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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington,WASHINGTON, D.C. 20549
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FORM 10-K
[X]/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended DecemberFOR THE FISCAL YEAR ENDED DECEMBER 31, 19992001
OR
[ ]/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from to
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Commission File No.FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 0-26456
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD.
(Exact name of Registrant as specified in its charter)
Delaware 06-1424716
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 Horseneck Lane
Greenwich, Connecticut 06830
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BERMUDA NOT APPLICABLE
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification)
WESSEX HOUSE
45 REID STREET
HAMILTON HM 12 BERMUDA
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 862-4300(441) 296-8240
Securities registered pursuant to Section 12(b) of the Act:
Name of each Exchange
Title of Each Class on which Registered
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NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per shareCOMMON SHARES, PAR VALUE $0.01 PER SHARE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or 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_______/X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]/X/
The aggregate market value of the voting stockcommon shares held by non-affiliates of
the Registrant as of March 27, 20008, 2002 was approximately $160,932,207$341,147,288 based on the
closing price on the Nasdaq National Market on that date.
As of March 27, 2000,8, 2002, there were 12,329,398 shares15,765,332 of the Registrant's Common Stockcommon shares
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts I and II incorporate by reference our definitive proxy statement for
a special meeting of our stockholders relating to the asset sale described in
this annual report. Part III incorporates by reference our definitive proxy
statement for the 2000 annual meeting of stockholders to be filed with the
Securities and Exchange Commission before April 30, 2000.- --------------------------------------------------------------------------------
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RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD.
TABLE OF CONTENTS
Item Page
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Part I
1. Business................................................................... 1
2. Properties................................................................ 25
3. Legal Proceedings......................................................... 25
4. Submission of Matters to a Vote of Security Holders....................... 25
Part II
5. Market for Registrant's Common Equity and Related Stockholder Matters..... 25
6. Selected Financial Data and Unaudited Pro Forma Condensed Consolidated
Financial Data....................................................... 27
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 35
7A.Quantitative and Qualitative Disclosures About Market Risk................ 52
8. Financial Statements and Supplementary Data............................... 52
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................. 52
Part III
10.Directors and Executive Officers of the Registrant........................ 52
11.Executive Compensation.................................................... 52
12.Security Ownership of Certain Beneficial Owners and Management............ 52
13.Certain Relationships and Related Transactions............................ 53
Part IV
14.Exhibits, Financial Statement Schedules and Reports on Form 8-K........... 53
ITEM PAGE
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PART I
ITEM 1. BUSINESS.................................................... 1
ITEM 2. PROPERTIES.................................................. 46
ITEM 3. LEGAL PROCEEDINGS........................................... 46
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 46
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS....................................... 47
ITEM 6. SELECTED FINANCIAL DATA..................................... 48
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 51
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK...................................................... 63
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................. 63
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.................................. 63
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 64
ITEM 11. EXECUTIVE COMPENSATION...................................... 66
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................ 76
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 84
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K....................................................... 85
i
Cautionary Note Regarding Forward-Looking StatementsCAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This Form 10-K, our Annual Report to
Stockholders, any proxy statement, any Form 10-Q or any Form 8-K of the company
or any other written or oral statements made by or on behalf of the company may
includereport includes forward-looking
statements which reflect our current views with respect to future events and
financial performance. All statements other than statements of historical fact
included in or incorporated by reference in this report are forward-looking
statements. Forward-looking statements can generally be identified by the use of
forward-looking terminology such as "may," "will," "expect," "intend,"
"estimate," "anticipate," "believe" or "continue" or their negative or
variations or similar terminology.
Forward-looking statements involve our current assessment of risks and
uncertainties. Actual events and results may differ materially from those
expressed or implied in these statements. Important factors relating to our
existing business that could cause
actual events or results to differ materially from those indicated in such
statements are discussed below and elsewhere in this report, including, without
limitation, the section entitled "Risk Factors," and include:
o the- our management's ability to successfully implement its business strategy,
as described herein;
- acceptance in the market of our reinsurance products;
o competition from new products (including products that may be offeredand services and security by the capital markets);
o the availabilitybrokers and
insureds;
- acceptance of investments on attractive terms;
o competition, including increased competition (bothour business strategy, security and financial condition by
rating agencies and regulators;
- general economic and market conditions (including as to underwritinginflation and
investment opportunities);
o changes in the performance of the insurance sector of the public
equity markets or market professionals' views as to such sector;
o the amount of underwriting capacity from time to time in the market;
o general economic conditionsforeign currency exchange rates) and conditions specific to the
reinsurance and investmentinsurance markets in which we operate;
o- competition, including increased competition, on the basis of pricing,
capacity, coverage terms or other factors;
- the integration of businesses we have acquired or may acquire into our
existing operations;
- greater than expected loss ratios on business written by us and adverse
development on claim and/or claim expense liabilities related to business
written by us;
- acts of terrorism, other hostilities or other unforecasted and
unpredictable events;
- losses relating to aviation business and business produced by a certain
managing underwriting agency for which we may be liable to the purchaser
of our prior reinsurance business or to others in connection with the
May 5, 2000 asset sale;
- availability to us of reinsurance to manage our gross and net exposures;
- the failure of reinsurers or others to meet their obligations to us;
- the timing of claims payments being faster or the receipt of reinsurance
recoverables being slower than anticipated by us;
- changes in the financial environment, including interest rates;
- changes in accounting principles or the application of such principles by
accounting firms or regulators;
- statutory or regulatory, changesincluding as to tax policy and conditions;
omatters and
insurance regulatory matters and government provision or back-stopping of
insurance (including for acts of terrorism); and
- rating agency policies and practices;
o claims development, including as to the frequency or severity of
claims and the timing of payments; and
o loss of key personnel.practices.
ii
In addition to risks and uncertainties related to our existing business, the
proposed sale of our reinsurance operations to Folksamerica Reinsurance Company
referred to in this report is subject to various risks and uncertainties
including the risks thatdiscussed in "Risk Factors," other general factors
could affect our results, including: (a) developments in the conditions to closing will not be satisfiedworld's financial
and that the costs of the transaction and purchase price and reserve adjustments
will be greater than currently expected with resulting effects on our book
value. These and other risks relating to the proposed asset salecapital markets and our access to such markets; (b) changes in regulations
or tax laws applicable to us, our subsidiaries, brokers or customers; and
(c) the effects of business after the sale are discussed in the "Risk Factors" section of our
definitive proxy statement for the special meeting of our stockholders relatingdisruption or economic contraction due to the asset sale. The special meeting proxy statement is filed as an exhibit to
this annual report and is incorporated by reference in its entirety.terrorism
or other hostilities.
All subsequent written and oral forward-looking statements attributable to
us or persons acting on our behalf are expressly qualified in their entirety by
these cautionary statements. The foregoing review of important factors should
not be construed as exhaustive and should be read in conjunction with other
cautionary statements that are included herein or elsewhere. We undertake no
obligation to publicly update or revise any forward-looking statement, whether
as a result of new information, future events or otherwise.
(ii)iii
PART I
ITEM 1. BUSINESS
In this document,report, unless the context requires otherwise: (a) "ACGL" refers to
Arch Capital Group Ltd., (b) "we," "us,"us" and "our" refer to ACGL and its
subsidiaries, (c) "Arch Re (Bermuda)" "our"refers only to our wholly owned Bermuda
reinsurance subsidiary, Arch Reinsurance Ltd., and (d) "Arch Re (US)" refers
only to our wholly owned U.S. reinsurance subsidiary, Arch Reinsurance Company.
The term "Arch US operations" refers to the insurance and reinsurance operations
conducted in the United States principally by our subsidiaries First American
Insurance Company, Arch Reinsurance Company, Cross River Insurance Company and
Rock River Insurance Company. The term "Arch worldwide operations" refers to
those operations conducted outside the United States principally by our
subsidiaries Arch Re (Bermuda) and Arch Risk Transfer Services Ltd. We sometimes
refer to these businesses collectively as our "core businesses." The term "other
businesses" refers principally to the insurance advisory and other businesses
conducted principally by our subsidiaries Hales & Company, Inc. and American
Independent Insurance Holding Company. The terms the "Warburg Pincus funds" and
the "company""Hellman & Friedman funds" refer to Risk Capital
Holdings, Inc. and/or Risk Capital Reinsurance Company,the Warburg Pincus LLC private equity
funds and the Hellman & Friedman LLC private equity funds.
OUR COMPANY
We are a Bermuda public limited liability company with $1.0 billion in
equity capital and, through operations in Bermuda and the United States, are
positioned to write insurance and reinsurance on a worldwide basis. While we are
positioned to provide a full range of property and casualty insurance and
reinsurance lines, we are focusing on writing specialty lines of insurance and
reinsurance profitably and earning a superior return on equity as we establish
an enduring underwriting franchise.
Recent events have provided a significant market opportunity for well
capitalized insurance companies that are not burdened by the context requires.
Certain terms used below are defineduncertainties
resulting from prior years' underwriting losses and material reinsurance
recoverable balances. As a result, we recently launched an underwriting
initiative that included the recruitment of new insurance and reinsurance
management teams and an equity capital infusion of $763.2 million. It is our
belief that our existing Bermuda and U.S.-based underwriting platform, our
strong management team and our $1.0 billion in capital that is unencumbered by
significant exposure to pre-2002 risks have enabled us both to establish an
immediate presence in an increasingly attractive insurance marketplace and to
actively participate in the "GlossaryJanuary 1, 2002 reinsurance renewal season. Since
January 1, 2002, we have entered into approximately 800 reinsurance treaties and
other reinsurance arrangements which are expected to provide approximately
$500 million of Selected Insurance
Terms" appearing on pages 21-24 of this report.
The Companygross written reinsurance premiums during 2002.
OUR HISTORY
We were incorporated in March 1995 under the laws of the State of Delaware
and commenced operations in September 1995 uponfollowing the completion of ourthe
initial public offering. Throughoffering of our wholly owned operating subsidiary,predecessor, Risk Capital Reinsurance Company ("RCRe"),Holdings Inc. From that
time until May 2000, we provideprovided reinsurance and other forms of capital either on a stand-alone basis, or as partto
insurance companies. On May 5, 2000, we sold our prior reinsurance book of
integrated solutions for insurance
companies with capital needs that cannot be met by reinsurance alone. RCRe is
rated "A-" (Excellent) by A.M. Best Company. Following the announcement of the
proposed sale of our reinsurance operationsbusiness to Folksamerica Reinsurance Company (see "--Recent Developments" below), A.M. Best announced on January 18,in an asset sale, but retained our
surplus and our U.S.-licensed reinsurance platform. On November 8, 2000,
that it was placingfollowing shareholder approval, we changed our A- rating under review. At December 31, 1999, RCRe had
statutory surplus of $290.1 million (or $230.1 million after giving pro forma
effectlegal domicile to our recent repurchase of 4,755,000 sharesBermuda in
order to benefit from Bermuda's favorable business, regulatory, tax and
financing environment.
During the period from May 2000 through the announcement of our common stock from XL
Capital Ltd.)underwriting
initiative in October 2001, we built and acquired insurance businesses that
enable us to generate both fee-based revenue (e.g., commissions and advisory and
management fees) and risk-based revenue (i.e., insurance premium). Based upon data available fromAs part of
this strategy, we built an underwriting platform that is intended to enable us
to
1
maximize risk-based revenue during periods in the Reinsurance Association of
America ("RAA")underwriting cycle when we
believe it is more favorable to assume underwriting risk. Recent events have led
us to conclude that underwriting conditions favor dedicating our attention
exclusively to building our insurance and reinsurance business.
PRINCIPAL EXECUTIVE OFFICES
Our registered office is located at Clarendon House, 2 Church Street,
Hamilton HM 11 Bermuda (telephone number: (441) 295-1422), RCRe is the 20th largest United States based broker market
oriented reinsurer as measured by its statutory surplus of $230 million.
Ourand our principal
executive offices are located at Wessex House, 45 Reid Street, Hamilton HM 12
Bermuda (telephone number: (441) 296-8240).
RECENT DEVELOPMENTS
THE CAPITAL INFUSION
On November 20, Horseneck Lane, Greenwich, Connecticut 06830,2001, investors led by the Warburg Pincus funds and our telephone number is (203) 862-4300.
Recent Developments
Folksamerica Transaction
As of January 10, 2000, we entered into an agreement with Folksamerica
Reinsurance Company and Folksamerica Holding Company (collectively,
"Folksamerica") pursuant to which Folksamerica Reinsurance Company will assume
RCRe's liabilities under the
reinsurance agreements transferred in the asset
sale and RCRe will transfer to Folksamerica Reinsurance Company assets in an
aggregate amount that is, in book value, equal to the book value of the
liabilities assumed. In considerationHellman & Friedman funds purchased from us, for the transfer of RCRe's book of
business, Folksamerica will pay $20.335$750.0 million in cash,
at35,072,795 series A convertible preference shares and 3,710,959 class A
warrants. At the same time, we also entered into a management subscription
agreement whereby certain members of our management (or entities affiliated with
them) agreed to purchase, for an aggregate of $13.2 million, 614,940 preference
shares and 65,066 class A warrants. The purpose of this capital infusion was to
provide a significant infusion of capital to launch our new underwriting
initiative to meet current and future demand in the global insurance and
reinsurance markets. On March 7, 2002, certain matters relating to the capital
infusion required to be approved by our shareholders were approved. Regulatory
approvals required in connection with the capital infusion have been obtained in
Nebraska, Missouri and Wisconsin, and required regulatory approvals are pending
in Pennsylvania and Florida.
Prior to the closing subjecton November 20, 2001, the Warburg Pincus funds and the
Hellman & Friedman funds assigned portions of their commitments to adjustment underthird
parties. At closing, we issued the circumstances set forth infollowing numbers of preference shares and
class A warrants for the asset purchase agreement.
The saleaggregate dollar amounts specified:
AGGREGATE
PREFERENCE SHARES CLASS A WARRANTS DOLLAR AMOUNT
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Warburg Pincus funds............................ 18,939,311 2,003,918 $405,000,000
Hellman & Friedman funds........................ 10,521,839 1,113,289 225,000,000
Trident II, L.P. and co-investment funds(1)..... 1,636,729 173,178 35,000,000
Farallon Capital investors...................... 1,169,093 123,698 25,000,000
Insurance Private Equity Investors, L.L.C.
(affiliated with GE Asset Management)......... 2,338,186 247,397 50,000,000
Orbital Holdings, Ltd. (affiliated with GE
Capital)...................................... 467,637 49,479 10,000,000
Management investors............................ 614,940 65,066 13,150,000
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Total....................................... 35,687,735 3,776,025 $763,150,000
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(1) In a related transaction, upon closing of our reinsurance business to Folksamerica is contingent on
approvalthe capital infusion, 905,397
previously existing class A warrants held by our stockholders, obtaining applicable regulatory approvals, the
retention of a key employee, obtaining certain third party consents, the absence
of a material adverse change in RCRe's business, and other customary closing
conditions. Marsh & McLennan Risk Capital
Holdings, Ltd. ("MMRCH")were canceled in exchange for 140,380 newly issued common
shares, and 1,770,601 class B warrants held by Marsh & McLennan Risk Capital
Holdings were canceled in exchange for a cash payment by us of $7.50 per
class B warrant (approximately $13.3 million in the aggregate). See
note (2) under "Security Ownership of Certain Beneficial Owners and
Management" for a description of the terms of the class B warrants. Marsh &
McLennan Risk Capital Holdings' pre-existing right to have an observer
attend meetings of our board of directors was terminated, and The Trident
Partnership, L.P. ("Trident")'s pre-existing right to designate a director for election
to our board of directors was terminated. We were
2
released from our remaining $11.0 million capital commitment to Trident II,
L.P. for new investments.
SUBSCRIPTION AGREEMENT
Set forth below is a summary of the material terms of the subscription
agreement entered into with the investors (other than the management investors)
in connection with the capital infusion. You should read this summary in
conjunction with the agreement, which is incorporated herein by reference. A
conformed copy of the subscription agreement is filed herewith as an exhibit.
PURCHASE PRICE. The purchase price for the preference shares and class A
warrants paid at closing was based on the book value of our common shares as of
June 30, 2001. The number of preference shares issued to each investor was equal
to the total dollar amount of that investor's investment divided by the
estimated per share price as determined under the subscription agreement
(approximately $21.384), which collectively represent
approximately 13.3%was based on an estimate of the book value of our
assets at June 30, 2001. The number of warrants issued to each investor was
equal to the Adjusted Warrant Amount times the number of common shares issuable
upon exercise of all outstanding class A warrants (2,531,079) divided by the
number of common shares outstanding as of June 30, 2001 (12,863,079). The
"Adjusted Warrant Amount" was equal to one-half of the quotient of the total
dollar amount of that investor's investment divided by the difference of the
estimated per share price minus $1.50. There would have been an adjustment to
the purchase price if any of the transactions contemplated by the subscription
agreement or the options granted to management concurrently therewith had
triggered an anti-dilution adjustment under our existing class A warrants or
class B warrants, but all holders of those warrants waived any rights to any
anti-dilution adjustment with respect to the issuance under the subscription
agreements or the grants to management contemplated thereby. For the ten trading
days ended October 23, 2001, the last trading day prior to the announcement of
the signing of the subscription agreements for the capital infusion and our new
underwriting initiative, the average closing price of our common shares on the
Nasdaq National Market was $16.86 per share.
PURCHASE PRICE ADJUSTMENTS. The subscription agreement provides that the
estimated per share price may be adjusted as described below. All determinations
to be made by the investors in connection with the purchase price adjustments
will be made by the Warburg Pincus funds and the Hellman & Friedman funds. These
adjustments are the sole remedy for any breach of representations and warranties
of the company under the subscription agreement.
AUDIT ADJUSTMENT. We agreed to engage PricewaterhouseCoopers as independent
accountants to audit our consolidated balance sheet as of June 30, 2001, an
independent actuary (to be selected by us and the Warburg Pincus funds and the
Hellman & Friedman funds) to review the reserves for claims and claims expenses
on our balance sheet, and an independent pricing service selected by us and the
Warburg Pincus funds and the Hellman & Friedman funds to determine the estimated
fair value of our investments in marketable securities as of the third business
day prior to closing. The independent pricing service, the public accountants
and the independent actuary are referred to below as the independent advisors.
If the audited per share price is greater than the estimated per share price
at closing, each investor will either pay the difference to us in cash or return
the equivalent amount in preference shares. If the estimated per share price at
closing is greater than the audited per share price, we will issue an amount of
preference shares to the investors representing the difference. We currently
estimate that we will issue an additional 875,765 preference shares during the
first quarter of 2002 in connection with the audit of the book value of our
assets at June 30, 2001 discussed above.
ADJUSTMENT FOR TRADING PRICE OR CHANGE OF CONTROL. In the event that on or
prior to September 19, 2005, (1) the closing price of our common shares is at
least $30.00 per share for at least 20 out of 30 consecutive trading days or
(2) a change of control occurs (either case, a "Triggering Event"), we
3
agreed to issue and deliver to each investor additional preference shares such
that the audited per share price is adjusted downward by $1.50 per preference
share. For this purpose "change of control" means the acquisition by any person
or group (within the meaning of section 13(d)(3) of the Exchange Act) of
beneficial ownership of 40% or more by either the voting power of our then
outstanding common stock
(after giving effectshares or the combined voting power of our then outstanding
voting securities entitled to vote generally in the election of directors;
provided that if such acquisition results in whole or in part from a transfer of
common shares or other voting securities by Marsh & McLennan Companies, Inc. or
any of its subsidiaries, such acquisition will not constitute a change of
control unless such transfer is effected pursuant to an offer by such acquiror
to purchase all of our outstanding common shares.
FINAL ADJUSTMENTS. We agreed to make another adjustment at the second
anniversary of closing (or such earlier date as the Warburg Pincus funds and the
Hellman & Friedman funds request and the Transaction Committee (described below
under "--Transaction Committee") agrees) based on an adjustment basket described
below.
The adjustment basket will be equal to:
- the difference between value realized upon sale and the book value at
closing (as adjusted based on a pre-determined growth rate) of the agreed
upon non-core businesses; plus
- the difference between the GAAP net book value of all of our insurance
balances with respect to any policy or contract written or having an
effective date prior to November 20, 2001 (I.E., premiums receivable,
unpaid claims and claims expenses recoverable, prepaid reinsurance
premiums, reinsurance balances receivable, deferred policy acquisition
costs, claims and claims expenses, unearned premiums, reinsurance balances
payable, and any other insurance balance attributable to our "core
insurance operations," as defined below) at the time of determination of
the final adjustment and those balances at the closing; minus
- reductions in book value arising from (without duplication of any expenses
included in the calculation of value realized upon sale of the non-core
businesses or any expense otherwise reflected in the determination of the
per share price) costs and expenses relating to the repurchaseinvestments and
transactions provided for under the subscription agreement, actual losses
arising out of 4,755,000 shares on March 2, 2000 from
XLbreach of representations under the subscription agreement
and certain other costs and expenses.
Our "core insurance operations" include:
- Arch Re (Bermuda);
- Arch Capital which is discussed below)Group (U.S.) Inc.;
- Arch Re (US);
- Cross River (including funding for Rock River);
- ART Services (including First American Financial Corporation);
- capital held at ACGL, gross of capital to be invested in unfunded private
equity commitments; and
- $2.5 million in segregated assets and liabilities in "cell" accounts
formed by Alternative Insurance Company Limited and Alternative Re, Ltd.
Non-core businesses are currently defined as American Independent Insurance
Holding Company, Hales & Company Inc., escrow assets under the Folksamerica
disposition agreement, all nonpublic securities held by ACGL, Arch Capital Group
(U.S.) Inc. and Arch Re (US) and all commitments to Trident II, L.P.,
Distribution Partners and Innovative Coverage Concepts LLC, as and when funded.
4
The adjustment basket will be calculated by our independent auditors as soon
as practicable after the second anniversary of the closing or such earlier date
as the Warburg Pincus funds and the Hellman & Friedman funds request and ACGL
agrees. ACGL and the Warburg Pincus funds and the Hellman & Friedman funds have
the right to make a full review of the adjustment basket determination. We
agreed to votecause our subsidiaries to maintain the components necessary to
calculate the adjustment basket under separate ledgers.
If the adjustment basket is less than zero, we agreed to issue additional
preference shares to the investors based on the decrease in favorthe value of the
asset
sale.
Detailed information regardingcomponents of the proposed asset sale can be foundadjustment basket. If the adjustment basket is greater than
zero, the subscription agreement allows us to use cash in an amount based on the
increase in value of the components of the adjustment basket to repurchase
common shares (other than any common shares issued upon conversion of the
preference shares or exercise of the class A warrants).
In addition, if the adjustment basket is less than zero and in the sectionsevent
that a Triggering Event occurs, we agreed to issue additional preference shares
to the investors as a further adjustment.
Finally, on the fourth anniversary of our special meeting proxy statement entitled "Questions and Answers
Aboutthe closing, there will be a
calculation of a further adjustment basket based on (1) liabilities in excess of
the Folksamerica escrow assets owed to Folksamerica under the Asset Sale," "Risk Factors," "The Asset Sale," "The Asset Purchase
Agreement"Agreement, dated as of January 10, 2000, between ACGL, Arch Re (US),
Folksamerica Holding Company, Inc. and "Other Transaction Agreements," which are incorporated by
reference. In addition, we have filedFolksamerica Reinsurance Company and
(2) specified tax and ERISA matters under the asset sale agreement,subscription agreement. As
described under the voting
agreements and other related agreements as exhibits to this annual report. The
above summary of the proposed transaction is qualified by these agreements,
which are incorporated by reference. Please also refer to "Unaudited Pro Forma
Condensed Consolidated Financial Data" andheading "Management's Discussion and Analysis of Financial
Condition and Results of Operations.Operation--General--May 2000 Sale of Our Prior
Reinsurance Operations," 1
XL Transaction
On March 2, 2000,in February 2002, we repurchased from XL Capital, then our single largest
stockholder, all of the 4,755,000 shares of our common stock held by it. Under
the terms ofreached a stock repurchasedefinitive settlement
agreement with XL Capital,Folksamerica pursuant to which we paid $12.45 per
share of our common stock, or a total of $59.2 million. The per share repurchase
price was determined as the lesser of (1) 85% of the average closing market
price of our common stock during the 20 trading days beginning on the third
business day following public announcement of the stock repurchase and asset
sale (January 21, 2000), which was $14.65, and (2) $15. We paid XL Capital the
consideration for the repurchase with: our interest in privately held LARC
Holdings, Ltd. (parent of Latin American Reinsurance Company Ltd.), valued at
$25 million (which was carried by us at $24 million at December 31, 1999); andwill satisfy all of our
interest in Annuity and Life Re (Holdings), Ltd., valued at $25.38
per share and $18.50 per warrant, or $37.8obligations under the escrow agreement for an amount equal to approximately
$17.0 million in the aggregate (which was
carried by us at $38.2 million at December 31, 1999). XL Capital paid us in cash
the difference (equal to $3.6 million) between our repurchase price and the
value of our interests in LARC Holdings and Annuity and Life Re. The value per
share of Annuity and Life Re was determined by taking the average of the closing
price of Annuity and Life Re shares for the same period usedescrowed assets, plus accrued interest on such amount.
RESTRICTIONS ON TRANSFER OF SECURITIES. The investors agreed not to
transfer, in determining the
repurchase price of our shares. The value of the warrants was determined using a
Black Scholes methodology. We have filed the stock repurchase agreement and
related voting and disposition agreement as exhibits to this annual report. The
above summary of theone transaction, is qualified by these agreements, which are
incorporated by reference.
As a result of this transaction, stockholders' equity, which was $346.5
million at December 31, 1999, has been reduced by $59.4 million and the number
of outstanding voting shares, which was 17,087,970 at December 31, 1999, was
12,332,970 at March 2, 2000.
RCRe's statutory surplus, which was $290.1 million at December 31, 1999,
was also reduced by $60 million for the distribution of the stock and warrants
in both LARC Holdings and Annuity and Life Re to us based on their statutory
carrying values at December 31, 1999.
Future Operations
After the sale of our reinsurance operations to Folksamerica is completed,
the company's objective will be to serve as a vehicle to effect business
combinations and ventures, whether by acquiring all or a portionseries of companies,
merger, exchange of stock or otherwise, with one or more operating companies
that our board of directors believes will have potential to increase stockholder
value. These business combinations and ventures may be with companies that are
not in the insurance business. The company may cease to pursue this business
objective at any time and may also consider alternatives. Please refer to the
section of our special meeting proxy statement entitled "Risk Factors" for a
discussion of certain risks relating to our business after the sale of our
reinsurance operations to Folksamerica Reinsurance Company.
The description of the company's business set forth below provides a
discussion of the company's business to date and, accordingly, does not describe
what we currently intend to be our business strategy following the asset sale.
Reinsurance Underwriting
We have sought to take advantage of underwriting opportunities in
connection with our equity investment activities and, where appropriate, to
provide reinsurance to insurers in which we invest.
We have also sought to write "large lines" (i.e., significant portions) on
a limited number of traditional and finite risk property and casualty
reinsurance treaties with a select number of insurance and reinsurance companies
located throughout the world (although our principal focus has been on large
United States and European-based insurance and reinsurance companies) and with
select Lloyd's syndicates.
We have focused our efforts on treaty reinsurance and have sought to establish
and cultivate long-term relationships with our reinsureds. In addition, we
intend to write conservatively in terms of the company's surplus capacity, which
helps enable us to maintain underwriting capacity and flexibility. At December
31, 1999, and after giving pro forma effect to our recent repurchase of
4,755,000 shares of our common stock from XL Capital, RCRe's premium-to-surplus
ratio was 1.3x, which represents an increase from our prior intention that
RCRe's premium-to-surplus ratio not exceed 1.0x. This increase is due to the
reduction in RCRe's surplus
2
resulting from the XL Capital stock repurchase as
well as from losses due to our poor underwriting performance.
We have agreed to transfer all of our reinsurance business to Folksamerica
Reinsurance Company. In reaching the determination to sell our reinsurance
business, we considered, among other things, the following factors:
o RCRe was incurring losses on its reinsurance business and faced
increasing competition, which has been adversely affecting results of
operations and financial condition;
o RCRe's surplus has decreased, while the surpluses of many of RCRe's
competitors have increased;
o the amount and volatility of our earnings, resulting from our
operating strategy and underwriting performance, severely limits our
ability to incur and service substantial indebtedness, which in turn
limits our ability to increase RCRe's statutory surplus; and
o our depressed stock price, combined with our inability to incur debt
as described above or otherwise use RCRe's cash because of RCRe's
statutory surplus, rating and operating requirements, have prevented
us from making acquisitions, which puts us, like many other small
reinsurance companies, at a severe competitive disadvantage in an
industry that has been experiencing rapid global consolidation.
See "Business--Recent Developments," "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Folksamerica Transaction" and
Note 14 of the accompanying notes to our consolidated financial statements. We
also refer you to the section of our special meeting proxy statement entitled
"Reasons for the Asset Sale and the Name Change; Our Board of Directors
Recommends the Asset Sale," which is incorporated by reference.
Operations
Net premiums written for 1999, 1998 and 1997 were as follows:
Net Premiums Written
(Dollars in millions)
Years Ended December 31,
-----------------------------------------------------------------------------------------
1999 1998 1997
--------------------------- ---------------------------- --------------------------
Amount % Amount % Amount %
----------- ----------- ------------ ----------- ----------- -----------
Property $78.9 25.7% $33.7 14.4% $17.8 12.3%
Casualty 64.1 20.9 80.3 34.2 69.7 48.1
Multi-Line 67.7 22.1 62.8 26.8 45.9 31.7
Other 7.6 2.5 16.5 7.0 10.0 6.9
Accident & Health 50.3 16.4
Aviation & Space 18.4 6.0 26.0 11.1
Marine 14.0 4.6 14.4 6.1 1.4 1.0
Surety & Fidelity 5.7 1.8 1.0 0.4
----------- ----------- ------------ ----------- ----------- -----------
Total $306.7 100.0% $234.7 100.0% $144.8 100.0%
=========== =========== ============ =========== =========== ===========
RCRe's assumed and ceded premiums written for the years ended December 31,
1999, 1998 and 1997 were as follows:
(In millions)
Years Ended December 31, Years
---------------------------------------------------------------------
1999 1998 1997
---------------------- ------------------ ---------------------
Assumed premiums written $386.8 $260.5 $147.8
Ceded premiums written 80.1 25.8 3.0
---------------------- ------------------ ---------------------
Net premiums written $306.7 $234.7 $144.8
====================== ================== =====================
3
We expanded our reinsurance business into marine and aviation and space
underwriting in 1997, surety and fidelity underwriting in 1998, and accident and
health underwriting in 1999. During 1999, we discontinued our aviation and space
lines of business.
RCRe's net premiums written increased 31% to $306.7 million in 1999 from
$234.7 million in 1998 and 62% to $234.7 million in 1998 from $144.8 million in
1997. Premium growth resulted from two key strategies, the integration of
investment with reinsurance and the diversification into "specialty" classes of
business, which for purposes of this discussion consist of accident and health,
aviation and space, marine and surety and fidelity.
Approximately 30%, 32% and 29% of net premiums written in 1999, 1998 and
1997, respectively, were generated from companies in which we have invested or
committed to invest funds ("integrated transactions").
Approximately 29%, 18% and 1% of net premiums written in 1999, 1998 and
1997, respectively, were produced from specialty classes of business. Specialty
classes of business accounted for 65% and 44% of the increase in net premiums
written for 1999 and 1998, respectively.
Approximately 15%, 32% and 28% of net premiums written in 1999, 1998 and
1997, respectively, were from non-United States clients, which are Lloyd's
syndicates or are located in the United Kingdom, Bermuda and Continental Europe.
Reinsurance is provided by RCRe both on a quota share and excess of loss
basis. In 1999, quota share reinsurance and excess of loss reinsurance amounted
to 93% and 7%, respectively, of the Company's net premiums written, compared to
(1) 81% and 19%, respectively, during 1998 and (2) 71% and 29%, respectively,
during 1997. The mix of quota share and excess of loss reinsurance depends on
market conditions and other relevant factors and cannot be predicted with
accuracy. Depending on future conditions, prior to the asset sale, we may also
write other types of reinsurance.
Net premiums written in 1999 include approximately $26 million relatedtransactions, to a single person or
group, of property reinsurance treaties that expired in 1999 covering crop hail
business underwritten on behalf of a start-up entity formed by Trident II, L.P.
This business was protected by extensive aggregate excess of loss retrocession
and generated a profit based upon underwriting results. We do not expect to
renew these treaties in 2000.
Net premiums written in 1999 for other business was reduced by $10.6
million for the retrocession of a treaty which covers future multiple rocket
launches that was recorded in 1996. The reduction of net premiums written
resulting from this retrocession increased the commission and operating expense
ratio components of the statutory composite ratio by 1.1 percentage points, but
had no impact on operating results.
Consistent with our strategy of writing a small number of large treaties
for our core business, two clients contributed approximately $81.3 million,common shares or 26.5%, of 1999 total net premiums written, with the largest client contributing
approximately 13.7% and the second contributing 12.8%. Approximately 70% of the
business written from the client that contributed 13.7% and all of the business
written from the client that contributed 12.8% are part of an integrated
transaction, and such business is subject to renewal at our option for two and
four remaining years, respectively.
In 1998, three clients contributed approximately $74 million, or 32%, of
1998 total net premiums written, with the largest client contributing
approximately 18% and the remaining two contributing 8% and 6%, respectively. In
1997, five clients contributed approximately $68 million, or 45%, of total net
premiums written, with the largest client contributing approximately 18% and the
remaining four contributing from 5% to 8%.
RCRe's ceded premiums increased to $80.1 million in 1999, compared to $25.8
million in 1998 and $3.0 million in 1997. Such ceded premiums primarily relate
to RCRe's property, multi-line, marine, aviation and space reinsurance business,
for which we seek to reduce RCRe's exposure to large and catastrophic losses.
Since the fourth quarter of 1998, we have purchased additional retrocessional
protection to reduce RCRe's exposures to both space and aviation risks.
Effective July 1, 1999, RCRe also purchased a retrocessional treaty for a one
year period covering earthquake, wind and other property catastrophe perils for
$10 millionsecurities convertible into common shares representing
in excess of a $15 million retention per occurrence.
For a discussioneither 51% of our in-force business at January 1, 2000, please referthe votes then entitled to "Management's Discussion and Analysis of Financial Condition and Results of
Operations--General--In-Force Business."
4
Investments
Our investment goals have been to support RCRe's reinsurance activities and
enhance our long-term profitability. The principal components of our strategy to
achieve these goals include: (1) supporting short-term liquidity requirements
through cash and fixed income investments and, if necessary, through the sale of
marketable equity securities from the company's investment portfolio; (2)
investing a significant portion of our assets in publicly traded and privately
held equity securities issued by insurance and reinsurance companies and
companies providing services to the insurance industry; (3) identifying trends
and investment opportunitiesbe cast in the insurance industry that could lead to
superior returns; (4) utilizing Marsh & McLennan Capital, Inc. ("MMCI"), an
experienced insurance industry advisor, as equity investment advisor; (5)
investing in insurers to which RCRe provides reinsurance, where appropriate; and
(6) when available, co-investing with Trident, a dedicated insurance industry
private equity fund, and an entity to which MMCI also provides equity investment
advisory services.
We have an investment advisory agreement with MMCI for managementelection of
our
portfolios of equity securities (including convertible securities) that are
publicly traded ("Public Portfolio") and privately held ("Private Portfolio").
The Private Portfolio includes equity securities which do not have a readily
ascertainable marketdirectors, or are subject to certain trading restrictions.
Effective July 1, 1999, we amended our investment advisory agreement with
MMCI, which governs the management of our portfolios of equity securities
(including convertible securities) that are publicly traded and privately held.
Pursuant to the amended agreement, which has a term of four years (subject
to renewal), MMCI provides us with investment management and advisory services
with respect to investments in the Private Portfolio whose value exceeds (i) $10
million during the first year51% of the term, (ii) $15 million during the second
yearthen outstanding common shares (taking into account
common shares issuable upon conversion of the term, and (iii) $20 million during the third and fourth years of the
term. Under the agreement, we pay MMCI an annual fee equal to (x) 20%
(previously 7.5%) of cumulative net realized gains including dividends, interest
and other distributions, received on the Private Portfolio over (y) cumulative
compensation previously paid in prior years on cumulative net realized gains (as
defined in the agreement) on the Private Portfolio managed by MMCI, but we will
not pay MMCI a management fee (previously 1.5% per annum of the quarterly
carrying value of the Private Portfolio). With respect to the management of our
Public Portfolio, we pay MMCI a fee equal to 0.50% of the first $50 million
under MMCI's management and 0.35% ofpreference shares) without giving
all amounts in excess of $50 million,
subject to a minimum fee of $250,000 per annum (previously 0.35% for the entire
Public Portfolio).
In connection with the amendments to our agreement with MMCI, we will
receive from MMCI $1.25 million per annum during the initial four-year term,
subject to certain conditions. The initial agreement provided for a minimum
aggregate cash fee to MMCI of $500,000 per annum through December 31, 1997. Fees
incurred under the agreements during fiscal years 1999, 1998 and 1997 were
approximately $1.5 million, $2.7 million and $1.3 million, respectively. In
addition, in 1999, 1998 and 1997, unrealized appreciation in the Private
Portfolio is net of accrued fees of approximately $256,000, $2.2 million and
$1.4 million, respectively.
In May 1999, we transferred the management of the fixed income and
short-term cash portfolios from The Putnam Advisory Company, Inc. ("Putnam") to
Alliance Capital. Previously, we had an investment advisory agreement with
Putnam, an affiliate of MMCI, for the management of our fixed income securities
and short-term cash portfolios through April 1999. For the fixed income
securities portfolio, we paid to Putnam a fee equal to the sum of 0.35% per
annum of the first $50 million of the market value of the portfolio, 0.30% per
annum on the next $50.0 million, 0.20% per annum on the next $100 million and
0.15% per annum of the market value of assets that exceeded $200 million. For
the short-term cash portfolio, we paid a fee equal to 0.15% per annum of the
total monthly average market value. Fees incurred under the Putnam agreement for
the period in 1999, 1998 and 1997 were approximately $173,000, $461,000 and
$493,000, respectively.
MMCI serves as investment manager to Trident and, accordingly, certain
restrictions exist with respect to MMCI's ability to make investment
recommendations to us with respect to investments which would be suitable for
both Trident and us. Under the Trident partnership agreement, until the earlier
of May 6, 2000 or the date on which at least 75% of the aggregate capital of
Trident has been drawn, neither MMCI nor any of its
5
affiliates may organize, or invest in, any new or existing risk assumption
entity unless Trident is first offered a reasonable opportunity to invest in
such entity. These restrictions may also apply to us. This limitation, however,
does not apply to investments in any such new entity where the total invested
capital of such entity does not exceed $10,000,000.
Pursuant to the Trident partnership agreement, where Trident has elected to
make part, but not all, of the full investment otherwise available to it, we may
not be offered the opportunity to participate in such investment unless Trident
first offers at least all Trident partners with capital commitments of at least
$50,000,000shareholders the right to participate in such transaction on the same or
substantially the same terms as the investors.
The shareholders agreement between us and the holders of preference shares
also contains restrictions on the transfer of preference shares, which
terminates upon consumation of any registered public offering of our common
shares generating net proceeds to us in excess of $25.0 million.
DISPOSITIONS; PENDING ACQUISITION. We agreed to sell, prior to the time of
the audit adjustment described above, the portion of our investment portfolio
specified in a schedule to the agreement, consisting of specified publicly
traded noninvestment grade debt securities and certain equity securities.
INFORMATION. The investors agreed to give us information regarding their
ownership of our company, ownership information concerning each of them and
other related information in connection with preparing disclosure in filings
under the United States Securities Act of 1933 (the "Securities Act") or the
Exchange Act on issues arising under the Internal Revenue Code, including the
rules applicable to "controlled foreign corporations."
INDEMNIFICATION; INSURANCE. We and the investors agreed to maintain all
rights to indemnification in favor of our directors, officers, employees and
agents or any of our subsidiaries with respect to their activities prior to the
closing (except that with respect to the Transaction Committee this covenant
will cover activities after the closing) (as provided for in our organizational
documents in effect on October 24, 2001) in full force and effect for a period
of not less than six years from the closing. The investors agreed not to cause
us to take any action inconsistent with this agreement.
5
We and the investors also agreed that we will indemnify each of our present
and former directors or officers against liabilities arising before the closing
(including the transactions contemplated by the subscription agreement) and,
with respect to the Transaction Committee, also after the closing. We and the
investors agreed that we will maintain our current level of directors' and
officers' liability insurance coverage for a period of at least six years after
the closing.
CERTAIN TAX MATTERS. With respect to each taxable year during which any of
the Warburg Pincus funds or the Hellman & Friedman funds owns our shares, we
agreed to use reasonable best efforts to cause us and each of our subsidiaries:
- not to constitute a "passive foreign investment company" within the
meaning of Section 1297 of the Code;
- not to satisfy the gross income requirement set forth in Section 542(a) of
the Code;
- not to satisfy the gross income requirement set forth in Section 552(a) of
the Code; and
- not to have any related person insurance income within the meaning of
Section 953(c)(2) of the Code.
In the event that we or any of our subsidiaries constitute a personal holding
company, a foreign personal holding company, a controlled foreign corporation, a
foreign investment company or a passive foreign investment company for U.S.
federal income tax purposes with respect to any taxable year, we agreed to
provide each of the Warburg Pincus funds or the Hellman & Friedman funds with
any information it requests to satisfy its legitimate tax, accounting or other
reporting requirements.
RIGHT TO EXCHANGE INTO SUBSIDIARY SHARES. We agreed to form a new, wholly
owned subsidiary to hold Arch Re (Bermuda) as well as all of the "core insurance
operations" other than Arch Re (US).
In the event that:
- we fail to obtain the regulatory approvals required in connection with the
investment before May 20, 2002 or
- the adjustments described above under "--Purchase Price Adjustments--Final
Adjustment" are less than zero and their absolute value exceeds
$250.0 million,
the Warburg Pincus funds, the Hellman & Friedman funds and the other holders of
our preference shares will have the option to exchange their preference shares
and class A warrants, in whole or in part (but not for less than $150.0 million
liquidation preference of preference shares), for preference shares and warrants
of our newly formed subsidiary bearing identical rights and privileges,
including the right to convert into, or be exercised for, common shares of our
newly formed subsidiary, but not including voting limitations to the extent such
limitations are not required pending the remaining regulatory approvals required
in connection with the capital infusion.
INVESTORS' COSTS AND EXPENSES. We agreed to reimburse the Warburg Pincus
funds and the Hellman & Friedman funds for their costs and expenses, and the GE
investors for up to $50,000 of their costs and expenses, in connection with the
investment and the related transactions.
TRANSACTION COMMITTEE. Until the date of the final determination of the
adjustment basket at the fourth anniversary of closing, approval of the
following actions by the Transaction Committee (as defined below) is deemed to
be approval by the entire board of directors:
- an amendment, modification or waiver of rights by ACGL under the
subscription agreement, the certificate of designation for the preference
shares, the class A warrants or the shareholders agreement;
- the enforcement of obligations of the investors under the above
agreements; or
6
- approval of actions relating to the disposition of non-core assets.
"Transaction Committee" means a committee of the board of directors
consisting of persons who either (a) were members of our board of directors on
October 22, 2001 and/or (b) were designated as members of the Transaction
Committee by a person who was a member of our board of directors on October 22,
2001. The Transaction Committee currently consists of Robert Clements, Peter A.
Appel, James J. Meenaghan and Robert F. Works.
SHAREHOLDERS AGREEMENT
On November 20, 2001 upon consummation of the capital infusion, we entered
into a shareholders agreement with the investors. Set forth below is a summary
of the material terms of the shareholders agreement. You should read this
summary in conjunction with the agreement. A conformed copy of the shareholders
agreement is filed herewith as an exhibit.
BOARD REPRESENTATION. Following the closing, the Warburg Pincus funds
exercised their right to designate one director to our board and the Hellman &
Friedman funds exercised their right to designate one director to our board.
Kewsong Lee is serving as the designee for the Warburg Pincus funds and John L.
Bunce, Jr. is serving as the designee for the Hellman & Friedman funds. Once the
remaining regulatory approvals required in connection with the capital infusion
have been obtained, we will increase the size of our board to up to 17 members
and the Warburg Pincus funds will have the right to designate or nominate five
additional directors and the Hellman & Friedman funds will have the right to
designate or nominate two additional directors. Continued representation on our
board of directors by these shareholders is based on the respective retained
percentages of their equity securities in according to the following schedules:
WARBURG PINCUS FUNDS HELLMAN & FRIEDMAN FUNDS
- ------------------------------------------------- -------------------------------------------------
PERCENTAGE MINIMUM NUMBER OF PERCENTAGE MINIMUM NUMBER OF
OF ORIGINAL DIRECTORS TO BE OF ORIGINAL DIRECTORS TO BE
INVESTMENT HELD NOMINATED INVESTMENT HELD NOMINATED
- ----------------------------- ----------------- ----------------------------- -----------------
greater than or equal to 75% 6 greater than or equal to 60% 3
60% greater than or equal to X < 75% 5 35% less than or equal to X < 60% 2
45% less than or equal to X < 60% 4 20% less than or equal to X < 35% 1
30% less than or equal to X < 45% 3
20% less than or equal to X < 30% 2
10% less than or equal to X < 20% 1
COMMITTEES OF THE BOARD. As long as at least one representative of the
Warburg Pincus funds is on the board, each board committee will include at least
one representative of the Warburg Pincus funds, and as long as at least one
representative of the Hellman & Friedman funds is on the board, each board
committee will include at least one representative of the Hellman & Friedman
funds. The foregoing is subject to any Nasdaq Stock Market or SEC restrictions
applicable to the audit committee.
INVESTOR PROTECTION MATTERS. Prior to the receipt of the remaining
regulatory approvals in connection with the capital infusion certain matters
require approval by at least one director representing the Warburg Pincus funds
(if the Warburg Pincus funds hold at least 25% of their original investment in
ACGL) and one director representing the Hellman & Friedman funds (if the
Hellman & Friedman funds hold at least 50% of their original investment in us).
Such matters include, among other things, subject to exceptions set forth in the
subscription agreements:
- any amendment to our organizational documents or the subscription
agreement;
- any change to our capital structure or the terms of our outstanding
securities;
- the declaration of any dividend or other distribution on, or repurchase
of, our securities;
7
- the issuance of any securities or the grant of any preemptive or
anti-dilutive rights to any holder of our securities, or the grant of
registration rights with respect to any of our securities;
- any amendment to any grants made under our Long Term Incentive Plan for
New Employees;
- the incurrence of any material indebtedness;
- our entering into any interested party transactions;
- the acquisition of any material assets;
- the acquisition of equity interests in any other person;
- any change in our independent auditors or any material change in any
method of financial accounting or accounting practice (other than changes
required under U.S. generally accepted accounting principles);
- any sale of material assets;
- significant changes in compensation arrangements with any officer or key
employee;
- our liquidation or dissolution, or certain mergers or consolidations, sale
of all or substantially all of our assets, or similar business
combination;
- entering into any transaction involving in excess of $1,000,000 or, if
such transaction is in the ordinary course of business consistent with
past practice, $5,000,000;
- the approval of our annual plan, annual capital expenditure budget or the
five-year plan of our company; or
- the removal or appointment of a new chief executive officer or chairman.
Notwithstanding the required approvals described above, the shareholders
agreement does not grant these shareholders any right or consent to the extent
that such right would result in such party being deemed to "control" any of our
insurance subsidiaries that are domiciled in any state in the United States,
where the exercise of such control would otherwise require the prior approval of
such state.
The rights of these shareholders described above terminate upon the
mandatory conversion of the preference shares or the earlier conversion of all
preference shares in accordance with their terms.
SPECIAL BOARD MEETINGS. We agreed to use best efforts (1) to cause a
special meeting of the board to be called upon the request of at least three
directors and (2) to cause to be submitted, at the 2002 annual general meeting
of our shareholders, a proposal to amend our bye-laws so that a special meeting
of the board may be called by three directors or a majority of the total number
of directors (whichever is fewer), in addition to the chairman of the board and
the president of ACGL.
VOTING. The signatories to the shareholders agreement agreed to vote all of
their voting shares in favor of the proposal to approve a grant of restricted
shares to Mr. Clements and an option grant to Mr. Pasquesi to be submitted for
approval at our next annual general meeting.
CHAIRMAN. The Warburg Pincus funds and the Hellman & Friedman funds agreed
to take all actions necessary to cause Robert Clements to be duly elected as
chairman of our board of directors for so long as he is willing and able to
serve.
CERTAIN TRANSACTIONS. The Warburg Pincus funds and the Hellman & Friedman
funds agreed that, for a period of two years after the closing, they will not,
directly or indirectly, without the prior
8
approval of a majority of directors who are not affiliated with either the
Warburg Pincus funds or the Hellman & Friedman funds:
- acquire securities or assets from us or any of our subsidiaries, except as
specifically contemplated by the subscription agreements, the preference
shares and the class A warrants;
- engage in any "Rule 13e-3 transaction" (as such term is defined in
Rule 13e-3(a)(3) under the Exchange Act) involving us; or
- engage in any other transaction that would result in the compulsory
acquisition of our common shares.
We and the Warburg Pincus funds and the Hellman & Friedman funds have agreed
to endeavor to include at all times two directors on our board who are not
affiliated with either the Warburg Pincus funds or the Hellman & Friedman funds.
The prior approval of a majority of such independent directors is required prior
to any change to or elimination of these provisions.
REGISTRATION RIGHTS. The shareholders agreement also grants the investors
registration rights described below.
DEMAND REGISTRATION RIGHTS. The Warburg Pincus funds and the Hellman &
Friedman funds have the right to request registration of their shares under the
Securities Act, at any time and on not more than five separate occasions, so
long as the request covers common shares with a market value on the date of the
request of at least $25.0 million.
PIGGY-BACK REGISTRATION RIGHTS. If at any time we propose to register any
common shares under the Securities Act on our own behalf or on behalf of any of
our shareholders (including pursuant to a demand registration as discussed
above), we are required to give reasonably prompt written notice to each
investor of our intention to do so and, upon request of any investor, but
subject to limitations in some cases, include the investor's shares for
registration.
REGISTRATION EXPENSES. We agreed to bear all registration, filing and
related fees (excluding underwriters' discounts or commissions) in connection
with any registration and listing of any common shares pursuant the registration
provisions described above.
INDEMNIFICATION; CONTRIBUTION. We agreed to indemnify each investor and its
officers, directors, employees and controlling persons, and each underwriter,
its partners, officers, directors, employees and controlling persons, in any
offering or sale of common shares, against certain liabilities in connection
with these registered offerings. Each investor agreed to indemnify us and our
officers, directors, employees and controlling persons, against certain
liabilities in connection with these registered offerings. In the event that the
indemnification provisions are unavailable, we and the investors agreed to
contribute such amounts as are appropriate to reflect the relative fault of the
parties.
TAG-ALONG/DRAG-ALONG RIGHTS. In the event that a Warburg Pincus fund, a
Hellman & Friedman fund or a GE investor proposes to transfer preference shares,
class A warrants or common shares issued upon conversion or exercise of such
securities to a third party, and the net proceeds of such sale are reasonably
expected to exceed $50.0 million, other investors may have rights under the
shareholders agreement to "tag along" in such sale. The following tag-along
rights are provided for in the shareholders agreement:
- The GE investors have tag-along rights only if (1) a Warburg Pincus fund
is the seller or (2) a Hellman & Friedman fund is the seller and the
Warburg Pincus funds also exercise their rights to tag along in the sale.
9
- Farallon has tag-along rights only if (1) a Hellman & Friedman fund is the
seller or (2) a Warburg Pincus fund is the seller and the Hellman &
Friedman funds also exercise their rights to tag along in the sale.
- Trident II has tag-along rights in the event that a Warburg Pincus fund or
a Hellman & Friedman fund is the seller.
Any sale effected in the public markets (including by means of a "block
trade" effected through any registered broker-dealer) or any distribution to
partners of any partnership in which a Warburg Pincus fund or a Hellman &
Friedman fund, or any of their respective affiliates, is the general partner
will not give rise to any tag-along rights.
In the event that a Warburg Pincus fund and/or a Hellman & Friedman fund
proposes to transfer preference shares, class A warrants or common shares issued
upon conversion or exercise of such securities representing either 51% of the
votes then entitled to be cast in the election of directors, or 51% of our then
outstanding common shares (taking into account common shares issuable upon
conversion of preference shares) in a transaction, or in a series of related
transactions, to a single person or group, the Warburg Pincus funds and the
Hellman & Friedman funds have the right to require that Trident II participate
in such transaction on a ratable basis.
RESTRICTIONS ON TRANSFER. Each investor has agreed not to sell more than
one-third of the shares purchased in its original investment until the earliest
to occur of
- November 20, 2002;
- any event that would cause our outstanding class B warrants to become
exercisable; or
- our completion of a registered public offering of common shares the net
proceeds of which to us exceed $25.0 million.
RESTRICTIONS ON CONVERSION/EXERCISE. Prior to receipt of the regulatory
approvals required in connection with the investment, the investors agreed not
to convert any preference shares or exercise class A warrants issued under the
subscription agreements unless all necessary approvals for the ownership of
common shares issued upon such conversion or exercise have been obtained.
RESTRICTIONS ON DIVIDENDS AND SHARE REPURCHASES. We agreed not to declare
any dividend or make any other distribution on our common shares, and not to
repurchase any common shares, until we have repurchased from the Warburg Pincus
funds, the Hellman & Friedman funds, and the other holders of our preference
shares, pro rata, on the basis of the amount of each of these shareholders'
retained investment in the company at the time of such repurchase, preference
shares having an aggregate value of $250.0 million, at a per share price
acceptable to these shareholders (subject to the exception described under
"--Subscription Agreement--Purchase Price Adjustments--Final Adjustments").
TERMINATION. The shareholders agreement terminates upon the earlier to
occur of:
- November 20, 2011; or
- mutual written agreement of us and the Warburg Pincus funds and the
Hellman & Friedman funds.
MANAGEMENT SUBSCRIPTION
In connection with the capital infusion, we entered into a management
subscription agreement, pursuant to which certain members of management (or
entities affiliated with them) agreed to purchase preference shares and class A
warrants on the same economic terms as the Warburg Pincus funds and the
Hellman & Friedman funds. The management subscription agreement is filed as an
exhibit to this report.
10
On November 20, 2001, each of the persons or entities listed purchased
preference shares and class A warrants for the amount opposite his or its names
set forth in the table below:
NAME AMOUNT
- ---- ------
SoundView Partners LP (an entity affiliated with Robert
Clements)............................................ $ 2,000,000
Otter Capital LLC (an entity affiliated with John M.
Pasquesi)............................................ 7,500,000
Peter A. Appel......................................... 1,000,000
Paul B. Ingrey......................................... 2,000,000
Dwight R. Evans........................................ 400,000
Marc Grandisson........................................ 250,000
-----------
Total................................................ $13,150,000
===========
CERTIFICATE OF DESIGNATIONS
Set forth below is a summary of the material terms of the certificate of
designations for our series A convertible preference shares. You should read
this summary in conjunction with the certificate, which is filed herewith as an
exhibit.
DIVIDENDS. The holders of preference shares are entitled to receive
dividends along with holders of our common shares, on an as-converted basis.
Dividends are payable on each outstanding preference share on an as-converted
basis. No dividends may be paid or declared on or with respect to our common
shares prior to the declaration and payment of a dividend on or with respect to
the preference shares. Dividends on the preference shares are noncumulative.
RANKING. The preference shares rank, with respect to dividends and upon
liquidation, winding up or dissolution:
- on a parity with those shares which, by the terms of our bye-laws or by
such rights, preferences or limitations as fixed by the board of
directors, are specifically entitled to share ratably with the preference
shares, and
- senior to each other class or series of our shares.
The shareholders agreement between us and the holders of our preference shares
includes a limitation on dividends on, and repurchases of, our common shares.
CONVERSION
GENERAL. Each preference share is convertible at any time and from time to
time at the option of the holder, initially, into one fully paid and
nonassessable common share, subject to adjustment for certain events as
described below under "--Adjustments." In connection with the conversion of any
preference shares, no fractional shares will be issued. Instead, we will pay a
cash amount for such fractional interest based on the current market price of
the common shares. As discussed above, the shareholders agreement between us and
the holders of our preference shares contains a limitation on conversion of the
preference shares until the receipt of certain shareholder and regulatory
approvals.
MANDATORY CONVERSION. The preference shares will automatically convert into
common shares following the later of: (a) the receipt of the regulatory
approvals required in connection with the November 20 capital infusion and
(b) 90 days following the consummation of the purchase price
11
adjustment to be performed at the fourth anniversary of closing (described above
under "The Capital Infusion--Purchase Price Adjustments").
ADJUSTMENTS. The number of common shares into which each preference share
is convertible is subject to adjustment from time to time in the event of:
- share splits or combinations of our common shares;
- the declaration and payment of dividends on the common shares in
additional common shares;
- the distribution of indebtedness, securities or assets to holders of our
common shares;
- transactions in which our common shares are exchanged (either for
different securities of our company or securities of a different company);
or
- offerings of our common shares, or securities convertible into or
exercisable for common shares, at a price below the market value for our
common shares at the time of issuance, subject to exceptions.
LIQUIDATION PREFERENCE. In the event of our voluntary or involuntary
liquidation, dissolution or winding-up, or a reduction or decrease in our share
capital resulting in a distribution of assets to the holders of any class or
series of our shares, each holder of preference shares is entitled to payment
out of our assets available for distribution of an amount equal to the
liquidation preference of $21.00 per preference share held by such holder, plus
all accumulated and unpaid dividends, before any distribution is made on any
common shares. If, in the event of our voluntary or involuntary liquidation,
dissolution or winding up or a reduction or decrease in our share capital, the
amounts payable with respect to preference shares and parity shares are not paid
in full, the holders of preference shares and the parity shares share equally
and ratably in any distribution of share assets in proportion to the full
liquidation preference and all accumulated and unpaid dividends to which each
such holder is entitled.
VOTING RIGHTS. Each holder of preference shares is entitled to the number
of votes equal to the number of whole common shares into which all of such
holder's preference shares are convertible, with respect to all matters
submitted for shareholder approval. Except as required by applicable Bermuda law
or by the express terms of the preference shares, holders will vote together
with holders of the common shares as a single class.
The affirmative vote of the holders of at least a majority of the
outstanding preference shares, voting with holders of shares of all other series
of preference shares affected in the same way as a single class, is required to
amend, repeal or change any provisions of the certificate of designations in any
manner which would adversely affect, alter or change the powers, preferences or
special rights of the preference shares and any such securities affected in the
same way. However, the creation, authorization or issuance of any other class or
series of shares or the increase or decrease in the amount of authorized shares
of any such class or series or of the preference shares, or any increase,
decrease or change in the par value of any class or series of shares (including
the preference shares) do not require the consent of the holders of the
preference shares and are not deemed to affect adversely, alter or change the
powers, preferences and special rights of the preference shares. With respect to
any matter on which the holders are entitled to vote as a separate class, each
preference share is entitled to one vote.
Notwithstanding the foregoing, prior to the receipt of the regulatory
approvals required in connection with the capital infusion by the Warburg Pincus
funds and the Hellman & Friedman funds, if the votes conferred by common shares
and preference shares beneficially owned by a given person would otherwise
represent more than 9.9% of the voting power of all shares of the company
entitled to vote generally at an election of directors, the vote of each
preference share held by that person will be
12
reduced by whatever amount is necessary so that after any reduction, the votes
conferred by the common shares and preference shares beneficially owned by that
person constitute 9.9% of the total voting power of all shares of the company
entitled to vote generally at any election of directors.
CLASS A WARRANTS
Set forth below is a summary of the material terms of the class A warrants.
You should read this summary in conjunction with the certificate for the
class A warrants, the form of which is filed as an exhibit herewith.
GENERAL. Each class A warrant entitles the holder to purchase one common
share for $20.00. The exercise price is subject to adjustments as discussed in
greater detail below under "--Anti-Dilution and Other Adjustments." The class A
warrants will expire on September 19, 2002.
EXERCISE OF THE CLASS A WARRANTS. Holders of the class A warrants may
exercise their purchase rights under the class A warrants by making payment of
the purchase price in cash or through a cashless exercise. Holders may effect a
cashless exercise by (a) delivering common shares equivalent in value to the
exercise price or (b) accepting a reduction in the number of common shares
deliverable upon exercise of the class A warrant by an amount which would be
equivalent in value to the exercise price. See "--Shareholders
Agreement--Restrictions on Conversion/Exercise" for a description of the
limitation on exercise of the class A warrants under the shareholders agreement.
ANTI-DILUTION AND OTHER ADJUSTMENTS. The exercise price will be adjusted
from time to time in order to prevent dilution. In addition, certain other
adjustments will be made to the terms of the class A warrants upon extraordinary
corporate events. Such anti-dilution and other adjustments include:
- offerings of our common shares at a price below the market value of our
common shares at the time of issuance will result in an adjustment to the
exercise price under the class A warrants;
- share splits or combinations of our common shares will result in an
adjustment to the exercise price under the class A warrants;
- a reorganization, reclassification, consolidation, merger or sale of
assets may result in the substitution of other securities, cash or
property upon exercise of the class A warrants; and
- issuance of assets or debt securities or rights or warrants to purchase
assets or securities by the company to its shareholders may result in an
adjustment to the exercise price under the class A warrants.
In addition, our board of directors may make such additional adjustments to
the exercise price or other terms of the class A warrants in order to protect
the rights of the holders of the class A warrants.
OPERATIONS
OUR REINSURANCE OPERATIONS
Our Reinsurance Group is worldwide, with U.S. and Bermuda-based operations.
It has two principal offices, one located in Hamilton, Bermuda and the other in
Morristown, New Jersey. As of March 14, 2002, the group has 36 employees
consisting of 20 underwriters, seven other professionals and nine
non-professionals. We expect that our Reinsurance Group will have approximately
55 total employees once fully staffed.
13
STRATEGY. Our Reinsurance Group's strategy is to capitalize on our
financial capacity, experienced management and operational flexibility to offer
multiple products through our Bermuda- and U.S.-based operations. The group's
operating principles are:
- ACTIVELY SELECT AND MANAGE RISKS. We will not underwrite business that
does not meet our profitability criteria, and we will emphasize
disciplined underwriting over premium growth. To this end, we will
maintain centralized control over reinsurance underwriting guidelines and
authorities.
- MAINTAIN FLEXIBILITY AND RESPOND TO CHANGING MARKET CONDITIONS. Our
organizational structure and philosophy allow us to take advantage of
increases or changes in demand or favorable pricing trends. We believe
that our existing Bermuda and U.S.-based platform, broad underwriting
expertise, and substantial capital will facilitate adjustments to our mix
of business geographically and by line and type of coverage. We believe
that this flexibility will allow us to participate in those market
opportunities that provide the greatest potential for underwriting
profitability.
- MAINTAIN A LOW COST STRUCTURE. We believe that maintaining tight control
over our staffing and operating as a broker market reinsurer will permit
us to maintain low operating costs relative to our capital and premiums.
LINES OF BUSINESS. We are seeking to write "large lines" (I.E., significant
portions) on a select number of specialty property and casualty reinsurance
treaties.
Our Reinsurance Group focuses on the following lines of business:
- PROPERTY CATASTROPHE REINSURANCE. Property catastrophe reinsurance
provides coverage on an excess of loss basis when aggregate losses and
loss adjustment expense from a single occurrence of covered peril exceed
the attachment point specified in the policy. Some of our property
catastrophe contracts limit coverage to one occurrence in a policy year,
but most contracts generally provide for at least one reinstatement of the
limit covered, which could result in two or more exposures to a given
risk.
- PROPERTY RISK EXCESS OF LOSS. We also write risk excess of loss property
reinsurance. Risk excess of loss reinsurance responds to a loss of the
reinsured on a single "risk" of the type reinsured rather than to
aggregate losses for all covered risks as does catastrophe reinsurance.
The risk excess of loss property protects the reinsured from losses in
excess of its retention level on a single risk. A "risk" in this context
might mean the insurance coverage on one building or a group of buildings
or the insurance coverage under a single policy, which the reinsured
treats as a single risk. Risk excess contracts are generally "all risk" in
nature, similar to property catastrophe reinsurance.
- PROPERTY PRO RATA. In pro rata reinsurance, we assume a specified portion
of the risk on the specified coverage and receive an equal proportion of
the premium. The ceding insurer receives a commission based upon the
premiums ceded to the reinsurer and may also be entitled to receive a
profit commission based on the ratio of losses, loss adjustment expense
and the reinsurer's expenses to premiums ceded. A pro rata reinsurer is
dependent upon the ceding insurer's underwriting, pricing and claims
administration to yield an underwriting profit. In some instances we may
be entitled to the benefit of other reinsurance, known as common account
reinsurance, purchased by the ceding company on an account reinsured by us
on a pro rata basis.
Pursuant- CASUALTY. We also write the following lines of business on both a pro rata
and excess of loss basis: general liability (including excess general
liability), workers' compensation, commercial transportation, non-standard
auto liability, surety, aviation & aerospace, marine, medical
14
malpractice, directors and officers, errors and omissions and energy. We
may write other lines, including trade credit and political risk.
Although we will seek to exclude terrorism from the termsproperty reinsurance
which we write, we may specifically reinsure risks resulting from terrorism on
an excess of loss basis, or, based on market factors, we may determine to
include terrorism risk. Our reinsurance business may also include clash covers
which are excess of loss agreements where the underlying amount to be retained
by the ceding insurer is at an amount which is higher than the limit on any one
reinsured policy. Such agreements provide payment of loss when the unusual
circumstances occur where two or more casualty policies (or, with respect to
workers compensation coverages, multiple employees) experience the same
occurrence of loss and the total amount of the payment of losses for the
multiple policies exceeds the clash cover retention amount.
We also write non-traditional business that is intended to provide insurers
with creative risk management solutions that complement traditional reinsurance.
Under these covers, we would assume a measured amount of insurance risk in
exchange for a specified margin. Coverages may include a combination of
sublimits and caps. Examples of such non-traditional business include aggregate
stop-loss coverages and financial quota share coverages.
UNDERWRITING PHILOSOPHY. We employ a disciplined, analytical approach to
underwriting reinsurance risks that is designed to specify an adequate premium
for a given exposure commensurate with the amount of capital we anticipate
placing at risk. Many of our equity advisory agreement, MMCI has agreedunderwriters are also actuaries. We believe that
it will not invest in such opportunities, and will not offer any such
opportunities to its affiliates, without first offeringemploying actuaries on the front-end of the underwriting process gives us an
opportunity to
make such investments.
Fixed income investments are used to provide shorter-term liquidityadvantage in evaluating risks and current returns. The fixed income securities portfolio generally is invested inconstructing a high quality liquid securities, including securities issued by United States
government agencies and United States government guaranteed securities.
In addition, we allocated in early 1998 approximately $35,000,000 for
investment in a diversified portfoliobook of high yielding below investment grade
fixed maturity investments managed by Miller Anderson & Sherrerd, LLP, a
subsidiary of Morgan Stanley & Co. Such amount was taken from funds that were
previously allocated for investing in short-term securities. Miller Anderson
manages the portfolio subject to investment guidelines established by the
Investment/Finance Committeebusiness.
As part of our boardunderwriting process, we typically assess a variety of
directors. At December 31, 1999,
our high yield portfolio included approximately $37.6 million of such
securities.
Since a significant portion of our investment portfolio is currently
comprised of equity securities issued by insurance and reinsurance companies and
companies providing services tofactors, including:
- the insurance industry, the portfolio lacks
industry diversification and is particularly subject to the performancereputation of the insurance industry. Such performance will affect the market prices of a
significant portion of our investment portfolioproposed cedent and the incomelikelihood of establishing a
long-term relationship with the cedent, the geographic area in which the
cedent does business, together with its catastrophe exposures, and return on
such investments, all of which could negatively affect our
underwriting
capacity. As our current investment strategy is to invest a significant portion
of its investment portfoliomarket share in equity securities, our investment income in any
fiscal period may be smaller,that area;
- historical loss data for the cedent and, where available, for the industry
as a percentage of investments, and less
predictable than other competitor reinsurance companies, which tend to invest
primarily in fixed income investments. Net realized and unrealized gains (or
losses) on investments may have a greater effect on our results of operations or
stockholders' equity at the end of any fiscal period than on those of our
competitor reinsurance companies.
After the sale of our reinsurance operations to Folksamerica is completed,
the company's objective will be to serve as a vehicle to effect business
combinations and ventures, whether by acquiring all or a portion of companies,
merger, exchange of stock or otherwise, with one or more operating companies
that our board of directors believes will have potential to increase stockholder
value. These business combinations and ventures may be with companies that are
notwhole in the insurance business. We refer yourelevant regions, in order to compare the sectioncedent's
historical loss experience to industry averages;
- projections of our special
meeting proxy statement entitled "Risk Factors," which is incorporated by
reference, for a discussion of certain risks relating to our business afterfuture loss frequency and severity; and
- the sale of our reinsurance operations to Folksamerica Reinsurance Company.
Operations
At December 31, 1999, cash and invested assets totaled approximately $585.9
million, consisting of $82.2 million of cash and short-term investments, $261.1
million of publicly traded fixed maturity investments, $158.6 million of
publicly traded equity securities and $84.0 million of privately held
securities.
The components of net investment income for the years ended December 31,
1999, 1998 and 1997 are summarized in a table found in Note 3 under the caption
"Investment Information"perceived financial strength of the accompanying notes tocedent.
For our consolidated financial
statements.
6
Our investments on a consolidated basis at December 31, 1999, 1998 and 1997
consisted of the following:
(Dollars in thousands)
December 31,
---------------------------------------------------------------------------------------------------
1999 1998 1997
------------------------------ ------------------------------- ------------------------------
Estimated Estimated Estimated
Fair Value Percent Fair Value Percent Fair Value Percent
---------- ------- ---------- ------- ---------- -------
Cash and short-term $ 82,242 14% $120,846 20% $ 98,181 19%
-------- -- -------- -- -------- --
Fixed maturities:
U.S. government and
government agencies 41,095 7 39,283 6 44,135 9
Municipal bonds 52,245 9 45,273 8 37,637 7
Corporate bonds 136,838 23 56,256 10 19,323 4
Mortgage and asset-
backed securities 27,298 5 33,532 6 30,487 6
Foreign governments 3,591 1 196 - 577 -
----- - --- -- --- --
Sub-total, fixed
maturities 261,067 45 174,540 30 132,159 26
Equity securities:
Publicly traded 158,631 27 154,678 27 180,052 36
Privately held 83,969 14 137,091 23 95,336 19
------ -- ------- -- ------ --
Sub-total, equity
securities 242,600 41 291,769 50 275,388 55
------- -- ------- -- ------- --
Total $585,909 100% $587,155 100% $505,728 100%
======== === ======== === ======== ===
Our current investment guidelines restrict the portion of our fixed
maturities portfolio that can be held in lower quality securities. At December
31, 1999, 88% of the fixed maturity and short-term investments were rated
investment grade by Moody's Investors Service, Inc. or Standard & Poor's
Corporation and had an average quality rating of AA and an average duration of
approximately 3.7 years.
Contractual maturities of our consolidated fixed maturity securities are
shown below. Expected maturities, which are our best estimates, will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
(In thousands)
December 31, 1999
-----------------
Estimated Amortized
Fair Value Cost
---------- ----
Available for sale:
Due in one year or less $10,210 $10,237
Due after one year through five years 68,182 69,956
Due after five years through 10 years 78,461 82,282
Due after 10 years 76,916 79,446
------ ------
Sub-total 233,769 241,921
Mortgage and asset-backed securities 27,298 28,424
------ ------
Total $261,067 $270,345
======== ========
At December 31, 1999, our investment portfolio included $158.6 million of
publicly traded equity securities and 12 investments in privately held
securities totaling $84.0 million, with additional investment portfolio
commitments in an aggregate amount of $23.2 million. At this date, all of our
equity investments were in securities issued by insurance andcatastrophe exposed reinsurance
companies or companies providing services to the insurance industry.
7
Please refer to Note 3 under the caption "Investment Information" of the
accompanying Notes to our consolidated financial statements for information
regarding our publicly traded and privately held securities and their carrying
values, and commitments made by us relating to our privately held securities.
We have not invested in derivative financial instruments such as futures,
forward contracts, swaps, or options or other financial instruments with similar
characteristics such as interest rate caps or floors and fixed-rate loan
commitments. Our portfolio includes market sensitive instruments, such as
mortgage-backed securities, which are subject to prepayment risk and changes in
market value in connection with changes in interest rates. Our investments in
mortgage-backed securities are classified as available for sale and are not held
for trading purposes. These investments amounted to approximately $27.3 million,
or 4.7% of cash and invested assets at December 31, 1999, $33.5 million, or 6%
of cash and invested assets at December 31, 1998, and $30.5 million, or 6% of
cash and invested assets at December 31, 1997.
Marketing
RCRe has obtained substantially all of its reinsurance business through
intermediaries representing the cedent in negotiations for the purchase of
reinsurance. The process of effecting a brokered reinsurance placement typically
begins when a cedent enlists the aid of an intermediary in structuring a
reinsurance program. Often the intermediary will consult with one or more lead
reinsurers as to the pricing and contract terms of the reinsurance protection
being sought. Once the cedent has approved the terms quoted by the lead
reinsurer, the intermediary offers participation to qualified reinsurers until
the program is fully subscribed to by reinsurers on terms agreed upon by all
parties.
By working through intermediaries to originate business, we have avoided
maintaining a substantial sales organization. In addition,developed
underwriting guidelines under which we believe that
submissionsgenerally limit the amount of exposure we
will assume from any one reinsured and the intermediary market are more numerous and diverse,
including certain targeted specialty coverages, than would be available through
a salaried sales organization and that we are able to exercise greater
selectivity than would be possible in dealing directly with cedents.
RCRe pays commissions to intermediaries based on negotiated percentagesamount of the premiums it writes. Direct writers ofaggregate exposure to
catastrophe losses in any geographic zone.
MARKETING. We market our reinsurance typically incur higher
fixed costs that are included in their underwriting expenses. Reinsurers using
intermediaries can lower these costs during a downturn in the market by writing
less business and incurring lower brokerage costs. Intermediariesproducts through brokers. Brokers do
not
generally have the authority to bind RCReus with respect to reinsurance agreements, nor does RCRe generallydo
we commit in advance to accept any portion of the business that intermediariesbrokers submit
to it.us. Reinsurance business from any cedent,ceding company, whether new or renewal, is
generally subject to acceptance by RCRe.
In 1999, (1) affiliates of Marsh & McLennan, including Balis & Co., Inc.,
Guy Carpenter & Company, Inc., Carpenter Bowring Ltd. and Cecar & Jutheau, S.A.
(collectively, "Marsh Affiliates"), (2)us.
CLAIMS MANAGEMENT. Claims management includes the Aon Group and (3) E.W. Blanch
Company accounted for approximately 33.1%, 17.4% and 5.7%, respectively, of
RCRe's assumed net premiums written. In 1998, (1) Marsh Affiliates, (2) Aon and
(3) E.W. Blanch accounted for approximately 43.2%, 16.5% and 10.9%,
respectively, of RCRe's assumed net premiums written. In 1997, (1) Marsh
Affiliates, (2) Aon and (3) E.W. Blanch accounted for approximately 47.3%,
19.1%, and 9.3%, respectively, of RCRe's assumed net premiums written. Loss of
all or a substantial portion of the business provided by any of these
intermediaries could have a short-term material adverse effect on the business
and operations of RCRe. We do not believe that the loss of such business would
have a long-term material adverse effect due to RCRe's competitive position
within the broker reinsurance market and the availability of business from other
intermediaries. The terms relating to RCRe's intermediary arrangements with
Marsh Affiliates have been negotiated on an arm's-length basis.
In addition to investment opportunities arising from the activities of MMCI
as our equity investment advisor, we are provided with investment opportunities
by reinsurance brokers and traditional financing sources, including investment
banking firms, venture capital firms and other banking and financing sources,
both acting as principal investors and intermediaries. Underwriting
opportunities may arise from such sources in connection with our investment
activities as part of integrated transactions.
Retrocessional Arrangements
Reinsurance companies enter into retrocessional arrangements for many of
the same reasons primary insurers seek reinsurance, including reducing the
effect of individual or aggregate losses and increasing
8
premium writing and risk capacity without requiring additional capital.
Retrocessional arrangements do not relieve RCRe from its obligations to the
insurers and reinsurers from which it assumes business. The failure of
retrocessionaires to honor their obligations could result in losses to RCRe.
RCRe utilizes retrocession agreements for the purpose of limiting its
exposure with respect to multiple claims arising from a single occurrence or
event. RCRe also participates in "common account" retrocessional arrangements
for certain reinsurance treaties, which are arrangements whereby the ceding
company purchases a cover for the benefit of the ceding company and the
reinsurers on the reinsurance treaty. Common account retrocessional arrangements
reduce the effect of individual or aggregate losses to all participating
companies with respect to a reinsurance treaty, including the cedent.
All retrocessionaires must conform to RCRe's standards and must be
specifically approved by RCRe's Security Committee, which consists of four
members of senior management, including the President. Business may not be
conducted with retrocessionaires that are not approved by the Security
Committee.
For additional information on our retrocessional arrangements and risk
management policies, please refer to "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Results of Operations--Net
Premiums Written," "--Aviation Business" and "--Risk Retention" and Note 7 of
the accompanying notes to our consolidated financial statements.
We continue to evaluate RCRe's retrocessional requirements periodically in
relation to many factors, including its surplus, gross line capacity and
changing market conditions.
Claims Administration
Claims are managed by our professional claims staff whose responsibilities
include the reviewreceipt of initial loss
reports, creation of claim files, determination of whether further investigation
is required, establishment and adjustment of case reserves and payment of
claims. In addition, our claims staff
conducts comprehensive claimsAdditionally, audits ofwill be conducted for both specific claims and
overall claims procedures at the offices of selected ceding companies. In certain instances,We may
make use of outside consultants for claims work.
15
OUR INSURANCE OPERATIONS
Our Insurance Group will have operations in the U.S. and Bermuda. As of
March 14, 2002, our Insurance Group has 37 employees consisting of 17
underwriters, 16 other professionals and 4 non-professionals. We expect that the
number of employees in our Insurance Group will increase significantly as partwe
expand our insurance operations.
STRATEGY. Our Insurance Group strategy is to write business profitably (on
both a gross and net basis) across all of our product lines. Our Group's
operating principles are:
- CAPITALIZE ON PROFITABLE UNDERWRITING OPPORTUNITIES. We believe that our
experienced management and underwriting team will be able to locate and
identify lines of business with attractive risk/ reward characteristics.
As profitable underwriting opportunities are identified, we will make
additions to our product portfolio in order to take advantage of market
trends. This could include adding underwriting and other professionals
with specific expertise in specialty lines of business.
- CENTRALIZE RESPONSIBILITY WITHIN EACH LINE OF BUSINESS. Our Insurance
Group will consist of "profit centers" consisting of individual lines of
business. Within each profit center, profit center managers will oversee
the underwriting and other functions within each business region, and
regional executives will be responsible for overall profitability within
each business line. We believe that this organizational structure will
allow close control of our profitability, and create clear accountability,
within each line of business and each region.
- MAINTAIN A DISCIPLINED UNDERWRITING PHILOSOPHY. Our underwriting
philosophy is to generate an underwriting profit through prudent risk
selection and proper pricing. We believe that the key to this approach is
strict adherence to uniform underwriting standards across all lines of
business. Our insurance senior management intends to provide close control
of the underwriting process.
- FOCUS ON PROVIDING SUPERIOR CLAIMS MANAGEMENT. We believe that claims
handling is an integral component of credibility in the market for
insurance products. Therefore, we believe that our ability to handle
claims expeditiously and satisfactorily will be a comprehensive risk evaluation process,key to our success. We
intend to use experienced internal claims professionals, as well as
nationally recognized external claims managers.
- UTILIZE AN OPEN BROKERAGE DISTRIBUTION SYSTEM. We believe that by avoiding
reliance on contractual relationships with brokers or other agents, we can
efficiently access a claims audit may be performed
priorbroad customer base while maintaining underwriting
control. We will compensate our distribution sources on a risk-by-risk
basis and we do not intend to assuming reinsuranceoffer additional incentives based on volume
or profitability.
LINES OF BUSINESS. Our Insurance Group will initially comprise six lines of
business or entering into"profit centers": property, casualty (including excess and
umbrella), executive assurance (including, but not limited to, financial and
commercial institution directors and officers liability and errors and omissions
coverage), medical malpractice, professional liability insurance (including, but
not limited to, architects and engineers, small to medium accounting firms and
lawyers professional liability) and program business (including alternative
risk). Once these units are operational, we will explore other opportunities in
new areas which may include: marine, environmental liability, construction risk
and surety.
16
UNDERWRITING PHILOSOPHY.
Our Insurance Group's underwriting philosophy is to generate an investment
transaction.
Reservesunderwriting
profit (on both a gross and net basis) through prudent risk selection and proper
pricing across all lines of business. One key to this philosophy will be the
strict adherence to uniform underwriting standards across each profit center
that will focus on the following:
- risk selection;
- desired attachment point;
- limits and retention management;
- due diligence, including as to financial condition, claims history,
management, and product, class and territorial exposure;
- underwriting authority and appropriate approvals; and
- collaborative decision-making.
MARKETING. Our Insurance Group's products will be marketed principally
through licensed independent brokers and wholesalers. We anticipate that a
majority of our volume may emanate from the top three insurance brokers.
CLAIMS MANAGEMENT. Our claims department will provide underwriting and loss
service support to all of our branches. In addition, claims personnel will fully
participate in the creation of insurance products. Members of our claims
department will work with our underwriting professionals as functional teams in
order to develop products and services that our customers desire and may use
independent national claims firms for Unpaid Claimsinvestigations and Claims Expenses
Asfield adjustments.
RESERVES
We believe we have applied, and will continue to so apply, a conservative
reserving philosophy for both our insurance and reinsurance company, RCRe is required to establish and maintain
reserves to cover its estimated ultimate liability for unpaid claims and claims
expensesoperations. We
utilize regular actuarial reviews. Reserve estimates are derived after extensive
consultation with respect to reported and unreported claims incurred asindividual underwriters, actuarial analysis of the end
of each accounting period (net of estimated related salvageloss
reserve development and subrogation
claimscomparison with market benchmarks. We are building our
actuarial staff and retrocession recoverables (if any) of RCRe). Thesewill utilize both internal and external actuaries.
Generally, reserves are established without regard to whether we may
subsequently contest the claim. We do not currently expect to discount our loss
reserves.
Loss reserves represent estimates involving actuarial and statistical projectionsof what the insurer or reinsurer
ultimately expects to pay on claims at a given time, of
what RCRe expects the ultimate settlement and administration of claims to cost based on facts and
circumstances then known, predictions of future events,
estimates of future trends in claims severity and other variable factorsit is possible that the ultimate liability may
exceed or be less than such as
inflationestimates. Even actuarially sound methods can lead
to subsequent adjustments to reserves that are both significant and new concepts of liability. For certain types of claims, it may
over time be necessaryirregular
due to revise estimated potential loss exposure and therefore
RCRe's unpaid claims and claims expense reserves. The inherent uncertainties of
estimating claims and claims expense reserves are exacerbated for reinsurers by
the significant periods of time (the "tail") that often elapse between the
occurrence of an insured claim, the reportingnature of the claim to the primary
insurerrisks written. See "Management's Discussion and
ultimately to the reinsurer,Analysis of Financial Condition and the primary insurer's paymentResults of that claimOperations--Critical Accounting
Policies, Estimates and subsequent indemnification by the reinsurer. As a consequence,
actual claimsRecent Accounting Pronouncements--Losses and claims expenses paid may deviate, perhaps substantially, from
estimates reflected in RCRe's reserves in its financial statements. The
estimation of reserves by new reinsurers, such as RCRe, may be less reliable
than the reserve estimations of a reinsurer with an established volume of
business and loss history. To the extent reserves prove to be inadequate, RCRe
may have to augment such reserves and incur a charge to earnings. Such a
development could result in a material charge to earnings or stockholders'
equity in future periods.
When a claim is reported to an insurance company that cedes business to
RCRe, its claims personnel establish a "case reserve" for the estimated amount
of the ultimate payment. The estimate reflects the informed judgment of such
personnel based on general insurance reserving practices and on the experience
and knowledge of such personnel regarding the nature and value of the specific
type of claim. RCRe, in turn, typically establishes a case reserve when it
receives a notice of a claim from the ceding company. Such reserves are based on
an independent evaluation by RCRe, taking into consideration coverage,
liability, severity of injury or damage, jurisdiction, RCRe's assessment of the
ceding company's ability to evaluate and handle the
9
claim and the amount of reserves recommended by the ceding company. Case
reserves are adjusted periodically by RCRe based on subsequent developments and
audits of ceding companies.
In accordance with industry practice, RCRe maintains incurred but not
reported ("IBNR") reserves. These reserves are established to provide for future
case reserves and loss payments on incurred claims which have not yet been
reported to an insurer or reinsurer. In calculating its IBNR reserves, RCRe uses
generally accepted actuarial reserving techniques that take into account
quantitative loss experience data, together, where appropriate, with qualitative
factors. IBNR reserves are based on loss experience of RCRe and the industry,
and are grouped both by class of business and by accident year. IBNR reserves
are also adjusted to take into account certain factors such as changes in the
volume of business written, reinsurance contract terms and conditions, the mix
of business, claims processing and inflation that can be expected to affect
RCRe's liability for losses over time.
The reconciliation of claims and claims expense reserves for the years
ended December 31, 1999, 1998 and 1997 is as follows:
(In thousands)
Years Ended
December 31,
-----------------------------------------------------------
1999 1998 1997
---- ---- ----
At beginning of year:
Gross claims and claims expense reserves $216,657 $70,768 $20,770
Reinsurance recoverables 30,468 _____ 522
------ -------
Net claims and claims expense reserves 186,189 70,768 20,248
Net claims and claims expenses incurred relating to:
Current year $275,455 178,957 73,385
Prior year 30,386 (2,832) 22
------ ------- -------
Total 305,841 176,125 73,407
Net paid claims and claims expenses incurred relating to:
Current year 95,367 41,910 13,649
Prior year 88,034 18,794 9,238
------ ------ -------
Total 183,401 60,704 22,887
At end of year:
Net claims and claims expense reserves current year 308,629 186,189 70,768
Reinsurance recoverables 55,925 30,468 _____
------ ------
Gross claims and claims expense reserves $364,554 $216,657 $70,768
-------- -------- -------
RCRe believes that its exposure, if any, to environmental impairment
liability and asbestos-related claims is minimal since it did not write business
prior to 1996.
RCRe does not currently discount its reserves to reflect the present value
of claims that may eventually be paid.
Subject to the foregoing, we believe that the reserves for claims and
claims expenses are adequate to cover the ultimate cost of claims and claims
expenses incurred through December 31, 1999. The estimates will be continuously
reviewed and as adjustments to these reserves become necessary, these
adjustments will be reflected in current operations.
Estimates of prior accident year claims were increased by approximately $30
million in 1999. A substantial portion of this amount resulted from (1) our
review of additional claims information and our continuing underwriting and
actuarial analysis of the business produced by a certain managing underwriting
agency, (2) notification of additional satellite losses received in 1999
pertaining to 1998, (3) aviation losses, principally the 1998 Swiss Air crash,
and (4) property losses reported on several international treaties that are in
run-off.
Estimates of prior accident year claims were reduced by approximately $2.8
million in 1998 primarily due to favorable claims development in the property
and multi-line classes of business.Loss
Adjustment Expenses."
The following table represents the development of generally accepted
accounting principles ("GAAP") balance sheet reserves for 1997 through
December 31, 2001. This table does not present accident or policy year
development data. Results for the period 1996 through 1999.to December 31, 2000 relate to our
prior reinsurance operations, which was sold on May 5, 2000 to Folksamerica
Reinsurance Company. The top line of the table shows the reserves, net of
reinsurance recoverables, at the balance sheet date for each of the indicated
years. This represents the estimated amounts of net claims and
17
claims expenses arising in all prior years that are unpaid at the balance sheet
date, including IBNR.incurred but not reported ("IBNR") reserves. The table also
shows the reestimated amount of the previously recorded reserve based on
experience as of the end of each succeeding year. The estimate changes as more
information becomes known about the frequency and severity of claims for
individual years. The "cumulative redundancy (deficiency)" represents the
aggregate change in the estimates over all prior years. The table also shows the
cumulative amounts paid as of successive years with respect to that reserve
liability. The lower portion ofIn addition, the table representsreflects the claim development of the gross
balance sheet reserves for 1996 through 1999.December 31, 2001.
With respect to the information in the table below, it should be noted that
each amount includes the effects of all changes in amounts for prior periods.
This table does not present accident or policy year development data. Conditions
and trends that have affected development of the liability in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future reserve development based on the following table. For additional information on RCRe's reservingour reserves, including a reconciliation of claims
and retrocessional activities,claims expense reserves for the years ended December 31, 2001, 2000 and
1999, please refer to "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Results of Operations--Risk Retention,"
"Business--Retrocessional Arrangements" and Notes 6 and 7Note 5 of the accompanying
notes toaccompanying our consolidated
financial statements.
Development ofDEVELOPMENT OF GAAP Reserves
Cumulative Redundancy (Deficiency)
(in millions)RESERVES
CUMULATIVE REDUNDANCY (DEFICIENCY)
Years Ended DecemberYEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------------------------------------------
1996 1997 1998 1999 ---------- ----------- ------------- -----------2000 2001
-------- -------- -------- -------- -------- --------
(IN MILLIONS)
Reserves for unpaid claims and claims adjustment
expenses, net of reinsurance recoverables $20 $71 $186 $309recoverables...... $ 20 $ 71 $ 186 $ 309 $ -- $ 23
Paid (cumulative) as of:
One year laterlater................................. 9 19 88 311 -- --
Two years laterlater................................ 10 33 216 311 -- --
Three years laterlater.............................. 12 64 216 -- -- --
Four years later............................... 18 64 -- -- -- --
Five years later............................... 18 -- -- -- -- --
Reserve reestimated as of:
One year laterlater................................. 20 68 216 -- -- --
Two years laterlater................................ 19 65 216 -- -- --
Three years laterlater.............................. 18 64 216 -- -- --
Four years later............................... 18 64 -- -- -- --
Five years later............................... 18 -- -- -- -- --
Cumulative redundancy (deficiency) $2 $6 ($30)
========== =========== =============
Percentage............... $ 2 $ 7 $ (30) $ (2) -- --
===== ==== ====== ===== ==== ====
Cumulative redundancy (deficiency) as a
percentage of net reserves..................... 10.0% 8.5% (16.1)% (1.0)% -- --
Gross reserve for claims and claims expenses $20 $71 $216 $365expenses..... $ 20 $ 71 $ 216 $ 365 -- $113
Reinsurance recoverable 0 0recoverable.......................... -- -- (30) (56) ---------- ----------- --------- ----------- (90)
----- ---- ------ ----- ---- ----
Net reserve for claims and claims expenses $20 $71 $186 $309
---------- ----------- --------- ---------expenses....... $ 20 $ 71 $ 186 $ 309 $ -- $ 23
----- ---- ------ ----- ---- ----
Gross reestimated reserve $18 $65 $246reserve........................ $ 18 $ 64 $ 246 $ 367 $ -- $113
Reestimated reinsurance recoverable 0 0recoverable.............. -- -- (30) ---------- ------------ ---------(56) -- (90)
----- ---- ------ ----- ---- ----
Net reestimated reserve $18 $65 $216reserve.......................... $ 18 $ 64 $ 216 $ 311 $ -- $ 23
Gross reestimated redundancy (deficiency) $2 $6 ($30)
---------- ----------- ---------........ $ 2 $ 7 $ (30) $ (2) -- --
===== ==== ====== ===== ==== ====
OverviewINVESTMENTS
At December 31, 2001, consolidated cash and invested assets totaled
approximately $1.0 billion, consisting of the Reinsurance Industry
Reinsurance$486.8 million of cash and short-term
investments, $468.3 million of publicly traded fixed
18
maturity investments, $22.2 million of fixed maturities held in escrow,
$41.6 million of privately held securities and $0.2 million of publicly traded
equity securities. Our strategy is a form of insurance into maximize our underwriting profitability
and fully deploy our capital through our underwriting activities. Consequently,
we have established an investment policy, which a reinsurer indemnifies a
primary insurer against part or all of the liability assumed by the primary
insurer under one or more insurance policies. Reinsurance is a contractual
11
agreement whereby an insurer or reinsurer (ceding company) remits a portion of
the premium it receives to a reinsurer (assuming company) as payment for the
assuming company's agreement to indemnify the ceding company for a portion of
the risk. Reinsurance provides insurers with several benefits which include the
following: reduction in net liability on individual risks, protection against
catastrophic losses and assistance in maintaining acceptable regulatory ratios
and additional underwriting capacity in that the primary insurer can accept
larger risks and can expand the book of business it writes at a faster rate than
would be possible without a corresponding increase in its capital and surplus
position. Reinsurance does not legally discharge the ceding company from its
liability with respect to its obligation to the insured.
There are two principal types of reinsurance: treaty reinsurance and
facultative reinsurance. Treaty reinsurance is a contractual arrangement,
usually renewable annually, between a primary insurer and a reinsurer under
which the primary insurer must cede and the reinsurer must assume a specified
portion of a type or category of risks. Facultative reinsurance is the
reinsurance of individual risks. Rather than agreeing to reinsure all or a
portion of a class of risk, the reinsurer separately rates and underwrites each
risk. In the underwriting of treaty reinsurance, the reinsurer need not
separately evaluate each of the individual risks assumed, as it must in the
underwriting of facultative reinsurance, and in general depends on the original
underwriting decisions made by the reinsured.
Both facultative and treaty reinsurance can be written on both an excess of
loss and a quota share basis. In quota share reinsurance, the reinsurer assumes
from the reinsured a percentage specified in the treaty of each risk in the
reinsured class of risk. Premiums that the reinsured pays to the reinsurer are
proportional to the portion of the risk that the reinsurer assumes, and the
reinsurer generally pays the reinsured a ceding commission to reimburse the
reinsured for the expenses incurred in obtaining the business (e.g.,
commissions, premium taxes, assessments and miscellaneous administrative
expenses). The ceding commission may also contain a profit component. In quota
share reinsurance, the reinsurer may receive the benefit of common account
reinsurance and, therefore, the reinsurer will have credit risk with respect to
the underlying reinsurers providing such common account reinsurance. In excess
of loss treaty reinsurance, the reinsurer indemnifies the reinsured for a
portion of the losses on underlying policies which exceed a specified loss
retention amount up to an amount per loss specified in the treaty. Premiums that
the reinsured pays to the reinsurer for excess of loss coverage are not directly
proportional to the premiums that the reinsured receives because the reinsurer
does not assume a proportionate risk. The reinsurer generally does not pay any
commission to the reinsured in connection with excess of loss reinsurance.
Excess of loss treaty reinsurance can, in turn, be written on a per risk or
catastrophe basis. Per risk excess of loss reinsurance protects the reinsured
against a loss resulting from a single risk or location. Catastrophe excess of
loss reinsurance protects a reinsured from an accumulation or large number of
related losses resulting from a variety of risks which may occur in a given
catastrophe and hence is a highly volatile business.
Excess of loss reinsurance is often written in layers, with one reinsurer
taking the risk from the primary insurer's retention layer up to a specified
amount, at which point another reinsurer assumes the excess liability or the
excess liability reverts back to the primary insurer. The reinsurer taking on
the risk just above the primary insurer's retention layer is said to write
"working" or "low layer" excess of loss reinsurance. A loss that reaches just
beyond the primary insurer's retention layer will create a loss for the lower
layer reinsurer, but not for the reinsurers on higher layers. Losses incurred in
low layer reinsurance tendwe consider to be more predictable than those in high layers due
to the greater availability of actuarial data.
Since facultative reinsurance, unlike treaty reinsurance, usually involves
the assumption of selected, individual risks and is sold in separate
transactions, facultative reinsurance typically generates higher profit margins
than treaty business. However, the reinsurer's losses may be higher for
facultative business because the reinsurer may assume a higher potential
liability and because the risks involved may be more volatile. In addition,
underwriting expenses and, in particular, personnel costs, are higher on
facultative business because each risk is individually underwritten and
administered. Facultative reinsurance is normally purchased by insurance
companies for individual risks not covered by their reinsurance treaties, for
excess losses on risks covered by their reinsurance treaties, and for unusual
risks. The demand for facultative reinsurance is typically inversely related to
the supply of treaty reinsurance.
Reinsurers may also purchase reinsurance, known as retrocessional
reinsurance, to cover their own risk exposure. Reinsurance companies enter into
retrocessional agreements for reasons similar to those that cause ceding
companies to purchase reinsurance.
12
The reinsurance market has two basic segments: reinsurers which primarily
obtain their business directly from insurers and other reinsurers ("direct
writers"), and those which, like RCRe, primarily obtain business through
reinsurance intermediaries or brokers.
Please seeconservative.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations--General--Recent Industry Performance.Operations--Investments."
CompetitionOur current investment guidelines stress preservation of capital, market
liquidity, and diversification of risk. To achieve this objective, our current
fixed income investment guidelines call for an average credit quality of "Aa3"
and "AA-" as measured by Moody's and Standard & Poor's, respectively.
Notwithstanding the foregoing, our investments are subject to market-wide risks
and fluctuations, as well as to risks inherent in particular securities.
At December 31, 2001, almost all of our fixed maturity and short-term
investments were rated investment grade by Moody's or Standard & Poor's and had
an average Standard & Poor's quality rating of "AA-" and an average duration of
approximately 1.9 years.
The propertyfollowing table summarizes the fair value of our investments and casualtycash
and short-term investments at the dates indicated.
DECEMBER 31,
---------------------------------------------------------------------------
2001 2000 1999
--------------------- --------------------- ---------------------
ESTIMATED % OF ESTIMATED % OF ESTIMATED % OF
FAIR VALUE TOTAL FAIR VALUE TOTAL FAIR VALUE TOTAL
---------- -------- ---------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
Cash and short-term investments.... $ 486,790 48% $108,868 39% $ 82,242 14%
Short-term investments held in
escrow........................... 22,156 2 -- -- -- --
---------- ---- -------- ---- -------- ----
Sub-total...................... 508,946 50 108,868 39 82,242 14
---------- ---- -------- ---- -------- ----
Fixed maturities:
U.S. government and government
agencies....................... 137,861 14 27,122 10 41,095 7
Municipal bonds.................. -- -- -- -- 52,245 9
Corporate bonds.................. 239,261 23 5,835 2 136,838 24
Mortgage and asset-backed
securities..................... 91,147 9 5,518 2 27,298 5
Foreign governments.............. -- -- -- -- 3,591 1
---------- ---- -------- ---- -------- ----
Sub-total.................... 468,269 46 38,475 14 261,067 46
---------- ---- -------- ---- -------- ----
Fixed maturities held in escrow.... -- -- 20,970 8 -- --
---------- ---- -------- ---- -------- ----
Equity securities:
Publicly traded.................. 235 -- 51,322 19 158,631 27
Privately held................... 41,608 4 56,418 20 77,934 13
---------- ---- -------- ---- -------- ----
Sub-total.................... 41,843 4 107,740 39 236,565 40
---------- ---- -------- ---- -------- ----
Total...................... $1,019,058 100% $276,053 100% $579,874 100%
========== ==== ======== ==== ======== ====
19
Primarily because of the potential for large claims payments, our investment
portfolio is structured to provide a high level of liquidity. The table below
shows the contractual maturities of our fixed maturities at December 31, 2001:
DECEMBER 31, 2001
--------------------------
ESTIMATED AMORTIZED
FAIR VALUE COST
---------- ---------
(IN THOUSANDS)
Available for sale:
Due in one year or less............................ $ 9,351 $ 10,438
Due after one year through five years.............. 322,923 321,315
Due after five years through ten years............. 34,751 31,445
Due after 10 years................................. 10,097 12,804
-------- --------
Sub-total........................................ 377,122 376,002
-------- --------
Mortgage and asset-backed securities............... 91,147 91,152
-------- --------
Total.......................................... $468,269 $467,154
======== ========
The table below presents the credit quality (according to Standard & Poor's)
distribution of our fixed maturities at December 31, 2001:
DECEMBER 31, 2001
-------------------------
ESTIMATED % OF
FAIR VALUE TOTAL
---------- --------
(IN THOUSANDS)
AAA............................................... $199,416 42.6%
AA................................................ 31,847 6.8%
A................................................. 147,679 31.5%
BBB............................................... 87,378 18.7%
B................................................. 1,949 0.4%
-------- ------
Total....................................... $468,269 100.0%
======== ======
RATINGS
Our reinsurance subsidiaries, Arch Re (US), Arch Re (Bermuda) and First
American Insurance Company, each currently have financial strength ratings of
"A-" (Excellent) from A.M. Best and American Independent Insurance Company has a
financial strength rating of "C++" (Marginal) from A.M. Best. We do not believe
that American Independent's non-standard automobile business is particularly
ratings sensitive because its insureds purchase insurance primarily to satisfy
state and local insurance and financial reporting requirements. Rock River has a
financial strength rating of "A+u" (Superior--under review) from A.M. Best and
Cross River has a financial strength rating of "NR-2" (Insufficient Size and/or
Operating Experience) from A.M. Best. We are currently seeking to improve the
financial strength for Rock River and Cross River, and we are also seeking
ratings for our other principal U.S. insurance subsidiaries.
Recently, rating agencies have been coming under increasing pressure as a
result of high-profile corporate bankruptcies and may, as a result, increase
their scrutiny of rated companies, revise their rating policies or take other
action. We can offer no assurances that our ratings will remain at their current
levels.
COMPETITION
The world-wide reinsurance and insurance businesses are highly competitive.
Competition is basedWe compete, and will continue to compete, with major U.S. and non-U.S. insurers
and reinsurers and others, some of which
20
have greater financial, marketing and management resources than us and have had
longer-term relationships with insureds and brokers than us. We compete with
other insurers and reinsurers primarily on many factors, including the perceivedbasis of overall financial
strength, ratings assigned by independent rating agencies, geographic scope of
the reinsurer,business, strength of client relationships, premiums charged, contract terms and
conditions, products and services offered, ratings assigned by independent rating agencies, speed of claims payment, reputation,
employee experience, and reputationqualifications and experience. In pursuinglocal presence.
OTHER OPERATIONS
During the period following the sale of our investmentprior reinsurance operations in
May 2000 through the announcement of our underwriting initiative in
October 2001, we built and acquired insurance businesses that enable us to
generate both fee-based revenue (E.G., commissions and advisory and management
fees) and risk-based revenue (I.E., insurance premium). As part of this
strategy, we have also competed with venture capitalists, buyout funds, merchant
banking firms, investment banking firmsacquired certain businesses, including Hales & Company Inc. (an
insurance advisory firm) and other banking and financing sourcesAmerican Independent Insurance Holding Company
(which principally writes non-standard automobile coverages), which are
considered "non-core businesses" for investment opportunities in publicly traded and privately held equity
securities. Competition is based on many factors, including the ability to
identify trends and investment opportunities that could lead to superior
returns, financial and personnel resourcespurposes of the investor, the abilitycapital infusion. See "The
Capital Infusion."
REGULATION
U.S. INSURANCE REGULATION
GENERAL. In common with other insurers, our U.S.-based insurance
subsidiaries are subject to negotiate investment terms effectively,extensive governmental regulation and the ability of the investor to
provide expertise and advice to companies targeted for investment.
We competesupervision in
the United Statesvarious states and international reinsurance markets and,
in the United States markets, we compete with both United States and
internationally domiciled reinsurers. Our competitors include independent
reinsurance companies, subsidiaries or affiliates of established worldwide
insurance companies, reinsurance departments of certain primary insurance
companies and domestic and international underwriting syndicates, many of which
have substantially greater financial resources than we do. Competitors include
direct writers and those that, like RCRe, write primarily through reinsurance
intermediaries.
Significant competitors of RCRe in the direct market include American
Re-Insurance Company, Employers Reinsurance Corporation, General Reinsurance
Corporation and Swiss Reinsurance Company. Significant competitors of RCRe in
the intermediary/broker market include Everest Reinsurance Company, GE Capital
Reinsurance Company, Gerling Global Reinsurance Corporation of America, NAC
Reinsurance Company, Odyssey Reinsurance Corporation, PartnerRe Ltd., PMA
Reinsurance Corporation, The St. Paul Companies, Inc., Transatlantic Reinsurance
Company, Trenwick America Reinsurance Corporation, Underwriters Reinsurance
Company and Zurich Re North America. In addition, we compete with Lloyd's
syndicates and certain companies operating in the London reinsurance market.
We also face competition from other market participants that determine to
devote greater amounts of capital to the types of business written by us. We may
also compete with new market entrants, including possibly other companies
organized by (or that may, in the future, be organized by) certain of our
initial investors, including MMRCH and Trident, their affiliates or entities
that they advise or in which such initial investors, their affiliates or
entitiesjurisdictions in which they advise,are domiciled and licensed to
conduct business. The laws and regulations of the state of domicile have (or may, in the
future, have)most significant investments.impact on operations. This regulation and supervision is
designed to protect policyholders rather than investors. Generally, regulatory
authorities have broad supervisory powers over such matters as licenses,
standards of solvency, premium rates, policy forms, marketing practices,
investments, security deposits, methods of accounting, form and content of
financial statements, reserves and provisions for unearned premiums, unpaid
losses and loss adjustment expenses, reinsurance, minimum capital and surplus
requirements, dividends and other distributions to shareholders, periodic
examinations and annual and other report filings. Certain insurance regulatory
requirements are highlighted below. In addition, affiliates of MMCI engage in activities in support of
their ongoing business strategies, which activities may compete with our
activities.
We believeregulatory authorities conduct
periodic financial and market conduct examinations.
CREDIT FOR REINSURANCE. Arch Re (US) is subject to insurance regulation and
supervision that the reinsurance industry is consolidating, and the largest
reinsurers are writing a larger proportion of total industry premiums as ceding
companies place increasing importance on size and financial strength in the
selection of reinsurers. Please see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--General--Recent Industry
Performance."
We have been unable to make acquisitions because of (1) our depressed stock
price, (2) our inability to use RCRe's cash due to RCRe's statutory surplus,
rating and operating requirements and (3) our inability to incur debt duesimilar to the amount and volatilityregulation of our earnings. This has put us, like many other small
reinsurance companies, at a severe competitive disadvantage inlicensed primary insurers.
However, the rapidly
consolidating reinsurance industry. We have also been facing increasing
competition, which has been adversely affecting our results of operations and
financial condition. These are some of the factors that led us to the proposed
sale of our reinsurance operations to Folksamerica. We refer you to the section
of our special meeting proxy statement entitled "Reasons for the Asset Sale and
the Name Change; Our Board of Directors Recommends the Asset Sale," which is
incorporated by reference.
Insurance ratings are used by insurers and reinsurance intermediaries as an
important means of assessing the financial strength and quality of reinsurers.
In addition, a ceding company's own rating may be adversely
13
affected by the lack of a rating of its reinsurer. A.M. Best is generally
considered to be a significant rating agency with respect to the evaluation of
insurance and reinsurance companies. A.M. Best's ratings reflect their
independent opinion of the financial strength, operating performance and market
profile of an insurer relative to standards established by A.M. Best, and are
not a warranty of an insurer's current or future ability to meet its obligations
to policyholders. In May 1999, A.M. Best Company revised its rating of RCRe from
A (Excellent) to A- (Excellent). While several factors were identified, the
rating action principally reflected the poor underwriting results reported by
RCRe in late 1998 and the first quarter of 1999 on its satellite book of
business and the business produced by a certain managing underwriting agency.
Following the announcement of the proposed sale of our reinsurance operations to
Folksamerica Reinsurance Company, A.M. Best announced on January 18, 2000 that
it was placing our rating under review. The ratings actions taken by A.M. Best
have decreased RCRe's ability to compete in the reinsurance markets in which it
operates. See "Business--Recent Developments," "Management's Discussion and
Analysis of Financial Condition and Results of Operations--General--Folksamerica
Transaction" and Note 14 of the accompanying notes to our consolidated financial
statements.
Insurance Regulation
General
The terms and conditions of reinsurance agreements generally are not
subject to regulation by any governmental authority with respect to rates or
policy terms. This contrasts with primary insurance policies and agreements, the
rates and terms of which generally are closely regulated by state insurance regulators.
As a practical matter, however, the rates charged by primary insurers do have an
effect on the rates that can be charged by reinsurers.
State Regulation
RCRe, in common with other insurers, is subject to extensive governmental
regulation and supervision in the various states and jurisdictions in which it
transacts business. The laws and regulations of the State of Nebraska, the
domicile of RCRe, have the most significant impact on its operations. This
regulation and supervision is designed to protect policyholders rather than
investors and relates to, among other things, the standards of solvency which
must be met and maintained, the nature of and limitations on investments,
restrictions on the size of risk which may be insured under a single policy, and
reserves and provisions for unearned premiums, losses and other purposes.
Some states are considering legislative proposals which would authorize the
establishment of an interstate compact concerning various aspects of insurer
insolvency proceedings, including interstate governance of receiverships and
guaranty funds. As of March 2000, such legislation had been adopted by three
states, including Illinois, Michigan and Nebraska.
Insurance departments also conduct periodic examinations of the affairs of
insurance companies and require the filing of annual and other reports relating
to the financial condition of companies and other matters. The Nebraska
Insurance Department completed an examination of RCRe's records, accounts and
business affairs for the period October 1995 through December 31, 1997 and
issued its final report for the examination on March 15, 1999, which report
included no material findings. Prior to this examination, RCRe had not been
examined by the Nebraska Insurance Department other than in connection with the
receipt of its insurance license in November 1995.
Credit for Reinsurance
A primary insurer ordinarily will enter into a reinsurance agreement only if
it can obtain credit for the reinsurance ceded on its statutory financial
statements. In general, credit for reinsurance is allowed in the following
circumstances:
(1)- if the reinsurer is licensed in the state in which the primary insurer is
domiciled or, in some instances, in certain states in which the primary
insurer is licensed;
(2)- if the reinsurer is an "accredited" or otherwise approved reinsurer in the
state in which the primary insurer is domiciled or, in some instances, in
certain states in which the primary insurer is licensed;
(3)21
- in some instances, if the reinsurer (a) is domiciled in a state that is
deemed to have substantially similar credit for reinsurance standards as
the state in which the primary insurer is domiciled and (b) meets certain
financial requirements; or
(4)- if none of the above apply, to the extent that the reinsurance obligations
of the reinsurer are collateralized appropriately, typically
14
through the
posting of a letter of credit for the benefit of the primary insurer or
the deposit of assets into a trust fund established for the benefit of the
primary insurer.
Therefore, asAs a result of the requirements relating to the provision of credit for
reinsurance, RCRe isArch Re (US) and Arch Re (Bermuda) are indirectly subject to
certain regulatory requirements imposed by jurisdictions in which ceding
companies are licensed.
As of March 27, 2000, RCRe8, 2002, Arch Re (US) is licensed or is an accredited or
otherwise approved reinsurer in 4443 states as follows: Alabama, Alaska, Arkansas,
Connecticut, Delaware,and the District of Columbia, Florida, Georgia, Hawaii, Idaho,
Illinois, Indiana, Iowa, Kentucky, Louisiana, Maryland, Michigan, Minnesota,
Mississippi, Missouri, Montana, Nebraska (state of domicile), Nevada, New
Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio,
Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota,
Tennessee, Texas, Utah, Vermont, Virginia, West Virginia, Wisconsin and Wyoming.
RCRe also holds a Certificate of Authority from the United States Treasury
Department for surety business. In addition, RCReFirst
American is an authorized reinsurer in
the Argentine Republic and Colombia, South America.
Investment Limitations
The Nebraska insurance laws contain rules governing the types and amounts
of investments that are permissible for Nebraska-domiciled insurers, including
RCRe. These rules are designed to ensure the safety and liquidity of an
insurer's investment portfolio. Investments in excess of statutory guidelines do
not constitute "admitted assets" (i.e., assets permitted by the Nebraska
insurance laws to be included in a domestic insurer's statutory financial
statements), unless special approval is obtained from the Nebraska Director of
Insurance (the "Nebraska Director"). Non-admitted assets do not count for the
purposes of various financial ratios and tests, including those governing
solvency and the ability to write premiums. An insurer may hold an investment
authorized under more than one provision of the Nebraska insurance laws under
the provision of its choice (exceptlicensed or otherwise approved as otherwise expressly provided by law).
Subject to the "basket" clause described below, the maximum amount of an
insurer's authorized investments in preferred stock and common stock of
insurance companies for calculation of admitted assets in Nebraska is the lesser
of (1) the amount by which admitted assets exceed required capital and
liabilities or (2) 50% of policyholders surplus. Based on RCRe's statutory or
policyholders surplus of $230.1 million following our recent repurchase of stock
from XL Capital described above under "Business--Recent Developments," such
amounts for RCRe were $225.1 million and $115.0 million, respectively. Stock of
insurance companies is valued for these purposes at cost. Unrealized
appreciation of such securities does not count for the purpose of determining
the percentage of certain admitted assets attributable to insurance stock
investments.
While there is a concentration restriction which precludes investment of
more than 5% of the insurer's admitted assets in any one issuer, this
restriction does not apply to investments in common and preferred stock of other
insurers whose senior debt obligations have received a designation of 1 or 2
from the Securities Valuation Office (the "SVO") of the National Association of
Insurance Commissioners (the "NAIC"). Designations assigned by the SVO range
from class 1 to class 6, with class 1 as the highest quality rating. Generally,
SVO designations of 1 and 2 are comparable to investment grade ratings by
Moody's and Standard & Poor's, and SVO designations of 3 to 6 are comparable to
below investment grade ratings by such rating organizations.
Other concentration restrictions preclude investment of more than 3%, 2%,
1% or 1/2% of an insurer's admitted assets in any one person whose senior debt
obligations have received a designation of 3, 4, 5 or 6, respectively, from the
SVO. In addition, an insurer's investments in debt obligations having a 4, 5 or
6 designation from the SVO may not exceed 4%, 2% or 1%, respectively, of RCRe's
admitted assets. Aggregate investments in obligations having any combination of
3, 4, 5 and 6 designations from the SVO may not exceed, in the aggregate, 15% of
the insurer's admitted assets.
An insurer's investments in equity interests of business entities (e.g.,
corporations, partnerships, limited liability companies and partnerships,
trusts, joint ventures, etc., including insurance companies) that are created or
existing under the laws of the United States or Canada (or any state or province
thereof) are also authorized under the Nebraska insurance laws, provided that,
in the case of an investment in a business entity other than an insurance
company, (1) the insurer may not generally invest in more than 10% of the total
equity interests of such entity and (2) the investment will be subject to the
concentration restrictions described above. In the case
15
of an investment in a business entity that is a corporation, such entity must
also meet certain requirements regarding retained earnings and dividend payment
history.
Authorized foreign investments by an insurer in foreign jurisdictions whose
sovereign debt has a designation49 states and the
District of 1, 2 or 3 from the SVO may not exceed, in
the aggregate, 15% of the insurer's admitted assets. Investments may not be made
in foreign jurisdictions whose sovereign debt has a designation of 4, 5 or 6
from the SVO. In addition, authorized foreign investments denominated in foreign
currencies may not exceed, in the aggregate, 5% of the insurer's admitted
assets. Authorized foreign investments must also have a minimum designation of 1
or 2 from the SVO (or corresponding investment grade rating from any rating
organization recognized by the SVO, including Moody's and Standard & Poor's),
and must be aggregated with investments of the same kinds and classes made under
the Nebraska insurance laws (except for the "basket" clause) for purposes of
determining compliance with the limitations contained in other sections.
Notwithstanding the foregoing or any other limitations under the Nebraska
insurance laws, thereColumbia, Cross River is a "basket" clause under which investments "not
otherwise authorized" are permitted up to a maximum of the greater of (1) the
lesser of (a) 25% of the amount by which admitted assets exceed total
liabilities, excluding capital, or (b) 5% of admitted assets (investments
authorized under this subsection of the "basket" clause may not include
obligations with SVO designations of 3, 4, 5 or 6), or (2) that portion of
policyholders surplus which is in excess of 50% of the insurer's annual net
written premiums. Derivative instruments otherwise authorized under the Nebraska
insurance laws may not be authorized under the "basket" clause. Based on RCRe's
statutory surplus of $230.1 million following our recent repurchase of stock
from XL Capital described above under "Business--Recent Developments," the
"basket" clause would have allowed RCRe to make investments not otherwise
authorized under the Nebraska insurance laws up to a maximum amount of $76.6
million.
The Nebraska insurance laws provide that the Nebraska Director may waive
any of the legal investment limitations upon application by an insurer. The
Nebraska Director is required to consider the following factors in determining
whether to approve or disapprove any such application: (1) the credit risk
quality of the proposed investment; (2) the liquidity of the proposed investment
and of the insurer's entire investment portfolio; (3) the extent of the
diversification of the insurer's investment portfolio; (4) the yield of the
proposed investment; (5) the reasonableness of the insurer's policyholders
surplus in relation to the insurer's outstanding liabilities and financial
needs; and (6) any other relevant considerations. From time to time, it may be
necessary for the Company to seek waivers from the Nebraska Director of the
legal investment limitations imposed by the Nebraska insurance laws; no
assurances can be given that such waivers can be obtained.
States in which RCRe is or may become licensed or authorized may also seekotherwise approved as an excess
and surplus lines insurer in 23 states and the District of Columbia, Rock River
is licensed or otherwise approved as an excess and surplus lines insurer in 47
states and the District of Columbia and American Independent Insurance Company
is licensed as an insurer in three states. Arch Re (Bermuda) is not, and does
not expect to impose their legal investment laws on RCRe. Such laws vary from state to
state and may not permit investments that are permitted under Nebraska law. To
the extent that any state disallows an investment that is permitted under
Nebraska law, RCRe's statutory surplus reflected in its statutory financial
statements filed in such state would be reduced by the amount of such
disallowance.
Holding Company Actsbecome, so licensed or approved.
HOLDING COMPANY ACTS. State insurance holding company system statutes and
related regulations provide a regulatory apparatus which is designed to protect
the financial condition of domestic insurers operating within a holding company
system. All insurance holding company statutes require disclosure and, in some
instances, prior approval of significantmaterial transactions between the domestic insurer
and an affiliate. Such transactions typically include sales, purchases,
exchanges, loans and extensions of credit, reinsurance agreements, service
agreements, guarantees and investments between an insurance company and its
affiliates, involving in the aggregate certain percentages of aan insurance
company's admitted assets or policyholders surplus, or dividends that exceed
certain percentages of thean insurance company's surplus or income.
The Nebraska insurance laws and the insurance laws of other states
generally regard an issuer as an "affiliate" of one of its investors if it is
controlled by, or is under common control with, the investor. Generally,
"control" means the possession of the power to direct or cause the direction of
the management and policies of the issuer, whether through the ownership of
voting securities, by contract or otherwise. Control is generally presumed to
exist if the investor, directly or indirectly, owns or controls 10% or more of
the voting securities of the issuer. The Nebraska insurance laws and the
insurance laws of other states generally allow investors to rebut this
presumption by filing a "disclaimer" that sets forth the bases for disclaiming
affiliation. In certain states, such as Nebraska, a disclaimer is deemed
effective once filed unless it is specifically disallowed by the
16
respective insurance department (after the parties in interest have been
provided notice and an opportunity to be heard). In other states, a disclaimer
must be specifically approved by the relevant insurance department. In cases
where RCRe may be presumed to "control," and therefore deemed an affiliate of,
an insurer under applicable holding company statutes, RCRe intends to continue
to file disclaimers with respect to such insurer unless prevented by the
surrounding circumstances.
Typically, the holding company statutes also require each of the insurance
subsidiaries periodically to file information with state insurance regulatory
authorities, including information concerning capital structure, ownership,
financial condition and general business operations. Under the terms of
applicable state statutes, any person or entity desiring to acquire control of a
domestic insurer is required first to obtain approval of the applicable state
insurance regulator.
Liquidation of Insurers
The liquidation of insurance companies, including reinsurers, is generally
conducted pursuant to state insurance law. In the event of the liquidation of
RCRe, such liquidation would be conducted by the Nebraska Director as the
domestic receiver of the properties, assets and business of RCRe. Liquidators
located in other states (known as ancillary liquidators) in which RCRe conducts
business may have jurisdiction over assets or properties located in such states
under certain circumstances. Under Nebraska law, all creditors of RCRe,
including but not limited to reinsureds under its reinsurance agreements, would
be entitled to payment of their allowed claims in full from the assets of RCRe
before we, as a stockholder of RCRe, would be entitled to receive any
distribution therefrom.
Regulation of Dividends and Other Payments from Insurance Subsidiaries
As an insurance holding company, we are largely dependent on dividends and
other permitted payments from RCRe to meet our obligations.REGULATION OF DIVIDENDS AND OTHER PAYMENTS FROM INSURANCE SUBSIDIARIES. The
ability of RCRean insurer to pay dividends or make other distributions is subject to
insurance regulatory limitations of Nebraska, the insurance company's state in which RCRe is domiciled. The Nebraska
insuranceof domicile.
Generally, such laws provide thatlimit the payment of dividends or other distributions together withabove
a specified level. Dividends or other dividends or distributions paid during the preceding 12 months, may not
exceed the greater of (i) 10% of statutory surplus as of the preceding December
31 or (ii) statutory net income from operations for the preceding calendar year
not including realized capital gains. Net income (exclusive of realized capital
gains) not previously distributed or paid as dividends from the preceding two
calendar years may be carried forward for dividend and distribution purposes.
Any proposed dividend or distribution in excess of such amount is called anthresholds
are "extraordinary" dividendand are subject to regulatory approval. Generally, during
2002, all dividends or distributionother distributions from Arch Re (US), First American and
may not be paid until either it has
been approved, or a 30-day waiting period has passed during which it has not
been disapproved, by the Nebraska Director. Notwithstanding the foregoing, the
Nebraskaour other insurance laws provide that any distribution that is a dividend may be
paid by RCRe only out of earned surplus arising from its business, which is
defined as unassigned funds (surplus) as reported in the statutory financial
statement filed by RCRe with the Nebraska Insurance Department for the most
recent year, including any surplus arising from unrealized capital gains or
revaluations of assets. Any distribution that is a dividend and that is in
excess of RCRe's unassigned funds, exclusive of any surplus arising from
unrealized capital gains or revaluation of assets,subsidiaries will be deemed an
"extraordinary" dividend subject to the foregoing requirements.regulatory approval. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and Notes 10 and 14Note 12, "Share Capital," of
the notes accompanying Notes to our consolidated financial statements.
INSURANCE REGULATORY INFORMATION SYSTEM RATIOS. The Nebraska insurance laws also require that the statutory surplusNational Association of
RCRe
following any dividend or distribution be reasonable in relation to its
outstanding liabilities and adequate to its financial needs. The Nebraska
Director is required to apply certain factors in determining the adequacy of an
insurer's surplus, including, among other things, the size of the insurer, the
extent to which the insurer's business is diversified, the number and size of
risks insured by each line of business, the extent of geographical dispersion of
insured risks and the reinsurance program, and characteristics of the investment
portfolio. In addition, the Nebraska insurance laws require that each insurer
give notice to the Nebraska Director of all dividends and other distributions
within five business days following declaration thereof and that any such
dividend or other distribution may not be paid within 10 business days of the
notice unless for good cause shown the Nebraska Director has approved such
payment within the such notice period.
Insurance Regulatory Information System Ratios
The NAIC'sCommissioners ("NAIC") Insurance Regulatory Information System
("IRIS") was developed by a committee of state insurance regulators and is
intended primarily to assist state insurance departments in executing their
statutory
17
mandates to oversee the financial condition of insurance companies
operating in their respective states. IRIS identifies 11 industry ratios and
specifies "usual values" for each ratio. Departure from the usual values of the
ratios can lead to inquiries from individual state insurance commissioners as to
certain aspects of an insurer's business. Insurers that report four or
22
more unusual values are generally targeted for regulatory review. For the year
ended December 31, 1999, RCRe's results2001, our U.S.-based insurance operations were within the
usual valuesnormal range of results except for eightAmerican Independent, which has not received
any notice of the 11 ratios. The "investment yield"
ratio was outside the usual value primarily due to our investment strategy of
investing a significant portion of our investment portfolio in equity
securities, which generally yield less current investment income than fixed
maturity investments. The "two year operating ratio" was outside the usual value
due to the combined impact of RCRe's "investment yield" ratio (described above)
and the 1999 and 1998 statutory combined ratios of 129.2% and 116.4%,
respectively, which reflect poor underwriting performance. RCRe's two year
statutory combined ratio was adversely affected by underwriting results from
RCRe's aviation and space lines of business and casualty and multi-line
reinsurance provided by RCRe on insurance business produced by a certain
managing underwriting agency. We have discontinued our aviation and space lines
of business. We have also discontinued our underwriting relationship with the
managing underwriting agency and the business and operations of the managing
underwriting agency are in run-off. For a related discussion, please refer to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations," --Operating Costs and Expenses," "--Managing
Underwriting Agency," "--Space and Aviation Business," "--Space Business" and
"--Aviation Business." The "change in surplus" ratio was outside the usual range
due to RCRe's operating results and the reduction in RCRe's unrealized
appreciation on invested assets.
Accreditationregulatory review.
ACCREDITATION. The NAIC has instituted its Financial Regulatory
Accreditation Standards Program ("FRASP") in response to federal initiatives to
regulate the business of insurance. FRASP provides a set of standards designed
to establish effective state regulation of the financial condition of insurance
companies. Under FRASP, a state must adopt certain laws and regulations,
institute required regulatory practices and procedures, and have adequate
personnel to enforce such items in order to become an "accredited" state. If a
state is not accredited, accredited states are not able to accept certain
financial examination reports of insurers prepared solely by the regulatory
agency in such unaccredited state.
The State
of Nebraska is accredited under FRASP; however, there can be no assurance that
it or any other state will remain accredited.
Risk-Based Capital RequirementsRISK-BASED CAPITAL REQUIREMENTS. In order to enhance the regulation of
insurer solvency, the NAIC adopted in December 1993 a formula and model law to
implement risk-based capital requirements for property and casualty insurance
companies. Effective January 1,
1994, Nebraska adopted risk-based capital legislation for property and casualty
companies which is similar to the NAIC risk-based capital requirements. These risk-based capital requirements are designed to assess capital
adequacy and to raise the level of protection that statutory surplus provides
for policyholder obligations. The risk-based capital model for property and
casualty insurance companies measures three major areas of risk facing property
and casualty insurers:
(1)- underwriting, which encompasses the risk of adverse loss developments and
inadequate pricing;
(2)- declines in asset values arising from credit risk; and
(3)- declines in asset values arising from investment risks.
Insurers having less statutory surplus than required by the risk-based
capital calculation will be subject to varying degrees of regulatory action,
depending on the level of capital inadequacy. Equity investments in common stock
typically are valued at 85% of their market value under the risk-based capital
guidelines. For equity investments in an insurance company affiliate, the
risk-based capital requirement for the equity securities of such affiliate would
generally be RCRe'sour U.S. insurance subsidiaries' proportionate share of the
affiliate's risk-based capital requirement.
ForUnder the approved formula, an insurer's statutory surplus is compared to
its risk-based capital requirement. If this ratio is above a discussionminimum threshold,
no company or regulatory action is necessary. Below this threshold are four
distinct action levels at which a regulator can intervene with increasing
degrees of "affiliate" statusauthority over an insurer as the ratio of surplus to risk-based
capital requirement decreases. The four action levels include:
- insurer is required to submit a plan for corrective action,
- insurer is subject to examination, analysis and specific corrective
action,
- regulators may place insurer under theregulatory control, and
- regulators are required to place insurer under regulatory control.
Each of our U.S. insurance laws, see
"Business--Insurance Regulation--Holding Company Acts."
RCRe'ssubsidiaries' surplus (as calculated for
statutory annual statement purposes) is
well above the risk-based capital thresholds
that would require either company or regulatory action.
Regulation of Certain Reinsurance Intermediaries
CertainGUARANTY FUNDS AND ASSIGNED RISK PLANS. Most states including Nebraska, have adopted legislation or regulation
that,require all admitted
insurance companies to participate in effect, places additional requirements upon insurance and reinsurance
intermediaries and brokers when,their respective guaranty funds which
cover certain claims against insolvent insurers. Solvent insurers licensed in
these states are required to cover the losses paid on behalf of insolvent
insurers by the guaranty funds and are generally subject to annual assessments
in the state by its guaranty fund to cover these losses. Some states also
require licensed insurance companies to participate in assigned risk plans which
provide coverage for automobile insurance and other lines for insureds which,
for various reasons, cannot otherwise obtain insurance in the open market. This
23
participation may take the form of reinsuring a portion of a pool of policies or
the direct issuance of policies to insureds. The calculation of an insured, they place business
with an insurance or reinsurance companyinsurer's
participation in these plans is usually based on the amount of premium for that
is affiliated with such
intermediary or broker. While we believetype of coverage that there is no such affiliation
between RCRe and reinsurance intermediaries that may be affiliated with Marsh &
McLennan Companies, Inc., no assurances can be given that other persons
(including
18
such intermediaries) may not takewas written by the insurer on a contrary position. While we believe that
compliance with such regulations would not be burdensome upon an intermediary or
broker, no assurances can be given asvoluntary basis in a prior
year. Assigned risk pools tend to whetherproduce losses which result in assessments to
insurers writing the same lines on a broker or intermediary would
decide to place or continue to place business with RCRe if such regulations were
viewed to be applicable.
Federal Regulationvoluntary basis.
FEDERAL REGULATION. Although state regulation is the dominant form of
regulation for insurance and reinsurance business, the federal government has
shown increasing concern over the adequacy of state regulation. It is not
possible to predict the future impact of any potential federal regulations or
other possible laws or regulations on RCRe'sArch Re (US)'s capital and operations, and
such laws or regulations could materially adversely affect its business.
LegislativeTHE GRAMM-LEACH-BLILEY ACT. The Gramm-Leach-Bliley Act of 1999 ("GLBA")
which implements fundamental changes in the regulation of the financial services
industry in the United States was enacted on November 12, 1999. The GLBA permits
the transformation of the already converging banking, insurance and Regulatory Proposalssecurities
industries by permitting mergers that combine commercial banks, insurers and
securities firms under one holding company, a "financial holding company." Bank
holding companies and other entities that qualify and elect to be treated as
financial holding companies may engage in activities, and acquire companies
engaged in activities, that are "financial" in nature or "incidental" or
"complementary" to such financial activities. Such financial activities include
acting as principal, agent or broker in the underwriting and sale of life,
property, casualty and other forms of insurance and annuities.
Until the passage of the GLBA, the Glass-Steagall Act of 1933 had limited
the ability of banks to engage in securities-related businesses, and the Bank
Holding Company Act of 1956 had restricted banks from being affiliated with
insurers. With the passage of the GLBA, among other things, bank holding
companies may acquire insurers, and insurance holding companies may acquire
banks. The ability of banks to affiliate with insurers may affect our U.S.
subsidiaries' product lines by substantially increasing the number, size and
financial strength of potential competitors.
LEGISLATIVE AND REGULATORY PROPOSALS. From time to time various regulatory
and legislative changes have been proposed in the insurance and reinsurance
industry, some of which could have an
effect on reinsurers.industry. Among the proposals that have in the past been or are at present being
considered are the possible introduction of federal regulation in addition to,
or in lieu of, the current system of state regulation of insurers. In addition,
there are a variety of proposals being considered by various state legislatures
(some of which proposals have been enacted). We are unable to predict whether
any of these laws and regulations will be adopted, the form in which any such
laws and regulations would be adopted, or the effect, if any, these developments
would have on our operations and financial condition.
Senior ManagementBERMUDA INSURANCE REGULATION
THE INSURANCE ACT 1978, AS AMENDED, AND RELATED REGULATIONS OF BERMUDA (THE
"INSURANCE ACT"). As a holding company, ACGL is not subject to Bermuda insurance
regulations. The Company's senior management team consists of:
Name Age Position
---- --- --------
Mark D. Mosca 46 President, Chief Executive OfficerInsurance Act, which will regulate the insurance business of
Arch Re (Bermuda), provides that no person shall carry on any insurance business
in or from within Bermuda unless registered as an insurer under the Insurance
Act by the Bermuda Supervisor of Insurance (the "Supervisor"), who is
responsible for the day-to-day supervision of insurers. Under the Insurance Act,
insurance business includes reinsurance business. The Supervisor, in deciding
whether to grant registration, has broad discretion to act as the Supervisor
thinks fit in the public interest. The Supervisor is required by the Insurance
Act to determine whether the applicant is a fit and Director
Robert Clements 67 Chairmanproper body to be engaged in
the insurance business and, Director
Peter A. Appel 38 Executive Vice President, Chief Operating Officer,
General Counselin particular, whether it has, or has available to
it, adequate knowledge and Secretary
Paul J. Malvasio 53 Managing Director, Chief Financial Officerexpertise. The registration
24
of an applicant as an insurer is subject to its complying with the terms of its
registration and Treasurer
- - -------------
Mark D. Mosca was electedsuch other conditions as Presidentthe Supervisor may impose from time to
time.
An Insurance Advisory Committee appointed by the Bermuda Minister of Finance
advises the Supervisor on matters connected with the discharge of the
Supervisor's functions and sub-committees thereof supervise and review the law
and practice of insurance in Bermuda, including reviews of accounting and
administrative procedures.
The Insurance Act imposes solvency and liquidity standards and auditing and
reporting requirements on Bermuda insurance companies and grants to the
Supervisor powers to supervise, investigate and intervene in the affairs of
insurance companies. Certain significant aspects of the Bermuda insurance
regulatory framework are set forth below.
CLASSIFICATION OF INSURERS. The Insurance Act distinguishes between
insurers carrying on long-term business and insurers carrying on general
business. There are four classifications of insurers carrying on general
business, with Class 4 insurers subject to the strictest regulation. Arch Re
(Bermuda) is registered as both a long-term insurer and a DirectorClass 4 insurer in
Bermuda, which we refer to in this prospectus supplement as a composite insurer,
and is regulated as such under the Insurance Act.
CANCELLATION OF INSURER'S REGISTRATION. An insurer's registration may be
canceled by the Supervisor on certain grounds specified in the Insurance Act,
including failure of the companyinsurer to comply with its obligations under the
Insurance Act or if, in June 1995 and as Chief Executive Officerthe opinion of the Supervisor after consultation with
the Insurance Advisory Committee, the insurer has not been carrying on business
in accordance with sound insurance principles.
PRINCIPAL REPRESENTATIVE. An insurer is required to maintain a principal
office in Bermuda and to appoint and maintain a principal representative in
Bermuda. For the purpose of the Insurance Act, the principal representative of
Arch Re (Bermuda) is Marsh Management Services (Bermuda) Ltd. and the principal
office of Arch Re (Bermuda) is at the offices of the principal representative at
Victoria Hall, 11 Victoria Street, Hamilton HM 11, Bermuda. Without a reason
acceptable to the Supervisor, an insurer may not terminate the appointment of
its principal representative, and the principal representative may not cease to
act as such, unless 30 days' notice in writing to the Supervisor is given of the
intention to do so. It is the duty of the principal representative, within
30 days of reaching the view that there is a likelihood of the insurer for which
the principal representative acts becoming insolvent or that a reportable
"event" has, to the principal representative's knowledge, occurred or is
believed to have occurred, to make a report in writing to the Supervisor setting
out all the particulars of the case that are available to the principal
representative. Examples of such a reportable "event" include failure by the
insurer to comply substantially with a condition imposed upon the insurer by the
Supervisor relating to a solvency margin or a liquidity or other ratio.
INDEPENDENT APPROVAL AUDITOR. Every registered insurer must appoint an
independent auditor who will annually audit and report on the statutory
financial statements and the statutory financial return of the insurer, both of
which, in the case of Arch Re (Bermuda), are required to be filed annually with
the Supervisor. The independent auditor of the insurer must be approved by the
Supervisor and may be the same person or firm which audits the insurer's
financial statements and reports for presentation to its shareholders. Our
independent auditor is PricewaterhouseCoopers (Bermuda).
APPROVED ACTUARY. Arch Re (Bermuda), as a registered long-term insurer, is
required to submit an annual actuary's certificate when filing its statutory
financial returns. The actuary, who will normally be a qualified life actuary,
must be approved by the Supervisor. Our approval actuary is John B. Kleiman of
PricewaterhouseCoopers.
LOSS RESERVE SPECIALIST. As a registered Class 4 insurer, Arch Re (Bermuda)
is required to submit an opinion of its approval loss reserve specialist with
its statutory financial return in respect of its loss
25
and loss expense provisions. The loss reserve specialist, who will normally be a
qualified casualty actuary, must be approved by the Supervisor. Our approved
loss reserve specialist is Simon Lambert of PricewaterhouseCoopers.
STATUTORY FINANCIAL STATEMENTS. An insurer must prepare annual statutory
financial statements. The Insurance Act prescribes rules for the preparation and
substance of such statutory financial statements (which include, in statutory
form, a balance sheet, an income statement, a statement of capital and surplus
and notes thereto). The insurer is required to give detailed information and
analyses regarding premiums, claims, reinsurance and investments. The statutory
financial statements are not prepared in accordance with U.S. generally accepted
accounting principles and are distinct from the financial statements prepared
for presentation to the insurer's shareholders under the Companies Act 1981 of
Bermuda (the "Companies Act"), which financial statements will be prepared in
accordance with U.S. generally accepted accounting principles. Arch Re
(Bermuda), as a general business insurer, is required to submit the annual
statutory financial statements as part of the annual statutory financial return.
The statutory financial statements and the statutory financial return do not
form part of the public records maintained by the Supervisor.
ANNUAL STATUTORY FINANCIAL RETURN. Arch Re (Bermuda) is required to file
with the Supervisor in Bermuda a statutory financial return no later than four
months after its financial year end (unless specifically extended). The
statutory financial return for a Class 4 insurer includes, among other matters,
a report of the approved independent auditor on the statutory financial
statements of such insurer, solvency certificates, the statutory financial
statements themselves, the opinion of the loss reserve specialist and a schedule
of reinsurance ceded. The solvency certificates must be signed by the principal
representative and at least two directors of the insurer who are required to
certify, among other matters, whether the minimum solvency margin has been met
and whether the insurer complied with the conditions attached to its certificate
of registration. The independent approved auditor is required to state whether
in its opinion it was reasonable for the directors to so certify. Where an
insurer's accounts have been audited for any purpose other than compliance with
the Insurance Act, a statement to that effect must be filed with the statutory
financial return.
MINIMUM SOLVENCY MARGIN AND RESTRICTIONS ON DIVIDENDS AND
DISTRIBUTIONS. Under the Insurance Act, Arch Re (Bermuda) must ensure that the
value of its long-term business assets exceed the amount of its long-term
business liabilities by at least $250,000. The Insurance Act also provides that
the value of the general business assets of Arch Re (Bermuda), as a Class 4
insurer, must exceed the amount of its general business liabilities by an amount
greater than the prescribed minimum solvency margin. Arch Re (Bermuda):
- is required, with respect to its general business, to maintain a minimum
solvency margin (the prescribed amount by which the value of its general
business assets must exceed its general business liabilities) equal to the
greatest of:
(A) $100,000,000,
(B) 50% of net premiums written (being gross premiums written less any
premiums ceded by the Company but the Company may not deduct more
than 25% of gross premiums when computing net premiums written), and
(C) 15% of loss and other insurance reserves;
- is prohibited from declaring or paying any dividends during any financial
year if it is in breach of its minimum solvency margin or minimum
liquidity ratio or if the declaration or payment of such dividends would
cause it to fail to meet such margin or ratio (if it has failed to meet
its minimum solvency margin or minimum liquidity ratio on the last day of
any financial year, Arch
26
Re (Bermuda) will be prohibited, without the approval of the Supervisor,
from declaring or paying any dividends during the next financial year);
- is prohibited from declaring or paying in any financial year dividends of
more than 25% of its total statutory capital and surplus (as shown on its
previous financial year's statutory balance sheet) unless it files (at
least 7 days before payment of such dividends) with the Supervisor an
affidavit stating that it will continue to meet the required margins;
- is prohibited, without the approval of the Supervisor, from reducing by
15% or more its total statutory capital as set out in its previous year's
financial statements and any application for such approval must include an
affidavit stating that it will continue to meet the required margins;
- is required, at any time if fails to meet its solvency margin, within
30 days (45 days where total statutory capital and surplus falls to
$75 million or less) after becoming aware of that failure or having reason
to believe that such failure has occurred, to file with the Supervisor a
written report containing certain information;
- is required to establish and maintain a long-term business fund; and
- is required to obtain a certain certification from its approved actuary
prior to declaring or paying any dividends and such certificate will not
be given unless the value of its long-term business assets exceeds its
long-term business liabilities, as certified by its approval actuary, by
the amount of the dividend and at least $250,000. The amount of any such
dividend shall not exceed the aggregate of the excess referenced in the
preceding sentence and other funds properly available for the payment of
dividends, being funds arising out of its business, other than its
long-term business.
MINIMUM LIQUIDITY RATIO. The Insurance Act provides a minimum liquidity
ratio for general business insurers. An insurer engaged in general business is
required to maintain the value of its relevant assets at not less than 75% of
the amount of its relevant liabilities. Relevant assets include cash and time
deposits, quoted investments, unquoted bones and debentures, first liens on real
estate, investment income due and accrued, account and premiums receivable and
reinsurance balances receivable. There are certain categories of assets which,
unless specifically permitted by the Supervisor, do not automatically qualify as
relevant assets, such as unquoted equity securities, investments in and advances
to affiliates and real estate and collateral loans. The relevant liabilities are
total general business insurance reserves and total other liabilities less
deferred income tax and sundry liabilities (by interpretation, those not
specifically defined).
LONG-TERM BUSINESS FUND. An insurer carrying on long-term business is
required to keep its accounts in respect of its long-term business separate from
any accounts kept in respect of any other business and all receipts of its
long-term business form part of its long-term business fund. No payment may be
made directly or indirectly from an insurer's long-term business fund for any
purpose other than a purpose related to the insurer's long-term business, unless
such payment can be made out of any surplus certified by the insurer's approved
actuary to be available for distribution otherwise than to policyholders. Arch
Re (Bermuda) may not declare or pay a dividend to any person other than a
policyholder unless the value of the assets in its long-term business fund, as
certified by its approved actuary, exceeds the liabilities of the insurer's
long-term business (as certified by the insurer's approved actuary) by the
amount of the dividend and at least the $250,000 minimum solvency margin
prescribed by the Insurance Act, and the amount of any such dividend may not
exceed the aggregate of that excess (excluding the said $250,000) and any other
funds properly available for payment of dividends, such as funds arising out of
business of the insurer other than long-term business.
27
RESTRICTIONS ON TRANSFER OF BUSINESS AND WINDING-UP. Arch Re (Bermuda), as
a long-term insurer, is subject to the following provisions of the Insurance
Act:
- all or any part of the long-term business, other than long-term business
that is reinsurance business, may be transferred only with and in
accordance with the sanction of the applicable Bermuda court; and
- an insurer or reinsurer carrying on long-term business may only be
wound-up or liquidated by order of the applicable Bermuda court, and this
may increase the length of time and costs incurred in the winding-up of
Arch Re (Bermuda) when compared with a voluntary winding-up or
liquidation.
SUPERVISION, INVESTIGATION AND INTERVENTION. The Supervisor may appoint an
inspector with extensive powers to investigate the affairs of an insurer if the
Supervisor believes that an investigation is required in the interest of the
insurer's policyholders or persons who may become policyholders. In order to
verify or supplement information otherwise provided to the Supervisor, the
Supervisor may direct an insure to produce documents or information relating to
matters connected with the insurer's business.
If it appears to the Supervisor that there is a risk of the insurer becoming
insolvent, or that it is in breach of the Insurance Act or any conditions
imposed upon its registration, the Supervisor may, among other things, direct
the insurer (1) not to take on any new insurance business, (2) not to vary any
insurance contract if the effect would be to increase the insurer's liabilities,
(3) not to make certain investments, (4) to realize certain investments, (5) to
maintain in, or transfer to the custody of a specified bank, certain assets,
(6) not to declare or pay any dividends or other distributions or to restrict
the making of such payments and/or (7) to limit its premium income.
DISCLOSURE OF INFORMATION. In addition to powers under the Insurance Act to
investigate the affairs of an insurer, the Supervisor may require certain
information from an insurer (or certain other persons) to be produced to him.
Further, the Supervisor has been given powers to assist other regulatory
authorities, including foreign insurance regulatory authorities with their
investigations involving insurance and reinsurance companies in Bermuda but
subject to restrictions. For example, the Supervisor must be satisfied that the
assistance being requested is in connection with the discharge of regulatory
responsibilities of the foreign regulatory authority. Further, the Supervisor
must consider whether to co-operate is in the public interest. The grounds for
disclosure are limited and the Insurance Act provides sanctions for breach of
the statutory duty of confidentiality.
CERTAIN BERMUDA LAW CONSIDERATIONS
ACGL and Arch Re (Bermuda) have been designated as non-resident for exchange
control purposes by the Bermuda Monetary Authority and are required to obtain
the permission of the Bermuda Monetary Authority for the issue and transfer of
all of their shares. The Bermuda Monetary Authority has given its consent for:
- The issue and subsequent transfer of ACGL's shares, up to the amount of
its authorized capital from time to time, to and among persons non
resident of Bermuda for exchange control purposes;
- The issue and transfer of up to 20% of ACGL's shares in issue from time to
time to and among persons resident in Bermuda for exchange control
purposes.
Transfers and issues of ACGL's common shares to any resident in Bermuda for
exchange control purposes may require specific prior approval under the Exchange
Control Act 1972. Arch Re (Bermuda)'s common shares cannot be issued or
transferred without the consent of the Bermuda Monetary Authority. Because we
are designated as non-resident for Bermuda exchange control
28
purposes, we are allowed to engage in transactions, and to pay dividends to
Bermuda non-residents who are holders of our common shares, in currencies other
than the Bermuda Dollar.
In accordance with Bermuda law, share certificates are issued only in the
names of corporations or individuals. In the case of an applicant acting in a
special capacity (for example, as an executor or trustee), certificates may, at
the request of the applicant, record the capacity in which the applicant is
acting. Notwithstanding the recording of any such special capacity, we are not
bound to investigate or incur any responsibility in respect of the proper
administration of any such estate or trust. We will take no notice of any trust
applicable to any of our common shares whether or not we have notice of such
trust.
ACGL and Arch Re (Bermuda) are incorporated in Bermuda as "exempted
companies." As a result, they are exempt from Bermuda laws restricting the
percentage of share capital that may be held by non-Bermudians, but they may not
participate in certain business transactions, including (1) the acquisition or
holding of land in Bermuda (except that required for their business and held by
way of lease or tenancy for terms of not more than 50 years) without the express
authorization of the Bermuda legislature, (2) the taking of mortgages on land in
Bermuda to secure an amount in excess of $50,000 without the consent of the
Minister of Finance, (3) the acquisition of any bonds or debentures secured by
any land in Bermuda, other than certain types of Bermuda government securities
or (4) the carrying on of business of any kind in Bermuda, except in furtherance
of their business carried on outside Bermuda or under license granted by the
Minister of Finance. While an insurer is permitted to reinsure risks undertaken
by any company incorporated in MarchBermuda and permitted to engage in the insurance
and reinsurance business, generally it is not permitted without a special
license granted by the Minister of Finance to insure Bermuda domestic risks or
risks of persons of, in or based in Bermuda.
ACGL and Arch Re (Bermuda) also need to comply with the provisions of the
Companies Act regulating the payment of dividends and making distributions from
contributed surplus. A company shall not declare or pay a dividend, or make a
distribution out of contributed surplus, if there are reasonable grounds for
believing that: (a) the company is, or would after the payment be, unable to pay
its liabilities as they become due; or (b) the realizable value of the company's
assets would thereby be less than the aggregate of its liabilities and its
issued share capital and share premium accounts. Under the Companies Act, where
a Bermuda company issues shares at a premium (that is for a price above the par
value), whether for cash or otherwise, a sum equal to the aggregate amount or
value of the premium on those shares must be transferred to an account, called
"the share premium account." The provisions of the Companies Act relating to the
reduction of the share capital of a company apply as if the share premium
account were paid-up share capital of that company, except for certain matters
such as premium arising on a particular class of shares may be used in paying up
unissued shares of the same class to be issued to shareholders as fully paid
bonus shares. The paid-up share capital may not be reduced if on the date the
reduction is to be effected there are reasonable grounds for believing that the
company is, or after the reduction would be, unable to pay its liabilities as
they become due.
Exempted companies, such as ACGL and Arch Re (Bermuda), must comply with
Bermuda resident representation provisions under the Companies Act. We do not
believe that such compliance will result in any material expense to us.
The Proceeds of Crime Act 1997 and the Proceeds of Crime (Money Laundering)
Regulations 1998 are anti-money laundering legislation, which apply to regulated
institutions. The legislation is aimed at identifying offenses that give rise to
proceeds of crime, including, in particular, money laundering. In addition to
creating certain specific money laundering offenses, the legislation confers
expansive information gathering powers upon the Bermuda policy relating to
investigations to identify proceeds of crime. The Bermuda court has been
empowered to make confiscation orders.
29
Regulated institutions have a duty of vigilance which require that they:
- verify their customers' bona fides;
- monitor, recognize and President, Chief Executive Officerreport to the policy suspicious transactions;
- maintain certain records for the time period prescribed; and
Director- train employees and staff so as to recognize possible unlawful activities.
Regulated institutions include a company or society registered under the
Insurance Act to the extent that it is carrying out long-term insurance (but not
reinsurance) business within the meaning of RCRethe Insurance Act, other than life
insurance or disability insurance. While life insurance and disability insurance
are not defined in August 1995,the proceeds of crime legislation nor in the Insurance Act,
such terms may be interpreted (as a guide) by using the meanings of similar
terms defined in the June 2001 by the government authority established under the
proceeds of crime legislation. While the Guidance Notes are not mandatory, they
are represented as good practice procedures to be followed in order to discharge
the duty of vigilance and has
served as acting Chief Underwriting Officercan provide a statutory defense. In the Guidance
Notes, reference is made to "life assurance, pensions or other risk management
business . . . where the transaction at its simplest . . . may involve placing
cash in the purchase of RCRe since March 1999. Priora single premium product from an insurer followed by
early cancellation and reinvestment." The implication is that a long-term
insurer that conducts variable life insurance or annuity business, and this may
include Arch Re (Bermuda) in the event of carrying on such business, may be a
regulated institution.
Under Bermuda law, non-Bermudians (other than spouses of Bermudians) may not
engage in any gainful occupation in Bermuda without an appropriate governmental
work permit. Our success may depend in part upon the continued services of key
employees in Bermuda. Certain key employees may neither be a Bermudian nor a
spouse of a Bermudian. Accordingly, any such key employee will require specific
approval to June 1995, he was Senior Vice Presidentwork for us in Bermuda. A work permit may be granted or extended
upon showing that, after proper public advertisement, no Bermudian (or spouse of
a Bermudian) is available who meets the minimum standards reasonably required by
the employer. The Bermuda government recently announced a new policy that places
a six year term limit on individuals with work permits, subject to certain
exemptions for key employees.
30
RISK FACTORS
RISKS RELATING TO OUR INDUSTRY
WE OPERATE IN A HIGHLY COMPETITIVE ENVIRONMENT, AND SINCE THE SEPTEMBER 11, 2001
EVENTS, NEW CAPITAL HAS ENTERED THE MARKET; THESE FACTORS MAY MITIGATE THE
BENEFITS THAT THE FINANCIAL MARKETS MAY PERCEIVE FOR THE PROPERTY AND CASUALTY
INSURANCE INDUSTRY, AND WE CANNOT OFFER ANY ASSURANCES THAT WE WILL BE ABLE TO
COMPETE SUCCESSFULLY IN OUR INDUSTRY.
The insurance industry is highly competitive. Trends toward consolidation in
the insurance industry could also lead to pricing pressure and Chief Underwriting Officer of Zurich
Reinsurance Centre Holdings, Inc.lower margins for
insurers and reinsurers. In addition, since the completionSeptember 11, 2001 events,
several newly formed offshore entities have announced their intention to address
the capacity issues in the insurance and reinsurance industry. Several publicly
traded insurance and reinsurance companies have also raised additional capital
to meet perceived demand in the current environment. Since September 11, 2001,
newly formed and existing insurance industry companies have reportedly raised in
excess of its initial public
offering$10.0 billion in May 1993. Prior thereto, Mr. Mosca served as a Vice President of NAC
Re Corporation ("NAC Re"), where he was managercapital, and some industries (in particular, the
airline industry) have announced that they may form industry consortia to
provide insurance coverage for their members, thereby taking those lines out of
the Treaty Division since
February 1986. From 1975commercial insurance and reinsurance markets in which we operate. In
addition, financial institutions and other capital markets participants offer
alternative products and services similar to 1986, Mr. Mosca was employedour own or alternative products
that compete with insurance and reinsurance products.
We can offer no assurances that we will be successful in competing with
others in our industry or that the intensity of competition in our industry will
not erode profitability for insurance and reinsurance companies generally,
including us. In addition, we can offer no assurances that we will participate
at all or to the same extent as more established or other companies in any price
increases or increased profitability in our industry. If we do not share in such
price increases or increased profitability, our financial condition and results
of operations could be materially adversely affected.
THE INSURANCE INDUSTRY IS HIGHLY CYCLICAL AND THE VALUE OF OUR COMMON SHARES MAY
BE ADVERSELY AFFECTED BY THIS CYCLICALITY.
Historically, insurers and reinsurers have experienced significant
fluctuations in operating results due to competition, frequency of occurrence or
severity of catastrophic events, levels of capacity, general economic
conditions, changes in legislation, case law and prevailing concepts of
liability and other factors. In particular, demand for reinsurance is influenced
significantly by General Reinsurance
Corporation where he was a Vice President. Mr. Mosca holds an A.B. degreethe underwriting results of primary insurers and prevailing
general economic conditions. The supply of reinsurance is related to prevailing
prices and levels of surplus capacity that, in turn, may fluctuate in response
to changes in rates of return being realized in the reinsurance industry. We can
offer no assurances as to the magnitude or duration of any price increases or
increased profitability in our industry or that factors that previously have
resulted in excess capacity and pricing pressures in our industry will not
recur.
WE COULD FACE UNANTICIPATED LOSSES FROM WAR, TERRORISM AND POLITICAL UNREST, AND
THESE OR OTHER UNANTICIPATED LOSSES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We may have substantial exposure to unexpected, large losses resulting from
Harvard University.
Robert Clements was electedfuture man-made catastrophic events, such as Chairmanacts of war, acts of terrorism and
Directorpolitical instability. Although we may attempt to exclude losses from terrorism
and certain other similar risks from some coverages written by us, we may not be
successful in doing so. These risks are inherently unpredictable, although
recent events may lead to increased frequency and severity of losses. It is
difficult to predict the timing of such events with statistical certainty or
estimate the amount of loss any given occurrence will generate. Accordingly, we
can offer no assurance that our reserves will be adequate to cover losses when
they materialize. It is not possible to eliminate completely our exposure to
unforecasted or unpredictable
31
events, and to the extent that losses from such risks occur, our financial
condition and results of operations could be materially adversely affected.
CLAIMS FOR CATASTROPHIC EVENTS COULD CAUSE LARGE LOSSES AND SUBSTANTIAL
VOLATILITY IN OUR RESULTS OF OPERATIONS, AND, AS A RESULT, THE VALUE OF OUR
COMMON SHARES MAY FLUCTUATE WIDELY.
We intend to underwrite property catastrophe reinsurance and will have large
aggregate exposure to disasters. Catastrophes can be caused by various events,
including hurricanes, floods, windstorms, earthquakes, hailstorms, explosions,
severe winter weather and fires, and we may have exposures to losses resulting
from acts of war or acts of terrorism (to the extent not excluded from policy
coverage) and political instability. Catastrophes can also cause losses in
non-property lines of business such as workers' compensation or general
liability. In addition to the nature of the companyproperty catastrophe business, we
believe that economic and geographic trends affecting insured property,
including inflation, property value appreciation and geographic concentration
tend to generally increase the size of losses from catastrophic events over
time. Therefore, claims for catastrophic events could expose us to large losses
and cause substantial volatility in our results of operations, which could cause
the value of our common shares to fluctuate widely.
UNDERWRITING CLAIMS AND RESERVING FOR LOSSES ARE BASED ON PROBABILITIES AND
RELATED MODELING, WHICH ARE SUBJECT TO INHERENT UNCERTAINTIES.
Our success is dependent upon our ability to assess accurately the risks
associated with the businesses that we insure and reinsure. Claim reserves
represent estimates involving actuarial and statistical projections, at a given
point in time, of our expectations of the ultimate settlement and administration
costs of claims incurred. We utilize actuarial models as well as historical
insurance industry loss development patterns to assist in the establishment of
appropriate claim reserves. Actual claims and claim expenses paid may deviate,
perhaps substantially, from the reserve estimates reflected in our financial
statements.
Like other reinsurers, we do not separately evaluate each of the individual
risks assumed under reinsurance treaties. Therefore, we will be largely
dependent on the original underwriting decisions made by ceding companies. We
are subject to the risk that the ceding companies may not have adequately
evaluated the risks to be reinsured and that the premiums ceded may not
adequately compensate us for the risks we assume.
If our claim reserves are determined to be inadequate, we will be required
to increase claim reserves at the time of such determination with a
corresponding reduction in our formationnet income in March 1995 and Chairman and Director of RCRe in
September 1995. He is currently an advisor to MMCI with whom he served as
Chairman and Chief Executive Officer from January 1994 to March 1996. Prior
thereto, he served as President of Marsh & McLennan Companies, Inc. since 1992,
having been Vice Chairman during 1991. He was Chairman of J&H Marsh & McLennan,
Incorporated (formerly Marsh & McLennan, Incorporated), a subsidiary of Marsh &
McLennan Companies, Inc., from 1988 until March 1992. He joined Marsh &
McLennan, Ltd., a Canadian subsidiary of Marsh & McLennan Companies, Inc., in
1959. Mr. Clements is a director of Marsh & McLennan Companies, Inc., XL
Capital, Annuity and Life Re (Holdings), Ltd., Stockton Reinsurance Limited and
Hiscox plc. He is Chairman of the Board of Trustees of The College of Insurance
and a member of Rand Corp. President's Council.
Peter A. Appel has been Executive Vice President, Chief Operating Officer
and a Director of both the company and RCRe since November 1999, and General
Counsel and Secretary of the company and RCRe since November 1995. Mr. Appel
previously served as a Managing Director of the company and RCRe from November
1995 to November 1999. From September 1987 to November 1995, Mr. Appel practiced
law with
19
the New York firm of Willkie Farr & Gallagher, where he was a partner from
January 1995. He holds an A.B. degree from Colgate University and a law degree
from Harvard University.
Paul J. Malvasio has been a Managing Director, Chief Financial Officer and
Treasurer of both the company and RCRe since September 1995 and a Director of
RCRe since November 1995. Prior to that time, he was Senior Vice President and
Chief Financial Officer of NAC Re since January 1986. From 1967 to 1986, Mr.
Malvasio was employed by the public accounting firm of Coopers & Lybrand, where
he was an audit partner from October 1979. Mr. Malvasio is a certified public
accountant and holds a B.B.A. degree in Accounting from St. Francis College.
Employees
At March 27, 2000, we employed a total of 29 full-time employees. Our
employees are not represented by a labor union and we believe that our employee
relations are good.
20
GLOSSARY OF SELECTED INSURANCE TERMS
Admitted assets.............................Assets permitted by state law to be
included as "assets" in an insurance
company's annual statement.
Annual Statement ........................... A report that an insurance company
must file annually with the state
insurance commissioner in its
domiciliary state and each other
stateperiod in which it does business.
The statement shows the current
statusdeficiency
is rectified. It is possible that claims in respect of events that have occurred
could exceed our claim reserves expenses,
assets, total liabilities and investment portfolio.
Assume ..................................... To take from an insurerhave a material adverse effect on our
results of operations, in a particular period, or reinsurer (a ceding company) all or
partour financial condition in
general. As a compounding factor, although most insurance contracts have policy
limits, the nature of property and casualty insurance and reinsurance is that
losses can exceed policy limits for a risk underwritten by such
person, along withvariety of reasons and could significantly
exceed the related
premiums losses and expenses.
Attachment point ............................The amountreceived on the underlying policies, thereby further
adversely affecting our financial condition.
WHILE REINSURANCE AND RETROCESSIONAL COVERAGE WILL BE USED TO LIMIT OUR EXPOSURE
TO RISKS, THE AVAILABILITY OF SUCH ARRANGEMENTS MAY BE LIMITED, AND COUNTERPARTY
CREDIT AND OTHER RISKS ASSOCIATED WITH OUR REINSURANCE ARRANGEMENTS MAY RESULT
IN LOSSES WHICH COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
For the purposes of limiting our risk of loss, (per occurrence
or inwe will use reinsurance and
also may use retrocessional arrangements. The availability and cost of
reinsurance and retrocessional protection is subject to market conditions, which
are beyond our control. Currently, the aggregate, as the casemarket for these arrangements is
experiencing high demand for various products and it is not certain that we will
be able to obtain adequate protection at cost effective levels.
32
As a result of such market conditions and other factors, we may be) above which excess of loss
coverage becomes operative.
Broker market reinsurer A reinsurer that marketsnot be able
successfully to alleviate risk through reinsurance and sells
reinsurance through brokers rather
than through its own employees.
Case reserves ...............................Loss reserves establishedretrocessional
arrangements. Further, we are subject to credit risk with respect to individual reported
claims.
Casualtyour
reinsurance and retrocessions because the ceding of risk to reinsurers and
retrocessionaires does not relieve us of our liability to the clients or
companies we insure or reinsure. Our failure to establish adequate reinsurance
or retrocessional arrangements or the failure of our existing reinsurance or
retrocessional arrangements to protect us from overly concentrated risk exposure
could adversely affect our financial condition and results of operations.
AS A RESULT OF RECENT EVENTS AND INSTABILITY IN THE MARKETPLACE FOR INSURANCE
PRODUCTS, THERE IS THE POTENTIAL FOR GOVERNMENT INTERVENTION IN OUR INDUSTRY
WHICH COULD HINDER OUR FLEXIBILITY AND NEGATIVELY AFFECT THE BUSINESS
OPPORTUNITIES WE PERCEIVE ARE AVAILABLE TO US IN THE MARKET.
In response to the current tightening of supply in certain insurance
..........................Insurance whichmarkets, as well as the impact of the September 11, 2001 events, it is primarilypossible
that the United States and other governments worldwide may intervene in the
insurance and reinsurance markets. Government regulators are generally concerned
with the losses causedprotection of policyholders to the exclusion of other constituencies,
including shareholders. While we cannot predict the type of government
intervention that may occur or its timing, such intervention could materially
adversely affect us by:
- disproportionately benefiting one country's companies over companies in
other countries;
- providing insurance and reinsurance capacity in the markets and to the
customers that we target;
- regulating the terms of insurance and reinsurance policies; or
- mandating participation in guaranty associations or other industry pools.
The insurance industry is also affected by injuriespolitical, judicial and legal
developments which have in the past resulted in new or expanded theories of
liability. These or other changes could impose new financial obligations on us,
require us to third persons (in other
words, persons other thanmake unplanned modifications to the policyholder)products and services that we
provide, or cause the delay or cancellation of products and services that we
provide. Substantial government intervention could adversely impact our ability
to achieve our goals.
In addition, we engage in intercompany reinsurance arrangements between our
U.S. operations and our Bermuda reinsurance operations. Some U.S. insurance
companies have been lobbying Congress to pass legislation intended to eliminate
certain perceived tax advantages of U.S. insurance companies with Bermuda
affiliates, which result principally from reinsurance arrangements between or
among U.S. insurance companies and their Bermuda affiliates.
RISKS RELATING TO OUR COMPANY
THE WARBURG PINCUS FUNDS AND THE HELLMAN & FRIEDMAN FUNDS TOGETHER CONTROL A
MAJORITY OF OUR VOTING POWER ON A FULLY DILUTED BASIS AND THESE SHAREHOLDERS
HAVE THE RIGHT TO HAVE DIRECTORS ON OUR BOARD AND THE RIGHT TO APPROVE MOST
TRANSACTIONS OUTSIDE OF THE ORDINARY COURSE OF OUR BUSINESS; THEIR INTERESTS MAY
MATERIALLY DIFFER FROM THE INTERESTS OF THE HOLDERS OF OUR COMMON SHARES.
On a fully diluted basis and after giving effect to the exercise of all
outstanding options and warrants and the legal
liability imposedconversion of all preference issues,
the Warburg Pincus funds and the Hellman & Friedman funds own 33.8% and 18.8% of
our common shares, respectively. These shareholders are non-U.S. persons (as
defined in the Internal Revenue Code) and, as such, they are not subject to the
voting limitation contained in our bye-laws. In addition, our shareholders
agreement prevents us from taking many actions outside the ordinary course of
our business without the approval of a director designated by the Warburg Pincus
funds and a director designated by the Hellman & Friedman funds. We have agreed
not to declare any dividend or make any other distribution on our common shares,
and not to repurchase any common shares, until we have repurchased from the
Warburg Pincus funds, the Hellman & Friedman funds and the other holders of
preference shares, pro rata, on the insured
resulting therefrom.
Catastrophe reinsurance .....................A formbasis of excess of loss
reinsurance that, subject to a
specified limit, indemnifies the
ceding company for the amount of lossthese shareholders'
investments in excessus at the time of such repurchase, preference shares
33
having an aggregate value of $250.0 million, at a per share price acceptable to
these shareholders. By reason of their ownership and the shareholders agreement
between us and the holders of preference shares, the Warburg Pincus funds and
the Hellman & Friedman funds are able to strongly influence or effectively
control actions to be taken by us, or our shareholders.
In addition, the Warburg Pincus funds and the Hellman & Friedman funds are
entitled to nominate a prescribed number of directors based on the respective
retained percentages of their equity securities purchased in November 2001.
Currently, our board consists of nine members, which includes one director
nominated by the Warburg Pincus funds and one director nominated by the
Hellman & Friedman funds. Once we have received the regulatory approvals
required in connection with the capital infusion, the size of our board will be
increased to up to 17 members. As long as the Warburg Pincus funds retain at
least 75% of their original investment and the Hellman & Friedman funds retain
at least 60% of their original investment, these shareholders will be entitled
to nominate six and three directors, respectively. Together they will nominate a
majority of directors to our board. The interests of these shareholders may
differ materially from the interests of the holders of our common shares, and
these shareholders could take actions or make decisions that are not in the
interests of the holders of our common shares.
WE MAY BE REQUIRED TO ISSUE ADDITIONAL PREFERENCE SHARES TO THE INVESTORS IN THE
CAPITAL INFUSION AS A RESULT OF VARIOUS PURCHASE PRICE ADJUSTMENTS AGREED TO IN
CONNECTION WITH IT, AND THE VALUE OF OUR COMMON SHARES MAY, THEREFORE, BE
FURTHER DILUTED.
The purchase price paid for the securities purchased in the capital infusion
was based on the estimated, unaudited U.S. GAAP book value of our common shares
as of June 30, 2001 (before giving effect to certain agreed transaction costs
incurred in connection with the capital infusion that had not yet been
determined), subject to certain adjustments. We are required to re-calculate, on
designated dates in the future, our June 30, 2001 book value on such dates
(after giving effect to the agreed transaction costs) and if that re-calculated
amount is less than the amount used to calculate the purchase price for the
preference shares and warrants, we will be required to issue additional
securities, convertible into our common shares, to those investors.
In particular, we agreed to adjust the purchase price paid for the
preference shares:
- based upon an audit of the book value of our assets at June 30, 2001
(after giving effect to the agreed transaction costs);
- if, on or prior to September 19, 2005, the closing price of our common
shares is at least $30.00 per share for at least 20 out of 30 consecutive
trading days or a change of control occurs (in which event, the purchase
price paid per preference share by the Warburg Pincus funds, the
Hellman & Friedman funds and the other holders of our preference shares
would be adjusted downward by $1.50);
- on the second anniversary of the closing date based upon the adjustment
basket described under the heading "The Capital Infusion--Subscription
Agreement--Purchase Price Adjustments--Final Adjustments" related to the
valuation of our core and non-core businesses; and
- on the fourth anniversary of the closing date based upon an adjustment
basket related to specified retentionliabilities connected to our asset sale to
Folksamerica and specified tax and ERISA matters. See "--Recent
Developments--The Capital Infusion--Subscription Agreement--Purchase Price
Adjustments--Final Adjustments."
We currently estimate that, principally because of the deduction of the
agreed transaction costs, we will issue an additional 875,765 preference shares
during the first quarter of 2002 in connection with the adjustments discussed in
the first bullet point above, and we currently estimate that we may be required
to issue an additional 2,831,174 preference shares in connection with the
trading price adjustment described in the second bullet point above.
34
OUR FAILURE TO OBTAIN REGULATORY APPROVAL FOR THE CAPITAL INFUSION WOULD HAVE A
MATERIAL ADVERSE IMPACT ON THE VALUE OF OUR COMMON SHARES.
In the event that:
- we fail to obtain the approval of the Florida insurance department with
respect to an
accumulationthe capital infusion before May 20, 2002; or
- the purchase price adjustment to be made on the second and fourth
anniversaries of losses resultingthe closing results in a downward adjustment to the
purchase price of the preference shares aggregating more than
$250.0 million,
the Warburg Pincus funds, the Hellman & Friedman funds and the other holders of
our preference shares will have the right to exchange their equity securities
for equity securities of a corporate entity which would hold our insurance and
reinsurance operating subsidiaries, other than Arch Re (US). See "--Recent
Developments--The Capital Infusion--Subscription Agreement--Right to Exchange
into Subsidiary Shares." In this event, we would own less than a majority of
those subsidiaries. This situation would have a material adverse impact on the
value of our common shares.
OUR MANAGEMENT TEAM HAS ONLY RECENTLY BEEN ASSEMBLED AND OUR BUSINESS STRATEGY
IS NEWLY FORMULATED; THEREFORE, THERE CAN BE NO ASSURANCE THAT WE WILL BE
SUCCESSFUL IN ACCOMPLISHING OUR GOALS.
We have recently assembled a new management team and other personnel in
connection with our new underwriting initiative to meet current and future
demand in the global insurance and reinsurance marketplaces. Our future success
depends on the successful integration of our new management team and other
personnel. The success of our management team in their past endeavors is not
necessarily predictive of future results. In addition, we cannot assure you that
we will be successful in integrating such executives and personnel into our
existing operations or that this new management team will have success with our
new underwriting initiative. In addition, the pool of talent from which we
actively recruit is limited. The inability to attract and retain qualified
personnel when available and the loss of services of key personnel could have a
material adverse effect on our financial condition and results of operations.
FUTURE SALES OF OUR COMMON SHARES, WHETHER BY US OR OUR SHAREHOLDERS, COULD
ADVERSELY AFFECT THEIR MARKET PRICE.
Generally, our board of directors has the power to issue new equity (to the
extent of authorized shares) without shareholder approval, except that
shareholder approval may be required under applicable law or Nasdaq National
Market rules for certain transactions. We may issue new equity to raise
additional capital to support our insurance and reinsurance operations or for
other purposes. Any additional issuance by us would have the effect of diluting
the percentage ownership of our shareholders and could have the effect of
diluting our earnings and our book value per share.
In addition, the market price of our common shares could fall substantially
if our shareholders sell large amounts of common shares in the public market
following this offering. The availability of a large number of shares for sale
could result in the need for sellers to accept a lower price in order to
complete a sale. After this offering, there will be 22,265,332 common shares
outstanding, assuming no exercise of the underwriters' over-allotment option.
There are up to 45,973,253 common shares issuable upon exercise of options,
conversion of convertible securities or exercise of outstanding class A
warrants.
We have granted the Warburg Pincus funds and Hellman & Friedman funds demand
registration rights and all of the investors in the capital infusion certain
"piggy-back" registration rights with respect to the common shares issuable to
them upon conversion of the preference shares or exercise of the class A
warrants. Certain other investors who purchased or acquired shares in
unregistered transactions also have demand and piggy-back registration rights.
They can exercise these rights at any time.
35
OUR BUSINESS WILL BE DEPENDENT UPON INSURANCE AND REINSURANCE BROKERS, AND THE
FAILURE TO DEVELOP OR THE LOSS OF IMPORTANT BROKER RELATIONSHIPS COULD
MATERIALLY ADVERSELY AFFECT OUR ABILITY TO MARKET OUR PRODUCTS AND SERVICES.
We intend to market our insurance and reinsurance products primarily through
brokers. We expect that we will derive a significant portion of our business
from a catastrophic event. The
actual reinsurance document is
called a "catastrophe cover."
Cede; Cedent; Ceding company ................When a party reinsureslimited number of brokers. Some of our competitors have had longer term
relationships with the brokers which we use than we have. Loss of all or part
of its risks with another, it
"cedes" business and is referred to
as the "cedent" or "ceding
company."
Common account reinsurance ..................Arrangements whereby the ceding
company enters the reinsurance
market and purchases a
cover for
the benefit of the ceding company
and the reinsurers on the
reinsurance treaty. A pro ratasubstantial portion of the costsbusiness provided by these brokers could have a
material adverse effect on us.
A DOWNGRADE IN OUR RATINGS OR OUR INABILITY TO OBTAIN A RATING FOR OUR OPERATING
INSURANCE SUBSIDIARIES MAY ADVERSELY AFFECT OUR RELATIONSHIPS WITH CLIENTS AND
BROKERS AND NEGATIVELY IMPACT SALES OF OUR PRODUCTS.
Financial strength and claims paying ratings from third party rating
agencies are instrumental in establishing the competitive positions of this
protection is deductedcompanies
in our industry. Periodically, rating agencies evaluate us to confirm that we
continue to meet their criteria for the ratings assigned to us by them.
Recently, rating agencies have been coming under increasing pressure as a result
of high-profile corporate bankruptcies and may, as a result, increase their
scrutiny of rated companies, revise their rating policies or take other action.
We can offer no assurances that our ratings will remain at their current levels.
A ratings downgrade, or the potential for such a downgrade, could adversely
affect both our relationships with agents, brokers, wholesalers and other
distributors of our existing products and services and new sales of our products
and services.
In addition, we are seeking ratings for our principal U.S. insurance
subsidiaries. Due to the perceived importance of financial strength ratings in
our industry, our failure to obtain adequate ratings for our unrated insurance
subsidiaries could cause our operations to be removed from the ceded premium.
Credit enhancement ..........................Useapproved lists of
some brokers or clients. Any ratings downgrade or failure to obtain a necessary
rating could adversely affect our ability to compete in our markets and have a
material adverse impact on our financial guarantycondition and results of operations.
See "Business--Ratings."
WE SOLD OUR PRIOR REINSURANCE OPERATIONS IN MAY 2000 AND MAY HAVE LIABILITY TO
THE PURCHASER AND CONTINUING LIABILITY FROM THOSE REINSURANCE OPERATIONS IF THE
PURCHASER SHOULD FAIL TO MAKE PAYMENTS ON THE REINSURANCE LIABILITIES IT
ASSUMED.
On May 5, 2000, we sold our prior reinsurance operations to upgradeFolksamerica
Reinsurance Company. The Folksamerica transaction was structured as a transfer
and assumption agreement (and not reinsurance), and, accordingly, the qualityloss
reserves (and any related reinsurance recoverables) relating to the transferred
business are not included as assets or liabilities on our balance sheet. In
addition, in connection with that sale, we made extensive representations and
warranties about us and our reinsurance operations, some of which survived the
closing of the asset sale. Breach of these representations and warranties could
result in liability to us. We also retained our tax and employee benefit
liabilities and other liabilities not assumed by Folksamerica, including all
liabilities not arising under our reinsurance subsidiary's reinsurance
agreements transferred to Folksamerica. In the event that Folksamerica is unable
to make payment for reserved losses transferred to it by us in the May 2000
sale, we would be liable for such claims. In addition, if amounts related to the
transferred liabilities turn out to be more than forecasted, we may be required
to issue additional preference shares to the holders of our preference shares.
SOME OF THE PROVISIONS OF OUR BYE-LAWS AND OUR SHAREHOLDERS AGREEMENT MAY HAVE
THE EFFECT OF HINDERING, DELAYING OR PREVENTING THIRD PARTY TAKEOVERS, WHICH MAY
PREVENT OUR SHAREHOLDERS FROM RECEIVING PREMIUM PRICES FOR THEIR SHARES IN AN
UNSOLICITED TAKEOVER.
Some provisions of our bye-laws could have the effect of discouraging
unsolicited takeover bids from third parties or the removal of incumbent
management. These provisions may encourage
36
companies interested in acquiring the company to negotiate in advance with our
board of directors, since the board has the authority to overrule the operation
of several of the limitations.
In addition, pursuant to the shareholders agreement which we entered into in
connection with the capital infusion, we cannot engage in transactions outside
the ordinary course of our business, including mergers and acquisitions, without
the consent of a director designated by the Warburg Pincus funds and a director
designated by the Hellman & Friedman funds. To the extent these provisions
discourage takeover attempts, they could deprive our shareholders of
opportunities to realize takeover premiums for their shares or could depress the
market price of our common shares.
OUR OPERATING INSURANCE AND REINSURANCE SUBSIDIARIES ARE SUBJECT TO REGULATION
IN VARIOUS JURISDICTIONS, AND MATERIAL CHANGES IN THE REGULATION OF THEIR
OPERATIONS COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our Bermuda reinsurance subsidiary, Arch Re (Bermuda), conducts its business
from its executive offices in Bermuda and is not licensed or admitted to do
business in any jurisdiction except Bermuda. We do not believe that Arch Re
(Bermuda) is subject to the insurance laws of any state in the United States;
however, recent scrutiny of the insurance and reinsurance industry in the U.S.
and other countries could subject Arch Re (Bermuda) to additional regulation.
In addition, our U.S. reinsurance subsidiary, Arch Re (US), and our U.S.
insurance subsidiaries, First American Insurance Company, Rock River Insurance
Company, Cross River Insurance Company and American Independent Insurance
Company, write reinsurance and insurance in the United States. These
subsidiaries are subject to extensive regulation under state statutes which
delegate regulatory, supervisory and administrative powers to state insurance
commissioners. Such regulation generally is designed to protect policyholders
rather than investors.
We periodically review our corporate structure in the United States so that
we can optimally deploy our capital. Changes in that structure require
regulatory approval, and we are in the process of seeking regulatory approval to
maximize our U.S. regulatory capital that will support our U.S. insurance
operations. Delays or failure in obtaining these approvals could limit the
amount of insurance that we can write in the United States.
If ACGL or any of our subsidiaries were to become subject to the laws of a
new jurisdiction where that subsidiary is not presently admitted, it may not be
in compliance with the laws of the new jurisdiction. Any failure to comply with
applicable laws could result in the imposition of significant restrictions on
our ability to do business, and could also result in fines and other sanctions,
any or all of which could adversely affect our financial condition and results
of operations.
IF OUR BERMUDA REINSURANCE SUBSIDIARY IS UNABLE TO PROVIDE COLLATERAL TO CEDING
COMPANIES, ITS ABILITY TO CONDUCT BUSINESS COULD BE SIGNIFICANTLY AND NEGATIVELY
AFFECTED.
Arch Re (Bermuda) is a registered Bermuda insurance company and is not
licensed or admitted as an insurer in any jurisdiction in the United States.
Because insurance regulations in the United States do not permit insurance
companies to take credit for reinsurance obtained from unlicensed or
non-admitted insurers on their statutory financial statements unless security through the use of an insurance
policy oris
posted, Arch Re (Bermuda)'s contracts generally require it to post a letter of
credit or provide other means.
Direct underwriter; Direct writer ...........An insurersecurity after a reinsured reports a claim. If we are
unable to post security in the form of letters of credit or reinsurertrust funds when
required, the operations of Arch Re (Bermuda) could be significantly and
negatively affected.
WE ARE SUBJECT TO CHANGES IN BERMUDA LAW OR POLITICAL CIRCUMSTANCES.
Under current Bermuda law, we are not subject to tax on income or capital
gains. Furthermore, we have obtained from the Minister of Finance of Bermuda
under the Exempted Undertakings Tax Protection Act, 1966, an undertaking that,
marketsin the event that Bermuda enacts legislation imposing tax computed on profits,
income, any capital asset, gain or appreciation, or any tax in the nature of
estate
37
duty or inheritance tax, then the imposition of the tax will not be applicable
to us or our operations until March 28, 2016. We could be subject to taxes in
Bermuda after that date. This undertaking does not, however, prevent the
imposition of taxes on any person ordinarily resident in Bermuda or any company
in respect of its ownership of real property or leasehold interests in Bermuda.
Bermuda's political structure is based upon a parliamentary system with two
major parties, the United Bermuda Party and sells insurance
directlythe Progressive Labour Party. In the
most recent election, the Progressive Labour Party gained control of the
legislative branch for the first time over the incumbent United Bermuda Party.
To date, the government's financial and regulatory policies have not been
changed in ways that we believe would materially affect us or our shareholders.
FOREIGN CURRENCY EXCHANGE RATE FLUCTUATION MAY ADVERSELY AFFECT OUR FINANCIAL
RESULTS.
We will write business on a worldwide basis, and our results of operations
may be affected by fluctuations in the value of currencies other than the U.S.
dollar. Changes in foreign currency exchange rates can reduce our revenues and
increase our liabilities and costs, as measured in the dollar as our functional
currency. We have not attempted and currently do not expect to its insuredsattempt to reduce
our exposure to these exchange rate risks by using hedging transactions. We may
therefore suffer losses solely as a result of exchange rate fluctuations.
EMPLOYEES OF OUR BERMUDA OPERATIONS ARE REQUIRED TO OBTAIN WORK PERMITS BEFORE
ENGAGING IN A GAINFUL OCCUPATION IN BERMUDA, AND WE CAN OFFER NO ASSURANCE THAT
REQUIRED WORK PERMITS WILL BE GRANTED OR REMAIN IN EFFECT.
Under Bermuda law, non-Bermudians (other than spouses of Bermudians) may not
engage in any gainful occupation in Bermuda without an appropriate governmental
work permit. Our success may depend in part on the continued services of key
employees in Bermuda. A work permit may be granted or reinsureds withoutrenewed upon showing that,
after proper public advertisement, no Bermudian (or spouse of a Bermudian) is
available who meets the assistanceminimum standards reasonably required by the employer.
The Bermuda government recently announced a new policy that places a six year
term limit on individuals with work permits, subject to certain exemptions for
key employees. A work permit is issued with an expiry date (up to five years)
and no assurances can be given that any work permit will be issued or, if
issued, renewed upon the expiration of brokers.
Excessthe relevant term.
THE ENFORCEMENT OF CIVIL LIABILITIES AGAINST US MAY BE DIFFICULT.
We are a Bermuda company and in the future some of loss reinsurance ..................A generic term describing
reinsurance that indemnifiesour officers and
directors may be residents of various jurisdictions outside the reinsured against allUnited States.
All or a specifiedsubstantial portion of lossesour assets and of those persons may be located
outside the United States. As a result, it may be difficult for you to effect
service of process within the United States upon those persons or to enforce in
United States courts judgments obtained against those persons.
We have appointed National Registered Agents, Inc., New York, New York, as
our agent for service of process with respect to actions based on underlying insurance policiesoffers and
sales of securities made in excessthe United States. We have been advised by our
Bermuda counsel, Conyers Dill & Pearman, that the United States and Bermuda do
not currently have a treaty providing for reciprocal recognition and enforcement
of judgments of U.S. courts in civil and commercial matters and that a final
judgment for the payment of money rendered by a court in the United States based
on civil liability, whether or not predicated solely upon the U.S. federal
securities laws, would, therefore, not be automatically enforceable in Bermuda.
We also have been advised by Conyers Dill & Pearman that a final and conclusive
judgment obtained in a court in the United States under which a sum of money is
payable as compensatory damages (i.e., not being a sum claimed by a revenue
authority for taxes or other charges of a specified amount,similar nature by a governmental
authority, or in respect of a fine or penalty or multiple or punitive damages)
may be the subject of an action on a debt in the Supreme Court of Bermuda under
the common law
38
doctrine of obligation. Such an action should be successful upon proof that the
sum of money is due and payable, and without having to prove the facts
supporting the underlying judgment, as long as:
- the court which gave the judgment had proper jurisdiction over the parties
to such judgment;
- such court did not contravene the rules of natural justice of Bermuda;
- such judgment was not obtained by fraud;
- the enforcement of the judgment would not be contrary to the public policy
of Bermuda;
- no new admissible evidence relevant to the action is submitted prior to
the rendering of the judgment by the courts of Bermuda; and
- there is due compliance with the correct procedures under Bermuda law.
A Bermuda court may impose civil liability on us or our directors or officers in
a suit brought in the Supreme Court of Bermuda against us or such persons with
respect to a violation of U.S. federal securities laws, provided that the facts
surrounding such violation would constitute or give rise to a cause of action
under Bermuda law.
RISKS RELATING TO TAXATION
WE AND OUR NON-U.S. SUBSIDIARIES MAY BECOME SUBJECT TO U.S. FEDERAL INCOME
TAXATION.
ACGL and its non-U.S. subsidiaries intend to operate their business in a
manner that will not cause them to be treated as engaged in a trade or business
in the United States and, thus, will not be required to pay U.S. federal income
taxes (other than withholding taxes on certain U.S. source investment income) on
their income. However, because there is uncertainty as to the activities which
constitute being engaged in a trade or business in the United States, there can
be no assurances that the U.S. Internal Revenue Service will not contend
successfully that ACGL or its non-U.S. subsidiaries are engaged in a trade or
business in the United States. If ACGL or any of its non-U.S. subsidiaries were
subject to U.S. income tax, our shareholders' equity and earnings could be
adversely affected. We may be a personal holding company in 2002, but do not
currently expect to have "undistributed personal holding company income." See
"--Tax Matters--Taxation of ACGL--United States--Personal Holding Company
Rules."
We changed our legal domicile from the United States to Bermuda in
November 2000. Legislation has recently been introduced which (if enacted) could
eliminate the tax benefits available to companies, like us, that changed their
legal domiciles to Bermuda. In addition, some U.S. insurance companies have been
lobbying Congress to pass legislation intended to eliminate certain perceived
tax advantages of U.S. insurance companies with Bermuda affiliates resulting
principally from reinsurance between or among U.S. insurance companies and their
Bermuda affiliates. Legislation, if passed, and other changes in U.S. tax laws,
regulations and interpretations thereof to address these issues could adversely
affect us.
U.S. PERSONS WHO HOLD OUR COMMON SHARES MAY BE SUBJECT TO U.S. INCOME TAXATION
AT ORDINARY INCOME RATES ON OUR UNDISTRIBUTED EARNINGS AND PROFITS. IN ADDITION,
THE HEIRS OR ESTATE OF ANY INDIVIDUAL HOLDER MAY NOT BE ENTITLED TO A "STEP-UP"
IN BASIS OF OUR COMMON SHARES WHICH MIGHT OTHERWISE BE AVAILABLE UPON SUCH
HOLDER'S DEATH.
We believe that we and our foreign subsidiaries currently are controlled
foreign corporations ("CFCs"), although our bye-laws are designed to preclude
any U.S. person from adverse tax consequences as a result of our CFC status. We
also believe that we are likely to be a foreign personal holding company in
2002, but do not currently expect to have undistributed foreign personal holding
company income. We do not believe that we are a passive foreign investment
company. Since these determinations and beliefs are based upon legal and factual
conclusions, some of which are described under "--Tax Matters," no assurances
can be given that the IRS or a court would concur with our conclusions. If they
were not to so concur, U.S. persons who hold our common shares may suffer
adverse tax consequences. See "--Tax Matters."
39
TAX MATTERS
The following summary of the taxation of ACGL and the taxation of our
shareholders is based upon current law and is for general information only.
Legislative, judicial or administrative changes may be forthcoming that could
affect this summary.
The following legal discussion (including and subject to the matters and
qualifications set forth in such summary) of certain tax considerations
(a) under "--Taxation of ACGL--Bermuda" and "--Taxation of Shareholders--Bermuda
Taxation" is based upon the advice of Conyers Dill & Pearman, Hamilton, Bermuda
and (b) under "--Taxation of ACGL--United States," "--Taxation of
Shareholders--United States Taxation," "--Taxation of Our U.S. Shareholders" and
"--United States Taxation of Non-U.S. Shareholders" is based upon the advice of
Cahill Gordon & Reindel, New York, New York (the advice of such firms does not
include accounting matters, determinations or conclusions relating to the
business or activities of ACGL). The summary is based upon current law and is
for general information only. The tax treatment of a holder of our common
shares, or of a person treated as a holder of our common shares for U.S. federal
income, state, local or non-U.S. tax purposes, may vary depending on the
holder's particular tax situation. Legislative, judicial or administrative
changes or interpretations may be forthcoming that could be retroactive and
could affect the tax consequences to us or to holders of our common shares.
TAXATION OF ACGL
BERMUDA
Under current Bermuda law, we are not subject to tax on income or capital
gains. We have obtained from the Minister of Finance under the Exempted
Undertakings Tax Protection Act 1966 an assurance that, in the event that
Bermuda enacts legislation imposing tax computed on profits, income, any capital
asset, gain or appreciation, or any tax in the nature of estate duty or
inheritance, the imposition of any such tax shall not be applicable to us or to
any of our operations or our shares, debentures or other obligations until
March 28, 2016. We could be subject to taxes in Bermuda after that date. This
assurance will be subject to the proviso that it is not to be construed so as to
prevent the application of any tax or duty to such persons as are ordinarily
resident in Bermuda (we are not so currently affected) or to prevent the
application of any tax payable in accordance with the provisions of the Land Tax
Act 1967 or otherwise payable in relation to any property leased to us or our
insurance subsidiary. We pay annual Bermuda government fees, and our Bermuda
reinsurance subsidiary pays annual insurance license fees. In addition, all
entities employing individuals in Bermuda are required to pay a payroll tax and
there are sundry other taxes payable, directly or indirectly, to the Bermuda
government.
UNITED STATES
ACGL and its non-U.S. subsidiaries intend to conduct their operations such
that they will not be engaged in a trade or business in the United States and,
therefore, will not be required to pay U.S. federal income taxes (other than
withholding taxes on dividends and certain other U.S. source investment income).
However, because definitive identification of activities which constitute being
engaged in a trade or business in the United States is not provided by the
Internal Revenue Code of 1986, as amended (the "Code"), or regulations or court
decisions, there can be no assurance that the Internal Revenue Service ("IRS")
will not contend successfully that ACGL or its non-U.S. subsidiaries will be
engaged in a trade or business in the United States. A foreign corporation
deemed to be so engaged would be subject to U.S. income tax, as well as the
branch profits tax, on its income, which is calledtreated as effectively connected
with the conduct of that trade or business unless the corporation is entitled to
relief under the permanent establishment provisions of a "level"tax treaty. Such income
tax, if imposed, would be based on effectively connected income computed in a
manner generally analogous
40
to that applied to the income of a domestic corporation, except that deductions
and credits generally are not permitted unless the foreign corporation has
timely filed a U.S. federal income tax return in accordance with applicable
regulations. Penalties may be assessed for failure to file tax returns. The 30%
branch profits tax is imposed on net income after subtracting the regular
corporate tax and making certain other adjustments.
Under the income tax treaty between Bermuda and the United States (the
"Treaty"), ACGL's Bermuda insurance subsidiaries will be subject to U.S. income
tax on any insurance premium income found to be effectively connected with a
U.S. trade or "retention."
Also knownbusiness only if that trade or business is conducted through a
permanent establishment in the United States. No regulations interpreting the
Treaty have been issued. While there can be no assurances, ACGL does not believe
that any of its Bermuda insurance subsidiaries have a permanent establishment in
the United States. Such subsidiaries would not be entitled to the benefits of
the Treaty if (i) less than 50% of ACGL's stock were beneficially owned,
directly or indirectly, by Bermuda residents or U.S. citizens or residents, or
(ii) any such subsidiary's income were used in substantial part to make
disproportionate distributions to, or to meet certain liabilities to, persons
who are not Bermuda residents or U.S. citizens or residents. While there can be
no assurances, ACGL believes that its Bermuda insurance subsidiaries will be
eligible for Treaty benefits after the sale of shares offered hereby.
Foreign corporations not engaged in a trade or business in the United States
are nonetheless subject to U.S. income tax on certain "fixed or determinable
annual or periodic gains, profits and income" derived from sources within the
United States as non-proportional
reinsurance. Excessenumerated in Section 881(a) of loss
reinsurancethe Code (such as dividends and
certain interest on investments).
PERSONAL HOLDING COMPANY RULES. A corporation will not be classified as a
personal holding company (a "PHC") in a given taxable year unless both (i) at
some time during the last half of such taxable year, five or fewer individuals
(without regard to their citizenship or residency) own or are deemed to own
(pursuant to certain constructive ownership rules) more than 50% of the
corporation's shares by value, and (ii) at least 60% of the adjusted ordinary
gross income of the corporation for such taxable year consists of PHC income (as
defined in Section 543 of the Code). For purposes of the 50% share ownership
test, all of our common shares owned by an investment partnership will be
attributed to each of its partners, if any, who are individuals. As a result of
this attribution rule, we believe that currently five or fewer individuals are
treated as owning more than 50% of the value of our common shares. Consequently,
we or one or more of our subsidiaries could be or become PHCs, depending on
whether we or any of our subsidiaries satisfy the PHC gross income test.
We will use reasonable best efforts to cause ACGL and each of its
subsidiaries not to satisfy the gross income requirement set forth in
Section 542(a) of the Code. If, however, we or any of our subsidiaries is writtenor
were to become a PHC in layers. A
reinsurera given taxable year, such company would be subject to
PHC tax (at the highest marginal rate on ordinary income applicable to
individuals) on its "undistributed PHC income" (which, in our case and the case
of our foreign subsidiaries, would include only PHC income that is from U.S.
sources and foreign source income to the extent that such income is effectively
connected with the conduct of a trade or groupbusiness in the U.S.). PHC income
generally would not include underwriting income or, in our case and the case of
reinsurers
acceptsour foreign subsidiaries, investment income derived from non-U.S. sources or
dividends received from non-U.S. subsidiaries. If we or any of our subsidiaries
is or becomes a bandPHC, there can be no assurance that the amount of coverage upPHC income
would be immaterial.
There can be no assurance that we and each of our subsidiaries are not or
will not become a PHC immediately following this offering or in the future
because of factors including factual uncertainties regarding the application of
the PHC rules, the makeup of our shareholder base and other circumstances that
affect the application of the PHC rules to us and our subsidiaries.
41
TAXATION OF SHAREHOLDERS
The following summary sets forth certain United States federal income tax
considerations related to the purchase, ownership and disposition of our common
shares. Unless otherwise stated, this summary deals only with shareholders
("U.S. Holders") that are United States Persons (as defined below) who hold
their common shares as capital assets. The following discussion is only a
general summary of the United States federal income tax matters described herein
and does not purport to address all of the United States federal income tax
consequences that may be relevant to a specified amount. Theparticular shareholder in light of such
shareholder's specific circumstances. In addition, the following summary does
not describe the United States federal income tax consequences that may be
relevant to certain types of shareholders, such as banks, insurance companies,
regulated investment companies, real estate investment trusts, financial asset
securitization investment trusts, dealers in securities or traders that adopt a
mark-to-market method of tax accounting, tax exempt organizations, expatriates
or persons who hold the common shares as part of a hedging or conversion
transaction or as part of a straddle, who may be subject to special rules or
treatment under the Code. This discussions is based upon the Code, the Treasury
regulations promulgated thereunder and any relevant administrative rulings or
pronouncements or judicial decisions, all as in effect on the date hereof and as
currently interpreted, and does not take into account possible changes in such
tax laws or interpretations thereof, which may apply retroactively. This
discussion does not include any description of the tax laws of any state or
local governments within the United States, or of any foreign government, that
may be applicable to the common shares or the shareholders. Persons considering
making an investment in the common shares should consult their own tax advisors
concerning the application of the United States federal tax laws to their
particular situations as well as any tax consequences arising under the laws of
any state, local or foreign taxing jurisdiction prior to making such investment.
If a partnership holds our common shares, the tax treatment of a partner
will generally depend upon the status of the partner and the activities of the
partnership. If you are a partner of a partnership holding common shares, you
should consult your tax advisor.
For purposes of this discussion, the term "United States Person" means:
- a citizen or resident of the United States,
- a corporation or entity treated as a corporation created or organized in
or under the laws of the United States, or any political subdivision
thereof,
- an estate the income of which is subject to United States federal income
taxation regardless of its source,
- a trust if either (x) a court within the United States is able to exercise
primary supervision over the administration of such trust and one or more
United States Persons have the authority to control all substantial
decisions of such trust or (y) the trust has a valid election in effect to
be treated as a United States Person for U.S. federal income tax purposes
or
- any other person or entity that is treated for U.S. federal income tax
purposes as if it were one of the foregoing.
BERMUDA TAXATION
Currently, there is no Bermuda withholding tax on dividends paid by us.
UNITED STATES TAXATION
TAXATION OF DIVIDENDS. Subject to the discussions below relating to the
potential application of the CFC and PFIC rules, cash distributions, if any,
made with respect to our common shares will constitute dividends for U.S.
federal income tax purposes to the extent paid out of our current or accumulated
42
earnings and profits (as computed using U.S. tax principles). To the extent such
distributions exceed our earnings and profits, they will be treated first as a
return of the U.S. Holder's basis in our common shares to the extent thereof,
and then as gain from the sale of a capital asset.
SALE, EXCHANGE OR OTHER DISPOSITION. Subject to the discussions below
relating to the potential application of the CFC, PFIC and foreign personal
holding company ("FPHC") rules, holders of common shares generally will
recognize capital gain or loss for U.S. federal income tax purposes on the sale,
exchange or disposition of common shares.
TAXATION OF OUR U.S. SHAREHOLDERS
CONTROLLED FOREIGN CORPORATION RULES
Under our bye-laws, the 9.9% voting restriction applicable to the Controlled
Shares of a U.S. Person (as defined in our bye-laws) generally does not apply to
certain of our investors. As a result of certain attribution rules, we believe,
therefore, that we and our foreign subsidiaries are controlled foreign
corporations ("CFCs"). That status as a CFC does not cause us or any of our
subsidiaries to be subject to U.S. federal income tax. Such status also has no
adverse U.S. federal income tax consequences for any U.S. Holder that is
considered to own less than 10% of the total coverage purchasedcombined voting power of our common
shares or those of our foreign subsidiaries. Only U.S. Holders that are
considered to own 10% or more of the total combined voting power of our common
shares or those of our foreign subsidiaries (taking into account common shares
actually owned by such U.S. Holder as well as common shares attributed to such
U.S. Holder under the Code or the regulations thereunder) (a "10% U.S. Voting
Shareholder") is affected by our status as a CFC. Our bye-laws are intended to
prevent any U.S. Holder from being considered a 10% U.S. Voting Shareholder by
limiting the votes conferred by the cedent is
referredControlled Shares (as defined in our
bye-laws) of any U.S. Person to as a "program" and will
typically be placed with
predetermined reinsurers in
prenegotiated layers. Any liability
exceeding the outer limit9.9% of the program revertstotal voting power of all our shares
entitled to vote. However, because under our bye-laws certain funds associated
with Warburg Pincus and Hellman & Friedman generally are entitled to vote their
directly owned common shares in full, a U.S. Holder that is attributed (under
the Code or the regulations thereunder) common shares owned by such funds may be
considered a 10% U.S. Voting Shareholder. If you are a direct or indirect
investor in a fund associated with Warburg Pincus or Hellman & Friedman
additional common shares could be attributed to you for purposes of determining
whether you are considered to be a 10% U.S. Voting Shareholder. As long as we
are a CFC, a U.S. Holder that is considered a 10% U.S. Voting Shareholder will
be subject to current U.S. federal income taxation (at ordinary income tax
rates) to the ceding
company, which also bears the
credit risk of a reinsurer's
insolvency.
Facultative reinsurance .....................The reinsuranceextent of all or a portion of the undistributed earnings and
profits of ACGL and our subsidiaries attributable to "subpart F income"
(including certain insurance providedpremium income and investment income) and may be
taxable at ordinary income tax rates on any gain realized on a sale or other
disposition (including by way of repurchase or liquidation) of our common shares
to the extent of the current and accumulated earnings and profits attributable
to such shares.
While our bye-laws are intended to prevent any member from being considered
a 10% U.S. Voting Shareholder (except as described above), there can be no
assurance that a U.S. Holder will not be treated as a 10% U.S. Voting
Shareholder, by attribution or otherwise, under the Code or any applicable
regulations thereunder. See "Risk Factors--Risks Relating to Taxation--U.S.
persons who hold our common shares may be subject to U.S. income taxation at
ordinary income rates on our undistributed earnings and profits."
RELATED PERSON INSURANCE INCOME RULES
We do not expect the gross "related person insurance income" ("RPII") of any
of our non-U.S. subsidiaries to equal or exceed 20% of its gross insurance
income in any taxable year for the foreseeable future and do not expect the
direct or indirect insureds (and related persons) of any such subsidiary to
directly or indirectly own 20% or more of either the voting power or value of
our
43
common stock. Consequently, we do not expect any U.S. person owning common
shares to be required to include in gross income for U.S. federal income tax
purposes RPII income, but there can be no assurance that this will be the case.
Section 953(c)(7) of the Code generally provides that Section 1248 of the
Code (which generally would require a U.S. Holder to treat certain gains
attributable to the sale, exchange or disposition of common shares as a
dividend) will apply to the sale or exchange by a single policy. Each policy
reinsuredU.S. shareholder of shares in
a foreign corporation that is separately negotiated.
21
Finite risk reinsurance .....................Similar to traditional reinsurance
withcharacterized as a CFC under the exception that thereRPII rules if the
foreign corporation would be taxed as an insurance company if it were a domestic
corporation, regardless of whether the U.S. shareholder is a finite risk10% U.S. Voting
Shareholder or whether the corporation qualifies for either the RPII 20%
ownership exception or the RPII 20% gross income exception. Although existing
Treasury Department regulations do not address the question, proposed Treasury
regulations issued in April 1991 create some ambiguity as to whether
Section 1248 and the requirement to file Form 5471 would apply when the foreign
corporation has a foreign insurance subsidiary that is a CFC for RPII purposes
and that would be taxed as an insurance company if it were a domestic
corporation. We believe that Section 1248 and the requirement to file Form 5471
will not apply to a less than 10% U.S. Shareholder because ACGL is not directly
engaged in the insurance business. There can be no assurance, however, that the
IRS will interpret the proposed regulations in this manner or that the Treasury
Department will not take the position that Section 1248 and the requirement to
file Form 5471 will apply to dispositions of our common shares.
If the IRS or U.S. Treasury Department were to make Section 1248 and the
Form 5471 filing requirement applicable to the reinsurersale of our common shares, we
would notify shareholders that Section 1248 of the Code and the requirement to
file Form 5471 will apply to dispositions of our common shares. Thereafter, we
would send a notice after the end of each calendar year to all persons who were
shareholders during the year notifying them that Section 1248 and the
requirement to file Form 5471 apply to dispositions of our common shares by U.S.
Holders. We would attach to this notice a copy of Form 5471 completed with all
our information and instructions for completing the shareholder information.
FOREIGN PERSONAL HOLDING COMPANY RULES
A foreign company will not be classified as an FPHC unless both (i) at some
time during the taxable year at issue, five or fewer individuals who are U.S.
citizens or residents own or are deemed to own (pursuant to certain constructive
ownership rules) more than 50% of all classes of its shares measured by voting
power or value and (ii) at least 60% (or in general 50% for any year after the
first year that a corporation is an FPHC) of its gross income is FPHC income (as
defined in Section 553 of the Code) (generally including passive income such as
dividends, interest and gains from the sale of stocks and securities). For
purposes of the share ownership test, all of our common shares owned by an
investment partnership will be attributed to each of its partners, if any, who
are individuals. As a result of this attribution rule, we believe that currently
five or fewer individuals are treated as owning more than 50% of the value of
our common shares. Consequently, we or one or more of our foreign subsidiaries
could be or become FPHCs, depending on whether we or any of our foreign
subsidiaries satisfy the FPHC gross income test.
We will use reasonable best efforts to cause us and each of our subsidiaries
not to satisfy the gross income requirement set forth in Section 552 of the
Code. If, however, we or any of our subsidiaries are or were to become an FPHC,
a portion of such company's "undistributed foreign personal holding company
income" (as defined in the Code) would be imputed to all of our U.S. Holders.
Such income would be taxable as a dividend, even if no cash dividend were
actually paid. In such event, subsequent cash distributions would first be
treated as a tax-free return of any previously taxed and undistributed amounts.
In addition, if we or any of our subsidiaries are or become an FPHC in any year,
the heirs or estate of any individual U.S. Holder who dies in the immediately
following year (whether or not we or
44
any of our subsidiaries are an FPHC in such year) would not be entitled to a
"step-up" in the basis of the common shares which might otherwise be available
under U.S. income tax laws.
There can be no assurance that we and each of our subsidiaries are not or
will not become an FPHC because of factors including factual uncertainties
regarding the application of the FPHC rules, the makeup of our shareholder base
and other circumstances that could affect the application of the FPHC rules to
us and our subsidiaries. If we or any of our subsidiaries are or were to become
an FPHC, such company would not be subject to the PHC rules described above.
PASSIVE FOREIGN INVESTMENT COMPANIES
Sections 1291 through 1298 of the Code contain special rules applicable with
respect to minimum and maximum
exposure in relationforeign corporations that are "passive foreign investment companies"
("PFICs"). In general, a foreign corporation will be a PFIC if 75% or more of
its income constitutes "passive income" or 50% or more of its assets produce
passive income. If we were to be characterized as a PFIC, U.S. Holders would be
subject to a penalty tax at the time of their sale of (or receipt of an "excess
distribution" with respect to) their common shares. In general, a shareholder
receives an "excess distribution" if the amount of the distribution is more than
125% of the average distribution with respect to the premiumshares during the three
preceding taxable years (or shorter period during which the taxpayer held the
stock). In general, the penalty tax is equivalent to be received.
Gross premiums written ......................Total premiums for insurance and
reinsurance assumedan interest charge on taxes
that are deemed due during the period the shareholder owned the shares, computed
by assuming that the excess distribution or gain (in the case of a given
period.
Incurred but not reported ("IBNR") ..........Reserves for estimated losses that
have been incurred by insureds and
reinsureds but not yet reportedsale) with
respect to the insurer or reinsurer, including
unknown future developments on
losses which are knownshares was taxable in equal portions throughout the holder's
period of ownership. The interest charge is equal to the insurer or reinsurer.
In-force premiums ...........................The totalapplicable rate imposed
on underpayments of estimated annualized
premiums of all policies in force
as of a certain date which would be
anticipated to generate net
premiums written during the annual
period being considered.
Intermediary/broker .........................One who negotiates contracts of
insurance between an insured and a
primary insurer on behalfU.S. federal income tax for such period. A U.S. shareholder
may avoid some of the insured and/or contractsadverse tax consequences of reinsurance betweenowning shares in a primary
insurer or other reinsured andPFIC by
making a reinsurer on behalfqualified electing fund ("QEF") election. A QEF election is revocable
only with the consent of the primary
insurer or reinsured,Internal Revenue Service and has the following
consequences to a shareholder:
- For any year in each case
receivingwhich ACGL is not a commission for
placement and other services
rendered.
Lloyd's syndicate ...........................Underwriting members of Lloyd's
(which can be individual "names"
and/or dedicated corporate members)
that group together annually to
form a syndicate to underwrite
insurance coverage. Each syndicate
is managed by a Lloyd's-approved
managing agent, which appoints one
or more active or named
underwriters who have the authority
to bind the syndicate to contracts
of insurance, pay claims and effect
recoveries.
Net premiums written ........................Gross premiums written for a given
period less premiums ceded to
retrocessionaires during such
period.
Primary insurer .............................An insurance company that contracts
with the insured to provide
insurance coverage. Such insurer
may then cede a portion of its
business to reinsurers.
Probable maximum loss .......................Under RCRe's current guidelines,
probable maximum loss is the
anticipated maximum exposure to an
event of a magnitude such that itPFIC, no income tax consequences would
be expected to occur once in
100 years.
Quota share or proportional
reinsurance .................................A generic term describing all forms
of reinsuranceresult.
- For any year in which the reinsurer sharesACGL is a proportional
partPFIC, the shareholder would include in
its taxable income a proportionate share of the original premiumsnet ordinary income and
lossesnet capital gains of the reinsured. (Also
known as pro rata reinsurance or
participating reinsurance.) In
proportional reinsurance, the
reinsurer generally pays the ceding
company a ceding commission.ACGL and certain of its non-U.S. subsidiaries.
The ceding commission generally is
based on the ceding company's cost
of acquiring the business being
reinsured (including commissions,
premium taxes, assessments and
miscellaneous administrative
expenses) and also may include a
profit factor. Generally, the
reinsurer gets the benefit of
common account reinsurance.
RAA .........................................Reinsurance Association of America,
a trade association of medium and
large property and casualty
reinsurers doing businessPFIC statutory provisions contain an express exception for income
"derived in the United States. The RAA provides
statistical data concerning the
markets,active conduct of an insurance business by a corporation which
voluntarily provide
such informationis predominantly engaged in an insurance business...." This exception is
intended to ensure that income derived by a bona fide insurance company is not
treated as passive income, except to the RAA.
Reinsurance .................................An arrangement in which an
insurance company, the reinsurer,
agreesextent such income is attributable to
indemnify another
insurance or reinsurance company,
the ceding company, against all or
a portion of the insurance or
reinsurance risks
22
underwritten by the ceding company
under one or more policies.
Reinsurance can provide a ceding
company with several benefits,
including a reduction in net
liability on individual risks and
catastrophe protection from large
or multiple losses. Reinsurance
also provides a ceding company with
additional underwriting capacity by
permitting it to accept larger
risks and write more business than
would be possible without a
concomitant increase in capital and
surplus, and facilitates the
maintenance of acceptable financial ratios by the ceding company.
Reinsurance does not legally
discharge the ceding company from
its liability with respect to its
obligations to the insured.
Reserves ....................................Liabilities established by insurers
and reinsurers to reflect the
estimated costs of claims payments
and the related expenses that the
insurer or reinsurer will
ultimately be required to pay in
respect of insurance or reinsurance
it has written. Reserves are
established for losses and for
unpaid claims and claims expenses
and for unearned premiums. Loss
reserves consist of case reserves
and IBNR reserves. For reinsurers,
unpaid claims and claims expense
reserves are generally not
significant because substantially
all of the unpaid claims and claims
expenses associated with particular
claims are incurred by the primary
insurer and reported to reinsurers
as losses. Unearned premium
reserves constitute the portion of
premiums paid in advance for
insurance or reinsurance that has
not yet been provided.
Retention ...................................The amount or portion of risk that
an insurer retains for its own
account. Losses in excess of the retention level are paid by the
reinsurer. In proportional
treaties, the retention may be a
percentagereasonable needs of the original policy's
limit. In excessinsurance business.
The PFIC statutory provisions contain a look-through rule that states that, for
purposes of loss business,
the retentiondetermining whether a foreign corporation is a dollar amount of
loss, a loss ratio or a percentage.
Retrocession ................................A transaction whereby a reinsurer
cedes to another reinsurer (the
"retrocessionaire") all or partPFIC, such foreign
corporation shall be treated as if it "received directly its proportionate share
of the reinsurance thatincome" and as if it "held its proportionate share of the first
reinsurer has assumed.
Retrocessions doassets" of any
other corporation in which it owns at least 25% of the stock. We will use
reasonable best efforts to cause us and each of our subsidiaries not legally
dischargeto
constitute a PFIC within the ceding reinsurer from
its liabilitymeaning of Section 1297 of the Code.
No regulations interpreting the substantive PFIC provisions have yet been
issued. Each U.S. Holder should consult his tax advisor as to the effects of
these rules.
UNITED STATES TAXATION OF NON-U.S. SHAREHOLDERS
TAXATION OF DIVIDENDS
Cash distributions, if any, made with respect to its
obligationscommon shares held by
shareholders who are not United States Persons ("Non-U.S. holders") generally
will not be subject to United States withholding tax.
45
SALE, EXCHANGE OR OTHER DISPOSITION
Non-U.S. holders of common shares generally will not be subject to U.S.
federal income tax with respect to gain realized upon the sale, exchange or
other disposition of common shares unless such gain is effectively connected
with a U.S. trade or business of the Non-U.S. holder in the United States or
such person is present in the United States for 183 days or more in the taxable
year the gain is realized and certain other requirements are satisfied.
INFORMATION REPORTING AND BACKUP WITHHOLDING
Non-U.S. holders of common shares will not be subject to U.S. information
reporting or backup withholding with respect to dispositions of common shares
effected through a non-U.S. office of a broker, unless the broker has certain
connections to the reinsured.
Reinsurance companies cede risks to
retrocessionaires for reasons
similar to those that cause primary
insurers to purchase reinsurance:
to reduce net liability on
individual risks, to protect
against catastrophic losses, to
stabilize financial ratios and to
obtain additional underwriting
capacity.
Statutory accounting principles
("SAP") ..................................The rules and procedures prescribed
or permitted by United States state
insurance regulatory authorities
includingor is a United States person. No U.S. backup
withholding will apply to payments of dividends, if any, on our common shares.
OTHER TAX LAWS
Shareholders should consult their own tax advisors with respect to the
NAIC, which govern
the preparation of financial
statements. Such rules and
procedures generally reflect a
liquidating, rather than going
concern, concept of accounting.
Statutory composite ratio ...................Provides an overall indication of
underwriting profitability. The
ratio is the sum of: the ratio of
commissions and other underwriting
expensesapplicability to premiums written, and
the ratio of claims and claims
expenses to premiums earned. A
statutory composite ratio under
100% indicates underwriting
profitability, while a composite
ratio exceeding 100% indicates an
underwriting loss.
Statutory surplus ...........................The excess of admitted assets over
total liabilities (including loss
reserves), determined in accordance
with SAP.
23
Tail.........................................The period of time that elapses
between the writingthem of the applicable insurance policy or the
loss event (or the insurer's
knowledgetax laws of the loss event) and
the payment in respect thereof.
Treaties ....................................The reinsurance of a specified type
or category of risks defined in a
reinsurance agreement (a "treaty")
between an insurer and a reinsurer
or between a reinsurer and a
retrocessionaire. In treaty
reinsurance, the cedent is
typically obligated to offer, and
the reinsurer or retrocessionaire
is obligated to accept, a specified
portion of a type or category of
risks insured by the ceding company
as set forth in the governing
contract. Treaty reinsurance may
provide for proportional or
non-proportional reinsurance.
Underwriting ................................The insurer's or reinsurer's
process of reviewing applications
submitted for insurance coverage,
deciding whether to accept all or
part of the coverage requested and
determining the applicable
premiums.
Underwriting capacity .......................The maximum amount that an
insurance company can underwrite.
The limit is generally determined
by the company's policyholders or
statutory surplus, which depends,
among other things, on the
insurer's admitted assets.
Reinsurance serves to increase a
company's capacity by reducing its
exposure from particular risks.
24
jurisdictions.
ITEM 2. PROPERTIES
In March 1996, we entered into a sublease agreement expiringACGL and its subsidiaries rent space for their offices in October
2002 for approximately 40,000 square feet of office space in Greenwich,
Connecticut, where our offices are located. FutureBermuda and the
United States under leases which expire at various times up to 2006. Our future
minimum rental charges for the remaining termterms of the sublease,our existing leases, exclusive
of escalation clauses and maintenance costs and net of rental income, will be
approximately $1,994,000.
Our$5,081,000. For the years ended December 31, 2001, 2000 and 1999,
our rental expense net of(income), including sublease income, during 1999, 1998 and 1997 was approximately
$(132,000), $190,000 and $576,000, 576,000 and $643,000, respectively. Commencing in 1996, we subleased approximately 13,000 square feet ofWe believe that the above
described office space is adequate for our needs. However, as we continue to
MMCI for a term expiring in Octoberdevelop our business, we expect that we will open additional office locations
during 2002. Future minimum rental
income under the remaining term of the sublease, exclusive of escalation clauses
and maintenance costs, will be approximately $1,218,000. Rental income for 1999,
1998 and 1997 was $430,000 for each year. MMCI also reimbursed the company
approximately $60,000 $100,000 and $574,000 in 1999, 1998 and 1997,
respectively, for MMCI's pro rata share of improvement and maintenance costs
under the sublease. In addition, commencing in 1997, we subleased approximately
6,000 square feet of the office space to another tenant for a term expiring in
October 2002. Rental income for 1999, 1998 and 1997 was $225,000, $225,000 and
$117,000, of which $89,000, $89,000 and $44,000, respectively, was paid to MMCI
as its pro rata share of such income. Effective March 31, 2000, the sublease
with this tenant will be terminated, and MMCI will assume the 6,000 square feet
of space and will be responsible for the costs associated with the space.
ITEM 3. LEGAL PROCEEDINGS
The company isWe, in common with the insurance industry in general, are subject to
litigation and arbitration in the normal course of our business. As of
December 31, 2001, we were not a party to any material litigation or arbitration
other than as a part of the ordinary course of its business.business in relation to claims
activity, none of which is expected by management to have a significant adverse
effect on our results of operation and financial condition and liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There were no matters submitted to a vote of security holders during the
fourth quarter of 1999.None.
46
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
Shares of ourMARKET INFORMATION
Our common stockshares are traded on the Nasdaq National Market under the symbol
"RCHI."ACGL." For the periods presented below, the high and low sales prices and
closing prices for our common stockshares as reported on the Nasdaq National Market
were as follows:
Three Months Ended
-----------------------------------------------------------------------------
DecemberTHREE MONTHS ENDED
------------------------------------------------------------------------------
DECEMBER 31, September2001 SEPTEMBER 30, June2001 JUNE 30, March2001 MARCH 31, 1999 1999 1999 1999
---- ----- ---- ----2001(1)
------------------ ------------------- -------------- ------------------
High................................ $15.69 $16.00 $17.38 $22.63$28.34 $19.20 $17.06 $18.06
Low................................. 11.00 13.00 13.50 12.0016.40 15.45 14.81 14.38
Close............................... 12.63 15.63 13.50 15.13
Three Months Ended
-----------------------------------------------------------------------------
December25.75 16.75 15.75 15.88
THREE MONTHS ENDED
---------------------------------------------------------------------------
DECEMBER 31, September2000 SEPTEMBER 30, June2000 JUNE 30, March2000 MARCH 31, 1998 1998 1998 1998
---- ---- ---- ----2000
------------------ ------------------- -------------- ---------------
High................................ $23.75 $25.50 $25.50 $24.00$15.88 $15.88 $16.63 $16.75
Low................................. 18.81 19.00 22.75 19.7513.88 14.63 14.56 11.38
Close............................... 21.75 22.00 24.94 24.0015.00 15.75 14.94 16.38
25
- --------------------------
(1) For the ten trading days ended October 23, 2001, the last trading day prior
to the announcement of the signing of the subscription agreements for the
capital infusion and our new underwriting initiative, the average closing
price of our common shares on the Nasdaq Stock Market was $16.86 per share.
On March 27, 2000,8, 2002, the high and low sales prices and the closing price for
our common stockshares as reported on the Nasdaq National Market were $16.13, $15.19$27.14, $26.70
and $15.50,$26.70, respectively.
HoldersHOLDERS
As of March 27, 2000,8, 2002, there were approximately 4753 holders of record of our
common stockshares and approximately 1,6001,663 beneficial holders of our common stock.
Dividends
We have not declared any dividends sinceshares,
and 23 holders of record and beneficial holders of our formation in 1995.preference shares.
DIVIDENDS
Any determination to pay dividends in the future will be at the discretion of our board of
directors and will be dependent upon our results of operations, financial
condition capital requirements, contractual restrictions and other factors deemed relevant by our board of directors. As a
holding company, we will depend on future dividends and other permitted payments
from our subsidiaries to pay dividends to our shareholders. Our subsidiaries'
ability to pay dividends, as well as our ability to pay dividends, is, and is
expected to be, subject to regulatory, contractual, rating agency and other
constraints. Our board of directors currently does not intend to declare
dividends or make any other distributions.
In addition, pursuant to our shareholders agreement, we have agreed not to
declare any dividend or make any other distribution on our common shares, and
not to repurchase any common shares, until we have repurchased from the Warburg
Pincus funds, the Hellman & Friedman funds and the other holders of our
preference shares, pro rata, on the basis of the amount of those shareholders'
investments in us at the time of such repurchase, preference shares having an
aggregate value of $250.0 million, at a per share price acceptable to those
shareholders.
RECENT SALES OF UNREGISTERED SECURITIES
On November 20, 2001, we issued in a private placement the securities
described under "Business--Recent Developments--The Capital Infusion." The paymentsales
of any
dividends will be dependent uponthese securities were exempt
47
from registration under the abilityprovisions of RCRe to provide funds to us.Section 4(2) of the Securities Act.
For a description of the restrictions onpurchasers, consideration for and terms of conversion
and exercise of the ability of RCRe to pay dividends or
make distributions to us,securities, please refer to "Business(Insurance
Regulation--Regulationthe information appearing above
under the subheading "The Capital Infusion" included as part of Dividends"Business,"
which information is incorporated by reference.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth summary historical consolidated financial and
Other Payments from Insurance
Subsidiaries,"operating data for the five-year period ended December 31, 2001. Such data for
the three-year period ended December 31, 2001 should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations(LiquidityOperations" and Capital Resources" and Note 10 of the
accompanying notes to our consolidated financial statements.
Our board intends to make a determination regarding repurchases of our
shares after the consummation of the sale of our reinsurance operations to
Folksamerica Reinsurance Company, but no decision has yet been made as to
whether any such repurchases will be made or the amount, timing or method of any
such repurchases, which will depend on future circumstances.
26
ITEM 6. SELECTED FINANCIAL DATA
Our and RCRe's selected consolidated historical financial data for the
years ended December 31, 1999, 1998, 1997, 1996 and for the period from June 23,
1995 (date of inception) to December 31, 1995 should be read in conjunction with
our audited consolidated financial statements and the related notesnotes.
Comparisons of our 2001 and unaudited pro forma condensed consolidated financial data contained elsewhere2000 results of operations to each other and to
prior year periods are not relevant due to the changes in this report.our business during
2000 and 2001, including (1) the sale of our prior reinsurance operations in
May 2000, (2) our change of legal domicile and reorganization completed in
November 2000, (3) our recent acquisition activity, (4) our new underwriting
initiative and (5) the capital infusion.
Period from
June 23, 1995
Years Ended DecemberYEAR ENDED DECEMBER 31,
to
--------------------------------------------------------------- December 31,
---------------------------------------------------------------------------------
2001 2000 1999 1998 1997
1996 1995
---- ---- ---- ---- ----
(Dollars in thousands, except share data)----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Statement of Operations DataSTATEMENT OF OPERATIONS DATA:
Revenues:
Net premiums earned............... $311,368 $206,194 $107,372 $35,761written........ $ 36,216 $ (10,604)(1) $ 306,726 $ 234,735 $ 144,834
Net premiums earned......... 30,918 87,530 311,368 206,194 107,372
Net investment income.............income....... 12,120 15,923 20,173 15,687 14,360 13,151 $4,578
Net realized investment
gains (losses)................................... 18,382 20,045 17,227 25,252 (760)
1,259 397
Total revenues.................... 348,768revenues.......... 76,454 127,634 344,800 247,133 120,972
50,171 4,975Income (loss) before income
taxes....................... 24,144 503 (56,199) 2,347 1,598
Net income (loss)................. (32,436) 3,091............. 22,016 (8,012) (35,636) 2,852 2,039
4,112 1,019
Comprehensive income (loss)....... ($52,286) ($4,375) $47,107 $9,817 $4,750
Average common shares
outstanding
Basic..........................outstanding:
Basic....................... 12,855,668 13,198,075 17,086,732 17,065,165 17,032,601
16,981,724 16,747,084
Diluted........................ 17,086,808Diluted..................... 17,002,231(2) 13,198,075 17,086,732 17,718,223 17,085,788 16,983,909 16,990,425
Per Share Data
Net income (loss) Basic........................ ($1.90) $0.18 $0.12 $0.24 $0.06
Diluted...................... ($1.90) $0.17 $0.12 $0.24 $0.06
Comprehensive Income
(loss)per common
share:
Basic....................... ($3.06) ($0.26) $2.77 $0.58 $0.28$ 1.71 $ (0.61) $ (2.09) $ 0.17 $ 0.12
Diluted..................... ($3.06) ($0.26) $2.76 $0.58 $0.28$ 1.29 $ (0.61) $ (2.09) $ 0.16 $ 0.12
Cash dividends per share.......... N/A N/A N/A N/A N/Ashare...... -- -- -- -- --
48
DecemberDECEMBER 31,
---------------------------------------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
1996 1995
--------------------------------------------------------------------------------
(Dollars in thousands, except share data)----------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
Balance Sheet DataBALANCE SHEET DATA:
Cash and invested assets.......... $585,909 $587,155 $505,728 $392,940 $347,327assets...... $ 1,019,058 $ 276,053 $ 579,874 $ 586,788 $ 505,728
Unpaid losses and loss
adjustment expenses
recoverable................. 90,442 -- 55,925 30,468 --
Total assets...................... 864,359 757,830assets.................. 1,313,701 295,907 860,175 757,463 581,247
432,486 350,986
Stockholders' equity.............. 346,514 398,002Reserves for losses and loss
adjustment expenses:
Before reinsurance
recoverable............... 113,507 -- 364,554 216,657 70,768
Net of reinsurance
recoverable............... 23,065 -- 308,629 186,189 70,768
Shareholders' equity.......... 1,020,369 272,299 342,330 397,763 401,031 352,213 340,215
Sharses outstanding
Basic.......................... 17,087,970 17,087,438 17,058,462 17,031,246 16,941,125
Diluted........................ 17,087,970 17,497,904 17,601,608 17,065,406 16,941,125
Book value per share
Basic.......................... $20.28 $23.29 $23.51 $20.68 $20.08
Diluted........................ $20.28 $22.75 $22.79 $20.64 $20.08
27
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA
The following unaudited pro forma balance sheet as of December 31, 1999
reflects our historical accounts as of that date, adjusted to give pro forma
effect to the sale of our reinsurance business to Folksamerica, which is subject
to stockholder approval, and our repurchase of 4,755,000 shares, or 27.8%, of
our outstanding common stock from XL Capital, which repurchase was completed on
March 2, 2000, as if those transactions had occurred on December 31, 1999.
The following unaudited pro forma statement of income and comprehensive
income for the year ended December 31, 1999 reflects our historical accounts for
that period, adjusted to give pro forma effect to the asset sale and the XL
Capital stock repurchase as if those transactions had occurred on January 1,
1999.
The pro forma financial data and accompanying notes should be read in
conjunction with the description of the asset sale and XL Capital stock
repurchase contained in this report and our audited consolidated financial
statements and related notes also included in this report as well as the
description included in our special meeting proxy statement. We believe that the
assumptions used in the following statements, which are set forth in the
accompanying notes, provide a reasonable basis on which to present the pro forma
financial data. The pro forma financial data is provided for informational
purposes only and should not be construed to be indicative of our financial
condition or results of operations had the asset sale and XL Capital stock
repurchase been consummated on the dates assumed and are not intended to project
our financial condition on any future date or results of operations for any
future period.
28
Risk Capital Holdings, Inc. and Subsidiaries
Pro Forma Condensed Consolidated Balance Sheet
December 31, 1999
(Dollars in thousands, except per share data)
Pro Forma Adjustments
---------------------
XL Folksamerica
Historical Transaction(1) Transaction(4) Pro Forma
---------- -------------- -------------- ---------DECEMBER 31,
-------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ----------- ----------- -----------
Assets
Investments:
Fixed maturities and short-term
investments $333,852 ($245,545)(5) $88,307 (10)
Publicly traded equity securities 158,631 ($38,169)(2) 120,462
Privately held securities 83,969 (24,040)(2) 59,929
--------- ----------------- --------------- -------
Total investments 576,452 (62,209) (245,545) 268,698
Cash 9,457 3,647 (2) 1,335 (8) 14,439
Accrued investment income 4,527 4,527
Premiums receivable 119,320 (119,320)(5)
Reinsurance recoverable 73,122 (73,122)(5)
Deferred policy acquisition costs 23,585 (23,585)(6)
Deferred income tax asset 7,834 127 (2) (5,352)(7) 2,609
Other assets 50,062 (36,975)(5) 13,087
--------- ----------------- -------------- --------
Total Assets 864,359 ($58,435) ($502,564) $303,360
========= ================= ============== ========
Liabilities
Claims and claims expenses $364,554 ($364,554)(5)
Unearned premiums 108,743 (108,743)(5)
Reinsurance balances payable 14,666 (14,666)(5)
Other liabilities 29,882 $1,000 (2) (24,541)(5) $6,341
--------- ------ -- ------------- ------
Total Liabilities 517,845 1,000 (512,504) 6,341
======== ========= ============= ======
Stockholders' Equity
Book value:
Per common share.......... $ 20.05(3) $ 21.43 $ 20.03 $ 23.28 $ 23.51
Diluted................... $ 19.59 $ 21.43 $ 20.03 $ 22.80 $ 22.90
Common stock, $.01 par value: 171 171
Additional paid-in capital 342,034 342,034
Deferred compensation under stock award plan
(317)
(317)
Retained earnings (deficit) (22,175) 10,959 (3) 6,080 (9) (5,136)
Less treasury stock, at cost (387) (59,200)(1) (59,587)
Accumulated other comprehensive income
consisting of unrealized appreciation of
investments, net of income tax 27,188 (11,194)(3) 3,860 (9) 19,854
--------- ------- --- -------- ------
Total Stockholders' Equity 346,514 (59,435)(2) 9,940 (9) 297,019
--------- ------- --- --------- ------
Total Liabilities and
Stockholders' Equity $864,359 ($58,435) ($502,564) $303,360
========= ======== ========= ========
Shares outstanding - basicshares outstanding:
Actual.................... 13,513,538 12,708,818 17,087,970 (4,755,000)(1) -- 12,332,970
========= ========== == ==========
Basic book value per share $20.28 $24.08
====== ======17,087,438 17,058,462
Diluted................... 52,097,108(4) 12,708,818 17,087,970 17,445,619 17,508,632
30
Notes- ------------------------
(1) Net premiums written for 2000 includes the reversal of $92.9 million of
premiums recorded in prior periods in connection with the sale of our prior
reinsurance operations in May 2000.
(2) For the purposes of calculating "Net income (loss) per common share,"
"Average common shares outstanding, Diluted" gives effect to Pro Forma Balance Sheet
1. Reflects our repurchase from XL Capital of allthe issuance
of the 4,755,000following Dilutive Shares, on a weighted average basis, calculated
using the treasury stock method, where applicable, and does not give effect
to the issuance of the following Contingently Issuable Shares.
Dilutive shares (the "Dilutive Shares"):
Common shares issuable upon conversion of
outstanding preference shares......................... 35,687,735
Common shares issuable upon exercise of
outstanding class A warrants.......................... 1,206,206(a)
----------
Subtotal............................................ 36,893,941
Common shares issuable upon conversion or exercise of
contingently issuable (the "Contingently Issuable
Shares"):
Preference shares(b).................................... 875,765
Preference shares(c).................................... 2,831,174
Class B warrants(d)..................................... 33,495
----------
Subtotal............................................ 3,740,434
----------
Total............................................. 40,634,375
==========
(a) Calculated using the treasury stock method. Class A warrants to purchase
an aggregate of 5,401,707 common shares were outstanding as of our common stock held by it for $59,200,000, or $12.45March 8,
2002. The class A warrants are currently exercisable at $20.00 per share
which represents 85%and expire on September 19, 2002.
49
(b) Represents our current estimate of our averagethe number of additional preference
shares that will be issued during the first quarter of 2002 pursuant to a
post-closing purchase price adjustment under the subscription agreement
entered into in connection with the capital infusion.
(c) Represents an estimate of the number of additional preference shares
that would be issued under the subscription agreement entered into in
connection with the capital infusion in the event that, on or prior to
September 19, 2005, the closing market price of our common shares is at least
$30.00 per share for at least 20 out of 30 consecutive trading days or a
change of control occurs.
(d) Calculated using the treasury stock for the twenty day trading period between January 21, 2000 and
February 17, 2000 in exchange for the following:
(i) our interest in LARC Holdings, Ltd., valued at $25 million, and
(ii) our interest in Annuity and Life Re (Holdings), Ltd. valued at
$37,847,000, consistingmethod. Class B warrants to purchase
an aggregate of 1,418,440150,000 common shares were outstanding as of
December 31, 2001 and expire on September 19, 2005. Class B warrants
become exercisable at $25.38$20.00 per share which representsif the average closing market price of
Annuity and Life Re (Holdings), Ltd. common shares for the twenty
day trading period between January 21, 2000 and February 17,
2000, and 100,000 warrants at $18.50 per warrant based on a
Black-Scholes option valuation model, and
We received cash from XL Capital of $3,647,000, which is the excess of the value
of the securities described in (i) and (ii) above over the purchase price of our common
stock repurchased from XL Capital.
2. The decreaseshares is at least $30.00 per share for at least 20 out of 30 consecutive
trading days or a change of control occurs.
(3) For the purposes of calculating "Book value, Historical, Per common share"
shareholders' equity at December 31, 2001 excludes the aggregate
liquidation preference of $749.4 million for the preference shares issued in
book value resulting from the XL Capital stock
repurchase is calculatedcapital infusion.
(4) "Diluted" information gives effect to the Dilutive Shares and the issuance
of 1,689,629 restricted shares issued as follows (in thousands):
Repurchasepart of 4,755,000 sharesthe capital infusion but
does not include the issuance of any Contingently Issuable Shares. Such
information excludes the effects of our outstanding common stock at
$12.45 per share, recorded as a reduction to stockholders' equity as
treasury stock, plus $59,200
Net loss on the disposition of securities and transaction costs as follows:
(In thousands)
----------------------------------------------------------
Annuity and
Life Re
LARC (Holdings) Ltd.
Holdings, Ltd Total
------------- ----------------- -----
Consideration received, consisting of cash of $3,647,000
and our common stock valued at $59,200,000 $25,000 $37,847 $62,847
Carrying values at December 31, 1999 24,040 38,169 62,209
Pre-tax gain (loss) before transaction costs $960 ($322) 638
======= ====== ========
Transaction costs 1,000
--------
Pre-tax loss (362)
Tax benefit (127)
Net loss (235)
--------
Net decrease in book value $59,435
==========
30
3. The gain recorded in retained earnings of $10,959,000 represents the
realized gain that will be recorded for the $11,194,000 of net
unrealized appreciation, net of tax, recordedoptions
(4,068,311) at December 31, 1999 for
LARC Holdings, Ltd. and Annuity and Life Re (Holdings), Ltd. and the
net loss of $235,000, which is discussed in note 2 above.
4. Reflects the asset sale, pursuant to which Folksamerica Reinsurance
Company will assume RCRe's liabilities under the reinsurance agreements
transferred to it and RCRe will transfer to Folksamerica Reinsurance
Company assets in an aggregate amount that is, in GAAP book value (as
set forth on our estimated closing date balance sheet), equal to the
GAAP book value (as set forth on our estimated closing date balance
sheet) of the liabilities assumed. In consideration for the transfer of
RCRe's book of business, Folksamerica will pay $20.335 million in cash
at the closing, subject to adjustment under the circumstances described
in our special meeting proxy statement under the heading "The Asset
Purchase Agreement--Purchase Price."
5. Represents securities and insurance assets and insurance liabilities to
be transferred to Folksamerica based on December 31, 1999 financial
statement amounts.
At the closing of the asset sale, RCRe and Folksamerica Reinsurance
Company will enter into a transfer and assumption agreement, under
which Folksamerica Reinsurance Company will assume RCRe's rights and
obligations under the reinsurance agreements being transferred in the
asset sale. Following the closing of the asset sale, Folksamerica
Reinsurance Company will notify the reinsureds under those of such
agreements that are in-force that it has assumed RCRe's obligations and
that, unless the reinsureds object to such assumption, RCRe will be
released from its obligations to those reinsureds. The pro forma
accounting for this transaction assumes that none of RCRe's reinsureds
will object to such assumption and, accordingly, the gross liabilities
for its reinsurance business will be removed from the accounts of RCRe
for statutory accounting and GAAP accounting purposes.
RCRe will continue to record gross liabilities in its accounts for
reinsureds that object to the release of RCRe from its obligations to
such reinsureds. In such instances, an offsetting accounts receivable
amount from Folksamerica Reinsurance Company would be recorded as an
asset equal to such gross liabilities.
6. Elimination of deferred policy acquisition costs related to the
liability for unearned premiums transferred to Folksamerica.
7. Net reduction in deferred income tax asset as follows (in thousands):
Reduction in net deferred tax asset for elimination of temporary
differences between financial statements and income tax return amounts
resulting from the Folksamerica transaction $13,957
Less, estimated tax benefit resulting from the transaction 8,605
Net reduction in deferred tax asset $ 5,352
========
31
8. Represents cash payment received from Folksamerica at the closing of
the asset sale of $20.335 million less estimated related transaction
costs of $19 million, which include investment banking, legal and
accounting fees, severance costs, tax reimbursement to Folksamerica and
costs to purchase additional reinsurance protection for Folksamerica.
9. The book value gain resulting from the Folksamerica transaction is
calculated as follows (in thousands):
Consideration received, consisting of the following:
Total liabilities transferred $512,504
Cash premium received 20,335
--------
532,839
--------
Assets transferred 474,962
Amortization of deferred policy acquisition costs 23,585
Transaction costs 19,000
-------
517,547
-------
Pre-tax gain 15,292
Tax expense 5,352
------
Net transaction gain 9,940
Realized loss, net of tax for securities transferred at market value
(3,860)
------
Net income 6,080
Change in net unrealized appreciation of investments, net of tax 3,860
-----
Comprehensive income and net book gain $9,940
======
The pro forma accounting for this transaction assumes that none of
RCRe's reinsureds will object to the release of RCRe under the transfer
and assumption agreement and, accordingly, the gross liabilities for
such business are removed from the accounts of RCRe for statutory and
GAAP accounting purposes (see note 5 above). RCRe will continue to
record gross liabilities in its accounts for reinsureds that object to
the release of RCRe from its obligations to such reinsureds. This would
result in a portion of the pre-tax gain on the transaction being
deferred and amortized into income as the gross liabilities are
extinguished.
10. Includes $20 million of fixed income securities deposited in an escrow
account for a five year period primarily to reimburse Folksamerica for
claims and claim expenses exceeding reserves recorded by RCRe as of the
closing date resulting from business produced on behalf of RCRe by a
certain managing underwriting agency. At December 31, 1999, such
reserves approximated $38.3 million, which were recorded based on
RCRe's actuarially determined best estimate for such business. We could
record a loss to the extent that such reserves turn out to be
deficient, due to our reimbursement of Folksamerica for such deficiency
to the extent of the escrowed funds. Amounts in escrow may also be
released to Folksamerica to satisfy its indemnification claims against
us relating to undisclosed liabilities, RCRe's reinsurance agreements
and the managing underwriting agency referred to above. Under the asset
purchase agreement, we may be required to deposit an additional amount
of up to $5 million into a supplemental escrow account a short time
following the closing of the asset sale. The above unaudited pro forma
condensed consolidated balance sheet has been prepared assuming that
such supplemental escrow account will not be required.
32
Risk Capital Holdings, Inc. and Subsidiaries
Pro Forma Condensed Consolidated Statement of Income and Comprehensive Income
For the Year Ended December 31, 1999
(Dollars in thousands, except per share data)
Pro Forma Adjustments
---------------------
XL Folksamerica
Historical Transaction(1) Transaction(2) Pro Forma
---------- -------------- -------------- ---------
Revenues
Net premiums written $306,726 ($306,726) --
(Increase) decrease in unearned premiums 4,642 (4,642) --
------- --------- --------
Net premiums earned 311,368 (311,368) --
Net investment income 20,173 $145 (10,253) $10,065
Net realized investment gains and losses 17,227 1,350 1,192 19,769
Total revenues 348,768 1,495 (320,429) 29,834
------- ----- -------- ------
Operating Costs and Expenses
Claims and claims expenses 305,841 (305,841)
Commissions and brokerage 80,540 (80,540)
Other operating expenses 14,816 (10,666) 4,150
(198) 198
------- ------- ---
Total operating costs and expenses 400,999 -- (396,849) 4,150
Income (Loss)
Income before income taxes, equity in net
income of investees and cumulative effect of
accounting change (52,231) 1,495 76,420 25,684
Federal income taxes expense (benefit) (19,557) 571 27,171 8,185
------- ----- ------ -----
Income before equity in net income of
investees and cumulative effect of accounting
change (32,674) 924 49,249 17,499
Equity in net income of investees 621 114 735
------ --- ----- ------
Income (loss) before cumulative effect of
accounting change (32,053) 1,038 9,249 18,234
------- ----- ----- ------
Cumulative effect of accounting change (383) 99 (284)
------- ----- ----- ------
Net income (loss) (32,436) 1,137 49,249 17,950
Other Comprehensive Income (Loss), Net of Tax
Change in net unrealized appreciation of
investments, net of tax (19,850) (1,914) 4,553 (17,211)
Comprehensive Income (Loss) ($52,286) ($777) $53,802 $739
======== ===== ======= ====
Average shares outstanding
Basic 17,086,732 (4,755,000) -- 12,331,732
Diluted 17,086,808 (4,755,000) -- 12,331,808
Per Share Data
Net Income (Loss) - Basic $1.46
($1.90
- Diluted $1.46
($1.90)
Comprehensive Income (Loss) - Basic $0.06
($3.06)
- - - Diluted $0.06
($3.06)
33
Notes to Pro Forma Statement of Income and Comprehensive Income
1. Represents all revenue and expense and other comprehensive income items
recorded during 1999 for LARC Holdings, Ltd. and Annuity and Life Re
(Holdings), Ltd., which were disposed of in the XL Capital stock
repurchase.
2. Represents all revenue and expense and other comprehensive income items
recorded during 1999 related to the sale of our reinsurance business to
Folksamerica Reinsurance Company. Net investment income, net realized
investment gains (losses) and unrealized appreciation (depreciation) of
investments have been allocated based on the proportion of the average
amount of fixed maturities and short term investments related to the
business that will be transferred to the average total fixed maturities and
short term investments in 1999.
All other revenue and expense items were allocated based on specific
identification.
342001.
50
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
General
The CompanyOPERATIONS
GENERAL
We are the holdinga Bermuda public limited liability company for RCRe, our wholly owned subsidiary which is
domiciledwith $1.0 billion in
Nebraska. We were incorporated in March 1995equity capital and, commencedthrough operations in September 1995 upon completion of our initial public offering. We
received aggregate net proceeds fromBermuda and the offering of approximately $335 million,
of which $328 million was contributed to the capital of RCRe. On November 6,
1995, RCRe was licensed under the insurance laws of the State of Nebraska and is
currently licensed or accredited as a reinsurer in 44 states. As of December 31,
1999, the statutory surplus of RCRe was approximately $290 million. In July
1998, RCRe capitalized its wholly owned subsidiary, Cross River, with $20
million. Cross River received its Nebraska insurance license in October 1998,
and is currently authorizedUnited States, are
positioned to write insurance and reinsurance on a worldwide basis. While we are
positioned to provide a full range of property and casualty insurance and
reinsurance lines, we are focusing on writing specialty lines of insurance and
reinsurance profitably and earning a superior return on equity as we establish
an enduring underwriting franchise.
Recent events have provided a significant market opportunity for well
capitalized insurance companies that are not burdened by the uncertainties
resulting from prior years' underwriting losses and material reinsurance
recoverable balances. As a result, we recently launched an underwriting
initiative that included the recruitment of new insurance and reinsurance
management teams and an equity capital infusion of $763.2 million. It is our
belief that our existing Bermuda and U.S.-based underwriting platform, our
strong management team and our $1.0 billion in capital that is unencumbered by
significant exposure to pre-2002 risks have enabled us both to establish an
immediate presence in an increasingly attractive insurance marketplace and to
actively participate in the January 1, 2002 reinsurance renewal season. Since
January 1, 2002, we have entered into approximately 800 reinsurance treaties and
other reinsurance arrangements which are expected to provide approximately
$500 million of gross written reinsurance premiums during 2002.
NEW UNDERWRITING INITIATIVE AND NOVEMBER 20, 2001 CAPITAL INFUSION
On October 24, 2001, we announced the launch of a new underwriting
initiative to meet current and future demand in the global insurance and
reinsurance markets. Simultaneously with the launch of this new underwriting
initiative, we entered into agreements with the Warburg Pincus funds and the
Hellman & Friedman funds and certain members of management to purchase from us
in a private placement, for $763.2 million in cash, 35,687,735 series A
convertible preference shares and 3,776,025 class A warrants. This capital
infusion was consummated on November 20, 2001. The proceeds of the capital
infusion were primarily contributed to our Bermuda and U.S. subsidiaries to
support the new underwriting initiative.
EVENTS PRIOR TO THE NEW UNDERWRITING INITIATIVE
2001 ACQUISITIONS. On February 28, 2001, we acquired one of our investee
companies, American Independent Insurance Company ("American Independent").
American Independent underwrites private passenger automobile liability and
physical damage insurance primarily in the Commonwealth of Pennsylvania. During
2001, 70% of American Independent's written premiums were ceded to third-party
reinsurers. During 2002, we expect that approximately 20% of American
Independent's written premiums will be ceded to third-party reinsurers.
On June 22, 2001, we acquired all of the remaining ownership interests in
Arch Risk Transfer Services Ltd. ("ART Services"), which provides insurance and
alternative risk transfer services through rent-a-captive and other facilities.
First American Insurance Company, a subsidiary of ART Services, is an admitted
insurer in 49 states with an A.M. Best rating of "A-" (Excellent). During 2001,
approximately 71% of ART Services' written premiums were ceded to third-party
reinsurers. During 2002, we expect that less than half of ART Services' written
premiums will be ceded to third-party reinsurers.
The results of operations of American Independent and ART Services are
included in our financial statements from the respective dates of acquisition.
Prior to the date of acquisition of ART Services, we accounted for our 27%
initial ownership interest in ART Services under the equity method.
51
We entered into a definitive agreement on September 24, 2001 to acquire Rock
River Insurance Company, an approved excess and surplus lines basisinsurer in 22 additional states.
Folksamerica Transaction
As45
states and the District of January 10, 2000, we entered intoColumbia and an agreement with Folksamerica
Reinsurance Company and Folksamerica Holding Company (collectively,
"Folksamerica") pursuant to which Folksamerica Reinsurance Company will assume
RCRe's liabilities under the reinsurance agreements transferredadmitted insurer in the asset
sale and RCRe will transfer to Folksamerica Reinsurance Company assets in an
aggregate amount that is, in book value, equal to the book value of the
liabilities assumed. In considerationtwo other states,
for the transfer of RCRe's book of
business, Folksamerica will pay $20.335 million in cash at the closing, subject
to adjustment under the circumstances set forth in the asset purchase agreement.$19.3 million. We consummated this acquisition on February 1, 2002. Under
the terms of the acquisition agreement, the existing policies and other
liabilities of Rock River reinsured or otherwise assumed by the seller, Sentry
Insurance, a mutual company, which has an A.M. Best rating of "A+" (Superior).
At February 1, 2002, Rock River had net assets of approximately $17.0 million.
FORMATION OF BERMUDA-BASED REINSURANCE SUBSIDIARY
On May 21, 2001, we will place $20formed our wholly owned Bermuda-based reinsurance
subsidiary, Arch Re (Bermuda). Under the Insurance Act of 1978, Arch Re
(Bermuda) is registered as a Class 4 and long-term insurer and reinsurer and, in
December 2001, Arch Re (Bermuda) and Arch Re (US), our wholly owned U.S.-based
reinsurance subsidiary, were assigned ratings of "A-" (Excellent) by A.M. Best.
CHANGE OF LEGAL DOMICILE TO BERMUDA
On November 8, 2000, we completed an internal reorganization that resulted
in our changing our legal domicile to Bermuda. In that transaction, the
shareholders of Arch Capital (US) (formerly Risk Capital Holdings Inc.) became
the shareholders of ACGL. Prior to the reorganization, ACGL had no significant
assets or capitalization and had not engaged in any business or prior activities
other than in connection with the reorganization.
MAY 2000 SALE OF OUR PRIOR REINSURANCE OPERATIONS
On May 5, 2000, we sold our prior reinsurance operations to Folksamerica
Reinsurance Company. The Folksamerica transaction was structured as a transfer
and assumption agreement (and not reinsurance), and, accordingly, the loss
reserves (and any related reinsurance recoverables) relating to the transferred
business are not included as assets or liabilities on our balance sheet.
However, in the event that Folksamerica is unable to make payment of claims on
the reinsurance business assumed by it in the May 2000 sale, we would be liable
for such claims. Folksamerica has an A.M. Best rating of "A-" (Excellent). See
Note 3, "Acquisition of Subsidiaries and Disposition of Prior Reinsurance
Operations," of the notes accompanying our financial statements. See "Risk
Factors--Risks Relating to Our Company--We sold our prior reinsurance operations
in May 2000 and may have liability to the purchaser and continuing liability
from those reinsurance operations if the purchaser should fail to make payments
on the reinsurance liabilities it assumed."
In connection with that sale we placed $20.0 million of the purchase price
in escrowescrow. The agreement required that these funds would be held for a period of
five years. These funds will be primarily usedyears to reimburse Folksamerica to the extent that theif certain loss reserves (which were $38.7 million at
December 31, 1999) relatingtransferred to business produced on behalf of RCRe by a certain
managing underwriting agency areit
in the asset sale became deficient as measured at the end of such five
yearfive-year
period or to satisfy certain indemnity claims Folksamerica may have had during
such period. To the extent that such loss reserves are redundant,In February 2002, we reached a definitive settlement agreement with
Folksamerica pursuant to which we will satisfy all of our obligations under the
escrowed funds will be returned to us and Folksamerica will pay usescrow agreement for an amount equal to approximately $17.0 million, plus
accrued interest income of $1.8 million, in cash.
LIQUIDITY AND CAPITAL RESOURCES
ACGL is a holding company whose assets primarily consist of the shares in
its subsidiaries. Generally, we depend on our available cash resources, liquid
investments and dividends or other distributions from our subsidiaries to make
payments, including the payment of operating expenses we may incur and for any
dividends our board of directors may determine, and we may need to utilize
52
funds from such redundancy. We willsources in connection with acquisitions. ACGL does not currently
intend to declare any dividends or make any other distributions.
The ability of our regulated insurance subsidiaries to pay dividends or make
distributions is dependent on their ability to meet applicable regulatory
standards. Prior approval of the Bermuda Supervisor of Insurance is required if
any dividend payments or other distributions of Arch Re (Bermuda) would reduce
its total statutory capital by 15% or more. At December 31, 2001, Arch Re
(Bermuda) had statutory capital of $508 million. As of December 31, 2001 our
U.S. insurance and reinsurance subsidiaries may not pay any significant
dividends or distributions during 2002 without prior regulatory approval. In
addition, the ability of our insurance subsidiaries to pay dividends could be
responsibleconstrained by our dependence on financial strength ratings from independent
rating agencies. Our ratings from these rating agencies depend to a large extent
on the capitalization levels of our insurance subsidiaries.
Pursuant to a shareholders agreement that we entered into in connection with
the capital infusion, we have agreed not to declare any dividend or make any
other distribution on our common shares, and not to repurchase any common
shares, until we have repurchased from the Warburg Pincus funds, the Hellman &
Friedman funds and the other holders of our preference shares, pro rata, on the
basis of the amount of each of these shareholders' investment in us at the time
of such repurchase, preference shares having an aggregate value of
$250.0 million, at a per share price acceptable to these shareholders.
Our new underwriting initiative and related capital infusion are designed to
position us to address current and anticipated future needs for certain tax costs incurred
by Folksamericacapacity in the
transaction, as well asglobal insurance marketplace. During the fourth quarter of 2001, we expanded our
own transactionunderwriting activities, initially with a primary focus on reinsurance, and severance
costs,we
intend to continue to expand significantly our insurance and certain reinsurance
costs incurred for the benefit of Folksamerica.
An additional amount of up to $5 million may be placed in escrow for a period of
five years to the extent that RCRe's reserves at closing are less by at least a
specified amount than those estimated by its independent actuaries. In
connection with either escrow arrangement, we will record a loss in an amount
equal to any probable deficiencyunderwriting activities in the related reserve that may become known
during or at the end of the five year period.
The sale of our reinsurance business to Folksamerica is contingent on
approval by our stockholders, obtaining applicable regulatory approvals, the
retention of a key employee, obtaining certain third party consents, the absence
of a material adverse change in RCRe's business,future.
Our aggregate invested assets, including cash and other customary closing
conditions. Marsh & McLennan Risk Capital Holdings, Ltd. and The Trident
Partnership, L.P., which collectively represent approximately 13.3% of the total
voting power of our outstanding common stock (after giving effect to the
repurchase of 4,755,000 shares on March 2, 2000 from XL Capital, which is
discussed below), have agreed to vote in favor of the asset sale.
Please see the sections of our special meeting proxy statement entitled
"Questions and Answers About the Asset Sale," "Risk Factors," "The Asset Sale,"
"The Asset Purchase Agreement" and "Other Transaction Agreements," which are
incorporated by reference. In addition, we have filed the asset sale agreement,
the voting agreements and other related agreements as exhibits to this annual
report. The above summary of the proposed transaction is qualified by these
agreements, which are incorporated by reference. Please also refer to "Unaudited
Pro Forma Condensed Consolidated Financial Data."
35
The GAAP book value of the assets and liabilities to be transferred to
Folksamerica recorded in the accompanying financial statementsshort-term investments,
totaled $1.0 billion at December 31, 1999 are as follows:
(In Millions)
Fixed maturities and short-term investments $245.6
Premiums receivable 119.3
Reinsurance recoverable 73.1
Deferred policy acquisition costs 23.6
Deferred income tax asset 13.9
Other insurance assets 37.0
------
Total Assets $512.5
------
Reserve for claims and claims expenses $364.6
Net unearned premium reserve 108.7
Reinsurance premiums payable 14.7
Other insurance liabilities 24.5
------
Total Liabilities $512.5
------
Net book value of assets and liabilities2001, compared to be transferred --
=======
The actual GAAP book value of the assets and liabilities transferred to
Folksamerica will be determined as of the closing date of the asset sale, and
will differ from that set forth above.
At the closing of the asset sale, RCRe and Folksamerica will enter into a
transfer and assumption agreement, under which Folksamerica will assume RCRe's
rights and obligations under the reinsurance agreements being transferred in the
asset sale. Following regulatory approval of these agreements, the reinsureds
under such agreements that are in-force will be notified that Folksamerica has
assumed RCRe's obligations and that, unless the reinsureds object to the
assumption, RCRe will be released from its obligations to those reinsureds.
Assuming that none of the reinsureds object to the assumption, the gross
liabilities for such business will be removed from the accounts of RCRe for
statutory accounting and GAAP accounting purposes.
RCRe will continue to record gross liabilities in its accounts for
reinsureds that object to the release of RCRe from its obligations to such
reinsureds. In such instances, an offsetting accounts receivable amount from
Folksamerica would be recorded as an asset equal to such gross liabilities. This
would also result in a portion of any pre-tax gain on the asset sale being
deferred and amortized into income as gross liabilities are extinguished.
XL Transaction
On March 2, 2000, we repurchased from XL Capital, then our single largest
stockholder, all of the 4,755,000 shares of our common stock held by it. Under
the terms of a stock repurchase agreement with XL Capital, we paid $12.45 per
share of our common stock, or a total of $59.2 million. The per share repurchase
price was determined as the lesser of (1) 85% of the average closing market
price of our common stock during the 20 trading days beginning on the third
business day following public announcement of the stock repurchase and asset
sale (January 21, 2000), which was $14.65, and (2) $15. We paid XL Capital the
consideration for the repurchase with: our interest in privately held LARC
Holdings, Ltd. (parent of Latin American Reinsurance Company Ltd.), valued at
$25 million (which was carried by us at $24$276.1 million at
December 31, 1999);2000. The increase in cash and allinvested assets from 2000 to 2001
resulted primarily from the receipt of our interestthe proceeds from the capital infusion in
Annuity and Life Re (Holdings), Ltd., valued at $25.38
per share and $18.50 per warrant, or $37.8 million in the aggregate (which was
carried by us at $38.2 million atNovember 2001.
As of December 31, 1999). XL Capital paid us in2001, our readily available cash, the difference (equal to $3.6 million) betweenshort-term investments
and marketable securities, excluding amounts held by our repurchase priceregulated insurance
subsidiaries, totaled $108.5 million. Such amount consisted of $26.4 million of
cash and the
value of our interests in LARC Holdingsshort-term investments and Annuity and Life Re. The value per
share of Annuity and Life Re was determined by taking the average of the closing
price of Annuity and Life Re shares for the same period used in determining the
repurchase price of our shares. The value of the warrants was determined using a
Black Scholes
methodology. We have filed the stock repurchase agreement and related voting and
disposition agreement as exhibits to this annual report. The above summary of
the transaction is qualified by these agreements, which are incorporated by
reference.
As a result of this transaction, stockholders' equity, which was $346.5$82.1 million at December 31, 1999, has been reduced by $59.4 million and the number
of outstanding voting shares, which was 17,087,970 at December 31, 1999, was
12,332,970 at March 2, 2000.
RCRe's statutory surplus, which was $290 million at December 31, 1999, was
also reduced by $60 million for the distribution of the stock and warrants in
both LARC Holdings, Ltd. and Annuity and Life Re Holdings, Ltd., to us, based on
their statutory carrying values at December 31, 1999.
RCRe Distribution
Upon payment of a contemplated distribution from RCRe to us that would
occur after the completion of the asset sale, our assets would consist of fixed maturity investments.
As of that date, investments that are restricted or generally unavailable for
liquidity purposes (other than our ownership interests in our subsidiaries and
short term investments, publicly traded equity securities andthe invested assets of our regulated insurance subsidiaries) included
$35.4 million of privately held securities and our remaining $19 million investment commitment
to Trident II, L.P. would remain in place. We would also continue to own all of
the outstanding capital stock of RCRe and Cross River, each with statutory
surplus of approximately $20 million (or any greater amount the Nebraska
Insurance Department requires RCRe to retain in the event there are any
objections from reinsureds to the release of RCRe from further liability
pursuant to the transfer and assumption agreement). See "--Liquidity and Capital
Resources" below for a discussion of the regulatory issues relating to
distributions by RCRe.
Future Operations
Following the sale of our reinsurance business to Folksamerica, our
intended strategy is to pursue business combinations and ventures with operating
businesses. Our success will depend almost entirely on the operations, financial
condition and management of the companies with which we may merge or which we
may acquire in whole or in part. We have not yet identified specific business
opportunities. Accordingly, the financial and operational risks that we may
encounter in the future cannot be specified. See the section of our special
meeting proxy statement entitled "Risk Factors--Risks Relating to Our Business
After the Asset Sale," which is incorporated by reference.
Recent Industry Performance
Demand for reinsurance is influenced significantly by underwriting results
of primary property and casualty insurers and prevailing general economic and
market conditions, all of which affect liability retention decisions of primary
insurers and reinsurance premium rates. The supply of reinsurance is directly
related to prevailing prices and levels of surplus capacity, which, in turn, may
fluctuate in response to changes in rates of return on investments being
realized in the reinsurance industry. The last three years have been difficult
periods from both a market and earnings perspective for most insurance markets.
The property and casualty insurance and reinsurance segments have experienced an
increasingly more difficult and highly competitive operating environment
characterized by a soft rate structure and overcapitalization. Other factors
that have contributed to the prevailing competitive conditions in the
reinsurance industry in recent years include new entrants to the reinsurance
market (including certain specialized reinsurance operations) and the presence
of certain reinsurance companies which operate within tax-advantaged
jurisdictions (e.g., Bermuda, Cayman Islands) that benefit from higher after-tax
investment returns. In addition, concerns with respect to the financial security
of Lloyd's that had adversely impacted the competitive position of that
marketplace have apparently been overcome by actions taken at Lloyd's over the
last few years, thereby enhancing its competitive position.
The industry's profitability can also be affected significantly by volatile
and unpredictable developments, including changes in the propensity of courts to
grant larger awards, natural disasters (such as catastrophic hurricanes,
windstorms, earthquakes, floods and fires), fluctuations in interest rates and
other changes in the investment environment that affect market prices of
investments and the income and returns on investments, and inflationary
pressures that may tend to affect the size of losses experienced by ceding
primary insurers. The reinsurance industry is highly competitive and dynamic,
and market changes may affect, among other things, demand for our products,
changes in investment opportunities (and the performance thereof), changes in
the products offered by us or changes in our business strategy.
Reinsurance treaties that are placed by intermediaries are typically for
one year terms with a substantial number that are written or renewed on January
1 each year. Other significant renewal dates include April 1, July 1 and October
1. The January 1, 2000 renewal period was marked by continuing intensified
competitive conditions in terms of premium rates and treaty terms and conditions
in both the property and casualty segments of the marketplace. These conditions
have been worsened due to large domestic primary companies retaining more of
their business and ceding less premiums to reinsurers. Commencing in late 1997,
in addition to our core business, we expanded into specialty classes of
reinsurance business, including marine and aviation and space in 1997, surety
and fidelity in 1998, and accident and health in 1999. In 1999, we discontinued
our aviation and space lines of business.
In-Force Business
At January 1, 2000, RCRe had approximately 330 renewable in-force
reinsurance treaties (such renewal is subject to negotiation and evaluation
during the renewal period), with approximately $249.1$22.2 million of estimated
annualized net premiums written, compared to $287.5 million at January 1, 1999
and $172.5 million at January 1, 1998, representing a decline of 13% and an
increase of 67% over the prior year, respectively. Such in-force premiums at
January 1, 2000 represent estimated annualized premiums from treaties entered
into during 1999 and the January 1, 2000 renewal period that are expected to
generate net premiums written during 2000. Such treaties at January 1, 2000 are
estimated to generate approximately $210.6 million of net premiums written over
the 12-month period ending December 31, 2000 without taking into account certain
factors, including the possibilities that (i) several treaties entered intofixed maturity
investments held in 1999 that are scheduled to expire during the remainder of 2000 may be renewed
and (ii) additional treaties may be bound during 2000.
The decline in in-force business of 13% in 1999 compared to 1998 is due to
several factors which include (i) discontinuing aviation and space business in
1999; (ii) non-renewals in other classes of business, due to (a) our adherence
to underwriting standards in competitive market conditions and (b) the effect on
cedents of our poor underwriting performance, coupled with a decline in RCRe's
A.M. Best rating from A to A-. Such decline was partially offset by increased
in-force premiums in Accident & Health business where significant underwriting
capacity has exited the market since 1998, and we believe reinsurance pricing
improvements have occurred in 1999 and 2000.
Results of Operations
We had consolidated comprehensive losses of $52.3 million and $4.4 million
for the years ended December 31, 1999 and 1998, respectively, and consolidated
comprehensive income of $47.1 million for the year ended December 31, 1997. Our
comprehensive income or loss is composed of net income and the change in
unrealized appreciation of investments. Net loss for the year ended December 31,
1999 was $32.4 million and net income for the years ended December 31, 1998 and
1997 was $3.1 million and $2.0 million, respectively. After-tax realized
investment gains (losses) of $11.2 million, $16.4 million and ($0.5 million)
were also included in net income for 1999, 1998 and 1997, respectively. Net
income for the years ended December 31, 1999, 1998 and 1997 included income
(losses) of $0.7 million, ($1.1 million), and ($0.2 million), respectively,
representing our equity in the net income (loss) of investee companies accounted
for under the equity method of accounting. Net loss for the year ended December
31, 1999 also included a loss of $383,000 from a cumulative effect of an
accounting change for start-up costs.
38
Following is a table of per share data for the years ended December 31, 1999,
1998 and 1997 on an after-tax basis:
Years Ended December 31,
----------------------------------------------------
1999 1998 1997
---- ---- ----
Basic earnings per share:
Underwriting loss ($3.42) ($1.39) ($0.45)
Net investment income 0.85 0.68 0.61
Net realized investment gains (losses) 0.66 0.96 (0.03)
Equity in net income (loss) of investees 0.03 (0.07) (0.01)
Cumulative effect of accounting change (0.02)
------- ------- -------
Net income (1.90) 0.18 0.12
Change in net unrealized appreciation of investments (1.16) (0.44) 2.65
Comprehensive income (loss) ($3.06) ($0.26) $2.77
====== ====== =====
Average Shares Outstanding (000's) 17,087 17,065 17,033
====== ====== ======
Diluted earnings per share:
Underwriting loss ($3.42) ($1.35) ($0.45)
Net investment income 0.85 0.65 0.61
Net realized investment gains (losses) 0.66 0.93 (0.03)
Equity in net income (loss) of investees 0.03 (0.06) (0.01)
Cumulative effect of accounting change
(0.02)
------- ------ -------
Net income ($1.90) $0.17 $0.12
====== ===== =====
Comprehensive income (loss) ($3.06) ($0.26) $2.76
====== ====== =====
Average shares outstanding (000's) 17,087 17,718 17,086
==== ====== ====== ======
Book Value Per Share, December 31:
Basic $20.28 $23.29 $23.51
Diluted $20.28 $22.75 $22.79
Shares outstanding (000's)
Basic 17,088 17,087 17,058
Diluted 17,088 17,498 17,602
39
Net Premiums Written
Net premiums written for the years ended December 31, 1999, 1998 and 1997
were as follows:
(In millions) Percent
Years Ended December 31, Change
------------------------ ------
1999 1998 1997 1998/1999
---- ---- ---- ---------
Property $78.9 $33.7 $17.8 134%
Casualty 64.1 80.3 69.7 (20%)
Multi-line 67.7 62.8 45.9 8%
Other 7.6 16.5 10.0 (54%)
Accident & Health 50.3
Aviation & Space 18.4 26.0 (29%)
Marine 14.0 14.4 1.4 (3%)
Surety & Fidelity 5.7 1.0 470%
----- ----- ------ -----
Total $306.7 $234.7 $144.8 31%
====== ====== ====== ==
Set forth below are RCRe's assumed and ceded premiums written for the years
ended December 31, 1999, 1998 and 1997:
(In millions)
Years Ended December 31,
------------------------
1999 1998 1997
---- ---- ----
Assumed premiums written $386.8 $260.5 $147.8
Ceded premiums written 80.1 25.8 3.0
Net premiums written $306.7 $234.7 $144.8
RCRe's net premiums written increased 31% to $306.7 million in 1999 from
$234.7 million in 1998 and 62% to $234.7 million in 1998 from $144.8 million in
1997. Premium growth resulted from two key strategies, the integration of
investment with reinsurance and the diversification into "specialty" classes of
business, which for purposes of this discussion consist of Accident & Health,
Aviation and Space, Marine and Surety & Fidelity.
Approximately 30%, 32% and 29% of net premiums written in 1999, 1998 and
1997, respectively, were generated from companies in which we have invested or
committed to invest funds ("integrated transactions").
Approximately 29%, 18% and 1% of net premiums written in 1999, 1998 and
1997, respectively, was produced from specialty classes of business. Specialty
classes of business accounted for 65% and 44% of the increase in net premiums
written for 1999 and 1998, respectively.
Approximately 15%, 32% and 28% of net premiums written in 1999, 1998 and
1997, respectively, were from non-United States clients, which are Lloyd's
syndicates or are located in the United Kingdom, Bermuda and Continental Europe.
Net premiums written in 1999 includes approximately $26 million related to
a group of property reinsurance treaties that expired in 1999 covering crop hail
business underwritten on behalf of a start-up entity formed by Trident II, L.P.
This business was protected by extensive aggregate excess of loss retrocession
and generated a profit based upon underwriting results. We do not expect to
renew these treaties in 2000.
Net premiums written in 1999 for other business was reduced by $10.6
million for the retrocession of a treaty which covers future multiple rocket
launches that was recorded in 1996. The reduction of net premiums written
resulting from this retrocession increased the commission and operating expense
ratio components of the statutory composite ratio by 1.1 percentage points, but
had no impact on operating results.
Consistent with our strategy of writing a small number of large treaties
for our core business, two clients contributed approximately $81.3 million or
26.5% of 1999 total net premiums written, with the largest client contributing
approximately 13.7% and the second contributing 12.8%. Approximately 70% of the
business
40
written from the client that contributed 13.7% and all of the business written
from the client that contributed 12.8% are part of an integrated transaction,
and such business is subject to renewal at our option for two and four remaining
years, respectively.
In 1998, three clients contributed approximately $74 million, or 32%, of
1998 total net premiums written, with the largest client contributing
approximately 18% and the remaining two contributing 8% and 6%, respectively. In
1997, five clients contributed approximately $68 million, or 45%, of total net
premiums written, with the largest client contributing approximately 18% and the
remaining four contributing from 5% to 8%.
RCRe's ceded premiums increased to $80.1 million in 1999, compared to $25.8
million in 1998 and $3.0 million in 1997. Such ceded premiums primarily relate
to RCRe's property, multi-line, marine, aviation and space reinsurance business,
for which we seek to reduce RCRe's exposure to large and catastrophic losses.
Since the fourth quarter of 1998, we have purchased additional retrocessional
protection to reduce RCRe's exposures to both space and aviation risks.
Effective July 1, 1999, RCRe also purchased a retrocessional treaty for a one
year period covering earthquake, wind and other property catastrophe perils for
$10 million in excess of a $15 million retention per occurrence. See "(Results
of Operations(Aviation Business" and "(Risk Retention," "Business(Retrocessional
Arrangements" and Note 7 of the accompanying notes to our consolidated financial
statements.
While not anticipated, prior to the asset sale, the reduction or loss of
business assumed from one or more large clients could have a material adverse
effect on our results of operations to the extent not offset by new business.
Operating Costs and Expenses
One traditional method of measuring the underwriting performance of a
property/casualty insurer, such as RCRe, is the statutory combined ratio. This
ratio, which is based upon statutory accounting principles (which differ from
generally accepted accounting principles in several respects), reflects
underwriting experience, but does not reflect income from investments. A
statutory combined ratio under 100% indicates underwriting profitability, while
a combined ratio exceeding 100% indicates an underwriting loss.
Set forth below are RCRe's statutory combined ratios for the years ended
December 31, 1999, 1998 and 1997 and the estimated aggregate statutory combined
ratios for domestic reinsurers and domestic broker market reinsurers based on
data reported by the Reinsurance Association of America ("RAA") as of such
dates:
Years Ended December 31,
-----------------------------------
1999 1998 1997
---- ---- ----
Claims and claims expenses 98.2% 85.4% 68.4%
Commissions and brokerage 26.3% 24.2% 28.8%
---- ---- ----
124.5% 109.6% 97.2%
Other operating expenses 4.7% 6.8% 9.1%
----- ------ -----
Statutory combined ratio 129.2% 116.4% 106.3%
===== ===== =====
Domestic reinsurer aggregate
Statutory combined ratios 113.8% 104.4% 102.3%
===== ===== =====
After-tax underwriting losses for the years indicated were as follows
(dollars in millions):
Years Ended December 31,
-----------------------------------
1999 1998 1997
---- ---- ----
After-tax underwriting loss
Amount $ 58.4 $ 23.0 $ 7.7
Per Share (Basic) $ 3.42 $ 1.39 $ 0.45
Statutory combined ratio after-tax underwriting results for 1999 and 1998
reflect very poor underwriting performance in competitive market conditions.
41
RCRe's 1999 and 1998 statutory combined ratios were adversely affected by
underwriting results from the sources identified below, which added 16 points
and 9 points to the combined ratios (excluding operating expenses), respectively
(dollars in millions):
1999 Year Underwriting Impact
-----------------------------
Managing
Underwriting Space &
Agency Aviation Total
------ -------- -----
Net premiums written $ 2.1 $ 18.4 $ 20.5
Earned premiums $ 6.4 $ 13.8 $ 20.2
After-tax underwriting loss
Amount $ 16.5 $ 19.7 $ 36.2
Per Share (Basic) $ 0.96 $ 1.15 $ 2.11
Combined Ratio Effect (in
percentage points) 7.7 8.3 16.0
1998 Year Underwriting Impact
--------------------------------------
Managing
Underwriting Space &
Agency Aviation Total
------ -------- -----
Net premiums written $ 16.3 $ 26.0 $ 42.3
Earned premiums $ 12.5 $ 21.3 $ 33.8
After-tax underwriting loss
Amount $ 6.5 $ 7.8 $ 14.3
Per Share (Basic) $ 0.38 $ 0.46 $ 0.84
Combined Ratio Effect (in
4.1 4.9 9.0
percentage points)
Managing Underwriting Agency
As identified above, during 1999 and 1998, we recorded after-tax
underwriting losses of $16.5 million, or $0.96 per share, and $6.5 million, or
$0.38 cents per share, respectively, from reinsurance on casualty and multi-line
business produced by the managing underwriting agency. We also recorded related
after-tax investment losses of $1.3 million, or $0.07 per share, and $862,000,
or $0.03 per share, in net realized investment losses in 1999 and 1998,
respectively. We have discontinued our underwriting relationship with the
managing underwriting agency. The business and operations of the managing
underwriting agency are in run-off.
The total estimated ultimate net premiums written and earned by RCRe on all
business produced by the managing underwriting agency recorded from inception in
late 1997 through December 31, 1999 are approximately $19.3 million and $19.1
million, respectively, resulting in an inception to date after-tax underwriting
loss of $22.4 million. Net reserves for claims and claims expenses for this
business approximated $38.7 million at December 31, 1999. See "--Folksamerica
Transaction" for a discussion of a $20 million escrow fund relating to such
reserves in connection with the sale of our prior reinsurance
businessoperations to Folksamerica.
Space & Aviation Business
As identified above, during 1999 and 1998, RCRe recorded after-tax
underwriting losses of $19.7 million, or $1.15 per share, and $7.8 million, or
$0.46 per share, respectively, for its space and aviation lines of business.
During 1999, RCRe discontinued both lines of business.
42
Space Business
The total estimated ultimate net premiums written and earned by RCRe for
space business from inceptionFolksamerica in 1998 through December 31, 1999 are $17.6
million each, resulting in an inception to date after-tax underwriting loss of
$13.1 million. Net reserves for claims and claims expenses for space business
approximated $2.4 millionMay 2000. In addition, at December 31, 1999.
At December 31, 1999, all satellite treaties have expired except for one
treaty covering future multiple rocket launches which was 100% retroceded in
1999.
Aviation Business
The total estimated ultimate net premiums written and earned by RCRe for
aviation business from inception in 1998 through December 31, 1999 are $26.8
million and $17.5 million, respectively, resulting in an inception2001, we
had investment commitments relating to date
after-tax underwriting loss of $14.3 million. Net reserves for aviation business
approximated $26 million at December 31, 1999.
Included in the 1999 after-tax underwriting loss for aviation business are
incurred losses for the 1998 Swiss Air and Korean Air crashes and certain 1999
crashes, including the Egypt Air, American Airlines, Korean Air and China Air
crashes. The additional loss recorded in 1999 for the Swiss Air crash was based
on a reallocation of the $642 million expected industry loss between the plane
manufacturer and Swiss Air. This reallocation adversely affected RCRe's gross
loss. The gross loss associated with the Swiss Air crash reported as of December
31, 1998 had exhausted RCRe's retrocessional protections applicable to this
occurrence. Therefore, none of such additional loss reported was ceded to
retrocessionaires. To the extent that either the expected industry loss
increases or additional loss is allocated to the plane manufacturer, RCRe could
record additional losses. For example, if the expected industry loss increases
by approximately $100 million, and assuming additional loss reallocations such
that one-third of the industry loss is allocated to the plane manufacturer, RCRe
would record additional aggregate loss (net of additional reinstatement
premiums)our privately held investment,
Distribution Investors, LLC, of approximately $2.7 million after-tax. However, we cannot be certain
of the ultimate industry loss or the final allocation of liability between the
plane manufacturer and Swiss Air, and there can be no assurances that the
ultimate industry loss will not be larger or that the plane manufacturer will
not be allocated a greater proportion of the industry loss. With respect to all
other reinsured crashes which occurred through December 31, 1999, we currently
believe that RCRe's gross loss will not exhaust RCRe's reinsurance protections
(although RCRe's net loss could increase within these protections based on the
ultimate industry loss, the ultimate allocation of losses between the plane
manufacturers and the airlines and other factors).
For the year ended December 31, 1999, aviation assumed gross premiums
earned, retroceded premiums earned, and net earned premiums were $43.7 million,
$32.5 million and $11.2 million, respectively. While RCRe discontinued writing
aviation business in 1999, RCRe currently has a number of assumed treaties that
will continue to expose it to significant risk of aviation losses through 2001.
Current estimates for gross aviation premiums that will be earned beyond 1999
aggregate approximately $20.5$0.6 million. Retrocessional premium charges to be
recorded for retrocessional treaties presently in-force that expire during 2000
total approximately $15.4 million. Such retrocessional premium costs do not
include additional retrocessional premium amounts that will be purchased to
provide Folksamerica with additional retrocessional protection inIn connection with
the salecapital infusion on November 20, 2001, we were released from our obligations
to make any further capital contributions to Trident II, other than with respect
to outstanding capital calls of ourapproximately $6.5 million, which we funded in
November 2001.
Cash flows are provided by premiums collected, fee income, investment income
(excluding net realized investment gains) and collected reinsurance business to Folksamerica.
Following the Egypt Air crash in October 1999, RCRe exhausted its initial
layer of retrocessional protection for 1999 aviation exposures. Since October
1999, RCRe's initial retention as well as its total retention for aviation
exposures are contingent on the size of insured industry losses, which could
materially impact the recoveries under such retrocessions and therefore the net
loss to us. Based on information currently available to us, we believe that
RCRe's maximum exposures (net of retrocessional recoveries and reinstatement
premiums) for future commercial airline losses vary depending on (i) the size of
insured industry losses, (ii) the declining gross loss exposures as current
in-force business expires, and (iii) the application of retrocessional
protections which expire throughout 2000. Based on such current information, set
forth below is our estimate of after-tax losses for RCRe's maximum exposures for
the size industryreceivable
balances, offset by reinsurance premiums payable, loss and the time period presented (in millions):
$700
to
Industry Loss: $50 $100 $200 $300 $500 $1,500
--- ---- ---- ---- ---- ------
Year 2000
From/To:
January 1
March 31 $1.5 $4.1 $3.4 $1.2 N/A $1.0
April 1
June 30 $1.5 $4.1 $6.5 $4.3 $2.4 $8.3
July 1
September 30 $1.3 $3.1 $6.5 $7.5 $5.8 $8.7
October 1
December 31 $1.6 $3.7 $3.6 $5.1 $6.2 $8.7
Year 2001 $1.6 $3.7 $5.3 $5.5 $5.5 $7.8
We are presently evaluating the impact of recent commercial airline crashes
that occurred in 2000, including the Alaska Air crash.
Other Underwriting Loss Activity
Except for multi-line business, all other classes of business also
contributed to the 1999 underwriting loss with the largest contribution from
property business. The after-tax underwriting loss for property business
approximated $4.9 million which included after-tax losses of $4.3 million for
two large catastrophes in 1999 (Rouge steel plant in Dearborn, Michiganexpense payments
and French storm losses).
The 1998 underwriting loss included an after-tax underwriting loss of $3.3
million for a property loss on a finite risk treaty.
1999 Prior Year Development
Estimates of prior accident year claims were increasedoperating costs. Consolidated cash flows provided by approximately $30
million in 1999 which added 10.2 points to the 1999 combined ratio. A
substantial portion of this amount stemmed from (i) our review of additional
claims information and our continuing underwriting and actuarial analysis of the
business produced by the managing underwriting agency, (ii) notification of
additional satellite losses received in 1999 pertaining to 1998, (iii) aviation
losses, principally the previously discussed 1998 Swiss Air crash, and (iv)
property losses reported on several international treaties that are in run-off.
Estimates of prior accident year claims were reduced by approximately $2.8
million in 1998 primarily due to favorable claim development in the property and
multi-line classes of business.
Claims and claims expenses generally represent our most significant and
uncertain costs. Reserves for these expenses are estimates involving actuarial
and statistical projections at a given time of what we expect the ultimate
settlement and administration of claims to cost based on facts and circumstances
then known. The reserves are based on estimates of claims and claims expenses
incurred and, therefore, the amount ultimately paid may be more or less than
such estimates. The inherent uncertainties of estimating claim reserves are
exacerbated for reinsurers by the significant periods of time (the "tail") that
often elapse between the occurrence of an insured loss, the reporting of the
loss to the primary insurer and, ultimately, to the reinsurer, and the primary
insurer's payment of that loss and subsequent indemnification by the reinsurer.
As a consequence, actual claims and claims expenses paid may deviate, perhaps
materially, from estimates reflected in our reserves reported in our financial
statements. The estimation of reserves by new reinsurers, such as us, may be
less reliable than the reserve estimations of a reinsurer with an established
volume of business and claims history. To the extent reserves prove to be
inadequate, we may have to augment such reserves and incur a charge to earnings.
44
Acquisition Costs
In pricing RCRe's reinsurance treaties, we focus on many factors, including
exposure to claims and commissions and brokerage expenses. Commissions and
brokerage expenses are acquisition costs that generally vary by the type of
treaty and line of business, and are considered by our underwriting and
actuarial staff in evaluating the adequacy of premium writings. In a number of
reinsurance treaties, provisional commissions are initially paid and
subsequently increased or decreased, subject to a minimum and maximum amount,
depending upon the claims and claims expenses experience of the assumed
business. We record the commission increase or decrease in accordance with
contractual terms based on the expected ultimate experience of the contract. The
claims and commissions and brokerage ratios reflect our business mix.
Other Operating Expenses
Other(used for) operating
expenses were $14.8 million in 1999, compared to $16.5
million and $13.5 millionactivities for the years ended December 31, 19982001, 2000 and 1997,1999 were
approximately ($5.6) million, $2.6 million and $7.5 million, respectively.
For 1999, the statutory operating expense ratio declined to 4.7%, compared
with 6.8% for 1998 and 9.1% in 1997. The
decline in our operating expense ratiocash flow in 2001 was primarily due to a decrease in other operating expenses and an increase in our net
premiums written from the comparable prior year period. In addition, commencing
in 1999, we allocated certain compensationreinsurance
recoverables at American Independent, and other operating expensesstart-up costs related to investmentthe new
underwriting initiative.
53
Our expanded underwriting activities inwill initially be supported by our
capital, and we expect that our other operational needs for the amountforeseeable
future will be met by our balance of $2.1 million to net investment income
based on internal time studies. Such allocations were not made in prior periods.
Due to such allocations, the 1999 statutory operating expense ratio improved by
approximately one point and net investment income was reduced by approximately
$0.08 per share, with no overall effect on operating results. On a pro-forma
basis, the statutory operating expense ratios for 1998 and 1997 would have been
5.8% and 7.6%, respectively.
Foreign Exchange
Pre-tax foreign exchange gains and losses are recorded separately from
statutory underwriting results and are therefore excluded from the statutory
composite ratio. Unhedged monetary assets and liabilities are translated at the
exchange rate in effect at the balance sheet date, with the resulting foreign
exchange gains or losses recognized in income. For the years ended December 31,
1999, 1998 and 1997, pretax foreign exchange gains and (losses) were $198,000,
$443,000 and ($682,000), respectively. Such future gains or losses may be
affected by changes in foreign exchange rates which are unpredictable and could
be material. For additional discussion, see "--Market Sensitive Instruments and
Risk Management" below.
Risk Retention
Given RCRe's current level of surplus, under its current underwriting
guidelines, the maximum net retention on any one claim for a given property or
casualty treaty risk is generally $10 million.
We monitor RCRe's earthquake and wind exposures and continuously reevaluate
its estimated probable maximum pre-tax loss for such exposures through the use
of modeling techniques. We generally seek to limit RCRe's probable maximum
pre-tax net loss to no more than 10% of its statutory surplus for severe
catastrophic events such as hurricanes and earthquakes that could be expected to
occur once in every 100 years. This limitation includes combined exposure to
underwriting losses, reinstatement costs for retrocessional arrangements which
may be in force at the time of the losses resulting from the catastrophic event,
and losses that RCRe may be exposed to as a result of its privately held
investments in insurance and insurance-related entities. While we believe RCRe's
risk management techniques are adequate, we cannot assure you that RCRe will not
suffer pre-tax losses greater than 10% of its statutory surplus from a
catastrophic event due to the inherent uncertainties in estimating the frequency
and severity of such exposures. In addition, we believe that we cannot
reasonably estimate RCRe's exposure to unrealized investment losses (if any)
that may result from RCRe's investments in publicly traded securities of
insurance and insurance-related entities.
With respect to integrated solutions (where we combine an equity,
equity-like or debt investment in a client company with the purchase by such
client of reinsurance from RCRe), we generally limit RCRe's combined
underwriting and investment exposure to pre-tax losses on any individual client
to no more than 10% of RCRe's total statutory surplus.
45
We continue to evaluate RCRe's potential catastrophe exposure, including
both gross loss estimates and the impact of available reinsurance protection.
While we believe our management of catastrophe exposures and underwriting
guidelines are adequate, an extremely large catastrophic event, multiple
catastrophic events or other unforeseen events could have a material adverse
effect on our financial condition and results of operations.
Net Investment Income
At December 31, 1999, approximately 59% of our invested assets consisted of
fixed maturitycash and short-term investments, comparedas well as
by funds generated from premiums and investment income and proceeds on the sale
or maturity of our investments.
We have an effective shelf registration statement with the Securities and
Exchange Commission. It permits us to 48% atissue various types of securities,
including unsecured debt securities, preference shares and common shares, from
time to time, up to an aggregate of $500 million.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Set forth below, in tabular form, is information as of December 31, 1998.
Net investment income was approximately $20.2 million in 1999, compared to $15.7
million and $14.4 million in 1998 and 1997, respectively. Such amounts for 1999,
1998 and 1997 are net of investment expenses of $5.5 million, $3.6 million and
$2.2 million, respectively. The investment expense amounts include investment
advisory fees of $2.0 million, $3.3 million and $1.8 million, respectively. The
1999 net investment income is also net of $1.1 million for the payment of
interest expense in connection with the settlement of satellite losses.
Our investment yields at amortized cost were as follows2001 for
the periods set
forth below:
Years Ended December 31,
---------------------------------------------
1999 1998 1997
---- ---- ----
Investment yields:
Pre-tax 3.6% 3.4% 3.7%
Net of tax 2.7% 2.5% 2.7%
Our investment yields are reflective of a significant allocation of the
total investment portfolio in equity securities, which yield less current income
than fixed maturity investments. At December 31, 1999indicated below concerning our obligations and 1998, investments in
public and private equity securities approximated 41% and 49%, respectively, of
total cash and invested assets. Additionally, such investment yields exclude our
equity in the net income or loss of private equity investments accounted forcommitments to make
future payments under the equity method.
Net Realized Gains (Losses) on Investments
Our source of net realized investment gains (losses) were as follows:long-term obligations:
In thousands
Years Ended December 31,
---------------------------------
1999 1998 1997
---- ---- ----CONTRACTUAL OBLIGATIONS
-----------------------
LESS THAN MORE THAN
TOTAL 1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS
-------- --------- ----------- --------- ---------
(IN THOUSANDS)
Net realized investment gain (losses)
Fixed maturity securities ($1,776) $1,472 $275
Publicly traded equity securities 16,798 16,582 3,878
Privately held securities 2,205 7,198 (4,913)
------- ------- ------
Sub-total 17,227 25,252 (760)
Income tax expense (benefit) 6,029 8,838 (266)
------- ------- ----
Net realized investment gains (losses), net of $11,198 $16,414 ($494)
======= ======= =====
tax
Operating Leases........................... $5,081 $1,213 $2,751 $1,117 --
====== ====== ====== ====== ======
Income Taxes
Our 1999 income tax benefit, 1998 effective tax rateWe are in the process of 5% and the 1997
income tax benefit are less than the 35% statutory rate on pre-tax operating
income due primarilyputting in place a letter of credit facility for up
to tax exempt income and the dividends received deductions.
The 1999, 1998 and 1997 gross deferred income tax benefits of approximately
$10.5 million, $7.3 million and $2.1 million, respectively, which are assets
considered recoverable from future taxable income, resulted from temporary
differences between financial and taxable income.
46
The net deferred income tax asset at December 31, 1999 was $7.8$200 million. We periodically evaluate the need for a valuation allowance for any portion of the
deferred tax assetexpect that our management believesthis facility will not be realized based on
current and future operating performance and available tax planning strategies.
While we believe that a valuation allowance is not necessary at December
31, 1999, continued future comprehensive losses or future decisions with respect
to business strategy following the sale of our reinsurance business may result
in the establishment of a valuation allowance in future financial statements.
We have a net operating loss carryforward which expiresone-year term. The
purpose of this facility is to issue standby letters of credit in 2019, forfavor of
primary insurance or reinsurance counterparties with which we have establishedentered into
reinsurance arrangements. Such letters of credit when issued will be secured by
a deferred income tax assetfirst priority, perfected security interest in investment securities. Any
issued letters of $7.3credit will expire 364 days from the date of issuance.
We have agreed to make a non-recourse loan of up to $13.5 million at December 31,
1999. The repurchase ofto our
common stock held by XL Capital resulted in a 27.8%
change in ownership by 5% shareholders. If, in the ensuing three years, there is
more than a 22.2% additional change in ownership by 5% shareholders, an
"ownership change" will have taken place for federal income tax purposes. If
such ownership change occurs, the amount of loss carryforwards that can be used
in any subsequent year may be severely limited and could be eliminated in
certain circumstances. See the section of our special meeting proxy statement
entitled "Risk Factors--The financing of our business plan may cause us to
forfeit certain tax benefits,"Chairman, which is incorporated by reference.
Investments
A principal component of our investment strategy is investing a significant
portion of RCRe's invested assets in publicly traded and privately held equity
securities, primarily issued by insurance and reinsurance companies and
companies providing services to the insurance industry. Cash and fixed maturity
investments and, if necessary, the sale of marketable equity securities will be used to support shorter-term liquidity requirements.
As a significant portion of RCRe's investment portfolio consists of equity
securities issued by insurancepay income and reinsurance companies and companies providing
servicesself-employment taxes, payable in
April 2002, on restricted shares granted to the insurance industry, the equity portfolio lacks industry
diversification and will be particularly subject to the performancehim on October 23, 2001. See
Note 9, "Commitments," of the insurance industry. Unlike fixed income securities, equity securities such as
common stocks, including the equity securities in which RCRe has invested,
generally are not and will not be rated by any nationally recognized rating
service. The values of equity securities generally are more dependent on thenotes accompanying our financial condition of the issuer and less dependent on fluctuations in interest
rates than are the values of fixed income securities. The market value of equity
securities generally is regarded as more volatile than the market value of fixed
income securities. The effects of such volatility on RCRe's equity portfolio
could be exacerbated to the extent that such portfolio is concentrated in the
insurance industry and in relatively few issuers. Fromstatements.
INVESTMENTS
At December 31, 1999 to
March 24, 2000, the market value2001, consolidated cash and invested assets totaled
approximately $1.0 billion, consisting of our public$486.8 million of cash and short-term
investments, $468.3 million of publicly traded fixed maturity investments,
$22.2 million of short-term investments held in escrow, $41.6 million of
privately held securities and $0.2 million of publicly traded equity portfolio has decreased by
approximately $28 million due to general stock market volatility, market decline
in the property and casualty insurance sector and the poor operating performance
of several of our investee companies. For additional discussion, see "--Market
Sensitive Instruments and Risk Management" below.
As our investment strategy is to invest a significant portion of RCRe's
investment portfolio in equity securities, our investment income in any fiscal
period may be smaller, as a percentage of investments, and less predictable than
that of other insurance and/or reinsurance companies, and net realized and
unrealized gains (losses) on investments may have a greater effect on our
results of operations or stockholders' equity at the end of any fiscal period
than would be the case for other insurance and/or reinsurance companies. Since
the realization of gains and losses on equity investments is not generally
predictable, such gains and losses have differed and will differ significantly
from period to period. Variability and declines in our results of operations
could be further exacerbated by private equity investments in start-up companies
which are accounted for under the equity method. Such start-up companies may be
expected initially to generate operating losses.securities.
Investments included in RCRe'sour private portfolio include securities issued by
privately held companies and by publicly traded companies that are generally restricted as to resale or are
otherwise illiquid and do not have readily ascertainable market values. The risk
of investing in such securities is generally greater than the risk of investing
in securities of widely held, publicly traded companies. Lack of a secondary
market and resale restrictions may result in an inability by us to sell a
security at a price that would otherwise be obtainable if such restrictions did
not exist and may substantially delay the sale of a security we seek to sell. At
December 31, 1999, cash and invested assets totaled approximately $585.9
million, consisting of $82.2 million of cash and short-term investments, $261.1
million of publicly traded fixed maturity investments,
47
$158.6 million of publicly traded equity securities, and $83.9 million of
privately held securities. Included in privately held securities are investments
totaling $42.6 million which are accounted for under the equity method.
At December 31, 1999, RCRe's2001, our private equity portfolio consisted of 12eight investments,
with additional investment portfolio commitments in an aggregate amount of
approximately $23.2$3.7 million. In 1999, we completed one integrated transaction with an existing client of
RCRe, a follow-on investment in an existing investee and one additional
investment commitment. In addition, we divested four of RCRe's investments. (See
note 3 under the captionSee Note 4, "Investment Information"Information," of the notes
accompanying notes to
our audited consolidated financial statements.)
In October 1998, we provided $5 million in financing on a fully secured
basis to a managing general agency, and received a related reinsurance
commitment expected to generate an aggregate of $90 million of reinsurance
premiums over three years pursuant to terms and conditions that we believe are
more favorable than those available in the open market.
On March 6, 2000, we extended a loan in an aggregate principal amount of
$3.5 million to American Independent Insurance Holding Company ("AIHC"), one of
our investee companies. The loan is secured by a second priority pledge of the
capital stock of AIHC and assets of AIHC, and matures on September 6, 2001
(which date may be extended to March 6, 2002 upon the occurrence of certain
events). The net proceeds of the loan were contributed to the surplus of AIHC's
subsidiary, American Independent Insurance Company. In connection with the loan,
we were issued warrants (in addition to the warrants issued to us in connection
with a prior loan to AIHC) granting us the right to acquire equity in AIHC.
See note 3 under the caption "Investment Information" of the accompanying
notes to our audited consolidated financial statements for certain information
regarding RCRe's publicly traded and privately held securities and their
carrying values, and commitments made by RCRe relating to its privately held
securities.
At December 31, 1999, approximately 88%2001, almost all of RCRe'sour fixed maturity and short-term
investments were rated investment grade by Moody's or Standard & Poor's and had
an average Standard & Poor's quality rating of AA"AA-" and an average duration of
approximately 3.71.9 years.
At December 31, 1999, RCRe is obligated under letters of credit in the
aggregate amount of approximately $9.7 million, which secure certain reinsurance
obligations. Securities with a carrying value of approximately $11.2 million54
We have been pledged as collateral for these letters of credit.
RCRe has not invested in derivative financial instruments such as futures,
forward contracts, swaps or options or other financial instruments with similar
characteristics such as interest rate caps or floors and fixed-rate loan
commitments. RCRe'sOur portfolio includes market sensitive instruments, such as
mortgage-backed securities, which are subject to prepayment risk and changes in
market value in connection with changes in interest rates. RCRe'sOur investments in
mortgage-backed securities, which amounted to approximately $27.3$91.1 million at
December 31, 1999,2001, or 4.7%8.9% of cash and invested assets, are classified as
available for sale and are not held for trading purposes.
Market Sensitive InstrumentsRESULTS OF OPERATIONS
Comparisons of our 2001 and Risk Management2000 results of operations to each other and to
prior year periods are not relevant due to the changes in our business during
2000 and 2001, including (1) the sale of our prior reinsurance operations in
May 2000, (2) our change of legal domicile and reorganization completed in
November 2000, (3) our recent acquisition activity, (4) our new underwriting
initiative and (5) the capital infusion. In addition, because of these factors,
as well as the other factors noted in "Cautionary Note Regarding Forward-Looking
Statements," our historical financial results do not provide you with a
meaningful measure of our future results. We have attempted to describe certain
of these potential changes below.
Statement of Financial Accounting Standards No. 131 requires certain
disclosures about operating segments in a manner that is consistent with how
management evaluates the performance of the segment. At December 31, 2001, our
primary operating segment was insurance. In 2002, we expect to operate in two
different business segments, insurance and reinsurance.
We had consolidated net income (loss) of $22.0 million, ($8.0) million and
($35.6) million for the years ended December 31, 2001, 2000 and 1999,
respectively. The increase in net income is primarily a result of the effects of
the sale of our prior reinsurance operations in May 2000, the realignment of our
investment portfolio in connection with the sale of our prior reinsurance
operations (and the realization of gains thereon in connection therewith), and
the reversal of a portion of the deferred tax valuation allowance, which was
originally established as a result of that sale. Such reversal resulted
primarily from the expected tax effects of the new underwriting initiative at
our U.S.-based underwriting operations.
Based on all information available to us to date, we believe that our
insurance and reinsurance subsidiaries do not have any material exposures to the
events of September 11, 2001.
UNDERWRITING ACTIVITIES
For the year ended December 31, 2001, premiums written, losses incurred and
commissions and brokerage resulted primarily from the acquisitions of American
Independent and ART Services. The corresponding amounts for the years ended
December 31, 2000 and December 31, 1999 reflect the results of our prior
reinsurance operations which were sold in May 2000. Approximately 55% of the
2001 net premiums written were attributable to American Independent, and
approximately 40% were attributable to ART Services. The remaining 5% was
attributable to new business written by Arch Re (Bermuda) effective
December 31, 2001. We expect that our new underwriting initiative and improving
market conditions will produce very substantial growth in our direct, assumed
and net premiums written in 2002.
55
A summary of premiums written is as follows:
YEAR ENDED DECEMBER 31,
-------------------------------
2001 2000 1999
-------- --------- --------
(IN MILLIONS)
Direct premiums written.................................. $117.4 $ -- $ --
Assumed premiums written................................. 1.8 102.0 386.8
------ ------ ------
Gross premiums written................................. 119.2 102.0 386.8
Ceded premiums written................................... (83.0) (19.7) (80.1)
------ ------ ------
Subtotal............................................... 36.2 82.3 306.7
Unearned premium portfolio transfer and assumption....... -- (92.9) --
------ ------ ------
Net premiums written................................... $ 36.2 $(10.6) $306.7
====== ====== ======
REINSURANCE CEDED
We follow the customary industry practice of reinsuring a portion of our
exposures, paying to reinsurers and retrocessionaires a part of the premiums
received on the policies we write. We monitor the financial condition of our
reinsurers and retrocessionaires and attempt to place coverages only with
substantial, financially sound carriers. During 2001, we ceded approximately
two-thirds of our business written on a proportional basis in accordance with
our then current business plan. Comparisons of premiums written between 2001 and
2000 are not meaningful because of the SEC's Financial Reporting Release No. 48,changes in our business discussed above.
At December 31, 2001, substantially all of our reinsurance recoverables were due
from carriers which had an A.M. Best rating of "A-" or better and we had no
amounts recoverable from a single entity or group of entities that exceeded 5%
of shareholders' equity. As a result of the new underwriting initiative and our
enhanced financial position, we expect to retain a significant amount of
business written by American Independent and ART Services as well as premiums
written by Arch Re (Bermuda) and Arch Re (US). In 2002, reinsurance may be
purchased on both a facultative and treaty basis primarily to reduce net
liability on individual risks and, if deemed necessary, to reduce our exposure
to catastrophic losses.
NET INVESTMENT INCOME
At December 31, 2001, approximately 94% of our invested assets consisted of
fixed maturity and short-term investments, exclusive of securities held in
escrow, compared to 53% at December 31, 2000. Net investment income was
approximately $12.1 million in 2001, compared to $15.9 million in 2000 and
$20.2 million in 1999. Such amounts for 2001, 2000 and 1999 are net of
investment expenses of $0.1 million, $0.9 million and $5.5 million,
respectively. The investment expense amounts include investment advisory fees of
$0.7 million, $0.8 million and $2.0 million, respectively. The 2001 and 2000 net
investment expenses are offset by advisory fee income that we received from MMC
Capital, Inc. in the amount of $1.25 million.
The decrease in net investment income in 2001 compared with 2000 reflected
primarily the decline in our average invested asset base resulting from the sale
of our prior reinsurance operations. The impact was partially offset by
investment income earned on the proceeds received from the capital infusion in
November 2001 as well as the inclusion of the results of American Independent
and ART Services. The decrease in net investment income in 2000 compared with
1999 primarily reflected the decline in our average invested asset base
resulting from the sale of our prior reinsurance operations, partially offset by
the decrease in investment expenses described above and a higher interest rate
environment.
56
Our investment yields at amortized cost were as follows for the periods set
forth below:
YEAR ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Investment yields:
Pre-tax......................................... 5.2% 4.3% 3.6%
Net of tax...................................... 4.6% 3.1% 2.7%
Proceeds from the capital infusion were initially invested in short
duration, high quality fixed maturities and short-term investments. Yields on
future investment income may vary based on investment allocation decisions,
economic conditions and other factors. Investment yields in 2000 and 1999
reflect a significant allocation of the total investment portfolio in equity
securities, which yield less current income than fixed maturity investments. At
December 31, 2000 and 1999, public and private equity securities approximated
40% and 41%, respectively, of total cash and invested assets. Additionally such
investment yields exclude the equity in net income or loss of private equity
investments accounted for under the equity method of accounting.
RESERVE FOR LOSS OF ESCROWED ASSETS
In connection with the definitive settlement agreement reached with
Folksamerica in February 2002 (as described above under "--General--May 2000
Sale of Our Prior Reinsurance Operations"), for 2001, we recorded an after-tax
benefit of $0.4 million to reflect the net effects of this agreement. During
2000, our net loss included an after-tax charge of $9.8 million related to the
escrowed assets. See Note 3, "Acquisition of Subsidiaries and Disposition of
Prior Reinsurance Operations," of the notes accompanying our consolidated
financial statements.
OTHER OPERATING EXPENSES
Other operating expenses were $27.7 million in 2001, compared to
$6.9 million and $14.2 million for the years ended December 31, 2000 and 1999,
respectively. The increase in operating expenses is primarily due to the 2001
acquisitions. In addition, during the fourth quarter of 2001, we incurred
approximately $4.0 million of costs from the formation of our new reinsurance
operations. We expect that we will incur a significant amount of additional
costs in 2002 in connection with the expected increase in our insurance and
reinsurance operations.
PROVISION FOR NON-CASH COMPENSATION
During 2001, we made certain grants to new and existing employees under our
stock incentive plans and other arrangements, resulting in pre-tax charges of
$2.8 million. These grants were made primarily in connection with our new
underwriting initiative, which resulted in the increase in non-cash compensation
in 2001. As a result of the new initiative, we expect to reflect a significant
increase in non-cash compensation in 2002. In 2000 and 1999, we made grants
under our stock incentive plans and other arrangements that resulted in pre-tax
charges of $1.1 million and $0.6 million, respectively.
57
NET REALIZED GAINS (LOSSES) ON INVESTMENTS
Our sources of net realized investment gains (losses) were as follows:
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
(IN THOUSANDS)
Fixed maturities......................................... $(2,116) $(15,550) $(1,776)
Publicly traded equity securities........................ 22,896 30,088 16,798
Privately held securities................................ (2,398) 177 2,205
------- -------- -------
Subtotal............................................... 18,382 14,715 17,227
Loss on fixed maturities included in gain on sale of
prior reinsurance operations........................... -- 5,330 --
------- -------- -------
Net realized investment gains........................ 18,382 20,045 17,227
Income tax expense....................................... 7,242 7,408 6,029
------- -------- -------
Net realized investment gains, net of tax............ $11,140 $ 12,637 $11,198
======= ======== =======
INCOME TAXES
Under current Bermuda law, we are not obligated to pay any taxes in Bermuda
based upon income or capital gains. We have received a written undertaking from
the Minister of Finance in Bermuda under the Exempted Undertakings Tax
Protection Act 1966 that, in the event that any legislation is enacted in
Bermuda imposing any tax computed on profits, income, gain or appreciation on
any capital asset, or any tax in the nature of estate duty or inheritance tax,
such tax will not be applicable to us or our operations until March 28, 2016.
This undertaking does not, however, prevent the imposition of taxes on any
person ordinarily resident in Bermuda or any company in respect of its ownership
of real property or leasehold interests in Bermuda.
ACGL and our Bermuda and other non-U.S. subsidiaries will be subject to U.S.
federal income tax to the extent that they derive U.S. source income that is
subject to U.S. withholding tax or income that is effectively connected with the
conduct of a trade or business within the United States and is not exempt from
U.S. tax under an applicable income tax treaty with the United States. They will
be subject to a withholding tax on dividends from U.S. investments and interest
from certain U.S. payors. In addition, Arch Re (Bermuda) will be subject to
excise taxes on United States insurance and reinsurance premiums received by it.
We do not consider ACGL or our Bermuda or other non-U.S. subsidiaries to be
engaged in a trade or business within the United States and, consequently, do
not expect them to be subject to direct U.S. income taxation. See "Risk
Factors--Risks Relating to Taxation" and "Business--Tax Matters." Our U.S.
subsidiaries will continue to be subject to U.S. income taxes on their worldwide
income.
Our 2001 income tax expense was $2.1 million, resulting in an effective tax
rate of 9%. The effective tax rate was lower than the U.S. federal income tax
rate of 35% primarily as a result of a reduction in the valuation allowance on
certain deferred tax assets, which was slightly offset by foreign losses not
subject to U.S. tax. This reduction resulted primarily from the expected tax
effects of the new underwriting initiative at our U.S.-based underwriting
operations, which included an increase in our on-shore investment portfolio.
Our 2000 income tax expense was $8.5 million, compared with an income tax
benefit of $20.9 million in 1999. In 2000, income tax expense on our pre-tax net
loss included a charge to establish a valuation allowance of $5.7 million that
adjusted our deferred income tax asset to its estimated realizable value. Income
tax expense for 2000 also included the write-off of certain deferred tax assets
in the amount of $3.0 million in connection with our change of legal domicile to
Bermuda. In
58
1999, Arch Re (US)'s underwriting results had significantly deteriorated,
resulting in a pre-tax net loss that generated an income tax benefit for the
year.
At December 31, 2001, the net deferred income tax asset was $13.7 million
after reflecting a valuation allowance of $9.6 million recorded to reduce the
net deferred income tax asset to the amount that management expects to more
likely than not be realized. This valuation allowance primarily relates to
certain deferred income tax assets of ART Services, which was acquired during
2001, and also reflects the reduction in the valuation allowance recorded at
December 31, 2000 due to the expected tax effects of the new underwriting
initiative, as discussed above. At December 31, 2000, we had a valuation
allowance of $5.7 million that adjusted the net deferred income tax asset to its
estimated realizable value of $8.2 million. At December 31, 1999, we did not
have a valuation allowance because we believed at that time the entire deferred
tax asset was realizable due to our ability to generate future taxable income.
See "--Critical Accounting Policies, Estimates and Recent Accounting
Pronouncements--Valuation Allowance."
We have net operating loss carryforwards totaling $43.3 million at
December 31, 2001. Such net operating losses are currently available to offset
our future taxable income and expire between 2011 and 2021. We also have an
alternative minimum tax credit carryforward in the amount of $1.0 million which
can be carried forward without expiration.
On November 20, 2001, we underwent an ownership change for U.S. federal
income tax purposes as a result of the capital infusion. As a result of this
ownership change, limitations are imposed upon the utilization of our existing
net operating losses.
Upon our change of legal domicile to Bermuda in November 2000, Arch Capital
(US) distributed substantially all of its public equity portfolio to its Bermuda
parent, ACGL, at the then current market values and realized gains for tax
purposes of $21.0 million. The associated U.S. federal income tax expense of
$7.4 million reduced our net operating loss carryforwards by a corresponding
amount. However, for financial reporting purposes, since the securities had not
been sold to an unrelated third party, the realized gain had been deferred and
was reported as unrealized appreciation in our consolidated financial
statements. Accordingly, the income tax expense was also deferred and reduced
unrealized appreciation in the consolidated financial statements. In 2001, we
divested of this public equity portfolio in its entirety and, accordingly, have
recognized the U.S. federal income tax expense of $7.4 million in our
consolidated financial statements for the year ended December 31, 2001. See
Note 7, "Income Taxes," of the notes accompanying our consolidated financial
statements.
MARKET SENSITIVE INSTRUMENTS AND RISK MANAGEMENT
The following analysis presents hypothetical losses in cash flows, earnings
and fair values of market sensitive instruments which are held by RCReus as of
December 31, 19992001 and are sensitive to changes in interest rates, foreign exchange rates and equity
security prices. This risk management discussion and the estimated amounts
generated from the following sensitivity analysis represent forward-looking
statements of market risk assuming certain adverse market conditions occur.
Actual results in the future may differ materially from these projected results
due to actual developments in the global financial markets. The analysis methods used by
us to assess and mitigate risk should not be considered projections of future
events ofor losses.
Market risk represents the risk of changes in the fair value of a financial
instrument and is comprised of several components, including liquidity, basis
and price risks. The focus of the SEC's market risk rules is on price risk. For
purposes of specific risk analysis, we employ sensitivity analysis to determine
the effects that market risk exposures could have on the future earnings, fair
values or cash flows of RCRe'sour financial instruments.
48
The financial instruments included in the following sensitivity analysis
consist of all of our cash and invested assets, excluding investments carried
under the equity method of accounting.
Equity Price Risk59
EQUITY PRICE RISK
We are exposed to equity price risks on the public and private equity securities
included in RCRe'sour investment portfolio. All of RCRe's publicly
traded equity securities andour privately held securities were
issued by insurance and reinsurance companies or companies providing services to
the insurance and reinsurance industry. We typically do not attempt to reduce or
eliminate RCRe'sour market exposure on these securities. Investments included in RCRe'sour
private portfolio include securities issued by privately held companies and securities issued by
public companies that are
generally restricted as to resale or are otherwise illiquid and do not have
readily ascertainable market values. Investments in privately held securities
issued by privately and publicly held companies may include both equity securities and
securities convertible into, or exercisable for, equity securities (some of
which may have fixed maturities).
RCRe's publicly traded andOur privately held equity securities, which at December 31, 1999, which are2001 were
carried at a fair value of $158.6$41.6 million, and $84.0 million,
respectively, have exposure to price risk. The
estimated potential losses in fair value for RCRe's publicly traded andour privately held equity
portfolios resulting from a hypothetical 10% decrease in quoted market prices,
dealer quotes or fair value are $15.9 million and $8.4 million, respectively.
Interest Rate Riskis $4.2 million.
INTEREST RATE RISK
The aggregate hypothetical loss generated from an immediate adverse shift in
the treasury yield curve of 100 basis points would result in a decrease in total
return of 4.1%1.9%, which would produce a decrease in market value of $10.6$8.6 million
on RCRe'sour fixed maturity investment portfolio, valued at $261.1$468.3 million at
December 31, 1999.2001. There would be no material impact on RCRe'sour short-term
investments.
Foreign Currency Exchange Rate RiskCRITICAL ACCOUNTING POLICIES, ESTIMATES AND RECENT ACCOUNTING PRONOUNCEMENTS
The preparation of consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities
(including reserves), revenues and expenses, and related disclosures of
contingent liabilities. On an ongoing basis, we evaluate our estimates,
including those related to insurance and other reserves, intangible assets, bad
debts, income taxes, pensions, contingencies and litigation. We base our
estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. We believe that the
following critical accounting policies affect our more significant judgments and
estimates used in the preparation of our consolidated financial statements.
PREMIUM REVENUES AND RELATED EXPENSES
Insurance premiums written are recorded in accordance with the terms of the
underlying policies. Reinsurance premiums assumed are recognized as income on a
straight line basis over the terms of the related reinsurance contracts. These
amounts are based on reports received from ceding companies, supplemented by our
own estimates of premiums for which ceding company reports have foreign currency risknot been
received. Subsequent differences arising on both reinsurance balances receivablesuch estimates are recorded in the
period they are determined. Unearned premium reserves represent the portion of
premiums written that relates to the unexpired terms of contracts in force.
Certain of our contracts included provisions that adjusted premiums or
acquisition costs based upon the experience under the contracts. Premiums
written and earned as well as related acquisition expenses under those contracts
are recorded based upon the expected ultimate experience under these contracts.
60
Acquisition costs, which vary with and are primarily related to the
acquisition of policies, consisting principally of commissions and brokerage
expenses incurred at the time a contract is issued, are deferred and amortized
over the period in which the related premiums are earned. Deferred acquisition
costs are carried at their estimated realizable value based on the related
unearned premiums and take into account anticipated losses and loss adjustment
expenses, based on historical and current experience and anticipated investment
income.
LOSSES AND LOSS ADJUSTMENT EXPENSES
Insurance reserves are inherently subject to uncertainty. Loss and loss
adjustment expense reserves represent estimates involving actuarial and
statistical projections at a given point in time of our expectations of the
ultimate settlement and administration costs of claims incurred. We utilize
actuarial models as well as historical insurance and reinsurance balances payable, including claims and claims expenses. We do not
currently utilize derivative instrumentsindustry loss
development patterns to manage our exposure to foreign
currency movements. At December 31, 1999, the substantial majority of the
Company's net receivable/payable position was denominated in United States
dollars. At such date, the largest foreign currency exposure related to
liabilities denominated in British Pounds Sterling. We had a net liability
balance in Sterling of approximately $2.6 million. A 10% increaseassist in the Sterling/United States dollar exchange rate wouldestablishment of appropriate claim
reserves. In contrast to casualty claims, which frequently can be determined
only through lengthy and unpredictable litigation, non-casualty property claims
tend to be reported promptly and usually are settled within a shorter period of
time. Nevertheless, for both casualty and property claims, actual losses and
loss adjustment expenses paid may deviate, perhaps substantially, from the
reserve estimates reflected in our financial statements. For reinsurance
assumed, such reserves are based on reports received from ceding companies,
supplemented by our estimates of reserves for which ceding company reports have
resultednot been received, and our own historical experience.
If our loss and loss adjustment expense reserves are determined to be
inadequate, we will be required to increase the reserves with a corresponding
reduction in net income in the period in which the deficiency is determined. It
is possible that claims in respect of events that have occurred could exceed our
reserves and have a material adverse effect on our results of operations in a
particular period or our financial condition in general.
Even though most insurance contracts have policy limits, the nature of
property and casualty insurance and reinsurance is that losses can exceed policy
limits for a variety of reasons and could very significantly exceed the premiums
received on the underlying policies.
We will attempt to limit our risk of loss through reinsurance and
retrocessional arrangements. The availability and cost of reinsurance and
retrocessional protection is subject to market conditions, which are beyond our
control.
COLLECTION OF INSURANCE BALANCES
We maintain allowances for doubtful accounts for probable losses resulting
from our inability to collect premiums. In addition, we are subject to credit
risk with respect to our reinsurance and retrocessions because the ceding of
risk to reinsurers and retrocessionaires does not relieve us of $268,000. Given our limited amountliability to
the companies we reinsure. If the financial condition of net assetour reinsurers or
liability balancesretrocessionaires were to deteriorate, resulting in other foreign currencies, any currency movementan impairment of 10% would not produce a
material loss for purposes of this discussion.
Liquidity and Capital Resources
We are a holding company and currently have no significant operations or
assets other than our ownership of the capital stock of RCRe. We rely on cash
dividends and distributions from RCRetheir
ability to make payments, includingadditional allowances may be required.
VALUATION ALLOWANCE
We record a valuation allowance to reduce our deferred tax assets to the
amount that is more likely than not to be realized. While we have considered
future taxable income and feasible tax planning strategies in assessing the need
for any
operating expensesa valuation allowance, in the event we were to determine that we may incurwould not
be able to realize all or part of our deferred tax assets in the future, an
adjustment to the deferred tax asset would be charged to income in the period
such determination was made. In addition, if we subsequently assessed that the
valuation allowance was no longer needed, then a benefit would be recorded to
income in the period such determination was made.
61
INVESTMENTS
We currently classify all of our publicly traded fixed maturity, short-term
investments and equity securities as "available for any dividendssale" and, accordingly, they
are carried at estimated fair value. The fair value of publicly traded fixed
maturity securities and publicly traded equity securities is estimated using
quoted market prices or dealer quotes.
STOCK ISSUED TO EMPLOYEES
We follow Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB No. 25"), and related interpretations in accounting
for our employee stock repurchases
as our boardoptions because the alternative fair value accounting
provided for under SFAS No. 123, "Accounting for Stock-Based Compensation,"
requires use of directors may determine. Our board currently doesoption valuation models that were not intenddeveloped for use in
valuing employee stock options. Accordingly, under APB No. 25, compensation
expense for stock option grants is recognized by us to declare dividends or make any other distributions. However, our board intends to
make a determination regarding stock repurchases following the consummationextent that the fair
value of the asset sale. See "Market for Registrant's Common Equity and Related
Stockholder Matters(Dividends" andunderlying stock exceeds the sections included in our special meeting
proxy statement entitled "Risk Factors-- We currentlyexercise price of the option at the
measurement date. In addition, under APB No. 25, we do not anticipate paying
dividends, but may consider share repurchases" and "Dividendrecognize
compensation expense for stock issued to employees under our stock purchase
plan. See Note 10, "Stock and Stock Repurchase Policy.Option Plans," RCRe's ability to pay dividends or make distributions to us
is dependent upon its ability to achieve satisfactory underwriting and
investment results and to meet regulatory standards of the State of Nebraska, as
described below. There are presently no contractual restrictions on RCRe's
payment of dividends or the making of distributions to us. We intend to cause
RCRe to make an extraordinary distribution to us following the asset sale. See
"--General--RCRe Distribution."
Nebraska insurance laws provide that, without prior approval of the
Nebraska Director, RCRe cannot pay a dividend or make a distribution (together
with other dividends or distributions paid during the preceding 12 months) that
exceeds the greater of (i) 10% of statutory surplus as of the preceding December
31 or
49
(ii) statutory net income from operations from the preceding calendar year not
including realized capital gains. Net income (exclusive of realized capital
gains) not previously distributed or paid as dividends from the preceding two
calendar years may be carried forward for dividends and distribution purposes.
Any proposed dividend or distribution in excess of such amount is called an
"extraordinary" dividend or distribution and may not be paid until either it has
been approved, or a 30-day waiting period has passed during which it has not
been disapproved, by the Nebraska Director. Notwithstanding the foregoing,
Nebraska insurance laws provide that any distribution that is a dividend may be
paid by RCRe only out of earned surplus arising from its business, which is
defined as unassigned funds (surplus) as reported in the statutorynotes accompanying our
financial statement filed by RCRe with the Nebraska Insurance Department for the most
recent year, including any surplus arising from unrealized capital gains or
revaluations of assets. Any distribution that is a dividend and that is in
excess of RCRe's unassigned funds, exclusive of any surplus arising from
unrealized capital gains or revaluation of assets, will be deemed an
"extraordinary" dividend subject to the foregoing requirements. Due to the
distribution that was required to be made in connection with the XL Capital
stock repurchase, we may not declare any other distribution for twelve months
from the closing date of the stock repurchase unless such subsequent
distribution is approved by the Nebraska Director. See "Business--Insurance
Regulation" and note 10 to our audited consolidated financial statements
included in this report for further details regarding statutory restrictions on
distributions by RCRe.
We, RCRe and Cross River file consolidated federal income tax returns and
have entered into a tax sharing agreement (the "Tax Sharing Agreement"),
allocating the consolidated income tax liability on a separate return basis.
Pursuant to the Tax Sharing Agreement, RCRe and Cross River make tax sharing
payments to us based on such allocation.
Net cash flow from operating activities for the years ended December 31,
1999, 1998 and 1997 was approximately $7.5 million, $68.5 million and $49.0
million, respectively, consisting principally of premiums received, investment
income (excluding net realized investment gains), offset by operating costs and
expenses. The primary sources of liquidity for Risk Capital Reinsurance are net
cash flow from operating activities, principally premiums received, the receipt
of dividends and interest on investments and proceeds from the sale or maturity
of investments. RCRe's cash flow is also affected by claims payments, some of
which have been large. For example, we experienced negative cash flow from
operations of approximately $25 million in the 1999 fourth quarter as a result
of significant paid loss activity. Such situations could reoccur as our book of
business matures, claims are settled and if we continue to experience poor
underwriting performance. Therefore, our cash flow could fluctuate significantly
from period to period.
RCRe does not currently have any material commitments for any capital
expenditures over the next 12 months. We expect that our financing and
operational needs for the foreseeable future will be met by our balance of cash
and short-term investments, as well as by funds generated from operations.
Following the sale of the reinsurance operations to Folksamerica, our objective
will be to pursue business combinations and ventures with operating businesses.
We have not yet identified any specific business opportunities. Accordingly, we
may need to secure additional financing to carry out our business plan. We
cannot assure you that we will be successful in the implementation of our
current or future business strategy. See the section of our special meeting
proxy statement entitled "Risk Factors--Risks Relating to Our Business After the
Asset Sale," which is incorporated by reference.
At December 31, 1999, our consolidated stockholders' equity totaled $346.5
million, or $20.28 per share based on issued and outstanding shares, and $20.28
per share on a diluted basis which includes outstanding dilutive warrants and
options. At such date, statutory surplus of RCRe was approximately $290 million.
As a result of the XL Capital stock repurchase, stockholders' equity has been
reduced by $59.4 million and book value per share has increased to $23.27 per
share on a fully diluted basis. RCRe's statutory surplus was also reduced by $60
million to $230 million due to the sale to XL Capital of the stock and warrants
in LARC Holdings, Ltd. and Annuity and Life Re Holdings, Ltd., based on their
statutory carrying values at December 31, 1999. Based on data from the RAA,
after giving effect to the XL Capital stock repurchase, RCRe was the 20th
largest domestic broker market oriented reinsurer as measured by its $230
million of statutory surplus.
50
Accounting Pronouncements
Derivatives and Hedgingstatements.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998,2001, the Financial Accounting Standards Board ("FASB") issued StatementSFAS
No. 133141, "Business Combinations." SFAS No. 141 requires, among other things, the
purchase method of accounting to be applied for business combinations initiated
after June 30, 2001 and eliminates the pooling-of-interests method. We do not
expect the application of SFAS No. 141 to have a material impact on our
financial position or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which became effective for us on January 1, 2002. SFAS No. 142
requires, among other things, the discontinuance of the amortization of goodwill
and the introduction of impairment testing in its place. In addition, SFAS
No. 142 includes provisions for the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. At December 31,
2001, we had goodwill of approximately $26.3 million. Pursuant to SFAS No. 142,
we will test our goodwill for impairment upon adoption and, if impairment is
indicated, record such impairment as a cumulative effect of an accounting
change. We have not yet developed an estimate of the impact of the adoption of
SFAS No. 142 on our consolidated results of operations. We believe that the
adoption of SFAS No. 142 will not have a material impact on our consolidated
financial condition.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Derivative Instrumentsthe Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and Hedging Activities.for Long-Lived Assets to
Be Disposed Of." This
statement requires thatSFAS No. 144 applies to all derivative financial instruments be recognized inlong-lived assets (including
discontinued operations) and consequently amends portions of Accounting
Principles Board Opinion No. 30, "Reporting Results of Operations--Reporting the
statementEffects of financial position as either assets or liabilities and measured
at fair value.
IfDisposal of a derivative instrument is not designated asSegment of a hedging instrument, gains
or losses resulting from changes in fair values of such derivative are required
to be recognized in earnings in the period of the change. If certain conditions
are met, a derivative may be designated as a hedging instrument, in which case
the recording of the changes in fair value will depend on the specific exposure
being hedged. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes on fair
values or cash flows.
This statementBusiness." SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after JuneDecember 15, 2000,
with initial application as of the beginning of the first quarter of the
applicable fiscal year.
We will adopt this statement in the first quarter of 2001. Historically,2001,
and we have not invested in derivative financial instruments. However, derivatives may
be embedded in other financial instruments, such as convertible securities and
prepayment options in mortgages. If the embedded derivative meets certain
criteria,adopted it must be bifurcated from the host contract and separately accounted
for consistent with other derivatives.
RCRe's portfolio includes market sensitive instruments, such as convertible
securities and mortgage-backed securities, which are subject to prepayment risk
and changes in market value in connection with changes in interest rates. Our
investments in mortgage-backed securities are classified as available for sale
and are not held for trading purposes. Assuming the current investment strategy
at the time of adoption, our presentation of financial information under the new
statement will not be materially different than the current presentation.
Start-Up Costs
Effectiveon January 1, 1999, we changed our method2002. We do not expect the application of accounting for start-up
costs in accordance with the Accounting Standards Executive Committee's
Statement of Position ("SOP") 98-5 "Reporting on the Costs of Start-Up
Activities." This statement requires costs of start-up activities, including
organization costs,SFAS
No. 144 to be expensed as incurred. The change in accounting
principle resulted in the write-off of the start-up costs capitalized as of
January 1, 1999 for us and RCRe's investee companies carried under the equity
method of accounting. The cumulative effect of the write-off, which totals
$383,000, after-tax, or $0.02 per share, has been expensed and is included in
the 1999 net loss. (See note 2 of the accompanying notes to our audited
consolidated financial statements.)
Insurance Regulation
RCRe, in common with other insurers, is subject to extensive governmental
regulation and supervision in the various states and jurisdictions in which it
transacts business. The laws and regulations of the State of Nebraska, the
domicile of RCRe, have the most significanta material impact on itsour financial position or results of
operations.
From time to time various regulatory and legislative changes have been
proposed in the insurance and reinsurance industry, some of which couldINFLATION
Inflation may have an effect on reinsurers. Among the proposals that haveus because inflationary factors can increase
damage awards and potentially result in the past been, or are at
present being considered, are (i) thelarger claims. Our underwriting
philosophy is to adjust premiums in response to
62
inflation, although this may not always be possible introduction of federal
regulation in additiondue to or in lieu of, the current system of state regulation
of insurers and (ii) proposals in various state legislatures (some of which
proposals have been enacted) to conform portions of their insurance laws and
regulations to various model acts adopted by the NAIC. We are unable to predict
whether any of such laws and regulationscompetitive pressure.
Inflationary factors will be adopted, the form in which any
such laws and regulations would be adopted, or the effect, if any, these
developments would have on our operations and financial condition. See
"Business--Insurance Regulation."
In March 1998, the NAIC adopted the codification of statutory accounting
principles project that will generally be applied to all insurance and
reinsurance company financial statements filed with insurance regulatory
authorities as early as the statutory filings made in 2001. Although the
codification is not expected to materially affect many existing statutory
accounting practices presently followed by most insurers and
51
reinsurers such as RCRe, there are several accounting practices that may be
changed. The most significant change would involve accounting for deferred
income taxes, which change would require a deferred tax liability to be recorded
for unrealized appreciation of invested assets, net of available deferred tax
assets, that would result in a reduction to statutory surplus. If such
requirement had been in effect in 1999, the statutory surplus of RCRe at
December 31, 1999 would have remained at $290 million.
Effects of Inflation
The effects of inflation on us are implicitly considered in pricing and
estimating reserves for unpaid claims and claims expenses. The actual effects of
inflationdetermining the premium level on our results cannot be accurately known until claimsany
multi-year policies at the time contracts are ultimately
settled.written.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Please refer to the information appearing above under the subheading
"Market Sensitive Instruments and Risk Management" included as part of the
"Management's
Discussion and Analysis of Financial Condition and Results of Operations,Operations--Market
Sensitive Instruments and Risk Management." which information is incorporated by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See our consolidated financial statements and notes thereto and required
financial statement schedules on pages F-1 through F-43F-44 and S-1 through S-7
below.S-7.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
63
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The informationfollowing individuals are our directors and executive officers and other
members of senior management:
NAME AGE POSITION
- ---- -------- ------------------------------------------
Robert Clements........................... 69 Chairman and Director of ACGL
Peter A. Appel............................ 40 President, Chief Executive Officer and
Director of ACGL
Paul B. Ingrey............................ 62 Chief Executive Officer of Arch Re
(Bermuda) and Director of ACGL
Constantine Iordanou...................... 52 Chief Executive Officer of Arch Capital
(US) and Director of ACGL
John D. Vollaro........................... 57 Executive Vice President and Chief
Financial Officer of ACGL
John L. Bunce, Jr......................... 43 Director of ACGL
Kewsong Lee............................... 36 Director of ACGL
James J. Meenaghan........................ 63 Director of ACGL
John M. Pasquesi.......................... 42 Executive Vice Chairman and Director of
ACGL
Robert F. Works........................... 54 Director of ACGL
Dwight R. Evans........................... 49 President of Arch Re (Bermuda)
Debra M. O'Connor......................... 42 Senior Vice President, Controller and
Treasurer
Louis T. Petrillo......................... 36 Senior Vice President, General Counsel and
Secretary
ROBERT CLEMENTS was elected chairman and director of ACGL at the time of our
formation in March 1995. From March 1996 to February 2001, he was an advisor to
MMC Capital, with whom he served as chairman and chief executive officer from
January 1994 to March 1996. Prior thereto, he served as president of Marsh &
McLennan Companies, Inc. since 1992, having been vice chairman during 1991. He
was chairman of J&H Marsh & McLennan, Incorporated (formerly Marsh & McLennan,
Incorporated), a subsidiary of Marsh & McLennan Companies, Inc., from 1988 until
March 1992. He joined Marsh & McLennan, Ltd., a Canadian subsidiary of Marsh &
McLennan Companies, Inc., in 1959. Mr. Clements was a director of XL Capital
from 1986 to 2002 and was formerly a director of Annuity and Life Re
(Holdings), Ltd. and Stockton Reinsurance Limited and ACE Ltd. He is chairman
emeritus of the board of overseers of the School of Risk Management, Insurance
and Actuarial Science of St. John's University and a member of Rand Corp.
President's Council.
PETER A. APPEL has been president and chief executive officer of ACGL since
May 5, 2000 and a director of ACGL since November 1999. He was executive vice
president and chief operating officer of ACGL from November 1999 to May 5, 2000,
and general counsel and secretary of ACGL from November 1995 to May 5, 2000.
Mr. Appel previously served as a managing director of ACGL from November 1995 to
November 1999. From September 1987 to November 1995, Mr. Appel practiced law
with the New York firm of Willkie Farr & Gallagher, where he was a partner from
January 1995. Mr. Appel is currently a member of the board of overseers and a
member of the executive committee of the School of Risk Management, Insurance
and Actuarial Science of St. John's University.
64
PAUL B. INGREY has served as a director of ACGL and as chief executive
officer of Arch Re (Bermuda) since October 2001. He was the founder of F&G
Re Inc., a reinsurance subsidiary of USF&G Corporation, and served as its
chairman and chief executive officer from 1983 to 1996. Prior to that, he was
senior vice president of Prudential Reinsurance, an underwriter of property and
casualty reinsurance. He has also served as a director of USF&G Corporation
(until its sale to The St. Paul Companies, Inc. in 1978) and E.W. Blanch
Holdings, Inc., the holding company for E.W. Blanch Co., which provides risk
management and distribution services through several subsidiaries (until its
sale to Benfield Greig, the London-based international reinsurance broker, in
April 2001) and is currently on the board of Fairfax Financial Holdings Limited,
an insurance and reinsurance company with a focus on property and casualty
insurance.
CONSTANTINE IORDANOU has served as a director of ACGL and as chief executive
officer of Arch Capital (U.S.) Inc. since January 1, 2002. From March 1992
through December 2001, Mr. Iordanou served in various capacities for Zurich
Financial Services and its affiliates, including as senior executive vice
president of group operations and business development of Zurich Financial
Services, president of Zurich-American Specialties Division, chief operating
officer and chief executive officer of Zurich-American and chief executive
officer of Zurich North America. Prior to joining Zurich, he served as president
of the commercial casualty division of the Berkshire Hathaway Group and served
as senior vice president with the American Home Insurance Company, a member of
the American International Group.
JOHN D. VOLLARO has been executive vice president and chief financial
officer since January 2002. Prior to joining us, Mr. Vollaro acted as an
independent consultant in the insurance industry since March 2000. Prior to
March 2000, Mr. Vollaro was president and chief operating officer of W.R.
Berkley Corporation from January 1996 and a director from September 1995 until
March 2000. Mr. Vollaro was chief executive officer of Signet Star
Holdings, Inc., a joint venture between W.R. Berkley Corporation and General Re
Corporation, from July 1993 to December 1995. Mr. Vollaro served as executive
vice president of W.R. Berkley Corporation from 1991 until 1993, chief financial
officer and treasurer of W.R. Berkley Corporation from 1983 to 1993 and senior
vice president of W.R. Berkley Corporation from 1983 to 1991.
JOHN L. (JACK) BUNCE, JR. has served as director of ACGL since
November 2001. Mr. Bunce has served as a managing director at Hellman & Friedman
since 1988. Before joining Hellman & Friedman, Mr. Bunce was vice president of
TA Associates. Previously, he was employed in the Mergers & Acquisitions and
Corporate Finance Departments of Lehman Brothers Kuhn Loeb. He is currently also
a director of Digitas, Inc., National Information Consortium, Inc., and Western
Wireless Corporation. He has also served as a director of Duhamel Falcon Cable
Mexico, Eller Media Company, Falcon Cable TV, National Radio Partners,
VoiceStream Wireless Corporation, and Young & Rubicam, Inc. Mr. Bunce also was
an advisor to American Capital Corporation and Post Oak Bank.
KEWSONG LEE has served as a director of ACGL since October 2001. Mr. Lee has
served as a member and managing director of Warburg Pincus LLC and a general
partner of Warburg Pincus & Co. since January 1, 1997. He has been employed at
Warburg Pincus since 1992. Prior to joining Warburg Pincus LLC, Mr. Lee was a
consultant at McKinsey & Company, Inc., a management consulting company, from
1990 to 1992. His present service as a director includes membership on the
boards of Knoll, Inc., Eagle Family Foods, Inc. and several privately held
companies.
JAMES J. MEENAGHAN has been a director of the Company since October 2001.
From October 1986 to 1993, Mr. Meenaghan was chairman, president and chief
executive officer of Home Insurance Companies. He also served as President and
Chief Executive Officer of John F. Sullivan Co. from 1983 to 1986. Prior
thereto, Mr. Meenaghan held various positions over 20 years with the Fireman's
Fund Insurance Company, including President and Chief Operating Officer and Vice
Chairman of its parent company, American Express Insurance Services Inc.
JOHN M. PASQUESI has been our vice chairman and a director since
November 2001. Mr. Pasquesi has been the managing member of Otter Capital LLC, a
private equity investment firm founded by him in January 2001. Prior to
January 2001, Mr. Pasquesi was a managing director of Hellman & Friedman LLC
since 1988.
65
ROBERT F. WORKS has been a Director of the Company since June 1999.
Mr. Works was a Managing Director of Jones Lang LaSalle (previously LaSalle
Partners) until he retired on December 31, 2001. He joined Jones Lang LaSalle in
1981, where he has served in various capacities, including manager of both the
Property Management and Investment Management teams of the Eastern Region of the
United States. Mr. Works was also manager for the Times Square Development
Advisory and Chelsea Piers Lease Advisory on behalf of New York State and the
President of GCT Ventures and the Revitalization of Grand Central Terminal for
the Metropolitan Transportation Authority until he retired on December 31, 2001.
DWIGHT R. EVANS has served as president of Arch Re (Bermuda) since
October 2001. From 1998 until October 2001, Mr. Evans was executive vice
president of St. Paul Re. From 1983 until 1998, Mr. Evans was employed as
executive vice president for F&G Re Inc. Prior to that, Mr. Evans served as
assistant vice president at Skandia Reinsurance Company and as a reinsurance
underwriter at Prudential Reinsurance Company (now Everest Re Company).
DEBRA M. O'CONNOR has been senior vice president, controller and treasurer
of ACGL since June 9, 2000. From 1995 to June 9, 2000, Ms. O'Connor was senior
vice president and controller of Arch Re (US). From 1986 until 1995,
Ms. O'Connor served at NAC Re Corp. in various capacities, including vice
president and controller. Prior to that, Ms. O'Connor was employed by General Re
Corp. and the accounting firm of Coopers & Lybrand. Ms. O'Connor is a certified
public accountant.
LOUIS T. PETRILLO has been senior vice president, general counsel and
secretary of ACGL since May 5, 2000. From 1996 until May 5, 2000, Mr. Petrillo
was vice president and associate general counsel of ACGL's reinsurance
subsidiary. Prior to that time, Mr. Petrillo practiced law at the New York firm
of Willkie Farr & Gallagher.
BOARD OF DIRECTORS COMPOSITION
Pursuant to our shareholders agreement, we have agreed to restrictions on
the composition of our board of directors. Pursuant to this agreement, the
Warburg Pincus funds and the Hellman & Friedman funds are entitled to nominate a
prescribed number of directors based on the respective retained percentages of
their preference shares purchased in November 2001. Currently, our board
consists of nine members, including one director nominated by the Warburg Pincus
funds and one director nominated by the Hellman & Friedman funds. Once we have
received the remaining regulatory approvals required by this item is incorporated by reference fromin connection with the
informationcapital infusion, the size of our board may be increased to up to 17 members. As
long as the Warburg Pincus funds retain at least 75% of their original
investment and Hellman & Friedman funds retain at least 60% of their original
investment, these shareholders together will be included inentitled to nominate a majority
of directors to our definitive proxy statement forboard.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our annual
meetingdirectors
and executive officers, and persons who own more than 10% of stockholders to be held in 2000, which we intendour common shares,
to file with the SEC before April 30, 2000, underinitial reports of beneficial ownership and reports of
changes in beneficial ownership of our common shares. Such persons are also
required by SEC regulation to furnish us with copies of all Section 16(a)
reports they file. To our knowledge, based solely on a review of the following headings: "Electioncopies of
Directors--Directorssuch reports furnished to us and Executive Officers--Nominees," "--Continuing Directors
and Executive Officers" and "Electionrepresentations that no other reports were
required, we believe that all persons subject to the reporting requirements of
Directors--Security Ownership of
Certain Beneficial Owners and Management--SectionSection 16(a) Beneficial Ownership
Reporting Compliance."filed the required reports on a timely basis during the year ended
December 31, 2001.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information requiredregarding compensation paid to
our executive officers for services rendered during fiscal years 2001, 2000 and
1999.
66
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
----------------------------------
PAY-
AWARD(S) OUTS
ANNUAL COMPENSATION ----------------------- --------
----------------------------------- RESTRICTED
OTHER ANNUAL SHARE SECURITIES LTIP ALL OTHER
NAME AND PRINCIPAL COMPENSATION AWARDS UNDERLYING PAYOUTS COMPENSATION
POSITION YEAR SALARY($) BONUS($) ($) ($)(1) OPTIONS(#) ($) ($)(2)
- ------------------ -------- --------- -------- ------------ ---------- ---------- -------- ------------
Peter A. Appel............... 2001 375,000 -- -- 750,000 422,407 50,841
President, Chief Executive 2000 375,000 500,000 -- 756,250 100,000 -- 49,711(5)
Officer and a Director of 1999 375,000 250,000 -- -- -- -- 51,339
ACGL
Paul B. Ingrey............... 2001 143,200 -- -- 7,366,778 422,407 -- --
Chairman and Chief
Executive Officer of Arch
Reinsurance Ltd. and a
Director of ACGL(3)
Dwight R. Evans.............. 2001 95,500 -- -- 872,000 100,000 -- --
President of Arch
Reinsurance Ltd.(3)
Debra M. O'Connor............ 2001 188,300 175,000 -- -- 20,000 -- 21,170
Senior Vice President, 2000 170,000 118,000 -- -- 10,000 -- 19,800(5)
Controller and Treasurer(4)
Louis T. Petrillo............ 2001 206,200 400,000 -- 75,000 50,000 -- 21,116
Senior Vice President, 2000 174,000 120,000 -- -- 10,000 -- 19,932(5)
General Counsel and
Secretary(4)
- --------------------------
(1) The value of each restricted share award is based upon the closing price of
the common shares as reported on the Nasdaq National Market as of the grant
date of such award. As of December 31, 2001, 422,407 unvested restricted
shares, with a value of $10,876,980, were held by Mr. Ingrey. Subject to the
applicable award agreement, such restricted shares will vest on October 23,
2004. An aggregate of 145,000 restricted shares vested to the named
executive officers from 1996 through 2001. During the vesting period, cash
dividends (if any) would be paid on outstanding shares of restricted stock.
Stock dividends issued with respect to such shares (if any) would be subject
to the same restrictions and other terms and conditions that apply to
restricted shares with respect to which such dividends are issued.
(2) Includes: (1) matching contributions under an employee 401(k) plan in the
amounts of (A) $7,650, $6,310 and $7,200 to Mr. Appel for 2001, 2000 and
1999, respectively; (B) $7,650 and $6,070 to Ms. O'Connor for 2001 and 2000,
respectively; and (C) $7,650 and $6,310 to Mr. Petrillo for 2001 and 2000,
respectively; (2) pension contributions under a money purchase pension plan
in the amounts of (A) $12,980, $13,190 and $12,370 to Mr. Appel for 2001,
2000 and 1999, respectively; and (B) $12,980 and $13,190 to each of
Ms. O'Connor and Mr. Petrillo, respectively, for 2001 and 2000;
(3) contributions to Mr. Appel under an executive supplemental non-qualified
savings and retirement plan in the amounts $29,725, $29,725 and $31,175 for
2001, 2000 and 1999, respectively; and (4) term life insurance premiums in
the amounts of (A) $486, $486 and $594 to Mr. Appel for 2001, 2000 and 1999,
respectively; (B) $540 to Ms. O'Connor for 2001 and 2000; and (C) $486 and
$432 to Mr. Petrillo for 2001 and 2000, respectively.
(3) Mr. Evans was appointed president of Arch Re (Bermuda), and Mr. Ingrey was
appointed to the board of directors of AGCL and as chief executive officer
of Arch Re (Bermuda) on October 23, 2001. See "--Employment Arrangements"
for a description of their respective employment arrangements.
(4) On June 9, 2000, Ms. O'Connor, formerly senior vice president and controller
of the company's reinsurance subsidiary, became our senior vice president,
controller and treasurer. On May 5, 2000, Mr. Petrillo, formerly vice
president and associate general counsel of the company's reinsurance
subsidiary, became our senior vice president, general counsel and secretary.
(5) See "--Change in Control Arrangements" for a description of certain payments
made upon the closing of the sale of our prior reinsurance operations on May
2000.
The following table provides information regarding grants of stock options
made during fiscal year 2001 to each of the named executive officers.
67
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
---------------------------------------
NUMBER OF % OF TOTAL POTENTIAL REALIZABLE VALUE AT
SECURITIES OPTIONS ASSUMED ANNUAL RATES OF
UNDERLYING GRANTED TO STOCK PRICE APPRECIATION FOR
OPTIONS EMPLOYEES IN EXERCISE OR OPTION TERM(3)
GRANTED FISCAL BASE PRICE EXPIRATION ------------------------------
NAME (#)(1) YEAR(2) ($/SH) DATE 5% 10%
- ---- ---------- ------------ ----------- ---------- ------------- --------------
Peter A. Appel..................... 422,407 22.1% $20.00 10/23/11 $5,312,990 $13,464,159
Paul B. Ingrey..................... 422,407 22.1% 20.00 10/23/11 5,312,990 13,464,159
Dwight R. Evans.................... 100,000 5.2% 20.00 10/23/11 1,257,789 3,187,485
Debra M. O'Connor.................. 10,000 0.5% 20.00 15.00 10/23/11 125,779 318,748
10,000 0.5% 01/30/11 82,699 203,692
Louis T. Petrillo.................. 40,000 2.1% 20.00 10/23/11 503,116 1,274,994
10,000 0.5% 15.00 01/30/11 82,699 203,692
- ------------------------
(1) The terms for the options, including vesting schedules, are described below
under the caption "Incentive Compensation for Management and Directors."
(2) Pursuant to applicable SEC rules, percentages listed are based on options to
purchase a total of 1,915,690 common shares granted to employees during
fiscal year 2001.
(3) Potential realizable value is calculated based on an assumption that the
fair market value of our common shares appreciates at the annual rates shown
(5% and 10%), compounded annually, from the date of grant until the end of
the option term. The 5% and 10% assumed rates are mandated by the SEC for
purposes of calculating realizable value and do not represent our estimates
or projections of future share prices.
The following table provides information regarding the number and value of
options held by each of our named executive officers as of December 31, 2001. No
options were exercised by any executive officer during 2001.
AGGREGATED 2001 FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-THE-
OPTIONS AT MONEY OPTIONS AT
DECEMBER 31, 2001 DECEMBER 31, 2001(1)
--------------------------- -----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ------------- -------------
Peter A. Appel.................................. 315,800 372,407 $2,103,556 $2,141,340
Paul B. Ingrey.................................. 140,802 281,605 809,613 1,619,229
Dwight R. Evans................................. 33,333 66,667 191,665 383,335
Debra M. O'Connor............................... 57,332 6,668 354,203 38,341
Louis T. Petrillo............................... 61,126 26,674 396,170 153,376
- ------------------------
(1) For purposes of the above table, options are "in-the-money" if the market
price of the common shares on December 31, 2001 (I.E., $25.75) exceeded the
exercise price of such options. The value of such options is calculated by
determining the difference between the aggregate market price of the common
shares subject to the options on December 31, 2001 and the aggregate
exercise price of such options.
EMPLOYMENT ARRANGEMENTS
In connection with the capital infusion, Arch Re (Bermuda) appointed a new
management team, consisting of Paul B. Ingrey and Dwight R. Evans. In addition,
we appointed John M. Pasquesi as our executive vice chairman. We also appointed
Constantine Iordanou as chief executive officer of Arch Capital
68
Group (U.S.) Inc. We further appointed John D. Vollaro as our executive vice
president and chief financial officer. Set forth below is a summary of the
material terms of the employment, restricted share and option agreements with
each of Messrs. Ingrey, Evans, Pasquesi, Iordanou and Vollaro. You should read
these summaries in conjunction with our new 2001 Long-Term Incentive Plan for
New Employees (the "Incentive Plan") and the employment, restricted share and
option agreements, which are filed as exhibits hereto and incorporated herein by
reference.
PAUL B. INGREY AND DWIGHT R. EVANS
Mr. Ingrey has been appointed to our board of directors and as chief
executive officer of Arch Re (Bermuda). His employment agreement provides for an
annual base salary of $750,000.
Mr. Evans has been appointed president of Arch Re (Bermuda). His employment
agreement provides for an annual base salary of $500,000.
The annual base salary is subject to review annually for increase at the
discretion of the board. The target rate for the annual cash bonus is 100% of
the annual base salary. Messrs. Ingrey and Evans are eligible to receive annual
cash bonuses and stock-based awards at the discretion of our board and to
participate in our employee benefit programs. The initial term of each
employment agreement ends on October 23, 2004, but we or the executive may
terminate his employment at any time. The agreement will be automatically
extended for additional one-year periods, unless we or the executive gives
notice at least 60 days prior to the expiration of the original term or any
extended term. The agreement provides that if the employment of Mr. Ingrey or
Mr. Evans is terminated without cause or for good reason before October 23,
2004, he will be entitled to receive an amount equal to his annual base salary.
Each of Messrs. Ingrey and Evans agreed that, during the employment period
and for the period of two years after termination of employment, he will not
compete with the businesses of the company or any of its subsidiaries as such
businesses exist or are in process or being planned as of the date of
termination. The noncompetition period will be one year following termination if
we terminate his employment without cause, he terminates for good reason or he
gives notice of his intent not to extend his employment term in accordance with
the employment agreement. In such case, we may extend the noncompetition period
to up to an additional six months following this one-year period if we pay his
base salary for the additional six-month period. Each of Messrs. Ingrey and
Evans also agreed that he will not, for a period of two years following
termination, induce or attempt to induce any of our employees to leave his or
her position with the company or induce any customer to cease doing business
with us.
On October 23, 2001, as inducements essential to their entering into
employment agreements, we granted Messrs. Ingrey and Evans restricted shares and
options under the Incentive Plan as set forth in the table below.
NAME OPTIONS RESTRICTED SHARES
- ---- -------- -----------------
Paul B. Ingrey....................................... 422,407 422,407
Dwight R. Evans...................................... 100,000 50,000
The options are exercisable at $20.00 per share and expire on October 23,
2011. For each of Messrs. Ingrey and Evans, one-third of his options vested and
became exercisable at the closing of the investments, one-third will become
exercisable on October 23, 2002 and the remaining one-third will become
exercisable on October 23, 2003. If we terminate Mr. Evans without cause, the
terminated employee's options will remain exercisable (to the extent then
exercisable) for 90 days following termination of employment (but not beyond the
term of the option). In the event that Mr. Evans ceases to be an employee due to
death or permanent disability, all such employee's options will vest in full and
remain exercisable for the remainder of the term of the option.
In the event that Mr. Ingrey's employment terminates due to his death or
permanent disability, all of his options shall immediately vest and become
exercisable. In the event that Mr. Ingrey is terminated for
69
cause, all of his options will cease to be exercisable and will be immediately
forfeited. In the event that we terminate his employment other than for cause or
he resigns for good reason, Mr. Ingrey's options will vest according to the
schedule in the preceding paragraph and have a remaining term of three years
following termination. In the event of termination for any other reason, all
vested options held by Mr. Ingrey will remain exercisable for a period of
90 days from termination. To the extent that any of Mr. Ingrey's options have
not vested at the time of his termination, the options will be forfeited.
The restricted shares will vest on October 23, 2004 for Messrs. Ingrey and
Evans. If Mr. Evans is terminated due to his death or permanent disability, the
restricted shares granted to him will vest based upon the following schedule:
VESTED AMOUNT UPON
DATE OF TERMINATION TERMINATION
- ---------------------------------------------------------- ------------------
Prior to first anniversary of grant date.................. 1/3 of shares
Prior to second anniversary of grant date, but after first
anniversary of grant date............................... 2/3 of shares
After second anniversary of grant date.................... All shares
Any unvested shares held by Mr. Evans will be forfeited if he otherwise
terminates his service with us. Further, in the event that Mr. Evans is
terminated within two years after a change of control without cause or due to
permanent disability or he terminates his employment for good reason, all of his
restricted shares will vest immediately upon such termination.
In the event that Mr. Ingrey's employment terminates due to his death or
permanent disability or his employment is terminated by us without cause or he
resigns for good reason, all of his restricted shares will immediately vest. In
the event that Mr. Ingrey's employment is terminated by us without cause or he
resigns for good reason, his restricted shares will become fully transferable
pursuant to the normal vesting schedule (except that, following such
termination, he may sell an amount of shares to fund any income and employment
taxes relating to the award). In the event of termination for any other reason,
all restricted shares held by Mr. Ingrey will be forfeited.
JOHN M. PASQUESI
Mr. Pasquesi has been appointed our executive vice chairman. Mr. Pasquesi's
employment agreement provides for an annual base salary of $30,000. The term of
the employment agreement ends on October 24, 2003, but we or Mr. Pasquesi may
terminate his employment at any time. The agreement provides that if
Mr. Pasquesi's employment is terminated without cause or for good reason before
October 24, 2003, he will be entitled to receive an amount equal to six months
of his monthly base salary, reduced by amounts he receives from other employment
or self employment during such period. As one of our executive officers, he is
not entitled to any additional compensation for his service as a director.
Mr. Pasquesi agreed that he will not, for a period of two years following
termination of employment, induce or attempt to induce any of our employees to
leave his or her position with us.
On October 23, 2001, as an inducement essential to his entering into the
employment agreement, we granted Mr. Pasquesi options under our Incentive Plan
to purchase 375,473 common shares at an exercise price of $20.00 per share.
These options will vest on October 23, 2003 and expire on October 23, 2011. If
Mr. Pasquesi's employment is terminated without cause or for good reason or due
to his death or permanent disability, these options will vest and be exercisable
for the remainder of the option period. If he terminates his employment without
good reason or his employment is terminated by us with cause his unvested
options will be forfeited, and his vested options, to the extent then
exercisable, may be exercised for the remainder of the option period.
In addition, on October 23, 2001, in consideration for his providing
structuring and advisory services to us in connection with the investment, we
granted Mr. Pasquesi options to purchase 750,946 common shares at an exercise
price of $20.00 per share. These options vested upon grant and expire on
October 23, 2011.
70
This grant of options to purchase 750,946 common shares will be rescinded if it
is not approved by our shareholders prior to October 23, 2002. We will seek
shareholder approval of this grant at our next annual general meeting, and the
investors have committed to vote in favor of approval of these grants.
CONSTANTINE IORDANOU
In January 2002, Mr. Iordanou was appointed to our board of directors and as
chief executive officer of Arch Capital Group (U.S.) Inc. As chief executive
officer of Arch Capital Group (U.S.) Inc., Mr. Iordanou will be responsible for
the general management and oversight of the U.S. insurance operations of Arch
Capital Group (U.S.) Inc. and its affiliates.
His employment agreement provides for an annual base salary of $1,000,000.
His base salary is subject to review annually for increase at the discretion of
the board. Mr. Iordanou is eligible to participate in an annual bonus plan on
terms established from time to time and to participate in our employee benefit
programs. The target rate for the annual cash bonus is 100% of his annual base
salary.
The initial term of Mr. Iordanou's employment agreement ends on January 1,
2007, but we or Mr. Iordanou may terminate his employment at any time. The
agreement provides that it will be automatically extended for successive
one-year periods after the initial five-year term unless either we or
Mr. Iordanou gives at least 12 months notice of the intention not to renew.
The agreement provides that if Mr. Iordanou's employment is terminated by
his death, he will receive a prorated portion of his bonus that would have been
paid for the year of his death and an amount equal to two times the sum of his
base salary and target annual bonus payable in a lump sum. His agreement also
provides that if his employment is terminated by permanent disability, he will
receive a prorated portion of his bonus that would have been paid for the year
in which he becomes disabled, as determined by the board, and an amount equal to
40% of his base salary payable in monthly installments during the period of his
disability extending through the time period provided for the company's
disability plan. The agreement further provides that if we terminate
Mr. Iordanou's employment without cause or he resigns for good reason, he will
receive a prorated portion of his bonus that would have been paid for the year
of his termination and an amount equal to two times the sum of his base salary
and target annual bonus payable over an 18-month period in equal monthly
installments. Mr. Iordanou's major medical insurance coverage benefits pursuant
to his employment agreement shall continue for 18 months after the date of
termination in the event that (1) his employment ends due to death or permanent
disability, (2) he is terminated other than for cause or (3) he resigns for good
reason (or until such time as he has major medical insurance coverage under the
plan of another employer). The agreement also provides that if Mr. Iordanou's
employment is terminated by the company for cause or he resigns other than for
good reason, he will receive his base salary through the date of termination.
Mr. Iordanou has agreed that, during the employment period and for the
period of 18 months after termination of employment, he will not compete with
the businesses of the company or any of its subsidiaries as such businesses
exist or are in process or being planned as of the date of termination. If we
terminate Mr. Iordanou's employment without cause or he terminates for good
reason, the term of his non-competition period will extend only as long as he is
receiving benefits under the company's major medical insurance coverage.
Further, Mr. Iordanou has agreed to extend the non-competition period for a
period of 18 months in the event of termination due to the expiration of the
five-year term of his agreement if he is paid an amount equal to two times his
base salary and annual target bonus (payable in equal monthly installments over
that period) and he remains covered by the company's major medical insurance
plan. Mr. Iordanou also agreed that he will not, for an 18-month period
following his date of termination, induce or attempt to induce any of our
employees to leave his or her position with the company or induce any customer
to cease doing business with us.
As inducements essential to his entering into his employment agreement, as
of January 1, 2002, we granted Mr. Iordanou, under the Incentive Plan, 106,383
restricted shares as a signing bonus, 325,000
71
additional restricted shares and options to purchase 425,000 common shares at an
exercise price equal to $23.50 per share.
Mr. Iordanou's options expire on January 1, 2012. One-third of his options
vested and became exercisable on the date of grant; one-third will become
exercisable on January 1, 2003; and the remaining one-third will become
exercisable on January 1, 2004. In the event that his employment terminates due
to his death or permanent disability, all of Mr. Iordanou's options shall
immediately vest and become exercisable. In the event that Mr. Iordanou is
terminated for cause, all of his options will cease to be exercisable and will
be immediately forfeited. In the event that we terminate his employment other
than for cause or he resigns for good reason, Mr. Iordanou's options will vest
according to the schedule described above and have a remaining term of three
years following termination. In the event of termination for any other reason,
all vested options held by Mr. Iordanou will remain exercisable for a period of
90 days from termination. To the extent that any of Mr. Iordanou's options have
not vested at the time of his termination, the options will be forfeited.
The restricted shares Mr. Iordanou received as a signing bonus will vest on
December 31, 2002, and the remainder of his restricted shares will vest on
December 31, 2006. In the event that his employment terminates due to his death
or permanent disability or his employment is terminated by the company without
cause or he resigns for good reason, all of his restricted shares will
immediately vest. In the case of termination by the company without cause or
resignation for good reason, however, the newly vested shares may not be
transferred (1) in the case of restricted shares granted as a signing bonus,
until December 31, 2002 and (2) in the case of all other restricted shares,
until December 31, 2006 (except that, following such termination, he may sell an
amount of shares to fund any income and employment taxes relating to the award).
In the event of termination for any other reason, all restricted shares held by
Mr. Iordanou will be forfeited.
JOHN D. VOLLARO
Mr. Vollaro has been appointed as our executive vice president and chief
financial officer. Mr. Vollaro's employment agreement provides for an annual
base salary of $400,000. Mr.Vollaro is eligible to participate in an annual
bonus plan on terms established from time to time by our board and to
participate in our employee benefit programs. The target rate for the annual
bonus is 100% of his annual base salary.
The term of his employment agreement ends on January 18, 2005, but we or
Mr. Vollaro may terminate his employment at any time. The agreement provides
that it will be automatically extended for successive one-year periods after the
initial three-year term unless either we or Mr. Vollaro gives at least 60 days
notice of the intention not to renew.
The agreement provides that if Mr. Vollaro's employment is terminated
without cause or for good reason before January 18, 2005, he will be entitled to
receive an amount equal to the greater of (1) 18 months of his base salary and
(2) the total remaining base salary which would have been paid for the remainder
of his employment term (payable in equal monthly installments commencing on the
first month anniversary of the date of termination). The agreement also provides
that if Mr. Vollaro's employment is terminated for cause, as a result of his
resignation or leaving employment other than for good reason, as a result of
death or permanent disability, or by written notice of the intention not to
renew the agreement by us or Mr. Vollaro, he will be entitled to receive solely
his base salary through the date of termination. The agreement further provides
that if Mr. Vollaro's employment is terminated by reason of death or permanent
disability, he will also be entitled to receive his annual bonus prorated
through the date of termination, provided that such bonus will not be less than
the average annual bonus received for the preceding three years; and, if he has
not received bonuses for three years, he will receive a prorated portion of the
average of the bonuses received, if any, but not less than a prorated portion of
90% of his base salary.
72
Mr. Vollaro has agreed that, during the employment period and for a period
of two years after termination of employment for cause or as a result of his
resignation or leaving employment other than for good reason, he will not
compete with the businesses of ACGL or any of its subsidiaries as such
businesses exist or are in process or being planned as of the date of
termination. If we terminate Mr. Vollaro's employment without cause or he
terminates for good reason, the term of his non-competition period will extend
only as long as he is receiving his severance payments and benefits under our
major medical insurance coverage. Further, Mr. Vollaro has agreed to a
non-competition period of two years if his termination results from notice of
the intent not to renew the agreement by us or Mr. Vollaro, and we agree in
writing to pay him the sum of base salary and target annual bonus for such
period, payable in monthly installments over such period. Mr. Vollaro also
agreed that he will not, for a period of two years following his date of
termination, induce or attempt to induce any of our employees to leave his or
her position with us or induce any customer to cease doing business with us.
As inducements essential to his entering into his employment agreement, on
January 18, 2002 we granted Mr. Vollaro, under our Incentive Plan, 50,000
restricted shares and options to purchase 85,000 common shares at an exercise
price of $25.30 per share.
Mr. Vollaro's options expire on January 18, 2012. One-third of his options
vested and became exercisable on the date of grant; one-third will become
exercisable on January 18, 2003; and the remaining one-third will become
exercisable on January 18, 2004. In the event that his employment terminates due
to his death or permanent disability, all of Mr. Vollaro's options shall
immediately vest and become exercisable. In the event that Mr. Vollaro is
terminated for cause, all of his options will cease to be exercisable and will
be immediately forfeited. In the event of termination for any other reason, all
vested options held by Mr. Vollaro will remain exercisable for a period of
90 days from termination. To the extent that any of Mr. Vollaro's options have
not vested at the time of his termination, the options will be forfeited.
Mr. Vollaro's restricted shares will vest on January 18, 2007. In the event
that his employment terminates due to his death or permanent disability or his
employment is terminated by the company without cause or he resigns for good
reason, or if his employment terminates due to written notice by us of the
intent not to extend his employment contract, a pro rata number of restricted
shares subject to the award will vest in full on the date of termination,
determined by multiplying the total number of restricted shares subject to the
award by a fraction, the numerator of which is the number of months or part of a
month elapsed since January 18, 2002 and the denominator of which is 60. In the
case of termination by us without cause or resignation by Mr. Vollaro for good
reason, however, the newly vested shares may not be transferred until
January 18, 2007 (except that, following such termination, he may sell an amount
of shares to fund any income and employment taxes relating to the award). In the
event of termination for any other reason, all restricted shares held by
Mr. Vollaro will be forfeited. In the event that, within two years following a
change of control of ACGL, Mr. Vollaro's employment terminates due to his death
or permanent disability or his employment is terminated by us without cause or
he resigns for good reason, all of his restricted shares will immediately vest.
INCENTIVE COMPENSATION FOR MANAGEMENT AND DIRECTORS
Also in connection with the investments, certain directors and members of
management were granted stock-based awards under our existing incentive
compensation plans or otherwise, as described below. You should read these
summaries in conjunction with the restricted share and option agreements, which
are filed as exhibits hereto and incorporated by reference.
ROBERT CLEMENTS
Mr. Clements, our chairman, was granted a total of 1,689,629 restricted
shares. Of this total, 1,668,157 restricted shares were granted on October 23,
2001 and 21,472 restricted shares were granted on November 19, 2001. The
restricted shares will vest in five equal annual installments commencing on
73
October 23, 2002. However, if Mr. Clements' service as chairman is terminated by
us or is not continued by us for any reason, or his service terminates due to
his death or permanent disability, the restricted shares will vest in full upon
such termination of service. Any unvested shares will be forfeited if
Mr. Clements otherwise terminates his service with us. In addition,
Mr. Clements has agreed that, in the event his service is terminated by us prior
to the fifth anniversary of the date of grant, he will not compete with us
during the period ending on the later of such fifth anniversary or one year
following such termination of service. These grants to Mr. Clements will be
rescinded if they are not approved by our shareholders prior to October 23,
2002. We will seek shareholder approval of these grants to Mr. Clements at our
next annual general meeting, and the investors have committed to vote in favor
of approval of these grants.
In connection with these transactions, we entered into a retention agreement
with Mr. Clements, which replaced our existing retention and change in control
agreement with Mr. Clements. Under the retention agreement, he will continue to
receive compensation at an annual rate equal to one-half of the salary of ACGL's
chief executive officer, payable in restricted shares that vest on January 1 of
the following year. For 2001, under this formula, he received 7,282 restricted
shares ($187,500 divided by $25.75, the closing market price of our common
shares on January 1, 2001), which will vest on January 1, 2002. Mr. Clements
will continue to be eligible to receive a cash bonus at the discretion of the
compensation committee. If Mr. Clements's service as chairman of our board is
terminated for any reason, he will be entitled to receive an amount equal to a
prorated portion of his compensation for that year. In addition, a subsidiary of
ACGL has agreed to make a loan of $13,530,000 to Mr. Clements, which will be
used to pay income and self employment taxes, payable in April 2002, on the
restricted shares granted to him on October 23, 2001. The loan will bear
interest at the applicable federal rate and mature on the fifth anniversary of
borrowing. If we terminate Mr. Clements' service as chairman of the board for
cause, the loan will become immediately payable. Mr. Clements will receive
additional compensation in cash in an amount sufficient to defray the interest
cost. In addition, we have agreed to make gross-up payments to him in the event
of certain tax liabilities. Mr. Clements agreed that, for a period of one year
after termination of service, he will not induce or attempt to induce any of our
employees to leave his or her position with the company. In connection with
these arrangements, Mr. Clements waived his right to receive any non-employee
director compensation. Mr. Clements' previous retention and change in control
agreement provided that upon involuntary termination (other than for cause) or
constructive termination within 24 months following a change in control,
Mr. Clements would be entitled to a payment equal to 2.99 times the sum of his
annual compensation plus his bonus for the previous year. This provision is no
longer in effect.
PETER APPEL. Mr. Appel, our chief executive officer, was granted options to
purchase a total of 422,407 common shares at an exercise price of $20.00 per
share. Of these options, 50,000 vested and became exercisable upon grant;
172,407 will become vested and exercisable on the Vesting Date, and 200,000 will
become vested on the Vesting Date and become exercisable on the later of
(x) the Vesting Date and (y) the earliest of (i) our common shares trading at or
above $30.00 per share for 20 out of 30 consecutive trading days, (ii) the
occurrence of a change of control and (iii) the date on which no class B
warrants are outstanding. "Vesting Date" means the earlier of (1) the date we
have consummated the sale or other disposition or settlement of at least 50% of
certain of our non-core assets and (2) October 23, 2002. If we terminate
Mr. Appel's service as chief executive officer for any reason, his service
terminates due to his death or permanent disability, or he terminates his
service for good reason, any unvested options granted to Mr. Appel will vest in
full upon such termination of service and continue to be exercisable for the
remainder of the option period. In the event that Mr. Appel terminates his
service without good reason, any vested options will continue to be, or become,
exercisable for the remainder of the option period, but any unvested options
will be forfeited. In addition, Mr. Appel has agreed that during the term of his
employment and, in the event his service with us is terminated for any reason,
for a period ending two years after his termination, (1) he will not compete
with any of our or our subsidiaries' insurance or reinsurance businesses as they
exist on the date of his termination and (2) he will not induce or attempt to
induce any of our employees to leave his or her position with the company.
74
DEBRA O'CONNOR AND LOUIS PETRILLO. Mr. Petrillo was granted options to
purchase 40,000 common shares and Ms. O'Connor was granted options to purchase
10,000 common shares. These options are exercisable at an exercise price of
$20.00 per share. One-third of these options became exercisable at the closing,
one-third will become exercisable on October 23, 2002 and the remaining
one-third will become exercisable on October 23, 2003. If we terminate
Mr. Petrillo or Ms. O'Connor without cause, the terminated employee's options
will remain exercisable (to the extent then exercisable) for 90 days following
termination of employment (but not beyond the option period). In the event that
any such employee ceases to be an employee due to death or permanent disability,
all such employee's options will vest in full and remain exercisable for the
remainder of the option period.
Ms. O'Connor's terms of employment provide for an annual base salary of
$225,000. The salary is subject to review annually for increase at the
discretion of the board. The target rate for the annual cash bonus for
Ms. O'Connor is 50% of her annual base salary. Ms. O'Connor is eligible to
receive an annual cash bonus and stock-based awards at the discretion of the
board and to participate in our employee benefit programs. The company or
Ms. O'Connor may terminate her employment at any time.
Mr. Petrillo's terms of employment provide for an annual base salary of
$275,000. The salary is subject to review annually for increase at the
discretion of the board. The target rate for the annual cash bonus for
Mr. Petrillo is 75% of his annual base salary. Mr. Petrillo is eligible to
receive an annual cash bonus and stock-based awards at the discretion of the
board and to participate in our employee benefit programs. The company or
Mr. Petrillo may terminate his employment at any time.
DIRECTORS. In addition, each current director of the company (other than
Messrs. Clements and Appel), and Mr. Ian Heap, who resigned from the board in
2001, were granted options to purchase 15,000 common shares at an exercise price
of $20.00 per share. These options vested upon grant and expire on October 23,
2011.
OTHER. The restricted share awards and option grants for Messrs. Ingrey,
Evans, Pasquesi, Iordanou and Vollaro are described under "--Employment
Arrangements."
CHANGE IN CONTROL ARRANGEMENTS
The sale of our prior reinsurance operations to Folksamerica Reinsurance
Company in May 2000 constituted a change in control for purposes of our prior
change in control arrangements. Under these arrangements, all unvested stock
options and restricted shares held by our employees and the members of our board
of directors (other than Mr. Clements) vested in connection with the asset sale.
In addition, the following payments were made to our executive officers upon
closing of the asset sale: Mark D. Mosca, $2,716,714; Peter A. Appel,
$1,476,563; Paul J. Malvasio, $1,220,625; and Debra M. O'Connor, $475,440. These
amounts were equal to a specified multiple of the sum of such executive
officer's annual base salary and target annual bonus (or, in the case of
Mr. Mosca, a notional target amount equal to 100% of his annual base salary).
The specified multiple was 2.99 for Mr. Mosca, 2.25 for Messrs. Appel and
Malvasio, and 2.0 for Ms. O'Connor. Such payments did not exceed an amount that
would trigger the payment of excise taxes, and were not subject to mitigation in
the event that such officer receives any compensation from other employment
following his termination. In addition, a prorated portion of the following
executive officer's target annual bonus (or, in the case of Mr. Mosca, a
prorated portion of a notional target amount equal to 100% of his annual base
salary) was paid to such officers at the closing of the asset sale, as follows:
Mr. Mosca: $156,398; Mr. Appel: $96,823; Mr. Malvasio: $80,040; Ms. O'Connor:
$30,457; and Mr. Petrillo: $30,446. Each executive officer is also entitled to
continuance of his health care, dental, disability and group-term and life
insurance benefits for prescribed periods. In addition, Robert Clements,
chairman of our board, received a special bonus
75
of $300,000 upon the consummation of the asset sale. There are no continuing
change in control arrangements with our present officers and employees, except
that in connection with his employment as general counsel and secretary, we
entered into a change in control arrangement with Mr. Petrillo which provides
that upon involuntary termination (other than for cause) or constructive
termination within 24 months following a change in control, Mr. Petrillo would
be entitled to a payment equal to 2.0 times the sum of his annual base salary
and target annual bonus. In addition, upon termination of his employment
following a change in control, we will pay him a prorated portion of his target
annual bonus for such year and continue health care, dental, disability and
group-term and life insurance benefits for 24 months.
DIRECTOR COMPENSATION
Each non-employee member of our board of directors is entitled to receive an
annual cash retainer fee in the amount of $25,000. Commencing with the 1999-2000
annual period, each non-employee director is entitled, at his option, to receive
this retainer fee in the form of common shares instead of cash. If so elected,
the number of shares distributed to the non-employee director is equal to 120%
of the amount of the annual retainer fee otherwise payable divided by the fair
market value of our common shares. Each non-employee director also receives from
the company a meeting fee of $1,000 for each board or committee meeting
attended. In addition, each non-employee director serving as chairman of the
(1) executive committee or compensation committee received an annual fee of
$3,000 and (2) audit committee received an annual fee of $5,000. All
non-employee directors are entitled to reimbursement for their reasonable
out-of-pocket expenses in connection with their travel to and attendance at
meetings of the board or committees. Directors who are also employees of the
company or its subsidiaries receive no cash compensation for serving as
directors or as members of board committees.
In 2001, pursuant to our long-term incentive and share award plans, upon
joining the board, each non-employee director received an option to purchase 300
common shares at an exercise price per share equal to the then market price of a
common share. In 2001, our plans also provided for automatic annual grants to
non-employee directors of options to purchase common shares on January 1 of each
year. Commencing January 1, 2000, the amount of shares covered by this item is incorporatedannual
grant was increased from 500 to 1,500 shares.
COMPENSATION AND STOCK AWARDS COMMITTEES INTERLOCKS AND INSIDER PARTICIPATION
The compensation committee of our board of directors currently consists of
John Bunce (chairman), Kewsong Lee, James Meenaghan and Robert Works. None of
the members of the committees are or have been officers or employees of the
company. In addition, no executive officer of the company served on any board of
directors or compensation committee of any entity (other than the company) with
which any member of our board serves as an executive officer. Pursuant to the
shareholders agreement entered into in connection with the private placement,
Messrs. Bunce and Lee have been designated as members of our board of directors
by reference form the
information to be included in the annual meeting proxy statement under the
headings "Election of Directors--Directorsfunds affiliated with Hellman & Friedman LLC and Executive Officers--Compensation
of Directors," "Election of Directors--Executive Compensation" and
"--Performance Graph."Warburg Pincus LLC,
respectively.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information requiredavailable to us as of March 8,
2002 with respect to the ownership of our voting shares by this item is incorporated by reference from the
information(1) each person known
to us to be includedthe beneficial owner of more than 5% of any class of our outstanding
voting shares, (2) each director and executive officer of ACGL, and (3) all of
the directors and executive officers of ACGL as a group. Except as otherwise
indicated, each person named below has sole investment and voting power with
respect to the securities shown.
76
Please note that this table addresses ownership of voting shares; it does
not address the voting power of those shares, which, in some cases, is different
than the percentage set forth below.
COMMON SHARES
- ---------------------------------------------------------------------------------------------------------
(A) (B) (C)
NUMBER OF
COMMON SHARES RULE 13D-3 FULLY-DILUTED
BENEFICIALLY OWNED PERCENTAGE OWNERSHIP PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER (1) (1) (2)
- ------------------------------------ ------------------ -------------------- -------------
Warburg Pincus (3) ........................... 20,943,229 57.1% 33.8%
c/o 466 Lexington Avenue
New York, New York 10017
H&F Corporate Investors IV
(Bermuda), Ltd. (4) ........................ 11,636,491 42.5 18.8
c/o A.S.&K. Services Ltd.
41 Cedar Avenue
Hamilton HM 12, Bermuda
Insurance Private Equity Investors, L.L.C. 2,585,583 14.1 4.2
(5) ........................................
3003 Summer Street
Stamford, CT 06905
EQSF Advisers, Inc. and M.J. Whitman
Advisers, Inc. (6) ......................... 2,426,905 15.4 3.9
767 Third Avenue
New York, New York 10017
Marsh & McLennan Risk Capital
Holdings, Ltd. (7) ......................... 1,632,231 10.3 2.6
1166 Avenue of the Americas
New York, New York 10036
Trident II, L.P. (8) ......................... 1,713,681 9.8 2.8
Craig Appin House
8 Wesley Street
Hamilton HM 11 Bermuda
The Trident Partnership, L.P. (9) ............ 1,636,079 9.5 2.6
Craig Appin House
8 Wesley Street
Hamilton, HM11, Bermuda
Farallon Partners, L.L.C. (10) ............... 1,292,791 7.6 2.1
One Maritime Plaza
Suite 1325
San Francisco, CA 94111
Artisan Partners Limited Partnership (11) .... 1,162,684 7.4 1.9
1000 North Water Street, #1770
Milwaukee, Wisconsin 53202
Beck, Mack & Oliver LLC (12) ................. 1,113,850 7.1 1.8
330 Madison Avenue
New York, New York 10017
Steinberg Priest Capital Management 1,438,147 9.1 2.3
77
COMMON SHARES
- ---------------------------------------------------------------------------------------------------------
(A) (B) (C)
NUMBER OF
COMMON SHARES RULE 13D-3 FULLY-DILUTED
BENEFICIALLY OWNED PERCENTAGE OWNERSHIP PERCENTAGE
NAME AND ADDRESS OF BENEFICIAL OWNER (1) (1) (2)
- ------------------------------------ ------------------ -------------------- -------------
Co., Inc. (13) .............................
12 East 49th Street
New York, New York 10017
Franklin Resources, Inc. (14) ................ 842,900 5.3 1.4
777 Mariners Island Boulevard
San Mateo, California 94404
Crabbe Huson Group, Inc. (15) ................ 809,887 5.1 1.3
121 SW Morrison, Suite 1400
Portland, Oregon 97204
Robert Clements (16).......................... 2,315,751 14.3 3.9
Peter A. Appel (17)........................... 502,406 3.1 1.4
John L. Bunce, Jr. (18)....................... 11,636,491 42.5 18.8
Paul B. Ingrey (19)........................... 666,632 4.2 1.5
Constantine Iordanou (20)..................... 573,050 3.6 1.4
Kewsong Lee (21).............................. 20,944,592 57.1 33.9
James J. Meenaghan (22)....................... 17,113 * *
John M. Pasquesi (23)......................... 1,138,784 6.7 2.5
Robert F. Works (24).......................... 23,972 * *
Dwight R. Evans (25).......................... 104,017 * *
John D. Vollaro (26).......................... 78,333 * *
Debra M. O'Connor (27)........................ 72,319 * *
Louis T. Petrillo (28)........................ 70,131 * *
All directors and executive officers (13 38,143,591 75.9% 64.2%
persons)....................................
SERIES A CONVERTIBLE PREFERENCE SHARES
- ---------------------------------------------------------------------------------------------------
NUMBER OF PREFERENCE RULE 13D-3
SHARES BENEFICIALLY OWNED PERCENTAGE OWNERSHIP
NAME AND ADDRESS OF BENEFICIAL OWNER (29) (29)
- ------------------------------------ ------------------------- --------------------
Warburg Pincus (3)............................... 18,939,311 53.1%
H&F Corporate Investors IV (Bermuda), Ltd. (4)... 10,521,839 29.5
Insurance Private Equity Investors, L.L.C. (5)... 2,338,186 6.6
Robert Clements (16)............................. 93,527 *
Peter A. Appel (17).............................. 46,763 *
John L. Bunce, Jr. (18).......................... 10,521,839 29.5
Paul B. Ingrey (19).............................. 93,527 *
Constantine Iordanou............................. 0 0
78
SERIES A CONVERTIBLE PREFERENCE SHARES
- ---------------------------------------------------------------------------------------------------
NUMBER OF PREFERENCE RULE 13D-3
SHARES BENEFICIALLY OWNED PERCENTAGE OWNERSHIP
NAME AND ADDRESS OF BENEFICIAL OWNER (29) (29)
- ------------------------------------ ------------------------- --------------------
Kewsong Lee (21)................................. 18,939,311 53.1
James J. Meenaghan............................... 0 0
John M. Pasquesi (23)............................ 350,728 1.0
Robert F. Works.................................. 0 0
Dwight R. Evans (25)............................. 18,705 *
Debra O'Connor................................... 0 0
Louis T. Petrillo................................ 0 0
All directors and executive officers (13
persons)....................................... 30,064,400 84.2%
- ------------------------
* Denotes beneficial ownership of less than 1.0%.
(1) Pursuant to Rule 13d-3 promulgated under the Exchange Act, amounts shown
include common shares that may be acquired by a person within 60 days of
March 8, 2002. Therefore, column (B) has been computed based on
(a) 15,765,332 common shares actually outstanding as of March 8, 2002 and
(b) common shares that may be acquired within 60 days of March 8, 2002 upon
the exercise of options and warrants and conversion of preference shares
held only by the person whose Rule 13d-3 Percentage Ownership of Common
Shares is being computed. Each preference share is convertible into one
common share, subject to adjustments. The preference shares are mandatorily
convertible under certain circumstances. Under the subscription agreements,
the purchase price for the preference shares is subject to certain
adjustments, which may result in the annual meeting proxy statementissuance of additional preference
shares and class A warrants to the purchasers. For a description of the
adjustments, see "Business--Recent Developments--The Capital
Infusion--Subscription Agreement--Purchase Price Adjustments."
(2) Amounts shown under column (C) in the above table have been computed based
on (a) 15,765,332 common shares actually outstanding as of March 8, 2002
and, (b) common shares that may be acquired upon the exercise of all
outstanding options and warrants and conversion of all preference shares,
whether or not such options and warrants are exercisable within 60 days held
by all persons, and as of March 8, 2002, there were outstanding
(i) class A warrants to purchase an aggregate of 5,401,707 common shares,
(ii) class B warrants to purchase an aggregate of 150,000 common shares,
(iii) options to purchase an aggregate of 4,883,811 common shares and
(iv) 35,687,735 preference shares. The class A warrants are currently
exercisable at $20 per share and expire on September 19, 2002. The class B
warrants are exercisable at $20 per share at any time after our common
shares have traded at or above $30 per share for 20 out of 30 consecutive
trading days or a change of control has occurred and expire on
September 19, 2005. See note (1) for a description of the preference shares.
(3) The security holders are Warburg Pincus (Bermuda) Private Equity VIII, L.P.
("WP VIII Bermuda"), Warburg Pincus (Bermuda) International Partners, L.P.
("WPIP Bermuda"), Warburg Pincus Netherlands International Partners I, C.V.
("WPIP Netherlands I") and Warburg Pincus Netherlands International Partners
II, C.V. ("WPIP Netherlands II"). Warburg Pincus (Bermuda) Private
Equity Ltd. ("WP VIII Bermuda Ltd.") is the sole general partner of WP VIII
Bermuda. Warburg Pincus (Bermuda) International Ltd. ("WPIP Bermuda Ltd.")
is the sole general partner of WPIP Bermuda. Warburg, Pincus & Co. ("WP") is
the sole general partner of WPIP Netherlands I and WPIP Netherlands II. WP
VIII Bermuda, WPIP Bermuda, WPIP Netherlands I
79
and WPIP Netherlands II are managed by Warburg Pincus LLC ("WP LLC"). The
foregoing is based on a Schedule 13D and a Form 3 dated November 30, 2001
filed with the SEC by these entities. Amounts in columns (A), (B) and
(C) reflect common shares issuable upon conversion of preference shares or
exercise of class A warrants issued under the heading "Electionsubscription agreements.
(4) The security holders are HFCP IV (Bermuda), L.P. ("HFCP IV Bermuda"), H&F
International Partners IV-A (Bermuda), L.P. ("HFIP IV-A Bermuda"), H&F
International Partners IV-B (Bermuda), L.P. ("HFIP IV-B Bermuda") and H&F
Executive Fund IV (Bermuda), L.P. ("HFEF Bermuda," and together with HFCP IV
Bermuda, HFIP IV-A Bermuda and HFIP IV-B Bermuda, the "H&F Funds"). H&F
Investors IV (Bermuda), L.P. ("HFI IV Bermuda") is the sole general partner
of Directors--Security Ownershipthe H&F Funds. H&F Corporate Investors IV (Bermuda) Ltd. ("HFCI Bermuda")
is the sole general partner of Certain Beneficial OwnersHFI IV Bermuda. HFI IV Bermuda may be deemed
to control the H&F Funds. The foregoing is based on a Schedule 13D and Management.a
Form 3 dated November 30, 2001 filed with the SEC by these entities. Amounts
in columns (A), (B) and (C) reflect (a) common shares issuable upon
conversion of preference shares or exercise of class A warrants issued under
the subscription agreements, (b) 1,263 common shares owned by Mr. Bunce for
the benefit of these entities and (c) 100 common shares issuable upon
exercise of currently exercisable options held by Mr. Bunce for the benefit
of these entities.
(5) Insurance Private Equity Investors, L.L.C. ("Insurance") is a wholly owned
subsidiary of General Electric Pension Trust ("GEPT"), which is an employee
benefit plan for the benefit of employees of General Electric Company
("GE"). GE Asset Management Incorporated ("GEAM"), a wholly owned subsidiary
of GE, acts as manager of Insurance and as investment manager of GEPT.
Insurance, GEPT and GEAM may be deemed to share beneficial ownership.
Excludes securities held by Orbital Holdings, Ltd., which is an indirect
wholly owned subsidiary of GE, as to which Insurance, GEPT and GEAM disclaim
beneficial ownership. Based on a Schedule 13D filed on November 30, 2001 by
these entities. Amounts in columns (A), (B) and (C) reflect common shares
issuable upon conversion of preference shares or exercise of class A
warrants issued under the subscription agreements.
(6) Based upon a Schedule 13G/A dated February 5, 2002, filed with the SEC
jointly by EQSF Advisers, Inc. and M.J. Whitman Advisers, Inc. ("MJWA"),
each an investment advisor, and Martin J. Whitman. In the Schedule 13G/A,
EQSF reported that it has sole voting power and sole dispositive power with
respect to 1,203,500 common shares and MJWA reported that it has sole
dispositive power with respect to 1,223,405 common shares and sole voting
power with respect to 1,144,355 common shares.
(7) Amounts in columns (A), (B) and (C) reflect common shares issuable upon
conversion of preference shares or exercise of class A warrants issued under
the subscription agreements and 1,536,005 common shares owned directly by
MMRCH. The preference shares and class A warrants are held by Marsh &
McLennan Capital Professionals Fund, L.P. and Marsh & McLennan Employees'
Securities Company, L.P., which are beneficially owned by employees of
Marsh & McLennan, Inc. A subsidiary of MMRCH is the sole general partner of
these funds, as well as the sole general partner of Trident II L.P. and The
Trident Partnership L.P.
(8) Amounts in columns (A), (B) and (C) reflect common shares issuable upon
conversion of preference shares or exercise of class A warrants issued under
the subscription agreements.
(9) Amounts in columns reflect (a) 250,000 common shares owned directly by The
Trident Partnership, L.P. and (b) 1,386,079 common shares issuable upon the
exercise of class A warrants held by The Trident Partnership, L.P. Based
upon a Schedule 13D dated March 27, 1998, filed with the SEC by The Trident
Partnership, L.P. The sole general partner of the partnership is a
subsidiary of MMRCH.
80
(10) The security holders are Farallon Capital Partners, L.P., Farallon Capital
Institutional Partners II, L.P., Farallon Capital Institutional Partners
III, L.P. and RR Capital Partners, L.P. Farallon Partners, L.L.C. is the
sole general partner of each of these holders. Amounts in columns (A),
(B) and (C) reflect common shares issuable upon conversion of preference
shares or exercise of class A warrants issued under the subscription
agreements.
(11) Based upon a Schedule 13G dated February 13, 2002, filed with the SEC by
Artisan Partners Limited Partnership and certain of its affiliates
(collectively, "Artisan"). In the Schedule 13G, Artisan reported that it has
sole voting power and sole dispositive power with respect to 1,162,684
common shares beneficially owned by one or more discretionary clients of
Artisan.
(12) Based upon a Schedule 13G dated February 11, 2002, filed with the SEC by
Beck, Mack & Oliver LLC, an investment advisor. In the Schedule 13G, Beck
reported that it has shared dispositive power with respect to 1,113,850
common shares beneficially owned by its clients.
(13) Based upon a Schedule 13G dated January 28, 2002, filed with the SEC
jointly by Steinberg Priest Capital Management Co., Inc. ("SPCM"), an
investment advisor, and Michael A. Steinberg & Co., Inc., a broker-dealer.
In the Schedule 13G, SPCM reported that it has sole voting power with
respect to 659,450 common shares and sole dispositive power with respect to
1,416,277 common shares, and Steinberg & Co. reported that it has sole
dispositive power with respect to 21,870 common shares.
(14) Based upon a Schedule 13G dated February 14, 2002, filed with the SEC by
Franklin Resources, Inc. and certain of its affiliates (collectively,
"FRI"). In the Schedule 13G, FRI reported that it has sole voting power and
sole dispositive power with respect to 842,900 common shares beneficially
owned by one or more managed accounts which are advised by investment
advisory subsidiaries of FRI.
(15) Based upon a Schedule 13G dated February 3, 2000, filed with the SEC by the
Crabbe Huson Group, Inc., an investment advisor. In the Schedule 13G, Crabbe
Huson reported that it has shared voting power with respect to 774,287
common shares and shared dispositive power with respect to 809,887 common
shares beneficially owned by its clients.
(16) Amounts in columns (A) and (B) reflect (a) 1,810,600 common shares owned
directly by Mr. Clements (including 1,696,911 restricted shares, which are
subject to vesting), (b) 200,000 common shares issuable upon exercise of
class A warrants owned directly by Mr. Clements, (c) 107,125 common shares
issuable upon exercise of currently exercisable options owned directly by
Mr. Clements, (d) 55,000 common shares owned by Taracay Investors,
(e) 39,603 common shares issuable upon exercise of class A warrants owned by
Taracay Investors and (f) common shares issuable upon conversion of
preference shares or exercise of class A warrants owned by SoundView
Partners, L.P. The amount in column (C) includes 107,198 common shares
issuable upon exercise of class B warrants, which are not currently
exercisable within 60 days of the date hereof. Taracay Investors is a
general partnership, the general partners of which consist of Mr. Clements
and members of his family and the managing partner of which is
Mr. Clements. Mr. Clements is the general partner of SoundView.
(17) Amounts in columns (A) and (B) reflect (a) 134,895 common shares owned
directly by Mr. Appel, (b) 315,800 common shares issuable upon exercise of
currently exercisable options and (c) common shares issuable upon conversion
of preference shares or exercise of class A warrants. The amount in column
(C) includes 372,407 common shares issuable upon exercise of stock options
that are not likely to become exercisable within 60 days of the date hereof.
(18) Amounts in all columns reflect securities held by or the benefit of the
entities listed in note (5). Mr. Bunce is a member of an investment
committee of HFCI Bermuda which has investment discretion over the
securities held by the H&F Funds. Mr. Bunce is a 9.9% shareholder of HFCI
81
Bermuda. All shares indicated as owned by Mr. Bunce are included because he
is a member of our board and is affiliated with HFCI Bermuda. Mr. Bunce may
be deemed to have an indirect pecuniary interest (within the meaning of
Rule 16a-1 under the Exchange Act) in an indeterminate portion of the shares
beneficially owned by the H&F Funds. Mr. Bunce disclaims beneficial
ownership of all shares owned by the H&F Funds, except to the extent of his
indirect pecuniary interest in the issuer held through the H&F Funds. Based
on a Form 3 dated November 30, 2001 filed with the SEC by Mr. Bunce.
(19) Amounts in columns (A) and (B) reflect (a) 422,407 restricted shares (all
of which are subject to vesting), (b) 140,802 common shares issuable upon
exercise of currently exercisable options and (c) common shares issuable
upon conversion of preference shares or exercise of class A warrants. The
amount in column (C) includes 281,605 common shares issuable upon exercise
of stock options that are not currently exercisable within 60 days of the
date hereof.
(20) Amounts in columns (A) and (B) reflect (a) 431,383 restricted shares (all
of which are subject to vesting) and (b) 141,667 common shares issuable upon
exercise of currently exercisable options. The amount in column (C) include
283,333 common shares issuable upon exercise of stock options that are not
currently exercisable within 60 days of the date hereof.
(21) Amounts reflect (a) securities held by the entities listed in note (4),
(b) 1,263 common shares owned directly by Mr. Lee and (c) 100 common shares
issuable upon exercise of currently exercisable options. Mr. Lee is a
general partner of WP, a managing director and member of WP LLC and a
beneficial owner of certain shares of capital stock of WP VIII Bermuda Ltd.
and WPIP Bermuda Ltd. All shares indicated as owned by Mr. Lee are included
because he is a member of our board and is affiliated with these Warburg
Pincus entities. Mr. Lee may be deemed to have an indirect pecuniary
interest (within the meaning of Rule 16a-1 under the Exchange Act) in an
indeterminate portion of the shares owned by WP VIII Bermuda, WPIP Bermuda,
WPIP Netherlands I and WPIP Netherlands II. Mr. Lee disclaims beneficial
ownership of all shares owned by these Warburg Pincus entities. Based on a
Form 3 dated November 30, 2001 filed with the SEC by Mr. Lee.
(22) Amounts in columns (A) and (B) reflect 1,813 common shares owned directly
by Mr. Meenaghan and 15,300 common shares issuable upon exercise of
currently exercisable options. The amount in column (C) includes 1,500
common shares issuable upon exercise of stock options that are not currently
exercisable within 60 days of the date hereof.
(23) Amounts in columns (A) and (B) reflect (a) 750,946 common shares issuable
upon exercise of currently exercisable options and (b) common shares
issuable upon conversion of preference shares or exercise of class A
warrants. The amount in column (C) includes 375,473 common shares issuable
upon exercise of stock options that are not currently exercisable within
60 days of the date hereof.
(24) Amounts in columns (A) and (B) reflect 5,672 common shares owned directly
by Mr. Works and 18,300 common shares issuable upon exercise of currently
exercisable options. The amount in column (C) includes 1,500 common shares
issuable upon exercise of stock options that are not currently exercisable
within 60 days hereof.
(25) Amounts in columns (A) and (B) reflect (a) 50,000 restricted shares (all of
which are subject to vesting), (b) 33,333 common shares issuable upon
exercise of currently exercisable options and (c) common shares issuable
upon conversion of preference shares or exercise of class A warrants. The
amount in column (C) includes 66,667 common shares issuable upon exercise of
stock options that are not currently exercisable within 60 days of the date
hereof.
(26) Amounts in columns (A) and (B) reflect (a) 50,000 restricted shares (all of
which are subject to vesting) and (b) 28,333 common shares issuable upon
exercise of currently exercisable options. The
82
amount in column (C) includes 56,667 common shares issuable upon exercise of
stock options that are not currently exercisable within 60 days hereof.
(27) Amounts in columns (A) and (B) reflect (a) 14,986 common shares owned
directly by Ms. O'Connor and (b) 57,333 common shares issuable upon exercise
of currently exercisable options. The amount in column (C) includes 6,667
common shares issuable upon exercise of stock options that are not currently
exercisable within 60 days hereof.
(28) Amounts in columns (A) and (B) reflect (a) 8,998 common shares owned
directly by Mr. Petrillo and (b) 61,133 common shares issuable upon exercise
of currently exercisable options. The amount in column (C) includes 26,667
common shares issuable upon exercise of stock options that are not currently
exercisable within 60 days hereof.
(29) Under the subscription agreements, the purchase price for the preference
shares is subject to certain adjustments, which may result in the issuance
of additional preference shares to the purchasers. For a description of the
adjustments, please see "Business--Recent Developments--The Capital
Infusion--Subscription Agreement--Purchase Price Adjustments."
5283
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
TheTRANSACTIONS
THE CAPITAL INFUSION
Please refer to the information required by this itemappearing above under the subheading "The
Capital Infusion" included as part of "Business," which information is
incorporated by referencereference. In addition, prior to the capital infusion, we also
had entered into certain non-binding letters of intent to acquire three
fee-based businesses, including Tri-City Brokerage, Inc. ("Tri-City"), each of
which would have been considered a non-core business. In connection with our
decision to concentrate our attention exclusively on building our insurance and
reinsurance business, our board of directors determined not to proceed with any
of these acquisitions. Our board of directors was informed that if the company
were not to pursue the acquisition of Tri-City, certain members of our
management, including Peter Appel, our president and chief executive officer,
and Robert Clements, our chairman, may participate, as investors, in an
acquisition of Tri-City. Subsequently, Messrs. Appel and Clements, together with
members of Tri-City management and certain other investors, including
Distribution Investors LLC, a private equity fund affiliated with Hales &
Company Inc. described below, acquired Tri-City. No member of our management has
any management responsibilities with Tri-City.
TRANSACTIONS INVOLVING AFFILIATES OF MARSH & MCLENNAN
On November 8, 2001, ACGL, funds affiliated with Warburg Pincus and
Hellman & Friedman, The Trident Partnership, L.P. ("Trident I"), Trident II,
L.P., Marsh & McLennan Risk Capital Holdings, Ltd. ("MMRCH") and employee
co-investment funds affiliated with MMRCH entered into an agreement. Trident I
and Trident II, L.P. are affiliates of MMRCH and MMRCH and MMC Capital are
affiliates of each other. Under this agreement, the Warburg Pincus investors
assigned their right and commitment to purchase $35.0 million of the preference
shares and Class A warrants to Trident II and the co-investment funds. MMRCH
agreed to exchange all of its existing Class A warrants for newly issued common
shares (assuming that they had been exercised pursuant to a cashless exercise)
and to exchange all of its Class B warrants for cash at a price equal to $7.50
per Class B warrant (see Note 12 of the notes accompanying our consolidated
financial statements).
In addition, the board observer and board nomination rights of MMRCH and
Trident I were terminated, and the company was also released from its remaining
$11.0 million capital commitment to Trident II for new investments. During 1999,
the company had committed to invest $25 million as a limited partner in Trident
II, a partnership managed by MMC Capital.
Pursuant to a certain investment advisory agreement, which terminates in
2003 (subject to renewal or early termination under certain circumstances), MMC
Capital provides the company with certain services. Fees incurred under the
agreements during fiscal years 2001, 2000 and 1999 were approximately $262,000,
$298,000 and $1.5 million, respectively. In connection with its amended
investment advisory agreement with MMC Capital, the company receives from MMC
Capital $1.25 million per annum during the initial four-year term, subject to
certain conditions (see Note 8 of the notes accompanying our consolidated
financial statements).
On June 22, 2001, the company completed the acquisition of all of the
remaining ownership interests in one of its investee companies, Arch Risk
Transfer Services Ltd., for a purchase price of approximately $38.8 million. Of
such amount, $38.4 million was paid in cash to MMRCH and Trident I in return for
their interests in ART Services, and the balance was paid in the form of our
common shares to certain management shareholders of ART Services. See Note 3 of
the notes accompanying our consolidated financial statements. In addition, the
company has made investments in entities in which affiliates of Marsh and
Trident have invested (see Note 4 of the notes accompanying our consolidated
financial statements).
Commencing in 1996, MMC Capital subleased office space from the informationcompany for
a term expiring in October 2002. Future minimum rental income, exclusive of
escalation clauses and maintenance costs,
84
under the remaining term of the sublease will be approximately $832,000. Rental
income was $1,032,000, $636,000 and $430,000 in 2001, 2000 and 1999,
respectively.
Affiliates of MMC Capital's ultimate parent, Marsh & McLennan
Companies, Inc. ("Marsh"), may act as reinsurance intermediaries or brokers for
our reinsurance and insurance operations (see note 15 of the notes accompanying
our consolidated financial statements). The company has also utilized affiliates
of Marsh as insurance brokers for the company's insurance needs.
DISTRIBUTIONS INVESTORS, LLC
As of December 31, 2001, the company has committed to invest approximately
$1.5 million as a member of Distribution Investors, LLC, the general partner of
a fund affiliated with our subsidiary, Hales & Company (see Note 4 of the notes
accompanying our consolidated financial statements). With $50 million of
committed capital, such fund focuses on equity investments in insurance
distribution and distribution-related service companies, and its target
investment amount is $3 million to $5 million.
OTHER
We have agreed to make a non-recourse loan of up to $13.5 million to our
chairman, which will be includedused to pay income and self employment taxes, payable in
April 2002, on restricted shares granted to him on October 23, 2001. See
Note 9, "Commitments," of the notes accompanying our financial statements.
Graham B. Collis, a director of certain of our non-U.S. subsidiaries, is
partner in the annual meeting proxy statementlaw firm of Conyers Dill & Pearman, which provides legal services
to the company and its subsidiaries.
In April 1996, we acquired a 33% economic interest (9.75% voting interest)
in Island Heritage Insurance Company, Ltd., a Cayman Islands insurer, for an
aggregate purchase price of $4.5 million. Certain of our directors and other
investors invested in the securities of Island Heritage at the same per share
price paid by us. In February 1999, we made an additional investment in Island
Heritage in the amount of approximately $1.0 million.
Investors affiliated with certain of our directors have certain rights to
require us to register under the headings "ElectionSecurities Act of Directors--Executive Compensation--Compensation Committee
Interlocks1933 the securities they
hold, and Insider Participation"to "piggyback" on registrations that we make. In connection with all
such registrations, we are required to bear all registration and "Electionselling
expenses (other than underwriting fees and commissions and the fees of Directors--Certain
Relationships and Related Transactions."
PART IVany
counsel for the holders participating in such registrations).
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
Financial Statements and SchedulesFINANCIAL STATEMENTS AND SCHEDULES
Financial statements and schedules listed in the accompanying index to our
financial statements and schedules on page F-1 are filed as part of this report,
and are included in Item 8.
ExhibitsEXHIBITS
The exhibits listed in the accompanying exhibit index are filed as part of
this report. These exhibits include, without limitation, certain management
contracts and compensatory plans as described therein.
ReportsREPORTS ON FORM 8-K
We filed a report on Form 8-K No reportsduring the 2001 fourth quarter on November 9,
2001 to report the capital infusion. We also filed Form 8-K were filed by us duringon January 4, 2002
(and an amendment thereto on January 7, 2002) to report the fourth quarterconsummation of 1999.
We didthat
transaction and to file Forms 8-K on (1) January 18, 2000 (reporting the proposed sale of
our reinsurance operationscertain exhibits relating to Folksamerica Reinsurance Company and the XL stock
repurchase) and (2) March 2, 2000 (reporting the closing of the XL stock
repurchase).
53it.
85
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
RISK CAPITAL HOLDINGS, INC.
(Registrant)
By: /s/ Mark D. Mosca
Name: Mark D. Mosca
Title: President and
ARCH CAPITAL GROUP LTD.
(Registrant)
By: /s/ PETER A. APPEL
-----------------------------------------
Name: Peter A. Appel
Title: President & Chief Executive Officer
March 29, 200018, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
Signature Title Date
/s/ Mark D. MoscaPETER A. APPEL President and Chief Executive
------------------------------------ Officer March 21, 2000
------------------------------- (Principal Executive March 18, 2002
Peter A. Appel Officer) and Mark D. Mosca Director
/s/ Robert Clements*
------------------------------------ Chairman and Director March 22, 2000
-------------------------------18, 2002
Robert Clements
/s/ Peter A. Appel
Executive Vice President and Chief
March 21, 2000
------------------------------- Operating Officer, General Counsel and
Peter A. Appel Director
/s/ Paul J. Malvasio Managing Director, Chief Financial March 21, 2000
------------------------------- Officer and Treasurer (Principal
Paul J. MalvasioJOHN D. VOLLARO Financial Officer (Principal
------------------------------------ Financial and Principal March 18, 2002
John D. Vollaro Accounting Officer)
/s/ Michael P. Esposito, Jr.*
------------------------------------ Director March 27, 2000
-------------------------------
Michael P. Esposito,18, 2002
John L. Bunce, Jr.
/s/ Lewis L. Glucksman*
------------------------------------ Director March 27, 2000
-------------------------------
Lewis L. Glucksman
/s/ Ian R. Heap18, 2002
Paul B. Ingrey
*
------------------------------------ Director March 22, 2000
-------------------------------
Ian R. Heap
/s/ Thomas V. A. Kelsey18, 2002
Constantine Iordanou
*
------------------------------------ Director March 27, 2000
-------------------------------
Thomas V. A. Kelsey
/s/ Robert F. Works18, 2002
Kewsong Lee
*
------------------------------------ Director March 23, 2000
-------------------------------
Robert F. Works
/s/ Philip L. Wroughton18, 2002
James J. Meenaghan
86
NAME TITLE DATE
---- ----- ----
*
------------------------------------ Director March 27, 2000
-------------------------------
Philip L. Wroughton18, 2002
John M. Pasquesi
*
------------------------------------ Director March 18, 2002
Robert F. Works
54
- - ----------------------------------------
* By Paul J. Malvasio,John D. Vollaro, as attorney-in-fact and agent, pursuant to a power of
attorney, a copy of which has been filed with the Securities and Exchange
Commission as Exhibit 24 to this report.
/s/ Paul J. Malvasio
-------------------------
Paul J. Malvasio
/s/ JOHN D. VOLLARO
--------------------------------------
Name: John D. Vollaro
Attorney-in-Fact
55
87
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Pages
Risk Capital Holdings, Inc. and Subsidiaries
Report of Independent Accountants on Financial
Statements .............................................. F-2
Consolidated Balance Sheet at December 31, 1999 and
1998 .................................................... F-3
Consolidated Statement of Income and Comprehensive
Income for the years ended December 31, 1999, 1998 and
1997 .................................................... F-4
Consolidated Statement of Changes in Stockholders'
Equity for the years ended December 31, 1999, 1998 and
1997 .................................................... F-5
Consolidated Statement of Cash Flows for the years
ended December 31, 1999, 1998 and 1997 .................. F-6
Notes to Consolidated Financial Statements .............. F-7 - F-43
Schedules
Report of Independent Accountants on Financial Statement
Schedules S-1
I. Summary of Investments Other Than Investments in
Related Parties at December 31, 1999 ............... S-2
II. Condensed Financial Information of Registrant ...... S-3 - S-5
III. Supplementary Insurance Information for the years
ended December 31, 1999, 1998 and 1997 ............. S-6
IV. Reinsurance for the years ended December 31, 1999,
1998 and 1997 ......................................
PAGES
--------
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
Report of Independent Accountants on Financial Statements......................... F-2
Consolidated Balance Sheets at December 31, 2001 and 2000......................... F-3
Consolidated Statements of Income for the years ended December 31, 2001, 2000 and
1999............................................................................ F-4
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2001, 2000 and 1999................................................ F-5
Consolidated Statements of Comprehensive Income for the years ended December 31,
2001, 2000 and 1999............................................................. F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000
and 1999........................................................................ F-7
Notes to Consolidated Financial Statements........................................ F-8
SCHEDULES
Report of Independent Accountants on Financial Statement Schedules................ S-1
I. Summary of Investments Other Than Investments in Related
Parties at December 31, 2001.............................. S-2
II. Condensed Financial Information of Registrant............... S-3
III. Supplementary Insurance Information for the years ended
December 31, 2001, 2000 and 1999.......................... S-6
IV. Reinsurance for the years ended December 31, 2001, 2000 and
1999...................................................... S-7
Schedules other than those listed above are omitted for the reason that they
are not applicable.
F-1
Report of Independent AccountantsREPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and StockholdersShareholders of
RiskArch Capital Holdings, Inc.Group Ltd.
In our opinion, the accompanying consolidated balance sheetsheets and the related
consolidated statements of income, and comprehensive income, of changes in
stockholders'shareholders' equity and of cash flows present fairly, in all material respects,
the financial position of RiskArch Capital Holdings, Inc.Group Ltd. and its subsidiaries at
December 31, 19992001 and 1998,2000, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1999,2001 in
conformity with accounting principles generally accepted in the United States.States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.our opinion.
/s/ PricewaterhouseCoopers
LLP
New York, New YorkHamilton, Bermuda
February 1, 2000,28, 2002, except as to the matters described in Note 14,18 to the
consolidated financial statements which isare as of March 2, 20007, 2002
See Notes to Consolidated Financial Statements
F-2
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(Dollars in thousands)
DecemberDECEMBER 31,
----------------------------------
1999 1998
------------- ----------------
Assets
Investments:---------------------
2001 2000
---------- --------
ASSETS
Investments:
Fixed maturities available for sale, at fair value
(amortized cost: 1999, $270,345; 1998, $173,379) $261,067 $174,5402001, $467,154; 2000, $37,849)........... $ 468,269 $ 38,475
Short-term investments available for sale, at fair value
(amortized cost: 2001, $477,058; 2000, $97,387)........... 476,820 97,387
Publicly traded equity securities available for sale, at
fair value (cost: 1999, $105,747; 1998, $110,598) 158,631 154,6782001, $960; 2000, $24,987).............. 235 51,322
Securities held in escrow, at fair value (amortized cost:
2001, $22,156; 2000, $20,887)............................. 22,156 20,970
Privately held securities (cost: 1999, $85,748; 1998, $109,966) 83,969 137,091
Short-term investments 72,785 108,809
------------- ----------------2001, $41,587; 2000,
$57,913).................................................. 41,608 56,418
---------- --------
Total investments 576,452 575,118
Cash 9,457 12,037investments........................................... 1,009,088 264,572
---------- --------
Cash........................................................ 9,970 11,481
Accrued investment income................................... 7,572 1,432
Premiums receivable......................................... 59,463 --
Unpaid losses and loss adjustment expenses recoverable...... 90,442 --
Paid losses and loss adjustment expenses recoverable........ 14,418 --
Prepaid reinsurance premiums................................ 58,961 --
Goodwill.................................................... 26,336 6,111
Deferred income 4,527 2,632
Premiums receivable 119,320 88,610
Reinsurance recoverable 73,122 30,575tax asset................................... 13,716 8,192
Deferred policy acquisition costs 23,585 23,515
Investment accounts receivable 3,928
Federal income tax recoverable 8,758
Deferred income tax asset 7,834costs........................... 5,412 --
Other insurance assets 36,975 16,832assets................................................ 18,323 4,119
---------- --------
TOTAL ASSETS................................................ $1,313,701 $295,907
========== ========
LIABILITIES
Reserve for losses and loss adjustment expenses............. $ 113,507 $ --
Unearned premiums........................................... 88,539 --
Reinsurance balances payable................................ 47,029 --
Reserve for loss of escrowed assets......................... 18,833 15,000
Other assets 4,329 4,583
------------- ----------------
Total Assets $864,359 $757,830
============= ================
Liabilities
Claims and claims expenses $364,554 $216,657
Unearned premiums 108,743 102,775
Reinsurance premiums payable 14,666 5,396
Investment accounts payable 3,981
Federal income tax payable 2,229
Deferred income tax liability 13,182
Other insurance liabilities 24,541 9,525
Other liabilities 5,341 6,083
------------- ----------------
Total Liabilities 517,845 359,828
------------- ----------------
Commitments (See Note 5)
Stockholders' Equity Preferred stock, $.01liabilities........................................... 25,424 8,608
---------- --------
TOTAL LIABILITIES........................................... 293,332 23,608
---------- --------
COMMITMENTS AND CONTINGENCIES (SEE NOTE 3 AND NOTE 9)
SHAREHOLDERS' EQUITY
Preference shares ($.01 par value:
20,000,000value, 50,000,000 shares
authorized, (none issued)issued: 2001, 35,687,735; 2000, 0)............ 357 --
Common stock, $.01shares ($.01 par value:
80,000,000value, 200,000,000 shares
authorized, (issued: 1999, 17,109,736; 1998, 17,102,503) 171 171issued: 2001, 13,513,538; 2000, 12,708,818)... 135 127
Additional paid-in capital 342,034 341,878capital.................................. 1,039,887 288,016
Deferred compensation under stockshare award plan (317) (1,062)plan................ (8,230) (341)
Retained earnings (deficit) (22,175) 10,261................................. (11,610) (33,626)
Accumulated other comprehensive income consisting of
unrealized appreciation (decline) in value of investments,
net of income tax 27,188 47,038
Less treasury stock, at cost (1999, 21,766; 1998, 15,065) (387) (284)
------------- ----------------
Total Stockholders' Equity 346,514 398,002
-------------
Total Liabilities and Stockholders' Equity $864,359 $757,830
============= ================tax......................................... (170) 18,123
---------- --------
TOTAL SHAREHOLDERS' EQUITY.................................. 1,020,369 272,299
---------- --------
TOTAL LIABILITIES & SHAREHOLDERS' EQUITY.................... $1,313,701 $295,907
========== ========
See Notes to Consolidated Financial Statements
F-3
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE DATA)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share data)
Years Ended DecemberYEARS ENDED DECEMBER 31,
---------------------------------------
2001 2000 1999
1998 1997
-------------- --------------- -----------------
Revenues----------- ----------- -----------
REVENUES
Net premiums written $306,726 $234,735 $144,834written.................................. $ 36,216 $ (10,604) $ 306,726
(Increase) decrease in unearned premiumspremiums.............. (5,298) 98,134 4,642
(28,541) (37,462)
-------------- -------------- ---------------------------- ----------- -----------
Net premiums earnedearned................................... 30,918 87,530 311,368 206,194 107,372
Net investment incomeincome................................. 12,120 15,923 20,173 15,687 14,360
Net realized investment gains (losses)................ 18,382 20,045 17,227
25,252 (760)
-------------- -------------- -----------------
Total revenues 348,768 247,133 120,972
-------------- -------------- -----------------
Operating Costs and Expenses
Claims and claims expenses 305,841 176,125 73,407
Commissions and brokerage 80,540 50,537 31,467
Other operating expenses 14,816 16,452 13,523
Foreign exchange (gain) loss (198) (443) 682
-------------- -------------- -----------------
Total operating costs and expenses 400,999 242,671 119,079
-------------- -------------- -----------------
Income (Loss)
Income (loss) before income taxes, equity in net income (loss)
of investees and cumulative effect of accounting change (52,231) 4,462 1,893
-------------- -------------- -----------------
Federal income taxes:
Current (9,021) 7,512 1,761
Deferred (10,536) (7,277) (2,099)
-------------- -------------- -----------------
Income tax expense (benefit) (19,557) 235 (338)
-------------- -------------- -----------------
Income (loss) before equity in net income (loss) of investees
and cumulative effect of accounting change (32,674) 4,227 2,231Fee income............................................ 12,426 -- --
Equity in net income (loss) of investees 621 (1,136) (192)
-------------- -------------- -----------------investees.............. 2,608 1,945 (3,968)
Gain on sale of prior reinsurance operations.......... -- 2,191 --
----------- ----------- -----------
TOTAL REVENUES........................................ 76,454 127,634 344,800
----------- ----------- -----------
EXPENSES
Losses and loss adjustment expenses................... 23,448 76,263 305,841
Net commissions and brokerage......................... 813 26,756 80,540
Other operating expenses.............................. 27,692 6,855 14,188
Provision for non-cash compensation................... 2,771 1,098 628
Provision for loss of escrowed assets, net of other
related reserves.................................... (2,414) 15,000 --
Foreign exchange (gain) loss.......................... -- 1,159 (198)
----------- ----------- -----------
TOTAL EXPENSES........................................ 52,310 127,131 400,999
----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE......................... 24,144 503 (56,199)
----------- ----------- -----------
Income (loss) before cumulative effecttaxes:
Current............................................... 656 -- (9,021)
Deferred.............................................. 1,472 8,515 (11,925)
----------- ----------- -----------
Income tax expense (benefit).......................... 2,128 8,515 (20,946)
----------- ----------- -----------
Income (Loss) Before Cumulative Effect of accounting change (32,053) 3,091 2,039Accounting
Change.............................................. 22,016 (8,012) (35,253)
Cumulative effect of accounting changechange................ -- -- (383)
-------------- -------------- -----------------
Net income (loss) (32,436) 3,091 2,039
-------------- -------------- -----------------
Other Comprehensive Income (Loss), Net of Tax
Change in net unrealized appreciation of investments, net of tax (19,850) (7,466) 45,068
-------------- -------------- -----------------
Comprehensive Income (Loss) ($52,286) ($4,375) $47,107
============== ============== =================
Average shares outstanding
Basic----------- ----------- -----------
NET INCOME (LOSS)..................................... $ 22,016 $ (8,012) $ (35,636)
=========== =========== ===========
NET INCOME (LOSS) PER SHARE DATA
Basic................................................. $ 1.71 $ (0.61) $ (2.09)
Diluted............................................... $ 1.29 $ (0.61) $ (2.09)
AVERAGE SHARES OUTSTANDING
Basic................................................. 12,855,668 13,198,075 17,086,732
17,065,165 17,032,601
Diluted 17,086,808 17,718,223 17,085,788
Per Share Data
Net Income (Loss) - Basic ($1.90) $0.18 $0.12
- Diluted ($1.90) $0.17 $0.12
Comprehensive Income (Loss) - Basic ($3.06) ($0.26) $2.77
- Diluted ($3.06) ($0.26) $2.76Diluted............................................... 17,002,231 13,198,075 17,086,732
See Notes to Consolidated Financial Statements
F-4
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands)
Years Ended DecemberYEARS ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
1998 1997
--------------- ---------------- ----------------
Common Stock---------- -------- --------
PREFERENCE SHARES
Balance at beginning of year................................ -- -- --
Preference shares issued.................................... $ 357 -- --
---------- -------- --------
BALANCE AT END OF YEAR...................................... 357 -- --
---------- -------- --------
COMMON SHARES
Balance at beginning of year................................ 127 $ 171 $ 171
Common shares issued........................................ 11 4 --
Common shares retired....................................... (3) (48) --
---------- -------- --------
BALANCE AT END OF YEAR...................................... 135 127 171
---------- -------- --------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year................................ 288,016 342,034 341,878
Common shares issued........................................ 11,345 5,736 156
Common shares retired....................................... (48) (59,754) --
Preference shares issued.................................... 740,380 -- --
Stock options issued........................................ 194 -- --
---------- -------- --------
BALANCE AT END OF YEAR...................................... 1,039,887 288,016 342,034
---------- -------- --------
DEFERRED COMPENSATION UNDER SHARE AWARD PLAN
Balance at beginning of year................................ (341) (317) (1,062)
Restricted common shares (issued) cancelled................. (10,466) (1,122) 117
Deferred compensation expense recognized.................... 2,577 1,098 628
---------- -------- --------
BALANCE AT END OF YEAR...................................... (8,230) (341) (317)
---------- -------- --------
RETAINED EARNINGS (DEFICIT)
Balance at beginning of year................................ (30,916) (22,175) 10,261
Adjustment to retroactively adopt the equity method of
accounting for the original investment in ART Services.... (2,710) (3,439) (239)
---------- -------- --------
Balance at beginning of year, $171 $171 $170
Issuance of common stock
Restricted common stock issued 1
--------------- --------------- ----------------as adjusted................... (33,626) (25,614) 10,022
Net income (loss)........................................... 22,016 (8,012) (35,636)
---------- -------- --------
BALANCE AT END OF YEAR...................................... (11,610) (33,626) (25,614)
---------- -------- --------
TREASURY SHARES, AT COST
Balance at endbeginning of year 171 171 171
Additional Paid-in Capitalyear................................ -- (387) (284)
Treasury shares purchased................................... (48) (59,415) (103)
Treasury shares retired..................................... 48 59,802 --
---------- -------- --------
BALANCE AT END OF YEAR...................................... -- -- (387)
---------- -------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME UNREALIZED
APPRECIATION (DECLINE) IN VALUE OF INVESTMENTS, NET OF
INCOME TAX
Balance at beginning of year................................ 18,432 27,188 47,038
Adjustment to retroactively adopt the equity method of
accounting for the original investment in ART Services.... (309) (745) --
---------- -------- --------
Balance at beginning of year, 341,878 341,162 340,435
Issuance of common stock 156 716 727
--------------- --------------- ----------------
Balance at end of year 342,034 341,878 341,162
--------------- --------------- ----------------
Deferred Compensation Under Stock Award Plan
Balance at beginning of year (1,062) (1,778) (2,959)
Restricted common stock (issued) cancelled 117 (296) (506)
Compensation expense recognized 628 1,012 1,687
--------------- --------------- ----------------
Balance at end of year (317) (1,062) (1,778)
--------------- --------------- ----------------
Retained Earnings (Deficit)
Balance at beginning of year 10,261 7,170 5,131
Net income (loss) (32,436) 3,091 2,039
--------------- --------------- ----------------
Balance at end of year (22,175) 10,261 7,170
--------------- --------------- ----------------
Treasury Stock, At Cost
Balance at beginning of year (284) (198)
Purchase of treasury stock (103) (86) (198)
--------------- --------------- ----------------
Balance at end of year (387) (284) (198)
--------------- --------------- ----------------
Accumulated Other Comprehensive Income Consisting
of Unrealized
Appreciation of Investments, Net of Income Tax
Balance at beginning of yearas adjusted................... 18,123 26,443 47,038 54,504 9,436
Change in unrealized appreciation (19,850) (7,466) 45,068
--------------- --------------- ----------------
Balance at end of year 27,188 47,038 54,504
--------------- --------------- ----------------
Total Stockholders' Equity
Balance at beginning of year 398,002 401,031 352,213
Issuance of common stock 156 716 728
Change in deferred compensation 745 716 1,181
Net income (loss) (32,436) 3,091 2,039
Purchase of treasury stock (103) (86) (198)
Change in unrealized appreciation of investments,
net of income tax
(19,850) (7,466) 45,068
--------------- --------------- ----------------
Balance at end of year $346,514 $398,002 $401,031
=============== =============== ================(decline)................. (18,293) (8,320) (20,595)
---------- -------- --------
BALANCE AT END OF YEAR...................................... (170) 18,123 26,443
---------- -------- --------
TOTAL SHAREHOLDERS' EQUITY.................................. $1,020,369 $272,299 $342,330
========== ======== ========
See Notes to Consolidated Financial Statements
F-5
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
Years Ended DecemberYEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
1998 1997
--------------- --------------- ----------------
Operating Activities-------- -------- --------
COMPREHENSIVE INCOME (LOSS)
Net income.................................................. $22,016 $ (8,012) $(35,636)
Other comprehensive income (loss) ($32,436) $3,091 $2,039
Adjustments to reconcile, net of tax
Unrealized appreciation (decline) of investments:
Unrealized holding gains (losses) arising during year... (7,153) 4,317 (9,397)
Less: reclassification of net realized gains included in
net income............................................ 11,140 12,637 11,198
------- -------- --------
Other comprehensive income to net cash
Provided by (used for) operating activities:
Liability for claims and claims expenses, net 147,897 145,889 49,998
Unearned premiums (4,642) 28,541 36,886
Premiums receivable (30,710) (41,103) (23,838)
Accrued investment income (1,895) 149 (630)
Reinsurance recoverable (31,938) (31,087) 1,098
Reinsurance balances payable 9,270 5,185 (325)
Deferred policy acquisition costs (70) (6,223) (10,274)
Net realized investment (gains)/losses (17,227) (25,252) 760
Deferred income tax asset (10,327) (7,889) (2,202)
Other liabilities 11,695 9,920 (78)
Other items, net (32,071) (12,715) (4,396)
--------------- --------------- ----------------
Net Cash Provided By Operating Activities 7,546 68,506 49,038
--------------- --------------- ----------------
Investing Activities
Purchases of fixed maturity investments (374,862) (295,912) (239,395)
Sales of fixed maturity investments 270,325 254,716 241,035
Net sales (purchases) of short-term investments 41,898 (16,924) 20,390
Purchases of equity securities (39,364) (110,321) (95,738)
Sales of equity securities 92,045 102,876 33,104
Purchases of furniture, equipment and leasehold improvements (338) (252) (910)
--------------- --------------- ----------------
Net Cash Used For Investing Activities (10,296) (65,817) (41,514)
--------------- --------------- ----------------
Financing Activities
Common stock issued 156 716 728
Purchase of treasury shares (103) (86) (198)
Deferred compensation on restricted stock 117 (296) (506)
--------------- --------------- ----------------
Net Cash Provided By Financing Activities 170 334 24
--------------- --------------- ----------------
Increase in cash (2,580) 3,023 7,548
Cash beginning of year 12,037 9,014 1,466
--------------- --------------- ----------------
Cash end of year $9,457 $12,037 $9,014
=============== =============== ================(loss)......................... (18,293) (8,320) (20,595)
------- -------- --------
COMPREHENSIVE INCOME (LOSS)................................. $ 3,723 $(16,332) $(56,231)
======= ======== ========
See Notes to Consolidated Financial Statements
F-6
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
--------- --------- --------
OPERATING ACTIVITIES
Net income (loss)........................................... $ 22,016 $ (8,012) $(35,636)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Net investment gains................................ (18,382) (11,542) (17,227)
Provision for non-cash compensation................. 2,771 1,098 628
Reserve for loss of escrowed assets................. 3,733 15,000 --
Changes in:
Reserve for losses and loss adjustment expenses,
net............................................. 8,309 7,069 147,897
Unearned premiums................................. 8,558 (5,226) (4,642)
Premiums receivable............................... (8,331) 10,733 (30,710)
Accrued investment income......................... (5,181) 3,095 (1,895)
Reinsurance recoverables.......................... (13,568) (11,093) (31,938)
Reinsurance balances payable...................... 560 (5,121) 9,270
Deferred policy acquisition costs................. (1,076) 344 (70)
Deferred income tax asset......................... 1,665 6,855 (10,327)
Other liabilities................................. (1,605) 8,098 11,695
Other items, net.................................. (5,098) (8,669) (29,499)
--------- --------- --------
NET CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES........ (5,629) 2,629 7,546
--------- --------- --------
INVESTING ACTIVITIES
Purchases of fixed maturity investments..................... (560,246) (131,788) (374,862)
Sales of fixed maturity investments......................... 182,904 228,456 270,325
Purchases of equity securities.............................. -- (18,233) (39,364)
Sales of equity securities.................................. 47,144 89,862 92,045
Net sales (purchases) of short-term investments............. (365,238) (171,173) 41,898
Acquisition of ART Services, net of cash.................... (34,546) -- --
Acquisition of American Independent Insurance Holding
Company, net of cash...................................... 102 -- --
Acquisition of Hales........................................ -- (1,792) --
Sales or disposal (purchases) of furniture, equipment and
other..................................................... (6,311) 6 (338)
Proceeds from sale of prior reinsurance operations.......... -- 517 --
--------- --------- --------
NET CASH PROVIDED BY (USED FOR) INVESTING ACTIVITIES........ (736,191) (4,145) (10,296)
--------- --------- --------
FINANCING ACTIVITIES
Common shares issued, primarily stock based compensation.... 10,923 5,620 156
Preference shares issued.................................... 740,737 -- --
Purchase of treasury shares................................. (48) 3,430 (103)
Deferred compensation on restricted shares.................. (10,466) (1,122) 117
Debt retirement............................................. (450) -- --
Shares issued in connection with acquisitions............... (387) (4,388) --
--------- --------- --------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES........ 740,309 3,540 170
--------- --------- --------
Increase (decrease) in cash................................. (1,511) 2,024 (2,580)
Cash beginning of year...................................... 11,481 9,457 12,037
--------- --------- --------
CASH END OF YEAR............................................ $ 9,970 $ 11,481 $ 9,457
========= ========= ========
Net income taxes paid (received)............................ $ 330 -- $ (8,605)
========= ========= ========
See Notes to Consolidated Financial Statements
F-7
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Formation, CapitalizationORGANIZATION
Arch Capital Group Ltd. ("ACGL") is a Bermuda public limited liability
company with more than $1 billion in equity capital, providing insurance and
Business
Riskreinsurance on a worldwide basis through its wholly owned subsidiaries.
ACGL was formed in September 2000 and became the sole shareholder of Arch
Capital Holdings,Group (U.S.) Inc. ("RCHI"Arch-U.S."), incorporated pursuant to an internal reorganization
transaction completed in November 2000, as described below. Arch-U.S. is a
Delaware company formed in March 1995 under the lawsoriginal name of "Risk Capital
Holdings, Inc." Arch-U.S. commenced operations following the Statecompletion of Delaware, is a holding company whose wholly owned
subsidiary, Risk Capital Reinsurance Company ("Risk Capital Reinsurance"), a
Nebraska corporation, was formed to provide, on a global basis, property and
casualty reinsurance and other forms of capital, either on a stand-alone basis
or as part of integrated capital solutions for insurance companies with capital
needs that cannot be met by reinsurance alone. RCHI and Risk Capital Reinsurance
are collectively referred to herein as the "Company". In September 1995, through its
initial public offering related exercise ofin September 1995. In connection with its initial public
offering, the underwriters'
over-allotment option and direct sales of 16,750,625 shares of RCHI's common
stock, par value $.01 per share (the "Common Stock"), at $20 per share, and the
issuance of warrants, RCHI was capitalized with net proceeds of approximately
$335.0 million, of which $328.0 million was contributed to the statutory capital
of Risk Capital Reinsurance. In July 1998, Risk Capital Reinsurance capitalized
its wholly owned subsidiary, Cross River Insurance Company ("Cross River"), with
$20 million. Cross River received its Nebraska license in October 1998, and is
currently authorized to write insurance on an excess and surplus lines basis in
22 additional states.issued Class A warrantsWarrants to purchase an aggregate of
2,531,079 shares of Common StockShares and Class B warrantsWarrants to purchase an aggregate of
1,920,601 shares of
Common Stock were issued in connection with the direct sales.Shares. Class A warrantsWarrants are immediately exercisable at $20 per
share and expire September 19, 2002. Class B warrants areWarrants will become exercisable at
$20 per share during the seven year period
commencing September 19, 1998, provided thatafter the Common Stock hasShares have traded at or above $30 per share for
20 out of 30 consecutive trading days.days or a change of control (as defined in the
Class B Warrants) has occurred. The Company generally seeksClass B Warrants expire on September 19,
2005.
Prior to write a small number of large reinsurance
treaty transactions that may also be integrated with an equity investment in
client companies. Such reinsurance may include traditional and finite risk
property and casualty reinsurance treaty coverages, including excess of lossMay 5, 2000, Arch-U.S. provided reinsurance and quota share or proportional reinsurance. Theother forms of
capital for insurance companies through its wholly owned subsidiary, Arch
Reinsurance Company also writes
treaty("Arch Re"), a Nebraska corporation formed in 1995 under the
original name of "Risk Capital Reinsurance Company."
On May 5, 2000, Arch-U.S. sold the reinsurance for ocean marine, aviation and space, fidelity and surety,
and accident and health risks. In 1999, the Company discontinued its aviation
and space linesoperations of business. The Company's investment strategy is focused on the
insurance industry. A principal component of this strategy is investing a
significant portion of invested assets in publicly traded and privately held
equity securities issued by insurance and reinsurance companies and companies
providing services to the insurance industry.
The Company obtains substantially all of its reinsurance through
intermediaries which represent the cedent in negotiations for the purchase of
reinsurance. In addition to investment opportunities arising from the activities
of Marsh & McLennan Capital, Inc. ("MMCI"), as the Company's equity investment
advisor, the Company is provided with investment opportunities by reinsurance
brokers and traditional financing sources, including investment banking firms,
venture capital firms and other banking and financing sources, both acting as
principal investors and intermediaries. Underwriting opportunities may arise
from such sources in connection with the Company's investment activities as part
of integrated transactions.
See Note 14 - Subsequent Events for information on the agreement entered
into by the Company to sell its reinsurance businessArch Re to
Folksamerica Reinsurance Company ("Folksamerica").
On November 8, 2000, following the approval of Arch-U.S.'s shareholders,
Arch-U.S. completed an internal reorganization that resulted in Arch-U.S.
becoming a wholly owned subsidiary of ACGL. ACGL performs the holding company
functions previously conducted by Arch-U.S., and the repurchase from XL Capital Ltd. ("XL"shareholders of Arch-U.S.
have become the shareholders of ACGL. Prior to the reorganization, ACGL had no
significant assets or capitalization and had not engaged in any business or
prior activities other than in connection with the reorganization. Arch-U.S.
remains the holding company for certain United States subsidiaries.
As used herein, the "Company" means ACGL and its subsidiaries, except when
referring to periods prior to November 8, 2000, when it means Arch-U.S. and its
subsidiaries. Similarly, "Common Shares" means the common shares, par value
$0.01, of ACGL, except when referring to periods prior to November 8, 2000, when
it means the common stock of Arch-U.S.
On October 24, 2001, the Company announced the launch of a new underwriting
initiative to meet current and future demand in the global insurance and
reinsurance markets. Simultaneously with the launch of its new underwriting
initiative, the Company entered into subscription agreements with investors led
by Warburg Pincus investment funds and Hellman & Friedman investment funds (the
"principal investors") and certain members of allmanagement. On November 20, 2001,
the Company issued 35,687,735 Series A convertible preference shares and
3,776,025 Class A Warrants in exchange for $763.2 million in cash under such
agreements (see Note 12). In a related transaction, upon the closing of the 4,755,000 shares of the Common Stockthis
investment, 905,397 previously existing Class A Warrants held by XL.
F-7Marsh &
McLennan Risk Capital Holdings, Ltd. ("MMRCH") were canceled in exchange for
140,380 newly issued Common Shares, and Class B Warrants to purchase 1,770,601
Common Shares held by MMRCH were canceled in exchange for a cash payment by the
Company of $7.50 per Class B Warrant (approximately $13.3 million in the
aggregate) (see Note 8).
F-8
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies
Basis of PresentationSIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles ("GAAP") in the United States and
include the accounts of RCHI,ACGL, Arch Reinsurance Ltd. ("Arch Re Bermuda"),
Arch-U.S., Hales & Company Inc. ("Hales"), American Independent Insurance
Holding Company ("AIHC"), Arch Risk Capital ReinsuranceTransfer Services Ltd., formerly known as
Altus Holdings, Ltd. ("ART Services"), Arch Re and Cross River.River Insurance Company
("Cross River"). All significant intercompany transactions and balances have
been eliminated in consolidation. The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Premium Revenuesestimates and Related Expenses
Premiumsassumptions.
(B) PREMIUM REVENUES AND RELATED EXPENSES
Insurance premiums written are recorded in accordance with the terms of the
underlying policies. Reinsurance premiums assumed are recognized as income on a
pro rata basis over the terms of the related reinsurance contracts. These
amounts are based on reports received from ceding companies, supplemented by the
Company's own estimates of premiums for which ceding company reports have not
been received. Subsequent differences arising on such estimates are recorded in
the period they are determined. Unearned premium reserves represent the portion
of premiums written that relates to the unexpired terms of contracts in force.
Certain of the Company's contracts includeincluded provisions that adjustadjusted premiums or
acquisition costs based upon the experience under the contracts. Premiums
written and earned as well as related acquisition expenses under thesethose contracts
are recorded based upon the expected ultimate experience under these contracts.
Acquisition costs, which vary with and are primarily related to the
acquisition of policies, consisting principally of commissions and brokerage
expenses incurred at the time a contract is issued, are deferred and amortized
over the period in which the related premiums are earned. Deferred acquisition
costs are limited tocarried at their estimated realizable value based on the related
unearned premiums and take into account anticipated claimslosses and claimsloss adjustment
expenses, based on historical and current experience, and anticipated investment
income.
Investments(C) REINSURANCE CEDED
In the normal course of business, the Company seeks to reduce the loss that
may arise from events that could cause unfavorable underwriting results by
reinsuring certain levels of risk with other insurance enterprises or
reinsurers. The Company uses quota-share, surplus share and excess of loss
reinsurance contracts. Reinsurance commissions are recognized as income on a pro
rata basis over the period of risk. The portion of such commissions that will be
earned in the future is deferred and reported as a reduction to policy
acquisition costs. The accompanying consolidated statement of income reflects
premiums and losses and loss adjustment expenses and policy acquisition costs,
net of reinsurance ceded (see Note 6). Ceded unearned premiums are reported as
prepaid reinsurance premiums and estimated amounts of reinsurance recoverable on
unpaid losses are included as unpaid losses and loss adjustment expenses
recoverable. Reinsurance premiums and unpaid losses and loss adjustment expenses
recoverable are estimated in a manner consistent with that of the original
policies
F-9
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
issued and the terms of the reinsurance contracts. To the extent that any
reinsurer does not meet its obligations under reinsurance agreements, the
Company must discharge the liability. Provision is made for estimated
unrecoverable reinsurance.
(D) FEE INCOME
Fee income in connection with advisory services is recognized when all
services have been performed and the underlying transactions are substantially
completed. Policy related fee income, such as billing, cancellation and
reinstatement fees are primarily recognized when billed.
(E) INVESTMENTS
The Company currently classifies all of its publicly traded fixed maturity,
short-term investments and equity securities as "available for sale" and,
accordingly, they are carried at estimated fair value. The fair value of
publicly traded fixed maturity securities and publicly traded equity securities
is estimated using quoted market prices or dealer quotes. Short-term investments, which have a maturity of
one year or less at the date of acquisition, are carried at cost, which
approximates fair value.
Investments in privately held securities, issued by privately and publicly
held companies, may include both equity securities and securities convertible
into, or exercisable for, equity securities (some of which may have fixed
maturities) and debt securities. Privately held securities are subject to
trading restrictions or are otherwise illiquid and do not have readily
ascertainable market values. The risk of investing in such securities is
generally greater than the risk of investing in securities of widely held,
publicly traded companies. Lack of a secondary market and resale restrictions
may result in the Company's inability to sell a security at a price that would
otherwise be obtainable if such restrictions did not exist and may substantially
delay the sale of a security which the Company seeks to sell. Such investments
are classified as "available for sale" and carried at estimated fair value,
except for investments in which the Company believes it has the ability to
exercise significant influence (generally defined as investments in which the
Company owns 20% or more of the outstanding voting common stock of the issuer),
which are carried under the equity method of accounting. Under this method, the
Company initially records an investment at cost, and then records its
proportionate share of comprehensive income or loss for such investment after
the date of acquisition. F-8
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
The estimated fair value of investments in privately
held securities, other than those carried under the equity method, is initially
equal to the cost of such investments until the investments are revalued based
principally on substantive events or other factors which could indicate a
diminution or appreciation in value, such as an arm's-length third party
transaction justifying an increased valuation or adverse development of a
significant nature requiring a write down.
The Company periodically reviews the valuation of
investments in privately held securities with MMCI, its equity investment
advisor.
Realized investmentInvestment gains or losses realized on the sale of investments are
determined by the first-in first-out method and recordedreflected in net income.
Unrealized appreciation or depreciationdecline in value of securities which are carried at
fair value is excluded from net income and recorded as a separate component of
stockholders' equity,other comprehensive income, net of applicable deferred income tax.
Net investment income, consisting of dividends and interest, net of
investment expenses, is recognized when earned. The amortization of premium and
accretion of discount for fixed maturity investments is computed utilizing the
interest method. Anticipated prepayments and expected maturities are used in
applying the interest method for certain investments such as mortgage and other
asset-backed securities. When actual prepayments differ significantly from
anticipated prepayments, the effective yield is recalculated to reflect actual
payments to date and anticipated future payments. The
F-10
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
net investment in the
securitysuch securities is adjusted to the amount that would have
existed had the new effective yield been applied since the acquisition of the
security. Such adjustments, if any, are included in net investment income.
Claims and Claims Expenses(F) LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for claimslosses and claimsloss adjustment expenses consists of estimates of
unpaid reported claimslosses and claimsloss expenses and estimates for claimslosses incurred but
not reported. These reserves are based on case basis evaluations and statistical
analysis, and are not discounted. For reinsurance assumed, such reserves are
based on reports received from ceding companies, supplemented by the Company's
estimates of reserves for which ceding company reports have not been received,
and the Company's own historical experience. To the extent that the Company's
own historical experience is inadequate for estimating reserves, such estimates
will beare determined based upon industry experience and management's judgment. The
ultimate liability may vary from such estimates, and any adjustments to such
estimates are reflected in income in the period in which they become known. Reservesare determined.
Losses and loss adjustment expenses are recorded without consideration of
potential salvage or subrogation recoveries which are estimated to be
immaterial. Such recoveries, when realized, are reflected as a reduction of
claimslosses incurred.
Foreign Exchange(G) FOREIGN EXCHANGE
The United States dollar is the functional currency for the Company's
foreign business. Gains and losses on the translation into United States dollars
of amounts that are denominated in foreign currencies are included in net
income. Foreign currency revenue and expenses are translated at average exchange
rates during the year. AssetsUnhedged monetary assets and liabilities denominated in
foreign currencies are translated at the rate of exchange in effect at the
balance sheet date.
Income Taxes(H) INCOME TAXES
The Company utilizes the liabilitybalance sheet method of accounting for income
taxes. Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. A valuation allowance is
recorded using theif it is "more-likely-than-not" criteria whenthat some or all of a deferred tax
asset may not be realized.
F-9
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
Comprehensive Income
In presenting its financial statements, the Company has adopted the
reporting of comprehensive income in a one financial statement approach,
consistent with Statement of Financial Accounting Standards ("SFAS") No. 130.
Comprehensive income as shown below is comprised of net income and other
comprehensive income, which for the Company consists of the change in net
unrealized appreciation or depreciation of investments, net of tax.
(In thousands, except per share data)
Years Ended December 31,
1999 1998 1997
------------ ----------- -------------
Net income (loss) ($32,436) $3,091 $2,039
Other comprehensive income net of tax:
Unrealized appreciation (depreciation) of investments:
Unrealized holdings gains (losses) arising during period (8,652) 8,948 44,574
Less, reclassification adjustment for net realized (gains)
losses included in net income (11,198) (16,414) 494
------------ ----------- --------------
Other comprehensive income (loss) (19,850) (7,466) 45,068
------------ ----------- --------------
Comprehensive income (loss) ($52,286) ($4,375) $47,107
============ =========== ==============
Comprehensive income (loss) per share:
Basic ($3.06) ($0.26) $2.77
============ =========== ==============
Diluted ($3.06) ($0.26) $2.76
============ =========== ==============
Earnings Per Share Data(I) EARNINGS PER SHARE DATA
Earnings per share are computed in accordance with SFAS No. 128, "Earnings
per share" (see Note 1213 for the Company's earnings per share computations).
Basic earnings per share excludesexclude dilution and is computed by dividing income
available to common stockholdersshareholders by the weighted average number of shares of
Common StockShares
outstanding for the periods. Diluted earnings per share reflect the potential
dilution that could occur if Preference Shares, Class A and B warrants,
nonvested restricted shares and employee stock options were exercised for Common
Stock.
Segment Information
In June 1997,Shares. When a loss occurs, diluted per share amounts are computed using basic
average shares outstanding because including dilutive securities would decrease
the Financial Accounting Standards Board ("FASB"), issued
SFAS No. 131 "Disclosure About Segments of an Enterpriseloss per share and Related
Information". This Statement establishes standards for the way that public
business enterprises report information about operating segments in annual and
interim financial reports issued to stockholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers.
Operating segments are defined as components of an enterprise for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker for purposes of deciding how to allocate
resources and in assessing performance. Generally, financial information is
required towould therefore be reported on the basis for which it is used internally for
evaluating segment performance and determining how to allocate resources to
segments.
F-10anti-dilutive.
F-11
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (continued)
The Company operates in one reportable business segment, of providing
property casualty reinsurance and other forms of capital to insurance and
reinsurance companies and making investments in insurance and insurance related
entities on a global basis. This segment includes the results of Risk Capital
Reinsurance and Cross River, and consists primarily of the premiums, claims and
claims expenses, other operating expenses and investment results. The Company's
adoption of SFAS No. 131 did not have a material impact on the Company's
financial statements or the accompanying notes. See Note 11 for information
concerning the Company's business.
See Note 14 - Subsequent Events for information on the agreement entered
into by the Company to sell its reinsurance business.
Market Risk Sensitive Instruments
The Securities and Exchange Commission ("SEC") issued Financial Reporting
Release No. 48 which included amended rules requiring domestic and foreign
issuers to clarify and expand existing disclosure for derivative financial
instruments, other financial instruments and derivative commodity instruments
(collectively, "market risk sensitive instruments"). The amendments require
enhanced disclosure of accounting policies for derivative financial instruments
and derivative commodity instruments (collectively, "derivatives"). In addition,
the amendments expand existing disclosure requirements to include quantitative
and qualitative information about market risk inherent in market risk sensitive
instruments, which disclosure will be subject to safe harbor protection under
the SEC rule (see the accompanying Management's Discussion and Analysis of
Financial Condition and Results of Operations). These amendments are designed to
provide additional information about market risk sensitive instruments which
investors can use to better understand and evaluate market risk exposures of
registrants, including the Company.
Employee Stock OptionsSIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(J) STOCK OPTIONS
The Company follows Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees" ("APB No. 25") and related interpretations in
accounting for its employee stock options because the alternative fair value
accounting provided for under FASB StatementSFAS No. 123 "Accounting for Stock-Based
Compensation" ("FASBSFAS No. 123") requires use of option valuation models that were
not developed for use in valuing employee stock options (see Note 8).
Underoptions. Accordingly, under APB
No. 25, no compensation expense for stock option grants is recognized by the
Company becauseto the exercise prices ofextent that the Company's employee stock options equal the
market pricesfair value of the underlying stock onexceeds the
dateexercise price of grant.the option at the measurement date. In addition, under APB
No. 25, the Company does not recognize compensation expense for stock issued to
employees under its stock purchase plan.
In March 2000, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation", an interpretation of APB No. 25 (the "Interpretation"). The
Interpretation became effective July 1, 2000 and is required to be applied
prospectively (subject to certain exceptions) to all new awards, modifications
to outstanding awards, and changes in employee status after that date. While
there are certain exceptions to prospective application, the Company has adopted
the Interpretation and its requirements are applied prospectively.
(K) AMORTIZATION OF INTANGIBLE ASSETS
Goodwill of acquired businesses represents the difference between the
purchase price and the fair value of the net assets of the acquired businesses
and is amortized on a straight-line basis over the expected life of the related
operations acquired, which generally does not exceed 15 years. The Company
recorded goodwill relating to its acquisitions of Hales, AIHC and ART Services
and has not allocated any amounts to other intangible assets relating to such
acquisitions. The Company evaluates the recoverability of the carrying value of
goodwill relating to acquired businesses on an undiscounted basis to ensure it
is properly valued. If it is determined that an impairment exists, the excess of
the unamortized balance will be charged to earnings at that time.
In connection with itsthe Company's acquisitions of privately held equity
securities recorded under the equity method of accounting, the Company amortizes goodwill is amortized
on a straight linestraight-line basis for periods from 5over 25 years to 25 years. Goodwill at
December 31, 1999(see Note 2 (n) and 1998 was $8,931,000 and $10,638,000, respectively.
Amortization of goodwill included in equity in net loss of investees in 1999,
1998 and 1997, was $400,000, $1,000,000 and $248,000, respectively.
F-11
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Summary of Significant Accounting Policies (continued)
Furniture, Equipment and Leasehold Improvements
The costs of furniture and equipment are charged against income over their
estimated service lives. Leasehold improvements are amortized over the term of
the office lease. Depreciation and amortization are computed on the
straight-line method. Maintenance and repairs are charged to expense as
incurred.
Furniture, equipment and leasehold improvements, net of accumulated
depreciation and amortization at December 31, 1999 and 1998 recorded in other
assets was $2,479,000 and $2,858,000, respectively.
ReclassificationsNote 4).
(L) RECLASSIFICATIONS
The Company has reclassified the presentation of certain prior year
information to conform to the current presentation. New Accounting Pronouncements
DerivativesSuch reclassifications had
no effect on the Company's net income, shareholders' equity or cash flows.
(M) RESTATEMENTS
The Company filed with the Securities and HedgingExchange Commission ("SEC") an
amended Form 10-K for the year ended December 31, 2000 and an amended Form 10-Q
for the quarter ended March 31, 2001 to restate the financial statements
included in such filings. The restatements were required as a result of the
Company's acquisition of the remaining ownership interests in ART Services in
June 2001. The Company was required under generally accepted accounting
principles governing a
F-12
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
"step acquisition" of an investee company to retroactively adopt the equity
method of accounting for its original minority ownership interest in ART
Services for the periods prior to the acquisition and to restate its historical
financial results (see Note 3). The accompanying consolidated financial
statements include the effects of this required restatement and should be read
in conjunction with the restated financial statements contained in such amended
SEC filings.
(N) RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998,2001, the Financial and Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 141 "Business
Combinations." SFAS No. 141 establishes accounting and reporting standards for
business combinations and requires the purchase method of accounting be applied
for all business combinations initiated after June 30, 2001 and eliminates among
other things, the pooling-of-interests method. The Company has accounted for its
recently completed acquisitions using the purchase method of accounting and does
not expect the application of SFAS No. 141 to have any material impact on its
financial position or results of operations.
In June 2001, the FASB issued StatementSFAS No. 133142, "Goodwill and Other Intangible
Assets," which will become effective for the Company on January 1, 2002. SFAS
No. 142 requires, among other things, the discontinuance of the amortization of
goodwill and the introduction of impairment testing in its place. The adoption
of SFAS No. 142 will result in the Company's discontinuation of amortization of
its goodwill beginning in 2002. The Company will continue to be required to test
goodwill for impairment under the new standard, which could have an adverse
effect on future results of operations to the extent an impairment exists. Under
SFAS No. 142, goodwill recorded after June 30, 2001 will not be amortized.
Goodwill recorded prior to July 1, 2001 has been amortized through the year
ended December 31, 2001. The Company did not record goodwill subsequent to
June 30, 2001 (see Note 3). In addition, the standard includes provisions for
the reclassification of certain existing recognized intangibles such as
goodwill, reassessment of the useful lives of existing recognized intangibles,
reclassification of certain intangibles out of previously reported goodwill and
the identification of reporting units for purposes of assessing potential future
impairments of goodwill. SFAS No. 142 also requires the Company to complete a
transitional goodwill impairment test six months from the date of adoption.
Pursuant to SFAS No. 142, the Company will test goodwill for impairment upon
adoption and, if impairment is indicated, record such impairment as a cumulative
effect of an accounting change. The Company is currently evaluating the effect
that the adoption may have on the consolidated results of operations and
financial position. The Company has not yet developed an estimate of the impact
of the adoption of SFAS No. 142 on its consolidated results of operations. The
Company does believe that the adoption of SFAS No. 142 will not have a material
impact on consolidated financial condition.
In August 2001, FASB issued SFAS No. 144, "Accounting for Derivative
Instrumentsthe Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and Hedging Activities.for Long-Lived Assets to
Be Disposed Of." This statement requires thatSFAS No. 144 applies to all derivative
financial instruments be recognized inlong-lived assets (including
discontinued operations) and, consequently, amends portions of Accounting
Principles Board Opinion No. 30, "Reporting Results of Operations--Reporting the
statementEffects of financial position as
either assets or liabilities and measured at fair value.
IfDisposal of a derivative instrument is not designated asSegment of a hedging instrument, gains
or losses resulting from changes in fair values of such derivative are required
to be recognized in earnings in the period of the change. If certain conditions
are met, a derivative may be designated as a hedging instrument, in which case
the recording of the changes in fair value will depend on the specific exposure
being hedged. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes on fair
values or cash flows.
This StatementBusiness." SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after JuneDecember 15, 2000,
with initial application as of2001,
and will be adopted by the beginning of the first quarter of the
applicable fiscal year.Company on January 1, 2002. The Company does not
expect that the application of SFAS No. 144 will adopt this Statement in the first quarterhave a material impact on its
financial position or results of 2001.
Generally, the Company has not invested in derivative financial instruments.
However, derivatives may be embedded in other financial instruments, such as
convertible securities and prepayment options in mortgages. If the embedded
derivative meets certain criteria, it must be bifurcated from the host contract
and separately accounted for consistent with other derivatives.
The Company's portfolio includes market sensitive instruments, such as
convertible securities and mortgage-backed securities, which are subject to
prepayment risk and changes in market value in connection with changes in
interest rates. The Company's investments in mortgage-backed securities are
classified as available for sale and are not held for trading purposes. Assuming
the current investment strategy at the time of adoption, the Company's
presentation of financial information under the new Statement will not be
materially different than the current presentation.
Start-Up Costs
Effective January 1, 1999, the Company changed its method of accounting for
start-up costs in accordance with the Accounting Standards Executive Committee's
Statement of Position ("SOP") 98-5 "Reporting on the Costs of Start-Up
Activities." This statement requires costs of start-up activities, including
organization costs, to be expensed as incurred.
F-12operations.
F-13
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2. Summary(CONTINUED)
3. ACQUISITION OF SUBSIDIARIES AND DISPOSITION OF PRIOR REINSURANCE OPERATIONS
AMERICAN INDEPENDENT INSURANCE HOLDING COMPANY
On February 28, 2001, the Company completed a transaction pursuant to which
the Company acquired all of Significant Accounting Policies (continued)
Start-up activities are defined broadlythe common stock of AIHC, previously one of its
investee companies (see Note 4). AIHC is a specialty property and casualty
insurance holding company that, through its subsidiaries, markets and
underwrites nonstandard personal automobile liability and physical damage lines
of insurance, primarily in Pennsylvania, as those one-time activities
relatedwell as in Maryland and Delaware.
The Company purchased a portion of the outstanding shares of AIHC for
$1.25 million. The remaining outstanding shares of AIHC were redeemed by AIHC in
exchange for the right to openingreceive a new facility, introducingportion of the proceeds resulting from the
final adjudication or settlement of certain lawsuits that AIHC, as plaintiff,
has previously filed against certain defendants. A third party also forgave the
obligations owing to it under certain notes previously issued by AIHC in the
aggregate principal amount of $4 million and returned certain warrants to
purchase shares of AIHC in exchange for the right to receive a new productportion of the
proceeds resulting from the final adjudication or service,
conducting businesssettlement of such lawsuits.
Immediately after the Company's purchase of AIHC, the Company contributed to the
capital of AIHC notes in the aggregate principal amount of $8.5 million that
were issued to the Company in connection with loans it had previously made to
AIHC and also returned certain warrants to purchase shares of AIHC. Following
the purchase, the Company also made a capital contribution to AIHC in the amount
of $11.0 million.
In connection with the loans the Company had previously made to AIHC, the
Company had obtained rights to provide reinsurance to AIHC's subsidiary,
American Independent Insurance Company ("American Independent"), for specified
periods, which rights had been transferred to Folksamerica in the asset sale on
May 5, 2000. In connection with the Company's acquisition of AIHC, Folksamerica
released American Independent from these reinsurance commitments at a cost to
American Independent of $1.5 million.
ARCH RISK TRANSFER SERVICES LTD.
On June 22, 2001, the Company completed the acquisition of all of the
remaining ownership interests in one of its investee companies, ART Services,
for a purchase price of approximately $38.8 million. The purchase price
consisted of approximately $38.4 million in cash and 24,200 ACGL Common Shares.
Through its wholly owned subsidiaries, including First American Insurance
Company ("First American"), an admitted insurer with licenses in 49 states and
an A.M. Best rating "A- (Excellent)," ART Services provides insurance and
alternative risk transfer services through rent-a-captive and other facilities.
After the Company's acquisition of its initial 27.9% ownership interest in
ART Services in March 1998, the investment was carried at its estimated fair
value from the initial purchase through March 31, 2001 in accordance with
generally accepted accounting principles. The Company accounted for its initial
interest in ART Services under "fair value" because the Company did not have the
ability to exercise significant influence over this investment due to the
Company's limited voting and consent rights. Upon acquiring the remaining
ownership interests in ART Services, the Company was required under generally
accepted accounting principles governing a "step acquisition" of an investee
company
F-14
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
3. ACQUISITION OF SUBSIDIARIES AND DISPOSITION OF PRIOR REINSURANCE OPERATIONS
(CONTINUED)
to retroactively adopt the equity method of accounting for its original minority
ownership interest in ART Services for the periods prior to the acquisition and
to restate its historical financial results.
The required change to the equity method of accounting for this investment
resulted in a new territory, conducting businessreduction in the Company's book value at December 31, 2001 in the
amount of $3.5 million and decreased net income by $475,000 for the year ended
December 31, 2001. Restating the amounts previously reported decreased the net
loss for the year ended December 31, 2000 by $729,000 and increased the net loss
for the year ended December 31, 1999 by $3.2 million, respectively (see
Note 4).
PRO FORMA FINANCIAL INFORMATION (UNAUDITED)
The following unaudited pro forma financial information includes the audited
financial information for ART Services and AIHC for the year ended December 31,
2001 and 2000 as if the acquisitions had occurred on January 1, 2000. The
unaudited pro forma financial information for the year ended December 31, 2000
excludes the acquisition of Hales (which occurred on December 4, 2000) because
it was not significant.
The pro forma financial information is based upon information available and
includes certain assumptions that the Company's management believes are
reasonable. The pro forma financial information does not purport to be
indicative of the Company's results of operations that would have occurred or
resulted had the transactions been completed on such dates nor is the
information intended to be a projection of the Company's results of operations
or financial condition for any future periods.
(IN THOUSANDS, EXCEPT SHARE DATA)
PRO FORMA RESULTS
YEARS ENDED DECEMBER 31,
---------------------------------
2001 2000
--------------- ---------------
Total Revenues................................. $101,872 $174,139
Net Income (Loss).............................. $ 24,876 $(20,854)
Basic earnings (loss) per share................ $ 1.93 $ (1.58)
Diluted earnings (loss) per share.............. $ 1.46 $ (1.58)
HALES & COMPANY
On December 4, 2000, the Company acquired substantially all of the assets of
Hales Capital Advisors, LLC, a privately held merchant banking firm specializing
in the insurance industry. Founded in 1973, Hales is a merger and acquisition
advisor to middle-market insurance organizations and the manager of the general
partner of Distribution Partners Investment Capital, L.P., a private equity fund
with $51 million of committed capital. Distribution Partners focuses on equity
investments in insurance distribution and distribution-related service
companies. The purchase price for the Hales assets consisted of 300,000 Common
Shares (which shares are subject to a new classtwo-year lock-up through December 4, 2002)
and $1.9 million in cash, representing a total purchase price of customer or beneficiary, initiating a new processapproximately
$6.4 million (based on the closing market price of the Common Shares on
December 4, 2000). Substantially all of this amount is reflected as goodwill.
F-15
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
3. ACQUISITION OF SUBSIDIARIES AND DISPOSITION OF PRIOR REINSURANCE OPERATIONS
(CONTINUED)
Hales provides merger and acquisition advisory and valuation services to its
clients. Hales' clients include insurance distributors, insurance companies,
banks and other financial institutions with interests in insurance distribution.
GOODWILL RELATING TO ACQUISITIONS
The carrying amount of goodwill at December 31, 2001 was $26.3 million,
consisting of $5.7 million, $13.6 million and $7.0 million, respectively,
relating to the acquisitions of Hales, AIHC and ART Services. At December 31,
2000, goodwill consisted of $6.1 million relating to the acquisition of Hales.
Amortization of goodwill for the year ended December 31, 2001 was $1.4 million
(see Note 2(n)).
FOLKSAMERICA TRANSACTION
On May 5, 2000, the Company sold the prior reinsurance operations of Arch Re
pursuant to an agreement entered into as of January 10, 2000 with Folksamerica
Reinsurance Company and Folksamerica Holding Company (collectively,
"Folksamerica"). Folksamerica Reinsurance Company assumed Arch Re's liabilities
under the reinsurance agreements transferred in the asset sale and Arch Re
transferred to Folksamerica Reinsurance Company assets estimated in an existing facilityaggregate
amount equal in book value to the book value of the liabilities assumed. In
consideration for the transfer of Arch Re's book of business, Folksamerica paid
$20.084 million (net of a credit equal to $251,000 granted to Folksamerica for
certain tax costs) in cash at the closing, subject to post-closing adjustments
based on an independent actuarial report of the claim liabilities transferred
and an independent audit of the net assets sold. Following the completion of
such report and audit, the parties agreed upon net post-closing adjustments in
the amount of approximately $3.2 million payable by the Company, which consisted
of a $4.2 million reduction in the purchase price less $1 million in net book
value of the assets and liabilities actually transferred at closing.
Under the terms of the agreement, $20 million of the purchase price has been
placed in escrow for a period of five years. Such amounts represent restricted
funds that appear under a separate caption entitled "Securities held in escrow"
on the Company's consolidated balance sheet. These funds will be used to
reimburse Folksamerica if the loss reserves (which were $32.3 million at the
closing of the asset sale) transferred to it in the asset sale relating to
business produced on behalf of Arch Re by a certain managing underwriting agency
are deficient as measured at the end of such five-year period or commencing some new operation. Start-up activitiesto satisfy
certain indemnity claims Folksamerica may have during such period. In connection
with the escrow arrangement, the Company would record a loss in an amount equal
to any probable deficiency in the related reserve that may become known during
or at the end of the five-year period. If such loss reserves are redundant, all
of the escrowed funds will be released from escrow to the Company and
Folksamerica will pay the Company an amount equal to such redundancy. The
agreement also include activitiesprovided that an additional amount of up to $5 million would be
placed in escrow for a period of five years to the extent that Arch Re's
reserves at closing on all business other than that covered by the $20 million
escrow were less by at least a specified amount than those estimated by its
independent actuaries. No such supplemental escrow was required.
As required under the agreement, Folksamerica reported to the Company that
adverse development had occurred in the loss reserves subject to the
Folksamerica escrow agreement for the period from May 5, 2000 to December 31,
2000. Based on such information and an independent
F-16
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
3. ACQUISITION OF SUBSIDIARIES AND DISPOSITION OF PRIOR REINSURANCE OPERATIONS
(CONTINUED)
actuarial analysis, the Company recorded in the 2000 fourth quarter a loss
contingency of $15 million, on a pre-tax basis, to recognize a probable
deficiency in such reserves. The actuarial analysis was based on estimates of
losses and loss adjustment expenses incurred as of December 31, 2000.
In February 2002, the Company reached a definitive settlement agreement with
Folksamerica to satisfy its obligations under the escrow agreement for
consideration of $17.0 million, plus accrued interest income of $1.8 million.
Accordingly, during the 2001 fourth quarter, the Company recorded an after-tax
benefit of $0.4 million, which consisted of a charge of $2.5 million, offset by
a reversal of a related reserve in the amount of $2.9 million. The related
reserve had been provided for the purchase of reinsurance, which is no longer
required due to organizingthe fact that the escrow arrangements have been terminated under
the above settlement agreement.
Under the terms of the agreement, the Company had also purchased in 2000
reinsurance protection covering the Company's transferred aviation business to
reduce the net financial loss to Folksamerica on any large commercial airline
catastrophe to $5.4 million, net of reinstatement premiums. Although the Company
believes that any such net financial loss will not exceed $5.4 million, the
Company has agreed to reimburse Folksamerica if a new entity.loss is incurred that exceeds
$5.4 million for aviation losses under certain circumstances prior to May 5,
2003. The changeCompany also made representations and warranties to Folksamerica about
the Company and the business transferred to Folksamerica for which the Company
retains exposure for certain periods. Although Folksamerica has not asserted
that any amount is currently due under any of the indemnities provided by the
Company under the asset purchase agreement, Folksamerica has indicated a
potential indemnity claim under the agreement in accounting principle resultedthe event of the occurrence of
certain future events. Based on all available information, the Company has
denied the validity of any such potential claim.
F-17
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
3. ACQUISITION OF SUBSIDIARIES AND DISPOSITION OF PRIOR REINSURANCE OPERATIONS
(CONTINUED)
The net book value gain resulting from the sale of the Company's prior
reinsurance operations to Folksamerica was calculated as follows (in thousands):
Consideration received, consisting of the following:
Total liabilities transferred............................... $514,330
Cash premium received....................................... 16,920
--------
531,250
--------
Assets transferred.......................................... 478,687
Amortization of deferred policy acquisition costs........... 23,242
Transaction costs........................................... 21,800
--------
523,729
--------
Pre-tax gain on sale of reinsurance operations.............. 7,521
Realized loss on securities transferred at market value..... (5,330)
--------
Net pre-tax gain............................................ 2,191
Income tax expense (1)...................................... 4,137
--------
Net loss reflected in the consolidated statement of
income.................................................... (1,946)
Change in net unrealized appreciation of investments, net of
tax (2)................................................... 5,330
--------
Comprehensive income and net book value gain................ $ 3,384
========
- ------------------------
(1) The income tax benefit of $1.5 million relating to post-closing
adjustments of $4.2 million was offset by an equivalent deferred tax
asset valuation allowance.
(2) The income tax benefit of $1.9 million relating to the realized loss
on securities transferred at market value was offset by an equivalent
deferred tax asset valuation allowance.
Transaction costs consisted of the following (in millions):
Severance and other related costs........................... $11.0
Reinsurance costs........................................... 4.8
Investment banking, legal and accounting fees............... 2.3
Write-off of furniture, equipment and leasehold
improvements.............................................. 1.7
Write-off of lease obligation............................... 1.3
Other....................................................... 0.7
-----
Total....................................................... $21.8
=====
As of December 31, 2001, accrued and unpaid transaction costs amounted to
approximately $477,000. Of such amount, $453,000 relates to the write-off of the
start-upCompany's lease obligation expected to be paid over the remainder of the lease
term expiring in October 2002. During the 2001 fourth quarter, the Company
reversed approximately $4.4 million of such accrued and unpaid transaction costs
capitalized asthat had been provided for the purchase of January 1, 1999 forreinsurance, which is no longer
required due to the fact
F-18
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
3. ACQUISITION OF SUBSIDIARIES AND DISPOSITION OF PRIOR REINSURANCE OPERATIONS
(CONTINUED)
that the purchase price escrow has been terminated under the definitive
settlement agreement between the Company and its
investee companies carriedFolksamerica, as described above.
The GAAP book value of the assets and liabilities transferred to
Folksamerica at closing were as follows (in millions):
Fixed maturities, short-term investments and accrued
interest income........................................... $249.9
Premiums receivable......................................... 108.6
Reinsurance recoverable..................................... 73.2
Deferred policy acquisition costs........................... 23.2
Deferred income tax asset................................... 13.5
Other insurance assets...................................... 47.0
------
Total assets................................................ $515.4
------
Reserve for losses and loss adjustment expenses............. $371.6
Net unearned premium reserve................................ 103.4
Reinsurance premiums payable................................ 9.5
Other insurance liabilities................................. 29.8
------
Total liabilities........................................... $514.3
------
Net book value of assets and liabilities transferred........ $ 1.1
======
At the closing of the asset sale, Arch Re and Folksamerica entered into a
transfer and assumption agreement, under which Folksamerica assumed Arch Re's
rights and obligations under the equity methodreinsurance agreements transferred in the asset
sale. The reinsureds under such agreements were notified that Folksamerica had
assumed Arch Re's obligations and that, unless the reinsureds object to the
assumption, Arch Re will be released from its obligations to those reinsureds.
None of accounting.
The cumulative effectsuch reinsureds objected to the assumption and, accordingly, the gross
liabilities for such business have been removed from the accounts of Arch Re for
statutory and GAAP accounting purposes. However, Arch Re will continue to be
liable under those reinsurance agreements if the notice is found not to be an
effective release by the reinsureds. Folksamerica has agreed to indemnify the
Company for any losses arising out of the write-off, which totals $383,000, after-tax,
or $0.02 per share, has been expensed and is includedreinsurance agreements transferred to
Folksamerica Reinsurance Company in the 1999 net loss.
3. Investment Information
Net Investment Incomeasset sale. However, in the event that
Folksamerica refuses or is unable to perform its obligations to the Company,
Arch Re may incur losses relating to the reinsurance agreements transferred in
the asset sale.
F-19
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
4. INVESTMENT INFORMATION
NET INVESTMENT INCOME
The components of net investment income were derived from the following
sources:
(In thousands)
Years Ended December(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
2001 2000 1999
1998 1997
------------------ ------------------ -------------------------- -------- --------
Fixed maturity securitiesmaturities................................. $ 6,750 $ 9,728 $14,924
$10,500 $7,105Short-term investments........................... 4,969 5,167 5,677
Publicly traded equity securitiessecurities................ 371 1,373 4,019 4,022 3,272
Privately held equity securitiessecurities........................ 146 513 1,007
426 157
Short-term investments 5,677 4,386 6,039
------------------ ------------------ ------------------------- ------- -------
Gross investment incomeincome.......................... 12,236 16,781 25,627
19,334 16,573
Investment expensesexpenses.............................. 116 858 5,454
3,647 2,213
------------------ ------------------ ------------------------- ------- -------
Net investment incomeincome............................ $12,120 $15,923 $20,173
$15,687 $14,360
================== ================== ========================= ======= =======
Realized and Unrealized Investment Gains (Losses)REALIZED AND UNREALIZED INVESTMENT GAINS (LOSSES)
Net realized investment gains (losses) were as follows:
(In thousands)
Years Ended December(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------------
2001 2000 1999
1998 1997
------------- -------------- -------------------- -------- --------
Fixed maturity securities ($1,776) $1,472 $275maturities................................ $(2,116) $(15,550) $(1,776)
Publicly traded equity securitiessecurities............... 22,896 30,088 16,798 16,582 3,878
Privately held securitiessecurities....................... (2,398) 177 2,205
7,198 (4,913)
------------- -------------- ------------
Sub-total------- -------- -------
18,382 14,715 17,227
25,252 (760)
------------- -------------- ------------Loss on fixed maturities included in gain on
sale of prior reinsurance operations.......... -- 5,330 --
------- -------- -------
Net realized investment gains................... 18,382 20,045 17,227
Income tax expense (benefit)expense.............................. 7,242 7,408 6,029
8,838 (266)
-------------
-------------- ------------------- -------- -------
Net realized investment gains, (losses), net of taxtax....... $11,140 $ 12,637 $11,198
$16,414 ($494)
============= ============== =================== ======== =======
F-13In 2000, net realized gains included $11.0 million of pre-tax losses, or
$8.7 million, after-tax, recorded during the 2000 fourth quarter resulting from
the restructuring of the Company's investment portfolio in connection with its
redomestication to Bermuda on November 8, 2000.
F-20
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. Investment Information (continued)(CONTINUED)
4. INVESTMENT INFORMATION (CONTINUED)
The following tables reconcile estimated fair value and carrying value to
the amortized cost of fixed maturitymaturities and equity securities:
(In thousands)
December(IN THOUSANDS)
DECEMBER 31, 1999
--------------------------------------------------------------------
Estimated
Fair Value
and Gross Gross
Carrying Unrealized Unrealized Amortized
Value Gains (Losses) Cost
-------------- ---------------- ---------------- -----------------
Fixed maturities:2001
------------------------------------------------
ESTIMATED
FAIR VALUE
AND GROSS GROSS
CARRYING UNREALIZED UNREALIZED AMORTIZED
VALUE GAINS (LOSSES) COST
---------- ---------- ---------- ---------
U.S. government and government agencies $41,095 $3 ($1,673) $42,765
Municipal bonds 52,245 136 (308) 52,417
Mortgage and asset backed securities 27,298 3 (1,129) 28,424
Corporate bonds 136,838 484 (6,694) 143,048
Foreign governments 3,591 (100) 3,691
-------------- --------------- ---------------- -----------------
Sub-total fixed maturities 261,067 626 (9,904) 270,345
Equity securities:
Publicly traded 158,631 66,724 (13,840) 105,747
Privately held 83,969 (1,779) 85,748
-------------- --------------- ---------------- -----------------
Sub-total equity securities 242,600 66,724 (15,619) 191,495
-------------- --------------- ---------------- -----------------
Total $503,667 $67,350 ($25,523) $461,840
============== =============== ================ =================
(In thousands)
December 31, 1998
------------------------------------------------------------------
Estimated
Fair Value Gross Gross
& Carrying Unrealized Unrealized Amortized
Value Gains (Losses) Cost
---------------- --------------- ---------------- ---------------
Fixed maturities:
U.S. government and government agencies $39,283 $606 ($60) $38,737
Municipal bonds 45,273 1,193 (11) 44,091agencies........... $137,861 $2,026 $ (782) $136,617
Corporate bonds................................... 239,261 1,414 (1,538) 239,385
Mortgage and asset backed securities 33,532 397 (46) 33,181
Corporate bonds 56,256 962 (1,882) 57,176
Foreign governments 196 2 194
---------------- --------------- --------------- ---------------
Sub-total fixed maturities 174,540 3,160 (1,999) 173,379securities.............. 91,147 321 (326) 91,152
-------- ------ ------- --------
468,269 3,761 (2,646) 467,154
-------- ------ ------- --------
Equity securities:
Publicly traded 154,678 51,093 (7,013) 110,598traded................................... 235 -- (725) 960
Privately held.................................... 41,608 21 -- 41,587
-------- ------ ------- --------
41,843 21 (725) 42,547
-------- ------ ------- --------
Total............................................. $510,112 $3,782 $(3,371) $509,701
======== ====== ======= ========
(IN THOUSANDS)
DECEMBER 31, 2000
------------------------------------------------
ESTIMATED
FAIR VALUE
AND GROSS GROSS
CARRYING UNREALIZED UNREALIZED AMORTIZED
VALUE GAINS (LOSSES) COST
---------- ---------- ---------- ---------
Fixed maturities:
U.S. government and government agencies........... $ 27,122 $ 523 $ (32) $ 26,631
Corporate bonds................................... 5,835 92 (14) 5,757
Mortgage and asset backed securities.............. 5,518 57 -- 5,461
-------- ------- ------- --------
38,475 672 (46) 37,849
-------- ------- ------- --------
Fixed maturities held 137,091 27,125 109,966
---------------- --------------- --------------- ---------------
Sub-total equity securities 291,769 78,218 (7,013) 220,564
---------------- --------------- --------------- ---------------
Total $466,309 $81,378 ($9,012) $393,943
================ =============== =============== ===============in escrow -- municipal
Bonds............................................. 20,970 84 (1) 20,887
-------- ------- ------- --------
Equity securities:
Publicly traded................................... 51,322 26,335 -- 24,987
Privately held.................................... 56,418 -- (1,495) 57,913
-------- ------- ------- --------
107,740 26,335 (1,495) 82,900
-------- ------- ------- --------
Total............................................. $167,185 $27,091 $(1,542) $141,636
======== ======= ======= ========
At December 31, 1999, all of the Company's equity investments were in
securities issued by insurance and reinsurance companies or companies providing
services to the insurance industry.
F-14F-21
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. Investment Information (continued)
At December 31, 1999, the publicly traded equity portfolio consisted of the
following investments:
(In thousands)
December 31, 1999
-----------------------------------------------------------
Estimated Fair
Value and Net Unrealized
Carrying Value Gain (Loss)
Cost
------------------ ---------------- ----------------
Common Stocks:
ACE Limited $5,397 ($2,745) $8,142
Annuity and Life Re (Holdings) Ltd.
(includes 100,000 warrants) (1) 38,169 18,169 20,000
Arthur J. Gallagher 19,425 9,231 10,194
XL Capital Ltd. 13,488 4,612 8,876
E.W. Blanch Holdings, Inc. 21,866 14,545 7,321
Farm Family Holdings, Inc. 3,802 819 2,983
IPC Holdings, Ltd. 7,988 (7,005) 14,993
Limit PLC 2,394 (492) 2,886
Meadowbrook Insurance Group 1,200 (1,882) 3,082
Partner Re, Ltd. 3,698 (1,263) 4,961
Renaissance Re 2,044 334 1,710
Terra Nova Holdings 26,572 18,096 8,476
WR Berkley Corp. 2,088 (453) 2,541
Preferred Stock:
St. Paul Companies, 6% Convertible Preferred 10,500 918 9,582
------------------ ---------------- ----------------
Total $158,631 $52,884 $105,747
================== ================ ================
(1) See Note 14 - Subsequent Events for information on the disposition of the
Company's interest in Annuity and Life Re (Holdings) Ltd. in connection
with the Company's repurchase from XL of all of the 4,755,000 shares of the
Common Stock held by XL.
F-15
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)(CONTINUED)
4. INVESTMENT INFORMATION (CONTINUED)
Privately held securities consistedconsist of the following:
(In thousands)
Percentage December(IN THOUSANDS)
DECEMBER 31,
-----------------------------------
Ownership 1999 1998
--------------- --------------- ---------------
Carried under the equity method:PERCENTAGE -------------------
OWNERSHIP 2001 2000
---------- -------- --------
CARRIED UNDER THE EQUITY METHOD:
The ARC Group, LLCLLC.............................. 27.0% $8,687 $9,448$ 8,725 $ 8,468
Arx Holding Corp.Corp................................ 35.2% 2,654 2,400
Capital Protection Insurance Services, LLC 250
First American Financial Corporation 9,8053,714 3,514
Island Heritage Insurance Company, Ltd. 33.0% 4,356 3,101
LARC Holdings, Ltd. (1) 23.9% 24,039 25,349Ltd.......... 33.4% 4,950 4,534
New Europe Insurance VenturesVentures................... 14.6% 819 1,083609 642
Sunshine State Holding Corporation 21.5% 1,885 1,688
--------------- ---------------
Sub-total 42,440 53,124
--------------- ---------------
Carried at fair value:
AltusCorporation.............. 23.0% 1,838 1,766
Arch Risk Transfer Services Ltd................. 27.9% -- 12,981
------- -------
19,836 31,905
------- -------
CARRIED AT FAIR VALUE:
Stockton Holdings Ltd. 28% 19,173 6,667Limited....................... 1.7% 10,000 10,000
Trident II, L.P................................. 2.0% 10,876 6,813
American Independent Insurance Holding Company 4,250
Annuity and Life Re (Holdings) Ltd. (2) 5.6% 34,243
Arbor Acquisition Corp. (Montgomery & Collins, 500
Inc.)Company.. -- 7,350
Distribution Investors, LLC..................... 2.5% 896 100
GuideStar Health Systems, Inc.Inc................... 2.6% 500 1,000
Sorrento Holdings, Inc. 1,517 5,113
Sovereign Risk Insurance Ltd. 246
Stockton Holdings Limited 1.7% 10,000 10,000
Terra Nova (Bermuda) Holdings, Ltd. (2) 21,323
TRG Associates, LLC 4,875
Trident II, L.P. 2.0% 6,089
--------------- ---------------
Sub-total 41,529 83,967
--------------- ---------------
Total $83,969 $137,091
=============== ===============0 250
------- -------
21,772 24,513
------- -------
Total........................................... $41,608 $56,418
======= =======
(1) See Note 14 - Subsequent Events for information on the disposition of the
Company's interest in LARC Holdings, Ltd. in connection with the Company's
repurchase from XL of all of the 4,755,000 shares of the Common Stock held
by XL.
(2) As of June 2, 1999, the Company reclassified the above privately held
securities as publicly traded equity securities. Pursuant to the existing
investment advisory agreement, the Company incurred a fee of $2.5 million
payable to MMCI upon the reclassification of such securities.
In addition, theThe Company had investment commitments relating to its privately held
securities in the amounts of $23.2$3.7 million and $10.4$22.6 million at December 31, 19992001
and 1998,2000, respectively.
The outstanding commitmentsGoodwill in privately held equity securities at December 31, 2001 and 2000
was $7.6 million and $8.0 million, respectively. Amortization of goodwill
included in equity in net income (loss) of investees in 2001, 2000 and 1999, included $19was
approximately $0.4 million committed to Trident II, L.P., a newly formed investment fund established by
MMCI dedicated to making private equity and equity related investments in the
global insurance, reinsurance and related industries.
F-16
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)each year (see Note 2(n)).
Set forth below is certain information relating to each of the Company's investments
and investment commitments in privately held securities at December 31, 1999.
Investments Carried Under The Equity Method:
The2001.
INVESTMENTS CARRIED UNDER THE EQUITY METHOD:
THE ARC Group,GROUP, LLC
In July 1997, the Company completed its acquisition, effective May 1997, ofacquired a 27.0% economic and voting interest in The
ARC Group, LLC ("ARC"), a Long
Island-based wholesaler of specialty insurance, for approximately $9.5 million. ARC, founded in 1986, is
an independent wholesale insurance broker and managing general agent
specializing in the placement of professional liability insurance, primarily
directors and officersofficers' liability coverage. The Company is a co-investor with
Marsh & McLennan RiskMMRCH, MMC Capital, Holdings, Ltd.Inc.'s ("MMRCH"MMC Capital"), MMCI's parent, and ARC's founders, who
continue to have managerial control over the daily operations.
The Company records its equity in the operating results of ARC on a
two-month lag basis.
Cumulativebasis and has received cumulative distributions received from ARC in the
amount of $4.7$8.5 million, which have been recorded as reductions to the carrying
value of the investment.
For the years ended 1999 and 1998 and for the period recorded in 1997, the
Company's equity in net income, net of goodwill amortization and net of tax, was
$827,000, or $0.05 per share, $1.0 million, or $0.06 per share, and $561,000, or
$0.03 per share, respectively.
Arx Holding Corp.F-22
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
4. INVESTMENT INFORMATION (CONTINUED)
ARX HOLDING CORP.
In December 1997, the Company acquired a 35.2% economic and voting interest
in Arx Holding Corp. ("ARX"), a Florida-based company, for $2,425,000. ARX, through its recently formed wholly owned
subsidiary American Strategic Insurance Corp., underwrites homeowners policies
in the State of Florida produced in the open market, and may also seek to offer
other lines of insurance in Florida and other states. The Company provides reinsurance for ARX. A subsidiary of XL is a
co-investor in ARX and also provides reinsurance for ARX.
The Company's net premiums written and net premiums earned from business
developed by ARX were $8.2 million and $5.6 million, respectively, in 1999 and
$2.8 million and $1.1 million, respectively, in 1998.
The Company records its equity in the operating results of ARX on a
quarter-lag basis.
For the years ended 1999 and 1998, the Company's equity in net income
(loss), net of goodwill amortization and net of tax, was $282,000 and ($63,000),
respectively.
Capital Protection Insurance Services, LLC
In May 1997, the Company acquired a 51% economic interest (49% voting
interest) in Capital Protection Insurance Services, LLC ("CPI"), a newly formed
managing underwriting agency headquartered in New York City offering specialty
risk and alternative market insurance solutions. The Company co-invested with
CPI's founders.
The Company also provided reinsurance capacity for the business CPI
developed. Net premiums written and net premiums earned recorded by the Company
from casualty and multi-line business developed by CPI were $2.1 million and
$6.4 million in 1999, $16.3 million and $12.3 million in 1998 and $857,399 and
$178,527, in 1997, respectively.
F-17
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
At December 31, 1998, the Company recorded a realized loss of $862,000 by
reducing the carrying value of its investment in CPI to $250,000.
During 1999, the Company wrote off its remaining investment carrying value
in CPI andArx is
recorded an after-tax realized investment loss of $1.3 million, which
represents actual and estimated costs associated with terminating leases and
divesting physical assets, and other costs to run-off the business of this
managing underwriting agency.
First American Financial Corporation
In February 1997, the Company acquired a 35.5% voting and economic interest
in First American Financial Corporation ("First American") for $6.5 million.
First American, a Missouri-based company, through its wholly owned subsidiaries
including First American Insurance Company, underwrites specialty vehicle
property and casualty insurance coverages with emphasis placed on collateral
protection.
In May 1999, Altus Holdings Ltd. ("Altus") agreed to acquire First American
in a share exchange, which closed in July 1999 upon receipt of regulatory
approval. During the 1999 second quarter, the Company reclassified its
investment in First American fromunder the equity method of accounting to an
investment accounted for at fair value and the carrying valueCompany records the
operating results of First American
was adjusted to $9.3 million in order to reflect the transaction value resulting
from the acquisition by Altus. The Company recorded an after-tax realized loss
of $0.7 million from the transaction. The Company's total investment in First
American (excluding repaid demand loans) was $10.4 million.
For the period recorded in 1999 and the year ended 1998, the Company's
equity in net loss, net of goodwill amortization and net of tax, was $320,000,
or $0.02 per share, and $1.3 million, or $0.08 per share, respectively. For the
period recorded in 1997, the Company's equity in the net income, net of goodwill
amortization and net of tax, was $32,036.
The Company's net premiums written and net premiums earned from business
developed by First American was $0.9 million each in 1999.
Island Heritage Insurance Company, Ltd.Arx on a quarter-lag basis.
ISLAND HERITAGE INSURANCE COMPANY, LTD.
In April 1996, the Company acquired a 33%33.4% economic interest (9.75% voting
interest) in Island Heritage Insurance Company, Ltd. ("Island Heritage"), a
Cayman Islands insurer, for an aggregate purchase price of $4.5 million, which
was funded through $1.7 million in cash and a trust account in an amount equal
to $2.8 million. Island
Heritage commenced operations in May 1996 as an insurer which writesof high value personal
and commercial property insurance in the Caribbean. Certain directors of the
Company and other investors invested in the securities of Island Heritage at the
same per share price as that paid by the Company. In February 1999, the Company
made an additional investment in Island Heritage in the amount of approximately
$1.0 million.
The investment in Island Heritage is recorded under the equity method of
accounting sinceand the Company believes it has the ability to exercise significant
influence over the operating and financial policies of Island Heritage due to
the Company's participation on the Board of Directors and through certain
consent rights attaching to the Company's holdings of non-voting shares.
F-18
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
The Company records its equity in the operating results of Island Heritage on a
quarter-lag basis.
For the year ended 1999, the Company's equity in net
income, net of tax, was $153,400, or $0.01 per share. For years ended 1998 and
1997, the Company's equity in net loss, net of tax, was $551,850, or $0.03 per
share, and $195,922, or $0.01 per share, respectively.
LARC Holdings, Ltd.NEW EUROPE INSURANCE VENTURES
In November 1997, the Company acquired shares and warrants representing a
23.9% economic interest (9.9% voting interest) in LARC Holdings, Ltd. ("LARC"),
a newly formed holding company located in Bermuda, for $24.5 million. LARC,
through its newly-formed wholly owned Bermuda subsidiary, Latin American
Reinsurance Company, Ltd. ("LARe"), provides multi-line reinsurance to the Latin
American reinsurance market, emphasizing short-tail, multi-peril property
reinsurance and, to a limited extent, casualty, marine, aviation and other lines
of reinsurance. LARe may also seek to enter other reinsurance niches on both a
treaty and facultative basis.
The Company co-invested with a subsidiary of XL, which holds a majority
interest in LARC, and the founders of LARC.
The investment in LARC is recorded under the equity method of accounting
since the Company believes it has the ability to exercise significant influence
over the operating and financial policies of LARC due to the Company's
participation on the Board of Directors and through certain consent rights
attaching to the Company's holdings of non-voting shares.
The Company records its equity in the operating results of LARC on a
quarter-lag basis.
For the year ended 1999, the Company's equity in net loss, net of goodwill
amortization and net of tax, was $113,750; for the year ended 1998 the Company's
equity in net income, net of goodwill amortization and net of tax was $531,700;
and for the period recorded in 1997, the Company's equity in net loss, net of
tax, was $18,936.
See Note 14 - Subsequent Events for information on the disposition of the
Company's interest in LARC in connection with the Company's repurchase from XL
of all of the 4,755,000 shares of the Common Stock held by XL.
New Europe Insurance Ventures
In March 1997, the Company, through a wholly owned special purpose subsidiary,
committed to pay $5 million over the long term to fund its partnership interest,
currently at 14.6%, in New Europe Insurance Ventures ("NEIV"), a Scottish
limited partnership that targets private equity investments in insurance and
insurance-related companies in Eastern Europe.
The Company records its participation in this partnership under the equity
method of accounting and applies the specialized accounting practices for
investment companies. Unrealized gains and losses on private equity investments,
consisting mostly of foreign exchange fluctuations, are recorded in the income
statement when such investments are revalued into United States dollars each
quarter.
During June 2000, the partners of NEIV determined to attempt to sell NEIV's
current investment holdings, and that further investments in existing portfolio
companies may be made but only on an exceptional basis and as part of a clear
exit strategy.
The $820,000Company's $609,000 investment balance at December 31, 1999 is composed of five2001 represents
four investments in Eastern Europe in insurance related companies. The Company's
remaining unfunded commitment remaining at December 31, 19992001 was approximately
$3.2 million.
F-19
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
The Company records its equity in the operating results of NEIV on a
quarter-lag basis. For the years ended 1999, 1998 and for the period recorded in
1997, the Company's equity in net loss, net of tax, was $345,150, $141,700 and
$54,532, respectively.
Sunshine State Holding CorporationSUNSHINE STATE HOLDING CORPORATION
In December 1997, the Company acquired a 21.5% economic and voting interest in
Sunshine State Holding Corporation ("Sunshine State"), a newly formed
Florida-based company, for $1.4 million. The
investment in Sunshine State is recorded under the equity method of accounting
and the Company records the operating results of Sunshine State on a quarter-lag
basis.
F-23
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
4. INVESTMENT INFORMATION (CONTINUED)
Sunshine State and its subsidiaries, which includes Sunshine State Insurance
Company, a Florida domiciledFlorida-domiciled insurer, underwrite homeowners policies in the
State of Florida obtained from the Florida Residential Property and Casualty
Joint Underwriting Association in accordance with the Market Challenge Program
of the Florida Department of Insurance. Sunshine State also insures homeowners
policies produced through the open market and offers other lines of insurance in
Florida and other states.
In connection with the investment, the
Company provides reinsurance for Sunshine State. A subsidiary of XL invested in
Sunshine State and will also provide reinsurance for Sunshine State during
specified periods.ARCH RISK TRANSFER SERVICES LTD.
The Company records its equityowned approximately 27.9% of ART Services through June 22, 2001.
On such date, the remaining ownership interests in the operating results of Sunshine State
on a quarter-lag basis.
The Company's net premiums written and net premiums earned from business
developedART Services were acquired by Sunshine State were $6.6 million and $5.6 million, respectively, in
1999 and $3.9 million and $4.5 million, respectively, in 1998.
For the years ended 1999 and 1998, the Company's equity in net income, net
of tax, was $179,000, or $0.01 per share, and $171,600, or $0.01 per share.
Investments Carried at Fair Value:
Altus Holdings, Ltd.
In March 1998, the Company purchased for $10 million an approximately 28.6%
economic interest (9.9% voting interest) in Altus, a new Cayman Islands company
formed to provide rent-a-captive and other underwriting management services for
risks of individual corporations and insurance programs developed by insurance
intermediaries. The Company's investment was funded two-thirds in cash and
one-third through a letter of credit. The balance of the $35 million of initial
capital invested in Altus was contributed by The Trident Partnership, L.P.
("Trident"), XL, MMRCH and members of Altus' management. The Company may provide
reinsurance capacity for business developed by Altus. The Company issued a
letter of credit in the amount of $5.8 million for Trident's unfunded investment
commitment in Altus for an annual fee of $58,000, or 100 basis points on the
letter of credit amount.
In May 1999, Altus acquired First American in a share exchange, which
closed in July 1999 upon receipt of regulatory approval.
During the 1999 second quarter, the Company reclassified its investment in
First American from the equity method of accounting to an investment accounted
for at fair value. At June 30, 1999, the carrying value of First American was
adjusted to $9.3 million, in order to reflect the transaction value resulting
from the acquisition by Altus resulting in the Company recording an after-tax
realized loss of $0.7 million.
In July 1999,
the Company and, Trident funded their investment commitments
to Altus (previously secured by lettersaccordingly, the financial results of credit) of $3.3 million and $5.8
million, respectively, and XL redeemed its shares in Altus at their original
costs. After Altus' acquisition of First American, such additional funding and
the XL redemption, the Company's economic ownership in Altus decreased from
28.6% to 28% (9.9% voting interest).
F-20
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
American Independent Insurance Holding Company
In February 1999,ART Services have been
consolidated with the Company loaned $5 million to American Independent
Insurance Holding Company ("AIHC")(see Note 3).
The promissory note, secured by the stock of
AIHC, matures in January 2003, and will accrue interest at rates per annum
expected to approximate 6%, depending on the investment returns on proceeds of
the loan which are invested by AIHC on the Company's behalf. Principal and
interest repayments are subject to prior approval by the Pennsylvania Department
of Insurance. In consideration for the loan, the Company received Class A
warrants to purchase shares of common stock of AIHC, constituting approximately
4% of AIHC's outstanding common stock on a fully-diluted basis. Interest income
recorded in 1999 was $148,000. At December 31, 1999, the Company recorded a
pre-tax unrealized loss of $750,000, which reflects a market value discount of
15% based on a comparison of the AIHC note to bonds with similar
characteristics.
In connection with this investment and the Company's prior $3.6 million
loan commitment to AIHC (which commitment expired on December 31, 1998), the
Company has the option to write an aggregate amount of premiums of at least
approximately $375 million over the next seven to eight year period, subject to
the amount of business written by AIIC. From inception through December 31,
1999, premiums written by the Company under these arrangements with AIHC and its
insurance subsidiary, American Independent Insurance Company ("AIIC"), totaled
$107.2 million. No assurances can be given that any such additional premiums
will be written by the Company. The Company's net premiums written and net
premiums earned from business developed by AIIC were $39.2 million and $43.7
million, respectively, in 1999, $42 million and $36 million, respectively, in
1998, and $25.9 million and $15.2 million, respectively, in 1997.
Annuity and Life Re (Holdings), Ltd.
In April 1998, the Company acquired for approximately $20 million a
minority interest in Annuity and Life Re (Holdings), Ltd. ("Annuity and Life
Re"), a new Bermuda-based reinsurance company formed to provide annuity and life
reinsurance. The Company coinvested with XL concurrently with the consummation
of Annuity and Life Re's initial public offering. The Company purchased
approximately 1.4 million common shares of Annuity and Life Re and warrants to
purchase at an exercise price of $15.00 per share (the initial public offering
price) an additional 100,000 common shares. The aggregate purchase price paid by
the Company was based on a price of $14.10 for a unit consisting of one common
share and certain warrants. The Company owns approximately 5.6% of the
outstanding common shares of Annuity and Life Re following the exercise of the
underwriters' over-allotment option. Annuity and Life Re's common shares are
quoted on The Nasdaq Stock Market's National Market ("NASDAQ") under the symbol
"ALRE."
At December 31, 1998, the Company recorded its investment in Annuity and
Life Re common stock and warrants at the closing price reported by NASDAQ on
such date less a discount for trading restrictions.
In June 1999, the Company reclassified its investment in Annuity and Life
Re to a publicly traded equity security.
See Note 14 - Subsequent Events for information on the disposition of the
Company's interest in Annuity and Life Re in connection with the Company's
repurchase from XL of all of the 4,755,000 shares of Common Stock held by XL.
F-21
RISK CAPITALINVESTMENTS CARRIED AT FAIR VALUE:
STOCKTON HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
Arbor Acquisition Corp. (Montgomery & Collins, Inc.)
In March 1998, the Company purchased for approximately $2.8 million a 34.5%
economic and voting interest in Arbor Acquisition Corp. ("Arbor"), the parent of
Montgomery & Collins, Inc. a Boston-based national surplus lines and wholesale
brokerage firm which operates in 11 cities, in addition to Boston. The
investment was made concurrently with investments by MMRCH.
In September 1998, the Company invested an additional $845,000 in Arbor,
increasing the Company's ownership interest to approximately 37.3%.
For the period recorded in 1998, the Company's equity in net loss, net of
goodwill amortization and net of tax, was $506,000 or $0.03 per share. In
addition, in December 1998, the Company recorded a realized loss of $2.4 million
by reducing the carrying value of its investment in Arbor to $500,000 and
reclassified this investment from the equity method of accounting to an
investment carried at fair value.
At June 30, 1999, the Company increased the carrying value of its
investment in Arbor from $500,000 to approximately $3.0 million based on the
expected net realizable value resulting from the sale of the business and
run-off of the operations.
The sale of the business occurred in two transactions that closed in June
and July 1999. It is expected that the wind-up of the remaining operations will
be substantially completed by July 2000.
GuideStar Health Systems, Inc.
In December 1997, the Company acquired a 2.6% economic and voting interest
in GuideStar Health Systems, Inc. ("GuideStar"), an Alabama-based managed care
organization, for $1 million.
Founded in late 1995, GuideStar provides comprehensive managed care
services to employers and individuals through strategic alliances with selected
insurance companies and health care providers. GuideStar develops health care
provider networks, and provides claims processing, customer relations and
comprehensive utilization management services.
In September 1999, the Company reduced the carrying value of GuideStar by
50% to $500,000 and realized an after tax loss of $325,000.
Sorrento Holdings, Inc.
In October 1998, the Company purchased for $5 million 5,000 shares of Class
C Cumulative Redeemable Preferred Stock (the "Preferred C Shares") of Sorrento
Holdings, Inc. ("Sorrento"). The Preferred C Shares accrue interest at the rate
of 6% per annum and are subject to mandatory redemptions through December 31,
2000. Sorrento's obligation to redeem the Preferred C Shares is secured by an
irrevocable letter of credit.
For the year ended December 31, 1999, the Company received $3.7 million
from Sorrento for the redemption of 3,483 shares of preferred stock of Sorrento,
which redemption amount included a payment of $1,000 per share and dividends of
approximately $233,000.
Sorrento was formed by Clarendon National Insurance Company ("Clarendon")
and the Arrowhead Group ("Arrowhead"), a managing agency. Sorrento intends to
form a wholly owned subsidiary, Sorrento Insurance Company, to underwrite
automobile liability and physical damage policies produced by Arrowhead. In
connection with the issuance of the Preferred C Shares, the Company is providing
reinsurance to Clarendon in respect of automobile physical damage policies and
may provide reinsurance on other business produced by Arrowhead.
F-22
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
The Company's net premiums written and net premiums earned from business
developed by Arrowhead were $30 million and $22.5 million, respectively, in
1999.
Sovereign Risk Insurance Ltd.
In July 1997, the Company acquired a 9.0% voting and economic interest in
Sovereign Risk Insurance Ltd. ("Sovereign Risk"), a newly formed Bermuda-based
managing general agency, for $237,500.
Sovereign Risk provides underwriting services for political risk insurance
coverages for the Company, ACE Insurance Company, Ltd. and a subsidiary of XL,
who are also co-investors in Sovereign Risk.
In June 1999, the Company sold its investment in Sovereign Risk to ACE
Limited and XL and recorded an after-tax net realized gain of $103,000. The
Company retained an option to provide certain reinsurance on business produced
by Sovereign Risk for a five-year period.
The Company's net premiums written and net premiums earned from business
developed by Sovereign Risk were $2.9 million and $2.4 million, respectively, in
1999, $1,397,000 and $887,000, respectively, in 1998 and $175,000 and $51,130,
respectively, in 1997.
Stockton Holdings LimitedLIMITED
In June 1998, the Company acquired for $10 million a 1.7% interest in
Stockton Holdings Limited ("Stockton Holdings"Stockton"), a Cayman Islands insurance holding
company. Stockton Holdings conducts a world-wide reinsurance business through its wholly
owned subsidiary, Stockton Reinsurance Limited, a
Bermuda-based reinsurance company writing specialty risks with a focus on finite
products.Limited. The Company's investment was
made as part of a private placement by Stockton Holdings.
During 1999, the Company received a dividend distribution of $157,000.
Terra Nova (Bermuda) Holdings, Ltd.
In October 1995, the Company acquired a 3.6% voting and economic interest
in Terra Nova (Bermuda) Holdings, Ltd. ("Terra Nova") for $8.9 million.
Terra Nova, based in Bermuda, is a holding company for two principal
operating insurance companies located in Bermuda and London that write property
and casualty reinsurance. In April 1996, Terra Nova completed the initial public
offering of its common stock, which is traded on the New York Stock Exchange
("NYSE") under the symbol "TNA."
In December 1998, the Company sold 41,000 shares of Terra Nova and recorded
a realized gain of approximately $800,000, reducing the Company's voting and
economic interest to 3.5%.
Dividend income recorded in 1999, 1998 and 1997 received from Terra Nova
was $213,000, $213,000 and $157,000, respectively.
In June 1999, the Company reclassified its investment in Terra Nova to a
publicly traded equity security.
TRG Associates, LLC
In October 1997, the Company acquired an 8.8% economic interest (7.7%
voting interest) in TRG Associates, LLC ("LLC"), a new limited liability company
formed for the purpose of holding all of the Class 1 common stock of TRG Holding
Corporation ("TRG Holdings"), for $4,875,000. TRG Holdings acquired all of the
common stock of The Resolution Group, Inc. ("TRG") in exchange for $150 million
in cash (funded by $50 million from the LLC and $100 million of debt incurred by
TRG Holdings) and $462 million face amount of the Class 2 common stock of TRG
Holdings.
F-23
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
TRG, located in Chicago, was formed to manage and pay off claims
liabilities on policies that insurance subsidiaries of Talegen Holdings, Inc., a
subsidiary of Xerox Corporation, had written prior to 1993.
In August 1999, the Company recorded an after-tax net realized gain of $2.2
million upon completion of the sale of this investment to Fairfax Financial
Holdings Limited.
TridentStockton.
TRIDENT II, L.P.
On June 4, 1999, the Company committed to invest $25 million as a limited
partner of
Trident II, L.P. ("Trident II"), a is an investment partnership, managed by MMCI.
Trident II will makewhich makes
private equity and equity related investments in the global insurance,
reinsurance and related industries. The fund will targettargets investments in existing
companies that are in need of growth capital or are under performing as well as
in newly formed companies.
On June 4, 1999, the Company committed to invest $25 million as a limited
partner of Trident II a partnership managed by MMC Capital. On November 8, 2001,
the Company was released from its remaining $11.0 capital commitment to Trident
II pursuant to an agreement entered into between ACGL, the principal investors,
The Company's Chairman is one of four
Senior Principals of MMCI who manage Trident II.Partnership, LP. ("Trident"), Trident II, and MMRCH (see Note 8).
The term of Trident II expires in 2009. However, the term may be extended
for up to a maximum of three one-year periods at the discretion of MMCIMMC Capital
to permit orderly dissolution.
During the first six years of the fund, the Company will pay an annual
management fee, payable semi-annually in advance, equal to 1.5% of the Company's
aggregate $25.0 million commitment as well as a percentage of cumulative net
gains on invested funds. After such six yearsix-year period, the annual management fee
will be 1.5% of the aggregate funded commitments.
ForDuring the periodyear ended December 31, 1999,2001, the Company funded its 1.96% share,
or $6.1$6.5 million of
investments made byits investment commitment to Trident II and wrote-down its carrying value in
various entities.Trident II by $2.1 million. Fees and expenses of $404,000, $375,000 and $250,000
were paid in 2001, 2000 and 1999, respectively, to MMCIMMC Capital relating to its
management of Trident II.
Fixed MaturitiesF-24
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
4. INVESTMENT INFORMATION (CONTINUED)
AMERICAN INDEPENDENT INSURANCE HOLDING COMPANY
On February 28, 2001, the Company completed a transaction pursuant to which
the Company acquired all of the common stock of AIHC. In connection with the
acquisition, the Company's outstanding loans to AIHC were contributed to AIHC's
capital and the Company also returned certain warrants to purchase shares of
AIHC (see Note 3).
DISTRIBUTION INVESTORS, LLC
In connection with the Company's acquisition of Hales, the Company has
committed to invest approximately $1.5 million as a member of Distribution
Investors, LLC ("Distribution Partners"), which is the general partner of
Distribution Partners Investment Capital, L.P. (the "Fund"), a private equity
fund affiliated with Hales. As part of the transaction, the Company also
acquired Hales' existing $100,000 investment in Distribution Investors. For the
year ended December 31, 2001, the Company funded $836,000 of its capital
commitment to the Fund. Distribution Investors, at $51 million of total
committed capital, focuses on equity investments of $3 million to $10 million in
insurance distribution and distribution-related service companies.
FIXED MATURITIES
Contractual maturities of fixed maturity securitiesmaturities at December 31, 19992001 are shown
below. Expected maturities, which are management's best estimates, will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
(In thousands)
December(IN THOUSANDS)
DECEMBER 31, 1999
---------------------------------------
Estimated
Fair Amortized
Value Cost
---------------- ---------------2001
---------------------
ESTIMATED
FAIR AMORTIZED
VALUE COST
--------- ---------
Available for sale:
Due in one year or less $10,210 $10,237less............................... $ 9,351 $ 10,438
Due after one year through five years 68,182 69,956years................. 322,923 321,315
Due after five years through 10 years 78,461 82,282years................. 34,751 31,445
Due after 10 years 76,916 79,446
---------------- ---------------
Sub-total 233,769 241,921years.................................... 10,097 12,804
-------- --------
377,122 376,002
Mortgage and asset-backed securities 27,298 28,424
---------------- ---------------
Total $261,067 $270,345
================ ===============
As of December 31, 1999, the weighted average contractual and expected
maturities of the fixed maturity investments, based on fair value, were
12.6 years and 8.1securities.................. 91,147 91,152
-------- --------
Total................................................... $468,269 $467,154
======== ========
As of December 31, 2001, the weighted average contractual and expected
maturities of the fixed maturity investments, based on fair value, were
3.2 years and 1.9 years, respectively.
F-24
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investment Information (continued)
Proceeds from the sale of fixed maturity securitiesmaturities during 1999, 19982001, 2000 and 19971999 were
approximately $270$183 million, $255$228 million and $241$270 million, respectively. Gross
gains of $1,522,000, $2,242,000$2,668,000, $1,097,000 and $858,000$1,522,000 were realized on those sales
during 1999, 19982001, 2000 and 1997,1999, respectively. Gross losses of $3,298,000, $770,000$4,784,000,
$16,647,000 (of which $7,611,000 million related to losses resulting from
restructuring the Company's investment portfolio in connection with its
redomestication to Bermuda in November 2000) and $583,000$3,298,000 were realized during
2001, 2000 and 1999, 1998 and 1997,
respectively.
F-25
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
4. INVESTMENT INFORMATION
Approximately 86%100% of the fixed maturity investments held by the Company at
December 31, 19992001 were consideredrated investment grade by Standard & Poor's Corporation
or Moody's Investors Service, Inc.
There arewere no investments in any entity in excess of 10% of the Company's
stockholders'shareholders' equity at December 31, 19992001 other than investments issued or
guaranteed by the United States government or its agencies and the Company's
investment in Annuity and Life Re.
Securities Pledged and on Deposit
Securities with a carrying value of approximately $11.1 million have been
pledged as collateral for letters of credit obtained in connection with certain
reinsurance obligations of the Company (see Note 5).agencies.
SECURITIES PLEDGED AND ON DEPOSIT
At December 31, 1999,2001, securities with a face amount of $5.8$15.3 million were on
deposit with the Insurance Department of the State of Nebraska and other states
in order to comply with insurance laws.
4. Agreements with Related Parties
Investment Advisory Agreements5. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table represents an analysis of losses and loss adjustment
expenses and a reconciliation of the beginning and ending reserve for losses and
loss adjustment expenses for the years indicated:
(IN THOUSANDS)
DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Reserve for losses and loss adjustment expenses at beginning
of year................................................... -- $364,554 $216,657
Unpaid losses and loss adjustment expenses recoverable...... -- (55,925) (30,468)
-------- -------- --------
Net unpaid losses and loss adjustment expenses at beginning
of year................................................... -- 308,629 186,189
Increase in net losses and loss adjustment expenses incurred
relating to losses occurring in:
Current year............................................ $ 23,025 73,563 275,455
Prior years............................................. 423 2,700 30,386
-------- -------- --------
Total net incurred losses and loss expenses......... 23,448 76,263 305,841
Net losses and loss adjustment expense reserves acquired.... 14,320 -- --
Less net losses and loss adjustment expenses paid relating
to losses occurring in:
Current year............................................ 10,635 311,330 95,367
Prior years............................................. 4,068 73,562 88,034
-------- -------- --------
Total net paid losses............................... 14,703 384,892 183,401
Net reserve for losses and loss adjustment expenses at end
of year................................................... 23,065 -- 308,629
Unpaid losses and loss adjustment expenses recoverable...... 90,442 -- 55,925
-------- -------- --------
Reserve for losses and loss expenses at end of year......... $113,507 $ -- $364,554
======== ======== ========
The Company believes that its exposure, if any, to environmental impairment
liability and asbestos-related claims was minimal since no business had been
written for periods prior to 1996.
Subject to the following, the Company believes that the reserves for unpaid
losses and loss adjustment expenses are adequate to cover the ultimate cost of
losses and loss adjustment expenses
F-26
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
5. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)
incurred through December 31, 2001. The reserves are based on estimates of
losses and loss adjustment expenses incurred and, therefore, due to the inherent
uncertainties of estimating claims and claims expense the ultimate reserves may
be more or less than such estimates. To the extent reserves prove to be
inadequate, the Company may have to augment such reserves and incur a charge to
earnings. Such a development could occur and result in a material charge to
earnings or stockholders' equity in future periods. Actual losses and loss
adjustment expenses paid may deviate, perhaps materially, from estimates
reflected in the Companies reserves reported in its financial statements.
Estimates of prior accident year claims were increased by approximately
$3 million in 2000 primarily due to aviation and property business. Estimates of
prior accident year claims were increased by approximately $30 million in 1999.
A substantial portion of this amount resulted from (i) the Company's review of
additional claims information and actuarial analysis of the business produced by
a certain managing underwriting agency, (ii) notification of additional
satellite losses received in 1999 pertaining to 1998, (iii) aviation losses,
principally the 1998 Swiss Air crash, and (iv) property losses reported on
several international treaties that were in run-off in 1999.
6. REINSURANCE
In the normal course of business, the Company's insurance subsidiaries cede
a substantial portion of their premium through quota share, surplus, excess of
loss and facultative reinsurance agreements. Reinsurance recoverables are
recorded as assets, predicated on the reinsurers' ability to meet their
obligations under the reinsurance agreements. If the reinsurers are unable to
satisfy their obligations under the agreements, the Company's insurance
subsidiaries would be liable for such defaulted amounts.
With respect to 2001 results reflected below, the following table sets forth
the effects of reinsurance on the Company's insurance subsidiaries, which were
acquired during 2001. With respect to 2000 results reflected below, the
following table sets forth the effects of reinsurance on the Company's prior
reinsurance operations, which were sold on May 5, 2000 to Folksamerica.
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
PREMIUMS WRITTEN:
Direct........................................ $117,406 -- --
Assumed....................................... 1,796 $102,034 $386,848
Ceded......................................... (82,986) (19,731) (80,122)
Unearned premium portfolio transfer and
assumption.................................. -- (92,907) --
-------- -------- --------
Net........................................... $ 36,216 $(10,604) $306,726
======== ======== ========
PREMIUMS EARNED:
Direct........................................ $110,022 -- --
Assumed....................................... 619 $107,404 $380,880
Ceded......................................... (79,723) (19,874) (69,512)
-------- -------- --------
Net........................................... $ 30,918 $ 87,530 $311,368
======== ======== ========
F-27
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
6. REINSURANCE (CONTINUED)
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED:
Direct........................................ $ 99,761 -- --
Assumed....................................... 1,091 $ 88,676 $348,979
Ceded......................................... (77,404) (12,413) (43,138)
-------- -------- --------
Net........................................... $ 23,448 $ 76,263 $305,841
======== ======== ========
7. INCOME TAXES
ACGL 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 a written undertaking from the Minister of
Finance in Bermuda under the Exempted Undertakings Tax Protection Act 1966 that,
in the event that any legislation is enacted in Bermuda imposing any tax
computed on profits, income, gain or appreciation on any capital asset, or any
tax in the nature of estate duty or inheritance tax, such tax will not be
applicable to ACGL or any of its operations until March 28, 2016. This
undertaking does not, however, prevent the imposition of taxes on any person
ordinarily resident in Bermuda or any company in respect of its ownership of
real property or leasehold interests in Bermuda.
ACGL will be subject to U.S. federal income tax only to the extent that it
derives U.S. source income that is subject to U.S. withholding tax or income
that is effectively connected with the conduct of a trade or business within the
U.S. and is not exempt from U.S. tax under an applicable income tax treaty with
the U.S. ACGL will be subject to a withholding tax on dividends from U.S.
investments and interest from certain U.S. payors. ACGL does not consider itself
to be engaged in a trade or business within the U.S. and, consequently, does not
expect to be subject to direct U.S. income taxation. However, because there is
uncertainty as to the activities which constitute being engaged in a trade or
business within the United States, there can be no assurances that the U.S.
Internal Revenue Service will not contend successfully that ACGL or non-U.S.
subsidiaries are engaged in a trade or business in the United States. If ACGL or
any of its non-U.S. subsidiaries were subject to U.S. income tax, ACGL's
shareholders' equity and earnings could be adversely affected. ACGL's U.S.
subsidiaries will continue to be subject to U.S. income taxes on their worldwide
income.
F-28
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
The components of income taxes attributable to operations for the years
ended December 31, 2001, 2000 and 1999 were as follows:
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Current (benefit) expense:
U.S. Federal................................... $ 506 -- $ (9,021)
U.S. State..................................... 150 -- --
Non-U.S........................................ -- -- --
------- ------ --------
$ 656 -- $ (9,021)
------- ------ --------
Deferred (benefit) expense:
U.S. Federal................................... 1,472 $8,515 (11,925)
U.S. State..................................... -- -- --
Non-U.S........................................ -- -- --
------- ------ --------
1,472 8,515 (11,925)
------- ------ --------
Total income tax (benefit) expense............... $ 2,128 $8,515 $(20,946)
======= ====== ========
A reconciliation from the federal statutory income tax rate of 35% to the
Company's effective tax rate for the years ended December 31, 2001, 2000 and
1999 follows:
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Income tax (benefit) expense computed on pre-tax
income at the federal statutory rate........... $ 8,450 $ 176 $(19,670)
Valuation allowance............................ (8,518) 5,650 --
Write-off of deferred tax asset................ 251 2,993 --
Goodwill....................................... 360 -- --
Tax-exempt investment income................... (12) (341) (733)
Dividend received deduction.................... -- (250) (958)
Limitation on executive compensation........... -- 397 --
Foreign (income) loss.......................... 880 (278) --
Other.......................................... 717 168 415
------- ------ --------
Income tax expense (benefit)................... $ 2,128 $8,515 $(20,946)
======= ====== ========
The Company had no current federal tax expense or benefit for the years
ended December 31, 2001 and 2000 due to its net operating losses and the full
utilization of the two year carry-back provision at December 31, 1999. During
2000, the Company recovered $8.6 million of previously paid income taxes. Actual
federal income taxes paid in 1999 was $1.9 million. The amount paid in 1999 was
the final installment related to the 1998 tax return.
The Company has net operating loss carryforwards totaling $43.3 million at
December 31, 2001. Such net operating losses are currently available to offset
future taxable income of the Company and
F-29
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
expire between 2011 and 2021. The Company also has an alternative minimum tax
("AMT") credit carryforward in the amount of $1.0 million which can be carried
forward without expiration.
On November 20, 2001, the Company underwent an ownership change for U.S.
federal income tax purposes as a result of the investment led by Warburg Pincus
funds and Hellman & Friedman funds. As a result of this ownership change,
limitations are imposed upon the utilization of existing net operating losses.
In 2000, upon the Company's redomestication to Bermuda, Arch-U.S.
distributed substantially all of its public equity of $21.0 million. The
associated income tax expense of $7.4 million reduced the Company's net
operating loss carryforwards by a corresponding amount. However, for financial
reporting purposes, since the securities had not been sold to an unrelated third
party, the realized gain was deferred and was reported as unrealized
appreciation in the consolidated financial statements. Accordingly, the related
income tax expense was also deferred and reduced unrealized appreciation in the
consolidated financial statements. In 2001, the Company divested its public
equity portfolio in its entirety and, accordingly, has recognized U.S. federal
income tax expense of $7.4 million in its consolidated financial statements. In
addition, in 2000, the Company had written off $2.0 million of deferred tax
assets relating to losses recognized in the consolidated financial statements on
the Company's privately held investments, which amount will not be deductible in
future U.S. income tax returns since Arch-U.S. distributed these investments to
ACGL, its Bermuda parent.
Deferred income tax assets and liabilities reflect temporary differences
based on enacted tax rates, between the carrying amounts of assets and
liabilities for financial reporting and income tax purposes. Significant
components of the Company's deferred income tax assets and liabilities as of
December 31, 2001 and 2000 were:
(IN THOUSANDS)
DECEMBER 31,
-------------------
2001 2000
-------- --------
Deferred income tax assets:
Net operating loss....................................... $15,151 $7,215
Reserve for loss of escrowed assets...................... 5,950 5,250
AMT credit carryforward.................................. 965 651
Discounting of net unpaid loss reserves.................. 335 --
Net unearned premium reserve............................. 1,975 --
Unrealized loss on marketable securities................. -- 606
Compensation liabilities................................. -- 250
Other, net............................................... 1,403 48
------- ------
Total deferred tax assets.................................. 25,779 14,020
------- ------
Deferred income tax liabilities:
Equity in net income on investees, net................... (551) (117)
Deferred policy acquisition cost......................... (1,718) --
Net unrealized appreciation of investments............... (240) (61)
------- ------
Total deferred tax liabilities............................. (2,509) (178)
------- ------
Valuation allowance........................................ (9,554) (5,650)
------- ------
Net deferred income tax asset.............................. $13,716 $8,192
======= ======
F-30
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
As of December 31, 2001, the Company has provided a valuation allowance to
reduce certain deferred tax assets to an amount which management expects to more
likely than not be realized. In addition, as a result of the Company's pursuit
of U.S.-based underwriting operations, which included an increase in the
Company's on-shore investment portfolio, the Company reversed a valuation
allowance on certain other deferred tax assets and recorded a benefit of
$7.8 million for the year ended December 31, 2001.
As of December 31, 2000, the Company had a valuation allowance of
$5.7 million that adjusted the net deferred income tax asset to its estimated
realizable value of $8.2 million. Deferred income tax expense for the year ended
December 31, 2000 included a charge for such allowance of $5.7 million.
8. AGREEMENTS WITH RELATED PARTIES
On November 8, 2001, ACGL, the principal investors, Trident, Trident II,
MMRCH and employee co-investment funds affiliated with MMRCH entered into an
agreement. Under this agreement, the Warburg Pincus investors assigned their
right and commitment to purchase $35.0 million of the preference shares and
Class A Warrants to Trident II and the co-investment funds. MMRCH agreed to
exchange all of its existing Class A Warrants for newly issued Common Shares
(assuming that they had been exercised pursuant to a cashless exercise) and to
exchange all of its Class B Warrants for cash at a price equal to $7.50 per
Class B Warrant (see Note 12).
In addition, the board observer and board nomination rights of MMRCH and
Trident were terminated, and the Company was also released from its remaining
$11.0 million capital commitment to Trident II for new investments. During 1999,
the Company had committed to invest $25 million as a limited partner in Trident
II, a partnership managed by MMC Capital.
Effective July 1, 1999, the Company amended its investment advisory
agreement with MMCI forMMC Capital, which governs management of the Company's portfoliosportfolio
of public equity securities (including convertible
securities) that are publicly traded ("Public Portfolio") and a portion of its portfolio
of privately held equity securities, primarily in issuers engaged in, or
providing services to, the insurance and reinsurance business ("Private
Portfolio"). The Private Portfolio includes equity securities which at
the time of acquisition do not have a readily ascertainable market or are
subject to certain trading restrictions. MMCIMMC Capital is also an investment advisor to Trident, a dedicated
insurance industry private equity fund organized by MMCIMMC Capital and three other
sponsors. MMCI'sMMC Capital's direct parent, MMRCH, owns 1,395,6251,632,231 shares, or
approximately 8.2%12% of the outstanding Common Stock, and Class A warrants and
Class B warrants to purchase 905,397 and 1,770,601 shares of Common Stock,
respectively.Shares. At December 31, 1999,2001,
Trident owns 250,000 shares, or approximately 1.5%2%, of the outstanding Common
Stock,Shares, and Class A warrants to purchase 1,386,079 shares of Common Stock.
Effective July 1, 1999, the Company amended its investment advisory
agreement with MMCI, which governs the management of the Company's portfolios of
equity securities (including convertible securities) that are publicly traded
and privately held.Shares.
Pursuant to the amended agreement, which has a term of four years (subject
to renewal)renewal or early termination under certain circumstances), MMCIMMC Capital
provides the Company with investment management and advisory services with
respect to investments in the Private Portfolio whose value exceeds
(i) $10 million during the first year of the term, (ii) $15 million during the
second year of the term, and (iii) $20 million during the third and fourth years
of the term. Under such amendments, the Company pays MMCIMMC Capital an annual fee
equal to (x) 20% (previously 7.5%) of cumulative net realized gains including
dividends, interest and other distributions, received on the Private Portfolio
over (y) cumulative compensation previously paid in prior years on cumulative
net realized gains (as defined in the agreement) on the Private Portfolio
managed by MMCI,MMC Capital, but the Company will not pay MMCIMMC Capital a management
fee (previously 1.5% per annum of the quarterly carrying value of the Private
Portfolio). With respect to the management of the Company's Public Portfolio,
the Company pays MMCIMMC Capital a fee equal to 0.50% of the first $50 million under
MMCI'sMMC Capital's
F-31
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
8. AGREEMENTS WITH RELATED PARTIES (CONTINUED)
management and 0.35% of all amounts in excess of $50 million (subject to a
minimum fee of $250,000 per annum). F-25
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Agreements with Related Parties (continued)Fees incurred under the agreements during
fiscal years 2001, 2000 and 1999 were approximately $262,000, $298,000 and
$1.5 million, respectively. In connection with the amendments to the Company'sits amended investment advisory
agreement with MMCI,
RCHI will receiveMMC Capital, the Company receives from MMCIMMC Capital $1.25 million
per annum during the initial four-year term, subject to certain conditions.
The initial agreement providedOn June 22, 2001, the Company completed the acquisition of all of the
remaining ownership interests in one of its investee companies, ART Services,
for a minimum aggregatepurchase price of approximately $38.8 million. Of such amount,
$38.4 million was paid in cash fee to MMCI of $500,000 per annum through December 31,
1997. Fees incurred underMMRCH and Trident in return for their
interests in ART Services and the agreements during fiscal years 1999, 1998 and 1997
were approximately $1.5 million, $2.7 million and $1.3 million, respectively. In
addition, in 1999, 1998 and 1997, unrealized appreciationbalance was paid in the Private
Portfolio is netform of accrued feesCommon Shares
to certain management shareholders of approximately $256,000, $2.2 million and
$1.4 million, respectively.
In May 1999, the Company transferred the management of the fixed income and
short term cash portfolios from The Putnam Advisory Company, Inc. ("Putnam") to
Alliance Capital. The Company had an investment advisory agreement with Putnam,
an affiliate of MMCI, for the management of the Company's fixed income
securities and short term cash portfolios through April 1999. For the fixed
income securities portfolio, the Company paid to Putnam a fee equal to the sum
of 0.35% per annum of the first $50 million of the market value of the
portfolio, 0.30% per annum on the next $50.0 million, 0.20% per annum on the
next $100 million and 0.15% per annum of the market value of assets that exceeds
$200 million. For the short term cash portfolio, the Company paid a fee equal to
0.15% per annum of the total monthly average market value. Fees incurred under
the Putnam agreement for the period in 1999, 1998 and 1997 were approximately
$173,000, $461,000 and $493,000, respectively.
Reinsurance Treaties
In addition to business assumed from insurance companies where the Company
has a private equity investment as described inART Services (see Note 3, the Company also assumed
premiums written and premiums earned of $5.2 million and $5.3 million,
respectively, in 1999, $3.3 million and $3.4 million, respectively, in 1998 and
$5.5 million and $2.5 million, respectively, in 1997 from XL, which owned
4,755,000 shares prior to the stock repurchase described in Note 14, or
approximately 27.8% of the outstanding Common Stock, and premiums written and
premiums earned of $17.4 million and $17.3 million, respectively, in 1999, $18.5
million and $20.7 million, respectively, in 1998 and $12.3 million and $6.8
million, respectively, in 1997 from majority-owned insurance companies of
Trident.
Other Agreements3).
Commencing in 1996, MMCIMMC Capital subleased office space from the Company for
a term expiring in October 2002. Future minimum rental income, exclusive of
escalation clauses and maintenance costs, under the remaining term of the
sublease will be approximately $1,218,000.$832,000. Rental income for 1999, 1998was $1,032,000, $636,000
and 1997 was $430,000 in each year.
In addition in2001, 2000 and 1999, 1998 and 1997, MMCI reimbursedrespectively.
As of December 31, 2001, the Company approximately $1,000, $11,000 and $530,000 (net of $59,000, $89,000 and $44,000
for certain sublease income allocated to MMCI) for their pro-rata share of
improvement and maintenance costs under the sublease.
During 1999, the Companyhas committed to invest $25approximately
$1.5 million as a limitedmember of the general partner of a fund affiliated with Hales
(see Note 4).
On March 2, 2000, the Company repurchased from XL Capital, then its single
largest shareholder, all of the Common Shares held by XL Capital in a
transaction described in Note 12.
Prior to sale of the Company's reinsurance operations on May 5, 2000,
affiliates of MMC Capital's ultimate parent, Marsh & McLennan Companies, Inc.
("Marsh"), acted as reinsurance intermediaries to Arch Re as indicated in
Note 15. The Company has also utilized affiliates of Marsh as insurance brokers
for the Company's insurance needs.
The Company also agreed to provide a loan to the Chairman of the Board of
Directors of the Company, which will be used to pay income and self-employment
taxes on restricted shares granted to him on October 23, 2001 (see Note 9).
In addition, the Company has made investments in entities in which
affiliates of Marsh, Trident II, a partnership managed by MMCI. Seeand XL Capital have invested (see Note 3.
F-264).
F-32
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. Commitments
Lease Agreement
The Company has a sublease agreement for office facilities for a term
expiring in October 2002. Future(CONTINUED)
9. COMMITMENTS
LEASES
At December 31, 2001, the future minimum rental charges under the remaining term
of the sublease,commitments, exclusive of
escalation clauses and maintenance costs and net of rental income for all of the
Company's operating leases with remaining non-cancelable terms in excess of one
year are as follows:
(In thousands)
----------------------
(IN THOUSANDS)
--------------
2002........................................................ $1,213
2003........................................................ 918
2004........................................................ 931
2005........................................................ 902
2006........................................................ 1,117
Thereafter.................................................. --
------
$5,081
======
All of these leases are for the rental of office space, with expiration
terms that range from 2002 to 2006. During 2001, 2000 $681
2001 716
2002 597
-------------------
$1,994
===================
Duringand 1999, 1998 and 1997, rental (income)
expense, net of income from subleases, was approximately ($132,000), $190,000
and $576,000, $576,000 and $643,000, respectively.
Letters of CreditEMPLOYMENT AND OTHER ARRANGEMENTS
At December 31, 1999,2001, the Company is obligated under letters of credit in
an aggregate amount of approximately $9.7 million, which secure certain of the
Company's reinsurance obligations.
Severance Arrangements
The Company has a program for all employees that provides for certain
severance payments, immediate vesting of restricted stock grants and option
awards and continuation of benefits in the event of termination of employment
resulting from a change in control. The extent of such payments depends on the
position of the employee. See Note 14 - Subsequent Events for information on the
agreement entered into by the Company to sell its reinsurance business to
Folksamerica, which constitutes a change in control for purposes of the
Company's employee benefit plans and agreements.
Employment Agreements
The Company has employment agreements
with certain of its executive officers. One of
these agreements has a five-year term initially expiring in September 2000, and
the remaining agreements may be terminated upon notice by either party. These
agreementsofficers for periods extending up to
October 2006. Such employment arrangements provide for compensation in the form
of base salary, annual bonus, stock-based awards, under the 1995 and 1999 Stock Plans (as hereinafter defined),
participation in the Company's
employee benefit programs and the reimbursementreimbursements of certain expenses.
Under oneThe Company has agreed to make a loan of up to $13.5 million to the Chairman
of the agreements,Board of Directors of the Company, guaranteed loanswhich will be used to pay income and
self-employment taxes, payable in the amount of $500,000 madeApril 2002, on restricted shares granted to
an executive by a financial institution to
fund such executive's purchase of 25,000 shares of Common Stock and related tax
liability under such stock's vesting provisions. In connection with such
guarantee, the Company is entitled to customary subrogation rights.
F-27
RISK CAPITAL HOLDINGS, INC.him on October 23, 2001 (see Note 10).
10. STOCK AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Claims and Claims Expenses
The reconciliation of claims and claims expense reserves is as follows:
(In thousands)
December 31,
1999 1998 1997
------------ ------------ ------------
At beginning of year:
Gross claims and claims expense reserves $216,657 $70,768 $20,770
Reinsurance recoverables 30,468 522
------------ ------------ ------------
Net claims and claims expense reserves 186,189 70,768 20,248
Net claims and claims expenses incurred relating to:
Current year 275,455 178,957 73,385
Prior year 30,386 (2,832) 22
------------ ------------ ------------
Total 305,841 176,125 73,407
Net paid claims and claims expenses incurred relating to:
Current year 95,367 41,910 13,649
Prior year 88,034 18,794 9,238
------------ ------------ ------------
Total 183,401 60,704 22,887
At end of year:
Net claims and claims expense reserves current year 308,629 186,189 70,768
Reinsurance recoverables 55,925 30,468 -
------------ ------------ ------------
Gross claims and claims expense reserves $364,554 $216,657 $70,768
============ ============ ============
The Company believes that its exposure, if any, to environmental impairment
liability and asbestos-related claims is minimal since no business has been
written for periods prior to 1996.
Subject to the following, the Company believes that the reserves for claims
and claims expenses are adequate to cover the ultimate cost of claims and claims
expenses incurred through December 31, 1999. The reserves are based on estimates
of claims and claims expenses incurred and, therefore, the amount ultimately
paid may be more or less than such estimates. The inherent uncertainties of
estimating claims and claims expense reserves are exacerbated for reinsurers by
the significant periods of time (the "tail") that often elapse between the
occurrence of an insured claim, the reporting of the claim to the primary
insurer and, ultimately, to the reinsurer, and the primary insurer's payment of
that claim and subsequent indemnification by the reinsurer. As a consequence,
actual claims and claims expenses paid may deviate, perhaps materially, from
estimates reflected in the Company's reserves reported in its financial
statements. The estimation of reserves by new reinsurers, such as the Company,
may be less reliable than the reserve estimations of a reinsurer with an
established volume of business and claims history. To the extent reserves prove
to be inadequate, the Company may have to augment such reserves and incur a
charge to earnings. Such a development could occur and result in a material
charge to earnings or stockholders equity in future periods.
Estimates of prior accident year claims were increased by approximately $30
million in 1999. A substantial portion of this amount resulted from (i) the
Company's review of additional claims information and its continuing
underwriting and actuarial analysis of the business produced by a certain
managing underwriting agency, (ii) notification of additional satellite losses
received in 1999 pertaining to 1998, (iii) aviation losses, principally the 1998
Swiss Air crash, and (iv) property losses reported on several international
treaties that are in run-off.
Estimates of prior accident year claims were reduced by approximately $2.8
million in 1998 primarily due to favorable claim development in the property and
multi-line classes of business.
F-28
RISK CAPITAL HOLDINGS, INC.STOCK OPTION PLANS
1995 LONG TERM INCENTIVE AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Retrocession Agreements
The Company utilizes retrocession agreements for the purpose of limiting
its exposure with respect to multiple claims arising from a single occurrence or
event. The Company also participates in "common account" retrocessional
arrangements for certain treaties. Such arrangements reduce the effect of
individual or aggregate losses to all companies participating on such treaties
including the reinsurer, such as the Company, and the ceding company.
Reinsurance recoverables are recorded as assets, predicated on the
retrocessionaires' ability to meet their obligations under the retrocessional
agreements. If the retrocessionaires are unable to satisfy their obligations
under the agreements, the Company would be liable for such defaulted amounts.
The effects of reinsurance on written and earned premiums and claims and
claims expenses are as follows:
(In thousands)
Years Ended December 31,
-----------------------------------------------------------
1999 1998 1997
---------------- ---------------- -----------------
Assumed premiums written $386,848 $260,566 $147,878
Ceded premiums written 80,122 25,831 3,044
----------------
---------------- -----------------
Net premiums written $306,726 $234,735 $144,834
================ ================ =================
Assumed premiums earned $380,880 $232,025 $110,992
Ceded premiums earned 69,512 25,831 3,620
---------------- ---------------- -----------------
Net premiums earned $311,368 $206,194 $107,372
================ ================ =================
Assumed claims and claims expenses incurred $348,979 $210,006 $73,407
Ceded claims and claims expenses incurred 43,138 33,881
---------------- ---------------- -----------------
Net claims and claims expenses incurred $305,841 $176,125 $73,407
================ ================ =================
At December 31, 1999, the Company's balance sheet reflects reinsurance
recoverable and reinsurance premiums payable balances as follows:
(In thousands)
December 31, December 31,
1999 1998
-------------------- --------------------
Reinsurance recoverable balances:
Unpaid claims and claim expenses $55,925 $30,468
Paid amounts 6,588 107
Unearned premiums 10,609
-------------------- --------------------
Total $73,122 $30,575
==================== ====================
Reinsurance premiums payable $14,666 $5,396
==================== ====================
F-29
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Employee Benefits and Compensation Arrangements
1995 Long Term Incentive and Share Award PlanSHARE AWARD PLAN
In September 1995, the Company adopted the 1995 Long Term Incentive and
Share Award Plan (the "1995 Stock Plan"), which is administered by the Compensation Committee of theCompany's
Board of Directors.Directors and its Stock Awards Committee. The Company may grant,
subject to certain restrictions, stock options, stock appreciation rights,
restricted shares, restricted share units payable in shares of Common StockShares or cash,
stock awards in lieu of cash awards, and other stock-based awards to eligible
employees and directors of the Company. Awards relating to not more than
1,700,000 shares of
Common StockShares may be made over the five-yearten-year term of the 1995 Stock
Plan.
In April 1999, the Company adopted the 1999 Long Term Incentive and Share
Award Plan (the "1999 Stock Plan"). The 1999 Stock Plan, like its predecessor,
is intended to provide incentives to attract, retain and motivate employees and
Directorsdirectors in order to achieve the Company's long termlong-term growth and profitability
objectives. The 1999 Stock Plan provides for the grant to eligible employees and
Directorsdirectors of stock options, stock appreciation rights, restricted shares,
restricted share units payable in shares of Common StockShares or cash, stock awards in lieu of
cash awards, dividend equivalents and other stock
F-33
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
10. STOCK AND STOCK OPTION PLANS (CONTINUED)
based awards. The 1999 Stock Plan also provides the Non-Employee Directorsnon-employee directors with
the opportunity to receive the annual Board retainer fee in shares of Common Stock.Shares. An
aggregate of 900,000 shares of Common StockShares has been reserved for issuance under the 1999
Stock Plan (of which no more than 300,000 of such shares may be issued pursuant
to grants of restricted shares, restricted share units, performance shares and
performance units), subject to anti-dilution adjustments in the event of certain
changes in the Company's capital structure.
Shares issued pursuant toAt December 31, 2001, substantially all of the shares reserved for issuance
under the 1995 and 1999 Stock Plans had been issued.
In October 2001, the Company adopted the 2001 Long Term Incentive Plan will be either authorized but unissuedfor
New Employees (the "2001 Stock Plan"). The 2001 Stock Plan is intended to
provide incentives to new employees as an inducement essential to such employees
entering into employment arrangements with the Company. An aggregate of
4,600,000 common shares or treasury shares.
Restrictedhas been reserved for issuance under the 2001 Stock
Plan.
RESTRICTED COMMON SHARES
During 1999, 19982001, 2000 and 1997,1999, the Company granted an aggregate of 627,949,
74,218, and 2,500
15,700, 24,000 shares, respectively, of restricted stock undershares for financial
statement purposes. In addition, the 1995 Stock
Plan. Grants of restricted stock generally vest at a rate of 20% per year over
five years commencing on the first anniversaryChairman of the dateBoard of grant.the Company was
granted a total of 1,689,629 restricted shares. Of such amount, 1,668,157
restricted shares were granted on October 23, 2001 and 21,472 restricted shares
were granted on November 19, 2001. These grants could be rescinded if they are
not approved by the Company's shareholders prior to October 23, 2002, and,
accordingly, are not reflected in the Company's consolidated financial
statements at December 31, 2001. The Company records a deferred expensecompensation equal
to the market value of the shares at the measurement date,
of grant which is amortized
and charged to income over the vesting period. The deferred expensecompensation was
$10.5 million, $1.1 million and ($117,000), $296,000 and $506,000, and the amortization of the deferred
expensecompensation was $2.6 million, $1.1 million and $628,000, $1,012,000,for 2001, 2000 and
$1,687,000, for 1999, 1998respectively. The issuance of restricted shares and 1997, respectively. Upon the closing of the sale of the Company's
reinsurance business to Folksamerica, all unvested restricted stock and all
unvestedamortization thereon
has no effect on consolidated shareholders' equity.
STOCK OPTIONS
The Company generally issues stock options will immediately become vested. See Note 14 - Subsequent
Events.
F-30
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Employee Benefitsto officers and Compensation Arrangements (continued)
Stock Options
The Company issues incentive stock options and/or non-qualified stock
options atdirectors, with
exercise prices equal to the fair market values atof the Common Shares on the
grant dates to officers and non-employee
Directors.dates. Options to officers generally vest and become exercisable at a rate
of 20% per year over five years from the date of grant. Incentive stock options
expire ten years after the grant date and non-qualified stock options expire
seven years after vesting. Initial options granted to non-employee Directors vest and become exercisable in three
equal installments commencing on the grant date ofand thereafter on the first and
second anniversary thereof and expire ten years after the grant date. Initial
options granted to non-employee directors vest and become exercisable in three
equal installments, commencing on the grant date and annually thereafter. Annual
options granted to non-employee Directorsdirectors in office on January 1 of each year
vest on the first anniversary of the date the option is granted. Upon the closing of the sale of the Company's
reinsurance business to Folksamerica, all unvested restricted stock and all
unvested stock options will immediately become vested. See Note 14 - Subsequent
Events.grant date.
F-34
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
10. STOCK AND STOCK OPTION PLANS (CONTINUED)
Information relating to the Company's stock options is set forth below:
Years Ended DecemberYEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------
2001 2000 1999
1998 1997
---------------- ---------------- ----------------
Number of options---------- ---------- ----------
NUMBER OF OPTIONS
Outstanding, beginning of yearyear........... 1,222,775 1,281,356 1,347,075
960,650 628,950
GrantedGranted.................................. 2,898,036 146,000 18,800
410,825 371,700
CanceledCanceled................................. (52,500) (204,581) (84,519)
(20,580) (39,500)
Exercised - (3,820) (500)Exercised................................ -- -- --
Outstanding, end of yearyear................. 4,068,311 1,222,775 1,281,356 1,347,075 960,650
Exercisable, end of yearyear................. 2,698,052 1,122,000 683,388
358,884 178,611
Average exercise price
Granted $17.25 $22.47 $22.86
Canceled $21.81 $20.97 $17.63
Exercised - $19.24 $17.63AVERAGE EXERCISE PRICE
Granted.................................. $ 19.97 $ 15.13 $ 17.25
Canceled................................. $ 15.33 $ 21.02 $ 21.81
Exercised................................ -- -- --
Outstanding, end of year $20.90 $21.00 $20.38year................. $ 20.09 $ 20.18 $ 20.90
Exercisable, end of year $20.45 $19.85 $19.32year................. $ 19.83 $ 20.23 $ 20.45
Exercise prices for options outstanding at December 31, 19992001 ranged from
$12.94$12.66 to $24.94.$24.25. The weighted averageweighted-average remaining contractual life of these
options is approximately 7.3eight years.
Employee Stock Purchase Plan
Effective December 1, 1995,PRO FORMA INFORMATION
As provided under SFAS No. 123, "Accounting for Stock-Based Compensation,"
the Company established a tax-qualified
employee stock purchase plan (the "Purchase Plan"). An aggregate of 120,000
shares of Common Stock have been reservedhas elected to continue to account for issuance understock-based compensation in
accordance with APB No. 25 and has provided the Purchase Plan.
Eligible employees may elect to participate in an annual offering period under
the Purchase Plan by authorizing after-tax payroll deductions of up to 20% (in
whole percentages) of their eligible compensation for the purchase of shares of
Common Stock at 85% of the lesser of the market value per share of the Common
Stock at the beginning or end of the annual offering period, subject to certain
restrictions. During 1999, 1998 and 1997, employees purchased approximately
8,509, 18,638 and 14,100 shares, respectively, of Common Stock under the
Purchase Plan.
F-31
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Employee Benefits and Compensation Arrangements (continued)
Pro Forma Information
Prorequired additional pro forma
information regarding net income and earnings per share is
required by FASB Statement No. 123.disclosures. Such information has been determined for the Company as if the
Company hashad accounted for its employee stock options under the fair value method
of this Statement.statement. The fair value for the Company's employee stock options has
been estimated at the date of grant using a Black-Scholes option valuation
model, with the following weighted-average assumptions for options issued in
2001, 2000 and 1999, 1998respectively: dividend yield of 0.0% for 2001, 2000 and
1997, respectively: (i) dividend yield: 0.0%;
(ii)1999; expected volatility factor:of 41.0% in 2001, 32.0% in 2000 and 25.0%; (iii) in 1999;
risk free interest rate of 4.0% in 2001, 5.0% in 2000 and 6.5% in 1999; and an
average expected option life of six years for all years;2001, 2000 and (iv) risk free interest rates of 6.5%, 4.9%, and 5.8%
respectively.1999. The
weighted-average fair value of options granted forduring the years ended
December 31, 2001, 2000 and 1999 1998was $26.0 million, $866,000 and 1997 was $123,000,
$3.3 millionrespectively.
F-35
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
10. STOCK AND STOCK OPTION PLANS (CONTINUED)
For purposes of the required pro forma information, the estimated fair value
of employee stock options is amortized to expense over the options' vesting
period. The Company's net income (loss) and $3.2
million, respectively.net income (loss) per share would
have been adjusted to the pro forma amounts indicated below:
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
Net income (loss), as reported.................. $22,016 $(8,012) $(35,636)
Pro forma net income (loss)..................... $16,378 $(9,902) $(37,294)
Earnings (loss) per share as reported:
Basic......................................... $ 1.71 $ (0.61) $ (2.09)
Diluted....................................... $ 1.29 $ (0.61) $ (2.09)
Pro forma earnings (loss) per share:
Basic......................................... $ 1.27 $ (0.75) $ (2.18)
Diluted....................................... $ 0.96 $ (0.75) $ (2.18)
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models, such as the Black-Scholes
model, require the input of highly subjective assumptions (particularly with
respect to the Company, which has a limited stock-trading history), including
expected stock price volatility. As the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, the Company believes that the existing option valuation
models, such as the Black-Scholes model, may not necessarily provide a reliable
single measure of the fair value of employee stock options.
For purposes of the required pro forma information, the estimated fair
value of employee stock options is amortized to expense over the options'
vesting period. The Company's pro forma information regarding net income and
earnings per share follows:
(In thousands, except per share data)
Years Ended December 31,
1999 1998 1997
---------------- ---------------- ----------------
Net income (loss), as reported ($32,436) $3,091 $2,039
Pro forma net income (loss) ($34,094) $1,633 $994
Earnings (loss) per share as reported:
Basic ($1.90) $0.18 $0.12
Diluted ($1.90) $0.17 $0.12
Pro forma earnings (loss) per share:
Basic ($2.00) $0.10 $0.06
Diluted ($2.00) $0.09 $0.06
The effects of applying FASBSFAS No. 123 as shown in the pro forma disclosures
may not be representative of the effects on reported net income for future
years.
The effect on net income and earnings per share after applying FASB
StatementSFAS
No. 123's fair valuation method to stock issued to employees under the Company's
Employee Stock Purchase Plan does not materially differ from the pro forma
information set forth above with respect to the Company's employee stock
options.
F-3211. RETIREMENT PLANS
For employee retirement benefits, the Company maintains defined contribution
retirement plans, which vary for each subsidiary. Contributions are based on the
participants' eligible compensation. In 2001, 2000 and 1999, the Company
expensed $0.4 million, $0.3 million and $0.6 million, respectively, related to
these retirement plans.
12. SHARE CAPITAL
The authorized share capital of the Company consists of 200,000,000 common
shares, par value U.S. $0.01 per share, and 50,000,000 preferred shares, par
value U.S. $0.01 per share. Prior to the reorganization described in Note 1,
authorized share capital of Arch-U.S. consisted of 80,000,000 shares
F-36
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 8. Employee Benefits(CONTINUED)
12. SHARE CAPITAL (CONTINUED)
of common stock, par value U.S. $0.01 per share, and Compensation Arrangements (continued)
Retirement Plans
Effective20,000,000 shares of
preferred stock, par value U.S. $0.01 per share.
At December 31, 2001, the bye-laws of ACGL contained a provision limiting
the voting rights of any person who owns (directly, indirectly or constructively
under the United States Internal Revenue Code) Common Shares with more than 9.9%
of the total voting power of all shares entitled to vote generally at an
election of directors to 9.9% of such voting power. This provision will not
restrict the ability of any person holding Common Shares that were either
(1) converted from shares of Arch-U.S. owned on September 8, 2000 or (2) issued
upon exercise of warrants owned by such person on September 8, 2000 which were
assumed by ACGL, from voting such shares except with respect to the election of
directors. This provision is intended to prevent ACGL from being characterized
as a controlled foreign corporation which could cause U.S. persons owning 10% or
more of January 1, 1996,the Common Shares to suffer adverse U.S. tax consequences.
The bye-laws of ACGL also contained a provision limiting the rights of any
group (within the meaning of the United States Securities Exchange Act of 1934)
that owns shares with more than 9.9% of the total voting power of all shares
entitled to vote generally at an election of directors to 9.9% of such voting
power. This provision will not restrict (a) the ability of any such group
holding Common Shares that were converted from shares of Arch-U.S. by such
person on September 8, 2000 or acquired upon exercise of warrants owned by such
person on September 8, 2000 which were assumed by ACGL or (b) any person or
group that the board of directors, by the affirmative vote of at least 75% of
the existing board, may exempt from this provision, from voting such shares.
See Note 18--Subsequent Event.
XL CAPITAL SHARE REPURCHASE
On March 2, 2000, the Company adoptedrepurchased from XL Capital, then the
Company's single largest shareholder, all of the 4,755,000 Common Shares held by
it for a tax-qualified,
non-contributory defined contribution money purchase pension plan (the "Pension
Plan"price of $12.45 per share, or a total of $59.2 million. The
per share repurchase price was determined as the lesser of (1) 85% of the
average closing market price of the Common Shares during the 20 trading days
beginning on the third business day following public announcement of the share
repurchase and asset sale (January 21, 2000), which was $14.65, and (2) $15.
The Company paid XL the consideration for the repurchase with: (i) the
Company's interest in privately held LARC Holdings, Ltd. (parent of Latin
American Reinsurance Company Ltd.) under which, valued at $25 million, and (ii) all of the
Company's interest in Annuity and Life Re (Holdings), Ltd., valued at $25.38 per
share and $18.50 per warrant, or $37.8 million in the aggregate. XL paid the
Company contributes for each eligible employee an amount
equalin cash the difference (equal to $3.6 million) between the sum of (i) 5% in 1999repurchase
price and 4% in 1998 and 1997 of eligible
compensation up to the taxable wage base (as such term is defined in the Pension
Plan; for 1999, 1998 and 1997, amounts were set at $72,600, $68,400 and $65,400,
respectively) and (ii) 10% in 1999 and 8% in 1998 and 1997 of eligible
compensation in excessvalue of the taxable wage base (up toCompany's interests in LARC Holdings and Annuity and
Life Re. The value per share of Annuity and Life Re was determined by taking the
applicable
compensation limit (the "compensation limit") imposed by Section 401(a)(17)average of the Internal Revenue Codeclosing price of 1986, as amended (the "Code"), whichAnnuity and Life Re shares for 1999, 1998
and 1997 was $160,000. Substantially all employeesthe same period
used in determining the repurchase price of the Company are eligible
for participation in the Pension Plan. In 1999, 1998 and 1997, the Company
expensed $344,000, $215,000 and $168,000, respectively, related to the Pension
Plan.
Effective as of January 1, 1996, the Company adopted a tax-qualified,
employee savings plan (the "Savings Plan"). Pursuant to Section 401(k)Common Shares. The value of the
Code, eligible employeeswarrants was determined using a Black Scholes methodology. The cost of the Company are ableshare
repurchase of $59.2 million was recorded as a reduction to make deferral contributions
of up to 15% of their eligible compensation, subject to limitations under
applicable law. The Company matches 100% of the first 3% of eligible
compensation deferred by employees and 50% of the next 3% of eligible
compensation so deferred. Substantially all employees of the Company are
eligible for participation in the Savings Plan. In 1999, 1998 and 1997, the
Company expensed $192,000, $165,000 and $123,000, respectively, related to the
Savings Plan.
Effectiveshareholders' equity
reflected as of January 1, 1996, the Company adopted a supplemental,
non-qualified executive savings and retirement plan (the "Supplemental Plan")
undertreasury shares, which the Company contributes 10% of eligible compensation in excess of
the compensation limit for eligible officers of the Company. Participants may
also defer certain amounts of eligible base compensation and bonus. Under the
Supplemental Plan, the Company matches 100% of the first 3% of eligible base
compensation in excess of the compensation limit that is deferred by
participants under the Supplemental Plan, and provides a 50% matching
contribution for the next 3% of such excess eligible compensation so deferred.
In 1999, 1998 and 1997, the Company expensed $96,000, $85,000 and $74,000,
respectively, related to the Supplemental Plan.
9. Income Taxes
RCHI, Risk Capital Reinsurance and Cross River file a consolidated federal
income tax return and have a tax sharing agreement (the "Tax Sharing
Agreement"), allocating the consolidated income tax liability on a separate
return basis. Pursuant to the Tax Sharing Agreement, Risk Capital Reinsurance
and Cross River make tax sharing payments to RCHI based on such allocation.
The provision for federal income taxes has been determined on the basis of
a consolidated tax return consisting of RCHI, Risk Capital Reinsurance and Cross
River.
F-33shares were subsequently cancelled.
F-37
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. Income Taxes (continued)
An analysis(CONTINUED)
12. SHARE CAPITAL
SERIES A CONVERTIBLE PREFERENCE SHARES AND CLASS A WARRANTS
On November 20, 2001, the Company issued 35,687,735 preference shares and
3,776,025 Class A Warrants for $763.2 million in cash. The purchase price for
the preference shares and Class A Warrants paid at closing was based on book
value of the Common Shares at June 30, 2001. Subject to the limitation described
below, each preference share will be convertible into one Common Share. This
conversion ratio is subject to customary anti-dilution protection. The
preference shares vote, together with the Common Shares, on an as-converted
basis.
The purchase price may be subject to a post-closing adjustment based on an
audit of the Company's effective tax ratebalance sheet as of June 30, 2001. In addition, if on or
prior to September 19, 2005 (1) the closing price of the Common Shares is at
least $30.00 per share for at least 20 out of 30 consecutive trading days or
(2) a change of control occurs, the years ended
December 31, 1999, 1998 and 1997 is as follows:
(In thousands)
Years Ended December 31,
1999 1998 1997
--------------- ------------ --------------
Income tax (benefit) computed on pre-tax income ($18,281) $1,562 $663
Reduction/increase in income tax (benefit) resulting from:
Tax-exempt investment income (733) (582) (524)
Dividend received deduction (958) (896) (650)
Restricted stock 140
Other 275 151 173
--------------- ------------ --------------
Income tax expense (benefit) on pre-tax income ($19,557) $235 ($338)
=============== ============ ==============
purchase price under the subscription
agreement will be adjusted downward by $1.50 per preference share purchased. The
Company's current federal tax expense (benefit) for 1999, 1998 and 1997
waspurchase price under the subscription agreement will also be adjusted based on
regular taxable income. Actual federal income taxes paidactual loss experience on the Company's pre-closing insurance operations and
certain other balance sheet developments during the period from July 1, 2001
through the second anniversary of closing (or such earlier date as is agreed
upon by the investors and the Company), with the possibility of a limited
further adjustment thereafter based on specified tax and other matters. Any
purchase price adjustment in 1999,
1998 and 1997 were $1.9 million, $5.3 million and $1.4 million, respectively.
The amount paid in 1999 wasfavor of the final installment relatedinvestors will be made through the
issuance of additional preference shares.
Pursuant to the 1998 tax
return.
The net deferred income tax asset reflects temporary differences betweenCompany's bye-laws (until amended by the carrying amountsshareholders), each
investor's voting rights were limited to 9.9% of assets and liabilities for financial reporting and
income tax purposes, netthe total voting power of all
outstanding voting shares. In addition, prior to shareholder approval,
conversion of the preference shares was limited so that the amount of Common
Shares issued did not exceed the amount permitted to be issued under Nasdaq
rules without shareholder approval. See Note 18--Subsequent Event. Finally,
prior to regulatory approval, conversion of the preference shares will be
limited so that the amount of Common Shares issued does not exceed the amount
permitted to be issued without regulatory approval. If the shareholder or
regulatory approvals are not obtained, or if the ultimate purchase price
adjustment exceeds $250.0 million, at the investors' option, the preference
shares will become convertible into a pro rata portion (assuming that all issued
preference shares are convertible) of the shares of a valuation allowance for any portionnewly-formed subsidiary of
the deferred tax assetCompany that management believes will not be realized. Significant
componentshold all of the Company's deferred income tax assetscore insurance and liabilities as of
December 31, 1999 and 1998 were:
(In thousands)
December 31,
1999 1998
---------------- -----------------
Deferred income tax assets:
Net claim reserve discount $15,639 $10,176
Net operating loss 7,334
Net unearned premium reserve 6,573 7,194
Compensation liabilities 372 622
Equity in net loss of investees, net 7 2,328
Other 165 56
---------------- -----------------
Total deferred tax assets 30,090 20,376
---------------- -----------------
Deferred income tax liabilities:
Deferred policy acquisition cost (8,255) (8,230)
Unrealized appreciation of investments (14,001) (25,328)
---------------- -----------------
Total deferred tax liabilities (22,256) (33,558)
---------------- ----------------
Net deferred income tax asset (liability) $7,834 ($13,182)
================ =================
The net deferred income tax asset at December 31, 1999 was $7.8 million.
The Company periodically evaluatesreinsurance
operations.
As a condition to the need for a valuation allowance for any
portionobligations of the deferred tax asset that management believes will not be realized
based on current and future operating performance and available tax planning
strategies.
Whileinvestors to purchase the
securities, the Company believes thathas entered into a valuation allowance is not necessary at
December 31, 1999, continued future comprehensive losses or future decisionsshareholders agreement with respectthe
investors (the "Shareholders Agreement"). Pursuant to business strategy following the saleShareholders
Agreement, since the closing, Warburg Pincus has the right to designate one
director for appointment to the Company's Board and H&F has the right to
designate one director for appointment to the Company's Board. In addition,
after receipt of the shareholder and regulatory approvals described above,
Warburg Pincus and H&F will have the right to designate additional directors.
After giving effect to the resignations and appointments contemplated, designees
of Warburg Pincus and H&F collectively will constitute a majority of the Board
of Directors. The Shareholders Agreement also provided the investors with
certain registration rights.
Pursuant to the subscription agreement, the Company agreed to hold a special
meeting of its shareholders, (1) to approve the issuance of such number of
Common Shares issuable upon conversion of the preference shares, that together
with the number of Common Shares issuable upon exercise of the Class A Warrants,
is in excess of the amount that may be issued without shareholder approval under
the Nasdaq Stock Market rules, (2) to approve the adoption of amendments to the
Company's
reinsurance business may result in the establishment of a valuation allowance in
future financial statements.
F-34F-38
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. Income Taxes (continued)(CONTINUED)
12. SHARE CAPITAL (CONTINUED)
bye-laws that restrict voting rights of shareholders and that require directors
of certain subsidiaries of the Company to be elected directly by shareholders of
the Company and (3) to elect Mr. Paul Ingrey as a director of Arch Re Bermuda
(see Note 18--Subsequent Event).
13. EARNINGS PER SHARE
The Company hasfollowing table sets forth the computation of basic and diluted earnings
per share:
(IN THOUSANDS, EXCEPT SHARE DATA)
YEARS ENDED DECEMBER 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
BASIC EARNINGS PER SHARE:
Net income (loss)..................................... $ 22,016 $ (8,012) $ (35,636)
Divided by:
Weighted average shares outstanding for the period.... 12,855,668 13,198,075 17,086,732
=========== =========== ===========
Basic earnings (loss) per share....................... $ 1.71 $ (0.61) $ (2.09)
=========== =========== ===========
DILUTED EARNINGS PER SHARE:
Net income (loss)..................................... $ 22,016 $ (8,012) $ (35,636)
Divided by:
Weighted average shares outstanding for the period.... 12,855,668 13,198,075 17,086,732
Effect of dilutive securities:
Preference shares................................. 4,106,534 -- --
Warrants.......................................... -- -- --
Nonvested restricted shares....................... 5,987 -- --
Employee stock options............................ 34,042 -- --
----------- ----------- -----------
Total shares.......................................... 17,002,231 13,198,075 17,086,732
=========== =========== ===========
Diluted earnings (loss) per share..................... $ 1.29 $ (0.61) $ (2.09)
=========== =========== ===========
Stock options to purchase 1,237,305, 1,101,004 and 1,273,856 Common Shares
at per share prices averaging $21.33, $20.82 and $20.93 were outstanding as of
December 31, 2001, 2000 and 1999, respectively, but were not included in the
computation of diluted earnings per share because the options' exercise prices
were greater than the average market prices of the Common Shares of $17.71,
$15.17 and $15.40, respectively. In addition, Class A Warrants to purchase
Common Shares at $20 per share were outstanding as of December 31, 2001, 2000,
and 1999 but were not included in the computation of diluted earnings per share
because the warrants' exercise price of $20.00 per share was greater than the
average market price of the Common Shares for such year. Diluted per share
amounts are computed using basic average shares outstanding when a net operating loss carryforward which expiresoccurs
since the inclusion of dilutive securities in 2019,dilutive earnings per share would
be anti-dilutive.
14. STATUTORY INFORMATION
BERMUDA
Under The Insurance Act of 1978 (as amended) and related regulations of
Bermuda, Arch Re Bermuda, the Company's Bermuda reinsurance subsidiary, is
required to prepare statutory financial
F-39
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
14. STATUTORY INFORMATION (CONTINUED)
statements and file a statutory financial return in Bermuda. The Insurance Act
also requires Arch Re Bermuda to maintain certain measures of solvency and
liquidity during the year. Declaration of dividends from retained earnings and
distributions from additional paid-in-capital is subject to these solvency and
liquidity requirements being met. At December 31, 2001, such requirements were
met.
Statutory capital and surplus for which it has established a deferred income tax asset of $7.3Arch Re Bermuda was $508 million at
December 31, 1999.2001, and statutory net income was $18,000 for the year ended
December 31, 2001. The repurchaseprimary difference between statutory net income and
statutory capital and surplus and net income and shareholders' equity presented
in accordance with GAAP are deferred acquisition costs and non-admitted assets.
Under the Insurance Act, Arch Re Bermuda is registered as a Class 4 insurer and
reinsurer, and is restricted with respect to the payment of dividends in any one
financial year to 15% of the prior year's statutory capital and surplus.
UNITED STATES
The Company's Common Stock heldU.S. insurance and reinsurance subsidiaries file financial
statements prepared in accordance with statutory accounting practices prescribed
or permitted by XL
resulted in a 27.8% change in ownership by 5% shareholders. If, in the ensuing
three years, there is more than 22.2% additional change in ownership by 5%
shareholders, an "ownership change" will have taken place for federal income tax
purposes. If such ownership change occurs, the amount of loss carryforwards that
can be used in any subsequent year may be severely limited and could be
eliminated in certain circumstances.
10. Statutory Information
The Insurance Department of the State of Nebraska issued to Risk Capital
Reinsurance its domiciliary insurance license on November 6, 1995.regulators. Statutory net income and surplus, of Risk Capital Reinsurance, as
reported to the insurance regulatory authorities, differdiffers in certain respects
from the amounts prepared in accordance with GAAP. The following tables reconcilemain differences between
statutory net lossincome and
surplus of Risk Capital Reinsurance to consolidated GAAP net income (loss)relate to deferred acquisition costs
and stockholders' equity:
(In thousands)
Years Ended December 31,
1999 1998 1997
---------------- ---------------- -----------------
Net Income (Loss):
Risk Capital Reinsurance
Statutory net loss ($44,561) ($11,973) ($5,649)
GAAP adjustments:
Privately held investments 1,179 2,623 (4,601)
Deferred acquisition costs 70 6,223 10,273
Deferred income taxes 10,536 7,277 2,099
Equity in net income (loss) of investees 621 (1,136) (192)
Cumulative effect of accounting change (370)
-------------- --------------- ----------------
GAAP net income (loss) (32,525) 3,014 1,930
RCHI (parent company only) operations 89 77 109
-------------- --------------- ----------------
Consolidated GAAP net income (loss) ($32,436) $3,091 $2,039
============== =============== ================
(In thousands)
December 31,
1999 1998
--------------- --------------
Stockholders' Equity:
Statutorydeferred income taxes. In addition to deferred acquisition costs and
deferred income tax assets, the main differences between statutory surplus and
shareholder's equity are unrealized appreciation or depreciation on investments
and non-admitted assets.
Combined statutory surplus $290,082 $358,702
Deferred acquisition costs 23,585 23,515
Unrealized appreciation (depreciation) (6,320) 298
Deferred income tax asset (liability), net 7,818 (13,164)
Privately held investments--non-admitted assets 13,695 11,080
Other non-admitted assets 3,693 4,190
Other 244 500
--------------- --------------
Investment in Risk Capital Reinsurance, GAAP 332,797 385,121
RCHI (parent company only):
Other net assets 13,717 12,881
--------------- --------------
Consolidated stockholders' equity, GAAP $346,514 $398,002
=============== ==============
F-35
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Statutory Information (continued)
RCHI is a holding company and has no significant operations or assets other
than its ownership of all of the capital stockCompany's U.S. insurance and reinsurance
subsidiaries was $306.8 million, $29.9 million and $290.1 million at
December 31, 2001, 2000 and 1999, respectively. The combined statutory net
income of Risk Capital Reinsurance. RCHI
will rely on cash dividendsthese operations was $7.9 million, $59.6 million and distributions from Risk Capital Reinsurance$44.6 million for
the years ended December 31, 2001, 2000 and 1999, respectively.
The Company's U.S. insurance and reinsurance subsidiaries are subject to
pay any cash dividends to, or repurchase any shares from, stockholders of RCHIinsurance laws and to pay any operating expenses that RCHI may incur. The payment of dividends
orregulations in the repurchase of shares by RCHI will be dependent upon the ability of Risk
Capital Reinsurance to provide funds to RCHI.jurisdictions in which they operate. The
ability of Risk Capital
Reinsurancethe Company's regulated insurance subsidiaries to pay dividends or
make distributions to RCHI is dependent upon
Risk Capital Reinsurance'son their ability to achieve satisfactory underwriting and
investment results and to meet certainapplicable regulatory
standards ofstandards. These regulations include restrictions that limit the State of
Nebraska. There are presently no contractual restrictions on the paymentamount of
dividends or the making ofother distributions, by Risk Capital Reinsurancesuch as loans or cash advances, available to
RCHI.
Nebraska insurance laws provide that,shareholders without prior approval of the Nebraska Directorinsurance regulatory authorities. As
of Insurance ("Nebraska Director"), Risk Capital Reinsurance
cannotDecember 31, 2001, the Company's insurance and reinsurance subsidiaries may
not pay a dividend or make a distribution (together with otherany significant dividends or distributions paid during 2002 without prior
regulatory approval.
The National Association of Insurance Commissioners (the "NAIC") adopted the
preceding 12 months) that exceedsCodification of Statutory Accounting Principles guidance, which replaces the
greater of
(i) 10% ofcurrent Accounting Practices and Procedures manual, as the NAIC's primary
guidance on statutory surplusaccounting as of January 1, 2001. The accounting
codification did not have a material impact on the precedingresults of operations or
policyholders' surplus of the Company's insurance subsidiaries.
15. SEGMENT INFORMATION
SFAS No. 131 requires certain disclosures about operating segments in a
manner that is consistent with how management evaluates the performance of the
segment. At December 31, ($290.1 million as
of December 31, 1999) or (ii) statutory net income from operations from2001, the preceding calendar year not including after tax realized capital gains ($54.3
million loss for 1999). Net income (exclusive of realized capital gains) not
previously distributed or paid as dividends from the preceding two calendar
years may be carried forward for dividend and distribution purposes. Any
proposed dividend or distribution in excess of such amount is called an
"extraordinary" dividend or distribution and may not be paid until either it has
been approved, or a 30-day waiting period has passed during which it has not
been disapproved, by the Nebraska Director. Notwithstanding the foregoing,
Nebraska insurance laws provide that any distribution that is a dividend may
only be paid out of earned surplus arising from its business, which is defined
as unassigned funds (surplus) as reported in the statutory statement for the
most recent years, including any surplus arising from unrealized capital gains
or revaluations of assets ($38 million deficit as of December 31, 1999). Any
distribution that is a dividend and that is in excess of Risk Capital
Reinsurance's unassigned funds, exclusive of any surplus arising from unrealized
capital gains or revaluation of assets ($78.5 million deficit as of December 31,
1999), will be deemed an "extraordinary" dividend subject to the foregoing
requirements. Therefore, Risk Capital Reinsurance cannot make a distribution
that is a dividend without the prior approval of the Nebraska Director during
2000.
Nebraska insurance laws also require that the statutory surplus of Risk
Capital Reinsurance following any dividend or distribution be reasonable in
relation to its outstanding liabilities and adequate to its financial needs. In
addition, Nebraska insurance laws require that each insurer give notice to the
Nebraska Director of all dividends and other distributions within five business
days following declaration thereof and that any such dividend or other
distribution may not be paid within 10 business days of such notice (the "Notice
Period") unless for good cause shown the Nebraska Director has approved such
payment within the Notice Period.
See Note 14 - Subsequent Events for information on distributions from Risk
Capital Reinsurance to RCHI which will reduce the GAAP book value and the
statutory surplus of Risk Capital Reinsurance. In light of such distributions,
and as required by the above statutory provisions, Risk Capital Reinsurance may
not declare any other distribution for a period of 12 months following the stock
repurchase described in Note 14 unless such subsequent distribution is approved
by the Nebraska Department.
F-36Company
F-40
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11. Business Information
As discussed(CONTINUED)
15. SEGMENT INFORMATION (CONTINUED)
had only one reportable operating segment--insurance. The Company's insurance
operating segment includes the operations of the following five business
entities: ART Services, which provides insurance and alternative risk transfer
services through rent-a-captive and other facilities; AIHC, which markets and
underwrites non-standard personal automobile liability and physical damage lines
of insurance, primarily in Note 2,Pennsylvania; Arch Re Bermuda, the Company's
Bermuda-based reinsurance subsidiary, and Arch Re and Cross River, U.S.-based
reinsurance and insurance subsidiaries of the Company.
At December 31, 2001, the Company's insurance operating segment included
total assets of $1.2 billion. For the year ended December 31, 2001, the
insurance operating segment generated revenues of $59.9 million and net income
of $12.4 million. The remaining portion of the Company's net income was
generated through the Company's investment activities, offset by other operating
expenses.
The results of the Company's advisory business conducted by Hales was not
material to the Company's consolidated results of operations or financial
position.
For the year ended December 31, 2001, the Company provides property casualtyproduced its business
through general agents and managing general agents, none of which accounted for
more than 10% of total gross premiums written. Since the Company sold its prior
reinsurance operations on May 5, 2000, the following data relating to insurance and reinsurance companies and other forms of capital and makes
investments in insurance and insurance-related entities on a global basis. The
Company operates from one domestic location in Greenwich, Connecticut.1999 is
not meaningful for 2000 or future years. During 1999, one client contributed
$42.1 million, or 13.7%, of net premiums written and $33.8 million, or 13.5%, of
net premiums earned, and a second client contributed $39.2 million, or 12.8%, of
net premiums written and $43.7 or 14%, of net premiums earned. For 1998, that second client company
contributed approximately $42 million, or 18%, of net premiums written and $36.6
million, or 17.8%, of net premiums earned. For 1997, such client company
contributed $25.9 million, or 18%, of net premiums written, and $15.1 million, or 14%, of net premiums earned.
The following lists individual broker business greater than 10% of the
1999 year's net premiums written with comparative amounts for the years ended 1998
and 1997, respectively:written:
Net Premiums Written
1999 1998 1997
------------------- --------------------- ---------------------
Balis & Co., Inc. (1)....................................... 15.0% 23.7% 22.7%
Guy Carpenter & Co. (1)..................................... 10.7%
11.3% 11.0%
Aon GroupGroup................................................... 17.4%
16.5% 19.1%
------------------ -------------------- --------------------
Total----
Total....................................................... 43.1%
51.5% 52.8%
================== ==================== ========================
- ------------------------
(1) In addition, approximately 7.4%, 8.2%, and 13.6% of net premiums written in 1999 1998 and 1997, respectively, were
produced by other brokers who are affiliated with Marsh & McLennan
Companies, Inc.
Net premiums written and earned recorded from client companies which arewere
Lloyd's syndicates or arewere located in the United Kingdom, Bermuda and
Continental Europe (some which are denominated in United StatesU.S. dollars) were:
1999 1998 1997
---------------------------- --------------------------- ---------------------------
Net Premiums Net Premiums Net Premiums
Written Earned Written Earned Written Earned
------------- ------------ ------------- ----------- ------------ -----------
Non U.S. Premiums $46.9 $58.0 $76.1 $65.9 $40.1 $25.8
% of Totalwere
$46.9 million and $58.0 million, respectively, which represented 15.3% and 18.6% 32.4% 32.0% 27.7% 24.0%
F-37
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Earnings Per Share
The following table sets forth the computation
of basicnet premiums written and diluted
earnings per share:
(In thousands, except share data)
Years Ended December 31,
1999 1998 1997
----------------- --------------- ----------------
Basic Earnings Per Share:
Net income (loss) ($32,436) $3,091 $2,039
Divided by:
Weighted average shares outstanding for the period 17,086,732 17,065,165 17,032,601
================ ============== ===============
Basic earnings (loss) per share ($1.90) $0.18 $0.12
================ ============== ===============
Diluted Earnings Per Share:
Net income (loss) ($32,436) $3,091 $2,039
Divided by:
Weighted average shares outstanding for the period 17,086,732 17,065,165 17,032,601
Effect of dilutive securities:
Warrants 581,327 24,836
Employee stock options 76 71,731 28,351
---------------- -------------- ---------------
Total shares 17,086,808 17,718,223 17,085,788
================ ============== ===============
Diluted earnings (loss) per share ($1.90) $0.17 $0.12
================ ============== ===============
Certain employee stock options to purchase 1,273,856, 22,750, and 448,250
shares of Common Stock at per share prices averaging $20.93, $23.61 and $22.62
were outstanding as of December 31, 1999, 1998, and 1997, respectively. These
options were not included in the computation of diluted earnings per share
because the options' average exercise prices were greater than the average
market prices of the Common Stock of $15.40, $23.00 and $20.11 for the years
ended December 31, 1999, 1998 and 1997. In addition, warrants to purchase
4,451,680 shares of Common Stock at $20 per share were outstanding as of
December 31, 1999, 1998 and 1997 but were not included in the computation of
diluted earnings per shareearned for the year ended December 31, 1999 because the
warrants' exercise price of $20.00 per share was greater than the average market
price of the Common Stock for such year. See Note 14 - Subsequent Events.
F-381999.
F-41
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
16. OTHER COMPREHENSIVE INCOME
The related tax effects allocated to each component of the change in other
comprehensive income (loss) were as follows:
BEFORE TAX TAX EXPENSE NET OF TAX
AMOUNT (BENEFIT) AMOUNT
---------- ----------- ----------
YEAR ENDED DECEMBER 31, 2001
Unrealized appreciation (decline) on investments:
Unrealized holding gains (losses) arising during year....... $ (6,993) $ 160 $ (7,153)
Less reclassification of net realized gains included in net
income.................................................... 18,382 7,242 11,140
-------- -------- --------
Change in other comprehensive income (loss)................. $(25,375) $ (7,082) $(18,293)
======== ======== ========
YEAR ENDED DECEMBER 31, 2000
Unrealized appreciation (decline) on investments:
Unrealized holding gains (losses) arising during year....... $ 4,745 $ 428 $ 4,317
Less reclassification of net realized gains included in net
income.................................................... 20,045 7,408 12,637
-------- -------- --------
Change in other comprehensive income (loss)................. $(15,300) $ (6,980) $ (8,320)
======== ======== ========
YEAR ENDED DECEMBER 31, 1999
Unrealized appreciation (decline) on investments:
Unrealized holding gains (losses) arising during year....... $(14,319) $ (4,922) $ (9,397)
Less reclassification of net realized gains included in net
income.................................................... 17,227 6,029 11,198
-------- -------- --------
Change in other comprehensive income (loss)................. $(31,546) $(10,951) $(20,595)
======== ======== ========
F-42
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED STATEMENTS (CONTINUED)
17. QUARTERLY FINANCIAL STATEMENTS
13. Quarterly Financial InformationINFORMATION (UNAUDITED)
The following is a summary of unaudited quarterly financial data, restated
where applicable, to conform to FASB Statement No. 128:data:
(In thousands, except per share data)
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
December(IN THOUSANDS, EXCEPT PER SHARE DATA)
QUARTER ENDED
---------------------------------------------------
DECEMBER 31, SeptemberSEPTEMBER 30, JuneJUNE 30, MarchMARCH 31,
1999 1999 1999 1999
------------------- ------------------- --------------- ---------------
Income Statement Data:2001 2001 2001 2001
------------ ------------- -------- ---------
INCOME STATEMENT DATA:
Net premiums written $74,023 $76,749 $91,517 $64,437written............................ $ 12,212 $14,448 $ 6,719 $ 2,837
Net premiums earned 80,995 80,463 86,988 62,922earned............................. 11,921 11,799 5,565 1,633
Fee income...................................... 3,476 3,524 3,711 1,715
Net investment income 4,908 5,965 4,817 4,483income........................... 3,373 2,509 3,078 3,160
Net realized investment gains (losses) (10,243) 5,236 23,386 (1,152)
Operating expenses 106,468 98,583 91,629 104,319.......... (37) (190) 9,605 9,004
Equity in net income (loss) of 188 400 196 (163)
investeesinvestees........ 721 966 33 888
Operating expenses.............................. 20,639 17,207 9,363 5,101
Net income (loss) (19,591) (3,737) 15,883 (24,991)
Comprehensive............................... $ 4,731 $ 892 $ 8,400 $ 7,993
PER SHARE DATA:
Net income (loss)
($15,021) ($10,494) $8,720 ($35,491)
Statutory Combined Ratio: 132.6% 120.4% 106.3% 167.0%Basic......................................... $ 0.37 $ 0.07 $ 0.65 $ 0.63
Diluted....................................... $ 0.16 $ 0.07 $ 0.65 $ 0.63
COMMON SHARE PRICES:
High.......................................... $ 28.34 $ 19.20 $ 17.06 $ 18.06
Low........................................... $ 16.40 $ 15.45 $ 14.81 $ 14.38
Close......................................... $ 25.75 $ 16.75 $ 15.75 $ 15.88
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
2000 2000 2000 2000
------------ ------------- -------- ---------
INCOME STATEMENT DATA:
Net premiums written............................ -- -- $(63,493) $52,889
Net premiums earned............................. -- -- 29,368 58,162
Net investment income........................... $ 3,017 $ 3,359 4,257 5,290
Net realized investment gains (losses).......... (12,789) 728 (367) 32,473
Equity in net income (loss) of investees........ 434 878 853 (220)
Operating expenses.............................. 17,205 1,502 34,069 74,355
Net income (loss)............................... $(15,388) $ 2,286 $ (2,607) $ 7,697
STATUTORY COMBINED RATIO:....................... -- -- -- 126.4%
Per Share Data:
Net income (loss)
Basic ($1.15) ($0.22) $0.93 ($1.46)
Diluted ($1.15) ($0.22) $0.93 ($1.46)
Comprehensive income (loss)
Basic ($0.88) ($0.61) $0.51 ($2.08)
Diluted ($0.88) ($0.61) $0.51 ($2.08)
Stockholders' equity per share
Basic $20.28 $21.15 $21.75 $21.23
Diluted $20.28 $21.15 $21.75 $21.23
Common Stock Prices:
High $15.69 $16.00 $17.38 $22.63
Low $11.00 $13.00 $13.50 $12.00
Close $12.63 $15.63 $13.50 $15.13and diluted............................. $ (1.23) $ 0.18 $ (0.21) $ 0.50
COMMON SHARE PRICES:
High.......................................... $ 15.88 $ 15.88 $ 16.63 $ 16.75
Low........................................... $ 13.88 $ 14.63 $ 14.56 $ 11.38
Close......................................... $ 15.00 $ 15.75 $ 14.94 $ 16.38
F-39F-43
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. Quarterly Financial Information (continued)
(In thousands, except per share data)
Quarter Quarter Quarter Quarter
Ended Ended Ended Ended
December 31, September 30, June 30, March 31,
1998 1998 1998 1998
----------------- ------------------ ---------------- ----------------
Income Statement Data:
Net premiums written $71,163 $66,628 $52,536 $44,408
Net premiums earned 63,545 52,670 48,477 41,502
Net investment income 3,757 3,995 4,331 3,604
Net realized investment gains (losses)
25,606 (425) 2,870 477
Operating expenses 80,808 (65,334) 51,756 44,773
Equity in net income (loss) of
investees (1,103) (1,046) 257 756
Net income (loss) 4,994 (6,631) 3,159 1,569
Comprehensive income (loss) $2,350 ($20,622) ($2,871) $16,768
Statutory Combined Ratio: 124.4% 123.8% 107.8% 105.9%
Per Share Data:
Net income (loss)
Basic $0.29 ($0.39) $0.19 $0.09
Diluted $0.29 ($0.39) $0.18 $0.09
Comprehensive income (loss)
Basic $0.14 ($1.21) ($0.17) $0.98
Diluted $0.14 ($1.21) ($0.17) $0.95
Stockholders' equity per share
Basic $23.29 $23.15 $24.35 $24.50
Diluted $22.75 $22.54 $23.01 $23.36
Common Stock Prices:
High $23.75 $25.50 $25.50 $24.00
Low $18.81 $19.00 $22.75 $19.75
Close $21.75 $22.00 $24.94 $24.00
F-40
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Subsequent Events
Folksamerica Transaction
On January 18, 2000,(CONTINUED)
18. SUBSEQUENT EVENT
ACGL held a special meeting of its shareholders as required by the
Company entered into ansubscription agreement, with
Folksamerica Reinsurance Company ("Folksamerica") pursuant to which Folksamerica
will acquire substantially allas indicated in Note 12. At such meeting, the
shareholders approved, among other things, (1) the issuance of such number of
Common Shares issuable upon conversion of the reinsurance operationspreference shares, that together
with the number of Common Shares issuable upon exercise of the Company's
wholly owned subsidiary Risk Capital Reinsurance, for a cash purchase price
equalClass A Warrants,
is in excess of the amount that may be issued without shareholder approval under
the Nasdaq Stock Market rules and (2) the adoption of amendments to the
GAAP book valueprovision of ACGL's bye-laws that limits voting rights of shareholders to 9.9%
of the assets and liabilities to be transferred to
Folksamerica plus $20.335 million, payable at closing.
Under the termstotal voting power of the agreement, the Company will place $20 million in
escrow for a period of five years. These funds will be primarily used to
reimburse Folksamerica to the extent that the loss reserves relating to business
produced on behalf of Risk Capital Reinsurance by CPI, a managing underwriting
agency, are deficient as measured at the end of such five-year period. Such
reserves were $38.7 million at December 31, 1999. To the extent that such loss
reserves are redundant, all of the escrowed funds will be returned to the
Company and Folksamerica will pay the Company an amount equal to such
redundancy. Amounts in the escrow may also be released to Folksamerica to
satisfy its indemnification claims against the Company relating to undisclosed
liabilities, the Company's reinsurance and retrocession treaties, and CPI and
the business produced by it. The Company will be responsible for certain tax
costs incurred by Folksamerica in the transaction, as well as its own
transaction and severance costs, and certain reinsurance costs incurred for the
benefit of Folksamerica. An additional amount of up to $5 million may be placed
in escrow for a period of five years to the extent that the Company's reserves
at closing are less by at least a specified amount than those estimated by Risk
Capital Reinsurance's independent actuaries. In connection with either escrow
arrangement, the Company will record a loss amount equal to any probable
deficiency in the related reserves that may become known during or at the end of
the five year period.
The sale of the Company's reinsurance business to Folksamerica is
contingent on obtaining applicable regulatory approvals, approval by the
Company's stockholders, expiration of the applicable waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act, the retention of a key employee,
obtaining certain third party consents, the absence of a material adverse change
in Risk Capital Reinsurance's business, and other customary closing conditions.
MMRCH and Trident, which collectively represent approximately 13.3% of the
12,329,494 outstanding voting shares of RCHI on March 2, 2000, have agreed to vote in favor of the transaction. XL gave Folksamerica a similar proxy, butprovide that proxy terminated upon the consummation of the repurchase of XL's interest in
RCHI described below.
F-41
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Subsequent Events (continued)
The GAAP book value of the assets and liabilitiessuch
voting limitation applies only to be transferred to
Folksamerica recorded in the accompanying financial statements at December 31,
1999 are as follows:
(In millions)
Fixed maturities and short-term investments $245.6
Premiums receivable 119.3
Reinsurance recoverable 73.1
Deferred policy acquisition costs 23.6
Deferred income tax asset 13.9
Other insurance assets 37.0
-----------------
Total Assets $512.5
-----------------
Reserve for claims and claims expenses $364.6
Net unearned premium reserve 108.7
Reinsurance premium 14.7
Other insurance liabilities 24.5
-----------------
Total Liabilities $512.5
-----------------
Net book value of assets and liabilities
to be transferred -
=================
The actual GAAP book value of the assets and liabilities transferred to
Folksamerica will be determined as of the closing date of the asset sale, and
will differ from that set forth above.
At the closing of the asset sale, Risk Capital Reinsurance and Folksamerica
will enter into a transfer and assumption agreement, under which Folksamerica
will assume Risk Capital Reinsurance's rights and obligations under the
reinsurance agreements being transferred in the asset sale. Following regulatory
approval of the agreement, the reinsureds under such agreements will be notified
that Folksamerica has assumed Risk Capital Reinsurance's obligations and that,
unless the reinsureds object to the assumption, Risk Capital Reinsurance will be
released from its obligations to those reinsureds. Assuming that none of the
reinsureds object to the assumption, the gross liabilities for such business
will be removed from the accounts of Risk Capital Reinsurance for statutory
accounting and GAAP accounting purposes.
Risk Capital Reinsurance will continue to record gross liabilities in its
accounts for reinsureds that object to the release of Risk Capital Reinsurance
from its obligations to such reinsureds. In such instances, an offsetting
accounts receivable amount from Folksamerica would be recorded as an asset equal
to such gross liabilities. This would also result in a portion of any pre-tax
gain on the transaction being deferred and amortized into income as the gross
liabilities are extinguished.
F-42
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Subsequent Events (continued)
XL Transaction
On March 2, 2000, RCHI repurchased from XL all of the 4,755,000votes conferred (directly or indirectly or by
attribution) by shares of Common StockACGL held by XL constitutingany U.S. person. Regulatory approvals
required in connection with the aggregate 27.8% and 20.8% of its
Common Stock on a basic basis and diluted basis (assuming all dilutive
securities are vested, exercised and converted into common stock, which consist
of 4,451,680 warrants exercisable at $20.00 per share and 1,281,356 stock
options exercisable at an average price of $20.90 per share), respectively.
Under the terms of the stock repurchase agreement with XL, RCHI paid to XL a
purchase price of $12.45 per share, for a total of $59.2 million. The per share
repurchase price was determined as the lesser of (i) 85% of the average closing
market price of the Common Stock during the twenty-day trading period beginning
January 21, 2000, which was $14.65, and (ii) $15.00. The consideration paid to
XL for the repurchase consisted of (i) its interestprivate placement completed in privately held LARC
Holdings, Ltd. (parent of Latin American Reinsurance Company), valued at $25
million (which interest was carried by the Company at $24 million at December
31, 1999), and (ii) all of the shares and warrants held by RCHI in Annuity and
Life Re (Holdings), Ltd., valued at $25.38 per share and $18.50 per warrant, or
$37.8 million in the aggregate (which interest was carried by the Company at
$38.2 million at December 31, 1999). XL paid RCHI in cash the $3.6 million
difference between the repurchase price and the value of its interests in LARC
Holdings and Annuity and Life Re. The value per share of Annuity and Life Re was
determined by taking the average of the closing prices of Annuity and Life Re
shares for the same twenty-day period used in determining the repurchase price
of RCHI's shares.
As a result of the repurchase, stockholder's equity of RCHI, which was
$346.5 million at December 31, 1999, has been reduced by $59.4 million to 287.1
million, and outstanding voting shares, which were 17,087,970 at December 31,
1999,November 2001
have been reduced to 12,332,970.
Risk Capital Reinsurance's stockholder's equityobtained in Nebraska, Missouri and statutory surplus,
which were $332.8 millionWisconsin, and $290.1 million, respectively, at December 31, 1999
were reduced by $62 millionrequired regulatory
approvals are pending in Pennsylvania and $60 million, respectively, following the
distribution of the shares and warrants in LARC Holdings, Ltd. and Annuity and
Life Re (Holdings), Ltd. to RCHI based on their GAAP and statutory carrying
values, respectively, at December 31, 1999.
Risk Capital Reinsurance Distribution
Upon payment of a contemplated distribution from Risk Capital Reinsurance
to the Company that would occur after the transfer of Risk Capital Reinsurance's
reinsurance-related assets and liabilities to Folksamerica (which distribution
is subject to regulatory approval), the assets of the Company would consist of
fixed maturity and short term investments, publicly traded equity securities,
and privately held securities and the Company's remaining $19 million investment
commitment to Trident II would remain in place. The Company would also continue
to own all of the outstanding capital stock of Risk Capital Reinsurance and
Cross River, each anticipated to have statutory surplus of approximately $20
million or any greater amount the Nebraska Insurance Department requires them to
retain in light of any objections from reinsureds under the transferred
reinsurance agreements.
F-43Florida.
F-44
Report of Independent Accountants on
Financial Statement SchedulesREPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULES
To the Board of Directors and StockholdersShareholders of
RiskArch Capital Holdings, Inc.Group Ltd.
Our auditaudits of the consolidated financial statements referred to in our
report dated February 1, 2000,28, 2002, except as to the matters described in Note 14,18 to
the consolidated financial statements which isare as of March 2, 20007, 2002, appearing
on Page F-2 of this Annual Report on Form 10-K also included an audit of the
financial statement schedules listed on Page F-1. In our opinion, these
financial statement schedules present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.
/s/ PricewaterhouseCoopers
LLP
New York, New YorkHamilton, Bermuda
February 1, 2000, except as to Note 14, which is as of
March 2, 200028, 2002
S-1
SCHEDULE I
RISKARCH CAPITAL HOLDINGS, INC.GROUP LTD. AND SUBSIDIARIES
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
(IN THOUSANDS)
SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTSDECEMBER 31, 2001
-------------------------------------
AMOUNT
AT WHICH
SHOWN IN
RELATED PARTIES
(In thousands)
December 31, 1999
--------------------------------------------------------
Amount
at Which
Shown in
Amortized Fair the Balance
Cost Value Sheet
-------------- ----------------- ----------------AMORTIZED FAIR THE BALANCE
COST VALUE SHEET
---------- ---------- -----------
Type of Investment:
FIXED MATURITY SECURITIES
U.S. government and government agencies
And authorities $42,765 $41,095 $41,095
Foreign governments 3,691 3,591 3,591and
authorities............................................ $ 136,617 $ 137,861 $ 137,861
Mortgage and asset-backed securities 28,424 27,298 27,298
States, municipalities and political subdivisions 52,417 52,245 52,245securities..................... 91,152 91,147 91,147
Corporate bonds 143,048 136,838 136,838
-------------- ----------------- ----------------bonds.......................................... 239,385 239,261 239,261
---------- ---------- ----------
Total Fixed Maturities 270,345 261,067 261,067Maturities................................. 467,154 468,269 468,269
EQUITY SECURITIES
Publicly traded 105,747 158,631 158,631traded.......................................... 960 235 235
Privately held 85,748 83,969 83,969
-------------- ----------------- ----------------held........................................... 41,587 41,608 41,608
---------- ---------- ----------
Total Equity Securities 191,495 242,600 242,600Securities................................ 42,547 41,843 41,843
SHORT-TERM INVESTMENTS
72,785 72,785 72,785
-------------- ----------------- ----------------Unrestricted............................................. 477,058 476,820 476,820
Held in escrow........................................... 22,156 22,156 22,156
---------- ---------- ----------
Total Investments $534,625 $576,452 $576,452
============== ================= ================Short-Term Investments........................... 499,214 498,976 498,976
========== ========== ==========
Total Investments...................................... $1,008,915 $1,009,088 $1,009,088
========== ========== ==========
S-2
SCHEDULE II
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEET
(PARENT COMPANY ONLY)
(DOLLARS IN THOUSANDS)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEET
(Parent Company Only)
(Dollars in thousands)
DecemberDECEMBER 31,
-----------------------------------
1999 1998
--------------- ---------------
Assets---------------------
2001 2000
---------- --------
ASSETS
Investment in wholly owned subsidiary $332,797 $385,121subsidiaries..................... $ 878,814 $ 57,271
Fixed maturities available for sale, at fair value
(amortized cost: 1999, $6,002; 1998, $8,007) 5,974 8,0572001, $79,717, 2000, $28,230)............ 79,872 28,646
Short-term investments 3,252 1,149
Cash 4,313 3,415available for sale, at fair value.... 11,536 75,746
Publicly traded equity securities available for sale, at
fair value (cost: 2000, $44,074).......................... -- 49,366
Securities held in escrow, at fair value (amortized cost:
2001, $22,156, 2000, $20,887)............................. 22,156 20,970
Privately held securities (cost: 2001, $26,722, 2000,
$42,086).................................................. 26,722 41,777
Cash........................................................ 11
Other assets 271 411
---------------- ---------------
Total Assets $346,607 $398,153
================ ===============
Liabilitiesassets................................................ 5,918 1,133
---------- --------
TOTAL ASSETS............................................ $1,025,029 $274,909
========== ========
LIABILITIES
Accounts payable and other liabilities 93 151
Stockholders' Equity
Preferred stock,liabilities...................... $ 4,660 $ 2,610
SHAREHOLDERS' EQUITY
Preference shares, $0.01 par value: 20,000,00050,000,000 shares
authorized (none issued)(issued: 2001, 35,687,735; 2000, 0)............ 357 --
Common stock,shares, $0.01 par value: 80,000,000200,000,000 shares
authorized (issued: 1999, 17,109,736; 1998, 17,102,503) 171 1712001, 13,513,538; 2000, 12,708,818)... 135 127
Additional paid-in capital 342,034 341,878capital.................................. 1,039,887 288,016
Deferred compensation under share award plan................ (8,230) (341)
Retained earnings (deficit)................................. (11,610) (33,626)
Accumulated other comprehensive income consisting of
unrealized appreciation (decline) in value of investments,
net of income tax 27,188 47,038
Deferred compensation under stock award plan (317) (1,062)
Retained earnings (deficit) (22,175) 10,261
Less treasury stock at cost (1999, 21,766; 1998, 15,065) (387) (284)
Total Stockholders' Equity 346,514 398,002
---------------- ---------------
Total Liabilities and Stockholders' Equity $346,607 $398,153
================ ===============tax......................................... (170) 18,123
---------- --------
TOTAL SHAREHOLDERS' EQUITY.............................. 1,020,369 272,299
---------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............. $1,025,029 $274,909
========== ========
S-3
SCHEDULE II
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF INCOME
(PARENT COMPANY ONLY)
(DOLLARS IN THOUSANDS)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (continued)
Statement of Income
(Parent Company Only)
(Dollars In thousands)
Years Ended DecemberSUCCESSOR (1) PREDECESSOR
------------------------ -----------------------
FOR THE FOR THE
YEAR PERIOD FROM PERIOD FROM YEAR
ENDED NOV. 8, 2000 JAN.1, 2000 ENDED
DEC. 31, TO TO DEC. 31,
2001 DEC. 31, 2000 NOV. 7, 2000 1999
1998 1997
---------------------- ------------- ------------ --------------
Revenues--------
REVENUES
Net investment income $641 $631 $524income.............................. $ 5,945 $ 1,245 $1,032 $ 641
Net investment gains/(losses)...................... (2,350) (11) (1) --
Loss on sale of reinsurance operations............. -- (442) --
------- ------- ------ --------
Total revenues..................................... 3,595 1,234 589 641
OPERATING COSTS AND EXPENSES
Operating Costs and Expenses
Operating expensesexpenses................................. 6,881 502 794 485
513 357
-------------- ------------ --------------------- ------- ------ --------
Income before income tax expenseexpense................... (3,286) 732 (205) 156 118 167
Income tax expenseexpense................................. -- -- (67) 55
41 58
-------------- ------------ --------------------- ------- ------ --------
Net income before equity in net income (loss) of wholly
owned subsidiaryearnings in
subsidiaries, investee company and cumulative
effect of accounting changechange...................... (3,286) 732 (138) 101 77 109
Equity in net income (loss) of wholly owned
subsidiary (32,525) 3,014 1,930subsidiaries..................................... 25,361 (8,950) 563 (35,725)
Equity in net income(loss) of investee............. (59) (219)
Cumulative effect of accounting changechange............. -- -- -- (12)
-------------- ------------ --------------
Net income (loss) (32,436) 3,091 2,039
Other Comprehensive Income (Loss), Net of Tax
Change in net unrealized depreciation, of investments, net of tax (51) 12 21
-------------- ------------ --------------
Comprehensive Income (Loss) ($32,487) $3,103 $2,060
============== ============ ==============------- ------- ------ --------
NET INCOME (LOSS).................................. $22,016 $(8,437) $ 425 $(35,636)
======= ======= ====== ========
- ------------------------
(1) Refer to reorganization described in Note 1 of the notes accompanying the
consolidated financial statements.
S-4
SCHEDULE II
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STATEMENT OF CASH FLOWS
(PARENT COMPANY ONLY)
(IN THOUSANDS)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT (continued)
Statement of Cash Flows
(Parent Company Only)
(In thousands)
Years Ended DecemberSUCCESSOR (1) PREDECESSOR
-------------------------- -----------------------
FOR THE FOR THE
YEAR PERIOD FROM PERIOD FROM YEAR
ENDED NOV. 8, 2000 JAN.1, 2000 ENDED
DEC. 31, TO TO DEC. 31,
2001 DEC. 31, 2000 NOV. 7, 2000 1999
1998 1997---------- ------------- ------------ ------------ ------------
Operating Activities--------
OPERATING ACTIVITIES
Net income from operations $89 $77 $109(loss)............................... $ 22,016 $ (8,437) $ 425 $(35,636)
Adjustments to reconcile net income (loss) to
net cash Usedprovided by (used for) operating
activities:
Equity in net (income) loss of wholly owned
subsidiaries.............................. (25,361) 8,950 (563) 35,725
Net investment (gains)/losses............... 2,350 11 1 --
Provisions for operating activities:non-cash compensation........ 2,771 -- -- 628
Net change in other assets and
liabilitiesliabilities............................... (1,074) 2,243 7,109 137
225 (650)
------------ ------------ ------------
Net Cash Provided By (Used For) Operating Activities 226 302 (541)
Investing Activities:--------- -------- ------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES....... 702 2,767 6,972 854
INVESTING ACTIVITIES:
Purchases of fixed maturitiesmaturities............... (490,256) (14,007) (3,500) (3,000) (4,999) (11,014)
Sales of fixed maturitiesmaturities................... 159,991 16,012 4,000 5,000 4,000 4,000
Net change in short-term investmentsinvestments........ (350,142) (4,772) (3,077) (2,036)
1,005 4,697
------------ ------------ ------------
Net Cash Provided By (Used For) Investing ActivitiesAcquisition of subsidiaries................. (61,043)
--------- -------- ------- --------
NET CASH PROVIDED BY (USED FOR) INVESTING
ACTIVITIES.................................... (741,450) (2,767) (2,577) (36)
6 (2,317)
Financing Provided By Activities:FINANCING ACTIVITIES:
Common stock issued 156 716 727shares issued........................ 10,923 -- 1,223 66
Preference shares issued.................... 740,737 -- -- --
Purchase of treasury sharesshares................. (48) -- 3,430 (103) (86) (197)
Common stock issued to Directors (90)
Deferred compensation on restricted
stock awardedshares.................................... (10,466) -- (1,122) 117
(296) (506)
Amortization of deferred compensation collected 628 1,302 3,367
------------ ------------ ------------
Net Cash Provided By Financing Activities 708 1,636 3,391Shares issued in connection with
acquisition............................... (387) -- -- --
--------- -------- ------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES....... 740,759 -- 3,531 80
Increase in cashcash................................ 11 0 7,926 898 1,944 533
Cash at beginning of periodperiod..................... 0 0 4,313 3,415
1,471 938
------------ ------------ --------------------- -------- ------- --------
Cash at end of period $4,313 $3,415 $1,471
============ ============ ============period........................... $ 11 $ 0 $12,239 $ 4,313
========= ======== ======= ========
- ------------------------
(1) Refer to reorganization described in Note 1 of the notes accompanying the
consolidated financial statements.
S-5
SCHEDULE SCHEDULE III
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(IN THOUSANDS)
RISK CAPITAL HOLDINGS, INC.FUTURE POLICY BENEFITS,
BENEFITS, CLAIMS,
DEFERRED LOSSES, LOSSES LOSSES
POLICY AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
Future
Policy
Benefits,
Deferred Losses,
Policy Claims and Net
Acquisition Claims Unearned Premium Investment
Costs Expenses Premiums Revenue IncomeLOSS NET AND
ACQUISITION ADJUSTMENT UNEARNED PREMIUM INVESTMENT SETTLEMENT
COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES
----------- -------------- -------------- -------------- -------------- --------------
December 31, 1999-------- -------- ---------- ----------
Property-Casualty
DECEMBER 31, 2001
Property-Casualty...................... $ 5,412 $ 23,065 $29,578 $ 30,918 $12,120 $ 23,448
------- -------- ------- -------- ------- --------
Total................................ $ 5,412 $ 23,065 $29,578 $ 30,918 $12,120 $ 23,448
======= ======== ======= ======== ======= ========
DECEMBER 31, 2000
Property-Casualty...................... -- -- -- $ 60,402 $15,923 $ 56,600
Accident and Health.................... -- -- -- 27,128 -- 19,663
Unearned premium portfolio transfer and
assumption........................... -- -- -- -- -- --
------- -------- ------- -------- ------- --------
Total................................ -- -- -- $ 87,530 $15,923 $ 76,263
======= ======== ======= ======== ======= ========
DECEMBER 31, 1999
Property-Casualty...................... $23,585 $277,271 $98,133 $261,029 $20,173 $267,622
Accident and HealthHealth.................... -- 31,358 -- 50,339 -------------- -------------- -------------- -------------- --------------
Total-- 38,219
------- -------- ------- -------- ------- --------
Total................................ $23,585 $308,629 $98,133 $311,368 $20,173 ============== ============== ============== ============== ==============
December$305,841
======= ======== ======= ======== ======= ========
AMORTIZATION
OF DEFERRED
POLICY OTHER
ACQUISITION OPERATING PREMIUMS
COSTS EXPENSES WRITTEN
------------ --------- --------
DECEMBER 31, 1998
Property-Casualty $23,515 $186,189 $102,775 $206,194 $15,6872001
Property-Casualty...................... $ 813 $27,692 $ 36,216
------- ------- --------
Total................................ $ 813 $27,692 $ 36,216
======= ======= ========
DECEMBER 31, 2000
Property-Casualty...................... $18,996 $ 6,855 $ 56,316
Accident and Health
-------------- -------------- -------------- -------------- --------------
Total $23,515 $186,189 $102,775 $206,194 $15,687
============== ============== ============== ============== ==============
December 31, 1997
Property-Casualty $17,292 $70,768 $74,234 $107,372 $14,360
AccidentHealth.................... 7,760 -- 25,987
Unearned premium portfolio transfer and
Health
-------------- -------------- -------------- -------------- --------------
Total $17,292 $70,768 $74,234 $107,372 $14,360
============== ============== ============== ============== ==============
S-6
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(In thousands)
Benefits, Amortization
Claims, of Deferred
Losses and Policy Other
Settlement Acquisition Operating Premiums
Expenses Costs Expenses Written
-------------- ---------------- -------------- --------------
Decemberassumption........................... -- -- (92,907)
------- ------- --------
Total................................ $26,756 $ 6,855 $(10,604)
======= ======= ========
DECEMBER 31, 1999
Property-Casualty $267,622Property-Casualty...................... $64,279 $14,816$14,188 $256,388
Accident and Health 38,219Health.................... 16,261 50,338
-------------- ---------------- -------------- --------------
Total $305,841------- ------- --------
Total................................ $80,540 $14,816$14,188 $306,726
============== ================ ============== ==============
December 31, 1998
Property-Casualty $176,125 $50,537 $16,452 $234,735
Accident and Health
-------------- ---------------- -------------- --------------
Total $176,125 $50,537 $16,452 $234,735
============== ================ ============== ==============
December 31, 1997
Property-Casualty $73,407 $31,467 $13,523 $144,834
Accident and Health
-------------- ---------------- -------------- --------------
Total $73,407 $31,467 $13,523 $144,834
============== ================ ============== ===================== ======= ========
S-6
SCHEDULE IV
ARCH CAPITAL GROUP LTD. AND SUBSIDIARIES
REINSURANCE
(IN THOUSANDS)
RISK CAPITAL HOLDINGS, INC. AND SUBSIDIARIES
REINSURANCE
(In thousands)
Assumed Percentage
Ceded to From of Amount
Gross Other Others Net Assumed to
Amount Companies Companies Amount Net
-----------ASSUMED FROM PERCENTAGE OF
CEDED TO OTHER OTHER AMOUNT ASSUMED
GROSS AMOUNT COMPANIES COMPANIES NET AMOUNT TO NET
------------ -------------- ------------ ---------- -------------- -------------- ----------------
December 31, 1999
Premiums Written:
Property
DECEMBER 31, 2001
Premiums Written:
Property-Casualty........ $117,406 $(82,986) $ 1,796 $ 36,216 5.0%
-------- -------- -------- -------- -----
Total.................. $117,406 $(82,986) $ 1,796 $ 36,216 5.0%
======== ======== ======== ======== =====
DECEMBER 31, 2000
Premiums Written:
Property-Casualty........ -- $ 19,731 $ 76,047 $ 56,316 135.0%
Accident and Casualty $80,122Health...... -- -- 25,987 25,987 100.0%
Unearned premium
portfolio transfer and
assumption............. -- -- (92,907) (92,907) --
-------- -------- -------- -------- -----
Total.................. -- $ 19,731 $ 9,127 $(10,604) N/M
======== ======== ======== ======== =====
DECEMBER 31, 1999
Premiums Written:
Property-Casualty........ -- $ 80,122 $336,510 $256,388 131.3%
Accident and HealthHealth...... -- -- 50,338 50,338 100.0%
----------- -------------- -------------- -------------- ----------------
Total $80,122-------- -------- -------- -------- -----
Total.................. -- $ 80,122 $386,848 $306,726 126.1%
=========== ============== ============== ============== ================
December 31, 1998
Premiums Written:
Property and Casualty $25,831 $260,566 $234,735 111.0%
Accident and Health
----------- -------------- -------------- -------------- ----------------
Total $25,831 $260,566 $234,735 111.0%
=========== ============== ============== ============== ================
December 31, 1997
Premiums Written:
Property and Casualty $3,044 $147,878 $144,834 102.1%
Accident and Health
----------- -------------- -------------- -------------- ----------------
Total $3,044 $147,878 $144,834 102.1%
=========== ============== ============== ============== ======================== ======== ======== ======== =====
S-7
EXHIBIT INDEX
Exhibit
Number Description
- - ------ -----------
3.1 Amended and Restated Certificate of Incorporation of Risk Capital Holdings,
Inc. ("RCHI")1(a)
3.2 Amended and Restated Bylaws of RCHI(b)
4.1 Specimen Common Stock Certificate(a)
4.2.1 Class A Common Stock Purchase Warrants issued to Marsh & McLennan Risk
Capital Holdings, Ltd. ("MMRCH") on September 19, 19952(b) and September
28, 19953(c)
4.2.2 Class A Common Stock Purchase Warrants issued to The Trident Partnership,
L.P. ("Trident") on September 19, 1995(b) and September 28, 1995(c)
4.2.3 Class A Common Stock Purchase Warrants issued to Taracay Investors
("Taracay") on September 19, 1995(b) and September 28, 1995(c)
4.3 Class B Common Stock Purchase Warrants issued to MMRCH on September 19,
1995(b) and September 28, 1995(c)
10.1.1 Employment Agreement, between RCHI and Mark D. Mosca(b)
EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
3.1 Memorandum of Association of Arch Capital Group Ltd.
("ACGL")(n)
3.2 Bye-Laws of ACGL(n)
3.3 Form of Amended and Restated Bye-law 45 and Bye-law 75(w)
3.4 Certificate of Designations of Series A Convertible
Preference Shares(w)
4.1 Specimen Common Share Certificate(s)
4.2.1 Class A Common Share Purchase Warrants issued to Marsh &
McLennan Risk Capital Holdings, Ltd. ("MMRCH") on September
19, 1995(b) and September 28, 1995(c)
4.2.2 Class A Common Share Purchase Warrants issued to The Trident
Partnership, L.P. ("Trident") on September 19, 1995(b) and
September 28, 1995(c)
4.2.3 Class A Common Share Purchase Warrants issued to Taracay
Investors ("Taracay") on September 19, 1995(b) and September
28, 1995(c)
4.3 Class B Common Share Purchase Warrants issued to MMRCH on
September 19, 1995(b) and September 28, 1995(c)
4.4 Form of Class A Warrant Certificate(w)
4.5 Shareholders Agreement, dated November 20, 2001, among ACGL
and the shareholders party thereto, conformed to reflect
amendments dated January 3, 2002 and March 15, 2002 (filed
herewith)
4.6 Subscription Agreement, dated as of October 24, 2001,
between ACGL and the purchasers party thereto, conformed to
reflect amendments dated November 20, 2001, January 3, 2002
and March 15, 2002 (filed herewith)
10.1.1 Amended and Restated Subscription Agreement, between ACGL
and Trident(b)
10.1.2 Amendment, dated October 31, 2000, to Subscription
Agreement, dated as of June 28, 1995, between ACGL and
Trident(o)
10.2.1 Amended and Restated Subscription Agreement, between ACGL
and MMRCH(b)
10.2.2 Amendment, dated October 31, 2000, to Subscription
Agreement, dated as of June 28, 1995, between ACGL and
MMRCH(o)
10.3 Amended and Restated Subscription Agreement, between ACGL
and Taracay(b)
10.4.1 Investment Advisory Agreement, between ACGL and MMC Capital,
Inc. ("MMC Capital")(b)
10.4.2 Investment Advisory Agreement, between Arch Reinsurance
Company (formerly known as Risk Capital Reinsurance Company,
"Arch Re") and MMC Capital(b)
10.5.1 Sublease Agreement, dated as of March 18, 1996, between Arch
Re and Coca-Cola Bottling Company of New York, Inc.
("Coca-Cola")(b)
10.5.2 Sublease Amendment Agreement and Consent, dated as of
November 11, 1997, between Arch Re and Coca-Cola(e)
10.5.3 Sub-Sublease Agreement, dated as of March 18, 1996, between
Arch Re and MMC Capital(f)
10.5.4 Amendment to Sub-Sublease Agreement, between Arch Re and MMC
Capital(k)
10.6.1 Tax Sharing Agreement, between Arch U.S. and Arch Re
(amended)(e)
10.6.2 Addition of Cross River Insurance Company to Tax Sharing
Agreement(g)
10.6.3 Addition of Hales & Company Inc. ("Hales") to Tax Sharing
Agreement(s)
10.7.1 ACGL 1999 Long Term Incentive and Share Award Plan(h)+
10.7.2 ACGL 1995 Long Term Incentive and Share Award Plan (the
"1995 Stock Plan")(b)+
10.7.3 First Amendment to the 1995 Stock Plan(c)+
10.1.2 Employment Agreement, between RCHI and Peter A. Appel(b)+
10.1.3 Employment Agreement, between RCHI and Bonnie L. Boccitto(b)+
10.1.4 Employment Agreement, between RCHI and Paul J. Malvasio(b)+
10.2 Amended and Restated Subscription Agreement, between RCHI and Trident(b)
10.3 Amended and Restated Subscription Agreement, between RCHI and MMRCH(b)
10.4 Amended and Restated Subscription Agreement, between RCHI and Taracay(b)
10.5 Purchase Agreement, between RCHI and X.L. Insurance Company, Ltd.(b)
E-1
Exhibit
Number Description
- - ------ -----------
10.6.1 Investment Advisory Agreement, between RCHI and Marsh & McLennan
Capital, Inc. ("MMCI")(b)
10.6.2 Investment Advisory Agreement, between Risk Capital Reinsurance Company
("RCRe") and MMCI(b)
10.6.3 Investment Advisory Agreement among, RCHI, RCRe and Alliance Capital
Management L.P.(i)
10.7 Management Agreement, among RCHI, RCRe and The Putnam Advisory Company,
Inc.(b) 10.8.1 Sublease Agreement, dated as of March 18, 1996, between
RCRe and Coca-Cola Bottling Company of New York, Inc. ("Coca-Cola")(b)
10.8.2 Sublease Amendment Agreement and Consent, dated as of November 11, 1997,
between RCRe and Coca-Cola(d)
10.8.3 Sub-Sublease Agreement, dated as of March 18, 1996, between RCRe and
MMCI(e)
10.8.4 Sub-Sublease Agreement, dated as of April 30, 1997, between RCRe and
Bank of Ireland Asset Management (US) Limited ("BOI"), as amended(e)
10.8.5 Sub-Sublease Termination Agreement, effective March 31, 2000, between
RCRe and BOI
EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
10.7.4 ACGL Long Term Incentive Plan for New Employees(y)+
10.8.1 Restricted Share Agreements--Executive Officers(d)+
10.8.2 Restricted Share Agreement--Peter A. Appel--April 24, 2000
grant(p)+ and as of January 30, 2001 grants(v)+
10.8.3 Restricted Share Agreements--Robert Clements--May 5, 2000
grants,(p)+ January 1, 2001 grant(s)+, as of January 30,
2001 grants(v)+, October 23, 2001 grant(w)+ and November 19,
2001 grant(w)+
10.8.4 Restricted Share Agreement, dated as of January 1, 2002,
between ACGL and Constantine Iordanou(w)+
10.8.5 Restricted Share Agreement, dated as of January 1, 2002,
between ACGL and Constantine Iordanou(w)+
10.8.6 Restricted Share Agreement, dated as of January 18, 2002,
between ACGL and John Vollaro (filed herewith)+
10.8.7 Restricted Share Agreement, dated as of October 23, 2001,
between ACGL and Paul Ingrey(v)+
10.8.9 Restricted Share Agreement, dated as of October 23, 2001,
between ACGL and Dwight Evans(v)+
10.8.10 Restricted Share Agreement, dated as of October 23, 2001,
between ACGL and Marc Grandisson(v)+
10.8.11 Restricted Share Agreement, dated as of January 30, 2001,
between ACGL and Louis Petrillo(v)+
10.9.1 Stock Option Agreements--Executive Officers--1995 and 1996
grants,(d) 1997 and 1998 grants(g) and 2000 grants(p)+
10.9.2 Stock Option Agreements--Robert Clements--1996 grant,(d)
1997 grant(e) and 1998 grant(g)
10.9.3 Amendments to Stock Option Agreements--Robert Clements
(dated March 22, 2000)(p) and Executive Officers+ and
Directors (dated May 5, 2000)(s)+
10.9.4 Stock Option Agreements--Non-Employee Directors--1996 and
1997 annual grants,(c)+ 1998 annual grants,(e)+ 1999 annual
grants,(g)+ 2000 annual grants(j)+ and 2001 annual
grants(s)+
10.9.5 Stock Option Agreements--Non-Employee Directors--initial
grants(g)(j)+
10.9.6 Share Option Agreement, dated October 23, 2001, between ACGL
and Ian Heap(aa)+
10.9.7 Employee Share Option Agreement, dated October 23, 2001,
between ACGL and John M. Pasquesi(w)+
10.9.8 Share Option Agreement, dated as of October 23, 2001,
between ACGL and John M. Pasquesi(w)+
10.9.9 Share Option Agreement, dated as of October 23, 2001,
between ACGL and Peter A. Appel(w)+
10.9.10 Stock Option Agreement, dated as of October 23, 2001,
between ACGL and Paul Ingrey(v)+
10.9.11 Stock Option Agreement, dated as of October 23, 2001,
between ACGL and Dwight Evans(v)+
10.9.12 Stock Option Agreement, dated as of October 23, 2001,
between ACGL and Marc Grandisson(v)+
10.9.13 Share Option Agreement, dated as of January 1, 2002, between
ACGL and Constantine Iordanou(w)+
10.9.14 Stock Option Agreement, dated as of January 18, 2002,
between ACGL and John Vollaro (filed herewith)
10.9.1 Tax Sharing Agreement, between RCHI and RCRe (amended)(d)
10.9.2 Addition of Cross River Insurance Company to Tax Sharing Agreement(g)
10.10.1 RCHI 1999 Long Term Incentive and Share Award Plan(f)+
10.10.2 RCHI 1995 Long Term Incentive and Share Award Plan (the "1995 Stock
Plan")(b)4+
10.10.3 First Amendment to the 1995 Stock Plan(c)5+
10.10.4 Restricted Stock Agreements--Executive Officers(h)+
10.10.5 Stock Option Agreements--Executive Officers--1995 and 1996 grants(h) and
1997 and 1998 grants(g)+
10.10.6 Stock Option Agreements--Chairman--1996 grant,(h) 1997 grant(d) and 1998
grant(g)
10.10.7 Stock Option Agreements--Non-Employee Directors--initial grants(g) (and
filed herewith)
E-2
Exhibit
Number Description
- - ------ -----------
10.10.8 Stock Option Agreements--Non-Employee Directors--1996 and 1997 annual
grants,(c) 1998 annual grants,(d) 1999 annual grants (g) and 2000 annual
grants (filed herewith)
10.11.1 Change in Control Agreement (as amended)--President(i)+
10.11.2 Change in Control Agreements (as amended)--Managing Directors(i)+
10.11.3 Form of Change in Control Agreements (as amended)--Senior Vice
Presidents(i)+
10.11.4 Change in Control Severance Plan (as amended)(i)+
10.12 RCHI 1995 Employee Stock Purchase Plan(j)+
10.13.1 RCRe Money Purchase Pension Plan (the "Pension Plan")(b)+
10.13.2 Amendment and Restatement of the Adoption Agreement relating to the
Pension Plan(c)+
10.13.3 Amendment to the Adoption Agreement relating to the Pension Plan(g)+
10.14.1 RCRe Employee Savings Plan (the "Savings Plan")(b)+
10.14.2 Amendment and Restatement of the Adoption Agreement relating to the
Savings Plan(c)+
10.14.3 Amendment to the Adoption Agreement relating to the Savings Plan(g)+
10.15.1 RCRe Executive Supplemental Non-Qualified Savings and Retirement Plan
(the "Supplemental Plan") and related Trust Agreement(b)+
10.15.2 Amendment No. 1 to the Adoption Agreement relating to the Supplemental
Plan(c)+
10.15.3 Amendment No. 2 to the Adoption Agreement relating to the Supplemental
Plan(g)+
10.16 Asset Purchase Agreement, dated as of January 10, 2000, amount RCHI,
Folksamerica Holding Company, Inc. ("FHC") and Folksamerica Reinsurance
Company ("FRC")(k)
10.17 Voting Agreement, dated as of January 10, 2000, among MMRCH, RCHI and
FHC(k)
10.18 Voting Agreement, dated as of January 10, 2000, among Trident, RCHI and
FHC(k)
10.19 Voting Agreement, dated as of January 10, 2000, among XL Capital Ltd
("XL"), Garrison Investments Inc. ("GI"), RCHI and FHC(k)
10.20 Form of Transfer and Assumption Agreement between RCRe and FRC(k)
10.21 Form of Balance Sheet of Assumed Business(k)
10.22 Form of Escrow Agreement among RCRe, FHC, FRC and the Escrow Agent(k)
10.23 Form of Supplemental Escrow Agreement among, RCRe, FHC, FRC and the
Escrow Agent(k)
10.24 Stock Repurchase Agreement, dated January 17, 2000, among RCHI, RCRe, XL
and GI(k)
10.25 Form of Voting and Disposition Agreement, among RCHI, RCRe, XL and GI(k)
21 Subsidiaries of Registrant(g)
23 Consent of PricewaterhouseCoopers LLP (filed herewith)
24 Power
EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
10.9.15 Stock Option Agreements, dated as of January 30, 2001 and
October 23, 2001, between ACGL and Debra O'Connor(v)+
10.9.16 Stock Option Agreements, dated as of January 30, 2001 and
October 23, 2001, between ACGL and Louis Petrillo(v)+
10.10.1 Retention Agreement, dated January 4, 2002, among ACGL, Arch
U.S. and Robert Clements, including Form of Promissory
Note(w)+
10.10.2 Employment Agreement dated as of June 9, 2000 between ACGL
and Debra M. O'Connor(m)+
10.10.3 Employment and Change in Control Agreement, dated as of May
5, 2000, between ACGL and Louis T. Petrillo(m)+
10.10.4 Employment Agreement, dated as of October 23, 2001, among
ACGL, Arch Reinsurance Ltd. (Arch Re Bermuda) and Paul
Ingrey(w)+
10.10.5 Employment Agreement, dated as of October 23, 2001, among
ACGL, Arch Re Bermuda and Dwight Evans(w)+
10.10.6 Employment Agreement, dated as of October 23, 2001, among
ACGL, Arch Re Bermuda and Marc Grandisson(w)+
10.10.7 Employment Agreement, dated as of December 20, 2001, among
ACGL, Arch U.S. and Constantine Iordanou(w)+
10.10.8 Employment Agreement, dated as of January 18, 2002, between
ACGL and John Vollaro (filed herewith)+
10.10.9 Employment Agreement, dated October 23, 2001, between ACGL
and John M. Pasquesi(w)+
10.11 Assumption of Change in Control Agreements(s)
10.12.1 ACGL 1995 Employee Stock Purchase Plan(a)+
10.12.2 Arch Re Money Purchase Pension Plan (the "Pension Plan")(b)+
10.12.3 Amendment and Restatement of the Adoption Agreement relating
to the Pension Plan(c)+
10.12.4 Amendment to the Adoption Agreement relating to the Pension
Plan(g)+
10.12.5 Arch Re Employee Savings Plan (the "Savings Plan")(b)+
10.12.6 Amendment and Restatement of the Adoption Agreement relating
to the Savings Plan(c)+
10.12.7 Amendment to the Adoption Agreement relating to the Savings
Plan(g)+
10.12.8 Arch Re Executive Supplemental Non-Qualified Savings and
Retirement Plan (the "Supplemental Plan") and related Trust
Agreement(b)+
10.12.9 Amendment No. 1 to the Adoption Agreement relating to the
Supplemental Plan(c)+
10.12.10 Amendment No. 2 to the Adoption Agreement relating to the
Supplemental Plan(g)+
10.13 Asset Purchase Agreement, dated as of January 10, 2000,
among Arch-U.S., Folksamerica Holding Company, Inc. ("FHC")
and Folksamerica Reinsurance Company ("FRC")(i)
10.14 Transfer and Assumption Agreement, dated May 5, 2000,
between Arch Re and FRC(l)
10.15 Escrow Agreement, dated December 28, 2000, among ACGL, FHC,
FRC and the Escrow Agent(s)
10.16 Agreement, dated May 5, 2000, among Arch-U.S., Arch Re, FHC
and FRC regarding Aviation Business(l)
10.17 Agreement and Plan of Merger, dated as of September 25,
2000, among Arch-U.S., ACGL, The Arch Purpose Trust and Arch
Merger Corp.(n)
10.18 Asset Purchase Agreement, dated as of October 31, 2000,
among Arch-U.S., Hales Capital Advisors, LLC, its members
and Hales(q)
10.19 Reorganization Agreement, dated as of December 31, 2000,
among ACGL, American Independent Insurance Holding Company
and other signatories thereto(r)
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EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
10.20 Stock Repurchase Agreement, dated January 17, 2000, among
ACGL, Arch Re and XL Capital Ltd(i)
10.21 Form of Voting and Disposition Agreement, among Arch U.S.,
Arch Re and XL Capital Ltd(i)
10.22 Agreement, dated November 20, 2001, among ACGL, Warburg
Pincus Private Equity VIII, L.P., Warburg Pincus
International Partners, L.P., Warburg Pincus Netherlands
International Partners I, C.V., Warburg Pincus Netherlands
International II, C.V. and HFCP IV (Bermuda), L.P.
(collectively, the "Original Signatories") and Orbital
Holdings, Ltd.(w)
10.23 Agreement, dated November 20, 2001, among ACGL, the Original
Parties and Insurance Private Equity Investors, L.L.C.(w)
10.24 Agreement, dated November 20, 2001, among ACGL, the Original
Parties and Farallon Capital Partners, L.P., Farallon
Capital Institutional Partners II, L.P., Farallon Capital
Institutional Partners III, L.P. and RR Capital Partners,
L.P.(w)
10.25 Agreement, dated as of November 8, 2001, among ACGL, the
Investors, Trident, Trident II, L.P., MMRCH, Marsh &
McLennan Capital Professionals Fund, L.P. and Marsh &
McLennan Employees' Securities Company, L.P.(v)
10.26 Management Subscription Agreement, dated as of October 24,
2001, between ACGL and certain members of management(v)
10.27 Reorganization Agreement, dated as of March 23, 2001, by and
among Altus Holdings, Ltd., Trident, TRYCO II, Ltd., MMRCH,
Glenn L. Ballew, David G. May and ACGL(u)
10.28 Administrative Services Agreement, between ACGL and Arch
U.S.(t)
21 Subsidiaries of Registrant (filed herewith)
23 Consent of PricewaterhouseCoopers (filed herewith)
24 Powers of Attorney (filed herewith)
27 Financial Data Schedule (filed herewith)
E-3
Exhibit
Number Description
- - ------ -----------
99.1 Definitive proxy statement for a special meeting of stockholders, filed
with the SEC on March 16, 2000 (excluding audited financial statements
and annexes thereto)
- - --------
1(a)------------------------
(a) Filed as an exhibit to Amendment No. 3 to our Registration Statement on Form S-1S-8
(No. 33-94184)33-99974), as filed with the Securities and Exchange Commission (the "SEC")SEC on August
11,December 4, 1995, and incorporated
by reference.
2(b)(b) Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 1995, as filed with the SEC on March 30, 1996, and incorporated
by reference.
3(c)(c) Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 1996, as filed with the SEC on March 31, 1997, and incorporated
by reference.
(d) Filed as an exhibit to our Report on Form 10-Q for the period ended
June 30, 1997, as filed with the SEC on August 14, 1997, and incorporated by
reference.
(e) Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 1997, as filed with the SEC on March 27, 1998, and incorporated
by reference.
(e)(f) Filed as an exhibit to our Report on Form 10-Q for the period ended
June 30, 1998, as filed with the SEC on August 14, 1998, and incorporated by reference.
(f) Filed as an exhibit to our Definitive Proxy Statement
filed with the SEC on April 14, 1999, and incorporated by
reference.
(g) Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 1998, as filed with the SEC on March 30, 1999, and incorporated
by reference.
4(h)(h) Filed as an exhibit to our Definitive Proxy Statement, as filed with the SEC
on April 14, 1999, and incorporated by reference.
(i) Filed as an exhibit to our Report on Form 8-K as filed with the SEC on
January 18, 2000, and incorporated by reference.
(j) Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 1999, as filed with the SEC on March 30, 2000, and incorporated
by reference.
E-4
(k) Filed as an exhibit to our Report on Form 10-Q for the period ended
June 30, 1997,March 31, 2000, as filed with the SEC on August 14, 1997,May 15, 2000, and incorporated by
reference.
(i)(l) Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on
May 19, 2000, and incorporated by reference.
(m) Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on
September 8, 2000, and incorporated by reference.
(n) Filed as an annex to our Definitive Proxy Statement/Prospectus included in
our Registration Statement on Form S-4 (No. 333-45418), as filed with the
SEC on September 26, 2000, and incorporated by reference.
(o) Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on
November 9, 2000, and incorporated by reference.
(p) Filed as an exhibit to our Report on Form 10-Q for the period ended
JuneSeptember 30, 1999,2000, as filed with the SEC on August 12, 1999,November 14, 2000, and
incorporated by reference.
(j)(q) Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on
December 5, 2000, and incorporated by reference.
(r) Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on
March 15, 2001, and incorporated by reference.
(s) Filed as an exhibit to our Annual Report on Form 10-K for the year ended
December 31, 2000, as filed with the SEC on April 2, 2001, and incorporated
by reference.
(t) Filed as an exhibit to our Report on Form 10-Q for the period ended
March 31, 2001, as filed with the SEC on May 15, 2001, and incorporated by
reference.
(u) Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on
July 6, 2001, and incorporated by reference.
(v) Filed as an exhibit to our Report on Form 10-Q for the period ended
September 30, 2001, as filed with the SEC on November 14, 2001, and
incorporated by reference.
(w) Filed as an exhibit to our Report on Form 8-K, as filed with the SEC on
January 4, 2002, and incorporated by reference.
(x) Filed as an exhibit to our Report on Form 8-K/A, as filed with the SEC on
January 7, 2002, and incorporated by reference.
(y) Filed as an exhibit to our Registration Statement on Form S-8
(No. 33-99974)333-72182), as filed with the SEC on December 4,
1995,January 8, 2002, and incorporated
by reference.
(k)(z) Filed as an exhibit to our ReportRegistration Statement on Form 8-KS-3
(No. 333-82612), as filed with the SEC on January 18, 2000,February 12, 2002, and
incorporated by reference.
(aa) Filed as an exhibit to our Registration Statement on Form S-8
(No. 333-82772), as filed with the SEC on February 14, 2002, and
incorporated by reference.
+ A management contract or compensatory plan or arrangement required to be
filed pursuant to Item 14(c) of Form 10-K.
E-5