SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended: Commission File Number:
March 31, 2002 1-13816
- ---------------------- -----------------------
Everest Reinsurance Holdings, Inc.
-----------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 22-3263609
- ------------------------ ----------------------------
(State or other juris- (IRS Employer Identification
diction of incorporation Number)
or organization)
477 Martinsville Road
Post Office Box 830
Liberty Corner, New Jersey 07938-0830
(908) 640-3000
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive office)
- --------------------------------------------------------------------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to the filing
requirements for at least the past 90 days.
YES X NO
------- -------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Number of Shares Outstanding
Class at May 10, 2002
----- ----------------------------
Common Stock, $.01 par value 1,000
The registrant meets the conditions set forth in General Instruction H(1)(a) and
(b) of Form 10-Q and is therefore filing this form with the reduced disclosure
format permitted by General Instruction H of Form 10-Q.
EVEREST REINSURANCE HOLDINGS, INC.
Index To Form 10-Q
PART I
FINANCIAL INFORMATION
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Page
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ITEM 1. FINANCIAL STATEMENTS
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Consolidated Balance Sheets at March 31, 2002 (unaudited)
and December 31, 2001 3
Consolidated Statements of Operations and Comprehensive
Income for the three months ended March 31, 2002 and
2001 (unaudited) 4
Consolidated Statements of Changes in Stockholders' Equity
for the three months ended March 31, 2002 and 2001 (unaudited) 5
Consolidated Statements of Cash Flows for the three months
ended March 31, 2002 and 2001 (unaudited) 6
Notes to Consolidated Interim Financial Statements 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
-----------------------------------------------------------
AND RESULTS OF OPERATIONS 15
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PART II
OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS 21
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ITEM 5. OTHER INFORMATION None
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 21
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Part I - Item 1
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except par value per share)
March 31, December 31,
------------ ------------
2002 2001
------------ ------------
(unaudited)
ASSETS:
Fixed maturities - available for sale,
at market value (amortized cost: 2002,
$3,985,456; 2001, $4,051,833) $ 4,053,350 $ 4,186,923
Equity securities, at market value
(cost: 2002, $69,984; 2001, $66,412) 70,959 67,453
Short-term investments 175,239 115,850
Other invested assets 29,252 32,039
Cash 85,020 67,509
------------ ------------
Total investments and cash 4,413,820 4,469,774
Accrued investment income 68,043 64,972
Premiums receivable 514,421 454,548
Reinsurance receivables 1,502,138 1,471,357
Funds held by reinsureds 134,742 149,710
Deferred acquisition costs 125,749 114,948
Prepaid reinsurance premiums 69,734 48,100
Deferred tax asset 177,223 178,476
Other assets 159,329 60,496
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TOTAL ASSETS $ 7,165,199 $ 7,012,381
============ ============
LIABILITIES:
Reserve for losses and adjustment expenses $ 4,335,370 $ 4,274,335
Unearned premium reserve 550,861 473,308
Funds held under reinsurance treaties 315,169 308,811
Losses in the course of payment 85,864 83,360
Contingent commissions 3,216 3,345
Other net payable to reinsurers 75,607 132,252
Current federal income taxes (23,738) (30,365)
8.5% Senior notes due 3/15/2005 249,715 249,694
8.75% Senior notes due 3/15/2010 199,097 199,077
Revolving credit agreement borrowings 105,000 105,000
Interest accrued on debt and borrowings 2,241 11,944
Other liabilities 153,203 90,211
------------ ------------
Total liabilities 6,051,605 5,900,972
------------ ------------
STOCKHOLDER'S EQUITY:
Common stock, par value: $0.01; 200 million
shares authorized; 1,000 shares issued in
2002 and 2001 - -
Additional paid-in capital 259,024 258,775
Accumulated other comprehensive income,
net of deferred income taxes of $16.9
million in 2002 and $40.8 million in 2001 31,624 76,003
Retained earnings 822,946 776,631
------------ ------------
Total stockholder's equity 1,113,594 1,111,409
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 7,165,199 $ 7,012,381
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
3
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Dollars in thousands, except per share amounts)
Three Months Ended
March 31,
----------------------------
2002 2001
----------- -----------
(unaudited)
REVENUES:
Premiums earned $ 458,118 $ 327,992
Net investment income 64,799 67,362
Net realized capital gain (loss) 1,039 (4,789)
Net derivative (expense) (250) -
Other income 1,578 646
----------- -----------
Total revenues 525,284 391,211
----------- -----------
CLAIMS AND EXPENSES:
Incurred loss and loss adjustment expenses 325,713 242,448
Commission, brokerage, taxes and fees 114,487 81,853
Other underwriting expenses 13,501 11,998
Interest expense on senior notes 9,728 9,724
Interest expense on credit facility 909 2,697
----------- -----------
Total claims and expenses 464,338 348,720
----------- -----------
INCOME BEFORE TAXES 60,946 42,491
Income tax expense 14,631 8,900
----------- -----------
NET INCOME $ 46,315 $ 33,591
=========== ===========
Other comprehensive (loss) income,
net of tax (44,379) 30,807
----------- -----------
COMPREHENSIVE INCOME $ 1,936 $ 64,398
=========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
4
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDER'S EQUITY
(Dollars in thousands, except per share amounts)
Three Months Ended
March 31,
----------------------------
2002 2001
----------- -----------
(unaudited)
COMMON STOCK (shares outstanding):
Balance, beginning of period 1,000 1,000
Issued during the period - -
----------- -----------
Balance, end of period 1,000 1,000
=========== ===========
COMMON STOCK (par value):
Balance, beginning of period $ - $ -
Common stock retired during the period - -
----------- -----------
Balance, end of period - -
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ADDITIONAL PAID IN CAPITAL:
Balance, beginning of period 258,775 255,359
Common stock issued during the period 249 946
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Balance, end of period 259,024 256,305
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ACCUMULATED OTHER COMPREHENSIVE INCOME,
NET OF DEFERRED INCOME TAXES:
Balance, beginning of period 76,003 56,747
Net (decrease) increase during the period (44,379) 30,807
----------- -----------
Balance, end of period 31,624 87,554
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RETAINED EARNINGS:
Balance, beginning of period 776,631 738,381
Net income 46,315 33,591
----------- -----------
Balance, end of period 822,946 771,972
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TOTAL STOCKHOLDER'S EQUITY, END OF PERIOD $ 1,113,594 $ 1,115,831
=========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
5
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Three Months Ended
March 31,
----------------------------
2002 2001
----------- -----------
(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 46,315 $ 33,591
Adjustments to reconcile net income
to net cash provided by operating
activities:
(Increase) in premiums receivable (60,544) (17,592)
Increase (decrease) in funds held, net 21,413 (4,041)
(Increase) in reinsurance receivables (31,693) (7,395)
Increase in deferred tax asset 25,157 1,721
Increase (decrease) in reserve for
losses and loss adjustment expenses 64,863 (1,509)
Increase in unearned premiums 77,731 62,472
(Increase) in other assets and
liabilities (123,550) (37,614)
Accrual of bond discount/amortization
of bond premium (1,791) (1,098)
Amortization of underwriting discount
on senior notes 41 38
Realized capital (gains) losses (1,039) 4,789
----------- -----------
Net cash provided by operating activities 16,903 33,362
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from fixed maturities matured/called
- available for sale 98,303 44,984
Proceeds from fixed maturities sold -
available for sale 187,869 21,994
Proceeds from equity securities sold 5,370 -
Proceeds from other invested assets sold 3,057 8
Cost of fixed maturities acquired -
available for sale (218,478) (224,649)
Cost of equity securities acquired (9,227) -
Cost of other invested assets acquired (191) (62)
Net (purchases) sales of short-term
securities (59,376) 213,651
Net (decrease) increase in unsettled
securities transactions (3,317) 14,499
----------- -----------
Net cash provided by investing activities 4,010 70,425
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CASH FLOWS FROM FINANCING ACTIVITIES:
Common stock issued during the period 249 946
Borrowing on revolving credit agreement 20,000 20,000
Repayments on revolving credit agreement (20,000) (123,000)
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Net cash provided by (used in) financing
activities 249 (102,054)
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EFFECT OF EXCHANGE RATE CHANGES ON CASH (3,651) (4,590)
----------- -----------
Net increase (decrease) in cash 17,511 (2,857)
Cash, beginning of period 67,509 68,397
----------- -----------
Cash, end of period $ 85,020 $ 65,540
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash transactions:
Income taxes paid, net $ (17,404) $ 2,353
Interest paid $ 20,299 $ 22,746
The accompanying notes are an integral part of the consolidated financial
statements.
6
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
For the Three Months Ended March 31, 2002 and 2001
1. GENERAL
As used in this document, "Holdings" means Everest Reinsurance Holdings, Inc.,
"Group" means Everest Re Group, Ltd., "Bermuda Re" means Everest Reinsurance
(Bermuda), Ltd., "Everest Re" means Everest Reinsurance Company and the
"Company" means Everest Reinsurance Holdings, Inc. and its subsidiaries.
The consolidated financial statements of the Company for the three months ended
March 31, 2002 and 2001 include all adjustments, consisting of normal recurring
accruals, which, in the opinion of management, are necessary for a fair
presentation of the results on an interim basis. Certain financial information,
which is normally included in annual financial statements prepared in accordance
with generally accepted accounting principles in the United States of America,
has been omitted since it is not required for interim reporting purposes. The
year-end consolidated balance sheet data was derived from audited financial
statements, but does not include all disclosures required by generally accepted
accounting principles in the United States of America. The results for the three
months ended March 31, 2002 and 2001 are not necessarily indicative of the
results for a full year. These financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
for the years ended December 31, 2001, 2000 and 1999 included in the Company's
most recent Form 10-K filing.
2. CONTINGENCIES
The Company continues to receive claims under expired contracts which assert
alleged injuries and/or damages relating to or resulting from toxic torts, toxic
waste and other hazardous substances, such as asbestos. The Company's asbestos
claims typically involve potential liability for bodily injury from exposure to
asbestos or for property damage resulting from asbestos or products containing
asbestos. The Company's environmental claims typically involve potential
liability for (a) the mitigation or remediation of environmental contamination
or (b) bodily injury or property damages caused by the release of hazardous
substances into the land, air or water.
The Company's reserves include an estimate of the Company's ultimate liability
for asbestos and environmental claims for which ultimate value cannot be
estimated using traditional reserving techniques. There are significant
uncertainties in estimating the amount of the Company's potential losses from
asbestos and environmental claims. Among the complications are: (a) potentially
long waiting periods between exposure and manifestation of any bodily injury or
property damage; (b) difficulty in identifying sources of asbestos or
environmental contamination; (c) difficulty in properly allocating
responsibility and/or liability for asbestos or environmental damage; (d)
changes in underlying laws and judicial interpretation of those laws; (e)
potential for an asbestos or environmental claim to involve many insurance
providers over many policy periods; (f) long reporting delays, both from
insureds to insurance companies and ceding companies to reinsurers; (g)
historical data concerning asbestos and environmental losses, which is more
limited than historical information on other types of casualty claims; (h)
questions concerning interpretation and application of insurance and reinsurance
coverage; and (i) uncertainty regarding the number and identity of insureds with
potential asbestos or environmental exposure.
7
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(continued)
For the Three Months Ended March 31, 2002 and 2001
Management believes that these factors continue to render reserves for asbestos
and environmental losses significantly less subject to traditional actuarial
methods than are reserves on other types of losses. Given these uncertainties,
management believes that no meaningful range for such ultimate losses can be
established. The Company establishes reserves to the extent that, in the
judgement of management, the facts and prevailing law reflect an exposure for
the Company or its ceding companies. In connection with the acquisition of Mt.
McKinley Insurance Company ("Mt. McKinley"), which has significant exposure to
asbestos and environmental claims, Prudential Property and Casualty Insurance
Company ("Prupac"), a subsidiary of The Prudential Insurance Company of America
("The Prudential"), provided reinsurance to Mt. McKinley covering 80% ($160.0
million) of the first $200.0 million of any adverse development of Mt.
McKinley's reserves as of September 19, 2000 and The Prudential guaranteed
Prupac's obligations to Mt. McKinley. Through March 31, 2002, cessions under
this reinsurance agreement have reduced the available remaining limits to $131.3
million net of coinsurance. Effective September 19, 2000, Mt. McKinley and
Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby
Mt. McKinley transferred, for what management believes to be arm's-length
consideration, all of its net insurance exposures and reserves, including
allocated and unallocated loss adjustment expenses to Bermuda Re. Due to the
uncertainties discussed above, the ultimate losses may vary materially from
current loss reserves and, depending on coverage under the Company's various
reinsurance arrangements, could have a material adverse effect on the Company's
future financial condition, results of operations and cash flows.
The following table shows the development of prior year asbestos and
environmental reserves on both a gross and net of retrocessional basis for the
three months ended March 31, 2002 and 2001:
(dollar amounts in thousands) Three Months Ended
March 31,
2002 2001
---------- ----------
Gross basis:
Beginning of period reserves $ 644,390 $ 693,704
Incurred losses 10,000 12,110
Paid losses (22,612) (15,155)
---------- ----------
End of period reserves $ 631,778 $ 690,659
========== ==========
Net basis:
Beginning of period reserves $ 276,169 $ 317,196
Incurred losses 628 -
Paid losses (11,652) (6,783)
---------- ----------
End of period reserves $ 265,145 $ 310,413
========== ==========
8
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(continued)
For the Three Months Ended March 31, 2002 and 2001
At March 31, 2002, the gross reserves for asbestos and environmental losses were
comprised of $109.2 million representing case reserves reported by ceding
companies, $48.7 million representing additional case reserves established by
the Company on assumed reinsurance claims, $152.5 million representing case
reserves established by the Company on direct excess insurance claims, including
Mt. McKinley, and $321.4 million representing incurred but not reported ("IBNR")
reserves.
The Company is involved from time to time in ordinary routine litigation and
arbitration proceedings incidental to its business. The Company does not believe
that there are any other material pending legal proceedings to which it or any
of its subsidiaries or their properties are subject.
The Prudential sells annuities which are purchased by property and casualty
insurance companies to settle certain types of claim liabilities. In 1993 and
prior years, the Company, for a fee, accepted the claim payment obligation of
these property and casualty insurers, and, concurrently, became the owner of the
annuity or assignee of the annuity proceeds. In these circumstances, the Company
would be liable if The Prudential were unable to make the annuity payments. The
estimated cost to replace all such annuities for which the Company was
contingently liable at March 31, 2002 was $147.9 million.
The Company has purchased annuities from an unaffiliated life insurance company
to settle certain claim liabilities of the Company. Should the life insurance
company become unable to make the annuity payments, the Company would be liable
for those claim liabilities. The estimated cost to replace such annuities at
March 31, 2002 was $14.0 million.
3. OTHER COMPREHENSIVE INCOME
The Company's other comprehensive income is comprised as follows:
(dollar amounts in thousands) Three Months Ended
March 31,
2002 2001
---------- ----------
Net unrealized (depreciation)
appreciation of investments, net of
deferred income taxes ($ 43,705) $ 33,492
Currency translation adjustments, net
of deferred income taxes
(674) (2,685)
---------- ----------
Other comprehensive (loss) income,
net of deferred income taxes ($ 44,379) $ 30,807
========== ==========
9
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(continued)
For the Three Months Ended March 31, 2002 and 2001
4. CREDIT LINE
On December 21, 1999, the Company entered into a three-year senior revolving
credit facility with a syndicate of lenders (the "Credit Facility"). First Union
National Bank is the administrative agent for the Credit Facility. The Credit
Facility is used for liquidity and general corporate purposes. The Credit
Facility provides for the borrowing of up to $150.0 million with interest at a
rate selected by the Company equal to either (i) the Base Rate (as defined
below) or (ii) an adjusted London InterBank Offered Rate ("LIBOR") plus a
margin. The Base Rate is the higher of the rate of interest established by First
Union National Bank from time to time as its prime rate or the Federal Funds
rate plus 0.5% per annum. On December 18, 2000, the Credit Facility was amended
to extend the borrowing limit to $235.0 million for a period of 120 days. This
120-day period expired during the three months ended March 31, 2001, after which
the limit reverted to $150.0 million. The amount of margin and the fees payable
for the Credit Facility depends upon the Company's senior unsecured debt rating.
Group has guaranteed all of the Company's obligations under the Credit Facility.
The Credit Facility requires Group to maintain a debt to capital ratio of not
greater than 0.35 to 1, the Company to maintain a minimum interest coverage
ratio of 2.5 to 1 and Everest Re to maintain its statutory surplus at $850.0
million plus 25% of aggregate net income and 25% of aggregate capital
contributions.
During the three months ended March 31, 2002 and 2001, the Company made payments
on the Credit Facility of $20.0 million and $123.0 million, respectively, and
made borrowings of $20.0 million and $20.0 million, respectively. As of March
31, 2002 and 2001, the Company had outstanding Credit Facility borrowings of
$105.0 million and $132.0 million, respectively. Interest expense incurred in
connection with these borrowings was $0.9 million and $2.7 million for the three
months ended March 31, 2002 and 2001, respectively.
5. SENIOR NOTES
During the first quarter of 2000, the Company completed a public offering of
$200.0 million principal amount of 8.75% senior notes due March 15, 2010 and
$250.0 million principal amount of 8.5% senior notes due March 15, 2005.
Interest expense incurred in connection with these senior notes was $9.7 million
and $9.7 million for the three months ended March 31, 2002 and 2001,
respectively.
10
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(continued)
For the Three Months Ended March 31, 2002 and 2001
6. SEGMENT REPORTING
The Company, through its subsidiaries, operates in four segments: U.S.
Reinsurance, U.S. Insurance, Specialty Reinsurance and International
Reinsurance. The U.S. Reinsurance operation writes property and casualty treaty
reinsurance through reinsurance brokers as well as directly with ceding
companies within the United States, in addition to property, casualty and
specialty facultative reinsurance through brokers and directly with ceding
companies within the United States. The U.S. Insurance operation writes property
and casualty insurance primarily through general agent relationships and surplus
lines brokers within the United States. The Specialty Reinsurance operation
writes accident and health, marine, aviation and surety business within the
United States and worldwide through brokers and directly with ceding companies.
The International Reinsurance operation writes property and casualty reinsurance
through the Company's branches in London, Canada, and Singapore, in addition to
foreign "home-office" business.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments principally based upon their
underwriting gain or loss ("underwriting results"). The Company utilizes
inter-affiliate reinsurance and such reinsurance does not impact segment results
as business is reported within the segment in which the business was first
produced. Underwriting results include earned premium less incurred loss and
loss adjustment expenses, commission and brokerage expenses and other
underwriting expenses.
The following tables present the relevant underwriting results for the operating
segments for the three months ended March 31, 2002 and 2001, with all dollar
values presented in thousands.
U.S. REINSURANCE
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2002 2001
----------- -----------
Earned premiums $ 172,626 $ 109,110
Incurred losses and loss
adjustment expenses 121,713 75,361
Commission and brokerage 44,846 26,530
Other underwriting expenses 4,172 3,240
----------- -----------
Underwriting gain $ 1,895 $ 3,979
=========== ===========
11
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(continued)
For the Three Months Ended March 31, 2002 and 2001
U.S. INSURANCE
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2002 2001
----------- -----------
Earned premiums $ 95,364 $ 52,141
Incurred losses and loss
adjustment expenses 67,955 37,199
Commission and brokerage 22,242 13,538
Other underwriting expenses 4,740 3,965
----------- -----------
Underwriting gain (loss) $ 427 ($ 2,561)
=========== ===========
SPECIALTY REINSURANCE
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2002 2001
----------- -----------
Earned premiums $ 108,341 $ 93,738
Incurred losses and loss
adjustment expenses 82,166 74,549
Commission and brokerage 31,619 23,935
Other underwriting expenses 1,366 1,372
----------- -----------
Underwriting (loss) ($ 6,810) ($ 6,118)
=========== ===========
INTERNATIONAL REINSURANCE
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2002 2001
----------- -----------
Earned premiums $ 81,787 $ 73,003
Incurred losses and loss
adjustment expenses 53,879 55,339
Commission and brokerage 15,780 17,850
Other underwriting expenses 3,009 3,167
----------- -----------
Underwriting gain (loss) $ 9,119 ($ 3,353)
=========== ===========
12
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(continued)
For the Three Months Ended March 31, 2002 and 2001
The following table reconciles the underwriting results for the operating
segments to income before tax as reported in the consolidated statements of
operations and comprehensive income, with all dollar values presented in
thousands:
----------------------------
Three Months Ended
March 31,
2002 2001
----------- -----------
Underwriting gain (loss) $ 4,631 ($ 8,053)
Net investment income 64,799 67,362
Realized gain (loss) 1,039 (4,789)
Net derivative (expense) (250) -
Corporate expenses (214) (254)
Interest expense (10,637) (12,421)
Other income 1,578 646
----------- -----------
Income before taxes $ 60,946 $ 42,491
=========== ===========
The Company writes premium in the United States and international markets. The
revenues, net income and identifiable assets of the individual foreign countries
in which the Company writes business are not material to the Company's financial
condition, results of operations and cash flows.
7. DERIVATIVES
The Company has in its product portfolio a credit default swap contract, which
provides credit default protection on a portfolio of securities. This contract
meets the definition of a derivative under Financial Accounting Standards No.
133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133").
The Company's position in this contract is unhedged and is accounted for as a
derivative in accordance with FAS 133. Accordingly, this contract is carried at
fair value with changes in fair value recorded in the statement of operations.
Due to changing market conditions and defaults, the Company recorded net
after-tax losses from this contract of $0.2 million in the three months ended
March 31, 2002.
8. NEW ACCOUNTING PRONOUNCEMENT
In June 2001, the Financial Accounting Standards Board ("FASB") issued FAS 142,
"Goodwill and Other Intangible Assets". FAS 142 established new accounting and
reporting standards for acquired goodwill and other intangible assets. It
requires that an entity determine if the goodwill or other intangible asset has
an indefinite useful life or a finite useful life. Those with indefinite useful
lives are not be subject to amortization and must be tested annually for
impairment. Those with finite useful lives are subject to amortization and must
be tested annually for impairment.
13
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(continued)
For the Three Months Ended March 31, 2002 and 2001
This statement is effective for all fiscal quarters of all fiscal years
beginning after December 15, 2001. The Company adopted FAS 142 on January 1,
2002. The implementation of this statement has not had a material impact on the
financial position, results of operations or cash flows of the Company.
9. RELATED-PARTY TRANSACTIONS
During the normal course of business, the Company, through its affiliates,
engages in what management believes to be arm's-length reinsurance and brokerage
and commission business transactions with companies controlled by or affiliated
with its outside directors. Such transactions, individually and in the
aggregate, are immaterial to the Company's financial condition, results of
operations and cash flows.
The Company engages in business transactions with Group and Bermuda Re.
Effective January 1, 2002, Everest Re and Bermuda Re entered into a Quota Share
Reinsurance Agreement, for what management believes to be arm's-length
consideration, whereby Everest Re cedes 20% of the net retained liability on all
new and renewal policies written during the term of this agreement. Effective
January 1, 2002, Everest Re, Everest National Insurance Company and Everest
Security Insurance Company entered into an Excess of Loss Reinsurance Agreement
with Bermuda Re, for what management believes to be arm's-length consideration,
covering workers' compensation losses occurring on and after January 1, 2002, as
respects new, renewal and in force policies effective on that date. Bermuda Re
is liable for any loss exceeding $100,000 per occurrence, with its liability not
to exceed $150,000 per occurrence. Effective October 1, 2001, Everest Re and
Bermuda Re entered into a loss portfolio reinsurance agreement, whereby Everest
Re transferred all of it's Belgium Branch net insurance exposures and reserves
to Bermuda Re for what management believes to be arm's-length consideration.
Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss
portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for
what management believes to be arm's-length consideration, all of its net
insurance exposures and reserves to Bermuda Re.
14
Part I - Item 2
EVEREST REINSURANCE HOLDINGS, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
INDUSTRY CONDITIONS
The worldwide reinsurance and insurance businesses are highly competitive yet
cyclical by product and market. The terrorist attacks on September 11, 2001 (the
"September 11th attacks") resulted in losses which reduced industry capacity and
were of sufficient magnitude to cause most individual companies to reassess
their capital position, tolerance for risk, exposure control mechanisms and the
pricing terms and conditions at which they are willing to take on risk. The
gradual and variable improving trend that had been apparent through 2000 and
earlier in 2001 firmed significantly. This firming generally took the form of
immediate and significant upward pressure on prices, more restrictive terms and
conditions and a reduction of coverage limits and capacity availability. Such
pressures were widespread with variability depending on the product and markets
involved, but mainly depending on the characteristics of the underlying risk
exposures. The magnitude of the changes was sufficient to create temporary
disequilibrium in some markets as individual buyers and sellers adapted to
changes in both their internal and market dynamics.
These changes reflect a reversal of the general trend from 1987 through 1999
toward increasingly competitive global market conditions across most lines of
business as reflected by decreasing prices and broadening contract terms. The
earlier trend resulted from a number of factors, including the emergence of
significant reinsurance capacity in Bermuda, changes in the Lloyds market,
consolidation and increased capital levels in the insurance and reinsurance
industries, as well as the emergence of new reinsurance and financial products
addressing traditional exposures in alternative fashions. Many of these factors
continue to exist and may be amplified as the result of market changes since the
September 11th attacks. As a result, although the Company is encouraged by the
recent improvements, and more generally, current market conditions, the Company
cannot predict with any reasonable certainty whether and to what extent these
improvements will persist.
SEGMENT INFORMATION
The Company, through its subsidiaries, operates in four segments: U.S.
Reinsurance, U.S. Insurance, Specialty Reinsurance and International
Reinsurance. The U.S. Reinsurance operation writes property and casualty treaty
reinsurance through reinsurance brokers as well as directly with ceding
companies within the United States, in addition to property, casualty and
specialty facultative reinsurance through brokers and directly with ceding
companies within the United States. The U.S. Insurance operation writes property
and casualty insurance primarily through general agent relationships and surplus
lines brokers within the United States. The Specialty Reinsurance operation
writes accident and health, marine, aviation and surety business within the
United States and worldwide through brokers and directly with ceding companies.
15
The International Reinsurance operation writes property and casualty reinsurance
through the Company's branches in London, Canada, and Singapore, in addition to
foreign "home-office" business.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments principally based upon their
underwriting results. The Company utilizes inter-affiliate reinsurance and such
reinsurance does not impact segment results as business is reported within the
segment in which the business was first produced.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
PREMIUMS. Gross premiums written increased 41.0% to $590.9 million in the three
months ended March 31, 2002 from $418.9 million in the three months ended March
31, 2001 as the Company took advantage of selected growth opportunities, while
continuing to maintain a disciplined underwriting approach. Premium growth areas
included a 56.3% ($71.6 million) increase in the U.S. Insurance operation,
principally attributable to growth in workers' compensation insurance, a 50.3%
($60.8 million) increase in the U.S. Reinsurance operation primarily reflecting
growth across casualty lines, a 23.7% ($17.9 million) increase in the
International Reinsurance operation, mainly attributable to growth in the
London, Canada and Latin American markets and a 22.7% ($21.7 million) increase
in the Specialty Reinsurance operation, principally attributable to growth in
medical stop loss business, a component of A&H writings. The Company continued
to decline business that did not meet its objectives regarding underwriting
profitability.
Ceded premiums increased to $76.8 million in the three months ended March 31,
2002 from $32.1 million in the three months ended March 31, 2001. This increase
was principally attributable to $38.0 million of ceded premiums relating to a
Quota Share Reinsurance Agreement between Everest Re and Bermuda Re, whereby
Everest Re cedes 20% of its net retained liability on all new and renewal
policies written during the term of this agreement, and from an Excess of Loss
Agreement between Everest Re, Everest National Insurance Company and Everest
Security Insurance Company and Bermuda Re, whereby Bermuda Re assumes liability
for primary insurance workers' compensation losses exceeding $100,000 per
occurrence, with its liability not to exceed $150,000 per occurrence.
Net premiums written increased by 32.9% to $514.1 million in the three months
ended March 31, 2002 from $386.8 million in the three months ended March 31,
2001. This increase was consistent with the increase in gross premiums written,
partially offset by the increase in ceded premiums.
PREMIUM REVENUES. Net premiums earned increased by 39.7% to $458.1 million in
the three months ended March 31, 2002 from $328.0 million in the three months
ended March 31, 2001. Contributing to this increase was an 82.9% ($43.2 million)
increase in the U.S. Insurance operation, a 58.2% ($63.5 million) increase in
the U.S. Reinsurance operation, a 15.6% ($14.6 million) increase in the
Specialty Reinsurance operation and a 12.0% ($8.8 million) increase in the
International Reinsurance operation. All of these changes reflect period to
period changes in net written premiums and business mix together with normal
variability in earnings patterns. Business mix changes occur not only as the
Company shifts emphasis between products, lines of business, distribution
16
channels and markets but also as individual contracts renew or non-renew, almost
always with changes in coverage, structure, prices and/or terms, and as new
contracts are accepted with coverages, structures, prices and/or terms different
from those of expiring contracts. As premium reporting and earnings and loss and
commission characteristics derive from the provisions of individual contracts,
the continuous turnover of individual contracts, arising from both strategic
shifts and day to day underwriting, can and does introduce appreciable
background variability in various underwriting line items.
EXPENSES. Incurred loss and loss adjustment expenses ("LAE") increased by 34.3%
to $325.7 million in the three months ended March 31, 2002 from $242.4 million
in the three months ended March 31, 2001. The increase in incurred losses and
LAE was principally attributable to the increase in net premiums earned and also
reflects the impact of changes in the Company's mix of business. Incurred losses
and LAE include catastrophe losses, which include the impact of both current
period events, and favorable and unfavorable development on prior period events
and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss
on property exposures of at least $5.0 million and has an event date of January
1, 1988 or later. Catastrophe losses, net of contract specific cessions but
before cessions under the corporate retrocessional program, were $1.4 million in
the three months ended March 31, 2002 compared to net catastrophe losses of
$14.9 million in the three months ended March 31, 2001. Incurred losses and LAE
for the three months ended March 31, 2002 reflected ceded losses and LAE of
$60.4 million compared to ceded losses and LAE in the three months ended March
31, 2001 of $32.6 million, with the increase principally attributable to $24.0
million of ceded losses and LAE in the three months ended March 31, 2002
relating to the reinsurance transactions between the Company and Bermuda Re
noted earlier.
Contributing to the increase in incurred losses and LAE in the three months
ended March 31, 2002 from the three months ended March 31, 2001 were an 82.7%
($30.8 million) increase in the U.S. Insurance operation principally reflecting
increased premium volume coupled with changes in this segments specific
reinsurance programs, a 61.5% ($46.4 million) increase in the U.S. Reinsurance
operation and a 10.2% ($7.6 million) increase in the Specialty Reinsurance
operation principally attributable to increased premium volume in A&H business.
These increases were partially offset by a 2.6% ($1.5 million) decrease in the
International Reinsurance operation. Incurred losses and LAE for each operation
were also impacted by variability relating to changes in the level of premium
volume and mix of business by class and type.
The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing
incurred losses and LAE by premiums earned, decreased by 2.8 percentage points
to 71.1% in the three months ended March 31, 2002 from 73.9% in the three months
ended March 31, 2001 reflecting the incurred losses and LAE discussed above. The
following table shows the loss ratios for each of the Company's operating
segments for the three months ended March 31, 2002 and 2001. The loss ratios for
all operations were impacted by the factors noted above.
Operating Segment Loss Ratios
- --------------------------------------------------------------------------------
Segment 2002 2001
- --------------------------------------------------------------------------------
U.S. Reinsurance 70.5% 69.1%
U.S. Insurance 71.3% 71.3%
Specialty Reinsurance 75.8% 79.5%
International Reinsurance 65.9% 75.8%
17
Underwriting expenses increased by 36.4% to $128.0 million in the three months
ended March 31, 2002 from $93.9 million in the three months ended March 31,
2001. Commission, brokerage, taxes and fees increased by $32.6 million,
principally reflecting increases in premium volume and changes in the mix of
business. Other underwriting expenses increased by $1.5 million as the Company
has expanded its business volume and operations. Contributing to these
underwriting expense increases were a 64.7% ($19.2 million) increase in the U.S.
Reinsurance operation, a 54.2% ($9.5 million) increase in the U.S. Insurance
operation and a 30.3% ($7.7 million) increase in the Specialty Reinsurance
operation. These increases were partially offset by a 10.6% ($2.2 million)
decrease in the International Reinsurance operation. The changes for each
operation's expenses principally resulted from changes in commission expenses
related to changes in premium volume and business mix by class and type and, in
some cases, changes in the use of specific reinsurance and the underwriting
performance of the underlying business. The Company's expense ratio, which is
calculated by dividing underwriting expenses by premiums earned, was 27.9% for
the three months ended March 31, 2002 compared to 28.6% for the three months
ended March 31, 2001.
The Company's combined ratio, which is the sum of the loss and expense ratios,
decreased by 3.5 percentage points to 99.0% in the three months ended March 31,
2002 compared to 102.5% in the three months ended March 31, 2001. The following
table shows the combined ratios for each of the Company's operating segments for
the three months ended March 31, 2002 and 2001. The combined ratios for all
operations were impacted by the loss and expense ratio variability noted above.
Operating Segment Combined Ratios
- --------------------------------------------------------------------------------
Segment 2002 2001
- --------------------------------------------------------------------------------
U.S. Reinsurance 98.9% 96.4%
U.S. Insurance 99.6% 104.9%
Specialty Reinsurance 106.3% 106.5%
International Reinsurance 88.9% 104.6%
INVESTMENT RESULTS. Net investment income decreased 3.8% to $64.8 million in the
three months ended March 31, 2002 from $67.4 million in the three months ended
March 31, 2001, principally reflecting the effects of the lower interest rate
environment, partially offset by the effect of investing the $287.3 million of
cash flow from operations in the twelve months ended March 31, 2002. The
following table shows a comparison of various investment yields as of March 31,
2002 and December 31, 2001, respectively, and for the periods ended March 31,
2002 and 2001, respectively.
18
2002 2001
----------------
Imbedded pre-tax yield of cash and invested
assets at March 31, 2002 and December 31, 2001 6.0% 6.0%
Imbedded after-tax yield of cash and invested
assets at March 31, 2002 and December 31, 2001 4.6% 4.6%
Annualized pre-tax yield on average cash and
invested assets for the three months ended
March 31, 2002 and 2001 6.0% 6.5%
Annualized after-tax yield on average cash and
invested assets for the three months ended
March 31, 2002 and 2001 4.6% 4.9%
Net realized capital gains were $1.0 million in the three months ended March 31,
2002, reflecting realized capital gains on the Company's investments of $7.4
million, partially offset by $6.4 million of realized capital losses, which
included $3.8 million relating to write-downs in the value of securities deemed
to be other than temporary, compared to net realized capital losses of $4.8
million in the three months ended March 31, 2001. The net realized capital
losses in the three months ended March 31, 2001 reflected realized capital
losses of $5.0 million, partially offset by $0.2 million of realized capital
gains.
Interest expense for the three months ended March 31, 2002 was $10.6 million
compared to $12.4 million for the three months ended March 31, 2001. Interest
expense for the three months ended March 31, 2002 reflects $9.7 million relating
to the Company's issuance of senior notes and $0.9 million relating to the
Company's borrowings under it's revolving credit facility. Interest expense for
the three months ended March 31, 2001 reflects $9.7 million relating to the
Company's issuance of senior notes and $2.7 million relating to the Company's
borrowings under its revolving credit facility.
Other income for the three months ended March 31, 2002 was $1.6 million compared
to $0.6 million for the three months ended March 31, 2001. Significant
contributors to other income for the three months ended March 31, 2002 were
foreign exchange gains as well as financing fees, offset by the amortization of
deferred expenses relating to the Company's issuance of senior notes in 2000.
Other income for the three months ended March 31, 2001 principally included
foreign exchange gains and financing fees. The foreign exchange gains for both
periods are attributable to fluctuations in foreign currency exchange rates.
The Company has a credit default swap which transaction meets the definition of
a derivative under FAS 133. Net derivative expense, essentially reflecting
changes in fair value, from this transaction for the three months ended March
31, 2002 was $0.3 million compared to $0.0 million for the three months ended
March 31, 2001.
INCOME TAXES. The Company recognized income tax expense of $14.6 million in the
three months ended March 31, 2002 compared to $8.9 million in the three months
ended March 31, 2001 principally reflecting improved underwriting results,
decreased interest expense and taxable capital gains.
19
NET INCOME. Net income was $46.3 million in the three months ended March 31,
2002 compared to $33.6 million in the three months ended March 31, 2001. This
increase generally reflects the improved underwriting results and decreased
interest expense.
MARKET SENSITIVE INSTRUMENTS. The Company's risks associated with market
sensitive instruments have not changed materially since the period ended
December 31, 2001.
SAFE HARBOR DISCLOSURE. This report contains forward-looking statements within
the meaning of the U.S. federal securities laws. The Company intends these
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements in the federal securities laws. In some cases, these
statements can be identified by the use of forward-looking words such as "may",
"will", "should", "could", "anticipate", "estimate", "expect", "plan",
"believe", "predict", "potential" and "intend". Forward-looking statements
contained in this report include information regarding the Company's reserves
for losses and LAE and estimates of the Company's catastrophe exposure.
Forward-looking statements only reflect the Company's expectations and are not
guarantees of performance. These statements involve risks, uncertainties and
assumptions. Actual events or results may differ materially from the Company's
expectations. Important factors that could cause actual events or results to be
materially different from the Company's expectations include those discussed
below under the caption "Risk Factors". The Company undertakes no obligation to
update or revise publicly any forward-looking statements, whether as a result of
new information, future events or otherwise.
20
EVEREST REINSURANCE HOLDINGS, INC.
OTHER INFORMATION
PART II - ITEM 1. LEGAL PROCEEDINGS
The Company is involved from time to time in ordinary routine litigation and
arbitration proceedings incidental to its business. The Company does not believe
that there are any other material pending legal proceedings to which it or any
of its subsidiaries or their properties are subject.
PART II - ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibit Index:
Exhibit No. Description Location
----------- ----------- --------
None
b) There were no reports on Form 8-K filed during the three-month period
ending March 31, 2002.
Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period covered.
21
EVEREST REINSURANCE HOLDINGS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Everest Reinsurance Holdings, Inc.
(Registrant)
/S/ STEPHEN L. LIMAURO
---------------------------------------
Stephen L. Limauro
Duly Authorized Officer, Executive Vice
President and Chief Financial Officer
Dated: May 10, 2002