at risk.
Underwriting opportunities presented are evaluated based upon a number of
factors including: the type and layer of
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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; 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; and 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 loss experience to industry averages. 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 one 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.
FINANCIAL PRODUCTS AND SERVICES
For the financial products and services business, the Company has
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 provides final
underwriting approval. For the capital markets related businesses, the Company
has established trading, credit, exposure and other risk guidelines and
practices.
MARKETING AND DISTRIBUTION
Clients are referred to the Company 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, the Company is not committed to
accept business from any particular broker, and brokers do not have the
authority to bind 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 deemed necessary.
During 2000, 1999 and 1998, approximately 22%, 21% and 34%, respectively,
of the Company's consolidated gross written premiums were generated from or
placed by Marsh & McLennan Companies. During 2000, 1999 and 1998, approximately
16%, 13% and 19%, respectively, 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, 2000, 1999 and 1998. 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."
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 of operations and financial condition.
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 judgment concerning sound financial practice and do not represent
any admission of liability with respect to any claim made against the Company.
The method of establishing case reserves for reported claims differs
between the Company's operations. For the insurance operations excluding Lloyd's
syndicates as discussed below, claims personnel determine whether to
8
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 own assessment process. Periodically, adjustments
to the case reserves may be made as additional information regarding the claims
is reported 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 using several
standard actuarial methodologies including paid and incurred loss development,
Bornhuetter-Ferguson and frequency and severity approaches. 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. Even such
actuarially sound methods can lead to subsequent adjustments to reserves that
are both significant and irregular due to the nature of the risks written.
Several aspects of the Company's casualty insurance operations complicate
the actuarial reserving techniques for loss reserves as compared to other
companies. These complications include policy forms that differ from more
traditional forms, the lack of historical loss data for losses of the type
intended to be covered by the policies, and the fact that losses in excess of
the attachment level of the Company's policies are 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 ultimate losses and loss expenses will not exceed the
total reserves.
Claims relating to property catastrophe and property risk excess treaties
are generally reported within approximately 18 to 24 months from the date of
occurrence. Conversely, claims on the casualty business are reported on average
5 to 8 years from the date of occurrence. Claims arising from business written
by the Lloyd's syndicates are generally reported within 36 months of the date of
the occurrence.
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 may be reported. As these are
reported, it may be necessary to adjust the reserves upward or downward. The
final liability may be significantly less or greater than the prior estimates.
The table below presents the development of unpaid loss and loss expense
reserves for 1990 through 2000. The top line of the table shows the estimated
liability, net of reinsurance recoveries as at the balance sheet date for each
of the indicated years. This represents the estimated amounts of net losses and
loss expenses, including IBNR, arising in all prior years that are unpaid at the
balance sheet date. 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 to date 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."
9
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
NET OF REINSURANCE RECOVERIES
(U.S dollars in millions)
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
------------------------------------------------------------------------------------------------
ESTIMATED LIABILITY FOR UNPAID
LOSSES AND LOSS EXPENSES,
NET OF REINSURANCE
RECOVERIES.................. $1,268 $1,486 $1,795 $2,057 $2,482 $2,899 $3,166 $3,609 $4,303 $4,537 $4,332
LIABILITY RE-ESTIMATED AS OF:
One year later.............. 1,269 1,468 1,800 2,089 2,455 2,885 2,843 3,354 4,016 4,142
Two years later............. 1,128 1,388 1,830 2,089 2,383 2,546 2,704 3,038 3,564
Three years later........... 960 1,299 1,819 2,115 2,190 2,445 2,407 2,737
Four years later............ 910 1,303 1,891 1,972 2,085 2,214 2,227
Five years later............ 858 1,384 1,856 1,950 1,927 2,050
Six years later............. 871 1,384 1,820 1,752 1,819
Seven years later........... 884 1,392 1,644 1,739
Eight years later........... 945 1,245 1,660
Nine years later............ 795 1,294
Ten years later............. 855
CUMULATIVE REDUNDANCY (1)...... 413 192 135 318 663 849 939 872 739 395
CUMULATIVE PAID LOSSES, NET OF
REINSURANCE RECOVERIES, AS
OF:
One year later.............. $ 223 $ 194 $ 267 $ 256 $ 317 $ 445 $ 234 $ 458 $ 812 $1,252
Two years later............. 307 393 468 521 709 667 576 932 1,594
Three years later........... 403 499 689 865 921 934 932 1,404
Four years later............ 456 632 937 1,033 1,110 1,143 1,235
Five years later............ 486 831 1,102 1,198 1,199 1,356
Six years later............. 585 924 1,253 1,273 1,328
Seven years later........... 597 974 1,319 1,360
Eight years later........... 633 1,020 1,391
Nine years later............ 662 1,083
Ten years later............. 678
(1) See "Management's Discussion and Analysis of Results of Operations and
Financial Condition" for further discussion.
10
The table below presents the development of the gross liability for unpaid
losses and loss expenses for the years 1992 through 2000:
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
GROSS OF REINSURANCE RECOVERABLES
(U.S. dollars in millions)
1992 1993 1994 1995 1996 1997 1998 1999 2000
------------------------------------------------------------------------------
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 $5,672
LIABILITY RE-ESTIMATED AS OF:
One year later................................ 1,996 2,309 2,764 3,244 3,221 3,763 4,735 5,266
Two years later............................... 2,037 2,323 2,721 2,872 3,164 3,496 4,352
Three years later............................. 2,043 2,373 2,494 2,793 2,902 3,243
Four years later.............................. 2,134 2,198 2,414 2,572 2,753
Five years later.............................. 2,067 2,208 2,268 2,415
Six years later............................... 2,065 2,022 2,165
Seven years later............................. 1,903 2,010
Eight years later............................. 1,921
CUMULATIVE REDUNDANCY............................ 56 259 595 823 870 729 545 103
The tables above show the cumulative redundancy net of reinsurance
recoveries which differs from the cumulative redundancy shown gross of
reinsurance recoveries. As different reinsurance programs are applied to their
respective underwriting years, net and gross loss experience will not develop
proportionately.
The following table presents an analysis of paid, unpaid and incurred
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
(U.S. dollars in thousands)
2000 1999 1998
------------------------------------
Unpaid losses and loss expenses at beginning of year........ $5,369,402 $4,896,643 $3,972,376
Unpaid losses and loss expenses recoverable................. (831,864) (593,960) (363,716)
------------------------------------
Net unpaid losses and loss expenses at beginning of year.... 4,537,538 4,302,683 3,608,660
Increase (decrease) in net losses and loss expenses incurred
in respect of losses occurring in:
Current year............................................. 1,827,443 1,591,414 1,097,161
Prior years.............................................. (394,884) (287,110) (255,644)
------------------------------------
Total net incurred losses and loss expenses........... 1,432,559 1,304,304 841,517
Interest incurred on experience reserves and exchange rate
effects................................................... (27,064) (5,950) 2,516
Net loss reserves acquired.................................. 52,932 30,003 580,879
Less net losses and loss expenses paid in respect of losses
occurring in:
Current year............................................. 411,685 281,806 272,456
Prior year............................................... 1,251,985 811,696 458,433
------------------------------------
Total net paid losses................................. 1,663,670 1,093,502 730,889
Net unpaid losses and loss expenses at end of year.......... 4,332,295 4,537,538 4,302,683
Unpaid losses and loss expenses recoverable................. 1,339,767 831,864 593,960
------------------------------------
Unpaid losses and loss expenses at end of year.............. $5,672,062 $5,369,402 $4,896,643
------------------------------------
11
Net losses incurred in 2000 increased over 1999, principally due to current
year development. Current year development reflects both the growth in business
assumed and an increase in loss ratios applied. The increase in the loss ratio
is due to the effect of competition which has depressed premium rates,
particularly on certain casualty lines. Current year losses also reflect the
early development of certain losses on the Company's large account business
within its insurance operations. Historically, the Company does not experience
the reporting of such losses at an early stage and the Company's reserving
methodology for these lines of business extrapolates these losses into the
projections of future development. If future development is eventually
determined to be less than the estimated ultimate losses recorded, loss reserves
will be reduced at that time. This occurred for the 1993 through 1996
underwriting years, resulting in a reduction in prior year losses.
Net losses incurred for 2000 also reflects reserve adjustments to several
unprofitable lines of business that the Company has now exited, including
trucking, inland energy and certain classes of aviation. A net reserve charge of
$114.0 million has been recorded for these lines.
There has been a high level of paid losses in 2000 due to the settlement of
previously established reserves, particularly catastrophe losses as noted below.
The Company's outward reinsurance programs in 2000 have mitigated part of
the overall loss development, as shown by the increase in the unpaid losses and
loss expenses recoverable, both in the insurance and reinsurance segments. In
relation to business lines exited from the Lloyd's operations, additional
reinsurance costs of $19.1 million were incurred in respect of expected loss
recoveries recorded of $38.0 million. In the reinsurance segment, $80.6 million
of additional reinsurance costs were recorded with $151.8 million of expected
loss recoveries. The purchase of additional reinsurance in 2000 relates
primarily to the casualty lines where the Company has taken advantage of
favorable pricing and terms.
Partially offsetting this increase in net incurred losses in 2000 compared
to 1999 was a reduction in the number and magnitude of catastrophe losses that
occurred. Catastrophe losses in 2000, which included an oil refinery loss in
Kuwait, several satellite losses, and the Singapore Airlines loss, totaled
approximately $95.0 million. By comparison, 1999 generated approximately
$185.0 million of catastrophe losses to the Company, including the European
storms in December, hailstorms in Sydney, tornadoes in Oklahoma and satellite
losses.
Net losses incurred in 1999 increased significantly over 1998 for a number
of reasons. The Company acquired Mid Ocean and Brockbank in August 1998 and
therefore only recognized the effect of their operations for five months in
1998. Incurred losses for these entities were approximately $475.0 million in
1999 compared to $260.0 million in 1998. Partially offsetting this, in 1998, the
Company incurred approximately $60.0 million in catastrophe losses relating to
Hurricane Georges and the SwissAir loss. These losses were incurred in the
reinsurance operations.
In 1999, the Lloyd's operations experienced loss deterioration on the U.K.
motor business principally from the 1998 and 1999 underwriting years of
approximately $20.0 million. The motor business was sold in December 1999 and
the Company retains residual liability on this business.
1999 incurred losses also include an increase to reinsurance loss reserves
of $95.0 million for NAC Re due to an alignment of reserving methodologies at
the time of the merger with the Company in June 1999.
The decrease in prior year incurred losses in all three years is driven
primarily by the Company's insurance liability excess of loss reserves. The
basis for establishing IBNR for these lines is relatively judgmental due to the
lack of industry data available. 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 has made its best estimate of loss reserves for each
underwriting year since 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. This trend is not necessarily expected to continue.
The increase in paid losses in 1999 reflects the acquisition of Mid Ocean
and Brockbank in 1998.
12
The Company's net incurred losses and loss expenses includes a charge of
$2.8 million, $10.6 million and $1.2 million in 2000, 1999 and 1998,
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. As at December 31, 2000 and 1999,
the reserve for potential non-recoveries from reinsurers was $25.6 million and
$25.8 million, respectively.
Except for certain workers' compensation liabilities, the Company does not
discount its 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%. The tabular
reserving methodology results in applying 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, 2000 and 1999 were $168.8 million and
$85.7 million, respectively. The related discounted unpaid losses and loss
expenses were $63.4 million and $28.1 million as of December 31, 2000 and 1999,
respectively.
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, 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 in respect of business written by the Lloyd's syndicates 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 may
adjust the case reserves it records from those advised by the bureaus as deemed
necessary.
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 specific claims and
claims procedures at the offices of selected ceding companies.
There have been no claims relating to business written by financial
products and services reported to the Company as at December 31, 2000. Where
management believes a future loss is probable and determinable, a specific
reserve for unpaid losses and loss adjustment expenses is recorded for the
estimated value of the loss.
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 while
focusing on preserving principal and maintaining liquidity. In this regard, at
December 31, 2000, the Company's fixed income investment portfolio included U.S.
and non-U.S. sovereign government obligations, corporate bonds and other
securities, 61.1% 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 may impose restrictions on the Company's investments whereby certain
types of investments such as unquoted equity securities, investments in
13
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,
2000 and 1999.
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, 2000:
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)
2000................................................ $9,058,811 $542,500 $ 50,571 5.99%
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%
(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 applicable investment expenses, excluding realized gains.
RATINGS
The Company's principal insurance and reinsurance subsidiaries and pools
have claims paying ratings of "AA" from S&P and "A+" from A.M. Best
Company, Inc. The Company's financial guaranty insurance and reinsurance
companies each have "AAA" ratings from S&P. An insurer rated "AA" by S&P has
very strong financial security characteristics, differing only slightly from
those rated higher, and an insurer rated "AAA" by S&P has extremely strong
financial security characteristics. 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. The Company's Lloyds'
syndicates at XL Brockbank have a five bell rating under S&P Lloyds' Syndicates
Performance Measure, representing a well above market level performance.
TAX MATTERS
See Note 17 to the Consolidated Financial Statements.
REGULATION
See Note 18 to the Consolidated Financial Statements.
EMPLOYEES
At December 31, 2000, the Company employed approximately 1,300 employees.
None of these employees are represented by a labor union.
ITEM 2. PROPERTIES
The Company rents space for its principal executive offices under leases
that expire up to 2013. Total rent expense for the years ended December 31,
2000, 1999 and 1998 was approximately $18.3 million, $13.0 million and
$9.0 million, respectively. In 1997, the Company acquired commercial real estate
in Bermuda for the purpose of securing long-term office space for its worldwide
headquarters. The total cost of this development, including the land, is
expected to be approximately $110.0 million, of which $101.0 million had been
spent as at December 31, 2000. It is estimated that the development will be
completed in April 2001. See Note 11 to the Consolidated Financial Statements
for discussion of the Company's lease commitments.
14
ITEM 3. LEGAL PROCEEDINGS
The Company, 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, 2000, the Company was not a party to any material
litigation or arbitration other than as part of the ordinary course of business
in relation to claims activity, none of which is expected by management to have
a significant 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.
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, 2000.
NAME AGE POSITION
- ---------------------------------------------------------------------------------------------------------------
Brian M. O'Hara........................ 52 President, Chief Executive Officer and Director of the
Company
Robert R. Lusardi...................... 44 Executive Vice President and Chief Financial Officer* of
the Company and Chief Executive Officer of Financial
Products and Services.
Nicholas M. Brown, Jr.................. 46 Executive Vice President of the Company and Chief Executive
Officer of Insurance Operations
K. Bruce Connell....................... 48 Executive Vice President and Group Underwriting Officer.
Paul S. Giordano....................... 38 Executive Vice President, General Counsel and Secretary of
the Company
Christopher V. Greetham................ 56 Executive Vice President and Chief Investment Officer of
the Company
Henry C. V. Keeling.................... 45 Executive Vice President of the Company and Chief Executive
Officer of Reinsurance Operations
Fiona Luck............................. 43 Executive Vice President of the Company, Group Operations
Clive R. Tobin......................... 48 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 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, and Chief Executive Officer of
Financial Products and Services since July 2000. Prior to joining the Company,
Mr. Lusardi was Managing Director at Lehman Brothers from 1980 to 1998.
Nicholas M. Brown, Jr. has been Executive Vice President of the Company
since July 1999 and Chief Executive Officer of Insurance operations since
July 2000. 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
15
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
through 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 Group Underwriting Officer since July 2000. Mr. Connell
previously served as President and Chief Operating Officer of XL Global Re from
November 1997 to August 1998, President of XL Global Re since December 1995 and
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 & 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 Re since August 1998. He was appointed Chief
Executive Officer of Reinsurance operations in July 2000. 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.
* Jerry M. de St. Paer was appointed to the position of Executive Vice
President and Chief Financial Officer of the Company on February 20, 2001,
succeeding Robert R. Lusardi. Mr. de St. Paer was previously Managing Director
of Hudson International Advisors in New York. Prior to forming Hudson
International in 1998, he served as Managing Director, Insurance at J.P.
Morgan & Company, Inc. Mr. de St Paer was previously employed at The Equitable
(now AXA Financial Advisors), from 1986 until 1997, serving most recently as
Senior Executive Vice President and Chief Financial Officer of The Equitable and
as Executive Vice President of Strategic Studies and Development of the AXA
Groupe.
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
-----------------
2000:
1st Quarter............................................... $55.375 $39.563
2nd Quarter............................................... 61.000 45.750
3rd Quarter............................................... 78.188 54.938
4th Quarter............................................... 88.563 69.375
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
Each Class A ordinary share has one vote, except that if, and so long as,
the Controlled Shares (defined below) 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 are limited, in the aggregate, to a
voting power of approximately 10%, pursuant to a formula specified in the
Articles of Association. "Controlled Shares" includes, 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 ordinary shares as of
December 31, 2000 was 671.
(c) In 2000, four regular quarterly dividends were paid at $0.45 per share
to all shareholders of record on February 15, May 25, August 15 and
November 15.
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 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 the Society of Lloyd's. See
Note 18 to the Consolidated Financial Statements for further discussion.
(d) Rights to purchase Class A ordinary shares ("the Rights") 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 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 Class A ordinary shares. Upon a person or
group without prior approval of the Board acquiring 20% or more of Class A
ordinary shares, each Right would entitle the holder (other than such an
acquiring person or group) to purchase Class A ordinary shares (or, in
17
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. The Company 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 issue upon
exercise of Rights.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data below is based upon the Company's
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.
2000 1999 1998 1997 1996
----------------------------------------------------------------
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
INCOME STATEMENT DATA:
Net premiums earned................ $ 2,035,240 $ 1,750,006 $1,324,291 $1,114,758 $1,038,643
Net investment income.............. 542,500 525,318 417,290 345,115 304,823
Net realized gains on
investments .................... 50,571 94,356 211,204 410,658 174,593
Equity in net income of
affiliates ..................... 74,355 40,907 50,292 64,959 59,084
Fee income and other............... 14,793 100,400 22,325 -- --
Losses and loss expenses........... 1,432,559 1,304,304 841,517 738,849 739,058
Acquisition costs, operating
expenses and exchange gains and
losses ......................... 743,067 689,005 436,598 318,107 277,801
Interest expense................... 32,147 37,378 33,444 29,622 22,322
Amortization of intangible
assets ......................... 58,597 49,141 26,881 7,403 368
Income before minority interest and
income tax expense.............. 451,089 431,159 686,962 841,509 537,594
Net income......................... 506,352 470,509 656,330 809,029 516,471
PER SHARE DATA:
Net income per share - basic
(3) ............................ $ 4.07 $ 3.69 $ 5.86 $ 7.95 $ 4.81
Net income per share - diluted
(3) ............................ $ 4.03 $ 3.62 $ 5.68 $ 7.74 $ 4.73
Weighted average shares
Outstanding - basic (3)............ 124,503 127,601 112,034 101,708 107,339
Weighted average shares
Outstanding - diluted (3).......... 125,697 130,304 116,206 105,005 109,908
Cash dividends per share (4)....... $ 1.80 $ 1.76 $ 1.64 $ 1.36 $ 0.95
BALANCE SHEET DATA:
Total investments available for
sale............................ $ 9,501,548 $ 9,122,591 $9,057,892 $6,562,609 $5,647,589
Cash and cash equivalents.......... 930,469 557,749 480,874 383,594 321,140
Investments in affiliates.......... 792,723 479,911 154,668 524,866 414,891
Total assets....................... 16,941,952 15,090,912 13,581,140 9,070,031 7,823,375
Unpaid losses and loss expenses ... 5,672,062 5,369,402 4,896,643 3,972,376 3,623,334
Notes payable and debt............. 450,032 410,726 613,873 453,866 323,858
Shareholders' equity............... 5,573,668 5,577,078 5,612,603 3,195,749 2,637,533
Book value per share............... $ 44.58 $ 43.64 $ 43.59 $ 31.55 $ 25.31
Fully diluted book value per
share .......................... $ 44.78 $ 43.13 $ 43.20 $ 31.42 $ 25.24
OPERATING RATIOS:
Loss and loss expense ratio (2).... 70.4% 74.5% 63.5% 66.3% 71.2%
Underwriting expense ratio (5)..... 36.4% 34.3% 30.3% 27.9% 26.2%
Combined ratio (6)................. 106.8% 108.8% 93.8% 94.2% 97.4%
18
(1) All prior period information includes the results of NAC as though it had
always been a part of the Company.
(2) The loss and loss expense ratio is the calculated by dividing the losses and
loss expenses incurred by the net premiums earned.
(3) 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.
(4) Cash dividends per share have not been adjusted for the pooling effect of
NAC.
(5) 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 and foreign exchange gains and losses have
not been included for purposes of calculating the underwriting expense
ratio. See Note 3 to the consolidated financial statements for further
information.
(6) The combined ratio is the sum of the loss and loss expense ratio and the
underwriting expense ratio. A combined ratio of under 100% represents an
underwriting profit and over 100% represents 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. See Note 6 to the audited Consolidated
Financial Statements for further details.
This "Management's Discussion and Analysis of Results of Operations and
Financial Condition" contains forward-looking statements which involve inherent
risks and uncertainties, including, but not limited to, business, financial and
integration risks associated with the Winterthur International acquisition and
the risk that the acquisition will not be consummated. Statements that are not
historical facts, including statements about the Company's 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 undue
reliance should not be placed on them. See "-Cautionary Note Regarding
Forward-Looking Statements" for a list of additional 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.
OVERVIEW
The insurance and reinsurance industry has remained competitive through
2000. The Company has experienced price increases on some of the short-tail
business, such as the property and property catastrophe lines as the
retrocession markets have become more capacity constrained. While the long tail
business, such as the excess casualty lines, have not experienced the equivalent
level of price increases, market pressure for rate reduction is no longer as
prevalent as in 1999. During 2000, the Company continued to evaluate its product
lines for profitability and exited certain lines where pricing remains at
unsatisfactory levels.
19
RESULTS OF OPERATIONS
The following table presents an after-tax analysis of the Company's net
income for the years ended December 31, 2000, 1999 and 1998 (U.S. dollars in
thousands, except per share amounts):
2000 1999 1998
------------------------------
Net income
excluding net realized gains on investments............. $442,932 $370,809 $457,402
Net realized gains on investments......................... 63,420 99,700 198,928
------------------------------
Net income................................................ $506,352 $470,509 $656,330
------------------------------
Earnings per share - basic................................ $4.07 $3.69 $5.86
Earnings per share - diluted.............................. $4.03 $3.62 $5.68
Net income increased in 2000 compared to 1999 due to an increase in net
investment income, equity in net income of affiliates and exchange gains and
losses. This increase was partially offset by an increase in the underwriting
loss. In 2000, the Company incurred after-tax charges of $124.6 million, or
$0.98 per share, which included certain reserve adjustments together with
employee severance charges and other costs associated with the realignment of
the Company's operations and the discontinuation of certain business lines.
These charges affected the underwriting results across all of the Company's
segments, excluding the financial products and services segment. In 1999, the
Company incurred losses of $125.0 million after-tax, or $0.97 per share, as a
result of two major European windstorms in December 1999. In addition, 1999
includes an increase to reserves of $95.0 million associated with the merger
with NAC. These two factors are the primary reason for the decrease in net
income excluding realized gains on investments in 1999 as compared to 1998.
Basic and diluted earnings per share increased in 2000 as compared to 1999
due to both an increase in net income and a reduction in the weighted average
number of shares outstanding. The decrease in the weighted average number of
shares outstanding in 2000 is a result of the Company repurchasing 5.1 million
shares during the year. The decrease in the basic and diluted earnings per share
in 1999 over 1998 is due to a reduction in net income.
SEGMENTS
The Company is organized into three underwriting segments - insurance,
reinsurance, and financial products and services - and a corporate segment,
which includes the investment operations of the Company. Lloyd's syndicates are
included in the insurance segment but are shown separately as the nature of
their operations and the market in which the syndicates underwrite is
significantly different to the Company's other insurance subsidiaries. See Item
1 and Item 8, Note 3 to the Consolidated Financial Statements for further
details.
INSURANCE OPERATIONS - EXCLUDING LLOYD'S SYNDICATES
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
% CHANGE % CHANGE
2000 00 VS 99 1999 99 VS 98 1998
----------------------------------------------------
Net premiums earned............................ $726,506 56.9% $463,069 12.9% $410,030
Fee income and other........................... 7,692 1.4% 7,584 (8.0%) 8,244
Losses and loss expenses....................... 502,898 62.7% 309,079 15.4% 267,823
Acquisition costs.............................. 117,251 79.5% 65,318 37.0% 47,688
Operating expenses............................. 94,129 32.4% 71,094 43.0% 49,702
Exchange gains................................. (2,344) NM (165) NM -
----------------------------------------------------
Underwriting profit............................ $ 22,264 (12.1%) $ 25,327 (52.3%) $ 53,061
----------------------------------------------------
NM = Not Meaningful
20
Growth in net premiums earned in 2000 over 1999 is mainly due to new
business, primarily environmental liability, written by ECS. ECS contributed
approximately $260.0 million in gross premiums written and $110.0 million in net
premiums earned in 2000. No premiums were written or earned by ECS in 1999 as
ECS only commenced writing business on behalf of the Company with effect from
January 1, 2000. Prior to this date, ECS had agency agreements in place with
other companies. In addition, XL Aerospace wrote aviation and satellite business
totaling $160.0 million in gross premiums written and $60.0 million in net
premiums earned. In 1999, this agency wrote this business on behalf of the
Lloyd's syndicates, of which the Company's share was approximately
$20.0 million in gross premium written and $11.5 million in net premium earned.
2000 also includes approximately $60.0 million in gross premiums written and
$25.0 million in net premiums earned of new professional liability business
written. Generally, in 2000, premium rates have continued to be negatively
affected by increased competition. Some price increases were experienced in 2000
in property lines, which have also contributed to the increase in net premiums
earned. However, pricing has remained relatively unchanged on the liability
lines of business. Contracts were not renewed where premium rates were not
deemed by the Company to be sufficient to cover the risks underwritten.
The increase in net premiums earned in 1999 over 1998 is primarily the
result of an increase in the gross premiums written in the primary property,
aviation and satellite, marine and other lines of business. Net premiums earned
in 1999 also reflect the purchase of Intercargo in May 1999, for which
approximately $33.0 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 that caused premium rates to decline.
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.
Fee income and other relates to fees relating to the provision of risk
management and other services. As the managing agencies write more business on
behalf of the Company, fee income from agency fees is expected to decline in
future years.
The increases in net losses and loss expenses, acquisition costs and
operating expenses are also primarily attributable to the new business generated
by ECS and XL Aerospace. These are included in the discussions below as part of
the analysis of the Company's underwriting ratios.
The decrease in the underwriting profit in each year in this segment is due
to higher loss and loss expense ratios as shown below. The following table
presents the ratios for this segment for each of the three years ended
December 31:
2000 1999 1998
----------------------
Loss and loss expense ratio................................. 69.2% 66.7% 65.4%
Underwriting expense ratio.................................. 29.1% 29.5% 23.8%
----------------------
Combined ratio.............................................. 98.3% 96.2% 89.2%
----------------------
The loss and loss expense ratio includes the effects of an intercompany
stop loss arrangement in place in 2000 and 1999 with a subsidiary in the
reinsurance segment. Losses incurred relating to this arrangement were
$33.5 million and $100.0 million in 2000 and 1999, respectively. There was no
such arrangement in place in 1998. The purpose of this arrangement is to
efficiently manage statutory surplus levels across the Company. The higher
losses in 1999 were the result of catastrophic losses that occurred in 1999. Had
this arrangement not been in place, the loss and loss expense ratio would have
been 64.6% and 45.2% in 2000 and 1999, respectively. The increase in the loss
ratio in 2000 over 1999 is due to several factors. In 2000, the Company applied
higher loss ratios to certain of its casualty lines written in 2000. These loss
ratios have been actuarially estimated and reflect the continued negative impact
that competitive market conditions have had on rates for these lines of business
written in 2000. There was a reduction of loss reserves in 1999 established on
the Company's liability lines due to updated actuarially determined
21
reserve estimates that reflect the favorable development of these lines relating
to prior years. Loss reserve adjustments were made in 2000 as discussed
previously. Partially offsetting the increases in 2000 are additional reductions
in loss reserves relating to liability lines written in prior years.
Excluding the effects of the stop loss arrangement, the loss ratio
decreased in 1999 compared to 1998 due to the reduction of liability loss
reserves relating to 1998 and prior years. Due to the lack of industry data
available, the Company estimates loss reserves based upon its own experience.
When the Company commenced writing this type of business in 1986, limited data
was available and the Company has made its best estimates for loss reserves for
each underwriting year since that time. Over time, the amount of data has
increased, providing a larger statistical base for estimating reserves.
Redundancies in prior year reserves have occurred where loss experience has
developed more favorably than expected. This trend is not necessarily expected
to continue.
The net decrease in the underwriting expense ratio in 2000 compared to 1999
is mainly due to the significant increase in net premiums earned year over year
and, unlike acquisition costs, operational expenses do not change as a direct
cost of net premiums earned. Partially offsetting this decrease is the inclusion
of expense charges of $13.9 million relating to employee severance and other
costs in 2000 associated with the realignment of operations and the
discontinuation of certain business lines. Excluding these costs, the
underwriting expense ratio in 2000 would have been 27.2%. The increase in the
expense ratio in 1999 over 1998 is due to two factors: changes in the product
mix towards U.S. primary business in 1999 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.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
The following table summarizes the underwriting results for the Lloyd's
syndicates (U.S. dollars in thousands):
% CHANGE % CHANGE
2000 00 VS 99 1999 99 VS 98 1998
----------------------------------------------------
Net premiums earned............................ $357,824 0.6% $355,769 131.2% $153,852
Fee income and other........................... (6,626) NM 65,892 NM 14,081
Losses and loss expenses....................... 260,372 (12.5%) 297,595 152.0% 118,111
Acquisition costs.............................. 119,870 34.4% 89,195 191.4% 30,614
Operating expenses............................. 28,727 (2.0%) 29,305 90.3% 15,399
Exchange gains................................. (5,986) NM (1,180) NM (524)
----------------------------------------------------
Underwriting (loss) profit..................... $(51,785) NM $ 6,746 55.7% $ 4,333
----------------------------------------------------
The small increase in net premiums earned in 2000 over 1999 reflect the
growth in business written by XL Brockbank and Denham due principally to an
increase in syndicate capacity provided by the Company from approximately 43% to
50% at XL Brockbank and from approximately 43% to 75% at Denham. The Company has
increased capacity at Denham to 100% for 2001. Partially offsetting this
increase is the reduction in net premiums earned relating to the motor business
that was sold effective December 31, 1999. The Company retains the residual
liability on this business. In the years ended December 31, 2000 and 1999, net
premiums earned on the motor business were $82.8 million and $135.9 million
respectively. Net premiums earned relating to the motor business will decline
substantially in subsequent years. In addition, net premiums earned were reduced
in 2000 relating to additional reinsurance costs recorded by XL Brockbank
relating to an outwards stop loss reinsurance policy. Under this policy,
additional premiums become payable as losses develop for certain lines of
business. Reinsurance costs of $23.3 million, $13.4 million and $7.6 million
were incurred for 2000, 1999 and 1998, respectively. Of the cost incurred for
2000, approximately $19.1 million relates to losses on certain business lines
that the Company will be exiting as part of the reorganization. Coverage
provided by this stop loss reinsurance policy has been significantly reduced for
2001 and while this may reduce reinsurance costs, it exposes XL Brockbank to
potentially higher net losses.
22
The increase in net premiums earned in 1999 compared to 1998 is a result of
the acquisition of Brockbank in August 1998. In addition, results for Denham
were not significant in 1998.
In 1999, fee income and other primarily relates to the sale by XL Brockbank
of its two motor insurance businesses, Admiral and Zenith, resulting in a gain
of $40.2 million. In addition, 1999 also included $42.1 million of fees
generated from the motor business prior to the sale. No such income was earned
in 2000. XL Brockbank's managing agencies may also earn profit commissions and
fees from syndicates they manage in order to offset their operating expenses.
1999 included $2.9 million in profit commissions. Due to the loss deterioration
in the Lloyd's market, no commissions were earned in 2000, resulting in expenses
in excess of fee income in 2000.
Exchange gains in 2000 and 1999 arise from the translation of foreign
currency assets and liabilities, primarily from exchange rate movements between
U.K sterling and the U.S. dollar in the year.
The following table presents the underwriting ratios:
2000 1999 1998
------------------------
Loss and loss expense ratio................................. 72.8% 83.6% 76.8%
Underwriting expense ratio.................................. 41.5% 33.3% 29.9%
------------------------
Combined ratio.............................................. 114.3% 116.9% 106.7%
------------------------
The decrease in the loss ratio and increase in the expense ratio in 2000
over 1999 primarily reflects the effect of the sale of the motor business. In
1999, the motor business had a loss ratio of approximately 101.1% and an expense
ratio of approximately 21.8%. Other business written by XL Brockbank and Denham
typically has lower loss ratios and higher commissions than the motor business.
The increase in the expense ratio in 2000 was also due to two other factors
(i) the reduction in net premiums earned due to the additional reinsurance costs
for the stop loss policy. Excluding the effects of this reinsurance cost, the
expense ratio would have been 39.0%, 32.1% and 28.5% for 2000, 1999 and 1998,
respectively, and (ii) 2000 includes a charge of $7.5 million for employee
severance and other costs associated with the realignment of the Company's
operations.
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 liabilities.
REINSURANCE OPERATIONS
The following table summarizes the underwriting results for this segment
(U.S. dollars in thousands):
% CHANGE % CHANGE
2000 00 VS 99 1999 99 VS 98 1998
-----------------------------------------------------
Net premiums earned............................ $927,195 1.9% $ 909,915 19.7% $760,409
Fee income and other........................... (2,197) NM - -
Losses and loss expenses....................... 663,173 (4.2%) 692,269 52.0% 455,583
Acquisition costs.............................. 247,352 10.2% 224,359 31.2% 171,039
Operating expenses............................. 102,132 0.1% 101,978 17.7% 86,670
Exchange (gains) losses........................ 3,868 NM 1,286 NM (1,129)
-----------------------------------------------------
Underwriting (loss) profit..................... $(91,527) 16.8% $(109,977) NM $ 48,246
-----------------------------------------------------
The increase in net premiums earned is mainly a result of an increase in
net premiums written across most lines of business. The Company has experienced
some premium rate increases in the other property, marine, aviation and
satellite lines of business in 2000 over 1999. However, pricing also remained
generally unchanged in the international property (excluding property
catastrophe) and liability lines of business written by the Company. Partially
offsetting this increase in net premiums earned is an increase in reinsurance
costs incurred in 2000 over 1999, primarily relating to stop loss reinsurance
policies. Under these policies, additional premiums become due once losses
exceed certain levels. Additional reinsurance costs of $80.6 million,
$20.5 million and $5.5 million were
23
incurred in 2000, 1999 and 1998, respectively, relating to these policies, where
reinsurance recoveries have been recorded of $151.8 million, $65.0 million and
$25.0 million, respectively, for each of the years.
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 from new business opportunities.
Fee income and other in 2000 relates primarily to non-underwriting costs
relating to an outward reinsurance contract that did not exist in 1999 or prior.
Operating expenses increased in 1999 over 1998 due to the acquisition of
Mid Ocean.
The following table presents the underwriting ratios for this segment:
2000 1999 1998
------------------------
Loss and loss expense ratio................................. 71.5% 76.1% 60.0%
Underwriting expense ratio.................................. 37.7% 35.9% 33.9%
------------------------
Combined ratio.............................................. 109.2% 112.0% 93.9%
------------------------
Net losses and loss expenses incurred in the segment reflect a recovery of
$33.5 million and $100.0 million respectively, under an intercompany stop loss
arrangement. The loss and loss expense ratio in 2000 and 1999 would have been
75.1% and 87.1% respectively, had this arrangement not been in place. Included
in net losses incurred in 2000 are loss reserve adjustments as discussed
previously. Excluding the effects of the intercompany stop loss agreement, the
loss ratio was higher in 1999 compared to both 2000 and 1998 primarily due to a
higher amount of catastrophe losses and a reserve adjustment of $95.0 million
relating to the merger with NAC. Loss events in 2000, which included an oil
refinery loss in Kuwait, several satellite losses and the Singapore Airlines
loss, totaled approximately $95.0 million. Catastrophe losses in 1999 included
European windstorms, hailstorms in Sydney, tornadoes in Oklahoma and satellite
losses totaling approximately $185.0 million. In addition, there was an increase
in the loss ratio in 2000 and 1999 in the casualty reinsurance business 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 losses and loss expenses is derived. Such loss ratios are
periodically adjusted to reflect comparisons with actual claims development,
inflation and other considerations.
Property catastrophe business has loss experience that 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.
The increase in the underwriting expense ratio in 2000 compared to 1999 is
primarily due to lower net earned premiums in 2000 relating to the additional
stop loss reinsurance costs incurred. Excluding the effect of these costs, the
underwriting expense ratio would have been 34.7%, 35.1% and 33.6% for 2000, 1999
and 1998, respectively. Underwriting expenses increased in 1999 over 1998
primarily due to an increase in profit commissions payable to cedents of
proportional business written by XL 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 a minimal 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, 2000, 1999, and 1998 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, 2000 is
set forth in Note 7 of the Notes to Consolidated Financial Statements.
24
FINANCIAL PRODUCTS AND SERVICES
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
% CHANGE
2000 00 VS 99 1999
-----------------------------
Net premiums earned....................................... $ 23,715 11.6% $ 21,253
Fee income and other...................................... 15,924 (40.9%) 26,924
Losses and loss expenses.................................. 6,116 14.1% 5,361
Acquisition costs......................................... 1,323 (37.2%) 2,108
Operating expenses........................................ 29,969 79.8% 16,670
Exchange (gains) losses................................... - - -
-----------------------------
Underwriting profit....................................... $ 2,231 (90.7%) $ 24,038
-----------------------------
Financial guaranty premiums are earned over the life of the exposure, which
is generally longer than that in the Company's other operating segments. Certain
premiums, such as those received on an installment basis are not earned until
the premium is reported. The increase in net premiums earned mainly reflects new
business written in 2000.
The Company may provide financial guaranties in credit default swap form
rather than in insurance form. Premiums received in respect of credit default
swaps, net of estimated losses, are included as fee income and earned over the
life of the policies. Fee income in 2000 relates primarily to credit default
swaps. From time to time, the Company will assist in structuring other financial
transactions that may result in fee income. These transactions tend to be
irregular in nature.
In late 2000, the Company established operations to provide insurance form
coverages that previously were available primarily in capital markets. No
premiums were written relating to this business in 2000. The Company intends to
hedge these risks as they are assumed.
The following table presents the underwriting ratios for the financial
products and services segment:
2000 1999
---------------
Loss and loss expense ratio................................. 25.8% 25.2%
Underwriting expense ratio.................................. 131.9% 88.4%
---------------
Combined ratio.............................................. 157.7% 113.6%
---------------
The financial guaranty operations write business with an expected loss
ratio of approximately 25%. Operating expenses for this segment include expenses
associated with the Company's activities in writing financial solutions and in
generating deposit liabilities. Revenues associated with these transactions are
reflected in investment income, net realized gains on investments and equity
earnings in affiliates. Thus, the expense ratio and combined ratio tend to be
higher than traditional insurance results. Not all premiums written have related
acquisition costs. The calculation of the expense ratio excludes fee income
derived from credit default swap transactions. If this income were included, the
expense ratio and the combined ratio would have been 81.8% and 107.6%
respectively in 2000 and 70.4% and 95.6% respectively in 1999. The high expense
ratio continues to reflect the start up nature of this segment.
25
INVESTMENT ACTIVITIES
The following table illustrates the change in net investment income and net
realized gains and losses for each of the three years ended December 31, 2000
(U.S dollars in thousands):
% CHANGE % CHANGE
2000 00 VS 99 1999 99 VS 98 1998
----------------------------------------------------
Net investment income.......................... $542,500 3.3% $525,318 25.9% $417,290
Net realized investment gains.................. $ 50,571 NM $ 94,356 NM $211,204
Annualized effective yield..................... 5.99% - 5.85% - 5.38%
External investment professionals manage the Company's portfolio under the
direction of the Company's management.
As at December 31, 2000 and 1999, total investments and cash, net of the
payable for investments purchased, were $9.1 billion, respectively. While there
was no significant change between the years, 2000 included the reinvestment of
investment income and realized gains, and the receipt of assets relating to the
loss portfolio transfers discussed further in "-Financial Condition and
Liquidity". These receipts were offset by the transfer of assets to limited
partnerships and affiliate investments, claim payments and the repurchase of the
Company's shares. 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 that 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, 2000 represented approximately 86.4% of investments available
for sale and were managed by several independent investment managers with
different strategies. Of the fixed income securities, approximately 88.9% were
investment grade, with 61.1% rated Aa or AA or better by a nationally recognized
rating agency.
The net payable for investments purchased relates to timing differences as
investments are accounted for on a trade date basis. This increased to
$1.4 billion at December 31, 2000 from $0.6 billion at December 31, 1999,
primarily due to higher investment in certain mortgage-backed securities where
the settlement period is generally longer than most fixed income investments.
The increase in investment income in the years presented is primarily due
to an increase in the annualized effective yield on the portfolio as the
proportion of fixed maturities held increased compared to the prior year. The
Company's investment base includes assets relating to deposit liabilities
assumed in 2000 and late 1999. Investment income earned on these assets is
reduced by the investment expense created by the accretion of these deposit
liabilities. Excluding the assets relating to deposit liabilities, the
investment base has declined in 2000 compared to 1999 due to claims payments,
repurchase of shares and reallocation of assets to other strategic investmnets.
However, investment yields have been higher in 2000 compared to 1999, which
together with additional income derived from the asset accumulation business,
has resulted in higher net investment income.
Net realized gains in 2000 include a $54.1 million gain on the sale of the
Company's investment in FSA Holdings, Inc. However, offsetting this gain, the
Company incurred realized capital losses of approximately $66.2 million in
certain other investments where the Company determined there to be an other than
temporary decline in value of such investments.
Net realized investment 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 realized gains where they
believed that valuations had reached their targets. However, 1999 equity gains
were offset by declining fixed income markets that 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.
26
OTHER REVENUES AND EXPENSES
The following table sets forth other revenues and expenses of the Company
for each of the three years ended December 31, 2000 (U.S. dollars in thousands):
% CHANGE % CHANGE
2000 00 VS 99 1999 99 VS 98 1998
---------------------------------------------------
Equity in net income of affiliates................ $ 74,355 81.8% $ 40,907 (18.7)% $50,292
Foreign exchange gains............................ 55,159 NM - - -
Amortization of intangible assets................. 58,597 19.2% 49,141 82.8% 26,881
Corporate operating expenses...................... 61,935 (30.4)% 89,037 NM 37,139
Interest expense.................................. 32,147 (14.0)% 37,378 11.8% 33,444
Minority interest................................. 1,093 NM 220 NM 749
Income tax........................................ (56,356) 42.4% (39,570) NM 29,883
The increase in equity earnings of affiliates in 2000 compared to 1999 is
primarily attributable to increased returns on the Company's holdings in
investment management companies and the funds managed by those companies, in
addition to new affiliate investments made in 2000. 1999 included a loss of
$3.6 million relating to Arch Capital (formerly Risk Capital), which was sold in
2000. This loss, together with the inclusion of only seven months of equity
earnings from the Company's equity position in Mid Ocean in 1998, contributed to
the decrease in equity in net income of affiliates in 1999 compared to 1998.
Foreign exchange gains in 2000 related to the revaluation of a deposit
liability denominated in U.K. Sterling. The exchange rate movement on the assets
matching this deposit liability is included in accumulated other comprehensive
income as those assets are designated as available for sale, and in net realized
gains on sale of investments. Effective January 1, 2001, the Company has
reorganized its corporate and operational structure for U.K. Sterling asset
accumulation business such that future exchange translation adjustments of this
nature will be matched against corresponding investment portfolio movements with
minimal effect on earnings.
The increase in the amortization of intangible assets in 2000 compared to
1999 primarily related to a full year's charge for ECS and XL Specialty,
acquired in the second quarter of 1999. The increase in 1999 over 1998 related
to the acquisition of Mid Ocean in 1998, where a full year's goodwill charge was
included in 1999.
Corporate operating expenses in 2000 included $5.7 million relating to
charges for employee severance and other costs relating to the realignment of
Company's operations. 1999 included $45.3 million of charges related to the
merger with NAC and 1998 included $17.5 million of charges associated with the
merger with Mid Ocean were included in corporate operating expenses. Excluding
these charges, the net increase in corporate operating expenses in each of the
years presented is due to the increase in the corporate infrastructure necessary
to support the growing worldwide operations of the Company.
Decreases in interest expense in 2000 compared to 1999 reflect a reduction
in debt carried by the Company through 2000 compared to 1999. The Company
extinguished convertible debt assumed in connection with the NAC merger in 1999.
In addition, the Company pooled capital with its existing operations as a result
of acquisitions in the U.S. in 1999, which facilitated repayment of debt in the
third quarter of 1999. This decrease was partially offset by interest expense
related to interim borrowings used to finance the repurchase of shares in the
year ended December 31, 2000. Increases in interest expense in 1999 compared to
1998 is due to the increase in the average long-term debt outstanding in 1999,
which was mainly used to finance the acquisitions of ECS and Intercargo, and the
repurchase of shares in both 1999 and 1998.
The change in the income taxes of the Company principally reflects the
decline in the profitability of the U.S. operations for each year. Deterioration
of the casualty book in 2000 and 1999 resulted in pre-tax net losses for U.S.
operations, generating an income tax benefit for both years. See Note 17 to the
Consolidated Financial Statements.
27
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 the Society of Lloyd's that are described more fully in
Note 18 to 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, 2000 was $5.6 billion, of
which $3.2 billion was retained earnings.
Certain business written by the Company has loss experience characterized
as 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 positive cash flow from operating activities.
In 2000, 1999 and 1998, the total amount of net losses paid by the Company
was $1.7 billion, $1.1 billion, $0.7 billion, respectively. The increase in 2000
compared to 1999 is due to an increase in the amount of net premiums written by
the Company, together with losses paid for the settlement of previously
established reserves, particularly catastrophe losses. Paid losses in 2000 also
include $74.0 million relating to a commutation payment. The increase in paid
losses in 1999 over 1998 is primarily due to the acquisition of Mid Ocean in
August 1998. The higher amount of paid claims in 2000 compared to 1999 has
contributed to the lower operational cash flow in 2000 as compared to 1999.
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 judgment 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 2000, the Company made the following investments:
(1) The Company exchanged its investment in Arch Capital (formerly known as
Risk Capital Holdings), an affiliate, and $3.6 million in cash for Arch
Capital's ownership in Latin American Re and 1.4 million shares and 100,000
warrants of Annuity & Life Re. The Company also acquired the remaining shares of
Latin American Re owned by that company's management in December 2000.
(2) The Company acquired ECS Re, a subsidiary of ECS Inc, for
$21.0 million in cash.
(3) The Company invested a further $177.2 million in affiliates, the
majority of which related to investment fund affiliates, and a further
$55.9 million in limited partnerships and other investments.
The Company assumed loss portfolio transfers during 2000 and 1999 that 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.
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.
28
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.
The Company has had several stock repurchase programs as part of its
capital management strategy. In June 1999, the Board of Directors rescinded the
Company's share repurchase program in place at that time. On January 9, 2000,
the Board of Directors authorized a new program for the repurchase of up to
$500.0 million. The new share repurchase program was announced in conjunction
with a dividend increase of $0.04 per share per annum. Under the current
program, in 2000, the Company purchased 5.1 million shares at a cost of
$247.7 million or an average of $48.82 per share.
As at December 31, 2000, the Company had bank, letter of credit and loan
facilities available from a variety of sources, including commercial banks,
totaling $2.6 billion comprising a 364-day facility, 5-year facilities, notes
payable and letter of credit facilities. Debt and notes outstanding at
December 31, 2000 were $450.0 million and letters of credit outstanding were
$1.1 billion. Letters of credit issued and outstanding, 14% 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.
Approximately 40% of the letters of credit outstanding were issued in connection
with intercompany reinsurance agreements.
During 2000 and 1999, borrowings under these facilities were
$250.3 million and $328.7 million, respectively, and repayments under the
facilities were $211.0 million and $339.7 million, respectively. The borrowings
in 2000 were used as interim funding of share buybacks and were repaid using
funds from the equity portfolio. The borrowings in 1999 facilitated the
repurchase of shares and the purchase of Intercargo and ECS. In June 1999, the
Company converted $100 million 5.25% Convertible Subordinate Debentures due 2002
through the issue of 1.8 million shares out of treasury. The total pre-tax
interest expense on notes and debt outstanding during the year ended
December 31, 2000 and 1999 was $32.1 million and $37.4 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.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 2 to the Consolidated Financial Statements for a discussion on
recent accounting pronouncements.
YEAR 2000 ISSUES
There was no significant impact of Year 2000 issues on the Company's
technology systems. The Company did not experience any significant disruption
due to the impact of Year 2000 issues on its service providers.
The Company continues to be subject to risks associated with Year 2000
issues based upon the underwriting exposures that it assumed. 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 substantial exposure to Year 2000-related coverage claims. See
generally "-Cautionary Note Regarding Forward-Looking Statements".
29
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The Company is exposed to potential loss from various market risks,
including 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 for trading
purposes, 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
significantly from these anticipated results due to actual developments in the
global financial markets. The results of analysis 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 6.1% or $480.0 million on the
Company's fixed income portfolio as of December 31, 2000.
In evaluating the impact of price changes of the equity portfolio, a 10%
change in equity prices would affect total return by approximately
$55.7 million at December 31, 2000.
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.
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 believe potential
gains exist in a particular currency, a forward contract may not be entered
into. At December 31, 2000, forward foreign exchange contracts with notional
principal amounts totaling $111.9 million were outstanding. The fair value of
these contracts as at December 31, 2000 was $109.6 million with unrealized
losses of $2.3 million. Gains of $28.1 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, 2000
would have resulted in approximately $0.4 million and $7.4 million in unrealized
losses, 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, 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, 2000, the Company had $54.9 million of such contracts
outstanding, and had recognized $1.5 million in realized and unrealized losses
for 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, 2000 would have resulted in approximately $6.1 million in
unrealized gains and $5.1 million in unrealized losses, respectively.
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 effectively closed by entering into an offsetting purchase
contract. At December 31, 2000, the Company had, as hedges, foreign exchange
contracts for the sale of $121.0 million and the purchase of $25.7 million of
foreign currencies at fixed rates, primarily Euros. The notional
30
value of fixed maturities denominated in foreign currencies that were hedged and
held by the Company as at December 31, 2000 was $100.6 million. 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, 2000 would have
resulted in approximately $12.1 million and $1.1 million in unrealized losses,
respectively.
In connection with these foreign exchange contracts directly hedging
foreign currency fixed maturity investments, unrealized foreign exchange gains
or losses are deferred and included in accumulated other comprehensive income.
As at December 31, 2000, unrealized losses amounted to $10.2 million. Realized
gains of $14.6 million were recognized in earnings during 2000.
During the year ended December 31, 2000, the Company used foreign exchange
contracts to manage its exposure to the effects of fluctuating foreign
currencies on the amount of its known claims payable in foreign currencies.
These contracts were not designated as specific hedges for financial reporting
purposes and therefore, realized and unrealized gains and losses on these
contracts were recorded in income in the period in which they occurred. As at
December 31, 2000, no contracts were outstanding. A loss of $6.8 million was
realized in the year in connection with these contracts.
In 2000, the Company used foreign exchange forward contracts to reduce its
exposure to premiums receivable denominated in foreign currencies. The forward
contract is closely matched with the receivable maturity date. Both the foreign
currency receivable and the offsetting forward contract are marked to market on
each balance sheet date, with any gains and losses recognized in the income
statement. As at December 31, 2000, the Company had forward contracts
outstanding for the sale of $10.0 million of foreign currencies at fixed rates,
primarily U.K. Sterling. Losses of $0.1 million were realized during 2000.
The Company attempts to manage the exchange volatility arising on certain
administration costs denominated in foreign currencies. Throughout the year,
forward contracts are entered into to acquire the foreign currency at an agreed
rate in the future. Any gains or losses on the forward contracts are deferred
and included as a component of shareholders' equity. As the administration
expenses are incurred, the gains and losses are recognized in the income
statement. At December 31, 2000, the Company had forward contracts outstanding
for the purchase of $12.8 million of Euros and U.K. Sterling at fixed rates.
Gains deferred in accumulated other comprehensive income as at December 31, 2000
were insignificant. No gains or losses were realized during the year.
FINANCIAL MARKET EXPOSURE
The Company invests in a synthetic equity portfolio of S&P Index futures
with an exposure approximately equal in amount to the market value of underlying
assets held in this fund. As at December 31, 2000, the portfolio held
$43.7 million in exposure to S&P 500 Index futures and underlying assets of
$43.2 million. Based on this value, a 10% increase or decrease in the price of
these futures would have resulted in exposure of $48.1 million and
$39.3 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, 2000, net realized losses from index futures totaled $0.2 million
as a result of the 10.1% decrease 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 and also to adjust the
duration of a portfolio of fixed income securities to match the duration of
related deposit liabilities. At December 31, 2000, bond and stock index futures
outstanding were $40.1 million with underlying investments having a market value
of $2.5 billion. A 10% appreciation or depreciation of these derivative
instruments at this time would have resulted in unrealized gains and losses of
$4.0 million, respectively.
CURRENT OUTLOOK
Most of the property and casualty markets in which the Company operates
have seen some improvements in pricing and policy terms and conditions for
renewals of contracts the Company has underwritten thus far for 2001. However,
the Company believes there will need to be a continuation of these improvements
for some time in order
31
for the industry to fully recover from the prolonged competitive downturn that
has negatively impacted most companies' results over the past several years.
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 or otherwise.
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, including, without limitation, the
Winterthur International acquisition; (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, 2000 and
1999...................................................... 33
Consolidated Statements of Income and Comprehensive income
for the years ended December 31, 2000, 1999 and 1998...... 34
Consolidated Statements of Shareholders' Equity for the
years ended December 31, 2000, 1999 and 1998.............. 35
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998.......................... 36
Notes to Consolidated Financial Statements for the years
ended December 31, 2000, 1999 and 1998.................... 37
32
XL CAPITAL LTD
CONSOLIDATED BALANCE SHEETS AS AT DECEMBER 31, 2000 AND 1999
(U.S. dollars in thousands, except share amounts)
2000 1999
-------------------------
A S S E T S
Investments:
Fixed maturities at fair value (amortized cost: 2000,
$8,714,196;
1999, $7,835,919)...................................... $ 8,605,081 $ 7,581,151
Equity securities, at fair value (cost: 2000, $515,440;
1999, $863,020)........................................ 557,460 1,136,180
Short-term investments, at fair value (amortized cost:
2000, $347,147;
1999, $405,375)........................................ 339,007 405,260
-------------------------
Total investments available for sale................ 9,501,548 9,122,591
Cash and cash equivalents................................... 930,469 557,749
Investments in affiliates................................... 792,723 479,911
Other investments........................................... 177,651 165,613
Accrued investment income................................... 143,235 111,590
Deferred acquisition costs.................................. 309,268 275,716
Prepaid reinsurance premiums................................ 391,789 217,314
Premiums receivable......................................... 1,119,723 1,126,397
Reinsurance balances receivable............................. 196,002 149,880
Unpaid losses and loss expenses recoverable................. 1,339,767 831,864
Intangible assets (accumulated amortization: 2000, $177,260;
1999, $118,663)........................................... 1,591,108 1,626,946
Deferred tax asset, net..................................... 152,168 97,928
Other assets................................................ 296,501 327,413
-------------------------
Total assets........................................ $16,941,952 $15,090,912
-------------------------
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............................. $ 5,672,062 $ 5,369,402
Deposit liabilities and policy benefit reserves............. 1,209,926 837,893
Unearned premiums........................................... 1,741,393 1,497,376
Notes payable and debt...................................... 450,032 410,726
Reinsurance balances payable................................ 441,900 387,916
Net payable for investments purchased....................... 1,372,476 622,260
Other liabilities........................................... 439,433 345,738
Minority interest........................................... 41,062 42,523
-------------------------
Total liabilities................................... $11,368,284 $ 9,513,834
-------------------------
Commitments and Contingencies
Shareholders' Equity:
Authorized, 999,990,000 ordinary shares, par value $0.01
Issued and outstanding:
Class A ordinary shares (2000, 125,020,676; 1999,
124,691,541)........................................... $ 1,250 $ 1,247
Class B ordinary shares (2000, Nil; 1999, 3,115,873)...... - 31
Contributed surplus......................................... 2,497,416 2,520,136
Accumulated other comprehensive (loss) income............... (104,712) 19,311
Deferred compensation....................................... (17,727) (28,797)
Retained earnings........................................... 3,197,441 3,065,150
-------------------------
Total shareholders' equity.......................... $ 5,573,668 $ 5,577,078
-------------------------
Total liabilities and shareholders' equity.......... $16,941,952 $15,090,912
-------------------------
See accompanying notes to Consolidated Financial Statements
33
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(U.S. dollars in thousands, except per share amounts)
2000 1999 1998
------------------------------------
Revenues:
Net premiums earned....................................... $2,035,240 $1,750,006 $1,324,291
Net investment income..................................... 542,500 525,318 417,290
Net realized gains on sales of investments................ 50,571 94,356 211,204
Equity in net income of affiliates........................ 74,355 40,907 50,292
Fee income and other...................................... 14,793 100,400 22,325
------------------------------------
Total revenues...................................... 2,717,459 2,510,987 2,025,402
------------------------------------
Expenses:
Losses and loss expenses.................................. 1,432,559 1,304,304 841,517
Acquisition costs......................................... 485,796 380,980 249,341
Operating expenses........................................ 316,892 308,083 188,910
Exchange gains............................................ (59,621) (58) (1,653)
Interest expense.......................................... 32,147 37,378 33,444
Amortization of intangible assets......................... 58,597 49,141 26,881
------------------------------------
Total expenses...................................... 2,266,370 2,079,828 1,338,440
------------------------------------
Income before minority interest and income tax expense...... 451,089 431,159 686,962
Minority interest in net income of subsidiary............. 1,093 220 749
Income tax (benefit) expense.............................. (56,356) (39,570) 29,883
------------------------------------
Net income.................................................. $ 506,352 $ 470,509 $ 656,330
------------------------------------
Change in net unrealized appreciation of investments........ (118,321) (211,842) (15,414)
Foreign currency translation adjustments.................... (5,702) (4,032) (872)
------------------------------------
Comprehensive Income........................................ $ 382,329 $ 254,635 $ 640,044
------------------------------------
Weighted average ordinary shares and ordinary share
equivalents outstanding - basic........................... 124,503 127,601 112,034
------------------------------------
Weighted average ordinary shares and ordinary share
equivalents outstanding - diluted......................... 125,697 130,304 116,206
------------------------------------
Earnings per ordinary share and ordinary share equivalent -
basic..................................................... $ 4.07 $ 3.69 $ 5.86
------------------------------------
Earnings per ordinary share and ordinary share equivalent -
diluted................................................... $ 4.03 $ 3.62 $ 5.68
------------------------------------
See accompanying notes to Consolidated Financial Statements
34
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(U.S. dollars in thousands)
2000 1999 1998
------------------------------------
Ordinary Shares:
Balance - beginning of year............................... $ 1,278 $ 1,287 $ 1,013
Issue of shares........................................... - 1 15
Issue of shares - Mid Ocean acquisition................... - - 291
Exercise of stock options................................. 23 5 3
Repurchase of treasury shares............................. (51) (15) (35)
------------------------------------
Balance - end of year............................... 1,250 1,278 1,287
------------------------------------
Contributed Surplus:
Balance - beginning of year............................... 2,520,136 2,508,062 506,452
Issue of shares........................................... 2,652 15,951 101,502
Issue of shares Mid Ocean acquisition..................... - - 2,093,426
Exercise of stock options................................. 74,538 11,711 9,147
Repurchase of treasury shares............................. (99,910) (15,588) (202,465)
------------------------------------
Balance - end of year............................... 2,497,416 2,520,136 2,508,062
------------------------------------
Accumulated other comprehensive (loss) income:
Balance - beginning of year............................... 19,311 235,185 251,471
Net change in unrealized gains on investment portfolio,
net of tax............................................. (112,031) (213,482) (10,352)
Net change in unrealized gains on investment portfolio
of affiliate........................................... (6,290) 1,640 (5,062)
Currency translation adjustments.......................... (5,702) (4,032) (872)
------------------------------------
Balance - end of year............................... (104,712) 19,311 235,185
------------------------------------
Deferred Compensation:
Balance - beginning of year............................... (28,797) (22,954) (18,263)
Forfeit (issue) of restricted shares...................... 1,555 (13,603) (10,506)
Amortization.............................................. 9,515 7,760 5,815
------------------------------------
Balance - end of year............................... (17,727) (28,797) (22,954)
------------------------------------
Retained Earnings:
Balance - beginning of year............................... 3,065,150 2,891,023 2,455,076
Net income................................................ 506,352 470,509 656,330
Cash dividends paid....................................... (225,572) (212,659) (156,482)
Repurchase of treasury shares............................. (148,489) (83,723) (63,901)
------------------------------------
Balance - end of year............................... 3,197,441 3,065,150 2,891,023
------------------------------------
Total shareholders' equity.................................. $5,573,668 $5,577,078 $5,612,603
------------------------------------
See accompanying notes to Consolidated Financial Statements
35
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(U.S. dollars in thousands)
2000 1999 1998
------------------------------------------
Cash flows provided by operating activities:
Net income................................................ $ 506,352 $ 470,509 $ 656,330
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Net realized gains on sales of investments................ (50,571) (94,356) (211,204)
Amortization of discounts on fixed maturities............. (47,099) (14,429) (14,718)
Equity in net income of affiliates........................ (74,355) (40,907) (50,292)
Amortization of deferred compensation..................... 8,861 7,657 5,815
Amortization of intangible assets......................... 58,597 49,141 26,881
Unpaid losses and loss expenses........................... 259,728 411,396 323,857
Unearned premiums......................................... 244,017 131,767 52,161
Premiums receivable....................................... 6,674 (166,027) 4,245
Unpaid losses and loss expenses recoverable............... (506,242) (212,928) (221,177)
Prepaid reinsurance premiums.............................. (174,475) (1,848) (45,961)
Reinsurance balances receivable........................... (46,122) (25,109) (31,103)
Other..................................................... 77,086 (25,632) 39,783
------------------------------------------
Total adjustments................................... (243,901) 18,725 (121,713)
------------------------------------------
Net cash provided by operating activities................. 262,451 489,234 534,617
Cash flows provided by (used in) investing activities:
Proceeds from sale of fixed maturities and short-term
investments............................................ 22,287,287 15,664,591 15,765,103
Proceeds from redemption of fixed maturities and
short-term investments................................. 460,733 134,565 516,418
Proceeds from sale of equity securities................... 1,480,853 1,017,177 918,501
Purchases of fixed maturities and short-term
investments............................................ (22,798,463) (16,075,719) (16,460,877)
Purchases of equity securities............................ (1,071,351) (803,728) (1,020,032)
Deferred (gains) losses on forward contracts.............. 9,388 (509) (12,163)
Investments in affiliates, net of dividends received...... (180,818) (342,142) 24,193
Acquisition of subsidiaries, net of cash acquired......... (3,094) (173,206) 41,483
Other investments......................................... (55,917) (120,717) 4,411
Deposit liabilities and policy benefit reserves........... 372,033 837,893 -
Other assets.............................................. (40,564) (35,133) 13,430
------------------------------------------
Net cash provided by (used in) investing activities......... 460,087 103,072 (209,533)
Cash flows provided by (used in) financing activities:
Issue of shares........................................... - 69 514
Proceeds from exercise of stock options................... 74,561 14,014 15,092
Repurchase of treasury shares............................. (248,450) (99,344) (266,401)
Dividends paid............................................ (225,572) (212,659) (156,481)
Proceeds from loans....................................... 250,300 328,700 655,000
Repayment of notes........................................ - (100,000) -
Repayment of loans........................................ (211,000) (339,735) (495,000)
Repayment of debentures................................... - (101,737) -
Minority interest......................................... 10,892 (4,900) 19,988
------------------------------------------
Net cash used in financing activities....................... (349,269) (515,592) (227,288)
Effects of exchange rate changes on foreign currency cash... (549) 161 (516)
Increase in cash and cash equivalents....................... 372,720 76,875 97,280
Cash and cash equivalents - beginning of year............... $ 557,749 $ 480,874 $ 383,594
------------------------------------------
Cash and cash equivalents - end of year..................... $ 930,469 $ 557,749 $ 480,874
------------------------------------------
Net taxes received (paid)................................... $ 13,347 $ (30,246) $ (31,200)
------------------------------------------
Interest paid............................................... $ (30,505) $ (28,268) $ (32,800)
------------------------------------------
See accompanying notes to Consolidated Financial Statements
36
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2000, 1999 AND 1998
(U.S. dollars in thousands, except per share amounts)
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. 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 these financial statements 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, 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 Re, formerly XL Mid Ocean Re, is organized under the laws of Bermuda. On
August 7, 1998, XL Mid Ocean Re was formed through the merger of XL Global
Reinsurance and Mid Ocean Re. Mid Ocean Re and Global Capital Re were organized
in 1992 and 1993, respectively, initially to write property catastrophe
reinsurance following a reduction in market capacity due to the effects of
severe hurricanes that struck the southeastern United States in the late 1980's
and early 1990's.
The Company further expanded into the U.S. in 1999 by completing the
acquisition of both Intercargo Corporation and ECS, Inc. Intercargo, renamed XL
Specialty, 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.
XL Brockbank, formerly Brockbank, was acquired through the merger with Mid
Ocean. XL Brockbank is organized under the laws of the United Kingdom and is a
leading Lloyd's managing agency that 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. The two corporate
syndicates, which commenced operations on January 1, 1996, underwrite property,
marine and energy, aviation, satellite, professional indemnity and other
specialty lines of insurance and reinsurance to a global client base. As a
managing agency, XL Brockbank may receive fees and commissions in respect of
underwriting services it provides to the non-related syndicates. In the fourth
quarter of 1999, XL Brockbank sold its two motor insurance businesses, Admiral
and Zenith.
37
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2000, 1999 AND 1998 (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
1. HISTORY (CONTINUED)
Denham Syndicate Management Limited was acquired in 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 has pursued a strategy of entering into ventures with other
organizations that possess expertise in lines of business that the Company
wishes to write. These ventures are considered to be of strategic importance.
The Company's principal ventures are in the areas of financial guaranty
insurance, life insurance for high net worth individuals, political risk
insurance and currency and related risk management. In July 1999, the Company
entered into a 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 most classes
of property and casualty 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 venture with FSA Holdings Ltd to write
financial guaranty insurance and reinsurance. Under the terms of the 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
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 American Re, a Bermuda
reinsurance company. The remaining minority interest was purchased in 2000.
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.
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 based upon the Company's 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 significant
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.
38
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2000, 1999 AND 1998 (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(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.
Financial guaranty installment premiums are recorded as premiums written when
reported. Premiums are earned on a monthly pro-rata basis over the period the
coverage is provided. Financial guaranty insurance premiums are earned over the
life of the exposure. 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.
Acquisition costs, which vary with and are 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, the anticipated
losses and other costs, together with investment income 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. Prepaid reinsurance premiums
represent the portion of premiums ceded that is applicable to the unexpired term
of policies in force. 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) FEE INCOME AND OTHER
Fee income and other includes fees earned for services, together with
premiums, net of loss reserve estimates, on credit default swaps. The Company
recognizes fee income over the estimated performance or risk period of the
related services provided. Any adjustments to those estimated periods any
cumulative adjustments resulting therefrom are reflected in income in the year
in which the adjustment is made.
(E) 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.
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 equities and fixed
income investments are determined on the basis of average cost and amortized
cost, respectively. Investment income is recognized when earned and includes
39
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2000, 1999 AND 1998 (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 accumulated other comprehensive income
until the corresponding investment asset is sold.
(F) CASH EQUIVALENTS
Cash equivalents include fixed interest deposits placed with a maturity of
under 90 days when purchased.
(G) 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, net of applicable deferred income taxes, is included in accumulated
other comprehensive income.
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.
(H) INVESTMENTS IN AFFILIATES
Investments in which the Company has significant influence over the
operations are classified as affiliates and are carried under the equity method
of accounting. Under this method, the Company records its proportionate share of
income or loss from such investments in its results of operations.
(I) OTHER INVESTMENTS
The Company accounts for its other investments, including investments in
limited partnerships, 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 an other than temporary decline in value. Income
is recorded when received.
(J) AMORTIZATION OF INTANGIBLE ASSETS
Intangible assets represent goodwill recorded in connection with the
Company's business combinations and are amortized on a straight-line basis over
the expected life of the related operations acquired, not exceeding 40 years.
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.
40
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2000, 1999 AND 1998 (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(K) 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 is established by management based
on amounts reported from insureds 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.
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 expense on the experience accounts is charged to investment income. In
the event the insured cancels the policy, the return of the experience account
is treated 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.
Certain workers' compensation reserves are considered fixed and
determinable and are subject to tabular reserving. Such tabular reserves are
discounted using an interest rate of 7%.
Management believes that the reserves for unpaid losses and loss expenses
are sufficient to pay 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.
(L) 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 initially recorded at the same amount as
assets received. An initial accretion rate is established based on actuarial
estimates whereby the deposit liability is increased to the estimated amount
payable over the term of the contract. This accretion charge is presented in the
period 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 also accounted for as deposits.
The Company will periodically re-assess the amount of deposit liabilities
and policy benefit reserves. Any changes to the estimated ultimate liability
will be reflected as an adjustment to earnings to reflect the cumulative effect
to date of the period the contract has been in force and by an adjustment to the
future accretion rate of the liability over the remaining estimated contract
term.
(M) INCOME TAXES
The Company utilizes the asset and liability method of accounting for
income taxes. Under this method, deferred income taxes reflect the net tax
effect of temporary differences between the carrying amounts of assets and
41
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2000, 1999 AND 1998 (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
(N) 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 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.
(O) 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.
(P) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value 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.
(Q) RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities," (FAS 133) in
June 1998. FAS 133 establishes accounting and reporting standards for derivative
instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activity. It requires an entity to recognize all
derivatives as either assets or liabilities in the balance sheet and measure
those instruments at fair value. The Company will adopt FAS 133, as amended, as
of January 1, 2001. Credit default swaps issued by the Company meet the
definition of a derivative under FAS 133. From January 1, 2001 the Company will
record these products at fair value, with the fair value adjustment being
recorded in earnings in each period. The level of such adjustments will be
dependent upon a number of factors including changes in interest rates, credit
spreads and other market factors.
The Company has established a committee and completed an implementation
plan to identify all derivatives, evaluate risk management hedging strategies
and determine appropriate valuation methodologies in order to assess the impact
that adoption of this statement will have on its financial position and results
of operation. Based on the Company's current accounting treatment for
derivatives and as a result of its review, the Company has estimated that
FAS 133, as amended, will not have a significant impact on the results of
operations, financial condition or liquidity in future periods.
3. SEGMENT INFORMATION
The Company is organized into three underwriting segments - insurance,
reinsurance, and financial products and services - in addition to a corporate
segment that includes the investment operations of the Company. Lloyd's
syndicates are part of the insurance segment but are described separately as the
nature of the business written and the market in which the Lloyd's syndicates
underwrite are significantly different to the Company's other insurance
42
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2000, 1999 AND 1998 (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
subsidiaries. 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 - EXCLUDING LLOYD'S SYNDICATES
Insurance business written includes general liability, other liability
including directors and officers, professional and employment practices
liability, environmental liability, property, program business, marine,
aviation, satellite and other product lines including U.S. Customs bonds,
surety, political risk and specialty lines.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
The Lloyd's syndicates write property, marine and energy, aviation and
satellite, professional indemnity, liability coverage and other specialty lines,
primarily of insurance but also reinsurance.
REINSURANCE OPERATIONS
Reinsurance 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.
FINANCIAL PRODUCTS AND SERVICES
Financial products and services business written includes insurance and
reinsurance solutions for complex financial risks. These include financial
guaranty insurance and reinsurance, credit enhancement swaps and other
collateralized transactions. While each of these is unique and is 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 risks to third
parties from time to time. In 1999, the Company began assuming large loss
portfolios as part of its new asset accumulation strategy.
43
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
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 allocate 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, 2000 INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
- ---------------------------- -------------------------------------------------------------
Net premiums earned......................... $726,506 $357,824 $927,195 $ 23,715 $2,035,240
Fee income and other........................ 7,692 (6,626) (2,197) 15,924 14,793
Net losses and loss expenses (2)............ 502,898 260,372 663,173 6,116 1,432,559
Acquisition costs........................... 117,251 119,870 247,352 1,323 485,796
Operating expenses (3)...................... 94,129 28,727 102,132 29,969 254,957
Exchange (gains) and losses................. (2,344) (5,986) 3,868 - (4,462)
-------------------------------------------------------------
Underwriting profit (loss).................. $ 22,264 $(51,785) $(91,527) $ 2,231 $ (118,817)
Net investment income....................... 542,500
Net realized gains on investments........... 50,571
Equity in net earnings of affiliates........ 74,355
Interest expense............................ 32,147
Amortization of intangible assets........... 58,597
Corporate operating expenses (3)............ 61,935
Other exchange gain......................... 55,159
Minority interest........................... 1,093
Income tax benefit.......................... 56,356
----------
Net income.................................. $ 506,352
----------
Loss and loss expense ratio................. 69.2% 72.8% 71.5% 25.8% 70.4%
Underwriting expense ratio.................. 29.1% 41.5% 37.7% 131.9% 36.4%
-------------------------------------------------------------
Combined ratio.............................. 98.3% 114.3% 109.2% 157.7% 106.8%
-------------------------------------------------------------
(1) Ratios are based on net premiums earned, excluding fee income and other. The
underwriting expense ratio excludes exchange gains and losses.
(2) Net losses and loss expenses for the insurance segment include, and the
reinsurance segment exclude, $33.5 million relating to an intercompany stop
loss arrangement. Total results are not affected. The loss and loss expense
ratio would have been 64.6% and 75.1% and the underwriting results would
have been a profit of $55.8 million and a loss of $125.0 million in the
insurance and reinsurance segments, respectively, had this stop loss
arrangement not been in place.
(3) Operating expenses exclude corporate operating expenses, shown separately.
44
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
LLOYD'S FINANCIAL
YEAR ENDED DECEMBER 31, 1999 INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
- ---------------------------- --------------------------------------------------------------
Net premiums earned........................ $463,069 $355,769 $ 909,915 $ 21,253 $1,750,006
Fee income and other....................... 7,584 65,892 - 26,924 100,400
Net losses and loss expenses (2)........... 309,079 297,595 692,269 5,361 1,304,304
Acquisition costs.......................... 65,318 89,195 224,359 2,108 380,980
Operating expenses (3)..................... 71,094 29,305 101,978 16,670 219,047
Exchange (gains) and losses................ (165) (1,180) 1,286 - (59)
--------------------------------------------------------------
Underwriting profit (loss)................. $ 25,327 $ 6,746 $(109,977) $ 24,038 $ (53,866)
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 (4)........... 89,037
Minority interest.......................... 220
Income tax benefit......................... (39,570)
----------
Net income................................. $ 470,509
----------
Loss and loss expense ratio................ 66.7% 83.6% 76.1% 25.2% 74.5%
Underwriting expense ratio................. 29.5% 33.3% 35.9% 88.4% 34.3%
--------------------------------------------------------------
Combined ratio............................. 96.2% 116.9% 112.0% 113.6% 108.8%
--------------------------------------------------------------
(1) Ratios are based on net premiums earned, excluding fee income and other. The
underwriting expense ratio excludes exchange gains and losses.
(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 arrangement. Total results are not affected. The loss and loss expense
ratio would have been 45.2% and 87.1% and the underwriting results would
have been a profit of $125.3 million and a loss of $210.0 million in the
insurance and reinsurance segments, respectively, had this stop loss
arrangement not been in place.
(3) Operating expenses exclude corporate operating expenses, shown separately.
(4) Corporate operating expenses include one-time charges of $45.3 million
related to the merger with NAC.
45
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
LLOYD'S FINANCIAL
YEAR ENDED DECEMBER 31, 1998 INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
- ---------------------------- -------------------------------------------------------------
Net premiums earned........................... $410,030 $153,852 $760,409 $ - $1,324,291
Fee income and other.......................... 8,244 14,081 - - 22,325
Net losses and loss expenses.................. 267,823 118,111 455,583 - 841,517
Acquisition costs............................. 47,688 30,614 171,039 - 249,341
Operating expenses (2)........................ 49,702 15,399 86,670 - 151,771
Exchange gains................................ - (524) (1,129) - (1,653)
-------------------------------------------------------------
Underwriting profit (loss).................... $ 53,061 $ 4,333 $ 48,246 $ - $ 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 (3).............. 37,139
Minority interest............................. 749
Income tax expense............................ 29,883
----------
Net income.................................... $ 656,330
----------
Loss and loss expense ratio................... 65.4% 76.8% 60.0% N/A 63.5%
Underwriting expense ratio.................... 23.8% 29.9% 33.9% N/A 30.3%
-------------------------------------------------------------
Combined ratio................................ 89.2% 106.7% 93.9% N/A 93.8%
-------------------------------------------------------------
(1) Ratios are based on net premiums earned, excluding fee income and other. The
underwriting expense ratio excludes exchange gains and losses
(2) Operating expenses exclude corporate operating expenses, shown separately.
(3) Corporate operating expenses include one-time charges of $17.5 million
related to the merger with Mid Ocean.
46
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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: 2000 1999 1998
------------------------------------
Casualty insurance.......................................... $ 634,189 $ 297,899 $ 411,405
Casualty reinsurance........................................ 493,362 481,392 311,057
Property catastrophe........................................ 159,771 147,372 80,420
Other property.............................................. 568,441 424,666 315,013
Marine, energy, aviation and satellite...................... 365,850 212,452 108,701
Lloyd's syndicates (1)...................................... 486,640 591,520 162,773
Other (2)................................................... 420,778 287,619 254,170
------------------------------------
Total....................................................... $3,129,031 $2,442,920 $1,643,539
------------------------------------
NET PREMIUM WRITTEN: 1999 1998
------------------------------------
Casualty insurance.......................................... $ 396,935 $ 232,614 $ 301,362
Casualty reinsurance........................................ 326,127 419,000 268,460
Property catastrophe........................................ 132,288 128,863 71,380
Other property.............................................. 404,749 311,312 231,690
Marine, energy, aviation and satellite...................... 230,356 152,783 82,484
Lloyd's syndicates (1)...................................... 311,814 423,880 145,691
Other (2)................................................... 313,971 233,431 223,197
------------------------------------
Total....................................................... $2,116,240 $1,901,883 $1,324,264
------------------------------------
NET PREMIUM EARNED: 1999 1998
------------------------------------
Casualty insurance.......................................... $ 358,653 $ 272,677 $ 287,438
Casualty reinsurance........................................ 390,452 331,778 282,245
Property catastrophe........................................ 132,818 133,420 122,583
Other property.............................................. 334,347 324,571 233,405
Marine, energy, aviation and satellite...................... 212,273 163,112 92,147
Lloyd's syndicates (1)...................................... 357,824 355,769 153,852
Other (2)................................................... 248,873 168,679 152,621
------------------------------------
Total....................................................... $2,035,240 $1,750,006 $1,324,291
------------------------------------
(1) Lloyd's syndicates write a variety of coverages encompassing most of the
above lines of business.
(2) Other premiums written and earned include political risk, surety, bonding
and warranty.
47
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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: 2000 1999 1998
------------------------------------
Bermuda..................................................... $ 609,609 $ 561,750 $ 534,092
United States............................................... 934,110 684,468 497,364
Europe and other............................................ 572,521 655,665 292,808
------------------------------------
Total....................................................... $2,116,240 $1,901,883 $1,324,264
------------------------------------
MAJOR CUSTOMERS
During 2000, 1999 and 1998, approximately 22%, 21% and 34%, respectively,
of the Company's consolidated gross written premiums were generated from or
placed by Marsh & McLennan Companies. During 2000, 1999 and 1998, approximately
16%, 13% and 19%, respectively, 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, 2000.
4. INVESTMENTS
Net investment income is derived from the following sources:
YEAR ENDED DECEMBER 31
------------------------------
2000 1999 1998
------------------------------
Fixed maturities, short-term investments and cash
equivalents............................................ $551,317 $538,169 $423,612
Equity securities........................................... 10,661 11,835 19,596
------------------------------
Total investment income............................. 561,978 550,004 443,208
Investment expenses......................................... 19,478 24,686 25,918
------------------------------
Net investment income....................................... $542,500 $525,318 $417,290
------------------------------
48
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
4. INVESTMENTS (CONTINUED)
The following represents an analysis of realized gains (losses) and the
change in unrealized appreciation on investments:
YEAR ENDED DECEMBER 31
---------------------------------
2000 1999 1998
---------------------------------
Net realized gains (losses):
Fixed maturities and short-term investments:
Gross realized gains...................................... $780,430 $ 116,226 $445,086
Gross realized losses..................................... (815,419) (214,196) (398,046)
---------------------------------
Net realized gains (losses)......................... (34,989) (97,970) 47,040
Equity securities:
Gross realized gains...................................... 303,503 254,779 613,186
Gross realized losses..................................... (149,842) (62,453) (463,159)
---------------------------------
Net realized gains.................................. 153,661 192,326 150,027
Write down of other investments............................. (66,200) - -
Net realized (loss)gain on sale of investment in
affiliate................................................. (1,901) - 14,137
---------------------------------
Net realized gains on investments................... 50,571 94,356 211,204
---------------------------------
Change in unrealized appreciation:
Fixed maturities and short-term investments............... 137,628 (333,868) (37,741)
Equity securities......................................... (231,140) 101,652 41,819
Deferred (losses) gains on forward contracts.............. (9,388) 762 (13,708)
Investment portfolio of affiliates........................ (6,290) (11,438) (5,062)
Change in deferred income tax liability................... (9,131) 31,050 (722)
---------------------------------
Net change in unrealized appreciation
on investments............................................ (118,321) (211,842) (15,414)
---------------------------------
Total net realized gains (losses) and change in
unrealized appreciation on investments............ $(67,750) $(117,486) $195,790
---------------------------------
There were no significant non-income producing investments as at
December 31, 2000, 1999 and 1998.
49
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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, 2000 COST GAINS LOSSES VALUE
- ----------------- -------------------------------------------------
Fixed maturities:
U.S. Government and Government agency.............. $1,361,972 $ 51,524 $ (1,373) $1,412,123
Corporate.......................................... 4,419,283 65,962 (255,122) 4,230,123
Mortgage-backed securities......................... 1,818,697 18,649 (6,951) 1,830,395
U.S. States and political subdivisions of the
States.......................................... 516,949 18,936 (2,100) 533,785
Non-U.S. Sovereign Government...................... 597,295 16,318 (14,958) 598,655
-------------------------------------------------
Total fixed maturities....................... $8,714,196 $171,389 $ (280,504) $8,605,081
-------------------------------------------------
Short-term investments:
U.S. Government and Government agency.............. $ 162,641 202 $ (27) $ 162,816
Corporate.......................................... 179,709 1,451 (9,539) 171,621
Non-U.S. Sovereign Government...................... 4,797 52 (279) 4,570
-------------------------------------------------
Total short-term investments................. $ 347,147 $ 1,705 $ (9,845) $ 339,007
-------------------------------------------------
Total equity securities.............................. $ 515,440 $ 84,650 $ (42,630) $ 557,460
-------------------------------------------------
GROSS COST ORGROSS
UNREALIZEDRTIUNREALIZED MARKET
DECEMBER 31, 1999 GAINS COST 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
-------------------------------------------------
50
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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, 2000 DECEMBER 31, 1999
----------------------- -----------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
-------------------------------------------------
Due after 1 through 5 years......................... $1,829,636 $1,791,752 $2,091,280 $2,025,736
Due after 5 through 10 years........................ 1.906,291 1,873,982 1,816,040 1,773,639
Due after 10 years.................................. 3,159,572 3,105,941 2,810,495 2,686,592
Mortgage-backed securities.......................... 1,818,697 1,833,406 1,118,104 1,095,184
-------------------------------------------------
$8,714,196 $8,605,081 $7,835,919 $7,581,151
-------------------------------------------------
At December 31, 2000 and 1999, approximately $113.1 million and
$89.4 million, respectively, of securities were on deposit with various U.S.
state or government insurance departments in order to comply with relevant
insurance regulations.
The Company has two facilities available for the issue of letters of credit
collateralized against the Company's investment portfolio with a value of
$483.0 million at December 31, 2000 and $791.4 million at December 31, 1999. At
December 31, 2000 and 1999, approximately $160.0 million and $591.0 million,
respectively, of letters of credit were issued and outstanding under these
facilities.
Included in cash and invested assets at December 31, 2000 and 1999 are
approximately $18.0 million and $16.6 million, respectively, of assets held in
an escrow account in accordance with U.S. insurance regulations.
5. INVESTMENTS IN AFFILIATES
The Company's investment in affiliates and equity in net income from such
affiliates are summarized below:
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
---------------------- ---------------------- ----------------------
EQUITY IN EQUITY IN EQUITY IN
NET INCOME NET INCOME NET INCOME
CARRYING FOR THE CARRYING FOR THE CARRYING FOR THE
VALUE YEAR VALUE YEAR VALUE YEAR
--------- ---------- --------- ---------- --------- ----------
Investment management companies
and related investment funds.... $571,022 $70,032 $291,723 $43,865 $ 10,609 $(1,400)
Insurance affiliates............. 221,700 4,323 188,188 2,958 144,059 51,692
-------- ------- -------- ------- -------- -------
$792,722 $74,355 $479,911 $40,907 $154,668 $50,292
The Company has minority investments ranging from 20% to 30% in several
investment fund managers. The significant investments include Highfields Capital
Management LP, a global equity investment firm, and MKP Capital Management, a
fixed income investment manager specializing in mortgage-backed securities. The
Company has invested in certain closed end funds, including funds managed by
these investment fund managers, all of which are included in investment
management companies and related investment funds, above.
51
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
5. INVESTMENTS IN AFFILIATES (CONTINUED)
The Company's significant insurance affiliate investments at December 31,
2000 include Le Mans Re, Annuity & Life Re ("ALRe") and FSA International, with
ownership in those entities at 49%, 11% and 20%, respectively. Insurance
affiliates included Risk Capital Holdings at December 31, 1999 and 1998, and Mid
Ocean at December 31, 1998.
The Company owned approximately 28% of the issued shares of Arch Capital
(formerly Risk Capital Holdings) at December 31, 1999. In 2000, the Company
exchanged its shares in Arch Capital and $3.6 million in cash for Arch Capital's
ownership in Latin American Re and 1.4 million shares and 100,000 warrants in
ALRe, in which the Company had an existing investment. ALRe is a Bermuda-based
company and is a leading provider of annuity and life reinsurance to insurance
companies in North America. Although the Company has beneficial ownership of
only 11% of ALRe's outstanding common shares, XL is deemed to have significant
influence as the Company has representatives on ALRe's board of directors. Based
upon the quoted market value of ALRe's common shares, the total market value of
the Company's investment was $91.1 million compared to a carrying value of $60.8
million at December 31, 2000.
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 most classes of property and casualty reinsurance
business together with a selective portfolio of life reinsurance business. The
Company contributed $31.2 million in additional capital during 2000.
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.
In certain investments, the carrying value is different from the underlying
share of the investee's net assets. The difference represents goodwill on
acquisition that is being amortized.
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 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.
52
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
6. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END (CONTINUED)
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
DECEMBER 1998 TOTAL REVENUES NET INCOME
- -------------- -----------------------------
XL Capital - year end November 30, 1998 as previously
reported.................................................. $1,217,648 $587,663
Less one month December 31, 1997............................ 93,835 57,168
Add one month December 31, 1998............................. 202,210 29,785
-----------------------------
XL Capital - year end December 31, 1998 as adjusted before
combination with NAC...................................... 1,326,023 560,280
NAC - year end December 31, 1998............................ 699,379 96,050
-----------------------------
Combined results - year end December 31, 1998............... $2,025,402 $656,330
-----------------------------
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.
(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.
ECS commenced underwriting policies on behalf of the Company's insurance and
reinsurance subsidiaries effective January 1, 2000.
In 1999, the Company acquired Intercargo, which 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.
Net 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 Ordinary 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
53
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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. Net cash acquired as a result of this merger was $41 million.
See Note 22 for further details.
7. LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses are comprised of:
YEAR ENDED DECEMBER 31
------------------------------------
2000 1999 1998
------------------------------------
Reserve for reported losses and loss expenses.......... $2,788,378 $2,175,688 $2,062,046
Reserve for losses incurred but not reported........... 2,883,684 3,193,714 2,834,597
------------------------------------
Unpaid losses and loss expenses........................ $5,672,062 $5,369,402 $4,896,643
------------------------------------
Net losses and loss expenses incurred comprise:
Loss and loss expense payments......................... $1,910,624 $1,392,024 $ 849,777
Change in unpaid losses and loss expenses.............. 625,043 303,140 285,775
Reinsurance recoveries................................. (1,103,108) (390,860) (294,035)
------------------------------------
Net losses and loss expenses incurred.................. $1,432,559 $1,304,304 $ 841,517
------------------------------------
54
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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 losses and
loss expenses for the years indicated:
2000 1999 1998
------------------------------------
Unpaid losses and loss expenses at beginning of year........ $5,369,402 $4,896,643 $3,972,376
Unpaid losses and loss expenses recoverable................. (831,864) (593,960) (363,716)
------------------------------------
Net unpaid losses and loss expenses at beginning of year.... 4,537,538 4,302,683 3,608,660
Increase (decrease) in net losses and loss expenses incurred
in respect of losses occurring in:
Current year........................................ 1,827,443 1,591,414 1,097,161
Prior years......................................... (394,884) (287,110) (255,644)
------------------------------------
Total net incurred losses and loss expenses.... 1,432,559 1,304,304 841,517
Interest incurred on experience reserves and exchange rate
effects................................................... (27,064) (5,950) 2,516
Net loss reserves acquired.................................. 52,932 30,003 580,879
Less net losses and loss expenses paid in respect of losses
occurring in:
Current year........................................ 411,685 281,806 272,456
Prior years......................................... 1,251,985 811,696 458,433
------------------------------------
Total net paid losses.......................... 1,663,670 1,093,502 730,889
Net unpaid losses and loss expenses at end of year.......... 4,332,295 4,537,538 4,302,683
Unpaid losses and loss expenses recoverable................. 1,339,767 831,864 593,960
------------------------------------
Unpaid losses and loss expenses at end of year.............. $5,672,062 $5,369,402 $4,896,643
------------------------------------
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.
Net losses incurred in 2000 increased over 1999, principally due to current
year development. Current year development reflects both the growth in business
assumed and an increase in loss ratios applied. The increase in the loss ratio
is due to the effect of competition which has depressed premium rates,
particularly on certain casualty lines. Current year losses also reflect the
early development of certain losses on the Company's large account business
within its insurance operations. Historically, the Company does not experience
the reporting of such losses at an early stage and the Company's reserving
methodology for these lines of business extrapolates these losses into the
projections of future development. If future development is eventually
determined to be less than the estimated
55
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
ultimate losses recorded, loss reserves will be reduced at that time. This
occurred for the 1993 through 1996 underwriting years, resulting in a reduction
in prior year losses.
Net losses incurred for 2000 also reflects reserve adjustments to several
unprofitable lines of business that the Company has now exited, including
trucking, inland energy and certain classes of aviation. A net reserve charge of
$114.0 million has been recorded for these lines.
There has been a high level of paid losses in 2000 due to the settlement of
previously established reserves, particularly catastrophe losses as noted below.
The Company's outward reinsurance programs in 2000 have mitigated part of
the overall loss development, as shown by the increase in the unpaid losses and
loss expenses recoverable, both in the insurance and reinsurance segments. In
relation to business lines exited from the Lloyd's operations, additional
reinsurance costs of $19.1 million were incurred in respect of expected loss
recoveries recorded of $38.0 million. In the reinsurance segment, $80.6 million
of additional reinsurance costs were recorded with $151.8 million of expected
loss recoveries. The purchase of additional reinsurance in 2000 relates
primarily to the casualty lines where the Company has taken advantage of
favorable pricing and terms.
Partially offsetting this increase in net incurred losses in 2000 compared
to 1999 was a reduction in the number and magnitude of catastrophe losses that
occurred. Catastrophe losses in 2000, which included an oil refinery loss in
Kuwait, several satellite losses, and the Singapore Airlines loss, totaled
approximately $95.0 million. By comparison, 1999 generated approximately
$185.0 million of catastrophe losses to the Company, including the European
storms in December, hailstorms in Sydney, tornadoes in Oklahoma and satellite
losses.
Net losses incurred in 1999 increased significantly over 1998 for a number
of reasons. The Company acquired Mid Ocean and Brockbank in August 1998 and
therefore only recognized the effect of their operations for five months in
1998. Incurred losses for these entities were approximately $475.0 million in
1999 compared to $260.0 million in 1998. Partially offsetting this, in 1998, the
Company incurred approximately $60.0 million in catastrophe losses relating to
Hurricane Georges and the SwissAir loss. These losses were incurred in the
reinsurance operations.
In 1999, the Lloyd's operations experienced loss deterioration on the U.K.
motor business principally from the 1998 and 1999 underwriting years of
approximately $20.0 million. The motor business was sold in December 1999 and
the Company retains residual liability on this business.
1999 incurred losses also include an increase to reinsurance loss reserves
of $95.0 million for NAC Re due to an alignment of reserving methodologies at
the time of the merger with the Company in June 1999.
The decrease in prior year incurred losses in all three years is driven
primarily by the Company's insurance liability excess of loss reserves. The
basis for establishing IBNR for these lines is relatively judgmental due to the
lack of industry data available. 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 has made its best estimate of loss reserves for each
underwriting year since 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. This trend is not necessarily expected to continue.
The increase in paid losses in 1999 reflects the acquisition of Mid Ocean
and Brockbank in 1998.
The Company's net incurred losses and loss expenses includes a charge of
$2.8 million, $10.6 million and $1.2 million in 2000, 1999 and 1998,
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
56
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
1986. As at December 31, 2000 and 1999, the reserve for potential non-recoveries
from reinsurers was $25.6 million and $25.8 million, respectively.
Except for certain workers' compensation liabilities, the Company does not
discount its 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%. The tabular
reserving methodology results in applying 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, 2000 and 1999 were $168.8 million and
$85.7 million, respectively. The related discounted unpaid losses and loss
expenses were $63.4 million and $28.1 million as of December 31, 2000 and 1999.
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.
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 related to business
written prior to 1986 for the years indicated is as follows:
YEAR ENDED DECEMBER 31
------------------------------
2000 1999 1998
------------------------------
Net unpaid losses and loss expenses at beginning of year.... $36,206 $34,850 $32,767
Net incurred losses and loss expenses....................... 1,053 4,416 5,541
Less net paid losses and loss expenses...................... 2,512 3,060 3,458
------------------------------
Net (decrease) increase in unpaid losses and loss
expenses.................................................. (1,459) 1,356 2,083
Net unpaid losses and loss expenses at end of year.......... 34,747 36,206 34,850
Unpaid losses and loss expenses recoverable at end of
year...................................................... 48,133 49,022 43,211
------------------------------
Gross unpaid losses and loss expenses at end of year........ $82,880 $85,228 $78,061
------------------------------
Incurred but not reported ("IBNR") losses, net of reinsurance, included in
the above table was $14.0 million in 2000, $16.1 million in 1999 and
$17.0 million in 1998. Unpaid losses recoverable are net of potential
uncollectable amounts.
As of December 31, 2000 and 1999, the Company had approximately 374 and 370
open claim files, respectively, for potential asbestos exposures and 613 and 689
open claim files, respectively, for potential environmental exposures on
business written prior to 1986. Approximately 45% and 46% of the open claim
files for 2000 and 1999, 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.
57
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
7. LOSSES AND LOSS EXPENSES (CONTINUED)
The Company believes it has made reasonable provision for its asbestos and
environmental exposures and is unaware of any specific issues that would
significantly 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.
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 losses 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.
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
------------------------------------- ------------------------------------
2000 1999 1998 2000 1999 1998
----------------------------------------------------------------------------
Direct.................... $ 1,688,923 $1,088,028 $ 779,551 $1,456,064 $ 994,339 $ 672,871
Assumed................... 1,440,108 1,354,892 863,988 1,455,694 1,259,632 926,730
Ceded..................... (1,012,791) (541,037) (319,275) (876,518) (503,965) (275,310)
----------------------------------------------------------------------------
Net....................... $ 2,116,240 $1,901,883 $1,324,264 $2,035,240 $1,750,006 $1,324,291
----------------------------------------------------------------------------
The Company recorded reinsurance recoveries on losses and loss expenses
incurred of $1.1 billion, $390.9 million and $294.0 million for the years ended
December 31, 2000, 1999 and 1998, respectively. The Company is the beneficiary
of letters of credit, trust accounts and funds withheld in the aggregate amount
of $371.0 million at December 31, 2000, collateralizing reinsurance recoverables
with respect to certain retrocessionnaires.
9. DEPOSIT LIABILITIES AND POLICY BENEFIT RESERVES
The Company has entered into certain contracts that transfer insufficient
risk to be accounted for as reinsurance under SFAS No. 113. These contracts have
been recorded as deposit liabilities and are matched by an equivalent amount of
investments. At December 31, 2000 and 1999, total deposit liabilities were
$628.4 million and $310.4 million, respectively.
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
transferred liabilities of $108.1 million in 2000 to a third party for an
equivalent consideration.
58
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
10. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS
As at December 31, 2000, the Company had bank, letter of credit and loan
facilities available from a variety of sources, including commercial banks,
totaling $2.6 billion (1999: $2.16 billion) of which $450.0 million (1999:
$410.7 million) was outstanding. In addition, $1.1 billion (1999:
$891.6 million) of letters of credit were outstanding, 14% of which were
collateralized by the Company's investment portfolio, supporting U.S.
non-admitted business and the Company's Lloyd's capital requirements.
Approximately 40% of the non-collateralized letters of credit were issued in
connection with intercompany quota share agreements between subsidiaries.
The financing structure at December 31, 2000 was as follows:
FACILITY
- -------- COMMITMENT IN USE/OUTSTANDING
--------------------------------
DEBT:
364 day Revolver.......................................... $ 500,000 $ -
2 facilities of 5 year Revolvers - total.................. 350,000 350,000
7.15% Senior Notes due 2005............................... 100,000 100,000
--------------------------------
$ 950,000 $ 450,000
--------------------------------
LETTERS OF CREDIT:
5 facilities - total...................................... $1,679,000 $1,109,000
--------------------------------
The financing structure at December 31, 1999 was as follows:
FACILITY
- -------- COMINTUSE/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 Company entered a $500.0 million 364-day revolving credit facility
effective June 5, 2000 to replace previous facilities of $650.0 million that
expired during the year. A syndicate of banks provides this facility and
borrowings are unsecured. The Company borrowed and repaid $200.0 million under
the expired facility during the first quarter of 2000. There were no borrowings
under the facilities during the remainder of the year ended December 31, 2000.
The weighted average interest rate on the funds borrowed was approximately 6.3%
during 2000 and approximately 5.41% during 1999.
Two syndicates of banks provide the two five-year facilities and borrowings
are unsecured. The amounts of $350.0 million and $299.7 million outstanding at
December 31, 2000 and 1999, respectively, relate primarily to the remaining
outstanding balance from the $300.0 million borrowed to finance the cash option
election available to shareholders in connection with the Mid Ocean acquisition
in August 1998, and the $109.7 million borrowed to finance the acquisition of
ECS and Intercargo during 1999. The weighted average interest rate on funds
borrowed during 2000 was approximately 6.6% and 5.43% during 1999.
59
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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.
The Company repaid an $11.0 million term note on September 29, 2000.
The Company has five letter of credit facilities available at December 31,
2000, two from two syndicates of banks, one from a U.K. bank and two from U.S.
banks. These facilities include a new $1.0 billion unsecured syndicated letter
of credit facility that replaced several syndicated and bilateral facilities
provided by U.K. banks, in addition to a new $304.0 million unsecured syndicated
facility that replaced several existing facilities supporting the Company's
Lloyd's capital requirements. The letter of credit facilities are used to
collateralize certain reinsureds' premium and unpaid loss reserves with the
Company and to support Lloyd's capital requirements of the Company's corporate
syndicates. Of the letters of credit outstanding at December 31, 2000,
$160.0 million (1999: $591.0 million) were collateralized against the Company's
investment portfolio and $949.0 million (1999: $300.6 million) were unsecured.
The Company plans to continue the process of transferring letters of credit into
one of the new syndicated facilities.
$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
$32.1 million, $37.4 million and $33.4 million for the years ended December 31,
2000, 1999 and 1998, 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.
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, 2000 and 1999, forward
foreign exchange contracts with notional principal amounts totaling
$111.9 million and $339.3 million, respectively, were outstanding. The fair
value of these contracts as at December 31, 2000 was $109.6 million (1999:
$341.1 million) with unrealized losses of $2.3 million (1999: $1.8 million).
Gains of $28.1 million and losses of $2.7 million were realized during 2000 and
1999, respectively.
60
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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, 2000, the Company had $54.9 million of such
contracts outstanding, and had recognized $1.5 million in realized and
unrealized losses for the year. 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
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, 2000, the Company had, as hedges, foreign exchange contracts for
the sale of $121.0 million (1999: $94.0 million) and the purchase of
$25.7 million (1999: $7.4 million) of foreign currencies at fixed rates,
primarily Euros. The notional value of fixed maturities denominated in foreign
currencies that were hedged and held by the Company as at December 31, 2000 and
1999 was $100.6 million and $85.2 million, respectively.
In connection with these foreign exchange contracts directly hedging
foreign currency fixed maturity investments, unrealized foreign exchange gains
or losses are deferred and included in accumulated other comprehensive (loss)
income. As at December 31, 2000, unrealized losses amounted to $10.2 million. As
at December 31, 1999, unrealized losses amounted to $2.0 million and were offset
by corresponding increases in the U.S. dollar value of the investments. As at
December 31, 2000, realized gains of $14.6 million were recognized in the income
statement. As at December 31, 1999, realized losses amounted to $0.7 million.
During the year ended December 31, 2000, the Company used foreign exchange
contracts to manage its exposure to the effects of fluctuating foreign
currencies on the amount of its known claims payable in foreign currencies.
These contracts were not designated as specific hedges for financial reporting
purposes and therefore, realized and unrealized gains and losses on these
contracts were recorded in income in the period in which they occurred. As at
December 31, 2000 no contracts were outstanding. A loss of $6.8 million was
realized in the year in connection with these contracts.
In 2000, the Company used foreign exchange forward contracts to reduce its
exposure to premiums receivable denominated in foreign currencies. The forward
contract is closely matched with the receivable maturity date. Both the foreign
currency receivable and the offsetting forward contract are marked to market on
each balance sheet date, with any gains and losses recognized in earnings. At
December 31, 2000, the Company had forward contracts outstanding for the sale of
$10.0 million of foreign currencies at fixed rates, primarily U.K. Sterling.
Losses of $0.2 million were realized during 2000.
The Company attempts to manage the exchange volatility arising from certain
administration costs denominated in foreign currencies. Throughout the year,
forward contracts are entered into to acquire the foreign currency at an agreed
rate in the future. Any gains or losses on the forward contracts are deferred
and included as a component of shareholders' equity. As the administration
expenses are incurred, the gains and losses are recognized in the income
statement. At December 31, 2000, the Company had forward contracts outstanding
for the purchase of $12.8 million of Euros and U.K. Sterling at fixed rates.
Gains and losses deferred in accumulated other comprehensive income and realized
throughout the year were insignificant.
61
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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, 2000, the portfolio held
$43.7 million (1999: $121.9 million) in exposure to S&P 500 Index futures and
underlying assets of $43.2 million (1999: $122.0 million). The value of the
futures is updated daily with the change recorded in income as a realized gain
or loss. For the years ended December 31, 2000 and 1999, results from index
futures totaled net realized losses of $0.2 million and net realized gains of
$11.3 million, respectively.
Derivative investments are also utilized to add value to the portfolio
where market inefficiencies are believed to exist and also to adjust the
duration of a portfolio of fixed income securities to match related deposit
liabilities. At December 31, 2000, bond and stock index futures outstanding were
$40.1 million (1999: $241.1 million), with underlying investments having a
market value of $2.5 billion (1999: $2.5 billion).
(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, 2000 and 1999.
(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 $103.0 and $65.4 million as at December 31,
2000 and 1999, respectively, with commitments to invest a further
$149.7 million over the next ten years. The Company received income from its
investments of $4.0 million and $9.4 million and for the years ended
December 31 2000 and 1999, respectively. The Company continually reviews the
performance of the partnerships to ensure there is no other than temporary
decline 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
that expire up to 2013. Total rent expense for the years ended December 31,
2000, 1999, and 1998 was approximately $18.3 million, $13 million,
62
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
and $9 million, respectively. Future minimum rental commitments under existing
leases are expected to be as follows:
Year ending December 31: 2001 $ 16,204
2002 15,611
2003 14,196
2004 11,505
2005 9,938
Later years 54,855
--------
Total minimum future rentals $122,309
--------
In 1997, the Company acquired commercial real estate in Bermuda for the
purpose of securing long-term office space for its worldwide headquarters. The
total cost of this development, including the land, is expected to be
approximately $110.0, of which $101.0 million had been spent as at December 31,
2000. It is estimated that the development will be completed in April 2001.
(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 or otherwise subject to taxation 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
or otherwise subject to taxation 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
significant adverse effect on the Company's results of operations and financial
condition.
(F) FINANCIAL GUARANTIES
The Company insures and reinsures financial guaranties issued to support
public and private borrowing arrangements. Financial guaranties are conditional
commitments that guaranty the performance of a customer to a third party. The
Company's potential liability in the event of non-performance 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, 2000, the Company's aggregate insurance
in force was $16.6 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.
63
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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. In June 2000, the Company's Class B ordinary shares were converted into
Class A ordinary shares on a one-for-one basis.
The following table is a summary of shares issued and outstanding (in
thousands):
YEAR ENDED DECEMBER 31
------------------------------
2000 1999 1998
------------------------------
Balance - beginning of year................................. 127,807 128,745 101,282
Exercise of options......................................... 2,247 443 425
Issue of restricted shares.................................. 21 107 289
Repurchase of shares........................................ (5,074) (1,488) (3,443)
Issue of Class A shares..................................... 19 - 27,076
Issue of Class B shares..................................... - - 3,116
------------------------------
Balance - end of year....................................... 125,020 127,807 128,745
------------------------------
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 program. 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. During 2000, the Company
repurchased 5.1 million shares at a total cost of $247.7 million, or an average
cost of $48.82 per share.
(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.
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 77,472
shares, 113,100 shares and 147,836 shares in 2000, 1999 and 1998, respectively.
Restricted stock awards granted by NAC prior to the merger amounted to 3,627
shares and 23,700 shares in 1999 and 1998. 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 5,000 shares
64
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
12. SHARE CAPITAL (CONTINUED)
each year thereafter. 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 7,846, nil and 2,737 in 2000, 1999 and 1998, respectively.
A second stock plan, intended to replace the directors' "Retirement Plan
for Non-Employee Directors," provides for the issue 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 January 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 13,237,
1,217 and 5,531 were issued for in 2000, 1999 and 1998, 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.
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 granted in 2000, 1999 and 1998, and net income and
earnings per share would have been reduced to the pro-forma amounts indicated
below:
YEAR ENDED DECEMBER 31,
------------------------------
2000 1999 1998
------------------------------
Net income - as reported.................................... $506,352 $470,509 $656,330
Net income - pro-forma...................................... $481,560 $437,592 $635,239
Basic earnings per share - as reported...................... $ 4.07 $ 3.69 $ 5.86
Basic earnings per share - pro-forma........................ $ 3.87 $ 3.43 $ 5.67
Diluted earnings per share - as reported.................... $ 4.03 $ 3.62 $ 5.68
Diluted earnings per share - pro-forma...................... $ 3.83 $ 3.36 $ 5.47
65
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
12. SHARE CAPITAL (CONTINUED)
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:
2000 1999 1998
---------------------------------
Dividend yield.............................................. 3.58% 3.43% 1.81%
Risk free interest rate..................................... 5.04% 5.90% 4.76%
Expected volatility......................................... 25.77% 24.66% 24.72%
Expected lives.............................................. 7.5 years 7.5 years 9.2 years
Total stock based compensation expensed was $9.5 million, $7.7 million and
$5.8 million, in 2000, 1999 and 1998, respectively.
(E) OPTIONS
Following is a summary of stock options and related activity:
2000 1999 1998
--------------------- --------------------- --------------------
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------------------------------------------------------------------
Outstanding - beginning of year............. 10,282,723 $46.50 7,685,414 $50.61 5,744,063 $35.28
Granted..................................... 579,852 $49.95 3,207,492 $57.06 1,749,885 $68.27
Granted - Mid Ocean conversion.............. - - - - 791,573 $72.44
Exercised................................... (2,515,774) $31.48 (421,163) $27.57 (425,251) $30.06
Cancelled................................... (183,784) $61.80 (189,020) $55.25 (174,856) $40.12
--------------------------------------------------------------------
Outstanding - end of year................... 8,163,017 $51.09 10,282,723 $46.50 7,685,414 $46.79
--------------------------------------------------------------------
Options exercisable......................... 5,034,693 5,287,657 4,288,434
--------------------------------------------------------------------
Options available for grant................. 9,904,918 * 1,028,853 * 2,455,190 *
--------------------------------------------------------------------
* Available for grant includes shares that may be granted as either stock
options or restricted stock.
66
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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, 2000:
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 - $32.93........ 600 $25.42 4.1 600 $25.42
$33.88 - $50.00........ 4,671 $46.03 7.2 2,615 $43.62
$50.31 - $64.69........ 1,753 $58.08 7.6 1,070 $59.39
$66.50 - $87.38........ 1,139 $74.58 7.8 750 $74.71
--------------------------------------------------------------------------------------------
$10.44 - $87.38........ 8,163 $51.09 7.1 5,035 $49.43
--------------------------------------------------------------------------------------------
(F) VOTING
The Company's Articles of Association restrict the voting power of any
person to less than approximately 10% of total voting power.
(G) SHARE RIGHTS PLAN
Rights to purchase Class A ordinary shares ("the Rights") 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 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 Class A ordinary shares. Upon a person or
group without prior approval of the Board acquiring 20% or more of Class A
ordinary shares, each Right would entitle the holder (other than such an
acquiring person or group) to purchase 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. The
Company 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 issue upon
exercise of 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.
67
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
13. RETIREMENT PLANS (CONTINUED)
At NAC, a qualified non-contributory defined benefit pension plan exists to
cover substantially all its U.S. employees. 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. 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
these plans, 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. 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
$21.3 million, $12.6 million and $12.3 million, respectively, as of
December 31, 2000 and $16.6 million, $10.0 million and $11.0 million,
respectively as of December 31, 1999. The discount rates used in determining the
actuarial present value of benefit obligations were 7.25% and 7.75% for 2000 and
1999, respectively. The rate of increase for future compensation levels was 6.0%
for 2000 and 6.5% for 1999. The assumed rate of return on plan assets was 9.0%
for both 2000 and 1999.
NAC also maintains a qualified contributory defined contribution plan for
substantially all its U.S. employees.
The Company's expenses for its retirement plans are not considered to be
significant.
14. ACCUMULATED OTHER COMPREHENSIVE INCOME
The related tax effects allocated to each component of the change in
accumulated other comprehensive income were as follows:
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
-------------------------------------
YEAR ENDED DECEMBER 31, 2000
Unrealized gains (losses) on investments:
Unrealized losses arising during year....................... $ (76,881) $(21,980) $ (54,901)
Less reclassification for gains (losses) realized in
income.................................................... 50,571 (12,849) 63,420
-------------------------------------
Net unrealized losses....................................... (127,452) (9,131) (118,321)
Foreign currency translation adjustments.................... (5,600) 102 (5,702)
-------------------------------------
Change in accumulated other comprehensive income............ $(133,052) $ (9,029) $(124,023)
-------------------------------------
YEAR ENDED DECEMBER 31, 1999
Unrealized gains (losses) on investments:
Unrealized losses arising during year....................... $(148,536) $(36,394) $(112,142)
Less reclassification for gains (losses) 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)
-------------------------------------
Change in accumulated other comprehensive income............ $(249,200) $(33,326) $(215,874)
-------------------------------------
68
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
14. ACCUMULATED OTHER COMPREHENSIVE INCOME (CONTINUED)
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
-------------------------------------
YEAR ENDED DECEMBER 31, 1998
Unrealized gains (losses) on investments:
Unrealized gains arising during year........................ $ 196,512 $ 12,998 $ 183,514
Less reclassification 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)
-------------------------------------
Change in accumulated other comprehensive income............ $ (16,034) $ 252 $ (16,286)
-------------------------------------
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 2000, four regular quarterly dividends were paid at $0.45 per share to
shareholders of record of February 15, May 25, August 15 and November 15.
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.
69
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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 has 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.
XL Brockbank, NAC Re International and XL 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, 2000
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% primarily due to tax-exempt investment income in
all years, merger related costs in 1999 and a change in management's valuation
allowance.
Significant components of the provision for income taxes attributable to
operations were as follows:
YEAR ENDED DECEMBER 31
------------------------------
2000 1999 1998
------------------------------
CURRENT (BENEFIT) EXPENSE:
U.S....................................................... $ (3,175) $(27,098) $10,490
Non U.S................................................... 8,612 9,664 14,680
------------------------------
Total current (benefit) expense........................ 5,437 (17,434) 25,170
------------------------------
DEFERRED (BENEFIT) EXPENSE:
U.S....................................................... (53,338) (17,534) 4,729
Non U.S................................................... (8,455) (4,602) (16)
------------------------------
Total deferred (benefit) expense....................... (61,793) (22,136) 4,713
------------------------------
TOTAL TAX (BENEFIT) EXPENSE................................. $(56,356) $(39,570) $29,883
------------------------------
70
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
17. TAXATION (CONTINUED)
The U.S. subsidiaries current U.S. taxable income for the years ended
December 31, 2000 and 1999 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.
Net taxes received in the year ended December 31, 2000 were approximately
$13.3 million. In the years ended December 31, 1999 and 1998, net taxes paid
were approximately $30.2 million and $31.2 million, respectively. The Company's
net current tax asset included in "other assets" in the accompanying financial
statements was $14.3 million at December 31, 2000.
Significant components of the Company's deferred tax assets and
liabilities, which principally relate to U.S. subsidiaries as of December 31,
2000 and 1999 were as follows:
YEAR ENDED DECEMBER
31
--------------------
2000 1999
--------------------
DEFERRED TAX ASSET:
Net unpaid loss reserve discount.......................... $ 83,230 $81,672
Net unearned premiums..................................... 13,929 10,264
Unrealized depreciation on investments.................... - 11,995
Compensation liabilities.................................. 9,271 8,960
Other..................................................... 55,429 12,516
--------------------
Deferred tax asset, gross of valuation allowance.......... 161,859 125,407
Valuation allowance....................................... - (11,995)
--------------------
Deferred tax asset, net of valuation allowance............ 161,859 113,412
DEFERRED TAX LIABILITY:
Deferred policy acquisition costs......................... $ - $ 6,850
Unrealized appreciation on investments.................... 7,553 -
Currency translation adjustments.......................... 566 566
Other..................................................... 1,572 8,068
--------------------
Deferred tax liability...................................... 9,691 15,484
--------------------
NET DEFERRED TAX ASSET...................................... $152,168 $97,928
--------------------
At December 31, 2000, the Company's management concluded that all deferred
tax assets are more likely than not to be realized and consequently, no
valuation allowance has been provided. At December 31, 1999, the Company's
management established a valuation allowance for certain deferred tax assets.
Shareholders' equity at December 31, 2000 and 1999 reflects tax benefits of
$3.3 million and $1.5 million, respectively, related to compensation expense
deductions for stock options exercised for one of the Company's U.S.
subsidiaries.
71
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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, the U.S.
and U.K., including Lloyd's. The Company relies primarily on cash dividends from
XL Insurance and XL Re.
BERMUDA
Under The Insurance Act, 1978, (as amended by the Insurance Act Amendment
1995) amendments thereto and related regulations of Bermuda, the Company's
Bermuda subsidiaries, the most significant of which are XL Insurance and XL 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 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 RE
------------------------------------ ------------------------------------
2000 1999 1998 2000 1999 1998
---------------------------------------------------------------------------
Statutory net income............... $ 744,139 $ 16,715 $ 361,663 $ 3,611 $ 155,534 $ 108,290
---------------------------------------------------------------------------
Statutory capital and surplus...... $2,061,422 $1,314,995 $1,297,461 $2,149,806 $2,062,421 $1,966,200
---------------------------------------------------------------------------
Minimum statutory capital and
surplus required by the Act...... $ 295,879 $ 427,939 $ 300,755 $ 370,317 $ 196,254 $ 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 Re are classified as a Class 4 insurer
and reinsurer, respectively. Therefore, they are restricted to the payment of
dividends in any one financial year of 25% of the prior year's statutory capital
and surplus, unless their directors attest that such dividends will not cause
the company to fail to meet its relevant statutory requirements. XL Insurance
and XL Re have not been prevented from paying dividends by this restriction.
UNITED STATES
The Company's U.S. insurance and reinsurance subsidiaries, the most
significant of which is NAC Re, 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 relate to deferred acquisition costs, deferred income
taxes and amortization of intangible assets. 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.
72
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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
---------------------------------
2000 1999 1998
---------------------------------
NET INCOME:
Statutory net income........................................ $(110,574) $ 8,948 $101,862
---------------------------------
GAAP net income (loss)...................................... $ (56,686) $ (1,060) $ 98,586
---------------------------------
SHAREHOLDERS' EQUITY:
Consolidated statutory surplus.............................. $ 575,575 $440,102 $737,114
---------------------------------
GAAP consolidated shareholder's equity...................... $ 823,099 $700,725 $750,725
---------------------------------
NAC Re is subject to the 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 deficit at December 31, 2000 and 1999
was $12.2 million and $27.7 million, respectively. Consequently, NAC Re cannot
make a dividend distribution at this time.
XL Brockbank, via Lloyd's, is a licensed insurer in the states of Illinois
and Kentucky and in the U.S. Virgin Islands ("USVI"). It is also an eligible
surplus lines writer in all states other than Kentucky and in the USVI, and an
accredited reinsurer in every state other than Michigan, Kansas and Arizona. XL
Aerospace 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 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, among 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 significant 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 underwrite risks throughout the European
Community (subject to certain restrictions) pursuant to the "Third Directive"
relating to non-life insurance. XL Europe's 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 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
73
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
18. STATUTORY FINANCIAL DATA (CONTINUED)
Accounts) Regulations, 1995, the European Communities (Non-Life Insurance)
Framework Regulations, 1994 and related administrative rules (the "Irish
Regulations").
In addition, XL Europe's insurance activities are subject to minimum
solvency and reserve standards and auditing and reporting requirements. The
Minister for Enterprise, Trade and Employment has wide powers to supervise,
investigate and intervene in the affairs of such insurers.
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. Through its branches and subsidiaries in London, the Company
is deemed to "effect and carry on" business in the United Kingdom and certain of
its subsidiaries are therefore regulated by the U.K. FSA.
LLOYD'S
The Company, XL 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 U.K. FSA will become ultimately responsible for Lloyds regulation in 2001.
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 the development and growth of Lloyd's worldwide business. The
Regulatory Board is responsible for developing and monitoring regulatory
practice and procedures. 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 XL 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.
OTHER REGULATION
The Company is subject to regulation in Australia, Singapore, Spain, Latin
America and Germany as a result of its representative offices and branches in
such jurisdictions.
74
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
19. EARNINGS PER SHARE
The following table sets forth the computation of the basic and diluted
earnings per share:
YEAR ENDED DECEMBER 31
---------------------------------
2000 1999 1998
---------------------------------
BASIC EARNINGS PER SHARE:
Net income.................................................. $506,352 $470,509 $656,330
Weighted average ordinary shares outstanding................ 124,503 127,601 112,034
Basic earnings per share.................................... $ 4.07 $ 3.69 $ 5.86
---------------------------------
Diluted earnings per share:
Net income.................................................. $506,352 $470,509 $656,330
Add back after-tax interest on convertible debentures....... -- 1,752 3,504
---------------------------------
Adjusted net income......................................... $506,352 $472,261 $659,834
---------------------------------
Weighted average ordinary shares outstanding -- basic....... 124,503 127,601 112,034
Average stock options outstanding (1)....................... 1,194 1,872 2,152
Conversion of convertible debentures (2).................... -- 831 2,020
---------------------------------
Weighted average ordinary shares outstanding -- diluted..... 125,697 130,304 116,206
---------------------------------
Diluted earnings per share.................................. $ 4.03 $ 3.62 $ 5.68
---------------------------------
(1) Net of shares repurchased under the treasury stock method.
(2) 1998 reflects the assumed conversion of the 5.25% Convertible Subordinated
Debentures due 2000. The Debentures were called in June 1999 and the actual
conversion is reflected in 1999.
20. SUBSEQUENT EVENTS
XL Capital announced on February 15, 2001 that it has agreed to purchase
Winterthur International from Winterthur Swiss Insurance Company ("Winterthur"),
a subsidiary of the Credit Suisse Group ("CSG"). The Company will be purchasing
a combination of insurance companies and selected Winterthur International
insurance portfolios. The all-cash transaction is valued at approximately
$600.0 million and may be funded by the Company with a combination of current
resources and external financing. Winterthur International is the international,
large commercial account property and casualty insurance business of Winterthur.
Winterthur International operates in 27 countries, has more than 1,000 employees
and in 2000 had gross premiums written and net premiums earned of approximately
$1.3 billion and $600.0 million, respectively. In terms of premium volume,
Winterthur International's top five markets are the U.K., Switzerland, Germany,
the U.S. and France. As at September 30, 2000, Winterthur International
(including certain operations to be retained by CSG) had investment assets of
approximately $1.0 billion.
75
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
21. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly financial data for
2000 and 1999:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-----------------------------------------
2000
Net premiums earned..................................... $494,499 $503,375 $539,945 $497,421
Net investment income................................... 128,527 136,440 134,624 142,909
Net realized gains (losses) on investments.............. 68,707 5,075 1,026 (24,237)
Equity in net income of affiliates...................... 17,479 25,756 18,447 12,673
Fee income and other.................................... 4,956 3,340 539 5,958
-----------------------------------------
Total revenues.......................................... $714,168 $673,986 $694,581 $634,724
-----------------------------------------
Income before income tax expense and minority interest.. $215,817 $140,832 $138,317 $(43,877)
-----------------------------------------
Net income.............................................. $223,759 $142,484 $139,461 $ 648
-----------------------------------------
Net income per share and share equivalent - basic....... $ 1.78 $ 1.15 $ 1.13 $ 0.01
-----------------------------------------
Net income per share and share equivalent - diluted..... $ 1.77 $ 1.13 $ 1.10 $ 0.01
-----------------------------------------
1999
Net premiums earned..................................... $386,753 $414,386 $488,729 $460,138
Net investment income................................... 135,680 132,593 126,560 130,485
Realized gains on investments........................... 67,476 17,584 (12,671) 21,967
Equity in net income (loss) of affiliates............... (7,307) 16,642 15,372 16,200
Fee income and other.................................... 10,551 3,870 28,800 57,179
-----------------------------------------
Total revenues.......................................... $593,153 $585,075 $646,790 $685,969
-----------------------------------------
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 $ 0.48
-----------------------------------------
Net income per share and share equivalent - diluted..... $ 1.58 $ 0.48 $ 1.07 $ 0.47
-----------------------------------------
In the fourth quarter of 2000, the Company incurred after-tax charges of
$124.6 million, or $0.98 per share, which included certain reserve adjustments
together with employee severance charges and other costs associated with the
realignment of the Company's operations and the discontinuation of certain
business lines. In the fourth quarter of 1999, the Company incurred after-tax
losses of $125.0 million, or $0.97 per share, as a result of two major European
windstorms in December 1999. The second quarter of 1999 included charges
relating to merger with NAC.
76
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
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, 1998.
PRO FORMA
1998
----------
Net premiums earned......................................... $1,588,791
Net investment income....................................... 494,389
Net realized gains on sale of investments................... 260,598
Equity in loss of affiliates................................ (1,897)
Fee income and other........................................ 28,006
----------
Total revenues............................................ 2,369,887
----------
Losses and loss expenses.................................... 921,018
Acquisition costs and operating expenses.................... 514,877
Interest expense............................................ 44,839
Amortization of intangible assets........................... 45,464
----------
Total expenses............................................ 1,526,198
----------
Income before minority interest and income tax expense...... 843,689
Minority interest and income tax............................ 34,535
----------
Net income................................................ $ 809,154
----------
Net income per share
Basic..................................................... $ 6.33
Diluted................................................... $ 6.13
Weighted average shares outstanding (000's)
Basic..................................................... 127,883
Diluted................................................... 132,036
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, 2000.
77
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This item is omitted because a definitive proxy statement that 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 that 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 that 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 that 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............................. 83
- Report of Ernst and Young LLP on Financial
Statements and Financial
Statement Schedules............................. 84
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,
2000.................................................... I 85
- Condensed Financial Information of Registrant, as of
December 31, 2000 and 1999 and for the years ended
December 31, 2000, 1999, and 1998....................... II 86
- Reinsurance, for the years ended December 31, 2000, 1999
and 1998................................................ IV 89
- Supplementary Information Concerning Property/Casualty
Insurance Operations for the years ended December 31,
2000, 1999 and 1998..................................... VI 90
78
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.
3.1 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 (Intentionally omitted)
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.
79
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 (Intentionally omitted)
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 (Intentionally omitted)
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.
10.12.5 (Intentionally omitted)
10.13.1 (Intentionally omitted)
10.13.2 Ronald L. Bornheutter Consulting Agreement dated as of July
1, 1999, incorporated by reference to Exhibit 10.14.19 to
the Company's Annual Report on form 10-K for the year ended
December 31, 1999.
10.13.3 Ronald L. Bornheutter Settlement Agreement dates as of June
30, 1999, incorporated by reference to Exhibit 10.14.19 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 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, incorporated by
reference to Exhibit 10.14.19 to the Company's Annual Report
on Form 10-K for the year ended December 31, 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 to 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, incorporated by
reference to Exhibit 10.14.19 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1999.
10.14.4 Amendment No.3 to Credit Agreement (5-year) between Mid
Ocean Limited and The Chase Manhattan Bank, incorporated by
reference to Exhibit 10.14.19 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1999.
10.14.5 (Intentionally omitted)
10.14.6 (Intentionally omitted)
10.14.7 (Intentionally omitted)
80
10.14.8 (Intentionally omitted)
10.14.9 (Intentionally omitted)
10.14.10 (Intentionally omitted)
10.14.11 (Intentionally omitted)
10.14.12 (Intentionally omitted)
10.14.13 (Intentionally omitted)
10.14.14 (Intentionally omitted)
10.14.15 (Intentionally omitted)
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., incorporated
by reference to Exhibit 10.14.19 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999.
10.14.20 Fourth Amendment to Revolving Credit Agreement between XL
Insurance Company, Ltd. and Mellon Bank, N.A., incorporated
by reference to Exhibit 10.14.19 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999.
10.14.21 Fifth Amendment to Revolving Credit Agreement between XL
Insurance Company, Ltd. and Mellon Bank, N.A., incorporated
by reference to Exhibit 10.14.19 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999.
10.14.22 (Intentionally omitted)
10.14.23 (Intentionally omitted)
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., incorporated by reference to Exhibit
10.14.19 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999.
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.,
incorporated by reference to Exhibit 10.14.19 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
10.14.26 (Intentionally omitted)
10.14.27 (Intentionally omitted)
10.14.28 (Intentionally omitted)
10.14.29 (Intentionally omitted)
10.14.30 (Intentionally omitted)
81
10.14.31 364-day Credit Agreement, dated as of July 5, 2000, between
XL Capital Ltd, X.L. America, Inc., XL Insurance Ltd, XL
Europe Ltd and XL Mid Ocean Reinsurance Ltd, as borrowers
and guarantors, the lenders named therein. The Chase
Manhattan Bank, as administrative agent, Chase Securities
Inc., as advisor, lead arranger and book manager, Deutsche
Bank AG, as syndication agent, and Mellon Bank, N.A. and
Citibank, N.A., as co-documentation agent, incorporated by
reference to the Company's quarterly report on Form 10-Q for
June 2000.
10.14.32 Letter of Credit and Reimbursement Agreement, dated as of
July 5, 2000, between XL Capital Ltd, X.L. America, Inc., XL
Insurance Ltd, XL Europe Ltd and XL Mid Ocean Reinsurance
Ltd, as account parties and guarantors, the lenders party
thereto, The Chase Manhattan Bank, as administrative agent,
Chase Securities Inc., as advisor, lead arranger and book
manager, Deutsche Bank AG, as syndication agent, and Mellon
Bank, N.A. and Citibank, N.A., as co-documentation agents,
incorporated by reference to the Company's quarterly report
on Form 10-Q for June 2000.
10.14.33 Letter of Credit and Reimbursement Agreement, dated
November 3, 2000, between the Company, the guarantors named
therein, the lenders named therein, Citibank International
plc, as agent and trustee for the lenders, and Solomon
Brothers International Limited, as arranger.
10.14.34 Second Amendment to Letter of Credit Facility and
Reimbursement Agreement, dated as of November 28, 2000, by
and among XL Insurance Ltd, XL Europe Ltd, XL Mid Ocean
Reinsurance Ltd, XL Brockbank Group plc, and XL Investments
Ltd and Mellon Bank.
10.14.35 1991 Performance Incentive Program as amended and restated
effective March 17, 2000, incorporated by reference to the
Company's proxy statement dated April 7, 2000.
10.14.36 Letter of Credit Agreement (Secured) between XL Mid Ocean
Reinsurance Ltd and Citibank International plc dated
May 19, 1993 (as amended) incorporated by reference to the
Company's Prospectus Supplement dated November 3, 1998.
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 2000.
82
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, 2000 and 1999, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2000, 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 did not audit the financial statements or
financial statement schedules of NAC Re Corp. as at December 31, 1998, which
statements reflect total revenues of $699.4 million for the year ended
December 31, 1998. 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 that date, is based
solely on the report of the other auditors. The consolidated financial
statements give retroactive effect to the merger with NAC Re Corp. on July 15,
1999 in a transaction accounted for as a pooling of interests, as described in
Note 6 to the consolidated financial statements. 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 and the report of other auditors provide a reasonable
basis for our opinion.
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 year ended November 30, 1998
prior to their restatement for the 1999 pooling of interests and change in
fiscal year.
PRICEWATERHOUSECOOPERS LLP
New York, New York
February 15, 2001
83
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
NAC Re Corporation:
We have audited the consolidated statements of income, stockholders' equity
and cash flows of NAC Re Corporation and subsidiaries for the year ended
December 31, 1998 (not presented separately herein). Our audit 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 audit in accordance with auditing standards generally
accepted in the United States of America. 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 results of NAC Re
Corporation and subsidiaries' operations and cash flows for the year ended
December 31, 1998, in conformity with accounting principles generally accepted
in the United States of America. 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
84
XL CAPITAL LTD
SUPPLEMENTAL SCHEDULE I
CONSOLIDATED SUMMARY OF INVESTMENTS--OTHER THAN
INVESTMENTS IN RELATED PARTIES
AS AT DECEMBER 31, 2000
(U.S dollars in thousands)
AMOUNT
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......................................... $1,361,972 $1,412,123 $1,412,123
U.S states and political subdivisions of the States.... 516,949 533,785 533,785
Non-U.S. sovereign governments......................... 597,295 598,655 598,655
Mortgage-backed securities............................. 1,818,697 1,830,395 1,830,395
All other corporate.................................... 4,419,283 4,230,123 4,230,123
-------------------------------------
Total fixed maturities.............................. $8,714,196 $8,605,081 $8,605,081
-------------------------------------
Equity Securities:.......................................... $ 515,440 $ 557,460 $ 557,460
-------------------------------------
Short-term investments...................................... $ 347,147 $ 339,007 $ 339,007
-------------------------------------
Total investments........................................... $9,576,783 $9,501,548 $9,501,548
-------------------------------------
(1) Investments in fixed maturities and short-term investments are shown at
amortized cost.
85
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS--PARENT COMPANY ONLY
AS AT DECEMBER 31, 2000 AND 1999
(U.S. dollars in thousands)
2000 1999
-----------------------
A S S E T S
Portfolio Investments:
Fixed maturities at fair value (amortized cost: 2000,
$292,759; 1999, $101,233).............................. $ 295,770 $ 99,816
Short-term investments at fair value (amortized cost:
2000, $11,032; 1999, $43,563).......................... 10,997 43,499
-----------------------
Total portfolio investments............................ 306,767 143,315
Cash and cash equivalents................................... 40,391 125,619
Investments in subsidiaries on an equity basis.............. 6,748,846 6,296,880
Investment in affiliates.................................... 162 74
Investments in limited partnerships......................... 35,712 39,352
Accrued investment income................................... 2,629 539
Other assets................................................ 22,049 8,952
-----------------------
Total assets........................................... $7,156,556 $6,614,731
-----------------------
L I A B I L I T I E S
Amount due to subsidiaries.................................. $1,515,071 $ 909,610
Accounts payable and accrued liabilities.................... 67,817 128,043
-----------------------
Total liabilities...................................... $1,582,888 $1,037,653
-----------------------
S H A R E H O L D E R S' E Q U I T Y
Ordinary shares............................................. $ 1,250 $ 1,278
Contributed surplus......................................... 2,497,416 2,520,136
Accumulated other comprehensive income...................... (104,712) 19,311
Deferred compensation....................................... (17,727) (28,797)
Retained earnings........................................... 3,197,441 3,065,150
-----------------------
Total shareholders' equity............................. $5,573,668 $5,577,078
-----------------------
Total liabilities and shareholders' equity............. $7,156,556 $6,614,731
-----------------------
86
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, 2000, 1999 AND 1998
(U.S. dollars in thousands)
2000 1999 1998
------------------------------
Net investment income....................................... $ 4,466 $ 1,890 $ 2,738
Net realized gains (losses)................................. 643 (278) 458
Equity in net earnings of subsidiaries (Dividends were Nil,
Nil and $117,900 in 2000, 1999 and 1998, respectively).... 576,502 560,166 632,521
Equity in net income of affiliates.......................... 88 - 49,878
Income from limited partnerships............................ 2,594 4,947 3,599
------------------------------
Total revenues.............................................. 584,293 566,725 689,194
Operating expenses.......................................... 77,941 96,216 32,864
------------------------------
Net income.................................................. 506,352 470,509 $656,330
Change in net unrealized appreciation on investments........ 4,458 (3,084) 1,603
------------------------------
Comprehensive income........................................ $510,810 $467,425 $657,933
------------------------------
87
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF CASH FLOWS--PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(U.S dollars in thousands)
2000 1999 1998
---------------------------------
Cash flows provided by operating activities:
Net income................................................ $ 506,352 $ 470,509 $ 656,330
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 earnings of subsidiaries, net of
dividends........................................... (586,663) (557,317) (503,838)
Equity in net income of affiliates, net of dividends... (88) - (31,410)
Accrued investment income.............................. (2,090) 1,428 (1,967)
Amount due to subsidiaries............................. 605,461 229,811 651,753
Accounts payable and accrued liabilities............... (60,226) 10,522 116,402
Amortization of intangible assets...................... 31,348 31,348 10,494
Amortization of deferred compensation.................. 8,861 7,657 5,815
Amortization of discounts on fixed maturities.......... 637 366 335
Other.................................................. (8,890) (5,069) (117)
---------------------------------
Total adjustments................................... (11,650) (281,254) 247,009
---------------------------------
Net cash provided by operating activities........... 494,702 189,255 903,339
---------------------------------
Cash flows provided by (used in) investing activities:
Proceeds from sale of fixed maturities and short-term
investments............................................ 230,110 118,756 198,893
Proceeds from redemption of fixed maturities and
short-term investments................................. 43,500 107,885 53,325
Purchases of fixed maturities and short term
investments............................................ (432,722) (121,995) (501,957)
Investment in subsidiaries................................ (25,000) - -
Investment in limited partnerships........................ 3,640 (18,974) (1,129)
---------------------------------
Net cash provided (used in) by investing activities.... (180,472) 85,672 (250,868)
---------------------------------
Cash flows used in financing activities:
Proceeds from exercise of options......................... 74,564 14,014 15,092
Dividends paid............................................ (225,572) (212,659) (156,481)
Repurchase of treasury shares............................. (248,450) (99,344) (362,401)
---------------------------------
Net cash used in financing activities............... (399,458) (297,989) (503,790)
---------------------------------
Net change in cash and cash equivalents............. (85,228) (23,062) $ 148,681
Cash and cash equivalents - beginning of year............... 125,619 148,681 -
---------------------------------
Cash and cash equivalents - end of year..................... $ 40,391 $ 125,619 $ 148,681
---------------------------------
88
XL CAPITAL LTD
SCHEDULE IV--REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(U.S. dollars in thousands)
CEDED ASSUMED
GROSS TO OTHER FROM OTHER NET
AMOUNT COMPANIES COMPANIES AMOUNT
-------------------------------------------------
2000............................... $1,688,923 $1,012,791 $1,440,108 $2,116,240
-------------------------------------------------
1999............................... $1,088,028 $ 541,037 $1,354,892 $1,901,883
-------------------------------------------------
1998............................... $ 779,551 $ 319,275 $ 863,988 $1,324,264
-------------------------------------------------
89
XL CAPITAL LTD
SCHEDULE VI
SUPPLEMENTARY INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(U.S dollars in thousands)
LOSSES AND LOSS EXPENSES
INCURRED RELATED TO NET
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
---------------------------------------------------------------------------------------------------------
2000.............. $309,268 $5,672,062 $1,741,393 $2,035,240 $542,500 $1,827,443 $(394,884) $1,663,670
---------------------------------------------------------------------------------------------------------
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 $1,097,161 $(255,644) $ 730,889
---------------------------------------------------------------------------------------------------------
AMORTIZATION
OF DEFERRED NET
ACQUISITION PREMIUMS
COSTS WRITTEN
-------------------------
2000.............. $485,796 $2,116,240
-------------------------
1999.............. $380,980 $1,901,883
-------------------------
1998.............. $249,341 $1,324,264
-------------------------
90
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 23, 2001
POWER OF ATTORNEY
We, the undersigned directors and executive officers of XL Capital Ltd,
hereby severally constitute Michael P. Esposito, Jr., Brian M. O'Hara and
Paul S. Giordano, and each of them singly, our true and lawful attorneys with
full power to them and each of them to sign for us, and in our names in the
capacities indicated below, any and all amendments to the Annual Report on
Form 10-K filed with the Securities and Exchange Commission, hereby ratifying
and confirming our signatures as they may be signed by our said attorneys to any
and all amendments to said Annual Report on Form 10-K.
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 23, 2001
Brian M. O'Hara (Principal Executive Officer)
/s/ ROBERT R. LUSARDI Executive Vice President and
------------------------------------------------ Chief Financial Officer February 19,
Robert R. Lusardi (Principal Financial Officer) 2001
/s/ MICHAEL A. SIESE Senior Vice President and
------------------------------------------------ Controller (Principal March 23, 2001
Michael A. Siese Accounting Officer)
/s/ MICHAEL P. ESPOSITO, JR.
------------------------------------------------ Director and Chairman of the March 23, 2001
Michael P. Esposito, Jr. Board of Directors
/s/ RONALD L. BORNHUETTER
------------------------------------------------ Director March 23, 2001
Ronald L. Bornhuetter
/s/ MICHAEL A. BUTT
------------------------------------------------ Director March 23, 2001
Michael A. Butt
/s/ ROBERT CLEMENTS
------------------------------------------------ Director March 23, 2001
Robert Clements
91
SIGNATURES TITLE DATE
---------- ----- ----
/s/ SIR BRIAN CORBY
------------------------------------------------ Director March 23, 2001
Sir Brian Corby
/s/ ROBERT R. GLAUBER
------------------------------------------------ Director March 23, 2001
Robert R. Glauber
/s/ IAN R. HEAP
------------------------------------------------ Director March 23, 2001
Ian R. Heap
/s/ PAUL JEANBART
------------------------------------------------ Director March 23, 2001
Paul Jeanbart
/s/ JOHN LOUDON
------------------------------------------------ Director March 23, 2001
John Loudon
/s/ DANIEL MCNAMARA
------------------------------------------------ Director March 23, 2001
Daniel McNamara
/s/ ROBERT S. PARKER
------------------------------------------------ Director March 23, 2001
Robert S. Parker
/s/ CYRIL RANCE
------------------------------------------------ Director March 23, 2001
Cyril Rance
/s/ ALAN Z. SENTER
------------------------------------------------ Director March 23, 2001
Alan Z. Senter
/s/ JOHN T. THORNTON
------------------------------------------------ Director March 23, 2001
John T. Thornton
/s/ ELLEN E. THROWER
------------------------------------------------ Director March 23, 2001
Ellen E. Thrower
/s/ JOHN WEISER
------------------------------------------------ Director March 23, 2001
John Weiser
92