INDEX TO FINANCIAL STATEMENTS
of
American International Speciality
Lines Insurance Company
Financial Statements
Report of Pricewaterhouse Coopers LLP..................................F-1
Statement of Admitted Assets, Liabilities, Capital and Surplus
(Statutory Basis) as of December 31, 1999 and December 31, 1998........F-2
Statements of Income and Capital and Surplus Account (Statutory Basis)
for Years Ended December 31, 1999, 1998 and 1997.......................F-3
Statement of Cash Flow (Statutory Basis) for Years Ended December
31, 1999, 1998 and 1997................................................F-4
Notes to Financial Statements..........................................F-5
10
Report of Independent Accountants
To the Board of Directors and Stockholders of American International Specialty
Lines Insurance Company:
We have audited the accompanying statements of admitted assets, liabilities,
capital and surplus (statutory basis) of American International Specialty Lines
Insurance Company (the "Company") as of December 31, 1999 and 1998 and related
statements of income and capital and surplus account, and cash flow (statutory
basis) for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits of the accompanying statutory basis financial statements
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.
As described more fully in Note 1 to the financial statements, the Company
prepared these financial statements using accounting practices prescribed or
permitted by the State of Alaska Department of Commerce and Economic
Development, Division of Insurance, which practices differ from generally
accepted accounting principles. The effects on the financial statements of the
variances between the statutory basis of accounting and generally accepted
accounting principles, although not reasonably determinable, are presumed to be
material.
In our opinion, because of the effects of the matter discussed in the preceding
paragraph, the financial statements referred to above do not present fairly, in
conformity with generally accepted accounting principles, the financial position
of American International Specialty Lines Insurance Company as of December 31,
1999 and 1998, or the results of its operations or its cash flows for each of
the three years in the period ended December 31, 1999.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the admitted assets, liabilities, capital and surplus of
American International Specialty Lines Insurance Company as of December 31, 1999
and 1998, and the results of its operations and its cash flow for each of the
three years in the period ended December 31, 1999, on the basis of accounting
described in Note 1.
March 24, 2000
F-1
AMERICAN INTERNATIONAL SPECIALTY LINES INSURANCE COMPANY
Statement of Admitted Assets, Liabilities, Capital and Surplus
(Statutory Basis)
As of December 31,
1999 1998
Admitted Assets
Bonds, at amortized cost (market value: 1999-$506,417,538; $507,687,764 $425,547,936
1998-$457,460,832)
Short-term investments, at amortized cost (approximates market value) 121,861 730,631
Other invested assets, at market value (cost: 1999-$1,154,959; 1998-$39,377,985) 1,149,805 39,376,538
Cash 27,821,345 3,622,642
-----------------------------------
Total invested assets and cash 536,780,775 469,277,747
Agents' balances or uncollected premiums:
Premiums in course of collection (including ceded reinsurance balances (61,340,356) 48,788,446
payable of, 1999-$316,802,723; 1998-$121,410,080)
Premiums and installments booked but deferred and not yet due 342,757,653 38,185,589
(including ceded reinsurance balances payable of, 1999-$1,145,676;
1998-$100,379,896)
Reinsurance recoverable on loss payments 56,103,025 47,014,930
Interest and dividends due and accrued 7,955,407 7,293,968
Federal income tax recoverable 0 3,294,852
Receivable from parent, subsidiaries and affiliates 15,587,336 6,911,531
Loss funds on deposit 5,686,063 5,622,057
Drafts outstanding 5,822,606 0
-----------------------------------
Total admitted assets $909,352,509 $626,389,120
===================================
Liabilities
Unpaid losses $174,862,924 $186,943,712
Unpaid loss adjustment expenses 34,047,726 35,010,432
Reinsurance payable on paid loss and loss adjustment expenses 27,835,495 28,464,421
Unearned premiums 140,024,796 104,710,777
Funds held under reinsurance treaties 252,560,723 4,231
Provision for reinsurance 9,825,207 9,639,712
Drafts outstanding 0 18,161,275
Federal income tax expense 90,339 0
Excess of statutory reserves over statement reserves 303,000 0
Other liabilities 1,463,453 2,574,715
-----------------------------------
Total liabilities 641,013,663 385,509,275
-----------------------------------
Capital and Surplus
Common capital stock, $33.35 par value, 150,000 shares
authorized, issued and outstanding 5,002,500 5,002,500
Capital in excess of par value 98,377,500 98,377,500
Unassigned surplus 164,958,846 137,499,845
-----------------------------------
Total capital and surplus 268,338,846 240,879,845
-----------------------------------
Total liabilities, capital and surplus $909,352,509 $626,389,120
===================================
See Notes to Financial Statements
F-2
AMERICAN INTERNATIONAL SPECIALTY LINES INSURANCE COMPANY
Statement of Income and Capital and Surplus Account
(Statutory Basis)
For the Years Ended December 31,
1999 1998 1997
Underwriting income:
Premiums earned $ 91,627,505 $101,205,883 $ 92,589,846
----------------------------------------------------
Deductions:
Losses incurred 54,688,920 75,094,310 65,849,794
Loss adjustment expenses incurred 18,655,500 8,460,105 11,326,894
Other underwriting expenses incurred 13,044,889 12,342,886 14,177,114
----------------------------------------------------
Total underwriting deductions 86,389,309 95,897,301 91,353,802
----------------------------------------------------
Net underwriting gain 5,238,196 5,308,582 1,236,044
----------------------------------------------------
Investment income:
Net investment income earned 26,885,580 23,980,761 23,736,924
Net realized capital gains 300,493 310,286 3,423,103
----------------------------------------------------
Net investment gain 27,186,073 24,291,047 27,160,027
----------------------------------------------------
Income before federal income taxes 32,424,269 29,599,629 28,396,071
Federal income tax provision 3,183,839 3,108,856 4,098,713
----------------------------------------------------
Net income $ 29,240,430 $ 26,490,773 $ 24,297,358
====================================================
Capital and Surplus Account
Total capital and surplus, December 31,
previous year $240,879,845 $212,200,853 $192,349,335
----------------------------------------------------
Gains and (losses) in surplus:
Net income 29,240,430 26,490,773 24,297,358
Change in non-admitted assets (1,292,934) 3,749,840 (4,689,758)
Change in provision for reinsurance (185,495) (1,561,621) 243,918
Change in excess of statutory reserves over statement reserves (303,000) 0 0
Change in surplus as regards policyholders
for the year 27,459,001 28,678,992 19,851,518
----------------------------------------------------
Total capital and surplus, December 31,
current year $268,338,846 $240,879,845 $212,200,853
====================================================
F-3
See Notes to Financial Statements
AMERICAN INTERNATIONAL SPECIALTY LINES INSURANCE COMPANY
Statement of Cash Flow
(Statutory Basis)
For the Years Ended December 31,
1999 1998 1997
Premiums collected (net of reinsurance) $(68,790,964) $128,512,329 $ 75,172,363
Loss and loss adjustment expenses paid
(net of salvage, subrogation and reinsurance) 114,266,195 81,613,422 75,092,150
Underwriting expenses paid 14,909,008 11,524,883 12,928,861
-----------------------------------------------------
Net cash flows from underwriting (197,966,167) 35,374,024 (12,848,648)
-----------------------------------------------------
Investment income collected (net of investment expenses paid) 26,105,007 23,702,715 24,030,469
Increase in net funds held under reinsurance treaties 252,556,492 0 0
Other income (expenses) 0 0 (1,266,850)
Federal income taxes paid 201,352 (5,513,673) (5,035,160)
-----------------------------------------------------
Net cash flows from operations 80,896,684 53,563,066 4,879,811
-----------------------------------------------------
Proceeds from investments sold, matured or repaid:
Bonds 14,894,030 12,022,873 79,455,746
Other invested assets 76,900,000 42,770,000 81,574,000
-----------------------------------------------------
Total investment proceeds 91,794,030 54,792,873 161,029,746
Cost of investments acquired (long-term only):
Bonds 96,433,013 44,686,991 59,405,759
Other invested assets 38,858,184 82,059,866 80,925,718
-----------------------------------------------------
Total investments acquired 135,291,197 126,746,857 140,331,477
-----------------------------------------------------
Net cash from investments (43,497,167) (71,953,984) 20,698,269
Other cash provided:
Net transfers from affiliates 0 0 15,868,276
Other cash provided 752,857 41,242,873 588,761
-----------------------------------------------------
Total other cash provided 752,857 41,242,873 16,457,037
Other cash applied: ------------------------------------------------------
Net transfers to affiliates 8,675,823 22,722,799 0
Other applications 5,886,612 987,316 43,461,704
-----------------------------------------------------
Total other cash applied 14,562,435 23,710,115 43,461,704
-----------------------------------------------------
Net cash from financing and miscellaneous sources (13,809,578) 17,532,758 (27,004,667)
-----------------------------------------------------
Net change in cash and short-term investments 23,589,939 (858,160) (1,426,587)
RECONCILIATION
Cash and short-term investments:
Beginning of year 4,353,267 5,211,433 6,638,020
-----------------------------------------------------
End of year $27,943,206 $4,353,273 $ 5,211,433
=====================================================
F-4
See Notes to Financial Statements
Notes to Financial Statements
1. Summary of Significant Accounting Policies:
(A) Organization
American International Specialty Lines Insurance Company (the "Company") is
owned by the following wholly owned subsidiaries of American International
Group, Inc. (the "Parent"): National Union Fire Insurance Company of
Pittsburgh, PA. (70%); The Insurance Company of the State of Pennsylvania
(20%); and Birmingham Fire Insurance Company of Pennsylvania (10%). The
Company has significant transactions with the Parent and affiliates (see
Notes 3 and 4). The Company is predominantly a writer of property and
casualty excess and surplus lines.
(B) Basis of Presentation
The accompanying financial statements were prepared in conformity with the
statutory accounting practices (SAP) of the National Association of
Insurance Commissioners (NAIC) and as prescribed or permitted by the State
of Alaska Department of Commerce and Economic Development, Division of
Insurance, which is a comprehensive basis of accounting other than
generally accepted accounting principles (GAAP). SAP varies in certain
respects from GAAP. Under GAAP: (1) costs incidental to acquiring business
related to premiums written and costs allowed by assuming reinsurers
related to premiums ceded are deferred and amortized over the periods
covered by the underlying policies or reinsurance agreements; (2) provision
is made for deferred income taxes relating to temporary differences between
financial reporting and taxable income; (3) provision is made for deferred
income taxes relating to unrealized appreciation on investments; (4)
adjustments relating to the difference between the amount recorded for
financial statement purposes and the amount subsequently filed on the tax
return are charged or credited directly to income as opposed to unassigned
surplus; (5) non-admitted assets and statutory basis reserves are restored
to surplus; (6) the reserve for losses and loss expenses and reserve for
unearned premiums are presented gross of ceded reinsurance by establishing
a reinsurance asset; and (7) debt securities deemed to be available for
sale are reported at fair value, and the difference between cost and fair
value is reflected net of related deferred income taxes, as a separate
component of accumulated other comprehensive income in shareholders'
equity.
(C) Codification
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance, which will replace the current Accounting Practices
and Procedures manual as the NAIC's primary guidance on statutory
accounting. The NAIC is now considering amendments to the Codification
guidance that would also be effective upon implementation. The Codification
provides guidance for areas where statutory accounting has been silent and
changes current statutory accounting in some areas, e.g. deferred income
taxes are recorded.
The State of Alaska Department of Commerce and Economic Development,
Division of Insurance has adopted the Codification guidance, effective
January 1, 2001. The Company has not estimated the potential effect of the
Codification guidance. However, the actual effect of adoption could differ
as changes are made to the Codification guidance, prior to its effective
date of January 1, 2001.
F-5
Significant statutory accounting practices are as follows:
A. The preparation of financial statements in conformity with the
accounting practices prescribed or permitted by the State of Alaska
Department of Commerce and Economic Development, Division of Insurance,
requires management to make estimates and assumptions that effect the
reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the
period. Actual results could differ from those estimates.
B. Investments are carried at values designated by the NAIC. Bonds are
carried at amortized cost, except those bonds not in good standing,
which are carried at NAIC designated values. Investment income is
recorded as earned. Realized gains or losses on the disposition of
investments are determined on the basis of specific identification.
C. Premiums written are primarily earned on a daily pro-rata basis over
the terms of the policies to which they relate. Accordingly, unearned
premiums represent the portion of premiums written which is applicable
to the unexpired terms of policies in force. Premium estimates for
retrospectively rated policies are recognized within the periods in
which the related losses are incurred. Ceded premiums are amortized
into income over the contract period in proportion to the protection
received.
D. Certain assets, principally furniture, equipment, and leasehold
improvements and certain overdue agents' balances, are designated
"non-admitted assets" and are directly charged to unassigned surplus.
E. The liabilities for unpaid losses and loss adjustment expenses,
including incurred but not reported losses, are determined on the basis
of claims adjustors' evaluations and other estimates, including
historical loss experience. The methods of making such estimates and
for establishing the resulting reserves are continually reviewed and
updated, and any resulting adjustments are recorded in the current
period. Accordingly, losses and loss adjustment expenses are charged to
income as incurred. Amounts recoverable from reinsurers are estimated
in a manner consistent with the claim liability associated with the
reinsured policy.
F. Certain required statutory basis reserves, principally the provision
for reinsurance, are charged to surplus and reflected as a liability
of the Company.
G. Commissions, premium taxes, and certain other underwriting expenses
related to premiums written are charged to income at the time the
premiums are written and are included in "Other underwriting expenses
incurred."
F-6
H. Unpaid losses and loss adjustment expenses have been reduced by
anticipated salvage and subrogation in the amount of approximately
$2,196,000 and $1,596,000 at December 31, 1999 and December 31, 1998,
respectively.
I. The Company considers all highly liquid debt securities with
maturities of twelve months or less to be short-term investments.
J. Other invested assets consist primarily of shares of an intermediate
bond mutual fund. The intermediate bond mutual fund is carried
principally at market value.
2. Federal Income Taxes:
The Company files a consolidated U.S. federal income tax return with the
Parent pursuant to a consolidated tax sharing agreement. The agreement
provides that the Parent will not charge the Company a greater portion of
the consolidated tax liability than would have been paid by the Company if
it had filed a separate federal income tax return. In addition, the
agreement provides that the Company will be reimbursed by the Parent for
tax benefits relating to any net losses of the Company utilized in filing
the consolidated return. The "Federal income tax recoverable" and "Federal
income tax expense" in the accompanying statement of admitted assets,
liabilities, capital and surplus are due to/from the Parent.
The U.S. federal income tax rate applicable to ordinary income is 35% for
1999,1998 and 1997. Actual tax expense on income from operations differs
from the "expected" amount principally as a result of tax-exempt investment
income, unearned premiums and the discounting of unpaid losses and loss
adjustment expenses.
3. Management Agreement:
The Company is managed and operated by American International Surplus Lines
Agency, Inc. ("Agency"), a wholly owned subsidiary of the Parent. The
management agreement provides the Agency with the authority to conduct a
significant portion of the business affairs of the Company. As compensation
for these services, the management agreement provides that the Company pay
the Agency an annual management fee of $100,000 plus actual expenses
incurred on behalf of managing the Company. The management fee and expense
reimbursement paid to the Agency was approximately $6,547,000, $5,767,000
and $4,783,000 in 1999, 1998 and 1997, respectively.
4. Related Party Transactions:
The Company cedes all agency business written in the State of Alaska to the
New Hampshire Insurance Company (a wholly owned subsidiary of the Parent).
The Company cedes 80% of its surplus lines insurance to National Union Fire
Insurance Company of Pittsburgh, PA through a reinsurance quota share
agreement. The Company also assumes reinsurance from Lexington Insurance
Company, an affiliate. In recent years the Company also entered into
accident year aggregate loss ratio and excess agreements with National
Union Fire Insurance Company of Pittsburgh, PA.
F-7
5. Investments:
The amortized cost and NAIC market values of investments in fixed
maturities carried at December 31, 1999 and December 31, 1998, were as
follows:
(in thousands)
------------------------------------ -------------- ----------------------- ----------------- -------------------
Gross Gross NAIC
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------------------------------ -------------- ----------------------- ----------------- -------------------
1999
Fixed maturities:
States, municipalities
And political
Subdivisions $507,688 $ 9,857 $ 11,127 $506,418
-------- -------- ------- --------
Total bonds $507,688 $ 9,857 $ 11,127 $506,418
======== ======== ======== ========
(in thousands)
------------------------------------ -------------- ----------------------- ----------------- -------------------
Gross Gross NAIC
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
------------------------------------ -------------- ----------------------- ----------------- -------------------
1998
Fixed maturities:
States, municipalities
And political
Subdivisions $425,548 $ 31,977 $ 64 $457,461
-------- -------- --- --------
Total bonds $425,548 $ 31,977 $ 64 $457,461
======== ======== === ========
F-8
The amortized cost and NAIC market values of fixed maturities at December
31, 1999, by contractual maturity, are shown below. Actual maturities may
differ from contractual maturities because borrowers may have the right to
call or prepay certain obligations with or without call or prepayment
penalties.
(in thousands)
-------------------------------------------------- -------------------- ----------------------
Amortized NAIC
Cost Market Value
-------------------------------------------------- -------------------- ----------------------
Due in one year or less $ 4,078 $ 4,068
Due after one year through five years 45,712 45,597
Due after five years through ten years 161,703 161,299
Due after ten years 296,195 295,454
Total $507,688 $506,418
======== ========
Proceeds from sales of investments in fixed maturities during 1999, 1998
and 1997 were $10,109,030, $40,033,470 and $71,565,746 respectively.
Gross gains of $497,567, $247,107 and $3,529,895 and gross losses of
$15,864, $213 and $0 were realized on those sales in 1999, 1998 and 1997,
respectively.
Securities carried at amortized cost of $10,697,637 and $10,687,625 were
deposited with regulatory authorities as required by law, at December 31,
1999, and December 31, 1998, respectively.
Included in "Net investment income earned" are investment expenses of
$274,240, $217,663 and $282,957 for 1999, 1998 and 1997, respectively.
F-9
6. Reinsurance:
In the ordinary course of business, the Company reinsures certain risks
with affiliates and other companies. Such arrangements serve to limit the
Company's maximum loss on catastrophes, large and unusually hazardous
risks. To the extent that any reinsuring company might be unable to meet
its obligations, the Company would be liable for its respective
participation in such defaulted amounts.
Reserves for unearned premiums and paid and unpaid losses and loss
adjustment expenses, including those incurred but not reported to the
Company, have been reduced for reinsurance ceded as follows:
(in thousands)
-------------------------------------------------- --------------------- --------------------------------
Unearned Premium Paid and Unpaid Losses and
Reserves Loss Adjustment Expenses
-------------------------------------------------- --------------------- --------------------------------
1999
Affiliates $781,276 $2,160,916
Non-Affiliates 71,107 166,646
---- -------
Total $852,383 $2,327,562
======== ==========
-------------------------------------------------- --------------------- --------------------------------
1998
Affiliates $589,427 $1,914,582
Non-Affiliates 49,186 137,120
---- -------
Total $638,613 $2,051,702
======== ==========
Net premiums written and earned comprise the following:
(in thousands)
-------------------------------------------------- --------------------- -------------------
Written Earned
-------------------------------------------------- --------------------- -------------------
1999
Direct business $ 1,003,581 $774,663
Reinsurance assumed
Affiliates 47,988 27,820
Non-Affiliates 0 0
--------------- ------------
Reinsurance ceded
Affiliates (835,065) (643,216)
Non-Affiliates (89,563) (67,639)
--- --------
Net premiums $ 126,941 $ 91,628
======== ========
F-10
(in thousands)
-------------------------------------------------- --------------------- -------------------
Written Earned
-------------------------------------------------- --------------------- -------------------
1998
Direct business $ 790,155 $ 651,942
Reinsurance assumed
Affiliates 26,545 31,046
Non-Affiliates 0 0
--------------- ------------
Reinsurance ceded
Affiliates (632,823) (533,520)
Non-Affiliates (65,291) (48,262)
======== ========
Net Premiums $ 118,586 $ 101,206
======== =========
(in thousands)
-------------------------------------------------- --------------------- -------------------
Written Earned
-------------------------------------------------- --------------------- -------------------
1997
Direct business $ 663,123 $ 644,974
Reinsurance assumed
Affiliates 31,963 26,398
Non-Affiliates 0 0
--------------- ------------
Reinsurance ceded
Affiliates (556,321) (531,213)
Non-Affiliates (36,770) (47,569)
======== ========
Net Premiums $101,995 $ 92,590
======== =========
For the years ended December 31, 1999, 1998 and 1997, reinsurance
recoveries, which reduced loss and loss expenses incurred, amounted to
$772,601,861, $683,127,314 and $596,374,228 respectively.
F-11
The following unsecured reinsurance recoverables exceeded 3% of the capital
and surplus of the Company at December 31, 1999:
(in thousands)
-------------------------------------------------- ------------------------ ----------------
Reinsurer Amount
-------------------------------------------------- ------------------------ ----------------
Affiliates 2,616,578
General Reinsurance Company 46,481
American Re-Insurance Company 19,213
Swiss Reinsurance America Corporation 17,612
Employers Reinsurance Corporation 11,786
Lloyd's Underwriter 8,243
Oddyssey Reinsurance Company 8,102
Total $2,728,015
==========
7. Dividend Restriction:
Under Alaska law, the Company may pay cash dividends only from earned
surplus determined on a statutory basis. Further, the Company is restricted
(on the basis of the lower of 10% of the Company's statutory surplus at the
end of the preceding twelve-month period or 100% of the Company's net
investment income for the preceding twelve-month period) as to the amount
of dividends it may declare or pay in any twelve-month period without the
prior approval of the State of Alaska Department of Commerce and Economic
Development, Division of Insurance. The maximum dividend payable without
prior approval at December 31, 1999, amounted to approximately $26,833,885.
8. Pension Plans and Deferred Compensation:
The Company's employees participate in benefit plans sponsored by the
Parent, including a noncontributory defined benefit pension plan, and a
voluntary savings plan (a 401(k) plan) which provides certain matching
contributions. These plans cover substantially all of the Company's
employees. The Parent's plans do not separately identify plan benefits and
plan assets attributable to employees of participating companies.
Some of the Company's officers and key employees are participants in the
Parent's Stock Option Plan.
F-12
9. Contingency:
The Company, in common with the insurance industry in general, is subject
to litigation, including claims for punitive damages, in the normal course
of its business. The Company does not believe that such litigation will
have a material adverse affect on its financial condition.
The Company has no known exposure to asbestos or environmental claims.
10. Liability for Unpaid Claims and Claim Adjustment Expenses:
Activity in the liability for unpaid claims and claim adjustment expenses
is summarized as follows:
(in thousands)
-------------------------------------- --------------------- ---------------- ---------------
1999 1998 1997
-------------------------------------- --------------------- ---------------- ---------------
Net Balance at January 1 $221,953 $218,679 $201,994
Incurred related to:
Current year 73,305 83,607 77,740
Prior years 41 (53) (563)
-- ---- -----
Total incurred 73,346 83,554 77,177
------ ------ ------
Paid related to:
Current year 12,999 10,257 7,517
Prior years 73,389 70,023 52,975
------ ------ ------
Total paid 86,388 80,280 60,492
------ ------ ------
Net Balance at December 31 $208,911 $221,953 $218,679
======== ======== ========
F-13