SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE
SECURITIES EXCHANGE ACT OF 1934
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
[ ] Preliminary proxy statement
[ ] Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)(2))
[X] Definitive proxy statement [ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to ss. 240.14a-11(c) or ss. 240.14a-12
RISK CAPITAL HOLDINGS, INC.
- - --------------------------------------------------------------------------------
(Name of Registrant as Specified in Its Charter)
Not Applicable
- - --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[ ] No fee required.
[X] Fee computed on table below per Exchange Act Rules 14(a)-6(i)(1) and 0-11.
1) Title of each class of securities to which transaction applies:
2) Aggregate number of securities to which transaction applies:
3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
filing fee is calculated and state how it was determined):
$20,335,000.00 (based on the purchase price in the transaction)
4) Proposed maximum aggregate value of transaction: $20,335,000.00
5) Total fee paid: $4,067.00
[X] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.
1) Amount Previously Paid:
2) Form, Schedule or Registration Statement No.:
3) Filing Party:
4) Date Filed:
[LETTERHEAD OF RISK CAPITAL HOLDINGS, INC.]
March 15, 2000
Dear Stockholder:
I am pleased to invite you to a special meeting of stockholders of Risk
Capital Holdings, Inc. on April 17, 2000 at 1:00 p.m. (local time), at our
offices, located at 20 Horseneck Lane, Greenwich, Connecticut 06830. At this
important meeting, you will be asked to approve the sale of our reinsurance
business through the transfer of the reinsurance assets and liabilities of our
operating subsidiary, Risk Capital Reinsurance Company, to Folksamerica
Reinsurance Company, and effective with the consummation of the asset sale, to
change the name of the company from "Risk Capital Holdings, Inc." to "Arch
Capital Group Ltd."
Our board of directors, taking into consideration the recommendation of a
special committee and the opinion of our financial advisor Donaldson, Lufkin &
Jenrette Securities Corporation, has unanimously determined that the asset sale
is in the best interests of our company. Accordingly, our board of directors
recommends that you vote FOR the asset sale.
This proposal requires the approval of the majority of our outstanding
shares. YOUR VOTE IS VERY IMPORTANT.
The accompanying notice and proxy statement contain details concerning this
proposal. Whether or not you plan to attend the meeting, please sign and return
your proxy card in the enclosed envelope to ensure that your shares will be
represented and voted. If you do attend the meeting, you may choose to withdraw
your proxy and vote your shares in person.
I appreciate your support in this important event.
Sincerely,
[Signature Logo]
ROBERT CLEMENTS
Chairman of the Board
This proxy statement is first being mailed to stockholders on or about March 15,
2000.
RISK CAPITAL HOLDINGS, INC.
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
Time: 1:00 p.m. (local time)
Date: April 17, 2000
Place: Risk Capital Holdings, Inc.
20 Horseneck Lane
Greenwich, Connecticut 06830
Purpose:
o To consider and vote upon a proposal to approve the sale of our
reinsurance business through the transfer of the reinsurance assets
and liabilities of our operating subsidiary, Risk Capital Reinsurance
Company, to Folksamerica Reinsurance Company, pursuant to the Asset
Purchase Agreement dated as of January 10, 2000 among Risk Capital
Holdings, Inc., Risk Capital Reinsurance Company, Folksamerica Holding
Company, Inc. and Folksamerica Reinsurance Company and, effective with
the consummation of the asset sale, to amend our certificate of
incorporation to change the name of the company from "Risk Capital
Holdings, Inc." to "Arch Capital Group Ltd."
o Conduct other business if properly raised.
Only stockholders of record on March 14, 2000 may vote at the meeting.
Your vote is very important. Please complete, sign, date and return your
proxy card in the enclosed envelope promptly.
[Signature Logo]
PETER A. APPEL
Executive Vice President, Chief Operating
Officer, General Counsel and Secretary
Greenwich, Connecticut
March 15, 2000
TABLE OF CONTENTS
Page
SUMMARY TERM SHEET.............................................................1
SUMMARY FINANCIAL DATA.........................................................6
QUESTIONS AND ANSWERS ABOUT THE ASSET SALE.....................................8
RISK FACTORS..................................................................10
THE STOCKHOLDERS' MEETING.....................................................18
Time and Place.........................................................18
Proposal...............................................................18
Record Date; Voting at the Stockholders' Meeting.......................18
Quorum; Vote Required for Approval.....................................18
Voting and Revocation of Proxies.......................................19
Solicitation of Proxies................................................19
Other Matters..........................................................19
THE ASSET SALE................................................................20
Background of the Asset Sale...........................................20
Reasons for the Asset Sale and the Name Change; Our Board
of Directors Recommends the Asset Sale...............................23
Donaldson, Lufkin & Jenrette Has Delivered a Fairness
Opinion Relating to the Asset Sale...................................25
Certain Stockholders Have Agreed to Vote for the Asset Sale............30
Management Changes.....................................................30
Accounting Treatment of the Asset Sale.................................30
Material Federal Income Tax Consequences of the Asset Sale.............30
Regulatory Matters.....................................................31
==
THE ASSET PURCHASE AGREEMENT..................................................32
Purchase Price.........................................................32
Tax Sharing Arrangement................................................32
Related Costs..........................................................33
Our Representations and Warranties.....................................33
Folksamerica's Representations and Warranties..........................34
Principal Covenants....................................................35
Employee Matters.......................................................36
Conditions to Closing..................................................36
Indemnification........................................................37
Termination............................................................37
Survival...............................................................38
OTHER TRANSACTION AGREEMENTS..................................................40
Transfer and Assumption Agreement......................................40
Escrow Agreement.......................................................40
Supplemental Escrow Agreement..........................................41
XL STOCK REPURCHASE...........................................................43
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Page
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................44
INTERESTS OF CERTAIN PERSONS IN MATTERS TO BE ACTED UPON......................48
Payments to Executive Officers and Chairman of the Board...............48
Vesting of Options and Restricted Shares...............................48
Ownership of Warrants..................................................49
DIVIDEND AND STOCK REPURCHASE POLICY..........................................50
SELECTED HISTORICAL FINANCIAL DATA............................................51
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..............................................52
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA.....................71
INDEPENDENT ACCOUNTANTS.......................................................78
WHERE YOU CAN FIND MORE INFORMATION...........................................78
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES..................................F-1
Annexes
Asset Purchase Agreement.....................................................A-1
Voting Agreements............................................................B-1
Form of Transfer and Assumption Agreement....................................C-1
Form of Escrow Agreement.....................................................D-1
Form of Supplemental Escrow Agreement........................................E-1
Opinion of Donaldson, Lufkin & Jenrette Securities Corporation...............F-1
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SUMMARY TERM SHEET
This summary term sheet highlights selected information from this document
and may not contain all of the information that is important to you. To
understand the asset sale fully and for a more complete description of the legal
terms of the asset sale, you should read carefully this entire proxy statement
and the other documents to which we have referred you. See "Where You Can Find
More Information" on page 78 of this proxy statement. In this document, "we,"
"us," "our" and the "company" refer to Risk Capital Holdings, Inc. and "you"
refers to Risk Capital Holdings, Inc.'s stockholders.
The Parties to the Asset Sale
Risk Capital Holdings, Inc........... Since incorporation in 1995, we
Risk Capital Reinsurance Company have, through our wholly owned Risk
20 Horseneck Lane Capital Reinsurance Company
Greenwich, Connecticut 06830 operating subsidiary, Risk Capital
(203) 862-4300 Reinsurance Company ("RCRe"), 20
Horseneck Lane integrated solutions
for insurance provided reinsurance
and other forms of capital, either
on a companies with (203) 862-4300
stand-alone Greenwich, Connecticut
06830 basis, or as part of capital
needs that cannot be met by
reinsurance alone. RCRe is rated
"A-" (Excellent) by A.M. Best
Company. On January 18, 2000, A.M.
Best announced that it was placing
our A- rating under review. At
December 31, 1999, RCRe had
statutory surplus of $290.1 million
(or $230.1 million after giving pro
forma effect to our recent
repurchase of 4,755,000 shares of
our common stock from XL Capital
Ltd). You can find more information
about us in the documents that are
incorporated by reference in this
proxy statement. See "Where You Can
Find More Information."
Folksamerica Holding Company, Inc.... Folksamerica Reinsurance Company,
Folksamerica Reinsurance Company an indirect wholly owned subsidiary
One Liberty Plaza of White Mountains Insurance Group,
New York, New York 10006 Ltd., is a multi-line broker-market
(212) 312-2500 reinsurance company which provides
reinsurance to insurers of property
and casualty risks in Caribbean.
Folksamerica Reinsurance the United
States, Canada, Latin America and
the Company is rated "A"
(Excellent) by A.M. Best Company.
At December 31, 1999, Folksamerica
Reinsurance Company had statutory
surplus of approximately $338.5
million. Folksamerica Reinsurance
Company is wholly owned by
Folksamerica Holding Company, Inc.
In this proxy statement, we refer
to Folksamerica Reinsurance Company
and Folksamerica Holding Company
collectively as "Folksamerica."
The Stockholders' Meeting
Time and Place....................... The stockholders' meeting will be
held at 1:00 p.m. (local
time) on April 17, 2000 at our
offices, located at 20 Horseneck
Lane, Greenwich, Connecticut 06830.
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Proposal............................. At the meeting, you will consider
and vote upon the proposal
to approve the sale of our
reinsurance business to
Folksamerica and, effective with
the consummation of the asset sale,
to amend our certificate of
incorporation to change our name
from "Risk Capital Holdings, Inc."
to "Arch Capital Group Ltd." See
"The Stockholders' Meeting--
Proposal."
Voting and Revocation of Proxies..... All stockholders of record as of
March 14, 2000 are entitled
to vote at the meeting. Even if you
plan to attend the meeting, please
sign and return your proxy card.
The affirmative vote of a majority
of our outstanding shares is
necessary to approve the proposal,
so a failure to send in a signed
proxy card or vote in person at the
meeting will have the effect of a
vote against the proposal. See "The
Stockholders' Meeting-- Quorum;
Vote Required for Approval."
Any proxy may be revoked by the
person giving it at any time before
it is voted. Proxies may be revoked
by either filing with us a written
notice of revocation bearing a
later date than the date of the
proxy or a later-dated proxy
relating to the same shares, or
attending the stockholders' meeting
and voting in person. See "The
Stockholders' Meeting-- Voting and
Revocation of Proxies."
See "Risk Factors" for a discussion
of some considerations you should
take into account before deciding
how to vote.
Your vote is very important. Please
sign, date and return the proxy
card as soon as possible.
Board Recommendation...................... Our board of directors recommends
that you vote FOR the asset
sale and the name change.
The board's recommendation is based
in part on the recommendation of a
special committee of the board and
an opinion of Donaldson Lufkin &
Jenrette that, as of the date of
that opinion, the consideration to
be received by us in the asset sale
is fair to us from a financial
point of view. See "The Asset
Sale-- Reasons for the Asset Sale
and the Name Change; Our Board of
Directors Recommends the Asset
Sale" and "The Asset Sale--
Donaldson Lufkin & Jenrette Has
Delivered a Fairness Opinion
Relating to the Asset Sale." The
fairness opinion is attached to
this proxy statement as Annex F.
Voting Agreements......................... Marsh & McLennan Risk Capital
Holdings, Ltd. and The Trident
Partnership, L.P., which together
control 13.3% of the total voting
power of our stock, have signed
voting agreements granting
Folksamerica proxies to vote their
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shares in favor of the asset sale.
See "The Asset Sale-- Certain
Stockholders Have Agreed to Vote
For the Asset Sale."
The Asset Sale........................... Folksamerica Reinsurance Company
will assume RCRe's
liabilities under the reinsurance
agreements transferred to it in the
asset sale and RCRe will transfer
to Folksamerica Reinsurance Company
assets in an aggregate amount that
is, in book value, equal to the
book value of the liabilities
assumed. In consideration for the
transfer of RCRe's book of
business, Folksamerica will pay
$20.335 million in cash at the
closing, subject to adjustment
under the circumstances set forth
in the asset purchase agreement.
Our costs and expenses related to
the transaction are estimated to be
$19 million. See "The Asset
Purchase Agreement."
Escrow Agreement........................ At closing, we will deposit $20
million of the purchase price
into a five-year escrow to
reimburse Folksamerica for losses
relating to business produced on
behalf of RCRe by a certain
managing underwriting agency.
Depending on whether the reserves
related to that business turn out
to have been deficient or redundant
as of the closing, following the
fifth anniversary of the closing,
we may be entitled to none, a
portion or all of the escrowed
funds. If those reserves turn out
to have been redundant, we will
also be entitled to receive from
Folksamerica the amount of the
redundancy. The funds in this
escrow will also be available to
indemnify Folksamerica for its
losses, if any, due to breaches of
certain of our representations and
warranties. See "Other Transaction
Agreements-- Escrow Agreement."
Supplemental Escrow Agreement........... We may be required to deposit an
additional amount of up to $5
million in a supplemental five-year
escrow if our reserves as of the
closing (other than reserves
covered by the escrow described
above) are more than one-half
percent (0.5%) less than our
independent actuary's estimate. If
the supplemental escrow is
required, depending on whether
those reserves turn out to have
been deficient or redundant,
following the fifth anniversary of
the closing, the escrow agent may
release to us none, a portion or
all of the escrowed funds. See
"Other Transaction Agreements--
Supplemental Escrow Agreement."
No Payment to Stockholders.............. The asset sale does not involve any
merger, consolidation or
liquidation; therefore, no payment
of cash or securities will be made
to stockholders.
Delaware law does not provide for
dissenters' rights in
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the context of an asset sale.
No Solicitation......................... We agreed not to solicit an
acquisition proposal from a third
party.
We also agreed not to take part in
any discussions regarding an
unsolicited acquisition proposal
unless our board determines, based
on the written advice of an
investment bank, that the
acquisition proposal is a superior
proposal and determines, based on
the advice of counsel, that it is
obligated to take part in such
discussions to comply with its
fiduciary duties. If there is such
a superior proposal, we may
terminate the asset purchase
agreement two business days after
giving notice to Folksamerica that
we are prepared to accept the
proposal. See "The Asset Purchase
Agreement-- No Solicitation."
Conditions to Closing................... The asset purchase agreement
contains conditions to closing,
including the receipt of regulatory
approval, the retention of a key
employee, third party consents and
stockholder approval and the
absence of a material adverse
change since the date of the asset
purchase agreement. See "The Asset
Purchase Agreement-- Conditions to
Closing."
Termination............................. The asset purchase agreement may be
terminated:
o if the parties mutually agree
to terminate it;
o if the closing has not
occurred prior to July 31,
2000;
o by the non-breaching party,
if (subject to materiality
exceptions) any of the
representations, warranties
or covenants is breached and
not cured;
o by Folksamerica, if we
violate the "no solicitation"
covenant;
o by us, if there is a superior
proposal; or
o if our stockholders vote
against approval of the asset
purchase agreement.
See "The Asset Purchase Agreement--
Termination."
Termination Fee......................... If we terminate the asset purchase
agreement in the event of a
superior proposal, we will be
required to pay to Folksamerica a
termination fee of $1.5 million two
days after the day we terminate the
asset purchase agreement.
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If, as a result of direct
solicitation by a third party, our
stockholders do not approve the
asset purchase agreement and
thereafter we or Folksamerica
terminate the asset purchase
agreement due to the failure of our
stockholders to approve it or
because the closing has not
occurred prior to July 31, 2000, we
must pay the $1.5 million
termination fee to Folksamerica if
we enter into or consummate an
acquisition proposal with the third
party that solicited our
stockholders within 12 months of
the day we terminate the asset
purchase agreement. See "The Asset
Purchase Agreement-- Termination
Fee."
Accounting Treatment.................... The asset sale will be reflected on
our consolidated balance
sheet as a sale of certain of our
assets and the transfer of certain
of our liabilities. See "The Asset
Sale-- Accounting Treatment of the
Asset Sale."
Tax Consequences........................ The asset sale will not result in
any federal income tax
consequences to you, but the asset
sale will be a taxable transaction
to RCRe for federal income tax
purposes. See "The Asset Sale--
Material Federal Income Tax
Consequences of the Asset Sale."
Regulatory Matters...................... The Nebraska Insurance Department
has approved the asset
sale. The asset purchase agreement
requires that the approval of the
insurance departments of New York
and Florida be obtained before the
asset sale can be consummated. We
have been granted early termination
of the waiting period requirement
under federal antitrust law . See
"The Asset Sale-- Regulatory
Matters."
Interest of Officers and Directors in... Our executive officers and the
the Asset Sale chairman of our board will be
entitled to receive payments
following the asset sale. See
"Interests of Certain Persons in
Matters to Be Acted Upon --
Payments to Executive Officers and
Chairman of the Board."
Upon stockholder and regulatory
approval of the asset sale, all
unvested stock options and shares
of restricted stock held by our
executive officers and members of
our board will immediately vest.
See "Interests of Certain Persons
in Matters to Be Acted Upon --
Vesting of Options and Restricted
Shares."
The chairman of our board and two
of our stockholders own, and will
continue to own after the asset
sale is completed, warrants to
purchase shares of our common
stock. See "Interests of Certain
Persons in Matters to Be Acted Upon
-- Ownership of Warrants."
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SUMMARY FINANCIAL DATA
The following tables reflect selected unaudited pro forma condensed
consolidated financial data for the year ended December 31, 1999 compared to our
and RCRe's consolidated historical data for the years ended December 31, 1999,
1998 and 1997.
The selected unaudited pro forma condensed consolidated financial data
have been derived from the unaudited pro forma condensed consolidated financial
information included elsewhere in this proxy statement. The unaudited pro forma
income statement and per share data reflect our historical accounts for the year
ended December 31, 1999, adjusted to give pro forma effect to the proposed sale
of our reinsurance business to Folksamerica and the stock repurchase from XL
Capital as if such transactions had occurred on January 1, 1999. The unaudited
pro forma balance sheet data reflect our historical accounts as of December 31,
1999, adjusted to give pro forma effect to the asset sale and stock repurchase
as if those transactions had occurred on December 31, 1999. The unaudited pro
forma data are presented for illustrative purposes only and are not indicative
of the results of operations or financial position that would have occurred if
the transactions had been completed on the assumed dates, nor are they
necessarily indicative of our future operating results or financial position.
Our selected consolidated historical data set forth below are derived
from our audited consolidated financial statements and should be read in
conjunction with the consolidated financial statements and the related notes
contained elsewhere in this proxy statement.
Years Ended December 31,
--------------------------------------------------------------------
Pro forma Historical
----------- -----------------------------------------------------
1999 1999 1998 1997
----------- ---------------- --------------- -------------
(Dollars in thousands, except per share data)
Statement of Operations Data
Net premiums earned -- $311,368 $206,194 $107,372
Total revenues $29,834 348,768 247,133 120,972
Net income (loss) 17,950 (32,436) 3,091 2,039
Comprehensive income (loss) 739 (52,286) (4,375) 47,107
Per Share Data
Net income (loss) - basic $1.46 ($1.90) $0.18 $0.12
- diluted $1.46 ($1.90) $0.17 $0.12
Comprehensive
income (loss) - basic $0.06 ($3.06) ($0.26) $2.77
- diluted $0.06 ($3.06) ($0.26) $2.76
Average shares
outstanding - basic 12,331,732 17,086,732 17,065,165 17,032,601
- diluted 12,331,808 17,086,808 17,718,223 17,085,788
Cash dividends per share N/A N/A N/A N/A
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Years Ended December 31,
--------------------------------------------------------------------
Pro forma Historical
----------- -----------------------------------------------------
1999 1999 1998 1997
----------- ---------------- --------------- -------------
(Dollars in thousands, except per share data)
Balance Sheet Data
Cash and invested assets $283,137 $585,909 $587,155 $505,728
Total assets 303,360 864,359 757,830 581,247
Stockholders' equity 297,019 346,514 398,002 401,031
Book value per
share - basic $24.08 $20.28 $23.29 $23.51
- diluted $24.08 $20.28 $22.75 $22.79
Shares
outstanding - basic 12,332,970 17,087,970 17,087,438 17,058,462
- diluted 12,332,970 17,087,970 17,497,904 17,601,608
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QUESTIONS AND ANSWERS ABOUT THE ASSET SALE
Q: What is being sold in the asset sale?
A: We are selling our reinsurance business through the transfer of the
reinsurance assets and liabilities of our operating subsidiary, Risk
Capital Reinsurance Company ("RCRe"), to Folksamerica Reinsurance Company
for a purchase price of $20.335 million.
Q: Will the company pay any dividends after the asset sale is completed?
A: We have no current intention to pay dividends or make any other
distribution to stockholders.
Q: Will the company be repurchasing shares?
A: Our board intends to reach a determination regarding repurchases of our
shares after consummation of the asset sale, but no decision has yet been
made as to whether any such repurchases will be made or the amount, timing
or method of any such repurchases, which will depend on future
circumstances.
Q: Will I continue to be able to sell my shares?
A: The asset sale will not affect stockholders' rights to sell or otherwise
transfer shares.
Q: Why is the transaction structured as a sale of the company's reinsurance
business rather than a sale of the entire company?
A: Our shares have been, for some time, trading at a significant discount to
book value. We believe that this transaction should result in greater value
realization than would a sale of the entire company, although we cannot
predict the overall market impact of the asset sale or any other
transaction on the trading price of our shares. We also believe that this
structure best reflects the intent of the parties and provides for future
flexibility.
Q: What will be the book value of the company's remaining assets?
A: As of December 31, 1999, our book value was $346.5 million, or $20.28 per
share. As of that date, assuming that the proposed asset sale to
Folksamerica and our repurchase of 4,755,000 shares from XL Capital Ltd,
described in this proxy statement, had occurred on that date, our book
value would have been $297.0 million, or $24.08 per share. Please read the
section entitled "Unaudited Pro Forma Condensed Consolidated Financial
Data" in this proxy statement for details regarding the assumptions
underlying these calculations.
On January 14, 2000, the trading day before we announced the asset sale,
the closing price of our common stock as reported on the Nasdaq National
Market was $14.875. On March 13, 2000, the closing sale price per share for
our common stock as reported on the Nasdaq National Market was $14.875.
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Q: What will the company do after the asset sale is completed?
A: The company's objective will be to serve as a vehicle to effect business
combinations and ventures, whether by acquiring all or a portion of
companies, merger, exchange of stock or otherwise, with one or more
operating companies that the board believes will have potential to increase
stockholder value. These business combinations and ventures may be with
companies that are not in the insurance business. The company may cease to
pursue this business objective at any time and may also consider
alternatives. In addition, as discussed above, our board intends to reach a
determination regarding repurchases of our shares.
Q: Will the company retain its insurance licenses?
A: We have no current intention to cause our insurance subsidiaries, RCRe and
Cross River Insurance Company, to relinquish or dispose of their insurance
licenses.
Q: Does the board have an alternative strategic plan in the event the
stockholders do not approve the asset sale?
A: At this time, the board does not have a specific alternative strategic
plan.
Q: Will I be able to vote separately on the change in the nature of the
company's business?
A: No. Stockholders will not have an opportunity to vote separately on the
change in the nature of the business of the company. Consequently, a vote
in favor of the approval of the asset sale and name change will in effect
constitute a vote in favor of changing the nature of the business of the
company as determined by our board of directors.
Q: When do you expect the asset sale to be completed?
A: We are working toward completing the asset sale as quickly as possible. In
addition to stockholder approval, we must satisfy certain other conditions
to closing, as described in this proxy statement in "The Asset Purchase
Agreement -- Conditions to Closing." We currently expect to complete the
asset sale in the second quarter of 2000.
Q: What should I do now?
A: After you have carefully reviewed this document, you should mail your
completed, dated and signed proxy card in the provided prepaid envelope as
soon as possible so that your shares will be voted at the stockholders'
meeting.
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RISK FACTORS
In deciding whether to approve the proposal, stockholders should consider
the following risk factors, as well as the other information in this document.
Cautionary note regarding forward-looking statements
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. All statements other than statements of
historical fact included in or incorporated by reference in this proxy statement
are forward-looking statements. Forward-looking statements can generally be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "intend," "estimate," "anticipate," "believe" or "continue" or their
negative or variations or similar terminology.
Forward-looking statements involve our current assessment of risks and
uncertainties. Actual events and results may differ materially from those
expressed or implied in these statements. Important factors relating to our
existing business that could cause actual events or results to differ materially
from those indicated in such statements are discussed below and elsewhere in
this proxy statement and include:
o the acceptance in the market of our reinsurance products;
o competition from new products (including products that may be offered
by the capital markets);
o the availability of investments on attractive terms;
o competition, including increased competition (both as to underwriting
and investment opportunities);
o changes in the performance of the insurance sector of the public
equity markets or market professionals' views as to such sector;
o the amount of underwriting capacity from time to time in the market;
o general economic conditions and conditions specific to the reinsurance
and investment markets in which we operate;
o regulatory changes and conditions;
o rating agency policies and practices; and
o claims development, including as to the frequency or severity of
claims and the timing of payments.
In addition to risks and uncertainties related to our existing business,
the transactions described in this proxy statement are subject to various risks
and uncertainties including the risks that the conditions to closing will not be
satisfied and that the costs of the transaction and purchase price and reserve
adjustments will be greater than currently expected with resulting effects on
our book value.
Forward-looking statements relating to the transaction that is the subject
of this proxy statement are discussed below and elsewhere in this proxy
statement and include:
o the purchase price to be paid by Folksamerica;
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o the tax consequences of the asset sale;
o RCRe's reserves for its book of business;
o our future business operations and strategy;
o potential stock repurchases; RCRe's payment of special distributions
to us following the asset sale;
o transaction costs incurred in connection with the asset sale and the
XL Capital stock repurchase;
o our book value and the trading price of our common stock after the
asset sale and the XL Capital stock repurchase;
o amount of premiums expected to be generated in 2000 from in-force
treaties;
o our estimate of after-tax losses relating to RCRe's maximum aviation
exposures; and
o our management of catastrophe exposures.
All subsequent written and oral forward-looking statements attributable to
us or persons acting on our behalf are expressly qualified in their entirety by
these cautionary statements. We undertake no obligation to publicly update or
revise any forward-looking statement, whether as a result of new information,
future events or otherwise.
Risks Relating to the Asset Sale
The ultimate purchase price to be paid by Folksamerica in the asset sale may be
less than $20.335 million.
Folksamerica Reinsurance Company will assume RCRe's reinsurance liabilities
and RCRe will transfer to Folksamerica Reinsurance Company assets in an
aggregate amount that is, in GAAP book value (as set forth on our estimated
closing date balance sheet), equal to the GAAP book value (as set forth on our
estimated closing date balance sheet) of the liabilities assumed. In
consideration for the transfer of RCRe's book of business, Folksamerica will pay
$20.335 million in cash at the closing, subject to adjustment under the
circumstances described below.
Following the closing, the closing date balance sheet will be audited by
our independent public accountants. Folksamerica is permitted to dispute the
closing date balance sheet (other than the component of the balance sheet that
relates to our loss reserves). Any dispute will be referred to neutral experts
mutually acceptable to us and Folksamerica for final resolution. In the event
that we overestimated the net value of the assumed business, we will be required
to pay to Folksamerica a post-closing purchase price adjustment. Conversely, if
we underestimated the net value of the assumed business, Folksamerica will be
required to pay us a post-closing purchase price adjustment.
We have agreed to indemnify Folksamerica in connection with the asset sale.
See "--We may be liable to Folksamerica for breaches of representations and
warranties" and "The Asset Purchase Agreement -- Indemnification."
At the closing, $20 million of the purchase price will be delivered into
escrow. The final disposition of this $20 million will generally be determined
five years after closing of the asset sale and will depend on whether our
closing date loss reserves relating to business produced on behalf of RCRe by a
certain managing underwriting agency turns out to have been redundant or
deficient. In the event that there is no deficiency, all
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of the amounts then in escrow will be released to us and, in addition,
Folksamerica will pay us in cash the amount of any redundancy. In the event that
there is a deficiency of less than $20 million, the amount of the deficiency
will be released from the escrow to Folksamerica and the remainder will be
released to us. In the event that the deficiency is more than $20 million, all
of the amounts then in escrow will be released to Folksamerica, but Folksamerica
will have no further recourse to us. Moreover, amounts in this escrow may be
released to Folksamerica to satisfy its indemnification claims against us under
the asset purchase agreement relating to undisclosed liabilities, RCRe's
reinsurance and retrocession treaties, accounts receivable and the managing
underwriting agency referred to above or the business produced by it.
We may be required to deposit an additional amount of up to $5 million in a
supplemental escrow for five years in the event that our closing date loss
reserves (other than reserves covered by the escrow described above) are less by
more than one-half percent (0.5%) than those estimated by our independent
actuary. This supplemental escrow will be governed by terms substantially
similar to the escrow described above, except that (1) if those reserves turn
out to have been redundant, the full escrow fund will be released to us, but
Folksamerica will have no obligation to make payments to us and (2) this escrow
will not be available to satisfy indemnification claims.
In connection with either escrow arrangement, we will record a loss in an
amount equal to any probable deficiency in the related reserve that may become
known during or at the end of the five year period.
Under the Internal Revenue Code, a purchaser of insurance assets may become
liable for a "bargain purchase price tax" if, in a transaction, the tax basis of
the assets it is purchasing is more than the tax basis of the liabilities it is
assuming plus the purchase price it is paying (including transaction costs). We
have agreed to grant Folksamerica a credit against the purchase price for a
portion of this potential tax by the following method:
To the extent it is determined that the tax basis of the assets being
transferred exceeds the sum of
o the tax basis of the liabilities being transferred,
o the final purchase price, and
o Folksamerica's transaction costs relating to the asset sale,
we will give Folksamerica a credit against the purchase price equal to:
o if the excess is $15 million or less, then the lesser of (1) 17.5% of
the excess and (2) $2 million; and
o if the excess is more than $15 million, then the sum of (1) $2 million
plus (2) 35% of the excess.
Under the asset purchase agreement, we have agreed to retain the
liabilities relating to our severance plans and agreements, as well as to pay to
Folksamerica at closing the amount by which the cost of reinsurance protection
on our aviation line of business exceeds the net premiums we earn on that
business after December 31, 1999. Furthermore, as described above, we are liable
for a portion of Folksamerica's bargain purchase price tax liability and our own
transaction costs. We estimate that these costs will be approximately $19
million in the aggregate, which amount will effectively reduce the purchase
price we will retain. These costs are reflected in the pro forma book value
amounts set forth under "Unaudited Pro Forma Condensed Consolidated Financial
Data."
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Folksamerica may be unable to make payments that they may become obligated to
make to us.
As described above, following the closing, Folksamerica will be required to
make payments to reinsureds under RCRe's reinsurance agreements transferred in
the asset sale and to indemnify us for losses arising out of or relating to
those agreements. The asset purchase agreement provides that if our closing date
loss reserves (other than reserves covered by the $20 million escrow) are found
to be redundant as of the fifth anniversary of the closing, Folksamerica will
pay us the amount of that redundancy up to $2 million. In addition, as described
above, Folksamerica may be required to make certain purchase price adjustment
payments to us under the asset purchase agreement and pay to us the amount of
any loss reserve redundancy under the $20 million escrow agreement, some of
which may be payable more than five years after the closing. Therefore, we
remain exposed to Folksamerica's creditworthiness and ability under applicable
regulatory requirements to make payments to us. Folksamerica may refuse or be
unable to make all the payments it may be required to make to us.
We may be liable to Folksamerica for breaches of representations and warranties.
Under the asset purchase agreement, we have made extensive representations
and warranties about us and the assumed business. Representations and warranties
are required to be reaffirmed as of the closing, and our inability to reaffirm
them will (if, in the case of representations and warranties that are not
already qualified by materiality, it would result in a material adverse effect)
entitle Folksamerica to terminate the agreement. Our representations and
warranties relating to the following matters will survive for one year following
the closing and, if breached, could result in liability to us:
o incorporation and authority to enter into the transaction;
o property and assets necessary to operate the assumed business
remaining in our company or our affiliates and outstanding
intercompany obligations relating to the assumed business;
o compliance with instruments, including our certificate of
incorporation and bylaws, and other agreements to which we are party;
o absence of undisclosed liabilities;
o title and rating of all of our fixed income investments being
transferred to Folksamerica;
o our transactions that combine capital investments with reinsurance
("Integrated Solutions") for which we had obligations as of September
30, 1999;
o absence of a material adverse change since September 30, 1999 relating
to the assumed business;
o absence of adjustments to case reserves since September 30, 1999,
except in the ordinary course consistent with past practice;
o actuarial reports of the company for periods ending on or after
December 31, 1995;
o reinsurance and retrocession agreements being transferred in the asset
sale;
o accounts receivable;
o non-competition covenants;
o agents through whom RCRe sells insurance; and
-13-
o broker's or finder's fees.
In addition, representations and warranties relating to tax matters will survive
until the expiration of the applicable statute of limitations. We retain our tax
and employee benefit liabilities and other liabilities not being assumed by
Folksamerica, including all liabilities not arising under RCRe's reinsurance
agreements transferred to Folksamerica Reinsurance Company. All of the
reinsurance agreements transferred to Folksamerica Reinsurance Company are
listed in a schedule to the asset purchase agreement.
RCRe may retain exposure on the reinsurance agreements that are being
transferred to Folksamerica Reinsurance Company.
Under the transfer and assumption agreement to be entered into at the
closing, Folksamerica Reinsurance Company will assume RCRe's obligations under
the reinsurance agreements being transferred in the asset sale. Following the
closing, Folksamerica Reinsurance Company will notify the reinsureds under the
in-force reinsurance agreements that it has assumed RCRe's obligations and that,
unless the reinsureds object to the assumption, RCRe will be released from its
obligations to those reinsureds. However, RCRe will continue to be liable under
those reinsurance agreements if the reinsureds object to the release of RCRe
from its obligations or the notice is found not to be an effective release by
the reinsureds. Folksamerica has agreed to indemnify us for any losses arising
out of the reinsurance agreements transferred to Folksamerica Reinsurance
Company in the asset sale. However, in the event that Folksamerica refuses or is
unable to perform its obligations to us, RCRe may incur losses relating to the
reinsurance agreements transferred in the asset sale.
Risks Relating to Our Business After the Asset Sale
We may have no operating history in our new line of business.
Following the asset sale, the company's objective will be to serve as a
vehicle to effect business combinations and ventures, whether by acquiring all
or a portion of companies, merger, exchange of stock or otherwise, with one or
more operating companies that the board believes will have potential to increase
stockholder value. These business combinations and ventures may be with
companies that are not in the insurance business. The company may cease to
pursue this business objective at any time and may also consider alternatives.
We may have had no operating history in our new line of business, although
members of our board of directors have broad business experience. Accordingly,
there can be no assurance that our future operations will generate cash flows or
operating or net income, and our prospects must therefore be considered in light
of the risks, expenses, problems and delays inherent in acquiring and/or
establishing a new business. We and our stockholders may suffer a substantial
loss should the new business plan prove to be unsuccessful.
Our success will depend almost entirely on the operations, financial
condition and management of the companies in which we may acquire interests or
with which we may merge. Further, these ventures may involve financial and
operational risks. Financial risks include the possible incurrence of
indebtedness by us in order to effect the acquisitions and the consequent need
to service that indebtedness. Operational risks include the possibility that a
venture does not ultimately provide the benefits we had originally anticipated
while we continue to incur operating and other expenses. In addition, if we make
a strategic investment by acquiring a minority interest in a company, we may
lack elements of control over the operations and strategy of the business in
which we invested. We cannot assure you that we will be successful in
identifying new operating businesses, completing and financing business
combination or venture transactions on favorable terms, or operating our new
business successfully. In implementing our strategy, we will attempt to minimize
the risk of unexpected liabilities and contingencies associated with our new
operating businesses through planning, investigation and negotiation, but
unexpected liabilities and contingencies may nevertheless accompany such
transactions.
-14-
We cannot specify the exact nature of the business risks we may encounter in the
future.
We have not identified the business opportunities and businesses in which
we will attempt to obtain an interest. We therefore cannot describe the specific
risks presented by such businesses. To the extent that we effect a business
combination with or invest in a financially unstable company or an entity in its
early stage of development or growth (including entities without established
records of revenues or income), we will become subject to numerous risks
inherent in the business and operations of financially unstable and early stage
or potential emerging growth companies. In addition, to the extent that we
effect a business combination with an entity in an industry characterized by a
high level of risk, we will become subject to the unascertainable risks of that
industry. An extremely high level of risk frequently characterizes industries
which experience rapid growth. Although we will endeavor to evaluate the risks
inherent in a particular new operating business or industry, we cannot assure
you that we will properly ascertain or assess all such risks. Such new operating
business may involve an unproven product, technology or marketing strategy, the
ultimate success of which cannot be assured. The new operating businesses may be
in competition with larger, more established firms that have competitive
advantages over us. Our investment in a business opportunity may be highly
illiquid and could result in a total loss to us if the opportunity is
unsuccessful.
We may need to secure additional financing to carry out our business plan.
We may be required to raise cash to consummate a business combination, to
provide funds for an additional infusion of capital into a new operating
business or to fund any share repurchases we may make. The amount and nature of
any borrowings by us will depend on numerous considerations, including our
capital requirements, our perceived ability to meet debt service on any such
borrowings and the then prevailing conditions in the financial markets, as well
as general economic conditions. If we are able to raise additional funds through
the incurrence of debt, and we do so, we would likely become subject to
restrictive financial covenants. Additionally, to the extent that debt financing
ultimately proves to be available, any borrowings may subject us to various
risks and restrictions traditionally associated with indebtedness, including the
risks of interest rate fluctuations and insufficiency of cash flow to service
that indebtedness. If additional funds are raised through the issuance of equity
securities, the percentage ownership of our then current stockholders would be
diluted, our earnings and book value per share could be diluted and, if such
equity securities take the form of preferred stock, the holders of such
preferred stock may have rights, preferences or privileges senior to those of
holders of common stock. We are not currently in discussions, nor have we had
any discussions, with respect to obtaining any debt or equity financing. We
cannot assure you that we will be able to raise equity capital, obtain capital
lease or bank financing or incur other indebtedness to fund any business
combination or the working capital and other capital requirements of a new
operating business on terms deemed by us to be commercially acceptable and in
our best interests.
We may incur significant costs to avoid investment company status and may suffer
other adverse consequences if deemed to be an investment company.
We may incur significant costs to avoid investment company status and may
suffer other adverse consequences if deemed to be an investment company under
the Investment Company Act of 1940. Some equity investments in other businesses
made by us to date and in the future constitute or may constitute investment
securities under the Investment Company Act. A company may be deemed to be an
investment company if it owns investment securities with a value exceeding 40%
of its total assets, subject to certain exclusions. Investment companies are
subject to registration under, and compliance with, the Investment Company Act
unless an exclusion applies. If we were deemed to be an investment company and
could not rely on an exclusion, unless we complied with the registration and
other extensive requirements of the Investment Company Act, we would be
prohibited from engaging in business or issuing our securities as we have in the
past and might be subject to civil and criminal penalties for noncompliance. In
addition, in such case, certain of our contracts might be voidable, and a
court-appointed receiver could take control of us and liquidate our business.
-15-
Our investment securities currently comprise more than 40% of our assets.
We currently rely on an exclusion under the Investment Company Act for insurance
companies. Immediately following the asset sale, when we will not have an
operating business, we will need to rely on one or more other exclusions from
regulation under the Investment Company Act. If at any time we could not rely on
an exclusion, we would attempt to reduce our investment securities as a
percentage of our total assets. This reduction can be attempted in a number of
ways, including the disposition of investment securities and the acquisition of
assets that do not constitute investment securities. These sales may be at
depressed prices and we may never realize the anticipated benefits from, or may
incur losses on, these investments. We may not be able to sell some investments
because of contractual or legal restrictions or our inability to locate a buyer.
Moreover, we may incur tax liabilities when we sell assets. We may also be
unable to purchase additional investment securities that may be important to our
future operating strategy. We may not be able to identify and acquire suitable
assets that do not constitute investment securities on acceptable terms.
Our ability to attract and retain key personnel may be limited.
Our future success depends on our ability to attract and retain key
management and other personnel with expertise required in connection with the
acquisition and/or growth and development of a new business. See "The Asset
Sale--Management Changes." We cannot assure you that we will be successful in
attracting and retaining such executives and personnel. Inability to attract and
retain qualified personnel and the loss of services of key personnel could have
a material adverse effect on our ability to acquire and/or enter new businesses
and on our results of operations.
We will face intense competition as we seek to complete acquisitions and other
business combinations.
We will be a small participant in the market of seeking mergers with and
acquisitions of all or a portion of other entities. We expect to encounter
intense competition from other entities having business objectives similar to
ours. Many of these entities are well-established and have extensive experience
in identifying and effecting business combinations directly or through
affiliates. Many of these competitors possess greater financial, technical,
human and other resources than ours and we cannot assure you that we will have
the ability to compete successfully. Our financial resources will be limited in
comparison to those of many of our competitors. We cannot assure you that we
will be able to achieve our stated business objectives.
The financing of our business plan may cause us to forfeit certain tax benefits.
We expect that our remaining net loss carry-forwards will remain available
for use by us following the asset sale. In general, under Internal Revenue Code
Section 382, a change in control occurs when the major stockholders of a
corporation with net operating losses increase their ownership of its stock
(including through the exercise of warrants and stock repurchases) by more than
50 percentage points within a three-year period ending on the day of any
ownership shift. If such a change in control occurs, the utilization of the
remaining net loss carry-forwards would be limited and possibly lost. In
general, the amount of this limitation is determined by taking the value of the
stock of the corporation multiplied by a "long-term tax-exempt rate." The
long-term tax-exempt rate is adjusted monthly by the Internal Revenue Service.
We cannot predict the degree of fluctuation in the long-term tax-exempt rate,
but the rate for March 2000 is 5.84%. To finance a business combination, we may
have to raise equity from persons or entities not presently our stockholders,
which could result in a change in control. We cannot assure you that we (or any
company successor) will be able to receive benefits from any net loss
carry-forwards. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Results of Operations--Income Taxes."
As a general rule, federal and state tax laws and regulations have a
significant impact upon the structuring of business combinations. We will
evaluate the possible tax consequences of any prospective business combination
and will endeavor to structure the business combination so as to achieve a
favorable tax treatment to us and our stockholders. We cannot assure you,
however, that the Internal Revenue Service or other tax
-16-
authorities will ultimately assent to our proposed tax treatment of a
consummated business combination. To the extent the IRS or other tax authorities
ultimately prevail in recharacterizing the tax treatment of a business
combination, there may be adverse tax consequences to us, the new operating
business and our stockholders.
The public market for our common stock may become limited.
There can be no assurance that an active trading market for our common
stock will continue. Historically, the market prices for securities of
non-operating companies in the business of seeking mergers and acquisitions have
been highly volatile. The market price of our common stock could be subject to
significant fluctuations in response to various factors and events, including
the liquidity of the market for our common stock, announcements of potential
business combinations and changes in the industry or industries which we may
enter, as well as general economic and market conditions. We expect to continue
to file and be current in our Securities Exchange Act reports as we pursue our
business objectives. Accordingly, we anticipate that our common stock will
continue to be quoted on the Nasdaq National Market.
We may issue new equity in order to help attain our new business plan.
Generally, the board of directors has the power to issue new equity (to the
extent of authorized shares) without stockholder approval, except that
stockholder approval may be required under applicable law or Nasdaq National
Market rules for certain transactions. We may issue new equity to raise
additional capital in connection with a business combination or venture
transaction with an operating business. Any additional issuance by us would have
the effect of diluting the percentage ownership of our stockholders, could have
the effect of diluting our earnings and our book value per share, could result
in stockholders of another company obtaining a controlling interest in us, and
could result in the adverse tax consequences described above. We have no current
arrangement, agreement or understanding with respect to the sale or issuance of
any new equity.
We currently do not anticipate paying dividends, but may consider share
repurchases.
Any determination to pay dividends in the future will be at the discretion
of our board of directors and will be dependent upon our results of operations,
financial condition, capital requirements, contractual restrictions and other
factors deemed relevant by our board of directors. Our board of directors
currently does not intend to declare dividends or make any other distributions.
Our board intends to make a determination regarding repurchases of our
shares after the consummation of the asset sale, but no decision has yet been
made as to whether any such repurchases will be made or the amount, timing or
method of any such repurchases, which will depend on future circumstances.
-17-
THE STOCKHOLDERS' MEETING
We are furnishing this proxy statement to holders of our common stock in
connection with the solicitation of proxies by our board of directors at the
stockholders' meeting, and at any adjournments and postponements of the meeting.
Time and Place
The stockholders' meeting will be held on April 17, 2000 at 1:00 p.m.
(local time) at our offices, located at 20 Horseneck Lane, Greenwich,
Connecticut 06830.
Proposal
At the stockholders' meeting, our stockholders will consider and vote on
the proposal to approve the sale of substantially all of the reinsurance
business of our operating subsidiary Risk Capital Reinsurance Company to
Folksamerica Reinsurance Company pursuant to the Asset Purchase Agreement dated
as of January 10, 2000 among Risk Capital Holdings, Inc., Risk Capital
Reinsurance Company, Folksamerica Holding Company, Inc. and Folksamerica
Reinsurance Company and, effective with the consummation of the asset sale, to
amend our certificate of incorporation to change the name of the company from
"Risk Capital Holdings, Inc." to "Arch Capital Group Ltd."
Stockholders will not have an opportunity to vote separately on the change
in the nature of the business of the company. Consequently, a vote in favor of
the approval of the asset sale and name change will in effect constitute a vote
in favor of changing the nature of the business of the company as determined by
our board of directors.
Record Date; Voting at the Stockholders' Meeting
The board of directors has fixed the close of business on March 14, 2000 as
the record date for determination of the stockholders entitled to notice of and
to vote at the stockholders' meeting and any and all postponements or
adjournments of the stockholders' meeting. On the record date, there were
approximately 12,329,424 shares of common stock outstanding and entitled to
vote, which were held by 47 holders of record and approximately 1,600 beneficial
holders. Each holder of record of common stock on the record date is entitled to
cast one vote per share. A stockholder may vote in person or by a properly
executed proxy on each proposal put forth at the stockholders' meeting.
Quorum; Vote Required for Approval
The presence in person or by properly executed proxy of a majority of our
common stock outstanding and entitled to vote at the stockholders' meeting is
necessary to constitute a quorum. If a quorum is not present, the stockholders'
meeting may be adjourned from time to time until a quorum is obtained. The
approval of the proposal requires the affirmative vote of the holders of a
majority of our common stock outstanding and entitled to vote.
Our officers and directors will be present at the stockholders' meeting and
available to respond to questions. Our independent accountants are expected to
be present at the stockholders' meeting, will have the opportunity to make a
statement if they desire to do so and are expected to be available to respond to
appropriate questions.
Under applicable rules, brokers that hold shares in street name for
customers are precluded from exercising their voting discretion on those shares.
Signed proxies held by brokers without instructions are referred to as "broker
non-votes." While broker non-votes will be counted for purposes of determining
whether there is
-18-
a quorum at the stockholders' meeting, absent specific instructions from the
beneficial owner of the shares, brokers are not empowered to vote these shares.
Since the affirmative vote of a majority of the common stock outstanding and
entitled to vote is required to approve the proposal, a broker non-vote or the
failure to vote in person or by proxy will have the effect of a vote against the
proposal.
Voting and Revocation of Proxies
All stockholders should complete, sign and return the enclosed form of
proxy. All shares of common stock represented at the stockholders' meeting by
properly executed proxies received before or at the stockholders' meeting,
unless those proxies have been revoked, will be voted at the stockholders'
meeting, including any postponement or adjournment of the stockholders' meeting.
If no instructions are indicated on a properly executed proxy, the proxies will
be deemed to be FOR approval of the proposal.
Any proxy given pursuant to this solicitation may be revoked by the person
giving it at any time before it is voted. Proxies may be revoked by either
o filing, including by facsimile, with the Secretary of Risk Capital
Holdings, Inc., before the vote at the stockholders' meeting is taken,
a written notice of revocation bearing a later date than the date of
the proxy or a later-dated proxy relating to the same shares, or
o attending the stockholders' meeting and voting in person.
In order to vote in person at the stockholders' meeting, stockholders must
attend the stockholders' meeting and cast their vote in accordance with the
voting procedures established for the stockholders' meeting. Attendance at a
stockholders' meeting will not in and of itself constitute a revocation of a
proxy. Any written notice of revocation or subsequent proxy must be sent so as
to be delivered at or before the taking of the vote at the stockholders' meeting
to Risk Capital Holdings, Inc., 20 Horseneck Lane, Greenwich, Connecticut 06830,
Facsimile: (203) 861-4508, Attention: Secretary.
Solicitation of Proxies
Proxies are being solicited by and on behalf of the board of directors. We
have retained MacKenzie Partners, Inc. to aid in the solicitation of proxies and
to verify records related to the solicitations. We will pay MacKenzie Partners,
Inc. approximately $4,500 plus expense reimbursement for its services. Brokerage
houses, nominees, fiduciaries and other custodians will be requested to forward
solicitation materials to beneficial owners and will be reimbursed for their
reasonable expenses incurred in so doing. We may request by telephone,
facsimile, mail, electronic mail or other means of communication the return of
the proxy cards.
Other Matters
As of the date of this proxy statement, our board of directors knows of no
matters that will be presented for consideration at the special meeting, other
than as described in this proxy statement. If any other matters shall properly
come before the special meeting or any adjournments or postponements of the
special meeting and shall be voted on, the enclosed proxies will be deemed to
confer discretionary authority on the individuals named as proxies therein to
vote the shares represented by such proxies as to any of those matters. The
persons named as proxies intend to vote or not vote in accordance with the
recommendation of our board of directors and management.
-19-
THE ASSET SALE
Background of the Asset Sale
Our board has continually monitored and reviewed the insurance industry and
general economic conditions, as well as the company's position in those
environments, with the objective of enhancing stockholder value. Our shares have
been, for some time, trading at a significant discount to book value.
Recognizing the need to have a comprehensive and thorough review of
strategic alternatives available to us, the board retained Donaldson, Lufkin &
Jenrette in March 1999. Its role would include identifying potential acquirors
and transactions, assisting us in the negotiation of the financial aspects of
any proposed transaction and rendering an opinion regarding the fairness to us
from a financial point of view of the consideration to be received in a
transaction. Donaldson, Lufkin & Jenrette's compensation arrangements, set forth
in letter agreements in May and November of 1999, are described under
"--Donaldson, Lufkin & Jenrette Has Delivered a Fairness Opinion Relating to the
Asset Sale."
On April 15, 1999, the board established a strategic alternative evaluation
committee, consisting of Robert Clements, Stephen Friedman, Lewis L. Glucksman
and Mark D. Mosca. The strategic alternative evaluation committee was directed
to evaluate possible business combinations and other strategic alternatives for
the purpose of presenting possible opportunities to the board.
In consultation with representatives of Donaldson, Lufkin & Jenrette, we
reviewed the various structuring possibilities for a transaction. After
consideration, we decided to pursue a sale of our reinsurance operations rather
than a business combination or a sale of the entire company.
In April 1999, Company X advised Donaldson, Lufkin & Jenrette that it was
interested in exploring a transaction for the purchase of RCRe's business for
consideration to consist of cash and shares of Company X common stock. On April
8, 1999, we and Company X executed a confidentiality agreement and formally
began conducting due diligence on each other's businesses. On May 11, 1999, our
board met to discuss the transaction with Company X and also identified certain
other prospective business partners that could provide us with additional
opportunities to increase stockholder value. We and Company X began to negotiate
the terms of a transaction. On May 27, 1999, the board, with its legal advisors
present, met to discuss the potential transaction with Company X and to
designate a special committee consisting of Thomas V.A. Kelsey, Mr. Glucksman
and Robert F. Works to evaluate and make recommendations to the full board with
respect to a potential transaction with Company X. We and Company X could not
reach agreement, however, and the discussions ended.
After discussions with Company X ended, we, in consultation with
representatives of Donaldson, Lufkin & Jenrette, determined that a sale
exploration process offered the best means of finding a purchaser that would
offer the most value for our reinsurance business. This sale exploration process
included identifying potential buyers, evaluating their preliminary interest and
conducting due diligence sessions. Representatives of Donaldson, Lufkin &
Jenrette conducted an extensive process to identify and solicit potential buyers
of our reinsurance business. They contacted a total of 18 additional parties, 12
of whom received a confidential information memorandum regarding our company and
its business, and several of whom conducted due diligence. The confidential
information memorandum indicated that, although we preferred a transaction
involving the sale of our reinsurance business, we were willing to consider any
form of transaction that we believed would be in the best interests of our
stockholders. Together with representatives of Donaldson, Lufkin & Jenrette, we
engaged in preliminary discussions regarding a transaction with several parties
who indicated interest. In each case other than with Folksamerica, the
discussions were terminated at an early stage.
In early June 1999, Folksamerica expressed an interest in acquiring RCRe's
business. On June 11, 1999, Folksamerica sent us a non-binding letter expressing
its interest in acquiring RCRe or RCRe's insurance business (as well as its
financial ability to do so) and its desire to conduct due diligence on RCRe. On
June 15,
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1999, Folksamerica executed a confidentiality agreement and formally began to
conduct due diligence. We began negotiating with representatives of Folksamerica
regarding the terms of a possible transaction. Our legal advisors and
representatives of Donaldson, Lufkin & Jenrette, as well as the legal and
financial advisors of Folksamerica, participated in some of these negotiations.
On September 14, 1999, the board designated a special committee consisting
of Mr. Kelsey, Mr. Glucksman and Mr. Works to evaluate a transaction with
Folksamerica and make a recommendation to the full board.
On October 25, 1999, we entered into a letter agreement with Folksamerica
whereby it agreed to conduct additional analysis to confirm its interest in a
possible acquisition of RCRe's reinsurance business in accordance with the terms
set forth on a preliminary term sheet. The letter stated that by November 1,
1999, Folksamerica aimed to confirm its interest in continuing to pursue the
proposed transaction pursuant to the terms set forth on the preliminary term
sheet. If confirmation was provided on that date consistent with the terms of
the preliminary term sheet, we agreed to either (1) provide Folksamerica with an
exclusivity period commencing at that time and continuing until November 15,
1999 to complete negotiation of a transaction or (2) reimburse Folksamerica for
50% of the costs incurred by it between October 25, 1999 and November 1, 1999
during its analysis of RCRe.
On October 28, 1999, the special committee met with members of management
and representatives of Donaldson, Lufkin & Jenrette to review the negotiations
with Folksamerica. Representatives of Donaldson, Lufkin & Jenrette reported that
the sale exploration process culminated in one proposal (from Folksamerica) that
would result in an acquisition of our reinsurance business at a price
potentially at or above book value, and further indicated the asset sale to
Folksamerica was attractive for a number of reasons, including among others, the
potential premium to book value represented by the proposal, market factors and
the alternatives available to us. The special committee authorized management to
discuss the Folksamerica proposal to determine whether a definitive agreement
could be entered into and requested Donaldson, Lufkin & Jenrette to prepare a
detailed financial analysis of the proposed transaction.
On November 10, 1999, counsel to Folksamerica provided us with an initial
draft of a purchase agreement.
On November 11, 1999, the special committee met with management and
representatives of Donaldson, Lufkin & Jenrette. Management updated the board as
to the negotiations of the Folksamerica transaction and stated that the asset
sale was the best alternative for the company. After detailed discussion of the
proposed transaction and future business opportunities available to the company,
the special committee requested Donaldson, Lufkin & Jenrette to present its full
financial analysis of the asset sale at the next board meeting and to address
the fairness of the consideration.
On November 12, 1999, the special committee met, with management, counsel
to the special committee, counsel to the company and representatives of
Donaldson, Lufkin & Jenrette present, to further discuss the asset sale to
Folksamerica. Management summarized the negotiations and present terms of the
Folksamerica transaction, and Donaldson, Lufkin & Jenrette stated that, based on
the draft documentation, the consideration to be received by us in the proposed
asset sale is fair to us from a financial point of view.
On November 12, 1999, the board of directors met, with its legal and
financial advisors present, to consider the Folksamerica transaction in the
context of other potential opportunities. The special committee discussed its
meetings and other work to date, the focus of which was the proposed asset sale
to Folksamerica and alternative transactions with other parties, and then
requested Donaldson, Lufkin & Jenrette to present to the board its analysis of
the Folksamerica transaction as reflected in the draft documentation. Donaldson,
Lufkin & Jenrette presented its financial analysis of the asset sale to
Folksamerica and reiterated its oral opinion that,
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based on the draft documentation, the consideration to be received by us in the
asset sale is fair to us from a financial point of view.
Members of the board discussed Donaldson, Lufkin & Jenrette's presentation
with representatives of Donaldson, Lufkin & Jenrette and management. Management
indicated that it believed the asset sale to Folksamerica was the best
alternative available to the company at the time. The special committee
recommended the Folksamerica transaction to the entire board as it was presently
being discussed, subject to acceptable final definitive documentation being
completed and receipt of an acceptable fairness opinion from Donaldson, Lufkin &
Jenrette. The board unanimously resolved that the special committee be delegated
the authority to respond to and approve changes made to the terms of the
transaction in the course of negotiating final documentation with Folksamerica,
unless those changes represented a substantial departure from the transaction
terms outlined to the board. Following that action, the board unanimously
determined that the asset sale was expedient and in the best interests of our
company and approved the transaction, subject to acceptable final documentation
and the receipt of an acceptable fairness opinion from Donaldson, Lufkin &
Jenrette.
Over the next two months, our management, together with our counsel and
representatives of Donaldson, Lufkin & Jenrette, negotiated the terms of the
asset sale within the parameters of the transaction approved by the board on
November 12, 1999. Our legal advisors and representatives of Donaldson, Lufkin &
Jenrette, as well as the legal and financial advisors of Folksamerica, were
involved in many of these negotiations. The special committee and its counsel
were kept apprised of the negotiations and received drafts of the transaction
documents.
In mid-December 1999, during a hiatus in the discussions with Folksamerica,
management had preliminary discussions with Company Y. On December 18, 1999, our
counsel delivered to Company Y a draft asset purchase agreement that, if
negotiations with Folksamerica ended, could serve as the basis for a possible
transaction. Discussions with Company Y were suspended in light of the
recommencement and advanced state of negotiations with Folksamerica, whose
proposal was considered to be more advantageous.
During the process of negotiating the asset sale with Folksamerica,
management learned of XL Capital's interest in having us repurchase our shares
held by them with the consideration for such repurchase to include our interest
in LARC Holdings, Ltd. and Annuity and Life Re (Holdings), Ltd. The board
referred the matter to the special committee. Negotiations followed, including
as to the repurchase price, which was agreed to be the lesser of (1) 85% of the
average closing market price of our common stock during the 20 trading days
beginning on the third business day following public announcement of the stock
repurchase and the asset sale (January 21, 2000) and (2) $15. Management
discussed with the special committee the stock repurchase from XL Capital at its
November 11, 1999 meeting. At that meeting, the special committee requested
Donaldson, Lufkin & Jenrette to prepare a financial analysis of the XL Capital
stock repurchase at the next board meeting. At the November 12, 1999 meeting of
the special committee, management presented the terms of the XL Capital stock
repurchase to the special committee. Representatives of Donaldson, Lufkin &
Jenrette discussed their views of the proposed XL Capital stock repurchase with
the special committee, including the positive impact that the transaction would
have on the company's book value per share. Representatives of Donaldson, Lufkin
& Jenrette indicated that they believed that they would be prepared to render a
fairness opinion to the board with respect to the XL Capital stock repurchase,
subject to review of definitive documentation and transaction terms. On November
12, 1999, the special committee determined that the XL Capital stock repurchase
is fair to and in the best interests of us and our stockholders other than XL
Capital and recommended that the board approve the stock repurchase, subject to
acceptable final definitive documentation being completed and receipt of an
acceptable fairness opinion from Donaldson, Lufkin & Jenrette. At the November
12, 1999 meeting of the board, management presented the terms of the XL Capital
stock repurchase and Donaldson, Lufkin & Jenrette presented its financial
analysis of the stock repurchase. The board discussed the impact of the stock
repurchase in light of Donaldson, Lufkin & Jenrette's presentation. Following
that, the board (with Michael P. Esposito, Jr., Ian R. Heap and Mr. Clements,
who are also directors of XL Capital, abstaining) determined that the XL Capital
stock repurchase is fair to and in the best interests of our stockholders other
than XL Capital and approved
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the stock repurchase, subject to acceptable final definitive documentation being
completed and receipt of an acceptable fairness opinion from Donaldson, Lufkin &
Jenrette.
On December 13, 1999, the special committee met, with its and the Company's
legal and financial advisors present, to receive an update from management as to
the negotiations for the asset sale and the XL Capital stock repurchase.
Management advised the special committee of the progress of the negotiation of
the documentation for the transactions. Representatives of Donaldson, Lufkin &
Jenrette presented their full financial analysis of both the asset sale and XL
Capital stock repurchase. In connection with that presentation, Donaldson,
Lufkin & Jenrette delivered its oral opinions that (1) the consideration to be
received by us in the asset sale is fair to us from a financial point of view
and (2) the consideration to be received by us in the XL Capital stock
repurchase is fair to us and our stockholders other than XL Capital from a
financial point of view. The special committee then confirmed its
recommendations of the proposed transactions and directed management to seek to
conclude negotiations with respect to both transactions.
On January 17, 2000, we reached definitive agreement with Folksamerica as
to the terms of the asset sale and executed the asset purchase agreement. Three
of our stockholders, XL Capital, Marsh & McLennan Risk Capital, Ltd. and The
Trident Partnership, L.P., executed voting agreements in which they granted
Folksamerica Holding Company proxies to vote their shares in favor of the asset
sale. Since we repurchased the shares held by XL Capital, those shares will not
be voted at the stockholder meeting and will not be counted for purposes of
determining the total number of shares entitled to vote. Donaldson, Lufkin &
Jenrette delivered to the board a written opinion that, as of the date we
executed that asset purchase agreement, the consideration to be received by us
in the asset sale was fair to us from a financial point of view.
On the same date, we executed the stock repurchase agreement with XL
Capital. Donaldson, Lufkin & Jenrette delivered to the board an opinion that, as
of the date we executed the stock repurchase agreement, the consideration to be
received by us in the stock repurchase was fair to us and our stockholders,
other than XL Capital, from a financial point of view.
Reasons for the Asset Sale and the Name Change; Our Board of Directors
Recommends the Asset Sale
As described above under "Background of the Asset Sale," the decision of
the board to approve the asset sale was the result of an extensive sale
exploration and negotiation process which included the substantial involvement
of our legal and financial advisors. Among the factors that the board considered
in such determination were:
o RCRe was incurring losses on its reinsurance business and faced
increasing competition, which was adversely affecting results of
operations and financial condition;
o RCRe's surplus has decreased, while the surpluses of many of RCRe's
competitors have increased;
o we are unable to make expenditures to repurchase our shares while
still operating as a reinsurance business because of RCRe's statutory
surplus, rating and operating requirements;
o the amount and volatility of our earnings, resulting from our
operating strategy and underwriting performance, severely limits our
ability to incur and service substantial indebtedness, which in turn
limits our ability to increase RCRe's statutory surplus;
o our depressed stock price, combined with our inability to incur debt
or otherwise use RCRe's cash, as described above, have prevented us
from making acquisitions, which puts us, like many other small
reinsurance companies, at a severe competitive disadvantage in an
industry that has been experiencing rapid global consolidation;
-23-
o the board considered the prospects of the company absent a transaction
such as the asset sale and determined that stockholder value would
likely continue to be diminished if strategic steps were not taken;
o our shares have been trading at a significant discount to book value,
and the board determined that the structure of the transaction with
Folksamerica, which will result in the removal of reinsurance
liabilities and uncertainties from our business, presented the best
opportunity for our shares to trade closer to their book value;
o a number of parties had been contacted (including 19 by Donaldson,
Lufkin & Jenrette) regarding a possible transaction with us, and
discussions and due diligence sessions were held with several of those
parties, but other than with Folksamerica, none of the discussions
with those parties resulted in an agreement;
o the asset sale to Folksamerica was the only proposed transaction or
structure that would result in our stockholders potentially realizing
value at or above the book value of the company;
o the asset purchase agreement is a result of extensive arm's-length
negotiations and its terms reflect such negotiations;
o the board's financial advisor, Donaldson, Lufkin & Jenrette,
determined that the consideration to be received by us in the
transaction is fair to us from a financial point of view; o the
special committee recommended that the board approve the asset sale;
and
o the various matters described in "Interests of Certain Persons in
Matters to Be Acted Upon" do not outweigh or materially detract from
the benefits of the asset sale to us.
The board also took into account the following negative aspects of the
asset sale:
o the asset sale does not provide liquidity for our stockholders and
creates uncertainty as to our future prospects;
o the asset purchase agreement limits our ability to consider other
proposals that could be more attractive and, if it is not consummated,
may require us to, under certain circumstances, pay to Folksamerica a
termination fee of $1.5 million;
o the purchase price could be significantly less than $20.335 million
(see "Risk Factors -- The ultimate purchase price to be paid by
Folksamerica in the asset sale may be less than $20.335 million");
o the asset sale is subject to state regulatory approvals, including the
approval of the insurance departments of Nebraska (which has been
obtained), New York and Florida; and while we believe those approvals
will be obtained, delays could prevent the timely completion of the
asset sale and result in additional expenditures by us;
o the consummation of the asset sale is subject to other conditions,
including, among others, third party consents, the retention of a key
employee and the absence of a material adverse change in the assumed
business; and
o the uncertainty as to the company's future plans and the uncertainties
and unquantifiable risks of entering into any new business ventures in
which we have not been previously engaged.
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After taking into account, among others, the factors set forth above, the
board unanimously determined that the asset sale is expedient and for the best
interests of the company and approved the asset sale. In view of the variety of
factors considered in connection with its evaluation of the asset sale, the
board did not find it practicable to, and did not, quantify or otherwise assign
relative strengths to specific factors considered in reaching its determination.
Under the asset purchase agreement, we agreed to cease the use of the name
"Risk Capital Reinsurance Company" or any similar name following the closing. In
light of that covenant, the board has proposed to change the name of our company
from "Risk Capital Holdings, Inc." to "Arch Capital Group Ltd."
THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR THE ASSET SALE AND THE
NAME CHANGE.
Donaldson, Lufkin & Jenrette Has Delivered a Fairness Opinion Relating to the
Asset Sale
We and RCRe requested Donaldson, Lufkin & Jenrette Securities Corporation,
as financial advisor to us and RCRe, to render an opinion to the board of
directors of each of us and RCRe regarding the fairness from a financial point
of view to us and RCRe of the consideration to be received by RCRe in the
transaction.
For purposes of its opinion, Donaldson, Lufkin & Jenrette defined the
consideration (or total value) receivable to be $15.0 million (which reflects
the purchase price of $20.335 million less the portion of that purchase price
that represents severance obligations to be reimbursed by Folksamerica to us)
plus the amount of GAAP book value of RCRe to be retained by RCRe.
For purposes of its analysis, based on information provided by us and RCRe
to Donaldson, Lufkin & Jenrette, Donaldson, Lufkin & Jenrette assumed the amount
of GAAP book value of RCRe to be $347.9 million. In addition, Donaldson, Lufkin
& Jenrette assumed that the total value received was a range which included
results reflecting receipt of none of the escrowed funds in five years or all of
the escrowed funds in five years. This analysis resulted in a range of total
value of $342.9 million to $362.9 million, which included the $20.335 million
payment to be made to RCRe, reduced to reflect the portion of that payment that
represents our severance obligations to be reimbursed by Folksamerica, and the
GAAP book value of RCRe.
On December 13, 1999, Donaldson, Lufkin & Jenrette expressed its oral
opinion to the special committee, acting on behalf of our full board, that, as
of that date, and based on and subject to the assumptions, limitations and
qualifications set forth in the written opinion, the consideration receivable by
RCRe in the proposed transaction was fair to us and RCRe from a financial point
of view. Donaldson, Lufkin & Jenrette subsequently confirmed its December 13,
1999 oral opinion in writing on January 17, 2000.
The full text of the January 17, 2000 Donaldson, Lufkin & Jenrette opinion
is attached as Annex F. We urge you to read the opinion carefully and in its
entirety for the procedures followed, assumptions made, other matters considered
and limits of the review by Donaldson, Lufkin & Jenrette in connection with its
opinion.
Donaldson, Lufkin & Jenrette prepared its oral and written opinion for our
board of directors and the board of RCRe. The opinions addressed only the
fairness from a financial point of view of the consideration receivable by RCRe
to us and RCRe as of their respective dates. Donaldson, Lufkin & Jenrette
necessarily based its opinion on economic, market, financial and other
conditions as they existed on the dates of its opinion and on the information
made available to it as of those dates. Although subsequent developments may
affect the assumptions, analyses or conclusions of the opinion, Donaldson,
Lufkin & Jenrette does not have any obligation to update, revise or reaffirm its
opinion. The opinion is not a recommendation to any stockholder as to how such
stockholder should vote on the transaction. The opinion does not address the
relative merits of the
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transaction compared to other business strategies considered by our board of
directors or the board of directors' decision to proceed with the transaction.
In arriving at its January 17, 2000 opinion, Donaldson, Lufkin & Jenrette:
o reviewed the execution copy of the asset purchase agreement and the
disclosure schedule and all exhibits thereto;
o reviewed financial and other information that was publicly available
or furnished to it by us, including information provided during
discussions with the management;
o reviewed earnings projections of RCRe for the period beginning January
1, 1999 and ending December 31, 2000 prepared by the management;
o compared our financial and securities data with data of various other
companies whose securities are traded in public markets;
o reviewed the historical share prices and trading volumes of our common
stock;
o reviewed prices paid in other relevant business combinations of
property-casualty insurance companies; and
o conducted such other financial studies, analyses and investigations as
Donaldson, Lufkin & Jenrette deemed appropriate for purposes of the
opinion.
Donaldson, Lufkin & Jenrette reviewed substantially identical information
in arriving at its December 13, 1999 opinion.
In rendering its oral and written opinion, Donaldson, Lufkin & Jenrette
relied upon and assumed the accuracy and completeness of all of the financial
and other information that was available to it from public sources, that was
provided to it by us or our representatives, or that it otherwise reviewed.
Management believes that the financial projections it provided to Donaldson,
Lufkin & Jenrette are based on reasonable assumptions. Donaldson, Lufkin &
Jenrette did not make any independent evaluation of any assets or liabilities or
make any independent verification of any of the information that it reviewed.
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The following is a summary of the presentation that Donaldson, Lufkin &
Jenrette made to the special committee at its December 13, 1999 meeting in
connection with rendering its December 13, 1999 fairness opinion. The chart
below summarizes the ranges of implied equity values based on Donaldson, Lufkin
& Jenrette's analyses and compares these ranges with the total value receivable
by RCRe. For a detailed description of each of Donaldson, Lufkin & Jenrette's
analyses, see the discussion of the individual analyses below:
[EXPLANATORY CHART]
1. Analysis of Consideration Receivable Based on Selected Publicly Traded
Property-Casualty Insurance Companies. Donaldson, Lufkin & Jenrette compared the
consideration receivable by RCRe to the range of equity values of RCRe implied
by the relative valuation multiples of the following publicly traded
property-casualty insurance companies:
o Ace Limited o PXRE Group Ltd.
o Everest Reinsurance Holdings, Inc. o Renaissance Re Holdings, Ltd.
o IPC Holdings, Ltd. o Transatlantic Holdings, Inc.
o LaSalle Re Holdings Ltd. o Trenwick Group Inc.
o PartnerRe Ltd. o XL Capital Ltd
Donaldson, Lufkin & Jenrette analyzed the equity value of each of these
selected companies using trading valuations as of December 10, 1999, measured as
a multiple of September 30, 1999 book value per share. Based on this analysis,
Donaldson, Lufkin & Jenrette developed the following range of valuation
multiples reflecting Donaldson, Lufkin & Jenrette's judgment as to the business
mix and trading levels of such companies:
0.60x - 1.10x for September 30, 1999 book value per share
In determining the range of equity values for RCRe, Donaldson, Lufkin &
Jenrette applied the preceding valuation multiple to RCRe's shareholder's equity
at September 30, 1999. The analysis resulted in a range of implied equity values
for RCRe of $208.7 million to $382.7 million. The range of consideration
receivable
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by RCRe is within the resulting implied range of equity values of RCRe, valuing
the $20 million escrow at full and zero value.
2. Analysis of Consideration Receivable Based on Acquisitions of
Property-Casualty Insurance Companies. Donaldson, Lufkin & Jenrette compared the
consideration receivable by RCRe to the range of values of RCRe implied by the
relative purchase price multiples generated from 15 acquisitions of
property-casualty insurance companies that have occurred since August 7, 1995.
These 15 selected acquisitions are:
o Swiss Reinsurance acquisition of Underwriters Re Group Inc.
o Markel Corporation acquisition of Terra Nova (Bermuda) Holdings Ltd.
o Trenwick Group, Inc. acquisition of Chartwell Re Corporation
o ACE Limited acquisition of Capital Re Corporation
o ACE Limited acquisition of CAT Limited
o XL Capital Ltd acquisition of NAC Re Corp.
o Gerling-Kozern Allegemeine Versicherungs AG acquisition of
Constitution Re
o Fund American Enterprises Holdings, Inc. acquisition of Folksamerica
Holding Company, Inc.
o XL Capital Ltd acquisition of Mid Ocean Limited
o Fairfax Financial Holdings Limited acquisition of Sphere Drake
Holdings Limited
o XL Capital Ltd acquisition of GCR Holdings Ltd
o PXRE Corporation acquisition of Transnational Re Corporation
o General Re Corporation acquisition of National Re Corporation
o ACE Limited acquisition of Tempest Reinsurance Company Limited
o Chartwell Re Corporation acquisition of Piedmont Management Company,
Inc.
Donaldson, Lufkin & Jenrette analyzed the equity value of each of the
acquired companies, measured as a multiple of book value per share for the most
recent quarter. Based on this analysis, Donaldson, Lufkin & Jenrette developed
the following range of acquisition multiples reflecting Donaldson, Lufkin &
Jenrette's judgment as to the business mix of such property-casualty insurance
companies involved in such acquisitions:
0.90x - 1.30x book value per share
Donaldson, Lufkin & Jenrette then applied this acquisition multiple to
RCRe's stockholders' equity to determine the range of implied equity values of
RCRe. The analysis resulted in a range of implied values for RCRe of $313.1
million to $452.3 million. The range of consideration receivable by RCRe is
within this range of implied values, valuing the $20 million escrow at full and
zero value.
3. Analysis of pro forma financial effect of the transaction on our
stockholders' equity. Donaldson, Lufkin & Jenrette calculated our pro forma
stockholders' equity per share using the range of consideration receivable. The
analysis resulted in the following range of stockholders' equity per share:
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Stockholders' Equity Per Share
--------------------------------
Basic Fully Diluted
--------- ----------------
As of September 30, 1999 $21.15 $20.91
Assumes we receive no escrowed funds $21.20 $20.95
Accretion 0.2% 0.2%
Assumes we receive all escrowed funds $21.96 $21.52
Accretion 3.8% 2.9%
The summary set forth above is not a complete description of the analyses
performed by Donaldson, Lufkin & Jenrette but summarizes the material elements
of its presentation to the special committee on December 13, 1999 in connection
with preparation of its December 13, 1999 opinion. Donaldson, Lufkin & Jenrette
performed substantially identical analyses in connection with its January 17,
2000 opinion. When Donaldson, Lufkin & Jenrette prepares a fairness opinion it
must determine the most appropriate and relevant methods of financial analysis
and apply these methods to the particular circumstances. Donaldson, Lufkin &
Jenrette conducted each of the analyses in order to provide a different
perspective on the transaction and to add to the total mix of information
available. In reaching its conclusion, Donaldson, Lufkin & Jenrette considered
the results of the analyses in light of each other and ultimately reached its
opinion based on the results of all analyses taken as a whole. Donaldson, Lufkin
& Jenrette did not place particular reliance or weight on any individual
analysis. Accordingly, Donaldson, Lufkin & Jenrette has indicated to our board
of directors and RCRe's board of directors that it believes that its analyses
must be considered as a whole and that selecting portions of its analyses and
the factors considered by it, without considering all analyses and factors,
could create an incomplete view of the evaluation process underlying its
opinion. The results of Donaldson, Lufkin & Jenrette's analyses are not
necessarily indicative of actual values or future results, which may be
significantly more or less favorable than suggested by such analyses.
Pursuant to letter agreements in May and November of 1999, we:
o have paid to Donaldson, Lufkin & Jenrette a retainer fee of $100,000;
o upon completion of the transaction, will pay to Donaldson, Lufkin &
Jenrette an additional $1,150,000, which includes a $500,000 fairness
opinion fee in connection with the January 17, 2000 opinion.
In addition, we have agreed to pay Donaldson, Lufkin & Jenrette a fee of
$250,000 in connection with its January 17, 2000 opinion, should the transaction
with Folksamerica not be consummated, and to reimburse Donaldson, Lufkin &
Jenrette from time to time for all out-of-pocket expenses, including the
reasonable fees and expenses of counsel, that it incurs in connection with its
engagement and to indemnify Donaldson, Lufkin & Jenrette and related persons
against specified liabilities in connection with its engagement, including
liabilities under U.S. federal securities laws.
Separately, Donaldson, Lufkin & Jenrette entered into an agreement with us
dated November 22, 1999 in connection with the stock repurchase from XL Capital.
We have paid Donaldson, Lufkin & Jenrette a fee of $500,000 relating to the
delivery of the fairness opinion related to the stock repurchase from XL
Capital.
Donaldson, Lufkin & Jenrette and we negotiated the terms of the fee
arrangements, and our board of directors was aware of the arrangements.
Donaldson, Lufkin & Jenrette believes that the terms of the arrangements are
customary for transactions of this nature.
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As part of its investment banking business, Donaldson, Lufkin & Jenrette
regularly engages in the valuation of businesses and securities in connection
with mergers, acquisitions, underwritings, sales and distributions of listed and
unlisted securities, private placements and valuations for corporate and other
purposes. In the ordinary course of its business, Donaldson, Lufkin & Jenrette
or its affiliates may at any time hold long or short positions, and may trade or
otherwise effect transactions, for its own account or for the accounts of
customers, in our equity or debt securities. Donaldson, Lufkin & Jenrette has
performed investment banking and other services for Folksamerica and XL Capital
and their affiliates in the past and has received compensation for its services.
Certain Stockholders Have Agreed to Vote for the Asset Sale
Marsh & McLennan Risk Capital Holdings, Ltd. and The Trident Partnership,
L.P., which together control 13.3% of the total voting power of our stock, have
given Folksamerica their proxies to vote their shares in favor of the asset sale
at the stockholders' meeting.
The proxies were given to Folksamerica pursuant to voting agreements dated
as of the same date as the asset purchase agreement. The proxies expire on July
31, 2000 and will terminate if either the asset purchase agreement or the voting
agreements are terminated. The voting agreements are included in this proxy
statement as Annexes B1 and B2.
XL Capital gave Folksamerica a similar proxy, but that proxy terminated
upon the consummation of the XL Capital stock repurchase.
Management Changes
It is contemplated that after the consummation of the asset sale, when our
company will no longer have reinsurance operations, our board of directors will
remain in place, Robert Clements will continue as chairman of the board and the
executive officers of our company will be Peter A. Appel and others to be
identified.
Accounting Treatment of the Asset Sale
The asset sale will be reflected on our consolidated balance sheet as a
sale of certain of our assets and the transfer of certain of our liabilities.
Upon consummation of the asset sale, we will recognize either a gain or a loss
equal to the final purchase price (net of transaction costs) plus the
liabilities assumed by Folksamerica, less the carrying value of the assets sold
to Folksamerica.
Material Federal Income Tax Consequences of the Asset Sale
The asset sale will not result in any federal income tax consequences to
you.
The asset sale will be a taxable transaction for RCRe for federal income
tax purposes. However, it is not expected that the asset sale will result in
material federal, state, local or foreign income tax liability, if any.
We have agreed to reimburse Folksamerica for a portion of the tax liability
it may incur as a result of the asset sale. See "The Asset Purchase
Agreement--Tax Sharing Arrangement."
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Regulatory Matters
Insurance Regulatory Law
The asset sale, as contemplated by the transfer and assumption agreement in
the form attached as Annex C to this proxy statement, was approved by the
Nebraska Insurance Department on February 11, 2000.
The transfer and assumption agreement approved by the Nebraska Insurance
Department provides for Folksamerica Reinsurance Company to notify the
reinsureds under RCRe's in-force treaties about the transaction and to give them
30 days to object to the release of RCRe from further liability under those
treaties. RCRe intends to apply to the Nebraska Insurance Department for
permission to distribute to us all of RCRe's remaining assets other than
statutory surplus of $20 million required for RCRe to maintain its insurance
licenses and authorizations in the states in which it is currently licensed or
authorized. While the permission of the Nebraska Insurance Department will
generally be required for any distribution by RCRe, RCRe expects that it will be
permitted to make such distribution subject to any greater amount that it may be
required by the Nebraska Insurance Department to retain in the event there are
any objections from reinsureds to the release of RCRe from further liability
pursuant to the transfer and assumption agreement. See footnote 10 to our
audited consolidated financial statements included in this proxy statement for
further details regarding statutory restrictions on distributions by RCRe.
The Florida Department of Insurance ("FDOI") has been notified of the
proposed transaction. In connection with RCRe's license in Florida, RCRe is
required to obtain approval from the FDOI if there is a material change in its
plan of operations in Florida. The FDOI approval relates to RCRe's Florida
certificate of authority, and the FDOI may take action against RCRe's
certificate of authority if it does not obtain the required approval. The
approval of the FDOI is a condition to the consummation of the asset sale.
The New York Insurance Department has also been notified of the proposed
transaction. The approval of the New York Insurance Department is a condition to
the consummation of the asset sale.
Antitrust Law
The Hart-Scott-Rodino Antitrust Improvements Act of 1976 and the related
rules and regulations prohibit us from consummating the asset sale until we and
Folksamerica have notified and furnished information to the United States
Federal Trade Commission and the Antitrust Division of the United States
Department of Justice and the specified waiting period requirements under the
Act expire or terminate. On February 22, 2000, in connection with the asset
sale, we and Folksamerica each filed with the FTC and the Antitrust Division a
Notification and Report Form under the Hart-Scott-Rodino Act. On March 3, 2000,
the FTC granted early termination of the review period under the
Hart-Scott-Rodino Act.
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THE ASSET PURCHASE AGREEMENT
The following is a description of the more significant terms of the asset
purchase agreement. We urge you to read carefully the entire asset purchase
agreement, which we have included in this proxy statement as Annex A.
Purchase Price
Folksamerica Reinsurance Company will assume RCRe's liabilities under the
reinsurance agreements transferred to it in the asset sale and RCRe will
transfer to Folksamerica Reinsurance Company assets in an aggregate amount that
is, in GAAP book value (as set forth on our estimated closing date balance
sheet), equal to the GAAP book value (as set forth on our estimated closing date
balance sheet) of the liabilities assumed. The decrease in our net GAAP book
value due to increases after September 30, 1999 in our loss reserves relating to
certain of our Swiss Air liabilities will be disregarded for purposes of the
closing date balance sheet up to an aggregate of $5 million, net of tax effects.
In consideration for the transfer of RCRe's book of business, Folksamerica will
pay $20.335 million in cash at the closing, subject to adjustment under the
circumstances described below.
Following the closing, the closing date balance sheet will be audited by
our independent public accountants. Folksamerica is permitted to dispute the
closing date balance sheet (other than the component of the balance sheet that
relates to our loss reserves). Any dispute will be referred to neutral experts
mutually acceptable to us and Folksamerica for final resolution. In the event
that we overestimated the net value of the assumed business, we will be required
to pay to Folksamerica a post-closing purchase price adjustment. Conversely, if
we underestimated the net value of the assumed business, Folksamerica will be
required to pay us a post-closing purchase price adjustment.
Folksamerica will designate independent experts to determine the sum of the
loss reserves relating to the assumed business (other than that portion of the
assumed business covered by the $20 million escrow described in "Other
Transaction Agreements--Escrow Agreement") as of the fifth anniversary of the
closing date plus the losses paid under those reinsurance agreements. If our
reserves for those agreements as of the closing date exceeds that sum, then
Folksamerica will be required to pay us in cash that excess up to $2 million. If
we dispute the calculation of this amount by those experts, the dispute will be
referred to neutral experts mutually acceptable to us and Folksamerica for final
resolution.
We may be required to deposit an additional amount of up to $5 million in a
supplemental escrow for five years in the event that our closing date loss
reserves (other than reserves covered by the $20 million escrow) are less by
more than one-half percent (0.5%) than those estimated by our independent
actuary. This supplemental escrow will be governed by the supplemental escrow
agreement described in "Other Transaction Agreements--Supplemental Escrow
Agreement."
Tax Sharing Arrangement
Under the Internal Revenue Code, a purchaser of insurance assets may become
liable for a "bargain purchase price tax" if, in a transaction, the tax basis of
the assets it is purchasing is more than the tax basis of the liabilities it is
assuming plus the purchase price (including transaction costs) it is paying. We
have agreed to grant Folksamerica a credit against the purchase price for a
portion of this potential tax by the following method:
To the extent it is determined that the tax basis of the assets being
transferred exceeds the sum of
o the tax basis of the liabilities being transferred,
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o the final purchase price, and
o Folksamerica's transaction costs relating to the asset sale,
we will give Folksamerica a credit against the purchase price equal to
o if the excess is $15 million or less, then the lesser of (1) 17.5% of
the excess and (2) $2 million; and
o if the excess is more than $15 million, then the sum of (1) $2 million
plus (2) 35% of the excess.
Related Costs
Under the asset purchase agreement, we have agreed to retain the
liabilities relating to our severance plans and agreements, as well as to pay to
Folksamerica at closing the amount by which the cost of reinsurance protection
on our aviation line of business exceeds the net premiums we earn on that
business after December 31, 1999. Furthermore, as described above, we are liable
for a portion of Folksamerica's bargain purchase price tax liability and our own
transaction costs. We estimate that these costs will be approximately $19
million in the aggregate, which amount will effectively reduce the purchase
price we will retain. These costs are reflected in the pro forma book value
amounts set forth under "Unaudited Condensed Consolidated Pro Forma Financial
Data."
Our Representations and Warranties
The asset purchase agreement contains representations and warranties by us,
including as to
o incorporation and authority to enter into the transaction;
o property and assets necessary to operate the assumed business
remaining in our company or our affiliates and outstanding
intercompany obligations relating to the assumed business;
o no defaults under any judgments relating to the assumed business;
o compliance with instruments, including the certificate of
incorporation and bylaws, and other agreements to which we are party;
o receipt of the necessary governmental approvals;
o accuracy of our SEC filings and statutory financial statements filed
with state insurance departments and the pro forma September 30, 1999
balance sheet of the assumed business;
o absence of undisclosed liabilities;
o title to and rating of all of our fixed income investments being
transferred to Folksamerica;
o the Integrated Solutions for which we had obligations as of September
30, 1999;
o absence of a material adverse change since September 30, 1999 relating
to the assumed business;
o the operation of the assumed business in the ordinary course of
business;
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o absence of adjustments to case reserves since September 30, 1999,
except in the ordinary course consistent with past practice;
o actuarial reports of the company for periods ending on or after
December 31, 1995;
o accuracy of the information in this proxy statement;
o judgments;
o pending or threatened litigation;
o compliance with laws;
o licenses and permits;
o ownership of and rights to use intellectual property;
o title to property;
o reinsurance and retrocession agreements being transferred in the asset
sale;
o accounts receivable;
o compliance with and validity of contracts and instruments other than
the reinsurance agreements, including noncompetition agreements;
o employee benefit matters;
o tax matters;
o agents through whom RCRe sells insurance products;
o year 2000 issue; and
o broker's or finder's fees.
Folksamerica's Representations and Warranties
The asset purchase agreement contains representations and warranties by
Folksamerica, including as to
o incorporation and authority to enter into the transaction;
o compliance with instruments, including the certificate of
incorporation and bylaws, and other agreements to which Folksamerica
is a party;
o pending or threatened litigation;
o receipt of the necessary governmental approvals;
o accuracy of statutory financial statements filed with state insurance
departments;
o financial ability of Folksamerica to complete the transaction;
-34-
o accuracy of information in this proxy statement supplied by
Folksamerica; and
o broker's or finder's fees.
Principal Covenants
Conduct of Business Before the Closing
We have agreed that, until closing, subject to certain exceptions, we will
conduct the assumed business in the ordinary course and in the same manner as
conducted prior to the date of the asset purchase agreement and will use our
commercially reasonable efforts to maintain intact our existing business
organization and will not take any actions out of the ordinary course of
business, without the prior consent of Folksamerica.
No Solicitation
We have agreed not to solicit, encourage or take part in any discussions
regarding an acquisition proposal. An acquisition proposal means an offer from a
party other than Folksamerica to purchase 15% or more of the company. We are,
however, allowed to engage in discussions and provide information to third
parties if
o the acquisition proposal is a "superior proposal," meaning that, based
on the written advice of a financial advisor of nationally recognized
reputation, our board of directors has determined that it is more
favorable to you than the asset purchase agreement; and
o in response to a superior proposal, our board of directors determines,
based on advice of our counsel, that it is necessary to do so in order
to comply with its fiduciary duties.
We also agreed that the board will not withdraw its recommendation to you
to vote for the approval of the asset sale and not approve, recommend to you or
propose any acquisition proposal or enter into any agreement relating to an
acquisition proposal. However, in the event of an unsolicited superior proposal,
our board of directors is permitted, two business days after we give notice to
Folksamerica specifying the material terms of the superior proposal and that we
are prepared to accept it, to
o terminate the asset purchase agreement;
o enter into an agreement relating to the superior proposal; and
o withdraw its recommendation of the asset purchase agreement and
recommend to you the superior proposal.
Termination Fee
If we terminate the asset purchase agreement in the event of a superior
proposal, we will be required to pay to Folksamerica a termination fee of $1.5
million two days after the day we terminate.
If, as a result of direct solicitation by a third party, our stockholders
do not approve the asset purchase agreement and thereafter we or Folksamerica
terminate the asset purchase agreement due to the failure of our stockholders to
approve it or because the closing has not occurred prior to July 31, 2000, we
must pay the $1.5 million termination fee to Folksamerica if we enter into or
consummate an acquisition proposal with the third party that solicited our
stockholders within 12 months of the day we terminate.
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Aviation Business
We have agreed to pay to Folksamerica at closing the amount by which the
cost of reinsurance protection on our aviation line of business exceeds the net
premiums we earn on that business after December 31, 1999.
Employee Matters
We have agreed to retain all of the liabilities under our benefit and
employment arrangements, and we will make a payment in the aggregate amount of
$665,000 at the closing to four of our employees who will become employees of
Folksamerica following the closing. We have agreed to offer to retain all of our
employees (other than our senior executives and the four employees mentioned in
the prior sentence) involved in the operation of the assumed business for a
period of up to 60 days following the closing. These employees will work at the
direction of Folksamerica and the cost of their employment will be reimbursed to
us by Folksamerica, except for those employees whose services Folksamerica
determines it does not require, whom we may redeploy or terminate. If
terminated, employees will be eligible for severance payments.
Conditions to Closing
Mutual Conditions
The obligation of us and Folksamerica to consummate the asset sale is
subject to the conditions set forth in the asset purchase agreement, including
the following:
o the representations and warranties must be true and the covenants must
be complied with where such inaccuracy or noncompliance would have a
material adverse effect (except for those representations and
warranties that are already qualified by materiality, which must be
true);
o no court or government body shall have issued an order restraining the
closing of the asset purchase agreement;
o all necessary governmental approvals must have been obtained;
o all third party consents must have been obtained, including those
approving:
o the transfer of the software licenses to our SICS Reinsurance System
to Folksamerica;
o the transfer of our letters of credit and/or the assets underlying
them to Folksamerica; and
o the transfer to Folksamerica of our reinsurance rights granted in
connection with four of our Integrated Solutions investments;
o expiration of the waiting period under the Hart-Scott-Rodino Act;
o the receipt of legal opinions; and
o the approval of the asset sale by our stockholders.
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Additional Conditions to the Obligation of Folksamerica
The following are additional conditions to Folksamerica's obligations to
close the asset sale:
o there being no material adverse change in the assumed business since
the date of the asset purchase agreement;
o Joanne DeBlasis, our accident and health underwriter, shall be in
RCRe's employ at the closing;
o we shall have purchased additional coverage for our aviation line of
business and aggregate excess reinsurance on behalf of Folksamerica
(the cost of which aggregate excess reinsurance will be reimbursed to
us by Folksamerica); and
o we shall have amended our broad-based severance plans to require that
only employees who remain working at our Greenwich, Connecticut
offices for a period of up to sixty days after closing to assist
Folksamerica in the transition (or whose employment is involuntarily
terminated by the company during that 60-day period) will be entitled
to receive severance payments.
Indemnification
We and Folksamerica have agreed to indemnify each other for breaches of
some representations, warranties and covenants contained in the asset purchase
agreement. Indemnification obligations, except for representations about our
authority, investments, reinsurance and retrocession agreements, accounts
receivable, agents and broker's fees, are subject to a $500,000 deductible. Our
liability to Folksamerica due to our breaches of representations and warranties
regarding the transferred reinsurance and retrocession agreements and accounts
receivable is limited to amounts then available under the escrow agreement. A $5
million aggregate limitation applies to the parties' indemnification obligations
with respect to the assumed business (including those involving representations
and warranties related to undisclosed liabilities, which are to be satisfied
solely out of amounts then available under the escrow agreement). There is no
limit on our indemnification obligations with respect to losses Folksamerica may
incur from liabilities not assumed by it in the asset sale, which liabilities
include any liabilities (other than liabilities under reinsurance agreements)
arising out of or related to the managing underwriting agency referred to in
"Other Transaction Agreements -- Escrow Agreement."
Termination
The asset purchase agreement may be terminated:
o by mutual consent of us and Folksamerica;
o by either us or Folksamerica, if the closing has not occurred prior
July 31, 2000, but this option is not available to a party whose
failure to fulfill its obligations prevented the closing;
o by Folksamerica, if we have breached or not complied with any
representation, warranty or covenant in the asset purchase agreement,
if such breach or failure would give rise to a failure of a condition
and we are not capable of curing it;
o by Folksamerica, if we breach our obligations under the "no
solicitation" provisions of the asset purchase agreement;
o by us, if Folksamerica has breached or not complied with any
representation, warranty or covenant in the asset purchase agreement,
if such breach or failure would give rise to failure of a condition
and Folksamerica is not capable of curing it;
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o by us, in the event of a superior proposal;
o by us or Folksamerica, if our stockholders have voted against approval
of the asset purchase agreement; and
o by Folksamerica, if the loss reserves recorded by us as of December
31, 1999 relating to the reinsurance agreements other than those
produced by a certain managing underwriting agency were more than 5%
less than our independent actuary's estimate of those reserves and we
failed to increase those reserves so that they were no longer more
than 5% less than our independent actuary's estimate within 10
business days of the delivery of our actuary's report (this
termination provision was not triggered).
Survival
Our representations and warranties relating to the following matters will
survive for one year following the closing and, if breached, may result in
liability to us:
o incorporation and authority to enter into the transaction;
o property and assets necessary to operate the assumed business
remaining in our company or our affiliates and outstanding
intercompany obligations relating to the assumed business;
o compliance with instruments, including the certificate of
incorporation and bylaws, and other agreements to which we are party;
o absence of undisclosed liabilities;
o title and rating of all of our fixed income investments being
transferred to Folksamerica;
o the Integrated Solutions for which we had obligations as of September
30, 1999;
o absence of a material adverse change since September 30, 1999 relating
to the assumed business;
o absence of adjustments to case reserves since September 30, 1999,
except in the ordinary course consistent with past practice;
o actuarial reports of the company for periods ending on or after
December 31, 1995;
o reinsurance and retrocession agreements being transferred in the asset
sale;
o accounts receivable;
o non-competition covenants;
o agents through whom RCRe sells insurance; and
o broker's or finder's fees.
In addition, representations and warranties relating to tax matters will survive
until the expiration of the applicable statute of limitations. We retain our tax
and employee benefit liabilities and other liabilities not being assumed by
Folksamerica, including all liabilities not arising under RCRe's reinsurance
agreements transferred to Folksamerica Reinsurance Company and all liabilities
(other than liabilities under reinsurance agreements)
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arising out of or relating to the managing underwriting agency referred to in
"Other Transaction Agreements -- Escrow Agreements." All of the reinsurance
agreements transferred to Folksamerica Reinsurance Company are listed in a
schedule to the asset purchase agreement.
Folksamerica's representations and warranties relating to incorporation and
authority to enter into the transaction; compliance with instruments, including
its certificate of incorporation and bylaws, and other agreements to which they
are party; and broker's or finders' fees will also survive for one year
following the closing.
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OTHER TRANSACTION AGREEMENTS
Transfer and Assumption Agreement
The following is a brief summary of the transfer and assumption agreement.
The form of transfer and assumption agreement is included in this proxy
statement as Annex C and we urge you to read the entire agreement.
RCRe and Folksamerica Reinsurance Company will enter into the transfer and
assumption agreement at the closing of the asset sale, under which Folksamerica
Reinsurance Company will assume RCRe's rights and obligations under the
reinsurance agreements being transferred in the asset sale. Following the
closing, Folksamerica Reinsurance Company will notify the reinsureds under the
in-force reinsurance agreements that it has assumed RCRe's obligations and that,
unless the reinsureds object to the assumption, RCRe will be released from its
obligations to those reinsureds. However, RCRe will continue to be liable under
those reinsurance agreements if the reinsureds object to the release of RCRe
from its obligations or such release is found not to be enforceable against the
reinsureds. Folksamerica has agreed to indemnify us for any losses arising out
of the reinsurance agreements transferred to Folksamerica Reinsurance Company in
the asset sale.
Escrow Agreement
The following is a brief summary of the escrow agreement. The form of
escrow agreement is included in this proxy statement as Annex D and we urge you
to read the entire agreement. The escrow agreement may be modified before
closing to reflect certain changes requested by the escrow agent and agreed to
by us and Folksamerica.
At closing, $20 million of the purchase price will be delivered into a
five-year escrow account established under an escrow agreement to be entered
into among RCRe, Folksamerica Holding Company, Inc., Folksamerica Reinsurance
Company and an escrow agent (which is expected to be Citibank, N.A.). Those
escrowed funds will primarily be used to reimburse Folksamerica for losses it
may incur under reinsurance agreements produced on our behalf by a certain
managing underwriting agency. Amounts in this escrow may be released to
Folksamerica to satisfy its indemnification claims against us relating to
undisclosed liabilities, our reinsurance and retrocession agreements, accounts
receivable and the managing underwriting agency referred to above or the
business produced by it. Our liability for indemnification claims relating to
our reinsurance and retrocession agreements and accounts receivable are limited
to amounts then in the escrow account and, with respect to claims for
undisclosed liabilities, is also subject to the aggregate $5 million dollar
limitation on indemnification described in "The Asset Purchase
Agreement--Indemnification." Claims against us for indemnification relating to
the managing underwriting agency referred to above (other than liabilities under
reinsurance agreements) are not subject to any limitation.
Distributions from the Escrow Account
The escrow agent may invest the escrowed funds only in investment grade
tax-exempt fixed income securities. The "escrowed funds" means, at any time:
o the amount we originally deposit in the escrow account, plus
o interest earned on that amount, minus
o any distribution made from the escrowed funds under the terms of the
escrow agreement.
The escrow agreement provides that the escrow agent will release funds to
us to reimburse us for any tax liability that we incur as a result of interest
on the escrowed funds, to the extent we actually pay those taxes.
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In the first calendar quarter in which the losses paid under the
reinsurance agreements exceed the loss reserves established by us as of the
closing for losses relating to business written on behalf of RCRe by a certain
managing underwriting agency, Folksamerica will notify us. That notice will be
accompanied by a report of independent accountants designated by Folksamerica
showing the calculation of the losses paid in respect of that business. We may
dispute that calculation and refer the matter to a neutral accounting firm. Upon
resolution, if it is determined that the paid losses do in fact exceed the
closing date reserves, then the escrow agent will release funds equal to that
excess to Folksamerica. After the initial release of escrowed funds,
Folksamerica may deliver reports of additional paid losses to the escrow agent
and the escrow agent will release funds in an amount equal to those losses to
Folksamerica.
Within ninety (90) days of the fifth anniversary of the closing of the
asset sale, Folksamerica will deliver to us
o a report of independent accountants designated by it showing the
calculation of all losses paid on the business covered by the escrow
in the five-year period;
o a report of an independent actuary designated by it showing the
calculation of the loss reserves for the business covered by the
escrow as of the fifth anniversary of the closing; and
o a report of the independent accountants designated by it showing the
difference of the reserves relating to the business covered by the
escrow as of the closing over the sum of the related paid losses and
those reserves as of the fifth anniversary of the closing. If the
difference is positive, that means those reserves as of the closing
were redundant, and if the difference is negative, that means those
reserves as of the closing were deficient.
In the event that those reserves turn out to have been redundant, all of
the amounts then in escrow will be released to us and, in addition, Folksamerica
will pay us in cash the amount by which those reserves were redundant. In the
event that those reserves turn out to have been deficient by less than $20
million, the amount by which those reserves were deficient will be released from
the escrow to Folksamerica and the remainder will be released to us. In the
event that those reserves were deficient by more than $20 million, all of the
amounts then in escrow will be released to Folksamerica. In that case,
Folksamerica will have no further recourse to us, except that we will be
required to deliver to Folksamerica all or a part of the distributions of
escrowed funds made to us to satisfy our tax liabilities. In each case, the
party receiving a payment will also be entitled to receive interest with respect
to that amount.
Supplemental Escrow Agreement
Under the circumstances described below, we may be required to enter into
the supplemental escrow agreement. The following is a brief summary of the
supplemental escrow agreement. The form of supplemental escrow agreement is
attached to this proxy statement as Annex E and we urge you to read the entire
agreement. The supplemental escrow agreement may be modified before closing to
reflect certain changes requested by the escrow agent and agreed to by us and
Folksamerica.
We may be required to deposit an additional amount of up to $5 million into
a five-year supplemental escrow under a supplemental escrow agreement that would
be entered into among RCRe, Folksamerica Holding Company, Inc., Folksamerica
Reinsurance Company and an escrow agent (which is expected to be Citibank,
N.A.), in the event that our closing date loss reserves (other than reserves
covered by the escrow agreement described above) are less by more than one-half
percent (0.5%) than those estimated by our independent actuary. This
supplemental escrow will be governed by terms substantially similar to the
escrow described above, except that (1) if those reserves turn out to have been
redundant, the full escrow fund will be released to us but Folksamerica will
have no obligation to make payments to us and (2) this escrow will not be
available to satisfy indemnification claims.
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XL STOCK REPURCHASE
On March 2, 2000, we repurchased from XL Capital, then our single largest
stockholder, all of the 4,755,000 shares of our common stock held by it. Set
forth below is a brief summary of the terms of the stock repurchase agreement.
We filed the stock repurchase agreement and the related voting disposition
agreement with the SEC as exhibits to our Current Report on Form 8-K on January
18, 2000. Those agreements are incorporated in this proxy statement by
reference, and we encourage you to read them carefully.
Under the terms of the stock repurchase agreement, we purchased from XL
Capital all of the 4,755,000 shares of our company held by it for a purchase
price of $12.45 per share, or a total of $59,200,000. The per share repurchase
price was determined as the lesser of (1) 85% of the average closing market
price of our common stock during the 20 trading days beginning on the third
business day following public announcement of the stock repurchase and asset
sale (January 21, 2000), which was $14.65, and (2) $15.
We paid XL Capital the consideration for the repurchase with:
o our interest in privately held LARC Holdings, Ltd. (parent of Latin
American Reinsurance Company Ltd.), valued at $25 million; and
o all of our interest in Annuity and Life Re (Holdings), Ltd., valued at
$25.38 per share and $18.50 per warrant, or $37,847,000 in the
aggregate.
XL Capital paid us in cash the difference (equal to $3,647,000) between our
repurchase price and the value of our interests in LARC Holdings and Annuity and
Life Re. The value per share of Annuity and Life Re was determined by taking the
average of the closing price of Annuity and Life Re shares for the same period
used in determining the repurchase price of our shares.
Prior to this transaction, XL Capital owned 75% of LARC Holdings, and we
owned 25% of LARC Holdings, exclusive of options held by management of LARC
Holdings. In addition, XL Capital and we each owned approximately 5 1/2% of the
outstanding shares of Annuity and Life Re. Several directors of XL Capital are
also directors of Annuity and Life Re.
The stock repurchase from XL Capital did not require stockholder approval.
Effective as of the closing of the stock repurchase, Ian R. Heap and
Michael P. Esposito, Jr. have continued to serve on our board, but not as XL
Capital's designees.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information available to us as of March 2,
2000 with respect to the ownership of our common stock by (i) each person known
to us to be the beneficial owner of more than 5% of our outstanding shares, (ii)
each director of the company, (iii) each executive officer of the company and
(iv) all of our directors and executive officers as a group. Except as otherwise
indicated, each person named below has sole investment and voting power with
respect to the securities shown.
Number of Shares Rule 13d-3
Name and Address Beneficially Percentage Fully-Diluted
of Beneficial Owner Owned(l) Ownership(l) Percentage(2)
- - --------------------------------------------------- ---------------- ------------- -------------
Marsh & McLennan Risk Capital
Holdings, Ltd. (3)............................ 2,301,022 17.4% 22.6%
1166 Avenue of the Americas
New York, New York 10036
Merrill Lynch & Co., Inc. (4)...................... 2,033,900 16.5 11.3
World Financial Center, North Tower
250 Vesey Street
New York, New York 10381
The Trident Partnership, L.P. (5).................. 1,636,079 11.9 9.1
Craig Appin House
8 Wesley Street
Hamilton, HM11, Bermuda
EQSF Advisers, Inc. and M.J. Whitman Advisers, Inc.
(6)........................................... 1,132,975 9.2 6.3
767 Third Avenue
New York, New York 10017
Franklin Resources, Inc. (7)....................... 1,064,100 8.6 5.9
777 Mariners Island Boulevard
San Mateo, California 94404
Beck, Mack & Oliver LLC (8)........................ 992,700 8.1 5.5
330 Madison Avenue
New York, New York 10017
Steinberg Asset Management Co.,
Inc. (9)...................................... 894,154 7.3 5.0
12 East 49th Street
New York, New York 10017
Crabbe Huson Group, Inc. (10)...................... 809,887 6.6 4.5
121 SW Morrison, Suite 1400
Portland, Oregon 97204
Mark D. Mosca (11)................................. 307,574 2.5 2.5
Robert Clements (12)............................... 232,292 1.9 2.5
Peter A. Appel (13)................................ 102,834 * 1.1
Paul J. Malvasio (14).............................. 96,651 * *
Michael P. Esposito, Jr. (15)...................... 7,804 * *
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Number of Shares Rule 13d-3
Name and Address Beneficially Percentage Fully-Diluted
of Beneficial Owner Owned(l) Ownership(l) Percentage(2)
- - --------------------------------------------------- ---------------- ------------- -------------
Lewis L. Glucksman (15)............................ 3,804 * *
Ian R. Heap (15)................................... 5,300 * *
Thomas V. A. Kelsey (15)........................... 6,554 * *
Robert F. Works (15)............................... 2,104 * *
Philip L. Wroughton (15)........................... 2,800 * *
All directors and executive officers
(11 persons).................................. 767,717 6.1% 7.3%
- - ---------------
* Denotes beneficial ownership of less than 1.0%.
(1) Pursuant to Rule 13d-3 promulgated under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), amounts shown under "Number of
Shares Beneficially Owned" and "Rule 13d-3 Percentage Ownership" include
shares of common stock that may be acquired by a person within 60 days of
the date of this proxy statement. Therefore, "Rule 13d-3 Percentage
Ownership" has been computed based on (1) 12,329,494 shares of common stock
actually outstanding as of March 2, 2000 and (2) shares of common stock
that may be acquired within 60 days of the date of this proxy statement
upon the exercise of options and warrants held by the person whose Rule
13d-3 Percentage Ownership is being computed, excluding those options and
restricted shares that would vest upon stockholder and regulatory approval
of the asset sale, as described in "Interests of Certain Persons in Matters
to be Acted Upon--Vesting of Options and Restricted Shares."
(2) Amounts shown under "Fully-Diluted Percentage," in the above table have
been computed based on 12,329,494 shares of common stock actually
outstanding as of March 2, 2000 and shares of common stock that may be
acquired upon the exercise of all outstanding options and warrants (whether
or not such options and warrants are exercisable within 60 days). As of
March 2, 2000, there were an aggregate of 5,713,781 shares of common stock
issuable under outstanding warrants and options as follows: (1) Class A
Warrants to purchase an aggregate of 2,531,079 shares of common stock (the
"Class A Warrants"), (2) Class B Warrants to purchase an aggregate of
1,920,601 shares of common stock (the "Class B Warrants") and (3) options
to purchase an aggregate of 1,262,201 shares of common stock. The Class A
Warrants are immediately exercisable at $20 per share and expire on
September 19, 2002. The Class B Warrants are exercisable at $20 per share
at any time after our common stock has traded at or above $30 per share for
20 out of 30 consecutive trading days and expire on September 19, 2005.
(3) Amounts include (1) 1,395,625 shares of common stock owned directly by
MMRCH and (2) 905,397 shares issuable upon the exercise of Class A Warrants
held by MMRCH. "Fully-Diluted Percentage" also reflects 1,770,601 shares of
common stock issuable upon the exercise of Class B Warrants held by MMRCH,
which warrants may become exercisable within 60 days of the date of this
proxy statement. Based upon a Schedule 13D, dated November 7, 1996, filed
with the SEC by Marsh & McLennan Companies, Inc.
(4) Based upon a Schedule 13G dated January 26, 2000, filed with the SEC
jointly by Merrill Lynch & Co., Inc., a parent holding company, and Merrill
Lynch Global Allocation Fund, Inc. ("MLGAF"), a registered investment
company. In the Schedule 13G, Merrill Lynch & Co. reported that it has
shared voting power and shared dispositive power with respect to 2,033,900
shares of common stock and MLGAF re-
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ported that it has shared voting power and shared dispositive power with
respect to 1,947,500 shares of common stock.
(5) Amounts include (1) 250,000 shares of common stock owned directly by The
Trident Partnership, L.P. ("Trident") and (2) 1,386,079 shares of common
stock issuable upon the exercise of Class A Warrants held by Trident. Based
upon a Schedule 13D, dated March 27, 1998, filed with the SEC by Trident.
(6) Based upon a Schedule 13G dated February 14, 2000, filed with the SEC
jointly by EQSF Advisers, Inc. ("EQSF") and M.J. Whitman Advisers, Inc.
("MJWA"), each an investment advisor, and Martin J. Whitman. In the
Schedule 13G, EQSF reported that it has sole voting power and sole
dispositive power with respect to 473,400 shares of common stock and MJWA
reported that it has sole voting power and sole dispositive power with
respect to 659,575 shares of common stock.
(7) Based upon a Schedule 13G dated January 31, 2000, filed with the SEC by
Franklin Resources, Inc. and certain of its affiliates (collectively,
"FRI"). In the Schedule 13G, FRI reported that it has sole voting power and
sole dispositive power with respect to 1,064,100 shares of common stock
beneficially owned by one or more managed accounts which are advised by
investment advisory subsidiaries of FRI.
(8) Based upon a Schedule 13G dated January 22, 1999, filed with the SEC by
Beck, Mack & Oliver LLC ("Beck"), an investment advisor. In the Schedule
13G, Beck reported that it has shared dispositive power with respect to
992,700 shares of common stock beneficially owned by its clients.
(9) Based on Schedule 13G dated February 10, 2000, filed with the SEC jointly
by Steinberg Asset Management Co., Inc., an investment adviser ("SAMC"),
and Michael A. Steinberg & Co., Inc., a broker-dealer. In the Schedule 13G,
SAMC reported that it has sole voting power with respect to 554,200 shares
of common stock and sole dispositive power with respect to 891,654 shares
of common stock, and Steinberg & Co. reported that it has sole dispositive
power with respect to 2,500 shares of common stock.
(10) Based upon a Schedule 13G dated February 3, 2000, filed with the SEC by the
Crabbe Huson Group, Inc. ("CHG"), an investment advisor. In the Schedule
13G, CHG reported that it has shared voting power with respect to 774,287
shares of common stock and shared dispositive power with respect to 809,887
shares of common stock beneficially owned by its clients.
(11) Amounts include (1) 141,071 shares of Common Stock owned directly by Mr.
Mosca (20,000 of such shares are subject to vesting) and (2) 166,503 shares
of Common Stock subject to immediately exercisable options. "Fully-Diluted
Percentage" also includes 145,897 shares of common stock subject to stock
options that may become exercisable within 60 days of the date of this
proxy statement. See "Interests of Certain Persons in Matters to be Acted
Upon -- Vesting of Options and Restricted Shares."
(12) Amounts include (1) 24,304 shares of common stock owned directly by Mr.
Clements, (2) Class A Warrants to purchase 80,000 shares of common stock,
(3) 33,385 shares of Common Stock subject to immediately exercisable
options and (4) 55,000 shares of common stock and Class A Warrants to
purchase 39,603 shares of common stock beneficially owned by Taracay
Investors, a general partnership ("Taracay"), the general partners of which
consist of Mr. Clements and members of his family. Mr. Clements is the
managing partner of Taracay. "Fully-Diluted Percentage," also includes (1)
73,740 shares of common stock subject to stock options (see "Interests of
Certain Persons in Matters to be Acted Upon -- Vesting of Options and
Restricted Shares") and (2) 150,000 shares of common stock issuable upon
the exercise of Class B Warrants, which options and Class B Warrants may
become exercisable within 60 days of the date of this proxy statement.
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(13) Amounts include (1) 31,171 shares of common stock owned directly by Mr.
Appel (5,000 of such shares are subject to vesting) and (2) 71,663 shares
subject to immediately exercisable options. "Fully-Diluted Percentage" also
includes 94,137 shares of common stock subject to stock options that may
become exercisable within 60 days of the date of this proxy statement. See
"Interests of Certain Persons in Matters to be Acted Upon -- Vesting of
Options and Restricted Shares."
(14) Amounts include (1) 29,988 shares of common stock owned directly by Mr.
Malvasio (5,000 of such shares are subject to vesting) and (2) 66,663
shares subject to immediately exercisable options. "Fully-Diluted
Percentage" also includes 74,137 shares of common stock subject to stock
options that may become exercisable within 60 days of the date of this
proxy statement. See "Interests of Certain Persons in Matters to be Acted
Upon -- Vesting of Options and Restricted Shares."
(15) Amounts include 1,800 shares (in the case of Messrs. Kelsey and Works,
1,550 and 100 shares, respectively) of common stock subject to immediately
exercisable options. "Fully-Diluted Percentage" also includes 1,500 shares
(in the case of Mr. Works, 1,700 shares) of common stock subject to stock
options that may become exercisable within 60 days of the date of this
proxy statement. See "Interests of Certain Persons in Matters to be Acted
Upon -- Vesting of Options and Restricted Shares."
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INTERESTS OF CERTAIN PERSONS IN MATTERS TO BE ACTED UPON
Payments to Executive Officers and Chairman of the Board
The asset sale will constitute a change in control for purposes of our
benefit and employment arrangements. The following payments, which will be made
to our executive officers upon closing of the asset sale, are estimated to be:
Mark D. Mosca, $2,716,714; Peter A. Appel, $1,476,563; and Paul J. Malvasio,
$1,220,625. These amounts are equal to a specified multiple of the sum of such
executive officer's annual base salary and target annual bonus (or, in the case
of Mr. Mosca, a notional target amount equal to 100% of his annual base salary).
The specified multiple is 2.99 for Mr. Mosca and 2.25 for Messrs. Appel and
Malvasio. In addition, a prorated portion of such executive officer's target
annual bonus (or, in the case of Mr. Mosca, a prorated portion of a notional
target amount equal to 100% of his annual base salary) will be paid to the
executive officers at the closing of the asset sale. Each executive officer will
also be entitled to continuance of his insurance benefits.
Robert Clements, chairman of the board, will receive a special bonus of up
to $500,000 upon the consummation of the asset sale.
Vesting of Options and Restricted Shares
Our executive officers and members of our board of directors currently hold
unvested stock options and shares of restricted stock as set forth below, all of
which will immediately vest upon stockholder and regulatory approval of the
asset sale:
Unvested Stock
Options Exercise Price
-------------- --------------
Mark D. Mosca 20,000 $ 20.00
29,600 17.63
43,258 23.00
53,039 22.44
Peter A. Appel 5,000 21.00
15,800 17.63
23,098 23.00
50,239 22.44
Paul J. Malvasio 5,000 20.00
15,800 17.63
23,098 23.00
30,239 22.44
Robert Clements 32,460 23.00
39,780 22.44
1,500 12.66
Michael P. Esposito, Jr. 1,500 12.66
Lewis L. Glucksman 1,500 12.66
Ian R. Heap 1,500 12.66
Thomas V.A. Kelsey 1,500 12.66
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Unvested Stock
Options Exercise Price
-------------- --------------
Robert F. Works 200 16.00
1,500 12.66
Philip L. Wroughton 1,500 12.66
Shares of Restricted Stock
--------------------------
Mark D. Mosca 20,000
Peter A. Appel 5,000
Paul J. Malvasio 5,000
Ownership of Warrants
There are outstanding, and will continue to be outstanding after the asset
sale, Class A Warrants to purchase an aggregate of 2,531,079 shares of our
common stock and Class B Warrants to purchase an aggregate of 1,920,601 shares
of our common stock. The Class A Warrants are immediately exercisable at $20 per
share and expire on September 19, 2002. The Class B Warrants are exercisable at
$20 per share at any time after our common stock has traded at or above $30 per
share for 20 out of 30 consecutive trading days and expire on September 19,
2005. Holders of Class A Warrants include Marsh & McLennan Risk Capital
Holdings, Ltd., The Trident Partnership, L.P. and Robert Clements, the chairman
of our board, members of his family and a family partnership. Holders of Class B
Warrants include Marsh & McLennan Risk Capital Holdings, Ltd., Mr. Clements and
members of his family. Please see footnotes 2, 3, 5 and 12 to the table in the
section entitled "Security Ownership of Certain Beneficial Owners and
Management" in the preceding pages of this proxy statement for details on the
ownership of the Class A Warrants and the Class B Warrants.
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DIVIDEND AND STOCK REPURCHASE POLICY
Any determination to pay dividends in the future will be at the discretion
of our board of directors and will be dependent upon our results of operations,
financial condition, capital requirements, contractual restrictions and other
factors deemed relevant by our board of directors. Our board of directors
currently does not intend to declare dividends or make any other distributions.
Our board intends to make a determination regarding repurchases of our
shares after the consummation of the asset sale, but no decision has yet been
made as to whether any such repurchases will be made or the amount, timing or
method of any such repurchases, which will depend on future circumstances.
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SELECTED HISTORICAL FINANCIAL DATA
Our and RCRe's selected consolidated historical financial data for the
years ended December 31, 1999, 1998, 1997, 1996 and for the period from June 23,
1995 (date of inception) to December 31, 1995 should be read in conjunction with
our audited consolidated financial statements and the related notes contained
elsewhere in this proxy statement.
Period from
June 23, 1995
to
Years Ended December 31, December 31,
----------------------------------------------------------- -------------
1999 1998 1997 1996 1995
----------- ---------- --------- --------- -------------
(Dollars in thousands, except share data)
Statement of Operations Data
Net premiums earned....................... $311,368 $206,194 $107,372 $35,761
Net investment income..................... 20,173 15,687 14,360 13,151 $4,578
Net realized investment gains
(losses)............................... 17,227 25,252 (760) 1,259 397
Total revenues............................ 348,768 247,133 120,972 50,171 4,975
Net income (loss)......................... (32,436) 3,091 2,039 4,112 1,019
Comprehensive income (loss)............... ($52,286) ($4,375) $47,107 $9,817 $4,750
Average shares outstanding
Basic.................................. 17,086,732 17,065,165 17,032,601 16,981,724 16,747,084
Diluted................................ 17,086,808 17,718,223 17,085,788 16,983,909 16,990,425
Per Share Data
Net income (loss)
Basic................................ ($1.90) $0.18 $0.12 $0.24 $0.06
Diluted.............................. ($1.90) $0.17 $0.12 $0.24 $0.06
Comprehensive Income (loss)
Basic.................................. ($3.06) ($0.26) $2.77 $0.58 $0.28
Diluted ............................... ($3.06) ($0.26) $2.76 $0.58 $0.28
December 31,
----------------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ---------- ----------- ----------- ------------
(Dollars in thousands, except share data)
Balance Sheet Data
Cash and invested assets.................. $585,909 $587,155 $505,728 $392,940 $347,327
Total assets.............................. 864,359 757,830 581,247 432,486 350,986
Stockholders' equity...................... 346,514 398,002 401,031 352,213 340,215
Shares outstanding
Basic.................................. 17,087,970 17,087,438 17,058,462 17,031,246 16,941,125
Diluted................................ 17,087,970 17,497,904 17,601,608 17,065,406 16,941,125
Book value per share
Basic.................................. $20.28 $23.29 $23.51 $20.68 $20.08
Diluted................................ $20.28 $22.75 $22.79 $20.64 $20.08
Cash dividends per share.................. N/A N/A N/A N/A N/A
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The Company
We are the holding company for Risk Capital Reinsurance ("RCRe"), our
wholly owned subsidiary which is domiciled in Nebraska. We were incorporated in
March 1995 and commenced operations in September 1995 upon completion of our
initial public offering. We received aggregate net proceeds from the offering of
approximately $335 million, of which $328 million was contributed to the capital
of RCRe. On November 6, 1995, RCRe was licensed under the insurance laws of the
State of Nebraska and is currently licensed or accredited as a reinsurer in 44
states. As of December 31, 1999, the statutory surplus of RCRe was approximately
$290 million. In July 1998, RCRe capitalized its wholly owned subsidiary, Cross
River Insurance Company ("Cross River"), with $20 million. Cross River received
its Nebraska insurance license in October 1998, and is currently authorized to
write insurance on an excess and surplus lines basis in 22 additional states.
Folksamerica Transaction
As of January 10, 2000, we entered into an agreement with Folksamerica
Reinsurance Company and Folksamerica Holding Company (collectively,
"Folksamerica") pursuant to which Folksamerica Reinsurance Company will assume
RCRe's liabilities under the reinsurance agreements transferred in the asset
sale and RCRe will transfer to Folksamerica Reinsurance Company assets in an
aggregate amount that is, in book value, equal to the book value of the
liabilities assumed. In consideration for the transfer of RCRe's book of
business, Folksamerica will pay $20.335 million in cash at the closing, subject
to adjustment under the circumstances set forth in the asset purchase agreement.
Under the terms of the agreement, we will place $20 million in escrow for a
period of five years. These funds will be primarily used to reimburse
Folksamerica to the extent that the loss reserves (which were $38.7 million at
December 31, 1999) relating to business produced on behalf of RCRe by a certain
managing underwriting agency are deficient as measured at the end of such five
year period. To the extent that such loss reserves are redundant, all of the
escrowed funds will be returned to us and Folksamerica will pay us an amount
equal to such redundancy. We will be responsible for certain tax costs incurred
by Folksamerica in the transaction, as well as our own transaction and severance
costs, and certain reinsurance costs incurred for the benefit of Folksamerica.
An additional amount of up to $5 million may be placed in escrow for a period of
five years to the extent that RCRe's reserves at closing are less by at least a
specified amount than those estimated by its independent actuaries. In
connection with either escrow arrangement, we will record a loss in an amount
equal to any probable deficiency in the related reserve that may become known
during or at the end of the five year period. See "The Asset Purchase Agreement"
and "Other Transaction Agreements" for a detailed description of the asset
purchase agreement and escrow agreements.
The sale of our reinsurance business to Folksamerica is contingent on
approval by our stockholders, expiration of the applicable waiting period under
the Hart-Scott-Rodino Antitrust Improvements Act, the retention of a key
employee, obtaining certain third party consents, the absence of a material
adverse change in RCRe's business, and other customary closing conditions. Marsh
& McLennan Risk Capital Holdings, Ltd. and The Trident Partnership, L.P., which
collectively represent approximately 13.3% of the total voting power of our
outstanding common stock (after giving effect to the repurchase of 4,755,000
shares on March 2, 2000 from XL Capital, which is discussed below), have agreed
to vote in favor of the asset sale.
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The GAAP book value of the assets and liabilities to be transferred to
Folksamerica recorded in the accompanying financial statements at December 31,
1999 are as follows:
(In Millions)
Fixed maturities and short-term investments $245.6
Premiums receivable 119.3
Reinsurance recoverable 73.1
Deferred policy acquisition costs 23.6
Deferred income tax asset 13.9
Other insurance assets 37.0
-------------
Total Assets $512.5
-------------
Reserve for claims and claims expenses $364.6
Net unearned premium reserve 108.7
Reinsurance premiums payable 14.7
Other insurance liabilities 24.5
-------------
Total Liabilities $512.5
-------------
Net book value of assets and liabilities to be transferred --
=============
The actual GAAP book value of the assets and liabilities transferred to
Folksamerica will be determined as of the closing date of the asset sale, and
will differ from that set forth above.
At the closing of the asset sale, RCRe and Folksamerica will enter into a
transfer and assumption agreement, under which Folksamerica will assume RCRe's
rights and obligations under the reinsurance agreements being transferred in the
asset sale. Following regulatory approval of these agreements, the reinsureds
under such agreements that are in-force will be notified that Folksamerica has
assumed RCRe's obligations and that, unless the reinsureds object to the
assumption, RCRe will be released from its obligations to those reinsureds.
Assuming that none of the reinsureds object to the assumption, the gross
liabilities for such business will be removed from the accounts of RCRe for
statutory accounting and GAAP accounting purposes.
RCRe will continue to record gross liabilities in its accounts for
reinsureds that object to the release of RCRe from its obligations to such
reinsureds. In such instances, an offsetting accounts receivable amount from
Folksamerica would be recorded as an asset equal to such gross liabilities. This
would also result in a portion of any pre-tax gain on the asset sale being
deferred and amortized into income as gross liabilities are extinguished.
XL Transaction
On March 2, 2000, we repurchased from XL Capital, then our single largest
stockholder, all of the 4,755,000 shares of our common stock held by it. Under
the terms of a stock repurchase agreement with XL Capital, we paid $12.45 per
share of our common stock, or a total of $59.2 million. The per share repurchase
price was determined as the lesser of (1) 85% of the average closing market
price of our common stock during the 20 trading days beginning on the third
business day following public announcement of the stock repurchase and asset
sale (January 21, 2000), which was $14.65, and (2) $15. We paid XL Capital the
consideration for the repurchase with: our interest in privately held LARC
Holdings, Ltd. (parent of Latin American Reinsurance Company Ltd.), valued at
$25 million (which was carried by us at $24 million at December 31, 1999); and
all of our interest in Annuity and Life Re (Holdings), Ltd., valued at $25.38
per share and $18.50 per warrant, or $37.8 million in the aggregate (which was
carried by us at $38.2 million at December 31, 1999). XL Capital paid us in cash
the difference (equal to $3.6 million) between our repurchase price and the
value of our interests
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in LARC Holdings and Annuity and Life Re. The value per share of Annuity and
Life Re was determined by taking the average of the closing price of Annuity and
Life Re shares for the same period used in determining the repurchase price of
our shares. The value of the warrants was determined using a Black Scholes
methodology.
As a result of this transaction, stockholders' equity, which was $346.5
million at December 31, 1999, has been reduced by $59.4 million and the number
of outstanding voting shares, which was 17,087,970 at December 31, 1999, was
12,332,970 at March 2, 2000.
RCRe's statutory surplus, which was $290 million at December 31, 1999, was
also reduced by $60 million for the distribution of the stock and warrants in
both LARC Holdings, Ltd. and Annuity and Life Re Holdings, Ltd., to us, based on
their statutory carrying values at December 31, 1999.
RCRe Distribution
Upon payment of a contemplated distribution from RCRe to us that would
occur after the completion of the asset sale, our assets would consist of fixed
maturity and short term investments, publicly traded equity securities and
privately held securities, and our remaining $19 million investment commitment
to Trident II, L.P. would remain in place. We would also continue to own all of
the outstanding capital stock of RCRe and Cross River, each with statutory
surplus of approximately $20 million (or any greater amount the Nebraska
Insurance Department requires RCRe to retain in the event there are any
objections from reinsureds to the release of RCRe from further liability
pursuant to the transfer and assumption agreement). See "--Liquidity and Capital
Resources" below for a discussion of the regulatory issues relating to
distributions by RCRe.
Future Operations
Following the sale of our reinsurance business to Folksamerica, our
intended strategy is to pursue business combinations and ventures with operating
businesses. Our success will depend almost entirely on the operations, financial
condition and management of the companies with which we may merge or which we
may acquire in whole or in part. We have not yet identified specific business
opportunities. Accordingly, the financial and operational risks that we may
encounter in the future cannot be specified. See "Risk Factors--Risks Relating
to Our Business After the Asset Sale."
Recent Industry Performance
Demand for reinsurance is influenced significantly by underwriting results
of primary property and casualty insurers and prevailing general economic and
market conditions, all of which affect liability retention decisions of primary
insurers and reinsurance premium rates. The supply of reinsurance is directly
related to prevailing prices and levels of surplus capacity, which, in turn, may
fluctuate in response to changes in rates of return on investments being
realized in the reinsurance industry. The last three years have been difficult
periods from both a market and earnings perspective for most insurance markets.
The property and casualty insurance and reinsurance segments have experienced an
increasingly more difficult and highly competitive operating environment
characterized by a soft rate structure and overcapitalization. Other factors
that have contributed to the prevailing competitive conditions in the
reinsurance industry in recent years include new entrants to the reinsurance
market (including certain specialized reinsurance operations) and the presence
of certain reinsurance companies which operate within tax-advantaged
jurisdictions (e.g., Bermuda, Cayman Islands) that benefit from higher after-tax
investment returns. In addition, concerns with respect to the financial security
of Lloyd's that had adversely impacted the competitive position of that
marketplace have apparently been overcome by actions taken at Lloyd's over the
last few years, thereby enhancing its competitive position.
The industry's profitability can also be affected significantly by volatile
and unpredictable developments, including changes in the propensity of courts to
grant larger awards, natural disasters (such as cata-
-53-
strophic hurricanes, windstorms, earthquakes, floods and fires), fluctuations in
interest rates and other changes in the investment environment that affect
market prices of investments and the income and returns on investments, and
inflationary pressures that may tend to affect the size of losses experienced by
ceding primary insurers. The reinsurance industry is highly competitive and
dynamic, and market changes may affect, among other things, demand for our
products, changes in investment opportunities (and the performance thereof),
changes in the products offered by us or changes in our business strategy.
Reinsurance treaties that are placed by intermediaries are typically for
one year terms with a substantial number that are written or renewed on January
1 each year. Other significant renewal dates include April 1, July 1 and October
1. The January 1, 2000 renewal period was marked by continuing intensified
competitive conditions in terms of premium rates and treaty terms and conditions
in both the property and casualty segments of the marketplace. These conditions
have been worsened due to large domestic primary companies retaining more of
their business and ceding less premiums to reinsurers. Commencing in late 1997,
in addition to our core business, we expanded into specialty classes of
reinsurance business, including marine and aviation and space in 1997, surety
and fidelity in 1998, and accident and health in 1999. In 1999, we discontinued
our aviation and space lines of business.
In-Force Business
At January 1, 2000, RCRe had approximately 330 renewable in-force
reinsurance treaties (such renewal is subject to negotiation and evaluation
during the renewal period), with approximately $249.1 million of estimated
annualized net premiums written, compared to $287.5 million at January 1, 1999
and $172.5 million at January 1, 1998, representing a decline of 13% and an
increase of 67% over the prior year, respectively. Such in-force premiums at
January 1, 2000 represent estimated annualized premiums from treaties entered
into during 1999 and the January 1, 2000 renewal period that are expected to
generate net premiums written during 2000. Such treaties at January 1, 2000 are
estimated to generate approximately $210.6 million of net premiums written over
the 12-month period ending December 31, 2000 without taking into account certain
factors, including the possibilities that (i) several treaties entered into in
1999 that are scheduled to expire during the remainder of 2000 may be renewed
and (ii) additional treaties may be bound during 2000.
The decline in in-force business of 13% in 1999 compared to 1998 is due to
several factors which include (i) discontinuing aviation and space business in
1999; (ii) non-renewals in other classes of business, due to (a) our adherence
to underwriting standards in competitive market conditions and (b) the effect on
cedents of our poor underwriting performance, coupled with a decline in RCRe's
A.M. Best rating from A to A-. Such declines were partially offset by increased
in-force premiums in Accident & Health business where significant underwriting
capacity has exited the market since 1998, and we believe reinsurance pricing
improvements have occurred in 1999 and 2000.
Results of Operations
We had consolidated comprehensive losses of $52.3 million and $4.4 million
for the years ended December 31, 1999 and 1998, respectively, and consolidated
comprehensive income of $47.1 million for the year ended December 31, 1997. Our
comprehensive income or loss is composed of net income and the change in
unrealized appreciation of investments. Net loss for the year ended December 31,
1999 was $32.4 million and net income for the years ended December 31, 1998 and
1997 was $3.1 million and $2.0 million, respectively. After-tax realized
investment gains (losses) of $11.2 million, $16.4 million and ($0.5 million)
were also included in net income for 1999, 1998 and 1997, respectively. Net
income for the years ended December 31, 1999, 1998 and 1997 included income
(losses) of $0.7 million, ($1.1 million), and ($0.2 million), respectively,
representing our equity in the net income (loss) of investee companies accounted
for under the equity method of accounting. Net loss for the year ended December
31, 1999 also included a loss of $383,000 from a cumulative effect of an
accounting change for start-up costs.
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Following is a table of per share data for the years ended December 31,
1999, 1998 and 1997 on an after-tax basis:
Years Ended December 31,
----------------------------------------------------
1999 1998 1997
------------ ------------ --------------
Basic earnings per share:
Underwriting loss ($3.42) ($1.39) ($0.45)
Net investment income 0.85 0.68 0.61
Net realized investment gains (losses) 0.66 0.96 (0.03)
Equity in net income (loss) of investees 0.03 (0.07) (0.01)
Cumulative effect of accounting change (0.02)
------------ ----------- ---------
Net income (1.90) 0.18 0.12
Change in net unrealized appreciation of investments (1.16) (0.44) 2.65
------------ ----------- ---------
Comprehensive income (loss) ($3.06) ($0.26) $2.77
============ =========== =========
Average Shares Outstanding (000's) 17,087 17,065 17,033
============ =========== =========
Diluted earnings per share:
Underwriting loss ($3.42) ($1.35) ($0.45)
Net investment income 0.85 0.65 0.61
Net realized investment gains (losses) 0.66 0.93 (0.03)
Equity in net income (loss) of investees 0.03 (0.06) (0.01)
Cumulative effect of accounting change (0.02)
------------ ----------- ---------
Net income ($1.90) $0.17 $0.12
============ =========== =========
Comprehensive income (loss) ($3.06) ($0.26) $2.76
============ =========== =========
Average shares outstanding (000's) 17,087 17,718 17,086
============ =========== =========
Book Value Per Share, December 31:
Basic $20.28 $23.29 $23.51
Diluted $20.28 $22.75 $22.79
Shares outstanding (000's)
Basic 17,088 17,087 17,058
Diluted 17,088 17,498 17,602
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Net Premiums Written
Net premiums written for the years ended December 31, 1999, 1998 and 1997
were as follows:
(In millions) Percent
Years Ended December 31, Change
1999 1998 1997 1998/1999
---------- ----------- ------------ ----------
Property $78.9 $33.7 $17.8 134%
Casualty 64.1 80.3 69.7 (20%)
Multi-line 67.7 62.8 45.9 8%
Other 7.6 16.5 10.0 (54%)
Accident & Health 50.3
Aviation & Space 18.4 26.0 (29%)
Marine 14.0 14.4 1.4 (3%)
Surety & Fidelity 5.7 1.0 470%
----------- ----------- ----------- ----------
Total $306.7 $234.7 $144.8 31%
=========== =========== =========== ==========
Set forth below are RCRe's assumed and ceded premiums written for the years
ended December 31, 1999, 1998 and 1997:
(In millions)
Years Ended December 31,
----------------------------------------------
1999 1998 1997
------------ ------------- ------------
Assumed premiums written $386.8 $260.5 $147.8
Ceded premiums written 80.1 25.8 3.0
------------ ------------- ------------
Net premiums written $306.7 $234.7 $144.8
============ ============= ============
RCRe's net premiums written increased 31% to $306.7 million in 1999 from
$234.7 million in 1998 and 62% to $234.7 million in 1998 from $144.8 million in
1997. Premium growth resulted from two key strategies, the integration of
investment with reinsurance and the diversification into "specialty" classes of
business, which for purposes of this discussion consist of Accident & Health,
Aviation and Space, Marine and Surety & Fidelity.
Approximately 30%, 32% and 29% of net premiums written in 1999, 1998 and
1997, respectively, were generated from companies in which we have invested or
committed to invest funds ("integrated transactions").
Approximately 29%, 18% and 1% of net premiums written in 1999, 1998 and
1997, respectively, was produced from specialty classes of business. Specialty
classes of business accounted for 65% and 44% of the increase in net premiums
written for 1999 and 1998, respectively.
Approximately 15%, 32% and 28% of net premiums written in 1999, 1998 and
1997, respectively, were from non-United States clients, which are Lloyd's
syndicates or are located in the United Kingdom, Bermuda and Continental Europe.
Net premiums written in 1999 includes approximately $26 million related to
a group of property reinsurance treaties that expired in 1999 covering crop hail
business underwritten on behalf of a start-up entity formed by Trident II, L.P.
This business was protected by extensive aggregate excess of loss retrocession
and generated a profit based upon underwriting results. We do not expect to
renew these treaties in 2000.
Net premiums written in 1999 for other business was reduced by $10.6
million for the retrocession of a treaty which covers future multiple rocket
launches that was recorded in 1996. The reduction of net premiums
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written resulting from this retrocession increased the commission and operating
expense ratio components of the statutory composite ratio by 1.1 percentage
points, but had no impact on operating results.
Consistent with our strategy of writing a small number of large treaties
for our core business, two clients contributed approximately $81.3 million or
26.5% of 1999 total net premiums written, with the largest client contributing
approximately 13.7% and the second contributing 12.8%. Approximately 70% of the
business written from the client that contributed 13.7% and all of the business
written from the client that contributed 12.8% are part of an integrated
transaction, and such business is subject to renewal at our option for two and
four remaining years, respectively.
In 1998, three clients contributed approximately $74 million, or 32%, of
1998 total net premiums written, with the largest client contributing
approximately 18% and the remaining two contributing 8% and 6%, respectively. In
1997, five clients contributed approximately $68 million, or 45%, of total net
premiums written, with the largest client contributing approximately 18% and the
remaining four contributing from 5% to 8%.
RCRe's ceded premiums increased to $80.1 million in 1999, compared to $25.8
million in 1998 and $4.2 million in 1997. Such ceded premiums primarily relate
to RCRe's property, multi-line, marine, aviation and space reinsurance business,
for which we seek to reduce RCRe's exposure to large and catastrophic losses.
Since the fourth quarter of 1998, we have purchased additional retrocessional
protection to reduce RCRe's exposures to both space and aviation risks.
Effective July 1, 1999, RCRe also purchased a retrocessional treaty for a one
year period covering earthquake, wind and other property catastrophe perils for
$10 million in excess of a $15 million retention per occurrence.
While not anticipated, the reduction or loss of business assumed from one
or more large clients could have a material adverse effect on our results of
operations to the extent not offset by new business.
Operating Costs and Expenses
One traditional method of measuring the underwriting performance of a
property/casualty insurer, such as RCRe, is the statutory combined ratio. This
ratio, which is based upon statutory accounting principles (which differ from
generally accepted accounting principles in several respects), reflects
underwriting experience, but does not reflect income from investments. A
statutory combined ratio under 100% indicates underwriting profitability, while
a combined ratio exceeding 100% indicates an underwriting loss.
Set forth below are RCRe's statutory combined ratios for the years ended
December 31, 1999, 1998 and 1997 and the estimated aggregate statutory combined
ratios for domestic reinsurers and domestic broker market reinsurers based on
data reported by the Reinsurance Association of America ("RAA") as of such
dates:
Years Ended December 31,
1999 1998 1997
Claims and claims expenses 98.2% 85.4% 68.4%
Commissions and brokerage 26.3% 24.2% 28.8%
----- ----- -----
124.5% 109.6% 97.2%
Other operating expenses 4.7% 6.8% 9.1%
----- ----- -----
Statutory combined ratio 129.2% 116.4% 106.3%
===== ===== =====
Domestic reinsurer aggregate
Statutory combined ratios 109.6%(1) 104.4% 102.3%
===== ===== =====
(1) Estimated based on RAA data published at September 30, 1999.
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After-tax underwriting losses for the years indicated were as follows
(dollars in millions):
Years Ended December 31,
---------------------------------------------------
1999 1998 1997
----------- ------------ ------------
After-tax underwriting loss
Amount $ 58.4 $ 23.0 $ 7.7
Per Share (Basic) $ 3.42 $ 1.39 $ 0.45
Statutory combined ratio after-tax underwriting results for 1999 and 1998
reflect very poor underwriting performance in competitive market conditions.
RCRe's 1999 and 1998 statutory combined ratios were adversely affected by
underwriting results from the sources identified below, which added 16 points
and 9 points to the combined ratios (excluding operating expenses), respectively
(dollars in millions):
1999 Year Underwriting Impact
-----------------------------------------------------
Managing
Underwriting Space &
Agency Aviation Total
Net premiums written $ 2.1 $ 18.4 $ 20.5
Earned premiums $ 6.4 $ 13.8 $ 20.2
After-tax underwriting loss
Amount $ 16.5 $ 19.7 $ 36.2
Per Share (Basic) $ 0.96 $ 1.15 $ 2.11
Combined Ratio Effect
(in percentage points) 7.7 8.3 16.0
1998 Year Underwriting Impact
-----------------------------------------------------
Managing
Underwriting Space &
Agency Aviation Total
Net premiums written $ 16.3 $ 26.0 $ 42.3
Earned premiums $ 12.5 $21.3 $ 33.8
After-tax underwriting loss
Amount $ 6.5 $ 7.8 $ 14.3
Per Share (Basic) $ 0.38 $ 0.46 $ 0.84
Combined Ratio Effect
(in percentage points) 4.1 4.9 9.0
Managing Underwriting Agency
As identified above, during 1999 and 1998, we recorded after-tax
underwriting losses of $16.5 million, or $0.96 per share, and $6.5 million, or
$0.38 cents per share, respectively, from reinsurance on casualty and multi-line
business produced by the managing underwriting agency. We also recorded related
after-tax investment losses of $1.3 million, or $0.07 per share, and $862,000,
or $0.03 per share, in net realized investment losses in 1999 and 1998,
respectively. We have discontinued our underwriting relationship with the
managing underwriting agency. The business and operations of the managing
underwriting agency are in run-off.
The total estimated ultimate net premiums written and earned by RCRe on all
business produced by the managing underwriting agency recorded from inception in
late 1997 through December 31, 1999 are approximately $19.3 million and $19.1
million, respectively, resulting in an inception to date after-tax underwriting
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loss of $22.4 million. Net reserves for claims and claim expenses for this
business approximated $38.7 million at December 31, 1999. See "-- Folksamerica
Transaction" for a discussion of a $20 million escrow fund relating to such
reserves in connection with the sale of our reinsurance business to
Folksamerica.
Space & Aviation Business
As identified above, during 1999 and 1998, RCRe recorded after-tax
underwriting losses of $19.7 million, or $1.15 per share and $7.8 million, or
$0.46 per share, respectively, for its space and aviation lines of business.
During 1999, RCRe discontinued both lines of business.
Space Business
The total estimated ultimate net premiums written and earned by RCRe for
space business from inception in 1998 through December 31, 1999 are $17.6
million each, resulting in an inception to date after-tax underwriting loss of
$13.1 million. Net reserves for claims and claim expenses for space business
approximated $2.4 million at December 31, 1999.
At December 31, 1999, all satellite treaties have expired except for one
treaty covering future multiple rocket launches which was 100% retroceded in
1999.
Aviation Business
The total estimated ultimate net premiums written and earned by RCRe for
aviation business from inception in 1998 through December 31, 1999 are $26.8
million and $17.5 million, respectively, resulting in an inception to date
after-tax underwriting loss of $14.3 million. Net reserves for aviation business
approximated $26 million at December 31, 1999.
Included in the 1999 after-tax underwriting loss for aviation business are
incurred losses for the 1998 Swiss Air and Korean Air crashes and certain 1999
crashes, including the Egypt Air, American Airlines, Korean Air and China Air
crashes. The additional loss recorded in 1999 for the Swiss Air crash was based
on a reallocation of the $642 million expected industry loss between the plane
manufacturer and Swiss Air. This reallocation adversely affected RCRe's gross
loss. The gross loss associated with the Swiss Air crash reported as of December
31, 1998 had exhausted RCRe's retrocessional protections applicable to this
occurrence. Therefore, none of such additional loss reported was ceded to
retrocessionaires. To the extent that either the expected industry loss
increases or additional loss is allocated to the plane manufacturer, RCRe could
record additional losses. For example, if the expected industry loss increases
by approximately $100 million, and assuming additional loss reallocations such
that one-third of the industry loss is allocated to the plane manufacturer, RCRe
would record additional aggregate loss (net of additional reinstatement
premiums) of approximately $2.7 million after-tax. However, we cannot be certain
of the ultimate industry loss or the final allocation of liability between the
plane manufacturer and Swiss Air, and there can be no assurances that the
ultimate industry loss will not be larger or that the plane manufacturer will
not be allocated a greater proportion of the industry loss. With respect to all
other reinsured crashes which occurred through December 31, 1999, we currently
believe that RCRe's gross loss will not exhaust RCRe's reinsurance protections
(although RCRe's net loss could increase within these protections based on the
ultimate industry loss, the ultimate allocation of losses between the plane
manufacturers and the airlines and other factors).
For the year ended December 31, 1999, aviation assumed gross premiums
earned, retroceded premiums earned, and net earned premiums were $43.7 million,
$32.5 million and $11.2 million, respectively. While RCRe discontinued writing
aviation business in 1999, RCRe currently has a number of assumed treaties that
will continue to expose it to significant risk of aviation losses through 2001.
Current estimates for gross aviation premiums that will be earned beyond 1999
aggregate approximately $20.5 million. Retrocessional premium charges to be
recorded for retrocessional treaties presently in-force that expire during 2000
total
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approximately $15.4 million. Such retrocessional premium costs do not include
additional retrocessional premium amounts that will be purchased to provide
Folksamerica with additional retrocessional protection in connection with the
sale of our reinsurance business to Folksamerica.
Following the Egypt Air crash in October 1999, RCRe exhausted its initial
layer of retrocessional protection for 1999 aviation exposures. Since October
1999, RCRe's initial retention as well as its total retention for aviation
exposures are contingent on the size of insured industry losses, which could
materially impact the recoveries under such retrocessions and therefore the net
loss to us. Based on information currently available to us, we believe that
RCRe's maximum exposures (net of retrocessional recoveries and reinstatement
premiums) for future commercial airline losses vary depending on (i) the size of
insured industry losses, (ii) the declining gross loss exposures as current
in-force business expires, and (iii) the application of retrocessional
protections which expire throughout 2000. Based on such current information, set
forth below is our estimate of after-tax losses for RCRe's maximum exposures for
the size industry loss and the time period presented (in millions):
$700
to
Industry Loss: $50 $100 $200 $300 $500 $1,500
------------- ------ ------- -------- -------- -------- -------
Year 2000
From/To:
January 1
March 31 $1.5 $4.1 $3.4 $1.2 N/A $1.0
April 1
June 30 $1.5 $4.1 $6.5 $4.3 $2.4 $8.3
July 1
September 30 $1.3 $3.1 $6.5 $7.5 $5.8 $8.7
October 1
December 31 $1.6 $3.7 $3.6 $5.1 $6.2 $8.7
Year 2001 $1.6 $3.7 $5.3 $5.5 $5.5 $7.8
We are presently evaluating the impact of recent commercial airline crashes
that occurred in 2000, including the Alaska Air crash.
Other Underwriting Loss Activity
Except for multi-line business, all other classes of business also
contributed to the 1999 underwriting loss, with the largest contribution from
property business. The after-tax underwriting loss for property business
approximated $4.9 million which included after-tax losses of $4.3 million for
two large catastrophes in 1999 (Rouge steel plant in Dearborn, Michigan and
French storm losses).
The 1998 underwriting loss included an after-tax underwriting loss of $3.3
million for a property loss on a finite risk treaty.
1999 Prior Year Development
Estimates of prior accident year claims were increased by approximately $30
million in 1999 which added 10.2 points to the 1999 combined ratio. A
substantial portion of this amount stemmed from (i) our review of additional
claims information and our continuing underwriting and actuarial analysis of the
business produced by the managing underwriting agency, (ii) notification of
additional satellite losses received in 1999
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pertaining to 1998, (iii) aviation losses, principally the previously discussed
1998 Swiss Air crash, and (iv) property losses reported on several international
treaties that are in run-off.
Estimates of prior accident year claims were reduced by approximately $2.8
million in 1998 primarily due to favorable claim development in the property and
multi-line classes of business.
Claims and claims expenses generally represent our most significant and
uncertain costs. Reserves for these expenses are estimates involving actuarial
and statistical projections at a given time of what we expect the ultimate
settlement and administration of claims to cost based on facts and circumstances
then known. The reserves are based on estimates of claims and claims expenses
incurred and, therefore, the amount ultimately paid may be more or less than
such estimates. The inherent uncertainties of estimating claim reserves are
exacerbated for reinsurers by the significant periods of time (the "tail") that
often elapse between the occurrence of an insured loss, the reporting of the
loss to the primary insurer and, ultimately, to the reinsurer, and the primary
insurer's payment of that loss and subsequent indemnification by the reinsurer.
As a consequence, actual claims and claims expenses paid may deviate, perhaps
materially, from estimates reflected in our reserves reported in our financial
statements. The estimation of reserves by new reinsurers, such as us, may be
less reliable than the reserve estimations of a reinsurer with an established
volume of business and claims history. To the extent reserves prove to be
inadequate, we may have to augment such reserves and incur a charge to earnings.
Acquisition Costs
In pricing RCRe's reinsurance treaties, we focus on many factors, including
exposure to claims and commissions and brokerage expenses. Commissions and
brokerage expenses are acquisition costs that generally vary by the type of
treaty and line of business, and are considered by our underwriting and
actuarial staff in evaluating the adequacy of premium writings. In a number of
reinsurance treaties, provisional commissions are initially paid and
subsequently increased or decreased, subject to a minimum and maximum amount,
depending upon the claims and claims expenses experience of the assumed
business. We record the commission increase or decrease in accordance with
contractual terms based on the expected ultimate experience of the contract. The
claims and commissions and brokerage ratios reflect our business mix.
Other Operating Expenses
Other operating expenses were $14.8 million in 1999, compared to $16.5
million and $13.5 million for the years ended December 31, 1998 and 1997,
respectively.
For 1999, the statutory operating expense ratio declined to 4.7%, compared
with 6.8% for 1998 and 9.1% in 1997. The decline in our operating expense ratio
was due to a decrease in other operating expenses and an increase in our net
premiums written from the comparable prior year period. In addition, commencing
in 1999, we allocated certain compensation and other operating expenses related
to investment activities in the amount of $2.1 million to net investment income
based on internal time studies. Such allocations were not made in prior periods.
Due to such allocations, the 1999 statutory operating expense ratio improved by
approximately one point and net investment income was reduced by approximately
$0.08 per share, with no overall effect on operating results. On a pro-forma
basis, the statutory operating expense ratios for 1998 and 1997 would have been
5.8% and 7.6%, respectively.
Foreign Exchange
Pre-tax foreign exchange gains and losses are recorded separately from
statutory underwriting results and are therefore excluded from the statutory
composite ratio. Unhedged monetary assets and liabilities are translated at the
exchange rate in effect at the balance sheet date, with the resulting foreign
exchange gains or losses recognized in income. For the years ended December 31,
1999, 1998 and 1997, pretax foreign exchange gains and (losses) were $198,000,
$443,000 and ($682,000), respectively. Such future gains or losses may be
-61-
affected by changes in foreign exchange rates which are unpredictable and could
be material. For additional discussion, see "--Market Sensitive Instruments and
Risk Management" below.
Risk Retention
Given RCRe's current level of surplus, under its current underwriting
guidelines, the maximum net retention on any one claim for a given property or
casualty treaty risk is generally $10 million.
We monitor RCRe's earthquake and wind exposures and continuously reevaluate
its estimated probable maximum pre-tax loss for such exposures through the use
of modeling techniques. We generally seek to limit RCRe's probable maximum
pre-tax net loss to no more than 10% of its statutory surplus for severe
catastrophic events such as hurricanes and earthquakes that could be expected to
occur once in every 100 years. This limitation includes combined exposure to
underwriting losses, reinstatement costs for retrocessional arrangements which
may be in force at the time of the losses resulting from the catastrophic event,
and losses that RCRe may be exposed to as a result of its privately held
investments in insurance and insurance-related entities. While we believe RCRe's
risk management techniques are adequate, we cannot assure you that RCRe will not
suffer pre-tax losses greater than 10% of its statutory surplus from a
catastrophic event due to the inherent uncertainties in estimating the frequency
and severity of such exposures. In addition, we believe that we cannot
reasonably estimate RCRe's exposure to unrealized investment losses (if any)
that may result from RCRe's investments in publicly traded securities of
insurance and insurance-related entities.
With respect to integrated solutions (where we combine an equity,
equity-like or debt investment in a client company with the purchase by such
client of reinsurance from RCRe), we generally limit RCRe's combined
underwriting and investment exposure to pre-tax losses on any individual client
to no more than 10% of RCRe's total statutory surplus.
We continue to evaluate RCRe's potential catastrophe exposure, including
both gross loss estimates and the impact of available reinsurance protection.
While we believe our management of catastrophe exposures and underwriting
guidelines are adequate, an extremely large catastrophic event, multiple
catastrophic events or other unforeseen events could have a material adverse
effect on our financial condition and results of operations.
Net Investment Income
At December 31, 1999, approximately 59% of our invested assets consisted of
fixed maturity and short-term investments, compared to 48% at December 31, 1998.
Net investment income was approximately $20.2 million in 1999, compared to $15.7
million and $14.4 million in 1998 and 1997, respectively. Such amounts for 1999,
1998 and 1997 are net of investment expenses of $5.5 million, $3.6 million and
$2.2 million, respectively. The investment expense amounts include investment
advisory fees of $2.0 million, $3.3 million and $1.8 million, respectively. The
1999 net investment income is also net of $1.1 million for the payment of
interest expense in connection with the settlement of satellite losses.
Our investment yields at amortized cost were as follows for the periods set
forth below:
Years Ended December 31,
1999 1998 1997
----------- ------------ ------------
Investment yields:
Pre-tax 3.6% 3.4% 3.7%
Net of tax 2.7% 2.5% 2.7%
Our investment yields are reflective of a significant allocation of the
total investment portfolio in equity securities, which yield less current income
than fixed maturity investments. At December 31, 1999 and 1998,
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investments in public and private equity securities approximated 41% and 49%,
respectively, of total cash and invested assets. Additionally, such investment
yields exclude our equity in the net income or loss of private equity
investments accounted for under the equity method.
Net Realized Gains (Losses) on Investments
Our sources of net realized investment gains (losses) were as follows:
In thousands
Years Ended December 31,
--------------------------------------
1999 1998 1997
--------- ---------- --------
Net realized investment gain (losses)
Fixed maturity securities ($1,776) $1,472 $275
Publicly traded equity securities 16,798 16,582 3,878
Privately held securities 2,205 7,198 (4,913)
------- ------- ------
Sub-total 17,227 25,252 (760)
Income tax expense (benefit) 6,029 8,838 (266)
------- ------- ------
Net realized investment gains (losses), net of tax $11,198 $16,414 ($494)
======= ======= ======
Income Taxes
Our 1999 income tax benefit, 1998 effective tax rate of 5% and the 1997
income tax benefit are less than the 35% statutory rate on pre-tax operating
income due primarily to tax exempt income and the dividends received deductions.
The 1999, 1998 and 1997 gross deferred income tax benefits of approximately
$10.5 million, $7.3 million and $2.1 million, respectively, which are assets
considered recoverable from future taxable income, resulted from temporary
differences between financial and taxable income.
The net deferred income tax asset at December 31, 1999 was $7.8 million. We
periodically evaluate the need for a valuation allowance for any portion of the
deferred tax asset that our management believes will not be realized based on
current and future operating performance and available tax planning strategies.
While we believe that a valuation allowance is not necessary at December
31, 1999, continued future comprehensive losses or future decisions with respect
to business strategy following the sale of our reinsurance business may result
in the establishment of a valuation allowance in future financial statements.
We have a net operating loss carryforward which expires in 2019, for which
we have established a deferred income tax asset of $7.3 million at December 31,
1999. The repurchase of our common stock held by XL Capital resulted in a 27.8%
change in ownership by 5% shareholders. If, in the ensuing three years, there is
more than a 22.2% additional change in ownership by 5% shareholders, an
"ownership change" will have taken place for federal income tax purposes. If
such ownership change occurs, the amount of loss carryforwards that can be used
in any subsequent year may be severely limited and could be eliminated in
certain circumstances. See "Risk Factors -- The financing of our business plan
may cause us to forfeit certain tax benefits."
Investments
A principal component of our investment strategy is investing a significant
portion of RCRe's invested assets in publicly traded and privately held equity
securities, primarily issued by insurance and reinsurance companies and
companies providing services to the insurance industry. Cash and fixed maturity
investments and, if necessary, the sale of marketable equity securities will be
used to support shorter-term liquidity requirements.
-63-
As a significant portion of RCRe's investment portfolio consists of equity
securities issued by insurance and reinsurance companies and companies providing
services to the insurance industry, the equity portfolio lacks industry
diversification and will be particularly subject to the performance of the
insurance industry. Unlike fixed income securities, equity securities such as
common stocks, including the equity securities in which RCRe has invested,
generally are not and will not be rated by any nationally recognized rating
service. The values of equity securities generally are more dependent on the
financial condition of the issuer and less dependent on fluctuations in interest
rates than are the values of fixed income securities. The market value of equity
securities generally is regarded as more volatile than the market value of fixed
income securities. The effects of such volatility on RCRe's equity portfolio
could be exacerbated to the extent that such portfolio is concentrated in the
insurance industry and in relatively few issuers. Since December 31, 1999, the
market value of our public equity portfolio has decreased by approximately $25
million due to general stock market volatility, market decline in the property
and casualty insurance sector and the poor operating performance of several of
our investee companies. For additional discussion, see "--Market Sensitive
Instruments and Risk Management" below.
As our investment strategy is to invest a significant portion of RCRe's
investment portfolio in equity securities, our investment income in any fiscal
period may be smaller, as a percentage of investments, and less predictable than
that of other insurance and/or reinsurance companies, and net realized and
unrealized gains (losses) on investments may have a greater effect on our
results of operations or stockholders' equity at the end of any fiscal period
than would be the case for other insurance and/or reinsurance companies. Since
the realization of gains and losses on equity investments is not generally
predictable, such gains and losses have differed and will differ significantly
from period to period. Variability and declines in our results of operations
could be further exacerbated by private equity investments in start-up companies
which are accounted for under the equity method. Such start-up companies may be
expected initially to generate operating losses.
Investments included in RCRe's private portfolio include securities issued
by privately held companies and by publicly traded companies that are generally
restricted as to resale or are otherwise illiquid and do not have readily
ascertainable market values. The risk of investing in such securities is
generally greater than the risk of investing in securities of widely held,
publicly traded companies. Lack of a secondary market and resale restrictions
may result in an inability by us to sell a security at a price that would
otherwise be obtainable if such restrictions did not exist and may substantially
delay the sale of a security we seek to sell.
At December 31, 1999, cash and invested assets totaled approximately $585.9
million, consisting of $82.2 million of cash and short-term investments, $261.1
million of publicly traded fixed maturity investments, $158.6 million of
publicly traded equity securities, and $83.9 million of privately held
securities. Included in privately held securities are investments totaling $42.6
million which are accounted for under the equity method.
At December 31, 1999, RCRe's private equity portfolio consisted of 12
investments, with additional investment portfolio commitments in an aggregate
amount of approximately $23.2 million.
In 1999, we completed one integrated transaction with an existing client of
RCRe, a follow-on investment in an existing investee and one additional
investment commitment. In addition, we divested four of RCRe's investments. (See
note 3 under the caption "Investment Information" of the accompanying notes to
our audited consolidated financial statements.)
In October 1998, we provided $5 million in financing on a fully secured
basis to a managing general agency, and received a related reinsurance
commitment expected to generate an aggregate of $90 million of reinsurance
premiums over three years pursuant to terms and conditions that we believe are
more favorable than those available in the open market.
-64-
On March 6, 2000, we extended a loan in an aggregate principal amount of
$3.5 million to American Independent Insurance Holding Company ("AIHC"), one of
our investee companies. The loan is fully secured with the capital stock of AIHC
and matures on September 6, 2001 (which date may be extended to March 6, 2002
upon the occurrence of certain events). The net proceeds of the loan were
contributed to the surplus of AIHC's subsidiary, American Independent Insurance
Company. In connection with the loan, we were issued warrants (in addition to
the warrants issued to us in connection with a prior loan to AIHC) granting us
the right to purchase equity in AIHC.
See note 3 under the caption "Investment Information" of the accompanying
notes to our audited consolidated financial statements for certain information
regarding RCRe's publicly traded and privately held securities and their
carrying values, and commitments made by RCRe relating to its privately held
securities.
At December 31, 1999, approximately 88% of RCRe's fixed maturity and
short-term investments were rated investment grade by Moody's or Standard &
Poor's and had an average quality rating of AA and an average duration of
approximately 3.7 years.
At December 31, 1999, RCRe is obligated under letters of credit in the
aggregate amount of approximately $9.7 million, which secure certain reinsurance
obligations. Securities with a carrying value of approximately $11.2 million
have been pledged as collateral for these letters of credit.
RCRe has not invested in derivative financial instruments such as futures,
forward contracts, swaps, or options or other financial instruments with similar
characteristics such as interest rate caps or floors and fixed-rate loan
commitments. RCRe's portfolio includes market sensitive instruments, such as
mortgage-backed securities, which are subject to prepayment risk and changes in
market value in connection with changes in interest rates. RCRe's investments in
mortgage-backed securities, which amounted to approximately $27.3 million at
December 31, 1999, or 4.7% of cash and invested assets, are classified as
available for sale and are not held for trading purposes.
Market Sensitive Instruments and Risk Management
In accordance with the SEC's Financial Reporting Release No. 48, the
following analysis presents hypothetical losses in cash flows, earnings and fair
values of market sensitive instruments which are held by RCRe as of December 31,
1999 and are sensitive to changes in interest rates, foreign exchange rates and
equity security prices. This risk management discussion and the estimated
amounts generated from the following sensitivity analysis represent
forward-looking statements of market risk assuming certain adverse market
conditions occur. Actual results in the future may differ materially from these
projected results due to actual developments in the global financial markets.
The analysis methods used by us to assess and mitigate risk should not be
considered projections of future events of losses.
Market risk represents the risk of changes in the fair value of a financial
instrument and is comprised of several components, including liquidity, basis
and price risks. The focus of the SEC's market risk rules is on price risk. For
purposes of specific risk analysis, we employ sensitivity analysis to determine
the effects that market risk exposures could have on the future earnings, fair
values or cash flows of RCRe's financial instruments.
The financial instruments included in the following sensitivity analysis
consist of all of our cash and invested assets, excluding investments carried
under the equity method of accounting.
Equity Price Risk
We are exposed to equity price risks on the public and private equity
securities included in RCRe's investment portfolio. All of RCRe's publicly
traded equity securities and privately held securities were issued by
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insurance and reinsurance companies or companies providing services to the
insurance industry. We typically do not attempt to reduce or eliminate RCRe's
market exposure on these securities. Investments included in RCRe's private
portfolio include securities issued by privately held companies and securities
issued by public companies that are generally restricted as to resale or are
otherwise illiquid and do not have readily ascertainable market values.
Investments in privately held securities issued by privately and publicly held
companies may include both equity securities and securities convertible into, or
exercisable for, equity securities (some of which may have fixed maturities).
RCRe's publicly traded and privately held equity securities at December 31,
1999, which are carried at a fair value of $158.6 million and $84.0 million,
respectively, have exposure to price risk. The estimated potential losses in
fair value for RCRe's publicly traded and privately held equity portfolios
resulting from a hypothetical 10% decrease in quoted market prices, dealer
quotes or fair value are $15.9 million and $8.4 million, respectively.
Interest Rate Risk
The aggregate hypothetical loss generated from an immediate adverse shift
in the treasury yield curve of 100 basis points would result in a decrease in
total return of 4.1%, which would produce a decrease in market value of $10.6
million on RCRe's fixed maturity investment portfolio valued at $261.1 million
at December 31, 1999. There would be no material impact on RCRe's short-term
investments.
Foreign Currency Exchange Rate Risk
We have foreign currency risk on both reinsurance balances receivable and
reinsurance balances payable, including claims and claims expenses. We do not
currently utilize derivative instruments to manage our exposure to foreign
currency movements. At December 31, 1999, the substantial majority of the
Company's net receivable/payable position was denominated in United States
dollars. At such date, the largest foreign currency exposure related to
liabilities denominated in British Pounds Sterling. We had a net liability
balance in Sterling of approximately $2.6 million. A 10% increase in the
Sterling/United States dollar exchange rate would have resulted in a loss to us
of $268,000. Given our limited amount of net asset or liability balances in
other foreign currencies, any currency movement of 10% would not produce a
material loss for purposes of this discussion.
Liquidity and Capital Resources
We are a holding company and currently have no significant operations or
assets other than our ownership of the capital stock of RCRe. We rely on cash
dividends and distributions from RCRe to make payments, including for any
operating expenses that we may incur and for any dividends or stock repurchases
as our board of directors may determine. Our board currently does not intend to
declare dividends or make any other distributions. However, our board intends to
make a determination regarding stock repurchases following the consummation of
the asset sale. See "Risk Factors -- We do not currently anticipate paying
dividends, but may consider share repurchases" and "Dividend and Stock
Repurchase Policy" elsewhere in this proxy statement. RCRe's ability to pay
dividends or make distributions to us is dependent upon its ability to achieve
satisfactory underwriting and investment results and to meet regulatory
standards of the State of Nebraska, as described below. There are presently no
contractual restrictions on RCRe's payment of dividends or the making of
distributions to us. We intend to cause RCRe to make an extraordinary dividend
to us following the asset sale. See "-- General -- RCRe Distribution."
Nebraska insurance laws provide that, without prior approval of the
Nebraska Director of Insurance ("Nebraska Director"), RCRe cannot pay a dividend
or make a distribution (together with other dividends or distributions paid
during the preceding 12 months) that exceeds the greater of (i) 10% of statutory
surplus as of the preceding December 31 or (ii) statutory net income from
operations from the preceding calendar year not
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including after tax realized capital gains. Net income (exclusive of realized
capital gains) not previously distributed or paid as dividends from the
preceding two calendar years may be carried forward for dividend and
distribution purposes. Any proposed dividend or distribution in excess of such
amount is called an "extraordinary" dividend or distribution and may not be paid
until either it has been approved, or a 30-day waiting period has passed during
which it has not been disapproved, by the Nebraska Director. Notwithstanding the
foregoing, Nebraska insurance laws provide that any distribution that is a
dividend may only be paid out of earned surplus arising from the business of the
insurer, which is defined as unassigned funds (surplus) as reported in the
statutory statement for the most recent year, including any surplus arising from
unrealized capital gains or revaluations of assets. Any distribution that is a
dividend and that is in excess of RCRe's unassigned funds, exclusive of any
surplus arising from unrealized capital gains or revaluation of assets, will be
deemed an "extraordinary" dividend subject to the foregoing requirements. Due to
the distribution that was made in connection with the XL Capital stock
repurchase, we may not declare any other distribution for twelve months from the
closing date of the stock repurchase without the prior approval of the Nebraska
Director. See footnote 10 to our audited consolidated financial statements
included in this proxy statement for further details regarding statutory
restrictions on distributions by RCRe.
We, RCRe and Cross River file consolidated federal income tax returns and
have entered into a tax sharing agreement (the "Tax Sharing Agreement"),
allocating the consolidated income tax liability on a separate return basis.
Pursuant to the Tax Sharing Agreement, RCRe and Cross River make tax sharing
payments to us based on such allocation.
Net cash flow from operating activities for the years ended December 31,
1999, 1998 and 1997 was approximately $7.5 million, $68.5 million and $49.0
million, respectively, consisting principally of premiums received, investment
income (excluding net realized investment gains), offset by operating costs and
expenses. The primary sources of liquidity for Risk Capital Reinsurance are net
cash flow from operating activities, principally premiums received, the receipt
of dividends and interest on investments and proceeds from the sale or maturity
of investments. RCRe's cash flow is also affected by claims payments, some of
which have been large. For example, we experienced negative cash flow from
operations of approximately $25 million in the 1999 fourth quarter as a result
of significant paid loss activity. Such situations could reoccur as our book of
business matures, claims are settled and if we continue to experience poor
underwriting performance. Therefore, our cash flow could fluctuate significantly
from period to period.
RCRe does not currently have any material commitments for any capital
expenditures over the next 12 months. We expect that our financing and
operational needs for the foreseeable future will be met by our balance of cash
and short-term investments, as well as by funds generated from operations.
Following the sale of the reinsurance operations to Folksamerica, our objective
will be to pursue business combinations and ventures with operating businesses.
We have not yet identified any specific business opportunities. Accordingly, we
may need to secure additional financing to carry out our business plan. We
cannot assure you that we will be successful in the implementation of our
current or future business strategy. See "Risk Factors--Risks Relating to Our
Business After the Asset Sale."
At December 31, 1999, our consolidated stockholders' equity totaled $346.5
million, or $20.28 per share based on issued and outstanding shares, and $20.28
per share on a diluted basis which includes outstanding dilutive warrants and
options. At such date, statutory surplus of RCRe was approximately $290 million.
As a result of the XL Capital stock repurchase, stockholders' equity has been
reduced by $59.4 million and book value per share has increased to $23.27 per
share on a fully diluted basis. RCRe's statutory surplus was also reduced by $60
million to $230 million due to the sale to XL Capital of the stock and warrants
in LARC Holdings, Ltd. and Annuity and Life Re Holdings, Ltd., based on their
statutory carrying values at December 31, 1999. Based on data from the RAA,
after giving effect to the XL Capital stock repurchase, RCRe was the 20th
largest domestic broker market oriented reinsurer as measured by its $230
million of statutory surplus.
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Accounting Pronouncements
Derivatives and Hedging
In June 1998, the Financial Accounting Standards Board issued Statement No.
133 "Accounting for Derivative Instruments and Hedging Activities." This
statement requires that all derivative financial instruments be recognized in
the statement of financial position as either assets or liabilities and measured
at fair value.
If a derivative instrument is not designated as a hedging instrument, gains
or losses resulting from changes in fair values of such derivative are required
to be recognized in earnings in the period of the change. If certain conditions
are met, a derivative may be designated as a hedging instrument, in which case
the recording of the changes in fair value will depend on the specific exposure
being hedged. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes on fair
values or cash flows.
This statement is effective for fiscal years beginning after June 15, 2000,
with initial application as of the beginning of the first quarter of the
applicable fiscal year.
We will adopt this statement in the first quarter of 2001. Historically, we
have not invested in derivative financial instruments. However, derivatives may
be embedded in other financial instruments, such as convertible securities and
prepayment options in mortgages. If the embedded derivative meets certain
criteria, it must be bifurcated from the host contract and separately accounted
for consistent with other derivatives.
RCRe's portfolio includes market sensitive instruments, such as convertible
securities and mortgage-backed securities, which are subject to prepayment risk
and changes in market value in connection with changes in interest rates. Our
investments in mortgage-backed securities are classified as available for sale
and are not held for trading purposes. Assuming the current investment strategy
at the time of adoption, our presentation of financial information under the new
statement will not be materially different than the current presentation.
Start-Up Costs
Effective January 1, 1999, we changed our method of accounting for start-up
costs in accordance with the Accounting Standards Executive Committee's
Statement of Position ("SOP") 98-5 "Reporting on the Costs of Start-Up
Activities." This statement requires costs of start-up activities, including
organization costs, to be expensed as incurred. The change in accounting
principle resulted in the write-off of the start-up costs capitalized as of
January 1, 1999 for us and RCRe's investee companies carried under the equity
method of accounting. The cumulative effect of the write-off, which totals
$383,000, after-tax, or $0.02 per share, has been expensed and is included in
the 1999 net loss. (See note 2 of the accompanying notes to our audited
consolidated financial statements.)
Insurance Regulation
RCRe, in common with other insurers, is subject to extensive governmental
regulation and supervision in the various states and jurisdictions in which it
transacts business. The laws and regulations of the State of Nebraska, the
domicile of RCRe, have the most significant impact on its operations.
From time to time various regulatory and legislative changes have been
proposed in the insurance and reinsurance industry, some of which could have an
effect on reinsurers. Among the proposals that have in the past been, or are at
present being considered, are (i) the possible introduction of federal
regulation in addition to, or in lieu of, the current system of state regulation
of insurers and (ii) proposals in various state legislatures (some of which
proposals have been enacted) to conform portions of their insurance laws and
regulations to various model acts adopted by the NAIC. We are unable to predict
whether any of such laws and regulations
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will be adopted, the form in which any such laws and regulations would be
adopted, or the effect, if any, these developments would have on our operations
and financial condition.
In March 1998, the NAIC adopted the codification of statutory accounting
principles project that will generally be applied to all insurance and
reinsurance company financial statements filed with insurance regulatory
authorities as early as the statutory filings made in 2001. Although the
codification is not expected to materially affect many existing statutory
accounting practices presently followed by most insurers and reinsurers such as
RCRe, there are several accounting practices that may be changed. The most
significant change would involve accounting for deferred income taxes, which
change would require a deferred tax liability to be recorded for unrealized
appreciation of invested assets, net of available deferred tax assets, that
would result in a reduction to statutory surplus. If such requirement had been
in effect in 1999, the statutory surplus of RCRe at December 31, 1999 would have
remained at $290 million.
Effects of Inflation
The effects of inflation on us are implicitly considered in pricing and
estimating reserves for unpaid claims and claims expenses. The actual effects of
inflation on our results cannot be accurately known until claims are ultimately
settled.
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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA
The following unaudited pro forma balance sheet as of December 31, 1999
reflects our historical accounts as of that date, adjusted to give pro forma
effect to the sale of our reinsurance business to Folksamerica, which is subject
to stockholder approval, and our repurchase of 4,755,000 shares, or 27.8%, of
our outstanding common stock from XL Capital, which repurchase was completed on
March 2, 2000, as if those transactions had occurred on December 31, 1999.
The following unaudited pro forma statement of income and comprehensive
income for the year ended December 31, 1999 reflects our historical accounts for
that period, adjusted to give pro forma effect to the asset sale and the XL
Capital stock repurchase as if those transactions had occurred on January 1,
1999.
The pro forma financial data and accompanying notes should be read in
conjunction with the description of the asset sale and XL Capital stock
repurchase contained in this proxy statement and our audited consolidated
financial statements and related notes also included in this proxy statement. We
believe that the assumptions used in the following statements, which are set
forth in the accompanying notes, provide a reasonable basis on which to present
the pro forma financial data. The pro forma financial data is provided for
informational purposes only and should not be construed to be indicative of our
financial condition or results of operations had the asset sale and XL Capital
stock repurchase been consummated on the dates assumed and are not intended to
project our financial condition on any future date or results of operations for
any future period.
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Risk Capital Holdings, Inc. and Subsidiaries
Pro Forma Condensed Consolidated Balance Sheet
December 31, 1999
(Dollars in thousands, except per share data)
Pro Forma Adjustments
----------------------------------
XL Folksamerica
Historical Transaction(1) Transaction(4) Pro Forma
---------------- -------------- --------------- -------------
Assets
Investments:
Fixed maturities and short-term
investments $333,852 ($245,545)(5) $88,307 (10)
Publicly traded equity securities 158,631 ($38,169)(2) 120,462
Privately held securities 83,969 (24,040)(2) 59,929
------------ ------------ -------------- ---------------
Total investments 576,452 (62,209) (245,545) 268,698
Cash 9,457 3,647 (2) 1,335 (8) 14,439
Accrued investment income 4,527 4,527
Premiums receivable 119,320 (119,320)(5)
Reinsurance recoverable 73,122 (73,122)(5)
Deferred policy acquisition costs 23,585 (23,585)(6)
Deferred income tax asset 7,834 127 (2) (5,352)(7) 2,609
Other assets 50,062 (36,975)(5) 13,087
------------ ------------ ------------- -------------
Total Assets 864,359 ($58,435) ($502,564) $303,360
============ ============ ============= =============
Liabilities
Claims and claims expenses $364,554 ($364,554)(5)
Unearned premiums 108,743 (108,743)(5)
Reinsurance balances payable 14,666 (14,666)(5)
Other liabilities 29,882 $1,000 (2) (24,541)(5) $6,341
------------ ------------ ------------- -------------
Total Liabilities 517,845 1,000 (512,504) 6,341
------------ ------------ ------------- -------------
Stockholders' Equity
Common stock, $.01 par value: 171 171
Additional paid-in capital 342,034 342,034
Deferred compensation under stock award plan
(317) (317)
Retained earnings (deficit) (22,175) 10,959 (3) 6,080 (9) (5,136)
Less treasury stock, at cost (387) (59,200)(1) (59,587)
Accumulated other comprehensive income
consisting of unrealized appreciation of
investments, net of income tax 27,188 (11,194)(3) 3,860 (9) 19,854
------------ ------------ ------------- -------------
Total Stockholders' Equity 346,514 (59,435)(2) 9,940 (9) 297,019
------------ ------------ ------------- -------------
Total Liabilities and
Stockholders' Equity $864,359 ($58,435) ($502,564) $303,360
============ ============ ============= =============
Shares outstanding - basic 17,087,970 (4,755,000)(1) -- 12,332,970
============ ============ ============= =============
Basic book value per share $20.28 $24.08
============ =============
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Notes to Pro Forma Balance Sheet
1. Reflects our repurchase from XL Capital of all of the 4,755,000 shares of
our common stock held by it for $59,200,000, or $12.45 per share, which
represents 85% of our average closing market price of our common stock for
the twenty day trading period between January 21, 2000 and February 17,
2000 in exchange for the following:
(i) our interest in LARC Holdings, Ltd., valued at $25 million, and
(ii) our interest in Annuity and Life Re (Holdings), Ltd. valued at
$37,847,000, consisting of 1,418,440 common shares at $25.38 per share,
which represents the average closing market price of Annuity and Life Re
(Holdings), Ltd. common shares for the twenty day trading period between
January 21, 2000 and February 17, 2000, and 100,000 warrants at $18.50 per
warrant based on a Black-Scholes option valuation model, and
We received cash from XL Capital of $3,647,000, which is the excess of the value
of the securities described in (i) and (ii) above over the purchase price of our
common stock repurchased from XL Capital.
2. The decrease in book value resulting from the XL Capital stock repurchase
is calculated as follows (in thousands):
Repurchase of 4,755,000 shares of our outstanding
common stock at $12.45 per share, recorded as a reduction
to stockholders' equity as treasury stock, plus $59,200
Net loss on the disposition of securities and transaction costs as follows:
(in thousands)
Annuity and
LARC Life Re
Holdings, Ltd. (Holdings) Ltd. Total
------------------ ---------------- -----------
Consideration received, consisting of cash of $3,647,000
and our common stock valued at $59,200,000 $25,000 $37,847 $62,847
Carrying values at December 31, 1999 24,040 38,169 62,209
------------------ ---------------- -----------
Pre-tax gain (loss) before transaction costs $960 ($322) 638
================== ================
Transaction costs 1,000
===========
Pre-tax loss (362)
Tax benefit (127)
-----------
Net loss (235)
-----------
Net decrease in book value $59,435
===========
3. The gain recorded in retained earnings of $10,959,000 represents the
realized gain that will be recorded for the $11,194,000 of net unrealized
appreciation, net of tax, recorded at December 31, 1999 for LARC Holdings,
Ltd. and Annuity and Life Re (Holdings), Ltd. and the net loss of $235,000,
which is discussed in note 2 above.
4. Reflects the asset sale, pursuant to which Folksamerica Reinsurance Company
will assume RCRe's liabilities under the reinsurance agreements transferred
to it and RCRe will transfer to Folksamerica Reinsurance Company assets in
an aggregate amount that is, in GAAP book value (as set forth on our
estimated closing date balance sheet), equal to the GAAP book value (as set
forth on our estimated clos-
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ing date balance sheet) of the liabilities assumed. In consideration for
the transfer of RCRe's book of business, Folksamerica will pay $20.335
million in cash at the closing, subject to adjustment under the
circumstances described in "The Asset Purchase Agreement--Purchase Price".
5. Represents securities and insurance assets and insurance liabilities to be
transferred to Folksamerica based on December 31, 1999 financial statement
amounts.
At the closing of the asset sale, RCRe and Folksamerica Reinsurance Company
will enter into a transfer and assumption agreement, under which
Folksamerica Reinsurance Company will assume RCRe's rights and obligations
under the reinsurance agreements being transferred in the asset sale.
Following the closing of the asset sale, Folksamerica Reinsurance Company
will notify the reinsureds under those of such agreements that are in-force
that it has assumed RCRe's obligations and that, unless the reinsureds
object to such assumption, RCRe will be released from its obligations to
those reinsureds. The pro forma accounting for this transaction assumes
that none of RCRe's reinsureds will object to such assumption and,
accordingly, the gross liabilities for its reinsurance business will be
removed from the accounts of RCRe for statutory accounting and GAAP
accounting purposes.
RCRe will continue to record gross liabilities in its accounts for
reinsureds that object to the release of RCRe from its obligations to such
reinsureds. In such instances, an offsetting accounts receivable amount
from Folksamerica Reinsurance Company would be recorded as an asset equal
to such gross liabilities.
6. Elimination of deferred policy acquisition costs related to the liability
for unearned premiums transferred to Folksamerica.
7. Net reduction in deferred income tax asset as follows (in thousands):
Reduction in net deferred tax asset for elimination of temporary differences
between financial statements and income tax return amounts resulting from the
Folksamerica transaction $13,957
Less, estimated tax benefit resulting from the transaction 8,605
-------
Net reduction in deferred tax asset $ 5,352
=======
8. Represents cash payment received from Folksamerica at the closing of the
asset sale of $20.335 million less estimated related transaction costs of
$19 million, which include investment banking, legal and accounting fees,
severance costs, tax reimbursement to Folksamerica and costs to purchase
additional reinsurance protection for Folksamerica.
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9. The book value gain resulting from the Folksamerica transaction is
calculated as follows (in thousands):
Consideration received, consisting of the following:
Total liabilities transferred $512,504
Cash premium received 20,335
------
532,839
-------
Assets transferred 474,962
Amortization of deferred policy acquisition costs 23,585
Transaction costs 19,000
------
517,547
-------
Pre-tax gain 15,292
Tax expense 5,352
-----
Net transaction gain 9,940
Realized loss, net of tax for securities transferred at market value (3,860)
------
Net income 6,080
Change in net unrealized appreciation of investments, net of tax 3,860
-----
Comprehensive income and net book gain $9,940
======
The pro forma accounting for this transaction assumes that none of RCRe's
reinsureds will object to the release of RCRe under the transfer and
assumption agreement and, accordingly, the gross liabilities for such
business are removed from the accounts of RCRe for statutory and GAAP
accounting purposes (see note 5 above). RCRe will continue to record gross
liabilities in its accounts for reinsureds that object to the release of
RCRe from its obligations to such reinsureds. This would result in a
portion of the pre-tax gain on the transaction being deferred and amortized
into income as the gross liabilities are extinguished.
10. Includes $20 million of fixed income securities deposited in an escrow
account for a five year period primarily to reimburse Folksamerica for
claims and claim expenses exceeding reserves recorded by RCRe as of the
closing date resulting from business produced on behalf of RCRe by a
certain managing underwriting agency. At December 31, 1999, such reserves
approximated $38.3 million, which were recorded based on RCRe's actuarially
determined best estimate for such business. We could record a loss to the
extent that such reserves turn out to be deficient, due to our
reimbursement of Folksamerica for such deficiency to the extent of the
escrowed funds. Amounts in escrow may also be released to Folksamerica to
satisfy its indemnification claims against us relating to undisclosed
liabilities, RCRe's reinsurance agreements and the managing underwriting
agency referred to above. Under the asset purchase agreement, we may be
required to deposit an additional amount of up to $5 million into a
supplemental escrow account a short time following the closing of the asset
sale. The above unaudited pro forma condensed consolidated balance sheet
has been prepared assuming that such supplemental escrow account will not
be required.
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Risk Capital Holdings, Inc. and Subsidiaries
Pro Forma Condensed Consolidated Statement of Income and Comprehensive Income
For the Year Ended December 31, 1999
(Dollars in thousands, except per share data)
Pro Forma Adjustments
---------------------------------
XL Folksamerica
Historical Transaction(1) Transaction(2) Pro Forma
------------ -------------- ------------- -----------
Revenues
Net premiums written $306,726 ($306,726) --
(Increase) decrease in unearned premiums 4,642 (4,642) --
---------- -------------- ------------- -----------
Net premiums earned 311,368 (311,368) --
Net investment income 20,173 145 (10,253) 10,065
Net realized investment gains and losses 17,227 1,350 1,192 19,769
---------- -------------- ------------- -----------
Total revenues 348,768 1,495 (320,429) 29,834
Operating Costs and Expenses
Claims and claims expenses 305,841 (305,841)
Commissions and brokerage 80,540 (80,540)
Other operating expenses 14,816 (10,666) 4,150
Foreign exchange (gain) (198) 198
---------- -------------- ------------- -----------
Total operating costs and expenses 400,999 -- 396,849 4,150
Income (Loss)
Income before income taxes, equity in net
income of investees and cumulative effect of
accounting change (52,231) 1,495 76,420 25,684
Federal income taxes expense (benefit) (19,557) 571 27,171 8,185
---------- -------------- ------------- -----------
Income before equity in net income of
investees and cumulative effect of accounting
change (32,674) 924 49,249 17,499
Equity in net income of investees 621 114 735
---------- -------------- ------------- -----------
Income (loss) before cumulative effect of
accounting change (32,053) 1,038 49,249 18,234
---------- -------------- ------------- -----------
Cumulative effect of accounting change (383) 99 (284)
---------- -------------- ------------- -----------
Net income (loss) (32,436) 1,137 49,249 17,950
Other Comprehensive Income (Loss), Net of Tax
Change in net unrealized appreciation of
investments, net of tax (19,850) (1,914) 4,553 (17,211)
---------- -------------- ------------- -----------
Comprehensive Income (Loss) ($52,286) ($777) $53,802 $739
========== ============== ============= ===========
Average shares outstanding
Basic 17,086,732 (4,755,000) -- 12,331,732
Diluted 17,086,808 (4,755,000) -- 12,331,808
Per Share Data
Net Income (Loss) - Basic ($1.90) $1.46
- Diluted ($1.90) $1.46
Comprehensive Income (Loss) Basic ($3.06) $0.06
Diluted ($3.06) $0.06
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Notes to Pro Forma Statement of Income and Comprehensive Income
1) Represents all revenue and expense and other comprehensive income items
recorded during 1999 for LARC Holdings, Ltd. and Annuity and Life Re
(Holdings), Ltd., which were disposed of in the XL Capital stock
repurchase.
2) Represents all revenue and expense and other comprehensive income items
recorded during 1999 related to the sale of our reinsurance business to
Folksamerica Reinsurance Company. Net investment income, net realized
investment gains (losses) and unrealized appreciation (depreciation) of
investments have been allocated based on the proportion of the average
amount of fixed maturities and short term investments related to the
business that will be transferred to the average total fixed maturities and
short term investments in 1999.
All other revenue and expense items were allocated based on specific
identification.
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INDEPENDENT ACCOUNTANTS
Our consolidated financial statements as of December 31, 1999 and 1998 and
for each of the three years in the period ended December 31, 1999 included in
this proxy statement have been audited by PricewaterhouseCoopers LLP,
independent accountants, as stated in their report appearing in this proxy
statement.
WHERE YOU CAN FIND MORE INFORMATION
As required by law, we file reports, proxy statements and other information
with the SEC (SEC file number: 0-26456). These reports, proxy statements and
other information contain additional information about us. You can inspect and
copy these materials at the SEC's Public Reference Room at 450 Fifth Street,
N.W., Judiciary Plaza, Washington, D.C. 20549. You can obtain information about
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC
maintains an internet web site that contains reports, proxy and information
statements and other information regarding companies that file electronically
with the SEC. The SEC's internet address is http://www.sec.gov. You can also
inspect these materials at the offices of the Nasdaq Stock Market, 1735 K
Street, N.W. Washington, D.C. 20006.
The SEC allows us to "incorporate by reference" information into this proxy
statement, which means that we can disclose important information by referring
you to another document filed separately with the SEC. Information incorporated
by reference is considered part of this proxy statement, except to the extent
that the information is superseded by information in this proxy statement.
This proxy statement incorporates by reference the information contained in
our Annual Report on Form 10-K for the year ended December 31, 1998, our proxy
statement for our annual meeting of stockholders held on May 11, 1999, our
Quarterly Reports on Form 10-Q for the quarters ended March 31, 1999, June 30,
1999 and September 30, 1999 and our Current Reports on Form 8-K dated January
18, 2000 and March 2, 2000. We also incorporate by reference the information
contained in all other documents that we file with the SEC after the date of
this proxy statement and before the special meeting. The information contained
in any of these documents will be considered part of this proxy statement from
the date these documents are filed.
Any statement contained in this proxy statement or in a document
incorporated or deemed to be incorporated by reference herein shall be deemed to
be modified or superseded for purposes of this proxy statement to the extent
that a statement contained herein or in any other subsequently filed document
which also is or is deemed to be incorporated by reference herein modifies or
supersedes such statement. Any statement so modified or superseded shall not be
deemed, except as so modified or superseded, to constitute a part of this proxy
statement.
If you are one of our stockholders and would like to receive a copy of any
document incorporated by reference into this proxy statement (which will not
include any of the exhibits to the document other than those exhibits that are
themselves specifically incorporated by reference into this proxy statement),
you should call or write to Risk Capital Holdings, Inc., 20 Horseneck Lane,
Greenwich, Connecticut 06830, Attention: Secretary (telephone (203) 862-4300).
We will provide these documents to our stockholders, without charge, by first
class mail within one business day of the day we receive a request. In order to
ensure timely delivery of the documents prior to the special meeting, you should
make any such request not later than April 4, 2000.
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You should rely only on the information contained in (or incorporated by
reference into) this proxy statement. We have not authorized anyone to give any
information different from the information contained in (or incorporated by
reference into) this proxy statement. This proxy statement is dated March 15,
2000. You should not assume that the information contained in this proxy
statement is accurate as of any later date, and the mailing of this proxy
statement to stockholders shall not mean otherwise.
By Order of the Board of Directors,
[Signature Logo]
PETER A. APPEL
Executive Vice President, Chief Operating
Officer, General Counsel and Secretary
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