1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended APRIL 30, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 001-14336 MID OCEAN LIMITED (Exact name of registrant as specified in its charter) Cayman Islands Not Applicable (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) Richmond House, 12 Par-la-Ville Road, Hamilton HM 08, Bermuda (Address of principal executive offices) Telephone Number: (441) 292-1358 (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 for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ As of June 5th, 1998 there were outstanding 36,088,148 Class A Ordinary Shares, 1,190,292 Class B Ordinary Shares and 1,860,000 Class C Ordinary Shares, each of $0.20 par value, of the registrant. 2 MID OCEAN LIMITED INDEX PART I - FINANCIAL INFORMATION Financial Statements: Page Consolidated Balance Sheets 3 at April 30, 1998 (unaudited) and October 31, 1997 Consolidated Statements of Operations 4 for the quarter and six months ended April 30, 1998 and 1997 (unaudited) Consolidated Statements of Cash Flows 5 for the six months ended April 30, 1998 and 1997 (unaudited) Notes to Consolidated Financial Statements (unaudited) 6 Management Discussion and Analysis of Financial 7 Condition and Results of Operations PART II - OTHER INFORMATION Item 4 Submission of Matters to a Vote of Security Holders 20 Item 6 Exhibits and Reports on Form 8-K 20 Exhibit 11 Computation of Earnings per Share 21 Signatures 22 3 PART I. FINANCIAL INFORMATION MID OCEAN LIMITED CONSOLIDATED BALANCE SHEETS (THOUSANDS OF UNITED STATES DOLLARS) APRIL 30, 1998 OCTOBER 31, 1997 ASSETS (UNAUDITED) (AUDITED) Investments available for sale at fair value: Fixed maturities (Amortized cost $1,374,054; 1997: $1,484,353) $ 1,383,867 $ 1,502,213 Equities (cost $188,006 1997: $22,388) 192,426 23,539 Short-term investments (Amortized cost $17,015; 1997: $21,087) 17,019 21,092 ----------- ----------- Total investments available for sale 1,593,312 1,546,844 Unquoted investments at cost 11,839 9,880 Cash and cash equivalents 209,673 122,784 Accrued investment income 16,537 22,076 Premiums receivable 416,977 262,405 Reinsurance balances receivable 26,553 20,775 Funds withheld by cedents 8,460 20,963 Outstanding losses recoverable from reinsurers 18,889 17,792 Prepaid reinsurance premiums 39,917 14,679 Profit commissions receivable 11,661 32,484 Investments pending settlement 2,629 1,809 Deferred acquisition costs 75,820 45,856 Goodwill 108,781 112,506 Other assets 36,060 39,752 ----------- ----------- TOTAL ASSETS $ 2,577,108 $ 2,270,605 =========== =========== LIABILITIES Losses and loss expenses $ 546,772 $ 496,952 Unearned premiums 469,277 321,845 Reinsurance balances payable 37,278 12,973 Loan Notes 10,767 10,573 Other liabilities 61,222 55,301 ----------- ----------- TOTAL LIABILITIES 1,125,316 897,644 ----------- ----------- SHAREHOLDERS' EQUITY Ordinary Shares (par value $0.20; authorized 200,000,000 shares; issued and outstanding, 39,138,440; 38,984,080) 7,828 7,797 Additional paid-in capital 746,565 740,538 Net unrealized appreciation on investments 14,237 18,679 Foreign currency translation adjustments 2,043 386 Deferred compensation (8,538) (5,286) Retained earnings 689,657 610,847 ----------- ----------- TOTAL SHAREHOLDERS' EQUITY 1,451,792 1,372,961 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,577,108 $ 2,270,605 =========== =========== See accompanying notes to consolidated financial statements. 3 4 MID OCEAN LIMITED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS) QUARTER ENDED SIX MONTHS ENDED REVENUES APRIL 30, 1998 APRIL 30, 1997 APRIL 30, 1998 APRIL 30, 1997 Gross premiums written $ 156,808 $ 137,858 $ 418,456 $ 397,694 Change in unearned premiums (18,463) 5,723 (144,642) (133,154) ------------ ------------ ------------ ------------ Premiums earned 138,345 143,581 273,814 264,540 Premiums ceded 43,403 21,806 55,908 31,503 Change in prepaid premiums (27,881) (8,997) (27,898) (5,812) ------------ ------------ ------------ ------------ Premiums ceded 15,522 12,809 28,010 25,691 Net premiums earned 122,823 130,772 245,804 238,849 Net investment income 28,010 25,335 54,393 49,175 Net gains (losses) on investments 11,627 (3,387) 25,907 (729) Exchange loss (1,410) (899) (4,048) (7,785) Managing agency income 3,568 3,157 7,247 6,406 Other income 4,579 2,454 6,346 3,494 ------------ ------------ ------------ ------------ Total Revenues 169,197 157,432 335,649 289,410 ------------ ------------ ------------ ------------ EXPENSES Losses and loss expenses incurred 61,090 63,678 129,764 120,908 Reinsurance recoveries (13,837) (6,667) (20,226) (12,460) ------------ ------------ ------------ ------------ Net losses and loss expenses incurred 47,253 57,011 109,538 108,448 Acquisition expenses 19,961 21,829 40,010 38,513 Managing agency expenses 1,789 1,683 3,592 1,670 Operational expenses 18,307 13,156 34,296 22,585 ------------ ------------ ------------ ------------ Total Expenses 87,310 93,679 187,436 171,216 ------------ ------------ ------------ ------------ Net income before tax and minority interest 81,887 63,753 148,213 118,194 Income tax (2,238) (1,216) (4,843) (3,222) Minority interest 0 379 0 (54) ------------ ------------ ------------ ------------ Net income $ 79,649 $ 62,916 $ 143,370 $ 114,918 ============ ============ ============ ============ PER SHARE DATA Net income per ordinary share: Basic $ 2.04 $ 1.66 $ 3.66 $ 3.11 Diluted $ 2.01 $ 1.65 $ 3.63 $ 3.09 Dividend per ordinary share $ 0.825 $ 0.75 $ 1.65 $ 1.50 Weighted average number of ordinary shares outstanding: Basic 39,134,793 37,843,218 39,125,535 36,904,783 Diluted 39,566,446 38,146,128 39,513,341 37,222,247 See accompanying notes to consolidated financial statements. 4 5 MID OCEAN LIMITED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (THOUSANDS OF UNITED STATES DOLLARS) SIX MONTHS ENDED APRIL 30, 1998 APRIL 30, 1997 CASH FLOWS FROM OPERATING ACTIVITIES (UNAUDITED) (UNAUDITED) Net Income $ 143,370 $ 114,918 Adjustments to reconcile net income to cash provided by operating activities: Amortization of premiums on investments (246) 2,336 Amortization of goodwill 3,724 909 Net (gains) losses on investments (25,907) 729 Change in: Accrued investment income 5,558 2,966 Premiums receivable (150,103) (110,237) Deferred acquisition costs (29,014) (21,519) Outstanding losses recoverable from reinsurers (748) (1,151) Prepaid reinsurance premiums (24,544) 1,436 Profit commissions receivable 21,672 -- Funds withheld by cedents 12,829 1,943 Reserve for losses and loss expenses 45,313 44,930 Reserve for unearned premiums 141,842 123,815 Reinsurance balances payable 23,948 7,225 Other 6,011 (33,589) ----------- ----------- Net cash provided by operating activities 173,705 134,711 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale and maturity of fixed maturities 1,725,976 2,406,482 Purchase of fixed maturities (1,593,271) (2,562,346) Proceeds from sale of equity securities 2,845 737 Purchase of equity securities (168,512) (6,924) Purchase of unquoted investments (3,754) (3,213) Other investing activities 10,239 249 ----------- ----------- Net cash applied to investing activities (26,477) (165,015) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Options exercised 575 61,301 Repurchase of shares 0 (12,484) Dividends paid (64,560) (56,849) ----------- ----------- Net cash applied to financing activities (63,985) (8,032) ----------- ----------- FOREIGN CURRENCY TRANSLATION ADJUSTMENTS 3,646 2,097 NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 86,889 (36,239) BALANCE AT BEGINNING OF PERIOD 122,784 163,968 ----------- ----------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 209,673 $ 127,729 =========== =========== See accompanying notes to consolidated financial statements 5 6 MID OCEAN LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Note A: Basis of Presentation The accompanying consolidated financial statements have not been audited except for the balance sheet at October 31, 1997. In the opinion of the Company's management, the financial statements reflect all adjustments necessary to present fairly the results of operations for the six month periods ended April 30, 1998 and 1997, the financial position at April 30, 1998 and the cash flows for the six month periods ended April 30, 1998 and 1997. Certain reclassifications of prior year amounts have been made to be consistent with the current presentation. The results of operations for the six months ended April 30, 1998 are not necessarily indicative of future financial results. Note B: Accounting policy The Company adopted Financial Accounting Standards Board Statement 128, effective November 1, 1997, that establishes new standards for computing and reporting earnings per share. Comparative amounts have been restated. Exhibit 11 shows the computation of earnings per share under the new standard. Note C: Other Events On March 16, 1998, EXEL Limited ("EXEL") and the Company announced that they had signed a definitive agreement to merge, creating an organization with assets in excess of $9.1 billion, shareholders' equity of approximately $4.8 billion and estimated market capitalization of more than $8.0 billion. EXEL would be the holding company of the new organization. EXEL and the Company plan to combine their reinsurance operations which will operate as X.L. Mid Ocean Reinsurance Company, Ltd. and will be headquartered in Bermuda. On April 29, 1998 EXEL and the Company entered into an Amended and Restated Agreement and Schemes of Arrangement to include a voluntary cash election feature involving up to $300 million in the aggregate. The transaction will result in EXEL issuing 1.0215 of its ordinary shares for each share of Mid Ocean Limited that it does not already own. On the date of the announcement, EXEL owned 9.7 million, or 26.82 percent of the outstanding shares of the Company. The transaction is subject to the approval of shareholders of both companies, as well as certain regulatory approvals. The merger is expected to be completed by mid summer 1998. 6 7 MID OCEAN LIMITED MANAGEMENT DISCUSSION & ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION This discussion and analysis should be read in conjunction with the attached unaudited consolidated financial statements and notes thereto of the Company for the quarter and six months ended April 30, 1998 together with the consolidated financial statements for the year ended October 31, 1997 and the notes thereto included in the Company's Annual Report on Form 10-K. The results of operations for any fiscal period are not necessarily indicative of future financial results. On March 16, 1998, EXEL Limited ("EXEL") and the Company announced that they have signed a definitive agreement to merge, creating an organization with assets in excess of $9.1 billion, shareholders' equity of approximately $4.8 billion and estimated market capitalization of more than $8.0 billion. EXEL would be the holding of the new organization. EXEL and the Company plan to combine their reinsurance operations which will operate as X.L. Mid Ocean Reinsurance Company, Ltd. and will be headquartered in Bermuda. On April 29, 1998 EXEL and the Company entered into an Amended and Restated Agreement and Schemes of Arrangement to include a voluntary cash election feature involving up to $300 million in the aggregate. The transaction will result in EXEL issuing 1.0215 of its ordinary shares for each share of Mid Ocean Limited that it does not already own. On the date of the announcement EXEL owned 9.7 million, or 26.82 percent of the outstanding shares of the Company. The transaction is subject to the approval of shareholders of both companies, as well as certain regulatory approvals. The merger is expected to be completed by mid summer 1998. Mid Ocean Limited is the parent company of Mid Ocean Holdings Limited ("Holdings") which has two wholly-owned subsidiaries, Mid Ocean Reinsurance Company Limited ("Mid Ocean Reinsurance") and Ridgewood Holdings Ltd ("Ridgewood"). Ridgewood is the Bermuda holding company of the Brockbank Group plc ("Brockbank"). Brockbank includes two Lloyds dedicated corporate syndicates ("corporate syndicates") and a Lloyds managing agency. The Company, through its subsidiaries, provides a broad range of reinsurance and insurance products on a global basis. The Company's fiscal year end is October 31. Brockbank's fiscal year end is December 31. Brockbank's results of operations for the quarter and six months ended March 31, 1998 and 1997 are included in the Company's results of operations for the quarter and six months ended April 30, 1998 and 1997 respectively. 7 8 RESULTS OF OPERATIONS SECOND QUARTER ENDED APRIL 30, 1998 COMPARED TO SECOND QUARTER ENDED APRIL 30, 1997. ($ millions) 1998 % Change 1997 ---- -------- ---- Net operating income (excluding net gain on investments) $68.0 2.6% $66.3 Net gains (losses) on investments 11.6 - (3.4) ----- ---- ----- Net income $79.6 26.5% $62.9 ===== ==== ===== Net income for the quarter ended April 30, 1998 increased $16.7 million over the second quarter ended April 30, 1997 due primarily to a $15.0 million increase in net gains on investments. Net operating income increased $1.7 million to $68.0 million for the quarter ended April 30, 1998. There was relatively low loss activity in both quarters. PREMIUMS NET PREMIUMS WRITTEN 1998 % Change 1997 ---- --------- ---- ($ millions) Property catastrophe $ 7.5 (55.6)% $ 16.9 Property other 9.5 (58.7)% 23.0 Marine & energy 5.6 115.4% 2.6 Aviation & satellite 0.0 (100.0)% 0.6 Corporate syndicates 86.2 13.4% 76.0 Other 4.6 -- (2.9) -------- ---- -------- Total $ 113.4 (2.3)% $ 116.1 ======== ==== ======== NET PREMIUMS EARNED 1998 % Change 1997 ---- -------- ---- ($ millions) Property catastrophe $ 31.1 (11.1)% $ 35.0 Property other 19.6 (29.5)% 27.8 Marine & energy 7.7 (44.6)% 13.9 Aviation & satellite 8.4 (10.6)% 9.4 Corporate syndicates 53.5 33.7% 40.0 Other 2.4 (48.9)% 4.7 -------- ---- -------- Total $ 122.8 (6.1)% $ 130.8 ======== ==== ======== The majority of premiums written by Mid Ocean Reinsurance renew on January 1. Approximately 40% of Brockbank's premiums renew on January 1 and are included in the Company's results for the quarter ended April 30, 1998. Net premiums written decreased $2.7 million or 2.3% in the second quarter of 1998 compared to the second quarter of 1997. This decline is due to a reduction of $12.9 million of net written premiums by Mid Ocean Reinsurance, which is partially offset by an increase of $10.2 million relating to the corporate syndicates. 8 9 The decrease in net premiums written by Mid Ocean Reinsurance was due to several factors. There were several adjustments to premium estimates on proportional contracts written in prior underwriting years as a result of an update of information received from the ceding company and / or broker. These adjustments related mainly to the other property class of business. In addition, there were three proportional contracts which incepted on January 1, 1997 with a total premium of $5 million which were not recorded until the quarter end April 30, 1997 due to late negotiations on these contracts. The premium written on the renewal of these contracts in 1998 was recorded in the quarter end January 31, 1998. Premium rates continued to decline in a competitive pricing environment across most classes of business written. Also affecting the net premium written is that the majority of Mid Ocean Reinsurance's Japanese contracts renew on April 1, largely in the property catastrophe and other property classes, and on an exposure adjusted basis, premium rates in this market declined approximately 15-30% in 1998 as compared to 1997. The increase in net premiums written by the corporate syndicates is largely due to a 48% increase in underwriting capacity provided to these syndicates for the 1998 underwriting year as compared to the 1997 underwriting year. Premiums ceded during the second quarter 1998 were $43.4 million compared with $21.8 million in the second quarter 1997. The majority of this increase is attributable to the corporate syndicates in line with their increase in gross premiums written. Most of the reinsurance purchased by the corporate syndicates incepts on January 1, is placed with many different reinsurers and is purchased at much lower attachment points than that purchased by Mid Ocean Reinsurance. Net premiums earned during the second quarter 1998 decreased $7.9 million or 6.1% over the first quarter 1997. This decrease is due to a $21.5 million decrease relating to Mid Ocean Reinsurance partially offset by an increase for the corporate syndicates of $13.5 million. Both of these movements were due to decreases and increases in net premiums written by Mid Ocean Reinsurance and the corporate syndicates respectively as described above. In particular, the premium adjustments to net premiums written by Mid Ocean Reinsurance on contracts written in prior underwriting years have had a direct effect on net premiums earned where the underlying risk periods on these contracts have largely expired. Premiums written are earned over the underlying risk period of each contract, commencing at the inception of the contract. The majority of contracts have a risk period of one year; however, for many contracts it is longer and therefore analysis between classes of business written and earned in any one quarter or year is not always comparable. INVESTMENT RESULTS 1998 % Change 1997 ---- -------- ---- ($ millions) Net investment income $28.0 10.7% $25.3 Net gains (losses) on investments 11.6 - (3.4) 9 10 The increases in net investment income resulted from the continued growth of the investment base and from the relatively higher returns. The investment portfolio, measured on a market value basis, yielded 6.4% for the second quarter 1998 compared with 6.3% in the second quarter 1997. The net unrealized market appreciation or depreciation attributable to securities held in the portfolio is included as a separate component of shareholders' equity. At April 30, 1998, shareholders' equity included unrealized appreciation of $14.2 million compared with $18.7 million at October 31, 1997. Total returns on investments, measured on a market value basis, were 1.78% in the second quarter 1998 compared to 0.73% in the second quarter of 1997 . Net gains on investments were made in the second quarter 1998 due to the sale of securities during a period of increasing market values as opposed to losses on investment sales made in the second quarter 1997 when market values were declining. OTHER REVENUE 1998 % Change 1997 ---- -------- ---- ($ millions) Exchange loss $(1.4) 55.5% $(0.9) Managing agency income 3.6 12.5% 3.2 Other income 4.6 84.0% 2.5 The exchange losses in the second quarters of 1998 and 1997 relate mainly to the British pound exchange rate movements and includes both realized and unrealized gains and losses on the revaluation of the Company's foreign currency assets and liabilities. Managing agency income relates to fees earned by the managing agency in respect of its management of Lloyd's underwriting syndicates and earned profit commissions which are estimated based on anticipated results of the syndicates it manages. Managing agency income attributable to the corporate syndicates is eliminated on consolidation. Profit commissions are paid to the managing agency three years after an underwriting year incepts. Other income relates to commission and fee income from other insurance related services of Brockbank. The increase in other income for the second quarter 1998 over 1997 is mainly due to an increase in net premiums written by the corporate syndicates. EXPENSES 1998 1997 ---- ---- Net loss and loss expense ratio 38.5% 43.6% Underwriting expense ratio 31.1% 26.7% ---- ---- Combined ratio 69.6% 70.3% ==== ==== The combined ratio is computed based on the relationship of net losses and underwriting expenses to net earned premiums. The combined ratio is a principal indicator of underwriting performance, with less than 100% indicating an underwriting profit. 10 11 LOSS AND LOSS EXPENSES 1998 1997 ---- ---- ($ millions) Loss and loss expenses $61.1 $63.7 Reinsurance recoveries (13.8) (6.7) ----- ----- Net loss and loss expenses $47.3 $57.0 ===== ===== Net loss and loss expense ratio 38.5% 43.6% During the second quarter 1998, the Company's incurred net loss and loss expenses decreased $9.7 million over the second quarter 1997. This decrease is due to a decrease in losses incurred relating to Mid Ocean Reinsurance offset by an increase in losses incurred by the corporate syndicates. Approximately 46% of Mid Ocean Reinsurance's gross written premium is property catastrophe, where loss experience is generally characterized as low frequency but high severity. Accordingly, where there is an absence of major catastrophic loss events, loss experience on business written by the corporate syndicates tends to be higher than for Mid Ocean Reinsurance and this has been the case during the second quarter 1998 and 1997. The decrease in the amount of net loss and losses incurred relating to Mid Ocean reinsurance is due to several factors. First, a reduction in the amount of net premiums earned in the second quarter 1998 over 1997 caused a decrease in the amount of incurred but not reported ("IBNR") loss reserves recorded as these are based upon initial expected loss ratios applied to net premiums earned. Second, there was a continued review and release of loss reserves established on business written in prior years. Mid Ocean Reinsurance has relied upon and consistently applied the Bornhuetter-Ferguson incurred loss actuarial method for estimating its loss reserves. Due to a relatively low level of losses as compared to historical experience, actual losses have not developed in accordance with initial estimates made by management. This has resulted in the release of loss reserves of net losses incurred for Mid Ocean Reinsurance. There were no significant catastrophic events during the second quarter 1998 and 1997. The increase in the amount of losses incurred relating to the corporate syndicates is due to the 33.7 % increase in the amount of net premiums earned by them in the second quarter 1998 over 1997. There has been no change in the classes of business written by the corporate syndicates. Business written by the corporate syndicates has loss experience which is expected to be higher in frequency but lower in severity than Mid Ocean Reinsurance. Reinsurance recoveries have increased from $6.7 million to $13.8 million in 1998, and is due to the corporate syndicates who have purchased more reinsurance than the prior year. The increase in net premiums earned by the corporate syndicates generally results in an increase in gross losses incurred and this in turn has increased the amount of reinsurance recoveries recorded. The net loss and loss expense ratio for the second quarter 1998 was 38.5% compared to 43.6% for the second quarter 1997. This is mainly due to a reduction in the loss ratio on the Mid Ocean Reinsurance book of business relating to the release of loss reserves described above. 11 12 Net loss reserves amounted to $527.9 million and $479.2 million at April 30, 1998 and October 31, 1997 respectively. Included in this amount are net reserves for IBNR losses of $332.3 million and $351.0 million respectively. This net decrease in the amount of IBNR reserves is due to the favorable loss development and release of loss reserves for Mid Ocean Reinsurance as described above. In determining that portion of loss and loss expenses for IBNR, management classifies business written by the Company into segments that could reasonably be expected to have similar loss characteristics. Reporting patterns and initial expected loss ratios are developed based upon Company and industry data, knowledge of the business written by the Company and general market trends in the reinsurance and insurance industry. UNDERWRITING EXPENSES ACQUISITION EXPENSES AND RATIO: 1998 1997 ---- ---- ($ millions) Acquisition expenses $ 20.0 $ 21.8 Acquisition expense ratio 16.2% 16.7% The $ 1.8 million decrease in acquisition expenses in the second quarter 1998 over 1997 is due to a decreased amount of net earned premiums. Acquisition expenses include brokerage, commissions, taxes and other expenses and are expensed over the same underlying risk periods as the premiums to which they relate. Deferred acquisition costs at April 30, 1998 were $ 75.8 million as compared to $ 64.8 million at January 31, 1998. The net increase of $ 11.0 million is due to the fact that approximately 40% of Brockbank's premiums renew on January 1 (which are included in the Company's results for the quarter ended April 30, 1998), together with the 13.4% increase in the amount of net premiums written by the corporate syndicates in 1998 as compared to 1997. The slight decrease in the acquisition expense ratio is attributable to a decrease in the acquisition expense of one of the corporate syndicates. OPERATIONAL EXPENSES AND RATIO: 1998 1997 ---- ---- ($ millions) Operational expenses $ 18.3 $ 13.2 Operational expense ratio 14.9% 10.1% The $5.1 million or 38.6% increase in operational expenses in second quarter 1998 over 1997 is largely due to an increase in the goodwill amortization charge associated with the completion of the acquisition of Brockbank in August 1997 together with the growth of operations at Brockbank. The increase in the operational expenses ratio is the result of the increase in the Company's operational expenses against a lower amount of net premiums earned in the second quarter 1998 compared to the second quarter 1997. 12 13 OTHER EXPENSES 1998 % Change 1997 ---- -------- ---- ($ millions) Managing agency expenses $ 1.8 5.9% $ 1.7 Income taxes $ 2.2 83.3% $ 1.2 Managing agency expenses are the costs of operating the Brockbank managing agency after an allocation of these costs has been made to the syndicates under management. Income taxes represent estimated income taxes in the United Kingdom for Brockbank and Mid Ocean Reinsurance's London branch operations. The increase for the quarter end April 30, 1998 over 1997 is due to increased profits of these entities. RESULTS OF OPERATIONS SIX MONTHS ENDED APRIL 30, 1998 COMPARED TO SIX MONTHS ENDED APRIL 30, 1997. ($ millions) 1998 % Change 1997 ---- -------- ---- Net operating income (excluding net gain on investments) $117.5 1.6% $115.6 Net gains (losses) on investments 25.9 -- (0.7) ------ ------ ------ Net income $143.4 24.8% $114.9 ====== ====== ====== Net income for the six months ended April 30, 1998 increased $28.9 million over the six months ended April 30, 1997 due primarily to a $26.6 million increase in net gains on investments. Net operating income increased $1.9 million to $117.5 million for the six months April 30, 1998. There was relatively low loss activity in both periods. PREMIUMS NET PREMIUMS WRITTEN 1998 % Change 1997 ---- --------- ---- ($ millions) Property catastrophe $ 76.6 (32.4)% $ 113.3 Property other 68.2 (13.8)% 79.1 Marine & energy 34.4 (14.4)% 40.2 Aviation & satellite 30.4 (5.6)% 32.2 Corporate syndicates 133.5 37.5% 97.1 Other 19.4 351.2% 4.3 -------- ------- -------- Total $ 362.5 (1.0)% $ 366.2 ======== ======= ======== 13 14 NET PREMIUMS EARNED 1998 % Change 1997 ---- -------- ---- ($ millions) Property catastrophe $ 65.2 (5.1)% $ 68.7 Property other 34.3 (33.5)% 51.6 Marine & energy 16.2 (40.9)% 27.4 Aviation & satellite 16.7 (8.2)% 18.2 Corporate syndicates 107.1 63.5% 65.5 Other 6.3 (14.9)% 7.4 ------ ---- ------ Total $ 245.8 2.9% $ 238.8 ====== ==== ====== Net premiums written decreased $3.7 million or 1.0% in the six months of 1998 compared to the six months of 1997. This slight decline is due to a reduction of $40.1 million of net written premiums by Mid Ocean Reinsurance, which is partially offset by an increase of $36.4 million relating to the corporate syndicates. The majority of premiums written by the Company renew on January 1. The decrease in net premiums written by Mid Ocean Reinsurance was due to a continual decline, since 1995, in premium rates in most markets and across most classes of business it writes. This decline is due to a competitive pricing environment which has been caused by an increase in supply of reinsurance capacity available and an absence of significant loss activity. In addition, in the first quarter 1997 there was a premium of $ 12.9 million on a contract which was written covering a two year period with no comparable premium in 1998. The increase in net premiums written by the corporate syndicates is due to a 48% increase in underwriting capacity provided to these syndicates for the 1998 underwriting year as compared to the 1997 underwriting year. Premiums ceded during the six months of 1998 were $55.9 million compared with $31.5 million in the six months of 1997. The majority of this increase relates to the corporate syndicates who purchase reinsurance at much lower attachment points and in larger amounts than Mid Ocean Reinsurance. The increase is in line with the increase in gross premiums written by the corporate syndicates in 1998 and 1997. Net premiums earned for the six months of 1998 increased $6.9 million or 2.9% over the six months of 1997. This increase is due to a $41.6 million increase relating to the corporate syndicates partially offset by a decrease for Mid Ocean Reinsurance of $34.7 million. These movements in net premiums earned by Mid Ocean Reinsurance and the corporate syndicates is due to the movements in net premiums written for each entity as described above. 14 15 INVESTMENT RESULTS 1998 % Change 1997 ---- -------- ---- ($ millions) Net investment income $ 54.4 10.6% $ 49.2 Net gains (losses) on investments 25.9 - % (0.7) The increases in net investment income resulted from the continued growth of the investment base and from the relatively higher returns. The investment portfolio, measured on a market value basis, yielded 6.4% for the six months of 1998 compared with 6.3% in the six months of 1997. Net investment gains recorded in the six months of 1998 were due to sales of securities where there has been an increase in market values. Net investment losses in the six months of 1997 are due to losses made in the second quarter 1997 during a period of declining market values. OTHER REVENUE 1998 % Change 1997 ---- -------- ---- ($ millions) Exchange loss $ (4.0) - % $ (7.8) Managing agency income 7.2 12.5% 6.4 Other income 6.3 80.0% 3.5 The exchange loss in the six months of 1998 and 1997 relate mainly to the British pound exchange rate movements and includes both realized and unrealized gains and losses on the revaluation of the Company's foreign currency assets and liabilities. Approximately 80% of the Company's net premium written is denominated in US dollars. Managing agency income increased 12.5% to $7.2 million for the six months 1998 as compared to 1997 due mainly to an increase in estimated profit commission earned by the managing agency from the Lloyds underwriting syndicates in manages. Other income relates to fee and commission income from other insurance related services of Brockbank. The increase in other income by 80% to $6.3 million is mainly due to the increase in net premiums written by the corporate syndicates. EXPENSES 1998 1997 ---- ---- Net loss and loss expense ratio 44.6% 45.4% Underwriting expense ratio 30.2% 25.6% ---- ---- Combined ratio 74.8% 71.0% ==== ==== The combined ratio is computed based on the relationship of net losses and underwriting expenses to net earned premiums. The combined ratio is a principal indicator of underwriting performance, with less than 100% indicating an underwriting profit. 15 16 LOSS AND LOSS EXPENSES 1998 1997 ---- ---- ($ millions) Loss and loss expenses $ 129.8 $ 120.9 Reinsurance recoveries (20.2) (12.5) --------- --------- Net loss and loss expenses $ 109.5 $ 108.4 ========= ========= Net loss and loss expense ratio 44.6% 45.4% During the six months of 1998 the Company's incurred net loss and loss expenses increased $8.8 million over the six months of 1997. This increase is due to an increase in the losses incurred relating to the corporate syndicates partially offset by a decrease in losses incurred by Mid Ocean Reinsurance. Approximately 46% of Mid Ocean Reinsurance's gross premium written is property catastrophe, where loss experience is generally characterized as low frequency but high severity. Accordingly, where there is an absence of major catastrophic loss events, loss experience on business written by the corporate syndicates tends to be higher than for Mid Ocean Reinsurance and this has been the case during the first half 1998 and 1997. The decrease in the amount of losses incurred by Mid Ocean Reinsurance is due to a reduction in the amount of net premiums earned in 1998 over 1997 together with a release of loss reserves established on business written in prior years. Mid Ocean reinsurance has relied upon and consistently applied the Bornhuetter-Ferguson incurred loss actuarial method for estimating its loss reserves. Due to a relatively low level of losses as compared to historical experience, actual losses have not developed in accordance with initial estimates made by management. This has resulted in the release of loss reserves and reduction in the amount of net losses incurred for Mid Ocean Reinsurance. There were no significant catastrophic events during the first half 1998 and 1997. The increase in the losses incurred relating to the corporate syndicates is due to the increase in the amount of net premiums earned by them in 1998 over 1997. Business written by the corporate syndicates is expected to have loss experience which is higher in frequency but lower in severity than Mid Ocean Reinsurance. The net loss and loss expense ratio for the six months ended April 30, 1998 was 44.6% compared to 43.6% for the six months of 1997. This is mainly due to a reduction in the loss ratio on the Mid Ocean Reinsurance book of business relating to the release of loss reserves described above. UNDERWRITING EXPENSES ACQUISITION EXPENSES AND RATIO: 1998 1997 ---- ---- ($ millions) Acquisition expense $ 40.0 $ 38.5 Acquisition expense ratio 16.3% 16.1% The $ 1.5 million increase in acquisition expenses in the six months of 1998 over 1997 is due to the increase in the company's net earned premiums. Acquisition expenses include 16 17 brokerage, commissions, taxes and other expenses and are expensed over the same underlying risk periods as the premiums to which they relate. Deferred acquisition costs at April 30, 1998 were $ 75.8 million as compared to $ 45.9 million at October 31, 1997. The net increase of $ 29.9 million is due to the fact that the majority of premiums written by Mid Ocean Reinsurance renew on January 1 and approximately 40% of Brockbank's premiums renew on January 1 (which are included in the Company's results for the quarter ended April 30, 1998), together with the 37.5 % increase in the amount of net premiums written by the corporate syndicates in 1998 over 1997. OPERATIONAL EXPENSES AND RATIO: 1998 1997 ---- ---- ($ millions) Operational expenses $ 34.3 $ 22.6 Operational expense ratio 14.0% 9.5% The $11.7 million or 51.8% increase in operational expenses in six months of 1998 compared to 1997 is due to an increase in the goodwill amortization charge associated with the completion of the acquisition of Brockbank in August 1997 together with the growth of the Brockbank operations. The increase in the operational expense ratio for 1998 over 1997 is due to the fact that the increase in the amount of operational expenses was greater than the increase in the Company's net earned premiums. OTHER EXPENSES 1998 % Change 1997 ---- -------- ---- ($ millions) Managing agency expenses $ 3.6 111.8% $ 1.7 Income taxes $ 4.8 50.0% $ 3.2 The increase in managing agency expenses in the six months of 1998 over 1997 is due to reduction of approximately $1.1 million in 1997 relating to a change in the allocation of a staff cost between that portion charged to the managing agency and that portion allocated to the syndicates under management at Brockbank. In previous quarters, this cost had all been charged to the managing agency. The increase in income tax expense in 1998 over 1997 is due to increased profits of both Brockbank and Mid Ocean Reinsurance's London branch. FINANCIAL CONDITION AND LIQUIDITY The Company's assets consist of its investment in the stock of Holdings, which is the parent company of Mid Ocean and Brockbank. The Company relies primarily on cash dividends from Holdings, which relies on dividends from its direct and indirect subsidiaries. The payment of such dividends is restricted by applicable law under Bermuda and United Kingdom insurance law and regulations, including those promulgated by the Society of Lloyd's. Currently there are no effective statutory restrictions on the payment of dividends by the Company or its subsidiaries. On 17 18 December 4, 1997 the Board of Directors approved an increase in annualized dividends to $3.30 from $3.00 during 1997. The payment of the dividend in any quarter is at the discretion of the Board of Directors of the Company. At April 30, 1998, shareholders' equity was $1,451.8 million, of which $689.7 million was retained earnings. At April 30, 1998, the Company held $209.7 million of cash and cash equivalents compared with $122.8 million at October 31, 1997. The Company's consolidated sources of funds consist primarily of net premiums written, investment income, and the proceeds from sales and maturities of investments. Funds are used primarily to pay claims, operating expenses and dividends and for the purchase of investments. Net cash flow provided by operating activities was $173.7 million in the six months of 1998 compared with $134.7 million in the six months of 1997. The increase is mainly due to the receipt of funds relating to the operating activities of Brockbank. The Company is unable to predict its cash outflows as they will be substantially determined by loss payments and particularly large catastrophes if they occur. As a consequence, cash flow may fluctuate between individual fiscal quarters and years. Primarily due to the potential for large loss payments, the Company's investment portfolio is structured to provide a high level of liquidity to meet its obligations. At April 30, 1998, the investment portfolio, measured at fair value, including accrued investment income, trades pending settlement and cash and cash equivalents, was $1,822.1 million compared with $1,693.5 million at October 31, 1997. The portfolio is presently made up of fixed maturities, equity securities, short-term investments and cash and cash equivalents. At April 30, 1998 83.0% and October 31, 1997, 84.7% of the fair value of debt securities held was in U.S. Government securities or in obligations rated A or better by Moody's Investors Service Inc. or Standard & Poor's Corporation. The Company presently has no investments in real estate or mortgage loans. The Company has committed to invest up to $18.7 million, principally as a special limited partner, in The Trident Partnership L.P., a limited partnership organized for investment in the insurance industry. At April 30, 1998, the investment in Trident was $5.0 million compared with $5.7 million at October 31, 1997. In connection with the completion of the acquisition of Brockbank in August 1997, the Company has issued loan notes and the value outstanding at April 30, 1998 was $ 10.7 million. Interest is payable on these notes semi-annually at a rate of 0.5% below LIBOR. These loan notes are redeemable at the option of the holder under various conditions and any loan notes outstanding at June 30, 2003 will be redeemed in full at par. The semi-annual LIBOR rate at April 30, 1998 was 5.8%. In 1997, the Company obtained multi-currency committed lines of credit provided by a syndicate of nine major international banks led by Chase Manhattan Bank, N.A., which provides for unsecured borrowing up to an aggregate amount of $200 million subject to certain conditions. There has been no drawdown on these facilities. Under the terms of certain reinsurance contracts, Mid Ocean Reinsurance is required to provide letters of credit to reinsureds in respect of loss reserves and/or unearned premiums. Mid 18 19 Ocean Reinsurance has a facility of approximately $ 263.3 million provided for the issuing of letters of credit. This facility is secured by a lien on a portion of Mid Ocean Reinsurance's investment portfolio. At April 30, 1998 Mid Ocean Reinsurance had provided letters of credit amounting to $235.0 million compared with $187.9 million at October 31, 1997. Included in this amount is the funding for the capital requirements of the two dedicated corporate syndicates of $162.6 million at April 30, 1998 compared to $ 109.0 million at October 31, 1997. The United States dollar is the Company's functional currency. However, certain of the Company's reinsurance balances receivable and payable are denominated in currencies other than the United States dollar. These balances are revalued at exchange rates current at each balance sheet date. Future losses in currencies other than the United States dollar represent a potential for foreign exchange exposure. The Company therefore expects that it could experience exchange gains or losses that, in turn, could affect the Company's consolidated statement of operations. The Company generally has not sought to hedge its currency exposures with respect to such losses before the occurrence of an event that produces a claim. However, certain of the Company's future cash flows are denominated in component currencies of its expected liability profile and it may hold investments, cash and cash equivalents denominated in some of these currencies; thus, the currency exposure on the underlying risks is reduced to some extent. Year 2000 The Company formed a committee in 1997 to address the Year 2000 issue and its potential impact on the Company. Consideration is being given to both computer systems that the Company uses internally and does have some direct influence and control over, together with those of third parties by whom the Company could be significantly affected and over whom the Company does not have control. These third parties who provide information upon which the Company relies, include intermediaries, banks, investment managers, software companies and cedents. The Company has developed a formal testing plan to ensure that all systems are Year 2000 compliant. Such testing has already begun and will continue throughout 1998 and 1999. In addition, the Company will be in contact will all third parties with regard to Year 2000 compliance. As testing is performed and inquiries are received, the Company will be in a position to judge the need to change, update, and/or acquire systems that are Year 2000 compliant, and will take action as appropriate. Due to the fact that the Company is only five years old, most of its systems and system related operations are on newer platforms requiring adjustments, updates, etc. that are not significant. The cost of such changes are estimated to be about $300,000 in 1998 and a lesser amount in 1999 for a total cost estimated to be approximately $500,000. Such amounts are not considered to be material to the Company. The Company does not believe that year 2000 related areas for which the Company has direct control over will have a material impact on the Company or its operations. However, no assurance can be given to the degree of impact on the Company or its operations caused by third parties despite the Company's best efforts to obtain assurances from such third parties. 19 20 PART II OTHER INFORMATION MID OCEAN LIMITED ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS At the Company's Annual Meeting of Stockholders, held March 5, 1998, the following actions were taken: a. The stockholders duly elected the following nominees as Class II Directors by over 99% of the votes cast: Sir Brian Corby Robert R. Glauber Paul Jeanbart Class I Directors will serve until the 2000 Annual Meeting of Stockholders. Class II Directors will serve until the the 2001 Annual Meeting. Class III Directors will serve until the 1999 Annual Meeting. b. The stockholders appointed KPMG Peat Marwick, Bermuda, to act as the independent auditors of the Company for the fiscal year ending October 31, 1998 by over 99% of the votes cast. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibit II - Computation of Earnings per share. b. Reports on Form 8-K The Company filed a current report on Form 8-k dated April 28, 1998 with respect to the announcement made on March 16, 1998 that EXEL Limited ("EXEL") and the Company have signed a definitive agreement to Merge. On April 29, 1998, EXEL and the Company entered into an Amended and Restated Agreement and Scheme of Arrangement to include a voluntary cash election feature involving an amount up to $300 million in the aggregate. Copies of the agreement were filed as an exhibit and incorporated by reference with the Form 8-K report. 20 21 MID OCEAN LIMITED SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MID OCEAN LIMITED ------------------------------------ (Registrant) /s/ Charles F Hays ------------------------------------ CHARLES F HAYS Senior Vice President, Chief Financial and Administrative Officer (Principal Financial Officer and Accounting Officer) Date : June 26, 1998 21