SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission file
December 31, 1998 number 1-10967
ENHANCE FINANCIAL SERVICES GROUP INC.
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(Exact name of registrant as specified in its charter)
New York 13-3333448
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
335 Madison Avenue, New York, NY 10017
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number,
including area code: 212-983-3100
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $.10 par value New York Stock Exchange, Inc.
- ---------------------------- -------------------------------------------
(Title of Class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
None
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(Title of class)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
The approximate aggregate market value of voting stock held by non-affiliates of
the registrant as of the close of trading on March 26, 1999 was $783,431,009.
The number of shares of Common Stock outstanding as of that date was
37,933,836. For purposes of this calculation, shares of Common Stock held by
directors, executive officers and shareholders whose ownership exceeds ten
percent of the Common Stock outstanding on that date were excluded. Exclusion of
shares held by any person should not be construed to indicate that such person
possesses the power, direct or indirect, to direct or cause the direction of the
management or policies of the registrant, or that such person is controlled by
or under common control with the registrant.
PART I
Item 1. Business.
GENERAL
Enhance Financial Services Group Inc. ("Enhance Financial," and together
with its consolidated subsidiaries, the "Company") is a holding company engaged,
through its subsidiaries, principally in the reinsurance of financial guaranties
of municipal and asset-backed debt obligations issued by monoline financial
guaranty insurers. The Company is also engaged in other insurance, reinsurance
and asset-based businesses that utilize the Company's expertise in performing
sophisticated analysis of complex, credit-based risks. The Company's businesses
are divided into two operating segments: insurance businesses and asset-based
businesses.
The Company's business strategy is to maintain its financial guaranty
business, both primary and reinsurance, and its commitment to intensive and
prudent credit underwriting and conservative investment policies; to utilize its
expertise in underwriting credit risks to expand and develop its other insurance
businesses; and to continue to pursue its asset-based businesses and
diversification efforts utilizing its credit analysis skills in areas that the
Company believes have strong profit and growth potential relative to risk. The
Company expects that a significant portion of its growth will come from
asset-based businesses and non-financial guaranty businesses. As part of its
diversification and expansion efforts, the Company expects to further develop
its strategic relationships with Mortgage Guaranty Insurance Corporation
("MGIC"), a leading U.S. provider of private mortgage insurance coverage, and
Swiss Reinsurance Company ("Swiss Re"), both initiated in 1996.
Reinsurance of financial guaranties issued by monoline financial guaranty
insurers represented 61.8% of the Company's gross premiums written for the year
ended December 31, 1998. During the year ended December 31, 1998, the Company
received 24.7% of the total reinsurance premiums ceded by all monoline financial
guaranty insurers.
The Company's other insurance businesses include the issuance of direct
financial guaranties of smaller debt obligations, trade credit reinsurance and
excess-SIPC/excess-ICS and similar types of bonds. These other insurance
businesses represent 38.2% of the Company's gross premiums written for the year
ended December 31, 1998.
The Company is also engaged in various asset-based businesses, including
the origination, purchase, servicing and/or securitization of special assets,
including state lottery awards, structured settlements, viatical settlements,
sub-performing/non-performing and seller-financed residential mortgages and
delinquent unsecured consumer assets. The Company is continuing to expand these
asset-based businesses and is diversifying its products and services into other
areas that the Company believes have strong growth potential and in which the
Company's strengths in credit analysis and securitization can provide a
competitive advantage.
Enhance Financial has since its inception conducted substantially its
entire insurance business through its wholly-owned indirect financial guaranty
insurance subsidiaries, Enhance Reinsurance Company ("Enhance Re") and Asset
Guaranty Insurance Company ("Asset Guaranty"; together, the "Insurance
Subsidiaries"). Enhance Re has been rated by Standard &
Poor's Corporation ("Standard & Poor's"), Moody's Investors Service, Inc.
("Moody's") and Duff & Phelps Credit Rating Company ("Duff & Phelps"), each of
which have assigned it triple-A claims-paying ability ratings, their highest
respective ratings. Asset Guaranty has been rated by Duff & Phelps and Standard
& Poor's, which have assigned it triple-A and double-A claims-paying ability
ratings, respectively.
On March 29, 1999, Moody's advised the Company that it had placed on
review for possible downgrade both the Aaa insurance financial strength rating
of Enhance Re and the Aa3 senior long-term debt rating of Enhance Financial.
Moody's explained that this action with respect to Enhance Re's rating was based
on the possible increased risk and strain to Enhance Re resulting from the
Company's diversification and on the increasing competition in the reinsurance
industry. Moody's explained this action with respect to Enhance Financial's debt
rating was based on the Company's diversification into what Moody's described as
higher-return non-insurance businesses with risk characteristics that are
distinct from the Company's traditional financial guaranty activities. On August
17, 1999, Moody's announced that it had downgraded the senior long-term debt
rating of Enhance Financial from Aa3 to A2 and downgraded the insurance
financial strength of Enhance Re from Aaa to Aa2. See "Description of Business
- -- Rating Agencies" in this section.
FINANCIAL GUARANTY INSURANCE INDUSTRY OVERVIEW
General
Financial guaranty insurance provides an unconditional and irrevocable
guaranty to the holder of a debt obligation of full and timely payment of
principal and interest. In the event of a default under the obligation, the
insurer has recourse against the issuer and/or any related collateral (which is
a more common component in the case of insured asset-backed obligations or other
non-municipal debt) for amounts paid under the terms of the policy. Payments
under the insurance policy may not be accelerated by the holder of the debt
obligation. Absent payment in full at the option of the insurer, in the event of
a default under an insured obligation, the holder continues to receive payments
of principal and interest on schedule, as if no default had occurred. Each
subsequent purchaser of the obligation generally receives the benefit of such
guaranty.
The issuer of the obligation pays the premium for financial guaranty
insurance either in full at the inception of the policy or, less commonly, in
installments on an annual basis. Premium rates are typically calculated as a
percentage of either the principal amount of the debt or total exposure
(principal and interest). Rate setting reflects such factors as the credit
strength of the issuer, type of issue, sources of income, collateral pledged,
restrictive covenants, maturity and competition from other insurers.
Premiums are generally non-refundable and are earned over the life of the
insured obligation. This long and relatively predictable earnings pattern is
characteristic of the financial guaranty insurance industry and provides a
relatively stable source of future revenues and claims-paying ability to
financial guaranty insurers and reinsurers.
There are currently four major monoline primary U.S. financial insurers:
MBIA Insurance Corporation ("MBIA"), AMBAC Assurance Corporation ("AMBAC"),
Financial Guaranty Insurance Company ("FGIC") and Financial Security Assurance
Inc. ("FSA"). Two previous primary U.S. financial insurers, Capital Market
Assurance Corporation ("CapMAC") and Construction Loan Insurance Corporation
("Connie Lee"), were acquired by MBIA in February 1998 and by AMBAC in December
1997, respectively.
Financial Guaranty Market
The primary financial guaranty insurance market consists of two main
sectors: municipal bond insurance and insurance on asset-backed debt.
Municipal Bond Market. Municipal bond insurance provides credit
enhancement of bonds, notes and other evidences of indebtedness issued by states
and their political subdivisions (for example, counties, cities, or towns),
utility districts, public universities and hospitals, public housing and
transportation authorities, and other public and quasi-public entities.
Municipal bonds are supported by the issuer's taxing power in the case of
general obligation or special tax-supported bonds, or by its ability to impose
and collect fees and charges for public services or specific projects in the
case of most revenue bonds. Insurance provided to the municipal bond market has
been and continues to be the major source of revenue for the financial guaranty
insurance industry.
2
The following table sets forth certain information regarding new-issue
long term (over one year) municipal bonds and new-issue insured long term
municipal bonds, in each case issued during the years indicated:
New Insured Volume
New New as Percent of
Year Total Volume (1) Insured Volume (1) New Total Volume
- ---- ---------------- ------------------ ----------------
(Dollars in billions)
1994 $165.0 $ 61.5 37.3%
1995 160.0 68.5 42.8
1996 185.0 85.7 46.3
1997 220.7 107.5 48.7
1998 286.0 145.3 50.8
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(1) Based upon estimated data provided by The Bond Buyer, February 9, 1999.
The overall increase in the volume of municipal bond issuance in 1998
resulted from an increase in refunding issues, which represented 28.5% of total
issuance compared to 27.3% in 1997, as well as a higher amount of bonds issued
for new money purposes, which increased to $161.7 billion in 1998 from $138.6
billion in 1997.
Asset-Backed Debt Market. Asset-backed transactions or securitizations
constitute a form of structured financing which are distinguished from unsecured
debt issues by being secured by a specific pool of assets held by the issuing
entity, rather than relying on the general unsecured creditworthiness of the
issuer of the obligation. While most asset-backed debt obligations represent
interests in pools of assets, such as residential and commercial mortgages and
credit card and auto loan receivables, monoline financial guarantors have also
insured asset-backed debt obligations secured by one or a few assets, such as
utility mortgage bonds and multi-family housing bonds. While the asset-backed
securities market has grown significantly in recent years, consensus estimates
are lacking as to the insured volume.
Reinsurance
Reinsurance is the commitment by one insurance company, the "reinsurer,"
to reimburse another insurance company, the "ceding company," for a specified
portion of the insurance risks underwritten by the ceding company. Because the
insured party contracts for coverage solely with the ceding company, the failure
of the reinsurer to perform does not relieve the ceding company of its
obligation to the insured party under the terms of the insurance contract.
While reinsurance provides various benefits to the ceding company, perhaps
most importantly it enables a primary insurer to write greater single risks and
greater aggregate risks without contravening the capital requirements of
applicable state insurance laws and rating agency guidelines. State insurance
regulators allow primary insurers to reduce the liabilities appearing on their
balance sheets to the extent of reinsurance coverage obtained from licensed
reinsurers or from unlicensed reinsurers meeting certain solvency and other
financial criteria. Similarly, the rating agencies permit such a reduction for
reinsurance in an amount that depends on the claims-paying ability rating of the
reinsurer. See "Insurance Regulatory Matters" and "Description of Business --
Rating Agencies" in this section.
3
The principal forms of reinsurance are treaty and facultative. Under a
treaty arrangement the ceding company is obligated to cede, and the reinsurer is
correspondingly obligated to assume, a specified portion of a specified type of
risk or risks insured by the ceding company during the term of the treaty
(although the reinsurance risk thereafter extends for the life of the respective
underlying obligations). Under a facultative agreement, the ceding company from
time to time during the term of the agreement offers a portion of specific risks
to the reinsurer, usually in connection with particular debt obligations. A
facultative arrangement further differs from a treaty arrangement in that under
a facultative arrangement the reinsurer oftentimes performs its own underwriting
credit analysis to determine whether to accept a particular risk, while in a
treaty arrangement the reinsurer generally relies on the ceding company's credit
analysis. Both treaty and facultative agreements are typically entered into for
an indefinite term, subject to a right of termination under certain
circumstances.
Treaty and facultative reinsurance are typically written on either a
proportional or non-proportional basis. Proportional relationships are those in
which the ceding company and the reinsurer share the premiums, as well as the
losses and expenses, of a single risk or group of risks in an agreed percentage.
In addition, the reinsurer generally pays the ceding company a ceding
commission, which is typically related to the ceding company's cost of obtaining
the business being reinsured. Non-proportional reinsurance relationships are
typically on an excess-of-loss basis. An excess-of-loss relationship provides
coverage to a ceding company up to a specified dollar limit for losses, if any,
incurred by the ceding company in excess of a specified threshold amount.
Reinsurers may also, in turn, purchase reinsurance under retrocessional
agreements to cover all or a portion of their own exposure for reasons similar
to those that cause primary insurers to purchase reinsurance. See "Description
of Business - Reinsurance Ceded" in this item.
DESCRIPTION OF BUSINESS
Insurance Businesses
Reinsurance of Monoline Financial Guaranty Insurers
The Company's principal business is the reinsurance of financial guaranty
insurance written by the U.S. monoline financial guaranty insurers. The Company
provides reinsurance on a treaty and/or a facultative basis for such companies.
See "Sources of Premiums" in this item. As of December 31, 1998, 39.6% of the
Company's insurance in force attributable to the monoline financial guaranty
insurers represented business underwritten on a treaty basis, with the balance
being facultative. The reinsurance written by the Company is subject to a
detailed underwriting review. Most of the Company's reinsurance activity is
written on a proportional reinsurance basis.
The Company believes that the reinsurance of municipal bond guaranties,
which the Company expects will grow in response to the anticipated long-term
growth in the municipal bond market, provides a relatively stable source of
premium income for the Company. In addition, premiums received are credited as
deferred premium revenue and are earned as the related risks amortize, thereby
providing a relatively stable, predictable source of earned premiums.
Premiums Ceded by Individual Primary Insurers. The following table sets
forth certain information regarding written premiums ceded to the Company by the
monoline financial guaranty insurers in 1998, 1997 and 1996:
4
Year Ended December 31,
-------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Gross Gross Gross
Premiums Percent of Premiums Percent of Premiums Percent of
Primary Insurer Ceded Total Ceded Total Ceded Total
- --------------- ----- ----- ----- ----- ----- -----
(Dollar amounts in millions)
MBIA (1) $24.8 30.8% $26.6 45.2% $23.9 42.0%
FSA 24.3 30.1 17.3 29.4 14.0 24.6
AMBAC (2) 24.2 30.0 10.1 17.2 11.7 20.6
FGIC 7.0 8.7 4.8 8.2 7.3 12.8
Other - Foreign 0.3 0.4 -- -- -- --
----- ----- ----- ----- ----- -----
Total $80.6 100.0% $58.8 100.0% $56.9 100.0%
===== ===== ===== ===== ===== =====
(1) Includes $5.9 million (or 7.3% of total), $8.0 million (or 13.6% of total)
and $6.2 million (or 10.9% of total) of gross premiums ceded for 1998, 1997
and 1996, respectively, by CapMAC, which was acquired by MBIA in February
1998.
(2) Includes $0.3 million (or 0.5% of total) and $2.3 million (or 4.0% of total)
of gross premiums ceded for 1997 and 1996, respectively, by Connie Lee,
which was acquired by AMBAC in December 1997.
Insurance Portfolio Data. The Company seeks to maintain a diversified
insurance portfolio designed to spread its risk based on issuer, type of debt
obligation insured and geographic concentration. The following table sets forth
the distribution of the Company's reinsured monoline-guarantied obligations by
bond type as of December 31, 1998.
As of December 31, 1998
------------------------------------------
Type of Obligation Insurance in Force(1) Percent of Total
- ------------------ --------------------- ----------------
(In billions)
Municipal:
General obligation/tax supported ............ $ 21.0 30.5%
Water/sewer/electric/gas .................... 11.2 16.2
Airports/transportation ..................... 7.7 11.2
Health care ................................. 7.1 10.3
Housing revenue ............................. 1.5 2.2
Other (2) ................................... 5.1 7.4
----- -----
Total municipal .......................... 53.6 77.8
----- -----
Non-municipal
Consumer obligations ........................ 7.0 10.2
Investor-owned utilities .................... 4.1 5.9
Commercial mortgage ......................... 0.2 0.3
Other (3) ................................... 4.0 5.8
----- -----
Total non-municipal ...................... 15.3 22.2
----- -----
Total .................................... $ 68.9 100.0%
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5
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(1) Represents the Company's proportionate share of the aggregate outstanding
principal and interest payable on such insured obligations.
(2) Represents other types of municipal obligations, none of which individually
constitutes a material amount or percentage of the Company's insurance in
force.
(3) Includes $1.7 billion collateralized by corporate debt obligations. The
balance represents other types of assets which collateralize obligations
reinsured by the Company, none of which individually constitutes a material
amount or percentage of the Company's insurance in force.
The following table identifies by issuer the Company's ten largest
single-risk insurance in force amounts outstanding as of December 31, 1998 and
the credit rating assigned by Standard & Poor's as of that date (in the absence
of financial guaranty insurance) to each such issuer:
Insurance in
Force as of
Credit Credit Rating Obligation Type December 31, 1998
- ------ ------------- --------------- -----------------
(In millions)
New York City Municipal
Water Finance Authority A- Water & Sewer $ 981.2
New York City, NY ........ BBB+ General Obligation 888.3
Port Authority of New York
and New Jersey ......... AA Transportation 771.2
State of California ...... A+ General Obligation 740.9
Commerzbank - Citibank
London ................. AAA Consumer Obligation 657.5
Commonwealth of
Puerto Rico ............ A General Obligation 635.6
Dade County, Florida Water
& Sewer System ......... A Water & Sewer 602.7
Houston, TX Combined Water
& Sewer System ......... A Water & Sewer 591.2
San Francisco
International Airport,
CA ..................... A+ Airport 558.3
Commonwealth of
Massachusetts .......... A+ General Obligation 540.5
The following table sets forth the distribution by state of the Company's
insurance in force in connection with its reinsurance of monoline-guarantied
obligations as of December 31, 1998:
As of December 31, 1998
-----------------------------------------
Jurisdiction Insurance in Force Percent of Portfolio
- ------------ ------------------ --------------------
(In billions)
California ............................ $8.2 11.9%
New York .............................. 7.5 10.9
Florida ............................... 4.5 6.5
Texas ................................. 3.8 5.5
Pennsylvania .......................... 3.2 4.6
Illinois .............................. 2.8 4.1
New Jersey ............................ 2.7 3.9
Massachusetts ......................... 2.6 3.8
6
Puerto Rico ........................... 2.2 3.2
Ohio .................................. 1.5 2.2
Other (1) ............................. 29.9 43.4
----- -----
Total $68.9 100.0%
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(1) Includes $14.8 billion related to pooled or foreign credits for which
specific allocation by state is not available. The balance represents all
remaining states, the District of Columbia and several foreign countries, in
which obligations insured and reinsured by the Company arise, none of which
individually constitutes a material portion of the Company's insurance in
force.
Underwriting Staffing, Policies and Procedures. The Company believes
that its underwriting discipline has been critical to its profitable growth. The
Company has a structured underwriting process to determine the characteristics
and creditworthiness of risks that it reinsures, which process supplements the
underwriting procedures of the primary insurers. Rather than relying entirely
upon the underwriting performed by the primary insurers, both the Company and
the rating agencies conduct extensive reviews of the primary insurers.
The Company conducts periodic detailed reviews of each monoline primary
carrier with which it does treaty or facultative business. That review entails
an examination of the primary insurer's operating, underwriting and surveillance
procedures; personnel; organization and existing book of business, as well as
the primary insurer's underwriting of a sample of business assumed under the
treaty. Facultative transactions are reviewed individually under procedures
adopted by the Company's credit committee. Any underwriting issues are discussed
internally by the Company's credit committee and with the primary insurer's
personnel.
Moreover, the Company relies on ongoing oversight by its credit
committee to avoid undue exposure concentration in any given type of obligation
or geographic area. Moreover, the ceding insurer is typically required to retain
at least 25% of the exposure on any single risk assumed.
Limitations on the Company's single-risk exposure derive from state
insurance regulation, rating agency guidelines and internally established
criteria. The primary factor in determining single-risk capacity is the class or
sector of business being underwritten. For municipal credits, the Company has
self-imposed single-risk guidelines which range widely, depending upon the
perceived risk of default of the municipal obligation reinsured. For
asset-backed transactions, the Company's single-risk guidelines generally follow
state insurance regulation limitations, as well as self-imposed single risk and
cumulative servicer-related risk. On individual underwritings, the Company's
credit committee may limit the allocation of capacity to an amount below that
allowed by the single-risk guidelines noted above.
The Company's surveillance procedures include reviews of those exposures
assumed as a reinsurer as to which it may have concerns. The Company also
maintains regular communication with the surveillance departments of the ceding
primary insurers.
7
Other Insurance Businesses
The Company services certain insurance specialty markets not served by
the monoline financial guaranty industry. In certain of these new business
areas, the Company operates as a primary insurer in areas or for transactions
where the monoline financial guaranty primaries may decline to provide coverage;
others involve the Company serving as a reinsurer for certain specialty primary
insurers, in some of which the Company has significant equity interests or is
otherwise a participant.
In writing these other insurance lines of business, the Company utilizes
its expertise in evaluating complex credit-based risks. These businesses
represent 38.2% of the Company's gross premiums written for the year ended
December 31, 1998, compared to 45.7% for the year ended December 31, 1997. The
Company's business strategy is to expand and develop further these other
insurance lines, which the Company believes have strong profit and growth
potential and where the Company's expertise can be utilized.
Premiums in respect of certain of the Company's other insurance
businesses are earned over a significantly shorter period than those in respect
of the Company's monoline reinsurance business. The Company's ability to realize
consistent levels of earned premiums in these insurance businesses will
therefore depend on its ability to write consistent levels of new insurance.
The following tables set forth certain information concerning the
Company's other insurance businesses as of December 31, 1998 and for the year
then ended:
Insurance in Force(1)
Category of Other Insurance Business As of December 31, 1998
- ------------------------------------ -----------------------
(In billions)
Municipal bonds - direct ..................................... $5.7
Multi-family housing-backed financings ....................... 0.3
Other (2) .................................................... 0.8
----
Total $6.8
====
- ----------------------
(1) Does not include insurance in force pursuant to the excess-SIPC/excess-ICS
program described below in this section.
(2) Includes $0.2 billion of financial responsibility bonds in force, a line
of business which the Company has decided to exit in 1999.
Year Ended December 31, 1998
---------------------------------
Net Premiums
Category of Other Insurance Business Written Premiums Earned
- ------------------------------------ ------- ---------------
(In millions)
Municipal bonds - direct ................... $17.6 $ 8.3
Trade credit reinsurance ................... 16.9 16.0
Other (1) .................................. 14.2 12.2
----- -----
Total $48.7 $36.5
===== =====
(1) Includes $1.8 million of Net Premiums Written and $2.5 million of Premiums
Earned for financial responsibility bonds, a line of business which the
Company has decided to exit in 1999.
8
Municipal bonds. The Company writes municipal bond insurance as a primary
insurer in certain transactions where the financial guaranty monoline primary
insurers generally elect not to participate. This writing is focused on various
market sectors including tax-backed obligations, infrastructure revenue bonds,
health-care bonds, higher education bonds and municipal lease obligations. Each
such issue, after being insured, is reviewed by Standard & Poor's and Duff &
Phelps, which determine the credit quality of the issue and report their
findings to the Company.
Trade Credit Reinsurance. Trade credit reinsurance protects sellers of
goods under certain circumstances against non-payment of the receivables they
hold from buyers of those goods. The Company covers receivables both where the
buyer and seller are in the same country as well as cross-border receivables.
Sometimes in the latter instance, the coverage extends to certain political
risks (foreign currency controls, expropriation, etc.) which interfere with the
payment from the buyer.
The Company is a member-reinsurer, together with Great American Insurance
Company, of the Foreign Credit Insurance Association ("FCIA"), which guaranties
export financing for transactions between exporters and foreign purchasers.
As of December 31, 1998, Enhance Financial owned an indirect 36.5% equity
interest in Exporters Insurance Company Ltd. ("Exporters"), an insurer of
domestic and foreign trade receivables for multinational companies. While
Enhance Financial's equity interest in Exporters represents 54% of the voting
interest, Enhance Financial believes that it does not control Exporters. The
Company provides significant reinsurance capacity to this joint venture on a
proportional quota-share basis.
In addition, the Company participates in proportional and non-proportional
reinsurance treaties with approximately 25 credit insurers, including many in
Europe. The largest relationships in terms of premiums are with the FCIA
(domiciled in the United States), the Euler Group (major subsidiaries domiciled
in France, Belgium, the Netherlands, the United Kingdom and the United States)
and Exporters (domiciled in Bermuda). In order to expand the trade credit
reinsurance business, the Company is in the process of establishing a contact
office in London, England to market and manage relationships with trade credit
primary insurers. Upon receipt of appropriate authorizations in the United
Kingdom, the London office will also underwrite trade credit insurance.
Excess-SIPC/Excess-ICS. The Company writes surety bonds for the protection
of customers of large securities brokers against the loss of securities, and in
some cases, cash, in their brokerage accounts in the event of the broker's
insolvency and liquidation. Bonds issued under this program typically provide
coverage for loss per account in excess of the $500,000 in the case of loss
covered by the U.S.-government-established Securities Investor Protection
Corporation ("SIPC"), or 48,000 pounds sterling (approximately $78,000) in the
case of loss covered by the U.K.-government-established Investors Compensation
Scheme ("ICS"). The coverage is offered only to the members of the securities
brokerage community that meet specific financial, legal and operating criteria
established by the Company.
Although the dollar value of customer account assets protected by the
Company's excess-SIPC/excess-ICS policies totals in the billions, the Company's
estimated exposure is considerably lower. Losses in a brokerage account occur
only to the extent, if any, a covered broker-dealer becomes insolvent and
securities are missing and the individual customer losses, which are prorated
among all the customers of that broker-dealer, exceed the applicable deductible
amount,
9
which ranges from $500,000 for losses covered by SIPC, or 48,000 pounds sterling
for losses covered by ICS. As part of its underwriting process, the Company
reviews the operations and exposure amounts of each broker-dealer applying for
coverage and calculates a maximum loss based on the normal day-to-day
operational exposures of that broker-dealer.
Financial Responsibility Bonds. The Company owns substantially the entire
interest in Van-American Insurance Company ("Van-Am"), which writes reclamation
bonds for the coal mining industry, generally in strip mining ventures, and
surety bonds covering the closure and post-closure obligations of landfill
operators. Asset Guaranty reinsures the reclamation bonds for the coal mining
industry issued by Van-Am on both a treaty and facultative basis and surety
bonds for landfill operators issued by Van-Am on a facultative basis only. Due
to intense pricing competition in Van-Am's core business and a poor strategic
fit with the Company's other operations, the Company has decided to exit this
line of business. The Company will either sell its interest in Van-Am or
wind-down Van-Am's operations and place them into "run-off." The Company has
engaged an investment bank to assist in completing the divestiture of Van-Am,
which, if at all, is expected to occur in 1999.
Underwriting Process and Surveillance. The underwriting criteria applied
in evaluating a given issue for primary insurance coverage and the internal
procedures (for example, credit committee review) for approval of the issue are
substantially the same as for the underwriting of reinsurance. See "Reinsurance
of Monoline Financial Guaranty Insurers -- Underwriting Staffing, Policies and
Procedures" in this section. The entire underwriting responsibility rests with
the Company as the primary insurer. As a result, the Company participates more
actively in the structuring of the transaction than it does as a reinsurer. The
Company conducts, in most cases annually, in-depth surveillance of issues
insured as a primary insurer.
Sources of Premiums
The following table sets forth certain information regarding insurance
business assumed and written by the Company:
10
Year Ended December 31, 1998
----------------------------------------------------------------------------------
Premiums
Gross Premiums Earned as
Written as Percent of
Gross Net Percent of Total Total Premium Earned
Premiums Premiums Premiums Gross Premiums Premiums as Percent of
Sources of Premiums Written Written Earned Written Earned Total Revenues
- ------------------- ------- ------- ------ ------- ------ --------------
(Dollars in millions)
Financial guaranty
reinsurance:
MBIA ........... $ 24.8 $ 24.6 $ 29.5 19.0% 28.8% 14.2%
AMBAC .......... 24.2 24.4 10.1 18.6 9.9 4.9
FSA ............ 24.3 24.3 15.6 18.6 15.2 7.5
FGIC ........... 7.0 7.0 10.3 5.4 10.1 5.0
Other - Foreign 0.3 0.3 0.3 0.2 0.3 0.1
Other insurance(1) . 49.8 48.7 36.5 38.2 35.7 17.6
------ ------ ------ ------ ------ ------
$130.4 $129.3 $102.3 100.0% 100.0% 49.3%
====== ====== ====== ====== ====== ======
- ----------
(1) Includes business written by the Company as a primary insurer. For the
year ended December 31, 1998, no single primary insurer included in "Other
insurance" provided greater than 2.2%, 2.2% and 2.8% of gross premiums
written, net premiums written and premiums earned, respectively.
The Company has maintained close and long-standing relationships with its
monoline financial guaranty insurer clients, dating essentially from either the
Company's or the given primary insurer's inception. In the Company's opinion,
these relationships provide the Company with a comprehensive understanding of
its clients' procedures and reinsurance requirements and allow the clients to
utilize the Company's underwriting expertise effectively, thus improving the
service they receive.
The Company is a party to facultative agreements with all, and a party to
treaty agreements with all except one of, the monoline financial guaranty
primary insurers. The Company's facultative and treaty agreements usually are
entered into for indefinite terms, subject to termination (i) upon written
notice (ranging from 90 to 120 days) prior to the specified deadline for renewal
or (ii) at the option of the primary insurer if the Company fails to maintain
certain financial, regulatory and rating agency criteria which are equivalent to
or more stringent than those the Company is otherwise required to maintain for
its own compliance with the New York Insurance Law (the "Insurance Law") and to
maintain a specified claims-paying ability rating for the particular Insurance
Subsidiary. Upon termination under the conditions set forth in (ii) above, the
Company may be required to return to the primary insurer all unearned premiums,
less ceding commissions, attributable to reinsurance ceded pursuant to such
agreements. Upon the occurrence of the conditions set forth in (ii) above,
whether or not an agreement is terminated, the Company may be required to obtain
a letter of credit or alternative form of security to collateralize its
obligation to perform under such agreement.
Of the Company's aggregate monoline reinsurance exposure of $68.9 billion
as of December 31, 1998, $60.2 billion, or 87.4%, was derived through its treaty
relationships with the primary insurers.
11
Reinsurance Ceded
The Company is a party to certain facultative retrocession agreements,
pursuant to which it cedes to certain retrocessionnaires a portion of its
reinsurance exposure. Since it is required to pay its obligations in full to the
primary insurer regardless of whether it is entitled to receive payments from
its retrocessionnaire, the Company therefore believes that in most cases it is
vital that retrocessions be made only to very creditworthy retrocessionnaires.
The Company also cedes to reinsurers a portion of its direct insurance exposure,
and the foregoing also describes in general the relationship between the Company
and its reinsurers.
The Company has historically retroceded relatively little of its financial
guaranty reinsurance exposure for risk management reasons. In its specialty
insurance businesses, the Company in recent years has increased the amount of
direct exposure which it reinsures out, particularly that incurred in its
excess-SIPC/excess-ICS program, principally in order to comply with applicable
regulatory single-risk limitations. Most of the reinsurance capacity for its
excess-SIPC/excess-ICS program is provided by certain of the primary financial
guaranty insurers, for which the Company serves as reinsurer in their municipal
bond and asset-backed transactions. In addition, the Company retrocedes a
portion of its trade credit reinsurance business from FCIA to several
international reinsurance companies.
Enhance Re is party to an excess-of-loss reinsurance agreement with
Hannover Ruckversicherungs AG ("Hannover Re") under which it will be entitled,
subject to certain conditions, to draw from Hannover Re up to $25 million under
certain circumstances. The agreement has a term of one year and is cancelable
annually at the option of either party, except that the Company has the option
to force a seven-year run-off period. Hannover Re is a German reinsurance
company which has a claims-paying ability rating from Standard & Poor's of AA+.
Gross written premiums of $1.1 million were ceded or retroceded by the
Insurance Subsidiaries to unaffiliated companies in 1998, of which amount 78.0%
was ceded or retroceded to insurance companies having AAA claims-paying ability
ratings from Standard & Poor's.
Loss Experience
The Company establishes a provision for losses and related loss adjustment
expenses ("LAE") when reported by primary insurers or when, in the Company's
opinion, an insured risk is in default or a default is probable and the amount
of the loss is reasonably estimable. Provisions for losses and LAE are
established based on the estimated loss, including expenses associated with
settlement of the loss, through the full term of the insured obligation. In the
case of obligations with fixed periodic payments, the provision for losses and
LAE represents the present value of the Company's ultimate expected losses,
adjusted for estimated recoveries under salvage or subrogation rights. On any
given municipal and asset-backed reinsurance transaction, the Company and its
primary insurer clients underwrite with a zero-loss underwriting objective. For
the trade credit reinsurance business, loss reserves are established based on
historical loss development patterns experienced by the Company and by ceding
companies in similar businesses. The estimate of reserves for losses and LAE,
which includes a non-specific loss reserve, is periodically evaluated by the
Company, and changes in estimate are reflected in income currently.
As it anticipated, the Company has experienced relatively higher loss
levels in certain of its other insurance businesses than it experienced in
connection with its financial guaranty
12
reinsurance business. See "Other Insurance Businesses" in this section. The
Company believes that the higher premiums it receives in these businesses
adequately compensate it for the risks involved.
At December 31, 1998, the Company had established $33.7 million in net
reserves for losses and LAE (of which $16.4 comprised incurred but not reported
and non-specific reserves). The following table sets forth certain information
regarding the Company's loss experience for the years indicated:
Year Ended December 31,
-------------------------------------------
1998 1997 1996
----- ----- -----
(In millions)
Net reserve for losses and LAE
beginning of year ........................... $31.0 $26.3 $29.0
Net provision for losses and LAE
Occurring in current year ............... 6.0 6.0 6.1
Occurring in prior years ................ 4.3 3.7 3.1
----- ----- -----
Total ............................... 10.3 9.7 9.2
----- ----- -----
Net payments for losses and LAE
Occurring in current year ................ 0.4 0.7 0.6
Occurring in prior years ................. 7.2 4.3 11.3
----- ----- -----
Total .............................. 7.6 5.0 11.9
----- ----- -----
Net reserve for losses and LAE at end of year $33.7 $31.0 $26.3
===== ===== =====
The incurred loss and paid loss information presented above is classified
as "current year" and "prior year" based upon the year in which the related
reinsurance contract or insurance policy was underwritten. Therefore, amounts
presented as "net incurred related to prior years" are not indicative of
redundancies or deficiences in total reserves held as of prior year ends. During
the years ended December 31, 1998, 1997 and 1996, the actual adverse (redundant)
development of reserves held as of prior year ends was $(0.2) million, $1.5
million and $0.5 million, respectively.
In 1998, 1997 and 1996 the Company recorded losses of $6.5 million, $8.1
million and $7.3 million, respectively, in connection with its credit and surety
businesses.
The Company believes that the reserves for losses and LAE, including the
case and non-specific reserves, are adequate to cover the ultimate net cost of
claims. However, the reserves are necessarily based on estimates, and there can
be no assurance that the ultimate liability will not exceed such estimates.
Asset-Based Businesses
The Company is engaged in several additional lines of business that
utilize its core skills in complex credit analysis and securitizations and, in
certain cases, its strategic relationships.
Enhance Financial's wholly-owned subsidiary, Singer Asset Finance Company,
L.L.C. ("Singer"), conducting business from New York City and Boca Raton,
Florida offices, purchases from individuals state lottery prizes, structured
settlement payment rights and other long-term payment streams. Working with
leading financial institutions, Singer securitizes lottery prizes and structured
settlement payment streams, i.e., sells pools of such assets into the securities
market. Singer markets its products targeted to individual consumers through a
combination of direct marketing activities, a direct sales force and the use of
commissioned brokers.
In August 1998, the Company formed Enhance Consumer Services, LLC and
subsidiary entities to conduct the viaticals business (the purchase of or the
making of loans secured by life insurance policies from customers living with a
terminal illness) and to utilize marketing and securitization techniques similar
to those used by Singer for lottery prizes and structured settlement payment
streams. Singer faces in all its business lines a variety of direct competitors,
including specialized single-product providers and diversified multi-line
entities. Some of these competitors have significantly greater financial
resources than those available to the Company.
13
Enhance Financial and MGIC each own an approximate 48% interest in
Credit-Based Asset Servicing and Securitization LLC ("C-BASS"), a New York
City-based joint venture. C-BASS purchases, invests in and securitizes
single-family residential sub-performing, non-performing and seller-financed
mortgage loans and real estate and subordinated residential mortgage-backed
securities. In addition, through a wholly-owned residential mortgage servicing
subsidiary, C-BASS engages in loss mitigation, default collection, collection of
insurance claims and guaranty collections under government-sponsored mortgage
programs.
C-BASS markets its products and services directly to financial
institutions and institutional investors originating or purchasing residential
mortgages and to entities issuing subordinated residential mortgage-backed
securities. In addition, in connection with its seller-financed-mortgage
business, C-BASS employs a direct sales force and direct mailings to sell or
purchase its products. There are a significant number of direct competitors of
C-BASS in its program to purchase, service and securitize residential mortgages
and subordinated residential mortgage-backed securities. These competitors
include major Wall Street investment firms and larger banking institutions, many
of which have greater financial and other resources than C-BASS. There are a
limited number of direct competitors of C-BASS in its seller-finance residential
mortgages purchase and servicing programs.
In December 1998, the Company and MGIC formed Sherman Financial Group LLC
("Sherman"), a New York City-based joint venture in which each owns a 45.5%
interest and which will purchase, service and securitize delinquent consumer
assets, including charged-off credit card receivables. To that end, Sherman
acquired the assets of a leading provider of marketing analytics and diligence
services to purchasers of unsecured delinquent consumer assets, and the Company
acquired a leading servicer and collector of delinquent consumer assets, which
it anticipates contributing to Sherman upon satisfaction of certain regulatory
requirements.
Enhance Financial and Swiss Re, respectively, own 25% equity interests in
Seguradora Brasiliera de Fiancas ("SBF"), one of Brazil's largest surety
companies. The remaining interest in SBF is held by Banco Pactual, S.A., one of
Brazil's largest investment banks. The terms of the joint venture call for the
expansion of SBF in the Latin American insurance and other credit-related
markets and opportunities.
In July 1998, the Company formed AGS Financial LLC ("AGS"), a New York
City-based venture in which it holds an 80% interest focused on structured
finance, asset servicing and specialized investment banking services in Latin
American markets. The Company formed AGS to utilize resources made available to
the Company through its interest in SBF. To date, AGS has been a major
participant in the development of some of the most innovative origination and
servicing capabilities critical to successful securitization programs in
selected Latin American markets.
14
Investments and Investment Policy
The Company's investment portfolio, consisting of municipal bonds,
mortgage-backed securities, corporate bonds and privately-placed securities is
managed with a view to maximizing after-tax income. As of December 31, 1998,
58.2% of the portfolio is managed internally, while the remaining 41.8% is
allocated to four external specialty managers. All investments are guided by the
Company's general investment objectives and policies, including guidelines
relating to average maturities and quality, which are periodically reviewed and
revised as appropriate. The investment policies are designed to achieve
diversification of the portfolio. Investments are almost entirely fixed income
securities, with a mix of taxable and tax-exempt investments looking to maximize
the net income of the Company.
The Company generally limits its investment in municipal debt of issuers
whose obligations it insures or reinsures ("Overlapping Investments"). However,
given the increasing percentage of high-grade municipal debt obligations that
are insured and the Company's significant market share in the insurance and
reinsurance of municipal debt obligations, a portion of the Company's investment
portfolio consists of Overlapping Investments. It is the Company's policy to
comply with any and all state regulatory requirements that govern such
Overlapping Investments, and such regulations have been incorporated into the
Company's investment guidelines.
The Company may from time to time be required to invest funds prior to
receiving current reinsurance exposure data from its primary insurers, which is
generally provided quarterly. The Company assures compliance with its investment
guidelines through periodic reviews of its investment portfolio, promptly
selling such Overlapping Investments as may be necessary to bring its investment
portfolio into compliance with such guidelines based on updated insurance and
reinsurance exposure data.
Specifically, the Company's investment guidelines require, among other
things, that (a) no single investment represent greater than 10% of the
Company's admitted assets (as determined in accordance with statutory accounting
principles) and (b) investments in securities of any one entity not exceed 3%
percent of the Company's admitted assets as of the prior year end. As of
December 31, 1998, such limits for Enhance Re were $67.2 million and $20.2
million, respectively and for Asset Guaranty were $23.9 million and $7.2
million, respectively.
As of December 31, 1998, the Company had an aggregate investment in
Overlapping Investments of $154.0 million, representing 0.2% of the Company's
$75.7 billion total insurance exposure as of such date.
The Company also complies with insurance risk exposure limits for any
single insured in accordance with the Insurance Law. At December 31, 1998, such
limits were $311.5 million for Enhance Re and $91.0 million for Asset Guaranty.
It is the Company's policy to review its investment portfolio in light of these
limits, and if the sum of the insurance risk exposure plus the investment
portfolio exposure of a single issuer exceeds the statutory limit for insurance
risk exposure, the Company reviews its investment portfolio of such issuer for
any necessary remedial action with respect to the Overlapping Investments.
15
In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 115, Accounting for Certain Investments in Debt and Equity Securities, the
Company classifies all securities at the time of purchase as either "held to
maturity" or "available for sale." Securities held to maturity are those
securities which the Company intends and has the ability to hold until maturity
and are carried at amortized cost. All other fixed maturity securities are
classified as available for sale, are carried at fair value and may be sold in
response to changes in interest rates, prepayment risk, payment of losses and
other factors. Unrealized gains and losses, net of taxes, on the
available-for-sale portfolio are charged or credited to accumulated other
comprehensive income.
The Company internally manages and controls invested assets representing
58.2% of the carrying value of the investment portfolio at December 31, 1998.
The Company intends to hold 20.8% (based on carrying value) of its invested
assets to maturity, and, accordingly, in accordance with SFAS No. 115, they are
accounted for on an amortized cost basis.
The following tables set forth certain information concerning the types of
investments and maturities composing the investment portfolio of the Company.
As of December 31, 1998
--------------------------------------------
Weighted Average
Investment Category (1) Carrying Value (2) Yield (3)
----------------------- ------------------ ---------
(Dollars in millions)
Fixed Maturities, held to maturity
Private placements ......................... $ 96.3 8.93%
Municipal obligations - tax exempt ......... 93.3 7.53
Corporate securities ....................... 4.7 8.27
U.S. Government obligations ................ 2.5 6.95
------
Total .................................... $196.8 8.23%
------
16
As of December 31, 1998
---------------------------------------------
Weighted Average
Investment Category (1) Carrying Value (2) Yield (3)
----------------------- --------------------- ---------
(Dollars in millions)
Fixed maturities, available for sale
Municipal obligations - tax exempt ..... $520.7 5.60%
Mortgage-backed securities ............. 95.0 7.09
Corporate securities ................... 48.4 7.09
Foreign securities ..................... 26.7 5.81
U.S. Government obligations ............ 3.6 6.30
------
Total ................................ $694.4 5.93%
------
Short-term investments .................. 50.8 4.30
Common stocks ........................... 0.8 8.57
------
Total Investments .................. $942.8 6.33%
======
- -------------
(1) Excludes investment in affiliates. See Note 5 of "Notes to Consolidated
Financial Statements."
(2) Investments in fixed maturities in the held-to-maturity portfolio are
carried at amortized cost. Investments in fixed maturities in the
available-for-sale portfolio are carried at market value. Short-term
investments are carried at cost, which approximates their market values.
Common stocks are carried at market value. Unrealized gains and losses on
fixed maturities available for sale and common stocks are reflected in
accumulated other comprehensive income net of tax.
(3) Represents yield to maturity on fixed maturities and current yield on
common stocks and certain short-term investments. All amounts are stated
on a pre-tax basis.
17
Maturity of Fixed Maturities Carrying Value As of December 31, 1998
---------------------------- --------------------------------------
(In millions)
Held to Maturity (1)
Due in one year or less .................................. $ 16.9
Due after one year through five years .................... 95.8
Due after five years through ten years ................... 51.8
Due after ten years ...................................... 32.3
------
Total(2) ............................................. $196.8
======
Available for Sale (3)
Due in one year or less .................................. $ 2.6
Due after one year through five years .................... 33.5
Due after five years through ten years ................... 152.9
Due after ten years ...................................... 505.4
------
Total(4) ............................................. $694.4
======
- --------------
(1) The weighted average maturity of the held to maturity portfolio is
estimated to be 4.4 years as of December 31, 1998.
(2) Investments in fixed maturities in the held-to-maturity portfolio are
carried at amortized cost. Total market value as of December 31, 1998 of
fixed maturities, held to maturity, was $205.8 million.
(3) The weighted average maturity of the available for sale portfolio as of
December 31, 1998 is estimated to be 10.2 years.
(4) Investments in fixed maturities in the available-for-sale portfolio are
carried at market value. Total amortized cost of fixed maturities,
available for sale, as of December 31, 1998 was $657.6 million.
The Company has an investment policy of maintaining an investment
portfolio having a weighted average credit rating of not lower than AA. The
Company's adherence to these policies is reflected in the following table
setting forth certain information concerning the rating of the Company's
investments by Standard & Poor's.
Percent of Investment Portfolio
Rating As of December 31, 1998
- ------ -----------------------
AAA (1) ............................................. 49.3%
AA .................................................. 31.5%
A ................................................... 15.2%
Other (2) ........................................... 4.0%
- ----------
(1) Includes U.S. Treasury and agency obligations, which constituted 8.1% of
the total portfolio as of December 31, 1998.
(2) Consists of common stock, unrated securities and securities rated less
than A.
18
Marketing
Most of the Company's business derives from relationships it has
established and maintains with primary insurance companies. These relationships
provide business for the Company in the following major areas: (1) reinsurance
for municipal bonds and asset-backed securities (in which area the Company
currently has either treaty or facultative agreements with all the monoline
primary companies); (2) trade credit reinsurance; and (3) reinsurance for
affiliated-companies reinsurance (including Exporters and FCIA).
The Company markets directly to the monoline insurers writing credit
enhancement business and has direct relationships with their affiliated primary
insurers. Specialist reinsurance intermediaries, most of which are located in
London, usually present to the Company reinsurance opportunities in the credit
insurance sector. These brokers work with the Company's marketing personnel in
introducing the Company to the primary credit insurance markets and in
structuring reinsurance to meet the needs of the primary insurers.
Intermediaries are typically compensated by the reinsurer based on a percentage
of premium assumed, which varies from agreement to agreement.
The Company markets its excess-SIPC/excess-ICS polices through specialist
intermediaries, primarily in New York and London. These brokers work with the
Company's marketing personnel in introducing the Company to large securities
brokers to meet the needs of such securities brokers. These brokers are
typically compensated by the Company based on a percentage of premium collected,
which varies from agreement to agreement.
Competition
Reinsurance of Monoline Financial Guaranties. The Company is subject to
competition from three companies that specialize in financial guaranty
reinsurance--Capital Reinsurance Company ("Capital Re"), Axa Reassurance
Finance, S.A ("Axa") and RAM Reinsurance Co. Ltd ("Ram Re"), which the Company
believes provide, together with the Company, most of the reinsurance capacity to
the monoline financial guaranty primary insurers. In addition, several multiline
insurers have recently increased their participation in financial guaranty
reinsurance. Certain of these multiline insurers have formed strategic alliances
with some of the U.S. primary financial guaranty insurers. The Company believes
that it and Capital Re have the largest and roughly equivalent shares of
financial guaranty premiums ceded by the monoline primary insurers inclusive of
both treaty and facultative business.
Competition in the financial guaranty reinsurance business is based upon
many factors, including overall financial strength, pricing, service and
evaluation by the rating agencies of claims-paying ability. The agencies allow
credit to a ceding primary insurer's capital requirements and single-risk limits
for reinsurance ceded in an amount which is a function of the claims-paying
ability rating of the reinsurer. See "Rating Agencies" in this section. The
Company believes that competition from multiline reinsurers and new monoline
financial guaranty insurers will continue to be limited due to (a) the declining
number of multiline insurers with the requisite financial strength and (b) the
barriers to entry for new reinsurers posed by state insurance law and rating
agency criteria governing minimum capitalization.
19
Financial guaranty insurance, including municipal bond insurance, also
competes with other forms of credit enhancement, including letters of credit and
guaranties provided primarily by foreign banks and other financial institutions,
some of which are governmental entities or have been assigned the highest credit
ratings awarded by one or more of the major rating agencies. However, these
credit enhancements serve to provide primary insurers with increased insurance
capacity only for rating agency purposes. They do not qualify as capital for
state regulatory purposes, nor do they constitute credit against specific
liabilities which would allow the primary insurer greater single-risk capacity.
Other Insurance Businesses. The Company believes that there are a number
of direct competitors of the Company in its other insurance businesses, some of
which have greater financial and other resources than the Company. The Company
has limited its activities in these market areas to those activities that are
not served by the Company's financial guaranty monoline primary insurer clients.
As a primary insurer, the Company writes insurance on those municipal bonds with
respect to which such primary insurers have generally declined to participate
because of the size or complexity of such bond issuances relative to the
anticipated returns. The Company also serves as a reinsurer for certain
specialty primary insurers which are not monoline financial guaranty insurers,
in which the Company has significant equity interests or is otherwise a
participant. Such reinsurance accounted for 5.3% of the Company's gross premiums
written in 1998. These specialty primary insurers are themselves subject to
competition from other primary insurers, many of which have greater financial
and other resources.
Rating Agencies
The rating agencies allow credit to a ceding primary insurer's capital
requirements and single-risk limits for reinsurance ceded in an amount depending
on the claims-paying ability rating of the reinsurer. The rating criteria used
by the rating agencies focus on the following factors: capital resources;
financial strength; primarily in the case of a reinsurer whose common equity is
not publicly traded, shareholder composition and commitment of the reinsurer's
institutional stockholders; demonstrated management expertise in financial
guaranty and traditional reinsurance; credit analysis; systems development;
marketing; capital markets and investment operations, including the ability to
raise additional capital; and a minimum policyholders' surplus comparable to
primary company requirements, with initial capital sufficient to meet projected
growth as well as access to such additional capital as may be necessary to
continue to meet standards for capital adequacy. As part of their rating
process, Standard & Poor's, Moody's and Duff & Phelps test the capital adequacy
of the Insurance Subsidiaries by subjecting them to a "worst-case depression
scenario." Expected losses over a depression period are established by applying
capital charges to the existing and projected insurance portfolio.
The claims-paying ability ratings assigned by the rating agencies to a
reinsurance or insurance company are based upon factors relevant to
policyholders and are not directed toward the protection of the reinsurer's or
insurer's securityholders. Such a rating is neither a rating of securities nor a
recommendation to buy, hold or sell any security. Claims-paying ability ratings
assigned to the Insurance Subsidiaries should not be viewed as indicative of or
relevant to any ratings which may be assigned to the Company's outstanding debt
securities by any rating agency and should not be considered an evaluation of
the likelihood of the timely payment of principal or interest under such
securities.
20
On March 29, 1999, Moody's advised the Company that it had placed on
review for possible downgrade both the Aaa insurance financial strength rating
of Enhance Re and the Aa3 senior long-term debt rating of Enhance Financial.
Moody's explained that this action with respect to Enhance Re's rating was based
on the possible increased risk and strain to Enhance Re resulting from the
Company's diversification and on the increasing competition in the reinsurance
industry. Moody's explained that this action with respect to Enhance Financial's
debt rating was based on the Company's diversification into what characteristics
that are distinct from the Company's traditional financial guaranty activities.
On August 17, 1999, Moody's announced that it had downgraded the senior
long-term debt rating of Enhance Financial from Aa3 to A2 and downgraded the
insurance financial strength of Enhance Re from Aaa to Aa2.
Management does not believe that a downgrade (should that be the result of
the Moody's review) would have an adverse effect on Enhance Re's competitive
position. This is because many of Enhance Re reinsurance competitors do not have
financial strength ratings of Aaa from Moody's, and the Company's principal
financial guaranty competitor has already been downgraded by Moody's. However,
insofar as a downgrade could diminish the value Enhance Re provides to the
primary insurers, they could seek an increase, which could be material, in the
costs to Enhance Re associated with cessions under their treaties with Enhance
Re. Should the Company fail to reach agreement with the primaries on the matter,
some of them will be entitled to exercise their treaty right triggered by the
downgrade to recapture business previously ceded to Enhance Re. While the
Company believes that the recapture of business by the primaries would otherwise
be inconsistent with their long-standing risk-management practices, such action,
if it occurs and depending on its magnitude, could have a material adverse
effect on the Company.
A substantial portion of Asset Guaranty's written business is subject to
similar provisions with respect to any downgrade of its Standard & Poor's or
Duff & Phelps rating. The Company believes that the same consequences as set
forth above would occur were Asset Guaranty to experience any such downgrade,
which, in turn, could materially adversely affect the Company's ability to
continue to engage in certain speciatly businesses, principally insurance of
municipal bonds. See "Other Insurance Businesses" in this section.
Data Processing
The Company believes that its data processing systems are adequate to
support its current needs and have the capacity to support a greater volume of
reinsurance business. The Company completed a significant upgrade of its
technology infrastructure in 1997, updating and modernizing its hardware,
software and network. This modernization program provides a more reliable and
resilient information technology environment. The Company has also improved the
speed, security and quality of information available to the Company. The Company
also has in progress, major application development programs that will provide
operational support to many departments. One of the ultimate objectives of these
development programs is to restructure, streamline and strengthen the Company's
databases that support important reporting and decision support processes.
See Item 7 "Management Discussion and Analysis of Financial Condition and
Results of Operations Year 2000" for a description of the Company's systems
preparedness for the Year 2000.
Employees
As of March 1, 1999, the Company (excluding Van-Am) had 260 employees.
None of the employees are covered by collective bargaining agreements. The
Company considers its employee relations to be good.
INSURANCE REGULATORY MATTERS
Financial Guaranty Insurance Regulations
The Insurance Subsidiaries are domiciled and licensed in the State of New
York as financial guaranty insurers under that portion of the Insurance Law
constituting the financial guaranty insurance statute. They are also subject to
the provisions of the Insurance Law and related rules and regulations governing
property-casualty insurers to the extent such provisions are not inconsistent
with the financial guaranty insurance statute. Both Insurance Subsidiaries are
also licensed under the Insurance Law to write surety insurance, credit
insurance and residual
21
value insurance, which are the only other types of insurance that a financial
guaranty insurer licensed under the Insurance Law may be authorized to write.
The Insurance Subsidiaries are required by New York and each other
jurisdiction in which they are licensed to make various filings, including
quarterly and annual financial statements prepared in accordance with statutory
accounting practices, with those jurisdictions and with the National Association
of Insurance Commissioners (the "NAIC").
The Insurance Law requires that each financial guaranty insurer and
reinsurer maintain both a reserve for unearned premiums and for incurred losses
(similar to the reserve described in "Description of Business -- Loss
Experience" in this section) and a special, formulaically derived "contingency
reserve" to protect policyholders against the impact of excessive losses
occurring during adverse economic cycles. As of December 31, 1998, the statutory
contingency reserves of the Insurance Subsidiaries aggregated $207.9 million.
Each calculated reserve may be drawn on with the approval of the New York
Insurance Department (the "Department") under specified but limited
circumstances.
The Insurance Law establishes single-risk limits applicable to all
obligations insured by a single entity and backed by a single revenue source and
aggregate risk limits on the basis of aggregate net liability and policyholders'
surplus requirements. The Insurance Law also regulates the types of securities
in which the Insurance Subsidiaries may invest their minimum policyholders'
surplus and imposes restrictions on the amount of dividends that the Insurance
Subsidiaries may pay. See Item 5. "Market for Registrant's Common Equity and
Related Stockholder Matters -- Dividend Policy."
The Company believes that each of the Insurance Subsidiaries is in
material compliance with all applicable laws and regulations of the State of New
York and the laws and regulations of the other jurisdictions in which such
Insurance Subsidiary is licensed pertaining to its business and operations.
The Insurance Subsidiaries are also subject to the insurance laws in each
jurisdiction in which they are licensed to transact insurance. Reinsurance
activities are generally not directly regulated by state law, but are generally
subject to limited indirect regulation in most states through the regulation of
ceding primary insurers domiciled in those states.
Insurance Holding Company Regulations
Enhance Financial, as the parent, and the Insurance Subsidiaries, as
controlled insurers, are subject to regulation under the insurance holding
company laws of New York, which require the Insurance Subsidiaries to register
with the Department and to file with it certain informational reports.
State holding company laws also require prior notice or regulatory
approval of direct or indirect changes in control of an insurer or its holding
company and of certain material intercorporate transfers within the holding
company structure. Upon obtaining control, the acquiror would become subject to
various ongoing regulatory requirements in New York and certain other states.
The Company believes that Enhance Financial and each of the Insurance
Subsidiaries is
22
in material compliance with all applicable insurance holding company laws and
regulations of the State of New York and the laws and regulations of the other
jurisdictions in which such Insurance Subsidiary is licensed pertaining to its
business and operations.
Under the Insurance Law, any person holding or acquiring, directly or
indirectly, 10% or more of the voting securities of an insurance company is
presumed to be holding or acquiring "control" of such company and its
subsidiaries, unless the Department determines upon application that such
acquiror would not control such company.
NAIC/IRIS Ratios
The NAIC developed the Insurance Regulatory Information System primarily
to assist state insurance departments in executing their statutory mandates to
oversee the financial condition of insurance companies operating in their
respective states. The system identifies eleven industry ratios and specifies
"usual values" for each ratio. Departure from these "usual values" on four or
more of the ratios can lead to inquiries from individual state insurance
commissioners as to certain aspects of an insurer's business. The values of such
ratios of the Insurance Subsidiaries all fell within these "usual values" except
for three of such ratios for Enhance Re: the liabilities to liquid assets ratio
fell outside the "usual value" as a result of an increase in the amount of funds
held by or deposited with reinsured companies; the change in net writings ratio
fell outside the "usual value" as a result of an increase in writing of
municipal bond reinsurance by Enhance Re; and the investment yield ratio fell
outside the "usual value" as a result of income on funds held or deposited with
reinsurance companies.
Accreditation
The NAIC has instituted the Financial Regulatory Accreditation Standards
Program ("FRASP") in response to federal initiatives to regulate the business of
insurance. FRASP provides standards intended to establish effective state
regulation of the financial condition of insurance companies. FRASP requires
states to adopt certain laws and regulations, institute required regulatory
practices and procedures, and have adequate personnel to enforce such items in
order to become "accredited." In accordance with the NAIC's Model Law on
Examinations, accredited states are not permitted to accept certain financial
examination reports of insurers prepared solely by the insurance regulatory
agency in states not accredited by January 1, 1994. Although the State of New
York is not accredited, no states where the Insurance Subsidiaries are licensed
have refused to accept the Department's Reports on Examination for the Insurance
Subsidiaries. However, there can be no assurance that, should the Department
remain unaccredited, other states that are accredited will continue to accept
financial examination reports prepared solely by New York. The Company does not
believe that the refusal by an accredited state to continue accepting financial
examination reports prepared by New York, should that occur, will have a
material adverse impact on the Company's insurance businesses.
Item 2. Properties.
The Company, excluding Singer, occupies approximately 45,000 square feet
of office space comprising its executive offices at 335 Madison Avenue, New
York, New York pursuant to a sublease expiring April 2000. Singer occupies
approximately 9,000 square feet of office space at the same address pursuant to
a sublease expiring August 1999 and approximately 35,000 square feet of office
space at 700 Banyan Trail Road, Boca Raton, Florida pursuant to a lease expiring
August 2005.
Item 3. Legal Proceedings.
The Company is not a party, nor is any of its property subject, to any
material legal proceedings.
Item 4. Submission of Matters to a Vote of Securityholders.
Not applicable.
23
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
SHARE INFORMATION
The following table sets forth the high and low sales prices for the
Common Stock for the calendar quarters indicated as reported in the New York
Stock Exchange consolidated transaction system. Sales prices reflect a 2:1 split
of Enhance Financial's stock effective June 1998.
High Low
---- ---
1997
1st quarter .............................. $19-3/4 $17-1/8
2nd quarter .............................. 22-19/32 18-13/16
3rd quarter .............................. 28 22
4th quarter .............................. 31-1/16 24-9/16
1998
1st quarter .............................. $35 $26
2nd quarter .............................. 37-19/32 30-5/8
3rd quarter .............................. 37- 5/16 25
4th quarter .............................. 30-3/8 17-5/16
1999
1st quarter (through March 26) ........... $30-1/8 $20-11/16
As of March 26, 1999, there were 115 holders of record of the Common Stock.
DIVIDEND POLICY
Enhance Financial paid an aggregate dividend of $0.23 per share in 1998,
and the board of directors, declared a dividend in the first quarter of 1999 of
$0.06 per share. The amount of dividends payable in the future will be reviewed
periodically by the board of directors in light of the Company's earnings,
financial condition and capital requirements. The declaration and payment of
dividends are subject to the discretion of the board of directors of Enhance
Financial, and there is no requirement or assurance that dividends will be paid.
Enhance Financial's ability to pay dividends as well as its operating,
debt service and other expenses depends upon the ability of the Insurance
Subsidiaries to pay dividends to Enhance Investment Corporation ("EIC"), a
wholly-owned subsidiary of Enhance Financial and the sole shareholder of the
Insurance Subsidiaries, and EIC's ability to pay dividends to Enhance Financial.
Enhance Financial's ability to pay dividends is also subject to restrictions
contained in an agreement relating to Enhance Financial's indebtedness. The
Insurance Subsidiaries' ability to pay dividends to EIC is subject to
restrictions contained in the Insurance Law. The Company expects that such
restrictions will not affect the ability of such subsidiaries to declare and pay
dividends to EIC in an amount sufficient to enable EIC to pay dividends to
Enhance Financial to support the payment of dividends by Enhance Financial
consistent with the practice adopted in recent years. Enhance
24
Financial is limited by the agreements relating to indebtedness in its ability
to pay dividends under certain circumstances. As of December 31, 1998, up to
$13.4 million was available for the payment of dividends to EIC by the Insurance
Subsidiaries without the prior approval of the insurance regulatory authorities.
See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources" and Note 8 of Notes to
Consolidated Financial Statements.
Item 6. Selected Historical Consolidated Financial Information.
The following table presents selected historical consolidated financial
information derived from the historical consolidated financial statements of the
Company as of and for each of the years in the five-year period ended December
31, 1998. This information should be read in conjunction with the historical
consolidated financial statements of the Company and the related notes thereto
and Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations." All references to number of common shares and per-share
information reflect the two-for-one stock split which was effective on June 26,
1998.
Year Ended December 31,
------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in millions except per share amounts)
Statement of Income Data:
Gross premiums
written .................. $ 130.4 $ 108.2 $ 98.6 $ 87.2 $ 85.1
Net premiums written ..... 129.3 100.5 95.7 83.0 80.7
Premiums earned .......... 102.3 85.4 77.4 63.0 61.8
Assignment sales ......... 45.4 29.2 -- -- --
Net realized gains
(losses) on sale
of investments ........... 2.4 0.7 4.0 3.5 (5.8)
Net investment income (1) 53.4 50.6 47.5 44.2 38.2
Total revenues ........... 207.5 170.4 131.6 112.5 95.7
Income before income
taxes .................... 112.8 94.0 76.4 63.8 32.7
Net income ............... 82.5 68.8 55.7 47.3 26.6
Basic earnings per
share .................... 2.20 1.86 1.56 1.36 .75
Diluted earnings per
share .................... 2.10 1.78 1.52 1.36 .75
Selected Financial
Ratios(2)
Loss ratio ............... 10.1% 11.4% 11.9% 15.1% 37.0%
Insurance Expense
ratio .................... 48.6% 50.3% 49.2% 50.9% 55.5%
Combined ratio ........... 58.7% 61.7% 61.1% 66.0% 92.5%
Year Ended December 31,
---------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
(Dollars in millions except per share amounts)
Balance Sheet Data:
Investment portfolio(3) .... $ 948.3 $ 875.9 $ 797.1 $ 749.2 $ 639.9
Total assets ............... 1,336.4 1,147.5 983.4 886.0 749.4
Deferred premium revenue ... 308.2 281.3 266.2 248.1 227.9
Total liabilities .......... 673.8 566.1 495.1 462.0 389.1
Total shareholders'
equity ..................... 662.6 581.4 488.3 423.9 360.3
25
Book value per
share ...................... 17.50 15.55 13.52 12.30 10.23
Statutory Basis Reserves(4):
Contingency reserves ....... $ 207.9 $ 171.7 $ 149.8 $ 120.8 $ 98.6
Policyholders' surplus ..... 324.2 324.2 312.0 294.5 287.6
------- ------- ------- ------- -------
Qualified statutory
capital .................... 532.1 495.9 461.8 415.3 386.2
Unearned premiums .......... 381.6 345.7 323.2 298.2 269.8
Losses and LAE reserves .... 30.8 22.5 17.7 22.0 19.5
------- ------- ------- ------- -------
Total policyholders'
reserves ................... $ 944.5 $ 864.1 $ 802.7 $ 735.5 $ 675.5
======= ======= ======= ======= =======
Leverage ratio(5) .......... 142:1 130:1 122:1 128:1 124:1
(1) Excludes capital gains and losses.
(2) The loss ratio is the quotient derived by dividing losses and LAE
incurred by premiums earned. The expense ratio is the quotient derived by
dividing underwriting and insurance related operating expenses by premiums
earned. The combined ratio is the sum of the loss and expense ratios. Such
ratios have been calculated using amounts determined in accordance with GAAP.
(3) Excludes investments in affiliates. See Note 5 of Notes to
Consolidated Financial Statements for information concerning Enhance Financial's
investments in affiliates.
(4) Represents the combined financial position of the Insurance
Subsidiaries presented on a statutory basis.
(5) Represents the quotient derived by dividing net insurance in force by
qualified statutory capital.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
The Company divides its business operations into two reportable operating
segments: insurance businesses and asset-based businesses.
The insurance businesses, which are engaged through the Insurance
Subsidiaries, include principally the reinsurance of financial guaranties of
municipal and asset backed debt obligations issued by monoline financial
guaranty insurers. In addition, the Company is engaged in other insurance,
reinsurance and non-insurance businesses that utilize the Company's expertise in
performing sophisticated analyses of complex, credit-based risks. The Company's
other insurance businesses involve the issuance of direct financial guaranties
of smaller municipal debt obligations, trade credit reinsurance, financial
institutions, credit insurance and financial responsibility bonds. Some of these
other insurance businesses are conducted by Van-American Insurance Company
("Van-Am"), a Kentucky domiciled insurer which writes reclamation bonds for the
coal mining industry, and surety bonds covering the closure and post-closure
obligations of landfill operators. The Company also provides surety and other
credit-related insurance products through its 25% ownership of Seguradora
Brasileira de Fiancas S.A.
The Company operates its asset-based businesses primarily through its
consolidated subsidiary, Singer Asset Finance Company, L.L.C. ("Singer") and a
partially owned affiliate, Credit-Based Asset Servicing and Securitization
L.L.C. ("C-BASS"). The Company's asset-based businesses include the origination,
purchase, servicing and/or securitization of special assets, including lottery
awards, structured settlement payments and sub-performing/non-performing and
seller-financed residential mortgages, real estate and subordinated residential
mortgage-backed securities.
The Company's revenues consist primarily of (a) premiums earned on
insurance and reinsurance contracts, (b) investment income and (c) the sale of
securitized lottery prizes and structured settlement payment streams.
Year Ended December 31, 1998 versus Year Ended December 31, 1997
Gross premiums written in 1998 increased 20.5% to $130.4 million from
$108.2 million in 1997. Total premium writings in 1998 benefited from a 37.1%
increase in monoline reinsurance.
26
Net premiums written increased 28.7% to $129.3 million in 1998 from $100.5
million in 1997, as a result of the increase in gross premiums and a decrease in
ceded premiums written from $7.6 million in 1997 to $1.1 million in 1998. The
following table shows net premiums written by line of business for the periods
presented:
Net Premiums Written (in millions) 1998 1997
- ---------------------------------- ---- ----
Municipal Reinsurance .................. $ 56.2 $ 34.3
Non-Municipal Reinsurance .............. 24.4 22.2
Other Insurance Lines .................. 48.7 44.0
------ ------
$129.3 $100.5
====== ======
The Company's other insurance lines include direct municipal bond
insurance, trade credit reinsurance, surety, excess-SIPC/excess-ICS and other
surety lines. Net premiums written from these businesses have grown from $18.3
million (21.1%) in 1993 to $48.7 million (37.7%) in 1998. The Company expects
that these other insurance lines will continue to contribute a significant
component of its premium revenues. In connection with certain of its other
insurance lines, the Company underwrites with the anticipation of higher loss
levels than those associated with its core municipal and non-municipal
reinsurance business. The Company takes into account these higher loss levels in
determining appropriate premium rates.
Net premiums earned grew 19.6% to $102.3 million in 1998 from $85.5
million in 1997. This growth in premiums earned was in large part attributable
to increased earnings from monoline reinsurance. The following table shows net
premiums earned by line of business for the periods presented:
Net Premiums Earned (in millions) 1998 1997
- -------------------------------------------- ------- -------
Municipal Reinsurance ...................... $ 42.0 $ 37.4
Non-Municipal Reinsurance .................. 23.8 12.6
Other Insurance Lines ...................... 36.5 35.5
------- -------
$ 102.3 $ 85.5
======= =======
Monoline reinsurance earned premiums increased $16.1 million (32.3%) as a
result of refunded earned premiums more than doubling from $8.6 million to $17.9
million as well as a $7.6 million (9.9%) growth in earned premiums before the
effect of refundings. Refunding activities increased throughout the year due to
a favorable interest rate environment. A refunding eliminates the Company's
reinsurance exposure to the refunded obligation and, as a result, the Company
recognizes in current earnings the remaining related deferred premium revenue.
The growth in premiums earned also reflects the amortization of the deferred
premium revenue balance, net of prepaid insurance premiums, which has grown to
$308.2 million at year-end 1998 from $281.3 million at year-end 1997.
Net investment income increased 5.5% to $53.4 million in 1998 from $50.6
million for 1997 reflecting the growth in invested assets in the period offset,
in part, by a shift in the portfolio toward tax-exempt securities. After-tax
investment income increased 7.6% in 1998 over 1997. The average yields on the
Company's investment portfolio, after deducting associated costs, were 6.1% and
6.2% for the years ended December 31, 1998 and 1997, respectively. The average
yields on the Company's investment portfolio on an after-tax basis, net of
associated costs were 5.1% and 5.1% for the years ended December 31, 1998 and
1997, respectively. In addition, the Company realized $2.4 million and $0.7
million of net capital gains in 1998 and 1997, respectively. Net investment
income is presented after deduction of both external investment management fees
and internal costs associated with managing the investment portfolio.
Assignment sales for 1998 and 1997 were $45.4 million and $29.2 million,
respectively. This revenue results from Singer's operations being consolidated
with the Company's, commencing March 21, 1997.
27
Incurred losses and loss adjustment expenses ("LAE") were $10.3 million in
1998 compared with $9.8 million in 1997. Of these amounts, $6.5 million and $8.1
million were incurred in connection with the Company's credit and surety
businesses in 1998 and 1997, respectively. In addition, $10.6 million in
municipal reinsurance losses were recorded, largely attributable to a $10
million case reserve established for anticipated losses related to reinsurance
of Delaware Valley Obligated Group (DVOG) debt. The Company's non-specific
reserve was reduced by $10 million accordingly. DVOG is an entity comprising
five hospitals and a medical university in the Philadelphia area that is part of
Allegheny Health, Education and Research foundation, based in Pittsburgh. The
Company believes that the reserves for losses and LAE, including case and
non-specific reserves, are adequate to cover the ultimate net cost of claims.
However, the reserves are necessarily based on estimates, and there can be no
assurance that the ultimate liability will not exceed or be less than such
estimates.
The Company's insurance operating expense ratio for 1998 was 48.6%
compared to 50.3% in 1997. Policy acquisition costs, which vary with and are
directly related to the generation of new and renewal premiums, totaled $35.0
million and $30.0 million in 1998 and 1997, respectively, representing 34.2% and
35.1% of premiums earned in those respective periods. Other insurance operating
expenses increased to $13.7 million in 1998 from $12.2 million in 1997.
Non-insurance expenses increased from $25.1 million in 1997 to $39.9 million in
1998 reflecting the continued growth in its Singer operations as well the growth
in expenses associated with the Company's diversification activities.
The Company realized income of $14.1 million from its investments in
affiliates in 1998 compared to $8.8 million in 1997 due to continued growth in
the Company's asset-based businesses.
Interest expense of $8.5 million was incurred in 1998 compared to $7.3
million in 1997 reflecting an increase in the average borrowings outstanding
under the Company's line of credit under a bank credit agreement (as amended,
the "Credit Agreement") in 1998 compared to 1997.
The Company's effective tax rate was 26.9% for 1998 compared to 26.8% in
1997.
Net income for 1998 increased 19.8% to $82.5 million from $68.8 million in
1997. On a per share basis, basic earnings per share increased 18.3% to $2.20 in
1998 from $1.86 in 1997, while diluted earnings per share increased 18.0% to
$2.10 in 1998 from $1.78 in 1997. Basic operating earnings per share increased
19.2% to $2.20 in 1998, while diluted operating earnings per share increased
18.6% to $2.10 in 1998. The Company defines operating earnings as net income,
less the effect of net realized capital gains and losses, foreign exchange gains
and losses, and certain non-recurring items.
The weighted average shares outstanding for 1998 was 37.52 million
compared to 37.07 million for 1997. The diluted weighted average shares
outstanding for 1998 was 39.28 million compared to 38.63 million for 1997.
All references to number of common shares and per-share information
reflect the two-for-one stock split which was effective on June 26, 1998.
28
Year Ended December 31, 1997 versus Year Ended December 31, 1996
Gross premiums written in 1997 increased 9.7% to $108.2 million from $98.6
million in 1996. Total premium writings in 1997 benefited from a 25.2% increase
in gross premiums derived from the Company's other insurance lines.
Net premiums written increased 5.1% to $100.5 million in 1997 from $95.7
million in 1996, as a result of the increase in gross premiums partially offset
by an increase in ceded premiums written from $2.9 million in 1996 to $7.6
million in 1997. The following table shows net premiums written by line of
business for the periods presented:
Net Premiums Written (in millions) 1997 1996
- ---------------------------------------------- ------- -------
Municipal Reinsurance ........................ $ 34.3 $ 41.2
Non-Municipal Reinsurance .................... 22.2 17.4
Other Insurance Lines ........................ 44.0 37.1
------- -------
$ 100.5 $ 95.7
======= =======
The Company's other insurance lines include direct municipal bond
insurance, credit reinsurance, financial responsibility, excess-SIPC/excess-ICS
and other surety lines. Net premiums written from these businesses have grown
from $8.6 million (15.6%) in 1991 to $44.0 million (43.8%) in 1997. The Company
expects that these other insurance lines will continue to contribute a
significant component of its premium revenues. In connection with certain of its
other insurance lines, the Company underwrites with the anticipation of higher
loss levels than those associated with its core municipal and non-municipal
reinsurance business. The Company takes into account these higher loss levels in
determining appropriate premium rates.
Net premiums earned grew 10.4% to $85.5 million in 1997 from $77.4 million
in 1996. This growth in premiums earned was in large part attributable to
increased earnings from the Company's other insurance lines as discussed in the
preceding paragraph. The following table shows net premiums earned by line of
business for the periods presented:
Net Premiums Earned (in millions) 1997 1996
- -------------------------------------------- ------- -------
Municipal Reinsurance ...................... $ 37.4 $ 34.4
Non-Municipal Reinsurance .................. 12.6 13.0
Other Insurance Lines ...................... 35.5 30.0
------- -------
$ 85.5 $ 77.4
======= =======
Monoline reinsurance earned premiums increased 5.3% as a result of a $3.9
million (10.4%) growth in earned premiums before the effect of refundings. This
growth was partially offset by a decrease in refunded earned premiums from $9.9
million in 1996 to $8.6 million in 1997. The growth in premiums earned also
reflects the amortization of the deferred premium revenue balance, net of
prepaid insurance premiums, which grew to $281.3 million at year-end 1997 from
$266.2 million at year-end 1996.
Net investment income increased 6.6% to $50.6 million in 1997 from $47.5
million for 1996 reflecting the growth in invested assets in the period offset,
in part, by a shift in the portfolio towards tax-exempt securities. After-tax
investment income increased 9.4% in 1997 over 1996. The average yields on the
Company's investment portfolio, after deducting associated costs, were 6.2% and
6.4% for the years ended December 31, 1997 and 1996, respectively. The average
yields on the Company's investment portfolio on an after-tax basis, net of
associated
29
costs were 5.1% and 5.0% for the years ended December 31, 1997 and 1996,
respectively. In addition, the Company realized $0.7 million and $4.0 million of
net capital gains in 1997 and 1996, respectively. Net investment income is
presented after deduction of both external investment management fees and
internal costs associated with managing the investment portfolio.
Assignment sales for 1997 were $29.2 million. This revenue results from
Singer's operations being consolidated with the Company's, commencing March 21,
1997.
Incurred losses and LAE were $9.8 million in 1997 compared with $9.2
million in 1996. Of these amounts, $8.1 million and $7.3 million were incurred
in connection with the Company's credit and surety businesses in 1997 and 1996,
respectively.
The Company's insurance operating expense ratio for 1997 was 50.3%
compared to 49.2% in 1996. Policy acquisition costs totaled $30.0 million and
$26.7 million in 1997 and 1996, respectively, representing 35.1% and 34.5% of
premiums earned in those respective periods. Other operating expenses increased
to $12.2 million in 1997 from $10.5 million in 1996.
Interest expense of $7.3 million was incurred in 1997 compared to $5.5
million in 1996 reflecting an increase in the average borrowings outstanding
under the Company's line of credit under a bank credit agreement (as amended,
the "Credit Agreement") in 1997 compared to 1996.
The Company's effective tax rate was 26.8% for 1997 compared to 27.1% in
1996. The lower 1997 rate reflects the Company's strategy of migrating a greater
proportion of its investment portfolio to tax-exempt securities in 1997
partially offset by an increase in income taxed at the statutory rate.
Net income for 1997 increased 23.5% to $68.6 million from $55.7 million in
1996. On a per share basis, basic earnings per share increased 18.9% to $1.86 in
1997 from $1.56 in 1996, while diluted earnings per share increased 17.1% to
$1.78 in 1997 from $1.52 in 1996. Basic operating earnings per share increased
24.2% to $1.85 in 1997, while diluted operating earnings per share increased
22.1% to $1.77 in 1997.
The per-share increases were offset, in part, by the higher weighted
average outstanding shares in 1997 following the issuance of 1,006,228 shares by
Enhance Financial to acquire its partner's 50% interest in Singer and 598,992
shares in connection with the exercise of employee stock options, partially
offset by the repurchase of 355,850 shares.
The weighted average shares outstanding for 1997 was 37.07 million
compared to 35.75 million for 1996.
All references to number of common shares and per-share information
reflect the two-for-one stock split which was effective on June 26, 1998.
Liquidity and Capital Resources
As a holding company, Enhance Financial finances the payment of its
operating expenses, principal and interest on its debt obligations, dividends,
if any, to its shareholders and the repurchase of its common stock primarily
from dividends and other payments from the
30
Insurance Subsidiaries, manages cash flows associated with the Company's
diversification activities and draws on its line of credit provided under the
Credit Agreement.
Payment of dividends to Enhance Financial by the Insurance Subsidiaries
are subject to restrictions relating to statutory capital and surplus and net
investment income. Enhance Re and Asset Guaranty declared and paid a total of
$21.0 and $3.0 million, respectively, in dividends in 1998. As of December 31,
1998, under the Insurance Law, the Insurance Subsidiaries had an additional
$13.4 million available for dividends to Enhance Financial compared with $14.4
million available as of December 31, 1997. Payments of dividends by Enhance
Financial to its shareholders are further restricted by the terms of the Credit
Agreement. At December 31, 1998, the maximum amount of quarterly dividends which
may be paid by Enhance Financial to its shareholders in compliance with the
terms of such agreement was $10.1 million. Enhance Financial paid dividends of
$8.6 million to shareholders in 1998.
As of December 31, 1998, the statutory policyholders' surplus of Enhance
Re and Asset Guaranty were $225.7 million and $98.5 million, respectively,
compared to the minimum $68.4 million required by each under the Insurance Law
and compared to $228.3 million and $94.9 million at December 31, 1997.
The Company maintains a credit facility providing for borrowings to be
used for general corporate purposes. During the second quarter of 1998, the
Company entered into a new unsecured credit agreement with four major commercial
banks for up to $100 million of borrowings, an increase of $25 million over the
previous agreement (which was terminated). The total outstanding under the
Credit Agreement at year-end 1998 was $53.5 million.
The Company believes that the operating liquidity needs of the Insurance
Subsidiaries can be funded exclusively from their respective operating cash
flows. The Company's cash flow from operations consists principally of insurance
and reinsurance premiums collected, income earned on invested assets and sales
of assignments, which in turn is applied to the payment of claims, operating
expenses and income taxes. The Company's cash flow from operations was $95.7
million, $67.8 million and $42.2 million for the years 1998, 1997 and 1996,
respectively. The Company paid a total of $7.6 million, $5.0 million and $11.9
million in claims in 1998, 1997 and 1996, respectively. Of the claim payments
made in 1998, $7.2 million related to reserves established in prior years.
Liquidity is also provided by the Company's sales of securities in its
available-for-sale portfolio as well as payments of principal on investments
upon maturity.
In July 1996, the Company formed Credit-Based Asset Servicing and
Securitization LLC ("C-BASS"), a joint venture in which Enhance Financial and
MGIC each own 48% interests. The Company contributed $15.8 million in cash in
1996, $6.8 million in cash in 1997 and $32.9 million in cash (plus its 100%
interest in LLSI) in 1998. In addition, in January 1998 the Company guarantied
repayment of up to $25 million of the amount outstanding under a $50 million
LIBOR-based unsecured revolving credit facility that C-BASS obtained from a
major commercial bank. The full amount of $50 million was drawn down by C-BASS
during the year. The outstanding principal under the facility currently is due
not later than July 31, 1999.
In 1995, Enhance Financial acquired a 50% joint venture interest in
Singer. In 1997 Enhance Financial acquired the remaining 50% of Singer in a
series of all-stock transactions. Enhance Financial issued 1,006,228 shares of
its common stock in connection with the 1997
31
transactions.
Enhance Financial makes available to Singer a $27 million LIBOR-based
secured revolving credit facility and a LIBOR-based working capital credit line
for its use in originating assets for securitization. At December 31, 1998,
Singer had no outstanding liabilities under the combined credit facilities.
In December 1996, the board of directors terminated the then existing
stock repurchase program and authorized the repurchase of up to 1,500,000 shares
of Enhance Financial's common stock from that date. In 1998, Enhance Financial
purchased 666,394 shares of its common stock for an aggregate consideration of
$17.8 million.
Based on the historical cash flow of the Company, the Company's current
financial results and the Company's expectation as to the level of the Company's
net premiums written during 1999, the Company believes that cash flow provided
by operating activities of the Insurance Subsidiaries during 1999 will provide
sufficient liquidity for the operations of the Company, as well as funds to
Enhance Financial so that Enhance Financial will be able to meet its debt
service and other obligations. The ability of Enhance Financial to meet its debt
service and other obligations after 1999 will depend upon the cash flow
generated by its operating activities and the availability to Enhance Financial
of sufficient amounts of funds from those operating activities in the form of
dividends or other payments. The cash flow to Enhance Financial after 1999 may
be influenced by a variety of factors, including market changes, insurance
regulatory changes and changes in general economic conditions. Consequently,
although Enhance Financial currently anticipates that it will be able to meet
all debt service and other obligations over the long term, no assurance can be
given that the available net cash provided by the Company's operating activities
will provide sufficient liquidity for Enhance Financial to meet all its
long-term liquidity needs.
At December 31, 1998, 1997 and 1996, the carrying value of the Company's
investment portfolio (total investments less investment in affiliates) was $948
million, $876 million and $797 million, respectively, on which was earned $53.4
million, $50.6 million and $47.5 million in those years, respectively, excluding
$2.4 million, $.7 million and $4.0 million of net realized capital gains in
those years, respectively. The increase in investments resulted principally from
cash flows from operations generated during the period. As of December 31, 1998,
the Company held approximately $50.8 million and $5.5 million in short-term
investments and cash and cash equivalents, respectively, to meet liquidity
needs.
In 1998, the Company incurred annual debt service on its long- and
short-term borrowings of $8.5 million and is anticipated to incur similar debt
service expense in 1999.
The Company has no other material commitments for capital or other
expenditures during 1999 or thereafter.
Year 2000
As the Year 2000 approaches, management is assessing the Company's potential
exposure to the so called "millenium bug" and the effects the century date
change may have on its electronic systems and those of its significant business
partners. Since certain computer programs were written using two digits rather
than four to define the applicable year, computing devices and
32
systems may recognize a date using the two digits "00" as 1900 rather than the
year 2000. Those that do not recognize a date correctly could generate erroneous
data and/or cause systems to fail.
As part of its firm-wide Year 2000 Project, the Company has established a
Year 2000 Task Force consisting of senior management of the Company, led by the
Chief Information Officer and General Counsel of Enhance Financial. It has also
retained an independent information technology consulting firm and outside legal
counsel to provide assistance with Year 2000 compliance and has adequate staff
to administer the Project. The progress of the Company's Year 2000 Project is
being monitored by the Audit Committee of the board of directors.
The Year 2000 Project covers both computer systems and infrastructure ("IT
systems") as well as other systems and equipment which utilize embedded
microchips ("non-IT systems"). It also considers the readiness of significant
third parties on which the Company depends, such as clients, vendors and service
providers. The Year 2000 Project has six phases: Project Development and
Resource Mobilization, Assessment, Remediation, Testing, Contingency Planning
and Implementation. The status of each phase is as follows. Project Development
and Resource Mobilization is substantially complete. Assessment of internal IT
systems and non-IT systems has proceeded through inventory and analysis of all
systems deemed critical by management. Assessment of exposure to third party
risks, by means of evaluation of questionnaires mailed to significant third
parties is in progress. As part of its third-party due diligence, the Company is
assessing the Year 2000 compliance of all major products and services purchased
from vendors and service providers of IT and non-IT components and systems.
Remediation and Testing of IT systems and non-IT systems are in progress and a
separate IT test environment has been established for selected applications
deemed critical by management. Contingency Planning, including disaster recovery
planning is in progress and will continue throughout 1999. Implementation of
contingency plans will be made as and when needed. Based on the assessment of
its major IT systems and non-IT systems, the Company expects that all necessary
remediation and testing will be completed to insure that it is substantially
Year 2000 compliant in all material respects.
Since 1997, Enhance has invested in a major initiative to replace and
upgrade its technology. This ongoing project, addresses, among other matters,
many of the Year 2000 issues of the Company's internal IT systems. The Company
has expended approximately $2 million on this project, which, accordingly,
includes a portion of the cost of Year 2000 compliance. Additional expenditures
for Year 2000 compliance, which will be funded through operating cash flow, are
expected to total approximately $1.5 million. These cost estimates are based
upon currently available information and may change as the Year 2000 Project
proceeds. However, the cost of Year 2000 compliance is not expected to affect
materially the financial condition of the Company.
The failure of IT systems and non-IT systems associated with cash
management, servicing, communications and building facilities would in varying
degrees have a material adverse effect on the Company. Such failures could
disrupt the Company's ability to conduct normal business operations, including
financial transactions such as payment of claims or debts, collecting or funding
of receivables and selling of commercial paper. The consequences of such
failures could include business interruption, lost revenue and illiquidity. The
magnitude of the financial impact of such potential failures is not known at
this time. The Year 2000 Project includes a provision for contingency planning
for systems and facilities that will generally involve processing that does not
rely upon computer systems and will utilize additional staff as
33
needed.
The Company has communicated with third parties with which it has material
dealings to determine the status of their Year 2000 readiness and it is in the
process of assessing its exposure to potential third party Year 2000 failures.
Management has determined that the following consequences to the Company could
result from the failure of such third parties to successfully address their Year
2000 issues: Obligors of insured issues (see also next paragraph) - increased
credit risk, claims, loss of premiums and renewals; Primaries and Reinsurers -
increased credit risk, uncollected claims, premium loss, impaired liquidity;
Counterparties and Issuers of Obligations - investment portfolio downgrade, loss
of income and/or principal; Financial Institutions and Lenders - impaired
liquidity, loss of income and/or principal; Vendors and Service Providers
interrupted power, building access, telecommunications, flow of goods, security
and professional and technical services.
The insurance policies issued or reinsured by the insurers of the Company
do not contain specific exclusions for Year 2000-related defaults. Generally, a
default by an obligor insured or reinsured by the insurers would be covered in
such case. Although the insurers would expect to eventually recover the amounts
paid in claims for Year 2000-related defaults by obligors, the coincidence of
several such unanticipated claims could result in short-term liquidity risk for
the insurers. Failure of a trustee or paying agent for an obligor insured by the
insurers to make payment on an obligation as a result of a Year 2000-related
event (or otherwise) would generally not be covered by policies insured or
reinsured and no such claims are expected. Nevertheless, the Company is
investigating whether its insured obligors as well as their trustees, paying
agents and other related parties will be Year 2000 compliant, and it will
establish appropriate contingency plans based upon the results of this inquiry.
In addition to other risks in connection with the Year 2000, general
uncertainty among market participants could cause a decline in business activity
and revenue in 1999 and 2000, as companies address their Year 2000 issues. The
Company cannot predict the magnitude of this possible decline or the impact that
it may have on its financial results for those years. However, the Company has
undertaken a thorough review of third party risks inherent in Year 2000 issues,
and it is working with the industry group allied with its core business to
identify and address credit and other business issues related to Year 2000. The
Company is also assessing potential effects of unexpected failures in local,
national or international systems, including power, communication and
transportation systems, on which the normal conduct of business depends, and it
will establish contingency plans to deal with such failures, although there can
be no assurance that such plans can be effective in such circumstances,
especially in the case of widespread economic disruption.
The Company believes that it will be substantially Year 2000 compliant on
or before December 31, 1999. However, there can be no assurance, due to the
uncertain nature of potential Year 2000 problems and the Company's lack of
control over some of them, especially the readiness of third parties, that all
Year 2000 issues will be foreseen and corrected in a timely fashion. While
management does not believe that Year 2000 issues will have a material adverse
effect on the Company, the failure of the efforts of the Company or its
significant third parties to address material Year 2000 issues, could result in
the disruption of the Company's normal business activities and have such a
material adverse effect on the Company.
34
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Market Risk
At year-end 1998, the Company's investment portfolio holdings are
approximately 96% U.S. dollar-denominated fixed-income securities consisting of
municipal bonds, mortgage and asset-backed securities, corporate bonds, and U.S.
government bonds; the balance of the portfolio holdings are in non-U.S.
dollar-denominated bonds in a variety of currencies. Although the Company has
not invested more than 1% of its portfolio in bonds denominated in any one
foreign currency, the Company uses currency forward contracts to manage its
foreign exchange risk.
The market values of the Company's reported financial instruments change
as interest rates change. In general, rate decreases cause asset prices to rise,
while rate increases cause asset prices to fall. Interest rate sensitivity can
be modeled using the assets' effective duration and convexity to estimate price
change for a given rate change. To model such changes, both spreads and yield
curve slope are held constant while the portfolio is subjected to a hypothetical
instantaneous rate change. Embedded optionality is considered, and municipal
rates are assumed to change at a rate equal to the prevailing taxable/tax exempt
ratio times the assumed taxable rate change.
Based on market values and prevailing interest rates as of year-end 1998,
a hypothetical instantaneous increase in rates of 100 basis points would produce
an after-tax decrease in the Company's financial instruments' market value of
approximately $33.5 million, or 3.5% of the Company's investment portfolio. Of
this total, $28.4 million, or 3.8% of the portfolio, would be attributable to
assets held as Available for Sale under SFAS 115; the balance, $5.1 million
would be attributable to assets held as Hold to Maturity, which are carried at
book value. Since the Company is able to hold its securities to maturity, it
does not expect to suffer any material adverse effect to its results of
operations under such a scenario.
35
Item 8. Financial Statements and Supplementary Data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
Page
----
Independent Auditors' Report 37
Consolidated Balance Sheets as of December 31, 1998
and 1997 38
Consolidated Statements of Income for the Years Ended
December 31, 1998, 1997 and 1996 39
Consolidated Statements of Shareholders' Equity for
the Years Ended December 31, 1998, 1997 and 1996 40
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1998, 1997 and 1996 41
Notes to Consolidated Financial Statements 42
All schedules not included are omitted because they are either not
applicable or because the information required therein is included in Notes to
Consolidated Financial Statements.
36
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Enhance Financial Services Group Inc.
We have audited the accompanying consolidated balance sheets of Enhance
Financial Services Group Inc. and Subsidiaries as of December 31, 1998 and 1997
and the related consolidated statements of income, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Enhance Financial Services Group
Inc. and Subsidiaries as of December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
March 19, 1999
New York, New York
37
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share amounts)
December 31, December 31,
1998 1997
---- ----
Assets
Investments:
Fixed maturities, held to maturity, at amortized cost $ 196,768 $ 210,436
(market value $205,792 and $219,763)
Fixed maturities available for sale, at market 694,374 608,077
(amortized cost $657,644 and $577,388)
Common stock - at market (cost $498) 839 833
Short-term investments 50,794 50,827
----------- -----------
Total Investments 942,775 870,173
Investment in affiliates 96,867 38,862
Cash and cash equivalents 5,542 5,686
Federal income taxes recoverable 9,717 3,366
Premiums and other receivables 35,950 29,958
Accrued interest and dividends receivable 15,241 12,959
Deferred policy acquisition costs 103,794 95,645
Prepaid reinsurance premiums 7,000 6,281
Reinsurance recoverable on unpaid losses 2,500 2,688
Receivable from affiliates 16,710 10,640
Receivable for securities 9,590 702
Other assets 90,731 70,549
----------- -----------
Total Assets $ 1,336,417 $ 1,147,509
=========== ===========
Liabilities and Shareholders' Equity
Liabilities
Losses and loss adjustment expenses $ 36,239 $ 33,675
Reinsurance payable on paid losses and loss
adjustment expenses 5,994 3,479
Deferred premium revenue 315,215 287,535
Accrued profit commissions 2,511 3,768
Deferred income taxes 79,569 64,680
Long-term debt 75,000 75,000
Short-term debt 54,290 43,500
Payable for securities 11,557 5,318
Accrued expenses and other liabilities 49,843 41,144
Payable to affiliates 43,553 8,017
----------- -----------
Total Liabilities $ 673,771 $ 566,116
----------- -----------
Shareholders' Equity
Common stock - $.10 par value
Authorized - 100,000,000 shares
Issued - 39,812,937 and 38,671,870 shares $ 3,981 $ 3,867
Additional paid-in capital 249,851 228,507
Retained earnings 418,214 344,402
Accumulated other comprehensive income 23,186 19,396
Treasury stock (32,586) (14,779)
----------- -----------
Total Shareholders' Equity $ 662,646 $ 581,393
----------- -----------
Total Liabilities and Shareholders' Equity $ 1,336,417 $ 1,147,509
=========== ===========
See notes to consolidated financial statements.
38
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share amounts)
Years ended December 31,
--------------------------------------------
1998 1997 1996
---- ---- ----
Revenues
Net premiums written .......................... $ 129,299 $ 100,506 $ 95,662
Increase in deferred premium revenue .......... (26,962) (15,051) (18,229)
--------- --------- ---------
Premiums earned ............................. 102,337 85,455 77,433
Net investment income ......................... 53,423 50,618 47,462
Net realized gains on sale of investments ..... 2,434 657 4,008
Assignment sales .............................. 45,376 29,200 --
Other income .................................. 3,914 4,463 2,738
--------- --------- ---------
Total revenues .............................. 207,484 170,393 131,641
--------- --------- ---------
Expenses
Losses and loss adjustment expenses ........... 10,324 9,755 9,184
Policy acquisition costs ...................... 35,007 30,020 26,703
Profit commissions ............................ 1,073 719 850
Other operating expenses - insurance .......... 13,683 12,225 10,537
- non-insurance ...... 39,873 25,141 2,660
--------- --------- ---------
Total expenses .............................. 99,960 77,860 49,934
--------- --------- ---------
Income from operations ........................ 107,524 92,533 81,707
Equity in income of affiliates ................ 14,066 8,778 274
Foreign currency loss ......................... (283) (38) (69)
Interest expense .............................. (8,500) (7,317) (5,522)
--------- --------- ---------
Income before income taxes .................. 112,807 93,956 76,390
Income taxes .................................. 30,350 25,150 20,686
--------- --------- ---------
Net income .................................. $ 82,457 $ 68,806 $ 55,704
========= ========= =========
Earnings per share - Basic ...................... $ 2.20 $ 1.86 $ 1.56
--------- --------- ---------
- Diluted .................... $ 2.10 $ 1.78 $ 1.52
--------- --------- ---------
Weighted average shares outstanding - Basic ..... 37,520 37,069 35,750
--------- --------- ---------
- Diluted ... 39,275 38,627 36,706
--------- --------- ---------
See notes to consolidated financial statements.
39
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(in thousands except share amounts)
Common Stock Treasury Stock
----------------------- ------------------------
Additional
Paid-In
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------
Balance, December 31, 1995 36,604,100 $ 3,660 2,125,350 ($ 18,043) $ 191,035
Comprehensive income: --
Net income for the period -- -- -- -- --
Unearned compensation adjustment (net
of tax of $31) -- -- -- -- --
Unrealized losses during the period
(net of tax of $3,697) -- -- -- -- --
Reclassification adjustment for losses
included in net income (net of tax of $1,928) -- -- -- -- --
Total comprehensive income: -- -- -- -- --
Amortization of unearned compensation -- -- -- -- 282
Dividends paid ($0.20 per share) -- -- -- -- --
Exercise of stock options 462,550 46 -- -- 4,699
Registration costs of common stock -- -- -- -- (184)
Reissuance of treasury stock -- -- (1,200,000) 10,323 4,162
Purchase of treasury stock -- -- 3,200 (38) --
---------- ---------- --------- --------- ----------
Balance, December 31, 1996 37,066,650 3,706 928,550 (7,758) 199,994
---------- ---------- --------- --------- ----------
Comprehensive income:
Net income for the period -- -- -- -- --
Unearned compensation adjustment (net
of tax of $7) -- -- -- -- --
Unrealized gains during the period
(net of tax of $7,106) -- -- -- -- --
Reclassification adjustment for gains
included in net income (net of tax of $87) -- -- -- -- --
Total comprehensive income: -- -- -- -- --
Dividends paid ($0.22 per share) -- -- -- -- --
Exercise of stock options 598,992 60 -- -- 7,281
Issuance of common stock 1,006,228 101 -- -- 21,232
Purchase of treasury stock -- -- 355,850 (7,021) --
---------- ---------- --------- --------- ----------
Balance, December 31, 1997 38,671,870 3,867 1,284,400 (14,779) 228,507
---------- ---------- --------- --------- ----------
Comprehensive income:
Net income for the period -- -- -- -- --
Unearned compensation adjustment (net
of tax of $202) -- -- -- -- --
Unrealized foreign currency translation
adjustment (net of tax of $159) -- -- -- -- --
Unrealized gains during the period (net
of tax of $2,183) -- -- -- -- --
Reclassification adjustment for gains
included in net income (net of tax of $718) -- -- -- -- --
Total comprehensive income: -- -- -- -- --
Dividends paid ($0.23 per share) -- -- -- -- --
Exercise of stock options 665,674 66 -- -- 9,854
Issuance of common stock 475,393 48 -- -- 11,490
Purchase of treasury stock -- -- 666,394 (17,807) --
---------- ---------- --------- --------- ----------
Balance, December 31, 1998 39,812,937 $ 3,981 1,950,794 $ (32,586) $ 249,851
---------- ---------- --------- --------- ----------
Accumulated
Other Comprehensive Income
----------------------------------------
Foreign
Currency Unrealized
Unearned Translation Holding Gains Retained
Compensation Adjustment (Losses) Earnings Total
------------ ---------- -------- -------- -----
Balance, December 31, 1995 ($ 104) $ 0 $ 12,104 $ 235,285 $ 423,937
Comprehensive income:
Net income for the period -- -- -- 55,704 --
Unearned compensation adjustment (net
of tax of $31) 84 -- -- -- --
Unrealized losses during the period
(net of tax of $3,697) -- -- (7,247) -- --
Reclassification adjustment for losses
included in net income (net of tax of $1,928) -- -- 3,779 -- --
Total comprehensive income: -- -- -- -- 52,320
Amortization of unearned compensation -- -- -- -- 282
Dividends paid ($0.20 per share) -- -- -- (7,198) (7,198)
Exercise of stock options -- -- -- -- 4,745
Registration costs of common stock -- -- -- -- (184)
Reissuance of treasury stock -- -- -- -- 14,485
Purchase of treasury stock -- -- -- -- (38)
---------- ---------- ---------- ---------- ----------
Balance, December 31, 1996 (20) -- 8,636 283,791 488,349
---------- ---------- ---------- ---------- ----------
Comprehensive income:
Net income for the period -- -- -- 68,806 --
Unearned compensation adjustment (net
of tax of $7) 20 -- -- -- --
Unrealized gains during the period
(net of tax of $7,106) -- -- 10,894 -- --
Reclassification adjustment for gains
included in net income (net of tax of $87) -- -- (134) -- --
Total comprehensive income: -- -- -- -- 79,586
Dividends paid ($0.22 per share) -- -- -- (8,195) (8,195)
Exercise of stock options -- -- -- -- 7,341
Issuance of common stock -- -- -- -- 21,333
Purchase of treasury stock -- -- -- -- (7,021)
---------- ---------- ---------- ---------- ----------
Balance, December 31, 1997 -- -- 19,396 344,402 581,393
---------- ---------- ---------- ---------- ----------
Comprehensive income:
Net income for the period -- -- -- 82,457 --
Unearned compensation adjustment (net
of tax of $202) (493) -- -- -- --
Unrealized foreign currency translation
adjustment (net of tax of $159) -- 714 -- -- --
Unrealized gains during the period (net
of tax of $2,183) -- -- 5,318 -- --
Reclassification adjustment for gains
included in net income (net of tax of $718) -- -- (1,749) -- --
Total comprehensive income: -- -- -- -- 86,247
Dividends paid ($0.23 per share) -- -- -- (8,645) (8,645)
Exercise of stock options -- -- -- -- 9,920
Issuance of common stock -- -- -- -- 11,538
Purchase of treasury stock -- -- -- -- (17,807)
---------- ---------- ---------- ---------- ----------
Balance, December 31, 1998 $ (493) $ 714 $ 22,965 $ 418,214 $ 662,646
---------- ---------- ---------- ---------- ----------
See notes to consolidated financial statements
40
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years ended December 31,
------------------------------------
1998 1997 1996
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 82,457 $ 68,806 $ 55,704
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization, net (7,696) (8,869) (8,333)
Gain on sale of investments, net (2,434) (657) (4,008)
Equity in income of affiliates (14,066) (8,778) (274)
Compensation, restricted stock award program -- 20 84
Change in assets and liabilities, net of effects of
purchase of Singer:
Premiums receivable (5,992) (4,775) (1,255)
Accrued interest and dividends receivable (2,282) (1,525) (695)
Accrued expenses and other liabilities 8,699 12,072 2,812
Deferred policy acquisition costs (8,149) (8,320) (6,128)
Deferred premium revenue, net 26,961 15,050 18,153
Accrued profit commissions (1,257) 718 (669)
Losses and loss adjustment expenses,net 5,267 5,745 (2,870)
Payable to (receivable from) affiliate 29,466 (5,671) --
Payable (receivable) for securities (2,649) 4,903 (17,611)
Other assets (18,932) (15,700) (2,741)
Income taxes, net 6,281 14,789 9,999
--------- --------- ---------
Net cash provided by operating activities 95,674 67,808 42,168
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,616) (2,027) (599)
Proceeds from sales and maturities of investments 309,582 412,892 663,573
Purchase of investments (364,674) (444,793) (717,735)
Sales(purchases) of short-term investments, net 33 (16,211) 10,856
Investment in affiliates (32,401) (10,640) (16,667)
Cash of previously unconsolidated subsidiary -- 147 --
--------- --------- ---------
Net cash used in investing activities (90,076) (60,632) (60,572)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Receivable from affiliates -- -- (21,260)
Capital stock 9,920 7,341 4,843
Short-term debt 10,790 1,000 27,575
Dividends paid (8,645) (8,195) (7,198)
Principal payment long-term debt -- -- (3,400)
Reissuance of treasury stock -- -- 14,485
Purchase of treasury stock (17,807) (7,021) (38)
--------- --------- ---------
Net cash provided by (used in) financing activities (5,742) (6,875) 15,007
--------- --------- ---------
Net change in cash and cash equivalents (144) 301 (3,397)
Cash and cash equivalents, beginning of year 5,686 5,385 8,782
--------- --------- ---------
Cash and cash equivalents, end of year $ 5,542 $ 5,686 $ 5,385
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the year for income taxes $ 3,000 $ 10,678 $ 4,608
========= ========= =========
Cash paid during the year for interest $ 8,591 $ 8,136 $ 6,326
========= ========= =========
See notes to consolidated financial statements.
41
ENHANCE FINANCIAL SERVICES GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1998, 1997 and 1996
Note 1 - Organization
Enhance Financial Services Group Inc. ("Enhance Financial", and together with
its consolidated subsidiaries, the "Company") is a holding company which was
incorporated in the State of New York in December 1985 and commenced operations
in November 1986. The Company principally engages, through its indirect
wholly-owned, New York-domiciled insurance subsidiaries Enhance Reinsurance
Company ("Enhance Re") and Asset Guaranty Insurance Company ("Asset Guaranty")
(together, the "Insurance Subsidiaries"), which are owned by a wholly-owned
subsidiary of Enhance Financial, Enhance Investment Corporation ("EIC"), in the
reinsurance of financial guaranties of municipal and asset backed debt
obligations issued by monoline financial guaranty insurers. In addition, the
Company is engaged in other insurance, reinsurance and non-insurance businesses
that utilize the Company's expertise in performing sophisticated analyses of
complex, credit-based risks.
The Company's other insurance businesses involve the issuance of direct
financial guaranties of smaller municipal debt obligations, trade credit
reinsurance, financial responsibility bonds and excess-SIPC/excess-ICS and
related type bonds. These other insurance businesses are conducted by the
Company's Insurance Subsidiaries, Van-American Companies, Inc. and subsidiaries
("Van-Am", see Note 5), and Enhance Reinsurance (Bermuda) Limited ("EnRe
Bermuda"), a Bermuda domiciled insurer.
The Company, through a consolidated subsidiary, Singer Asset Finance Company,
LLC ("Singer", see Note 5) and partially-owned affiliates, Credit-Based Asset
Servicing and Securitization LLC ("C-BASS", see Note 5) and Sherman Financial
Group LLC ("Sherman" see Note 5 ), is also engaged in the origination, purchase,
servicing and/or securitization of special assets, including lottery awards,
structured settlement payments, sub-performing/non-performing residential
mortgages and unsecured delinquent consumer assets including credit cards
receivables.
Note 2 - Significant Accounting Policies
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles ("GAAP"), which, for
the Insurance Subsidiaries, differ in certain material respects from the
accounting practices prescribed or permitted by regulatory authorities (see Note
3). The preparation of the financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those
estimates. The significant accounting policies of Enhance Financial and its
subsidiaries are as follows:
Consolidation
The accompanying financial statements include the accounts of Enhance Financial,
EIC, the Insurance Subsidiaries, Singer, Van-Am and EnRe Bermuda (collectively
the "Company"). All
42
significant intercompany accounts and transactions, and intercompany profits and
losses, have been eliminated. Investments in immaterial wholly-owned
subsidiaries and in investments in which the Company owns from 20% to 50% of
those companies are accounted for in accordance with the equity method of
accounting (see Note 5).
Investments
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115
"Accounting for Certain Investments in Debt and Equity Securities," management
classifies all securities at the time of purchase as "held to maturity" or
"available for sale." Fixed maturity securities held to maturity are those
securities which the Company intends and has the ability to hold until maturity
and are carried at amortized cost. There were no sales or transfers of
securities classified as held-to-maturity for the years ended December 31, 1998,
1997 and 1996. All other fixed maturity securities are classified as available
for sale and carried at fair value. Unrealized gains and losses, net of taxes,
on the available for sale portfolio are charged or credited to accumulated other
comprehensive income.
Common stocks are carried at fair value. Short-term investments are carried at
cost, which approximates market. Unrealized gains and losses, net of taxes, on
common stocks are reflected in accumulated other comprehensive income. Realized
gains or losses on sales of investments are determined on the basis of specific
identification.
Derivatives
The Company uses forward currency contracts to hedge foreign currency exchange
risk associated with fixed maturity investments denominated in foreign
currencies. Gains and losses on open forward currency exchange contracts, which
qualify as accounting hedges are deferred and recognized as an adjustment of the
carrying amount of the hedged assets. Gains and losses on expired contracts are
recognized currently.
The Company uses forward treasury lock agreements to hedge interest rate risk
associated with unsecuritized assets held and anticipated acquisitions of assets
by Singer. Gains and losses on such instruments that qualify as accounting
hedges are deferred until the underlying hedged asset is sold, at which time the
gain or loss on the related hedge is recognized in income.
The counterparties to the Company's foreign currency contracts and forward
treasury lock agreements are substantial and creditworthy multinational
commercial banks or other financial institutions which are recognized market
makers.
Premium Revenue Recognition
Premiums are earned in proportion to the level amortization of insured principal
over the contract period. Deferred premium revenue represents that portion of
premiums which will be earned over the remainder of the contract period. When
insured issues are refunded or called, the remaining deferred premium revenue is
generally earned at that time, since the risk to the Company is considered to
have been eliminated.
43
Reinsurance
In the normal course of business, the Insurance Subsidiaries reinsure portions
of their direct and assumed exposures with other insurance companies through
contracts designed to limit losses from certain risks and to protect capital and
surplus.
The following summarizes the effect of reinsurance on premiums written and
earned:
In thousands Years Ended December 31,
1998 1997 1996
---- ---- ----
Written Earned Written Earned Written Earned
Direct $ 30,484 $ 19,704 $ 25,477 $ 13,950 $ 16,946 $ 9,676
Assumed 99,922 84,248 82,675 75,665 81,642 70,145
Ceded (1,107) (1,615) (7,646) (4,160) (2,926) (2,388)
--------- --------- --------- -------- -------- --------
Net premiums $ 129,299 $ 102,337 $ 100,506 $ 85,455 $ 95,662 $ 77,433
========= ========= ========= ======== ======== ========
The effect of reinsurance on losses and loss adjustments expenses for the years
ended December 31, 1998, 1997 and 1996 was a decrease of $1,230,000, $335,000
and $678,000, respectively.
In the event that any or all of the reinsurers were unable to meet their
obligations, the Insurance Subsidiaries would be liable for such defaulted
amounts.
The percentage of assumed premiums written as a part of net premiums written for
the years ended December 31, 1998, 1997 and 1996 was 77.3%, 82.3% and 85.3%,
respectively.
Assignment Sales
The Company acquires financial assets from individuals, including the rights to
receive lottery awards and structured settlement payments, and securitizes these
payment streams. The Company recognizes revenue from assignment sales in
accordance with the requirements of SFAS 125.
Through the securitization process, the Company transfers control over such
financial assets and recognizes income to the extent that net sale proceeds upon
such transfer of control exceeds amounts paid to individuals, after deducting
commissions and other fees paid to third parties.
Deferred Policy Acquisition Costs
Deferred policy acquisition costs comprise those expenses that vary with and are
primarily related to the production of insurance premiums, including:
commissions paid on reinsurance assumed, salaries and related costs of
underwriting and marketing personnel, rating agency fees, premium taxes and
certain other underwriting expenses, offset by ceding commission income on
premiums ceded to reinsurers. Acquisition costs are deferred and amortized over
the period in which the related premiums are earned. Deferred policy acquisition
costs are reviewed periodically to determine that they do not exceed or be less
than recoverable amounts, after considering investment income.
Losses and Loss Adjustment Expenses ("LAE")
Reserves for losses and LAE in the financial guaranty business are established
based on the Company's best estimate of specific and non-specific losses,
including expenses associated with settlement of such losses, on its
44
insured and reinsured obligations. The Company's estimation of total reserves
considers known defaults, reports and individual loss estimates reported by
primary insurers and annual increases in the total net par amount outstanding of
the Company's insured obligations ($75.7 billion, as of December 31, 1998). The
Company records a specific provision for losses and related LAE when reported by
primary insurers or when, in the Company's opinion, an insured risk is in
default or a default is probable and the amount of the loss is reasonably
estimable. In the case of obligations with fixed periodic payments, the
provision for losses and LAE represents the present value of the Company's
ultimate expected losses, adjusted for estimated recoveries under salvage or
subrogation rights. The non-specific reserves represent the Company's best
estimate of total reserves, less provisions for specific reserves. Generally,
when a case basis reserve is established or adjusted, a corresponding adjustment
is made to the non-specific reserve. The Company discounts certain financial
guaranty liabilities at annual rates ranging from 5.14% to 6.36%. These
discounted liabilities at December 31,1998 and 1997 were $17.5 million and $19.0
million, respectively, net of discounts of $11.0 million and $2.5 million,
respectively.
Reserves for losses and LAE for the Company's other lines of business, primarily
trade credit reinsurance, are based on reports and individual loss estimates
received from ceding companies, net of anticipated estimated recoveries under
salvage and subrogation rights. In addition, a liability is included for losses
and LAE incurred but not reported.
The Company periodically evaluates its estimates for losses and LAE and may
adjust such reserves based on the Company's actual loss experience, mix of
business and economic conditions. Changes in total estimates for losses and LAE
are reflected in current earnings. The Company believes that its total reserves
for losses and LAE are adequate to cover the ultimate cost of all claims net of
reinsurance recoveries. However, the reserves are based on estimates of losses
and LAE, and there can be no assurance that the ultimate liability of the
Company will not exceed such estimates.
Federal Income Taxes
In accordance with SFAS No. 109, "Accounting for Income Taxes," deferred federal
income taxes are provided for temporary differences between the tax and
financial reporting basis of assets and liabilities that will result in
deductible or taxable amounts in future years when the reported amount of the
asset or liability is recovered or settled. In the case of the Company, such
temporary differences relate principally to premium revenue recognition and
deferred acquisition costs.
The Internal Revenue Code permits municipal bond insurance companies to deduct
from taxable income, subject to certain limitations, the amounts added to the
statutory mandatory contingency reserve during the year. The deduction taken is
allowed only to the extent that U.S. Treasury non-interest-bearing tax and loss
bonds are purchased at their par value prior to the original due date of the
Company's consolidated federal tax return and held in an amount equal to the tax
benefit attributable to such deductions. The amounts deducted must be included
in taxable income when the contingency reserve is released, at which time the
Company may redeem the tax and loss bonds to satisfy the additional tax
liability. The purchases of tax and loss bonds are recorded as payments of
federal income taxes and are not reflected in the Company's current tax
provision.
Post-Retirement And Post-Employment Benefits
The Company provides various post-retirement and post-employment benefits,
including pension, health and life insurance benefits covering substantially all
employees who meet certain age and service criteria. The Company accounts for
these benefits under the accrual method of accounting. Amounts related to
anticipated obligations under the defined benefit pension plan and
post-retirement benefits are recorded based on actuarial determinations.
Stock Compensation Plans
The Company has in effect a stock option program for key employees and a
directors' stock option program for the benefit of directors who are not
employees of the Company. In March 1998, the board of directors adopted the
Director Stock Ownership Plan. Under these programs, awards are granted to
eligible employees and directors of the Company in the form of Incentive Stock
Options, where they qualify under the Internal Revenue Code, or Non-Qualified
Stock
45
Options. The Company follows the intrinsic value based method of
accounting for stock based compensation as prescribed by APB Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"). In accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation", the Company has provided pro
forma disclosures of net income and earnings per share as if the fair value
based method of accounting had been applied (see Note 12).
Earnings Per Share
In accordance with SFAS No. 128, "Earnings per Share," the Company reports
"basic" and "diluted" earnings per share ("EPS"). Basic EPS is determined by
dividing net income by the weighted average number of common shares outstanding
for the period. Diluted EPS reflects the potential dilution that would occur if
securities such as employee stock options were exercised. Diluted EPS is
computed using the treasury stock method to determine the weighted average
number of common stock equivalents outstanding during each year. For all periods
presented common stock equivalents are comprised of outstanding options pursuant
to the Company's stock option programs.
Following is a reconciliation of weighted average common shares outstanding to
weighted average common and common equivalent shares outstanding for the years
ended December 31, 1998, 1997 and 1996.
In thousands
1998 1997 1996
------ ------ ------
Weighted average common shares
outstanding 37,520 37,069 35,750
Dilutive effect of common stock options 1,755 1,558 956
------ ------ ------
Weighted average common and common
equivalent shares outstanding 39,275 38,627 36,706
====== ====== ======
New Accounting Pronouncements
During 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
Enterprise and Related Information". This pronouncement requires a company to
present disaggregated information based on the internal segments used in
managing its business. The adoption of this statement did not impact the
Company's financial position or results of operations, but it did affect the
presentation of the Company's segment disclosures (see Note 17).
Effective in 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income." This pronouncement established new rules for the reporting and display
of comprehensive income and its components in a full set of general purpose
financial statements. The adoption of this statement had no impact on the
Company's financial position or results of operations. SFAS No. 130 requires the
Company's unrealized gains and losses and changes in foreign currency
translation adjustment to be included in other comprehensive income. Prior years
financial statements have been reclassified to conform to these requirements.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivatives Instruments and Hedging Activities," which
becomes effective for the Company January 1, 2000. This pronouncement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. The Company will be required to recognize all derivatives
46
as either assets or liabilities in the statement of financial position and
measure those instruments at fair value. The accounting for a change in fair
value of a derivative in earnings or other comprehensive income will depend on
the intended use of the derivative and the resulting designation. Derivatives
can be designated as (a) a hedge of the exposure to changes in the fair value of
a recognized asset or liability or a firm commitment, (b) a hedge of the
exposure to variable cash flows of a forecast transaction. or (c) a hedge of
foreign currency exposure of a net investment in foreign operations, an
unrecognized firm commitment, an available-for-sale security, or a foreign
currency denominated forecasted transaction. The Company is currently reviewing
the impact of the implementation of SFAS No. 133 on its financial statements.
In March 1998, the National Association of Insurance Commissioners adopted the
Codification of Statutory Accounting Principles (the "Codification"). The
Codification is intended to standardize regulatory accounting and reporting for
the insurance industry and is proposed to be effective January 1, 2001. However,
statutory accounting principles will continue to be established by individual
state laws and permitted practices, and it is uncertain when or if, the State of
New York will require adoption of the Codification for the preparation of
statutory financial statements. The Company has not finalized the quantification
of the effects of Codification on its statutory financial statements
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly
liquid short-term investments with an original maturity of three months or less
to be cash equivalents.
Stock Split
All references to number of common shares and per-share information reflect the
two-for-one stock split which was effective on June 26, 1998.
Reclassifications
Certain of the prior years' amounts have been reclassified to conform to the
current year presentation.
Note 3 -Insurance Regulatory Matters
The consolidated financial statements are prepared on the basis of GAAP which,
for the Insurance Subsidiaries, differ in certain material respects from
accounting practices prescribed or permitted by insurance regulatory
authorities. The significant differences result from statutory accounting
practices which treat premiums earned, policy acquisition costs, deferred income
taxes, investments in fixed maturities and loss reserves differently.
At December 31, 1998, the statutory basis policyholders' surplus of Enhance Re
and Asset Guaranty, as reported to insurance regulatory authorities, was $225.7
million and $98.5 million, respectively. Statutory net income of Enhance Re and
Asset Guaranty was $51.7 million and $11.0 million, respectively, for the year
ended December 31, 1998. At December 31, 1997, the statutory basis
policyholders' surplus of Enhance Re and Asset Guaranty, as reported to
insurance regulatory authorities, was $228.3 million and $94.9 million,
respectively. Statutory net income
47
of Enhance Re and Asset Guaranty was $40.7 million and $11.7 million,
respectively, for the year ended December 31, 1997. Statutory net income of
Enhance Re and Asset Guaranty was $46.5 million and $8.8 million, respectively,
for the year ended December 31, 1996.
The New York Insurance Law requires financial guaranty insurers to maintain a
minimum policyholders' surplus of $65 million. When added to the minimum
policyholders' surplus of $3.4 million separately required for the other lines
of insurance which it is licensed to write, each of the Insurance Subsidiaries
is required to have an aggregate minimum policyholders' surplus of $68.4
million.
Under the New York Insurance Law, the Insurance Subsidiaries may declare or
distribute dividends only out of earned surplus. The maximum amount of dividends
which may be paid by the Insurance Subsidiaries to Enhance Financial without
prior approval of the Superintendent of Insurance is subject to restrictions
relating to statutory surplus and net investment income as defined by statute.
Enhance Re declared a dividend of $22 million and paid $21 million, and Asset
Guaranty declared and paid a dividend of $3 million to Enhance Financial for the
year ended December 31, 1998. At December 31, 1998, the Insurance Subsidiaries
had an additional $13.4 million available for dividend distribution.
The New York Insurance Law establishes single-risk limits applicable to all
obligations issued by a single entity and backed by a single revenue source.
Under the limit applicable to municipal bonds, the insured average annual debt
service for a single risk, net of reinsurance and collateral, may not exceed 10%
of the sum of the insurer's policyholders' surplus and contingency reserves. In
addition, insured principal of municipal bonds attributable to any single risk,
net of reinsurance and collateral, is limited to 75% of the insurer's
policyholders' surplus and contingency reserves. Additional single risk limits,
which generally are more restrictive than the municipal bond single risk limit,
are also specified for several other categories of insured obligations.
Note 4 - Investments
The following is a summary of the Company's investments in fixed maturities at
December 31, 1998 and 1997:
Gross Gross
In thousands Amortized Unrealized Unrealized
1998 Cost Gains Losses Fair Value
---- ----- ------ ---------
HELD TO MATURITY
Private placements $ 96,289 $ -- $ -- $ 96,289
Municipal obligations 93,290 8,401 -- 101,691
Corporate securities 4,695 394 -- 5,089
U.S. Government obligations 2,494 229 -- 2,723
-------- ------- ------ --------
Total held to maturity $196,768 $ 9,024 $ -- $205,792
======== ======= ====== ========
AVAILABLE FOR SALE
Municipal obligations $489,477 $31,233 $ 35 $520,675
Mortgage-backed securities 95,956 2,644 3,640 94,960
Corporate securities 46,732 2,349 605 48,476
48
Foreign securities 22,203 4,497 3 26,697
U.S. Government obligations 3,276 290 -- 3,566
-------- ------- ------ --------
Total available for sale $657,644 $41,013 $4,283 $694,374
======== ======= ====== ========
Gross Gross
In thousands Amortized Unrealized Unrealized
1997 Cost Gains Losses Fair Value
---- ----- ------ ---------
HELD TO MATURITY
Private placements $105,125 $ -- $ -- $105,125
Municipal obligations 96,959 8,877 -- 105,836
Corporate securities 5,832 324 -- 6,156
U.S. Government obligations 2,520 126 -- 2,646
-------- ------- ---- --------
Total held to maturity $210,436 $ 9,327 $ -- $219,763
======== ======= ==== ========
AVAILABLE FOR SALE
Municipal obligations $415,131 $23,917 $ 6 $439,042
Mortgage-backed securities 71,361 2,375 -- 73,736
Corporate securities 44,836 2,077 2 46,911
Foreign securities 33,282 2,663 516 35,429
U.S. Government
obligations 12,778 183 2 12,959
-------- ------- ---- --------
Total available for sale $577,388 $31,215 $526 $608,077
======== ======= ==== ========
The amortized cost and estimated fair value of fixed maturities at December 31,
1998 by contractual maturity are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
In thousands
Amortized Cost Fair Value
-------------- ----------
Fixed maturities, held to maturity
Due in one year or less $ 16,926 $ 16,963
Due after one year through five years 95,837 99,167
Due after five years through ten years 51,825 54,669
Due after ten years 32,180 34,993
-------- --------
$196,768 $205,792
======== ========
Fixed maturities, available for sale
Due in one year or less $ 2,550 $ 2,581
Due after one year through five years 31,742 33,473
Due after five years through ten years 144,473 152,887
Due after ten years 478,879 505,433
-------- --------
$657,644 $694,374
======== ========
49
Proceeds from sales of available for sale investments in fixed maturities during
1998, 1997 and 1996 were approximately $301 million, $407 million and $640
million, respectively. Gross gains of $5.0 million and gross losses of $2.6
million were realized on those sales in 1998. Gross gains of $4.8 million and
gross losses of $4.2 million were realized on those sales in 1997. Gross gains
of $7.7 million and gross losses of $3.7 million were realized on those sales in
1996.
Sources of the Company's consolidated net investment income are as follows:
In thousands Years Ended December 31,
1998 1997 1996
------- ------- -------
Fixed maturities $53,312 $50,258 $46,102
Short-term investments and cash
equivalents 2,148 1,872 3,184
Other 416 572 188
------- ------- -------
Total investment income 55,876 52,702 49,474
Less investment expenses 2,453 2,084 2,012
------- ------- -------
Net investment income $53,423 $50,618 $47,462
======= ======= =======
The net unrealized appreciation of investments included as a component of other
comprehensive income at December 31, 1998 and 1997 is as follows (in thousands):
1998 1997
---- ----
Difference between market value and amortized
cost of available for sale portfolio
Fixed maturities $ 36,730 $ 30,689
Equity securities 341 335
-------- --------
37,071 31,024
Deferred tax expense (14,106) (11,628)
-------- --------
Net unrealized appreciation of investments $ 22,965 $ 19,396
======== ========
Unrealized appreciation of investments in equity securities at December 31, 1998
and 1997 includes gross unrealized gains of $341,000 and $335,000, respectively.
Under agreements with its primaries and in accordance with statutory
requirements, the Insurance Subsidiaries maintain funds (fixed maturities and
cash equivalents) in trust accounts principally for the benefit of reinsured
companies and for the protection of policyholders in states in which the
Insurance Subsidiaries are not licensed. The Company maintains full control over
the management of assets held in trust accounts. The carrying amount of such
restricted balances amounted to approximately $312 million and $286 million at
December 31, 1998 and December 31, 1997, respectively.
Note 5 - Investment in Affiliates
The Company owns 360,000 shares of EIC Corporation Ltd. ("EIC"), an insurance
holding company which, through its wholly-owned insurance subsidiary licensed in
Bermuda, insures foreign trade receivables. The Company's investment represented
an equity interest of approximately 41% at the date of acquisition and
approximately 36.5% at December 31, 1998. The Company accounts for its
investment in EIC in accordance with the equity method of accounting, as the
control of EIC does not rest with the Company.
In 1997, as part of the recapitalization of Van-Am, the Company contributed $2.0
million to Van-Am. The Company owns a controlling equity interest in the
outstanding stock of Van-Am and accounts for its investment on a consolidated
basis. Due to intense pricing competition in Van-Am's core business and a poor
strategic fit with the Company's other operations, the Company has decided to
exit the surety line of business and sell its interest in Van Am, if possible.
If the Company is unable to sell its interest in Van Am, the Company plans to
run-off its insurance liabilities, which may take ten or more years. An
estimated $2.3 million of expenses associated with this action have been
recognized in the 1998 fourth quarter.
In 1995, the Company acquired all of the outstanding shares of Litton Loan
Servicing, Inc. ("LLSI"), a Houston-based loss mitigation residential mortgage
servicer. The purchase price approximated the fair market value of the acquired
assets and liabilities at the date of acquisition.
50
In 1996, the Company and MGIC Investment Corporation formed C-BASS, with members
of management thereof. C-BASS evaluates, purchases, services and securitizes
sub-performing , non-performing, and seller financed residential mortgages and
real estate and subordinated residential mortgage-backed securities. The Company
owns approximately a 48% interest in C-BASS, which is being accounted for on the
equity basis of accounting. In 1998, the Company contributed its interest in
LLSI to C-BASS as part of its initial capital commitment. Due to the nature of
servicing sub-performing mortgages, LLSI is an integral part of the operational
activities of C-BASS. At December 31, 1998, the Company had contributed $55.5
million of capital to C-BASS. The following table sets forth combined C-BASS
financial data for the three preceding years (In millions):
1998 1997 1996
------ ------ ------
Mortgage-related
assets $550.1 $189.6 $ 83.2
Other assets 73.4 40.0 20.0
------ ------ ------
Total assets 623.5 229.6 103.2
====== ====== ======
Funding arrangements 360.8 121.9 53.7
Other liabilities 107.6 45.0 15.2
------ ------ ------
Total liabilities 468.4 166.9 68.9
====== ====== ======
Total revenues 69.7 36.2 6.7
Total expenses 43.7 21.0 6.5
------ ------ ------
Net income $ 26.0 $ 15.2 $ 0.2
====== ====== ======
In January 1998, C-BASS entered into a revolving credit facility agreement with
a major commercial bank. At March 19, 1999, Enhance Financial had guaranteed $25
million under this facility.
In 1995, the Company acquired, for cash, a 50% joint venture interest in Singer,
which originates, securitizes and sells various types of special assets such as
lottery awards, structured settlement payments and similar obligations. In 1997,
the Company acquired the remaining 50% of Singer in a series of all-stock
transactions for an aggregate purchase price valued at $21.3 million. The excess
(approximately $20.4 million) of the Company's aggregate cost over the fair
value of the net assets of Singer represents goodwill and is being amortized on
a straight line basis over 20 years.
In 1997, the Company purchased at book value a 25% interest in Seguradores
Brasilieras de Fiancas S.A. ("SBF"), a Brazilian-based surety insurance company.
SBF is a joint venture among the Company, Swiss Re and Banco Pactual S.A.
through which the Company anticipates developing and marketing innovative
credit-based insurance products throughout Latin America. The Company's
investment in SBF at December 31, 1998 was approximately $4.5 million.
In July 1998, the Company formed AGS Financial LLC ("AGS"), a New York-based
venture with the management thereof. AGS provides structured finance, asset
servicing and specialized investment-banking services in Latin American markets.
At December 31, 1998, the Company had contributed of $300,000 of its required
initial capital contribution commitment of $3.1 million.
51
In November 1998, the Company acquired through merger all of the outstanding
shares of Alegis Group, Inc. ("Alegis"), the parent holding company of a
Houston-based servicer and collector of delinquent consumer assets for an
aggregate purchase price of approximately $11.7 million which approximated the
fair market value of Alegis (see Note 8).
In December 1998, the Company and MGIC formed a joint venture, Sherman Financial
Group LLC ("Sherman") with members of management thereof, to provide analytic
and due diligence services to purchasers of unsecured delinquent consumer assets
and purchases, services and securitizes unsecured delinquent consumer assets.
The Company owns a 45.5% interest in Sherman, which is being accounted for on
the equity basis of accounting. As part of its commitment to capitalize Sherman,
the Company will contribute its entire interest in Alegis to Sherman.
Total assets of the Company's unconsolidated subsidiaries and affiliates
accounted for by the equity method of accounting at December 31, 1998 and 1997
were $707.2 million and $293.4 million respectively. Total liabilities at
December 31, 1998 and 1997 were $507.3 million and $194.7 million, respectively.
Total net income for the years' ended December 31, 1998 and 1997 was $30.5
million, and $17.1 million, respectively.
Note 6 - Income Taxes
The Company files a consolidated federal income tax return with its includable
subsidiaries. Subject to the provisions of a tax sharing agreement, income tax
allocation is based upon separate return calculations.
The components of the Company's consolidated provision for income taxes are as
follows:
In thousands Years Ended December 31,
1998 1997 1996
---- ---- ----
Current income taxes $10,815 $10,311 $ 9,992
Deferred income taxes 19,535 14,839 10,694
------- ------- -------
Tax provision $30,350 $25,150 $20,686
======= ======= =======
A reconciliation from the tax provision calculated at the federal statutory rate
of 35% to the actual tax is as follows:
In thousands Years Ended December 31,
1998 1997 1996
---- ---- ----
Tax provision at statutory rate $ 39,482 $ 32,884 $ 26,736
Tax exempt interest and dividends (9,796) (7,878) (6,492)
Other, net 664 144 442
-------- -------- --------
Actual tax provision $ 30,350 $ 25,150 $ 20,686
======== ======== ========
52
The components of the net deferred income tax liability as of December 31, 1998
and 1997 are as follows:
In thousands December 31, 1998 December 31, 1997
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Contingency reserves $ 49,129 $ 43,027
Deferred policy acquisition costs 36,327 33,547
Deferred premium revenue 10,060 10,446
Unrealized capital gains 14,106 11,628
Capitalized expenditures $ 990 $ 1,183
Assignment sales income 16,689 8,438
Tax and loss bonds 29,267 24,797
Alternative minimum tax
credit carryforward 8,545 6,334
Losses and LAE reserves 4,241 5,509
Deferred income 1,455 1,883
Other 3,900 1,656 5,816 3,116
-------- -------- --------- ---------
$ 48,398 $127,967 $ 45,522 $ 110,202
======== ======== ========= =========
Note 7 - Long-Term Debt And Credit Facility
The carrying value of the Company's indebtedness is as follows:
In thousands December 31,
1998 1997
-------- --------
Debentures, due 2003 $ 75,000 $ 75,000
Short term debt 54,290 43,500
-------- --------
Total $129,290 $118,500
======== ========
The debentures were issued at par and bear interest at 6.75% payable in March
and September each year. The debentures are non-callable obligations of Enhance
Financial.
Enhance Financial maintains an unsecured credit facility through a credit
agreement (the "Credit Agreement") with major commercial banks providing for
borrowing by Enhance Financial of up to $100 million to be used for general
corporate purposes. Advances under the Credit Agreement bear interest at
variable LIBOR-based rates. The average interest rate paid on such advances in
1998 was 6.09%. The Credit Agreement prohibits the Company from incurring
additional indebtedness to the extent the resulting total would exceed 25% of
the Company's total capitalization as defined and includes certain convenants,
none of which significantly restricts the Company's operating activities or
dividend-paying ability. The total outstanding under the Credit Agreement at
December 31, 1998 was $53.5 million.
In 1995, the Company entered into a reverse interest-rate swap transaction based
on a notional amount of $50 million over the term equal to the remaining term of
Enhance Financial's 6.75% Debentures. On June 1, 1995, the Company terminated
the swap and realized a gain on termination in the amount of $4.6 million. The
gain has been deferred and is being amortized over the original term of the
swap.
53
Note 8 - Shareholders' Equity And Dividends
In December 1996, the board of directors terminated the then existing repurchase
program and authorized the repurchase of up to 1,500,000 shares of its common
stock from that date. Enhance Financial purchased 666,394, 355,850 and 3,200
shares of its common stock at an average price of $26.72, $19.73 and $11.91 per
share in 1998, 1997, and 1996 respectively.
In connection with its repurchase program, Enhance Financial entered into a
forward purchase agreement during 1997 regarding 256,394 shares of its common
stock at a forward purchase price of $21.25 per share. The agreement settles
quarterly on a net basis in shares of Enhance Financial stock or in cash at
Enhance Financials' election. To the extent that the market price of Enhance
Financial common stock on a settlement date was higher (lower) than the forward
purchase price, the net differential was received (paid) by Enhance Financial.
During 1998, settlements resulted in Enhance Financial receiving 106,394 shares,
which were recorded as treasury shares. The agreement terminated in June 1998
after Enhance Financial repurchased the full amount under the program.
During 1998, Enhance Financial issued 454,473 shares of common stock in
connection with its acquisition of Alegis Group Inc. (see Note 5).
During 1997, Enhance Financial issued 1,006,228 shares of common stock in
connection with its acquisition of the remaining 50% ownership interest in
Singer (see Note 5).
In 1996, Swiss Reinsurance Company ("Swiss Re") acquired from Enhance Financial
and one of its shareholders, respectively 1,200,000 and 800,000 shares of
Enhance Financial common stock at a purchase price of $12.24 per share. In 1997,
Swiss Re acquired an additional 1,400,000 shares of Enhance Financial common
stock in the open market.
Under the terms of the Credit Agreement, the maximum amount of dividends which
may be paid by Enhance Financial as of December 31, 1998 was $10.1 million. In
connection with the Company's two-for-one stock split in June 1998, an
additional 40,000,000 shares of common stock were authorized.
Note 9 - Fair Values Of Financial Instruments
The following estimated fair value amounts have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessarily required to interpret market data
to develop the estimates of fair value. Accordingly, the estimates presented
herein are not necessarily indicative of the amount the Company could realize in
a current market exchange. The use of different market assumptions and/or
estimation methodologies may have a material effect on the estimated fair value
amounts.
Fixed Maturity Securities - The fair values of fixed maturity securities are
based on quoted market prices or dealer quotes. For private placements, fair
value approximates amortized cost.
Short-Term Investments - Fair values of short-term investments are assumed to
equal cost.
Deferred Premium Revenue - The fair value of the Company's deferred premium
revenue, net of prepaid reinsurance premium, is based on the estimated cost of
entering into a cession of the
54
entire portfolio with third-party reinsurers under market conditions. This
figure was determined by using the statutory basis unearned premiums adjusted
for ceding commission based on current market rates.
Loss And Loss Adjustment Reserves - The carrying amount, net of reinsurance
recoverable on unpaid losses, is composed of the present value of the expected
cash flows for specifically identified claims combined with a general estimate
for non-specific reserves. Therefore, the carrying amount is a reasonable
estimate of the fair value of the reserve.
Long-Term Debt - The fair value is estimated based on the quoted market prices
for the same or similar issue or on the current rates offered to the Company for
debt of the same remaining maturities.
Short-Term Debt -The fair value of short-term debt, which bears interest at
variable rates, is assumed to equal the carrying value of the debt.
Derivative Instruments - The fair values of foreign currency contracts are based
on the estimated termination values as of the balance sheet date. The fair
values of forward treasury lock agreements (notional amount of $40 million at
December 31,1998) are determined by the Company using relevant market
information and appropriate valuation methodologies.
The carrying amounts and estimated fair values of these financial instruments
are as follows:
In thousands December 31, 1998 December 31, 1997
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
ASSETS:
Fixed maturity securities $891,142 $ 900,166 $818,513 $827,840
Common stock 839 839 833 833
Short-term investments 50,794 50,794 50,827 50,827
LIABILITIES:
Deferred premium revenue . 308,215 267,574 281,254 242,708
Loss and loss adjustment
Expense reserve 33,739 33,739 30,987 30,987
Long-term debt 75,000 78,083 75,000 75,458
Short-term debt 54,290 54,290 43,500 43,500
DERIVATIVE INSTRUMENTS:
Foreign currency contracts 256 256 -- --
Forward treasury lock
agreements (664) (664) -- --
Note 10 - Insurance In Force
The Company principally insures and reinsures financial guaranties issued to
support public and private borrowing arrangements, including commercial paper,
bond financings, and similar transactions. Financial guaranties are conditional
commitments which guaranty the performance of a customer to a third party.
The Company's potential liability in the event of nonperformance by the issuer
of the insured obligation is represented by its proportionate share of the
aggregate outstanding principal and
55
interest payable ("insurance in force") on such insured obligation. At December
31, 1998, the Company's aggregate insurance in force was $75.7 billion. The
Company's insured portfolio as of December 31, 1998 was broadly diversified by
geographic and bond market sector with no single credit representing more than
0.9% of the Company's net insurance in force.
The composition of the Company's insurance in force by type of issue and by
state of issue was as follows:
Type of Issue
In billions December 31,
1998 1997
------- -------
General obligation and other
tax backed $ 21.0 $ 18.8
Non-municipal 15.3 13.5
Utilities 11.2 10.3
Health care 7.1 6.8
Airport/Transportation 7.7 6.8
Housing 1.5 1.5
Other municipal 5.1 2.4
Other insurance businesses 6.8 4.3
------- -------
Total $ 75.7 $ 64.4
======= =======
State of Issue
In billions December 31,
1998 1997
------- -------
California $ 8.9 $ 7.7
New York 8.1 6.2
Florida 4.7 4.1
Texas 4.3 3.7
Pennsylvania 3.7 2.9
Illinois 3.3 2.5
Other (each less than 3.3% for
1998 and 2.5% for 1997) 42.7 37.3
------- -------
Total $ 75.7 $ 64.4
======= =======
The Company manages its exposure to credit risk through a structured
underwriting process which includes detailed credit analysis, review of
primaries' underwriting guidelines, surveillance policies and procedures, and
the use of reinsurance.
Note 11 - Employee Benefits
The Company maintains a non-contributory defined benefit pension plan for the
benefit of all eligible employees. Employer contributions are based upon a fixed
percentage of employee salaries determined at the discretion of the Company.
Plan assets consist of domestic equity and high quality fixed income securities.
The actuarially computed net pension cost for 1998, 1997 and 1996, using the
projected unit credit actuarial method of attribution includes the following
components:
56
In thousands Years Ended December 31,
1998 1997 1996
---- ---- ----
Service Cost $ 1,022 $ 900 $ 1,298
Interest Cost 485 494 485
Expected return on plan assets (415) (377) (322)
Amortization of transition obligation 2 2 2
Amortization of prior service cost 53 53 53
Recognized net actuarial gain (129) (101) (107)
------- ----- -------
Net periodic benefits cost $ 1,018 $ 971 $ 1,409
======= ===== =======
The following table sets forth the funding status of the plan and the accrued
pension cost recognized in the Company's consolidated balance sheets at December
31, 1998 and 1997:
In thousands December 31,
1998 1997
Change in benefit obligation
Benefit obligation at beginning of year $ 8,131 $ 6,475
Service cost 1,022 900
Interest cost 485 494
Actuarial (gain) losses (1,092) 931
Benefits paid (1,463) (669)
------- -------
Benefit obligation at year end 7,083 8,131
------- -------
Change in plan assets
Fair value of plan assets at beginning of year 4,726 4,437
Actual return on plan assets 810 958
Employer contribution 565 --
Benefits paid (1,463) (669)
------- -------
Fair value of plan assets at end of year 4,638 4,726
------- -------
Funded Status (2,445) (3,405)
Unrecognized transition obligation 13 14
Unrecognized prior service cost 907 961
Unrecognized net actuarial gain (3,624) (2,266)
------- -------
Accrued benefit cost $(5,149) $(4,696)
======= =======
Actuarial assumptions utilized to determine the projected benefit obligation and
estimated unrecognized net actuarial gain were as follows:
Years ended December 31,
1998 1997 1996
------ ------ ------
Discount rate 7.0% 7.0% 7.5%
Expected return on plan assets 8.5% 8.5% 8.5%
Rate of compensation increase 6.0% 6.0% 6.0%
57
In addition to pension benefits, the Company provides certain health care
benefits for retired employees. Substantially all employees of Enhance Financial
and the Insurance Subsidiaries may become eligible for these benefits if they
reach retirement age while working for the Company.
The net post-retirement benefit cost for 1998, 1997, and 1996 was $140,000,
$127,000 and $118,000, respectively, and includes service cost, interest cost
and amortization of the transition obligation and prior service cost.
At December 31, 1998 and 1997 the accumulated post-retirement benefit obligation
was $715,000 and $592,000, respectively, and was not funded. The discount rate
used in determining the accumulated post-retirement benefit obligation was 7%
and the health care cost trend rate was 12%, graded to 6% over 7 years. A
one-percentage point change in assumed healthcare cost trend rates would have
the following effects (In thousands):
1-Percentage 1-Percentage
Point Increase Point Decrease
Effect on total of service and interest
cost components $29 ($22)
Effect on post-retirement benefit
obligation $144 ($113)
In January 1996, the Company implemented a 401(k) retirement savings plan
covering substantially all employees of the Company. Under this plan, the
Company provides a matching contribution of 50% on contributions up to 6% of
base salary made to the plan by eligible employees. The Company's matching
contributions were $120,000, $106,000 and 98,000 in 1998, 1997 and 1996,
respectively.
Note 12 - Stock Option Programs
The Company maintains a stock option program for its key employees.
Substantially all options issued under the program vest in four equal annual
installments commencing one year after the date of grant. The Company also
maintains a directors' option program pursuant to which directors of Enhance
Financial and the Insurance Subsidiaries who are not employees of the Company
are granted non-qualified stock options. Options under this program vest in two
equal annual installments commencing on December 31 next following the date of
grant.
In March 1998, the board of directors adopted the Director Stock Ownership Plan,
which as amended, allows each outside director to elect to receive up to 100% of
his or her director fees in the form of shares of common stock valued at the
closing price of the common stock on the New York Stock Exchange on that date.
Each eligible director is entitled to make a new election annually for that
coming year's fee.
All options are exercisable at the option price, being the fair value of the
stock at the date of grant. The board of directors has authorized a maximum of
9,900,000 shares of common stock to be awarded as options, of which 6,055,604
options for shares (net of expirations and cancellations) had been awarded as of
December 31, 1998. Information regarding activity in the option programs
follows:
58
Weighted
Option Price Per Average Exercise
1998 Options Number of Shares Share Price
------------ ---------------- ----- -----
Outstanding at beginning of year 5,635,108 $ 7.25 - $29.062 $14.81
Granted - Employees 1,168,980 $24.937 - $34.281 25.49
- Directors 91,000 $30.00 30.00
Exercised (666,374) $ 7.25 - $20.75 9.89
Expired or canceled (173,110) $ 8.00 - $28.813 24.07
---------
Outstanding at year-end 6,055,604 $ 7.25 - $34.281 17.38
---------
Exercisable at year-end - Employees 3,234,202 $ 7.25 - $28.844 12.21
- Directors 306,166 $ 8.563 - $29.75 14.46
Weighted
Option Price Per Average Exercise
1997 Options Number of Shares Share Price
------------ ---------------- ----- -----
Outstanding at beginning of year 5,106,220 $ 7.25 - $18.25 $10.91
Granted - Employees 1,220,374 $19.44 - $28.844 27.21
- Directors 91,000 $29.75 29.75
Exercised (598,792) $ 7.25 - $17.00 9.47
Expired or canceled (183,694) $ 8.00 - $19.44 13.36
---------
Outstanding at year-end 5,635,108 $ 7.25 - $29.75 14.81
---------
Exercisable at year-end - Employees 3,117,688 $ 7.25 - $19.44 10.27
- Directors 256,666 $ 8.56 - $18.25 11.07
Weighted
Option Price Per Average Exercise
1996 Options Number of Shares Share Price
------------ ---------------- ----- -----
Outstanding at beginning of year 4,831,442 $ 7.25 - $13.31 $ 9.61
Granted - Employees 800,220 $13.44 - $17.00 16.54
- Directors 52,000 $18.25 18.25
Exercised (462,550) $ 7.25 - $10.13 8.18
Expired or canceled (114,892) $ 8.00 - $11.94 10.55
--------
Outstanding at year-end 5,106,220 $ 7.25 - $18.25 10.91
--------
Exercisable at year-end - Employees 2,642,914 $ 7.25 - $11.94 9.61
- Directors 286,666 $ 8.26 - $13.31 9.96
Options Outstanding Options Exercisable
------------------- -------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Range of at December Contract Exercise at December Exercise
Exercise Prices 31, 1998 Life Price 31, 1998 Price
- --------------- -------- ---- ----- -------- -----
$ 7.00 - $10.50 2,161,125 4.6 $ 9.05 2,161,125 $ 9.05
$11.00 - $19.50 1,497,380 7.5 14.48 1,029,165 14.16
$20.00 - $34.25 2,397,099 9.5 26.69 350,078 27.94
--------- ---------
6,055,604 3,540,368
========= =========
The Company applies the provisions of APB Opinion No. 25 "Accounting for Stock
Issued to Employees" in accounting for its stock option program. Accordingly, no
compensation expense has been recognized for options granted under its stock
option program, and the Company has adopted the disclosure-only provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation." Had compensation cost
for the Company's current and past stock option programs been determined based
upon the fair value at the grant date for awards under these plans consistent
with the methodology prescribed under SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
1998 1997 1996
---- ---- -----
Net income - as reported $82,457 $68,806 $55,704
- pro forma $80,906 $67,475 $55,046
Basic earnings per share - as reported $2.20 $1.86 $1.56
- pro forma $2.16 $1.82 $1.54
59
Diluted earnings per share - as reported $2.10 $1.78 $1.52
- pro forma $2.06 $1.75 $1.50
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model. The weighted average grant date fair value
of option grants were $16.62, $12.01, and $5.44 in 1998, 1997 and 1996,
respectively. The following assumptions were used for option grants awarded in
1998, 1997 and 1996:
Options Granted
1998 1997 1996
---- ---- ----
Dividend yield 0.6% to 1.0% 0.8% to 1.1% 1.1% to 1.5%
Volatility 24.1% to 75.1% 18.7% to 30.3% 20.5% to 30.3%
Risk-free interest rate 4.3% to 5.8% 5.8% to 6.7% 6.2% to 6.8%
Assumed annual forfeiture rate 3.0% 3.0% 3.0%
Expected life 10 years 10 years 10 years
Note 13 - Lease Commitments
The Company has committed to lease office space under non-cancelable leases
which expire in August 1999, November 1999, April 2000, August 2000, June 2001,
August 2001, July 2003 and June 2005. The leases provided for escalations
resulting from increased assessments for taxes, utilities and maintenance.
Future minimum rental payments on all leases, before any deductions for
estimated sublease income, are as follows:
In thousands
Years Ended December 31, Operating Leases
----------------
1999 $ 2,825
2000 1,337
2001 449
2002 492
2003 572
Thereafter 936
-----
$ 6,611
Rent expense, net of sublease income, was $1,528,000, $1,699,000, and $1,139,000
for the years ended December 31, 1998, 1997 and 1996, respectively.
60
Note 14 - Parent Company Financial Information
The following are the condensed balance sheets of Enhance Financial as of
December 31, 1998 and 1997 and its condensed statements of income and cash flows
for the years ended December 31, 1998, 1997 and 1996.
Condensed Balance Sheets
In thousands December 31,
1998 1997
---- ----
ASSETS
Cash $ 2,715 $ --
Investments 7,095 12,706
Investment in affiliated companies 784,235 658,609
Other assets 4,865 46,161
-------- --------
$798,910 $717,476
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY:
Long-term debt $ 75,000 $ 75,000
Other liabilities 61,264 61,083
Shareholders' equity 662,646 581,393
-------- --------
$798,910 $717,476
-------- --------
Condensed Statements Of Income
In thousands Years Ended December 31,
1998 1997 1996
---- ---- ----
Total revenues $ 812 $ 510 $ 1,312
Total expenses 17,514 14,652 12,343
--------- -------- --------
(16,702) (14,142) (11,031)
Equity in income of affiliates 102,459 77,500 61,727
--------- -------- --------
Income before income taxes 85,757 63,358 50,696
Income tax (expense) benefit (3,300) 5,448 5,008
--------- -------- --------
Net income $ 82,457 $ 68,806 $ 55,704
========= ======== ========
61
Condensed Statements Of Cash Flows
In thousands Years Ended December 31,
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net income $ 82,457 $ 68,806 $55,704
Adjustments to reconcile net
income to net cash from operating
activities
Equity in income of affiliates (102,459) (77,500) (61,727)
Other 55,239 29,799 (22,188)
--------- -------- --------
Net cash provided by (used) in
operating activities 35,237 21,105 (28,211)
--------- -------- --------
Cash flows from investing activities:
Investment in affiliates net of
dividends received (32,401) (7,186) (3,423)
Sale of investments 741 (2,396) 750
Sales of short-term investments,
net 4,880 (4,648) (5,529)
--------- -------- --------
Net cash used in
investing activities (26,780) (14,230) (8,202)
--------- -------- --------
Cash flows from financing activities:
Capital stock 9,920 7,341 4,843
Short-term debt 10,790 1,000 27,500
Dividends paid (8,645) (8,195) (7,198)
Principal payment - senior notes -- -- (3,400)
Reissuance of treasury stock -- -- 14,485
Purchase of treasury stock (17,807) (7,021) (38)
------- ------ ---
Net cash provided by (used in)
financing activities (5,742) (6,875) 36,192
--------- -------- --------
Net increase (decrease) in cash 2,715 -- (221)
Cash, beginning of year -- -- 221
--------- -------- --------
Cash, end of year $ 2,715 $ -- $ --
========= ======== ========
Note 15 - Major Customers
The Company derives a substantial portion of its premium writings from a small
number of primary insurers. The following table states the percentage of gross
premiums written for the years ended December 31, 1998, 1997 and 1996 for the
Company's four most significant primary insurers:
For year ended
December 31, Insurer #1 Insurer# 2 Insurer# 3 Insurer# 4
------------ ---------- ---------- ---------- ----------
1998 19% 19% 19% 5%
1997 25% 16% 9% 4%
1996 24% 14% 12% 7%
This customer concentration results from the small number of primary insurance
companies which are licensed to write financial guaranty insurance. Prior years'
data has been restated to give retroactive effect to mergers between our primary
insurers.
62
Note 16- Losses and Loss Adjustment Expenses
Activity in the liability for losses and loss adjustment expenses ("LAE") is
summarized as follows:
In thousands Years Ended December 31,
1998 1997 1996
---- ---- ----
Balance at January 1, $33,675 $28,081 $30,799
Less reinsurance
recoverables 2,688 1,823 1,853
------- ------- -------
Net balance at January 1, 30,987 26,258 28,946
------- ------- -------
Net incurred related to:
Current year 6,000 6,002 6,087
Prior years 4,324 3,753 3,097
------- ------- -------
Net incurred 10,324 9,755 9,184
------- ------- -------
Net paid related to:
Current year 352 720 587
Prior years 7,220 4,306 11,285
------- ------- -------
Net paid 7,572 5,026 11,872
------- ------- -------
Net balance at December 31, 33,739 30,987 26,258
Plus reinsurance recoverables 2,500 2,688 1,823
------- ------- -------
Balance at December 31, $36,239 $33,675 $28,081
======= ======= =======
The incurred loss and paid loss information presented above is classified as
"current year" and "prior year" based upon the year in which the related
reinsurance contract or insurance policy was underwritten. Therefore, amounts
presented as "net incurred related to prior years" are not indicative of
redundancies or deficiencies in total reserves held as of prior year ends.
During the years ended December 31, 1998, 1997 and 1996, the actual
adverse(redundant) development of reserves held as of prior year ends was $(0.2)
million, $1.5 million and $0.5 million, respectively.
63
Note 17 - Segment Reporting
The Company has two reportable segments: insurance and asset-based businesses.
The insurance segment provides credit-related insurance coverage to meet the
needs of customers in a wide variety of domestic and international markets. The
Company's largest insurance business is the provision of reinsurance to the
monoline primary financial guaranty insurers for both municipal bonds and
non-municipal obligations. The Company also provides trade credit reinsurance,
financial responsibility bonds, excess-SIPC insurance and direct financial
guaranty insurance. The asset-based businesses segment deals primarily with
credit-based servicing and securitization of assets in underserved markets, in
particular, the origination, purchase, servicing and securitization of special
assets, including lottery awards, structured settlement payments,
sub-performing/non-performing and seller-financed residential mortgages and
delinquent consumer assets. The Company's reportable segments are strategic
business units which are managed separately as each business requires different
marketing and sales expertise.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on profit or loss from operating earnings, which it defines as net income
excluding the impact of capital and foreign exchange gains and losses, and
certain non-recurring items, net of taxes. Summarized financial information
concerning the Company's operating segments is presented in the following
tables:
1998
----
In thousands
Insurance Asset-Based Totals
--------- ----------- ------
Revenues from external customers $ 104,820 $ 46,807 $ 151,627
Interest revenue 53,423 0 53,423
Interest expense 7,223 1,277 8,500
Equity in income of affiliates 1,623 12,443 14,066
Income tax expense 23,558 6,792 30,350
Operating earnings 66,500 16,021 82,521
Investments in affiliates 96,867 0 96,867
Deferred policy acquisition cost 103,794 0 103,794
Identifiable assets 1,242,758 93,659 1,336,417
1997
----
In thousands
Insurance Asset-Based Totals
--------- ----------- ------
Revenues from external customer $ 88,966 $30,152 $ 119,118
Interest revenue 50,618 0 50,618
Interest expense 5,881 1,436 7,317
Equity in income of affiliates 733 8,045 8,778
Income tax expense 19,486 5,664 25,150
Operating earnings 60,029 8,374 68,403
Investments in affiliates 38,862 0 38,862
Deferred policy acquisition cost 95,645 0 95,645
Identifiable assets 1,049,596 97,913 1,147,509
64
1996
----
In thousands
Insurance Asset-Based Totals
--------- ----------- ------
Revenues from external customers 80,171 0 80,171
Interest revenue 47,462 0 47,462
Interest expense 5,522 0 5,522
Equity in income of affiliates 274 0 274
Income tax expense 20,686 0 20,686
Operating earnings 53,144 0 53,144
Investments in affiliates 24,181 0 24,181
Deferred policy acquisition cost 87,325 0 87,325
Identifiable assets 983,443 0 983,443
The following are reconciliations of reportable segment revenues and profit to
Enhance Financial's consolidated totals:
In thousands
1998 1997 1996
--------- -------- --------
Revenues
Total revenues from external
customers for reportable segments $ 151,627 $119,118 $ 80,171
Total interest revenue for
reportable segments 53,423 50,618 47,462
Realized gains 2,434 657 4,008
--------- -------- --------
Total consolidated revenues $ 207,484 $170,393 $131,641
========= ======== ========
Net income
Operating earnings for reportable
segments $ 82,521 $ 68,403 $ 53,144
Capital and foreign exchange gains
net of tax 1,398 403 2,560
Non-recurring Van-Am expense, net
of tax (1,462) -- --
--------- -------- --------
Net income $ 82,457 $ 68,806 $ 55,704
========= ======== ========
The Company's revenues from external customers, by product line, are as follows:
In thousands
1998 1997 1996
--------- -------- --------
Insurance:
Financial guaranty reinsurance $ 66,264 $ 49,913 $ 47,408
Financial guaranty direct 10,246 6,319 3,526
Trade credit reinsurance 15,973 19,165 16,581
Other 12,337 13,569 12,656
Asset-Based 46,807 30,152 --
--------- -------- --------
Total Revenues from External Customers $151,627 $119,118 $ 80,171
======== ======== ========
65
Note 18- Quarterly Financial Information (Unaudited)
In millions except per share amounts
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Year
-------- -------- -------- -------- ----
1998
Net premiums written $ 33.7 $ 27.3 $ 27.6 $ 40.7 $ 129.3
Premiums earned 23.7 24.4 29.0 25.2 102.3
Investment and other income 14.2 15.0 17.4 13.2 59.8
Assignment sales 10.4 12.1 12.7 10.2 45.4
Losses and loss adjustment
expenses 2.3 1.6 4.6 1.8 10.3
Equity in income of affiliates 2.6 3.8 3.2 4.5 14.1
Income before income taxes 27.1 28.2 30.8 26.7 112.8
Net income 19.2 20.5 22.7 20.1 82.5
Earnings per share - Basic $ 0.51 $ 0.55 $ 0.61 $ 0.53 $ 2.20
------- ------- ------- ------- -------
- Diluted $ 0.49 $ 0.52 $ 0.58 $ 0.51 $ 2.10
------- ------- ------- ------- -------
1997
Net premiums written $ 21.6 $ 25.7 $ 25.5 $ 27.7 $ 100.5
Premiums earned 19.5 21.3 21.3 23.4 85.5
Investment and other income 10.5 13.9 13.2 18.1 55.7
Assignment sales 2.5 9.9 7.6 9.2 29.2
Losses and loss adjustment
expenses 2.0 2.2 2.7 2.9 9.8
Equity in income of affiliates 0.1 0.2 3.8 4.7 8.8
Income before income taxes 18.4 23.4 23.6 28.6 94.0
Net income 13.9 17.0 17.5 20.4 68.8
Earnings per share - Basic $ 0.38 $ 0.46 $ 0.47 $ 0.55 $ 1.86
------- ------- ------- ------- -------
- Diluted $ 0.37 $ 0.44 $ 0.45 $ 0.52 $ 1.78
------- ------- ------- ------- -------
Item 9. - Changes in and Disagreements with Accountants on Accounting and
Disclosure
Not applicable.
66
PART III
Item 10. Directors and Executive Officers of the Registrant.
Set forth below is certain information concerning directors and executive
officers of Enhance Financial. Each director holds office (subject to Enhance
Financial's by-laws) until the next annual meeting of shareholders and until his
or her successor has been elected and qualified. The information concerning the
directors has been furnished by them to Enhance Financial.
Position with Enhance
Name Age(1) Financial
- ------- -------- ---------------------------
Allan R. Tessler 62 Chairman of the Board
Wallace O. Sellers 69 Vice Chairman of the Board
Daniel Gross 56 President, Chief Executive
Officer and Director
Samuel Bergman 51 Executive Vice President and
Secretary
Ronald M. Davidow 48 Executive Vice President and
Chief Financial Officer
Arthur Dubroff 48 Executive Vice President
Elaine J. Eisenman 50 President, Credit-Based
Businesses, Alliances and
Ventures
Tony M. Ettinger 42 Executive Vice President
Brian Kleinberg (2) 41 Executive Vice President
Paul C. Kwiatkoski 43 Executive Vice President
Stephen Steinberg 54 Executive Vice President
Brenton W. Harries 71 Director
David R. Markin 68 Director
Robert P. Saltzman 56 Director
Richard J. Shima 59 Director
Spencer R. Stuart 76 Director
Adrian U. Sulzer 52 Director
Frieda K. Wallison 56 Director
Jerry Wind 61 Director
- -------------------------
(1) As of March 15, 1999.
67
(2) Commenced employment with the Company in January 1999.
Mr. Tessler has held the position with Enhance Financial set forth above
since its inception. He has also since 1987 been Chairman of the Board and Chief
Executive Officer of International Financial Group, Inc., a merchant banking
concern, and since 1992 served as Co-Chairman of the Board and Co-Chief
Executive Officer of Data Broadcasting Corporation ("DBC"), a provider of market
data services to the investment community. Mr. Tessler is also Chairman of the
Board of Checker Holdings Inc. and of Jackpot Enterprises Inc. ("Jackpot") and a
director of The Limited, Inc., Allis-Chalmers Corporation and Marketwatch.com.
Mr. Sellers has held the position with Enhance Financial set forth above
since 1995, and he also serves as a consultant to the Company. Prior thereto, he
served as President, Chief Executive Officer and a director of Enhance Financial
and Chairman of the Board and Chief Executive Officer of the Insurance
Subsidiaries from their inception. Mr. Sellers also serves as a director of
Danielson Holding Corporation.
Mr. Gross has held the position with Enhance Financial set forth above and
has served as Chief Executive Officer of the Insurance Subsidiaries since 1995.
Prior thereto he held senior executive positions with Enhance Financial and
Enhance Re from their inception and was among the founders of the Company in
1986. Previously, he held various insurance industry positions, including
serving as co-founder and Chairman of F.G. Holding Company, Kramer Capital
Consultants and various senior executive capacities for Colonial Penn Group. Mr.
Gross also serves as a director of MGIC.
Mr. Bergman has been Executive Vice President of the Company since 1991.
He has been Secretary of Enhance Financial since 1991 and Secretary of each of
the Insurance Subsidiaries since their inception. He was a member of the law
firm of Shea & Gould from 1980 to 1991.
Messrs. Davidow and Kwiatkoski have each served as senior executive
officers of the Insurance Subsidiaries since such companies' inception, and as
officers of Enhance Financial since 1990.
Mr. Dubroff has held the position with Enhance Financial set forth above
since 1996. From 1993 to 1996, Mr. Dubroff served in various senior management
capacities at First Data Corporation, a provider of high-volume information
processing and related services. Mr. Dubroff served as a director of Enhance
Financial from 1986 to 1991 and from 1992 to 1996 and of Enhance Re from 1986 to
1992. Mr. Dubroff also serves on the board of directors of the Kobren Insight
Funds.
Ms. Eisenman has held the position with Enhance Financial set forth above
since January 1998, having previously served as an independent consultant to the
Company. From 1994 to 1997 she served as Senior Vice President - Worldwide
Staffing, Development and Succession of American Express Company. From 1990 to
1994 she served as Vice President and General Manager of the Eastern Region of
Personnel Decisions International, Inc. Ms. Eisenman also serves as a director
of UST, Inc.
68
Mr. Ettinger has held the position with Enhance Financial set forth above
since March 1999. Prior thereto since 1995, he was Executive Vice President of
Enhance Financial. From 1992 to 1994, he rendered independent, strategic
management consulting services to major financial services institutions. From
1989 to 1991 he was a General Partner of Hannibal Management, L.P., an
investment partnership focused on undervalued, healthy community thrift
institutions. From 1985 to 1989, he was Vice President, Head of Mergers and
Acquisitions and Corporate Development, and holding company Chief Operating
Officer for seven financial services subsidiaries of the Mutual Insurance
Company of New York.
Mr. Kleinberg has held the position with Enhance Financial set forth above
as well as Chief Executive Officer of Singer since January 1999. From 1980 to
1998, Mr. Kleinberg served in various executive positions with American Express
Company, most recently as Executive Vice President, American Express Financial
Advisors, overseeing their Financial Direct Group and prior thereto as Executive
Vice President and General Manager, Travel Related Services, responsible for new
customers and products in the Consumer Card Services Group.
Mr. Steinberg has held the position with Enhance Financial set forth above
since April 1998. From 1993 to 1997, Mr. Steinberg served as Senior Vice
President and head of Systems and Technology for CapMAC Holdings Inc., the
parent company of CapMAC. From 1972 to 1992, Mr. Steinberg served in various
senior technology positions at Citibank, N.A., in Treasury Operations, the
Private Banking Group, and the North American Investment Bank.
Mr. Harries has served as a director of Enhance Financial since 1991,
having previously served as a director of the Insurance Subsidiaries since 1986.
He has been retired since 1986, having previously served from 1985 as President
of Global Electronic Markets Company, a joint venture of McGraw-Hill and
Citicorp dealing in electronic trading of commodities. Mr. Harries also serves
as a trustee of the Alliance Funds, Inc. and the Hudson River Trust.
Mr. Markin has served as a director of Enhance Financial since 1986. He
has served as President of Checker Motors Corporation for more than five years.
From 1989 to December 1996, he also served as President and Chief Executive
Officer of International Controls Corp. and its successor corporation, Great
Dane Holdings, Inc. Mr. Markin serves as a director of Jackpot and DBC.
Mr. Saltzman has served as a director of Enhance Financial since 1996. He
has been President and Chief Executive Officer of Jackson Life Insurance Company
since 1994. He previously served from 1983 as Executive Vice President of
SunAmerica Inc. and as President of its subsidiary life insurance companies.
Mr. Shima has served as a director of Enhance Financial since 1993. He has
been an independent consultant since 1993, having previously thereto from 1992
served as Managing Director of Russell Miller, Inc., an investment banking
concern specializing in the insurance industry. Mr. Shima also serves as a
director of CTG Resources, Inc. and a trustee of the Evergreen Mutual Funds.
Mr. Stuart has served as a director of Enhance Financial since 1992,
having also served as
69
a director of Asset Guaranty from its inception until 1995. He has for over ten
years served as an independent consultant regarding organizational and personnel
matters. He served from 1990 to 1992 as Chairman of the Council of Management
Advisors of Dean Witter Reynolds Inc. He is the founder and honorary chairman of
Spencer Stuart Executive Recruiting Consultants.
Mr. Sulzer has served as a director of Enhance Financial since 1996. He
has since 1991 served in various management capacities with Swiss Re, a
shareholder of Enhance Financial, currently serving since October 1998 as a
member of the managing board of NCM, Amsterdam, a 50% Swiss Re-owned credit
insurance company, and since 1997 as Co-Head of Underwriting in Swiss Re's New
Markets Division. Previously thereto, from 1991 he served as head of Swiss Re's
Credit and Bonding Department. Mr. Sulzer also serves as a director of Societa
Italiana Cauzioni, Rome, Italy; American Credit Indemnity, Baltimore, Maryland;
and Xenum Finance, Zurich, Switzerland.
Ms. Wallison has served as a director of Enhance Financial since 1992,
having also served as a director of each of the Insurance Subsidiaries since its
inception until 1995. She currently is a private investor, having retired from
the law firm of Jones, Day, Reavis & Pogue, where since 1983 she had been a
member, resident in its Washington, D.C. office.
Mr. Wind has served as a director of Enhance Financial since 1996. He has
been on the faculty of the Wharton School of the University of Pennsylvania
since 1967, currently serving as The Lauder Professor and Professor of
Marketing. He also serves as a business consultant to several publicly and
privately held, U.S. and non-U.S. corporations and has served on the editorial
boards of and as a contributor to numerous journals on marketing.
70
Item 11. Executive Compensation.
Summary Compensation Table.
The following table sets forth certain information regarding compensation
paid during each of the Company's last three fiscal years to the Company's Chief
Executive Officer and each of the Company's four other most highly compensated
executive officers, based on salary and bonus earned during 1998. Except as
described below under "Agreements with Executive Officers," "Management
Severance Protection Program" and "Other Senior Executive Officer Compensation,"
the Company has not entered with any executive officer into (i) an employment
agreement or (ii) any compensatory plan or arrangement which is activated upon
the resignation, termination or retirement of the executive officer or upon a
change in control of the Company or change in the executive officer's
responsibilities following a change in control.
Long-Term
Annual Compensation Compensation
------------------- ------------
Securities Underlying
Name and Principal Position Year Salary Bonus Options/SARs
- --------------------------- ---- ------ ----- ------------
Daniel Gross 1998 $530,000 $1,060,000 200,000
President and Chief 1997 500,000 1,150,000 350,000
Executive Officer 1996 480,000 675,000 150,000
Tony M. Ettinger 1998 288,850 360,000 70,000
President, Credit-Based 1997 273,863 260,000 40,000
Businesses, Alliances and
Ventures 1996 261,041 132,500 33,000
Samuel Bergman 1998 331,250 210,000 30,000
Executive Vice President 1997 313,281 200,000 28,000
and Secretary 1996 301,042 145,000 28,000
Elaine J. Eisenman (1) 1998 283,550 215,000 77,000(2)
Executive Vice President
Paul C. Kwiatkoski 1998 270,300 190,000 30,000
Executive Vice President 1997 255,000 165,000 27,000
1996 250,000 95,000 30,000
- ----------
(1) Became an officer of the Company in January 1998.
(2) Includes a grant of a stock option for 32,000 shares of Common Stock
granted to Ms. Eisenman upon commencement of her employment.
71
Option/SAR Grants During 1998.
The following table provides information regarding stock options/SARs
granted to the named executive officers during 1998:
Individual Grants
------------------------------------------------------------------------------
Number of Percent of
Securities Total Options
Underlying Granted to
Name and Options Employees in Exercise or Expiration Grant Date
Principal Position Granted(1) Fiscal Year Base Price Date Present Value(2)
- ------------------ ---------- ----------- ---------- ---- ----------------
Daniel Gross 200,000 17.1 $24.94 12/31/08 $3,320,000(3)
President and
Chief Executive
Officer
Tony M. Ettinger 70,000 6.0 24.94 12/31/08 1,162,000(3)
President,
Credit-Based
Businesses,
Alliances and
Ventures
Samuel Bergman 30,000 2.6 24.94 12/31/08 498,000(3)
Executive Vice
President and
Secretary
Elaine J. Eisenman 32,000 2.7 28.84 01/12/08 437,120(4)
Executive Vice 45,000 3.8 24.94 12/31/08 747,000(3)
President
Paul C. Kwiatkoski 30,000 2.6 24.94 12/31/08 498,000(3)
Executive Vice
President
- --------------------
(1) Stock options granted pursuant to the 1997 Incentive Plan. Such stock
options vest, subject to continuation of employment, in 25% increments
during the consecutive four-year period commencing on the last date of the
month of grant. The stock options are not transferable except by the laws
of descent and distribution and, accordingly, may be exercised during the
life of the optionee only by the optionee or the optionee's legal
representative and after the optionee's death only by the beneficiary
previously designated by the optionee.
(2) The present value is, in each case, based upon the Black-Scholes option
valuation model. The valuation assumes no specific time of exercise since
this is viewed by the Company as entirely indeterminate, but takes into
account the term of the option, ten years in each case. The actual value,
if any, an executive may realize will depend on the excess of the stock
price over the exercise price on the date the option is exercised, so that
there is no assurance
72
the value realized will be at or near the value estimated by the
Black-Scholes model.
(3) The Black-Scholes option valuation assumes a volatility of 74.2, a
risk-free rate of return of 4.5%, a dividend yield of 0.69% and a discount
due to the risk of forfeiture of 3.0%.
(4) The Black-Scholes option valuation assumes a volatility of 29.7, a
risk-free rate of return of 5.4%, a dividend yield of 0.99% and a discount
due to the risk of forfeiture of 3.0%.
Aggregated Option/SAR Exercises During 1998
and Fiscal Year-End Option Values
The following table provides information as to the named executive
officers regarding stock option exercises and the number and value of stock
options/SARs held by them at December 31, 1998.
No. of Securities Underlying Value of Unexercised
Unexercised Stock In-the Money
Options/SARs at Options/SARs at
December 31, 1998 December 31, 1998(1)
----------------- --------------------
Shares
Name and Acquired Value
Principal Position on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ------------------ ----------- -------- ----------- ------------- ----------- -------------
Daniel Gross -0- -0- 727,500 567,500 $13,060,663 $3,755,048
President and
Chief Executive
Officer
Tony M. Ettinger -0- -0- 64,000 127,750 953,390 807,683
President,
Credit-Based
Businesses,
Alliances and
Ventures
Samuel Bergman 5,200 $169,000 171,000 75,000 3,223,089 539,422
Executive Vice
President and
Secretary
Elaine J. Eisenman -0- -0- 8,000 69,000 9,248 255,557
Executive Vice
President
Paul C. Kwaitkoski -0- -0- 121,750 71,250 2,246,994 479,284
Executive Vice
President
-----------------------
(1) Calculated on the basis of (a) the excess of the closing price of the
Common Stock as reported by the New York Stock Exchange on December 31,
1998 over the stock option exercise price multiplied by (b) the number of
shares of Common Stock underlying the stock option.
73
Enhance Reinsurance Pension Plan
The Company maintains a defined benefit pension plan named the "Enhance
Reinsurance Pension Plan" (the "Pension Plan") which is intended to be a
tax-qualified plan under Section 401(a) of the Internal Revenue Code of 1986, as
amended (the "Code"). All employees of the Company (other than Singer and
Van-American Companies, Inc.) who have attained age 21 and who have completed at
least one year of service are eligible to participate in the Pension Plan. The
Pension Plan provides a normal retirement benefit at normal retirement (the
earlier of the date on which a participant (a) has attained age 65 or completed
five years of participation or (b) has attained age 62 or completed 10 years of
participation) equal to 2.25% of the participant's compensation multiplied by
his or her years of service up to his or her first 15 years, plus 1.75% of the
participant's compensation multiplied by his or her years of service for his or
her next 10 years, plus 1% of the participant's compensation multiplied by his
or her years of service for his or her next five years. Compensation is defined
as the average of the participant's three highest consecutive years of earnings.
(See Note 2 to the table below regarding the maximum compensation considered
"earnings" for the foregoing purposes. No such maximum applies with respect to
the determination of compensation for purposes of the Summary Compensation Table
above.) A participant whose service terminates prior to normal retirement is
eligible for a benefit at the normal retirement date based on the participant's
compensation and years of service at the date of termination multiplied by the
vested percentage. The actuarial equivalent of such vested benefit may be
distributed in a lump sum prior to normal retirement age. The vested percentage
of a participant increases 20% per year beginning after two years of service,
such that his or her vested percentage is 100% after six years. For purposes of
determining a participant's retirement benefit and vested percentage, "years of
service" and "years of participation," while not synonymous, include service
with the Company and certain service with predecessor employers.
The following table illustrates annual pension benefits payable under the
Pension Plan assuming retirement at normal retirement age at various levels of
compensation and years of service. Such benefits are based on a straight life
annuity and are not subject to any deduction for Social Security or other offset
amounts.
PENSION PLAN TABLE
Highest
Average
Earnings Years of Service
-------- -----------------------------------------------------------------------------
15 20 25 30 35*
-----------------------------------------------------------------------------
$100,000 $ 33,750 $ 42,500 $ 51,250 $ 56,250 $ 56,250
125,000 42,188 53,125 64,063 70,313 70,313
150,000 50,625 63,750 76,875 84,375 84,375
175,000(2) 59,063 74,375 89,688 98,438 98,438
200,000(2) 67,500 85,000 102,500 112,500 112,500
225,000(2) 75,938 95,625 115,313 126,563 126,563
250,000(2) 84,375 106,250 128,125 140,625(1) 140,625(1)
300,000(2) 101,250 127,500 153,750(1) 168,750(1) 168,750(1)
400,000(2) 135,000(1) 170,000(1) 205,000(1) 225,000(1) 225,000(1)
74
450,000(2) 151,875(1) 191,250(1) 230,625(1) 253,125(1) 253,125(1)
500,000(2) 168,750(1) 212,500(1) 256,250(1) 281,250(1) 281,250(1)
- ----------
* Plan limits service to 30 years for benefit purposes.
(1) These are hypothetical benefits based upon the Pension Plan's normal
retirement benefit formula. The maximum annual benefit permitted under
Section 415 of the Code in 1998 and 1999 is $130,000.
(2) The benefits shown corresponding to these compensation ranges are
hypothetical benefits based upon the Pension Plan's normal retirement
benefit formula. Under Section 401(a)(17) of the Code, a participant's
compensation in excess of a specified maximum (as such may change from
time to time in the future, the "Code Maximum") is disregarded for
purposes of determining highest average earnings. (Such specified maximum
amount (as adjusted to reflect cost of living increases) was $235,840 for
the plan year beginning November 1, 1993, decreasing to $150,000 for plan
years beginning November 1, 1994, November 1, 1995 and November 1, 1996
and has increased to $160,000 for plan years beginning thereafter.)
In addition, Enhance Financial has adopted, effective July 1, 1999, a
non-qualified restoration pension plan (the "Restoration Plan"). All employees
of the Company eligible to participate in the Pension Plan and who receive total
annual compensation in excess of the Code Maximum and above are eligible to
participate in the Restoration Plan. The Restoration Plan provides a retirement
benefit supplemental to benefits provided by the Pension Plan equal to 1.75% of
the participant's compensation above the Code Maximum multiplied by his or her
years of service up to his or her first 25 years, plus 1.0% of the participant's
compensation above the Code Maximum multiplied by his or her years of service
for his or her next five years. Compensation is defined as the average of the
participant's three highest consecutive years of earnings. The vested percentage
of a participant will be the lower of (a) 20% per year of service beginning
after two years of service such that his or her vested percentage is 100% after
six years, and (b) such other rate per year as will cause a given participant to
be fully vested at age 60. For purposes of determining a participant's
retirement benefit and vested percentage, "years of service" and "years of
participation," while not synonymous, include service with the Company and
certain service with predecessor employers. Also, for purposes of the
Restoration Plan, in addition to each such executive officer's actual years of
service, upon becoming fully vested under the terms of the Pension Plan, Mr.
Ettinger will be credited with five additional years of service and each other
participant in the Restoration Plan who is or subsequently becomes an executive
officer of Enhance Financial at the level of Executive Vice President and above,
will be credited with additional years of employment services under the
Restoration Plan equal to the excess of five over the actual years of employment
service credited to that officer under the Restoration Plan prior to its
effective date.
As of December 31, 1998, Messrs. Gross, Ettinger, Bergman and Kwiatkoski
and Ms. Eisenman had eleven, three, six, fourteen and zero years of service,
respectively, under the
75
Pension Plan and the Restoration Plan and eleven, three, six, eleven and zero
years of participation, respectively, under the Pension Plan.
Agreements with Executive Officers
Enhance Financial and Arthur Dubroff, Executive Vice President and Chief
Financial Officer, are parties to an employment agreement which provides for the
payment of an annual base salary to Mr. Dubroff of not less than $275,000 plus
an annual target bonus of 45% of such base salary. Under the employment
agreement, Mr. Dubroff was granted in 1996, 1997 and 1998 options to purchase
150,000, 40,000 and 40,000 shares of Common Stock, respectively. If Mr.
Dubroff's employment is terminated by Enhance Financial within a 12-month period
following a change of control (as defined), Enhance Financial is required to pay
Mr. Dubroff a prorated portion of his annual bonus and, for the greater of the
remainder of the term of his employment agreement and 12 months from the date of
termination of his employment, his base salary. The employment agreement
terminates on December 31, 1999.
Enhance Financial and Brian C. Kleinberg, Executive Vice President of
Enhance Financial and Chief Executive Officer of Singer are parties to an
agreement which provides for the payment of an annual base salary of $300,000
per year, plus an annual target bonus of not less than 50% of his then base
salary (or such higher rate consistent with Enhance Financial's senior executive
compensation programs); provided that his bonus for 1999 will equal or exceed
$250,000 (to be prorated should his employment be terminated prior to the
expiration of twelve months by Enhance Financial other than for cause or by Mr.
Kleinberg for cause). Under the employment agreement, Mr. Kleinberg was granted
options to purchase 85,000 shares of Common Stock. Also, in connection with the
Management Severance Protection Program described below, for 1999 Mr.
Kleinberg's prior year's annual bonus is to equal the average of the bonuses
awarded to Enhance Financial's Executive Vice Presidents for 1998. In addition,
in March 1999, Enhance Financial granted Mr. Kleinberg a stock option under the
1997 Incentive Plan for 25,000 shares in lieu of establishing at the start of
1999 a cash incentive compensation program for Mr. Kleinberg based on the
performance of the Singer businesses in 1999 and in order to compensate Mr.
Kleinberg for a portion of the anticipated 1999 income which he forewent by
having departed his prior employment to become an employee of the Company.
Management Severance Protection Program
In 1998, the Company established a management severance protection program
(the "Management Severance Protection Program") which provides for the payments
and benefits to be accorded to officers in the event of the termination of their
employment by the Company under certain circumstances. The program has been
designed to attract new, highly qualified officers by establishing a competitive
level of severance, to reduce uncertainty and to retain officers who may
otherwise depart upon a potential change in ownership, to maintain the
objectivity of Enhance Financial's senior officers in the face of potential job
loss in a "change of control" (as defined below) transaction and to minimize the
need for negotiation of individual severance arrangements upon the termination
of an officer's employment with the Company.
Under the Management Severance Protection Program, an officer of Enhance
Financial
76
with a title of at least Vice President who is terminated by the Company without
cause or who departs with good reason (an "Involuntary Termination Event") is
entitled to cash severance equal to a number of months (up to one year) of base
salary plus, in the case of senior officers with a title of at least Senior Vice
President, a prorated bonus based on such officers' prior year's annual bonus,
such number of months of salary and proration of bonus to be based on such
officers' tenure with the Company. In addition, covered officers will receive
outplacement assistance and remain covered under the Company's welfare benefit
programs for a period of time after such termination.
Senior executive officers of Enhance Financial are entitled to cash
severance in a lump sum equal to two or three times pay (depending on level of
seniority) if such senior officer undergoes an Involuntary Termination Event
within a specified time after a change of control. Such senior officers will
also receive bonus for the year of termination pro rata through the date of such
termination. In addition, such senior officers are entitled to receive
outplacement assistance, will remain covered under the Company's welfare benefit
and perquisite programs and will be entitled to continue to participate in the
Company's 401(k) program (including the receipt of Company matching
contributions) for a period of time following termination.
As used in the Management Severance Protection Program, a "change of
control" means (a) the acquisition by one person or entity of at least 35% of
Enhance Financial's outstanding voting stock, (b) a change in the majority of
the board of directors of Enhance Financial, (c) the consummation of a merger,
consolidation or reorganization unless more than 65% of the continuing interest
in the surviving entity is retained by Enhance Financial's shareholders
immediately prior to such transaction or (d) a liquidation, dissolution or sale
of all or substantially all of the assets of the Company.
In addition, pursuant to the Management Severance Protection Program, all
options and other long-term incentives previously granted to employees and
directors of the Company become immediately vested upon a change in control,
without regard to the termination of such employee or director.
Other Senior Executive Officer Compensation
The Company has established a flexible perquisite allowance program to
encourage senior executive officers of the Company to avail themselves of a
range of business-related benefits for which they are not otherwise eligible for
reimbursement by the Company, including but not limited to, club memberships,
parking at the Company's offices, automobile transportation service to and from
the Company's offices, personal development and individual financial services.
Beginning in 1999, in January of each year, the President of Enhance Financial
is to be paid $30,000 and each President of a business unit and Executive Vice
President of Enhance Financial is to be paid $15,000 pursuant to this program on
a non-accountable basis.
In addition, the Company has arranged and will pay premium for
supplemental long-term disability insurance for the President and each Executive
Vice President in addition to the $7,500 maximum monthly benefit available to
all employees of the Company, up to an aggregate $25,000 maximum monthly
benefit. The amount of such additional coverage for each executive officer
77
which will be paid by the Company will vary depending on the premium for such
executive officer's coverage as set by the insurance provider. In addition, this
insurance provides benefits for partial disability and cost of living increases
in payments under the policy.
Directors' Compensation
Fee Compensation. Directors who are employees of the Company receive no
fees or other compensation for services rendered as members of the board of
directors of Enhance Financial. Mr. Tessler received a basic fee of $105,000 in
1998, and each other director of Enhance Financial who is not employed by the
Company received a basic fee of $16,000. In addition, each such outside director
who also served as chair of any committee of the board received in 1998 an
additional $5,000 for all committees chaired by such director. Each outside
director also received an additional $2,000 for each regular meeting of the
board of directors attended plus $1,250 for each committee meeting attended
which was held on a day other than a day on which the board met. No directors'
fees were payable to corporate shareholders in respect of directorships occupied
by their designees. All directors are reimbursed for travel and related expenses
incurred in attending meetings of the board or committees.
In March 1998, the board of directors adopted the Director Stock Ownership
Plan, which, as amended, allows each outside director to elect to receive up to
100% of the aforesaid fees in the form of shares of Common Stock valued at the
closing price of the Common Stock on the New York Stock Exchange on that date.
Each outside director is entitled to make a new election annually for the coming
year's fees.
Non-Employee-Director Stock Option Plan. Pursuant to the Directors' Option
Plan, on each December 31, each outside director of Enhance Financial or either
Insurance Subsidiary is granted a non-qualified stock option to purchase 7,000
shares of Common Stock at an exercise price equal to the closing price of the
Common Stock on the New York Stock Exchange on that date. There are reserved for
issuance upon the exercise of options under the Directors' Option Plan 800,000
shares of Common Stock (subject to anti-dilutive adjustment), of which options
for 442,666 shares were subject to outstanding options after the option grants
made on December 31, 1998.
Stock options granted under the Directors' Option Plan become exercisable
as to one half the shares subject thereto on each of the first and second
anniversaries of grant, subject to continuation of service on the board of
directors and other terms of the stock option grants; expire on the tenth
anniversary of the date of grant; are not transferable except by the laws of
descent and distribution; and, accordingly, may be exercised during the life of
the optionee only by the optionee or the optionee's legal representative and
after the optionee's death only by the beneficiary previously designated by the
optionee. The unvested portion of an outstanding stock option lapses upon the
resignation or removal of the optionee from the boards of directors of Enhance
Financial and the Insurance Subsidiaries.
Compensation Committee Interlocks and Insider Participation
The persons who served as members of the Compensation and Nominating
Committee
78
during 1998 are Spencer R. Stuart (Chairman), Brenton W. Harries, David R.
Markin, Richard J. Shima and Allan R. Tessler. The only person of the foregoing
who is currently or has at any time been an officer or employee of the Company
is Mr. Tessler, who serves as Chairman of the Board of Enhance Financial.
Non-Competition Agreements
Messrs. Tessler, Sellers and Gross are parties to non-competition
agreements with Enhance Financial prohibiting them from, among other things,
competing with the Company for a period of two years following their respective
cessation of employment by or service to the Company.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information with respect to the
beneficial ownership of the Common Stock as of March 26, 1999 by (a) each
shareholder known to Enhance Financial to be the beneficial owner, within the
meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), of more than 5% of the outstanding shares of Common Stock; (b)
each director of Enhance Financial; (c) each of the five most highly compensated
executive officers of Enhance Financial; and (d) all executive officers and
directors of Enhance Financial as a group. Unless otherwise indicated, the
address of each such person is c/o Enhance Financial Services Group Inc., 335
Madison Avenue, New York, New York 10017.
Name and Address Number of Shares (1) Percent of Class
-------------------- ----------------
Swiss Reinsurance Company 3,400,000(2) 9.0
Mythenquai 50/60
8022 Zurich, Switzerland
Morgan Stanley Dean Witter & Co. 2,773,160(3) 7.3
1585 Broadway
New York, New York 10036
Legg Mason, Inc. 2,213,235(4) 5.8
100 Light Street
Baltimore, Maryland 21202
Allan R. Tessler ............................. 498,500(5)(6) 1.3
Wallace O. Sellers ........................... 835,800(5)(6) 2.2
Daniel Gross ................................. 1,147,500(5) 2.9
Samuel Bergman ............................... 179,700(5) *
Elaine Eisenman .............................. 9,200(5) *
Tony M. Ettinger ............................. 64,200(5) *
Paul C. Kwiatkoski ........................... 160,490(5) *
Brenton W. Harries ........................... 29,500(5) *
David R. Markin .............................. 238,477(6)(7) *
Robert P. Saltzman ........................... 127,500(6)(8) *
Richard J. Shima ............................. 25,606(6) *
79
Spencer R. Stuart ............................ 30,606(6)(9) *
Adrian U. Sulzer ............................. 7,500(6) *
Frieda K. Wallison ........................... 33,772(6) *
Jerry Wind ................................... 18,031(6) *
All executive officers and
directors as a group 3,776,682(10) 9.1
- ----------
* Less than 1%
(1) The table in this section is based upon information supplied by directors,
officers, and principal shareholders and Schedules 13D and 13G, if any,
filed with the Securities and Exchange Commission. Unless otherwise
indicated in the footnotes to the table and subject to the community
property laws where applicable, each of the shareholders named in this
table has sole voting and investment power with respect to the shares
shown as beneficially owned by him or her.
(2) See "Certain Relationships and Related Transactions" for information
regarding an agreement between Enhance Financial and Swiss Reinsurance
Company ("Swiss Re") regarding future sales and purchases by Swiss Re of
voting shares of Enhance Financial.
(3) On February 10, 1999, Morgan Stanley Dean Witter & Co. ("MSDW&Co") and its
wholly-owned subsidiary, Morgan Stanley Dean Witter Investment Management
Limited ("DWIM") jointly filed a Schedule 13G describing their respective
ownership of shares of Common Stock at December 31, 1998 as follows:
MSDW&Co has shared voting power over 2,428,177 shares of Common Stock and
shared dispositive power over 2,773,160 shares of Common Stock, and DWIM
has shared voting power over 1,767,632 shares of Common Stock and shared
dispositive power over 2,097,532 shares of Common Stock. Accounts managed
on a discretionary basis by DWIM, are known to have the right to receive
or the power to direct the receipt of proceeds for the dividends from the
sale of such shares of Common Stock. No such account holds more than 5% of
outstanding shares of the Common Stock.
(4) On February 16, 1999, Legg Mason, Inc. filed a Schedule 13G describing its
ownership of shares of Common Stock at December 31, 1998 as follows: Legg
Mason, Inc. has sole voting and dispositive power over 2,126,500 shares of
Common Stock and shared voting and dispositive power over 86,735 shares of
Common Stock. Such shares of Common Stock are held by various identified
subsidiaries of Legg Mason, Inc. and by various of their clients, all of
which have the power to dispose of the shares held by them.
(5) Includes the shares set forth in: (a) Column A below issuable to the named
officer upon the exercise of currently exercisable stock options granted
under Enhance Financial's employee stock option programs, and (b) Column B
below owned by the named officer's spouse and children or in trusts of
which such officer is a trustee (as to which shares such officer disclaims
beneficial ownership).
80
Name A B
---- - -
Allan R. Tessler 43,000 4,000
Wallace O. Sellers 307,300 517,000
Daniel Gross 727,500 204,000
Samuel Bergman 171,000 8,700
Elaine J. Eisenman 8,000 -0-
Tony M. Ettinger 64,000 -0-
Paul C. Kwiatkoski 121,750 400
(6) Includes shares issuable upon the exercise of the presently exercisable
portion of options granted to such director under the Directors' Option
Plan, as follows: Allan R. Tessler -- 11,500 shares; Wallace O. Sellers --
7,500 shares; Brenton W. Harries -- 27,500 shares; David R. Markin --
27,500 shares; Robert P. Saltzman -- 7,500 shares; Richard J. Shima --
19,500 shares; Spencer R. Stuart -- 27,500 shares; Adrian U. Sulzer --
7,500 shares; Frieda K. Wallison -- 27,500 shares; and Jerry Wind -- 7,500
shares.
(7) Includes 200,000 shares held in a limited partnership in which Mr. Markin
and his wife are the limited partners and a trust controlled by Mr. Markin
is the general partner.
(8) Held in a living trust account of which Mr. Saltzman and his wife are
co-trustees.
(9) Mr. Stuart's wife holds a durable power of attorney granting her joint
voting and dispositive power over the shares owned by Mr. Stuart.
(10) Includes 263,666 shares issuable to the directors of Enhance Financial who
are not employees of the Company (as of the date of grant) upon the
exercise of the presently exercisable portion of stock options granted to
them under the Directors' Option Plan; 1,702,800 shares issuable to the
executive officers upon the exercise of presently exercisable options
granted to them under the 1987 Incentive Plan and the 1997 Incentive Plan;
and 734,100 shares owned by spouses of executive officers in trusts of
which such officers are trustees or by executive officers or their spouses
as custodians for their children. Such persons disclaim beneficial
ownership of such shares owned by their spouses, individually or as
custodians, or by such trusts.
Item 13. Certain Relationships and Related Transactions.
U S WEST
The certificate of incorporation of Enhance Financial grants to U S WEST,
Inc. ("U S WEST") the right to preclude the Company from entering into certain
activities or owning an equity interest in any entity that engages in any such
activity unless they are determined by U S WEST's legal counsel not to be
prohibited to U S WEST and its subsidiaries under the Modification of Final
Judgment (the "Judgment") entered in 1984 in connection with the settlement of
the legal action entitled United States v. Western Electric Company, Inc. These
activities consist of providing information services or long distance telephone
service or manufacturing telecommunications equipment.
81
Although the Company has not entered, and does not intend to enter, into
any of the specified activities, and, accordingly, the aforesaid provision has
not had, and is not expected to have, any material effect on the business of the
Company, since US WEST or its subsidiaries cease to own shares of Common Stock,
Enhance Financial intends to propose at the 1999 Annual Meeting of Shareholders
the elimination of the aforesaid provision from the certificate of
incorporation, which will require the vote of the holders of a majority of
shares of Common Stock outstanding. At the 1999 Annual Meeting of Shareholders
held on June 3, 1999, the shareholders of Enhance Financial approved the
elimination of the aforesaid provision from the certificate of incorporation and
the certificate of incorporation of Enhance Financial was amended on July 7,
1999.
Swiss Re
Enhance Financial and Swiss Re are parties to an agreement pursuant to
which Swiss Re has agreed that, subject to certain exceptions, neither Swiss Re
nor any of its affiliates will until the year 2006 (a) acquire, alone or as part
of a group, any voting securities of Enhance Financial (or securities
convertible into such voting securities) which would result in Swiss Re
(together with its affiliates) or such group owning beneficially more than 15%
of Enhance Financial voting securities outstanding or (b) dispose of Enhance
Financial voting securities to any person or group which disposition would give
such person or group beneficial ownership of or the right to acquire more than
15% of Enhance Financial voting securities outstanding.
Pursuant to a registration rights agreement, dated October 31, 1986, as
amended, between Swiss Re and Enhance Financial, Swiss Re has one demand and
unlimited piggyback registration rights, subject to certain limitations.
Substantially all the expenses of any future demand or piggyback registration
are to be borne by Enhance Financial. The registration rights agreement contains
cross-indemnification covenants by Enhance Financial, on the one hand, and Swiss
Re, on the other hand, for damages sustained and expenses incurred resulting
from material misstatements or omissions in connection with any such offering.
Seguradora Brasileira de Fiancas
Since November 1997, Enhance Financial and Swiss Re have each owned 25%
equity interests in Seguradora Brasileira de Fiancas which they purchased for
respective initial investments of $3.3 million. It is anticipated that the
Company and Swiss Re will from time to time make additional investments in such
company as its capital needs may require. See Item 1. "Business - Description of
Business - Other Businesses and Investments."
82
PART IV
Item 14. - Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) The following documents are filed as a part of this report:
(1) Financial Statements - See Part II, Item 8.
(2) Financial Statement Schedules:
All schedules are omitted, as the required information is
nonapplicable or the information is presented in the financial
statements or related notes.
(3) Exhibits:
3.1.1 Restated certificate of incorporation of the registrant filed
with the State of New York on February 18, 1992. (Incorporated
by reference to Exhibit 3.3.1 to the Annual Report on Form 10-K
for the year ended December 31, 1991 of the registrant.)
3.1.2 Certificate of amendment to the restated certificate of
incorporation of the registrant filed with the State of New York
on June 6, 1996. (Incorporated by reference to Exhibit 3.1.2 to
the Annual Report on Form 10-K for the year ended December 31,
1996 of the registrant (the "1996 Form 10-K").)
3.1.3 Certificate of amendment to the restated certificate of
incorporation of the registrant filed with the State of New York
on June 3, 1998. (Incorporated by reference to Exhibit 3.3. to
the Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1998 of the registrant (the "1998(Q2) Form 10-Q").)
3.2 By-laws of the registrant, as amended through December 3, 1991.
(Incorporated by reference to Exhibit 3.2 to Amendment No. 1
filed with the Securities and Exchange Commission (the
"Commission") on January 21, 1992 ("Amendment No. 1") to the
registrant's Registration Statement on Form S-1 (File No.
33-44322) filed with the Commission on December 11, 1991 (the
"1991 Registration Statement").)
4.1 Specimen certificate evidencing shares of Common Stock.
(Incorporated by reference to Exhibit 4.1 to Amendment No. 4 to
the 1991 Registration Statement, filed with the Commission on
February 12, 1992 ("Amendment No. 4").)
4.2.1 Credit Agreement dated as of June 30, 1998 (the "Credit
Agreement"), among the registrant; Fleet National Bank, as
lender, Administrative Agent and Administrator; and The Bank of
Tokyo-Mitsubishi, Ltd., New York Branch; The First National Bank
of Chicago; and Deutsche Bank AG, New York and/or Cayman Island
Branches, as lenders. (Incorporated by reference to Exhibit 4.2
to
83
the 1998(Q2) Form 10-Q.)
4.2.2 Amendment No.1 and Waiver Agreement, dated as of
December 31, 1998, to the Credit Agreement. (Incorporated by
reference to Exhibit 4.2.2 to the Annual Report on Form 10-K
for the year ended December 31, 1998 of the registrant as
filed with the Securities and Exchange Commission on March 31,
1999 (the "1998 10-K).)
4.2.3 Amendment No. 2, dated as of February 15, 1999, to the Credit
Agreement. (Incorporated by reference to Exhibit 4.2.3 to the
1998 10-K.)
4.3.1 Form of Indenture dated as of February ____, 1993 (the
"Indenture") between the registrant and Chase, as Trustee.
(Incorporated by reference to Exhibit 4.1 to Amendment No. 2
filed with the Commission on February 10, 1993 ("Amendment No.
2") to the Registration Statement on Form S-1 (File No.
33-55958) filed with the Commission on December 18, 1992 (the
"1992 Registration Statement").
4.3.2 Form of Enhance Financial Services Group Inc. ____% Debentures
due 2003. (Incorporated by reference to Exhibit 4.3.3 to
Amendment No. 2 to the 1992 Registration Statement.)
10.1.1 Non-competition agreement dated as of March 5, 1986 between the
registrant and Allan R. Tessler. (Incorporated by reference to
Exhibit 10.2.1 to the 1991 Registration Statement.)
10.1.2 Non-competition agreement dated as of March 5, 1986 between the
registrant and Wallace O. Sellers. (Incorporated by reference to
Exhibit 10.2.2 to the 1991 Registration Statement.)
10.1.3 Non-competition agreement dated as of March 5, 1986 between the
registrant and Daniel J. Gross. (Incorporated by reference to
Exhibit 10.2.3 to the 1991 Registration Statement.)
10.2.1 1987 Long Term Incentive Plan for Key Employees, as amended (the
"1987 Incentive Plan"). (Incorporated by reference to Exhibit
10.2.2 to the 1996 Form 10-K.)
10.2.2 1997 Long Term Incentive Plan for Key Employees (the "1997
Incentive Plan"). (Incorporated by reference to Exhibit 10.2.3
to the Annual Report on Form 10-K for the year ended December
31, 1997 of the registrant.)
10.2.3 Form of option grant certificate under the 1997 Incentive Plan
for options granted in December 1998. (Incorporated by reference
to Exhibit 10.2.3 to the 1998 10-K.)
10.3.1 Non-Employee-Director Stock Option Plan, as amended (the
"Directors' Option Plan"). (Incorporated by reference to Annex A
to the definitive proxy statement of the registrant on Form 14A,
as filed with the Securities and Exchange Commission on May 4,
1998.)
84
10.3.2 Form of option grant certificate under the Directors' Option
Plan for options granted in 1992. (Incorporated by reference to
Exhibit 10.6.5 to the 1992 Registration Statement.)
10.3.3 Director Stock Ownership Plan, as amended. (Incorporated by
reference to Exhibit 10.3.3 to the 1998 10-K.)
10.4 Initial Purchasers' Registration Rights Agreement dated as of
March 5, 1986 among the registrant and certain of its employees.
(Incorporated by reference to Exhibit 10.7 to the 1991
Registration Statement.)
10.5.1 Subscribers' Registration Rights Agreement dated as of October
31, 1986 among the registrant and certain of its shareholders
(the "Registration Rights Agreement"). (Incorporated by
reference to Exhibit 10.8.1 to Amendment No. 1 to the 1991
Registration Statement.)
10.5.2 Amendment No. 1 dated as of April 1, 1987 to the Registration
Rights Agreement. (Incorporated by reference to Exhibit 10.8.2
to the 1991 Registration Statement.)
10.5.3 Amendment No. 2 dated as of May 10, 1988 to the Registration
Rights Agreement. (Incorporated by reference to Exhibit 10.8.3
to the 1991 Registration Statement.)
10.5.4 Combined Amendments to Registration Rights Agreements dated as
of June 29, 1990 (including Amendment No. 3 to the Registration
Rights Agreement). (Incorporated by reference to Exhibit 10.8.4
to the 1991 Registration Statement.)
10.5.5 Amendment No. 4 dated as of December 19, 1991 to the
Registration Rights Agreement. (Incorporated by reference to
Exhibit 10.8.5 to Amendment No. 1 to the 1991 Registration
Statement.)
10.5.6 Amendment No. 6 dated February 23, 1996 to the Registration
Rights Agreement. (Incorporated by reference to Exhibit 10.4 to
the Registration Statement on Form S-3 (File No. 333-2064) filed
with the Commission on March 8, 1996 (the "1996 Registration
Statement")).
10.6 Employment agreement dated July 16, 1996 between the registrant
and Arthur Dubroff. (Incorporated by reference to Exhibit 10.6
of the 1996 Form 10-K.)
10.7 Agreement dated January 4, 1999 between the registrant and Brian
C. Kleinberg. (Incorporated by reference to Exhibit 10.7 to the
1998 10-K.)
10.8 Stock purchase agreement dated February 9, 1996 among the
registrant, The Manufacturers Life Insurance Company, Manulife
(International) Limited and Swiss Reinsurance Company.
(Incorporated by reference to Exhibit 10.1 to the 1996
Registration Statement.)
21.1 Subsidiaries of the registrant. (Incorporated by reference to
Exhibit 21.1 to the 1998 10-K.)
85
24.1 Power of Attorney. (Included on signature pages to the 1998
10-K.)
27 Financial Data Schedule.
(b) Reports on Form 8-K.
The Company did not file any reports on Form 8-K during the fourth quarter of
1998.
86
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on October 28, 1999.
ENHANCE FINANCIAL SERVICES GROUP INC.
By: /s/ Daniel Gross
-------------------------------------
Daniel Gross
President and Chief Executive Officer
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below on October 28, 1999 by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
/s/ Daniel Gross
----------------------------------------
Daniel Gross
President and Chief Executive
Officer and a director (principal
executive officer)
/s/ Richard J. Dunn
----------------------------------------
Richard J. Dunn
Executive Vice President
(principal financial officer
and principal accounting
officer)
87
*
----------------------------------------
Brenton W. Harries
Director
*
----------------------------------------
David R. Markin
Director
*
----------------------------------------
Wallace O. Sellers
Director
*
----------------------------------------
Richard J. Shima
Director
*
----------------------------------------
Robert P. Saltzman
Director
*
----------------------------------------
Spencer R. Stuart
Director
*
----------------------------------------
Allan R. Tessler
Director
*
----------------------------------------
Frieda K. Wallison
Director
*
----------------------------------------
Jerry Wind
Director
*By: /s/ Samuel Bergman
-------------------------------------
Samuel Bergman
Attorney-in-Fact
88