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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001 Commission file number 1-13816
EVEREST REINSURANCE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware 22-3263609
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
477 Martinsville Road
Post Office Box 830
Liberty Corner, New Jersey 07938-0830
(908) 640-3000
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive office)
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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8.5% Senior Notes Due 2005 NYSE
8.75% Senior Notes Due 2010 NYSE
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Securities registered pursuant to Section 12(g) of the Act: None
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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 for 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. [ X ]
At March 28, 2002, the number of common shares of the registrant
outstanding was 1,000, all of which are owned by Everest Re Group, Ltd.
The Registrant meets the conditions set forth in General Instruction
I(1)(a) and (b) of Form 10-K and is therefore filing this form with the reduced
disclosure format permitted by General Instruction I of Form 10-K.
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TABLE OF CONTENTS
Item Page
- ---- ----
PART I
1. Business
2. Properties
3. Legal Proceedings
4. Submission of Matters to a Vote of Security Holders
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters
6. Selected Financial Data
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
7A. Quantitative and Qualitative Disclosures About Market Risk
8. Financial Statements and Supplementary Data
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
PART III
10. Directors and Executive Officers of the Registrant
11. Executive Compensation
12. Security Ownership of Certain Beneficial Owners and Management
13. Certain Relationships and Related Transactions
PART IV
14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K
3
PART I
UNLESS OTHERWISE INDICATED, ALL FINANCIAL DATA IN THIS DOCUMENT HAVE BEEN
PREPARED USING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP"). AS USED IN
THIS DOCUMENT, "HOLDINGS" MEANS EVEREST REINSURANCE HOLDINGS, INC.; "GROUP"
MEANS EVEREST RE GROUP, LTD. (FORMERLY EVEREST REINSURANCE GROUP, LTD.);
"EVEREST RE" MEANS EVEREST REINSURANCE COMPANY AND ITS SUBSIDIARIES (UNLESS THE
CONTEXT OTHERWISE REQUIRES); "BERMUDA RE" MEANS EVEREST REINSURANCE (BERMUDA),
LTD. AND THE "COMPANY" MEANS HOLDINGS AND ITS SUBSIDIARIES (UNLESS THE CONTEXT
OTHERWISE REQUIRES).
ITEM 1. BUSINESS
THE COMPANY
Holdings, a Delaware corporation, is a wholly-owned subsidiary of Group, which
is a Bermuda holding company whose common shares are publicly traded in the
United States on the New York Stock Exchange under the symbol "RE". Group files
an annual report on Form 10-K with the Securities and Exchange Commission with
respect to its consolidated operations, including Holdings. Holdings became a
wholly-owned subsidiary of Group on February 24, 2000 in a corporate
restructuring pursuant to which holders of shares of common stock of Holdings
automatically became holders of the same number of common shares of Group.
On March 14, 2000, Holdings completed public offerings of $200 million principal
amount of 8.75% senior notes due March 15, 2010 and $250 million principal
amount of 8.50% senior notes due March 15, 2005. This abbreviated filing is
required as a result of this outstanding debt. During 2000, the net proceeds of
these offerings and additional funds were distributed by Holdings to Group.
The Company's principal business, conducted through its operating subsidiaries,
is the underwriting of reinsurance and insurance in the United States and
international markets. The Company underwrites reinsurance both through brokers
and directly with ceding companies, giving it the flexibility to pursue business
regardless of the ceding company's preferred reinsurance purchasing method. The
Company underwrites insurance principally through general agency relationships.
The Company's operating subsidiaries, excluding Mt. McKinley Insurance Company,
are each rated A+ ("Superior") by A.M. Best Company ("A.M. Best"), an
independent insurance industry rating organization that rates insurance
companies on factors of concern to policyholders.
Following is a summary of the Company's operating subsidiaries:
o Everest Re, a Delaware insurance company and a direct subsidiary of
Holdings, is a licensed property and casualty insurer and/or reinsurer
in all states (except Nevada and Wyoming), the District of Columbia,
Puerto Rico and Canada, and is authorized to conduct reinsurance
business in the United Kingdom and Singapore. Everest Re underwrites
property and casualty reinsurance on a treaty and facultative basis for
insurance and reinsurance companies in the United States and
international markets. Everest Re had statutory surplus at December 31,
2001 of $1,293.8 million.
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o Everest National Insurance Company ("Everest National"), an Arizona
insurance company and a direct subsidiary of Everest Re, is licensed in
42 states and the District of Columbia and is authorized to write
property and casualty insurance in the states in which it is licensed.
This is often called writing insurance on an admitted basis.
o Everest Insurance Company of Canada ("Everest Canada"), a Canadian
insurance company and a direct subsidiary of Everest Re, is licensed in
all Canadian provinces and territories and is federally licensed to
write property and casualty insurance under the Insurance Companies Act
of Canada.
o Everest Indemnity Insurance Company ("Everest Indemnity"), a Delaware
insurance company and a direct subsidiary of Everest Re, engages in the
excess and surplus lines insurance business in the United States.
Excess and surplus lines insurance is specialty property and liability
coverage that an insurer not licensed to write insurance in a
particular state is permitted to provide when the specific specialty
coverage is unavailable from admitted insurers. This is often called
writing insurance on a non-admitted basis. Everest Indemnity is
licensed in Delaware and is eligible to write business on a
non-admitted basis in 41 states, the District of Columbia and Puerto
Rico.
o Everest Security Insurance Company ("Everest Security"), formerly
Southeastern Security Insurance Company, a Georgia insurance company
and a direct subsidiary of Everest Re, was acquired in January 2000 and
writes property and casualty insurance on an admitted basis in Georgia.
o Mt. McKinley Managers, L.L.C. ("Managers"), a New Jersey limited
liability company and a direct subsidiary of Holdings, is licensed in
New Jersey as an insurance producer. An insurance producer is any
intermediary, such as an agent or broker, which acts as the conduit
between an insurance company and an insured. Managers, which is
licensed to act in New Jersey as an insurance producer in connection
with policies written on both an admitted and a surplus lines basis, is
the underwriting manager for Everest Indemnity. As a result of a 1998
acquisition of the assets of insurance agency operations in Alabama
and Georgia, the continuing insurance agency operations are now carried
on by subsidiaries of Managers. These subsidiaries are WorkCare
Southeast, Inc., an Alabama insurance agency, and WorkCare Southeast
of Georgia, Inc., a Georgia insurance agency.
o Mt. McKinley Insurance Company (f/k/a Gibraltar Casualty Company,
"Gibraltar") ("Mt. McKinley"), a Delaware insurance company and a
direct subsidiary of Holdings, was acquired by Holdings in September
2000 from The Prudential. Mt. McKinley was formed by Everest Re in
1978 to engage in the excess and surplus lines insurance business
in the United States. In 1985, Mt. McKinley ceased writing new and
renewal insurance and now its ongoing operations relate to servicing
claims arising from its previously written business. Mt. McKinley
was a subsidiary of Everest Re until 1991 when Everest Re distributed
the stock of Mt. McKinley to a wholly-owned subsidiary of The
Prudential.
o Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda company and a
direct subsidiary of Everest Re, was formed in 1998 and owns Everest Re
Ltd., a United Kingdom company that is in the process of being
dissolved because its reinsurance operations have been converted into
branch operations of Everest Re. Everest Ltd. also holds $104.3 million
of investments, the management of which constitutes its principal
operations.
2
REINSURANCE INDUSTRY OVERVIEW
Reinsurance is an arrangement in which an insurance company, the reinsurer,
agrees to indemnify another insurance company, the ceding company, against all
or a portion of the insurance risks underwritten by the ceding company under one
or more insurance contracts. Reinsurance can provide a ceding company with
several benefits, including a reduction in net liability on individual or
classes of risks, catastrophe protection from large or multiple losses and
assistance in maintaining acceptable financial ratios. Reinsurance also provides
a ceding company with additional underwriting capacity by permitting it to
accept larger risks and write more business than would be possible without a
concomitant increase in capital and surplus. Reinsurance, however, does not
discharge the ceding company from its liability to policyholders.
There are two basic types of reinsurance arrangements: treaty and facultative
reinsurance. In treaty reinsurance, the ceding company is obligated to cede and
the reinsurer is obligated to assume a specified portion of a type or category
of risks insured by the ceding company. Treaty reinsurers do not separately
evaluate each of the individual risks assumed under their treaties and,
consequently, after a review of the ceding company's underwriting practices, are
largely dependent on the original risk underwriting decisions made by the ceding
company. In facultative reinsurance, the ceding company cedes and the reinsurer
assumes all or part of the risk under a single insurance contract. Facultative
reinsurance is negotiated separately for each insurance contract that is
reinsured. Facultative reinsurance normally is purchased by ceding companies for
individual risks not covered by their reinsurance treaties, for amounts in
excess of the dollar limits of their reinsurance treaties and for unusual risks.
Both treaty and facultative reinsurance can be written on either a pro rata
basis or an excess of loss basis. Under pro rata reinsurance, the ceding company
and the reinsurer share the premiums as well as the losses and expenses in an
agreed proportion. Under excess of loss reinsurance, the reinsurer indemnifies
the ceding company against all or a specified portion of losses and expenses in
excess of a specified dollar amount, known as the ceding company's retention or
reinsurer's attachment point, generally subject to a negotiated reinsurance
contract limit.
Premiums paid by the ceding company to a reinsurer for excess of loss
reinsurance are not directly proportional to the premiums that the ceding
company receives because the reinsurer does not assume a proportionate risk. In
pro rata reinsurance, the reinsurer generally pays the ceding company a ceding
commission. The ceding commission generally is based on the ceding company's
cost of acquiring the business being reinsured (commissions, premium taxes,
assessments and miscellaneous administrative expense). There is usually no
ceding commission on excess of loss reinsurance.
Reinsurers may purchase reinsurance to cover their own risk exposure.
Reinsurance of a reinsurer's business is called a retrocession. Reinsurance
companies cede risks under retrocessional agreements to other reinsurers, known
as retrocessionaires, for reasons similar to those that cause insurers to
purchase reinsurance: to reduce net liability on individual or classes of risks,
protect against catastrophic losses, stabilize financial ratios and obtain
additional underwriting capacity.
Reinsurance can be written through professional reinsurance brokers or directly
with ceding companies. From a ceding company's perspective, both the broker
market and the direct market have advantages and disadvantages. A ceding
company's decision to select one market over the other will be influenced by its
perception of such advantages and disadvantages relative to the reinsurance
coverage being placed.
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BUSINESS STRATEGY
The Company's underwriting strategies seek to capitalize on its financial
capacity, its employee expertise and its flexibility to offer multiple products
through multiple distribution channels. The Company's strategies include
effective management of the property and casualty underwriting cycle, which
refers to the tendency of insurance premiums, profits and the demand for and
availability of coverage to rise and fall over time. The Company also seeks to
manage its catastrophe exposures and retrocessional costs. Efforts to control
expenses and to operate in a cost-efficient manner are also a continuing focus
for the Company.
The Company's products include the full range of property and casualty
reinsurance and insurance coverages, including marine, aviation, surety, errors
and omissions liability ("E&O"), directors' and officers' liability ("D&O"),
medical malpractice, other specialty lines, accident and health ("A&H"), workers
compensation, and other standard lines. The Company's distribution channels
include both the direct and broker reinsurance markets, U.S. and international
markets, reinsurance, both treaty and facultative, and insurance, both admitted
and non-admitted.
The Company's underwriting strategy emphasizes underwriting profitability rather
than premium volume, writing specialized property and casualty risks and
integration of underwriting expertise across all underwriting units. Key
elements of this strategy are prudent risk selection, appropriate pricing
through strict underwriting discipline and continuous adjustment of the
Company's business mix to respond to changing market conditions. The Company
focuses on reinsuring companies that effectively manage the underwriting cycle
through proper analysis and pricing of underlying risks and whose underwriting
guidelines and performance are compatible with its objectives.
The Company's underwriting strategy also emphasizes flexibility and
responsiveness to changing market conditions, such as increased demand or
favorable pricing trends. The Company believes that its existing strengths,
including its broad underwriting expertise, U.S. and international presence and
substantial capital, facilitate adjustments to its mix of business
geographically, by line of business and by type of coverage, allowing it to
capitalize on those market opportunities that provide the greatest potential for
underwriting profitability. The Company's insurance infrastructure further
facilitates this strategy by allowing the Company to develop business that
requires the Company to issue insurance policies. The Company also carefully
monitors its mix of business to avoid inappropriate concentrations of geographic
or other risk.
RATINGS
The following table shows the financial strength ratings of the Company's
operating subsidiaries as reported by A.M. Best, Standard & Poor's Ratings
Services ("Standard & Poor's) and Moody's Investors Service ("Moody's"). These
ratings are based upon factors of concern to policyholders and should not be
considered an indication of the degree or lack of risk involved in an equity
investment in an insurance company.
4
Operating Subsidiary A.M. Best Standard & Poor's Moody's
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Everest Re A+ (Superior) AA- (Very Strong) Aa3 (Excellent)
Everest National A+ (Superior) AA- (Very Strong) Not Rated
Everest Indemnity A+ (Superior) Not Rated Not Rated
Everest Security A+ (Superior) BB pi Not Rated
Everest Canada A+ (Superior) Not Rated Not Rated
Mt. McKinley Not Rated B pi Not Rated
A.M. Best states that the "A+" ("Superior") rating is assigned to those
companies which, in its opinion, have, on balance, achieved superior financial
strength, operating performance and market profile when compared to the
standards established by A.M. Best and have demonstrated a very strong ability
to meet their ongoing obligations to policyholders. The "A+" ("Superior") rating
is the second highest of fifteen ratings assigned by A.M. Best, which range from
"A++" ("Superior") to "F" ("In Liquidation"). Additionally, A.M. Best has eleven
classifications within the "Not Assigned" category. Standard & Poor's states
that the "AA-" rating is assigned to those insurance companies which, in its
opinion, offer excellent financial security and whose capacity to meet
policyholder obligations is strong under a variety of economic and underwriting
conditions. The "AA-" rating is the fourth highest of nineteen ratings assigned
by Standard & Poor's, which range from "AAA" (Superior) to "R" (Regulatory
Action). Ratings from AA to B may be modified by the use of a plus or minus sign
to show relative standing of the insurer within those rating categories.
Ratings, denoted with a "pi" subscript, are ratings based on Standard & Poor's
analysis of published financial information and do not reflect in-depth meetings
with the Company's management. The "BB pi" and "B pi" ratings are the twelfth
and fifteenth highest of the nineteen Standard & Poor's ratings. Moody's states
that insurance companies rated "Aa" offer excellent financial security. Together
with the Aaa rated companies, Aa rated companies constitute what are generally
known as high grade companies, with Aa rated companies generally having somewhat
larger long-term risks. Moody's rating gradations are shown through the use of
nine distinct symbols, each symbol representing a group of ratings in which the
financial security is broadly the same. The "Aa3" (Excellent) rating is the
fourth highest of ratings assigned by Moody's, which range from "Aaa"
(Exceptional) to "C" (Lowest). Moody's further distinguishes the ranking of an
insurer within its generic rating classification from Aa to B with 1, 2 and 3
("1" being the highest).
The following table shows the investment grade ratings of the Holdings' senior
notes due March 15, 2005 and March 15, 2010 by A.M. Best, Standard & Poor's and
Moody's. Debt ratings are a current assessment of the credit-worthiness of an
obligor with respect to a specific obligation.
A.M. Best Standard & Poor's Moody's
- --------------------------------------------------------------------------------
Senior Notes a A- A3
A company with a debt rating of "a" is considered by A.M. Best to have a strong
capacity and willingness to meet the terms of the obligation and possesses a low
level of credit risk. The "a" rating is the sixth highest of 19 ratings assigned
by A.M. Best, which range from "aaa" to "ccc". A company with a debt rating of
"A-" is considered by Standard & Poor's to have a strong capacity to pay
interest and repay principal, although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher rated categories. The "A-" rating from Standard & Poor's is the seventh
highest of 24 ratings assigned by Standard & Poor's, which range from "AAA" to
"D". A company with a debt rating of "A3" is considered to be an
upper-medium-grade obligation by Moody's. This rating represents adequate
5
capacity with respect to repayment of principal and interest, but elements may
be present which suggest a susceptibility to impairment sometime in the future.
The "A3" rating is the seventh highest of 21 ratings assigned by Moody's which
range from "AAA" to "C".
All of the above-mentioned ratings are continually monitored and revised, if
necessary, by each of the rating agencies.
COMPETITION
The worldwide reinsurance and insurance businesses are highly competitive. The
September 11 terrorist attacks resulted in losses which reduced industry
capacity and were of sufficient magnitude to cause most individual companies to
reassess their capital position, tolerance for risk, exposure control mechanisms
and the pricing terms and conditions at which they are willing to take on risk.
The gradual and variable improving trend, which has been apparent through 2000
and earlier in 2001 firmed significantly. This firming generally took the form
of immediate and significant upward pressure on prices, including more
restrictive terms and conditions and a reduction of coverage limits and capacity
availability. Such pressures were widespread with some variability depending on
the product and markets involved, but mainly depending on the characteristics of
the underlying risk exposures. The magnitude of the changes was sufficient to
create temporary disequilibrium in some markets as individual buyers and sellers
adapted to changes in both their internal and market dynamics.
These changes reflect a reversal of the general trend from 1987 through 1999
toward increasingly competitive global market conditions across most lines of
business as reflected by decreasing prices and broadening contract terms. The
earlier trend resulted from a number of factors including the emergence of
significant reinsurance capacity in Bermuda, changes in the Lloyds market,
consolidation and increased capital levels in the insurance and reinsurance
industries, as well as the emergence of new reinsurance and financial products
addressing traditional exposures in alternative fashions. Many of these factors
continue to exist. As a result, although the Company is encouraged by the recent
improvements, and more generally, current market conditions, the Company cannot
predict with any reasonable certainty whether and to what extent these
improvements will persist.
Competition with respect to the types of reinsurance and insurance business in
which the Company is engaged is based on many factors, including the perceived
overall financial strength of the reinsurer or insurer, the A.M. Best and/or
Standard & Poor's rating of the reinsurer or insurer, underwriting expertise,
the jurisdictions where the reinsurer or insurer is licensed or otherwise
authorized, capacity and coverages offered, premiums charged, other terms and
conditions of the reinsurance and insurance business offered, services offered,
speed of claims payment and reputation and experience in lines written. The
Company competes in the United States and international reinsurance and
insurance markets with numerous international and domestic reinsurance and
insurance companies. The Company's competitors include independent reinsurance
and insurance companies, subsidiaries or affiliates of established worldwide
insurance companies, reinsurance departments of certain insurance companies and
domestic and international underwriting operations, including underwriting
syndicates at Lloyd's. Some of these competitors have greater financial
resources than the Company and have established long-term and continuing
business relationships throughout the industry, which can be a significant
competitive advantage. In addition, the potential for securitization of
reinsurance and insurance risks through capital markets provides an additional
source of potential reinsurance and insurance capacity and competition.
6
EMPLOYEES
As of March 1, 2002, the Company employed 345 persons. Management believes that
its employee relations are good. None of the Company's employees are subject to
collective bargaining agreements, and the Company is not aware of any current
efforts to implement such agreements.
ITEM 2. PROPERTIES
Everest Re's corporate offices are located in approximately 112,000 square feet
of leased office space in Liberty Corner, New Jersey. The Company's other
thirteen locations occupy a total of approximately 67,000 square feet, all of
which are leased. Management believes that the above-described office space is
adequate for its current and anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in ordinary routine litigation and
arbitration proceedings incidental to its business. The Company does not believe
that there are any other material pending legal proceedings to which it or any
of its subsidiaries or their properties are subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Information for this Item 4 is not required pursuant to General Instruction I(2)
of Form 10-K.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION AND HOLDER OF COMMON STOCK
As of December 31, 2001, all of the Company's common stock was owned by Group
and was not publicly traded.
During 2000 and 1999, the Company declared dividends on its common stock
totaling $495.0 million and $11.6 million, respectively. The Company did not pay
any dividends during 2001.
The declaration and payment of future dividends, if any, 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 and growth
objectives, capital and surplus requirements of operating subsidiaries,
regulatory restrictions, rating agency considerations and other factors. As an
insurance holding company, the Company is dependent on dividends and other
permitted payments from its subsidiaries to pay cash dividends to its
stockholders. The payment of dividends to Holdings by Everest Re is subject to
limitations imposed by Delaware law. Generally, Everest Re may only pay
dividends out of its statutory earned surplus, which was $915.2 million at
December 31, 2001, and only after it has given 10 days prior notice to the
Delaware Insurance Commissioner. During this 10-day period, the Commissioner
may, by order, limit or disallow the payment of ordinary dividends if the
Commissioner finds the insurer to be presently or potentially in financial
distress. Further the maximum amount of dividends that may be paid without the
prior approval of the Delaware Insurance Commissioner in any twelve month period
is the greater of (1) 10% of an insurer's statutory surplus as of the end of the
prior calendar year or (2) the insurer's statutory net income, not including
realized capital gains, for the prior calendar year. Under this definition, the
maximum amount that will be available for the payment of dividends by Everest Re
in 2002 without triggering the requirement for prior approval of regulatory
authorities in connection with a dividend is $129.4 million. See Note 11A of
Notes to Consolidated Financial Statements.
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RECENT SALES OF UNREGISTERED SECURITIES
None.
ITEM 6. SELECTED FINANCIAL DATA
Information for this Item 6 is not required pursuant to General Instruction I(2)
of Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a discussion of the results of operations and financial
condition of Everest Reinsurance Holdings, Inc. and its subsidiaries (the
"Company"). This discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto presented under ITEM 8.
RESTRUCTURING
On February 24, 2000, a corporate restructuring was completed and Everest Re
Group, Ltd. ("Group") became the new parent holding company of the Company,
which remains the holding company for Group's U.S. based operations. Holders of
the Company's common stock automatically became holders of the same number of
Group common shares. The Company is filing this report as a result of its public
issuance of senior notes on March 14, 2000. See ITEM 1 - "Business - The
Company" for a further discussion.
ACQUISITIONS
On September 19, 2000, the Company completed the acquisition of all of the
issued and outstanding capital stock of Gibraltar Casualty Company ("Gibraltar")
from The Prudential Insurance Company of America ("The Prudential") for $51.8
million, which approximated book value. As a result of the acquisition,
Gibraltar became a wholly owned subsidiary of the Company and, immediately
following the acquisition, its name was changed to Mt. McKinley Insurance
Company ("Mt. McKinley"). In connection with the acquisition of Mt. McKinley,
which has significant exposure to asbestos and environmental claims, Prudential
Property and Casualty Insurance Company ("Prupac"), a subsidiary of The
Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million)
of the first $200.0 million of any adverse development of Mt. McKinley's
reserves as of September 19, 2000 and The Prudential guaranteed Prupac's
obligation to Mt. McKinley. There were $22.2 million of cessions under this
reinsurance at December 31, 2001, reducing the limit available under this
contract to $137.8 million.
In connection with the Mt. McKinley acquisition, Prupac also provided excess of
loss reinsurance for 100% of the first $8.5 million of loss with respect to
certain of Mt. McKinley's retrocessions and potentially uncollectible
reinsurance coverage. There were $2.5 million and $3.6 million of cessions under
this reinsurance during the periods ending December 31, 2000 and 2001,
respectively, reducing the limit available under the contract to $2.4 million.
Mt. McKinley, a run-off property and casualty insurer in the United States, has
had a long relationship with the Company and its principal operating company,
Everest Reinsurance Company ("Everest Re"). Mt. McKinley was formed in 1978 by
Everest Re and wrote insurance until 1985, when it was placed in run-off. In
1991, Mt. McKinley became a subsidiary of The Prudential. Mt. McKinley is also a
reinsurer of Everest Re. Under a series of transactions dating to 1986, Mt.
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McKinley reinsured several components of Everest Re's business. In particular,
Mt. McKinley provided stop-loss reinsurance protection, in connection with the
Company's October 5, 1995 IPO, for any adverse loss development on Everest Re's
June 30, 1995 (December 31, 1994 for catastrophe losses) reserves, with $375.0
million in limits, of which $89.4 million remains available (the "Stop Loss
Agreement"). The Stop Loss Agreement and other reinsurance contracts between Mt.
McKinley and Everest Re remain in effect following the acquisition. However,
these contracts have become transactions with affiliates with the financial
impact eliminated in consolidation.
Effective September 19, 2000, Mt. McKinley and Everest Reinsurance (Bermuda),
Ltd. ("Bermuda Re") entered into a loss portfolio transfer reinsurance
agreement, whereby Mt. McKinley transferred, for arm's-length consideration, all
of its net insurance exposures and reserves, including allocated and unallocated
loss adjustment expenses, to Bermuda Re.
During 2000, the Company completed an additional acquisition, Everest Security
Insurance Company ("Everest Security"), formerly known as Southeastern Security
Insurance Company, a United States property and casualty company whose primary
business is non-standard automobile insurance.
RESULTS OF OPERATIONS
Unusual Loss Events. As a result of the terrorist attacks at the World Trade
Center, the Pentagon and on various airlines on September 11, 2001 (collectively
the "September 11 attacks"), the Company incurred pre-tax losses, based on an
estimate of ultimate exposure developed through a review of its coverages, which
totaled $213.2 million gross of reinsurance and $55.0 million net of
reinsurance. Associated with this reinsurance were $60.0 million of pre-tax
charges, predominantly from adjustment premiums, resulting in a total pre-tax
loss from the September 11 attacks of $115.0 million. After tax recoveries
relating specifically to this unusual loss event, the net loss from the
September 11 attacks totaled $75.0 million. Over 90% of the losses ceded were to
treaties where the reinsurers' obligations are secured, which in the Company's
opinion eliminates material reinsurance collection risk.
As a result of the Enron bankruptcy, the Company has incurred losses, after-tax
and reinsurance, amounting to $18.6 million. This unusual loss reflects all of
the Company's exposures, including underwriting, credit and investment.
INDUSTRY CONDITIONS. The worldwide reinsurance and insurance businesses are
highly competitive. The September 11 attacks resulted in losses which reduced
industry capacity and were of sufficient magnitude to cause most individual
companies to reassess their capital position, tolerance for risk, exposure
control mechanisms and the pricing terms and conditions at which they are
willing to take on risk. The gradual and variable improving trend, which has
been apparent through 2000 and earlier in 2001 firmed significantly. This
firming generally took the form of immediate and significant upward pressure on
prices, including more restrictive terms and conditions and a reduction of
coverage limits and capacity availability. Such pressures were widespread with
variability depending on the product and markets involved, but mainly depending
on the characteristics of the underlying risk exposures. The magnitude of the
changes was sufficient to create temporary disequilibrium in some markets as
individual buyers and sellers adapted to changes in both their internal and
market dynamics.
These changes reflect a reversal of the general trend from 1987 through 1999
toward increasingly competitive global market conditions across most lines of
business as reflected by decreasing prices and broadening contract terms. The
earlier trend resulted from a number of factors including the emergence of
significant reinsurance capacity in Bermuda, changes in the Lloyds market,
9
consolidation and increased capital levels in the insurance and reinsurance
industries, as well as the emergence of new reinsurance and financial products
addressing traditional exposures in alternative fashions. Many of these factors
continue to exist. As a result, although the Company is encouraged by the recent
improvements, and more generally, current market conditions, the Company cannot
predict with any reasonable certainty whether and to what extent these
improvements will persist.
SEGMENT INFORMATION
The Company, through its subsidiaries, operates in four segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting, and International. The U.S.
Reinsurance operation writes property and casualty reinsurance on both a treaty
and facultative basis through reinsurance brokers as well as directly with
ceding companies within the United States. The U.S. Insurance operation writes
property and casualty insurance primarily through general agent relationships
and surplus lines brokers within the United States. The Specialty Underwriting
operation writes accident and health ("A&H"), marine, aviation and surety
business within the United States and worldwide through brokers and directly
with ceding companies. The International operation writes property and casualty
reinsurance through the Company's branches in Belgium, London, Canada, and
Singapore, in addition to foreign "home-office" business.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments principally based upon their
underwriting results.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
PREMIUMS. Gross premiums written increased 34.6% to $1,849.8 million in 2001
from $1,374.0 million in 2000, as the Company took advantage of selected growth
opportunities, while continuing to maintain a disciplined underwriting approach.
Premium growth areas included a 100.6% ($251.9 million) increase in the U.S.
Insurance operation, principally attributable to growth in worker's compensation
insurance, a 30.1% ($95.7 million) increase in the Specialty Underwriting
operation, mainly attributable to growth in A&H medical stop loss writings and a
26.7% ($128.8 million) increase in the U.S. Reinsurance operation, primarily
reflecting improved market conditions. These increases were partially offset by
a 0.2% ($0.8 million) decrease in the International operation. The Company
continued to decline business that did not meet its objectives regarding
underwriting profitability.
Ceded premiums increased to $432.9 million in 2001 from $166.7 million in 2000.
This increase was principally attributable to $123.2 million of ceded premiums
in 2001 relating to an arm's-length loss portfolio reinsurance transaction,
whereby the Company transferred the net exposures and reserves of its Belgium
branch to Bermuda Re. In addition, ceded premiums in 2001 also reflect $81.3
million of adjustment premiums incurred under the 2001 accident year aggregate
excess of loss element of the Company's corporate retrocessional program
relating to losses incurred as a result of the September 11 attacks and the
Enron bankruptcy. In addition, ceded premiums for 2001 and 2000 also include
adjustment premiums of $58.1 million and $35.2 million, respectively, relating
to claims made under the 1999 accident year aggregate excess of loss element of
the Company's corporate retrocessional program. The increase in ceded premiums
in 2001 also reflects the impact on the U.S. Insurance operation's specific
reinsurance protections resulting from this unit's volume increase.
Net premiums written increased by 17.4% to $1,416.9 million in 2001 from
$1,207.3 million in 2000. This increase was consistent with the increase in
gross premiums written and the increase in ceded premiums.
10
PREMIUM REVENUES. Net premiums earned increased by 14.7% to $1,333.5 million in
2001 from $1,162.6 million in 2000. Contributing to this increase were a 189.7%
($192.6 million) increase in the U.S. Insurance operation, a 22.9% ($69.2
million) increase in the Specialty Underwriting operation and a 5.5% ($26.0
million) increase in the U.S. Reinsurance operation. These increases were
partially offset by a 40.8% ($116.9 million) decrease in the International
operation principally attributable to $122.3 million relating to the reinsurance
transaction between the Company and Bermuda Re noted earlier. All of these
changes reflect period to period variability in gross written and ceded
premiums, and business mix, together with normal variability in earnings
patterns. Business mix changes occur not only as the Company shifts emphasis
between products, lines of business, distribution channels and markets but also
as individual contracts renew or non-renew, almost always with changes in
coverage, structure, prices and/or terms, and as new contracts are accepted with
coverages, structures, prices and/or terms different from those of expiring
contracts. As premium reporting and earnings and loss and commission
characteristics derive from the provisions of individual contracts, the
continuous turnover of individual contracts, arising from both strategic shifts
and day to day underwriting, can and does introduce appreciable background
variability in various underwriting line items.
EXPENSES. Incurred loss and loss adjustment expenses ("LAE") increased by 22.9%
to $1,079.2 million in 2001 from $878.2 million in 2000. The increase in
incurred losses and LAE was principally attributable to an increase in business
volume as reflected by the increase in net premiums earned, the impact of
incurred losses relating to the September 11 attacks and the Enron bankruptcy
and modest reserve strengthening in select areas, together with the impact of
changes in the Company's mix of business. The Enron bankruptcy contributed $34.0
million of unusual losses in 2001, before cessions under the corporate
retrocessional program. Incurred losses and LAE include catastrophe losses,
which reflect the impact of both current period events and favorable and
unfavorable development on prior period events and are net of reinsurance. A
catastrophe is an event that causes a pre-tax loss on property exposures of at
least $5.0 million and has an event date of January 1, 1988 or later.
Catastrophe losses, net of contract specific cessions but before cessions under
the corporate retrocessional program in 2001, were $222.6 million, relating
principally to the September 11 attacks, tropical storm Alison, the Petrobras
Oil Rig loss and the El Salvador earthquake loss, compared to $13.9 million in
2000. Incurred losses and LAE in 2001 reflected ceded losses and LAE of $619.4
million compared to ceded losses and LAE in 2000 of $176.4 million, with the
increase principally attributable to cessions relating to the September 11
attack losses and the Enron bankruptcy, together with increased cessions under
specific reinsurance arrangements in the U.S. Insurance operation. The ceded
losses and LAE for 2001 reflect $164.0 million of losses ceded under the 2001
accident year aggregate excess of loss component of the Company's corporate
retrocessional program. The ceded losses and LAE for 2001 and 2000 reflect
$105.0 million and $70.0 million, respectively, of losses ceded under the 1999
accident year aggregate excess of loss component of the Company's corporate
retrocessional program, with the amounts in both periods reflecting reserve
strengthening in select lines. In addition, ceded losses and LAE in 2001 also
reflects $119.4 million relating to the reinsurance transaction between the
Company and Bermuda Re noted earlier.
Contributing to the increase in incurred losses and LAE in 2001 from 2000 were a
200.7% ($141.0 million) increase in the U.S. Insurance operation principally
reflecting increased premium volume, a 41.5% ($131.9 million) increase in the
U.S. Reinsurance operation, principally reflecting losses in connection with the
September 11 attacks and tropical storm Alison and a 30.1% ($76.5 million)
increase in the Specialty Underwriting operation principally attributable to
increased premium volume in A&H medical stop loss business together with marine,
11
aviation and surety losses relating to the September 11 attacks, the Enron
bankruptcy and the Petrobras Oil Rig loss event. These increases were partially
offset by a 62.9% ($148.5 million) decrease in the International operation
principally attributable to $119.4 million relating to the reinsurance
transaction between the Company and Bermuda Re noted earlier, and to more
favorable loss experience. Incurred losses and LAE for each operation were also
impacted by variability relating to changes in the level of premium volume and
mix of business by class and type.
The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing
incurred losses and LAE by premiums earned, increased by 5.4 percentage points
to 80.9% in 2001 from 75.5% in 2000 reflecting the incurred losses and LAE
discussed above. The following table shows the loss ratios for each of the
Company's operating segments for 2001 and 2000. The loss ratios for all
operations were impacted by the expense factors noted above, the impact on ceded
premiums of adjustment premiums under the Company's corporate retrocessional
program.
OPERATING SEGMENT LOSS RATIOS
- --------------------------------------------------------------------------------
Segment 2001 2000
- --------------------------------------------------------------------------------
U.S. Reinsurance 90.4% 67.4%
U.S. Insurance 71.8% 69.2%
Specialty Underwriting 89.0% 84.0%
International 51.5% 82.3%
Underwriting expenses increased by 41.3% to $448.9 million in 2001 from $317.7
million in 2000. Commission, brokerage, taxes and fees increased by $126.2
million, principally reflecting increases in premium volume and changes in the
mix of business. In addition, in 2000, the Company's reassessment of the
expected losses on a multi-year reinsurance treaty led to a $33.8 million
decrease in contingent commissions with a corresponding increase to losses.
Other underwriting expenses increased by $5.0 million as the Company has
expanded its business volume and operations. Contributing to the underwriting
expense increase were a 122.7% ($45.6 million) increase in the U.S. Insurance
operation, mainly relating to the increased premium volume, a 70.8% ($68.0
million) increase in the U.S. Reinsurance operation, which included the impact
of the contingent commission adjustment noted above and a 22.5% ($19.8 million)
increase in the Specialty operation. These increases were partially offset by a
0.2% ($1.9 million) decrease in the International operation. Except as noted,
the changes for each operation's expenses principally resulted from changes in
commission expenses related to changes in premium volume and business mix by
class and type and, in some cases, the underwriting performance of the
underlying business. The Company's expense ratio, which is calculated by
dividing underwriting expenses by premiums earned, increased by 6.4 percentage
points to 33.7% in 2001 compared to 27.3% in 2000.
The Company's combined ratio, which is the sum of the loss and expense ratios,
increased by 11.8 percentage points to 114.6% in 2001 compared to 102.8% in
2000. The following table shows the combined ratios for each of the Company's
operating segments for 2001 and 2000. The combined ratios for all operations
were impacted by the loss and expense ratio variability noted above as well as
by the impact on ceded premiums of adjustment premiums under the Company's
corporate retrocessional program and, for the International operation, the
effect on the expense ratio related to the ceded premium associated with the
reinsurance transaction between the Company and Bermuda Re noted earlier.
12
OPERATING SEGMENT COMBINED RATIOS
- --------------------------------------------------------------------------------
Segment 2001 2000
- --------------------------------------------------------------------------------
U.S. Reinsurance 123.3% 88.0%
U.S. Insurance 99.9% 105.8%
Specialty Underwriting 118.0% 113.1%
International 106.2% 115.4%
INVESTMENTS. Net investment income decreased by 0.2% to $265.9 million in 2001
from $271.4 million in 2000, principally reflecting the effect of investing the
$303.8 million of cash flow from operations in 2001, offset by the lower
interest rate environment and increased interest expense on funds held relating
to the utilization of the 1999 and 2001 accident year aggregate excess of loss
elements of the corporate retrocessional program. The following table shows a
comparison of various investment yields as of December 31, 2001 and 2000,
respectively, and for the periods then ended.
2001 2000
-------------------------
Imbedded pre-tax yield of cash and
invested assets at end of period 6.0% 6.7%
Imbedded after-tax yield of cash and
invested assets at end of period 4.6% 5.0%
Annualized pre-tax yield on average
cash and invested assets 6.2% 6.5%
Annualized after-tax yield on average
cash and invested assets 4.7% 5.0%
Net realized capital losses were $15.7 million in 2001, reflecting realized
capital losses on the Company's investments of $45.5 million, which includes
$3.1 million relating to write-downs in the value of securities deemed to be
other than temporary, partially offset by $29.8 million of realized capital
gains, compared to realized capital gains of $0.3 million in 2000. The net
realized capital gains in 2000 reflected realized capital gains of $30.3
million, which were partially offset by $30.0 million of realized capital
losses. The net realized capital losses for 2001 allowed the Company to
recapture taxes paid on net realized capital gains in prior periods. The
realized capital gains in 2001 and 2000 arose mainly from activity in the
Company's equity portfolio. The realized capital losses in 2001 and 2000 arose
mainly from activity in the Company's fixed maturity portfolios.
Interest expense was $46.0 million for 2001 compared to $39.4 million in 2000.
Interest expense for 2001 reflects $38.9 million relating to the Company's
senior notes issued on March 14, 2000 and $7.1 million relating to the company's
borrowing under its revolving credit facility. Interest expense for 2000
reflects $30.9 million relating to the Company's issuance of senior notes and
$8.5 million relating to the Company's borrowing under its revolving credit
facility.
Other income was $26.6 million in 2001 compared to $3.3 million in 2000. Other
income for 2001 includes $25.9 million arising from a non-recurring receipt of
shares in connection with the demutualization of a former insurance company
client, which issued annuities, owned by the Company, in connection with certain
claim settlement transactions. In addition, other income for 2001 includes
foreign exchange gains as well as financing fees from Everest Security, offset
by the amortization of deferred expenses relating to the Company's issuance of
13
senior notes. Significant contributors to other income for 2000 were foreign
exchange gains as well as financing fees from Everest Security, partially offset
by net derivative expense and the amortization of deferred expenses relating to
Holdings' issuance of senior notes. The foreign exchange gains and losses are
attributable to fluctuations in foreign currency exchange rates.
During 2000, the Company added to its product portfolio a credit default swap,
which it no longer offers, that has characteristics which allow this transaction
to be analyzed using approaches consistent with those used in the Company's
other operations. This product meets the definition of a derivative under
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"). Net derivative expense from this
transaction in 2001 was $7.0 million, principally attributable to credit default
losses relating to the Enron bankruptcy.
INCOME TAXES. The Company generated income tax benefits of $9.2 million in 2001
compared to income tax expense of $43.8 million in 2000. This tax benefit
primarily resulted from the impact of losses relating to the September 11
attacks, the Enron bankruptcy and realized capital losses recognized in 2001,
which reduced taxable income, partially offset by the impact of income tax
expense relating to the non-recurring receipt of shares in connection with a
former client's demutualization.
NET INCOME. Net income was $38.3 million in 2001 compared to $158.5 million in
2000. This decrease generally reflects the losses attributable to the September
11 attacks and the Enron bankruptcy, partially offset by improved investment
results and the non-recurring receipt of shares in connection with a former
client's demutualization.
SAFE HARBOR DISCLOSURE
This report contains forward-looking statements within the meaning of the U.S.
federal securities laws. The Company intends these forward-looking statements to
be covered by the safe harbor provisions for forward-looking statements in the
federal securities laws. In some cases, these statements can be identified by
the use of forward-looking words such as "may", "will", "should", "could",
"anticipate", "estimate", "expect", "plan", "believe", "predict", "potential"
and "intend". Forward-looking statements contained in this report include
information regarding the Company's reserves for losses and LAE and estimates of
the Company's catastrophe exposure. Forward-looking statements only reflect the
Company's expectations and are not guarantees of performance. These statements
involve risks, uncertainties and assumptions. Actual events or results may
differ materially from the Company's expectations. Important factors that could
cause actual events or results to be materially different from the Company's
expectations include those discussed below under the caption "Risk Factors". The
Company undertakes no obligation to update or revise publicly any
forward-looking statements, whether as a result of new information, future
events or otherwise.
RISK FACTORS
The following risk factors, in addition to the other information provided in
this report, should be considered when evaluating the Company. The risks and
uncertainties described below are not the only ones the Company faces. There may
be additional risks and uncertainties. If any of the following risks actually
occur, the Company's business, financial condition or results of operations
could be materially and adversely affected and the trading price of the
Company's common shares could decline significantly.
THE COMPANY'S RESULTS MAY FLUCTUATE AS A RESULT OF FACTORS GENERALLY AFFECTING
THE INSURANCE AND REINSURANCE INDUSTRY.
The results of companies in the insurance and reinsurance industry historically
have been subject to significant fluctuations and uncertainties. Factors that
14
affect the industry in general could also cause the Company's results to
fluctuate. The industry's profitability can be affected significantly by:
o fluctuations in interest rates, inflationary pressures and other changes
in the investment environment, which affect returns on invested capital
and may impact the ultimate payout of loss amounts;
o rising levels of actual costs that are not known by companies at the
time they price their products;
o volatile and unpredictable developments, including weather-related and
other natural catastrophes;
o events like the September 11, 2001 attacks, which affect the insurance
and reinsurance markets generally;
o changes in reserves resulting from different types of claims that may
arise and the development of judicial interpretations relating to the
scope of insurers' liability; and
o the overall level of economic activity and the competitive environment
in the industry.
IF THE COMPANY'S LOSS RESERVES ARE INADEQUATE TO MEET ITS ACTUAL LOSSES, THE
COMPANY'S NET INCOME WOULD BE REDUCED OR IT COULD INCUR A LOSS.
The Company is required to maintain reserves to cover its estimated ultimate
liability of losses and loss adjustment expenses for both reported and
unreported claims incurred. These reserves are only estimates of what the
Company thinks the settlement and administration of claims will cost based on
facts and circumstances known to the Company. Because of the uncertainties that
surround estimating loss reserves and loss adjustment expenses, the Company
cannot be certain that ultimate losses will not exceed these estimates of losses
and loss adjustment reserves. If the Company's reserves are insufficient to
cover its actual losses and loss adjustment expenses, the Company would have to
augment its reserves and incur a charge to its earnings. These charges could be
material. The difficulty in estimating the Company's reserves is increased
because the Company's loss reserves include reserves for potential asbestos and
environmental liabilities. Asbestos and environmental liabilities are especially
hard to estimate for many reasons, including the long waiting periods between
exposure and manifestation of any bodily injury or property damage, difficulty
in identifying the source of the asbestos or environmental contamination, long
reporting delays and difficulty in properly allocating liability for the
asbestos or environmental damage.
THE COMPANY'S INABILITY TO ASSESS UNDERWRITING RISK ACCURATELY COULD REDUCE ITS
NET INCOME.
The Company's success is dependent on its ability to assess accurately the risks
associated with the businesses on which the risk is retained. If the Company
fails to assess accurately the risks it retains, the Company may fail to
establish appropriate premium rates and the Company's reserves may be inadequate
to cover its losses, requiring augmentation of the Company's reserves, which in
turn, could reduce the Company's net income.
DECREASES IN RATES FOR PROPERTY AND CASUALTY REINSURANCE AND INSURANCE COULD
REDUCE THE COMPANY'S NET INCOME.
15
The Company primarily writes property and casualty reinsurance and insurance.
The property and casualty industry historically has been highly cyclical. Rates
for property and casualty reinsurance and insurance are influenced primarily by
factors that are outside of the Company's control. Any significant decrease in
the rates for property and casualty insurance or reinsurance could reduce the
Company's net income.
IF RATING AGENCIES DOWNGRADE THEIR RATINGS OF THE COMPANY'S INSURANCE COMPANY
SUBSIDIARIES, THE COMPANY'S FUTURE PROSPECTS FOR GROWTH AND PROFITABILITY COULD
BE SIGNIFICANTLY AND ADVERSELY AFFECTED.
The Company's insurance company subsidiaries, other than Mt. McKinley, currently
hold an A+ ("Superior") financial strength rating from A.M. Best Company, an AA-
("Very Strong") financial strength rating from Standard & Poor's Ratings
Services and an Aa3 ("Excellent") financial strength rating from Moody's
Investors Service, Inc. Financial strength ratings are used by insurers and
reinsurance and insurance intermediaries as an important means of assessing the
financial strength and quality of reinsurers. In addition, the rating of a
company purchasing reinsurance may be adversely affected by an unfavorable
rating or the lack of a rating of its reinsurer. A downgrade or withdrawal of
any of these ratings might adversely affect the Company's ability to market its
insurance products and would have a significant and adverse effect on its future
prospects for growth and profitability.
THE COMPANY'S REINSURERS MAY NOT SATISFY THEIR OBLIGATIONS.
The Company is subject to credit risk with respect to its reinsurers because the
transfer of risk to a reinsurer does not relieve the Company of its liability to
the insured. In addition, reinsurers may be unwilling to pay the Company even
though they are able to do so. The failure of one or more of the Company's
reinsurers to honor their obligations in a timely fashion would impact the
Company's cash flow and reduce its net income and could cause the Company to
incur a significant loss.
IF THE COMPANY IS UNABLE TO PURCHASE REINSURANCE AND TRANSFER RISK TO
REINSURERS, ITS NET INCOME COULD BE REDUCED OR THE COMPANY COULD INCUR A LOSS.
The Company attempts to limit its risk of loss by purchasing reinsurance to
transfer a portion of the risks it assumes. The availability and cost of
reinsurance is subject to market conditions, which are outside of the Company's
control. As a result, the Company may not be able to successfully purchase
reinsurance and transfer risk through reinsurance arrangements. A lack of
available reinsurance might adversely affect the marketing of the Company's
programs and/or force the Company to retain all or a part of the risk that
cannot be reinsured. If the Company were required to retain these risks and
ultimately pay claims with respect to these risks, the Company's net income
could be reduced or the Company could incur a loss.
THE COMPANY'S INDUSTRY IS HIGHLY COMPETITIVE AND THE COMPANY MAY NOT BE ABLE TO
COMPETE SUCCESSFULLY IN THE FUTURE.
The Company's industry is highly competitive and has experienced severe price
competition over the last several years. The Company competes in the United
States and international markets with domestic and international insurance
companies. Some of these competitors have greater financial resources than the
Company, have been operating for longer than the Company and have established
long-term and continuing business relationships throughout the industry, which
can be a significant competitive advantage. In addition, the Company expects to
face further competition in the future. The Company may not be able to compete
successfully in the future.
16
THE COMPANY IS DEPENDENT ON ITS KEY PERSONNEL.
The Company's success has been, and will continue to be, dependent on its
ability to retain the services of its existing key executive officers and to
attract and retain additional qualified personnel in the future. The loss of the
services of any of its key executive officers or the inability to hire and
retain other highly qualified personnel in the future could adversely affect the
Company's ability to conduct its business.
THE VALUE OF THE COMPANY'S INVESTMENT PORTFOLIO AND THE INVESTMENT INCOME IT
RECEIVES FROM THAT PORTFOLIO COULD DECLINE AS A RESULT OF MARKET FLUCTUATIONS
AND ECONOMIC CONDITIONS.
A significant portion of the Company's investment portfolio consists of fixed
income securities and a smaller portion consists of equity securities. Both the
fair market value of these assets and the investment income from these assets
fluctuate depending on general economic and market conditions. For example, the
fair market value of the Company's fixed income securities generally increases
or decreases in an inverse relationship with fluctuations in interest rates. The
fair market value of the Company's fixed income securities can also decrease as
a result of any downturn in the business cycle that causes the credit quality of
those securities to deteriorate. The net investment income that the Company
realizes from future investments in fixed income securities will generally
increase or decrease with interest rates. Interest rate fluctuations can also
cause net investment income from investments that carry prepayment risk, such as
mortgage-backed and other asset-backed securities, to differ from the income
anticipated from those securities at the time the Company bought them. Because
all of the Company's securities are classified as available for sale, changes in
the market value of the Company's securities are reflected in its financial
statements. Similar treatment is not available for liabilities. As a result, a
decline in the value of the securities in the Company's portfolio could reduce
its net income or cause the Company to incur a loss.
INSURANCE LAWS AND REGULATIONS RESTRICT THE COMPANY'S ABILITY TO OPERATE.
The Company is subject to extensive regulation under U.S., state and foreign
insurance laws. These laws limit the amount of dividends that can be paid to the
Company by its operating subsidiaries, impose restrictions on the amount and
type of investments that they can hold, prescribe solvency standards that must
be met and maintained by them and require them to maintain reserves. These laws
also require disclosure of material intercompany transactions and require prior
approval of certain "extraordinary" transactions. These "extraordinary"
transactions include declaring dividends from operating subsidiaries that exceed
statutory thresholds. These laws also generally require approval of changes of
control. The Company's failure to comply with these laws could subject it to
fines and penalties and restrict it from conducting business. The application of
these laws could affect the Company's liquidity and ability to pay dividends on
its common shares and could restrict the Company's ability to expand its
business operations through acquisitions involving the Company's insurance
subsidiaries.
FAILURE TO COMPLY WITH INSURANCE LAWS AND REGULATIONS COULD HAVE A MATERIAL
ADVERSE EFFECT ON THE COMPANY'S BUSINESS.
The Company cannot assure that it has or can maintain all required licenses and
approvals or that its business fully complies with the wide variety of
applicable laws and regulations or the relevant authority's interpretation of
the laws and regulations. In addition, some regulatory authorities have
relatively broad discretion to grant, renew or revoke licenses and approvals. If
the Company does not have the requisite licenses and approvals or do not comply
17
with applicable regulatory requirements, the insurance regulatory authorities
could preclude or temporarily suspend the Company from carrying on some or all
of its activities or monetarily penalize the Company. These types of actions
could have a material adverse effect on the Company's business.
THE COMPANY MAY EXPERIENCE EXCHANGE LOSSES IF IT DOES NOT MANAGE ITS FOREIGN
CURRENCY EXPOSURE PROPERLY.
The Company's functional currency is the United States dollar. However, the
Company writes a portion of its business and receives a portion of its premiums
in currencies other than United States dollars. The Company also maintains a
portion of its investment portfolio in investments denominated in currencies
other than United States dollars. Consequently, the Company may experience
exchange losses if its foreign currency exposure is not properly managed or
otherwise hedged. If the Company seeks to hedge its foreign currency exposure by
using forward foreign currency exchange contracts or currency swaps, the Company
will be subject to the risk that the counter parties to those arrangements will
fail to perform, or that those arrangements will not precisely offset the
Company's exposure.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET SENSITIVE INSTRUMENTS
The Securities and Exchange Commission Financial Reporting Release #48 requires
registrants to clarify and expand upon the existing financial statement
disclosure requirements for derivative financial instruments, derivative
commodity instruments, and other financial instruments (collectively, "market
sensitive instruments").
The Company's current investment strategy seeks to maximize after-tax income
through a high quality, diversified, taxable and tax-preferenced fixed maturity
portfolio, while maintaining an adequate level of liquidity. The Company's mix
of taxable and tax-preferenced investments is adjusted continuously, consistent
with its current and projected operating results, market conditions, and tax
position. The fixed maturities in the investment portfolio are comprised of
non-trading available for sale securities. Additionally, the Company invests in
equity securities, which it believes will enhance the risk-adjusted total return
of the investment portfolio. The Company has also engaged in a credit default
swap, the market sensitivity of which is believed to be immaterial.
The overall investment strategy considers the scope of present and anticipated
Company operations. In particular, estimates of the financial impact resulting
from non-investment asset and liability transactions, together with the
Company's capital structure and other factors, are used to develop a net
liability analysis. This analysis includes estimated payout characteristics for
which the investments of the Company provide liquidity. This analysis is
considered in the development of specific investment strategies for asset
allocation, duration, and credit quality. The change in overall market sensitive
risk exposure principally reflects the asset changes that took place during the
year together with minor changes in the underlying risk characteristics.
The $4.5 billion investment portfolio is comprised of fixed maturity securities
that are subject to interest rate risk and foreign currency rate risk, and
equity securities that are subject to equity price risk. The impact of these
risks in the investment portfolio is generally mitigated by changes in the value
of operating assets and liabilities and their associated income statement
impact.
18
Interest rate risk is the potential change in value of the fixed maturity
portfolio due to change in market interest rates. Further, it includes
prepayment risk in a declining interest rate environment on the $450.8 million
of the $4.3 billion fixed maturity portfolio, which consists of mortgage-backed
securities. Prepayment risk results from potential accelerated principal
payments that shorten the average life and thus, the expected yield of the
security.
The tables below display the potential impact of market value fluctuations and
after-tax unrealized appreciation on the fixed maturity portfolio as of December
31, 2001 and 2000 based on parallel 200 basis point shifts in interest rates up
and down in 100 basis point increments. For legal entities with a U.S. dollar
functional currency, this modeling was performed on each security individually.
To generate appropriate price estimates on mortgage-backed securities, changes
in prepayment expectations under different interest rate environments are taken
into account. For legal entities with a non-U.S. dollar functional currency, the
effective duration of the involved portfolio of securities was used as a proxy
for the market value change under the various interest rate change scenarios.
All amounts are in U.S. dollars and are presented in millions.
2001
INTEREST RATE SHIFT IN BASIS POINTS
- ------------------------------------------------------------------------------------------
-200 -100 0 100 200
- ------------------------------------------------------------------------------------------
Total Market Value $ 4,875.7 $ 4,578.3 $ 4,302.8 $ 4,043.8 $ 3,807.1
Market Value Change
from Base (%) 13.3% 6.4% 0.0% (6.0%) (11.5%)
Change in Unrealized
Appreciation After-tax
from Base ($) $ 372.4 $ 179.1 $ - $ (168.3) $ (322.2)
2000
INTEREST RATE SHIFT IN BASIS POINTS
- ------------------------------------------------------------------------------------------
-200 -100 0 100 200
- ------------------------------------------------------------------------------------------
Total Market Value $ 4,637.3 $ 4,384.1 $ 4,150.6 $ 3,923.7 $ 3,710.2
Market Value Change
from Base (%) 11.8% 5.6% 0.0% (5.5%) (10.6%)
Change in Unrealized
Appreciation After-tax
from Base ($) $ 316.4 $ 151.8 $ - $ (147.5) $ (286.3)
Foreign currency rate risk is the potential change in value, income, and cash
flow arising from adverse changes in foreign currency exchange rates. The
Company's foreign operations each maintain capital in the currency of the
country of its geographic location consistent with local regulatory guidelines.
Generally, the Company prefers to maintain the capital of its foreign operations
in U.S. dollar assets although this varies by regulatory jurisdiction in
accordance with market needs. Each foreign operation may conduct business in its
19
local currency as well as the currency of other countries in which it operates.
The primary foreign currency exposures are the Canadian Dollar, the British
Pound Sterling and the Euro for these foreign operations. The Company mitigates
foreign exchange exposure by a general matching of the currency and duration of
its assets to its corresponding operating liabilities. In accordance with
Financial Accounting Standards Board Statement No. 52, the Company translates
the assets, liabilities and income of non-U.S. dollar functional currency legal
entities to the U.S. dollar. This translation amount is reported as a component
of other comprehensive income. The primary functional foreign currency exposures
are the Canadian Dollar, the Belgian Franc and the British Pound Sterling for
these foreign operations.
The tables below display the potential impact of a parallel 20% increase and
decrease in foreign exchange rates on the valuation of invested assets subject
to foreign currency exposure in 10% increments as of December 31, 2001 and 2000.
This analysis includes the after-tax impact of translation from transactional
currency to functional currency as well as the after-tax impact of translation
from functional currency to the U.S. dollar reporting currency. All amounts are
in U.S. dollars and are presented in millions.
2001
CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT
- ---------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ---------------------------------------------------------------------------------
Total After-tax Foreign
Exchange Exposure ($ 40.7) ($ 21.6) $ - $ 23.3 $ 47.9
2000
CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT
- ---------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ---------------------------------------------------------------------------------
Total After-tax Foreign
Exchange Exposure ($ 42.9) ($ 22.5) $ - $ 24.2 $ 49.5
Equity risk is the potential change in market value of the common stock and
preferred stock portfolios arising from changing equity prices. The Company
invests in index mutual funds and high quality common and preferred stocks that
are traded on the major exchanges in the United States. The primary objective in
managing the $67.5 million equity portfolio is to provide long-term capital
growth through market appreciation and income.
The tables below display the impact on market value and after-tax unrealized
appreciation of a 20% change in equity prices up and down in 10% increments as
of December 31, 2001 and 2000. All amounts are in U.S. dollars and are presented
in millions.
2001
CHANGE IN EQUITY VALUES IN PERCENT
- ----------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ----------------------------------------------------------------------------------
Market Value of the
Equity Portfolio $ 54.0 $ 60.7 $ 67.5 $ 74.2 $ 80.9
After-tax Change in
Unrealized Appreciation (8.8) (4.4) - 4.4 8.8
20
2000
CHANGE IN EQUITY VALUES IN PERCENT
- ----------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ----------------------------------------------------------------------------------
Market Value of the
Equity Portfolio $ 29.3 $ 33.0 $ 36.6 $ 40.3 $ 44.0
After-tax Change in
Unrealized Appreciation (4.8) (2.4) - 2.4 4.8
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information for this Item 10 is not required pursuant to General Instruction
I(2) of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information for this Item 11 is not required pursuant to General Instruction
I(2) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information for this Item 12 is not required pursuant to General Instruction
I(2) of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information for this Item 13 is not required pursuant to General Instruction
I(2) of Form 10-K.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND SCHEDULES
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
EXHIBITS
The exhibits listed on the accompanying Index to Exhibits on page E-1 are filed
as part of this report.
REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the last quarter of 2001.
21
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 on March 28, 2002.
EVEREST REINSURANCE HOLDINGS, INC.
By: /s/ JOSEPH V. TARANTO
-----------------------------------------
Joseph V. Taranto
(Chairman and Chief Executive Officer)
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.
/s/ JOSEPH V. TARANTO Chairman and Chief March 28, 2002
- ------------------------ Executive Officer and
Joseph V. Taranto Director (Principal
Executive Officer)
/s/ STEPHEN L. LIMAURO Executive Vice President, March 28, 2002
- ------------------------ Chief Financial Officer and
Stephen L. Limauro Director (Principal Financial
and Accounting Officer)
/s/ THOMAS J. GALLAGHER Director March 28, 2002
- ------------------------
Thomas J. Gallagher
22
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Pages
-----
Everest Reinsurance Holdings, Inc.
Report of Independent Accountants on Financial
Statements and Schedules F-2
---
Consolidated Balance Sheets at December 31, 2001 and 2000 F-3
---
Consolidated Statements of Operations and Comprehensive Income
for the years ended December 31, 2001, 2000 and 1999 F-4
---
Consolidated Statements of Changes in Stockholder's Equity
for the years ended December 31, 2001, 2000 and 1999 F-5
---
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 F-6
---
Notes to Consolidated Financial Statements F-7
---
Schedules
I Summary of Investments Other Than Investments in Related
Parties at December 31, 2001 S-1
---
II Condensed Financial Information of Registrant:
Balance Sheets as of December 31, 2001 and 2000 S-2
---
Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999 S-3
---
Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 S-4
---
III Supplementary Insurance Information as of
December 31, 2001 and 2000 and for the years
ended December 31, 2001, 2000 and 1999 S-5
---
IV Reinsurance for the years ended December 31, 2001,
2000 and 1999 S-6
---
Schedules other than those listed above are omitted for the reason that they are
not applicable or the information is otherwise contained in the Financial
Statements.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder
of Everest Reinsurance Holdings, Inc.
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Everest Reinsurance Holdings, Inc. and its subsidiaries at December 31, 2001 and
2000, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedules listed in the accompanying index
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements. These
financial statements and financial statement schedules are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
February 14, 2002
F-2
Part I - Item 1
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except par value per share)
December 31, December 31,
------------ ------------
2001 2000
------------ ------------
ASSETS:
Fixed maturities - available for sale,
at market value (amortized cost:
2001, $4,051,833; 2000, $3,793,279) $ 4,186,923 $ 3,879,335
Equity securities, at market value
(cost: 2001, $66,412; 2000, $22,395) 67,453 36,634
Short-term investments 115,850 271,216
Other invested assets 32,039 29,211
Cash 67,509 68,397
------------ ------------
Total investments and cash 4,469,774 4,284,793
Accrued investment income 64,972 64,508
Premiums receivable 454,548 393,229
Reinsurance receivables 1,471,357 996,689
Funds held by reinsureds 149,710 161,350
Deferred acquisition costs 114,948 92,478
Prepaid reinsurance premiums 48,100 58,196
Deferred tax asset 178,476 174,451
Other assets 60,496 37,622
------------ ------------
TOTAL ASSETS $ 7,012,381 $ 6,263,316
============ ============
LIABILITIES:
Reserve for losses and loss
adjustment expenses $ 4,274,335 $ 3,785,747
Unearned premium reserve 473,308 401,148
Funds held under reinsurance
treaties 308,811 110,464
Losses in the course of payment 83,360 101,995
Contingent commissions 3,345 9,380
Other net payable to reinsurers 132,252 60,332
Current federal income taxes (30,365) (8,210)
8.5% Senior notes due 3/15/2005 249,694 249,615
8.75% Senior notes due 3/15/2010 199,077 199,004
Revolving credit agreement
borrowings 105,000 235,000
Accrued interest on debt and
borrowings 11,944 12,212
Other liabilities 90,211 56,142
------------ ------------
Total liabilities 5,900,972 5,212,829
------------ ------------
Commitments and contingencies (Note 12)
STOCKHOLDER'S EQUITY:
Common stock, par value: $0.01; 200
million shares authorized; 1,000
shares issued in 2001 and 2000 - -
Additional paid-in capital 258,775 255,359
Accumulated other comprehensive
income, net of deferred income
taxes of $40.8 million in 2001
and deferred income taxes of
$30.4 million in 2000 76,003 56,747
Retained earnings 776,631 738,381
------------ ------------
Total stockholder's equity 1,111,409 1,050,487
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 7,012,381 $ 6,263,316
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Dollars in thousands, except per share amounts)
Years Ended December 31,
-------------------------------------------
2001 2000 1999
----------- ----------- -----------
REVENUES:
Premiums earned $ 1,333,501 $ 1,162,597 $ 1,071,451
Net investment income 265,924 271,389 252,999
Net realized capital
(loss) gain (15,745) 291 (16,760)
Net derivative (expense) (7,020) - -
Other income (expense) 26,565 3,341 (1,030)
----------- ----------- -----------
1,603,225 1,437,618 1,306,660
----------- ----------- -----------
CLAIMS AND EXPENSES:
Incurred losses and loss
adjustment expenses 1,079,219 878,241 771,570
Commission, brokerage,
taxes and fees 393,645 267,410 285,957
Other underwriting expenses 55,292 50,264 48,263
Non-recurring restructure
expenses - - 2,798
Interest expense on senior
notes 38,903 30,896 -
Interest expense on credit
facility 7,101 8,490 1,490
----------- ----------- -----------
1,574,160 1,235,301 1,110,078
----------- ----------- -----------
INCOME BEFORE TAXES 29,065 202,317 196,582
Income tax (benefit) expense (9,185) 43,822 38,521
----------- ----------- -----------
NET INCOME $ 38,250 $ 158,495 $ 158,061
=========== =========== ===========
Other comprehensive income
(loss), net of tax 19,256 73,448 (202,219)
----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ 57,506 $ 231,943 $ (44,158)
=========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDER'S EQUITY
(Dollars in thousands, except per share amounts)
Years Ended December 31,
-------------------------------------------
2001 2000 1999
----------- ----------- -----------
COMMON STOCK (shares outstanding):
Balance, beginning of period 1,000 46,457,817 49,989,204
Issued during the period - 8,500 17,400
Treasury stock acquired during
the period - (650,400) (3,554,047)
Treasury stock reissued during
the period - 1,780 5,260
Common stock retired during the
period - (45,817,697) -
Issued during the period - 1,000 -
----------- ----------- -----------
Balance, end of period 1,000 1,000 46,457,817
=========== =========== ===========
COMMON STOCK (par value):
Balance, beginning of period $ - $ 509 $ 509
Common stock retired during
the period - (509) -
----------- ----------- -----------
Balance, end of period - - 509
----------- ----------- -----------
ADDITIONAL PAID IN CAPITAL:
Balance, beginning of period 255,359 390,912 390,559
Retirement of treasury stock
during the period - (138,546) -
Common stock issued during
the period 3,416 2,339 317
Treasury stock reissued
during period - (2) 36
Contribution from subsidiary - 198 -
Common stock retired during
the period - 458 -
----------- ----------- -----------
Balance, end of period 258,775 255,359 390,912
----------- ----------- -----------
UNEARNED COMPENSATION:
Balance, beginning of period - (109) (240)
Net increase during the period - 109 131
----------- ----------- -----------
Balance, end of period - - (109)
----------- ----------- -----------
ACCUMULATED OTHER COMPREHENSIVE
INCOME, NET OF DEFERRED INCOME
TAXES:
Balance, beginning of period 56,747 (16,701) 185,518
Net increase (decrease) during
the period 19,256 73,448 (202,219)
----------- ----------- -----------
Balance, end of period 76,003 56,747 (16,701)
----------- ----------- -----------
RETAINED EARNINGS:
Balance, beginning of period 738,381 1,074,941 928,500
Net income 38,250 158,495 158,061
Restructure adjustments - (55) -
Dividends paid to parent - (495,000) (11,620)
----------- ----------- -----------
Balance, end of period 776,631 738,381 1,074,941
----------- ----------- -----------
TREASURY STOCK AT COST:
Balance, beginning of period - (122,070) (25,642)
Treasury stock retired
during the period - 138,454 -
Treasury stock acquired
during period - (16,426) (96,551)
Treasury stock reissued
during period - 42 123
----------- ----------- -----------
Balance, end of period - - (122,070)
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY,
END OF PERIOD $ 1,111,409 $ 1,050,486 $ 1,327,482
=========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31,
-------------------------------------------
2001 2000 * 1999
----------- ----------- -----------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income $ 38,250 $ 158,495 $ 158,061
Adjustments to reconcile net
income to net cash provided
by operating activities net
of effects from the purchase
of Mt. McKinley Insurance
Company
(Increase) in premiums
receivable (62,901) (101,894) (36,179)
Decrease in funds held by
reinsureds, net 209,558 29,135 23,007
(Increase) decrease in
reinsurance receivables (476,736) (173,954) 239,763
(Increase) in deferred tax asset (15,968) (16,247) (17,169)
Increase (decrease) in reserve
for losses and loss adjustment
expenses 506,128 827 (133,706)
Increase in unearned premiums 73,201 95,076 25,077
Decrease (increase) in other
assets and liabilities 22,179 (16,887) (67,106)
Non cash compensation expense - 109 131
Accrual of bond discount/
amortization of bond premium (5,836) (7,553) (5,203)
Amortization of underwriting
discount on senior notes 152 112 -
Restructure adjustment - (55) -
Realized capital losses (gains) 15,745 (291) 16,760
----------- ----------- -----------
Net cash provided by (used in)
operating activities 303,772 (33,127) 203,436
----------- ----------- -----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Proceeds from fixed maturities
matured/called - available
for sale 265,316 181,381 205,669
Proceeds from fixed maturities
sold - available for sale 470,561 730,589 665,873
Proceeds from equity
securities sold 33,373 49,556 69,397
Proceeds from other invested
assets sold 47 - 181
Cost of fixed maturities
acquired - available for sale (1,036,759) (1,174,662) (990,369)
Cost of equity securities
acquired (64,267) (2,732) (16,643)
Cost of other invested assets
acquired (1,497) (1,698) (23,109)
Net sales (purchases) of
short-term securities 156,735 (205,524) (38,200)
Net increase (decrease) in
unsettled securities
transactions 1,595 (955) (47)
Payment for purchase of Mt.
McKinley Insurance Company,
net of cash acquired - 349,743 -
----------- ----------- -----------
Net cash (used in) investing
activities (174,896) (74,302) (127,248)
----------- ----------- -----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Acquisition of treasury stock
net of reissuances - (16,478) (96,392)
Common stock issued during
the period 3,416 2,288 317
Dividends paid to stockholders - (495,000) (11,620)
Proceeds from issuance of
senior notes - 448,507 -
Borrowings on revolving credit
agreement 22,000 176,000 59,000
Repayments on revolving credit
agreement (152,000) - -
Contribution from subsidiary - 198 -
----------- ----------- -----------
Net cash (used in) provided
by financing activities (126,584) 115,515 (48,695)
----------- ----------- -----------
EFFECT OF EXCHANGE RATE
CHANGES ON CASH (3,180) (1,916) (4,592)
----------- ----------- -----------
Net (decrease) increase in cash (888) 6,170 22,901
Cash, beginning of period 68,397 62,227 39,326
----------- ----------- -----------
Cash, end of period $ 67,509 $ 68,397 $ 62,227
=========== =========== ===========
Supplemental cash flow
information
Cash transactions:
Income taxes paid, net $ 24,370 $ 62,141 $ 59,586
Interest paid $ 46,120 $ 27,169 $ 1,384
Non-cash operating/investing
transaction:
Shares received from
demutualization $ 25,921 $ - $ -
Non-cash financing
transaction:
Issuance of common stock $ - $ 109 $ 131
* In the quarter ended September 30, 2000, the Company purchased all of the
capital stock of Mt. McKinley Insurance Company for $51,800. In conjunction
with the acquisition, the fair value of assets acquired was $679,672 and
liabilities was $627,872.
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2001, 2000 and 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BUSINESS AND BASIS OF PRESENTATION
Everest Re Group, Ltd. ("Group"), a Bermuda company with its principal executive
office in Barbados, was established in 1999 as a wholly-owned subsidiary of
Everest Reinsurance Holdings, Inc. ("Holdings"). On February 24, 2000, a
corporate restructuring was completed and Group became the new parent holding
company of Holdings. Holders of shares of common stock of Holdings automatically
became holders of the same number of common shares of Group. The "Company" means
Holdings and its subsidiaries, unless the context otherwise requires. The
Company, through its subsidiaries, principally provides property and casualty
reinsurance and insurance in the United States and internationally. The Company
is filing this report as a result of its public issuance of senior notes on
March 14, 2000. See also Note 5.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles in the United States of
America. The statements include the following domestic and foreign direct and
indirect subsidiaries of the Company: Everest Reinsurance Company ("Everest
Re"), Everest National Insurance Company ("Everest National"), Everest Indemnity
Insurance Company ("Everest Indemnity"), Everest Re Holdings, Ltd. ("Everest
Ltd."), a Bermuda domiciled successor company of Everest Re Ltd. (the assets of
which funded Everest Ltd. and which was formerly known as Everest Reinsurance
Ltd.), Everest Security Insurance Company ("Everest Security"), formerly
Southeastern Security Insurance Company, Everest Insurance Company of Canada
("Everest Canada"), Mt. McKinley Managers, L.L.C. ("Managers"), Workcare
Southeast, Inc. ("Workcare Southeast"), Workcare Southeast of Georgia, Inc.
("Workcare Georgia"), Workcare, Inc and Mt. McKinley Insurance Company ("Mt.
McKinley"). All amounts are reported in U.S. dollars.
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities (and disclosure of contingent assets and liabilities) at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
B. INVESTMENTS
Fixed maturity investments are all classified as available for sale. Unrealized
appreciation and depreciation, as a result of temporary changes in market value
during the period, are reflected in shareholders' equity, net of income taxes in
"accumulated other comprehensive income". Equity securities are carried at
market value with unrealized appreciation or depreciation, as a result of
temporary changes in market value during the period, are reflected in
shareholders' equity, net of income taxes in "accumulated other comprehensive
income". Unrealized losses on fixed maturities and equity securities, which are
deemed other than temporary, are charged to net income as realized capital
losses. Short-term investments are stated at cost, which approximates market
value. Realized gains or losses on sale of investments are determined on the
basis of identified cost. For non-publicly traded securities, market prices are
determined through the use of pricing models that evaluate securities relative
to the U.S. Treasury yield curve, taking into account the issue type, credit
quality and cash flow characteristics of each security. For publicly traded
securities, market value is based on quoted market prices. Retrospective
adjustments are employed to recalculate the values of loan-backed and
asset-backed securities. Each acquisition lot is reviewed to recalculate the
effective yield. The recalculated effective yield is used to derive a book value
as if the new yield were applied at the time of acquisition. Outstanding
principal factors from the time of acquisition to the adjustment date are used
F-7
to calculate the prepayment history for all applicable securities. Conditional
prepayment rates, computed with life to date factor histories and weighted
average maturities, are used to affect the calculation of projected and
prepayments for pass through security types. Other invested assets include
limited partnerships and rabbi trusts. Limited partnerships are valued pursuant
to the equity method of accounting, which management believes approximates
market value. The Supplemental Retirement Plan rabbi trust is carried at market
value, while the Deferred Compensation Plan rabbi trust and Supplemental Savings
Plan rabbi trust are carried at cost, which approximates market value. Cash
includes cash and bank time deposits with original maturities of ninety days or
less.
C. UNCOLLECTIBLE REINSURANCE BALANCES
The Company provides reserves for uncollectible reinsurance balances based on
management's assessment of the collectibility of the outstanding balances. Such
reserves were $34.1 million at December 31, 2001 and $27.9 million at December
31, 2000. See also Note 8.
D. DEFERRED ACQUISITION COSTS
Acquisition costs, consisting principally of commissions and brokerage expenses
and certain premium taxes and fees associated with the Company's reinsurance and
insurance business incurred at the time a contract or policy is issued, are
deferred and amortized over the period in which the related premiums are earned,
generally one year. Deferred acquisition costs are limited to their estimated
realizable value based on the related unearned premiums, anticipated claims and
claim expenses and anticipated investment income. Deferred acquisition costs
amortized to income (expense) were $22.7 million, $10.1 million and $12.4
million in 2001, 2000 and 1999, respectively.
E. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for unpaid losses and loss adjustment expenses ("LAE") is based on
individual case estimates and reports received from ceding companies. A
provision is included for losses and LAE incurred but not reported ("IBNR")
based on past experience. A provision is also included for certain potential
liabilities relating to asbestos and environmental exposures, which liabilities
cannot be estimated with traditional reserving techniques. See also Note 12. The
reserves are reviewed continually and any changes in estimates are reflected in
earnings in the period the adjustment is made. Management believes that adequate
provision has been made for the Company's losses and LAE. Loss and LAE reserves
are presented gross of reinsurance receivables and incurred losses and LAE are
presented net of ceded reinsurance.
Accruals for contingent commission liabilities are established for reinsurance
contracts that provide for the stated commission percentage to increase or
decrease based on the loss experience of the contract. Changes in the estimated
liability for such arrangements are recorded as contingent commissions. Accruals
for contingent commission liabilities are determined through the review of the
contracts that have these adjustable features and are estimated based on
expected loss and loss adjustment expenses.
F. PREMIUM REVENUES
Premiums written are earned ratably over the periods of the related insurance
and reinsurance contracts or policies. Unearned premium reserves are established
to cover the remainder of the unexpired contract period. Such reserves are
established based upon reports received from ceding companies or computed using
F-8
pro rata methods based on statistical data. Written and earned premiums, and the
related costs, which have not yet been reported to the Company are estimated and
accrued. Premiums are net of ceded reinsurance.
G. INCOME TAXES
The Company and its wholly-owned subsidiaries file a consolidated U.S. federal
income tax return. Group and its other subsidiaries, not included in Holdings'
consolidated tax return, file separate company U.S. federal income tax returns,
where required. Deferred income taxes have been recorded to recognize the tax
effect of temporary differences between the financial reporting and income tax
bases of assets and liabilities.
H. FOREIGN CURRENCY TRANSLATION
Assets and liabilities relating to foreign operations are translated into U.S.
dollars at the exchange rates in effect at the balance sheet date; revenues and
expenses are translated into U.S. dollars using average exchange rates. Gains
and losses resulting from translating foreign currency financial statements, net
of deferred income taxes, are excluded from net income and accumulated in
stockholder's equity.
I. UNUSUAL LOSS EVENTS
As a result of the terrorist attacks at the World Trade Center, the Pentagon and
on various airlines on September 11, 2001 (collectively the "September 11
attacks"), the Company incurred pre-tax losses, based on an estimate of ultimate
exposure developed through a review of its coverages, which totaled $213.2
million gross of reinsurance and $55.0 million net of reinsurance. Associated
with this reinsurance were $60.0 million of pre-tax charges, predominantly from
adjustment premiums, resulting in a total pre-tax loss from the September 11
attacks of $115.0 million. After tax recoveries relating specifically to this
unusual loss event, the net loss from the September 11 attacks totaled $75.0
million. Over 90% of the losses ceded were to treaties where the reinsurers'
obligations are secured, which in the Company's opinion eliminates material
reinsurance collection risk.
As a result of the Enron bankruptcy, the Company has incurred losses, after-tax
and reinsurance, amounting to $18.6 million. This unusual loss reflects all of
the Company's exposures, including underwriting, credit and investment.
J. ACQUISITIONS
On September 19, 2000, the Company acquired Mt. McKinley, f/k/a Gibraltar
Casualty Company, for $51.8 million. Mt. McKinley is a run-off property and
casualty insurer in the United States. No goodwill was generated in the
transaction. The acquisition was recorded using the purchase method of
accounting. Accordingly, the December 31, 2000 consolidated financial statements
of the Company include the results of Mt. McKinley from September 19, 2000.
In connection with the acquisition of Mt. McKinley, Prudential Property and
Casualty Insurance Company ("Prupac"), a subsidiary of The Prudential Insurance
Company of America ("The Prudential"), provided reinsurance to Mt. McKinley
covering 80% ($160.0 million) of the first $200.0 million of any adverse
development of Mt. McKinley's reserves as of September 19, 2000 and The
Prudential guaranteed Prupac's obligation to Mt. McKinley. The stop loss
reinsurance protection that was provided by Mt. McKinley at the time of the
Company's Initial Public Offering ("IPO") and other reinsurance contracts
F-9
between Mt. McKinley and Everest Re remain in effect following the acquisition.
However, these contracts have become transactions with affiliates, with the
financial impact eliminated in consolidation.
The following unaudited pro forma information assumes the acquisition of Mt.
McKinley occurred at the beginning of each year presented. The unaudited pro
forma financial information is presented for informational purposes only and is
not necessarily indicative of the operating results that would have occurred had
the acquisition been consummated at the beginning of each year presented, nor is
it necessarily indicative of future operating results.
Years ended December 31,
------------------------------------
2000 1999
(Dollars in thousands) (Unaudited)
------------------------------------
Revenues $ 1,457,284 $ 1,336,672
Net income 161,079 82,919
The Company also completed the acquisition of Everest Security during 2000, a
United States property and casualty company whose primary business is
non-standard auto. The purchase price of the acquisition was approximately $10.1
million. Goodwill of $3.0 million was generated as a result of the acquisition
and was recorded using the purchase method of accounting.
K. SEGMENTATION
The Company, through its subsidiaries, operates in four segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting and International. See also
Note 14.
M. CODIFICATION
The NAIC has published a codification of statutory accounting principles, which
has been adopted by the states of domicile of the Company's U.S. operating
subsidiaries with an effective date of January 1, 2001. On January 1, 2001,
significant changes to the statutory-basis of accounting became effective. The
cumulative effect of these changes has been recorded as a direct adjustment to
statutory surplus.
M. DERIVATIVES
Effective January 1, 2001, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities". SFAS No. 133 requires that all derivative instruments be recognized
as either assets or liabilities on the balance sheet and measured at their fair
value. Gains or losses from changes in the derivative values are accounted for
based on how the derivative is used and whether it qualifies for hedge
accounting.
N. FUTURE APPLICATION OF ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142,
"Goodwill and Other Intangible Assets". SFAS 142 establishes new accounting and
reporting standards for acquired goodwill and other intangible assets. It
requires that an entity determine if the goodwill or other intangible asset has
an indefinite useful life or a finite useful life. Those with indefinite useful
lives will not be subject to amortization and must be tested annually for
impairment. Those with finite useful lives will be subject to amortization and
must be tested annually for impairment. This statement is effective for all
F-10
fiscal quarters of all fiscal years beginning after December 15, 2001. The
implementation of this statement will not have a material impact on the
financial position, results of operations or cash flows of the Company.
2. INVESTMENTS
The amortized cost, market value, and gross unrealized appreciation and
depreciation of fixed maturity investments and equity securities are presented
in the tables below:
(dollar values in thousands) Amortized Unrealized Unrealized Market
Cost Appreciation Depreciation Value
----------------------------------------------------------
As of December 31, 2001
Fixed maturities - available for sale
U.S. Treasury securities and
obligations of U.S. government
agencies and corporations $ 114,046 $ 5,242 $ 127 $ 119,161
Obligations of U.S. states and
political subdivisions 1,762,867 78,427 2,768 1,838,526
Corporate securities 1,295,371 41,342 31,717 1,304,996
Mortgage-backed securities 432,330 18,663 237 450,756
Foreign government securities 194,920 18,145 123 212,942
Foreign corporate securities 252,299 10,098 1,855 260,542
----------------------------------------------------------
Total fixed maturities $ 4,051,833 $ 171,917 $ 36,827 $ 4,186,923
==========================================================
Equity securities $ 66,412 $ 1,480 $ 439 $ 67,453
==========================================================
As of December 31, 2000
Fixed maturities - available for sale
U.S. Treasury securities and
obligations of U.S. government
agencies and corporations $ 133,053 $ 4,777 $ - $ 137,830
Obligations of U.S. states and
political subdivisions 1,514,099 85,261 423 1,598,937
Corporate securities 1,198,216 25,865 66,089 1,157,992
Mortgage-backed securities 449,438 13,932 495 462,875
Foreign government securities 211,711 17,137 130 228,718
Foreign corporate securities 286,762 7,735 1,514 292,983
----------------------------------------------------------
Total fixed maturities $ 3,793,279 $ 154,707 $ 68,651 $ 3,879,335
==========================================================
Equity securities $ 22,395 $ 14,266 $ 27 $ 36,634
==========================================================
F-11
The amortized cost and market value of fixed maturities are shown in the
following table by contractual maturity. Mortgage-backed securities generally
are more likely to be prepaid than other fixed maturities. As the stated
maturity of such securities may not be indicative of actual maturities, the
total for mortgage-backed securities is shown separately.
December 31, 2001,
---------------------------
Amortized Market
(dollar values in thousands) Cost Value
----------- -----------
Fixed maturities - available for sale
Due in one year or less $ 82,047 $ 83,307
Due after one year through five years 777,004 815,642
Due after five years through ten years 1,163,696 1,204,077
Due after ten years 1,596,756 1,633,141
Mortgage-backed securities 432,330 450,756
----------- -----------
Total $ 4,051,833 $ 4,186,923
=========== ===========
Proceeds from sales of fixed maturity investments during 2001, 2000 and 1999
were $470.6 million, $730.6 million and $665.9 million, respectively. Gross
gains of $16.4 million, $8.7 million and $0.9 million, and gross losses of $42.4
million, $27.7 million and $28.5 million were realized on those fixed maturity
sales during 2001, 2000 and 1999, respectively. Proceeds from sales of equity
security investments during 2001, 2000 and 1999 were $33.4 million, $49.6
million and $69.4 million, respectively. Gross gains of $13.4 million, $20.6
million and $16.3 million and gross losses of $0.1 million, $1.4 million and
$5.4 million were realized on those equity sales during 2001, 2000 and 1999,
respectively.
The changes in net unrealized gains (losses) of investments of the Company are
derived from the following sources:
Years Ended December 31,
----------------------------------------
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Increase (decrease) during the
period between the market value
and cost of investments carried
at market value, and deferred
tax thereon:
Equity securities $ (13,199) $ (26,229) $ (14,018)
Fixed maturities 49,033 141,403 (304,872)
Other invested assets 20 23 (42)
Deferred taxes (12,549) (40,319) 111,626
---------- ---------- ----------
Increase (decrease) in unrealized
appreciation, net of deferred
taxes, included in stockholder's
equity $ 23,305 $ 74,878 $ (207,306)
========== ========== ==========
F-12
The components of net investment income are presented in the table below:
Years Ended December 31,
-------------------------------------
(dollar values in thousands) 2001 2000 1999
--------- --------- ---------
Fixed maturities $ 270,570 $ 274,905 $ 256,067
Equity securities 896 1,198 3,796
Short-term investments 4,991 6,908 3,702
Other interest income 4,567 3,081 1,652
--------- --------- ---------
Total gross investment income 281,024 286,092 265,217
--------- --------- ---------
Interest on funds held 11,909 11,316 9,133
Other investment expenses 3,191 3,387 3,085
--------- --------- ---------
Total investment expenses 15,100 14,703 12,128
--------- --------- ---------
Total net investment income $ 265,924 $ 271,389 $ 252,999
========= ========= =========
The components of realized capital (losses) gains are presented in the table
below:
Years Ended December 31,
-------------------------------------
(dollar values in thousands) 2001 2000 1999
--------- --------- ---------
Fixed maturities $ (29,074) $ (18,967) $ (27,615)
Equity securities 13,326 19,260 10,836
Short-term investments 3 (2) 19
--------- --------- ---------
Total $ (15,745) $ 291 $ (16,760)
========= ========= =========
The net realized capital losses for 2001 include $3.1 million relating to
write-downs in the value of securities deemed to be other than temporary.
Securities with a carrying value amount of $260.9 million at December 31, 2001
were on deposit with various state or governmental insurance departments in
compliance with insurance laws.
During 2000, the Company entered into a credit swap derivative contract, which
provides credit default protection on a portfolio of referenced securities. Due
to changing credit market conditions and defaults, the Company recorded net
after-tax losses from this contract of $4.6 million in 2001 to reflect it at
fair value, with the 2001 losses principally attributable to the Company's
exposure to the Enron bankruptcy. As of December 31, 2001, the remaining maximum
after-tax net loss exposure under this contract is $2.4 million.
The Company's position in this contract is unhedged and is accounted for as a
derivative in accordance with SFAS 133. Accordingly, this contract is carried at
fair value with changes in fair value recorded in the statement of operations.
F-13
3. RESERVE FOR LOSSES AND LAE
Activity in the reserve for losses and LAE expenses is summarized as follows:
Years Ended December 31,
-----------------------------------------
(dollar values in thousands) 2001 2000 1999
----------- ----------- -----------
Reserves at January 1 $ 3,785,747 $ 3,646,992 $ 3,800,041
Less reinsurance recoverables 980,396 727,780 915,741
----------- ----------- -----------
Net balance at January 1 2,805,351 2,919,212 2,884,300
----------- ----------- -----------
Incurred related to:
Current year 1,074,053 870,454 806,930
Prior years 5,166 7,787 (35,360)
----------- ----------- -----------
Total incurred losses and LAE 1,079,219 878,241 771,570
----------- ----------- -----------
Paid related to:
Current year 387,100 318,673 252,407
Prior years 675,620 673,429 484,251
----------- ----------- -----------
Total paid losses and LAE 1,062,720 992,102 736,658
----------- ----------- -----------
Net balance at December 31 2,821,850 2,805,351 2,919,212
Plus reinsurance recoverables (1) 1,452,485 980,396 727,780
----------- ----------- -----------
Balance at December 31 $ 4,274,335 $ 3,785,747 $ 3,646,992
=========== =========== ===========
(1) Reinsurance recoverables for 2001 include $115,342 resulting from the loss
portfolio from Everest Re to Bermuda Re. In addition, reinsurance
recoverables for 2001 and 2000 include $453,777 and $491,572, respectively,
resulting from the loss portfolio transfer from Mt. McKinley to Bermuda Re.
See also Note 1J.
Prior year incurred losses increased by $5.2 million in 2001, increased by $7.8
million in 2000 and decreased by $35.4 million in 1999. These changes were the
result of normal reserve development inherent in the uncertainty in establishing
loss and LAE reserves, as well as the impact of foreign exchange rate
fluctuations on loss reserves and, for 1999, changes in the Company's
coinsurance in connection with stop loss reinsurance protection provided by Mt.
McKinley at the time of the Company's IPO of ($6.0) million. Although coverage
remains under this reinsurance, the acquisition of Mt. McKinley causes the
financial impact of any cession under this reinsurance to eliminate in
consolidation. See also Note 1J.
4. CREDIT LINE
On December 21, 1999, the Company entered into a three-year senior revolving
credit facility with a syndicate of lenders (the "Credit Facility"). First Union
National Bank is the administrative agent for the Credit Facility. The Credit
Facility will be used for liquidity and general corporate purposes and to
refinance existing debt under the Company's prior credit facility, which has
been terminated. The Credit Facility provides for the borrowing of up to $150.0
million with interest at a rate selected by the Company equal to either (1) the
Base Rate (as defined below) or (2) an adjusted London InterBank Offered Rate
("LIBOR") plus a margin. The Base Rate is the higher of the rate of interest
established by First Union National Bank from time to time as its prime rate or
the Federal Funds rate plus 0.5% per annum. On December 18, 2000, the Credit
Facility was amended to extend the borrowing limit to $235.0 million for a
period of 120 days, at which time the limit reverts back to $150.0 million. The
F-14
amount of margin and the fees payable for the Credit Facility depend upon the
Company's senior unsecured debt. Group has guaranteed all of the Company's
obligations under the Credit Facility.
The Credit Facility agreement requires Group to maintain a debt to capital ratio
of not greater than 0.35 to 1, Holdings to maintain a minimum interest coverage
ratio of 2.5 to 1 and Everest Re to maintain statutory surplus at $850.0 million
plus 25% of future aggregate net income and 25% of future aggregate capital
contributions.
As of December 31, 2001 and 2000, the Company had outstanding borrowings of
$105.0 million and $235.0 million, respectively. Interest expense incurred in
connection with these borrowings was $7.1 million, $8.5 million and $1.5 million
for the periods ending December 31, 2001, December 31, 2000 and December 31,
1999, respectively.
5. SENIOR NOTES
On March 14, 2000, the Company completed public offerings of $200.0 million
principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million
principal amount of 8.5% senior notes due March 15, 2005. During 2000, the net
proceeds of these offerings and additional funds were distributed by the Company
to Group. Interest expense incurred in connection with these senior notes was
$38.9 million and $30.9 million for the periods ending December 31, 2001 and
December 31, 2000, respectively.
6. OPERATING LEASE AGREEMENTS
The future minimum rental commitments, exclusive of cost escalation clauses, at
December 31, 2001 for all of the Company's operating leases with remaining
non-cancelable terms in excess of one year are as follows:
----------------------------
(dollar values in thousands)
----------------------------
2002 $ 4,364
2003 4,412
2004 4,353
2005 3,862
2006 3,996
Thereafter 15,560
----------------------------
Net commitments $ 36,547
============================
All of these leases, the expiration terms of which range from 2001 to 2010, are
for the rental of office space. Rental expense, net of sublease rental income,
was $5.6 million, $4.4 million and $4.2 million for 2001, 2000 and 1999,
respectively.
F-15
7. INCOME TAXES
The components of income taxes for the periods presented are as follows:
Years Ended December 31,
----------------------------------
(dollar values in thousands) 2001 2000 1999
-------- -------- --------
Current tax:
U.S. $ (529) $ 61,401 $ 53,076
Foreign 5,912 (289) 2,615
-------- -------- --------
Total current tax 5,383 61,112 55,691
Total deferred U.S. tax (benefit) (14,568) (17,290) (17,170)
-------- -------- --------
Total income tax (benefit) provision $ (9,185) $ 43,822 $ 38,521
======== ======== ========
A reconciliation of the U.S. federal income tax rate to the Company's effective
tax rate is as follows:
Years Ended December 31,
-------------------------------
2001 2000 1999
------- ------- -------
Federal income tax rate 35.0% 35.0% 35.0%
Increase (reduction) in
taxes resulting from:
Tax exempt income (95.9) (14.7) (17.5)
Other, net 29.3 1.4 2.1
------- ------- -------
Effective tax rate (31.6%) 21.7% 19.6%
======= ======= =======
Deferred income taxes reflect the tax effect of the temporary differences
between the value of assets and liabilities for financial statement purposes and
such values as measured by the U.S. tax laws and regulations. The principal
items making up the net deferred income tax asset are as follows:
December 31,
--------------------------
(dollar values in thousands) 2001 2000
---------- ----------
Deferred tax assets:
Reserve for losses and loss
adjustment expenses $ 226,532 $ 188,364
Unearned premium reserve 29,765 24,007
Foreign currency translation 6,848 4,670
Net operating loss carryforward 21,159 22,514
Other assets - 2,360
Net unrealized depreciation of
investments - -
---------- ----------
Total deferred tax assets 284,304 241,915
---------- ----------
Deferred tax liabilities:
Deferred acquisition costs 40,232 32,367
Net unrealized appreciation of
investments 64,598 35,097
Other liabilities 998 -
---------- ----------
Total deferred tax liabilities 105,828 67,464
---------- ----------
Net deferred tax assets $ 178,476 $ 174,451
========== ==========
F-16
The Company and its subsidiaries have total net operating loss carryforwards of
$43.6 million that expire during years 2002 - 2021. Management believes that it
is more likely than not that the Company will realize the benefits of its net
deferred tax assets and, accordingly, no valuation allowance has been recorded
for the periods presented.
Tax benefits of $3.4 million related to compensation expense deductions for
stock options exercised in 2001 are reflected in the change in stockholder's
equity in "additional paid in capital".
8. REINSURANCE
The Company utilizes reinsurance agreements to reduce its exposure to large
claims and catastrophic loss occurrences. These agreements provide for recovery
from reinsurers of a portion of losses and loss expenses under certain
circumstances without relieving the insurer of its obligation to the
policyholder. Losses and LAE incurred and earned premiums are after deduction
for reinsurance. In the event reinsurers were unable to meet their obligations
under reinsurance agreements, the Company would not be able to realize the full
value of the reinsurance recoverable balances. The Company may hold partial
collateral, including letters of credit, under these agreements. See also Note
1(C).
The Company purchases corporate level retrocessions covering the potential
accumulation of all exposures. For 1999, the Company purchased an accident year
aggregate excess of loss retrocession agreement which provided up to $175.0
million of coverage if Everest Re's consolidated statutory basis accident year
loss ratio exceeded a loss ratio attachment point provided in the contract for
the 1999 accident year. During 2000 and 2001, the Company ceded $70.0 million
and $105.0 million of losses, respectively, to this cover, reducing the limit
available under the contract to $0.0 million. For 2001, the Company purchased an
accident year aggregate excess of loss retrocession agreement which provided up
to $175.0 million of coverage if Everest Re's consolidated statutory basis
accident year loss ratio exceeded a loss ratio attachment point provided in the
contract for the 2001 accident year. During 2001, the Company ceded $164.0
million of losses to this cover, reducing the limit available under the contract
to $11.0 million.
In addition, the Company has coverage under an aggregate excess of loss
reinsurance agreement provided by Prudential Property and Casualty Insurance
Company of Indiana ("Prupac"), a wholly-owned subsidiary of The Prudential, in
connection with the Company's acquisition of Mt. McKinley in September 2000.
This agreement covers 80% or $160 million of the first $200 million of any
adverse loss reserve development on the carried reserves of Mt. McKinley at the
date of acquisition and reimburses the Company as such losses are paid by the
Company. There were $22.2 million of cessions under this reinsurance at December
31, 2001, reducing the limit available under the contract to $137.8 million.
In connection with the Mt. McKinley acquisition, Prupac also provided excess of
loss reinsurance for 100% of the first $8.5 million of loss with respect to
certain of Mt. McKinley's retrocessions and potentially uncollectible
reinsurance coverage. There were $2.5 million and $3.6 million of cessions under
this reinsurance during the periods ending December 31, 2000 and 2001,
respectively, reducing the limit available under the contract to $2.4 million.
Effective September 19, 2000, Mt. McKinley and Everest Reinsurance (Bermuda),
Ltd. ("Bermuda Re") entered into a loss portfolio transfer reinsurance
agreement, whereby Mt. McKinley transferred, for what management believes to be
arm's-length consideration, all of its net insurance exposures and reserves,
including allocated and unallocated loss adjustment expenses to Bermuda Re.
F-17
Effective October 1, 2001, Everest Re and Bermuda Re entered into a loss
portfolio transfer reinsurance agreement, whereby Everest Re transferred, for
what management believes to be arm's-length consideration, its Belgium branches'
net insurance exposures and reserves, including allocated and unallocated loss
adjustment expenses to Bermuda Re.
Written and earned premiums are comprised of the following:
Years Ended December 31,
-----------------------------------------
(dollar values in thousands) 2001 2000 1999
----------- ----------- -----------
Written premium
Direct $ 438,837 $ 224,177 $ 70,473
Assumed 1,410,963 1,149,848 1,071,344
Ceded (432,872) (166,704) (46,248)
----------- ----------- -----------
Net written premium $ 1,416,928 $ 1,207,321 $ 1,095,569
=========== =========== ===========
Earned premium
Direct $ 380,178 $ 138,982 $ 73,822
Assumed 1,396,211 1,145,142 1,042,921
Ceded (442,888) (121,527) (45,292)
----------- ----------- -----------
Net earned premium $ 1,333,501 $ 1,162,597 $ 1,071,451
=========== =========== ===========
The amounts deducted from losses and LAE incurred for net reinsurance recoveries
were $619.4 million, $173.1 million and $7.4 million for the years ended
December 31, 2001, 2000 and 1999, respectively. The net reinsurance recoveries
for 2001 include $119.4 million relating to the reinsurance transaction between
Everest Re and Bermuda Re noted earlier. The net reinsurance recoveries for 1999
were impacted by cessions to stop loss reinsurance provided by Mt. McKinley at
the time of the Company's IPO.
As of December 31, 2001, the Company carried as an asset $1,471.4 million in
reinsurance receivables with respect to losses ceded. Of this amount, $584.6
million, or 39.7%, was receivable from Bermuda Re, $339.0 million, or 23.0%, was
receivable from subsidiaries of London Reinsurance Group ("London Life") and
$145.0 million, or 9.9%, was receivable from Continental Insurance Company
("Continental"). As of December 31, 2000, the Company carried as an asset $996.7
million in reinsurance receivables with respect to losses ceded. Of this amount,
$491.6 million, or 49.3%, was receivable from Bermuda Re, $145.0 million, or
14.5%, was receivable from Continental Insurance Company ("Continental") and
$70.0 million, or 7.0%, was receivable from subsidiaries of London Reinsurance
Group ("London Life"). No other retrocessionaire accounted for more than 5% of
the Company's receivables. See also Note 3.
The Company's arrangements with Bermuda Re are secured through the use of trust
agreements. The Company's arrangements with London Life and Continental are
managed on a funds held basis, which means that the Company has not released
premium payments to the retrocessionaire but rather retains such payments to
secure obligations of the retrocessionaire, records them as a liability, credits
interest on the balances and reduces the liability account as payments become
due. As of December 31, 2001, such funds had reduced the Company's net exposure
to London Life to $158.9 million, 100% of which has been secured by letters of
credit, and its exposure to Continental to $67.9 million. As of December 31,
2000, such funds had reduced the Company's net exposure to Continental to $74.4
million, and its exposure to London Life to $33.5 million, 100% of which has
been secured by letters of credit.
F-18
9. COMPREHENSIVE INCOME
The components of comprehensive income for the periods ending December 31, 2001,
2000 and 1999 are shown in the following table:
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Net income $ 38,250 $ 158,495 $ 158,061
---------- ---------- ----------
Other comprehensive income,
before tax:
Foreign currency translation
adjustments (6,228) (2,201) 7,824
Unrealized gains (losses)
on securities arising
during the period 20,112 115,488 (302,172)
Less: reclassification
adjustment for realized
losses (gains) included in
net income 15,745 (291) 16,760
---------- ---------- ----------
Other comprehensive income
(loss), before tax 29,629 112,996 (311,108)
---------- ---------- ----------
Income tax expense (benefit)
related to items of other
comprehensive income:
Tax (benefit) expense from
foreign currency translation (2,179) (771) 2,737
Tax expense (benefit) from
unrealized gains (losses)
arising during period 7,041 40,421 (105,760)
Tax expense (benefit) from
realized gains (losses)
included in net income (5,511) 102 (5,866)
---------- ---------- ----------
Income tax expense (benefit)
related to items of other
comprehensive income: 10,373 39,548 (108,889)
Other comprehensive income
(loss), net of tax 19,256 73,448 (202,219)
---------- ---------- ----------
Comprehensive income (loss) $ 57,506 $ 231,943 $ (44,158)
========== ========== ==========
F-19
The following table shows the components of the change in accumulated other
comprehensive income for the years ending December 31, 2001 and 2000.
(dollar values in thousands) 2001 2000
---------------------------------------------------
Beginning balance of accumulated
other comprehensive income (loss) $ 56,747 $ (16,701)
--------- ----------
Beginning balance of foreign
currency translation adjustments $ (8,433) $ (7,003)
Current period change in foreign
currency translation adjustments (4,049) (4,049) (1,430) (1,430)
---------- --------- ---------- ----------
Ending balance of foreign currency
translation adjustments (12,482) (8,433)
---------- ----------
Beginning balance of unrealized
gains on securities 65,180 (9,698)
Current period change in
unrealized gains on securities 23,305 23,305 74,878 74,878
---------- --------- ---------- ----------
Ending balance of unrealized
gains on securities 88,485 65,180
---------- ----------
Current period change in accumulated
other comprehensive income 19,256 73,448
--------- ----------
Ending balance of accumulated other
comprehensive income $ 76,003 $ 56,747
========= ==========
10. EMPLOYEE BENEFIT PLANS
The Company maintains both a qualified and a non-qualified defined benefit
pension plan for its U.S. employees. Generally, the Company computes the
benefits based on average earnings over a period prescribed by the plans and
credited length of service. The Company has not been required to fund
contributions to its qualified defined benefit pension plan for the years ended
December 31, 2001 and 2000 because the Company's qualified plan was subject to
the full funding limitation under the Internal Revenue Service guidelines. The
Company's non-qualified defined benefit pension plan, effected in October 1995,
provides compensating pension benefits for participants whose benefits have been
curtailed under the qualified plan due to Internal Revenue Code limitations.
Although not required under Internal Revenue Service guidelines, the Company
contributed $0.3 million and $0.9 million to the qualified and non-qualified
plans respectively in 2001. The change in the accumulated pension benefit
obligation for 2001 reflects the net effect of amendments made to the plans as a
result of the Economic Growth and Tax Relief Reconciliation Act of 2001. Pension
expense for the Company's plans for the years ended December 31, 2001, 2000 and
1999 were $1.6 million, $1.0 million and $1.5 million, respectively.
F-20
The following table summarizes the status of these plans:
Years Ended December 31,
------------------------
(dollar values in thousands) 2001 2000
--------- ---------
Change in projected benefit obligation:
Benefit obligation at beginning of year $ 24,572 $ 22,060
Service cost 1,398 1,351
Interest cost 1,921 1,628
Change in accumulated benefit obligation 36 -
Actuarial gain (loss) 3,786 (252)
Benefits paid (311) (215)
--------- ---------
Benefit obligation at end of year 31,402 24,572
--------- ---------
Change in plan assets:
Fair value of plan assets at beginning of year 20,200 21,375
Actual return on plan assets (250) (960)
Actual contributions during the year 1,229 -
Benefits paid (311) (215)
--------- ---------
Fair value of plan assets at end of year 20,868 20,200
--------- ---------
Funded status (10,534) (4,372)
Unrecognized prior service cost 924 1,034
Unrecognized net (gain) 4,099 (1,820)
--------- ---------
(Accrued) pension cost $ (5,511) $ (5,158)
========= =========
Plan assets are comprised of shares in investment trusts with approximately 64%
and 36% of the underlying assets consisting of equity securities and fixed
maturities, respectively.
Net periodic pension cost included the following components:
Years Ended December 31,
----------------------------------
(dollar values in thousands) 2001 2000 1999
-------- -------- --------
Service cost $ 1,397 $ 1,351 $ 1,476
Interest cost 1,921 1,628 1,532
Expected return on assets (1,905) (1,915) (1,625)
Amortization of net loss (gain)
from earlier periods 21 (225) 6
Amortization of unrecognized
prior service cost 147 147 147
-------- -------- --------
Net periodic pension cost $ 1,582 $ 986 $ 1,536
======== ======== ========
The weighted average discount rates used to determine the actuarial present
value of the projected benefit obligation for 2001, 2000 and 1999 are 7.0%, 7.5%
and 7.5%, respectively. The rate of compensation increase used to determine the
actuarial present value of the projected benefit obligation for 2001, 2000 and
1999 is 4.50%. The expected long-term rate of return on plan assets for 2001,
2000 and 1999 is 9.0%.
F-21
The Company also maintains both qualified and non-qualified defined contribution
plans ("Savings Plan" and "Non-Qualified Savings Plan", respectively) covering
U.S. employees. Under the plans, the Company contributes up to a maximum 3% of
the participants' compensation based on the contribution percentage of the
employee. The Non-Qualified Savings Plan provides compensating savings plan
benefits for participants whose benefits have been curtailed under the Savings
Plan due to Internal Revenue Code limitations. The Company's incurred expenses
related to these plans were $0.6 million, $0.6 million and $0.6 million for
2001, 2000 and 1999, respectively.
In addition, the Company maintains several defined contribution pension plans
covering non-U.S. employees. Each non-U.S. office (Canada, London, Belgium, Hong
Kong, and Singapore) maintains a separate plan for the non-U.S. employees
working in that location. The Company contributes various amounts based on
salary, age, and/or years of service. The contributions as a percentage of
salary for the branch offices range from 2% to 12%. The contributions are
generally used to purchase pension benefits from local insurance providers. The
Company's incurred expenses related to these plans were $0.4 million, $0.3
million and $0.3 million for 2001, 2000 and 1999, respectively.
11. DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION
A. DIVIDEND RESTRICTIONS
Delaware law provides that an insurance company which is either an insurance
holding company or a member of an insurance holding system and is domiciled in
the state shall not pay dividends without giving prior notice to the Insurance
Commissioner of Delaware and may not pay dividends without the approval of the
Insurance Commissioner if the value of the proposed dividend, together with all
other dividends and distributions made in the preceding twelve months, exceeds
the greater of (1) 10% of statutory surplus or (2) net income, not including
realized capital gains, each as reported in the prior year's statutory annual
statement. In addition, no dividend may be paid in excess of unassigned earned
surplus. At December 31, 2001, Everest Re had $129.4 million available for
payment of dividends in 2002 without prior regulatory approval.
B. STATUTORY FINANCIAL INFORMATION
Everest Re prepares its statutory financial statements in accordance with
accounting practices prescribed or permitted by the National Association of
Insurance Commissioners ("NAIC") and the Delaware Insurance Department.
Prescribed statutory accounting practices are set forth in the NAIC Accounting
Practices and Procedures Manual. The capital and statutory surplus of Everest Re
was $1,293.8 million (unaudited) and $1,272.7 million at December 31, 2001 and
2000, respectively. The statutory net income of Everest Re was $78.9 million
(unaudited), $165.3 million and $149.9 million for the years ended December 31,
2001, 2000 and 1999, respectively.
F-22
C. CODIFICATION
The Company's operating subsidiaries file statutory-basis financial statements
with the state departments of insurance in the states in which the subsidiary is
licensed. On January 1, 2001, significant changes to the statutory-basis of
accounting became effective. The cumulative effect of these changes has been
recorded as a direct adjustment to statutory surplus. The cumulative effect of
these changes increased Everest Re's statutory surplus by $57.1 million
(unaudited).
12. CONTINGENCIES
The Company continues to receive claims under expired contracts that assert
alleged injuries and/or damages relating to or resulting from toxic torts, toxic
waste and other hazardous substances, such as asbestos. The Company's asbestos
claims typically involve liability or potential liability for bodily injury from
exposure to asbestos or for property damage resulting from asbestos or products
containing asbestos. The Company's environmental claims typically involve
potential liability for (1) the mitigation or remediation of environmental
contamination or (2) bodily injury or property damages caused by the release of
hazardous substances into the land, air or water.
The Company's reserves include an estimate of the Company's ultimate liability
for asbestos and environmental claims for which ultimate value cannot be
estimated using traditional reserving techniques. There are significant
uncertainties in estimating the amount of the Company's potential losses from
asbestos and environmental claims. Among the complications are: (1) potentially
long waiting periods between exposure and manifestation of any bodily injury or
property damage; (2) difficulty in identifying sources of asbestos or
environmental contamination; (3) difficulty in properly allocating
responsibility and/or liability for asbestos or environmental damage; (4)
changes in underlying laws and judicial interpretation of those laws; (5)
potential for an asbestos or environmental claim to involve many insurance
providers over many policy periods; (6) long reporting delays, both from
insureds to insurance companies and ceding companies to reinsurers; (7)
historical data concerning asbestos and environmental losses, which is more
limited than historical information on other types of casualty claims; (8)
questions concerning interpretation and application of insurance and reinsurance
coverage; and (9) uncertainty regarding the number and identity of insureds with
potential asbestos or environmental exposure.
Management believes that these factors continue to render reserves for asbestos
and environmental losses significantly less subject to traditional actuarial
methods than are reserves on other types of losses. Given these uncertainties,
management believes that no meaningful range for such ultimate losses can be
established. The Company establishes reserves to the extent that, in the
judgment of management, the facts and prevailing law reflect an exposure for the
Company or its ceding company. Due to the uncertainties discussed above, the
ultimate losses may vary materially from current loss reserves and could have a
material adverse effect on the Company's future financial condition, results of
operations and cash flows. See also Note 8.
F-23
The following table shows the development of prior year asbestos and
environmental reserves on both a gross and net of retrocessional basis for the
years ended:
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Gross basis
Beginning of reserves $ 693,704 $ 614,236 $ 660,793
Incurred losses 29,674 (5,852) 3,690
Paid losses (78,988) 85,320 (50,247)
---------- ---------- ----------
End of period reserves $ 644,390 $ 693,704 $ 614,236
========== ========== ==========
Net basis
Beginning of reserves $ 317,196 $ 365,069 $ 263,542
Incurred losses - (5,645) -
Paid losses (1) (41,027) (42,228) 101,527
---------- ---------- ----------
End of period reserves $ 276,169 $ 317,196 $ 365,069
========== ========== ==========
(1) Net of $0.0 million, $0.0 million and $118.8 million ceded paid losses in
2001, 2000 and 1999, respectively, under the stop loss reinsurance
protection provided by Mt. McKinley at the time of the Company's IPO.
At December 31, 2001, the gross reserves for asbestos and environmental losses
were comprised of $107.1 million representing case reserves reported by ceding
companies, $59.5 million representing additional case reserves established by
Everest Re on assumed reinsurance claims, $65.5 million representing case
reserves established by Everest Re on direct excess insurance claims, $88.6
million representing case reserves resulting from the acquisition of Mt.
McKinley and $323.7 million representing IBNR reserves.
The Company is also named in various legal proceedings incidental to its normal
business activities. In the opinion of the Company, none of these proceedings
would have a material adverse effect upon the financial condition, results of
operations or cash flows of the Company.
The Prudential sells annuities which are purchased by property and casualty
insurance companies to settle certain types of claim liabilities. In 1993 and
prior, Everest Re, for a fee, accepted the claim payment obligation of the
property and casualty insurer, and, concurrently, became the owner of the
annuity or assignee of the annuity proceeds. In these circumstances, Everest Re
would be liable if The Prudential were unable to make the annuity payments. The
estimated cost to replace all such annuities for which Everest Re was
contingently liable at December 31, 2001 and 2000 was $147.1 million and $148.7
million, respectively. In 2001, the Company received shares in The Prudential
valued at $25.9 million, as a result of The Prudential's demutualization
process, representing The Prudential common equity interest attributed to these
annuities. The value of these shares was recorded in "other income" in the
consolidated statement of operations and comprehensive income. These shares in
no way affect the underlying contingent liability of the Company.
Everest Re has purchased annuities from an unaffiliated life insurance company
to settle certain claim liabilities of Everest Re. Should the life insurance
company become unable to make the annuity payments, Everest Re would be liable.
The estimated cost to replace such annuities at December 31, 2001 and 2000 was
$13.7 million and $12.6 million, respectively.
F-24
13. RELATED-PARTY TRANSACTIONS
During the normal course of business, the Company, through its affiliates,
engages in what mangement believes to be arm's-length reinsurance and brokerage
and commission business transactions with companies controlled or affiliated
with its outside directors. These transactions are immaterial to the Company's
financial condition, results of operations and cash flows.
The Company engages in business transactions with Group and Bermuda Re.
Effective October 1, 2001, Everest Re and Bermuda Re entered into a loss
portfolio reinsurance agreement, whereby Everest Re transferred it's Belgium
Branch, for what management believes to be arm's-length consideration, net
insurance exposures and reserves to Bermuda Re. During 2000, the Company
distributed $495.0 million to Group to facilitate the completion of the
corporate restructuring. In addition, effective September 19, 2000, Mt. McKinley
and Bermuda Re entered into a loss portfolio transfer reinsurance agreement,
whereby Mt. McKinley transferred, for what management believes to be
arm's-length consideration, all of its net insurance exposures and reserves,
including allocated and unallocated loss adjustment expenses to Bermuda Re.
14. SEGMENT REPORTING
The Company, through its subsidiaries, operates in four segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting and International. The U.S.
Reinsurance operation writes property and casualty treaty reinsurance through
reinsurance brokers as well as directly with ceding companies within the United
States, in addition to property, casualty and specialty facultative reinsurance
through brokers and directly with ceding companies within the United States. The
U.S. Insurance operation writes property and casualty insurance primarily
through general agent relationships and surplus lines brokers within the United
States. The Specialty Underwriting operation writes accident and health, marine,
aviation and surety business within the United States and worldwide through
brokers and directly with ceding companies. The International operation writes
property and casualty reinsurance through the Company's branches in Belgium,
London, Canada, and Singapore, in addition to foreign "home-office" business.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments based upon their underwriting gain or
loss ("underwriting results"). Underwriting results include earned premium less
losses and LAE incurred, commission and brokerage expenses and other
underwriting expenses. The accounting policies of the operating segments are the
same as those described in Note 1K, Summary of Significant Accounting Policies.
The Company does not maintain separate balance sheet data for its operating
segments. Accordingly, the Company does not review and evaluate the financial
results of its operating segments based upon balance sheet data.
F-25
The following tables present the relevant underwriting results for the operating
segments for the three years ended December 31, 2001, 2000 and 1999.
U.S. REINSURANCE
- --------------------------------------------------------------------------------
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Earned premiums $ 497,600 $ 471,631 $ 456,572
Incurred losses and loss
adjustment expenses 449,635 317,735 316,507
Commission and brokerage 148,807 78,978 112,285
Other underwriting expenses 15,211 17,039 18,270
---------- ---------- ----------
Underwriting (loss) gain $ (116,053) $ 57,879 $ 9,510
========== ========== ==========
U.S. INSURANCE
- --------------------------------------------------------------------------------
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Earned premiums $ 294,225 $ 101,576 $ 57,791
Incurred losses and loss
adjustment expenses 211,311 70,277 41,077
Commission and brokerage 63,512 25,487 15,702
Other underwriting expenses 19,185 11,646 8,593
---------- ---------- ----------
Underwriting gain (loss) $ 217 $ (5,834) $ (7,581)
========== ========== ==========
SPECIALTY UNDERWRITING
- --------------------------------------------------------------------------------
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Earned premiums $ 371,805 $ 302,637 $ 265,343
Incurred losses and loss
adjustment expenses 330,841 254,302 185,608
Commission and brokerage 102,144 81,794 76,024
Other underwriting expenses 5,688 6,253 4,702
---------- ---------- ----------
Underwriting (loss) $ (66,868) $ (39,712) $ (991)
========== ========== ==========
INTERNATIONAL
- --------------------------------------------------------------------------------
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Earned premiums $ 169,871 $ 286,753 $ 291,745
Incurred losses and loss
adjustment expenses 87,432 235,927 228,378
Commission and brokerage 79,182 81,151 81,946
Other underwriting expenses 13,829 13,798 14,892
---------- ---------- ----------
Underwriting (loss) $ (10,572) $ (44,123) $ (33,471)
========== ========== ==========
F-26
The following table reconciles the underwriting results for the operating
segments to income before tax as reported in the consolidated statements of
operations and comprehensive income:
(dollar values in thousands) 2001 2000 1999
---------- ---------- ----------
Underwriting (loss) $ (193,276) $ (31,790) $ (32,533)
Net investment income 265,924 271,389 252,999
Realized (loss) gain (15,745) 291 (16,760)
Net derivative (expense) (7,020) - -
Corporate expenses (1,379) (1,528) (4,604)
Interest expense (46,004) (39,386) (1,490)
Other income (expense) 26,565 3,341 (1,030)
---------- ---------- ----------
Income before taxes $ 29,065 $ 202,317 $ 196,582
========== ========== ==========
The Company writes premium in the United States and international markets. The
revenues, net income and identifiable assets of the individual foreign countries
in which the Company writes business are not material.
Approximately 13.6%, 12.9% and 17.9% of the Company's gross premiums written in
2001, 2000 and 1999, respectively, were sourced through the Company's largest
intermediary.
F-27
15. UNAUDITED QUARTERLY FINANCIAL DATA
Summarized quarterly financial data were as follows:
(dollar values in thousands
except per share amounts) 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
2001 Operating data:
Gross written premium $ 418,926 $ 482,578 $ 487,081 $ 461,215
Net written premium 386,822 416,736 363,972 249,398
Earned premium 327,992 391,085 343,828 270,596
Net investment income 67,362 68,747 65,316 64,499
Net realized capital
(loss) gain (4,789) 4,084 (991) (14,049)
Total claims and
underwriting expenses 336,299 401,320 482,595 307,942
Net income (loss) 33,591 39,762 (53,082) 17,979
========= ========= ========= =========
2000 Operating data:
Gross written premium $ 304,252 $ 326,225 $ 355,550 $ 387,998
Net written premium 287,537 295,129 302,043 322,612
Earned premium 266,184 285,780 291,191 319,442
Net investment income 63,809 66,941 71,281 69,388
Net realized capital
gain (loss) 7,864 (8,185) (89) 701
Total claims and
underwriting expenses 273,555 292,675 298,336 331,349
Net income 49,051 31,541 40,390 37,513
========= ========= ========= =========
F-28
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE I - SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2001
(Dollars in thousands)
Column A Column B Column C Column D
- --------------------------------- ----------- ----------- -----------
Amount
Shown in
Market Balance
Cost Value Sheet
----------- ----------- -----------
Fixed maturities-available
for sale
Bonds:
U.S. government and
government agencies $ 114,046 $ 119,161 $ 119,161
State, municipalities and
political subdivisions 1,762,867 1,838,526 1,838,526
Foreign government securities 194,920 212,942 212,942
Foreign corporate securities 252,299 260,542 260,542
Public utilities 151,029 153,547 153,547
All other corporate bonds 1,081,871 1,087,892 1,087,892
Mortgage pass-through securities 432,330 450,756 450,756
Redeemable preferred stock 62,471 63,557 63,557
----------- ----------- -----------
Total fixed maturities-available
for sale 4,051,833 4,186,923 4,186,923
Equity securities 66,412 67,453 67,453
Short-term investments 115,850 115,850 115,850
Other invested assets 32,039 32,039 32,039
Cash 67,509 67,509 67,509
----------- ----------- -----------
Total investments and cash $ 4,333,643 $ 4,469,774 $ 4,469,774
=========== =========== ===========
S-1
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED BALANCE SHEET
(Dollars in thousands, except par value per share)
December 31, 2001 December 31, 2000
----------------- -----------------
ASSETS
Equity securities, at market value
(cost: 2001, $55; 2000, $55) $ 141 $ 143
Short-term investments 711 26,359
Cash 74 28
Investment in subsidiaries, at
equity in the underlying net assets 1,667,808 1,706,111
Receivable from affliate (2,153) (2,488)
Deferred tax asset 15,165 14,653
Accrued investment income 2 4
Other assets 2,617 3,312
----------------- -----------------
Total assets $ 1,684,365 $ 1,748,122
================= =================
LIABILITIES
8.5% Senior notes due 3/15/2005 $ 249,694 $ 249,615
8.75% Senior notes due 3/15/2010 199,077 199,004
Revolving credit facility 105,000 235,000
Current federal income taxes (26,644) -
Accrued interest on debt and borrowings 11,944 12,212
Due to affilitates 33,860 1,748
Other liabilities 25 56
----------------- -----------------
Total liabilities 572,956 697,635
----------------- -----------------
STOCKHOLDER'S EQUITY
Common stock, par value: $0.01; 200
million shares authorized; 1,000
issued in 2001 and 2000 - -
Paid-in capital 258,775 255,359
Accumulated other comprehensive
income, net of deferred taxes
of $40.8 million in 2001 and
$30.4 million in 2000 76,003 56,747
Retained earnings 776,631 738,381
----------------- -----------------
Total stockholder's equity 1,111,409 1,050,487
----------------- -----------------
Total liabilities and stockholder's
equity $ 1,684,365 $ 1,748,122
================= =================
See notes to consolidated financial statements.
S-2
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENT OF OPERATIONS
(Dollars in thousands)
For Years Ended December 31,
----------------------------------------
2001 2000 1999
---------- ---------- ----------
REVENUES
Net investment income $ 241 $ 1,371 $ 612
Net realized capital gain 1 - -
Other (expense) (543) (416) -
Equity in undistributed
change in retained
earnings of subsidiaries 68,027 184,191 161,388
---------- ---------- ----------
Total revenues 67,726 185,146 162,000
---------- ---------- ----------
EXPENSES
Interest expense 46,004 39,386 1,490
Other expenses 427 5 2,489
---------- ---------- ----------
Income before taxes 21,295 145,755 158,021
Income tax (benefit) (16,955) (12,740) (40)
---------- ---------- ----------
Net income $ 38,250 $ 158,495 $ 158,061
========== ========== ==========
See notes to consolidated financial statements.
S-3
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENT OF CASHFLOWS
(Dollars in thousands)
For Years Ended December 31,
------------------------------------------
2001 2000 1999
---------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 38,250 $ 158,495 $ 158,061
Adjustments to reconcile net income
to net cash provided by operating
activities:
Equity in undistributed change in
retained earnings of subsidiaries (68,027) (585,734) (161,388)
Increase (decrease) in other
liabilities 32,085 (1,352) 1,488
(Decrease) increase in accrued
interest on debt and borrowings (268) 12,106 106
(Increase) in deferred tax asset (27,156) (12,709) (40)
Decrease (increase) in other
assets 697 (2,881) (435)
(Increase) decrease in receivable
from affliates (335) 568 20,754
Restructure adjustment - (55) -
Accrual of bond discount (107) (877) -
Amortization of underwriting
discount on senior notes 152 112 -
Realized capital (gain) (1) - -
Non-cash compensation - 109 131
---------- ----------- -----------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES (24,710) (432,218) 18,677
CASH FLOWS FROM INVESTING ACTIVITIES
Additional investment in
subsidiaries, net of cash acquired - 349,743 50
Cost of equity securities acquired - (55) -
Net sales (purchases) of short-term
securities 25,756 (25,482) -
---------- ----------- -----------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES 25,756 324,206 50
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowing on revolving credit line 22,000 176,000 59,000
Repayments on revolving credit line (152,000) - -
Proceeds from issuance of senior
notes - 448,507 -
Acquisition of treasury stock net
of reissuances - (16,478) (62,106)
Effect of restructuring - (11,706) -
Common stock issued during the
period - 2,288 317
Contribution from subsidiaries 129,000 198 -
Dividends paid to stockholders - (495,000) (11,707)
---------- ----------- -----------
NET CASH PROVIDED BY (USED IN)
FINANCING ACTIVITIES (1,000) 103,809 (14,496)
Net increase in cash 46 (4,203) 4,231
Cash, begining of period 28 4,231 -
---------- ----------- -----------
Cash, end of period $ 74 $ 28 $ 4,231
========== =========== ===========
Supplemental cash flow
information
Non-cash operating transaction:
Dividends received from
subsidiaries in the form of
forgiveness of liabilities $ - $ - $ 836
See notes to consolidated financial statements.
S-4
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
Column A Column B Column C Column D Column F Column G Column H Column I Column J Column K
- --------------------- -------- ---------- --------- ---------- --------- ---------- --------- --------- ----------
Reserve Incurred
for Losses Loss Amortization
Deferred and Loss Unearned Net and Loss of Deferred Other
Acquisition Adjustment Premium Earned Investment Adjustment Acquisition Operating Written
Geographic Area Costs Expenses Reserves Premium Income Expenses Costs Expenses Premium
- --------------------- -------- ---------- --------- ---------- --------- ---------- --------- --------- ----------
December 31, 2001
Domestic $ 98,491 $3,641,323 $ 412,139 $1,163,630 $ 231,567 $ 991,787 $ 314,463 $ 41,463 $1,224,118
International 16,457 633,012 61,169 169,871 34,357 87,432 79,182 13,829 192,810
-------- ---------- --------- ---------- --------- ---------- --------- --------- ----------
Total $114,948 $4,274,335 $ 473,308 $1,333,501 $ 265,924 $1,079,219 $ 393,645 $ 55,292 $1,416,928
======== ========== ========= ========== ========= ========== ========= ========= ==========
December 31, 2000
Domestic $ 75,436 $3,176,004 $ 340,509 $ 875,844 $ 236,079 $ 642,314 $ 186,259 $ 36,466 $ 902,946
International 17,042 609,743 60,639 286,753 35,310 235,927 81,151 13,798 304,375
-------- ---------- --------- ---------- --------- ---------- --------- --------- ----------
Total $ 92,478 $3,785,747 $ 401,148 $1,162,597 $ 271,389 $ 878,241 $ 267,410 $ 50,264 $1,207,321
======== ========== ========= ========== ========= ========== ========= ========= ==========
December 31, 1999 (1)
Domestic $ 779,706 $ 209,617 $ 543,192 $ 198,323 $ 41,857 $ 799,265
International 291,745 43,382 228,378 81,946 14,892 296,304
---------- --------- ---------- --------- --------- ----------
Total $1,071,451 $ 252,999 $ 771,570 $ 280,269 $ 56,749 $1,095,569
========== ========= ========== ========= ========= ==========
(1) The 1999 amounts have been restated to conform to the 2001 and 2000 segment
presentation.
S-5
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE IV - REINSURANCE
(Dollars in thousands)
Column A Column B Column C Column D Column E Column F
- ---------------------------- --------- --------------- --------------- ----------- ----------
Gross Ceded To Assumed From Net Assumed to
Amount Other Companies Other Companies Amount Net
--------- --------------- --------------- ----------- ----------
December 31, 2001
Total property and liability
insurance earned premium $ 380,178 $ 442,888 $ 1,396,211 $ 1,333,501 104.7%
December 31, 2000
Total property and liability
insurance earned premium $ 138,982 $ 121,527 $ 1,145,142 $ 1,162,597 98.5%
December 31, 1999
Total property and liability
insurance earned premium $ 73,822 $ 45,292 $ 1,042,921 $ 1,071,451 97.3%
S-6
INDEX TO EXHIBITS
Exhibit No. Page
- ----------- ----
2.1 Agreement and Plan of Merger among Everest Reinsurance
Holdings, Inc., Everest Re Group, Ltd. and Everest Re
Merger Corporation, incorporated herein by reference
to Exhibit 2.1 to the Registration Statement on Form
S-4 (No. 333-87361)
3.1 Certificate of Incorporation of Everest Reinsurance
Holdings, Inc., incorporated herein by reference to
Exhibit 4.1 to the Registration Statement on Form S-8
(No. 333-05771)
3.2 Bye-Laws of Everest Reinsurance Holdings, Inc.,
incorporated herein by reference to Exhibit 3.2 to the
Everest Reinsurance Holdings, Inc. Quarterly Report on
Form 10-Q for the quarter ended March 31, 2000
4.1 Indenture, dated March 14, 2000, between Everest
Reinsurance Holdings, Inc. and The Chase Manhattan
Bank, as Trustee, incorporated herein by reference to
Exhibit 4.1 to Everest Reinsurance Holdings, Inc. Form
8-K filed on March 15, 2000
4.2 First Supplemental Indenture relating to the 8.5%
Senior Notes due March 15, 2005, dated March 14, 2000,
between Everest Reinsurance Holdings, Inc. and The
Chase Manhattan Bank, as Trustee, incorporated herein
by reference to Exhibit 4.2 to Everest Reinsurance
Holdings, Inc. Form 8-K filed on March 15, 2000
4.3 Second Supplemental Indenture relating to the 8.75%
Senior Notes due March 15, 2010, dated March 14, 2000,
between Everest Reinsurance Holdings, Inc. and The
Chase Manhattan Bank, as Trustee, incorporated herein
by reference to Exhibit 4.3 to the Everest Reinsurance
Holdings, Inc. Form 8-K filed on March 15, 2000
*10.1 Employment Agreement with Joseph V. Taranto executed
on July 15, 1998, incorporated herein by reference to
Exhibit 10.21 to Everest Reinsurance Holdings, Inc.
Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998 (the "second quarter 1998 10-Q")
*10.2 Amendment of Employment Agreement by and among
Everest Reinsurance Company, Everest Reinsurance
Holdings, Inc., Everest Re Group, Ltd. and Joseph V.
Taranto dated February 15, 2000, incorporated herein
by reference to Exhibit 10.29 to Everest Re Group,
E-1
Ltd. Annual Report on Form 10-K for the year ended
December 31, 1999 (the "1999 10-K")
*10.3 Change of Control Agreement with Joseph V. Taranto
effective July 15, 1998, incorporated herein by
reference to Exhibit 10.22 to the second quarter 1998
10-Q
*10.4 Amendment of Change of Control Agreement by and among
Everest Reinsurance Company, Everest Reinsurance
Holdings, Inc., Everest Re Group, Ltd. and Joseph V.
Taranto dated February 15, 2000, incorporated herein
by reference to Exhibit 10.30 to the 1999 10-K
10.5 Credit Agreement Between Everest Reinsurance Holdings,
Inc., the Lenders Named Therein and First Union
National Bank dated December 21, 1999 providing for a
$150 million Senior Revolving Credit Facility,
incorporated herein by reference to Exhibit 10.30 to
Everest Reinsurance Holdings, Inc. Form 8-K filed on
December 28, 1999
10.6 First Amendment to Credit Agreement dated as of
December 21, 1999 between Everest Reinsurance
Holdings, Inc., the Lenders Named Therein and First
Union National Bank, incorporated herein by reference
to Exhibit 10.19 to Everest Re Group, Ltd. Annual
Report on Form 10-K for the year ended December 31,
2000 (the "2000 10-K")
10.7 Parent Guaranty dated February 24, 2000 made by
Everest Re Group, Ltd. in favor of the Lenders under
Everest Reinsurance Holdings, Inc.'s Credit Facility,
incorporated herein by reference to Exhibit 10.33 to
the 1999 10-K
10.8 Guarantor Consent dated December 18, 2000 made by
Everest Re Group, Ltd. in favor of the Lenders under
Everest Reinsurance Holdings, Inc.'s Credit Facility,
incorporated herein by reference to Exhibit 10.21 to
the 2000 10-K
10.9 Stock Purchase Agreement between The Prudential
Insurance Company of America and Everest Reinsurance
Holdings, Inc. for the sale of common stock of
Gibraltar Casualty Company dated February 24, 2000,
incorporated herein by reference to Exhibit 10.32 to
the 1999 10-K
10.10 Amendment No. 1 to Stock Purchase Agreement between
The Prudential Insurance Company of America and
Everest Reinsurance Holdings, Inc. for the sale of
common stock of Gibraltar Casualty Company dated
August 8, 2000, incorporated herein by reference to
Exhibit 10.1 to the Everest Re Group, Ltd. Quarterly
Report on Form 10-Q for the quarter ended June 30,
2000
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10.11 Proportional Excess of Loss Reinsurance Agreement
entered into between Gibraltar Casualty Company and
Prudential Property and Casualty Insurance Company,
incorporated herein by reference to Exhibit 10.24 to
the 2000 10-K
10.12 Guarantee Agreement made by The Prudential Insurance
Company of America in favor of Gibraltar Casualty
Company, incorporated herein by reference to Exhibit
10.25 to the 2000 10-K
10.13 Lease, effective December 26, 2000 between OTR, an
Ohio general partnership, and Everest Reinsurance
Company, incorporated herein by reference to Exhibit
10.26 to the 2000 10-K
*10.14 Amendment of Employment Agreement by and among
Everest Reinsurance Company, Everest Reinsurance
Holdings, Inc., Everest Re Group, Ltd., Everest Global
Services, Inc. and Joseph V. Taranto, dated March 30,
2001, incorporated herein by reference to Exhibit 10.1
to Everest Re Group, Ltd. Report on Form 10-Q for the
quarter ended March 31, 2001 (the "first quarter 2001
10-Q")
*10.15 Amendment of Employment Agreement by and among
Everest Reinsurance Company, Everest Reinsurance
Holdings, Inc., Everest Re Group, Ltd., Everest Global
Services, Inc. and Joseph V. Taranto, dated April 20,
2001, incorporated herein by reference to Exhibit 10.2
to the first quarter 2001 10-Q.
*10.16 Amendment of Change of Control Agreement by and among
Everest Reinsurance Company, Everest Reinsurance
Holdings, Inc., Everest Re Group, Ltd., Everest Global
Services, Inc. and Joseph V. Taranto, dated March 30,
2001, incorporated herein by reference to Exhibit 10.3
to the first quarter 2001 10-Q
23.1 Consent of PricewaterhouseCoopers LLP, filed herewith
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* Management contract or compensatory plan or arrangement.
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