Scottish Annuity & Life Insurance Company (Cayman) Ltd.
Report of Independent Auditors.................................................1
Consolidated Balance Sheets as of December 31, 2003 and 2002...................2
Consolidated Statements of Income for the years ended December 31, 2003,
2002 and 2001..................................................................3
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2003, 2002 and 2001...............................................4
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 2003, 2002 and 2001...............................................5
Consolidated Statements of Cash Flows for the years ended December 31,
2003, 2002 and 2001............................................................6
Notes to Consolidated Financial Statements.....................................7
Unaudited Consolidated Balance Sheets as of September 30, 2004 and 2003.......23
Unaudited Consolidated Statements of Income for the nine months ended
September 30, 2004 and 2003...................................................24
Unaudited Consolidated Statements of Comprehensive Income for the nine
months ended September 30, 2004 and 2003......................................25
Unaudited Consolidated Statements of Shareholders' Equity for the nine
months ended September 30, 2004 and 2003......................................26
Unaudited Consolidated Statements of Cash Flows for the nine months ended
September 30, 2004 and 2003...................................................27
Notes to Consolidated Financial Statements....................................28
Report of Independent Auditors
To the Shareholder and Board of Directors of Scottish Annuity & Life Insurance
Company (Cayman) Ltd.
We have audited the accompanying consolidated balance sheets of Scottish Annuity
& Life Insurance Company (Cayman) Ltd. and subsidiaries as of December 31, 2003
and 2002, and the related consolidated statements of income, comprehensive
income, shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 2003. 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 in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Scottish Annuity & Life Insurance Company (Cayman) Ltd. and subsidiaries at
December 31, 2003 and 2002, and the consolidated results of their operations and
their cash flows for the each of the three years in the period ended December
31, 2003, in conformity with accounting principles generally accepted in the
United States of America.
As discussed in Note 2 to the financial statements, in 2003 the Company changed
its accounting related to its funds withheld at interest.
ERNST & YOUNG LLP
February 10, 2004
1
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Consolidated
Balance Sheets
(Expressed in thousands of United States Dollars)
Year Ended Year Ended
December 31, 2003 December 31, 2002
-------------------- -------------------
Assets
Fixed maturity investments, available for sale,
at fair value (amortized cost $1,834,382; 2002 -
$874,663) $ 1,854,492 $ 883,886
Preferred stock (cost $125,460) 126,449 -
Cash and cash equivalents 270,421 116,298
Other investments 17,664 5,619
Funds withheld at interest 1,469,425 1,101,836
-------------------- -------------------
Total investments 3,738,451 2,107,639
Accrued interest receivable 18,845 8,461
Reinsurance balances and risk fees receivable 156,323 61,848
Deferred acquisition costs 304,849 206,530
Amounts recoverable from reinsurers 713,248 -
Fixed assets 4,627 4,012
Due from related party 20,011 -
Other assets 35,953 2,251
Deferred tax asset 32,051 7,169
Segregated assets 403,037 289,899
-------------------- -------------------
Total assets $ 5,427,395 $ 2,687,809
==================== ===================
Liabilities
Reserves for future policy benefits $ 1,393,220 $ 297,639
Interest sensitive contract liabilities 2,633,346 1,567,176
Accounts payable and accrued expenses 26,305 4,417
Reinsurance payable 122,188 31,744
Due to related party - 14,167
Other liabilities 9,571 74
Current income tax payable 12,113 1,229
Long term debt 47,500 17,500
Segregated liabilities 403,037 289,899
-------------------- -------------------
Total liabilities 4,647,280 2,223,845
-------------------- -------------------
Minority interest 9,295 -
Shareholders' equity
Share capital, par value $0.01 per share:
Issued and fully paid: 25,000,000 ordinary shares
(2002 - 25,000,000) 250 250
Additional paid-in capital 714,892 420,081
Accumulated other comprehensive income 15,958 6,451
Retained earnings 39,720 37,182
-------------------- -------------------
Total shareholders' equity 770,820 463,964
-------------------- -------------------
Total liabilities and shareholders' equity $ 5,427,395 $ 2,687,809
==================== ===================
See accompanying notes to Consolidated Financial Statements.
2
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Consolidated Statements
of Income
(Expressed in thousands of United States Dollars)
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2003 2002 2001
---------------- ---------------- ------------------
Revenues
Premiums earned $ 266,086 $ 129,046 $ 68,344
Investment income, net 137,615 99,612 50,572
Fee income 6,060 4,520 2,688
Realized losses (7,396) (4,852) (3,883)
Change in value of embedded derivatives 13,904 -
---------------- ---------------- ------------------
Total revenues 416,269 228,326 117,721
---------------- ---------------- ------------------
Benefits and expenses
Claims and other policy benefits 192,857 96,059 51,245
Interest credited to interest sensitive 89,020 48,140 17,578
contract liabilities
Acquisition costs and other insurance 91,771 51,205 24,013
expenses
Operating expenses 32,681 32,408 15,675
Interest expense 1,244 728 1,405
---------------- ---------------- ------------------
Total benefits and expenses 407,573 228,540 109,916
---------------- ---------------- ------------------
Income (loss) before income taxes and 8,696 (214) 7,805
minority interest
Income tax benefit (expense) 13,441 4,164 (58)
---------------- ---------------- ------------------
Income before minority interest 22,137 3,950 7,747
Minority interest (62) - 70
---------------- ---------------- ------------------
Income before cumulative effect of change
in accounting principle 22,075 3,950 7,817
Cumulative effect of change in accounting
principle (net of taxation of $3,415; 2002
- - nil; 2001 - nil) (19,537) - (406)
---------------- ---------------- ------------------
Net income $ 2,538 $ 3,950 $ 7,411
================ ================ ==================
See accompanying notes to Consolidated Financial Statements.
3
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Consolidated Statements
of Comprehensive Income
(Expressed in thousands of United States Dollars)
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2003 2002 2001
------------------ ---------------- -----------------
Net income $ 2,538 $ 3,950 $ 7,411
------------------ ---------------- -----------------
Other comprehensive income (loss), net of tax:
Unrealized appreciation (depreciation) on 11,631 15,510 (3,000)
investments
Add: reclassification adjustment for (2,124) (5,433) 3,196
investment (gains) losses included
in net income
------------------ ---------------- -----------------
Other comprehensive income, net of income 9,507 10,077 196
tax expense of $2,349 and $3,818 and
$1,025
------------------ ---------------- -----------------
Comprehensive income $ 12,045 $ 14,027 $ 7,607
================== ================ =================
See accompanying notes to Consolidated Financial Statements.
4
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Consolidated Statements
of Shareholders' Equity
(Expressed in thousands of United States Dollars, except for number of shares)
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2003 2002 2001
----------------- ----------------- -----------------
Ordinary Shares:
Beginning of year 25,000,000 25,000,000 18,568,440
Shares issued - - 6,431,560
----------------- ----------------- -----------------
End of year 25,000,000 25,000,000 25,000,000
================= ================= =================
Share capital
Beginning of year $ 250 $ 250 $ 186
Shares issued - - 64
----------------- ----------------- -----------------
End of year 250 250 250
----------------- ----------------- -----------------
Additional paid-in capital
Beginning of year 420,081 250,249 250,313
Shares issued - - (64)
Capital contributed by parent 294,811 169,832 -
----------------- ----------------- -----------------
End of year 714,892 420,081 250,249
----------------- ----------------- -----------------
Accumulated other comprehensive
gain (loss)
Beginning of year 6,451 (3,626) (3,822)
Unrealized appreciation on
investments 9,507 10,077 196
----------------- ----------------- -----------------
End of year 15,958 6,451 (3,626)
----------------- ----------------- -----------------
Retained earnings
Beginning of year 37,182 33,232 25,821
Net income 2,538 3,950 7,411
----------------- ----------------- -----------------
End of year 39,720 37,182 33,232
----------------- ----------------- -----------------
Total shareholders' equity $ 770,820 $ 463,964 $ 280,105
================= ================= =================
See accompanying notes to Consolidated Financial Statements.
5
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Consolidated Statements
of Cash Flows
(Expressed in thousands of United States Dollars)
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2003 2002 2001
------------------ ----------------- -----------------
Operating activities
Income before cumulative effect of change
in accounting principle $ 22,075 $ 3,950 $ 7,817
Items not affecting cash:
Net realized losses 7,396 4,852 3,883
Changes in value of embedded derivatives 13,903 - -
Amortization of investments 4,090 (381) (1,484)
Amortization of deferred acquisition costs 58,002 28,138 11,094
Changes in assets and liabilities:
Accrued interest (6,692) (1,732) (19)
Reinsurance balances and risk fees (13,731) 14,684 (38,273)
receivables and payables
Deferred acquisition costs (154,192) (121,194) (93,646)
Deferred tax benefit (17,389) (2,309) (1,293)
Due to/ from related party (34,178) 58,002 1,403
Other assets and liabilities (26,140) 3,628 873
Interest sensitive contract liabilities, 25,546 16,260 9,485
net of funds withheld at interest
Reserve for future policy benefits 148,076 (16,378) 131,626
Accounts payable and accrued expenses 21,348 (141) 137
Current income tax payable (1,732) 1,229 1,351
Other 5,617 (1,254) (1,899)
------------------ ----------------- -----------------
Net cash provided by (used in) operating 51,999 (12,646) 31,055
activities ------------------ ----------------- -----------------
Investing Activities
Purchase of fixed maturity investments (1,167,247) (662,691) (309,373)
Proceeds from sales of fixed maturity 275,374 176,930 297,337
investments
Proceeds from maturity of fixed maturity 190,222 111,795 86,135
investments
Purchase of preferred stock (82,717) - -
Proceeds from sale of preferred stock 2,263 - -
Proceeds from maturity of preferred stock 5,137 - -
Cost of acquisition of subsidiary net of (140,228) - -
cash acquired
(Purchase) sale of other investments (640) 5,598 (17,741)
------------------ ----------------- -----------------
Net cash provided by (used in) investing (917,836) (368,368) 56,358
activities ------------------ ----------------- -----------------
Financing activities
Deposits to interest sensitive contract 736,884 320,338 83,137
liabilities
Withdrawals from interest sensitive (40,782) (27,627) (200,751)
contract liabilities
Issuance of long term debt 29,047 17,500 -
Capital contributed from parent 294,811 169,832 -
Borrowings - (65,145) 65,145
------------------ ----------------- -----------------
Net cash provided by (used in) financing 1,019,960 414,898 (52,469)
activities ------------------ ----------------- -----------------
Net change in cash and cash equivalents 154,123 33,884 34,944
Cash and cash equivalents, beginning of year 116,298 82,414 47,470
------------------ ----------------- -----------------
Cash and cash equivalents, end of year $ 270,421 $ 116,298 $ 82,414
================== ================= =================
See accompanying notes to Consolidated Financial Statements.
6
Notes to Consolidated Financial Statements
(Stated in thousands of United States Dollars)
1. Organization, business and basis of presentation
Organization
Scottish Annuity & Life Insurance Company (Cayman) Ltd. was incorporated as an
exempted company with limited liability on June 3, 1998 under the laws of the
Cayman Islands. We are a wholly owned subsidiary of Scottish Re Group Limited
(formerly Scottish Annuity & Life Holdings, Ltd.), a holding company organized
under the laws of the Cayman Islands with its principal executive office in
Bermuda. Scottish Re Group Limited is quoted on the New York Stock Exchange. On
July 8, 1998, we received an unrestricted Class "B" insurer's license under the
insurance laws of the Cayman Islands. During 2002, we obtained an insurance
permit to operate in Bermuda.
We are a reinsurer of life insurance, annuities and annuity-type products. These
products are written by life insurance companies and other financial
institutions located principally in the United States, as well as around the
world. Scottish Re (Dublin) Limited, one of our subsidiaries, assumes business
from an affiliate, Scottish Re Limited, a U.K. reinsurance company specializing
in niche markets in developed countries and broader life reinsurance markets in
the developing world. We refer to this portion of our business as Life
Reinsurance. To a lesser extent, we directly issue variable life insurance and
variable annuities and similar products to high net worth individuals and
families for insurance, investment and estate planning purposes. This business
and other revenues and expenses not related to Life Reinsurance are reported in
the Other segment. We have operating companies in Bermuda, the Cayman Islands,
Ireland, and the United States.
Business
Life Reinsurance
In our Life Reinsurance business, we provide solutions to insurance companies
seeking reinsurance of life insurance, annuities and annuity-type products. We
reinsure lines of business that may be subject to significant reserve or capital
requirements by regulatory and rating agencies.
We assume risks associated with primary life insurance policies and annuities,
both in force and new business. We reinsure: (i) mortality, (ii) investment,
(iii) persistency, and (iv) expense risks. We originate reinsurance business
predominantly by marketing our products and services directly to U.S. life
insurance and reinsurance companies.
Wealth Management
In our Wealth Management business, we directly issue variable life insurance and
variable annuities and similar products to high net worth individuals and
families, for insurance, investment and estate planning purposes. For us, high
net worth generally means individuals and families with a liquid net worth in
excess of $10 million. Variable life insurance and variable annuities have a
cash value component that is placed in a separate account and invested by us on
behalf of the policyholder with a money manager. Through our Bermuda and Cayman
Islands insurance companies, we have the flexibility to offer policies that
permit the use of private independent money managers to manage the separate
accounts. The money managers can utilize investment strategies not typically
available in variable insurance products issued to the general public.
Basis of presentation
Accounting Principles--Our consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and all amounts are reported in thousands of United States
dollars (except per share amounts). Certain items in the prior year financial
statements have been reclassified to conform with the current year presentation.
7
Consolidation--We consolidate the results of all our subsidiaries. All
significant intercompany transactions and balances have been eliminated on
consolidation. Prior period results have been reclassified to conform to the
current year presentation.
Estimates, risks and uncertainties--The preparation of consolidated financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the amounts reported on the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. Our most significant assumptions are for assumed reinsurance
liabilities and deferred acquisition costs. We review and revise these estimates
as appropriate. Any adjustments made to these estimates are reflected in the
period the estimates are revised.
Certain prior period amounts have been reclassified to conform to the current
year presentation.
2. Summary of significant accounting policies
The following are our significant accounting policies.
A. Fixed maturity investments
Fixed maturities are classified as available for sale, and accordingly, we carry
these investments at fair values on our consolidated balance sheets. The fair
value of fixed maturities is calculated using quoted market prices provided by
independent pricing services. The cost of fixed maturities is adjusted for
prepayments and the amortization of premiums and discounts. The unrealized
appreciation (depreciation) is the difference between fair value and amortized
cost and is recorded directly to equity with no impact to net income. The change
in unrealized appreciation (depreciation) is included in accumulated other
comprehensive income (loss) in shareholders' equity. Investment transactions are
recorded on the trade date with balances pending settlement reflected in the
balance sheet as a component of other assets or other liabilities. Interest is
recorded on the accrual basis.
Short-term investments are carried at cost, which approximates fair value.
Realized gains (losses) on securities are determined on a specific
identification method. We track the cost of each security purchased so that we
are able to identify and record a gain or loss when it is subsequently sold. In
addition, declines in fair value that are determined to be other than temporary
are included in realized gains (losses) in the consolidated statements of
income. Realized gains and losses are stated net of associated amortization of
deferred acquisition costs.
EITF Issue No. 99-20, "Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial Assets"
("EITF 99-20"), applies to all securities, purchased or retained, which
represent beneficial interests in securitized assets, unless they meet certain
exception criteria. Such securities include many collateralized mortgage, bond,
debt and loan obligations (CMO, CBO, CDO, and CLO), mortgage-backed securities
and asset-backed securities. Under EITF 99-20, a decline in fair value below the
"amortized cost" basis is considered to be an other than temporary impairment
whenever there is an adverse change in the amount or timing of cash flows to be
received, regardless of the resulting yield, unless the decrease is solely a
result of changes in market interest rates. Interest income is based on
prospective estimates of future cash flows.
EITF 99-20 is effective for fiscal quarters beginning after March 15, 2001. We
reviewed all applicable securities held at June 30, 2001 and identified a
required write down in the amount of $406,000. This is shown in the consolidated
statements of income as a cumulative effect of change in accounting principle.
Management reviews securities with material unrealized losses and tests for
other than temporary impairments on a quarterly basis. Factors involved in the
determination of potential impairment include fair value as compared to cost,
length of time the value has been below cost, credit worthiness of the issuer,
forecasted financial performance of the issuer, position of the security in the
issuer's capital structure, the presence and estimated value of collateral or
other credit enhancement, length of time to maturity, interest rates and our
intent and ability to hold the security until the market value recovers.
8
When a decline is considered to be "other than temporary" a realized loss is
incurred and the cost basis of the impaired asset is adjusted to its fair value.
B. Cash and cash equivalents
Cash and cash equivalents include fixed deposits with an original maturity, when
purchased, of three months or less. Cash and cash equivalents are recorded at
face value, which approximates fair value.
C. Funds withheld at interest
Funds withheld at interest are funds held by ceding companies under modified
coinsurance and coinsurance funds withheld agreements whereby we receive the
interest income earned on the funds. The balance of funds held represents the
statutory reserves of the ceding company. These agreements are considered to
include embedded derivatives as further discussed in Note 2M.
D. Revenue recognition
(i) Reinsurance premiums from traditional life policies and annuity
policies with life contingencies are generally recognized as revenue
when due from policyholders. Traditional life policies include those
contracts with fixed and guaranteed premiums and benefits, and consist
principally of whole life and term insurance policies. Our premiums
earned are recorded in accordance with information received from our
ceding companies, or are estimated where this information is not
current with the reporting period. These premium estimates are based
on historical experience as adjusted for current treaty terms and
other information. Actual results could differ from these estimates.
Management monitors actual experience, and should circumstances
warrant, will revise its estimates of premiums earned.
Benefits and expenses are matched with such income so as to result in
the recognition of profits over the life of the contracts. This
is achieved by means of the provision for liabilities for future
policy benefits and deferral and subsequent amortization of
policy acquisition costs.
From time to time we acquire blocks of in-force business and account
for these transactions as purchases. Results of operations only
include the revenues and expenses from the respective dates of
acquisition of these blocks of in-force business. The initial
transfer of assets and liabilities are recorded on the balance
sheet.
Reinsurance assumed on annuity business does not generate premiums but
generates investment income over time on the assets we receive
from ceding companies.
(ii) Fee income is recorded on an accrual basis.
(iii)Investment income is reported on an accrual basis after deducting the
related investment manager's fees.
(iv) Realized capital gains and losses include gains and losses on the sale
of investments available for sale and fixed assets and amounts
recognized for other than temporary impairments on fixed maturities.
Realized capital gains and losses are stated net of associated
amortization of deferred acquisition costs.
E. Deferred acquisition costs
Costs of acquiring new business, which vary with and are primarily related to
the production of new business, have been deferred to the extent that such costs
are deemed recoverable from future premiums or gross profits. Such costs include
commissions and allowances as well as certain costs of policy issuance and
underwriting. We perform periodic tests to determine that the cost of business
acquired remains recoverable, and the cumulative amortization is re-estimated
and adjusted by a cumulative charge or credit to current operations.
9
Deferred acquisition costs related to traditional life insurance contracts,
substantially all of which relate to long-duration contracts, are amortized over
the premium-paying period of the related policies in proportion to the ratio of
individual period premium revenues to total anticipated premium revenues over
the life of the policy. Such anticipated premium revenues are estimated using
the same assumptions used for computing liabilities for future policy benefits.
Deferred acquisition costs related to interest-sensitive life and
investment-type policies are amortized over the lives of the policies, in
relation to the present value of estimated gross profits from mortality,
investment income, and expense margins.
The development of and amortization of deferred acquisition costs for our
products requires management to make estimates and assumptions. Actual results
could differ materially from those estimates. Management monitors actual
experience, and should circumstances warrant, will revise its assumptions and
the related estimates.
F. Fixed assets and leasehold improvements
Fixed assets include leasehold improvements, furniture and fittings and computer
equipment. They are recorded at cost and are depreciated over their estimated
useful lives ranging between 1 and 5 years on a straight-line basis. Accumulated
depreciation at December 31, 2003 and 2002 amounted to $3.2 million and $1.8
million, respectively.
G. Reserves for future policy benefits
The development of policy reserves for our products requires management to make
estimates and assumptions regarding mortality, lapse, expense and investment
experience. Interest rate assumptions for individual life reinsurance reserves
range from 2.5 to 7.0%. The interest assumptions for immediate and deferred
annuities range from 4.0 to 6.5%.
These estimates are based primarily on historical experience and information
provided by ceding companies. Actual results could differ materially from those
estimates. Management monitors actual experience, and where circumstances
warrant, revises the assumptions and the related reserve estimates.
For traditional life policies, future benefits are estimated using a net level
premium method on the basis of actuarial assumptions as to mortality,
persistency and interest established at policy issue. Assumptions established at
policy issue as to mortality and persistency are based on anticipated
experience, which, together with interest and expense assumptions, provide a
margin for adverse deviation. If the liabilities for future policy benefits plus
the present value of expected future gross premiums for a product are
insufficient to provide for expected future benefits and expenses for that
product, deferred acquisition costs will be written off and thereafter, if
required, a premium deficiency reserve will be established by a charge to
income.
H. Interest sensitive contract liabilities
The liabilities for interest sensitive contract liabilities equal the
accumulated account values of the policies or contracts as of the valuation date
and include funds received plus interest credited less funds withdrawn and
interest paid. Benefit liabilities for fixed annuities during the accumulation
period equal their account values; after annuitization, they equal the
discounted present value of expected future payments.
I. Income taxes
Income tax liability and deferred tax assets are recorded in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 109. In accordance with
this statement we record deferred income taxes that reflect the net tax effect
of the temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. A valuation allowance is applied to deferred tax assets where the
recoverability is uncertain.
10
J. Segregated assets
Separate account investments are in respect of wealth management clients and
include the net asset values of the underlying funds plus separate cash and cash
equivalent balances less separate account fees payable to us. The funds in the
separate accounts are not part of our general funds and are not available to
meet our general obligations. The assets and liabilities of these transactions
move in tandem. The client bears the investment risk on the account and we
receive an asset-based fee for providing this service that is recorded as fee
income.
K. Segregated liabilities
Separate account liabilities include amounts set aside to pay the deferred
variable annuities and the cash values associated with life insurance policies.
These balances consist of the initial premiums paid after consideration of the
net investment gains/losses attributable to each separate account, less fees and
withdrawals.
L. Fair value of financial instruments
The fair value of assets and liabilities included on the consolidated balance
sheets which qualify as financial instruments under SFAS No. 107 "Disclosure
About Fair Value of Financial Instruments", approximate the carrying amount
presented in the consolidated financial statements.
M. Derivatives
Our funds withheld at interest arise on modified coinsurance and funds withheld
coinsurance transactions. Derivatives Implementation Group Issue No. B36
"Embedded Derivatives: Bifurcation of a Debt Instrument that Incorporates Both
Interest Rate and Credit Rate Risk Exposures that are Unrelated or Only
Partially Related to the Creditworthiness of the Issuer of that Instrument"
indicates that these transactions contain embedded derivatives. The embedded
derivative feature in our funds withheld treaties is similar to a fixed-rate
total return swap on the assets held by the ceding companies. The swap consists
of two parts. The first is the market value of the underlying asset portfolio
and the second is a hypothetical loan to the ceding company. The hypothetical
loan is based on the expected cash flows of the underlying reinsurance
liability. We have developed models to systematically estimate the value of the
total return swap. The fair value of the embedded derivative is affected by
changes in expected cash flows, credit spreads of the assets and changes in
"risk-free" interest rates. The change in fair value is included in our
calculation of estimated gross profits and, therefore, also affects the
amortization of deferred acquisition costs. In addition to our quota share
indemnity funds withheld contracts, we have entered into various financial
reinsurance treaties that, although considered funds withheld, do not transfer
significant insurance risk and are recorded on a deposit method of accounting.
As a result of the experience refund provisions of these treaties the value of
the embedded derivative is currently considered immaterial.
We adopted DIG B36 on October 1, 2003. The initial adoption has resulted in a
loss, after tax and after related amortization of deferred acquisition costs of
$19.5 million. This has been recorded as a cumulative effect of change in
accounting principle in our consolidated statement of income for the year ended
December 31, 2003. The change in fair value of the derivative between October 1,
2003 and December 31, 2003 was a gain of $13.9 million, net of related
amortization of deferred acquisition costs. The fair value of the derivative of
$9.3 million at December 31, 2003 is included in other assets.
3. Business Acquisitions
On December 22, 2003, we completed the purchase of 95% of Scottish Re Life
Corporation (formerly ERC Life) for $151.0 million in cash subject to certain
post closing adjustments. The adjustments are dependant on the completion of the
audit of the 2003 financial statements of Scottish Re Life Corporation prepared
in accordance with U.S. statutory accounting principles. We have estimated the
post closing adjustment at approximately $20.0 million on the basis of
information currently available. There was no goodwill arising on the
acquisition. The balance sheet of Scottish Re Life Corporation at the date of
acquisition is as follows:
11
December 22, 2003
-----------------
Fixed maturity investments.......................... $ 263,301
Funds withheld at interest.......................... 204,256
Cash and other investments.......................... 106,656
-----------------
574,213
Reinsurance balances receivable..................... 105,242
Amounts recoverable from reinsurers................. 713,248
Other assets........................................ 45,370
-----------------
Total assets........................................ $ 1,438,073
=================
Reserves for future policy benefits................. $ 951,899
Interest sensitive contract liabilities............. 177,485
Reinsurance balances payable........................ 108,894
Other liabilities................................... 15,141
-----------------
Total liabilities................................... $ 1,253,419
=================
The following pro forma information related to our acquisition of Scottish Re
Life Corporation for the years ended December 31, 2003 and 2002 illustrates the
effects of the acquisition as if it had occurred at the beginning of the years
presented.
Year Ended Year Ended
December 31, 2003 December 31, 2002
----------------- -----------------
Revenue............................. $ 768,223 $ 473,032
Net Income.......................... $ 67,663 $ 29,127
The acquisitions described above were accounted for by the purchase method of
accounting. In accordance with APB Opinion No. 16, "Business Combinations," the
accompanying consolidated statements of income do not include any revenues or
expenses related to this acquisition prior to the closing date.
4. Business Segments
We report segments in accordance with SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information". The segment reporting for the lines
of business is as follows:
Year Ended December 31, 2003
----------------------------
Life
Reinsurance Other Total
----------- ----- -------
Premiums earned...................... $ 266,086 $ - $ 266,086
Investment income, net............... 133,542 4,073 137,615
Realized gains (losses).............. (8,554) 1,158 (7,396)
Change in value of embedded derivative 13,904 - 13,904
Fee income........................... 4,067 1,993 6,060
----------- ----- -------
Total revenues.................... 409,045 7,224 416,269
----------- ----- -------
Claims and other policy benefits..... 192,857 - 192,857
Interest credited to interest
sensitive contract liabilities....... 89,020 - 89,020
Acquisition costs and other insurance
expenses, net........................ 90,300 1,471 91,771
Operating expenses................... 21,617 11,064 32,681
Interest expense..................... 1,110 134 1,244
----------- ----- -------
Total benefits and expenses....... 394,904 12,669 407,573
----------- ----- -------
Income (loss) before income taxes and
minority interest.................... $ 14,141 $(5,445) $ 8,696
========= ======== =========
12
Year Ended December 31, 2002
-------------------------------------
Life Reinsurance Other Total
---------------- ------ -------
Premiums earned..................... $ 129,046 $ - $ 129,046
Investment income, net.............. 96,108 3,504 99,612
Realized losses..................... (4,833) (19) (4,852)
Fee income.......................... 3,148 1,372 4,520
-------- ----- -------
Total revenues................... 223,469 4,857 228,326
-------- ----- -------
Claims and other policy benefits.... 96,059 - 96,059
Interest credited to interest
sensitive contract liabilities...... 48,140 - 48,140
Acquisition costs and other insurance
expenses, net....................... 48,960 2,245 51,205
Operating expenses.................. 26,515 5,893 32,408
Interest expense.................... 84 644 728
-------- ----- -------
Total benefits and expenses...... 219,758 8,782 228,540
-------- ----- -------
Income (loss) before income taxes and
minority interest................... $ 3,711 $ (3,925) $ (214)
========= ======== =========
Year Ended December 31, 2001
----------------------------
Life Reinsurance Other Total
---------------- ----- -----
Premiums earned.................... $ 68,344 $ - $ 68,344
Investment income, net............. 43,036 7,535 50,571
Realized gains (losses)............ (4,500) 618 (3,882)
Fee income......................... 1,685 1,003 2,688
-------- ------- --------
Total revenues.................. 108,565 9,156 117,721
-------- ------- --------
Claims and other policy benefits... 51,245 - 51,245
Interest credited to interest
sensitive contract liabilities..... 17,578 - 17,578
Acquisition costs and other
insurance expenses, net............ 23,411 602 24,013
Operating expenses................. 11,114 4,561 15,675
Interest expense................... - 1,405 1,405
-------- ------- --------
Total benefits and expenses..... 103,348 6,568 109,916
-------- ------- --------
Income (loss) before income taxes
and minority interest.............. $ 5,217 $ 2,588 $ 7,805
========= ======== =========
December 31, December 31,
Assets 2003 2002
----------- ------------
Life Reinsurance.................... $4,937,190 $2,299,494
Other...................... 490,205 388,315
---------- ----------
Total...................... $5,427,395 $2,687,809
========== ==========
13
5. Foreign sales and operations
Our operations include Bermuda, the Cayman Islands, Ireland and the United
States.
Financial information relating to geographic areas:
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
----------------- ----------------- -----------------
Revenues
U.S. business........ $378,285 $208,532 $ 91,020
Non-U.S. business.... 37,984 19,794 26,701
-------- -------- --------
Total................ $416,269 $228,326 $117,721
======== ======== ========
6. Investments
The amortized cost, gross unrealized appreciation and depreciation, and
estimated fair values of our fixed maturity investments are as follows:
December 31, 2003
-------------------------------------------------------------------
Gross Gross
Unrealized Unrealized Estimated Fair
Amortized Cost Appreciation Depreciation Value
-------------- ------------ ------------ -------------
U.S. Treasury securities and U.S.
government agency obligations $ 57,386 $ 376 $ (338) $ 57,424
Corporate securities 978,489 22,881 (3,106) 998,264
Mortgage and asset backed securities 798,507 10,165 (9,868) 798,804
---------- -------- ---------- ----------
$1,834,382 $ 33,422 $ (13,312) $1,854,492
========== ======== ========== ==========
December 31, 2002
-------------------------------------------------------------------
Gross Gross
Unrealized Unrealized Estimated
Amortized Cost Appreciation Depreciation Fair Value
-------------- ------------ ------------ -------------
U.S. Treasury securities and U.S.
government agency obligations $ 12,943 $ 864 $ - $ 13,807
Corporate securities 424,883 14,285 (5,244) 433,924
Mortgage and asset backed securities 436,837 10,139 (10,821) 436,155
---------- -------- ---------- ----------
$ 874,663 $ 25,288 $ (16,065) $ 883,886
========== ======== ========== ==========
The contractual maturities of the fixed maturities are as follows (actual
maturities may differ as a result of calls and prepayments):
December 31, 2003
Amortized Estimated
Cost Fair Value
Due in one year or less ................... $ 37,162 $ 37,550
Due in one year through five years......... 322,833 331,972
Due in five years through ten years........ 560,524 569,015
Due after ten years........................ 115,356 117,151
------------ -----------
1,035,875 1,055,688
Mortgage and asset backed securities....... 798,507 798,804
------------ -----------
$1,834,382 $1,854,492
============ ===========
14
Gross realized gains and losses are as follows:
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
Proceeds from sale of investments.... $ 275,816 $ 176,930 $ 297,337
==================== =================== =================
Gross realized gains................. $ 7,082 $ 7,942 $ 5,160
Gross realized losses (1)............ (12,460) (12,788) (9,065)
-------------------- ------------------- ------------------
Net realized losses.................. (5,378) (4,846) (3,905)
Other gains and (losses)............. (2,018) (6) 22
-------------------- ------------------- ------------------
Realized losses...................... $ (7,396) $ (4,852) $ (3,883)
==================== =================== ==================
(1) Includes $6.3 million, $10.0 million and $4.0 million in 2003, 2002 and
2001, respectively in respect of fixed maturity investments written down to
estimated realizable values and $2.9 million, $2.5 million and $2.9 million
in 2003, 2002 and 2001 respectively in respect of modified coinsurance
receivables written down to estimated realizable values.
At December 31, 2003 and 2002, we did not have a material concentration of
investments in fixed income securities in a single issuer, industry or
geographic location.
The following tables provide information on the length of time securities have
been continuously in an unrealized loss position:
December 31, 2003
------------------------------------------------------------------------------------
Days Book Estimated Unrealized
Value % Fair Value % Loss %
--------------- -------- --------------- -------- --------------- -------
Dollars in thousands
0-90.................... $ 281,107 56.7% $ 277,556 57.6% $ (3,551) 26.1%
91-180.................. 92,053 18.6 90,229 18.7 (1,824) 13.4
181-270................. 52,236 10.5 51,220 10.6 (1,016) 7.5
271-360................. 11,100 2.2 10,751 2.2 (349) 2.6
Greater than 360........ 58,975 12.0 52,102 10.9 (6,873) 50.4
--------------- -------- --------------- -------- --------------- -------
Total................... $ 495,471 100.0% $ 481,858 100.0% $ (13,613) 100.0%
=============== ======== =============== ======== =============== =======
December 31, 2002
------------------------------------------------------------------------------------
Estimated Fair Unrealized
Days Book Value % Value % Loss %
--------------- -------- --------------- -------- --------------- -------
Dollars in thousands
0-90.................... $ 77,150 36.9% $ 75,062 38.9% $ (2,088) 13.0%
91-180.................. 53,663 25.7 50,082 25.9 (3,581) 22.3
181-270................. 19,463 9.3 16,080 8.3 (3,383) 21.1
271-360................. 7,227 3.5 6,212 3.2 (1,015) 6.3
Greater than 360........ 51,578 24.6 45,579 23.7 (5,998) 37.3
--------------- -------- --------------- -------- --------------- -------
Total................... $209,081 100.0% $ 193,015 100.0% $ (16,065) 100.0%
=============== ======== =============== ======== =============== =======
7. Funds withheld at interest
At December 31, 2003, funds withheld at interest were in respect of six fixed
annuity reinsurance contracts with three ceding companies. At December 31, 2002
we had four fixed annuity reinsurance contracts with two ceding companies. We
had three contracts with Lincoln National Insurance Company that accounted for
$1.3 billion at December 31, 2003 and $1.1 billion at December 31, 2002, which
represented 86% and 98% of the funds withheld balances. The other contracts were
with Illinois Mutual Insurance Company and American Founders Life Insurance
Company. Lincoln National Insurance Company has financial strength ratings of
"A+" from A.M. Best, "AA-" from Standard & Poor's, "Aa3" from Moody's and "AA"
from Fitch. In the event of insolvency of the ceding companies on these
arrangements we would need to exert a claim on the assets supporting the
contract liabilities.
15
However, the risk of loss is mitigated by our ability to offset amounts owed to
the ceding company with the amounts owed to us by the ceding company.
According to data provided by our ceding companies, the amortized cost, gross
unrealized appreciation and depreciation and estimated fair values of assets,
excluding cash, backing our funds withheld at interest at December 31, 2003 and
2002 are as follows:
December 31, 2003
----------------------------------------------------------------------
Gross Gross
Unrealized Unrealized Estimated Fair
Amortized Cost Appreciation Depreciation Value
----------------- --------------- ---------------- ------------------
U.S. Treasury securities and U.S.
government agency obligations.......... $ 31,577 $ 526 $ (144) $ 31,959
Corporate securities..................... 970,157 77,966 (2,074) 1,046,049
Municipal bonds.......................... 22,481 835 (248) 23,068
Mortgage and asset backed securities..... 318,151 12,254 (1,482) 328,923
----------------- --------------- ---------------- ------------------
1,342,366 91,581 (3,948) 1,429,999
Commercial mortgage loans................ 120,178 9,694 (496) 129,376
----------------- --------------- ---------------- ------------------
Total.................................... $ 1,462,544 $ 101,275 $ (4,444) $ 1,559,375
================= =============== ================ ==================
December 31, 2002
----------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated Fair
Cost Appreciation Depreciation Value
----------------- --------------- ---------------- ------------------
U.S. Treasury securities and U.S.
government agency obligations......... $ 10,230 $ 343 $ - $ 10,573
Corporate securities.................... 778,251 56,377 (12,468) 822,160
Municipal bonds......................... 501 8 - 509
Mortgage and asset backed securities.... 201,887 11,364 (101) 213,150
----------------- --------------- ---------------- ------------------
990,869 68,092 (12,569) 1,046,392
Commercial mortgage loans............... 101,360 10,908 - 112,268
----------------- --------------- ---------------- ------------------
Total................................... $ 1,092,229 $ 79,000 $(12,569) $ 1,158,660
================= =============== ================ ==================
According to data provided by our ceding companies, the contractual maturities,
excluding cash, of the assets backing our funds withheld fixed maturities are as
follows (actual maturities may differ as a result of calls and prepayments):
December 31, 2003
-------------------------------
Estimated
Amortized Cost Fair Value
--------------- --------------
Due in one year or less............................... $ 10,582 $ 10,938
Due in one year through five years.................... 268,943 288,941
Due in five years through ten years................... 665,959 720,158
Due after ten years................................... 78,731 81,039
--------------- --------------
1,024,215 1,101,076
Mortgage and asset backed securities.................. 318,151 328,923
--------------- --------------
Total ................................................ $1,342,366 $1,429,999
=============== ==============
16
8. Reinsurance ceded
Premiums earned are analyzed as follows:
Year ended Year ended Year ended
December 31, December 31, December 31,
2003 2002 2001
------------- ------------- -------------
Premiums assumed..................................... $279,612 $150,198 $90,239
Premiums ceded....................................... (13,526) (21,152) (21,895)
------------- ------------- -------------
Premiums earned...................................... $266,086 $129,046 $68,344
============= ============= =============
Reinsurance contracts do not relieve us from our obligations to policyholders.
Failure of reinsurers to honor their obligations could result in losses to us.
We evaluate the financial condition of our reinsurers to minimize our exposure
to losses from reinsurer insolvencies. Claims and other policy benefits are net
of reinsurance recoveries of $4.4 million, $0.4 million and $0.1 million during
the years ended December 31, 2003, 2002 and 2001.
9. Reinsurance transactions
The following table summarizes the acquisitions of in-force reinsurance
transactions completed by us during 2002 and 2001. There were no acquisitions of
in-force reinsurance transactions in 2003. These transactions are accounted for
as purchases. Our results of operations include the effects of these purchases
only from the respective acquisition dates.
December 31, 2002 December 31, 2001
----------------- -----------------
Fair value of assets acquired................. $ 18,222 $107,353
Deferred acquisition costs.................... 4,600 11,000
----------------- -----------------
Fair value of assets acquired................. $ 22,822 $118,353
================= =================
Fair value of liabilities assumed............. $ 22,822 $118,353
================= =================
10. Deferred acquisition costs
The change in deferred acquisition costs is as follows:
December 31, December 31, December 31,
2003 2002 2001
-------------- -------------- --------------
Balance at beginning of year ............ $206,530 $113,474 $ 30,922
Expenses deferred........................ 154,192 124,875 81,153
Amortization expense..................... (58,002) (28,338) (11,094)
Deferred acquisition costs on in-force
reinsurance transactions purchased....... - 4,600 11,000
Deferred acquisition costs on realized
losses................................... 2,129 (8,081) 1,493
-------------- -------------- --------------
Balance at end of year .................. $304,849 $206,530 $113,474
============== ============== ==============
11. Related parties
The amount due from/ to related party represents amounts owed from/ to Scottish
Re Group Limited. The amounts outstanding are unsecured and interest-free. The
amounts due relate to fees paid by us and our subsidiaries for net worth
maintenance, investment management and other corporate services. These fees
amounted to $29.0 million, $25.4 million, and $11.5 million in the years ended
December 31, 2003, 2002 and 2001 respectively.
Included in net premiums earned is $35.4 million of premiums ceded by Scottish
Re Limited, an affiliated company (2002 - $6.3 million).
17
12. Long term debt
Capital securities
On December 4, 2002, Scottish Holdings Statutory Trust I, a Connecticut
statutory business trust ("Capital Trust") issued and sold in a public offering
$17.5 million Capital Floating Rate Capital Securities ("the capital
securities"). All of the common shares of the Capital Trust are owned by
Scottish Holdings, Inc., our wholly owned subsidiary.
The capital securities mature on December 4, 2032. They are redeemable in whole
or in part at any time after December 4, 2007. Interest is payable quarterly at
a rate equivalent to 3 month LIBOR plus 4%. At December 31, 2003 the interest
rate was 5.15%. Prior to December 4, 2007 interest cannot exceed 12.5%. The
Capital Trust may defer payment of the interest for up to 20 consecutive
quarterly periods, but no later than December 4, 2032. Any deferred payments
would accrue interest quarterly on a compounded basis if Scottish Holdings, Inc.
defers interest on the Debentures due December 4, 2032 (as defined below).
The sole assets of the Capital Trust consist of $18.0 million principal amount
of Floating Rate Debentures (the "Debentures") issued by Scottish Holdings, Inc.
The Debentures mature on December 4, 2032 and interest is payable quarterly at a
rate equivalent to 3 month LIBOR plus 4%. At December 31, 2003 the interest rate
was 5.15%. Prior to December 4, 2007 interest cannot exceed 12.5%. Scottish
Holdings, Inc. may defer payment of the interest for up to 20 consecutive
quarterly periods, but no later than December 4, 2032. Any deferred payments
would accrue interest quarterly on a compounded basis. Scottish Holdings, Inc.
may redeem the Debentures at any time after December 4, 2007 in the event of
certain changes in tax or investment company law.
We have guaranteed Scottish Holdings, Inc.'s obligations under the Debentures,
and distributions and other payments due on the capital securities.
Preferred trust securities
On October 29, 2003, Scottish Holdings, Inc. Statutory Trust II, a Connecticut
statutory business trust ("Capital Trust II") issued and sold in a private
offering of $20.0 million Preferred Trust Securities ("the preferred trust
securities"). All of the common shares of Capital Trust II are owned by Scottish
Holdings, Inc.
The preferred trust securities mature on October 29, 2033. They are redeemable
in whole or in part at any time after October 29, 2003. Interest is payable
quarterly at a rate equivalent to 3 month LIBOR plus 3.95%. At December 31,
2003, the interest rate was 5.10%. Prior to October 29, 2008, interest cannot
exceed 12.45%. Capital Trust II may defer payment of the interest for up to 20
consecutive quarterly periods, but no later than October 29, 2033. Any deferred
payments would accrue interest quarterly on a compounded basis if Scottish
Holdings, Inc. defers interest on the Floating Rate Debentures due October 29,
2033 (as described below).
The sole assets of Capital Trust II consist of $20.6 million principal amount of
Floating Rate Debentures (the "Floating Rate Debentures") issued by Scottish
Holdings, Inc. The Floating Rate Debentures mature on October 29, 2033 and
interest is payable quarterly at 3 month LIBOR plus 3.95%. At December 31, 2003
the interest rate was 5.10%. Prior to October 29, 2008, interest cannot exceed
12.45%. Scottish Holdings, Inc. may defer payment of the interest for up to 20
consecutive quarterly periods, but no later than October 29, 2033. Any deferred
payments would accrue interest quarterly on a compounded basis. Scottish
Holdings, Inc. may redeem the Floating Rate Debentures at any time after October
29, 2008 and in the event of certain changes in tax or investment company law.
We have guaranteed Scottish Holdings, Inc.'s obligations under the Floating Rate
Debentures and distributions and other payments due on the preferred trust
securities.
Trust Preferred Securities
On November 14, 2003, GPIC Holdings Inc. Statutory Trust, a Delaware statutory
business trust ("GPIC Trust") issued and sold in a private offering of $10.0
million Trust Preferred Securities ("the trust preferred securities"). All of
the common shares of GPIC Trust are owned by Scottish Holdings, Inc.
18
The trust preferred securities mature on September 30, 2033. They are redeemable
in whole or in part at any time after September 30, 2008. Interest is payable
quarterly at a rate equivalent to 3 month LIBOR plus 3.90%. At December 31,
2003, the interest rate was 5.05%. GPIC Trust may defer payment of the interest
for up to 20 consecutive quarterly periods, but no later than September 30,
2033. Any deferred payments would accrue interest quarterly on a compounded
basis if Scottish Holdings, Inc. defers interest on the Junior Subordinated
Notes due September 30, 2033 (as described below).
The sole assets of GPIC Trust consist of $10.3 million principal amount of
Junior Subordinated Notes (the "Notes") issued by Scottish Holdings, Inc. The
Notes mature on September 30, 2033 and interest is payable quarterly at 3 month
LIBOR plus 3.90%. At December 31, 2003 the interest rate was 5.05%. Scottish
Holdings, Inc. may defer payment of the interest for up to 20 consecutive
quarterly periods, but no later than September 30, 2033. Any deferred payments
would accrue interest quarterly on a compounded basis. Scottish Holdings, Inc.
may redeem the Notes at any time after September 30, 2008 and in the event of
certain changes in tax or investment company law.
We have guaranteed Scottish Holdings, Inc.'s obligations under the Notes and
distribution and other payments due on the trust preferred securities.
13. Shareholders' equity
We are authorized to issue 100,000,000 ordinary shares of par value $0.01 each.
As at December 31, 2003 and 2002, 25,000,000 ordinary shares were outstanding.
During the years ended December 31, 2003 and 2002 Scottish Re Group Limited
contributed capital of $294.8 million and $169.8 million, respectively.
14. Employee benefit plans
We provide retirement benefits for all employees under defined contribution
plans. Defined contribution plan expense totaled $343,000, $380,000 and $232,000
for the years ended December 31, 2003, 2002 and 2001, respectively.
15. Taxation
There is presently no taxation imposed on income or capital gains by the
Governments of the Bermuda and the Cayman Islands. Our Bermuda companies have
been granted an exemption from taxation in Bermuda until 2016. If any taxation
were to be enacted in the Cayman Islands, we have been granted an exemption
therefrom until 2018. These companies operate in a manner such that they will
owe no United States tax other than premium excise taxes and withholding taxes
on certain investment income.
Undistributed earnings of our foreign subsidiaries are considered to be
indefinitely reinvested and, accordingly, no provision for U.S. federal
withholding taxes has been provided thereon. Upon distribution of current or
accumulated earnings and profits in the form of dividends or otherwise, we would
be subject to U.S. withholding taxes at a 5% rate.
At December 31, 2003, we had net operating loss carryforwards of approximately
$168.4 million (2002 - $83.8 million) for income tax purposes that expire in
years 2012 through 2018. These carryforwards resulted primarily from our 1999
acquisition of Scottish Re (U.S.), Inc. and from current operations of Scottish
Re (U.S.), Inc.
19
Significant components of our deferred tax assets and liabilities are as
follows:
December 31, 2003 December 31, 2002
------------------- -------------------
Deferred tax assets:
Net operating losses................................. $61,077 $28,968
Reserves for future policy benefits.................. 13,656 -
Unrealized depreciation on investments............... 231 -
Negative proxy deferred acquisition costs............ 1,816 389
Other................................................ 2,654 1,194
------------------- -------------------
Total deferred tax assets.................................... 79,434 30,551
------------------- -------------------
Deferred tax liabilities:
Unrealized appreciation on investments............... (8,387) (4,432)
Deferred acquisition costs........................... (21,300) (11,919)
Reserves for future policy benefits.................. (16,835) (6,844)
Other................................................ (861) (187)
------------------- -------------------
Total deferred tax liabilities....................... (47,383) (23,382)
------------------- -------------------
Net deferred tax asset....................................... $32,051 $ 7,169
=================== ===================
For the years ended December 31, 2003 and 2002 we have income tax benefit
(expense) from operations as follows:
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
------------------- ------------------- -------------------
Current tax expense................... $ (175) $(1,727) $(1,350)
Deferred tax benefit.................. 13,616 5,891 1,292
------------------- ------------------- -------------------
Total tax benefit (expense) .......... $13,441 $ 4,164 $ (58)
=================== =================== ===================
Income tax benefit (expense) attributable to continuing operations differ from
the amount of income tax benefit (expense) that would result from applying the
federal statutory rates to pretax income from operating due to the following:
Year Ended Year Ended Year Ended
December 31, 2003 December 31, 2002 December 31, 2001
------------------- ------------------- -------------------
Pretax GAAP income at 34%..................... $ (2,956) $ 73 $ (2,654)
Income not subject to tax at 34%.............. 14,352 6,383 3,410
Foreign taxes................................. (772) (1,727) (1,265)
Negative DAC ................................. 1,427 (695) (61)
Other......................................... 1,390 130 512
------------------- ------------------- -------------------
Tax benefit $ 13,441 $ 4,164 $ (58)
=================== =================== ===================
16. Statutory requirements and dividend restrictions
Our Bermuda insurance companies are required to maintain a minimum capital of
$0.25 million. Under The Insurance Law of the Cayman Islands, Scottish Annuity &
Life Insurance Company (Cayman) Ltd. must maintain a minimum net capital worth
of $0.24 million.
The maximum amount of dividends that can be paid by Scottish Re (U.S.), Inc. (a
Delaware domiciled insurance company) without prior approval of the Insurance
Commissioner is subject to restrictions relating to statutory surplus and
operating earnings. The maximum dividend payment that may be made without prior
approval is limited to the greater of the net gain from operations for the
preceding year or 10% of statutory capital and surplus as of December 31 of the
preceding year. The statutory surplus of Scottish Re (U.S.), Inc. at December
31, 2003 was $52.0 million (2002 - $52.1 million). The maximum dividend that
could be paid in 2003 without prior approval is $5.2 million (2002- $5.2
million). Scottish Re (U.S.), Inc.'s net assets which are restricted by the
above are $172.4 million (2002 - $119.2 million).
20
The maximum amount of dividends that can be paid by Scottish Re Life Corporation
(a Missouri domiciled insurance company) without prior approval of the Director
of Insurance in any twelve month period is subject to restrictions relating to
statutory surplus and operating earnings. The maximum dividend payment that may
be made without prior approval is limited to the greater of the net gain from
operations for the preceding year or 10% of policyholders surplus, as of
December 31 of the preceding year, provided however, that dividends may be paid
only from earned surplus, although the Director of Insurance may permit the
payment of dividends from other than earned surplus. The statutory surplus of
Scottish Re Life Corporation at December 31, 2003 was $143.8 million. As a
result of previously paid dividends, however, Scottish Re Life Corporation had
negative unassigned surplus at December 31, 2003. Thus, the permission of the
Director must be sought for the payment of any dividend in 2004. Scottish Re
Life Corporation intends to seek the Director's approval to restate unassigned
surplus to zero pursuant to the certain reorganization provisions.
The National Association of Insurance Commissioners prescribes risk-based
capital (``RBC'') requirements for U.S. domiciled life and health insurance
companies. As of December 31, 2003 and 2002, Scottish Re (U.S.), Inc. exceeded
all minimum RBC requirements.
17. Commitments and contingencies
Credit facilities
During 2003, we renewed our credit facilities, which currently consist of:
(a) a credit facility totaling $50.0 million, of which $25.0 million
is available on an unsecured basis and $25.0 million is available
on a secured basis. The facility provides capacity for borrowings
and letters of credit. The interest rates on amounts borrowed
under the secured facility is LIBOR plus 50 basis points and
under the unsecured facility is LIBOR plus 75 basis points. This
facility expires in October 2004 but it is renewable upon the
agreement of both parties.
(b) a secured credit facility totaling $50.0 million. This facility
provides a combination of borrowings and letters of credit.
Interest rates on amounts borrowed under this facility is LIBOR
plus 45 basis points. This facility expires in September 2004 but
is renewable upon the agreement of both parties.
One of the facilities requires that Scottish Annuity & Life Insurance Company
(Cayman) Ltd. maintains shareholders' equity of at least $340.0 million. At
December 31, 2003, Scottish Annuity & Life Insurance Company (Cayman) Ltd's
shareholders' equity was $770.8 million. The other facility requires that
Scottish Re Group Limited maintain consolidated net worth of $520.0 million, a
maximum debt to total capitalization ratio of 30% and uncollateralized assets of
1.2 times any unsecured borrowings. At December 31, 2003, Scottish Re Group
Limited's net worth was $659.8 million and the ratio of debt to total
capitalization was 16.9%. Our failure to comply with the requirements of the
credit facilities would, subject to grace periods, result in an event of
default, and we could be required to repay any outstanding borrowings. At
December 31, 2003, there were no borrowings under the facilities. Outstanding
letters of credit under these facilities amounted to $31.2 million (2002 - $9.1
million).
We also have a reverse repurchase agreement with a major broker/dealer. Under
this agreement, we have the ability to sell agency mortgage backed securities
with the agreement to repurchase them at a fixed price, providing the dealer
with a spread that equates to an effective borrowing cost linked to one-month
LIBOR. This agreement is renewable monthly at the discretion of the
broker/dealer. At December 31, 2003 and December 31, 2002, there were no
borrowings under this agreement.
Lease commitments
Scottish Annuity & Life Insurance Company (Cayman) Ltd. and its subsidiaries
lease office space in the countries in which they conduct business under
operating leases that expire at various dates through 2012. Total rent expense
with respect to these operating leases for the years ended December 31, 2003,
2002 and 2001 were approximately $548,000, $485,000, and $694,000 respectively.
21
Future minimum lease payments under the leases, are expected to be:
Year ending December 31
- -----------------------------------------------------------------------
2004.................................................... $ 594
2005.................................................... 534
2006.................................................... 483
2007.................................................... 483
2008.................................................... 483
Later years............................................. 1,932
----------
Total future lease commitments.......................... $ 4,509
==========
Legal proceedings
In the normal course of our business, we and our subsidiaries are occasionally
involved in litigation. The ultimate disposition of such litigation is not
expected to have a material adverse effect on our financial condition, liquidity
or results of operations.
22
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Consolidated Balance
Sheets--September 30, 2004 (Unaudited) and December 31, 2003
(Dollars in thousands)
September 30, 2004 December 31,
(unaudited) 2003
------------------ ------------------
ASSETS
Fixed maturity investments, available for sale, at fair value
(Amortized cost $2,621,940; 2003 - $1,834,382)................ $2,652,770 $1,854,492
Preferred stock, available for sale, at fair value (Cost
$124,663; 2003 -$125,460)..................................... 125,082 126,449
Cash and cash equivalents..................................... 155,311 270,421
Other investments............................................. 16,398 17,664
Funds withheld at interest.................................... 1,477,870 1,469,425
------------------ ------------------
Total investments........................................ 4,427,431 3,738,451
Accrued interest receivable................................... 19,499 18,845
Reinsurance balances and risk fees receivable................. 193,499 156,323
Due from related parties 2,152 20,011
Deferred acquisition costs.................................... 406,437 304,849
Amount recoverable from reinsurers............................ 676,601 713,248
Present value of in-force business............................ 27,320 -
Fixed assets.................................................. 4,258 4,627
Current income tax receivable................................. 7,755 -
Other assets.................................................. 10,161 35,953
Deferred tax benefit.......................................... 30,724 32,051
Segregated assets............................................. 466,075 403,037
------------------ ------------------
Total assets............................................. $6,271,912 $5,427,395
================== ==================
LIABILITIES
Reserves for future policy benefits........................... $1,451,037 $1,393,220
Interest sensitive contract liabilities....................... 3,136,931 2,633,346
Structured finance facility liability......................... 200,000 -
Accounts payable and accrued expenses......................... 18,446 26,305
Reinsurance balances payable.................................. 81,502 122,188
Other liabilities............................................. 22,072 9,571
Current income tax payable.................................... - 12,113
Long term debt................................................ 79,500 47,500
Segregated liabilities........................................ 466,075 403,037
------------------ ------------------
Total liabilities........................................ 5,455,563 4,647,280
------------------ ------------------
MINORITY INTEREST............................................. 9,535 9,295
SHAREHOLDERS' EQUITY
Share capital, par value $0.01 per share:
Issued and fully paid: 25,000,000 ordinary shares.......... 250 250
Additional paid-in capital.................................... 718,525 714,892
Accumulated other comprehensive income........................ 23,560 15,958
Retained earnings............................................. 64,479 39,720
------------------ ------------------
Total shareholders' equity............................... 806,814 770,820
------------------ ------------------
Total liabilities and shareholders' equity............... $6,271,912 $5,427,395
================== ==================
See Accompanying Notes to Unaudited Consolidated Financial Statements
23
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Unaudited Consolidated
Statements of Income - Nine months ended September 30, 2004 and 2003
(Dollars in thousands, except per share data)
Nine Months ended
--------------------------------------
September 30, 2004 September 30, 2003
------------------ ------------------
REVENUES
Premiums earned............................................... $368,072 $180,156
Investment income, net........................................ 151,329 98,605
Fee income.................................................... 7,496 5,798
Realized losses............................................... (3,635) (4,708)
Change in value of embedded derivatives....................... 456 -
------------------ ------------------
Total revenues........................................... 523,718 279,851
------------------ ------------------
BENEFITS AND EXPENSES
Claims and other policy benefits.............................. 278,263 131,037
Interest credited to interest sensitive contract liabilities.. 77,342 65,925
Acquisition costs and other insurance expenses, net........... 105,180 61,340
Operating expenses............................................ 40,317 22,623
Interest expense.............................................. 2,892 812
------------------ ------------------
Total benefits and expenses.............................. 503,994 281,737
------------------ ------------------
Income (loss) before income taxes and minority interest....... 19,724 (1,886)
Income tax benefit ............................................. 5,390 8,190
------------------ ------------------
Income before minority interest............................... 25,114 6,304
Minority interest............................................. (355) -
------------------ ------------------
Net income $ 24,759 $ 6,304
================== ==================
See Accompanying Notes to Unaudited Consolidated Financial Statements
24
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Unaudited Consolidated
Statements of Comprehensive Income - Nine months ended September 30, 2004 and
2003
(Dollars in thousands)
Nine Months ended
--------------------------------
September 30, September 30,
2004 2003
-------------- ---------------
Net income................................. $ 24,759 $ 6,304
-------------- ---------------
Other comprehensive income, net of tax:
Unrealized appreciation on investments: 9,511 14,965
Add: reclassification adjustment for
investment losses included in net income (1,909) (1,463)
-------------- ---------------
Unrealized appreciation on investments net
of income tax expense of $1,028 and $85... 7,602 13,502
-------------- ---------------
Comprehensive income...................... $ 32,361 $ 19,806
============== ===============
See Accompanying Notes to Unaudited Consolidated Financial Statements
25
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Unaudited Consolidated
Statements of Shareholders' Equity - Nine months ended September 30, 2004 and
2003
(Dollars in thousands)
Nine months ended
--------------------------------------------
September 30, 2004 September 30, 2003
--------------------- ----------------------
ORDINARY SHARES:
Beginning and end of period...................... 25,000,000 25,000,000
===================== ======================
SHARE CAPITAL:
Beginning and end of period...................... $ 250 $ 250
ADDITIONAL PAID-IN CAPITAL:
Beginning of period.............................. 714,892 420,081
Capital contributed by parent.................... 3,633 145,649
--------------------- ----------------------
End of period.................................... 718,525 565,730
--------------------- ----------------------
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Unrealized appreciation on investments
Beginning of period.............................. 15,958 6,451
Change in period (net of tax).................... 7,602 13,502
--------------------- ----------------------
End of period.................................... 23,560 19,953
--------------------- ----------------------
RETAINED EARNINGS:
Beginning of period.............................. 39,720 37,182
Net income....................................... 24,759 6,304
--------------------- ----------------------
End of period.................................... 64,479 43,486
--------------------- ----------------------
TOTAL SHAREHOLDERS' EQUITY............................ $ 806,814 $ 629,419
===================== ======================
See Accompanying Notes to Unaudited Consolidated Financial Statements
26
Scottish Annuity & Life Insurance Company (Cayman) Ltd. Unaudited Consolidated
Statements of Cash Flows - Nine months ended September 30, 2004 and 2003
(Dollars in thousands)
Nine months ended
------------------------------------------
September 30, 2004 September 30, 2003
-------------------- --------------------
OPERATING ACTIVITIES
Net income ................................................... $ 24,759 $ 6,304
Items not affecting cash:
Realized losses.......................................... 3,635 4,708
Change in value of embedded derivatives.................. (456) -
Amortization of investments.............................. 7,001 2,773
Amortization of deferred acquisition costs............... 54,216 35,747
Amortization of present value of in-force business....... 2,536 -
Changes in assets and liabilities:
Accrued interest..................................... (654) (3,969)
Reinsurance balances and risk fees receivable........ (110,253) 10,905
Deferred acquisition costs........................... (156,420) (107,639)
Deferred tax liability............................... (11,106) (8,926)
Other assets......................................... 16,219 10,621
Current income tax receivable and payable............ (22,932) (692)
Reserves for future policy benefits.................. 129,752 110,106
Interest sensitive contract liabilities, net of
funds withheld at interest........................... 35,741 12,111
Due from related parties 17,908 (26,254)
Accounts payable and accrued expenses................ (4,793) (329)
Other................................................ (2,957) (6,611)
-------------------- --------------------
Net cash (used in) provided by operating activities........... (17,804) 38,855
-------------------- --------------------
INVESTING ACTIVITIES
Purchase of fixed maturity investments........................ (1,514,420) (887,676)
Proceeds from sales of fixed maturity investments............. 479,478 187,155
Proceeds from maturity of investments......................... 241,381 149,720
Purchase of preferred stock................................... (23,662) (50,036)
Proceeds from sales of preferred stock........................ 18,605 453
Proceeds from maturity of preferred stock..................... 4,805 1,588
Other......................................................... 1,635 (1,057)
-------------------- --------------------
Net cash used in investing activities......................... (792,178) (599,853)
-------------------- --------------------
FINANCING ACTIVITIES
Issuance of long term debt.................................... 32,000 -
Proceeds from structured finance liability.................... 200,000 -
Deposits to interest sensitive contract liabilities........... 518,451 449,185
Withdrawals from interest sensitive contract liabilities...... (59,211) (27,635)
Capital contributed by parent................................. 3,632 145,649
-------------------- --------------------
Net cash provided by financing activities..................... 694,872 567,199
-------------------- --------------------
Net change in cash and cash equivalents....................... (115,110) 6,201
Cash and cash equivalents, beginning of period................ 270,421 116,298
-------------------- --------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 155,311 $ 122,499
==================== ====================
See Accompanying Notes to Unaudited Consolidated Financial Statements
27
Notes to Unaudited Consolidated Financial Statements - September 30, 2004
1. Basis of presentation
Accounting Principles--The accompanying unaudited consolidated financial
statements have been prepared in accordance with generally accepted accounting
principles in the United States of America ("GAAP") and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. The results for the period are not necessarily indicative of the
results to be expected for the entire year.
Consolidation--We consolidate the results of all our subsidiaries and all
variable interest entities for which we are the primary beneficiary. All
significant intercompany transactions and balances have been eliminated on
consolidation.
Estimates, risks and uncertainties--The preparation of consolidated financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the amounts reported on the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. Our most significant assumptions are for assumed reinsurance
liabilities and deferred acquisition costs. We review and revise these estimates
as appropriate. Any adjustments made to these estimates are reflected in the
period the estimates are revised.
All tabular amounts are reported in thousands of United States dollars (except
per share amounts).
Certain prior period amounts have been reclassified to conform to the current
year presentation.
2. New Accounting Pronouncements
In July 2003, the Accounting Standards Executive Committee issued Statement of
Position 03-01 ("SOP"), "Accounting and Reporting by Insurance Enterprises for
Certain Nontraditional Long-Duration Insurance Contracts and for Separate
Accounts". This SOP provides guidance on accounting and reporting by insurance
enterprises for certain nontraditional long-duration contracts and for separate
accounts and is effective for financial statements for fiscal years beginning
after December 15, 2003. In implementing the SOP we have made various
determinations, such as qualification for separate account treatment,
classification of securities in separate account arrangements, significance of
mortality and morbidity risk, adjustments to contract holder liabilities, and
adjustments to estimated gross profits as defined in Statement of Financial
Accounting Standards ("SFAS") No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments". Implementation of this SOP has not had a
material effect on our financial statements.
Effective December 31, 2003, we adopted the disclosure requirements of Emerging
Issues Task Force 03-1 ("EITF 03-1") "The Meaning of Other-Than-Temporary
Impairments and Its Application to Certain Investments". This EITF provides
guidance on disclosures for other than temporary impairments of debt and
marketable equity investments that have been accounted for under SFAS No. 115
"Accounting for Certain Investments in Debt and Equity Securities". During the
quarter ended September 30, 2004 the effective date of the application of EITF
03-1 for debt securities that are impaired because of interest rate and/or
sector spread increases was delayed pending issuance of further guidance.
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" ("FIN 46"). FIN 46 provides a framework for
identifying variable interest entities and determining when a company should
include its assets, liabilities, non-controlling interests and results of
activities in the consolidated financial statements. A variable interest entity
is a legal structure used to conduct activities or hold assets that either (1)
has an insufficient amount of equity to carry out its principal activities
without additional subordinated financial support, (2) has a group of equity
owners that are unable to make significant decisions about its activities, or
(3) has a group of equity owners that do not have the
28
obligation to absorb losses or the right to receive returns generated by its
operations. FIN 46 requires a variable interest entity to be consolidated if a
party with an ownership, contractual or other financial interest in the variable
interest entity is obligated to absorb a majority of the risk of loss from the
variable interest entity's activities, is entitled to receive a majority of the
variable interest entity's residual returns, or both. A variable interest holder
that consolidates the variable interest entity is called the primary
beneficiary. We have adopted FIN 46 in respect of the structured finance
facility discussed in note 7. We hold no interests in unconsolidated variable
interest entities.
3. Business acquisitions
On October 18, 2004, we announced that we had agreed to acquire the individual
life reinsurance business of ING. On December 31, 2004 we closed this
acquisition. We have reinsured the liabilities of all of ING's individual life
reinsurance business through a coinsurance transaction. ING has transferred to
us assets equal to reserves of approximately $800.0 million and paid us a ceding
commission of $560.0 million. These assets will be held in trust to secure the
reserve obligations of the business. Additionally, ING has transferred certain
operating assets associated with the business. We now have approximately $1.0
trillion of face amount of life reinsurance in-force, $8.8 billion in assets and
$2.1 billion in revenues.
In addition to the assets to be transferred by ING, Scottish Re Group Limited
raised an additional $230.0 million in new capital, which will satisfy the
capital requirements for the acquired business. This new capital includes $180.0
million provided by The Cypress Group, a private equity firm, and an additional
$50.0 million of trust preferred securities.
On December 22, 2003, we completed the acquisition of 95% of the outstanding
capital stock of ERC Life Reinsurance Corporation for $151.0 million in cash,
subject to certain post closing adjustments. During the quarter ended September
30, 2004, we agreed and settled the post closing adjustment at $18.9 million,
resulting in a final acquisition cost of $169.9 million. There was no goodwill
arising on the acquisition. The present value of in-force of the business
acquired was $29.9 million.
ERC has requested a refund of $8.0 million in respect of a settlement of a tax
liability. We have disputed ERC's right to this refund. In the event that ERC
are successful in their request, the present value of in-force business would
increase to $37.8 million. On February 19, 2004, ERC Life Reinsurance
Corporation's name was changed to Scottish Re Life Corporation.
4. Business segments
We report segments in accordance with SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information".
Nine months ended September 30, 2004
-------------------------------------------------------
Life Reinsurance Other Total
------------------ ---------------- -----------------
Premiums earned...................................... $ 368,072 $ - $ 368,072
Investment income, net............................... 150,540 789 151,329
Fee income........................................... 5,795 1,701 7,496
Realized (losses) gains.............................. (1,315) (2,320) (3,635)
Change in value of embedded derivatives.............. 456 - 456
------------------ ---------------- -----------------
Total revenues....................................... 523,548 170 523,718
------------------ ---------------- -----------------
Claims and other policy benefits..................... 278,263 - 278,263
Interest credited to interest sensitive contract
liabilities....................................... 77,342 - 77,342
Acquisition costs and other insurance expenses, net.. 104,187 993 105,180
Operating expenses................................... 28,677 11,640 40,317
Interest expense..................................... 2,892 - 2,892
------------------ ---------------- -----------------
Total benefits and expenses.......................... 491,361 12,633 503,994
------------------ ---------------- -----------------
Income (loss) before income taxes and minority
interest.......................................... $ 32,187 $ (12,463) $ 19,724
================== ================ =================
29
Nine months ended September 30, 2003
------------------------------------------------------
Life Reinsurance Other Total
------------------ --------------- ---------------
Premiums earned.......................... $180,156 $ - $180,156
Investment income, net................... 95,595 3,010 98,605
Fee income............................... 4,524 1,274 5,798
Realized (losses) gains.................. (5,342) 634 (4,708)
------------------ --------------- ---------------
Total revenues........................... 274,933 4,918 279,851
------------------ --------------- ---------------
Claims and other policy benefits......... 131,037 - 131,037
Interest credited to interest sensitive
contract liabilities.................. 65,925 - 65,925
Acquisition costs and other insurance
expenses, net......................... 60,329 1,011 61,340
Operating expenses....................... 13,784 8,839 22,623
Interest expense......................... 812 - 812
------------------ --------------- ---------------
Total benefits and expenses.............. 271,887 9,850 281,737
------------------ --------------- ---------------
Loss before income taxes and minority
interest.............................. $ 3,046 $ (4,932) $ (1,886)
================== =============== ================
Assets September 30, 2004 December 31, 2003
- ------ ---------------------- -----------------------
Life Reinsurance......................... $5,784,746 $4,937,190
Other.................................... 487,166 490,205
---------------------- -----------------------
Total.................................... $6,271,912 $5,427,395
====================== =======================
5. Derivatives
During the quarter ended September 30, 2004, we entered into an interest rate
swap contract in the amount of $100.0 million in relation to certain of our
investment assets not supporting reinsurance liabilities. This contract is
accounted for in accordance with SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 requires that all derivatives
be recognized as either assets or liabilities on the balance sheet and be
measured at fair value. This derivative has not been designated as a hedge. The
fair value of the swap at September 30, 2004 was a negative $2.2 million. This
loss of $2.2 million has been included in realized gains (losses) in the
statement of income.
6. Deferred acquisition costs
The change in deferred acquisition costs is as follows:
Nine months ended
---------------------------------
September 30, September 30,
2004 2003
---------------- ----------------
Balance beginning of period...................... $304,849 $206,530
Expenses deferred................................ 156,420 107,639
Amortization expense............................. (54,216) (35,747)
Deferred acquisition costs on realized gains
(losses)......................................... (616) 1,367
---------------- ----------------
Balance end of period....................... $406,437 $279,789
================ ================
7. Structured finance facility liability
On June 25, 2004, we closed a structured finance facility with HSBC Bank USA,
N.A. This facility provides $200.0 million that can be used to collateralize
reinsurance obligations under intercompany reinsurance agreements.
Simultaneously we entered into a total return swap with HSBC Bank USA, N.A.
under which we are entitled to the total return of the investment portfolio of
the trust established for this facility. In accordance with FIN 46 we are
considered to hold a beneficial interest in the trust, which is in turn
considered to be a variable interest entity. As a result, the trust has been
consolidated in these financial statements.
30
The assets of the variable interest entity have been recorded as fixed maturity
investments. Our consolidated income statements show the investment return of
the variable interest entity as investment income and the cost of the facility
in acquisition costs and other insurance expenses.
The creditors of the variable interest entity have no recourse against our
general assets.
8. Long-term debt
Long-term debt consists of:
September 30, 2004 December 31, 2003
------------------------ ------------------------
Capital securities due 2032................. $ 17,500 $ 17,500
Trust preferred securities due 2033......... 20,000 20,000
Trust preferred securities due 2033......... 10,000 10,000
Trust preferred securities due 2034......... 32,000 -
------------------------ ------------------------
Total....................................... $ 79,500 $ 47,500
======================== ========================
Capital securities due 2032
On December 4, 2002, Scottish Holdings Statutory Trust I, a Connecticut
statutory business trust (the "Capital Trust") issued and sold in a private
offering an aggregate of $17.5 million Floating Rate Capital Securities (the
"Capital Securities"). All of the common shares of the Capital Trust are owned
by Scottish Holdings, Inc., our wholly owned subsidiary.
The Capital Securities mature on December 4, 2032. They are redeemable in whole
or in part at any time after December 4, 2007. Interest is payable quarterly at
a rate equivalent to 3 month LIBOR plus 4%. At September 30, 2004 and December
31, 2003, the interest rates were 6.02% and 5.15%, respectively. Prior to
December 4, 2007, interest cannot exceed 12.5%. The Capital Trust may defer
payment of the interest for up to 20 consecutive quarterly periods, but no later
than December 4, 2032. Any deferred payments would accrue interest quarterly on
a compounded basis if Scottish Holdings, Inc. defers interest on the Debentures
due December 4, 2032 (as defined below).
The sole assets of the Capital Trust consist of $18.0 million principal amount
of Floating Rate Debentures (the "Debentures") issued by Scottish Holdings, Inc.
The Debentures mature on December 4, 2032 and interest is payable quarterly at a
rate equivalent to 3 month LIBOR plus 4%. At September 30, 2004 and December 31,
2003, the interest rates were 6.02% and 5.15%, respectively. Prior to December
4, 2007, interest cannot exceed 12.5%. Scottish Holdings, Inc. may defer payment
of the interest for up to 20 consecutive quarterly periods, but no later than
December 4, 2032. Any deferred payments would accrue interest quarterly on a
compounded basis. Scottish Holdings, Inc. may redeem the Debentures at any time
after December 4, 2007 in the event of certain changes in tax or investment
company law.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed Scottish
Holdings, Inc.'s obligations under the Debentures and distributions and other
payments due on the Capital Securities.
Trust preferred securities due 2033
On October 29, 2003, Scottish Holdings, Inc. Statutory Trust II, a Connecticut
statutory business trust ("Capital Trust II") issued and sold in a private
offering an aggregate of $20.0 million Preferred Trust Securities (the "Trust
Preferred Securities"). All of the common shares of Capital Trust II are owned
by Scottish Holdings, Inc.
The Trust Preferred Securities mature on October 29, 2033. They are redeemable
in whole or in part at any time after October 29, 2008. Interest is payable
quarterly at a rate equivalent to 3 month LIBOR plus 3.95%. At September 30,
2004 and December 31, 2003, the interest rates were 5.97% and 5.10%,
respectively. Prior to
31
October 29, 2008, interest cannot exceed 12.45%. Capital Trust II may defer
payment of the interest for up to 20 consecutive quarterly periods, but no later
than October 29, 2033. Any deferred payments would accrue interest quarterly on
a compounded basis if Scottish Holdings, Inc. defers interest on the 2033
Floating Rate Debentures due October 29, 2033 (as described below).
The sole assets of Capital Trust II consist of $20.6 million principal amount of
Floating Rate Debentures (the "2033 Floating Rate Debentures") issued by
Scottish Holdings, Inc. The 2033 Floating Rate Debentures mature on October 29,
2033 and interest is payable quarterly at 3 month LIBOR plus 3.95%. At September
30, 2004 and December 31, 2003, the interest rates were 5.97% and 5.10%,
respectively. Prior to October 29, 2008, interest cannot exceed 12.45%. Scottish
Holdings, Inc. may defer payment of the interest for up to 20 consecutive
quarterly periods, but no later than October 29, 2033. Any deferred payments
would accrue interest quarterly on a compounded basis. Scottish Holdings, Inc.
may redeem the 2033 Floating Rate Debentures at any time after October 29, 2008
and in the event of certain changes in tax or investment company law.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed Scottish
Holdings, Inc.'s obligations under the Floating Rate Debentures and
distributions and other payments due on the Trust Preferred Securities.
Trust preferred securities due 2033
On November 14, 2003, GPIC Holdings Inc. Statutory Trust, a Delaware statutory
business trust (the "GPIC Trust") issued and sold in a private offering an
aggregate of $10.0 million Trust Preferred Securities (the "2033 Trust Preferred
Securities"). All of the common shares of GPIC Trust are owned by Scottish
Holdings, Inc.
The 2033 Trust Preferred Securities mature on September 30, 2033. They are
redeemable in whole or in part at any time after September 30, 2008. Interest is
payable quarterly at a rate equivalent to 3 month LIBOR plus 3.90%. At September
30, 2004 and December 31, 2003, the interest rates were 5.92% and 5.05%,
respectively. GPIC Trust may defer payment of the interest for up to 20
consecutive quarterly periods, but no later than September 30, 2033. Any
deferred payments would accrue interest quarterly on a compounded basis if
Scottish Holdings, Inc. defers interest on the Junior Subordinated Notes due
September 30, 2033 (as described below).
The sole assets of the GPIC Trust consist of $10.3 million principal amount of
Junior Subordinated Notes (the "Junior Subordinated Notes") issued by Scottish
Holdings, Inc. The Junior Subordinated Notes mature on September 30, 2033 and
interest is payable quarterly at 3 month LIBOR plus 3.90%. At September 30, 2004
and December 31, 2003, the interest rates were 5.92% and 5.05%, respectively.
Scottish Holdings, Inc. may defer payment of the interest for up to 20
consecutive quarterly periods, but no later than September 30, 2033. Any
deferred payments would accrue interest quarterly on a compounded basis.
Scottish Holdings, Inc. may redeem the Junior Subordinated Notes at any time
after September 30, 2008 and in the event of certain changes in tax or
investment company law.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed Scottish
Holdings, Inc.'s obligations under the Junior Subordinated Notes and
distributions and other payments due on the 2033 Trust Preferred Securities.
Trust preferred securities due 2034
On May 12, 2004, Scottish Holdings, Inc. Statutory Trust III, a Connecticut
statutory business trust ("Capital Trust III") issued and sold in a private
offering an aggregate of $32.0 million Trust Preferred Securities (the "2034
Trust Preferred Securities"). All of the common shares of Capital Trust III are
owned by Scottish Holdings, Inc.
The 2034 Trust Preferred Securities mature on June 17, 2034. They are redeemable
in whole or in part at any time after June 17, 2009. Interest is payable
quarterly at a rate equivalent to 3 month LIBOR plus 3.80%. At September 30,
2004, the interest rate was 5.82%. Prior to June 17, 2009, interest cannot
exceed 12.50%. Capital Trust III may defer payment of the interest for up to 20
consecutive quarterly periods, but no later than June 17, 2034. Any deferred
payments would accrue interest quarterly on a compounded basis if Scottish
Holdings, Inc. defers interest on the 2034 Floating Rate Debentures due June 17,
2034 (as described below).
32
The sole assets of Capital Trust III consist of $33.0 million principal amount
of Floating Rate Debentures (the "2034 Floating Rate Debentures") issued by
Scottish Holdings, Inc. The 2034 Floating Rate Debentures mature on June 17,
2034 and interest is payable quarterly at 3 month LIBOR plus 3.80%. At September
30, 2004 the interest rate was 5.82%. Prior to June 17, 2009, interest cannot
exceed 12.50%. Scottish Holdings, Inc. may defer payment of the interest for up
to 20 consecutive quarterly periods, but no later than June 17, 2034. Any
deferred payments would accrue interest quarterly on a compounded basis.
Scottish Holdings, Inc. may redeem the 2034 Floating Rate Debentures at any time
after June 17, 2009 and in the event of certain changes in tax or investment
company law.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed Scottish
Holdings, Inc.'s obligations under the 2034 Floating Rate Debentures and
distributions and other payments due on the 2034 Trust Preferred Securities.
9. Shareholders' equity
During the nine months ended September 30, 2004 and 2003, we received capital
contributions of $3.6 million and $145.6 million, respectively.
10. Credit and collateral facilities
During 2003, we had two credit facilities, which consisted of:
a) a credit facility totaling $50.0 million, of which $25.0 million was
available on an unsecured basis and $25.0 million was available on a
secured basis. The facility provided capacity for borrowings and
letters of credit. The interest rate on amounts borrowed under the
secured facility was LIBOR plus 50 basis points and under the
unsecured facility was LIBOR plus 75 basis points. This facility was
scheduled to expire in October 2004 and was extended to December 31,
2004. This credit facility has been replaced by a facility entered
into on December 29, 2004, which is described below.
b) a secured credit facility totaling $50.0 million. This facility
provided a combination of borrowings and letters of credit. The
interest rate on amounts borrowed under this facility was LIBOR plus
45 basis points. This facility was scheduled to expire in September
2004 and was extended to December 31, 2004. This credit facility has
been replaced by a facility entered into on December 29, 2004, which
is described below
One of the facilities required that we maintain shareholders' equity of at least
$340.0 million. At September 30, 2004, our shareholders' equity was $806.8
million. The other facility required that Scottish Re Group Limited maintain
consolidated net worth of $520.0 million, a maximum debt to total capitalization
ratio of 30% and uncollateralized assets of 1.2 times any unsecured borrowings.
At September 30, 2004, Scottish Re Group Limited's net worth was $807 million
and the ratio of debt to total capitalization was 10%. At September 30, 2004,
there were no borrowings under the facilities. Outstanding letters of credit
under these facilities amounted to $33.8 million as at September 30, 2004 and
$31.2 million at December 31, 2003.
On December 29, 2004, we, Scottish Re (Dublin) Limited, Scottish Re (U.S.),
Inc., and Scottish Re Limited closed a $175 million, 364-day revolving credit
facility with a syndicate of banks led by Bank of America, N.A. The facility
provides capacity for borrowing and for extending letters of credit. The
proceeds from the facility will be used for working capital, capital
expenditures and general corporate purposes. The facility is a direct financial
obligation of each of the borrowers; however, we have guaranteed the payment of
obligations of Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc., and
Scottish Re Limited.
The facility may be increased to an aggregate principal amount of $200 million,
in which increase the lenders may, but are not obligated to, participate on a
pro rata basis. Standby letters of credit issued under the facility will be
unconditional, irrevocable and will have a maximum term of one year from the
date of issuance.
33
The facility will terminate and all amounts outstanding thereunder will be due
364 days from the closing date, unless the term out option is exercised. The
term out option may be exercised if there are no events of default under the
credit facility and if all representations and warranties are true and correct
as of the date of conversion.
The interest rate on each loan made under the facility, as determined by the
nature of the loan, will be at (i) the Federal Funds Rate plus 0.50%, (ii) the
prime rate as announced by Bank of America, N.A., or (iii) the British Bankers
Association LIBOR Rate plus an applicable margin. We may select interest periods
of 1, 2 or 3 months for LIBOR loans, subject to availability. Interest will be
payable at least quarterly, at the end of each interest period.
Under the terms of the facility, the following constitute events of default:
nonpayment of principal, interest, fees or other amounts due under any loan or
letter of credit obligation thereunder; failure to adhere to the terms of any
covenants contained therein; any material misstatement made in any
representation or warranty contained therein; default on any indebtedness or
guarantee in the amount of $10 million or more by us or any of our subsidiaries;
any attachment or levy against all or part of any of our property, if not
released within 30 days after such attachment or levy; the institution of
bankruptcy or insolvency proceedings, whether voluntary or involuntary; entry of
a final judgment against us or subsidiary for payment greater than a certain
threshold amount, or any non-monetary judgment that could reasonably be expected
to have, individually or in the aggregate, a material adverse effect; actual or
asserted invalidity of any loan documentation; a change of control; or customary
ERISA defaults. If an event of default occurs and is continuing, the entire
principal thereof and interest accrued thereon may be declared to be due and
payable immediately.
The facility requires that Scottish Annuity & Life Insurance Company (Cayman)
Ltd. maintain a minimum amount of shareholders' equity, a debt to capitalization
ratio of less than 20% and uncollateralized assets of 1.2 times borrowings. In
addition, the facility requires that Scottish Re Group Limited maintain a
minimum amount of shareholders' equity, and a debt to capitalization ratio of
less than 30%. The facility also requires that Scottish Re (U.S.), Inc. maintain
minimum capital and surplus equal to the greater of (i) $20 million or (ii) the
amount necessary to prevent a company action level event from occurring under
the risk based capital laws of Delaware.
We also have a reverse repurchase agreement with a major broker/dealer. Under
this agreement, we have the ability to sell agency mortgage backed securities
with the agreement to repurchase them at a fixed price, providing the dealer
with a spread that equates to an effective borrowing cost linked to one-month
LIBOR. This agreement is renewable monthly at the discretion of the
broker/dealer. At September 30, 2004 and December 31, 2003, there were no
borrowings under this agreement.
34