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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
COMMISSION FILE NUMBER 1-10804
XL CAPITAL LTD
(Exact name of registrant as specified in its charter)
CAYMAN ISLANDS 98-0191089
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
XL HOUSE, ONE BERMUDIANA ROAD, HM 11
HAMILTON, BERMUDA (Zip Code)
(Address of principal executive offices)
(441) 292-8515
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Class A Ordinary Shares, Par New York Stock Exchange, Inc.
Value $0.01 per Share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the shares of all classes of voting stock of
the registrant held by non-affiliates of the registrant on March 18, 2002 was
approximately $12.5 billion computed upon the basis of the closing sales price
of the Ordinary Shares on that date. For purposes of this computation, shares
held by directors and officers of the registrant have been excluded. Such
exclusion is not intended, nor shall it be deemed, to be an admission that such
persons are affiliates of the registrant.
As of March 18, 2002, there were outstanding 135,496,713 Class A Ordinary
Shares, $0.01 par value per share, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION PURSUANT TO REGULATION 14A RELATING TO THE ANNUAL MEETING OF
SHAREHOLDERS TO BE HELD ON MAY 9, 2002 IS INCORPORATED BY REFERENCE IN PART III
OF THIS FORM 10-K.
XL CAPITAL LTD
TABLE OF CONTENTS
PAGE
PART I
Item 1. Business ........................................................... 1
Item 2. Properties ......................................................... 17
Item 3. Legal Proceedings .................................................. 17
Item 4. Submission of Matters to a Vote of Security Holders ................ 17
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters ........................................ 19
Item 6. Selected Financial Data ............................................ 20
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition ................................................ 21
Item 7A. Quantitative and Qualitative Discussion of Market Risk ............. 41
Item 8. Financial Statements and Supplementary Data ........................ 45
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ............................................... 93
PART III
Item 10. Directors and Executive Officers of the Registrant ................. 94
Item 11. Executive Compensation ............................................. 94
Item 12. Security Ownership of Certain Beneficial Owners and Management ..... 94
Item 13. Certain Relationships and Related Transactions ..................... 94
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ... 94
THIS ANNUAL REPORT ON FORM 10-K CONTAINS "FORWARD-LOOKING STATEMENTS" AS
DEFINED IN THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. A NON-EXCLUSIVE
LIST OF THE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THOSE IN SUCH FORWARD-LOOKING STATEMENTS IS SET FORTH HEREIN
UNDER THE CAPTION "MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION-CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS."
PART I
ITEM 1. BUSINESS
HISTORY
XL Capital Ltd (the "Company") is a leading provider of insurance and
reinsurance coverages and financial products and services to industrial,
commercial, and professional service firms, insurance companies and other
enterprises on a worldwide basis. The Company was incorporated with limited
liability under the Cayman Islands Companies Act on March 16, 1998, as EXEL
Merger Company. The Company was formed as a result of the merger of EXEL Limited
and Mid Ocean Limited on August 7, 1998, and was renamed EXEL Limited on that
date.
EXEL Limited and Mid Ocean are companies that were incorporated in the
Cayman Islands in 1986 and 1992, respectively. At a special general meeting held
on February 1, 1999, the shareholders of the Company approved a resolution
changing the name of the Company to XL Capital Ltd.
On June 18, 1999, XL Capital Ltd merged with NAC Re Corp ("NAC"), a
Delaware corporation organized in 1985, in a stock merger. This merger was
accounted for as a pooling of interests under U.S. generally accepted accounting
principles ("GAAP"). Accordingly, all prior period information contained in this
document includes the results of NAC as though it had always been a part of the
Company. Following the merger, the Company changed its fiscal year end from
November 30 to December 31 as a conforming pooling adjustment.
On July 25, 2001, the Company completed the acquisition of certain
Winterthur International insurance operations ("Winterthur International") to
extend its predominantly North American based large corporate insurance business
globally. This was an all-cash transaction preliminarily valued at approximately
$405.6 million. The preliminary purchase price of the acquisition was based on
audited financial statements as at December 31, 2000 for the business being
acquired, and is subject to adjustment based on the audited June 30, 2001
financial statements of Winterthur International, which are not expected to be
completed until later in 2002. Results of operations of Winterthur International
have been included from July 1, 2001, the date from which the economic interest
was transferred to the Company.
In October 2000, the Company realigned management responsibilities within
its three main operating segments: insurance, reinsurance and financial products
and services. In connection with this realignment, the Company decided to exit
from certain unprofitable lines of business. The Company renamed certain of its
business units into a common XL brand identity. XL Mid Ocean Re was renamed XL
Re Ltd, and NAC Reinsurance Corporation was renamed XL Reinsurance America Inc.
In 2001, XL Brockbank Ltd was renamed XL London Market Ltd.
In 1999, the Company signed a joint venture agreement with Les Mutuelles du
Mans Assurances Group to form a French reinsurance company, Le Mans Re, in which
the Company acquired a 49% shareholding. Le Mans Re underwrites a worldwide
portfolio comprising most classes of property and casualty reinsurance business
together with a selective portfolio of life reinsurance business. The Company
acquired a 67% majority stake in Le Mans Re effective January 1, 2002.
For further information, see the Notes to the Consolidated Financial
Statements in Item 8.
INSURANCE OPERATIONS - EXCLUDING LLOYD'S SYNDICATES
GENERAL
The Company provides property and casualty insurance on a global basis. The
Company generally writes specialty coverages for commercial customers.
1
Specific lines of business written include third party general liability
insurance, environmental liability insurance, directors and officers liability
insurance, professional liability insurance, aviation and satellite insurance,
employment practices liability insurance, surety, marine insurance, property
insurance and other insurance covers including program business and political
risk insurance. Premiums written vary by jurisdiction principally due to local
market conditions and legal requirements.
The Company's insurance business is largely excess in nature and is subject
to large deductibles, self-insurance or primary insurance obtained from sources
other than the Company. The excess nature of many of the Company's insurance
products, coupled with historically large policy limits, creates a book of
business that may be described as low frequency and high severity. As a result,
large losses, though infrequent, can have a significant impact on results of
operations, financial condition and liquidity when they occur. The Company
attempts to mitigate this risk through a program of strict underwriting
guidelines and various reinsurance arrangements, discussed below.
Aggregate exposures to potential catastrophic losses are monitored at an
entity level and also at the corporate level. In addition to internal controls
designed to mitigate the Company's exposure to a specific client, class of
business or geographic exposure, the Company maintains various reinsurance
programs to protect the Company against foreseeable catastrophic risks.
The majority of the Company's insurance loss reserves are long-tailed in
nature and the time between receipt of premium for a coverage and settlement of
claims may span many years. This is especially true of most liability insurance.
Property lines are considered short-tailed in nature as claims tend to be known
and paid more promptly. In order to establish adequate reserves for such
long-tailed lines, actuarial techniques are used to estimate the Company's
ultimate liabilities in excess of reserves established for known losses. These
reserves are reviewed regularly by internal and external actuaries.
Because the Company's insurance products are primarily specialty coverages,
underwriting guidelines and policy forms differ by product offering as well as
by legal jurisdiction. Liability insurance is written on both an excess and a
primary basis, typically on occurrence-reported or claims-made policy forms.
Policies typically cover occurrences causing unexpected and unintended personal
injury or property damage to third parties arising from events or conditions
which commence at or subsequent to an inception date, or retroactive date, if
applicable (but not prior to January 1, 1986), and prior to the expiration of
the policy provided that proper notice is given during the term of the policy or
the discovery period. Traditional occurrence coverage is also available for
restricted classes of risk and is generally written on a follow-form basis where
the policy adopts the terms, conditions and exclusions of the underlying policy.
The Company does not specifically exclude terrorism coverage on liability
coverage, but rather utilizes guidelines to underwrite these risks on a
case-by-case basis.
Environmental liability is written for both single and multiple years on an
excess claims-made basis. Directors and officers coverage is written on both a
primary and excess claims-made basis. Professional liability errors and
omissions risks are generally written on an excess basis.
Employment practices liability risks are written on a claims-reported
basis. The policy covers claims brought by an employee against an insured for
certain employment practices. Coverage is generally provided on an excess basis
or is subject to a significant retention.
Insurance for satellite risks is written on a proportional basis to provide
coverage for first party physical damage or loss. Coverage includes all phases
of operation. Aviation insurance is offered for large aviation risks on a
proportional basis, providing for both aviation liability and physical damage.
General aviation insurance is also written on a primary basis.
Marine and energy risks are written in various classes, often on a
proportional basis. Classes written include cargo, marine hull, excess marine
liabilities, onshore and offshore energy, oil and petrochemical, specialty
chemicals and mining exposures, and builders risk.
2
Property insurance risks are written on a lead or follow-form basis that
usually provides coverage for all risks of physical damage and business
interruption. Maximum limits are generally subject to sub-limits for coverage in
critical earthquake zones. Losses related to acts of terrorism for property
coverages are now generally excluded as market conditions permit. Property
insurance is written on both a pro-rata and excess basis. Policies written on a
pro-rata basis generally have losses attaching at lower levels, resulting in
loss experiences that demonstrate higher frequency and lower severity.
Surety products written include bid, performance and payment bonds to the
construction industry including general contractors, highway and bridge
contractors, mechanical and electrical contractors, other trades and
manufacturers. The Company also offers customs bonds, license and permit bonds,
court bonds, public official bonds and other miscellaneous bonds to a broad
spectrum of clients.
Political risk insurance written by the Company generally covers risks
arising from expropriation, currency inconvertibility and war or political
violence. Such insurance is typically provided to financial institutions, equity
investors, export credit agencies and multilateral agencies in connection with
direct and other types of investments in emerging market countries in Latin
America, Asia and Eastern Europe. The Company manages its exposures by type of
risk, country and region.
Product recall insurance is provided on both a primary and an excess basis.
This coverage is designed to protect companies against loss of profits and costs
of product or brand rehabilitation following a malicious product tampering or
accidental contamination.
Following the acquisition of Winterthur International, accident and health
insurance is also written by the Company in Europe. Coverage includes group
personal accident insurance, workers compensation and medical expense insurance
for expatriates and third country nationals. The Company also offers traditional
multinational pooling arrangements for accident and health contracts and pension
services to financial institutions and pension funds in Germany as well as
services for credit life insurance in Europe.
The Company offers multi-year combined line policies for traditional
liability coverages including general, directors and officers liability,
employment practices liability, professional liability and property coverage, in
addition to a blended finite coverage for risks which traditionally have been
difficult to place through traditional risk transfer mechanisms.
PREMIUMS
See "Management's Discussion and Analysis of Results of Operations and
Financial Condition" and Item 8, Note 3 to the Consolidated Financial
Statements.
REINSURANCE CEDED
In certain cases, the risks assumed by the Company are partially reinsured
with unrelated reinsurers. Reinsurance ceded varies by location and line of
business based on factors including, among others, market conditions. The
benefits of ceding risks to other reinsurers include reducing exposure on
individual risks, protecting against catastrophic risks and maintaining
acceptable capital ratios. Reinsurance ceded does not legally discharge the
Company from its liabilities in respect of the risk being reinsured.
The Company uses reinsurance to support the underwriting and retention
guidelines of each entity as well as to control the aggregate exposure of the
Company to a particular risk or class of risks. Reinsurance is purchased at
several levels ranging from reinsurance of risks assumed on individual contracts
to reinsurance covering the aggregate exposure of groups of companies. Under the
Company's reinsurance security policy, reinsurers are generally required to be
rated A or better by Standard & Poor's ("S&P") or, in the case of Lloyd's
syndicates, S&P "Four Bells" and/or B+ from Moody's Investor Service
("Moody's"). The Company's Chief Credit Officer will consider reinsurers that
are not rated or do not fall within the above rating categories on a
case-by-case basis. See Item 8, Note 10 to the Consolidated Financial Statements
for further information.
3
The Company purchases a quota share treaty to protect both the general
liability occurrence-notified and occurrence business written. During 2001, the
Company also purchased excess of loss reinsurance and an excess cessions
reinsurance treaty to protect the directors and officers, professional liability
and employment practices liability business written. A variety of other programs
are designed to reduce Company's net exposure to environmental, aviation,
satellite and marine and energy single loss events. Facultative reinsurance is
utilized to reduce the Company's net retention to satellite risks. In addition,
a variable surplus treaty, excess of loss reinsurance and catastrophe
reinsurance, is used to protect the property business written with various
layers and excess of varying attachment points.
COMPETITION
The worldwide property and casualty insurance and reinsurance industry is
highly competitive. The markets for the Company's insurance and reinsurance
products are characterized by strong and, at times, intense price competition,
driven largely by the substantial amount of excess capacity. Although most of
the property and casualty markets in which the Company operates have seen
substantial improvements in pricing and policy terms and conditions in late
2001, the Company believes that competitive forces will continue to be present
in the industry, in part due to the significant amount of new or additional
capital that entered the industry in late 2001. Some of the Company's
competitors possess significantly greater financial and other resources than the
Company. The Company generally competes on the basis of financial strength,
coverage terms, claims paying rating and reputation, price and customer service.
See Industry Overview included in "Management's Discussion and Analysis of
Results of Operations and Financial Condition" for further discussion of current
market conditions.
UNDERWRITING
The Company underwrites and prices most risks individually following a
review of the exposure and in accordance with the Company's underwriting
guidelines. Most of the Company's insurance operations have underwriting
guidelines that are industry-specific. The Company seeks to control its exposure
on an individual insurance contract through terms and conditions, policy limits
and sub-limits, attachment points, and facultative reinsurance arrangements on
certain types of risks.
The Company's rating methodology seeks to set premiums in accordance with
claims potential as measured by past experience and future expectations, the
attachment point and amount of underlying insurance, the nature and scope of the
insured's operations including the industry group in which the insured operates,
exposures to loss, and other specific risk factors relevant in the judgment of
the Company's underwriters to the type of business being written. Underwriters
generally evaluate each industry category and sub-groups within each category.
Premiums are then set and adjusted for an insured based, in large part, on the
industry group in which the insured is placed and the insured's perceived risk
relative to the other risks in that group. Rates may vary significantly
according to the industry group of the insured as well as the insured's risk
relative to the group.
The Company's rating methodology for large property risks is based on a
global rating tool that establishes premium rates in accordance with claims
potential as measured by past experience and future expectations. Other factors
typically include the attachment point and amount of underlying insurance, the
nature and scope of insured operations including the industry group in which the
insured operates, natural hazard exposures, risk management quality, as well as
other specific risk factors deemed relevant in the judgment of the underwriters.
Underwriting and loss experience is reviewed regularly for loss trends,
emerging exposures, changes in the regulatory or legal environment as well as
the efficacy of policy terms and conditions.
MARKETING AND DISTRIBUTION
Clients are referred to the Company through a large number of brokers and
captive managers who receive from the insured or ceding company a set fee or
brokerage commission usually equal to a percentage of gross premiums.
4
In general, the Company is not committed to accept business from any particular
broker, and brokers do not have the authority to bind the Company, except in the
case where underwriting authority may be delegated to selected administrators.
These administrators are subject to a financial and operational review prior to
any delegation of authority and ongoing reviews are carried out as deemed
necessary. See Item 8, Note 15(c) to the Consolidated Financial Statements for
information on major brokers.
CLAIMS ADMINISTRATION
Claims management for the insurance operations includes the review of
initial loss reports, administration of a claims database, generation of
appropriate responses to claims reports, identification and handling of coverage
issues, determination of whether further investigation is required and, where
appropriate, retention of claims counsel, establishment of case reserves,
payment of claims, and notification to reinsurers.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
GENERAL
The Company's ongoing Lloyd's operations are conducted by XL London Market
Ltd. XL London Market, formerly XL Brockbank which comprised both Brockbank and
Denham Syndicate Management Limited, is organized under the laws of the U.K. and
is a leading Lloyd's managing agency that provides underwriting and similar
services to four Lloyd's syndicates. Syndicates 1209 and 990 are dedicated
corporate syndicates whose capital is provided solely by the Company. Prior to
January 1, 2002, Syndicate 1209 wrote in parallel with two other syndicates
managed by XL London Market, Syndicates 588 and 861 whose capital was provided
by third parties.
In November 2001, the Company announced that XL London Market would be
realigned effective January 1, 2002 and that the Company would be providing 100%
of the capacity for Syndicates 1209 and 990. Syndicates 588 and 861, backed
entirely by third-party capital providers for the 2001 underwriting year of
account, no longer write business as of January 1, 2002. Effective 2002,
Syndicate 1209 is focusing on its core specialty marine and energy lines, war
and political risks, aviation, professional indemnity, property programs, specie
and bloodstock and no longer participates in the excess of loss treaty, accident
and health, and property accounts. Syndicate 990 will continue to write a
general non-marine account with an emphasis on long-tail business throughout
2002.
Insurance for marine hull and machinery provides protection against
physical damage, collision liability and loss of earnings principally for blue
water ship operators and owners. Energy risks provide physical damage and
liability cover for offshore risks including oil and gas exploration, extraction
and transportation. A broad international cargo account is written, specializing
in technology sector and in large plant and project equipment. Marine liability
risks include pollution insurance, financiers' exposures and certificates of
financial responsibility reinsurance, as well as the more traditional liability
cover, such as charters' liabilities.
Political violence risks cover assets against physical damage arising from
terrorism, war on land, strikes, riots and civil commotion. Political risk
business written protects owners or financiers of overseas assets against
arbitrary acts of foreign government. Financial and credit risks written cover
exporters or importers of goods and services against the inability to enjoy
their contractual right to a wide range of commercial perils. War cover is also
written for ships and aircraft.
Aviation risks provide cover for airline hull, spares and liability risks,
as well as a number of associated lines.
Specie risks provide cover for fine art, cash in transit, financial
institutions and jewlery. Bloodstock risks include cover for risks of mortality
to horses and livestock, in addition to illness or accident.
5
PREMIUMS
See "Management's Discussion and Analysis of Results of Operations and
Financial Condition" and Item 8, Note 3 to the Consolidated Financial
Statements.
REINSURANCE CEDED
The Company's Lloyd's operations purchase reinsurance to protect the
syndicates against extraordinary loss or loss involving one or more underwriting
classes. The amount purchased is determined with reference to the syndicates'
aggregate exposure and potential loss scenarios. Prior to January 1, 2002, each
reinsurer was required to be approved by a reinsurance security committee. The
syndicates purchased separate whole account non-proportional reinsurance
programs on an excess and proportional basis. The classes of business included
in the main program were hull, cargo, specie, war, political risks, energy,
property and marine liability. Stand-alone programs were purchased for aviation,
bloodstock, casualty, personal accident, space and excess of loss treaty. Under
the Company's reinsurance security policy, reinsurers are generally required to
be rated A or better by S&P or, in the case of Lloyd's syndicates, S&P "Four
Bells" and/or B+ from Moody's. The Company's Chief Credit Officer will consider
reinsurers that are not rated or do not fall within the above rating categories
on a case-by-case basis. See further information in Item 8, Note 10 to the
Consolidated Financial Statements.
Since January 1, 2002, the Company's Lloyd's operations have followed the
same reinsurance practices as the Company's other insurance operations. The
syndicates purchase a range of reinsurance, including proportional,
non-proportional and facultative cover.
COMPETITION
XL London Market competes with other Lloyd's operations as well as
international and domestic insurers. Markets for business written by the
Company's Lloyd's operations are characterized by strong competition driven
largely by substantial amounts of excess capacity. Premium rates began to
increase during 2000, and following the terrorist loss events at the World Trade
Center in New York City, in Washington, D.C., and in Pennsylvania on September
11, 2001 (collectively "the September 11 event"), pricing and terms and
conditions have improved significantly. However, the Company believes that
competitive forces will continue to be present in these markets.
UNDERWRITING
The Lloyd's syndicates underwrite a broad range of risks, and the factors
taken into consideration in the underwriting process vary between classes of
business. The underwriters may use actuaries to assist in the review and rating
of risks. The daily acceptance of risk is performed by the active underwriter,
the class underwriters and individuals with specific delegated authority.
Underwriting authority limits are agreed between the active underwriter, the
class underwriter and the managing agency's board of directors. Underwriters may
delegate underwriting authority on a contractual basis to individuals who are
approved and monitored. Syndicates also participate on market facilities where
underwriting authority is delegated to the lead insurer.
MARKETING AND DISTRIBUTION
The Company's Lloyd's syndicates deal largely with Lloyd's accredited
brokers, who in turn source business from a large international network of
wholesale and retail brokers. The syndicates also deal directly with insureds
and non-Lloyd's accredited brokers through a service company wholly owned by the
Company. In certain circumstances, the Company's Lloyd's syndicates may delegate
underwriting authority on a contractual basis either to selected brokers, or to
lead insurers under market facilities. See Item 8, Note 15(c) to the
Consolidated Financial Statements for further information on major brokers.
CLAIMS ADMINISTRATION
Claims in respect of business written by the Lloyd's syndicates are
primarily notified by various central market bureaus. Where a syndicate is a
"leading" syndicate on a Lloyd's policy, its underwriters and claims adjusters
will
6
deal with the broker or insured on behalf of itself and the following market for
any particular claim. This may involve appointing attorneys or loss adjusters.
The claims bureaus and the leading syndicate advise movement in loss reserves to
all syndicates participating on the risk. A claims department may adjust the
case reserves it records from those advised by the bureaus as deemed necessary.
REINSURANCE OPERATIONS
GENERAL
The Company provides property, casualty and life reinsurance products on a
global basis with business being written on both a proportional and excess of
loss basis.
The Company's casualty reinsurance includes general liability, professional
liability, automobile and workers' compensation, and commercial and personal
property risks and specialty risks, including fidelity and surety and ocean
marine. Business written on an excess of loss basis generally indemnifies an
insurer for a portion of the losses on insurance policies in excess of a
specified loss amount. Business written on a proportional basis provides for the
Company to receive an agreed percentage of the premium and to be liable for the
same percentage of the incurred losses of the primary insurer as specified in
the treaty of each risk of the reinsured class.
The Company's property business is primarily short-tail in nature and
includes property catastrophe, property excess of loss, property proportional,
marine and energy, aviation and satellite and various other reinsurance to
insurers and reinsurers on a worldwide basis. A significant portion of business
underwritten consists of large aggregate exposures to man-made and natural
disasters, and generally, loss experience is characterized as low frequency and
high severity. This may result in volatility in the Company's results of
operations and financial condition.
The Company seeks to manage its exposures to catastrophic events by
limiting the amount of its exposure in each geographic zone worldwide, requiring
that its property catastrophe contracts provide for aggregate limits and
including varying attachment points. The Company protects its aggregate
exposures by peril and zone through the purchase of reinsurance programs.
The Company's property catastrophe reinsurance account is generally "all
risk" in nature. As a result, the Company is exposed to losses from sources as
diverse as windstorms, earthquakes, freezing, riots, floods, industrial
explosions, fires, and many other potential disasters. In accordance with market
practice, the Company's policies generally exclude certain risks such as war,
nuclear contamination or radiation and, following the September 11 event,
terrorism cover is also excluded in certain classes. The Company's predominant
exposure under such coverage is to property damage.
Property catastrophe reinsurance provides coverage on an excess of loss
basis when aggregate losses and loss adjustment expenses from a single
occurrence of a covered event exceed the attachment point specified in the
policy. Some of the Company's property catastrophe contracts limit coverage to
one occurrence in any single policy year, but most contracts generally enable
one reinstatement to be purchased by the reinsured.
The Company also writes property risk excess of loss reinsurance. Risk
excess of loss reinsurance covers a loss of the reinsured on a single risk of
the type reinsured rather than to aggregate losses for all covered risks as is
the case with catastrophe reinsurance.
The Company's property proportional account includes reinsurance of direct
property insurance. The Company considers this business to be related to its
catastrophe and other property exposures. In proportional reinsurance, the
Company assumes a specified proportion of the risk on the specified coverage and
receives an equal proportion of the premium. The ceding insurer receives a
commission, based upon the premiums ceded to the Company, and the ceding insurer
may also be entitled to receive a profit commission based upon the ratio of
losses, loss adjustment expenses and the Company's expenses to premium for a
given exposure that is intended to be commensurate with achieving adequate
compensation for the amount of capital it anticipates placing at risk.
7
PREMIUMS
See "Management's Discussion and Analysis of Results of Operations and
Financial Condition" and Item 8, Note 3 to the Consolidated Financial
Statements.
REINSURANCE CEDED
A corporate multi-year program is purchased for global property exposures.
This protection gives total limits in various layers and excess of varying
attachment points according to territorial exposure. The Company has
co-reinsurance retentions within this program. The Company's casualty
reinsurance program covers multiple claims arising from two or more risks from a
single occurrence or event. In addition, the Company had coverage from 1997
through 2002 in the event that the accident year loss and loss expense ratio
exceeded a pre-determined amount, with coverage up to specified limits. See Item
8, Note 10 to the Consolidated Financial Statements for further information.
COMPETITION
See "Competition" under Insurance Operations - Excluding Lloyd's
Syndicates.
UNDERWRITING
Underwriting opportunities are evaluated using a number of factors
including the type and layer of risk to be assumed, the actuarial evaluation of
premium adequacy, the cedent's underwriting and claims experience, the cedent's
financial condition and claims paying rating, the exposure and or experience
with the cedent, and the line of business to be underwritten.
In addition, the Company assesses a variety of other circumstances
including: the reputation of the proposed cedent and the likelihood of
establishing a long-term relationship with the cedent; the geographic area in
which the cedent does business and its market share; detailed assessment of
catastrophe and risk exposures; and historical loss data for the cedent and,
where available, for the industry as a whole in the relevant regions, in order
to compare the cedent's historical loss experience to industry averages.
On-site underwriting reviews are performed where it is deemed necessary to
determine the quality of a current or prospective cedent's underwriting
operation.
For the property catastrophe reinsurance business, the Company has
developed underwriting guidelines under which it generally limits the amount of
exposure it will directly underwrite for any one reinsured and the amount of the
aggregate exposure to catastrophic losses in any one geographic zone. The
Company believes it has defined zones such that a single occurrence, for example
an earthquake or hurricane, generally should not affect more than one zone. The
definition of the Company's zones is subject to periodic review and change. The
Company also generally seeks an attachment point for its property catastrophe
reinsurance at a level that is high enough to produce a low frequency of loss.
The Company seeks to limit its aggregate exposure in the proportional business
because it is sometimes difficult to allocate risks associated with such
business to specific geographic areas.
MARKETING AND DISTRIBUTION
See "Marketing and Distribution" under Insurance Operations - Excluding
Lloyd's Syndicates and Item 8, Note 15(c) to the Consolidated Financial
Statements.
CLAIMS ADMINISTRATION
Claims management for the reinsurance operations includes the receipt of
loss notifications, the establishment of loss reserves and approval of loss
payments. Additionally, claims audits are conducted for specific claims and
claims procedures at the offices of selected ceding companies.
8
FINANCIAL PRODUCTS AND SERVICES OPERATIONS
GENERAL
The Company provides insurance and reinsurance solutions for complex
financial risks. These include financial guaranty insurance and reinsurance,
credit default swaps and other collateralized transactions. While each of these
transactions is unique and tailored to the specific needs of the insured, they
are typically multi-year transactions. Obligations guaranteed or enhanced by the
Company range in duration and premiums are received either on an installment
basis or up front. In 2001, the Company also began to write weather risk
management products and to trade in weather related derivatives.
Financial guaranty insurance and reinsurance, through two AAA-rated S&P
companies, generally guarantees payments of interest and principal on an
issuer's obligations when due. Credit default swaps provide coverage for losses
upon the occurrence of specified credit events set forth in the swap
documentation.
Asset-backed obligations insured or reinsured by the Company are generally
issued in structured transactions backed by pools of assets of specified types,
such as residential mortgages, auto loans and other consumer receivables,
equipment leases and corporate debt obligations having an ascertainable cash
flow or market value.
Municipal obligations insured or reinsured consist mainly of general or
special obligations of state and local governments, supported by the issuers'
ability to charge fees for specified services or projects.
Corporate risk-based obligations underwritten by the Company include
essential infrastructure projects and obligations backed by receivables from the
future sales of commodities and other specified services.
The Company also offers weather risk management products to end users while
hedging the risks within the capital markets. As of December 31, 2001, a
majority of these contracts were due to expire on or before December 31, 2002.
During 2001, the Company implemented a strategic plan with early activities
centered on establishing a life company platform. In 2002, the Company expects
to begin underwriting business owned life insurance and funding agreements as
well as issuing municipal guaranteed investment contracts. In support of these
products, the Company is in the process of developing and implementing credit
and control procedures.
PREMIUMS
See "Management's Discussion and Analysis of Results of Operations and
Financial Condition" and Item 8, Note 3 to the Consolidated Financial
Statements.
REINSURANCE CEDED
Similar to the Company as a whole, effective use of outwards reinsurance
for the financial products and services operations is critical for capital
management purposes. For single risk and portfolio management purposes, the
Company has retroceded risks on a facultative basis. These facultative cessions
to third-party reinsurers provide the Company greater flexibility to manage
large single risks and reduce concentrations in specific bond sectors or
geographic regions. See Item 8, Note 10 to the Consolidated Financial Statements
for further information.
COMPETITION
The principal competitors in the municipal and asset-backed insured markets
include other AAA/Aaa-rated monoline financial guarantors and AAA/Aaa-rated
multiline insurance companies and banks. There are also many means by which
issuers may borrow money without using third party credit enhancement. For
example, structured financings may be executed by issuing a subordinated tranche
of debt that effectively substitutes for third party enhancement. Additionally,
issuers may raise debt financing by issuing corporate debt or by borrowing from
banks. Such borrowing alternatives effectively constitute a form of competition
for financial guarantor insurance companies.
9
With respect to the Company's weather risk management business, the Company
competes directly in the U.S. and on a worldwide basis, encountering competition
from companies within the energy, insurance and, to an increasing extent, the
financial sectors. Among the principal competitive factors affecting the
Company's business are its financial strength ratings, its products and services
and relative pricing, its capability in originating and marketing innovative
products and services and its reputation.
UNDERWRITING
The Company has underwriting guidelines for the various products and asset
classes comprising the credit enhancement business, which include single and
aggregate risk limitations on specified exposures. A credit committee provides
final underwriting approval.
The Company's underwriting policy is to credit enhance obligations and
exposures that would otherwise be lower investment grades, although on a very
limited exception basis, the Company will consider underwriting high
non-investment grade risks.
The Company seeks to identify, assess, monitor and manage, in accordance
with defined policies and procedures, its market, credit, operational and legal
risks. The Company's senior management takes an active role in the risk
management process and has developed and implemented policies and procedures
that require specific administrative and business functions to assist in the
identification, assessment and control of various risks. Due to the changing
nature of the global marketplace, the Company's risk management policies,
procedures and methodologies are evolving and are subject to ongoing review and
modification. See Item 7A. "Quantitative and Qualitative Disclosure of Market
Risk" for further discussion.
MARKETING AND DISTRIBUTION
With respect to Company's financial guaranty business, marketing is
targeted, depending on the type and stage of completion of the transaction.
These parties include investment bankers, issuers of and investors in
credit-enhanced transactions and concessionaires in certain transactions. Other
financial guaranty insurers or reinsurers or other counterparties may also be a
source of new business.
With respect to the Company's weather risk management business, clients are
predominantly referred to the Company through a number of brokers who receive a
fee that is a function of the size of the transaction and, to a lesser extent,
as a result of direct marketing. Utility companies have been the Company's main
clients.
See Item 8, Note 15(c) to the Consolidated Financial Statements for further
information on major brokers.
CLAIMS ADMINISTRATION
Claims management for the financial guaranty and credit default swap
business includes the identification of potential claims through systematic
surveillance of the insured portfolio, the establishment of reserves for losses
that are both probable and estimable, the accounting for loss adjustment
expenses, the receipt of claims, the approval of claim payments and the
notification to reinsurers. Surveillance also involves proactive efforts to
prevent or mitigate potential claims once they are identified. If a claim is
paid, recoveries will be sought based on the security pledged under the policy.
External attorneys and consultants are often enlisted to assist in loss
mitigation and recovery.
Claims administration for weather insurance contracts is generally handled
as in the insurance segment. See "Claims Administration" under Insurance
Operations - Excluding Lloyd's Syndicates for further information.
UNPAID LOSSES AND LOSS EXPENSES
Certain aspects of the Company's business have loss experience
characterized as low frequency and high severity. This may result in volatility
in both the Company's results of operations and financial condition and
liquidity.
10
Loss reserves are established due to the significant periods of time that
may lapse between the occurrence, reporting and payment of a loss. To recognize
liabilities for unpaid losses, the Company estimates future amounts needed to
pay claims and related expenses with respect to insured events. The Company's
reserving practices and the establishment of any particular reserve reflect
management's judgment concerning sound financial practice and do not represent
any admission of liability with respect to any claim made against the Company.
The method of establishing case reserves for reported claims differs
between the Company's operations. For the insurance operations, excluding
Lloyd's syndicates as discussed below, claims personnel determine whether to
establish a case reserve for the estimated amount of the ultimate settlement, if
any. The estimate reflects the judgment of claims personnel based on general
corporate reserving practices, and on the experience and knowledge of such
personnel regarding the nature and value of the specific type of claim and,
where appropriate, advice of counsel. Reserves are also established to provide
for the estimated expense of settling claims, including legal and other fees and
the general expenses of administering the claims adjustment process. A similar
process is followed in the reinsurance and Lloyd's operations when the Company
is a lead underwriter. Other reinsurance and Lloyd's business case reserves are
established based upon reports received from insureds and reinsureds,
supplemented by the Company's own assessment process. Periodically, adjustments
to the case reserves may be made as additional information regarding the claims
is reported or payments are made.
Most of the Company's incurred but not reported ("IBNR") loss reserves are
derived from casualty business. Casualty business generally has a longer tail
than the Company's other lines of business. IBNR is calculated using several
standard actuarial methodologies including paid and incurred loss development,
Bornhuetter-Ferguson and frequency and severity approaches. The Company believes
the methods presently adopted provide a reasonably objective result as it is
based upon the Company's loss data rather than more theoretical models often
used in the low frequency, high layer business the Company writes. Even such
actuarially sound methods can lead to subsequent adjustments to reserves that
are both significant and irregular due to the nature of the risks written.
Several aspects of the Company's casualty insurance operations complicate
the actuarial reserving techniques for loss reserves as compared to other
companies. These complications include policy forms that differ from more
traditional forms, the lack of historical loss data for losses of the type
intended to be covered by the policies, and the fact that losses in excess of
the attachment level of the Company's policies are characterized by low
frequency and high severity, limiting the utility of claims experience of other
insurers for similar claims. While management believes it has made a reasonable
estimate of ultimate losses, the ultimate claims experience may not be as
reliably predicted as may be the case with other insurance operations, and there
can be no assurance that ultimate losses and loss expenses will not exceed the
total reserves.
Claims relating to property catastrophe and property risk excess treaties
are generally reported within approximately eighteen to twenty four months from
the date of occurrence. Conversely, claims on the casualty business are reported
on average five to eight years from the date of occurrence. Claims arising from
business written by the Lloyd's syndicates are generally reported within thirty
six months of the date of the occurrence.
Losses and loss expenses are charged to income as incurred. The reserve for
unpaid losses and loss expenses represents the accumulation of case reserves,
loss expense reserves and IBNR. During the loss settlement period, additional
facts regarding individual claims and trends may be reported. As these are
reported, it may be necessary to adjust the reserves upward or downward. The
final liability may be significantly less or greater than the prior estimates.
The tables below present the development of loss and loss expense reserves
on both a net and gross basis. The cumulative redundancy (deficiency) calculated
on a net basis differs from that calculated on a gross basis. As different
reinsurance programs are applied to their respective underwriting years, net and
gross loss experience will not develop proportionately. The top line of the
tables show the estimated liability, net of reinsurance recoveries, as at the
balance sheet date for each of the indicated years. This represents the
estimated amounts of losses and loss expenses, including IBNR, arising in the
current and all prior years that are unpaid at the balance sheet date of the
indicated year. The tables show the re-estimated amount of the previously
recorded reserve liability based on expe-
11
rience as of the end of each succeeding year. The estimate changes as more
information becomes known about the frequency and severity of claims for
individual years. The cumulative redundancy (deficiency) represents the
aggregate change to date with respect to that liability originally estimated.
The lower portion of the first table also reflects the cumulative paid losses
relating to these reserves. Conditions and trends that have affected development
of liabilities in the past may not necessarily occur in the future. Accordingly,
it may not be appropriate to extrapolate future redundancies or deficiencies
based on the tables below. See "Management's Discussion and Analysis of Results
of Operations and Financial Condition - Cautionary Note Regarding
Forward-Looking Statements."
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
NET OF REINSURANCE RECOVERIES
(U.S. dollars in millions)
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
- ------------------------------------------------------------------------------------------------------------------------------------
ESTIMATED LIABILITY FOR UNPAID LOSSES AND
LOSS EXPENSES, NET OF REINSURANCE
RECOVERABLES ........................... $1,486 $1,795 $2,057 $2,482 $2,899 $3,166 $3,609 $4,303 $4,537 $4,332 $6,792
LIABILITY RE-ESTIMATED AS OF:
One year later ......................... 1,468 1,800 2,089 2,455 2,885 2,843 3,354 4,016 4,142 4,507
Two years later ........................ 1,388 1,830 2,089 2,383 2,546 2,704 3,038 3,564 4,085
Three years later ...................... 1,299 1,819 2,115 2,190 2,445 2,407 2,737 3,580
Four years later ....................... 1,303 1,891 1,972 2,085 2,214 2,227 2,658
Five years later ....................... 1,384 1,856 1,950 1,927 2,050 2,144
Six years later ........................ 1,384 1,820 1,752 1,819 2,010
Seven years later ...................... 1,392 1,644 1,739 1,823
Eight years later ...................... 1,245 1,660 1,752
Nine years later ....................... 1,294 1,689
Ten years later ........................ 1,256
CUMULATIVE REDUNDANCY (DEFICIENCY) (1) 230 106 305 659 889 1,022 951 723 452 (175)
CUMULATIVE PAID LOSSES, NET OF
REINSURANCE RECOVERIES, AS OF:
One year later ......................... $ 194 $ 267 $ 256 $ 317 $ 445 $ 234 $ 458 $ 812 $1,252 $1,184
Two years later ........................ 393 468 521 709 667 576 932 1,594 1,828
Three years later ...................... 499 689 865 921 934 932 1,404 1,928
Four years later ....................... 632 937 1,033 1,110 1,143 1,235 1,525
Five years later ....................... 831 1,102 1,198 1,199 1,356 1,313
Six years later ........................ 924 1,253 1,273 1,328 1,408
Seven years later ...................... 974 1,319 1,360 1,365
Eight years later ...................... 1,020 1,391 1,387
Nine years later ....................... 1,083 1,414
Ten years later ........................ 1,103
(1) See "Management's Discussion and Analysis of Results of Operations and
Financial Condition" for further discussion.
12
ANALYSIS OF CONSOLIDATED LOSS AND LOSS EXPENSE RESERVE DEVELOPMENT
GROSS OF REINSURANCE RECOVERABLES
(U.S. dollars in millions)
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
- ---------------------------------------------------------------------------------------------------------------------
ESTIMATED GROSS LIABILITY FOR UNPAID
LOSSES AND LOSS EXPENSES: $1,977 $2,269 $2,760 $3,238 $3,623 $3,972 $4,897 $5,369 $5,672 $11,826
LIABILITY RE-ESTIMATED AS OF:
One year later .................. 1,996 2,309 2,764 3,244 3,221 3,763 4,735 5,266 6,122
Two years later ................. 2,037 2,323 2,721 2,872 3,164 3,496 4,352 5,147
Three years later ............... 2,043 2,373 2,494 2,793 2,902 3,243 4,316
Four years later ................ 2,134 2,198 2,414 2,572 2,753 3,139
Five years later ................ 2,067 2,208 2,268 2,415 2,663
Six years later ................. 2,065 2,022 2,165 2,379
Seven years later ............... 1,903 2,010 2,177
Eight years later ............... 1,921 2,033
Nine years later ................ 1,951
CUMULATIVE REDUNDANCY (DEFICIENCY) . 26 236 583 859 960 833 581 222 (450)
The following table presents an analysis of paid, unpaid and incurred
losses and loss expenses and a reconciliation of beginning and ending unpaid
losses and loss expenses for the years indicated:
RECONCILIATION OF UNPAID LOSSES AND LOSS EXPENSES
(U.S. dollars in thousands)
2001 2000 1999
===============================================
Unpaid losses and loss expenses at beginning of year ....... $ 5,672,062 $5,369,402 $4,896,643
Unpaid losses and loss expenses recoverable ................ (1,339,767) (831,864) (593,960)
-----------------------------------------------
Net unpaid losses and loss expenses at beginning of year ... 4,332,295 4,537,538 4,302,683
Increase (decrease) in net losses and loss expenses
incurred in respect of losses occurring in:
Current year ........................................... 2,743,094 1,827,443 1,591,414
Prior years ............................................ 175,804 (394,884) (287,110)
-----------------------------------------------
Total net incurred losses and loss expenses ......... 2,918,898 1,432,559 1,304,304
Exchange rate effects ...................................... 61,598 (27,064) (5,950)
Net loss reserves acquired ................................. 1,296,362 52,932 30,003
Less net losses and loss expenses paid in respect
of losses occurring in :
Current year ........................................... 633,141 411,685 281,806
Prior year ............................................. 1,184,284 1,251,985 811,696
-----------------------------------------------
Total net paid losses ............................... 1,817,425 1,663,670 1,093,502
Net unpaid losses and loss expenses at end of year ......... 6,791,728 4,332,295 4,537,538
Unpaid losses and loss expenses recoverable ................ 5,033,952 1,339,767 831,864
-----------------------------------------------
Unpaid losses and loss expenses at end of year ............. $11,825,680 $5,672,062 $5,369,402
===============================================
Current year net losses incurred in 2001 increased significantly over 2000
mainly due to losses related to the September 11 event, where the Company has
estimated and recorded losses incurred of approximately $760.0 million, net of
reinsurance recoveries, based upon preliminary reports and estimates of loss and
damage. This preliminary estimate could change as more information becomes
available. Current year net losses incurred in 2001 also include: (i) Winterthur
International from July 1, 2001, which had net incurred losses of $241.2
million; (ii) cat-
13
astrophic and other loss events, including the bankruptcy of Enron Corp.,
several satellite losses, the Toulouse, France petrochemical plant explosion,
Tropical Storm Allison, the Petrobras oil rig loss in Brazil, the Seattle
earthquake and several other European property losses; and (iii) other growth of
the Company's operations related to new business assumed.
Prior year loss development in 2001 related primarily to continued adverse
loss development in the Company's casualty reinsurance business written for the
1997 to 1999 underwriting years. This deterioration occurred industry-wide
primarily as a result of competitive pressures on pricing. The Company recorded
adverse development for this business of approximately $180.0 million in the
fourth quarter of 2001.
In 2000, current year development reflected the growth in business assumed
over 1999, an increase in loss ratios applied due to a competitive market
environment which reduced premium rates, and also the early development of
certain losses on the Company's large account business within its insurance
operations. Historically, the Company had not experienced the reporting of such
losses at an early stage and the Company's reserving methodology for these lines
of business extrapolates these losses into the projections of future
development. If future development is eventually determined to be less than the
estimated ultimate losses recorded, loss reserves will be reduced at that time.
This occurred for the 1993 through 1996 underwriting years, resulting in a
reduction in prior year losses in 2000 and 1999.
Net losses incurred for 2000 also reflected reserve adjustments to several
unprofitable lines of business that the Company exited, including trucking,
inland energy and certain classes of aviation. A net reserve charge of $114.0
million was recorded for these lines.
The decrease in prior year incurred losses in 2000 and 1999 was driven
primarily by the Company's insurance liability excess of loss reserves. The
basis for establishing IBNR for these lines is relatively judgmental due to the
lack of industry data available. Consequently, the Company estimates loss
reserves through actuarial models based upon its own experience. When the
Company commenced writing this type of business in 1986, limited data was
available and the Company has made its best estimate of loss reserves for each
underwriting year since that time. Over time, the amount of data has increased,
providing a larger statistical base for estimating reserves. Redundancies in
prior year loss reserves have occurred where loss experience has developed more
favorably than expected. This trend did not continue in 2001 where the
competitive effect of pricing has necessitated an increase to prior year loss
reserves, particularly in the casualty lines as discussed above. In 1999, the
Lloyd's operations experienced loss deterioration on the U.K. motor business
principally from the 1998 and 1999 underwriting years of approximately $20.0
million.
Partially offsetting the increase in net incurred losses in 2000 compared
to 1999 was a reduction in the number and magnitude of catastrophe losses that
occurred. Catastrophe losses in 2000 included an oil refinery loss in Kuwait,
several satellite losses, and the Singapore Airlines loss, and totaled
approximately $95.0 million. By comparison, 1999 generated approximately $185.0
million of catastrophe losses to the Company, including the European storms in
December, hailstorms in Sydney, tornadoes in Oklahoma and satellite losses.
1999 incurred losses also included an increase to casualty reinsurance loss
reserves of $95.0 million related to an alignment of reserving methodologies at
the time of the merger with NAC in June 1999.
Net loss reserves acquired in 2001 related primarily to the acquisition of
Winterthur International. The Company has contractual post-closing protection
with respect to adverse development of reserves, including unearned premium
reserves, resulting from Winterthur International business written prior to July
1, 2001. Business in force at June 30, 2001 carries a maximum exposure to a
combined ratio of 105%. Exchange rate effects on net loss reserves in 2001 also
related primarily to Winterthur International which has several operations where
the functional currency is not the U.S dollar. Translation of loss reserves into
U.S. dollars and movements in the exchange rates, particularly the Swiss franc,
have given rise to the increase in the exchange rate effects in 2001.
The amount of paid losses increased in 2001 over 2000 due mainly to an
increase in current year loss events. However, the majority of net losses
incurred related to the September 11 event and other loss events in the fourth
14
quarter of 2001 had not been reported to the Company as paid losses by December
31, 2001. Consequently, the Company expects a higher level of paid losses in
2002 related to these 2001 loss events.
Higher paid losses in 2000 as compared to 1999 was due to the settlement of
previously established reserves, particularly catastrophe losses as noted above.
The Company's net incurred losses and loss expenses included a charge of
$21.5 million, $2.8 million and $10.6 million in 2001, 2000 and 1999,
respectively, for estimates of actual and potential non-recoveries from
reinsurers. Such charges for non-recoveries relate mainly to the September 11
event and reinsurance ceded for casualty business written prior to 1986. As at
December 31, 2001 and 2000, the reserve for potential non-recoveries from
reinsurers was $49.7 million and $25.6 million, respectively.
Except for certain workers compensation liabilities, the Company does not
discount its unpaid losses and loss expenses. The Company utilizes tabular
reserving for workers compensation unpaid losses that are considered fixed and
determinable, and discounts such losses using an interest rate of 7%. The
tabular reserving methodology results in applying uniform and consistent
criteria for establishing expected future indemnity and medical payments
(including an explicit factor for inflation) and the use of mortality tables to
determine expected payment periods. Tabular unpaid losses and loss expenses, net
of reinsurance, at December 31, 2001 and 2000 were $231.0 million and $168.8
million, respectively. The related discounted unpaid losses and loss expenses
were $98.0 million and $63.4 million as of December 31, 2001 and 2000,
respectively.
The nature of the Company's high excess of loss liability and catastrophe
business can result in loss payments that are both irregular and significant.
Similarly, adjustments to reserves for individual years can be irregular and
significant. Such adjustments are part of the normal course of business for the
Company. Conditions and trends that have affected development of liability in
the past may not necessarily occur in the future. Accordingly, it is
inappropriate to extrapolate future redundancies or deficiencies based upon
historical experience. See generally "Management's Discussion and Analysis of
Results of Operations and Financial Condition - Cautionary Note Regarding
Forward-Looking Statements".
INVESTMENTS
Management oversees the Company's investment strategy, establishes
guidelines for the various external managers and implements investment decisions
with the assistance of such managers. The current investment strategy seeks to
maximize investment income through a high-quality, diversified portfolio while
focusing on preserving principal and maintaining liquidity. In this regard, at
December 31, 2001, the Company's fixed income investment portfolio included U.S.
and non-U.S. sovereign government obligations, corporate bonds and other
securities, 63% of which were rated Aa or AA or better by a nationally
recognized rating agency. The Company also maintains a portfolio of equity
securities. Under current investment guidelines, up to 30% of the Company's
investment portfolio may be invested in equity securities. Insurance laws and
regulations may impose restrictions on the Company's investments whereby certain
types of investments such as unquoted equity securities, investments in
affiliates, real estate and collateral loans may not qualify as admitted assets.
The Company did not have an aggregate investment in a single entity, other than
the U.S. government, in excess of 10% of shareholders' equity at December 31,
2001 or 2000.
For additional information concerning the Company's investments, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Investment Operations".
15
The following table reflects investment results for the Company for each of
the five years in the period ended December 31, 2001:
NET PRE-TAX ANNUALIZED
AVERAGE INVESTMENT EFFECTIVE
YEAR ENDED DECEMBER 31 INVESTMENTS (1) INCOME (2) YIELD
- ---- ----------- -------- ----
(U.S. DOLLARS IN THOUSANDS)
2001 ................................ $11,053,110 $562,606 5.09%
2000 ................................ $ 9,058,811 $542,500 5.99%
1999 ................................ $ 8,981,833 $525,318 5.85%
1998 ................................ $ 7,762,931 $417,290 5.38%
1997 ................................ $ 6,274,946 $345,115 5.50%
(1) Average of the beginning and ending amounts of investments and cash and
cash equivalents net of pending trades for the period. Investment
securities are carried at market value.
(2) After applicable investment expenses, excluding net realized gains and
losses on investments and net realized and unrealized gains and losses on
derivative instruments.
The Company continues to build a diversified program of ownership positions
in specialty investment managers and the investment funds they manage across the
full spectrum of the capital markets. The Company's strategy is to build
relationships with selected smaller firms that typically will include the
Company taking a minority equity position in the investment management
organization and in the funds they manage. The Company will continue to develop
additional opportunities in this area.
The Company also has an asset accumulation strategy whereby it assumes loss
portfolios recorded as deposit liabilities that are matched by an equivalent
amount of investments.
RATINGS
The Company's ability to underwrite business is largely dependent upon the
quality of its claims paying and financial strength ratings as evaluated by
independent agencies. The Company's principal insurance and reinsurance
subsidiaries and pools have claims paying ratings of AA from S&P, Aa from
Moody's and A+ from A.M. Best Company, Inc ("A.M. Best"). The Company's
financial guaranty insurance and reinsurance companies each have AAA or Aaa
ratings from S&P, Moody's, and Fitch Ratings ("Fitch"). An insurer rated AA by
S&P has very strong financial security characteristics, differing only slightly
from those rated higher. An insurer rated AAA or equivalent by S&P, Moody's and
Fitch has extremely strong financial security characteristics. An insurer rated
A+ by A.M. Best has superior financial strength, operating performance and
market profile when compared to standards established by A.M. Best, and have a
very strong ability to meet their ongoing obligations to policyholders.
TAX MATTERS
See Item 8, Note 21 to the Consolidated Financial Statements.
REGULATION
See Item 8, Note 22 to the Consolidated Financial Statements.
EMPLOYEES
At December 31, 2001, the Company employed approximately 2,700 employees.
At that date, approximately 130 of the Company's employees were represented by
unions or workers' councils and approximately 40 of the Company's employees were
subject to collective bargaining agreements. The Company believes that it has a
good relationship with its employees.
16
ITEM 2. PROPERTIES
In 1997, the Company acquired commercial real estate in Bermuda for the
purpose of securing long-term office space for its worldwide headquarters. The
development was completed in April 2001. The total cost of this development,
including the land, was approximately $125.0 million. The Company also rents
space at its other worldwide locations. Total rent expense for the years ended
December 31, 2001, 2000 and 1999 was approximately $18.9 million, $18.3 million
and $13.0 million, respectively. See Item 8, Note 15(e) to the Consolidated
Financial Statements for discussion of the Company's lease commitments.
ITEM 3. LEGAL PROCEEDINGS
The Company, in common with the insurance and reinsurance industry in
general, is subject to litigation and arbitration in the normal course of its
business. As of December 31, 2001, the Company was not a party to any material
litigation or arbitration other than as part of the ordinary course of business
in relation to claims activity, none of which is expected by management to have
a significant adverse effect on the Company's results of operation and financial
condition and liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the fourth
quarter of the fiscal year covered by this report.
EXECUTIVE OFFICERS OF THE COMPANY
The table below sets forth the names, ages and titles of the persons who
were the executive officers of the Company for the year ended December 31, 2001:
NAME AGE POSITION
- --------------------------------------------------------------------------------
Brian M. O'Hara ........... 53 President, Chief Executive Officer and Director
Fiona E. Luck ............. 44 Executive Vice President, Group Operations and
Assistant Secretary
Jerry M. de St. Paer ...... 60 Executive Vice President, Chief Financial
Officer, Treasurer and Assistant Secretary
Paul S. Giordano .......... 39 Executive Vice President, General Counsel
and Secretary
Christopher V. Greetham ... 57 Executive Vice President and Chief Investment
Officer
K. Bruce Connell .......... 49 Executive Vice President and Group Underwriting
Officer
Nicholas M. Brown, Jr ..... 47 Executive Vice President of the Company and
Chief Executive of Insurance Operations
Henry C.V. Keeling ........ 46 Executive Vice President of the Company and
Chief Executive of Reinsurance Operations
Robert R. Lusardi ......... 45 Executive Vice President of the Company and
Chief Executive of Financial Products and
Services Operations
Brian M. O'Hara has been President and Chief Executive Officer of the
Company since 1994 and a Director of the Company since 1986, having previously
served as Vice Chairman of the Company from 1987. He is Chairman of XL Insurance
(Bermuda) Ltd and XL Re Ltd and was Chief Executive Officer of XL Insurance
(Bermuda) Ltd until 1998, having previously served as Chairman, President and
Chief Executive Officer from 1994, President and Chief Executive Officer from
1992, and as President and Chief Operating Officer from 1986.
Fiona E. Luck has been Executive Vice President of Group Operations of the
Company since July 1999 and Assistant Secretary since January 2002. Ms. Luck was
previously employed at ACE Bermuda as Executive Vice President from 1998, and
Senior Vice President
17
from 1997. From 1992 to 1997, Ms. Luck was the Managing Director of the Marsh &
McLennan Global Broking office in Bermuda.
Jerry M. de St. Paer was appointed to the position of Executive Vice
President and Chief Financial Officer of the Company on February 14, 2001,
succeeding Robert R. Lusardi. Mr. de St. Paer was appointed Treasurer and
Assistant Secretary of the Company in January 2002. Mr. de St. Paer was
previously Managing Director of Hudson International Advisors in New York. Prior
to forming Hudson International in 1998, he served as Managing Director,
Insurance at J.P. Morgan & Company, Inc. Mr. de St. Paer was previously employed
at The Equitable (now AXA Financial Advisors), from 1986 until 1997, serving
most recently as Senior Executive Vice President and Chief Financial Officer of
The Equitable and as Executive Vice President of Strategic Studies and
Development of the AXA Groupe.
Paul S. Giordano has been Executive Vice President and General Counsel of
the Company since June 1999. Mr. Giordano served as Senior Vice President since
January 1997 and was appointed Secretary of the Company on December 31, 1997.
Mr. Giordano was associated with Cleary, Gottlieb, Steen & Hamilton and Clifford
Chance in New York and London prior to joining the Company.
Christopher V. Greetham has been Executive Vice President of the Company
since December 1998 and has served as Chief Investment Officer of the Company
since 1996. Prior to joining the Company, Mr. Greetham served as Senior Vice
President and Chief Financial Officer of OIL Insurance Ltd from 1982 to 1996 and
as Vice President of Bankers Trust Company from 1975 to 1982.
K. Bruce Connell has been Executive Vice President of the Company since
March 1998 and Group Underwriting Officer since July 2000. Mr. Connell
previously served as President and Chief Operating Officer of XL Global Re from
November 1997 to August 1998, President of XL Global Re since December 1995 and
Senior Vice President of XL Insurance (Bermuda) Ltd from 1990 to 1995.
Nicholas M. Brown, Jr. has been Executive Vice President of the Company
since July 1999 and Chief Executive of Insurance operations since July 2000. He
was President and Chief Executive Officer of NAC Re Corp, (now known as XL
America) from January 1999, having previously served as President and Chief
Operating Officer of NAC Re Corp and President and Chief Executive Officer of
NAC Re (now known as XL Re America) from 1996. Prior to joining XL Re America,
Mr. Brown served as Executive Vice President and Chief Operating Officer of St.
Paul Fire and Marine Insurance Company from 1994 to 1996 and as President of St.
Paul Specialty from 1993 to 1994. From 1976 through 1993, he served in various
positions at Aetna Life and Casualty Companies.
Henry C.V. Keeling has been Executive Vice President of the Company and
Chief Executive of XL Re since August 1998. He was appointed Chief Executive
Officer of Reinsurance operations in July 2000. Mr. Keeling was President and
Chief Operating and Underwriting Officer of Mid Ocean Re (now known as XL Re
Ltd) from 1992 to 1998. He previously served as a director of Taylor Clayton
(Underwriting Agencies) Ltd and deputy underwriter for syndicate 51 at Lloyd's
from 1984 through 1992.
Robert R. Lusardi has been Executive Vice President of the Company since
February 1998, and Chief Executive Officer of Financial Products and Services
Operations since July 2000. Mr. Lusardi served as Chief Financial Officer of the
Company from 1998 through February 2001. Prior to joining the Company, Mr.
Lusardi was Managing Director at Lehman Brothers from 1980 to 1998.
18
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
(a) The Company's Class A ordinary shares, $0.01 par value, are listed on
the New York Stock Exchange under the symbol XL.
The following table sets forth the high, low and closing sales prices per
share of the Company's Class A ordinary shares per fiscal quarter, as reported
on the New York Stock Exchange Composite Tape.
HIGH LOW CLOSE
-----------------------------
2001:
1st Quarter ............ $87.500 $67.600 $76.070
2nd Quarter ............ 83.600 67.180 82.100
3rd Quarter ............ 83.000 62.000 79.000
4th Quarter ............ 96.120 79.500 91.360
2000:
1st Quarter ............ $55.375 $39.563 $55.375
2nd Quarter ............ 61.000 45.750 54.125
3rd Quarter ............ 78.188 54.938 74.000
4th Quarter ............ 88.563 69.375 87.375
Each Class A ordinary share has one vote, except that if, and so long as,
the Controlled Shares (defined below) of any person constitute ten percent (10%)
or more of the issued Class A ordinary shares, the voting rights with respect to
the Controlled Shares owned by such person are limited, in the aggregate, to a
voting power of approximately 10%, pursuant to a formula specified in the
Articles of Association. "Controlled Shares" includes, among other things, all
Class A ordinary shares for which such person is deemed to beneficially own
directly, indirectly or constructively (within the meaning of Section 13(d)(3)
of the Securities Exchange Act of 1934).
(b) The number of record holders of ordinary shares as of December 31, 2001
was 614.
(c) In 2001, four regular quarterly dividends were paid at $0.46 per share
to all shareholders of record on February 15, May 25, August 15 and November 30.
In 2000, four regular quarterly dividends were paid at $0.45 per share to all
shareholders of record on February 15, May 25, August 15 and November 15.
The declaration and payment of future dividends by the Company will be at
the discretion of the Board of Directors and will depend upon many factors,
including the Company's earnings, financial condition, business needs, capital
and surplus requirements of the Company's operating subsidiaries and regulatory
restrictions.
As a holding company, the Company's principal source of income is dividends
or other statutorily permissible payments from its subsidiaries. The ability to
pay such dividends is limited by the applicable laws and regulations of the
various countries that the Company operates in, including Bermuda, the United
States, and the U.K., and those of the Society of Lloyd's. See Item 8, Note 22
to the Consolidated Financial Statements for further discussion.
(d) Rights to purchase Class A ordinary shares ("the Rights") were
distributed as a dividend at the rate of one Right for each Class A ordinary
share held of record as of the close of business on October 31, 1998. Each Right
entitles holders of Class A ordinary shares to buy one ordinary share at an
exercise price of $350. The Rights would be exercisable, and would detach from
the Class A ordinary shares, only if a person or group were to acquire 20% or
more of the Company's outstanding Class A ordinary shares, or were to announce a
tender or exchange offer that, if consummated, would result in a person or group
beneficially owning 20% or more of Class A ordinary shares. Upon a person or
group without prior approval of the Board acquiring 20% or more of Class A
ordinary shares, each Right would entitle the holder (other than such an
acquiring person or group) to purchase Class A ordinary shares (or, in certain
circumstances, Class A ordinary shares of the acquiring person) with a value of
twice the Rights
19
exercise price upon payment of the Rights exercise price. The Company will be
entitled to redeem the Rights at $0.01 per Right at any time until the close of
business on the tenth day after the Rights become exercisable. The Rights will
expire at the close of business on September 30, 2008, and do not initially have
a fair value. The Company has initially reserved 119,073,878 Class A ordinary
shares being authorized and unissued for issue upon exercise of Rights.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data below is based upon the Company's
fiscal year end of December 31. The selected consolidated financial data should
be read in conjunction with the Consolidated Financial Statements and the Notes
thereto presented under Item 8.
2001 2000 1999 1998 1997
------------------------------------------------------------------
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
INCOME STATEMENT DATA:
Net premiums earned -
general operations ................. $ 2,779,927 $ 2,035,240 $ 1,750,006 $ 1,324,291 $1,114,758
Net premiums earned -
life operations .................... 695,595 -- -- -- --
Net investment income .................. 562,606 542,500 525,318 417,290 345,115
Net realized (losses) gains
on investments ..................... (93,237) 45,090 66,800 212,910 309,817
Net realized and unrealized (losses)
gains on derivative instruments .... (12,176) 5,481 27,566 (1,706) 100,841
Equity in net income of
investment affiliates .............. 80,580 70,032 43,865 811 1,283
Fee income and other ................... 43,464 14,793 100,400 22,325 --
Net losses and loss expenses incurred -
general operations ................. 2,918,898 1,432,559 1,304,304 841,517 738,849
Claims and policy benefit reserves -
life operations .................... 698,675 -- -- -- --
Acquisition costs, operating expenses
and exchange gains and losses ....... 1,073,903 743,067 689,005 436,598 318,107
Interest expense ....................... 65,350 32,147 37,378 33,444 29,622
Amortization of intangible assets ...... 58,569 58,597 49,141 26,881 7,403
(Loss) income before minority interest,
equity in net income of insurance
affiliates and income tax expense .. (758,636) 446,766 434,117 637,481 777,833
Net (loss) income ...................... (576,135) 506,352 470,509 656,330 809,029
PER SHARE DATA:
Net income per share - basic (2) ....... $ (4.55) $ 4.07 $ 3.69 $ 5.86 $ 7.95
Net income per share - diluted (2) ..... $ (4.55) $ 4.03 $ 3.62 $ 5.68 $ 7.74
Weighted average shares
Outstanding - basic (2) ................ 126,676 124,503 127,601 112,034 101,708
Weighted average shares
Outstanding - diluted (2) .............. 126,676 125,697 130,304 116,206 105,005
Cash dividends per share (3) ........... $ 1.84 $ 1.80 $ 1.76 $ 1.64 $ 1.36
20
2001 2000 1999 1998 1997
------------------------------------------------------------------
(U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
BALANCE SHEET DATA:
Total investments available for sale ... $12,429,845 $ 9,501,548 $ 9,122,591 $ 9,057,892 $6,562,609
Cash and cash equivalents .............. 1,863,861 930,469 557,749 480,874 383,594
Investments in affiliates .............. 1,037,344 792,723 479,911 154,668 524,866
Unpaid losses and loss expenses
recoverable ........................ 5,033,952 1,339,767 831,864 593,960 363,716
Total assets ........................... 27,963,075 16,941,952 15,090,912 13,581,140 9,070,031
Unpaid losses and loss expenses ........ 11,825,680 5,672,062 5,369,402 4,896,643 3,972,376
Notes payable and debt ................. 1,604,877 450,032 410,726 613,873 453,866
Shareholders' equity ................... 5,437,184 5,573,668 5,577,078 5,612,603 3,195,749
Book value per share ................... $ 40.35 $ 44.58 $ 43.64 $ 43.59 $ 31.55
Fully diluted book value per share ..... $ 40.35 $ 44.58 $ 43.13 $ 43.20 $ 31.42
OPERATING RATIOS:
Loss and loss expense ratio (4) ........ 105.0% 70.4% 74.5% 63.5% 66.3%
Underwriting expense ratio (5) ......... 34.9% 36.4% 34.3% 30.3% 27.9%
Combined ratio (6) ..................... 139.9% 106.8% 108.8% 93.8% 94.2%
(1) All information for 1999 and prior years includes the results of NAC as
though it had always been a part of the Company.
(2) Net income per share is based on the basic and diluted weighted average
number of ordinary shares and ordinary share equivalents outstanding for
each period. Net loss per share is based on the basic weighted average
number of ordinary shares outstanding.
(3) Cash dividends per share for 1999 and prior years have not been adjusted
for the pooling effect of NAC.
(4) The loss and loss expense ratio is calculated by dividing the losses and
loss expenses incurred by the net premiums earned for general operations.
(5) The underwriting expense ratio is the sum of acquisition expenses and
operating expenses divided by net premiums earned on general operations.
Operating expenses relating to the corporate segment and foreign exchange
gains and losses have not been included for purposes of calculating the
underwriting expense ratio. See Item 8, Note 3 to the Consolidated
Financial Statements for further information.
(6) The combined ratio is the sum of the loss and loss expense ratio and the
underwriting expense ratio. A combined ratio under 100% represents an
underwriting profit and over 100% represents an underwriting loss.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
GENERAL
The following is a discussion of the Company's results of operations and
financial condition. Certain aspects of the Company's business have loss
experience characterized as low frequency and high severity. This may result in
volatility in both the Company's results of operations and financial condition.
The Company's results for the year ended December 31, 2001 include the
results of Winterthur International with effect from July 1, 2001. The audited
financial statements of Winterthur International as at June 30, 2001, on which
the final purchase price will be based, are not expected to be completed until
later in 2002, at which time any final adjustments will be made. See Item 8,
Note 5 to the Consolidated Financial Statements for further information.
The Company's results for 2001 also include the effects of terrorist
attacks at the World Trade Center in New York City, in Washington, D.C. and in
Pennsylvania on September 11, 2001 (collectively, the "September 11 event"). See
Item 8, Note 4 to the Consolidated Financial Statements for further information.
21
Information presented for 1999 is the combination of the results formerly
presented by the Company and NAC, as required for a business combination
accounted for by the pooling of interests method, which assumes NAC had always
been a part of the Company. See Item 8, Note 5 to the Consolidated Financial
Statements for further information.
As part of the Company's strategy to expand its life business, the Company
assumed a large portfolio of long duration annuity reserves in the fourth
quarter of 2001. Life premiums earned are presented separately in the Company's
segment results. Life business currently includes life and annuity business that
transfers significant mortality and morbidity risks.
As a result of the above, period to period comparisons may not be
meaningful.
This "Management's Discussion and Analysis of Results of Operations and
Financial Condition" contains forward-looking statements which involve inherent
risks and uncertainties. Statements that are not historical facts, including
statements about the Company's beliefs and expectations, are forward
looking-statements. These statements are based upon current plans, estimates and
expectations. Actual results may differ materially from those projected in such
forward-looking statements, and therefore undue reliance should not be placed on
them. See " - Cautionary Note Regarding Forward-Looking Statements" for a list
of additional factors that could cause actual results to differ materially from
those contained in any forward-looking statement.
This discussion and analysis should be read in conjunction with the
audited Consolidated Financial Statements and Notes thereto presented under Item
8.
CRITICAL ACCOUNTING POLICIES
The following are considered to be the Company's critical accounting
policies due to the judgments and uncertainties affecting the application of
these policies and/or the likelihood that materially different amounts would be
reported under different conditions or using different assumptions. If actual
events differ significantly from the underlying assumptions or estimates applied
for any or all of the accounting policies (either individually or in the
aggregate), there could be a material adverse effect on the Company's results of
operations and financial condition and liquidity.
Other significant accounting policies are nevertheless important to an
understanding of the Company's Consolidated Financial Statements. Policies such
as those related to revenue recognition, financial instruments and consolidation
require difficult judgments on complex matters that are often subject to
multiple sources of authoritative guidance. Certain of these matters are among
topics currently under reexamination by accounting standard setters and
regulators. See Item 8, Note 2 to the Consolidated Financial Statements.
LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses includes reserves for unpaid reported
losses and loss expenses and for losses incurred but not reported. The reserve
for unpaid reported losses and loss expenses is established by management based
on amounts reported from insureds or ceding companies and consultation with
independent legal counsel, and represents the estimated ultimate cost of events
or conditions that have been reported to or specifically identified by the
Company.
The reserve for losses incurred but not reported has been estimated by
management and reviewed by independent actuaries, based on loss development
patterns determined by reference to the Company's underwriting practices, the
policy form, type of insurance program and the experience of the relevant
industries.
Specifically, several aspects of the Company's casualty insurance
operations complicate the actuarial reserving techniques for loss reserves as
compared to other companies. These complications include policy forms that
differ from more traditional forms, the lack of historical loss data for losses
of the type intended to be covered by the policies, and the fact that losses in
excess of the attachment level of the Company's policies are characterized by
low
22
frequency and high severity, limiting the utility of claims experience of other
insurers for similar claims. While management believes the reserves for unpaid
losses and loss expenses are sufficient to cover losses that fall within
coverages assumed by the Company, the ultimate claims experience may not be as
reliably predicted as may be the case with other insurance operations, and there
can be no assurance that ultimate losses and loss expenses will not exceed the
total reserves.
The methodology of estimating loss reserves is periodically reviewed to
ensure that the assumptions made continue to be appropriate and any adjustments
resulting therefrom are reflected in income of the year in which the adjustments
are made.
The establishment of unpaid loss and loss expense reserves also includes
reinsurance recoveries. Due to the size of the gross losses arising from the
September 11 event and the related reinsurance recoveries and the magnitude of
the September 11 event on the reinsurance industry, the Company, in addition to
its normal review process, further analyzed the recoverability of these assets.
Approximately 96% of the relevant reinsurers currently fall into Standard &
Poor's financial strength rating categories or equivalent of A or better, with
approximately 65% rated AA or better. Accordingly, the Company believes that
substantially all insurance will be recoverable. An allowance has been
established for estimated uncollectible recoverables.
DERIVATIVE INSTRUMENTS AND WEATHER RISK MANAGEMENT PRODUCTS
The Financial Accounting Standards Board issued FAS 133, "Accounting for
Derivative Instruments and Hedging Activities" in June 1998. FAS 133 establishes
accounting and reporting standards for derivative instruments including those
embedded in other contracts (collectively referred to as derivatives), and for
hedging activity. It requires an entity to recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at fair
value. Non-exchange traded weather products are not covered by FAS 133, however
are also recorded at fair value. The Company adopted FAS 133, as amended, as of
January 1, 2001. The Company conducts activities in three main types of
instruments: credit default swap derivatives, weather risk management products
and investment related derivative instruments. There was no significant impact
from the adoption of FAS 133. See Item 8, Note 14 for further information on
these derivative instruments.
CREDIT DEFAULT SWAPS
The Company considers credit default swaps to be, in substance, financial
guaranty contracts as the Company intends to hold them to maturity. Fair value
is determined using a model developed by the Company and is dependent upon a
number of factors, including changes in interest rates, credit spreads, changes
in credit quality and other market factors. The change in fair value in a period
is split between premiums, net losses and loss expenses, and net realized and
unrealized gains and losses on derivative instruments. The change resulting from
movements in credit spreads is unrealized as the credit default swaps are not
traded to realize this value and is included in net realized and unrealized
gains and losses on derivative instruments. Other elements of the change in fair
value are based upon pricing established at the inception of the contract. Prior
to the adoption of FAS 133, the net premiums earned and loss and loss expenses
were included in fee income and other.
WEATHER RISK MANAGEMENT PRODUCTS
Weather risk management products are recorded at fair value with the
changes in fair value included in fee income and other. Fair value is determined
using a quantitative analytical model developed by the Company and is dependent
upon a number of factors including, among others, realized weather results,
forecasted weather conditions, changes in interest rates and other market
factors.
INVESTMENT RELATED DERIVATIVE INSTRUMENTS
The Company uses investment derivatives to manage duration and currency
exposure for its investment portfolio. None of these investment derivatives are
designated hedges, and accordingly, financial futures, options and forward
currency contracts are carried at fair value, with the corresponding realized
and unrealized gains and losses included in net realized gains and losses on
derivative instruments.
23
OTHER THAN TEMPORARY DECLINES IN INVESTMENTS AND OTHER INVESTMENTS
Investments are reviewed periodically to determine if they have sustained
an impairment of value that is considered to be other than temporary. The
identification of potentially impaired investments involves significant
management judgment, which includes the determination of their fair value and
the assessment of whether any decline in value is other than temporary. If
investments are determined to be impaired, a realized loss is recognized. The
current economic environment and recent volatility of securities markets
increase the difficulty in determining impairment. For other investments that
are not quoted, fair value is determined using the financial information
received and other economic and market knowledge as appropriate.
INCOME TAXES
The Company utilizes the asset and liability method of accounting for
income taxes. Under this method, deferred income taxes reflect the net tax
effect of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. The deferral of tax losses is evaluated based upon management's
estimates of the future profitability of the Company's taxable entities based on
current forecasts. A valuation allowance is established for any portion of a
deferred tax asset that management believes will not be realized. Should the
taxable income of these entities fall below expectations, a further valuation
allowance would have to be established, which could be significant. In addition,
if any further losses are generated by these entities, these losses may not be
tax effected.
INTANGIBLE ASSETS
Intangible assets are carried at estimated fair value, which is typically
less than the value based on undiscounted operating earnings. There are many
assumptions and estimates underlying fair value. Other assumptions could produce
a significantly different result.
RESULTS OF OPERATIONS
The following table presents an after-tax analysis of the Company's net
income for the years ended December 31, 2001, 2000 and 1999 (U.S. dollars in
thousands, except per share amounts):
2001 2000 1999
------------------------------
Net operating (loss) income (1) ............... $(465,186) $442,932 $370,809
Net realized (losses) gains on investments .... (98,773) 57,939 72,144
Net realized and unrealized (losses) and
gains on derivative instruments ............ (12,176) 5,481 27,556
------------------------------
Net (loss) income ............................. $(576,135) $506,352 $470,509
==============================
(Loss) Earnings per share - basic ............. $ (4.55) $ 4.07 $ 3.69
(Loss) Earnings per share - diluted (2) ....... $ (4.55) $ 4.03 $ 3.62
Weighted average number of ordinary shares
and ordinary share equivalents - Basic ..... 126,676 124,503 127,601
Weighted average number of ordinary shares
and ordinary share equivalents -
Diluted (2) ................................ 126,676 125,697 130,304
(1) Net operating (loss) income excludes after-tax net realized gains and
losses on investments and net realized and unrealized gains and losses on
derivative instruments.
(2) Average stock options outstanding have been excluded where anti-dilutive to
earnings per share.
Net operating income decreased significantly in 2001 primarily due to net
losses arising from the September 11 event. Losses were mainly incurred on the
property, aviation, personal accident and business interruption lines. Both the
insurance and reinsurance segments were affected by this event. The Company's
results for 2001 also
24
include the effects of terrorist attacks at the World Trade Center in New York
City, in Washington, D.C. and in Pennsylvania on September 11, 2001
(collectively, the "September 11 event"). While this loss has been provided for,
it is management's best estimate at this time and could change significantly as
more information becomes available. See Item 8, Note 4 to the Consolidated
Financial Statements.
The following is an analysis of the underwriting profit or loss by segment
for the year ended December 31, 2001, first including the effects of the
September 11 event and then excluding the effect of the September 11 event (U.S.
dollars in thousands):
YEAR ENDED DECEMBER 31, 2001 INCLUDING THE EFFECTS OF THE
SEPTEMBER 11 EVENT:
FINANCIAL
LLOYD'S PRODUCTS AND
GENERAL OPERATIONS: INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
--------------------------------------------------------------------
Net premiums earned .......................... $1,222,196 $ 481,307 $1,029,618 $46,806 $ 2,779,927
Fee income and other ......................... 22,065 (3,707) (7,180) 32,286 43,464
Net losses and loss expenses ................. 859,812 610,823 1,428,772 19,491 2,918,898
Acquisition costs ............................ 187,443 155,804 292,069 3,730 639,046
Operating expenses ........................... 178,530 22,215 87,169 42,404 330,318
Exchange losses .............................. 4,924 3,198 4,062 -- 12,184
LIFE OPERATIONS:
Life premiums earned ......................... -- -- 695,595 -- 695,595
Claims and policy benefit reserves ........... -- -- 698,675 -- 698,675
---------------------------------------------------------------------
Underwriting profit (loss) ................... $ 13,552 $(314,440) $ (792,714) $13,467 $(1,080,135)
Loss and loss expense ratio .................. 70.4% 126.9% 138.8% 41.6% 105.0%
Underwriting expense ratio ................... 29.9% 37.0% 36.8% 98.6% 34.9%
---------------------------------------------------------------------
Combined ratio ............................... 100.3% 163.9% 175.6% 140.2% 139.9%
---------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2001 EXCLUDING THE EFFECTS OF THE SEPTEMBER 11 EVENT:
FINANCIAL
LLOYD'S PRODUCTS AND
GENERAL OPERATIONS: INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
--------------------------------------------------------------------
Net premiums earned .......................... $1,226,096 $ 502,707 $1,150,018 $46,806 $ 2,925,627
Fee income and other ......................... 22,065 (3,707) (7,180) 32,286 43,464
Net losses and loss expenses ................. 757,762 395,023 986,622 19,491 2,158,898
Acquisition costs ............................ 187,443 155,804 292,069 3,730 639,046
Operating expenses ........................... 178,530 22,215 87,169 42,404 330,318
Exchange (gains) losses ...................... 4,924 3,198 4,062 -- 12,184
LIFE OPERATIONS:
Life premiums earned ......................... -- -- 695,595 -- 695,595
Claims and policy benefit reserves ........... -- -- 698,675 -- 698,675
---------------------------------------------------------------------
Underwriting profit (loss) ................... $ 119,502 $ (77,240) $ (230,164) $13,467 $ (174,435)
Loss and loss expense ratio .................. 61.8% 78.6% 85.8% 41.6% 73.8%
Underwriting expense ratio ................... 29.8% 35.4% 33.0% 98.6% 33.1%
--------------------------------------------------------------------
Combined ratio ............................... 91.6% 114.0% 118.8% 140.2% 106.9%
25
In addition, net losses incurred in the year ended December 31, 2001
included adverse prior period loss development on the 1997 through 1999
underwriting years of the reinsurance casualty book, the bankruptcy of Enron
Corp. and related matters of approximately $75.0 million, and other large losses
including the Sri Lanka airport loss, satellite losses, the Toulouse, France
petrochemical plant explosion, the Petrobras oil rig in Brazil and Tropical
Storm Allison. The components of these loss events are discussed within each
segment. In the year ended December 31, 2000, total losses incurred from all
catastrophic events were not as large as those experienced in 2001 or 1999.
Net loss in 2001 was also affected by significant amount of investment and
derivative losses. This is discussed further under " - Investment Activities".
Net income increased in 2000 compared to 1999 due to an increase in net
investment income, equity in net income of affiliates and exchange gains and
losses. This increase was partially offset by an increase in the underwriting
loss. In 2000, the Company incurred after-tax charges of $124.6 million, or
$0.98 per share, which included certain reserve adjustments together with
employee severance charges and other costs associated with the realignment of
the Company's operations and the discontinuation of certain business lines.
These charges affected the underwriting results across the Company's insurance
and reinsurance segments. In 1999, the Company incurred losses of $125.0 million
after-tax, or $0.97 per share, as a result of two major European windstorms in
December 1999. In addition, 1999 included an increase to reserves of $95.0
million associated with the merger with NAC.
The Company issued 9.2 million common shares on November 7, 2001, which did
not significantly dilute the weighted average shares outstanding for 2001.
During 2002, the weighted average shares will increase significantly as the 9.2
million shares will be weighted for the full year.
Basic and diluted earnings per share increased in 2000 as compared to 1999
due to both an increase in net income and a reduction in the weighted average
number of shares outstanding. The decrease in the weighted average number of
shares outstanding in 2000 is a result of the Company repurchasing 5.1 million
shares during the year.
SEGMENTS
The Company is organized into three underwriting segments - insurance,
reinsurance, and financial products and services - and a corporate segment,
which includes the investment operations of the Company. Lloyd's syndicates are
included in the insurance segment but are shown separately. See Item 1 and Item
8, Note 3 to the Consolidated Financial Statements for further information.
INSURANCE OPERATIONS - EXCLUDING LLOYD'S SYNDICATES
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
% CHANGE % CHANGE
GENERAL: 2001 01 VS 00 2000 00 VS 99 1999
-------------------------------------------------------------
Net premiums earned ................................ $1,222,196 68.2% $726,506 56.9% $463,069
Fee income and other ............................... 22,065 186.9% 7,692 1.4% 7,584
Losses and loss expenses ........................... 859,812 71.0% 502,898 62.7% 309,079
Acquisition costs .................................. 187,443 60.0% 117,251 79.5% 65,318
Operating expenses ................................. 178,530 90.0% 94,129 32.4% 71,094
Exchange losses (gains) ............................ 4,924 NM (2,344) NM (165)
--------------------------------------------------------------
Underwriting profit ................................ $ 13,552 (39.1)% $ 22,264 (12.1)% $ 25,327
==============================================================
Net unrealized gains on credit default swaps ....... $ 14,738 NM -- NM --
==============================================================
NM= Not Meaningful
Effective July 1, 2001, the insurance segment included the results of
Winterthur International. Each of the above line items experienced growth
primarily as a result of the inclusion of business written and earned by
Winterthur International. Consequently, period to period comparisons may not be
meaningful.
26
Excluding Winterthur International, net premiums earned increased in the
year ended December 31, 2001 over 2000 due to new business written and price
increases. This resulted in an increase in net premiums earned from
environmental business of $85.0 million, professional lines of $50.0 million and
aviation and satellite business of $60.0 million. This was partially offset by
decreases in net premiums earned from business discontinued in 2000. Net
premiums earned by Winterthur International totaled $353.1 million. Net premiums
earned are expected to increase on all lines in 2002 mainly due to the growth in
gross premiums written subsequent to September 11 and a full year's results of
Winterthur International.
Growth in net premiums earned in 2000 over 1999 is mainly due to new
business, primarily environmental business, written by ECS. ECS contributed
approximately $110.0 million in net premiums earned in 2000. No premiums were
earned by ECS in 1999 as ECS only commenced writing business on behalf of the
Company with effect from January 1, 2000. Prior to this date, ECS had agency
agreements in place with other companies. In addition, the Company wrote
aviation and satellite business totaling $60.0 million in net premiums earned.
In 1999, this business was written on behalf of the Lloyd's syndicates, of which
the Company's share was approximately $11.5 million in net premiums earned. 2000
also included approximately $25.0 million in net premiums earned of new
professional liability business written.
Fee income and other for the year ended December 31, 2001 includes $9.1
million related to Winterthur International for the provision of consulting and
administration services for employee benefit plans of unrelated companies. In
2000, fee income and other related primarily to the provision of risk management
and other consulting services provided by ECS.
The decrease in the underwriting profit in each year in this segment is due
to higher loss and loss expense ratios as shown below. The following table
presents the ratios for this segment for each of the three years ended December
31:
2001 2000 1999
---------------------------
Loss and loss expense ratio ............. 70.4% 69.2% 66.7%
Underwriting expense ratio .............. 29.9% 29.1% 29.5%
---------------------------
Combined ratio .......................... 100.3% 98.3% 96.2%
============================
The loss ratio was higher in the year ended December 31, 2001 compared to
2000 due primarily to net losses of $102.0 million incurred related to the
September 11 event. This loss was partially offset by favorable loss development
from prior accident years. There were no significant catastrophic loss events
for this segment in the year ended December 31, 2000. In addition, the 2001 loss
ratio increased primarily as a result of the inclusion of losses related to the
inclusion of Winterthur International effective July 1, 2001. Business in force
at June 30, 2001 for Winterthur International carries a maximum exposure to a
combined ratio of 105%. As described in Note 5 to the Consolidated Financial
Statements, the accounting for the purchase of Winterthur International required
the Company to fair value the acquired assets and liabilities on June 30, 2001.
The fair value adjustment to the loss reserves resulted in an accretion of
discount for the year ended December 31, 2001 of $1.4 million.
The loss and loss expense ratio in 2000 and 1999 includes the effects of an
intercompany stop loss arrangement with a subsidiary in the reinsurance segment.
There was no such arrangement in place in 2001. Losses incurred related to this
arrangement were $33.5 million and $100.0 million in 2000 and 1999,
respectively. Had this arrangement not been in place, the loss and loss expense
ratio would have been 64.6% and 45.2% in 2000 and 1999, respectively. The
increase in the loss ratio in 2000 over 1999 is due to several factors. In 2000,
the Company applied higher loss ratios to certain of its casualty lines written
in 2000. These loss ratios have been actuarially estimated and reflect the
continued negative impact that competitive market conditions have had on rates
for these lines of business written in 2000. There was a reduction of loss
reserves in 1999 established on the Company's liability lines due to updated
actuarially determined reserve estimates that reflected the favorable
development of these lines relating to prior years. Loss reserve adjustments
were made in 2000 as discussed previously. Partially offsetting the increases in
2000 were additional reductions in loss reserves related to liability lines
written in prior years.
27
The underwriting expense ratio increased slightly in the year ended
December 31, 2001 compared to 2000 due to the reallocation of certain operating
expenses from the reinsurance segment to insurance segment and a general
expansion of operations. Winterthur International acquisition costs and
operating expenses were $47.8 million and $69.8 million, respectively,
representing an expense ratio of 33.3%. The expense ratio was reduced by the
effect of purchase accounting treatment on the acquisition costs of Winterthur
International. Had an historical level of deferred acquisition costs been
amortized, the expense ratio for the segment would have been 31.4% in the year
ended December 31, 2001. The expense ratio will continue to be affected by this
purchase accounting adjustment through the second quarter of 2002.
The net decrease in the underwriting expense ratio in 2000 compared to 1999
was mainly due to the significant increase in net premiums earned year over year
and, unlike acquisition costs, operational expenses do not change as a direct
cost of net premiums earned. Partially offsetting this decrease is the inclusion
of expense charges of $13.9 million related to employee severance and other
costs in 2000 associated with the realignment of operations and the
discontinuation of certain business lines. Excluding these costs, the
underwriting expense ratio in 2000 would have been 27.2%.
The Company also began to write credit default swaps at primary layers in
2001 in this segment. See Item 8, Note 14(a) to the Consolidated Financial
Statements.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
The following table summarizes the underwriting results for the Lloyd's
syndicates (U.S. dollars in thousands):
% CHANGE % CHANGE
GENERAL: 2001 01 VS 00 2000 00 VS 99 1999
-----------------------------------------------------------
Net premiums earned ........................ $ 481,307 34.5% $357,824 0.6% $355,769
Fee income and other ....................... (3,707) 44.1% (6,626) NM 65,892
Losses and loss expenses ................... 610,823 134.6% 260,372 (12.5)% 297,595
Acquisition costs .......................... 155,804 30.0% 119,870 34.4% 89,195
Operating expenses ......................... 22,215 (22.7)% 28,727 (2.0)% 29,305
Exchange losses (gains) .................... 3,198 NM (5,986) NM (1,180)
-----------------------------------------------------------
Underwriting (loss) profit ................. $(314,440) NM $ (51,785) NM $ 6,746
============================================================
Net premiums earned for the year ended December 31, 2001 increased over
2000 primarily as a result of additional syndicate capacity provided by the
Company, currently at 63% compared to 53% in the prior year. In addition, net
premiums earned increased due to greater premiums written in the prior year than
originally estimated. The increase in net premiums earned was partially offset
by the net reinstatement premiums of $21.4 million as a result of losses
incurred from the September 11 event.
In November 2001, the Company realigned its Lloyd's operations effective
January 1, 2002 and from that time, provides 100% of the capacity for Syndicates
1209 and 990. The Company believes that the expected increase in premiums
generated from higher ownership will be reduced by premiums on discontinued
lines such as excess of loss treaty, accident and health and certain property
accounts.
The small increase in net premiums earned in 2000 over 1999 reflected the
growth in business written due principally to an increase in syndicate capacity
provided by the Company from approximately 43% to 53%. Partially offsetting this
increase is the reduction in net premiums earned related to the motor business
that was sold effective December 31, 1999. The Company retains the residual
liability on this business. In the years ended December 31, 2000 and 1999, net
premiums earned on the motor business were $82.8 million and $135.9 million
respectively. In addition, net premiums earned were reduced in 2000 as a result
of additional reinsurance costs related to an outwards stop loss reinsurance
policy as losses developed for certain lines of business. Coverage provided by
this stop loss reinsurance policy was significantly reduced for 2001.
28
Fee income was generated by the Company's Lloyd's managing agencies and
may, depending upon underwriting results, earn profit commissions from third
party capital providers for syndicates they manage. This income was offset by
managing agency operating expenses allocated to these capital providers.
Although nominal commissions were received in the year ended December 31, 2001,
managing agency expenses exceeded fee income and commissions for 2001 and 2000
due to loss deterioration, consistent with the Lloyd's market. As a result of
the change in capacity as previously noted, less expense will be allocated to
the third party capital providers in 2002.
In 1999, fee income and other primarily related to the sale of the
Company's two motor insurance businesses, resulting in a gain of $40.2 million.
In addition, 1999 also included $42.1 million of fees generated from the motor
business prior to the sale. No such income was earned in 2001 or 2000.
The exchange loss in 2001 was due to the decrease in the U.K. sterling
exchange rate against the U.S. dollar applied to net monetary assets denominated
in U.K. sterling. Conversely, in 2000 and 1999, the exchange rate moved in the
opposite direction.
The following table presents the underwriting ratios:
2001 2000 1999
-----------------------------
Loss and loss expense ratio ........... 126.9% 72.8% 83.6%
Underwriting expense ratio ............ 37.0% 41.5% 33.3%
-----------------------------
Combined ratio ........................ 163.9% 114.3% 116.9%
=============================
The loss and loss expense ratio increased in the year ended December 31,
2001 compared to 2000 primarily due to net losses incurred for the September 11
event of approximately $215.8 million and other significant losses including the
Toulouse petrochemical plant explosion and the airport loss event in Sri Lanka,
totaling approximately $19.0 million. In addition, the Company experienced loss
deterioration on business written in previous underwriting years of
approximately $23.0 million. The underwriting expense ratio was lower in 2001
compared to 2000 primarily due to savings generated from merging the managing
agency operations against a higher net premiums earned base.
The decrease in the loss ratio and increase in the expense ratio in 2000
over 1999 primarily reflected the effect of the sale of the motor business. In
1999, the motor business had a loss ratio of approximately 101.1% and an expense
ratio of approximately 21.8%. Non-motor business written typically has lower
loss ratios and higher commissions than the motor business. The increase in the
expense ratio in 2000 was also principally due to additional reinsurance costs
and a charge of $7.5 million for employee severance and other costs associated
with the realignment of the Company's operations.
REINSURANCE OPERATIONS
The following table summarizes the underwriting results for this segment
(U.S. dollars in thousands):
% CHANGE % CHANGE
GENERAL: 2001 01 VS 00 2000 00 VS 99 1999
---------------------------------------------------------------
Net premiums earned ........................... $1,029,618 11.0% $927,195 1.9% $ 909,915
Fee income and other .......................... (7,180) NM (2,197) NM --
Losses and loss expenses ...................... 1,428,772 115.4% 663,173 (4.2)% 692,269
Acquisition costs ............................. 292,069 18.1% 247,352 10.2% 224,359
Operating expenses ............................ 87,169 (14.7)% 102,132 0.1% 101,978
Exchange losses ............................... 4,062 5.0% 3,868 NM 1,286
LIFE:
Life premiums earned .......................... 695,595 NM -- -- --
Claims and policy benefit reserves ............ 698,675 NM -- -- --
----------------------------------------------------------
Underwriting loss ............................ $ (792,714) NM $ (91,527) 16.8% $(109,977)
==========================================================
29
Underwriting results for the year ended December 31, 2001 were
significantly affected by the September 11 event. Net premiums earned in 2001
increased over 2000 due to additional premiums earned in 2001, primarily on
property lines, from increased premium rates and new business written. This was
partially offset by approximately $120.4 million of net reinstatement premiums
resulting from the September 11 event. Net premiums earned are expected to grow
in 2002 due to continuing premium rate increases and the consolidation of the
results of Le Mans Re, in which the Company increased its ownership to 67%
effective January 1, 2002.
The increase in net premiums earned in 2000 as compared to 1999 was mainly
a result of an increase in net premiums written across most lines of business.
In 2000, the Company had experienced some premium rate increases in the other
property, marine, aviation and satellite lines of business. Pricing remained
generally unchanged in the international property, excluding property
catastrophe, and liability lines of business written by the Company. Partially
offsetting this increase in net premiums earned was an increase in reinsurance
costs incurred in 2000 over 1999, primarily relating to stop loss reinsurance
policies where additional premiums became due once losses exceed certain levels.
Life premiums earned included $549.3 million related to a large contract
consisting of long duration annuity reserves assumed in the fourth quarter of
2001. While the Company expects to write more of these contracts, the frequency
of these transactions will likely be irregular. The remaining life premiums
earned related to smaller contracts of a similar nature.
Fee income and other in 2001 and 2000 related primarily to non-underwriting
costs for an outward reinsurance contract that did not exist in 1999.
The following table presents the underwriting ratios for this segment:
2001 2000 1999
-------------------------------
Loss and loss expense ratio .......... 138.8% 71.5% 76.1%
Underwriting expense ratio ........... 36.8% 37.7% 35.9%
-------------------------------
Combined ratio ....................... 175.6% 109.2% 112.0%
===============================
Property catastrophe business has loss experience that is generally
categorized as low frequency but high severity in nature. This may result in
volatility in the Company's financial results for any fiscal year or quarter.
Property catastrophe losses generally are notified and paid within a short
period of time from the covered event.
Net losses and loss expenses in 2001 included $442.1 million related to the
September 11 event, primarily on the property and aviation reinsurance lines of
business. The combined ratio also increased in 2001 over 2000 due to the effects
of the reinstatement premium expense noted above. In addition, net losses and
loss expenses in 2001 included losses incurred related to continued adverse
development in the casualty book of approximately $180.0 million in the 1997
through 1999 accident years. Actuarial assumptions are used to establish initial
expected loss ratios employed in the actuarial methodologies from which the
reserve for losses and loss expenses is derived. Such loss ratios are
periodically adjusted to reflect comparisons with actual claims development,
inflation and other considerations.
In addition, other large losses in 2001 totaled approximately $93.0
million, including the Sri Lanka airport loss, Tropical Storm Allison, the
Petrobras loss in Brazil and the Seattle earthquake. Loss events in 2000, which
included an oil refinery loss in Kuwait, several satellite losses and the
Singapore Airlines loss, totaled approximately $95.0 million. Barring any
significant catastrophes, the Company expects the combined ratio to improve
significantly in 2002 due to business anticipated to be written at higher rates
and at improved terms and conditions.
In 2000 and 1999, net losses and loss expenses incurred in the segment
reflected a recovery of $33.5 million and $100.0 million respectively, under an
intercompany stop loss arrangement. The loss and loss expense ratio in 2000 and
1999 would have been 75.1% and 87.1% respectively, had this arrangement not been
in place. Included in net losses incurred in 2000 are loss reserve adjustments
as discussed previously. Excluding the effects of the inter-
30
company stop loss agreement, the loss ratio was higher in 1999 compared to 2000
due to a higher amount of catastrophe losses and a reserve adjustment of $95.0
million related to the merger with NAC. Catastrophe losses in 1999 included
European windstorms, hailstorms in Sydney, tornadoes in Oklahoma and satellite
losses totaling approximately $185.0 million. In addition, there was an increase
in the loss ratio in 2000 and 1999 in the casualty reinsurance business related
primarily to deterioration in premium rates as described above.
The underwriting expense ratio decreased in the year ended December 31,
2001 compared to the same period in 2000 primarily due to a reduction in
operating expenses related to certain compensation expenses of approximately
$7.0 million accrued in previous years.
The increase in the underwriting expense ratio in 2000 compared to 1999 is
primarily due to lower net earned premiums in 2000 related to the additional
stop loss reinsurance costs incurred. Excluding the effect of these costs, the
underwriting expense ratio would have been 34.7% and 35.1% for 2000 and 1999,
respectively.
The Company's casualty business included a minimal element of asbestos and
environmental claims on business written prior to 1986. The Company's reserving
process includes a supplemental evaluation of claims liabilities from exposure
to asbestos and environmental claims, including related loss adjustment
expenses. However, the Company's loss and loss expense reserves for such
exposures, net of reinsurance, as of December 31, 2001, 2000 and 1999 is less
than 1% of its total reserves. A reconciliation of the Company's gross and net
liabilities for such exposures for the three years ending December 31, 2001 is
set forth in Item 8, Note 9 to the Consolidated Financial Statements.
FINANCIAL PRODUCTS AND SERVICES OPERATIONS
The following table summarizes the underwriting profit for this segment
(U.S. dollars in thousands):
% CHANGE % CHANGE
GENERAL: 2001 01 VS 00 2000 00 VS 99 1999
--------------------------------------------------------
Net premiums earned ............................. $ 46,806 97.4% $23,715 11.6% $21,253
Fee income and other ............................ 32,286 102.8% 15,924 (40.9)% 26,924
Losses and loss expenses ........................ 19,491 NM 6,116 14.1% 5,361
Acquisition costs ............................... 3,730 NM 1,323 (37.2)% 2,108
Operating expenses .............................. 42,404 41.5% 29,969 79.8% 16,670
--------------------------------------------------------
Underwriting profit ............................. $ 13,467 NM $ 2,231 (90.7)% $24,038
========================================================
Net unrealized losses on credit default swaps ... $(41,552) NM -- NM --
========================================================
Net premiums earned in 2001 increased compared to 2000 due to significantly
greater net premiums written in 2001 in the financial guaranty business. This
translated into an increase in net premiums earned of approximately $8.8 million
as such premiums are earned over a relatively long time period. In 2001,
financial guaranty business included primary and secondary municipal portfolios,
asset-backed securities, structured finance transactions and reinsurance
assumed. In 2000, most of the business was treaty business assumed from one
financial guaranty company. Net premiums earned in 2001 also included weather
related risk management transactions. The increase in net premiums earned in
2001 also included approximately $9.8 million of installment premiums from
credit default swaps
The increase in fee income for 2001 related to trading gains and the change
in the fair value of weather risk management products, reflecting the continued
growth in this business. An analysis of the Company's risk management, controls
and methodologies is provided within Item 7A, "Quantitative and Qualitative
Disclosure of Market Risk."
The vast majority of financial guaranty coverage that is written in swap
form pertains to tranches of collateralized debt obligations and asset backed
securities, particularly the higher rated tranches with 91% covering A to AAA
31
tranches. As at December 31, 2001, the financial guaranty operations executed
credit default swaps with a par insured of $7.9 billion. Since most of the
transactions tend to be unique and there is no traded market or any intention to
sell such exposures, the Company marks such transactions to market by modeling
its exposures and creating indices by using proxies of the spreads on similar
categories of exposures. In the third and fourth quarters of 2001, spreads
widened considerably causing a mark to market net unrealized loss of $41.6
million, included in net realized and unrealized gains and losses on derivative
instruments. Credit downgrades or upgrades are included in the calculation of
fair value. The model requires significant judgments to be made by management
and is sensitive to changes in market conditions, particularly credit spreads.
The following table presents the underwriting ratios for the financial
products and services segment:
2001 2000 1999
------------------------------
Loss and loss expense ratio .............. 41.6% 25.8% 25.2%
Underwriting expense ratio ............... 98.6% 131.9% 88.4%
------------------------------
Combined ratio ........................... 140.2% 157.7% 113.6%
==============================
The Company's financial guaranty operations write business with an expected
loss ratio of approximately 25%. The increase in the loss ratio in 2001 related
to a loss on a weather related risk management contract. The corresponding hedge
of this contract realized a weather related derivative gain that is recorded in
fee income and other. In 2001, there were no credit events that resulted in
incurred losses for credit default swaps in this segment.
The underwriting expense ratio decreased due to the increase in net
premiums earned as a result of the change in presentation noted above. The high
expense ratio reflects operating expenses incurred in the generation of fee
income and other that is not included in the ratio calculation.
In 2002, the Company expects to begin underwriting business-owned life
insurance and funding agreements as well as issuing municipal guaranteed
investment contracts as part of the Company's strategy to expand its life
business.
INVESTMENT ACTIVITIES
The following table illustrates the change in net investment income and net
realized gains and losses for each of the three years ended December 31, 2001
(U.S. dollars in thousands):
% CHANGE % CHANGE
2001 01 VS 00 2000 00 VS 99 1999
------------------------------------------------------
Net investment income ................................ $562,606 3.7% $542,500 3.3% $525,318
Net realized (losses) gains on investments ........... $(93,237) NM $ 45,090 NM $ 66,800
Net realized and unrealized gains on investment
derivative instruments(1) ......................... $ 14,638 NM $ 5,481 NM $ 27,556
Annualized effective yield ........................... 5.09% -- 5.99% -- 5.85%
(1) Excludes unrealized losses from changes in fair value of credit default
swaps, discussed in the insurance operations excluding Lloyd's syndicates
and financial products and services segments. For a summary of realized and
unrealized gains and losses on derivative instruments and weather risk
management products, see Item 8, Note 14 to the Consolidated Financial
Statements.
External investment professionals manage the Company's portfolio under the
direction of the Company's management in accordance with detailed investment
guidelines provided by the Company.
Net investment income increased in the year ended December 31, 2001
compared to 2000 due primarily to a higher investment base in 2001. The
investment base in 2001 included the receipt of net funds of $1.1 billion
related to new debt issued by the Company during the second and third quarters
of 2001. As previously noted, the
32
Company also acquired the net assets of Winterthur International from July 1,
2001, increasing the Company's investment assets by $1.4 billion. In addition,
in November 2001, the Company issued 9.2 million shares for net proceeds of
$787.7 million. The effect of the higher investment base was offset by decreases
in the general interest rate levels as a result of the lowering of rates by the
Federal Reserve Bank through 2001. Investment income is not expected to increase
significantly in 2002 from the increased premium flows, due to payments expected
to be made with respect to the September 11 event and to the continued low level
of investment rates. See further discussion in " - Financial Condition and
Liquidity".
Assets related to deposit liabilities are included in investments available
for sale. Interest earned on deposit liability assets is reduced by the
investment expense related to the accretion of deposit liabilities. See further
discussion in Item 8, Note 6 and Note 11 to the Consolidated Financial
Statements.
The investment base for 2000 declined as compared to 1999 as a result of
claims payments, the repurchase of the Company's shares and the reallocation of
assets to other strategic investments. The balance at December 31, 2000 included
the reinvestment of investment income and realized gains, and the receipt of
assets related to the loss portfolio transfers. These receipts were also offset
by the transfer of assets to limited partnerships and affiliate investments.
However, investment yields were higher in 2000 compared to 1999, which together
with additional income derived from the asset accumulation business, resulted in
higher net investment income.
Net realized losses on investments in 2001 included losses related to a
write-down of certain of the Company's fixed income and equity securities
available for sale of $66.4 million and certain other investments of $49.1
million, in circumstances where the Company believed there was an other than
temporary decline in the value of those investments. To determine whether an
investment has experienced an other than temporary decline, the Company applies
the methodology as described in Item 8, Note 2(f) to the Consolidated Financial
Statements. As at December 31, 2001 and 2000, total investments available for
sale and cash, net of the payable for investments purchased, were $13.0 billion
and $9.1 billion, respectively.
Net realized gains in 2000 include a $54.1 million gain on the sale of the
Company's investment in FSA Holdings, Inc. However, offsetting this gain, the
Company incurred realized capital losses of approximately $66.2 million in
certain other investments where the Company determined there to be an other than
temporary decline in value of such investments.
Net realized investment gains in 1999 reflected the strong performance of
the equity market. However, 1999 equity gains were offset by declining fixed
income markets.
Net realized and unrealized gains on investment derivatives result from the
Company's investment strategy to economically hedge against interest and foreign
exchange risk within the investment portfolio. See Item 7A. "Quantitative and
Qualitative Disclosure of Market Risk," and " - Financial Condition and
Liquidity" for a more detailed analysis.
OTHER REVENUES AND EXPENSES
The following table sets forth other revenues and expenses of the Company
for each of the three years ended December 31, 2001 (U.S. dollars in thousands):
% CHANGE % CHANGE
2001 01 VS 00 2000 00 VS 99 1999
------------------------------------------------------
Equity in net income of investment affiliates ......... $ 80,580 15.1% $ 70,032 59.7% $ 43,865
Equity in net (loss) income of insurance affiliates ... (5,300) NM 4,323 NM (2,958)
Other foreign exchange gains .......................... -- NM 55,159 NM --
Amortization of intangible assets ..................... 58,569 NM 58,597 19.2% 49,141
Corporate operating expenses .......................... 92,355 49.1% 61,935 (30.4)% 89,037
Interest expense ...................................... 65,350 103.3% 32,147 (14.0)% 37,378
Minority interest ..................................... 2,113 93.3% 1,093 NM 220
Income tax ............................................ (189,914) NM (56,356) 42.4% (39,570)
33
Equity in net income of investment affiliates includes returns from the
Company's investments in closed-end investment funds. The increase in 2001
compared to 2000 and 2000 compared to 1999 is primarily due to increased returns
and additional investment in these funds.
Equity in net income of insurance affiliates included a loss attributable
to the Company's share of the loss in Le Mans Re, mainly related to the
September 11 event in 2001, and in Annuity & Life Re. This loss was partially
offset by income related to the Company's share of income from FSA
International. 1999 included a loss of $3.6 million related to Arch Capital
(formerly Risk Capital), which was sold in 2000.
Other foreign exchange gains in 2000 related to the revaluation of a
deposit liability denominated in U.K. sterling. The exchange rate movement on
the assets matching this deposit liability was included in accumulated other
comprehensive loss as those assets are designated as available for sale, and in
net realized gains on sales of investments. Effective January 1, 2001, the
Company reorganized its corporate and operational structure for U.K. sterling
asset accumulation business such that exchange translation adjustments of this
nature were largely matched against corresponding investment portfolio movements
with minimal exchange rate effect on net income.
Amortization expense did not change significantly in 2001 from 2000. The
increase in the amortization of intangible assets in 2000 compared to 1999
primarily related to a full year's charge for ECS and XL Specialty acquired in
the second quarter of 1999. In 2002, following the adoption of Financial
Accounting Standard 142, "Goodwill and Other Intangible Assets," goodwill and
intangible assets with indefinite lives will not be amortized. The Company has
commenced an initial assessment of the effect of the adoption of FAS 142 for
goodwill, excluding Winterthur International, and will continue this assessment
in accordance with the standard. Amortization expense may decrease in 2002 and
future periods, however the assessment of any required impairment charge under
the new standard has not yet been completed. See Item 8, Note 2(t) to the
Consolidated Financial Statements for further discussion.
Corporate operating expenses in 2001 included a charge of $14.0 million
related to Winterthur International integration costs. Corporate operating
expenses in 2000 included $5.7 million relating to charges for employee
severance and other costs relating to the realignment of Company's operations.
1999 included $45.3 million of charges related to the merger with NAC. Excluding
these charges, the net increase in corporate operating expenses in each of the
years presented is due to the increase in the corporate infrastructure necessary
to support the growing worldwide operations of the Company.
The increase in interest expense in 2001 over 2000 reflects the effect of
$1.1 billion of new debt raised by the Company in the second and third quarters
of 2001. The Company raised a further $600.0 million in Guaranteed Senior Notes
in January 2002. $350.0 million of the amount raised was used to pay down
outstanding revolving credit in February 2002 that would have expired in June
2002. Interest expense is expected to increase in 2002 as a result of a full
year's charge for this incremental debt. The continuing existence of the debt at
existing interest rates is dependent upon the Company's continued compliance
with its debt covenants. For further discussion see the Company's financing
structure as outlined in "-Financial Condition and Liquidity."
Decreases in interest expense in 2000 compared to 1999 reflect a reduction
in debt carried by the Company through 2000 compared to 1999. The Company
extinguished convertible debt assumed in connection with the NAC merger in 1999.
In addition, the Company pooled capital with its existing operations as a result
of acquisitions in the U.S. in 1999, which facilitated repayment of debt in the
third quarter of 1999. This decrease was partially offset by interest expense
related to interim borrowings used to finance the repurchase of shares in the
year ended December 31, 2000.
The change in the Company's income taxes principally reflects the effects
of losses arising from the September 11 event and the decline in the
profitability of the U.S. operations for each year. Deterioration of the
casualty book in 2001, 2000 and 1999 resulted in pre-tax net losses for U.S.
operations, generating an income tax benefit for both years. The deferral of tax
losses is evaluated based upon the future profitability of the Company's taxable
entities and under current projections, the Company anticipates using this asset
by 2007. The Company's net deferred tax asset
34
at December 31, 2001 is $419.2 million, which consists principally of net
operating losses generated by subsidiaries in the U.S. and U.K. Should the
taxable income of these entities fall below expectations, a further valuation
allowance may have to be established which could be significant. In addition, if
any further losses are generated by these entities, these losses may not be tax
effected. See Item 8, Note 21 to the Consolidated Financial Statements.
FINANCIAL CONDITION AND LIQUIDITY
As a holding company, the Company's assets consist primarily of its
investments in subsidiaries and the Company's future cash flows depend on the
availability of dividends or other statutorily permissible payments from its
subsidiaries. The ability to pay such dividends is limited by the applicable
laws and regulations of the various countries the Company operates in,
including, among others, Bermuda, the United States, Ireland, Switzerland and
the United Kingdom, and those of the Society of Lloyd's. No assurance can be
given that the Company or its subsidiaries will be permitted to pay dividends in
the future.
The Company's ability to underwrite business is largely dependent upon the
quality of its claims paying and financial strength ratings as evaluated by
independent agencies. The Company regularly provides financial information to
these agencies to both maintain and enhance existing ratings.
The Company's shareholders' equity at December 31, 2001 was $5.4 billion,
of which $2.3 billion was retained earnings. Shareholders' equity included the
issue of 9.2 million ordinary shares for net proceeds of $787.7 million during
the year ended December 31, 2001 to support capital requirements following the
September 11 event. These shares were issued under the Company's $1.5 billion
universal shelf registration statement filed with the SEC in November 2001.
Subsequently, this shelf was replaced by a substantially identical shelf.
The Company's balance sheet changed significantly since December 31, 2000.
The assets and liabilities increased as a result of the purchase of Winterthur
International and the effects of the September 11 event. The purchase of
Winterthur International increased assets by $4.8 billion and liabilities by
$4.6 billion at July 1, 2001. The September 11 event resulted in an increase in
loss reserves and reinsurance recoverables of $1.8 billion and $1.1 billion,
respectively. The Company's exposure to the September 11 event from Winterthur
International is protected through a loss reserve seasoning mechanism. Both loss
reserves and reinsurance recoverables increased by $321.0 million. See Item 8,
Notes 4 and 5 to the Consolidated Financial Statements.
The Company establishes reserves to provide for estimated claims, the
general expenses of administering the claims adjustment process and for losses
incurred but not reported. These reserves are calculated using actuarial and
other reserving techniques to project the estimated ultimate net liability for
losses and loss expenses. The Company's reserving practices and the
establishment of any particular reserve reflect management's judgment concerning
sound financial practice and does not represent any admission of liability with
respect to any claims made against the Company's subsidiaries. No assurance can
be given that actual claims made and payments related thereto will not be in
excess of the amounts reserved.
The establishment of unpaid losses and loss expense reserves also includes
reinsurance recoveries. Due to the size of the gross losses arising from the
September 11 event and the related reinsurance recoveries and the magnitude of
the September 11 event on the reinsurance industry, the Company, in addition to
its normal review process, further analyzed the recoverability of these assets.
Approximately 96% of the relevant reinsurers currently fall into Standard &
Poor's financial strength rating categories or equivalent of A or better, with
approximately 65% rated AA or better. Accordingly, the Company believes that
substantially all insurance will be recoverable. An allowance has been
established for estimated uncollectible recoverables. See Item 8, Note 10 for
further information on the Company's reinsurance.
As at December 31, 2001, currency translation adjustments were $37.3
million. This is shown as part of accumulated other comprehensive loss and
primarily related to unrealized losses on foreign currency exchange rate
movements at Winterthur International where some operations have a functional
currency that is not the U.S. dollar.
35
Inflation can have an effect on the Company in that inflationary factors
can increase damage awards and potentially result in larger claims. The
Company's underwriting philosophy is to adjust premiums in response to
inflation, although this may not always be possible due to competitive pressure.
Inflationary factors are considered in determining the premium level on any
multi-year policies at the time contracts are written.
The Company's liquidity depends on operating, investing and financing cash
flows, discussed below.
Certain business written by the Company has loss experience generally
characterized as having low frequency and high severity. This may result in
volatility in both the Company's results and operational cash flows. Operational
cash flows during 2001 improved compared to 2000 primarily due to growth in
premiums written, including life premiums. Cash flow has not yet been negatively
affected by the September 11 event as the majority of losses are in unpaid loss
and loss reserves at December 31, 2001. Settlement of these claims is expected
to occur mostly throughout 2002. Due to their nature, recoveries are expected to
lag. This cash outflow is expected to be partially offset by an anticipated
increased flow of premiums in 2002. The Company has reviewed the anticipated
cash flow from the September 11 event and believes it has sufficient liquidity
to meet its obligations due to the additional capital raised and debt issued in
2001.
In 2001, 2000 and 1999, the total amount of net losses paid by the Company
was $1.8 billion, $1.7 billion and, $1.1 billion respectively. The increase in
2001 compared to 2000 is due to growth in operations and the acquisition of
Winterthur International. The increase in 2000 compared to 1999 is due to an
increase in the amount of net premiums written by the Company, together with
losses paid for the settlement of previously established reserves, particularly
catastrophe losses. The higher amount of paid claims in 2000 compared to 1999
contributed to lower operational cash flow in 2000 as compared to 1999.
In 2001, the Company made the following significant investments:
(1) On July 25, 2001, the Company completed the acquisition of Winterthur
International. This was an all-cash transaction preliminarily valued at
approximately $405.6 million at that date. The preliminary purchase price of the
acquisition was based on audited financial statements as at December 31, 2000
for the business acquired, and is subject to adjustment based on the audited
June 30, 2001 financial statements of Winterthur International. These audited
financial statements are not expected to be completed until later in 2002. The
Company does not anticipate any significant income statement impact related to
the completion of these audited statements. See Item 8, Note 5 to the
Consolidated Financial Statements for further information.
(2) The Company acquired The London Assurance Company of America, Inc., a
shell company licensed in forty five U.S. states, for the purpose of obtaining
licenses for the financial guaranty operations of the Company. The cost of the
acquisition less cash acquired was $16.5 million.
(3) The Company invested a further $185.1 million in affiliates, the
majority of which related to investment fund affiliates, and a further $109.0
million in limited partnerships and other investments.
The Company has had several share repurchase programs in the past as part
of its capital management strategy. On January 9, 2000, the Board of Directors
authorized a program for the repurchase of shares up to $500.0 million. The
repurchase of shares was announced in conjunction with a small dividend increase
of $0.04 per share per annum. Under this plan, the Company has purchased 6.6
million shares at an aggregate cost of $364.6 million or an average cost of
$55.24 per share. The Company has $135.4 million remaining in its share
repurchase authorization.
As at December 31, 2001, the Company had bank, letter of credit and loan
facilities available from a variety of sources, including commercial banks,
totaling $4.4 billion of which $1.6 billion in debt was outstanding. In
addition, $2.0 billion of letters of credit were outstanding as at December 31,
2001, 5% of which were collateralized by the Company's investment portfolio
supporting U.S. non-admitted business and the Company's Lloyd's capital
requirements.
36
During 2001 and 2000, borrowings under these facilities were $1.2 billion
and $250.3 million, respectively, and repayments under the facilities were $50.0
million and $211.0 million, respectively. Borrowings in 2001 were used to
repurchase $66.4 million of the Company's shares and for general corporate
purposes. The borrowings in 2000 were used as interim funding of share buybacks
and were repaid using funds from the equity portfolio. The total pre-tax
interest expense on notes and debt outstanding during the years ended December
31, 2001 and 2000 was $65.4 million and $32.1 million, respectively. Associated
with the Company's bank and loan commitments are various loan covenants with
which the Company was in compliance throughout the year ended December 31, 2001.
The Company amended its facilities following the September 11 event in order to
modify certain covenants going forward, although as stated above, the Company
was in compliance throughout 2001. These facilities contain various cross
default provisions and covenants, including a minimum rating requirement, as
further described below under "Cross Defaults and Other Provisions In Debt
Documents".
In connection with the weather risk management business, the Company issues
guaranties to counterparties in most of its transactions. As of December 31,
2001, a majority of the Company's outstanding weather contracts were due to
mature on or before December 31, 2002, at which time the Company may terminate
any associated guaranties or continue to enter into new transactions which would
extend the obligations under such associated guaranties.
The following tables present the Company's indebtedness under outstanding
securities and lenders' commitments as at December 31, 2001 (U.S. dollars in
thousands):
PAYMENTS DUE BY PERIOD
----------------------------------------------
YEAR OF LESS THAN 1 TO 3 4 TO 5 AFTER 6
NOTES PAYABLE AND DEBT COMMITMENT IN USE EXPIRY 1 YEAR YEARS YEARS YEARS
- ---------------------- -----------------------------------------------------------------------------------
364-day revolver ............ $ 500,000 $ -- 2002 $ -- $ -- $ -- $ --
5-year revolver (1) ......... 250,000 250,000 2002 250,000 -- -- --
5-year revolver (1) ......... 100,000 100,000 2002 100,000 -- -- --
7.15% Senior Notes .......... 100,000 99,970 2005 -- -- 100,000 --
6.58% Guaranteed
Senior Notes ............. 255,000 255,000 2011 -- -- -- 255,000
Zero Coupon Convertible
Debentures (2) ........... 609,692 609,692 2021 -- -- -- 1,010,833
Liquid Yield Option
Notes(TM)2) .............. 290,147 290,147 2021 -- -- -- 508,842
Other operating debt ........ 68 68 2002 68 -- -- --
-----------------------------------------------------------------------------------
Total $2,104,907 $1,604,877 $350,068 $ -- $100,000 $1,774,675
====================================================================================
(1) These revolvers were repaid in full on February 19, 2002 and have been
terminated.
(2) "Commitment" and "In Use" data represent December 31, 2001 accreted values.
"After 6 years" data represents ultimate redemption values for 2021. The
convertibles may be "put" or converted by the bondholders at various times
prior to the 2021 redemption date. The Company may also choose to "call"
the debt from May and September 2004 onwards.
AMOUNT OF COMMITMENT
EXPIRATION PER PERIOD
--------------------------------------------
OTHER COMMERCIAL YEAR OF LESS THAN 1 TO 3 4 TO 5 AFTER 6
COMMITMENTS COMMITMENT IN USE EXPIRY 1 YEAR YEARS YEARS YEARS
- ------------------------------------------------------------------------------------------------------------------
Letter of Credit Facilities (1) ... $2,274,000 $2,029,000 2002 $2,274,000 -- -- --
(1) The Company entered into a new secured letter of credit facility in January
2002. The $150.0 million facility is unutilized and will expire at the end
of 2002.
37
The Company has several letter of credit facilities provided on a
syndicated and bilateral basis from commercial banks and, in the case of the
Winterthur International operations, from the previous owner of those
operations. These facilities are utilized to support non-admitted insurance and
reinsurance operations in the U.S. and capital requirements at Lloyd's. All of
the commercial facilities are scheduled for renewal during 2002, and the
Winterthur International arrangement will also terminate during 2002. In
addition to letters of credit, the Company has established insurance trusts in
the U.S. that provide cedents with statutory relief required under state
insurance regulation in the U.S. It is anticipated that the commercial
facilities will be renewed on expiry but such renewals are subject to the
availability of credit from banks utilized by the Company. In the event that
such credit support is insufficient, the Company could be required to provide
alternative security to cedents. This could take the form of additional
insurance trusts supported by the Company's investment portfolio or funds
withheld using the Company's cash resources. The value of letters of credit
required is driven by, among other things, loss development of existing
reserves, the payment pattern of such reserves, the expansion of business
written by the Company and the loss experience of such business.
In January 2002, the Company issued $600.0 million par value 6.5%
Guaranteed Senior Notes due January 2012 under the Company's universal shelf
registration statement referred to above. The Company has approximately $900.0
million remaining in capacity under this shelf registration statement. The issue
price was $99.469 with gross proceeds of $596.8 million. The notes were issued
through a finance vehicle referred to under "Special Purpose Vehicles and Other
Off-Balance Sheet Arrangements" below and were guaranteed by XL Capital Ltd.
CONVERTIBLE DEBT SECURITIES
In 2001, the Company consummated two convertible debt securities as further
described below and in the indentures relating to such bonds. These bonds carry
a zero coupon, meaning that, under normal circumstances, the Company is not
required to pay cash interest at any time during the life of the bonds or at
maturity.
In May 2001, the Company issued $1,010.8 million principal amount at
maturity (subject to adjustment in the event there is an upward interest
adjustment) of Zero Coupon Convertible Debentures ("CARZ") at $593.57 per bond
and, unless converted or repaid before their due date of May 2021, they will be
repaid in May 2021 at $1,000 per bond, at a total cost of $1.01 billion. The
accretion rate is 2.625% per annum on a semi-annual basis or 2.6422% per annum
on an annual basis. In September 2001, the Company also issued $508.8 million
principal amount at maturity (subject to adjustment in the event there is an
upward interest adjustment) of Liquid Yield Option Notes(TM) ("LYONs") at an
initial price of $565.01 per bond. The LYONs will also be repaid at $1,000 each,
unless converted or repaid before their due date of September 2021, at a total
cost of $508.8 million. The accretion rate on the LYONs is 2.875% per annum on a
semi-annual basis or 2.89566% per annum on an annual basis. Although both the
CARZ and LYONs are due to be repaid in 2021, there are several features that may
result in the bonds being repaid or converted into the Company's Class A
Ordinary Shares before the redemption date. As these features include
market-driven features and options available to the Company and bondholders, it
is not possible to determine if the bonds will remain outstanding until their
scheduled maturity in 2021.
Each of the CARZ and LYONs provide the bondholders the right to require the
Company to repurchase the bonds on predetermined dates ("put" dates) at
predetermined values as set forth in the relevant indenture. The put dates for
the CARZ occur on May 23 of 2002, 2004, 2006, 2008, 2011 and 2016. The put dates
for the LYONs occur on September 7 of 2002, 2003, 2004, 2006, 2008, 2011 and
2016. The Company may, at its option, pay the repurchase price in cash or Class
A ordinary shares or a combination thereof.
In addition, each of the CARZ and LYONs provide for a contingent conversion
feature that gives the bondholders the right to convert the bonds into the
Company's shares at other times during the life of the bonds should the market
price of the Company's shares trade at certain levels. Accordingly, if the
Company's share price is at least 110% of the accreted conversion price for at
least twenty of the thirty days during the relevant conversion period, the
bondholders would have the right to convert the bonds into Class A Ordinary
Shares. If converted for shares, each CARZ would be converted into 5.9467 shares
and each holder of a LYONs would receive 5.277 shares. The
38
accreted values would be determined by applying the accretion rate to the
initial issue price. In the example of CARZ, the accreted price on May 23, 2002
will be $609.25 determined by adding one year's accretion of 2.6422% per annum
on an annual basis to the original issue price of $593.57.
The holders of each of the CARZ and LYONs also have the right to convert
the bonds for shares in the event that the trading price of the bonds for a
predetermined period falls below 95% of the value of the equivalent number of
shares, provided however, if the shares are trading at a predetermined premium
to the accreted price of the bonds, holders may receive cash, shares or a
combination thereof in lieu of shares upon conversion.
These bonds also provide for interest rates to be adjusted in the event
that the Company's stock price falls below levels specified in the relevant
indenture relative to the conversion price.
In addition, in the event that the credit ratings assigned to the bonds by
Standard & Poor's fall below the specified level of BBB+, the bonds would be
convertible into shares at 5.9467 shares per CARZ and 5.277 per LYON. The rating
assigned to the bonds at the time of issue was A+. Some corporate transactions,
such as a change of control of the Company, would give the bondholders the right
to require the Company to repurchase the bonds at the accreted value of the
bonds at that time.
The bonds become immediately due if an event of default occurs and 25% or
more of the bondholders demand repayment of the accreted value at the time of
such event. Such an event of default would include failure to pay amounts due on
the notes, an event of default occurring under the Company's other credit
facilities, or certain other events such as bankruptcy or insolvency of the
Company. A further description of the events of default are contained in the
indentures and consequences to the Company are described under "Cross Default
and Other Provisions in Debt Documents".
The bonds are also callable as the Company has the right to redeem the
bonds for cash, in full or in part, at their accreted value at any time after
May 23, 2004, in the case of the CARZ, and September 7, 2004, in the case of the
LYONs.
The puts and the interest rate adjustment features embedded in the CARZ and
LYONs are considered derivatives and are subject to fair value. There is
currently minimal value ascribed to the puts, as the contingent events of these
features are considered unlikely to occur or to the interest rate adjustment
feature due to the current trading value of the bonds. Due to the contingent
nature of the conversion features of these debt securities, there is no impact
on fully diluted earnings (loss) per share at this time.
CROSS-DEFAULT AND OTHER PROVISIONS IN DEBT DOCUMENTS
The following describes certain terms of the documents referred to below.
All documents referred to below have been filed with the SEC and should be
referred to for an assessment of the complete contractual obligations of the
Company.
In general, all of the Company's bank facilities, indentures and other
documents relating to the Company's outstanding indebtedness (collectively, the
"Company's Debt Documents"), as described above, contain cross default
provisions to each other and the Company's Debt Documents (other than the LYONs,
CARZ and 6.5% Guaranteed Senior Notes indentures) contain affirmative covenants.
These covenants provide for, among other things, minimum required ratings of the
Company's insurance and reinsurance operating subsidiaries (other than its AAA
financial guaranty companies) and the level of secured indebtedness in the
future. In addition, generally each of the Company's Debt Documents provide for
an event of default in the event of a change of control of the Company or some
events involving bankruptcy, insolvency or reorganization of the Company. The
Company's credit facilities and the 6.58% Guaranteed Senior Notes also contain
minimum consolidated net worth covenants.
Under the Company's 364-day facility, five-year credit facilities and
ten-year private placement notes described above, in the event that the Company
fails to maintain a claims paying rating of at least A from A.M. Best or the
Company's insurance and reinsurance rated operating subsidiaries (other than its
AAA financial guaranty companies) fail to maintain a rating of at least A from
S&P, an event of default would occur.
39
Each of the LYONs, CARZ and 6.5% Guaranteed Senior Notes indentures
contains a cross default provision. In general, in the event that the Company
defaults in the payment of indebtedness in the amount of $50.0 million or more,
an event of default would be triggered under both the LYONs and 6.5% Guaranteed
Senior Notes indentures. Under the CARZ indenture, in the event that the Company
defaults in the payment of indebtedness in the amount of $100 million or more,
an event of default would be triggered.
Given that all of the Company's Debt Documents contain cross default
provisions, this may result in all holders declaring such debt due and payable
and an acceleration of all debt due under those documents. If this were to
occur, the Company may not have funds sufficient at that time to repay any or
all of such indebtedness.
In addition, the Company's unsecured Lloyd's letter of credit facility
provides that, in the event that the Company's insurance and reinsurance rated
operating subsidiaries fall below A (as generally measured by the lower of the
financial strength rating from A.M. Best or S&P at any time), the facility would
then be required to be fully secured by the Company, at which time the Company
would be required to either (i) provide an amount in cash to cover an amount
equal to the aggregate letters of credit outstanding at that time or (ii)
deposit assets in trust securing 105% of the aggregate letters of credit
outstanding at that time. If this were to occur, the Company may not be able to
provide the collateral required in order to maintain this facility.
SPECIAL PURPOSE VEHICLES AND OTHER OFF-BALANCE SHEET ARRANGEMENTS
The Company utilizes special purpose vehicles to a limited extent both
indirectly and directly in the ordinary course of the Company's business. At the
transactional level, the Company provides various forms of credit enhancement
including financial guaranty insurance and reinsurance of structured
transactions backed by pools of assets of specified types, municipal obligations
supported by the issuers' ability to charge fees for specified services or
projects, and corporate risk based obligations including essential
infrastructure projects and obligations backed by receivables from future sales
of commodities and other specified services. The obligations related to these
transactions are often securitized through off-balance sheet vehicles. In
synthetic transactions, the Company guarantees payment obligations of
counterparties, including special purpose vehicles, under credit default swaps
referencing asset portfolios. The Company only provides financial guaranty
insurance, or indirectly reinsurance, of these vehicles for fixed premiums at
market rates but does not hold any equity positions or subordinated debt in
these off-balance sheet arrangements. Accordingly, these vehicles are not
consolidated.
The Company has a 38% direct investment in an asset-backed commercial paper
company that invests funds provided through a commercial paper and a Euro Medium
Term Note program. The assets of this company are guaranteed by an unrelated
third party. The Company has a further indirect investment that does not provide
any additional control. The Company accounts for this investment on an equity
basis. The Company has loaned a $30.0 million note to this investment company.
The investment company has assets and liabilities of $950.0 million at December
31, 2001 and generated income net of start-up costs totaling $1.2 million. The
Company believes its investment in this company and note receivable are
realizable
The Company created XL Capital Finance (Europe) plc to facilitate the
January 2002 issue of 6.5% Guaranteed Senior Notes referred to above. This
finance vehicle is wholly-owned and controlled by the Company and, therefore,
will be consolidated in the Company's consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
See Item 8, Note 2(t) to the Consolidated Financial Statements for a
discussion on recent accounting pronouncements.
CURRENT OUTLOOK
Prior to the September 11 event, premium rates in 2001 across the majority
of the Company's property and casualty lines of business had begun to increase
after several years of intense competition. Since the September 11 event, the
largest ever man-made insured loss in recent history, premium rates, terms and
conditions have significantly improved. The favorable changes have also had the
effect of attracting new entrants to the industry, which to
40
date has only affected the Company to a limited extent. The Company believes
that, given its global presence with the acquisition of Winterthur
International, it is well positioned to participate in a strong recovery in the
property and casualty insurance and reinsurance markets.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The Company is exposed to potential loss from various market risks,
including changes in interest rates, foreign currency exchange rates, equity
prices and commodity values, as it relates to the Company's participation in the
weather risk management market. The Company manages its market risks based on
guidelines established by senior management. The Company enters into derivatives
and other financial instruments for trading and risk management purposes. These
derivative instruments are carried at fair market value with the resulting gains
and losses recognized in income in the period in which they occur.
This risk management discussion and the estimated amounts generated from
the sensitivity and value-at-risk ("VaR") analyses presented in this document
are forward-looking statements of market risk assuming certain adverse market
conditions occur. Actual results in the future may differ materially from these
estimated results due to, among other things, actual developments in the global
financial markets. The results of analysis used by the Company to assess and
mitigate risk should not be considered projections of future events of losses.
See generally "Cautionary Note Regarding Forward-Looking Statements."
COMMODITY RISK
The Company offers weather risk management products in insurance or
derivative form to end-users, while hedging the risks in the over-the-counter
and exchange traded derivatives markets. In addition to entering into
transactions with end-users, the Company also maintains a weather derivatives
trading portfolio. As of the year ended December 31, 2001, a majority of the
Company's outstanding weather contracts were due to mature on or before December
31, 2002. The fair values of these transactions are determined using
quantitative analysis. The models used to determine these fair values are
consistent with the models used to estimate the Company's VaR exposure to
weather risk.
MARKET RISK
Market risk for the Company's commodity portfolio relates to changes in
underlying weather conditions (i.e., changes in climatic variables such as
temperature and precipitation). The Company has underwritten risks in Asia,
Europe, and North America, with its primary market risk related to temperature
changes within the United States.
The Company manages its weather portfolio by employing a variety of
strategies. These strategies include geographical and directional
diversification of risk exposures, direct hedging within the capital markets,
and reinsurance. Portfolio risk management is undertaken on a Company-wide
basis, rather than on an individual product basis, to maintain a portfolio that
the Company believes is well diversified and which remains within the aggregate
risk tolerance as established by the Company's senior management.
VALUE-AT-RISK
A statistical technique known as VaR is one of the tools used by management
to measure, monitor and review the market risk exposures of the Company's
weather risk portfolio. VaR, as it relates to commodity risk, is calculated on a
daily basis by the Company's risk management professionals and distributed daily
to the appropriate members of management. The Company estimates VaR based on the
historical simulation of each of the seasonal books into which weather
transactions are segregated.
The Company's high, low and average aggregate seasonal VaR amounts during
2001 were $48.6 million, $4.7 million and $30.1 million, respectively,
calculated at a 99% confidence level. The Company calculates its aggregate VaR
by summing the VaR amounts for each of its seasonal portfolio. Since VaR
statistics are estimates based on historical position and market data, VaR
should not be viewed as an absolute, predictive gauge of future financial
performance or as a way for the Company to predict risk. There can be no
assurance that the Company's actual future losses will not exceed its VaR
amounts.
41
CREDIT RISK
The Company is exposed to credit risk, or the risk that counterparties to
weather transactions will fail to perform their contractual payment or other
obligations leading to possible losses. In order to control its risk exposures,
the Company has implemented a credit risk control framework centered on a
management credit committee, credit policies and credit limits. All
credit-sensitive transactions are reviewed and approved by the Company's risk
management personnel and/or management credit committee and exposures are
accommodated under authorized credit limits before the Company enters into
weather derivative transactions. To address counterparty risk concerns and to
support credit exposures in certain cases, the Company may require
counterparties to provide a guaranty or a letter of credit or to post margin or
collateral. The Company monitors its credit exposures on a continual basis to
ensure adherence to all policies and limits.
The following table summarizes the movement in the fair value of contracts
outstanding during the year ended December, 31, 2001 (U.S. dollars in
thousands):
Fair value of contacts outstanding, beginning of the year ..... $ --
Contracts realized or otherwise settled ....................... (22,626)
Fair value of new contracts ................................... 38,072
Other changes in fair value ................................... (16,550)
--------
Fair value of contracts outstanding, end of year .............. $ (1,104)
========
The following table summarizes the maturity of contracts outstanding at
December 31, 2001 (U.S. dollars in thousands):
GREATER
LESS THAN 1 1-3 4-5 THAN 5 TOTAL FAIR
SOURCE OF FAIR VALUE YEAR YEARS YEARS YEARS VALUE
----------------------------------------------------------
Prices actively quoted ................................ $ 39 $ -- $ -- $ -- $ 39
Prices based on models and other valuation methods .... (2,369) 1,226 -- -- (1,443)
----------------------------------------------------------
Total fair value of contracts outstanding ............. $(2,330) $1,226 $ -- $ -- $(1,104)
==========================================================
The Company seeks to identify, assess, monitor and manage, in accordance
with defined policies and procedures its market, credit, operational and legal
risks. The Company's senior management takes an active role in the risk
management process and has developed and implemented policies and procedures
that require specific administrative and business functions to assist in the
identification, assessment and control of various risks. Due to the changing
nature of the global marketplace, the Company's risk management policies,
procedures and methodologies are evolving and are subject to ongoing review and
modification. Market, credit, operational, legal and other risks are inherent in
the Company's weather risk management business and cannot be wholly eliminated
or reduced despite the Company's risk management policies, procedures and
methodologies, which are subject to limitations and assumptions.
Beginning in 2002, the Company anticipates entering the energy risk
management market, particularly in respect of natural gas and electricity, and
applying methodologies for determining fair value and VaR generally consistent
with those used in relation to its weather based business.
OPERATIONAL RISK
Operational risk refers generally to the risk of loss resulting from the
Company's weather risk trading operations, including, but not limited to,
improper or unauthorized execution and processing of transactions, deficiencies
in the Company's operating systems, and inadequacies or breaches in the
Company's control procedures and processes. The Company relies on the ability of
its employees and systems to process its transactions, because weather
transactions may cross multiple markets and involve different currencies. In the
event of a breakdown or
42
improper operation of systems or improper action by employees, the Company could
suffer, among other things, financial loss, regulatory sanctions, reputation
damage or other material adverse consequences.
In order to mitigate and control operational risk, the Company has
developed and continues to enhance specific policies and procedures that are
designed to identify and manage operational risk at appropriate levels. For
example, the Company's weather risk management business has implemented
procedures that require that all transactions are accurately recorded and
properly reflected in the Company's books and records and are confirmed with
counterparties at least annually. Critical systems are backed up on a daily
basis, and redundancies are built into the systems as deemed appropriate. The
Company also uses periodic self-assessments and internal audit reviews as a
further check on operational risk. Moreover, trading position valuations are
subject to periodic independent review and audit.
LEGAL RISK
Legal risk, generally, is the risk that a derivative transaction will not
be properly documented. Proper documentation is critical to assure not only that
a counterparty has the authority to enter into the transaction, but also that
derivative transactions are enforceable as negotiated between parties and
excluded from preferential transfer provisions in the event of counterparty
insolvency. As a result, the Company obtains an executed International Swap
Dealers Association, Inc. ("ISDA") Master Agreement or a form of confirmation
which incorporates by reference the ISDA Master Agreement and Schedule.
The ISDA Master Agreement Schedule adopted and periodically enhanced by the
Company incorporates, among other provisions, the following contractual
protections: the netting of transactions between the Company and the
counterparty; a right of set-off for the Company; a representations and
warranties provision; and a customized event of default and termination section
(typically based upon credit ratings downgrades identified by the Company's risk
management department). Further, legal documentation may be required when the
Company enters into a weather derivative transaction with a non-U.S.
counterparty.
The Company anticipates that further regulation of weather and energy
derivative contracts is reasonably likely to occur based upon recent events and
failures in the energy market. Based upon the evolving regulatory developments
in energy trading, the Company will continue to monitor and enhance its credit,
operational and legal procedures and processes to comply with future regulation.
INVESTMENT MARKET RISK
The Company's investment portfolio consists of fixed income and equity
securities, denominated in both U.S. and foreign currencies. Accordingly,
earnings will be affected by, among other things, changes in interest rates,
equity prices and foreign currency exchange rates. External investment
professionals manage the Company's portfolio under the direction of the
Company's management in accordance with detailed investment guidelines provided
by the Company. These guidelines encompass investments in derivatives.
Derivatives can only be utilized for purposes of managing interest rate risk,
foreign exchange risk and credit risk, provided the use of such instruments are
incorporated in the overall portfolio duration, spread, convexity and other
relevant portfolio metrics. The use of derivatives is not permitted to
economically leverage the portfolio outside of the stated guidelines.
VALUE-AT-RISK
VaR is one of the tools used by management to measure potential losses in
fair values using historical rates, market movements, credit spreads and default
rates to estimate the volatility and correlation of these factors to calculate
the maximum loss that could occur over a defined period of time given a certain
probability. The VaR of the investment portfolio and all investment related
derivatives at December 31, 2001 was approximately $351.0 million and $18.0
million, respectively.
VAR METHODOLOGY, ASSUMPTIONS AND LIMITATIONS
The Company's investment VaR is computed by an affiliate that uses a
technique called "Monte Carlo simulation." The Monte Carlo simulation projects
thousands of possible different prices of equity securities, fixed income
43
securities, derivatives and currencies, taking into account the volatility of
each security and the historical correlation between security price changes in a
one-month forecast horizon. VaR is calculated based on a 95% confidence level
and the result is presented as an absolute VaR.
INTEREST RATE AND EQUITY PRICE RISK
An immediate 100 basis point adverse shift in the treasury yield curve
would result in a decrease in total return of 5.0% or $542.0 million on the
Company's fixed income portfolio as of December 31, 2001. In evaluating the
impact of price changes of the equity portfolio, a 10% change in equity prices
would affect total return by approximately $55.0 million at December 31, 2001.
The Company has short-term debt and long-term debt outstanding. Interest
rates on short-term debt are LIBOR based. Accordingly, any changes in interest
rates will affect interest expense.
The Company also uses derivative investments to add value to the investment
portfolio where market inefficiencies are believed to exist, to equitize cash
holdings of equity managers and to adjust the duration of a portfolio of fixed
income securities to match the duration of related deposit liabilities.
At December 31, 2001, bond and stock index futures outstanding were $695.6
million with underlying investments having a market value of $9.7 billion.
Losses of $1.0 million were realized on these contracts for the year ended
December 31, 2001. A 10% appreciation or depreciation of these derivative
instruments would have resulted in realized gains and realized losses of $82.4
million, respectively. The Company reduces its exposure to these futures through
offsetting transactions, including options and forwards.
FOREIGN CURRENCY EXCHANGE RISK
The Company uses foreign exchange contracts to manage its exposure to the
effects of fluctuating foreign currencies on the value of certain of its foreign
currency fixed maturities and equity investments. These contracts are not
designated as specific hedges for financial reporting purposes and therefore,
realized and unrealized gains and losses on these contracts are recorded in
income in the period in which they occur. These contracts generally have
maturities of three months or less. In addition, where the Company's investment
managers believe potential gains exist in a particular currency, a forward
contract may not be entered into. At December 31, 2001, forward foreign exchange
contracts with notional principal amounts totaling $45.6 million were
outstanding. The fair value of these contracts as at December 31, 2001 was $45.7
million with unrealized gains of $0.1 million. For the year ended December 31,
2001, realized gains of $5.3 million and unrealized gains of $2.3 million were
recorded in net realized and unrealized gains and losses on derivative
instruments. Based on this value, a 10% appreciation or depreciation of the U.S.
dollar as compared to the level of other currencies under contract at December
31, 2001 would have resulted in approximately $23.5 million of unrealized losses
and $18.4 million in unrealized gains, respectively.
CREDIT RISK
The Company is exposed to credit risk in the event of non-performance by
the other parties to the forward contracts, however the Company does not
anticipate non-performance. The difference between the notional principal
amounts and the associated market value is the Company's maximum credit
exposure.
EMBEDDED DEBT DERIVATIVES
The puts and the interest rate adjustment features embedded in the CARZ and
LYONs are considered derivatives and are subject to fair value. There is
currently minimal fair value ascribed to (i) the puts, as the contingent events
of these features are considered unlikely to occur or (ii) the interest rate
adjustment feature due to the current trading value of the bonds.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 ("PSLRA") provides a
"safe harbor" for forward-looking statements. Any prospectus, prospectus
supplement, the Company's Annual Report to Shareholders, any proxy state-
44
ment, any other Form 10-K, Form 10-Q or Form 8-K of the Company or any other
written or oral statements made by or on behalf of the Company may include
forward-looking statements which reflect the Company's current views with
respect to future events and financial performance. Such statements include
forward-looking statements both with respect to the Company in general, and the
insurance, reinsurance and financial products and services sectors in particular
(both as to underwriting and investment matters). Statements which include the
words "expect", "intend", "plan", "believe", "project", "anticipate", "will",
and similar statements of a future or forward-looking nature identify
forward-looking statements for purposes of the PSLRA or otherwise.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in such
statements. The Company believes that these factors include, but are not limited
to, the following: (i) rate increases and improvements in terms and conditions
may not be as large or significant as the Company is currently projecting; (ii)
the size of the Company's claims may change due to the preliminary nature of
reports and estimates of loss and damage, particularly in relation to the
attacks in the United States on September 11, 2001; (iii) the timely and full
recoverability of reinsurance placed by the Company with third parties; (iv) the
projected amount of ceded reinsurance recoverables and the ratings and
creditworthiness of reinsurers may change; (v) the timing of claims payments
being faster or the receipt of reinsurance recoverables being slower than
anticipated by the Company; (vi) ineffectiveness or obsolescence of the
Company's business strategy due to changes in current or future market
conditions; (vii) increased competition on the basis of pricing, capacity,
coverage terms or other factors; (viii) greater frequency or severity of claims
and loss activity, including as a result of natural or man-made catastrophic
events, than the Company's underwriting, reserving or investment practices
anticipate based on historical experience or industry data; (ix) developments in
the world's financial and capital markets which adversely affect the performance
of the Company's investments and the Company's access to such markets; (x) the
potential impact of U.S. solutions to make available insurance coverage for acts
of terrorism; (xi) developments in the Enron Corp. bankruptcy proceedings or
other developments related to Enron Corp. insofar as they affect property and
casualty insurance and reinsurance coverages; (xii) availability of borrowings
and letters of credit under the Company's credit facilities; (xiii) changes in
regulation or tax laws applicable to the Company and its subsidiaries, brokers
or customers; (xiv) acceptance of the Company's products and services, including
new products and services; (xv) changes in the availability, cost or quality of
reinsurance; (xvi) changes in the distribution or placement of risks due to
increased consolidation of insurance and reinsurance brokers; (xvii) loss of key
personnel; (xviii) the effects of mergers, acquisitions and divestitures,
including, without limitation, the Winterthur International acquisition; (xix)
changes in rating agency policies or practices; (xx) changes in accounting
policies or practices; (xxi) legislative or regulatory developments; (xxii)
changes in general economic conditions, including inflation, foreign currency
exchange rates and other factors; (xxiii) the effects of business disruption or
economic contraction due to terrorism or other hostilities; and (xxiv) the other
factors set forth in the Company's other documents on file with the SEC. The
foregoing review of important factors should not be construed as exhaustive and
should be read in conjunction with the other cautionary statements that are
included herein or elsewhere. The Company undertakes no obligation to publicly
update or revise any forward-looking statement, whether as a result of new
information, future developments or otherwise.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES PAGE
Consolidated Balance Sheets as at December 31, 2001 and 2000 ................ 46
Consolidated Statements of Income and Comprehensive income
for the years ended December 31, 2001, 2000 and 1999 ..................... 47
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2001, 2000 and 1999 ......................................... 48
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 ......................................... 49
Notes to Consolidated Financial Statements for the years ended
December 31, 2001, 2000 and 1999 ......................................... 50
45
XL CAPITAL LTD
CONSOLIDATED BALANCE SHEETS AS AT DECEMBER 31, 2001 AND 2000
(U.S. dollars in thousands, except share amounts)
A S S E T S
2001 2000
------------------------
Investments:
Fixed maturities at fair value (amortized cost:
2001, $10,945,568; 2000, $8,714,196) ........... $10,831,927 $8,605,081
Equity securities, at fair value
(cost: 2001, $575,090; 2000, $515,440) ......... 547,805 557,460
Short-term investments, at fair value
(amortized cost: 2001, $1,050,015;
2000, $347,147) ............................... 1,050,113 339,007
------------------------
Total investments available for sale ....... 12,429,845 9,501,548
Investments in affiliates ......................... 1,037,344 792,723
Other investments ................................. 273,528 177,651
------------------------
Total investments .......................... 13,740,717 10,471,922
Cash and cash equivalents ............................ 1,863,861 930,469
Accrued investment income ............................ 180,305 143,235
Deferred acquisition costs ........................... 394,258 309,268
Prepaid reinsurance premiums ......................... 846,081 391,789
Premiums receivable .................................. 2,182,348 1,119,723
Reinsurance balances receivable ...................... 1,246,106 196,002
Unpaid losses and loss expenses recoverable .......... 5,033,952 1,339,767
Intangible assets (accumulated amortization:
2001, $194,045; 2000, $135,476) ................... 1,616,943 1,591,108
Deferred tax asset, net .............................. 419,222 152,168
Other assets ......................................... 439,282 296,501
------------ -----------
Total assets ............................... $27,963,075 $16,941,952
=========== ===========
L I A B I L I T I E S A N D S H A R E H O L D E R S' E Q U I T Y
Liabilities:
Unpaid losses and loss expenses ...................... $11,825,680 $5,672,062
Deposit liabilities and policy benefit reserves ...... 2,374,164 1,209,926
Unearned premiums .................................... 2,682,089 1,741,393
Notes payable and debt ............................... 1,604,877 450,032
Reinsurance balances payable ......................... 1,672,122 441,900
Net payable for investments purchased ................ 1,247,027 1,372,476
Other liabilities .................................... 1,071,402 439,433
Minority interest .................................... 48,530 41,062
------------ -----------
Total liabilities .......................... $22,525,891 $11,368,284
============ ===========
Commitments and Contingencies
Shareholders' Equity:
Authorized, 999,990,000 Class A ordinary shares,
par value $0.01
Issued and outstanding: (2001, 134,734,491;
2000, 125,020,676) ............................. $ 1,347 $ 1,250
Contributed surplus .................................. 3,378,549 2,497,416
Accumulated other comprehensive loss ................. (213,013) (104,712)
Deferred compensation ................................ (27,177) (17,727)
Retained earnings .................................... 2,297,478 3,197,441
------------ -----------
Total shareholders' equity ..................... $5,437,184 $5,573,668
------------ -----------
Total liabilities and shareholders' equity ..... $27,963,075 $16,941,952
============ ===========
See accompanying Notes to Consolidated Financial Statements
46
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(U.S. dollars in thousands, except per share amounts)
2001 2000 1999
------------------------------------
REVENUES:
Net premiums earned - general operations ..................... $2,779,927 $2,035,240 $1,750,006
Net premiums earned - life operations ........................ 695,595 -- --
Net investment income ........................................ 562,606 542,500 525,318
Net realized (losses) gains on investments ................... (93,237) 45,090 66,800
Net realized and unrealized (losses) gains on
derivative instruments .................................... (12,176) 5,481 27,556
Equity in net income of investment affiliates ................ 80,580 70,032 43,865
Fee income and other ......................................... 43,464 14,793 100,400
------------------------------------
Total revenues ........................................... 4,056,759 2,713,136 2,513,945
------------------------------------
EXPENSES:
Net losses and loss expenses incurred - general operations ... 2,918,898 1,432,559 1,304,304
Claims and policy benefit reserves - life operations ......... 698,675 -- --
Acquisition costs ............................................ 639,046 485,796 380,980
Operating expenses ........................................... 422,673 316,892 308,083
Exchange losses (gains) ...................................... 12,184 (59,621) (58)
Interest expense ............................................. 65,350 32,147 37,378
Amortization of intangible assets ............................ 58,569 58,597 49,141
------------------------------------
Total expenses ........................................... 4,815,395 2,266,370 2,079,828
------------------------------------
(Loss) income before minority interest, income tax expense
and equity in net income of insurance affiliates .......... (758,636) 446,766 434,117
Minority interest in net income of subsidiary ................ 2,113 1,093 220
Income tax benefit ........................................... (189,914) (56,356) (39,570)
Equity in net loss (income) of insurance affiliates .......... 5,300 (4,323) 2,958
------------------------------------
Net (loss) income ............................................... $ (576,135) $ 506,352 $ 470,509
------------------------------------
Change in net unrealized appreciation of investments ............ (71,004) (118,321) (211,842)
Foreign currency translation adjustments ........................ (37,297) (5,702) (4,032)
------------------------------------
Comprehensive (loss) income ..................................... $ (684,436) $ 382,329 $ 254,635
====================================
Weighted average ordinary shares and ordinary share
equivalents outstanding - basic .............................. 126,676 124,503 127,601
====================================
Weighted average ordinary shares and ordinary share
equivalents outstanding - diluted ............................ 126,676 125,697 130,304
====================================
(Loss) earnings per ordinary share and ordinary share
equivalent - basic ........................................... $ (4.55) $ 4.07 $ 3.69
====================================
(Loss) earnings per ordinary share and ordinary share
equivalent - diluted ......................................... $ (4.55) $ 4.03 $ 3.62
====================================
See accompanying Notes to Consolidated Financial Statements
47
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(U.S. dollars in thousands)
2001 2000 1999
------------------------------------
ORDINARY SHARES:
Balance - beginning of year ............ $ 1,250 $ 1,278 $ 1,287
Issue of shares ........................ 94 -- 1
Exercise of stock options .............. 18 23 5
Repurchase of shares ................... (15) (51) (15)
------------------------------------
Balance - end of year .............. 1,347 1,250 1,278
------------------------------------
CONTRIBUTED SURPLUS:
Balance - beginning of year ............ 2,497,416 2,520,136 2,508,062
Issue of shares ........................ 808,916 2,652 15,951
Exercise of stock options .............. 103,135 74,538 11,711
Repurchase of shares ................... (30,918) (99,910) (15,588)
------------------------------------
Balance - end of year .............. 3,378,549 2,497,416 2,520,136
------------------------------------
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME:
Balance - beginning of year ............ (104,712) 19,311 235,185
Net change in unrealized gains on
investment portfolio, net of tax ..... (72,272) (112,031) (213,482)
Net change in unrealized gains on
investment portfolio of affiliate .... 1,268 (6,290) 1,640
Currency translation adjustments ....... (37,297) (5,702) (4,032)
------------------------------------
Balance - end of year .............. (213,013) (104,712) 19,311
------------------------------------
DEFERRED COMPENSATION:
Balance - beginning of year ............ (17,727) (28,797) (22,954)
(Issue) forfeit of restricted shares ... (19,802) 1,555 (13,603)
Amortization ........................... 10,352 9,515 7,760
------------------------------------
Balance - end of year .............. (27,177) (17,727) (28,797)
------------------------------------
RETAINED EARNINGS:
Balance - beginning of year ............ 3,197,441 3,065,150 2,891,023
Net (loss) income ...................... (576,135) 506,352 470,509
Cash dividends paid .................... (237,628) (225,572) (212,659)
Repurchase of shares ................... (86,200) (148,489) (83,723)
------------------------------------
Balance - end of year .............. 2,297,478 3,197,441 3,065,150
------------------------------------
Total shareholders' equity ............... $5,437,184 $5,573,668 $5,577,078
====================================
See accompanying Notes to Consolidated Financial Statements
48
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(U.S. dollars in thousands)
2001 2000 1999
=======================================
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
Net (loss) income ...................................................... $ (576,135) $ 506,352 $ 470,509
---------------------------------------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Net realized losses (gains) on sales of investments .................... 93,237 (45,090) (66,800)
Net realized and unrealized losses (gains) on derivative instruments ... 12,176 (5,481) (27,556)
Amortization of discounts on fixed maturities .......................... (38,589) (47,099) (14,429)
Equity in net income of investment and insurance affiliates ............ (75,280) (74,355) (40,907)
Amortization of deferred compensation .................................. 10,352 8,861 7,657
Amortization of intangible assets ...................................... 58,569 58,597 49,141
Unpaid losses and loss expenses ........................................ 3,555,484 259,728 411,396
Unearned premiums ...................................................... 427,613 244,017 131,767
Premiums receivable .................................................... 76,076 6,674 (166,027)
Unpaid losses and loss expenses recoverable ............................ (2,360,127) (506,242) (212,928)
Policy benefit reserves ................................................ 623,298 -- --
Prepaid reinsurance premiums ........................................... (277,053) (174,475) (1,848)
Reinsurance balances receivable ........................................ (1,025,413) (46,122) (25,109)
Reinsurance balances payable ........................................... 831,364 46,076 204,256
Deferred tax asset ..................................................... (267,054) (54,240) (55,924)
Other .................................................................. 369,084 85,250 (173,964)
---------------------------------------
Total adjustments .................................................. 2,013,737 (243,901) 18,725
---------------------------------------
Net cash provided by operating activities .............................. 1,437,602 262,451 489,234
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Proceeds from sale of fixed maturities and short-term investments ...... 28,396,278 22,287,287 15,664,591
Proceeds from redemption of fixed maturities and
short-term investments ............................................. 1,543,550 460,733 134,565
Proceeds from sale of equity securities ................................ 882,501 1,480,853 1,017,177
Purchases of fixed maturities and short-term investments ............... (31,975,544) (22,798,463) (16,075,719)
Purchases of equity securities ......................................... (739,872) (1,071,351) (803,728)
Investments in affiliates, net of dividends received ................... (185,106) (180,818) (342,142)
Acquisition of subsidiaries, net of cash acquired ...................... (262,001) (3,094) (173,206)
Other investments ...................................................... (108,993) (55,917) (120,717)
Fixed assets and other ................................................. (21,898) (31,176) (35,642)
---------------------------------------
Net cash (used in) provided by investing activities ...................... (2,471,085) 88,054 (734,821)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Issue of shares ........................................................ 787,678 -- --
Proceeds from exercise of stock options ................................ 105,233 74,561 14,083
Repurchase of shares ................................................... (117,133) (248,450) (99,344)
Dividends paid ......................................................... (237,628) (225,572) (212,659)
Proceeds from notes payable and debt ................................... 1,172,533 250,300 328,700
Repayment of notes payable and debt .................................... (50,000) (211,000) (541,472)
Deposit liabilities .................................................... 306,664 372,033 837,893
Minority interest ...................................................... (24) 10,892 (4,900)
---------------------------------------
Net cash provided by financing activities ................................ 1,967,323 22,764 322,301
Effects of exchange rate changes on foreign currency cash ................ (448) (549) 161
Increase in cash and cash equivalents .................................... 933,392 372,720 76,875
Cash and cash equivalents - beginning of year ............................ $ 930,469 $ 557,749 $ 480,874
=======================================
Cash and cash equivalents - end of year .................................. $ 1,863,861 $ 930,469 $ 557,749
=======================================
Net taxes received (paid) ................................................ $ 10,025 $ 13,347 $ (30,246)
=======================================
Interest paid ............................................................ $ (36,509) $ (30,505) $ (28,268)
=======================================
See accompanying Notes to Consolidated Financial Statements
49
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31 2001, 2000 AND 1999
(U.S. dollars in thousands, except per share amounts)
1. HISTORY
XL Capital Ltd (the "Company") is a holding company organized under the
laws of the Cayman Islands. The Company was incorporated on March 16, 1998, as
the successor to EXEL Limited, a Cayman Islands corporation organized in 1986,
in connection with EXEL Limited's merger with Mid Ocean Limited, a Cayman
Islands corporation. The Company operated under the name EXEL Limited from
completion of the merger until February 1, 1999, when its current name was
approved by the requisite vote of the Company's shareholders. The Company is a
leading provider of insurance and reinsurance coverages and financial products
and services to industrial, commercial and professional service firms, insurance
companies and other enterprises on a worldwide basis.
On July 25, 2001, the Company completed the acquisition of certain
Winterthur International insurance operations ("Winterthur International") to
extend its predominantly North American based large corporate business globally.
Effective July 1, 2001, the Company's results include Winterthur International.
See Note 5 for additional information.
In 1999, XL Capital Ltd merged with NAC Re Corp ("NAC"), a Delaware
corporation. NAC was organized in 1985 and writes property and casualty
insurance and reinsurance in the U.S., Canada and Europe. Subsequent to the
merger, the Company amended its financial year from November 30 to December 31.
XL Re Ltd, formerly XL Mid Ocean Re, was organized under the laws of
Bermuda in 1992 initially to write property catastrophe reinsurance following a
reduction in market capacity due to the effects of severe hurricanes that struck
the southeastern United States in the late 1980s and early 1990s.
The Company further expanded into the U.S. in 1999 by completing the
acquisition of both Intercargo Corporation and ECS, Inc. Intercargo, renamed XL
Specialty, underwrites specialty insurance products for companies engaged in
international trade, including customs bonds and marine cargo insurance. ECS is
an underwriting manager, which specializes in environmental insurance coverages
and risk management services.
XL London Market, formerly XL Brockbank which comprised both Brockbank and
Denham Syndicate Management Limited, is organized under the laws of the U.K. and
is a leading Lloyd's managing agency that provides underwriting and similar
services to four Lloyd's syndicates. The Company provides 100% of the capacity
for two of these syndicates. These syndicates underwrite property, marine and
energy, aviation, satellite, professional indemnity and other specialty lines of
insurance and reinsurance to a global client base.
In July 1999, the Company entered into a venture with Les Mutuelles du Mans
Assurances Group to form a new French reinsurance company, Le Mans Re. Le Mans
Re underwrites a worldwide portfolio comprising most classes of property and
casualty reinsurance business together with a selective portfolio of life
reinsurance business.
In 1999, the Company made strategic minority investments in two investment
management firms. The Company acquired minority investments in Highfields
Capital Management LP, a global equity investment firm, and MKP Capital
Management, a New York based fixed income investment manager specializing in
mortgage-backed securities.
50
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PREPARATION AND CONSOLIDATION
These consolidated financial statements include the accounts of the Company
and all of its subsidiaries and have been prepared in accordance with U.S. GAAP
("GAAP"). Effective July 1, 2001, they include the acquired Winterthur
International operations under the purchase method of accounting, described in
Note 5. The consolidated financial statements also include the merger with NAC,
which occurred in June 1999, and which has been accounted for as a pooling of
interests. Results of operations, statements of position and cash flows include
NAC as though it had always been a part of the Company. All significant
intercompany accounts and transactions have been eliminated. The preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. These estimates and assumptions include the loss
events of September 11, 2001, described in Note 4. Actual results could differ
from these estimates.
Certain reclassifications have been made to prior year consolidated
financial statement amounts to conform to current year presentation.
(B) PREMIUMS AND ACQUISITION COSTS
Premiums written are recorded in accordance with the terms of the
underlying policies. Reinsurance premiums written are recorded at the inception
of the policy and are estimated based upon information received from ceding
companies and any subsequent differences arising on such estimates are recorded
in the period they are determined. Financial guaranty installment premiums are
recorded as premiums written when reported. Premiums are earned on a monthly
pro-rata basis over the period the coverage is provided. Financial guaranty
insurance premiums are earned over the life of the exposure. Unearned premiums
represent the portion of premiums written applicable to the unexpired terms of
policies in force. Net premiums earned are presented after deductions for
reinsurance ceded to other insurance companies.
Reinstatement premiums are written at the time a loss event occurs where
coverage limits for the remaining life of the contract are reinstated under
pre-defined contract terms and are earned over the remaining risk period.
Premiums from long duration contracts that transfer significant mortality
or morbidity risks are recognized as revenue and earned when due from
policyholders. Premiums from long duration contracts that do not subject the
Company to risks arising from policyholder mortality or morbidity are accounted
for as deposit liabilities, discussed further in Note 2(m).
Acquisition costs, which vary with and are related to the acquisition of
policies, primarily commissions paid to brokers, are deferred and amortized over
the period the premiums are earned. Future earned premiums, the anticipated
losses and other costs, together with investment income related to those
premiums are also considered in determining the level of acquisition costs to be
deferred.
(C) REINSURANCE
In the normal course of business, the Company seeks to reduce the loss that
may arise from events that could cause unfavorable underwriting results by
reinsuring certain levels of risk in various areas of exposure with other
insurers or reinsurers. Reinsurance premiums ceded are expensed and any
commissions recorded thereon are earned on a monthly pro-rata basis over the
period the reinsurance coverage is provided. Prepaid reinsurance premiums
51
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
represent the portion of premiums ceded applicable to the unexpired term of
policies in force. Reinstatement premiums ceded are recognized at the time a
loss event occurs where coverage limits for the remaining life of the contract
are reinstated under pre-defined contract terms and are expensed over the
remaining risk period. Amounts recoverable from reinsurers are estimated in a
manner consistent with the claim liability associated with the reinsured policy.
Provision is made for estimated unrecoverable reinsurance.
(D) FEE INCOME AND OTHER
Fee income and other includes fees earned for insurance related services
provided and is earned over the service period of the contract. Any adjustments
to fees earned or the service period are reflected in income in the period when
determined. Fee income and other also includes changes in the fair value of
weather risk management products, as discussed in Note 2(e).
(E) DERIVATIVE INSTRUMENTS AND WEATHER RISK MANAGEMENT PRODUCTS
The Financial Accounting Standards Board issued FAS 133, "Accounting for
Derivative Instruments and Hedging Activities" in June 1998. FAS 133 establishes
accounting and reporting standards for derivative instruments including those
embedded in other contracts (collectively referred to as derivatives), and for
hedging activity. It requires an entity to recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at fair
value. Non-exchange traded weather products are not covered by FAS 133, however
they are also recorded at fair value. The Company adopted FAS 133, as amended,
as of January 1, 2001. The Company conducts activities in three main types of
instruments: credit default swap derivatives, weather risk management products
and investment related derivative instruments. There was no significant impact
from the adoption of FAS 133. See Note 14 for further information on these
derivative instruments.
CREDIT DEFAULT SWAP DERIVATIVES
The Company considers credit default swaps to be, in substance, financial
guaranty contracts as the Company intends to hold them to maturity. Fair value
is determined using a model developed by the Company and is dependent upon a
number of factors including changes in interest rates, credit spreads, changes
in credit quality and other market factors. The change in fair value in a period
is split between premiums, net losses and loss expenses, and net realized and
unrealized gains and losses on derivative instruments. The change resulting from
movements in credit and quality spreads is unrealized as the credit default
swaps are not traded to realize this value and is included in net realized and
unrealized gains and losses on derivative instruments. Other elements of the
change in fair value are based upon pricing established at the inception of the
contract. Prior to the adoption of FAS 133, the net premiums earned and loss and
loss expenses were included in fee income and other.
WEATHER RISK MANAGEMENT PRODUCTS
Weather risk management products are recorded at fair value with the
changes in fair value included in fee income and other. Fair value is determined
using a quantitative analytical model developed by the Company and is dependent
upon a number of factors including, among others, realized weather results,
forecasted weather conditions, changes in interest rates and other market
factors.
52
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTMENT RELATED DERIVATIVE INSTRUMENTS
The Company uses investment derivatives to manage duration and currency
exposure for its investment portfolio. None of these investment derivatives are
designated hedges, and accordingly, financial futures, options and forward
currency contracts are carried at fair value, with the corresponding realized
and unrealized gains and losses included in net realized and unrealized gains
and losses on derivative instruments.
(F) INVESTMENTS AVAILABLE FOR SALE
Investments are considered available for sale and are carried at fair
value. The fair value of investments is based upon quoted market values where
available or by reference to broker or underwriter bid indications. The net
unrealized appreciation or depreciation on investments, net of tax, is included
in accumulated other comprehensive loss. Any unrealized depreciation in value
considered by management to be other than temporary is charged to income in the
period that it is determined. An other than temporary decline is also considered
to occur in investments where there has been a sustained reduction in market
value and the Company has considered any mitigating factors.
Short-term investments comprise investments with a maturity equal to or
greater than 90 days but less than one year. Equity securities include
investments in open end mutual funds. All investment transactions are recorded
on a trade date basis. Realized gains and losses on sales of equities and fixed
income investments are determined on the basis of average cost and amortized
cost, respectively. Investment income is recognized when earned and includes
interest and dividend income together with the amortization of premium and
discount on fixed maturities and short-term investments.
(G) CASH EQUIVALENTS
Cash equivalents include fixed interest deposits placed with a maturity of
under 90 days when purchased.
(H) FOREIGN CURRENCY TRANSLATION
Assets and liabilities of foreign operations whose functional currency is
not the U.S. dollar are translated at year end exchange rates. Revenue and
expenses of such foreign operations are translated at average exchange rates
during the year. The effect of the translation adjustments for foreign
operations, net of applicable deferred income taxes, is included in accumulated
other comprehensive loss.
Other monetary assets and liabilities denominated in foreign currencies are
revalued at the exchange rate in effect at the balance sheet date with the
resulting foreign exchange gains and losses recognized in income. Revenue and
expense transactions are translated at the average exchange rates prevailing
during the year.
(I) INVESTMENTS IN AFFILIATES
Investments in which the Company has significant influence over the
operations are classified as affiliates and are carried under the equity method
of accounting. Under this method, the Company records its proportionate share of
income or loss from such investments in its results for the period. Significant
influence is deemed to exist where the Company has an investment of 3% or
greater in closed end funds or limited partnerships. Significant influence is
considered for other strategic investments on a case-by-case basis. The equity
in net income of affiliates is shown separately between equity in net income of
strategic insurance affiliates and equity in net income of investment fund
related affiliates.
53
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(J) OTHER INVESTMENTS
The Company accounts for its other investments on a cost basis, as it has
no significant influence over these entities. Investments are written down to
their estimated realizable value where management considers there is an other
than temporary decline in value, based on financial information received. Income
is recorded when received.
(K) AMORTIZATION OF INTANGIBLE ASSETS
Intangible assets primarily represent goodwill recorded in connection with
the Company's business combinations and are amortized on a straight-line basis
over the expected life of the related operations acquired, not exceeding 40
years. The Company evaluates the recoverability of its intangible assets
whenever changes in circumstances warrant. If it is determined that an
impairment exists, the excess of the unamortized balance over the fair value of
the intangible asset will be charged to income at that time. See Note 2(t) for
further information.
(L) LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses includes reserves for unpaid reported
losses and loss expenses and for losses incurred but not reported. The reserve
for unpaid reported losses and loss expenses is established by management based
on amounts reported from insureds or ceding companies and consultation with
independent legal counsel, and represents the estimated ultimate cost of events
or conditions that have been reported to or specifically identified by the
Company.
The reserve for losses incurred but not reported is estimated by management
and reviewed by independent actuaries, based on loss development patterns
determined by reference to the Company's underwriting practices, the policy
form, type of insurance program and the experience of the relevant industries.
Certain workers compensation reserves are considered fixed and determinable
and are subject to tabular reserving. Such tabular reserves are discounted.
Management believes that the reserves for unpaid losses and loss expenses
are sufficient to cover losses that fall within coverages assumed by the
Company. However, there can be no assurance that losses will not exceed the
Company's total reserves. The methodology of estimating loss reserves is
periodically reviewed to ensure that the assumptions made continue to be
appropriate and any adjustments resulting therefrom are reflected in income of
the year in which the adjustments are made.
(M) DEPOSIT LIABILITIES
Contracts entered into by the Company which are not deemed to transfer
significant underwriting and/or timing risk are accounted for as deposits,
whereby liabilities are initially recorded at the same amount as assets
received. An initial accretion rate is established based on actuarial estimates
whereby the deposit liability is increased to the estimated amount payable over
the term of the contract. Accretion expense is recorded against investment
income generated from the related invested assets. The Company periodically
reassesses the estimated ultimate liability. Any changes to this liability are
reflected as an adjustment to interest income to reflect the cumulative effect
to date of the period the contract has been in force, and by an adjustment to
the future accretion rate of the liability over the remaining estimated contract
term.
54
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(N) POLICY BENEFIT RESERVES
Long duration contracts that do transfer significant mortality or morbidity
risks to the Company are accounted for as insurance contracts and policy benefit
reserves are established based on the present value of the estimated ultimate
liability. An initial accretion rate is established based on actuarial estimates
and the policy benefit reserve is increased to the estimated amounts payable
over the term of the contract. This accretion charge is recorded in the period
as life claims and policy benefit reserves. The Company periodically reassesses
the estimated ultimate policy benefits. Any changes to this estimate will be
reflected as an adjustment to life claims and policy benefit reserves to reflect
the cumulative effect to date of the period the contract has been in force and
by an adjustment to the future accretion rate of the liability over the
remaining estimated contract term.
(O) INCOME TAXES
The Company utilizes the asset and liability method of accounting for
income taxes. Under this method, deferred income taxes reflect the net tax
effect of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. A valuation allowance is established for any portion of a deferred tax
asset that management believes will not be realized.
(P) STOCK PLANS
The Company accounts for stock compensation plans in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees". Accordingly, compensation expense for stock option grants and stock
appreciation rights is recognized to the extent that the fair value of the stock
exceeds the exercise price of the option at the measurement date.
(Q) PER SHARE DATA
Basic earnings per share is based on weighted average common shares
outstanding and excludes any dilutive effects of options and convertible
securities. Diluted earnings per share assumes the conversion of dilutive
convertible securities and the exercise of all dilutive stock options.
(R) SPECIAL PURPOSE VEHICLES
The Company accounts for its investments in and relationships with special
purpose vehicles in accordance with GAAP. The Company considers several factors
to determine whether effective control exists. These factors include, but are
not limited to, the initial equity investment made in the vehicle, the degree of
exposure to the risks of the underlying assets and liabilities of the vehicle
and the potential to benefit from the rewards. Those special purpose vehicles
that the Company deems necessary to consolidate are accounted for in accordance
with the accounting policy for subsidiaries in Note 2(a). Those which the
Company does not consider should be consolidated are accounted for in accordance
with the terms of the transactions and contractual agreements in place.
GAAP is potentially subject to change during 2002 and this accounting
policy will be amended if necessary. See Note 15(a) to the Consolidated
Financial Statements for further discussion.
(S) FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of certain assets and liabilities are based on published market
values, if available, or estimates of fair values of similar issues.
55
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(T) RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued FAS 141, "Business
Combinations," and FAS 142, "Goodwill and Other Intangible Assets," in July
2001. The Company has adopted these standards for the acquisition of Winterthur
International. FAS 141 addresses financial accounting and reporting for the
acquisition of other companies and is applicable for new transactions effective
after June 30, 2001. For previous transactions, this standard is effective for
fiscal years beginning after December 15, 2001. FAS 142 addresses financial
accounting and reporting for goodwill and other intangible assets both upon
acquisition and after these assets have initially been recognized in the
financial statements. The Company has commenced an initial assessment of the
effect of the adoption of FAS 142 for goodwill, excluding Winterthur
International, and will continue this assessment in accordance with the
standard. Amortization expense may reduce in 2002 and future periods, however
the assessment of any required impairment charge has not yet been completed.
3. SEGMENT INFORMATION
The Company is organized into three underwriting segments - insurance,
reinsurance, and financial products and services - in addition to a corporate
segment that includes the investment and financing operations of the Company.
Lloyd's syndicates are part of the insurance segment but are described
separately. The Company evaluates performance of each segment based on
underwriting profit or loss. Other items of revenue and expenditure of the
Company are not evaluated at the segment level. In addition, management does not
currently allocate assets by segment as it considers the underwriting results
separately from the performance of the investment portfolio.
Certain business written by the Company has loss experience characterized
as low frequency and high severity. This may result in volatility in both the
Company's results and operational cash flows. General operations and Life
operations are disclosed separately within each segment. General operations
include property and casualty lines of business and financial products and
services.
INSURANCE OPERATIONS - EXCLUDING LLOYD'S SYNDICATES
Insurance business written includes general liability, other liability
including directors and officers, professional and employment practices
liability, environmental liability, property, program business, marine,
aviation, satellite and other product lines including customs bonds, surety,
political risk and specialty lines.
INSURANCE OPERATIONS - LLOYD'S SYNDICATES
The Lloyd's syndicates write property, marine and energy, aviation and
satellite, professional indemnity, liability coverage and other specialty lines.
REINSURANCE OPERATIONS
Reinsurance business written includes treaty and facultative reinsurance to
primary insurers of casualty risks, principally: general liability; professional
liability; automobile and workers compensation; commercial and personal property
risks; specialty risks including fidelity and surety and ocean marine; property
catastrophe; property excess of loss; property pro-rata; marine and energy;
aviation and satellite; and various other reinsurance to insurers on a worldwide
basis. The Company endeavors to manage its exposures to catastrophic events by
limiting the amount of its exposure in each geographic zone worldwide and
requires that its property catastrophe contracts provide for aggregate limits
and varying attachment points.
56
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
FINANCIAL PRODUCTS AND SERVICES
Financial products and services business written includes insurance,
reinsurance and derivative solutions for complex financial risks. These include
financial guaranty insurance and reinsurance, credit enhancement swaps, other
collateralized transactions and weather risk management products. While each of
these is unique and is tailored for the specific needs of the insured or user,
they are often multi-year contracts. Due to the nature of these types of
contracts, premium volume as well as underwriting results can vary significantly
from period to period.
The following is an analysis of the underwriting profit or loss by segment
together with a reconciliation of underwriting profit or loss to net income or
loss:
FINANCIAL
LLOYD'S PRODUCTS AND
YEAR ENDED DECEMBER 31, 2001: INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
- ---------------------------- --------------------------------------------------------------------
GENERAL OPERATIONS:
Net premiums earned .................. $ 1,222,196 $ 481,307 $ 1,029,618 $46,806 $ 2,779,927
Fee income and other ................. 22,065 (3,707) (7,180) 32,286 43,464
Net losses and loss expenses ......... 859,812 610,823 1,428,772 19,491 2,918,898
Acquisition costs .................... 187,443 155,804 292,069 3,730 639,046
Operating expenses (2) ............... 178,530 22,215 87,169 42,404 330,318
Exchange losses ...................... 4,924 3,198 4,062 -- 12,184
LIFE OPERATIONS:
Life premiums earned ................. -- -- 695,595 -- 695,595
Claims and policy benefit reserves ... -- -- 698,675 -- 698,675
--------------------------------------------------------------------
Underwriting profit (loss) ........... $ 13,552 $(314,440) $ (792,714) $13,467 $(1,080,135)
Net investment income ................ 562,606
Net realized losses on investments ... 93,237
Net realized and unrealized losses
on derivative instruments .......... 12,176
Equity in net income of affiliates ... 75,280
Interest expense ..................... 65,350
Amortization of intangible assets .... 58,569
Corporate operating expenses (3) ..... 92,355
Minority interest .................... 2,113
Income tax benefit ................... 189,914
-----------
Net loss ............................. $ (576,135)
===========
Loss and loss expense ratio .......... 70.4% 126.9% 138.8% 41.6% 105.0%
Underwriting expense ratio ........... 29.9% 37.0% 36.8% 98.6% 34.9%
--------------------------------------------------------------------
Combined ratio ....................... 100.3% 163.9% 175.6% 140.2% 139.9%
====================================================================
(1) Ratios are based on net premiums earned from general operations, excluding
fee income and other. The underwriting expense ratio excludes exchange
gains and losses.
(2) Operating expenses exclude corporate operating expenses, shown separately.
(3) Corporate operating expenses include charges of $14.0 million related to
the acquisition of Winterthur International.
57
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
FINANCIAL
LLOYD'S PRODUCTS AND
YEAR ENDED DECEMBER 31, 2001: INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
- ---------------------------- -----------------------------------------------------------------
GENERAL OPERATIONS:
Net premiums earned .................. $ 726,506 $ 357,824 $ 927,195 $23,715 $ 2,035,240
Fee income and other ................. 7,692 (6,626) (2,197) 15,924 14,793
Net losses and loss expenses (2) ..... 502,898 260,372 663,173 6,116 1,432,559
Acquisition costs .................... 117,251 119,870 247,352 1,323 485,796
Operating expenses (3) ............... 94,129 28,727 102,132 29,969 254,957
Exchange (gains) losses .............. (2,344) (5,986) 3,868 -- (4,462)
----------------------------------------------------------------
Underwriting profit (loss) ........... $ 22,264 $ (51,785) $ (91,527) $ 2,231 $ (118,817)
Net investment income ................ 542,500
Net realized gains on investments .... 45,090
Net realized and unrealized gains
on derivative instruments .......... 5,481
Equity in net income of affiliates ... 74,355
Interest expense ..................... 32,147
Amortization of intangible assets .... 58,597
Corporate operating expenses (3) ..... 61,935
Other exchange gain .................. 55,159
Minority interest .................... 1,093
Income tax benefit ................... 56,356
---------
Net income ........................... $ 506,352
=========
Loss and loss expense ratio .......... 69.2% 72.8% 71.5% 25.8% 70.4%
Underwriting expense ratio ........... 29.1% 41.5% 37.7% 131.9% 36.4%
----------------------------------------------------------------
Combined ratio ....................... 98.3% 114.3% 109.2% 157.7% 106.8%
================================================================
(1) Ratios are based on net premiums earned, excluding fee income and other.
The underwriting expense ratio excludes exchange gains and losses.
(2) Net losses and loss expenses for the insurance segment include, and the
reinsurance segment exclude, $33.5 million relating to an intercompany stop
loss arrangement. Total results are not affected. The loss and loss expense
ratio would have been 64.6% and 75.1% and the underwriting results would
have been a profit of $55.8 million and a loss of $125.0 million in the
insurance and reinsurance segments, respectively, had this stop loss
arrangement not been in place.
(3) Operating expenses exclude corporate operating expenses, shown separately.
58
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
FINANCIAL
LLOYD'S PRODUCTS AND
YEAR ENDED DECEMBER 31, 1999: INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
- --------------------------- ----------------------------------------------------------------
GENERAL OPERATIONS:
Net premiums earned .................. $ 463,069 $ 355,769 $ 909,915 $21,253 $ 1,750,006
Fee income and other ................. 7,584 65,892 -- 26,924 100,400
Net losses and loss expenses (2) ..... 309,079 297,595 692,269 5,361 1,304,304
Acquisition costs .................... 65,318 89,195 224,359 2,108 380,980
Operating expenses (3) ............... 71,094 29,305 101,978 16,670 219,047
Exchange (gains) losses .............. (165) (1,180) 1,286 -- (59)
----------------------------------------------------------------
Underwriting profit (loss) ........... $ 25,327 $ 6,746 $(109,977) $24,038 $ (53,866)
Net investment income ................ 525,318
Net realized gains on investments .... 66,800
Net realized and unrealized gains
on derivative instruments .......... 27,556
Equity in net income of affiliates ... 40,907
Interest expense ..................... 37,378
Amortization of intangible assets .... 49,141
Corporate operating expenses (4) ..... 89,037
Minority interest .................... 220
Income tax benefit ................... 39,570
-----------
Net income ........................... $ 470,509
===========
Loss and loss expense ratio .......... 66.7% 83.6% 76.1% 25.2% 74.5%
Underwriting expense ratio ........... 29.5% 33.3% 35.9% 88.4% 34.3%
----------------------------------------------------------------
Combined ratio ....................... 96.2% 116.9% 112.0% 113.6% 108.8%
================================================================
(1) Ratios are based on net premiums earned, excluding fee income and other.
The underwriting expense ratio excludes exchange gains and losses.
(2) Net losses and loss expenses for the insurance segment include, and the
reinsurance segment exclude, $100.0 million relating to an intercompany
stop loss arrangement. Total results are not affected. The loss and loss
expense ratio would have been 45.2% and 87.1% and the underwriting results
would have been a profit of $125.3 million and a loss of $210.0 million in
the insurance and reinsurance segments, respectively, had this stop loss
arrangement not been in place.
(3) Operating expenses exclude corporate operating expenses, shown separately.
(4) Corporate operating expenses include charges of $45.3 million related to
the merger with NAC.
59
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
3. SEGMENT INFORMATION (CONTINUED)
SUPPLEMENTAL SEGMENT AND GEOGRAPHIC INFORMATION
The following table is an analysis of the Company's gross premiums written,
net premiums written and net premiums earned from general operations, by line of
business for the years ended December 31:
GROSS PREMIUM WRITTEN: 2001 2000 1999
------------------------------------
Casualty ................................. $1,699,460 $1,127,551 $ 779,291
Property ................................. 1,276,075 728,212 572,038
Marine, energy, aviation and satellite ... 510,291 365,850 212,452
Lloyd's syndicates (1) ................... 693,016 486,640 591,520
Other (2) ................................ 604,880 420,778 287,619
------------------------------------
Total .................................... $4,783,722 $3,129,031 $2,442,920
====================================
NET PREMIUM WRITTEN: 2001 2000 1999
------------------------------------
Casualty ................................. $1,073,474 $ 723,062 $ 651,614
Property ................................. 546,575 537,037 440,175
Marine, energy, aviation and satellite ... 310,197 230,356 152,783
Lloyd's syndicates (1) ................... 537,614 311,814 423,880
Other (2) ................................ 460,566 313,971 233,431
------------------------------------
Total .................................... $2,928,426 $2,116,240 $1,901,883
====================================
NET PREMIUM EARNED: 2001 2000 1999
------------------------------------
Casualty ................................. $1,017,565 $ 749,105 $ 604,455
Property ................................. 624,644 467,165 457,991
Marine, energy, aviation and satellite ... 287,387 212,273 163,112
Lloyd's syndicates (1) ................... 481,307 357,824 355,769
Other (2) ................................ 369,024 248,873 168,679
------------------------------------
Total .................................... $2,779,927 $2,035,240 $1,750,006
====================================
(1) Lloyd's syndicates write a variety of coverages encompassing most of the
above lines of business.
(2) Other premiums written and earned include political risk, surety, bonding
and warranty.
The following table shows an analysis of the Company's net premiums written
by geographical location of subsidiary for the years ended December 31:
NET PREMIUMS WRITTEN: .................... 2001 2000 1999
------------------------------------
Bermuda .................................. $ 667,760 $ 609,609 $ 561,750
United States ............................ 1,277,668 934,110 684,468
Europe and other ......................... 982,998 572,521 655,665
------------------------------------
Total .................................... $2,928,426 $2,116,240 $1,901,883
====================================
60
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
4. THE SEPTEMBER 11 EVENT
Terrorist attacks at the World Trade Center in New York City, in
Washington, D.C. and in Pennsylvania on September 11, 2001 (collectively, "the
September 11 event") are estimated to have caused the largest ever man-made
insured losses for the property and casualty insurance industry. The Company has
exposure to this event with claims expected to arise mainly from its aviation,
property, personal accident and business interruption insurance and reinsurance
coverages.
The Company has performed a detailed analysis of contracts it believes are
exposed to this event. The process varied between segments, due to the specific
nature of each of their operations, and by line of business. For the property
lines of business, which are the main areas affected, the Company was able to
identify a limited number of relevant contracts soon after the event. The
process included identification of possible claims using underwriting systems to
determine potential exposures on a case-by-case basis. The exposures were then
analyzed to determine the exact location and magnitude of the potential loss.
This process was complicated in the reinsurance operations where the
Company is not a direct insurer. Potential losses on certain business lines were
easily estimated, such as aviation and direct property catastrophe. Estimates
related to the retrocessional book of business were more difficult to ascertain
due to the inherent nature of determining the effect from losses arising on the
underlying contracts.
The amount of reinsurance recoveries was calculated in accordance with
underlying reinsurance contract terms and management believes that the credit
rating of the relevant reinsurers continues to provide confidence in ultimate
recoverability of these balances.
The Company estimates losses incurred of approximately $760.0 million, net
of reinsurance recoveries, based on preliminary reports and estimates of loss
and damage. This is management's best estimate at this time, however, it could
change as more information becomes available. The following is an analysis of
the impact on the Company's segments and total results of operations from the
September 11 event for the year ended December 31, 2001:
FINANCIAL
LLOYD'S PRODUCTS AND
INSURANCE SYNDICATES REINSURANCE SERVICES TOTAL
----------------------------------------------------------
Gross premium written .............. $ -- $ -- $ 147,900 $ -- $ 147,900
Reinsurance ceded .................. 3,900 21,400 340,400 -- 365,700
Net premiums earned ................ (3,900) (21,400) (120,400) -- (145,700)
Net losses and loss expenses ....... 102,050 215,800 442,150 -- 760,000
------------------------------------------------------------
Underwriting loss .................. $(105,950) $(237,200) $(562,550) -- $(905,700)
-----------------------------------------------
Equity in net loss of affiliates ... (27,000)
Income tax benefit ................. 136,760
---------
Net loss ........................... $(795,940)
=========
Premiums written, ceded and earned related to reinstatement and adjustment
premiums that are typically received and paid when a catastrophic event occurs.
The premium is paid to reinstate coverage for the remaining life of the
contract. Net losses and loss expenses comprise gross claims of $1.9 billion
with estimated reinsurance recoveries of $1.1 billion, both excluding Winterthur
International, discussed below. Approximately 96% of the relevant reinsurers
currently fall into Standard & Poor's financial strength rating categories or
equivalent of A or better, with approximately 65% rated AA or better.
61
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
4. THE SEPTEMBER 11 EVENT (CONTINUED)
Winterthur International incurred gross losses of $321.0 million related to
the September 11 event, which the Company expects to recover from third-party
reinsurers or under the net loss reserve seasoning mechanism in the Sale and
Purchase Agreement (defined in Note 5), or a combination of the two. These
losses related to business written by Winterthur International prior to July 1,
2001.
5. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END
(A) WINTERTHUR INTERNATIONAL
On July 25, 2001, the Company completed the acquisition of Winterthur
International primarily to extend its predominantly North American based large
corporate insurance business globally. This was an all-cash transaction. The
preliminary purchase price of approximately $405.6 million was based on audited
financial statements as at December 31, 2000 for the business being acquired,
and is subject to final determination based on the audited financial statements
of Winterthur International as at June 30, 2001. These audited financial
statements are not expected to be completed until later in 2002, at which time
any final adjustment payment will be made or receivable collected. Results of
operations of Winterthur International have been included from July 1, 2001, the
date from which the economic interest was transferred to the Company.
The Second Amended and Restated Agreement for the Sale and Purchase of
Winterthur International ("the Sale and Purchase Agreement") provides the
Company with significant post-closing protection with respect to adverse
development of reserves with respect to Winterthur International business
written prior to July 1, 2001. This protection is based upon actual net loss
experience and development over a three year post closing seasoning period based
on loss development experience, collectible reinsurance, reinsurance recoveries
and certain other factors. Business in force at June 30, 2001 carries a maximum
exposure to a combined ratio of 105%. The Company's exposure to a deficiency in
the net reserves and the run-off of expiring business of the acquired Winterthur
International operations, including by reason of uncollectible reinsurance, is
limited to $61.0 million. Certain Winterthur International businesses and
product lines were not purchased, primarily asbestos, certain insurance
liabilities in respect of 1985 and prior years, certain captive management,
alternative risk and life insurance business.
The acquisition has been accounted for under the purchase method of
accounting and, therefore, the identifiable assets and liabilities of Winterthur
International were recorded at their estimated fair value on June 30, 2001 based
on the unaudited financial statements prepared by the seller and provided to the
Company at that time. The process of determining the fair value of such assets
and liabilities acquired, as required under purchase accounting, included
management's estimates and independent valuations. The purchase price was
preliminarily allocated to the acquired assets and liabilities based upon their
estimated fair value at June 30, 2001. The excess of the purchase price over
acquired tangible net assets was then applied to intangible assets with finite
and indefinite lives. The remaining purchase price excess over fair value of net
assets was allocated to goodwill. The Company's estimate of the fair value of
loss reserves is approximately $5.0 million less than the carrying value
recorded by the seller at July 1, 2001. This difference will be charged to
income over the next six years. The Company has included the $61.0 million
exposure in establishing its risk premium adjustment inherent in the fair value
of loss reserves.
The fair value adjustment estimate consists of two components: (i)
discounting the net loss reserves and unearned premium reserves to present value
using a risk-free rate of return, net of deferred taxes, and (ii) developing an
expense, profit and risk margin for the acquired reserves based on management's
estimate of current market pricing and the terms in the Sale and Purchase
Agreement.
62
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
5. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END (CONTINUED)
The expected payment patterns for the gross loss reserves and the
associated reinsurance recoverable amounts are derived by developing separate
payment patterns for the gross loss reserves using historical Winterthur
International data by line of business and for the associated reinsurance
recoverable amounts by lagging the gross payout patterns. In addition,
management has estimated a 5% risk and profit margin within these reserves. This
margin is based on current pricing quotes expected from a prospective reinsurer
or other third party assuming the same risks and takes into account the reserve
seasoning protection provided by the seller to the Company. Determination of a
fair value for the net unearned premium reserve follows a similar approach to
that applied to the loss reserves but with some minor adjustments.
The fair value of significant assets and liabilities acquired by the
Company include $0.2 billion of cash, $1.2 billion of invested assets, $1.1
billion of premiums receivable, $1.3 billion of unpaid losses and loss expenses
recoverable, $2.6 billion of unpaid losses and loss expenses, $513.0 million of
unearned premiums and $391.9 million of reinsurance balances payable.
Allocation of the purchase price is as follows:
Fair value of assets acquired .......................... $4,791,338
Fair value of liabilites acquired ...................... 4,564,376
----------
Fair value of tangible net assets acquired ............. $ 226,962
Fair value of intangible assets acquired ............... 29,800
Goodwill related to the acquisition .................... 40,476
----------
$ 297,238
----------
Adjusted preliminary purchase price .................... $ 274,738
Other costs of acquisition ............................. 22,500
----------
$ 297,238
----------
The decrease in purchase price to $274.7 million as compared to the
preliminary purchase price of $405.6 million at December 31, 2000 reflects the
decline in the net asset value of Winterthur International as presented in the
unaudited financial statements as at June 30, 2001. The difference of $130.9
million, which is subject to final adjustment upon completion of the audit, will
be recoverable from the seller when the audited financial statements at June 30,
2001 are available and is included in other assets at December 31, 2001. As
additional information becomes available, the Company may be required to make
certain reclassifications to balance sheet items with minimal impact on net
income.
The Company has made a preliminary estimate of the value of intangible
assets acquired and estimates that $14.7 million relates to insurance licenses
and sales force, which have an indefinite life and are not therefore subject to
amortization. The remaining $15.1 million relates to the value of business in
force, which is estimated to have a finite life of up to five years and is being
amortized over that period.
The following unaudited pro forma financial information for the year ended
December 31, 2001 includes the unaudited financial information for Winterthur
International for the year ended December 31, 2001 as if the acquisition
occurred on January 1, 2001. The unaudited pro forma financial information for
the year ended December 31, 2000 includes the audited financial information for
Winterthur International for the year ended December 31, 2000 as if the
acquisition occurred on January 1, 2000.
63
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
5. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END (CONTINUED)
Winterthur International results of operations for the first six months of
2001 and the year ended December 31, 2000 included in the pro forma financial
information have not been adjusted for the contractual protection that the
Company has received from the seller with effect from July 1, 2001.
The pro forma financial information is based upon information currently
available and certain assumptions that the Company's management believes are
reasonable. The financial information of Winterthur International for both
periods presented is taken from the financial statements of the seller and were
prepared on a GAAP basis for the first time. The pro forma financial information
does not purport to represent what the Company's results of operations or
financial condition would have been had the transaction occurred on such dates
or to project the Company's results of operations or financial condition for any
future period or date. The pro forma financial information necessarily does not
give effect to any changes in underwriting, reinsurance, investment policies or
other practices that are or may be instituted post-closing. In addition, they
also do not give effect to any integration of the Winterthur International
operations with certain insurance operations of the Company. As a result of the
above, the pro forma financial information should be reviewed with caution and
undue reliance should not be placed on such information.
(UNAUDITED) (UNAUDITED)
PRO FORMA PRO FORMA
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
-------------------------
Net premiums earned - general operations ....... $ 3,119,977 $2,568,867
Net premiums earned - life operations .......... 695,595 --
Net investment income .......................... 587,676 612,486
Net realized (losses) gains on investments ..... (93,318) 56,107
Net realized and unrealized gains and
losses on derivative instruments ............. (12,176) 5,481
Equity in net income of investment
affiliates .................................... 80,580 70,032
Fee income and other ........................... 55,421 26,978
-------------------------
Total revenues ................................. $ 4,433,755 $3,339,951
-------------------------
Net losses and loss expenses incurred -
general operations ........................... $ 3,294,452 $1,866,269
Claims and policy benefit reserves -
life operations .............................. 698,675 --
Acquisition costs, operating expense and
foreign currency gains and losses ............ 1,214,828 872,883
Interest expense ............................... 69,100 39,647
Amortization of intangible assets .............. 59,069 97,458
-------------------------
Total expenses ................................. $ 5,336,124 $2,876,257
-------------------------
Net (loss) income .............................. $ (729,129) $ 527,158
=========================
(Loss) earnings per ordinary share - Basic ..... $(5.76) $4.23
(Loss) earnings per ordinary share - Diluted ... $(5.76) $4.19
(B) THE LONDON ASSURANCE COMPANY OF AMERICA, INC.
In the first quarter of 2001, the Company acquired The London Assurance
Company of America, Inc., a shell company licensed in forty five U.S. states,
for the purpose of obtaining licenses for the financial guaranty operations of
the Company. The cost of the acquisition less cash acquired was $16.5 million.
Goodwill arising from the acquisition was $11.2 million.
64
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
5. BUSINESS COMBINATIONS AND CHANGE IN FISCAL YEAR END (CONTINUED)
(C) NAC RE CORP
On June 18, 1999, the Company merged with NAC in an all-stock transaction.
Shareholders of NAC received 0.915 Company shares for each NAC share in a
tax-free exchange. Approximately 16.9 million of the Company's ordinary shares
were issued in this transaction. The merger transaction was accounted for as a
pooling of interests under GAAP.
Following the merger, the Company changed its fiscal year end from November
30 to December 31 as a conforming pooling adjustment. No adjustments were
necessary to conform NAC's accounting policies, although certain
reclassifications were made to the NAC financial statements to conform to the
Company's presentation. NAC was renamed XL America Inc.
(D) ECS, INC AND INTERCARGO CORPORATION
In 1999, the Company acquired ECS, an underwriting manager that specializes
in environmental insurance coverages and risk management services. ECS commenced
underwriting policies on behalf of the Company's insurance and reinsurance
subsidiaries effective January 1, 2000.
In 1999, the Company acquired Intercargo, which underwrites specialty
insurance products for companies engaged in international trade, including
customs bonds and marine cargo insurance. The Intercargo and ECS acquisitions
were accounted for under the purchase method of accounting. The combined
purchase price was $222.8 million and the resulting goodwill of $159.6 million
is being amortized over 20 years. Net cash acquired as a result of the
acquisition was $49.6 million. Intercargo was renamed XL Specialty during 2000.
6. INVESTMENTS
Net investment income is derived from the following sources:
YEAR ENDED DECEMBER 31
--------------------------------
2001 2000 1999
--------------------------------
Fixed maturities, short-term investments
and cash equivalents ...................... $657,163 $622,826 $552,333
Equity securities ........................... 9,646 10,661 11,835
--------------------------------
Total gross investment income ............ 666,809 633,487 564,168
Accretion charge for deposit liabilities .... 81,686 71,509 14,164
Investment expenses ......................... 22,517 19,478 24,686
--------------------------------
Net investment income ....................... $562,606 $542,500 $525,318
================================
65
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
6. INVESTMENTS (CONTINUED)
The following represents an analysis of net realized gains (losses) and the
change in unrealized appreciation on investments:
YEAR ENDED DECEMBER 31
-------------------------------------
2001 2000 1999
-------------------------------------
Net realized gains (losses):
Fixed maturities and short-term investments:
Gross realized gains ................................. $ 343,564 $ 254,647 $ 97,493
Gross realized losses ................................ (373,651) (295,117) (223,019)
-------------------------------------
Net realized gains (losses) ....................... (30,087) (40,470) (125,526)
Equity securities:
Gross realized gains ................................. 126,853 303,503 254,779
Gross realized losses ................................ (140,864) (149,842) (62,453)
-------------------------------------
Net realized gains (losses) ....................... (14,011) 153,661 192,326
Write down of other investments (see Note 8) ............ (49,139) (66,200) --
Net realized loss on sale of investment
in affiliate ......................................... -- (1,901) --
-------------------------------------
Net realized gains (losses) on investments ........ (93,237) 45,090 66,800
-------------------------------------
Net realized and unrealized gains (losses)
on investment derivative instruments ........... 14,638 5,481 27,556
-------------------------------------
Change in unrealized appreciation:
Fixed maturities and short-term investments .......... 3,712 137,628 (333,868)
Equity securities .................................... (69,305) (231,140) 101,652
Transfer of U.K. sterling investments ................ (21,000) -- --
Deferred gains (losses) gains on forward contracts ... 10,283 (9,388) 762
Investment portfolio of affiliates ................... 1,266 (6,290) (11,438)
Change in deferred income tax liability .............. 4,040 (9,131) 31,050
-------------------------------------
Net change in unrealized appreciation
On investments ....................................... (71,004) (118,321) (211,842)
-------------------------------------
Total net realized gains (losses) and change
in unrealized appreciation on investments ...... $(149,603) $ (67,750) $(117,486)
=====================================
Gross realized losses included $66.4 million of provisions for declines in
fair value considered to be other than temporary, for fixed maturities and
equity securities in the year ended December 31, 2001. In addition to specific
review by management, an other than temporary decline is considered to occur in
investments where there has been a sustained reduction.
The transfer of U.K. sterling investments arose when the Company
reorganized its corporate and operational structure for U.K. sterling asset
accumulation business from a U.S. dollar denominated entity to a U.K. sterling
denominated branch.
66
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
6. INVESTMENTS (CONTINUED)
The cost (amortized cost for fixed maturities and short-term investments),
market value and related unrealized gains (losses) of investments are as
follows:
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 2001 COST GAINS LOSSES VALUE
----------------------------------------------------
Fixed maturities:
U.S. Government and Government agency .................. $ 1,047,642 $ 19,044 $ (27,034) $ 1,039,652
Corporate .............................................. 5,095,415 115,427 (212,385) 4,998,457
Mortgage-backed securities ............................. 3,278,103 24,707 (9,733) 3,293,077
U.S. States and political subdivisions of the States ... 58,978 1,832 (585) 60,225
Non-U.S. Sovereign Government .......................... 1,465,430 6,072 (30,986) 1,440,516
----------------------------------------------------
Total fixed maturities ............................. $10,945,568 $167,082 $(280,723) $10,831,927
====================================================
Short-term investments:
U.S. Government and Government agency .................. $ 592,011 1,001 $ (1,099) $ 591,913
Corporate .............................................. 419,331 2,218 (400) 421,149
Non-U.S. Sovereign Government .......................... 38,673 33 (1,655) 37,051
----------------------------------------------------
Total short-term investments ....................... $ 1,050,015 $ 3,252 $ (3,154) $ 1,050,113
====================================================
Total equity securities ................................... $ 575,090 $ 42,679 $ (69,964) $ 547,805
====================================================
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 2000 COST GAINS LOSSES VALUE
----------------------------------------------------
Fixed maturities:
U.S. Government and Government agency .................. $ 1,361,972 $ 51,524 $ (1,373) $ 1,412,123
Corporate .............................................. 4,419,283 65,962 (255,122) 4,230,123
Mortgage-backed securities ............................. 1,818,697 18,649 (6,951) 1,830,395
U.S. States and political subdivisions of the States ... 516,949 18,936 (2,100) 533,785
Non-U.S. Sovereign Government .......................... 597,295 16,318 (14,958) 598,655
----------------------------------------------------
Total fixed maturities ............................. $ 8,714,196 $171,389 $(280,504) $ 8,605,081
====================================================
Short-term investments:
U.S. Government and Government agency .................. $ 162,641 202 $ (27) $ 162,816
Corporate .............................................. 179,709 1,451 (9,539) 171,621
Non-U.S. Sovereign Government .......................... 4,797 52 (279) 4,570
----------------------------------------------------
Total short-term investments ....................... $ 347,147 $ 1,705 $ (9,845) $ 339,007
====================================================
Total equity securities ................................... $ 515,440 $ 84,650 $ (42,630) $ 557,460
====================================================
The contractual maturities of fixed maturity securities are shown below.
Actual maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
67
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
6. INVESTMENTS (CONTINUED)
DECEMBER 31, 2001 DECEMBER 31, 2000
------------------------------------------------
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
------------------------------------------------
Due after 1 through 5 years ... $ 2,173,907 $ 2,164,112 $1,829,636 $1,791,752
Due after 5 through 10 years .. 2,415,964 2,331,334 1,906,291 1,873,982
Due after 10 years ............ 3,077,594 3,043,404 3,159,572 3,108,952
Mortgage-backed securities .... 3,278,103 3,293,077 1,818,697 1,830,395
------------------------------------------------
$10,945,568 $10,831,927 $8,714,196 $8,605,081
================================================
At December 31, 2001 and 2000, approximately $328.3 million and $113.1
million, respectively, of securities were on deposit with various U.S. state or
government insurance departments in order to comply with relevant insurance
regulations. The increase in 2001 from 2000 related primarily to deposits
required for the Company's Lloyd's operations related to the September 11 event.
The Company has two facilities available for the issue of letters of credit
collateralized against the Company's investment portfolio with a value of $169.0
million at December 31, 2001 and $483.0 million at December 31, 2000. At
December 31, 2001 and 2000, approximately $120.0 million and $160.0 million,
respectively, of letters of credit were issued and outstanding under these
facilities.
Included in cash and invested assets at December 31, 2001 and 2000 are
approximately $14.8 million and $18.0 million, respectively, of assets held in
an escrow account in accordance with Internal Revenue Service regulations.
7. INVESTMENTS IN AFFILIATES
The Company's investment in affiliates and equity in net income from such
affiliates are summarized below:
DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999
--------------------------------------------------------------------------
EQUITY IN EQUITY IN EQUITY IN
NET INCOME NET INCOME NET INCOME
CARRYING (LOSS) FOR CARRYING (LOSS) FOR CARRYING (LOSS) FOR
VALUE THE YEAR VALUE THE YEAR VALUE THE YEAR
--------------------------------------------------------------------------
Investment management companies
and related investment funds ... $ 798,075 $ 80,580 $571,022 $ 70,032 $291,723 $ 43,865
Insurance affiliates ............. 239,269 (5,300) 221,700 4,323 188,188 (2,958)
--------------------------------------------------------------------------
$1,037,344 $ 75,280 $792,722 $ 74,355 $479,911 $ 40,907
==========================================================================
The Company has minority investments ranging from 20% to 30% in several
investment fund managers. The significant investments include Highfields Capital
Management LP, a global equity investment firm, and MKP Capital Management, a
fixed income investment manager specializing in mortgage-backed securities. The
Company has invested in certain closed end funds, including funds managed by
these investment fund managers, all of which are included in investment
management companies and related investment funds, above.
68
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
7. INVESTMENTS IN AFFILIATES (CONTINUED)
The Company's significant insurance affiliate investments at December 31,
2001 and 2000 include Le Mans Re, Annuity & Life Re and FSA International, with
ownership in those entities at 49%, 12% and 20%, respectively. Insurance
affiliates included Risk Capital Holdings at December 31, 1999. See Note 25 for
further discussion of the Company's investment in Le Mans Re.
In certain investments, the carrying value is different from the underlying
share of the investee's net assets. The difference represents goodwill on
acquisition that is being amortized over a period not exceeding 30 years.
8. OTHER INVESTMENTS
Other investments include strategic investments over which the Company does
not have significant influence and whose fair value is generally unquoted. This
includes investments in limited partnerships where the Company does not
participate in the management of the partnerships. The Company received income
from its limited partnership investments of $5.8 million and $4.0 million for
the years ended December 31, 2001 and 2000, respectively. See Note 15(d) for
further information.
The Company continually reviews the performance of these other investments.
The Company recorded losses of $49.1 million and $66.2 million in 2001 and 2000,
respectively, due to other than temporary declines in values of these
investments. Included in the Company's other investments at December 31, 2001 is
a convertible debenture issued by Mutual Risk Management Ltd carried at $63.2
million. Although the market value of Mutual Risk Management has declined
significantly, the Company has assessed the value of the debenture and, due to
underlying security features, believes there is no impairment.
9. LOSSES AND LOSS EXPENSES
Unpaid losses and loss expenses are comprised of:
YEAR ENDED DECEMBER 31
---------------------------------------
2001 2000 1999
---------------------------------------
Reserve for reported losses
and loss expenses ................. $ 7,313,253 $2,788,378 $2,175,688
Reserve for losses incurred
but not reported .................. 4,512,427 2,883,684 3,193,714
---------------------------------------
Unpaid losses and loss expenses ..... $11,825,680 $5,672,062 $5,369,402
=======================================
Net losses and loss expenses incurred are comprised of:
YEAR ENDED DECEMBER 31
---------------------------------------
2001 2000 1999
---------------------------------------
Loss and loss expense payments ...... $ 2,651,566 $1,910,624 $1,392,024
Change in unpaid losses
and loss expenses ................. 3,263,049 625,043 303,140
Reinsurance recoveries .............. (2,995,717) (1,103,108) (390,860)
---------------------------------------
Net losses and loss
expenses incurred ................. $ 2,918,898 $1,432,559 $1,304,304
=======================================
69
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
9. LOSSES AND LOSS EXPENSES (CONTINUED)
The following table represents an analysis of paid and unpaid losses and
loss expenses and a reconciliation of the beginning and ending unpaid losses and
loss expenses for the years indicated:
2001 2000 1999
-----------------------------------------
Unpaid losses and loss expenses at beginning of year ....... $ 5,672,062 $5,369,402 $4,896,643
Unpaid losses and loss expenses recoverable ................ (1,339,767) (831,864) (593,960)
-----------------------------------------
Net unpaid losses and loss expenses at beginning of year ... 4,332,295 4,537,538 4,302,683
Increase (decrease) in net losses and loss expenses
incurred in respect of losses occurring in:
Current year ........................................ 2,743,094 1,827,443 1,591,414
Prior years ......................................... 175,804 (394,884) (287,110)
-----------------------------------------
Total net incurred losses and loss expenses ............. 2,918,898 1,432,559 1,304,304
Exchange rate effects ...................................... 61,598 (27,064) (5,950)
Net loss reserves acquired ................................. 1,296,362 52,932 30,003
Less net losses and loss expenses paid in respect of
losses occurring in :
Current year ........................................ 633,141 411,685 281,806
Prior year .......................................... 1,184,284 1,251,985 811,696
-----------------------------------------
Total net paid losses ................................... 1,817,425 1,663,670 1,093,502
Net unpaid losses and loss expenses at end of year ......... 6,791,728 4,332,295 4,537,538
Unpaid losses and loss expenses recoverable ................ 5,033,952 1,339,767 831,864
-----------------------------------------
Unpaid losses and loss expenses at end of year ............. $11,825,680 $5,672,062 $5,369,402
=========================================
Certain aspects of the Company's business has loss experience characterized
as low frequency but high severity in nature. This may result in volatility in
the Company's results of operations and financial condition and liquidity.
Actuarial assumptions used to establish the liability for losses and loss
expenses are periodically adjusted to reflect comparisons to actual loss and
loss expense development, inflation and other considerations.
Several aspects of the Company's casualty insurance operations complicate
the actuarial reserving techniques for loss reserves as compared to other
insurance operations. Among these aspects are the differences in the policy
forms from more traditional forms, the lack of complete historical loss data for
losses of the same type intended to be covered by the policies and the
expectation that losses in excess of the attachment level of the Company's
policies generally will be characterized by low frequency and high severity,
limiting the utility of claims experience of other insureds for similar claims.
While management believes it has made a reasonable estimate of ultimate losses,
the ultimate claims experience may not be as reliably predicted as may be the
case with other insurance operations, and there can be no assurance that losses
and loss expenses will not exceed the total reserves.
Current year net losses incurred in 2001 increased significantly over 2000
mainly due to losses related to the September 11 event, where the Company has
estimated and recorded losses incurred of approximately $760.0 million, net of
reinsurance recoveries, based upon preliminary reports and estimates of loss and
damage. This preliminary estimate could change as more information becomes
available. Current year net losses incurred in 2001 also include: (i) Winterthur
International from July 1, 2001, which had net incurred losses of $241.2
million; (ii) catastrophic and other loss events, including the bankruptcy of
Enron Corp., several satellite losses, the Toulouse, France petrochemical plant
explosion, Tropical Storm Allison, the Petrobras oil rig loss in Brazil, the
Seattle earthquake and several other European property losses; and (iii) other
growth of the Company's operations related to new business assumed.
70
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
9. LOSSES AND LOSS EXPENSES (CONTINUED)
Prior year loss development in 2001 related primarily to continued adverse
loss development in the Company's casualty reinsurance business written for the
1997 to 1999 underwriting years. This deterioration occurred industry-wide
primarily as a result of competitive pressures on pricing. The Company recorded
adverse development for this business of approximately $180.0 million in the
fourth quarter of 2001.
In 2000, current year development reflected the growth in business assumed
over 1999, an increase in loss ratios applied due to a competitive market
environment which reduced premium rates, and also the early development of
certain losses on the Company's large account business within its insurance
operations. Historically, the Company had not experienced the reporting of such
losses at an early stage and the Company's reserving methodology for these lines
of business extrapolates these losses into the projections of future
development. If future development is eventually determined to be less than the
estimated ultimate losses recorded, loss reserves will be reduced at that time.
This occurred for the 1993 through 1996 underwriting years, resulting in a
reduction in prior year losses in 2000 and 1999.
Net losses incurred for 2000 also reflected reserve adjustments to several
unprofitable lines of business that the Company exited, including trucking,
inland energy and certain classes of aviation. A net reserve charge of $114.0
million was recorded for these lines.
The decrease in prior year incurred losses in 2000 and 1999 was driven
primarily by the Company's insurance liability excess of loss reserves. The
basis for establishing IBNR for these lines is relatively judgmental due to the
lack of industry data available. Consequently, the Company estimates loss
reserves through actuarial models based upon its own experience. When the
Company commenced writing this type of business in 1986, limited data was
available and the Company has made its best estimate of loss reserves for each
underwriting year since that time. Over time, the amount of data has increased,
providing a larger statistical base for estimating reserves. Redundancies in
prior year loss reserves have occurred where loss experience has developed more
favorably than expected. This trend did not continue in 2001 where the
competitive effect of pricing has necessitated an increase to prior year loss
reserves, particularly in the casualty lines as discussed above. In 1999, the
Lloyd's operations experienced loss deterioration on the U.K. motor business
principally from the 1998 and 1999 underwriting years of approximately $20.0
million.
Partially offsetting the increase in net incurred losses in 2000 compared
to 1999 was a reduction in the number and magnitude of catastrophe losses that
occurred. Catastrophe losses in 2000 included an oil refinery loss in Kuwait,
several satellite losses, and the Singapore Airlines loss, and totaled
approximately $95.0 million. By comparison, 1999 generated approximately $185.0
million of catastrophe losses to the Company, including the European storms in
December, hailstorms in Sydney, tornadoes in Oklahoma and satellite losses.
1999 incurred losses also included an increase to casualty reinsurance loss
reserves of $95.0 million related to an alignment of reserving methodologies at
the time of the merger with NAC in June 1999.
Net loss reserves acquired in 2001 related primarily to the acquisition of
Winterthur International. The Company has contractual post-closing protection
with respect to adverse development of reserves, including unearned premium
reserves, resulting from Winterthur International business written prior to July
1, 2001. Business in force at June 30, 2001 carries a maximum exposure to a
combined ratio of 105%. Exchange rate effects on net loss reserves in 2001 also
related primarily to Winterthur International which has several operations where
the functional currency is not the U.S dollar. Translation of loss reserves into
U.S. dollars and movements in the exchange rates, particularly the Swiss franc,
have given rise to the increase in the exchange rate effects in 2001.
71
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
9. LOSSES AND LOSS EXPENSES (CONTINUED)
The amount of paid losses increased in 2001 over 2000 due mainly to an
increase in current year loss events. However, the majority of net losses
incurred related to the September 11 event and other loss events in the fourth
quarter of 2001 had not been reported to the Company as paid losses by December
31, 2001. Consequently, the Company expects a higher level of paid losses in
2002 related to these 2001 loss events.
Higher paid losses in 2000 as compared to 1999 was due to the settlement of
previously established reserves, particularly catastrophe losses as noted above.
The Company's net incurred losses and loss expenses included a charge of
$21.5 million, $2.8 million and $10.6 million in 2001, 2000 and 1999,
respectively, for estimates of actual and potential non-recoveries from
reinsurers. Such charges for non-recoveries relate mainly to the September 11
event and reinsurance ceded for casualty business written prior to 1986. As at
December 31, 2001 and 2000, the reserve for potential non-recoveries from
reinsurers was $49.7 million and $25.6 million, respectively.
Except for certain workers compensation liabilities, the Company does not
discount its unpaid losses and loss expenses. The Company utilizes tabular
reserving for workers compensation unpaid losses that are considered fixed and
determinable and discounts such losses using an interest rate of 7%. The tabular
reserving methodology results in applying uniform and consistent criteria for
establishing expected future indemnity and medical payments (including an
explicit factor for inflation) and the use of mortality tables to determine
expected payment periods. Tabular unpaid losses and loss expenses, net of
reinsurance, at December 31, 2001 and 2000 were $231.0 million and $168.8
million, respectively. The related discounted unpaid losses and loss expenses
were $98.0 million and $63.4 million as of December 31, 2001 and 2000,
respectively.
ASBESTOS AND ENVIRONMENTAL RELATED CLAIMS
The Company's reserving process includes a continuing evaluation of the
potential impact on unpaid liabilities from exposure to asbestos and
environmental claims, including related loss adjustment expenses. Liabilities
are established to cover both known and incurred but not reported claims.
A reconciliation of the opening and closing unpaid losses and loss expenses
related to asbestos and environmental exposure claims related to business
written prior to 1986 for the years indicated is as follows:
YEAR ENDED DECEMBER 31
-------------------------------
2001 2000 1999
-------------------------------
Net unpaid losses and loss expenses at beginning of year ..... $34,747 $36,206 $34,850
Net incurred losses and loss expenses ........................ 2,016 1,053 4,416
Less net paid losses and loss expenses ....................... 3,611 2,512 3,060
-------------------------------
Net (decrease) increase in unpaid losses and loss expenses ... (1,595) (1,459) 1,356
Net unpaid losses and loss expenses at end of year ........... 33,152 34,747 36,206
Unpaid losses and loss expenses recoverable at end of year ... 60,166 48,133 49,022
-------------------------------
Gross unpaid losses and loss expenses at end of year ......... $93,318 $82,880 $85,228
===============================
Incurred but not reported losses, net of reinsurance, included in the above
table was $8.0 million in 2001, $14.0 million in 2000 and $16.1 million in 1999.
Unpaid losses recoverable are net of potential uncollectible amounts.
72
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
9. LOSSES AND LOSS EXPENSES (CONTINUED)
As of December 31, 2001 and 2000, the Company had approximately 453 and 374
open claim files, respectively, for potential asbestos exposures and 543 and 613
open claim files, respectively, for potential environmental exposures on
business written prior to 1986. Approximately 44% and 45% of the open claim
files for 2001 and 2000, respectively, are due to precautionary claim notices.
Precautionary claim notices are submitted by the ceding companies in order to
preserve their right to receive coverage under the reinsurance contract. Such
notices do not contain an incurred loss amount to the Company.
The Company believes it has made reasonable provision for its asbestos and
environmental exposures and is unaware of any specific issues that would
significantly affect its estimate for losses and loss expenses.
The estimation of loss and loss expense liabilities for asbestos and
environmental exposures is subject to much greater uncertainty than is normally
associated with the establishment of liabilities for certain other exposures due
to several factors, including: i) uncertain legal interpretation and application
of insurance and reinsurance coverage and liability; ii) the lack of reliability
of available historical claims data as an indicator of future claims
development; iii) an uncertain political climate which may impact, among other
areas, the nature and amount of costs for remediating waste sites; and iv) the
potential of insurers and reinsurers to reach agreements in order to avoid
further significant legal costs. Due to the potential significance of these
uncertainties, the Company believes that no meaningful range of loss and loss
expense liabilities beyond recorded reserves can be established. As these
uncertainties are resolved, additional reserve provisions, which could be
material in amount, may be necessary.
10. REINSURANCE
The Company utilizes reinsurance and retrocession agreements principally to
increase aggregate capacity and to reduce the risk of loss on business assumed.
The Company's reinsurance and retrocession agreements provide for recovery of a
portion of losses and loss expenses from reinsurers and reinsurance recoverables
are recorded as assets. The Company is liable if the reinsurers are unable to
satisfy their obligations under the agreements. Under the Company's reinsurance
security policy, reinsurers are generally required to be rated A or better by
Standard & Poor's ("S&P") or, in the case of Lloyd's syndicates, S&P "Four
Bells" and/or B+ from Moody's Investor Service. The Company's Chief Credit
Officer will consider reinsurers that are not rated or do not fall within the
above rating categories on a case-by-case basis.
The effect of reinsurance and retrocessional activity on premiums written
and earned from general operations is shown below:
PREMIUMS WRITTEN PREMIUMS EARNED
YEAR ENDED DECEMBER 31 YEAR ENDED DECEMBER 31
----------------------------------------------------------------------------------------
2001 2000 1999 2001 2000 1999
----------------------------------------------------------------------------------------
Direct ........ $ 2,978,370 $ 1,688,923 $1,088,028 $ 2,763,288 $1,456,064 $ 994,339
Assumed ....... 1,805,352 1,440,108 1,354,892 1,751,464 1,455,694 1,259,632
Ceded ......... (1,855,296) (1,012,791) (541,037) (1,734,825) (876,518) (503,965)
----------------------------------------------------------------------------------------
Net ........... $ 2,928,426 $ 2,116,240 $1,901,883 $ 2,779,927 $2,035,240 $1,750,006
========================================================================================
73
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
10. REINSURANCE (CONTINUED)
The Company recorded reinsurance recoveries on losses and loss expenses
incurred of $3.0 billion, $1.1 billion and $390.9 million for the years ended
December 31, 2001, 2000 and 1999, respectively. The Company is the beneficiary
of letters of credit, trust accounts and funds withheld in the aggregate amount
of $1.3 billion at December 31, 2001, collateralizing reinsurance recoverables
with respect to certain retrocessionnaires.
Unpaid losses and loss expenses recoverable increased significantly during
2001 primarily due to the acquisition of Winterthur International and the
September 11 event. See Notes 4 and 5 for further information. No reinsurer
accounted for 10% or more of the outstanding reinsurance recoverable balance at
December 31, 2001. At December 31, 2001, the largest reinsurance balance
receivable and unpaid loss recoverable from a single reinsurer was $355.2
million due from Hannover Re (Ireland) Ltd, and $79.1 million from their
affiliate, E+S Reinsurance (Ireland), Ltd, which are both rated A+ by A.M. Best.
11. DEPOSIT LIABILITIES
The Company has entered into certain contracts that transfer insufficient
risk to be accounted for as insurance or reinsurance. These contracts have been
recorded as deposit liabilities and are matched by an equivalent amount of
investments. At December 31, 2001 and 2000, total deposit liabilities were $1.7
billion and $1.2 million, respectively.
The Company has investment risk related to its ability to generate
sufficient investment income to enable the total invested assets to cover the
payment of the estimated ultimate liability. The Company establishes an initial
accretion rate at inception of the contract, which is reviewed and adjusted
periodically based on claims activity and current investment yields.
12. POLICY BENEFIT RESERVES
During 2001, the Company entered into long duration contracts that subject
the Company to mortality and morbidity risks and which were accounted for as
life premiums earned. Policy benefit reserves were established using a net
premium method and assumptions for investment yields, mortality, morbidity,
terminations and expenses, applicable at the time the insurance contracts were
made. The assumptions include provisions for the risk of adverse deviations. At
December 31, 2001, policy benefit reserves related to these contracts were
$625.1 million. The average rate of assumed investment yield for these contracts
was 5.1% per annum.
13. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS
As at December 31, 2001, the Company had bank, letter of credit and loan
facilities available from a variety of sources, including commercial banks,
totaling $4.4 billion (2000: $2.6 billion) of which $1.6 billion (2000: $450.0
million) of debt was outstanding. In addition, $2.0 billion (2000: $1.1 billion)
of letters of credit were outstanding, 5% of which were collateralized by the
Company's investment portfolio, supporting U.S. non-admitted business and the
Company's Lloyd's capital requirements.
74
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
13. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS (CONTINUED)
The financing structure at December 31, 2001 was as follows:
IN USE/
FACILITY COMMITMENT OUTSTANDING
-----------------------
DEBT:
364-day Revolver ................................. $ 500,000 $ --
2 facilities of 5-year Revolvers - total ......... 350,000 350,000
7.15% Senior Notes due 2005 ...................... 100,000 99,970
6.58% Guaranteed Senior Notes due 2011 ........... 255,000 255,000
Zero Coupon Convertible Debentures due 2021 ...... 609,692 609,692
Liquid Yield Option NotesTM due 2021 ............. 290,147 290,147
Other operating debt ............................. 68 68
-----------------------
$2,104,907 $1,604,877
=======================
LETTERS OF CREDIT:
6 facilities - total $2,274,000 $2,029,000
=======================
The financing structure at December 31, 2000 was as follows:
IN USE/
FACILITY COMMITMENT OUTSTANDING
-----------------------
DEBT:
364-day Revolver ................................. $ 500,000 $ --
2 facilities of 5 year Revolvers - total ......... 350,000 350,000
7.15% Senior Notes due 2005 ...................... 100,000 99,964
Other operating debt ............................. 68 68
-----------------------
$ 950,068 $ 450,032
=======================
LETTERS OF CREDIT:
5 facilities - total $1,679,000 $1,109,000
=======================
The Company entered into a $500.0 million 364-day revolving credit facility
effective June 29, 2001, to replace a facility of $500.0 million that expired
during 2001. A syndicate of banks provides this facility and borrowings are
unsecured. The Company borrowed and repaid $200.0 million under a prior facility
during the first quarter of 2000. The Company borrowed $50.0 million under the
expired facility in March 2001 and repaid the borrowing in April 2001. There
were no other borrowings under the facilities during the remainder of 2001. The
weighted average interest rate on the funds borrowed during 2001 and 2000 was
approximately 5.4% and 6.3%, respectively.
Two syndicates of banks provide the two five-year facilities and borrowings
are unsecured. The amount of $350.0 million outstanding at both December 31,
2001 and 2000 related primarily to acquisitions of subsidiaries. The weighted
average interest rate on funds borrowed during 2001 was approximately 5.3% and
6.6% during 2000.
The Company issued $100.0 million of 7.15% Senior Notes due November 15,
2005 through a public offering at a price of $99.9 million in 1995.
In April 2001, the Company issued at par $255.0 million of 6.58% Guaranteed
Senior Notes due April 2011 through a private placement to institutional
investors. Proceeds of the debt were used for general corporate purposes.
75
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
13. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS (CONTINUED)
In May 2001, the Company issued $1,010.8 million principal amount at
maturity (subject to adjustment in the event there is an upward interest
adjustment) of Zero Coupon Convertible Debentures ("CARZ") at $593.57 per bond
and, unless converted or repaid before their due date of May 2021, they will be
repaid in May 2021 at $1,000 per bond, at a total cost of $1.01 billion. The
accretion rate is 2.625% per annum on a semi-annual basis or 2.6422% per annum
on an annual basis.
In September 2001, the Company also issued $508.8 million principal amount
at maturity (subject to adjustment in the event there is an upward interest
adjustment) of Liquid Yield Option Notes(TM) ("LYONs") at an initial price of
$565.01 per bond. The LYONs will also be repaid at $1,000 each, unless converted
or repaid before their due date of September 2021, at a total cost of $508.8
million. The accretion rate on the LYONs is 2.875% per annum on a semi-annual
basis or 2.89566% per annum on an annual basis.
Although both the CARZ and LYONs are due to be repaid in 2021, there are
several features that may result in the bonds being repaid or converted into the
Company's Class A Ordinary Shares before the redemption date. As these features
include market-driven features and options available to the Company and
bondholders, it is not possible to determine if the bonds will remain
outstanding until their scheduled maturity in 2021
Each of the CARZ and LYONs provide the bondholders the right to require the
Company to repurchase the bonds on predetermined dates ("put" dates) at
predetermined values as set forth in the relevant indenture. The put dates for
the CARZ occur on May 23 of 2002, 2004, 2006, 2008, 2011 and 2016. The put dates
for the LYONs occur on September 7 of 2002, 2003, 2004, 2006, 2008, 2011 and
2016. The Company may, at its option, pay the repurchase price in cash or Class
A ordinary shares or a combination thereof.
In addition, each of the CARZ and LYONs provide for a contingent conversion
feature that gives the bondholders the right to convert the bonds into the
Company's shares at other times during the life of the bonds should the market
price of the Company's shares trade at certain levels. Accordingly, if the
Company's share price is at least 110% of the accreted conversion price for at
least twenty of the thirty days during the relevant conversion period, the
bondholders would have the right to convert the bonds into Class A Ordinary
Shares. If converted for shares, each CARZ would be converted into 5.9467 shares
and each holder of a LYONs would receive 5.277 shares. The accreted values would
be determined by applying the accretion rate to the initial issue price. In the
example of CARZ, the accreted price on May 23, 2002 will be $609.25 determined
by adding one year's accretion of 2.6422% per annum on an annual basis to the
original issue price of $593.57.
The holders of each of the CARZ and LYONs also have the right to convert
the bonds for shares in the event that the trading price of the bonds for a
predetermined period falls below 95% of the value of the equivalent number of
shares, provided however, if the shares are trading at a predetermined premium
to the accreted price of the bonds, holders may receive cash, shares or a
combination thereof in lieu of shares upon conversion.
These bonds also provide for interest rates to be adjusted in the event
that the Company's stock price falls below levels specified in the relevant
indenture relative to the conversion price.
In addition, in the event that the credit ratings assigned to the bonds by
Standard & Poor's fall below the specified level of BBB+, the bonds would be
convertible into shares at 5.9467 shares per CARZ and 5.277 per LYON. The rating
assigned to the bonds at the time of issue was A+. Some corporate transactions,
such as a change of control of the Company, would give the bondholders the right
to require the Company to repurchase the bonds at the accreted value of the
bonds at that time.
76
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
13. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS (CONTINUED)
The bonds become immediately due if an event of default occurs and 25% or
more of the bondholders demand repayment of the accreted value at the time of
such event. Such an event of default would include failure to pay amounts due on
the notes, an event of default occurring under the Company's other credit
facilities, or certain other events such as bankruptcy or insolvency of the
Company.
The bonds are also callable as the Company has the right to redeem the
bonds for cash, in full or in part, at their accreted value at any time after
May 23, 2004, in the case of the CARZ, and September 7, 2004, in the case of the
LYONs.
The puts and the interest rate adjustment features embedded in the CARZ and
LYONs are considered derivatives and are subject to fair value. There is
currently minimal value ascribed to the puts, as the contingent events of these
features are considered unlikely to occur or to the interest rate adjustment
feature due to the current trading value of the bonds. Due to the contingent
nature of the conversion features of these debt securities, there is no impact
on fully diluted earnings (loss) per share at this time.
Total pre-tax interest expense on the borrowings described above was $65.4
million, $32.1 million and $37.4 million for the years ended December 31, 2001,
2000 and 1999, respectively. Associated with the Company's bank and loan
commitments are various covenants that include, among other things, the
requirement to maintain a minimum credit and financial strength rating and a
minimum amount of consolidated shareholders' equity. The Company was in
compliance with these covenants throughout the three years ended December 31,
2001.
The Company had six letter of credit facilities available at December 31,
2001, two from two syndicates of banks, one from a U.K. bank, two from U.S.
banks and one from the seller of Winterthur International. These facilities
include a $1.0 billion unsecured syndicated letter of credit facility that
replaced a syndicated facility that expired during the year. In addition, the
Company entered into a new $390.0 million unsecured syndicated facility that
replaced an expired syndicate facility that supports the Company's Lloyd's
capital requirements. These facilities are utilized to support non-admitted
insurance and reinsurance operations in the U.S. and capital requirements at
Lloyd's. All of these facilities are scheduled for renewal during 2002, and the
Winterthur International arrangement will also terminate during 2002. Of the
letters of credit outstanding at December 31, 2001, $110.0 million (2000: $160.0
million) were collateralized against the Company's investment portfolio and $1.9
billion (2000: $949.0 million) were unsecured. The letters of credit outstanding
increased during 2001 due to the effects of the September 11 event.
14. DERIVATIVE INSTRUMENTS AND WEATHER RISK MANAGEMENT PRODUCTS
The Company enters into derivative instruments for both risk management and
trading purposes. The Company is exposed to potential loss from various market
risks, including changes in interest rates, foreign currency exchange rates and
commodity values, as it relates to the Company's participation in the weather
risk management market. The Company manages its market risks based on guidelines
established by management. These derivative instruments are carried at fair
value with the resulting gains and losses recognized in income in the period in
which they occur.
77
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
14. DERIVATIVE INSTRUMENTS (CONTINUED)
The following table summarizes these instruments and the effect on net
income in income in the years ended December 31, 2001, 2000 and 1999:
2001 2000 1999
------------------------------
CREDIT DEFAULT SWAPS:
Net premiums earned ....................................... $ 12,394 $ -- $ --
Losses and loss expenses .................................. 13,667 _ _
Net unrealized losses on derivative instruments ........... (26,814) _ _
Fee income and other ...................................... 8,661 15,924 _
------------------------------
Total ..................................................... $(19,426) $15,924 $ --
------------------------------
WEATHER RISK MANAGEMENT PRODUCTS:
Fee income and other ...................................... $ 16,556 $ -- $ --
INVESTMENT DERIVATIVES:
Net realized gains on derivative instruments .............. $ (1,332) $ 9,753 $21,648
Net unrealized gains (losses) on derivative instruments ... 15,970 (4,272) 5,908
------------------------------
Total ..................................................... $ 14,638 $ 5,481 $27,556
------------------------------
IMPACT ON NET INCOME (LOSS) .................................. $ 11,768 $21,405 $27,556
==============================
(A) CREDIT DEFAULT SWAPS
Credit default swaps issued by the Company meet the definition of a
derivative under FAS 133. Effective January 1, 2001, the Company has recorded
these products at fair value, modeled on prevailing market conditions and
certain other factors relating to the structure of the transaction. The Company
considers credit default swaps to be, in substance, financial guaranty contracts
as the Company has the intent to hold them to maturity. The change resulting
from movement in credit spreads is unrealized as the credit default swaps are
not traded to realize this value and is included in net unrealized gains and
losses on derivatives. Other elements of the change in fair value are based on
pricing established at the inception of the contract.
Credit default swaps generally enhance a synthetic portfolio of securities.
The credit ratings of the underlying securities vary and a single rating is
calculated for the portfolio at the inception of the transaction by an
independent agency. In order to effectively price and market the transaction,
different tranches are modeled for the purpose of assigning credit ratings based
upon the level of subordination. Generally, a primary layer is created to enable
the originator of the transaction to participate in the risks. The Company
generally participates in senior or rated tranches of a risk, but may
participate in the primary layer in selected instances.
The Company fair values transactions related to the primary layers of
credit default swaps using a model that calculates the net present value of the
premiums and expected losses. The change in fair value recorded for transactions
pertaining to primary layers as of December 31, 2001 was a gain of $8.1 million.
Credit default swaps where the Company participates in the rated tranche
are considered, in substance, financial guaranty transactions as the Company
intends to hold them to maturity. Since the Company underwrites all financial
guaranty transactions in the expectation of not incurring a loss, the net
present value method described above is not considered appropriate. The rated
tranches are therefore fair valued using changes in credit spreads to reflect
current market conditions. The Company will also consider the characteristics
and credit ratings of the
78
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
14. DERIVATIVE INSTRUMENTS (CONTINUED)
underlying portfolio in order to apply the model to obtain an estimate of fair
value. The change in fair value recorded for the rated tranches as of December
31, 2001 was a loss of $27.5 million. In accordance with FAS 133, the Company
recorded a transition adjustment to recognize the difference between the
carrying values and the fair values of the credit default swaps at January 1,
2001. This adjustment was not significant.
(B) WEATHER RISK MANAGEMENT PRODUCTS
The Company maintains a weather related derivatives trading portfolio. The
fair value of these transactions is determined using internally developed
models. The models used to determine these fair values are consistent with the
models used to estimate the Company's Value-at-Risk ("VaR") exposure to weather
risk. The VaR methodology is a comprehensive statistical measure that uses
historical weather results to calculate the potential losses that could occur
over a defined period of time given a certain probability. Currently, the
Company believes that the methodology utilized is appropriate based upon a
comparison with the VaR approaches used in other markets.
Calculation of the fair value is based on historically realized weather
results, including heating and cooling degree days. Historical data is then
adjusted for any underlying weather trends and the expected potential payout is
computed for each transaction. Actual weather results impacting each transaction
are then compared to historical weather data and the fair value adjusted
accordingly.
The change in fair value recorded for the weather risk management products
as of December 31, 2001 was a loss of $1.1 million and the realized gains
totaled $17.7 million. These amounts have both been included in fee income and
other.
(C) INVESTMENT DERIVATIVES, INCLUDING EMBEDDED DERIVATIVES
FOREIGN CURRENCY EXPOSURE MANAGEMENT
The Company uses foreign exchange contracts to manage its exposure to the
effects of fluctuating foreign currencies on the value of certain of its foreign
currency fixed maturities and equity investments. These contracts are not
designated as specific hedges for financial reporting purposes and therefore,
realized and unrealized gains and losses on these contracts are recorded in
income in the period in which they occur. These contracts generally have
maturities of three months or less. In addition, where the Company's investment
managers believe potential gains exist in a particular currency, a forward
contract may not be entered into. At December 31, 2001 and 2000, forward foreign
exchange contracts with notional principal amounts totaling $45.5 million and
$166.8 million, respectively were outstanding. The fair value of these contracts
as at December 31, 2001 and 2000 was $45.7 million and $164.5 million,
respectively, with unrealized gains of $0.1 million in 2001 and unrealized
losses of $2.3 million in 2000. For the years ended December 31, 2001 and 2000,
realized gains of $5.3 million and $48.3 million, respectively, and unrealized
gains of $2.3 million and unrealized losses of $4.3 million, respectively, were
recorded in net realized and unrealized gains and losses on derivative
instruments.
79
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
14. DERIVATIVE INSTRUMENTS (CONTINUED)
Until 2001, the Company attempted to hedge directly the foreign currency
exposure of a portion of its foreign currency fixed maturity investments using
forward foreign exchange contracts that generally had maturities of three months
or less, and which were rolled over to provide continuing coverage for as long
as the investments were held. Where an investment was sold, the related foreign
exchange sale contract was closed by entering in to an offsetting purchase
contract. At December 31, 2000, the Company had, as hedges, foreign exchange
contracts for the sale of $121.0 million and the purchase of $25.7 million of
foreign currencies at fixed rates, primarily Euros. The notional value of fixed
maturities denominated in foreign currencies that were hedged and held by the
Company as at December 31, 2000 was $100.6 million. In connection with these
foreign exchange contracts directly hedging foreign currency fixed maturity
investments, unrealized foreign exchange gains or losses were deferred and
included in accumulated other comprehensive loss. As at December 31, 2000,
unrealized losses amounted to $10.2 million and realized losses totaled $0.7
million. Since 2000, contracts the Company enters into are not designated as
specific hedges, and consequently all realized and unrealized gains and losses
are recorded in income in the period in which they occur.
In 2000, the Company used foreign exchange contracts to manage its exposure
to the effects of fluctuating foreign currencies on certain of its known claims
payable in foreign currencies. These contracts were not designated as specific
hedges for financial reporting purposes and therefore, realized and unrealized
gains and losses on the contracts were recorded in income in the period in which
they occurred. A loss of $6.8 million was realized in 2000 in connection with
these contracts. At December 31, 2000, no such contracts were outstanding and no
contracts were entered into in 2001.
The Company has entered into other investment derivative instruments in
2001 and 2000. Results of these transactions are insignificant.
The Company is exposed to credit risk in the event of non-performance by
the other parties to the forward contracts, however the Company does not
anticipate non-performance. The difference between the notional principal
amounts and the associated market value is the Company's maximum credit
exposure.
FINANCIAL MARKET EXPOSURE
The Company also uses bond and stock index futures to add value to the
portfolio where market inefficiencies are believed to exist, to equitize cash
holdings of equity managers and to adjust the duration of a portfolio of fixed
income securities to match the duration of related deposit liabilities. These
instruments are marked to market on a daily basis and changes in fair values are
recorded through net realized and unrealized gains and losses on derivative
instruments. The Company measures potential losses in fair values using various
statistical techniques, including VaR. The Company calculates VaR for investment
related derivatives based on a 95% confidence interval with a one month horizon.
At December 31, 2001 and 2000, bond and stock index futures outstanding
were $695.6 million (2000: $83.8 million) with underlying investments having a
market value of $9.7 billion (2000: $2.5 billion). Losses of $1.0 million and
$32.4 million on these contracts were realized during the years ended December
31, 2001 and 2000, respectively. The Company reduces its exposure to these
futures through offsetting transactions, including options and forwards. The VaR
of the total investment portfolio and of all investment related derivatives at
December 31, 2001 was approximately $351.0 and $18.0 million, respectively.
80
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
14. DERIVATIVE INSTRUMENTS (CONTINUED)
OTHER INVESTMENT DERIVATIVES
The Company holds warrants in conjunction with certain of its other
investments. These warrants are recorded at fair value based on quoted market
prices. At December 31, 2001, the Company recorded a gain of $13.6 million
related the change in fair value of these warrants. No such warrants were held
in 2000.
The Company entered into a treasury rate lock agreement with the
underwriters of the 6.58% Guaranteed Senior Notes due 2011. The Notes were
priced using a margin over the yield of a U.S. Treasury note with a similar
maturity. The treasury rate lock agreement was designed to eliminate underlying
pricing risk of the Company's debt that would have resulted from an increase in
the yield of the comparable U.S. Treasury issue between the initiation of the
transaction and the pricing of the transaction. A loss of $5.6 million was
realized and recorded in net realized and unrealized gains and losses on
derivative instruments in the year ended December 31, 2001 related to this
treasury rate lock agreement.
15. COMMITMENTS AND CONTINGENCIES
(A) SPECIAL PURPOSE VEHICLES
The Company utilizes special purpose vehicles to a limited extent both
indirectly and directly in the ordinary course of the Company's business. At the
transactional level, the Company provides various forms of credit enhancement
including financial guaranty insurance and reinsurance of structured
transactions backed by pools of assets of specified types, municipal obligations
supported by the issuers' ability to charge fees for specified services or
projects, and corporate risk based obligations including essential
infrastructure projects and obligations backed by receivables from future sales
of commodities and other specified services. The obligations related to these
transactions are often securitized through off-balance sheet vehicles. In
synthetic transactions, the Company guarantees payment obligations of
counterparties including special purpose vehicles under credit default swaps
referencing asset portfolios. The Company only provides financial guaranty
insurance, or indirectly reinsurance, of these vehicles for fixed premiums at
market rates but does not hold any equity positions or subordinated debt in
these off-balance sheet arrangements. Accordingly, these vehicles are not
consolidated.
The Company has a 38% investment in an asset-backed commercial paper
company that invests funds provided through a commercial paper and a Euro Medium
Term Note program. The assets of this company are guaranteed by an unrelated
third party. The Company has a further indirect investment that does not provide
any additional control. The Company accounts for this investment on an equity
basis. The Company has loaned a $30.0 million note to this investment vehicle.
The investment company has assets and liabilities of $950.0 million at December
31, 2001 and generated income net of start-up costs totaling $1.2 million. The
Company believes its investment in this company and note receivable are
realizable.
The Company created XL Capital Finance (Europe) plc to facilitate the
January 2002 issue of 6.5% Guaranteed Senior Notes in January 2002. This special
purpose vehicle is wholly-owned and will be consolidated in the Company's
consolidated financial statements.
(B) EXPOSURES UNDER FINANCIAL GUARANTIES
The Company provides and reinsures financial guaranties issued to support
public and private borrowing arrangements. Financial guaranties are conditional
commitments that guaranty the performance of an obligor to a third party. The
Company's potential liability in the event of non-payment by the issuer of the
insured obligation is represented by its proportionate share of the aggregate
outstanding principal and interest payable ("insurance in force") on such
insured obligation. In synthetic transactions, the Company guaranties payment
obligations of coun-
81
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
terparties under credit default swaps. At December 31, 2001, the Company's net
aggregate insurance in force was $29.0 billion. The range of maturity of the
insured obligations is one to thirty five years.
The Company does not record a carrying value for future installment
premiums as they are recognized over the term of the contract. The present value
of future installment premiums discounted at 7% is $205.9 million at December
31, 2001.
The Company manages its exposures to underwriting risk on these
transactions through a structured process which includes but is not limited to
detailed credit analysis, review of and adherence to underwriting guidelines and
the use of reinsurance. The Company has also implemented surveillance policies
and procedures to monitor its exposure throughout the life of the transactions.
In addition, the structure of the transactions are such that the insured
obligation is backed by a stream of cash flows, pools of assets or some other
form of collateral. This collateral would typically become the Company's upon
the payment of a claim by the Company.
(C) CONCENTRATIONS OF CREDIT RISK
The creditworthiness of a counterparty is evaluated by the Company, taking
into account credit ratings assigned by independent agencies. The credit
approval process involves an assessment of factors including, among others, the
counterparty, country and industry credit exposure limits. Collateral may be
required, at the discretion of the Company, on certain transactions based on the
creditworthiness of the counterparty.
The areas where significant concentrations of credit risk may exist include
unpaid losses and loss expenses recoverable and reinsurance balances receivable
(collectively "reinsurance assets"), investments and cash and cash equivalent
balances. The Company's reinsurance assets at December 31, 2001 amounted to $6.3
billion and resulted from reinsurance arrangements in the course of its
operations. A credit exposure exists with respect to reinsurance assets as they
may be uncollectible. The Company manages its credit risk in its reinsurance
relationships by transacting with reinsurers that it considers financially
sound, and if necessary, the Company may hold collateral in the form of funds,
trust accounts and/or irrevocable letters of credit. This collateral can be
drawn on for amounts that remain unpaid beyond specified time periods on an
individual reinsurer basis. See Note 10 for further information.
In addition, the Company underwrites a significant amount of its business
through brokers and a credit risk exists should any of these brokers be unable
to fulfill their contractual obligations with respect to the payments of
insurance and reinsurance balances to the Company. During 2001, 2000 and 1999,
approximately 23%, 22% and 21%, respectively, of the Company's consolidated
gross written premiums from general operations were generated from or placed by
Marsh & McLennan Companies. During 2001, 2000 and 1999, approximately 16%, 16%
and 13%, respectively, of the Company's consolidated gross written premiums from
general operations were generated from or placed by AON Corporation and its
subsidiaries. Both of these companies are large, well established companies and
there are no indications that either of them is financially troubled. No other
broker and no one insured or reinsured accounted for more than 10% of gross
premiums written from general operations in each of the three years ended
December 31, 2001.
The Company's available for sale investment portfolio is managed by
external managers in accordance with guidelines that have been tailored to meet
specific investment strategies, including standards of diversification, which
limit the allowable holdings of any single issue. The Company did not have an
aggregate investment in a single entity, other than the U.S. government, in
excess of 10% of shareholders' equity at December 31, 2001 and 2000.
82
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(D) OTHER INVESTMENTS
The Company has committed to invest in several limited partnerships as part
of its overall corporate strategy. The primary purpose of these partnerships is
to invest capital provided by the partners in various insurance and reinsurance
ventures. The Company had invested $163.3 million and $103.0 million as at
December 31, 2001 and 2000, respectively, with commitments to invest a further
$144.8 million over the next ten years. The Company does not actively
participate in the management of the partnerships.
(E) PROPERTIES
The Company rents space for its principal executive offices under leases
that expire up to 2014. Total rent expense for the years ended December 31,
2001, 2000 and 1999 was approximately $18.9 million, $18.3 million and $13.0
million, respectively. Future minimum rental commitments under existing leases
are expected to be as follows:
Year ending December 31: 2002 $ 16,643
2003 15,681
2004 14,080
2005 12,668
2006 10,126
Later years 48,590
--------
Total minimum future rentals $117,788
--------
In 1997, the Company acquired commercial real estate in Bermuda for the
purpose of securing long-term office space for its worldwide headquarters.
Development was completed in April 2001. The total cost of this development,
including the land, was approximately $125.0 million.
(F) TAX MATTERS
The Company is a Cayman Islands corporation and, except as described below,
neither it nor its non-U.S. subsidiaries have paid United States corporate
income taxes (other than withholding taxes on dividend income) on the basis that
they are not engaged in a trade or business or otherwise subject to taxation in
the United States. However, because definitive identification of activities
which constitute being engaged in trade or business in the United States is not
provided by the Internal Revenue Code of 1986, regulations or court decisions,
there can be no assurance that the Internal Revenue Service will not contend
that the Company or its non-U.S. subsidiaries are engaged in trade or business
or otherwise subject to taxation in the United States. If the Company or its
non-U.S. subsidiaries were considered to be engaged in trade or business in the
United States (and, if the Company or such subsidiaries were to qualify for the
benefits under the income tax treaty between the United States and Bermuda or
Ireland, such businesses were attributable to a "permanent establishment" in the
United States), the Company or such subsidiaries could be subject to U.S. tax at
regular tax rates on its taxable income that is effectively connected with its
U.S. trade or business plus an additional 30% "branch profits" tax on such
income remaining after the regular tax, in which case there could be a
significant adverse effect on the Company's results of operations and financial
condition.
83
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
16. SHARE CAPITAL
(A) AUTHORIZED AND ISSUED
The authorized share capital is 999,990,000 ordinary shares of a par value
of $0.01 each. Holders of Class A ordinary shares are entitled to one vote for
each share. In June 2000, the Company's Class B ordinary shares were converted
into Class A ordinary shares on a one-for-one basis. All shares in issue at
December 31, 2001 are Class A ordinary shares.
The following table is a summary of shares issued and outstanding (in
thousands):
YEAR ENDED DECEMBER 31
-------------------------------
2001 2000 1999
-------------------------------
Balance - beginning of year ................ 125,020 127,807 128,745
Exercise of options ........................ 1,812 2,247 443
Issue of restricted shares ................. 235 40 107
Repurchase of shares ....................... (1,533) (5,074) (1,488)
Issue of shares ............................ 9,200 -- --
-------------------------------
Balance - end of year ...................... 134,734 125,020 127,807
===============================
The Company issued 9.2 million shares during 2001 at a price of $89.00 per
share to support capital requirements subsequent to the September 11 event. Net
proceeds received were $787.7 million.
(B) SHARE REPURCHASES
The Company has had several stock repurchase plans in the past as part of
its capital management program. In June 1999, the Board of Directors rescinded
the Company's share repurchase plans. On January 9, 2000, the Board of Directors
authorized the repurchase of shares up to $500.0 million. During 2001, the
Company repurchased 1.5 million shares at a total cost of $116.9 million, or an
average cost of $76.40 per share. During 2000, the Company repurchased 5.1
million shares at a total cost of $247.7 million, or an average cost of $48.82
per share.
(C) STOCK PLANS
The Company's executive stock plan, the 1991 Performance Incentive Program,
as amended and restated effective March 17, 2000, provides for grants of
non-qualified or incentive stock options, restricted stock awards and stock
appreciation rights ("SARs"). The plan is administered by the Company and the
Compensation Committee of the Board of Directors. Stock options may be granted
with or without SARs. Grant prices are established at the fair market value of
the Company's common stock at the date of grant. Options and SARs have a life of
not longer than ten years and vest as set forth by the Compensation Committee at
the time of grant. Options currently vest annually over three years from date of
grant.
Restricted stock awards issued under the 1991 Performance Incentive Program
plan vest over such periods as the Compensation Committee may approve. These
shares contained certain restrictions, prior to vesting, relating to, among
other things, forfeiture in the event of termination of employment and
transferability. As the shares are issued, deferred compensation equivalent to
the fair market value on the date of the grant is charged to shareholders'
equity and subsequently amortized over the vesting period. Restricted stock
issued under the plan totaled 227,795 shares, 77,472 shares and 113,100 shares
in 2001, 2000 and 1999, respectively. Restricted stock awards granted by NAC
prior to the merger amounted to 3,627 shares in 1999. Vesting for restricted
stock awards generally occurs over a four to six year period.
84
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
16. SHARE CAPITAL (CONTINUED)
All options granted to non-employee directors are granted under the 1991
Performance Incentive Program. All options vest immediately on the grant date.
Directors may also make an irrevocable election preceding the beginning of each
fiscal year to defer cash compensation that would otherwise be payable as his or
her annual retainer in increments of $5,000. The deferred payments are credited
in the form of shares calculated by dividing 110% of the deferred payment by the
market value of the Company's stock at the beginning of the fiscal year. These
shares are distributed under the terms of the plan. Shares issued under the plan
totaled 4,240, 8,179 and nil in 2001, 2000 and 1999, respectively.
A second stock plan is provided for the directors that grants share units
equal to their annual retainer divided by market price of the Company's stock on
January 1 of each year. These units receive dividends in the form of additional
units equal to the cash value divided by the market price on the payment date.
Stock units totaling 7,318, 12,903 and 1,217 were issued in 2001, 2000 and 1999,
respectively. Total units are granted as shares upon retirement.
Following the merger with NAC, new option plans were created in the Company
to adopt the NAC plans. Options generally have a five or six year vesting
schedule, with the majority expiring ten years from the date of grant; the
remainder having no expiration. A stock plan is also maintained for non-employee
directors. Options expire ten years from the date of grant and are fully
exercisable six months after their grant date.
In 1999, the Company adopted the 1999 Performance Incentive Plan under
which 1,250,000 options were available and issued to employees who were not
directors or executive officers of the Company.
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standard 123, "Accounting for Stock-Based Compensation."
Had the Company adopted the accounting provisions of FAS 123, compensation costs
would have been determined based on the fair value of the stock option awards
granted in 2001, 2000 and 1999, and net income and earnings per share would have
been reduced to the pro-forma amounts indicated below:
YEAR ENDED DECEMBER 31
---------------------------------
2001 2000 1999
---------------------------------
Net (loss) income - as reported ............ $(576,135) $506,352 $470,509
Net (loss) income - pro-forma .............. $(615,868) $481,560 $437,592
Basic (loss) earnings per share -
as reported .............................. $(4.55) $4.07 $3.69
Basic (loss) earnings per share -
pro-forma ................................ $(4.86) $3.87 $3.43
Diluted (loss) earnings per share -
as reported .............................. $(4.55) $4.03 $3.62
Diluted (loss) earnings per share -
pro-forma ................................ $(4.86) $3.83 $3.36
(D) FAS 123 PRO FORMA DISCLOSURE
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions:
2001 2000 1999
---------------------------------
Dividend yield ............................. 2.26% 3.58% 3.43%
Risk free interest rate .................... 4.65% 5.04% 5.90%
Expected volatility ........................ 26.01% 25.77% 24.66%
Expected lives ............................. 5.0 years 7.5 years 7.5 years
Total stock based compensation expensed, which related to amortization of
restricted stock, was $10.4 million, $9.5 million and $7.7 million in 2001, 2000
and 1999, respectively.
85
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
16. SHARE CAPITAL (CONTINUED)
(E) OPTIONS
Following is a summary of stock options and related activity:
2001 2000 1999
---------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------------------------------------------------------------------------
Outstanding - beginning of year ... 8,163,017 $51.09 10,282,723 $46.50 7,685,414 $50.61
Granted ........................... 3,089,999 $79.42 579,852 $49.95 3,207,492 $57.06
Exercised ......................... (1,943,966) $47.61 (2,515,774) $31.48 (421,163) $27.57
Cancelled ......................... (114,918) $66.26 (183,784) $61.80 (189,020) $55.25
---------------------------------------------------------------------------
Outstanding - end of year ......... 9,194,132 $61.10 8,163,017 $51.09 10,282,723 $46.50
===========================================================================
Options exercisable ............... 5,021,748 5,034,693 5,287,657
===========================================================================
Options available for grant ....... 5,915,430 * 9,904,918 * 1,028,853 *
===========================================================================
*Available for grant includes shares that may be granted as either stock options
or restricted stock.
The following table summarizes information about the Company's stock
options (including stock appreciation rights) for options outstanding as of
December 31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- ----------------------------
AVERAGE
REMAINING
RANGE OF NUMBER OF AVERAGE CONTRACTUAL NUMBER OF AVERAGE
EXERCISE PRICES OPTIONS EXERCISE PRICE LIFE OPTIONS EXERCISE PRICE
- --------------- ---------------------------------------- ----------------------------
$10.44 - $32.93 378,237 $25.24 3.1 years 378,237 $25.24
$33.88 - $50.00 3,410,925 $46.48 5.4 years 2,491,064 $45.37
$51.00 - $64.69 1,447,971 $57.80 4.9 years 1,057,496 $58.71
$66.50 - $93.25 3,956,999 $78.33 8.5 years 1,094,951 $74.97
------------------------------------------------------------------------------
$10.44 - $93.25 9,194,132 $61.10 7.2 years 5,021,748 $53.12
==============================================================================
(F) VOTING
The Company's Articles of Association restrict the voting power of any
person to less than approximately 10% of total voting power.
(G) SHARE RIGHTS PLAN
Rights to purchase Class A ordinary shares ("the Rights") were distributed
as a dividend at the rate of one Right for each Class A ordinary share held of
record as of the close of business on October 31, 1998. Each Right entitles
holders of Class A ordinary shares to buy one ordinary share at an exercise
price of $350. The Rights would be exercisable, and would detach from the Class
A ordinary shares, only if a person or group were to acquire 20% or more of the
Company's outstanding Class A ordinary shares, or were to announce a tender or
exchange offer that, if
86
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
16. SHARE CAPITAL (CONTINUED)
consummated, would result in a person or group beneficially owning 20% or more
of Class A ordinary shares. Upon a person or group without prior approval of the
Board acquiring 20% or more of Class A ordinary shares, each Right would entitle
the holder (other than such an acquiring person or group) to purchase Class A
ordinary shares (or, in certain circumstances, Class A ordinary shares of the
acquiring person) with a value of twice the Rights exercise price upon payment
of the Rights exercise price. The Company will be entitled to redeem the Rights
at $0.01 per Right at any time until the close of business on the tenth day
after the Rights become exercisable. The Rights will expire at the close of
business on September 30, 2008, and do not initially have a fair value. The
Company has initially reserved 119,073,878 Class A ordinary shares being
authorized and unissued for issue upon exercise of Rights.
17. RETIREMENT PLANS
The Company maintains both defined contribution and defined benefit
retirement plans, which vary for each subsidiary. Plan assets are invested
principally in equity securities and fixed maturities.
The Company has a qualified defined contribution plan which is managed
externally and whereby employees and the Company contribute a certain percentage
of the employee's gross salary into the plan each month. The Company's
contribution generally vests over 5 years. The Company's expenses for its
qualified contributory defined contribution retirement plans were $9.7 million,
$7.4 million and $4.8 million in the years ended December 31, 2001, 2000 and
1999, respectively.
At XL America, a qualified non-contributory defined benefit pension plan
exists to cover substantially all its U.S. employees. This plan also includes a
non-qualified supplemental defined benefit plan designed to compensate
individuals to the extent their benefits under the Company's qualified plan are
curtailed due to Internal Revenue Code limitations. Benefits are based on years
of service and compensation, as defined in the plan, during the highest
consecutive three years of the employee's last ten years of employment. Under
these plans, the Company's policy is to make annual contributions to the plan
that are deductible for federal income tax purposes and that meet the minimum
funding standards required by law. The contribution level is determined by
utilizing the entry age cost method and different actuarial assumptions than
those used for pension expense purposes. The projected benefit obligation,
accumulated benefit obligation and fair value of the assets for this plan with
accumulated benefit obligations in excess of plan assets were $24.9 million,
$15.1 million and $12.4 million, respectively, as of December 31, 2001, and
$21.3 million, $12.6 million and $12.3 million, respectively, as of December 31,
2000.
Winterthur International pension benefits and retirement plans are subject
to transition provisions in the Sale and Purchase Agreement. Under these plans,
employees accrue benefits based on years of credited service, average
compensation and age. The pension obligation under these arrangements will
continue with the seller until contractual terms are satisfied and the liability
under a GAAP basis has been quantified and agreed between the Company and the
seller, at which point all Winterthur International employees will be covered
under a Company plan. Definition of various contractual rights and obligations
and valuation of the plans are not expected to be completed until later in 2002.
The seller will provide the assets to fund the pension liability. It is not
believed that adoption of these plans will have a significant effect on the
results of operations, financial position and liquidity of the Company.
87
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
18. ACCUMULATED OTHER COMPREHENSIVE LOSS
The related tax effects allocated to each component of the change in
accumulated other comprehensive income were as follows:
BEFORE TAX NET OF
TAX EXPENSE TAX
AMOUNT (BENEFIT) AMOUNT
--------------------------------
YEAR ENDED DECEMBER 31, 2001:
Unrealized gains (losses) on investments:
Unrealized losses arising during year .... $(160,201) $ 9,576 $(169,777)
Less reclassification for gains (losses)
realized in income ..................... (93,237) 5,536 (98,773)
--------------------------------
Net unrealized losses on investments ........ (66,964) 4,040 (71,004)
Foreign currency translation adjustments .... (31,882) 5,415 (37,297)
--------------------------------
Change in accumulated other
comprehensive loss ........................ $ (98,846) $ 9,455 $(108,301)
================================
YEAR ENDED DECEMBER 31, 2000:
Unrealized gains (losses) on investments:
Unrealized losses arising during year .... $ (82,362) $(21,980) $ (60,382)
Less reclassification for gains (losses)
realized in income ..................... 45,090 (12,849) 57,939
--------------------------------
Net unrealized losses on investments ........ (127,452) (9,131) (118,321)
Foreign currency translation adjustments .... (5,600) 102 (5,702)
--------------------------------
Change in accumulated other
comprehensive loss ........................ $(133,052) $ (9,029) $(124,023)
================================
YEAR ENDED DECEMBER 31, 1999:
Unrealized gains (losses) on investments:
Unrealized gains arising during year ..... $(176,092) $(36,394) $(139,698)
Less reclassification for gains realized
in income .............................. 66,800 (5,344) 72,144
--------------------------------
Net unrealized losses on investments ........ (242,892) (31,050) (211,842)
Foreign currency translation adjustments .... (6,308) (2,276) (4,032)
--------------------------------
Change in accumulated other
comprehensive loss ........................ $(249,200) $(33,326) $(215,874)
================================
19. CONTRIBUTED SURPLUS
Under the laws of the Cayman Islands, the use of the Company's contributed
surplus is restricted to the issue of fully paid shares (i.e. stock dividend or
stock split) and the payment of any premium on the repurchase of ordinary
shares.
20. DIVIDENDS
In 2001, four regular quarterly dividends were paid at $0.46 per share to
shareholders of record of February 15, May 25, August 15 and November 30.
In 2000, four regular quarterly dividends were paid at $0.45 per share to
shareholders of record of February 15, May 25, August 15 and November 15.
In 1999, four regular quarterly dividends were paid at $0.44 per share to
shareholders of record at February 5, April 23, July 12 and September 24. This
relates to the Company without inclusion of the pooling effect with NAC.
88
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
21. TAXATION
The Company is not subject to any taxes in the Cayman Islands on either
income or capital gains under current Caymans law. The Company has received an
undertaking that the Company will be exempted from Cayman Islands income or
capital gains taxes until June 2018 in the event of any such taxes being
imposed.
The Company's Bermuda subsidiaries are not subject to any income,
withholding or capital gains taxes under current Bermuda law. In the event that
there is a change such that these taxes are imposed, the Bermuda subsidiaries
would be exempted from any such tax until March 2016 pursuant to the Bermuda
Exempted Undertakings Tax Protection Act of 1966, and Amended Act of 1987.
The Company's U.S. subsidiaries are subject to federal, state and local
corporate income taxes and other taxes applicable to U.S. corporations. The
provision for federal income taxes has been determined under the principles of
the consolidated tax provisions of the Internal Revenue Code and Regulations
thereunder. Should the U.S. subsidiaries pay a dividend to the Company,
withholding taxes will apply.
The Company has operations in subsidiary and branch form in various other
jurisdictions around the world, including but not limited to the U.K.,
Switzerland, Ireland, Germany, France and Luxembourg that are subject to
relevant taxes in those jurisdictions.
The income tax provisions for the years ended December 31, 2001, 2000 and
1999 are as follows:
YEAR ENDED DECEMBER 31
-------------------------------
2001 2000 1999
-------------------------------
CURRENT (BENEFIT) EXPENSE:
U.S ....................................... $ 5,398 $ (3,175) $(27,098)
Non U.S ................................... 16,506 8,612 9,664
-------------------------------
Total current expense (benefit) .............. 21,904 5,437 (17,434)
-------------------------------
DEFERRED BENEFIT:
U.S ....................................... (69,384) (53,338) (17,534)
Non U.S ................................... (142,434) (8,455) (4,602)
-------------------------------
Total deferred benefit ....................... (211,818) (61,793) (22,136)
-------------------------------
TOTAL TAX BENEFIT ......................... $(189,914) $(56,356) $(39,570)
===============================
The weighted average expected tax provision has been calculated using the
pre-tax accounting income (loss) in each jurisdiction multiplied by that
jurisdiction's applicable statutory tax rate. Reconciliation of the difference
between the provision for income taxes and the expected tax provision at the
weighted average tax rate for the years December 31, 2001 and 2000 is provided
below:
2001 2000
---------------------
Expected tax provision at weighted average rate ... $(178,371) $(61,625)
Permanent differences:
Tax-exempt interest ............................. (8,964) (12,184)
Goodwill ........................................ 691 6,000
Other ........................................... (3,270) 11,453
Net withholding taxes ............................. -- --
---------------------
Total tax benefit ................................. $(189,914) $(56,356)
---------------------
89
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
21. TAXATION (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 2001 and 2000 were as follows:
2001 2000
--------------------
DEFERRED TAX ASSET:
Net unpaid loss reserve discount .................... $112,646 $ 83,230
Net unearned premiums ............................... 12,224 13,929
Compensation liabilities ............................ 8,396 9,271
Net operating losses ................................ 241,235 53,563
Currency translation adjustments .................... 1,693 --
Other ............................................... 52,656 1,866
Deferred tax asset, gross of valuation allowance ....... 428,850 161,859
Valuation allowance - foreign tax credit ............... 2,508 --
--------------------
Deferred tax asset, net of valuation allowance ......... 426,342 161,859
--------------------
DEFERRED TAX LIABILITY:
Net unrealized appreciation on investments .......... 2,686 7,553
Currency translation adjustments .................... -- 566
Other ............................................... 4,434 1,572
--------------------
Deferred tax liability ................................. 7,120 9,691
--------------------
NET DEFERRED TAX ASSET ................................. $419,222 $152,168
====================
At December 31, 2001 and 2000, the Company's management concluded that all
deferred tax assets are more likely than not to be realized. A valuation
allowance was taken for the U.S. foreign tax credits due to expire in 2002. U.S.
net operating loss carryforwards at December 31, 2001 were approximately $285.0
million and will expire in future years through 2019. As at December 31, 2001,
net operating loss carryforwards in the U.K. were $447.0 million and have no
expiration.
Shareholders' equity at December 31, 2001 and 2000 reflected tax benefits
of $9.1 million and $3.3 million, respectively, related to compensation expense
deductions for stock options exercised for one of the Company's U.S.
subsidiaries.
22. STATUTORY FINANCIAL DATA
The Company's ability to pay dividends is subject to certain regulatory
restrictions on the payment of dividends by its subsidiaries. The payment of
such dividends is limited by applicable laws and statutory requirements of the
jurisdictions the Company operates in, including Bermuda, the U.S. and the U.K.,
among others. Statutory capital and surplus as reported to relevant regulatory
authorities for the principal operating subsidiaries of the Company was as
follows:
BERMUDA U.S. U.K. AND EUROPE
------------------------------------------------------------------------
DECEMBER 31 DECEMBER 31 DECEMBER 31
------------------------------------------------------------------------
2001 2000 2001 2000 2001 2000
------------------------------------------------------------------------
Required statutory capital and surplus $1,208,968 $ 791,251 $121,000 $111,000 $ 87,144 $ 8,000
Actual statutory capital and surplus. $3,578,807 $4,189,834 $639,422 $575,575 $449,449 $276,400
90
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
22. STATUTORY FINANCIAL DATA (CONTINUED)
The difference between statutory financial statements and statements
prepared in accordance with GAAP vary by jurisdiction however the primary
difference is that statutory financial statements do not reflect deferred policy
acquisition costs, deferred income tax net assets, intangible assets, unrealized
appreciation on investments and any unauthorized/authorized reinsurance charges.
With the exception of XL Re America, there are no statutory restrictions on
the payment of dividends from retained earnings by any of the Company's
subsidiaries as applicable minimum levels of solvency and liquidity have been
met and all regulatory requirements and licensing rules complied with. At
December 31, 2001 and 2000, XL Re America had a statutory earned deficit and is
restricted from making a dividend distribution at this time by the New York
Insurance Department.
23. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
YEAR ENDED DECEMBER 31
------------------------------
2001 2000 1999
------------------------------
BASIC (LOSS) EARNINGS PER SHARE:
Net (loss) income .............................. $(576,135) $506,352 $470,509
Weighted average ordinary shares outstanding ... 126,676 124,503 127,601
Basic (loss) earnings per share ................ $ (4.55) $ 4.07 $ 3.69
==============================
DILUTED (LOSS) EARNINGS PER SHARE:
Net (loss) income .............................. $(576,135) $506,352 $470,509
Add back after-tax interest on convertible
debentures (3) ............................... -- -- 1,752
------------------------------
Adjusted net (loss) income ..................... $(576,135) $506,352 $472,261
------------------------------
Weighted average ordinary shares
outstanding - basic ........................... 126,676 124,503 127,601
Average stock options outstanding (1) (2) ...... -- 1,194 1,872
Conversion of convertible debentures (3) ....... -- -- 831
------------------------------
Weighted average ordinary shares
outstanding - diluted ......................... 126,676 125,697 130,304
------------------------------
Diluted (loss) earnings per share .............. $ (4.55) $ 4.03 $ 3.62
==============================
(1) Net of shares repurchased under the treasury stock method.
(2) Average stock options outstanding have been excluded where anti-dilutive to
earnings per share.
(3) The 5.25% Convertible Subordinated Debentures due 2000 were called in June
1999 and the actual conversion is reflected in 1999.
Future weighted average number of shares outstanding may be affected by the
convertible debt issued during 2001. See Note 13 for further information.
24. RELATED PARTY TRANSACTIONS
In 2001, a limited partnership, XL Capital Principal Partners I, L.L.C.
("the Partnership"), was formed. The general partner of the Partnership is a
newly-formed wholly-owned subsidiary of the Company. All of the limited partners
of the Partnership are current or former senior officers or directors of the
Company or its subsidiaries. The Company's investment in this partnership is
included in other investments.
91
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
24. RELATED PARTY TRANSACTIONS (CONTINUED)
The stated purpose of the Partnership is to achieve long-term capital
appreciation for its investors through a portfolio of investments including,
without limitation: private equity, venture capital and hedge funds; equity and
equity-related securities of all types; investments in debt securities,
preferred shares and other financial instruments; and securities issued by
companies providing financial guaranty, insurance and reinsurance contracts.
Generally, the Partnership is expected to co-invest in investments made by the
Company substantially on the same terms as the similar investments made by the
Company.
The aggregate capital commitment of the Partnership is $49.1 million, of
which $8.7 million was invested at December 31, 2001. The capital commitment of
the general partner is $39.3 million and the capital commitments of the limited
partners in the aggregate is $9.8 million.
25. SUBSEQUENT EVENTS
Effective January 2002, the Company completed the acquisition of a 67%
majority shareholding in Le Mans Re, increasing its shareholding from 49% at
December 31, 2001. Les Mutuelles du Mans Assurances Group, which previously held
51% of the French reinsurer, will retain a 33% stake in Le Mans Re.
In January 2002, the Company issued $600.0 million par value Guaranteed
Senior Notes due January 2012. The Notes were issued at $99.469 and gross
proceeds were $596.8 million. The Guaranteed Senior Notes have a coupon of 6.5%.
Related expenses of the offering amounted to $7.9 million. Proceeds of the Notes
were used to pay down $350.0 million of outstanding revolving credit in February
2002 that would have expired in June 2002, and for general corporate purposes.
The Company registered its Dividend Reinvestment and Share Purchase Plan
effective January 2002. This plan is intended to provide registered holders of
XL Capital Class A ordinary shares with a convenient and economical way to
reinvest all or a portion of their cash dividends and to make additional cash
investments, subject to minimum and maximum purchase limitations, in its Class A
ordinary shares.
26. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly financial data for
2001 and 2000:
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- --------- ---------
2001
Net premiums earned - general operations ..................... $542,154 $640,984 $ 705,277 $ 891,512
Net premiums earned - life operations ........................ $ -- $ -- $ 46,247 $ 649,348
Underwriting profit (loss) ................................... $ 33,467 $ 51,219 $(925,087) $(239,734)
Net income (loss) ............................................ $218,929 $128,606 $(840,032) $ (83,638)
Net income (loss) per share and share equivalent - basic ..... $ 1.76 $ 1.03 $ (6.70) $ (0.64)
Net income (loss) per share and share equivalent - diluted ... $ 1.73 $ 1.01 $ (6.70) $ (0.64)
2000
Net premiums earned - general operations ..................... $494,499 $503,375 $ 539,945 $ 497,421
Underwriting profit (loss) ................................... $ 36,530 $ 8,792 $ 23,462 $(187,601)
Net income ................................................... $223,759 $142,484 $ 139,461 $ 648
Net income per share and share equivalent - basic ............ $ 1.78 $ 1.15 $ 1.13 $ 0.01
Net income per share and share equivalent - diluted .......... $ 1.77 $ 1.13 $ 1.10 $ 0.01
92
XL CAPITAL LTD
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. dollars in thousands, except per share amounts)
26. UNAUDITED QUARTERLY FINANCIAL DATA (CONTINUED)
In the fourth quarter of 2001, the Company incurred adverse loss
development of its casualty reinsurance business written prior to 1999 of
approximately $140.0 million after-tax, and losses related to certain other
events, including the bankruptcy of Enron Corp., American Airlines Flight 587
and several large European property losses.
In the third quarter of 2001, the Company recorded net losses of
approximately $795.9 million after tax due to the September 11 event. In
addition, the effect of other loss events, including the Sri Lanka airport
attack, Toulouse plant explosion, satellite losses and adverse development in
the Company's Lloyd's operations, were $103.7 million after taxes.
In the fourth quarter of 2000, the Company incurred after-tax charges of
$124.6 million, or $0.98 per share, which included certain reserve adjustments
together with employee severance charges and other costs associated with the
realignment of the Company's operations and the discontinuation of certain
business lines.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or any disagreements with accountants
regarding accounting and financial disclosure within the twenty-four months
ending December 31, 2001.
93
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This item is omitted because a definitive proxy statement that involves the
election of directors will be filed with the Securities and Exchange Commission
not later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
This item is omitted because a definitive proxy statement that involves the
election of directors will be filed with the Securities and Exchange Commission
not later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This item is omitted because a definitive proxy statement that involves the
election of directors will be filed with the Securities and Exchange Commission
not later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is omitted because a definitive proxy statement that involves the
election of directors will be filed with the Securities and Exchange Commission
not later than 120 days after the close of the fiscal year pursuant to
Regulation 14A, which proxy statement is incorporated by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements, Financial Statement Schedules and Exhibits.
PAGE
----
- Report of PricewaterhouseCoopers LLP on
Financial Statements and Financial Statement Schedules ........ 101
1. FINANCIAL STATEMENTS
Included in Part II - See Item 8 of this report.
2. FINANCIAL STATEMENT SCHEDULES
Included in Part IV of this report:
SCHEDULE
NUMBER PAGE
-----------------
- Consolidated Summary of Investments-Other than
Investments in Related Parties, as of
December 31, 2001 .................................. I 102
- Condensed Financial Information of Registrant,
as of December 31, 2001 and 2000 and for the
years ended December 31, 2001, 2000, and 1999 ...... II 103
- Reinsurance, for the years ended December 31, 2001,
2000 and 1999 ...................................... IV 106
- Supplementary Information Concerning Property/Casualty
Insurance Operations for the years ended
December 31, 2001, 2000 and 1999 ................... VI 107
Other Schedules have been omitted as they are not applicable to the
Company.
94
3. EXHIBITS
1.1 Underwriting Agreement, dated November 1, 2001, by and among XL
Capital Ltd, Goldman, Sachs & Co., Morgan Stanley & Co.
Incorporated, Banc of America Securities LLC, Credit Suisse First
Boston Corporation, J.P. Morgan Securities Inc. and Merrill
Lynch, Pierce, Fenner & Smith Incorporated, incorporated by
reference to the Company's Current Report on Form 8-K dated
November 7, 2001.
1.2 Pricing Agreement, dated November 1, 2001, by and among XL
Capital Ltd, Goldman, Sachs & Co., Morgan Stanley & Co.
Incorporated, Banc of America Securities LLC, Credit Suisse First
Boston Corporation, J.P. Morgan Securities Inc. and Merrill
Lynch, Pierce, Fenner & Smith Incorporated, incorporated by
reference to the Company's Current Report on Form 8-K dated
November 7, 2001.
1.3 Underwriting Agreement, dated January 7, 2002, by and among XL
Capital Finance (Europe) plc, XL Capital Ltd, Salomon Smith
Barney Inc., J.P. Morgan Securities Inc., Banc of America
Securities LLC, Barclays Capital Inc. and Credit Lyonnais
Securities (USA) Inc., incorporated by reference to the Company's
Current Report on Form 8-K dated November 7, 2001.
1.4 Pricing Agreement, dated January 7, 2002, by and among XL Capital
Finance (Europe) plc, XL Capital Ltd, Salomon Smith Barney Inc.,
J.P. Morgan Securities Inc., Banc of America Securities LLC,
Barclays Capital Inc. and Credit Lyonnais Securities (USA) Inc.,
incorporated by reference to the Company's Current Report on Form
8-K dated November 7, 2001.
3.1 Memorandum of Association, incorporated by reference to Annex G
to the Joint Proxy Statement of EXEL Limited and Mid Ocean
limited dated July 2, 1998.
3.2 Articles of Association, incorporated by reference to Annex G to
the Joint Proxy Statement of EXEL Limited and Mid Ocean Limited
dated July 2, 1998.
4.1 Rights Agreement, dated September 11, 1998, between the Company
and Chase Mellon Shareholder Services, L.L.C., as Rights Agent,
incorporated by reference to the Company's Current Report on Form
8-K dated October 21, 1998.
4.2 Registration Rights Agreement, dated May 23, 2001, between XL
Capital Ltd and Goldman, Sachs & Co., Deutsche Banc Alex. Brown,
and Dresdner Kleinwort Wasserstein L.L.C., as initial purchasers,
as incorporated by reference to the Company's Registration
Statement on Form S-3 (No. 333-66976).
4.3 Registration Rights Agreement, dated September 4, 2001, between
XL Capital Ltd and Merrill Lynch, Pierce, Fenner & Smith
Incorporated, incorporated by reference to Exhibit 4.51 to the
Company's quarterly report on Form 10-Q for the period ended
September 30, 2001.
4.4 Indenture, dated January 10, 2002, by and among XL Capital
Finance (Europe) plc, XL Capital Ltd and State Street Bank and
Trust Company, incorporated by reference to the Company's Current
Report on Form 8-K dated January 10, 2002.
4.5 Form of XL Capital Finance (Europe) plc Debt Security,
incorporated by reference to the Company's Current Report on Form
8-K dated January 10, 2002.
4.6 Excerpts from the Authorizing Resolutions of the Board of
Directors of XL Capital Finance (Europe) plc, dated January 7,
2002, incorporated by reference to the Company's Current Report
on Form 8-K dated January 10, 2002.
4.7 Indenture, dated September 4, 2001, between XL Capital Ltd and
State Street Bank & Trust Company relating to the Liquid-Yield
Option Notes due 2021, incorporated by reference to Exhibit 4.49
to the Company's quarterly report on Form 10-Q for the period
ended September 30, 2001.
4.8 Form of Liquid-Yield Option Note due 2021 (referred to in Exhibit
4.7 above) and incorporated by reference to Exhibit 4.50 to the
Company's quarterly report on Form 10-Q for the period ended
September 30, 2001.
95
4.9 Indenture, dated May 23, 2001, between XL Capital Ltd and
Goldman, Sachs & Co., Deutsche Banc Alex. Brown, and Dresdner
Kleinwort Wasserstein L.L.C., as initial purchasers, incorporated
by reference to Exhibit 4(a) to the Company's Registration
Statement on Form S-3 (No. 333-66976).
4.10 Form of Zero Coupon Convertible debenture, due May 23, 2021
(referred to in Exhibit 4.8 above) and incorporated by reference
to Exhibit 10.14.41 to the Company's quarterly report on Form
10-Q for the period ended June 30, 2001.
4.11 Form of Note Purchase Agreement, dated April 12, 2001, relating
to 6.58% Guaranteed Senior Notes due April 12, 2011, incorporated
by reference to Exhibit 10.14.43 to the Company's quarterly
report on Form 10-Q for the period ended June 30, 2001.
4.12 Form of Note Purchase Agreement, dated November 1995, relating to
7.15% senior notes due November 15, 2005, incorporated by
reference to NAC Re Corporation's Registration Statement on Form
S-3 (No. 33-97878).
10.1 Money Accumulation Savings Program, incorporated by reference to
Exhibit 10.15 to the Company's Registration Statement on Form S-1
(No. 33-40533).
10.2 1991 Performance Incentive Plan, incorporated by reference to
Exhibit 10.17 to the Company's Registration Statement on Form S-1
(No. 33-40533).
10.3 First Amendment to the 1991 Performance Incentive Program,
incorporated by reference to Exhibit 10.4 to the Company's Annual
Report on Form 10-K for the year ended November 30, 1996.
10.4 1991 Performance Incentive Program as amended and restated,
effective March 17, 2000, incorporated by reference to the
Company's Proxy Statement dated April 7, 2000.
10.5 Retirement Plan for Non-employee Directors of XL Capital Ltd, as
amended, incorporated by reference to Exhibit 10.5 to the
Company's Annual Report on Form 10-K for the year ended November
30, 1996.
10.6 XL Capital Ltd Directors Stock and Option Plan, as amended,
incorporated by reference to Exhibit 10.6 to the Company's Annual
Report on Form 10-K for the year ended November 30, 1996.
10.7 XL Capital Ltd Stock Plan for Non-employee Directors,
incorporated by reference to Exhibit 10.6 to the Company's Annual
report on Form 10-K for the year ended November 30, 1996.
10.8 Fourth Amendment to EXEL Limited Directors Stock and Option Plan,
incorporated by reference to Exhibit 10.6.2 to the Company's
Annual Report on Form 10-K for the year ended November 30, 1998.
10.9 Mid Ocean Limited 1993 Long Term Incentive and Share Award Plan,
incorporated by reference to Exhibit 10.9.1 to the Company's
Annual report on form 10-K for the year ended November 30, 1998.
10.10 Amendment to Mid Ocean Limited 1993 Long Term Incentive and Share
Award Plan, incorporated by reference to Exhibit 10.9.2 to the
Company's Annual Report on Form 10-K for the year ended November
30, 1998.
10.11 Mid Ocean Ltd. Stock & Deferred Compensation Plan for
Non-employee Directors, incorporated by reference to Exhibit
10.10.1 to the Company's Annual Report on Form 10-K for the year
ended November 30, 1998.
10.12 Form of Severance Contract between NAC Re Corporation and the
executive officers of NAC Re Corporation, incorporated herein by
reference to the Company's Annual Report on Form 10-K of NAC Re
Corporation for the year ended December 30, 1988.
10.13 1997 Incentive and Capital Accumulation Plan, incorporated by
reference to Exhibit A to the NAC Re Corporation definitive Proxy
Statement filed with the Securities and Exchange Commission.
10.14 Dividend Reinvestment and Share Purchase Plan, dated January 18,
2002, incorporated by reference to the Company's Registration
Statement on Form S-3 (No. 333-76988).
96
10.15 Mark E. Brockbank Consultancy Agreement, incorporated by
reference to Exhibit 10.12.1 to the Company's Annual Report on
Form 10-K for the year ended November 30, 1998.
10.16 Henry C. V. Keeling Employment Agreement, incorporated by
reference to Exhibit 10.11.2 to the Company's Annual Report on
Form 10-K for the year ended November 30, 1998.
10.17 Amendment to Henry C. V. Keeling Service Agreement, incorporated
by reference to Exhibit 10.12.2 to the Company's Annual Report on
Form 10-K for the year ended November 30, 1998.
10.18 Michael A. Butt Employment Agreement, incorporated by reference
to Exhibit 10.11.5 to the Company's Annual Report on Form 10-K
for the year ended November 30, 1998.
10.19 Amendment to Michael A. Butt Service Agreement, incorporated by
reference to Exhibit 10.12.4 to the Company's Annual Report on
Form 10-K for the year ended November 30, 1998.
10.20 Ronald L. Bornheutter Consulting Agreement, dated July 1, 1999,
incorporated by reference to Exhibit 10.14.19 to the Company's
Annual Report on form 10-K for the year ended December 31, 1999.
10.21 Ronald L. Bornheutter Settlement Agreement, dated June 30, 1999,
incorporated by reference to Exhibit 10.14.19 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999.
10.22 Nicholas M. Brown, Jr. Employment Contract, dated June 30, 1998,
incorporated herein by reference to NAC Re Corporation's
quarterly report on Form 10-Q for the period ended June 30, 1998.
10.23 Amended and Restated Employment Agreement with Nicholas M. Brown,
Jr., dated June 18, 1999, incorporated by reference to Exhibit
10.14.19 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999.
10.24 Jerry de St. Paer Employment Agreement, dated March 1, 2001,
incorporated by reference to Exhibit 10.14.37 to the Company's
quarterly report on Form 10-Q for the period ended June 30, 2001.
10.25 Credit Agreement (5-Year), between Mid Ocean Limited and The
Chase Manhattan Bank, incorporated by reference to Exhibit
10.14.1 to the Company's Annual Report on Form 10-K for the year
ended November 30, 1998.
10.26 Amendment No. 1, to Credit Agreement (5-Year) between Mid Ocean
Limited and The Chase Manhattan Bank, incorporated by reference
to Exhibit 10.14.2 to the Company's Annual Report on Form 10-K
for the year ended November 30, 1998.
10.27 Amendment No. 2, to Credit Agreement (5-year) between Mid Ocean
Limited and The Chase Manhattan Bank, incorporated by reference
to Exhibit 10.14.19 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1999.
10.28 Amendment No. 3, to Credit Agreement (5-year) between Mid Ocean
Limited and The Chase Manhattan Bank, incorporated by reference
to Exhibit 10.14.19 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1999.
10.29 Revolving Credit Agreement, dated as of June 6, 1997, between XL
Insurance Company, Ltd X.L. Reinsurance Company, Ltd, and Exel
Acquisition Ltd, as the banks, and Mellon Bank N.A., as agent,
incorporated by reference to Exhibit (b)(2) of the GCR Schedule
14D-1, incorporated by reference to Exhibit 10.14.14 to the
Company's Annual Report on Form 10-K for the year ended November
30, 1998.
10.30 First Amendment, dated as of November 5, 1997, to Revolving
Credit Agreement dated as of June 6, 1997, incorporated by
reference to Exhibit 10.14.15 to the Company's Annual Report on
Form 10-K for the year ended November 30,1998.
10.31 Second Amendment, dated as of August 3, 1998, to Revolving Credit
Agreement dated as of June 6, 1997, incorporated by reference to
Exhibit 10.14.16 to the Company's Annual Report on Form 10-K for
the year ended November 30, 1998.
97
10.32 Third Amendment, dated as of December 4, 1998, to Revolving
Credit Agreement dated as of June 6, 1997, incorporated by
reference to Exhibit 10.14.19 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1999.
10.33 Fourth Amendment, dated as of June 30, 1999, to Revolving Credit
Agreement dated as of June 6, 1997, incorporated by reference to
Exhibit 10.14.19 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1999.
10.34 Fifth Amendment, dated as of February 25, 2000, to Revolving
Credit Agreement dated as of June 6, 1997, incorporated by
reference to Exhibit 10.14.19 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1999.
10.35 Sixth Amendment, dated as of August 27, 2001, to Revolving Credit
Agreement dated as of June 6, 1997, incorporated by reference to
Exhibit 10.47 to the Company's quarterly report on Form 10-Q for
the period ended September 30, 2001.
10.36 Seventh Amendment, dated as of September 26, 2001, to Revolving
Credit Agreement dated as of June 6, 1997, incorporated by
reference to Exhibit 10.46 to the Company's quarterly report on
Form 10-Q for the period ended September 30, 2001.
10.37 Letter of Credit Facility and Reimbursement Agreement, dated as
of June 30, 1999, by and among XL Insurance (Bermuda) Ltd
(formerly known as XL Insurance Ltd) XL Capital Ltd, XL Europe
Ltd, XL Re Ltd (formerly known as Mid Ocean Reinsurance Ltd), The
Brockbank Group plc, as account parties and XL Insurance
(Bermuda) Ltd, XL Capital Ltd, XL Re Ltd, and XL Investments Ltd,
as guarantors and Mellon Bank, N.A., as issuing bank and agent
incorporated by reference to Exhibit 10.14.19 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999.
10.38 First Amendment dated as of January 21, 2000, to Letter of Credit
Facility and Reimbursement Agreement dated June 30, 1999,
incorporated by reference to Exhibit 10.14.19 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999.
10.39 Second Amendment dated as of November 28, 2000, to Letter of
Credit Facility and Reimbursement Agreement dated June 30, 1999,
incorporated by reference to Exhibit 10.14.34 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2000.
10.40 364-day Credit Agreement, dated as of July 5, 2000, between XL
Capital Ltd, X.L. America, Inc., XL Insurance Ltd, XL Europe Ltd
and XL Mid Ocean Reinsurance Ltd, as borrowers and guarantors,
the lenders named therein, The Chase Manhattan Bank, as
administrative agent, Chase Securities Inc., as advisor, lead
arranger and book manager, Deutsche Bank AG, as syndication
agent, and Mellon Bank, N.A. and Citibank, N.A., as
co-documentation agent, incorporated by reference to Exhibit
10.14.31 to the Company's quarterly report on Form 10-Q for the
period ended June 30, 2000.
10.41 Letter of Credit and Reimbursement Agreement, dated as of July 5,
2000, between XL Capital Ltd, X.L. America, Inc., XL Insurance
Ltd, XL Europe Ltd and XL Mid Ocean Reinsurance Ltd, as account
parties and guarantors, the lenders party thereto, The Chase
Manhattan Bank, as administrative agent, Chase Securities Inc.,
as advisor, lead arranger and book manager, Deutsche Bank AG, as
syndication agent, and Mellon Bank, N.A. and Citibank, N.A., as
co-documentation agents, incorporated by reference to Exhibit
10.14.32 to the Company's quarterly report on Form 10-Q for the
period ended June 30, 2000.
10.42 Letter of Credit and Reimbursement Agreement, dated November 3,
2000, between XL Capital Ltd, XL America Inc., XL Insurance
(Bermuda) Ltd (formerly known as XL Insurance Ltd), XL Europe and
XL Re Ltd (formerly known as XL Mid Ocean Reinsurance Ltd), the
guarantors, the lenders named therein, Citibank International
plc, as agent and security trustee and Solomon Brothers
International Limited, as arranger, incorporated by reference to
Exhibit 10.14.33 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2000.
98
10.43 Amendment No. 1, dated as of September 26, 2001, to the Letter of
Credit and Reimbursement Agreement dated November 3, 2000 between
XL Capital Ltd as account party and guarantor, and X.L. America,
Inc., XL Insurance Ltd, XL Europe Ltd and XL Re Ltd, as
guarantors, and the lenders party thereto and Citibank
International plc, as agent and security trustee for the lenders
and Salomon Brothers International Limited, as arranger,
incorporated by reference to Exhibit 10.49 to the Company's
quarterly report on Form 10-Q for the period ended September 30,
2001.
10.44 Letter of Credit Agreement (Secured), between XL Mid Ocean
Reinsurance Ltd and Citibank International plc dated May 19, 1993
(as amended) incorporated by reference to the Company's
Prospectus Supplement dated November 3, 1998.
10.45 364-day Credit Agreement, dated as of June 29, 2001, between XL
Capital Ltd, X.L. America, Inc., XL Insurance Ltd, XL Europe Ltd
and XL Re Ltd, as borrowers and guarantors, the lenders party
thereto, and The Chase Manhattan Bank, as administrative agent,
J.P. Morgan Securities Inc., as advisor, lead arranger and
bookrunner and Mellon Bank, N.A. and Citibank, N.A., as
co-syndication agents, incorporated by reference to Exhibit
10.14.38 to the Company's quarterly report on Form 10-Q for the
period ended June 30, 2001.
10.46 Amendment No. 1, dated as of September 26, 2001, to the 364-day
Credit Agreement dated as of June 29, 2001 between XL Capital
Ltd, X.L. America, Inc., XL Insurance Ltd, XL Europe Ltd and XL
Re Ltd, as borrowers and guarantors and the lenders party thereto
and The Chase Manhattan Bank, as administrative agent,
incorporated by reference to Exhibit 10.45 to the Company's
quarterly report on Form 10-Q for the period ended September 30,
2001.
10.47 Letter of Credit and Reimbursement Agreement, dated as of June
29, 2001, between XL Capital Ltd, X.L. America, Inc., XL
Insurance Ltd, XL Europe Ltd and XL Re Ltd, as account parties
and guarantors, and The Chase Manhattan Bank, as administration
agent, incorporated by reference to Exhibit 10.14.39 to the
Company's quarterly report on Form 10-Q for the period ended June
30, 2001.
10.48 Amendment No. 1, dated as of September 26, 2001, to the Letter of
Credit and Reimbursement Agreement dated as of June 29, 2001
between XL Capital Ltd, X.L. America, Inc., XL Insurance Ltd, XL
Europe Ltd and XL Re Ltd, each an account party and guarantor,
the lenders party thereto and The Chase Manhattan Bank, as
administrative agent, incorporated by reference to Exhibit 10.48
to the Company's quarterly report on Form 10-Q for the period
ended September 30, 2001.
10.49 Amended and Restated Credit Agreement, dated August 31, 2001,
between XL Capital Ltd, XL Insurance Ltd, XL Re Ltd and Mid Ocean
Limited, as borrowers and guarantors, and The Chase Manhattan
Bank as administrative agent.*
10.50 Amendment No. 1, dated as of September 26, 2001, to the Amended
and Restated Credit Agreement dated as of August 31, 2001 between
XL Capital Ltd, XL Insurance Ltd, XL Re Ltd and Mid Ocean
Limited, as borrowers and guarantors, the banks party thereto and
The Chase Manhattan Bank, as administrative agent, incorporated
by reference to Exhibit 10.44 to the Company's quarterly report
on Form 10-Q for the period ended September 30, 2001.
10.51 Second Amended and Restated Agreement for the Sale and Purchase
of Winterthur International, dated February 15, 2001,
incorporated by reference to the Company's Current Report on Form
8-K dated July 25, 2001.
10.52 Letter of Credit Facility and Reimbursement Agreement, dated
November 20, 2001, between XL Capital Ltd X.L. America, Inc., XL
Europe Ltd, XL Insurance (Bermuda) Ltd and XL Re Ltd as
guarantors and Citibank International Plc as agent and security
trustee and Salomon Brothers International Limited as the
arranger and the lenders party thereto.*
* Filed herewith
99
10.53 Letter of Credit Facility and Reimbursement Agreement, dated as
of December 31, 2001, between XL Capital Ltd, X.L. America Inc.,
XL Insurance (Bermuda) Ltd, XL Europe Ltd and XL Re Ltd, as
account parties and guarantors and Mellon Bank, as issuing bank,
agent and arranger.*
10.54 Pledge Agreement, dated as of December 18, 2001, made by XL
Investments Ltd, XL Re Ltd, XL Insurance (Bermuda) Ltd and XL
Europe Ltd as guarantors and in favor of Citibank, N.A.*
10.55 Limited Liability Company Agreement of XL Capital Principal
Partners I, L.L.C., dated June 26, 2001.*
10.56 Amended and Restated Agreement of Limited Partnership of XL
Capital Partners I, L.P., dated May 31, 2001.*
10.57 Amended and Restated Agreement of Limited Partnership of XL
Principal Partners I, L.P., dated June 28, 2001.*
12.1 Statement regarding computation of ratios.*
21.1 List of subsidiaries of the Registrant.*
23.1 Consent of PricewaterhouseCoopers LLP.*
99.1 The audited financial statements of Winterthur International as
at and for the year ended December 31, 2000, incorporated by
reference to the Company's Current Report on Form 8-K dated July
25, 2001.
99.2 Consent of KPMG Audit plc, incorporated by reference to the
Company's Current Report on Form 8-K dated July 25, 2001.
99.3 The unaudited pro forma condensed financial information as at and
for year ended December 31, 2000, incorporated by reference to
the Company's Current Report on Form 8-K dated July 25, 2001.
99.4 Press Release, dated August 6, 2001, incorporated by reference to
the Company's Current Report on Form 8-K dated July 25, 2001.
99.5 XL Capital Assurance Inc. audited financial statements as at and
for the years ended December 31, 2001, 2000, and 1999.*
99.6 XL Financial Assurance Ltd. audited financial statements as at
and for the years ended December 31, 2001 and 2000, and as at and
for the 63 week period ended December 31, 1999.*
(b) Reports on Form 8-K
(1) Current Report on Form 8-K filed on October 4, 2001, under
Item 5 thereof.
(2) Current Report on Form 8-K filed on October 29, 2001, under
Item 5 thereof.
(3) Current Report on Form 8-K filed on November 2, 2001, under
Item 5 thereof.
* Filed herewith
100
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of XL Capital Ltd:
In our opinion, based upon our audits, the accompanying consolidated balance
sheets, the related consolidated statements of income and comprehensive income,
of shareholders' equity and of cash flows present fairly, in all material
respects, the financial position of XL Capital Ltd and its subsidiaries at
December 31, 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 Item 14(a) of this Form 10-K, when considered in relation to the basic
financial statements taken as a whole, present fairly, in all material respects,
the information required to be included therein. These financial statements and
financial statement schedules are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedules based on our audits. The
consolidated financial statements give retroactive effect to the merger with NAC
Re Corp. on July 15, 1999 in a transaction accounted for as a pooling of
interests, as described in Note 6 to the consolidated financial statements. We
conducted our audits of these statements and schedules in accordance with
generally accepted auditing standards in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
New York, New York
February 12, 2002
101
XL CAPITAL LTD
SUPPLEMENTAL SCHEDULE I
CONSOLIDATED SUMMARY OF INVESTMENTS-OTHER THAN
INVESTMENTS IN RELATED PARTIES
AS AT DECEMBER 31, 2001
(U.S dollars in thousands)
AMOUNT
SHOWN
COST OR IN THE
AMORTIZED MARKET BALANCE
TYPE OF INVESTMENT COST (1) VALUE SHEET
------------------------------------
Fixed Maturities:
Bonds and notes:
U.S. Government and
Government agency ................. $ 1,047,642 $ 1,039,652 $ 1,039,652
-------------------------------------
Corporate ........................... 5,095,415 4,998,457 4,998,457
Mortgage-backed securities .......... 3,278,103 3,293,077 3,293,077
U.S. States and political
subdivisions of the States ........ 58,978 60,225 60,225
Non-U.S. Sovereign Government ....... 1,465,430 1,440,516 1,440,516
-------------------------------------
Total fixed maturities ........ $10,945,568 $10,831,927 $10,831,927
-------------------------------------
Equity Securities: ...................... $ 575,090 $ 547,805 $ 547,805
-------------------------------------
Short-term investments .................. $ 1,050,015 $ 1,050,113 $ 1,050,113
-------------------------------------
Other investments ....................... $ 273,528 $ 273,528 $ 273,528
-------------------------------------
Total investments other than
related parties ....................... $12,844,201 $12,703,373 $12,703,373
-------------------------------------
(1) Investments in fixed maturities and short-term investments are shown at
amortized cost.
102
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS-PARENT COMPANY ONLY
AS AT DECEMBER 31, 2001 AND 2000
(U.S. dollars in thousands)
2001 2000
----------------------
A S S E T S
Investments available for sale:
Fixed maturities at fair value (amortized cost:
2001, $145,713; 2000, $292,759) ................... $ 149,318 $ 295,770
Equity securities at fair value
(cost: 2001, $375; 2000: nil) ..................... 376 --
Short-term investments at fair value
(amortized cost: 2001, $240,490: 2000, $11,032) ... 241,193 10,997
----------------------
Total investments available for sale ............ 390,887 306,767
Cash and cash equivalents ............................. 303,628 40,391
Investments in subsidiaries on an equity basis ........ 6,130,799 6,748,846
Investment in affiliates .............................. 31,400 162
Investments in limited partnerships ................... 42,342 35,712
Accrued investment income ............................. 2,330 2,629
Other assets .......................................... 31,432 22,049
----------------------
Total assets ................................... $6,932,818 $7,156,556
======================
L I A B I L I T I E S
Amount due to subsidiaries ............................ $ 535,781 $1,515,071
Notes payable and debt ................................ 899,838 --
Accounts payable and accrued liabilities .............. 60,015 67,817
----------------------
Total liabilities .............................. $1,495,634 $1,582,888
======================
S H A R E H O L D E R S' E Q U I T Y
Ordinary shares ....................................... $ 1,347 $ 1,250
Contributed surplus ................................... 3,378,549 2,497,416
Accumulated other comprehensive loss .................. (213,013) (104,712)
Deferred compensation ................................. (27,177) (17,727)
Retained earnings ..................................... 2,297,478 3,197,441
----------------------
Total shareholders' equity ..................... $5,437,184 $5,573,668
----------------------
Total liabilities and shareholders' equity ..... $6,932,818 $7,156,556
======================
103
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF INCOME AND COMPREHENSIVE INCOME-PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(U.S. dollars in thousands)
2001 2000 1999
-------------------------------
Net investment income ........................ $ 18,251 $ 4,466 $ 1,890
Net realized gains (losses) on investments
and derivative instruments ................. 5,992 643 (278)
Equity in net (loss) earnings of
subsidiaries (Dividends were Nil
in 2001, 2000 and 1999, respectively) ...... (481,566) 576,502 560,166
Equity in net (loss) income of affiliates .... (957) 88 --
Income from limited partnerships ............. 1,719 2,594 4,947
-------------------------------
Total revenues ............................... (456,561) 584,293 566,725
-------------------------------
Operating expenses ........................... 96,589 77,941 96,216
Interest expense ............................. 22,985 -- --
-------------------------------
Total expenses ............................... 119,574 77,941 96,216
-------------------------------
Net (loss) income ............................ (576,135) 506,352 470,509
Change in net unrealized appreciation
on investments ............................. 1,790 4,458 (3,084)
-------------------------------
Comprehensive (loss) income .................. $(574,345) $510,810 $ 467,425
===============================
104
XL CAPITAL LTD
SCHEDULE II
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF CASH FLOWS-PARENT COMPANY ONLY
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(U.S dollars in thousands)
2001 2000 1999
-------------------------------------
Cash flows provided by (used in) operating activities:
Net (loss) income .......................................................... $(576,135) $ 506,352 $ 470,509
Adjustments to reconcile net income to net cash provided by
operating activities:
Net realized gains (losses) on investments and derivative instruments ... (5,992) -- --
Equity in net loss (earnings) of subsidiaries, net of dividends ......... 483,461 (586,663) (557,317)
Equity in net loss (income) of affiliates, net of dividends ............. 1,198 (88) --
Amortization of intangible assets ....................................... 31,348 31,348 31,348
Amortization of deferred compensation ................................... 10,352 8,861 7,657
Amortization of discounts on fixed maturities ........................... 1,708 637 366
Accretion of notes payable and debt ..................................... 12,339 -- --
Accrued investment income ............................................... 299 (2,090) 1,428
Accounts payable and accrued liabilities ................................ (7,875) (60,226) 10,522
Other ................................................................... 10,034 (8,890) (5,069)
-------------------------------------
Total adjustments .................................................... 536,872 (617,111) (511,065)
-------------------------------------
Net cash (used in) provided by operating activities .................. (39,263) (110,759) (40,556)
-------------------------------------
Cash flows provided by (used in) investing activities:
Proceeds from sale of fixed maturities and short-term investments .......... 497,940 230,110 118,756
Proceeds from redemption of fixed maturities and
short-term investments .................................................. 80,299 43,500 107,885
Purchases of fixed maturities and short term investments ................... (658,872) (432,722) (121,995)
Investment in subsidiaries ................................................. (6,770) (25,000) --
Investment in affiliates ................................................... (29,860) -- --
Investment in limited partnerships ......................................... (6,630) 3,640 (18,974)
-------------------------------------
Net cash provided by (used in) investing activities .................. (123,893) (180,472) 85,672
-------------------------------------
Cash flows provided by (used in) financing activities:
Issue of shares ............................................................ 787,678 -- --
Proceeds from exercise of options .......................................... 105,233 74,564 14,014
Dividends paid ............................................................. (237,628) (225,572) (212,659)
Amount due to subsidiaries ................................................. (979,290) 605,461 229,811
Repurchase of shares ....................................................... (117,133) (248,450) (99,344)
Proceeds from loans ........................................................ 917,533 -- --
Repayment of loans ......................................................... (50,000) -- --
-------------------------------------
Net cash provided by (used in) financing activities .................. 426,393 206,003 68,178)
-------------------------------------
Net change in cash and cash equivalents .............................. 263,237 (85,228) (23,062)
Cash and cash equivalents - beginning of year ................................. 40,391 125,619 148,681
-------------------------------------
Cash and cash equivalents - end of year ....................................... $ 303,628 $ 40,391 $ 125,619
=====================================
105
XL CAPITAL LTD
SCHEDULE IV-REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(U.S dollars in thousands)
CEDED ASSUMED
GROSS TO OTHER FROM OTHER NET
AMOUNT COMPANIES COMPANIES AMOUNT
----------------------------------------------------
2001 ................. $2,978,370 $1,855,296 $1,805,352 $2,928,426
----------------------------------------------------
2000 ................. $1,688,923 $1,012,791 $1,440,108 $2,116,240
----------------------------------------------------
1999 ................. $1,088,028 $ 541,037 $1,354,892 $1,901,883
----------------------------------------------------
106
XL CAPITAL LTD
SCHEDULE VI
SUPPLEMENTARY INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(U.S dollars in thousands)
LOSSES AND LOSS EXPENSES NET PAID
RESERVES INCURRED RELATED TO LOSSES AMORTIZATION
DEFERRED FOR LOSSES RESERVES FOR NET ------------------------ AND OF DEFERRED NET
ACQUISITION AND LOSS UNEARNED NET EARNED INVESTMENT CURRENT PRIOR LOSS ACQUISITION PREMIUMS
COSTS EXPENSES PREMIUMS PREMIUMS INCOME YEAR YEAR EXPENSES COSTS WRITTEN
---------------------------------------------------------------------------------------------------------------------------
2001 ... $394,258 $11,825,680 $2,682,089 $2,779,927 $562,606 $2,743,094 $ 175,804 $1,817,425 $639,046 $2,928,426
---------------------------------------------------------------------------------------------------------------------------
2000 ... $309,268 $ 5,672,062 $1,741,393 $2,035,240 $542,500 $1,827,443 $(394,884) $1,663,670 $485,796 $2,116,240
---------------------------------------------------------------------------------------------------------------------------
1999 ... $275,716 $ 5,369,402 $1,497,376 $1,750,006 $525,318 $1,591,414 $(287,110) $1,093,502 $380,980 $1,901,883
---------------------------------------------------------------------------------------------------------------------------
107
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
XL CAPITAL LTD
By /s/ BRIAN M. O'HARA
-----------------------------------------
Brian M. O'Hara
PRESIDENT AND CHIEF EXECUTIVE OFFICER
March 22, 2002
POWER OF ATTORNEY
We, the undersigned directors and executive officers of XL Capital Ltd,
hereby severally constitute Michael P. Esposito, Jr., Brian M. O'Hara and Paul
S. Giordano, and each of them singly, our true and lawful attorneys with full
power to them and each of them to sign for us, and in our names in the
capacities indicated below, any and all amendments to the Annual Report on Form
10-K filed with the Securities and Exchange Commission, hereby ratifying and
confirming our signatures as they may be signed by our said attorneys to any and
all amendments to said Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ BRIAN M. O'HARA President, Chief Executive March 22, 2002
- --------------------------- Officer and Director
Brian M. O'Hara (Principal Executive Officer)
/s/ JERRY M. DE ST. PAER Executive Vice President March 22, 2002
- --------------------------- (Principal Financial Officer
Jerry M. de St Paer and Principal Accounting Officer)
/s/ MICHAEL P. ESPOSITO JR. Director and Chairman of the March 22, 2002
- --------------------------- Board of Directors
Michael P. Esposito, Jr.
/s/ RONALD L. BORNHUETTER Director March 22, 2002
- ---------------------------
Ronald L. Bornhuetter
/s/ MICHAEL A. BUTT Director March 22, 2002
- ---------------------------
Michael A. Butt
/s/ ROBERT CLEMENTS Director March 22, 2002
- ---------------------------
Robert Clements
/s/ DALE COMEY Director March 22, 2002
- ---------------------------
Dale Comey
/s/ SIR F. BRIAN CORBY Director March 22, 2002
- ---------------------------
Sir F. Brian Corby
/s/ ROBERT R. GLAUBER Director March 22, 2002
- ---------------------------
Robert R. Glauber
108
SIGNATURES TITLE DATE
---------- ----- ----
/s/ PAUL E. JEANBART Director March 22, 2002
- ---------------------------
Paul E. Jeanbart
/s/ JOHN LOUDON Director March 22, 2002
- ---------------------------
John Loudon
/s/ ROBERT S. PARKER Director March 22, 2002
- ---------------------------
Robert S. Parker
/s/ CYRIL E. RANCE Director March 22, 2002
- ---------------------------
Cyril E. Rance
/s/ ALAN Z. SENTER Director March 22, 2002
- ---------------------------
Alan Z. Senter
/s/ JOHN T. THORNTON Director March 22, 2002
- ---------------------------
John T. Thornton
/s/ ELLEN E. THROWER Director March 22, 2002
- ---------------------------
Ellen E. Thrower
/s/ JOHN W. WEISER Director March 22, 2002
- ---------------------------
John W. Weiser
109