| | 2002 | | 2001 | |
| |
| |
| |
| CASH FLOWS PROVIDED BY OPERATING ACTIVITIES: | | | | | | | |
| Net income for the period | | $ | 44,191 | | $ | 25,784 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | |
| Realized gains on investments | | | (12,671 | ) | | (12,388 | ) |
| Net realized and unrealized losses (gains) on derivative instruments | | | (3,637 | ) | | 6,851 | |
| Amortization of discount on fixed maturities | | | (857 | ) | | (703 | ) |
| Accrued investment income | | | 1,362 | | | (143 | ) |
| Reinsurance premiums receivable | | | 9,675 | | | 1,992 | |
| Deferred acquisition costs | | | 1,608 | | | (5,000 | ) |
| Prepaid reinsurance premiums | | | (51,894 | ) | | (2,476 | ) |
| Unpaid losses & loss expenses recoverable | | | (3,051 | ) | | (330 | ) |
| Amounts due from parent and affiliates | | | (7,722 | ) | | (1,813 | ) |
| Other assets | | | (9 | ) | | (188 | ) |
| Accounts payable and accrued liabilities | | | (624 | ) | | 229 | |
| Reinsurance premiums payable | | | 12,124 | | | 2,444 | |
| Deferred premium revenue | | | 75,220 | | | 22,184 | |
| Unpaid losses and loss expenses | | | 12,040 | | | 4,999 | |
| Portfolio transfer | | | — | | | 25,669 | |
| | |
| |
| |
| Total adjustments | | | 31,564 | | | 41,327 | |
| | |
| |
| |
| Net cash provided by operating activities | | | 75,755 | | | 67,111 | |
| | |
| |
| |
| CASH FLOWS USED IN INVESTING ACTIVITIES : | | | | | | | |
| Proceeds from sale of fixed maturities and short-term investments | | | 1,927,070 | | | 1,813,675 | |
| Proceeds from redemption of fixed maturities and short-term investments | | | 179,452 | | | 15,558 | |
| Purchase of fixed maturities and short-term investments | | | (2,133,939 | ) | | (1,863,924 | ) |
| | |
| |
| |
| Net cash used in investing activities | | | (27,417 | ) | | (34,691 | ) |
| CASH FLOWS USED IN FINANCING ACTIVITY | |
| |
| |
| Dividends paid on preferred shares | | | (6,665 | ) | | (1,492 | ) |
| | |
| |
| |
| INCREASE IN CASH AND CASH EQUIVALENTS | | | 41,673 | | | 30,928 | |
| CASH AND CASH EQUIVALENTS – BEGINNING OF PERIOD | | | 50,243 | | | 17,154 | |
| | |
| |
| |
| CASH AND CASH EQUIVALENTS – END OF PERIOD | | $ | 91,916 | | $ | 48,082 | |
| | |
| |
| |
The accompanying notes are an integral part of these condensed financial statements.
XL FINANCIAL ASSURANCE LTD.
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(U.S. DOLLARS IN THOUSANDS)
1. ORGANIZATION AND BUSINESS
XL Financial Assurance Ltd. (the “Company”) was incorporated with limited liability under the Bermuda Companies Act 1981 on October 14, 1998 and is registered as a Class 3 insurer under The Insurance Act 1978, amendments thereto and related regulations. At September 30, 2002 and 2001, the Company was approximately 85% owned by XL Insurance (Bermuda) Ltd (a wholly-owned subsidiary of XL Capital Ltd); 6% by Financial Security Assurance Inc. (a wholly-owned subsidiary of Financial Security Assurance Holdings Ltd.) and 9% by Financial Security Assurance International Ltd. (owned 20% by XL Insurance (Bermuda) Ltd and 80% by Financial Security Assurance Inc.). The Company is an integral part of a joint venture agreement between XL Capital Ltd and Financial Security Assurance Holdings Ltd.
The Company is primarily engaged in the business of providing reinsurance of financial guaranties on asset-backed and municipal obligations underwritten by XL Insurance (Bermuda) Ltd, Financial Security Assurance Inc. and XL Capital Assurance Inc. (a wholly-owned subsidiary of XL Capital Ltd) and other monoline and multiline insurance companies. This may be in the form of traditional financial guaranty insurance or via a credit default swap execution. The Company’s underwriting policy is to provide reinsurance of asset-backed and municipal obligations that would be of a lower investment-grade quality without the benefit of the Company’s reinsurance. The asset-backed obligations reinsured by the Company are generally issued in structured transactions and are backed by pools of assets such as residential mortgage loans, consumer or trade receivables, securities or other assets having ascertainable cash flows or market value. The municipal obligations reinsured by the Compan y consist primarily of general obligation bonds that are supported by the issuers’ taxing power and of special revenue bonds and other special obligations of states and local governments that are supported by the issuers’ ability to impose and collect fees and charges for public services or specific projects. Reinsurance written by the Company guarantees payment when due of scheduled payments on an issuers’ obligation. In the case of a payment default on an insured obligation, the Company is generally required to pay the principal, interest or other such amounts due in accordance with the obligations’ original payment schedule or, at its option, to pay such amounts on an accelerated basis. The Company conducts surveillance on its exposures to try and ensure early identification of any loss events. In addition, in the normal course of business, the Company seeks to reduce the loss that may arise from such events by reinsuring certain levels of risks in various areas of exposure with other insurance enterprises or reinsurers.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PREPARATION
The accompanying condensed financial statements have been prepared by the Company and are unaudited. In the opinion of management, all adjustments, which include only normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows at September 30, 2002 and for all periods presented, have been made.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These statements should be read in conjunction with the Company’s December 31, 2001 financial statements and notes thereto. The year-end condensed balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results of operations for the periods ended September 30, 2002 and 2001 are not necessarily indicative of the operating results for the full year.
XL FINANCIAL ASSURANCE LTD.
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(U.S. DOLLARS IN THOUSANDS)
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PREPARATION (CONTINUED)
The preparation of condensed financial statements 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. Any such adjustments are reflected in income in the period in which the adjustments are made. The financial statement estimates subject to most uncertainty are estimates for loss reserves and calculation of the fair value of credit default swap instruments.
Certain comparative figures have been reclassified to conform with the current year’s presentation.
3. DERIVATIVE INSTRUMENTS
The Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (SFAS) No. 133,“Accounting for Derivative Instruments and Hedging Activity”, in June 1998. SFAS No. 133 establishes accounting and reporting standards for derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activity. It requires that an entity recognize all derivatives as either other assets or other liabilities in the balance sheet and measure those instruments at fair value. The Company adopted SFAS No. 133, as amended, as of January 1, 2001.
Credit default swaps meet the definition of a derivative under FAS 133. The Company has recorded these products at management’s estimate of fair value. Credit default swaps are considered, in substance, financial guaranty contracts as the Company has the intent to hold them to maturity. Therefore, the change in fair value is split between premiums, loss and loss adjustment expenses, and adjustments to fair value, which are reported in “net realized gains/(losses) on derivative instruments”. The level of fair value adjustments is dependent upon a number of factors including changes in interest rates, credit spreads and other market factors. The fair value adjustment for the three and nine month periods ended September 30, 2002 was a gain of $3.6 million and $13.7 million respectively, which was recorded as follows:
| | Three months
ended 09/30/02 | | Nine months
ended 09/30/02 | |
| Net premiums earned | | $ | 9,938 | | $ | 13,444 | |
| Losses and loss expenses | | | (2,485 | ) | | (3,361 | ) |
| Net realized and unrealized (losses) gains on derivative instruments | | | (3,874 | ) | | 3,637 | |
| |
| |
| |
| Total fair value adjustment | | $ | 3,579 | | $ | 13,720 | |
| |
| |
| |
4. FACULTATIVE QUOTA SHARE REINSURANCE TREATY
On October 6, 1999, the Company entered into a Facultative Quota Share Reinsurance Treaty (“Treaty”) with XL Capital Assurance Inc. (“XLCA”). The Treaty was amended and restated on June 22, 2001. Under the terms of this Treaty, the Company agrees to reinsure up to 90% of the XLCA’s acceptable risks. The Company is subject to a 30% ceding commission on premiums assumed under the terms of this Treaty.
5. SPECIAL PURPOSE VEHICLES
The Company utilizes special purpose vehicles to a limited extent indirectly in the normal course of the Company’s business. The Company provides financial guaranty insurance of structured transactions backed by pools of assets of specified types, municipal obligations supported by the issuers’ ability to charge fees for specified services or projects, and corporate risk obligations including essential infrastructure projects and obligations backed by receivables from future sales of commodities and other specified services. The obligations related to these transactions are often securitized through off-balance sheet special purpose vehicles by the transferors. In synthetic transactions, the Company guarantees payment obligations of counterparties, including special purpose vehicles, through credit default swaps referencing asset portfolios. The Company only provides financial guaranty insurance of these special purpose vehicles for fixed premiums at market rates but does not hold any equity positions or subordinated debt in these off-balance sheet arrangements. Accordingly, these special purpose vehicles are not consolidated.
XL FINANCIAL ASSURANCE LTD.
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR NINE MONTH PERIODS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(U.S. DOLLARS IN THOUSANDS)
6. REINSURANCE
The effect of reinsurance on premiums written and earned for the three and nine month periods ended September 30, 2002 and 2001 is shown below:
| | Direct | | Ceded | | Net | |
| |
| |
| |
| |
| Three months ended September 30, 2001 | | | | | | | | | | |
| Premium written | | $ | 24,205 | | $ | (4,043 | ) | $ | 20,162 | |
| Premium earned | | | 7,038 | | | (1,312 | ) | | 5,726 | |
| Losses and loss adjustment expenses | | | 3,506 | | | (296 | ) | | 3,210 | |
| Three months ended September 30, 2002 | | | | | | | | | | |
| Premium written | | $ | 29,182 | | $ | (23,410 | ) | $ | 5,772 | |
| Premium earned | | | 19,681 | | | (5,922 | ) | | 13,759 | |
| Losses and loss adjustment expenses | | | 4,917 | | | (1,447 | ) | | 3,470 | |
| Nine months ended September 30, 2001 | | | | | | | | | | |
| Premium written | | $ | 42,120 | | $ | (4,176 | ) | $ | 37,944 | |
| Premium earned | | | 19,936 | | | (1,700 | ) | | 18,236 | |
| Losses and loss adjustment expenses | | | 4,999 | | | (330 | ) | | 4,669 | |
| Nine months ended September 30, 2002 | | | | | | | | | | |
| Premium written | | $ | 123,151 | | $ | (64,501 | ) | $ | 58,650 | |
| Premium earned | | | 48,198 | | | (12,606 | ) | | 35,592 | |
| Losses and loss adjustment expenses | | | 12,040 | | | (3,051 | ) | | 8,989 | |
