SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
COMMISSION FILE NUMBER 1-10804
XL CAPITAL LTD
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
CAYMAN ISLANDS 98-0191089
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
XL HOUSE, ONE BERMUDIANA ROAD, HAMILTON, BERMUDA HM11
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(441) 292-8515
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 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 [ ]
As of May 10, 2002, there were 135,465,673 outstanding Class A Ordinary
Shares, $0.01 par value per share, of the registrant.
XL CAPITAL LTD
INDEX TO FORM 10-Q
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets as at March 31, 2002 and
December 31, 2001 (Unaudited).............................. 1
Consolidated Statements of Income and Comprehensive Income
for the Three Months Ended March 31, 2002 and 2001
(Unaudited)................................................ 2
Consolidated Statements of Shareholders' Equity for the
Three Months Ended March 31, 2002 and 2001
(Unaudited)................................................ 3
Notes to Unaudited Consolidated Financial Statements ...... 5
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition ........................ 13
Item 3. Quantitative and Qualitative Disclosure about Market Risk.. 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ......................................... 26
Item 4. Submission of Matters to a Vote of Shareholders ........... 26
Item 6. Exhibits and Reports on Form 8-K .......................... 26
Signatures
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
XL CAPITAL LTD
CONSOLIDATED BALANCE SHEETS
(U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
-----------------------------
MARCH 31, DECEMBER 31,
2002 2001
------------ ------------
ASSETS
Investments:
Fixed maturities at fair value (amortized cost: 2002, $11,752,123;
2001, $10,945,568) ..................................................... $ 11,525,883 $ 10,831,927
Equity securities, at fair value (cost: 2002, $684,441; 2001, $575,090) .. 678,319 547,805
Short-term investments, at fair value (amortized cost: 2002, $630,074;
2001, $1,050,015) ...................................................... 629,399 1,050,113
------------ ------------
Total investments available for sale .............................. 12,833,601 12,429,845
Investments in affiliates ................................................ 1,162,725 1,037,344
Other investments ........................................................ 250,384 273,528
------------ ------------
Total investments ................................................. 14,246,710 13,740,717
Cash and cash equivalents ................................................... 2,066,413 1,863,861
Accrued investment income ................................................... 193,662 180,305
Deferred acquisition costs .................................................. 614,717 394,258
Prepaid reinsurance premiums ................................................ 1,080,629 846,081
Premiums receivable ......................................................... 3,404,981 2,182,348
Reinsurance balances receivable ............................................. 1,398,557 1,246,106
Unpaid losses and loss expenses recoverable ................................. 5,063,661 5,033,952
Goodwill and other intangible assets......................................... 1,677,597 1,616,943
Deferred tax asset, net ..................................................... 340,875 419,222
Other assets ................................................................ 629,983 439,282
------------ ------------
Total assets ....................................................... $ 30,717,785 $ 27,963,075
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Unpaid losses and loss expenses ............................................. $ 12,275,728 $ 11,825,680
Deposit liabilities and policy benefit reserves ............................. 2,409,481 2,374,164
Unearned premiums ........................................................... 4,091,367 2,682,089
Notes payable and debt ..................................................... 1,857,670 1,604,877
Reinsurance balances payable ................................................ 1,886,357 1,672,122
Net payable for investments purchased ....................................... 1,483,177 1,247,027
Other liabilities ........................................................... 1,215,846 1,071,402
Minority interest ........................................................... 48,095 48,530
------------ ------------
Total liabilities .................................................. $ 25,267,721 $ 22,525,891
------------ ------------
Commitments and Contingencies
Shareholders' Equity:
Authorized, 999,990,000 Class A ordinary shares, par value $0.01
Issued and outstanding: (2002, 135,511,183; 2001, 134,734,491) ........... $ 1,355 $ 1,347
Contributed surplus ......................................................... 3,427,920 3,378,549
Accumulated other comprehensive loss ........................................ (260,250) (213,013)
Deferred compensation ....................................................... (41,965) (27,177)
Retained earnings ........................................................... 2,323,004 2,297,478
------------ ------------
Total shareholders' equity ......................................... $ 5,450,064 $ 5,437,184
------------ ------------
Total liabilities and shareholders' equity ......................... $ 30,717,785 $ 27,963,075
============ ============
See accompanying Notes to Consolidated Financial Statements
1
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(U.S. DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
---------------------------
2002 2001
----------- -----------
REVENUES:
Net premiums earned - general operations ................................ $ 1,032,953 $ 542,154
Net premiums earned - life operations ................................... 39,193 --
Net investment income ................................................... 171,127 143,096
Net realized (losses) gains on investments .............................. (106,020) 62,535
Net realized and unrealized losses on derivative instruments ............ (13,200) (2,364)
Equity in net income of investment affiliates ........................... 32,185 20,374
Fee income and other..................................................... 8,868 7,069
----------- -----------
Total revenues .................................................. 1,165,106 772,864
----------- -----------
EXPENSES:
Net losses and loss expenses incurred - general operations .............. 646,924 330,204
Claims and policy benefit reserves - life operations .................... 47,763 --
Acquisition costs ....................................................... 185,732 125,872
Operating expenses ...................................................... 145,145 73,058
Exchange gains .......................................................... (8,364) (1,170)
Interest expense ....................................................... 41,622 21,257
Amortization of intangible assets ..................................... 614 14,468
----------- -----------
Total expenses ..................................................... 1,059,436 563,689
----------- -----------
Income before minority interest, income tax expense and equity in net
income of insurance affiliates ............................................. 105,670 209,175
Minority interest in net income of subsidiary ........................... 2,255 1,169
Income tax expense (benefit) ............................................ 13,954 (2,909)
Equity in net income of insurance affiliates ............................ (32) (8,014)
----------- -----------
Net income ................................................................... $ 89,493 $ 218,929
----------- -----------
Change in net unrealized depreciation of investments ......................... (104,314) (29,407)
Foreign currency translation adjustments ..................................... 57,077 (47,122)
----------- -----------
Comprehensive income ......................................................... $ 42,256 $ 142,400
=========== ===========
Weighted average ordinary shares and ordinary share
equivalents outstanding-basic ............................................. 135,119 124,464
=========== ===========
Weighted average ordinary shares and ordinary share
equivalents outstanding - diluted ......................................... 137,843 126,782
=========== ===========
Earnings per ordinary share and ordinary share
equivalent-basic........................................................... $ 0.66 $ 1.76
=========== ===========
Earnings per ordinary share and ordinary share
equivalent - diluted....................................................... $ 0.65 $ 1.73
=========== ===========
See accompanying Notes to Consolidated Financial Statements
2
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(U.S. DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
---------------------------
2002 2001
----------- -----------
ORDINARY SHARES:
Balance-beginning of year ......................................... $ 1,347 $ 1,250
Issue of shares ................................................... -- --
Exercise of stock options ......................................... 8 3
Repurchase of shares .............................................. -- (2)
----------- -----------
Balance-end of year .......................................... 1,355 1,251
----------- -----------
CONTRIBUTED SURPLUS:
Balance-beginning of year ......................................... 3,378,549 2,497,416
Issue of shares ................................................... -- --
Exercise of stock options ......................................... 49,371 16,699
Repurchase of shares .............................................. -- (3,904)
----------- -----------
Balance-end of year .......................................... 3,427,920 2,510,211
----------- -----------
ACCUMULATED OTHER COMPREHENSIVE LOSS:
Balance-beginning of year ......................................... (213,013) (104,712)
Net change in unrealized gains on investment portfolio, net of tax (103,836) (50,407)
Net change in unrealized gains on investment portfolio of affiliate (478) --
Currency translation adjustments .................................. 57,077 (26,122)
----------- -----------
Balance-end of year .......................................... (260,250) (181,241)
----------- -----------
DEFERRED COMPENSATION:
Balance-beginning of year ......................................... (27,177) (17,727)
Issue of restricted shares ........................................ (18,150) (1,240)
Amortization ...................................................... 3,362 1,998
----------- -----------
Balance-end of year .......................................... (41,965) (16,969)
----------- -----------
RETAINED EARNINGS:
Balance-beginning of year ......................................... 2,297,478 3,197,441
Net income ........................................................ 89,493 218,929
Cash dividends paid ............................................... (63,967) (58,090)
Repurchase of shares .............................................. -- (9,726)
----------- -----------
Balance-end of year .......................................... 2,323,004 3,348,554
----------- -----------
$ 5,450,064 $ 5,661,806
TOTAL SHAREHOLDERS' EQUITY ............................................. =========== ===========
See accompanying Notes to Consolidated Financial Statements
3
XL CAPITAL LTD
CONSOLIDATED STATEMENTS OF CASH FLOWS
(U.S. DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
-----------------------------
2002 2001
------------ ------------
CASH FLOWS PROVIDED (USED IN) BY OPERATING ACTIVITIES:
Net income ........................................................... $ 89,493 $ 218,929
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Net realized losses (gains) on sales of investments ................... 106,020 (62,535)
Net realized and unrealized losses on derivative instruments .......... 13,200 2,364
Amortization of discounts on fixed maturities ......................... (7,743) (11,850)
Equity in net income of investment and insurance affiliates ........... (32,212) (28,388)
Amortization of deferred compensation ................................. 3,362 1,998
Amortization of intangible assets ..................................... 614 14,468
Accretion of deposit liabilities ...................................... 13,870 22,250
Unpaid losses and loss expenses ....................................... (52,635) 174,097
Unearned premiums ..................................................... 1,339,880 314,286
Premiums receivable ................................................... (1,150,144) (246,394)
Unpaid losses and loss expenses recoverable ........................... 25,401 (183,837)
Prepaid reinsurance premiums .......................................... (226,174) (57,125)
Reinsurance balances receivable ....................................... (89,718) (36,306)
Deferred acquisition costs ............................................ (220,209) (64,009)
Reinsurance balances payable .......................................... 145,068 111,738
Deferred tax asset .................................................... 81,911 (5,840)
Other ................................................................. (83,304) 36,713
------------ ------------
Total adjustments ................................................ (132,813) (18,370)
------------ ------------
Net cash (used in) provided by operating activities ................... (43,320) 200,559
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Proceeds from sale of fixed maturities and short-term investments ..... 12,166,903 7,477,629
Proceeds from redemption of fixed maturities and short-term investments 978,384 167,189
Proceeds from sale of equity securities ............................... 208,126 350,307
Purchases of fixed maturities and short-term investments .............. (12,970,202) (7,810,907)
Purchases of equity securities ........................................ (89,354) (287,367)
Investments in affiliates, net of dividends received .................. (219,822) (48,647)
Acquisition of subsidiaries, net of cash acquired ..................... (45,466) (20,586)
Other investments ..................................................... 9,440 (27,361)
Fixed assets and other ................................................ (1,170) (5,749)
------------ ------------
Net cash provided by (used in) investing activities ................... 36,839 (205,492)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Proceeds from exercise of stock options ............................... 30,187 14,606
Repurchase of shares .................................................. -- (13,632)
Dividends paid ........................................................ (63,967) (58,090)
Proceeds from notes payable and debt .................................. 596,814 50,000
Repayment of notes payable and debt ................................... (350,000) --
Deposit liabilities ................................................... (3,973) 20,000
------------ ------------
Net cash provided by financing activities .................................. 209,061 12,884
Effects of exchange rate changes on foreign currency cash .................. (28) (1,134)
------------ ------------
Increase in cash and cash equivalents ...................................... 202,552 6,817
Cash and cash equivalents - beginning of year .............................. $ 1,863,861 $ 930,469
============ ============
Cash and cash equivalents - end of year .................................... $ 2,066,413 $ 937,286
============ ============
See accompanying Notes to Consolidated Financial Statements
4
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(U.S. DOLLARS IN THOUSANDS)
1. BASIS OF PREPARATION AND CONSOLIDATION
These unaudited consolidated financial statements include the accounts of
XL Capital Ltd and all of its subsidiaries (collectively referred to as the
"Company") and have been prepared in accordance with U.S. generally accepted
accounting principles ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by GAAP for complete
financial statements. In the opinion of management, these unaudited financial
statements reflect all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation of financial position and results
of operations as at the end of and for the periods presented. The results of
operations for any interim period are not necessarily indicative of the results
for a full year. All significant intercompany accounts and transactions have
been eliminated. The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and 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 these estimates.
Certain reclassifications have been made to prior year consolidated
financial statement amounts to conform to current year presentation. There was
no effect on net income from this change in presentation.
2. ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002, the Company adopted Financial Accounting
Standard ("FAS") 142, "Goodwill and Other Intangible Assets". FAS 142 addresses
financial accounting and reporting for goodwill and other intangible assets both
upon acquisition and after these assets have initially been recognized in the
financial statements. Adoption of FAS 142 has resulted in the Company ceasing to
amortize goodwill. The Company believes there will be no significant effect on
its financial position following the final assessment of the adoption of FAS
142, expected to be completed in the second quarter of 2002.
The following is the pro forma effect on net income and earnings per share
for the quarter ended March 31, 2001 had FAS 142 been effective January 1, 2001
as compared to the net income and earnings per share for the quarter ended March
31, 2002
THREE MONTHS ENDED MARCH 31
---------------------------
2002 2001
-------- ---------
NET INCOME :
Reported net income ........................... $ 89,493 $ 218,929
Add back : Goodwill amortization ............... -- 14,104
-------- ---------
Adjusted net income ............................ $ 89,493 $ 233,033
-------- ---------
BASIC EARNINGS PER SHARE
Reported basic earnings per share .............. $ 0.66 $ 1.76
Goodwill amortization .......................... -- 0.11
-------- ---------
Adjusted basic earnings per share .............. $ 0.66 $ 1.87
-------- ---------
DILUTED EARNINGS PER SHARE
Reported diluted earnings per share ............ $ 0.65 $ 1.73
Goodwill amortization .......................... -- 0.11
-------- ---------
Adjusted diluted earnings per share ............ $ 0.65 $ 1.84
-------- ---------
Of the total goodwill and other intangible assets at March 31, 2002 of
$1,677,597, approximately $1,630,000 is goodwill. The remaining balance is
intangible assets which are being amortized over their estimated useful lives of
periods between six and twenty years.
5
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION
The Company is organized into three underwriting segments - insurance,
reinsurance and financial products and services - in addition to a corporate
segment that includes the investment and financing operations of the Company.
General operations and life operations are disclosed separately within each
segment. There were no significant life operations in the quarter ended March
31, 2001. General operations include property and casualty lines of business and
financial products and services. Effective January 1, 2002, the Company provides
100% of the capacity of its Lloyd's syndicates and these operations are no
longer shown separately within the insurance segment.
The Company evaluates the performance of each segment based on underwriting
profit or loss. Other items of revenue and expenditure of the Company are not
evaluated at the segment level for general operations. In addition, the Company
does not allocate assets by segment for its general operations. Investment
assets related to the Company's life operations are held in portfolios that are
separately managed. Net investment income from these assets are included in net
income from life operations.
Certain general business written by the Company has loss experience
generally characterized as low frequency and high severity. This may result in
volatility in both the Company's and an individual segment's results and
operational cash flows.
6
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION (CONTINUED)
The following is an analysis of the underwriting profit or loss by segment,
together with a reconciliation of underwriting results to net income:
QUARTER ENDED MARCH 31, 2002:
TOTAL FINANCIAL
INSURANCE AND PRODUCTS AND
INSURANCE REINSURANCE REINSURANCE SERVICES TOTAL
--------- ----------- ----------- ------------ ---------
GENERAL OPERATIONS:
Net premiums earned $ 592,656 $ 421,167 $ 1,013,823 $ 19,130 $1,032,953
Fee income and other 6,545 899 7,444 1,422 8,866
Net losses and loss expenses 376,380 264,632 641,012 5,912 646,924
Acquisition costs 91,965 92,214 184,179 958 185,137
Operating expenses (1) 88,973 18,686 107,659 14,990 122,649
Exchange gains (2,112) (6,252) (8,364) -- (8,364)
--------- --------- ----------- --------- ----------
Underwriting profit (loss) $ 43,995 $ 52,786 $ 96,781 $ (1,308) $ 95,473
--------- --------- ----------- --------- ----------
LIFE OPERATIONS:
Life premiums earned $ -- $ 39,193 39,193 $ -- $ 39,193
Fee income and other -- 2 2 -- 2
Claims and policy benefit reserves -- 47,763 47,763 -- 47,763
Acquisition costs and operating expenses -- 1,678 1,678 -- 1,678
Net investment income -- 15,518 15,518 -- 15,518
Net realized losses on investments -- 618 618 -- 618
--------- --------- ----------- --------- ----------
Net income from life operations $ -- $ 4,654 $ 4,654 $ -- $ 4,654
--------- --------- ----------- --------- ----------
Net investment income 155,609
Net realized and unrealized losses on
investments and derivative instruments 118,602
Equity in net income of affiliates 32,217
Interest expense 41,622
Amortization of intangible assets 614
Corporate operating expenses (1) 21,413
Minority interest 2,255
Income tax expense 13,954
----------
Net income $ 89,493
==========
Loss and loss expense ratio (2) 63.5% 62.8% 63.2%
Underwriting expense ratio (2) 30.5% 26.3% 28.8%
----- ----- -----
Combined ratio (2) 94.0% 89.1% 92.0%
===== ===== =====
(1) Operating expenses exclude corporate operating expenses, shown separately.
(2) Ratios are based on net premiums earned from general insurance and
reinsurance operations, excluding fee income and other. The underwriting
expense ratio excludes exchange gains.
7
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION (CONTINUED)
QUARTER ENDED MARCH 31, 2001:
TOTAL FINANCIAL
INSURANCE AND PRODUCTS AND
INSURANCE REINSURANCE REINSURANCE SERVICES TOTAL
--------- --------- ------------- ------------- ---------
GENERAL OPERATIONS:
Net premiums earned $ 269,473 $ 266,860 $ 536,333 $ 5,821 $ 542,154
Fee income and other 2,625 (563) 2,062 5,007 7,069
Net losses and loss expenses 160,131 168,458 328,589 1,615 330,204
Acquisition costs 55,951 69,600 125,551 321 125,872
Operating expenses (1) 32,787 16,706 49,493 11,357 60,850
Exchange (gains) losses (1,382) 212 (1,170) -- (1,170)
--------- --------- --------- --------- ---------
Underwriting profit (loss) $ 24,611 $ 11,321 $ 35,932 $ (2,465) $ 33,467
--------- --------- --------- --------- ---------
Net investment income 143,096
Net realized and unrealized gains on
investments and derivative instruments 60,171
Equity in net income of affiliates 28,388
Interest expense 21,257
Amortization of intangible assets 14,468
Corporate operating expenses (1) 12,208
Minority interest 1,169
Income tax benefit 2,909
---------
Net income $ 218,929
=========
Loss and loss expense ratio (2) 59.4% 63.1% 61.3%
Underwriting expense ratio (2) 32.9% 32.4% 32.6%
----- ----- -----
Combined ratio (2) 92.3% 95.5% 93.9%
===== ===== =====
(1) Operating expenses exclude corporate operating expenses, shown separately.
(2) Ratios are based on net premiums earned from general insurance and
reinsurance operations, excluding fee income and other. The underwriting
expense ratio excludes exchange gains and losses.
8
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
3. SEGMENT INFORMATION (CONTINUED)
The following tables summarize the Company's gross premiums written, net
premiums written and net premiums earned by line of business:
QUARTER ENDED MARCH 31, 2002:
GROSS PREMIUMS NET PREMIUMS NET PREMIUMS
WRITTEN WRITTEN EARNED
---------- ---------- ----------
Casualty insurance $ 495,236 $ 365,476 $ 236,868
Casualty reinsurance 450,329 376,442 159,845
Property catastrophe 197,746 177,402 60,325
Other property 579,257 379,764 229,785
Marine, energy, aviation and satellite 297,870 226,257 103,787
Lloyd's syndicates (1) 333,725 263,814 120,362
Accident and health (2) 127,906 104,977 19,658
Financial products and services 71,796 69,185 19,130
Other insurance (3) 125,599 98,740 57,059
Other reinsurance (3) 132,207 105,351 26,134
---------- ---------- ----------
Total general operations 2,811,671 2,167,408 1,032,953
Life 38,528 36,968 39,193
---------- ---------- ----------
Total $2,850,199 $2,204,376 $1,072,146
========== ========== ==========
QUARTER ENDED MARCH 31, 2001:
GROSS PREMIUMS NET PREMIUMS NET PREMIUMS
WRITTEN WRITTEN EARNED
---------- ---------- ----------
Casualty insurance $ 189,187 $ 111,709 $ 85,008
Casualty reinsurance 171,390 123,045 71,389
Property catastrophe 102,158 97,842 36,822
Other property 177,546 126,893 94,331
Marine, energy, aviation and satellite 177,577 115,408 61,822
Lloyd's syndicates (1) 216,996 134,540 92,159
Financial products and services 11,989 11,933 5,821
Other insurance (3) 66,687 42,654 33,579
Other reinsurance (3) 37,315 48,230 61,223
---------- ---------- ----------
Total $1,150,845 $ 812,254 $ 542,154
========== ========== ==========
(1) The Company's Lloyd's syndicates write a variety of coverages encompassing
most of the above lines of business.
(2) The Company did not write any significant accident and health business in
the quarter ended March 31, 2001.
(3) Other insurance and reinsurance premiums written and earned include
political risk, surety, bonding and warranty lines.
9
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
4. BUSINESS COMBINATIONS
(A) LE MANS RE
Effective January 2002, the Company increased its shareholding in Le Mans
Re from 49% at December 31, 2001 to 67% in order to acquire a majority ownership
and to expand its international reinsurance operations. Le Mans Re underwrites a
worldwide portfolio comprising most classes of property and casualty reinsurance
business together with a selective portfolio of life reinsurance business. The
remaining 33% ownership is held by Les Mutuelles du Mans Assurances Group
("MMA"). However, MMA does not have any economic interest in the future earnings
of Le Mans Re as a result of this ownership. Accordingly, no minority interest
has been recorded. The Company has the option to buy the remaining shares from
MMA for cash in the amount of approximately $119.0 million on December 13, 2002.
MMA has the option to sell the remaining shares to the Company on December 13,
2003, or earlier if specific events occur, for approximately $119.0 million in
cash. These events include, but are not limited to, a reduction of the Standard
& Poor's rating of Le Mans Re and a change of control in either the Company or
Le Mans Re. If the Company or MMA have not exercised their options by December
13, 2003, the parties may agree to extend the exercise period. The Company has
accrued a liability for the purchase of the remaining shares at approximately
$119.0 million, included in other liabilities at March 31, 2002.
The cost of the acquisition, including the liability discussed above was
approximately $171.1 million. Goodwill arising from the acquisition was
approximately $50.0 million. The Company is continuing its assessment of the
value of tangible net assets and intangible assets acquired. Cash paid, net of
cash acquired was $45.5 million during the quarter ended March 31, 2002.
(B) LYNDON LIFE INS. CO.
In the first quarter of 2002, the Company acquired Lyndon Life Ins. Co., a
shell company licensed in forty nine U.S. states, for the purpose of obtaining
licenses for the Company's life operations. The cost of the acquisition was
$13.5 million, paid in April 2002, and intangible assets arising from the
acquisition were $3.5 million.
(C) WINTERTHUR INTERNATIONAL
On July 25, 2001, the Company completed the acquisition of Winterthur
International, a division of Winterthur Swiss Insurance Company, specializing in
writing property and casualty insurance coverages to large multinational
companies.
The following unaudited pro forma financial information for the three
months ended March 31, 2001, include the unaudited financial information for
Winterthur International for the three months ended March 31, 2001 as if the
acquisition of the Winterthur International operations occurred on January 1,
2001. Winterthur International results of operations for the three months ended
March 31, 2001, included in the pro forma financial information have not been
adjusted for the contractual protection that the Company has received from the
seller with effect from July 1, 2001.
The pro forma financial information is based upon information currently
available and certain assumptions that the Company's management believes are
reasonable. The pro forma financial information does not purport to represent
what the Company's results of operations or financial condition would have been
had the transaction occurred on such dates or to project the Company's results
of operations or financial condition for any future period or date. As a result
of the above, the pro forma financial information should be reviewed with
caution and undue reliance should not be placed on such information.
ACTUAL PRO FORMA
QUARTER ENDED QUARTER ENDED
MARCH 31, 2002 MARCH 31, 2001
-------------- --------------
Total revenues $1,165,106 $961,362
Net income $89,493 $142,432
Earnings per ordinary share -- Basic $0.66 $1.14
Earnings per ordinary share -- Diluted $0.65 $1.12
10
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
5. NOTES PAYABLE AND DEBT AND FINANCING ARRANGEMENTS
In January 2002, the Company issued $600.0 million par value Guaranteed
Senior Notes due January 2012. The Notes were issued at $99.469 and gross
proceeds were $596.8 million. The Guaranteed Senior Notes have a coupon of 6.5%.
Related expenses of the offering amounted to $7.9 million. Proceeds of the Notes
were used to pay down $350.0 million of outstanding revolving credit in February
2002 that would have expired in June 2002, and for general corporate purposes.
6. DERIVATIVE INSTRUMENTS
The Company enters into derivative instruments for both risk management and
trading purposes. The Company is exposed to potential loss from various market
risks, including changes in interest rates, foreign currency exchange rates and
commodity values. The commodity risk relates to the Company's participation in
the weather risk management market. The Company manages its market risks based
on guidelines established by management. These derivative instruments are
carried at fair value with the resulting gains and losses recognized in income
in the period in which they occur.
The following table summarizes these instruments and the effect on net
income in the quarters ended March 31, 2002 and 2001:
2002 2001
-------- --------
CREDIT DEFAULT SWAPS:
Net premiums earned ............................ $ 7,431 $ --
Losses and loss expenses ....................... (4,626) --
Net unrealized losses on derivative
instruments .................................. (1,449) --
Fee income and other ........................... -- 3,344
-------- --------
Total .......................................... $ 1,356 $ 3,344
-------- --------
WEATHER RISK MANAGEMENT PRODUCTS:
Fee income and other ........................... $ 919 $ 687
INVESTMENT DERIVATIVES:
Net realized gains (losses) on derivative
instruments .................................. $ 1,307 $(12,683)
Net unrealized (losses) gains on derivative
instruments .................................. (13,058) 10,319
-------- --------
Total .......................................... $(11,751) $ (2,364)
-------- --------
EFFECT ON NET INCOME .............................. $ (9,476) $ 1,667
======== ========
The Company holds warrants in conjunction with certain of its other
investments. These warrants are recorded at fair value based on quoted market
prices. At March 31, 2002, the Company recorded an unrealized loss of $13.4
million related to the change in fair value of these warrants, included in net
unrealized (losses) gains on derivative instruments.
11
XL CAPITAL LTD
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(U.S. DOLLARS IN THOUSANDS)
7. COMPUTATION OF EARNINGS PER ORDINARY SHARE AND ORDINARY SHARE EQUIVALENT
THREE MONTHS ENDED
MARCH 31
--------------------
2002 2001
-------- --------
BASIC EARNINGS PER SHARE:
Net income ............................................. $ 89,493 $218,929
Weighted average ordinary shares outstanding ........... 135,119 124,464
Basic earnings per share ............................... $ 0.66 $ 1.76
======== ========
DILUTED EARNINGS PER SHARE:
Net income ............................................. $ 89,493 $218,929
Weighted average ordinary shares outstanding-basic ..... 135,119 124,464
Average stock options outstanding (1) .................. 2,724 2,318
-------- --------
Weighted average ordinary shares outstanding-diluted ... 137,843 126,782
-------- --------
Diluted earnings per share........................... $ 0.65 $ 1.73
======== ========
DIVIDENDS PER SHARE $ 0.47 $ 0.46
======== ========
(1) Net of shares repurchased under the treasury stock method.
Future weighted average number of shares outstanding may increase by the
convertible debt issued during 2001. Due to the contingent nature of the
conversion features of the debt, there is no effect on diluted earnings per
share for the quarter ended March 31, 2002.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2002
COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2001
(U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
GENERAL
The following is a discussion of the Company's results of operations and
financial condition. Certain aspects of the Company's business have loss
experience characterized as low frequency and high severity. This may result in
volatility in both the Company's results of operations and financial condition.
The Company's results for the three months ended March 31, 2002 include the
results of Winterthur International, a division of Winterthur Swiss Insurance
Company specializing in writing property and casualty insurance coverages to
large multinational companies, that was acquired by the Company with effect from
July 1, 2001. They also include the results of Le Mans Re, accounted for as a
subsidiary with effect from January 1, 2002. Previously, the Company's share of
Le Mans Re's net income was included in equity in net income of insurance
affiliates. Consequently, period to period comparisons of the Company's results
of operations and financial condition may not be meaningful.
This "Management's Discussion and Analysis of Results of Operations and
Financial Condition" contains forward-looking statements which involve inherent
risks and uncertainties. Statements that are not historical facts, including
statements about the Company's beliefs and expectations, are forward-looking
statements. These statements are based upon current plans, estimates and
projections. Actual results may differ materially from those projected in such
forward-looking statements, and therefore undue reliance should not be placed on
them. See Item 3, "Cautionary Note Regarding Forward-Looking Statements", for a
list of factors that could cause actual results to differ materially from those
contained in any forward-looking statement.
This discussion and analysis should be read in conjunction with the
"Management's Discussion and Analysis of Results of Operations and Financial
Condition", and the audited Consolidated Financial Statements and notes thereto
presented under Item 7 and Item 8, respectively, of the Company's Form 10-K for
the year ended December 31, 2001.
CRITICAL ACCOUNTING POLICIES
For a full description of the Company's critical accounting policies, refer
to Item 7 of the Company's Form 10-K for the year ended December 31, 2001.
RESULTS OF OPERATIONS
The following table presents an after-tax analysis of the Company's net
income and earnings per share for the three months ended March 31, 2002 and
2001:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
-----------------------
2002 2001
--------- ---------
Net operating income (1) $ 210,384 $ 156,734
Net realized (losses) gains on investments (107,691) 64,559
Net realized and unrealized losses on derivative
instruments (13,200) (2,364)
--------- ---------
Net income $ 89,493 $ 218,929
========= =========
Earnings per share - basic $ 0.66 $ 1.76
========= =========
Earnings per share - diluted $ 0.65 $ 1.73
========= =========
13
(1) Net operating income excludes after-tax net realized gains and losses on
investments and net realized and unrealized losses on derivative
instruments.
Net operating income increased in the first quarter of 2002 compared to the
first quarter of 2001 primarily due to an increase in underwriting profits.
Underwriting results increased primarily due to growth and pricing increases in
premiums in the insurance and reinsurance segments and the inclusion of
Winterthur International and Le Mans Re.
Net income was significantly reduced by net realized investment losses in
the first quarter of 2002 compared to the same prior year quarter. Included in
net realized losses on investments was a $69.3 million write-down of certain of
the Company's fixed income and equity investments in circumstances where the
Company believed that there was an other than temporary decline in the value of
those investments.
SEGMENTS
INSURANCE OPERATIONS
General insurance business written includes general liability, other
liability including directors and officers, professional and employment
practices liability, environmental liability, property, program business,
marine, aviation, satellite and other product lines including customs bonds,
surety, political risk and specialty lines. No life insurance business has been
written in this segment.
The following table summarizes the underwriting results for this segment:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
-----------------------
2002 2001 % CHANGE
--------- --------- --------
GENERAL:
Net premiums earned $ 592,656 $ 269,473 119.9%
Fee income and other 6,545 2,625 149.3%
Net losses and loss expenses 376,380 160,131 135.0%
Acquisition costs 91,965 55,951 64.4%
Operating expenses 88,973 32,787 171.4%
Exchange gains (2,112) (1,382) 52.8%
--------- --------- -----
Underwriting profit $ 43,995 $ 24,611 78.8%
========= ========= =====
Net unrealized losses on credit default
swaps $ 6,748 $ -- NM
========= ========= ======
*NM - Not Meaningful
In the quarter ended March 31, 2002, the insurance segment included the
results of Winterthur International, which acquisition was effective July 1,
2001. Each of the above line items experienced growth primarily as a result of
the inclusion of business written and earned by Winterthur International.
Consequently, period to period comparisons may not be meaningful.
Net premiums earned included $161.6 million from Winterthur International
in the quarter ended March 31, 2002. Excluding Winterthur International, net
premiums earned increased in the quarter ended March 31, 2002 compared to the
quarter ended March 31, 2001 by approximately $131.0 million due to growth in
new business written and pricing increases across all lines of business,
principally risk management, professional lines, program business and aviation
and marine. Pricing increases were partially in response to market corrections
following the terrorist attacks on September 11, 2001. The Lloyds' syndicates
contributed approximately $30.0 million of additional net premiums earned,
mainly as a result
14
of the acquisition of full ownership of the underwriting capacity of the
syndicates and the earning of increased premiums written in 2001.
The increase in fee income and other for the first quarter of 2002 over the
first quarter of 2001 related primarily to consulting and administration
services provided by Winterthur International for employee benefit plans of
unrelated companies.
In 2001, the Company began to write credit default swaps at primary layers
in this segment. During the quarter ended March 31, 2002 the Company recorded an
unrealized loss of $6.7 million related to the fair value adjustment for these
credit default swaps.
The following table presents the ratios for the insurance segment:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
------------------------
2002 2001
---------- ---------
Loss and loss expense ratio 63.5% 59.4%
Underwriting expense ratio 30.5% 32.9%
---------- ---------
Combined ratio 94.0% 92.3%
========== =========
The loss ratio increased in the quarter ended March 31, 2002 compared to
the same period of 2001 due to the emergence of a lower level of reported losses
in the quarter ended March 31, 2001 for prior underwriting years. In addition,
the loss ratio in the quarter ended March 31, 2002 included approximately $107.3
million of losses related to premiums earned by Winterthur International. It is
uncertain at this time whether the ongoing political and economic crisis in
Argentina will result in losses under political risk insurance policies written
by the Company's insurance operations. Although no such losses were paid or
payable in the first quarter of 2002, the Company believes both the possibility
and magnitude of such losses are likely to increase the longer the crisis
remains unsolved, potentially increasing this segment's loss and loss expense
ratio in future quarters.
The underwriting expense ratio in the quarter ended March 31, 2002 included
acquisition and operating expenses for Winterthur International of $47.4
million. These expenses were reduced by the effect of purchase accounting
treatment on the deferred acquisition costs. Had an historical level of deferred
acquisition costs for Winterthur International been amortized, the expense ratio
for this segment would have been 32.2% in the quarter ended March 31, 2002.
REINSURANCE OPERATIONS
GENERAL
General reinsurance business written includes treaty and facultative
reinsurance to primary insurers of casualty risks, principally: general
liability; professional liability; automobile and workers compensation;
commercial and personal property risks; specialty risks including fidelity and
surety and ocean marine; property catastrophe; property excess of loss; property
pro-rata; marine and energy; aviation and satellite; political risk, and various
other reinsurance to insurers on a worldwide basis. The Company endeavors to
manage its exposures to catastrophic events by limiting the amount of its
exposure in each geographic zone worldwide and requiring that its property
catastrophe contracts provide for aggregate limits and varying attachment
points.
15
The following table summarizes the underwriting results for general
operations for this segment:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
--------------------------
2002 2001 % CHANGE
---------- ---------- --------
Net premiums earned $ 421,167 $ 266,860 57.8%
Fee income and other 899 (563) NM
Net losses and loss expenses 264,632 168,458 57.1%
Acquisition costs 92,214 69,600 32.5%
Operating expenses 18,686 16,706 11.9%
Exchange (gains) losses (6,252) 212 NM
---------- ---------- --------
Underwriting profit $ 52,786 $ 11,321 NM
========== ========== ========
Net premiums earned in the first quarter of 2002 increased compared to the
first quarter of 2001 primarily due to strong growth and pricing increases in
business written in 2002 and the latter half of 2001 across most lines of
business, notably casualty reinsurance and property lines. In addition, the
inclusion of Le Mans Re consolidated as a subsidiary effective January 1, 2002
contributed $63.6 million of additional net premiums earned for the first
quarter of 2002. The increase in net premiums earned also reflected significant
price increases across all lines of business in response to market corrections
following the terrorist attacks on September 11, 2001.
Fee income and other in the quarter ended March 31, 2001 was negative due
to certain non-underwriting costs for outward reinsurance. There were no such
costs in the quarter ended March 31, 2002.
The following table presents the ratios for the reinsurance segment:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
-------------------------
2002 2001
------- -------
Loss and loss expense ratio 62.8% 63.1%
Underwriting expense ratio 26.3% 32.4%
------- -------
Combined ratio 89.1% 95.5%
======= =======
The loss and loss expense ratio for the quarter ended March 31, 2001
included losses arising from the Petrobras oil rig loss and the Seattle
earthquake. There were no significant catastrophe losses in the first quarter of
2002. The change in the loss and loss expense ratio and in the underwriting
expense ratio for the period ended March 31, 2002 reflected the inclusion of Le
Mans Re, which generally carries a higher loss ratio and lower underwriting
expense ratio than other entities in this segment. The reinsurance operations of
the Company have some exposure to political risk losses related to Argentina if
and to the extent any such losses materialize, potentially increasing this
segment's loss and loss expense ratio in future quarters.
The underwriting expense ratio was reduced in the quarter ended March 31,
2002 by the effect of the purchase accounting treatment on the deferred
acquisition costs of Le Mans Re of $4.3 million. In addition, the underwriting
expense ratio was reduced by approximately $8.0 million related to the
curtailment of a pension plan in the U.S. during the quarter ended March 31,
2002.
16
LIFE
Life business written by the Company includes long duration annuity
contracts and traditional mortality risk reinsurance. No such contracts were
written in the first quarter of 2001. Due to the nature of some of these
contracts, premium volume may vary significantly from period to period. The
following summarizes net income from life operations:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
----------------------------
2002 2001
---------- --------
Net premiums earned $ 39,193 $ --
Fee income and other 2 --
Claims and policy benefit reserves 47,763 --
Acquisition costs 595 --
Operating expenses 1,083 --
Net investment income 15,518 --
Net realized losses on investments 618 --
---------- --------
Net income from life operations $ 4,654 $ --
========== ========
Net investment income is included in net income from life operations as it
relates to income earned on portfolios of segregated life investment assets
received that are matched by the assumption of policy benefit reserves on
contracts written. The accretion of the policy benefit reserves is included in
claims and policy benefit reserves.
FINANCIAL PRODUCTS AND SERVICES OPERATIONS
Financial products and services business written includes insurance,
reinsurance and derivative solutions for complex financial risks. These include
financial guaranty insurance and reinsurance, credit enhancement swaps, other
collateralized transactions and weather and other commodity risk management
products. While each of these is unique and is tailored for the specific needs
of the insured or user, they are often multi-year contracts. Due to the nature
of these types of contracts, premium volume as well as underwriting results may
vary significantly from period to period.
Financial guaranties are conditional commitments that guarantee the
performance of certain financial obligations by an obligor to a third party. The
Company's potential liability in the event of non-performance by the issuer of
the insured obligation is represented by its proportionate share of the
aggregate outstanding principal and interest payable ("insurance in force") on
such insured obligation. The Company also guaranties payment obligations of
counterparties under credit default swaps. At March 31, 2002, the Company's net
aggregate insurance in force was approximately $30.5 billion. The range of
maturity of the insured obligations is one to thirty five years.
17
The following table summarizes the underwriting results for this segment:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
--------------------------------
2002 2001 % CHANGE
-------- -------- --------
GENERAL:
Net premiums earned $ 19,130 $ 5,821 228.6%
Fee income and other 1,422 5,007 (71.6%)
Net losses and loss expenses 5,912 1,615 266.1%
Acquisition costs 958 321 198.4%
Operating expenses 14,990 11,357 32.0%
-------- -------- -----
Underwriting loss $ (1,308) $ (2,465) (46.9%)
======== ======== =====
Net unrealized gains on credit default swaps $ 5,299 $ -- NM
======== ======== ======
Net premiums earned increased in the first quarter of 2002 as compared to
the first quarter of 2001 primarily due to significantly greater premiums
written in the financial guaranty business. Net premiums earned in the first
quarter of 2002 also included approximately $2.1 million of weather related risk
management transactions. There were no premiums earned from weather related risk
management transactions in the first quarter of 2001.
A component of financial guaranty business is written in credit default
swap form. The Company fair values credit default swaps by modeling its
exposures and creating indices by using proxies of the spreads on similar
categories of exposures. For the first quarter of 2001, all adjustments to the
fair value of credit default swaps were included in fee income and other. For
the first quarter of 2002, the components of the fair value changes are included
in net premiums earned, net losses and loss expenses and in net realized and
unrealized gains and losses on derivative instruments.
Net losses and loss expenses increased in the quarter ended March 31, 2002
relative to the growth in net premiums earned. The increase in operating
expenses reflected the continued expansion of operations in this segment. These
expenses, relative to the segment's revenues, have improved compared to the
prior year's quarter as the growing portfolio of aggregate insurance in force is
earned.
INVESTMENT OPERATIONS
The following table illustrates the change in net investment income and net
realized (losses) gains on investments for the quarters ended March 31, 2002 and
2001:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
------------------------------------
2002 2001 % CHANGE
--------- --------- --------
Net investment income $ 155,609 $ 143,096 8.7%
Net realized (losses) gains on investments (105,402) 62,535 NM
Net realized and unrealized losses on investment
derivative instruments (11,751) (2,364) NM
Net investment income increased in the first quarter of 2002 as compared to
the first quarter of 2001 due primarily to a higher investment base in 2002. The
growth in the investment base included the receipt of funds related to new debt
and equity issued by the Company and the addition of assets from Winterthur
International and Le Mans Re. The effect of the higher investment base was
partially offset by decreases in
18
general interest rate levels for the three months ended March 31, 2002 compared
to the three months ended March 31, 2001.
Assets related to deposit liabilities are included in investments available
for sale. Interest earned on deposit liability assets is included in investment
income, however the investment expense related to the accretion of deposit
liabilities is included in interest expense. Previously, the accretion charge
was included in net investment income. The first quarter of 2001 has been
reclassified for this change. There was no effect on net income from this change
in presentation.
Net realized losses on investments in the first quarter of 2002 included a
loss of approximately $69.3 million related to a write-down of certain of the
Company's fixed income and equity investments in circumstances where the Company
believed that there was an other than temporary decline in the value of those
investments.
Net realized and unrealized losses on investment derivative instruments
resulted primarily from the fair value of warrants held by the Company in
conjunction with certain of its other investments, based on quoted market
values. See Item 3, "Quantitative and Qualitative Disclosure About Market
Risk", for a more detailed analysis.
OTHER REVENUES AND EXPENSES
The following table sets forth other revenues and expenses for the three
months ended March 31, 2002 and 2001:
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
---------------------------------
2002 2001 % CHANGE
-------- -------- --------
Equity in net income of investment affiliates $ 32,185 $ 20,374 58.0%
Equity in net income of insurance affiliates 32 8,014 (99.6%)
Amortization of intangible assets 614 14,468 (95.8%)
Corporate operating expenses 21,413 12,208 75.4%
Interest expense 41,622 21,257 95.8%
Minority interest 2,255 1,169 92.9%
Income tax expense (benefit) 13,954 (2,909) NM
Equity in net income of investment affiliates increased in the first
quarter of 2002 over the first quarter of 2001 due primarily to an increase in
returns on the Company's investments in closed-end investment funds and the
management companies that administer these investment funds.
The decrease in equity in net income of insurance affiliates primarily
resulted from the acquisition of a majority shareholding in Le Mans Re, and its
consolidation as a subsidiary of the Company effective January 1, 2002.
Previously, the Company's share of Le Mans Re's net income was included in
equity in net income of insurance affiliates.
Amortization of intangible assets decreased in the first quarter of 2002
compared to the first quarter of 2001 due to the adoption of FAS 142, where the
Company is no longer required to amortize goodwill. Had FAS 142 been effective
January 1, 2001, the amortization expense would have been approximately $364 in
the quarter ended March 31, 2001. The Company believes there will be no
significant effect on its financial position following the final assessment of
the adoption of FAS 142.
Corporate operating expenses in the quarter ended March 31, 2002 have
increased compared to the three months ended March 31, 2001 due to the continued
worldwide expansion of the Company's operations.
19
The increase in interest expense primarily reflects an increase in the
level of indebtedness from March 31, 2001 to March 31, 2002. The Company's
financing structure is outlined in "--Financial Condition and Liquidity."
The change in the income taxes of the Company primarily reflected an
improvement in the profitability of the Company's operations in the first
quarter of 2002 as compared to the first quarter of 2001.
FINANCIAL CONDITION AND LIQUIDITY
As a holding company, the Company's assets consist primarily of its
investments in subsidiaries, and the Company's future cash flows depend on the
availability of dividends or other statutorily permissible payments from its
subsidiaries. The ability to pay such dividends is limited by the applicable
laws and regulations of the various countries the Company operates in including,
among others, Bermuda, the United States, Ireland, Switzerland and the United
Kingdom, and those of the Society of Lloyd's. No assurance can be given that the
Company or its subsidiaries will be permitted to pay dividends in the future.
The Company's ability to underwrite business is largely dependent upon the
quality of its claims paying and financial strength ratings as evaluated by
independent agencies. The Company regularly provides financial information to
these agencies to both maintain and enhance existing ratings.
The Company's shareholders' equity at March 31, 2002 was $5.5 billion of
which $2.3 billion was retained earnings.
The Company's fixed income investments including short-term investments and
cash equivalents at March 31, 2002 represented approximately 90% of invested
assets and were managed by several outside investment management firms.
Approximately 92.5% of fixed income securities are investment grade, with 68.4%
rated Aa or AA or better by a nationally recognized rating agency. The average
quality of the fixed income portfolio was Aa2.
At March 31, 2002, total investments available for sale and cash, net of
unsettled investment trades, were $13.4 billion compared to $13.0 billion at
December 31, 2001. The net payable for investments purchased increased from $1.2
billion at December 31, 2001 to $1.5 billion at March 31, 2002. This increase
results from timing differences as investments are accounted for on a trade date
basis.
For the quarter ended March 31, 2002, currency translation adjustments were
$57.1 million. This is shown as part of accumulated other comprehensive loss and
primarily related to unrealized gains on foreign currency exchange rate movement
at Winterthur International and Le Mans Re, where most operations have a
functional currency that is not the U.S. dollar.
The Company establishes reserves to provide for estimated claims, the
general expenses of administering the claims adjustment process and for losses
incurred but not reported. These reserves are calculated using actuarial and
other reserving techniques to project the estimated ultimate net liability for
losses and loss expenses. The Company's reserving practices and the
establishment of any particular reserve reflect management's judgment concerning
sound financial practice and does not represent any admission of liability with
respect to any claims made against the Company. No assurance can be given that
actual claims made and payments related thereto will not be in excess of the
amounts reserved.
Inflation can, among other things, lead to increased damage awards and
potentially result in larger claims. The Company's underwriting philosophy is to
adjust premiums in response to inflation, although this may not always be
possible due to competitive pressures. Inflationary factors are considered in
determining the premium level on any multi-year policies at the time contracts
are written.
The Company's liquidity depends on operating, investing and financing cash
flows, discussed below.
20
Certain business written by the Company has loss experience generally
characterized as having low frequency and high severity. This may result in
volatility in both the Company's results and operational cash flows. Operational
cash flows during the first three months of 2002 decreased from the same period
of 2001 primarily due to increased losses paid in 2002. In the three months
ended March 31, 2002 and 2001, the net amount of losses paid by the Company was
$636.8 million and $334.6 million, respectively. The increase in 2002 is due to
growth in operations and the inclusion of Winterthur International and Le Mans
Re. This cash outflow is expected to be partially offset by an anticipated
increased flow of premiums in the remaining quarters of 2002.
The Company's cash flow has not yet been adversely affected by the
terrorist attacks on September 11, 2001 as the majority of losses are in unpaid
losses and loss expense reserves at March 31, 2002. Settlement of most of these
claims is expected to occur beginning in 2002. The Company has reviewed the
anticipated cash flow from the terrorist attacks on September 11, 2001 and
believes it has sufficient liquidity to meet its obligations.
In the three months ended March 31, 2002, the Company made the following
significant investments:
(1) Effective January 2002, the Company completed the acquisition of a 67%
majority shareholding in Le Mans Re, increasing its shareholding from 49% at
December 31, 2001. Cash paid, net of cash acquired, was $45.5 million.
(2) The Company invested a further $219.9 million in affiliates, the
majority of which related to investments in alternative investment managers and
related investment funds.
As at March 31, 2002, the Company had bank, letter of credit and loan
facilities available from a variety of sources including commercial banks
totaling $4.8 billion, of which $1.9 billion in debt was outstanding. In
addition, $2.0 billion of letters of credit were outstanding, 6% of which were
collateralized by the Company's investment portfolio, supporting U.S.
non-admitted business and the Company's Lloyd's capital requirements.
The following tables present the Company's indebtedness under outstanding
securities and lenders' commitments as at March 31, 2002:
PAYMENTS DUE BY PERIOD
----------------------------------------------------
LESS
YEAR OF THAN 1 TO 3 4 TO 5 AFTER 6
NOTES PAYABLE AND DEBT COMMITMENT IN USE EXPIRY 1 YEAR YEARS YEARS YEARS
- ---------------------- ---------- ---------- ------- ---------- ---------- ---------- ----------
364-day revolver ...................... $ 500,000 $ -- 2002 $ -- $ -- $ -- $ --
7.15% Senior Notes .................... 100,000 99,974 2005 -- 100,000 -- --
6.58% Guaranteed Senior Notes . ....... 255,000 255,000 2011 -- -- -- 255,000
6.50% Guaranteed Senior Notes ......... 600,000 596,894 2012 -- -- -- 600,000
Zero Coupon Convertible Debentures (1) 613,603 613,603 2021 -- -- -- 1,010,833
Liquid Yield Option Notes(TM) (1) ..... 292,199 292,199 2021 -- -- -- 508,842
---------- ---------- ---------- ---------- ---------- ----------
Total ................................. $2,360,802 $1,857,670 $ -- $ 100,000 $ -- $2,374,675
========== ========== ========== ========== ========== ==========
(1) "Commitment" and "In Use" data represent March 31, 2002 accreted values.
"After 6 years" data represent ultimate redemption values. The convertibles
may be "put" or converted by the bondholders at various times prior to the
2021 redemption date. The Company may also choose to "call" the debt from
May and September 2004 onwards.
In January 2002, the Company issued $600.0 million par value 6.50%
Guaranteed Senior Notes due January 2012. The notes were issued at $99.469 and
gross proceeds were $596.8 million. Related expenses of the offering amounted to
$7.9 million. Proceeds of the Notes were used to pay down two 5-year revolving
credit facilities of $350.0 million and for general corporate purposes. These
credit facilities were subsequently canceled.
21
The total pre-tax interest expense on the borrowings described above was
$27.7 million and $8.5 million for the three months ended March 31, 2002 and
2001, respectively.
AMOUNT OF COMMITMENT
EXPIRATION PER PERIOD
----------------------------------------------------
LESS
YEAR OF THAN 1 TO 3 4 TO 5 AFTER 6
OTHER COMMERCIAL COMMITMENTS COMMITMENT IN USE EXPIRY 1 YEAR YEARS YEARS YEARS
- ---------------------------- ---------- ---------- ------- ---------- ---------- ---------- ----------
Letter of Credit Facilities........... $ 2,474,000 $ 1,990,000 2002 $ 2,474,000 -- -- --
The Company has several letter of credit facilities provided on a
syndicated and bilateral basis from commercial banks and, in the case of the
Winterthur International operations, from the previous owner of those
operations. These facilities are utilized to support non-admitted insurance and
reinsurance operations in the U.S. and capital requirements at Lloyd's. All of
the commercial facilities are scheduled for renewal during 2002, and the
Winterthur International arrangement will terminate in July 2002. In addition to
letters of credit, the Company has established insurance trusts in the U.S. that
provide cedents with statutory relief required under state insurance regulation
in the U.S. It is anticipated that the commercial facilities will be renewed on
expiry but such renewals are subject to the availability of credit from banks
utilized by the Company. In the event that such credit support is insufficient,
the Company could be required to provide alternative security to cedents. This
could take the form of additional insurance trusts supported by the Company's
investment portfolio or funds withheld using the Company's cash resources. The
value of letters of credit required is driven by, among other things, loss
development of existing reserves, the payment pattern of such reserves, the
expansion of business written by the Company and the loss experience of such
business.
The letter of credit facilities included a $150.0 million secured letter of
credit facility established in January 2002. This facility is unutilized and
will expire at the end of 2002. In addition, Le Mans Re has a secured letter of
credit facility, included in the table above, under which letters of credit
amounting to $42.0 million were issued.
For information on cross-default and other provisions in the Company's debt
documents, see Item 7 of the Company's Form 10-K for the year ended December 31,
2001.
The Company has had several share repurchase programs in the past as part
of its capital management strategy. On January 9, 2000, the Board of Directors
authorized a program for the repurchase of shares up to $500.0 million. Under
this plan, the Company has purchased 6.6 million shares at an aggregate cost of
$364.6 million or an average cost of $55.24 per share. The Company has $135.4
million remaining in its share repurchase authorization. No shares were
repurchased during the quarter ended March 31, 2002.
As previously reported by the Company, XL Capital Partners L.L.P., an
investment partnership (the "Partnership"), was formed in 2001. The general
partner (the "General Partner") of the Partnership is a wholly-owned subsidiary
of the Company and the limited partners include current and former employees and
directors of the Company. The Partnership has determined not to make any
additional investments in which current or former senior officers or directors
participate or co-invest with the General Partner and return uninvested cash to
such individuals. After giving effect to maximum committed investments, the
General Partner would have invested approximately $16.2 million in the
Partnership.
CURRENT OUTLOOK
In the first quarter of 2002, the Company recognized record levels of net
premiums earned, primarily due to increases in pricing across virtually all
property and casualty lines of insurance and reinsurance business following the
terrorist attacks on September 11, 2001, the acquisition of Winterthur
International effective July 1, 2001 and taking a majority ownership stake in Le
Mans Re, effective January 1, 2002. The Company believes current market
conditions will prevail through 2002 for most lines of property and casualty
business the Company writes, which should translate to sustained rates and
improved terms and conditions. These improvements are, however, tempered by,
among other things, a challenging investment income environment and potential
unusual loss events.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
The Company is exposed to potential loss from various market risks,
including changes in interest rates, foreign currency exchange rates, equity
prices and commodity values, as it relates to the Company's participation in the
weather risk management market. The Company manages its market risks based on
guidelines established by senior management. The Company enters into derivatives
and other financial instruments for trading and risk management purposes. These
derivative instruments are carried at fair market value with the resulting gains
and losses recognized in income in the period in which they occur.
This risk management discussion and the estimated amounts generated from
the sensitivity and value-at-risk ("VaR") analyses presented in this document
are forward-looking statements of market risk assuming certain adverse market
conditions occur. Actual results in the future may differ materially from these
estimated results due to, among other things, actual developments in the global
financial markets. The results of analysis used by the Company to assess and
mitigate risk should not be considered projections of future events of losses.
See generally "Cautionary Note Regarding Forward-Looking Statements."
COMMODITY RISK
The Company offers weather risk management products in insurance or
derivative form to end-users, while hedging the risks in the over-the-counter
and exchange traded derivatives markets. In addition to entering into
transactions with end-users, the Company also maintains a weather derivatives
trading portfolio, with the majority of contracts outstanding for less than
twelve months. The fair values of these transactions are determined using
quantitative analysis. The models used to determine these fair values are
consistent with the models used to estimate the Company's VaR exposure to
weather risk.
The Company's high, low and average aggregate seasonal VaR amounts during
the period ended March 31, 2002 were $25.1 million, $1.8 million and $8.8
million, respectively, calculated at a 99% confidence level. The Company
calculates its aggregate VaR by summing the VaR amounts for each of its seasonal
portfolio. Since VaR statistics are estimates based on historical position and
market data, VaR should not be viewed as an absolute, predictive gauge of future
financial performance or as a way for the Company to predict risk. There can be
no assurance that the Company's actual future losses will not exceed its VaR
amounts.
The following table summarizes the movement in the fair value of contracts
outstanding during the quarter ended March 31, 2002:
Fair value of contracts outstanding, beginning of the year.......... $(1,104)
Contracts realized or otherwise settled ............................ (8,343)
Fair value of new contracts ........................................ 4,497
Other changes in fair value......................................... 10,769
-------
Fair value of contracts outstanding, end of period.................. $ 5,819
-------
23
The following table summarizes the maturity of contracts outstanding at
March 31, 2002:
Greater
Less than than 5 Total Fair
Source of Fair Value 1 Year 1-3 Years 4-5 Years Years Value
-------------------- ------ --------- --------- ------- ----------
Prices actively quoted............................... $ (241) $ -- $ -- $ -- $ (241)
Prices based on models and other valuation methods... 5,387 673 -- -- 6,060
------ ---- ---- ---- ------
Total fair value of contracts outstanding............ $5,146 $673 $ -- $ -- $5,819
------ ---- ---- ---- ------
The Company seeks to identify, assess, monitor and manage, in accordance
with defined policies and procedures its market, credit, operational and legal
risks. The Company's senior management takes an active role in the risk
management process and has developed and implemented policies and procedures
that require specific administrative and business functions to assist in the
identification, assessment and control of various risks. Due to the changing
nature of the global marketplace, the Company's risk management policies,
procedures and methodologies are evolving and are subject to ongoing review and
modification. Market, credit, operational, legal and other risks are inherent in
the Company's weather risk management business and cannot be wholly eliminated
or reduced despite the Company's risk management policies, procedures and
methodologies, which are subject to limitations and assumptions.
The Company has written a small number of exchange traded energy contracts
in the first quarter of 2002. The fair value of those contracts is not
significant.
INVESTMENT MARKET RISK
The Company's investment portfolio consists of fixed income and equity
securities, denominated in both U.S. and foreign currencies. Accordingly,
earnings will be affected by, among other things, changes in interest rates,
equity prices and foreign currency exchange rates. External investment
professionals manage the Company's portfolio under the direction of the
Company's management in accordance with detailed investment guidelines provided
by the Company. These guidelines encompass investments in derivatives.
Derivatives can only be utilized for purposes of managing interest rate risk,
foreign exchange risk and credit risk, provided the use of such instruments are
incorporated in the overall portfolio duration, spread, convexity and other
relevant portfolio metrics. The use of derivatives is not permitted to
economically leverage the portfolio outside of the stated guidelines.
VaR is one of the tools used by management to measure potential losses in
fair values using historical rates, market movements and credit spreads to
estimate the volatility and correlation of these factors to calculate the
maximum loss that could occur over a defined period of time given a certain
probability. The VaR of the investment portfolio, including all investment
related derivatives, at March 31, 2002 was approximately $260.0 million.
The Company also uses derivative investments to add value to the investment
portfolio where market inefficiencies are believed to exist, to equitize cash
holdings of equity managers and to adjust the duration of a portfolio of fixed
income securities to match the duration of related deposit liabilities.
At March 31, 2002, bond and stock index futures outstanding were $193.4
million with underlying investments having a market value of $1.8 billion. Gains
of $2.1 million were realized on these contracts for the three months ended
March 31, 2002. The Company reduces its exposure to these futures through
offsetting transactions, including options and forwards. The VaR of all
investment related derivatives at March 31, 2002 was approximately $5.8 million.
The Company holds warrants in conjunction with certain of its other
investments. These warrants are recorded at fair value based on quoted market
prices. For the quarter ended March 31, 2002, the Company recorded an unrealized
loss of $13.4 million related to the change in fair value of these warrants.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 ("PSLRA") provides a
"safe harbor" for forward-looking statements. Any prospectus, prospectus
supplement, the Company's Annual Report to
24
Shareholders, any proxy statement, any Form 10-K, Form 10-Q or Form 8-K of the
Company or any other written or oral statements made by or on behalf of the
Company may include forward-looking statements which reflect the Company's
current views with respect to future events and financial performance. Such
statements include forward-looking statements both with respect to the Company
in general, and the insurance, reinsurance and financial products and services
sectors in particular (both as to underwriting and investment matters).
Statements that are not historical facts, including statements about the
Company's beliefs and expectations, are forward-looking statements. These
statements are based on current plans, estimates and projections. Statements
which include the words "expect", "intend", "plan", "believe", "project",
"anticipate", "will", and similar statements of a future or forward-looking
nature identify forward-looking statements for purposes of the PSLRA or
otherwise.
All forward-looking statements address matters that involve inherent risks
and uncertainties. Accordingly, there are or will be important factors that
could cause actual results to differ materially from those indicated in such
forward-looking statements. The Company believes that these factors include, but
are not limited to, the following: (i) rate increases and improvements in terms
and conditions may not be as large or sustainable as the Company is currently
projecting; (ii) the size of the Company's claims may change due to the
preliminary nature of reports and estimates of loss and damage, or due to
adverse development over time, including in relation to the attacks in the
United States on September 11, 2001; (iii) the timely and full recoverability of
reinsurance placed by the Company with third parties; (iv) the projected amount
of ceded reinsurance recoverables and the ratings and creditworthiness of
reinsurers may change; (v) the timing of claims payments being faster or the
receipt of reinsurance recoverables being slower than anticipated by the
Company; (vi) ineffectiveness or obsolescence of the Company's business strategy
due to changes in current or future market conditions; (vii) increased
competition on the basis of pricing, capacity, coverage terms or other factors;
(viii) greater frequency or severity of claims and loss activity, including as a
result of natural or man-made catastrophic events, than the Company's
underwriting, reserving or investment practices anticipate based on historical
experience or industry data; (ix) developments in the world's financial and
capital markets which adversely affect the performance of the Company's
investments and the Company's access to such markets; (x) the potential impact
of government-sponsored solutions to make available insurance coverage for acts
of terrorism; (xi) developments in the Enron Corp. bankruptcy proceedings or
other developments related to Enron Corp. in so far as they affect property and
casualty insurance and reinsurance coverages; (xii) availability of borrowings
and letters of credit under the Company's credit facilities; (xiii) changes in
regulation or tax laws applicable to the Company and its subsidiaries, brokers
or customers; (xiv) acceptance of the Company's products and services, including
new products and services; (xv) changes in the availability, cost or quality of
reinsurance; (xvi) changes in the distribution or placement of risks due to
increased consolidation of insurance and reinsurance brokers; (xvii) loss of key
personnel; (xviii) the effects of mergers, acquisitions and divestitures,
including, without limitation, the Winterthur International acquisition; (xix)
changes in rating agency policies or practices; (xx) changes in accounting
policies or practices that could adversely affect the Company's financial
statutory and other statements and reports; (xxi) legislative, tax or regulatory
developments that could adversely affect the Company or the ability of customers
or brokers to do business with the Company; (xxii) changes in general economic
conditions, including inflation, foreign currency exchange rates and other
factors; (xxiii) the effects of business disruption or economic contraction due
to terrorism or other hostilities; (xxiv) developments relating to Argentina,
including the impact of any potential International Monetary Fund assistance or
structural reforms within Argentina; and (xxv) the other factors set forth in
the Company's most recent report on Form 10-K and the Company's other documents
on file with the SEC. The foregoing review of important factors should not be
construed as exhaustive and should be read in conjunction with the other
cautionary statements that are included herein or elsewhere. The Company
undertakes no obligation to publicly update or revise any forward-looking
statement, whether as a result of new information, future developments or
otherwise.
25
XL CAPITAL LTD
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a party to various legal proceedings, including
arbitrations, arising in the ordinary course of business. Such legal proceedings
generally relate to claims asserted by or against the Company's subsidiaries in
the ordinary course of their respective insurance, reinsurance and financial
products and services operations. The Company does not believe that the eventual
resolution of any of the legal proceedings to which it is a party will result in
a material adverse effect on its financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
10.58 Nicholas M. Brown, Jr. Employment Agreement, dated April 1, 2002.
10.59 Nicholas M. Brown, Jr. Retirement Agreement, dated April 1, 2002.
10.60 Amendment No. 2, dated March 15, 2002, to the 364-Day Credit Agreement,
dated June 29, 2001 between XL Capital Ltd, X.L. America, Inc., XL
Insurance (Bermuda) Ltd, XL Europe Ltd, XL Re Ltd, as borrowers and
guarantors, the lenders party thereto and JPMorgan Chase Bank (formerly
The Chase Manhattan Bank), as administrative agent.
10.61 Amendment No. 2, dated March 15, 2002, to the Letter of Credit and
Reimbursement Agreement, dated June 29, 2001 between XL Capital Ltd,
X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd, XL Re
Ltd, as account parties and guarantors, the lenders party thereto and
JPMorgan Chase Bank (formerly The Chase Manhattan Bank), as
administrative agent.
10.62 Amendment No. 1, dated March 21, 2002 to the Letter of Credit Facility
and Reimbursement Agreement, dated November 20, 2001 between XL Capital
Ltd, X.L. America, Inc., XL Insurance (Bermuda) Ltd, XL Europe Ltd, XL
Re Ltd, as guarantors and Citibank International Plc, as agent and
security trustee.
99.7 XL Capital Assurance Inc. unaudited condensed financial statements for
the three month periods ended March 31, 2002 and 2001.
99.8 XL Financial Assurance Ltd. unaudited condensed financial statements
for the three month periods ended March 31, 2002 and 2001.
(B) REPORTS ON FORM 8-K
None.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
XL CAPITAL LTD
---------------------------------------------------------
(REGISTRANT)
/S/ BRIAN M. O'HARA
---------------------------------------------------------
BRIAN M. O'HARA
PRESIDENT AND CHIEF EXECUTIVE OFFICER
/S/ JERRY DE ST. PAER
---------------------------------------------------------
JERRY DE ST. PAER
EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
27