================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-K
--------------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002 Commission file number 1-15731
EVEREST RE GROUP, LTD.
(Exact name of registrant as specified in its charter)
BERMUDA 98-0365432
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
C/O ABG FINANCIAL & MANAGEMENT SERVICES, INC.
PARKER HOUSE
WILDEY BUSINESS PARK, WILDEY ROAD
ST. MICHAEL, BARBADOS
(246) 228-7398
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive office)
--------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- ---------------------
Common Shares, $.01 par value per share New York Stock Exchange
--------------
Securities registered pursuant to Section 12(g) of the Act: None
--------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes _X_ No___
The aggregate market value on June 28, 2002, the last business day of the
registrant's most recently completed second quarter, of the voting stock
held by non-affiliates of the registrant was $2,871.2 million.
At March 14, 2003, the number of shares outstanding of the registrant's
common shares was 50,901,893.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12, and 13 of Form 10-K is
incorporated by reference into Part III hereof from the registrant's proxy
statement for the 2003 Annual General Meeting of Shareholders, which will be
filed with the Securities and Exchange Commission within 120 days of the close
of the registrant's fiscal year ended December 31, 2002.
================================================================================
2
TABLE OF CONTENTS
ITEM PAGE
---- ----
PART I
1. Business
2. Properties
3. Legal Proceedings
4. Submission of Matters to a Vote of Security Holders
PART II
5. Market for Registrant's Common Equity and Related
Shareholder Matters
6. Selected Financial Data
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations
7A. Quantitative and Qualitative Disclosures About Market Risk
8. Financial Statements and Supplementary Data
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
PART III
10. Directors and Executive Officers of the Registrant
11. Executive Compensation
12. Security Ownership of Certain Beneficial Owners and Management
and Related Shareholder Matters
13. Certain Relationships and Related Transactions
14. Controls and Procedures
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
3
PART I
UNLESS OTHERWISE INDICATED, ALL FINANCIAL DATA IN THIS DOCUMENT HAVE BEEN
PREPARED USING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP") IN THE UNITED
STATES OF AMERICA. AS USED IN THIS DOCUMENT, "EVEREST RE" MEANS EVEREST
REINSURANCE COMPANY AND ITS SUBSIDIARIES (UNLESS THE CONTEXT OTHERWISE
REQUIRES); "HOLDINGS" MEANS EVEREST REINSURANCE HOLDINGS, INC.; "GROUP" MEANS
EVEREST RE GROUP, LTD. (FORMERLY EVEREST REINSURANCE GROUP, LTD.); "CAPITAL
TRUST" MEANS EVEREST RE CAPITAL TRUST; AND THE "COMPANY" MEANS GROUP AND ITS
SUBSIDIARIES, EXCEPT WHEN REFERRING TO PERIODS PRIOR TO FEBRUARY 24, 2000, WHEN
IT MEANS HOLDINGS AND ITS SUBSIDIARIES.
ITEM 1. BUSINESS
THE COMPANY
Group, a Bermuda company, with its principal executive office in Barbados, was
established in 1999 as a wholly-owned subsidiary of Holdings. On February 24,
2000, a corporate restructuring was completed and Group became the new parent
holding company of Holdings, which remains the holding company for the Company's
U.S. based operations. Holders of shares of common stock of Holdings
automatically became holders of the same number of common shares of Group. Prior
to the restructuring, Group had no significant assets or capitalization and had
not engaged in any business or prior activities other than in connection with
the restructuring. The Company had gross premiums written in 2002 of $2,846.5
million and shareholders' equity at December 31, 2002 of $2,368.6 million.
In connection with the restructuring, Group established a Bermuda-based
reinsurance subsidiary, Everest Reinsurance (Bermuda), Ltd. ("Bermuda Re"),
which commenced business in the second half of 2000. Group also formed Everest
Global Services, Inc., a Delaware subsidiary, to perform administrative and
back-office functions for Group and its U.S.-based and non-U.S. based
subsidiaries.
Holdings, a Delaware corporation, was established in 1993 to serve as the parent
holding company of Everest Re, a Delaware property and casualty reinsurer formed
in 1973. Until October 6, 1995, Holdings was an indirect wholly-owned subsidiary
of The Prudential Insurance Company of America ("The Prudential"). On October 6,
1995, The Prudential sold its entire interest in the shares of common stock of
Holdings in an initial public offering (the "IPO").
The Company's principal business, conducted through its operating subsidiaries,
is the underwriting of reinsurance and insurance in the United States, Bermuda
and international markets. The Company underwrites reinsurance both through
brokers and directly with ceding companies, giving it the flexibility to pursue
business regardless of the ceding company's preferred reinsurance purchasing
method. The Company underwrites insurance principally through general agent
relationships and surplus lines brokers. Group's operating subsidiaries,
excluding Mt. McKinley Insurance Company ("Mt. McKinley") and Everest
International Reinsurance, Ltd. ("Everest International"), are each rated A+
("Superior") by A.M. Best Company ("A.M. Best"), an independent insurance
industry rating organization that rates insurance companies on factors of
concern to policyholders.
1
Following is a summary of the Company's operating subsidiaries:
o Everest Re, a Delaware insurance company and a direct subsidiary of
Holdings, is a licensed property and casualty insurer and/or reinsurer
in all states (except Nevada and Wyoming), the District of Columbia,
Puerto Rico and is authorized to conduct reinsurance business in the
United Kingdom, Canada and Singapore. Everest Re underwrites property
and casualty reinsurance for insurance and reinsurance companies in the
United States and international markets. Everest Re had statutory
surplus at December 31, 2002 of $1,494.0 million.
o Bermuda Re, a Bermuda insurance company and a direct subsidiary of
Group, is registered in Bermuda as a Class 4 insurer and long-term
insurer and is authorized to write property and casualty business and
life and annuity business. Bermuda Re commenced business in the second
half of 2000. In December 2000, Bermuda Re acquired all of the issued
and outstanding shares of AFC Re Ltd. ("AFC Re"), a Bermuda long-term
insurance company. AFC Re wrote annuity reinsurance business, which
business has been assumed by Bermuda Re. In September 2001, AFC Re was
sold to Group and renamed Everest International and is currently
inactive. Bermuda Re had capital at December 31, 2002 of $931.9 million
based on U.S. generally accepted accounting principles.
o Everest National Insurance Company ("Everest National"), an Arizona
insurance company and a direct subsidiary of Everest Re, is licensed in
45 states and the District of Columbia and is authorized to write
property and casualty insurance in the jurisdictions in which it is
licensed. This is often called writing insurance on an admitted basis.
o Everest Indemnity Insurance Company ("Everest Indemnity"), a Delaware
insurance company and a direct subsidiary of Everest Re, engages in the
excess and surplus lines insurance business in the United States.
Excess and surplus lines insurance is specialty property and liability
coverage that an insurer not licensed to write insurance in a
particular jurisdiction is permitted to provide to insureds when the
specific specialty coverage is unavailable from admitted insurers. This
is often called writing insurance on a non-admitted basis. Everest
Indemnity is licensed in Delaware and is eligible to write business on
a non-admitted basis in 48 states, the District of Columbia and Puerto
Rico.
o Everest Security Insurance Company ("Everest Security"), formerly
Southeastern Security Insurance Company, a Georgia insurance company
and a direct subsidiary of Everest Re, was acquired in January 2000 and
writes property and casualty insurance on an admitted basis in Georgia
and Alabama.
o Mt. McKinley Managers, L.L.C. ("Managers"), a New Jersey limited
liability company and a direct subsidiary of Holdings, is licensed in
New Jersey as an insurance producer. An insurance producer is any
intermediary, such as an agent or broker, which acts as the conduit
between an insurance company and an insured. Managers, which is
licensed to act in New Jersey as an insurance producer in connection
with policies written on both an admitted and a non-admitted basis, is
the underwriting manager for Everest Indemnity. Managers is also the
parent company for WorkCare Southeast, Inc., an Alabama insurance
agency, and WorkCare Southeast of Georgia, Inc., a Georgia insurance
agency.
2
o Mt. McKinley (f/k/a Gibraltar Casualty Company, "Gibraltar") ("Mt.
McKinley"), a Delaware insurance company and a direct subsidiary of
Holdings, was acquired by Holdings in September 2000 from The
Prudential. Mt. McKinley was formed by Everest Re in 1978 to engage in
the excess and surplus lines insurance business in the United States.
In 1985, Mt. McKinley ceased writing new and renewal insurance and now
its ongoing operations relate to servicing claims arising from its
previously written business. Mt. McKinley was a subsidiary of Everest
Re until 1991 when Everest Re distributed the stock of Mt. McKinley to
a wholly-owned subsidiary of The Prudential.
o Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda company and a
direct subsidiary of Everest Re, was formed in 1998 and owned Everest
Re Ltd., a United Kingdom company that was dissolved after its
reinsurance operations were converted into branch operations of Everest
Re. Everest Ltd. holds $79.4 million of investments, the management
of which constitutes its principal operations.
REINSURANCE INDUSTRY OVERVIEW
Reinsurance is an arrangement in which an insurance company, the reinsurer,
agrees to indemnify another insurance company, the ceding company, against all
or a portion of the insurance risks underwritten by the ceding company under one
or more insurance contracts. Reinsurance can provide a ceding company with
several benefits, including a reduction in net liability on individual or
classes of risks, catastrophe protection from large or multiple losses and
assistance in maintaining acceptable financial ratios. Reinsurance also provides
a ceding company with additional underwriting capacity by permitting it to
accept larger risks and write more business than would be possible without a
concomitant increase in capital and surplus. Reinsurance, however, does not
discharge the ceding company from its liability to policyholders.
There are two basic types of reinsurance arrangements: treaty and facultative
reinsurance. In treaty reinsurance, the ceding company is obligated to cede and
the reinsurer is obligated to assume a specified portion of a type or category
of risks insured by the ceding company. Treaty reinsurers do not separately
evaluate each of the individual risks assumed under their treaties and,
consequently, after a review of the ceding company's underwriting practices, are
largely dependent on the original risk underwriting decisions made by the ceding
company. In facultative reinsurance, the ceding company cedes and the reinsurer
assumes all or part of the risk under a single insurance contract. Facultative
reinsurance is negotiated separately for each insurance contract that is
reinsured. Facultative reinsurance normally is purchased by ceding companies for
individual risks not covered by their reinsurance treaties, for amounts in
excess of the dollar limits of their reinsurance treaties and for unusual risks.
Both treaty and facultative reinsurance can be written on either a pro rata
basis or an excess of loss basis. Under pro rata reinsurance, the ceding company
and the reinsurer share the premiums as well as the losses and expenses in an
agreed proportion. Under excess of loss reinsurance, the reinsurer indemnifies
the ceding company against all or a specified portion of losses and expenses in
excess of a specified dollar amount, known as the ceding company's retention or
reinsurer's attachment point, generally subject to a negotiated reinsurance
contract limit.
Premiums paid by the ceding company to a reinsurer for excess of loss
reinsurance are not directly proportional to the premiums that the ceding
company receives because the reinsurer does not assume a proportionate risk. In
pro rata reinsurance, the reinsurer generally pays the ceding company a ceding
commission. The ceding commission generally is based on the ceding company's
cost of acquiring the business being reinsured (commissions, premium taxes,
assessments and miscellaneous administrative expense). There is usually no
ceding commission on excess of loss reinsurance.
3
Reinsurers may purchase reinsurance to cover their own risk exposure.
Reinsurance of a reinsurer's business is called a retrocession. Reinsurance
companies cede risks under retrocessional agreements to other reinsurers, known
as retrocessionaires, for reasons similar to those that cause insurers to
purchase reinsurance: to reduce net liability on individual or classes of risks,
protect against catastrophic losses, stabilize financial ratios and obtain
additional underwriting capacity.
Reinsurance can be written through professional reinsurance brokers or directly
with ceding companies. From a ceding company's perspective, both the broker
market and the direct market have advantages and disadvantages. A ceding
company's decision to select one market over the other will be influenced by its
perception of such advantages and disadvantages relative to the reinsurance
coverage being placed.
BUSINESS STRATEGY
The Company's underwriting strategies seek to capitalize on its financial
capacity, its employee expertise and its flexibility to offer multiple products
through multiple distribution channels. The Company's strategies include
effective management of the property and casualty underwriting cycle, which
refers to the tendency of insurance premiums, profits and the demand for and
availability of coverage to rise and fall over time. The Company also seeks to
manage its catastrophe exposures and retrocessional costs. Efforts to control
expenses and to operate in a cost-efficient manner are also a continuing focus
for the Company.
The Company's products include: (1) the full range of property and casualty
reinsurance and insurance coverages, including marine, aviation, surety, errors
and omissions liability ("E&O"), directors' and officers' liability ("D&O"),
medical malpractice, other specialty lines, accident and health ("A&H"),
workers' compensation and other standard lines; and (2) reinsurance of life and
annuity business. The Company's distribution channels include both the direct
and broker reinsurance markets, U.S., Bermuda and international markets,
reinsurance, both treaty and facultative, and insurance, both admitted and
non-admitted.
The Company's underwriting strategy emphasizes underwriting profitability rather
than premium volume, writing specialized property and casualty risks and
integration of underwriting expertise across all underwriting units. Key
elements of this strategy are prudent risk selection, appropriate pricing
through strict underwriting discipline and continuous adjustment of the
Company's business mix to respond to changing market conditions. The Company
focuses on reinsuring companies that effectively manage the underwriting cycle
through proper analysis and pricing of underlying risks and whose underwriting
guidelines and performance are compatible with its objectives.
The Company's underwriting strategy also emphasizes flexibility and
responsiveness to changing market conditions, such as increased demand or
favorable pricing trends. The Company believes that its existing strengths,
including its broad underwriting expertise, U.S., Bermuda and international
presence, high ratings and substantial capital, facilitate adjustments to its
mix of business geographically, by line of business and by type of coverage,
allowing it to capitalize on those market opportunities that provide the
greatest potential for underwriting profitability. The Company's insurance
operations complement these strategies by allowing the Company access to
business that would not likely be available to it on a reinsurance basis. The
Company carefully monitors its mix of business across all operations to avoid
inappropriate concentrations of geographic or other risk.
4
MARKETING
The Company writes business on a worldwide basis for many different customers
and for many lines of business, providing a broad array of coverages. The
Company is not materially dependent on any single customer, small group of
customers, line of business or geographical area. For the 2002 calendar year, no
single customer (ceding company or insured) generated more than 7.4% of the
Company's gross premiums written. The Company does not believe that a reduction
of business from any one customer would have a material adverse effect on its
future financial condition or results of operations due to the Company's
competitive position in the market place and the continuing availability of
other sources of business.
Approximately 48.6%, 22.5% and 28.9% of the Company's 2002 gross premiums
written were written in the broker reinsurance, direct reinsurance and insurance
markets, respectively. The Company's ability to write reinsurance both through
brokers and directly with ceding companies gives it the flexibility to pursue
business regardless of the ceding company's preferred reinsurance purchasing
method.
The reinsurance broker market consists of several substantial national and
international brokers and a number of smaller specialized brokers. Brokers do
not have the authority to bind the Company with respect to reinsurance
agreements, nor does the Company commit in advance to accept any portion of the
business that brokers submit to it. Reinsurance business from any ceding
company, whether new or renewal, is subject to acceptance by the Company.
Brokerage fees are generally paid by reinsurers. The Company's ten largest
brokers accounted for an aggregate of approximately 39.0% of gross premiums
written in 2002, with each of the two largest brokers accounting for
approximately 12.9% and 12.4% of gross premiums written, respectively. The
Company does not believe that a reduction of business assumed from any one
broker would have a materially adverse effect on the Company due to its
competitive position in the market place, relationships with ceding companies
and the continuing availability of other sources of business.
The direct market remains an important distribution system for reinsurance
business written by the Company. Direct placement of reinsurance enables the
Company to access clients who prefer to place their reinsurance directly with
reinsurers based upon the reinsurer's in-depth understanding of the ceding
company's needs. The Company's insurance business is written principally through
general agent relationships and surplus lines brokers. The Company's largest
agency relationship accounted for approximately 15.9% of gross premiums written,
which consists of approximately 27,800 individual workers' compensation
policies.
The Company evaluates each business relationship, including the underwriting
expertise and experience of each distribution channel selected, performs
analyses to evaluate financial security and monitors performance.
SEGMENT INFORMATION
The Company, through its subsidiaries, operates in five segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda.
The U.S. Reinsurance operation writes property and casualty reinsurance on both
a treaty and facultative basis through reinsurance brokers as well as directly
with ceding companies within the United States. The U.S. Insurance operation
writes property and casualty insurance primarily through general agent
relationships and surplus lines brokers within the United States. The Specialty
Underwriting operation writes A&H, marine, aviation and surety business within
the United States and worldwide through brokers and directly with ceding
companies. The International operation writes property and casualty reinsurance
5
through the Company's branches in London, Canada and Singapore, in addition to
foreign business written through the Company's New Jersey headquarters and Miami
office. The Bermuda operation writes property, casualty, life and annuity
business through brokers and directly with ceding companies.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments principally based upon their
underwriting results. The Company utilizes inter-affiliate reinsurance but such
reinsurance does not impact segment results, since business is generally
reported within the segment in which the business was first produced. For
selected financial information regarding these segments, see Note 17 of Notes to
Consolidated Financial Statements.
UNDERWRITING OPERATIONS
The following table presents the distribution of the Company's gross premiums
written by its U.S. Reinsurance, U.S. Insurance, Specialty Underwriting,
International and Bermuda operations for the years ended December 31, 2002,
2001, 2000, 1999 and 1998, classified according to whether the premium is
derived from property or casualty business and, for reinsurance business,
whether it represents pro rata or excess of loss business:
6
GROSS PREMIUMS WRITTEN BY OPERATION
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------- ----------------- --------------- ---------------- ---------------
$ % $ % $ % $ % $ %
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
(DOLLARS IN MILLIONS)
U.S. REINSURANCE
Property
Pro Rata(1) $ 148.7 5.2% $ 62.9 3.4% $ 60.2 4.3% $ 48.6 4.3% $ 30.1 2.9%
Excess 177.8 6.2 104.0 5.5 75.6 5.5 67.0 5.9 65.1 6.2
Casualty
Pro Rata(1) 219.2 7.7 191.2 10.2 151.1 10.9 152.9 13.4 183.9 17.6
Excess 348.9 12.3 252.3 13.5 194.7 14.1 222.1 19.5 212.5 20.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 894.6 31.4 610.4 32.6 481.6 34.8 490.6 43.0 491.6 47.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
U.S. INSURANCE
Property
Pro Rata(1) 6.5 0.2 6.2 0.3 9.3 0.7 3.8 0.3 3.1 0.3
Excess - 0.0 - 0.0 - 0.0 - 0.0 - 0.0
Casualty
Pro Rata(1) 815.0 28.6 496.1 26.5 241.2 17.4 66.6 5.8 75.5 7.2
Excess - 0.0 - 0.0 - 0.0 - 0.0 - 0.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 821.5 28.9 502.4 26.8 250.5 18.1 70.4 6.2 78.6 7.5
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
SPECIALTY UNDERWRITING
Property
Pro Rata(1) 397.5 14.0 356.3 19.0 274.0 19.8 213.6 18.7 92.9 8.9
Excess 43.8 1.5 35.0 1.9 19.3 1.4 19.7 1.7 15.8 1.5
Casualty
Pro Rata(1) 41.9 1.5 18.4 1.0 21.4 1.5 32.3 2.8 39.3 3.8
Excess 5.3 0.2 4.3 0.2 3.6 0.3 2.9 0.3 3.0 0.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 488.5 17.2 414.0 22.1 318.3 23.0 268.5 23.5 151.0 14.4
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
TOTAL U.S.
Property
Pro Rata(1) 552.7 19.4 425.5 22.7 343.4 24.8 266.0 23.3 126.1 12.1
Excess 221.6 7.8 139.0 7.4 94.9 6.9 86.7 7.6 80.9 7.7
Casualty
Pro Rata(1) 1,076.1 37.8 705.8 37.6 413.8 29.9 251.8 22.1 298.7 28.6
Excess 354.2 12.4 256.7 13.7 198.3 14.3 225.1 19.7 215.6 20.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 2,204.6 77.4 1,526.8 81.4 1,050.4 75.9 829.5 72.7 721.2 69.1
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
INTERNATIONAL
Property
Pro Rata(1) 328.4 11.5 171.0 9.1 143.4 10.3 124.6 10.9 141.9 13.6
Excess 122.9 4.3 60.0 3.2 55.6 4.0 54.8 4.8 45.8 4.4
Casualty
Pro Rata(1) 35.3 1.2 54.3 2.9 78.4 5.7 84.4 7.4 93.4 8.9
Excess 54.3 1.9 37.5 2.0 46.2 3.3 48.5 4.3 43.6 4.2
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 540.9 19.0 322.8 17.2 323.6 23.4 312.3 27.4 324.7 31.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
BERMUDA OPERATIONS
Property
Pro Rata(1) 37.1 1.3 6.2 0.3 - 0.0 - 0.0 - 0.0
Excess 36.0 1.3 0.6 0.0 - 0.0 - 0.0 - 0.0
Casualty
Pro Rata(1) 15.1 0.5 18.1 1.0 11.6 0.8 - 0.0 - 0.0
Excess 12.8 0.4 0.1 0.0 - 0.0 - 0.0 - 0.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) (3) 101.0 3.5 25.0 1.3 11.6 0.8 - 0.0 - 0.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
TOTAL COMPANY
Property
Pro Rata(1) 918.2 32.3 602.6 32.1 486.8 35.1 390.6 34.2 268.0 25.6
Excess 380.5 13.4 199.6 10.6 150.5 10.9 141.4 12.4 126.6 12.1
Casualty
Pro Rata(1) 1,126.5 39.6 778.1 41.5 503.8 36.4 336.2 29.4 392.1 37.5
Excess 421.3 14.8 294.3 15.7 244.5 17.6 273.6 24.0 259.2 24.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) $2,846.5 100.0% $1,874.6 100.0% $1,385.6 100.0% $1,141.8 100.0% $1,045.9 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
- -------------
(1) For purposes of the presentation above, pro rata includes reinsurance
attaching to the first dollar of loss incurred by the ceding company and
insurance.
(2) Certain totals and subtotals may not reconcile due to rounding.
(3) Includes immaterial amounts of life and annuity premium.
7
U.S. REINSURANCE OPERATION. The Company's U.S. Reinsurance operation writes
property and casualty reinsurance, both treaty and facultative, through
reinsurance brokers as well as directly with ceding companies within the United
States. The Company targets certain brokers and, through the broker market,
specialty companies and small to medium sized standard lines companies. On a
direct basis, the Company targets companies that place their business
predominantly in the direct market, including small to medium sized regional
ceding companies, and seeks to develop long-term relationships with those
companies. In addition, the U.S. Reinsurance operation writes portions of
reinsurance programs for larger, national insurance companies.
In 2002, $230.9 million of gross premiums written were attributable to U.S.
treaty property business, of which 35.6% was written on an excess of loss basis
and 64.4% was written on a pro rata basis. The Company's property underwriters
utilize sophisticated underwriting methods which management believes are
necessary to analyze and price property business, particularly that segment of
the property market which has catastrophe exposure.
U.S. treaty casualty business accounted for $418.1 million of gross premiums
written in 2002, of which 47.6% was written on an excess of loss basis and 52.4%
was written on a pro rata basis. The treaty casualty portfolio consists of
professional liability, D&O liability, workers' compensation, excess and surplus
lines, and other liability coverages. As a result of the complex technical
nature of most of these risks, the Company's casualty underwriters tend to
specialize by line of business and work closely with the Company's pricing
actuaries.
The Company's facultative unit conducts business both through brokers and
directly with ceding companies, and consists of four underwriting units
representing property, casualty, specialty and national brokerage lines of
business. Business is written from a facultative headquarters office in New York
and satellite offices in Chicago and Oakland. In 2002, $71.4 million, $133.5
million, $17.3 million and $23.4 million of gross premiums written were
attributable to the property, casualty, specialty and national brokerage lines
of business, respectively.
In 2002, 79.9% and 20.1% of the U.S. Reinsurance operation's gross premiums
written were written in the broker and direct reinsurance markets, respectively.
U.S. INSURANCE OPERATION. In 2002, the Company's U.S. Insurance operation wrote
$821.5 million of gross premiums, of which 99.2% was casualty and 0.8% was
property. Of the casualty business, the predominant class was workers'
compensation insurance. Everest National wrote $706.1 million and Everest Re
wrote $14.1 million, with both principally targeting commercial property and
casualty business written through general agency relationships with program
administrators. Everest Indemnity wrote $78.1 million, principally targeting
excess and surplus lines insurance business written through surplus lines
brokers. Everest Security wrote $23.2 million, principally targeting
non-standard auto business written through retail agency relationships. With
respect to insurance written through general agents and surplus lines brokers,
the Company supplements the initial underwriting process with periodic claims,
underwriting and operational reviews and ongoing monitoring.
8
SPECIALTY UNDERWRITING OPERATION. The Company's Specialty Underwriting operation
writes A&H, marine, aviation and surety reinsurance. The A&H unit primarily
focuses on health reinsurance of traditional indemnity plans, self-insured
health plans and specialty medical plans. The marine and aviation unit focuses
on ceding companies with a particular expertise in marine and aviation business.
The marine and aviation business is written primarily through brokers and
contains a significant international component written primarily in the London
market. Surety business underwritten by the Company consists mainly of
reinsurance of contract surety bonds.
Gross premiums written by the A&H unit in 2002 totaled $314.4 million, of which
$78.1 million was written through the broker market and $236.3 million was
written through the direct market.
Gross premiums written by the marine and aviation unit in 2002 totaled $94.1
million, substantially all of which was written on a treaty basis and 86.6% of
which was sourced through reinsurance brokers. Marine treaties represented 49.9%
of marine and aviation gross premiums written in 2002 and consisted mainly of
hull and liability coverage. Approximately 69.4% of the marine unit premiums in
2002 were written on a pro rata basis and 30.6% as excess of loss. Aviation
premiums accounted for 50.1% of marine and aviation gross premiums written in
2002 and included reinsurance for airlines, general aviation and satellites.
Approximately 88.8% of the aviation unit's premiums in 2002 were written on a
pro rata basis and 11.2% as excess of loss.
In 2002, gross premiums written by the surety unit totaled $80.1 million.
Approximately 69.4% of the surety unit premiums in 2002 were written on a pro
rata basis and 30.6% on an excess of loss basis. Most of the portfolio is
reinsurance of contract surety bonds written directly with ceding companies,
with the remainder being credit reinsurance, mostly in international markets.
INTERNATIONAL OPERATION. The Company's International operation is designed to
enable it to capitalize on the growth opportunities in the international
reinsurance market. The Company targets several international markets,
including: Europe and the London markets, which are serviced by a branch in
London; Canada, with a branch in Toronto; Asia and Australia, with a branch in
Singapore; and Latin America, Africa and the Middle East, which business is
serviced from Everest Re's New Jersey headquarters and Miami office. The Company
also writes "home-foreign" business, which provides reinsurance on the
international portfolios of U.S. insurers, from New Jersey. Approximately 83.4%
of the gross premiums written by the Company's international underwriters in
2002 represented property business, while the balance represented casualty
business. As with its U.S. operations, the Company's International operation
focuses on financially sound companies that have strong management and
underwriting discipline and expertise. Approximately 73.4% of the Company's
international business was written through brokers, with the remainder written
directly with ceding companies.
In 2002, the Company's gross premiums written by its London branch totaled
$186.5 million and consisted of pro rata property (56.8%), excess property
(24.1%), pro rata casualty (3.9%) and excess casualty (15.2%). Substantially all
of the London premiums consisted of treaty reinsurance.
9
Gross premiums written by the Company's Canadian office totaled $74.0 million in
2002 and consisted of pro rata property (51.3%), excess property (21.5%), pro
rata multi-line (2.7%) and excess casualty (24.4%). Approximately 76.4% of the
Canadian premiums consisted of treaty reinsurance, while 23.4% was facultative
reinsurance.
The Company's Singapore branch covers the Asian and Australian markets and
accounted for $25.5 million of gross written premiums in 2002. This business
consisted of pro rata property (56.4%), excess property (33.4%), pro rata
casualty (9.0%) and excess casualty (1.2%).
International business written out of Everest Re's New Jersey and Miami offices
accounted for $254.9 million of gross premiums written in 2002 and consisted of
pro rata treaty property (66.8%), pro rata treaty casualty (9.3%), excess treaty
property (15.5%), excess treaty casualty (2.6%) and excess facultative property
and casualty (5.8%). Of this international business, 67.6% was sourced from
Latin America, 27.3% was sourced from the Middle East, 3.2% was sourced from
Europe, Africa and Asia, and 1.9% was "home-foreign" business.
BERMUDA OPERATION. The Company's Bermuda operation writes property, casualty,
life and annuity business through Bermuda Re. In 2002, the Bermuda operation
continued to scale up and had gross property and casualty premiums written of
$101.0 million.
GEOGRAPHIC AREAS
The Company conducts its business in Bermuda, in the United States and in a
number of foreign countries. For select financial information about geographic
areas, see Note 17 of Notes to the Consolidated Financial Statements. Risks
attendant to the foreign operations of the Company parallel those attendant to
the United States operations of the Company, with the primary exception of
foreign exchange risks. See ITEM 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Safe Harbor Disclosure".
UNDERWRITING PROCESS
The Company offers ceding companies full service capability, including
actuarial, claims, accounting and systems support, either directly or through
the broker community. The Company's capacity for both property and casualty
risks allows it to underwrite entire contracts or major portions thereof that
might otherwise need to be syndicated among several reinsurers. The Company's
strategy is to act as "lead" reinsurer in many of the reinsurance treaties it
underwrites. The lead reinsurer on a treaty generally accepts one of the largest
percentage shares of the treaty and is in a stronger position to negotiate
price, terms and conditions than is a reinsurer that takes a smaller position.
Management believes this strategy enables it to more effectively influence the
terms and conditions of the treaties on which it participates. When the Company
does not lead the treaty, it may still suggest changes to any aspect of the
treaty. The Company may decline to participate in a treaty based upon its
assessment of all relevant factors.
10
The Company's treaty underwriting process emphasizes a team approach among the
Company's underwriters, actuaries and claim staff. Treaties are reviewed for
compliance with the Company's general underwriting standards and certain larger
treaties are evaluated in part based upon actuarial analyses by the Company. The
actuarial models used in such analyses are tailored in each case to the
exposures and experience underlying the specific treaty and the loss experience
for the risks covered by such treaties. The Company does not separately evaluate
each of the individual risks assumed under its treaties. The Company does,
however, generally evaluate the underwriting guidelines of its ceding companies
to determine their adequacy prior to entering into a treaty. The Company, when
appropriate, also conducts underwriting, operational and claim audits at the
offices of ceding companies to ensure that the ceding companies operate within
such guidelines. Underwriting audits focus on the quality of the underwriting
staff, the selection and pricing of risks and the capability of monitoring price
levels over time. Claim audits, when appropriate, are performed in order to
evaluate the client's claims handling abilities and practices.
The Company's U.S. facultative underwriters operate within guidelines specifying
acceptable types of risks, limits and maximum risk exposures. Specified classes
of risks and large premium risks are referred to Everest Re's New York
facultative headquarters for specific review before premium quotations are given
to clients. In addition, the Company's guidelines require certain types of risks
to be submitted for review because of their aggregate limits, complexity or
volatility, regardless of premium amount or size of the insured on the
underlying contract.
The Company's insurance operations principally write property and casualty
coverages for homogeneous risks through select program managers. These programs
are evaluated based upon actuarial analysis and the program manager's
capabilities. The Company's rates, forms and underwriting guidelines are
tailored to specific risk types. The Company's underwriting, actuarial, claim
and financial functions work closely with its program managers to establish
appropriate underwriting and processing guidelines as well as appropriate
monitoring mechanisms.
RISK MANAGEMENT AND RETROCESSION ARRANGEMENTS
The Company manages its risk of loss through a combination of aggregate exposure
limits, underwriting guidelines that take into account risks, prices and
coverage, and retrocessional arrangements.
The Company is exposed to multiple insured losses arising out of a single
occurrence, whether a natural event, such as a hurricane or an earthquake, or
other catastrophe, such as an explosion at a major factory. Any such
catastrophic event could generate insured losses in one or many of the Company's
treaties or lines of business, including property and/or casualty exposures. The
Company employs various techniques, including licensed software modeling, to
assess its accumulated exposure. Such techniques are inherently more difficult
to apply to non-property exposures. Accumulated exposures with respect to
catastrophe losses are generally summarized in terms of the probable maximum
loss ("PML"). The Company defines PML as its anticipated maximum loss, taking
into account contract limits, caused by a single catastrophe affecting a broad
contiguous geographic area, such as that caused by a hurricane or earthquake of
such a magnitude that it is expected to occur once in every 100 years.
Management believes that the Company's greatest catastrophe exposure world wide
from any single event is to an earthquake affecting the west coast of the United
States where the Company estimates it has a PML exposure of $338 million,
including workers' compensation exposures. The Company further estimates that
its PML exposure with respect to its greatest windstorm exposure, which relates
to a hurricane affecting the east coast of the United States, is $264 million
and that its single event International PML exposure is $197 million. There can
11
be no assurance that the Company will not experience losses from one or more
catastrophic events that exceed, perhaps by a substantial amount, its estimated
PML.
The U.S. Terrorism Risk Insurance Act of 2002 was signed into law in November
2002. This legislation provides Federal reimbursement of 90% of insured losses,
in excess of statutory retention levels, due to acts of terrorism carried out by
foreign powers on U.S. soil or against U.S. air carriers, vessels or foreign
missions. This coverage does not apply to reinsurance. Reinsurance contracts
generally exclude losses arising from terrorist events, except where such
coverage has been specifically included in the underwriting and pricing of the
involved reinsurance. The Company does not believe that this legislation will
have a significant impact on its operations.
Underwriting guidelines have been established for each business unit. These
guidelines place dollar limits on the amount of business that can be written
based on a variety of factors, including ceding company, line of business,
geographical location and risk hazards. In each case, those guidelines permit
limited exceptions, which must be authorized by the Company's senior management.
The Company employs a retrocessional approach under which the Company may
purchase reinsurance to cover specific business written or exposure
accumulations or as a corporate level retrocessional program covering the
potential accumulation or aggregation of exposures across some or all of the
Company's operations. All reinsurance purchasing decisions consider both the
potential coverage and market conditions with respect to the pricing, terms,
conditions and availability of such coverage, with the aim of securing
cost-effective protection. The level of reinsurance coverage varies over time,
reflecting the underwriter's and/or Company's view of the changing dynamics of
both the underlying exposure and the reinsurance markets.
The Company does not typically purchase reinsurance to cover specific
reinsurance business written, but it does from time to time purchase
retrocessional protections where underwriting management deems it to be prudent
and/or cost-effective to reinsure a portion of the specific risks being assumed.
In 2001 and 2000, the Company purchased an excess property facultative
retrocessional program and an excess workers' compensation retrocessional
program. In addition, the Company purchased an excess property catastrophe
retrocessional program for losses incurred outside of the U.S. for 2002, 2001
and 2000. The Company also participates in "common account" retrocessional
arrangements for certain reinsurance treaties. Common account reinsurance
arrangements are arrangements whereby the ceding company purchases reinsurance
for the benefit of itself and its reinsurers on one or more of its reinsurance
treaties. Common account retrocessional arrangements reduce the effect of
individual or aggregate losses to all participating companies, including the
ceding company, with respect to the involved treaties.
The Company typically considers the purchase of reinsurance to cover insurance
programs written by the U.S. Insurance operation. Such consideration includes
balancing the underlying exposures against the availability of cost-effective
reinsurance protection. For policies incepting on or after November 1998, the
Company purchased a workers' compensation reinsurance program that provided for
statutory limits coverage in excess of $75,000 of losses per occurrence on the
Company's workers' compensation insurance business written prior to November 1,
2000. Since November 1, 2000, this primary workers' compensation reinsurance
12
program provides statutory limits coverage in excess of $250,000 of losses per
occurrence for business written prior to December 31, 2001. The Company has not
purchased such coverage for the period subsequent to December 31, 2001. In
addition, for the twelve-month period commencing July 31, 2000, the Company
purchased reinsurance for a specific program of business. The reinsurance,
subject to certain aggregate limits, covered U.S. Longshore and Harbor Workers'
Compensation Act and state act workers' compensation business for 100% of loss
occurrences up to $100 million. Consistent with the $1 million limits of the
underlying policies in the program, reinsurance for 100% of Maritime Employers
Liability and Employers Liability was also provided. Neither the program nor the
reinsurance were purchased in 2002 or 2001.
The Company also considers purchasing corporate level retrocessional protection
covering the potential accumulation of exposures. Such consideration includes
balancing the underlying exposures against the availability of cost-effective
retrocessional protection. For 2001, the Company purchased an accident year
aggregate excess of loss retrocession agreement which provides up to $175.0
million of coverage if Everest Re's consolidated statutory basis accident year
loss ratio exceeds a loss ratio attachment point provided in the contract for
the 2001 accident year. The attachment point is net of inuring reinsurance and
retrocessions and includes adjustable premium provisions that effectively cause
the Company to offset, on a pre-tax income basis, up to 52.9% of such ceded
losses, depending upon the character of the underlying losses, through
additional premiums. The maximum recovery is $175.0 million before giving effect
to a maximum adjustable premium of $82.5 million. Cessions under this cover have
reduced the limit available to $0.0 million at December 31, 2002. Similar
coverage was purchased and remains in effect for the 2000 accident year.
Cessions under this cover have reduced the limit available to $85.0 million as
of December 31, 2002. The Company has not purchased similar coverage for the
period subsequent to December 31, 2001.
Although certain of the Company's catastrophe and aggregate excess of loss
retrocessions have terms which provide for additional premiums to be paid to the
retrocessionaire in the event that losses are ceded, all aspects of the
Company's retrocessional program have been structured to permit these agreements
to be accounted for as reinsurance under Financial Accounting Standard ("FAS")
No. 113.
If a single catastrophe were to occur in the United States that resulted in $338
million of gross losses and allocated loss adjustment expenses ("ALAE") in 2003
(an amount equivalent to the Company's PML, including its property and workers'
compensation exposures), management estimates that the effect on the Company's
income would be approximately $338 million and $264 million before and after
taxes, respectively.
In addition, the Company has coverage under an aggregate excess of loss
reinsurance agreement provided by Prudential Property and Casualty Insurance
Company of Indiana ("Prupac"), a wholly-owned subsidiary of The Prudential, in
connection with the Company's acquisition of Mt. McKinley in September 2000.
This agreement covers 80% or $160 million of the first $200 million of any
adverse loss reserve development on the carried reserves of Mt. McKinley at the
date of acquisition and reimburses the Company as such losses are paid by the
Company. There were $78.9 million of cessions under this reinsurance at December
31, 2002, reducing the limit available under the contract to $81.1 million.
In connection with the Mt. McKinley acquisition, Prupac also provided excess of
loss reinsurance for 100% of the first $8.5 million of loss with respect to
certain of Mt. McKinley's retrocessions and potentially uncollectible
reinsurance coverage. There were $0.0 million and $3.6 million of cessions under
this reinsurance during the periods ending December 31, 2002 and 2001,
respectively, reducing the limit available under the contract to $2.4 million.
13
As of December 31, 2002, the Company carried as an asset $1,116.4 million in
reinsurance receivables with respect to losses ceded. Of this amount, $440.0
million, or 39.4%, was receivable from subsidiaries of London Reinsurance Group
("London Life"), $145.0 million, or 13.0%, was receivable from Continental
Insurance Company ("Continental") and $78.9 million, or 7.1% was receivable from
Prupac. No other retrocessionaire accounted for more than 5% of the Company's
receivables. See ITEM 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition".
The Company's arrangements with London Life and Continental are managed on a
funds held basis, which means that the Company has not released premium payments
to the retrocessionaire but rather retains such payments to secure obligations
of the retrocessionaire, records them as a liability, credits interest on the
balances and reduces the liability account as payments become due. As of
December 31, 2002, such funds had reduced the Company's net exposure to London
Life to $190.2 million, effectively 100% of which has been secured by letters of
credit, and its exposure to Continental to $60.9 million. Prupac's obligations
are guaranteed by The Prudential.
No assurance can be given that the Company will seek or be able to obtain
retrocessional coverage in the future similar to that in place currently or in
the past. The Company continuously evaluates its exposures and risk capacities
in the context of reinsurance market conditions, at both the specific and
corporate level. Although management carefully selects its reinsurers, the
Company is subject to credit risk with respect to its reinsurance because the
ceding of risk to reinsurers does not relieve the Company of its liability to
insureds or ceding companies.
MT. MCKINLEY INSURANCE COMPANY-ACQUISITION
The Company completed its acquisition of Gibraltar, subsequently renamed Mt.
McKinley, in September 2000. In connection with the acquisition, the seller
provided the reinsurance described above and the Company terminated certain
relationships between Mt. McKinley and its former parent, The Prudential, and
its affiliates. Mt. McKinley's ongoing operations relate to servicing claims
arising from (1) insurance written by Mt. McKinley or Everest Re prior to 1985,
(2) reinsurance of insurance business and certain Everest Re reinsurance
business written prior to 1991 which had previously been reinsured with third
parties and commuted with those third parties into Mt. McKinley and (3) exposure
to adverse loss reserve development on Everest Re's reserves as of June 30,
1995, which exposure was assumed by Mt. McKinley at the time of the Company's
initial public offering. Effective September 19, 2000, Mt. McKinley and Bermuda
Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt.
McKinley transferred, for what management believes to be arm's-length
consideration, all of its net insurance exposures and reserves to Bermuda Re.
CLAIMS
Reinsurance claims are managed by the Company's professional claims staff whose
responsibilities include reviewing initial loss reports and coverage issues,
monitoring claims handling activities of ceding companies, establishing and
adjusting proper case reserves and approving payment of claims. In addition to
claims assessment, processing and payment, the claims staff selectively conducts
comprehensive claim audits of both specific claims and overall claim procedures
at the offices of selected ceding companies. Insurance claims, except those
relating to Mt. McKinley's business, are generally handled by third party claims
services providers who have limited authority and are subject to oversight by
the Company's professional claims staff.
14
The Company intensively manages its asbestos and environmental ("A&E") exposures
through dedicated, centrally managed claim staffs for Mt. McKinley and Everest
Re. Both are staffed with experienced claim and legal professionals that
specialize in the handling of such exposures. These units actively manage each
individual insured and reinsured account, responding to claim developments with
evaluations of the involved exposures and adjustment of reserves as appropriate.
Specific or general claim developments that may have material implications for
the Company are regularly communicated to senior management, and as appropriate,
to actuarial, legal and financial areas. Meetings among these areas, claim
management and senior management are held at least quarterly to review the
Company's overall reserve positions and make changes, if appropriate. The
Company continually reviews its internal processing, communications and
analytics to determine whether it can enhance the management of it's A&E
exposures, in particular in the context of changes in the landscape of asbestos
claims and litigation.
RESERVES FOR UNPAID PROPERTY AND CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES
Significant periods of time may elapse between the occurrence of an insured
loss, the reporting of the loss to the insurer and the reinsurer and the payment
of that loss by the insurer and subsequent payments to the insurer by the
reinsurer. To recognize liabilities for unpaid losses and loss adjustment
expenses ("LAE"), insurers and reinsurers establish reserves, which are balance
sheet liabilities representing estimates of future amounts needed to pay
reported and unreported claims and related expenses on losses that have already
occurred. Actual losses and LAE paid may deviate, perhaps substantially, from
such reserves. To the extent reserves prove to be insufficient to cover actual
losses and LAE after taking into account available reinsurance coverage, the
Company would have to augment such reserves and incur a charge to earnings,
which could be material in the period such augmentation takes place. See ITEM 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Loss and LAE Reserves".
While the reserving process is difficult and subjective for insurance companies,
the inherent uncertainties of estimating such reserves are even greater for the
reinsurer, due primarily to the longer time between the date of an occurrence
and the reporting of any attendant claims to the reinsurer, the diversity of
development patterns among different types of reinsurance treaties or
facultative contracts, the necessary reliance on the ceding companies for
information regarding reported claims and differing reserving practices among
ceding companies. In addition, trends that have affected development of
liabilities in the past may not necessarily occur or affect liability
development to the same degree in the future. As a result, actual losses and LAE
may deviate, perhaps substantially, from estimates of reserves reflected in the
Company's consolidated financial statements.
Like many other property and casualty insurance and reinsurance companies, the
Company has experienced adverse loss development for prior accident years, which
has led to adjustments in losses and LAE reserves. The increase in net reserves
for prior accident years reduced net income for the periods in which the
adjustments were made. There can be no assurance that adverse development from
prior years will not continue in the future or that such adverse development
will not have a material adverse effect on net income.
CHANGES IN HISTORICAL RESERVES
The following table shows changes in historical loss reserves for the Company
for 1992 and subsequent years. The table is presented on a GAAP basis except
15
that the Company's loss reserves for its Canadian branch operations are
presented in Canadian dollars, the impact of which is not material. The top line
of each table shows the estimated reserves for unpaid losses and LAE recorded at
each year-end date. Each amount in the top line represents the estimated amount
of future payments for losses and LAE on claims occurring in that year and in
all prior years. The upper (paid) portion of the table presents the cumulative
amounts paid through each subsequent year on those claims for which reserves
were carried as of each specific year end. The lower (liability re-estimated)
portion shows the re-estimated amount of the previously recorded reserves based
on experience as of the end of each succeeding year. The reserve estimate
changes as more information becomes known about the actual claims for which the
initial reserves were carried. The cumulative redundancy/deficiency line
represents the cumulative change in estimates since the initial reserve was
established. It is equal to the latest liability re-estimated amount less the
initial reserve.
Each amount other than the original reserves in the top half of the table below
includes the effects of all changes in amounts for prior periods. For example,
if a loss settled in 1995 for $100,000 was first reserved in 1992 at $60,000 and
remained unchanged until settlement, the $40,000 deficiency (actual loss minus
original estimate) would be included in the cumulative redundancy (deficiency)
in each of the years in the period 1992 through 1994 shown below. Conditions and
trends that have affected development of liability in the past are not
indicative of future developments. Accordingly, it is not appropriate to
extrapolate future redundancies or deficiencies based on this table.
16
TEN YEAR GAAP LOSS DEVELOPMENT TABLE PRESENTED NET OF REINSURANCE
WITH SUPPLEMENTAL GROSS DATA (1) (2) (3)
Years Ended December 31,
------------------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in millions)
Reserves for unpaid
loss and LAE $1,854.7 $1,934.2 $2,104.2 $2,316.1 $2,551.6 $2,810.0 $2,953.5 $2,977.4 $3,364.9 $3,472.5 $3,895.8
Paid (cumulative)
as of:
One year later 461.5 403.5 359.5 270.4 331.2 450.8 484.3 673.4 718.1 892.7
Two years later 740.1 627.7 638.0 502.8 619.2 747.9 955.3 1,159.1 1,264.2
Three years later 897.0 820.5 828.0 682.0 813.7 1,101.5 1,295.5 1,548.3
Four years later 1,036.0 953.0 983.6 806.3 1,055.9 1,363.1 1,575.9
Five years later 1,141.0 1,071.5 1,143.4 990.9 1,253.0 1,592.5
Six years later 1,232.7 1,202.2 1,294.8 1,131.5 1,450.2
Seven years later 1,334.8 1,324.0 1,412.2 1,300.0
Eight years later 1,433.3 1,421.1 1,538.6
Nine years later 1,512.3 1,528.2
Ten years later 1,603.7
Liability
re-estimated as of:
One year later 1,929.2 2,008.5 2,120.8 2,286.5 2,548.4 2,836.2 2,918.1 2,985.2 3,364.9 3,612.6
Two years later 1,988.9 2,015.4 2,233.7 2,264.5 2,575.9 2,802.2 2,921.6 2,977.2 3,484.6
Three years later 2,010.0 2,119.0 2,271.2 2,285.1 2,546.0 2,794.7 2,910.3 3,070.5
Four years later 2,111.9 2,164.5 2,452.3 2,260.7 2,528.0 2,773.5 2,924.5
Five years later 2,155.3 2,344.9 2,381.7 2,254.5 2,515.7 2,765.2
Six years later 2,332.3 2,278.3 2,382.0 2,247.3 2,507.9
Seven years later 2,269.9 2,279.1 2,380.8 2,243.9
Eight years later 2,273.0 2,277.3 2,367.3
Nine years later 2,268.3 2,265.6
Ten years later 2,252.8
Cumulative
(deficiency)/
redundancy $ (398.1) $ (331.4) $ (263.1) $ 72.2 $ 43.7 $ 44.8 $ 29.0 $ (93.1) $ (119.7) $ (140.1)
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Gross
liability-end
of year $2,476.7 $2,576.0 $2,752.7 $3,017.0 $ 3,298.2 $3,498.7 $3,869.2 $3,705.2 $3,853.7 $4,356.0 $4,985.8
Reinsurance
receivable 622.0 641.8 648.5 700.9 746.6 688.7 915.7 727.8 488.8 883.5 1,090.0
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net liability-end
of year 1,854.7 1,934.2 2,104.2 2,316.1 2,551.6 2,810.0 2,953.5 2,977.4 3,364.9 3,472.5 $3,895.8
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ========
Gross re-estimated
liability at
December 31, 2002 3,434.2 3,371.9 3,396.4 3,492.4 3,618.6 3,744.1 3,870.8 4,045.3 4,334.2 4,727.7
Re-estimated
receivable at
December 31, 2002 1,181.4 1,106.3 1,029.1 1,248.5 1,110.7 978.9 946.4 974.9 849.6 1,115.1
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net re-estimated
liability at
December 31, 2002 2,252.8 2,265.6 2,367.3 2,243.9 2,507.9 2,765.2 2,924.5 3,070.5 3,484.6 3,612.6
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Gross cumulative
(deficiency)/
redundancy $ (957.5) $ (795.9) $ (643.7) $(475.4) $ (320.4) $ (245.4) $ (1.6) $ (340.1) $ (480.5) $ (371.7)
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
- ----------
(1) Includes $480.9 million relating to Mt. McKinley at December 31, 2000,
principally reflecting $491.1 million of Mt. McKinley reserves at the
acquisition date.
(2) The Canadian Branch reserves are reflected in Canadian dollars.
(3) Some totals may not reconcile due to rounding.
17
For years prior to 1992, management believes that two factors had the most
significant impact on loss development. First, through the mid-1980s, a number
of industry and external factors, such as the propensity of courts to award
large damage awards in liability cases, combined to increase loss frequency and
severity to unexpectedly high levels. Second, contracts written prior to 1986
contained coverage terms which, for the Company and the industry in general,
have been interpreted by courts to provide coverage for asbestos and
environmental exposures not contemplated by either the pricing or the initial
reserving of the contracts. Legal developments during the mid-1980s necessitated
additional reserving for such exposures on both a case basis and an incurred but
not reported ("IBNR") basis. More recently, particularly as reflected for
periods subsequent to 1998, the Company has experienced unforeseen adverse
shifts in loss emergence patterns, particularly in classes of business where the
underlying exposures have been impacted by unfavorable trends in litigation and
economic variability. The change between 1994 and 1995 reflects the impact of a
stop loss reinsurance agreement with Mt. McKinley, which was then a subsidiary
of The Prudential. This stop loss agreement commenced in 1995 when The
Prudential sold the Company in an initial public offering. This coverage became
an inter-affiliate reinsurance transaction with the acquisition of Mt. McKinley
in 2000. See Footnote 1L to Notes to Consolidated Financial Statements.
Management believes that adequate provision has been made for the Company's loss
and LAE reserves. While there can be no assurance that reserves for and losses
from these claims will not increase in the future, management believes that the
Company's existing reserves, reserving methodologies and retrocessional
arrangements lessen the probability that any such increases would have a
material adverse effect on the Company's financial condition, results of
operations or cash flows. These statements regarding the Company's loss reserves
are forward looking statements within the meaning of the U.S. federal securities
laws and are intended to be covered by the safe harbor provisions contained
therein. See ITEM 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Safe Harbor Disclosure."
The following table is derived from the Ten Year GAAP Loss Development Table
above and summarizes the effect of reserve re-estimates, net of reinsurance, on
calendar year operations for the same ten-year period ended December 31, 2002.
Each column represents the amount of reserve re-estimates made in the indicated
calendar year and shows the accident years to which the re-estimates are
applicable. The amounts in the total accident year column on the far right
represent the cumulative reserve re-estimates for the indicated accident years.
EFFECT OF RESERVE REESTIMATES ON CALENDAR YEAR OPERATIONS (1)
Cumulative Re-
Calendar Year Ended December 31, estimates for
--------------------------------------------------------------------------------------------- each Accident
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Year
------- ------ ------ ------- ------ ------- ------ ------ ------ ------- -------------
(Dollars in millions)
Accident
Years
1992 & prior $ (74.5) $(59.7) $(21.1) $(101.9) $(43.4) $(176.9) $ 62.4 $ (3.1) $ 4.7 $ 15.6 $(398.1)
1993 (14.5) 14.2 (1.7) (2.1) (3.5) 4.2 2.3 (2.8) (4.0) (7.9)
1994 (9.8) (9.3) 8.0 (0.7) 4.1 0.4 (0.6) 1.9 (6.0)
1995 142.4 59.6 160.4 (46.2) 6.5 6.1 (10.2) 318.7
1996 (18.9) (6.8) 5.5 11.8 5.0 4.5 1.1
1997 1.3 4.1 (10.4) 8.9 0.4 4.3
1998 1.4 (11.0) (9.8) (22.5) (41.9)
1999 (4.3) (3.3) (79.1) (86.7)
2000 (7.9) (26.4) (34.4)
2001 (20.4) (20.4)
Total calendar
year effect $ (74.5) $(74.3) $(16.7) $ 29.6 $ 3.2 $ (26.2) $ 35.4 $ (7.8) $ 0.0 $(140.1) $(271.4)
(1) Some totals may not reconcile due to rounding.
18
As illustrated by this table, the factors that caused the deficiencies shown in
the Ten Year GAAP Loss Development Table relate mainly to accident years prior
to 1992 principally reflecting the impact of asbestos and environmental
exposures discussed above. The significant favorable development experienced for
the 1995 accident year is due to aggregate excess of loss reinsurance provided
to the Company at the time of its initial public offering. This contract,
because of its 1995 inception date, is attributed to the 1995 accident year. The
adverse development experienced in the 1998 through 2001 accident years relates
principally to a limited number of business classes, mainly casualty classes,
including D&O, surety and certain international business where adverse loss
experience has emerged as the result of unforeseen loss trend shifts affecting
the underlying exposures. The Company's loss reserving methodologies
continuously monitor the emergence of such loss trend shifts, seeking both to
adjust reserves for their impact and to factor such developments into its
underwriting and pricing on a prospective basis.
The following table presents a reconciliation of beginning and ending reserve
balances for the years indicated on a GAAP basis:
RECONCILIATION OF RESERVES FOR LOSSES AND LAE
Years Ended December 31,
-------------------------------------
2002 2001 2000
--------- --------- ---------
(Dollars in millions)
Reserves at beginning of period $ 4,278.3 $ 3,786.2 $ 3,647.0
--------- --------- ---------
Incurred related to:
Current year 1,489.3 1,209.5 876.8
Prior years 140.1 - 7.8
--------- --------- ---------
Total incurred losses 1,629.4 1,209.5 884.6
--------- --------- ---------
Paid related to:
Current year (1) 314.5 393.9 (166.9)
Prior years 892.7 718.1 673.4
--------- --------- ---------
Total paid losses 1,207.2 1,112.0 506.5
--------- --------- ---------
Change in reinsurance receivables on
unpaid losses and LAE 205.1 394.6 (238.9)
--------- --------- ---------
Reserves at end of period $ 4,905.6 $ 4,278.3 $ 3,786.2
========= ========= =========
(1) Current year paid losses for 2000 are net of ($483.8) million resulting
from the acquisition of Mt. McKinley.
Prior year incurred losses increased by $140.1 million in 2002 and were stable
in 2001. These changes were the result of the reserve development noted above,
as well as inherent uncertainty in establishing loss and LAE reserves. See also
Note 1L of Notes to Consolidated Financial Statements.
19
RESERVES FOR ASBESTOS AND ENVIRONMENTAL LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company's reserves include an estimate of the Company's ultimate liability
for A&E claims for which ultimate value cannot be estimated using traditional
reserving techniques. There are significant uncertainties in estimating the
amount of the Company's potential losses from A&E claims. See ITEM 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asbestos and Environmental Exposures" and Note 3 of Notes to
Consolidated Financial Statements.
Mt. McKinley's book of direct A&E exposed insurance is relatively small and
homogenous. The book of business is based principally on excess liability
policies; thus the claim/legal staff does not have to analyze exposure under
many different policy forms, but rather can focus on a limited number of
policies and policy forms. As a result of this focused structure, the Company
believes that it is able to comprehensively analyze its exposures, allowing it
to identify and analyze those claims on which it has unusual exposure, such as
policies in which it may be exposed to pay expenses in addition to policy limits
or non-products asbestos claims, for concentrated ongoing attention.
The Company aims to be actively engaged with every insured account posing
significant potential asbestos exposure to Mt. McKinley. Such engagement can
take the form of a final settlement, negotiation, litigation, or the monitoring
of claim activity under Coverage in Place ("CIP") agreements. CIP agreements
generally condition an insurer's payment upon the actual claim experience of the
insured and may have annual payment caps or other measures to control the
insurer's payments. The Company's Mt. McKinley operations are currently managing
five CIP agreements, all of which were executed prior to the acquisition of Mt.
McKinley in 2000. Its preference with respect to coverage settlements is to
execute settlements that call for a fixed schedule of payments, because such
settlements eliminate future uncertainty.
During 2002, the Company significantly enhanced its classification of insureds
by exposure characteristics, as well as its analysis by insured for those it
considers to be more exposed or active. Those insureds identified as relatively
less exposed or active are subject to less rigorous, but still active
management, with an emphasis on monitoring those characteristics which may
indicate an increasing exposure or levels of activity. The Company continually
focuses on further enhancement of the detailed estimation processes used to
evaluate potential exposure of policyholders, including those that may not have
reported significant A&E losses.
Everest Re's book of assumed reinsurance is relatively concentrated within a
modest number of A&E exposed relationships. Because the book of business is
relatively concentrated and the Company has been managing the A&E exposures for
many years, its claim staff is familiar with the ceding companies that have
generated most of these liabilities in the past and which are therefore most
likely to generate future liabilities. The Company's claim staff has developed
familiarity both with the nature of the business written by its ceding companies
and the claims handling and reserving practices of those companies. This level
of familiarity enhances the quality of the Company's analysis of its exposure
through those companies. As a result, the Company believes that it can identify
those claims on which it has unusual exposure, such as non-products asbestos
claims, for concentrated attention.
20
The following table summarizes the composition of the Company's total reserves
for A&E losses, gross and net of reinsurance, for the years ended December 31,
2002, 2001 and 2000.
YEARS ENDED DECEMBER 31,
-----------------------------------
2002 2001 2000 (1)
------- ------- -------
(Dollars in millions)
Case reserves reported by ceding companies $ 112.5 $ 107.1 $ 106.8
Additional reserves established by the Company
(assumed reinsurance) 55.5 59.5 74.0
Case reserves established by the Company 262.1 154.1 118.3
IBNR reserves 237.8 323.7 394.6
------- ------- -------
Gross reserves 667.9 644.4 693.7
Reinsurance receivable (140.4) (75.8) (65.2)
------- ------- -------
Net reserves $ 527.5 $ 568.6 $ 628.5
======= ======= =======
- ------------------
(1) In 2000, Holdings acquired Mt. McKinley, resulting in an increase to the
Company's gross and net asbestos and environmental exposure.
Additional losses, including those relating to currently unrecognized latent
injuries, the type or magnitude of which cannot be foreseen by the Company, or
the reinsurance and insurance industry generally, may emerge in the future. Such
future emergence, to the extent not covered by existing retrocessional
contracts, could have material adverse effects on the Company's future financial
condition, results of operations and cash flows.
FUTURE POLICY BENEFIT RESERVES
Future policy benefit liabilities for annuities are reported at the accumulated
fund balance of these contracts. Reserves for those liabilities include both
mortality and morbidity provisions with respect to life and annuity claims, both
reported and unreported. Actual experience in a particular period may be worse
than assumed experience and, consequently, may adversely affect the Company's
operating results for the period. See Note 1F of Notes to Consolidated Financial
Statements.
INVESTMENTS
The Company's overall financial strength and results of operations are, in part,
dependent on the quality and performance of its investment portfolio. Net
21
investment income and net realized capital gains (losses) on the Company's
invested assets constituted 11.8%, 17.7%, and 20.4% of the Company's revenues
for the years ending December 31, 2002, 2001 and 2000, respectively. The
Company's cash and invested assets totaled $7,259.1 million at December 31,
2002, of which 94.5% were cash or investment-grade fixed maturities.
The Company's current investment strategy seeks to maximize after-tax income,
through a high quality, diversified, taxable bond and tax-preferenced fixed
maturity portfolio, while maintaining an adequate level of liquidity. The
Company's mix of taxable and tax-preferenced investments is adjusted
continuously, consistent with the Company's current and projected operating
results, market conditions and tax position. Additionally, the Company invests
in equity securities, which it believes will enhance the risk-adjusted total
return of the investment portfolio.
The board of directors of each company is responsible for establishing
investment policy and guidelines and, together with senior management, for
overseeing their execution. The Company's investment portfolio is in compliance
with the insurance laws of the jurisdictions in which its subsidiaries are
regulated. An independent investment advisor is utilized to manage the Company's
investment portfolio within the established guidelines and is required to report
activities on a current basis and to meet with the Company periodically to
review and discuss the portfolio structure, securities selection and performance
results.
The Company's investment guidelines include a current duration guideline of five
to six years. The duration of an investment is based on the maturity of the
security but also reflects the payment of interest and the possibility of early
prepayment of such security. This investment duration guideline is established
and periodically revised by management, which considers economic and business
factors. An important factor considered by management is the Company's average
duration of potential liabilities, which, at December 31, 2002, is estimated at
approximately five years based on the estimated payouts of underwriting
liabilities using standard duration calculations.
Approximately 7.6% of the Company's consolidated reserves for losses and LAE and
unearned premiums represent estimated amounts payable in foreign currencies. For
each currency in which the Company has established substantial reserves, the
Company seeks to maintain invested assets denominated in such currency in an
amount approximately comparable to the estimated liabilities.
As of December 31, 2002, 98.6% of the Company's total investments and cash were
comprised of fixed maturity investments or cash and 94.5% of the Company's fixed
maturities consisted of investment grade securities. The average maturity of
fixed maturities was 8.1 years at December 31, 2002, and their overall duration
was 5.4 years. As of December 31, 2002, the Company did not have any investments
in commercial real estate or direct commercial mortgages or any material
holdings of derivative investments or securities of issuers that are
experiencing cash flow difficulty to an extent that the Company's management
believes could threaten the issuer's ability to meet debt service payments,
except where other than temporary impairments have been recognized.
As of December 31, 2002, the Company's common stock portfolio had a market value
of $47.5 million, comprising 0.7% of total investments and cash. The common
stock portfolio is managed with a growth orientation.
22
The following table reflects investment results for the Company for each of the
five years in the period ended December 31, 2002:
Pre-Tax
Pre-Tax Realized Net
Average Investment Effective Capital (Losses)
Years Ended December 31, Investments(1) Income(2) Yield Gains
- ------------------------ -------------- ------------ --------- ---------------
(Dollars in millions)
2002 $ 6,064.8 $ 350.6 5.78% $ (50.0)
2001 5,374.9 340.4 6.33 (22.3)
2000 4,824.0 301.5 6.25 0.8
1999 4,219.4 253.0 6.00 (16.8)
1998 4,243.3 244.9 5.77 (0.8)
- -----------------
(1) Average of the beginning and ending carrying values of investments and
cash, less net funds held and non-interest bearing cash. Bonds, common
stock and redeemable and non-redeemable preferred stocks are carried at
market value.
(2) After investment expenses, excluding realized net capital gains (losses).
The following table summarizes fixed maturities as of December 31, 2002 and
2001:
Amortized Unrealized Unrealized Market
Cost Appreciation Depreciation Value
--------- ------------ ------------ ---------
(Dollars in millions)
December 31, 2002:
U.S. Treasury securities and obligations of U.S.
government agencies and corporations $ 506.6 $ 10.1 $ 0.5 $ 516.2
Obligations of states and political subdivisions 2,520.6 144.6 2.6 2,662.6
Corporate securities 2,066.0 119.2 31.7 2,153.5
Mortgage-backed securities 839.5 43.0 1.1 881.4
Foreign government securities 312.7 25.2 - 337.9
Foreign corporate securities 215.4 14.3 1.4 228.3
--------- ------------ ------------ ---------
Total $ 6,460.8 $ 356.4 $ 37.3 $ 6,779.9
========= ============ ============ =========
December 31, 2001:
U.S. Treasury securities and obligations of U.S.
government agencies and corporations $ 114.8 $ 5.2 $ 0.1 $ 119.9
Obligations of states and political subdivisions 1,762.9 78.4 2.8 1,838.5
Corporate securities 2,254.7 77.6 39.5 2,292.8
Mortgage-backed securities 701.2 28.3 0.8 728.7
Foreign government securities 194.9 18.1 0.1 212.9
Foreign corporate securities 260.4 10.2 1.8 268.8
--------- ------------ ------------ ---------
Total $ 5,288.9 $ 217.8 $ 45.1 $ 5,461.6
========= ============ ============ =========
23
The following table presents the credit quality distribution of the Company's
fixed maturities as of December 31, 2002:
Percent of
Rating Agency Credit Quality Distribution Amount Total
- ----------------------------------------- --------- ----------
(Dollars in millions)
AAA/AA/A $ 5,612.5 82.8%
BBB 797.0 11.8
BB 306.2 4.5
B 56.9 0.8
CCC/CC/C 2.4 0.0
CI/D 4.9 0.1
--------- ----------
Total $ 6,779.9 100.0%
========= ==========
The following table summarizes fixed maturities by contractual maturity as of
December 31, 2002:
Percent of
Amount Total
--------- ----------
(Dollars in millions)
Maturity category:
Less than one year $ 75.8 1.1%
1-5 years 1,628.6 24.0
5-10 years 1,519.7 22.4
After 10 years 2,674.4 39.4
--------- ----------
Subtotal (2) 5,898.5 87.0
Mortgage-backed securities (1) 881.4 13.0
--------- ----------
Total (2) $ 6,779.9 100.0%
========= ==========
- -----------
(1) Mortgage-backed securities generally are more likely to be prepaid than
other fixed maturities. Therefore, contractual maturities are excluded from
this table since they may not be indicative of actual maturities.
(2) Certain totals may not reconcile due to rounding.
24
RATINGS
The following table shows the financial strength ratings of the Company's
operating subsidiaries as reported by A.M. Best, Standard & Poor's Rating
Services ("Standard & Poor's") and Moody's Investor Service, Inc. ("Moody's").
These ratings are based upon factors of concern to policyholders and should not
be considered an indication of the degree or lack of risk involved in an equity
investment in an insurance company.
Operating Subsidiary A.M. Best Standard & Poor's Moody's
- --------------------------------------------------------------------------------------
Everest Re A+ (Superior) AA- (Positive) Aa3 (Excellent)
Bermuda Re A+ (Superior) AA- (Positive) Aa3 (Excellent)
Everest National A+ (Superior) AA- (Positive) Not Rated
Everest Indemnity A+ (Superior) Not Rated Not Rated
Everest Security A+ (Superior) Not Rated Not Rated
Mt. McKinley Not Rated Not Rated Not Rated
Everest International Not Rated Not Rated Not Rated
A.M. Best states that the "A+" ("Superior") rating is assigned to those
companies which, in its opinion, have, on balance, achieved superior financial
strength, operating performance and market profile when compared to the
standards established by A.M. Best and have demonstrated a very strong ability
to meet their ongoing obligations to policyholders. The "A+" ("Superior") rating
is the second highest of fifteen ratings assigned by A.M. Best, which range from
"A++" ("Superior") to "F" ("In Liquidation"). Additionally, A.M. Best has eleven
classifications within the "Not Assigned" category. Standard & Poor's states
that the "AA-" rating is assigned to those insurance companies which, in its
opinion, offer excellent financial security and whose capacity to meet
policyholder obligations is strong under a variety of economic and underwriting
conditions. The "AA-" rating is the fourth highest of nineteen ratings assigned
by Standard & Poor's, which range from "AAA" to "R". Ratings from AA to B may be
modified by the use of a plus or minus sign to show relative standing of the
insurer within those rating categories. Moody's states that insurance companies
rated "Aa" offer excellent financial security. Together with the Aaa rated
companies, Aa rated companies constitute what are generally known as high grade
companies, with Aa rated companies generally having somewhat larger long-term
risks. Moody's rating gradations are shown through the use of nine distinct
symbols, each symbol representing a group of ratings in which the financial
security is broadly the same. The "Aa3" (Excellent) rating is the fourth highest
of ratings assigned by Moody's, which range from "Aaa" (Exceptional) to "C"
(Lowest). Moody's further distinguishes the ranking of an insurer within its
generic rating classification from Aa to B with 1, 2 and 3 ("1" being the
highest).
25
The following table shows the investment grade ratings of the Holdings' senior
notes due March 15, 2005, Holdings' senior notes due March 15, 2010 and Capital
Trust's trust preferred securities by A.M. Best, Standard & Poor's and Moody's.
Debt ratings are a current assessment of the credit-worthiness of an obligor
with respect to a specific obligation.
A.M. Best Standard & Poor's Moody's
- -----------------------------------------------------------------------------------
Senior Notes a A- A3
Trust Preferred Securities a- BBB Baa1
A company with a debt rating of "a" or "a-" is considered by A.M. Best to have a
strong capacity and willingness to meet the terms of the obligation and
possesses a low level of credit risk. The "a" and "a-" ratings are the sixth and
seventh highest of 19 ratings assigned by A.M. Best, which range from "aaa" to
"ccc". A company with a debt rating of "A-" is considered by Standard & Poor's
to have a strong capacity to pay interest and repay principal, although it is
somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than debt in higher rated categories. A company with a debt
rating of "BBB" is considered by Standard & Poor's to have adequate capacity to
pay interest and repay principal, but is susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories. The "A-" and "BBB" ratings from Standard & Poor's are the seventh
and ninth highest of 24 ratings assigned by Standard & Poor's, which range from
"AAA" to "D". A company with a debt rating of "A3" is considered to be an
upper-medium-grade obligation by Moody's. This rating represents adequate
capacity with respect to repayment of principal and interest, but elements may
be present which suggest a susceptibility to impairment sometime in the future.
A company with a debt rating of "Baa1" is considered to be a medium-grade
obligation by Moody's. This rating represents adequate capacity with respect to
repayment of principal and interest, but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
The "A3" and "Baa1" ratings are the seventh and eighth highest of 21 ratings
assigned by Moody's, which range from "AAA" to "C".
All of the above-mentioned ratings are continually monitored and revised, if
necessary, by each of the rating agencies.
COMPETITION
The worldwide reinsurance and insurance businesses are highly competitive, yet
cyclical by product and market. The terrorist attacks on September 11, 2001 (the
"September 11 attacks") resulted in losses which reduced industry capacity and
were of sufficient magnitude to cause most companies to reassess their capital
position, tolerance for risk, exposure control mechanisms and the pricing terms
and conditions at which they are willing to take on risk. The gradual and
variable improving trend that had been apparent through 2000 and earlier in 2001
firmed significantly after the September 11 attacks. This firming generally took
the form of immediate and significant upward pressure on prices, more
restrictive terms and conditions and a reduction of coverage limits and capacity
availability. Such pressures were widespread, with variability depending on the
product and markets involved, but mainly depending on the characteristics of the
underlying risk exposures. The magnitude of the changes was sufficient to create
temporary disequilibrium in some markets as individual buyers and sellers
adapted to changes in both their internal and market dynamics.
26
During 2002, the reinsurance and insurance markets continued to firm. This
firming reflects the losses arising from the September 11 attacks as well as
reactions to broad and growing recognition that competition in the late 1990s
reached extremes in many classes and markets, which ultimately led to inadequate
pricing and overly broad terms, conditions and coverages. The effect of these
extremes, which is becoming apparent through excessive loss emergence, varies
widely by company depending on product offerings, markets accessed, underwriting
and operating practices, competitive strategies and business volumes. Across all
market participants; however, the aggregate effect has been impaired financial
results and erosion of the industry capital base. Coupled with deteriorating
investment market conditions and results, and renewed concerns regarding
longer-term industry specific issues, including asbestos exposure and sub-par
capital returns, these financial impacts have introduced substantial, and in
some cases extreme, pressure for the initiation and/or strengthening of
corrective action by individual market participants. These pressures have
resulted in firming prices, more restrictive terms and conditions and tightened
coverage availability across most classes and markets.
These changes reflect a clear reversal of the general trend from 1987 through
1999 toward increasingly competitive global market conditions across most lines
of business as reflected by decreasing prices and broadening contract terms. The
earlier trend resulted from a number of factors, including the emergence of
significant reinsurance capacity in Bermuda, changes in the Lloyd's market,
consolidation and increased capital levels in the insurance and reinsurance
industries, as well as the emergence of new reinsurance and financial products
addressing traditional exposures in alternative fashions. Many of these factors
continue to exist and have taken on additional importance as the result of the
firming conditions which have emerged. As a result, although the Company is
encouraged by the recent improvements, and more generally, by current market
conditions, the Company cannot predict with any reasonable certainty whether and
to what extent these improvements will persist.
Competition with respect to the types of reinsurance and insurance business in
which the Company is engaged is based on many factors, including the perceived
overall financial strength of the reinsurer or insurer, A.M. Best's and/or
Standard & Poor's rating of the reinsurer or insurer, underwriting expertise,
the jurisdictions where the reinsurer or insurer is licensed or otherwise
authorized, capacity and coverages offered, premiums charged, other terms and
conditions of the reinsurance and insurance business offered, services offered,
speed of claims payment and reputation and experience in lines written. The
Company competes in the United States, Bermuda and international reinsurance and
insurance markets with numerous international and domestic reinsurance and
insurance companies. The Company's competitors include independent reinsurance
and insurance companies, subsidiaries or affiliates of established worldwide
insurance companies, reinsurance departments of certain insurance companies and
domestic and international underwriting operations, including underwriting
syndicates at Lloyd's. Some of these competitors have greater financial
resources than the Company and have established long-term and continuing
business relationships throughout the industry, which can be a significant
competitive advantage. In addition, the potential for securitization of
reinsurance and insurance risks through capital markets provides an additional
source of potential reinsurance and insurance capacity and competition.
EMPLOYEES
As of March 1, 2003, the Company employed 536 persons. Management believes that
its employee relations are good. None of the Company's employees are subject to
collective bargaining agreements, and the Company is not aware of any current
efforts to implement such agreements.
27
REGULATORY MATTERS
The Company and its insurance subsidiaries are subject to regulation under the
insurance statutes of the various jurisdictions in which they conduct business,
including essentially all states of the United States, Canada, Singapore, the
United Kingdom and Bermuda. These regulations vary from jurisdiction to
jurisdiction and are generally designed to protect ceding insurance companies
and policyholders by regulating the Company's conduct of business, financial
integrity and ability to meet its obligations relating to its business
transactions and operations. Many of these regulations require reporting of
information designed to allow insurance regulators to closely monitor the
Company's performance.
INSURANCE HOLDING COMPANY REGULATION. Under applicable United States laws and
regulations, no person, corporation or other entity may acquire a controlling
interest in the Company, unless such person, corporation or entity has obtained
the prior approval for such acquisition from the Insurance Commissioners of
Delaware and the other states in which the Company's insurance subsidiaries are
domiciled or deemed domiciled, currently Arizona, California and Georgia. Under
these laws, "control" is presumed when any person acquires, directly or
indirectly, 10% or more of the voting securities of an insurance company. To
obtain the approval of any change in control, the proposed acquirer must file an
application with the relevant insurance commissioner disclosing, among other
things, the background of the acquirer and that of its directors and officers,
the acquirer's financial condition and its proposed changes in the management
and operations of the insurance company. U.S. state regulators also require
prior notice or regulatory approval of material inter-affiliate transactions
within the holding company structure. See "Dividends".
The Insurance Companies Act of Canada also requires prior approval by the
Minister of Finance of anyone acquiring a significant interest in an authorized
Canadian insurance company. In addition, the Company is subject to regulation by
the insurance regulators of other states and foreign jurisdictions in which it
does business. Certain of these states and foreign jurisdictions impose
regulations regulating the ability of any person to acquire control of an
insurance company authorized to do business in that jurisdiction without
appropriate regulatory approval similar to those described above.
DIVIDENDS. Under Bermuda law, Group is prohibited from declaring or paying a
dividend if such payment would reduce the realizable value of its assets to an
amount less than the aggregate value of its liabilities and its issued share
capital and share premium (additional paid-in capital) accounts. Group's ability
to pay dividends and its operating expenses is partially dependent upon
dividends from its subsidiaries. The payment of dividends by insurance
subsidiaries is limited under Bermuda law as well as the laws of the various
U.S. states in which Group's insurance and reinsurance subsidiaries are licensed
to transact business. The limitations are generally based upon net income and
compliance with applicable policyholders' surplus or minimum solvency margin and
liquidity ratio requirements as determined in accordance with the relevant
statutory accounting practices. As Holdings has outstanding debt obligations, it
is dependent upon dividends and other permissible payments from its operating
subsidiaries to enable it to meet its debt and operating expense obligations and
to pay dividends to Group.
The payment of dividends to Holdings by Everest Re is subject to limitations
imposed by Delaware law. Generally, Everest Re may only pay dividends out of its
statutory earned surplus, which was $921.0 million at December 31, 2002, and
only after it has given 10 days prior notice to the Delaware Insurance
28
Commissioner. During this 10-day period, the Commissioner may, by order, limit
or disallow the payment of ordinary dividends if the Commissioner finds the
insurer to be presently or potentially in financial distress. Further, the
maximum amount of dividends that may be paid without the prior approval of the
Delaware Insurance Commissioner in any twelve month period is the greater of (1)
10% of an insurer's statutory surplus as of the end of the prior calendar year
or (2) the insurer's statutory net income, not including realized capital gains,
for the prior calendar year. Under this definition, the maximum amount that will
be available for the payment of dividends by Everest Re in 2003 without
triggering the requirement for prior approval of regulatory authorities in
connection with a dividend is $149.4 million.
Under Bermuda law, Bermuda Re is unable to declare or make payment of a dividend
if it fails to meet its minimum solvency margin or minimum liquidity ratio. As a
long-term insurer, Bermuda Re is also unable to declare or pay a dividend to
anyone who is not a policyholder unless, after payment of the dividend, the
value of the assets in its long-term business fund, as certified by its approved
actuary, exceeds its liabilities for long-term business by at least the $250,000
minimum solvency margin. Prior approval of the Bermuda Monetary Authority is
required if Bermuda Re's dividend payments would reduce its prior year-end total
statutory capital by 15.0% or more. At December 31, 2002, Bermuda Re met its
solvency and liquidity requirements by a significant margin.
INSURANCE REGULATION. U.S. domestic property and casualty insurers, including
reinsurers, are subject to regulation by their state of domicile and by those
states in which they are licensed. The regulation of reinsurers is typically
related to the reinsurer's financial condition, investments, management and
operation. The rates and policy terms of reinsurance agreements are generally
not subject to direct regulation by any governmental authority.
The operations of Everest Re's foreign branch offices in Canada, Singapore and
the United Kingdom are subject to regulation by the insurance regulatory
officials of those jurisdictions. Management believes that the Company is in
material compliance with applicable laws and regulations pertaining to its
business and operations.
Bermuda Re is not admitted to do business as an insurer in any jurisdiction in
the U.S. Bermuda Re conducts its insurance business from its offices in Bermuda.
In Bermuda, Bermuda Re is regulated by the Insurance Act 1978 (as amended) and
related regulations (the "Act"). The Act establishes solvency and liquidity
standards, auditing and reporting requirements and subjects Bermuda Re to the
supervision, investigation and intervention powers of the Bermuda Monetary
Authority. Under the Act, Bermuda Re, as a Class 4 insurer, is required to
maintain $100 million in statutory capital and surplus, to have an independent
auditor approved by the Bermuda Monetary Authority conduct an annual audit and
report on its statutory financial statements and filings and to have an
appointed loss reserve specialist (also approved by the Bermuda Monetary
Authority) review and report on its loss reserves annually.
Bermuda Re is also registered under the Act as a long-term insurer and is
thereby authorized to write life and annuity business. As a long-term insurer,
Bermuda Re is required to maintain a long-term business fund, to separately
account for this business and to have an approved actuary prepare a certificate
concerning its long-term business assets and liabilities to be filed annually.
Everest Indemnity, Everest National, Everest Security and Mt. McKinley are
subject to regulations similar to the U.S. regulations applicable to Everest Re.
In addition, Everest National and Everest Security must comply with substantial
regulatory requirements in each state where they conduct business. These
additional requirements include, but are not limited to, rate and policy form
requirements, requirements with regard to licensing, agent appointments,
participation in residual markets and claim handling procedures. These
regulations are primarily designed for the protection of policyholders.
29
LICENSES. Everest Re is a licensed property and casualty insurer and/or
reinsurer in all states (except Nevada and Wyoming), the District of Columbia
and Puerto Rico. In New Hampshire and Puerto Rico, Everest Re is licensed for
reinsurance only. Such licensing enables U.S. domestic ceding company clients to
take credit for reinsurance ceded to Everest Re.
Everest Re is licensed as a property and casualty reinsurer in Canada. It is
also authorized to conduct reinsurance business in the United Kingdom and
Singapore. Everest Re can also write reinsurance in other foreign countries.
Because some jurisdictions require a reinsurer to register in order to be an
acceptable market for local insurers, Everest Re is registered as a foreign
insurer and/or reinsurer in the following countries: Argentina, Bolivia, Chile,
Colombia, Ecuador, El Salvador, Guatemala, Mexico, Peru, Venezuela and the
Philippines. Everest National is licensed in 45 states and the District of
Columbia. Everest Indemnity is licensed in Delaware and is eligible to write
insurance on a surplus lines basis in 48 states, the District of Columbia and
Puerto Rico. Everest Security is licensed in Georgia and Alabama. Mt. McKinley
is licensed in Delaware and California. Bermuda Re is registered as a Class 4
insurer and a long-term insurer in Bermuda.
PERIODIC EXAMINATIONS. Everest Re, Everest National, Everest Indemnity, Everest
Security and Mt. McKinley are subject to periodic financial examination (usually
every 3 years) of their affairs by the insurance departments of the states in
which they are licensed, authorized or accredited. Everest Re's, Everest
Security's, Everest Indemnity's and Mt. McKinley's last examination reports were
as of December 31, 2000, while Everest National's last examination was as of
December 31, 2001. None of these reports contained any material findings or
recommendations. In addition, U.S. insurance companies are subject to
examinations by the various state insurance departments where they are licensed
concerning compliance with applicable conduct of business regulations.
NAIC RISK-BASED CAPITAL REQUIREMENTS. The U.S. National Association of Insurance
Commissioners ("NAIC") employs a formula to measure the amount of capital
appropriate for a property and casualty insurance company to support its overall
business operations in light of its size and risk profile. The major categories
of a company's risk profile are its asset risk, credit risk, and underwriting
risk. The standards are an effort by the NAIC to prevent insolvencies, to ward
off other financial difficulties of insurance companies and to establish uniform
regulatory standards among state insurance departments.
Under the approved formula, a company's statutory surplus is compared to its
risk based capital ("RBC"). If this ratio is above a minimum threshold, no
action is necessary. Below this threshold are four distinct action levels at
which a regulator can intervene with increasing degrees of authority over a
domestic insurer as the ratio of surplus to RBC decreases. The mildest
intervention requires the company to submit a plan of appropriate corrective
actions. The most severe action requires the company to be rehabilitated or
liquidated.
Based on their financial positions at December 31, 2002, Everest Re, Everest
National, Everest Indemnity and Everest Security exceed the minimum thresholds.
Since Mt. McKinley ceased writing new and renewal insurance in 1985, its
domiciliary regulator, Delaware, has exempted Mt. McKinley from complying with
RBC requirements. Various proposals to change the RBC formula arise from time to
time. The Company is unable to predict whether any such proposal will be
adopted, the form in which any such proposals would be adopted or the effect, if
any, the adoption of any such proposal or change in the RBC calculations would
have on the Company.
30
CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES. The NAIC has published a
codification of statutory accounting principles, which has been adopted by the
states of domicile of the Company's U.S. operating subsidiaries with an
effective date of January 1, 2001. On January 1, 2001, significant changes to
the statutory-basis of accounting became effective. The cumulative effect of
these changes in 2001 was a $57.1 million increase to Everest Re's statutory
surplus.
TAX MATTERS. The following summary of the taxation of the Company is based on
current law. There can be no assurances that legislative, judicial, or
administrative changes will not be enacted that materially affect this summary.
BERMUDA. Under current Bermuda law, no income, withholding or capital gains
taxes are imposed upon Group and its Bermuda subsidiaries. Group and its Bermuda
subsidiaries have received an undertaking from the Minister of Finance in
Bermuda that, in the event of any taxes being imposed, Group and its Bermuda
subsidiaries will be exempt from taxation in Bermuda until March 2016.
Non-Bermuda branches of Bermuda subsidiaries are subject to local taxes in the
jurisdictions in which they operate.
BARBADOS. Group, a Bermuda company with its principal office in Barbados, is
registered as an external company under the Companies Act, Cap. 308 of Barbados
and is licensed as an international business company under the Barbados
International Business Companies Act, 1991-24. As a result, Group is subject to
a preferred rate of corporation tax on profits and gains in Barbados and is
exempt from withholding tax on dividends, interest, royalties, management fees,
fees or other income paid or deemed paid to a person who is not resident in
Barbados or who, if so resident, carries on an international business. No tax is
imposed on capital gains.
UNITED STATES. Group's U.S. subsidiaries conduct business in and are subject to
taxation in the United States. Non-U.S. branches of U.S. subsidiaries are
subject to local taxation in the jurisdictions in which they operate. Should the
U.S. subsidiaries distribute current or accumulated earnings and profits in the
form of dividends or otherwise to Group, the Company would be subject to
withholding taxes. Group and its Bermuda subsidiaries believe that they have
operated and will continue to operate their business in a manner that will not
cause them to generate income treated as effectively connected with the conduct
of a trade or business within the United States. On this basis, Group does not
expect that it and its Bermuda subsidiaries will be required to pay U.S.
corporate income taxes other than withholding taxes on certain investment income
and premium excise taxes. If Group or Bermuda Re were subject to U.S. income
tax, there could be a material adverse effect on the Company's financial
condition, results of operations or cash flows.
AVAILABLE INFORMATION
The Company's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, proxy statements and amendments to those reports
are available free of charge through the Company's internet website at
HTTP://WWW.EVERESTRE.COM as soon as reasonably practicable after such reports
are electronically filed with the Securities and Exchange Commission.
ITEM 2. PROPERTIES
Everest Re's corporate offices are located in approximately 115,000 square feet
of leased office space in Liberty Corner, New Jersey. Bermuda Re's corporate
offices are located in approximately 3,600 total square feet of leased office
31
space in Hamilton, Bermuda. The Company's other twelve locations occupy a total
of approximately 64,000 square feet, all of which are leased. Management
believes that the above-described office space is adequate for its current and
anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, the Company is involved in lawsuits,
arbitrations and other formal and informal dispute resolution procedures, the
outcomes of which will determine the Company's rights and obligations under
insurance and reinsurance agreements and other more general contracts. In some
disputes, the Company seeks to enforce its rights under an agreement or to
collect funds owing to it. In other matters, the Company is resisting attempts
by others to collect funds or enforce alleged rights. Such disputes are resolved
through formal and informal means, including litigation and arbitration.
In all such matters, the Company believes that its positions are legally and
commercially reasonable. The Company also regularly evaluates those positions,
and where appropriate, establishes or adjusts insurance reserves to reflect its
evaluation. The Company's aggregate reserves take into account the possibility
that the Company may not ultimately prevail in each and every disputed matter.
The Company believes its aggregate reserves reduce the potential that an adverse
resolution of one or more of these matters, at any point in time, would have a
material impact on the Company's financial condition or results of operations.
However, there can be no assurances that adverse resolutions of such matters in
any one period or in the aggregate will not result in a material adverse effect
on the Company's results of operations.
The Company does not believe that there are any other material pending legal
proceedings to which it or any of its subsidiaries or their properties are
subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
MARKET INFORMATION
The common shares of Group trade on the New York Stock Exchange under the
symbol, "RE". Quarterly high and low market prices of the Company's common
shares in 2002 and 2001 were as follows:
High Low
First Quarter 2002: 75.0000 66.0000
Second Quarter 2002: 71.7000 55.9400
Third Quarter 2002: 57.9700 43.2500
Fourth Quarter 2002: 62.4900 52.1800
First Quarter 2001: 68.8750 55.3750
Second Quarter 2001: 74.8000 62.0000
Third Quarter 2001: 72.9700 48.7500
Fourth Quarter 2001: 78.5000 63.8000
32
NUMBER OF HOLDERS OF COMMON SHARES
The number of record holders of common shares as of March 1, 2003 was 68. That
number excludes the beneficial owners of shares held in "street" name or held
through participants in depositories, such as The Depository Trust Company.
DIVIDEND HISTORY AND RESTRICTIONS In 1995, the Board of Directors of Holdings
established a policy of declaring regular quarterly cash dividends and has paid
a regular quarterly dividend in each quarter since the fourth quarter of 1995.
The Company declared and paid its regular quarterly cash dividend of $0.07 per
share for each quarter of 2001 and $0.08 per share for each quarter of 2002. A
committee of the Company's Board of Directors declared a dividend of $0.09 per
share, payable on or before March 21, 2003 to shareholders of record on March 3,
2003.
The declaration and payment of future dividends, if any, by the Company will be
at the discretion of the Board of Directors and will depend upon many factors,
including the Company's earnings, financial condition, business needs and growth
objectives, capital and surplus requirements of its operating subsidiaries,
regulatory restrictions, rating agency considerations and other factors. As an
insurance holding company, the Company is partially dependent on dividends and
other permitted payments from its subsidiaries to pay cash dividends to its
stockholders. The payment of dividends to Group by Holdings and to Holdings by
Everest Re is subject to Delaware regulatory restrictions and the payment of
dividends to Group by Bermuda Re will be subject to Bermuda insurance regulatory
restrictions. See "Regulatory Matters - Dividends" and Note 13A of Notes to
Consolidated Financial Statements.
RECENT SALES OF UNREGISTERED SECURITIES
The following securities were issued by the Company during 2002 and were not
registered under the U.S. Securities Act of 1933:
- - On April 1, 2002, 724 common shares of the Company and on July 1, 2002, 892
common shares of the Company were distributed.
- - The securities were distributed to the Company's four non-employee
Directors.
- - The securities were issued as compensation to the non-employee Directors
for services rendered to the Company in their capacities as Directors.
- - Exemption from registration was claimed pursuant to Section 4(2) of the
Securities Act of 1933. There was no public offering and the participants
in the transactions were the Company and its non-employee Directors.
- - Not applicable.
- - Not applicable.
33
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated GAAP financial data of the Company as of and
for the years ended December 31, 2002, 2001, 2000, 1999 and 1998 were derived
from the consolidated financial statements of the Company, which were audited by
PricewaterhouseCoopers LLP. The following financial data should be read in
conjunction with the Consolidated Financial Statements and accompanying notes.
Years Ended December 31,
---------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- ---------- --------- ----------
(Dollars in millions, except per share amounts)
OPERATING DATA:
Gross premiums written $ 2,846.5 $ 1,874.6 $ 1,385.6 $ 1,141.8 $ 1,045.9
Net premiums written 2,637.6 1,560.1 1,218.9 1,095.6 1,016.6
Net premiums earned 2,273.7 1,467.5 1,174.2 1,071.5 1,068.0
Net investment income 350.6 340.4 301.5 253.0 244.9
Net realized capital (losses) gains (50.0) (22.3) 0.8 (16.8) (0.8)
Losses and LAE incurred (including
catastrophes) 1,629.4 1,209.5 884.6 771.6 778.4
Total catastrophe losses (1) 30.2 222.6 13.9 45.9 30.6
Commission, brokerage, taxes and fees 551.8 396.8 272.4 286.0 274.6
Other underwriting expenses 69.9 58.9 51.6 48.3 49.6
Interest expense 42.4 46.0 39.4 1.5 -
Income before taxes 262.0 90.3 231.7 196.6 212.7
Income tax expense (benefit) 30.7 (8.7) 45.4 38.5 47.5
Net income (2) $ 231.3 $ 99.0 $ 186.4 $ 158.1 $ 165.2
========= ========= ========== ========= ==========
Net income per basic share (3) $ 4.60 $ 2.14 $ 4.06 $ 3.26 $ 3.28
========= ========= ========== ========= ==========
Net income per diluted share (4) $ 4.52 $ 2.10 $ 4.02 $ 3.25 $ 3.26
========= ========= ========== ========= ==========
Dividends paid per share $ 0.32 $ 0.28 $ 0.24 $ 0.24 $ 0.20
========= ========= ========== ========= ==========
CERTAIN GAAP FINANCIAL RATIOS: (5)
Loss and LAE ratio 71.7% 82.4% 75.3% 72.0% 72.9%
Underwriting expense ratio 27.4 31.1 27.6 31.5 30.3
--------- --------- ---------- --------- ----------
Combined ratio (2) 99.0% 113.5% 102.9% 103.5% 103.2%
========= ========= ========== ========= ==========
Balance sheet data (at end of period):
Total investments and cash $ 7,259.1 $ 5,783.5 $ 5,493.0 $ 4,139.2 $ 4,325.8
Total assets 9,864.6 7,796.2 7,013.1 5,704.3 5,996.7
Loss and LAE reserves 4,905.6 4,278.3 3,786.2 3,647.0 3,800.0
Total debt 518.9 553.8 683.6 59.0 -
Total liabilities 7,286.0 6,075.6 5,429.7 4,376.8 4,517.5
Trust preferred securities 210.0 - - - -
Shareholders' equity 2,368.6 1,720.5 1,583.4 1,327.5 1,479.2
Book value per share (6) 46.55 37.19 34.40 28.57 29.59
- ------------
(1) Catastrophe losses are net of reinsurance. A catastrophe is defined, for
purposes of the Selected Consolidated Financial Data, as an event that
causes a pre-tax loss on property exposures before reinsurance of at least
$5.0 million and has an event date of January 1, 1988 or later.
(2) Some amounts may not reconcile due to rounding.
(3) Based on weighted average basic shares outstanding of 50.3 million, 46.2
million, 45.9 million, 48.5 million and 50.4 million for 2002, 2001, 2000,
1999 and 1998, respectively.
(4) Based on weighted average diluted shares outstanding of 51.1 million, 47.1
million, 46.4 million, 48.7 million and 50.7 million for 2002, 2001, 2000,
1999 and 1998, respectively.
(5) Loss ratio is the GAAP losses and LAE incurred as a percentage of GAAP net
premiums earned. Underwriting expense ratio is the GAAP commissions,
brokerage, taxes, fees and general expenses as a percentage of GAAP net
premiums earned. Combined ratio is the sum of the loss ratio and
underwriting expense ratio.
(6) Based on 50.9 million, 46.3 million, 46.0 million, 46.5 million and 50.0
million shares outstanding for December 31, 2002, 2001, 2000, 1999 and
1998, respectively.
34
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a discussion of the results of operations and financial
condition of Everest Re Group, Ltd. and its subsidiaries. This discussion and
analysis should be read in conjunction with the consolidated financial
statements and the notes thereto presented under ITEM 8.
RESTRUCTURING
On February 24, 2000, a corporate restructuring was completed and Everest Re
Group, Ltd. ("Group") became the new parent holding company of Everest
Reinsurance Holdings, Inc. ("Holdings"), which remains the holding company for
Group's U.S. based operations. The "Company" means Group and its subsidiaries,
except when referring to periods prior to February 24, 2000, when it means
Holdings and its subsidiaries.
ACQUISITIONS
On September 19, 2000, Holdings completed the acquisition of all of the issued
and outstanding capital stock of Gibraltar Casualty Company ("Gibraltar") from
The Prudential Insurance Company of America ("The Prudential") for $51.8
million, which approximated book value. As a result of the acquisition,
Gibraltar became a wholly owned subsidiary of Holdings and, immediately
following the acquisition, its name was changed to Mt. McKinley Insurance
Company ("Mt. McKinley"). In connection with the acquisition of Mt. McKinley,
which has significant exposure to asbestos and environmental claims, Prudential
Property and Casualty Insurance Company ("Prupac"), a subsidiary of The
Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million)
of the first $200.0 million of any adverse development of Mt. McKinley's
reserves as of September 19, 2000. In addition, The Prudential guaranteed
Prupac's obligation to Mt. McKinley. There were $78.9 million of cessions under
this reinsurance at December 31, 2002, reducing the limit available under this
contract to $81.1 million.
In connection with the Mt. McKinley acquisition, Prupac also provided excess of
loss reinsurance for 100% of the first $8.5 million of loss with respect to
certain of Mt. McKinley's retrocessions and potentially uncollectible
reinsurance coverage. There were $0.0 million and $3.6 million of cessions under
this reinsurance during the periods ending December 31, 2002 and 2001,
respectively, reducing the limit available under the contract to $2.4 million.
Mt. McKinley, a run-off property and casualty insurer in the United States, has
had a long relationship with Holdings and its principal operating company,
Everest Reinsurance Company ("Everest Re"). Mt. McKinley was formed in 1978 by
Everest Re and wrote insurance until 1985, when it was placed in run-off. In
1991, Mt. McKinley became a subsidiary of The Prudential. Mt. McKinley is also a
reinsurer of Everest Re. Under a series of transactions dating to 1986, Mt.
McKinley reinsured several components of Everest Re's business. In particular,
Mt. McKinley provided stop-loss reinsurance protection, in connection with the
Company's October 5, 1995 initial public offering, for any adverse loss
development on Everest Re's June 30, 1995 (December 31, 1994 for catastrophe
losses) reserves, with $375.0 million in limits, of which $103.9 million remains
available (the "Stop Loss Agreement"). The Stop Loss Agreement and other
reinsurance contracts between Mt. McKinley and Everest Re remain in effect
following the acquisition. However, these contracts became transactions with
affiliates effective on the date of the Mt. McKinley acquisition, and their
financial impact is thereafter eliminated in consolidation. Effective September
19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer
reinsurance agreement, whereby Mt. McKinley transferred, for what management
believes to be arm's-length consideration, all of its net insurance exposures
and reserves to Bermuda Re.
35
During 2000, the Company completed two additional acquisitions, Everest Security
Insurance Company ("Everest Security"), formerly known as Southeastern Security
Insurance Company, a United States property and casualty company whose primary
business is non-standard automobile insurance, and Everest International
Reinsurance, Ltd. ("Everest International"), formerly known as AFC Re, Ltd., a
Bermuda based life and annuity reinsurer.
INDUSTRY CONDITIONS
The worldwide reinsurance and insurance businesses are highly competitive, yet
cyclical by product and market. The terrorist attacks on September 11, 2001 (the
"September 11 attacks") resulted in losses which reduced industry capacity and
were of sufficient magnitude to cause most companies to reassess their capital
position, tolerance for risk, exposure control mechanisms and the pricing terms
and conditions at which they are willing to take on risk. The gradual and
variable improving trend that had been apparent through 2000 and earlier in 2001
firmed significantly after the September 11 attacks. This firming generally took
the form of immediate and significant upward pressure on prices, more
restrictive terms and conditions and a reduction of coverage limits and capacity
availability. Such pressures were widespread, with variability depending on the
product and markets involved, but mainly depending on the characteristics of the
underlying risk exposures. The magnitude of the changes was sufficient to create
temporary disequilibrium in some markets as individual buyers and sellers
adapted to changes in both their internal and market dynamics.
During 2002, the reinsurance and insurance markets continued to firm. This
firming reflects the losses arising from the September 11 attacks as well as
reactions to broad and growing recognition that competition in the late 1990s
reached extremes in many classes and markets, which ultimately led to inadequate
pricing and overly broad terms, conditions and coverages. The effect of these
extremes, which is becoming apparent through excessive loss emergence, varies
widely by company depending on product offerings, markets accessed, underwriting
and operating practices, competitive strategies and business volumes. Across all
market participants however, the aggregate effect has been impaired financial
results and erosion of the industry capital base. Coupled with deteriorating
investment market conditions and results, and renewed concerns regarding
longer-term industry specific issues, including asbestos exposure and sub-par
capital returns, these financial impacts have introduced substantial, and in
some cases extreme, pressure for the initiation and/or strengthening of
corrective action by individual market participants. These pressures have
resulted in firming prices, more restrictive terms and conditions and tightened
coverage availability across most classes and markets.
These changes reflect a clear reversal of the general trend from 1987 through
1999 toward increasingly competitive global market conditions across most lines
of business as reflected by decreasing prices and broadening contract terms. The
earlier trend resulted from a number of factors, including the emergence of
significant reinsurance capacity in Bermuda, changes in the Lloyd's market,
consolidation and increased capital levels in the insurance and reinsurance
industries, as well as the emergence of new reinsurance and financial products
addressing traditional exposures in alternative fashions. Many of these factors
continue to exist and have taken on additional importance as the result of the
firming conditions which have emerged. As a result, although the Company is
encouraged by the recent improvements and, more generally, by current market
conditions, the Company cannot predict with any reasonable certainty whether and
to what extent these improvements will persist.
36
SEGMENT INFORMATION
The Company, through its subsidiaries, operates in five segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda.
The U.S. Reinsurance operation writes property and casualty reinsurance on both
a treaty and facultative basis through reinsurance brokers as well as directly
with ceding companies within the United States. The U.S. Insurance operation
writes property and casualty insurance primarily through general agent
relationships and surplus lines brokers within the United States. The Specialty
Underwriting operation writes accident and health ("A&H"), marine, aviation and
surety business within the United States and worldwide through brokers and
directly with ceding companies. The International operation writes property and
casualty reinsurance through the Company's branches in London, Canada, and
Singapore, in addition to foreign business written through the Company's New
Jersey headquarters and Miami office. The Bermuda operation writes property,
casualty, life and annuity business through brokers and directly with ceding
companies.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments principally based upon their
underwriting results. The Company utilizes inter-affiliate reinsurance but such
reinsurance does not impact segment results, since business is generally
reported within the segment in which the business was first produced.
RESULTS OF OPERATIONS
Unusual Loss Events in 2001. As a result of the September 11 attacks, the
Company incurred pre-tax losses, based on an estimate of ultimate exposure
developed through a review of its coverages, which totaled $213.2 million gross
of reinsurance and $55.0 million net of reinsurance. Associated with this
reinsurance were $60.0 million of pre-tax charges, predominantly from adjustment
premiums, resulting in a total pre-tax loss from the September 11 attacks of
$115.0 million. After tax recoveries relating specifically to this unusual loss
event, the net loss from the September 11 attacks totaled $75.0 million. Over
90% of the losses ceded by the Company were pursuant to treaties, where the
reinsurers' obligations are secured, which the Company believes eliminates
material reinsurance collection risk.
As a result of the Enron bankruptcy in 2001, the Company incurred losses,
after-tax and net of reinsurance, amounting to $25.0 million. This unusual loss
reflects all of the Company's exposures to this event, including underwriting,
credit and investment.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Premiums. Gross premiums written increased 51.8% to $2,846.5 million in 2002
from $1,874.6 million in 2001, as the Company took advantage of selected growth
opportunities and improving pricing in many classes of business, while
continuing to maintain a disciplined underwriting approach. Premium growth areas
included a 303.8% ($76.0 million) increase in the Bermuda operation, which
continues to expand its product line offerings, a 67.6% ($218.1 million)
increase in the International operation, mainly attributable to growth in the
London, Canadian and Latin American markets, a 63.5% ($319.1 million) increase
in the U.S. Insurance operation, principally attributable to growth in worker's
compensation insurance, a 46.5% ($284.1 million) increase in the U.S.
Reinsurance operation, primarily reflecting growth across property and casualty
lines, and an 18.0% ($74.6 million) increase in the Specialty Underwriting
operation, mainly attributable to growth in marine, aviation and surety
business. The Company continued to decline business that did not meet its
objectives regarding underwriting profitability.
37
Ceded premiums decreased to $208.9 million in 2002 from $314.5 million in 2001.
This decrease was principally attributable to a reduction in cessions made under
the Company's corporate retrocessional program and to a decrease in ceded
premiums in the U.S. Insurance operation as a result of changes in this
segment's specific reinsurance programs. Ceded premiums in 2002 included $5.1
million and $49.4 million in adjustment premiums relating to claims made under
the 2001 and 2000 accident year aggregate excess of loss elements of the
Company's corporate retrocessional programs, respectively. Ceded premiums in
2001 included $81.3 million and $58.1 million in adjustment premiums relating to
claims made under the 2001 and 1999 accident year aggregate excess of loss
elements of the Company's corporate retrocessional programs, respectively, with
the 2001 accident year cessions principally relating to losses incurred as a
result of the September 11 attacks and Enron bankruptcy.
Net premiums written increased by 69.1% to $2,637.6 million in 2002 from
$1,560.1 million in 2001. This increase was a result of the increase in gross
premiums written and the decrease in ceded premiums.
PREMIUM REVENUES. Net premiums earned increased by 54.9% to $2,273.7 million in
2002 from $1,467.5 million in 2001. Contributing to this increase were a 154.4%
($25.3 million) increase in the Bermuda operation, a 94.8% ($278.8 million)
increase in the U.S. Insurance operation, a 64.4% ($185.1 million) increase in
the International operation, a 46.0% ($228.8 million) increase in the U.S.
Reinsurance operation and a 23.7% ($88.2 million) increase in the Specialty
Underwriting operation. All of these changes reflect period to period
variability in gross written and ceded premiums and business mix, together with
normal variability in earnings patterns. Business mix changes occur not only as
the Company shifts emphasis between products, lines of business, distribution
channels and markets but also as individual contracts renew or non-renew, almost
always with changes in coverage, structure, prices and/or terms, and as new
contracts are accepted with coverages, structures, prices and/or terms different
from those of expiring contracts. As premium reporting and earnings and loss and
commission characteristics derive from the provisions of individual contracts,
the continuous turnover of individual contracts, arising from both strategic
shifts and day to day underwriting, can and does introduce appreciable
background variability in various underwriting line items.
EXPENSES. Incurred loss and loss adjustment expenses ("LAE") increased by 34.7%
to $1,629.4 million in 2002 from $1,209.5 million in 2001. The increase in
incurred losses and LAE was principally attributable to the increase in net
premiums earned and modest reserve strengthening in select areas, most notably
in directors and officers liability, surety and workers' compensation lines, and
with respect to asbestos exposures, partially offset by lower catastrophe losses
and improvements in rates, terms and conditions in many classes of business, as
well as the impact of changes in the Company's mix of business. Incurred losses
and LAE include catastrophe losses, which reflect the impact both of current
period events and favorable and unfavorable development on prior period events
and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss
on property exposures of at least $5.0 million and has an event date of January
1, 1988 or later. Catastrophe losses, net of contract specific cessions but
before cessions under the corporate retrocessional program, were $30.2 million
in 2002, principally relating to European flood losses and Hurricanes Isidore
and Kenna, compared to net catastrophe losses of $222.6 million in 2001, which
was principally related to the September 11 attacks. Incurred losses and LAE in
2002 reflected ceded losses and LAE of $287.7 million compared to ceded losses
and LAE in 2001 of $486.3 million. The ceded losses and LAE in 2002 included
$11.0 million and $90.0 million of losses ceded under the 2001 and 2000 accident
year aggregate excess of loss components of the Company's corporate
retrocessional program, respectively. The ceded losses and LAE in 2001 included
$164.0 million and $105.0 million of losses ceded under the 2001 and 1999
accident year aggregate excess of loss components of the Company's corporate
38
retrocessional program, respectively, with the 2001 accident year cessions
relating principally to losses incurred as the result of the September 11
attacks.
Contributing to the increase in incurred losses and LAE in 2002 from 2001 were a
242.3% ($36.7 million) increase in the Bermuda operation, principally reflecting
reserve strengthening with respect to Mt. McKinley asbestos exposures and
increased premium volume, a 104.9% ($221.6 million) increase in the U.S.
Insurance operation, principally reflecting increased premium volume coupled
with changes in this segment's specific reinsurance programs, a 45.8% ($92.8
million) increase in the International operation, principally reflecting
increased premium volume and a 19.2% ($86.3 million) increase in the U.S.
Reinsurance operation, principally due to increased premium volume, partially
offset by decreased catastrophe losses. These increases were partially offset by
a 5.3% ($17.5 million) decrease in the Specialty Underwriting operation,
principally attributable to decreased catastrophe losses. Incurred losses and
LAE for each operation were also impacted by variability relating to changes in
the level of premium volume and mix of business by class and type.
The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing
incurred losses and LAE by premiums earned, decreased by 10.7 percentage points
to 71.7% in 2002 from 82.4% in 2001, reflecting the earned premium and incurred
losses and LAE discussed above. The following table shows the loss ratios for
each of the Company's operating segments for 2002 and 2001. The loss ratios for
all operations were impacted by the expense factors noted above as well as by
the impact on ceded premiums of the adjustment premiums under the Company's
corporate retrocessional program.
OPERATING SEGMENT LOSS RATIOS
- --------------------------------------------------------------------------------
Segment 2002 2001
- --------------------------------------------------------------------------------
U.S. Reinsurance 73.8% 90.4%
U.S. Insurance 75.5% 71.8%
Specialty Underwriting 68.1% 89.0%
International 62.5% 70.5%
Bermuda 124.2% 92.3%
Underwriting expenses increased by 36.4% to $621.7 million in 2002 from $455.7
million in 2001. Commission, brokerage, taxes and fees increased by $155.0
million, principally reflecting increases in premium volume and changes in the
mix of business. Other underwriting expenses increased by $11.0 million as the
Company expanded its operations to support its increased business volume.
Contributing to the underwriting expense increase were a 95.6% ($4.0 million)
increase in the Bermuda operation, a 79.7% ($65.9 million) increase in the U.S.
Insurance operation, a 31.9% ($29.8 million) increase in the International
operation, a 27.0% ($29.1 million) increase in the Specialty operation and a
22.8% ($37.4 million) increase in the U.S. Reinsurance operation. The changes
for each operation's expenses principally resulted from changes in commission
expenses related to changes in premium volume and business mix by class and type
and, in some cases, the underwriting performance of the underlying business. The
Company's expense ratio, which is calculated by dividing underwriting expenses
by premiums earned, decreased by 3.8 percentage points to 27.3% in 2002 compared
to 31.1% in 2001.
The Company's combined ratio, which is the sum of the loss and expense ratios,
decreased by 14.5 percentage points to 99.0% in 2002 compared to 113.5% in 2001.
39
The following table shows the combined ratios for each of the Company's
operating segments for 2002 and 2001. The combined ratios for all operations
were impacted by the loss and expense ratio variability noted above as well as
by the impact on ceded premiums of the adjustment premiums under the Company's
corporate retrocessional program.
OPERATING SEGMENT COMBINED RATIOS
- --------------------------------------------------------------------------------
Segment 2002 2001
- --------------------------------------------------------------------------------
U.S. Reinsurance 101.5% 123.3%
U.S. Insurance 101.5% 99.9%
Specialty Underwriting 97.9% 118.0%
International 88.6% 103.0%
Bermuda 143.8% 117.9%
INVESTMENTS. Net investment income increased by 3.0% to $350.6 million in 2002
from $340.4 million in 2001, principally reflecting the effect of investing the
$736.1 million of cash flow from operations in 2002, $346.3 million of net
proceeds from the offering of common shares in February 2002 and $203.4 million
of net proceeds from Everest Re Capital Trust's ("Capital Trust") issuance of
trust preferred securities in November 2002, partially offset by the lower
interest rate environment. The following table shows a comparison of various
investment yields as of December 31, 2002 and 2001, respectively, and for the
periods then ended.
2002 2001
------------------
Imbedded pre-tax yield of cash and invested
assets at end of period 5.3% 6.0%
Imbedded after-tax yield of cash and invested
assets at end of period 4.6% 5.0%
Annualized pre-tax yield on average cash and
invested assets 5.6% 6.2%
Annualized after-tax yield on average cash and
invested assets 4.6% 5.0%
Net realized capital losses were $50.0 million in 2002, reflecting realized
capital losses on the Company's investments of $142.8 million, which includes
$101.3 million relating to write-downs in the value of securities deemed to be
impaired on an other than temporary basis, of which $33.0 million were for
WorldCom, partially offset by $92.8 million of realized capital gains, compared
to net realized capital losses of $22.3 million in 2001. The net realized
capital losses in 2001 reflected realized capital losses of $55.1 million, which
included $22.6 million relating to write-downs in the value of securities deemed
to be impaired on an other than temporary basis, which were partially offset by
$32.8 million of realized capital gains.
Interest expense was $42.4 million for 2002 compared to $46.0 million for 2001.
Interest expense for 2002 reflects $38.9 million relating to Holdings' senior
notes and $3.5 million relating to Holdings' borrowing under its revolving
credit facility. Interest expense for 2001 reflects $38.9 million relating to
Holdings' senior notes and $7.1 million relating to Holdings' borrowing under
its revolving credit facility. In addition, 2002 includes incurred expense of
$2.1 million for distributions on Capital Trust's trust preferred securities.
Other expense was $2.1 million in 2002 compared to other income of $28.2 million
in 2001. Significant contributors to other expense in 2002 were foreign exchange
losses, normal provision for uncollectible audit premium in the U.S. Insurance
40
operation and the amortization of deferred expenses relating to Holdings'
issuance of senior notes and Capital Trust's issuance of trust preferred
securities, partially offset by fee income. Other income for 2001 includes $25.9
million arising from a non-recurring receipt of shares in connection with the
demutualization of a former insurance company client that had issued annuities
to the Company in connection with certain claim settlement transactions. In
addition, other income for 2001 includes foreign exchange gains as well as fee
income, offset by the amortization of deferred expenses relating to Holdings'
issuance of senior notes.
The Company has a small number of credit default swaps, which it no longer
writes, and specialized equity put options in its product portfolio. These
products meet the definition of a derivative under Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"). Net derivative expense from these derivative
transactions in 2002, essentially reflecting changes in fair value, was $14.5
million, principally relating to the specialized equity put options, compared to
$12.2 million in 2001, principally relating to the credit default swaps. Net
after tax exposure remaining on the credit default agreements is $3.1 million.
See also Footnote 2 to Notes to the Consolidated Financial Statements.
INCOME TAXES. The Company generated income tax expense of $30.7 million in 2002
compared to income tax benefits of $8.7 million in 2001. The tax expense in 2002
was mainly attributable to improved underwriting and investment results. The tax
benefit in 2001 primarily resulted from the impact of losses relating to the
September 11 attacks, the Enron bankruptcy and realized capital losses
recognized in 2001, which reduced taxable income, partially offset by taxable
income relating to the non-recurring receipt of shares in connection with a
former client's demutualization.
NET INCOME. Net income was $231.3 million in 2002 compared to $99.0 million in
2001. This increase generally reflects the improved underwriting and investment
results, partially offset by increased tax expense, realized capital losses,
derivative expense and a reduction in other income.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Premiums. Gross premiums written increased 35.3% to $1,874.6 million in 2001
from $1,385.6 million in 2000, as the Company took advantage of selected growth
opportunities, while continuing to maintain a disciplined underwriting approach.
Premium growth areas included a 115.9% ($13.4 million) increase in the Bermuda
operation, a 100.6% ($251.9 million) increase in the U.S. Insurance operation,
principally attributable to growth in worker's compensation insurance, a 30.1%
($95.7 million) increase in the Specialty Underwriting operation, mainly
attributable to growth in A&H medical stop loss writings, and a 26.7% ($128.8
million) increase in the U.S. Reinsurance operation, primarily reflecting
improved market conditions. These increases were partially offset by a 0.2%
($0.8 million) decrease in the International operation. The Company continued to
decline business that did not meet its objectives regarding underwriting
profitability.
Ceded premiums increased to $314.5 million in 2001 from $166.7 million in 2000.
This increase was principally attributable to $81.3 million of adjustment
premiums incurred under the 2001 accident year aggregate excess of loss element
of the Company's corporate retrocessional program relating to losses incurred as
a result of the September 11 attacks and the Enron bankruptcy. In addition,
ceded premiums for 2001 and 2000 also include adjustment premiums of $58.1
million and $35.2 million, respectively, relating to claims made under the 1999
accident year aggregate excess of loss element of the Company's corporate
retrocessional program. The increase in ceded premiums in 2001 also reflects the
impact on the U.S. Insurance operation's specific reinsurance protections
resulting from this segment's volume increase.
41
Net premiums written increased by 28.0% to $1,560.1 million in 2001 from
$1,218.9 million in 2000. This increase was a result of the increase in gross
premiums written and the increase in ceded premiums.
PREMIUM REVENUES. Net premiums earned increased by 25.0% to $1,467.5 million in
2001 from $1,174.2 million in 2000. Contributing to this increase were a 189.7%
($192.6 million) increase in the U.S. Insurance operation, a 41.6% ($4.8
million) increase in the Bermuda operation, a 22.9% ($69.2 million) increase in
the Specialty Underwriting operation, a 5.5% ($26.0 million) increase in the
U.S. Reinsurance operation and a 0.2% ($0.7 million) increase in the
International operation. All of these changes reflect period to period
variability in gross written and ceded premiums, and business mix, together with
normal variability in earnings patterns. Business mix changes occur not only as
the Company shifts emphasis between products, lines of business, distribution
channels and markets but also as individual contracts renew or non-renew, almost
always with changes in coverage, structure, prices and/or terms, and as new
contracts are accepted with coverages, structures, prices and/or terms different
from those of expiring contracts. As premium reporting and earnings and loss and
commission characteristics derive from the provisions of individual contracts,
the continuous turnover of individual contracts, arising from both strategic
shifts and day to day underwriting, can and does introduce appreciable
background variability in various underwriting line items.
EXPENSES. Incurred loss and LAE increased by 36.7% to $1,209.5 million in 2001
from $884.6 million in 2000. The increase in incurred losses and LAE was
principally attributable to an increase in business volume as reflected by the
increase in net premiums earned, the impact of incurred losses relating to the
September 11 attacks and the Enron bankruptcy and modest reserve strengthening
in select areas, together with the impact of changes in the Company's mix of
business. The Enron bankruptcy contributed $34.0 million of unusual losses in
2001 before cessions under the corporate retrocessional program. Incurred losses
and LAE include catastrophe losses, which reflect the impact of both current
period events and favorable and unfavorable development on prior period events
and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss
on property exposures of at least $5.0 million and has an event date of January
1, 1988 or later. Catastrophe losses, net of contract specific cessions but
before cessions under the corporate retrocessional program in 2001, were $222.6
million, relating principally to the September 11 attacks, tropical storm
Alison, the Petrobras Oil Rig loss and the El Salvador earthquake, compared to
$13.9 million in 2000. Incurred losses and LAE in 2001 reflected ceded losses
and LAE of $486.3 million compared to ceded losses and LAE in 2000 of $161.6
million, with the increase principally attributable to cessions relating to the
September 11 attack losses and the Enron bankruptcy, together with the increased
cessions under specific reinsurance arrangements in the U.S. Insurance
operation. The ceded losses and LAE for 2001 reflect $164.0 million of losses
ceded under the 2001 accident year aggregate excess of loss component of the
Company's corporate retrocessional program. The ceded losses and LAE for 2001
and 2000 reflect $105.0 million and $70.0 million, respectively, of losses ceded
under the 1999 accident year aggregate excess of loss component of the Company's
corporate retrocessional program, with the amounts in both periods reflecting
reserve strengthening in select lines, including with respect to 1999 accident
year catastrophes.
Contributing to the increase in incurred losses and LAE in 2001 from 2000 were a
200.7% ($141.0 million) increase in the U.S. Insurance operation, principally
reflecting increased premium volume, a 137.5% ($8.8 million) increase in the
Bermuda operation, principally reflecting increased premium volume, a 41.5%
($131.9 million) increase in the U.S. Reinsurance operation, principally
42
reflecting losses in connection with the September 11 attacks and tropical storm
Alison and a 30.1% ($76.5 million) increase in the Specialty Underwriting
operation, principally attributable to increased premium volume in A&H medical
stop loss business together with marine, aviation and surety losses relating to
the September 11 attacks, the Enron bankruptcy and the Petrobras Oil Rig loss.
These increases were partially offset by a 14.1% ($33.3 million) decrease in the
International operation, principally due to more favorable loss experience.
Incurred losses and LAE for each operation were also impacted by variability
relating to changes in the level of premium volume and mix of business by class
and type.
The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing
incurred losses and LAE by premiums earned, increased by 7.1 percentage points
to 82.4% in 2001 from 75.3% in 2000, reflecting the incurred losses and LAE
discussed above. The following table shows the loss ratios for each of the
Company's operating segments for 2001 and 2000. The loss ratios for all
operations were impacted by the expense factors noted above as well as by the
impact on ceded premiums of the adjustment premiums under the Company's
corporate retrocessional program.
OPERATING SEGMENT LOSS RATIOS
- --------------------------------------------------------------------------------
Segment 2001 2000
- --------------------------------------------------------------------------------
U.S. Reinsurance 90.4% 67.4%
U.S. Insurance 71.8% 69.2%
Specialty Underwriting 89.0% 84.0%
International 70.5% 82.3%
Bermuda 92.3% 55.0%
Underwriting expenses increased by 40.6% to $455.7 million in 2001 from $324.1
million in 2000. Commission, brokerage, taxes and fees increased by $124.4
million, principally reflecting increases in premium volume and changes in the
mix of business. In addition, in 2000, the Company's reassessment of the
expected losses on a multi-year reinsurance treaty led to a $33.8 million
decrease in contingent commissions with a corresponding increase to losses.
Other underwriting expenses increased by $7.3 million as the Company expanded
its business volume and operations. Contributing to the underwriting expense
increase were a 122.7% ($45.6 million) increase in the U.S. Insurance operation,
mainly relating to the increased premium volume, a 70.8% ($68.0 million)
increase in the U.S. Reinsurance operation, which included the impact of the
contingent commission adjustment noted above, and a 22.5% ($19.8 million)
increase in the Specialty operation. These increases were partially offset by a
29.0% ($1.7 million) decrease in the Bermuda operation and a 1.5% ($1.4 million)
decrease in the International operation. Except as noted, the changes for each
operation's expenses principally resulted from changes in commission expenses
related to changes in premium volume and business mix by class and type and, in
some cases, the underwriting performance of the underlying business. The
Company's expense ratio, which is calculated by dividing underwriting expenses
by premiums earned, increased by 3.5 percentage points to 31.1% in 2001 compared
to 27.6% in 2000.
The Company's combined ratio, which is the sum of the loss and expense ratios,
increased by 10.6 percentage points to 113.5% in 2001 compared to 102.9% in
2000. The following table shows the combined ratios for each of the Company's
operating segments for 2001 and 2000. The combined ratios for all operations
were impacted by the loss and expense ratio variability noted above as well as
by the impact on ceded premiums of the adjustment premiums under the Company's
corporate retrocessional program.
43
OPERATING SEGMENT COMBINED RATIOS
- --------------------------------------------------------------------------------
Segment 2001 2000
- --------------------------------------------------------------------------------
U.S. Reinsurance 123.3% 87.8%
U.S. Insurance 99.9% 105.8%
Specialty Underwriting 118.0% 113.1%
International 103.0% 115.4%
Bermuda 117.9% 106.0%
INVESTMENTS. Net investment income increased by 12.9% to $340.4 million in 2001
from $301.5 million in 2000, principally reflecting the effect of investing the
$406.0 million of cash flow from operations in 2001, partially offset by the
lower interest rate environment and increased interest expense on funds held
relating to the utilization of the 1999 and 2001 accident year aggregate excess
of loss elements of the corporate retrocessional program. The following table
shows a comparison of various investment yields as of December 31, 2001 and
2000, respectively, and for the periods then ended.
2001 2000
-------------------
Imbedded pre-tax yield of cash and invested
assets at end of period 6.0% 6.7%
Imbedded after-tax yield of cash and invested
assets at end of period 5.0% 5.4%
Annualized pre-tax yield on average cash and
invested assets 6.2% 6.3%
Annualized after-tax yield on average cash and
invested assets 5.0% 5.0%
Net realized capital losses were $22.3 million in 2001, reflecting realized
capital losses on the Company's investments of $55.1 million, which includes
$22.6 million relating to write-downs in the value of securities deemed to be
impaired on an other than temporary basis, partially offset by $32.8 million of
realized capital gains, compared to realized capital gains of $0.8 million in
2000. The net realized capital gains in 2000 reflected realized capital gains of
$30.9 million, which were partially offset by $30.1 million of realized capital
losses. The net realized capital losses for 2001 allowed the Company to
recapture taxes paid on net realized capital gains in prior periods. The
realized capital gains in 2001 and 2000 arose mainly from activity in the
Company's equity portfolio. The realized capital losses in 2001 and 2000 arose
mainly from activity in the Company's fixed maturity portfolios.
Interest expense was $46.0 million for 2001 compared to $39.4 million in 2000.
Interest expense for 2001 reflects $38.9 million relating to Holdings' senior
notes and $7.1 million relating to Holdings' borrowing under its revolving
credit facility. Interest expense for 2000 reflects $30.9 million relating to
Holdings' senior notes and $8.5 million relating to Holdings' borrowing under
its revolving credit facility.
Other income was $28.2 million in 2001 compared to $3.3 million in 2000. Other
income for 2001 includes $25.9 million arising from a non-recurring receipt of
shares in connection with the demutualization of a former insurance company
client that had issued annuities to the Company in connection with certain claim
settlement transactions. In addition, other income for 2001 includes foreign
exchange gains as well as financing fees from Everest Security, offset by the
amortization of deferred expenses relating to Holdings' issuance of senior
notes. Significant contributors to other income for 2000 were foreign exchange
44
gains as well as financing fees from Everest Security, partially offset by net
derivative expense and the amortization of deferred expenses relating to
Holdings' issuance of senior notes. The foreign exchange gains and losses are
attributable to fluctuations in foreign currency exchange rates.
During 2000 and 2001, the Company added to its product portfolio a small number
of credit default swaps, which it no longer writes, and specialized equity put
options. These products meet the definition of a derivative under FAS 133. Net
derivative expense from these transactions in 2001 was $12.2 million.
INCOME TAXES. The Company generated income tax benefits of $8.7 million in 2001
compared to income tax expense of $45.4 million in 2000. This tax benefit
primarily resulted from the impact of losses relating to the September 11
attacks, the Enron bankruptcy and realized capital losses recognized in 2001,
which reduced taxable income, partially offset by taxable income relating to the
non-recurring receipt of shares in connection with a former client's
demutualization.
NET INCOME. Net income was $99.0 million in 2001 compared to $186.4 million in
2000. This decrease generally reflects the losses attributable to the September
11 attacks and the Enron bankruptcy, partially offset by improved investment
results and the non-recurring receipt of shares in connection with a former
client's demutualization.
CRITICAL ACCOUNTING POLICIES
LOSS AND LAE RESERVES. The Company's most critical accounting policy is the
determination of its loss and LAE reserves. The Company maintains reserves to
cover its estimated ultimate liability for losses and LAE with respect to
reported and unreported claims. Because reserves are estimates of ultimate
losses and LAE, management monitors reserve adequacy over time, evaluating new
information as it becomes known and adjusting reserves as necessary. Management
considers many factors when setting reserves, including: (1) its exposure base,
generally its earned premiums; (2) its expected loss ratios on current year
writings as determined through extensive interaction between its underwriters
and actuaries by product and class categories (3) internal actuarial
methodologies which analyze the Company's experience with similar cases,
information from ceding companies and historical trends, such as reserving
patterns, loss payments, pending levels of unpaid claims and product mix; (4)
current legal interpretations of coverage and liability; (5) economic
conditions; and (6) the uncertainties discussed below regarding reserve
requirements for asbestos and environmental claims. Based on these
considerations, management believes that adequate provision has been made for
the Company's loss and LAE reserves. Actual losses and LAE ultimately paid may
deviate, perhaps substantially, from such reserves, impacting income in the
period in which the change is made. See also Footnote 1 to Notes to the
Consolidated Financial Statements.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. The Company continues to receive claims
under expired contracts which assert alleged injuries and/or damages relating to
or resulting from environmental pollution and hazardous substances, including
asbestos. The Company's asbestos claims typically involve potential liability
for bodily injury from exposure to asbestos or for property damage resulting
from asbestos or products containing asbestos. The Company's environmental
claims typically involve potential liability for (a) the mitigation or
remediation of environmental contamination or (b) bodily injury or property
damage caused by the release of hazardous substances into the land, air or
water.
The Company's reserves include an estimate of the Company's ultimate liability
for asbestos and environmental ("A&E") claims for which ultimate value cannot be
estimated using traditional reserving techniques. There are significant
45
uncertainties in estimating the amount of the Company's potential losses from
A&E claims. Among the complications are: (a) potentially long waiting periods
between exposure and manifestation of any bodily injury or property damage; (b)
difficulty in identifying sources of A&E contamination; (c) difficulty in
properly allocating responsibility and/or liability for A&E damage; (d) changes
in underlying laws and judicial interpretation of those laws; (e) potential for
an A&E claim to involve many insurance providers over many policy periods; (f)
long reporting delays, both from insureds to insurance companies and ceding
companies to reinsurers; (g) historical data on A&E losses, which is more
limited and variable than historical information on other types of casualty
claims; (h) questions concerning interpretation and application of insurance and
reinsurance coverage; and (i) uncertainty regarding the number and identity of
insureds with potential A&E exposure.
With respect to asbestos claims in particular, several additional factors have
emerged recently that further compound the difficulty in estimating the
Company's liability. These developments include: (a) continued growth in the
number of claims filed, in part reflecting a much more aggressive plaintiff bar;
(b) a disproportionate percentage of claims filed by individuals with no
functional injury from asbestos, claims with little to no financial value but
that have increasingly been considered in jury verdicts and settlements; (c) the
growth in the number and significance of bankruptcy filings by companies as a
result of asbestos claims; (d) the growth in claim filings against defendants
formerly regarded as "peripheral"; (e) the concentration of claims in a small
number of states that favor plaintiffs; (f) the growth in the number of claims
that might impact the general liability portion of insurance policies rather
than the product liability portion; (g) responses in which specific courts have
adopted measures to ameliorate the worst procedural abuses; and (h) the
potential that the U. S. Congress or state legislatures may consider legislation
to address the asbestos litigation issue.
These uncertainties and factors continue to render reserves for A&E losses
significantly less subject to traditional actuarial analysis than are reserves
for other types of losses. As a result, management believes that no meaningful
range for such ultimate losses can be established. The Company establishes
reserves to the extent that, in the judgment of management, the facts and
prevailing law reflect an exposure for the Company or its ceding companies. In
connection with the acquisition of Mt. McKinley, which has significant exposure
to A&E claims, Prupac, a subsidiary of The Prudential, provided reinsurance to
Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any
adverse development of Mt. McKinley's reserves as of September 19, 2000. In
addition, The Prudential guaranteed Prupac's obligations to Mt. McKinley.
Through December 31, 2002, cessions under this reinsurance agreement have
reduced the available remaining limits to $81.1 million net of coinsurance. Due
to the uncertainties discussed above, the ultimate losses may vary materially
from current loss reserves and, depending on coverage under the Company's
various reinsurance arrangements, could have a material adverse effect on the
Company's future financial condition, results of operations and cash flows. See
also Footnote 1 and 3 to Notes to the Consolidated Financial Statements.
REINSURANCE RECEIVABLE. The Company utilizes reinsurance agreements to reduce
its exposure to large claims and catastrophic loss occurrences. These agreements
provide for recovery from reinsurers of a portion of losses and loss expenses
under certain circumstances without relieving the insurer of its obligation to
the policyholder. In the event reinsurers were unable to meet their obligations
under these reinsurance agreements, the Company would not be able to realize the
full value of the reinsurance recoverable balance. In some cases, the Company
may hold partial collateral, including letters of credit and funds held
arrangements, for these agreements. The Company establishes reserves for
uncollectible balances based on management's assessment of the collectibility of
the outstanding balances. To minimize exposure from uncollectible reinsurance
46
receivables, the Company has a reinsurance credit security committee that
generally evaluates the financial strength of a reinsurer prior to entering into
a reinsurance arrangement. Additionally, creditworthy foreign reinsurers of
business written in the United States are generally required to secure their
obligations. Management believes that adequate provision has been made for the
Company's uncollectible balances. Actual uncollectible amounts may vary, perhaps
substantially, from such reserves, impacting income in the period in which the
change is made. See also Footnote 1 to Notes to the Consolidated Financial
Statements.
PREMIUMS WRITTEN AND EARNED. Premiums written by the Company are earned ratably
over the periods of the related insurance and reinsurance contracts or policies.
Unearned premium reserves are established to cover the remainder of the
unexpired contract period. Such reserves are established based upon reports
received from ceding companies or computed using pro rata methods based on
statistical data. Written and earned premiums, and the related costs, which have
not yet been reported to the Company are estimated and accrued. As earned
premium generally correlates with the Company's estimate of its exposure base,
variations in premium earnings are to a large degree offset by related
variability in incurred losses and commission expense. See also Footnote 1 to
Notes to the Consolidated Financial Statements.
INVESTMENT VALUATION. The Company's investment portfolio consists of investments
available for sale and accordingly these securities are marked to market on a
quarterly basis. Most securities are traded on national exchanges where market
values are readily available. The Company holds some privately placed securities
that are either valued by an investment advisor or by the Company using cash
flow projections. Unrealized gains and losses from market fluctuations are
reflected as comprehensive income, while market value declines that are
considered other than temporary are reflected in the income statement as
realized capital losses. The Company considerers many factors when determining
whether a market value decline is other than temporary, including: (1) the
length of time the market value has been below book value, (2) the credit
strength of the issuer, (3) the issuer's market sector and (4) the length of
time to maturity. Due to the uncertainty of these factors, investment losses may
arise and could have a material adverse effect on the Company's future financial
condition, results of operations and cash flows. See also Footnote 1 to Notes to
the Consolidated Financial Statements.
FINANCIAL CONDITION
CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and
short-term investments, were $7,259.1 million at December 31, 2002, $5,783.5
million at December 31, 2001 and $5,493.0 million at December 31, 2000. The
increase in cash and invested assets from 2001 to 2002 resulted primarily from
$736.1 million in cash flows from operations generated in 2002, $346.3 million
of net proceeds from the offering of common shares in February 2002, $203.4
million of net proceeds from Capital Trust's issuance of trust preferred
securities in November 2002 and $135.9 million in net unrealized appreciation of
the Company's investments. These increases were partially offset by $35.0
million in net payments on Holdings' credit facility and $22.9 million in share
repurchases. The increase in cash and invested assets from 2000 to 2001 resulted
primarily from $406.0 million in cash flows from operations generated in 2001
and $57.3 million in net unrealized appreciation of the Company's investments.
These increases were partially offset by $130.0 million in net payments on
Holdings' credit facility.
LOSS AND LAE RESERVES. Gross loss and LAE reserves totaled $4,905.6 million at
December 31, 2002, $4,278.3 million at December 31, 2001 and $3,786.2 million at
December 31, 2000. The increase in 2002 was primarily attributable to increased
premiums earned, modest reserve strengthening in select areas and normal
47
variability in claim settlements. The increase in 2001 was primarily
attributable to increased catastrophe losses resulting from the September 11
attacks, together with increased earned premiums and normal variability in claim
settlements. Reinsurance receivables totaled $1,116.4 million at December 31,
2002, $895.1 million at December 31, 2001 and $509.0 million at December 31,
2000, with the changes in 2002 principally reflecting losses ceded under the
accident year aggregate excess of loss element of the Company's corporate
retrocessional program and losses ceded as part of a reinsurance agreement
between Mt. McKinley and Prupac. At December 31, 2002, $440.0 million, or 39.4%,
was receivable from subsidiaries of London Reinsurance Group ("London Life").
These receivables are effectively secured by a combination of letters of credit
and funds held arrangements under which the Company has retained the premium
payments due the retrocessionaires, recognized liabilities for such amounts and
reduced such liabilities as payments are due from the retrocessionaire. In
addition, $145.0 million, or 13.0%, was receivable from Continental Insurance
Company ("Continental), which is partially secured by funds held arrangements,
and $78.9 million or 7.1%, was receivable from Prupac, whose obligations are
guaranteed by The Prudential. No other retrocessionaire accounted for more than
5% of the Company's receivables.
The Company generally has exposure to A&E losses through its Mt. McKinley
operation with respect to insurance policies and through Everest Re with respect
to reinsurance contracts. In each case, the Company's management and analysis of
its exposures takes into account a number of features of its business that
differentiate the Company's exposures from many other insurers and reinsurers
that have significant A&E exposures.
Mt. McKinley began writing small amounts of A&E exposed insurance in 1975 and
increased the volume of its writings in 1977. These writings ceased in 1984,
giving Mt. McKinley an approximate 10-year window of potential A&E exposure,
which is appreciably shorter than is the case for many companies with
significant A&E exposure. Additionally, due to changes in and standardization of
policy forms, it is rare for policies in the 1970s and 1980s to have been issued
without aggregate limits on at least the product liability coverage offered;
policies issued in earlier decades are generally more at risk of not having
aggregate limits.
The vast majority of Mt. McKinley's A&E exposed insurance policies are excess
casualty policies, with aggregate coverage limits, which by definition also have
protection afforded by underlying coverage. Mt. McKinley's attachment points
vary but usually are protected by millions, often tens of millions, of dollars
of underlying coverage. The excess nature of most of Mt. McKinley's policies
also offers protection against non-product claims (for example, claims arising
under general liability coverage). Although under some circumstances an excess
policy could be exposed to non-product claims, such claims generally pose more
of a risk to primary policies because non-product claims are generally less
likely to aggregate. In addition, environmental claims arise under general
liability coverage, and generally do not aggregate. Thus, these claims tend to
create exposure for primary policies to a greater extent than excess policies.
Virtually all of the Mt. McKinley policies that are still potentially exposed to
claims have policy language providing that expenses were paid within limits
rather than in addition to limits. This is a substantial difference from primary
coverage, which would most often cover expenses in addition to limits.
Everest Re was formed in 1973 but was not fully engaged in underwriting casualty
business under which A&E exposures generally arise until 1974, and it
effectively eliminated A&E exposures through contract exclusions effected in
1984. Therefore, Everest Re has an approximate 11-year window of A&E exposure,
48
much shorter than that of many reinsurance companies that have significant A&E
exposures. In the earlier years of its existence, Everest Re was not as heavily
involved in casualty business as in property business, which generally is not
exposed to asbestos claims. Everest Re generally took smaller lines of exposure
per contract than many other reinsurers operating in the casualty reinsurance
market and those lines were generally also smaller than the excess limits
provided by Mt. McKinley policies. This means that the potential adverse
development on Everest Re's reinsurance business would not be subject to the
same level of volatility as would be the case for companies having greater
exposures per risk. Everest Re reinsured both primary and excess policies.
However, its claim experience to date indicates that the majority of its
reinsurance supported excess policies. As a result, most of Everest Re's
exposure derives from excess policies similar to those written by Mt. McKinley.
With respect to both the Mt. McKinley and Everest Re operations, the Company was
not a member of the Asbestos Claims Facility ("Wellington") or the Center for
Claims Resolution ("CCR") claim settlement facilities. Insurers supporting those
facilities made broad commitments concerning the application of insurance
coverage to asbestos claims. With respect to its direct insurance exposures, the
fact that the Company has not made those commitments may allow it to resolve
insurance exposure to Wellington/CCR insureds more economically than if it had
joined these facilities. With respect to its reinsurance exposures, although the
Company was not a signatory to the Wellington or CCR facilities, it has, within
the bounds of its reinsurance contracts, generally supported ceding companies
that were signatories. Because the insurers supporting these facilities have
generally paid their exposures more quickly than non-signatory insurers, the
Company believes that this has generally meant that it has paid its reinsurance
exposure more quickly than it likely would have if it had not been subject to
Wellington/CCR payments.
The Company believes that its A&E exposures are unique and differentiated from
those insurers and reinsurers with appreciable A&E exposure by the points noted
above, but there can be no assurance that such factors will protect the Company
from adverse development, perhaps material, or allow it to secure advantages in
the settlement of its claims obligations.
Additional losses, including those relating to currently unrecognized latent
injuries, the type or magnitude of which cannot be foreseen by the Company, or
the reinsurance and insurance industry generally, may emerge in the future. Such
future emergence, to the extent not covered by existing retrocessional
contracts, could have material adverse effects on the Company's future financial
condition, results of operations and cash flows.
49
The table below summarizes the Company's overall reserves and claim activity for
asbestos and environmental claims, on both a gross and net of ceded reinsurance
basis, for the periods indicated:
ASBESTOS AND ENVIRONMENTAL RESERVES
YEARS ENDED DECEMBER 31,
-----------------------------------------
2002 2001 2000
------- ------- -------
(DOLLARS IN MILLIONS)
Gross Basis:
Beginning of period reserves $ 644.4 $ 693.7 $ 614.2
------- ------- -------
Incurred losses and LAE:
Reported losses 180.9 100.5 (51.1)
Change in IBNR (85.9) (70.8) 45.3
------- ------- -------
Total incurred losses and LAE 95.0 29.7 (5.8)
Paid losses (71.5) (79.0) 85.3
------- ------- -------
End of period reserves $ 667.9 $ 644.4 $ 693.7
======= ======= =======
Net Basis:
Beginning of period reserves $ 568.6 $ 628.5 $ 365.1
------- ------- -------
Incurred losses and LAE:
Reported losses (1) 102.7 67.7 (173.0)
Change in IBNR (79.2) (62.5) 167.2
------- ------- -------
Total incurred losses and LAE 23.5 5.2 (5.8)
Paid losses (1) (64.6) (65.1) 269.2
------- ------- -------
End of period reserves $ 527.5 $ 568.6 $ 628.5
======= ======= =======
- --------------------------------------------------------------------------------
1) Reported losses and paid losses for 2000 are net of ($311.3) million and
$311.3 million, respectively, reflecting the establishment of Mt.
McKinley's reserves at the acquisition date. Net paid losses, excluding the
impact of the Mt. McKinley acquisition transaction, were ($42.3) million.
The gross reserves for asbestos and environmental exposures increased in 2002,
principally due to an increase in management's estimate of the ultimate asbestos
and environmental exposures, the effect of which was partially offset by paid
losses. The net reserves for asbestos and environmental exposures decreased in
2002, principally due to an increase in losses ceded as part of a reinsurance
agreement between Mt. McKinley and Prupac, the effect of which was partially
offset by paid losses. The gross and net reserves for asbestos and environmental
exposures in 2000 include Holdings' acquisition of Mt. McKinley.
Industry analysts have developed a measurement, known as the survival ratio, to
compare the asbestos and environmental reserves among companies with such
liabilities. The survival ratio is typically calculated by dividing a company's
current reserves by the three-year average of paid losses, and therefore
measures the number of years that it would take to exhaust the current reserves
based on historical payment patterns. Using this measurement, the Company's net
three-year asbestos and environmental survival ratio was 9.2 years at December
31, 2002. Adjusting these ratios to include the effect of the remaining limits
of reinsurance available under the reinsurance agreement with Prupac, the
measures rise to the equivalent of 10.6 years at December 31, 2002. Because the
survival ratio was developed as a comparative measure of reserve strength and
50
not of absolute reserve adequacy, the Company considers, but does not rely on,
the survival ratio when evaluating its reserves.
As noted earlier, there were developments in 2002 affecting asbestos exposures
in general and the Company's asbestos exposures in particular. These
developments together with enhancements in the Company's claim management and
analytical processes resulted in the reserve strengthening noted earlier. These
developments and actions have increased the emphasis on asbestos exposures as a
separate component of the Company's A&E exposures. Despite the Company's
approach of handling A&E exposures on a combined basis, management believes
additional disclosure of the asbestos element of its A&E exposures is
appropriate.
The following tables summarize reserves and claim activity for asbestos claims,
on both a gross and net of ceded reinsurance basis, for the periods indicated
with particular emphasis on the differentiation of insured categories within the
Mt. McKinley operation, which the Company believes reflects the most volatile
element of its asbestos exposures.
51
GROSS ASBESTOS EXPOSURES (1)
(DOLLARS IN MILLIONS)
--------------------------------
2002 2001 2000
------ ------ ------
Beginning of period reserves:
Direct Operations (Mt. McKinley)
Coverage in place ("CIP") settlements (2) $ 43.5 $ 32.1 $ 12.0
Actively managed (3) 32.2 5.6 -
Remaining high profile insureds 41.2 34.6 10.8
Other direct exposures 2.5 11.4 10.6
Incurred by not reported ("IBNR") 100.6 133.0 90.0
------ ------ ------
220.0 216.6 123.4
Reinsurance Operations (Everest Re)
Case reserves 120.5 117.7 140.0
IBNR 117.3 154.1 176.5
------ ------ ------
237.7 271.8 316.5
Total beginning of period reserves 457.7 488.4 439.8
------ ------ ------
Incurred losses and LAE:
Direct Operations (Mt. McKinley)
CIP settlements 32.8 16.1 26.6
Actively managed (0.3) 36.1 10.5
Remaining high profile insureds 108.2 7.2 24.0
Other direct exposures 3.2 2.7 (104.3)
IBNR (8.9) (32.3) 43.0
------ ------ ------
135.0 29.7 (0.2)
Reinsurance Operations (Everest Re)
Reported Losses 29.0 36.9 20.5
IBNR (29.0) (36.9) (22.3)
------ ------ ------
- - (1.9)
Total incurred losses and LAE 135.0 29.7 (2.1)
------ ------ ------
Paid losses:
Direct Operations (Mt. McKinley)
CIP settlements 4.2 4.7 6.6
Actively managed 25.3 9.5 4.9
Remaining high profile insureds 1.7 0.5 0.2
Other direct exposures (4) 4.0 11.6 (105.1)
------ ------ ------
35.2 26.3 (93.5)
Reinsurance Operations (Everest Re) 16.1 34.1 42.8
Total paid losses 51.3 60.4 (50.7)
------ ------ ------
End of period reserves:
Direct Operations (Mt. McKinley)
CIP settlements 72.1 43.5 32.1
Actively managed 6.6 32.2 5.6
Remaining high profile insureds 147.7 41.2 34.6
Other direct exposures 1.7 2.5 11.4
IBNR 91.7 100.6 133.0
------ ------ ------
319.8 220.0 216.6
Reinsurance Operations (Everest Re)
Case reserves 133.3 120.5 117.7
IBNR 88.2 117.3 154.1
------ ------ ------
221.6 237.7 271.8
Total end of period reserves $541.4 $457.7 $488.4
====== ====== ======
(1) Some totals may not reconcile due to rounding.
(2) Under CIP agreements, payments depend upon the insured's actual claims
experience and may be subject to annual caps or other controls on the rate
of payment.
(3) Actively Managed means that Mt. McKinley is managing the defense of claims
against the insured.
(4) Includes ($114.8) million of paid loss impact arising from the Mt. McKinley
acquisition in 2000.
52
NET ASBESTOS EXPOSURES (1)
(DOLLARS IN MILLIONS)
------------------------------------
2002 2001 2000
------- ------- -------
Beginning of period reserves:
Direct Operations (Mt. McKinley)
CIP settlements (2) $ 39.4 $ 28.2 $ -
Actively managed (3) 28.5 4.9 -
Remaining high profile insureds 36.8 30.5 -
Losses Ceded to Prupac (19.6) - -
Other direct exposures 1.8 10.3 -
IBNR 94.5 120.4 7.1
------- ------- -------
181.5 194.3 7.1
Reinsurance Operations (Everest Re)
Case reserves 110.7 106.9 109.8
IBNR 97.3 131.5 133.2
------- ------- -------
207.9 238.5 243.1
Total beginning of period reserves 389.4 432.8 250.2
------- ------- -------
Incurred losses and LAE:
Direct Operations (Mt. McKinley)
CIP settlements 29.8 15.4 29.7
Actively managed 1.1 30.9 5.9
Remaining high profile insureds 97.5 6.8 30.6
Losses Ceded to Prupac (61.1) (19.6) -
Other direct exposures 2.8 (2.6) (185.6)
IBNR (9.7) (25.9) 113.3
------- ------- -------
60.4 5.0 (6.2)
Reinsurance Operations (Everest Re)
Reported Losses 27.0 34.3 5.8
IBNR (27.1) (34.3) (1.7)
------- ------- -------
(0.1) - 4.1
Total incurred losses and LAE 60.3 5.0 (2.0)
------- ------- -------
Paid losses:
Direct Operations (Mt. McKinley)
CIP settlements 3.8 4.2 1.4
Actively managed 23.7 7.2 1.0
Remaining high profile insureds 1.5 0.5 0.2
Other direct exposures (4) 3.1 5.9 (196.0)
------- ------- -------
32.1 17.9 (193.3)
Reinsurance Operations (Everest Re) 14.2 30.5 8.7
Total paid losses 46.3 48.4 (184.6)
------- ------- -------
End of period reserves:
Direct Operations (Mt. McKinley)
CIP settlements 65.4 39.4 28.2
Actively managed 5.9 28.5 4.9
Remaining high profile insureds 132.8 36.8 30.5
Losses Ceded to Prupac (80.7) (19.6) -
Other direct exposures 1.5 1.8 10.3
IBNR 84.8 94.5 120.4
------- ------- -------
209.7 181.5 194.3
Reinsurance Operations (Everest Re)
Case reserves 123.5 110.7 106.9
IBNR 70.2 97.3 131.5
------- ------- -------
193.7 207.9 238.5
Total end of period reserves (5) (6) $ 403.4 $ 389.4 $ 432.8
======= ======= =======
(1) Some totals may not reconcile due to rounding.
(2) Under CIP agreements, payments depend upon the insured's actual claims
experience and may be subject to annual caps or other controls on the rate
of payment.
(3) Actively Managed means that Mt. McKinley is managing the defense of claims
against the insured.
(4) Includes ($215.1) million of paid loss impact arising from the Mt. McKinley
acquisition in 2000.
(5) Net liabilities represent Everest Re's inception-to-date losses and Mt.
McKinley's losses since its acquisition in 2000.
(6) Includes $203.8 million ceded to and collected from The Prudential as part
of the Company's Stop Loss protection resulting from the initial public
offering in 1995.
53
The Company's net three year survival ratio on its asbestos exposures was 9.7
years for the period ended December 31, 2002. This three year survival ratio
when adjusted to exclude the CIP and actively managed reserves was 11.9 years,
and when adjusted to exclude the CIP and actively managed reserves and to
include stop loss protection from The Prudential was 14.8 years.
SHAREHOLDERS' EQUITY. The Company's shareholders' equity increased to $2,368.6
million as of December 31, 2002 from $1,720.5 million as of December 31, 2001,
principally reflecting $346.3 million in net proceeds from the Company's
offering of 5.0 million common shares in February 2002, $231.3 million of net
income in 2002 and an increase of $104.2 million in net unrealized appreciation
of investments, partially offset by $22.9 million in share repurchases and $16.3
million in shareholder dividends. Shareholders' equity increased to $1,720.5
million as of December 31, 2001 from $1,583.4 million as of December 31, 2000,
principally reflecting an increase of $86.1 million in retained earnings, an
increase of $44.8 million in net unrealized appreciation of investments and
$10.0 million in common shares issued during the year in connection with the
exercise of stock options. Dividends of $16.3 million, $12.9 million and $11.0
million were declared and paid by the Company in 2002, 2001 and 2000,
respectively. During the year ended December 31, 2002, the Company repurchased
0.450 million of its common shares at an average price of $50.86 per share with
all such repurchases occurring in the three months ended September 30, 2002. At
December 31, 2002, 1.730 million shares remained under the existing repurchase
authorization. As part of the Company's restructuring, the treasury shares held
by the Company prior to February 24, 2000 were retired, resulting in a reduction
to treasury shares with a corresponding reduction of paid-in capital and common
shares.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL. The Company's business operations are in part dependent on the
Company's financial strength, and the market's perception thereof, as measured
by shareholders' equity, which was $2,368.6 million and $1,720.5 million at
December 31, 2002 and 2001, respectively. The Company has flexibility with
54
respect to capitalization as the result of its perceived financial strength,
including its financial strength ratings as assigned by independent rating
agencies, and its access to the debt and equity markets. The Company
continuously monitors its capital and financial position, as well as investment
and security market conditions, both in general and with respect to the
Company's securities, and responds accordingly.
On July 30, 2002, the Company filed a shelf registration statement on Form S-3
with the Securities and Exchange Commission, providing for the issuance of up to
$475.0 million of securities. Generally, under this shelf registration
statement, Group may issue common shares, preferred shares, debt, warrants and
hybrid securities, Holdings may issue debt securities and warrants and Capital
Trust may issue trust preferred securities.
In November 2002, pursuant to a trust agreement between Holdings and JPMorgan
Chase Bank, the property trustee, and Chase Manhattan Bank USA, the Delaware
trustee, Capital Trust completed a public offering of $210.0 million of 7.85%
trust preferred securities, resulting in net proceeds of $203.4 million. The
proceeds of the issuance were used to purchase $210 million of 7.85% junior
subordinated debt securities of Holdings that will be held in trust by the
property trustee for the benefit of the holders of the preferred securities.
Holdings used the proceeds from the sale of the junior subordinated debt for
general corporate purposes and made capital contributions to its operating
subsidiaries.
Capital Trust will redeem all of the outstanding trust preferred securities when
the junior subordinated debt securities are paid at maturity on November 15,
2032. Holdings may elect to redeem the junior subordinated debt securities, in
whole or in part, at any time after November 14, 2007. If such an early
redemption occurs, the outstanding trust preferred securities will also be
proportionately redeemed.
Distributions on the trust preferred securities are cumulative and are paid
quarterly in arrears. Disbributions relating to the trust preferred securities
for the year ended December 31, 2002 were $2.1 million.
On November 7, 2001, the Company filed a shelf registration statement on Form
S-3 with the Securities and Exchange Commission, providing for the issuance of
up to $575.0 million of common equity. On February 27, 2002, the Company
completed an offering of 5,000,000 of its common shares at a price of $69.25 per
share, which resulted in $346.3 million of proceeds before expenses of
approximately $0.5 million related to the offering. The Company has used the net
proceeds for working capital and general corporate purposes. On October 2, 2002,
the Company filed a Post- Effective Amendment to this registration statement
that removed the remaining securities from registration.
On March 14, 2000, Holdings completed public offerings of $200.0 million
principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million
principal amount of 8.5% senior notes due March 15, 2005. During 2000, the net
proceeds of these offerings and additional funds were distributed by Holdings to
Group. Interest expense incurred in connection with these senior notes was $38.9
million, $38.9 million and $30.9 million for the years ended December 31, 2002,
2001 and 2000, respectively.
LIQUIDITY. The Company's liquidity requirements are met on a short-term and
long-term basis by funds provided by premiums collected, investment income and
collected reinsurance receivables balances, and by the sale and maturity of
investments, together with the availability of funds under the Company's
revolving credit facility. The Company's net cash flows from operating
55
activities were $736.1 million, $406.0 million and $90.0 million for the years
ended December 31, 2002, 2001 and 2000, respectively. The following table shows
cash flows from operating activities, as well as the impact of select
transactions on those cash flows, for the years ended December 31, 2002, 2001
and 2000.
- --------------------------------------------------------------------------------
2002 2001 2000
- --------------------------------------------------------------------------------
Cash flow from operations $736.1 $406.0 $ 90.0
Catastrophe loss payments 62.0 32.5 44.1
Stop Loss Agreement recoveries (1) - - (9.5)
Derivative settlement payments 39.5 1.5 -
Net tax payments (2) 10.0 24.9 63.7
Non-recurring receipt of shares (3) - (25.9) -
------ ------ ------
Cash flow from operations, net of
adjustments $847.6 $439.0 $188.3
====== ====== ======
(1) Recoveries under the Stop Loss Agreement with Mt. McKinley prior to the
acquisition of Mt. McKinley.
(2) Net tax payments for 2001 include a $35.0 million payment to the Internal
Revenue Service in connection with the Company's 1997 tax year liabilities.
This one-time payment effectively settled a deferred tax liability relating
to the tax basis losses incurred in the 1997 tax year. This payment, which
related to a timing item, had no impact on the Company's results of
operations for the period.
(3) Non-recurring receipt of shares in a demutualized insurer.
The growth in net cash flows from operating activities reflects improvements in
product pricing, together with growth in the Company's invested asset base, and
is generally consistent with expectations, given the Company's investment
strategies and mix of business and the normal variability of premium collections
and the payout of loss reserves.
The Company's current investment strategy seeks to maximize after-tax income
through a high quality, diversified, taxable bond and tax-preferenced fixed
maturity portfolio, while maintaining an adequate level of liquidity. The
Company's mix of taxable and tax-preferenced investments is adjusted
continuously, consistent with the Company's current and projected operating
results, market conditions and the Company's tax position. Proceeds from sales,
calls and maturities and investment asset acquisitions were $2,822.1 million and
$3,929.7 million, respectively, in 2002 compared to $1,492.2 million and
$1,767.4 million, respectively, in 2001 and $1,006.5 million and $2,024.6
million, respectively, in 2000.
On December 21, 1999, Holdings entered into a three-year senior revolving credit
facility with a syndicate of lenders (the "Credit Facility"). On November 21,
2002, the maturity date of the Credit Facility was extended to December 19,
2003. Wachovia Bank, National Association (formerly First Union National Bank)
is the administrative agent for the Credit Facility. The Credit Facility is used
for liquidity and general corporate purposes. The Credit Facility provides for
the borrowing of up to $150.0 million with interest at a rate selected by
Holdings equal to either (1) the Base Rate (as defined below) or (2) an adjusted
London InterBank Offered Rate ("LIBOR") plus a margin. The Base Rate is the
higher of the rate of interest established by Wachovia Bank from time to time as
its prime rate or the Federal Funds rate plus 0.5% per annum. On December 18,
2000, the Credit Facility was amended to extend the borrowing limit to $235.0
million for a period of 120 days. This 120-day period expired during the three
months ended March 31, 2001 and the limit reverted to $150.0 million. The amount
of margin and the fees payable for the Credit Facility depend upon Holding's
senior unsecured debt rating. Group has guaranteed Holdings' obligations under
the Credit Facility.
56
The Credit Facility requires the Company to maintain a debt to capital ratio of
not greater than 0.35 to 1, Holdings to maintain a minimum interest coverage
ratio of 2.5 to 1 and Everest Re to maintain its statutory surplus at $850.0
million plus 25% of future aggregate net income and 25% of future aggregate
capital contributions. As of December 31, 2002, the Company was in compliance
with these requirements.
During the years ended December 31, 2002, 2001 and 2000, Holdings made payments
on the Credit Facility of $80.0 million, $152.0 million and $0.0 million,
respectively. During the years ended December 31, 2002, 2001 and 2000, Holdings
had new Credit Facility borrowings of $45.0 million, $22.0 million and $176.0
million, respectively. As of December 31, 2002 and 2001, Holdings had
outstanding Credit Facility borrowings of $70.0 million and $105.0 million,
respectively. Interest expense incurred in connection with these borrowings was
$3.5 million, $7.1 million and $8.5 million for the years ended December 31,
2002, 2001 and 2000, respectively.
The cash flow activity in 2002 included $346.3 million of new cash resulting
from the offering of common shares in February and $210.0 million of new cash
from the issuance of trust preferred securities in November. The cash flow
activity in 2000 included $340.1 million of new cash resulting from the
acquisitions of Mt. McKinley and Everest International and $448.5 million in
proceeds from Holdings' offering of senior notes.
The Company has arrangements available for the issue of letters of credit, which
letters are generally collateralized by the Company's cash or investments. At
December 31, 2002, $156.5 million of letters of credit were issued and
outstanding under these arrangements.
EXPOSURE TO CATASTROPHES. As with other reinsurers, the Company's operating
results and financial condition can be adversely affected by volatile and
unpredictable natural and other disasters, such as hurricanes, windstorms,
earthquakes, floods, fires and explosions. Any such catastrophic event could
generate insured losses in one or many of the Company's treaties or lines of
business, including property and/or casualty exposures. Although the Company
attempts to limit its exposure to acceptable levels, including through the
purchase of reinsurance when considered to be cost effective, it is possible
that an actual catastrophic event or multiple catastrophic events could have a
material adverse effect on the financial condition, results of operations and
cash flows of the Company.
The Company employs various techniques, including licensed software modeling, to
assess its accumulated exposure. Such techniques are inherently more difficult
to apply to non-property exposures. Accumulated exposures with respect to
catastrophe losses are generally summarized in terms of the probable maximum
loss ("PML"). The Company defines PML as its anticipated maximum loss, taking
into account contract limits, caused by a single catastrophe affecting a broad
contiguous geographic area, such as that caused by a hurricane or earthquake of
such a magnitude that it is expected to occur once in every 100 years.
Management believes that the Company's greatest catastrophe exposure worldwide
from any single event is to an earthquake affecting the west coast of the United
States where the Company estimates it has a PML exposure of $338 million,
including workers' compensation exposures. The Company further estimates that
its PML exposure with respect to its greatest windstorm exposure, which relates
to a hurricane affecting the east coast of the United States, is $264 million
and that its single event International PML exposure is $197 million. There can
be no assurance that the Company will not experience losses from one or more
catastrophic events that exceed, perhaps by a substantial amount, its estimated
PML.
57
The Company employs a retrocessional approach under which the Company may
purchase reinsurance to cover specific business written or exposure
accumulations or as a corporate level retrocessional program covering the
potential accumulation or aggregation of exposures across some or all of the
Company's operations. All reinsurance purchasing decisions consider both the
potential coverage and market conditions with respect to the pricing, terms,
conditions and availability of such coverage, with the aim of securing cost-
effective protection. The level of reinsurance coverage varies over time,
reflecting the underwriter's and/or Company's view of the changing dynamics of
both the underlying exposure and the reinsurance markets.
If a single catastrophe were to occur in the United States that resulted in $338
million of gross losses and allocated loss adjustment expenses ("ALAE") in 2003
(an amount equivalent to the Company's PML including its property and workers'
compensation exposures), management estimates that the effect on the Company's
income before and after taxes would be approximately $338 million and $264
million, respectively. Such impact represents approximately 11.1% of the
Company's beginning of year capital.
For 2002 and initially in 2003, the Company has chosen not to purchase corporate
retrocessional protection and to generally de-emphasize the purchase of specific
reinsurance by its underwriters reflecting the Company's view that its exposures
in the context of its capital and financial position do not warrant reinsurance
purchases at current price levels. For both 2000 and 2001, the Company purchased
accident year aggregate excess of loss retrocession coverage, which provides up
to $175.0 million of recoveries if Everest Re's consolidated statutory basis
accident year loss ratio exceeds a loss ratio attachment point provided in the
contract for the respective accident years. Each arrangement provides for an
adjustment premium, which reduces the net benefit by approximately 50%, in the
event that the coverage is used. The remaining limit available under these
coverages is $85.0 million and $0.0 million, respectively. See ITEM 1 - "Risk
Management and Retrocession Arrangements" for further details.
DIVIDENDS
During 2002, 2001 and 2000, the Company declared and paid shareholder dividends
of $16.3 million, $12.9 million and $11.0 million, respectively. As an insurance
holding company, the Company is partially dependent on dividends and other
permitted payments from its subsidiaries to pay cash dividends to its
shareholders. The payment of dividends to Group by Holdings and to Holdings by
Everest Re is subject to Delaware regulatory restrictions and the payment of
dividends to Group by Bermuda Re is subject to Bermuda insurance regulatory
restrictions. Management expects that, absent significant catastrophe losses,
such restrictions should not affect Everest Re's ability to declare and pay
dividends sufficient to support Holdings' general corporate needs and Holdings'
and Bermuda Re's ability to declare and pay dividends sufficient to support
Group's general corporate needs. See ITEM 1, "Business - Regulatory Matters -
Dividends" and Note 13A of Notes to Consolidated Financial Statements.
MARKET SENSITIVE INSTRUMENTS
The Securities and Exchange Commission Financial Reporting Release #48 requires
registrants to clarify and expand upon the existing financial statement
disclosure requirements for derivative financial instruments, derivative
commodity instruments, and other financial instruments (collectively, "market
sensitive instruments"). The Company does not enter into market sensitive
instruments for trading purposes.
The Company's current investment strategy seeks to maximize after-tax income
through a high quality, diversified, taxable and tax-preferenced fixed maturity
58
portfolio, while maintaining an adequate level of liquidity. The Company's mix
of taxable and tax-preferenced investments is adjusted continuously, consistent
with its current and projected operating results, market conditions, and the
Company's tax position. The fixed maturities in the investment portfolio are
comprised of non-trading available for sale securities. Additionally, the
Company invests in equity securities, which it believes will enhance the
risk-adjusted total return of the investment portfolio. The Company has also
engaged in a small number of credit default swaps and specialized equity
options, the market sensitivity of which is believed not to be material.
The overall investment strategy considers the scope of the Company's present and
anticipated operations. In particular, estimates of the financial impact
resulting from non-investment asset and liability transactions, together with
the Company's capital structure and other factors, are used to develop a net
liability analysis. This analysis includes estimated payout characteristics for
which the investments of the Company provide liquidity. This analysis is
considered in the development of specific investment strategies for asset
allocation, duration and credit quality. The change in overall market sensitive
risk exposure principally reflects the asset changes that took place during the
year, with no material change in the underlying risk characteristics.
The Company's $7.3 billion investment portfolio is principally comprised of
fixed maturity securities that are subject to interest rate risk and foreign
currency rate risk, and equity securities that are subject to equity price risk.
The impact of these risks on the investment portfolio is generally mitigated by
changes in the value of operating assets and liabilities and their associated
income statement impact.
Interest rate risk is the potential change in value of the fixed maturity
portfolio, including short-term investments, due to change in market interest
rates. In a declining interest rate environment, it includes prepayment risk on
the $881.4 million of mortgage-backed securities in the $6.9 billion fixed
maturity portfolio. Prepayment risk results from potential accelerated principal
payments that shorten the average life and thus the expected yield of the
security.
The tables below display the potential impact of market value fluctuations and
after-tax unrealized appreciation on the fixed maturity portfolio as of December
31, 2002 and 2001 based on parallel 200 basis point shifts in interest rates up
and down in 100 basis point increments. For legal entities with a U.S. dollar
functional currency, this modeling was performed on each security individually.
To generate appropriate price estimates on mortgage-backed securities, changes
in prepayment expectations under different interest rate environments are taken
into account. For legal entities with a non-U.S. dollar functional currency, the
effective duration of the involved portfolio of securities was used as a proxy
for the market value change under the various interest rate change scenarios.
All amounts are in U.S. dollars and are presented in millions.
59
2002
INTEREST RATE SHIFT IN BASIS POINTS
- --------------------------------------------------------------------------------------------------
-200 -100 0 100 200
- --------------------------------------------------------------------------------------------------
Total Market Value $7,985.3 $7,480.3 $6,949.0 $6,514.4 $6,116.2
Market Value Change from Base
(%) 14.9% 7.7% 0.0% (6.3)% (12.0)%
Change in Unrealized
Appreciation After-tax from
Base ($) $ 764.8 $ 401.8 $ - $ (313.5) $ (604.0)
2001
INTEREST RATE SHIFT IN BASIS POINTS
- --------------------------------------------------------------------------------------------------
-200 -100 0 100 200
- --------------------------------------------------------------------------------------------------
Total Market Value $6,332.1 $5,957.7 $5,610.4 $5,283.2 $4,982.7
Market Value Change from
Base (%) 12.9% 6.2% 0.0% (5.8)% (11.2)%
Change in Unrealized
Appreciation After-tax from
Base ($) $ 521.1 $ 250.8 $ - $ (236.6) $ (454.2)
Foreign currency rate risk is the potential change in value, income and cash
flow arising from adverse changes in foreign currency exchange rates. Each of
the Company's foreign operations maintains capital in the currency of the
country of its geographic location consistent with local regulatory guidelines.
Generally, the Company prefers to maintain the capital of its foreign operations
in U.S. dollar assets, although this varies by regulatory jurisdiction in
accordance with market needs. Each foreign operation may conduct business in its
local currency as well as the currency of other countries in which it operates.
The primary foreign currency exposures for these foreign operations are the
Canadian Dollar, the British Pound Sterling and the Euro. The Company mitigates
foreign exchange exposure by a general matching of the currency and duration of
its assets to its corresponding operating liabilities. In accordance with
Financial Accounting Standards Board Statement No. 52, the Company translates
the assets, liabilities and income of non-U.S. dollar functional currency legal
entities to the U.S. dollar. This translation amount is reported as a component
of other comprehensive income. The primary functional foreign currency exposures
for these foreign operations are the Canadian Dollar, the Euro and the British
Pound Sterling.
The tables below display the potential impact of a parallel 20% increase and
decrease in foreign exchange rates on the valuation of invested assets subject
to foreign currency exposure in 10% increments as of December 31, 2002 and 2001.
This analysis includes the after-tax impact of translation from transactional
currency to functional currency as well as the after-tax impact of translation
from functional currency to the U.S. dollar reporting currency. All amounts are
in U.S. dollars and are presented in millions.
60
2002
CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT
- --------------------------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- --------------------------------------------------------------------------------------------------
Total After-tax Foreign
Exchange Exposure $ (44.5) $(24.3) $ - $26.7 $56.8
2001
CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT
- --------------------------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- --------------------------------------------------------------------------------------------------
Total After-tax Foreign
Exchange Exposure $(40.7) $(21.6) $ - $23.3 $47.9
Equity risk is the potential change in market value of the common stock and
preferred stock portfolios arising from changing equity prices. The Company
invests in high quality common and preferred stocks that are traded on the major
exchanges in the United States and funds investing in such securities. The
primary objective in managing the $47.5 million equity portfolio is to provide
long-term capital growth through market appreciation and income.
The tables below display the impact on market value and after-tax unrealized
appreciation of a 20% change in equity prices up and down in 10% increments as
of December 31, 2002 and 2001. All amounts are in U.S. dollars and are presented
in millions.
2002
CHANGE IN EQUITY VALUES IN PERCENT
- --------------------------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- --------------------------------------------------------------------------------------------------
Market Value of the Equity Portfolio $ 38.0 $ 42.7 $ 47.5 $ 52.2 $ 57.0
After-tax Change in Unrealized Appreciation $ (6.2) $ (3.1) $ - $ 3.1 $ 6.2
2001
CHANGE IN EQUITY VALUES IN PERCENT
- --------------------------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- --------------------------------------------------------------------------------------------------
Market Value of the Equity Portfolio $ 53.8 $ 60.6 $ 67.3 $ 74.0 $ 80.8
After-tax Change in Unrealized Appreciation $ (8.8) $ (4.4) $ - $ 4.4 $ 8.8
Although not considered material in the context of the Company's aggregate
exposure to market sensitive instruments, the Company has issued five
specialized equity put options based on the Standard & Poor's 500 ("S&P 500")
index that are market sensitive and sufficiently unique to warrant supplemental
disclosure.
The duration and nature of these specialized instruments are such that no active
trading market exists. This was recognized at the time the transactions were
entered into and was the principal rationale for the Company's use of a
61
probability weighted cash flow model for its analysis of the economics of these
transactions, an approach quite similar to analytical models used throughout the
Company's reinsurance business.
As these specialized equity put options are derivatives within the framework of
FAS No.133, the Company is required to report the fair value of these
instruments in its balance sheet and record any changes to fair value in its
statement of operations. The Company has recorded fair values for its
obligations on these specialized equity put options at December 31, 2002 and
December 31, 2001 of $22.4 million and $13.0 million, respectively; however, the
Company does not believe that the ultimate settlement of these transactions is
likely to require a payment that would exceed the initial consideration received
or any payment at all.
As there is no active market for these instruments, the determination of their
fair value is based on an industry accepted option pricing model which requires
estimates and assumptions, including those regarding volatility and expected
rates of return. The table below estimates the impact of potential movements in
interest rates and the S&P 500 index, which are the principal factors affecting
fair value of these instruments, looking forward from the fair value at December
31, 2002. These are estimates and there can be no assurances regarding future
market performance.
AS OF DECEMBER 31, 2002
S & P 500 INDEX PUT OPTIONS OBLIGATION - SENSITIVITY ANALYSIS
(Dollar amounts in millions)
Interest Rate Shift in Basis Points: -100 -50 0 50 100
------------------------------------------------------------
Total Market Value $ 35.6 $ 28.3 $ 22.4 $ 17.6 $ 13.7
Market Value Change from Base (%) (59.0)% (26.5)% 0.0% 21.4% 38.6%
S & P Index Shift in Points: -200 -100 0 100 200
------------------------------------------------------------
Total Market Value $ 32.6 $ 26.9 $ 22.4 $ 18.8 $ 15.9
Market Value Change from Base (%) (45.3)% (20.0)% 0.0% 16.1% 29.1%
Combined Interest Rate/S & P Index Shift:
-100/-200 -50/-100 0/0 50/100 100/200
------------------------------------------------------------
Total Market Value $ 49.5 $ 33.7 $ 22.4 $ 14.6 $ 9.4
Market Value Change from Base (%) (121.1)% (50.2)% 0.0% 34.7% 58.2%
62
AS OF DECEMBER 31, 2001
S & P 500 INDEX PUT OPTIONS OBLIGATION - SENSITIVITY ANALYSIS
(Dollar amounts in millions)
Interest Rate Shift in Basis Points: -100 -50 0 50 100
------------------------------------------------------------
Total Market Value $ 21.2 $ 16.4 $ 13.0 $ 9.7 $ 7.4
Market Value Change from Base (%) (62.5)% (26.2)% 0.0% 25.2% 43.0%
S & P Index Shift in Points: -200 -100 0 100 200
------------------------------------------------------------
Total Market Value $ 17.2 $ 14.7 $ 13.0 $11.0 $ 9.6
Market Value Change from Base (%) (31.7)% (12.9)% 0.0% 15.4% 26.1%
Combined Interest Rate/S & P Index Shift: -100/-200 -50/-100 0/0 50/100 100/200
------------------------------------------------------------
Total Market Value $ 27.7 $ 18.9 $ 13.0 $ 8.4 $ 5.7
Market Value Change from Base (%) (112.5)% (44.8)% 0.0% 35.7% 55.9%
SAFE HARBOR DISCLOSURE
This report contains forward-looking statements within the meaning of the U.S.
federal securities laws. The Company intends these forward-looking statements to
be covered by the safe harbor provisions for forward-looking statements in the
federal securities laws. In some cases, these statements can be identified by
the use of forward-looking words such as "may", "will", "should", "could",
"anticipate", "estimate", "expect", "plan", "believe", "predict", "potential"
and "intend". Forward-looking statements contained in this report include
information regarding the Company's reserves for losses and LAE, the adequacy of
the Company's provision for uncollectible balances, estimates of the Company's
catastrophe exposure, the effects of catastrophic events on the Company's
financial statements, the ability of Everest Re, Holdings and Bermuda Re to pay
dividends and the settlement costs of the Company's specialized equity put
options. Forward-looking statements only reflect the Company's expectations and
are not guarantees of performance. These statements involve risks, uncertainties
and assumptions. Actual events or results may differ materially from the
Company's expectations. Important factors that could cause actual events or
results to be materially different from the Company's expectations include those
discussed below under the caption "Risk Factors". The Company undertakes no
obligation to update or revise publicly any forward-looking statements, whether
as a result of new information, future events or otherwise.
RISK FACTORS
The following risk factors, in addition to the other information provided in
this report, should be considered when evaluating the Company. If any of the
following risks actually occur, the Company's business, financial condition or
results of operations could be materially and adversely affected and the trading
price of the Company's common shares could decline significantly.
THE COMPANY'S RESULTS MAY FLUCTUATE AS A RESULT OF FACTORS GENERALLY AFFECTING
THE INSURANCE AND REINSURANCE INDUSTRY.
The results of companies in the insurance and reinsurance industry historically
have been subject to significant fluctuations and uncertainties. Factors that
63
affect the industry in general could also cause the Company's results to
fluctuate. The industry's profitability can be affected significantly by:
o fluctuations in interest rates, inflationary pressures and other
changes in the investment environment, which affect returns on
invested capital and may impact the ultimate payout of loss amounts;
o rising levels of actual costs that are not known by companies at the
time they price their products;
o volatile and unpredictable developments, including weather-related and
other natural catastrophes;
o events like the September 11, 2001 attacks, which affect the insurance
and reinsurance markets generally;
o changes in reserves resulting from different types of claims that may
arise and the development of judicial interpretations relating to the
scope of insurers' liability; and
o the overall level of economic activity and the competitive environment
in the industry.
IF THE COMPANY'S LOSS RESERVES ARE INADEQUATE TO MEET ITS ACTUAL LOSSES, THE
COMPANY'S NET INCOME WOULD BE REDUCED OR IT COULD INCUR A LOSS.
The Company is required to maintain reserves to cover its estimated ultimate
liability of losses and loss adjustment expenses for both reported and
unreported claims incurred. These reserves are only estimates of what the
Company thinks the settlement and administration of claims will cost based on
facts and circumstances known to the Company. Because of the uncertainties that
surround estimating loss reserves and loss adjustment expenses, the Company
cannot be certain that ultimate losses will not exceed these estimates of losses
and loss adjustment reserves. If the Company's reserves are insufficient to
cover its actual losses and loss adjustment expenses, the Company would have to
augment its reserves and incur a charge to its earnings. These charges could be
material. The difficulty in estimating the Company's reserves is increased
because the Company's loss reserves include reserves for potential asbestos and
environmental liabilities. Asbestos and environmental liabilities are especially
hard to estimate for many reasons, including the long waiting periods between
exposure and manifestation of any bodily injury or property damage, difficulty
in identifying the source of the asbestos or environmental contamination, long
reporting delays and difficulty in properly allocating liability for the
asbestos or environmental damage.
THE COMPANY'S INABILITY TO ASSESS UNDERWRITING RISK ACCURATELY COULD REDUCE ITS
NET INCOME.
The Company's success is dependent on its ability to assess accurately the risks
associated with the businesses on which the risk is retained. If the Company
fails to assess accurately the risks it retains, the Company may fail to
establish appropriate premium rates and the Company's reserves may be inadequate
to cover its losses, requiring augmentation of the Company's reserves, which in
turn, could reduce the Company's net income.
64
DECREASES IN RATES FOR PROPERTY AND CASUALTY REINSURANCE AND INSURANCE COULD
REDUCE THE COMPANY'S NET INCOME.
The Company primarily writes property and casualty reinsurance and insurance.
The property and casualty industry historically has been highly cyclical. Rates
for property and casualty reinsurance and insurance are influenced primarily by
factors that are outside of the Company's control. Any significant decrease in
the rates for property and casualty insurance or reinsurance could reduce the
Company's net income.
IF RATING AGENCIES DOWNGRADE THEIR RATINGS OF THE COMPANY'S INSURANCE COMPANY
SUBSIDIARIES, THE COMPANY'S FUTURE PROSPECTS FOR GROWTH AND PROFITABILITY COULD
BE SIGNIFICANTLY AND ADVERSELY AFFECTED.
The Company's insurance company subsidiaries, other than Mt. McKinley and
Everest International, currently hold an A+ ("Superior") financial strength
rating from A.M. Best Company. Everest Re, Bermuda Re and Everest National hold
an AA- ("Positve") financial strength rating from Standard & Poor's Ratings
Services. Everest Re and Bermuda Re hold an Aa3 ("Excellent") financial strength
rating from Moody's Investors Service, Inc. Financial strength ratings are used
by insurers and reinsurance and insurance intermediaries as an important means
of assessing the financial strength and quality of reinsurers. In addition, the
rating of a company purchasing reinsurance may be adversely affected by an
unfavorable rating or the lack of a rating of its reinsurer. A downgrade or
withdrawal of any of these ratings might adversely affect the Company's ability
to market its insurance products and would have a significant and adverse effect
on its future prospects for growth and profitability.
THE COMPANY'S REINSURERS MAY NOT SATISFY THEIR OBLIGATIONS.
The Company is subject to credit risk with respect to its reinsurers because the
transfer of risk to a reinsurer does not relieve the Company of its liability to
the insured. In addition, reinsurers may be unwilling to pay the Company even
though they are able to do so. The failure of one or more of the Company's
reinsurers to honor their obligations in a timely fashion would impact the
Company's cash flow and reduce its net income and could cause the Company to
incur a significant loss.
IF THE COMPANY IS UNABLE TO PURCHASE REINSURANCE AND TRANSFER RISK TO
REINSURERS, ITS NET INCOME COULD BE REDUCED OR THE COMPANY COULD INCUR A LOSS.
The Company attempts to limit its risk of loss by purchasing reinsurance to
transfer a portion of the risks it assumes. The availability and cost of
reinsurance is subject to market conditions, which are outside of the Company's
control. As a result, the Company may not be able to successfully purchase
reinsurance and transfer risk through reinsurance arrangements. A lack of
available reinsurance might adversely affect the marketing of the Company's
business and/or force the Company to retain all or a part of the risk that
cannot be reinsured. If the Company were required to retain these risks and
ultimately pay claims with respect to these risks, the Company's net income
could be reduced or the Company could incur a loss.
THE COMPANY'S INDUSTRY IS HIGHLY COMPETITIVE AND THE COMPANY MAY NOT BE ABLE TO
COMPETE SUCCESSFULLY IN THE FUTURE.
The Company's industry is highly competitive and has experienced significant
price competition. The Company competes in the Bermuda, United States and
international markets with domestic and international insurance companies. Some
of these competitors have greater financial resources than the Company, have
been operating for longer than the Company and have established long-term and
continuing business relationships throughout the industry, which can be a
significant competitive advantage. In addition, the Company expects to face
further competition in the future. The Company may not be able to compete
successfully in the future.
65
THE COMPANY IS DEPENDENT ON ITS KEY PERSONNEL.
The Company's success has been, and will continue to be, dependent on its
ability to retain the services of its existing key executive officers and to
attract and retain additional qualified personnel in the future. The loss of the
services of any of its key executive officers or the inability to hire and
retain other highly qualified personnel in the future could adversely affect the
Company's ability to conduct its business. This dependency is particularly
important for the Company's Bermuda operations where, under Bermuda law,
non-Bermudians, other than spouses of Bermudians, are not permitted to engage in
any gainful occupation in Bermuda without a work permit issued by the Bermuda
government. A work permit is only granted or extended if the employer can show
that, after proper public advertisement, no Bermudian or spouse of a Bermudian,
is available who meets the minimum standards for the position. The Bermuda
government has announced a policy that places a six-year term limit on
individuals with work permits, subject to specified exemptions for persons
deemed to be key employees. These restrictions make it difficult to hire and
retain highly qualified personnel in Bermuda. If work permits are not obtained
or renewed for the Company's key employees in Bermuda, the Company could lose
their services, which could adversely affect the Company's ability to conduct
its business.
THE VALUE OF THE COMPANY'S INVESTMENT PORTFOLIO AND THE INVESTMENT INCOME IT
RECEIVES FROM THAT PORTFOLIO COULD DECLINE AS A RESULT OF MARKET FLUCTUATIONS
AND ECONOMIC CONDITIONS.
A significant portion of the Company's investment portfolio consists of fixed
income securities and a smaller portion consists of equity securities. Both the
fair market value of these assets and the investment income from these assets
fluctuate depending on general economic and market conditions. For example, the
fair market value of the Company's fixed income securities generally increases
or decreases in an inverse relationship with fluctuations in interest rates. The
fair market value of the Company's fixed income securities can also decrease as
a result of any downturn in the business cycle that causes the credit quality of
those securities to deteriorate. The net investment income that the Company
realizes from future investments in fixed income securities will generally
increase or decrease with interest rates. Interest rate fluctuations can also
cause net investment income from investments that carry prepayment risk, such as
mortgage-backed and other asset-backed securities, to differ from the income
anticipated from those securities at the time the Company bought them. In
addition, if issuers of individual investments are unable to meet their
obligations, investment income will be reduced and realized capital losses may
arise. Because all of the Company's securities are classified as available for
sale, changes in the market value of the Company's securities are reflected in
its financial statements. Similar treatment is not available for liabilities. As
a result, a decline in the value of the securities in the Company's portfolio
could reduce its net income or cause the Company to incur a loss.
INSURANCE LAWS AND REGULATIONS RESTRICT THE COMPANY'S ABILITY TO OPERATE.
The Company is subject to extensive regulation under U.S., state and foreign
insurance laws. These laws limit the amount of dividends that can be paid to the
Company by its operating subsidiaries, impose restrictions on the amount and
type of investments that they can hold, prescribe solvency standards that must
be met and maintained by them and require them to maintain reserves. These laws
also require disclosure of material intercompany transactions and require prior
approval of certain "extraordinary" transactions. These "extraordinary"
transactions include declaring dividends from operating subsidiaries that exceed
statutory thresholds. These laws also generally require approval of changes of
control. The Company's failure to comply with these laws could subject it to
66
fines and penalties and restrict it from conducting business. The application of
these laws could affect the Company's liquidity and ability to pay dividends on
its common shares and could restrict the Company's ability to expand its
business operations through acquisitions involving the Company's insurance
subsidiaries.
FAILURE TO COMPLY WITH INSURANCE LAWS AND REGULATIONS COULD HAVE A MATERIAL
ADVERSE EFFECT ON THE COMPANY'S BUSINESS.
The Company may not have all required licenses and approvals or may not comply
with the wide variety of applicable laws and regulations or the relevant
authorities' interpretation of the laws and regulations. If the Company does not
have the requisite licenses and approvals or does not comply with applicable
regulatory requirements, the insurance regulatory authorities could preclude or
temporarily suspend the Company from carrying on some or all of its activities
or monetarily penalize the Company. These types of actions could have a material
adverse effect on the Company's business.
THE COMPANY'S HOLDING COMPANY STRUCTURE COULD PREVENT IT FROM PAYING DIVIDENDS
ON ITS COMMON SHARES.
Group is a holding company whose most significant assets consist of the stock of
its operating subsidiaries. Thus, Group's ability to pay dividends on its common
shares in the future may be dependent on the earnings and cash flows of its
subsidiaries and the ability of the subsidiaries to pay dividends or to advance
or repay funds to Group. This ability is subject to general economic, financial,
competitive, regulatory and other factors beyond the Company's control. Payment
of dividends and advances and repayments from some of Group's operating
subsidiaries are regulated by U.S., state and foreign insurance laws and
regulatory restrictions, including minimum solvency and liquidity thresholds.
Accordingly, Group's operating subsidiaries may not be able to pay dividends or
advance or repay funds to Group in the future, which could prevent the Company
from paying dividends or making other payments or distributions on its
securities.
THE COMPANY MAY EXPERIENCE EXCHANGE LOSSES IF IT DOES NOT MANAGE ITS FOREIGN
CURRENCY EXPOSURE PROPERLY.
The Company's functional currency is the United States dollar. However, the
Company writes a portion of its business and receives a portion of its premiums
in currencies other than United States dollars. The Company also maintains a
portion of its investment portfolio in investments denominated in currencies
other than United States dollars. Consequently, the Company may experience
exchange losses if its foreign currency exposure is not properly managed or
otherwise hedged. If the Company seeks to hedge its foreign currency exposure by
using forward foreign currency exchange contracts or currency swaps, the Company
will be subject to the risk that the counter parties to those arrangements will
fail to perform, or that those arrangements will not precisely offset the
Company's exposure.
IF U.S. TAX LAW CHANGES, THE COMPANY'S NET INCOME MAY BE REDUCED.
In the last few years, some members of Congress have expressed concern about
U.S. corporations that move their place of incorporation to low-tax
jurisdictions. Also, some members of Congress have expressed concern over a
competitive advantage that foreign-controlled insurers and reinsurers may have
over U.S. controlled insurers and reinsurers due to the purchase of reinsurance
by U.S. insurers from affiliates operating in some foreign jurisdictions,
including Bermuda. Legislation has recently been proposed in Congress that would
increase the U.S. tax burden on so-called "inverting" companies and increase the
67
U.S. tax burden on related-party reinsurance transactions. The Company does not
know whether this legislation or any similar legislation will ever be enacted
into law. If it were enacted, the U.S. tax burden on the Company's Bermuda
operations, or on some business ceded from its licensed U.S. subsidiaries to
some offshore reinsurers, could be increased. This could reduce the Company's
net income.
GROUP AND/OR BERMUDA RE MAY BE SUBJECT TO U.S. CORPORATE INCOME TAX, WHICH WOULD
REDUCE THE COMPANY'S NET INCOME.
The income of Bermuda Re is a significant portion of the Company's worldwide
income from operations. The Company has established guidelines for the conduct
of its Bermuda operations that are designed to ensure that Bermuda Re is not
engaged in the conduct of a trade or business in the United States. Based on its
compliance with those guidelines, the Company believes that Bermuda Re should
not be required to pay U.S. corporate income tax, other than withholding tax on
U.S. source dividend income. However, if the IRS successfully contended that
Bermuda Re was engaged in a trade or business in the United States, Bermuda Re
would be required to pay U.S. corporate income tax on any income that is subject
to the taxing jurisdiction of the United States, and possibly the U.S. branch
profits tax. Even if the IRS successfully contended that Bermuda Re was engaged
in a U.S. trade or business, the U.S.-Bermuda tax treaty would preclude the IRS
from taxing Bermuda Re's income except to the extent that its income were
attributable to a permanent establishment maintained by that subsidiary. The
Company does not believe that Bermuda Re has a permanent establishment in the
United States. If the IRS successfully contended that Bermuda Re did have income
attributable to a permanent establishment in the United States, it would be
subject to U.S. tax on that income.
The Company believes it qualifies for benefits under the U.S.-Barbados tax
treaty. Based on the Company's compliance with guidelines designed to ensure
that it generates only immaterial amounts, if any, of income that is subject to
the taxing jurisdiction of the United States, the Company believes that it
should be required to pay only immaterial amounts, if any, of U.S. corporate
income tax, other than withholding tax on U.S. source dividend income. However,
if the IRS successfully contended that the Company had material amounts of
income that is subject to the taxing jurisdiction of the United States, the
Company would be required to pay U.S. corporate income tax on that income, and
possibly the U.S. branch profits tax. Even if the IRS successfully contended
that the Company had material amounts of income that is subject to the taxing
jurisdiction of the United States, the U.S.-Barbados tax treaty would preclude
the IRS from taxing the Company's income, except to the extent that its income
were attributable to a permanent establishment maintained in the United States.
The Company does not believe that it has material amounts of income attributable
to a permanent establishment in the United States. If the IRS successfully
contended, however, that the Company did have income attributable to a permanent
establishment in the United States, the Company would be subject to U.S. tax on
that income. If Bermuda Re became subject to U.S. income tax on its income or if
the Company became subject to U.S. income tax on more than immaterial amounts of
income, the Company's income could also be subject to the U.S. branch profits
tax. In that event, Group and Bermuda Re would be subject to taxation at a
higher combined effective rate than if they were organized as U.S. corporations.
The combined effect of the 35% U.S. corporate income tax rate and the 30% branch
profits tax rate is a net tax rate of 54.5%. The imposition of these taxes would
reduce the Company's net income.
68
HOLDERS OF THE COMPANY'S COMMON SHARES COULD BE SUBJECT TO U.S. TAXES ON
UNDISTRIBUTED INCOME OF GROUP AND/OR BERMUDA RE.
U.S. holders of common shares generally will not be subject to any U.S. tax
until they receive a distribution from Group or dispose of their common shares.
However, special provisions of the U.S. Internal Revenue Code of 1986, which the
Company refers to in this document as the Code, may apply to U.S. taxpayers who
directly, indirectly or by attribution own 10% or more of the total combined
voting power of all classes of share capital of Group and/or Bermuda Re. Under
these provisions, those taxpayers generally will be required to include in their
income their pro rata share of the income of Group and/or Bermuda Re as earned,
even if not distributed. The Company has attempted to avoid having its
shareholders become subject to these provisions by including in Group's by-laws
provisions that limit the ownership of the common shares to levels that will not
subject U.S. shareholders to U.S. tax on undistributed income under these
provisions. Based on these bye-laws, the Company believes that its shareholders
should not be subject to U.S. tax on undistributed income.
In addition, special provisions of the Code apply to U.S. persons who are
shareholders of a foreign insurance company and have related person insurance
income allocated to them. Related person insurance income, often called RPII, is
investment income and premium income derived from the direct or indirect
insurance or reinsurance of the risk of:
o any U.S. tax payer who directly or indirectly through foreign entities
owns shares of a foreign insurance company; or
o any person related to a U.S. taxpayer meeting the above definition.
The RPII provisions of the Code could apply to U.S. taxpayers who directly,
indirectly or by attribution own any shares of Bermuda Re if:
o 25% or more of the value or voting power of the share capital of
Bermuda Re is owned directly, indirectly or by attribution by U.S.
taxpayers;
o 20% or more of the value or voting power of the share capital of
Bermuda Re is owned directly, indirectly or by attribution by U.S.
taxpayers, or persons related to U.S. taxpayers, who are insured or
reinsured by Bermuda Re; and
o Bermuda Re has gross RPII equal to 20% or more of its gross insurance
income.
The Company currently believes that less than 20% of the value or voting power
of the share capital of Bermuda Re is owned directly, indirectly or by
attribution by U.S. taxpayers insured or reinsured by it or persons related to
those taxpayers, and/or that less than 20% of the gross insurance income of
Bermuda Re for any taxable year will constitute RPII. However, if neither of
these conditions is satisfied, since the Company's U.S. shareholders are treated
by the Code as indirectly owning shares of Bermuda Re, they will be required to
include in their income their pro rata share of Bermuda Re's RPII as earned,
even if not distributed.
GAINS RESULTING FROM THE SALE OF THE COMPANY'S COMMON SHARES BY U.S.
SHAREHOLDERS COULD BE TAXED IN THE U.S. AS DIVIDENDS.
Generally, a U.S. shareholder will realize capital gain or loss on the sale or
exchange of the common shares. However, the IRS could contend that special
provisions of the Code apply and that the amount of any gain equal to the
69
Company's allocable untaxed earnings and profits should be taxed as a dividend.
If the IRS successfully contended that those provisions apply to the Company,
shareholders would be taxed on that amount of gain at the rates applicable to
ordinary income rather than the lower rates applicable to long-term capital
gains. Assuming that none of the Company's non- U.S. subsidiaries have any RPII,
the Company believes that these provisions of the Code should not apply to the
disposition of any common shares by a U.S. shareholder who holds less than 10%
of the outstanding common shares.
THE ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT AND THE EUROPEAN UNION
ARE CONSIDERING MEASURES THAT MIGHT INCREASE THE COMPANY'S TAXES AND REDUCE ITS
NET INCOME.
A number of multinational organizations, including the Organization for Economic
Cooperation and Development ("OECD"), the European Union, the Financial Action
Task Force and the Financial Stability Forum have all recently identified some
countries as not participating in adequate information exchange, engaging in
harmful tax practices or maintaining adequate controls to prevent corruption,
such as money laundering activities. The OECD has threatened non-member
jurisdictions that do not agree to cooperate with the OECD with punitive
sanctions by OECD member countries, though specific sanctions have yet to be
adopted by OECD member countries. It is as yet unclear as to what these
sanctions will be, who will adopt them and when or if they will be imposed. On
April 18, 2002, the OECD published a list of "uncooperative tax havens," which
are those jurisdictions from whom the OECD has not received commitments to the
OECD's principles of regulatory and tax transparency and effective exchange
information. The governments of both Bermuda and Barbados have made these
commitments. As a result, neither Bermuda nor Barbados was listed as an
uncooperative tax haven.
GROUP AND/OR BERMUDA RE MAY BECOME SUBJECT TO BERMUDA TAX, WHICH WOULD REDUCE
THE COMPANY'S NET INCOME.
Group and Bermuda Re currently are not subject to income or capital gains taxes
in Bermuda. Both companies have received an assurance from the Bermuda Minister
of Finance under The Exempted Undertakings Tax Protection Act 1966 of Bermuda to
the effect that if any legislation is enacted in Bermuda that imposes any tax
computed on profits or income, or computed on any capital asset, gain or
appreciation, or any tax in the nature of estate duty or inheritance tax, then
that tax will not apply to them or to any of their operations or their shares,
debentures or other obligations until March 28, 2016. This assurance does not
prevent the application of any of those taxes to persons ordinarily resident in
Bermuda and does not prevent the imposition of any tax payable in accordance
with the provisions of The Land Tax Act of 1967 of Bermuda or otherwise payable
in relation to any property leased to the Company. There are currently no
procedures for extending these assurances. As a result, Group and Bermuda Re
could be subject to taxes in Bermuda after March 28, 2016, which could reduce
the Company's net income.
GROUP MAY BECOME SUBJECT TO BARBADOS TAX, WHICH WOULD REDUCE THE COMPANY'S NET
INCOME.
Group has obtained an international business company license under the Barbados
International Business Companies Act, 1991-24. Based on this license, Group is
entitled to special tax benefits, including a preferred rate of tax on profits
and gains and an exemption from withholding tax in respect of any dividends,
interest, royalties, fees or management fees deemed to be paid to another
international business company or to a person not resident in Barbados. Group
has also obtained from the Ministry of Economic Development a fifteen year
70
guarantee in accordance with Section 27 of the International Business Companies
Act with respect to its continued eligibility for this preferred status. This
guarantee is applicable until 2014 and is subject to negative resolution, which
means that this guarantee can be revoked at any time. In addition, there are
currently no procedures for extending this guarantee. As a result, Group could
be ineligible for these benefits after that period, which could reduce the
Company's net income.
THE COMPANY'S NET INCOME WILL BE REDUCED IF U.S. EXCISE AND WITHHOLDING TAXES
ARE INCREASED.
Bermuda Re is subject to an excise tax on reinsurance and insurance premiums it
collects with respect to risks located in the United States. In addition,
Bermuda Re may be subject to withholding tax on dividend income from United
States sources. These taxes could increase and other taxes could be imposed in
the future on Bermuda Re's business, which could reduce the Company's net
income.
REGULATORY CHALLENGES IN THE UNITED STATES COULD ADVERSELY AFFECT THE ABILITY OF
BERMUDA RE TO CONDUCT BUSINESS.
Bermuda Re does not intend to be licensed or admitted as an insurer or reinsurer
in any U.S. jurisdiction. Under current law, Bermuda Re generally is permitted
to reinsure U.S. risks from its office in Bermuda without obtaining those
licenses. However, the insurance and reinsurance regulatory framework has become
subject to increased scrutiny. In the past, there have been congressional and
other initiatives in the United States regarding increased supervision and
regulation of the insurance industry, including proposals to supervise and
regulate reinsurers domiciled outside the United States. If Bermuda Re were to
become subject to any insurance laws of the United States or any U.S. state at
any time in the future, it might be required to post deposits or maintain
minimum surplus levels and might be prohibited from engaging in lines of
business or from writing types of policies. Complying with those laws could have
a material adverse effect on the Company's ability to conduct business in the
Bermuda market.
BERMUDA RE MAY NEED TO BE LICENSED OR ADMITTED IN ADDITIONAL JURISDICTIONS TO
DEVELOP ITS BUSINESS.
As Bermuda Re's business develops, it will monitor the need to obtain licenses
in jurisdictions other than Bermuda in order to comply with applicable law or to
be able to engage in additional insurance-related activities. In addition,
Bermuda Re may be at a competitive disadvantage in jurisdictions where it is not
licensed or does not enjoy an exemption from licensing relative to competitors
that are so licensed or exempted from licensing. Bermuda Re may not be able to
obtain any additional licenses that it determines are necessary or desirable.
Furthermore, the process of obtaining those licenses is often costly and may
take a long time.
BERMUDA RE'S ABILITY TO WRITE REINSURANCE MAY BE SEVERELY LIMITED IF IT IS
UNABLE TO ARRANGE FOR SECURITY TO BACK ITS REINSURANCE.
Many jurisdictions do not permit insurance companies to take credit for
reinsurance obtained from unlicensed or non-admitted insurers on their statutory
financial statements without appropriate security. Bermuda Re's reinsurance
clients generally require it to post a letter of credit or enter into other
security arrangements. If Bermuda Re is unable to obtain or maintain a letter of
credit facility on commercially acceptable terms or unable to arrange for other
types of security, its ability to operate its business may be severely limited.
If Bermuda Re defaults on any letter of credit that it obtains, it may be
required to prematurely liquidate a substantial portion of its investment
portfolio and other assets pledged as collateral.
71
SECURITY HOLDERS MAY NOT BE ABLE TO RECOVER DAMAGES FROM THE COMPANY AND SOME OF
ITS DIRECTORS, OFFICERS AND EXPERTS NAMED IN THIS REPORT.
The Company is organized under the laws of Bermuda. Some of its directors and
officers, as well as some of the experts named in this report, may reside
outside the United States. A substantial portion of the Company's and their
assets are or may be located in jurisdictions outside the United States.
Security holders may not be able to effect service of process within the United
States on directors and officers of the Company and those experts who reside
outside the United States. Security holders also may not be able to recover
against them or the Company on judgments of U.S. courts or to obtain original
judgments against them or the Company in Bermuda courts, including judgments
predicated upon civil liability provisions of the U.S. federal securities laws.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Sensitive Instruments" in ITEM 7.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to the sections captioned "Election of Directors",
"Information Concerning Nominees", "Information Concerning Continuing Directors
and Executive Officers" and "Compliance with Section 16(a) of the Exchange Act"
in the Company's proxy statement for the 2003 Annual General Meeting of
Shareholders, which will be filed with the Commission within 120 days of the
close of the Company's fiscal year ended December 31, 2002 (the "Proxy
Statement"), which sections are incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Reference is made to the sections captioned "Directors' Compensation" and
"Compensation of Executive Officers" in the Proxy Statement, which are
incorporated herein by reference, except that the Compensation Committee Report
and the Performance Graph are not so incorporated.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREHOLDER MATTERS
Reference is made to the sections captioned "Common Share Ownership by Directors
and Executive Officers", "Principal Holders of Common Shares" and "Equity
Compensation Plans" in the Proxy Statement, which are incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to the section captioned "Certain Transactions with Directors"
in the Proxy Statement, which is incorporated herein by reference.
72
ITEM 14. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation was
carried out under the supervision and with the participation of the Company's
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the disclosure controls and procedures (as defined in
Rule 13a-14I under the Securities Exchange Act of 1934). Based on their
evaluation, the Chief Executive Officer and Chief Financial Officer believe that
the Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. Subsequent to the date of their evaluation, there were no significant
changes in the Company's internal controls or in other factors that could
significantly affect these controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND SCHEDULES
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
EXHIBITS
The exhibits listed on the accompanying Index to Exhibits on page E-1 are filed
as part of this report.
REPORTS ON FORM 8-K
A report on Form 8-K dated February 20, 2003 was filed on February 20, 2003
reporting an increase in the Company's quarterly dividend and declared a
dividend.
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on March 14, 2003.
EVEREST RE GROUP, LTD.
By: /s/ JOSEPH V. TARANTO
-------------------------------------
Joseph V. Taranto
(Chairman and Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ JOSEPH V. TARANTO Chairman and Chief Executive March 14, 2003
- --------------------- Officer and Director (Principal
Joseph V. Taranto Executive Officer)
/s/ STEPHEN L. LIMAURO Executive Vice President and March 14, 2003
- ---------------------- Chief Financial Officer (Principal
Stephen L. Limauro Financial Officer)
/s/ KEITH T. SHOEMAKER Comptroller (Principal Accounting March 14, 2003
- ---------------------- Officer)
Keith T. Shoemaker
/s/ MARTIN ABRAHAMS Director March 14, 2003
- -------------------
Martin Abrahams
/s/ KENNETH J. DUFFY Director March 14, 2003
- --------------------
Kenneth J. Duffy
/s/ JOHN R. DUNNE Director March 14, 2003
- -----------------
John R. Dunne
/s/ THOMAS J. GALLAGHER Director March 14, 2003
- -----------------------
Thomas J. Gallagher
/s/ WILLIAM F. GALTNEY, JR. Director March 14, 2003
- ---------------------------
William F. Galtney, Jr.
74
I, Joseph V. Taranto, certify that:
1. I have reviewed this annual report on Form 10-K of Everest Re Group, Ltd;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
March 17, 2003 /s/ JOSEPH V. TARANTO
- -------------- -----------------------
Joseph V. Taranto
Chairman and
Chief Executive Officer
I, Stephen L. Limauro, certify that:
1. I have reviewed this annual report on Form 10-K of Everest Re Group, Ltd;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
March 17, 2003 /s/ STEPHEN L. LIMAURO
- -------------- ---------------------------
Stephen L. Limauro
Executive Vice President
and Chief Financial Officer
INDEX TO EXHIBITS
EXHIBIT NO. PAGE
- ----------- ----
2.1 Agreement and Plan of Merger among Everest Reinsurance Holdings,
Inc., Everest Re Group, Ltd. and Everest Re Merger Corporation,
incorporated herein by reference to Exhibit 2.1 to the Registration
Statement on Form S-4 (No. 333-87361)
3.1 Memorandum of Association of Everest Re Group, Ltd., incorporated
herein by reference to Exhibit 3.1 to the Registration Statement on
Form S-4 (No. 333-87361)
3.2 By-Laws of Everest Re Group, Ltd., incorporated herein by
reference to Exhibit 3.2 to the Everest Re Group, Ltd. Annual
Report on Form 10-K for the year ended December 31, 1999 (the "1999
10-K")
4.1 Specimen Everest Re Group, Ltd. Common share certificate,
incorporated herein by reference to Exhibit 4.1 of the Registration
Statement on Form S-4 (No. 333-87361)
4.2 Indenture, dated March 14, 2000, between Everest Reinsurance
Holdings, Inc. and The Chase Manhattan Bank, as Trustee,
incorporated herein by reference to Exhibit 4.1 to Everest
Reinsurance Holdings, Inc. Form 8-K filed on March 15, 2000
4.3 First Supplemental Indenture relating to the 8.5% Senior Notes due
March 15, 2005, dated March 14, 2000, between Everest Reinsurance
Holdings, Inc. and The Chase Manhattan Bank, as Trustee,
incorporated herein by reference to Exhibit 4.2 to Everest
Reinsurance Holdings, Inc. Form 8-K filed on March 15, 2000
4.4 Second Supplemental Indenture relating to the 8.75% Senior Notes
due March 15, 2010, dated March 14, 2000, between Everest
Reinsurance Holdings, Inc. and The Chase Manhattan Bank, as
Trustee, incorporated herein by reference to Exhibit 4.3 to the
Everest Reinsurance Holdings, Inc. Form 8-K filed on March 15, 2000
*10.1 Everest Re Group, Ltd. Annual Incentive Plan effective January 1,
1999, incorporated herein by reference to Exhibit 10.1 to Everest
Reinsurance Holdings, Inc. Annual Report on Form 10-K for the year
ended December 31, 1998 (the "1998 10-K")
E-1
*10.2 Everest Re Group, Ltd. Amended 1995 Stock Incentive Plan,
incorporated herein by reference to Exhibit 10.3 to Everest
Reinsurance Holdings, Inc. Annual Report on Form 10-K for the year
ended December 31, 1995 (the "1995 10-K")
*10.3 Everest Re Group, Ltd. 1995 Stock Option Plan for Non-Employee
Directors, incorporated herein by reference to Exhibit 4.3 to the
Registration Statement on Form S-8 (No. 333-05771)
*10.4 Resolution adopted by Board of Directors of Everest Reinsurance
Holdings, Inc. on April 1, 1999 awarding stock options to outside
Directors, incorporated herein by reference to Exhibit 10.25 to
Everest Reinsurance Holdings, Inc. Quarterly Report on Form 10-Q
for the quarter ended June 30, 1999 (the "second quarter 1999
10-Q")
*10.5 Resolution adopted by the Board of Directors of Everest Reinsurance
Holdings, Inc. on February 23, 2000 awarding stock options to
outside Directors, incorporated herein by reference to Exhibit 10.8
to the 1999 10-K
*10.6 Form of Non-Qualified Stock Option Award Agreement to be entered
into between Everest Re Group, Ltd. and participants in the 1995
Stock Incentive Plan, incorporated herein by reference to Exhibit
10.15 to the 1995 10-K
*10.7 Form of Restricted Stock Agreement to be entered into between
Everest Re Group, Ltd. and participants in the 1995 Stock Incentive
Plan, incorporated herein by reference to Exhibit 10.16 to the 1995
10-K
*10.8 Form of Stock Option Agreement (Version 1) to be entered into
between Everest Re Group, Ltd. and participants in the 1995 Stock
Option Plan for Non-Employee Directors, incorporated herein by
reference to Exhibit 10.17 to the 1995 10-K
*10.9 Form of Stock Option Agreement (Version 2) to be entered into
between Everest Re Group, Ltd. and participants in the 1995 Stock
Option Plan for Non-Employee Directors, incorporated herein by
reference to Exhibit 10.18 to the 1995 10-K
*10.10 Form of Stock Option Agreement for Non-Employee Directors,
incorporated herein by reference to Exhibit 10.34 to the 1999 10-K
*10.11 Deferred Compensation Plan, as amended, for certain United States
employees of Everest Re Group, Ltd. and its participating
subsidiaries incorporated herein by reference to Exhibit 10.20 to
the 1998 10-K
E-2
*10.12 Senior Executive Change of Control Plan, incorporated herein by
reference to Exhibit 10.24 to Everest Reinsurance Holdings, Inc.
Quarterly Report on Form 10-Q for the quarter ended September 30,
1998
*10.13 Executive Performance Annual Incentive Plan adopted by stockholders
on May 20, 1999, incorporated herein by reference to Exhibit 10.26
to the second quarter 1999 10-Q
*10.14 Employment Agreement with Joseph V. Taranto executed on July 15,
1998, incorporated herein by reference to Exhibit 10.21 to Everest
Reinsurance Holdings, Inc. Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 (the "second quarter 1998 10-Q")
*10.15 Amendment of Employment Agreement by and among Everest Reinsurance
Company, Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd.
and Joseph V. Taranto dated February 15, 2000, incorporated herein
by reference to Exhibit 10.29 to the 1999 10-K
*10.16 Change of Control Agreement with Joseph V. Taranto effective July
15, 1998, incorporated herein by reference to Exhibit 10.22 to the
second quarter 1998 10-Q
*10.17 Amendment of Change of Control Agreement by and among Everest
Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re
Group, Ltd. and Joseph V. Taranto dated February 15, 2000,
incorporated herein by reference to Exhibit 10.30 to the 1999 10-K
10.18 Credit Agreement Between Everest Reinsurance Holdings, Inc., the
Lenders Named Therein and First Union National Bank dated December
21, 1999 providing for a $150 million Senior Revolving Credit
Facility, incorporated herein by reference to Exhibit 10.30 to
Everest Reinsurance Holdings, Inc. Form 8-K, filed on December 28,
1999
10.19 First Amendment to Credit Agreement dated as of December 21, 1999
between Everest Reinsurance Holdings, Inc., the Lenders named
therein and First Union National Bank, incorporated herein by
reference to Exhibit 10.19 to the Everest Re Group, Ltd. Annual
Report on Form 10-K for the year ended December 31, 2000 (the "2000
10-K")
10.20 Parent Guaranty dated February 24, 2000 made by Everest Re Group,
Ltd. in favor of the Lenders under Everest Reinsurance Holdings,
Inc.'s Credit Facility, incorporated herein by reference to Exhibit
10.33 to the 1999 10-K
E-3
10.21 Guarantor Consent dated December 18, 2000 made by Everest Re Group,
Ltd. in favor of the Lenders under Everest Reinsurance Holdings,
Inc.'s Credit Facility, incorporated herein by reference to Exhibit
10.21 to the 2000 10-K
10.22 Stock Purchase Agreement between The Prudential Insurance Company
of America and Everest Reinsurance Holdings, Inc. for the sale of
common stock of Gibraltar Casualty Company dated February 24,
2000, incorporated herein by reference to Exhibit 10.32 to the 1999
10-K
10.23 Amendment No. 1 to Stock Purchase Agreement between The Prudential
Insurance Company of America and Everest Reinsurance Holdings, Inc.
for the sale of common stock of Gibraltar Casualty Company dated
August 8, 2000, incorporated herein by reference to Exhibit 10.1 to
the Everest Re Group, Ltd. Quarterly Report on Form 10-Q for the
quarter ended June 30, 2000
10.24 Proportional Excess of Loss Reinsurance Agreement entered into
between Gibraltar Casualty Company and Prudential Property and
Casualty Insurance Company, incorporated herein by reference to
Exhibit 10.24 to the 2000 10-K
10.25 Guarantee Agreement made by The Prudential Insurance Company of
America in favor of Gibraltar Casualty Company, incorporated
herein by reference to Exhibit 10.25 to the 2000 10-K
10.26 Lease, effective December 26, 2000 between OTR, an Ohio general
partnership, and Everest Reinsurance Company, incorporated herein
by reference to Exhibit 10.26 to the 2000 10-K
*10.27 Amendment of Employment Agreement by and among Everest
Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re
Group, Ltd., Everest Global Services, Inc. and Joseph V. Taranto,
dated March 30, 2001, incorporated herein by reference to Exhibit
10.1 to Everest Re Group, Ltd. Report on Form 10-Q for the quarter
ended March 31, 2001 (the "first quarter 2001 10-Q")
*10.28 Amendment of Employment Agreement by and among Everest
Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest
Re Group, Ltd., Everest Global Services, Inc. and Joseph V.
Taranto, dated April 20, 2001, incorporated herein by reference to
Exhibit 10.2 to the first quarter 2001 10-Q.
E-4
*10.29 Amendment of Change of Control Agreement by and among Everest
Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re
Group, Ltd., Everest Global Services, Inc. and Joseph V. Taranto,
dated March 30, 2001, incorporated herein by reference to Exhibit
10.3 to the first quarter 2001 10-Q
*10.30 Resolution adopted by the Board of Directors of Everest Re
Group, Ltd. on September 20, 2001 awarding stock options to outside
Directors, incorporated herein by reference to Exhibit 10.30 to
Everest Re Group, Ltd. Report on Form 10-K for the year ended
December 31, 2001 (the "2001 10-K")
10.31 Second Amendment to Credit Agreement dated as of November 21, 2002
between Everest Reinsurance Holdings, Inc., the Lenders named
therein and Wachovia Bank, National Association (formerly known as
First Union National Bank), filed herewith
*10.32 Employment Agreement executed on April 15, 2002, between Peter
J. Bennett and Everest Reinsurance (Bermuda), Ltd., filed herewith
*10.33 Special Employment Agreement executed on March 22, 2002, between
Janet J. Burak and Everest Global Services, Inc., filed herewith
*10.34 Everest Re Group, Ltd. 2002 Stock Incentive Plan, incorporated
herein by reference to Appendix A to Everest Re Group, Ltd. Proxy
Statement in connection with the Annual General Meeting of
Shareholders on May 22, 2002
11.1 Statement regarding computation of per share earnings, filed
herewith
21.1 Subsidiaries of the registrant, filed herewith
23.1 Consent of PricewaterhouseCoopers LLP, filed herewith
99.1 Certification of Chief Executive Officer and Chief Financial
Officer, filed herewith
- --------------------------
* Management contract or compensatory plan or arrangement.
E-5
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Pages
Everest Re Group, Ltd.
Report of Independent Accountants on Financial Statements and Schedules F-2
---
Consolidated Balance Sheets at December 31, 2002 and 2001 F-3
---
Consolidated Statements of Operations and Comprehensive Income for the
years ended December 31, 2002, 2001 and 2000 F-4
---
Consolidated Statements of Changes in Shareholders' Equity for the
years ended December 31, 2002, 2001 and 2000 F-5
---
Consolidated Statements of Cash Flows for the years ended December
31, 2002, 2001 and 2000 F-6
---
Notes to Consolidated Financial Statements F-7
---
Schedules
I Summary of Investments Other Than Investments in Related
Parties at December 31, 2002 S-1
---
II Condensed Financial Information of Registrant:
Balance Sheets as of December 31, 2002 and 2001 S-2
---
Statements of Operations for the Years Ended
December 31, 2002, 2001 and 2000 S-3
---
Statements of Cash Flows for the Years Ended December 31,
2002, 2001 and 2000 S-4
---
III Supplementary Insurance Information as of December 31, 2002
and 2001 and for the years ended December 31, 2002,
2001 and 2000 S-5
---
IV Reinsurance for the years ended December 31, 2002, 2001 and 2000 S-6
---
Schedules other than those listed above are omitted for the reason that they are
not applicable or the information is otherwise contained in the Financial
Statements.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Everest Re Group, Ltd.
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Everest Re Group, Ltd. and its subsidiaries at December 31, 2002 and 2001, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedules listed in the accompanying index present
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedules are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
February 6, 2003
F-2
EVEREST RE GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except par value per share)
December 31, December 31,
------------ ------------
2002 2001
------------ ------------
ASSETS:
Fixed maturities - available for sale, at market value
(amortized cost: 2002, $6,460,839; 2001, $5,288,860) $ 6,779,858 $ 5,461,584
Equity securities, at market value
(cost: 2002, $56,841; 2001, $66,357) 47,473 67,311
Short-term investments 169,116 148,851
Other invested assets 53,856 33,899
Cash 208,830 71,878
------------ ------------
Total investments and cash 7,259,133 5,783,523
Accrued investment income 85,959 83,088
Premiums receivable 673,377 468,897
Reinsurance receivables 1,116,362 895,061
Funds held by reinsureds 121,308 149,969
Deferred acquisition costs 207,416 130,709
Prepaid reinsurance premiums 63,437 47,185
Deferred tax asset 139,176 178,507
Other assets 198,435 59,221
------------ ------------
TOTAL ASSETS $ 9,864,603 $ 7,796,160
============ ============
LIABILITIES:
Reserve for losses and adjustment expenses $ 4,905,582 $ 4,278,267
Future policy benefit reserve 227,925 238,753
Unearned premium reserve 872,340 489,171
Funds held under reinsurance treaties 347,360 267,105
Losses in the course of payment 45,511 89,492
Contingent commissions 1,932 2,119
Other net payable to reinsurers 61,244 66,462
Current federal income taxes (16,696) (30,459)
8.5% Senior notes due 3/15/2005 249,780 249,694
8.75% Senior notes due 3/15/2010 199,158 199,077
Revolving credit agreement borrowings 70,000 105,000
Accrued interest on debt and borrowings 13,481 11,944
Other liabilities 308,340 109,013
------------ ------------
Total liabilities 7,285,957 6,075,638
------------ ------------
Company-obligated mandatorily redeemable preferred securities
of subsidiary trusts holding solely subordinated debentures
("trust preferred securities") 210,000 -
------------ ------------
SHAREHOLDERS' EQUITY:
Preferred shares, par value: $0.01; 50 million shares authorized;
no shares issued and outstanding - -
Common shares, par value: $0.01; 200 million shares authorized;
50.9 million shares issued in 2002 and 46.3 million shares
issued in 2001 513 463
Additional paid-in capital 618,521 269,945
Unearned compensation (340) (115)
Accumulated other comprehensive income, net of
deferred income taxes of $74.4 million in 2002 and
$40.8 million in 2001 221,542 113,880
Retained earnings 1,551,360 1,336,404
Treasury shares, at cost; 0.5 million shares
in 2002 and 0.0 million shares in 2001 (22,950) (55)
------------ ------------
Total shareholders' equity 2,368,646 1,720,522
------------ ------------
TOTAL LIABILITIES, TRUST PREFERRED SECURTIES
AND SHAREHOLDERS' EQUITY $ 9,864,603 $ 7,796,160
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Dollars in thousands, except per share amounts)
Years Ended December 31,
--------------------------------------------------------
2002 2001 2000
------------ ------------- ------------
REVENUES:
Premiums earned $ 2,273,677 $ 1,467,477 $ 1,174,183
Net investment income 350,603 340,441 301,493
Net realized capital (loss) gain (50,043) (22,313) 807
Net derivative (expense) (14,509) (12,218) -
Other (expense) income (2,091) 28,158 3,341
------------ ------------- ------------
2,557,637 1,801,545 1,479,824
------------ ------------- ------------
CLAIMS AND EXPENSES:
Incurred losses and loss adjustment expenses 1,629,382 1,209,517 884,616
Commission, brokerage, taxes and fees 551,787 396,797 272,447
Other underwriting expenses 69,916 58,884 51,633
Distribuitions related to trust preferred securities 2,091 - -
Interest expense on senior notes 38,916 38,903 30,896
Interest expense on credit facility 3,501 7,101 8,490
------------- ------------- ------------
2,295,593 1,711,202 1,248,082
------------- ------------- ------------
INCOME BEFORE TAXES 262,044 90,343 231,742
Income tax expense (benefit) 30,741 (8,675) 45,362
------------- ------------- ------------
NET INCOME $ 231,303 $ 99,018 $ 186,380
============= ============= ============
Other comprehensive income, net of tax 107,662 41,034 89,547
------------- ------------- ------------
COMPREHENSIVE INCOME $ 338,965 $ 140,052 $ 275,927
============= ============= ============
PER SHARE DATA:
Average shares outstanding (000's) 50,325 46,174 45,873
Net income per common share - basic $ 4.60 $ 2.14 $ 4.06
============= ============= ============
Average diluted shares outstanding (000's) 51,139 47,114 46,358
Net income per common share - diluted $ 4.52 $ 2.10 $ 4.02
============= ============= ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share amounts)
Years Ended December 31,
----------------------------------------------------
2002 2001 2000
------------ ------------ ------------
COMMON SHARES (shares outstanding):
Balance, beginning of period 46,269,015 46,029,354 46,457,817
Issued during the period 5,062,678 239,661 220,157
Treasury shares acquired during the period (450,000) - (650,400)
Treasury shares reissued during the period - - 1,780
------------ ------------ ------------
Balance, end of period 50,881,693 46,269,015 46,029,354
============ ============ ============
COMMON SHARES (par value):
Balance, beginning of period $ 463 $ 460 $ 509
Retirement of common shares during the period - - (51)
Issued during the period 50 3 2
------------ ------------ ------------
Balance, end of period 513 463 460
------------ ------------ ------------
ADDITIONAL PAID IN CAPITAL:
Balance, beginning of period 269,945 259,958 390,912
Retirement of treasury shares during the period - - (138,546)
Common shares issued during the period 348,576 9,987 7,594
Treasury shares reissued during period - - (2)
------------ ------------ ------------
Balance, end of period 618,521 269,945 259,958
------------ ------------ ------------
UNEARNED COMPENSATION:
Balance, beginning of period (115) (170) (109)
Net (decrease) increase during the period (225) 55 (61)
------------ ------------ ------------
Balance, end of period (340) (115) (170)
------------ ------------ ------------
ACCUMULATED OTHER COMPREHENSIVE INCOME,
NET OF DEFERRED INCOME TAXES:
Balance, beginning of period 113,880 72,846 (16,701)
Net increase during the period 107,662 41,034 89,547
------------ ------------ ------------
Balance, end of period 221,542 113,880 72,846
------------ ------------ ------------
RETAINED EARNINGS:
Balance, beginning of period 1,336,404 1,250,313 1,074,941
Net income 231,303 99,018 186,380
Dividends declared ( $0.32 per share in 2002, $0.28 per
share in 2001 and $0.24 per share in 2000) (16,347) (12,927) (11,008)
------------ ------------ ------------
Balance, end of period 1,551,360 1,336,404 1,250,313
------------ ------------ ------------
TREASURY SHARES AT COST:
Balance, beginning of period (55) (55) (122,070)
Retirement of treasury shares during the period - - 138,399
Treasury shares acquired during the period (22,895) - (16,426)
Treasury shares reissued during the period - - 42
------------ ------------ ------------
Balance, end of period (22,950) (55) (55)
------------ ------------ ------------
TOTAL SHAREHOLDERS' EQUITY, END OF PERIOD $ 2,368,646 $ 1,720,522 $ 1,583,352
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
EVEREST RE GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Twelve Months Ended December 31,
-------------------------------------------
2002 2001 2000
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 231,303 $ 99,018 $ 186,380
Adjustments to reconcile
net income to net cash provided by
operating activities net of effects
from the purchase of subsidiaries:
(Increase) in premiums receivable (196,940) (76,342) (102,802)
Decrease in funds held by reinsureds, net 112,906 167,593 29,135
(Increase) in reinsurance receivables (201,644) (388,131) (69,160)
Decrease (increase) in deferred tax asset 5,713 (27,226) (16,248)
Increase in reserve for losses and loss
adjustment expenses 564,029 509,629 1,257
(Decrease) increase in future policy benefit reserve (10,828) 32,164 -
Increase in unearned premiums 380,150 89,064 95,076
(Increase) in other assets and liabilities (191,043) (13,760) (22,780)
Non cash compensation (benefit) expense (225) 55 (61)
Accrual of bond discount/amortization of bond premium (7,503) (8,494) (10,138)
Amortization of underwriting discount on senior notes 167 152 112
Realized capital losses (gains) 50,043 22,312 (807)
---------- ---------- ----------
Net cash provided by operating activities 736,128 406,034 89,964
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from fixed maturities matured/called -
available for sale 663,088 454,389 191,850
Proceeds from fixed maturities sold -
available for sale 2,029,129 757,825 764,432
Proceeds from equity securities sold 19,940 33,373 50,259
Proceeds from other invested assets sold 4,017 305 -
Cost of fixed maturities acquired - available for sale (3,877,205) (1,699,010) (1,762,183)
Cost of equity securities acquired (9,788) (64,267) (3,380)
Cost of other invested assets acquired (24,614) (4,121) (1,698)
Net (purchases) sales of short-term securities (18,100) 244,509 (256,421)
Net increase (decrease) in unsettled
securities transactions 105,958 1,832 (955)
Payment for purchase of subsidiaries,
net of cash acquired - - 340,130
---------- ---------- ----------
Net cash (used in) investing activities (1,107,575) (275,165) (677,966)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Acquisition of treasury shares net of reissuances (22,895) - (16,533)
Common shares issued during the period 348,626 9,990 7,545
Dividends paid to shareholders (16,347) (12,927) (11,008)
Proceeds from issuance of senior notes - - 448,507
Proceeds from trust preferred securities 210,000 - -
Borrowing on revolving credit agreement 45,000 22,000 176,000
Repayments on revolving credit agreement (80,000) (152,000) -
---------- ---------- ----------
Net cash provided by (used in) financing activities 484,384 (132,937) 604,511
---------- ---------- ----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 24,015 (2,877) (1,913)
---------- --------- ----------
Net increase (decrease) in cash 136,952 (4,945) 14,596
Cash, beginning of period 71,878 76,823 62,227
---------- ---------- ----------
Cash, end of period $ 208,830 $ 71,878 $ 76,823
========== ========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION
CASH TRANSACTIONS:
Income taxes paid, net $ 9,993 $ 24,923 $ 63,682
Interest paid $ 42,805 $ 46,120 $ 27,169
NON-CASH OPERATING/INVESTING TRANSACTION:
Shares received from demutualization $ - $ 25,921 $ -
NON-CASH FINANCING TRANSACTION:
Issuance of common shares $ (225) $ 55 $ (61)
In the quarter ended December 31, 2000, the Company purchased all of the capital
stock of AFC Re, Ltd. for $16,573. In conjunction with the acquisition, the fair
value of assets acquired was $231,874 and liabilities assumed was $215,301.
In the quarter ended September 30, 2000, the Company purchased all of the
capital stock of Mt. McKinley Insurance Company for $51,800. In conjunction with
the acquisition, the fair value of assets acquired was $679,672 and liabilities
assumed was $627,872.
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
EVEREST RE GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BUSINESS AND BASIS OF PRESENTATION
Everest Re Group, Ltd. ("Group"), a Bermuda company with its principal executive
office in Barbados, was established as a wholly-owned subsidiary of Everest
Reinsurance Holdings, Inc. ("Holdings"). On February 24, 2000, a corporate
restructuring was completed and Group became the new parent holding company of
Holdings. Holders of shares of common stock of Holdings automatically became
holders of the same number of common shares of Group. Prior to the
restructuring, Group had no significant assets or capitalization and had not
engaged in any business or prior activities other than in connection with the
restructuring. Group, through its subsidiaries, principally provides reinsurance
and insurance in the United States, Bermuda and international markets. As used
in this document, the "Company" means Group and its subsidiaries, except when
referring to periods prior to February 24, 2000, when it means Holdings and its
subsidiaries.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles in the United States of
America. The statements include the following domestic and foreign direct and
indirect subsidiaries of Group: Holdings, Everest Reinsurance (Bermuda), Ltd.
("Bermuda Re"), Everest Re Capital Trust ("Capital Trust"), Everest
International Reinsurance, Ltd. ("Everest International"), formerly AFC Re Ltd.,
Mt. McKinley Insurance Company ("Mt. McKinley"), formerly Gibraltar Casualty
Company, Everest Global Services, Inc. ("Global Services"), Everest Advisors
(Ireland) Limited, Everest Re Advisors, Ltd., Everest Reinsurance Company
("Everest Re"), Everest National Insurance Company ("Everest National"), Everest
Indemnity Insurance Company ("Everest Indemnity"), Everest Re Holdings, Ltd.
("Everest Ltd."), Everest Security Insurance Company ("Everest Security"),
formerly Southeastern Security Insurance Company, Everest Insurance Company of
Canada ("Everest Canada"), Mt. McKinley Managers, L.L.C. ("Managers"), Workcare
Southeast, Inc. ("Workcare Southeast"), Workcare Southeast of Georgia, Inc.
("Workcare Georgia") and Workcare, Inc. All amounts are reported in U.S.
dollars.
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities (and disclosure of contingent assets and liabilities) at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
B. INVESTMENTS
Fixed maturity investments are all classified as available for sale. Unrealized
appreciation and depreciation, as a result of temporary changes in market value
during the period, are reflected in shareholders' equity, net of income taxes in
"accumulated other comprehensive income". Equity securities are carried at
market value with unrealized appreciation or depreciation, as a result of
temporary changes in market value during the period, are reflected in
shareholders' equity, net of income taxes in "accumulated other comprehensive
income". Unrealized losses on fixed maturities and equity securities, which are
deemed other than temporary, are charged to net income as realized capital
losses. Short-term investments are stated at cost, which approximates market
value. Realized gains or losses on sale of investments are determined on the
basis of identified cost. For non-publicly traded securities, market prices are
determined through the use of pricing models that evaluate securities relative
to the U.S. Treasury yield curve, taking into account the issue type, credit
quality and cash flow characteristics of each security. For publicly traded
securities, market value is based on quoted market prices. Retrospective
F-7
adjustments are employed to recalculate the values of loan-backed and
asset-backed securities. Each acquisition lot is reviewed to recalculate the
effective yield. The recalculated effective yield is used to derive a book value
as if the new yield were applied at the time of acquisition. Outstanding
principal factors from the time of acquisition to the adjustment date are used
to calculate the prepayment history for all applicable securities. Conditional
prepayment rates, computed with life to date factor histories and weighted
average maturities, are used to affect the calculation of projected and
prepayments for pass through security types. Other invested assets include
limited partnerships and rabbi trusts. Limited partnerships are valued pursuant
to the equity method of accounting, which management believes approximates
market value. The Supplemental Retirement Plan rabbi trust is carried at market
value, while the Deferred Compensation Plan rabbi trust and Supplemental Savings
Plan rabbi trust are carried at cost, which approximates market value. Cash
includes cash and bank time deposits with original maturities of ninety days or
less.
C. UNCOLLECTIBLE REINSURANCE BALANCES
The Company provides reserves for uncollectible reinsurance balances based on
management's assessment of the collectibility of the outstanding balances. Such
reserves were $31.6 million at December 31, 2002 and $34.4 million at December
31, 2001. See also Note 10.
D. DEFERRED ACQUISITION COSTS
Acquisition costs, consisting principally of commissions and brokerage expenses
and certain premium taxes and fees associated with the Company's reinsurance and
insurance business incurred at the time a contract or policy is issued, are
deferred and amortized over the period in which the related premiums are earned,
generally one year. Deferred acquisition costs are limited to their estimated
realizable value based on the related unearned premiums, anticipated claims and
claim expenses and anticipated investment income. Deferred acquisition costs
amortized to income were $551.8 million, $396.8 million and $272.4 million in
2002, 2001 and 2000, respectively.
The present value of in force annuity business is included in deferred
acquisition costs. This value is amortized over the expected life of the
business at the time of acquisition. The amortization each year will be a
function of the gross profits each year in relation to the total gross profits
expected over the life of the business, discounted at an assumed net credit
rate.
E. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for losses and loss adjustment expenses ("LAE") is based on
individual case estimates and reports received from ceding companies. A
provision is included for losses and LAE incurred but not reported ("IBNR")
based on past experience. A provision is also included for certain potential
liabilities relating to asbestos and environmental exposures, which liabilities
cannot be estimated with traditional reserving techniques. See also Note 3. The
reserves are reviewed continually and any changes in estimates are reflected in
earnings in the period the adjustment is made. Management believes that adequate
provision has been made for the Company's losses and LAE. Loss and LAE reserves
are presented gross of reinsurance receivables and incurred losses and LAE are
presented net of ceded reinsurance.
Accruals for contingent commission liabilities are established for reinsurance
contracts that provide for the stated commission percentage to increase or
decrease based on the loss experience of the contract. Changes in the estimated
liability for such arrangements are recorded as contingent commissions. Accruals
F-8
for contingent commission liabilities are determined through the review of the
contracts that have these adjustable features and are estimated based on
expected loss and loss adjustment expenses.
F. FUTURE POLICY BENEFIT RESERVE
Liabilities for future policy benefits on annuity policies are carried at their
accumulated values. Reserves for policy benefits include both mortality and
morbidity claims in the process of settlement and claims that have been incurred
but not yet reported. Interest rate assumptions used to estimate liabilities for
policy benefits range from 4.5% to 6.4%. Actual experience in a particular
period may vary.
G. PREMIUM REVENUES
Premiums written are earned ratably over the periods of the related insurance
and reinsurance contracts or policies. Unearned premium reserves are established
to cover the remainder of the unexpired contract period. Such reserves are
established based upon reports received from ceding companies or computed using
pro rata methods based on statistical data. Written and earned premiums, and the
related costs, which have not yet been reported to the Company are estimated and
accrued. Premiums are net of ceded reinsurance.
Annuity premiums are recognized as revenue over the premium-paying period of the
policies.
H. INCOME TAXES
Holdings and its wholly-owned subsidiaries file a consolidated U.S. federal
income tax return. Group and its other subsidiaries, not included in Holdings'
consolidated tax return, file separate company U.S. federal income tax returns,
where required. Deferred income taxes have been recorded to recognize the tax
effect of temporary differences between the financial reporting and income tax
bases of assets and liabilities.
I. FOREIGN CURRENCY TRANSLATION
Assets and liabilities relating to foreign operations are translated into U.S.
dollars at the exchange rates in effect at the balance sheet date; revenues and
expenses are translated into U.S. dollars using average exchange rates. Gains
and losses resulting from translating foreign currency financial statements, net
of deferred income taxes, are excluded from net income and accumulated in
shareholders' equity.
J. EARNINGS PER SHARE
Basic earnings per share are calculated by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share reflects
the potential dilution that could occur if options granted under various
stock-based compensation plans were exercised resulting in the issuance of
common shares that then shared in the earnings of the entity. See also Note 15.
Net income per common share has been computed below, based upon weighted average
common and dilutive shares outstanding.
F-9
(dollar values in thousands, except per share
amounts) 2002 2001 2000
-------- -------- --------
Net income (numerator) $231,303 $ 99,018 $186,380
======== ======== ========
Weighted average common and effect of
dilutive shares used in the computation of
net income per share:
Weighted average shares outstanding -
basic (denominator) 50,325 46,174 45,873
Effect of dilutive shares 814 940 485
-------- -------- --------
Weighted average shares outstanding -
diluted (denominator) 51,139 47,114 46,358
======== ======== ========
Net income per common share:
Basic $ 4.60 $ 2.14 $ 4.06
Diluted $ 4.52 $ 2.10 $ 4.02
Options to purchase 212,000 common shares at prices ranging from $63.31 to
$70.18 per share and 15,000 common shares at prices ranging from $46.09 to
$64.97 per share were outstanding at the end of 2002 and 2000, respectively, but
were not included in the computation of earnings per diluted share for the
respective years because the options' exercise price was greater than the
average market price of the common shares at the end of such years. All options
to purchase common shares at the end of 2001 were included in the computation of
earnings per diluted share because the average market price of the common shares
was greater than the options' exercise price at the end of 2001. The options
expire on or between October 6, 2005 and September 26, 2012.
K. UNUSUAL LOSS EVENTS IN 2001
As a result of the terrorist attacks at the World Trade Center, the Pentagon and
on various airlines on September 11, 2001 (collectively the "September 11
attacks"), the Company incurred pre-tax losses, based on an estimate of ultimate
exposure developed through a review of its coverages, which totaled $213.2
million gross of reinsurance and $55.0 million net of reinsurance. Associated
with this reinsurance were $60.0 million of pre-tax charges, predominantly from
adjustment premiums, resulting in a total pre-tax loss from the September 11
attacks of $115.0 million. After tax recoveries relating specifically to this
unusual loss event, the net loss from the September 11 attacks totaled $75.0
million. Over 90% of the losses ceded were to treaties, where the reinsurers'
obligations are secured, which the Company believes eliminates material
reinsurance collection risk.
As a result of the Enron bankruptcy in 2001, the Company incurred losses,
after-tax and net of reinsurance, amounting to $25.0 million. This unusual loss
reflects all of the Company's exposures to this event, including underwriting,
credit and investment.
L. ACQUISITIONS
On September 19, 2000, Holdings acquired Mt. McKinley, f/k/a Gibraltar Casualty
Company, for $51.8 million. Mt. McKinley is a run-off property and casualty
insurer in the United States. No goodwill was generated in the transaction. The
acquisition was recorded using the purchase method of accounting. Accordingly,
the December 31, 2000 consolidated financial statements of the Company include
the results of Mt. McKinley from September 19, 2000.
F-10
In connection with the acquisition of Mt. McKinley, Prudential Property and
Casualty Insurance Company ("Prupac"), a subsidiary of The Prudential Insurance
Company of America ("The Prudential"), provided reinsurance to Mt. McKinley
covering 80% ($160.0 million) of the first $200.0 million of any adverse
development of Mt. McKinley's reserves as of September 19, 2000 and The
Prudential guaranteed Prupac's obligation to Mt. McKinley. The stop loss
reinsurance protection that was provided by Mt. McKinley at the time of the
Company's initial public offering and other reinsurance contracts between Mt.
McKinley and Everest Re remain in effect following the acquisition. However,
these contracts became transactions with affiliates effective on the date of the
Mt. McKinley acquisition, and their financial impact is thereafter eliminated in
consolidation. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered
into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley
transferred, for what management believes to be arm's-length consideration, all
of its net insurance exposures and reserves to Bermuda Re.
The following unaudited pro forma information assumes the acquisition of Mt.
McKinley occurred at the beginning of the year presented. The unaudited pro
forma financial information is presented for informational purposes only and is
not necessarily indicative of the operating results that would have occurred had
the acquisition been consummated at the beginning of the year presented, nor is
it necessarily indicative of future operating results.
Years ended December 31,
------------------------
2000
(dollars in thousands, except per share amounts) (Unaudited)
------------------------
Revenues $ 1,499,490
Net income $ 188,964
Basic earnings per share $ 4.12
Diluted earnings per share $ 4.08
The Company also completed two additional acquisitions during 2000, Everest
Security, a United States property and casualty company, whose primary business
is non-standard auto and Everest International, a Bermuda based life and annuity
company. The combined purchase price of the acquisitions was approximately $27.0
million. Goodwill of $3.0 million and $0.0 million for Everest Security and
Everest International, respectively, was generated as a result of these
acquisitions and both were recorded using the purchase method of accounting.
M. SEGMENTATION
The Company, through its subsidiaries, operates in five segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda.
See also Note 17.
N. CODIFICATION
The NAIC published a codification of statutory accounting principles, which was
adopted by the states of domicile of the Company's U.S. operating subsidiaries
with an effective date of January 1, 2001. On January 1, 2001, significant
changes to the statutory-basis of accounting became effective. The cumulative
effect of these changes was recorded as a direct adjustment to statutory
surplus. See also Note 13C.
F-11
O. DERIVATIVES
The Company has in its product portfolio three credit default swaps, which it no
longer offers, and five specialized equity put options. These products meet the
definition of a derivative under Statement of Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133").
The Company's position in these contracts is unhedged and is accounted for as a
derivative in accordance with FAS 133. Accordingly, these contracts are carried
at fair value and are recorded in "Other liabilities" in the statement of
financial position and changes in fair value are recorded in the statement of
operations.
P. DEPOSIT ASSETS AND LIABILITIES
In the normal course of its operations, the Company enters into contracts that
do not meet the risk transfer provisions of FAS No. 113, "Accounting and
Reporting for Reinsurance of Short Duration and Long Duration Contracts". These
contracts are accounted for using the deposit accounting method. For these
contracts, the Company originally records deposit liabilities for an amount
equivalent to the assets received. Actuarial studies are used to estimate the
final liabilities under these contracts with any change reflected in the
Statement of Operations.
Q. STOCK-BASED EMPLOYEE COMPENSATION
Prior to 2002, the Company accounted for its stock-based employee compensation
plans (See Note 15) under the recognition and measurement provisions of APB
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations. Effective January 1, 2002, the Company adopted the fair value
recognition provisions of FAS No. 123, "Accounting for Stock-Based Compensation,
prospectively to all employee awards granted, modified or settled after January
1, 2002.
Had the compensation cost for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates for awards prior to
January 1, 2002 under those plans consistent with the method of FAS No. 123, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below:
(dollar values in thousands, except per
share amounts) 2002 2001 2000
-------- ------- --------
Net income As reported $231,303 $99,018 $186,380
Pro forma $227,562 $95,011 $181,558
Earnings per share - basic As reported $4.60 $2.14 $4.06
Pro forma $4.52 $2.06 $3.96
Earnings per share - diluted As reported $4.52 $2.10 $4.02
Pro forma $4.45 $2.02 $3.92
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: (i) dividend
yields ranging from 0.5% to 0.9%, (ii) expected volatility ranging from 29.3% to
45.8%, (iii) risk-free interest rates ranging from a low of 3.4% to a high of
7.0% and (iv) expected life of 7.3-7.5 years.
F-12
R. POLICYHOLDER DIVIDENDS
The Company issues certain insurance policies with dividend payment features.
These policyholders share in the operating results of their respective policies
in the form of dividends declared. Dividends to policyholders are accrued during
the period in which the related premiums are earned and are determined based on
the terms of the individual policies.
S. APPLICATION OF NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board issued FAS 142, "Goodwill
and Other Intangible Assets". FAS 142 established new accounting and reporting
standards for acquired goodwill and other intangible assets. It requires that an
entity determine if other intangible assets have an indefinite useful life or a
finite useful life. Goodwill and those intangible assets with indefinite useful
lives are not subject to amortization and must be tested at least annually for
impairment. Those with finite useful lives are subject to amortization and must
be tested annually for impairment. This statement is effective for all fiscal
quarters of all fiscal years beginning after December 15, 2001. The Company
adopted FAS 142 on January 1, 2002. The implementation of this statement has not
had a material impact on the financial position, results of operations or cash
flows of the Company.
F-13
2. INVESTMENTS
The amortized cost, market value, and gross unrealized appreciation and
depreciation of fixed maturity investments and equity securities are presented
in the tables below:
(dollar values in thousands) Amortized Unrealized Unrealized Market
Cost Appreciation Depreciation Value
---------- ------------ ------------ ----------
As of December 31, 2002
Fixed maturities - available for sale
U.S. Treasury securities and obligations
of U.S. government agencies and corporations $ 506,583 $ 10,143 $ 475 $ 516,251
Obligations of U.S. states and political
subdivisions 2,520,597 144,574 2,593 2,662,578
Corporate securities 2,066,060 119,234 31,770 2,153,524
Mortgage-backed securities 839,477 43,038 1,086 881,429
Foreign government securities 312,723 25,152 - 337,875
Foreign corporate securities 215,399 14,273 1,471 228,201
---------- ------------ ------------ ----------
Total fixed maturities $6,460,839 $ 356,414 $ 37,395 $6,779,858
========== ============ ============ ==========
Equity securities $ 56,841 $ 66 $ 9,435 $ 47,473
========== ============ ============ ==========
As of December 31, 2001
Fixed maturities - available for sale
U.S. Treasury securities and obligations
of U.S. government agencies and corporations $ 114,814 $ 5,243 $ 127 $ 119,930
Obligations of U.S. states and political
subdivisions 1,762,867 78,427 2,768 1,838,526
Corporate securities 2,254,674 77,643 39,516 2,292,801
Mortgage-backed securities 701,175 28,260 790 728,645
Foreign government securities 194,920 18,145 123 212,942
Foreign corporate securities 260,410 10,191 1,861 268,740
---------- ------------ ------------ ----------
Total fixed maturities $5,288,860 $ 217,909 $ 45,185 $5,461,584
========== ============ ============ ==========
Equity securities $ 66,357 $ 1,393 $ 439 $ 67,311
========== ============ ============ ==========
F-14
The amortized cost and market value of fixed maturities are shown in the
following table by contractual maturity. Mortgage-backed securities generally
are more likely to be prepaid than other fixed maturities. As the stated
maturity of such securities may not be indicative of actual maturities, the
total for mortgage-backed securities is shown separately.
December 31, 2002
--------------------------
Amortized Market
(dollar values in thousands) Cost Value
---------- ----------
Fixed maturities - available for sale
Due in one year or less $ 74,008 $ 75,821
Due after one year through five years 1,554,004 1,628,579
Due after five years through ten years 1,442,819 1,519,724
Due after ten years 2,550,531 2,674,305
Mortgage-backed securities 839,477 881,429
---------- ----------
Total $6,460,839 $6,779,858
========== ==========
Proceeds from sales of fixed maturity investments during 2002, 2001 and 2000
were $2,029.1 million, $757.8 million and $764.4 million, respectively. Gross
gains of $91.9 million, $19.3 million and $9.3 million and gross losses of
$106.0 million, $46.0 million and $27.8 million were realized on those fixed
maturity sales during 2002, 2001 and 2000, respectively. Proceeds from sales of
equity security investments during 2002, 2001 and 2000 were $19.9 million, $33.3
million and $50.3 million, respectively. Gross gains of $0.9 million, $13.4
million and $21.0 million and gross losses of $0.3 million, $0.1 million and
$1.7 million were realized on those equity sales during 2002, 2001 and 2000,
respectively.
The changes in net unrealized gains (losses) of investments of the Company are
derived from the following sources:
Years Ended December 31,
--------------------------------------
(dollar values in thousands) 2002 2001 2000
--------------------------------------
Increase (decrease) during the period between the
market value and cost of investments carried at
market value, and deferred tax thereon:
Equity securities $(10,323) $(13,197) $(26,318)
Fixed maturities 146,295 70,511 157,560
Other invested assets (32) 20 24
Deferred taxes (31,741) (12,550) (40,288)
-------- -------- --------
Increase in unrealized appreciation, net of
deferred taxes, included in shareholders' equity $104,199 $ 44,784 $ 90,978
======== ======== ========
F-15
The components of net investment income are presented in the table below:
Years Ended December 31,
--------------------------------------
(dollar values in thousands) 2002 2001 2000
--------------------------------------
Fixed maturities $379,062 $ 358,980 $302,094
Equity securities 861 895 1,198
Short-term investments 5,087 7,562 9,968
Other interest income 1,708 4,132 3,145
--------------------------------------
Total gross investment income 386,718 371,569 316,405
--------------------------------------
Interest on funds held 19,205 11,463 11,316
Interest credited to future policy
benefit reserves 14,036 14,557 -
Other investment expenses 2,874 5,108 3,596
--------------------------------------
Total investment expenses 36,115 31,128 14,912
--------------------------------------
Total net investment income $350,603 $ 340,441 $301,493
======================================
The components of realized capital (losses) gains are presented in the table
below:
Years Ended December 31,
--------------------------------------
(dollar values in thousands) 2002 2001 2000
--------------------------------------
Fixed maturities $(50,689) $(35,645) $(18,402)
Equity securities 620 13,326 19,261
Short-term investments 26 6 (52)
--------------------------------------
Total $(50,043) $(22,313) $ 807
======================================
The net realized capital losses for 2002 and 2001 include $101.3 million and
$22.6 million respectively, relating to write-downs in the value of securities
deemed to be impaired on an other than temporary basis.
Securities with a carrying value amount of $424.2 million at December 31, 2002
were on deposit with various state or governmental insurance departments in
compliance with insurance laws.
During 2001, the Company sold five European put options based on the Standard &
Poor's 500 ("S & P 500") index for total consideration, net of commission, of
$16.9 million. These contracts each have a single exercise date with maturities
ranging from 18 to 30 years and strike prices ranging from $1,141.21 to
$1,540.63. No amounts would be payable under these contracts if the S & P 500
index is at or above the strike price on the exercise dates. If the S & P 500
index is lower than the strike price on the applicable exercise date, the amount
due would vary proportionately with the percentage the index was below the
strike price. Based on historical index values and trends, the Company estimates
the probability for each contract of the S & P index being below the strike
price on the exercise date ranges from .78% to 10.64%. The theoretical maximum
payouts under the contracts would occur if on each of the exercise dates the S&P
500 index value were zero. The present value of these theoretical maximum
payouts using a 6% discount factor is $144.1 million.
Since there are no published market values available for these long term index
put options, a Black-Scholes model is used to estimate market value. The factors
used in determining market value are; the S & P 500 index value at the financial
statement date, current interest rates matching the duration of the puts, and
estimated volatility with current market option volatility extrapolated to the
put maturities using historical data. Movements in the mark to model are
reflected through the income statement.
F-16
During 2000, the Company entered into three credit swap derivative contracts
which provide credit default protection on a portfolio of referenced securities.
Due to changing credit market conditions and defaults, the Company recorded net
after-tax losses from these contracts of $3.9 million and $13.7 million in 2002
and 2001, respectively, to reflect them at fair value, with the 2001 losses
principally attributable to the Company's exposure to the Enron bankruptcy. As
of December 31, 2002 and 2001, the remaining maximum after-tax net loss exposure
under these contracts is $3.1 million and $6.6 million, respectively.
The Company's position in these contracts is unhedged and is accounted for as
derivatives in accordance with FAS 133. Accordingly, these contracts are carried
at fair value with changes in fair value recorded in the statement of
operations.
3. RESERVE FOR LOSSES AND LAE
Activity in the reserve for losses and LAE is summarized as follows:
Years Ended December 31,
------------------------------------------
(dollar values in thousands) 2002 2001 2000
---------- ---------- ----------
Reserves at January 1 $4,278,267 $3,786,178 $3,646,992
Less reinsurance recoverables 883,460 488,824 727,780
---------- ---------- ----------
Net balance at January 1 3,394,807 3,297,354 2,919,212
---------- ---------- ----------
Incurred related to:
Current year 1,489,271 1,209,470 876,829
Prior years 140,111 47 7,787
---------- ---------- ----------
Total incurred losses and LAE 1,629,382 1,209,517 884,616
---------- ---------- ----------
Paid related to:
Current year (1) 314,506 393,958 (166,955)
Prior years 892,690 718,106 673,429
---------- ---------- ----------
Total paid losses and LAE 1,207,196 1,112,064 506,474
---------- ---------- ----------
Net balance at December 31 3,816,993 3,394,807 3,297,354
Plus reinsurance recoverables 1,088,589 883,460 488,824
---------- ---------- ----------
Balance at December 31 $4,905,582 $4,278,267 $3,786,178
========== ========== ==========
- -----------
(1) Current year paid losses for 2000 are net of ($483,789) resulting from the
acquisition of Mt. McKinley.
Prior year incurred losses increased by $140.1 million in 2002 and $7.8 million
in 2000. The increase in 2002 was the result of modest reserve strengthening in
select areas, most notably in directors and officers, surety and workers'
compensation lines, and with respect to asbestos exposures, while the increase
in 2000 was the result of normal reserve development inherent in the uncertainty
in establishing loss and LAE reserves, as well as the impact of foreign exchange
rate fluctuations on loss reserves for both periods. See also Note 1L.
F-17
Activity in the reserve for future policy benefits is summarized as follows:
Years Ended December 31,
--------------------------------------
(dollar values in thousands) 2002 2001 2000
-------- -------- --------
Balance at beginning of year $238,753 $206,589 $ -
Liabilities assumed 6,563 42,439 206,589
Adjustments to reserves 8,519 10,802 -
Benefits paid in the current year (25,910) (21,077) -
-------- -------- --------
Balance at end of year $227,925 $238,753 $206,589
======== ======== ========
The Company continues to receive claims under expired contracts which assert
alleged injuries and/or damages relating to or resulting from environmental
pollution and hazardous substances, including asbestos. The Company's asbestos
claims typically involve potential liability for bodily injury from exposure to
asbestos or for property damage resulting from asbestos or products containing
asbestos. The Company's environmental claims typically involve potential
liability for (a) the mitigation or remediation of environmental contamination
or (b) bodily injury or property damages caused by the release of hazardous
substances into the land, air or water.
The Company's reserves include an estimate of the Company's ultimate liability
for asbestos and environmental ("A&E") claims for which ultimate value cannot be
estimated using traditional reserving techniques. There are significant
uncertainties in estimating the amount of the Company's potential losses from
asbestos and environmental claims. Among the complications are: (a) potentially
long waiting periods between exposure and manifestation of any bodily injury or
property damage; (b) difficulty in identifying sources of asbestos or
environmental contamination; (c) difficulty in properly allocating
responsibility and/or liability for asbestos or environmental damage; (d)
changes in underlying laws and judicial interpretation of those laws; (e)
potential for an asbestos or environmental claim to involve many insurance
providers over many policy periods; (f) long reporting delays, both from
insureds to insurance companies and ceding companies to reinsurers; (g)
historical data on asbestos and environmental losses, which is more limited and
variable than historical information on other types of casualty claims; (h)
questions concerning interpretation and application of insurance and reinsurance
coverage; and (i) uncertainty regarding the number and identity of insureds with
potential asbestos or environmental exposure.
With respect to asbestos claims in particular, several additional factors have
emerged recently that further compound the difficulty in estimating the
Company's liability. These developments include: (a) continued growth in the
number of claims filed, in part reflecting a much more aggressive plaintiff bar;
(b) a disproportionate percentage of claims filed by individuals with no
functional injury from asbestos, claims with little to no financial value but
that have increasingly been considered in jury verdicts and settlements; (c) the
growth in the number and significance of bankruptcy filings by companies as a
result of asbestos claims; (d) the growth in claim filings against defendants
formerly regarded as "peripheral"; (e) the concentration of claims in a small
number of states that favor plaintiffs; (f) the growth in the number of claims
that might impact the general liability portion of insurance policies rather
than the product liability portion; (g) responses in which specific courts have
adopted measures to ameliorate the worst procedural abuses; and (h) the
potential that the U. S. Congress or state legislatures may consider legislation
to address the asbestos litigation issue.
Management believes that these uncertainties and factors continue to render
reserves for A&E losses significantly less subject to traditional actuarial
analysis than are reserves for other types of losses. Given these uncertainties,
F-18
management believes that no meaningful range for such ultimate losses can be
established. The Company establishes reserves to the extent that, in the
judgment of management, the facts and prevailing law reflect an exposure for the
Company or its ceding companies. In connection with the acquisition of Mt.
McKinley, which has significant exposure to asbestos and environmental claims,
Prupac, a subsidiary of The Prudential, provided reinsurance to Mt. McKinley
covering 80% ($160.0 million) of the first $200.0 million of any adverse
development of Mt. McKinley's reserves as of September 19, 2000 and The
Prudential guaranteed Prupac's obligations to Mt. McKinley. Through December 31,
2002, cessions under this reinsurance agreement have reduced the available
remaining limits to $81.1 million net of coinsurance. Due to the uncertainties
discussed above, the ultimate losses may vary materially from current loss
reserves and, depending on coverage under the Company's various reinsurance
arrangements, could have a material adverse effect on the Company's future
financial condition, results of operations and cash flows.
The following table shows the development of prior year A&E reserves on both a
gross and net of retrocessional basis for the years ended December 31, 2002,
2001 and 2000:
(dollar values in thousands) 2002 2001 2000
---------------------------------------
Gross basis
Beginning of reserves $644,390 $693,704 $614,236
Incurred losses 95,004 29,673 (5,852)
Paid losses (71,472) (78,987) 85,320
-------- -------- --------
End of period reserves $667,922 $644,390 $693,704
======== ======== ========
Net basis
Beginning of reserves $568,592 $628,535 $365,069
Incurred losses 23,491 5,155 (5,800)
Paid losses (1) (64,621) (65,098) 269,266
-------- -------- --------
End of period reserves $527,462 $568,592 $628,535
======== ======== ========
(1) Reported losses and paid losses for 2000 are net of ($311.3) million and
$311.3 million, respectively, reflecting the establishment of Mt.
McKinley's reserves at the acquisition date. Net paid losses, excluding the
impact of the Mt. McKinley acquisition transaction, were ($42.3) million.
At December 31, 2002, the gross reserves for asbestos and environmental losses
were comprised of $112.5 million representing case reserves reported by ceding
companies, $55.5 million representing additional case reserves established by
the Company on assumed reinsurance claims, $110.5 million representing case
reserves established by the Company on direct excess insurance claims, including
Mt. McKinley, $151.6 million representing case reserves resulting from the
acquisition of Mt. McKinley and $237.8 million representing IBNR reserves.
4. CREDIT LINE
On December 21, 1999, Holdings entered into a three-year senior revolving credit
facility with a syndicate of lenders (the "Credit Facility"). On November 21,
2002, the maturity date of the Credit Facility was extended to December 19,
2003. Wachovia Bank, National Association (formerly First Union National Bank)
is the administrative agent for the Credit Facility. The Credit Facility is used
F-19
for liquidity and general corporate purposes. The Credit Facility provides for
the borrowing of up to $150.0 million with interest at a rate selected by
Holdings equal to either (1) the Base Rate (as defined below) or (2) an adjusted
London InterBank Offered Rate ("LIBOR") plus a margin. The Base Rate is the
higher of the rate of interest established by Wachovia Bank from time to time as
its prime rate or the Federal Funds rate plus 0.5% per annum. On December 18,
2000, the Credit Facility was amended to extend the borrowing limit to $235.0
million for a period of 120 days. This 120-day period expired during the three
months ended March 31, 2001 and the limit reverted to $150.0 million. The amount
of margin and the fees payable for the Credit Facility depend upon Holding's
senior unsecured debt rating. Group has guaranteed Holdings' obligations under
the Credit Facility.
The Credit Facility agreement requires the Company to maintain a debt to capital
ratio of not greater than 0.35 to 1, Holdings to maintain a minimum interest
coverage ratio of 2.5 to 1 and Everest Re to maintain statutory surplus at
$850.0 million plus 25% of future aggregate net income and 25% of future
aggregate capital contributions. As of December 31, 2002, the Company was in
compliance with these requirements.
During the years ended December 31, 2002, 2001 and 2000, Holdings made payments
on the Credit Facility of $80.0 million, $152.0 million and $0.0 million,
respectively. During the years ended December 31, 2002, 2001 and 2000, Holdings
had new Credit Facility borrowings of $45.0 million, $22.0 million and $176.0
million, respectively. As of December 31, 2002 and 2001, Holdings had
outstanding Credit Facility borrowings of $70.0 million and $105.0 million,
respectively. Interest expense incurred in connection with these borrowings was
$3.5 million, $7.1 million and $8.5 million for the years ended December 31,
2002, 2001 and 2000, respectively.
5. SENIOR NOTES
On March 14, 2000, Holdings completed public offerings of $200.0 million
principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million
principal amount of 8.5% senior notes due March 15, 2005. During 2000, the net
proceeds of these offerings and additional funds were distributed by Holdings to
Group. Interest expense incurred in connection with these senior notes was $38.9
million, $38.9 million and $30.9 million for the years ending December 31, 2002,
2001, and 2000, respectively.
6. TRUST PREFERRED SECURITIES
In November 2002, pursuant to a trust agreement between Holdings and JPMorgan
Chase Bank, the property trustee, and Chase Manhattan Bank USA, the Delaware
trustee, Capital Trust completed a public offering of $210.0 million of 7.85%
trust preferred securities, resulting in net proceeds of $203.4 million. The
proceeds of the issuance were used to purchase $210 million of 7.85% junior
subordinated debt securities of Holdings that will be held in trust by the
property trustee for the benefit of the holders of the trust preferred
securities. Holdings used the proceeds from the sale of the junior subordinated
debt for general corporate purposes and made capital contributions to its
operating subsidiaries.
Capital Trust will redeem all of the outstanding trust preferred securities when
the junior subordinated debt securities are paid at maturity on November 15,
2032. Holdings may elect to redeem the junior subordinated debt securities, in
whole or in part, at any time after November 14, 2007. If such an early
redemption occurs, the outstanding trust preferred securities will also be
proportionately redeemed.
Distributions on the trust preferred securities will be cumulative and pay
quarterly in arrears. Distributions relating to the trust preferred securities
for the year ended December 31, 2002 were $2.1 million.
F-20
7. LETTERS OF CREDIT
The Company has arrangements available for the issue of letters of credit, which
letters are generally collateralized by the Company's cash and investments. At
December 31, 2002, $156.5 million of letters of credit were issued and
outstanding under these arrangements, generally supporting reinsurance provided
by the Company's non-U.S. operations. The following table summarizes the
Company's letters of credit as of December 31, 2002. All dollar amounts are in
the thousands.
Year of
Bank Commitment In Use Expiry
- ------------------------------------------------------------------------------------------
Citibank $100,000 $ 25,411 12/31/2003
$ 64,000 12/31/2006
Wachovia $100,000 $ - N/A
Citibank (London) Individual $ 3,208 1/28/2005
$ 1,272 12/31/2005
$ 62,641 12/31/2006
8. OPERATING LEASE AGREEMENTS
The future minimum rental commitments, exclusive of cost escalation clauses, at
December 31, 2002 for all of the Company's operating leases with remaining
non-cancelable terms in excess of one year are as follows:
--------------------------
(dollar values in thousands)
--------------------------
2003 $ 5,518
2004 5,445
2005 4,954
2006 4,849
2007 4,680
Thereafter 15,068
--------------------------
Net commitments $40,514
==========================
All of these leases, the expiration terms of which range from 2004 to 2013, are
for the rental of office space. Rental expense, net of sublease rental income,
was $6.7 million, $5.8 million and $4.5 million for 2002, 2001 and 2000,
respectively.
9. INCOME TAXES
Under current Bermuda law, no income or capital gains taxes are imposed on Group
and its Bermuda subsidiaries. The Minister of Finance of Bermuda has also
assured Group and its Bermuda subsidiaries that, pursuant to The Exempted
Undertakings Tax Protection Act of 1966, they will be exempt until 2016 from any
such taxes imposed in the future. In Barbados, Group is registered as an
external company and licensed as an international business company. This
provides Group with certain tax benefits, including a preferred rate of
F-21
corporation tax on profits and gains in Barbados and exemption from withholding
tax on dividend payments. No tax is imposed on capital gains.
All the income of the U.S. subsidiaries is subject to the applicable federal,
foreign, state and local taxes on corporations. The provision for income taxes
in the consolidated statement of income has been determined by reference to the
individual income of each entity and the respective applicable tax laws. It
reflects the permanent differences between financial and taxable income relevant
to each entity. The significant components of the provision are as follows:
Years Ended December 31,
------------------------------------
(dollar values in thousands) 2002 2001 2000
------- ------- -------
Current tax:
U.S. $12,717 $ (46) $62,941
Foreign 12,317 5,938 (289)
------- ------- -------
Total current tax 25,034 5,892 62,652
Total deferred U.S. tax expense (benefit) 5,707 (14,567) (17,290)
------- ------- -------
Total income tax expense (benefit) $30,741 $(8,675) $45,362
======= ======= =======
The weighted average expected tax provision has been calculated using the
pre-tax income (loss) in each jurisdiction multiplied by that jurisdiction's
applicable statutory tax rate. Reconciliation of the difference between the
provision for income taxes and the expected tax provision at the weighted
average tax rate for the years ended December 31, 2002 and 2001 is provided
below:
Years Ended December 31,
------------------------
(dollar values in thousands) 2002 2001
------- --------
Expected tax provision at weighted average rate $49,354 $ 10,676
Increase (reduction) in taxes resulting from:
Tax exempt income (36,949) (33,039)
Disallowed expenses 5,671 5,310
State taxes, net of federal benefit 750 1,000
Other 11,915 7,378
------- --------
Total income tax (benefit) provision $30,741 $ (8,675)
======= ========
Deferred income taxes reflect the tax effect of the temporary differences
between the value of assets and liabilities for financial statement purposes and
such values as measured by the U.S. tax laws and regulations. The principal
items making up the net deferred income tax asset are as follows:
F-22
December 31,
-------------------------
(dollar values in thousands) 2002 2001
-------- --------
Deferred tax assets:
Reserve for losses and LAE $184,963 $226,532
Unearned premium reserve 46,224 29,765
Foreign currency translation 4,965 6,848
Impairments 7,799 -
Deferred compensation 7,599 -
Capital loss carryforward 371 -
Net operating loss and foreign tax
credit carryforwards 17,956 21,159
Other assets 17,632 -
-------- --------
Total deferred tax assets 287,509 284,304
-------- --------
Deferred tax liabilities:
Deferred acquisition costs 58,638 40,232
Investments 8,019 -
Net unrealized appreciation of
investments 79,357 47,616
Other liabilities 2,319 17,949
-------- --------
Total deferred tax liabilities 148,333 105,797
-------- --------
Net deferred tax assets $139,176 $178,507
======== ========
Management believes that it is more likely than not that the Company will
realize the benefits of its net deferred tax assets and, accordingly, no
valuation allowance has been recorded for the periods presented.
Tax benefits of $0.7 million and $3.4 million related to compensation expense
deductions for stock options exercised in 2002 and 2001, respectively, are
reflected in the change in shareholders' equity in "additional paid in capital".
10. REINSURANCE
The Company utilizes reinsurance agreements to reduce its exposure to large
claims and catastrophic loss occurrences. These agreements provide for recovery
from reinsurers of a portion of losses and loss expenses under certain
circumstances without relieving the insurer of its obligation to the
policyholder. Losses and LAE incurred and earned premiums are after deduction
for reinsurance. In the event reinsurers were unable to meet their obligations
under reinsurance agreements, the Company would not be able to realize the full
value of the reinsurance recoverable balances. The Company may hold partial
collateral, including letters of credit and funds held, under these agreements.
See also Note 1C.
The Company considers the purchase of corporate level retrocessions covering the
potential accumulation of all exposures. For 1999, the Company purchased an
accident year aggregate excess of loss retrocession agreement which provided up
to $175.0 million of coverage if Everest Re's consolidated statutory basis
accident year loss ratio exceeded a loss ratio attachment point provided in the
contract for the 1999 accident year. During 2000 and 2001, the Company ceded
$70.0 million and $105.0 million of losses, respectively, to this cover,
reducing the limit available under the contract to $0.0 million. For 2000, the
Company purchased an accident year aggregate excess of loss retrocession
agreement which provided up to $175.0 million of coverage if Everest Re's
consolidated statutory basis accident year loss ratio exceeded a loss ratio
attachment point provided in the contract for the 2000 accident year. During
2002, the Company ceded $90.0 million of losses to this cover, reducing the
F-23
limit available under the contract to $85.0 million. For 2001, the Company
purchased an accident year aggregate excess of loss retrocession agreement which
provided up to $175.0 million of coverage if Everest Re's consolidated statutory
basis accident year loss ratio exceeded a loss ratio attachment point provided
in the contract for the 2001 accident year. During 2001 and 2002, the Company
ceded $164.0 million and $11.0 million of losses, respectively, to this cover,
reducing the limit available under the contract to $0.0 million.
In addition, the Company has coverage under an aggregate excess of loss
reinsurance agreement provided by Prupac, a wholly-owned subsidiary of The
Prudential, in connection with the Company's acquisition of Mt. McKinley in
September 2000. This agreement covers 80% or $160 million of the first $200
million of any adverse loss reserve development on the carried reserves of Mt.
McKinley at the date of acquisition and reimburses the Company as such losses
are paid by the Company. There were $78.9 million of cessions under this
reinsurance at December 31, 2002, reducing the limit available under the
contract to $81.1 million.
In connection with the Mt. McKinley acquisition, Prupac also provided excess of
loss reinsurance for 100% of the first $8.5 million of loss with respect to
certain of Mt. McKinley's retrocessions and potentially uncollectible
reinsurance coverage. There were $0.0 million and $3.6 million of cessions under
this reinsurance during the periods ending December 31, 2002 and 2001,
respectively, reducing the limit available under the contract to $2.4 million.
Written and earned premiums are comprised of the following:
Years Ended December 31,
---------------------------------------------
(dollar values in thousands) 2002 2001 2000
---------- ---------- ----------
Written premium:
Direct $ 864,335 $ 438,837 $ 224,606
Assumed 1,982,166 1,435,804 1,161,004
Ceded (208,881) (314,499) (166,704)
---------- ---------- ----------
Net written premium $2,637,620 $1,560,142 $1,218,906
========== ========== ==========
Earned premium:
Direct $ 672,823 $ 380,178 $ 139,413
Assumed 1,793,461 1,412,734 1,156,297
Ceded (192,607) (325,435) (121,527)
---------- ---------- ----------
Net earned premium $2,273,677 $1,467,477 $1,174,183
========== ========== ==========
The amounts deducted from losses and LAE incurred for net reinsurance recoveries
were $287.7 million, $486.3 million and $161.6 million for the years ended
December 31, 2002, 2001 and 2000, respectively.
As of December 31, 2002, the Company carried as an asset $1,116.4 million in
reinsurance receivables with respect to losses ceded. Of this amount, $440.0
million, or 39.4%, was receivable from subsidiaries of London Reinsurance Group
("London Life"), $145.0 million, or 13.0%, was receivable from Continental
Insurance Company ("Continental") and $78.9 million, or 7.1%, was receivable
from Prupac. As of December 31, 2001, the Company carried as an asset $895.1
million in reinsurance receivables with respect to losses ceded. Of this amount,
$339.0 million, or 37.9%, was receivable from subsidiaries of London Life and
$145.0 million, or 16.2%, was receivable from Continental. No other
retrocessionaire accounted for more than 5% of the Company's receivables.
F-24
The Company's arrangements with London Life and Continental are managed on a
funds held basis, which means that the Company has not released premium payments
to the retrocessionaire but rather retains such payments to secure obligations
of the retrocessionaire, records them as a liability, credits interest on the
balances and reduces the liability account as payments become due. As of
December 31, 2002, such funds had reduced the Company's net exposure to London
Life to $190.2 million, effectively 100% of which has been secured by letters of
credit, and its exposure to Continental to $60.9 million. As of December 31,
2001, such funds reduced the Company's net exposure to London Life to $158.9
million, 100% of which was secured by letters of credit, and its exposure to
Continental to $67.9 million. Prupac's obligations are guaranteed by The
Prudential.
11. COMPREHENSIVE INCOME
The components of comprehensive income for the periods ending December 31, 2002,
2001 and 2000 are shown in the following table:
(dollar values in thousands) 2002 2001 2000
-------- -------- --------
Net income $231,303 $ 99,018 $186,380
-------- -------- --------
Other comprehensive income, before tax:
Foreign currency translation adjustments 5,346 (5,931) (2,202)
Unrealized gains on securities arising during the
period 85,897 35,021 131,822
Less: reclassification adjustment for
realized losses (gains) included in net
income 50,043 22,313 (807)
-------- -------- --------
Other comprehensive income, before tax
141,286 51,403 128,813
-------- -------- --------
Income tax expense related to items of other
comprehensive income:
Tax expense (benefit) from foreign
currency translation 1,883 (2,181) (771)
Tax expense from unrealized
gains arising during the period 13,146 7,039 40,319
Tax (benefit) expense from realized (losses) gains
included in net income (18,595) (5,511) 282
-------- -------- --------
Income tax expense related to
items of other comprehensive income: 33,624 10,369 39,266
Other comprehensive income, net of tax 107,662 41,034 89,547
-------- -------- --------
Comprehensive income $338,965 $140,052 $275,927
======== ======== ========
F-25
The following table shows the components of the change in accumulated other
comprehensive income for the years ending December 31, 2002 and 2001.
(dollar values in thousands) 2002 2001
-----------------------------------------------------------
Beginning balance of accumulated other
comprehensive income $113,880 $ 72,846
-------- --------
Beginning balance of foreign currency
translation adjustments $ (12,184) $ (8,434)
Current period change in foreign currency
translation adjustments 3,463 3,463 (3,750) (3,750)
--------- -------- -------- --------
Ending balance of foreign currency
translation adjustments (8,721) (12,184)
--------- --------
Beginning balance of unrealized gains on
securities 126,064 81,280
Current period change in unrealized gains
on securities 104,199 104,199 44,784 44,784
--------- -------- -------- --------
Ending balance of unrealized gains on
securities 230,263 126,064
--------- --------
Current period change in accumulated
other comprehensive income 107,662 41,034
-------- --------
Ending balance of accumulated other
comprehensive income $221,542 $113,880
======== ========
12. EMPLOYEE BENEFIT PLANS
A. DEFINED BENEFIT PENSION PLANS
The Company maintains both qualified and non-qualified defined benefit pension
plans for its U.S. employees. Generally, the Company computes the benefits based
on average earnings over a period prescribed by the plans and credited length of
service. The Company was not required to fund contributions to its qualified
defined benefit pension plan for the years ended December 31, 2001 and 2000
because the Company's qualified plan was subject to the full funding limitation
under the Internal Revenue Service guidelines. The Company's non-qualified
defined benefit pension plan, effected in October 1995, provides compensating
pension benefits for participants whose benefits have been curtailed under the
qualified plan due to Internal Revenue Code limitations.
Although not required under Internal Revenue Service guidelines, the Company
contributed $3.2 million and $2.0 million to the qualified, and non-qualified
plans respectively in 2002. The change in the accumulated pension benefit
obligation reflects the net effect of amendments made to the plans during 2002
and 2001. Pension expense for the Company's plans for the years ended December
31, 2002, 2001 and 2000 were $3.6 million, $1.6 million and $1.0 million,
respectively.
F-26
The following table summarizes the status of these plans:
Years Ended December 31,
-----------------------
(dollar values in thousands) 2002 2001
------- -------
Change in projected benefit obligation:
Benefit obligation at beginning of year $31,402 $24,572
Service cost 1,877 1,398
Interest cost 2,376 1,921
Change in accumulated benefit obligation 784
36
Actuarial gain 3,666 3,786
Benefits paid (309) (311)
------- -------
Benefit obligation at end of year 39,796 31,402
------- -------
Change in plan assets:
Fair value of plan assets at beginning of year 20,868 20,200
Actual return on plan assets (2,387) (250)
Actual contributions during the year 5,172 1,229
Benefits paid (309) (311)
------- -------
Fair value of plan assets at end of year 23,344 20,868
------- -------
Funded status (16,453) (10,534)
Unrecognized prior service cost 811 924
Unrecognized net loss 11,738 4,099
------- -------
(Accrued) pension cost $(3,904) $(5,511)
======= =======
Plan assets are comprised of shares in investment trusts with approximately 77%
and 23% of the underlying assets consisting of equity securities and fixed
maturities, respectively.
Net periodic pension cost included the following components:
Years Ended December 31,
--------------------------------------
(dollar values in thousands) 2002 2001 2000
------- ------- -------
Service cost $ 1,877 $ 1,397 $ 1,351
Interest cost 2,376 1,921 1,628
Expected return on assets (1,861) (1,905) (1,915)
Amortization of net loss (gain) from earlier periods 275 21 (225)
Amortization of unrecognized prior service cost 898 148 147
------- ------- -------
Net periodic pension cost $ 3,565 $ 1,582 $ 986
======= ======= =======
The weighted average discount rates used to determine the actuarial present
value of the projected benefit obligation for 2002, 2001 and 2000 are 6.75%,
7.0% and 7.5%, respectively. The rate of compensation increase used to determine
the actuarial present value of the projected benefit obligation for 2002, 2001
and 2000 is 4.50%. The expected long-term rate of return on plan assets for
2002, 2001 and 2000 is 9.0%.
The Company also maintains both qualified and non-qualified defined contribution
plans ("Savings Plan" and "Non-Qualified Savings Plan", respectively) covering
U.S. employees. Under the plans, the Company contributes up to a maximum 3% of
F-27
the participants' compensation based on the contribution percentage of the
employee. The Non-Qualified Savings Plan provides compensating savings plan
benefits for participants whose benefits have been curtailed under the Savings
Plan due to Internal Revenue Code limitations. The Company's incurred expenses
related to these plans were $0.7 million, $0.6 million and $0.6 million for
2002, 2001 and 2000, respectively.
In addition, the Company maintains several defined contribution pension plans
covering non-U.S. employees. Each non-U.S. office (Canada, London, Belgium, Hong
Kong, Singapore and Bermuda) maintains a separate plan for the non-U.S.
employees working in that location. The Company contributes various amounts
based on salary, age, and/or years of service. The contributions as a percentage
of salary for the branch offices range from 2% to 12%. The contributions are
generally used to purchase pension benefits from local insurance providers. The
Company's incurred expenses related to these plans were $0.4 million, $0.4
million and $0.3 million for 2002, 2001 and 2000, respectively.
B. POST-RETIREMENT PLAN
Beginning January 1, 2002, the Company established the Retiree Health Plan. This
plan provides health care benefits for eligible retired employees (and their
eligible dependants), who have elected coverage to traditional formula. The
Company currently anticipates that most covered employees will become eligible
for these benefits if they retire while working for the Company. The cost of
these benefits is shared with the retiree. The Company accrues the
postretirement benefit expense during the period of the employee's service.
A health care inflation rate of 9.0% in 2002, was assumed to change to 8.0% in
2003; and then decrease one percentage point annually to 5.0% in 2006; and then
remain at that level.
Changes in the assumed health care cost trend can have a significant effect on
the amounts reported for the health care plans. A one percent change in the rate
would have the following effects on:
Percentage Percentage
(Dollars in thousands) Point Increase Point Decrease
----------------------------------------
a. Effect on total service and $148 ($114)
interest cost components
b. Effect on accumulated
postretirement $952 ($745)
Benefit expense for this plan for the year ended December 31, 2002 was $0.6
million.
F-28
The following table summarizes the status of these plans:
Years Ended December 31,
------------------------
(dollar values in thousands) 2002 2001
------- ----
Change in projected benefit obligation:
Benefit obligation at beginning of year $ - $ -
Accrual for Retiree Health Plan 3,888 -
Service cost 327
Interest cost 294 -
Actuarial gain (208) -
Benefits paid (29) -
------- ----
Benefit obligation at end of year 4,272 -
------- ----
Funded status (4,271) -
Unrecognized net loss (208) -
------- ----
(Accrued) cost $(4,479) $ -
======= ====
Net periodic cost included the following components:
Years Ended December 31,
-----------------------------
(dollar values in thousands) 2002 2001 2000
----- ---- ----
Service cost $ 327 $ - $ -
Interest cost 294 - -
----- ---- ----
Net periodic cost $ 621 $ - $ -
===== ==== ====
13. DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION
A. DIVIDEND RESTRICTIONS
Under Bermuda law, Group is prohibited from declaring or paying a dividend if
such payment would reduce the realizable value of its assets to an amount less
than the aggregate value of its liabilities and its issued share capital and
share premium (additional paid-in capital) accounts. Group's ability to pay
dividends and its operating expenses is dependent upon dividends from its
subsidiaries. The payment of such dividends by insurer subsidiaries is limited
under Bermuda law and the laws of the various U.S. states in which Group's
insurance and reinsurance subsidiaries are licensed to transact business. The
limitations are generally based upon net income and compliance with applicable
policyholders' surplus or minimum solvency margin and liquidity ratio
requirements as determined in accordance with the relevant statutory accounting
practices.
Under Bermuda law, Bermuda Re is prohibited from declaring or making payment of
a dividend if it fails to meet its minimum solvency margin or minimum liquidity
ratio. As a long-term insurer, Bermuda Re is also unable to declare or pay a
dividend to anyone who is not a policyholder unless, after payment of the
dividend, the value of the assets in its long-term business fund, as certified
by its approved actuary, exceeds its liabilities for long-term business by at
least the $250,000 minimum solvency margin. Prior approval of the Bermuda
Monetary Authority is required if Bermuda Re's dividend payments would reduce
its prior year-end total statutory capital by 15.0% or more.
F-29
Delaware law provides that an insurance company which is either an insurance
holding company or a member of an insurance holding system and is domiciled in
the state shall not pay dividends without giving prior notice to the Insurance
Commissioner of Delaware and may not pay dividends without the approval of the
Insurance Commissioner if the value of the proposed dividend, together with all
other dividends and distributions made in the preceding twelve months, exceeds
the greater of (1) 10% of statutory surplus or (2) net income, not including
realized capital gains, each as reported in the prior year's statutory annual
statement. In addition, no dividend may be paid in excess of unassigned earned
surplus. At December 31, 2002, Everest Re had $149.4 million available for
payment of dividends in 2003 without prior regulatory approval.
B. STATUTORY FINANCIAL INFORMATION
Everest Re prepares its statutory financial statements in accordance with
accounting practices prescribed or permitted by the National Association of
Insurance Commissioners ("NAIC") and the Delaware Insurance Department.
Prescribed statutory accounting practices are set forth in the NAIC Accounting
Practices and Procedures Manual. The capital and statutory surplus of Everest Re
was $1,494.0 million (unaudited) and $1,293.8 million at December 31, 2002 and
2001, respectively. The statutory net income of Everest Re was $77.6 million
(unaudited), $78.9 million and $165.3 million for the years ended December 31,
2002, 2001 and 2000, respectively.
Bermuda Re prepares its statutory financial statements in conformity with the
accounting principles set forth in Bermuda in The Insurance Act 1978, amendments
thereto and Related Regulations. The statutory capital and surplus of Bermuda Re
was $931.9 million (unaudited) and $451.9 million at December 31, 2002 and 2001,
respectively. The statutory net income of Bermuda Re was $88.1 million
(unaudited), $46.2 million and $21.2 million for the years ended December 31,
2002, 2001, and 2000 respectively.
C. CODIFICATION
The Company's U.S. insurance subsidiaries file statutory-basis financial
statements with the state departments of insurance in the states in which the
subsidiary is licensed. On January 1, 2001, significant changes to the
statutory-basis of accounting became effective. The cumulative effect of these
changes has been recorded as a direct adjustment to statutory surplus. The
cumulative effect of these changes in 2001 increased Everest Re's statutory
surplus by $57.1 million.
14. CONTINGENCIES
In the ordinary course of business, the Company is involved in lawsuits,
arbitrations and other formal and informal dispute resolution procedures, the
outcomes of which will determine the Company's rights and obligations under
insurance and reinsurance agreements and other more general contracts. In some
disputes, the Company seeks to enforce its rights under an agreement or to
collect funds owing to it. In other matters, the Company is resisting attempts
by others to collect funds or enforce alleged rights. Such disputes are resolved
through formal and informal means, including litigation and arbitration.
In all such matters, the Company believes that its positions are legally and
commercially reasonable. The Company also regularly evaluates those positions,
and where appropriate, establishes or adjusts insurance reserves to reflects its
F-30
evaluation. The Company's aggregate reserves take into account the possibility
that the Company may not ultimately prevail in each and every disputed matter.
The Company believes its aggregate reserves reduce the potential that an adverse
resolution of one or more of these matters, at any point in time, would have a
material impact on the Company's financial condition or results of operations.
However, there can be no assurances that adverse resolutions of such matters in
any one period or in the aggregate will not result in a material adverse effect
on the Company's results of operations.
The Company does not believe that there are any other material pending legal
proceedings to which it or any of its subsidiaries or their properties are
subject.
The Prudential sells annuities which are purchased by property and casualty
insurance companies to settle certain types of claim liabilities. In 1993 and
prior years, the Company, for a fee, accepted the claim payment obligation of
these property and casualty insurers, and, concurrently, became the owner of the
annuity or assignee of the annuity proceeds. In these circumstances, the Company
would be liable if The Prudential were unable to make the annuity payments. The
estimated cost to replace all such annuities for which the Company was
contingently liable at December 31, 2002 and 2001 was $150.5 million and $147.1
million, respectively.
The Company has purchased annuities from an unaffiliated life insurance company
with an A+ (Superior) rating from A.M. Best to settle certain claim liabilities
of the Company. Should the life insurance company become unable to make the
annuity payments, the Company would be liable for those claim liabilities. The
estimated cost to replace such annuities at December 31, 2002 and 2001 was $14.8
million and $13.7 million respectively.
15. STOCK BASED COMPENSATION PLANS
The Company has a 2002 Stock Incentive Plan ("2002 Employee Plan"), its 1995
Stock Incentive Plan ("1995 Employee Plan"), its 1995 Stock Option Plan for
Non-Employee Directors ("1995 Director Plan") and Board actions in 2001, 2000
and 1999 which award options to non-employee directors. The Company implemented
FAS No. 123 in 2002, and related interpretations in accounting for these plans
and Board actions. Accordingly, option compensation expense of $0.6 million has
been recognized in the accompanying consolidated financial statements in respect
of stock options granted under the 2002 Employee Plan.
F-31
A summary of the status of the Company's shareholder approved and non-approved
plans as of December 31, 2002, 2001 and 2000 and changes during the years then
ended is presented in the following table:
Compensation Plans Approved by Shareholders:
2002 2001 2000
---------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
Outstanding,
beginning of year 2,038,474 $ 37.52 1,805,749 $ 30.39 1,628,099 $ 30.50
Granted 477,000 55.66 572,800 54.77 439,300 26.68
Exercised 58,850 29.58 236,425 26.08 218,250 23.32
Forfeited 49,100 38.26 103,650 34.63 43,400 32.61
--------- --------- ---------
Outstanding, end of
year 2,407,524 $41.23 2,038,474 $37.52 1,805,749 $30.39
--------- --------- ---------
Options exercisable at
year-end 1,092,879 784,984 697,099
========= ========= =========
Weighted-average fair
value of options
exercisable at
year-end $ 35.72 $ 27.05 $ 13.95
======== ======== ========
The 2002 Employee Plan replaced the 1995 Employee Plan, therefore no further
awards will be granted under the 1995 Employee Plan. Under the 2002 Employee
Plan 4,000,000 common shares have been authorized to be granted as stock
options, stock awards or restricted stock awards to officers and key employees
of the Company. At December 31, 2002, there were 3,528,500 remaining shares
available to be granted under the 2002 Employee Plan. Under the 1995 Director
Plan, a total of 50,000 common shares have been authorized to be granted as
stock options to non-employee directors of the Company. At December 31, 2002,
there were 38,145 remaining shares available to be granted.
F-32
Compensation Plans Not Approved by Shareholders:
2002 2001 2000
--------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Outstanding,
beginning of year 96,000 $ 36.22 56,000 $ 27.80 26,000 $ 30.63
Granted - - 40,000 48.01 30,000 25.34
Exercised - - - - - -
Forfeited - - - - - -
------ ------ ------
Outstanding, end of
year 96,000 $ 36.22 96,000 $ 36.22 56,000 $27.80
------ ------ ------
Options exercisable at
year-end 59,333 27,360 8,684
====== ====== ======
Weighted-average fair
value of options
exercisable at
year-end $ 32.76 $ 28.69 $ 30.63
======== ======== =========
Compensation plans not approved by shareholders refer to Board actions in 2001,
2000 and 1999 which awarded options to non-employee directors. The Board actions
were designed to award non-employee directors with the options to purchase
common stock to increase the ownership interest in the Company of non-employee
directors whose services are considered essential to the Company's continued
progress, to align such interests with those of the shareholders of the Company
and to provide them with a further incentive to serve as directors to the
Company. Under Board actions in 2001, 2000 and 1999 a total of 40,000, 30,000
and 26,000 common shares have been granted as stock options to non-employee
directors of the Company. There were no common shares granted as stock options
to non-employee directors in 2002.
Options granted under the 2002 Employee Plan and the 1995 Employee Plan vest at
20% per year over five years, options granted under the 1995 Director Plan vest
at 50% per year over two years and options granted under the 2001, 2000 and 1999
Board actions vest at 33% per year over three years. All options are exercisable
at fair market value of the stock at the date of grant and expire ten years
after the date of grant. Restricted stock granted under the 2002 Employee Plan
and the 1995 Employee Plan vests, beginning one year after the date of grant, in
equal annual installments over five years.
F-33
The following table summarizes information about stock options outstanding at
December 31, 2002:
Options
Options Outstanding Exercisable
---------------------------------------------------------------------------------
Weighted-
Number Average Weighted- Number Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/02 Contractual Life Exercise Price at 12/31/02 Exercise Price
- --------------------------- ----------- ---------------- -------------- ----------- --------------
$14.04 - $21.05 86,100 2.8 $17.14 86,100 $17.14
$21.05 - $28.07 493,174 6.1 $24.96 281,702 $24.67
$28.07 - $35.09 320,650 6.2 $30.86 193,250 $30.79
$35.09 - $42.11 534,050 5.2 $38.23 464,150 $38.32
$42.11 - $49.13 386,050 8.6 $47.97 84,010 $47.96
$49.13 - $56.14 468,500 9.7 $55.60 - -
$56.14 - $63.16 3,000 6.7 $56.60 - -
$63.16 - $70.18 212,000 8.3 $66.17 43,000 $66.10
----------- -------------- ----------- --------------
2,503,524 7.1 $41.09 1,152,212 $33.88
=========== ============== =========== ==============
In addition to the 2002 Employee Plan, the 1995 Employee Plan and 1995 Director
Plan, Group issued 2,248 common shares in 2002. Group issued 2,604 and 3,732
common shares in 2001 and 2000 respectively, and Holdings issued 1,780 shares of
treasury stock in 2000. These issuances had aggregate values of $145,000,
$179,500 and $179,500 to the Company's non-employee directors as compensation
for their service as directors in 2002, 2001 and 2000, respectively.
Since its 1995 initial public offering, the Company has issued to certain key
employees of the Company 66,100 restricted shares of stock. Upon issuance of
restricted shares, unearned compensation is charged to shareholders' equity for
the cost of the restricted stock and is amortized over the vesting period. The
amount of earned compensation recognized as expense with respect to restricted
stock awards was $339,994, $114,708 and $69,684 for 2002, 2001 and 2000,
respectively. The Company acquired 488 common shares at a cost of $26,882 in
2002 from employees who chose to pay required withholding taxes with shares
exercised under the stock option grants. There were no such transactions in
2001. Also in 2002 and 2001, the Company recorded contributions of paid in
capital in the amount of $0.7 million and $3.4 million, respectively,
representing the tax benefits attributable to the difference between the amount
of compensation expense deductible for tax purposes with respect to the stock
awards and the amount of such compensation expense reflected in the Company's
financial statements.
16. RELATED-PARTY TRANSACTIONS
During the normal course of business, the Company, through its affiliates,
engages in reinsurance and brokerage and commission business transactions, which
management believes to be at arm's-length, with companies controlled by or
affiliated with its outside directors. Such transactions, individually and in
the aggregate, are not material to the Company's financial condition, results of
operations and cash flows.
F-34
17. SEGMENT REPORTING
The Company, through its subsidiaries, operates in five segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda.
The U.S. Reinsurance operation writes property and casualty reinsurance on both
a treaty and facultative basis through reinsurance brokers as well as directly
with ceding companies within the United States. The U.S. Insurance operation
writes property and casualty insurance primarily through general agent
relationships and surplus lines brokers within the United States. The Specialty
Underwriting operation writes accident and health ("A&H"), marine, aviation and
surety business within the United States and worldwide through brokers and
directly with ceding companies. The International operation writes property and
casualty reinsurance through the Company's branches in London, Canada, and
Singapore, in addition to foreign business written through the Company's New
Jersey headquarters and Miami office. The Bermuda operation writes property,
casualty, life and annuity business through brokers and directly with ceding
companies.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments based upon their underwriting gain or
loss ("underwriting results"). The Company utilizes inter-affiliate reinsurance
and such reinsurance does not impact segment results, since business is
generally reported within the segment in which the business was first produced.
Underwriting results include earned premium less losses and LAE incurred,
commission and brokerage expenses and other underwriting expenses. The
accounting policies of the operating segments are generally the same as those
described in Note 1M, Summary of Significant Accounting Policies.
The Company does not maintain separate balance sheet data for its operating
segments. Accordingly, the Company does not review and evaluate the financial
results of its operating segments based upon balance sheet data.
The following tables present the relevant underwriting results for the operating
segments for the three years ended December 31, 2002, 2001 and 2000.
U.S. REINSURANCE
- --------------------------------------------------------------------------------------
(dollar values in thousands) 2002 2001 2000
--------- --------- ---------
Earned premiums $ 726,352 $ 497,600 $ 471,631
Incurred losses and loss adjustment
expenses 535,950 449,635 317,735
Commission and brokerage 182,558 148,807 78,978
Other underwriting expenses 18,876 15,211 17,039
--------- --------- ---------
Underwriting (loss) gain $ (11,032) $(116,053) $ 57,879
========= ========= =========
F-35
U.S. INSURANCE
- --------------------------------------------------------------------------------------
(dollar values in thousands) 2002 2001 2000
--------- --------- ---------
Earned premiums $ 573,081 $ 294,225 $ 101,576
Incurred losses and loss adjustment
expenses 432,917 211,311 70,277
Commission and brokerage 122,806 63,512 25,487
Other underwriting expenses 25,802 19,185 11,646
--------- --------- ---------
Underwriting (loss) gain $ (8,444) $ 217 $ (5,834)
========= ========= =========
SPECIALTY UNDERWRITING
- --------------------------------------------------------------------------------------
(dollar values in thousands) 2002 2001 2000
--------- --------- ---------
Earned premiums $ 459,973 $ 371,805 $ 302,637
Incurred losses and loss adjustment
expenses 313,352 330,841 254,302
Commission and brokerage 130,552 102,144 81,794
Other underwriting expenses 6,363 5,688 6,253
--------- --------- ---------
Underwriting gain (loss) $ 9,706 $ (66,868) $ (39,712)
========= ========= =========
INTERNATIONAL
- --------------------------------------------------------------------------------------
(dollar values in thousands) 2002 2001 2000
--------- --------- ---------
Earned premiums $ 472,542 $ 287,446 $ 286,753
Incurred losses and loss adjustment
expenses 295,349 202,591 235,927
Commission and brokerage 110,160 79,678 81,151
Other underwriting expenses 13,196 13,829 13,798
--------- --------- ---------
Underwriting gain (loss) $ 53,837 $ (8,652) $ (44,123)
========= ========= =========
BERMUDA OPERATIONS
- --------------------------------------------------------------------------------------
(dollar values in thousands) 2002 2001 2000
--------- --------- ---------
Earned premiums $ 41,729 $ 16,401 $ 11,586
Incurred losses and loss adjustment
expenses 51,814 15,139 6,375
Commission and brokerage 5,711 2,656 5,037
Other underwriting expenses 2,493 1,539 868
--------- --------- ---------
Underwriting (loss) $ (18,289) $ (2,933) $ (694)
========= ========= =========
F-36
The following table reconciles the underwriting results for the operating
segments to income before tax as reported in the consolidated statements of
operations and comprehensive income:
(dollar values in thousands) 2002 2001 2000
--------- ---------- ---------
Underwriting gain (loss) $ 25,778 $ (194,289) $ (32,484)
Net investment income 350,603 340,441 301,493
Realized (loss) gain (50,043) (22,313) 807
Net derivative (expense) (14,509) (12,218) -
Corporate expenses (3,186) (3,432) (2,029)
Distributions on trust
preferred securities (2,091) - -
Interest expense (42,417) (46,004) (39,386)
Other (expense) income (2,091) 28,158 3,341
--------- ---------- ---------
Income before taxes $ 262,044 $ 90,343 $ 231,742
========= ========== =========
The Company produces business in its United States, Bermuda and international
operations. The net income and assets of the individual foreign countries in
which the Company writes business are not identifiable in the Company's
financial records. The largest country, other than the United States, in which
the Company writes business is the United Kingdom, with $224.5 million of
written premium for the year ended December 31, 2002. No other country
represented more than 5% of the Company's revenues.
Approximately 15.9%, 13.4% and 12.8% of the Company's gross premiums written in
2002, 2001 and 2000, respectively, were sourced through the Company's largest
intermediary.
F-37
18. UNAUDITED QUARTERLY FINANCIAL DATa
Summarized quarterly financial data were as follows:
(dollar values in thousands, except
per share amounts)
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
2002 Operating data:
Gross written premium $ 596,310 $ 630,055 $ 707,977 $ 912,159
Net written premium 565,016 600,673 660,640 811,291
Earned premium 491,208 502,330 555,600 724,539
Net investment income 85,540 90,830 86,412 87,821
Net realized capital (loss) (3,855) (31,008) (7,680) (7,500)
Total claims and underwriting expenses 487,640 490,221 537,337 735,887
Net income $ 61,061 $ 53,407 $ 61,270 $ 55,565
========= ========= ========= =========
Net income per common share - basic $ 1.27 $ 1.04 $ 1.20 $ 1.09
Net income per common share - diluted $ 1.24 $ 1.02 $ 1.19 $ 1.08
2001 Operating data:
Gross written premium $ 419,429 $ 484,289 $ 501,930 $ 468,993
Net written premium 387,326 418,443 378,825 375,545
Earned premium 328,493 392,797 347,229 398,958
Net investment income 86,155 87,095 83,993 83,198
Net realized capital (loss) gain (5,057) 3,936 (6,525) (14,667)
Total claims and underwriting expenses 338,179 403,568 490,005 433,446
Net income (loss) $ 50,130 $ 57,291 ($ 43,765) $ 35,362
========= ========= ========= =========
Net income (loss) per common
share - basic $ 1.09 $ 1.24 ($ 0.95) $ 0.76
Net income (loss) per common
share - diluted $ 1.07 $ 1.22 ($ 0.95) $ 0.75
F-38
EVEREST RE GROUP, LTD.
SCHEDULE I - SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2002
(Dollars in thousands)
Column A Column B Column C Column D
- ----------------------------------------------------- ----------- ----------- -----------
Amount
Shown in
Market Balance
Cost Value Sheet
----------- ----------- -----------
Fixed maturities-available for sale
Bonds:
U.S. government and government agencies $ 506,583 $ 516,251 $ 516,251
State, municipalities and political subdivisions 2,520,597 2,662,578 2,662,578
Foreign government securities 312,723 337,875 337,875
Foreign corporate securities 215,399 228,201 228,201
Public utilities 161,304 168,286 168,286
All other corporate bonds 1,858,374 1,935,795 1,935,795
Mortgage pass-through securities 839,477 881,429 881,429
Redeemable preferred stock 46,382 49,443 49,443
----------- ----------- -----------
Total fixed maturities-available for sale 6,460,839 6,779,858 6,779,858
Equity securities 56,841 47,473 47,473
Short-term investments 169,116 169,116 169,116
Other invested assets 53,887 53,856 53,856
Cash 208,830 208,830 208,830
----------- ----------- -----------
Total investments and cash $ 6,949,513 $ 7,259,133 $ 7,259,133
=========== =========== ===========
S-1
EVEREST RE GROUP, LTD.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED BALANCE SHEET
(Dollars in thousands, except par value per share)
December 31, December 31,
----------- -----------
2002 2001
----------- -----------
ASSETS
Fixed maturities - available for sale, at market value
(amortized cost: 2002, $127,048; 2001, $133,198) $ 133,203 $ 136,438
Short-term investments 3,678 3,071
Cash 343 541
Investment in subsidiaries, at equity in the underlying net assets 2,229,241 1,578,675
Accrued investment income 1,452 1,873
Receivable from affliate 760 104
Other assets 752 462
----------- -----------
Total assets $ 2,369,429 $ 1,721,164
=========== ===========
LIABILITIES
Due to affiliates $ 541 $ 256
Other liabilities 242 386
----------- -----------
Total liabilities 783 642
----------- -----------
SHAREHOLDERS' EQUITY
Preferred shares, par value: $0.01; 50 million shares authorized;
no shares issued and outstanding - -
Common shares, par value: $0.01; 200 million shares authorized;
50.9 million shares issued in 2002 and 46.3 million shares issued
in 2001 513 463
Paid-in capital 618,521 269,945
Unearned compensation (340) (115)
Accumulated other comprehensive income, net of deferred taxes
of $74.4 million in 2002 and $40.5 million in 2001 221,542 113,880
Treasury shares, at cost; 0.5 million shares in 2002 and 2001 (22,950) (55)
Retained earnings 1,551,360 1,336,404
----------- -----------
Total shareholders' equity 2,368,646 1,720,522
----------- -----------
Total liabilities and shareholders' equity $ 2,369,429 $ 1,721,164
=========== ===========
See notes to consolidated financial statements.
S-2
EVEREST RE GROUP, LTD.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENT OF OPERATIONS
(Dollars in thousands)
For Years Ended December 31,
---------------------------------------------
2002 2001 2000
--------- -------- ---------
REVENUES
Dividends received from subsidiaries $ - $ - $ 495,000
Net investment income 13,570 17,305 8,680
Net realized capital gain/(loss) 1,363 2,453 (17)
Other (expense) (628) (20) -
Equity in undistributed change in retained earnings of subsidiaries 217,909 80,343 (315,283)
--------- -------- ---------
Total revenues 232,214 100,081 188,380
--------- -------- ---------
EXPENSES
Other expenses 904 1,077 500
--------- -------- ---------
Income before taxes 231,310 99,004 187,880
Income tax expense (benefit) 7 (14) 1,500
--------- -------- ---------
Net income $ 231,303 $ 99,018 $ 186,380
========= ======== =========
See notes to consolidated financial statements.
S-3
EVEREST RE GROUP, LTD.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENT OF CASH FLOWS
(Dollars in thousands)
For Years Ended December 31,
----------------------------------------------
2002 2001 2000
----------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 231,303 $ 99,018 $ 186,380
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed change in retained earnings of subsidiaries (217,909) (80,343) 315,283
Increase (decrease) in other liabilities 141 (19) 603
Decrease (increase) in other assets 132 894 (3,229)
(Increase) in receivable from affliates (656) (75) (29)
Accrual of bond discount/amortization of bond premium (252) (665) (1,088)
Realized capital (gains) losses (1,363) (2,453) 17
Non-cash compensation (225) 55 (61)
--------- -------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 11,171 16,412 497,876
--------- -------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Additional investment in subsidiaries (350,000) (119,369) (250,001)
Proceeds from fixed maturities matured/called - available for sale 388,115 189,532 2,701
Cost of fixed maturities acquired - available for sale (380,779) (115,985) (206,229)
Net sales (purchases) of short-term securities (179) 35,180 (37,280)
--------- -------- ---------
NET CASH (USED IN) INVESTING ACTIVITIES (342,843) (10,642) (490,809)
--------- -------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Effect of restructuring - - 14,003
Treasury shares, at cost - - (16,533)
Common shares issued during the period 347,893 6,574 7,545
Dividends paid to shareholders (16,419) (12,927) (11,008)
--------- -------- ---------
Net cash provided by (used in) financing activities 331,474 (6,353) (5,993)
Net (decrease) increase in cash (198) (583) 1,074
Cash, beginning of period 541 1,124 50
--------- -------- ---------
Cash, end of period $ 343 $ 541 $ 1,124
========= ======== =========
See notes to consolidated financial statements.
S-4
EVEREST RE GROUP, LTD.
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
(DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I COLUMN J
- ----------------- --------- ---------- --------- ---------- --------- ---------- --------- -------- ----------
RESERVE FOR INCURRED AMORTIZATION
DEFERRED LOSSES & Loss UNEARNED NET LOSS AND LOSS OF DEFERRED OTHER NET
ACQUISITION ADJUSTMENT PREMIUM EARNED INVESTMENT ADJUSTMENT ACQUISITION OPERATING WRITTEN
GEOGRAPHIC AREA COSTS EXPENSES RESERVES PREMIUM INCOME EXPENSES COSTS EXPENSES PREMIUM
- ----------------- --------- ---------- --------- ---------- --------- ---------- --------- -------- ----------
DECEMBER 31, 2002
Domestic $ 133,824 $3,481,424 $ 702,970 $1,759,406 $ 229,990 $1,282,219 $ 435,916 $ 52,860 $2,026,526
International 27,626 749,836 106,843 472,542 27,932 295,349 110,160 13,196 533,972
Bermuda 45,966 674,322 62,527 41,729 92,681 51,814 5,711 3,860 77,122
--------- ---------- --------- ---------- --------- ---------- --------- -------- ----------
Total $ 207,416 $4,905,582 $ 872,340 $2,273,677 $ 350,603 $1,629,382 $ 551,787 $ 69,916 $2,637,620
========= ========== ========= ========== ========= ========== ========= ======== ==========
DECEMBER 31, 2001
Domestic $ 98,491 $3,072,439 $ 411,224 $1,163,630 $ 231,863 $ 991,787 $ 314,463 $ 42,369 $1,224,117
International 16,457 632,962 61,169 287,446 34,357 202,591 79,678 13,829 311,239
Bermuda 15,761 572,866 16,778 16,401 74,221 15,139 2,656 2,686 24,786
--------- ---------- --------- ---------- --------- ---------- --------- -------- ----------
Total $ 130,709 $4,278,267 $ 489,171 $1,467,477 $ 340,441 $1,209,517 $ 396,797 $ 58,884 $1,560,142
========= ========== ========= ========== ========= ========== ========= ======== ==========
DECEMBER 31, 2000
Domestic $ 875,844 $ 236,079 $ 642,314 $ 186,259 $ 36,467 $ 902,945
International 286,753 35,310 235,927 81,151 13,798 304,375
Bermuda 11,586 30,104 6,375 5,037 1,368 11,586
---------- --------- ---------- --------- -------- ----------
Total $1,174,183 $ 301,493 $ 884,616 $ 272,447 $ 51,633 $1,218,906
========== ========= ========== ========= ======== ==========
S-5
EVEREST RE GROUP, LTD.
SCHEDULE IV - REINSURANCE
(DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- ---------------------------- --------- --------- ----------- ----------- --------
GROSS CEDED TO ASSUMED FROM NET ASSUMED TO
AMOUNT OTHER COMPANIES OTHER COMPANIES AMOUNT NET
--------- --------- ----------- ----------- --------
DECEMBER 31, 2002
Total property and liability
insurance earned premium $ 672,823 $ 192,607 $ 1,793,461 $ 2,273,677 78.9%
DECEMBER 31, 2001
Total property and liability
insurance earned premium $ 380,178 $ 325,435 $ 1,412,734 $ 1,467,477 96.3%
DECEMBER 31, 2000
Total property and liability
insurance earned premium $ 139,413 $ 121,527 $ 1,156,297 $ 1,174,183 98.5%
S-6