Back to GetFilings.com
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________to _______________
Commission File Number 1-15259
PXRE GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda 98-0214719
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Swan Building P.O. Box HM 1282
26 Victoria Street Hamilton HM FX
Hamilton HM 12 Bermuda
Bermuda
(Address, including zip code,
of principal executive offices) (Mailing address)
(441) 296-5858
(Registrant's telephone number, including area code)
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 |_|
As of August 4, 2003 12,173,009 common shares, $1.00 par value per
share, of the Registrant were outstanding.
PXRE GROUP LTD.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002 3
Consolidated Statements of Income and Comprehensive Income for the three
and six months ended June 30, 2003 and 2002 4
Consolidated Statements of Stockholders' Equity for the three and six months
ended June 30, 2003 and 2002 5
Consolidated Statements of Cash Flows for the three and six months ended
June 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 43
Item 4. Controls and Procedures. 43
PART II. OTHER INFORMATION 43
Item 1. Legal Proceedings.
Item 2. Changes in Securities and Use of Proceeds.
Item 3. Defaults Upon Senior Securities.
Item 4. Submission of Matters to a Vote of Security Holders.
Item 5. Other Information.
Item 6. Exhibits and Reports on Form 8-K.
PXRE Consolidated Balance Sheets
Group Ltd. (Dollars in thousands, except par value per share)
- -------------------------------------------------------------------------------
JUNE 30, DECEMBER 31,
2003 2002
---- ----
(Unaudited)
Assets Investments:
Fixed maturities:
Available-for-sale (amortized cost $554,667 and $465,963, respectively) $ 571,265 $ 478,878
Trading (cost $18,323 and $19,521, respectively) 20,976 21,871
Short-term investments 143,766 133,318
Hedge funds (cost $79,448 and $84,915, respectively) 110,757 113,105
Other invested assets (cost $9,833 and $10,522, respectively) 10,968 11,529
----------- -----------
Total investments 857,732 758,701
Cash 101,544 46,630
Accrued investment income 6,535 5,788
Premiums receivable, net 62,897 77,290
Other receivables 31,884 27,052
Reinsurance recoverable on paid losses 24,072 29,653
Reinsurance recoverable on unpaid losses 164,658 207,444
Ceded unearned premiums 7,586 10,496
Deferred acquisition costs 9,427 22,721
Income tax recoverable 6,169 -
Other assets 47,913 51,367
----------- -----------
Total assets $ 1,320,417 $ 1,237,142
=========== ===========
Liabilities Losses and loss expenses $ 442,997 $ 447,829
Unearned premiums 43,447 63,756
Debt payable - 30,000
Reinsurance balances payable 66,502 81,090
Deposit liabilities 69,367 35,149
Income tax payable - 2,486
Payable for securities purchased 37,393 22
Other liabilities 33,342 29,011
----------- -----------
Total liabilities 693,048 689,343
----------- -----------
Minority interest in consolidated subsidiaries:
Company-obligated mandatorily redeemable capital trust
pass-through securities of subsidiary trusts holding solely a
company-guaranteed related subordinated debt 126,838 94,335
----------- ---------
Stockholders' Serial convertible preferred stock, $1.00 par value, $10,000
Equity stated value -- 10 million shares authorized, 0.02 million shares
issued and outstanding 165,504 159,077
Common stock, $1.00 par value -- 50 million shares
authorized, 12.2 million and 12.0 million shares issued
and outstanding, respectively 12,169 12,030
Additional paid-in capital 172,096 168,866
Accumulated other comprehensive income net of deferred income
tax expense of $4,044 and $2,866, respectively 9,834 7,142
Retained earnings 145,256 108,062
Restricted stock at cost (0.3 million and 0.2 million shares, respectively) (4,328) (1,713)
----------- -----------
Total stockholders' equity 500,531 453,464
----------- -----------
Total liabilities and stockholders' equity $ 1,320,417 $ 1,237,142
=========== ============
The accompanying notes are an integral part of these statements.
3
PXRE Consolidated Statements of Income and Comprehensive Income
Group Ltd. (Dollars in thousands, except per share amounts)
- -------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
(Unaudited)
Revenues Net premiums earned $ 84,015 $ 45,763 $168,788 $104,919
Net investment income 8,557 8,445 14,032 12,532
Net realized investment gains 110 514 109 1,003
Fee income 1,108 586 2,384 1,839
-------- -------- -------- --------
93,790 55,308 185,313 120,293
-------- -------- -------- --------
Losses and Losses and loss expenses incurred 44,799 18,863 77,653 36,086
Expenses Commissions and brokerage 14,618 5,276 34,645 17,719
Other operating expenses 9,851 6,223 19,013 15,094
Interest expense 245 754 2,504 1,499
Minority interest in consolidated subsidiaries 2,428 2,199 4,533 4,423
-------- -------- -------- --------
71,941 33,315 138,348 74,821
-------- -------- -------- --------
Income before income taxes 21,849 21,993 46,965 45,472
Income tax provision 371 2,949 1,880 8,196
-------- -------- -------- --------
Net income before preferred stock dividends $ 21,478 $ 19,044 $ 45,085 $ 37,276
-------- -------- -------- --------
Preferred stock dividends 3,245 2,900 6,427 2,900
-------- -------- -------- --------
Net income available to common stockholders $ 18,233 $ 16,144 $ 38,658 $ 34,376
======== ======== ======== ========
Comprehensive Net income before preferred stock dividends $ 21,478 $ 19,044 $ 45,085 $ 37,276
Income, Net Net unrealized appreciation on investments 1,635 5,923 1,746 4,508
of Tax Net unrealized (depreciation) appreciation on cash flow hedge - (140) 946 62
-------- -------- -------- --------
Comprehensive income $ 23,113 $ 24,827 $ 47,777 $ 41,846
======== ======== ======== ========
Per Share Basic:
Net income before preferred stock dividends $ 1.80 $ 1.62 $ 3.79 $ 3.18
Preferred stock dividends (0.27) (0.25) (0.54) (0.25)
-------- -------- -------- --------
Net income available to common stockholders $ 1.53 $ 1.37 $ 3.25 $ 2.93
======== ======== ======== ========
Average shares outstanding (000's) 11,921 11,768 11,911 11,752
======== ======== ======== ========
Diluted:
Net income $ 0.93 $ 0.88 $ 1.96 $ 2.21
======== ======== ======== ========
Average shares outstanding (000's) 23,183 21,655 22,959 16,863
======== ======== ======== ========
The accompanying notes are an integral part of these statements.
4
PXRE Consolidated Statements of Stockholders' Equity
Group Ltd. (Dollars in thousands)
- -------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
(Unaudited)
Preferred Stock Balance at beginning of period $ 162,259 $ - $ 159,077 $ -
Issuance of shares, net - 150,000 - 150,000
Dividends to preferred stockholders 3,245 2,900 6,427 2,900
--------- --------- --------- ---------
Balance at end of period $ 165,504 $ 152,900 $ 165,504 $ 152,900
========= ========= ========= =========
Common Stock Balance at beginning of period $ 12,177 $ 11,944 $ 12,030 $ 11,873
Issuance of shares, net (8) 22 139 93
--------- --------- --------- ---------
Balance at end of period $ 12,169 $ 11,966 $ 12,169 $ 11,966
========= ========= ========= =========
Additional Balance at beginning of period $ 172,271 $ 176,694 $ 168,866 $ 175,405
Paid-in Capital Issuance of shares (201) (8,643) 3,140 (7,336)
Other 26 (17) 90 (35)
--------- --------- --------- ---------
Balance at end of period $ 172,096 $ 168,034 $ 172,096 $ 168,034
========= ========= ========= =========
Accumulated Balance at beginning of period $ 8,198 $ (1,512) $ 7,142 $ (299)
Other Change in unrealized gains 1,636 5,924 1,746 4,509
Comprehensive Change in cash flow hedge - (140) 946 62
Income --------- --------- --------- ---------
Balance at end of period $ 9,834 $ 4,272 $ 9,834 $ 4,272
========= ========= ========= =========
Retained Balance at beginning of period $ 127,755 $ 72,989 $ 108,062 $ 55,473
Earnings Net income before preferred stock dividends 21,478 19,044 45,085 37,276
Dividends to preferred stockholders (3,245) (2,900) (6,427) (2,900)
Dividends to common stockholders (732) (719) (1,464) (1,435)
--------- --------- --------- ---------
Balance at end of period $ 145,256 $ 88,414 $ 145,256 $ 88,414
========= ========= ========= =========
Restricted Stock Balance at beginning of period $ (4,782) $ (2,798) $ (1,713) $ (2,672)
Issuance of restricted stock (764) (237) (4,609) (1,040)
Amortization of restricted stock 1,218 391 1,994 1,068
--------- --------- --------- ---------
Balance at end of period $ (4,328) $ (2,644) $ (4,328) $ (2,644)
========= ========= ========= =========
Total Balance at beginning of period $ 477,878 $ 257,317 $ 453,464 $ 239,780
Stockholders' Issuance of preferred shares - 150,000 - 150,000
Equity Issuance of shares (209) (8,621) 3,279 (7,243)
Restricted stock, net 454 154 (2,615) 28
Unrealized appreciation on investments, net of deferred
income tax 1,636 5,924 1,746 4,509
Unrealized (depreciation) appreciation on cash flow hedge,
net of deferred income tax - (140) 946 62
Net income before preferred stock dividends 21,478 19,044 45,085 37,276
Dividends to common stockholders (732) (719) (1,464) (1,435)
Other 26 (17) 90 (35)
--------- --------- --------- ---------
Balance at end of period $ 500,531 $ 422,942 $ 500,531 $ 422,942
========= ========= ========= =========
The accompanying notes are an integral part of these statements.
5
PXRE Consolidated Statements of Cash Flows
Group Ltd. (Dollars in thousands)
- -------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
---- ---- ---- ----
(Unaudited)
Cash Flow Net income before preferred stock dividends $ 21,478 $ 19,044 $ 45,085 $ 37,276
from Operating Adjustments to reconcile net income to net cash
Activities provided by operating activities:
Losses and loss expenses 5,386 (17,078) (4,831) (28,538)
Unearned premiums (25,971) (25,039) (17,399) 19,430
Deferred acquisition costs 6,221 (1,228) 13,294 (6,413)
Receivables 11,206 16,077 9,561 (7,088)
Reinsurance balances payable (10,093) 5,394 (14,588) 20,081
Reinsurance recoverable 14,916 2,719 48,367 (411)
Income taxes (7,727) (65) (9,742) 7,688
Equity in earnings of limited partnerships (5,472) (3,706) (7,849) (5,407)
Trading portfolio purchased 0 (19,973) (5,688) (19,973)
Trading portfolio disposed 8,496 - 8,496 -
Deposit liability 3,281 16,261 34,218 16,695
Other 9,770 860 8,486 (52)
--------- -------- --------- --------
Net cash provided (used) by operating activities 31,491 (6,734) 107,410 33,288
--------- -------- --------- --------
Cash Flow Fixed maturities available for sale purchased (147,979) (243,445) (151,793) (243,648)
from Investing Fixed maturities available for sale disposed or matured 26,748 9,494 61,910 11,713
Activities Payable for securities 37,138 14,385 37,371 14,292
Net change in short-term investments 74,027 108,805 (10,448) 52,381
Hedge funds purchased (3,000) (26,366) (7,000) (26,366)
Hedge funds disposed 9,005 1,365 16,841 33,154
Other invested assets purchased (16) - (121) -
Other invested assets disposed 660 5,257 1,038 7,715
--------- -------- --------- --------
Net cash used by investing activities (3,417) (130,505) (52,202) (150,759)
--------- -------- --------- --------
Cash Flow Proceeds from issuance of preferred stock - 140,938 - 140,938
from Financing Proceeds from issuance of common stock 256 308 542 1,194
Activities Proceeds from issuance of minority interest in consolidated
subsidiaries 32,500 - 32,500 -
Cash dividends paid to common stockholders (732) (719) (1,464) (1,435)
Repayment of debt (10,000) (10,000) (30,000) (20,000)
Repurchase of minority interest in consolidated subsidiary - (2,187) - (2,967)
Cost of stock repurchased (1,230) (105) (1,872) (558)
--------- -------- --------- --------
Net cash provided (used) by financing activities 20,794 128,235 (294) 117,172
--------- -------- --------- --------
Net change in cash 48,868 (9,004) 54,914 (299)
Cash, beginning of period 52,676 31,593 46,630 22,888
--------- -------- --------- --------
Cash, end of period $ 101,544 $ 22,589 $ 101,544 $ 22,589
========= ======== ========= ========
The accompanying notes are an integral part of these statements.
6
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
1. Significant Accounting Policies
Basis of Presentation and Consolidation
The consolidated financial statements have been prepared in U.S.
dollars in conformity with accounting principles generally accepted ("GAAP") in
the United States of America. These statements reflect the consolidated
operations of PXRE Group Ltd. (the "Company" or collectively with its various
subsidiaries, "PXRE") and its wholly-owned subsidiaries, including PXRE
Corporation ("PXRE Delaware"), PXRE Reinsurance Company ("PXRE Reinsurance"),
PXRE Reinsurance Ltd. ("PXRE Bermuda"), PXRE Reinsurance (Barbados) Ltd. ("PXRE
Barbados"), PXRE Solutions Inc. ("PXRE Solutions"), PXRE Solutions, S.A. ("PXRE
Europe"), Cat Fund L.P., PXRE Capital Trust I, PXRE Capital Statutory Trust II,
PXRE Capital Trust III and PXRE Limited. All material inter-company transactions
have been eliminated in preparing these consolidated financial statements.
GAAP requires management to make estimates and assumptions that affect
the reported amount of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The interim consolidated financial statements are unaudited; however,
in the opinion of management, such consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair statement of the results for the interim periods. These interim statements
should be read in conjunction with the 2002 audited consolidated financial
statements and related notes. The preparation of interim consolidated financial
statements relies significantly upon estimates. Use of such estimates, and the
seasonal nature of the reinsurance business, necessitate caution in drawing
specific conclusions from interim results.
Certain reclassifications have been made for 2002 to conform to the
2003 presentation.
Stock-Based Compensation
At June 30, 2003, PXRE has stock option plans, which are accounted for
under the recognition and measurement principles of the Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. No stock-based compensation cost is reflected in net income, as
all options granted under those plans had an exercise price equal to the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share if PXRE had applied
the fair value recognition provisions of the Financial Accounting Standards
Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation to stock-based employee compensation.
7
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
($000's, except per share data) 2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income before preferred stock dividends:
As reported $ 21,478 $ 19,044 $ 45,085 $ 37,276
Deduct:
Total stock-based compensation expense
determined under fair value based method for
all awards, net of related tax effects (1,345) (608) (1,845) (1,216)
---------- ---------- ---------- ----------
Pro-forma $ 20,133 $ 18,436 $ 43,240 $ 36,060
========== ========== ========== ==========
Basic income per share:
As reported $ 1.53 $ 1.37 $ 3.25 $ 2.93
Pro-forma $ 1.42 $ 1.32 $ 3.09 $ 2.82
Diluted income per share:
As reported $ 0.93 $ 0.88 $ 1.96 $ 2.21
Pro-forma $ 0.87 $ 0.85 $ 1.88 $ 2.14
Debt and Equity Classification
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within the scope of the statement as a liability (or an asset in some
circumstances). For the Company, this statement is effective for the quarter
ending September 30, 2003. As a result of this statement, the Company's
mandatorily redeemable capital trust pass-through securities will be
reclassified on its balance sheet from its current presentation to liabilities,
and the Company will also modify the description used in its Consolidated
Statements of Income and Comprehensive Income for the interest expense related
to these securities from "Minority interest in consolidated subsidiary" to
"Interest expense-trust preferred securities." The adoption of this statement is
not expected to have any effect on PXRE's financial position or results of
operations.
2. Reinsurance
PXRE purchases catastrophe retrocessional coverage for its own
protection, depending on market conditions. PXRE purchases reinsurance primarily
to reduce its exposure to severe losses related to any one event or catastrophe.
The Company currently has many reinsurance treaties in place with several
different coverages, territories, limits and retentions that would serve to
reduce a large gross loss emanating from any one event. In addition, primarily
related to our exposure assumed on per-risk treaties, we purchase clash
reinsurance protection which allows us to recover losses ceded by more than one
reinsured related to any one particular property. In the event that
retrocessionaires are unable to meet their contractual obligations, PXRE would
remain liable for the underlying covered claims. The effects of such
retrocessional coverage on premiums written and earned are as follows:
8
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended Increase Six Months Ended Increase
June 30, (Decrease) June 30, (Decrease)
-------------------------- -------------------------
($000's) 2003 2002 % 2003 2002 %
----------- ----------- -------- ----------- ---------- --------
Premiums written
Gross premiums written $ 66,378 $ 41,791 $ 178,848 $ 167,147
Ceded premiums written (8,333) (21,068) (27,459) (42,763)
----------- ----------- ----------- ----------
Net premiums written $ 58,045 $ 20,723 180 $ 151,389 $ 124,384 22
=========== =========== =========== ==========
Premiums earned
Gross premiums earned $ 100,795 $ 65,693 $ 199,157 $ 143,700
Ceded premiums earned (16,780) (19,930) (30,369) (38,781)
----------- ----------- ----------- ----------
Net premiums earned $ 84,015 $ 45,763 84 $ 168,788 $ 104,919 61
=========== =========== =========== ==========
3. Earnings Per Share
The table below presents the computation of basic and diluted earnings
per share:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
(000's, except per share data) 2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income available to common stockholders:
Income before preferred stock dividends $ 21,478 $ 19,044 $ 45,085 $ 37,276
Preferred stock dividends (3,245) (2,900) (6,427) (2,900)
----------- ----------- ----------- -----------
Net income available to common stockholders $ 18,233 $ 16,144 $ 38,658 $ 34,376
=========== =========== =========== ===========
Weighted average shares of common stock outstanding:
Weighted average shares of common stock outstanding 11,921 11,768 11,911 11,752
Equivalent shares of stock options 236 415 280 319
Equivalent shares of restricted stock 75 136 103 124
Equivalent shares of convertible preferred stock 10,951 9,336 10,665 4,668
----------- ----------- ----------- -----------
Weighted average common equivalent shares (diluted) 23,183 21,655 22,959 16,863
=========== =========== =========== ===========
Per share amounts:
Basic:
Net income before preferred stock dividends $ 1.80 $ 1.62 $ 3.79 $ 3.18
Preferred stock dividends (0.27) (0.25) (0.54) (0.25)
----------- ----------- ----------- -----------
Net income available to common stockholders $ 1.53 $ 1.37 $ 3.25 $ 2.93
=========== =========== =========== ===========
Diluted:
Net income before preferred stock dividends $ 0.93 $ 0.88 $ 1.96 $ 2.21
=========== =========== =========== ===========
9
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
4. Income Taxes
The Company is incorporated under the laws of Bermuda and, under
current Bermuda law, is not obligated to pay any taxes in Bermuda based upon
income or capital gains. The Company has received an undertaking from the
Supervisor of Insurance in Bermuda pursuant to the provisions of the Exempted
Undertakings Tax Protection Act, 1966, which exempts the Company from any
Bermuda taxes computed on profits, income or any capital asset, gain or
appreciation, or any tax in the nature of estate duty or inheritance tax, at
least until the year 2016.
The Company does not consider itself to be engaged in a trade or
business in the United States and accordingly does not expect to be subject to
direct United States income taxation.
The United States subsidiaries of PXRE file a consolidated U.S. federal
income tax return.
5. Stockholders' Equity
On April 4, 2002, the Company raised $150 million of additional capital
through the issuance of 15,000 Convertible Voting Preferred Shares (the
"Preferred Share Investment"). The Preferred Share Investment occurred pursuant
to a Share Purchase Agreement, dated as of December 10, 2001, between the
Company and Capital Z Financial Services Fund II, L.P., Capital Z Financial
Services Private Fund II, L.P., Reservoir Capital Master Fund, L.P., Reservoir
Capital Partners, L.P. and Richard E. Rainwater. The capital infusion from the
Preferred Share Investment is enabling PXRE to increase underwriting capacity
and therefore maximize participation in the hardening reinsurance market
following the September 11, 2001 terrorist attacks. On February 12, 2002, the
stockholders approved the sale and issuance of three series of convertible
preferred shares pursuant to the Share Purchase Agreement, including 7,500
Series A Convertible Preferred Shares, 5,000 Series B Convertible Preferred
Shares, and 2,500 Series C Convertible Preferred Shares. Proceeds, net of
offering expenses of $9.1 million, amounted to $140.9 million.
The Preferred Shares accrue cumulative dividends per share at the rate
per annum of 8% of the sum of the stated value of each share plus any accrued
and unpaid dividend thereon, payable on a quarterly basis. The stockholders also
voted to approve the division of 20 million of PXRE's 50 million authorized
common shares into three new classes of convertible common shares including 10
million Class A Convertible Voting Common Shares ("Class A Common Shares"),
6,666.667 Class B Convertible Voting Common Shares ("Class B Common Shares"),
and 3,333.333 Class C Convertible Voting Common Shares ("Class C Common
Shares").
Preferred shares are convertible into convertible common shares at the
option of the holder at any time equal to the original purchase cost plus
accrued but unpaid dividends at a conversion price subject to adjustment if the
Company experiences adverse loss development in excess of a $7 million after-tax
threshold. As of June 30, 2003, the Company has incurred $15.6 million of net
adverse development above this $7 million threshold resulting in an adjusted
conversion price of $14.64. Preferred shares mandatorily convert on April 4,
2005 for two thirds of the shares issued, and the balance on April 4, 2008.
Preferred shares vote on a fully converted basis on all matters other than the
election of directors.
10
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
6. Segment Information
PXRE operates in four reportable property and casualty reinsurance
segments - catastrophe and risk excess, finite business, other lines and exited
lines - based on PXRE's approach to managing the business. Commencing with the
2002 underwriting renewal season, PXRE returned its focus to its core
catastrophe and risk excess and finite businesses. Businesses that were not
renewed in 2002 are reported as exited lines. In addition, PXRE operates in two
geographic segments - North American representing North American based risks
written by North American based clients and International (principally the
United Kingdom, Continental Europe, Latin America, the Caribbean, Australia and
Asia) representing all other premiums written.
There are no significant differences among the accounting policies of
the segments as compared to PXRE's consolidated financial statements.
PXRE does not maintain separate balance sheet data for each of its
operating segments nor does it allocate net investment income, net realized
investment gains, operating expenses, unrealized foreign exchange gains or
losses and financing costs to these segments. Accordingly, PXRE does not review
and evaluate the financial results of its operating segments based upon balance
sheet data and these other income statement items.
11
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The following tables summarize the net premiums written and earned by
PXRE's business segments:
Net Premiums Written
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
----------------------- ---------------------- ----------------------- -----------------------
($000's) Amount Percent Amount Percent Amount Percent Amount Percent
---------- --------- ---------- ------- ---------- -------- -------- ---------
Catastrophe and Risk
Excess
North American $ 14,770 $ 9,269 $ 30,646 $ 22,029
International 36,987 19,766 115,965 75,604
Excess of Loss
Cessions (480) (6,474) (8,568) (10,904)
--------- --------- --------- ---------
51,277 88% 22,561 109% 138,043 91% 86,729 70%
--------- --------- --------- ---------
Finite Business
North American 3,044 (669) 5,405 29,692
International - - - -
--------- --------- --------- ---------
3,044 5 (669) (3) 5,405 4 29,692 24
--------- --------- --------- ---------
Other Lines
North American 1,542 991 4,086 2,800
International (1) 1 (1) 42
--------- --------- --------- ---------
1,541 3 992 5 4,085 3 2,842 2
--------- --------- --------- ---------
Exited Lines
North American 609 526 905 8,313
International 1,574 (2,687) 2,951 (3,192)
--------- --------- --------- ---------
2,183 4 (2,161) (11) 3,856 2 5,121 4
--------- ---- --------- ---- --------- ---- --------- ----
Total $ 58,045 100% $ 20,723 100% $ 151,389 100% $124,384 100%
========= ==== ========= ==== ========= ==== ======== ====
12
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
Net Premiums Earned
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
----------------------- ---------------------- ----------------------- -----------------------
($000's) Amount Percent Amount Percent Amount Percent Amount Percent
---------- --------- ---------- ------- ---------- -------- -------- ---------
Catastrophe and Risk
Excess
North American $ 16,946 $ 11,509 $ 31,729 $ 21,312
International 55,099 32,722 107,257 64,897
Excess of Loss
Cessions (6,261) (6,193) (12,645) (10,904)
---------- --------- --------- ---------
65,784 78% 38,038 83% 126,341 75% 75,305 72%
---------- --------- --------- ---------
Finite Business
North American 13,364 (260) 34,214 8,314
International - - - -
---------- --------- --------- ---------
13,364 16 (260) (1) 34,214 20 8,314 8
---------- --------- --------- ---------
Other Lines
North American 2,805 1,304 3,947 3,726
International (1) 3 (1) 102
---------- --------- --------- ---------
2,804 3 1,307 3 3,946 2 3,828 4
---------- --------- --------- ---------
Exited Lines
North American 736 3,985 1,531 12,051
International 1,327 2,693 2,756 5,421
---------- --------- --------- ---------
2,063 3 6,678 15 4,287 3 17,472 16
---------- ---- --------- ---- --------- ---- --------- ----
Total $ 84,015 100% $ 45,763 100% $ 168,788 100% $ 104,919 100%
========== ==== ========= ==== ========= ==== ========= ====
13
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The following table summarizes the underwriting income (loss) by
segment:
Underwriting Income (Loss)
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
----------------------- ---------------------- ----------------------- -----------------------
($000's) Amount Percent Amount Percent Amount Percent Amount Percent
---------- --------- ---------- ------- ---------- -------- -------- ---------
Catastrophe and Risk
Excess
North American $ 5,380 $ 10,756 $ 16,666 $ 22,133
International 32,140 19,815 71,266 41,567
Excess of Loss
Cessions (6,063) (2,736) (16,041) (4,405)
--------- --------- --------- ---------
31,457 126% 27,835 121% 71,891 127% 59,295 111%
--------- --------- --------- ---------
Finite Business
North American (1,806) (698) (4,731) 2,167
International - - - -
--------- --------- --------- ---------
(1,806) (7) (698) (3) (4,731) (8) 2,167 4
--------- --------- --------- ---------
Other Lines
North American 109 2,082 476 2,260
International 81 (73) 127 243
--------- --------- --------- ---------
190 1 2,009 9 603 1 2,503 5
--------- --------- --------- ---------
Exited Lines
North American (5,908) (5,108) (8,611) (8,796)
International 1,003 (1,018) (2,433) (1,736)
--------- --------- --------- ---------
(4,905) (20) (6,126) (27) (11,044) (20) (10,532) (20)
--------- ---- --------- ---- --------- ---- --------- ----
Total $ 24,936 100% $ 23,020 100% $ 56,719 100% $ 53,433 100%
========= ==== ========= ==== ========= ==== ========= ====
14
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
The following table reconciles the underwriting income (loss) for the
operating segments to income before income taxes as reported in the Consolidated
Statements of Income and Comprehensive Income:
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ -----------------------------
($000's) 2003 2002 2003 2002
--------------- ------------ ------------- -------------
Net underwriting income $ 24,936 $ 23,020 $ 56,719 $ 53,433
Net investment income 8,557 8,445 14,032 12,532
Net realized investment gains 110 514 109 1,003
Interest expense (245) (754) (2,504) (1,499)
Minority interest in consolidated subsidiaries (2,428) (2,199) (4,533) (4,423)
Other operating expenses (9,851) (6,223) (19,013) (15,094)
Unrealized foreign exchange gains (losses) on
losses incurred 771 (787) 2,176 (422)
Other loss (1) (23) (21) (58)
------------ ------------ ------------ -------------
Income before income taxes $ 21,849 $ 21,993 $ 46,965 $ 45,472
============ ============ ============ =============
7. Minority Interest in Consolidated Subsidiaries
The minority interest in consolidated subsidiaries comprises
Company-obligated mandatorily redeemable capital trust pass-through securities
of subsidiary trusts holding solely a company-guaranteed related subordinated
debt as follows:
June 30, December 31,
($000's) 2003 2002
--------- -------------
$94.8 million 8.85% fixed rate TRUPS(sm) due February 1, 2027 $ 94,338 $ 94,335
$17.5 million 7.35% fixed/floating rate I-PreTS(sm) due May 15, 2033 17,500 -
$15.0 million 9.75% fixed rate InCapS(sm) due May 23, 2033 15,000 -
--------- --------
$ 126,838 $ 94,335
========= ========
The Company has the option to defer interest payments on these
securities, and redeem them earlier than the due dates, subject to limits and
penalties as set out in the relevant indentures. The $94.8 million 8.85% fixed
rate Capital Trust Pass-through Securities (sm) ("TRUPS(sm)") due February 1,
2027 pay interest semi-annually and are redeemable from February 1, 2007 at
104.180% declining to 100.418% at February 1, 2016, and at par thereafter. The
$17.5 million 7.35% fixed/floating rate junior subordinated deferrable interest
capital securities ("I-PreTS(sm)") due May 15, 2033 initially bear interest
payable quarterly at a fixed rate of 7.35% for 5 years and then at a floating
rate of LIBOR + 4.1% reset quarterly thereafter, and are redeemable at par from
May 15, 2008. The $15 million 9.75% fixed rate junior subordinated capital
securities ("InCapS(sm)") due May 23, 2033 pay interest quarterly and are
redeemable from May 23, 2008 at 104.875% declining to 100.975% at May 23, 2013,
and at par thereafter.
15
PXRE
Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- --------------------------------------------------------------------------------
8. Contingencies
In April 2000, PXRE Reinsurance entered into an Aggregate Excess of
Loss Retrocessional Reinsurance Agreement (the "Agreement") with a U.S. based
cedent. In the Agreement, PXRE Reinsurance reinsured a portfolio of treaties
(the "Protected Portfolio") underwritten by a former business unit of the cedent
which had been divested. Pursuant to this Agreement, PXRE Reinsurance agreed to
indemnify the cedent for losses in excess of a 75% paid loss ratio on the
underlying Protected Portfolio up to a 100% paid loss ratio, subject to an
aggregate limit of liability of $50 million. The latest loss reports related to
the Agreement provided by the cedent forecast an ultimate net loss ratio in
excess of 100%, which could result in a full limit loss to the Company.
In June 2003, PXRE Reinsurance performed an audit of the Protected
Portfolio reinsured under the Agreement. As a result of this audit, management
identified problems and believes that the cedent may have breached its
contractual obligations and fiduciary duties under the Agreement. PXRE
Reinsurance therefore filed suit against the cedent on July 24, 2003 in a United
Stated District Court seeking rescission of the Agreement and/or compensatory
and punitive damages.
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to vigorously prosecute its suit. As of June 30, 2003, we have
recorded $34 million of loss reserves related to the Agreement. If our lawsuit
is unsuccessful, we could potentially incur additional losses under the
Agreement of up to $10.4 million on an after-tax basis.
In May 1999, PXRE Delaware entered into weather option agreements with
two counterparties. In April 2000, these counterparties submitted invoices to
PXRE Delaware in the aggregate sum of $8.3 million seeking payment under the
weather option agreements, which invoices have been paid. PXRE Delaware insured
its obligations under these weather option agreements through two Commercial
Inland Marine Weather Insurance Policies issued by Terra Nova Insurance Company
Limited ("Terra Nova"). PXRE Delaware submitted claims under these policies to
Terra Nova in April 2000. Terra Nova had denied coverage, contending that its
Managing General Agent had no authority to issue these policies.
PXRE Delaware disagreed with Terra Nova's denial and filed suit against
Terra Nova in the United States District Court for the District of New Jersey.
On June 10, 2002, PXRE Delaware was awarded a verdict of $8.3 million plus
accumulated interest of $1.5 million by a jury at the conclusion of the trial of
this dispute. The aggregate sum of $9.8 million is included in Other Assets.
Terra Nova has appealed this verdict to the United States Court of Appeals for
the Third Circuit, but management has concluded that it is unlikely that they
will prevail, and that no valuation allowance is necessary. The appeal was
submitted to the Third Circuit on June 3, 2003.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
Unless the context otherwise requires, references in this Form 10-Q to
"PXRE", "we", the "Company", "us" and "our" include PXRE Group Ltd., a Bermuda
company and its subsidiaries, which principally include PXRE Corporation ("PXRE
Delaware"), PXRE Reinsurance Company ("PXRE Reinsurance"), PXRE Reinsurance Ltd.
("PXRE Bermuda"), PXRE Reinsurance (Barbados) Ltd. ("PXRE Barbados"), PXRE
Solutions Inc. ("PXRE Solutions") and PXRE Solutions, S.A. ("PXRE Europe").
References to GAAP refer to accounting principles generally accepted in the
United States ("GAAP"). References to SAP refer to statutory accounting
principles ("SAP") in either the State of Connecticut where PXRE Reinsurance is
domiciled or Bermuda where PXRE Bermuda is domiciled.
The following is a discussion and analysis of the Company's results of
operations for the three and six months ended June 30, 2003 compared with the
three and six months ended June 30, 2002, and also a discussion of our financial
condition as of June 30, 2003. This discussion and analysis should be read in
conjunction with the attached unaudited consolidated financial statements and
notes thereto and the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 (the "10-K"), including the audited consolidated financial
statements and notes thereto and the discussion of Certain Risks and
Uncertainties (including the discussion of Critical Accounting Policies)
contained in the 10-K.
Overview
The Company provides reinsurance products and services to a worldwide
marketplace through subsidiary operations in the United States, Europe, Bermuda
and Barbados. Our primary focus is providing property catastrophe reinsurance
and retrocessional coverage to a worldwide group of clients. Property
catastrophe reinsurance generally covers claims arising from large catastrophes
such as hurricanes, windstorms, hailstorms, earthquakes, volcanic eruptions,
fires, industrial explosions, freezes, riots, floods and other man-made or
natural disasters. Substantially all of our non-finite reinsurance products have
been, and will continue to be, offered on an excess-of-loss basis with aggregate
limits on our exposure to losses. This means that we do not begin to pay our
clients' claims until their claims exceed a certain specified amount and our
obligation to pay those claims is limited to a specified aggregate amount. Of
the client groups that we service, primary insurers comprise approximately 88%
and reinsurance companies comprise approximately 12%.
We also offer our clients property-per-risk, marine and aviation
reinsurance and retrocessional products. Unlike property catastrophe
reinsurance, which protects against the accumulation of a large number of
related losses arising out of one catastrophe, per-risk excess-of-loss
reinsurance protects our clients against a large loss arising from a single risk
or location. Substantially all of our property-per-risk and marine and aviation
business is also written on an excess-of-loss basis with aggregate limits on our
exposure to losses.
17
We also provide our clients with finite reinsurance products. Finite
reinsurance contracts are highly customized for each transaction. If the loss
experience with respect to the risks assumed by us is as expected or better than
expected, our finite clients may share in the profitability of the underlying
business through premium adjustments or profit commissions. If the loss
experience is worse than expected, our finite clients may participate in this
negative outcome to a certain extent. In addition, we offer finite reinsurance
products where investment returns on the funds transferred to us affect the
profitability of the contract and the magnitude of any premium or commission
adjustments.
Cautionary Statement Regarding Forward-Looking Statements
This report contains various forward-looking statements and includes
assumptions concerning our operations, future results and prospects. Statements
included herein, as well as statements made by or on our behalf in press
releases, written statements or other documents filed with the Securities and
Exchange Commission (the "SEC"), or in our communications and discussions with
investors and analysts in the normal course of business through meetings, phone
calls and conference calls, which are not historical in nature are intended to
be, and are hereby identified as, "forward-looking statements" for purposes of
the safe harbor provided by Section 21E of the Securities Exchange Act of 1934
as amended. These forward-looking statements, identified by words such as
"intend," "believe," "anticipate," or "expects" or variations of such words or
similar expressions are based on current expectations and are subject to risks
and uncertainties. In light of the risks and uncertainties inherent in all
future projections, the inclusion of forward-looking statements in this report
should not be considered as a representation by us or any other person that our
objectives or plans will be achieved. We caution investors and analysts that
actual results or events could differ materially from those set forth or implied
by the forward-looking statements and related assumptions, depending on the
outcome of certain important factors including, but not limited to, the
following:
(i) significant catastrophe losses or losses under other
coverages, the timing and amount of which are difficult to
predict;
(ii) changes in the level of competition in the reinsurance or
primary insurance markets that impact the volume or
profitability of business (these changes include, but are not
limited to, the intensification of price competition, the
entry of new competitors, existing competitors exiting the
market and competitors' development of new products);
(iii) the lowering or loss of one of the financial or claims paying
ratings of ours or one or more of our subsidiaries;
18
(iv) changes in the demand for reinsurance, including changes in
the amount of risk that our clients elect to maintain for
their own account;
(v) adverse development on loss reserves related to business
written in current and prior years;
(vi) lower than estimated retrocessional recoveries on unpaid
losses, including the effects of losses due to a decline in
the creditworthiness of our retrocessionaires;
(vii) increases in interest rates, which cause a reduction in the
market value of our interest rate sensitive investments,
including our fixed income investment portfolio, and potential
underperformance in our finite coverages;
(viii) decreases in interest rates causing a reduction of income
earned on net cash flow from operations and the reinvestment
of the proceeds from sales, calls or maturities of existing
investments and shortfalls in cash flows necessary to pay
fixed rate amounts due to finite contract counterparties;
(ix) market fluctuations with respect to our portfolio of hedge
funds and other privately held securities: liquidity risk,
credit risk and market risk;
(x) foreign currency fluctuations resulting in exchange gains or
losses;
(xi) a contention by the United States Internal Revenue Service
that the Company or our offshore subsidiaries are subject to
U.S. taxation; and
(xii) changes in tax laws, tax treaties, tax rules and
interpretations.
In addition to the factors outlined above that are directly related to
our business, we are also subject to general business risks, including, but not
limited to, adverse state, federal or foreign legislation and regulation,
adverse publicity or news coverage, changes in general economic factors and the
loss of key employees. The factors listed above should not be construed as
exhaustive.
We undertake no obligation to release publicly the results of any
future revisions we may make to forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Comparison of Second Quarter Results for 2003 with 2002
For the quarter ended June 30, 2003, net income before preferred stock
dividends was $21.5 million compared to net income of $19 million for the
comparable period of 2002. The diluted net income per common share was $0.93 for
the second quarter of 2003 compared to a diluted net income per share of $0.88
for the second quarter of 2002, based on diluted average shares outstanding of
approximately 23.2 million in the second quarter of 2003 and 21.7 million in the
second quarter of 2002.
19
Gross and net premiums written for the second quarter of 2003 and 2002
were as follows:
Three Months Ended June 30,
---------------------------
% Increase
($000's) 2003 2002 (Decrease)
-------- -------- ----------
Gross premiums written $ 66,378 $ 41,791 59
Ceded premiums written (8,333) (21,068) (60)
-------- --------
Net premiums written $ 58,045 $ 20,723 180
======== ========
The increase in gross and net premiums written primarily reflects
growth in the Catastrophe and Risk Excess segment. Improved pricing, increased
participation with long-standing clients and increased amounts of new business
in our core Catastrophe and Risk Excess segment resulted in a $28.7 million or
127% increase in net premiums written for the quarter in this key segment as
compared to the corresponding prior-year period. The Finite segment increased
$3.7 million during the second quarter of 2003 versus the prior-year comparable
quarter on a net written basis primarily due to finite reinsurance contracts
reinsuring Tower Insurance Company of New York ("Tower"). With respect to our
Finite segment, we take an opportunistic approach and do not believe our
business in this segment is best measured by premiums written or earned from
quarter to quarter. Compared to our other lines of business, our finite business
involves a relatively small number of large reinsurance contracts. We therefore
expect that the Finite segment premiums written and earned will vary widely from
quarter to quarter reflecting this strategy. The Exited Lines segment increased
$4.3 million on a net written basis to $2.2 million compared to the
corresponding period of 2002. Since we have decided to re-focus on our core
Catastrophe and Risk Excess segment and to discontinue the businesses we have
classified as Exited Lines, we do not expect to report material premiums written
and earned in the Exited Lines segment during 2003. On an overall basis,
reinsurance premiums ceded decreased by 60% to $8.3 million for the second
quarter of 2003 compared to $21.1 million for the second quarter of 2002,
primarily as a result of the decrease in finite business ceded and the timing of
ceded excess of loss premium deposits.
Finite contracts that do not contain sufficient risk transfer are not
booked as premiums, but rather are treated as deposits. We have entered into
contracts that have $69.4 million of deposit liabilities to ceding companies at
June 30, 2003 on this deposit accounting basis. We also have two finite
retrocessional agreements in place with Select Reinsurance Ltd. ("Select Re")
that are accounted for as deposits, totaling $21.7 million in deposit assets
including investment income earned to June 30, 2003. We believe these
retrocessional agreements enhance the long-term profitability of the finite
contracts to which they relate.
20
Gross and net premiums earned for the second quarter of 2003 and 2002
were as follows:
Three Months Ended June 30,
---------------------------
% Increase
($000's) 2003 2002 (Decrease)
-------- -------- ----------
Gross premiums earned $ 100,795 $ 65,693 53
Ceded premiums earned (16,780) (19,930) (16)
--------- --------- ---------
Net premiums earned $ 84,015 $ 45,763 84
========= ========= =========
Gross premiums earned for the second quarter of 2003 increased 53% to
$100.8 million from $65.7 million in the second quarter of 2002. Net premiums
earned for the second quarter of 2003 increased 84% to $84 million from $45.8
million for the corresponding period of 2002. The Catastrophe and Risk Excess
segment increased 73% on a net earned basis and the Finite segment increased
significantly on a net earned basis compared to the corresponding prior-year
period. The Exited Lines segment experienced a decline of 69% on a net earned
basis for the second quarter of 2003 as compared to the second quarter of 2002.
A summary of our second quarter 2003 and 2002 net premiums written and
earned by business segment is included in Note 6 to the Consolidated Financial
Statements.
Fee income was $1.1 million for the three months ended June 30, 2003
compared to $0.6 million for the three months ended June 30, 2002.
The underwriting results of a property and casualty insurer are
discussed frequently by reference to its loss ratio, underwriting expense ratio
(including the commission and brokerage ratio, net of fee income, and the
operating expense ratio) and combined ratio. The loss ratio is the result of
dividing losses and loss expenses incurred by net premiums earned. The
underwriting expense ratio is the result of dividing underwriting expenses
(including commission and brokerage reduced by fee income, if any, and other
operating expenses) by net premiums written for purposes of SAP and net premiums
earned for purposes of GAAP. The combined ratio is the sum of the loss ratio and
the underwriting expense ratio. A combined ratio under 100% indicates
underwriting profits and a combined ratio exceeding 100% indicates underwriting
losses. The combined ratio does not reflect the effect of investment income on
operating results. The ratios discussed below have been calculated on a GAAP
basis.
The following table summarizes the loss ratio, expense ratio and
combined ratio for the quarters ended June 30, 2003 and 2002, respectively:
(%) Three Months Ended June 30,
--- ----------------------------
2003 2002
----- ------
Loss ratio 53.3 41.2
Expense ratio 27.8 23.9
---- ----
Combined ratio 81.1 65.1
==== ====
Losses incurred amounted to $44.8 million in the second quarter of 2003
compared to $18.9 million in the second quarter of 2002. Our loss ratio was
53.3% for the second quarter of 2003 compared to 41.2% for the comparable
prior-year period. The increase in loss ratio is due to incurred losses related
to the May 2003 Midwest Storms and adverse development from prior-year losses.
21
During the second quarter of 2003, we experienced net development of
$18.1 million for prior-year losses and loss expenses, primarily due to $6.4
million of loss development on our exited direct casualty reinsurance operations
and $6.5 million of loss development from aerospace claims primarily from the
Company's first receipt of notice that the increase in industry losses related
to a 1998 air crash had resulted in the exhaustion of deductibles under three
aerospace contracts between the Company and Reliance Insurance Company. The loss
ratio for the comparable period of 2002 was affected by net adverse development
of $10.5 million for prior-year loss and loss expenses mainly due to $6 million
of loss development on our exited direct reinsurance operations.
The expense ratio was 27.8% for the second quarter of 2003 compared to
23.9% during the comparable year earlier period. The increase was primarily due
to commissions associated with Finite contracts. The commission and brokerage
ratio, net of fee income, was 16.1% for the second quarter of 2003 compared with
10.3% for the second quarter of 2002. The operating expense ratio was 11.7% for
the three months ended June 30, 2003 compared with 13.6% for the comparable
period of 2002. As a result of the above, our combined ratio was 81.1% for the
second quarter of 2003 compared with a combined ratio of 65.1% for the
comparable prior-year period.
Other operating expenses increased 60% to $9.9 million for the three
months ended June 30, 2003 from $6.2 million in the comparable period of 2002.
This increase is largely due to various compensation costs of $1.2 million
relating to the retirement of the Company's former Chief Executive Officer,
Gerald L. Radke, on June 30, 2003 and his transition into a consulting role, as
well as expenses incurred with hiring new underwriters and relocating other
underwriters to our Bermuda office.
Underwriting income (loss) as described in Note 6 to the Consolidated
Financial Statements include premiums earned, losses incurred and commission and
brokerage net of management fees, but does not include investment income,
realized gains or losses, operating expenses, unrealized foreign exchange gains
or losses on losses incurred or financing costs.
Interest expense decreased to $0.2 million for the three months ended
June 30, 2003 from $0.8 million for the three months ended June 30, 2002. The
decrease in interest expense is due to the repayment of the remaining balance of
$10 million on May 16, 2003 under the Company's primary bank credit facility.
The Company incurred minority interest expense amounting to $2.4 million and
$2.2 million related to PXRE's $94.8 million of 8.85% Capital Trust Pass-through
Securities'(sm)' ("TRUPS(sm)"), PXRE's $17.5 million of 7.35% fixed/floating
rate junior subordinated deferrable interest capital securities ("I-PreTS(sm)")
and PXRE's $15 million of 9.75% fixed rate junior subordinated capital
securities ("InCapS(sm)") during the three month periods ended June 30, 2003 and
2002, respectively (see "Liquidity and Capital Resources" below for a full
description of the TRUPS(sm) , I-PreTS(sm) and InCapS(sm)).
22
Net investment income for the second quarter of 2003 increased 2% to
$8.6 million from $8.4 million in the second quarter of 2002 primarily as a
result of a $4.5 million increase in income from hedge funds as well as an
increase in the average invested balance due to cash flows from operations.
Offsetting these increases was a decrease in the book yield of fixed maturity
and short-term investment portfolios from 4.2% during the second quarter of 2002
to 3.6% during this quarter. In addition, there were two non-recurring
transactions in the second quarter of 2002; investment income of $1.5 million of
judgment interest from the Terra Nova Insurance Company Limited ("Terra Nova")
lawsuit and a $3 million special distribution from a private limited
partnership. Investment income related to our hedge fund portfolio increased to
$5.3 million in the second quarter of 2003 from $0.8 million in the second
quarter of 2002. Investment in hedge funds produced a return of 4.7% for the
second quarter of 2003 compared with 0.8% in the comparable prior-year period.
Investment income for the quarter was also affected by various finite
and other reinsurance contracts where premiums payable under such contracts were
retained on a funds withheld basis. In order to reduce credit risk or to comply
with regulatory credit for reinsurance requirements, a portion of premiums paid
under such reinsurance contracts are retained by the cedent pending payment of
losses or commutation of the contract. Investment income on such withheld funds
is typically for the benefit of the reinsurer and the cedent may provide a
minimum investment return on such funds. We have both ceded and assumed
reinsurance contracts that involve the withholding of premiums by the cedent. On
assumed reinsurance contracts, cedents held premiums and accrued investment
income due to us of $25.5 million and $25.9 million as of June 30, 2003 and
2002, respectively, for which we have recognized $0.4 million of investment
income for each of the three month periods ended June 30, 2003 and 2002. On
ceded reinsurance contracts, we held premiums and accrued investment income of
$124.8 million and $130 million due to reinsurers as of June 30, 2003 and 2002,
respectively, for which we recognized a charge to investment income of $2.3
million and $2.6 million for the second quarter of 2003 and 2002, respectively.
On a net basis, this reduction to investment income was only $0.3 million and
$0.6 million for the quarters ended June 30, 2003 and 2002, respectively,
representing the difference between the stated investment return under such
contracts and the overall yield achieved on our total investment portfolio for
the quarter. The weighted average contractual investment return on the funds
held by PXRE is 6.8% and 7.8% for the quarters ended June 30, 2003 and 2002,
respectively, and we expect to be obligated for this contractual investment
return for the life of the underlying liabilities, which is expected to be six
and seven years as of June 30, 2003 and 2002, respectively, on a weighted
average basis.
Net realized investment gains for the second quarter of 2003 were
minimal compared to net realized investment gains of $0.5 million in the second
quarter of 2002. Included in the net realized investment gains for the second
quarter of 2002 were gains of $0.5 million realized on the repurchase of $2.7
million of our TRUPS(sm) Securities.
23
PXRE recognized a tax expense of $0.4 million in the second quarter of
2003 compared to a tax expense of $2.9 million in the comparable prior-year
period. The tax expense in the second quarter of 2003 differed from the
statutory rate primarily due to the mix of business between the U.S. and
Bermuda, as well as tax-exempt income. In this regard, as additional
underwriters were hired in our Bermuda office, the amount of business written by
our Bermuda subsidiary in relation to the total amount written by the Company
increased in the second quarter of 2003 from the comparable prior-year period.
Comparison of Year-to-Date Results for 2003 and 2002
For the six months ended June 30, 2003, net income before preferred
stock dividends was $45.1 million compared to net income of $37.3 million for
the comparable period of 2002. The diluted net income per common share was $1.96
for the first six months of 2003 compared to a diluted net income per share of
$2.21 for the first six months of 2002, based on diluted average shares
outstanding of approximately 23 million in the first six months of 2003 and 16.9
million in the first six months of 2002.
Gross and net premiums written for the first six months of 2003 and
2002 were as follows:
Six Months Ended June 30,
---------------------------
% Increase
($000's) 2003 2002 (Decrease)
--------- --------- ----------
Gross premiums written $ 178,848 $ 167,147 7
Ceded premiums written (27,459) (42,763) (36)
--------- ---------
Net premiums written $ 151,389 $ 124,384 22
========= =========
The increase in gross and net premiums written primarily reflects
growth in the Catastrophe and Risk Excess segment offset, in part, by a decline
in both the Finite and Exited Lines segments. Improved pricing, increased
participation with long-standing clients and increased amounts of new business
in our core Catastrophe and Risk Excess segment resulted in a $51.3 million or
59% increase in net premiums written for the first six months of 2003 in this
key segment as compared to the corresponding prior-year period. The Finite
segment decreased $24.3 million during the first six months of 2003 versus the
prior-year comparable period on a net written basis primarily due to finite
reinsurance contracts reinsuring Tower. The Exited Lines segment decreased $1.3
million on a net written basis during the first six months of 2003 compared to
the corresponding period of 2002. On an overall basis, reinsurance premiums
ceded decreased by 36% to $27.5 million for the first six months of 2003
compared to $42.8 million for the first six months of 2002, primarily as a
result of the decrease in finite business ceded and cessions on the per-risk
portion of the Catastrophe and Risk Excess segment.
24
Gross and net premiums earned for the first six months of 2003 and 2002
were as follows:
Six Months Ended June 30,
---------------------------
% Increase
($000's) 2003 2002 (Decrease)
--------- --------- ----------
Gross premiums earned $ 199,157 $ 143,700 39
Ceded premiums earned (30,369) (38,781) (22)
--------- ---------
Net premiums earned $ 168,788 $ 104,919 61
========= =========
Gross premiums earned for the first six months of 2003 increased 39% to
$199.2 million from $143.7 million in the first six months of 2002. Net premiums
earned for the first six months of 2003 increased 61% to $168.8 million from
$104.9 million for the corresponding period of 2002. The Catastrophe and Risk
Excess segment increased 68% on a net earned basis while the Finite segment
increased 312% on a net earned basis for the first six months of 2003 compared
to the corresponding prior-year period. The Exited Lines segment experienced a
decline of 75% on a net earned basis for the first six months of 2003 as
compared to the first six months of 2002.
A summary of our net premiums written and earned by business segment
for the first six months of 2003 and 2002 is included in Note 6 to the
Consolidated Financial Statements.
Fee income was $2.4 million for the six months ended June 30, 2003
compared to $1.8 million for the six months ended June 30, 2002.
The following table summarizes the loss ratio, expense ratio and
combined ratio for the first six months ended June 30, 2003 and 2002,
respectively:
(%) Six Months Ended June 30,
--- ---------------------------
2003 2002
----- -----
Loss ratio 46.0 34.4
Expense ratio 30.4 29.5
---- ----
Combined ratio 76.4 63.9
==== ====
Losses incurred for the six months ended June 30, 2003 amounted to
$77.7 million compared to $36.1 million in the prior comparable period. Our loss
ratio was 46.0% for the first six months of 2003 compared to 34.4% for the
comparable prior-year period. The increase in loss ratio is due to incurred
losses related to the May 2003 Midwest Storms and adverse development from
prior-year losses.
During the first six months of 2003, we experienced net development of
$31.2 million for prior-year losses and loss expenses, primarily due to $9.7
million on our exited direct casualty reinsurance operations, $9.5 million loss
development from aerospace claims including the Company's first receipt of
notice that the increase in industry losses related to a 1998 air crash had
resulted in the exhaustion of deductibles under three aerospace contracts
between the Company and Reliance Insurance Company and $4.6 million of
development from credit losses. The loss ratio for the comparable period of 2002
was affected by net adverse development of $14.8 million for prior-year loss and
loss expenses mainly due to $9 million of loss development on our exited direct
reinsurance operations.
25
The expense ratio was 30.4% for the first six months of 2003 compared
to 29.5% during the comparable earlier-year period. The increase was primarily
due to a fee on commutation of the P-1 Re Ltd. ("P-1") reinsurance agreement
(see "Recent Developments" below) offset by the effect of an increase in net
premiums earned on fixed operating costs. The commission and brokerage ratio,
net of fee income, was 19.1% for the first six months of 2003 compared with
15.1% for the first six months of 2002. During the six months of 2003, we
incurred $4 million of structuring fees related to the P-1 reinsurance agreement
and the subsequent commutation thereof. This is the primary reason for the
increase in the commission and brokerage ratio, net of fee income. We do not
expect to incur any additional costs related to the structuring and unwinding of
this agreement. The operating expense ratio was 11.3% for the six months ended
June 30, 2003 compared with 14.4% for the comparable period of 2002. As a result
of the above, our combined ratio was 76.4% for the first six months of 2003
compared with a combined ratio of 63.9% for the comparable prior-year period.
Other operating expenses increased 26% to $19 million for the six
months ended June 30, 2003 from $15.1 million in the comparable period of 2002.
This increase is largely due to various compensation costs of $1.2 million
relating to the retirement of the Company's former Chief Executive Officer,
Gerald L. Radke, on June 30, 2003 and his transition into a consulting role as
well as expenses incurred with hiring new underwriters and relocating other
underwriters to our Bermuda office.
Interest expense increased to $2.5 million for the six months ended
June 30, 2003 from $1.5 million for the six months ended June 30, 2002.
Following the repayments of $20 million on March 31, 2003 and repayment of the
remaining $10 million on May 16, 2003 under the Company's primary bank credit
facility, an interest rate swap previously accounted for as a cash flow hedge is
no longer effective. Consequently $1.2 million has been charged as interest
expense in the first six months of 2003. This charge did not impact
stockholders' equity because it was previously recorded as a component of other
comprehensive income. In addition there was an acceleration of the amortization
of expenses related to this bank facility of $0.3 million during the first six
months of 2003. The Company incurred minority interest expense amounting to $4.5
million and $4.4 million related to PXRE's $94.8 million of 8.85% TRUPS(sm),
PXRE's $17.5 million of 7.35% fixed/floating rate I-PreTS(sm) and PXRE's $15
million of 9.75% fixed rate InCapS(sm) during the six month periods ended June
30, 2003 and 2002, respectively (see "Liquidity and Capital Resources" below for
a full description of the TRUPS(sm), I-PreTS(sm) and InCapS(sm)).
26
Net investment income for the first six months of 2003 increased 12% to
$14 million from $12.5 million in the first six months of 2002 primarily as a
result of a $4.4 million increase in income from hedge funds as well as an
increase in the average invested balance due to cash flows from operations.
Offsetting these increases was a decrease in the book yield of fixed maturity
and short-term investment portfolios from 4.3% during the six months ended June
30, 2002 to 3.8% during the six months ended June 30, 2003. In addition, there
were two non-recurring transactions in the first six months of 2002; investment
income of $1.5 million of judgment interest from the Terra Nova lawsuit and a $3
million special distribution from a private limited partnership. Investment
income related to our hedge fund portfolio increased to $7.5 million in the
first six months of 2003 from $3 million in the first six months of 2002.
Investment in hedge funds produced a return of 6.7% for the first six months of
2003 compared with 3.1% in the comparable prior-year period.
Investment income for the first six month of 2003 was also affected by
various finite and other reinsurance contracts where premiums payable under such
contracts were retained on a funds withheld basis. In order to reduce credit
risk or to comply with regulatory credit for reinsurance requirements, a portion
of premiums paid under such reinsurance contracts are retained by the cedent
pending payment of losses or commutation of the contract. Investment income on
such withheld funds is typically for the benefit of the reinsurer and the cedent
may provide a minimum investment return on such funds. We have both ceded and
assumed reinsurance contracts that involve the withholding of premiums by the
cedent. On assumed reinsurance contracts, cedents held premiums and accrued
investment income due to us of $25.5 million and $25.9 million as of June 30,
2003 and 2002, respectively, for which we have recognized $0.8 million of
investment income for each of the six month periods ended June 30, 2003 and
2002. On ceded reinsurance contracts, we held premiums and accrued investment
income of $124.8 million and $130 million due to reinsurers as of June 30, 2003
and 2002, respectively, for which we recognized a charge to investment income of
$4.7 million and $5 million for the first six months of 2003 and 2002,
respectively. On a net basis, this reduction to investment income was only $1
million and $1.4 million for the six months ended June 30, 2003 and 2002,
respectively, representing the difference between the stated investment return
under such contracts and the overall yield achieved on our total investment
portfolio for the quarter. The weighted average contractual investment return on
the funds held by PXRE is 7.1% and 7.8% for the six months ended June 30, 2003
and 2002, respectively, and we expect to be obligated for this contractual
investment return for the life of the underlying liabilities, which is expected
to be six and seven years as of June 30, 2003 and 2002, respectively, on a
weighted average basis.
Net realized investment gains for the first six months of 2003 were
minimal compared to net realized investment gains of $1 million in the first six
months of 2002. Included in the net realized investment gains for the first six
months of 2002 were gains of $1.2 million realized on the repurchase of $4.2
million of our TRUPS(sm) Securities.
PXRE recognized a tax expense of $1.9 million in the first six months
of 2003 compared to a tax expense of $8.2 million in the comparable prior-year
period. The tax expense in the first six months of 2003 differed from the
statutory rate primarily due to the mix of business between the U.S. and
Bermuda, as well as tax-exempt income. In this regard, as additional
underwriters were hired in our Bermuda office, the amount of business written by
our Bermuda subsidiary in relation to the total amount written by the Company
increased in the first six months of 2003 from the comparable prior-year period.
27
Update on Critical Accounting Policies
The Company's Annual Report on Form 10-K for the year ended December
31, 2002 discloses certain risks and uncertainties relating to critical
accounting policies (See Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operations - Certain Risks and Uncertainties
Relating to Critical Accounting Policies contained in the Company's Annual
Report on Form 10-K for the year ended December 31, 2002). This included
disclosure concerning our estimation of losses and loss expenses, the
assumptions used in making such estimation and the various factors that
contribute to uncertainty in those estimates.
Estimation of Loss and Loss Expenses
In this regard, we noted as a property catastrophe reinsurer, our
estimations of losses are inherently less reliable than for reinsurers of risks
that have an established historical pattern of losses such as casualty risks. In
addition, with respect to insured events that occur near the end of a reporting
period, as well as with respect to our retrocessional book of business, the
significant delay in losses being reported to insurance carriers, reinsurers and
finally retrocessionaires requires us to make estimates of losses based on
limited information from our clients, industry loss estimates and our own
underwriting data. Because of the uncertainty in the process of estimating our
losses from insured events, there is a risk that our liabilities for losses and
loss expenses could prove to be inadequate, with a consequent adverse impact on
our future earnings and stockholders' equity. Additionally, as a consequence of
our emphasis on property reinsurance, we may forgo potential investment income
because property losses are typically settled within a shorter period of time
than casualty losses.
In reserving for non-catastrophe losses from recent years, we are
required to make assumptions concerning the expected loss ratio usually for
broad lines of business, but sometimes by contract. We consider historical loss
ratios for each line of business and estimates provided by underwriters and
actuaries concerning the impact of pricing and coverage changes. We also utilize
information provided by our clients when we reserve heterogeneous lines by
selecting expected loss ratios based upon loss ratio projections from pricing
analyses. As experience emerges, we revise our prior estimates concerning
pricing adequacy and non-catastrophe loss potential for our coverages and we
will eventually rely solely on our estimated development pattern in projecting
ultimate losses.
In reserving for catastrophe losses, our estimates are initially
influenced to a significant degree by industry catastrophe models and
underwriting information provided by our clients. This can cause significant
development for an accident year when events occur late in the year, as happened
in 1999. As an event matures, we rely more and more on our company development
patterns by type of event as well as contract information to project ultimate
losses for the event. This process can cause our ultimate estimates to differ
significantly from initial projections. The French Storm Martin that occurred on
December 27, 1999 presents an extreme example of these potential uncertainties.
We based our reserves to a significant degree on the average estimate of the
cost of this storm by two major catastrophe modelers, which was approximately $1
billion. In 2001, the cost was estimated to be $2.5 billion by SIGMA, a widely
used industry publication. Our gross loss estimate at December 31, 1999 for this
event was $31.3 million. Our gross loss estimate at December 31, 2002 for this
event was $66 million. Thus, the original industry loss estimate increased by
150%, and our loss estimate has increased by 111%.
28
Excluding the extraordinary development of French Storms Martin and
Lothar in 2000, during the last 10 years, reserve development in any single year
from prior year losses, expressed as a percentage of stockholders' equity,
ranged from 15% adverse development in 1993 (primarily arising from Hurricane
Andrew) to 4% favorable development in 1996.
In addition, the risk for recent underwriting years includes the
increased casualty exposures assumed by us through our casualty and finite
businesses. Unlike property losses that tend to be reported more promptly and
usually are settled within a shorter time period, casualty losses are frequently
slower to be reported and may be determined only through the lengthy,
unpredictable process of litigation. Moreover, given our limited experience in
the casualty and finite businesses, we do not have established historical loss
development patterns that can be used to establish these loss liabilities. We
must therefore rely on the inherently less reliable historical loss development
patterns reported by our clients and industry loss development data in
calculating our liabilities.
During the second quarter of 2003, we experienced net development of
$18.1 million for prior-year loss and loss expenses, primarily due to $6.4
million of adverse development on our exited direct casualty reinsurance
operations and $6.5 million of loss development from aerospace claims. The loss
ratio for the comparable period of 2002 was affected by net adverse development
of $10.5 million for prior-year loss and loss expenses mainly due to $6 million
of loss development on our exited direct reinsurance operations.
While there were no changes in key assumptions during the period ended
June 30, 2003, there were as described below, changes in weightings of those
assumptions previously utilized, in response to the new information that emerged
through reports to the Company during the period.
The $6.4 million of development attributable to our exited direct
casualty reinsurance operations relates primarily to the 2000 and 2001 accident
years for the general liability line. Specifically, $4.4 million more losses
were reported than were expected based on our actuarial estimates, of which $1.2
million was attributable to an excess of policy limits award on a claim which
had been reserved at full limits. During the second quarter, we applied more
weight to loss development techniques for accident years prior to 2001 and we
also selected higher expected loss ratios in the Bornhuetter-Ferguson technique
for later accident years. As such, the negative reported variance mentioned
above resulted in additional reserves of $3.3 million in excess of what would
have been recorded without these changes.
29
The $6.5 million adverse development on our aerospace business
primarily arises from the Company's receipt during the quarter of a first notice
from Reliance Insurance Company that an increase in industry loss estimates
relating to the Swiss Air crash in 1998 would cause Reliance to exceed the
contractual retentions on three aerospace reinsurance contracts, which caused
the Company to record additional loss reserves of $3 million relating to this
event.
Loss and loss expense liabilities as estimated by the Company's
actuaries and recorded by management in the statement of financial position as
of June 30, 2003 were as follows:
($000's) Gross Net
-------- --------
Catastrophe and Risk Excess $204,793 $ 87,110
Finite Business 115,933 83,114
Other Lines 8,182 6,349
Exited Lines 114,089 101,766
-------- --------
Total $442,997 $278,339
======== ========
The most significant component of net loss reserves for which the
Company provided a range of loss reserve estimates as determined by its
actuaries is the Exited Lines segment. The low and high ends of a range of
reasonable loss reserves for the Company's Exited Lines segment is $11.3 million
below, and $12.1 million above, the $101.8 million best estimate displayed in
the table above. The low and high ends of a range of reasonable loss reserves
for the Company's Catastrophe and Risk Excess segment are $13.5 million below
and $15 million above the $87.1 million best estimate displayed above. The low
and high ends of a range of reasonable loss reserves for the Company's Finite
segment are $16.2 million below and $18.6 million above the $83.1 million best
estimate displayed above. The low and high ends of a range of reasonable loss
reserves for the Company's Other Lines segment are $0.8 million below and $0.9
million above the $6.3 million best estimate displayed above. On an overall
basis, the low and high ends of a range of reasonable loss reserves are $30.8
million below and $34 million above the $278.3 million best estimate displayed
above. Note that the range around the overall estimate is not the sum of the
ranges about the component segments due to the benefits of diversification when
the reserve levels are considered in total.
Recent Developments
On April 23, 2003, PXRE commuted its quota share reinsurance agreement
with P-1 in consideration of a commutation fee of $1.8 million payable by P-1 to
PXRE. The commutation is effective as of January 1, 2003 and PXRE will retain
all reinsurance premiums that would have been ceded to P-1. PXRE elected to
commute this reinsurance facility because it believes that it will earn a higher
risk-adjusted profit by retaining the business ceded to P-1 than it could earn
from the management fee that was payable under the P-1 reinsurance agreement.
30
PXRE had established the P-1 facility in December 2002 to manage the
potential for excess growth in PXRE's property-catastrophe peak zone exposures.
Under the P-1 reinsurance agreement, the quota share ceded to P-1 was determined
based upon the amount of exposure PXRE wrote in excess of certain minimum
retained amounts established by PXRE. PXRE met planned internal growth targets
during the January 1, 2003 renewal season for its property-catastrophe business,
but it did not experience significant peak zone exposure growth beyond its
internal targets and the property catastrophe quota share ceded to P-1 was only
2.74%. As a result, the bulk of the business ceded to P-1 was well rated
aviation, satellite and risk excess business. Such aviation, satellite and risk
excess business is not highly correlated to PXRE's property-catastrophe
exposures and the reassumption of this business improves the expected return on
PXRE's reinsurance portfolio.
FINANCIAL CONDITION
Liquidity and Capital Resources
The Company relies primarily on dividend payments and net tax
allocation payments from its subsidiaries, including PXRE Reinsurance and PXRE
Bermuda, to pay its operating expenses and income taxes, to meet its debt
service obligations and to pay dividends. The payment of dividends by PXRE
Reinsurance to PXRE Delaware is subject to limits imposed under the insurance
laws and regulations of Connecticut, the state of incorporation and domicile of
PXRE Reinsurance. Under the Connecticut insurance law, the maximum amount of
dividends or distributions that PXRE Reinsurance may declare and pay during
2003, without regulatory approval, is $45.7 million. During the six months ended
June 30, 2003, $58.6 million in dividends were paid by PXRE Reinsurance,
including $26.8 million in extraordinary dividends, which were approved by the
Insurance Department of the State of Connecticut.
The payment of dividends by PXRE Bermuda is limited under Bermuda
insurance laws, which requires PXRE Bermuda to maintain certain measures of
solvency and liquidity. At June 30, 2003, the statutory capital and surplus of
PXRE Bermuda was estimated to be $317.8 million and the amount required to be
maintained was estimated to be $15.3 million. In addition, under Bermuda law,
PXRE Bermuda may not reduce its total statutory capital of $70.6 million, as set
out in its statutory financial statement dated December 31, 2002, by 15% or more
without the prior approval of Bermuda's Minister of Finance.
Under Barbados law, PXRE Barbados may only pay a dividend out of its
realized profits. PXRE Barbados may not pay a dividend unless (a) after payment
of the dividend it is able to pay its liabilities as they become due, and (b)
the realizable value of its assets is greater than the aggregate value of its
liabilities, and (c) the stated capital accounts are maintained in respect of
all classes of shares.
31
On April 4, 2002, the Company raised $150 million of additional capital
through the issuance of 15,000 Convertible Voting Preferred Shares (the
"Preferred Share Investment"). The Preferred Share Investment occurred pursuant
to a Share Purchase Agreement, dated as of December 10, 2001, between the
Company and Capital Z Financial Services Fund II, L.P., Capital Z Financial
Services Private Fund II, L.P. (together with Capital Z Financial Services Fund
II, L.P., "Capital Z"), Reservoir Capital Master Fund, L.P., Reservoir Capital
Partners, L.P. (together with Reservoir Capital Master Fund, L.P., "Reservoir")
and Richard E. Rainwater ("Rainwater") (each of Capital Z, Reservoir and
Rainwater, a "Purchaser", and together, the "Purchasers"). The Preferred Share
Investment involved the issuance of 7,500 shares of Series A Preferred Shares,
allocated to two sub-series of shares, 5,000 shares allocated to sub-series A1
(A1 Preferred Shares) and 2,500 shares allocated to sub-series A2 (A2 Preferred
Shares); the purchase of 5,000 shares of Series B Preferred Shares, allocated to
two sub-series of shares, 3,333.333 shares allocated to Series B1 (B1 Preferred
Shares) and 1,666.667 shares allocated to Series B2 (B2 Preferred Shares); and
2,500 shares of Series C Preferred Shares, allocated to two sub-series of
shares, 1,666.667 shares allocated to Series C1 (C1 Preferred Shares) and
833.333 shares allocated to Series C2 (C2 Preferred Shares). The Company's
common shareholders approved the transaction on February 12, 2002.
The issuance of the Preferred Shares is not expected to have a material
effect on our liquidity during the three-year period following the issuance. In
this regard, the Preferred Shares will be entitled to receive, when, as and if
declared by our Board of Directors and to the extent of funds legally available
for the payment of dividends, cumulative dividends per share at the rate per
annum of 8% of the sum of the stated value on each share plus any accrued and
unpaid dividends thereon, payable on a quarterly basis. To the extent such
dividends are not paid when due, dividends shall be payable and accrue at the
rate of 10% per annum compounded quarterly until paid. Such dividends, if
declared by our Board of Directors, shall be payable in additional Preferred
Shares prior to the third anniversary of the closing and cash thereafter. We, at
our sole election, may decide, in substitution in whole or in part for dividends
payable in shares, to pay dividends in cash to the extent of any dividends that,
if paid in additional shares of Preferred Shares, would otherwise cause the
Purchasers and their affiliates to own more than 49.9% of the capital stock of
the Company on a fully-diluted and fully-converted basis.
The A1 Preferred Shares, B1 Preferred Shares and C1 Preferred Shares
will be mandatorily convertible into Class A Common Shares, Class B Common
Shares and Class C Common Shares, respectively, on April 4, 2005, and all
remaining Preferred Shares will be mandatorily convertible into Convertible
Common Shares on April 4, 2008. Notwithstanding the foregoing, on any conversion
date, to the extent necessary to prevent the initial Purchasers of Preferred
Shares and their affiliates from owning more than 49.9% of the capital shares of
the Company following conversion, we shall have the right (but not the
obligation) to make a cash payment in lieu of Convertible Common Shares equal to
the fair market value of the Convertible Common Shares that would have been
received in excess of the 49.9% limitation in connection with any conversion,
plus an additional tax gross up amount to take into account in appropriate
circumstances the difference between the federal income tax rate on long-term
capital gains and the federal ordinary income tax rate that might apply to the
recipient on the receipt of a cash payment in lieu of Convertible Common Shares.
If the A2 Preferred Shares, B2 Preferred Shares and C2 Preferred Shares are not
voluntarily converted on or prior to the third anniversary of their issuance, an
annual 8% dividend, payable in cash, will accrue until these Preferred Shares
are converted.
32
PXRE Delaware entered into a Credit Agreement dated as of December 30,
1998 (as amended and restated, the "Credit Agreement") with Wachovia Bank,
National Association (formerly known as First Union National Bank, "Wachovia")
as Agent and as a Lender, pursuant to which Wachovia agreed to make available to
PXRE Delaware a $75 million revolving credit facility. On May 18, 1999, pursuant
to various Joinder Agreements and Assignment and Acceptance Agreements, Wachovia
syndicated the revolving credit facility, joining Fleet National Bank, Credit
Lyonnais New York Branch and Bank One (formerly, The First National Bank of
Chicago) as additional lenders (collectively with Wachovia, the "Lenders"). At
December 31, 1998, PXRE Delaware had outstanding borrowings under the Credit
Agreement of $50 million, and in October 1999, the remaining $25 million was
borrowed. On each of March 31, 2000, 2001, 2002 and April 4, 2002 PXRE Delaware
fulfilled its commitment and made principal payments of $10 million. In
addition, PXRE Delaware paid $5 million on July 1, 2002 and $20 million on March
31, 2003, and the remaining $10 million on May 16, 2003 so as of this date,
amounts due under the Credit Agreement have been paid in full.
In connection with the Credit Agreement, PXRE Delaware and Wachovia
entered into a cash flow hedge interest rate swap which had the intended effect
of converting the $50 million borrowings by PXRE Delaware into a fixed rate
borrowing at an effective annual interest rate of 7.59%. Prior to 2003, this
interest rate swap was accounted for as a hedge. During the first quarter of
2003, we concluded that the swap was no longer effectively hedging the cash
flows associated with the Credit Agreement and, as such, recognized through
earnings the fair value of the swap. This charge did not impact stockholders'
equity since it was previously recorded as a component of other comprehensive
income.
On January 29, 1997, PXRE Capital Trust I ("PXRE Capital Trust"), a
Delaware statutory trust and a wholly-owned subsidiary of PXRE Delaware, issued
$100 million principal amount of its 8.85% TRUPS(sm) due February 1, 2027 in an
institutional private placement. Proceeds from the sale of these securities were
used to purchase PXRE Delaware's 8.85% Junior Subordinated Deferrable Interest
Debentures due February 1, 2027 (the "Subordinated Debt Securities"). On April
23, 1997, PXRE Delaware and PXRE Capital Trust completed the registration with
the SEC of an exchange offer for these securities and the securities were
exchanged for substantially similar securities (the "Capital Securities").
Distributions on the Capital Securities (and interest on the related
Subordinated Debt Securities) are payable semi-annually, in arrears, on February
1 and August 1 of each year, commencing August 1, 1997.
We believe that the TRUPS(sm) may trade at an under-valued price. In
order to take advantage of this opportunity, we may cause one or more of our
subsidiaries to purchase some of the outstanding TRUPS(sm) and hold them for
investment purposes. If consummated, such a purchase is not expected to be
treated as a redemption. We did not purchase any TRUPS(sm) during the second
quarter of 2003.
33
On May 15, 2003, PXRE Capital Statutory Trust II, a Connecticut
statutory trust and wholly-owned subsidiary of the Company, sold in a private
transaction, $17.5 million principal amount of I-PreTS(sm) based on an equal
principal amount of the Company's fixed/floating rate junior subordinated
deferrable interest debentures due May 15, 2033. The securities bear interest at
an initial rate of 7.35%. The Company used the net proceeds of the sale to repay
the balance of $10 million outstanding under its Credit Agreement, and to
provide additional capital to PXRE Bermuda.
Interest on the I-PreTS(sm) is payable quarterly in arrears on August
15, November 15, February 15 and May 15 of each year commencing August 15, 2003,
at an annual rate equal to 7.35% until May 15, 2008 and thereafter at an annual
rate of three Month LIBOR plus 4.1%, reset quarterly. The Company at its option
is able to redeem the I-PreTS(sm) securities in whole or in part at any interest
payment date after May 15, 2008 at 100% of the outstanding principal amount. The
Company also has the right to defer payment of interest on the I-PreTS(sm)
securities for up to 20 consecutive quarterly periods. Interest will continue to
accrue and be compounded at the rate of interest payable on the I-PreTS(sm)
securities in such period. If the Company exercises its right to defer interest
on the I-PreTS(sm) securities, then in that period, the Company will not be able
to pay any dividends or distributions on, or redeem, purchase, acquire, or make
a liquidation payment with respect to, any of the Company's common shares or
preferred shares; or make any payment of principal of, or interest or premium
on, or repay, repurchase or redeem any debt securities of the Company that rank
pari passu in all respects with or junior in interest to the debentures.
On May 23, 2003, the Company and PXRE Capital Trust III, a Delaware
statutory trust and a wholly-owned subsidiary of the Company, sold in a private
transaction, $15 million principal amount of 9.75% fixed rate InCapS(sm) due May
23, 2033. Proceeds from the sale of the InCapS(sm) securities were used to
purchase the Company's 9.75% fixed rate junior subordinated debt securities due
May 23, 2033, and the net proceeds used to provide additional capital to PXRE
Bermuda.
Interest on the InCapS(sm) securities is fixed throughout the term, and
payable quarterly in arrears, on February 23, May 23, August 23 and November 23
of each year, commencing on August 23, 2003. The Company, at its option, is able
to redeem the InCapS(sm) securities in whole or in part, on any interest payment
date on or after May 23, 2008, as follows:
Optional redemption during the Optional redemption price
12 month period beginning May 23 as percentage of principal amount
-------------------------------- ---------------------------------
2008 104.875
2009 103.900
2010 102.925
2011 101.950
2012 100.975
2013 or thereafter 100.000
34
The Company also has the right to defer payments of interest on the
InCapS(sm) securities for up to 20 consecutive quarterly periods. Interest will
continue to accrue and be compounded quarterly at 9.75%, the rate of interest
payable on the InCapS(sm) securities. If the Company exercises its right to
defer interest on the InCapS(sm) securities, then in that period, the Company
may not declare or pay any dividends or distributions on, or redeem, purchase,
acquire, or make a liquidation payment with respect to, any of the Company's
common shares or preferred shares, make any payment of principal of or premium
or interest on or repay, repurchase or redeem, any debt securities of the
Company that rank in all respects pari passu with or junior in interest to the
InCapS(sm) securities or make any payment under any guarantees of the Company
that rank in all respects pari passu with or junior in interest to the
InCapS(sm) securities.
PXRE Delaware files U.S. income tax returns for itself and all of its
direct or indirect subsidiaries that satisfy the stock ownership requirements
for consolidation (collectively, the "U.S. Subsidiaries"). PXRE Delaware is
party to an Agreement Concerning Filing of Consolidated Federal Income Tax
Returns (the "Tax Allocation Agreement") pursuant to which each U.S. Subsidiary
makes tax payments to PXRE Delaware in an amount equal to the federal income tax
payment that would have been payable by such U.S. Subsidiary for such year if it
had filed a separate income tax return for such year. PXRE Delaware is required
to provide for payment of the consolidated federal income tax liability for the
entire group. If the aggregate amount of tax payments made in any tax year by a
U.S. Subsidiary is less than (or greater than) the annual tax liability for such
U.S. Subsidiary on a stand-alone basis for such year, such U.S. Subsidiary will
be required to make up such deficiency to PXRE Delaware (or will be entitled to
receive a credit if payments exceed the separate return tax liability of the
U.S. Subsidiary).
Investments
As of June 30, 2003, our investment portfolio, at fair value, was
allocated 69% in bonds, 16.8% in short-term investments, 12.9% in hedge funds
and 1.3% in other investments.
35
The following table summarizes our investments at June 30, 2003 and
December 31, 2002 at fair value:
Analysis of Investments
June 30, 2003 December 31, 2002
---------------------- -----------------------
($000's, except percentages) Amount Percent Amount Percent
--------- ------- -------- --------
Fixed maturities:
United States treasury securities $ 46,697 5.4% $ 46,165 6.1%
Foreign denominated securities 20,976 2.4 21,871 2.9
Foreign government securities - - 315 -
United States government sponsored agency debentures 84,721 9.9 38,062 5.0
United States government sponsored agency
mortgage-backed securities 57,731 6.8 42,467 5.6
Other mortgage and asset-backed securities 146,112 17.0 143,736 19.0
Municipal securities 63,065 7.3 76,522 10.1
Corporate securities 172,939 20.2 131,611 17.3
-------- ----- -------- -----
Total fixed maturities 592,241 69.0 500,749 66.0
Short-term investments 143,766 16.8 133,318 17.6
-------- ----- -------- -----
Total fixed maturities and short-term investments 736,007 85.8 634,067 83.6
Hedge funds 110,757 12.9 113,105 14.9
Other investments 10,968 1.3 11,529 1.5
-------- ----- -------- -----
Total investment portfolio $857,732 100.0% $758,701 100.0%
======== ===== ======== =====
At June 30, 2003, 96.5% of the fair value of our fixed maturities and
short-term investments portfolio was in obligations rated "A" (strong) or better
by Moody's or S&P. Mortgage and asset-backed securities accounted for 27.7% of
fixed maturities and short-term investments or 23.7% of our total investment
portfolio based on fair value at June 30, 2003. The average yield on our fixed
maturities and short-term investments at June 30, 2003 and 2002 was 2.9% and
4.6%, respectively.
Fixed maturity investments, other than trading securities, are reported
at fair value, with the net unrealized gain or loss, net of tax, reported as a
separate component of stockholders' equity. Fixed maturity investments
classified as trading securities are reported at fair value, with the net
unrealized gain or loss reported as investment income. At June 30, 2003, an
after-tax unrealized gain of $9.8 million (gain of 42 cents per share, after
considering convertible preferred shares) was included in stockholders' equity.
Short-term investments are carried at amortized cost, which
approximates fair value. Our short-term investments, principally short-term
agencies and United States treasuries, amounted to $143.8 million at June 30,
2003, compared to $133.3 million at December 31, 2002.
36
A principal component of our investment strategy is investing a portion
of our invested assets in a diversified portfolio of hedge funds. At June 30,
2003, total hedge fund investments amounted to $110.8 million, representing
12.9% of the total investment portfolio. At December 31, 2002, total hedge fund
investments amounted to $113.1 million, representing 14.9% of the total
investment portfolio. For the six months ended June 30, 2003, our hedge funds
yielded a return of 6.7% as compared to 3.1% in the six months ended June 30,
2002. At June 30, 2003, hedge fund investments with fair values ranging from
$1.8 million to $16 million were administered by fifteen managers.
Our hedge fund managers invest in a variety of markets utilizing a
variety of strategies, generally through the medium of private investment
companies or other entities. Criteria for the selection of hedge fund managers
include, among other factors, the historical performance and/or recognizable
prospects of the particular manager and a substantial personal investment by the
manager in the investment program. However, managers without past trading
histories or substantial personal investment may also be considered. Generally,
our hedge fund managers may be compensated on terms that may include fixed
and/or performance-based fees or profit participations.
Through our hedge fund managers, we may invest or trade in any
securities or instruments including, but not limited to, U.S. and non-U.S.
equities and equity-related instruments, currencies, commodities and
fixed-income and other debt-related instruments and derivative instruments.
Hedge fund managers may use both over-the-counter and exchange traded
instruments (including derivative instruments such as swaps, futures and forward
agreements), trade on margin and engage in short sales. Substantially all hedge
fund managers are expected to employ leverage, to varying degrees, which
magnifies both the potential for gain and the exposure to loss, which may be
substantial. Leverage may be obtained through margin arrangements, as well as
repurchase, reverse repurchase, securities lending and other techniques. Trades
may be on or off exchanges and may be in thinly traded securities or
instruments, which creates the risk that attempted purchases or sales may
adversely affect the price of a particular investment or its liquidation and may
increase the difficulty of valuing particular positions.
While we seek capital appreciation with respect to our hedge fund
investments, we are also concerned with preservation of capital. Therefore, our
hedge fund portfolio is designed to take advantage of broad market opportunities
and diversify risk. Nevertheless, our investment policies with respect to our
hedge fund investments generally do not restrict us from participating in
particular markets, strategies or investments. Further, our hedge fund
investments may generally be deployed and redeployed in whatever investment
strategies are deemed appropriate under prevailing economic and market
conditions in an attempt to achieve capital appreciation, including, if
appropriate, a concentration of investments in a relatively small group of
strategies or hedge fund managers. Accordingly, the identity and number of hedge
fund managers is likely to change over time.
Mariner Investment Group, Inc. ("Mariner"), as investment advisor,
allocates assets to the hedge fund managers. Mariner monitors hedge fund
performance and periodically reallocates assets in its discretion. Mariner is
familiar with a number of hedge fund investment strategies utilized by our hedge
fund managers. Mariner has invested in some of these strategies and has a
varying level of knowledge of others. New strategies, or strategies not
currently known to Mariner, may come to Mariner's attention and may be adopted
from time to time.
37
As of June 30, 2003, our investment portfolio also included $11 million
of other invested assets of which 98% is in two mezzanine bond funds. The
remaining aggregate cash call commitments in respect of such investments are
$1.1 million.
Hedge funds and other limited partnership investments are accounted for
under the equity method. Total investment income for the six months ended June
30, 2003, included $7.8 million attributable to hedge funds and other
investments.
Our hedge fund and other privately held securities program should be
viewed as exposing us to the risk of substantial losses, which we seek to reduce
through our multi-asset and multi-management strategy. There can be no
assurance, however, that this strategy will prove to be successful.
Liquidity
The primary sources of liquidity for our principal operating
subsidiaries are net cash flow from operating activities (including interest
income from investments), the maturity or sale of investments, borrowings,
capital contributions and advances. Funds are applied primarily to the payment
of claims, operating expenses, income taxes and to the purchase of investments.
Premiums are typically received in advance of related claim payments.
Net cash flows provided by operations were $31.5 million in the second
quarter of 2003 compared to $6.7 million used by operations in the second
quarter of 2002 due to the effects of timing of collection of receivables and
reinsurance recoverables and payments of losses. Because of the nature of the
coverages we provide, which typically can produce infrequent losses of high
severity, it is not possible to accurately predict our future cash flows from
operating activities. As a consequence, cash flows from operating activities may
fluctuate, perhaps significantly, between individual quarters and years.
In connection with the capitalization of PXRE Lloyd's Syndicate 1224,
PXRE Reinsurance had placed on deposit a $35.6 million par value U.S. Treasury
security as collateral for Lloyd's. Cash and invested assets held by PXRE
Lloyd's Syndicate 1224, amounting to $11.4 million at June 30, 2003, are
restricted from being paid as a dividend until the run-off has been completed.
We may be subject to gains and losses resulting from currency
fluctuations because substantially all of our investments are denominated in
U.S. dollars, while some of our net liability exposure is in currencies other
than U.S. dollars. We hold, and expect to continue to hold, currency positions
and have made, and expect to continue to make, investments denominated in
foreign currencies to mitigate, in part, the effects of currency fluctuations on
our results of operations. Investments in foreign denominated securities held as
part of our trading securities amount to 2.4% of our investment portfolio and,
in our opinion are sufficiently liquid for our needs.
38
Dividends declared to common shareholders in the second quarter of 2003
and 2002 were $0.7 million. The expected annual dividend based on common shares
outstanding at June 30, 2003 is approximately $2.9 million.
Book value per common share was $21.32 at June 30, 2003 after
considering convertible preferred shares.
Commitments and Contingencies
As of June 30, 2003, other commitments and pledged assets include (a)
letters of credit amounting to $14 million which are secured by cash and
securities amounting to $14.3 million, (b) securities with a par value of $9.2
million on deposit with various state insurance departments in order to comply
with insurance laws, (c) securities with a fair value of $59.3 million deposited
in a trust for the benefit of a cedent in connection with certain finite
reinsurance transactions, (d) funding commitments to certain limited
partnerships of $1.1 million, (e) a commitment to lend up to $3.3 million to
finance the construction of an office building that we intend to use as our
headquarters in Bermuda, (f) a contingent liability amounting to $1.1 million
under the 1992 Restated Employee Annual Incentive Bonus Plan plus interest, and
(g) commitments under TRUPS(sm), I-PreTS(sm) and InCapS(sm) discussed above.
We entered into a joint venture agreement, dated June 2001 (the "JV
Agreement"), with BF&M Properties Limited to form a Bermuda corporation, Barr's
Bay Properties Limited ("Barr's Bay"). Barr's Bay was formed to construct an
office building in Hamilton, Bermuda, in which we will have the option to lease
office space for three consecutive five-year terms. We own 40% of the
outstanding shares of Barr's Bay. Pursuant to the JV Agreement, we have agreed
to lend up to $7 million to Barr's Bay to finance the construction of the office
building of which $3.7 million has been advanced as of June 30, 2003. Such loans
are secured by a first mortgage on the property.
In April 2000, PXRE Reinsurance entered into an Aggregate Excess of
Loss Retrocessional Reinsurance Agreement (the "Agreement") with a U.S. based
cedent.. In the Agreement, PXRE Reinsurance reinsured a portfolio of treaties
(the "Protected Portfolio") underwritten by a former business unit of the cedent
which has been divested. Pursuant to this Agreement, PXRE Reinsurance agreed to
indemnify the cedent for losses in excess of a 75% paid loss ratio on the
underlying Protected Portfolio up to a 100% paid loss ratio, subject to an
aggregate limit of liability of $50 million. The latest loss reports related to
the Agreement provided by the cedent forecast an ultimate net loss ratio in
excess of 100%, which could result in a full limit loss to the Company.
39
In June 2003, PXRE Reinsurance performed an audit of the Protected
Portfolio reinsured under the Agreement. As a result of this audit, management
identified problems and believes that the cedent may have breached its
contractual obligations and fiduciary duties under the Agreement. PXRE
Reinsurance therefore filed suit against the cedent on July 24, 2003 in a United
Stated District Court seeking rescission of the Agreement and/or compensatory
and punitive damages.
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to vigorously prosecute its suit. As of June 30, 2003, we have
recorded $34 million of loss reserves related to the Agreement. If our lawsuit
is unsuccessful, we could potentially incur additional losses under the
Agreement of up to $10.4 million on an after-tax basis.
In May 1999, PXRE Delaware entered into weather option agreements with
two counterparties. In April 2000, these counterparties submitted invoices to
PXRE Delaware in the aggregate sum of $8.3 million seeking payment under the
weather option agreements, which invoices have been paid. PXRE Delaware insured
its obligations under these weather option agreements through two Commercial
Inland Marine Weather Insurance Policies issued by Terra Nova. PXRE Delaware
submitted claims under these policies to Terra Nova in April 2000. Terra Nova
had denied coverage, contending that its Managing General Agent had no authority
to issue these policies.
PXRE Delaware disagreed with Terra Nova's denial and filed suit against
Terra Nova in the United States District Court for the District of New Jersey.
On June 10, 2002, PXRE Delaware was awarded a verdict of $8.3 million plus
accumulated interest of $1.5 million by a jury at the conclusion of the trial of
this dispute. The aggregate sum of $9.8 million is included in Other Assets.
Terra Nova has appealed this verdict to the United States Court of Appeals for
the Third Circuit, but management has concluded that it is unlikely that they
will prevail, and that no valuation allowance is necessary. The appeal was
submitted to the Third Circuit on June 3, 2003.
Certain Transactions
PXRE Reinsurance is a party to a retrocessional agreement (as amended
from time to time, the "Select Re Quota Share Agreement") with Select Re,
pursuant to which we offer to cede a proportional share of our non-casualty
reinsurance business. In 2003 and 2002, the proportional share of our
non-casualty business ceded to Select Re under that agreement was 8.0%. As a
complement to the Select Re Quota Share Agreement, we cede an additional
proportional share to Select Re on certain agreed risks under a variable quota
share agreement. In connection with the Select Re Quota Share Agreement, we have
entered into an undertaking to use commercially reasonable efforts to present
Select Re with aggregate annual premiums equal to a minimum of 20% of Select
Re's shareholders' equity (as defined in the undertaking). This undertaking was
amended in November 2002 and extended until 2005. In return, Select Re is
obligated to pay us a management fee of 15% based on the gross premiums ceded to
them under these quota share agreements.
40
In addition to the Select Re Quota Share Agreement, we have entered
into several other reinsurance transactions with Select Re whereby: (i) Select
Re provided retrocessional support on several finite and other lines reinsurance
transactions underwritten by PXRE; (ii) Select Re provided us with aggregate
excess of loss retrocessional coverage in 2001 that protects us against large
losses arising from a single catastrophe event and against the accumulation of
aggregate losses arising from a number of events; and (iii) we provided Select
Re with catastrophe excess of loss retrocessional coverage that protects them in
the event they incur significant losses arising from a single catastrophe event
which involved premiums of $0.8 million in 2003 and $0.7 million in the first
six months of 2002.
During the first six months of 2003, we ceded reinsurance premiums of
$13 million to Select Re.
As of June 30, 2003, net assets of $70.3 million were due in the
aggregate from Select Re, all of which is fully secured by way of reinsurance
trusts. In addition to the collateralization requirements, we have various
additional protections to ensure Select Re's performance of its obligations to
us. In this regard, pursuant to the Select Re Quota Share Agreement, among other
rights, we have the right to designate one member of Select Re's board of
directors and we have the right to limit the amount of non-PXRE reinsurance
business assumed by Select Re.
Select Re is a Class 3 Bermuda reinsurance company that was formed in
1997. As of December 31, 2002, it had shareholders' equity of approximately $137
million and is privately owned by approximately 120 shareholders. In accordance
with our contractual rights under the Select Re Quota Share Agreement, we had
designated Jeffrey L. Radke, our President and Chief Executive Officer, to serve
on Select Re's board of directors. Prior to joining us in 1999, Jeffrey Radke
had served as the President of Select. Jeffrey Radke receives no remuneration
for serving on Select Re's board.
Gerald Radke, Chairman of our Board of Directors and Jeffrey Radke,
each individually hold Select Re shares, but each such person holds less than 1%
of Select Re's outstanding shares. Pursuant to an agreement with shareholders of
Select Re, Gerald Radke and Jeffrey Radke have each given notice of redemption
to Select Re to sell all of their Select Re shares. The redemption of shares was
effective December 31, 2002 and will be settled by October 2003 in accordance
with the terms of the agreement.
Mr. William Michaelcheck is the Chairman of the Board of Select Re and
also one of its founding shareholders. Mr. Michaelcheck is also the President
and sole shareholder of Mariner. Mariner acts as the investment manager for our
hedge fund and alternative investment portfolio. During the six months ended
June 30, 2003 and 2002, we incurred investment management fees of $0.4 million
and $0.3 million, respectively, relating to services provided by Mariner.
41
The Company's Board of Directors reviews the various transactions with
Select Re at each of its meetings. In addition, the Board of Directors requires
the prior approval of the Company's Chief Financial Officer for any transaction
entered into with Select Re.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We have reviewed our exposure to market risks at June 30, 2003 and the
changes in exposure since December 31, 2002. The principal market risks we are
exposed to continue to be interest rate and credit risk. The additional risks
associated with our hedge fund investments are described earlier.
The composition of our fixed maturity portfolio did not change
materially during the second quarter of 2003. There was no material change in
our exposure to market risks or our risk management strategy during the second
quarter of 2003.
Item 4. Controls and Procedures
An evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures as of August 6, 2003 was conducted under the
supervision and with the participation of our management, including our chief
executive officer and chief financial officer. Based on that evaluation, our
management, including our chief executive officer and chief financial officer,
concluded that our disclosure controls and procedures were effective as of June
30, 2003. There have been no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
last evaluation of such internal controls.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
In April 2000, PXRE Reinsurance entered into an Aggregate Excess of
Loss Retrocessional Reinsurance Agreement (the "Agreement") with a U.S. based
cedent. In the Agreement, PXRE Reinsurance reinsured a portfolio of treaties
(the "Protected Portfolio") underwritten by a former business unit of the cedent
which has been divested. Pursuant to this Agreement, PXRE Reinsurance agreed to
indemnify the cedent for losses in excess of a 75% paid loss ratio on the
underlying Protected Portfolio up to a 100% paid loss ratio, subject to an
aggregate limit of liability of $50 million. The latest loss reports related to
the Agreement provided by the cedent forecast an ultimate net loss ratio in
excess of 100%, which could result in a full limit loss to the Company.
42
In June 2003, PXRE Reinsurance performed an audit of the Protected
Portfolio reinsured under the Agreement. As a result of this audit, management
identified problems and believes that the cedent may have breached its
contractual obligations and fiduciary duties under the Agreement. PXRE
Reinsurance therefore filed suit against the cedent on July 24, 2003 in a United
Stated District Court seeking rescission of the Agreement and/or compensatory
and punitive damages.
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to vigorously prosecute its suit. As of June 30, 2003, we have
recorded $34 million of loss reserves related to the Agreement. If our lawsuit
is unsuccessful, we could potentially incur additional losses under the
Agreement of up to $10.4 million on an after-tax basis.
In May 1999, PXRE Delaware entered into weather option agreements with
two counterparties. In April 2000, these counterparties submitted invoices to
PXRE Delaware in the aggregate sum of $8.3 million seeking payment under the
weather option agreements, which invoices have been paid. PXRE Delaware insured
its obligations under these weather option agreements through two Commercial
Inland Marine Weather Insurance Policies issued by Terra Nova. PXRE Delaware
submitted claims under these policies to Terra Nova in April 2000. Terra Nova
had denied coverage, contending that its Managing General Agent had no authority
to issue these policies.
PXRE Delaware disagreed with Terra Nova's denial and filed suit against
Terra Nova in the United States District Court for the District of New Jersey.
On June 10, 2002, PXRE Delaware was awarded a verdict of $8.3 million plus
accumulated interest of $1.5 million by a jury at the conclusion of the trial of
this dispute. The aggregate sum of $9.8 million is included in Other Assets.
Terra Nova has appealed this verdict to the United States Court of Appeals for
the Third Circuit, but management has concluded that it is unlikely that they
will prevail, and that no valuation allowance is necessary. The appeal was
submitted to the Third Circuit on June 3, 2003.
Item 2. Changes in Securities and Use of Proceeds.
On May 15, 2003, PXRE Capital Statutory Trust II, a Connecticut
statutory trust and a wholly-owned subsidiary of the Company, sold in a private
transaction, $17.5 million principal amount of I-PreTS(sm) based on an equal
principal amount of the Company's fixed/floating rate junior subordinated
deferrable interest debentures due May 15, 2033. The securities bear interest at
an initial rate of 7.35%. The Company used the net proceeds of the sale to repay
the balance of $10 million outstanding under its Credit Agreement, and to
provide additional capital to PXRE Bermuda.
Interest on the I-PreTS(sm) is payable quarterly in arrears on August
15, November 15, February 15 and May 15 of each year commencing August 15, 2003,
at an annual rate equal to 7.35% until May 15, 2008 and thereafter at an annual
rate of three month LIBOR plus 4.1%, reset quarterly. The Company also has the
right to defer payment of interest on the I-PreTS(sm) securities for up to 20
consecutive quarterly periods. Interest will continue to accrue and be
compounded at the rate of interest payable on the I-PreTS(sm) securities in such
period. If the Company exercises its right to defer interest on the I-PreTS(sm)
securities, then in that period, the Company will not be able to pay any
dividends or distributions on, or redeem, purchase, acquire, or make a
liquidation payment with respect to, any of the Company's common shares or
preferred shares or make any payment of principal of or interest or premium on,
or repay, repurchase or redeem any debt securities of the Company that rank pari
passu in all respects with or junior in interest to the debentures.
43
On May 23, 2003, the Company and PXRE Capital Trust III, a Delaware
statutory trust and a wholly-owned subsidiary of the Company, sold in a private
transaction, $15 million principal amount 9.75% fixed rate InCapS(sm) due May
23, 2033. The Company used the net proceeds of the sale to provide additional
capital to PXRE Bermuda.
Interest on the InCapS(sm) securities is fixed throughout the term, and
payable quarterly in arrears, on February 23, May 23, August 23 and November 23
of each year, commencing on August 23, 2003. The Company also has the right to
defer payments of interest on the InCapS(sm) securities for up to 20 consecutive
quarterly periods. Interest will continue to accrue and be compounded quarterly
at 9.75%, the rate of interest payable on the InCapS(sm) securities. If the
Company exercises its right to defer interest on the InCapS(sm) securities, then
in that period, the Company may not declare or pay any dividends or
distributions on, or redeem, purchase, acquire, or make a liquidation payment
with respect to, any of the Company's common shares or preferred shares, make
any payment of principal of or premium or interest on or repay, repurchase or
redeem, any debt securities of the Company that rank in all respects pari passu
with or junior in interest to the InCapS(sm) securities or make any payment
under any guarantees of the Company that rank in all respects pari passu with or
junior in interest to the InCapS(sm) securities.
During the quarter ended June 30, 2003, the Company issued the
following equity securities in transactions that were not registered under the
Securities Act of 1933, as amended (the "Act"):
(a) Securities sold. On June 30, 2003, the Company issued 324.52
Convertible Voting Preferred Shares to the existing holders of
the Company's Convertible Preferred Shares in payment of its
dividend obligation thereon. The 324.52 Convertible Voting
Preferred Shares issued were allocated among Series as
follows:
i. 162.26 shares of Series A Convertible Voting
Preferred Shares, allocated to two sub-series of
shares, 108.17 shares allocated to sub-series Al and
54.09 shares allocated to sub-series A2;
44
ii. 108.17 shares of Series B Convertible Voting
Preferred Shares, allocated to two sub-series of
shares, 72.11 shares allocated to Series B1 and 36.06
shares allocated to Series B2; and
iii. 54.09 shares of Series C Convertible Voting Preferred
Shares, allocated to two sub-series of shares, 36.06
shares allocated to Series Cl and 18.03 shares
allocated to Series C2.
(b) Underwriters and other purchasers. No underwriter
participated. The additional Convertible Voting Preferred
Shares were issued to the holders of record on June 13, 2003
of the outstanding Convertible Voting Preferred Shares.
(c) Consideration. The Convertible Voting Preferred Shares were
issued in satisfaction of the Company's obligation to pay a
quarterly dividend of $3.2 million to the holders of the
outstanding Convertible Voting Preferred Shares.
(d) Exemption from registration claimed. Exemption from
registration under the Act was claimed based upon Section 4(2)
of the Act as a sale by an issuer not involving a public
offering.
(e) Terms of conversion and exercise. The description of the terms
of the Preferred Shares contained in Part II, Item 5 of the
Company's Annual Report on Form 10-K for the year ended
December 31, 2002 is incorporated herein by reference.
(f) Use of proceeds. Not applicable.
Item 3. Defaults Upon Senior Securities.
None.
45
Item 4. Submission of Matters to a Vote of Security Holders.
At the Company's Annual General Meeting of Shareholders held on May 28,
2003, the Company's shareholders approved the following:
(i) The election of three Class II directors to serve until the
2006 Annual Meeting of Shareholders and until their successors
have been elected and have qualified:
Nominee Votes For Votes Withheld
Robert W. Fiondella 9,400,897 82,373
Halbert D. Lindquist 9,400,897 82,373
Philip R. McLoughlin 9,400,897 82,373
(ii) The appointment of KPMG as PXRE's independent auditors for the
fiscal year ending December 31, 2003, and referral to the
Board of the determination of their remuneration by the vote
of 15,156,193 votes for, 1,550 votes against, 625 votes
abstaining;
(iii) The adoption of an amendment to the PXRE Director Stock Plan
("the "Director Stock Plan") to (a) increase the number of
Common Shares authorized thereunder by 250,000; (b) increase
the annual grant of restricted shares thereunder from 1,000 to
2,500 restricted shares; (c) permit Class IV Directors to
cause PXRE to grant the options and/or restricted shares that
such Class IV Directors are otherwise entitled to receive
directly to their employer or to an affiliate of their
employer; and (d) extend the expiration date of the Director
Stock Plan from 2005 to 2013 by a vote of 14,694,980 votes
for, 41,872 votes against, 417,750 votes abstaining.
Item 5. Other Information.
Following the Company's Annual General Meeting of
Shareholders, and effective as of July 25, 2003, Halbert D.
Lindquist resigned as a director of the Board in consideration
of certain family issues. Management has undertaken a search
to identify a replacement director as soon as practicable.
Item 6. Exhibits and Reports on Form 8-K.
a. Exhibits
10.1 Amended and Restated Declaration of Trust of PXRE Capital Statutory
Trust II, dated as of May 15, 2003, among PXRE Group Ltd., as Sponsor,
the Administrators thereof, U.S. Bank National Association, as
Institutional Trustee, and the holders from time to time of undivided
beneficial interests in the assets of PXRE Capital Statutory Trust II.
46
10.2 Indenture for Fixed/Floating Rate Junior Subordinated Deferrable
Interest Debentures due 2033, dated as of May 15, 2003, among PXRE
Group Ltd. as Issuer, and U.S. Bank National Association, as Trustee.
10.3 Guarantee Agreement, dated as of May 15, 2003, executed and delivered
by PXRE Group Ltd., as Guarantor, and Wilmington Trust Company, as
Trustee, for the benefit of the holders from time to time of the
Capital Securities of PXRE Capital Statutory Trust II.
10.4 Capital Securities Subscription Agreement, dated as of May 15, 2003,
among PXRE Capital Statutory Trust II and PXRE Group Ltd. as Offerors,
and I-Preferred Term Securities II, Ltd., as Purchaser.
10.5 Placement Agreement, dated as of April 25, 2003, among PXRE Group Ltd.
and PXRE Capital Statutory Trust II, as Offerors, and FTN Financial
Capital Markets and Keefe, Bruyette & Woods, Inc., as Placement Agents.
10.6 Amended and Restated Declaration of Trust of PXRE Capital Trust III,
dated as of May 22, 2003, among PXRE Group Ltd., as Sponsor, the
Administrators thereof, Wilmington Trust Company, as Delaware and
Institutional Trustee, and the holders from time to time of undivided
beneficial interests in the assets of PXRE Capital Trust III.
10.7 Indenture for Fixed Rate Junior Subordinated Debt Securities due 2033,
dated as of May 22, 2003, among PXRE Group Ltd. as Issuer, and
Wilmington Trust Company, as Trustee.
10.8 Guarantee Agreement, dated as of May 22, 2003, executed and delivered
by PXRE Group Ltd., as Guarantor, and Wilmington Trust Company, as
Trustee, for the benefit of the holders from time to time of the
Capital Securities of PXRE Capital Trust III.
10.9 Common Securities Subscription Agreement, dated as of May 22, 2003,
among PXRE Capital Trust III, and PXRE Group Ltd., as Buyer of the
Common Securities of PXRE Capital Trust III.
10.10 Capital Securities Subscription Agreement, dated as of May 13, 2003,
among PXRE Capital Trust III and PXRE Group Ltd. as Offerors, and
InCapS Funding I, Ltd., as Purchaser.
10.11 Debenture Subscription Agreement, dated as of May 22, 2003, among PXRE
Group Ltd. and PXRE Capital Trust III.
10.12 Placement Agreement, dated as of May 13, 2003, among PXRE Capital Trust
III and PXRE Group Ltd., as Offerors, and Sandler O'Neill & Partners,
L.P., as Placement Agents.
47
10.13 Employment Agreement, dated as of June 30, 2003, among PXRE Group Ltd.
and Jeffrey L. Radke.
31.1 Certification by the Chief Executive Officer Relating to a Periodic
Report Containing Financial Statements pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification by the Chief Financial Officer Relating to a Periodic
Report Containing Financial Statements Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Periodic Report Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
b. Current Reports on Form 8-K
On June 4, 2003, the Company filed a Current Report on Form 8-K
with the SEC relating to the retirement of Gerald L. Radke, its
Chief Executive Officer on June 30, 2003, who will continue as
non-executive Chairman of its Board of Directors, and will be
engaged on a consulting basis commencing July 1, 2003 as Chairman
of the Underwriting Committees.
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
10.1 Amended and Restated Declaration of Trust of PXRE Capital Statutory
Trust II, dated as of May 15, 2003, among PXRE Group Ltd., as Sponsor,
the Administrators thereof, U.S. Bank National Association, as
Institutional Trustee, and the holders from time to time of undivided
beneficial interests in the assets of PXRE Capital Statutory Trust II.
10.2 Indenture for Fixed/Floating Rate Junior Subordinated Deferrable
Interest Debentures due 2033, dated as of May 15, 2003, among PXRE
Group Ltd. as Issuer, and U.S. Bank National Association, as Trustee.
10.3 Guarantee Agreement, dated as of May 15, 2003, executed and delivered
by PXRE Group Ltd., as Guarantor, and Wilmington Trust Company, as
Trustee, for the benefit of the holders from time to time of the
Capital Securities of PXRE Capital Statutory Trust II.
10.4 Capital Securities Subscription Agreement, dated as of May 15, 2003,
among PXRE Capital Statutory Trust II and PXRE Group Ltd. as Offerors,
and I-Preferred Term Securities II, Ltd., as Purchaser.
48
10.5 Placement Agreement, dated as of April 25, 2003, among PXRE Group Ltd.
and PXRE Capital Statutory Trust II, as Offerors, and FTN Financial
Capital Markets and Keefe, Bruyette & Woods, Inc., as Placement Agents.
10.6 Amended and Restated Declaration of Trust of PXRE Capital Trust III,
dated as of May 22, 2003, among PXRE Group Ltd., as Sponsor, the
Administrators thereof, Wilmington Trust Company, as Delaware and
Institutional Trustee, and the holders from time to time of undivided
beneficial interests in the assets of PXRE Capital Trust III.
10.7 Indenture for Fixed Rate Junior Subordinated Debt Securities due 2033,
dated as of May 22, 2003, among PXRE Group Ltd. as Issuer, and
Wilmington Trust Company, as Trustee.
10.8 Guarantee Agreement, dated as of May 22, 2003, executed and delivered
by PXRE Group Ltd., as Guarantor, and Wilmington Trust Company, as
Trustee, for the benefit of the holders from time to time of the
Capital Securities of PXRE Capital Trust III.
10.9 Common Securities Subscription Agreement, dated as of May 22, 2003,
among PXRE Capital Trust III, and PXRE Group Ltd., as Buyer of the
Common Securities of PXRE Capital Trust III.
10.10 Capital Securities Subscription Agreement, dated as of May 13, 2003,
among PXRE Capital Trust III and PXRE Group Ltd. as Offerors, and
InCapS Funding I, Ltd., as Purchaser.
10.11 Debenture Subscription Agreement, dated as of May 22, 2003, among PXRE
Group Ltd. and PXRE Capital Trust III.
10.12 Placement Agreement, dated as of May 13, 2003, among PXRE Capital Trust
III and PXRE Group Ltd., as Offerors, and Sandler O'Neill & Partners,
L.P., as Placement Agents.
10.13 Employment Agreement, dated as of June 30, 2003, among PXRE Group Ltd.
and Jeffrey L. Radke.
31.1 Certification by the Chief Executive Officer Relating to a Periodic
Report Containing Financial Statements pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification by the Chief Financial Officer Relating to a Periodic
Report Containing Financial Statements Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Periodic Report Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
49
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report or amendment thereto to be signed on
its behalf by the undersigned thereunto duly authorized.
PXRE GROUP LTD.
August 8, 2003 By:/s/ John M. Modin
-----------------
John M. Modin
Senior Vice President
and Chief Financial Officer
50