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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------
FORM 1O-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2006
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Transition period from _____ to _____
Commission File Number: 001-16855
SCOTTISH RE GROUP LIMITED
(Exact Name of Registrant as Specified in Its Charter)
Cayman Islands 98-0362785
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
P.O. Box HM 2939
Crown House, Second Floor
4 Par-la-Ville Road
Hamilton HMO8
Bermuda
(Address of Principal Executive Offices)
Not Applicable
(Zip Code)
(441) 295-4451
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year.
if changed since last report)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No
Indicate by checkmark whether the registrant is a large accelerated filer,
or a non-accelerated filer. See definition of "accelerated filer" and "large
accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes No [X]
As of November 6, 2006, the Registrant had 60,554,104 ordinary shares
outstanding.
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Table of Contents
PART I. FINANCIAL INFORMATION................................................2
Item 1. Financial Statements.................................................2
Consolidated Balance Sheets -- September 30, 2006
(unaudited) and December 31, 2005....................................2
Consolidated Statements of Income (Loss) -- Three and nine months
ended September 30, 2006 and 2005 (unaudited).........................3
Consolidated Statements of Comprehensive Income (Loss) -- Three
and nine months ended September 30, 2006 and 2005
(unaudited)...........................................................4
Consolidated Statements of Shareholders' Equity -- Nine
months ended September 30, 2006 and 2005 (unaudited)..................5
Consolidated Statements of Cash Flows -- Nine months ended
September 30, 2006 and 2005 (unaudited)...............................6
Notes to Consolidated Financial Statements (unaudited). ..............7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................22
Item 3. Quantitative and Qualitative Disclosures about
Market Risk..........................................................50
Item 4. Controls and Procedures..............................................51
PART II. OTHER INFORMATION....................................................52
Item 1. Legal Proceedings....................................................52
Item 2. Unregistered Sales of Equity Securities
and Use of Proceeds.................................................54
Item 3. Defaults upon Senior Securities.....................................55
Item 4. Submission of Matters to a Vote of Security Holders.................55
Item 5. Other Information...................................................55
Item 6. Exhibits............................................................55
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SCOTTISH RE GROUP LIMITED
CONSOLIDATED BALANCE SHEETS
(Expressed in Thousands of United States dollars, except share data)
September 30,
2006 December
(unaudited) 31, 2005
----------- --------
ASSETS
Fixed maturity investments, available for sale, at fair value
(Amortized cost $7,567,968; 2005 -- $5,323,488)............................... $ 7,526,756 $ 5,292,595
Preferred stock, available for sale, at fair value (Cost $134,037;
2005 -- $137,271)............................................................. 129,977 133,804
Cash and cash equivalents......................................................... 1,356,092 1,420,205
Other investments................................................................. 65,130 54,619
Funds withheld at interest........................................................ 2,076,097 2,597,416
------------ -----------
Total investments............................................................. 11,154,052 9,498,639
Accrued interest receivable....................................................... 59,767 44,012
Reinsurance balances and risk fees receivable..................................... 423,759 325,372
Deferred acquisition costs........................................................ 620,412 594,583
Amount recoverable from reinsurers................................................ 570,834 551,288
Present value of in-force business................................................ 51,471 54,743
Goodwill.......................................................................... 34,125 34,125
Other assets...................................................................... 172,072 87,198
Deferred tax assets............................................................... - 55,453
Segregated assets................................................................. 739,410 760,707
------------- -------------
Total assets.................................................................. $ 13,825,902 $ 12,006,120
============= =============
LIABILITIES
Reserves for future policy benefits............................................... $ 3,663,489 $ 3,477,222
Interest sensitive contract liabilities........................................... 3,582,687 3,907,573
Collateral finance facilities..................................................... 3,745,918 1,985,681
Accounts payable and other liabilities............................................ 101,862 83,130
Reinsurance balances payable...................................................... 260,101 114,078
Current income tax payable........................................................ 4,451 9,155
Deferred tax liabilty............................................................. 47,106 -
Long term debt.................................................................... 244,500 244,500
Segregated liabilities............................................................ 739,410 760,707
------------ ------------
Total liabilities................................................................. 12,389,524 10,582,046
------------ ------------
MINORITY INTEREST................................................................. 9,329 9,305
MEZZANINE EQUITY.................................................................. 143,512 143,057
SHAREHOLDERS' EQUITY
Ordinary shares, par value $0.01:
Issued: 60,554,104 shares (2005 -- 53,391,939)................................ 606 534
Preferred shares, par value $0.01:
Issued: 5,000,000 shares (2005 -- 5,000,000).................................. 125,000 125,000
Additional paid-in capital........................................................ 1,049,790 893,767
Accumulated other comprehensive loss.............................................. (6,068) (9,991)
Retained earnings ................................................................ 114,209 262,402
------------- -------------
Total shareholders' equity.................................................... 1,283,537 1,271,712
------------- -------------
Total liabilities, minority interest, mezzanine equity and
shareholders' equity.......................................................... $ 13,825,902 $ 12,006,120
============= =============
See Accompanying Notes to Consolidated Financial Statements (unaudited)
2
SCOTTISH RE GROUP LIMITED
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(UNAUDITED)
(Expressed in Thousands of United States dollars, except share data)
Three months ended Nine months ended
---------------------- ---------------------------
September September September September
30, 2006 30, 2005 30, 2006 30, 2005
--------- --------- ---------- ---------
Revenues
Premiums earned........................................... $ 453,521 $ 470,094 $ 1,347,484 $ 1,370,667
Investment income, net.................................... 162,408 92,132 439,407 256,165
Fee income................................................ 2,380 2,801 10,752 9,210
Realized gains (losses), net.............................. (1,072) 1,344 (25,971) 5,573
Change in value of embedded derivatives, net.............. (5,891) (2,631) 11,621 (19,266)
----------- ----------- ---------- ----------
Total revenues........................................ 611,346 563,740 1,783,293 1,622,349
----------- ----------- ---------- ----------
Benefits and expenses
Claims and other policy benefits.......................... 377,713 356,127 1,124,277 1,030,893
Interest credited to interest sensitive contract
liabilities........................................... 42,423 36,724 140,523 99,089
Acquisition costs and other insurance expenses,
net................................................... 86,241 91,214 278,644 305,350
Operating expenses........................................ 39,447 32,909 109,904 83,978
Collateral finance facilities expense..................... 67,323 13,230 145,646 32,471
Interest expense.......................................... 5,005 5,690 16,964 16,097
----------- ---------- ---------- ---------
Total benefits and expenses........................... 618,152 535,894 1,815,928 1,567,878
----------- ---------- ---------- ---------
Income (loss) before income taxes and minority
interest.............................................. (6,806) 27,846 (32,665) 54,471
Income tax benefit (expense).............................. (20,841) 6,677 (102,427) 15,232
----------- ---------- ---------- ---------
Income (loss) before minority interest.................... (27,647) 34,523 (135,092) 69,703
Minority interest......................................... 232 (113) (64) (282)
----------- ---------- ---------- ---------
Net income (loss)......................................... (27,415) 34,410 (135,156) 69,421
Dividend declared on non-cumulative perpetual preferred
shares................................................ (2,266) (2,492) (6,797) (2,492)
Imputed dividend on prepaid variable share forward
contract.............................................. (809) - (881) -
----------- ---------- ---------- ---------
Net income (loss) available to ordinary
shareholders.......................................... $ (30,490) $ 31,918 $ (142,834) $ 66,929
========== =========== =========== ==========
Earnings (loss) per ordinary share -- Basic .............. $ (0.54) $ 0.70 $ (2.61) $ 1.56
========== =========== =========== ==========
Earnings (loss) per ordinary share -- Diluted............. $ (0.54) $ 0.66 $ (2.61) $ 1.42
========== =========== =========== ==========
Dividends declared per ordinary share..................... $ - $ 0.05 $ 0.10 $ 0.15
========== =========== =========== ==========
Weighted average number of ordinary shares outstanding
Basic..................................................... 56,933,566 45,517,832 54,708,914 43,004,046
========== ========== ========== ==========
Diluted................................................... 56,933,566 48,543,262 54,708,914 47,080,247
========== ========== ========== ==========
See Accompanying Notes to Consolidated Financial Statements (unaudited)
3
SCOTTISH RE GROUP LIMITED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(Expressed in Thousands of United States dollars)
Three months ended Nine months ended
---------------------- ----------------------
September September September September
30, 2006 30, 2005 30, 2006 30, 2005
-------- -------- -------- --------
Net income (loss) ....................................... $ (27,415) $ 34,410 $(135,156) $ 69,421
Other comprehensive income (loss), net of tax:
Unrealized appreciation (depreciation) on investments ... 86,716 (44,580) (18,998) (18,393)
Add: reclassification adjustment for investment losses
(gains) included in net income ...................... 3,805 (21) 14,807 (1,360)
--------- -------- --------- --------
Net unrealized appreciation (depreciation) on investments
net of income tax benefit (expense) and deferred
acquisition costs of $(53,916), $34,056, $5,779, and
$23,173 ............................................. 90,521 (44,601) (4,191) (19,753)
Cumulative translation adjustment ....................... (790) (1,745) 8,114 (8,147)
--------- -------- --------- --------
Other comprehensive income (loss) ....................... 89,731 (46,346) 3,923 (27,900)
--------- -------- --------- --------
Comprehensive income (loss) ............................. $ 62,316 $ (11,936) $(131,233) $ 41,521
========= ======== ========= ========
See Accompanying Notes to Consolidated Financial Statements (unaudited)
4
SCOTTISH RE GROUP LIMITED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED)
(Expressed in Thousands of United States dollars, except share data)
Nine months ended
-----------------------------------
September 30, September 30,
2006 2005
------------- ---------------
Ordinary shares:
Beginning of period ......................................................... 53,391,939 39,931,145
Issuance to employees on exercise of options ................................ 583,217 318,900
Issuance on exercise of warrants ............................................ - 5,377,327
Ordinary shares issued ...................................................... 6,578,948 -
----------- ----------
End of period ............................................................... 60,554,104 45,627,372
=========== ==========
Preferred shares:
Beginning of period ......................................................... 5,000,000 -
Non-cumulative perpetual preferred shares issued ............................ - 5,000,000
----------- ----------
End of period ............................................................... 5,000,000 5,000,000
----------- ----------
Share capital:
Ordinary shares:
Beginning of period ......................................................... $ 534 $ 399
Issuance to employees on exercise of options ................................ 6 3
Issuance on conversion of warrants .......................................... - 54
Ordinary shares issued ...................................................... 66 -
----------- -----------
End of period ............................................................... 606 456
----------- -----------
Preferred shares:
Beginning of period ......................................................... 125,000 -
Non-cumulative perpetual preferred shares issued ............................ - 125,000
----------- -----------
End of period ............................................................... 125,000 125,000
----------- -----------
Additional paid-in capital:
Beginning of period ......................................................... 893,767 684,719
Ordinary shares issued ...................................................... 147,318 -
Conversion of 7.00% Convertible Junior Subordinated Notes ................... - 42,061
Issuance to employees on exercise of options ................................ 6,795 3,710
Option and restricted stock unit expense .................................... 1,483 3,871
Costs of issue of non-cumulative perpetual preferred shares ................. - (4,588)
Other ....................................................................... 427 -
----------- -----------
End of period ............................................................... 1,049,790 729,773
----------- -----------
Accumulated other comprehensive income (loss):
Unrealized depreciation on investments
Beginning of period ......................................................... (17,879) 13,661
Change in period (net of tax and deferred acquisition costs) ................ (4,191) (19,753)
----------- -----------
End of period ............................................................... (22,070) (6,092)
----------- -----------
Cumulative translation adjustment
Beginning of period ......................................................... 7,888 17,943
Change in period (net of tax) ............................................... 8,114 (8,147)
----------- -----------
End of period ............................................................... 16,002 9,796
----------- -----------
Total accumulated other comprehensive income (loss) ............................. (6,068) 3,704
----------- -----------
Retained earnings:
Beginning of period ......................................................... 262,402 145,952
Net income (loss) ........................................................... (135,156) 69,421
Dividends declared on ordinary shares ....................................... (5,359) (6,706)
Dividends declared on non-cumulative perpetual preferred shares ............. (6,797) (2,492)
Imputed dividend on prepaid variable share forward contract ................. (881) -
------------ -----------
End of period ............................................................... 114,209 206,175
------------ -----------
Total shareholders' equity ...................................................... $ 1,283,527 $ 1,065,108
============ ===========
See Accompanying Notes to Consolidated Financial Statements (unaudited)
5
SCOTTISH RE GROUP LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Expressed in Thousands of United States dollars)
Nine months ended
----------------------------
September 30, September 30,
2006 2005
------------ -------------
Operating activities
Net income (loss) .......................................................... $ (135,156) $ 69,421
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Net realized (gains) losses ............................................ 25,971 (5,572)
Change in value of embedded derivatives, net ........................... (11,621) 19,267
Amortization of discount on investments ................................ 12,270 13,900
Amortization of deferred acquisition costs ............................. 71,798 55,417
Amortization of present value of in-force business ..................... 3,278 5,362
Changes in assets and liabilities:
Accrued interest receivable ........................................ (14,539) (9,516)
Reinsurance balances and risk fees receivable ...................... 49,910 (12,731)
Deferred acquisition costs ......................................... (94,147) (134,515)
Deferred tax asset and liability ................................... 106,834 (4,149)
Other assets ....................................................... (65,490) (32,488)
Current income tax payable ......................................... (5,044) (8,910)
Reserves for future policy benefits, net of amounts recoverable from
reinsurers ...................................................... 111,264 298,279
Interest sensitive contract liabilities, net of funds withheld at ..
interest ........................................................ 452,891 58,113
Accounts payable and other liabilities ............................. 18,728 288
Other .............................................................. 5,845 12,045
------------ -------------
Net cash provided by operating activities .................................. 532,892 324,211
------------ -------------
Investing activities
Purchase of fixed maturity investments ..................................... (3,927,956) (2,551,109)
Proceeds from sales of fixed maturity investments .......................... 1,311,070 587,963
Proceeds from maturity of fixed maturity investments ....................... 377,652 373,996
Purchase of preferred stock investments .................................... (10,299) (36,736)
Proceeds from sales and maturity of preferred stock investments ............ 12,901 2,612
Purchase of other investments .............................................. (9,608) (33,358)
Other ...................................................................... (7,244) (4,237)
------------ -------------
Net cash used in investing activities ...................................... (2,253,484) (1,660,869)
------------ -------------
Financing activities
Proceeds from collateral finance facilities ................................ 1,760,237 850,000
Deposits to interest sensitive contract liabilities ........................ 122,194 157,881
Withdrawals from interest sensitive contract liabilities ................... (632,527) (96,808)
Proceeds from issuance of ordinary shares .................................. 153,731 3,767
Net proceeds from drawdown of Stingray facilty ............................. 265,000 -
Net proceeds from issuance of non-cumulative perpetual preferred shares .... - 120,412
Dividends paid on ordinary shares .......................................... (5,359) (6,706)
Dividends paid on perpetual preferred shares ............................... (6,797) -
------------ -------------
Net cash provided by financing activities .................................. 1,656,479 1,028,546
------------ -------------
Net change in cash and cash equivalents .................................... (64,113) (308,112)
Cash and cash equivalents, beginning of period ............................. 1,420,205 794,639
------------ -------------
Cash and cash equivalents, end of period ................................... $ 1,356,092 $ 486,527
============ =============
See Accompanying Notes to Consolidated Financial Statements (unaudited)
6
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
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 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 interim period are not necessarily indicative of
the results to be expected for the full year ending December 31, 2006. These
unaudited consolidated financial statements should be read in conjunction with
the consolidated financial statements and notes thereto included in our 2005
Annual Report on Form 10-K for the year ended December 31, 2005 ("2005 Annual
Report").
Consolidation -- We consolidate the results of all of 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
materially from those estimates and assumptions used by management. Our most
significant assumptions are for assumed reinsurance liabilities, premiums
receivable, deferred acquisition costs, realization of deferred tax assets and
valuation of investment impairments. 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 share and per share data, or as otherwise noted.
Certain prior period amounts have been reclassified to conform to the
current period presentation.
2. New accounting pronouncements
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes
In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes".
FIN 48 prescribes detailed guidance for the financial statement recognition,
measurement and disclosure of uncertain tax positions recognized in an
enterprise's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes." Tax positions must meet a "more likely than not"
recognition threshold at the effective date to be recognized upon the adoption
of FIN 48 and in subsequent periods.
FIN 48 will be effective for fiscal years beginning after December 15, 2006
and the provisions of FIN 48 will be applied to all tax positions upon initial
adoption. The cumulative effect of applying the provisions of FIN 48 will be
reported as an adjustment to the opening balance of retained earnings for that
fiscal year. We are currently evaluating the potential impact of FIN 48 on our
financial statements.
7
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
2. New accounting pronouncements (continued)
FASB Statement No. 156, Accounting for Servicing of Financial Assets -- an
amendment of FASB Statement No. 140
In March 2006, the FASB issued Statement No. 156 ("SFAS No. 156"),
"Accounting for Servicing of Financing Assets", which permits an entity to
choose either of the following measurement methods for each class of separately
recognized servicing assets and servicing liabilities:
o Amortization method -- amortize servicing assets or servicing
liabilities in proportion to and over the period of net servicing
income or net servicing loss and assess the servicing assets or
liabilities for impairment or increased obligation based on fair value
at each reporting date. This method is consistent with current
subsequent measurement guidance for servicing rights.
o Fair value measurement method -- measure servicing assets or servicing
liabilities at fair value at each reporting date and report changes in
fair value in earnings in the period in which the change occurs.
SFAS No. 156 is effective as of the beginning of an entity's first fiscal
year that begins after September 15, 2006. We are currently assessing the impact
of SFAS No. 156 on our results of operations and financial position.
FASB Statement No. 157, Fair Value Measurements
In September 2006, the FASB issued Statement No. 157 ("SFAS No. 157"),
"Fair Value Measurements", which defines fair value, establishes a framework for
measuring fair value under GAAP and expands disclosures about fair value
measurements. We are required to adopt SFAS No. 157 on January 1, 2008 and are
evaluating the implications of SFAS No. 157 on our results of operations and
financial position.
8
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
3. Business segments
We measure segment performance primarily based on income or loss before
income taxes and minority interest. Our reportable segments are strategic
business units that are primarily segregated by geographic region. We report
segments in accordance with SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". Our segments are Life Reinsurance North
America, Life Reinsurance International and Corporate and Other. The segment
reporting is as follows:
Three months ended September 30, 2006
---------------------------------------------------
Life Reinsurance
--------------------------
North Corporate
America International & Other Total
---------- ------------ ---------- ----------
Premiums earned ....................................... $ 421,707 $ 31,814 $ - $ 453,521
Investment income, net ................................ 151,872 8,528 2,008 162,408
Fee income ............................................ 1,620 - 760 2,380
Realized gains (losses), net .......................... 173 (2,832) 1,587 (1,072)
Change in value of embedded derivatives, net .......... (5,891) - - (5,891)
--------- --------- --------- ----------
Total revenues ........................................ 569,481 37,510 4,355 611,346
--------- --------- --------- ----------
Claims and other policy benefits ...................... 360,968 16,745 - 377,713
Interest credited to interest sensitive contract
liabilities ....................................... 42,423 - - 42,423
Acquisition costs and other insurance expenses, net ... 74,082 9,396 2,763 86,241
Operating expenses .................................... 14,569 7,678 17,200 39,447
Collateral finance facilities expense ................. 63,866 - 3,457 67,323
Interest expense ...................................... 2,986 - 2,019 5,005
--------- --------- --------- ----------
Total benefits and expenses ........................... 558,894 33,819 25,439 618,152
--------- --------- --------- ----------
Income (loss) before income taxes and minority interest $ 10,587 $ 3,691 $ (21,084) $ (6,806)
========= ========= ========= =========
9
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
3. Business segments (continued)
Three months ended September 30, 2005
---------------------------------------------------
Life Reinsurance
-------------------------
North Corporate
America International & Other Total
---------- ------------- ---------- ----------
Premiums earned .............................................. $ 427,224 $ 42,870 $ - $ 470,094
Investment income, net ....................................... 88,490 2,734 908 92,132
Fee income ................................................... 2,010 - 791 2,801
Realized gains (losses), net ................................. (160) (82) 1,586 1,344
Change in value of embedded derivatives, net ................. (2,631) - - (2,631)
---------- ------------ ---------- ----------
Total revenues ............................................... 514,933 45,522 3,285 563,740
---------- ------------ ---------- ----------
Claims and other policy benefits ............................. 330,035 26,092 - 356,127
Interest credited to interest sensitive contract liabilities.. 36,724 - - 36,724
Acquisition costs and other insurance expenses, net .......... 80,762 9,933 519 91,214
Operating expenses ........................................... 12,981 6,728 13,200 32,909
Collateral finance facilities expense ........................ 11,850 - 1,380 13,230
Interest expense ............................................. 3,062 - 2,628 5,690
---------- ------------ ---------- ----------
Total benefits and expenses .................................. 475,414 42,753 17,727 535,894
---------- ------------ ---------- ----------
Income (loss) before income taxes and minority interest ...... $ 39,519 $ 2,769 $ (14,442) $ 27,846
========== ============ ========== ==========
Nine months ended September 30, 2006
---------------------------------------------------
Life Reinsurance
-------------------------
North Corporate
America International & Other Total
---------- ------------- ----------- -----------
Premiums earned .............................................. $ 1,258,174 $ 89,310 $ - $ 1,347,484
Investment income, net ....................................... 412,576 20,488 6,343 439,407
Fee income ................................................... 8,516 - 2,236 10,752
Realized gains (losses), net ................................. (19,225) (10,878) 4,132 (25,971)
Change in value of embedded derivatives, net ................. 11,621 - - 11,621
----------- ----------- ----------- ------------
Total revenues ............................................... 1,671,662 98,920 12,711 1,783,293
----------- ----------- ----------- ------------
Claims and other policy benefits ............................. 1,046,874 77,403 - 1,124,277
Interest credited to interest sensitive contract liabilities.. 140,523 - - 140,523
Acquisition costs and other insurance expenses, net .......... 255,770 18,398 4,476 278,644
Operating expenses ........................................... 43,699 21,329 44,876 109,904
Collateral finance facilities expense ........................ 140,300 - 5,346 145,646
Interest expense ............................................. 8,586 - 8,378 16,964
----------- ----------- ----------- ------------
Total benefits and expenses .................................. 1,635,752 117,130 63,076 1,815,958
----------- ----------- ----------- ------------
Income (loss) before income taxes and minority interest ...... $ 35,910 $ (18,210) $ (50,365) $ (32,665)
=========== =========== =========== ============
10
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
3. Business segments (continued)
Nine months ended September 30, 2005
---------------------------------------------------
Life Reinsurance
------------------------
North Corporate
America International & Other Total
---------- ------------- ---------- ----------
Premiums earned .............................................. $ 1,273,196 $ 97,471 $ - $ 1,370,667
Investment income, net ....................................... 246,977 7,676 1,512 256,165
Fee income ................................................... 6,917 - 2,293 9,210
Realized gains, net .......................................... 3,490 503 1,580 5,573
Change in value of embedded derivatives, net ................. (19,266) - - (19,266)
----------- ----------- ----------- -----------
Total revenues ............................................... 1,511,314 105,650 5,385 1,622,349
----------- ----------- ----------- -----------
Claims and other policy benefits ............................. 967,822 63,071 - 1,030,893
Interest credited to interest sensitive contract liabilities.. 99,089 - - 99,089
Acquisition costs and other insurance expenses, net .......... 286,967 16,831 1,552 305,350
Operating expenses ........................................... 34,875 19,862 29,241 83,978
Collateral finance facilities expense ........................ 28,483 - 3,988 32,471
Interest expense ............................................. 8,427 - 7,670 16,097
Total benefits and expenses .................................. 1,425,663 99,764 42,451 1,567,878
----------- ----------- ----------- -----------
Income (loss) before income taxes and minority interest....... $ 85,651 $ 5,886 $ (37,066) $ 54,471
=========== =========== =========== ===========
Assets September 30, 2006 December 31, 2005
- ------ ------------------ -----------------
Life Reinsurance
North America ............................................................. $12,395,164 $10,472,863
International ............................................................. 481,358 460,888
----------- -----------
Total Life Reinsurance......................................................... 12,875,522 10,933,751
Corporate & Other ............................................................. 950,380 1,072,369
----------- -----------
Total ......................................................................... $13,825,902 $12,006,120
=========== ===========
11
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
4. Earnings per ordinary share
The following table sets forth the computation of basic and diluted
earnings per ordinary share.
Three months ended Nine months ended
--------------------------------- ----------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
---------------- ---------------- -------------- ---------------
Numerator:
Net income (loss)................................. $ (27,415) $ 34,410 $ (135,156) $ 69,421
Dividend declared on non-cumulative perpetual
preferred shares.............................. (2,266) (2,492) (6,797) (2,492)
Imputed dividend on prepaid variable share
forward contract ............................. (809) - (881) -
------------- -------------- -------------- ---------------
Net income (loss) available to ordinary
shareholders.................................. $ (30,490) $ 31,918 $ (142,834) $ 66,929
============= ============== ============== ===============
Denominator:
Denominator for basic earnings per ordinary
share - weighted average number of
ordinary shares...............................
56,933,566 45,517,832 54,708,914 43,004,046
Effect of dilutive securities ....................
- Stock options and restricted stock units.... - 1,170,122 - 759,262
- Warrants.................................... - 1,024,426 - 2,645,944
- 4.50% senior convertible notes and
Hybrid Capital Units........................... - 830,882 - 670,995
------------- -------------- -------------- ---------------
Denominator for dilutive earnings (loss) per
ordinary share................................ 56,933,566 48,543,262 54,708,914 47,080,247
============= ============== ============== ==============
Basic earnings (loss) per ordinary share.......... $ (0.54) $ 0.70 $ (2.61) $ 1.56
============= ============== ============== ==============
Diluted earnings (loss) per ordinary share........ $ (0.54) $ 0.66 $ (2.61) $ 1.42
============= ============== ============== ==============
In accordance with SFAS No. 128, "Earnings Per Share", the exercise of
options and warrants or conversion of convertible securities is not assumed
unless it would reduce earnings per share or increase loss per share.
5. Collateral finance facilities
On May 2, 2006, Ballantyne Re plc, an orphan special purpose vehicle
incorporated under the laws of Ireland issued in a private offering $1.74
billion of debt to external investors and $178.0 million of debt to Scottish
Annuity & Life Insurance Company (Cayman) Ltd. The total debt issued to external
investors (collectively, the "Notes") consisted of:
o $250.0 million of Class A-1 Floating Rate Notes,
o $500.0 million of Class A-2 Floating Rate Guaranteed Notes Series A,
o $500.0 million of Class A-2 Floating Rate Guaranteed Notes Series B,
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series A,
12
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
5. Collateral finance facilities (continued)
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series B,
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series C,
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series D,
o $10.0 million of Class B-1 7.51244% Subordinated Notes,
o $40.0 million of Class B-2 Subordinated Floating Rate Notes, and
o $42.0 million of Class C-1 Subordinated Variable Interest Rate Notes.
The debt issued to Scottish Annuity & Life Insurance Company (Cayman) Ltd.
consisted of $8.0 million of Class C-1 Subordinated Variable Interest Rate Notes
and $170.0 million Class C-2 Subordinated Variable Interest Rate Notes, which
Scottish Annuity & Life Insurance Company (Cayman) Ltd. intends to hold
(collectively, the "SALIC Notes"; and together with the Notes, the "Ballantyne
Notes"). Concurrently with its offering of the Ballantyne Notes, Ballantyne Re
issued (i) $500,000 of Class D Convertible Notes, which were purchased by
Scottish Re Group Limited, (ii) 163.0 million Redeemable Preference Shares of
U.S. $1.00 par value per share which were purchased by Scottish Annuity & Life
Insurance Company (Cayman) Ltd., and (iii) 18.2 million Non-Redeemable
Preference Shares of U.S. $1.00 par value per share which were also purchased by
Scottish Annuity & Life Insurance Company (Cayman) Ltd.
Interest on the principal amount of the Ballantyne Notes is payable in
intervals ranging from every 28 days to monthly to annually, depending on the
note, initially at a rate equivalent to one-month LIBOR plus 0.61% for the Class
A-1 Floating Rate Notes (and after May 2, 2022, one-month LIBOR plus 1.22%),
one-month LIBOR plus 0.31% for the Class A-2 Floating Rate Guaranteed Notes
Series A (and after May 2, 2027, one-month LIBOR plus 0.62%), one-month LIBOR
plus 0.36% for the Class A-2 Floating Rate Guaranteed Notes Series B (and after
May 2, 2027, one-month LIBOR plus 0.72%), 4.99%, 4.99%, 5.00% and 5.01% for
Series A, Series B, Series C, and Series D of the Class A-3 Notes, respectively
(with the rate on the Class A-3 Notes to reset every 28 days), 7.51% for the
Class B-1 Subordinated Notes, one-month LIBOR plus 2.00% for the Class B-2
Subordinated Floating Rate Notes, and a variable rate based on performance of
the underlying block of business for the Class C-1 Subordinated Variable
Interest Rate Notes and the Class C-2 Subordinated Variable Interest Rate Notes.
Proceeds from this offering were used to fund the Regulation XXX reserve
requirements for the business acquired from ING America Insurance Holdings, Inc.
$1.65 billion of the proceeds from the Ballantyne Notes have been deposited into
a series of accounts that collateralize the reserve obligations of Scottish Re
(U.S.), Inc.
The holders of the Ballantyne Notes cannot require repayment from us or any
of our subsidiaries. The timely payment of the scheduled interest payments and
the principal on the maturity date of Series A of the Class A-2 Notes and Series
A, Series B, Series C, Series D and, if issued, Series E of the Class A-3 Notes
has been guaranteed by Ambac Assurance UK Limited. The timely payment of the
scheduled interest payments and the principal on the maturity date of Series B
of the Class A-2 Notes and, if issued, Series F of the Class A-3 Notes has been
guaranteed by Assured Guaranty (UK) Ltd.
13
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
5. Collateral finance facilities (continued)
In accordance with FASB Interpretation No. 46 (revised December 2003) ("FIN
46R"), "Consolidation of Variable Interest Entities", Ballantyne Re is
considered to be a variable interest entity and we are considered to hold the
primary beneficial interest. As a result, Ballantyne Re is consolidated in our
financial statements beginning in the second quarter of 2006. The assets of
Ballantyne Re are recorded as fixed maturity investments and cash and cash
equivalents. Our consolidated statements of income include the investment return
of Ballantyne Re as investment income and the cost of the facility is reflected
in collateral finance facilities expense.
6. Commitments
Credit facilities
On July 14, 2005, Scottish Annuity & Life Insurance Company (Cayman) Ltd.,
Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc. and Scottish Re Limited
entered into a $200.0 million, three-year revolving unsecured senior credit
facility with a syndicate of banks (the "$200 Million Credit Agreement"). The
facility provides capacity for borrowing and extending letters of credit. The
facility is a direct financial obligation of each of the borrowers; however,
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed the
payment of obligations of Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc.
and Scottish Re Limited. There were no outstanding borrowings at September 30,
2006. Outstanding letters of credit under this facility amounted to $42.8
million at September 30, 2006. On September 21, 2006, Scottish Annuity & Life
Insurance Company (Cayman) Ltd. gave notice that it will permanently reduce the
aggregate commitments under the $200 Million Credit Agreement, effective
September 22, 2006, to $42.8 million. The aggregate commitments under the $200
Million Credit Agreement will be further permanently reduced dollar for dollar
by the amount of each letter of credit returned undrawn or, if drawn, upon
payment of the obligation by the applicable borrower. Also on September 21,
2006, Scottish Annuity & Life Insurance Company (Cayman) Ltd. sent a notice to
the syndicate of banks that it did not wish to have the expiry dates extended
pursuant to the evergreen feature contained in the outstanding letters of credit
that were issued. The majority of such letters of credit have a current expiry
date of December 31, 2006, and the remainder have current expiry dates on or
prior to September 15, 2007. Outstanding letters of credit under the facility
amounted to $25.3 million at November 8, 2006.
On August 18, 2005, Scottish Re (Dublin) Limited entered into a $30.0
million three-year revolving, unsecured letter of credit facility with a
syndicate of banks (the "$30 Million Credit Agreement"). The facility is a
direct financial obligation of Scottish Re (Dublin) Limited, however, Scottish
Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed the payment
obligations of Scottish Re (Dublin) Limited. Effective September 22, 2006,
Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Re (Dublin)
Limited terminated the $30 Million Credit Agreement. All letters of credit
outstanding under the agreement, in an aggregate of $10.0 million, were
cancelled.
The financial covenants set forth in the $200 Million Credit Agreement
require that Scottish Annuity & Life Insurance Company (Cayman) Ltd. maintain a
minimum amount of consolidated shareholders' equity (during any four quarter
period, $750.0 million plus 50% of consolidated net income for the period plus
50% of any increases to shareholders' equity during the period) and maintain a
ratio of unencumbered assets to aggregate borrowings under the facility of 1.2
times borrowings. In addition, this facility requires Scottish Re Group Limited
to maintain a minimum amount of consolidated shareholders' equity (during any
four quarter period, $760.0 million plus 50% of consolidated net income for the
period plus 50% of any increases to shareholders' equity during the period) and
a debt to capitalization ratio of less than 30%. For the purposes of computing
the financial covenants, the collateral facilities and their associated costs
are excluded. The facility also contains certain covenants on borrowing entities
in respect of, among other things, dividends or loans to the parent, debt
incurrence and affiliate transactions.
Failure to comply with the requirements of the credit facility would,
subject to grace periods, result in an event of default and we would be required
to repay any outstanding borrowings. At September 30, 2006, Scottish Annuity
14
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
6. Commitments (continued)
& Life Insurance Company (Cayman) Ltd. and Scottish Re Group Limited were in
compliance with the financial covenants noted in the preceding paragraph.
7. Derivatives
Interest Rate Swap
During 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 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging
Activities", which 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 change in fair value of the
swap during the three and nine months ended September 30, 2006 amounted to a
gain of $1.8 million and $4.3 million, respectively. The change in fair value of
the swap during the three months and nine months ended September 30, 2005
amounted to a gain of $1.7 million and $1.6 million, respectively. These gains
and losses are included in realized gains (losses) in the consolidated
statements of income. On August 2, 2006, we terminated the swap contract for net
proceeds of $3.5 million.
Tartan Capital Limited
On May 4, 2006, we entered into an agreement that provides two classes
totaling $155.0 million of collateralized catastrophe protection with Tartan
Capital Limited ("Tartan"), a special purpose Cayman Islands company which was
funded through a catastrophe bond transaction. This coverage is for the period
January 1, 2006 to December 31, 2008 and provides Scottish Annuity & Life
Insurance Company (Cayman) Ltd. with protection from losses arising from higher
than normal mortality levels within the United States, as reported by the U.S.
Centers for Disease Control and Prevention or other designated reporting agency.
This coverage is based on a mortality index, which is based on age and gender
weighted mortality rates for the United States constructed from publicly
available data sources, as defined at inception, and which compares the
mortality rates over consecutive 2 year periods to a reference index value. Upon
the occurrence of a loss event, where the indexed losses exceeds the trigger
level for a given tranche, the percentage of the original principal for each
tranche paid to Scottish Annuity & Life Insurance Company (Cayman) Ltd.
increases linearly between the trigger level and exhaustion level. Since the
amount of any recovery is based on the mortality index, the amount of the
recovery may be different than the ultimate claims paid by Scottish Annuity and
Life Insurance Company (Cayman) Ltd.'s and any of its affiliates resulting from
the loss event.
In accordance with SFAS No. 133, this contract is considered to be a
derivative. We record this contract at fair value which is included in "Other
assets" and "Other liabilities" in the Consolidated Balance Sheets with any
changes in the value reflected in "Acquisition costs and other insurance
expenses" in the Consolidated Statements of Income. There is no quoted market
value available for this derivative. The fair value is estimated utilizing
published mortality data. Expenses related to this transaction are included in
"Acquisition costs and other insurance expenses" in the Corporate and Other
Segment.
Tartan is a variable interest entity under the provisions of FIN 46R. We
are not the primary beneficiary of this entity and are, therefore, not required
to consolidate it in our consolidated financial statements.
8. Shareholders' equity
Prepaid variable share forward contract
In connection with the December 23, 2005 ordinary share offering, we
entered into forward sales agreements with affiliates of Bear, Stearns & Co.
Inc. and Lehman Brothers, Inc. (the "forward purchasers") and the forward
15
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
8. Shareholders' equity (continued)
purchasers borrowed and sold an aggregate of approximately 3,150,000 ordinary
shares as their initial hedge of the forward sale agreements. Pursuant to the
forward sale agreements, the forward purchasers agreed to pay us an aggregate of
approximately $75.0 million on September 29, 2006 and an aggregate of
approximately $75.0 million on December 29, 2006, subject to our right to
receive a portion of such payment prior to the settlement dates. In exchange, on
each of such dates we would deliver to the forward purchasers a variable number
of ordinary shares based on the average market price of the ordinary shares,
subject to a floor price of $22.80 and a cap price of $28.80. We also have the
right to net share settle or cash settle the forward sale agreements. The fair
value of the forward sales agreements at inception was reflected in
shareholders' equity (as a reduction in additional paid-in capital) and the fair
value is not adjusted until the settlement date of the forward. In addition, the
underwriting costs of the forward sales agreements were reflected in
shareholders' equity (as a reduction in additional paid-in capital).
On June 26, 2006, we exercised our right of prepayment under the forward
sale agreements and received 75% of the $150.0 million proceeds totaling $110.0
million, net of prepayment discounts of $2.5 million. This prepayment was
recorded as a separate component of consolidated shareholders' equity. The total
amount of the discount related to the prepayment transaction was recorded as an
imputed dividend charge over the applicable contract settlement period. The
prepayment option on the forward sale agreements provides the counterparty
liquidation preferences that are similar to other ordinary shareholders.
On August 9, 2006, the forward purchasers notified us of the occurrence of
"Increased Cost of Stock Borrow" under the forward sale agreements and proposed
price adjustments thereto. Pursuant to the forward sales agreements, upon
receipt of such notification, we were entitled to elect to (a) agree to amend
the transactions to take into account the price adjustments; (b) pay the forward
purchasers an amount corresponding to the price adjustments; or (c) terminate
the transactions. On August 11, 2006, the forward purchasers proposed an
amendment to the forward sales agreements which provided us an additional
alternative, the acceleration of the scheduled maturity date to August 14, 2006
under each of the forward sales agreements. We agreed to this amendment on
August 14, 2006. On August 17, 2006, we received cash proceeds of $36.5 million
and issued 6.6 million ordinary shares, which satisfied in full our obligation
to deliver shares pursuant to the forward sales agreements and the forward
purchasers' obligations to pay us under such agreements. An imputed dividend was
charged to earnings based on the pro-rated amount of time that elapsed from the
original prepayment date until settlement date. The balance of the discount
reduced the net proceeds on issuance of the shares.
Upon the settlement of the forward sales agreements, we have received
$147.3 million in the aggregate and issued an aggregate of 6.6 million ordinary
shares.
9. Stock based compensation
Prior to January 1, 2006, we accounted for stock-based compensation in
accordance with SFAS No. 123 ("SFAS No. 123"), "Accounting for Stock-Based
Compensation", as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure". Under the fair value recognition
provisions of SFAS No. 123, stock-based compensation expense for all stock-based
awards issued from January 1, 2003 was measured at the grant date based on the
value of the award and was recognized as expense over the service period for
awards that were expected to vest.
In December 2004, the FASB revised SFAS No. 123 by issuing "Share-Based
Payment" ("SFAS No. 123(R)"). SFAS No. 123(R) requires us to recognize, in the
determination of income, the grant date fair value of all stock options and
other equity based compensation issued to employees.
Effective January 1, 2006, we adopted SFAS No.123(R) "Share Based Payment",
using the modified-prospective transition method. Under the modified-prospective
transition method, compensation cost recognized
16
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
9. Stock based compensation (continued)
includes compensation costs for all share-based payments granted prior to, but
not yet vested, as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS No. 123, and
compensation costs for all share-based payments granted subsequent to January 1,
2006, based on the grant date fair value estimated in accordance with the
provisions of SFAS No. 123(R). Results for prior periods have not been restated.
As a result of adopting SFAS No. 123(R) "Share Based Payment", loss before
income taxes for the three and nine months ended September 30, 2006 are $0.1
million and $0.4 million higher, respectively, and net loss for the three and
nine months ended September 30, 2006 are $0.1 million and $0.4 million higher,
respectively, than if we had continued to account for stock-based compensation
awarded before January 1, 2003 under Accounting Principles Board Opinion No. 25.
Diluted loss per share for the three and nine months ended September 30, 2006
would be $0.53 and $2.60 per share, respectively, without the adoption of SFAS
No. 123(R).
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123(R) for periods prior to the adoption of SFAS No.
123(R), and has been determined as if we accounted for all employee equity based
compensation under the fair value method of SFAS No 123(R).
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period using the
Black-Scholes model. The Black-Scholes pricing model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected price volatility,
dividend yield, risk free interest rate and expected life (in years). In
management's opinion, because our employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, the
Black-Scholes model does not necessarily provide a reliable single measure of
the fair value of our employee stock options.
Our pro forma information for the three and nine months ended September 30,
2005 is as follows:
Three months Nine months
ended ended
September 30, September 30,
2005 2005
-------------- ----------------
Net income as reported........................................................ $34,410 $69,421
Dividend declared on non-cumulative perpetual preferred shares................ (2,492) (2,492)
--------------- ---------------
Net income available to ordinary shareholders................................. 31,918 66,929
Stock-based employee compensation cost, net of related tax effects,
included in the determination of net income as reported.................. 1,397 3,871
Stock-based employee compensation cost, net of related tax effects, that would
have been included in the determination of net income if the fair value
based method had been applied to all awards.............................. (1,549) (4,427)
--------------- ---------------
Net income pro forma.......................................................... $31,766 $66,373
=============== ==============
Per share data:
Basic earnings per ordinary share as reported................................. $0.70 $1.56
Basic earnings per ordinary share pro forma................................... $0.70 $1.54
Diluted earnings per ordinary share as reported............................... $0.66 $1.42
Diluted earnings per ordinary share pro forma................................. $0.65 $1.41
17
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
9. Stock based compensation (continued)
We have four stock option plans (the "1998 Plan", the "1999 Plan", the
"Harbourton Plan" and the "2001 Plan", collectively the "Option Plans"). The
Option Plans allow us to grant non-statutory options, subject to certain
restrictions, to eligible employees, non-employee directors, advisors and
consultants. The minimum exercise price of the options will be equal to the fair
market value, as defined in the Option Plans, of our ordinary shares at the date
of grant. The term of the options is between seven and ten years from the date
of grant. Unless otherwise provided in each option agreement, all options
granted between January 1, 2002 and May 4, 2004, will become exercisable in five
equal installments commencing on the first anniversary of the grant date, except
for annual grants to each director, which are fully exercisable on the date of
grant. All options issued after May 5, 2004, become exercisable in three equal
annual installments commencing on the first anniversary of the grant date,
except for grants to directors, which are fully exercisable on the date of
grant. Total options authorized under the Option Plans are 3,750,000.
The equity incentive compensation plan ("2004 ECP") allows us to grant
non-statutory options and restricted share units, subject to certain
restrictions, to eligible employees, non-employee directors, advisors and
consultants. For the first year of the 2004 ECP or the first 250,000 options
issued, the minimum exercise price of the options will be equal to 110% of fair
market value. At the discretion of our Compensation Committee, option grants
after the first year of the 2004 ECP or in excess of 250,000 options may have a
minimum exercise price equal to the fair market value of our ordinary shares at
the date of grant. The term of the options shall not be more than ten years from
the date of grant. Options will become exercisable in three equal installments
commencing on the first anniversary of the grant date, except for grants to
directors, which are fully exercisable on the date of grant. Total options
authorized under the 2004 ECP are 750,000. In addition, 1,000,000 restricted
share units have been authorized under the 2004 ECP of which at least 750,000
will vest based on achievement of certain performance goals. The performance
measures that must be met for vesting to occur are established at the beginning
of each three year performance period. Depending on the performance, the actual
amount of restricted share units could range from 0% to 100%. The remaining
250,000 restricted share units may be issued without performance goals.
Stock Options
Option activity under all Option Plans and the 2004 ECP is as follows:
Three months ended Nine months ended
--------------------------- ---------------------------
September 30 September 30 September 30 September 30
2006 2005 2006 2005
------------ ------------ ------------ ------------
Outstanding, beginning of period . 2,346,821 2,727,370 2,586,237 2,491,236
Granted .......................... - 125,001 154,000 566,001
Exercised ........................ (230,000) (163,500) (583,217) (318,300)
Cancelled ........................ (224,302) (24,734) (264,501) (74,800)
------------ ------------ ------------ ------------
Outstanding end of period ........ 1,892,519 2,664,137 1,892,519 2,664,137
------------ ------------ ------------ ------------
Options exercisable, end of period 1,221,039 1,687,270 1,221,039 1,687,270
============ ============ ============ ============
Outstanding, beginning of period . $ 18.4278 $ 16.6756 $ 17.5411 $ 14.8860
============ ============ ============ ============
Granted .......................... $ - $ 24.6720 $ 24.5487 $ 25.5967
============ ============ ============ ============
Exercised ........................ $ 7.7500 $ 10.4489 $ 11.6619 $ 11.6653
============ ============ ============ ============
Cancelled ........................ $ 19.7564 $ 21.1140 $ 20.0815 $ 20.3950
============ ============ ============ ============
Outstanding, end of period ....... $ 19.5680 $ 17.3917 $ 19.5680 $ 17.3917
============ ============ ============ ============
Weighted average exerciseable price per share at September 30, 2006 and
2005 was $17.3178 and $14.0945, respectively.
18
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
9. Stock based compensation (continued)
During the three and nine months ended September 30, 2006 and 2005, the
following activity occurred under our plans:
Three months ended Nine months ended
------------------------------ ---------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
------------- ------------ --------------- -----------------
Weighted average grant date fair value of $ - $ 11.7955 $ 11.9471 $ 11.0535
options..........................................
------------- ------------ --------------- -----------------
Total intrinsic value of options exercised.......... $ 590,000 $ 2,326,907 $ 4,151,363 $ 3,959,294
------------- ------------ --------------- -----------------
Total fair value of options vested.................. $ 1,554,733 $ 310,221 $ 5,723,297 $ 3,075,426
------------- ------------ --------------- -----------------
Summary of options outstanding at September 30, 2006:
Options Outstanding Options Exercisable
-------------------------------------------- ------------------------------------------------
Weighted Weighted
Average Average
Number of Weighted Remaining Number of Weighted Remaining
Year of Range of Shares Average Contractual Shares Average Contractual
Grant Exercise Prices Outstanding Exercise Price Life Exercisable Exercise Price Life
- -------- ----------------- ----------- -------------- ----------- ------------- -------------- -----------
1998.... $ 15.0000 300,002 $15.0000 2.17 300,002 $15.0000 2.17
1999.... $ 8.0625-15.0000 146,100 $12.3883 1.79 146,100 $12.3883 1.79
2000.... $ 7.9375- 9.0000 76,000 $ 8.8158 3.52 76,000 $ 8.8158 3.52
2001.... $ 13.5000-18.7600 126,167 $15.0890 4.10 126,167 $15.0890 4.10
2002.... $ 15.5000-21.5100 326,250 $17.9455 5.44 241,550 $17.9992 5.42
2003.... $ 17.4700-17.7500 79,000 $17.7234 6.57 37,000 $17.7084 6.57
2004.... $ 21.7000-23.8700 198,000 $23.4199 7.60 125,534 $23.3989 7.62
2005.... $ 23.6000-26.1030 521,000 $25.5626 8.56 158,686 $25.6746 8.47
2006.... $ 18.9000-24.7500 120,000 $24.4917 9.39 10,000 $24.7500 9.38
----------------- ----------- -------------- ----------- ------------- -------------- -----------
$ 7.9375-26.1030 1,892,519 $19.5680 5.85 1,221,039 $17.3178 5.85
================= =========== ============== =========== ============= ============== ===========
The aggregate intrinsic value of options outstanding and exercisable
amounted to $310,533 at September 30, 2006.
The fair value of each option award is estimated on the date of grant using
the Black-Scholes option-pricing model, which uses the assumptions noted in the
following table. Expected dividend yield is based on the historical dividend
patterns as a percentage of the market value of the stock. Expected volatility
is based on implied volatilities from options traded on our ordinary shares. The
expected term of options granted is derived using the "simplified" method as
allowed under the provisions of the Securities and Exchange Commission's Staff
Accounting Bulletin No. 107 and represents the period of time that options
granted are expected to be outstanding. The risk-free interest rate for periods
within the contractual life of the option is based on the U.S. Treasury yield
curve in effect at the time of grant.
September 30, 2006 December 31, 2005
----------------- -----------------
Expected dividend yield................................ 0.00% 0.77%
Risk free interest rate................................ 4.56%-4.92% 3.53%-4.01%
Expected life of options............................... 7 years 7 years
Expected volatility.................................... 0.64 0.35
Compensation expense for stock options for the three and nine months ended
September 30, 2006 was $0.6 million and $3.0 million, respectively. Compensation
expense for stock options for the three and nine months ended September 30, 2005
was $0.7 million and $2.0 million, respectively. We recognize compensation costs
for stock options with pro-rata vesting evenly over the requisite service
period. There was no tax benefit during the nine months ended September 30,
2006.
19
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
9. Stock based compensation (continued)
As of September 30, 2006, there was $5.9 million of total unrecognized
compensation costs related to stock options. These costs are expected to be
recognized over a period of up to three years.
During the three and nine months ended September 30, 2006, the amount of
cash received from the exercise of share options was $2.0 million and $7.8
million, respectively, and there was no tax benefit realized from stock options.
Restricted Share Awards
Restricted share award activity under the 2004 ECP is as follows:
Three months ended Nine months ended
------------------------------- -------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
------------ ------------ ------------- -------------
Outstanding, beginning of period.................... 890,700 464,700 659,200 95,700
Granted............................................. 15,000 175,000 280,500 544,000
Cancelled........................................... (234,500) (3,000) (268,500) (3,000)
--------- -------- -------- ---------
Outstanding end of period ....................... 671,200 636,700 671,200 636,700
========= ======= ======== =========
Restricted share units exercisable, end of period... - - - -
========= ======= ======== =========
Weighted average exercise price for restricted share units is $0.
During the three and nine months ended September 30, 2006 and 2005, the
following activity occurred under our plans:
Three months ended Nine months ended
------------------------------ ----------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
-------------- ------------ ------------- ------------
Weighted average grant date fair value of
awards........................................... $ 10.0367 $ 24.4866 $ 23.6080 $ 24.1920
-------------- ------------ ------------- ------------
We have three restricted share award traunches based on the year of grant
and service and performance period related to them: "2004-2006 Grants",
"2005-2007 Grants" and "2006-2008 Grants". "2005-2007 Grants" and "2006-2008
Grants" are comprised of two components - restricted stock units and performance
shares. The third traunche "2004-2006 Grants" is comprised of performance shares
only. During the quarter ended September 30, 2006, we concluded that the
performance targets of the performance shares in all three traunches were no
longer probable of being achieved and as a result we reversed $4.1 million of
compensation expense relating to these performance shares.
Compensation expense for restricted share awards for the three and nine
months ended September 30, 2006 was $(3.6) million and $(1.4) million,
respectively. Compensation expense for restricted share awards for the three and
nine months ended September 30, 2005 was $0.7 million and $1.9 million,
respectively. We recognize compensation costs for restricted share awards with
cliff vesting evenly over the requisite service period. There was no tax benefit
during the nine months ended September 30, 2006.
As of September 30, 2006, there was $1.9 million of total unrecognized
compensation costs related to restricted stock units. These costs are expected
to be recognized over a period of up to three years.
20
]
SCOTTISH RE GROUP LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2006
(UNAUDITED)
10. Income taxes
Income tax expense in the third quarter ended September 30, 2006 was $20.8
million compared to an income tax benefit of $6.7 million in the same period in
2005. The change in our effective tax rate in the third quarter ended September
30, 2006 compared to the same period in 2005 is primarily related to a $30.1
million valuation allowance established on deferred tax assets.
The valuation allowance principally relates to current period tax benefit
not being recognized (as previously indicated, the Company can no longer
recognize tax benefits for certain legal entities) and an additional valuation
allowance established on prior period deferred tax assets resulting from revised
statutory and tax projections related to certain legal entities. At the end of
the third quarter, the remaining gross deferred tax asset is supported by the
reversal of deferred tax liabilities within the carry forward period and tax
planning strategies for which management believes that it is more likely than
not that the deferred tax assets will be utilized in subsequent periods,
although there is a risk that we will need to establish additional valuation
allowances in future quarters.
11. Mediation
On June 16, 2005, we requested mediation from Employers Reinsurance
Corporation ("ERC") pursuant to the stock purchase agreement transferring a 95%
interest in Scottish Re Life Corporation (formerly ERC Life Corporation) to
Scottish Holdings, Inc. We assert that ERC breached certain representations and
warranties under the agreement. Any negative outcome from this mediation will
not have a material adverse impact on our financial position because the
asserted breaches have already been fully reflected in our financial position at
September 30, 2006. The parties have held two mediation sessions, but have been
unable to resolve the dispute. No date has been scheduled for a future mediation
session.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
Forward-Looking Statements
Some of the statements contained in this report are not historical facts
and are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act. Forward-looking statements involve known and unknown
risks, uncertainties and other factors, which may cause the actual results to
differ materially from the forward-looking statements. Words such as
"anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates",
"may", "will", "continue", "project", and similar expressions, as well as
statements in the future tense, identify forward-looking statements.
These forward-looking statements are not guarantees of our future
performance and are subject to risks and uncertainties that could cause actual
results to differ materially from the results contemplated by the
forward-looking statements. These risks and uncertainties include:
o uncertainties relating to to our ratings;
o uncertainties about our ability to raise equity capital or other
sources of liquidity to support ongoing capital, liquidity and
collateral needs;
o uncertainties about our ability to maintain a flow of new business
given our current ratings;
o risk that our risk analysis and underwriting may be inadequate;
o changes in expectations regarding future realization of gross deferred
tax assets;
o exposure to mortality experience which differs from our assumptions;
o risks arising from our investment strategy, including risks related to
the market value of our investments, fluctuations in interest rates
and our need for liquidity;
o uncertainties arising from control of our invested assets by third
parties;
o developments in global financial markets that could affect our
investment portfolio and fee income;
o changes in the rate of policyholder withdrawals or recapture of
reinsurance treaties;
o risk that our retrocessionaires may not honor their obligations to us;
o terrorist attacks on the United States and the impact of such attacks
on the economy in general and on our business in particular;
o political and economic risks in developing countries;
o the impact of acquisitions, including the ability to successfully
integrate acquired businesses, the competing demands for our capital
and the risk of undisclosed liabilities;
o risk that an ownership change will result in a limitation on the
ability to fully utilize tax net operating losses;
o loss of the services of any of our key employees;
22
o losses due to foreign currency exchange rate fluctuations;
o uncertainties relating to government and regulatory policies (such as
subjecting us to insurance regulation or taxation in additional
jurisdictions);
o risks relating to recent class action litigations;
o the competitive environment in which we operate and associated pricing
pressures; and
o changes in accounting principles.
The effects of these factors are difficult to predict. New factors emerge
from time to time and we cannot assess the financial impact of any such factor
on our business or the extent to which any factor, or combination of factors,
may cause results to differ materially from those contained in any
forward-looking statement. Any forward-looking statement speaks only as of the
date of this report and we do not undertake any obligation, other than as may be
required under the Federal securities laws, to update any forward looking
statements to reflect events or circumstances after the date of such statement
or to reflect the occurrence of unanticipated events.
This discussion and analysis should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the audited Consolidated Financial Statements and Notes thereto,
presented under Item 7 and Item 8, respectively, of our 2005 Annual Report.
Overview
See "Overview" in Item 7 of our 2005 Annual Report.
Status of Credit and Financial Strength Rating
Following the announcement of our second quarter results, the various
rating agencies downgraded our insurer financial strength ratings. Our current
insurer financial strength ratings are as follows:
Moody's
A.M. Best Investors Standard
Company Fitch Ratings Service & Poor's
--------------- ------------------ --------------- ----------------
As at As at As at As at As at As at As at As at
June November June November June November June November
30, 8, 30, 8, 30, 8, 30, 8,
2006 2006 2006 2006 2006 2006 2006 2006
----- --------- ----- ---------- ----- -------- ------ --------
Insurer Financial Strength Ratings:
Scottish Annuity and Life Insurance A- B+* A BBB** A3* Baa3*** A- BBB-**
Company (Cayman) Ltd
Scottish Re (U.S.), Inc A- B+* A BBB** A3* Baa3*** A- BBB-**
Scottish Re Ltd A- B+* A BBB** - - A- BBB-**
Scottish Re Life Corporation A- B+* - - - - A- BBB-**
- --------------------------------------------------------------------------------
* Under review with negative implications
** Negative watch
*** Ratings under review, direction uncertain
Some of our ratings are on negative outlook, which highlights the
respective rating agencies' diminished confidence that there will not be further
adverse developments over the near to medium term. In addition, the rating
agencies have noted that our financial flexibility and competitive position have
deteriorated and they have concerns about our ability to raise equity financing
to support our ongoing capital and liquidity needs. Finally, the rating agencies
have expressed concern over our ability to maintain a flow of new business which
may reduce our future earnings growth.
23
Moody's Investor Services have changed the direction of review of our
ratings to uncertain from possible downgrade as a result of the possibility that
our ratings could be downgraded, upgraded or confirmed depending on the future
developments of the Company.
The ability to write reinsurance partially depends on an insurer's
financial condition and its financial strength ratings. These ratings are based
on an insurance company's ability to pay policyholder obligations and are not
directed toward the protection of investors. Our ability to raise capital for
our business and the cost of this capital is influenced by our credit ratings. A
security rating is not a recommendation to buy, sell or hold securities. It is
subject to revision or withdrawal at any time by the assigning rating
organization, and each rating should be evaluated independently of any other
rating.
Critical Accounting Policies
See the discussion of our Critical Accounting Policies in Item 7 of our
Form 10-K for the year ended December 31, 2005.
Results of Operations
All amounts are reported in thousands of United States dollars, except share
amounts.
Consolidated results of operations
Three months ended Nine months ended
----------------------------- ------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
------------ ------------ ----------- -------------
Premiums earned.............................. $ 453,521 $ 470,094 $ 1,347,484 $ 1,370,667
Investment income, net....................... 162,408 92,132 439,407 256,165
Fee income................................... 2,380 2,801 10,752 9,210
Realized gains (losses), net................. (1,072) 1,344 (25,971) 5,573
Change in value of embedded derivatives, net. (5,891) (2,631) 11,621 (19,266)
------------ ------------ ----------- -------------
Total revenues............................... 611,346 563,740 1,783,293 1,622,349
------------ ------------ ----------- -------------
Claims and other policy benefits............. 377,713 356,127 1,124,277 1,030,893
Interest credited to interest sensitive contract
liabilities............................... 42,423 36,724 140,523 99,089
Acquisition costs and other insurance expenses,
net....................................... 86,241 91,214 278,644 305,350
Operating expenses........................... 39,447 32,909 109,904 83,978
Collateral finance facilities expense........ 67,323 13,230 145,646 32,471
Interest expense............................. 5,005 5,690 16,964 16,097
------------ ------------ ------------ -------------
Total benefits and expenses.................. 618,152 535,894 1,815,958 1,567,878
------------ ------------ ------------ -------------
Income (loss) before income taxes and minority
interest.................................. (6,806) 27,846 (32,665) 54,471
Income tax benefit(expense).................. (20,841) 6,677 (102,427) 15,232
------------ ------------ ------------ -------------
Income (loss) before minority interest....... (27,647) 34,523 (135,092) 69,703
Minority interest............................ 232 (113) (64) (282)
------------ ------------ ------------ -------------
Net income (loss)............................ (27,415) 34,410 (135,156) 69,421
Dividend declared on non-cumulative perpetual
preferred shares.......................... (2,266) (2,492) (6,797) (2,492)
Imputed dividend on prepaid variable share
forward contract.......................... (809) - (881) -
------------ ------------ ------------ -------------
Net income (loss) available to ordinary
shareholders.............................. $ (30,490) $ 31,918 $ (142,834) $ 66,929
============ ============ ============ =============
24
Total revenues in the third quarter ended September 30, 2006 increased 8%
to $611.3 million compared to $563.7 million in the same period in 2005. Net
premiums earned in the third quarter ended September 30, 2006 decreased 4% to
$453.5 compared to $470.1 million in the same period in 2005. Net premiums for
the quarter were adversely impacted by a $16.5 million one time adjustment
relating to experience refunds in our Life Reinsurance North America Segment.
Net investment income in the third quarter ended September 30, 2006 increased
76% to $162.4 million compared to $92.1 million in the same period in 2005. The
increase in investment income is primarily due to the income on higher total
investments from the new securitization structures including Ballantyne Re,
Orkney II and HSBC II (each of which is described below under "Collateral"),
combined with higher interest rates.
Total benefits and expenses in the third quarter ended September 30, 2006
increased 15% to $618.2 million from $535.9 million in the same period in 2005.
The increase was principally due to $54.1 million higher collateral finance
facilities expenses and $21.6 million higher claims and other policy benefits
due to adjustments arising from updated cedant reporting and other reserve
increases.
The loss before income taxes and minority interest in the third quarter
ended September 30, 2006 was $6.8 million compared to income before income taxes
and minority interest of $27.8 million in the same period in 2005.
Income tax expense in the third quarter ended September 30, 2006 was $20.8
million compared to an income tax benefit of $6.7 million in the same period in
2005. The change in our effective tax rate in the third quarter ended September
30, 2006 compared to the same period in 2005 is primarily related to a $30.1
million valuation allowance established on deferred tax assets. The valuation
allowance principally relates to current period tax benefit not being recognized
(as previously indicated, the Company can no longer recognize tax benefits for
certain legal entities) and an additional valuation allowance established on
prior period deferred tax assets resulting from revised statutory and tax
projections related to certain legal entities. At the end of the third quarter,
the remaining gross deferred tax asset is supported by the reversal of deferred
tax liabilities within the carry forward period and tax planning strategies for
which management believes that it is more likely than not that the deferred tax
assets will be utilized in subsequent periods, although there is a risk that we
will need to establish additional valuation allowances in future quarters. See
"Income Taxes" below for a more detailed discussion of the deferred tax asset.
Total revenues during the nine months ended September 30, 2006 increased
10% to $1,783.3 million compared to $1,622.3 million in the same period in 2005.
Net premiums earned during the nine months ended September 30, 2006 decreased 2%
to $1,347.5 million compared to $1,370.7 million in the same period in 2005. Net
premiums for the period were affected by increased retrocession costs and the
adverse effect of several one time negative estimation adjustments. The one time
negative estimation adjustments related to prior period client reported premium
estimates, changes to our assumptions and estimates for external retrocession,
experience refunds and cedant balance true-ups.
Net investment income during the nine months ended September 30, 2006
increased 72% to $439.4 million compared to $256.2 million in the same period in
2005. The increase in investment income is primarily due to the income on higher
total investments from the new securitization structures, including Ballantyne
Re, Orkney Re II and HSBC II, combined with higher interest rates.
Total benefits and expenses during the nine months ended September 30, 2006
increased 16% to $1,816.0 million compared to $1,567.9 million in the same
period in 2005. The increase was principally due to $113.2 million higher
collateral finance facilities expenses as a result of our Regulation XXX
transactions effected in December 2005 and May 2006 and $93.4 million higher
claims and other policy benefits due to external retrocession and reserve
adjustments resulting from improved data and administrative systems.
The loss before income taxes and minority interest was $32.7 million for
the nine months ended September 30, 2006 compared to income before income taxes
and minority interest of $54.5 million in the same period in 2005.
Income tax expense during the nine months ended September 30, 2006 was
$102.4 million compared to an income tax benefit of $15.2 million for the same
period in 2005. The change in our effective tax rate for the nine months ended
September 30, 2006 compared to the same period in 2005 is primarily related to
the valuation
25
allowance established on deferred tax assets during the second and
third quarters of the year. The valuation allowance resulted from our revised
statutory and tax projections combined with a reassessment of certain tax
planning strategies. See "Income Taxes" below for a more detailed discussion of
the deferred tax asset.
Segment Operating Results
Life Reinsurance North America
Three months ended Nine months ended
-------------------------------- ----------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
----------------- ------------ ------------ ------------
Premiums earned................................. $ 421,707 $ 427,224 $1,258,174 $ 1,273,196
Investment income, net.......................... 151,872 88,490 412,576 246,977
Fee income...................................... 1,620 2,010 8,516 6,917
Realized gains (losses), net.................... 173 (160) (19,225) 3,490
Change in value of embedded derivatives, net.... (5,891) (2,631) 11,621 (19,266)
----------------- ------------ ------------ ------------
Total revenues.................................. 569,481 514,933 1,671,662 1,511,314
----------------- ------------ ------------ ------------
Claims and other policy benefits................ 360,968 330,035 1,046,874 967,822
Interest credited to interest sensitive contract
liabilities.................................. 42,423 36,724 140,523 99,089
Acquisition costs and other insurance expenses,
net.......................................... 74,082 80,762 255,770 286,967
Operating expenses.............................. 14,569 12,981 43,699 34,875
Collateral finance facilities expense........... 63,866 11,850 140,300 28,483
Interest expense................................ 2,986 3,062 8,586 8,427
----------------- ------------ ------------ ------------
Total benefits and expenses..................... 558,894 475,414 1,635,752 1,425,663
----------------- ------------ ------------ ------------
Income before income taxes and minority interest $ 10,587 $ 39,519 $ 35,910 $ 85,651
================= ============ ============ ============
In our Life Reinsurance North America Segment, we reinsure life insurance,
annuities and annuity-type products through yearly renewable term agreements,
coinsurance and modified coinsurance agreements. These reinsurance arrangements
are predominantly on an automatic basis and written by life insurance companies
and other financial institutions located principally in the United States.
Premiums earned for the quarter ended September 30, 2006 decreased 1% to
$421.7 million compared to $427.2 million in the same period in 2005. Although
we are reporting a generally consistent quarterly premium level, during the
third quarter of 2006, we recorded an experience refund adjustment for our
assumed business of $16.5 million that reduced our premiums in the third quarter
of 2006.
In connection with our periodic internal review of the underlying
performance of our treaties, we recorded a $16.5 million experience refund
adjustment that reduced our third quarter 2006 premiums. These experience
refunds relate to the underlying profitability of specific assumed treaties,
most notably within our ING block. Treaty provisions for these contracts permit
our clients to participate in the overall profitability of the business,
assuming certain financial measurement thresholds are met. Excluding this
adjustment, premiums earned for the three months ended September 30, 2006 would
have been $438.2 million, a 3% increase over the comparable 2005 period. This
increase is primarily due to an increase in renewal premiums of $21.7 million in
our organic block of business, partially offset by increased retrocession costs.
While the rating agency downgrades have impacted our ability to generate new
business, they did not have a material impact on our premiums in the third
quarter of 2006.
Net investment income for the quarter ended September 30, 2006 increased
72% to $151.9 million compared to $88.5 million in the same period in 2005. The
increase is principally due to the growth in our average invested assets but was
also favorably impacted by an increase in interest rates. Our total invested
assets have increased significantly due to the proceeds of our Regulation XXX
transactions that closed in December 2005 and May 2006. Ballantyne Re, which
closed in May 2006, contributed approximately $1.7 billion of additional
invested assets. In addition, a large portion of the proceeds from the December
2005 equity issuance was contributed to the Life
26
Reinsurance North America Segment to support continued growth. Additionally, the
Life Reinsurance North America Segment received a capital contribution of
approximately $120.0 million in May 2006.
Yields on the portfolio managed by our external investment managers
relating to fixed rate assets were 5.4% and 5.1% at September 30, 2006 and 2005,
respectively. Yields on floating rate assets are indexed to LIBOR and increased
to 5.7% at September 30, 2006 from 4.4% at September 30, 2005. Yields on our
cash and cash equivalents increased to 5.1% at September 30, 2006 from 3.4% at
September 30, 2005.
Claims and other policy benefits for the quarter ended September 30, 2006
increased 9% to $361.0 million compared to $330.0 million in the same period in
2005. Claims and other policy benefits as a percentage of net earned premiums
were 86% and 77% for the three months ended September 30, 2006 and 2005,
respectively. As part of our quarterly reserve review process, reserving models
are updated to reflect most recent policy level inforce information provided by
our clients and for other normal modeling refinements. During the third quarter
of 2006, we increased our net policy reserves by $7.0 million, to more
accurately reflect emerging differences between actual and expected lapse
pattern distributions and net amounts at risk relating to the underlying
treaties. Additionally, during the third quarter of 2006, and in connection with
ongoing initiatives to improve the quality of our cedant information, we
received updated claims totaling $9.2 million relating to the 2004 and 2005
years. Although the increased claims from cedant reporting were largely
mitigated by offsetting premium adjustments, these have the impact of
artificially increasing the claims and benefits ratio for the quarter. Excluding
these claim and reserve adjustments and adjusting our third quarter 2006 net
earned premiums for the experience refund adjustment noted above ($16.5
million), the adjusted claims and benefits ratio for the third quarter of both
2006 and 2005 was 78%. These ratios, combined with our adjusted claims and other
policy benefit ratios of 81% and 77%, in the first and second quarter of 2006,
respectively, confirms that our overall mortality (net of retrocessions and
related experience refunds) continues to be consistent with our expectations.
Interest credited to interest sensitive contract liabilities in the quarter
ended September 30, 2006 increased 16% to $42.4 million compared to $36.7
million in the same period in 2005. The increase is principally due to a large
interest sensitive contract written in late 2005, along with increases in
interest credited on existing treaties due to increasing average liability
balances. Also, during the third quarter of 2006, we terminated four funding
agreements, resulting in a decrease to our interest sensitive contract
liabilities of approximately $650.0 million. Interest sensitive contract
liabilities amounted to $3.3 billion ($4.0 billion prior to the termination of
the funding agreements) at September 30, 2006 and 2005.
Acquisition costs and other insurance expenses in the quarter ended
September 30, 2006 decreased 8% to $74.1 million compared to $80.8 million in
the same quarter in 2005. As a percentage of net premiums earned, acquisition
and other insurance expenses were 18% and 19% for the 2006 and 2005 quarterly
periods, respectively. During the third quarter of 2006, we recorded a favorable
adjustment of $8.9 million relating to marketing development allowances
incurred on certain interest sensitive contract business in prior years in which
it was determined that a refund of such allowances was due us. Treaty provisions
allow us to recover these marketing development allowances at pre-determined
intervals over the life of the underlying treaties if certain minimum financial
thresholds are not met. Excluding this marketing development allowance recovery
and adjusting the 2006 premiums earned amount for the premium adjustments noted
above, the adjusted 2006 acquisition ratio would be 19%, consistent with the
prior year period.
Operating expenses for the quarter ended September 30, 2006 increased 12%
to $14.6 million compared to $13.0 million in the same period in 2005. Operating
expenses as a percentage of operating revenues (total revenues excluding
realized gains and losses and changes in the value of embedded derivatives) were
3% in both the 2006 (after excluding the premium adjustments noted above) and
the 2005 period. However, the overall increase in operating expenses relates
primarily to executive severance costs of $2.0 million and increases in
compensation costs, legal fees and depreciation expenses. Partially offsetting
these amounts was the reversal of previously recognized restricted share expense
of $0.9 million.
Collateral finance facilities expense in the quarter ended September 30,
2006 increased 437% to $63.9 million compared to $11.9 million in the same
period of 2005. The increase is due to the impact of the Regulation XXX
transactions that closed in December 2005 and May 2006. In addition, beginning
in the second half of 2005, a portion of the cost of the Stingray facility was
charged to the Life Reinsurance North America Segment. Due to our
27
downgrades by the rating agencies, our collateral finance facilities expenses in
the third quarter of 2006 increased by $2.0 million as a result of increased
fees to be paid to the financial guarantors of our securitization transactions.
Premiums earned during the nine months ended September 30, 2006 decreased
1% to $1,258.2 million compared to $1,273.2 million in the same period in 2005.
Notwithstanding the relatively consistent premium amounts year over year, during
2006, we recorded a number of significant premium adjustments that reduced our
net earned premium amounts.
As noted in our Form 10-Q for the period ended June 30, 2006, we recorded
adjustments relating to differences in actual amounts reported by our clients
that differed from the amounts previously estimated ($8.0 million) and changes
to assumptions and estimates relating to external retrocession premium amounts
($13.0 million), resulting in a reduction to our net premiums earned of $21.0
million. Additionally, as noted above, we recorded a $16.5 million experience
refund adjustment that reduced our third quarter 2006 premiums. As a result, our
year to date September 30, 2006 premiums has been negatively impacted by $37.5
million. Excluding these adjustments 2006 net earned premiums were $1,295.7
million, an increase of 2% over the 2005 period. This increase is primarily due
to an increase in renewal premiums, offset by increased retrocession costs and
reduced first year premiums. The reduction in first year premiums is due in part
to recent rating agency downgrades.
Investment income for the nine months ended September 30, 2006 increased
67% to $412.6 million compared to $247.0 million for the 2005 period. The
increase is principally due to the growth in our average invested assets and was
also favorably impacted by an increase in interest rates. Our total invested
assets have increased significantly because the proceeds of our Regulation XXX
transactions that closed in December 2005 and May 2006 and the closing of a
large interest sensitive contract at the end of 2005. The Life Reinsurance North
America Segment also benefited from a capital infusion of approximately $120.0
million in May 2006.
The change in value of embedded derivatives for the nine months ended
September 30, 2006 resulted in an $11.6 million gain compared to a loss of $19.3
million in the same period in 2005. The primary reason for the increase was
related to the realization of losses on certain securities held under a modified
coinsurance arrangement that were sold in the first quarter of 2006 in order to
provide collateral for the Ballantyne Re securitization.
Claims and other policy benefits for the nine months ended September 30,
2006 increased 8% to $1,046.9 million compared to $967.8 million for the 2005
period. Claims and other policy benefits as a percentage of net earned premiums
were 83% and 76% for the nine months ended September 30, 2006 and 2005,
respectively. As noted in our Form 10-Q for the period ended June 30, 2006, due
to improved retrocession data and related administration changes, we increased
net claims and policy benefits by $8.0 million. Additionally, during the third
quarter of 2006, we increased our net policy reserves by $7.0 million,
principally due to emerging differences in our lapse distribution assumptions in
connection with our quarterly reserve review process. Additionally, during the
third quarter of 2006, and in connection with ongoing initiatives to improve the
quality of our client information, we received updated claims totaling $9.2
million relating to the 2004 and 2005 years. The 2005 results include a purchase
accounting adjustment to the ING block which decreased reserves by $17.7
million. Excluding these claim items and the aforementioned premium adjustments,
the adjusted claims and other policy benefits ratio for the nine months ended
September 30, 2006 and 2005 was 78% and 77%, respectively.
Interest credited to interest sensitive contract liabilities increased 42%
to $140.5 million in the nine months ended September 30, 2006 compared to $99.1
million in the same period in 2005. The increase is principally due to a large
interest sensitive contract written in late 2005, along with increases in
interest credited on existing treaties due to increasing average liability
balances. During the third quarter of 2006, we terminated four funding
agreements, resulting in a decrease to our interest sensitive contract
liabilities of approximately $650.0 million.
Acquisition costs and other insurance expenses decreased 11% to $255.8
million in the nine months ended September 30, 2006 compared to $287.0 million
for the 2005 period. Acquisition costs and other insurance expenses as a
percentage of net earned premiums for the 2006 and 2005 periods were 20% and
23%, respectively. During 2006, we recorded adjustments of $13.6 million (of
which $13.0 million was recorded in the second quarter) to increase deferred
acquisition cost amortization relating to several deferred fixed annuity
treaties in which emerging lapse experience was significantly higher than
expected. This adjustment was partially offset by a $6.2 million rebate from ING
as a result of the Ballantyne Re securitization. In addition, acquisition costs
have declined
28
by approximately $8.2 million due to a reduction in letter of credit fees as a
result of the Regulation XXX transactions completed in December 2005 and May
2006. During the third quarter of 2006, we recorded a favorable adjustment of
$8.9 million relating to marketing development allowances incurred on certain
interest sensitive contract business in prior years in which it was determined
that a refund of such allowances was due us. Treaty provisions allow us to
recover these marketing development allowances at pre-determined intervals over
the life of the underlying treaties if certain minimum financial thresholds are
not met. The 2005 acquisition costs were impacted by the $17.7 million
adjustment which increased acquisition costs with a corresponding decrease to
the change in reserves related to the purchase accounting adjustments for the
ING block. Adjusting for these unusual items and after consideration of the 2006
premiums adjustments noted above, the acquisition cost ratio the 2006 and 2005
nine month periods were 20% and 21%, respectively.
Operating expenses for the nine months ended September 30, 2006 increased
25% to $43.7 million compared to $34.9 million in the same period in 2005.
Operating expenses as a percentage of operating revenues (total revenues
excluding realized gains and losses and changes in the value of embedded
derivatives) were 3% for both the 2006 (after consideration of the
aforementioned premium adjustments) and the 2005 periods. The overall increase
in operating expenses relates primarily to executive severance costs of $3.1
million and increases in compensation costs, legal fees and depreciation
expenses. Partially offsetting these amounts was the reversal of previously
recognized restricted share expense of $0.9 million.
Collateral finance facilities expense for the nine months ended September
30, 2006 increased 393% to $140.3 million compared to $28.5 million in the same
period in 2005. This increase is due to the interest costs relating to the
Regulation XXX transactions. In addition, beginning in the second half of 2005,
a portion of the cost of the Stingray facility was charged to the Life
Reinsurance North America Segment. Due to rating agency downgrades, our 2006
collateral finance facilities expenses increased by $2.0 million as a result of
increased fees to be paid to the financial guarantors of our securitization
transactions.
Life Reinsurance International
Three months ended Nine months ended
------------------------------ -----------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
--------------- ------------ ------------- --------------
Premiums earned.............................. $ 31,814 $ 42,870 $ 89,310 $ 97,471
Investment income, net....................... 8,528 2,734 20,488 7,676
Realized gains (losses), net................. (2,832) (82) (10,878) 503
--------------- ------------ ------------- --------------
Total revenues............................... 37,510 45,522 98,920 105,650
--------------- ------------ ------------- --------------
Claims and other policy benefits............. 16,745 26,092 77,403 63,071
Acquisition costs and other insurance
expenses, net.............................. 9,396 9,933 18,398 16,831
Operating expenses........................... 7,678 6,728 21,329 19,862
--------------- ------------ ------------- --------------
Total benefits and expenses.................. 33,819 42,753 117,130 99,764
--------------- ------------ ------------- --------------
Income (loss) before income taxes and minority
interest................................... $ 3,691 $ 2,769 $ (18,210) $ 5,886
=============== ============ ============= ==============
Prior to 2005, our Life Reinsurance International Segment specialized in
niche markets in developed countries and broader life insurance markets in the
developing world and focused on the reinsurance of short term group life
policies and aircrew "loss of license" insurance. In 2005, our Life Reinsurance
International Segment became actively engaged in marketing the reinsurance of
U.K. and Irish protection business and has been seeking to reinsure U.K. and
Irish annuity products. The life insurance and annuity products are similar to
those offered in the Life Reinsurance North America Segment. A number of
significant treaties have been won in 2006 which are beginning to contribute to
earnings. In addition, the International Business entered its first significant
annuity transaction in the second quarter of 2006, although the transaction was
recaptured in the third quarter of 2006. The recapture resulted in a number of
one-off items which amounted to a pre-tax profit of $3.7 million.
29
Net premiums earned during the quarter ended September 30, 2006 decreased
26% to $31.8 million compared to $42.9 million in the same period in 2005. The
quarter ended September 30, 2005 included a premium adjustment of $9.0 million
as a result of revised information received in relation to our share of two
Lloyd's of London's syndicates. New protection treaties in 2006 contributed $4.0
million of earned premium in the quarter but were offset as expected by $5.0
million of reduced premium due to expected lapsation, cancellations and other
portfolio effects.
Investment income in the quarter ended September 30, 2006 increased 212% to
$8.5 million compared to $2.7 million for the same period in 2005. The increase
is mainly due to the significant annuity deal described above which provided
$5.1 million of investment income during the quarter. The remaining increase
relates to funds withheld interest of $0.6 million.
Realized losses were $2.8 million in the quarter ended September 30, 2006
compared to a $0.1 million loss for the same period in 2005. The net realized
loss in the quarter related almost entirely to the realization of previously
unrealized investment losses of $3.5 million on the recapture of the annuity
agreement described above.
Claims and other policy benefits decreased by 36% to $16.7 million in the
quarter ended September 30, 2006 from $26.1 million in the same period in 2005.
Claims decreased $6.7 million due to the recapture of the annuity transaction.
This was partially offset by two large claims of $1.2 million in relation to our
U.S. business. In the quarter ended September 30, 2005, the amount of claims
included the negative effect of the revision of claims information from our
share of two Lloyds of London life syndicates, which accounted for approximately
$5.3 million and was not repeated in 2006.
Acquisition costs and other insurance expenses decreased 5% to $9.4 million
in the quarter ended September 30, 2006 from $9.9 million in the same period in
2005. The expense for the quarter included $3.5 million in respect of the costs
related to our honoring of secondary collateral obligations to the cedent in
respect of the recaptured annuity agreement. In the quarter ended September 30,
2005, the revised information in respect of our Lloyd's of London syndicates
accounted for $4.0 million of one-off acquisition expenses.
Operating expenses increased 14% to $7.7 million in the quarter ended
September 30, 2006 from $6.7 million in the same period in 2005. The main
drivers of expenses are additional senior level staff hired to support our our
new business initiatives in our U.K. and other international operations
partially offset by the release of the provision for restricted share expense of
$0.4 million.
Net premiums earned during the nine months ended September 30, 2006
decreased by 8% to $89.3 million compared to $97.5 million in the same period in
2005. In 2005, premiums earned included an amount of $9.0 million in respect of
revised information received regarding our share of two Lloyd's of London
syndicates. The $6.6 million increase in premiums earned from a number of new
protection treaties written were offset by expected lapsation and cancellations.
Investment income in the nine months ended September 30, 2006 increased
167% to $20.5 million compared to $7.7 million for the same period in 2005. The
increase is mainly due to the recaptured annuity agreement which provided $11.3
million of additional investment income during the period.
Realized losses for the nine months ended September 30, 2006 were $10.9
million compared to a $0.5 million gain for the same period in 2005. The net
realized loss for the year to date includes a $7.2 million loss related to the
restructuring of the investment portfolio in respect of the recaptured annuity
agreement in the quarter ended June 30, 2006 and an additional loss of $3.3
million arising from a previously unrealized loss position becoming realized at
the recapture of the treaty.
Claims and other policy benefits increased by 23% to $77.4 million in the
nine months ended September 30, 2006 from $63.1 million in the same period in
2005. Previous year claims were higher than normal due to $5.3 million of claims
in relation to information received from two of our syndicates in Lloyd's of
London. The impact of the recapture of the annuity transaction was to decrease
claims cost by $1.2 million. Included in the current year was $1.2 million in
relation to two large claims in the U.S. book. The most significant increase in
policy benefit
30
costs, however, related to the first quarter of 2006, where adverse mortality
and morbidity experience of $4.0 million, updated cedent reporting of $7.0
million and a reduction of estimated retrocession recoveries on certain large
claims of $3.8 million contributed to the increase in claims and other policy
benefits. Other changes in the first, second and third quarter of 2006 amounted
to $2.0 million of increased claims costs.
Acquisition costs and other insurance expenses increased 9% to $18.4
million in the nine months ended September 30, 2006 from $16.8 million in the
same period in 2005. In general, acquisition costs and other insurance expenses
have increased due to a shift in business mix towards long term protection
business which carries a higher average commission rate. As highlighted above,
the secondary collateral costs of $3.5 million increased other insurance
expenses in the period, but were offset by $4.0 million of reduced costs against
2005 due to one-off costs in respect of our Lloyd's of London syndicates.
Operating expenses for the nine months ended September 30, 2006 increased
7% to $21.3 million compared to $19.9 million for the same period in 2005. An
increase in personnel costs in response to the anticipated growth in the Life
Reinsurance International Segment in addition to severance costs, including
those related to the International Business head office relocation from Windsor
to London, were offset by reductions primarily in various professional services
costs and adjustments related to non-commission deferred acquisition costs.
Corporate & Other
Three months ended Nine months ended
----------------------------- ------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
------------- ------------- ------------- ---------------
Investment income, net.................... $ 2,008 $ 908 $ 6,343 $ 1,512
Fee income................................ 760 791 2,236 2,293
Realized gains, net ...................... 1,587 1,586 4,132 1,580
------------- ------------- ------------- ---------------
Total revenues............................ 4,355 3,285 12,711 5,385
------------- ------------- ------------- ---------------
Acquisition costs and other insurance
expenses, net........................... 2,763 519 4,476 1,552
Operating expenses........................ 17,200 13,200 44,876 29,241
Collateral finance facilities expense..... 3,457 1,380 5,346 3,988
Interest expense.......................... 2,019 2,628 8,378 7,670
------------- ------------- ------------- ---------------
Total benefits and expenses............... 25,439 17,727 63,076 42,451
------------- ------------- ------------- ---------------
Loss before income taxes.................. $ (21,084) $ (14,442) $ (50,365) $ (37,066)
============= ============= ============= ===============
The Corporate and Other Segment is comprised of revenues and expenses that
are not included in the Life Reinsurance Segments and includes corporate
overhead.
Investment income increased 121% to $2.0 million for the quarter ended
September 30, 2006 compared to $0.9 million in the same period in 2005.
Investment income arises in the Corporate and Other Segment due to capital not
specifically allocated to the Life Reinsurance North America or Life Reinsurance
International segments. Investment income will increase or decrease as capital
is raised and deployed to the operating segments. The increase in investment
income is principally due to an increase in Corporate and Other Segment
investment assets arising from the borrowing on the Stingray facility and due to
the proceeds received on the forward share sale agreement.
Acquisition costs and other insurance expenses increased 432% to $2.8
million in the quarter ended September 30, 2006 compared to $0.5 million in the
same quarter in 2005. During the third quarter of 2006, costs related to the
Tartan Capital Limited catastrophe bond issued in May 2006 were $1.2 million.
The segment also incurred $1.0 million of federal excise tax related to payments
made to offshore companies.
Operating expenses include the costs of running our principal office in
Bermuda, our senior executive officers, legal and capital markets departments,
compensation and other costs for our Board of Directors and legal and
professional fees including those in respect of corporate governance legislation
and regulations. Operating
31
expenses increased 30% to $17.2 million for the quarter ended September 30, 2006
compared to $13.2 million in the same period in 2005. The significant increase
in costs relate to severance costs of $3.5 million and higher professional
expenses of $2.8 million related to higher than anticipated Sarbanes-Oxley
compliance costs, higher legal fees related to the government investigations,
and assistance with our Form 10Q filings. Fees related to director activities
were higher by $1.7 million compared to the same period in the prior year. These
costs were slightly offset by lower compensation benefit costs of $4.1 million
compared to the same quarter in the prior year mainly due to the reversal of
previously recognized costs related to restricted share awards with
performance-based vesting. It was determined that the performance thresholds
related to these awards are unlikely to be met and, in accordance with SFAS No.
123(R), "Share Based Payment", costs are reversed in the current period.
Collateral finance facilities expense increased 151% to $3.5 million for
the quarter ended September 30, 2006 compared to $1.4 million in the same period
in 2005. The increase is primarily due to the borrowing under the Stingray
facility.
Interest expense decreased 23% to $2.0 million for the quarter ended
September 30, 2006 compared to $2.6 million in the same period in 2005. The
decrease relates to the use of the Stingray facility, which is charged to
collateral facilities expense.
Investment income increased 320% to $6.3 million for the nine months ended
September 30, 2006 compared to $1.5 million in the same period in 2005. The
increase is principally due to an increase in investment assets held by the
Corporate and Other Segment arising from the borrowing under the Stingray
facility and proceeds received on the forward share sale agreement.
Acquisition costs and other insurance expenses increased 188% to $4.5
million for the nine months ended September 20, 2006 compared to $1.6 million in
the same period in 2005. During the nine months ended September 30, 2006, other
insurance expenses increased $2.0 million related to the Tartan Capital Limited
catastrophe bond issued in May 2006. The current year also included costs of
$1.0 million related to federal excise taxes.
Operating expenses increased 53% to $44.9 million for the nine months ended
September 30, 2006 compared to $29.2 million in the same period in 2005.
Compensation expense was $7.4 million higher than the prior year period.
Salaries were $9.3 million higher due to $6.6 million of severance costs paid to
Scott Willkomm and Michael French and the balance of the increase related to
more employees allocated to the Corporate and Other Segment. These higher costs
were partially offset by $1.4 million of lower benefit costs, mainly relating to
the reversal of previously recognized expense for restricted share awards with
performance-based vesting. It was determined that the performance thresholds
related to these awards are unlikely to be met and in accordance with SFAS No.
123(R), "Share Based Payments", costs are reversed in the current period.
Other operating expense increases compared to the prior year period
includes $4.5 million of increased professional fees and $2.1 million of
increased director expenses. In professional fees, the main cost drivers were
$2.0 million of increased audit fees, $2.9 million of increased legal fees
related to the ongoing strategic alternatives, government investigations and
assistance with our Form 10Q filings, offset by $0.5 million lower consulting
costs. The higher director costs are primarily due to $1.0 million related to
the Office of the Chairman and $0.6 million related to higher D&O insurance
costs.
Collateral finance facilities expense increased 34% to $5.3 million for the
nine months ended September 30, 2006 compared to $4.0 million in the same period
in 2005. The collateral finance facilities expense consists of the put premium
and interest costs under the Stingray facility. Costs increased during the
current period due to the borrowing under the Stingray facility.
Interest expense increased 9% to $8.4 million for the nine months ended
September 30, 2006 compared to $7.7 million in the same period in 2005. This
increase is as a result of our utilization of our credit facilities and reverse
repurchase agreements during the current year period. Other interest expense
includes interest on the 4.5% senior convertible notes and the 1.0% dividend
payable on the convertible preferred shares of our Hybrid Capital Units.
32
Realized gains (losses)
During the third quarter ended September 30, 2006, consolidated net
realized losses amounted to $1.1 million in comparison with net realized gains
of $1.3 million in the same period in 2005. Included in realized gains and
losses is a gain of $1.8 million and $1.7 million for the third quarter ended
September 30, 2006 and 2005, respectively, resulting from the mark to market of
an interest rate swap. During the third quarter ended September 30, 2006, there
were losses of $0.3 million in respect of other than temporary impairments.
There were no other than temporary impairments during the third quarter ended
September 30, 2005.
During the nine months ended September 30, 2006, consolidated net realized
losses amounted to $26.0 million compared to net realized gains of $5.6 million
in the same period in 2005. The major component of the realized losses in the
nine months ended September 30, 2006 relates to the second quarter loss of $11.3
million plus a loss of $13.6 million in the first quarter of 2006 mainly due to
the realization of losses on certain securities held under a modified
coinsurance arrangement that were sold in preparation of the Ballantyne Re
transaction. During the nine months quarter ended September 30, 2006 and 2005,
there were losses of $0.9 million and $2.2 million, respectively, in respect of
other than temporary impairments.
Income Taxes
We determine our income tax provision in accordance with SFAS No. 109
("SFAS No.109") "Accounting for Income Taxes". The consolidated income tax
expense or benefit is determined by applying the income tax rate for each
subsidiary to its pre-tax income or loss. The tax rates for our subsidiaries
vary from jurisdiction to jurisdiction and range from zero to approximately 39%.
Income tax expense arises in periods where taxes on subsidiaries with pre-tax
income exceed the tax benefit on subsidiaries with pre-tax losses. An income tax
benefit arises in periods where the tax benefit on subsidiaries with pre-tax
losses exceeds the taxes on subsidiaries with pre-tax income.
Our effective tax rate in each reporting period is determined by dividing
the net tax benefit (expense) by our pre-tax income or loss. The change in our
effective tax rate is due primarily to the amount in any reporting period of
pre-tax earnings attributable to different subsidiaries (which changes from time
to time), each of which is subject to different statutory tax rates, as well as
to the valuation allowance recorded in the second and third quarter. Pre-tax
earnings of certain subsidiaries in any period may be impacted by the amount of
various inter-company charges, including but not limited to net worth
maintenance fees and other management fees paid to Scottish Annuity & Life
Insurance Company (Cayman) Ltd. and to the parent holding company. These fees
are charged in accordance with our inter-company charging policy and may be
adjusted periodically within limits prescribed by applicable transfer pricing
regulations.
We generate deferred tax assets principally due to net operating losses,
reserves and unrealized losses on investment securities. In accordance with
GAAP, we must conclude whether the future realization of our deferred tax asset
is "more likely than not". The evaluation regarding realizability of deferred
tax assets is made on a gross as opposed to a net basis. Sources of support for
the gross deferred tax asset are the reversal of deferred tax liabilities within
the carry forward period (which in the United States is 15 years), projected
future taxable income and tax planning strategies. Pursuant to the guidance
under SFAS No. 109, we are currently unable to rely on projections of future
taxable income. Therefore, we must rely heavily on tax planning strategies for
support of the gross deferred tax asset.
Prior to the second quarter of 2006, these tax planning strategies provided
justification to support our deferred tax asset. The combination of the
increased pressure on our existing tax planning strategies, the operating loss
for the second quarter, and the prospects of a ratings downgrade during the
second quarter led management to conclude that it was no longer "more likely
than not" that the full amount of the gross deferred tax asset could be
realized. Accordingly, we established a valuation allowance of $112.0 million
during the second quarter. During the third quarter an additional valuation
allowance of $30.1 million was recorded. The valuation allowance principally
relates to current period tax benefit not being recognized (as previously
indicated, the Company can no longer recognize tax benefits for certain legal
entities) and an additional valuation allowance established on prior period
deferred tax assets resulting from revised statutory and tax projections related
to certain legal entities. At the end of the third quarter, the remaining gross
deferred tax asset is supported by the reversal of deferred tax liabilities
within the carry forward period and tax planning strategies for which management
believes that it is more likely than not
33
that the deferred tax assets will be utilized in subsequent periods, although
there is a risk that we will need to establish additional valuation allowances
in future quarters. At the end of the third quarter, the remaining gross
deferred tax asset is supported by the reversal of deferred tax liabilities
within the carry forward period and tax planning strategies for which management
believes that it is more likely than not that the deferred tax assets will be
utilized in subsequent periods, although there is a risk that we will need to
establish additional valuation allowances in future quarters.
Future quarterly tax amounts will be dependent upon the relationship
between pre-tax GAAP profits and statutory profits and will also be impacted by
the size and timing of certain statutory related deferred tax liabilities.
Moreover, management will continue to assess and determine the need for, and the
amount of the valuation allowance in subsequent periods in accordance with the
requirements of SFAS No. 109.
Financial Condition
Investments
At September 30, 2006, the portfolio controlled by us consisted of $8.8
billion of fixed income securities, preferred stock and cash. The portfolio
controlled by us excludes the assets held by ceding insurers under modified
coinsurance and funds withheld coinsurance arrangements. The majority of these
assets are publicly traded; however, $550.0 million of this amount represents
investments in private securities. Of the total portfolio controlled by us, $7.6
billion represents the fixed income and preferred stock portfolios managed by
external investment managers and $1.2 billion represents other cash balances. At
December 31, 2005, the portfolio controlled by us consisted of $6.7 billion of
fixed income securities, preferred stock and cash. The majority of these assets
were publicly traded; however, $452.9 million represented investments in private
securities. Of the total portfolio, $5.4 billion represented the fixed income
and preferred stock portfolio managed by external investment managers and $1.3
million represented other cash balances. At September 30, 2006, the average
Standard & Poor's rating of the portfolio was "AA", the average effective
duration was 2.9 years and the average book yield was 5.5%, as compared with an
average rating of "AA", an average effective duration of 2.9 years and an
average book yield of 4.9% at December 31, 2005. At September 30, 2006, the
unrealized depreciation on investments, net of tax and deferred acquisition
costs, was $22.1 million as compared with unrealized depreciation on
investments, net of tax and deferred acquisition costs, of $17.9 million at
December 31, 2005. The unrealized depreciation on investments is included in our
Consolidated Balance Sheet as part of shareholders' equity.
The table below sets forth the total returns earned by our portfolio for
the quarter ended September 30, 2006, compared to the returns earned by three
indices: the Lehman Brothers Global Bond Index, the S&P 500, and a customized
index that we developed to take into account our investment guidelines. We
believe that this customized index is a more relevant benchmark for our
portfolio's performance.
Quarter ended
September 30,
2006
--------------
Portfolio performance.............................. 2.89%
Customized index................................... 2.95%
Lehman Brothers Global Bond Index.................. 3.43%
S&P 500............................................ 5.66%
The following table presents the investment portfolio (market value) credit
exposure by category as assigned by Standard & Poor's.
September 30, 2006 December 31, 2005
--------------------------- ---------------------------
Ratings $ in millions % $ in millions %
- ------- ------------- --------- ------------- --------
AAA................................ $ 3,833.3 43.4% $ 3,017.4 44.8%
AA................................. 2,002.3 22.7 1,069.1 15.9
A.................................. 2,027.2 23.0 1,646.9 24.4
BBB................................ 939.3 10.6 977.7 14.5
BB or below........................ 24.0 0.3 28.0 0.4
------------ ------- ------------ ------
Total.............................. $ 8,826.1 100.0% $ 6,739.1 100.0%
============ ======= ============ ======
34
The following table illustrates the investment portfolio (market value)
sector exposure.
September 30, 2006 December 31, 2005
-------------------- ----------------------
Sector $ in millions % $ in millions %
- ------ -------------------- ----------------------
U.S. Treasury securities and U.S.
government agency obligations.......... $ 65.6 0.7% $ 47.9 0.7%
Corporate securities..................... 2,603.4 29.5 2,057.0 30.5
Municipal bonds.......................... 53.0 0.6 37.6 0.6
Mortgage and asset backed securities..... 4,786.7 54.2 3,150.1 46.7
Preferred stock.......................... 148.0 1.7 133.8 2.0
----------- ------ ----------- ------
7,656.7 86.7 5,426.4 80.5
Cash..................................... 1,169.4 13.3 1,312.7 19.5
----------- ------ ----------- ------
Total.................................... $ 8,826.1 100.0% $ 6,739.1 100.0%
=========== ====== =========== ======
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. When a
decline is considered to be "other-than-temporary", the cost basis of the
impaired asset is adjusted to its fair value and a corresponding realized
investment loss is recognized in the consolidated statements of income. The
actual value at which such financial instruments could actually be sold or
settled with a willing buyer may differ from such estimated fair values.
The following tables present the estimated fair values and gross unrealized
losses for the fixed maturity investments and preferred stock that have
estimated fair values below amortized cost or cost as of September 30, 2006 and
December 31, 2005. These investments are presented by class and grade of
security, as well as the length of time the related market value has remained
below amortized cost or cost.
September 30, 2006
-----------------------------------------------------------------------------------
Equal to or greater
Less than 12 months than 12 months Total
--------------------------- ------------------------- -------------------------
Estimated Unrealized Estimated Unrealized Estimated Unrealized
fair value loss fair value loss fair value loss
------------- ----------- ---------- ------------ ----------- -------------
Investment Grade Securities:
- ----------------------------
CMO............................. $ 426,350 $ (2,825) $ 231,671 $ (5,379) $ 658,021 $ (8,204)
Corporates...................... 826,712 (17,787) 779,422 (28,964) 1,606,134 (46,751)
Governments..................... 31,266 (470) 21,145 (689) 52,411 (1,159)
MBS............................. 8,152 (89) 141,835 (5,184) 149,987 (5,273)
Municipals...................... 19,828 (153) 16,902 (596) 36,730 (749)
Other structured securities..... 562,584 (2,407) 641,195 (12,433) 1,203,779 (14,840)
Preferred stocks................ 15,674 (457) 108,176 (4,063) 123,850 (4,520)
---------- ----------- ----------- ----------- ----------- -----------
Total Investment grade
securities.................... 1,890,566 (24,188) 1,940,346 (57,308) 3,830,912 (81,496)
---------- ----------- ----------- ----------- ----------- -----------
Below Investment Grade
- ----------------------
Securities Corporates
---------------------
Corporates...................... 3,184 (97) 11,288 (643) 14,472 (740)
Other structured securities..... 915 (363) 3,269 (1,029) 4,184 (1,392)
Preferred stock................. - - 672 (32) 672 (32)
----------- ----------- ----------- ----------- ----------- ------------
Total below investment grade
securities.................... 4,099 (460) 15,229 (1,704) 19,328 (2,164)
----------- ----------- ----------- ----------- ----------- ------------
Total........................... $ 1,894,665 $ (24,648) $ 1,955,575 $ (59,012) $ 3,850,240 $ (83,660)
=========== =========== =========== =========== =========== ============
35
December 31, 2005
------------------------------------------------------------------------------------
Equal to or greater
Less than 12 months than 12 months Total
--------------------------- ------------------------ -------------------------
Estimated Unrealized Estimated Unrealized Estimated Unrealized
fair value loss fair value loss fair value loss
------------- ------------ ----------- ----------- ----------- -------------
Investment Grade Securities:
- ---------------------------
CMO............................. $ 467,314 $ (4,865) $ 85,305 $ (1,688) $ 552,619 $ (6,553)
Corporates...................... 1,132,840 (23,950) 94,218 (2,545) 1,227,058 (26,495)
Governments..................... 36,297 (774) 1,999 (71) 38,296 (845)
MBS............................. 143,956 (3,383) 42,682 (1,611) 186,638 (4,994)
Municipals...................... 17,738 (330) 1,621 (68) 19,359 (398)
Other structured securities..... 1,028,657 (11,882) 135,341 (3,113) 1,163,998 (14,995)
Preferred stocks................ 98,263 (2,287) 24,106 (1,295) 122,369 (3,582)
---------- ----------- ----------- ------------ ----------- ------------
Total Investment grade
securities.................... 2,925,065 (47,471) 385,272 (10,391) 3,310,337 (57,862)
---------- ----------- ----------- ------------ ----------- ------------
Below Investment Grade
- ----------------------
Securities Corporates 10,676 (655) 1,841 (59) 12,517 (714)
---------------------
Other structured securities..... 3,552 (555) 7,260 (29) 10,812 (584)
Preferred stock................. 392 (12) 340 (19) 732 (31)
---------- ----------- ----------- ------------ ----------- ------------
Total below investment grade
securities.................... 14,620 (1,222) 9,441 (107) 24,061 (1,329)
---------- ----------- ----------- ------------ ----------- ------------
Total........................... $ 2,939,685 $ (48,693) $ 394,713 $ (10,498) $ 3,334,398 $ (59,191)
=========== =========== =========== ============ =========== ===========
At September 30, 2006, our fixed income portfolio had 2,904 positions and
$83.7 million of gross unrealized losses. No single position had an unrealized
loss greater than $1.5 million. There were $39.9 million of unrealized gains on
the remainder of the portfolio. There were 134 private securities in an
unrealized loss position totaling $6.7 million in our fixed income portfolio. At
December 31, 2005, our fixed income portfolio had 2,493 positions and $59.2
million of gross unrealized losses. No single position had an unrealized loss
greater than $0.5 million. There were $25.5 million of unrealized gains on the
remainder of the portfolio. There were 127 private securities in an unrealized
loss position totaling $4.3 million in our fixed income portfolio.
Based on our analysis of each security whose price has been below market
for greater than twelve months, we believe that the financial strength,
liquidity, leverage, future outlook, and our ability and intent to hold the
security until recovery support the view that the security was not
"other-than-temporarily" impaired as of September 30, 2006. The unrealized
losses on fixed maturity securities are primarily a result of rising interest
rates, changes in credit spreads and the long-dated maturities of the
securities. Additionally, as of September 30, 2006, approximately 97% of the
gross unrealized losses are associated with investment grade securities.
Unrealized losses on securities that have been in an unrealized loss
position for periods greater than two years amounted to $7.2 million at
September 30, 2006 and $1.1 million at December 31, 2005. Unrealized losses on
non-investment grade securities amounted to $2.2 million and $1.3 million at
September 30, 2006 and December 31, 2005, respectively. Of these amounts,
non-investment grade securities with unrealized losses of $1.7 million at
September 30, 2006 and $0.1 million at December 31, 2005 had been in an
unrealized loss position for a period greater than one year.
The following tables illustrate the industry analysis of the unrealized
losses at September 30, 2006 and December 31, 2005.
36
September 30, 2006
--------------------------------------------------------------------------------
Estimated Fair Unrealized
Amortized Cost % Value % Loss %
-------------- ------ --------------- ----- --------------- ------
Industry
- --------
Mortgage and asset backed
securities.................... $ 2,045,677 52.0% $ 2,015,969 52.4% $ (29,708) 35.5%
Banking......................... 306,528 7.8 299,287 7.8 (7,241) 8.7
Communications.................. 209,688 5.3 200,305 5.2 (9,383) 11.2
Consumer noncyclical............ 148,121 3.8 143,142 3.7 (4,979) 6.0
Insurance....................... 145,941 3.7 142,295 3.7 (3,646) 4.4
Financial other................. 128,037 3.3 124,492 3.2 (3,545) 4.2
Finance companies............... 127,111 3.2 124,331 3.2 (2,780) 3.3
Consumer cyclical............... 124,672 3.2 120,432 3.1 (4,240) 5.1
Electric........................ 114,361 2.9 110,959 2.9 (3,402) 4.1
Other........................... 583,764 14.8 569,028 14.8 (14,736) 17.5
-------------- ------ --------------- ----- --------------- ------
Total........................... $ 3,933,900 100.0% $ 3,850,240 100.0% $ (83,660) 100.0%
============== ====== =============== ===== =============== ======
December 31, 2005
--------------------------------------------------------------------------------
Amortized Estimated Unrealized
Cost % Fair Value % Loss %
-------------- ------ --------------- ----- --------------- ------
Industry
- --------
Mortgage and asset backed
securities.................... $ 1,941,193 57.2% $ 1,914,068 57.4% $ (27,125) 45.8%
Banking......................... 210,360 6.2 206,189 6.2 (4,171) 7.1
Insurance....................... 192,282 5.7 186,480 5.6 (5,802) 9.8
Financial other................. 114,199 3.4 111,488 3.3 (2,711) 4.6
Brokerage....................... 124,998 3.7 122,134 3.7 (2,864) 4.8
Finance companies............... 103,455 3.0 101,663 3.0 (1,792) 3.0
Communications.................. 117,803 3.5 115,767 3.5 (2,036) 3.4
Other........................... 589,299 17.3 576,609 17.3 (12,690) 21.5
-------------- ------ --------------- ----- --------------- ------
Total........................... $ 3,393,589 100.0% $ 3,334,398 100.0% $ (59,191) 100.0%
============== ====== =============== ===== =============== ======
The expected maturity dates of securities that have unrealized losses at
September 30, 2006 and December 31, 2005 are presented in the tables below.
September 30, 2006
--------------------------------------------------------------------------------
Amortized Estimated Unrealized
Cost % Fair Value % Loss %
-------------- ------ --------------- ----- --------------- ------
Maturity
- --------
Due in one year or less......... $ 320,908 8.1% $ 318,046 8.3% $ (2,862) 3.4%
Due in one through five years... 1,587,879 40.4 1,563,769 40.6 (24,110) 28.8
Due in five through ten years... 1,200,028 30.5 1,171,854 30.4 (28,174) 33.7
Due after ten years............. 825,085 21.0 796,571 20.7 (28,514) 34.1
-------------- ------ --------------- ----- --------------- ------
Total........................... $ 3,933,900 100.0% $ 3,850,240 100.0% $ (83,660) 100.0%
============== ====== =============== ===== =============== ======
December 31, 2005
--------------------------------------------------------------------------------
Estimated Unrealized
Book Value % Fair Value % Loss %
-------------- ------ --------------- ----- --------------- ------
Maturity
- --------
Due in one year or less......... $ 269,410 7.9% $ 267,712 8.0% $ (1,698) 2.9%
Due in one through five years... 1,659,946 48.9 1,636,102 49.1 (23,844) 40.3
Due in five through ten years... 925,650 27.3 905,973 27.2 (19,677) 33.2
Due after ten years............. 538,583 15.9 524,611 15.7 (13,972) 23.6
-------------- ------ --------------- ----- --------------- ------
Total........................... $ 3,393,589 100.0% $ 3,334,398 100.0% $ (59,191) 100.0%
============== ====== =============== ===== =============== ======
37
At September 30, 2006, there were 1,847 securities with unrealized loss
positions and at December 31, 2005, there were 1,698 securities with unrealized
loss positions.
At September 30, 2006, there were three securities with a fair value that
traded continuously at less than 80% of amortized cost for at least six months
or 90% of amortized cost for at least 12 months. The total unrealized loss on
these securities amounted to $0.8 million. At December 31, 2005, there was one
security with a fair value that traded continuously at less than 80% of
amortized cost for at least six months or 90% of amortized cost for at least 12
months. The total unrealized loss on this security amounted to $0.5 million.
The following tables provide details of the sales proceeds, realized loss,
length of time the security has been in an unrealized loss position and reason
for sale for those securities sold at a loss during the periods ended September
30, 2006 and 2005. These tables exclude gains or losses from modified
coinsurance portfolios, foreign exchange and swaps or other derivatives.
Three months ended September 30, 2006
--------------------------------------------------------------------------------------
Credit Concern Relative Value Tactical Total
------------------- -------------------- ------------------ --------------------
Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss
--------- ------- --------- --------- -------- -------- --------- ---------
Days
- ----
0-90....................... $ 11,555 $ - $ 81 $ (2) $190,764 $ (467) $ 202,400 $ (469)
91-180..................... - - 906 (14) 37,405 (203) 38,311 (217)
181-270.................... - - - - 3,223 (13) 3,223 (13)
Greater than 270........... - - 1,851 (121) 17,069 (160) 18,920 (281)
--------- ------- --------- --------- -------- -------- --------- ---------
Total...................... $ 11,555 $ - $ 2,838 $ (137) $248,461 $ (843) $ 262,854 $ (980)
========= ======= ========= ========= ======== ======== ========= =========
Three months ended September 30, 2005
--------------------------------------------------------------------------------------
Credit Concern Relative Value Tactical Total
------------------- -------------------- ------------------ --------------------
Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss
--------- ------- --------- --------- -------- -------- --------- ---------
Days
- ----
0-90....................... $ 18,020 $ (318) $ 13,014 $ (100) $ 60,662 $ (67) $ 91,696 $ (485)
91-180..................... - - 2,606 (15) 1,330 (46) 3,936 (61)
181-270.................... 2,881 (740) 200 - - - 3,081 (740)
Greater than 270........... - - 13 - 460 (11) 473 (11)
--------- ------- --------- --------- -------- -------- --------- ---------
Total...................... $ 20,901 $(1,058) $ 15,833 $ (115) $ 62,452 $ (124) $ 99,186 $ (1,297)
========= ======= ========= ========= ======== ======== ========= =========
Nine months ended September 30, 2006
--------------------------------------------------------------------------------------
Credit Concern Relative Value Tactical Total
------------------- -------------------- ------------------ --------------------
Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss
--------- ------- --------- --------- -------- -------- --------- ---------
Days
- ----
0-90....................... $ 19,452 $ (822) $ 193,855 $ (3,909) $260,546 $ (845) $ 473,853 $ (5,576)
91-180..................... 4,105 (81) 11,597 (331) 61,052 (822) 76,754 (1,234)
181-270.................... 8,072 (798) 2,099 (34) 7,978 (186) 18,149 (1,018)
Greater than 270........... 3,540 (351) 16,864 (480) 30,655 (551) 51,059 (1,382)
--------- ------- --------- --------- -------- -------- --------- ---------
Total...................... $ 35,169 $(2,052) $ 224,415 $ (4,754) $360,231 $ (2,404) $ 619,815 $ (9,210)
========= ======= ========= ========= ======== ======== ========= =========
Nine months ended September 30, 2005
--------------------------------------------------------------------------------------
Credit Concern Relative Value Tactical Total
------------------- -------------------- ------------------ --------------------
Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss
--------- ------- --------- --------- -------- -------- --------- ---------
Days
- ----
0-90....................... $ 37,641 $(1,318) $ 31,823 $ (260) $ 186,391 $(1,030) $ 255,855 $ (2,608)
91-180..................... 355 (83) 12,021 (42) 1,330 (46) 13,706 (171)
181-270.................... 3,862 (792) 397 (3) 81 (1) 4,340 (796)
Greater than 270........... 54 (11) 378 (1) 459 (11) 891 (23)
--------- -------- --------- --------- -------- -------- --------- ---------
Total...................... $ 41,912 $(2,204) $ 44,619 $ (306) $188,261 $ (1,088) $ 274,792 $ (3,598)
========= ======== ========= ========= ======== ======== ========= ==========
38
Funds withheld at interest
Funds withheld at interest arise on contracts written under modified
coinsurance agreements and funds withheld coinsurance agreements. In substance,
these agreements are identical to coinsurance treaties except that the ceding
company retains control of and title to the assets. The deposits paid to the
ceding company by the underlying policyholders are held in a segregated
portfolio and managed by the ceding company or by investment managers appointed
by the ceding company. These treaties transfer a quota share of the risks. The
funds withheld at interest represent our share of the ceding companies'
statutory reserves. The cash flows exchanged with each monthly settlement are
netted and include, among other items, our quota share of investment income on
our proportionate share of the portfolio, realized losses, realized gains
(amortized to reflect the statutory rules relating to interest maintenance
reserve), interest credited and expense allowances.
At September 30, 2006, the funds withheld at interest totaled $2.1 billion
with an average rating of "A", an average effective duration of 4.9 years and an
average book yield of 6.0%, as compared to $2.6 billion with an average rating
of "A+", an average effective duration of 5.1 years and an average book yield of
5.6% at December 31, 2005. These are fixed income investments and include
marketable securities, commercial mortgages, private placements and cash. The
market value of the funds withheld amounted to $2.1 billion and $2.6 billion at
September 30, 2006 and December 31, 2005, respectively.
At September 30, 2006 and December 31, 2005, funds withheld at interest
were in respect of nine contracts with six ceding companies, respectively. At
September 30, 2006, we had one contract with Lincoln National Life Insurance
Company that accounted for $1.1 billion or 53% of the funds withheld balances.
Additionally, we had one contract with Security Life of Denver International
Limited that accounted for $305.0 million or 15% of the funds withheld balances
and one contract with Fidelity & Guaranty Life that accounted for $599.0 million
or 29% of the funds withheld balances. The remaining contracts were with
Illinois Mutual Insurance Company, American Founders Life Insurance Company,
Unity Financial Life Insurance Company and Unity Mutual Life Insurance Company.
Lincoln National Life Insurance Company has financial strength ratings of "A+"
from AM. 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. 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. Reserves for future policy benefits and interest sensitive contract
liabilities relating to these contracts amounted to $1.8 billion and $2.4
billion at September 30, 2006 and December 31, 2005, respectively.
The investment objectives for these arrangements are included in the
modified coinsurance and funds withheld coinsurance agreements. The primary
objective is to maximize current income, consistent with the long-term
preservation of capital. The overall investment strategy is executed within the
context of prudent asset/liability management. The investment guidelines permit
investments in fixed maturity securities, and include marketable securities,
commercial mortgages, private placements and cash. The maximum percentage of
below investment grade securities is 10%, and other guidelines limit risk,
ensure issuer and industry diversification, and maintain liquidity and overall
portfolio credit quality.
39
According to data provided by our ceding companies, the following table
reflects the market value of assets backing the funds withheld at interest
portfolio using the lowest rating assigned by the three major rating agencies.
September 30, 2006 December 31, 2005
----------------------- -------------------------
Ratings $ in millions % $ in millions %
------- ---------------- ----- ---------------- ------
AAA....................................... $ 413.4 20.0% $ 705.9 27.4%
AA........................................ 166.5 8.1 146.0 5.7
A......................................... 627.9 30.4 741.6 28.9
BBB....................................... 674.6 32.7 785.8 30.6
BB or below............................... 77.3 3.8 78.0 3.0
---------------- ----- ---------------- ------
1,959.7 95.0 2,457.3 95.6
Commercial mortgage loans................. 103.5 5.0 112.6 4.4
---------------- ----- ---------------- ------
Total..................................... $ 2,063.2 100.0% $ 2,569.9 100.0%
================ ===== ================ ======
According to data provided by our ceding companies, the following table
reflects the market value of assets backing the funds withheld at interest
portfolio by sector.
September 30, 2006 December 31, 2005
----------------------- -------------------------
Sector $ in millions % $ in millions %
------- ---------------- ----- ---------------- ------
U.S. Treasury securities and U.S.
government agency obligations............ $ 45.9 2.2% $ 62.3 2.4%
Corporate securities...................... 1,430.9 69.4 1,634.4 63.6
Municipal bonds........................... 29.2 1.4 33.0 1.3
Mortgage and asset backed securities...... 489.1 23.7 595.1 23.1
Commercial mortgage loans................. 103.5 5.0 112.6 4.4
Cash...................................... (35.4) (1.7) 132.5 5.2
---------------- ----- ---------------- ------
Total..................................... $ 2,063.2 100.0% $ 2,569.9 100.0%
================ ===== ================ ======
Liquidity and Capital Resources
Liquidity
Cash flow
Cash provided by operating activities amounted to $532.9 million in the
first nine months of 2006 compared to cash provided by operating activities of
$324.2 million in the same period of 2005. Operating cash flow includes cash
inflows from premiums, fees and investment income, and cash outflows for
benefits and expenses paid. In periods of growth of new business our operating
cash flow may decrease due to first year commissions paid on new business
generated. For income recognition purposes these commissions are deferred and
amortized over the life of the business. During the first nine months of 2006,
$442.3 million of funds withheld were released as a result of the Ballantyne Re
transaction.
We believe cash flows from operations will be positive over time. However,
they may be positive or negative in any one period depending on the amount of
new life reinsurance business written, the level of ceding commissions paid in
connection with writing that business, the level of renewal premiums earned in
the period and the timing of receipt of reinsurance receivables and settlement
of reinsurance payables.
Net cash used in investing activities was $2,253.5 million and $1,660.9
million in the nine months ended September 30, 2006 and the comparable period in
2005, respectively. The increase in cash used in investing activities
principally relates to the purchases of fixed maturity securities. In the
current year, these were primarily related to the investment of the proceeds of
the Regulation XXX transactions closed in December 2005 and May
40
2006 and the excess cash generated by operating and financing activities. In the
same period in 2005, these were primarily related to the investment of the
proceeds of the collateral finance facilities and the excess cash generated by
operating and financing activities and investment of funds received on the ING
acquisition.
Net cash provided by financing activities was $1,656.5 million in the nine
months ended September 30, 2006 and $1,028.5 million in the same period of 2005.
The current period financings included $1,760.2 million raised in collateral
finance facilities, $265.0 million from the drawdown of the Stingray facility
$147.3 milion from the prepaid variable share forward contract and reduced
slightly by approximately $500.0 million related to withdrawals from interest
sensitive contracts. Prior year financings mainly relate to collateral finance
facilities proceeds.
Credit facilities
On July 14, 2005, Scottish Annuity & Life Insurance Company (Cayman) Ltd.,
Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc. and Scottish Re Limited
entered into a $200.0 million, three-year revolving unsecured senior credit
facility with a syndicate of banks (the "$200 Million Credit Agreement"). The
facility provides capacity for borrowing and extending letters of credit. The
facility is a direct financial obligation of each of the borrowers; however,
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed the
payment of obligations of Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc.
and Scottish Re Limited. There were no outstanding borrowings at September 30,
2006. Outstanding letters of credit under this facility amounted to $42.8
million at September 30, 2006. On September 21, 2006, Scottish Annuity & Life
Insurance Company (Cayman) Ltd. gave notice that it will permanently reduce the
aggregate commitments under the $200 Million Credit Agreement, effective
September 22, 2006, to $42.8 million. The aggregate commitments under the $200
Million Credit Agreement will be further permanently reduced dollar for dollar
by the amount of each letter of credit returned undrawn or, if drawn, upon
payment of the obligation by the applicable borrower. Also on September 21,
2006, Scottish Annuity & Life Insurance Company (Cayman) Ltd. sent a notice to
the syndicate of banks that it did not wish to have the expiry dates extended
pursuant to the evergreen feature contained in the outstanding letters of credit
that were issued. The majority of such letters of credit have a current expiry
date of December 31, 2006, and the remainder have current expiry dates on or
prior to September 15, 2007. Outstanding letters of credit under the facility
amounted to $25.3 million at November 8, 2006.
On August 18, 2005, Scottish Re (Dublin) Limited entered into a $30.0
million three-year revolving, unsecured letter of credit facility with a
syndicate of banks (the "$30 Million Credit Agreement"). The facility is a
direct financial obligation of Scottish Re (Dublin) Limited, however, Scottish
Annuity & Life Insurance Company (Cayman) Ltd. has guaranteed the payment
obligations of Scottish Re (Dublin) Limited. Effective September 22, 2006,
Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Re (Dublin)
Limited terminated the $30 Million Credit Agreement. All letters of credit
outstanding under the agreement, in an aggregate of $10.0 million, were
cancelled.
The financial covenants set forth in the $200 Million Credit Agreement
require that Scottish Annuity & Life Insurance Company (Cayman) Ltd. maintain a
minimum amount of consolidated shareholders' equity (during any four quarter
period, $750.0 million plus 50% of consolidated net income for the period plus
50% of any increases to shareholders' equity during the period) and maintain a
ratio of unencumbered assets to aggregate borrowings under the facility of 1.2
times borrowings. In addition, this facility requires Scottish Re Group Limited
to maintain a minimum amount of consolidated shareholders' equity (during any
four quarter period, $760.0 million plus 50% of consolidated net income for the
period plus 50% of any increases to shareholders' equity during the period) and
a debt to capitalization ratio of less than 30%. For the purposes of computing
the financial covenants, the collateral facilities and their associated costs
are excluded. The facility also contains certain covenants on borrowing entities
in respect of, among other things, dividends or loans to the parent, debt
incurrence and affiliate transactions.
Failure to comply with the requirements of the credit facility would,
subject to grace periods, result in an event of default and we would be required
to repay any outstanding borrowings. At September 30, 2006, Scottish Annuity &
Life Insurance Company (Cayman) Ltd. and Scottish Re Group Limited were in
compliance with the financial covenants noted in the preceding paragraph.
41
The Holding Company
We are a holding company whose primary uses of liquidity include, but are
not limited to, operating expenses, the immediate capital needs of our operating
companies, dividends paid to our shareholders and interest payments on our
indebtedness. See Note 10, "Debt Obligations" in the Notes to the Consolidated
Financial Statements to our 2005 Annual Report on Form 10-K. The primary sources
of our liquidity include proceeds from our capital raising efforts, interest
income on corporate investments and dividends from operating subsidiaries. The
holding company also receives funding from its subsidiaries through transfer
pricing reflecting services performed by the holding company on behalf of its
subsidiaries. We will continue to be dependent upon these sources of liquidity.
Other Sources and Uses of Liquidity
Based on our known sources and uses of liquidity, our liquidity position is
very tight over the near term. Our most significant liquidity use relates to the
4.5% Senior Convertible Notes, pursuant to which the noteholders have the right
to put the notes to us for cash on December 6, 2006. If our outstanding credit
facility is terminated as a result of replacing the remaining $25.3 million of
letters of credit with either replacement letters of credit or assets in trust,
the restrictions on dividends or loans from Scottish Annuity & Life Insurance
Company (Cayman) Ltd. to the holding company will be removed. This will allow
cash from Scottish Annuity & Life Insurance Company (Cayman) Ltd. to be
available to repay the 4.5% Senior Convertible Notes. No assurances can be
given, however, that we will be successful in replacing these letters of credit.
During the third quarter of 2006, we successfully completed a reinsurance
transaction that provided approximately $120.0 million of liquidity to the
Company. To further enhance our liquidity position, we are pursuing discussions
with various lending institutions for alternative credit facilities and actively
negotiating reinsurance transactions to provide both liquidity and capital
relief. No assurances can be given that we will be successful in completing any
of these additional transactions to provide us with needed liquidity. To the
extent that we are not able to obtain these sources of additional liquidity, we
face the possibility of running out of liquidity as early as the end of the
second quarter of 2007 unless affirmative steps are taken to restructure or sell
our business. Over the longer term, we will need significant amounts of new
capital to support existing business and any new business. This need over the
long and short term may impact our ability to affect one or more strategic
alternatives currently being studied by the Company and the economic terms of
any such strategic alternatives.
Capital and Long-Term Debt
Total capitalization at September 30, 2006 and December 31, 2005 is as
follows:
September 30, December 31,
2006 2005
--------------- ---------------
Shareholders' equity..................................... $ 1,283,537 $ 1,271,712
Mezzanine equity......................................... 143,512 143,057
Long-term debt........................................... 244,500 244,500
--------------- ---------------
Total.................................................... $ 1,671,549 $ 1,659,269
=============== ===============
The increase in shareholders' equity is due to the settlement of the
prepaid variable share forward contract where we received $147.3 million in the
aggregate and issued an aggregate of 6.6 million ordinary shares, offset by our
net loss of $135.2 million plus other comprehensive loss of $6.1 million in the
nine months ended September 30, 2006. Other comprehensive loss includes the
increase in unrealized depreciation on investments (net of taxes and deferred
acquisition costs) of $22.1 million.
Prepaid variable share forward contract
In connection with the December 23, 2005 ordinary share offering, we
entered into forward sales agreements with affiliates of Bear, Stearns & Co.
Inc. and Lehman Brothers, Inc. (the "forward purchasers") and the forward
purchasers borrowed and sold an aggregate of approximately 3,150,000 ordinary
shares as their initial hedge of the
42
forward sale agreements. Pursuant to the forward sale agreements, the forward
purchasers agreed to pay us an aggregate of approximately $75.0 million on
September 29, 2006 and an aggregate of approximately $75.0 million on December
29, 2006, subject to our right to receive a portion of such payment prior to the
settlement dates. In exchange, on each of such dates we would deliver to the
forward purchasers a variable number of ordinary shares based on the average
market price of the ordinary shares, subject to a floor price of $22.80 and a
cap price of $28.80. We also have the right to net share settle or cash settle
the forward sale agreements. The fair value of the forward sales agreements at
inception was reflected in shareholders' equity (as a reduction in additional
paid-in capital) and the fair value is not adjusted until the settlement date of
the forward. In addition, the underwriting costs of the forward sales agreements
were reflected in shareholders' equity (as a reduction in additional paid-in
capital).
On June 26, 2006, we exercised our right of prepayment under the forward
sale agreements and received 75% of the $150.0 million proceeds totaling $110.0
million, net of prepayment discounts of $2.5 million. This prepayment was
recorded as a separate component of consolidated shareholders' equity. The total
amount of the discount related to the prepayment transaction was recorded as an
imputed dividend charge over the applicable contract settlement period. The
prepayment option on the forward sale agreements provides the counterparty
liquidation preferences that are similar to other ordinary shareholders.
On August 9, 2006, the forward purchasers notified us of the occurrence of
"Increased Cost of Stock Borrow" under the forward sale agreements and proposed
price adjustments thereto. Pursuant to the forward sales agreements, upon
receipt of such notification, we were entitled to elect to (a) agree to amend
the transactions to take into account the price adjustments; (b) pay the forward
purchasers an amount corresponding to the price adjustments; or (c) terminate
the transactions. On August 11, 2006, the forward purchasers proposed an
amendment to the forward sales agreements which provided us an additional
alternative, the acceleration of the scheduled maturity date to August 14, 2006
under each of the forward sales agreements. We agreed to this amendment on
August 14, 2006. On August 17, 2006, we received cash proceeds of $36.5 million
and issued 6.6 million ordinary shares, which satisfied in full our obligation
to deliver shares pursuant to the forward sales agreements and the forward
purchasers' obligations to pay us under such agreements. An imputed dividend was
charged to earnings based on the pro-rated amount of time that elapsed from the
original prepayment date until settlement date. The balance of the discount
reduced the net proceeds on issuance of shares.
Upon the settlement of the forward sales agreements, we have received
$147.3 million in the aggregate and issued an aggregate of 6.6 million ordinary
shares.
Long-term debt
Included in long-term debt is $115.0 million of 4.5% Senior Convertible
Notes due December 1, 2022. The notes are general unsecured obligations, ranking
on a parity in right of payment with all our existing and future unsecured
senior indebtedness, and senior in right of payment to all our future
subordinated indebtedness. We may redeem the notes at our option in whole or in
part beginning on December 6, 2006 at 100% of their principal amount plus
accrued and unpaid interest and additional amounts, if any, payable in cash. If
a change of control of Scottish Re Group Limited occurs, note holders may
require us to repurchase all or part of the notes at a repurchase price of 100%
of their principal amount plus accrued and unpaid interest and additional
amounts, if any, payable in cash. Note holders may also require us to repurchase
all or part of the notes on December 6, 2006, December 1, 2010, December 1, 2012
and December 1, 2017 at a repurchase price of 100% of their principal amount
plus accrued and unpaid interest and additional amounts, if any, payable in
cash. In addition, as a result of the recent ratings downgrade of the 4.5%
Senior Convertible Notes by Moody's, the notes are currently convertible at a
rate of 46.0617 ordinary shares per $1,000 principal amount. On conversion, we
would pay the notes in cash, based on the average sale price of our ordinary
shares for a period of 20 consecutive trading days prior to conversion.
Shareholder dividends
On July 28, 2006, the Board of Directors suspended the dividend on the
ordinary shares. All future payments of dividends are at the discretion of our
Board of Directors and will depend on our income, capital requirements,
insurance regulatory conditions, operating conditions and such other factors as
the Board of Directors may deem relevant.
Collateral
We must have sufficient assets available for use as collateral to support
borrowings, letters of credit and certain reinsurance transactions. With
reinsurance transactions, the need for collateral or letters of credit arises in
the following ways:
o Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re
(Dublin) Limited or Scottish Re Limited enter into a reinsurance
treaty with a U.S. customer which require us to contribute assets into
a reserve credit trust with a U.S. bank or issue a letter of credit to
enable the ceding company to obtain reserve credit for the reinsurance
transaction;
o Scottish Re (U.S.), Inc. enters into a reinsurance transaction which
typically incurs a need for additional statutory capital. This need
can be met by its own capital surplus, an infusion of cash or assets
from us or an affiliate or by ceding a portion of the transaction to
another company within the group or an unrelated reinsurance company,
in which case that reinsurer must provide reserve credit by
contributing assets in a reserve credit trust or a letter of credit;
o Scottish Re (U.S.), Inc. is licensed, accredited, approved or
authorized to write reinsurance in 50 states and the District of
Columbia. When Scottish Re (U.S.), Inc. enters into a reinsurance
transaction with a customer domiciled in a state in which it is not a
licensed, accredited, authorized or approved reinsurer, it likewise
must provide a reserve credit trust or letter of credit;
o Scottish Re Life Corporation is licensed, accredited, approved or
authorized to write reinsurance in 50 states, the District of
Columbia, Guam and the Federated States of Micronesia. When Scottish
Re Life Corporation enters into a reinsurance transaction with a
customer domiciled in a state in which it is not a licensed,
accredited, authorized or approved reinsurer, it likewise must provide
a reserve credit trust or letter of credit; and
o Scottish Re (U.S.), Inc. is licensed, accredited, approved or
authorized to write reinsurance in a state, it may still agree with a
customer to provide a reserve credit trust or letter of credit
voluntarily to mitigate the counter-party risk from the customer's
perspective, thereby enabling transactions that would otherwise be
unavailable or would be available only on significantly less
attractive terms.
ING Collateral Arrangement
ING is obligated to maintain collateral for the Regulation XXX and AXXX
reserve requirements of the business we acquired from them for the duration of
such requirements (which relate to state insurance law reserve requirements
applying to reserves for level premium term life insurance policies and
universal life policies). We pay ING a fee based on the face amount of the
collateral provided until satisfactory alternative collateral arrangements are
made. In the normal course of business and our capital planning we are always
looking for opportunities to relieve capital strain relating to XXX reserve
requirements for our existing business, as well as the business acquired from
ING. We completed three financing solutions relating to these requirements in
December 2005 and one in May 2006. The vast majority of the Regulation XXX
business has been permanently financed with alternative sources and the
principal obligation left for ING is related to the Regulation AXXX business.
HSBC I
In 2004, we entered into a collateral finance facility with HSBC Bank USA,
N.A. ("HSBC I"). This facility provides up to $200.0 million that can be used
to collateralize reinsurance obligations under inter-company 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 FASB
Interpretation No. 46 (revised December 2003) ("FIN 46R"), "Consolidation of
Variable Interest Entities", the trust is considered to be a variable interest
entity and we are deemed to hold the primary beneficial interest in the trust.
As a result, the trust has been consolidated in our financial statements. The
assets of the trust have been recorded as fixed maturity investments. Our
consolidated statements of income show the investment return of the
43
trust as investment income and the cost of the facility is reflected in
collateral finance facilities expense. The creditors of the trust have no
recourse against our general assets. As at September 30, 2006, $188.5 million of
this facility was being utilized.
Due to the recent rating agency downgrades after our announcement of
earnings for the second quarter, HSBC requested additional collateral under the
total return swap agreements related to both HSBC I and HSBC II (see below). In
exchange for us agreeing to provide HSBC with additional collateral of up to
$65.0 million, HSBC agreed to forbear from demanding any amounts of additional
collateral through December 6, 2006. To date, we have provided HSBC with $57
million of additional collateral, which would be increased by $8.0 million upon
the occurrence of either 1) a further rating agency downgrade of Scottish
Annuity & Life Insurance Company (Cayman) Ltd. or 2) Scottish Annuity & Life
Insurance Company (Cayman) Ltd. entering into any new liquidity source.
Stingray
On January 12, 2005, we entered into a put agreement with Stingray Investor
Trust ("Stingray") for an aggregate value of $325.0 million. Under the terms of
the put agreement, we acquired an irrevocable put option to issue funding
agreements to Stingray in return for the assets in a portfolio of 30-day
commercial paper. This put option may be exercised at any time. In addition, we
may be required to issue funding agreements to Stingray under certain
circumstances, including, but not limited to, the non-payment of the put option
premium and a non-payment of interest under any outstanding funding agreements
under the put agreement. The facility matures on January 12, 2015. This
transaction may also provide collateral for Scottish Re (U.S.), Inc. for
reinsurance obligations under inter-company reinsurance agreements. At September
30, 2006, $58.0 million was in use for this purpose. We drew down most of the
remaining funds, in the amount of $265.0 million, under this facility on August
14, 2006. The put premium and interest costs incurred during the three and nine
months ended September 30, 2006 amounted to $3.0 million and $5.4. million,
respectively, and is included in collateral finance facilities expense in the
consolidated statements of income. The put premium incurred during the three and
nine months ended September 30, 2005 amounted to $1.2 million and $3.5 million,
respectively. In accordance with FIN 46R, we are not considered to be the
primary beneficiary of Stingray and as a result we are not required to
consolidate Stingray. The $265.0 million of funds drawn on the facility are
included in interest sensitive contract liabilities on our balance sheet.
Orkney Re, Inc.
On February 11, 2005, Orkney Holdings, LLC, a Delaware limited liability
company ("Orkney I"), issued and sold in a private offering an aggregate of
$850.0 million Series A Floating Rate Insured Notes due February 11, 2035 (the
"Orkney Notes"). Orkney I was organized for the limited purpose of holding the
stock of Orkney Re, Inc., a South Carolina special purpose captive insurance
company, and issuing the Orkney Notes. Scottish Re (U.S.), Inc. holds all of the
limited liability company interest in Orkney I. Proceeds from this offering were
used to fund the Regulation XXX reserve requirements for a defined block of
level premium term life insurance policies issued between January 1, 2000 and
December 31, 2003 reinsured by Scottish Re (U.S.), Inc. to Orkney Re, Inc.
Proceeds from the Orkney Notes have been deposited into a series of trusts that
collateralize the notes.
The holders of the Orkney Notes cannot require repayment from us or any of
our subsidiaries, other than Orkney I. The timely payment of interest and
ultimate payment of principal for the Orkney Notes are guaranteed by MBIA
Insurance Corporation.
Interest on the principal amount of the Orkney Notes is payable quarterly
at a rate equivalent to three month LIBOR plus 0.53%. At September 30, 2006, the
interest rate was 5.93%. Any payment of principal, including by redemption, or
interest on the Orkney Notes is sourced from dividends from Orkney Re, Inc. and
the balances available in a series of trust accounts. Dividends may only be made
with the prior approval of the Director of Insurance of the State of South
Carolina in accordance with the terms of its licensing orders and in accordance
with applicable law. The Orkney Notes also contain a customary limitation on
lien provisions and customary events of default provisions, which, if breached,
could result in the accelerated maturity of the Orkney Notes. Orkney I has the
option to redeem all or a portion of the Orkney Notes prior to and on or after
February 11, 2010, subject to certain call premiums.
44
In accordance with FIN 46R, Orkney I is considered to be a variable
interest entity and we are considered to hold the primary beneficial interest.
As a result, Orkney I has been consolidated in our financial statements. The
assets of Orkney I have been recorded as fixed maturity investments and cash and
cash equivalents. Our consolidated statements of income show the investment
return of Orkney I as investment income and the cost of the facility is
reflected in collateral finance facilities expense.
Orkney Re II plc
On December 21, 2005, Orkney Re II plc, an orphan special purpose vehicle
incorporated under the laws of Ireland ("Orkney II"), whose issued ordinary
shares are held by a share trustee and its nominees in trust for charitable
purposes, issued in a private offering $450.0 million of debt to external
investors. The debt consisted of $382.5 million Series A-1 Floating Rate
Guaranteed Notes (the "Series A-1 Notes"), $42.5 million in aggregate principal
amount of Series A-2 Floating Rate Notes (the "Series A-2 Notes"), and $25.0
million Series B Floating Rate Notes (the "Series B Notes"), all due December
31, 2035 (collectively, the "Orkney II Notes"). The Orkney II Notes are listed
on the Irish Stock Exchange. Proceeds from this offering were used to fund the
Regulation XXX reserve requirements for a defined block of level premium term
life insurance policies issued between January 1, 2004 and December 31, 2004
reinsured by Scottish Re (U.S.), Inc. to Orkney II. Proceeds from the Orkney II
Notes have been deposited into a series of trusts that collateralize the notes.
The holders of the Orkney II Notes cannot require repayment from us or any
of our subsidiaries, only from Orkney II. Assured Guaranty (UK) Ltd. has
guaranteed the timely payment of the scheduled interest payments and the
principal on the maturity date, December 21, 2035, of the Series A-1 Notes.
Interest on the principal amount of the Orkney II Notes is payable
quarterly at a rate equivalent to three-month LIBOR plus 0.425% for the Series
A-1 Notes, three-month LIBOR plus 0.73% for the Series A-2 Notes, and
three-month LIBOR plus 3.0% for the Series B Notes. At September 30, 2006, the
interest rate on the Series A-1 Notes was 5.83%, Series A-2 Notes was 6.13%, and
Series B Notes was 8.40%. The Orkney II Notes also contain a customary
limitation on lien provisions and customary events of default provisions, which,
if breached, could result in the accelerated maturity of the Orkney II Notes.
Orkney II has the option to redeem all or a portion of the Orkney II Notes prior
to and on or after February 11, 2007, subject to certain call premiums.
In accordance with FIN 46R, Orkney II is considered to be a variable
interest entity and we are considered to hold the primary beneficial interest.
As a result, Orkney II has been consolidated in our financial statements. The
assets of Orkney II have been recorded as fixed maturity investments and cash
and cash equivalents. Our consolidated statements of income show the investment
return of Orkney II as investment income and the cost of the facility is
reflected in collateral finance facilities expense.
HSBC II
On December 22, 2005, we entered into a second collateral finance facility
with HSBC Bank USA, N.A. ("HSBC II"). This facility is a 20 year collateral
finance facility that provides up to $1.0 billion of Regulation XXX collateral
support for the business acquired from ING and can be used to collateralize
reinsurance obligations under inter-company 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 46R the trust is
considered to be a variable interest entity and we are deemed to hold the
primary beneficial interest in the trust. As a result, the trust has been
consolidated in our financial statements. The assets of the trust have been
recorded as fixed maturity investments, cash and cash equivalents. Our
consolidated statements of income show the investment return of the trust as
investment income and the cost of the facility is reflected in collateral
finance facilities expense. The creditors of the trust have no recourse against
our general assets. As at September 30, 2006, $517.9 million of this facility
was being utilized.
See HSBC I above for a discussion of the additional collateral paid to HSBC
under this facility.
45
Ballantyne Re plc
On May 2, 2006, Ballantyne Re plc, an orphan special purpose vehicle
incorporated under the laws of Ireland issued in a private offering $1.74
billion of debt to external investors and $178.0 million of debt to Scottish
Annuity & Life Insurance Company (Cayman) Ltd. The total debt issued to external
investors (collectively, the "Notes") consisted of:
o $250.0 million of Class A-1 Floating Rate Notes,
o $500.0 million of Class A-2 Floating Rate Guaranteed Notes Series A,
o $500.0 million of Class A-2 Floating Rate Guaranteed Notes Series B,
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series A,
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series B,
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series C,
o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series D,
o $10.0 million of Class B-1 7.51244% Subordinated Notes,
o $40.0 million of Class B-2 Subordinated Floating Rate Notes, and
o $42.0 million of Class C-1 Subordinated Variable Interest Rate Notes.
The debt issued to Scottish Annuity & Life Insurance Company (Cayman) Ltd.
consisted of $8.0 million of Class C-1 Subordinated Variable Interest Rate Notes
and $170.0 million Class C-2 Subordinated Variable Interest Rate Notes, which
Scottish Annuity & Life Insurance Company (Cayman) Ltd. intends to hold
(collectively, the "SALIC Notes"; and together with the Notes, the "Ballantyne
Notes"). Concurrently with its offering of the Ballantyne Notes, Ballantyne Re
issued (i) $500,000 of Class D Convertible Notes, which were purchased by
Scottish Re Group Limited, (ii) 163.0 million Redeemable Preference Shares of
U.S. $1.00 par value per share which were purchased by Scottish Annuity & Life
Insurance Company (Cayman) Ltd., and (iii) 18.2 million Non-Redeemable
Preference Shares of U.S. $1.00 par value per share which were also purchased by
Scottish Annuity & Life Insurance Company (Cayman) Ltd.
Interest on the principal amount of the Ballantyne Notes is payable in
intervals ranging from every 28 days to monthly to annually, depending on the
note, initially at a rate equivalent to one-month LIBOR plus 0.61% for the Class
A-1 Floating Rate Notes (and after May 2, 2022, one-month LIBOR plus 1.22%),
one-month LIBOR plus 0.31% for the Class A-2 Floating Rate Guaranteed Notes
Series A (and after May 2, 2027, one-month LIBOR plus 0.62%), one-month LIBOR
plus 0.36% for the Class A-2 Floating Rate Guaranteed Notes Series B (and after
May 2, 2027, one-month LIBOR plus 0.72%), 4.99%, 4.99%, 5.00% and 5.01% for
Series A, Series B, Series C, and Series D of the Class A-3 Notes, respectively
(with the rate on the Class A-3 Notes to reset every 28 days), 7.51% for the
Class B-1 Subordinated Notes, one-month LIBOR plus 2.00% for the Class B-2
Subordinated Floating Rate Notes, and a variable rate based on performance of
the underlying block of business for the Class C-1 Subordinated Variable
Interest Rate Notes and the Class C-2 Subordinated Variable Interest Rate Notes.
Proceeds from this offering were used to fund the Regulation XXX reserve
requirements for the business acquired from ING America Insurance Holdings, Inc.
$1.65 billion of the proceeds from the Ballantyne Notes have been deposited into
a series of accounts that collateralize the reserve obligations of Scottish Re
(U.S.), Inc.
The holders of the Ballantyne Notes cannot require repayment from us or any
of our subsidiaries. The timely payment of the scheduled interest payments and
the principal on the maturity date of Series A of the Class A-2 Notes and Series
A, Series B, Series C, Series D and, if issued, Series E of the Class A-3 Notes
has been guaranteed
46
by Ambac Assurance UK Limited. The timely payment of the scheduled interest
payments and the principal on the maturity date of Series B of the Class A-2
Notes and, if issued, Series F of the Class A-3 Notes has been guaranteed by
Assured Guaranty (UK) Ltd.
In accordance with FASB Interpretation No. 46 (revised December 2003) ("FIN
46R"), "Consolidation of Variable Interest Entities", Ballantyne Re is
considered to be a variable interest entity and we are considered to hold the
primary beneficial interest. As a result, Ballantyne Re is consolidated in our
financial statements beginning in the second quarter of 2006. The assets of
Ballantyne Re are recorded as fixed maturity investments and cash and cash
equivalents. Our consolidated statements of income include the investment return
of Ballantyne Re as investment income and the cost of the facility is reflected
in collateral finance facilities expense.
Reinsurance Facility
On December 22, 2005, we entered into a long term reinsurance facility
("Reinsurance Facility"), with a third-party Bermuda-domiciled reinsurer that
provides up to $1.0 billion of Regulation XXX collateral support for the
business acquired from ING. The Bermuda reinsurer provides security in the form
of letters of credit in trust equal to the statutory reserves. All risks and
returns arising out of the underlying book of business are retained by us.
Collateral Summary
At September 30, 2006, we had $3.7 billion of collateral finance facility
obligations relating to the HSBC I, HSBC II, Orkney I, Orkney II and Ballantyne
Re transactions. In connection with these transactions, we have assets in trust
of approximately $5.3 billion that represent assets supporting the economic
reserves, excess reserves, additional funding amounts and surplus in the
transactions. The assets in trust are managed in accordance with predefined
investment guidelines as to permitted investments, portfolio quality,
diversification and duration.
As described above, we have a number of facilities in place to provide
collateral for our reinsurance business, including our credit facilities, HSBC I
and Stingray. However, the aggregate commitment under the credit facility was
reduced to $42.8 million, which is the outstanding letters of credit balance at
September 30, 2006. No additional borrowing capacity is available under this
facility. In addition, our HSBC I facility has been fully utilized and it is
uncertain if a similar facility can be completed or if the current facility will
remain available for future use following a permanent Regulation XXX transaction
which would reduce the current usage of the HSBC I facility. Finally, the
Stingray facility has been fully utilized. Other existing sources of collateral
include cash and other assets which are available.
Based on our sources and uses of collateral, our collateral position
remains very tight over the near term. During the third quarter of 2006, we
successfully completed a reinsurance transaction that provided approximately
$120 million of liquidity and collateral to the Company. To further enhance our
liquidity and collateral position, we are pursuing discussions with various
lending institutions for alternative credit facilities and actively negotiating
reinsurance transactions to provide both liquidity and capital relief. No
assurances can be given that we will be successful in completing any of these
additional transactions to provide us with needed liquidity. To the extent that
we are not able to obtain these sources of additional liquidity, we face the
possibility of running out of liquidity as early as the end of the second
quarter of 2007 unless affirmative steps are taken to restructure or sell our
business. Over the longer term, we will need significant amounts of new capital
to support existing business and any new business. This need over the long and
short term may impact our ability to affect one or more strategic alternatives
currently being studied by the Company and the economic terms of any such
strategic alternatives.
Regulatory Capital Requirements
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has agreed with
Scottish Re (U.S.), Inc. that it will (1) cause Scottish Re (U.S.), Inc. to
maintain capital and surplus equal to the greater of $20.0 million or such
amount necessary to prevent the occurrence of a Company Action Level Event under
the risk-based capital laws of the State
47
of Delaware and (2) provide Scottish Re (U.S.), Inc. with enough liquidity to
meet its obligations in a timely manner.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. has agreed with
Scottish Re Life Corporation that it will (1) cause Scottish Re Life Corporation
to maintain capital and surplus equal to at least 175% of Company Action Level
RBC, as defined under the laws of the State of Delaware and (2) provide Scottish
Re Life Corporation with enough liquidity to meet its obligations in a timely
manner.
Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Re
Group Limited have agreed with Scottish Re Limited that in the event Scottish Re
Limited is unable to meet its obligations under its insurance or reinsurance
agreements, Scottish Annuity & Life Insurance Company (Cayman) Ltd. or if
Scottish Annuity & Life Insurance Company (Cayman) Ltd. cannot fulfill such
obligations, then Scottish Re Group Limited will assume all of Scottish Re
Limited's obligations under such agreements.
Scottish Re Group Limited and Scottish Annuity & Life Insurance Company
(Cayman) Ltd. have executed similar agreements for Scottish Re (Dublin) Limited
and Scottish Re Life (Bermuda) Limited and may, from time to time, execute
additional agreements guaranteeing the performance and/or obligations of their
subsidiaries.
All of our regulated insurance entities are in excess of their minimum
regulatory capital requirements as of September 30, 2006 and we expect them to
remain as such through the near term.
Tartan Capital Limited
On May 4, 2006, we entered into an agreement that provides two classes
totaling $155.0 million of collateralized catastrophe protection with Tartan
Capital Limited ("Tartan"), a special purpose Cayman Islands company which was
funded through a catastrophe bond transaction. This coverage is for the period
January 1, 2006 to December 31, 2008 and provides Scottish Annuity & Life
Insurance Company (Cayman) Ltd. with protection from losses arising from higher
than normal mortality levels within the United States, as reported by the U.S.
Centers for Disease Control and Prevention or other designated reporting agency.
This coverage is based on a mortality index, which is based on age and gender
weighted mortality rates for the United States constructed from publicly
available data sources, as defined at inception, and which compares the
mortality rates over consecutive 2 year periods to a reference index value. Upon
the occurrence of a loss event, where the indexed losses exceeds the trigger
level for a given tranche, the percentage of the original principal for each
tranche paid to Scottish Annuity & Life Insurance Company (Cayman) Ltd.
increases linearly between the trigger level and exhaustion level. Since the
amount of any recovery is based on the mortality index, the amount of the
recovery may be different than the ultimate claims paid by Scottish Annuity and
Life Insurance Company (Cayman) Ltd.'s and any of its affiliates resulting from
the loss event.
In accordance with SFAS No. 133, this contract is considered to be a
derivative. We record this contract at fair value which is included in "Other
assets" and "Other liabilities" in the Consolidated Balance Sheets with any
changes in the value reflected in "Acquisition costs and other insurance
expenses" in the Consolidated Statements of Income. There is no quoted market
value available for this derivative. The fair value is estimated utilizing
published mortality data. Expenses related to this transaction are included in
"Acquisition costs and other insurance expenses" in the Corporate and Other
Segment.
Tartan is a variable interest entity under the provisions of FIN 46R. We
are not the primary beneficiary of this entity and are, therefore, not required
to consolidate it in our consolidated financial statements.
Off Balance Sheet Arrangements
We have no obligations, assets or liabilities other than those disclosed in
the financial statements; no trading activities involving non-exchange traded
contracts accounted for at fair value; and no relationships and transactions
with persons or entities that derive benefits from their non-independent
relationship with us or our related parties.
48
New Accounting Standards
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes
In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes".
FIN 48 prescribes detailed guidance for the financial statement recognition,
measurement and disclosure of uncertain tax positions recognized in an
enterprise's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes." Tax positions must meet a "more likely than not"
recognition threshold at the effective date to be recognized upon the adoption
of FIN 48 and in subsequent periods.
FIN 48 will be effective for fiscal years beginning after December 15, 2006
and the provisions of FIN 48 will be applied to all tax positions upon initial
adoption. The cumulative effect of applying the provisions of FIN 48 will be
reported as an adjustment to the opening balance of retained earnings for that
fiscal year. We are currently evaluating the potential impact of FIN 48 on our
financial statements.
FASB Statement No. 123(R), Share-Based Payment
In December 2004, the FASB revised SFAS No. 123 by issuing SFAS No. 123(R)
which requires us to recognize, in the determination of income, the grant date
fair value of all stuck options and other equity based compensation issued to
employees. We adopted SFAS No. 123(R) on January 1, 2006.
FASB Statement No. 156, Accounting for Servicing of Financial Assets -- an
amendment of FASB Statement No. 140
In March 2006, the FASB issued Statement No. 156 ("SFAS No. 156"),
"Accounting for Servicing of Financing Assets", which permits an entity to
choose either of the following measurement methods for each class of separately
recognized servicing assets and servicing liabilities:
o Amortization method - amortize servicing assets or servicing
liabilities in proportion to and over the period of net servicing
income or net servicing loss and assess the servicing assets or
liabilities for impairment or increased obligation based on fair value
at each reporting date. This method is consistent with current
subsequent measurement guidance for servicing rights.
o Fair value measurement method - measure servicing assets or servicing
liabilities at fair value at each reporting date and report changes in
fair value in earnings in the period in which the change occurs.
SFAS No. 156 is effective as of the beginning of an entity's first fiscal
year that begins after September 15, 2006. We are currently assessing the impact
of SFAS No. 156 on our results of operations and financial position.
FASB Statement No. 157, Fair Value Measurements
In September 2006, the FASB issued Statement No. 157 ("SFAS No. 157"),
"Fair Value Measurements," which defines fair value, establishes a framework for
measuring fair value under GAAP and expands disclosures about fair value
measurements. We are required to adopt SFAS No. 157 on January 1, 2008 and are
evaluating the implications of SFAS No. 157 on our results of operations and
financial position.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Please refer to Part II "Item 1a: Risk Factors" and "Item 7A: Quantitative
and Qualitative Disclosures about Market Risk" in our 2005 Annual Report.
49
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures
Our Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on
such evaluation, such officers have concluded that our disclosure controls and
procedures were effective as of September 30, 2006 to ensure that information
required to be disclosed by us in the reports filed and submitted by us under
the Exchange Act were recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms.
Changes in internal controls
- ----------------------------
There have not been any changes in our internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated by the SEC
under the Securities Exchange Act of 1934) during our most recently completed
fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
50
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On August 2, 2006, a putative class action lawsuit was filed against us;
Glenn Schafer, the Chairman of our Board of Directors; Dean E. Miller, our Chief
Financial Officer; Scott E. Willkomm, our former Chief Executive Officer; and
Seth Vance, our former Chief Executive Officer - North America, in the U.S.
District Court for the Southern District of New York ("S.D.N.Y.") on behalf of a
putative class consisting of investors who purchased our publicly traded
securities between December 16, 2005 and July 28, 2006. Between August 7, 2006
and October 2, 2006, seven additional related class action lawsuits were filed
against us, certain of our current and former officers and directors, and
certain third parties. Each of the eight complaints filed alleges that the
defendants made materially false and misleading statements and/or omissions
concerning our business and operations, thereby causing investors to purchase
our securities at artificially inflated prices, in violation of Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and Rule l0b-5 promulgated thereunder. Two of the complaints also allege
violations of Sections 11 and 15 of the Securities Act of 1933, related to a
2005 preferred stock offering. Each of the class actions filed seek an
unspecified amount of damages, as well as other forms of relief. On October 12,
2006, all of the class actions were consolidated. We contest the allegations
that have been asserted and plan to vigorously defend our interests in the
actions.
In addition, on or about October 20, 2006, a shareholder derivative lawsuit
was filed against our directors in the U.S. District Court for the Southern
District of New York. The derivative lawsuit alleges, among other things, that
defendants improperly permitted us to make false and misleading statements to
investors concerning our business and operations, thereby exposing us to
liability from class action suits alleging violations of the U.S. securities
laws. The derivative lawsuit asserts claims against defendants for breach of
fiduciary duty, abuse of control, gross mismanagement, constructive fraud, and
unjust enrichment.
Item 1a. Risk Factors
The recent downgrades, and any further downgrades, could make us less
competitive and will increase our cost of capital.
Ratings are an important factor in attracting business in our life
reinsurance business. Rating organizations periodically review the financial
performance and condition of insurers, including our insurance subsidiaries.
Rating organizations assign ratings based upon several factors. Although most of
the factors considered relate to the rated company, some of the factors take
into account general economic conditions and circumstances outside the rated
company's control. The objective of rating organizations is to provide an
opinion of an insurer's financial strength and ability to meet ongoing
obligations to its policyholders. These ratings are subject to periodic review
by the relevant rating agency and may be revised downward or withdrawn at the
sole discretion of the rating agency. In addition, these ratings are not an
evaluation directed to investors in our securities and are not recommendations
to buy, sell or hold our securities. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Overview - Status of Credit
and Financial Strength Ratings" for a description of our subsidiaries' ratings.
The rating agencies have warned that further adverse developments in the
business, including with respect to additional one-time charges, loss of
in-force business and liquidity, could cause them to downgrade our ratings.
Although there are few in-force treaties with recapture provisions that are
triggered by a ratings downgrade, the recent downgrades have and will continue
to adversely affect our ability to sell products, write new treaties, retain
existing business (through the termination of open treaties for new business),
and compete for attractive acquisition opportunities. In addition, as a result
of the downgrades, the interest rates for our credit facilities and
securitization transactions have increased. Our ability to raise capital for our
business and the cost of such capital will be adversely affected by downgrades
in our credit ratings.
Our inability to attract and retain qualified employees or the loss of any of
our key employees could negatively impact our business.
Our success substantially depends upon our ability to attract and retain
qualified employees and upon the ability of our senior management and other key
employees to implement our business strategy. We believe there are only a
limited number of available qualified executives in the business lines in which
we compete. We rely substantially upon the services of Glenn Schafer, the
non-executive Chairman of our Board of Directors; Bill Caulfeild-Browne,
Vice-Chairman of our Board of Directors; Paul Goldean, our President and Chief
Executive Officer; David Howell, the Chief Executive Officer of our Life
Reinsurance International Segment; Hugh McCormick, our Executive Vice President
of Corporate Development; Dean Miller, our Chief Financial Officer; and Clifford
Wagner, the Chief Executive Officer of our Life Reinsurance North America
Segment. Each of the foregoing members of senior management has employment
agreements and we maintain a $2,500,000 key man life insurance policy for Mr.
51
Wagner. The loss of the services of members of our senior management, or our
inability to hire and retain other talented personnel from the very limited pool
of qualified insurance professionals, could delay or prevent us from fully
implementing our business strategy which could harm our financial performance.
Our ability to pay dividends depends on our subsidiaries' ability to distribute
funds to us.
We are a holding company, with our principal assets consisting of the stock
of our insurance company subsidiaries. Our ability to pay dividends on our
ordinary shares, HyCUs, our non-cumulative perpetual preferred shares, and to
pay debt service on any of our indebtedness, depends significantly on the
ability of our insurance company subsidiaries, our principal sources of cash
flow, to declare and distribute dividends or to advance money to us in the form
of intercompany loans or service fees. Our insurance company subsidiaries are
subject to various state and foreign government statutory and regulatory
restrictions applicable to insurance companies generally that limit the amount
of dividends, loans and advances and other payments to affiliates. Our existing
credit facility also contains restrictions on the ability of Scottish Annuity &
Life Insurance Company (Cayman) Ltd. and certain of our operating subsidiaries
to pay dividends or make loans to us. If insurance regulators at any time
determine that payment of a dividend or any other payment to an affiliate would
be detrimental to an insurance subsidiary's policyholders or creditors, because
of the financial condition of the insurance subsidiary or otherwise, the
regulators may block dividends or other payments to affiliates that would
otherwise be permitted without prior approval.
The market price for our ordinary shares has been and may continue to be highly
volatile.
The market price for our ordinary shares has fluctuated significantly,
ranging between $24.84 per share on March 31, 2006 and $2.95 per share on July
31, 2006. The overall market and the price of our ordinary shares may continue
to be volatile. There may be a significant effect on the market price for our
ordinary shares due to, among other things:
o changes in investors' and analysts' perceptions of the risks and
conditions of our business,
o changes in investors' and analysts' perception of the likelihood of
our completing any strategic alternatives,
o the size of the public float of our ordinary shares,
o the announcement of acquisitions by us or our competitors,
o variations in our anticipated or actual operating results or the
results of our competitors,
o regulatory developments,
o market conditions, and
o general economic conditions.
Future transactions or changes in our financial condition may limit our ability
to use our net operating loss carry forwards.
As of December 31, 2005, we had actual net operating loss carry forwards,
or NOLs, of approximately $615.5 million of which $603.1 million was
attributable to the U.S. operations and $12.4 million was attributable to the
U.K. operations. The U.K. NOL has an unlimited carry forward period. The U.S.
NOLs may be used to offset future taxable income and thereby reduce our U.S.
federal income taxes otherwise payable. Section 382 of the Internal Revenue Code
imposes an annual limit on the ability of a corporation that undergoes an
"ownership change" to use its NOLs to reduce its tax liability. It is possible
that future transactions (including issuances of new shares and sales of our
shares) would cause us to undergo an ownership change. In that event, we would
not be able to use our pre-ownership-change NOLs in excess of the limitation
imposed by Section 382. This would also result in a write-off of our associated
transferred tax asset for GAAP purposes.
52
We generate deferred tax assets principally due to NOLs, reserves and
unrealized losses on investment securities. In accordance with SFAS No. 109, we
must conclude whether the future realization of our deferred tax asset is "more
likely than not". The evaluation regarding realizability of deferred tax assets
is made on a gross as opposed to a net basis. Sources of support for the gross
deferred tax asset are the reversal of deferred tax liabilities within the carry
forward period (which in the United States is 15 years), projected future
taxable income and tax planning strategies. Pursuant to the guidance under SFAS
No. 109, we are currently unable to rely on projections of future taxable
income. Therefore, we must rely heavily on tax planning strategies for support
of the gross deferred tax asset. Prior to the quarter ended June 30, 2006, these
tax planning strategies provided justification to support our deferred tax
asset. The combination of the increased pressure on our existing tax planning
strategies, the operating loss for the quarter, and the prospects of a ratings
downgrade during the second quarter led management to conclude that it was no
longer "more likely than not" that the full amount of the gross deferred tax
asset could be realized. Accordingly, we established a valuation allowance of
$112.4 million and $30.1 million during the second and third quarter of 2006,
respectively. The valuation allowance principally relates to current period tax
benefit not being recognized (as previously indicated, the Company can no longer
recognize tax benefits for certain legal entities) and an additional valuation
allowance established on prior period deferred tax assets resulting from revised
statutory and tax projections related to certain legal entities. At the end of
the third quarter, the remaining gross deferred tax asset is supported by the
reversal of deferred tax liabilities within the carry forward period and tax
planning strategies for which management believes that it is more likely than
not that the deferred tax assets will be utilized in subsequent periods,
although there is a risk that we will need to establish additional valuation
allowances in future quarters. Management will continue to assess and determine
the need for, and the amount of, the valuation allowance in subsequent periods
in accordance with the requirements of SFAS No. 109, and there is a risk that we
may need to establish additional valuation allowances in future quarters, which
could adversely impact our reported earnings and financial condition.
Several class action securities lawsuits have been filed against us and certain
of our current and former officers and directors, and we cannot predict the
outcome of these lawsuits.
We and certain of our current and former officers and directors have been
named defendants in federal securities class action lawsuits. The plaintiffs in
these lawsuits may make additional claims, expand existing claims and/or expand
the time periods covered by the complaints, and other plaintiffs may bring
additional actions with other claims. We expect to incur significant defense
costs regardless of the outcome of these lawsuits. If we do not prevail in any
such actions, we could be required to pay substantial damages or settlement
costs, part or all of which may not be covered by insurance. These lawsuits may
result in a diversion of our management's time and attention and the incurrence
of increased costs.
Our existing sources of liquidity and collateral may be insufficient or
unavailable to fund our expected future liquidity needs and we are required to
raise new sources of equity capital, liquidity and collateral , which sources,
if available, will be on less advantageous terms than our historical sources.
Based on our known sources and uses of liquidity, our liquidity position is
very tight over the near term. Our most significant liquidity use relates to the
4.5% Senior Convertible Notes, pursuant to which the noteholders have the right
to put the notes to us for cash on December 6, 2006. As a result of the losses
in the second quarter of 2006, we have either completely drawn down or
terminated certain of our liquidity facilities, including for example our bank
credit facility and the Stingray facility. During the third quarter of 2006, we
successfully completed a reinsurance transaction that provided approximately
$120.0 million of liquidity to the Company, and to further enhance our liquidity
position, we are pursuing discussions with various lending institutions for
alternative credit facilities and capital and negotiating reinsurance
transactions. Without new sources of capital we face the risk of running out of
liquidity as early as the end of the second quarter of 2007. No assurances can
be given that we will be successful in completing any of these alternatives, and
if not successful and we are not otherwise able to consummate one or more
strategic alternatives of selling the Company or raising equity capital by the
end of the second quarter of 2007, we will face a default on our obligations to
fund our collateral and to meet our capital needs.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
53
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable.
Item 6. Exhibits
Except as otherwise indicated, the following Exhibits are filed herewith
and made a part hereof:
3.1 Memorandum of Association of Scottish Re Group Limited, as amended
as of April 7, 2005 (incorporated herein by reference to Scottish Re
Group Limited's Current Report on Form 8-K). (6)
3.2 Articles of Association of Scottish Re Group Limited, as amended as
of April 7, 2005 (incorporated herein by reference to Scottish Re
Group Limited's Current Report on Form 8-K). (6)
4.1 Specimen Ordinary Share Certificate (incorporated herein by
reference to Exhibit 4.1 to Scottish Re Group Limited's Registration
Statement on Form S-1). (1)
4.2 Form of Amended and Restated Class A Warrant (incorporated herein by
reference to Exhibit 4.2 to Scottish Re Group Limited's Registration
Statement on Form S-1). (1)
4.3 Form of Securities Purchase Agreement for the Class A Warrants
(incorporated herein by reference to Exhibit 4.4 to Scottish Re
Group Limited's Registration Statement on Form S-1). (1)
4.4 Form of Securities Purchase Agreement between Scottish Re Group
Limited and the Shareholder Investors (incorporated herein by
reference to Exhibit 4.10 to Scottish Re Group Limited's
Registration Statement on Form S-1). (1)
4.5 Form of Securities Purchase Agreement between Scottish Re Group
Limited and the Non-Shareholder Investors (incorporated herein by
reference to Exhibit 4.12 to Scottish Re Group Limited's
Registration Statement on Form S-1). (1)
4.6 Certificate of Designations of Convertible Preferred Shares of
Scottish Re Group Limited (incorporated herein by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (10)
4.7 Certificate of Designations of Scottish Re Group Limited's
Non-Cumulative Perpetual Preferred Shares, dated June 28, 2005
(incorporated herein by reference to Scottish Re Group Limited's
Current Report on Form 8-K). (16)
4.8 Specimen Stock Certificate for the Company's Non-Cumulative
Perpetual Preferred Shares (incorporated herein by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (16)
10.1 Employment Agreement dated June 18, 1998 between Scottish Re Group
Limited and Michael C. French (incorporated herein by reference to
Exhibit 10.1 to Scottish Re Group Limited's Registration Statement
on Form S-1). (1)(22)
54
10.2 Second Amended and Restated 1998 Stock Option Plan effective October
22, 1998 (incorporated herein by reference to Exhibit 10.3 to
Scottish Re Group Limited's Registration Statement on Form S-1).
(1)(22)
10.3 Form of Stock Option Agreement in connection with 1998 Stock Option
Plan (incorporated herein by reference to Exhibit 10.4 to Scottish
Re Group Limited's Registration Statement on Form S-1). (1)(22)
10.4 Investment Management Agreement dated October 22, 1998 between
Scottish Re Group Limited and General Re-New England Asset
Management, Inc. (incorporated herein by reference to Exhibit 10.14
to Scottish Re Group Limited's Registration Statement on Form S-1).
(1)
10.5 Form of Omnibus Registration Rights Agreement (incorporated herein
by reference to Exhibit 10.17 to Scottish Re Group Limited's
Registration Statement on Form S-1). (1)
10.6 1999 Stock Option Plan (incorporated herein by reference to Exhibit
10.14 to Scottish Re Group Limited's 1999 Annual Report on Form
10-K). (2)(22)
10.7 Form of Stock Options Agreement in connection with 1999 Stock Option
Plan (incorporated herein by reference to Exhibit 10.15 to Scottish
Re Group Limited's 1999 Annual Report on Form 10-K). (2)(22)
10.8 Employment Agreement dated September 18, 2000 between Scottish Re
(U.S.), Inc. and Oscar R. Scofield (incorporated herein by reference
to Exhibit 10.16 to Scottish Re Group Limited's 2000 Annual Report
on Form 10-K). (3)(22)
10.9 Share Purchase Agreement by and between Scottish Re Group Limited
and Pacific Life dated August 6, 2001 (incorporated by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (7)
10.10 Amendment No. 1, dated November 8, 2001, to Share Purchase Agreement
dated August 6, 2001 by and between Scottish Re Group Limited and
Pacific Life (incorporated by reference to Scottish Re Group
Limited's Current Report on Form 8-K). (5)
10.11 2001 Stock Option Plan (incorporated herein by reference to Exhibit
10.17 to Scottish Re Group Limited's 2001 Annual Report on Form
10-K). (4)(22)
10.12 Form of Nonqualified Stock Option Agreement in connection with 2001
Stock Option Plan (incorporated herein by reference to Exhibit 10.17
to Scottish Re Group Limited's 2001 Annual Report on Form 10-K).
(4)(22)
10.13 Tax Deed of Covenant dated December 31, 2001 between Scottish Re
Group Limited and Pacific Life (incorporated by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (5)
10.14 Letter Agreement dated December 28, 2001 between Scottish Re Group
Limited and Pacific Life (incorporated by reference to Scottish Re
Group Limited's Current Report on Form 8-K). (5)
10.15 Form of Indemnification Agreement between Scottish Re Group Limited
and each of its directors and officers (incorporated by reference to
Scottish Re Group Limited's Amended Quarterly Report on Form 10-Q/A
for the period ended September 30, 2002). (8)(22)
10.16 Employment Agreement dated July 1, 2002 between Scottish Annuity &
Life Insurance Company (Cayman) Ltd. and Thomas A. McAvity, Jr.
(incorporated by reference to Scottish Re Group Limited's Amended
Quarterly Report on Form 10-Q/A for the period ended September 30,
2002). (8)(22)
10.17 Employment Agreement dated June 1, 2002 between Scottish Re Group
Limited and Paul Goldean (incorporated herein by reference to
Scottish Re Group Limited's Quarterly Report on Form 10-Q for the
period ended March 31, 2004). (14)(22)
55
10.18 Employment Agreement dated July 1, 2002 between Scottish Re Group
Limited and Elizabeth Murphy (incorporated by reference to Scottish
Re Group Limited's Amended Quarterly Report on Form 10-Q/A for the
period ended September 30, 2002). (8)(22)
10.19 Employment Agreement dated June 1, 2002 between Scottish Re Group
Limited and Clifford J. Wagner (incorporated by reference to
Scottish Re Group Limited's Amended Quarterly Report on Form 10-Q/A
for the period ended September 30, 2002). (8)(22)
10.20 Employment Agreement dated July 8, 2002 between Scottish Re Group
Limited and Scott E. Willkomm (incorporated by reference to Scottish
Re Group Limited's Amended Quarterly Report on Form 10-Q/A for the
period ended September 30, 2002). (8)(22)
10.21 Employment Agreement dated February 10, 2003 between Scottish Re
(Group Limited and Michael C. French (incorporated herein by
reference to Scottish Re Group Limited's 2002 Annual Report on Form
10-K). (12)(22)
10.22 Employment Agreement dated February 10, 2003 between Scottish Re
(U.S.), Inc. and Oscar R. Scofield (incorporated herein by reference
to Scottish Re Group Limited's 2002 Annual Report on Form 10-K).
(12)(22)
10.23 Amended Employment Agreement dated February 10, 2003 between
Scottish Re Group Limited and Thomas A. McAvity (incorporated herein
by reference to Scottish Re Group Limited's 2002 Annual Report on
Form 10-K). (12)(22)
10.24 Indenture, dated November 22, 2002, between Scottish Re Group
Limited and The Bank of New York (incorporated herein by reference
to Scottish Re Group Limited's Registration Statement on Form S-3).
(9)
10.25 Registration Rights Agreement, dated November 22, 2002, by and among
Scottish Re Group Limited and Bear Stearns & Co. and Putnam Lovell
Securities Inc. (incorporated herein by reference to Scottish Re
Group Limited's Registration Statement on Form S-3). (9)
10.26 Employment Agreement dated May 1, 2003 between Scottish Re Holdings
Limited and David Huntley (incorporated herein by reference to
Scottish Re Group Limited's Quarterly Report on Form 10-Q for the
period ended September 30, 2003). (13)(22)
10.27 Stock Purchase Agreement, dated as of October 24, 2003, by and among
Scottish Re Group Limited, Scottish Holdings, Inc. and Employers
Reinsurance Corporation (incorporated herein by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (11)
10.28 Tax Matters Agreement, dated as of January 22, 2003, by and among
Scottish Re Group Limited, Scottish Holdings, Inc. and Employers
Reinsurance Corporation (incorporated herein by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (11)
10.29 Transition Services Agreement, dated as of January 22, 2003, by and
among Scottish Holdings, Inc. and Employers Reinsurance Corporation
(incorporated herein by reference to Scottish Re Group Limited's
Current Report on Form 8-K). (11)
10.30 Employment Agreement dated April 21, 2004, by and among Scottish
Holdings, Inc. and Seth W. Vance (incorporated herein by reference
to Scottish Re Group Limited's Quarterly Report on Form 10-Q for the
period ended March 31, 2004). (14)(22)
10.31 Amendment to Employment Agreement dated March 29, 2004, by and
between Scottish Re (U.S.), Inc. and Oscar R. Scofield (incorporated
herein by reference to Scottish Re Group Limited's Quarterly Report
on Form 10-Q for the period ended June 30, 2004, filed with the SEC
on August 9, 2004). (22)
56
10.32 Asset Purchase Agreement, dated as of October 17, 2004, by and among
Security Life of Denver Insurance Company, Security Life of Denver
International Limited, ING America Insurance Holdings, Inc. (for
purposes of Section 11.11), Scottish Re Group Limited, Scottish Re
(U.S.), Inc., Scottish Annuity & Life Insurance Company (Cayman)
Ltd. (for purposes of Section 5.26) and Scottish Re Life Corporation
(for purposes of Section 5.24) (incorporated herein by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (15)
10.33 Securities Purchase Agreement, dated as of October 17, 2004, by and
among Scottish Re Group Limited and Cypress Merchant B Partners II
(Cayman) L.P., Cypress Merchant Banking II-A C.V., 55th Street
Partners II (Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P.
(including form of Subordinated Note, Class C Warrant, Shareholders'
Agreement and Amendments to Articles of Association) (incorporated
herein by reference to Scottish Re Group Limited's Current Report on
Form 8-K). (15)
10.34 Form of Voting Agreement, by and among Cypress Merchant B Partners
II (Cayman) L.P., Cypress Merchant Banking Il-A C.V., 55th Street
Partners II (Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P.,
Scottish Re Group Limited and, respectively, each director and each
officer of Scottish Re Group Limited (incorporated herein by
reference to Scottish Re Group Limited's Current Report on Form
8-K). (15)
10.35 Voting Agreement, dated as of October 15, 2004, by and among
Scottish Re Group Limited, Cypress Merchant B Partners II (Cayman)
L.P., Cypress Merchant Banking II-A C.V., 55th Street Partners II
(Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P. and Pacific
Life Insurance Company (incorporated herein by reference to Scottish
Re Group Limited's Current Report on Form 8-K). (15)
10.36 Letter Agreement, dated as of October 17, 2004, by and among
Scottish Re Group Limited and Cypress Merchant B Partners II
(Cayman) L.P., Cypress Merchant Banking II-A C.V., 55th Street
Partners II (Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P.
(incorporated herein by reference to Scottish Re Group Limited's
Current Report on Form 8-K). (15)
10.37 First Supplemental Indenture, dated as of October 26, 2004, between
Scottish Re Group Limited and The Bank of New York (incorporated
herein by reference to Scottish Re Group Limited's Current Report on
Form 8-K, filed with the SEC on October 29, 2004).
10.38 Amendment to Employment Agreement dated as of March 29, 2004, by and
among the Company and Michael C. French (incorporated herein by
reference to Scottish Re Group Limited's Quarterly Report on Form
10-Q for the nine month period ended September 30, 2004, filed with
the SEC on November 8, 2004). (22)
10.39 Employment Agreement, dated as of March 29, 2004, by and among the
Company and Deborah G. Percy (incorporated herein by reference to
Scottish Re Group Limited's Quarterly Report on Form 10-Q for the
nine month period ended September 30, 2004, filed with the SEC on
November 8, 2004). (22)
10.40 Employment Agreement, dated as of January 1, 2005, between Scottish
Holdings, Inc. and Gary Dombowsky (incorporated herein by reference
to Scottish Re Group Limited's 2004 Annual Report on Form 10-K).
(20)(22)
10.41 Amendment to Employment Agreement, dated as of February 7, 2005,
between Scottish Re Group Limited and Michael C. French
(incorporated herein by reference to Scottish Re Group Limited's
2004 Annual Report on Form 10-K). (20)(22)
10.42 Employment Agreement, dated as of February 1, 2005, between Scottish
Re Group Limited and Hugh T. McCormick (incorporated herein by
reference to Scottish Re Group Limited's 2004 Annual Report on Form
10-K). (20)(22)
57
10.43 Employment Agreement, dated as of December 1, 2004, between Scottish
Holdings, Inc. and Kenneth R. Stott (incorporated herein by
reference to Scottish Re Group Limited's 2004 Annual Report on Form
10-K). (20)(22)
10.44 Credit Agreement, dated as of December 29, 2004, among Scottish
Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re (Dublin)
Limited, Scottish Re (U.S.), Inc., and Scottish Re Limited, as
borrowers, Bear Stearns Corporate Lending, Inc. and Wachovia Bank,
National Association as Co-Syndication Agents, Bank of America,
N.A., as Administrative Agent and L/C Issuer, and The Other Lenders
Party Hereto, Banc of America Securities LLC, as Sole Lead Arranger
and Sole Book Manager (incorporated herein by reference to Scottish
Re Group Limited's 2004 Annual Report on Form 10-K). (20)
10.45 Administrative Services Agreement, dated as of December 31, 2004,
between Security Life of Denver Insurance Company and Security Life
of Denver International Limited and Scottish Re (U.S.), Inc.
(incorporated herein by reference to Scottish Re Group Limited's
2004 Annual Report on Form 10-K). (20)
10.46 Coinsurance Agreement dated December 31, 2004 between Security Life
of Denver Insurance Company and Scottish Re (U.S.), Inc.
(incorporated herein by reference to Scottish Re Group Limited's
2004 Annual Report on Form 10-K). (20)
10.47 Coinsurance/Modified Coinsurance Agreement, dated December 31, 2004,
between Security Life of Denver Insurance Company and Scottish Re
(U.S.), Inc. (incorporated herein by reference to Scottish Re Group
Limited's 2004 Annual Report on Form 10-K). (20)
10.48 Retrocession Agreement, dated December 31, 2004, between Scottish Re
(U.S.), Inc. and Security Life of Denver Insurance Company
(incorporated herein by reference to Scottish Re Group Limited's
2004 Annual Report on Form 10-K). (20)
10.49 Retrocession Agreement, dated December 31, 2004, between Scottish Re
Life (Bermuda) Limited Bermuda and Security Life of Denver Insurance
Company (incorporated herein by reference to Scottish Re Group
Limited's 2004 Annual Report on Form 10-K). (20)
10.50 Reserve Trust Agreement, dated as of December 31, 2004, between
Scottish Re (U.S.) Inc., as Grantor, and Security Life of Denver
Insurance Company, as Beneficiary, and The Bank of New York, as
Trustee, and The Bank of New York, as Securities Intermediary
(incorporated herein by reference to Scottish Re Group Limited's
2004 Annual Report on Form 10-K). (20)
10.51 Security Trust Agreement, dated as of December 31, 2004, by and
among Scottish Re (U.S.), Inc., as Grantor, Security Life of Denver
Insurance Company, as Beneficiary, The Bank of New York, as Trustee,
and The Bank of New York, as Securities Intermediary (incorporated
herein by reference to Scottish Re Group Limited's 2004 Annual
Report on Form 10-K). (20)
10.52 Coinsurance Agreement, dated December 31, 2004, between Security
Life of Denver International Limited and Scottish Re Life (Bermuda)
Limited (incorporated herein by reference to Scottish Re Group
Limited's 2004 Annual Report on Form 10-K). (20)
10.53 Coinsurance/Modified Coinsurance Agreement, dated December 31, 2004,
between Security Life of Denver International Limited and Scottish
Re Life (Bermuda) Limited (incorporated herein by reference to
Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20)
10.54 Coinsurance Funds Withheld Agreement, dated December 31, 2004,
between Security Life of Denver International Limited and Scottish
Re Life (Bermuda) Limited (incorporated herein by reference to
Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20)
58
10.55 Reserve Trust Agreement, dated December 31, 2004, between Scottish
Re Life (Bermuda) Limited, as Grantor, and Security Life of Denver
International Limited, as Beneficiary, and The Bank of New York, as
Trustee, and The Bank of New York, as Securities Intermediary
(incorporated herein by reference to Scottish Re Group Limited's
2004 Annual Report on Form 10-K). (20)
10.56 Security Trust Agreement, dated as of December 31, 2004, by and
among Scottish Re Life (Bermuda) Limited, as Grantor, Security Life
of Denver International Limited, as Beneficiary, The Bank of New
York, as Trustee, and the Bank of New York, as Securities
Intermediary (incorporated herein by reference to Scottish Re Group
Limited's 2004 Annual Report on Form 10-K). (20)
10.57 Technology Transfer and License Agreement, dated as of December 31,
2004, between Security Life of Denver Insurance Company, ING North
America Insurance Corporation and Scottish Re (U.S.), Inc.
(incorporated herein by reference to Scottish Re Group Limited's
2004 Annual Report on Form 10-K). (20)
10.58 Transition and Integration Services Agreement, dated December 31,
2004, between Security Life of Denver Insurance Company and Scottish
Re (U.S.), Inc. (incorporated herein by reference to Scottish Re
Group Limited's Current Report on Form 8-K). (19)
10.59 Form of Remarketing Agreement, between the Company and Lehman
Brothers, Inc., as Remarketing Agent (incorporated herein by
reference to Scottish Re Group Limited's Current Report on Form
8-K). (16)
10.60 Amended and Restated Credit Agreement, dated as of July 14, 2005,
among Scottish Annuity & Life Insurance Company (Cayman) Ltd.,
Scottish Re (Dublin) Limited, Scottish Re (U.S.), Inc., and Scottish
Re Limited, as Borrowers, Bear Stearns Corporate Lending, Inc., HSBC
Bank USA, National Association, and Wachovia Bank, National
Association as Syndication Agents, Bank of America, N.A., as
Administrative Agent and L/C Issuer, and the Other Lenders Party
Hereto, Banc of America Securities LLC, as Sole Lead Arranger and
Sole Book Manager (incorporated herein by reference to Scottish Re
Group Limited's Current Report on Form 8-K). (17)
10.61 Scottish Re Group Limited 2004 Equity Incentive Compensation Plan
(incorporated herein by reference to Scottish Re Group Limited's
Proxy Statement filed with the SEC on April 1, 2004).
10.62 Amendment No. 1 to Scottish Re Group Limited 2004 Equity Incentive
Compensation Plan (incorporated herein by reference to Scottish Re
Group Limited's Current Report on Form 8-K). (18) (22)
10.63 Amendment No. 2 to Scottish Re Group Limited 2004 Equity Incentive
Compensation Plan (incorporated herein by reference to Scottish Re
Group Limited's Current Report on Form 8-K). (18) (22)
10.64 Form of Management Stock Option Agreement under the Scottish Re
Group Limited 2004 Equity Incentive Compensation Plan (incorporated
herein by reference to Scottish Re Group Limited's Current Report on
Form 8-K). (18) (22)
10.65 Form of Management Performance Share Unit Agreement under the
Scottish Re Group Limited 2004 Equity Incentive Compensation Plan
(incorporated herein by reference to Scottish Re Group Limited's
Current Report on Form 8-K). (18) (22)
10.66 Form of Management Restricted Share Unit Agreement under the
Scottish Re Group Limited 2004 Equity Incentive Compensation Plan
(incorporated herein by reference to Scottish Re Group Limited's
Current Report on Form 8-K). (18) (22)
59
10.67 Employment Agreement, dated as of July 18, 2005, between Scottish Re
Group Limited and Dean Miller (incorporated herein by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (19) (22)
10.68 Letter of Credit Agreement, dated as of August 18, 2005, among
Scottish Re (Dublin) Limited, as Borrower, Scottish Annuity & Life
Insurance Company (Cayman) Ltd., as Guarantor, Bank of America,
N.A., as Administrative Agent and L/C Issuer, and the Other Lenders
Party Hereto, and Bank of America Securities LLC, as Sole Lead
Arranger and Sole Book Manager (incorporated herein by reference to
Scottish Re Group Limited's Current Report on Form 8-K). (21)
10.69 Amendment to Employment Agreement, dated as of October 29, 2006,
between Scottish Re Group Limited and Paul Goldean (incorporated
herein by reference to Scottish Re Group Limited's Current Report on
Form 8-K which was filed with the SEC on November 2, 2006).
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ----------
(1) Scottish Re Group Limited's Registration Statement on Form S-1
was filed with the SEC on June 19, 1998, as amended.
(2) Scottish Re Group Limited's 1999 Annual Report on Form 10-K
was filed with the SEC on April 3, 2000.
(3) Scottish Re Group Limited's 2000 Annual Report on Form 10-K
was filed with the SEC on March 30, 2001.
(4) Scottish Re Group Limited's 2001 Annual Report on Form 10-K
was filed with the SEC on March 5, 2002.
(5) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on December 31, 2001.
(6) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on June 2, 2005.
(7) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on August 9, 2001.
(8) Scottish Re Group Limited's Amended Quarterly Report on Form
10-Q/A was filed with the SEC on August 8, 2002.
(9) Scottish Re Group Limited's Registration Statement on Form S-3
was filed with the SEC on January 31, 2003, as amended.
(10) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on December 17, 2003.
60
(11) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on January 6, 2004.
(12) Scottish Re Group Limited's 2002 Annual Report on Form 10-K
was filed with the SEC on March 31, 2003.
(13) Scottish Re Group Limited's Quarterly Report on Form 10-Q was
filed with the SEC on August 12, 2003.
(14) Scottish Re Group Limited's Quarterly Report on Form 10-Q was
filed with the SEC on May 10, 2004.
(15) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on October 21, 2004.
(16) Scottish Re Group Limiteds Current Report on Form 8-K was
tiled with the SEC on July 1, 2005.
(17) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on July 18, 2005.
(18) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on August 8, 2005.
(19) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on August 4, 2005.
(20) Scottish Re Group Limited's 2004 Annual Report on Form 10-K
was filed with the SEC on March 18, 2005.
(21) Scottish Re Group Limited's Current Report on Form 8-K was
filed with the SEC on August 22, 2005.
(22) This exhibit is a management contract or compensatory plan or
arrangement.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SCOTTISH RE GROUP LIMITED
Date: November 9, 2006 By: /s/ Paul Goldean
--------------------
Paul Goldean
President and Chief Executive Officer
Date: November 9, 2006 By: /s/ Dean E. Miller
----------------------
Dean E. Miller
Chief Financial Officer
62