1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INDUSTRY OVERVIEW
The demand for insurance is influenced primarily by general economic conditions,
while the supply of insurance is directly related to available capacity, i.e.,
the level of policyholders' surplus employed in the industry and the willingness
of insurance management to risk that capital. The adequacy of premium rates is
affected mainly by the severity and frequency of claims, which are influenced by
many factors, including natural disasters, regulatory measures and court
decisions that define and expand the extent of coverage and the effects of
economic inflation on the amount of compensation due for injuries or losses. In
addition, investment rates of return may impact policy rates. These factors can
have a significant impact on ultimate profitability because a property casualty
insurance policy is priced before its costs are known, as premiums usually are
determined long before claims are reported. Over the past several years a
significant increase in capacity has produced a trend of increasing price
competition, which continued in 1999.
OPERATING RESULTS FOR THE YEAR ENDED
DECEMBER 31, 1999 AS COMPARED TO THE YEAR
ENDED DECEMBER 31, 1998
The net loss attributable to common stockholders for 1999 was $37 million, or
$1.43 per diluted share, compared to net income of $46 million, or $1.59 per
diluted share, in 1998. The operating loss, which is defined as net loss before
realized gains and losses, changes in accounting principle and extraordinary
gains and losses on early extinguishments of long-term debt, was $31 million in
1999, or $1.19 per diluted share, compared with operating income of $35 million,
or $1.19 per diluted share, in 1998. Adjusting for the restructuring charge (see
page 19), the operating loss was $23 million, or $.91 per diluted share, in
1999. The deterioration in operating results in 1999 was primarily due to an
increase in loss reserves and to the effects of competition on rate adequacy.
Net premiums written increased 6% to $1,428 million from $1,346 million written
during 1998. Regional net premiums written grew 1% to $650 million as growth
opportunities were impeded by inadequate rates and competitive market
conditions. Reinsurance net premiums written increased 15% to $309 million due
primarily to growth in pro-rata treaty business. Specialty net premiums written
were $260 million, an increase of 3% over 1998, as new business growth was
partially offset by the non-renewal of loss-producing business, primarily in the
commercial transportation unit. Alternative markets net premiums written
increased 15% to $122 million due primarily to growth in businesses that began
operations in 1998. International net premiums written increased 15% to $86
million, reflecting the first full year of operations in the Philippines.
Net investment income decreased 6% to $190 million in 1999 due to a reduction in
invested assets, which resulted from the repurchase of common and preferred
shares during 1998 and 1999, and to a lower average pre-tax return on
investments. (See "Liquidity and Capital Resources.") The portfolio yield
decreased to approximately 6.5% in 1999 from approximately 6.9% in 1998 as a
result of a higher concentration in municipal bonds on average during 1999 and a
lower yield on the trading portfolio.
Management fees and commissions consist primarily of fees earned by the
alternative markets segment. Management fees and commissions increased 2% to $72
million in 1999 as market conditions continued to restrain the growth of the
alternative risk market.
Realized investment losses were $6 million in 1999 compared to realized
investment gains of $25 million in 1998. Realized gains and losses on fixed
income securities resulted primarily from the Company's strategy of maintaining
an appropriate balance between the duration of its fixed income portfolio and
the duration of its liabilities and from provisions for other than temporary
impairment of securities; realized gains and losses on equity securities arise
primarily as a result of a vari-
18
2
ety of factors which influence the Company's valuation criteria for such
securities. The majority of the 1999 and 1998 realized gains and losses resulted
from fixed maturity securities.
The combined ratio represents a measure of underwriting profitability, excluding
investment income. A number in excess of 100 generally indicates an underwriting
loss; a number below 100 generally indicates an underwriting gain. The
consolidated combined ratio (on a statutory basis) of the Company's insurance
operations increased to 112.2% in 1999 from 106.6% in 1998 mainly due to an
increase in the consolidated loss ratio. The consolidated loss ratio (losses and
loss expenses incurred expressed as a percentage of premiums earned) increased
to 76.5% from 71.2% primarily as a result of increased losses in the regional
segment and commercial transportation unit. The regional segment loss ratio
increased to 84.7% from 76.0% in 1998 due to a loss reserve adjustment of $55
million in the fourth quarter of 1999 and to the continued effects of
competition on rate adequacy. Approximately $40 million of the loss reserve
adjustment related to losses incurred in 1998 and prior years, with the balance
relating to losses incurred in 1999. In 1998, the Company reported a pre-tax
charge of $31 million for additional reinsurance premiums and loss reserves for
the regional segment. The increased losses in the commercial transportation unit
were the result of a rise in claim frequency and severity and of intense price
competition. Weather-related losses for the Company were $60 million in 1999
compared with $59 million in 1998. The overall increase in incurred losses in
1999 was partially offset by recoveries under the aggregate reinsurance cover
(see "Reinsurance") and by favorable reserve development on business written in
prior years by the specialty and alternative markets segments.
Other operating costs and expenses, which consist of the expenses of the
Company's insurance and alternative markets operations, as well as the Company's
corporate and investment expenses, increased by 9% to $605 million from $556
million in 1998. The increase in other operating costs is primarily due to a 10%
growth in premiums earned, which in turn results in an increase in underwriting
expenses. The consolidated expense ratio of the Company's insurance operations
(underwriting expenses expressed as a percentage of premiums written) increased
to 35.4% for the 1999 period from 34.9% for the comparable 1998 period due
primarily to higher reinsurance commissions rates for the specialty and
reinsurance segments. The regional expense ratio increased to 36.1% from 35.8%
due to the impact of additional reinsurance premiums and to certain costs
directly attributable to the restructuring. Adjusting for these items, the
regional expense ratio would have been 34.1% in 1999.
The Federal and foreign income tax benefit in 1999 was $46 million compared with
an expense of $5 million in 1998. The tax benefit in 1999, as compared to a tax
expense in 1998, was due to a loss before income taxes in 1999 and to an
increase in the percentage of revenues that are tax-exempt. In addition, the
1999 Federal income tax benefit reflects the closing with the Internal Revenue
Service of tax years 1992 through 1994. (See "Liquidity and Capital Resources.")
The 1999 results include an after-tax restructuring charge of $7 million, or
$.28 per diluted share, primarily related to the Company's restructuring of
certain of its operating units. The restructuring, which was substantially
completed in 1999, is expected to result in annual after-tax savings of
approximately $12 million. Under generally accepted accounting principles, the
restructuring charge does not include additional costs related to system
changes, financial incentives and other activities, although they are directly
related to the restructuring plan. The Company incurred such additional costs of
approximately $3 million, on an after-tax basis, in 1999.
As previously disclosed, during 1999 the Company adopted AICPA Statement of
Position 97-3, "Accounting By Insurance and Other Enterprises for
Insurance-Related Assessments." The adoption of this statement resulted in a
non-cash, after-tax charge of $3 million, or $.12 per diluted share, which is
reflected as a cumulative effect of a change in accounting principle.
19
3
The Company reported an after-tax extraordinary gain of $735,000 in 1999,
related to the repurchase and retirement of $10 million (face amount) of capital
trust securities. In 1998, the Company reported an after-tax extraordinary loss
of $5 million, related to the repurchase and retirement of $34.7 million (face
amount) of long-term debt.
OPERATING RESULTS FOR THE YEAR ENDED
DECEMBER 31, 1998 AS COMPARED TO THE YEAR
ENDED DECEMBER 31, 1997
Net income attributable to common stockholders for 1998 declined to $46 million,
or $1.59 per share diluted, from $91 million, or $3.02 diluted, in 1997.
Operating income in 1998 was $35 million or $1.19 per diluted share compared to
$83 million or $2.74 per diluted share in 1997. The decline in earnings was due
primarily to deterioration in underwriting results, attributable to an increase
in weather-related losses and the effects of competition on rate adequacy.
Net premiums written in 1998 rose 14% to $1,346 million from $1,178 million
written during 1997 due to growth recorded by all segments of the Company. Net
premiums written by the regional operations grew by 4% to $641 million from $619
million written in 1997. The growth was generated by the issuance of additional
policies. Net premiums written by the reinsurance segment increased by 30% to
$270 million from $207 million in 1997. This increase was substantially due to
an increase in pro rata treaty business. Net premiums written by the specialty
operations grew by 16% to $254 million from $219 million in 1997, due to
increases in all sectors of this business. This growth was due to an increase in
units insured. Net premiums written by the alternative markets operations grew
by 16% to $106 million from $91 million in 1997 due to the commencement of
operations of Key Risk Insurance Company (which underwrote business previously
managed on behalf of a self-insurance association). This increase more than
offset a decline in premiums written by Midwest Employers Casualty Company. Net
premiums written by the international operations grew by 79% to $75 million from
$42 million. This increase was due to 1997 acquisitions in Argentina and the
start-up of a life insurance and endowment insurance company in the Philippines.
Pre-tax net investment income increased to $202 million from $200 million earned
in 1997. This growth was due to an increase in investable assets produced by
cash flow from operations, which was partially offset by the effects of the
repurchase of common stock, and a decrease in pre-tax investment yield. The
decline in pre-tax investment yield was due to an increase in the percentage of
the portfolio invested in municipal bonds and lower yields earned on the trading
portfolio. (See "Liquidity and Capital Resources.")
Management fees and commissions consist primarily of fees earned by the
alternative markets segment. Management fees and commissions remained at $71
million as intense competition inhibited growth.
Realized investment gains increased to $25 million from $13 million in 1997.
Realized gains on fixed income securities resulted primarily from the Company's
strategy of maintaining an appropriate balance between the duration of its fixed
income portfolio and the duration of its liabilities; realized gains on equity
securities arise primarily as a result of a variety of factors which influence
the Company's valuation criteria for such securities. The majority of the 1998
realized gains resulted from the sale of fixed maturity securities while the
majority of 1997 realized gains resulted from the sale of equity securities.
The consolidated combined ratio (on a statutory basis) of the Company's
insurance operations increased to 106.6% in 1998 from 101.2% in 1997 mainly due
to an increase in the consolidated loss ratio. The consolidated loss ratio
(losses and loss expenses incurred expressed as a percentage of premiums earned)
increased to 71.2% from 66.4% due to a number of factors. Weather-related losses
for 1998 were $59 million compared with $33 million in 1997, which accounted for
an increase of 1.6% of the loss ratio. The regional operations were adversely
impacted by a rise in the frequency and sever-
20
4
ity of commercial property and liability claims, especially in the fourth
quarter. The increase in severity resulted in an accrual for additional ceded
premiums due under certain sliding scale reinsurance treaties. These factors
were somewhat offset by favorable loss development on business written in prior
years.
Other operating costs and expenses, which consist of the expenses of the
Company's insurance and alternative markets operations, as well as the Company's
corporate and investment expenses, increased by 14% to $556 million from $488
million in 1997. The increase in other operating costs is primarily due to the
substantial premium growth discussed above, which in turn results in an increase
in underwriting expenses. The consolidated expense ratio of the Company's
insurance operations increased to 34.9% for the 1998 period from 34.4% for the
comparable 1997 period. This increase resulted primarily from the cost of
expansion incurred by several regional companies and higher growth rate in
international operations, which operate at a higher expense ratio than domestic
operations.
The Federal income tax provision resulted in an effective tax rate of 9% in 1998
(24% in 1997). The tax rate is lower than the statutory tax rate of 35% because
a substantial portion of investment income is tax-exempt. The decrease in the
effective tax rate in 1998 is due primarily to an increase in the percentage of
pre-tax income that is tax-exempt.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL The Company's subsidiaries are highly liquid, receiving substantial cash
from premiums, investment income, management fees and proceeds from sales and
maturities of portfolio investments. The principal outflows of cash are payments
of claims, taxes, interest and operating expenses. The net cash provided from
operating activities (before trading account transactions) was $49 million in
1999, $224 million in 1998 and $229 million in 1997. The decrease in cash flow
in 1999 was primarily due to a higher level of claims activity. The 1998 cash
flow was impacted favorably by the assumption of a portfolio of loss reserves
for which the Company received proceeds of approximately $60 million.
As a holding company, the Company derives cash from its subsidiaries in the form
of dividends, tax payments and management fees. The Company is obligated to
service its debt, pay consolidated Federal income taxes and pay its expenses.
The Company also provides capital to its subsidiaries, including amounts
required under agreements with state insurance departments. Tax payments and
management fees from the insurance subsidiaries are made under agreements which
generally are subject to approval by state insurance departments. Maximum
amounts of dividends that can be taken without regulatory approval are
prescribed by statute. (See Note 18 of "Notes to Consolidated Financial
Statements.")
In addition to its other cash requirements in 2000, the Company is required to
repay $25 million of senior notes that mature on March 6, 2000 and to contribute
approximately $28 million to an insurance subsidiary during the first quarter of
2000. The Company anticipates receiving additional distributions from insurance
subsidiaries and borrowing under its credit facility to satisfy these
requirements.
FINANCING ACTIVITY During 1998, the Company issued $40 million face value of
6.375% medium term notes due April 15, 2005. Also in 1998, the Company
repurchased $34.7 million face amount of 9.875% and 8.7% senior notes and
debentures for $41.8 million and retired $10 million face value of 8.95% senior
notes upon maturity. In December 1998, one of the Company's subsidiaries issued
an $8 million five-year note. In 1999, the Company redeemed all outstanding
Series A Preferred Stock for $98 million and repurchased $10 million (face
value) of capital trust securities for $8.8 million.
During 1998, the Company purchased 3,172,222 shares of its common stock for
approximately $118 million. During 1999, the Company purchased 905,000 shares of
its common stock for approximately $22 million, leaving a balance as of December
31, 1999 of 1,095,000 shares available for repurchase under its current
authorization.
21
5
As of December 31, 1999 and 1998, the Company had $35 million and $55.5 million,
respectively, of outstanding short-term debt under its unsecured bank credit
facility. As of December 31, 1999, the Company had an additional $40 million of
short-term debt available under this facility. The credit facility expires on
and must be extended by December 8, 2000.
The Company has on file a "shelf" registration statement with the Securities and
Exchange Commission with a remaining balance of $150 million in additional
equity and/or debt securities. The securities may be offered from time to time
as determined by funding requirements and market conditions.
INVESTMENTS In its investment strategy, the Company establishes a level of cash
and highly liquid short-term and intermediate-term securities which, combined
with expected cash flow, is believed adequate to meet foreseeable payment
obligations. As part of this strategy, the Company attempts to maintain an
appropriate relationship between the average duration of the investment
portfolio and the approximate duration of its liabilities, i.e., policy claims
and debt obligations.
The Company's investment policy with respect to fixed maturity securities is
generally to purchase instruments with the expectation of holding them to their
maturity. However, active management of the portfolio is considered necessary to
maintain an approximate matching of assets and liabilities as well as to adjust
the portfolio as changes in financial market conditions alter the assumptions
underlying the purchase of certain securities.
The investment portfolio (including the trading account receivable from brokers
and clearing organizations and trading securities sold but not yet purchased),
on a cost basis, decreased in 1999 by $104 million to approximately $3,040
million primarily due to the repurchases of common and preferred stock discussed
above.
The Company's investments are currently comprised of fixed income securities and
trading account equity securities. At December 31, 1999, the portfolio mix of
the fixed income securities was as follows: tax-exempt securities were 40% (42%
in 1998); U.S. Government securities and cash equivalents were 24% (23% in
1998); mortgage-backed securities were 17% (18% in 1998); corporate fixed
maturity securities were 17% (15% in 1998); and the balance of 2% was invested
in other fixed income securities.
The Company had net trading account assets (trading account equity securities
plus trading account receivables from brokers and clearing organizations less
trading account equity securities sold but not yet purchased) of $356 million as
of December 31, 1999, as compared to $321 million as of December 31, 1998. The
net trading account assets represented approximately 12% and 10% of the
Company's net invested assets as of December 31, 1999 and 1998, respectively.
MARKET RISK The Company's market risk generally represents the risk of gain or
loss that may result from the potential change in the fair value of the
Company's investment portfolio as a result of fluctuations in prices, interest
rates and currency exchange rates. As discussed above, the Company attempts to
manage its interest rate risk by maintaining an appropriate relationship between
the average duration of the investment portfolio and the approximate duration of
its liabilities, i.e., policy claims and debt obligations.
The Company's investments are categorized as either fixed maturity securities or
equity securities. The principal market risk for the Company's fixed maturity
securities is interest rate risk. The Company uses various models and stress
test scenarios to monitor and manage interest rate risk. The following table
outlines the groups of fixed maturity securities and the components of the
interest rate risk:
Market Effective Fair Value
Group Yield Duration (000's)
- ------------------------------------------------------------------
U. S. Government securities 6.48% 4.56 $ 319,168
State and municipal 5.58 6.24 1,057,142
Corporate 7.99 4.42 432,283
Mortgage-backed securities 7.51 7.10 452,283
- ------------------------------------------------------------------
Total 6.49% 5.80 $2,260,876
==================================================================
As a general rule, a portfolio's duration measures the expected change in
portfolio value due to a change in interest rates. The portfolio's duration is
further modified to accurately
22
6
reflect a portfolio's expected price movement as interest rates change. Based
upon a pricing model, the Company determines the estimated change in fair value
of the fixed maturity securities, assuming immediate parallel shifts in the
treasury yield curve while keeping spreads between individual securities and
treasury securities static. The fair value at specified levels at December 31,
1999 would be as follows:
Estimated Fair Estimated
Value of Financial Change in
Instruments Fair Value
Change in interest rates $(000's) $(000's)
- --------------------------------------------------------------
300 basis point rise $1,902,197 $(358,679)
200 basis point rise 2,012,189 (248,687)
100 basis point rise 2,131,397 (129,479)
base scenario 2,260,876 --
100 basis point decline 2,396,814 135,938
200 basis point decline 2,536,639 275,763
300 basis point decline 2,687,992 427,116
==============================================================
The estimated changes in fair value, based upon the above table, would be offset
by the Company's liabilities if they were marked to market.
The Company's equity securities are used primarily for merger arbitrage. Merger
arbitrage is the business of investing in the securities of publicly held
companies which are the targets in announced tender offers and mergers. Merger
arbitrage differs from other types of investments in its focus on transactions
and events believed likely to bring about a change in value over a relatively
short time period (usually four months or less). The Company believes that this
makes merger arbitrage investments less vulnerable to changes in general stock
market conditions. Potential changes in market conditions are also mitigated by
the implementation of hedging strategies, including short sales. Additionally,
the merger arbitrage positions are generally hedged against market declines by
purchasing put options, selling call options or entering into swap contracts.
Based upon these characteristics, the Company's equity securities are primarily
exposed to the completion of announced deals, which are subject to regulatory as
well as political and other risks.
The Company also has net assets held by its foreign subsidiaries that are
subject to foreign currency risk. As of December 31, 1999, the Company had $28
million (net of minority interest) invested in subsidiaries in Argentina, as
well as $7 million (net of minority interest) invested in subsidiaries in the
Philippines. As of December 31, 1999, approximately 81% and 49% of the invested
assets in Argentina and the Philippines, respectively, were denominated in US
Dollars. The effect of foreign subsidiaries maintaining US Dollar denominated
assets is an offset against fluctuations in foreign currency.
Argentina has established a currency board exchange rate mechanism that creates
a dollar for dollar relationship between the US Dollar and the Argentine Peso.
Because of this dollar for dollar relationship, devaluation risk is viewed to be
low.
The Company's investment in the Philippines is affected by fluctuations in the
exchange rate between the US Dollar and the Philippine Peso. For every one
percent change in the exchange rate, the Company's unrealized foreign currency
gain/(loss) would change approximately $73,000, net of minority interest.
FEDERAL AND FOREIGN INCOME TAXES The Company files a consolidated income tax
return in the U.S. and foreign tax returns in the countries of its overseas
operations. At December 31, 1999, the Company had a deferred tax liability of
$82 million, which primarily relates to deferred policy acquisition costs and
intangible assets, and a deferred tax asset of $164 million, which primarily
relates to the discounting of loss reserves for Federal income tax purposes,
unearned premiums, unrealized investment losses and an alternative minimum tax
credit carry forward.
The realization of the deferred tax asset is dependent upon the Company's
ability to generate sufficient taxable income in future periods. Based on
historical results and the prospects for current operations, management
anticipates that it is more likely than not that future taxable income will be
sufficient for the realization of this asset.
23
7
REINSURANCE
The Company follows the customary industry practice of reinsuring a portion of
its exposures, paying to reinsurers a part of the premiums received on the
policies it writes. Reinsurance is purchased principally to reduce net liability
on individual risks and to protect against catastrophic losses. Although
reinsurance does not legally discharge an insurer from its primary liability for
the full amount of the policies, it does make the assuming reinsurer liable to
the insurer to the extent of the reinsurance coverage. The Company monitors the
financial condition of its reinsurers and attempts to place its coverages only
with substantial, financially sound carriers.
REGIONAL OPERATIONS In 1999, the Mid-Atlantic and Southern regional companies
generally retained $300,000 on individual property casualty risks while the
Midwest and New England companies generally retained $500,000 on individual
property casualty risks. The New England company retained up to $2.1 million per
bond for surety business. The other regional companies writing surety business
retained up to $450,000. The regional group also maintained catastrophe
reinsurance protection for approximately 100% of weather-related losses above $6
million per occurrence up to a maximum of $34 million. In addition, the regional
operating units carried additional aggregate catastrophe protection of 74% of
$4.5 million in excess of $7 million for storms exceeding $1.5 million.
Effective January 1, 1999, the Company purchased additional aggregate
reinsurance protection for the regional property casualty insurance segment.
Pursuant to the contract, the reinsurer will indemnify the regional companies
for losses occurring during 1999 in excess of 71% of earned premiums, up to a
limit of $35 million. Premiums of $21 million and losses of $35 million were
ceded to the reinsurer in 1999.
REINSURANCE OPERATIONS Signet Star's catastrophe retrocession program provides
coverage for property losses in five layers as follows: (i) 100% of $7.5 million
in excess of $6 million per occurrence; (ii) 95% of $6.5 million in excess of
$13.5 million per occurrence; (iii) 95% of $10 million in excess of $20 million
per occurrence; (iv) 95% of $10 million in excess of $30 million per occurrence;
and (v) 100% of $25 million (for California only and only under certain
conditions) and 100% of $10 million (for Florida only and only under certain
conditions). In 1999, Signet Star had a variable quota share program on its
casualty facultative business with retentions varying from $425,000 up to $2.5
million depending on the certificate limit. Property facultative business is
covered on a per risk basis for $700,000 in excess of $300,000 and 98.5% of $4
million in excess of $1 million. These coverages apply to Signet Star's
individual certificate and master certificate business. During 1999, Signet Star
had retrocession coverage for its fidelity and surety business for 100% of each
loss up to $2.5 million in excess of $750,000 per occurrence and 100% of each
loss up to $2.5 million in excess of $3.25 million per occurrence and 86.5% of
each surety loss up to $13 million in excess of $5.75 million per occurrence.
During 1999, the Latin American and Caribbean division retained $250,000 per
risk for property, marine, energy and aviation business and $500,000 per risk
for casualty.
SPECIALTY OPERATIONS Admiral's retention in 1999 was $183,750 from January 1 to
June 30 and $173,750 from July 1 to December 31 per risk for most classes of
business. Retentions varied between $2 million and $5 million based upon policy
size, per insured, for business written by Monitor Liability Managers. Nautilus
generally retained $140,000 per risk in 1999 and Carolina maintained its
retention at $300,000 on property liability exposures. In 1999, Carolina (on
business underwritten by Monitor Surety Managers) retained up to $500,000 on a
per principal basis. Great Divide retained $140,000 per risk in 1999. The
specialty group (except Carolina) is also covered under the regional group's
property catastrophe protection for 100% of $34 million in excess of $6 million.
24
8
ALTERNATIVE MARKETS OPERATIONS Midwest Employers' retention is generally $1
million per occurrence above the self-insured's underlying retention. Key Risk
Insurance Company's retention in 1999 was $300,000 per risk. Signet Star's
alternative markets operation maintains specific retrocessional coverage on
certain treaties and is also covered under the reinsurance group's catastrophe
retrocessional program. Preferred Employers' retention in 1999 was $250,000 per
risk.
INTERNATIONAL OPERATIONS The international operations generally retained between
$50,000 and $250,000 per occurrence or individual risk.
Year 2000
the Company's critical primary operating software was modified or replaced as
necessary for Year 2000 compliance, and the Company did not experience any
significant disruption or other adverse impact on its business at January 1,
2000 or thereafter as a result of the Year 2000 date change.
It is the Company's practice in the normal course of business to upgrade
technology, including hardware and software, as appropriate. As a result of this
practice, much of the Company's Year 2000 readiness was accomplished in the
ordinary course. Through December 31, 1999, the Company incurred approximately
$7 million of costs for Year 2000 compliance.
The Year 2000 issue may be a concern for the Company from an underwriting
standpoint to the extent of possible liability for coverage under general
liability, property, directors and officers liability and other policies.
Through December 31, 1999, no significant losses have arisen or come to light
with respect to Year 2000 claims exposure for the Company's insurance and
reinsurance subsidiaries. Additionally, certain of the Company's insurance
subsidiaries may either include or exclude insurance coverage for Year 2000
exposures. However, claims have been made against other insurers seeking
recovery of costs incurred to achieve Year 2000 compliance. While these or other
kinds of Year 2000 claims against insurers may not prove successful, there
exists a potential for judicial decisions which reformulate policies to expand
their coverage for previously unforeseen theories of liability which may produce
unanticipated claims. As a result, and because there is no prior history of such
claims, the amount of any such potential Year 2000 coverage liabilities is not
determinable.
The discussion herein with regard to Year 2000 matters contains forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. These statements are subject to certain risks and uncertainties that could
cause actual results to differ materially from those reflected in such
forward-looking statements. The inclusion of such forward-looking statements
herein shall not be considered a representation by the Company that the
objectives, plans or expectations of the Company, or other matters addressed by
the forward-looking statements, will be achieved.
CAPITALIZATION
For the year ended December 31, 1999, stockholders' equity decreased by
approximately $270 million. The decrease in stockholders' equity is primarily
attributable to the Company's repurchase of shares of its common and preferred
stock for approximately $120 million; to an after-tax decline in unrealized
investment gains (losses) of approximately $99 million; and to a net loss of $37
million. Accordingly, the Company's total capitalization decreased to $1,185
million at December 31, 1999 and the percentage of the Company's capital
attributable to long-term debt increased to 33% at December 31, 1999 from 27% at
December 31, 1998.
25
9
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
Years ended December 31, 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues:
Net premiums written $1,427,719 $1,346,254 $1,177,641
Change in net unearned premiums (13,335) (67,855) (65,894)
- -----------------------------------------------------------------------------------------------------------------------------------
Premiums earned 1,414,384 1,278,399 1,111,747
Net investment income 190,316 202,420 199,588
Management fees and commissions 72,344 70,727 71,456
Realized investment gains (losses) (6,064) 25,400 13,186
Other income 2,688 5,571 4,333
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenues 1,673,668 1,582,517 1,400,310
Operating costs and expenses:
Losses and loss expenses 1,085,826 914,762 734,424
Other operating costs and expenses 604,784 556,155 487,776
Interest expense 50,801 48,819 48,869
Restructuring charge 11,505 -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest (79,248) 62,781 129,241
Federal and foreign income tax benefit (expense) 45,766 (5,465) (30,668)
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before minority interest (33,482) 57,316 98,573
Minority interest (566) 1,444 474
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) before preferred dividends (34,048) 58,760 99,047
Preferred dividends (497) (7,548) (7,828)
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) before change in accounting and extraordinary gain (loss) (34,545) 51,212 91,219
Cumulative effect of change in accounting principle (net of taxes) (3,250) -- --
Extraordinary gain (loss) on early extinguishment
of long-term debt (net of taxes) 735 (5,017) --
===================================================================================================================================
Net income (loss) attributable to common stockholders $ (37,060) $ 46,195 $ 91,219
===================================================================================================================================
Earnings (loss) per share:
Basic
Net income (loss) before change in accounting and extraordinary gain (loss) $ (1.35) $ 1.82 $ 3.09
Cumulative effect of change in accounting principle (net of taxes) (.12) -- --
Extraordinary gain (loss) on early extinguishment of long-term debt .03 (.18) --
===================================================================================================================================
Net income (loss) attributable to common stockholders $ (1.44) $ 1.64 $ 3.09
===================================================================================================================================
Diluted
Net income (loss) before change in accounting and extraordinary gain (loss) $ (1.34) $ 1.76 $ 3.02
Cumulative effect of change in accounting principle (net of taxes) (.12) -- --
Extraordinary gain (loss) on early extinguishment of long-term debt .03 (.17) --
===================================================================================================================================
Net income (loss) attributable to common stockholders $ (1.43) $ 1.59 $ 3.02
===================================================================================================================================
See accompanying notes to consolidated financial statements.
26
10
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
December 31, 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Invested cash $ 295,423 $ 370,155
Fixed maturity securities:
Held to maturity, at cost (fair value $150,465 and $183,469) 152,657 170,150
Available for sale, at fair value (cost $2,180,509 and $2,224,244) 2,110,411 2,306,619
Equity securities, at fair value:
Available for sale (cost $54,437 and $59,890) 61,380 65,869
Trading account (cost $236,453 and $373,164) 253,430 389,310
Cash 20,051 16,123
Premiums and fees receivable 380,887 377,501
Due from reinsurers 620,446 513,297
Accrued investment income 36,925 37,842
Prepaid reinsurance premiums 91,005 79,530
Deferred policy acquisition costs 182,348 168,894
Real estate, furniture and equipment at cost, less accumulated depreciation 128,735 136,884
Deferred Federal and foreign income taxes 81,976 --
Excess of cost over net assets acquired 76,523 76,645
Trading account receivable from brokers and clearing organizations 258,454 229,520
Other assets 34,140 45,092
- ----------------------------------------------------------------------------------------------------------------------------------
$4,784,791 $4,983,431
==================================================================================================================================
LIABILITIES, RESERVES, DEBT AND STOCKHOLDERS' EQUITY
Liabilities and reserves:
Reserves for losses and loss expenses $2,361,238 $2,126,566
Unearned premiums 689,826 664,861
Due to reinsurers 144,712 130,517
Deferred Federal and foreign income taxes -- 6,877
Trading securities sold but not yet purchased, at fair value (proceeds $137,801 and $283,310) 155,826 298,165
Short-term debt 35,000 55,500
Other liabilities 183,218 213,453
- ----------------------------------------------------------------------------------------------------------------------------------
3,569,820 3,495,939
- ----------------------------------------------------------------------------------------------------------------------------------
Long-term debt 394,792 394,444
- ----------------------------------------------------------------------------------------------------------------------------------
Company-obligated mandatorily redeemable capital securities of a subsidiary trust holding
solely 8.197% junior subordinated debentures of the corporation due December 15, 2045 198,126 207,988
Minority interest 30,275 23,779
- ----------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock, par value $.10 per share:
Authorized 5,000,000 shares:
7 3/8% Series A Cumulative Redeemable Preferred Stock
653,952 shares issued and outstanding -- 65
Common stock, par value $.20 per share:
Authorized 80,000,000 shares, issued and outstanding,
net of treasury shares, 25,616,578 and 26,504,404 shares 7,281 7,281
Additional paid-in capital 331,640 429,611
Retained earnings 551,401 601,908
Accumulated other comprehensive income (loss) (44,500) 54,672
Treasury stock, at cost, 10,787,489 and 9,899,663 shares (254,044) (232,256)
- ----------------------------------------------------------------------------------------------------------------------------------
591,778 861,281
- ----------------------------------------------------------------------------------------------------------------------------------
$4,784,791 $4,983,431
==================================================================================================================================
See accompanying notes to consolidated financial statements.
27
11
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands, except per share data)
Years ended December 31, 1999, 1998 and 1997
Preferred
and common
stock and Accumulated
Total additional other
stockholders' paid-in Retained comprehensive Treasury
equity capital earnings income (loss) stock
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 $879,732 $476,439 $490,338 $ 31,075 $(118,120)
Net income attributable to common stockholders 91,219 -- 91,219 -- --
Change in other comprehensive income 27,131 -- -- 27,131 --
Issuance of common shares 3,130 1,190 -- -- 1,940
Repurchase of preferred stock (41,523) (41,523) -- -- --
Dividends to common stockholders ($.42 per share) (12,397) -- (12,397) -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 947,292 436,106 569,160 58,206 (116,180)
Net income attributable to common stockholders 46,195 -- 46,195 -- --
Change in other comprehensive income (loss) (3,534) -- -- (3,534) --
Issuance of common shares 2,719 851 -- -- 1,868
Purchase of treasury stock (117,944) -- -- -- (117,944)
Dividends to common stockholders ($.48 per share) (13,447) -- (13,447) -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 861,281 436,957 601,908 54,672 (232,256)
Net (loss) attributable to common stockholders (37,060) -- (37,060) -- --
Change in other comprehensive income (loss) (99,172) -- -- (99,172) --
Issuance of common shares 387 56 -- -- 331
Purchase of treasury stock (22,119) -- -- -- (22,119)
Repurchase of preferred stock (98,092) (98,092) -- -- --
Dividends to common stockholders ($.52 per share) (13,447) -- (13,447) -- --
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 $591,778 $338,921 $551,401 $(44,500) $(254,044)
===================================================================================================================================
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) attributable to common stockholders $ (37,060) $46,195 $ 91,219
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss)
Unrealized holding gain (losses) on investment securities arising
during the period (net of taxes of ($51,246), ($9,941) and $10,915) ( 95,171) (18,462) 20,271
Less: Reclassification adjustment for net change in unrealized gains (losses)
during the period (net of taxes of ($2,122), $8,890 and $4,615) (3,942) 16,510 8,571
- -----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gain (loss) (99,113) (1,952) 28,842
Change in unrealized foreign exchange (losses) (59) (1,582) (1,711)
- -----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) (99,172) (3,534) 27,131
- -----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $(136,232) $42,661 $118,350
===================================================================================================================================
See accompanying notes to consolidated financial statements.
28
12
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years ended December 31, 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) before minority interest, preferred dividends and extraordinary items $ (36,732) $ 57,316 $ 98,573
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Increase in reserves for losses and loss expenses, net of due to/from reinsurers 141,718 169,285 137,312
Depreciation and amortization 23,598 22,658 11,852
Change in unearned premiums and prepaid reinsurance premiums 13,490 68,095 67,023
Change in premiums and fees receivable (3,386) (45,727) (64,858)
Change in Federal income taxes (34,289) (26,923) (1,408)
Change in deferred policy acquisition costs (12,457) (22,057) (24,465)
Realized investment (gains) losses 6,064) (25,400) (13,186)
Other, net (49,491) 27,023 18,601
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities before
trading account sales (purchases) 48,515 224,270 229,444
Trading account sales (purchases), net 554 (4,567) (89,245)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 49,069 219,703 140,199
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows provided by (used in) investing activities:
Proceeds from sales, excluding trading account:
Fixed maturity securities available for sale 594,993 715,459 718,789
Equity securities 17,200 52,727 43,204
Proceeds from maturities and prepayments of fixed maturity securities 147,668 297,303 120,944
Cost of purchases, excluding trading account:
Fixed maturity securities available for sale (695,928) (1,033,190) (984,961)
Fixed maturity securities held to maturity -- (3,034) --
Equity securities (14,397) (33,217) (28,028)
Cost of acquired companies, net of acquired cash and invested cash (1,533) (3,304) 585
Net additions to real estate, furniture and equipment (8,127) (27,167) (17,898)
Other, net (435) 3,956) (9,904)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 39,441 (30,467) (157,269)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Repurchase of preferred stock (98,092) -- (41,523)
purchase of common treasury shares (22,119) (117,944) --
Net change in short-term debt (20,500) 55,500 --
Repurchase of Company-obligated mandatorily redeemable capital securities
of a subsidiary trust holding solely 8.197% junior subordinated debentures (8,774) -- --
Cash dividends to common stockholders (13,888) (13,518) (11,695)
Cash dividends to preferred stockholders (2,001) (7,356) (8,717)
Other, net (6,060) 735 13,367
Net proceeds from issuance of long-term debt -- 47,882 --
Repurchase of long-term debt -- (49,104) --
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (159,314) (83,805) (48,568)
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and invested cash (70,804) 105,431 (65,638)
Cash and invested cash at beginning of year 386,278 280,847 346,485
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and invested cash at end of year $315,474 $386,278 $280,847
====================================================================================================================================
Supplemental disclosure of cash flow information:
Interest paid on debt $ 50,801 $ 48,976 $ 45,950
====================================================================================================================================
Federal income taxes (received) paid $(12,973) $ 32,090 $ 32,258
====================================================================================================================================
See accompanying notes to consolidated financial statements.
29
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 1999, 1998 and 1997
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) Principles of consolidation and basis of presentation
The consolidated financial statements, which include the accounts of W. R.
Berkley Corporation and its subsidiaries ("the Company"), have been prepared on
the basis of generally accepted accounting principles ("GAAP"). All significant
intercompany transactions and balances have been eliminated. Reclassifications
have been made in the 1998 and 1997 financial statements to conform them to the
presentation of the 1999 financial statements. The preparation of financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the revenues and expenses reflected during the reporting period.
Actual results could differ from those estimates.
(B) Revenue recognition
Insurance premiums written are recognized as earned generally on a pro-rata
basis over the contract period. Management fees on insurance service contracts
are recorded as earned primarily on a pro-rata basis over the policy period.
Commission income is recognized as earned on the effective date of the
applicable insurance policies.
(C) Investments
The Company has classified its investments into three categories. Securities
that the Company has the positive intent and ability to hold to maturity are
classified as "held to maturity" and reported at amortized cost. Securities
which the Company purchased with the intent to sell in the near-term are
classified as "trading" and are reported at estimated fair value, with
unrealized gains and losses reflected in the statement of operations. The
remaining securities are classified as "available for sale" and carried at
estimated fair value, with unrealized gains and losses, net of applicable income
taxes, excluded from earnings and reported as comprehensive income (loss) and a
separate component of stockholders' equity. Fair value is generally determined
using published market values.
Realized gains or losses represent the difference between the cost of securities
sold and the proceeds realized upon sale. The cost of securities is adjusted
where appropriate to include a provision for significant decline in value which
is considered to be other than temporary. The Company uses the specific
identification method where possible, and the first-in, first-out method in
other instances, to determine the cost of securities sold. Realized gains or
losses, including any provision for decline in value, are included in the
statement of operations.
(D) Trading account
The long portfolio positions are presented in the balance sheet as trading
account assets. The short sales and short call options used in trading account
activities are presented as trading securities sold but not yet purchased. The
trading account receivable from brokers and clearing organizations is comprised
of unsettled trades within the trading account and the net margin balances held
by the clearing broker.
(E) Per share data
Basic per share data is based upon the weighted average number of shares
outstanding during the year. Diluted per share data reflects the potential
dilution that would occur if employee stock-based compensation plans were
exercised. Shares issued in connection with loans to shareholders are not
considered to be outstanding for the purposes of calculating basic per share
amounts and have been excluded from stockholders' equity.
(F) Deferred policy acquisition costs
Acquisition costs (primarily commissions and premium taxes) incurred in writing
insurance and reinsurance business are deferred and amortized ratably over the
terms of the related contracts. Deferred policy acquisition costs are limited to
the amounts estimated to be recoverable from the applicable unearned premiums
and the related anticipated investment income by giving effect to anticipated
losses, loss adjustment expenses and expenses necessary to maintain the
contracts in force.
(G) Reserves for losses and loss expenses
Reserves for losses and loss expenses are an accumulation of amounts determined
on the basis of (1) evaluation of claims for business written directly by the
Company; (2) estimates received from other companies for reinsurance assumed;
and (3) estimates for losses incurred but not reported (based on Company and
industry experience). These estimates are
30
14
periodically reviewed and, as experience develops and new information becomes
known, the reserves are adjusted as necessary. Such adjustments are reflected in
results of operations in the period in which they are determined.
The Company discounts its liabilities for excess workers' compensation ("EWC")
losses and loss expenses using a "risk-free" rate. EWC liabilities are
discounted because of the long period of time over which it pays losses. The
Company believes that utilizing a "risk-free" rate to discount these reserves
more closely reflects the economics associated with the EWC line of business
(see Note 15 of notes to consolidated financial statements).
(H) Reinsurance ceded
Ceded unearned premiums are reported as prepaid reinsurance premiums and
estimated amounts of reinsurance recoverable on unpaid losses are included in
due from reinsurers. To the extent any reinsurer does not meet its obligations
under reinsurance agreements, the Company must discharge the liability. Amounts
due from reinsurers are reflected net of funds held where the right of offset is
present. The Company has provided reserves for uncollectible reinsurance.
(I) Excess of cost over net assets acquired
Costs in excess of the net assets of subsidiaries acquired are being amortized
on a straight-line basis over 25 to 40 years. The Company continually evaluates
the amortization period of its intangible assets. Estimates of useful lives are
revised when circumstances or events indicate that the original estimate is no
longer appropriate. Amortization (including adjustments) of the excess of cost
over net assets acquired was $3,866,000, $3,178,000 and $2,950,000 for 1999,
1998 and 1997, respectively.
(J) Federal and foreign income taxes
The Company files a consolidated income tax return in the U.S. and foreign tax
returns in the countries of its overseas operations.
The Company's method of accounting for income taxes is the asset and liability
method. Under the asset and liability method, deferred tax assets and
liabilities are measured using tax rates currently in effect or expected to
apply in the years in which those temporary differences are expected to reverse.
(K) Stock options
The Company accounts for its stock options in accordance with Financial
Accounting Standards Board ("FASB") Statement No. 123, "Accounting for
Stock-Based Compensation" (FAS 123), which provides that stock-based
compensation may be disclosed in the footnotes to financial statements.
(L) Foreign currency
Revenues and expenses in foreign currencies are translated at the weighted
average exchange rate during the year. Assets and liabilities are translated at
the rate of exchange in effect at the close of the period. Unrealized gains or
losses (losses of $3,352,000 and $3,293,000 as of December 31, 1999 and 1998,
respectively) resulting from translating foreign currency financial statements
are reported as a component of common stockholders' equity. Gains or losses
(losses of $381,000 for 1999 and gains of $1,543,000 and $1,408,000 for 1998 and
1997, respectively) resulting from foreign currency transactions (transactions
denominated in a currency other than the entity's functional currency) are
included in other income (gains) or other operating costs and expenses (losses)
in the statement of operations.
(M) Real estate, furniture and equipment
Real estate, furniture and equipment are carried at cost less accumulated
depreciation. Depreciation is calculated using the estimated useful lives of the
respective assets. Depreciation expense was $16,291,000, $17,114,000 and
$12,799,000 for 1999, 1998 and 1997, respectively.
(N) Other Comprehensive Income (loss)
Comprehensive income (loss) encompasses all changes in stockholder's equity
(except those arising from transactions with shareholders) and includes net
income, net unrealized capital gains or losses on available-for-sale securities
and unrealized foreign currency translation adjustments.
(O) Insurance Related Assessments
As of January 1, 1999, the Company adopted the American Institute of Certified
Public Accountants (AICPA) Statement of Position ("SOP") 97-3, "Accounting by
Insurance and Other Enterprises for Insurance Related Assessments." This
statement provides guidance for determining when an entity should recog-
31
15
nize liabilities for guarantee fund and other insurance related assessments, how
to measure those liabilities and when an asset may be recognized for the
recovery of such assessments through premium tax offsets or policy surcharges.
The adoption of this statement resulted in an after tax charge of $3,250,000 for
the year ended December 31, 1999, which is reflected as a cumulative effect of a
change in accounting principle.
(P) RECENT ACCOUNTING PRONOUNCEMENTS
During 1999, the FASB issued FAS 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB 133, and Amendment
of FASB 133" which extended the effective date of FAS 133 to January 1, 2001.
FAS 133, "Accounting for Derivative Instruments and Hedging Activities,"
establishes accounting and reporting standards for derivative instruments. This
statement will not have a material impact on the Company's results of operations
or financial condition.
(2) ACQUISITIONS
During 1999, 1998 and 1997, several international and other acquisitions were
completed for an aggregate consideration of approximately $1,533,000,
$13,389,000 and $7,238,000, respectively. The acquisitions were accounted for as
purchases and, accordingly, the results of operations of the companies have been
included from the respective dates of acquisition. Proforma results of
operations have been omitted as such effects are not significant.
Net assets of the acquired companies for 1999, 1998 and 1997 were as
follows: Investments in fixed maturity and equity securities of $0, $1,786,000
and $2,192,000; cash and invested cash of $0, $10,085,000 and $7,823,000; excess
of cost over net assets acquired of $3,744,000, $6,847,000 and $2,688,000; and
other liabilities, net of other assets of $5,277,000, $5,329,000 and $5,465,000.
(3) COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES
Neither the Company nor any of its subsidiaries is engaged in any litigation
known to the Company which management believes will have a material adverse
effect upon the Company's business. As is common with other insurance companies,
the Company's subsidiaries are regularly engaged in the defense of claims
arising out of the conduct of the insurance business.
(4) LEASE OBLIGATIONS
The Company and several of its subsidiaries use office space and equipment under
leases expiring at various dates through September 1, 2004. These leases are
considered operating leases for financial reporting purposes. Some of these
leases have options to extend the length of the leases and contain clauses for
cost of living, operating expense and real estate tax adjustments. Rental
expense was approximately: $16,109,000, $14,095,000 and $12,564,000 for 1999,
1998 and 1997, respectively. Future minimum lease payments (without provision
for sublease income) are $13,059,000 in 2000; $9,887,000 in 2001; $7,611,000 in
2002; $5,653,000 in 2003; and $4,368,000 thereafter.
(5) RESTRUCTURING PLAN
In the first quarter of 1999, the Company implemented a plan to restructure
certain of its operating units. Under the plan, the Company consolidated ten of
its regional units into four; merged two of its alternative market units; and
combined two of its international units. In connection with the restructuring
plan, the Company expects to reduce its workforce by approximately 386
employees. The Company reported a restructuring charge of $11,505,000 in the
first quarter of 1999 to reflect the estimated costs of the plan. These charges
consist mainly of severance payments of $7,562,000, contractual lease payments
related to abandoned facilities and abandoned equipment and property owned. The
activities under the plan were substantially completed in 1999. The Company has
paid $6,916,000 related to the restructuring charge of which $4,221,000 relates
to severance payments. The remaining restructuring accrual is $4,589,000 at
December 31, 1999.
32
16
(6) DEBT
Long-term debt consists of the following:
Description Rate Maturity Face Value Carrying Value
- -----------------------------------------------------------------------------------------------------------------------------
Senior Notes 6.31% March 6, 2000 $ 25,000,000 $ 24,995,000
Senior Notes 6.71% March 4, 2003 25,000,000 24,939,000
Note Payable (1) December 30, 2003 8,000,000 8,000,000
Senior Subordinated Notes 6.50% July 1, 2003 35,793,000 35,793,000
Senior Notes 6.375% April 15, 2005 40,000,000 39,825,000
Senior Notes 6.25% January 15, 2006 100,000,000 99,215,000
Senior Notes 9.875% May 15, 2008 88,800,000 86,368,000
Senior Debentures 8.70% January 1, 2022 76,503,000 75,657,000
- -----------------------------------------------------------------------------------------------------------------------------
$399,096,000 $394,792,000
=============================================================================================================================
(1)Floating rate equal to Libor plus 50 basis points.
The difference between the face value of long-term debt and the carrying value
is unamortized discount. All outstanding long-term debt is not redeemable until
maturity and ranks on a parity with all other outstanding indebtedness of the
Company.
The Company has on file a "shelf" registration statement with the Securities
and Exchange Commission with a remaining balance of $150,000,000 in additional
equity and/or debt securities. The securities may be offered from time to time
as determined by funding requirements and market conditions.
SHORT-TERM DEBT As of December 31, 1999 and 1998, the Company had $35,000,000
and $55,500,000, respectively, of outstanding short-term debt under its
unsecured line-of-credit. During 1999 and 1998, the average interest rate of the
Company's short-term debt was 5.36% and 5.59%. As of December 31, 1999, the
Company had an additional $40,000,000 of short-term debt available under its
line-of-credit.
(7) COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF A SUBSIDIARY
TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF THE CORPORATION DUE
DECEMBER 15, 2045
The Company-obligated mandatorily redeemable preferred securities of a
subsidiary trust holding solely junior subordinated debentures ("Capital Trust
Securities") were issued by the W.R. Berkley Capital Trust ("the Trust") in
1996. All of the common securities of the Trust are owned by the Company. The
sole assets of the Trust are $210,000,000 aggregate principal amount of 8.197%
Junior Subordinated Debentures due December 15, 2045, issued by the Company (the
"Junior Subordinated Debentures"). The Company's guarantee of payments of cash
distributions and payments on liquidation of the Trust and redemption of the
Capital Trust Securities, when taken together with the Company's obligations
under the Trust Agreement under which the Capital Trust Securities were issued,
the Junior Subordinated Debentures and the Indenture under which the Junior
Subordinated Debentures were issued, including its obligations to pay costs,
expenses, debts and liabilities of the Trust (other than with respect to the
Capital Trust Securities), provide a full and unconditional guarantee of the
Trust's obligations under the Capital Trust Securities. The Company records the
preferential cumulative cash dividends arising from the payments of interest on
the Junior Subordinated Debentures as interest expense in its consolidated
statement of operations.
The Capital Trust Securities are subject to mandatory redemption in a like
amount (i) in whole but not in part, on the stated maturity date, upon repayment
of the Junior subordinated Debentures, (ii) in whole but not in part, at any
time contemporaneously with the optional prepayment of the Junior Subordinated
Debentures by the Company upon the occurrence and continuation of a certain
event and (iii) in whole or in part, on or after December 15, 2006,
contemporaneously with the optional prepayment by the Company of Junior
Subordinated Debentures. In September 1999, a subsidiary of the Company
purchased $10 million (face amount) of the Capital Trust Securities for
$8,774,000.
33
17
(8) REINSURANCE CEDED
The Company follows the customary industry practice of reinsuring a portion of
its exposures principally to reduce net liability on individual risks and to
protect against catastrophic losses. The following amounts arising under
reinsurance ceded contracts have been deducted in arriving at the amounts
reflected in the statement of operations:
(Dollars in thousands) 1999 1998 1997
- ------------------------------------------------------------------
Premiums written $307,170 $292,238 $240,754
Premiums earned $294,823 $286,170 $239,233
Losses and loss expenses $248,767 $211,389 $129,405
Effective January 1, 1999, the Company purchased additional aggregate
reinsurance protection for its regional segment. Pursuant to the contract, the
reinsurer will indemnify the regional companies for losses occuring during 1999
in excess of 71% of earned premiums, up to a limit of $35,000,000. Premiums of
$21,000,000 and losses of $35,000,000 were ceded to the reinsurer in 1999.
(9) SUPPLEMENTAL FINANCIAL STATEMENT DATA
Other operating costs and expenses consist of the following:
(Dollars in thousands) 1999 1998 1997
- ---------------------------------------------------------------------
Amortization of
deferred policy
acquisition costs $444,289 $394,612 $337,871
Other operating costs
and expenses of
insurance operations 77,617 77,596 65,993
Other costs and expenses 82,878 83,947 83,912
- ---------------------------------------------------------------------
Total $604,784 $556,155 $487,776
=====================================================================
(10) STOCK OPTION PLAN
The Company has a stock option plan (the "Stock Option Plan") under which
7,125,000 shares of Common Stock were reserved for issuance. Pursuant to the
Stock Option Plan, options may be granted at prices determined by the Board of
Directors but not less than fair market value on the date of grant.
The following table summarizes option information, including options
granted under both the 1992 and prior plans:
- ----------------------------------------------------------------------------------------------------------------------------
1999 1998 1997
--------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
- ----------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 3,929,333 $34.25 3,218,762 $29.52 2,491,222 $26.03
Granted 68,600 25.73 1,036,975 47.08 1,154,354 34.68
Exercised 14,925 21.91 106,938 23.57 280,498 20.87
Canceled 320,223 34.39 219,466 30.56 146,316 27.42
- ----------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 3,662,785 $34.12 3,929,333 $34.25 3,218,762 $29.52
- ----------------------------------------------------------------------------------------------------------------------------
Options exercisable at year end 998,450 $25.28 640,161 $23.72 558,210 $22.66
- ----------------------------------------------------------------------------------------------------------------------------
Options available for future grant 3,326,102 3,073,916 3,892,439
============================================================================================================================
The fair value of the options granted is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions for 1999 and 1998, respectively: (a) dividend yield of 1%, (b)
expected volatility of 20%, (c) risk free interest rate of 5.61% and 5.79% and
(d) expected life of 7.5 years. The following table summarizes information about
stock options outstanding at December 31, 1999 and 1998:
34
18
- ----------------------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------------------------
Weighted Weighted
Range of Remaining Weighted Average
Exercise Number Contractual Average Number Exercise
Prices Outstanding Life Price Exercisable Price
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 1999
$14 to $27 736,415 3.9 $23.40 654,815 $23.14
27 to 32 875,144 6.2 29.06 337,210 29.17
32 to 48 2,051,226 7.8 40.13 6,425 38.29
- ----------------------------------------------------------------------------------------------------------------------------
Total 3,662,785 6.6 $34.12 998,450 $25.28
============================================================================================================================
December 31, 1998
$14 to $27 731,983 4.4 $23.25 554,759 $22.67
27 to 32 1,034,346 7.1 29.12 84,502 30.35
32 to 48 2,163,004 8.8 40.43 900 47.38
- ----------------------------------------------------------------------------------------------------------------------------
Total 3,929,333 7.6 $34.25 640,161 $23.72
============================================================================================================================
The Company applies APB Opinion 25 and related interpretations in accounting for
these plans. Accordingly, no compensation cost has been recognized for the stock
option plans. Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below (000's omitted except per share data):
Net Income Basic Earnings per Share Diluted Earnings per Share
---------------------- ------------------------ --------------------------
As Reported Proforma As Reported Proforma As Reported Proforma
- -----------------------------------------------------------------------------------------------------------------------------------
1999
Before change in accounting and extraordinary item $(34,545) $(37,644) $(1.35) $(1.46) $(1.34) $(1.45)
Attributable to Common Stockholders $(37,060) $(40,159) $(1.44) $(1.56) $(1.43) $(1.55)
- -----------------------------------------------------------------------------------------------------------------------------------
1998
Before change in accounting and extraordinary item $ 51,212 $ 48,078 $ 1.82 $ 1.71 $ 1.76 $ 1.65
Attributable to Common Stockholders $ 46,195 $ 43,061 $ 1.64 $ 1.53 $ 1.59 $ 1.48
- -----------------------------------------------------------------------------------------------------------------------------------
(11) COMPENSATION PLAN
The Company and its subsidiaries have profit sharing retirement plans in which
substantially all employees participate. The plans provide for minimum annual
contributions of 5% of eligible compensation; contributions above the minimum
are discretionary and vary with each participating subsidiary's profitability.
Employees become eligible to participate in the Retirement Plans on the first
day of the month following the first full three months in which they are
employed. Profit sharing expense amounted to $7,768,000, $8,524,000 and
$8,402,000 for 1999, 1998 and 1997, respectively.
In May 1997, the Common Stockholders approved the Long-Term Incentive
Compensation Plan ("LTIP"). The LTIP provides for incentive compensation to key
executives, is based on long-term corporate performance and is based upon
criteria established by the Compensation and Stock Option Committee of the Board
of Directors (the "Committee"). Key employees are awarded participation units
("units") as determined by the Committee. The Units vest and become exercisable
over a maximum term of five years from the date of their award. The units are
payable in cash or up to 50% in shares of Common Stock. In 1997, 266,250 units
were awarded which amounted to an expense of $1,705,000. There was no LTIP
expense in 1998 or 1999.
35
19
(12) INVESTMENTS
At December 31, 1999 and 1998, there were no investments, other than investments
in United States government securities, which exceeded 10% of stockholders'
equity. At December 31, 1999 and 1998, investments were as follows:
(Dollars in thousands)
Gross Gross
unrealized unrealized Fair Carrying
Type of investment Cost(a) gains losses value value
- ----------------------------------------------------------------------------------------------------------------------------------
December 31, 1999
Fixed maturity securities held to maturity:
State and municipal $ 56,172 $ 2,268 $ (951) $ 57,489 $ 56,172
Corporate 12,839 78 (248) 12,669 12,839
Mortgage-backed securities 83,646 135 (3,474) 80,307 83,646
- ----------------------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities held to maturity 152,657 2,481 (4,673) 150,465 152,657
- ----------------------------------------------------------------------------------------------------------------------------------
Fixed maturity securities available for sale:
United States Government(b) 334,114 473 (15,419) 319,168 319,168
State and municipal 1,020,716 9,905 (30,968) 999,653 999,653
Corporate 437,501 1,332 (19,219) 419,614 419,614
Mortgage-backed securities 388,178 1,657 (17,859) 371,976 371,976
- ----------------------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities available for sale 2,180,509 13,367 (83,465) 2,110,411 2,110,411
- ----------------------------------------------------------------------------------------------------------------------------------
Common stocks 8,676 7,613 (80) 16,209 16,209
Preferred stocks 45,761 206 (796) 45,171 45,171
- ----------------------------------------------------------------------------------------------------------------------------------
Total equity securities available for sale 54,437 7,819 (876) 61,380 61,380
- ----------------------------------------------------------------------------------------------------------------------------------
Trading account 236,453 24,241 (7,264) 253,430 253,430
- ----------------------------------------------------------------------------------------------------------------------------------
Invested cash(c) 295,423 -- -- 295,423 295,423
- ----------------------------------------------------------------------------------------------------------------------------------
Total investments $2,919,479 $47,908 $(96,278) $2,871,109 $2,873,301
==================================================================================================================================
December 31, 1998
Fixed maturity securities held to maturity:
State and municipal $ 60,492 $6,528 $ (72) $ 66,948 $ 60,492
Corporate 13,353 772 -- 14,125 13,353
Mortgage-backed securities 96,305 6,091 -- 102,396 96,305
- ----------------------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities held to maturity 170,150 13,391 (72) 183,469 170,150
- ----------------------------------------------------------------------------------------------------------------------------------
Fixed maturity securities available for sale:
United States Government(b) 293,761 9,797 (170) 303,388 303,388
State and municipal 1,117,691 53,387 (959) 1,170,119 1,170,119
Corporate 411,234 15,047 (6,106) 420,175 420,175
Mortgage-backed securities 401,558 12,278 (899) 412,937 412,937
- ----------------------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities available for sale 2,224,244 90,509 (8,134) 2,306,619 2,306,619
- ----------------------------------------------------------------------------------------------------------------------------------
Common stocks 8,150 4,712 (341) 12,521 12,521
Preferred stocks 51,740 1,750 (142) 53,348 53,348
- ----------------------------------------------------------------------------------------------------------------------------------
Total equity securities available for sale 59,890 6,462 (483) 65,869 65,869
- ----------------------------------------------------------------------------------------------------------------------------------
Trading account 373,164 23,371 (7,225) 389,310 389,310
- ----------------------------------------------------------------------------------------------------------------------------------
Invested cash(c) 370,155 -- -- 370,155 370,155
- ----------------------------------------------------------------------------------------------------------------------------------
Total investments $3,197,603 $133,733 $(15,914) $3,315,422 $3,302,103
==================================================================================================================================
(a) Adjusted as necessary for amortization of premium or discount.
(b) Includes United States government agencies and authorities.
(c) Short-term investments which mature within three months of the date of
purchase.
36
20
The amortized cost and fair value of fixed maturity securities at December 31,
1999, by contractual maturity, are shown below. Actual maturities may differ
from contractual maturities because certain issuers may have the right to call
or prepay obligations:
(Dollars in thousands) 1999
- -----------------------------------------------------------------------------------------------
Cost Fair value
- -----------------------------------------------------------------------------------------------
Due in one year or less $ 68,307 $ 68,329
Due after one year through five years 372,376 371,743
Due after five years through ten years 600,055 586,027
Due after ten years 820,604 782,494
Mortgage-backed securities 471,824 452,283
- -----------------------------------------------------------------------------------------------
Total $2,333,166 $2,260,876
===============================================================================================
Realized gains (losses) and the change in difference between fair value and cost
of investments, before applicable income taxes, are as follows:
(Dollars in thousands) 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------
Realized gains (losses):
Fixed maturity securities(a) $ 2,792 $23,004 $ (3,308)
Equity securities (76) 3,506 16,537
Net change in provision for decline in value(b):
Fixed maturity securities (8,300) -- 103
Equity securities -- -- 581
Other (480) (1,110) (727)
- -----------------------------------------------------------------------------------------------------------------------------
(6,064) 25,400 13,186
- -----------------------------------------------------------------------------------------------------------------------------
Change in difference between fair value and cost of investments:
Fixed maturity securities (167,984) 877 58,476
Equity securities 964 (4,130) (5,356)
- -----------------------------------------------------------------------------------------------------------------------------
(167,020) (3,253) 53,120
- -----------------------------------------------------------------------------------------------------------------------------
Total $(173,084) $22,147 $66,306
=============================================================================================================================
(a) During 1999, 1998 and 1997, gross gains of $15,022,000, $26,054,000, and
$7,988,000, respectively, and gross losses of $12,230,000, $3,050,000, and
$11,296,000, respectively, were realized.
(b) The provision for decline in value of investments is $11,100,000,
$2,800,000, and $2,800,000 as of December 31, 1999, 1998 and 1997,
respectively.
Investment income consists of the following:
(Dollars in thousands) 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------
Investment income earned on:
Fixed maturity securities $148,081 $156,961 $159,199
Invested cash 12,804 9,771 10,829
Equity securities 3,306 4,670 5,139
Trading account(a) 33,532 32,997 28,831
Other 833 1,666 1,814
- -----------------------------------------------------------------------------------------------------------------------------
Gross investment income 198,556 206,065 205,812
Interest on funds held under reinsurance treaties (8,240) (3,645) (6,224)
- -----------------------------------------------------------------------------------------------------------------------------
Net investment income $190,316 $202,420 $199,588
=============================================================================================================================
(a) The primary focus of the trading account is merger arbitrage. Merger
arbitrage is the business of investing in the securities of publicly held
companies which are the targets in announced tender offers and mergers.
Merger arbitrage differs from other types of investments in its focus on
transactions and events believed likely to bring about a change in value
over a relatively short time period (usually four months or less). The
Company believes that this makes merger arbitrage investments less
vulnerable to changes in general financial market conditions. Potential
changes in market conditions are also mitigated by the implementation of
hedging strategies, including short sales.
The arbitrage positions are generally hedged against market declines by
purchasing put options, selling call options or entering into swap
contracts. Therefore, just as long portfolio positions may incur losses
during market declines, hedge positions may also incur losses during market
advances. As of December 31, 1999, the notional amount of long option
contracts outstanding is $36,331,000 and short option contracts outstanding
is $50,797,000.
Investment income earned from net trading account activity includes
unrealized trading losses of $4,897,000 for 1999 and unrealized trading
gains of $1,291,000 and $13,737,000 for 1998 and 1997, respectively.
37
21
(13) STOCKHOLDERS' EQUITY
COMMON EQUITY The Company has calculated per share data in accordance with FAS
128. Treasury shares have been excluded from average outstanding shares from the
date of acquisition. The weighted average number of shares used in the
computation of basic earnings per share was 25,823,000, 28,194,000 and
29,503,000 for 1999, 1998 and 1997, respectively. The weighted average number of
shares used in the computations of diluted earnings per share was 25,927,000,
29,115,000 and 30,185,000 for 1999, 1998 and 1997, respectively. The difference
in calculating basic and diluted earnings per share is attributable entirely to
the dilutive effect of stock-based compensation plans.
Changes in shares of Common Stock outstanding, net of treasury shares, are
as follows:
(in thousands) 1999 1998 1997
- ------------------------------------------------------------------
Balance, beginning of year 26,504 29,568 29,454
Shares issued 18 108 114
Shares repurchased (905) (3,172) --
- ------------------------------------------------------------------
Balance, end of year 25,617 26,504 29,568
==================================================================
PREFERRED EQUITY During 1997, the Company purchased 276,855 shares of Series A
Preferred Stock for an aggregate cost of $41,523,000. On January 25, 1999, all
remaining outstanding shares of the Series A Preferred Stock were redeemed for
$98,092,000.
On May 11, 1999, the Company declared a dividend distribution of one Right
for each outstanding share of Common Stock. Each Right entitles the holder to
purchase a unit consisting of one one-thousandth of a share of Series A Junior
Participating Preferred Stock at a purchase price of $120 per unit (subject to
adjustment) upon the occurrence of certain events relating to potential changes
in control of the Company. The Rights expire on May 11, 2009, unless earlier
redeemed by the Company as provided in the Rights Agreement.
(14) FEDERAL AND FOREIGN INCOME TAXES
Federal and foreign income tax expense (before the cumulative effect of change
in accounting and extraordinary items) consists of:
(Dollars in thousands) 1999 1998 1997
- -------------------------------------------------------------------
Current (expense) benefit $11,785 $(30,283) $(21,999)
Deferred (expense) benefit 33,981 (24,818) (8,669)
- -------------------------------------------------------------------
Total (expense) benefit $45,766 $ (5,465) $(30,668)
===================================================================
A reconciliation of Federal and foreign income tax (expense) benefit and the
amounts computed by applying the Federal and foreign income tax rate of 35% to
pre-tax income are as follows:
(Dollars in thousands) 1999 1998 1997
- --------------------------------------------------------------------
Computed "expected" tax
(expense) benefit $27,737 $(21,973) $(45,234)
Tax-exempt investment income 17,853 18,412 15,432
Other, net 176 (1,904) (866)
- --------------------------------------------------------------------
Total (expense) benefit $45,766 $ (5,465) $(30,668)
====================================================================
At December 31, 1999 and 1998, the tax effects of differences that give rise to
significant portions of the deferred tax asset and deferred tax liability are as
follows:
(Dollars in thousands) 1999 1998
- ----------------------------------------------------------------------
DEFERRED TAX ASSET
Loss reserve discounting $64,946 $62,288
Unearned premiums 40,663 39,652
Deferred taxes on unrealized investment losses 22,297 --
Alternative minimum tax credit carry forward 20,656 --
Other 22,097 11,389
- ----------------------------------------------------------------------
Gross deferred tax asset 170,659 113,329
Less: valuation allowance (7,000) (7,000)
- ----------------------------------------------------------------------
Deferred tax asset 163,659 106,329
======================================================================
DEFERRED TAX LIABILITY
Amortization of intangibles 9,625 11,460
Deferred policy acquisition costs 57,317 55,370
Realized investment gains -- 2,960
Deferred taxes on unrealized
investment gains -- 31,070
Depreciation 8,985 5,900
Other 5,756 6,446
- ----------------------------------------------------------------------
Deferred tax liability 81,683 113,206
- ----------------------------------------------------------------------
Net deferred tax asset (liability) $81,976 $(6,877)
======================================================================
Federal income tax expense (benefit) applicable to realized investment gains
(losses) was ($2,122,000), $8,890,000 and $4,615,000 in 1999, 1998 and 1997,
respectively. The Company had a current income tax receivable of $8,939,000 and
$10,532,000 at December 31, 1999 and 1998, respectively. The Company's tax
returns through December 31, 1994 have been examined by the Internal Revenue
Service.
The realization of the deferred tax asset is dependent upon the Company's
ability to generate sufficient taxable income in future periods. Based on
historical results and the prospects for current operations, management
anticipates that it is more likely than not that future taxable income will be
sufficient for the realization of this net asset.
38
22
(15) RESERVES FOR LOSSES AND LOSS EXPENSES
The table below provides a reconciliation of the beginning and ending reserve
balances, on a gross of reinsurance basis:
(Dollars in thousands) 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------------------------
Net reserves at beginning of year $1,583,304 $1,433,011 $1,333,122
- -----------------------------------------------------------------------------------------------------------------------------
Net reserves of companies acquired 2,189 4,984
Net provision for losses and loss expenses:
Claims occurring during the current year 1,032,089 944,887 747,977
Increase (decrease) in estimates for claims occurring in prior years 28,351 (42,929) (21,313)
Amortization of discount 10,473 9,111 7,760
- -----------------------------------------------------------------------------------------------------------------------------
1,070,913 911,069 734,424
=============================================================================================================================
Net payments for claims
Current year 433,942 397,787 315,370
Prior years 496,410 365,178 324,149
- -----------------------------------------------------------------------------------------------------------------------------
930,352 762,965 639,519
- -----------------------------------------------------------------------------------------------------------------------------
Net reserves at end of year 1,723,865 1,583,304 1,433,011
Ceded reserves at end of year 617,025 537,219 476,677
- -----------------------------------------------------------------------------------------------------------------------------
Gross reserves at end of year $2,340,890 $2,120,523 $1,909,688
=============================================================================================================================
The balance sheet includes $20,348,000 and $6,043,000 as of december 31, 1999
and 1998, respectively, relating to reserves for life insurance which are not
included in the table above, and the statement of operations includes
$14,913,000 and $3,693,000 for the years ended december 31, 1999 and 1998,
respectively, relating to the policyholder benefits incurred on life insurance
which are not included in the above table. The 1999 increase in reserves related
to prior years is due to reserve strengthening in the regional segment partially
offset by favorable reserve development in the specialty and alternative markets
segments.
Due to the nature of Excess Workers Compensation ("EWC") business and the
long period of time over which losses are paid in this line of business, the
Company discounts the liability for losses and loss expenses established for the
EWC line of business. Discounting liabilities for losses and loss expenses gives
recognition to the time value of money. Discounting is intended to appropriately
match losses and loss expenses to income earned on investment securities
supporting the liabilities. The expected losses and loss expense payout pattern
subject to discounting was derived from the Company's loss payout experience and
is supplemented with data compiled from insurance companies writing workers'
compensation on an excess-of-loss basis. The expected payout pattern has a very
long duration because it reflects the nature of losses generally which penetrate
self-insured retention limits contained in EWC policies. The Company has limited
the estimated payout duration to 30 years in order to introduce an additional
level of conservatism into the discounting process. The liabilities for losses
and loss expenses have been discounted using "risk-free" discount rates
determined by reference to the U.S. Treasury yield curve weighted for the EWC
premium volume to reflect the seasonality of the anticipated duration of losses
associated with such coverages. The weighted average discount rate for accident
years 1999, 1998, 1997, 1996 and 1995 and prior is 5.90%, 5.90%, 5.98%, 5.90%
and 5.80%, respectively. The aggregate net discount, after reflecting the
effects of ceded reinsurance, is $186,981,000, $186,964,000 and $189,600,000 at
December 31, 1999, 1998 and 1997, respectively. For statutory purposes, the
Company uses a discount rate of 3.0% as permitted by the Department of Insurance
of the State of Ohio.
To date, known pollution and environmental claims at the insurance company
subsidiaries have not had a material impact on the Company's operations.
Environmental claims have not materially impacted the Company because its
subsidiaries generally did not insure larger industrial companies which are
subject to significant environmental exposures.
The Company's net reserves for losses and loss adjustment expenses relating
to pollution and environmental claims were $30,944,000 and $33,391,000 at
December 31, 1999 and 1998, respectively. The Company's gross reserves for
losses and loss adjustment expenses relating to pollution and environmental
claims were $65,966,000 and $69,283,000 at December 31, 1999 and 1998,
respectively. Net incurred losses and loss expenses for reported pollution and
environmental claims were approximately $1,371,000, $2,227,000 and $79,000 in
1999, 1998 and 1997, respectively. Net paid losses and loss expenses were
approximately $3,819,000, $2,614,000 and $2,175,000 in 1999, 1998 and 1997,
respectively. The estimation of these liabilities is subject to significantly
greater than normal variation and uncertainty because it is difficult to make a
reasonable actuarial estimate of these liabilities due to the absence of a
generally accepted actuarial methodology for these exposures and the potential
effect of significant unresolved legal matters, including coverage issues as
well as the cost of litigating the legal issues. Additionally, the determination
of ultimate damages and the final allocation of such damages to financially
responsible parties are highly uncertain.
39
23
(16) INDUSTRY SEGMENTS
The Company's operations are presently conducted through five basic segments:
specialty; alternative markets; reinsurance; regional; and international. The
specialty lines of insurance consist primarily of excess and surplus lines,
commercial transportation, professional liability, directors and officers
liability and surety. The Company's alternative markets segment specializes in
insuring, reinsuring and administering self-insurance programs and other
alternative risk transfer mechanisms for public entities, private employers and
associations. The Company's reinsurance segment specializes in underwriting
property, casualty and surety reinsurance on both a treaty and facultative
basis. The regional property casualty insurance segment writes standard
commercial and personal lines insurance for such risks as automobiles, homes and
businesses. Finally, the international operations represent the Company's joint
venture with Northwestern Mutual Life International (65% owned by the Company),
which writes property and casualty, as well as life insurance, internationally.
For the years ended December 31, 1999, 1998 and 1997, the joint venture wrote
life premiums of $24,548,000, $7,994,000 and $639,000, respectively.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. Income tax expense (benefits)
were calculated in accordance with the Company's tax sharing agreements, which
provide for the recognition of tax loss carryforwards only to the extent of
taxes previously paid. Summary financial information about the company's
operating segments is presented in the following table. Income before income
taxes by segment consists of revenues less expenses related to the respective
segment's operations. These amounts include realized gains (losses) where
applicable. intersegment revenues consist primarily of dividends, interest on
intercompany debt and fees paid by subsidiaries for portfolio management and
other services to the Company. Identifiable assets by segment are those assets
used in the operation of each segment.
Revenues
--------------------------------------------------------- Income Income Tax
Investment Unaffiliated Inter- (loss) before Expense
(Dollars in thousands) Income Customers Segment Total income taxes (Benefits)
- ----------------------------------------------------------------------------------------------------------------------------
December 31, 1999:
Regional $ 52,639 $ 700,667 $ 1,462 $ 702,129 $(97,362) $ (7,589)
Reinsurance 47,288 341,201 739 341,940 14,091 1,992
Specialty 50,231 310,373 (1,305) 309,068 39,261 8,692
Alternative Markets 36,355 221,690 586 222,276 24,919 4,653
International 6,469 93,878 -- 93,878 3,535 1,443
Corporate and other 1,011 5,859 114,398 120,257 32,612 (47,210)
Adjustments and eliminations (3,677) -- (115,880) (115,880) (96,304) (7,747)
- ----------------------------------------------------------------------------------------------------------------------------
Consolidated $ 190,316 $ 1,673,668 -- $1,673,668 $(79,248) $ (45,766)
============================================================================================================================
December 31, 1998:
Regional $ 53,942 $ 680,505 $ 2,014 $ 682,519 $(24,524) $ 3,323
Reinsurance 47,643 296,100 1,044 297,144 33,858 6,911
Specialty 59,345 309,047 2,908 311,955 85,889 24,349
Alternative Markets 34,667 205,024 911 205,935 36,501 9,505
International 5,469 80,287 -- 80,287 (7,017) 349
Corporate and other 7,927 11,554 81,983 93,537 9,288 5,465
Adjustments and eliminations (6,573) -- (88,860) (88,860) (71,214) (44,437)
- ----------------------------------------------------------------------------------------------------------------------------
Consolidated $ 202,420 $ 1,582,517 -- $ 1,582,517 $ 62,781 $ 5,465
============================================================================================================================
December 31, 1997:
Regional $ 51,920 $ 634,468 $ 674 $ 635,142 $ 47,624 $ 14,833
Reinsurance 45,520 241,204 882 242,086 42,193 10,641
Specialty 60,162 281,630 2,691 284,321 68,088 18,529
Alternative Markets 34,390 183,904 829 184,733 34,733 10,257
International 3,623 45,360 -- 45,360 (3,566) (181)
Corporate and other 10,565 13,744 48,351 62,095 (19,815) 30,849
Adjustments and eliminations (6,592) -- (53,427) (53,427) (40,016) (54,260)
- ----------------------------------------------------------------------------------------------------------------------------
Consolidated $ 199,588 $1,400,310 -- $ 1,400,310 $129,241 $ 30,668
============================================================================================================================
40
24
W.R. BERKLEY CORPORATION AND SUBSIDIARIES
Interest expense for the alternative markets and reinsurance segments was
$2,870,000, $2,327,000 and $2,327,000 for the years ended December 31, 1999,
1998 and 1997, respectively. Additionally, corporate interest expense (net of
intercompany amounts) was $47,931,000, $46,492,000 and $46,542,000 for the
corresponding periods. Identifiable assets by segment are as follows:
December 31, 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------
Regional $1,436,575 $1,370,849 $1,264,962
Reinsurance 1,022,776 996,186 863,784
Specialty 1,370,837 1,502,366 1,403,068
Alternative Markets 878,125 863,578 749,724
International 177,675 151,832 119,792
Corporate and other 1,362,345 1,545,744 1,602,907
Elimination (1,463,542) (1,447,124) (1,459,919)
- ---------------------------------------------------------------------------------------------------------------
Consolidated $4,784,791 $4,983,431 $4,544,318
===============================================================================================================
(17) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments as of December 31, 1999 and 1998:
(Dollars in thousands) 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------
Carrying Carrying
Amount Fair value Amount Fair value
- -----------------------------------------------------------------------------------------------------------------------------
Investments $2,873,301 $2,871,109 $3,302,103 $3,315,422
Long-term debt 394,792 383,901 394,444 435,702
Capital Trust Securities 198,126 172,547 207,988 206,464
- -----------------------------------------------------------------------------------------------------------------------------
The estimated fair value of investments is based on quoted market prices as of
the respective reporting dates. The fair value of the long-term debt is based on
rates available for borrowings similar to the Company's outstanding debt as of
the respective reporting dates.
(18) DIVIDENDS FROM SUBSIDIARIES AND STATUTORY FINANCIAL INFORMATION
The Company's insurance subsidiaries are restricted by law as to the amount of
dividends they may pay without the approval of regulatory authorities. During
2000, the maximum amount of dividends which can be paid without such approval is
approximately $77,264,000.
Combined net income and policyholders' surplus of the Company's consolidated
insurance subsidiaries, as determined in accordance with statutory accounting
practices, are as follows:
(Dollars in thousands) 1999 1998 1997
- ------------------------------------------------------------
Net income (loss) $ (34,598) $ 67,014 $121,300
============================================================
Policyholders' surplus $865,672 $941,853 $971,749
============================================================
The significant variances between statutory accounting practices and GAAP are:
For statutory purposes, bonds are carried at amortized cost, acquisition costs
are charged to operations as incurred, deferred federal income taxes are not
provided for temporary differences between book and tax assets and liabilities,
EWC reserves are discounted at a 3.0% rate and certain assets designated as
"non-admitted assets" are charged against surplus.
At December 31, 1999 and 1998, bonds with a fair value of $209,485,000 and
$185,206,000 were on deposit with various state insurance departments as
required by state laws.
The National Association of Insurance Commissioners ("NAIC") has risk-based
capital ("RBC") requirements that require insurance companies to calculate and
report information under a risk-based formula which measures statutory capital
and surplus needs based on a regulatory definition of risk in a company's mix of
products and its balance sheet. RBC did not affect the operations of the
Company's insurance subsidiaries since all of its subsidiaries have an RBC
amount above the authorized control level RBC, as defined by the NAIC.
The NAIC recently completed a process intended to codify statutory
accounting practices for certain insurance enterprises. As a result of this
process, the NAIC will issue a revised statutory accounting practices and
procedures manual, which will be effective January 1, 2001. The Company has not
yet determined the impact that this change will have on the statutory capital
and surplus of its insurance subsidiaries.
41
25
(19) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following is a summary of quarterly financial data:
(Dollars in thousands except per share data)
Three months ended
----------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1999 1998 1999 1998 1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues $407,713 $383,275 $416,250 $396,910 $427,823 $394,425 $421,882 $407,907
===================================================================================================================================
Net income (loss) before
preferred dividends $ 2,472 $ 25,673 $ 5,624 $ 22,743 $ (1,356) $ 12,261 $(40,788) $ (1,917)
====================================================================================================================================
Net income (loss) before
change in accounting and
extraordinary gain (loss) $ 1,975 $ 23,786 $ 5,624 $ 20,856 $ (1,356) $ 10,374 $(40,788) $ (3,804)
===================================================================================================================================
Net income (loss) attributable
to common stockholders $ (1,275) $ 21,351 $ 5,624 $ 18,274 $ (621) $ 10,374 $(40,788) $ (3,804)
===================================================================================================================================
Earnings (loss) per share:
Basic
Before change in accounting
and extraordinary gain (loss) $ .07 $ .81 $ .22 $ .73 $ (.06) $ .37 $ (1.59) $ (.14)
Net income (loss) $ (.05) $ .73 $ .22 $ .64 $ (.02) $ .37 $ (1.59) $ (.14)
Diluted
Before change in accounting
and extraordinary gain (loss) $ .07) $ .78 $ .22 $ .70 $ (.05) $ .36 $ (1.59) $ (.14)
Net income (loss) $ (.05) $ .71 $ .22 $ .61 $ (.02) $ .36 $ (1.59) $ (.14)
===================================================================================================================================
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
W.R. Berkley Corporation
We have audited the consolidated balance sheets of W. R. Berkley Corporation and
subsidiaries as of December 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity, comprehensive income and cash
flows for each of the years in the three-year period ended December 31, 1999.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of W. R. Berkley
Corporation and subsidiaries at December 31, 1999 and 1998, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1999, in conformity with generally accepted accounting
principles.
As discussed in Note 1 to the consolidated financial statements, the Company has
changed its method of accounting for insurance-related assessments in 1999.
New York, New York KPMG LLP
February 24, 2000
42