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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 Commission file number 1-13816
EVEREST REINSURANCE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware 22-3263609
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
477 Martinsville Road
Post Office Box 830
Liberty Corner, New Jersey 07938-0830
(908) 604-3000
(Address, including zip code, and telephone number,
including area code, of registrant's
principal executive office)
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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Common Stock, $.01 par value per share New York Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No _
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value on March 3, 1998 of the voting stock held by
non-affiliates of the registrant was $1,841 million.
At March 3, 1998, the number of shares outstanding of the registrant's
common stock was 50,482,326.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12, and 13 of Form 10-K is
incorporated by reference into Part III hereof from the registrant's proxy
statement for the 1998 Annual Meeting, which will be filed with the Securities
and Exchange Commission within 120 days of the close of the registrant's fiscal
year ended December 31, 1997.
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TABLE OF CONTENTS
Item Page
- ---- ----
PART I
1. Business .................................................... 1
2. Properties .................................................. 21
3. Legal Proceedings ........................................... 21
4. Submission of Matters to a Vote of Security
Holders .................................................... 21
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters ........................................ 21
6. Selected Financial Data ..................................... 22
7. Management's Discussion and Analysis of Financial
Condition and Results of Operation ......................... 24
7A. Quantitative and Qualitative Disclosures About
Market Risk ................................................ 32
8. Financial Statements and Supplementary Data ................. 32
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure ........................ 33
PART III
10. Directors and Executive Officers of the Registrant .......... 33
11. Executive Compensation ...................................... 33
12. Security Ownership of Certain Beneficial Owners
and Management ............................................. 33
13. Certain Relationships and Related Transactions .............. 33
PART IV
14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K ........................................ 33
PART I
UNLESS OTHERWISE INDICATED, (I) ALL FINANCIAL DATA IN THIS DOCUMENT HAVE BEEN
PREPARED USING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP"), AND (II) ALL
STATUTORY FINANCIAL DATA REFERRED TO IN THIS DOCUMENT REFER TO STATUTORY
FINANCIAL DATA OF EVEREST RE. AS USED IN THIS DOCUMENT, "EVEREST RE" MEANS
EVEREST REINSURANCE COMPANY (FORMERLY PRUDENTIAL REINSURANCE COMPANY) AND ITS
SUBSIDIARIES (UNLESS THE CONTEXT OTHERWISE REQUIRES); "HOLDINGS" MEANS EVEREST
REINSURANCE HOLDINGS, INC. (FORMERLY PRUDENTIAL REINSURANCE HOLDINGS, INC.); AND
THE "COMPANY" MEANS HOLDINGS AND ITS SUBSIDIARIES.
ITEM 1. BUSINESS
THE COMPANY
Everest Reinsurance Holdings, Inc., a Delaware corporation, was established in
1993 to serve as the parent holding company of Everest Reinsurance Company
(formed in 1973), a property and casualty reinsurance operation. Until October
6, 1995, the Company was an indirect wholly-owned subsidiary of The Prudential
Insurance Company of America ("The Prudential"). On October 6, 1995, The
Prudential sold its entire interest in Holdings' shares of common stock in an
initial public offering (the "IPO").
Holdings, through its wholly-owned subsidiary, Everest Re, underwrites property
and casualty reinsurance on a treaty and facultative basis for insurance and
reinsurance companies in the United States and selected international markets.
Everest Re writes reinsurance both through brokers and directly with ceding
insurance companies, giving it the flexibility to pursue business regardless of
the ceding company's preferred reinsurance purchasing method. The Company had
gross premiums written in 1997 of $1,075.0 million and stockholders' equity at
December 31, 1997 of $1,307.5 million and Everest Re had statutory surplus at
December 31, 1997 of $908.8 million. Based on industry data at December 31, 1997
published by the Reinsurance Association of America ("RAA"), Everest Re is the
sixth largest reinsurance company in the United States, ranked by statutory
surplus, and is rated "A+" ("Superior") by A.M. Best, an independent insurance
industry rating organization which rates insurance companies on factors of
concern to policyholders.
Everest Re has four subsidiaries: Everest Re Ltd. ("Everest Ltd.", formerly
Everest Reinsurance Ltd. and Le Rocher Reinsurance Ltd.), Everest National
Insurance Company ("Everest National", formerly Prudential National Insurance
Company), Everest Insurance Company of Canada ("Everest Canada") and Everest
Indemnity Insurance Company ("Everest Indemnity"). Everest Ltd., a United
Kingdom company, was authorized to engage in the reinsurance business in the
United Kingdom and, prior to January 1, 1997, it reinsured risks worldwide. In
1996, Everest Re obtained authorization to engage in the reinsurance business in
the United Kingdom, and the operations of Everest Ltd. were converted to branch
operations of Everest Re, effective January 1, 1997. Everest National, an
Arizona insurance company, is licensed in 39 states and the District of Columbia
and writes primary insurance on an admitted basis. On December 31, 1996, Everest
Re acquired Everest Canada (formerly OTIP/RAEO Insurance Company Inc.) from a
subsidiary of The Prudential. All liabilities incurred before the acquisition
date, including insurance obligations under expired and in-force business, were
assumed by Prudential of America General Insurance Company (Canada), a
subsidiary of The Prudential which was subsequently sold to Liberty Mutual
Insurance Company, whereupon it was renamed Liberty Insurance Company of Canada.
Everest Canada is federally licensed to write primary insurance under the
Insurance Companies Act of Canada and licensed in all Canadian provinces and
territories. In 1997, Everest Re formed Everest Indemnity, a Delaware insurance
company, to engage in the excess and surplus lines primary insurance business in
the United States. Everest Indemnity is licensed in Delaware and is in the
process of obtaining eligibility to write business in all states on a
non-admitted basis.
In 1997, Holdings formed Mt. McKinley Managers, L.L.C. ("Mt. McKinley"), a New
Jersey limited liability corporation, which is licensed as an insurance
producer, including surplus lines authority, in New Jersey.
REINSURANCE INDUSTRY OVERVIEW
Reinsurance is an arrangement in which an insurance company, the reinsurer,
agrees to indemnify another insurance company, the ceding company, against all
or a portion of the insurance risks underwritten by the ceding company under one
or more insurance contracts. Reinsurance can provide a ceding company with
several benefits, including a reduction in net liability on individual risks,
catastrophe protection from large or multiple losses and assistance in
maintaining acceptable financial ratios. Reinsurance also provides a ceding
company with additional underwriting capacity by permitting it to accept larger
risks and write more business than would be possible without a concomitant
increase in capital and surplus. Reinsurance, however, does not discharge the
ceding company from its liability to policyholders.
There are two basic types of reinsurance arrangements: treaty and facultative
reinsurance. In treaty reinsurance, the ceding company is obligated to cede and
the reinsurer is obligated to assume a specified portion of a type or category
of risks insured by the ceding company. Treaty reinsurers, including Everest Re,
do not separately evaluate each of the individual risks assumed under their
treaties and, consequently, after a review of the ceding company's underwriting
practices, are largely dependent on the original risk underwriting decisions
made by the ceding company. Such dependence subjects reinsurers in general,
including Everest Re, to the possibility that the ceding companies have not
adequately evaluated the risks to be reinsured and, therefore, that the premiums
ceded in connection therewith may not adequately compensate the reinsurer for
the risk assumed. The reinsurer's evaluation of the ceding company's risk
management and underwriting practices, therefore, will usually impact the
pricing of the treaty. In facultative reinsurance, the ceding company cedes and
the reinsurer assumes all or part of the risk under a single insurance contract.
Facultative reinsurance is negotiated separately for each insurance contract
that is reinsured. Facultative reinsurance normally is purchased by ceding
companies for individual risks not covered by their reinsurance treaties, for
amounts in excess of the dollar limits of their reinsurance treaties and for
unusual risks. Underwriting expenses and, in particular, personnel costs, are
higher on facultative business because each risk is individually underwritten
and administered. The ability to separately evaluate each risk reinsured,
however, increases the probability that the reinsurer can price the contract to
more accurately reflect the risks involved.
Both treaty and facultative reinsurance can be written on either a pro rata
basis or an excess of loss basis. With respect to pro rata reinsurance, the
ceding company and the reinsurer share the premiums as well as the losses and
expenses in an agreed proportion. In the case of reinsurance written on an
excess of loss basis, the reinsurer indemnifies the ceding company against all
or a specified portion of losses and expenses in excess of a specified dollar
amount, known as the ceding company's retention or reinsurer's attachment point,
generally subject to a negotiated reinsurance contract limit.
Premiums payable by the ceding company to a reinsurer for excess of loss
reinsurance are not directly proportional to the premiums that the ceding
company receives because the reinsurer does not assume a proportionate risk. In
contrast, premiums that the ceding company pays to the reinsurer for pro rata
reinsurance are proportional to the premiums that the ceding company receives,
consistent with the proportional sharing of risk. In addition, in pro rata
reinsurance the reinsurer generally pays the ceding company a ceding commission.
The ceding commission generally is based on the ceding company's cost of
acquiring the business being reinsured (commissions, premium taxes, assessments
and miscellaneous administrative expense) and also may include a profit factor
for producing the business.
Reinsurers typically purchase reinsurance to cover their own risk exposure.
Reinsurance of a reinsurer's business is called a retrocession. Reinsurance
companies cede risks under retrocessional agreements to other reinsurers, known
as retrocessionaires, for reasons similar to those that cause primary insurers
to purchase reinsurance: to reduce net liability on individual risks, protect
against catastrophic losses, stabilize financial ratios and obtain additional
underwriting capacity.
Reinsurance can be written through professional reinsurance brokers or directly
for ceding companies. From a ceding company's perspective, both the broker
market and the direct market have advantages and disadvantages. A ceding
company's decision to select one market over the other will be influenced by its
perception of such advantages and disadvantages relative to the reinsurance
coverage being placed.
BUSINESS STRATEGY
The Company's business strategies include effective management of the
underwriting cycle, management of catastrophe exposures and retrocessional cost
and expense control. The underwriting strategies seek to capitalize on the
Company's staff resources and its flexibility to offer multiple products through
multiple production sources in a cost efficient manner.
The Company's products include the full range of property and casualty
coverages, including marine, aviation, surety, errors & omissions liability
("E&O"), directors' & officers' liability ("D&O"), medical malpractice, other
specialty lines, accident and health, workers compensation, non-standard auto
and loss portfolios. The Company's distribution sources include both the direct
and broker reinsurance markets, international and domestic markets, reinsurance,
both treaty and facultative, and insurance, both admitted and non-admitted.
The Company's underwriting strategy emphasizes underwriting profitability rather
than premium volume, writing specialized risks and integration of underwriting
expertise across all underwriting units. Key elements of this strategy are
prudent risk selection, appropriate pricing through strict underwriting
discipline and adjusting the Company's business mix to respond to changing
market conditions. Management intends to focus on reinsuring companies that
effectively manage the underwriting cycle through proper analysis and pricing of
underlying risks and whose underwriting guidelines and performance are
compatible with the Company's profitability objectives.
2
The Company's underwriting strategy also emphasizes flexibility and
responsiveness to changing market conditions, such as increased demand or
favorable pricing trends. Management believes that Everest Re's existing
strengths, including its broad underwriting expertise, international presence
and substantial capital, will facilitate adjustments to its mix of business
geographically, by line of business and by type of coverage, allowing it to
capitalize on those market opportunities that provide the greatest potential for
underwriting profitability. The Company's primary insurance infrastructure will
facilitate this strategy by allowing the Company to develop business that
requires the Company to issue primary insurance policies. The Company will also
continue to carefully monitor its mix of business to avoid inappropriate
concentrations of geographic or other risk.
The Company's underwriting guidelines seek to limit the accumulation of known
risks in exposed areas, to require that business which is exposed to catastrophe
losses be written with greater geographic spread and to maintain a
cost-effective retrocession program. The Company's underwriting guidelines also
seek to better reflect the relationship between premiums and risk assumed while
maintaining the Company's probable maximum loss at appropriate levels.
Efforts to control expenses and to operate in a more cost-efficient manner
continue to be a focus of the Company. These efforts have resulted in a 45.7%
reduction in employees to 377 at December 31, 1997 from 694 at June 30, 1994,
the restructuring of the Company's facultative operations in 1995 and changes in
certain vendor relationships. These changes were implemented to improve
efficiency and eliminate redundant positions. Additionally, the Company is in
the process of implementing a plan to improve the cost effectiveness of its
information systems.
MARKETING
The Company writes its business on a worldwide basis for many different
customers and for many lines of property and casualty business. Its products
provide a broad array of coverages. The Company is not materially dependent on
any single customer, small group of customers, line of business or geographical
area. For the 1997 underwriting year, no single customer generated more than
3.6% of the Company's gross premiums written. The Company does not believe that
the reduction of business assumed from any one customer will have a materially
adverse effect on its future financial condition or results of operations due to
the Company's competitive position in the market place and the continuing
availability of other sources of business.
Approximately 64.8% and 35.2% of Everest Re's 1997 gross premiums written were
written in the broker and direct market, respectively. Everest Re's ability to
write reinsurance both through brokers and directly with ceding companies gives
it the flexibility to pursue business regardless of the ceding company's
preferred reinsurance purchasing method.
The reinsurance broker market consists of several substantial national and
international brokers and a number of smaller specialized brokers. Brokers do
not have the authority to bind Everest Re with respect to reinsurance
agreements, nor does Everest Re commit in advance to accept any portion of the
business that brokers submit to it. Reinsurance business from any ceding
company, whether new or renewal, is subject to acceptance by Everest Re.
Brokerage fees generally are paid by reinsurers. The Company's largest ten
brokers accounted for an aggregate of approximately 51.3% of gross premiums
written in 1997 with the two largest brokers accounting for approximately 19.3%
and 8.3%, respectively, of gross premiums written. The Company does not believe
that the reduction of business assumed from any one broker will have a
materially adverse effect on the Company due to its competitive position in the
market place, relationships with ceding companies and the continuing
availability of other sources of business.
The direct market remains an important distribution system for reinsurance
business written by Everest Re and primary insurance written through Everest
National and Everest Indemnity in the United States and Everest Canada in
Canada. Direct placement of reinsurance enables Everest Re to access clients who
prefer to place their reinsurance directly with their reinsurers based upon the
reinsurer's in-depth understanding of the ceding company's needs. The Company's
primary insurance business is written principally through general agency
relationships. The Company evaluates each business relationship, including the
underwriting expertise and experience of each distribution channel selected,
performs an analysis to evaluate financial security and monitors performance.
UNDERWRITING UNITS
The following table presents the distribution of Everest Re's gross premiums
written by its U.S. broker treaty, U.S. direct treaty reinsurance and insurance,
marine, aviation and surety, U.S. facultative and international operations for
the years ended December 31, 1997, 1996, 1995, 1994 and 1993, classified
according to whether such premium is derived from property or casualty business
and whether it represents pro rata or excess of loss business:
3
GROSS PREMIUMS WRITTEN BY UNDERWRITING UNIT
Years Ended December 31,
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1997 1996 1995 1994 1993
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(Dollars in millions) $ % $ % $ % $ % $ %
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U.S. Broker Treaty
Property
Pro Rata(1) $ 62.8 5.8% $ 45.4 4.4% $ 51.7 5.4% $ 59.7 6.3% $ 80.3 8.7%
Excess 53.3 5.0 60.4 5.8 59.0 6.2 53.9 5.7 88.8 9.7
Casualty
Pro Rata(1) 84.6 7.9 63.4 6.1 18.5 1.9 29.6 3.1 28.2 3.1
Excess 124.3 11.6 137.5 13.2 122.6 12.9 113.5 11.9 103.7 11.3
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Total(2) 325.0 30.2 306.8 29.4 251.8 26.5 256.6 26.9 301.0 32.8
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U.S. Direct Treaty
Reinsurance and
Insurance
Property
Pro Rata(1) 11.7 1.1 12.6 1.2 3.3 0.3 5.4 0.6 17.3 1.9
Excess 4.4 0.4 8.9 0.9 9.1 1.0 12.5 1.3 10.9 1.2
Casualty
Pro Rata(1) 128.0 11.9 114.5 11.0 99.8 10.5 83.2 8.7 56.2 6.1
Excess 14.3 1.3 12.5 1.2 10.0 1.1 38.6 4.0 46.3 5.0
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Total(2) 158.4 14.7 148.6 14.2 122.2 12.9 139.7 14.7 130.7 14.2
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Marine, Aviation
and Surety
Property
Pro Rata(1) 92.9 8.6 94.6 9.1 89.2 9.4 74.1 7.8 67.3 7.3
Excess 16.9 1.6 17.8 1.7 18.7 2.0 16.8 1.8 16.3 1.8
Casualty
Pro Rata(1) 45.4 4.2 43.1 4.1 53.0 5.6 66.0 6.9 48.6 5.3
Excess 6.4 0.6 5.6 0.5 6.0 0.6 4.8 0.5 10.5 1.1
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Total(2) 161.6 15.0 161.1 15.4 166.9 17.6 161.7 17.0 142.7 15.5
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U.S. Facultative
Property
Pro Rata(1) - - - - - - - - - -
Excess 29.0 2.7 26.9 2.6 22.3 2.3 27.4 2.9 20.9 2.3
Casualty
Pro Rata(1) - - - - - - - - - -
Excess 53.4 5.0 61.8 5.9 46.6 4.9 39.3 4.1 35.0 3.8
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Total(2) 82.4 7.7 88.7 8.5 68.8 7.2 66.7 7.0 55.9 6.1
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Total U.S.
Property
Pro Rata(1) 167.4 15.6 152.6 14.6 144.2 15.2 139.2 14.6 164.9 18.0
Excess 103.6 9.6 114.0 10.9 109.1 11.5 110.6 11.6 136.9 14.9
Casualty
Pro Rata(1) 258.0 24.0 221.1 21.2 171.3 18.0 178.8 18.8 133.0 14.5
Excess 198.4 18.5 217.6 20.8 185.2 19.5 196.1 20.6 195.5 21.3
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Total(2) 727.4 67.7 705.2 67.5 609.7 64.2 624.7 65.5 630.3 68.7
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International
Property
Pro Rata(1) 144.2 13.4 124.2 11.9 136.2 14.3 147.0 15.4 122.1 13.3
Excess 62.9 5.9 79.8 7.6 84.9 8.9 89.2 9.4 81.5 8.9
Casualty
Pro Rata(1) 99.2 9.2 90.5 8.7 66.4 7.0 49.6 5.2 44.4 4.8
Excess 41.3 3.8 44.4 4.3 52.3 5.5 42.7 4.5 39.8 4.3
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Total(2) 347.6 32.4 338.8 32.5 339.8 35.8 328.5 34.5 287.8 31.3
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Total Company
Property
Pro Rata(1) 311.6 29.0 276.7 26.5 280.4 29.5 286.2 30.0 287.0 31.3
Excess 166.5 15.5 193.8 18.6 194.0 20.4 199.8 21.0 218.4 23.8
Casualty
Pro Rata(1) 357.2 33.2 311.6 29.8 237.6 25.0 228.4 24.0 177.4 19.3
Excess 239.7 22.3 261.9 25.1 237.5 25.0 238.8 25.1 235.3 25.6
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Total(2) $ 1,075.0 100.0% $ 1,044.0 100.0% $ 949.5 100.0% $ 953.2 100.0% $ 918.1 100.0%
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(1) For purposes of the presentation above, pro rata reinsurance means
reinsurance attaching to the first dollar of loss incurred by the ceding
company.
(2) Certain totals and subtotals may not reconcile due to rounding.
4
U.S. BROKER TREATY OPERATIONS. Everest Re's U.S. broker treaty operations write
property, accident and health and casualty reinsurance through reinsurance
brokers. The Company targets certain brokers and, through the broker market,
specialty companies and small to medium sized standard lines companies. The U.S.
broker treaty operations also write portions of reinsurance programs for larger,
national insurance companies.
In 1997, $116.1 million of gross premiums written were attributable to domestic
property business (which in 1997 included accident and health business), of
which 45.9% was written on an excess of loss basis and 54.1% was written on a
pro rata basis. This unit utilizes sophisticated underwriting methods which
management believes are necessary to analyze and price property business,
particularly that segment of the property market which has catastrophe exposure.
Domestic casualty business accounted for $208.9 million of gross premiums
written in 1997, of which 59.5% was written on an excess of loss basis and 40.5%
was written on a pro rata basis. The treaty casualty portfolio consists
principally of professional liability, directors' & officers' liability,
workers' compensation, excess and surplus lines, and other liability coverages.
As a result of the complex technical nature of most of these risks, the
Company's casualty underwriters tend to specialize by line of business and work
closely with the Company's pricing actuaries.
DIRECT TREATY REINSURANCE AND INSURANCE OPERATIONS. The Company's direct treaty
reinsurance operation writes a full line of property and casualty business. In
1997, direct treaty business accounted for $83.5 million of gross premiums
written, of which 22.4% was written on an excess of loss basis and 77.6% was
written on a pro rata basis. The U.S. direct treaty underwriters target
companies which place their business predominantly in the direct market,
including small to medium sized regional ceding companies, and seek to develop
long-term relationships with such companies. A broad array of coverages are
offered.
In 1997, the Company's domestic insurance operation consisted of $74.9 million
of gross premiums written primarily through Everest National, which is licensed
in 39 states and the District of Columbia to write primary insurance. Everest
National targets commercial property and casualty business written through
agency relationships with program administrators. With respect to primary
insurance written through such agents, the Company supplements the initial
underwriting process with periodic claims and underwriting reviews.
MARINE, AVIATION AND SURETY OPERATIONS. The Company's marine and aviation unit
focuses on ceding companies with a particular expertise in marine and aviation
business. The marine and aviation business is written primarily through brokers
and contains a significant international component written primarily in the
London market. Surety business underwritten by the Company consists mainly of
reinsurance of contract surety bonds.
Gross premiums written by the marine and aviation unit in 1997 totaled $106.5
million, substantially all of which was written on a treaty basis and 69.1% of
which was sourced through reinsurance brokers. Marine treaties represented 51.4%
of marine and aviation gross premiums written in 1997 and consisted of hull and
liability coverage. Approximately 85.6% of the marine unit premiums in 1997 were
written on a pro rata basis and 14.4% as excess of loss. Aviation premiums
accounted for 48.6% of marine and aviation gross premiums written in 1997 and
included reinsurance for airlines, general aviation and satellites.
Approximately 87.7% of the aviation unit's premiums in 1997 were written on a
pro rata basis and 12.3% as excess of loss.
In 1997, gross premiums written by the surety unit totaled $55.1 million.
Approximately 83.6% of the surety unit premiums in 1997 were written on a pro
rata basis and 16.4% on an excess of loss basis. Most of the portfolio is
reinsurance of contract surety bonds written directly with ceding companies,
with the remainder being credit reinsurance, mostly in international markets.
The unit's strategy is to maintain long-term relationships with major surety and
fidelity writers and to continue to expand its international business.
FACULTATIVE OPERATIONS. The Company's U.S. facultative unit conducts business
both through brokers and directly with ceding companies. The U.S. facultative
operations consist of three underwriting units representing property, casualty
and specialty lines of business. Business is written from a facultative
headquarters office in New York and satellite offices in Chicago and San
Francisco. In 1997, $26.5 million, $29.0 million, and $26.9 million of gross
premiums written were attributable to property, general casualty and specialty
lines of business, respectively.
INTERNATIONAL. Everest Re's international operations are designed to
enable it to capitalize on the growth opportunities in the international
reinsurance market. The Company targets several international markets,
including: Europe and the London market, which are serviced by branch
operations in London and Brussels and a representative office in Moscow;
Canada, with branch operations in Toronto; Asia and Australia, with branch
operations in Hong Kong and Singapore; and Latin America, Africa and the
Middle East, which business is serviced from Everest Re's New Jersey
5
headquarters and Miami office. The Company also writes "home-foreign" business,
which provides reinsurance on the international portfolios of U.S. insurers,
from its headquarters in New Jersey. Approximately 59.6% of the gross premiums
written by the Company's international underwriters in 1997 represented property
business, while the balance represented casualty business. As with its U.S.
operations, Everest Re's international operations focus on financially sound
companies that have strong management and underwriting discipline and expertise.
Approximately 81.1% of the Company's international business was written through
brokers, with the remainder written directly with ceding companies.
In 1997, Everest Re's gross premiums written by its London and Brussels
operations totaled $159.1 million and consisted of pro rata property (29.5%),
excess property (21.2%), pro rata casualty (38.0%) and excess casualty (11.3%).
Substantially all of the London and Brussels premiums consisted of treaty
reinsurance. The Brussels office focuses on the continental European reinsurance
markets, while the London office covers international business written through
the London market. Gross premiums written in 1997 from the Brussels and London
offices totaled $83.2 million and $75.9 million, respectively.
Gross premiums written by Everest Re's Canadian operation totaled $57.7 million
in 1997 and consisted of pro rata property (5.2%), excess property (11.0%), pro
rata multi-line (46.6%), excess casualty (33.7%) and primary insurance written
by Everest Canada (3.5%). Approximately 69.4% of the Canadian premiums consisted
of treaty reinsurance while 27.1% was facultative reinsurance and 3.5% was
primary insurance.
Everest Re's Hong Kong and Singapore offices cover the Asian and Australian
markets and accounted for $45.2 million of gross written premiums in 1997. This
business consisted of pro rata treaty property (87.9%), excess treaty property
(11.1%) and excess facultative casualty (1.0%). No premiums were written in 1997
from the Singapore office, which opened in the fourth quarter of the year.
International business written out of Everest Re's New Jersey and Miami offices
accounted for $85.6 million of Everest Re's 1997 gross premiums written and
consisted of pro rata treaty property (61.7%), pro rata treaty casualty (13.5%),
excess treaty property (13.7%), excess treaty casualty (1.8%), excess
facultative property (6.6%) and excess facultative casualty (2.7%). Of the
treaty business 54.5% was sourced from Latin America, 19.8% was sourced from the
Middle East, 6.7% was sourced from Europe, 5.4% was sourced from Africa, 1.3%
was sourced from Asia and 12.3% was "home-foreign" business.
UNDERWRITING PROCESS
Everest Re offers ceding companies full service capability, including actuarial,
claims, accounting and systems support, either directly or through the broker
community. Everest Re's capacity for both casualty and property risks allows it
to underwrite entire contracts or major portions thereof that might otherwise
need to be syndicated among several reinsurers. Everest Re's strategy is to act
as "lead" reinsurer in the reinsurance treaties it underwrites. The lead
reinsurer on a treaty generally accepts one of the largest percentage shares of
the treaty and is in a stronger position to negotiate price, terms and
conditions than is a reinsurer which takes a smaller position. Management
believes this strategy enables it to influence more effectively the terms and
conditions of the treaties on which it participates. When Everest Re does not
lead the treaty, it may still suggest changes to any aspect of the treaty.
Everest Re may decline to participate in a treaty based upon its assessment of
all relevant factors.
Everest Re's treaty underwriting process emphasizes a team approach among
Everest Re's underwriters, actuaries and claims staff. Treaties are reviewed for
compliance with Everest Re's general underwriting standards and certain larger
treaties are evaluated in part based upon actuarial analyses conducted by
Everest Re. The actuarial models used in such analyses are tailored in each case
to the exposures and experience underlying the specific treaty and the loss
experience for the risks covered by such treaties. Everest Re does not
separately evaluate each of the individual risks assumed under its treaties.
Everest Re does, however, generally evaluate the underwriting guidelines of its
ceding companies to determine their adequacy prior to entering into a treaty.
Everest Re, when appropriate, also conducts underwriting audits at the offices
of ceding companies to ensure that the ceding companies operate within such
guidelines. Underwriting audits focus on the quality of the underwriting staff,
the selection and pricing of risks and the capability of monitoring price levels
over time. Claim audits, when appropriate, are performed in order to evaluate
the client's claims handling abilities and practices.
Everest Re's domestic facultative underwriters operate within guidelines
specifying acceptable types of risks, limits and maximum risk exposures.
Specified classes of risks and large premium risks are referred to the
Company's New York facultative headquarters for specific review before premium
quotations are given to clients. In addition, Everest Re's guidelines
6
require certain types of risks to be submitted for review because of their
aggregate limits, complexity or volatility regardless of premium amount or size
of the insured on the underlying contract.
Everest National and Everest Canada write property, casualty and professional
liability coverages for homogeneous risks through select program managers. These
commercial programs are evaluated based upon actuarial analysis and the program
manager's capabilities. The Company's rates, forms and underwriting guidelines
are tailored to specific risk types.
RISK MANAGEMENT AND RETROCESSION ARRANGEMENTS
Everest Re manages its risk of loss through a combination of aggregate exposure
limits, underwriting guidelines that take into account risks, prices and
coverage, and retrocessional arrangements.
Everest Re is exposed to multiple insured losses arising out of a single
occurrence, whether a natural event such as a hurricane or an earthquake, or
other catastrophe, such as a riot or an explosion at a major factory. Any such
catastrophic event could generate insured losses in one or many of Everest Re's
treaties or lines of business. Everest Re employs various techniques, including
licensed software modeling, to assess its accumulated exposure to property
catastrophe losses and summarizes that exposure in terms of the probable maximum
loss ("PML"). The Company defines PML as its anticipated maximum loss, taking
into account contract limits, caused by a single catastrophe affecting a broad
contiguous geographic area, such as that caused by a hurricane or earthquake of
such a magnitude that it is expected to occur once in every 100 years.
Management estimates that the Company's greatest catastrophe exposure worldwide
from any single event is to hurricanes and earthquakes in the coastal regions of
the United States, where Everest Re estimates it has a PML exposure, before
reinsurance, of approximately $200 million in each such region based on its
current book of business. Similarly, management estimates that the largest
current PML exposure, before reinsurance, outside the United States is
approximately $116 million. There can be no assurance that Everest Re will not
experience losses from one or more catastrophic events that exceed, perhaps by a
substantial amount, its estimated PML.
Underwriting guidelines have been established for each business unit. These
guidelines place dollar limits on the amount of business that can be written
based on a variety of factors, including ceding company, line of business,
geographical location and risk hazards. In each case, those guidelines permit
limited exceptions, which must be authorized by the Company's senior management.
Everest Re does not typically retrocede individual risks, but does, from time to
time, purchase retrocessional protections where the underwriter deems it to be
prudent to reinsure a portion of the specific risk being assumed. In addition,
Everest Re has purchased a three layer property facultative retrocession program
which provides $18 million of coverage in excess of $2 million of retained
losses per facultative certificate and purchases three retrocessional workers'
compensation excess of loss treaties which collectively provide $115 million of
coverage in excess of $5 million of retained losses on accidental death and
dismemberment claims resulting from a catastrophe loss. The Company also
purchases a worker's compensation reinsurance program which provides for
statutory limits coverage in excess of $250,000 per occurrence on the Company's
primary worker's compensation insurance business.
The Company also purchases catastrophe retrocessions covering the potential
accumulation of all property exposures that may be involved in the same
catastrophe, such as an earthquake or hurricane. Effective January 1, 1997, the
Company's worldwide catastrophe retrocession program was amended to provide
coverage in each of the three years, 1997 through 1999, subject to the
retrocessionaire's right to cancel on November 1, 1998. The attachment point,
net of inuring retrocessions, of the worldwide catastrophe retrocession program
is $25 million per catastrophe. In 1997, the Company could have retroceded 75.0%
of the next $75.0 million of losses in excess of the attachment point incurred
on a per catastrophe and aggregate basis. In 1998, the Company can retrocede
75.0% of the next $112.5 million of losses in excess of the attachment point
incurred on a per catastrophe and aggregate basis. Fifty percent of the unused
portion of the 1998 year's coverage increases the limit of coverage for 1999 (up
to 75.0% of $168.75 million). The maximum recoverable under the worldwide
catastrophe retrocession program over the three-year period is $126.56 million.
For the period from May 1, 1997 through May 1, 1998, the Company's catastrophe
retrocession program also provides coverage of 76.0% of $20.0 million per
occurrence in excess of $10.0 million in losses incurred by the Company outside
of the United States. And, for the period from May 23, 1997 through May 23,
1998, the Company's catastrophe retrocession program provides coverage of 75.0%
of $25.0 million per occurrence in excess of $30.0 million in losses incurred by
the Company in the Caribbean, Israel, Canada and Colombia. In each of 1997 and
1998, Everest Re purchased an accident year aggregate excess of loss
retrocession agreement which provides up to $100.0 million of limit if Everest
Re's statutory loss ratio exceeds 79.0% for the respective accident years.
7
Although the catastrophe and aggregate excess of loss retrocessions have terms
which provide for additional premiums to be paid to the retrocessionaire in the
event that losses are ceded, all aspects of the Company's retrocessional program
have been structured to permit these agreements to be accounted for as
reinsurance under Statement of Financial Accounting Standards ("SFAS") No. 113.
If a single catastrophe were to occur in the United States that resulted in
$200.0 million of gross losses and allocated loss adjustment expenses ("ALAE")
in 1998 (an amount equivalent to Everest Re's PML), management estimates that
the effect (including additional premiums and retained losses and ALAE) on the
Company's income before taxes would be $108.2 million. This pre-tax net loss
estimate assumes that Everest Re's aggregate losses and ALAE for 1998 would
exceed the 79.0% loss ratio requirement in the aggregate excess of loss cover by
at least $100.0 million.
In addition, Everest Re purchased an aggregate stop loss retrocession agreement
(the "Stop Loss Agreement") from Gibraltar Casualty Company ("Gibraltar"), an
affiliate of The Prudential. See "Stop Loss Agreement".
As of December 31, 1997, Everest Re had retrocessional arrangements with 418
retrocessionaires, and it carried as an asset $692.5 million in reinsurance
receivables with respect to losses ceded to retrocessionaires, substantially all
of which will not be due to Everest Re until Everest Re makes payment on the
underlying claims. Of this amount, $324.9 million, or 46.9%, was receivable from
Gibraltar ($88.9 million, net of collateral held and liability balances for
which Everest Re has a contractual right of offset). An additional $150.0
million, or 21.7%, was receivable from Continental Insurance Company
("Continental"). None of the reinsurance receivables from Gibraltar or
Continental was in dispute or more than 90 days in arrears. Everest Re's
arrangement with Continental is managed on a funds held basis, which means that
Everest Re did not release premium payments to the retrocessionaire but rather
retains such payments to secure obligations of the retrocessionaire, records
them as a liability and reduces the liability account as payments become due. As
of December 31, 1997, such funds had reduced Everest Re's net exposure to
Continental to $95.3 million. No other retrocessionaire accounted for more than
$20.5 million of Everest Re's receivables.
No assurance can be given that the Company will be able to obtain retrocessional
coverage similar to that currently in place in the future. Although management
carefully selects its retrocessionaires, the Company is subject to credit risk
with respect to its retrocessions because the ceding of risk to
retrocessionaires does not relieve the reinsurer of its liability to ceding
companies.
RELATIONSHIPS WITH GIBRALTAR
During its early years, Everest Re also wrote some direct insurance. In 1978,
Everest Re expanded its direct insurance operation by forming Gibraltar as a
subsidiary. In 1985, Gibraltar and Everest Re ceased writing new and renewal
direct insurance, and Gibraltar was put into run-off.
While Gibraltar actively wrote direct insurance, it was able to reinsure certain
business through Everest Re's management underwriting facility ("MUF"). Begun in
1977, MUF was a reinsurance arrangement pursuant to which Everest Re ceded
certain business to a number of insurance and reinsurance companies (the "MUF
Participants"), many of them domiciled outside the United States. Gibraltar
ceded its MUF-qualifying business first to Everest Re, which then immediately
and entirely retroceded it to the MUF Participants. As a result of these
cessions to Everest Re, Everest Re became, and remains, a reinsurer of Gibraltar
with respect to the Gibraltar MUF cessions. As of December 31, 1997, Gibraltar's
reinsurance receivables from Everest Re totaled $132.4 million. MUF became
inactive with respect to new business in 1991.
Following the 1985 decision to put Gibraltar in runoff, Everest Re and Gibraltar
entered into the following agreements pursuant to which Gibraltar became, and
remains, a reinsurer of Everest Re (the "Gibraltar Contracts"):
* In 1986, Gibraltar reinsured all insurance obligations of Everest
Re pursuant to certain insurance contracts written by Everest Re's
former direct excess insurance operations, which ceased writing
business in 1985 (the "Ceded Direct Insurance") (the "Direct
Excess Retrocession").
* In 1989, Gibraltar reinsured Everest Re's medical malpractice and
other professional liability reinsurance written in 1988 and prior
years (the "Professional Liability Retrocession").
* During 1985 through 1990, Gibraltar and Everest Re commuted the
obligations of a number of MUF Participants. In exchange for a
cash payment from each commuted MUF Participant, Gibraltar assumed
the obligations of such MUF Participant. The commuted business
included assumed reinsurance originally retroceded to MUF
Participants by Everest Re and direct insurance ceded by Everest
Re and Gibraltar.
8
In 1991, Everest Re distributed the stock of Gibraltar to PRUCO, Inc., a direct,
wholly-owned subsidiary of The Prudential ("PRUCO"). Simultaneously, PRUCO and
Gibraltar entered into a surplus maintenance agreement pursuant to which PRUCO
agreed to purchase such amount of surplus notes as may be necessary to maintain
Gibraltar's statutory surplus at no less than $15 million at all times. PRUCO
shortly thereafter distributed the stock of Gibraltar to The Prudential.
The Direct Excess Retrocession can be terminated by either Gibraltar or Everest
Re upon 90 days' notice, whereas the Professional Liability Retrocession can
only be terminated by Everest Re. A total of $94.1 million of the Gibraltar
receivables is attributable to the Direct Excess Retrocession. If the Direct
Excess Retrocession is terminated, all outstanding claims, including incurred
but not reported losses ("IBNR"), will be commuted with the value of such
claims, which may not exceed Everest Re's then outstanding loss reserves with
respect thereto, to be mutually agreed upon or, if no agreement can be reached,
determined by an actuary or appraiser mutually appointed. At the time of the
IPO, the parties agreed that if Gibraltar terminates the Direct Excess
Retrocession and the parties cannot agree on the value of the claims to be
commuted, Everest Re's chief actuary will determine such value. Gibraltar could
arbitrate the actuary's determination. If the Direct Excess Retrocession were to
be so terminated and Everest Re's ultimate losses on the Ceded Direct Insurance
were to exceed the commutation amount, the resulting reserve increases would
constitute adverse development eligible for coverage under the Stop Loss
Agreement (described below), subject to the applicable limits thereof.
STOP LOSS AGREEMENT
On October 5, 1995, Everest Re and Gibraltar entered into an aggregate stop loss
retrocession agreement (the "Stop Loss Agreement"). The Stop Loss Agreement is
intended to mitigate the impact on the Company's future earnings that could
result from the adverse development, if any, of Everest Re's consolidated
reserves for losses, allocated LAE and uncollectible reinsurance as of June 30,
1995, including IBNR; provided, that adverse development, if any, of such
reserves relating to catastrophes (as defined in the Stop Loss Agreement) will
only be covered to the extent that the catastrophe event to which such reserves
relate occurred prior to January 1, 1995. Such adverse development is referred
to herein as "Adverse Development". For a description of the Stop Loss
Agreement, see Note 7 of Notes to Consolidated Financial Statements. Also see
Note 8F of Notes to the Consolidated Financial Statements.
STANDBY CAPITAL CONTRIBUTION AGREEMENT AND PRUCO INDEMNITY
On October 5, 1995, Holdings agreed, pursuant to a Standby Capital Contribution
Agreement (the "Capital Contribution Agreement"), to make certain capital
contributions ("Capital Contributions") to Everest Re. And, on October 5, 1995,
PRUCO agreed to make payments ("Indemnity Payments") to Holdings, pursuant to an
Indemnity Agreement (the "PRUCO Indemnity"), in an amount equal to the Capital
Contributions. For a description of the Capital Contribution Agreement and the
PRUCO Indemnity, see Note 8A of Notes to the Consolidated Financial Statements.
PRUDENTIAL GUARANTEES
On October 5, 1995, The Prudential guaranteed (i) up to $775.0 million of
Gibraltar's obligations to Everest Re, and (ii) PRUCO's obligation to make the
Indemnity Payments (the "Prudential Guarantees"). The Prudential agreed, subject
to the terms and conditions thereof, to guarantee Gibraltar's payment
obligations with respect to (i) the Stop Loss Agreement, subject to maximum
aggregate payments of $375.0 million, and (ii) payment obligations under the
Gibraltar Contracts, subject to maximum aggregate payments of $400.0 million.
The maximum aggregate payments under the Prudential Guarantee of Gibraltar's
obligations will be reduced in certain circumstances to take account of payments
made and collateral provided in respect of the guaranteed obligations.
As of December 31, 1997, based on publicly available information, The Prudential
had statutory basis total assets of $194.0 billion, statutory surplus of $9.2
billion and total equity on a GAAP basis of $19.7 billion.
CLAIMS
Claims are managed by the Company's professional claims staff whose
responsibilities include reviewing initial loss reports and coverage issues,
monitoring claims handling activities of ceding companies, establishing and
adjusting proper case reserves and approving payment of claims. In addition to
claims assessment, processing and payment, the claims staff selectively conducts
comprehensive claims audits of both specific claims and overall claims
procedures at the offices of selected ceding companies.
9
RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Significant periods of time may elapse between the occurrence of an insured
loss, the reporting of the loss to the ceding company and the reinsurer and the
ceding company's payment of that loss and subsequent payments to the ceding
company by the reinsurer. To recognize liabilities for unpaid losses and loss
adjustment expenses ("LAE"), insurers and reinsurers establish reserves, which
are balance sheet liabilities representing estimates of future amounts needed to
pay reported and unreported claims and related expenses on losses that have
already occurred. Actual losses and LAE paid may deviate, perhaps substantially,
from such reserves. To the extent reserves prove to be insufficient to cover
actual losses and LAE after taking into account available retrocessional
coverage, including the reinsurance provided through the Stop Loss Agreement,
Everest Re would have to augment such reserves and incur a charge to earnings
which could be material in the period such augmentation takes place. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Loss and LAE Reserves".
While the reserving process is difficult and subjective for the ceding
companies, the inherent uncertainties of estimating such reserves are even
greater for the reinsurer, due primarily to the longer time between the date of
an occurrence and the reporting of any attendant claims to the reinsurer, the
diversity of development patterns among different types of reinsurance treaties
or facultative contracts, the necessary reliance on the ceding companies for
information regarding reported claims and differing reserving practices among
ceding companies. In addition, trends that have affected development of
liabilities in the past may not necessarily occur or affect liability
development to the same degree in the future. Thus, actual losses and LAE may
deviate, perhaps substantially, from estimates of reserves reflected in the
Company's consolidated financial statements.
Like many other property and casualty insurance and reinsurance companies,
Everest Re has experienced adverse loss development for prior accident years,
which has led to adjustments in losses and LAE reserves. The increase in
reserves for prior accident years reduced net income for the periods in which
the adjustments were made. There can be no assurance that adverse development
from prior years will not continue in the future or that such adverse
development will not have a material adverse effect on net income. Adverse
Development will be reinsured under the Stop Loss Agreement, up to the maximum
limits thereunder and subject to the other terms and conditions thereof. See
"Relationships with Gibraltar" and "Stop Loss Agreement".
CHANGES IN HISTORICAL RESERVES
The following table shows changes in historical loss reserves for Everest Re for
1987 and subsequent years. The top line of each table shows the estimated
reserves for unpaid losses and LAE recorded at each year end date. Each amount
in the top line represents the estimated amount of future payments for losses
and LAE on claims occurring in that year and in all prior years. The upper
(paid) portion of the table presents the cumulative amounts paid through each
subsequent year on those claims for which reserves were carried as of each
specific year end. The lower (liability re-estimated) portion shows the
re-estimated amount of the previously recorded reserves based on experience as
of the end of each succeeding year. The estimate changes as more information
becomes known about the actual claims for which the initial reserves were
carried. The cumulative redundancy/deficiency line represents the cumulative
change in estimates since the initial reserve was established. It is equal to
the latest liability re-estimated amount less the initial reserve.
Each amount other than the original reserves in the top half of the table below
includes the effects of all changes in amounts for prior periods. For example,
if a loss settled in 1990 for $100,000 was first reserved in 1987 at $60,000 and
remained unchanged until settlement, the $40,000 deficiency (actual loss minus
original estimate) would be included in the cumulative redundancy (deficiency)
in each of the years in the period 1987 through 1989 shown below. Conditions and
trends that have affected development of liability in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.
10
TEN YEAR STATUTORY LOSS DEVELOPMENT TABLE PRESENTED NET OF REINSURANCE
WITH SUPPLEMENTAL GROSS DATA (1)
Years Ended December 31,
-------------------------------------------------------------------------------------------------------------
(Dollars in millions) 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
-------------------------------------------------------------------------------------------------------------
Reserves for unpaid
loss and LAE $ 1,676.7 $ 1,775.8 $ 1,766.7 $ 1,891.9 $ 1,752.9 $ 1,854.7 $ 1,934.2 $ 2,104.2 $ 2,316.0 $ 2,551.6 $ 2,810.0
Paid (cumulative)
as of:
One year later 345.7 299.1 321.9 597.1 333.3 461.5 403.5 359.5 270.4 331.2
Two years later 582.3 522.3 829.5 785.9 550.4 740.1 627.7 638.0 502.8
Three years later 757.0 984.3 966.3 933.1 758.3 897.0 820.5 828.0
Four years later 1,189.1 1,096.1 1,078.2 1,096.9 868.1 1,036.0 953.0
Five years later 1,278.7 1,189.5 1,209.0 1,176.9 970.0 1,141.0
Six years later 1,358.6 1,308.9 1,276.3 1,257.3 1,052.9
Seven years later 1,478.7 1,367.9 1,346.6 1,329.8
Eight years later 1,532.0 1,430.7 1,407.9
Nine years later 1,591.1 1,489.0
Ten years later 1,646.7
Liability re-
estimated as of:
One year later 1,768.0 1,794.6 1,835.4 1,866.3 1,737.8 1,929.2 2,008.5 2,120.8 2,286.5 2,548.4
Two years later 1,841.5 1,813.2 1,834.3 1,872.8 1,775.7 1,988.9 2,015.4 2,233.7 2,264.5
Three years later 1,839.6 1,805.6 1,849.5 1,907.5 1,843.3 2,010.0 2,119.0 2,271.2
Four years later 1,879.1 1,867.6 1,913.6 1,976.5 1,855.7 2,111.9 2,164.5
Five years later 1,942.2 1,934.5 1,982.3 1,984.3 1,955.1 2,155.3
Six years later 2,029.1 2,007.6 1,984.1 2,080.0 1,995.8
Seven years later 2,118.0 2,008.0 2,089.4 2,123.2
Eight years later 2,125.2 2,122.6 2,135.9
Nine years later 2,243.1 2,167.6
Ten years later 2,287.5
Cumulative
redundancy/
(deficiency) $ (610.8) $ (391.8) $ (369.2) $ (231.3) $ (242.9) $ (300.6) $ (230.3) $ (167.0) $ 51.5 $ 3.2
============================================================================================================
Gross liability -
end of year $2,576.0 $2,752.7 $3,016.9 $3,298.2 $3,498.7
Reinsurance
receivable 641.8 648.5 700.9 746.6 688.7
------------------------------------------------
Net liability-end
of year 1,934.2 2,104.2 2,316.0 2,551.6 2,810.0
--------------------------------------- ========
Gross re-estimated
liability at
December 31, 1997 3,056.9 3,096.2 3,228.7 3,380.0
Re-estimated
receivable at
December 31, 1997 892.4 825.0 964.2 831.6
---------------------------------------
Net re-estimated
liability at
December 31, 1997 2,164.5 2,271.2 2,264.5 2,548.4
---------------------------------------
Gross cumulative
redundancy/
(deficiency) $ (480.9) $ (343.5) $ (211.8) $ (81.8)
=======================================
- ----------
(1) Includes Gibraltar data through September 30, 1991
11
For years prior to 1987, management believes that two factors had the most
significant impact on loss development. First, through the mid-1980's, a number
of industry and external factors, such as the propensity of courts to award
large damage awards in liability cases, combined to increase loss frequency and
severity to unexpectedly high levels. Second, contracts written prior to 1986
contained coverage terms which, for Everest Re and the industry in general, have
been interpreted by courts to provide coverage for asbestos and environmental
exposures not contemplated by either the pricing or the initial reserving of the
contracts. Legal developments during the mid-1980's necessitated additional
reserving for such exposures on both a case and IBNR basis. Incurred losses with
respect to asbestos and environmental claims, net of reinsurance, were $3.5
million, -0-, -0-, $40.5 million and $70.6 million in 1997, 1996, 1995, 1994 and
1993, respectively. Substantially all of these losses related to pre-1986
exposures. The absence of net incurred losses in 1996 and 1995 is attributable
to coverage under the Company's Stop Loss Agreement. The net incurred losses in
1997 reflected coinsurance under the Stop Loss Agreement.
To the extent loss reserves on assumed reinsurance need to be increased, Everest
Re would be entitled to certain payments under the Stop Loss Agreement. See
"Stop Loss Agreement". Additionally, Holdings may be required to make payments
under the Capital Contribution Agreement for which it would be entitled to
indemnification under the PRUCO Indemnity. See "Standby Capital Contribution
Agreement and PRUCO Indemnity". To the extent loss reserves on the Ceded Direct
Insurance need to be increased and subject to the terms of the Gibraltar
Contracts, Everest Re will be entitled to 100% protection from Gibraltar under
the Gibraltar Contracts, which reinsurance obligations are guaranteed by The
Prudential subject to the terms and conditions of the applicable Prudential
Guarantee. See "Relationships with Gibraltar" and "Prudential Guarantees".
Management believes that adequate provision has been made for Everest Re's loss
and LAE reserves regardless of the availability of any such payments under the
Stop Loss Agreement, the PRUCO Indemnity, and the Prudential Guarantees.
Additionally, while there can be no assurance that reserves for and losses from
these claims will not increase in the future, management believes that Everest
Re's existing reserves and retrocessional arrangements and payments available
under the Stop Loss Agreement, the PRUCO Indemnity and the Prudential Guarantees
lessen the probability that such increases would have a material adverse effect
on the Company's financial condition, results of operations or cash flows.
The Ten Year Statutory Loss Development Table includes Gibraltar data until
September 30, 1991, at which time Everest Re distributed the stock of Gibraltar
to PRUCO. Thus the 1987-1990 "Reserves for unpaid loss and LAE" includes the
Gibraltar liability. Similarly, the "Paid (cumulative) as of" and "Liability
re-estimated as of" data include Gibraltar experience until September 30, 1991.
At the time of the distribution of Gibraltar, Gibraltar still had $288.5 million
of reserves outstanding. To more accurately reflect reserve development, the
Gibraltar reserves were removed from the reserves for unpaid losses and LAE line
for periods after 1991 and the $288.5 million was treated as a paid loss. The
amount so treated as paid in 1991 was $285.6 million for the year ended 1987 and
$288.5 for each of the years 1988 through 1990. The following table identifies
the cumulative reserve redundancy/(deficiency) relating to Gibraltar only,
Everest Re excluding Gibraltar and the consolidated group.
CUMULATIVE RESERVE REDUNDANCY/(DEFICIENCY) ATTRIBUTABLE TO GIBRALTAR
Years Ended December 31,
----------------------------------------------------------------------------------------------------
(Dollars in millions) 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
----------------------------------------------------------------------------------------------------
Everest Re excluding
Gibraltar $ (434.2) $ (261.9) $ (271.1) $ (201.3) $ (242.9) $ (300.6) $ (230.3) $ (167.0) $ 51.5 $ 3.2
Gibraltar (176.6) (129.9) (98.1) (30.0) - - - - - -
----------------------------------------------------------------------------------------------------
Consolidated $ (610.8) $ (391.8) $ (369.2) $ (231.3) $ (242.9) $ (300.6) $ (230.3) $ (167.0) $ 51.5 $ 3.2
====================================================================================================
The following table is derived from the Ten Year Statutory Loss Development
Table above and summarizes the effect of reserve re-estimates, net of
reinsurance, on calendar year operations for the same ten year period ended
December 31, 1997. Each column represents the amount of reserve re-estimates
made in the indicated calendar year and shows the accident years to which the
re-estimates are applicable. The amounts in the total accident year column on
the far right represent the cumulative reserve re-estimates for the indicated
accident years.
12
EFFECT OF RESERVE REESTIMATES ON CALENDAR YEAR OPERATIONS
Cumulative
Calendar Year Ended December 31, Re-estimates for
(Dollars in ----------------------------------------------------------------------------------------------- each Accident
millions) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Year
---------------------------------------------------------------------------------------------------------------
Accident
Years
1987 & prior $ (91.4) $ (73.5) $ 2.0 $ (39.5) $ (63.1) $ (86.9) $ (88.9) $ (7.2) $ (117.9) $ (44.4) $ (610.8)
1988 54.8 (20.6) 47.1 1.1 20.0 15.8 6.8 3.4 (0.7) 127.7
1989 (50.1) (6.5) 46.8 2.8 4.4 (1.4) 9.2 (1.5) 3.7
1990 24.5 8.7 29.4 (0.4) (6.0) 9.7 3.3 69.2
1991 21.6 (3.2) 1.4 (4.6) (3.8) 2.5 13.9
1992 (36.6) 7.9 (8.7) (2.5) (2.7) (42.6)
1993 (14.5) 14.2 (1.7) (2.1) (4.1)
1994 (9.8) (9.2) 8.0 (11.0)
1995 142.4 59.6 202.0
1996 (18.8) (18.8)
Total calendar
year effect $ (91.4) $ (18.7) $ (68.7) $ 25.6 $ 15.1 $ (74.5) $ (74.3) $ (16.7) $ 29.6 $ 3.2 $ (270.8)
As illustrated by this table, the factors which caused the deficiencies shown in
the Ten Year Statutory Loss Development Table relate almost entirely to accident
years prior to 1987. With the exception of the 1992 accident year, which
included Hurricane Andrew, the original reserves established for each accident
year since 1987 have developed either positively or in a manner that is not
materially adverse. Adverse development relating to accident years prior to July
1, 1995 (prior to January 1, 1995 for catastrophe losses) is mitigated by
recoveries under the Stop Loss Agreement. As the Stop Loss Agreement was entered
into in 1995, recoveries thereunder are reflected in the 1995 accident year
rather than in the accident year which included the underlying adverse
development.
The following table presents a reconciliation of beginning and ending reserve
balances for the years indicated on a GAAP basis:
RECONCILIATION OF RESERVES FOR LOSSES AND LAE
Years Ended December 31,
------------------------------------------
(Dollars in millions) 1997 1996 1995
------------------------------------------
Reserves at beginning of period $ 3,246.9 $ 2,969.3 $ 2,706.4
------------------------------------------
Incurred related to:
Current year 768.6 745.6 658.0
Prior years (3.2) (29.6) 16.7
------------------------------------------
Total incurred losses 765.4 716.0 674.7
------------------------------------------
Paid related to:
Current year 185.3 213.9 104.6
Prior years 331.2 270.4 359.5
------------------------------------------
Total paid losses 516.5 484.3 464.1
------------------------------------------
Change in reinsurance receivables
on unpaid losses and LAE (58.0) 45.9 52.3
------------------------------------------
Reserves at end of period $ 3,437.8 $ 3,246.9 $ 2,969.3
==========================================
13
The reconciliation of reserves on a GAAP basis to reserves reported on a
statutory basis for each of the three years in the period ended December 31,
1997 is shown below:
RECONCILIATION OF RESERVES FOR LOSSES AND LAE
FROM STATUTORY BASIS TO GAAP BASIS
Years Ended December 31,
--------------------------------------------
(Dollars in millions) 1997 1996 1995
--------------------------------------------
Statutory reserves-net (1) $ 2,778.6 $ 2,313.0 $ 2,108.3
Statutory retroactive
reinsurance reserves 31.4 15.4 5.4
Financing arrangement - (10.3) (10.3)
--------------------------------------------
Subtotal 2,810.0 2,318.1 2,103.4
Foreign subsidiary reserves (1) - 233.5 212.6
--------------------------------------------
Subtotal-net reserves as
shown in loss development
schedule 2,810.0 2,551.6 2,316.0
Reinsurance receivable on unpaid
losses 688.7 746.6 700.9
--------------------------------------------
Subtotal-gross reserves as
shown in loss development
schedule 3,498.7 3,298.2 3,016.9
Foreign translation effect of
Canadian reserves (2) (60.9) (51.3) (47.6)
--------------------------------------------
Reserves on a GAAP basis $ 3,437.8 $ 3,246.9 $ 2,969.3
============================================
- -----------
(1) On January 1, 1997 the insurance operations of Everest Re Ltd. were
converted to branches of Everest Re. For 1997, the net reserves for the
branches are included in statutory net reserves, and for 1996 and 1995, the
Everest Re Ltd. reserves are shown as foreign subsidiary reserves.
(2) Pursuant to statutory accounting conventions, reserves with respect to the
Canadian Branch are reflected in Canadian dollars.
Statutory reserves are presented net of reinsurance receivables on unpaid loss
and LAE for years ended December 31, 1997, 1996 and 1995. The amounts shown as
financing arrangement in 1996 and 1995 relate to a single treaty which did not
qualify for reinsurance accounting under GAAP.
RESERVES FOR ASBESTOS AND ENVIRONMENTAL LOSSES AND LOSS ADJUSTMENT EXPENSES
Everest Re's reserves include an estimate of Everest Re'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 Everest Re's potential losses from asbestos and
environmental claims. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Asbestos and Environmental
Exposures" and Note 11 of Notes to Consolidated Financial Statements.
The following table summarizes the composition of Everest Re's total reserves
for asbestos and environmental losses, gross and net of reinsurance for the
years ended December 31, 1997, 1996 and 1995.
Years Ended December 31,
--------------------------------------------
(Dollars in millions) 1997 1996 1995
--------------------------------------------
Case reserves reported
by ceding companies $ 125.9 $ 101.2 $ 108.5
Additional reserves
established by Everest Re
(assumed reinsurance) 52.0 50.1 43.8
Case reserves established
by Everest Re (Ceded
Direct Insurance) 45.8 52.8 50.3
IBNR reserves 222.4 219.2 225.9
--------------------------------------------
Gross reserves 446.1 423.3 428.5
Reinsurance receivable (233.7) (223.7) (242.5)
--------------------------------------------
Net reserves $ 212.4 $ 199.6 $ 186.0
============================================
Everest Re's asbestos and environmental claims are managed by an experienced
staff consisting of seven people. This claims unit works closely with members of
Everest Re's in-house legal staff on legal developments. The claims unit also
meets with the management of primary insurance companies to understand their
asbestos and environmental exposures and reserving practices.
14
Additional losses, the type or magnitude of which cannot be foreseen by the
Company, or the reinsurance industry generally, may emerge in the future. Such
future emergence, to the extent not covered by existing retrocessional
contracts, including the Stop Loss Agreement, could have material adverse
effects on the Company's future financial condition, results of operations and
cash flows.
INVESTMENTS
Everest Re's overall financial strength and results of operations are, in part,
dependent on the quality and performance of its investment portfolio. Net
investment income and net realized capital gains (losses) on Everest Re's
invested assets constituted 18.8%, 16.9% and 21.1% of the Company's revenues for
the years ending December 31, 1997, 1996 and 1995, respectively. The Company's
cash and invested assets totalled $4,163.3 million at December 31, 1997 of which
95.2% were cash or investment grade fixed maturities.
Everest Re's investment strategy emphasizes maintaining a high quality
investment portfolio while maximizing long-term after-tax investment income.
Everest Re's current investment strategy seeks to maximize after-tax income
through a high quality, diversified, taxable bond and tax-exempt municipal bond
portfolio, while maintaining an adequate level of liquidity. Everest Re's mix of
taxable and tax-preferenced investments is adjusted continuously, consistent
with Everest Re's current and projected operating results, market conditions and
tax position. Additionally, Everest Re invests in marketable equity securities
which it believes will enhance the risk-adjusted total return of the investment
portfolio.
The Investment Committee of Everest Re's Board of Directors is responsible for
establishing investment policy and guidelines and, together with senior
management, for overseeing their execution. Everest Re's investment portfolio is
in compliance with the insurance laws of the state of Delaware, its domiciliary
state, and of other jurisdictions in which it is regulated. These laws prescribe
the kind, quality and concentration of investments which may be made by
insurance companies. In general, these laws permit investments, within specified
limits and subject to certain qualifications, in government obligations,
corporate bonds, preferred and common stocks, real estate mortgages and real
estate. An independent investment advisor is utilized to manage the Company's
investment portfolio within the established guidelines and is required to report
activities on a current basis and to meet with the Company periodically to
review and discuss the portfolio structure, securities selection and performance
results.
Everest Re's investment guidelines include a duration guideline of five to six
years. The duration of an investment is based on the maturity of the security
but also reflects the possibility of early prepayment of such security without a
prepayment penalty. This investment duration guideline is sensitive to Everest
Re's average duration of potential liabilities which, at December 31, 1997, was
approximately five years. Liability duration is determined based on the
estimated payouts of underwriting liabilities using standard duration
calculations.
Approximately 12.6% of the Company's consolidated reserves for losses and LAE
and unearned premiums represents estimated amounts payable in foreign
currencies. For each currency in which the Company has established substantial
reserves, the Company seeks to maintain invested assets denominated in such
currency in an amount approximately equal to the estimated liabilities which are
denominated in such currency.
As of December 31, 1997, 99.3% of Everest Re's fixed maturities consisted of
investment grade securities. The average maturity of fixed maturities was 8.7
years at December 31, 1997, and their overall duration was 5.6 years. As of
December 31, 1997, Everest Re did not have any material holdings of issuers who
management believes are experiencing cash flow difficulty to an extent that the
ability of the obligor to meet debt service payments is threatened. Everest Re's
current investment strategy does not contemplate additional investment in
non-investment grade securities or any investments in commercial real estate or
direct commercial mortgages. Also, investments in derivative products (i.e.,
products which include features such as futures, forwards, swaps, options and
other investments with similar characteristics) are generally prohibited,
without the prior approval of Everest Re's Investment Committee. At December 31,
1997, the Company had no investments in derivative products.
As of December 31, 1997, the common stock portfolio was $158.8 million at market
value, is managed with a growth and income orientation and consisted primarily
of investments in dividend paying mid and large capitalization companies.
15
The following table reflects investment results for Everest Re for each of the
five years in the period ended December 31, 1997:
Pre-Tax
Pre-Tax Realized Net
Average Investment Effective Capital Gains
Years Ended December 31, Investments(1) Income(2) Yield (Losses)
(Dollars in millions) --------------------------------------------------------------
1997 $ 3,888.9 $ 228.5 5.88% $ 15.9
1996 3,416.4 191.9 5.62 5.7
1995 2,894.9 166.0 5.73 33.8
1994 2,620.9 143.6 5.48 (10.5)
1993 2,532.2 141.1 5.57 78.8
- ------------
(1) Average of the beginning and ending carrying values of investments and
cash, less net funds held and non-interest bearing cash. Common stocks and
nonredeemable preferred stocks are carried at fair market value. Bonds and
redeemable preferred stocks are carried at fair market value except for
1993 where such investments are shown at amortized cost.
(2) After investment expenses, excluding realized net capital gains (losses).
The following table summarizes fixed maturities as of December 31, 1997 and
1996:
Amortized Unrealized Unrealized Market
(Dollars in millions) Cost Appreciation Depreciation Value
-----------------------------------------------------------
December 31, 1997:
U.S. Treasury securities and
obligations of U.S. government
agencies and corporations $ 144.1 $ 3.1 $ 0.1 $ 147.1
Obligations of states and
political subdivisions 1,610.2 112.2 0.3 1,722.1
Corporate securities 893.9 39.2 - 933.1
Mortgage-backed securities 521.0 20.5 - 541.5
Foreign debt securities (1) 489.2 34.0 0.1 523.1
-----------------------------------------------------------
Total $ 3,658.4 $ 209.0 $ 0.5 $ 3,866.9
===========================================================
December 31, 1996:
U.S. Treasury securities and
obligations of U.S. government
agencies and corporations $ 192.6 $ 1.2 $ 1.4 $ 192.4
Obligations of states and
political subdivisions 1,309.9 56.1 1.0 1,365.0
Corporate securities 740.0 11.4 0.3 751.1
Mortgage-backed securities 487.1 7.7 2.0 492.8
Foreign debt securities (1) 545.2 24.7 0.9 569.0
-----------------------------------------------------------
Total $ 3,274.8 $ 101.1 $ 5.6 $ 3,370.3
===========================================================
- -------------
(1) At December 31, 1997, foreign debt securities at amortized cost are
comprised of $232.8 million and $256.4 million in foreign government
securities and foreign corporate bonds, respectively, compared to $299.3
million and $245.9 million, respectively, at December 31, 1996. At December
31, 1997, foreign debt securities at market value are comprised of $253.3
million and $269.8 million in foreign government securities and foreign
corporate bonds, respectively, compared to $315.0 million and $254.0
million, respectively, at December 31, 1996.
16
The following table presents the credit quality distribution by the National
Association of Insurance Commissioners ("NAIC") rating of Everest Re's fixed
maturities as of December 31, 1997:
(Dollars in millions)
NAIC Percent of
Rating(1) Standard and Poor's Equivalent Description Amount Total
- --------------------------------------------------------------------------------
1 AAA/AA/A $ 3,355.9 86.8%
2 BBB 481.9 12.5
3 BB 27.5 0.7
4 B 0.2 0.0
5 CCC/CC/C - -
6 CI/D 1.4 0.0
----------------------
Total $ 3,866.9 100.0%
======================
- ------------
(1) The Securities Valuation Office of the NAIC maintains a security valuation
system that assigns a numerical rating to securities. The numerical ratings
generally correspond to S & P's classifications, as indicated, although S &
P has not necessarily rated the securities indicated. Rating categories 1
and 2 are considered investment grade and categories 3 through 6 are
considered non-investment grade.
The following table summarizes fixed maturities by contractual maturity as of
December 31, 1997:
Percent of
(Dollars in millions) Amount Total
------------------------------
Maturity category:
Less than one year $ 56.4 1.5%
Due after 1-5 years 482.0 12.5
Due after 5-10 years 1,294.2 33.5
Due after 10 years 1,492.6 38.6
------------------------------
Subtotal 3,325.2 86.0
Mortgage-backed securities (1) 541.6 14.0
------------------------------
Total (2) $ 3,866.8 100.0%
==============================
- ------------
(1) Mortgage-backed securities generally are more likely to be prepaid than
other fixed maturities. Therefore contractual maturities are excluded from
this table since they may not be indicative of actual maturities.
(2) Certain totals may not reconcile due to rounding.
YEAR 2000 ISSUES
Like many other companies, the Company faces potential business disruption and
costs associated with the possible inability of many computer systems to
accurately process data containing information about the year 2000 or later. For
a discussion of these issues, see Management's Discussion and Analysis, Item 7.
RATINGS
Everest Re currently has a rating of "A+" ("Superior") from A.M. Best, an
independent insurance industry rating organization which rates companies on
factors of concern to policyholders. A.M. Best states that the "A+" ("Superior")
rating is assigned to those companies which, in its opinion, have, on balance,
achieved superior financial strength, operating performance and market profile
when compared to the standards established by A.M. Best and have demonstrated a
very strong ability to meet their ongoing obligations to policyholders. The "A+"
("Superior") rating is the second highest of fifteen ratings assigned by A.M.
Best, which range from "A++" ("Superior") to "F" ("In liquidation").
Additionally, A.M. Best has eleven classifications within the "Not Assigned"
category.
Everest Re currently has a claims-paying ability rating of "A+" (Good) from
Standard & Poor's, an independent rating organization which rates an insurance
company's financial capacity to meet the obligations of its insurance policies
in accordance with their terms. Standard & Poor's states that the "A+" rating is
assigned to those companies which, in its opinion, have secure financial
capacity to meet policyholder obligations. The "A+" rating is the fifth highest
of eighteen ratings assigned by Standard & Poor's, which range from "AAA"
(Superior) to "R" (Regulatory Action). Ratings from AA to B may be modified by
the use of a plus or minus sign to show relative standing of the insurer within
those rating categories.
17
Everest Re currently has an insurance financial strength rating of "A2" (Good)
from Moody's. Moody's states that insurance companies rated "A" offer good
financial security. However, elements may be present which suggest a
susceptibility to impairment sometime in the future. Moody's rating gradations
are shown through the use of nine distinct symbols, each symbol representing a
group of ratings in which the financial security is broadly the same. The "A2"
(Good) rating is the sixth highest of ratings assigned by Moody's, which range
from "Aaa" (Exceptional) to "C" (Lowest). Moody's further distinguishes the
ranking of an insurer within its generic rating classification from Aa to B with
1, 2 and 3 ("1" being the highest).
A.M. Best's, Standard & Poor's and Moody's ratings are based upon factors of
concern to policyholders and should not be considered an indication of the
degree or lack of risk involved in an equity investment in an insurance company.
Each of these rating agencies reviews its ratings periodically, and there can be
no assurance that Everest Re's ratings will be maintained in the future.
COMPETITION
The worldwide property and casualty reinsurance business is highly competitive.
Competition with respect to the types of reinsurance in which Everest Re is
engaged is based on many factors, including the perceived overall financial
strength of the reinsurer, A.M. Best's and/or Standard & Poor's rating of the
reinsurer, underwriting expertise, the jurisdictions where the reinsurer is
licensed or otherwise authorized, premiums charged, other terms and conditions
of the reinsurance offered, services offered, speed of claims payment and
reputation and experience in lines written. Everest Re competes for its business
in the United States and international reinsurance markets with numerous
international and domestic reinsurance companies, some of which have greater
financial resources than Everest Re.
Everest Re's competitors include independent reinsurance companies, subsidiaries
or affiliates of established worldwide insurance companies, reinsurance
departments of certain primary insurance companies and domestic and
international underwriting operations. Some of these competitors have greater
financial resources than Everest Re, have been operating for longer than Everest
Re, and have established long-term and continuing business relationships
throughout the industry, which can be a significant competitive advantage.
Although most U.S. reinsurance companies operate in the broker market, most of
Everest Re's largest competitors work directly with ceding companies, competing
with brokers. Management believes that Everest Re's major competitors are large
U.S. and foreign reinsurance companies.
Since 1987, the industry has experienced increased global competition. During
this period, primary insurers have retained an increasing portion of their
business, which, together with rate pressure at the primary insurance level and
ample reinsurance capacity, precluded reinsurance rate improvement and resulted
in generally low rates of premium growth, if any. In the early 1990s, several
well-capitalized new Bermuda-based companies entered the reinsurance industry,
and added significant capacity, particularly in the catastrophe reinsurance
market, and rendered future rate improvement uncertain. In addition, Lloyd's of
London relaxed its requirement that syndicate members have unlimited liability
for losses and allows limited liability investors to join syndicates, thereby
increasing the reinsurance capacity at Lloyd's. In 1996, Lloyd's implemented its
reconstruction and renewal plan in an attempt to separate past losses from the
current market participants and to provide a more secure market going forward.
Management believes that since 1987, a number of factors, including global
competition, the emergence of significant reinsurance capacity from the Bermuda
and rejuvenated Lloyds' markets, higher retentions by primary insurance
companies and consolidation in the insurance industry, have resulted in
increasingly competitive market conditions and have influenced the continuing
pressure on insurance and reinsurance rates and the expansion of contract terms
in the current marketplace.
The Company may, in the future, face additional competition from other
well-capitalized companies or from market participants that may devote more of
their capital to the reinsurance business or from the capital markets entry into
insurance and reinsurance investment products. And, the Company believes that
the insurance and reinsurance industries, including reinsurance brokers, will
continue to undergo further consolidation and that reinsurers will need
significant size and financial strength to compete effectively.
EMPLOYEES
As of March 2, 1998, Everest Re employed 369 persons. Management believes that
its employee relations are good. None of Everest Re's employees are subject to
collective bargaining agreements, and the Company is not aware of any current
efforts to implement such agreements at Everest Re.
18
INFORMATION RELATING TO DOMESTIC AND FOREIGN OPERATIONS
Financial information relating to geographic segments set forth in Note 13 of
Notes to Consolidated Financial Statements of the Company is incorporated herein
by reference.
REGULATORY MATTERS
The Company is subject to regulation under the insurance statutes of various
jurisdictions, including Delaware, the domiciliary state of Everest Re and
Everest Indemnity, Arizona, the domiciliary state of Everest National and
Canada, the domiciliary jurisdiction of Everest Canada.
INSURANCE HOLDING COMPANY REGULATION. Insurance holding company laws and
regulations generally require the holding company to register with the relevant
state regulatory authorities and file certain reports which include current
information concerning the capital structure, ownership, management, financial
condition and general business operations of the insurance holding company and
its subsidiaries licensed in the state. State regulators also require prior
notice or regulatory approval of changes in control of an insurer or its holding
company and of certain material inter-affiliate transactions within the holding
company structure. See "-Dividends by Everest Re".
Under the Delaware and Arizona Codes and regulations thereunder, no person,
corporation or other entity may acquire a controlling interest in the Company,
unless such person, corporation or entity has obtained the prior approval of the
Delaware and Arizona Insurance Commissioners for such acquisition. For the
purposes of the Delaware and Arizona Codes, any person acquiring, directly or
indirectly, 10% or more of the voting securities of an insurance company is
presumed to have acquired "control" of such company. To obtain the approval of
any such change in control, the proposed acquirer must file an application with
the Delaware and Arizona Insurance Commissioners. This application requires the
acquirer to disclose its background, financial condition, the financial
condition of its affiliates, the source and amount of funds by which it will
effect the acquisition, the criteria used in determining the nature and amount
of consideration to be paid for the acquisition, proposed changes in the
management and operations of the insurance company and any other related
matters.
The Insurance Companies Act of Canada also requires prior approval by the
Minister of Finance of anyone acquiring a significant interest in an authorized
Canadian insurance company. In addition, the Company is subject to regulation by
the insurance regulators of other states and foreign jurisdictions in which it
does business. Certain of these states and foreign jurisdictions impose
regulations regulating the ability of any person to acquire control of an
insurance company without appropriate regulatory approval similar to those
described above.
DIVIDENDS BY EVEREST RE. Because the operations of the Company are conducted
through Everest Re and its subsidiaries, the Company is dependent upon dividends
and other permissible payments from Everest Re to meet its obligations and to
pay dividends in the future should Holdings' Board of Directors decide to do so.
The payment of dividends to Holdings by Everest Re is subject to limitations
imposed by Delaware law.
Under the Delaware Code, before a Delaware domiciled insurer may pay any
dividend it must give 10 days prior notice to the Delaware Insurance
Commissioner. During this 10-day period, the Commissioner may, by order, limit
or disallow the payment of ordinary dividends if the Commissioner finds the
insurer to be presently or potentially in financial distress. A Delaware
domiciled insurer may only pay cash dividends from the portion of its available
and accumulated surplus funds derived from realized net operating profits and
realized capital gains. Additionally, a Delaware domiciled insurer may not pay
any "extraordinary" dividend or distribution until (i) 30 days after the
Delaware Insurance Commissioner has received notice of a declaration thereof and
has not within such period disapproved such a payment or (ii) the Delaware
Insurance Commissioner has approved such payment within the 30-day period. Under
the Delaware Code, an "extraordinary" dividend of a property and casualty
insurer is a dividend the amount of which, together with all other dividends and
distributions made in the preceding 12 months, exceeds the greater of (i) 10% of
an insurer's statutory surplus as of the end of the prior calendar year or (ii)
the insurer's statutory net income, not including realized capital gains, for
the prior calendar year. Under this definition, the maximum amount that will be
available for the payment of dividends by Everest Re in 1998 without triggering
the requirement for prior approval of regulatory authorities in connection with
an extraordinary dividend is $177.6 million. As of December 31, 1997, Everest
Re's accumulated statutory surplus from realized net operating profits and
realized gains was $535.8 million.
INSURANCE REGULATION. U.S. domestic property and casualty insurers, including
reinsurers, are subject to regulation by their state of domicile and by those
states in which they are licensed. The rates and policy terms of reinsurance
agreements generally are not subject to regulation by any governmental
authority. This contrasts with primary insurance policies and agreements, the
rates and policy terms of which are generally regulated closely by state
insurance departments.
19
Everest Re is subject primarily to regulation and supervision that relate to
licensing requirements, solvency requirements, investment requirements,
restrictions on the size of risks which may be insured, deposit of securities
for the benefit of ceding companies and/or policyholders, accounting
requirements, periodic examinations of financial condition and affairs, the form
and content of financial statements that must be filed with regulators and the
level of minimum reserves necessary to cover unearned premiums, losses and other
purposes. In general, such regulation is designed to protect ceding insurers
and, ultimately, their policyholders, rather than stockholders. The operations
of Everest Re's foreign branch offices in Canada, Hong Kong, Singapore and the
United Kingdom are subject to regulation by the insurance regulatory officials
of those jurisdictions. Management believes that the Company is in material
compliance with applicable laws and regulations pertaining to its business and
operations.
Everest Canada, Everest Indemnity and Everest National are subject to similar
regulation and, in addition, Everest National must comply with substantial
regulatory requirements in each state where it does business. These additional
requirements include, but are not limited to, rate and policy form requirements,
requirements with regard to licensing, agent appointments, participation in
residual markets and claims handling procedures. These regulations are primarily
designed for the protection of policyholders.
LICENSES. Ordinarily, in the United States, a primary insurer will only enter
into reinsurance agreements if it can obtain credit for the reinsurance on its
statutory financial statements. Credit is usually granted when the reinsurer is
licensed or accredited in a state where the primary insurer is domiciled. In
addition, many states permit credit for reinsurance ceded to a reinsurer that is
domiciled and licensed in another state. Such a reinsurer must meet certain
financial requirements and, in some instances, the domiciliary state of such a
reinsurer must have substantially similar reinsurance credit law requirements as
the domiciliary state of the primary insurer or if credit for reinsurance is not
available, the primary insurer may reduce its liabilities on its statutory
financial statements if it is provided with collateral to secure the reinsurer's
obligations.
Everest Re is a licensed property/casualty insurer and/or reinsurer in all
states and the District of Columbia with the exception of Nevada, North
Carolina, West Virginia and Wyoming. In New Hampshire and Puerto Rico, Everest
Re is licensed for reinsurance only.
Everest Re is licensed as a property/casualty reinsurer in Canada. It is also
authorized to conduct reinsurance business in the United Kingdom, Hong Kong and
Singapore. Everest Re can also write reinsurance in other foreign countries.
Because some jurisdictions require a reinsurer to register in order to be an
acceptable market for local insurers, Everest Re is registered as a foreign
insurer and/or reinsurer in the following countries: Argentina, Bolivia, Chile,
Colombia, Ecuador, Guatemala, Mexico, Peru, Venezuela and the Philippines.
Everest National is licensed in 39 states and the District of Columbia. Everest
Indemnity is licensed in Delaware and is eligible to write insurance on a
surplus lines basis in 11 states and the District of Columbia. Everest Canada is
federally licensed under the Insurance Companies Act of Canada and licensed in
all Canadian provinces and territories.
PERIODIC EXAMINATIONS. Everest Re, Everest National and Everest Indemnity are
subject to examination of their affairs by the insurance departments of the
states in which they are licensed, authorized or accredited. Delaware and
Arizona, the domiciliary states of Everest Re and Everest Indemnity, and Everest
National, respectively, usually conduct examinations of domestic companies every
3 years and may do so at such other times as are deemed advisable by the
respective insurance commissioner. Everest Re's and Everest National's last
examination reports were as of December 31, 1994. Neither report contained any
material recommendations. Everest Indemnity's last examination report was
conducted upon its organization in 1997. This report did not contain any
material recommendations.
NAIC RISK-BASED CAPITAL REQUIREMENTS. The NAIC has instituted a formula to
measure the amount of capital appropriate for a property and casualty insurance
company to support its overall business operations in light of its size and risk
profile. The major categories of a company's risk profile are its asset risk,
credit risk, and underwriting risk. The new standards are an effort by the NAIC
to prevent insolvencies, to ward off other financial difficulties of insurance
companies, and to establish uniform regulatory standards among state insurance
departments.
Under the approved formula, a company's statutory surplus is compared to its
risk based capital (RBC). If this ratio is above a minimum threshold, no action
is necessary. Below this threshold are four distinct action levels at which a
regulator can intervene with increasing degrees of authority over a domestic
insurer as the ratio of surplus to RBC decreases. The mildest intervention
requires the company to submit a plan of appropriate corrective actions. The
most severe action requires the company to be rehabilitated or liquidated.
20
Based upon Everest Re's, Everest National's and Everest Indemnity's financial
positions at December 31, 1997, Everest Re, Everest National and Everest
Indemnity exceed the minimum thresholds. Various proposals to change the RBC
formula have been proposed. The Company is unable to predict whether any such
proposal will be adopted, the form in which any such proposals would be adopted
or the effect, if any, the adoption of any such proposal or change in the RBC
calculations would have on the Company.
LEGISLATIVE AND REGULATORY PROPOSALS. Various regulatory and legislative changes
have from time to time been proposed that could affect reinsurers and insurers.
Among the proposals that have in the past been or are at present being
considered are the possible introduction of federal regulation in addition to,
or in lieu of, the current system of state regulation of insurers, Superfund
re-authorization, modernization of financial services regulation, product
liability and tort reform, state and federal involvement in insuring
catastrophes, limitations on the ability of primary insurance carriers to effect
premium rate increases or to cancel or not renew existing policies,
modifications to investment limitations, creation of interstate compacts for
multi-state insurer receivership proceedings or multi-state insurance regulation
and the codification of Statutory Accounting Principles. The Company is unable
to predict whether any of these proposals will be adopted, the form in which any
such proposals would be adopted, or the impact, if any, such adoption would have
on the Company.
ITEM 2. PROPERTIES
Everest Re's corporate offices are located in Liberty Corner, New Jersey, and
occupy approximately 112,000 square feet of office space under a sublease with
The Prudential Insurance Company of America that expires on November 29, 2003.
Everest Re's other ten office locations occupy a total of approximately 62,600
square feet, all of which are leased. Management believes that the above
described office space is adequate for its current and anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in litigation and arbitration in the normal course of
its business. Management does not believe that any such pending litigation or
arbitration will have a material adverse effect on the Company's results of
operations, financial condition and cash flows. However, no assurance can be
given as to the decisions that may be rendered by the courts or arbitration
panels in any of such litigation and arbitration matters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. (A) MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
Since October 3, 1995, the common stock of Holdings has been traded on the New
York Stock Exchange under the symbol "RE". Quarterly high and low market prices
of Holdings' common stock in 1997 and 1996 were as follows:
High Low
----------------------
First Quarter 1997: 32.75 26.00
Second Quarter 1997: 40.25 26.75
Third Quarter 1997: 41.125 34.50
Fourth Quarter 1997: 43.00 33.00
First Quarter 1996: 25.125 20.125
Second Quarter 1996: 26.50 21.375
Third Quarter 1996: 26.50 22.50
Fourth Quarter 1996: 29.50 23.875
NUMBER OF HOLDERS OF COMMON STOCK
The number of record holders of common stock as of March 2, 1998 was 108. That
number excludes the beneficial owners of shares held in "street" names or held
through participants in depositories, such as The Depository Trust Company.
21
DIVIDEND HISTORY AND RESTRICTIONS
In 1995, the Board of Directors of the Company established a policy of declaring
regular quarterly cash dividends. The first such dividend was $0.03 per share,
declared and paid in the fourth quarter of 1995. The Company declared and paid
its regular quarterly cash dividend of $0.03 per share for each quarter of 1996.
The Company declared and paid its regular quarterly cash dividend of $0.04 per
share for each quarter of 1997. On February 26, 1998, the Board of Directors
raised the quarterly dividend to $0.05 per share and declared a dividend,
payable on or before March 27, 1998 to shareholders of record on March 9, 1998.
The declaration and payment of future dividends, if any, by the Company will be
at the discretion of the Board of Directors and will depend upon many factors,
including the Company's earnings, financial condition and business needs,
capital and surplus requirements of the Company's operating subsidiaries,
regulatory considerations and other factors, and the ability of Everest Re to
pay dividends to the Company.
As an insurance holding company, the Company depends on payments from Everest Re
to pay cash dividends to stockholders. The payment of dividends by Everest Re is
subject to certain limitations imposed by the Delaware Code. See "Regulatory
Matters -- Dividends by Everest Re" and Note 10A of Notes to Consolidated
Financial Statements.
(B) RECENT SALES OF UNREGISTERED SECURITIES
Information required by Item 701 of Regulation S-K:
(a) On October 1, 1997, 1,085 common shares of the Company (previously
held as treasury shares) were distributed.
(b) The securities were distributed to the Company's five non-employee
Directors.
(c) The securities were issued as compensation to the non-employee
Directors for services rendered to the Company during the third
quarter of 1997.
(d) Exemption from registration was claimed pursuant to Section 4(2) of
the Securities Act of 1933. There was no public offering and the
participants in the transactions were the Company and its non-employee
Directors.
(e) Not applicable.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated GAAP financial data of the Company as of and
for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 were derived
from the consolidated financial statements of the Company, which were audited by
Coopers and Lybrand L.L.P. (1997 and 1996) and Deloitte and Touche LLP (1993 -
1995), independent auditors. The statutory data have been derived from statutory
financial statements of Everest Re filed with the Delaware Insurance Department.
Such statutory financial statements are prepared in accordance with SAP, which
differ from GAAP. The statutory financial statements are unconsolidated and
reflect the net assets of Everest Re's subsidiaries, Everest Ltd., Everest
National, Everest Canada and Everest Indemnity on the equity method. The
following financial data should be read in conjunction with the Consolidated
Financial Statements and accompanying notes. The supplemental information for
1995 excludes the effects of an IPO-related premium charge of $140.0 million
($91.0 million after taxes) for the Stop Loss Agreement and an IPO-related
compensation expense charge of $13.3 million ($8.7 million after taxes)
principally for stock awards to the Company's Chief Executive Officer. Such
supplemental information is presented to facilitate an understanding of the
impact on the Company's results of operations of these non-recurring charges,
but should not, however, be considered as an alternative to the respective
amounts determined in accordance with GAAP as an indicator of the Company's
operating performance.
22
Years Ended December 31,
----------------------------------------------------------------
(Dollars in millions, except 1997 1996 1995 1994 1993
per share amounts) ----------------------------------------------------------------
Operating data:
Gross premiums written $ 1,075.0 $ 1,044.0 $ 949.5 $ 953.2 $ 918.1
Net premiums written 1,031.1 1,030.5 783.2 863.2 892.3
Net premiums earned 1,049.8 973.6 753.3 853.3 883.2
Net investment income 228.5 191.9 166.0 143.6 141.1
Net realized capital gains
(losses)(1) 15.9 5.7 33.8 (10.5) 78.8
Total revenue 1,299.2 1,169.3 948.9 982.8 1,098.3
Losses and LAE incurred
(including catastrophes) 765.4 716.0 674.7 720.8 687.4
Catastrophe losses(2):
Hurricane Andrew - - 0.5 3.9 30.4
Northridge earthquake - - - 70.9 -
Other(3) 8.6 7.1 30.9 7.1 (7.8)
Total catastrophe
losses(4) 8.6 7.1 31.4 81.9 22.7
Commission, brokerage, taxes
and fees 274.8 254.6 227.4 197.9 189.6
Other underwriting expenses 51.7 54.9 60.0 68.3 64.7
Compensation related to public
offering - - 13.3 - -
Restructuring and early
retirement costs - - - 7.8 -
Total expenses(4) 1,091.9 1,025.5 975.4 994.8 941.7
Income (loss) before taxes(4) 207.3 143.8 (26.6) (12.0) 156.5
Income tax (benefit) 52.3 31.8 (27.3) (22.6) 30.2
Net income (4) $ 155.0 $ 112.0 $ 0.7 $ 10.7 $ 126.4
================================================================
Net income per basic
share (5) $ 3.07 $ 2.22 $ 0.01 $ 0.21 $ 2.53
================================================================
Net income per diluted
share (6) $ 3.05 $ 2.21 $ 0.01 $ 0.21 $ 2.53
================================================================
Dividends paid per share $ 0.16 $ 0.12 $ 0.14 $ 0.15 $ -
================================================================
Certain GAAP financial ratios:
Loss and LAE ratio(7) 72.9% 73.5% 89.6% 84.5% 77.8%
Underwriting expense ratio(8) 31.1 31.8 39.9 31.2 28.8
----------------------------------------------------------------
Combined ratio 104.0% 105.3% 129.5% 115.7% 106.6%
================================================================
Certain SAP data(9):
Ratio of net premiums written
to surplus(10) 1.4x 1.2x 1.0x 1.2x 1.3x
Statutory surplus $ 908.8 $ 772.7 $ 686.9 $ 600.7 $ 607.7
Loss and LAE ratio(11) 75.7% 71.2% 92.2% 85.8% 81.0%
Underwriting expense ratio(12) 25.6 31.7 38.9 32.6 29.1
----------------------------------------------------------------
Combined ratio 101.3% 102.9% 131.1% 118.4% 110.1%
================================================================
Balance sheet data (at end
of period):
Total investments and cash $ 4,163.3 $ 3,624.6 $3,238.3 $2,573.2 $ 2,610.8
Total assets 5,538.0 5,047.8 4,647.8 4,040.6 3,920.6
Loss and LAE reserves 3,437.8 3,246.9 2,969.3 2,706.4 2,540.1
Total liabilities 4,230.5 3,961.7 3,664.2 3,299.6 3,045.2
Stockholders' equity(13) 1,307.5 1,086.0 983.6 741.0 875.4
Book value per share(14) 25.90 21.51 19.36 14.82 17.51
Supplemental information,
excluding IPO-related charges:
Net premiums written $ 923.2
Net premiums earned 893.3
Income before taxes 126.8
Net income $ 100.4
========
Net income per basic and
diluted share $ 2.00
========
Supplemental GAAP financial
ratios:
Loss and LAE ratio 75.5%
Underwriting expense ratio 32.2
--------
Combined ratio 107.7%
========
Supplemental SAP data:
Ratio of net premiums
written to surplus 1.2x
Loss and LAE ratio 75.5%
Underwriting expense ratio 32.0
--------
Combined ratio 107.5%
========
23
- -----------
(1) After-tax operating income (loss), before after-tax net realized capital
gains or losses, was $144.6 million (or $2.86 per basic share and $2.85 per
diluted share), $108.3 million (or $2.14 per basic and diluted share),
($21.2) million (or ($0.42) per basic and diluted share), $17.5 million (or
$0.35 per basic and diluted share) and $75.2 million (or $1.50 per basic
and diluted share) for the years ended December 31, 1997, 1996, 1995, 1994
and 1993, respectively. Supplemental after-tax operating income, before net
realized gains and excluding IPO-related charges was, $78.4 million (or
$1.56 per basic and diluted share) for the year ended December 31, 1995.
(2) Catastrophe losses are net of reinsurance. A catastrophe is defined, for
purposes of the Selected Consolidated Financial Data, as an event that
causes a pre-tax loss before reinsurance of at least $5.0 million and has
an event date of January 1, 1988 or later.
(3) Other catastrophe losses include adverse (favorable) development on loss
reserves for other catastrophes occurring on or after January 1, 1988.
(4) Some amounts may not reconcile due to rounding.
(5) Based on weighted average basic shares outstanding of 50.5 million, 50.6
million, 50.2 million, 50.0 million and 50.0 million for 1997, 1996, 1995,
1994 and 1993, respectively.
(6) Based on weighted average diluted shares outstanding of 50.8 million, 50.7
million, 50.2 million, 50.0 million and 50.0 million for 1997, 1996, 1995,
1994 and 1993, respectively.
(7) GAAP losses and LAE incurred as a percentage of GAAP net premiums earned.
(8) GAAP underwriting expenses as a percentage of GAAP net premiums earned.
Including restructuring and early retirement costs, incurred in the fourth
quarter of 1994, the Company's GAAP underwriting expense ratio in 1994 was
32.1%.
(9) Statutory results are on a Everest Re legal entity basis; consequently,
investments in subsidiary operations are accounted for on an equity basis.
Effective January 1, 1997, the reinsurance operations of Everest Ltd. were
transferred to Everest Re on a portfolio basis. Excluding the impact of the
portfolio transaction, the 1997 ratio of net written premiums to surplus,
the 1997 loss and LAE ratio, the 1997 underwriting expense ratio and the
1997 combined ratio were 1.1x, 70.5%, 32.2% and 102.7%, respectively.
(10) Statutory net premiums written as a percentage of period-end surplus.
(11) Statutory losses and LAE incurred as a percentage of SAP net premiums
earned.
(12) Statutory underwriting expenses as a percentage of SAP net premiums
written.
(13) Excluding net unrealized appreciation (depreciation) of investments,
stockholder's equity was $1,147.1 million, $1,008.3 million, $899.9
million, $799.1 million and $794.6 million as of December 31, 1997, 1996,
1995, 1994 and 1993, respectively.
(14) Based on 50.5 million shares outstanding for December 31, 1997 and 1996,
50.8 million shares outstanding for December 31, 1995 and 50.0 million
shares outstanding for December 31, 1994 and 1993, respectively.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
INDUSTRY CONDITIONS. Since 1987, a number of factors, including global
competition, the emergence of significant reinsurance capacity from the Bermuda
and rejuvenated Lloyds' markets, higher retentions by primary insurance
companies and consolidation in the insurance industry, have caused increasingly
competitive market conditions across most lines of business and have influenced
the softening of prices and contract terms in the current market place. The
Company cannot predict with any reasonable certainty, if, when or to what extent
market conditions as a whole will change. See "Business-Competition" for a
further discussion.
INITIAL PUBLIC OFFERING. On October 6, 1995 the Company's former ultimate
parent, The Prudential Insurance Company of America, ("The Prudential"),
completed an initial public offering ("IPO") of 100% of the outstanding stock of
the Company. In connection with the IPO, the Company incurred a non-recurring
premium charge of $140.0 million ($91.0 million after-tax) for aggregate excess
of loss reinsurance coverage (the "Stop Loss Agreement") provided by Gibraltar
Casualty Company ("Gibraltar") an affiliate of the former parent. This coverage
protects the Company's consolidated earnings against up to $375.0 million of the
first $400.0 million of adverse development, if any, on the Company's
consolidated reserves for losses, allocated loss adjustment expenses and
uncollectible reinsurance at June 30, 1995 (December 31, 1994 for catastrophe
losses). At the same time, The Prudential paid $140.0 million to the Company, of
which amount $91.0 million was a contribution to capital and $49.0 million was a
payment in respect of the tax benefit of the premium paid for the Stop Loss
Agreement. In addition, the Company incurred $13.3 million ($8.7 million
after-tax) of non-recurring compensation expense, including $12.5 million in
connection with IPO-related stock awards to the Chief Executive Officer. All of
these IPO-related transactions had the effect of reducing cash flow for 1995 by
$0.8 million and increasing stockholders' equity by $3.8 million. The following
table shows the Company's 1995 results of operations as reported in the
accompanying statement of operations and as adjusted to exclude these
IPO-related charges:
24
IPO
related
(Dollars in thousands) As reported charges As adjusted
-------------------------------------------
Revenues:
Net earned premiums $ 753,321 $ 140,000 $ 893,321
Net investment income 166,023 0 166,023
Other income (loss) (4,315) 0 (4,315)
Net realized capital gains 33,835 0 33,835
-------------------------------------------
948,864 140,000 1,088,864
-------------------------------------------
Claims and expenses:
Incurred losses and loss
adjustment expenses 674,696 0 674,696
Commission, brokerage, taxes
and fees 227,376 0 227,376
Other underwriting expenses 60,017 0 60,017
Compensation related to public
offering 13,343 (13,343) 0
-------------------------------------------
975,432 (13,343) 962,089
-------------------------------------------
INCOME (LOSS) BEFORE TAXES (26,568) 153,343 126,775
Income tax (benefit) (27,315) 53,670 26,355
-------------------------------------------
NET INCOME $ 747 $ 99,673 $ 100,420
===========================================
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
The following discussion and analysis is focused on a comparison of 1997 results
of operations to 1996 results of operations.
PREMIUMS. Gross premiums written increased 3.0% to $1,075.0 million in 1997 from
$1,044.0 million in 1996, as the Company maintained a cautious approach to the
increasingly competitive market conditions. Factors contributing to this
increase included a 5.9% ($18.2 million) increase in U.S. broker treaty
premiums, largely attributable to product line expansion, a 6.6% ($9.8 million)
increase in U.S. direct treaty reinsurance and insurance due to the growth in
primary insurance written through Everest National, a 2.6% ($8.8 million)
increase in international premiums, and a 0.3% ($0.5 million) increase in
marine, aviation, and surety premiums. These increases were partially offset by
a 7.2% ($6.4 million) decrease in facultative premiums.
Ceded premiums increased by 224.7% to $43.8 million in 1997 from $13.5 million
in 1996, principally as a result of a return premium in 1996 under the Company's
catastrophe retrocessional protection, coupled with increased retrocessional
protections for international catastrophe exposures and increases in the
Company's contract specific retrocessions in 1997.
Net premiums written increased by 0.1% to $1,031.1 million in 1997 from $1,030.5
million in 1996, reflecting the growth in U.S. broker, U.S. direct treaty
reinsurance and insurance, international and marine, aviation and surety gross
written premiums offset by the decrease in facultative gross premiums written
and the increase in ceded premiums.
REVENUES. Net premiums earned increased by 7.8% to $1,049.8 million in 1997 from
$973.6 million in 1996, with the increase attributable to normal earnings
patterns coupled with a decrease in the rate of written premium growth.
Net investment income increased 19.1% to $228.5 million in 1997 from $191.9
million in 1996, reflecting the effect of investing the $376.4 million of cash
flow from operating activities in 1997 and the increase in the Company's pre-tax
yield on average cash and invested assets to 5.9% in 1997 from 5.6% in 1996.
Net realized capital gains increased 179.5% to $15.9 million in 1997 from $5.7
million in 1996, with the gains in both periods mainly arising from activity in
the Company's portfolio of equity securities, including, in 1997, a $14.0
million gain on the sale of the Company's remaining investment in the common
stock of Corporacion MAPFRE, a publicly traded Spanish insurer.
EXPENSES. Incurred losses and loss adjustment expenses ("LAE") increased by 6.9%
to $765.4 million in 1997 from $716.0 million in 1996. The Company's loss and
LAE ratio decreased by 0.6 percentage points to 72.9% in 1997 from 73.5% in
1996. This improvement was attributable principally to changes in the Company's
business mix consistent with the Company's underwriting strategy together with
modest and comparable catastrophe losses in both years. Net incurred losses and
LAE for 1997 reflected ceded losses and LAE of $109.6 million, including $45.0
million ceded under the Stop Loss Agreement, compared to ceded losses and LAE of
$206.0 million in 1996, including $116.5 million ceded under the Stop Loss
Agreement.
25
Underwriting expenses increased by 5.5% to $326.5 million in 1997 from $309.5
million in 1996. Commission, brokerage, taxes and fees increased by $20.2
million attributable primarily to increases in written premium and changes in
the Company's business mix. Other underwriting expenses decreased by $3.2
million, as the impact of the continued reductions in the number of employees
over the course of 1996 and 1997 together with other cost reduction initiatives
more than offset the impact of salary and other expense increases that were
generally in line with inflation. The Company's expense ratio decreased by 0.7
points to 31.1% in 1997 from 31.8% in 1996 as the increase of premiums earned
more than offset the increases in underwriting expenses.
The Company's combined ratio decreased by 1.3 points to 104.0% in 1997 from
105.3% in 1996, reflecting the lower loss ratio and increased premiums.
INCOME TAXES. The Company had income tax expense of $52.3 million in 1997
compared to $31.8 million in 1996, with the difference substantially
attributable to the improvement in pre-tax income to $207.3 million in 1997 from
$143.8 million in 1996.
NET INCOME. Net income was $155.0 million in 1997 compared to $112.0 million in
1996. This improvement mainly reflects higher premiums earned, higher investment
income, higher capital gains and a lower combined ratio, offset by higher income
taxes.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
The following discussion and analysis is focused on a comparison of 1996 results
of operations to 1995 results of operations, as adjusted to exclude the
IPO-related charges.
PREMIUMS. Gross premiums written increased 10.0% to $1,044.0 million in 1996
from $949.5 million in 1995. Factors contributing to this increase included a
21.8% ($55.0 million) increase in U.S. broker treaty premiums, principally from
increased writings in specialty casualty, workers' compensation and substandard
automobile lines, a 21.6% ($26.4 million) increase in U.S. direct treaty
reinsurance and insurance due to the growth in primary insurance written through
Everest National and a 28.9% ($19.9 million) increase in U.S. facultative
premiums, reflecting growth in casualty and specialty casualty lines, as the
unit completed its first full year after its major restructuring and took
advantage of significant dislocation in the market. These increases were
partially offset by a 3.5% ($5.8 million) decrease in marine, aviation and
surety premiums and a 0.3% ($0.9 million) decrease in international premiums.
Ceded premiums, as adjusted, decreased by 48.7% to $13.5 million in 1996 from
$26.3 million in 1995, principally as a result of a return premium under the
Company's catastrophe retrocessional protection, partially offset by increases
in common account retrocessions by ceding sources.
Net premiums written, as adjusted, increased by 11.6% to $1,030.5 million in
1996 from $923.2 million in 1995, reflecting the growth in U.S. broker, U.S.
direct treaty reinsurance and insurance and facultative gross written premiums
coupled with decreased retrocessional costs.
REVENUES. Net premiums earned, as adjusted, increased by 9.0% to $973.6 million
in 1996 from $893.3 million in 1995, generally consistent with the change in net
premiums written.
Net investment income increased 15.6% to $191.9 million in 1996 from $166.0
million in 1995, reflecting the effect of investing the $414.0 million of cash
flow from operating activities in 1996. The Company's pre-tax yield on average
cash and invested assets decreased to 5.6% in 1996 from 5.7% in 1995 reflecting
the dilutive effect of new money investment rates.
Net realized capital gains decreased 83.1% to $5.7 million in 1996 from $33.8
million in 1995, principally reflecting the sale in 1995 of one half of the
Company's investment in the common stock of Corporacion MAPFRE. Realized capital
gains on the sale of equity securities totalled $17.4 million in 1996, as
generally favorable conditions continued in the U.S. equity securities market,
and were partially offset by $11.7 million in realized capital losses on the
sale of fixed maturities.
EXPENSES. Incurred losses and LAE increased by 6.1% to $716.0 million
in 1996 from $674.7 million in 1995. Catastrophe losses on events with
ultimate gross losses estimated at $5.0 million or greater ("catastrophe
losses") in 1996 were $7.1 million, which included $10.0 million estimated
for Hurricane Fran and $2.9 million of net favorable development on prior
year occurrences, compared with $31.4 million in 1995, which included
$30.9 million estimated for the Kobe, Japan earthquake and Hurricanes
Marilyn and Opal and $0.5 million of net adverse development on prior year
occurrences. The Company's loss and LAE ratio, as adjusted, decreased by 2.0
percentage points to 73.5% in 1996 from 75.5% in 1995. This improvement was
attributable principally to the lower catastrophe losses and changes in
26
the Company's business mix in line with the new underwriting strategy. Net
incurred losses and LAE for 1996 reflected ceded losses and LAE of $206.0
million, including $116.5 million ceded under the Stop Loss Agreement, compared
to ceded losses and LAE of $119.1 million in 1995, including $23.7 million ceded
under the Stop Loss Agreement.
Underwriting expenses, as adjusted, increased by 7.7% to $309.5 million in 1996
from $287.4 million in 1995. Commission, brokerage, taxes and fees increased by
$27.2 million attributable primarily to increases in written premium and changes
in the Company's business mix. Other underwriting expenses decreased by $5.1
million, as the impact of the significant reduction in employees over the course
of 1995 and 1996 and other cost reduction initiatives more than offset the
impact of salary and other expense increases that were generally in line with
inflation. The Company's expense ratio, as adjusted, decreased by 0.4 points to
31.8% in 1996 from 32.2% in 1995 as the increase of premiums earned more than
offset the increases in underwriting expenses.
The Company's combined ratio, as adjusted, decreased by 2.4 points to 105.3% in
1996 from 107.7% in 1995, reflecting the lower loss and expense ratios and
increased premiums.
INCOME TAXES. The Company had income tax expense, as adjusted, of $31.8 million
in 1996 compared to $26.4 million in 1995, with the difference substantially
attributable to the improvement in pre-tax income to $143.8 million in 1996 from
$126.8 million in 1995.
NET INCOME. Net income was $112.0 million in 1996 compared to $100.4 million, as
adjusted, in 1995. This improvement mainly reflects higher premiums earned,
higher investment income and a lower combined ratio, offset by lower realized
capital gains and higher income taxes.
FINANCIAL CONDITION
CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and
short-term investments, were $4,163.3 million at December 31, 1997, $3,624.6
million at December 31, 1996 and $3,238.3 million at December 31, 1995. The
change in invested assets resulted primarily from cash flows from operations
generated during the period together with net realized and unrealized gains
(losses) on investments.
LOSS AND LAE RESERVES
GENERAL. Gross loss and LAE reserves totaled $3,437.8 million at December 31,
1997, $3,246.9 million at December 31, 1996 and $2,969.3 million at December 31,
1995. These increases were consistent with the continued growth in the Company's
book of business.
Everest Re maintains reserves to cover its estimated ultimate liability for
losses and LAE with respect to reported and unreported claims. Because reserves
are estimates of ultimate losses and LAE, management monitors reserve adequacy
over time, evaluating new information as it becomes known and adjusting
reserves, as necessary. Management considers many factors when setting reserves,
including: (i) current legal interpretations of coverage and liability; (ii)
economic conditions; (iii) internal methodologies which analyze Everest Re's
experience with similar cases, information from ceding companies and historical
trends, such as reserving patterns, loss payments, pending levels of unpaid
claims and product mix; and (iv) the uncertainties discussed below regarding
reserve requirements for asbestos and environmental claims. Based on these
considerations, management believes that adequate provision has been made for
Everest Re's loss and LAE reserves. Actual losses and LAE ultimately paid may
deviate, perhaps substantially, from such reserves.
ASBESTOS AND ENVIRONMENTAL EXPOSURES. Everest Re's asbestos claims typically
involve liability or potential liability for bodily injury from exposure to
asbestos or liability for property damage resulting from asbestos or asbestos
containing materials. Everest Re's environmental claims typically involve
potential liability for the mitigation or remediation of environmental
contamination or bodily injury or property damages caused by the release of
hazardous substances into the land, air or water. In addition to the previously
described general uncertainties inherent in estimating reserves, there are
significant uncertainties in estimating the amount of Everest Re's potential
losses from asbestos and environmental claims. Among the complications
are: (i) potentially long waiting periods between exposure and manifestation
of any bodily injury or property damage; (ii) difficulty in identifying
sources of asbestos or environmental contamination; (iii) difficulty in
properly allocating responsibility and/or liability for asbestos or
environmental damage;(iv) changes in underlying laws and judicial interpretation
of those laws; (v) potential for an asbestos or environmental claim to
involve many insurance providers over many policy periods; (vi) long reporting
delays, both from insureds to insurance companies and ceding companies to
reinsurers; (vii) limited historical data concerning asbestos and environmental
losses; (viii) questions concerning interpretation and application of insurance
and reinsurance coverage; and (ix) uncertainty regarding the number and
identity of insureds with potential asbestos or environmental exposure.
27
Management believes that these issues are not likely to be resolved in the near
future. Everest Re establishes reserves to the extent that, in the judgment of
management, the facts and prevailing law reflect an exposure for Everest Re or
its ceding company. Due to the uncertainties discussed above, the ultimate
losses may vary materially from current loss reserves and, if coverage under the
Stop Loss Agreement were exhausted, could have a material adverse effect on the
Company's future financial condition, results of operations and cash flows.
The table below summarizes reserves and claim activity for asbestos and
environmental claims, on both a gross and net of ceded reinsurance basis, for
the periods indicated:
Asbestos and
Environmental Reserves
Years Ended December 31,
--------------------------------
(Dollars in millions) 1997 1996 1995
--------------------------------
Gross Basis:
Beginning of period reserves $ 423.3 $ 428.5 $ 445.5
--------------------------------
Incurred losses and LAE:
Reported losses 80.5 36.7 31.9
Change in IBNR 3.2 (6.7) (14.6)
--------------------------------
Total 83.7 30.0 17.3
Paid losses (60.9) (35.2) (34.3)
--------------------------------
End of period reserves $ 446.1 $ 423.3 $ 428.5
================================
Net Basis:
Beginning of period reserves $ 199.6 $ 186.0 $ 203.7
--------------------------------
Incurred losses and LAE:
Reported losses (18.3) (4.4) 5.5
Change in IBNR 21.8 4.4 (5.5)
--------------------------------
Total (1) 3.5 0.0 0.0
Paid losses (2) 9.3 13.6 (17.7)
--------------------------------
End of period reserves $ 212.4 $ 199.6 $ 186.0
================================
- ----------
(1) Net of $41.2 million in 1997, $24.2 million in 1996 and $16.7 million in
1995 ceded under the incurred loss reimbursement feature of the Stop Loss
Agreement.
(2) Net of $22.6 million in 1997, $34.5 million in 1996 and $5.0 million in
1995 ceded as paid losses under the Stop Loss Agreement.
The $233.7 million of reinsurance receivables as of December 31, 1997 was
attributable principally to two retrocessional arrangements: (i) $135.4 million
was due from various insurance and reinsurance companies, including Gibraltar,
in connection with their participation in Everest Re's management underwriting
facility ("MUF"), a reinsurance arrangement begun in 1977 pursuant to which
Everest Re ceded certain reinsurance and direct excess insurance business; and
(ii) $91.5 million was due as a result of the Company's former direct excess
insurance operations, which ceased writing business in 1985 and which has been
100% ceded to Gibraltar since 1986.
STOP LOSS AGREEMENT AND PRUDENTIAL GUARANTEES. To the extent reserves as of June
30, 1995 (December 31, 1994 for catastrophe losses) for losses, allocated LAE
and uncollectible reinsurance experience adverse development ("Adverse
Development"), Everest Re is entitled, at the time reserves are increased, to
payments under the Stop Loss Agreement, subject to the limit and other terms
thereof. Gibraltar's obligations to make payments to Everest Re under the Stop
Loss Agreement are guaranteed by The Prudential. Management expects that the
general effect of the Stop Loss Agreement will be to protect the Company's
consolidated earnings against up to $375.0 million of the first $400.0 million
of Adverse Development. There can be no assurance, however, that the Company's
net liability for such Adverse Development will be limited to $25.0 million.
With respect to liquidity, the incurred loss reimbursement features of these
agreements provide the Company with cash on or prior to the time it is required
to make payment on account of such Adverse Development. Through December 31,
1997, cessions under the Stop Loss Agreement have aggregated $185.2 million with
remaining limits available of $189.8 million as respects the next $210.9 million
of Adverse Development.
STOCKHOLDERS' EQUITY. Holdings' stockholders' equity increased to
$1,307.5 million as of December 31, 1997 from $1,086.0 million as
of December 31, 1996 principally reflecting $146.9 million in retained
earnings for the year and an increase of $82.6 million in unrealized
appreciation of investments. Stockholders' equity as of December 31, 1996
28
increased to $1,086.0 million from $983.6 million as of December 31, 1995
principally reflecting an increase of $106.0 million in retained earnings.
Dividends of $8.1 million, $6.1 million and $7.0 million were declared and paid
by Holdings in 1997, 1996 and 1995, respectively.
Holdings' stockholders' equity exceeded Everest Re's statutory-basis surplus by
$398.7 million at December 31, 1997. The primary differences between GAAP and
SAP as they relate to the Company are: (i) the deferral of acquisition costs
under GAAP, which are immediately expensed under SAP; (ii) the provision for
deferred taxes on temporary tax differences under GAAP, which are excluded under
SAP; and (iii) the carrying at market value of fixed maturities available for
sale under GAAP, as compared to at amortized cost under SAP.
LIQUIDITY AND CAPITAL RESOURCES
EVEREST RE. Everest Re's liquidity requirements are met on both a short- and
long-term basis by funds provided by premiums collected, investment income and
collected reinsurance receivables balances, and from the sale and maturity of
investments. The Company's net cash flows from operating activities were $376.4
million, $414.0 million and $397.9 million, as adjusted, in 1997, 1996 and 1995,
respectively. The decreases from 1996 in cash provided by operating activities
were principally a result of increases in net paid losses offset by improved
profitability. Recoveries under the Company's Stop Loss Agreement with Gibraltar
contributed $99.8 million, $53.4 million and $12.0 million of such net cash
flows in 1997, 1996 and 1995 respectively.
Proceeds and applications from sales and acquisitions of investment assets were
$1,077.0 million and $1,482.8 million, respectively, in 1997, compared to
$1,632.9 million and $2,014.9 million, respectively, in 1996 and $1,101.0
million and $1,494.7 million, respectively, in 1995. Everest Re's current
investment strategy seeks to maximize after-tax income through a high quality,
diversified, duration sensitive, taxable bond and tax-exempt municipal bond
portfolio, while maintaining an adequate level of liquidity.
EXPOSURE TO CATASTROPHES. As with other reinsurers, Everest Re's operating
results and financial condition can be adversely affected by volatile and
unpredictable natural and other disasters, such as hurricanes, windstorms,
earthquakes, floods, fires and explosions. Although Everest Re attempts to limit
its exposure to acceptable levels, it is possible that an actual catastrophic
event or multiple catastrophic events could have a material adverse effect on
the financial condition, results of operations and cash flows of the Company.
The Company maintains a corporate-level retrocessional protection program, above
and beyond retrocessions purchased with respect to specific assumed coverages,
to mitigate the potential impact of catastrophe losses. At December 31, 1997,
the attachment point of this program was $25.0 million per catastrophe in the
U.S. and $10.0 million per catastrophe outside the U.S. No losses were ceded
under the corporate-level retrocession program during 1997 or 1996. All aspects
of the retrocession program have been structured to permit the program to be
accounted for as reinsurance under SFAS No. 113.
HOLDINGS. Holdings is a holding company whose only material asset is the capital
stock of Everest Re. Holdings' cash flow will consist primarily of dividends and
other permissible payments from Everest Re. Holdings depends upon such payments
for funds for general corporate purposes and for the payment of any dividends on
its common stock.
On June 16, 1997, the Company finalized a 364 day revolving line of credit with
First Union National Bank. This credit facility, which will be used for
liquidity and general corporate purposes, provides for the borrowing of up to
$50 million with interest at a rate selected by the Company equal to either (i)
the Base Rate (as defined below), (ii) an adjusted London InterBank Offered Rate
("LIBOR") plus a margin (the "Margin") or (iii) a Money Market Rate, which is a
daily uncommitted advised rate. The Base Rate is the higher of the rate of
interest established by the bank from time to time as its reference rate in
making loans or the Federal Funds rate plus 0.5% per annum. The amount of the
Margin and the commitment fee payable to the bank for the credit facility depend
upon the insurance strength or claims paying ability ratings of Everest Re. The
credit facility agreement requires that Everest Re maintain statutory surplus of
not less than $575 million and that the Company not allow its ratio of certain
debt to capital to be greater than a specified amount.
The payment of dividends to Holdings by Everest Re is subject to limitations
imposed by the Delaware Code. Based upon these restrictions, the maximum
amount that will be available for payment of dividends to Holdings by
Everest Re in 1998 without the prior approval of regulatory authorities
is $177.6 million. Everest Re's future cash flow available to Holdings may
be influenced by a variety of factors, including cyclical changes in the
property and casualty reinsurance market, Everest Re's financial results,
insurance regulatory changes and changes in general economic conditions.
29
The availability of such cash flow to Holdings could also be influenced by,
among other things, changes in the limitations imposed by the Delaware Code on
the payment of dividends by Everest Re. Holdings expects that, absent
significant catastrophe losses, such restrictions should not affect Everest Re's
ability to declare and pay dividends sufficient to support Holdings' current
dividend policy.
During 1997, 1996 and 1995 Holdings declared and paid dividends of $8.1 million,
$6.1 million and $7.0 million, respectively.
On March 21, 1996 the Holdings' Board of Directors approved a stock repurchase
plan authorizing the repurchase of an aggregate amount of 2.5 million shares of
common stock from time to time in open market transactions. To date, no shares
have been repurchased pursuant to this plan.
TAX CONSOLIDATION WITH THE PRUDENTIAL
The Internal Revenue Service ("IRS") has completed its examinations of The
Prudential's tax returns for all years through 1992. As those examinations
relate to Everest Re, the IRS has disallowed that portion of the fresh start
benefit which relates to 1986 reserve strengthening as defined by the IRS. As a
result of conflicting decisions by two U.S. Circuit Courts, the Supreme Court of
the United States will consider the issue in reviewing ATLANTIC MUTUAL INSURANCE
CO. V. COMMISSIONER to determine whether the Treasury regulation that defines
the term "reserve strengthening" is a valid interpretation of the law. The
Supreme Court's decision in this case is expected to bring about a uniform
resolution of this question. The Company agrees with the petitioner in this case
in that the term "reserve strengthening" as used in the statute involves changes
in assumptions or methodologies. The Company believes that, because there were
no changes in reserving assumptions or methodologies between 1985 and 1986, all
increases to reserves in 1986 for which a fresh start benefit was taken are
normal reserve additions and, therefore, does not constitute reserve
strengthening that is not eligible for the fresh start benefit. If the IRS
position prevails, the Company will be required to reimburse The Prudential,
thereby incurring an additional charge of approximately $9.4 million, including
the after-tax cost of interest through December 31, 1997.
YEAR 2000 ISSUES
Many computers and software programs were designed to accommodate only two-digit
date fields to represent a given year (E.G., "97" represents 1997). It is
possible that such systems will not be able to accurately process data
containing information about the year 2000 or later. The "year 2000 issue" has
the potential to affect the Company through (i) the disruption of the processing
of business and general corporate transactions both at the Company and between
the Company and other businesses with which it interacts, and (ii) claims which
may be brought asserting that costs associated with the issue may be covered
under insurance or reinsurance contracts in which the Company participates.
The Company depends, in varying degrees, on many computerized information
systems, both within the Company and at others with whom it does business, which
may be affected by the year 2000 issue. In the absence of a response to the year
2000 issue, the Company could have difficulty efficiently processing
transactions, and the costs of doing its business could increase, perhaps
materially. To address the issue, the Company has initiated a year 2000
initiative to address potential concerns relating to both the Company's own
processing environment and companies with which it does business.
Within the Company's own processing environment, a review has been made
of all the computer hardware and software the Company uses and whether
such hardware and software is year 2000 compliant. With respect to computer
hardware, the Company is upgrading or replacing hardware as necessary.
Nearly all of the critical computerized business systems used by the Company are
based on software products licensed from third parties that specialize in
software development. For licensed software which is not yet compliant,
the Company has been in contact with the vendors of such software to
determine whether such products will be made compliant. Virtually all
vendors contacted by the Company have indicated that their products will be
made compliant on a timely basis. The Company believes that each of those
vendors has a critical business need to make its products compliant and will
therefore exercise its best efforts to make its products compliant on a timely
basis. With respect to those few products which will not be made year 2000
compliant, the Company is planning to license replacement products which are
compliant. The Company has, and expects to use beyond the year 2000, a number
of application programs that it has developed internally; the Company has
assessed which of those programs are critical to its business and its implemen-
tation plan anticipates the modification of those programs. While the Company
believes that its computer hardware, software licensed from third parties and
internally developed software critical to its business will be made compliant on
a timely basis, there can be no assurance that every such product will be
compliant on a timely basis and there can be no assurance that there will
30
be no material disruption to the Company's business if such products are not
compliant. The Company believes that the actual expenses involved in making its
internal processing environment and software licensed from third parties year
2000 compliant will not be material.
Because the Company's business relies upon data received from and given to many
business partners (E.G., ceding companies) and service providers (E.G., banks),
the Company's business could be disrupted if those entities are not year 2000
compliant. The Company has actively surveyed its significant business partners
and service providers to determine their compliance status. With respect to
entities with which the Company has direct electronic interfaces, meetings have
been held to address the compliance issue. The information received to date from
business partners and service providers has not identified any significant
barriers to year 2000 compliance, and the Company believes that these entities
will be sufficiently compliant that the year 2000 issue will not cause material
disruption in the Company's business. However, there can be no assurance that
there will not be material disruptions to the Company's business or an increase
in the cost of the Company's doing business.
It is possible that individuals or entities which experience business
disruption, increased costs or other problems associated with the year 2000
issue may assert claims against their own insurance carrier to recover such
costs or against other entities for damages, which entities may in turn assert
that such potential damages are covered by insurance. It is not yet possible to
determine whether any such claims will be made against insurers, whether such
claims will be held to have merit or whether such claims might be made against
insurance or reinsurance contracts in which the Company participates.
SAFE HARBOR DISCLOSURE
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995 (the "Act"), the Company sets forth below
cautionary statements identifying important factors, among others, that in some
cases have affected and that could cause its actual results to differ materially
from those which might be projected, forecasted, or estimated in its
forward-looking statements, as defined in the Act, made by or on behalf of the
Company in press releases, written statements or documents filed with the
Securities and Exchange Commission, or in its communications and discussions
with investors and analysts in the normal course of business through meetings,
phone calls and conference calls.
Such statements may include, but are not limited to, projections of premium
revenue, investment income, other revenue, losses, expenses, earnings (including
earnings per share), cash flows, plans for future operations, common
stockholders' equity (including book value per share), investments, financing
needs, capital plans, dividends, plans relating to products or services of the
Company, and estimates concerning the effects of litigation or other disputes,
as well as assumptions for any of the foregoing and are generally expressed with
words such as "believes," "estimates," "expects," "anticipates," "plans,"
"projects," "forecasts," "goals," "could have," "may have" and similar
expressions. Undue reliance on any forward-looking statements should be avoided.
The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause the Company's results to differ materially from
such forward-looking statements. Such risks, uncertainties and other factors
include, but are not limited to, the following:
1) Changes in the level of competition in the domestic and international
reinsurance or primary insurance markets that adversely affect the
volume or profitability of the Company's reinsurance or insurance
business. These changes include, but are not limited to, the
intensification of price and contract terms competition, the entry of
new competitors, consolidation in the reinsurance and insurance
industry and the development of new products by new and existing
competitors;
2) Changes in the demand for reinsurance and insurance products of the
type offered by the Company and its ceding insurer customers;
3) The ability of the Company to execute its strategies;
4) Catastrophe losses in the Company's domestic or international
reinsurance or insurance business;
5) Adverse development on claim and claim expense liabilities related to
business written in prior years, including, but not limited to,
evolving case law and its effect on environmental and other latent
injury claims, changing government regulations, newly identified
toxins, newly reported claims, new theories of liability, or new
insurance and reinsurance contract interpretations, to the extent that
such adverse development exceeds the limits available under or is not
covered by the Stop Loss Agreement;
31
6) Greater than expected loss ratios on reinsurance or insurance written
by the Company;
7) Changes in inflation that affect the profitability of the Company's
current reinsurance and insurance businesses or the adequacy of its
claim and claim expense liabilities;
8) Changes in the Company's retrocessional arrangements;
9) Lower than estimated retrocessional or reinsurance recoveries on
losses, including, but not limited to, losses due to a decline in the
creditworthiness of the Company's retrocessionaires or reinsurers;
10) Changes in the reinsurance/retrocessional market impacting the
Company's ability to cede risks above its desired level of retention.
11) Changes in interest rates, increases in which cause a reduction in the
market value of the Company's fixed income investment portfolio, and
its common stockholders' equity, and decreases in which cause a
reduction of income earned on new cash flow from operations as well as
on the reinvestment of the proceeds from sales, calls or maturities of
existing investments;
12) Decline in the value of the Company's common equity investments;
13) Changes in the composition of the Company's investment portfolio;
14) Gains or losses related to changes in foreign currency exchange rates;
15) Changes in the role of reinsurance brokers and the relationship of the
Company with such brokers;
16) Impact of Year 2000 computer hardware and software issues on the
Company's operations and potential for Year 2000 claims under
reinsurance and insurance contracts written by the Company;
17) Adverse results in litigation matters, including, but not limited to,
litigation related to environmental, asbestos and other potential mass
tort claims;
18) Changes in the Company's capital needs;
19) Changes in the Company's ratings;
20) The impact of current and future regulatory environments on the ability
of the Company's subsidiaries to enter and exit reinsurance or
insurance markets; and
21) Changes in the commission or brokerage levels that competitors are
willing to offer to ceding companies, brokers or agents.
In addition to the factors outlined above that are directly related to the
Company's businesses, the Company is also subject to general business risks,
including, but not limited to, adverse state, federal or foreign legislation and
regulation, adverse publicity or news coverage, changes in general economic
factors, and the loss of key employees.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
32
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On August 9, 1996, the Company filed a Form 8-K with the Securities and Exchange
Commission reporting that Coopers & Lybrand L.L.P. replaced Deloitte & Touche
LLP on August 6, 1996 as the Company's independent accountants, with the
approval of the Company's audit committee.
During the 1994 and 1995 fiscal years and the interim period January 1, 1996
through August 6, 1996, there were no disagreements with Deloitte & Touche LLP
on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, which disagreements, if not resolved
to the satisfaction of Deloitte & Touche LLP, would have caused them to make
reference to the subject matter of the disagreement in their reports. Also,
there were no reportable events of the nature described in Regulation S-K Item
304(a)(1)(v) during the Company's 1994 and 1995 fiscal years and the interim
period January 1, 1996 through August 6, 1996.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Reference is made to "Election of Directors", "Information Concerning Nominees"
and "Information Concerning Continuing Directors and Executive Officers" in the
Company's proxy statement for the 1998 Annual Meeting of Stockholders, which
will be filed with the Commission within 120 days of the close of the Company's
fiscal year ended December 31, 1997 (the "Proxy Statement"), and which are
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Reference is made to "Directors' Compensation" and "Compensation of Executive
Officers" in the Proxy Statement, which is incorporated herein by reference,
except that the Compensation Committee Report and the Performance Graph are not
so incorporated.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to "Common Stock Ownership by Directors and Executive
Officers" and "Principal Holders of Common Stock" in the Proxy Statement, which
are incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Reference is made to "Certain Transactions with Directors" in the Proxy
Statement, which is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND SCHEDULES
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
EXHIBITS
The exhibits listed on the accompanying Index to Exhibits on page E-1 are filed
as part of this report.
REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the last quarter of 1997.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 on March 18, 1998.
EVEREST REINSURANCE HOLDINGS, INC.
By: /s/ JOSEPH V. TARANTO
--------------------------------------------
JOSEPH V. TARANTO
(CHAIRMAN AND CHIEF EXECUTIVE OFFICER)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ JOSEPH V. TARANTO Chairman and Chief March 18, 1998
- ------------------------------ Executive Officer and
Joseph V. Taranto Director
/s/ ROBERT P. JACOBSON Chief Financial Officer March 18, 1998
- ------------------------------ and Director
Robert P. Jacobson
/s/ STEPHEN L. LIMAURO Comptroller March 18, 1998
- ------------------------------
Stephen L. Limauro
/s/ MARTIN ABRAHAMS Director March 18, 1998
- ------------------------------
Martin Abrahams
/s/ KENNETH J. DUFFY Director March 18, 1998
- ------------------------------
Kenneth J. Duffy
/s/ JOHN R. DUNNE Director March 18, 1998
- ------------------------------
John R. Dunne
/s/ THOMAS J. GALLAGHER Director March 18, 1998
- ------------------------------
Thomas J. Gallagher
/s/ WILLIAM F. GALTNEY, JR. Director March 18, 1998
- ------------------------------
William F. Galtney, Jr.
/s/ ROBERT A. MULDERIG Director March 18, 1998
- ------------------------------
Robert A. Mulderig
34
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGES
-----
EVEREST REINSURANCE HOLDINGS, INC.
Reports of Independent Auditors on Financial
Statements and Schedules..............................................F-2
Consolidated Balance Sheets at December 31,
1997 and 1996.........................................................F-4
Consolidated Statements of Operations for the
years ended December 31, 1997, 1996 and 1995..........................F-5
Consolidated Statements of Changes in Stockholders'
Equity for the years ended December 31, 1997, 1996
and 1995..............................................................F-6
Consolidated Statements of Cash Flows for the
years ended December 31, 1997, 1996 and 1995..........................F-7
Notes to Consolidated Financial Statements.............................F-8
SCHEDULES
I Summary of Investments Other Than Investments in
Related Parties at December 31, 1997..................................S-1
II Condensed Financial Information of Registrant:
Balance Sheets as of December 31, 1997 and 1996.......................S-2
Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995.....................................S-3
Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995.....................................S-4
III Supplementary Insurance Information as of
December 31, 1997 and 1996 and for the years
ended December 31, 1997, 1996 and 1995................................S-5
IV Reinsurance for the years ended December 31,
1997, 1996 and 1995...................................................S-6
Schedules other than those listed above are omitted for the reason that they are
not applicable or the information is otherwise contained in the Financial
Statements.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
The Stockholders and Board of Directors
Everest Reinsurance Holdings, Inc.
We have audited the consolidated financial statements and the financial
statement schedules of Everest Reinsurance Holdings, Inc. and Subsidiaries ("the
Company") as of December 31, 1997 and 1996, and for the years then ended, as
listed in the index on page F-1 of this Form 10-K. These consolidated financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedules based upon
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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Everest
Reinsurance Holdings, Inc. and Subsidiaries as of December 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each
of the two years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles. In addition, in our opinion, the
financial statement schedules referred to above, when considered in relation to
the basic financial statements taken as a whole, present fairly, in all material
respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
New York, New York
February 17, 1998
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Everest Reinsurance Holdings, Inc. (formerly
Prudential Reinsurance Holdings, Inc.)
Liberty Corner, New Jersey
We have audited the accompanying consolidated statements of income,
stockholders' equity, and cash flows of Everest Reinsurance Holdings, Inc. and
subsidiaries for the year ended December 31, 1995. Our audit also included the
financial statement schedules listed in the Index on page F-1 of this Form 10-K
for the year then ended. These financial statements and financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion on the financial statements and financial statement
schedules based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, such consolidated statements of income, stockholders' equity,
and cash flows present fairly, in all material respects, the results of
operations and cash flows of Everest Reinsurance Holdings, Inc. and subsidiaries
for the year ended December 31, 1995 in conformity with generally accepted
accounting principles. Also, in our opinion, such financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly in all material respects the information set forth
therein.
As discussed in Note 1I, the accompanying 1995 financial statements have been
restated for the adoption of Statement of Financial Accounting Standard Number
128, "Earnings per Share".
DELOITTE & TOUCHE LLP
Parsippany, New Jersey
February 23, 1996 (February 27, 1998 as to Note 1I)
F-3
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31,
-------------------------------------
(Dollars in thousands, except 1997 1996
par value per share) -------------------------------------
ASSETS:
Fixed maturities - held to
maturity, at amortized cost
(market value: 1997, $0;
1996, $88,374) $ - $ 80,522
Fixed maturities - available
for sale, at market value
(amortized cost: 1997,
$3,658,370 ; 1996, $3,194,246) 3,866,860 3,281,972
Equity securities, at market
value (cost: 1997, $120,510;
1996, $115,367) 158,784 147,280
Short-term investments 75,244 49,486
Other invested assets 10,848 12,750
Cash 51,578 52,595
-------------------------------------
Total investments and cash 4,163,314 3,624,605
Accrued investment income 60,424 50,211
Premiums receivable 256,191 226,502
Reinsurance receivables 692,473 749,062
Funds held by reinsureds 186,454 173,386
Deferred acquisition costs 82,332 84,123
Prepaid reinsurance premiums 8,980 5,265
Deferred tax asset 74,434 124,664
Other assets 13,418 9,949
-------------------------------------
TOTAL ASSETS $ 5,538,020 $ 5,047,767
=====================================
LIABILITIES:
Reserve for losses and
adjustment expenses $ 3,437,818 $ 3,246,858
Unearned premium reserve 337,383 355,908
Funds held under reinsurance
treaties 190,639 177,921
Losses in the course of payment 55,969 33,386
Contingent commissions 100,027 83,279
Other net payable to reinsurers 13,231 8,779
Current federal income taxes 13,567 25,879
Other liabilities 81,903 29,734
-------------------------------------
Total liabilities 4,230,537 3,961,744
-------------------------------------
Commitments and contingencies
(Note 11)
STOCKHOLDERS' EQUITY:
Preferred stock, par value:
$0.01; 50 million shares
authorized; no shares issued
and outstanding - -
Common stock, par value:
$0.01; 200 million shares
authorized; 50.8 million
shares issued 508 508
Additional paid-in capital 389,876 389,196
Unearned compensation (514) (374)
Net unrealized appreciation
of investments, net of
deferred income taxes 160,397 77,766
Cumulative foreign currency
translation adjustment, net
of deferred income taxes (8,078) (354)
Retained earnings 773,380 626,501
Treasury stock, at cost;
0.3 million shares (8,086) (7,220)
-------------------------------------
Total stockholders' equity 1,307,483 1,086,023
-------------------------------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 5,538,020 $ 5,047,767
=====================================
The accompanying notes are an integral part of the consolidated financial statements.
F-4
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
---------------------------------------------------
(Dollars in thousands, 1997 1996 1995
except per share amounts) ---------------------------------------------------
REVENUES:
Premiums earned:
Before stop loss premium $ 1,049,847 $ 973,611 $ 893,321
Stop loss premium - - 140,000
---------------------------------------------------
Net premiums earned 1,049,847 973,611 753,321
Net investment income 228,546 191,901 166,023
Net realized capital gain 15,916 5,695 33,835
Other income/(loss) 4,880 (1,867) (4,315)
---------------------------------------------------
1,299,189 1,169,340 948,864
---------------------------------------------------
CLAIMS AND EXPENSES:
Incurred losses and loss
adjustment expenses 765,421 716,033 674,696
Commission, brokerage,
taxes and fees 274,796 254,598 227,376
Other underwriting expenses 51,672 54,870 60,017
Compensation related to
public offering - - 13,343
---------------------------------------------------
1,091,889 1,025,501 975,432
---------------------------------------------------
INCOME (LOSS) BEFORE TAXES 207,300 143,839 (26,568)
Income tax (benefit) 52,345 31,812 (27,315)
---------------------------------------------------
NET INCOME $ 154,955 $ 112,027 $ 747
===================================================
PER SHARE DATA:
Average shares
outstanding (000's) 50,476 50,567 50,189
Net income per common
share - basic $ 3.07 $ 2.22 $ 0.01
===================================================
Average diluted shares
outstanding (000's) 50,765 50,711 50,209
Net income per common
share - diluted $ 3.05 $ 2.21 $ 0.01
===================================================
The accompanying notes are an integral part of the consolidated financial statements.
F-5
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31,
---------------------------------------------------
(Dollars in thousands, 1997 1996 1995
except per share amounts) ---------------------------------------------------
COMMON STOCK (shares
outstanding):
Balance, beginning of
period 50,490,273 50,792,869 50,000,000
Issued during the period 22,600 3,800 792,869
Treasury stock acquired
during period (37,287) (306,396) -
Treasury stock reissued
during period 3,685 - -
---------------------------------------------------
Balance, end of period 50,479,271 50,490,273 50,792,869
===================================================
COMMON STOCK (par value):
Balance, beginning of period $ 508 $ 508 $ 500
Issued during the period - - 8
---------------------------------------------------
Balance, end of period 508 508 508
---------------------------------------------------
ADDITIONAL PAID IN CAPITAL:
Balance, beginning of period 389,196 387,349 283,076
Contributions during the
period - 1,783 91,000
Common stock issued during
the period 636 64 13,273
Treasury stock reissued
during period 44 - -
---------------------------------------------------
Balance, end of period 389,876 389,196 387,349
---------------------------------------------------
UNEARNED COMPENSATION:
Balance, beginning of period (374) (692) -
Net increase (decrease)
during the period (140) 318 (692)
---------------------------------------------------
Balance, end of period (514) (374) (692)
---------------------------------------------------
NET UNREALIZED APPRECIATION
(DEPRECIATION) OF INVESTMENTS,
NET OF DEFERRED INCOME TAXES:
Balance, beginning of period 77,766 83,726 (58,172)
Net increase (decrease) during
the period 82,631 (5,960) 141,898
---------------------------------------------------
Balance, end of period 160,397 77,766 83,726
---------------------------------------------------
CUMULATIVE TRANSLATION
ADJUSTMENTS, NET OF DEFERRED
INCOME TAXES:
Balance, beginning of period (354) (7,838) (11,255)
Net increase (decrease) during
the period (7,724) 7,484 3,417
---------------------------------------------------
Balance, end of period (8,078) (354) (7,838)
---------------------------------------------------
RETAINED EARNINGS:
Balance, beginning of period 626,501 520,541 526,818
Net income 154,955 112,027 747
Dividends declared ($0.16 per
share in 1997, $0.12 per
share in 1996 and $0.14 per
share in 1995) (8,076) (6,067) (7,024)
---------------------------------------------------
Balance, end of period 773,380 626,501 520,541
---------------------------------------------------
TREASURY STOCK AT COST:
Balance, beginning of period (7,220) - -
Treasury stock acquired
during period (953) (7,220) -
Treasury stock reissued
during period 87 - -
---------------------------------------------------
Balance, end of period (8,086) (7,220) -
---------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY,
END OF PERIOD $ 1,307,483 $ 1,086,023 $ 983,594
===================================================
The accompanying notes are an integral part of the consolidated financial statements.
F-6
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
------------------------------------------------
(Dollars in thousands) 1997 1996 1995
------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 154,955 $ 112,027 $ 747
Adjustments to reconcile net income
to net cash provided by operating
activities:
(Increase) decrease in premiums
receivable (30,867) 38,285 24,986
(Increase) decrease in funds held
by reinsureds, net (1,065) (21,606) 31,511
(Increase) decrease in reinsurance
receivables 56,544 (37,084) (20,656)
(Increase) decrease in deferred
tax asset 10,451 (13,065) (8,143)
Increase in reserve for losses
and loss adjustment expenses 202,191 281,590 248,789
Increase (decrease) in unearned
premiums (16,970) 60,293 30,268
(Increase) decrease in other
assets and liabilities 17,706 (1,064) 16,343
Non cash compensation expense (140) 318 12,589
Accrual of bond discount/
amortization of bond premium (500) (46) 4,264
Realized capital (gains) (15,916) (5,695) (33,835)
------------------------------------------------
Net cash provided by operating
activities 376,389 413,953 306,863
------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from fixed maturities
matured/called - held to maturity 2,155 20,582 30,961
Proceeds from fixed maturities matured/
called - available for sale 132,231 143,114 145,543
Proceeds from fixed maturities sold -
available for sale 880,189 1,281,882 699,869
Proceeds from equity securities sold 59,494 160,429 164,723
Proceeds from other invested assets
sold 1,368 - -
Cost of fixed maturities acquired -
held to maturity - (17,378) (10)
Cost of fixed maturities acquired -
available for sale (1,413,516) (1,836,274) (1,370,981)
Cost of equity securities acquired (45,825) (150,861) (121,569)
Cost of other invested assets acquired - (7,184) (2,133)
Net (purchases) sales of short-term
securities (23,422) 26,890 58,408
Net increase (decrease) in unsettled
securities transactions 1,533 (3,166) 1,526
------------------------------------------------
Net cash (used in) investing activities (405,793) (381,966) (393,663)
------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock (822) (7,220) -
Contributions during the period - 1,783 91,000
Common stock issued during the period 636 64 -
Dividends paid to stockholders (8,076) (6,067) (7,024)
Net increase (decrease) in collateral
for loaned securities 47,119 (19,897) 12,372
------------------------------------------------
Net cash provided by (used in)
financing activities 38,857 (31,337) 96,348
------------------------------------------------
EFFECT OF EXCHANGE RATE CHANGES
ON CASH (10,470) 1,033 (3,044)
------------------------------------------------
Net increase (decrease) in cash (1,017) 1,683 6,504
Cash, beginning of period 52,595 50,912 44,408
------------------------------------------------
Cash, end of period $ 51,578 $ 52,595 $ 50,912
================================================
SUPPLEMENTAL CASH FLOW INFORMATION
Cash transactions:
Income taxes paid (received), net $ 53,645 $ 38,055 $ (50,944)
Non-cash financing transaction:
Issuance of common stock in
connection with public offering $ (140) $ 318 $ 12,589
The accompanying notes are an integral part of the consolidated financial statements.
F-7
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1997, 1996 and 1995
For purposes of footnote presentation, all dollar values, except per share
amounts, are presented in thousands.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BUSINESS AND BASIS OF PRESENTATION
Everest Reinsurance Holdings, Inc. ("Holdings") (formerly known as Prudential
Reinsurance Holdings, Inc.), is a holding company incorporated in the state of
Delaware. Prior to an initial public offering ("IPO") of all 50 million shares
outstanding on October 6, 1995, Holdings was a direct wholly owned subsidiary of
PRUCO, Inc. ("PRUCO"), which is wholly owned by The Prudential Insurance Company
of America ("The Prudential"). The stock of Everest Reinsurance Company
("Everest Re") (formerly known as Prudential Reinsurance Company) was
contributed by PRUCO to Holdings effective December 31, 1993. The contribution
has been accounted for at historical cost in a manner similar to the pooling of
interests method of accounting as the entities were under common control.
Everest Re's principal business is reinsuring property and casualty risks of
domestic and foreign insurance companies under excess and pro rata reinsurance
contracts.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities (and disclosure of
contingent assets and liabilities) at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The consolidated financial statements include the domestic and foreign
subsidiaries of Everest Re: Everest National Insurance Company ("Everest
National") (formerly known as Prudential National Insurance Company), Everest
Indemnity Insurance Company ("Everest Indemnity"), Everest Re Ltd. ("Everest
Ltd.") (formerly known as Everest Reinsurance Ltd. and Le Rocher Reinsurance
Ltd.) and Everest Insurance Company of Canada ("Everest Canada") (formerly known
as OTIP/RAEO Insurance Company, Inc.), which was acquired from The Prudential
for $3,700 on December 31, 1996. The acquisition of Everest Canada has been
accounted for by the purchase method. Had this acquisition occurred at the
beginning of either 1995 or 1996, there would have been no material effect on
the Company's results of operations. All material intercompany balances and
transactions have been eliminated in consolidation.
Certain reclassifications have been made to the 1995 and 1996 financial
statements to conform to the 1997 presentation.
B. INVESTMENTS
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
requires that a company segment its fixed maturity investment portfolio between
held to maturity (carried at amortized cost), available for sale (carried at
market value, with unrealized appreciation or depreciation, net of applicable
deferred income taxes, reflected as a separate component of stockholder's
equity) and trading (carried at market value with unrealized appreciation or
depreciation reflected in income). Investments that are available for sale are
expected to be held for an indefinite period but may be sold depending on tax
position, interest rates and other considerations. Short-term investments are
stated at cost, which approximates market value. Equity securities are carried
at market value with unrealized appreciation or depreciation of equity
securities, net of applicable deferred income tax, credited or charged directly
to stockholder's equity. Realized gains or losses on sale of investments are
determined on the basis of identified cost. With respect to securities which are
not publicly traded, market value has been determined based on pricing models.
For publicly traded securities, market value is based on quoted market prices.
Cash includes cash and bank time deposits with original maturities of ninety
days or under.
C. UNCOLLECTIBLE REINSURANCE RECOVERABLE BALANCES
The Company provides reserves for uncollectible reinsurance balances based on
management's assessment of the collectibility of the outstanding balances. Such
reserves were $14,399 and $14,267 at December 31, 1997 and December 31, 1996,
respectively (see also Note 7).
F-8
D. DEFERRED ACQUISITION COSTS
Acquisition costs, consisting principally of commissions and brokerage expenses
and certain premium taxes and fees associated with the Company's primary
insurance business incurred at the time a contract or policy is issued, are
deferred and amortized over the period in which the related premiums are earned,
generally one year. Deferred policy acquisition costs are limited to their
estimated realizable value based on the related unearned premiums, anticipated
claims and claim expenses and anticipated investment income. Deferred
acquisition costs amortized to income were $270,605, $252,928 and $226,819 in
1997, 1996 and 1995, respectively.
E. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE
The reserve for unpaid losses and loss adjustment expenses is based on
individual case estimates and reports received from ceding companies. A
provision is included for losses and loss adjustment expenses incurred but not
reported ("IBNR") based on past experience. A provision is also included for
certain potential liabilities relating to asbestos and environmental exposures,
which liabilities cannot be estimated with traditional reserving techniques (see
also Note 11). The reserves are reviewed continually and any changes in
estimates are reflected in earnings in the period the adjustment is made.
Management believes that adequate provision has been made for the Company's loss
and loss adjustment expenses. Loss and loss adjustment expense reserves are
presented gross of reinsurance receivables and incurred losses and loss
adjustment expenses are presented net of ceded reinsurance. Accruals for
contingent commission liabilities are estimated based on carried loss and loss
adjustment expense reserves.
F. PREMIUM REVENUES
Premiums written are earned ratably over the periods of the related insurance
and reinsurance contracts or policies. Unearned premium reserves are established
to cover the remainder of the unexpired contract period. Such reserves are
established based upon reports received from ceding companies or computed using
pro rata methods based on statistical data. Written and earned premiums, and the
related costs, which have not yet been reported to the Company are estimated and
accrued. Premiums are net of retrocessions (ceded reinsurance).
G. INCOME TAXES
The Company and its subsidiaries file their own federal tax returns and
calculate their current tax provisions accordingly. Deferred income taxes have
been recorded to recognize the tax effect of temporary differences between the
financial reporting and income tax bases of assets and liabilities. Prior to the
IPO, the Company was a member of a group of affiliated companies which joined in
filing a consolidated federal tax return. Current tax liabilities were
determined for individual companies based upon their separate return basis
taxable income. Members with taxable income incurred an amount in lieu of the
separate return basis federal tax. Members with a loss for tax purposes
recognized a current benefit in proportion to the amount of their losses
utilized in computing consolidated taxable income.
H. FOREIGN CURRENCY TRANSLATION
Assets and liabilities relating to foreign operations are translated into U.S.
dollars at the exchange rates in effect at the balance sheet date; revenues and
expenses are translated into U.S. dollars using average exchange rates. Gains
and losses resulting from translating foreign currency financial statements, net
of deferred income taxes, are excluded from income and accumulated in
stockholder's equity.
I. EARNINGS PER SHARE
The Company adopted SFAS No. 128, "Earnings Per Share", in 1997 which requires
retroactive application for all prior periods presented. SFAS No. 128 requires
an enterprise to present basic and diluted earnings per share on the income
statement. Basic earnings per share, which is calculated by dividing net income
by the weighted average number of common shares outstanding, replaces primary
earnings per share from the prior standard. For all periods previously reported
by the Company, basic earnings per share is the same as primary earnings per
share, since the impact of the Company's common stock equivalents for those
periods did not reach the significance threshold prescribed to require
adjustment under the prior standard. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the entity. Diluted
earnings per share is computed similarly to fully diluted earnings per share
from the prior standard.
Net income per common share has been computed below in accordance with SFAS No.
128, based upon weighted average common and dilutive shares outstanding.
F-9
1997 1996 1995
-----------------------------------------
Net income (numerator) $ 154,955 $ 112,027 $ 747
=========================================
Weighted average common and
effect of dilutive shares
used in the computation of
net income per share:
Average shares outstanding -
basic (denominator) 50,476 50,567 50,189
Effect of dilutive shares 289 144 20
-----------------------------------------
Average shares outstanding -
diluted (denominator) 50,765 50,711 50,209
=========================================
Net income per common share:
Basic $ 3.07 $ 2.22 $ 0.01
Diluted 3.05 2.21 0.01
Options to purchase 337,750, 20,000 and 20,000 shares of common stock at $39.16,
$26.63 and $20.94 per share were outstanding at the end of 1997, 1996 and 1995,
respectively, but were not included in the computation of earnings per diluted
share for the respective years, because the options' exercise price was greater
than the average market price of the common shares for such years. The options,
which expire on September 26, 2007, November 18, 2006 and November 20, 2005,
respectively, were still outstanding at the end of 1997.
J. FUTURE APPLICATION OF ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income".
SFAS No. 130 requires an enterprise to present items of other comprehensive
income in a financial statement and to display accumulated balances of other
comprehensive income in the equity section of a financial statement. SFAS No.
130 is effective for fiscal years beginning after December 15, 1997. As the
components of other comprehensive income consist of items already reflected as
direct charges or credits to the Company's stockholder's equity, the only impact
of adopting this standard will be to reflect an additional presentation of these
items. When adopted, the additional required presentation will be provided for
earlier periods.
2. INVESTMENTS
The amortized cost, market value, and gross unrealized appreciation and
depreciation of fixed maturity investments are presented in the tables below:
Amortized Unrealized Unrealized Market
Cost Appreciation Depreciation Value
------------------------------------------------------------
As of December 31, 1997
Fixed maturities - available
for sale
U.S. Treasury securities
and obligations of U.S.
government agencies and
corporations $ 144,079 $ 3,076 $ 86 $ 147,069
Obligations of states and
political subdivisions 1,610,190 112,211 293 1,722,108
Corporate securities 893,885 39,189 16 933,058
Mortgage-backed securities 521,048 20,504 2 541,550
Foreign debt securities 489,168 33,966 59 523,075
------------------------------------------------------------
TOTAL $ 3,658,370 $ 208,946 $ 456 $ 3,866,860
============================================================
As of December 31, 1996
Fixed maturities - held
to maturity
U.S. Treasury securities
and obligations of U.S.
government agencies and
corporations $ 30,182 $ 307 $ 54 $ 30,435
Obligations of states and
political subdivisions 50,340 7,824 225 57,939
------------------------------------------------------------
TOTAL $ 80,522 $ 8,131 $ 279 $ 88,374
============================================================
Fixed maturities - available
for sale
U.S. Treasury securities
and obligations of U.S.
government agencies and
corporations $ 162,406 $ 909 $ 1,361 $ 161,954
Obligations of states and
political subdivisions 1,259,544 48,277 733 1,307,088
Corporate securities 739,997 11,440 315 751,122
Mortgage-backed securities 487,145 7,692 2,007 492,830
Foreign debt securities 545,154 24,660 836 568,978
------------------------------------------------------------
TOTAL $ 3,194,246 $ 92,978 $ 5,252 $ 3,281,972
============================================================
F-10
During 1997, the Company transferred all of the fixed maturity securities in its
held-to-maturity classification (with an amortized cost of $78,974 and market
value of $85,508) to the available-for-sale classification to enhance
management's flexibility with respect to future portfolio management. The net
financial statement impact at the time of the transfer was a $4,247 increase in
net after-tax unrealized appreciation of investments.
The amortized cost and market value of fixed maturities are shown in the
following table by contractual maturity. Actual maturities may differ from
contractual maturities because securities may be called or prepaid with or
without call or prepayment penalties.
December 31, 1997
-----------------------------
Amortized Market
Cost Value
-----------------------------
Fixed maturities - available for sale
Due in one year or less $ 55,757 $ 56,437
Due after one year through five years 469,121 482,049
Due after five years through ten years 1,214,417 1,294,212
Due after ten years 1,398,027 1,492,612
Mortgage-backed securities 521,048 541,550
-----------------------------
TOTAL $ 3,658,370 $ 3,866,860
=============================
Proceeds from sales of fixed maturity investments during 1997, 1996 and 1995
were $880,189, $1,281,882 and $699,869, respectively. Gross gains of $6,766,
$9,146 and $7,058, and gross losses of $9,439, $20,952 and $12,058 were realized
on those sales during 1997, 1996 and 1995, respectively.
The cost, market value and gross unrealized appreciation and depreciation of
investments in equity securities is presented in the table below:
December 31,
--------------------------
1997 1996
--------------------------
Cost $ 120,510 $ 115,367
Unrealized appreciation 39,162 33,015
Unrealized depreciation 888 1,102
--------------------------
Market value $ 158,784 $ 147,280
==========================
The changes in net unrealized gains (losses) of investments of the Company
(including unrealized gains and losses on fixed maturities not reflected in
stockholders' equity) are derived from the following sources:
Years Ended December 31,
---------------------------------------
1997 1996 1995
---------------------------------------
Increase (decrease) during the
period between the market value
and cost of investments carried
at market value, and deferred tax
thereon:
Equity securities $ 6,361 $ 5,897 $ (8,153)
Fixed maturities 120,764 (14,440) 226,459
Other invested assets - - -
Deferred taxes (44,494) 2,583 (76,408)
---------------------------------------
Increase (decrease) in unrealized
appreciation, net of deferred
taxes, included in stockholder's
equity 82,631 (5,960) 141,898
Increase (decrease) during the
period between the market value
and cost of fixed maturities
carried at amortized cost (7,852) (4,288) 3,294
---------------------------------------
TOTAL $ 74,779 $ (10,248) $ 145,192
=======================================
F-11
The components of net investment income are presented in the table below:
Years Ended December 31,
-----------------------------------------
1997 1996 1995
-----------------------------------------
Fixed maturities $ 232,779 $ 198,947 $ 168,268
Equity securities 4,473 2,835 2,017
Short-term securities 3,435 5,357 9,005
Other interest income 2,582 1,450 860
-----------------------------------------
Total gross investment income 243,269 208,589 180,150
-----------------------------------------
Interest on funds held 11,173 12,294 9,451
Other investment expenses 3,550 4,394 4,676
-----------------------------------------
Total investment expenses 14,723 16,688 14,127
-----------------------------------------
Total net investment income $ 228,546 $ 191,901 $ 166,023
=========================================
The components of realized capital gains (losses) are presented in the table
below:
Years Ended December 31,
------------------------------------------
1997 1996 1995
------------------------------------------
Fixed maturities $ (2,673) $ (11,805) $ (5,000)
Equity securities 18,572 17,443 38,833
Short-term investments 17 57 2
------------------------------------------
TOTAL $ 15,916 $ 5,695 $ 33,835
==========================================
Securities with a carrying value amount of $288,433 at December 31, 1997 were on
deposit with various state or governmental insurance departments in compliance
with insurance laws. The Company had no investments in derivative financial
instruments for the years ended December 31, 1997, 1996 and 1995.
3. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the reserve for losses and loss adjustment expenses is summarized as
follows:
Years Ended December 31,
-------------------------------------------------
1997 1996 1995
-------------------------------------------------
Reserves at January 1 $ 3,246,858 $ 2,969,341 $ 2,706,429
Less reinsurance recoverables 746,640 700,877 648,550
-------------------------------------------------
Net balance at January 1 2,500,218 2,268,464 2,057,879
-------------------------------------------------
Incurred related to:
Current year 768,597 745,594 658,039
Prior years (3,176) (29,561) 16,657
-------------------------------------------------
Total incurred losses and
loss adjustment expenses 765,421 716,033 674,696
-------------------------------------------------
Paid related to:
Current year 185,310 213,832 104,636
Prior years 331,205 270,447 359,475
-------------------------------------------------
Total paid losses and loss
adjustment expenses 516,515 484,279 464,111
-------------------------------------------------
Net balance at December 31 2,749,124 2,500,218 2,268,464
Plus reinsurance recoverables 688,694 746,640 700,877
-------------------------------------------------
Balance at December 31 $ 3,437,818 $ 3,246,858 $ 2,969,341
=================================================
F-12
4. CREDIT LINE
On June 16, 1997, the Company finalized a 364 day revolving line of credit with
First Union National Bank. This credit facility, which will be used for
liquidity and general corporate purposes, provides for the borrowing of up to
$50 million with interest at a rate selected by the Company equal to either (i)
the Base Rate (as defined below), (ii) an adjusted London InterBank Offered Rate
("LIBOR") plus a margin (the "Margin") or (iii) a Money Market Rate, which is a
daily uncommitted advised rate. The Base Rate is the higher of the rate of
interest established by the bank from time to time as its reference rate in
making loans or the Federal Funds rate plus 0.5% per annum. The amount of the
Margin and the commitment fee payable to the bank for the credit facility depend
upon the insurance strength or claims paying ability ratings of Everest Re. The
credit facility agreement requires that Everest Re maintain statutory surplus of
not less than $575 million and that the Company not allow its ratio of certain
debt to capital to be greater than a specified amount.
5. OPERATING LEASE AGREEMENTS
The future minimum rental commitments, exclusive of cost escalation clauses, as
of December 31, 1997 for all of the Company's operating leases with remaining
noncancelable terms in excess of one year are as follows:
(in thousands)
1998 $ 4,124
1999 3,821
2000 3,705
2001 3,689
2002 3,302
Thereafter 2,845
----------
Total payments 21,486
Sublease rental income 589
----------
Net Commitments $ 20,897
==========
All of these leases, the expiration terms of which range from 1999 to 2004, are
for the rental of office space. Rental expense, net of sublease rental income,
was $4,903, $5,334 and $7,337 for 1997, 1996 and 1995, respectively.
6. INCOME TAXES
The components of income taxes for the periods presented are as follows:
Years Ended December 31,
---------------------------------------
1997 1996 1995
---------------------------------------
Current tax (benefit):
U.S. $ 18,892 $ 24,363 $ (35,435)
Foreign 23,000 20,735 18,351
---------------------------------------
Total current tax (benefit) 41,892 45,098 (17,084)
Total deferred U.S. tax (benefit) 10,453 (13,286) (10,231)
---------------------------------------
Total income tax (benefit) $ 52,345 $ 31,812 $ (27,315)
=======================================
A reconciliation of the U.S. Federal income tax rate to the Company's effective
tax rate is as follows:
Years Ended December 31,
-----------------------------------
1997 1996 1995
-----------------------------------
Federal income tax rate 35.0% 35.0% (35.0)%
Increase (reduction) in
taxes resulting from:
Tax exempt income (12.1) (15.1) (73.4)
Other, net 2.4 2.2 5.6
-----------------------------------
Effective tax rate 25.3% 22.1% (102.8)%
===================================
F-13
Deferred income taxes reflect the tax effect of the temporary differences
between the value of assets and liabilities for financial statement purposes and
such values as measured by the tax laws and regulations. The principal items
making up the net deferred income tax asset are as follows:
December 31,
----------------------------
1997 1996
----------------------------
Deferred tax assets:
Reserve for losses and loss
adjustment expenses $ 155,666 $ 164,477
Unearned premium reserve 22,988 24,545
Foreign currency translation 4,480 232
Net operating loss carryforward 1,222 1,579
Other assets 8,866 6,569
----------------------------
Total deferred tax assets 193,222 197,402
----------------------------
Deferred tax liabilities:
Deferred acquisition costs 28,816 29,443
Net unrealized appreciation
of investments 86,368 41,874
Other liabilities 3,604 1,421
----------------------------
Total deferred tax liabilities 118,788 72,738
----------------------------
Net deferred tax assets $ 74,434 $ 124,664
============================
Pursuant to the terms of a separation agreement, The Prudential retained the net
operating loss carryforwards attributable to the Company at the date of the IPO
and paid the Company for the tax benefits thereof in 1996. Holdings has total
net operating loss carryforwards of $3,491, of which $343 expire in 2011, $2,408
expire in 2012 and $740 expire in 2013. Management believes that it is more
likely than not that the Company will realize the benefits of its net deferred
tax assets and, accordingly, no valuation allowance has been recorded for the
periods presented.
Everest Re has not provided for U.S. Federal income or foreign withholding taxes
on $9,393 of pre-1987 undistributed earnings of non-U.S. subsidiaries, because
such earnings are intended to be retained by the foreign subsidiaries
indefinitely. If these earnings were distributed, foreign tax credits are
available under current law to reduce or eliminate any resulting income tax
liability.
The Internal Revenue Service ("IRS") has completed its examinations of The
Prudential's tax returns for all years through 1992. As those examinations
relate to Everest Re, the IRS has disallowed that portion of the fresh start
benefit which relates to 1986 reserve strengthening as defined by the IRS. As a
result of conflicting decisions by two U.S. Circuit Courts, the Supreme Court of
the United States will consider the issue in reviewing ATLANTIC MUTUAL INSURANCE
CO. V. COMMISSIONER to determine whether the Treasury regulation that defines
the term "reserve strengthening" is a valid interpretation of the law. The
Supreme Court's decision in this case is expected to bring about a uniform
resolution of this question. The Company agrees with the petitioner in this case
in that the term "reserve strengthening" as used in the statute involves changes
in assumptions or methodologies. The Company believes that, because there were
no changes in reserving assumptions or methodologies between 1985 and 1986, all
increases to reserves in 1986 for which a fresh start benefit was taken are
normal reserve additions and, therefore, does not constitute reserve
strengthening that is not eligible for the fresh start benefit. If the IRS
position prevails, the Company will be required to reimburse The Prudential,
thereby incurring an additional charge of approximately $9,445, including the
after-tax cost of interest through December 31, 1997.
7. RETROCESSIONS
The Company utilizes retrocessional (reinsurance) agreements to reduce its
exposure to large claims and catastrophic loss occurrences. These agreements
provide for recovery from retrocessionaires of a portion of losses and loss
expenses under certain circumstances without relieving the insurer of its
obligation to the policyholder. Losses and loss adjustment expenses incurred and
earned premiums are after deduction for retrocessions. In the event
retrocessionaires were unable to meet their obligations under retrocession
agreements, the Company would not be able to realize the full value of the
reinsurance recoverable balances. The Company may hold partial collateral under
these agreements and has never suffered a significant loss because of a
retrocessionaire's default. (see Note 1(C) and the following paragraph).
F-14
Effective October 5, 1995, Everest Re entered into a stop loss agreement (the
"Stop Loss Agreement") with Gibraltar Casualty Company ("Gibraltar") (see Note
8). This agreement, for a premium of $140,000, provides protection against 100%
of the first $150,000 of adverse development, if any, and 90% of the next
$250,000 of adverse development, if any, of Everest Re's consolidated reserves
for losses and uncollectable reinsurance as of June 30, 1995, including
allocated loss adjustment expense and incurred but not reported losses, provided
that adverse development, if any, relating to catastrophes will be covered only
to the extent that the catastrophe event occurred prior to January 1, 1995. All
such adverse development is referred to herein as "Adverse Development".
Payments will be made to Everest Re under the Stop Loss Agreement as Adverse
Development is incurred by Everest Re. The $375,000 aggregate limit under the
Stop Loss Agreement will be reduced by an amount equal to the Adverse
Development which is not ceded, in accordance with the terms of the Stop Loss
Agreement, to Gibraltar (see Note 8A). Coverage under the Stop Loss Agreement
terminates on December 31, 2007, or earlier if coverage is exhausted. Through
December 31, 1997 and 1996, cessions under the Stop Loss Agreement have
aggregated $185,231 and $140,231, respectively.
Written and earned premiums are comprised of the following:
Years Ended December 31,
--------------------------------------------
1997 1996 1995
--------------------------------------------
Written premium:
Direct $ 75,653 $ 59,691 $ 16,064
Assumed 999,316 984,340 933,436
Retroceded (43,827) (13,497) (166,309)
--------------------------------------------
Net written premium $ 1,031,142 $ 1,030,534 $ 783,191
============================================
Earned premium
Direct $ 77,784 $ 37,963 $ 10,784
Assumed 1,012,168 945,698 907,995
Retroceded (40,105) (10,050) (165,458)
--------------------------------------------
Net earned premium $ 1,049,847 $ 973,611 $ 753,321
============================================
The amounts deducted from losses and loss adjustment expenses incurred for
retrocessional recoveries were $109,574, $206,032 and $119,115 for the years
ended December 31, 1997, 1996 and 1995, respectively.
8. TRANSACTIONS WITH FORMER AFFILIATES
A. INDEMNITY AGREEMENT
On October 5, 1995, Holdings agreed, pursuant to a Standby Capital Contribution
Agreement (the "Capital Contribution Agreement"), to make capital contributions
("Capital Contributions") to Everest Re in respect of the first $375,000 of
Adverse Development experienced by Everest Re that is not ceded, in accordance
with the terms of the Stop Loss Agreement, to Gibraltar. Each Capital
Contribution, if any, will equal the amount of such Adverse Development,
adjusted to reflect an assumed tax rate of 36%, although the Company's actual
tax rate may be greater than or less than 36%. Holdings' obligation to make
Capital Contributions shall be limited to an aggregate maximum amount of
$240,000, which amount shall be reduced by 64% of the amount of Adverse
Development ceded to Gibraltar under the Stop Loss Agreement.
Also on October 5, 1995, PRUCO agreed to make payments ("Indemnity Payments") to
Holdings, pursuant to an Indemnity Agreement (the "PRUCO Indemnity"), in an
amount equal to the Capital Contributions at such times as such Capital
Contributions, if any, are required to be paid by Holdings to Everest Re. The
Capital Contribution Agreement and the PRUCO Indemnity are intended to mitigate
the impact of up to the first $375,000 of Adverse Development on the Company's
earnings not otherwise covered by the Stop Loss Agreement.
B. REINSURANCE
The Company engages in reinsurance activities with certain Prudential entities,
including Prudential Property and Casualty Insurance Company, Gibraltar, and The
Prudential.
The following summarizes the financial statement impact of certain reinsurance
transactions with Gibraltar and other former affiliates, while they were
affiliated, for the period presented.
F-15
January 1
Through
October 5,
1995
----------
Income statement:
Premiums earned - assumed
Gibraltar $ -
Other 24,298
Premiums earned - retroceded
Gibraltar 140,000
Incurred losses and loss
adjustment expenses - assumed
Gibraltar 37,877
Other 13,587
Incurred losses and loss
adjustment expenses- retroceded
Gibraltar 27,640
Other 16
The Prudential has guaranteed all of Gibraltar's obligations under the Stop Loss
Agreement, all of PRUCO's obligations under the PRUCO Indemnity and up to
$400,000 of Gibraltar's net obligations that became due after June 30, 1995
under all other reinsurance agreements between Gibraltar and Everest Re. At
December 31, 1997, Gibraltar's net obligations under such other reinsurance
agreements consisted of the following balances:
Reinsurance receivables from Gibraltar $ 304,939
Reserve for losses and loss adjustment
expenses assumed from Gibraltar (131,305)
Losses in the course of payment assumed
from Gibraltar (1,073)
Funds held by Everest Re under reinsurance
treaties with Gibraltar (103,627)
---------
Net obligations of Gibraltar $ 68,934
=========
In addition, since June 30, 1995, Gibraltar has paid $75,931 to Everest Re in
respect of such other reinsurance agreements.
C. EXPENSES
Everest Re has service and lease agreements with The Prudential. Under these
agreements, The Prudential has furnished services of its employees, provided
supplies, use of equipment and office space, and made payment to third parties
for general expenses on behalf of Everest Re. The agreements obligate Everest Re
to reimburse The Prudential for disbursements made on Everest Re's behalf and to
pay for providing these services. The cost of such services for the period
January 1 through October 5, 1995 was $10,789. Everest Re also has a service
agreement with Gibraltar pursuant to which Gibraltar manages the run-off of
Everest Re's former direct excess insurance operations.
D. EMPLOYEE RETIREMENT PLAN
The Prudential sponsored a defined benefit pension plan which covered
substantially all of the employees of Everest Re through October 6, 1995. The
benefits are generally based on average earnings over a period prescribed by the
plan and credited length of service. In connection with the IPO, the Company has
established its own employee retirement plan which is substantially the same as
The Prudential's plan (see also Note 9). In September 1996, The Prudential
completed a plan-to-plan asset transfer of $13,270 to fully fund the Company's
projected benefit obligations as of the IPO date, plus interest from the IPO
date. No pension expense for contributions to the Prudential plan has been
charged to Everest Re for the year ended December 31, 1995 because the
Prudential plan was subject to the full funding limitation under the IRS
guidelines.
E. POSTRETIREMENT BENEFIT PLANS
The Prudential sponsors postretirement defined benefit plans which provide
certain life insurance and health care benefits ("postretirement benefits") for
Everest Re's employees eligible to retire at October 6, 1995. The Company is
considering establishing its own plan for its employees who were not eligible to
retire at October 6, 1995. The expense allocated to the Company for the cost of
these benefits incurred by The Prudential was $239 for the period ending October
6, 1995.
F-16
F. CAPITAL CONTRIBUTION
Immediately prior to the IPO, The Prudential paid $140,000 to the Company, of
which amount $91,000 was a contribution to capital and $49,000 was a payment in
respect of the tax benefit of the premium paid for the Stop Loss Agreement.
9. PENSION PLAN
The Company has an employee retirement plan under which the benefits are
generally based on average earnings over a period prescribed by the plan and
credited length of service. The Company has not been required to fund
contributions to the pension plan for the years ended December 31, 1997 and 1996
because the Company's plan was subject to the full funding limitation under the
IRS guidelines. Pension expense for the Company's plan for the years ended
December 31, 1997, 1996 and for the period of October 6, 1995 through December
31, 1995 was $770, $901 and $312, respectively.
The following table summarizes the plan's funded status:
Years Ended December 31,
------------------------------
1997 1996
------------------------------
Accumulated benefit obligation
Vested $ 8,513 $ 7,985
Non-vested 1,681 -
------------------------------
Total 10,194 7,985
Additional benefits based on
estimated future salary levels 6,921 7,146
------------------------------
Projected benefit obligation 17,115 15,131
Fair value of plan assets 17,389 14,610
------------------------------
Unfunded projected benefit
obligation 274 (521)
Unrecognized net loss or (gain) (2,257) (692)
------------------------------
Unfunded (accrued) or prepaid
pension cost in the financial
statements $ (1,983) $ (1,213)
==============================
Plan assets are comprised of shares in investment trusts with approximately 70%
and 30% of the underlying assets consisting of equity securities and fixed
maturities, respectively.
Net periodic pension cost included the following components:
October 6
Through
Years Ended December 31, December 31,
------------------------------------------
1997 1996 1995
------------------------------------------
Service cost $ 1,063 $ 1,102 $ 382
Interest cost 1,031 948 328
Actual return on assets (2,824) (1,841) (638)
Net asset gain during period
deferred for later recognition 1,510 692 240
Amortization of net gain from
earlier periods (10) - -
------------------------------------------
Net periodic pension cost $ 770 $ 901 $ 312
==========================================
The weighted average discount rate and rate of compensation increase used to
determine the actuarial present value of the projected benefit obligation are
7.0% and 4.5%, respectively. The expected long-term rate of return on plan
assets is 9.0%.
10. DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION
A. DIVIDEND RESTRICTIONS
Delaware law provides that an insurance company which is either an insurance
holding company or a member of an insurance holding system and is domiciled in
the state shall not pay dividends without giving prior notice to the
Insurance Commissioner of Delaware and may not pay dividends without the
approval of the Insurance Commissioner if the value of the proposed
dividend, together with all other dividends and distributions made in the
preceding twelve months, exceeds the greater of (1) 10% of statutory surplus
or (2) net income, not including realized capital gains, each as reported in the
F-17
prior year's statutory annual statement. In addition, no dividend may be paid in
excess of unassigned earned surplus. At December 31, 1997, Everest Re had
$177,567 available for payment of dividends in 1998 without prior regulatory
approval.
B. STATUTORY FINANCIAL INFORMATION
Everest Re prepares its statutory financial statements in accordance with
accounting practices prescribed or permitted by the National Association of
Insurance Commissioners ("NAIC") and the Delaware Insurance Department.
Prescribed statutory accounting practices are set forth in a variety of
publications of the NAIC, as well as state laws, regulations, and general
administrative rules. The capital and statutory surplus of Everest Re was
$908,766 and $772,691 at December 31, 1997 and 1996, respectively. The statutory
net income (loss) of Everest Re was $193,057, $88,517 and $(736) for the years
ended December 31, 1997, 1996 and 1995, respectively.
11. CONTINGENCIES
Everest Re 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. Everest Re's asbestos
claims typically involve liability or potential liability for bodily injury from
exposure to asbestos or for property damage resulting from asbestos or products
containing asbestos. Everest Re's environmental claims typically involve
potential liability for (i) the mitigation or remediation of environmental
contamination or (ii) bodily injury or property damages caused by the release of
hazardous substances into the land, air or water.
Everest Re's reserves include an estimate of Everest Re'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 Everest Re's potential losses from asbestos and
environmental claims. Among the complications are: (i) potentially long waiting
periods between exposure and manifestation of any bodily injury or property
damage; (ii) difficulty in identifying sources of asbestos or environmental
contamination; (iii) difficulty in properly allocating responsibility and/or
liability for asbestos or environmental damage; (iv) changes in underlying laws
and judicial interpretation of those laws; (v) potential for an asbestos or
environmental claim to involve many insurance providers over many policy
periods; (vi) long reporting delays, both from insureds to insurance companies
and ceding companies to reinsurers; (vii) limited historical data concerning
asbestos and environmental losses; (viii) questions concerning interpretation
and application of insurance and reinsurance coverage; and (ix) uncertainty
regarding the number and identity of insureds with potential asbestos or
environmental exposure.
Management believes that these issues are not likely to be resolved in the near
future. Given these uncertainties, management believes that no meaningful range
for such ultimate losses can be established. Everest Re establishes reserves to
the extent that, in the judgment of management, the facts and prevailing law
reflect an exposure for Everest Re or its ceding company. Due to the
uncertainties discussed above, the ultimate losses may vary materially from
current loss reserves and, if coverage under the Stop Loss Agreement is
exhausted, could have a material adverse effect on the Company's future
financial condition, results of operations and cash flows (see Note 7).
The following table shows the development of prior year asbestos and
environmental reserves on both a gross and net of retrocessional basis for the
years ended:
1997 1996 1995
------------------------------------------------
Gross basis
Beginning of reserves $ 423,336 $ 428,495 $ 445,537
Incurred losses 83,724 30,028 17,269
Paid losses (60,928) (35,187) (34,311)
------------------------------------------------
End of period reserves $ 446,132 $ 423,336 $ 428,495
================================================
Net basis
Beginning of reserves $ 199,557 $ 185,981 $ 203,676
Incurred losses (1) 3,490 - -
Paid losses (2) 9,329 13,576 (17,695)
------------------------------------------------
End of period reserves $ 212,376 $ 199,557 $ 185,981
================================================
- --------------
(1) Net of $41,178, $24,196 and $16,687 ceded in 1997, 1996 and 1995,
respectively, under the incurred loss reimbursement feature of the Stop
Loss Agreement.
(2) Net of $22,610, $34,451 and $5,000 ceded paid losses in 1997, 1996 and
1995, respectively, under the Stop Loss Agreement.
F-18
At December 31, 1997, the gross reserves for asbestos and environmental losses
were comprised of $125,937 representing case reserves reported by ceding
companies, $51,960 representing additional case reserves established by Everest
Re on assumed reinsurance claims, $45,776 representing case reserves established
by Everest Re on direct excess insurance claims and $222,459 representing IBNR
reserves.
To the extent loss reserves for claims incurred on June 30, 1995 (December 31,
1994 for catastrophe losses) or prior on assumed reinsurance needed to be
increased, and were not ceded to unaffiliated reinsurers under existing
reinsurance agreements, Everest Re would be entitled to certain reimbursements
under the Stop Loss Agreement (see Note 7). To the extent loss reserves on
direct excess insurance policies needed to be increased and were not ceded to
unaffiliated reinsurers under existing reinsurance agreements, Everest Re would
be entitled to 100% protection under a 100% quota share retrocession entered
into with Gibraltar in 1986. While there can be no assurance that reserves for
and losses from these claims would not increase in the future, management
believes that Everest Re's existing reserves and ceded reinsurance arrangements
and reimbursements available under the Stop Loss Agreement lessen the
probability that such increases, if any, would have a material effect on Everest
Re's financial condition, results of operations or cash flows.
Everest Re is also named in various legal proceedings incidental to its normal
business activities. In the opinion of Everest Re, none of these proceedings
would have a material adverse effect upon the financial condition, results of
operations or cash flows of Everest Re.
The Prudential sells annuities which are purchased by property and casualty
insurance companies to settle certain types of claim liabilities. In 1993 and
prior, Everest Re, for a fee, accepted the claim payment obligation of the
property and casualty insurer, and, concurrently, became the owner of the
annuity or assignee of the annuity proceeds. In these circumstances, Everest Re
would be liable if The Prudential were unable to make the annuity payments. The
estimated cost to replace all such annuities for which Everest Re was
contingently liable at December 31, 1997 and 1996 was $140,478 and $136,234,
respectively.
Everest Re has purchased annuities from an unaffiliated life insurance company
to settle certain claim liabilities of Everest Re. Should the life insurance
company become unable to make the annuity payments, Everest Re would be liable.
The estimated cost to replace such annuities at December 31, 1997 and 1996 was
$9,968 and $9,208, respectively.
12. STOCK BASED COMPENSATION PLANS
The Company has in place its 1995 Stock Incentive Plan for key employees ("the
1995 Employee Plan") and its 1995 Stock Option Plan for Non-Employee Directors
(the "1995 Director Plan") and applies APB Opinion 25 and related
interpretations in accounting for these plans. Accordingly, no compensation
expense has been recognized in the accompanying financial statements in respect
of stock options granted under these plans.
Under the 1995 Employee Plan, a total of 3,949,000 shares of common stock have
been authorized to be granted as stock options, stock awards or restricted stock
awards to officers and key employees of the Company. At December 31, 1997, there
were 2,143,581 remaining shares available to be granted. Under the 1995 Director
Plan, a total of 50,000 shares of common stock have been authorized to be
granted as stock options to non-employee directors of the Company. At December
31, 1997, there were 37,130 remaining shares available to be granted. Options
granted under the 1995 Employee Plan vest at 20% per year over five years and
options granted under the 1995 Director Plan vest at 50% per year over two
years. All options are exercisable at fair market value of the stock at the date
of grant and expire ten years after the date of grant. Restricted stock granted
under the 1995 Employee Plan vests, beginning one year after the date of grant,
in equal annual installments over five years.
F-19
A summary of the status of the Company's stock options as of December 31, 1997,
1996 and 1995 and changes during the years then ended is presented below:
1997 1996 1995
------------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Shares Exercise Price Shares Exercise Price Shares Exercise Price
------------------------------------------------------------------------------------------
Outstanding, beginning of
year 732,570 $ 19.72 459,700 $ 16.93 - $ xx
Granted 339,250 39.13 286,270 24.10 459,700 16.93
Exercised 11,100 16.75 3,800 16.75 - xx
Forfeited 61,700 19.00 9,600 18.25 - xx
---------- ---------- ----------
Outstanding, end of
year 999,020 $ 26.39 732,570 $ 19.72 459,700 $ 16.93
========== ========== ==========
Options exercisable at
year-end 215,313 91,496 -
========== ========== ==========
Weighted-average fair
value of options
granted during the
year $ 18.37 $ 11.55 $ 7.92
============ =========== =============
The following table summarizes information about stock options outstanding at
December 31, 1997:
Options
Options Outstanding Exercisable
---------------------------------------------------------------------------------------
Weighted-
Number Average Weighted- Number Weighted-
Range of Outstanding Remaining Average Exercisable Average
Exercise Prices at 12/31/97 Contractual Life Exercise Price at 12/31/97 Exercise Price
- -----------------------------------------------------------------------------------------------------------------
$16.75 to $20.94 394,800 7.8 years $ 16.96 157,380 $ 16.96
22.56 to 26.63 264,970 8.7 24.11 57,933 24.04
$33.00 to $39.16 339,250 9.7 39.13 - -
----------- -----------
999,020 8.7 $ 26.39 215,313 $ 18.87
=========== ===========
In conjunction with its 1995 initial public offering, the Company issued to
certain key employees of the Company 746,269 shares of stock and 46,600
restricted shares of stock, respectively. In 1997, an additional 11,500
restricted shares of stock were issued to certain key employees of the Company,
while 6,400 restricted shares were forfeited. In 1995, the Company expensed
$12,500 in recognition of the unrestricted stock awards. Upon issuance of
restricted shares, unearned compensation is charged to stockholder's equity for
the cost of the restricted stock and is amortized over the vesting period. The
amount of earned compensation recognized as expense with respect to restricted
stock awards was $203, $318 and $89 for 1997, 1996 and 1995, respectively. The
Company acquired 30,887 shares of its common stock at a cost of $846 in 1997
and, pursuant to the 1995 Employee Plan, 306,396 shares of its common stock at a
cost of $7,220 in 1996, primarily from the Company's Chief Executive Officer, to
fund required withholding taxes. Also, the Company recorded contributions to
paid in capital representing the tax benefits attributable to the difference
between the amount of compensation expense deductible for tax purposes with
respect to stock awards and the amount of such compensation expense reflected in
the Company's financial statements.
F-20
Had the compensation cost for the Company's stock based compensation 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:
1997 1996 1995
---------------------------------------
Net Income As reported $ 154,955 $ 112,027 $ 747
Pro forma $ 153,492 $ 110,850 $ 514
Earnings per share - basic As reported $ 3.07 $ 2.22 $ 0.01
Pro forma $ 3.04 $ 2.19 $ 0.01
Earnings per share - diluted As reported $ 3.05 $ 2.21 $ 0.01
Pro forma $ 3.02 $ 2.19 $ 0.01
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: (i) dividend
yields ranging from 0.5% to 0.7%, (ii) expected volatility ranging from 32.86%
to 34.33%, (iii) risk-free interest rates ranging from a low of 5.90% to a high
of 7.01%, and (iv) expected life of 7.5 years.
In addition to the 1995 Employee Plan and 1995 Director Plan, the Company
transferred during 1997 a total of 3,685 shares of treasury stock having an
aggregate value of $131 to its non-employee directors as compensation for their
service as directors.
13. SEGMENT INFORMATION
Everest Re's principal business is reinsuring property and casualty risks of
domestic and foreign insurance companies. The following table provides summary
financial information by geographic region for the periods disclosed.
Years Ended December 31,
--------------------------------------------
1997 1996 1995
--------------------------------------------
Premiums earned:
Domestic $ 696,645 $ 655,097 $ 565,540
Canada 59,420 63,615 57,133
Other international 293,782 254,899 270,648
Premium for Stop Loss
Agreement - - (140,000)
--------------------------------------------
Total premiums earned $ 1,049,847 $ 973,611 $ 753,321
============================================
Net income (loss):
Domestic $ 115,728 $ 70,978 $ 37,305
Canada 15,223 8,548 17,774
Other international 24,004 32,501 45,341
After-tax cost of Stop Loss
Agreement and compensation
related to public offering - - (99,673)
--------------------------------------------
Total net income $ 154,955 $ 112,027 $ 747
============================================
December 31,
----------------------------
1997 1996
----------------------------
Total identifiable assets:
Domestic $ 4,714,134 $ 4,204,570
Canada 303,162 303,369
Other international 520,724 539,828
----------------------------
Total identifiable assets $ 5,538,020 $ 5,047,767
============================
Approximately 19.3%, 15.9% and 6.3% of the Company's gross premiums written in
1997, 1996 and 1995, respectively, were sourced through one intermediary. The
increase is principally attributable to acquisitions made by this intermediary
during the three year period.
F-21
14. UNAUDITED QUARTERLY FINANCIAL DATA
Summarized quarterly financial data were as follows:
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------------------------------------------------
1997 OPERATING DATA:
Gross written premium $ 246,011 $ 253,233 $ 285,796 $ 289,928
Net written premium 233,811 246,072 275,915 275,344
Earned premium 230,443 247,515 271,520 300,368
Net investment income 54,042 57,368 57,917 59,219
Net realized capital gain (loss) (199) 13,410 2,722 (17)
Incurred losses and LAE 166,841 180,191 204,234 214,155
Underwriting expenses 74,754 78,237 76,677 96,799
Underwriting loss (11,152) (10,913) (9,391) (10,586)
Net income (loss) $ 34,464 $ 44,338 $ 38,432 $37,721
================================================
Weighted average basic shares
outstanding (000's) 50,490 50,469 50,466 50,479
Net income per common share - basic $ 0.68 $ 0.88 $ 0.76 $ 0.75
Weighted average diluted shares
outstanding (000's) 50,725 50,738 50,791 50,807
Net income per common share - diluted $ 0.68 $ 0.87 $ 0.76 $ 0.74
1996 OPERATING DATA:
Gross written premium $ 229,963 $ 247,392 $ 282,399 $ 284,277
Net written premium 218,743 235,914 275,009 300,868
Earned premium 210,269 218,806 245,341 299,195
Net investment income 44,768 46,261 49,467 51,405
Net realized capital gain (loss) 3,812 3,672 (6,505) 4,716
Incurred losses and LAE 155,125 161,430 179,856 219,622
Underwriting expenses 68,350 69,846 79,152 92,120
Underwriting loss (13,206) (12,470) (13,667) (12,547)
Net income (loss) $ 27,751 $ 28,739 $ 23,219 $ 32,318
================================================
Weighted average basic shares
outstanding (000's) 50,793 50,497 50,487 50,488
Net income per common share - basic $ 0.55 $ 0.57 $ 0.46 $ 0.64
Weighted average diluted shares
outstanding (000's) 50,909 50,627 50,630 50,676
Net income per common share - diluted $ 0.55 $ 0.57 $ 0.46 $ 0.64
F-22
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE I - SUMMARY OF INVESTMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1997
Column A Column B Column C Column D
- -----------------------------------------------------------------------------
Amount
Shown in
Market Balance
(Dollars in thousands) Cost Value Sheet
----------------------------------------
Fixed maturities-
available for sale
Bonds:
U.S. Government and
government agencies $ 144,079 $ 147,069 $ 147,069
State, municipalities
and political
subdivisions 1,610,190 1,722,108 1,722,108
Foreign debt
securities (1) 489,168 523,075 523,075
Public utilities 48,479 50,727 50,727
All other corporate bonds 835,434 871,943 871,943
Mortgage pass-through
securities 521,048 541,550 541,550
Redeemable preferred stock 9,972 10,388 10,388
----------------------------------------
Total fixed maturities-
available for sale 3,658,370 3,866,860 3,866,860
Equity securities 120,510 158,784 158,784
Short-term investments 75,244 75,244 75,244
Other invested assets 10,848 10,848 10,848
Cash 51,578 51,578 51,578
----------------------------------------
Total investments and cash $3,916,550 $4,163,314 $4,163,314
========================================
- ---------------
(1) At December 31, 1997, foreign debt securities at amortized cost are
comprised of $232,815 and $256,353 in foreign government securities and
foreign corporate bonds, respectively. At December 31, 1997, foreign debt
securities at market value are comprised of $253,298 and $269,777 in
foreign government securities and foreign corporate bonds, respectively.
S-1
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED BALANCE SHEET
December 31,
----------------------------------------
(Dollars in thousands, 1997 1996
except par value per share) ----------------------------------------
ASSETS
Cash - -
Investment in subsidiaries, at
equity in the underlying net
assets $ 1,301,913 $ 1,080,131
Receivable from affiliate 5,731 3,431
Current tax receivable - 2,918
Deferred tax asset 1,688 1,688
----------------------------------------
Total assets $ 1,309,332 $ 1,088,168
========================================
LIABILITIES
Other liabilities $ 1,849 $ 2,145
----------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock, par value:
$0.01; 50 million shares authorized;
no shares issued and outstanding - -
Common stock, par value: $0.01;
200 million shares authorized;
50.8 shares issued 508 508
Paid-in capital 389,876 389,196
Unearned compensation (514) (374)
Net unrealized appreciation of
investments, net of deferred
income taxes 160,397 77,766
Cumulative foreign currency
translation adjustment, net of
deferred income taxes (8,078) (354)
Treasury stock, at cost; 0.3 million
shares (8,086) (7,220)
Retained earnings 773,380 626,501
----------------------------------------
Total stockholders' equity 1,307,483 1,086,023
----------------------------------------
Total liabilities and stockholders'
equity $ 1,309,332 $ 1,088,168
========================================
See notes to consolidated financial statements.
S-2
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENT OF OPERATIONS
For Years Ended December 31,
--------------------------------------------------
(Dollars in thousands) 1997 1996 1995
--------------------------------------------------
REVENUES
Dividends received
from subsidiary $ 9,270 $ 17,924 $ 13,722
Equity in undistributed
net income (loss) of
subsidiary 146,970 95,242 (9,956)
--------------------------------------------------
Total revenues 156,240 113,166 3,766
--------------------------------------------------
EXPENSES
Other expenses 943 1,752 4,612
--------------------------------------------------
Income (loss) before
taxes 155,297 111,414 (846)
Income tax (benefit) 342 (613) (1,593)
--------------------------------------------------
Net income $ 154,955 $ 112,027 $ 747
==================================================
See notes to consolidated financial statements.
S-3
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT
CONDENSED STATEMENT OF CASHFLOWS
For Years Ended December 31,
-------------------------------------------------
(Dollars in thousands) 1997 1996 1995
-------------------------------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES
Net income $ 154,955 $ 112,027 $ 747
Adjustments to reconcile
net income to net cash
provided by operating
activities:
Equity in undistributed
(earnings) loss of
subsidiaries (146,970) (95,242) 9,956
(Decrease) in other
liabilities (296) (364) (4,586)
Decrease (increase) in
current tax receivable 2,918 (972) (1,151)
(Increase) in receivable
from affiliates (2,300) (3,431) -
Non-cash compensation 203 407 2,500
-------------------------------------------------
Net cash provided by
operating activities 8,510 12,425 7,466
CASH FLOWS FROM INVESTING
ACTIVITIES
Additional investment in
subsidiaries (248) - -
CASH FLOWS FROM FINANCING
ACTIVITIES
Purchase of treasury stock (822) (7,220) -
Common stock issued during
the period 636 420 -
Dividends paid to stockholders (8,076) (6,067) (7,024)
-------------------------------------------------
Net cash used in financing
activities (8,262) (12,867) (7,024)
Net increase in cash - (442) 442
Cash, beginning of period - 442 -
-------------------------------------------------
Cash, end of period $ - $ - $ 442
=================================================
SUPPLEMENTAL CASH FLOW
INFORMATION
Cash transaction:
Income tax received - - $ 442
Non-cash operating
transactions:
Dividends received from
subsidiary in the form of
forgiveness of liabilities $ 1,536 $ 1,767 6,698
Non-cash financing transaction:
Issuance of common stock in
connection with public offering. - - $ 12,500
See notes to consolidated financial statements.
S-4
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE III -
SUPPLEMENTARY INSURANCE INFORMATION
(Dollars in thousands)
Column A Column B Column C Column D Column F Column G Column H Column I Column J Column K
- ----------------------------------------------------------------------------------------------------------------------------------
Reserve
for Losses Incurred Amortization
Deferred and Loss Unearned Net Loss and Loss of Deferred Other
Acquisition Adjustment Premium Earned Investment Adjustment Acquisition Operating Written
SEGMENT Costs Expenses Reserves Premium Income Expenses Costs Expenses Premium
- ----------------------------------------------------------------------------------------------------------------------------------
December 31, 1997
Domestic $ 56,747 $2,914,616 $ 244,335 $ 696,645 $ 175,053 $ 514,021 $ 185,885 $ 38,267 $ 695,211
Canada 7,030 144,070 22,422 59,420 20,889 38,145 16,129 4,124 56,392
Other international 18,555 379,132 70,626 293,782 32,604 213,255 68,591 13,472 279,539
-----------------------------------------------------------------------------------------------------------
Total $ 82,332 $3,437,818 $ 337,383 $1,049,847 $ 228,546 $ 765,421 $ 270,605 $ 55,863 $1,031,142
===========================================================================================================
December 31, 1996
Domestic $ 56,676 $2,751,282 $ 242,654 $ 655,097 $ 143,301 $ 508,247 $ 175,241 $ 43,738 $ 694,053
Canada 7,640 142,346 25,835 63,615 17,489 37,896 15,731 2,299 65,030
Other international 19,807 353,230 87,419 254,899 31,111 169,890 61,956 10,503 271,451
-----------------------------------------------------------------------------------------------------------
Total $ 84,123 $3,246,858 $ 355,908 $ 973,611 $ 191,901 $ 716,033 $ 252,928 $ 56,540 $1,030,534
===========================================================================================================
December 31, 1995
Domestic $ 55,743 $2,504,947 $ 200,886 $ 565,540 $ 125,676 $ 474,864 $ 151,187 $ 60,673 $ 590,717
Canada 7,716 133,559 24,456 57,133 16,112 35,571 11,650 2,515 64,064
Other international 16,560 330,835 68,949 270,648 24,235 164,261 63,982 10,729 268,410
Premium for Stop Loss
Agreement - - - (140,000) - - - - (140,000)
-----------------------------------------------------------------------------------------------------------
Total $ 80,019 $2,969,341 $ 294,291 $ 753,321 $ 166,023 $ 674,696 $ 226,819 $ 73,917 $ 783,191
===========================================================================================================
S-5
EVEREST REINSURANCE HOLDINGS, INC.
SCHEDULE IV - REINSURANCE
Column A Column B Column C Column D Column E Column F
- --------------------------------------------------------------------------------------------------------------
Gross Ceded To Assumed From Net Assumed to
(Dollars in thousands) Amount Other Companies Other Companies Amount Net
----------------------------------------------------------------------------------
December 31, 1997
Total property and
liability insurance
earned premium $ 77,784 $ 40,105 $ 1,012,168 $ 1,049,847 96.4%
December 31, 1996
Total property and
liability insurance
earned premium $ 37,963 $ 10,050 $ 945,698 $ 973,611 97.1%
December 31, 1995
Total property and
liability insurance
earned premium $ 10,784 $ 165,458 $ 907,995 $ 753,321 120.5%
S-6
INDEX TO EXHIBITS
Exhibit
No.
- -----------
3.1 Certificate of Incorporation of Everest Reinsurance Holdings,
Inc., incorporated herein by reference to Exhibit 4.1 to the
Registration Statement on Form S-8 (No. 333-05771)
3.2 By-Laws (as amended and restated) of Everest Reinsurance Holdings,
Inc., filed herewith
10.1 Sublease, effective as of January 1, 1994, between The Prudential
Insurance Company of America and Everest Reinsurance Company,
incorporated herein by reference to Exhibit 10.3 to the
Registration Statement on Form S-1 (No. 33-71652)
10.2 Stop Loss Agreement entered into between Everest Reinsurance
Company and Gibraltar Casualty Company, incorporated herein by
reference to Exhibit 10.6 to the Registration Statement on Form
S-1 (No. 33-71652)
10.3 Everest Reinsurance Holdings, Inc. Amended 1995 Stock Incentive
Plan, incorporated herein by reference to Exhibit 10.3 to the
Annual Report on Form 10-K for the year ended December 31, 1995
(the "1995 10-K")
10.4 Everest Reinsurance Holdings, Inc. Amended Annual Incentive Plan,
incorporated herein by reference to Exhibit 10.4 to the 1995 10-K
10.5 Sublease, effective as of February 1, 1997 between The Prudential
Insurance Company of America and Everest Reinsurance Company,
incorporated herein by reference to Exhibit 10.5 to the 1996 10-K
*10.6 Everest Reinsurance Holdings, Inc. 1995 Stock Option Plan for
Non-Employee Directors, incorporated herein by reference to
Exhibit 4.3 to the Registration Statement on Form S-8 (No.
333-05771)
*10.7 Amended and Restated Employment Agreement between Everest
Reinsurance Company and Joseph V. Taranto, incorporated herein by
reference to Exhibit 10.50 to the Registration Statement on
Form S-1 (No. 33-71652)
*10.8 Resolution adopted by the Compensation Committee of Everest
Reinsurance Holdings, Inc. on February 24, 1997 establishing a
Chief Executive Officer's Bonus Plan filed herewith
10.9 Standby Capital Contribution Agreement between Everest Reinsurance
Holdings, Inc. and Everest Reinsurance Company, incorporated
herein by reference to Exhibit 10.69 to the Registration Statement
on Form S-1 (No. 33-71652)
10.10 Indemnification Agreement between PRUCO, Inc. and Everest
Reinsurance Holdings, Inc., incorporated herein by reference to
Exhibit 10.70 to the Registration Statement on Form S-1 (No.
33-71652)
10.11 Guarantee made by The Prudential Insurance Company of America in
favor of Everest Reinsurance Company, incorporated herein by
reference to Exhibit 10.71 to the Registration Statement on Form
S-1 (No. 33-71652)
10.12 Guarantee made by The Prudential Insurance Company of America in
favor of Everest Reinsurance Holdings, Inc., incorporated herein
by reference to Exhibit 10.72 to the Registration Statement on
Form S-1 (No. 33-71652)
10.13 1995 Service Contract between Everest Reinsurance Company and
Gibraltar Casualty Company, incorporated herein by reference to
Exhibit 10.73 to the Registration Statement on Form S-1 (No.
33-71652)
10.14 Separation Agreement among The Prudential Insurance Company of
America, Gibraltar Casualty Company, Everest Reinsurance Company,
PRUCO, Inc., and Everest Reinsurance Holdings, Inc., incorporated
herein by reference to Exhibit 10.2 to the Registration Statement
on Form S-1 (No. 33-71652)
*10.15 Form of Non-Qualified Stock Option Award Agreement to be entered
into between Everest Reinsurance Holdings, Inc. and participants
in the 1995 Stock Incentive Plan, incorporated herein by reference
to Exhibit 10.15 to the 1995 10-K
E-1
*10.16 Form of Restricted Stock Agreement to be entered into between
Everest Reinsurance Holdings, Inc. and participants in the 1995
Stock Incentive Plan, incorporated herein by reference to Exhibit
10.16 to the 1995 10-K
*10.17 Form of Stock Option Agreement (Version 1) to be entered into
between Everest Reinsurance Holdings, Inc. and participants in the
1995 Stock Option Plan for Non-Employee Directors, incorporated
herein by reference to Exhibit 10.17 to the 1995 10-K
*10.18 Form of Stock Option Agreement (Version 2) to be entered into
between Everest Reinsurance Holdings, Inc. and participants in the
1995 Stock Option Plan for Non-Employee Directors, incorporated
herein by reference to Exhibit 10.18 to the 1995 10-K
10.19 Credit agreement between Everest Reinsurance Holdings, Inc. and
First Union National Bank dated June 16, 1997 providing for a $50
million revolving credit facility, incorporated herein by
reference to Exhibit 10.19 to the Form 8-K filed on June 24, 1997
*10.20 Deferred Compensation Plan for certain United States employees of
Everest Reinsurance Holdings, Inc. and its participating
subsidiaries filed herewith.
11.1 Statement regarding computation of per share earnings
16.1 Letter from Deloitte & Touche LLP, dated August 8, 1996,
incorporated herein by reference to Exhibit 16 to the Form 8-K
filed on August 9, 1996
21.1 Subsidiaries of the registrant filed herewith
23.1 Consent of Deloitte & Touche LLP filed herewith
23.2 Consent of Coopers & Lybrand L.L.P. filed herewith
27.1 Financial Data Schedule filed herein
- --------------------------
* Management contract or compensatory plan or arrangement.
E-2