Back to GetFilings.com
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the Fiscal Year Ended December 31, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from __________ to ___________
Commission File No. 0-26456
RISK CAPITAL HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 06-1424716
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 Horseneck Lane
Greenwich, Connecticut 06830
- --------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 862-4300
Securities registered pursuant to Section 12(b) of the Act:
Name of each Exchange
Title of Each Class on which Registered
------------------- ---------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.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 for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 24, 1999 was approximately $172,976,563 based on the
closing price on the Nasdaq National Market on that date.
As of March 24, 1999, there were 17,086,266 shares of the Registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates certain information by reference to the Registrant's
definitive proxy statement to be filed with respect to the Registrant's Annual
Meeting of Stockholders to be held on May 11, 1999, which proxy statement will
be filed with the Securities and Exchange Commission within 120 days of the
close of the Registrant's fiscal year ended December 31, 1998.
================================================================================
RISK CAPITAL HOLDINGS, INC.
TABLE OF CONTENTS
Item Page
- ---- ----
Part I
1. Business................................................................ 1
2. Properties.............................................................. 26
3. Legal Proceedings....................................................... 26
4. Submission of Matters to a Vote of Security Holders..................... 26
Part II
5. Market for Registrant's Common Equity and Related Stockholder Matters... 26
6. Selected Financial Data................................................. 28
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................... 29
7A. Quantitative and Qualitative Disclosures About Market Risk.............. 43
8. Financial Statements and Supplementary Data............................. 43
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................... 43
Part III
10. Directors and Executive Officers of the Registrant...................... 43
11. Executive Compensation.................................................. 43
12. Security Ownership of Certain Beneficial Owners and Management.......... 43
13. Certain Relationships and Related Transactions.......................... 43
Part IV
14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......... 44
-i-
Cautionary Note Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This Form 10-K, the Company's Annual
Report to Stockholders, any proxy statement, any Form 10-Q or any Form 8-K of
the Company or any other written or oral statements made by or on behalf of the
Company may include forward-looking statements which reflect the Company's
current views with respect to future events and financial performance. Such
statements include forward-looking statements both with respect to the Company
and the insurance sector in general (both as to underwriting and investment
opportunities). 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, acceptance in the market of the Company's reinsurance products;
competition from new products (including products that may be offered by the
capital markets); the availability of investments on attractive terms;
competition, including increased competition (both as to underwriting and
investment opportunities); changes in the performance of the insurance sector of
the public equity markets or market professionals' views as to such sector; the
amount of underwriting capacity from time to time in the market; general
economic conditions and conditions specific to the reinsurance and investment
markets in which the Company operates; regulatory changes and conditions; rating
agency policies and practices; claims development, including as to the frequency
or severity of claims and the timing of payments; and loss of key personnel.
Changes in any of the foregoing may affect the Company's ability to realize its
business strategy or may result in changes in the Company's business strategy.
The foregoing review of important factors should not be construed as exhaustive
and should be read in conjunction with 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 events or otherwise.
-ii-
PART I
ITEM 1. BUSINESS
Certain terms used below are defined in the "Glossary of Selected
Insurance Terms" appearing on pages 22-25 of this Report.
General
The Company
Risk Capital Holdings, Inc. ("RCHI") was incorporated in March 1995 under
the laws of the State of Delaware with the objective of becoming a global
reinsurance company which integrates sound reinsurance underwriting with an
investment strategy focused on the insurance industry. RCHI believes that
reinsurance underwriting and investment skills can be mutually reinforcing and
that successfully employing such skills in an integrated manner can result in
enhanced stockholder returns. RCHI operates through its wholly owned subsidiary,
Risk Capital Reinsurance Company ("Risk Capital Reinsurance" and, together with
RCHI, unless the context otherwise requires, the "Company"), whose primary focus
is on property and casualty reinsurance treaty coverages, including excess of
loss reinsurance and quota share or proportional reinsurance. Based upon data
available from the Reinsurance Association of America ("RAA"), Risk Capital
Reinsurance is the twelfth largest United States based broker market oriented
reinsurer as measured by statutory surplus at December 31, 1998. As of that
date, Risk Capital Reinsurance had statutory capital and surplus of $358.7
million and an "A (Excellent)" rating from A.M. Best Company ("A.M. Best").
In September 1995, RCHI completed an (i) initial public offering of
9,775,000 shares of its common stock, par value $0.01 per share (the "Common
Stock"), and (ii) concurrent direct sales of (x) an aggregate of 6,975,625
shares of Common Stock and (y) warrants to purchase 4,451,680 shares of Common
Stock (of which 2,531,079 shares are subject to immediately exercisable
warrants) for aggregate proceeds, net of underwriting expenses, of approximately
$335.0 million (collectively, the "Offerings"). RCHI contributed $328.0 million
of such proceeds to the capital of Risk Capital Reinsurance. In November 1995,
Risk Capital Reinsurance was licensed under the insurance laws of the State of
Nebraska.
In October 1998, the Company received regulatory authorization for a newly
formed insurance subsidiary, Cross River Insurance Company ("Cross River"). As a
surplus lines carrier, Cross River is licensed in only its state of domicile,
Nebraska, and expects to write primary insurance business on a non-admitted
basis in selected states.
Marsh & McLennan Capital, Inc. (formerly Marsh & McLennan Risk Capital
Corp.; herein referred to as "MMCI"), a subsidiary of Marsh & McLennan
Companies, Inc. (together with its subsidiaries, unless the context otherwise
requires, "Marsh & McLennan"), is the Company's equity investment advisor. MMCI
and its affiliates have successfully invested in various newly-formed insurance
and reinsurance ventures, principally ACE Limited, XL Capital Ltd. (formerly
EXEL Limited; herein referred to as "XL"), Mid Ocean Limited and Centre
Reinsurance Holdings Limited. MMCI is also the investment advisor to The Trident
Partnership, L.P. ("Trident"), a $667.0 million investment fund capitalized by
institutional investors, including Marsh & McLennan, to invest selectively on a
global basis in the insurance and reinsurance industry.
The stockholders of RCHI owning the largest number of shares of Common
Stock are (i) XL, which owns 4,755,000 shares of Common Stock, or approximately
27.8% of the outstanding Common Stock (20.8% assuming the exercise of all
outstanding warrants and options to purchase Common Stock); and (ii) Marsh &
McLennan Risk Capital Holdings, Ltd. ("MMRCH"), which owns 1,395,625 shares of
Common Stock, or approximately 8.2% of the outstanding Common Stock, and
warrants to purchase 2,675,998 shares of Common Stock, which, if fully
exercised, would increase MMRCH's ownership of the Common Stock to 17.8%
assuming the exercise of all outstanding warrants and options to purchase Common
Stock.
Pursuant to Trident's registration rights, the Company registered for sale
by Trident 1,750,000 shares of Common Stock owned by Trident under a shelf
registration statement which was declared effective by the Securities and
Exchange Commission (the "SEC") in September 1997. Under such registration
statement, Trident sold 1,500,000 shares of Common Stock, of which 1,000,000
were sold to XL. As of the date of this Report, Trident continues to own 250,000
shares of Common Stock and warrants to purchase 1,386,079 shares
-1-
of Common Stock, which represent, in the aggregate, approximately 7.1% of the
Common Stock assuming the exercise of all outstanding warrants and options to
purchase Common Stock.
The Company's offices are located at 20 Horseneck Lane, Greenwich,
Connecticut 06830, and its telephone number is (203) 862-4300.
Business Strategy
Risk Capital Reinsurance is a company that assumes risk and provides
capital within the worldwide insurance and reinsurance marketplace. This scope
of activity allows the Company to engage in at least three kinds of transactions
for its customers: reinsurance, other forms of financing, including direct
capital investments, and a combination of both sets of reinsurance and financial
tools into Integrated Solutions(R), highly customized packages of reinsurance
and financing techniques used together to create optimal solutions to the
Company's clients' needs. Using all of the tools available within the previously
separate disciplines of reinsurance and finance gives the Company the
opportunity to provide better and more flexible solutions to the risk
transfer/risk management/financial needs of the insurance industry. The Company
believes that the following elements assist it in implementing its business
strategy:
o as a relatively new company, its distribution and overhead
structure, as well as its organizational philosophy, is not
encumbered with a traditional, territorial outlook; rather the
Company is positioned to respond to the functional and global
approach to the placement of insurance and reinsurance;
o a small, centralized staff is well motivated by incentive
compensation and is assisted by new information technology;
o management seeks to use both the Company's reinsurance underwriting
capacity and its investment portfolio to provide increased capacity
to insurers through the provision of reinsurance and other forms of
capital;
o the extensive experience and relationships of the Company's
management and MMCI assist in identifying and capitalizing on
underwriting and investment opportunities; and
o the Company believes that attractive underwriting opportunities are
presented to it in connection with the investment activities of the
Company and MMCI as the Company's equity investment advisor, and
that investment opportunities arise from the Company's underwriting
activities.
Reinsurance Underwriting
Strategy
The principal components of the Company's underwriting strategy are: (i)
identifying and committing the Company's underwriting capacity to those types of
reinsurance where management believes that above average underwriting results
can be achieved; (ii) promoting client loyalty by providing a full range of
sophisticated risk management products closely tailored to its clients' needs;
(iii) conserving capacity to react to changing market conditions; (iv)
soliciting business primarily through reinsurance intermediaries; (v) taking
advantage of underwriting opportunities that may arise in connection with the
Company's and MMCI's equity investment activities; (vi) providing reinsurance to
insurers in which the Company invests, where appropriate; (vii) maintaining a
small, highly skilled, performance-motivated staff; and (viii) maintaining a low
expense structure.
The Company seeks to write "large lines" (i.e., significant portions) on a
limited number of traditional and finite risk property and casualty reinsurance
treaties with a select number of insurance and reinsurance companies located
throughout the world (although the Company's principal focus is on large United
States and European-based insurance and reinsurance companies) and with select
Lloyd's syndicates. The Company may also provide credit enhancement, time and
distance and other risk management products, the nature and demand for which
will vary over time depending on existing capacity, profitability, tax,
regulatory and accounting aspects, and other circumstances pertaining to such
products.
The Company focuses its efforts on treaty reinsurance. The Company
believes in the value of long-term mutually profitable treaty relationships. The
Company intends to continue to establish and cultivate such long-term
relationships with its reinsureds and believes it will be assisted therein by
the extensive experience of its management and MMCI. In addition, the Company
intends to write conservatively in terms of the Company's
-2-
surplus capacity. The Company does not currently intend for its
premium-to-surplus ratio to exceed 1.0x, which represents an increase from the
Company's prior intention that its premium-to-surplus ratio not exceed 0.7x.
This increase is due to the fact that the Company's mix of business includes a
higher proportion of quota share reinsurance and the average duration of the
Company's loss reserves is shorter than originally anticipated, which generally
presents less risk and less variability of results for the Company. However,
depending on business opportunities and the mix of business that may comprise
the Company's portfolio, the Company may consider underwriting at a higher
premium-to-surplus ratio than 1.0x. Underwriting conservatively in terms of
surplus capacity will help enable the Company to maintain underwriting capacity
and flexibility. The Company believes that these objectives should, if realized,
place the Company in a position (without being overly dependent on the
underwriting cycle) to take advantage of underwriting opportunities that are
generally only available to well-capitalized reinsurers willing to underwrite
large lines.
The Company participates at Lloyd's through the provision of whole account
quota share reinsurance to selected Lloyd's syndicates. The Company may
participate at Lloyd's in other ways, including through investments in Lloyd's
corporate members and/or managing agents. (See Note 3 under the caption
"Investment Information" of the accompanying Notes to the Consolidated Financial
Statements of the Company).
The Company determines the aggregate amount of reinsurance it writes based
upon market and other factors, including its assessment of underwriting
opportunities and its premium-to-surplus ratio at the time of determination. The
Company believes that insurance companies with certain identifiable
characteristics have historically performed better than the industry throughout
the underwriting cycle and believes that the experience of the Company's
management and MMCI assist in focusing on such companies for reinsurance and
investment opportunities. The Company believes that these characteristics
include underwriting performance, underwriting focus and discipline
(irrespective of the underwriting cycle), the ability to take advantage of
opportunities and changing circumstances in the insurance industry, low expense
ratio, specialization, the ability to take a lead role in structuring
substantial insurance and reinsurance contracts, substantial capacity and
effective use of reinsurance.
The Company employs a disciplined, multi-disciplinary and highly
analytical approach to underwriting designed to specify premium that is intended
to be commensurate with the amount of its capital the Company estimates it is
placing at risk. As part of its underwriting process, the Company focuses on the
financial characteristics (including capital needs) and reputation of the
proposed cedent, the likelihood of establishing a long-term relationship with
the cedent, the geographic area in which the cedent does business, the cedent's
market share, 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.
Operations
The Company's mix of business on the basis of net premiums written for
1998, 1997 and 1996 is set forth in the following table:
-3-
Net Premiums Written
(Dollars in millions)
Years Ended December 31,
------------------------------------------------------------------------------
1998 1997 1996
----------------------- ------------------------ ------------------------
Amount % Amount % Amount %
Core Business
Property $33.7 14.4% $17.8 12.3% $19.4 27%
Casualty 80.3 34.2 69.7 48.1 17.6 24
Multi-Line 62.8 26.8 45.9 31.7 21.8 30
Other 16.5 7.0 10.0 6.9 13.7 19
---------- ---------- ---------- ---------- ---------- ----------
Sub-Total Core Business $193.3 82.4% $143.4 99.0% $72.5 100.0%
---------- ---------- ---------- ---------- ---------- ----------
Specialty Business
Aviation & Space $26.0 11.1%
Marine 14.4 6.1 $1.4 1.0%
Surety 1.0 0.4
---------- ---------- ---------- ---------- ---------- ----------
Sub-Total Specialty
Business $41.4 17.6% $1.4 1.0%
---------- ---------- ---------- ----------
Total $234.7 100.0% $144.8 100.0% $72.5 100.0%
========== ========== ========== ========== ========== ==========
The Company's assumed and ceded premiums for the years ended December 31,
1998, 1997 and 1996 were as follows:
(In millions)
Years Ended December 31,
----------------------------------
1998 1997 1996
------ ------ -----
Assumed premiums written $260.5 $147.8 $73.7
Ceded premiums written 25.8 3.0 1.2
------ ------ -----
Net premiums written $234.7 $144.8 $72.5
====== ====== ======
In 1998, the Company's net premiums written increased by 62% from $144.8
million in 1997 to $234.7 million in 1998. The Company's premium growth resulted
from continued efforts in the Company's two key strategies, the integration of
investment with reinsurance and the diversification into specialty classes of
reinsurance.
The Company extended its reinsurance business into marine and aviation and
space underwriting in 1997, surety and fidelity underwriting in 1998, and
accident and health underwriting in 1999.
For 1998, 1997 and 1996, approximately 32%, 28% and 30%, respectively, of
net premiums written were from non-United States clients, which are Lloyd's
syndicates or are located in the United Kingdom or Continental Europe.
Approximately 32%, 29% and 5% of net premiums written in 1998, 1997 and 1996,
respectively, were generated from companies in which the Company has invested or
committed to invest funds.
Reinsurance is provided by the Company both on a quota share and excess of
loss basis. In 1998, quota share reinsurance and excess of loss reinsurance
amounted to 81% and 19%, respectively, of the Company's net premiums written,
compared to (i) 71% and 29%, respectively, during 1997 and (ii) 58% and 42%,
respectively, during 1996. In the future, the mix of quota share and excess of
loss reinsurance will depend on market conditions and other relevant factors and
cannot be predicted with accuracy. Depending on future conditions, the Company
may also write other types of reinsurance.
Consistent with the Company's strategy of writing a small number of large
treaties for its core business, three clients contributed approximately $74
million, or 32%, of the Company's 1998 total net premiums written, with the
largest client contributing approximately 18% and the remaining two contributing
8% and 6%, respectively. The business written from the client that contributed
18% is part of an integrated transaction, and such business is subject to
renewal at the Company's option for five years. In 1997, five clients
contributed
-4-
approximately $68 million, or 45%, of the Company's total net premiums written,
with the largest client contributing approximately 18% and the remaining four
contributing from 5% to 8%.
While not anticipated, the reduction or loss of business assumed from one
or more large clients could have a material adverse effect on the Company's
financial condition or results of operations to the extent not offset by new
business.
Approximately $32.9 million, or 46%, of net premiums written for 1996
resulted from unearned premium portfolios and other non-recurring transactions.
This amount included $11.9 million of specialty premiums written from contracts
pursuant to which the Company reinsures a portion of one underlying policy for
multiple years. Such premiums will be earned over the multiple periods as the
exposures expire. In 1998 and 1997, there were no significant unearned premium
portfolios or other non-recurring transactions included in net premiums written.
For a discussion of the Company's in-force business at January 1, 1999,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations--General--In-Force Business."
Investments
Strategy
The Company's investment goals are to support the Company's reinsurance
activities and enhance the Company's long-term profitability. The principal
components of the Company's strategy to achieve these goals include: (i)
supporting short-term liquidity requirements through cash and fixed income
investments and, if necessary, through the sale of marketable equity securities
from the Company's investment portfolio; (ii) investing a significant portion of
the Company's assets in publicly traded and privately held equity securities
principally issued by insurance and reinsurance companies and companies
providing services to the insurance industry; (iii) identifying trends and
investment opportunities in the insurance industry that could lead to superior
returns; (iv) utilizing MMCI, an experienced insurance industry advisor, as
equity investment advisor; (v) investing in insurers to which the Company
provides reinsurance, where appropriate; and (vi) when available, co-investing
with Trident, a dedicated insurance industry private equity fund, and an entity
to which MMCI also provides equity investment advisory services.
The Company intends to invest a substantial portion of its investment
portfolio in equity securities, principally issued by insurance and reinsurance
companies and companies providing services to the insurance industry pursuant to
advice from MMCI. The Company does not believe that the provision of reinsurance
to insureds in which the Company invests should subject the Company to any
significant additional investment risk; however, the operating performance of an
insured in which the Company also invests could affect the Company more than an
entity in which the Company only invests or to which the Company only provides
reinsurance. The Company believes that, over the long term, a portfolio of
equity securities offers a greater potential return and growth in book value
than one comprised of fixed maturity securities, and that such a portfolio
should most effectively maximize long term stockholders' equity. The Company
also believes that an equity portfolio is appropriate for the Company because of
the long-tail nature of certain of the reinsurance business that the Company may
write and the Company's conservative premium-to-surplus ratio.
The Company entered into an equity investment advisory agreement (the
"Equity Advisory Agreement") with MMCI with respect to the management of the
Company's equity investment portfolio and a fixed income investment advisory
agreement (the "Fixed Income Advisory Agreement") with The Putnam Advisory
Company, Inc. ("Putnam"), a subsidiary of Marsh & McLennan, with respect to the
management of the Company's fixed income securities and short-term cash
portfolios. Subject to investment guidelines determined from time to time by the
Investment/Finance Committee of the Board of Directors of the Company (the
"Investment Committee"), MMCI and Putnam have the authority, among other things,
to buy, sell, retain or exchange the type of investments for which they have
been retained to manage. The Equity Advisory Agreement provides that, subject to
general guidelines established from time to time by the Investment Committee,
the Company may not invest in, purchase or dispose of equity securities unless
such investment, purchase or disposition (including the terms thereof) has been
approved by MMCI. Equity securities include common stocks, preferred stocks and
securities (including debt securities) convertible into or exercisable or
exchangeable for common stocks or preferred stocks, and any similar securities
or instruments, and any debt securities that were originally issued together
with any such securities or instruments. The Company may, however, make
strategic investments without the approval of MMCI. Strategic investments are
generally acquisitions (not being made for resale) of
-5-
securities of companies engaged in the reinsurance business or other businesses,
provided that the Company obtains control of such companies.
Under the Equity Advisory Agreement, MMCI receives compensation on both
public securities owned by the Company (the "Public Portfolio") and private
equity securities owned by the Company (the "Private Portfolio"). With respect
to equity securities in the Public Portfolio, the Company pays an annual fee
equal to 0.35% of the daily average of the market prices of such securities.
With respect to the Private Portfolio, the Company pays an annual fee equal to
the sum of (i) 1.5% per annum on the first $250,000,000 in carrying value of
securities in the Private Portfolio and (ii) 1.0% per annum on the carrying
value of such securities in the Private Portfolio that exceeds $250,000,000.
MMCI is also entitled to annual compensation equal to the excess, if any, of (x)
7.5% of cumulative net realized gains (as defined in the Equity Advisory
Agreement) on equity securities in the Private Portfolio over (y) cumulative
incentive compensation previously paid in prior years on cumulative net realized
gains. The Equity Advisory Agreement provided for a minimum aggregate cash fee
to MMCI of $500,000 per annum through December 31, 1997. Fees incurred under the
Equity Advisory Agreement during fiscal years 1998, 1997 and 1996 were
approximately $2,700,000, $1,300,000 and $686,000, respectively.
Under the Fixed Income Advisory Agreement, the Company pays annual fees,
based on the market value of assets included in the Company's fixed income
portfolio, at the following rates: 0.35% per annum on the first $50,000,000,
0.30% per annum on the next $50,000,000, 0.20% per annum on the next
$100,000,000 and 0.15% per annum on the market value of assets that exceed
$200,000,000. For the short-term cash portfolio, the Company pays a fee equal to
0.15% per annum of the total monthly average market value of such portfolio.
Fees incurred under the Fixed Income Advisory Agreement during 1998, 1997 and
1996 were approximately $461,000, $493,000 and $547,000, respectively.
MMCI serves as investment manager to Trident and, accordingly, certain
restrictions exist with respect to MMCI's ability to make investment
recommendations to the Company with respect to investments which would be
suitable for both Trident and the Company. Under the Trident partnership
agreement, until the earlier of May 6, 2000 or the date on which at least 75% of
the aggregate capital of Trident has been drawn, neither MMCI nor any of its
affiliates may organize, or invest in, any new or existing risk assumption
entity unless Trident is first offered a reasonable opportunity to invest in
such entity. Such restrictions may also apply to the Company. Such limitation,
however, does not apply to investments in any such new entity where the total
invested capital of such entity does not exceed $10,000,000.
Pursuant to the Trident partnership agreement, where Trident has elected
to make part, but not all, of the full investment otherwise available to it, the
Company may not be offered the opportunity to participate in such investment
unless Trident first offers at least all Trident partners with capital
commitments of at least $50,000,000 the right to participate in such additional
investment on a pro rata basis. Pursuant to the terms of the Equity Advisory
Agreement, MMCI has agreed that it will not invest in such opportunities, and
will not offer any such opportunities to its affiliates, without first offering
the Company an opportunity to make such investment.
Fixed income investments will be used to provide shorter-term liquidity
and current returns. The fixed income securities portfolio generally will be
invested in high quality, liquid securities, including securities issued by
United States government agencies and United States government guaranteed
securities.
In addition, the Company allocated in early 1998 approximately $35,000,000
for investing in a diversified portfolio of high yielding fixed maturity
investments managed by Miller Anderson & Sherrerd, LLP ("MAS"), a subsidiary of
Morgan Stanley & Co. Such amount was taken from funds that were previously
allocated for investing in short-term securities. MAS manages the portfolio
subject to investment guidelines established by the Investment Committee.
Since a significant portion of the Company's investment portfolio will
generally be equity securities issued by insurance and reinsurance companies and
companies providing services to the insurance industry, the portfolio will lack
industry diversification and will be particularly subject to the performance of
the insurance industry. Such performance will affect the market prices of a
significant portion of the Company's investment portfolio and the income and
return on such investments, all of which could negatively affect the Company's
underwriting capacity. As the Company's investment strategy is to invest a
significant portion of its investment portfolio in equity securities, its
investment income in any fiscal period may be smaller, as a percentage of
investments, and less predictable than other competitor reinsurance companies,
which tend to invest primarily in fixed income
-6-
investments. Net realized and unrealized gains (losses) on investments may have
a greater effect on the Company's results of operations or stockholders' equity
at the end of any fiscal period than its competitor reinsurance companies.
Operations
At December 31, 1998, cash and invested assets totaled approximately
$587.2 million, consisting of $120.9 million of cash and short-term investments,
$174.5 million of publicly traded fixed maturity investments, $154.7 million of
publicly traded equity securities and $137.1 million of privately held
securities.
Note 3 under the caption "Investment Information" of the accompanying
Notes to the Consolidated Financial Statements of the Company provides a table
summarizing the components of net investment income for the years ended December
31, 1998, 1997 and 1996.
The Company's investments on a consolidated basis at December 31, 1998,
1997 and 1996 consisted of the following:
(Dollars in thousands)
December 31,
---------------------------------------------------------------------------------------
1998 1997 1996
------------------------ ------------------------ -------------------------
Estimated Estimated Estimated
Fair Value Percent Fair Value Percent Fair Value Percent
---------- ------- ---------- ------- ---------- --------
Cash and short-term $120,846 20% $ 98,181 19% $106,352 27%
-------- -------- -------- -------- -------- ---------
Fixed maturities:
U.S. government and
government agencies 39,283 6 44,135 9 35,796 9
Municipal bonds 45,273 8 37,637 7 60,041 15
Corporate bonds 56,256 10 19,323 4 17,316 5
Mortgage and asset-
backed securities 33,532 6 30,487 6 26,709 7
Foreign governments 196 -- 577 -- 519 --
-------- -------- -------- -------- -------- ---------
Sub-total, fixed
maturities 174,540 30 132,159 26 140,381 36
Equity securities:
Publicly traded 154,678 27 180,052 36 117,360 30
Privately held 137,091 23 95,336 19 28,847 7
-------- -------- -------- -------- -------- ---------
Sub-total, equity
securities 291,769 50 275,388 55 146,207 37
-------- -------- -------- -------- -------- ---------
Total $587,155 100% $505,728 100% $392,940 100%
======== ========= ======== ========= ======== =========
Guidelines established by the Company restrict the portion of the fixed
maturities portfolio that can be held in lower quality securities. At December
31, 1998, 89% of the fixed maturity and short-term investments were rated
investment grade by Moody's Investors Service, Inc. ("Moody's") or Standard &
Poor's Corporation ("Standard & Poor's") and had an average quality rating of AA
and an average duration of approximately 2.8 years.
-7-
Contractual maturities of the Company's consolidated fixed maturity
securities are shown below. Expected maturities, which are management's best
estimates, will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
(In thousands)
December 31, 1998
--------------------------
Estimated Amortized
Fair Value Cost
---------- ---------
Available for sale:
Due in one year or less $4,117 $4,106
Due after one year through five years 55,113 54,293
Due after five years through 10 years 47,709 48,468
Due after 10 years 34,069 33,331
-------- --------
Sub-total 141,008 140,198
Mortgage and asset-backed securities 33,532 33,181
-------- --------
Total $174,540 $173,379
======== ========
At December 31, 1998, the Company's investment portfolio included
approximately $154.7 million of publicly traded equity securities and 17
investments in privately held securities totaling approximately $137.1 million,
with additional investment portfolio commitments in an aggregate amount of
approximately $10.4 million. At such date, all of the Company's equity
investments were in securities issued by insurance and reinsurance companies or
companies providing services to the insurance industry.
See Note 3 under the caption "Investment Information" of the accompanying
Notes to the Consolidated Financial Statements of the Company for certain
information regarding the Company's publicly traded and privately held
securities and their carrying values, and commitments made by the Company
relating to its privately held securities. Over the long-term, the Company
intends to continue to allocate a substantial portion of its cash and short-term
investments into publicly traded and privately held equity securities, subject
to market conditions and opportunities in the marketplace.
The Company has not invested in derivative financial instruments such as
futures, forward contracts, swaps, or options or other financial instruments
with similar characteristics such as interest rate caps or floors and fixed-rate
loan commitments. The Company's portfolio includes market sensitive instruments,
such as mortgage-backed securities, which are subject to prepayment risk and
changes in market value in connection with changes in interest rates. The
Company's investments in mortgage-backed securities, which amounted to
approximately $33.5 million, or 6% of cash and invested assets at December 31,
1998, and $30.5 million, or 6% of cash and invested assets at December 31, 1997,
are classified as available for sale and are not held for trading purposes.
Marketing
The Company obtains substantially all of its reinsurance business through
intermediaries representing the cedent in negotiations for the purchase of
reinsurance. The process of effecting a brokered reinsurance placement typically
begins when a cedent enlists the aid of an intermediary in structuring a
reinsurance program. Often the intermediary will consult with one or more lead
reinsurers as to the pricing and contract terms of the reinsurance protection
being sought. Once the cedent has approved the terms quoted by the lead
reinsurer, the intermediary will offer participation to qualified reinsurers
until the program is fully subscribed to by reinsurers at terms agreed upon by
all parties.
By working through intermediaries to originate its business, the Company
need not maintain a substantial sales organization which, during periods of
reduced premium volume, would comprise a significant and non-productive part of
overhead. In addition, management believes that submissions from the
intermediary market are more numerous and diverse, including certain targeted
specialty coverages, than would be available through a salaried sales
organization and that the Company is able to exercise greater selectivity than
would be possible in dealing directly with cedents.
-8-
The Company pays commissions to intermediaries based on negotiated
percentages of the premium it writes. Direct writers of reinsurance typically
incur higher fixed costs that are included in their underwriting expenses.
Reinsurers using intermediaries can lower these costs during a downturn in the
market by writing less business and incurring lower brokerage costs.
Intermediaries do not generally have the authority to bind the Company with
respect to reinsurance agreements nor does the Company generally commit in
advance to accept any portion of the business that intermediaries submit to it.
Reinsurance business from any cedent, whether new or renewal, is generally
subject to acceptance by the Company.
In 1998, (i) affiliates of Marsh & McLennan, including Balis & Co., Inc.
("Balis"), Guy Carpenter & Company, Inc., Carpenter Bowring Ltd. and Cecar &
Jutheau, S.A. (collectively, "Marsh Affiliates"), (ii) the Aon Group ("Aon") and
(iii) E.W. Blanch Company ("E.W. Blanch") accounted for approximately 43.2%,
16.5% and 10.9%, respectively, of the Company's assumed net premiums written. In
1997, (i) Marsh Affiliates, (ii) Aon and (iii) E.W. Blanch accounted for
approximately 47.3%, 19.1% and 9.3%, respectively, of the Company's assumed net
premiums written. In 1996, (i) Marsh Affiliates, (ii) U.S. Reinsurance
Corporation, and (iii) Aon accounted for approximately 41%, 25%, and 21.9%,
respectively, of the Company's assumed net premiums written. Loss of all or a
substantial portion of the business provided by any of these intermediaries
could have a short-term material adverse effect on the business and operations
of the Company. The Company does not believe that the loss of such business
would have a long-term material adverse effect due to the Company's competitive
position within the broker reinsurance market and the availability of business
from other intermediaries. The terms relating to the Company's intermediary
arrangements with Marsh Affiliates have been negotiated on an arm's-length
basis.
In addition to investment opportunities arising from the activities of
MMCI as the Company's equity investment advisor, the Company is provided with
investment opportunities by reinsurance brokers and traditional financing
sources, including investment banking firms, venture capital firms and other
banking and financing sources, both acting as principal investors and
intermediaries. Underwriting opportunities may arise from such sources in
connection with the Company's investment activities as part of integrated
transactions.
Retrocessional Arrangements
Reinsurance companies enter into retrocessional arrangements for many of
the same reasons primary insurers seek reinsurance, including reducing the
effect of individual or aggregate losses and increasing premium writings and
risk capacity without requiring additional capital.
Given the Company's current level of surplus, under its current
underwriting guidelines, the maximum net retention per risk for property
treaties and per occurrence for casualty treaties is generally $10,000,000.
Other than the Company's participation in "common account" retrocessional
arrangements for certain reinsurance treaties and as provided below for certain
classes of its specialty business, the Company does not maintain retrocessional
arrangements on a per risk or per treaty basis, or for the purpose of limiting
its exposure with respect to catastrophe losses or unusual accumulations of
losses resulting from a single occurrence involving two or more reinsured
policies. The Company may purchase retrocessional protection for catastrophic
losses before the commencement of the hurricane season. Common account
reinsurance arrangements are arrangements whereby the ceding company enters into
the reinsurance market and purchases a cover for the benefit of the ceding
company and the reinsurers on the reinsurance treaty. Common account
retrocessional arrangements reduce the effect of individual or aggregate losses
to all participating companies with respect to a reinsurance treaty, including
the cedent.
In connection with the Company's expansion into marine and aviation
reinsurance underwriting in 1997, the Company entered into excess of loss
retrocessional arrangements beginning in late 1997 covering aggregate exposures
on the Company's marine and aviation business. Under the Company's current
underwriting guidelines for 1999, retrocessional protection for marine business
is provided in an amount of $37 million in excess of a $3 million initial
retention, and additional co-participations, with the Company retaining a total
of approximately $8 million. For 1999, the Company is finalizing retrocessional
protection for aviation business in an amount of $65 million in excess of a $1
million initial retention, and additional co-participations, with the Company
retaining a total of approximately $5.4 million. There can be no assurances
-9-
that such retrocessional protections will be sufficient to prevent the
occurrence of underwriting losses to the Company for such business.
The Company will continue to evaluate its retrocessional requirements
periodically in relation to many factors, including its surplus, gross line
capacity and changing market conditions. Retrocessional arrangements do not
relieve the Company from its obligations to the insurers and reinsurers from
which it assumes business. The failure of retrocessionaires to honor their
obligations could result in losses to the Company. All retrocessionaires must
conform to the Company's standards and must be specifically approved by the
Company's Security Committee, which consists of four members of senior
management, including the President. The evaluation process involves financial
analysis of current audited financial data and comparative analysis of such data
in accordance with guidelines established by the Company. Business may not be
conducted with retrocessionaires that are not approved by the Security
Committee.
For additional discussion regarding the Company's risk management
policies, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations--Risk Retention,""--Operating Costs
and Expenses" and "--Subsequent Underwriting Losses."
Claims Administration
Claims are managed by the Company's professional claims staff whose
responsibilities include the review of initial loss reports, creation of claim
files, determination of whether further investigation is required, establishment
and adjustment of case reserves and payment of claims. In addition, the claims
staff conducts comprehensive claims audits of both specific claims and overall
claims procedures at the offices of selected ceding companies. In certain
instances, as part of a comprehensive risk evaluation process, a claims audit
may be performed prior to assuming reinsurance business or entering into an
investment transaction.
Reserves for Unpaid Claims and Claims Expenses
As a reinsurance company, the Company is required to establish and
maintain reserves to cover its estimated ultimate liability for unpaid claims
and claims expenses with respect to reported and unreported claims incurred as
of the end of each accounting period (net of estimated related salvage and
subrogation claims and retrocession recoverables (if any) of the Company). These
reserves are estimates involving actuarial and statistical projections at a
given time of what the Company expects the ultimate settlement and
administration of claims to cost based on facts and circumstances then known,
predictions of future events, estimates of future trends in claims severity and
other variable factors such as inflation and new concepts of liability. For
certain types of claims, it may over time be necessary to revise estimated
potential loss exposure and therefore the Company's unpaid claims and claims
expense reserves. The inherent uncertainties of estimating claims and claims
expense reserves are exacerbated for reinsurers by the significant periods of
time (the "tail") that often elapse between the occurrence of an insured claim,
the reporting of the claim to the primary insurer and ultimately to the
reinsurer, and the primary insurer's payment of that claim and subsequent
indemnification by the reinsurer. As a consequence, actual claims and claims
expenses paid may deviate, perhaps substantially, from estimates reflected in
the Company's reserves in its financial statements. The estimation of reserves
by new reinsurers, such as the Company, may be less reliable than the reserve
estimations of a reinsurer with an established volume of business and loss
history. To the extent reserves prove to be inadequate, the Company may have to
augment such reserves and incur a charge to earnings. Such a development, while
not anticipated, could result in a material charge to earnings or stockholders'
equity in future periods.
When a claim is reported to an insurance company that cedes business to
the Company, its claims personnel establish a "case reserve" for the estimated
amount of the ultimate payment. The estimate reflects the informed judgment of
such personnel based on general insurance reserving practices and on the
experience and knowledge of such personnel regarding the nature and value of the
specific type of claim. The Company, in turn, typically establishes a case
reserve when it receives a notice of a claim from the ceding company. Such
reserves are based on an independent evaluation by the Company, taking into
consideration coverage, liability, severity of injury or damage, jurisdiction,
the Company's assessment of the ceding company's ability to evaluate and handle
the claim and the amount of reserves recommended by the ceding company. Case
reserves are adjusted periodically by the Company based on subsequent
developments and audits of ceding companies.
In accordance with industry practice, the Company maintains incurred but
not reported ("IBNR") reserves. Such reserves are established to provide for
future case reserves and loss payments on incurred claims which have not yet
been reported to an insurer or reinsurer. In calculating its IBNR reserves, the
Company uses
-10-
generally accepted actuarial reserving techniques that take into account
quantitative loss experience data, together, where appropriate, with qualitative
factors. IBNR reserves are based on loss experience of the Company and the
industry, and are grouped both by class of business and by accident year. IBNR
reserves are also adjusted to take into account certain factors such as changes
in the volume of business written, reinsurance contract terms and conditions,
the mix of business, claims processing and inflation that can be expected to
affect the Company's liability for losses over time.
The reconciliation of claims and claims expense reserves for the years
ended December 31, 1998, 1997 and December 31, 1996 is as follows:
(In thousands)
Years Ended
December 31,
----------------------------------------------
1998 1997 1996
--------- --------- ---------
At beginning of year:
Gross claims and claims expense reserves $70,768 $20,770 --
Reinsurance recoverables -- 522 --
-------- ------- -------
Net claims and claims expense reserves 70,768 20,248 --
Net claims and claims expenses incurred relating to:
Current year 178,957 73,385 $24,079
Prior year (2,832) 22 --
-------- ------- -------
Total 176,125 73,407 24,079
Net paid claims and claims expenses incurred relating to:
Current year 41,910 13,649 3,831
Prior year 18,794 9,238 --
-------- ------- -------
Total 60,704 22,887 3,831
At end of year:
Net claims and claims expense reserves current year 186,189 70,768 20,248
Reinsurance recoverables 30,468 -- 522
-------- ------- -------
Gross claims and claims expense reserves $216,657 $70,768 $20,770
======== ======= =======
The Company believes that its exposure, if any, to environmental
impairment liability and asbestos-related claims is minimal since no business
has been written prior to 1996. The Company does not currently discount its
reserves to reflect the present value of claims that may eventually be paid.
For a discussion of subsequent underwriting losses due to claims and
claims expenses related to reinsurance provided by the Company on satellite
risks and business produced by a certain managing underwriting agency, please
refer to "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations--Subsequent Underwriting Losses"
and Note 14 of the accompanying Notes to the Consolidated Financial Statements
of the Company.
Subject to the foregoing, the Company believes that the reserves for
claims and claims expenses are adequate to cover the ultimate cost of claims and
claims expenses incurred through December 31, 1998. The estimates will be
continuously reviewed and as adjustments to these reserves become necessary,
such adjustments will be reflected in current operations.
The following table represents the development of generally accepted
accounting principles ("GAAP") balance sheet reserves for 1996 through 1998. The
top line of the table shows the reserves, net of reinsurance recoverables, at
the balance sheet date for each of the indicated years. This represents the
estimated amounts of net claims and claims expenses arising in all prior years
that are unpaid at the balance sheet date, including IBNR. The table also shows
the reestimated amount of the previously recorded reserve based on experience as
of the end of each succeeding year. The estimate changes as more information
becomes known about the frequency and severity of claims for individual years.
The "Cumulative Redundancy" represents the aggregate change in the estimates
over all prior years. The table also shows the cumulative amounts paid as of
successive years with respect to that reserve liability. The lower portion of
the table represents the claim development of the gross balance sheet reserves
for years 1996 and 1998.
-11-
With respect to the information in the table below, it should be noted
that each amount includes the effects of all changes in amounts for prior
periods. This table does not present accident or policy year development data.
Conditions and trends that have affected development of the liability in the
past may not necessarily occur in the future. Accordingly, it may not be
appropriate to extrapolate future reserve development based on the following
table. For additional discussion regarding the Company's reserving and
retrocessional activities, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations--Risk
Retention," "Business--Retrocessional Arrangements" and Notes 6 and 7 of the
accompanying Notes to the Consolidated Financial Statements of the Company.
Development of GAAP Reserves
Cumulative Redundancy
(in millions)
Years Ended December 31,
-----------------------------------------
1996 1997 1998
------------ ------------- -----------
Reserves for unpaid claims and claims adjustment
expenses, net of reinsurance recoverables $20 $71 $186
Paid (cumulative) as of:
One year later 13 31
Two years later 14
Reserve reestimated as of:
One year later 20 69
Two years later 19
Cumulative redundancy $1 $2
========= ========
Percentage 5.0% 2.8%
Gross reserve for claims and claims expenses $20 $71 $216
Reinsurance recoverable 0 0 (30)
--------- -------- --------
Net reserve for claims and claims expenses $20 $71 $186
--------- -------- --------
Gross reestimated reserve $19 $69
Reestimated reinsurance recoverable 0 0
--------- --------
Net reestimated reserve $19 $69
Gross reestimated redundancy $1 $2
--------- --------
-12-
Overview of the Reinsurance Industry
Reinsurance is a form of insurance in which a reinsurer indemnifies a
primary insurer against part or all of the liability assumed by the primary
insurer under one or more insurance policies. Reinsurance is a contractual
agreement whereby an insurer or reinsurer (ceding company) remits a portion of
the premium it receives to a reinsurer (assuming company) as payment for the
assuming company's agreement to indemnify the ceding company for a portion of
the risk. Reinsurance provides insurers with several benefits which include the
following: reduction in net liability on individual risks, protection against
catastrophic losses and assistance in maintaining acceptable regulatory ratios
and additional underwriting capacity in that the primary insurer can accept
larger risks and can expand the book of business it writes at a faster rate than
would be possible without a corresponding increase in its capital and surplus
position. Reinsurance does not legally discharge the ceding company from its
liability with respect to its obligation to the insured.
There are two principal types of reinsurance: treaty reinsurance and
facultative reinsurance. Treaty reinsurance is a contractual arrangement,
usually renewable annually, between a primary insurer and a reinsurer under
which the primary insurer must cede and the reinsurer must assume a specified
portion of a type or category of risks. Facultative reinsurance is the
reinsurance of individual risks. Rather than agreeing to reinsure all or a
portion of a class of risk, the reinsurer separately rates and underwrites each
risk. In the underwriting of treaty reinsurance, the reinsurer need not
separately evaluate each of the individual risks assumed, as it must in the
underwriting of facultative reinsurance, and in general depends on the original
underwriting decisions made by the reinsured.
Both facultative and treaty reinsurance can be written on both an excess
of loss and a quota share basis. In quota share reinsurance, the reinsurer
assumes from the reinsured a percentage specified in the treaty of each risk in
the reinsured class of risk. Premiums that the reinsured pays to the reinsurer
are proportional to the portion of the risk that the reinsurer assumes, and the
reinsurer generally pays the reinsured a ceding commission to reimburse the
reinsured for the expenses incurred in obtaining the business. The ceding
commission may also contain a profit component. In quota share reinsurance, the
reinsurer may receive the benefit of common account reinsurance and, therefore,
the reinsurer will have credit risk with respect to the underlying reinsurers
providing such common account reinsurance. In excess of loss treaty reinsurance,
the reinsurer indemnifies the reinsured for a portion of the losses on
underlying policies which exceed a specified loss retention amount up to an
amount per loss specified in the treaty. Premiums that the reinsured pays to the
reinsurer for excess of loss coverage are not directly proportional to the
premiums that the reinsured receives because the reinsurer does not assume a
proportionate risk. The reinsurer generally does not pay any commission to the
reinsured in connection with excess of loss reinsurance. Excess of loss treaty
reinsurance can, in turn, be written on a per risk or catastrophe basis. Per
risk excess of loss reinsurance protects the reinsured against a loss resulting
from a single risk or location. Catastrophe excess of loss reinsurance protects
a reinsured from an accumulation or large number of related losses resulting
from a variety of risks which may occur in a given catastrophe and hence is a
highly volatile business.
Excess of loss reinsurance is often written in layers, with one reinsurer
taking the risk from the primary insurer's retention layer up to a specified
amount, at which point another reinsurer takes over the excess liability or the
excess liability reverts back to the primary insurer. The reinsurer taking on
the risk just above the primary insurer's retention layer is said to write
"working" or "low layer" excess of loss reinsurance. A loss that reaches just
beyond the primary insurer's retention layer will create a loss for the lower
layer reinsurer, but not for the reinsurers on higher layers. Losses incurred in
low layer reinsurance tend to be more predictable than those in high layers due
to the availability of greater actuarial data.
Excess of loss and pro rata reinsurance are priced differently because the
probability of loss is different for the two types of coverage. Premiums that
the ceding company pays to the reinsurer for excess of loss reinsurance are not
directly proportional to the premiums that the ceding company receives because
the reinsurer does not assume a proportionate risk. In contrast, premiums that
the ceding company pays to the reinsurer for pro rata reinsurance are
proportional to the premiums that the ceding company receives, consistent with
the proportional sharing of risk. In addition, in pro rata reinsurance the
reinsurer generally pays the ceding company a ceding commission. The ceding
commission generally is based on the ceding company's cost of acquiring the
business being reinsured (commissions, premium taxes, assessments and
miscellaneous administrative expense) and also may include a profit factor.
-13-
Since facultative reinsurance, unlike treaty reinsurance, usually involves
the assumption of selected, individual risks and is sold in separate
transactions, facultative reinsurance is typically priced for higher profit
margins than treaty business. However, the reinsurer's losses may be higher for
facultative business because the reinsurer may assume a higher potential
liability and because the risks involved may be more volatile. In addition,
underwriting expenses and, in particular, personnel costs, are higher on
facultative business because each risk is individually underwritten and
administered. Facultative reinsurance is normally purchased by insurance
companies for individual risks not covered by their reinsurance treaties, for
excess losses on risks covered by their reinsurance treaties, and for unusual
risks. The demand for facultative reinsurance is typically inversely related to
the supply of treaty reinsurance.
Reinsurers may also purchase reinsurance, known as retrocessional
reinsurance, to cover their own risk exposure. Reinsurance companies enter into
retrocessional agreements for reasons similar to those that cause ceding
companies to purchase reinsurance.
The reinsurance market has two basic segments: reinsurers which primarily
obtain their business directly from insurers and other reinsurers ("direct
writers"), and those which, like the Company, primarily obtain business through
reinsurance intermediaries or brokers.
Competition
The property and casualty reinsurance business is highly competitive.
Competition is based on many factors, including the perceived overall financial
strength of the reinsurer, premiums charged, contract terms and conditions,
services offered, ratings assigned by independent rating agencies, speed of
claims payment and reputation and experience. The Company, in pursuing its
investment strategy, also competes with venture capitalists, buyout funds,
merchant banking firms, investment banking firms and other banking and financing
sources for investment opportunities in publicly traded and privately held
equity securities. Competition is based on many factors, including the ability
to identify trends and investment opportunities that could lead to superior
returns, financial and personnel resources of the investor, the ability to
negotiate investment terms effectively, and the ability of the investor to
provide expertise and advice to companies targeted for investment.
The Company competes in the United States and international reinsurance
markets and, in the United States markets, competes with both United States and
internationally domiciled reinsurers. The Company's competitors include
independent reinsurance companies, subsidiaries or affiliates of established
worldwide insurance companies, reinsurance departments of certain primary
insurance companies and domestic and international underwriting syndicates, many
of which have substantially greater financial resources than the Company.
Competitors include direct writers and those that, like the Company, write
primarily through reinsurance intermediaries.
Significant competitors of the Company in the direct market include
American Re-Insurance Company, Employers Reinsurance Corporation, General
Reinsurance Corporation and Swiss Reinsurance Company. Significant competitors
of the Company in the intermediary/broker market include Constitution
Reinsurance Corporation, Everest Reinsurance Company, GE Capital Reinsurance
Company, NAC Reinsurance Company, PMA Reinsurance Corporation, The St. Paul
Companies, Inc., TIG Reinsurance Corporation, Transatlantic Reinsurance Company,
Trenwick America Reinsurance Corporation, Underwriters Reinsurance Company and
Zurich Re North America. In addition, the Company competes with Lloyd's
syndicates and certain companies operating in the London reinsurance market. The
Company may also face competition from other market participants that determine
to devote greater amounts of capital to the types of business written by the
Company.
The Company believes that the reinsurance industry is consolidating, and
the largest reinsurers are writing a larger proportion of total industry
premiums as ceding companies place increasing importance on size and financial
strength in the selection of reinsurers.
The Company may also compete with new market entrants, including possibly
other companies organized by (or that may, in the future, be organized by)
certain of the Company's initial investors, including MMRCH, XL and Trident,
their affiliates or entities that they advise or in which such initial
investors, their affiliates or entities that they advise, have (or may, in the
future, have) significant investments. In addition, affiliates of MMCI engage in
activities in support of their ongoing business strategies, which activities may
compete with those of the Company.
-14-
Insurance ratings are used by insurers and reinsurance intermediaries as
an important means of assessing the financial strength and quality of
reinsurers. In addition, a ceding company's own rating may be adversely affected
by the lack of a rating of its reinsurer. A.M. Best is generally considered to
be a significant rating agency with respect to the evaluation of insurance and
reinsurance companies. In May 1998, the Company was assigned an initial rating
of "A (Excellent)" by A.M. Best. This rating is assigned by A.M. Best to
companies which A.M. Best considers to have, on balance, excellent financial
strength, operating performance and market profile when compared to established
standards and a strong ability to meet their ongoing obligations to
policyholders. A.M. Best's ratings reflect their independent opinion of the
financial strength, operating performance and market profile of an insurer
relative to standards established by A.M. Best, and are not a warranty of an
insurer's current or future ability to meet its obligations to policyholders.
In March 1997, Demotech, Inc., an Ohio-based ratings firm ("Demotech"),
issued to Risk Capital Reinsurance a Financial Stability Rating of A double
prime Unsurpassed, Demotech's highest financial stability rating.
The Company cannot predict whether the ratings assigned to Risk Capital
Reinsurance by A.M. Best and Demotech will increase Risk Capital Reinsurance's
ability to compete in the reinsurance markets in which it operates.
Insurance Regulation
General
The terms and conditions of reinsurance agreements generally are not
subject to regulation by any governmental authority with respect to rates or
policy terms. This contrasts with primary insurance policies and agreements, the
rates and terms of which generally are closely regulated by state insurance
regulators. As a practical matter, however, the rates charged by primary
insurers do have an effect on the rates that can be charged by reinsurers.
State Regulation
Risk Capital Reinsurance, in common with other insurers, is subject to
extensive governmental regulation and supervision in the various states and
jurisdictions in which it transacts business. The laws and regulations of the
State of Nebraska, the domicile of Risk Capital Reinsurance, have the most
significant impact on its operations. This regulation and supervision is
designed to protect policyholders rather than investors and relates to, among
other things, the standards of solvency which must be met and maintained, the
nature of and limitations on investments, restrictions on the size of risk which
may be insured under a single policy, and reserves and provisions for unearned
premiums, losses and other purposes.
Some states are considering legislative proposals which would authorize
the establishment of an interstate compact concerning various aspects of insurer
insolvency proceedings, including interstate governance of receiverships and
guaranty funds. As of March 1999, such legislation had been adopted by three
states, including Illinois, Michigan and Nebraska.
Insurance departments also conduct periodic examinations of the affairs of
insurance companies and require the filing of annual and other reports relating
to the financial condition of companies and other matters. The Nebraska
Insurance Department recently completed an examination of Risk Capital
Reinsurance's records, accounts and business affairs for the period October 1995
through December 31, 1997. The Nebraska Department issued its final report for
such examination on March 15, 1999, which report included no material findings.
Prior to such examination, Risk Capital Reinsurance had not been examined by the
Nebraska Insurance Department other than in connection with the receipt of its
insurance license in November 1995.
Credit for Reinsurance
A primary insurer ordinarily will enter into a reinsurance agreement only
if it can obtain credit for the reinsurance ceded on its statutory financial
statements. In general, credit for reinsurance is allowed in the following
circumstances: (i) if the reinsurer is licensed in the state in which the
primary insurer is domiciled and, in some instances, in certain states in which
the primary insurer is licensed; (ii) if the reinsurer is an "accredited" or
otherwise approved reinsurer in the state in which the primary insurer is
domiciled and, in some instances, in certain states in which the primary insurer
is licensed; (iii) in some instances, if the reinsurer (a) is
-15-
domiciled in a state that is deemed to have substantially similar credit for
reinsurance standards as the state in which the primary insurer is domiciled and
(b) meets certain financial requirements; or (iv) if none of the above apply, to
the extent that the reinsurance obligations of the reinsurer are collateralized
appropriately, typically through the posting of a letter of credit for the
benefit of the primary insurer or the deposit of assets into a trust fund
established for the benefit of the primary insurer. Therefore, as a result of
the requirements relating to the provision of credit for reinsurance, the
Company is indirectly subject to certain regulatory requirements imposed by
jurisdictions in which ceding companies are licensed.
As of March 24, 1999, Risk Capital Reinsurance is licensed or is an
accredited or otherwise approved reinsurer in 43 states as follows: Alaska,
Arkansas, Connecticut, Delaware, District of Columbia, Florida, Georgia, Hawaii,
Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan,
Minnesota, Mississippi, Missouri, Montana, Nebraska (state of domicile), Nevada,
New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota,
Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South
Dakota, Tennessee, Texas, Utah, Vermont, Virginia, West Virginia, Wisconsin and
Wyoming. Risk Capital Reinsurance also holds a Certificate of Authority from the
United States Treasury Department for surety business. In addition, Risk Capital
Reinsurance is an authorized reinsurer in the Argentine Republic. Risk Capital
Reinsurance intends to apply for licenses or reinsurance authorizations in the
remainder of the states as applicable requirements are met. If necessary, and
until such time that all remaining reinsurance authorizations are granted, Risk
Capital Reinsurance intends to appropriately collateralize its reinsurance
obligations. The Company cannot predict if and when such authorizations will be
granted.
Investment Limitations
The Nebraska insurance laws contain rules governing the types and amounts
of investments that are permissible for Nebraska-domiciled insurers, including
Risk Capital Reinsurance. These rules are designed to ensure the safety and
liquidity of an insurer's investment portfolio. Investments in excess of
statutory guidelines do not constitute "admitted assets" (i.e., assets permitted
by the Nebraska insurance laws to be included in a domestic insurer's statutory
financial statements), unless special approval is obtained from the Nebraska
Director of Insurance (the "Nebraska Director"). Non-admitted assets do not
count for the purposes of various financial ratios and tests, including those
governing solvency and the ability to write premiums. An insurer may hold an
investment authorized under more than one provision of the Nebraska insurance
laws under the provision of its choice (except as otherwise expressly provided
by law).
Subject to the "basket" clause described below, the maximum amount of an
insurer's authorized investments in preferred stock and common stock of
insurance companies for calculation of admitted assets in Nebraska is the lesser
of (i) the amount by which admitted assets exceed required capital and
liabilities or (ii) 50% of policyholders surplus. At December 31, 1998, such
amounts for Risk Capital Reinsurance were $353.7 million and $179.4 million,
respectively. Stock of insurance companies is valued for these purposes at cost.
Unrealized appreciation of such securities does not count for the purpose of
determining the percentage of certain admitted assets attributable to insurance
stock investments.
While there is a concentration restriction which precludes investment of
more than 5% of the insurer's admitted assets in any one issuer, this
restriction does not apply to investments in common and preferred stock of other
insurers whose senior debt obligations have received a designation of 1 or 2
from the Securities Valuation Office (the "SVO") of the National Association of
Insurance Commissioners (the "NAIC"). Designations assigned by the SVO range
from class 1 to class 6, with class 1 as the highest quality rating. Generally,
SVO designations of 1 and 2 are comparable to investment grade ratings by
Moody's and Standard & Poor's, and SVO designations of 3 to 6 are comparable to
below investment grade ratings by such rating organizations.
Other concentration restrictions preclude investment of more than 3%, 2%,
1% or 1/2% of an insurer's admitted assets in any one person whose senior debt
obligations have received a designation of 3, 4, 5 or 6, respectively, from the
SVO. In addition, an insurer's investments in debt obligations having a 4, 5 or
6 designation from the SVO may not exceed 4%, 2% or 1%, respectively, of the
Company's admitted assets. Aggregate investments in obligations having any
combination of 3, 4, 5 and 6 designations from the SVO may not exceed, in the
aggregate, 15% of the insurer's admitted assets.
An insurer's investments in equity interests of business entities (e.g.,
corporations, partnerships, limited liability companies and partnerships,
trusts, joint ventures, etc.; including insurance companies) that are created or
existing under the laws of the United States or Canada are also authorized under
the Nebraska insurance laws,
-16-
provided that, in the case of an investment in a business entity other than an
insurance company, (i) the insurer may not generally invest in more than 10% of
the total equity interests of such entity and (ii) the investment will be
subject to the concentration restrictions described above. In the case of an
investment in a business entity that is a corporation, such entity must also
meet certain requirements regarding retained earnings and dividend payment
history.
Authorized foreign investments by an insurer in foreign jurisdictions
whose sovereign debt has a designation of 1, 2 or 3 from the SVO may not exceed,
in the aggregate, 15% of the insurer's admitted assets. Investments may not be
made in foreign jurisdictions whose sovereign debt has a designation of 4, 5 or
6 from the SVO. In addition, authorized foreign investments denominated in
foreign currencies may not exceed, in the aggregate, 5% of the insurer's
admitted assets. Authorized foreign investments must also have a minimum
designation of 1 or 2 from the SVO (or corresponding investment grade rating
from any rating organization recognized by the SVO, including Moody's and
Standard & Poor's), and must be aggregated with investments of the same kinds
and classes made under the Nebraska insurance laws (except for the "basket"
clause) for purposes of determining compliance with the limitations contained in
other sections.
Notwithstanding the foregoing or any other limitations under the Nebraska
insurance laws, there is a "basket" clause under which investments "not
otherwise authorized" are permitted up to a maximum of the greater of (i) the
lesser of (a) 25% of the amount by which admitted assets exceed total
liabilities, excluding capital, or (b) 5% of admitted assets (investments
authorized under this subsection of the "basket" clause may not include
obligations with SVO designations of 3, 4, 5 or 6), or (ii) that portion of
policyholders surplus which is in excess of 50% of the insurer's annual net
written premiums. Derivative instruments otherwise authorized under the Nebraska
insurance laws may not be authorized under the "basket" clause. As of December
31, 1998, the "basket" clause would have allowed Risk Capital Reinsurance to
make investments not otherwise authorized under the Nebraska insurance laws up
to a maximum amount of $241.3 million.
The Nebraska insurance laws provide that the Nebraska Director may waive
any of the legal investment limitations upon application by an insurer. The
Nebraska Director is required to consider the following factors in determining
whether to approve or disapprove any such application: (i) the credit risk
quality of the proposed investment; (ii) the liquidity of the proposed
investment and of the insurer's entire investment portfolio; (iii) the extent of
the diversification of the insurer's investment portfolio; (iv) the yield of the
proposed investment; (v) the reasonableness of the insurer's policyholders
surplus in relation to the insurer's outstanding liabilities and financial
needs; and (vi) any other relevant considerations. From time to time, it may be
necessary for the Company to seek waivers from the Nebraska Director of the
legal investment limitations imposed by the Nebraska insurance laws; no
assurances can be given that such waivers can be obtained.
States in which Risk Capital Reinsurance may become licensed or authorized
may also seek to impose their legal investment laws on Risk Capital Reinsurance.
Such laws vary from state to state and may not permit investments that are
permitted under Nebraska law. To the extent that any state disallows an
investment that is permitted under Nebraska law, Risk Capital Reinsurance's
statutory surplus reflected in its statutory financial statements filed in such
state would be reduced by the amount of such disallowance.
Holding Company Acts
State insurance holding company statutes provide a regulatory apparatus
which is designed to protect the financial condition of domestic insurers
operating within a holding company system. All holding company statutes require
disclosure and, in some instances, prior approval of significant transactions
between the domestic insurer and an affiliate. Such transactions typically
include sales, purchases, exchanges, loans and extensions of credit, and
investments between an insurance company and its affiliates, involving in the
aggregate certain percentages of a company's admitted assets or policyholders
surplus, or dividends that exceed certain percentages of the company's surplus
or income.
The Nebraska insurance laws and the insurance laws of other states
generally regard an issuer as an "affiliate" of one of its investors if it is
controlled by, or is under common control with, the investor. Generally,
"control" means the possession of the power to direct or cause the direction of
the management and policies of the issuer, whether through the ownership of
voting securities, by contract or otherwise. Control is generally presumed to
exist if the investor, directly or indirectly, owns or controls 10% or more of
the voting securities of the issuer. The Nebraska insurance laws and the
insurance laws of other states generally allow investors to rebut this
presumption by filing a "disclaimer" that sets forth the bases for disclaiming
affiliation. In certain states,
-17-
such as Nebraska, a disclaimer is deemed effective once filed unless it is
specifically disallowed by the respective insurance department (after the
parties in interest have been provided notice and an opportunity to be heard).
In other states, a disclaimer must be specifically approved by the relevant
insurance department. In cases where Risk Capital Reinsurance may be presumed to
"control," and therefore deemed an affiliate of, an insurer under applicable
holding company statutes, Risk Capital Reinsurance intends to continue to file
disclaimers with respect to such insurer unless prevented by the surrounding
circumstances.
Typically, the holding company statutes also require each of the insurance
subsidiaries periodically to file information with state insurance regulatory
authorities, including information concerning capital structure, ownership,
financial condition and general business operations. Under the terms of
applicable state statutes, any person or entity desiring to acquire control of a
domestic insurer is required first to obtain approval of the applicable state
insurance regulator.
Liquidation of Insurers
The liquidation of insurance companies, including reinsurers, is generally
conducted pursuant to state insurance law. In the event of the liquidation of
Risk Capital Reinsurance, such liquidation would be conducted by the Nebraska
Director as the domestic receiver of the properties, assets and business of Risk
Capital Reinsurance. Liquidators located in other states (known as ancillary
liquidators) in which Risk Capital Reinsurance conducts business may have
jurisdiction over assets or properties located in such states under certain
circumstances. Under Nebraska law, all creditors of Risk Capital Reinsurance,
including but not limited to reinsureds under its reinsurance agreements, would
be entitled to payment of their allowed claims in full from the assets of Risk
Capital Reinsurance before RCHI, as a stockholder of Risk Capital Reinsurance,
would be entitled to receive any distribution therefrom.
Regulation of Dividends and Other Payments from Insurance Subsidiaries
As an insurance holding company, RCHI will be largely dependent on
dividends and other permitted payments from Risk Capital Reinsurance to meet its
obligations. The ability of Risk Capital Reinsurance to pay dividends or make
other distributions is subject to insurance regulatory limitations of Nebraska,
the state in which Risk Capital Reinsurance is domiciled. The Nebraska insurance
laws provide that dividends or other distributions, together with other
dividends or distributions paid during the preceding 12 months, may not exceed
the greater of (i) 10% of statutory surplus as of the preceding December 31 or
(ii) statutory net income from operations for the preceding calendar year not
including realized capital gains. Net income (exclusive of realized capital
gains) not previously distributed or paid as dividends from the preceding two
calendar years may be carried forward for dividend and distribution purposes.
Any proposed dividend or distribution in excess of such amount is called an
"extraordinary" dividend or distribution and may not be paid until either it has
been approved, or a 30-day waiting period has passed during which it has not
been disapproved, by the Nebraska Director. Notwithstanding the foregoing, the
Nebraska insurance laws provide that any distribution that is a dividend may be
paid by Risk Capital Reinsurance only out of earned surplus arising from its
business, which is defined as unassigned funds (surplus) as reported in the
statutory financial statement filed by Risk Capital Reinsurance with the
Nebraska Insurance Department for the most recent year. In addition, the
Nebraska insurance laws also provide that any distribution that is a dividend
and that is in excess of Risk Capital Reinsurance's unassigned funds (exclusive
of any surplus arising from unrealized capital gains or revaluation of assets)
will be deemed an "extraordinary" dividend subject to the foregoing
requirements. See Note 10 of the accompanying Notes to the Consolidated
Financial Statements of the Company.
The Nebraska insurance laws also require that the statutory surplus of
Risk Capital Reinsurance following any dividend or distribution be reasonable in
relation to its outstanding liabilities and adequate to its financial needs. The
Nebraska Director is required to apply certain factors in determining the
adequacy of an insurer's surplus, including, among other things, the size of the
insurer, the extent to which the insurer's business is diversified, the number
and size of risks insured by each line of business, the extent of geographical
dispersion of insured risks and the reinsurance program, and characteristics of
the investment portfolio. In addition, the Nebraska insurance laws require that
each insurer give notice to the Nebraska Director of all dividends and other
distributions within five business days following declaration thereof and that
any such dividend or other distribution may not be paid within 10 business days
of such notice (the "Notice Period") unless for good cause shown the Nebraska
Director has approved such payment within the Notice Period.
-18-
Insurance Regulatory Information System Ratios
The NAIC's Insurance Regulatory Information System ("IRIS") was developed
by a committee of state insurance regulators and is intended primarily to assist
state insurance departments in executing their statutory mandates to oversee the
financial condition of insurance companies operating in their respective states.
IRIS identifies 11 industry ratios and specifies "usual values" for each ratio.
Departure from the usual values of the ratios can lead to inquiries from
individual state insurance commissioners as to certain aspects of an insurer's
business. For the year ended December 31, 1998, Risk Capital Reinsurance's
results were within the usual values for eight of the 11 ratios. The "change in
writings" ratio was outside the usual value as a result of RCRe's continued
efforts in two key strategies, the integration of investment with reinsurance
and the diversification into specialty classes of reinsurance. The "investment
yield" ratio was outside the usual value primarily due to Risk Capital
Reinsurance's investment strategy of investing a significant portion of its
investment portfolio in equity securities, which generally yield less current
investment income than fixed maturity investments. The "two year operating
ratio" was outside the usual value due to the combined impact of RCRe's
"investment yield" ratio (described above) and the 1998 statutory combined ratio
of 116.4%. The Company's 1998 statutory combined ratio was adversely affected
during the second half of the year by underwriting results from the Company's
satellite business, casualty reinsurance provided by the Company on business
produced by a certain managing underwriting agency and a property loss on a
finite risk treaty. While the Company believes that it is taking adequate steps
to reduce its exposure to losses from this business, there can be no assurances
that such business will not continue to generate additional underwriting losses
in the future or that significant loss activity will not develop from other
areas of the Company's underwriting or other activities. For a related
discussion of subsequent underwriting losses due to claims and claims expenses
related to reinsurance provided by the Company on satellite risks and business
produced by the managing underwriting agency, please refer to "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations--Subsequent Underwriting Losses" and Note 14
of the accompanying Notes to the Consolidated Financial Statements of the
Company.
Accreditation
The NAIC has instituted its Financial Regulatory Accreditation Standards
Program ("FRASP") in response to federal initiatives to regulate the business of
insurance. FRASP provides a set of standards designed to establish effective
state regulation of the financial condition of insurance companies. Under FRASP,
a state must adopt certain laws and regulations, institute required regulatory
practices and procedures, and have adequate personnel to enforce such items in
order to become an "accredited" state. If a state was not accredited by January
1, 1994, accredited states are not able to accept certain financial examination
reports of insurers prepared solely by the regulatory agency in such
unaccredited state. The State of Nebraska is accredited under FRASP; however,
there can be no assurance that it or any other state will remain accredited.
Risk-Based Capital Requirements
In order to enhance the regulation of insurer solvency, the NAIC adopted
in December 1993 a formula and model law to implement risk-based capital
requirements for property and casualty insurance companies. Effective January 1,
1994, Nebraska adopted risk-based capital legislation for property and casualty
companies which is similar to the NAIC risk-based capital requirements. These
risk-based capital requirements are designed to assess capital adequacy and to
raise the level of protection that statutory surplus provides for policyholder
obligations. The risk-based capital model for property and casualty insurance
companies measures three major areas of risk facing property and casualty
insurers: (i) underwriting, which encompasses the risk of adverse loss
developments and inadequate pricing; (ii) declines in asset values arising from
credit risk; and (iii) declines in asset values arising from investment risks.
Insurers having less statutory surplus than required by the risk-based capital
calculation will be subject to varying degrees of regulatory action, depending
on the level of capital inadequacy. Equity investments in common stock typically
are valued at 85% of their market value under the risk-based capital guidelines.
For equity investments in an insurance company affiliate, the risk-based capital
requirement for the equity securities of such affiliate would generally be the
Company's proportionate share of the affiliate's risk-based capital requirement.
For a discussion of "affiliate" status under the insurance laws, see
"Business--Insurance Regulation--Holding Company Acts."
The Company's surplus (as calculated for statutory annual statement
purposes) is well above the risk-based capital thresholds that would require
either company or regulatory action.
-19-
Regulation of Certain Reinsurance Intermediaries
Certain states, including Nebraska, have adopted legislation or regulation
that, in effect, places additional requirements upon insurance and reinsurance
intermediaries and brokers when, on behalf of an insured, they place business
with an insurance or reinsurance company that is affiliated with such
intermediary or broker. While the Company believes that there is no such
affiliation between the Company and reinsurance intermediaries that may be
affiliated with Marsh & McLennan, no assurances can be given that other persons
(including such intermediaries) may not take a contrary position. While the
Company believes that compliance with such regulations would not be burdensome
upon an intermediary or broker, no assurances can be given as to whether a
broker or intermediary would decide to place or continue to place business with
the Company if such regulations were viewed to be applicable.
Federal Regulation
Although the federal government does not directly regulate the insurance
or reinsurance industries, federal initiatives often affect the insurance
business in a variety of ways. Although state regulation remains the dominant
form of regulation, the federal government has shown increasing concern over the
adequacy of state regulation.
It is not possible to predict the future impact of any of these or other
possible laws or regulations on Risk Capital Reinsurance's capital and
operations, and such laws or regulations could materially adversely affect its
business.
Legislative and Regulatory Proposals
From time to time various regulatory and legislative changes have been
proposed in the insurance and reinsurance industry, some of which could have an
effect on reinsurers. Among the proposals that have in the past been or are at
present being considered are the possible introduction of federal regulation in
addition to, or in lieu of, the current system of state regulation of insurers
and proposals in various state legislatures (some of which proposals have been
enacted) to conform portions of their insurance laws and regulations to various
model acts adopted by the NAIC. The Company is unable to predict whether any of
these laws and regulations will be adopted, the form in which any such laws and
regulations would be adopted, or the effect, if any, these developments would
have on the operations and financial condition of the Company.
Senior Management
The Company's senior management team consists of:
Name Age Position
- ---- --- --------
Mark D. Mosca 45 President, Chief Executive Officer and Director
Robert Clements 66 Chairman and Director
Peter A. Appel 37 Managing Director, General Counsel and Secretary
Paul J. Malvasio 52 Managing Director, Chief Financial Officer and
Treasurer
- ----------
Mark D. Mosca was elected President and Director of RCHI in June 1995 and
Chief Executive Officer of RCHI in March 1998, and President, Chief Executive
Officer and Director of Risk Capital Reinsurance in August 1995, and has served
as acting Chief Underwriting Officer of Risk Capital Reinsurance since March
1999. Prior to June 1995, he was Senior Vice President and Chief Underwriting
Officer of Zurich Reinsurance Centre Holdings, Inc. since the completion of its
initial public offering in May 1993. Prior thereto, Mr. Mosca served as a Vice
President of NAC Re Corporation ("NAC Re"), where he was manager of the Treaty
Division since February 1986. From 1975 to 1986, Mr. Mosca was employed by
General Reinsurance Corporation where he was a Vice President. Mr. Mosca holds
an A.B. degree from Harvard University.
Robert Clements was elected Chairman and Director of RCHI at its formation
in March 1995 and Chairman and Director of Risk Capital Reinsurance in September
1995. He is currently an advisor to MMCI with whom he served as Chairman and
Chief Executive Officer from January 1994 to March 1996. Prior thereto, he
served as President of Marsh & McLennan Companies, Inc. since 1992, having been
Vice Chairman during 1991. He was Chairman of J&H Marsh & McLennan, Incorporated
(formerly Marsh & McLennan, Incorporated), a
-20-
subsidiary of Marsh & McLennan Companies, Inc., from 1988 until March 1992. He
joined Marsh & McLennan, Ltd., a Canadian subsidiary of Marsh & McLennan
Companies, Inc., in 1959. Mr. Clements is a director of XL and Hiscox plc. He is
Chairman of the Board of Trustees of The College of Insurance and a member of
Rand Corp. President's Council.
Peter A. Appel has been a Managing Director, General Counsel and Secretary
of both RCHI and Risk Capital Reinsurance since November 1995. From September
1987 to November 1995, Mr. Appel practiced law with the New York firm of Willkie
Farr & Gallagher, where he was a partner from January 1995. He holds an A.B.
degree from Colgate University and a law degree from Harvard University.
Paul J. Malvasio has been a Managing Director, Chief Financial Officer and
Treasurer of both RCHI and Risk Capital Reinsurance since September 1995 and a
Director of Risk Capital Reinsurance since November 1995. Prior to that time, he
was Senior Vice President and Chief Financial Officer of NAC Re since the
completion of NAC Re's initial public offering in February 1986. From 1967 to
1986, Mr. Malvasio was employed by the public accounting firm of Coopers &
Lybrand, where he was an audit partner from October 1979. Mr. Malvasio is a
certified public accountant and holds a B.B.A. degree in Accounting from St.
Francis College.
Employees
At March 24, 1999, the Company employed a total of 40 full-time employees.
The Company will continue to increase its staff over time commensurate with the
expansion of operations. The Company's employees are not represented by a labor
union and the Company believes that its employee relations are good.
-21-
GLOSSARY OF SELECTED INSURANCE TERMS
Admitted assets ........................Assets permitted by state law to be
included as "assets" in an insurance
company's annual statement.
Annual Statement .......................A report that an insurance company must
file annually with the state insurance
commissioner in its domiciliary state
and each other state in which it does
business. The statement shows the
current status of reserves, expenses,
assets, total liabilities and investment
portfolio.
Assume .................................To take from an insurer or reinsurer (a
ceding company) all or part of a risk
underwritten by such person, along with
the related premiums, losses and
expenses.
Attachment point .......................The amount of loss (per occurrence or in
the aggregate, as the case may be) above
which excess of loss coverage becomes
operative.
Broker market reinsurer ................A reinsurer that markets and sells
reinsurance through brokers rather than
through its own employees.
Case reserves ..........................Loss reserves established with respect
to individual reported claims.
Casualty insurance .....................Insurance which is primarily concerned
with the losses caused by injuries to
third persons (in other words, persons
other than the policyholder) and the
legal liability imposed on the insured
resulting therefrom.
Catastrophe reinsurance ................A form of excess of loss reinsurance
that, subject to a specified limit,
indemnifies the ceding company for the
amount of loss in excess of a specified
retention with respect to an
accumulation of losses resulting from a
catastrophic event. The actual
reinsurance document is called a
"catastrophe cover."
Cede; Cedent; Ceding company ...........When a party reinsures all or part of
its risks with another, it "cedes"
business and is referred to as the
"cedent" or "ceding company."
Common account reinsurance .............Arrangements whereby the ceding company
enters the reinsurance market and
purchases a cover for the benefit of the
ceding company and the reinsurers on the
reinsurance treaty. A pro rata portion
of the costs of this protection is
deducted from the ceded premium.
Credit enhancement .....................Use of financial guaranty to upgrade the
quality of a security through the use of
an insurance policy or letter of credit
or other means.
Direct underwriter; Direct writer ......An insurer or reinsurer that markets and
sells insurance directly to its insureds
or reinsureds without the assistance of
brokers.
Excess of loss reinsurance .............A generic term describing reinsurance
that indemnifies the reinsured against
all or a specified portion of losses on
underlying insurance policies in excess
of a specified amount, which is called a
"level" or "retention." Also known as
non-proportional reinsurance. Excess of
loss reinsurance is written in layers. A
reinsurer or group of reinsurers accepts
a band of coverage up to a specified
amount. The total coverage purchased by
the cedent is referred to as a "program"
and will typically be placed with
predetermined reinsurers in
prenegotiated layers. Any liability
exceeding the outer limit of the program
reverts to the ceding company, which
also bears the credit risk of a
reinsurer's insolvency.
Facultative reinsurance ................The reinsurance of all or a portion of
the insurance provided by a single
policy. Each policy reinsured is
separately negotiated.
-22-
Finite risk reinsurance ................Similar to traditional reinsurance with
the exception that there is a finite
risk to the reinsurer with respect to
minimum and maximum exposure in relation
to the premium to be received.
Gross premiums written .................Total premiums for insurance and
reinsurance assumed during a given
period.
Incurred but not reported ("IBNR") .....Reserves for estimated losses that have
been incurred by insureds and reinsureds
but not yet reported to the insurer or
reinsurer, including unknown future
developments on losses which are known
to the insurer or reinsurer.
In-force premiums ......................The total of estimated annualized
premiums of all policies in force as of
a certain date which would be
anticipated to generate net premiums
written during the annual period being
considered.
Intermediary/broker ....................One who negotiates contracts of
insurance between an insured and a
primary insurer on behalf of the insured
and/or contracts of reinsurance between
a primary insurer or other reinsured and
a reinsurer on behalf of the primary
insurer or reinsured, in each case
receiving a commission for placement and
other services rendered.
Lloyd's syndicate ......................Underwriting members of Lloyd's (which
can be individual "names" and/or
dedicated corporate members) that group
together annually to form a syndicate to
underwrite insurance coverage. Each
syndicate is managed by a
Lloyd's-approved managing agent, which
appoints one or more active or named
underwriters who have the authority to
bind the syndicate to contracts of
insurance, pay claims and effect
recoveries.
Net premiums written ...................Gross premiums written for a given
period less premiums ceded to
retrocessionaires during such period.
Primary insurer ........................An insurance company that contracts with
the insured to provide insurance
coverage. Such insurer may then cede a
portion of its business to reinsurers.
Probable maximum loss ..................Under Risk Capital Reinsurance's current
guidelines, probable maximum loss is the
anticipated maximum exposure to an event
of a magnitude such that it would be
expected to occur once in 100 years.
Quota share or proportional
reinsurance .........................A generic term describing all forms of
reinsurance in which the reinsurer
shares a proportional part of the
original premiums and losses of the
reinsured. (Also known as pro rata
reinsurance or participating
reinsurance.) In proportional
reinsurance, the reinsurer generally
pays the ceding company a ceding
commission. The ceding commission
generally is based on the ceding
company's cost of acquiring the business
being reinsured (including commissions,
premium taxes, assessments and
miscellaneous administrative expenses)
and also may include a profit factor.
Generally, the reinsurer gets the
benefit of common account reinsurance.
RAA ....................................Reinsurance Association of America, a
trade association of medium and large
property and casualty reinsurers doing
business in the United States. The RAA
provides statistical data concerning the
markets, which voluntarily provide such
information to the RAA.
Reinsurance ............................An arrangement in which an insurance
company, the reinsurer, agrees to
indemnify another insurance or
reinsurance company, the ceding company,
against all or a portion of the
insurance or reinsurance risks
underwritten by the ceding company under
one or more policies.
-23-
Reinsurance can provide a ceding company
with several benefits, including a
reduction in net liability on individual
risks and catastrophe protection from
large or multiple losses. Reinsurance
also provides a ceding company with
additional underwriting capacity by
permitting it to accept larger risks and
write more business than would be
possible without a concomitant increase
in capital and surplus, and facilitates
the maintenance of acceptable financial
ratios by the ceding company.
Reinsurance does not legally discharge
the ceding company from its liability
with respect to its obligations to the
insured.
Reserves ...............................Liabilities established by insurers and
reinsurers to reflect the estimated
costs of claims payments and the related
expenses that the insurer or reinsurer
will ultimately be required to pay in
respect of insurance or reinsurance it
has written. Reserves are established
for losses and for unpaid claims and
claims expenses and for unearned
premiums. Loss reserves consist of case
reserves and IBNR reserves. For
reinsurers, unpaid claims and claims
expense reserves are generally not
significant because substantially all of
the unpaid claims and claims expenses
associated with particular claims are
incurred by the primary insurer and
reported to reinsurers as losses.
Unearned premium reserves constitute the
portion of premiums paid in advance for
insurance or reinsurance that has not
yet been provided.
Retention ..............................The amount or portion of risk that an
insurer retains for its own account.
Losses in excess of the retention level
are paid by the reinsurer. In
proportional treaties, the retention may
be a percentage of the original policy's
limit. In excess of loss business, the
retention is a dollar amount of loss, a
loss ratio or a percentage.
Retrocession ...........................A transaction whereby a reinsurer cedes
to another reinsurer (the
"retrocessionaire") all or part of the
reinsurance that the first reinsurer has
assumed. Retrocessions do not legally
discharge the ceding reinsurer from its
liability with respect to its
obligations to the reinsured.
Reinsurance companies cede risks to
retrocessionaires for reasons similar to
those that cause primary insurers to
purchase reinsurance: to reduce net
liability on individual risks, to
protect against catastrophic losses, to
stabilize financial ratios and to obtain
additional underwriting capacity.
Statutory accounting principles
("SAP") .............................The rules and procedures prescribed or
permitted by United States state
insurance regulatory authorities
including the NAIC, which govern the
preparation of financial statements.
Such rules and procedures generally
reflect a liquidating, rather than going
concern, concept of accounting.
Statutory composite ratio ..............Provides an overall indication of
underwriting profitability. The ratio is
the sum of: the ratio of commissions and
other underwriting expenses to premiums
written, and the ratio of claims and
claims expenses to premiums earned. A
statutory composite ratio under 100%
indicates underwriting profitability,
while a composite ratio exceeding 100%
indicates an underwriting loss.
Statutory surplus ......................The excess of admitted assets over total
liabilities (including loss reserves),
determined in accordance with SAP.
Tail ...................................The period of time that elapses between
the writing of the applicable insurance
policy or the loss event (or the
insurer's knowledge of the loss event)
and the payment in respect thereof.
-24-
Treaties ...............................The reinsurance of a specified type or
category of risks defined in a
reinsurance agreement (a "treaty")
between an insurer and a reinsurer or
between a reinsurer and a
retrocessionaire. In treaty reinsurance,
the cedent is typically obligated to
offer, and the reinsurer or
retrocessionaire is obligated to accept,
a specified portion of a type or
category of risks insured by the ceding
company as set forth in the governing
contract. Treaty reinsurance may provide
for proportional or non-proportional
reinsurance.
Underwriting ...........................The insurer's or reinsurer's process of
reviewing applications submitted for
insurance coverage, deciding whether to
accept all or part of the coverage
requested and determining the applicable
premiums.
Underwriting capacity ..................The maximum amount that an insurance
company can underwrite. The limit is
generally determined by the company's
policyholders or statutory surplus,
which depends, among other things, on
the insurer's admitted assets.
Reinsurance serves to increase a
company's capacity by reducing its
exposure from particular risks.
-25-
ITEM 2. PROPERTIES
In March 1996, the Company entered into a sublease agreement initially
expiring in October 2002 for approximately 40,000 square feet of office space in
Greenwich, Connecticut, at which the Company's offices are located. Future
minimum rental charges for the remaining term of the sublease, exclusive of
escalation clauses and maintenance costs and net of rental income, will be
approximately $2,198,000. The Company's rental expense, net of sublease income,
during 1998, 1997 and 1996 was approximately $576,000, $643,000 and $613,000,
respectively.
Commencing in 1996, the Company subleased approximately 13,000 square feet
of the office space to MMCI for a term expiring in October 2002. Future minimum
rental income under the remaining term of the sublease, exclusive of escalation
clauses and maintenance costs, will be approximately $1,648,000. Rental income
for 1998, 1997 and 1996 was $430,000, $430,000 and $264,000, respectively. MMCI
also reimbursed the Company approximately $100,000 and $574,000 in 1998 and
1997, respectively, for MMCI's pro rata share of improvement and maintenance
costs under the sublease. In addition, commencing in 1997, the Company subleased
approximately 6,000 square feet of the office space to another tenant for a term
expiring in October 2002. Future minimum rental income under the remaining term
of the sublease, exclusive of escalation clauses and maintenance costs, will be
approximately $549,000. Rental income for 1998 and 1997 was $225,000 and
$117,000, of which $89,000 and $44,000, respectively, was paid to MMCI as its
pro rata share of such income.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to litigation and arbitration in the ordinary
course of its business. The Company is not currently involved in any litigation
or arbitration.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the
fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Shares of the Common Stock are traded on the Nasdaq National Market tier
of The Nasdaq Stock Market under the symbol "RCHI." For the periods presented
below, the high and low sales prices and closing prices for the Common Stock as
reported on the Nasdaq National Market were as follows:
Three Months Ended
---------------------------------------------------------------------
December 31, September 30, June 30, March 31,
1998 1998 1998 1998
------------ ------------- -------- ---------
High................................ $23.75 $25.50 $25.50 $24.00
Low................................. 18.81 19.00 22.75 19.75
Close............................... 21.75 22.00 24.94 24.00
-26-
Three Months Ended
---------------------------------------------------------------------
December 31, September 30, June 30, March 31,
1997 1997 1997 1997
------------ ------------- -------- ---------
High................................ $23.38 $23.38 $21.00 $19.25
Low................................. 20.88 20.50 16.00 16.13
Close............................... 22.25 23.00 21.00 17.00
On March 24, 1999, the high and low sales prices and the closing price for
the Common Stock as reported on the Nasdaq National Market were $16.75, $14.25
and $16.63, respectively.
Holders
As of March 24, 1999, there were approximately 50 holders of record of the
Common Stock and approximately 1,501 beneficial holders of the Common Stock.
Dividends
The Company has not declared any dividends since its formation in 1995.
The declaration and payment of dividends will be at the discretion of the Board
of Directors of RCHI and will depend upon the Company's results of operations
and cash flows, the financial position and capital requirements of the Company,
general business conditions, legal, tax and regulatory restrictions on the
payment of dividends, and other factors the Board of Directors of RCHI deems
relevant. There is no requirement or assurance that dividends will be declared
or paid in the future. The payment of dividends by RCHI will be dependent upon
the ability of Risk Capital Reinsurance to provide funds to RCHI. For a
description of the restrictions on the ability of Risk Capital Reinsurance to
pay dividends or make distributions to RCHI, see "Business--Insurance
Regulation--Regulation of Dividends and Other Payments from Insurance
Subsidiaries," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and Note 10 of the accompanying Notes to the Consolidated
Financial Statements of the Company.
-27-
ITEM 6. SELECTED FINANCIAL DATA
Set forth below is certain selected consolidated financial information for
fiscal years 1998, 1997 and 1996, and the period from June 23, 1995 (date of
inception) to December 31, 1995. This information should be read in conjunction
with the accompanying Consolidated Financial Statements of the Company and the
Notes thereto and Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Period from
June 23, 1995 to
Years Ended December 31, December 31,
1998 1997 1996 1995
---------- ---------- ---------- ----------
(In thousands, except share data)
Income Statement Data
Net premiums earned .......................... $206,194 $107,372 $35,761
Net investment income ........................ 15,687 14,360 13,151 $4,578
Net realized investment
gains (losses) ........................... 25,252 (760) 1,259 397
Total revenues ............................... 247,133 120,972 50,171 4,975
Net income ................................... 3,091 2,039 4,112 1,019
Comprehensive income
(loss) ................................... ($4,375) $47,107 $9,817 $4,750
Average shares outstanding
Basic .................................... 17,065,165 17,032,601 16,981,724 16,747,084
Diluted .................................. 17,718,223 17,085,788 16,983,909 16,990,425
Per Share Data
Net income
Basic .................................. $0.18 $0.12 $0.24 $0.06
Diluted ................................ $0.17 $0.12 $0.24 $0.06
Comprehensive income
Basic .................................. ($0.26) $2.77 $0.58 $0.28
Diluted ................................ ($0.26) $2.76 $0.58 $0.28
At December 31,
1998 1997 1996 1995
---------- ---------- ---------- ----------
(In thousands, except share data)
Balance Sheet Data
Total assets ................................. $757,830 $581,247 $432,486 $350,986
Total stockholders' equity ................... $398,002 $401,031 $352,213 $340,215
Shares outstanding
Basic .................................... 17,087,438 17,058,462 17,031,246 16,941,125
Diluted .................................. 17,497,904 17,601,608 17,065,406 --
Book value per share
Basic .................................... $23.29 $23.51 $20.68 $20.08
Diluted .................................. $22.75 $22.79 $20.64 --
-28-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
General
The Company
RCHI is the holding company for Risk Capital Reinsurance, its wholly owned
subsidiary which is domiciled in Nebraska. RCHI was incorporated in March 1995
and commenced operations during September 1995 upon completion of the Offerings.
RCHI received aggregate net proceeds from the Offerings of approximately $335
million, of which $328 million was contributed to the capital of Risk Capital
Reinsurance. On November 6, 1995, Risk Capital Reinsurance was licensed under
the insurance laws of the State of Nebraska. As of December 31, 1998, the
statutory surplus of Risk Capital Reinsurance was approximately $359 million. In
July 1998, Risk Capital Reinsurance capitalized its wholly owned subsidiary,
Cross River Insurance Company ("Cross River"), with $20 million. Cross River
received its Nebraska insurance license in October 1998, and intends to seek
authorization to operate in most other states as an excess and surplus lines
insurer.
Recent Industry Performance
Demand for reinsurance is influenced significantly by underwriting results
of primary property and casualty insurers and prevailing general economic and
market conditions, all of which affect liability retention decisions of primary
insurers and reinsurance premium rates. The supply of reinsurance is directly
related to prevailing prices and levels of surplus capacity, which, in turn, may
fluctuate in response to changes in rates of return on investments being
realized in the reinsurance industry. The 1998 year was a difficult period from
both a market and earnings perspective for most insurance markets. The property
and casualty insurance and reinsurance segments have experienced an increasingly
more difficult and highly competitive operating environment characterized by a
soft rate structure and overcapitalization. Other factors that have contributed
to the prevailing competitive conditions in the reinsurance industry in recent
years include new entrants to the reinsurance market (including certain
specialized reinsurance operations) and the presence of certain reinsurance
companies which operate within tax-advantaged jurisdictions (e.g., Bermuda,
Cayman Islands) that benefit from higher after-tax investment returns. In
addition, concerns with respect to the financial security of Lloyd's that had
adversely impacted the competitive position of that marketplace have apparently
been overcome by actions taken at Lloyd's over the last few years, thereby
enhancing its competitive position.
The industry's profitability can also be affected significantly by
volatile and unpredictable developments, including changes in the propensity of
courts to grant larger awards, natural disasters (such as catastrophic
hurricanes, windstorms, earthquakes, floods and fires), fluctuations in interest
rates and other changes in the investment environment that affect market prices
of investments and the income and returns on investments, and inflationary
pressures that may tend to affect the size of losses experienced by ceding
primary insurers. The reinsurance industry is highly competitive and dynamic,
and market changes may affect, among other things, demand for the Company's
products, changes in investment opportunities (and the performance thereof),
changes in the products offered by the Company or changes in the Company's
business strategy. (See "Cautionary Note Regarding Forward-Looking Statements.")
Reinsurance treaties that are placed by intermediaries are typically for
one year terms with a substantial number that are written or renewed on January
1 each year. Other significant renewal dates include April 1, July 1 and October
1. The January 1, 1999 renewal period was marked by continuing intensified
competitive conditions in terms of premium rates and treaty terms and conditions
in both the property and casualty segments of the marketplace. These conditions
have been worsened due to large domestic primary companies retaining more of
their business and ceding less premiums to reinsurers. While the Company is
initially somewhat disadvantaged compared to many of its competitors, which are
larger, have greater resources and longer operating histories than the Company,
it believes it has been able to generate attractive opportunities in the
marketplace due to its substantial unencumbered capital base, experienced
management team, relationship with its equity investment advisor and strategic
focus on generating a small number of large reinsurance treaty transactions that
may also be integrated with an equity investment in client companies. Commencing
in late 1997, in addition to its core business, the Company expanded into
specialty
-29-
classes of reinsurance business, including marine and aviation and space in
1997, surety and fidelity in 1998, and accident and health in 1999.
In-Force Business
At January 1, 1999, the Company had approximately 421 renewable
reinsurance treaties that are in- force, with approximately $287.5 million of
estimated annualized net premiums written, compared to $172.5 million at January
1, 1998, representing an increase of 67%. Such in-force premiums at January 1,
1999 represent estimated annualized premiums from treaties entered into during
1998 and the January 1, 1999 renewal period that are expected to generate net
premiums written during 1999. Such renewable treaties at January 1, 1999 are
estimated to generate approximately $225 million of net premiums written over
the 12-month period ending December 31, 1999 without taking into account certain
factors, including the possibility that (i) several treaties entered into in
1998 that are scheduled to expire during the remainder of 1999 may be renewed
and (ii) additional treaties may be bound during 1999.
Results of Operations
The Company had consolidated comprehensive loss of $4.4 million for the
year ended December 31, 1998 and consolidated comprehensive income of $47.1
million and $9.8 million for the years ended December 31, 1997 and 1996,
respectively. Comprehensive income for the Company is composed of net income and
the change in unrealized appreciation of investments. Net income for the years
ended December 31, 1998, 1997 and 1996 was $3.1 million, $2.0 million and $4.1
million, respectively. After-tax realized investment gains (losses) of $16.4
million, ($0.5 million) and $0.8 million were also included in net income for
1998, 1997 and 1996, respectively. Net income for the years ended December 31,
1998, 1997 and 1996 included losses of $1.1 million, $0.2 million and $0.2
million, respectively, representing the Company's equity in the net loss of
investee companies accounted for under the equity method of accounting.
Following is a table of per share data for the years ended December 31,
1998, 1997 and 1996 on an after-tax basis:
Years Ended December 31,
--------------------------------------------------
1998 1997 1996
---------- ---------- ----------
Basic earnings per share:
Underwriting loss ($1.39) ($0.45) ($0.38)
Net investment income 0.68 0.61 0.58
Net realized investment gains (losses) 0.96 (0.03) 0.05
Equity in net income (loss) of investees (0.07) (0.01) (0.01)
---------- ---------- ----------
Net income 0.18 0.12 0.24
Change in net unrealized appreciation of investments (0.44) 2.65 0.34
========== ========== ==========
Comprehensive income (loss) ($0.26) $2.77 $0.58
========== ========== ==========
Average Shares Outstanding (000's) 17,065 17,033 16,982
========== ========== ==========
Diluted earnings per share:
Underwriting loss ($1.35) ($0.45) ($0.38)
Net investment income 0.65 0.61 0.58
Net realized investment gains (losses) 0.93 (0.03) 0.05
Equity in net income (loss) of investees (0.06) (0.01) (0.01)
========== ========== ==========
Net income $0.17 $0.12 $0.24
========== ========== ==========
Comprehensive income (loss) ($0.26) $2.76 $0.58
========== ========== ==========
Average shares outstanding (000's) 17,718 17,086 16,984
========== ========== ==========
Book Value Per Share, December 31:
Basic $23.29 $23.51 $20.68
Diluted $22.75 $22.79 $20.64
-30-
Net Premiums Written
Net premiums written for the year ended December 31, 1998 compared to 1997
and 1996 was as follows:
(In millions) Percent
Years Ended December 31, Change
----------------------------------------- ---------
Core Business 1998 1997 1996 1998/1997
------- ------- ------- ---------
Property $ 33.7 $ 17.8 $ 19.4 89%
Casualty 80.3 69.7 17.6 15
Multi-line 62.8 45.9 21.8 37
Other 16.5 10.0 13.7 65
------- ------- ------- -------
Sub-total Core Business $ 193.3 $ 143.4 $ 72.5 35%
------- ------- ------- -------
Specialty Business
Aviation & Space $ 26.0
Marine 14.4 $ 1.4 N/M
Surety 1.0
------- ------- ------- -------
Sub-total Specialty Business $ 41.4 $ 1.4 N/M
------- ------- ------- -------
Total $ 234.7 $ 144.8 $ 72.5 62%
======= ======= ======= =======
The Company's assumed and ceded premiums written for the years ended
December 31, 1998, 1997 and 1996 were as follows:
(In millions)
Years Ended December 31,
-----------------------------------------
1998 1997 1996
------- ------- -------
Assumed premiums written $ 260.5 $ 147.8 $ 73.7
Ceded premiums written 25.8 3.0 1.2
======= ======= =======
Net premiums written $ 234.7 $ 144.8 $ 72.5
======= ======= =======
In 1998, the Company's net premiums written increased by 62% from $144.8
million in 1997 to $234.7 million in 1998. The Company's premium growth resulted
from continued efforts in the Company's two key strategies, the integration of
investment with reinsurance and the diversification into specialty classes of
reinsurance.
Approximately 32%, 29% and 5% of net premiums written in 1998, 1997 and
1996, respectively, were generated from companies in which the Company has
invested or committed to invest funds. Approximately 32%, 28% and 30% of net
premiums written in 1998, 1997 and 1996, respectively, were from non-United
States clients, which are Lloyd's syndicates or are located in the United
Kingdom, Bermuda and Continental Europe.
Consistent with the Company's strategy of writing a small number of large
treaties for its core business, three clients contributed approximately $74
million, or 32%, of the Company's 1998 total net premiums written, with the
largest client contributing approximately 18% and the remaining two contributing
8% and 6%, respectively. The business written from the client that contributed
18% is part of an integrated transaction, and such business is subject to
renewal at the Company's option for five years. In 1997, five clients
contributed approximately $68 million, or 45%, of the Company's total net
premiums written, with the largest client contributing approximately 18% and the
remaining four contributing from 5% to 8%.
While not anticipated, the reduction or loss of business assumed from one
or more large clients could have a material adverse effect on the Company's
results of operations to the extent not offset by new business.
-31-
The Company's ceded premiums increased to $25.8 million in 1998, compared
to $3 million in 1997. This increase was primarily due to the Company's
expansion in 1997 into marine and aviation and space reinsurance business, for
which the Company seeks to reduce its exposure to large and catastrophic losses.
See "--Results of Operations--Risk Retention" and "Business--Retrocessional
Arrangements."
Approximately $32.9 million, or 46%, of net premiums written in 1996
resulted from unearned premium portfolios and other non-recurring transactions.
This amount included $11.9 million of specialty premiums written from contracts
pursuant to which the Company reinsures a portion of one underlying policy for
multiple years. Such premiums will be earned over the multiple periods as the
exposures expire. In 1998 and 1997, there were no significant unearned premium
portfolios or other non-recurring transactions included in net premiums written.
Operating Costs and Expenses
One traditional means of measuring the underwriting performance of a
property/casualty insurer, such as the Company, is the statutory composite
ratio. This ratio, which is based upon statutory accounting principles (which
differ from generally accepted accounting principles in several respects),
reflects underwriting experience, but does not reflect income from investments.
A statutory composite ratio under 100% indicates underwriting profitability,
while a composite ratio exceeding 100% indicates an underwriting loss.
Set forth below are the Company's statutory composite ratios for the years
ended December 31, 1998, 1997 and 1996 and the estimated aggregate statutory
composite ratios for domestic reinsurers and domestic broker market reinsurers
based on data reported by the RAA as of such dates:
Years Ended December 31,
----------------------------------------
1998 1997 1996
------ ------ ------
Claims and claims expenses 85.4% 68.4% 67.3%
Commissions and brokerage 24.2 28.8 23.7
------ ------ ------
109.6 97.2 91.0
Other operating expenses 6.8 9.1 15.3
------
====== ======
Statutory composite ratio 116.4% 106.3% 106.3%
====== ====== ======
Domestic reinsurer aggregate
Statutory composite ratios 104.4% 102.3% 103.1%
====== ====== ======
The Company's 1998 statutory composite ratio was adversely affected during
the second half of the year by underwriting results from the Company's satellite
business, casualty reinsurance provided by the Company on business produced by a
certain managing underwriting agency, and a property loss on a finite risk
treaty, as set forth below (dollars in millions):
1998
-------------------------------------------------------
Net Effect Upon After-Tax
Premiums Composite Underwriting
Written Ratio Loss
------------ ------------ ------------
Satellite business $ 12.9 6.1% $ 8.3
Managing underwriting agency 15.4 4.1 6.6
Finite risk property treaty 5.0 2.3 3.3
------------ ------------ ------------
$ 33.3 12.5% $ 18.2
============ ============ ============
The frequency of satellite failures during 1998 has far exceeded the
previous worst year in the history of this line of business. In order to
mitigate the impact of possible future loss activity, in the fourth quarter of
1998, the Company commenced the process of re-underwriting and reducing its
satellite business and seeking
-32-
additional retrocessional protection. There can be no assurances that any such
retrocessional protection, if purchased, will be sufficient to preclude the
occurrence of additional underwriting losses.
The Company increased its loss reserves at December 31, 1998 relating to
the reinsurance provided by the Company on business produced by the managing
underwriting agency based upon reported loss activity and the results of an
underwriting audit performed by the Company. The underwriting relationship has
been discontinued. All deferred acquisition costs, which approximated $1
million, related to the unearned premium reserve at December 31, 1998 have been
written off by the Company.
For a discussion of subsequent losses due to claims and claims expenses
related to reinsurance provided by the Company on satellite risks and business
produced by the managing underwriting agency, see "--Results of
Operations--Subsequent Underwriting Losses" below and Note 14 of the
accompanying Notes to the Consolidated Financial Statements of the Company.
While the Company believes that it is taking adequate steps to reduce its
exposure to losses from its satellite business and business produced by the
managing underwriting agency, there can be no assurances that such business will
not continue to generate additional underwriting losses in the future or that
significant loss activity will not develop from other areas of the Company's
underwriting or other activities.
Estimates of prior accident year claims were reduced by approximately $2.8
million in 1998 primarily due to favorable claim development in the property and
multi-line classes of business.
The Company's 1997 statutory composite ratio, while essentially unchanged
from the 1996 ratio, contained a higher aggregate claims and claims expenses and
commissions and brokerage ratio components in 1997, which reflects a business
mix with a higher casualty content. Such increase was offset by a lower other
operating expenses ratio as the Company continued to leverage its infrastructure
with increased premium writings.
Claims and claims expenses generally represent the Company's most
significant and uncertain costs. Reserves for these expenses are estimates
involving actuarial and statistical projections at a given time of what the
Company expects the ultimate settlement and administration of claims to cost
based on facts and circumstances then known. The reserves are based on estimates
of claims and claims expenses incurred and, therefore, the amount ultimately
paid may be more or less than such estimates. The inherent uncertainties of
estimating claim reserves are exacerbated for reinsurers by the significant
periods of time (the "tail") that often elapse between the occurrence of an
insured loss, the reporting of the loss to the primary insurer and, ultimately,
to the reinsurer, and the primary insurer's payment of that loss and subsequent
indemnification by the reinsurer. As a consequence, actual claims and claims
expenses paid may deviate, perhaps substantially, from estimates reflected in
the Company's reserves reported in its financial statements. The estimation of
reserves by new reinsurers, such as the Company, may be less reliable than the
reserve estimations of a reinsurer with an established volume of business and
claims history. To the extent reserves prove to be inadequate, the Company may
have to augment such reserves and incur a charge to earnings. See "--Results of
Operations--Subsequent Underwriting Losses" below and Note 14 of the
accompanying Notes to Consolidated Financial Statements of the Company.
In pricing its reinsurance treaties, the Company focuses on many factors,
including exposure to claims and commissions and brokerage expenses. Commissions
and brokerage expenses are acquisition costs that generally vary by the type of
treaty and line of business, and are considered by the Company's underwriting
and actuarial staff in evaluating the adequacy of premium writings. In a number
of reinsurance treaties, provisional commissions are initially paid and
subsequently increased or decreased, subject to a minimum and maximum amount,
depending upon the claims and claims expenses experience of the assumed
business. The Company records the commission increase or decrease in accordance
with contractual terms based on the expected ultimate experience of the
contract.
Other operating expenses increased to $16.5 million in 1998, compared to
$13.5 million and $11.4 million for the years ended December 31, 1997 and 1996,
respectively. Assuming the successful execution
-33-
of the Company's business strategy, the Company expects other operating expenses
to grow with maturing operations, but expects other operating expenses to
decline moderately as a percentage of net premiums written because increases in
premium writings are generally expected to exceed the growth in such expenses.
Pre-tax foreign exchange gains and losses are recorded separately from
statutory underwriting results and are therefore excluded from the statutory
composite ratio. Unhedged monetary assets and liabilities are translated at the
exchange rate in effect at the balance sheet date, with the resulting foreign
exchange gains or losses recognized in income. For the years ended December 31,
1998, 1997 and 1996, pretax foreign exchange gains and (losses) were $443,000,
($682,000) and $104,000, respectively. Such future gains or losses may be
affected by changes in foreign exchange rates which are unpredictable and could
be material. (For additional discussion, see "--Market Sensitive Instruments and
Risk Management" below.)
Subsequent Underwriting Losses
In March 1999, the Company was notified of additional satellite losses
pertaining to 1998 in the amount of approximately $4 million, after-tax, that
will be recorded in the first quarter of 1999. In order to mitigate the impact
of possible future loss activity, in the fourth quarter of 1998, the Company
commenced the process of re-underwriting and reducing its satellite business and
seeking additional retrocessional protection. There can be no assurances that
any such retrocessional protection, if purchased, will be sufficient to preclude
the occurrence of additional underwriting losses.
Based on a review of additional claims information and its continuing
underwriting and actuarial analysis of the business produced by the managing
underwriting agency, the Company expects to record additional after-tax
underwriting losses of approximately $18 million in the first quarter of 1999
from claims, claims expenses, commissions and brokerage, net of earned premium,
relating to reinsurance on business produced by the managing underwriting
agency.
Total estimated ultimate premiums for all business produced on behalf of
the Company by the managing underwriting agency, including policies that have
expired and policies that will expire in 1999 and 2000, are approximately $26
million, of which $17 million and $13 million, respectively, were recorded as
net premiums written and net premiums earned through December 31, 1998.
Substantially all of the remaining $9 million and $13 million, respectively, of
net premiums written and net premiums earned will be recorded in the first
quarter of 1999. The Company has discontinued its underwriting relationship with
the managing underwriting agency.
Therefore, the total after-tax underwriting losses that will be recorded
in the first quarter of 1999 generated from reinsurance on satellite risks and
business produced by the managing underwriting agency will be approximately $22
million. While such loss estimate represents the Company's current expectation
based on all information available to the Company to date, there can be no
assurances that the actual amount will not differ from such estimate due to the
inherent uncertainties of estimating reserves. See also Note 14 of the
accompanying Notes to the Consolidated Financial Statements of the Company.
While the Company believes that it is taking adequate steps to reduce its
exposure to losses from its satellite business and business produced by the
managing underwriting agency, there can be no assurances that such business will
not continue to generate additional underwriting losses in the future or that
significant loss activity will not develop from other areas of the Company's
underwriting or other activities.
Risk Retention
Given the Company's current level of surplus, under its current
underwriting guidelines, the maximum net retention on any one claim for a given
property or casualty treaty risk is generally $10.0 million.
The Company monitors its earthquake and wind exposures and continuously
reevaluates its estimated probable maximum pre-tax loss for such exposures
through the use of modeling techniques. The Company generally seeks to limit its
probable maximum pre-tax loss to no more than 10% of its statutory surplus for
severe catastrophic events that could be expected to occur once in every 100
years. This limitation includes combined exposure to underwriting losses,
reinstatement costs for retrocessional arrangements which may be in force at the
time of the losses resulting from the catastrophic event, and losses that the
Company may be
-34-
exposed to as a result of its privately held investments in insurance and
insurance-related entities. While the Company believes its risk management
techniques are adequate, there can be no assurances that the Company will not
suffer pre-tax losses greater than 10% of its statutory surplus from a
catastrophic event due to the inherent uncertainties in estimating the frequency
and severity of such exposures. In addition, the Company believes that it cannot
reasonably estimate its exposure to unrealized investment losses (if any) that
may result from the Company's investments in publicly traded securities of
insurance and insurance-related entities.
With respect to integrated transactions (where the Company combines an
equity or equity-like investment in a client company with the purchase by such
client of reinsurance from the Company), the Company generally limits its
combined underwriting and investment exposure to pre-tax losses on any
individual client to no more than 10% of its total statutory surplus, and
subjects these commitments to scrutiny by the combined professional staffs of
both the Company and MMCI.
During 1998, the Company maintained catastrophe reinsurance protection for
its marine and aviation business. For 1999, the Company has reinsurance
protection for marine business of $37 million in excess of a $3 million initial
retention, and additional co-participations, with the Company retaining a total
of approximately $8 million. For 1999, the Company is finalizing reinsurance
protection for aviation business in an amount of $65 million in excess of a $1
million initial retention, and additional co-participations, with the Company
retaining a total of approximately $5.4 million. Catastrophic reinsurance
protection has not been purchased for the Company's earthquake and wind
exposures.
The Company continues to evaluate its potential catastrophe exposure,
including both gross loss estimates and the impact of available reinsurance
protection. While the Company believes its management of catastrophe exposures
and underwriting guidelines are adequate, an extremely large catastrophic event,
multiple catastrophic events or other unforeseen events could have a material
adverse effect on the financial condition and results of operations of the
Company.
Net Investment Income
At December 31, 1998, approximately 48% of the Company's invested assets
consisted of fixed maturity and short-term investments, compared to 45% at
December 31, 1997. Net investment income was approximately $15.7 million in
1998, compared to $14.4 million and $13.2 million in 1997 and 1996,
respectively. Such amounts for 1998, 1997 and 1996 are net of investment
expenses of $3.6 million, $2.2 million and $1.5 million, respectively. The
investment expense amounts include investment advisory fees of $3.3 million,
$1.8 million and $1.2 million, respectively. The amount of investment income
from quarter to quarter may vary and could diminish as the Company continues to
employ its strategy of investing a substantial portion of its investment
portfolio in publicly traded and privately held equity securities, which
generally yield less current investment income than fixed maturity investments.
The Company's investment yields at amortized cost were as follows for the
periods set forth below:
Years Ended December 31,
-----------------------------------------
1998 1997 1996
------ ------ ------
Investment yields:
Pre-tax 3.4% 3.7% 3.8%
Net of tax 2.5% 2.7% 2.8%
Assuming a stable interest rate environment, the Company anticipates such
yields to slightly decline as funds invested in short-term securities continue
to be allocated by the Company into investments in equity securities, which
yield less current income than fixed maturity investments. Additionally, such
investment yields exclude the Company's equity in the net income or loss of
private equity investments accounted for under the equity method.
-35-
Net Realized Gains (Losses) on Investments
(In thousands)
Years Ended December 31,
1998 1997 1996
------- ------- -------
Net realized investment gains (losses):
Fixed maturity securities $ 1,472 $ 275 ($ 359)
Publicly traded equity securities 16,582 3,878 1,549
Privately held securities 7,198 (4,913) 69
------- ------- -------
Sub-total 25,252 (760) 1,259
Income tax expense (benefit) 8,838 (266) 441
------- ------- -------
Net realized investment gains (losses), net of tax $16,414 ($ 494) $ 818
======= ======= =======
Income Taxes
The Company's effective tax rate of 5% for 1998, income tax benefit for
1997 and effective tax rate of 7% for 1996 are less than the 35% statutory rate
on pre-tax operating income due to tax exempt income and the dividends received
deductions. The 1998, 1997 and 1996 gross deferred income tax benefits of
approximately $7.3 million, $2.1 million and $1.8 million, respectively, which
are assets considered recoverable from future taxable income, resulted from
temporary differences between financial and taxable income.
Investments
A principal component of the Company's investment strategy is investing a
significant portion of invested assets in publicly traded and privately held
equity securities, primarily issued by insurance and reinsurance companies and
companies providing services to the insurance industry. Cash and fixed maturity
investments and, if necessary, the sale of marketable equity securities will be
used to support shorter-term liquidity requirements.
As a significant portion of the Company's investment portfolio will
generally consist of equity securities issued by insurance and reinsurance
companies and companies providing services to the insurance industry, the equity
portfolio will lack industry diversification and will be particularly subject to
the performance of the insurance industry. Unlike fixed income securities,
equity securities such as common stocks, including the equity securities in
which the Company may invest, generally are not and will not be rated by any
nationally recognized rating service. The values of equity securities generally
are more dependent on the financial condition of the issuer and less dependent
on fluctuations in interest rates than are the values of fixed income
securities. The market value of equity securities generally is regarded as more
volatile than the market value of fixed income securities. The effects of such
volatility on the Company's equity portfolio could be exacerbated to the extent
that such portfolio is concentrated in the insurance industry and in relatively
few issuers. (For additional discussion, see "--Market Sensitive Instruments and
Risk Management.")
As the Company's investment strategy is to invest a significant portion of
its investment portfolio in equity securities, its investment income in any
fiscal period may be smaller, as a percentage of investments, and less
predictable than that of other insurance and/or reinsurance companies, and net
realized and unrealized gains (losses) on investments may have a greater effect
on the Company's results of operations or stockholders' equity at the end of any
fiscal period than other insurance and/or reinsurance companies. Since the
realization of gains and losses on equity investments is not generally
predictable, such gains and losses may differ significantly from period to
period. Variability and declines in the Company's results of operations could be
further exacerbated by private equity investments in start-up companies, which
are accounted for under the equity method. Such start-up companies may be
expected initially to generate operating losses.
Investments that are or will be included in the Company's private
portfolio include securities issued by privately held companies and by publicly
traded companies that are generally restricted as to resale or are otherwise
illiquid and do not have readily ascertainable market values. The risk of
investing in such securities is generally greater than the risk of investing in
securities of widely held, publicly traded
-36-
companies. Lack of a secondary market and resale restrictions may result in an
inability by the Company to sell a security at a price that would otherwise be
obtainable if such restrictions did not exist and may substantially delay the
sale of a security the Company seeks to sell.
At December 31, 1998, cash and invested assets totaled approximately
$587.2 million, consisting of $120.9 million of cash and short-term investments,
$174.5 million of publicly traded fixed maturity investments, $154.7 million of
publicly traded equity securities, and $137.1 million of privately held
securities. Included in privately held securities are investments totaling $53.6
million which are accounted for under the equity method.
At December 31, 1998, the Company's private equity portfolio consisted of
17 investments, with additional investment portfolio commitments in an aggregate
amount of approximately $10.4 million. Since December 31, 1997, the portfolio
increased by five additional investments and two follow-on investments, and was
decreased by two divestments. In addition, the Company has written down the
value of two investments to their net realizable value (one of which included
the Company's investment in the managing underwriting agency discussed above).
In October 1998, the Company provided $5 million in financing on a fully
secured basis to a managing general agency, and received a related reinsurance
commitment expected to generate an aggregate of $90 million of reinsurance
premiums over the next three years pursuant to terms and conditions that the
Company believes are more favorable than those available in the open market.
See Note 3 under the caption "Investment Information" of the accompanying
Notes to Consolidated Financial Statements of the Company for certain
information regarding the Company's publicly traded and privately held
securities and their carrying values, and commitments made by the Company
relating to its privately held securities. Over the long-term, the Company
intends to continue to allocate a substantial portion of its cash and short-term
investments into publicly traded and privately held equity securities, subject
to market conditions and opportunities in the marketplace.
At December 31, 1998, approximately 89% of the Company's fixed maturity
and short-term investments were rated investment grade by Moody's or Standard &
Poor's and had an average quality rating of AA and an average duration of
approximately 2.8 years.
At December 31, 1998, the Company is obligated under letters of credit in
the aggregate amount of approximately $33.3 million, which secure certain
reinsurance obligations and investment commitments in amounts of approximately
$24.1 million and $9.2 million, respectively. Securities with a carrying value
of approximately $38.3 million have been pledged as collateral for these letters
of credit.
The Company has not invested in derivative financial instruments such as
futures, forward contracts, swaps, or options or other financial instruments
with similar characteristics such as interest rate caps or floors and fixed-rate
loan commitments. The Company's portfolio includes market sensitive instruments,
such as mortgage-backed securities, which are subject to prepayment risk and
changes in market value in connection with changes in interest rates. The
Company's investments in mortgage-backed securities, which amounted to
approximately $33.5 million at December 31, 1998, or 6% of cash and invested
assets, are classified as available for sale and are not held for trading
purposes.
Market Sensitive Instruments and Risk Management
In accordance with the SEC's Financial Reporting Release No. 48, the
following analysis presents hypothetical losses in cash flows, earnings and fair
values of market sensitive instruments which are held by the Company as of
December 31, 1998 and are sensitive to changes in interest rates, foreign
exchange rates and equity security prices. This risk management discussion and
the estimated amounts generated from the following sensitivity analysis
represent forward-looking statements of market risk assuming certain adverse
market conditions occur. Actual results in the future may differ materially from
these projected results due to actual developments in the global financial
markets. The analysis methods used by the Company to assess and mitigate risk
should not be considered projections of future events of losses.
Market risk represents the risk of changes in the fair value of a
financial instrument and is comprised of several components, including
liquidity, basis and price risks. The focus of the SEC's market risk rules is on
price risk. For purposes of specific risk analysis, the Company employs
sensitivity analysis to determine the
-37-
effects that market risk exposures could have on the future earnings, fair
values or cash flows of the Company's financial instruments.
The financial instruments included in the following sensitivity analysis
consist of all of the Company's cash and invested assets, excluding investments
carried under the equity method of accounting.
Equity Price Risk
The Company is exposed to equity price risks on the public and private
equity securities included in its investment portfolio. All of the Company's
publicly traded equity securities and privately held securities were issued by
insurance and reinsurance companies or companies providing services to the
insurance industry. The Company typically does not attempt to reduce or
eliminate its market exposure on these securities. Investments included in the
Company's private portfolio include securities issued by privately held
companies and securities issued by public companies that are generally
restricted as to resale or are otherwise illiquid and do not have readily
ascertainable market values. Investments in privately held securities issued by
privately and publicly held companies may include both equity securities and
securities convertible into, or exercisable for, equity securities (some of
which may have fixed maturities).
The Company's publicly traded and privately held equity securities at
December 31, 1998, which are carried at a fair value of $154.7 million and $83.5
million, respectively (including unrealized gains of $44.1 million and $27.1
million), have exposure to price risk. The estimated potential losses in fair
value for the Company's publicly traded and privately held equity portfolios
resulting from a hypothetical 10% decrease in quoted market prices, dealer
quotes or fair value are $15.5 million and $8.4 million, respectively.
Interest Rate Risk
The aggregate hypothetical loss generated from an immediate adverse shift
in the treasury yield curve of 100 basis points would result in a decrease in
total return of 4.4%, which would produce a decrease in market value of $7.7
million on the Company's fixed maturity investment portfolio valued at $174.5
million at December 31, 1998. There would be no material impact on the Company's
short-term investments.
Foreign Currency Exchange Rate Risk
The Company has foreign currency risk on both reinsurance balances
receivable and reinsurance balances payable, including claims and claims
expenses. The Company does not currently utilize derivative instruments to
manage the Company's exposure to foreign currency movements. At December 31,
1998, the majority of the Company's net receivable/payable position was
denominated in United States dollars. At such date, the largest foreign currency
exposure related to cash and premiums receivable denominated in European
Currency Units ("ECUs"; now effectively Eurodollars) in an amount equal to $10.6
million. A 10% decline in the ECU/United States dollar exchange rate would have
resulted in a loss to the Company of $605,000. In addition, the Company had a
net liability balance in Sterling equal to $3.1 million. A 10% increase in
Sterling/United States dollar exchange rate would have resulted in a loss to the
Company of $311,000. Given the Company's limited amount of net receivable
balances in other foreign countries, no other currency movement has been
considered for purposes of this discussion.
Liquidity and Capital Resources
RCHI is a holding company and has no significant operations or assets
other than its ownership of all of the capital stock of Risk Capital
Reinsurance, whose primary and predominant business activity is providing
reinsurance and other forms of capital to insurance and reinsurance companies
and making investments in insurance-related companies. RCHI will rely on cash
dividends and distributions from Risk Capital Reinsurance to pay any cash
dividends to stockholders of RCHI and to pay any operating expense that RCHI may
incur. The payment of dividends by RCHI will be dependent upon the ability of
Risk Capital Reinsurance to provide funds to RCHI. The ability of Risk Capital
Reinsurance to pay dividends or make distributions to RCHI is dependent upon
Risk Capital Reinsurance's ability to achieve satisfactory underwriting and
investment results and to meet certain regulatory standards of the State of
Nebraska. There are presently no contractual restrictions on the payment of
dividends or the making of distributions by Risk Capital Reinsurance to RCHI.
-38-
Nebraska insurance laws provide that, without prior approval of the
Nebraska Director, Risk Capital Reinsurance cannot pay a dividend or make a
distribution (together with other dividends or distributions paid during the
preceding 12 months) that exceeds the greater of (i) 10% of statutory surplus as
of the preceding December 31 or (ii) statutory net income from operations from
the preceding calendar year not including realized capital gains. Net income
(exclusive of realized capital gains) not previously distributed or paid as
dividends from the preceding two calendar years may be carried forward for
dividends and distribution purposes. Any proposed dividend or distribution in
excess of such amount is called an "extraordinary" dividend or distribution and
may not be paid until either it has been approved, or a 30-day waiting period
has passed during which it has not been disapproved, by the Nebraska Director.
Notwithstanding the foregoing, Nebraska insurance laws provide that any
distribution that is a dividend may be paid by Risk Capital Reinsurance only out
of earned surplus arising from its business, which is defined as unassigned
funds (surplus) as reported in the statutory financial statement filed by Risk
Capital Reinsurance with the Nebraska Insurance Department for the most recent
year. In addition, Nebraska insurance laws also provide that any distribution
that is a dividend and that is in excess of Risk Capital Reinsurance's
unassigned funds, exclusive of any surplus arising from unrealized capital gains
or revaluation of assets, will be deemed an "extraordinary" dividend subject to
the foregoing requirements. See "Business--Insurance Regulation--Regulation of
Dividends and Other Payments from Insurance Subsidiaries" and Note 10 of the
accompanying Notes to the Consolidated Financial Statements of the Company.
RCHI, Risk Capital Reinsurance and Cross River file consolidated federal
income tax returns and have entered into a tax sharing agreement (the "Tax
Sharing Agreement"), allocating the consolidated income tax liability on a
separate return basis. Pursuant to the Tax Sharing Agreement, Risk Capital
Reinsurance and Cross River make tax sharing payments to RCHI based on such
allocation.
Net cash flow from operating activities for the years ended December 31,
1998, 1997 and 1996 was approximately $69 million, $49 million and $31 million,
respectively, consisting principally of premiums received, investment income
(excluding net realized investment gains), offset by operating costs and
expenses. The primary sources of liquidity for Risk Capital Reinsurance are net
cash flow from operating activities, principally premiums received, the receipt
of dividends and interest on investments and proceeds from the sale or maturity
of investments. The Company's cash flow is also affected by claims payments,
some of which could be large. Therefore, the Company's cash flow could fluctuate
significantly from period to period.
The Company does not currently have any material commitments for any
capital expenditures over the next 12 months other than in connection with the
further development of the Company's infrastructure. The Company expects that
its financing and operational needs for the foreseeable future will be met by
the Company's balance of cash and short-term investments, as well as by funds
generated from operations. However, no assurance can be given that the Company
will be successful in the implementation of its business strategy.
At December 31, 1998, the Company's consolidated stockholders' equity
totaled $398 million, or $23.29 per share based on issued and outstanding
shares, and $22.75 per share on a diluted basis which includes outstanding
dilutive warrants and options. At such date, statutory surplus of Risk Capital
Reinsurance was approximately $359 million. Based on data available as of
December 31, 1998 from the RAA, Risk Capital Reinsurance is the 12th largest
domestic broker market oriented reinsurer as measured by statutory surplus.
The Year 2000 Issues
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results by or at the year
2000. The year 2000 issue affects virtually all companies and organizations.
The Company has instituted a comprehensive year 2000 compliance plan
designed to help avoid unexpected interruption in conducting its business. The
Company's year 2000 initiative includes the following strategic steps:
o Inventory of business systems and operating facilities;
-39-
o Assessment of potential year 2000 problems;
o Repair/replacement of non-compliant systems and facilities;
o Testing of systems and facilities; and
o Implementation of year 2000 compliant systems and facilities.
The Company has completed the assessment phase for its business systems
and operating facilities, and is currently in the remediation and testing phases
to ensure that the Company's systems and facilities are capable of processing
information for the year 2000 and beyond. The Company does not currently
anticipate any material year 2000 compliance problems with respect to its
internal business systems and operating facilities. Based on information
currently available, the cost of this internal compliance effort, while not
quantified, is not expected to have a material adverse effect on the Company's
financial position or results of operations.
However, due to the interdependent nature of systems and facilities, the
Company may be adversely impacted depending upon whether its business partners
and vendors address this issue successfully. Therefore, the Company is
continuing to survey its key business partners and vendors in an attempt to
determine their respective level of year 2000 compliance. As part of this
initiative, the Company is evaluating the year 2000 exposures to insurers
included in the Company's investment portfolio. The effect, if any, on the
Company's financial position or results of operations from the possible failure
of these entities to be year 2000 compliant is not determinable.
The Company has not established a contingency plan for noncompliance of
its internal systems and operating facilities as the Company does not currently
expect any material year 2000 compliance problems with respect to such internal
systems and facilities. At this time, the Company is not aware of any material
business partners or vendors that will not be year 2000 compliant. If the
Company becomes aware of non- compliant business partners or vendors, one option
will be to evaluate replacing the non-compliant business partners and vendors.
The Company intends to continue to assess and attempt to mitigate its risks in
the event these third parities fail to be year 2000 compliant, and will consider
appropriate contingency arrangements for such potential noncompliance by such
entities. In certain instances, the establishment of a contingency plan is not
possible or is cost prohibitive. In these situations, noncompliance by the
Company's material business partners or vendors could have a material adverse
impact on the Company's financial position and results of operations.
In addition, property and casualty reinsurance companies, like the
Company, may have underwriting exposure related to the year 2000. The year 2000
issue is a risk for some of the Company's reinsureds and is therefore considered
during the underwriting process similar to any other risk to which the Company's
clients may be exposed. Due to a significant number of variables associated with
the extent and severity of the year 2000 problem, the Company's potential
underwriting exposure to year 2000 losses cannot be determined at this time.
These variables include, but are not limited to, actual pervasiveness and
severity of year 2000 system flaws, the magnitude of the amount of costs and
expenses directly attributable to year 2000 failures, the portion of such amount
(if any) that constitutes insurable losses, and the extent of governmental
intervention. The Company's underwriting staff has considered the risks with
respect to the year 2000 problem that might be associated with underwriting
their various lines of business, and have developed internal guidelines intended
to minimize these risks. The Company seeks to minimize its potential year 2000
underwriting exposures by (i) assisting clients in the evaluation of their
potential year 2000 underwriting exposures, (ii) performing underwriting
evaluations of its clients' potential year 2000 exposure, (iii) structuring
contract language to mitigate potential exposure where appropriate and (iv)
recommending technical support as appropriate. However, the Company cannot be
certain that these steps will adequately minimize its year 2000 underwriting
exposures. Given the possible extent and severity of the year 2000 problem, the
Company may incur a significant amount of year 2000 related losses, and such
losses may have a material adverse impact on the Company's financial condition
or results of operations.
-40-
New Accounting Pronouncements
Derivatives and Hedging
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133 "Accounting for Derivative Instruments and Hedging Activities." This
statement requires that all derivative financial instruments be recognized in
the statement of financial position as either assets or liabilities and measured
at fair value.
If a derivative instrument is not designated as a hedging instrument,
gains or losses resulting from changes in fair values of such derivative are
required to be recognized in earnings in the period of the change. If certain
conditions are met, a derivative may be designated as a hedging instrument, in
which case the recording of the changes in fair value will depend on the
specific exposure being hedged. The key criterion for hedge accounting is that
the hedging relationship must be highly effective in achieving offsetting
changes on fair values or cash flows.
This statement is effective for fiscal years beginning after June 15,
1999, with initial application as of the beginning of the first quarter of the
applicable fiscal year.
The Company will adopt this statement in the first quarter of 2000.
Generally, the Company has not invested in derivative financial instruments.
However, derivatives may be embedded in other financial instruments, such as
convertible securities and prepayment options in mortgages. If the embedded
derivative meets certain criteria, it must be bifurcated from the host contract
and separately accounted for consistent with other derivatives.
The Company's portfolio includes market sensitive instruments, such as
convertible securities and mortgage-backed securities, which are subject to
prepayment risk and changes in market value in connection with changes in
interest rates. The Company's investments in mortgage-backed securities are
classified as available for sale and are not held for trading purposes. Assuming
the current investment strategy at the time of adoption, the Company's
presentation of financial information under the new statement will not be
materially different than the current presentation.
Start-Up Costs
In April 1998, the Accounting Standards Executive Committee ("AcSEC")
issued Statement of Position ("SOP") 98-5 "Reporting on the Costs of Start-Up
Activities." This statement requires costs of start-up activities, including
organization costs, to be expensed as incurred. Unless another conceptual basis
exists under other generally accepted accounting literature to capitalize the
cost of an activity, costs of start-up activities cannot be capitalized.
Start-up activities are defined broadly as those one-time activities
related to opening a new facility, introducing a new product or service,
conducting business in a new territory, conducting business with a new class of
customer or beneficiary, initiating a new process in an existing facility or
commencing some new operation. Start-up activities also include activities
related to organizing a new entity.
SOP 98-5 is effective for fiscal years beginning after December 15, 1998.
The Company will adopt the new statement in the first quarter of 1999 as a
cumulative effect of a change in accounting principle in accordance with the
provisions of Accounting Principles Board Opinion No. 20.
The Company and its investee companies currently defer and amortize
organization and start-up costs over a three to five year period. This change in
accounting principle will result in the write-off of previously capitalized
start up costs. At December 31, 1998, the Company's unamortized capitalized
start-up costs, including its proportionate share of such costs deferred by
investee companies, was approximately $0.7 million.
-41-
Internal-Use Software
In March 1998, AcSEC issued SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. SOP 98-1 is effective for
fiscal years beginning after December 15, 1998. This SOP requires companies to
capitalize certain costs incurred in connection with an internal use software
project. Such costs are not significant for the Company. Accordingly, the
adoption of SOP 98-1 will not have a material impact on the Company's financial
statements.
Insurance Regulation
Risk Capital Reinsurance, in common with other insurers, is subject to
extensive governmental regulation and supervision in the various states and
jurisdictions in which it transacts business. The laws and regulations of the
State of Nebraska, the domicile of Risk Capital Reinsurance, have the most
significant impact on its operations.
From time to time various regulatory and legislative changes have been
proposed in the insurance and reinsurance industry, some of which could have an
effect on reinsurers. Among the proposals that have in the past been, or are at
present being considered, are (i) the possible introduction of federal
regulation in addition to, or in lieu of, the current system of state regulation
of insurers and (ii) proposals in various state legislatures (some of which
proposals have been enacted) to conform portions of their insurance laws and
regulations to various model acts adopted by the NAIC. The Company is unable to
predict whether any of such laws and regulations will be adopted, the form in
which any such laws and regulations would be adopted, or the effect, if any,
these developments would have on the operations and financial condition of the
Company. See "Business--Insurance Regulation."
In March 1998, the NAIC adopted the codification of statutory accounting
principles project that will generally be applied to all insurance and
reinsurance company financial statements filed with insurance regulatory
authorities as early as the statutory filings made in 2001. Although the
codification is not expected to materially effect many existing statutory
accounting practices presently followed by most insurers and reinsurers such as
the Company, there are several accounting practices that may be changed. The
most significant change would involve accounting for deferred income taxes,
which change would require a deferred tax liability to be recorded for
unrealized appreciation of invested assets, net of available deferred tax
assets, that would result in a reduction to statutory surplus. If such
requirement had been in effect in 1998, the statutory surplus of the Company at
December 31, 1998 would have been reduced by approximately $6 million, from $359
million to $353 million, due to a net deferred tax liability.
Effects of Inflation
The effects of inflation on the Company will be implicitly considered in
pricing and estimating reserves for unpaid claims and claims expenses. The
actual effects of inflation on the results of the Company cannot be accurately
known until claims are ultimately settled.
-42-
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to the information appearing above under the subheading
"Market Sensitive Instruments and Risk Management" under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," which information is hereby incorporated by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See the Consolidated Financial Statements and Notes thereto and required
financial statement schedules on pages F-1 through F-39 and S-1 through S-7
below.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference to the captions "Election of
Directors--Directors and Executive Officers--Nominees," "--Continuing
Directors and Executive Officers" and "Election of Directors--Security
Ownership of Certain Beneficial Owners and Management--Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's definitive proxy statement for
the Company's Annual Meeting of Stockholders to be held on May 11, 1999 (the
"Proxy Statement"), which statement the Company intends to file with the SEC
within 120 days after December 31, 1998.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to the captions "Election of
Directors--Directors and Executive Officers--Compensation of Directors,"
"Election of Directors--Executive Compensation" and
"--Performance Graph" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to the caption "Election of
Directors--Security Ownership of Certain Beneficial Owners and Management" in
the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Incorporated herein by reference to the captions "Election of
Directors--Executive Compensation--Compensation Committee Interlocks and Insider
Participation" and "Election of Directors--Certain Relationships and Related
Transactions" in the Proxy Statement.
-43-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements and Schedules
Financial Statements and Schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this Report,
and are included in Item 8.
Exhibits
The exhibits listed in the accompanying Exhibit Index are filed as part of
this Report. Such exhibits include, without limitation, certain management
contracts and compensatory plans as therein described.
Reports on Form 8-K
No Reports on Form 8-K were filed by the Company during the fourth quarter
of 1998.
-44-
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.
RISK CAPITAL HOLDINGS, INC.
(Registrant)
By: /s/ Mark D. Mosca
-------------------------------------
Mark D. Mosca,
Dated: March 26, 1999 President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
President and Chief Executive Officer March 26, 1999
/s/ Mark D. Mosca (Principal Executive Officer) and
- -------------------------------- Director
Mark D. Mosca
/s/ Robert Clements* Chairman and Director March 26, 1999
- --------------------------------
Robert Clements
/s/ Paul J. Malvasio Managing Director, Chief Financial March 26, 1999
- -------------------------------- Officer and Treasurer (Principal
Paul J. Malvasio Financial Officer and Principal
Accounting Officer)
/s/ Michael P. Esposito, Jr.* Director March 26, 1999
- --------------------------------
Michael P. Esposito, Jr.
/s/ Stephen Friedman* Director March 26, 1999
- --------------------------------
Stephen Friedman
/s/ Lewis L. Glucksman* Director March 26, 1999
- --------------------------------
Lewis L. Glucksman
/s/ Ian R. Heap* Director March 26, 1999
- --------------------------------
Ian R. Heap
/s/ Thomas V. A. Kelsey* Director March 26, 1999
- --------------------------------
Thomas V. A. Kelsey
/s/ Philip L. Wroughton* Director March 26, 1999
- --------------------------------
Philip L. Wroughton
-45-
- ----------
* By Paul J. Malvasio, as attorney-in-fact and agent, pursuant to a power of
attorney, a copy of which has been filed with the Securities and Exchange
Commission as Exhibit 24 hereto.
/s/ Paul J. Malvasio
- ----------------------------------
Paul J. Malvasio
Attorney-in-Fact
-46-
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Risk Capital Holdings, Inc. and Subsidiary Pages
-----
Report of Independent Accountants on Financial Statements.......... F-2
Consolidated Balance Sheet at December 31, 1998 and 1997........... F-3
Consolidated Statement of Income and Comprehensive Income for the
years ended December 31, 1998, 1997 and 1996..................... F-4
Consolidated Statement of Changes in Stockholders' Equity for the
years ended December 31, 1998, 1997 and 1996...................... F-5
Consolidated Statement of Cash Flows for the years ended December 31,
1998, 1997 and 1996............................................... F-6
Notes to Consolidated Financial Statements.......................... F-7
Schedules
Report of Independent Accountants on Financial Statement Schedules S-1
I. Summary of Investments Other Than Investments in Related Parties
at December 31, 1998 ........................................ S-2
II. Condensed Financial Information of Registrant.................. S-3 to S-5
III. Supplementary Insurance Information for the years ended
December 31, 1998, 1997 and 1996................................ S-6
IV. Reinsurance for the years ended December 31, 1998, 1997 and 1996.. S-7
Schedules other than those listed above are omitted for the reason that
they are not applicable.
F-1
Report of Independent Accountants
To the Board of Directors and Stockholders of
Risk Capital Holdings, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income and comprehensive income, of changes in
stockholders' equity and of cash flows present fairly, in all material respects,
the financial position of Risk Capital Holdings, Inc. and its subsidiaries at
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
New York, New York
January 29, 1999, except as to Note 14,
which is as of March 25, 1999
F-2
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
(Dollars in thousands)
December 31,
-----------------------------
1998 1997
--------- ---------
Assets
Investments:
Fixed maturities (amortized cost: 1998, $173,379; 1997, $129,887) $ 174,540 $ 132,159
Publicly traded equity securities (cost: 1998, $110,598; 1997, $116,258) 154,678 180,052
Privately held securities (cost: 1998, $109,966; 1997, $77,550) 137,091 95,336
Short-term investments 108,809 89,167
--------- ---------
Total investments 575,118 496,714
Cash 12,037 9,014
Accrued investment income 2,632 2,781
Premiums receivable 88,610 47,507
Reinsurance recoverable 31,087
Deferred policy acquisition costs 23,515 17,292
Other assets 24,831 7,939
--------- ---------
Total Assets $ 757,830 $ 581,247
========= =========
Liabilities
Claims and claims expenses $ 216,657 $ 70,768
Unearned premiums 102,775 74,234
Reinsurance premiums payable 5,396 211
Investment accounts payable 3,981 1,996
Deferred income tax liability 13,182 25,090
Other liabilities 17,837 7,917
--------- ---------
Total Liabilities 359,828 180,216
--------- ---------
Stockholders' Equity
Preferred stock, $.01 par value:
20,000,000 shares authorized (none issued)
Common stock, $.01 par value:
80,000,000 shares authorized
(issued: 1998, 17,102,503; 1997, 17,069,845) 171 171
Additional paid-in capital 341,878 341,162
Deferred compensation under stock award plan (1,062) (1,778)
Retained earnings 10,261 7,170
Accumulated other comprehensive income consisting of unrealized
appreciation of investments, net of income tax 47,038 54,504
Less treasury stock, at cost (1998, 15,065; 1997, 11,383 shares) (284) (198)
--------- ---------
Total Stockholders' Equity 398,002 401,031
--------- ---------
Total Liabilities and Stockholders' Equity $ 757,830 $ 581,247
========= =========
See Notes to Consolidated Financial Statements
F-3
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share data)
Years Ended December 31,
1998 1997 1996
------------ ------------ ------------
Revenues
Net premiums written $ 234,735 $ 144,834 $ 72,532
Increase in unearned premiums (28,541) (37,462) (36,771)
------------ ------------ ------------
Net premiums earned 206,194 107,372 35,761
Net investment income 15,687 14,360 13,151
Net realized investment gains (losses) 25,252 (760) 1,259
------------ ------------ ------------
Total revenues 247,133 120,972 50,171
------------ ------------ ------------
Operating Costs and Expenses
Claims and claims expenses 176,125 73,407 24,079
Commissions and brokerage 50,537 31,467 10,197
Other operating expenses 16,452 13,523 11,389
Foreign exchange (gain) loss (443) 682 (104)
------------ ------------
Total operating costs and expenses 242,671 119,079 45,561
------------ ------------ ------------
Income
Income before income taxes and equity in net loss of investees 4,462 1,893 4,610
------------ ------------ ------------
Federal income taxes:
Current 7,512 1,761 2,147
Deferred (7,277) (2,099) (1,810)
------------ ------------ ------------
Income tax expense (benefit) 235 (338) 337
------------ ------------ ------------
Income before equity in net loss of investees 4,227 2,231 4,273
Equity in net loss of investees (1,136) (192) (161)
------------ ------------ ------------
Net income 3,091 2,039 4,112
------------ ------------ ------------
Other Comprehensive Income (Loss), Net of Tax
Change in net unrealized appreciation (depreciation) of
investments, net of tax (7,466) 45,068 5,705
------------ ------------ ------------
Comprehensive Income (Loss) ($ 4,375) $ 47,107 $ 9,817
============ ============ ============
Average shares outstanding
Basic 17,065,165 17,032,601 16,981,724
Diluted 17,718,223 17,085,788 16,983,909
Per Share Data
Net Income (Loss) - Basic $ 0.18 $ 0.12 $ 0.24
- Diluted $ 0.17 $ 0.12 $ 0.24
Comprehensive Income (Loss) - Basic ($ 0.26) $ 2.77 $ 0.58
- Diluted ($ 0.26) $ 2.76 $ 0.58
See Notes to Consolidated Financial Statements
F-4
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
Years Ended December 31,
1998 1997 1996
--------- --------- ---------
Common Stock
Balance at beginning of year $ 171 $ 170 $ 169
Issuance of common stock
Restricted common stock issued 1 1
--------- --------- ---------
Balance at end of year 171 171 170
--------- --------- ---------
Additional Paid-in Capital
Balance at beginning of year 341,162 340,435 338,737
Issuance of common stock 716 727 1,698
--------- --------- ---------
Balance at end of year 341,878 341,162 340,435
--------- --------- ---------
Deferred Compensation Under Stock Award Plan
Balance at beginning of year (1,778) (2,959) (3,441)
Restricted common stock issued (296) (506) (1,487)
Compensation expense recognized 1,012 1,687 1,969
--------- --------- ---------
Balance at end of year (1,062) (1,778) (2,959)
--------- --------- ---------
Retained Earnings
Balance at beginning of year 7,170 5,131 1,019
Net income 3,091 2,039 4,112
--------- --------- ---------
Balance at end of year 10,261 7,170 5,131
--------- --------- ---------
Treasury Stock, At Cost
Balance at beginning of year (198)
Purchase of treasury shares (86) (198)
--------- --------- ---------
Balance at end of year (284) (198)
--------- --------- ---------
Accumulated Other Comprehensive Income Consisting of Unrealized
Appreciation (Depreciation) of Investments, Net of Income Tax
Balance at beginning of year 54,504 9,436 3,731
Change in unrealized appreciation (7,466) 45,068 5,705
--------- --------- ---------
Balance at end of year 47,038 54,504 9,436
--------- --------- ---------
Total Stockholders' Equity
Balance at beginning of year 401,031 352,213 340,215
Issuance of common stock 716 728 1,699
Change in unrealized appreciation of investments, net of income tax (7,466) 45,068 5,705
Change in deferred compensation 716 1,181 482
Net income 3,091 2,039 4,112
Purchase of treasury shares (86) (198)
--------- --------- ---------
Balance at end of year $ 398,002 $ 401,031 $ 352,213
========= ========= =========
See Notes to Consolidated Financial Statements
F-5
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Years Ended December 31,
1998 1997 1996
--------- --------- ---------
Operating Activities
Net income $ 3,091 $ 2,039 $ 4,112
Adjustments to reconcile net income to net cash
Provided by (used for) operating activities:
Liability for claims and claims expenses, net 145,889 49,998 20,770
Unearned premiums 28,541 36,886 37,348
Premiums receivable (41,103) (23,838) (23,669)
Accrued investment income 149 (630) 291
Reinsurance recoverable (31,087) 1,098 (1,098)
Reinsurance balances payable 5,185 (325) 536
Deferred policy acquisition costs (6,223) (10,274) (7,018)
Net realized investment (gains)/losses (25,252) 760 (1,259)
Deferred income tax asset (7,889) (2,202) (1,897)
Other liabilities 9,920 (78) 4,560
Other items, net (12,715) (4,396) (1,687)
--------- --------- ---------
Net Cash Provided By Operating Activities 68,506 49,038 30,989
--------- --------- ---------
Investing Activities
Purchases of fixed maturity investments (295,912) (239,395) (232,568)
Sales of fixed maturity investments 254,716 241,035 226,927
Net sales (purchases) of short-term investments (16,924) 20,390 53,982
Purchases of equity securities (110,321) (95,738) (110,551)
Sales of equity securities 102,876 33,104 34,352
Purchases of furniture, equipment and leasehold improvements (252) (910) (2,859)
--------- --------- ---------
Net Cash Used For Investing Activities (65,817) (41,514) (30,717)
--------- --------- ---------
Financing Activities
Common stock issued 716 728 1,699
Purchase of treasury shares (86) (198)
Deferred compensation on restricted stock (296) (506) (1,487)
--------- --------- ---------
Net Cash Provided By Financing Activities 334 24 212
--------- --------- ---------
Increase in cash 3,023 7,548 484
Cash beginning of year 9,014 1,466 982
--------- --------- ---------
Cash end of year $ 12,037 $ 9,014 $ 1,466
========= ========= =========
See Notes to Consolidated Financial Statements
F-6
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Formation and Capitalization
Risk Capital Holdings, Inc. ("RCHI"), incorporated in March 1995
under the laws of the State of Delaware, is a holding company whose wholly
owned subsidiary, Risk Capital Reinsurance Company ("Risk Capital
Reinsurance"), a Nebraska corporation, was formed to provide, on a global
basis, property and casualty reinsurance and other forms of capital,
either on a stand-alone basis or as part of integrated capital solutions
for insurance companies with capital needs that cannot be met by
reinsurance alone. RCHI and Risk Capital Reinsurance are collectively
referred to herein as the "Company". In September 1995, through its
initial public offering, related exercise of the underwriters'
over-allotment option and direct sales of 16,750,625 shares of RCHI's
common stock, par value $.01 per share (the "Common Stock"), at $20 per
share, and the issuance of warrants, RCHI was capitalized with net
proceeds of approximately $335.0 million, of which $328.0 million was
contributed to the statutory capital of Risk Capital Reinsurance. In July
1998, Risk Capital Reinsurance capitalized its wholly owned subsidiary,
Cross River Insurance Company ("Cross River"), with $20 million. Cross
River received its Nebraska license in October 1998, and intends to seek
authorization to operate in most other states as an excess and surplus
lines insurer.
Class A warrants to purchase an aggregate of 2,531,079 shares of
Common Stock and Class B warrants to purchase an aggregate of 1,920,601
shares of Common Stock were issued in connection with the direct sales.
Class A warrants are immediately exercisable at $20 per share and expire
September 19, 2002. Class B warrants are exercisable at $20 per share
during the seven year period commencing September 19, 1998, provided that
the Common Stock has traded at or above $30 per share for 20 out of 30
consecutive trading days.
The Company generally seeks to write a small number of large
reinsurance treaty transactions that may also be integrated with an equity
investment in client companies. Such reinsurance may include traditional
and finite risk property and casualty reinsurance treaty coverages,
including excess of loss reinsurance and quota share or proportional
reinsurance. The Company also writes treaty reinsurance for ocean marine,
aviation and satellite, fidelity and surety, and accident and health
risks. The Company's investment strategy is focused on the insurance
industry. A principal component of this strategy is investing a
significant portion of invested assets in publicly traded and privately
held equity securities issued by insurance and reinsurance companies and
companies providing services to the insurance industry.
The Company obtains substantially all of its reinsurance through
intermediaries which represent the cedent in negotiations for the purchase
of reinsurance. In addition to investment opportunities arising from the
activities of Marsh & McLennan Capital, Inc. ("MMCI"), as the Company's
equity investment advisor, the Company is provided with investment
opportunities by reinsurance brokers and traditional financing sources,
including investment banking firms, venture capital firms and other
banking and financing sources, both acting as principal investors and
intermediaries. Underwriting opportunities may arise from such sources in
connection with the Company's investment activities as part of integrated
transactions.
2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements have been prepared in
conformity with generally accepted accounting principles ("GAAP") and
include the accounts of RCHI, Risk Capital Reinsurance and Cross River.
All intercompany transactions and balances have been eliminated in
consolidation. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. See Note 14 Subsequent
Events.
F-7
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies (continued)
Premium Revenues and Related Expenses
Premiums are recognized as income on a pro rata basis over the terms
of the related reinsurance contracts. These amounts are based on reports
received from ceding companies, supplemented by the Company's own
estimates of premiums for which ceding company reports have not been
received. Unearned premium reserves represent the portion of premiums
written that relates to the unexpired terms of contracts in force. Certain
of the Company's contracts include provisions that adjust premiums based
upon the experience under the contracts. Premiums written and earned as
well as related acquisition expenses under these contracts are recorded
based upon the expected ultimate experience under these contracts.
Acquisition costs, which vary with and are primarily related to the
acquisition of policies, consisting principally of commissions and
brokerage expenses incurred at the time a contract is issued, are deferred
and amortized over the period in which the related premiums are earned.
Deferred acquisition costs are limited to their estimated realizable value
based on the related unearned premiums and take into account anticipated
claims and claims expenses, based on historical and current experience,
and anticipated investment income.
Investments
The Company classifies all of its publicly traded fixed maturity and
equity securities as "available for sale" and, accordingly, they are
carried at estimated fair value. The fair value of publicly traded fixed
maturity securities and publicly traded equity securities is estimated
using quoted market prices or dealer quotes. Short-term investments, which
have a maturity of one year or less at the date of acquisition, are
carried at cost, which approximates fair value.
Investments in privately held securities, issued by privately and
publicly held companies, may include both equity securities and securities
convertible into, or exercisable for, equity securities (some of which may
have fixed maturities). Privately held securities are subject to trading
restrictions or are otherwise illiquid and do not have readily
ascertainable market values. The risk of investing in such securities is
generally greater than the risk of investing in securities of widely held,
publicly traded companies. Lack of a secondary market and resale
restrictions may result in the Company's inability to sell a security at a
price that would otherwise be obtainable if such restrictions did not
exist and may substantially delay the sale of a security which the Company
seeks to sell. Such investments are classified as "available for sale" and
carried at estimated fair value, except for investments in which the
Company believes it has the ability to exercise significant influence
(generally defined as investments in which the Company owns 20% or more of
the outstanding voting common stock of the issuer), which are carried
under the equity method of accounting. Under this method, the Company
records its proportionate share of income or loss for such investments in
results of operations.
The estimated fair value of investments in privately held
securities, other than those carried under the equity method, is initially
equal to the cost of such investments until the investments are revalued
based principally on substantive events or other factors which could
indicate a diminution or appreciation in value, such as an arm's-length
third party transaction justifying an increased valuation or adverse
development of a significant nature requiring a write down. The Company
periodically reviews the valuation of investments in privately held
securities with MMCI, its equity investment advisor.
Realized investment gains or losses on the sale of investments are
determined by the specific identification method and recorded in net
income. Unrealized appreciation or depreciation of securities which are
carried at fair value is excluded from net income and recorded as a
separate component of stockholders' equity, net of applicable deferred
income tax.
F-8
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies (continued)
Net investment income, consisting of dividends and interest, net of
investment expenses, is recognized when earned. The amortization of
premium and accretion of discount for fixed maturity investments is
computed utilizing the interest method. Anticipated prepayments and
expected maturities are used in applying the interest method for certain
investments such as mortgage and other asset-backed securities. When
actual prepayments differ significantly from anticipated prepayments, the
effective yield is recalculated to reflect actual payments to date and
anticipated future payments. The net investment in the security is
adjusted to the amount that would have existed had the new effective yield
been applied since the acquisition of the security. Such adjustments, if
any, are included in net investment income.
Claims and Claims Expenses
The reserve for claims and claims expenses consists of unpaid
reported claims and claims expenses and estimates for claims incurred but
not reported. These reserves are based on reports received from ceding
companies, supplemented by the Company's estimates of reserves for which
ceding company reports have not been received, and the Company's own
historical experience. To the extent that the Company's own historical
experience is inadequate for estimating reserves, such estimates will be
determined based upon industry experience and management's judgment. The
ultimate liability may vary from such estimates, and any adjustments to
such estimates are reflected in income in the period in which they become
known (see Note 14 Subsequent Events). Reserves are recorded without
consideration of potential salvage or subrogation recoveries which are
estimated to be immaterial. Such recoveries, when realized, are reflected
as a reduction of claims incurred.
Foreign Exchange
The United States dollar is the functional currency for the
Company's foreign business. Gains and losses on the translation into
United States dollars of amounts denominated in foreign currencies are
included in net income. Foreign currency revenue and expenses are
translated at average exchange rates during the year. Assets and
liabilities denominated in foreign currencies are translated at the rate
of exchange in effect at the balance sheet date.
Income Taxes
The Company utilizes the liability method of accounting for income
taxes. Deferred income taxes reflect the net tax effect of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and amounts used for income tax purposes. A
valuation allowance is recorded using the "more-likely-than-not" criteria
when some or all of a deferred tax asset may not be realized.
Comprehensive Income
In presenting its financial statements, the Company has adopted the
reporting of comprehensive income in a one financial statement approach,
consistent with Statement of Financial Accounting Standards ("SFAS") No.
130. Comprehensive income is comprised of net income and other
comprehensive income, which for the Company consists of the change in net
unrealized appreciation or depreciation of investments, net of tax. In
addition, prior periods have been reclassified to reflect the new
accounting standard in order to make prior results comparable to current
reporting.
Comprehensive income for the Company consists of net income (loss)
and the change in unrealized appreciation or depreciation, net of income
tax, as follows:
F-9
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies (continued)
(In thousands, except per share data)
Years Ended December 31,
1998 1997 1996
-------- -------- --------
Net income $ 3,091 $ 2,039 $ 4,112
Other comprehensive income net of tax:
Unrealized appreciation (depreciation) of investments:
Unrealized holdings gains arising during period 8,948 44,574 6,523
Less, reclassification adjustment for net realized
(gains) losses included in net income (16,414) 494 (818)
-------- -------- --------
Other comprehensive income (loss) (7,466) 45,068 5,705
-------- -------- --------
Comprehensive income (loss) ($ 4,375) $ 47,107 $ 9,817
======== ======== ========
Comprehensive income (loss) per share:
Basic ($ 0.26) $ 2.77 $ 0.58
======== ======== ========
Diluted ($ 0.26) $ 2.76 $ 0.58
======== ======== ========
Earnings Per Share Data
Earnings per share are computed in accordance with SFAS No. 128,
"Earnings per share" (see Note 12 for the Company's earnings per share
computations). Basic earnings per share excludes dilution and is computed
by dividing income available to common stockholders by the weighted
average number of shares of Common Stock outstanding for the periods.
Diluted earnings per share reflect the potential dilution that could occur
if Class A and B warrants and employee stock options were exercised or
converted into Common Stock. All earnings per share amounts for all
periods presented, where necessary, have been restated to conform to the
SFAS No. 128 requirements.
Segment Information
In June 1997, the Financial Accounting Standards Board ("FASB"),
issued SFAS No. 131 "Disclosure About Segments of an Enterprise and
Related Information". This Statement establishes standards for the way
that public business enterprises report information about operating
segments in annual and interim financial reports issued to stockholders.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers.
Operating segments are defined as components of an enterprise for
which separate financial information is available that is evaluated
regularly by the chief operating decision maker for purposes of deciding
how to allocate resources and in assessing performance. Generally,
financial information is required to be reported on the basis for which it
is used internally for evaluating segment performance and determining how
to allocate resources to segments.
The Company operates in one reportable business segment, of
providing property casualty reinsurance and other forms of capital to
insurance and reinsurance companies and making investments in insurance
and insurance related entities on a global basis. This segment includes
the results of Risk Capital Reinsurance and Cross River, and consists
primarily of the premiums, claims and claims expenses, other operating
expenses and investment results. The Company's adoption of SFAS No. 131
did not have a material impact on the Company's financial statements or
the accompanying notes. See Note 11 for information concerning the
Company's business.
F-10
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies (continued)
Market Risk Sensitive Instruments
The Securities and Exchange Commission ("SEC") issued Financial
Reporting Release ("FRR") No. 48 which included amended rules requiring
domestic and foreign issuers to clarify and expand existing disclosure for
derivative financial instruments, other financial instruments and
derivative commodity instruments (collectively, "market risk sensitive
instruments"). The amendments require enhanced disclosure of accounting
policies for derivative financial instruments and derivative commodity
instruments (collectively, "derivatives"). In addition, the amendments
expand existing disclosure requirements to include quantitative and
qualitative information about market risk inherent in market risk
sensitive instruments, which disclosure will be subject to safe harbor
protection under the new SEC rule (see Management's Discussion and
Analysis of Financial Condition and Results of Operations included in the
accompanying Annual Report on Form 10-K of the Company). These amendments
are designed to provide additional information about market risk sensitive
instruments which investors can use to better understand and evaluate
market risk exposures of registrants, including the Company.
Employee Stock Options
The Company follows Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" ("APB No. 25") and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under FASB Statement No.
123 "Accounting for Stock-Based Compensation" ("FASB No. 123") requires
use of option valuation models that were not developed for use in valuing
employee stock options (see Note 8). Under APB No. 25, no compensation
expense is recognized by the Company because the exercise price of the
Company's employee stock options equal the market price of the underlying
stock on the date of grant. In addition, under APB No. 25, the Company
does not recognize compensation expense for stock issued to employees
under its stock purchase plan.
Goodwill
In connection with its acquisitions of privately held equity
securities recorded under the equity method of accounting, the Company
amortizes goodwill on a straight line basis for periods from five years to
25 years. Goodwill at December 31, 1998 and 1997 was $10,638,000,
$12,566,000, respectively. Amortization of goodwill included in equity in
net loss of investees in 1998 and 1997 was $1,000,000 and $248,000,
respectively. There was no goodwill recorded in 1996.
Furniture, Equipment and Leasehold Improvements
The costs of furniture and equipment are charged against income over
their estimated service lives. Leasehold improvements are amortized over
the term of the office lease. Depreciation and amortization are computed
on the straight-line method. Maintenance and repairs are charged to
expense as incurred.
Reclassifications
The Company has reclassified the presentation of certain prior year
information to conform with the current presentation.
New Accounting Pronouncements
Derivatives and Hedging
In June 1998, the FASB issued Statement No. 133 "Accounting for
Derivative Instruments and Hedging Activities." This statement requires
that all derivative financial instruments be recognized in the statement
of financial position as either assets or liabilities and measured at fair
value.
F-11
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies (continued)
If a derivative instrument is not designated as a hedging
instrument, gains or losses resulting from changes in fair values of such
derivative are required to be recognized in earnings in the period of the
change. If certain conditions are met, a derivative may be designated as a
hedging instrument, in which case the recording of the changes in fair
value will depend on the specific exposure being hedged. The key criterion
for hedge accounting is that the hedging relationship must be highly
effective in achieving offsetting changes on fair values or cash flows.
This Statement is effective for fiscal years beginning after June
15, 1999, with initial application as of the beginning of the first
quarter of the applicable fiscal year.
The Company will adopt this Statement in the first quarter of 2000.
Generally, the Company has not invested in derivative financial
instruments. However, derivatives may be embedded in other financial
instruments, such as convertible securities and prepayment options in
mortgages. If the embedded derivative meets certain criteria, it must be
bifurcated from the host contract and separately accounted for consistent
with other derivatives.
The Company's portfolio includes market sensitive instruments, such
as convertible securities and mortgage-backed securities, which are
subject to prepayment risk and changes in market value in connection with
changes in interest rates. The Company's investments in mortgage-backed
securities are classified as available for sale and are not held for
trading purposes. Assuming the current investment strategy at the time of
adoption, the Company's presentation of financial information under the
new Statement will not be materially different than the current
presentation.
Start-Up Costs
In April 1998, the Accounting Standards Executive Committee
("AcSEC"), issued Statement of Position ("SOP") 98-5 "Reporting on the
Costs of Start-Up Activities." This Statement requires costs of start-up
activities, including organization costs, to be expensed as incurred.
Unless another conceptual basis exists under other generally accepted
accounting literature to capitalize the cost of an activity, costs of
start-up activities cannot be capitalized.
Start-up activities are defined broadly as those one-time activities
related to opening a new facility, introducing a new product or service,
conducting business in a new territory, conducting business with a new
class of customer or beneficiary, initiating a new process in an existing
facility or commencing some new operation. Start-up activities also
include activities related to organizing a new entity.
SOP 98-5 is effective for fiscal years beginning after December 15,
1998. The Company will adopt the new Statement in the first quarter of
1999 as a cumulative effect of a change in accounting principle in
accordance with the provisions of Accounting Principles Board Opinion No.
20.
The Company and its investee companies currently defer and amortize
organization and start-up costs over a three to five year period. The
change in accounting principle will result in the write-off of previously
capitalized start up costs. At December 31, 1998, the Company's
unamortized capitalized start-up costs, including its proportionate share
of such costs deferred by investee companies, was approximately $0.7
million.
F-12
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2. Summary of Significant Accounting Policies (continued)
Internal-Use Software
In March 1998, AcSEC issued SOP 98-1, Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use. The SOP is
effective for fiscal years beginning after December 15, 1998. The SOP
requires companies to capitalize certain costs incurred in connection with
an internal-use software project. Internal-use software includes software
internally developed, acquired or modified solely to meet the Company's
internal needs and no plan exists during the development to market the
software externally. Such costs are not significant for the Company.
Accordingly, the adoption of SOP 98-1 will not have a material impact on
the Company's financial statements.
3. Investment Information
Net Investment Income
The components of net investment income were derived from the
following sources:
(In thousands)
Years Ended December 31,
-----------------------------------------
1998 1997 1996
------- ------- -------
Fixed maturity securities $10,500 $ 7,105 $ 7,470
Publicly traded equity securities 4,022 3,272 1,606
Privately held equity securities 426 157 56
Short-term investments 4,386 6,039 5,491
------- ------- -------
Gross investment income 19,334 16,573 14,623
Investment expenses 3,647 2,213 1,472
------- ------- -------
Net investment income $15,687 $14,360 $13,151
======= ======= =======
Realized and Unrealized Investment Gains (Losses)
Realized investment gains (losses) were as follows:
(In thousands)
Years Ended December 31,
------------------------------------------
1998 1997 1996
------- ------- -------
Net realized investment gains (losses):
Fixed maturity securities $ 1,472 $ 275 ($ 359)
Publicly traded equity securities 16,582 3,878 1,549
Privately held securities 7,198 (4,913) 69
------- ------- -------
Sub-total 25,252 (760) 1,259
------- ------- -------
Income tax expense (benefit) 8,838 (266) 441
------- ------- -------
Net realized investment gains
(losses), net of tax $16,414 ($ 494) $ 818
======= ======= =======
F-13
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
The following tables reconcile estimated fair value and carrying
value to the amortized cost of fixed maturity and equity securities:
(In thousands)
December 31, 1998
----------------------------------------------------
Estimated
Fair Value
and Gross Gross
Carrying Unrealized Unrealized Amortized
Value Gains (Losses) Cost
--------- --------- --------- ---------
Fixed maturities:
U.S. government and government agencies $ 39,283 $ 606 ($ 60) $ 38,737
Municipal bonds 45,273 1,193 (11) 44,091
Mortgage and asset backed securities 33,532 397 (46) 33,181
Corporate bonds 56,256 962 (1,882) 57,176
Foreign governments 196 2 194
--------- --------- --------- ---------
Sub-total fixed maturities 174,540 3,160 (1,999) 173,379
Equity securities:
Publicly traded 154,678 51,093 (7,013) 110,598
Privately held 137,091 27,125 109,966
--------- --------- --------- ---------
Sub-total equity securities 291,769 78,218 (7,013) 220,564
--------- --------- --------- ---------
Total $ 466,309 $ 81,378 ($ 9,012) $ 393,943
========= ========= ========= =========
(In thousands)
December 31, 1997
----------------------------------------------------
Estimated
Fair Value
and Gross Gross
Carrying Unrealized Unrealized Amortized
Value Gains (Losses) Cost
--------- --------- --------- ---------
Fixed maturities:
U.S. government and government agencies $ 44,135 $ 303 ($ 3) $ 43,835
Municipal bonds 37,637 1,104 36,533
Mortgage and asset backed securities 30,487 408 (3) 30,082
Corporate bonds 19,323 419 (21) 18,925
Foreign governments 577 65 512
--------- --------- --------- ---------
Sub-total fixed maturities 132,159 2,299 (27) 129,887
Equity securities:
Publicly traded 180,052 63,794 116,258
Privately held 95,336 17,786 77,550
--------- --------- --------- ---------
Sub-total equity securities 275,388 81,580 193,808
--------- --------- --------- ---------
Total $ 407,547 $ 83,879 ($ 27) $ 323,695
========= ========= ========= =========
At December 31, 1998, all of the Company's equity investments were
in securities issued by insurance and reinsurance companies or companies
providing services to the insurance industry.
F-14
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
At December 31, 1998, the publicly traded equity portfolio consisted
of the following:
(In thousands)
December 31, 1998
-------------------------------------------
Estimated Fair Net
Value and Unrealized
Carrying Value Gains Cost
-------------- -------- --------
Common Stocks:
ACE Limited $ 16,716 $ 6,177 $ 10,539
American International Group, Inc. 16,290 7,304 8,986
Arthur J. Gallagher 19,856 5,039 14,817
Centris Group 936 (94) 1,030
XL Capital Ltd. 29,250 16,565 12,685
E.W. Blanch Holdings, Inc. 25,403 14,043 11,360
Farm Family Holdings, Inc. 3,060 77 2,983
IPC Holdings, Ltd. 11,292 (2,664) 13,956
LaSalle Re Holdings, Ltd. 8,874 (3,613) 12,487
Limit PLC 2,706 (180) 2,886
Meadowbrook Insurance Group 329 (192) 521
Partner Re, Ltd. 1,702 79 1,623
Pennsylvania Mfrs. Corp. 978 (7) 985
Poe & Brown 971 (17) 988
Trenwick Group Inc. 4,362 (247) 4,609
Preferred Stock:
St. Paul Companies, 6% Convertible Preferred 11,953 1,810 10,143
-------- -------- --------
Total $154,678 $ 44,080 $110,598
======== ======== ========
F-15
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
Privately held securities consisted of the following:
(In thousands)
Percentage December 31,
Ownership 1998 1997
---------- ---------- ----------
Carried under the equity method:
Arbor Acquisition Corp. (Montgomery & Collins, Inc.) 37.3% $ 500
The ARC Group, LLC 27.0% 9,448 $ 10,341
Arx Holding Corp. 35.2% 2,400 2,425
Capital Protection Insurance Services, LLC 51.0% 250 182
First American Financial Corporation 37.9% 9,805 6,572
Island Heritage Insurance Company, Ltd. 33.0% 3,101 3,950
LARC Holdings, Ltd. 23.9% 25,349 24,496
New Europe Insurance Ventures 14.6% 1,083 730
Providers' Assurance Corporation 34.3% -- 3,637
Sunshine State Holding Corporation 21.5% 1,688 1,424
---------- ----------
Sub-total 53,624 53,757
---------- ----------
Carried at fair value:
Altus Holdings, Ltd. 28.6% 6,667
Annuity and Life Re (Holdings) Ltd. 5.6% 34,243
GuideStar Health Systems, Inc. 2.6% 1,000 1,000
Peregrine Russell Miller Insurance Fund of Asia Limited 44.0% 4,399
Sorrento Holdings, Inc. n/a 5,113
Sovereign Risk Insurance Ltd. 9.0% 246 246
Stockton Holdings Limited 1.7% 10,000
Terra Nova (Bermuda) Holdings, Ltd. 3.5% 21,323 23,250
TRG Associates, LLC 8.8% 4,875 4,875
Venton Holdings, Ltd. 9.9% 7,809
---------- ----------
Sub-total 83,467 41,579
---------- ----------
Total $ 137,091 $ 95,336
========== ==========
In addition, the Company had investment commitments relating to its
privately held securities in the amounts of $10.4 million and $22.6
million at December 31, 1998 and 1997, respectively.
Set forth below is certain information relating to each of the
Company's investments and investment commitments in privately held
securities at December 31, 1998.
Investments Carried Under The Equity Method:
Arbor Acquisition Corp. (Montgomery & Collins, Inc.)
In March 1998, the Company purchased for approximately $2.8 million
a 34.5% economic and voting interest in Arbor Acquisition Corp. ("Arbor"),
the parent of Montgomery & Collins, Inc., a Boston-based national surplus
lines and wholesale brokerage firm which operates in 11 cities, in
addition to Boston. The investment was made concurrently with investments
by Marsh & McLennan Risk Capital Holdings, Ltd. ("MMRCH"), MMCI's parent.
F-16
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
In September 1998, the Company invested an additional $845,000 in
Arbor, increasing the Company's ownership interest to approximately 37.3%.
In December 1998, the Company recorded a realized loss of $2.4
million by reducing the carrying value of its investment in Arbor to
$500,000.
The Company records its equity in the operating results of Arbor on
a quarter-lag basis.
For the period recorded in 1998, the Company's equity in net loss,
net of goodwill amortization and net of tax, was $506,000 or $0.03 per
share.
The ARC Group, LLC
In July 1997, the Company completed its acquisition, effective May
1997, of a 27.0% economic and voting interest in The ARC Group, LLC
("ARC"), a Long Island-based wholesaler of specialty insurance for
approximately $9.5 million. ARC, founded in 1986, is an independent
whole-sale insurance broker and managing general agent specializing in the
placement of professional liability insurance, primarily directors and
officers liability coverage. The Company is a co-investor with MMRCH and
ARC's founders, who continue to have managerial control over the daily
operations.
In January 1998 and August 1998, the Company received distributions
of $1.3 million and $1.3 million, respectively, from ARC. Such
distributions were recorded as a reduction to the carrying value of the
investment.
The Company records its equity in the operating results of ARC on a
two-month lag basis.
For the year ended 1998 and for the period recorded in 1997, the
Company's equity in net income, net of goodwill amortization and net of
tax, was $1.0 million, or $0.06 per share, and $561,000, or $0.03 per
share, respectively.
Arx Holding Corp.
In December 1997, the Company acquired a 35.2% economic and voting
interest in Arx Holding Corp. ("ARX"), a Florida-based company for
$2,425,000. ARX, through its recently formed wholly owned subsidiary
American Strategic Insurance Corp., underwrites homeowners policies in the
State of Florida produced in the open market, and may also seek to offer
other lines of insurance in Florida and other states.
The Company provides reinsurance for ARX. A subsidiary of XL Capital
Ltd. ("XL") is a co-investor in ARX and also provides reinsurance for ARX.
The Company's net premiums written and net premiums earned from
business developed by ARX were $2.8 million and $1.1 million,
respectively, in 1998.
The Company records its equity in the operating results of ARX on a
quarter-lag basis.
For the year ended 1998, the Company's equity in net loss, net of
goodwill amortization and net of tax, was $63,000.
Capital Protection Insurance Services, LLC
In May 1997, the Company acquired a 51% economic interest (49%
voting interest) in Capital Protection Insurance Services, LLC ("CPI"), a
newly formed underwriting management company headquartered in New York
City offering specialty risk and alternative market insurance solutions.
The Company co-invested with CPI's founders.
F-17
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
The Company also provided reinsurance capacity for the business CPI
develops. Net premiums written and net premiums earned recorded by the
Company from casualty and multi-line business developed by CPI were $16.3
million and $12.3 million, respectively, in 1998 and $857,399 and
$178,527, respectively, in 1997.
At December 31, 1998, the Company recorded a realized loss of
$862,000 by reducing the carrying value of its investment in CPI to
$250,000.
The Company records its equity in the operating results of CPI on a
one-month lag basis.
For the year ended 1998 and the period recorded in 1997, the
Company's equity in the net loss, net of tax, was $115,700, or $0.01 per
share, and $279,786, or $0.02 per share. See Note 14 Subsequent Events.
First American Financial Corporation
In February 1997, the Company acquired a 35.5% voting and economic
interest in First American Financial Corporation ("FAFC") for $6.5
million.
First American, a Missouri-based company, through its wholly owned
subsidiaries including First American Insurance Company, underwrites
specialty vehicle property and casualty insurance coverages with emphasis
placed on collateral protection.
In June 1998, the Company invested an additional $3.8 million in
FAFC, bringing the total investment to approximately $10 million,
representing an approximately 38% interest. The investment was made in
connection with the purchase by The Trident Partnership, L.P. ("Trident"),
a dedicated insurance industry private equity fund managed by MMCI, of the
remaining approximately 62% of the outstanding capital stock of FAFC.
In December 1998, the Company loaned to FAFC $1.3 million in the
form of a demand note. Interest will accrue at a fixed rate of 10% per
annum, compounded semi-annually.
The Company records its equity in the operating results of FAFC on a
quarter-lag basis.
For the year ended 1998, the Company's equity in net loss, net of
goodwill amortization and net of tax, was $1.3 million, or $0.08 per
share, and for the period recorded in 1997, the Company's equity in the
net income, net of goodwill amortization and net of tax, was $32,036.
Island Heritage Insurance Company, Ltd.
In April 1996, the Company acquired a 33% economic interest (9.75%
voting interest) in Island Heritage Insurance Company, Ltd. ("Island
Heritage"), a Cayman Islands insurer, for an aggregate purchase price of
$4.5 million, which was funded through $1.7 million in cash and a trust
account in an amount equal to $2.8 million. Island Heritage commenced
operations in May 1996 as an insurer which writes high value personal and
commercial property insurance in the Caribbean. Certain directors of the
Company and other investors invested in the securities of Island Heritage
at the same per share price as that paid by the Company.
The investment in Island Heritage is recorded under the equity
method of accounting since the Company believes it has the ability to
exercise significant influence over the operating and financial policies
of Island Heritage due to the Company's participation on the Board of
Directors and through certain consent rights attaching to the Company's
holdings of non-voting shares.
The Company records its equity in the operating results of Island
Heritage on a quarter-lag basis.
F-18
3. Investment Information (continued)
For the years ended 1998 and 1997 and the period recorded in 1996,
the Company's equity in net loss, net of tax, was $551,850, or $0.03 per
share, $195,922, or $0.01 per share, and $161,000, or $0.01 per share,
respectively.
LARC Holdings, Ltd.
In November 1997, the Company acquired a 23.9% economic interest
(9.9% voting interest) in LARC Holdings, Ltd. ("LARC"), a newly formed
holding company located in Bermuda, for $24.5 million. LARC, through its
newly-formed wholly owned Bermuda subsidiary, Latin American Reinsurance
Company, Ltd. ("LARe"), provides multi-line reinsurance to the Latin
American reinsurance market, emphasizing short-tail, multi-peril property
reinsurance and, to a limited extent, casualty, marine, aviation and other
lines of reinsurance. LARe may also seek to enter other reinsurance niches
on both a treaty and facultative basis.
The Company co-invested with a subsidiary of XL, which holds a
majority interest in LARC, and the founders of LARC.
The investment in LARC is recorded under the equity method of
accounting since the Company believes it has the ability to exercise
significant influence over the operating and financial policies of LARC
due to the Company's participation on the Board of Directors and through
certain consent rights attaching to the Company's holdings of non-voting
shares.
The Company records its equity in the operating results of LARC on a
one-month lag basis.
For the year ended 1998, the Company's equity in net income, net of
goodwill amortization and net of tax, was $531,700, or $0.03 per share,
and for the period recorded in 1997, the Company's equity in the net loss,
net of tax, was $18,936.
New Europe Insurance Ventures
In March 1997, the Company, through a wholly owned special purpose
subsidiary, committed to pay $5 million over the long term to fund its
partnership interest, currently at 14.6%, in New Europe Insurance Ventures
("NEIV"), a Scottish limited partnership that targets private equity
investments in insurance and insurance-related companies in Eastern
Europe.
The Company records its participation in this partnership under the
equity method of accounting and applies the specialized accounting
practices for investment companies. Unrealized gains and losses on private
equity investments, expected to consist mostly of foreign exchange
fluctuations, will be recorded in the income statement when such
investments are revalued into United States dollars each quarter.
The $1.1 million investment balance at December 31, 1998 is composed
of four investments in insurance related companies and unamortized
organizational costs, placement fees and other start-up expenses.
The unfunded commitment remaining at December 31,1998 was
approximately $3.7 million.
The Company records its equity in the operating results of NEIV on a
quarter-lag basis.
For the year ended 1998 and for the period recorded in 1997, the
Company's equity in the net loss, net of tax, was $141,700 and $54,532,
respectively.
F-19
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
Providers' Assurance Corporation
In April 1997, the Company acquired a 34.3% economic and voting
interest in Providers' Assurance Corporation ("Providers"), a Nashville
Tennessee-based underwriting management company with a Bermuda insurance
subsidiary, for $4 million. Providers, formed in June 1995, develops and
markets workers' compensation insurance programs through joint operating
arrangements with community-based healthcare providers, and offers other
workers' compensation-related consulting services to the healthcare
community.
Under the agreements with Providers, the Company had the right to
provide certain reinsurance on insurance programs developed by Providers
during specified time periods.
In November 1998, the Company sold its interest in Providers for
approximately $1.2 million, resulting in a net realized investment loss,
net of tax, of $1.2 million, or $0.07 cents per share.
The Company recorded its equity in the operating results of
Providers on a two-month lag basis.
For the year ended December 31, 1998 and for the period recorded in
1997, the Company's equity in the net loss, net of goodwill amortization
and net of tax, was $214,000, or $0.01 per share, and $236,104, or $0.01
per share.
The Company's net premiums written and net premiums earned from
business developed by Providers were $371,175 and $310,360, respectively,
in 1998 and $344,118 and $86,030, respectively in 1997.
Sunshine State Holding Corporation
In December 1997, the Company acquired a 21.5% economic and voting
interest in Sunshine State Holding Corporation ("Sunshine State"), a newly
formed Florida-based company, for $1.4 million.
Sunshine State and its subsidiaries, which includes Sunshine State
Insurance Company, a Florida domiciled insurer, underwrite homeowners
policies in the State of Florida obtained from the Florida Residential
Property and Casualty Joint Underwriting Association in accordance with
the Market Challenge Program of the Florida Department of Insurance.
Sunshine State also insures homeowners policies produced through the open
market and offers other lines of insurance in Florida and other states. In
connection with the investment, the Company provides reinsurance for
Sunshine State. A subsidiary of XL invested in Sunshine State and will
also provide reinsurance for Sunshine State during specified periods.
The Company records its equity in the operating results of Sunshine
on a quarter-lag basis.
The Company's net premiums written and net premiums earned from
business developed by Sunshine State were $3.9 million and $4.5 million,
respectively, in 1998.
For the year ended 1998, the Company's equity in net loss, net of
tax, was $171,600, or $0.01 per share.
Investments Carried at Fair Value:
Altus Holdings, Ltd.
In March 1998, the Company purchased for $10 million an
approximately 28.3% economic interest (9.9% voting interest) in Altus
Holdings, Ltd. ("Altus"), a new Cayman Islands company formed to provide
rent-a-captive and other underwriting management services for risks of
individual corporations and insurance programs developed by insurance
intermediaries. The Company's investment was funded through two-thirds
cash and one-third through a letter of credit. The balance of the $35
million of initial capital invested in
F-20
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
Altus was contributed by Trident, XL, MMRCH and members of Altus'
management. The Company may provide reinsurance capacity for business
developed by Altus.
The Company issued a letter of credit in the amount of $5.8 million
for Trident's unfunded investment commitment in Altus for an annual fee of
$58,000, or 100 basis points on the letter of credit amount.
Annuity and Life Re (Holdings), Ltd.
In April 1998, the Company acquired for approximately $20 million a
minority interest in Annuity and Life Re (Holdings), Ltd. ("Annuity and
Life Re"), a new Bermuda-based reinsurance company formed to provide
annuity and life reinsurance. The Company coinvested with XL concurrently
with the consummation of Annuity and Life Re's initial public offering.
The Company purchased approximately 1.4 million common shares of Annuity
and Life Re and warrants to purchase at an exercise price of $15.00 per
share (the initial public offering price) an additional 100,000 common
shares. The aggregate purchase price paid by the Company was based on a
price of $14.10 for a unit consisting of one common share and certain
warrants. The Company owns approximately 5.6% of the outstanding common
shares of Annuity and Life Re following the exercise of the underwriters'
over-allotment option. Annuity and Life Re's common shares are quoted on
The Nasdaq Stock Market's National Market ("NASDAQ") under the symbol
"ALRE." The Company is subject to a one-year lock-up period and therefore
carries this investment at a discount to its current market price until
such restriction expires in April 1999.
At December 31, 1998, the Company recorded its investment in Annuity
and Life Re at the closing price reported by NASDAQ on such date less a
discount for trading restrictions.
GuideStar Health Systems, Inc.
In December 1997, the Company acquired a 2.6% economic and voting
interest in GuideStar Health Systems, Inc. ("GuideStar"), an Alabama-based
managed care organization, for $1 million.
Founded in late 1995, GuideStar provides comprehensive managed care
services to employers and individuals through strategic alliances with
selected insurance companies and health care providers. GuideStar develops
health care provider networks, and provides claims processing, customer
relations and comprehensive utilization management services.
At December 31, 1998, the Company has an additional capital
commitment of $1 million to fund GuideStar's operations.
Trident also invested in GuideStar.
Peregrine Russell Miller Insurance Fund of Asia Limited
In March 1996, the Company acquired a 44% economic interest (18%
voting interest) in the Peregrine Russell Miller Insurance Fund of Asia
Limited ("Asian Fund") for $9.0 million. The Asian Fund, based in Hong
Kong, invested in publicly traded and privately held insurance companies
incorporated or operating in Asia.
MMRCH co-invested in the Asian Fund. At December 31, 1996, the
Company had recorded its investment in the Asian Fund based on the
Company's interest in the unaudited net asset value of the Asian Fund
reported in United States dollars at November 29, 1996.
During the fourth quarter of 1997, the Asian Fund discontinued
investment operations and commenced liquidating its investments.
F-21
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
At December 31, 1997, the Company recorded a net realized investment
loss, net of tax, of $3.0 million, or $0.18 cents per share, based on the
Company's interest in the unaudited net asset value of the Asian Fund
reported in United States dollars on January 6, 1998.
In February 1998, the Company's investment in the Asian Fund was
redeemed.
Sorrento Holdings, Inc.
In October 1998, the Company purchased $5 million of Class C
Cumulative Redeemable Preferred Stock (the "Preferred C Shares") of
Sorrento Holdings, Inc. ("Sorrento"). The Preferred C Shares will accrue
interest at the rate of 6% per annum and are subject to mandatory
redemptions through December 31, 2000. Sorrento's obligation to redeem the
Preferred C Shares is secured by an irrevocable letter of credit.
Sorrento was formed by Clarendon National Insurance Company
("Clarendon") and the Arrowhead Group ("Arrowhead"), a managing agency.
Sorrento intends to form a wholly owned subsidiary, Sorrento Insurance
Company, to underwrite automobile liability and physical damage policies
produced by Arrowhead. In connection with the issuance of the Preferred C
Shares, the Company is providing reinsurance to Clarendon in respect of
automobile physical damage policies and may provide reinsurance on other
business produced by Arrowhead.
Sovereign Risk Insurance Ltd.
In July 1997, the Company acquired a 9.0% voting and economic
interest in Sovereign Risk Insurance Ltd. ("Sovereign Risk"), a newly
formed Bermuda-based managing general agency, for $237,500.
Sovereign Risk provides underwriting services for political risk
insurance coverages for the Company, ACE Insurance Company, Ltd. and a
subsidiary of XL, who are also co-investors in Sovereign Risk.
The Company's net premiums written and net premiums earned from
business developed by Sovereign Risk were $1,397,000 and $887,000,
respectively, in 1998 and $175,000 and $51,130, respectively, in 1997.
Stockton Holdings Limited
In June 1998, the Company acquired for $10 million a 1.7% interest
in Stockton Holdings Limited ("Stockton Holdings"), a Cayman Islands
insurance holding company. Stockton Holdings conducts a world-wide
reinsurance business through its wholly owned subsidiary Stockton
Reinsurance Limited, a Bermuda-based reinsurance company writing specialty
risks with a focus on finite products. The Company's investment was made
as part of a private placement by Stockton Holdings.
Terra Nova (Bermuda) Holdings, Ltd.
In October 1995, the Company acquired a 3.6% voting and economic
interest in Terra Nova (Bermuda) Holdings, Ltd. ("Terra Nova") for $8.9
million.
Terra Nova, based in Bermuda, is a holding company for two principal
operating insurance companies located in Bermuda and London that write
property and casualty reinsurance. In April 1996, Terra Nova completed the
initial public offering of its common stock, which is traded on the New
York Stock Exchange ("NYSE") under the symbol "TNA."
F-22
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
At December 31, 1998 and 1997, the Company recorded its investment
in Terra Nova at the closing price reported on the NYSE on such date.
In December 1998, the Company sold 41,000 shares of Terra Nova and
recorded a realized gain of approximately $800,000, reducing the Company's
voting and economic interest to 3.5%.
Dividend income recorded in 1998, 1997 and 1996 received from Terra
Nova was $ 213,000, $157,000 and $56,000, respectively.
TRG Associates, LLC
In October 1997, the Company acquired an 8.8% economic interest
(7.7% voting interest) in TRG Associates, LLC ("LLC"), a new limited
liability company formed for the purpose of holding all of the Class 1
common stock of TRG Holding Corporation ("TRG Holdings"), for $4,875,000.
TRG Holdings acquired all of the common stock of The Resolution Group,
Inc. ("TRG") in exchange for $150 million in cash (funded by $50 million
from the LLC and $100 million of debt incurred by TRG Holdings) and $462
million face amount of the Class 2 common stock of TRG Holdings.
TRG, located in Chicago, was formed to manage and pay off claims
liabilities on policies that insurance subsidiaries of Talegen Holdings,
Inc., a subsidiary of Xerox Corporation, had written prior to 1993. Such
liabilities include substantial amounts of claims from asbestos,
environmental and other latent exposures, which are subject to
significantly greater uncertainty than normally associated with the
establishment of claims liabilities for other exposures.
The investors in LLC are entitled to receive an annual 10% dividend
return, which is dependent upon various factors, including the adequacy of
claims liabilities, the availability of funds and the satisfaction of
certain conditions, including the required payment of interest and
principal on debt as well as board approval. Subject to additional
considerations, LLC may also share in further dividends. The Company
received a dividend of approximately $103,000 during the 1998 second
quarter, of which approximately $35,000 was reinvested in LLC.
Venton Holdings, Ltd.
In April 1996, the Company acquired a 9.9% voting and economic
interest in Venton Holdings, Ltd. ("Venton"), a Bermuda-based holding
company, which owns a managing agency at Lloyd's, London ("Lloyd's") and a
corporate capital vehicle at Lloyd's that provides dedicated underwriting
capacity. The Company's initial investment in Venton was made for a
combination of $1.1 million in cash and a $4.2 million capital
contribution commitment to Venton to fund its capital requirements at
Lloyd's. The Company's additional capital commitment was increased from
$4.2 million to $8.7 million at December 31, 1996. The Company is a
co-investor with Trident, which is a majority shareholder of Venton, and a
subsidiary of XL.
In June 1997, the Company recorded an increase of $3.4 million in
the carrying value of its investment in Venton to $4.5 million to
partially reflect the purchase price paid by the subsidiary of XL for its
20% ownership in Venton. The new carrying value was established by taking
the mid-point between the per share purchase price paid by the Company in
April 1996 and the per share purchase price paid by the subsidiary of XL
in July 1997.
In December 1997, the Company participated at its existing 9.9%
economic interest with Trident and the subsidiary of XL in a rights
offering issued by Venton. In that connection, the Company made an
additional cash investment of $3.3 million and increased its capital
contribution commitment to $13.3 million.
F-23
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Investment Information (continued)
The Company also reinsured certain Lloyd's Syndicates managed by
Venton. The Company's net premiums written and net premiums earned from
such Lloyd's Syndicates were $3.5 million and $2.4 million, respectively,
in 1998 and $11.8 million and $6.8 million, respectively, in 1997 and $2.9
million and $1.0 million, respectively, in 1996.
In October 1998, the Company sold its interest in Venton to an
independent third party and recorded a realized gain, net of tax, of $7.6
million, or $0.44 per share.
Fixed Maturities
Contractual maturities of fixed maturity securities at December 31,
1998 are shown below. Expected maturities, which are management's best
estimates, will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
(In thousands)
December 31, 1998
Estimated Fair Amortized
Value Cost
-------------- ---------
Available for sale:
Due in one year or less $ 4,117 $ 4,106
Due after one year through five years 55,113 54,293
Due after five years through 10 years 47,709 48,468
Due after 10 years 34,069 33,331
-------- --------
Sub-total 141,008 140,198
Mortgage and asset-backed securities 33,532 33,181
-------- --------
Total $174,540 $173,379
======== ========
As of December 31, 1998, the weighted average contractual and
expected maturities of the fixed maturity investments, based on fair
value, were 11.7 years and 7.7 years, respectively.
Proceeds from the sale of fixed maturity securities during 1998,
1997 and 1996 were approximately $255 million, $241 million and $227
million, respectively. Gross gains of $2,242,000, $858,000 and $1,071,000
were realized on those sales during 1998, 1997 and 1996, respectively.
Gross losses of $770,000, $583,000 and $1,430,000 were realized during
1998, 1997 and 1996, respectively.
Approximately 89% of fixed maturity investments held by the Company
at December 31, 1998 were considered investment grade by Standard & Poor's
Corporation or Moody's Investors Service, Inc.
There are no investments in any entity in excess of 10% of the
Company's stockholders' equity at December 31, 1998 other than investments
issued or guaranteed by the United States government or its agencies.
Securities Pledged and on Deposit
Securities with a carrying value of approximately $38.3 million have
been pledged as collateral for letters of credit obtained in connection
with certain reinsurance obligations of the Company (see Note 5).
At December 31, 1998, securities with a face amount of $5.8 were on
deposit with the Insurance Department of the State of Nebraska and other
states in order to comply with insurance laws.
F-24
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. Agreements with Related Parties
Investment Advisory Agreements
The Company has an investment advisory agreement with MMCI for
management of the Company's portfolios of equity securities (including
convertible securities) that are publicly traded ("Public Portfolio") and
privately held ("Private Portfolio"). The Private Portfolio includes
equity securities which at the time of acquisition do not have a readily
ascertainable market or are subject to certain trading restrictions. MMCI
is also an investment advisor to Trident, a dedicated insurance industry
private equity fund organized by MMCI and three other sponsors. MMCI's
direct parent, MMRCH, owns 1,395,625 shares, or approximately 8.2% of the
outstanding Common Stock, and Class A warrants and Class B warrants to
purchase 905,397 and 1,770,601 shares of RCHI Common Stock, respectively.
At December 31, 1998, Trident owns 250,000 shares, or approximately 1.5%
of the outstanding Common Stock, and Class A warrants to purchase
1,386,079 shares of RCHI Common Stock.
The Company pays an annual fee equal to 0.35% of the daily average
market value of the Public Portfolio. With respect to the Private
Portfolio, the Company pays an annual fee equal to the sum of (i) 1.5% per
annum on the first $250.0 million in carrying value of the Private
Portfolio and (ii) 1.0% per annum on the carrying value of the Private
Portfolio that exceeds $250.0 million. MMCI is also entitled to annual
compensation, equal to the excess, if any, of (x) 7.5% of cumulative net
realized gains including dividends, interest and other distributions,
received on the Private Portfolio over (y) cumulative compensation
previously paid in prior years on cumulative net realized gains.
The agreement has an initial term expiring on December 31, 2001 and
will be automatically renewed for successive one-year terms thereafter,
unless either party delivers written notice of termination at least one
year prior to the end of the then current term. The agreement provided for
a minimum aggregate cash fee to MMCI of $500,000 per annum through
December 31, 1997. Fees incurred under the agreement during fiscal years
1998, 1997 and 1996 were approximately $2.7 million, $1.3 million and
$686,000, respectively. In addition, in 1998, 1997 and 1996, unrealized
appreciation in the Private Portfolio is net of accrued fees of
approximately $2.2 million, $1.4 million and $443,000, respectively
The Company has an investment advisory agreement with The Putnam
Advisory Company, Inc. ("Putnam"), an affiliate of MMCI, for the
management of the Company's fixed income securities and short term cash
portfolios. For the fixed income securities portfolio, the Company pays a
fee equal to the sum of 0.35% per annum of the first $50 million of the
market value of the portfolio, 0.30% per annum on the next $50.0 million,
0.20% per annum on the next $100 million and 0.15% per annum of the market
value of assets that exceeds $200 million. For the short term cash
portfolio, the Company pays a fee equal to 0.15% per annum of the total
monthly average market value. Fees incurred under the agreement during
1998, 1997 and 1996 were approximately $461,000, $493,000, $547,000,
respectively. The agreement is subject to termination by either party upon
30 days' written notice.
Reinsurance Treaties
In addition to business assumed from insurance companies where the
Company has a private equity investment as described in Note 3, the
Company also assumed premiums written and premiums earned of $3.3 million
and $3.4 million, respectively, in 1998 and $5.5 million and $2.5 million,
respectively, in 1997 from XL, which owns 4,755,000 shares, or
approximately 27.8% of the outstanding Common Stock, and premiums written
and premiums earned of $18.5 million and $20.7 million, respectively, in
1998 and $12.3 million and $6.8 million, respectively, in 1997 from
majority-owned insurance companies of Trident.
F-25
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. Agreements with Related Parties (continued)
Other Agreements
Commencing in 1996, MMCI subleased office space from the Company for
a term expiring in October 2002. Future minimum rental income, exclusive
of escalation clauses and maintenance costs, under the remaining term of
the sublease will be approximately $1,648,000. Rental income for 1998,
1997 and 1996 was $430,000, $430,000 and $264,000, respectively.
In addition in 1998 and 1997, MMCI reimbursed the Company
approximately $11,000 and $530,000 (net of $89,000 and $44,000 for certain
sublease income allocated to MMCI) for their pro-rata share of improvement
and maintenance costs under the sublease.
5. Commitments
Lease Agreement
The Company has a sublease agreement for office facilities for a
term expiring in October 2002. Future minimum rental charges under the
remaining term of the sublease, exclusive of escalation clauses and
maintenance costs and net of rental income, are as follows:
(In thousands)
--------------
1999 $576
2000 574
2001 572
2002 476
------
$2,198
======
During 1998, 1997 and 1996, rental expense, net of income from
subleases, was approximately $576,000, $643,000 and $613,000,
respectively.
Letters of Credit
At December 31, 1998, the Company is obligated under letters of
credit in an aggregate amount of approximately $33.3 million, which secure
certain of the Company's reinsurance obligations and investment
commitments (see Note 3).
Severance Arrangements
The Company has a program for all employees that provides for
certain severance payments and continuation of benefits in the event of
termination of employment resulting from a change in control. The extent
of such payments depends on the position of the employee.
Employment Agreements
The Company has employment agreements with its executive officers.
One of these agreements has a five-year term initially expiring in
September 2000, and the remaining agreements may be terminated upon notice
by either party. These agreements provide for compensation in the form of
base salary, annual bonus, stock-based awards under the Stock Plan (as
hereinafter defined), participation in the Company's employee benefit
programs and the reimbursement of certain expenses. Under one of the
agreements, the Company guaranteed loans in the amount of $500,000 made to
an executive by a financial institution to fund such executive's purchase
of 25,000 shares of Common Stock and related tax liability under such
stock's vesting provisions. In connection with such guarantee, the Company
is entitled to customary subrogation rights.
F-26
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6. Claims and Claims Expenses
The reconciliation of claims and claims expense reserves is as follows:
(In thousands)
December 31,
1998 1997 1996
--------- --------- ---------
At beginning of year:
Gross claims and claims expense reserves $ 70,768 $ 20,770 --
Reinsurance recoverables 522 --
--------- --------- ---------
Net claims and claims expense reserves 70,768 20,248 --
Net claims and claims expenses incurred relating to:
Current year 178,957 73,385 $ 24,079
Prior year (2,832) 22 --
--------- --------- ---------
Total 176,125 73,407 24,079
Net paid claims and claims expenses incurred relating to:
Current year 41,910 13,649 3,831
Prior year 18,794 9,238 --
--------- --------- ---------
Total 60,704 22,887 3,831
At end of year:
Net claims and claims expense reserves current year 186,189 70,768 20,248
Reinsurance recoverables 30,468 -- 522
--------- --------- ---------
Gross claims and claims expense reserves $ 216,657 $ 70,768 $ 20,770
========= ========= =========
The Company believes that its exposure, if any, to environmental
impairment liability and asbestos-related claims is minimal since no
business has been written for periods prior to 1996.
Subject to the following, the Company believes that the reserves for
claims and claims expenses are adequate to cover the ultimate cost of
claims and claims expenses incurred through December 31, 1998. The
reserves are based on estimates of claims and claims expenses incurred
and, therefore, the amount ultimately paid may be more or less than such
estimates. The inherent uncertainties of estimating claims and claims
expense reserves are exacerbated for reinsurers by the significant periods
of time (the "tail") that often elapse between the occurrence of an
insured claim, the reporting of the claim to the primary insurer and,
ultimately, to the reinsurer, and the primary insurer's payment of that
claim and subsequent indemnification by the reinsurer. As a consequence,
actual claims and claims expenses paid may deviate, perhaps substantially,
from estimates reflected in the Company's reserves reported in its
financial statements. The estimation of reserves by new reinsurers, such
as the Company, may be less reliable than the reserve estimations of a
reinsurer with an established volume of business and claims history. To
the extent reserves prove to be inadequate, the Company may have to
augment such reserves and incur a charge to earnings. Such a development,
could occur and result in a material charge to earnings or stockholders
equity in future periods (see Note 14 Subsequent Events).
7. Retrocession Agreements
The Company utilizes retrocession agreements for the purpose of
limiting its exposure with respect to multiple claims arising from a
single occurrence or event. The Company also participates in "common
account" retrocessional arrangements for certain treaties. Such
arrangements reduce the effect of individual or aggregate losses to all
companies participating on such treaties including the reinsurer, such as
the Company, and the ceding company.
F-27
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7. Retrocession Agreements (continued)
Reinsurance recoverables are recorded as assets, predicated on the
retrocessionaires' ability to meet their obligations under the
retrocessional agreements. If the retrocessionaires are unable to satisfy
their obligations under the agreements, the Company would be liable for
such defaulted amounts.
The effects of reinsurance on written and earned premiums and claims
and claims expenses are as follows:
(In thousands)
Years Ended December 31,
1998 1997 1996
-------- -------- --------
Assumed premiums written $260,566 $147,878 $ 73,685
Ceded premiums written 25,831 3,044 1,153
-------- -------- --------
Net premiums written $234,735 $144,834 $ 72,532
======== ======== ========
Assumed premiums earned $232,025 $110,992 $ 36,337
Ceded premiums earned 25,831 3,620 576
-------- -------- --------
Net premiums earned $206,194 $107,372 $ 35,761
======== ======== ========
Assumed claims and claims expenses incurred $210,006 $ 73,407 $ 24,601
Ceded claims and claims expenses incurred 33,881 522
-------- -------- --------
Net claims and claims expenses incurred $176,125 $ 73,407 $ 24,079
======== ======== ========
At December 31, 1998, the Company's balance sheet reflects
reinsurance recoverable balances as follows:
(In thousands)
December 31,
1998 1997
-------- --------
Reinsurance recoverable balances:
Unpaid claims and claim expenses $ 31,087
Ceded balances payable (5,396) ($ 211)
-------- --------
Reinsurance balances, net $ 25,691 ($ 211)
======== ========
Reinsurance recoverable on unearned premium -- --
======== ========
8. Employee Benefits and Compensation Arrangements
1995 Long Term Incentive and Share Award Plan
In September 1995, the Company adopted the 1995 Long Term Incentive
and Share Award Plan (the "Stock Plan") which is administered by the
Compensation Committee of the Board of Directors. The Company may grant,
subject to certain restrictions, stock options, stock appreciation rights,
restricted shares, restricted share units payable in shares of Common
Stock or cash, stock awards in lieu of cash awards, and other stock-based
awards to eligible employees of the Company. Awards relating to not more
than 1,700,000 shares of Common Stock may be made over the five-year term
of the Stock Plan.
F-28
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. Employee Benefits and Compensation Arrangements (continued)
Restricted Stock
During 1998, 1997 and 1996, the Company granted an aggregate of
15,700, 24,000, 76,000 shares, respectively, of restricted stock under the
Stock Plan. Grants of restricted stock generally vest at a rate of 20% per
year over five years commencing on the first anniversary of the date of
grant. The Company records a deferred expense equal to the market value of
the shares at the date of grant which is amortized and charged to income
over the vesting period. The deferred expense was $296,000, $506,000 and
$1,487,000, and the amortization of the deferred expense was $1,012,000,
$1,687,000, and $1,969,000, for 1998, 1997 and 1996, respectively.
Stock Options
The Company issues incentive stock options and/or non-qualified
stock options at fair market values at the grant dates to officers and
non-employee directors. Options to officers generally vest and become
exercisable at a rate of 20% per year over five years from the date of
grant. Incentive stock options expire ten years after the grant date and
non-qualified stock options expire seven years after vesting. Initial
options granted to non-employee directors vest and become exercisable in
three equal installments, commencing on the date of grant and annually
thereafter. Annual options granted to non-employee directors in office on
January 1 of each year vest on the first anniversary of the date the
option is granted.
Information relating to the Company's stock options is set forth
below:
Years Ended December 31,
1998 1997 1996
---------- ---------- ----------
Number of options
Outstanding, beginning of year 960,650 628,950 192,700
Granted 410,825 371,700 436,350
Canceled (20,580) (39,500) --
Exercised (3,820) (500) (100)
Outstanding, end of year 1,347,075 960,650 628,950
Exercisable, end of year 358,884 178,611 39,500
Average exercise price
Granted $ 22.47 $ 22.86 $ 17.98
Canceled $ 20.97 $ 17.63 --
Exercised $ 19.24 $ 17.63 $ 20.00
Outstanding, end of year $ 21.00 $ 20.38 $ 18.74
Exercisable, end of year $ 19.85 $ 19.32 $ 20.43
Exercise prices for options outstanding at December 31, 1998 ranged
from $16.38 to $24.94. The weighted average remaining contractual life of
these options is approximately 8.5 years.
F-29
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. Employee Benefits and Compensation Arrangements (continued)
Employee Stock Purchase Plan
Effective December 1, 1995, the Company established a tax-qualified
employee stock purchase plan (the "Purchase Plan"). An aggregate of
120,000 shares of Common Stock have been reserved for issuance under the
Purchase Plan. Eligible employees may elect to participate in an annual
offering period under the Purchase Plan by authorizing after-tax payroll
deductions of up to 20% (in whole percentages) of their eligible
compensation for the purchase of shares of Common Stock at 85% of the
lesser of the market value per share of the Common Stock at the beginning
or end of the annual offering period, subject to certain restrictions.
During 1998, 1997 and 1996, employees purchased approximately 18,638,
14,100 and 14,000 shares, respectively, of Common Stock under the Purchase
Plan.
Pro Forma Information
Pro forma information regarding net income and earnings per share is
required by FASB Statement No. 123. Such information has been determined
for the Company as if the Company has accounted for its employee stock
options under the fair value method of this Statement. The fair value for
the Company's employee stock options has been estimated at the date of
grant using a Black-Scholes option valuation model, with the following
weighted-average assumptions for options issued in 1998, 1997 and 1996,
respectively; (i) dividend yield: 0.0%; (ii) volatility factor: 25.0%;
(iii) average expected option life of six years for all years; and (iv)
risk free interest rates of 4.9%, 5.8%, and 6.0% respectively. The
weighted-average fair value of options granted for the years ended
December 31, 1998, 1997 and 1996 was $3.3 million, $3.2 million and $3.0
million, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option valuation
models, such as the Black-Scholes model, require the input of highly
subjective assumptions (particularly with respect to the Company, which
has a limited stock-trading history), including expected stock price
volatility. As the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes
in the subjective input assumptions can materially affect the fair value
estimate, the Company believes that the existing option valuation models,
such as the Black-Scholes model, may not necessarily provide a reliable
single measure of the fair value of employee stock options.
For purposes of the required pro forma information, the estimated
fair value of employee stock options is amortized to expense over the
options' vesting period. The Company's pro forma information regarding net
income and earnings per share follows:
(In thousands, except per share data)
Years Ended December 31,
1998 1997 1996
--------- --------- ---------
Net income, as reported $ 3,091 $ 2,039 $ 4,112
Pro forma net income $ 1,633 $ 994 $ 3,569
Earnings per share as reported:
Basic $ 0.18 $ 0.12 $ 0.24
Diluted $ 0.17 $ 0.12 $ 0.24
Pro forma earnings per share:
Basic $ 0.10 $ 0.06 $ 0.21
Diluted $ 0.09 $ 0.06 $ 0.21
The effects of applying FASB 123 as shown in the pro forma
disclosures may not be representative of the effects on reported net
income for future years.
F-30
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. Employee Benefits and Compensation Arrangements (continued)
The effect on net income and earnings per share after applying FASB
Statement No. 123's fair valuation method to stock issued to employees
under the Purchase Plan does not materially differ from the pro forma
information set forth above with respect to the Company's employee stock
options.
Retirement Plans
Effective as of January 1, 1996, the Company adopted a
tax-qualified, non-contributory defined contribution money purchase
pension plan (the "Pension Plan") under which the Company contributes for
each eligible employee an amount equal to the sum of (i) 4% of eligible
compensation up to the taxable wage base (as such term is defined in the
Pension Plan; for 1998, 1997 and 1996, amounts were set at $68,400,
$65,400 and $62,700, respectively) and (ii) 8% of eligible compensation in
excess of the taxable wage base (up to the applicable compensation limit
(the "compensation limit") imposed by Section 401(a)(17) of the Internal
Revenue Code of 1986, as amended (the "Code"), which for 1998 and 1997 was
$160,000, and for 1996 was $150,000). Substantially all employees of the
Company are eligible for participation in the Pension Plan. In 1998, 1997
and 1996, the Company expensed $215,000, $168,000 and $90,000,
respectively, related to the Pension Plan.
Effective as of January 1, 1996, the Company adopted a
tax-qualified, employee savings plan (the "Savings Plan"). Pursuant to
Section 401(k) of the Code, eligible employees of the Company are able to
make deferral contributions of up to 15% of their eligible compensation,
subject to limitations under applicable law. The Company matches 100% of
the first 3% of eligible compensation deferred by employees and 50% of the
next 3% of eligible compensation so deferred. Substantially all employees
of the Company are eligible for participation in the Savings Plan. In
1998, 1997 and 1996, the Company expensed $165,000, $123,000 and $75,000,
respectively, related to the Savings Plan.
Effective as of January 1, 1996, the Company adopted a supplemental,
non-qualified executive savings and retirement plan (the "Supplemental
Plan") under which the Company contributes 8% of eligible compensation in
excess of the compensation limit for eligible officers of the Company.
Participants may also defer certain amounts of eligible base compensation
and bonus. Under the Supplemental Plan, the Company matches 100% of the
first 3% of eligible base compensation in excess of the compensation limit
that is deferred by participants under the Supplemental Plan, and provides
a 50% matching contribution for the next 3% of such excess eligible
compensation so deferred. In 1998, 1997 and 1996, the Company expensed
$85,000, $74,000 and $46,000, respectively, related to the Supplemental
Plan.
9. Income Taxes
RCHI, Risk Capital Reinsurance and Cross River file a consolidated
federal income tax return and have a tax sharing agreement (the "Tax
Sharing Agreement"), allocating the consolidated income tax liability on a
separate return basis. Pursuant to the Tax Sharing Agreement, Risk Capital
Reinsurance and Cross River make tax sharing payments to RCHI based on
such allocation.
The provision for federal income taxes has been determined on the
basis of a consolidated tax return consisting of RCHI, Risk Capital
Reinsurance and Cross River.
F-31
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
9. Income Taxes (continued)
An analysis of the Company's effective tax rate for the years ended
December 31, 1998, 1997 and 1996 is as follows:
(In thousands)
Years Ended December 31,
1998 1997 1996
------- ------- -------
Amount Amount Amount
------- ------- -------
Income taxes computed on pre-tax income $ 1,562 $ 663 $ 1,614
Reduction in income taxes resulting from:
Tax-exempt investment income (582) (524) (979)
Dividend received deduction (896) (650) (341)
Other 151 173 43
------- ------- -------
Income tax expense (benefit) on pre-tax income $ 235 ($ 338) $ 337
======= ======= =======
The Company's current federal tax expense (benefit) for 1998, 1997
and 1996 was based on regular taxable income. Federal income taxes paid in
1998, 1997 and 1996 were $5.3 million, $1.4 million and $1.7 million,
respectively.
The net deferred income tax liability reflects temporary differences
between the carrying amounts of assets and liabilities for financial
reporting and income tax purposes, net of a valuation allowance for any
portion of the deferred tax asset that management believes will not be
realized. Significant components of the Company's deferred income tax
assets and liabilities as of December 31, 1998 and 1997 were as follows:
(In thousands)
December 31,
1998 1997
-------- --------
Deferred income tax assets:
Net claim reserve discount $ 10,176 $ 4,036
Net unearned premium reserve 7,194 5,197
Compensation liabilities 622 675
Foreign currency 84 239
Equity in net loss of investees, net 2,328 190
-------- --------
Total deferred tax assets 20,404 10,337
-------- --------
Deferred income tax liabilities:
Deferred policy acquisition cost (8,230) (6,052)
Unrealized appreciation of investments (25,328) (29,348)
Other (28) (27)
-------- --------
Total deferred tax liabilities (33,586) (35,427)
-------- --------
Net deferred income tax liability ($13,182) ($25,090)
======== ========
F-32
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10. Statutory Information
The Insurance Department of the State of Nebraska issued to Risk
Capital Reinsurance its domiciliary insurance license on November 6, 1995.
Statutory net income and surplus of Risk Capital Reinsurance, as reported
to insurance regulatory authorities, differ in certain respects from the
amounts prepared in accordance with GAAP. The following tables reconcile
statutory net income and surplus of Risk Capital Reinsurance to
consolidated GAAP net income and stockholders' equity:
(In thousands)
Years Ended December 31,
1998 1997 1996
-------- -------- --------
Net Income:
Risk Capital Reinsurance
Statutory net income (loss) ($11,973) ($ 5,649) ($ 4,636)
GAAP adjustments:
Dividend Income (2,635)
Deferred acquisition costs 6,223 10,273 7,018
Realized loss 5,258 (4,601)
Deferred income taxes 7,277 2,099 1,810
Equity in net loss of investees (1,136) (192) (161)
-------- -------- --------
GAAP net income 3,014 1,930 4,031
RCHI (parent company only) operations 77 109 81
-------- -------- --------
Consolidated GAAP net income $ 3,091 $ 2,039 $ 4,112
======== ======== ========
(In thousands)
December 31,
1998 1997
--------- ---------
Stockholders' Equity:
Statutory surplus $ 358,702 $ 385,007
Deferred acquisition costs 23,515 17,292
Unrealized appreciation 4,579 7,464
Deferred income tax liability, net (13,164) (25,079)
Non-admitted assets 11,489 4,899
--------- ---------
Investment in Risk Capital Reinsurance, GAAP 385,121 389,583
RCHI (parent company only):
Other net assets 12,881 11,448
--------- ---------
Consolidated stockholders' equity, GAAP $ 398,002 $ 401,031
========= =========
RCHI is a holding company and has no significant operations or
assets other than its ownership of all of the capital stock of Risk
Capital Reinsurance. RCHI will rely on cash dividends and distributions
from Risk Capital Reinsurance to pay any cash dividends to stockholders of
RCHI and to pay any operating expenses that RCHI may incur. The payment of
dividends by RCHI will be dependent upon the ability of Risk Capital
Reinsurance to provide funds to RCHI. The ability of Risk Capital
Reinsurance to pay dividends or make distributions to RCHI is dependent
upon Risk Capital Reinsurance's ability to achieve satisfactory
underwriting and investment results and to meet certain regulatory
standards of the State of Nebraska. There are presently no contractual
restrictions on the payment of dividends or the making of distributions by
Risk Capital Reinsurance to RCHI.
F-33
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
10. Statutory Information (continued)
Nebraska insurance laws provide that, without prior approval of the
Nebraska Director of Insurance ("Nebraska Director"), Risk Capital
Reinsurance cannot pay a dividend or make a distribution (together with
other dividends or distributions paid during the preceding 12 months) that
exceeds the greater of (i) 10% of statutory surplus as of the preceding
December 31 ($358.7 million as of December 31, 1998) or (ii) statutory net
income from operations from the preceding calendar year not including
after tax realized capital gains ($25.0 million loss for 1998). Net income
(exclusive of realized capital gains) not previously distributed or paid
as dividends from the preceding two calendar years may be carried forward
for dividends and distribution purposes. Any proposed dividend or
distribution in excess of such amount is called an "extraordinary"
dividend or distribution and may not be paid until either it has been
approved, or a 30-day waiting period has passed during which it has not
been disapproved, by the Nebraska Director. Notwithstanding the foregoing,
Nebraska insurance laws provide that any distribution that is a dividend
may only be paid out of earned surplus arising from its business, which is
defined as unassigned funds (surplus) as reported in the statutory
statement for the most recent years ($30.6 million as of December 31,
1998). In addition, Nebraska insurance laws also provide that any
distribution that is a dividend and that is in excess of Risk Capital
Reinsurance's unassigned funds, exclusive of any surplus arising from
unrealized capital gains or revaluation of assets ($32.8 million deficit
as of December 31, 1998) will be deemed an "extraordinary" dividend
subject to the foregoing requirements. Therefore, Risk Capital Reinsurance
cannot make a distribution that is a dividend without the prior approval
of the Nebraska Director during 1999.
Nebraska insurance laws also require that the statutory surplus of
Risk Capital Reinsurance following any dividend or distribution be
reasonable in relation to its outstanding liabilities and adequate to its
financial needs. In addition, Nebraska insurance laws require that each
insurer give notice to the Nebraska Director of all dividends and other
distributions within five business days following declaration thereof and
that any such dividend or other distribution may not be paid within 10
business days of such notice (the "Notice Period") unless for good cause
shown the Nebraska Director has approved such payment within the Notice
Period.
11. Business Information
As discussed in Note 2, the Company provides property casualty
reinsurance to insurance and reinsurance companies and other forms of
capital and makes investments in insurance and insurance-related entities
on a global basis. The Company operates from one domestic location in
Greenwich, Connecticut.
During 1998, one client company contributed approximately $42 million,
or 18%, of net premiums written and $36.6 million, or 17.8%, of net
premiums earned. For the 1997 year, that client company contributed $25.9
million, or 18%, of net premiums written, and $15.1 million, or 14%, of net
premiums earned.
The following lists individual broker business greater than 10% of
the 1998 year's net premiums written with comparative amounts for the
years ended 1997 and 1996, respectively:
F-34
Net Premiums Written
1998 1997 1996
------ ------ ------
Balis & Co., Inc. (1) 23.7% 22.7% 8.4%
Guy Carpenter & Co. (1) 11.3% 11.0% 7.2%
Cecar & Jutheau S. A. (1) 13.7%
Aon Group 16.5% 19.1% 21.9%
E.W. Blanch 10.9% 9.3%
U.S. Re Corp. 25.0%
------ ------ ------
Total 62.4% 62.1% 76.2%
====== ====== ======
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(1) In addition, approximately 8.2%, 13.6% and 11.7% of net premiums
written in 1998, 1997 and 1996, respectively, were produced by other
brokers who are affiliated with Marsh & McLennan Companies, Inc.
11. Business Information (continued)
Net premiums written and earned recorded from client companies which
are Lloyd's syndicates or are located in the United Kingdom, Bermuda and
Continental Europe (some which are denominated in United States dollars)
were:
1998 1997 1996
---------------------- ---------------------- ----------------------
Net Premiums Net Premiums Net Premiums
Written Earned Written Earned Written Earned
-------- ------- ------- ------ ------- ------
Non U.S. Premiums $76.1 $65.9 $40.1 $25.8 $21.8 $ 4.6
% of Total 32.4% 32.0% 27.7% 24.0% 30.1% 12.8%
F-35
12. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
(In thousands, except share data)
Years Ended December 31,
1998 1997 1996
----------- ----------- -----------
Basic Earnings Per Share:
Net income $ 3,091 $ 2,039 $ 4,112
Divided by:
Weighted average shares
outstanding for the period 17,065,165 17,032,601 16,981,724
Basic earnings per share $ 0.18 $ 0.12 $ 0.24
Diluted Earnings Per Share:
Net income $ 3,091 $ 2,039 $ 4,112
Divided by:
Weighted average shares
outstanding for the period 17,065,165 17,032,601 16,981,724
Effect of dilutive securities:
Warrants 581,327 24,836
Employee stock options 71,731 28,351 2,185
----------- ----------- -----------
Total shares 17,718,223 17,085,788 16,983,909
=========== =========== ===========
Diluted earnings per share $ 0.17 $ 0.12 $ 0.24
Certain employee stock options to purchase 22,750, 448,250 and
251,850 shares of Common Stock at per share prices averaging $23.61,
$22.62 and $20.40 were outstanding as of December 31, 1998, 1997 and 1996,
respectively. These options were not included in the computation of
diluted earnings per share because the options' average exercise prices
were greater than the average market prices of the Common Stock of $23.00,
$20.11 and $18.99 for the years ended December 31, 1998, 1997 and 1996. In
addition, warrants to purchase 4,451,680 shares of Common Stock at $20 per
share were outstanding as of December 31, 1998, 1997 and 1996 but were not
included in the computation of diluted earnings per share for the year
ended December 31, 1996 because the warrants' exercise price was greater
than the average market price of the Common Stock for such year.
F-36
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13. Quarterly Financial Information (Unaudited)
The following is a summary of unaudited quarterly financial data,
restated where applicable, to conform to FASB Statement No. 128:
(In thousands, except per share data)
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
December 31, September 30, June 30, March 31,
1998 1998 1998 1998
---------- ---------- ---------- ----------
Income Statement Data:
Net premiums written $ 71,163 $ 66,628 $ 52,536 $ 44,408
Net premiums earned 63,545 52,670 48,477 41,502
Net investment income 3,757 3,995 4,331 3,604
Net realized investment gains
(losses) 25,606 (425) 2,870 477
Operating expenses 80,808 (65,334) 51,756 44,773
Equity in net income (loss) of
investees (1,103) (1,046) 257 756
Net income (loss) 4,994 (6,631) 3,159 1,569
Comprehensive Income (loss) $ 2,350 ($ 20,622) ($ 2,871) $ 16,768
Statutory Composite Ratio: 124.4% 123.8% 107.8% 105.9%
Per Share Data:
Net Income (loss)
Basic $ 0.29 ($ 0.39) $ 0.19 $ 0.09
Diluted $ 0.29 ($ 0.39) $ 0.18 $ 0.09
Comprehensive Income (loss)
Basic $ 0.14 ($ 1.21) ($ 0.17) $ 0.98
Diluted $ 0.14 ($ 1.21) ($ 0.17) $ 0.95
Stockholders' equity per share
Basic $ 23.29 $ 23.15 $ 24.35 $ 24.50
Diluted $ 22.75 $ 22.54 $ 23.01 $ 23.36
Common Stock Prices:
High $ 23.75 $ 25.50 $ 25.50 $ 24.00
Low $ 18.81 $ 19.00 $ 22.75 $ 19.75
Close $ 21.75 $ 22.00 $ 24.94 $ 24.00
F-37
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13. Quarterly Financial Information (Unaudited)
(In thousands, except per share data)
Quarter Quarter Quarter
Ended Ended Ended Quarter
December 31, September 30, June 30, Ended
1997 1997 1997 March 31, 1997
------------ ------------- -------- --------------
Income Statement Data:
Net premiums written $ 45,972 $ 34,906 $ 30,090 $ 33,866
Net premiums earned 41,744 24,655 19,901 21,072
Net investment income 3,586 3,798 3,525 3,451
Net realized investment gains
(losses) (4,377) 4,062 (420) (25)
Operating expenses 44,505 27,655 22,523 24,396
Equity in net income (loss) of
investees 281 (168) (215) (90)
Net income (loss) (1,758) 3,255 344 198
Comprehensive income (loss) $ 4,340 $ 16,646 $ 21,362 $ 4,759
Statutory Composite Ratio: 106.6% 107.3% 104.4% 107.6%
Per Share Data:
Net Income
Basic ($ 0.10) $ 0.19 $ 0.02 $ 0.01
Diluted ($ 0.10) $ 0.19 $ 0.02 $ 0.01
Comprehensive income (loss)
Basic ($ 0.25) $ 0.98 $ 1.25 ($ 0.28)
Diluted ($ 0.25) $ 0.95 $ 1.25 ($ 0.28)
Primary and fully-diluted as
previously reported: ($ 0.10) $ 0.19 $ 0.02 $ 0.01
Stockholders' equity per share
Basic $ 23.51 $ 23.26 $ 22.26 $ 21.00
Diluted $ 22.79 $ 22.35 $ 21.91 $ 21.00
Common Stock Prices:
High $ 23.38 $ 23.38 $ 21.00 $ 19.25
Low $ 20.88 $ 20.50 $ 16.00 $ 16.13
Close $ 22.25 $ 23.00 $ 21.00 $ 17.00
F-38
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Subsequent Events
During 1998, the Company recorded after-tax underwriting losses
totaling $18.2 million from claims, claims expenses, commissions and
brokerage, net of earned premiums, from the following three sources:
satellite business ($8.3 million); casualty reinsurance provided by the
Company on business produced by a certain managing underwriting agency
($6.6 million); and a property loss on a finite risk treaty ($3.3
million).
In March 1999, the Company was notified of additional satellite
losses pertaining to 1998 in the amount of approximately $4 million,
after-tax, that will be recorded in the first quarter of 1999. In order to
mitigate the impact of possible future loss activity, in the fourth
quarter of 1998, the Company commenced the process of re-underwriting and
reducing its satellite business and seeking additional retrocessional
protection. There can be no assurances that any such retrocessional
protection, if purchased, will be sufficient to preclude the occurrence of
additional underwriting losses.
Based on a review of additional claims information and its
continuing underwriting and actuarial analysis of the business produced by
the managing underwriting agency, the Company expects to record additional
after-tax underwriting losses of approximately $18 million in the first
quarter of 1999 from claims, claims expenses, commissions and brokerage,
net of earned premium, relating to reinsurance on business produced by the
managing underwriting agency.
Total estimated ultimate premiums for all business produced on
behalf of the Company by the managing underwriting agency, including
policies that have expired and policies that will expire in 1999 and 2000,
are approximately $26 million, of which $17 million and $13 million,
respectively, were recorded as net premiums written and net premiums
earned through December 31, 1998. Substantially all of the remaining $9
million and $13 million, respectively, of net premiums written and net
premiums are expected to be recorded in the first quarter of 1999. The
Company has discontinued its underwriting relationship with the managing
underwriting agency.
Therefore, the total after-tax underwriting losses that will be
recorded in the first quarter of 1999 generated from reinsurance on
satellite risks and business produced by the managing underwriting agency
will be approximately $22 million. While such loss estimate represents the
Company's current expectation based on all information available to the
Company to date, there can be no assurances that the actual amount will
not differ from such estimate due to the inherent uncertainties of
estimating reserves.
While the Company believes that it is taking adequate steps to reduce
its exposure to losses from its satellite business and business produced by
the managing underwriting agency, there can be no assurances that such
business will not continue to generate additional underwriting losses in
the future or that significant loss activity will not develop from other
areas of the Company's underwriting or other activities.
F-39
Report of Independent Accountants on
Financial Statement Schedules
To the Board of Directors and Stockholders of
Risk Capital Holdings, Inc.
Our audit of the consolidated financial statements referred to in our report
dated January 29, 1999, except as to Note 14, which is as of March 25, 1999
appearing on Page F-2 of this Annual Report on Form 10-K also included an audit
of the Financial Statement Schedules listed on Page F-1 of this Form 10-K. In
our opinion, these Financial Statement Schedules present fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.
PricewaterhouseCoopers LLP
New York, New York
January 29, 1999, except as to Note 14,
which is as of March 25, 1999
S-1
SCHEDULE I
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
(In thousands)
December 31, 1998
--------------------------------------
Amount
at Which
Shown in
Amortized Fair the Balance
Cost Value Sheet
--------- -------- -----------
Type of Investment:
FIXED MATURITY SECURITIES
U.S. government and government
agencies and authorities $ 38,737 $ 39,283 $ 39,283
Foreign governments 194 196 196
Mortgage and asset-backed securities 33,181 33,532 33,532
States, municipalities and political subdivisions 44,091 45,273 45,273
Corporate bonds 57,176 56,256 56,256
-------- -------- --------
Total Fixed Maturities 173,379 174,540 174,540
EQUITY SECURITIES
Publicly traded 110,598 154,678 154,678
Privately held 109,966 137,091 137,091
-------- -------- --------
Total Equity Securities 220,564 291,769 291,769
SHORT-TERM INVESTMENTS 108,809 108,809 108,809
-------- -------- --------
Total Investments $502,752 $575,118 $575,118
======== ======== ========
S-2
SCHEDULE II
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEET
(Parent Company Only)
(Dollars in thousands)
December 31,
-------------------------
1998 1997
--------- ---------
Assets
Investment in wholly owned subsidiary $ 385,121 $ 389,583
Fixed maturities (amortized cost: $8,007) 8,057 7,043
Short-term investments 1,149 2,073
Cash 3,415 1,471
Due from subsidiary 813
Other assets 411 268
--------- ---------
Total Assets $ 398,153 $ 401,251
========= =========
Liabilities
Accounts payable and other liabilities 151 220
Stockholders' Equity
Preferred stock, $0.01 par value:
20,000,000 shares authorized (none issued)
Common stock, $0.01 par value:
80,000,000 shares authorized
(issued: 1998, 17,102,503; 1997, 17,069,845) 171 171
Additional paid-in capital 341,878 341,162
Accumulated other comprehensive income consisting of unrealized
appreciation of investments, net of income tax 47,038 54,504
Deferred compensation under stock award plan (1,062) (1,778)
Retained earnings 10,261 7,170
Less treasury stock at cost (1998, 15,065; 1997, 11,383 shares) (284) (198)
--------- ---------
Total Stockholders' Equity 398,002 401,031
--------- ---------
Total Liabilities and Stockholders' Equity $ 398,153 $ 401,251
========= =========
S-3
SCHEDULE II
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (continued)
Statement of Income
(Parent Company Only)
(Dollars In thousands)
Years Ended December 31,
1998 1997 1996
------ ------ ------
Revenues
Net investment income $ 631 $ 524 $ 317
Operating Costs and Expenses
Operating expenses 513 357 193
------ ------ ------
Income before income tax expense 118 167 124
Income tax expense 41 58 43
------ ------ ------
Net income before equity in net income of
wholly owned subsidiary 77 109 81
Equity in net income of wholly owned subsidiary 3,014 1,930 4,031
------ ------ ------
Net income 3,091 2,039 4,112
Other Comprehensive Income, Net of Tax
Change in net unrealized appreciation, of
investments, net of tax 12 21
------ ------ ------
Comprehensive Income $3,103 $2,060 $4,112
====== ====== ======
S-4
SCHEDULE II
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (continued)
Statement of Cash Flows
(Parent Company Only)
(In thousands)
Years Ended December 31,
1998 1997 1996
-------- -------- --------
Operating Activities
Net income from operations $ 77 $ 109 $ 81
Adjustments to reconcile net income to net cash
used for operating activities:
Net change in other assets and liabilities 226 (650) 723
-------- -------- --------
Net Cash Provided By (Used For) Operating Activities 303 (541) 804
Investing Activities:
Purchases of fixed maturities (4,999) (11,014)
Sales of fixed maturities 4,000 4,000
Net change in short-term investments 1,005 4,697 (905)
-------- -------- --------
Net Cash (Used For) Investing Activities 6 (2,317) (905)
Financing Provided By Activities:
Common stock issued 716 727 1,699
Purchase of treasury shares (86) (197)
Deferred compensation on restricted stock awarded (296) (506) (1,487)
Amortization of deferred compensation collected 1,302 3,367 454
-------- -------- --------
Net Cash Provided By Financing Activities 1,636 3,391 666
Increase in cash 1,945 533 565
Cash at beginning of period 1,471 938 373
-------- -------- --------
Cash at end of period $ 3,416 $ 1,471 $ 938
======== ======== ========
S-5
SCHEDULE III
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
Future
Policy
Benefits,
Deferred Losses,
Policy Claims and
Acquisition Claims Unearned Premium
Costs Expenses Premiums Revenue
----------- ----------- -------- --------
December 31, 1998
Property-Casualty $23,515 $186,189 $102,775 $206,195
Accident and Health
------- -------- -------- --------
Total $23,515 $186,189 $102,775 $206,195
======= ======== ======== ========
December 31, 1997
Property-Casualty $17,292 $ 70,768 $ 74,234 $107,372
Accident and Health
------- -------- -------- --------
Total $17,292 $ 70,768 $ 74,234 $107,372
======= ======== ======== ========
December 31, 1996
Property-Casualty $ 7,018 $ 20,770 $ 37,348 $ 35,761
Accident and Health
------- -------- -------- --------
Total $ 7,018 $ 20,770 $ 37,348 $ 35,761
======= ======== ======== ========
Benefits,
Claims, Amortization of
Net Losses and Deferred Policy Other
Investment Settlement Acquisition Operating Premiums
Income Expenses Costs Expenses Written
---------- ---------- --------------- --------- --------
December 31, 1998
Property-Casualty $15,687 $176,125 $50,537 $16,452 $234,735
Accident and Health
------- -------- ------- ------- --------
Total $15,687 $176,125 $50,537 $16,452 $234,735
======= ======== ======= ======= ========
December 31, 1997
Property-Casualty $14,360 $ 73,407 $31,467 $13,523 $144,834
Accident and Health
------- -------- ------- ------- --------
Total $14,360 $ 73,407 $31,467 $13,523 $144,834
======= ======== ======= ======= ========
December 31, 1996
Property-Casualty $13,151 $ 24,079 $10,197 $11,285 $ 72,532
Accident and Health
------- -------- ------- ------- --------
Total $13,151 $ 24,079 $10,197 $11,285 $ 72,532
======= ======== ======= ======= ========
S-6
SCHEDULE IV
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARY
REINSURANCE
(In thousands)
Ceded to Assumed From Percentage of
Gross Other Other Amount Assumed
Amount Companies Companies Net Amount to Net
-------- --------- ------------ ---------- --------------
December 31, 1998
Premiums Written:
Property and Casualty $ 25,831 $260,566 $234,735 111.0%
Accident and Health
-------- -------- -------- -------- --------
Total $ 25,831 $260,566 $234,735 111.0%
======== ======== ======== ======== ========
December 31, 1997
Premiums Written:
Property and Casualty $ 3,044 $147,878 $144,834 102.1%
Accident and Health
-------- -------- -------- -------- --------
Total $ 3,044 $147,878 $144,834 102.1%
======== ======== ======== ======== ========
December 31, 1996
Premiums Written:
Property and Casualty $ 1,153 $ 73,685 $ 72,532 101.6%
Accident and Health
-------- -------- -------- -------- --------
Total $ 1,153 $ 73,685 $ 72,532 101.6%
======== ======== ======== ======== ========
S-7
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
3.1 Amended and Restated Certificate of Incorporation of Risk Capital
Holdings, Inc.(a)
3.2 Amended and Restated Bylaws of Risk Capital Holdings, Inc.(b)
4.1 Specimen Common Stock Certificate(a)
4.2.1 Class A Common Stock Purchase Warrants issued to Marsh & McLennan
Risk Capital Holdings, Ltd. on September 19, 1995(b) and September
28, 1995(c)
4.2.2 Class A Common Stock Purchase Warrants issued to The Trident
Partnership, L.P. on September 19, 1995(b) and September 28, 1995(c)
4.2.3 Class A Common Stock Purchase Warrants issued to Taracay Investors
on September 19, 1995(b) and September 28, 1995(c)
4.3 Class B Common Stock Purchase Warrants issued to Marsh & McLennan
Risk Capital Holdings, Ltd. on September 19, 1995(b) and September
28, 1995(c)
10.1.1 Employment Agreement, between Risk Capital Holdings, Inc. and Mark
D. Mosca(b)+
10.1.2 Employment Agreement, between Risk Capital Holdings, Inc. and Peter
A. Appel(b)+
10.1.3 Employment Agreement, between Risk Capital Holdings, Inc. and Bonnie
L. Boccitto(b)+
10.1.4 Employment Agreement, between Risk Capital Holdings, Inc. and Paul
J. Malvasio(b)+
10.2 Amended and Restated Subscription Agreement, between Risk Capital
Holdings, Inc. and The Trident Partnership, L.P.(b)
10.3 Amended and Restated Subscription Agreement, between Risk Capital
Holdings, Inc. and Marsh & McLennan Risk Capital Holdings, Ltd.(b)
10.4 Amended and Restated Subscription Agreement, between Risk Capital
Holdings, Inc. and Taracay Investors(b)
10.5 Purchase Agreement, between Risk Capital Holdings, Inc. and X.L.
Insurance Company, Ltd. (b)
- ----------
(a) Incorporated by reference to Amendment No. 3 to the Registrant's
Registration Statement on Form S-1 (No. 33-94184), as filed with the
Securities and Exchange Commission (the "SEC") on August 11, 1995.
(b) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995, as filed with the SEC on March 30,
1996.
(c) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1996, as filed with the SEC on March 31,
1997.
(d) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1997, as filed with the SEC on March 27,
1998.
(e) Incorporated by reference to the Registrant's Report on Form 10-Q for the
period ended June 30, 1998, as filed with the SEC on August 14, 1998.
E-1
10.6.1 Investment Advisory Agreement, between Risk Capital Holdings, Inc.
and Marsh & McLennan Capital, Inc. (b)
10.6.2 Investment Advisory Agreement, between Risk Capital Reinsurance
Company and Marsh & McLennan Capital, Inc. (b)
10.7 Management Agreement, among Risk Capital Holdings, Inc., Risk
Capital Reinsurance Company and The Putnam Advisory Company, Inc.(b)
10.8.1 Sublease Agreement, dated as of March 18, 1996, between Risk Capital
Reinsurance Company and Coca-Cola Bottling Company of New York, Inc.
(b)
10.8.2 Sublease Amendment Agreement and Consent, dated as of November 11,
1997, between Risk Capital Reinsurance Company and Coca-Cola
Bottling Company of New York, Inc. (c)
10.8.3 Sub-Sublease Agreement, dated as of March 18, 1996, between Risk
Capital Reinsurance Company and Marsh & McLennan Capital, Inc. (e)
10.8.4 Sub-Sublease Agreement, dated as of April 30, 1997, between Risk
Capital Reinsurance Company and Bank of Ireland Asset Management
(US) Limited (as amended) (e)
10.9.1 Tax Sharing Agreement, between Risk Capital Holdings, Inc. and Risk
Capital Reinsurance Company (amended)(d)
10.9.2 Addition of Cross River Insurance Company to Tax Sharing Agreement
10.10.1 Risk Capital Holdings, Inc. 1995 Long Term Incentive and Share Award
Plan (the "1995 Stock Plan")(b)+
10.10.2 First Amendment to the 1995 Stock Plan(c)+
10.10.3 Restricted Stock Agreements--Executive Officers(f)+
10.10.4 Stock Option Agreements--Executive Officers--1995 and 1996
grants(f) and 1997 and 1998 grants +
10.10.5 Stock Option Agreement--Chairman--1996 grant,(f) 1997 grant(d) and
1998 grant
10.10.6 Stock Option Agreements--Non-Employee Directors--initial grants
10.10.7 Stock Option Agreements--Non-Employee Directors--1996 and 1997
annual grants,(c) 1998 annual grants(d) and 1999 annual grants
10.11.1 Change in Control Agreement--President (g)+
10.11.2 Change in Control Agreements--Managing Directors (g)+
- ----------
(f) Incorporated by reference to the Registrant's Report on Form 10-Q for the
period ended June 30, 1997, as filed with the SEC on August 14, 1997.
(g) Incorporated by reference to the Registrant's Report on Form 10-Q for the
period ended September 30, 1998, as filed with the SEC on November 13,
1998.
(h) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 (No. 33-99974), as filed with the SEC on December 4, 1995.
+ A management contract or compensatory plan or arrangement required to be
filed pursuant to Item 14(c) of Form 10-K.
E-2
10.12 Risk Capital Holdings, Inc. 1995 Employee Stock
Purchase Plan(h)+
10.13.1 Risk Capital Reinsurance Company Money Purchase Pension
Plan (the "Pension Plan")(b)+
10.13.2 Amendment and Restatement of the Adoption Agreement
relating to the Pension Plan(c)+
10.13.3 Amendment to the Adoption Agreement relating to the
Pension Plan+
10.14.1 Risk Capital Reinsurance Company Employee Savings Plan
(the "Savings Plan")(b)+
10.14.2 Amendment and Restatement of the Adoption Agreement
relating to the Savings Plan(c)+
10.14.3 Amendment to the Adoption Agreement relating to the
Savings Plan+
10.15.1 Risk Capital Reinsurance Company Executive Supplemental
Non-Qualified Savings and Retirement Plan (the
"Supplemental Plan") and related Trust Agreement(b)+
10.15.2 Amendment No. 1 to the Adoption Agreement relating to
the Supplemental Plan(c)+
10.15.3 Amendment No. 2 to the Adoption Agreement relating to
the Supplemental Plan+
21 Subsidiaries of the Registrant
23 Consent of PricewaterhouseCoopers LLP
24 Power of Attorney
27 Financial Data Schedule
E-3