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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition period from to
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Commission file no. 0-28188
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Chartwell Re Holdings Corporation
(Exact name of registrant as specified in its charter)
DELAWARE 06-1438493
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Four Stamford Plaza, 107 Elm Street
Stamford, Connecticut 06902
(Address of principal executive offices and zip code)
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Registrant's telephone number, including area code: (203) 705-2500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [_]
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]
Documents Incorporated by Reference: None
The Registrant meets the conditions set forth in General Instruction I (1) (a)
and (b) of Form 10-K and is therefore filing this Annual Report on Form 10-K in
the reduced disclosure format.
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CHARTWELL RE HOLDINGS CORPORATION
TABLE OF CONTENTS
Page
Item Number
---- ------
PART I
1. Business----------------------------------------------------------------------------- 1
2. Properties--------------------------------------------------------------------------- 18
3. Legal Proceedings-------------------------------------------------------------------- 18
4. Submission of Matters to a Vote of Security Holders---------------------------------- 18
PART II
5. Market for the Registrant's Common Stock and Related Stockholder Matters------------- 18
6. Selected Financial Data-------------------------------------------------------------- 19
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations--------------------------------------------------------------------------- 19
7A. Quantitative and Qualitative Disclosures About Market Risk--------------------------- 32
8. Financial Statements and Supplementary Data------------------------------------------ 32
9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures ------------------------------------------------------------------------- 32
PART III
10 - 13. -------------------------------------------------------------------------------- 33
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K--------------------- 33
i
PART I
Item 1. Business
Overview
Chartwell Re Holdings Corporation ("Chartwell" or the "Company") is a
wholly-owned subsidiary of Chartwell Re Corporation ("Chartwell Re"), an
insurance holding company with global underwriting and service operations which
conducts its business in the United States and in the Lloyd's market. Chartwell
was formed in 1995 to act as an intermediate level holding company for Chartwell
Re and, as such, it conducts its business through its principal operating
subsidiaries, Chartwell Reinsurance Company ("Chartwell Reinsurance"), The
Insurance Corporation of New York ("INSCORP"), Chartwell Managing Agents Limited
("CMA") and Dakota Specialty Insurance Company ("Dakota"). As of December 31,
1998, Chartwell had over $1.5 billion of total assets and stockholder's equity
of $307.9 million. For the year ended December 31, 1998, Chartwell's gross
premiums written amounted to $343.0 million. Of such amount, $159.2 million, or
46.4%, represented gross reinsurance premiums, $111.1 million, or 32.4%,
represented gross insurance premiums and $72.6 million, or 21.2%, represented
premiums from Oak Dedicated Limited, Oak Dedicated Two Limited and ADIT One
Limited, CMA's dedicated Lloyd's corporate capital vehicles (the "Dedicated
CCV's").
Chartwell Reinsurance is a broker market reinsurer with $302.9 million of
policyholders' surplus which underwrites treaty reinsurance for casualty,
property, marine and aviation risks. INSCORP is a primary insurance company with
$131.7 million of policyholders' surplus that develops property and casualty
insurance programs through specialty production sources focusing on a specific
line of business and geographic region. Chartwell and INSCORP are each licensed
or authorized to transact business in 49 states and the District of Columbia.
INSCORP is also approved to transact business in Canada. CMA is the 12th largest
managing agency at Lloyd's, managing seven Lloyd's syndicates with total
underwriting capacity of approximately (pound)300 million ($500 million) for the
1999 year of account. Approximately 46% of CMA syndicates' 1999 capacity is
supplied by Chartwell, and it is estimated that approximately 65% of CMA's 1999
premium volume will be derived from non-U.S. sources.
History
Chartwell Reinsurance was founded in 1979 as a wholly-owned subsidiary of
Northwestern National Life Insurance Company ("NWNL"). Chartwell Re was formed
in 1989 to act as the parent company of Chartwell Reinsurance, and, in March of
1992, Chartwell Re was acquired (the "1992 Acquisition") by an acquisition group
including members of Chartwell Re's senior management.
INSCORP was acquired by Chartwell Re as a result of the merger of INSCORP's
former parent, Piedmont Management Company Inc. ("Piedmont"), with and into
Chartwell Re, with Chartwell Re as the surviving corporation (the "Piedmont
Merger"). The Piedmont Merger was completed in December, 1995, and upon
consummation of the Piedmont Merger, Chartwell Re assumed all of Piedmont's
obligations under its Contingent Interest Notes due 2006 (the "CI Notes") which
were issued by Piedmont to its stockholders just prior to the Piedmont Merger.
In November, 1996, Chartwell Holdings Limited ("Holdings Limited"), a
newly-formed, indirect wholly-owned subsidiary of Chartwell, acquired CMA in a
cash tender offer for all of the outstanding ordinary shares of Chartwell UK
plc, formerly Archer Group Holdings plc ("Chartwell UK"), the holding company
for CMA. Chartwell UK was publicly traded on the London Stock Exchange prior to
its acquisition by Chartwell.
Ratings
Chartwell Reinsurance is rated "A" (Excellent) by A.M. Best Company.
INSCORP and Dakota, its surplus lines subsidiary, are both rated "A-"
(Excellent) by A.M. Best Company. All three companies are assigned an A-claims
paying ability rating by Standard & Poor's. All of CMA's syndicates enjoy the
benefit of the ratings of Lloyd's, which is rated "A" (Excellent) by A.M. Best
Company and has an A+ claims paying ability rating from Standard & Poor's. These
ratings are based upon factors that may be of concern to policy or contract
holders, agents and intermediaries, but may not reflect the considerations
applicable to an equity investment in a reinsurance or insurance company. A
change in any such rating is at the discretion of the respective rating
agencies.
1
Corporate Structure
[GRAPHIC OF FLOWCHART OMITTED]
Property and Casualty Reinsurance
Reinsurance is an arrangement in which an insurance company, the reinsurer,
agrees to indemnify another insurance company, the ceding company, for all or a
portion of the insurance risks underwritten by the ceding company under one or
more insurance policies. Reinsurance can benefit a ceding company in a number of
ways, including reducing net liability exposure on individual risks, providing
catastrophe protection from large or multiple losses, stabilizing financial
results and assisting in maintaining acceptable operating leverage ratios.
Reinsurance also provides a ceding company with additional underwriting capacity
by permitting it to accept larger risks and underwrite a greater number of risks
without a corresponding increase in its capital and surplus.
Reinsurance is contracted either through treaties or facultative
certificates. A reinsurance treaty is an agreement whereby the ceding company is
obligated to cede, and the reinsurer is obligated to assume, a specified portion
or category of risk under all qualifying policies issued by the ceding company
during the term of the treaty. Facultative reinsurance arrangements are
separately negotiated for each insurance policy to be reinsured and result in a
facultative certificate under which the ceding company cedes, and the reinsurer
assumes, all or part of the risk under a specific insurance policy. Facultative
reinsurance is normally purchased by insurance companies for individual risks
not covered under reinsurance treaties or for amounts in excess of limits on
risks covered under reinsurance treaties. In the underwriting of treaty
reinsurance, the reinsurer does not evaluate each individual risk assumed, as it
must in the underwriting of facultative reinsurance, and generally accepts the
original underwriting decisions made by the ceding insurer.
Both treaty and facultative reinsurance can be written on either a pro rata
(also known as quota share or proportional) or excess of loss basis. Under pro
rata reinsurance, the reinsurer indemnifies the ceding company against an agreed
upon portion or share of the losses and loss adjustment expenses ("LAE")
incurred by the ceding company under the reinsured policy or policies. Premiums
that the ceding company pays to the reinsurer for pro rata reinsurance are
proportional to the premiums that the ceding company receives, consistent with
the proportional sharing of risk, generally less a ceding commission. The ceding
commission is negotiated between the reinsurer and the ceding company to
reimburse the ceding company for its acquisition costs relating to the
underlying policies and may include a contingent component that varies depending
upon the loss experience of the underlying business. As a consequence, the
underwriting results of the reinsurer may not parallel the underwriting results
of the ceding company.
Under excess of loss reinsurance, the reinsurer indemnifies the ceding
company against all or a specified portion of losses and LAE on the reinsured
policy or policies in excess of a specified dollar amount, known as the ceding
company's retention or reinsurance attachment point, generally subject to a
negotiated limit. Such reinsurance can cover losses from a single risk or from a
variety of risks in connection with a single occurrence (generally referred to
as catastrophe coverage). Excess of loss reinsurance is often written in
multiple layers. One or a group of reinsurers typically assumes that portion of
the risk immediately above the ceding company's retention up to a specified
amount, at which point another reinsurer or group of reinsurers assumes, or the
ceding company retains, the excess liability. The reinsurer assuming the risk
immediately above the ceding company's retention point is said to write working
layer (or low layer) reinsurance. A loss that is greater in amount than the
ceding company's retention will result in a loss to the working layer reinsurer,
but may not result in a loss to the reinsurers on higher layers. Since the
probability of loss for the reinsurer providing excess of loss coverage differs
from that to which the ceding company is subject, such reinsurance coverage is
priced separately from the pricing set by the ceding company with respect to its
own risks.
2
Reinsurers may also purchase reinsurance, known as retrocessional
reinsurance, to cover their own risks assumed from primary ceding companies.
Reinsurance companies enter into retrocessional agreements for reasons similar
to those for which ceding companies purchase reinsurance.
Underwriting
Underwriting opportunities presented to Chartwell are evaluated based upon
a number of factors including an historical analysis of results, an estimation
of future loss costs based upon an analysis of exposure, a review of other
programs displaying similar exposure characteristics, the primary insurer's
underwriting and claims experience and the primary insurer's financial
condition.
In general, prior to authorization, underwriting submissions are reviewed
by at least two underwriters, including the manager of the relevant underwriting
unit. Large, complex or unusual submissions are generally further reviewed by
senior management.
Client Segments
Chartwell has organized its marketing and underwriting activities into
client segments differentiated from one another based on the nature of the
clientele and their businesses or products. Accordingly, Chartwell has
established three principal underwriting units - Reinsurance, Controlled Source
Insurance and CMA Dedicated Facilities. The Reinsurance unit is further divided
based upon client characteristics into four units: Specialty Accounts, Global
Accounts, Regional Accounts and Marine & Aviation Accounts. Each unit consists
of specialized, dedicated underwriters who are supported by Chartwell's
technical resources and personnel, including its actuarial, claims and
accounting departments. Chartwell employs a focused cycle management approach to
marketing and underwriting pursuant to which it seeks to emphasize different
types of business during various phases of the underwriting cycle. During soft
markets, Chartwell concentrates on identifying and pursuing underwriting
opportunities in areas exhibiting adequate profit potential and ceding
additional business upon advantageous terms. During hard markets, Chartwell's
general strategy is to expand its premium writings in all market segments.
The table set forth below shows gross premiums written by underwriting
client segment for the periods indicated:
Gross Premiums Written by Underwriting Client Segment
(Dollars in thousands)
Year Ended December 31,
-------------------------------------------------------------------------
1998 1997 1996
--------------------- --------------------- ---------------------
Amount % of Total Amount % of Total Amount % of Total
------ ---------- ------ ---------- ------ ----------
Reinsurance Operations
Specialty Accounts .................... $110,829 32.3% $140,965 38.9% $100,817 38.2%
Global Accounts
Domestic ........................... 12,461 3.6 19,658 5.4 19,818 7.5
International ...................... 10,530 3.1 22,723 6.3 24,120 9.2
-------- ----- -------- ----- -------- -----
Subtotal Global Accounts .............. 22,991 6.7 42,381 11.7 43,938 16.7
Regional Accounts ..................... 15,069 4.4 24,718 6.8 25,967 9.8
Marine & Aviation Accounts ............ 10,358 3.0 28,050 7.7 27,780 10.5
-------- ----- -------- ----- -------- -----
Total Reinsurance .................. 159,247 46.4 236,114 65.1 198,502 75.2
-------- ----- -------- ----- -------- -----
Non-Reinsurance Operations
Controlled Source Insurance ........... 111,131 32.4 106,543 29.4 58,752 22.3
INSCORP Run-off ....................... -- -- -- -- 6,584 2.5
CMA Dedicated Facilities .............. 72,573 21.2 20,113 5.5 -- --
-------- ----- -------- ----- -------- -----
Total Non-Reinsurance .............. 183,704 53.6 126,656 34.9 65,336 24.8
-------- ----- -------- ----- -------- -----
TOTAL .................................... $342,951 100.0% $362,770 100.0% $263,838 100.0%
======== ===== ======== ===== ======== =====
The growth of 30.0% in gross premiums written for the period from 1996 to
1998 is due principally to the development of the Controlled Source Insurance
portfolio, as well as the addition of premium income from Chartwell's
participation on CMA's syndicates through support of its Dedicated CCV's.
3
Reinsurance Business
Chartwell segments its reinsurance marketing and underwriting activities
into four specific client units Specialty Accounts, Global Accounts, Regional
Accounts and Marine & Aviation Accounts.
Specialty Accounts. Specialty Accounts primarily covers non-standard,
non-traditional risks that require specialized underwriting, claims and
actuarial skills. Currently, these coverages include workers compensation,
professional liability, directors' and officers' liability, surety/fidelity
programs, non-standard automobile, accident & health, political risk, employment
practices liability and managing general agencies, as well as coverages for
excess and surplus lines insurers and start-up companies. In addition, Specialty
Accounts writes business arising from the alternative risk transfer segment with
a particular emphasis in the professional liability and medical malpractice
areas.
Global Accounts. Global Accounts is principally engaged in two activities.
Global Accounts provides reinsurance to large U.S. based domestic insurance
companies with $100 million or more in surplus which write business in more than
10 states and writes specific reinsurance programs for international ceding
companies including reinsurance of select syndicates at Lloyd's and for other
insurers and reinsurers writing non-U.S. risks.
Regional Accounts. Regional Accounts includes reinsurance of the standard
risks of insurance companies that either operate in 10 or fewer states or have a
surplus of $100 million or less.
Marine and Aviation Accounts. Marine & Aviation Accounts includes
reinsurance of domestic and international ceding companies, managing general
agencies and select Lloyd's syndicates, as well as Chartwell's participation in
certain marine & aviation pools. The majority of Chartwell's marine reinsurance
business is in the bluewater hull and energy areas. Chartwell's aviation
business is derived primarily from reinsuring general aviation and satellite
business. Business emanating from INSCORP's participation in the marine pool
managed by Navigators Group, Inc. is also included in this client segment.
Mix of Reinsurance Business. Chartwell writes excess of loss and pro rata
reinsurance as well as casualty clash and property catastrophe coverages, all on
a treaty basis. Chartwell typically focuses on the working layers of a ceding
company's reinsurance program. Chartwell does not currently write facultative
reinsurance but may commence writing such coverages depending on market
conditions.
4
Chartwell's mix of reinsurance business, on the basis of gross and net
reinsurance premiums written, is set forth in the following table for the
periods indicated:
Mix of Reinsurance Business
(dollars in thousands)
Year Ended December 31,
1998 1997 1996 1995 1994
----------------- ------------------ ------------------ ------------------ -----------------
Amount %of Total Amount % of Total Amount % of Total Amount % of Total Amount %of Total
------ --------- ------ ---------- ------ ---------- ------ ---------- ------ ---------
Gross Premiums Written
Casualty:
Excess of Loss .............. $ 29,559 18.6% $ 36,659 15.5% $ 32,679 16.5% $ 40,089 31.6% $ 32,674 28.1%
Pro Rata .................... 88,899 55.8 134,495 57.0 94,223 47.5 41,570 32.7 43,328 37.2
Clash ....................... 1,267 0.8 1,983 0.8 1,816 0.8 2,704 2.1 3,498 2.9
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total Casualty ................. 119,725 75.2 173,137 73.3 128,718 64.8 84,363 66.4 79,500 68.2
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Property:
Excess of Loss .............. 4,435 2.8 12,912 5.5 6,267 3.2 4,730 3.7 2,656 2.3
Pro Rata .................... 34,772 21.8 49,583 21.0 62,455 31.5 35,841 28.2 31,030 26.7
Catastrophe ................. 315 0.2 482 0.2 1,062 0.5 2,034 1.7 3,210 2.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total Property ................. 39,522 24.8 62,977 26.7 69,784 35.2 42,605 33.6 36,896 31.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total Gross Premiums Written .. $159,247 100.0% $236,114 100.0% $198,502 100.0% $126,968 100.0% $116,396 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
Net Premiums Written
Casualty:
Excess of Loss .............. $ 23,740 22.6% $ 35,413 17.4% $ 32,567 18.6% $ 40,043 32.5% $ 32,680 28.7%
Pro Rata .................... 56,950 54.3 118,446 58.1 81,349 46.6 40,727 33.0 43,319 38.0
Clash ....................... 919 0.9 1,920 0.9 1,807 1.0 2,691 2.2 3,492 3.1
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total Casualty ................. 81,609 77.8 155,779 76.4 115,723 66.2 83,461 67.7 79,491 69.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Property:
Excess of Loss .............. 2,930 2.8 11,456 5.6 5,941 3.4 4,440 3.6 2,476 2.2
Pro Rata .................... 20,161 19.2 36,251 17.8 51,978 29.8 33,667 27.3 28,928 25.4
Catastrophe ................. 211 0.2 472 0.2 1,016 0.6 1,746 1.4 3,067 2.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total Property ................. 23,302 22.2 48,179 23.6 58,935 33.8 39,853 32.3 34,471 30.2
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total Net Premiums Written ..... $104,911 100.0% $203,958 100.0 $174,658 100.0% $123,314 100.0% $113,962 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
Chartwell's percentage of property writings in its overall mix of business
decreased for the year ended December 31, 1998 as compared to the year ended
December 31, 1997, principally as a result of increased competition in the
property market.
Ceding Companies. During the year ended December 31, 1998, Chartwell
received approximately 37.9% of its gross reinsurance premiums written from four
groups of ceding companies, of which LDG Reinsurance Underwriters accounted for
approximately 14.4%, American International Group accounted for approximately
11.0%, Clarendon Insurance Group accounted for approximately 6.9% and Somerset
Marine accounted for approximately 5.6%. No other ceding company or group of
affiliated ceding companies accounted for more than 5% of Chartwell's gross
reinsurance premiums written for the year ended December 31, 1998.
Brokers. During the year ended December 31, 1998, Chartwell received
approximately 51.8% of its gross reinsurance premiums written from three
reinsurance brokers, of which AON Reinsurance Agency accounted for approximately
24.2%, Guy Carpenter & Co., Inc. accounted for approximately 15.4%, and E.W.
Blanch Co. accounted for approximately 12.2%. No other broker accounted for more
than 5% of the company's gross reinsurance premiums written for the year ended
December 31, 1998.
In order to reduce the potential adverse effect arising from the
termination of any specific business relationship, Chartwell seeks business from
a large number of reinsurance brokers and ceding companies. While management
believes that its relationships with these reinsurance brokers and ceding
companies are satisfactory, the termination of all or a substantial number of
these relationships could have a material adverse effect on the business and
operations of Chartwell.
Insurance Operations
Controlled Source Insurance. Controlled Source Insurance develops insurance
programs through specialty production sources with a focus on a specific line or
lines of business, with a limited geographic emphasis, and where the program
administrator's compensation is adjusted based on the underwriting results of
the business.
Controlled Source Insurance gross written premiums grew 4.3%, 81.3%, and
9.8% for the years ended December 31, 1998, 1997, and 1996, respectively, over
the prior year. The increases in premium reflect the geographic expansion of
existing programs as well as the development of new programs during the periods
shown.
5
The table set forth below shows the gross premiums written for Controlled
Source Insurance by INSCORP for the periods indicated:
Controlled Source Insurance
Gross premiums Written by Line of Business
(Dollars in thousands)
Year Ended December 31,
--------------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
Amount Total Amount Total Amount Total
-------- ----- -------- ----- -------- -----
Commercial Multiple Peril ................ $ 45,737 41.2% $ 48,404 45.4% $ 33,014 56.2%
General Liability ........................ 31,575 28.4 30,418 28.6 14,889 25.3
Automobile ............................... 23,354 21.0 22,267 20.9 10,849 18.5
Workers Compensation ..................... 4,224 3.8 4,169 3.9 -- --
Homeowners and Other ..................... 6,241 5.6 1,285 1.2 -- --
-------- ----- -------- ----- -------- -----
Total .................................... $111,131 100.0% $106,543 100.0% $ 58,752 100.0%
======== ===== ======== ===== ======== =====
During the year ended December 31, 1998, Chartwell wrote approximately
88.7% of its Controlled Source gross insurance premiums through four managing
general agents, of which Florida Intracoastal Underwriters accounted for
approximately 41.6%, HDR Insurance Services accounted for approximately 24.5%,
Inter-Reco accounted for approximately 11.7% and Professional Insurance
Underwriters accounted for approximately 10.9%. No other managing general agent
accounted for more than 5% of Chartwell's Controlled Source gross insurance
premiums written for such period.
In order to reduce the potential adverse effect arising from the
termination of any specific business relationship, Chartwell continues to seek
to establish and develop relationships with a large number of managing general
agents. While management believes that its relationships with its managing
general agents are satisfactory, the termination of all or a substantial number
of these relationships could have a material adverse effect on the business and
operations of Chartwell.
CMA Dedicated Facilities
Classes of business covered by CMA's syndicates include marine, non-marine
property, non-marine liability, aviation, motor and life. CMA manages seven
Lloyd's syndicates with total underwriting capacity of approximately (pound)300
million ($500 million) for the 1999 year of account. Approximately 46% of CMA
syndicates' 1999 capacity is supplied by Chartwell.
CMA Dedicated Corporate Capital Facilities
Gross Premiums Written by Lloyd's Market Segment
(Dollars in thousands)(1)
Year Ended December 31,
--------------------------------------------------
1998 1997
------------------- ---------------------
Amount % of Total Amount % of Total
------ ---------- ------ ----------
Motor .................. $36,212 49.9% $ 7,445 37.0%
Non-Marine ............. 31,121 42.9 9,969 49.6
Aviation ............... 3,194 4.4 1,569 7.8
Marine ................. 1,757 2.4 984 4.9
Life ................... 289 0.4 146 0.7
------- ----- ------- -----
Total .................. $72,573 100.0% $20,113 100.0%
======= ===== ======= =====
(1) Business at CMA is conducted in pounds sterling. The dollar amounts shown
here have been converted from pounds sterling at the average exchange rate for
each of the years presented. Data is not shown for years prior to 1997 because
Chartwell acquired CMA in November 1996, and Chartwell's consolidated results
prior to 1997 did not include amounts attributable to CMA. All amounts are
presented in accordance with U.S. GAAP.
6
Retrocessional Arrangements
Chartwell utilizes retrocessions primarily to provide protection from large
or multiple losses and may in the future use additional retrocessions to
increase underwriting capacity. Chartwell seeks to establish long-term
relationships with its leading retrocessionaires in order to achieve continuity
and stability of coverage. Chartwell purchases property catastrophe coverage for
its Global, Regional and Specialty Accounts business to provide coverage for
losses arising from an aggregation of claims under various insurance policies
from a single event. Chartwell's current property catastrophe program, effective
January 1, 1999, provides 100% coverage for $9.5 million of exposure
in excess of a $2.5 million retention, with additional coverage provided by
reinstatement provisions. In addition, during 1998, Chartwell purchased a
property catastrophe program to protect against an accumulation of losses for
Chartwell and INSCORP from the same event; this program provides 100% coverage
for $2.5 million of exposure in excess of a combined $2.0 million retention,
with additional coverage provided by reinstatement provisions. INSCORP purchases
specific reinsurance programs for each of the programs underwritten.
Chartwell renewed its retrocessional marine program, as of April 1, 1998,
which provides $1.45 million of coverage, per risk or per event, in excess of a
$0.3 million retention, with additional coverage provided by reinstatement
provisions.
In 1997 and 1998, the Company entered into aggregate excess of loss
treaties. These treaties provide the Company with a layer of protection against
adverse results in all lines of business in excess of specified loss ratios.
Liabilities held by the Company under such treaties were $37.0 million and $10.5
million at December 31, 1998 and 1997, respectively.
Since Chartwell is contingently liable with respect to reinsurance ceded in
the event that a retrocessionaire is unable to meet its obligations assumed
under a retrocession agreement, the financial strength of each retrocessionaire
is evaluated. As of December 31, 1998, the reinsurance recoverable balance of
Chartwell Reinsurance of $86.5 million is attributable to retrocessional
arrangements with over 140 retrocessionaires. At December 31, 1998, Chartwell
Reinsurance had a reserve for uncollectable reinsurance of $3.4 million.
As of December 31, 1998, the reinsurance recoverable balance of INSCORP of
$156.8 million was attributable to retrocessional arrangements with over 290
retrocessionaires. At December 31, 1998, INSCORP had a reserve for uncollectable
reinsurance of approximately $3.0 million.
Claims
Chartwell's claims department analyzes loss exposure in order to
establish case reserves, pays claims and assists in the underwriting process by
reviewing the claims activities of prospective ceding companies. In performing
these functions, the claims department consults with Chartwell's underwriting
and actuarial departments. The claims department also assists the accounting
department in reporting Chartwell's retrocessional claims and in seeking
collection of such claims on a timely basis.
In evaluating loss exposure, Chartwell's claims department reviews loss
reports received from ceding companies to confirm that submitted claims are
covered under the contract terms, establishes reserves on an individual case
basis and monitors the adequacy of such reserves. The department also tracks
industry loss activity as well as other industry trends to facilitate
management's evaluation of Chartwell's overall risk profile. Chartwell also has
an environmental claims unit to evaluate the complex toxic tort and latent
injury claims inherited through the Piedmont Merger.
Reserves
General. A significant period of time may elapse between each of: (i) the
occurrence of an event causing an insured loss; (ii) the reporting of the loss
to the ceding company; (iii) the reporting of the loss by the ceding company to
Chartwell; (iv) the ceding company's adjustment and payment of the loss; and (v)
payment to the ceding company by Chartwell. To recognize liabilities for unpaid
losses, Chartwell establishes loss and loss expense reserves which are balance
sheet liabilities representing estimates of future amounts needed to pay claims
and related expenses with respect to insured events. Loss and LAE reserves have
two components: case loss and LAE reserves, which are estimates of future loss
and LAE with respect to insured events that have been reported to the reinsurer,
and incurred but not reported reserves ("IBNR"). IBNR reserves are actuarially
determined and reflect (i) an estimate of the ultimate loss amount that will be
paid by the reinsurer on claims that have occurred but have not yet been
reported to the reinsurer and (ii) the expected change in the value of those
claims that have already been reported to the reinsurer.
When a claim is reported to the ceding company, its claims personnel
establish a liability for the estimated amount of the ultimate settlement cost
of the reported claim. The estimate reflects the judgment of the ceding company,
based on the experience and knowledge of its claims personnel, regarding the
nature and value of the claim. The ceding company may periodically adjust the
amount of case reserves as additional information becomes known or partial
payments are made.
Upon notification of loss from a ceding company, Chartwell establishes case
reserves, including LAE, based upon Chartwell's share of the amount of reserves
established by the ceding company and Chartwell's independent evaluation of the
loss. Where appropriate, Chartwell establishes case reserves in excess of its
share of the reserves established by the ceding company. These reserves are
periodically reviewed by Chartwell's claims department based on its evaluation
of reports from the ceding company and its audits of claims activities of the
ceding company.
7
During the claims settlement period, which may extend over a protracted
period of time, additional facts regarding claims and trends may become known.
As Chartwell becomes aware of new information, it may adjust its estimates of
its ultimate liability. The revised estimates of ultimate liability may prove to
be less than or greater than the actual settlement or award amount for which the
claim is finally discharged.
Actuarial Methods. Chartwell utilizes the two most common methods of
actuarial evaluation used within the insurance industry, the
Bornhuetter-Ferguson method and the loss development method. The
Bornhuetter-Ferguson method involves the application of selected loss ratios to
Chartwell's earned premiums to determine estimates of ultimate expected loss and
LAE for each underwriting year. Multiplying expected losses by underwriting year
by a selected loss reporting pattern gives an estimate of reported and
unreported IBNR losses. When the IBNR is added to the loss and LAE amounts with
respect to claims that have been reported to date, an estimated ultimate
expected loss results. This method provides a more stable estimate of IBNR that
is insulated from wide variations in reported losses. In contrast, the loss
development method extrapolates the current value of reported losses to ultimate
expected losses by using selected reporting patterns of losses over time. The
selected reporting patterns are based on historical information (organized into
loss development triangles) and are adjusted to reflect the changing
characteristics of the book of business written by Chartwell.
Chartwell employs a combination of both methods outlined above. For the
older years, when reported losses have generally stabilized, Chartwell gives
greater weight to the loss development result. For the more recent years, when
reported loss activity is either less reliable in the aggregate or non-existent,
Chartwell gives greater weight to the Bornhuetter-Ferguson method. Because
losses are reported relatively earlier for property and other short tail
coverages, the weighting for those types of coverages shifts from the
Bornhuetter-Ferguson method to the loss development method at an earlier point
than for casualty and other long tail coverages.
In the reserve setting process, Chartwell includes provisions for inflation
and "social inflation" if appropriate, as losses are generally not determined
until some time in the future. Chartwell continually monitors legislative
activity and evaluates the potential effect of any legislative changes on its
reserve liabilities.
Chartwell's reserves are carried at the full amount estimated for ultimate
expected losses and LAE without any discount to reflect the time value of money
in accordance with both Statutory Accounting Practices ("SAP") and Generally
Accepted Accounting Principles ("GAAP").
Chartwell's actuarial department regularly performs loss reserve analyses
for Chartwell Reinsurance and INSCORP. Such loss reserves are also reviewed by
Milliman & Robertson, Inc. ("M&R"), an independent actuarial consulting firm,
which prepared a Statement of Actuarial Opinion as of December 31, 1998 for each
of Chartwell Reinsurance and INSCORP (the "M&R Statements"). The M&R Statements
were prepared solely for the use of and only to be relied upon by Chartwell and
the various state insurance departments with which Chartwell files annual
statements. The M&R Statements were not prepared for the use of investors.
Chartwell provides capital to its Dedicated CCV's which support the
underwriting capacity of the Lloyd's syndicates managed by CMA. Loss reserves
for this business are established using methods similar to those used by
Chartwell Reinsurance and INSCORP. CMA, a subsidiary of Chartwell, has engaged
Bacon & Woodrow London Market Services Ltd. ("B&W"), an independent actuarial
consulting firm, to review the loss reserves and prepare an actuarial opinion
for each of its syndicates, including the actuarial opinion required by Lloyd's
solvency regulations. The B&W opinions, which are prepared solely for the use of
Lloyd's regulators and are only to be relied upon by CMA, assist its syndicates
in establishing appropriate reserve estimates for both the reinsurance to close
and the open years of account.
Analysis of Reserve Development. The following table presents the
development of reserves of Chartwell Reinsurance for losses and LAE for calendar
years 1988 through 1998. The first line of the table sets forth the estimated
liability for losses and LAE for claims arising in each of the indicated years
as recorded on the balance sheet of Chartwell Reinsurance as of the end of years
1988-1994, including IBNR. For the years ended December 31, 1995, 1996, 1997 and
1998, the first line includes the consolidated reserves of Chartwell Reinsurance
and INSCORP. For the years ended December 31, 1997 and 1998 the first line also
includes the loss reserves associated with the capital provided by Chartwell to
the Dedicated CCV's. The upper portion of the table shows the cumulative amounts
paid as of the end of each successive year for such claims. The bottom portion
of the table also shows the re-estimated amount of the previously recorded
liability based on experience as of the end of each succeeding year, including
cumulative payments. The estimates are readjusted as more information becomes
known about the frequency and severity of claims for each year. A redundancy
(deficiency) exists when the original liability estimate is greater (less) than
the re-estimated liability at the end of a year. The cumulative redundancy
(deficiency) shown in the table is the aggregate net change in estimate over the
period of years subsequent to the calendar year reflected at the top of the
particular columns.
8
In evaluating the information in the table, it should be noted that each
amount entered incorporates the effects of all changes in amounts entered for
prior periods. Thus, if the 1998 estimate for a previously incurred loss was
$150,000 and the loss was reserved at $100,000 in 1988, the $50,000 deficiency
(later estimate minus original estimate) would be included in the cumulative
redundancy (deficiency) in each of the years 1988-1998 shown in table. It should
further be noted that the table does not present accident or policy year
development data. In addition, conditions and trends that have affected the
development of liability in the past may not necessarily recur in the future.
Accordingly, it may not be appropriate to extrapolate future redundancies or
deficiencies from the table.
9
Analysis of Loss and LAE
Reserve Development
(Dollars in thousands)
Year Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995
- ------------------------------------------------------------------------------------------------------------------------------------
Reserves for Loss and LAE(1) $ 156,869 $ 130,939 $ 126,746 $ 126,292 $ 189,386 $ 201,013 $ 232,733 $741,467
Cumulative paid as of:
One year later 39,084 15,946 19,745 9,074 31,354 30,085 46,363 157,172
Two years later 53,101 34,928 26,338 24,227 49,686 57,368 73,462 255,876
Three years later 69,914 40,622 39,933 37,935 68,147 73,926 90,999 334,819
Four years later 75,034 52,514 52,436 51,135 78,135 84,281 101,430
Five years later 86,463 63,479 62,922 56,822 84,402 90,577
Six years later 97,020 72,347 68,070 60,207 88,111
Seven years later 104,840 76,481 70,839 62,689
Eight years later 108,913 78,808 73,147
Nine years later 111,223 80,976
Ten years later 113,341
Reserves re-estimated as of:
One year later 158,048 129,333 125,919 126,926 192,496 204,094 233,738 754,286
Two years later 156,185 128,655 127,627 126,193 192,363 206,965 232,964 764,432
Three years later 155,224 132,406 128,740 127,102 194,876 205,369 229,253 735,913
Four years later 161,868 132,783 129,707 127,459 193,369 201,458 224,428
Five years later 159,912 133,112 129,989 126,004 188,594 197,919
Six years later 160,195 132,474 129,996 122,525 186,298
Seven years later 162,142 133,808 127,239 119,309
Eight years later 163,268 131,627 124,279
Nine years later 161,525 129,273
Ten years later 159,171
Cumulative redundancy (deficiency) (2,302) 1,666 2,467 6,983 3,088 3,094 8,305 5,554
Cumulative % (1.5%) 1.3% 1.9% 5.5% 1.6% 1.5% 3.6% 0.7%
- ---------------------------------------------------------------------------
1996 1997 1998
- ---------------------------------------------------------------------------
Reserves for Loss and LAE(1) $ 747,858 $ 788,240 $ 878,617
Cumulative paid as of:
One year later 196,470 154,697
Two years later 297,598
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Reserves re-estimated as of:
One year later 758,748 766,462
Two years later 730,954
Three years later
Four years later
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative redundancy (deficiency) 16,904 21,778
Cumulative % 2.3% 2.8%
- ---------------
(1) Reserves for loss and LAE are presented net of reinsurance recoverables for
the periods 1988 through 1991. In 1992, Chartwell adopted SFAS No. 113 which,
among other things, requires Chartwell to record its reserves for unpaid losses
and LAE without reduction for amounts that would be recovered from
retrocessionaires. The amount recoverable from retrocessionaires is recorded as
an asset on Chartwell's balance sheet. The net of such asset and the reserves
for loss and LAE is $639.6, $585.6, $575.5, $561.6, $197.3 and $167.4 million at
December 31, 1998, 1997, 1996, 1995, 1994, 1993, respectively.
10
Net reserves on accident years since 1988 have developed modest
redundancies or deficiencies. The gross redundancy of $21.8 million at December
31, 1998 becomes a net redundancy of $7.4 million after accounting for
reinsurance recoverables. (See Note 12 of the Notes to Consolidated Financial
Statements contained herein).
Commutation of treaties and large loss payments distort the payment
patterns represented in the table. In 1989, Chartwell Reinsurance commuted an
assumed treaty for $18.0 million affecting calendar years from 1986 to 1989. The
commutation ensured that no further adverse development on that treaty occurred
in subsequent years. In 1992, Chartwell Reinsurance commuted a retrocession
arrangement which resulted in a reduction of net paid losses for the prior
calendar years of $4.4 million. In 1993, Chartwell Reinsurance paid
approximately $12.0 million in gross losses related to Hurricanes Andrew and
Iniki. In 1995, Chartwell Reinsurance paid $10.9 million to settle three large
claims from business written prior to 1986 and to commute a group of assumed
contracts from business written prior to 1995.
At December 31, 1998, the GAAP basis reserves, before reduction for ceded
reinsurance, were $878.6 million compared to SAP basis reserves, before
reduction for ceded reinsurance, of $878.3 million. The difference is due to
adjustments for foreign currency transactions. At December 31, 1998, 1997 and
1996, GAAP basis reserves, net of amounts recoverable from retrocessionaires,
were $639.6 million, $585.6 million and $575.5 million, respectively, compared
to SAP net reserves of $598.9 million, $548.0 million and $537.2 million,
respectively. The significant differences between GAAP and SAP amounts are
mainly due to the implementation of Statement of Financial Accounting Standards
No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and
Long-Duration Contracts" ("SFAS No. 113") (approximately $39.5 million for each
of 1998, 1997 and 1996). The remaining difference relates principally to foreign
exchange adjustments.
Activity for loss and loss adjustment expenses as of December 31, 1998,
1997 and 1996 is herein incorporated by reference to Note 12 of the consolidated
financial statements of Chartwell included elsewhere herein.
Management believes that Chartwell's reserves are adequate. However, the
process of estimating reserves is inherently imprecise and involves an
evaluation of many variables, including potentially unpredictable social and
economic conditions. Accordingly, there can be no assurance that Chartwell's
ultimate liability will not vary significantly from amounts reserved. The
inherent uncertainties of estimating such reserves are greater for reinsurers
than for primary insurers, primarily due to the longer-term reporting nature of
the reinsurance business, the diversity of development patterns among different
types of reinsurance, the necessary reliance on ceding companies for information
regarding reported claims and differing reserving practices among ceding
companies. Reserves also include provisions for latent injury or toxic tort
claims that cannot be estimated with traditional reserving techniques. Because
of inconsistent court decisions in federal and state jurisdictions and the wide
variation among insureds with respect to underlying facts and coverage,
uncertainty exists with respect to these claims as to liabilities of ceding
companies and, consequently, reinsurance coverage. Management believes that
Chartwell Reinsurance's exposure to such latent losses is lessened because of
its relatively recent entry into the reinsurance business in 1979, its low
historical levels of premium volume prior to 1985 and its retrocessional
programs. In addition, management believes that INSCORP's exposure to adverse
development related to latent losses is lessened because a significant portion
of the $25 million net reserve strengthening recorded by INSCORP in 1995 was in
respect of such losses. In addition, the amount payable under Chartwell Re's
Contingent Interest Notes due 2006 (the "CI Notes") is subject to reduction in
the event of such adverse reserve development.
Reserves for Chartwell's participation in Lloyd's syndicates through its
Dedicated CCV's are included in the 1997 and 1998 year end reserves. Part of the
reserve represents reinsurance to close balances brought forward to the open
years of account (for example, 1995 reinsured into the 1996 open year).
Favorable or unfavorable development of the prior year's reserves can influence
the results of the open years of 1996, 1997 and 1998. Consequently, there can be
no assurance as to the adequacy of reserves and the risk of future developments,
both favorable and unfavorable, exists.
11
The following table presents a three-year development of Chartwell's
reserves for losses and LAE associated with environmental and other latent
injury claims. All of the development relates to business written prior to 1984.
Year Ended December 31,
(Dollars in thousands)
-----------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------
Gross Net Gross Net Gross Net
------- ------- ------- ------- ------- -------
Liability, beginning of year ................... $70,923 $48,052 $65,717 $46,958 $66,936 $46,450
Incurred during the year ....................... 15,387 13,244 19,851 8,660 9,482 6,538
Less amount paid during the year ............... 7,336 6,370 14,645 7,566 10,701 6,030
------- ------- ------- ------- ------- -------
Liability, end of year ......................... $78,974 $54,926 $70,923 $48,052 $65,717 $46,958
======= ======= ======= ======= ======= =======
Deficiency for year ............................ $15,387 $13,244 $19,851 $ 8,660 $ 9,482 $ 6,538
======= ======= ======= ======= ======= =======
At December 31, 1998, Chartwell Reinsurance carried loss and LAE reserves
of $351.2 million ($268.1 million after reduction for reinsurance recoverable),
of which $10.8 million gross ($6.6 million after reduction for reinsurance
recoverable), were loss reserves and allocated LAE attributable to asbestos
claims and environmental pollution claims. For the three years ended December
31, 1998, the effect of asbestos and environmental pollution claims was not
material to Chartwell Reinsurance's results of operations.
At December 31, 1998, INSCORP carried loss and LAE reserves of $394.3
million ($253.8 million after reduction for reinsurance recoverable), of which
$68.2 million ($48.3 million after reduction for reinsurance recoverable) were
case reserves and allocated LAE attributable to asbestos claims and
environmental pollution claims.
Of the 1998 net deficiency of $13.2 million for asbestos and environmental
reserves, $11.3 million results from development on business underwritten by
INSCORP prior to the Piedmont Merger and, therefore, is subject to the
protection provided by the CI Notes, as described below. However, due to the
favorable development on non-asbestos and non-environmental exposed business
underwritten by INSCORP prior to the Piedmont Merger, there was no net adverse
development on the reserves covered by the CI Notes for the year ended December
31, 1998.
Reserve Indemnification Agreement. In connection with the 1992 Acquisition,
Chartwell Re entered into a reserve indemnification agreement (the "Reserve
Indemnification Agreement") with NWNL and its parent company, ReliaStar
Financial Corporation ("RLR"), pursuant to which NWNL and RLR agreed jointly and
severally to provide to Chartwell Re limited indemnification and reimbursement
for adverse development of the net loss and LAE reserves and related accounts
(the "Covered Reserves") of Chartwell Reinsurance for accident years ending on
or before December 31, 1991 (the "Covered Years"). Pursuant to the Reserve
Indemnification Agreement as originally drafted, if Chartwell Reinsurance's
Covered Reserves as of December 31, 1996 for the Covered Years were greater than
its Covered Reserves as of December 31, 1991, RLR and NWNL would jointly and
severally indemnify and reimburse Chartwell Re at that time in an amount equal
to (i) 85% of the first $20 million of such difference in excess of $100,000
plus (ii) 60% of the next $10 million of such difference, up to a maximum amount
of $23 million, representing 18% of loss reserves as of December 31, 1991. If
Chartwell Reinsurance's Covered Reserves as of December 31, 1996 for the Covered
Years were less than its Covered Reserves as of December 31, 1991, Chartwell Re
agreed to reimburse NWNL at that time in an amount equal to fifty percent (50%)
of the first $10 million of such difference in excess of $100,000, up to a
maximum amount of $5 million. The Reserve Indemnification Agreement, which by
its terms was scheduled to be settled as of the end of 1996, was settled early
by mutual agreement with RLR. On June 28, 1996, Chartwell Re received $7.9
million as a final settlement of the Reserve Indemnification Agreement. The
settlement did not materially affect operating results for the year.
Contingent Interest Notes. Upon consummation of the Piedmont Merger,
Chartwell Re assumed all of Piedmont's obligations under the CI Notes which were
issued by Piedmont to its stockholders just prior to the Piedmont Merger. The CI
Notes, which mature on June 30, 2006, are designed to provide Chartwell Re with
protection against adverse development of INSCORP's reserves for losses and loss
adjustment expenses. In the event there is no adverse development, Chartwell Re
will be required to pay the holders of the CI Notes approximately $55 million in
contingent interest. This contingent interest payment is in addition to the $1
million principal amount of the CI Notes and interest on such principal amount
at 8% per annum (collectively, the "Fixed Amount") which Chartwell Re in any
event must pay at maturity or earlier redemption of the CI Notes.
12
In general, assuming the CI Notes are settled at maturity, the contingent
interest will be equal to $55 million (a) less an amount equal to (i) the amount
of any adverse development of the loss and LAE reserves and related accounts
(including certain reinsurance recoverable, commissions and unearned premiums)
of INSCORP recorded as of March 31, 1995, minus (ii) $25 million, (b) plus the
amount of certain tax benefits received or recorded by Chartwell Re as a result
of the amount determined pursuant to clause (a) above. The amount so calculated
may not be greater than $55 million nor less than a minimum amount equal to the
lesser of (a) $10 million less the Fixed Amount and (b) the tax benefits
referred to above. In the event that the CI Notes are settled prior to maturity,
the foregoing formula will in general apply, except that the $55 million maximum
amount of the CI Notes will be reduced to an amount equal to $55 million
discounted back from June 30, 2006 at a discount rate of 8% per annum,
compounded annually, and the tax benefits will be calculated in a prescribed
manner.
The carrying value of the CI Notes on Chartwell Re's consolidated financial
statements at December 31, 1998 was $32.1 million, representing the sum of the
aggregate principal amount of the CI Notes and the present value as of such date
of the maximum amount of contingent interest payable on the CI Notes at their
stated maturity in 2006. During the term of the CI Notes, the discounted
carrying value of the CI Notes will be increased to reflect accretion of (i)
interest on the principal amount and (ii) the discounted contingent interest. To
the extent that adverse development of INSCORP's reserves (including IBNR
reserves) occurs prior to the maturity or redemption of the CI Notes, the
contingent interest payable on the CI Notes (and, therefore, the then-current
carrying value of such CI Notes) will be reduced. Such reductions in the
carrying value of the CI Notes would offset in part, in the period in which such
adverse development occurs, any reduction in Chartwell Re's GAAP net income and
stockholders' equity resulting from such adverse reserve development (that
would, however, still be reflected in the Company's statutory underwriting
results and in the policyholders' surplus of INSCORP and, if INSCORP continues
to be a subsidiary thereof, of Chartwell Reinsurance).
At its option, Chartwell Re may settle the CI Notes with shares of Common
Stock of Chartwell Re instead of payment of cash. For purposes of settlement of
the CI Notes, such Common Stock would be valued at 85% of its average closing
market price over a specified period prior to the settlement date. However,
Chartwell Re may not settle the CI Notes in Common Stock unless (i) such stock
is registered under the Securities Act (or is otherwise freely tradeable other
than by certain affiliates of Chartwell Re), (ii) such stock is listed on a
national securities exchange or NASDAQ and (iii) all CI Notes are settled in
such Common Stock. Moreover, Chartwell Re may not settle the CI Notes in Common
Stock if the CI Notes are being settled following acceleration thereof due to an
event of default under the CI Notes.
Investments
Chartwell's investment policies are established and approved by its Board
of Directors. Chartwell's investment policy is to maintain a portfolio with an
average rating of A or better from Moody's Investors Service ("Moody's") and to
retain such securities for sale in response to changes in interest rates and
liquidity needs. However, it is not Chartwell's policy to sell securities merely
to generate profits on short-term differences in price. The performance of
Chartwell's advisors and the fees associated therewith are periodically reviewed
by both management and the Board of Directors of Chartwell. Investments by
Chartwell Reinsurance, INSCORP and Dakota must comply with the insurance laws of
the States of Minnesota, New York and North Dakota, their respective domiciliary
states.
Chartwell's investment portfolio consists primarily of investment-grade
fixed maturity debt securities. As of December 31, 1998, approximately 92.2% of
the fixed income portfolio (exclusive of cash and investments held by CMA
managed syndicates) was rated A or better by Moody's.
13
The following table summarizes the investments of Chartwell (at carrying
value):
Composition of Investment Portfolio
(Dollars in thousands)
December 31,
-----------------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- ---------------------
Amount % of Total Amount % of Total Amount % of Total
-------- ---------- -------- ---------- -------- ----------
Fixed Income Securities
Corporate ........................................... $240,442 29.5% $225,587 30.8% $200,899 29.8%
U.S. Government & Government Agency (1) ............. 212,088 26.0 240,226 32.8 249,416 37.0
Obligations of States & Political Subdivisions ...... 171,883 21.0 161,544 22.1 134,769 20.0
Foreign Government & Government Agency .............. 28,456 3.5 28,867 3.9 23,807 3.5
Redeemable Preferred Stocks ......................... 37,422 4.6 38,379 5.2 33,773 5.0
Other (2) ............................................... 36,358 4.5 38,043 5.2 30,896 4.7
Investments Held by CMA Managed Syndicates .............. 89,228 10.9 -- -- -- --
-------- ----- -------- ----- -------- -----
Total Investments ....................................... $815,877 100.0% $732,646 100.0% $673,560 100.0%
======== ===== ======== ===== ======== =====
Cash & Cash Equivalents ................................. $ 60,319 $ 29,534 $ 50,343
======== ======== ========
- ----------
(1) At December 31, 1998, 1997 and 1996, $98.7, $107.1 and $170.2 million of
these securities were backed by the full faith and credit of the U.S. Government
and $113.4, $133.1 and $79.2 million were obligations of issuing agencies.
(2) Other investments include equity securities and partnership interests. In
1996, Chartwell made a commitment to invest $15 million in a private equity
fund, High Ridge Capital Limited Partnership, which makes investments in the
insurance industry. Chartwell has contributed a total of $9.8 million to this
fund as of December 31, 1998.
The following table reflects investment results for Chartwell for the
periods indicated:
Investment Results
(Dollars in thousands)
Year Ended December 31,
--------------------------------------
1998 1997 1996
--------- --------- ---------
Average Invested Assets ......................................... $ 792,921 $ 723,174 $ 716,004
Net Investment Income (1) ....................................... $ 48,824 $ 43,457 $ 43,598
Net Effective Yield (2) ......................................... 6.2% 5.9% 6.2%
Net Realized Capital Gains (Losses).............................. $ 29 $ (3) $ 1,157
Effective Yield Including Realized Capital Gains (Losses)(3)..... 6.2% 5.9% 6.3%
- ----------
(1) After investment expenses, excluding net realized investment gains (losses).
(2) Net investment income for the year-end period divided by average invested
assets for the same period.
(3) Net investment income for the year-end period plus net realized capital
gains (losses) for the period divided by average invested assets for the same
period.
14
The following table indicates the composition of Chartwell's fixed income
portfolio (at carrying value), excluding cash and cash equivalents and cash and
investments held by CMA managed syndicates, by rating:
Composition of Fixed Income Portfolio
By Rating (1)
(Dollars in thousands)
December 31, 1998
----------------------
Amount Percent
-------- -------
U.S. Government and Government Agency Fixed Income Securities ..... $212,088 30.7%
Aaa ............................................................... 164,399 23.8
Aa ................................................................ 92,856 13.5
A ................................................................. 163,331 23.7
Baa ............................................................... 57,617 8.3
-------- -----
Total ......................................................... $690,291 100.0%
======== =====
(1) Rating as assigned by Moody's. Such ratings are generally assigned upon the
issuance of the securities and subject to revision on the basis of ongoing
evaluations. Ratings in the table are as of the date indicated. Those government
guaranteed securities that are specifically rated are included in the
appropriate rating category.
Moody's rating system utilizes nine symbols to indicate the relative
investment quality of a rated bond. Aaa rated bonds are judged to be of the best
quality and are considered to carry the smallest degree of investment risk. Aa
rated bonds are also judged to be of high quality by all standards. Together
with Aaa bonds, these bonds comprise what are generally known as high grade
bonds. Bonds rated A possess many favorable investment attributes and are
considered to be upper medium grade obligations. Baa rated bonds are considered
as medium grade obligations; they are neither highly protected nor poorly
secured. Bonds rated Ba or lower (those rated B, Caa, Ca and C) are considered
to be too speculative to be of investment quality.
National Association of Insurance Commissioners ("NAIC") investment ratings
are provided annually at December 31 of each year. At December 31, 1998, 88.6%
of Chartwell's fixed maturity investments (excluding investments held by CMA
managed syndicates) were rated "Class 1," and 11.4% of Chartwell's fixed
maturity investments (excluding investments held by CMA managed syndicates) were
rated "Class 2," the two highest ratings assigned by the NAIC.
The following table indicates the composition of Chartwell's fixed income
portfolio (at carrying value), excluding cash and cash equivalents and cash and
investments held by CMA managed syndicates, by time to maturity (1) (dollars in
thousands):
December 31, 1998
-----------------------
Amount Percent
-------- -------
One year or less ............................. $ 33,918 4.9%
Over 1 year through 5 years .................. 194,558 28.2
Over 5 years through 10 years ................ 198,138 28.7
Over 10 years through 20 years ............... 46,381 6.7
Over 20 years ................................ 79,815 11.6
Mortgage backed securities ................... 137,481 19.9
-------- -----
Total .................................... $690,291 100.0%
======== =====
(1) Based on stated maturity dates without prepayment assumptions.
Certain mortgage backed securities are subject to prepayment risk. Mortgage
backed securities represent 15.7% of Chartwell's total cash and investments at
December 31, 1998. During periods of significant interest rate volatility, the
underlying mortgages may prepay more quickly than anticipated. If the repayment
of principal occurs earlier than anticipated during periods of declining
interest rates, investment income may decline due to the reinvestment of these
funds at the lower current market rates. Management does not believe that the
prepayment risk associated with Chartwell's portfolio of mortgage backed
securities is significant.
15
The following table sets forth certain information concerning Chartwell's
mortgage backed investments:
Distribution of Mortgage Backed Securities Portfolio
By Type (1)
(Dollars in thousands)
December 31, 1998
--------------------------------------------
Estimated
Market Amortized
Value Cost Par Value
-------- -------- --------
Collateralized Mortgage Obligations .................... $ 22,563 $ 22,112 $ 22,754
Pass-throughs (primarily GNMA, FNMA and FHLMC) ......... 114,918 112,733 112,314
-------- -------- --------
Total .............................................. $137,481 $134,845 $135,068
======== ======== ========
- ----------
(1) At December 31, 1998, agency backed securities represented 97.0% of
Chartwell's mortgage backed investments. Other mortgage backed securities
represented 3.0%. These other mortgage backed securities are rated either Aaa or
A which is the highest rating category used by the SVO.
Competition
The property and casualty reinsurance and insurance business is highly
competitive. Competition with respect to the types of reinsurance and insurance
in which Chartwell is engaged is based on many factors including perceived
overall financial strength of the insurer, ratings of the insurer by A.M. Best
Company and Standard & Poor's, underwriting expertise, reputation and experience
in the lines written, premiums charged, other terms and conditions of the
insurance or reinsurance offered, services offered, and speed of claims
payments.
Chartwell competes with numerous international and domestic reinsurance and
insurance companies. These competitors, many of which have substantially greater
financial and staff resources than Chartwell, include independent insurance and
reinsurance companies, as well as subsidiaries, affiliates or insurance or
reinsurance departments of established insurance companies and underwriting
syndicates.
Insurance Regulation
General. Chartwell Reinsurance, INSCORP and Dakota are subject to the
insurance laws and regulations of Minnesota, New York and North Dakota,
respectively, their domiciliary states, and to administrative supervision by the
regulatory authorities of such states. In addition, each is subject to similar
laws, regulations and supervision in the various states in which it is licensed
or authorized to transact business, primarily with regard to solvency,
accounting practices, reports on financial condition and operations, investments
and reserves. Under state insurance law, property and casualty reinsurers and
surplus lines insurers are generally not subject to filing or other regulatory
requirements applicable to primary insurers with respect to rates, policy forms
or contract wording. Licensed insurers such as INSCORP are required to comply
with all applicable filing or regulatory requirements. In supervising and
regulating insurance companies, including reinsurers, state agencies, charged
primarily with protecting policyholders and the public rather than investors,
enjoy broad authority and discretion in applying applicable insurance laws and
regulations for the protection of policyholders and the public.
Lloyd's. Both CMA and the Dedicated CCV's, as a Lloyd's managing general
agent and Lloyd's corporate members, respectively, are subject to regulation and
supervision by the Council of Lloyd's. Lloyd's operates under a self-regulatory
regime under the Lloyd's Act 1982 and has the power to set, interpret and change
the rules which govern the operation of the Lloyd's market, subject to
regulation for solvency purposes by the Financial Services Authority ("FSA").
Lloyd's prescribes, in respect of its managing agents and corporate members,
certain minimum standards relating to their management and control, solvency and
various other requirements. In addition, Lloyd's imposes restrictions against
persons becoming controllers and major shareholders of managing agents and
corporate members without the consent of Lloyd's first having been obtained. The
United Kingdom government has established the FSA as a single regulator to
supervise securities, banking and insurance business, including Lloyd's. When
the Financial Services and Market Bill becomes law, probably in late 2000, the
FSA will have wide authorization and intervention powers in relation to Lloyd's.
A consultation process has commenced in relation to Lloyd's regulatory
framework.
16
Insurance Holding Company Systems Regulations. Chartwell Reinsurance,
INSCORP and Dakota and their affiliates are subject to regulation pursuant to
the insurance holding company systems statutes of Minnesota, New York and North
Dakota. While the insurance holding company systems laws and regulations vary
from state to state, they generally require an insurance holding company and
insurers and reinsurers that are members of such insurance holding company's
system to register with the state regulatory authorities, to file with those
authorities certain reports disclosing information including their capital
structure, ownership, financial condition, certain intercompany transactions
including material transfers of assets and intercompany business agreements, and
to report material changes in such information. Such laws may also require that
intercompany transactions be fair and reasonable and that an insurer's
policyholder surplus following a dividend distribution to affiliated
stockholders be adequate to meet its financial needs.
In general, state insurance holding company systems statutes also require
prior notice to, or regulatory agency approval of, direct or indirect changes in
control of ownership of a domestic insurer or reinsurer. Under Minnesota, New
York and North Dakota law, no person, corporation or other entity may acquire,
directly or indirectly, a controlling interest in the capital stock of a
domestic insurer or reinsurer unless such person, corporation or other entity
has obtained prior approval from the insurer's domestic regulator ("Regulator")
for such acquisition of control. Pursuant to the Minnesota, New York and North
Dakota insurance holding company systems statutes, any person, corporation or
other entity acquiring, controlling or holding with the power to vote, directly
or indirectly, ten percent or more of the voting securities of an insurance
company (or reinsurer), is presumed to have "control" of such company. The party
may rebut this presumption by filing with the Regulator a disclaimer of
affiliation. Other jurisdictions where Chartwell Reinsurance, INSCORP or Dakota
are licensed to transact business may have similar requirements for an
acquisition of control of insurers or reinsurers licensed or authorized in such
jurisdictions. Additional requirements in such jurisdictions may include
relicensing or subsequent approval for renewal of existing licenses upon an
acquisition of control.
Restrictions on Dividends. The principal source of funds for servicing debt
of the Company and paying dividends to stockholders of Chartwell is derived from
receipt of dividends from its insurance subsidiaries. While dividend
restrictions vary from state to state, they generally require insurers and
reinsurers to pay dividends only from earned surplus, which is defined as
unassigned funds (surplus) as reported in the statutory financial statement
filed by the insurer or reinsurer with the Regulator for the most recent period.
Subject to such constraints, the insurer or reinsurer may declare and pay
non-extraordinary dividends, subject to certain notice requirements to the
Regulator, and extraordinary dividends to stockholders subject to certain notice
and approval requirements by the Regulator. Lastly, with respect to payments of
all dividends to affiliated shareholders, following the payment of such a
dividend, an insurer's or reinsurer's policyholders' surplus must be reasonable
in relation to its outstanding liabilities and adequate for its financial needs.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources."
On November 25, 1997, Chartwell Reinsurance paid a $3.0 million dividend to
Chartwell and on February 24, 1999, Chartwell Reinsurance paid a $5.5 million
dividend to Chartwell. No dividends were paid in 1996 or 1998.
Investment Limitations. State insurance laws and regulations prescribe the
kind, quality and concentration of investments that are permissible for
insurance and reinsurance companies domiciled in such state. The purpose of
these laws is to protect the interests of policyholders, claimants, creditors
and the general public by promoting the safety, yield and growth of an insurance
company's investment principal, the liquidity necessary to meet the insurance
company's expected business needs, and investment diversification. For example,
under Minnesota, New York and North Dakota law, non-life insurance companies,
such as Chartwell Reinsurance, INSCORP and Dakota are authorized to invest in
specifically prescribed investments. Subject to certain conditions, such
investments include federal, state and municipal government obligations, bank
obligations, obligations and stocks of corporations and business trusts, real
estate and mortgages on real estate, collateral loans, options, foreign and
other investments. Such investment obligations, however, may not be in default
as to payments of principal and interest. Property and casualty insurance and
reinsurance companies are subject to risk-based capital guidelines which could
influence investment decisions. See "Risk-Based Capital." Management of
Chartwell believes that Chartwell Reinsurance, INSCORP and Dakota are in
compliance with all applicable state insurance investment laws for non-life
insurance companies.
17
Regulatory Examinations. The business and operations of Chartwell
Reinsurance, INSCORP and Dakota are subject to periodic examination by the
insurance departments of the jurisdictions in which each is licensed or
authorized to transact business. The Regulators have broad authority to conduct
examinations at any time. The report made with respect to the most recent
periodic examination of Chartwell Reinsurance is dated as of December 31, 1994
and contained no material adverse findings. The most recent periodic examination
of INSCORP was as of December 31, 1993, and the report related to such
examination has not yet been released. The most recent report of examination of
Dakota is dated as of November 21, 1996 and contained no material adverse
findings.
Risk-Based Capital. In order to enhance the regulation of insurer solvency,
the NAIC adopted risk-based capital ("RBC") requirements for property and
casualty insurance and reinsurance companies commencing with filings made in
1995 covering the 1994 year. These RBC requirements are designed to monitor
capital adequacy and to raise the level of protection that statutory surplus
provides for policyholders. The RBC formula measures four major areas of risk
facing property and casualty insurers: (i) underwriting risk, which is the risk
of errors in pricing and reserves; (ii) asset risk, which is the risk of asset
default for fixed income assets and loss in market value for equity assets;
(iii) credit risk, which is the risk of losses from unrecoverable reinsurance
and the inability of insurers to collect agents' balances and other receivables;
and (iv) off-balance sheet risk, which is primarily the risk created by
excessive growth. Insurers and reinsurers having less statutory surplus than
that required by the RBC formula will be subject to varying degrees of
regulatory action depending on the level of capital inadequacy.
The RBC formula provides a mechanism for the calculation of an insurance
company's Authorized Control Level RBC and its total adjusted capital. The
formula sets forth the points at which a commissioner of insurance is authorized
and expected to take regulatory action. The first level is known as the Company
Action Level RBC, which is set at twice the Authorized Control Level RBC. The
second level is the Regulatory Action Level RBC, set at 1.5 times the Authorized
Control Level RBC. The third is the Authorized Control Level RBC, and the fourth
is the Mandatory Control Level RBC, set at 70 percent of the Authorized Control
Level RBC.
If an insurance company's adjusted capital is higher than or equal to the
Regulatory Action Level RBC but below the Company Action Level RBC, the
insurance company must submit to its commissioner of insurance an RBC plan which
shall contain, among other things, proposals of corrective action. If an
insurance company's adjusted capital is higher than or equal to the Authorized
Control Level RBC but lower than the Regulatory Action Level RBC, the
commissioner of insurance shall perform any examination or analysis as deemed
necessary of the insurer's business and operations and issue any appropriate
corrective orders to address the insurance company's financial problems. If an
insurer's adjusted capital is higher than or equal to the Mandatory Control
Level RBC but lower than the Authorized Control Level RBC, the commissioner may
place the insurer under regulatory control. If the insurance company's adjusted
capital falls below the Mandatory Control Level RBC, the commissioner will be
required to place the insurer under regulatory control. At December 31, 1998,
the adjusted capital of each of Chartwell Reinsurance, INSCORP and Dakota was
higher than the Company Action Level RBC, and as a result, no regulatory action
is required. Should a future deficiency occur, Chartwell will be subject to an
increased level of regulatory attention and, depending on the capital
deficiency, possibly to actual control by the appropriate regulatory
authorities. There can be no assurance that any such deficiency will not occur
in the future.
NAIC-IRIS Ratios. The NAIC's Insurance Regulatory Information System
("IRIS") was developed by a committee of state insurance regulators and is
primarily intended to assist state insurance departments in executing their
statutory mandates to oversee the financial condition of insurance companies
operating in their respective states. IRIS identifies 11 industry ratios and
specifies "usual values" for each ratio. Departure by an insurer from the usual
values on four or more of the ratios generally leads to inquiries from
individual state insurance commissioners as to certain aspects of such insurer's
business. Departure from a usual value does not necessarily indicate an adverse
condition, but rather a deviation from the norm.
For the year ended December 31, 1998, Chartwell Reinsurance fell outside
the range of usual IRIS values with respect to two ratios and INSCORP fell
outside the range of usual IRIS values with respect to one ratio. The Company
does not believe such 1998 ratios are indicative of an adverse condition. For
the year ended December 31, 1998, Dakota did not fall outside the range of usual
IRIS values with respect to any ratio.
18
Employees
As of December 31, 1998, Chartwell had 326 employees, including the
employees of its subsidiary, CMA. None of these employees is represented by a
labor union, and Chartwell believes that its employee relations are excellent.
Item 2. Properties.
Chartwell leases approximately 53,000 square feet of space for its
principal executive offices in Stamford, Connecticut. Chartwell also leases
approximately 39,000 square feet of space in London, England for the operations
of CMA. INSCORP is located in Jericho, New York, occupying approximately 1,150
square feet of office space. Management believes Chartwell's current office
space is adequate for its needs.
Item 3. Legal Proceedings.
In 1996 and early 1997, the Company entered into certain assumption of
liability endorsements ("ALEs") pursuant to an agreement with American Eagle
Insurance Company ("American Eagle"), which provided for the assumption of
certain policy liabilities by the Company in the event of an insolvency of
American Eagle. As part of such arrangements, the Company obtained from American
Eagle a trust fund to collateralize any potential obligations arising out of the
issuance of the ALEs by the Company. On December 3, 1997, American Eagle was
placed in receivership by the Texas Department of Insurance.
On June 16, 1998, the California Insurance Guarantee Association ("CIGA")
filed suit in the Superior Court of California, County of Los Angeles, against
INSCORP seeking, among other things, a declaratory judgment that the ALEs
covered claims arising prior to the dates upon which the ALEs were issued. On
September 1, 1998, the Superior Court of California granted INSCORP's motion to
strike those portions of CIGA's complaint which sought a general declaratory
judgment that all claims under American Eagle policies with ALEs attached are
the obligation of INSCORP rather than CIGA. CIGA's claim is now solely related
to the specific American Eagle policy and accompanying ALE initially giving rise
to the dispute.
On December 2, 1998, CIGA filed a second suit in the Superior Court of
California, County of Los Angeles, against INSCORP seeking a declaratory
judgment with respect to the obligation of INSCORP on a second claim arising
prior to the effective date of the applicable ALE. The Superior Court of
California has found that the two CIGA cases are related cases and they have
been assigned to the same judge.
The Company believes, and has been so advised by counsel handling the case,
that it has a number of valid defenses to the litigation pending against it.
Such cases are, and will continue to be, vigorously defended. However, it is not
possible to predict the outcome of such cases. Litigation is subject to many
uncertainties, and it is possible that such cases could be decided or settled
unfavorably. At this time, the Company does not believe that an unfavorable
decision or settlement of such cases would materially adversely affect the
Company's results of operations or financial position.
In addition to the foregoing lawsuits, the Company is subject to the
litigation of disputes and arbitration in the normal course of their business.
The Company does not believe that any such pending litigation or arbitration to
which it is a party, or of which any of its properties or assets are subject, is
likely to have a materially adverse effect on its current financial position or
results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the
fourth quarter of 1998.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
There is no established public trading market for the Company's common
stock. All of the outstanding shares of the Company's common stock are owned by
Chartwell Re.
The Company pays dividends from time to time upon the direction of its
Board of Directors; however, the agreements governing the Senior Notes (as
hereinafter defined) and the Credit Facility (as hereinafter defined) restrict
the ability of the Company to pay dividends based upon the operational
performance and liquidity of the Company.
19
Item 6. Selected Financial Data.
Information required by Item 6 has been omitted because the Registrant
meets the conditions set forth in General Instruction I (1) (a) and (b) of Form
10-K and is therefore filing this Annual Report on Form 10-K in the reduced
disclosure format.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial condition and results of
operations of Chartwell should be read in conjunction with the consolidated
financial statements and notes thereto of Chartwell included elsewhere herein.
The following discussion does not include any information relating to CMA's
historical results of operations prior to November 19, 1996 or INSCORP's
historical results of operations prior to December 13, 1995. CMA's results of
operations for the period from November 19, 1996 to December 31, 1996 were
immaterial to Chartwell and, therefore, have not been included. INSCORP's
results of operations for the period from December 13, 1995 to December 31, 1995
were immaterial to Chartwell; Chartwell has accounted for the Piedmont Merger as
though it had occurred on December 31, 1995.
Recent Industry Performance
The property and casualty insurance and reinsurance industry has
historically been highly cyclical. Demand for reinsurance is influenced
significantly by prevailing market conditions, including the underwriting
results of primary insurers. The supply of reinsurance is primarily related to
levels of underwriting capacity in the reinsurance industry and the relative
cost and terms of reinsurance coverage. The industry's profitability and the
cyclical trends in the industry can be affected significantly by volatile and
unpredictable developments, including the occurrence of natural disasters, other
catastrophic events, competitive pressures on pricing (premium rates),
fluctuations in interest rates, other variations in the investment environment,
changes in the judicial system regarding tort law, general economic conditions
and trends, such as inflationary pressures, that may tend to affect the size of
profits and losses experienced by ceding primary insurers and other factors such
as changes in tax laws and regulations. Many sectors of the industry are
currently in a cyclical downturn and it cannot be predicted if or when market
conditions will improve or when other sectors may experience a deterioration in
pricing and terms.
Commencing in the later part of the 1980s, primary property and casualty
insurers began to retain more of their business. This reduction in the amount of
business ceded to reinsurers, combined with the growth in reinsurance capacity,
resulted in renewed price competition and less attractive pricing for
reinsurers. This caused a downturn for the reinsurance industry, resulting in
increased underwriting losses which have continued to the present.
The following table presents the statutory combined ratios of Chartwell and
the property and casualty reinsurance industry during the 1994 to 1998 years.
The combined ratio is the sum of the loss ratio (incurred losses and loss
adjustment expenses divided by net premiums earned) and the underwriting expense
ratio (underwriting expenses divided by net premiums written). A combined ratio
of over 100% indicates unprofitable underwriting. Although an insurance
company's underwriting may be unprofitable, the company may be profitable after
including investment income.
Statutory Combined Ratios
Year Ended December 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
----- ----- ----- ----- -----
Chartwell (1)
Loss Ratio ............................................ 53.8% 65.5% 71.9% 72.9% 75.4%
Underwriting expense ratio ............................ 41.2 36.2 35.2 32.5 30.3
----- ----- ----- ----- -----
Combined ratio ........................................ 95.0% 101.7% 107.1% 105.4% 105.7%
===== ===== ===== ===== =====
Property and Casualty Reinsurance Industry (2)
Loss Ratio ............................................ 70.7% 69.6% 72.7% 78.2% 76.8%
Underwriting expense ratio ............................ 33.7 32.7 30.8 30.1 29.9
----- ----- ----- ----- -----
Combined ratio ........................................ 104.4% 102.3% 103.5% 108.3% 106.7%
===== ===== ===== ===== =====
- -----------------------------------------
(1) Beginning in 1996, the combined ratio includes both Chartwell Reinsurance
and INSCORP.
(2) Source: RAA Underwriting Report for the year ended December 31,
1998.
20
Consolidated Results of Operations
Year Ended December 31, 1998 Compared With Year Ended December 31, 1997
Revenues: Total revenues for the year ended December 31, 1998 decreased
7.5% to $298.0 million, compared to $322.3 million for the comparable period in
1997. The following table summarizes gross and net premiums written and total
revenues for the periods indicated:
Revenues
Year Ended
December 31,
--------------------------
1998 1997
--------- ---------
(Dollars in thousands)
Gross premiums written ...................... $ 342,951 $ 362,770
========= =========
Net premiums written ........................ $ 217,054 $ 268,260
========= =========
Premiums earned ............................. 229,504 245,700
Net investment income ....................... 48,824 43,457
Net realized capital gains (losses) ......... 29 (3)
Service and other revenue ................... 14,289 28,322
Equity in net earnings of investees ......... 5,327 4,794
--------- ---------
Total ................................. $ 297,973 $ 322,270
========= =========
Underwriting Operations
Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross
premiums written for the year ended December 31, 1998 were $343.0 million, a
decrease of 5.5% compared to the same period in 1997. The decrease in gross
premiums written was principally attributable to the opportunistic underwriting
of certain reinsurance accounts in 1997, which did not renew for 1998, as well
as Chartwell's response to the persistence of intense price competition in the
reinsurance industry. On a consolidated basis, pro forma for the elimination of
the opportunistic accounts underwritten in 1997, gross premiums written grew by
approximately 16.2% in 1998 compared to 1997.
Net premiums written for the year ended December 31, 1998 decreased 19.1%
to $217.1 million, compared to $268.3 million for the same period in 1997. The
decrease in net premiums written was principally attributable to the reasons
described above for the decrease in gross premiums written. Net premiums earned
for the year ended December 31, 1998 were $229.5 million, a decrease of 6.6%
compared to the same period in 1997.
Loss and Loss Adjustment Expenses. The Company's principal expense, loss
and LAE related to the settlement of claims was $135.3 million for the year
ended December 31, 1998, a 15.9% decrease compared to $160.8 million for the
comparable period in 1997. The decrease is principally attributable to the
decrease in net premiums written and the benefits of new reinsurance programs,
including an aggregate excess of loss reinsurance treaty. Net losses and LAE
expressed as a percentage of net earned premiums (the loss and LAE ratio)
improved to 58.9% for the year ended December 31, 1998, from 65.5% recorded for
the same period in 1997. The improvement of 6.6 percentage points in the loss
and LAE ratio for the year ended December 31, 1998 was a result of a change in
the mix of business, the benefits of the new reinsurance programs described
above and the enhancement of existing reinsurance programs.
Policy Acquisition Costs. Policy acquisition costs, consisting primarily of
commissions paid to ceding companies and agents and brokerage fees paid to
intermediaries, less commissions received on business ceded to other reinsurers,
were $61.6 million for the year ended December 31, 1998, compared to $72.7
million for the same period in 1997. Policy acquisition costs expressed as a
percentage of net earned premiums (the acquisition expense ratio) decreased to
26.8% from 29.6% in 1997. The decrease is primarily due to the effect of the
1998 aggregate excess of loss reinsurance treaty.
21
Other Expenses. Other expenses related to underwriting operations, which
include underwriting and administrative expenses, were $24.0 million for the
year ended December 31, 1998 compared to $16.5 million for the same period in
1997. Other expenses expressed as a percentage of net earned premiums increased
to 10.5% for the year ended December 31, 1998 compared to 6.7% for the same
period in 1997. The increase reflects the reduced level of premium volume and an
increased share of expenses related to Chartwell's underwriting participation on
syndicates managed by CMA.
Net Underwriting Results. The Company produced an underwriting profit (net
premiums earned minus losses, LAE and underwriting expenses) of $8.7 million for
the year ended December 31, 1998 as compared to an underwriting loss of $4.3
million for the same period in 1997. The combined ratio computed in accordance
with GAAP for the year ended December 31, 1998 decreased to 96.2% from 101.9%
for 1997. Although the loss ratio component improved to 58.9% for the year ended
December 31, 1998 from 65.5% recorded for the same period in 1997, the expense
ratio increased to 37.3% for the year ended December 31, 1998 from 36.4%
recorded for the same period in 1997, for the reasons noted above.
Service Operations
Revenue from service operations, exclusive of net investment income,
decreased to $19.6 million for the year ended December 31, 1998 compared to
$33.1 million for the same period in 1997. The decline principally reflects the
decrease in profit commissions, advisory fee revenues and equity in the earnings
of investee companies. In March 1998, New London Capital plc ("NLC") notified
Chartwell Advisers Limited ("Chartwell Advisers") that it chose not to renew the
Advisory Agreement between NLC and Chartwell Advisers (the "Advisory Agreement")
after its contractual expiration on December 31, 1998. In 1997 and 1998 the
Advisory Agreement produced base fees of $1.7 and $1.3 million, respectively,
and profit commissions of $0.7 and $(0.3) million, respectively, for Chartwell
Advisers. Following expiration of the Advisory Agreement, Chartwell Advisers
will continue to earn profit commissions on the open years of account (1996,
1997 and 1998) to the extent such years are profitable.
Corporate
Interest and Amortization. Interest and amortization expenses were $10.7
million for the year ended December 31, 1998 compared to $9.6 million for the
same period in 1997. Interest and amortization on the Chartwell 10.25% Senior
Notes due 2004 (the "Senior Notes") was $5.2 million for the years ended
December 31, 1998 and 1997. Also included in interest and amortization expense
for the years ended December 31, 1998 and 1997 is $4.3 million and $3.4 million,
respectively, related to a credit facility with First Union National Bank
("First Union") established to fund the acquisition of CMA and replace an
existing $20 million credit facility.
Consolidated
Net Investment Income and Net Realized Capital Gains (Losses). Consolidated
net investment income, exclusive of realized and unrealized capital gains and
losses, for 1998 was $48.8 million, an increase of $5.4 million, or 12.4%, over
1997. The improvement principally reflects the positive cash flow from
operations of $33.8 million. The average annual tax equivalent yield on invested
assets (excluding investment income from the Dedicated CCV's) before investment
expenses was 6.5% for 1998, as compared to 6.7% for 1997. The Company realized
net capital gains of $29,000 for 1998 compared to net capital losses of $3,000
for the same period in 1997.
Income Before Income Taxes, Minority Interest and Extraordinary Item. Net
income before income taxes increased to $48.6 million for the year ended
December 31, 1998 compared to $40.5 million for the same period in 1997. The
increase resulted primarily from the favorable results in both loss and loss
adjustment expense and from the increase in net investment income.
Income Tax Expense. The provision for Federal income taxes for the year
ended December 31, 1998 increased to $15.4 million compared with $12.2 million
for the same period in 1997. The effective tax rate was 31.6% and 30.1% for the
years ended December 31, 1998 and 1997, respectively. The principal factor in
the decline below the statutory rate of 35% for both periods results from the
benefit recognized on investments in tax-exempt securities.
22
Net Income Before Minority Interest. Net income before minority interest
increased to $33.2 million for the year ended December 31, 1998 as compared to
$28.3 million for the same period in 1997.
Minority Interest. The Company recognized $1.9 million of minority interest
during the year ended December 31, 1998 and $(0.5) million during the year ended
December 31, 1997, in each case representing Chartwell Re's ownership interest
in the net income of Holdings Limited.
Net Income. The Company realized a net profit of $35.2 million for the year
ended December 31, 1998 compared with a net profit of $27.8 million for the
comparable 1997 period because of the factors discussed above.
Year Ended December 31, 1997 Compared With Year Ended December 31, 1996
Revenues: Total revenues for the year ended December 31, 1997 increased
23.4% to $322.3 million, compared to $261.2 million for the comparable period in
1996. The following table summarizes gross and net premiums written and total
revenues for the periods indicated:
Revenues
Year Ended
December 31,
---------------------------
1997 1996
---------------------------
(Dollars in thousands)
Gross premiums written ...................... $ 362,770 $ 263,838
========= =========
Net premiums written ........................ 268,260 192,251
========= =========
Premiums earned ............................. 245,700 209,503
Net investment income ....................... 43,457 43,598
Net realized capital gains (losses) ......... (3) 1,157
Service and other revenue ................... 28,322 3,367
Equity in net earnings of investees ......... 4,794 3,559
--------- ---------
Total .............................. $ 322,270 $ 261,184
========= =========
Underwriting Operations
Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross
premiums written for the year ended December 31, 1997 were $362.8 million, an
increase of 37.5% compared to the same period in 1996. The increase in gross
premiums written reflects new programs and products developed during the year
with ceding companies in the Specialty Reinsurance and Controlled Source
Insurance client segments and the addition of gross premiums written through
CMA's two Dedicated CCV's. Gross premiums written by the Global Accounts,
Regional Accounts and Marine & Aviation Accounts client segments either declined
or remained constant as a result of continued competitive pressures.
Net premiums written for the year ended December 31, 1997 increased 39.5%
to $268.3 million, compared to $192.3 million for the same period in 1996. The
increase in net premiums written was principally attributable to the reasons
described above for the increase in gross premiums written. Net premiums earned
for the year ended December 31, 1997 were $245.7 million, an increase of 17.3%
compared to the same period in 1996.
Loss and Loss Adjustment Expenses. The Company's principal expense, loss
and LAE related to the settlement of claims, was $160.8 million for the year
ended December 31, 1997, a 6.8% increase compared to $150.6 million for the
comparable period in 1996. The increase is principally attributable to the
increase in net premiums written as noted above. Net losses and LAE expressed as
a percentage of net earned premiums (the loss and LAE ratio) decreased to 65.5%
for the year ended December 31, 1997 from 71.9% recorded for the same period in
1996. The improvement of 6.4 percentage points in the loss and LAE ratio for the
year ended December 31, 1997 was a result of a change in the mix of business as
well as the benefits of new reinsurance programs, including aggregate excess of
loss reinsurance treaties, and the enhancement of existing reinsurance programs.
In addition, the 1997 results were not materially affected by the run-off of
reinsurance programs written by INSCORP prior to December 1995, a factor which
impacted the 1996 results.
23
Policy Acquisition Costs. Policy acquisition costs, consisting primarily of
commissions paid to ceding companies and agents and brokerage fees paid to
intermediaries, less commissions received on business ceded to other reinsurers,
were $72.7 million for the year ended December 31, 1997, compared to $52.0
million for the same period in 1996. Policy acquisition costs expressed as a
percentage of net earned premiums (the acquisition expense ratio) increased to
29.6% from 24.8% in 1996. The increase was primarily due to the effect of the
aggregate excess of loss reinsurance treaties entered into in 1997 which reduced
net earned premium for the year without providing any reduction in commission
expenses. Also contributing to the increase was the modestly higher commission
structure, as noted above, for proportional business.
Other Expenses. Other expenses related to underwriting operations, which
include underwriting and administrative expenses, were $16.5 million for the
year ended December 31, 1997 compared to $15.8 million for the same period in
1996. Other expenses expressed as a percentage of net earned premiums decreased
to 6.7% for the year ended December 31, 1997 compared to 7.5% for the same
period in 1996.
Net Underwriting Results. The Company incurred an underwriting loss (net
premiums earned minus losses, LAE and underwriting expenses) of $4.3 million for
the year ended December 31, 1997 as compared to an underwriting loss of $8.9
million for the same period in 1996. The combined ratio computed in accordance
with GAAP for the year ended December 31, 1997 decreased to 101.9% from 104.2%
for 1996. Although the loss ratio component improved to 65.5 % for the year
ended December 31, 1997 from 71.9 % recorded for the same period in 1996, the
expense ratio increased to 36.4% for the year ended December 31, 1997 from the
32.3 % recorded for the same period in 1996, for the reasons noted above.
Service Operations
Revenue from service operations, exclusive of net investment income,
increased to $33.1 million for the year ended December 31, 1997 compared to $6.9
million for the same period in 1996. The improvement reflects increases in
advisory fee revenues, equity in the earnings of investee companies and the
inclusion, for the first time, of profit commissions and fees from CMA
operations. In March 1998, NLC notified Chartwell Advisers that it chose not to
renew the Advisory Agreement after its contractual expiration on December 31,
1998. In 1997, the Advisory Agreement produced base fees of $1.7 million and a
profit commission of $0.7 million for Chartwell Advisers. Following expiration
of the Advisory Agreement, Chartwell Advisers will continue to earn profit
commissions on the open years of account (1996, 1997 and 1998) to the extent
such years are profitable.
Corporate
Interest and Amortization. Interest and amortization expenses were $9.6
million for the year ended December 31, 1997 compared to $7.8 million for the
same period in 1996. Interest and amortization on the Senior Notes was $5.2
million for the year ended December 31, 1997 and $6.0 million for the comparable
period in 1996. Also included in interest and amortization expense for the year
ended December 31, 1997 is $3.4 million related to a credit facility with First
Union established to fund the acquisition of CMA and replace an existing $20
million credit facility.
Consolidated
Net Investment Income and Net Realized Capital Gains (Losses). Consolidated
net investment income, exclusive of realized and unrealized capital gains and
losses, for 1997 was $43.5 million, compared to $43.6 million in 1996. The
average annual tax equivalent yield on invested assets before investment
expenses for 1997 and 1996 was 6.7%.
The Company realized net capital losses of $3,000 for 1997 compared to net
capital gains of $1.2 million in 1996. The 1996 net capital gains were realized
principally to reposition certain sectors of the portfolio and to modify the
portfolio to improve credit quality without sacrificing yield.
Income Before Income Taxes, Minority Interest and Extraordinary Item. Net
income before income taxes and extraordinary items increased to $40.5 million
for the year ended December 31, 1997 compared to $31.7 million for the same
period in 1996. The increase resulted primarily from the increase in earned
premiums, the favorable results in both loss and loss adjustment expense and
other expenses, and the contributions from CMA to income from service
operations.
24
Income Tax Expense. The provision for Federal income taxes for the year
ended December 31, 1997 increased to $12.2 million compared with $9.3 million
for the same period in 1996. The effective tax rate was 30.1% and 29.4% for the
years ended December 31, 1997 and 1996, respectively. The principal factor in
the decline below the statutory rate of 35.0% for both periods was the benefit
of an increase during late 1996 and early 1997 of investments in tax-advantaged
securities.
Net Income Before Minority Interest and Extraordinary Item. Net income
before minority interest and extraordinary item increased to $28.3 million for
the year ended December 31, 1997 as compared to $22.4 million for the same
period in 1996.
Minority Interest. The Company recognized $(525,000) of minority interest
during the year ended December 31, 1997, representing Chartwell Re's ownership
interest in the net income of Holdings Limited.
Extraordinary Item, Net of Income Tax. The Company recognized a net
after-tax extraordinary expense of $1.9 million for the year ended December 31,
1996 for the write-off of unamortized debt issuance costs and a redemption
premium associated with the redemption of 35% of the Senior Notes.
Net Income. The Company realized a net profit of $27.8 million for the year
ended December 31, 1997 compared with a net profit of $20.5 million for the
comparable 1996 period because of the factors discussed above.
Liquidity and Capital Resources
Chartwell is a wholly-owned subsidiary of Chartwell Re. As a holding
company, Chartwell's assets consist primarily of the stock of its direct and
indirect operating subsidiaries, Chartwell Reinsurance, INSCORP and CMA.
Chartwell's cash flow, therefore, depends largely on dividends and other
statutorily permissible payments from its operating subsidiaries. Chartwell's
sources of funds consist primarily of net premiums, reinsurance recoveries,
investment income and proceeds from sales and redemptions of investments. Funds
are applied primarily to payments of claims, operating expenses and income taxes
and to the purchase of investments, largely fixed income securities. Cash and
short-term investments are maintained for the payment of claims and expenses.
For the years ended December 31, 1998, 1997 and 1996, Chartwell's
consolidated cash flow provided by operations was $33.8 million, $25.5 million
and $14.7 million, respectively. The increase in 1998 is due to the inclusion of
Chartwell's share of the operating cash flow of syndicates managed by CMA,
offset by a decline in cash provided by the reinsurance segment due to a
reduction in premiums written and the collection of premiums on a monthly
installment basis on certain accounts in the Controlled Source Insurance
segment. The cash flow from operations in 1997 was greater than that in 1996 due
to improved underwriting cash flows comprising premiums received less paid
losses and LAE and underwriting expenses. The 1996 cash flow from operations was
reduced as a result of the run-off of INSCORP's reinsurance reserves.
Sales of available for sale investments were $158.4 million, $200.8 million
and $500.7 million for the years ended December 31, 1998, 1997 and 1996,
respectively. Trading activity increased during 1996 primarily to modify the
portfolio by sector and to capitalize on some opportunities to improve on credit
quality without sacrificing yield. There was no unusual trading activity during
1997 and 1998.
At December 31, 1998, the carrying value of total investments, including
cash and cash equivalents, increased 15.0%, to $876.2 million compared to $762.2
million at December 31, 1997. The primary reasons for the increase were cash and
investments acquired through the purchase of Oak Dedicated Two Limited and the
remainder of Archer Dedicated plc (the holding company for ADIT One Limited),
positive cash flow from operations and an increase in the market value of the
investment portfolio.
Financing activities have also been a source of liquidity for Chartwell and
its subsidiaries. On March 17, 1994, Chartwell Re completed the offering of
$75.0 million principal amount of the Senior Notes. The net proceeds to
Chartwell Re after transaction expenses were $71.9 million. As of December 31,
1998, $48.8 million in principal amount of the Senior Notes were outstanding.
The Senior Notes bear interest at a rate of 10 1/4% per annum and are due on
March 1, 2004. In conjunction with the Piedmont Merger, the Company assumed all
of Chartwell Re's obligations with respect to the Senior Notes.
In the first half of 1996, Chartwell Re completed a public offering of
2,725,000 shares of common stock at $23.00 per share. The net proceeds to
Chartwell Re were $58.5 million after deduction of underwriting discount and
expenses. Of the net proceeds, $48.5 million was contributed by Chartwell Re to
the Company of which $20.0 million was contributed to the statutory surplus of
Chartwell Reinsurance and $28.5 million was used to retire 35% of the Senior
Notes plus accrued interest. The remaining funds were retained for general
corporate purposes. This redemption reduced Chartwell's annual expense for
interest and amortization of debt issuance costs under the Senior Notes by $2.8
million per year.
25
In connection with the acquisition of CMA, stockholders of Chartwell UK
could elect to receive Loan Notes in the amount of one Pound Sterling for each
Pound Sterling of cash consideration. The aggregate amount of Loan Notes issued
in connection with the consummation of the acquisition of CMA was $9.4 million
(denominated in Pounds Sterling). The Loan Notes, which are guaranteed by First
Union as described below, pay interest semi-annually at the rate per annum
calculated as one percent below the Sterling London Interbank Offered Rate
("LIBOR") and will mature in June, 2002 unless redeemed at an earlier date. As
of December 31, 1998, $3.8 million of the Loan Notes have been redeemed.
Also in connection with the acquisition of CMA, Chartwell entered into a
new credit facility with First Union, as agent (the "Credit Facility"). The
Credit Facility provides for (i) a Tranche A-1 $20.0 million loan, (ii) a
Tranche A-2 $10.0 million loan, (iii) a Tranche B $22.0 million loan
(denominated in Pounds Sterling) (Tranche A-1, Tranche A-2 and Tranche B
collectively, the "First Union Loans"), and (iv) a $25.0 million revolving
credit facility (subsequently increased to $60.0 million) (the "First Union
Revolver").
The First Union Loans have six-year terms and the First Union Revolver has
a five-year term but may be extended with the consent of the lenders. Tranche
A-1 and A-2 require repayment of principal starting in year 3, $6.0 million;
year 4, $7.5 million; year 5, $7.5 million and year 6, $9.0 million. Tranche B
requires repayment of principal starting in year 3, $4.2 million; year 4, $5.3
million; year 5, $5.3 million and year 6, $6.4 million. Borrowings under the
First Union Revolver are available at any time prior to maturity, subject to
minimum funding amounts. Both the First Union Loans and the First Union Revolver
will bear interest at a rate selected by Chartwell equal to either (1) the Base
Rate (as defined below) or (2) U.S. dollar or Sterling LIBOR plus a margin (the
"Margin"), as applicable. The amount of the Margin will depend on the higher of
Chartwell's senior debt rating by Standard & Poor's or Moody's and can range
from 0.75% to 1.125%. Based on Chartwell's current senior debt ratings, the
Margin over LIBOR is currently at 1.00%. The U.S. dollar Base Rate is the higher
of (1) First Union's prime commercial lending rate or (2) the federal funds rate
plus 0.5%. The Sterling Base Rate is the rate per annum announced by Midland
Bank plc plus the Margin. Chartwell will also pay (1) an unused commitment fee
equal to 0.25% on the aggregate unused portion of the revolver, (2) utilization
fees for the issuance of letters of credit and guarantees of Loan Notes, issued
in connection with the acquisition of CMA, at a rate per annum of 0.375% (if
secured) or the Margin (if unsecured) plus a 0.075% facing fee, currently
totaling 1.075% (if unsecured) on the outstanding amount of potential credit
exposure, and (3) certain other fees customary in connection with syndicated
loans of this nature. All payments of interest and fees with respect to each of
the First Union Loans shall be made in the same currency in which the principal
of such loan is required.
At December 31, 1998, $20.0 million, $10.0 million and $15.9 million were
outstanding under the Tranche A-1, Tranche A-2 and Tranche B loans,
respectively. During 1998, the Tranche B loan increased by $1.8 million to fund
the redemption of Loan Notes for the same amount, resulting in a balance of $5.5
million used to guarantee the Loan Notes. A $5.0 million line of credit and a
total of $53.6 million in letters of credit were extended under the First Union
Revolver. All amounts denominated in Pounds Sterling were converted to U.S.
dollars at the rate of (pound)1=$1.66, the exchange rate in effect at December
31, 1998.
On June 30, 1998, the Company entered into an interest rate swap agreement
(the "Swap") for other than trading purposes with First Union to convert a
specific portion of the floating rate loans outstanding under the Credit
Facility to a fixed rate. The Swap requires the Company to pay First Union
interest on a notional amount equivalent to the principal outstanding
((pound)10,280,000 at December 31, 1998) at a fixed annual rate throughout the
term of the related debt obligation of 6.85% and for First Union to pay the
Company interest equal to the three month LIBOR interest rate determined at the
commencement of each calendar quarter. The Swap terminates on December 31, 2002.
The weighted average LIBOR rate payable by First Union in 1998 under the Swap
was 7.62%.
The notional amount set forth in the Swap does not represent an amount
exchanged by the Company and First Union, and thus is not a measure of exposure
of the Company. Since First Union is not required to collateralize its
obligations under the Swap, the Company is exposed to loss if First Union were
to default on its obligations under the Swap. The Company does not believe that
any reasonably likely change in interest rates would cause the Swap to have a
material adverse effect on the financial position, the results of operations or
cash flows of the Company. The Swap was reviewed with and approved by the
Company's Board of Directors.
26
Upon consummation of the Piedmont Merger, Chartwell Re became the successor
to Piedmont under the CI Notes. The CI Notes were issued in an aggregate
principal amount of $1 million, which principal amount will accrue interest at a
rate of 8% per annum, compounded annually. Such interest will not be payable
until maturity or earlier redemption of the CI Notes. In addition, the CI Notes
will entitle the holders thereof to receive at maturity, in proportion to the
principal amount of the CI Notes held by them, an aggregate of from $10 million
up to $55 million in contingent interest. Settlement of the CI Notes may be made
by payment of cash or, under certain specified conditions, by delivery of shares
of Chartwell Re's common stock. The CI Notes mature on June 30, 2006.
Chartwell and its subsidiaries may incur additional indebtedness in the
future, subject to the limitations contained in the Senior Notes indenture, the
agreements governing the Credit Facility and the CI Notes indenture.
Chartwell is largely dependent upon receipt of dividends and other
statutorily permissible payments from its subsidiaries to meet its obligations,
including the obligations to pay interest and principal on the Senior Notes and
under the Credit Facility. Further, dividend payments by Chartwell Reinsurance
and INSCORP are subject to limits under the laws of the States of Minnesota and
New York, respectively. Under the applicable provisions of the insurance holding
company laws of the State of Minnesota, Chartwell Reinsurance may, upon five
days notice to the Commissioner of Insurance of the State of Minnesota ("the
Commissioner") following the declaration of dividends to stockholders, and upon
at least ten days notice to the Commissioner prior to dividend payments, pay
dividends without the approval of the Commissioner, unless such dividends,
together with other dividends paid within the preceding twelve months, exceed
the greater of (i) 10% of Chartwell Reinsurance's policyholders' surplus as of
the end of the prior calendar year or (ii) Chartwell Reinsurance's statutory net
income, excluding realized capital gains, for the prior calendar year. Any
dividend in excess of the amount determined pursuant to the foregoing formula
would be characterized as an "extraordinary dividend" requiring the prior
approval of the Commissioner. In any case, the maximum amount of dividends
Chartwell Reinsurance may pay is limited to its earned surplus, also known as
unassigned funds. As of December 31, 1998, Chartwell Reinsurance reported
unassigned funds, as defined, in the amount of $103.8 million. Up to $30.3
million is available under the foregoing formula for the payment of dividends by
Chartwell Reinsurance without regulatory approval in 1999. On November 25, 1997,
Chartwell Reinsurance paid a $3.0 million dividend to Chartwell and on February
24, 1999, Chartwell Reinsurance paid a $5.5 million dividend to Chartwell.
Chartwell Reinsurance paid no dividends in 1996 or 1998.
Under New York law, which is applicable to INSCORP, the maximum ordinary
dividend payable in any twelve month period without the approval of the
Superintendent may not exceed the lesser of (a) 10% of policyholders surplus as
shown on the company's last annual statement or any more recent quarterly
statement or (b) the company's adjusted net investment income. Adjusted net
investment income is defined as net investment income for the twelve months
preceding the declaration of the dividend plus the excess, if any, of net
investment income over dividends declared or distributed during the period
commencing thirty-six months prior to the declaration or distribution of the
current dividend and ending twelve months prior thereto. In any case, New York
law permits the payment of an ordinary dividend by an insurer or reinsurer only
out of earned surplus. Moreover, notwithstanding the receipt of any dividend
from INSCORP, Chartwell Reinsurance may make dividend payments to Chartwell only
to the extent permitted under the Minnesota provisions described above.
In addition to the foregoing limitation, the New York Insurance Department,
as is its practice in any change of control situation, required Chartwell to
commit to preclude the acquired New York-domiciled insurer, INSCORP, from paying
any dividends for two years after the Piedmont Merger without prior regulatory
approval. The foregoing restriction expired on December 13, 1997. INSCORP paid
no dividends in 1997 or 1998.
The maximum dividend permitted by law is not indicative of an insurer's
actual ability to pay dividends, which may be constrained by business and
regulatory considerations, such as the impact of dividends on surplus, which
could affect an insurer's ratings or competitive position, the amount of
premiums that can be written and the ability to pay future dividends.
Furthermore, beyond the limits described in the preceding paragraph, the
Commissioner and Superintendent have discretion to limit the payment of
dividends by insurance companies domiciled in Minnesota and New York,
respectively.
Management believes that current levels of cash flow from operations and
assets held at the holding company level provide the Company with sufficient
liquidity to meet its operating needs in the short term (over the next 12
months). Management expects Chartwell to be able to continue to meet its
operating needs after the next 12 months from internally generated funds. Since
the ability of Chartwell to meet its obligations in the long term (beyond such
12-month period) is dependent upon such factors as market changes, insurance
regulatory changes and economic conditions, no assurance can be given that the
available net cash flow will be sufficient to meet its operating needs. The
Company expects that, in order to repay the principal amount of the Senior Notes
on maturity or otherwise, it will be required to seek additional financing or
engage in asset sales or similar transactions, and would be required to take
similar actions in order to repay the CI Notes on maturity or otherwise, in the
event it chose or was required to settle the CI Notes in cash rather than common
stock. There can be no assurance that sufficient funds for any of the foregoing
purposes would be available to the Company at such time.
27
Market Risk Disclosures
Chartwell's primary market risk exposures are: foreign currency exchange
risk, in particular the U.S. dollar to the British pound sterling; interest rate
risk on fixed and variable rate U.S. dollar and British pound sterling
denominated short and long-term instruments; and equity price risk.
Foreign Currency Exchange Rate Risk: Foreign currency risk is the risk that
Chartwell will incur economic losses due to adverse changes in foreign currency
exchange rates. This risk arises from Chartwell's international operations, debt
obligations denominated in foreign currencies and foreign equity investments. At
December 31, 1998, Chartwell had a net investment of approximately $33.2 million
in foreign subsidiaries, $26.8 million in debt obligations denominated in
foreign currencies and $3.3 million in foreign equity investments.
A portion of Chartwell's reinsurance operations is denominated in
international currencies, particularly the British pound sterling and the
Canadian dollar. This exchange rate exposure is somewhat mitigated by investing
the premiums received in currencies in which the liabilities are denominated.
Based upon data as at December 31, 1998, management estimates that a 10%
immediate unfavorable change in each of the foreign currency exchange rates to
which Chartwell is exposed would decrease the fair value of its foreign
denominated instruments by approximately $2.9 million. Chartwell's net exposure
to exchange rates consist of $19.7 million to the British pound sterling, $5.3
million to the Canadian dollar and an aggregate of $3.7 million to all other
foreign currencies.
Interest Rate Risk: Chartwell's fixed maturity investments and indebtedness
are subject to interest rate risk. Increases and decreases in prevailing
interest rates generally translate into decreases and increases in the fair
value of fixed maturity investments and the interest payable on Chartwell's
outstanding variable rate debt. On occasion, Chartwell utilizes stand-alone
derivatives to manage and mitigate the volatility of interest rates on certain
of its interest rate sensitive instruments. Additionally, the fair value of
interest rate sensitive instruments may be affected by the creditworthiness of
the issuer, prepayment option, relative values of alternative investments,
liquidity of the investment and other general market conditions.
The table below summarizes the estimated effects of hypothetical increases
and decreases in interest rates. It is assumed that the changes occur
immediately and uniformly to each category of instrument containing interest
rate risks. The hypothetical changes in market interest rates reflect what could
be deemed best or worst case scenarios. Significant variations in market
interest rates could produce changes in the timing of repayments due to
prepayment options available. The fair value of such instruments could be
affected and therefore actual results might differ from those reflected in the
table, which follows:
Estimated Fair Value Hypothetical
Hypothetical Change After Hypothetical Percentage Increase
Fair Value at in Interest Rate Change in (Decrease) in
December 31, 1998 (bp=basis points) Interest Rate Stockholders' Equity
Assets: (1) ----------------- ----------------- ------------- --------------------
- -------------------------- (dollars in thousands)
U.S Treasury Securities $212,467 100 bp decrease $221,863 3.2%
and Obligations of US 100 bp increase 202,243 (3.5)
Government Corporation 200 bp increase 191,429 (7.2)
and Agencies 300 bp increase 172,585 (13.6)
Other fixed maturity $479,071 100 bp decrease $504,577 8.7%
investments 100 bp increase 451,318 (9.5)
200 bp increase 421,962 (19.5)
300 bp increase 370,807 (37.0)
Liabilities:
- --------------------------
Borrowings Under $112,162 100 bp decrease $112,315 0.3%
Investment Agreements 100 bp increase 112,012 (0.3)
and other debt 200 bp increase 111,862 (0.5)
300 bp increase 111,713 (0.8)
(1) Excludes investments held by CMA managed syndicates.
28
Equity Price Risk: The carrying values of investments subject to equity price
risks are based on quoted market prices or management's estimates of fair value
as of the balance sheet date. Market prices are subject to fluctuation and,
consequently, the amount realized in the subsequent sale of an investment may
significantly differ from the reported market value. Fluctuation in the market
price of a security may result from perceived changes in the underlying economic
characteristics of the investee, the relative price of alternative investments
and general market conditions. Furthermore, amounts realized in the sale of a
particular security may be affected by the relative quantity of the security
being sold.
Chartwell's common equity portfolio of $36.4 million primarily consists of
long term strategic minority positions in illiquid equity securities of managing
general agents of Controlled Source Insurance. A 10% immediate decrease in the
market prices of all equity securities held by Chartwell at December 31, 1998,
would result in an approximate 1.2% decrease in Chartwell's stockholders'
equity.
The above analyses do not take into account any correlation among foreign
currency exchange rates, or any correlation among various markets (i.e., the
fixed income markets and foreign exchange and equity markets). Chartwell's
actual experience may differ from the results noted above due to the correlation
assumptions utilized, or if events occur that were not included in the
methodology, such as significant liquidity or market events. The selection of
the amount of increases or decreases in currency exchange rates, interest rates
and equity values in the above analyses should not be construed as a prediction
of future market events, but rather, to illustrate the potential impact of such
an event.
Year 2000 Compliance
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. The Company's
computer equipment, software and devices with imbedded technology that are time
sensitive may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions or engage in other normal business activities. The
consequences to the Company of such failures could include business
interruption, lost revenue or illiquidity. The magnitude of the financial impact
of such potential failures on the Company is not known at this time.
The Company believes that it has identified all significant computer
hardware and software applications and devices with imbedded time sensitive
technology that are employed by the Company in its operations that will require
modification to ensure Year 2000 Compliance. The Company is using both internal
and external resources to test all significant computer systems and applications
and to make the modifications necessary for Year 2000 Compliance. The testing
and modification process, which is proceeding on schedule, is 95% complete and
is expected to be fully completed by June 30, 1999. The testing and modification
process has not materially interfered with the Company's Information Technology
operations or the operations of the Company .
In addition, the Company has contacted all of its significant business
partners and service vendors to determine their Year 2000 Compliance readiness,
as well as the extent to which the Company is vulnerable to any third party Year
2000 issues. However, there can be no guarantee that the systems of other
companies on which the Company's systems rely will become Year 2000 compliant in
a timely manner, or that the failure by a third party to become Year 2000
compliant would not have a material adverse effect on the Company.
The Company is revising its existing disaster recovery contingency plans to
address issues specific to the Year 2000 problem. These revisions are expected
to be completed by June 30, 1999. Such plans are intended to enable the Company
to continue to operate by performing certain processes manually, changing
vendors and repairing or replacing existing systems, where feasible.
The total cost to the Company to test and modify all systems to be Year
2000 compliant has not been, and is not expected to be, material to its
financial position or results of operations in any given year. To date, the
Company has budgeted $50,000 to accomplish its Year 2000 testing and remediation
goals and approximately 50% of the amount budgeted has been expended.
Expenditures to fund Year 2000 testing and modification have to date and will
continue to be funded from operating cash flows.
The anticipated completion dates for Year 2000 compliance and the Company's
contingency plans and the cost estimates for the completion of the Company's
Year 2000 compliance program are based on management's best estimates utilizing
current data regarding available resources, coordination with third parties and
other relevant factors and information about systems conversion. However, there
can be no assurance that these estimates will be achieved, and actual results
could differ from the current plan.
29
In addition, the Company may also have material exposure in its property
and casualty operations to claims related to the Year 2000 issue. It is not yet
possible to determine whether such claims might be made against insurance or
reinsurance contracts in which the Company participates or if such claims will
be held to have merit.
Readers are cautioned that forward-looking statements contained in this
description of the Company's treatment of the Year 2000 issue should be read in
conjunction with the Company's disclosures under the heading "Cautionary Note
Regarding Forward-Looking Statements" below.
Accounting Standards
Accounting for Derivative Instruments and Hedging Activities - SFAS No. 133
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which becomes effective for the
Company January 1, 2000. SFAS No. 133 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 as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. The
accounting for a change in the 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
forecasted transaction, or (c) a hedge of the 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 difference between a derivative's previous carrying amount and its fair
value at the date of implementation of SFAS No. 133 shall be reported as a
transition adjustment. Such adjustment shall be reported in net income or other
comprehensive income as the effect of a change in accounting principle and
presented in a manner similar to the cumulative effect of a change in accounting
principle in accordance with APB Opinion No. 20, "Accounting Changes." The
Company is currently reviewing the impact of the implementation of SFAS No. 133
on its financial statements.
Disclosures About Segments of an Enterprise and Related Information Footnotes -
SFAS No. 131
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information Footnotes," which became effective for the
Company beginning January 1, 1998. SFAS No. 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. The adoption
of SFAS No. 131 had no impact on the Company's financial position or results of
operations. Prior year segment information has been reclassified to conform to
the SFAS No. 131 requirements.
Reporting Comprehensive Income - SFAS No. 130
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which became effective for the Company beginning January 1, 1998. SFAS
No. 130 establishes standards for reporting and display of comprehensive income
and its components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. This Statement requires that all items
that are required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. It does not require a
specific format for that financial statement but requires that an enterprise
display an amount representing total comprehensive income for the period in that
financial statement. The adoption of SFAS No. 130 had no impact on the Company's
financial position or results of operations. Prior year financial statements
have been reclassified to conform to the SFAS No. 130 requirements.
Regulatory Accounting Practices
In March 1998, the National Association of Insurance Commissioners adopted
the Codification of Statutory Accounting Principles ("Codification"). The
Codification, which is intended to standardize regulatory accounting and
reporting for the insurance industry, 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 states of Minnesota, New York and North Dakota will require adoption of
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.
30
Effects of Inflation
The effects of inflation on Chartwell are considered in pricing and
estimating reserves for unpaid losses and loss adjustment expenses. The actual
effects of inflation on Chartwell's results cannot be accurately determined
until ultimate losses are settled. However, based on the actual results reported
to date, management believes that premium rates and loss reserves, including
reserves for losses that have been incurred but not reported, adequately
incorporate the effects of inflation. See Item 1, "Business--Reserves."
Cautionary Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains statements that may be considered
to be "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended.
Such statements may include, without limitation, insofar as they may be
considered to be forward-looking statements, certain statements in (i)
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Consolidated Results of Operations - Year Ended December 31, 1998
Compared With Year Ended December 31, 1997" and "--Consolidated Results of
Operations - Year Ended December 31, 1997 Compared With Year Ended December 31,
1996" concerning (A) certain relationships among gross premiums written, net
premiums written and net premiums earned and (B) the development of reserves in
respect of all or a portion of the Company's insurance and reinsurance business;
(ii) "Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" concerning the potential effects of
certain events on the Company's indebtedness and portfolios of fixed income and
equity instruments, foreign currency exposure, derivatives positions and certain
other types of instruments; (iii) "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Market Risk Disclosures"
concerning the potential effects of changes in the equity markets, interest
rates and currency exchange rates; (iv) "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Year 2000 Compliance" concerning
the costs and effects of Year 2000 compliance; (v) such other statements
contained in this Annual Report that may be considered to be forward-looking
statements; and (vi) variations of the foregoing statements wherever they appear
in this Annual Report.
All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in such
statements. The Company believes that these include the following non-exclusive
factors:
i. the impact of changing market conditions on the Company's business
strategy;
ii. the effects of increased competition on pricing, coverage terms,
retention of customers and ability to attract new customers;
iii. greater severity or frequency of the types of large or catastrophic
losses which the Company's subsidiaries insure or reinsure; iv. faster
or more adverse loss development experience than that on which the
Company's underwriting, reserving and investment practices are based;
v. changes in the Company's retrocessional arrangements;
vi. developments in global financial markets which could adversely affect
the performance of the Company's investment portfolio;
vii. litigation, regulatory or tax developments that could adversely affect
the Company's business;
viii. risks associated with the introduction of new products and services; and
ix. the impact of mergers and acquisitions.
The facts set forth above should be considered in connection with any
forward-looking statement contained in this Annual Report. The important factors
that could affect such forward-looking statements are subject to change, and the
Company does not intend to update any forward-looking statement or the foregoing
list of important factors. By this cautionary note, the Company intends to avail
itself of the safe harbor from liability with respect of forward-looking
statements provided by Section 27A and Section 21E referred to above.
31
Item 7A. Quantitative and Qualitative disclosures About Market Risk
See "Market Risk Disclosures" contained in Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations.
Item 8. Financial Statements and Supplementary Data.
See the Consolidated Financial Statements and Notes thereto and the
Schedules on pages F-1 through F-26 and S-1 through S-7 included in Part IV,
Item 14.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosures.
None.
32
PART III
Items 10-13. Information required by Items 10 through 13 has been omitted
because the Registrant meets the conditions set forth in General Instruction I
(1) (a) and (b) of Form 10-K and is therefore filing this Annual Report on Form
10-K in the reduced disclosure format.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Financial Statements and Schedules--The financial statements and
schedules listed in the accompanying Index to Financial Statements and
Schedules on page F-1 are filed as part of this Annual Report on Form 10-K.
(b) Exhibits--The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Annual Report on Form 10-K.
(c) Reports on Form 8-K-- None
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Stamford, State of
Connecticut, on March 26, 1999.
CHARTWELL RE HOLDINGS CORPORATION
By /s/ Charles E. Meyers
--------------------------------
Charles E. Meyers
Senior Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Signatures Title Date
- ---------- ----- ----
/s/ Richard E. Cole Chief Executive Officer and Chairman of the March 26, 1999
- ---------------------------- Board of Directors (Principal Executive
Richard E. Cole Officer)
/s/ Charles E. Meyers Senior Vice President and Chief Financial March 26, 1999
- ---------------------------- Officer (Principal Financial Officer)
Charles E. Meyers
/s/ Richard B. Primerano Vice President and Controller (Principal March 26, 1999
- ---------------------------- Accounting Officer)
Richard B. Primerano
/s/ Steven J. Bensinger Director March 26, 1999
- ----------------------------
Steven J. Bensinger
/s/ Jacques Q. Bonneau Director March 26, 1999
- ----------------------------
Jacques Q. Bonneau
34
CHARTWELL RE HOLDINGS CORPORATION
Index to Financial Statements
Independent Auditors' Report......................................................................... F-2
Consolidated Balance Sheets at December 31, 1998 and 1997............................................ F-3
Consolidated Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996........... F-4
Consolidated Statements of Stockholder's Equity for the Years Ended
December 31, 1998, 1997 and 1996................................................................ F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 .......... F-6
Notes to Consolidated Financial Statements for the Years Ended December 31, 1998, 1997 and 1996...... F-7
Index to Schedules
Schedule I -- Summary of Investments--Other than Investments in Related Parties.................... S-1
Schedule II -- Condensed Financial Information of Registrant-Balance Sheets........................ S-2
Schedule II -- Condensed Financial Information of Registrant-Statements of Operations.............. S-3
Schedule II -- Condensed Financial Information of Registrant-Statements of Cash Flows.............. S-4
Schedule IV -- Reinsurance......................................................................... S-5
Schedule V -- Valuation and Qualifying Accounts................................................... S-6
Schedule VI -- Supplemental Information Concerning Property/Casualty Insurance Operations.......... S-7
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholder
Chartwell Re Holdings Corporation
Stamford, Connecticut
We have audited the accompanying consolidated balance sheets of Chartwell
Re Holdings Corporation and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of operations, stockholder's equity, and
cash flows for each of the three years in the period ended December 31, 1998.
Our audits also included the financial statement schedules listed in the Index
on page F-1. These financial statements and financial statement schedules are
the responsibility of the Company's management. Our responsibility is to express
an opinion on the financial statements and financial statement schedules 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 Chartwell Re Holdings
Corporation 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. Also, in our opinion, such financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, present fairly in all material respects the information set forth
therein.
DELOITTE & TOUCHE LLP
Parsippany, New Jersey
February 2, 1999
F-2
CHARTWELL RE HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
(dollars in thousands, except share amounts)
1998 1997
---------- ----------
ASSETS:
Investments:
Fixed maturities:
Held to maturity (market value 1998, $31,786; 1997, $37,421) .......................... $ 30,539 $ 36,630
Available for sale (amortized cost 1998, $637,747; 1997, $645,108) .................... 659,752 657,973
Other investments ........................................................................ 36,358 38,043
Investments held by managed syndicates ..................................................... 89,228
Cash and cash equivalents .................................................................. 49,388 29,534
Cash and cash equivalents held by managed syndicates ....................................... 10,931
---------- ----------
Total investments and cash ...................................................... 876,196 762,180
Accrued investment income .................................................................. 10,723 10,667
Premiums in process of collection .......................................................... 143,879 126,537
Reinsurance recoverable: on paid losses .................................................. 19,746 34,502
on unpaid losses ................................................ 239,059 202,593
Prepaid reinsurance ........................................................................ 40,933 29,929
Goodwill ................................................................................... 51,902 54,259
Deferred policy acquisition costs .......................................................... 24,084 26,100
Deferred income taxes ...................................................................... 23,159 29,847
Deposits ................................................................................... 19,975 19,040
Other assets ............................................................................... 78,898 69,406
---------- ----------
Total assets .................................................................... $1,528,554 $1,365,060
========== ==========
LIABILITIES:
Loss and loss adjustment expenses .......................................................... $ 878,617 $ 788,240
Unearned premiums .......................................................................... 108,495 111,149
Other reinsurance balances ................................................................. 53,323 33,723
Accrued expenses and other liabilities ..................................................... 64,143 49,345
Long term debt ............................................................................. 108,477 104,126
---------- ----------
Total liabilities ............................................................... 1,213,055 1,086,583
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 14)
MINORITY INTEREST .......................................................................... 7,576 9,425
---------- ----------
STOCKHOLDER'S EQUITY
Common stock, par value $1.00 per share; authorized 1,000 shares; shares
issued and outstanding 100
Additional paid-in capital ................................................................ 217,866 217,866
Accumulated other comprehensive income:
Net unrealized appreciation of investments ............................................... 12,534 8,741
Foreign currency translation adjustment .................................................. 217 296
Retained earnings .......................................................................... 77,306 42,149
---------- ----------
Total stockholder's equity ...................................................... 307,923 269,052
---------- ----------
Total liabilities and stockholder's equity ...................................... $1,528,554 $1,365,060
========== ==========
See notes to consolidated financial statements.
F-3
CHARTWELL RE HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(dollars in thousands)
1998 1997 1996
--------- --------- ---------
UNDERWRITING OPERATIONS:
Premiums earned ........................................................ $ 229,504 $ 245,700 $ 209,503
Net investment income .................................................. 47,545 42,228 42,995
Net realized capital gains (losses) .................................... (339) (3) 1,106
--------- --------- ---------
Total revenues .............................................. 276,710 287,925 253,604
--------- --------- ---------
Loss and loss adjustment expenses ...................................... 135,265 160,848 150,621
Policy acquisition costs ............................................... 61,564 72,655 52,030
Other expenses ......................................................... 23,989 16,473 15,774
--------- --------- ---------
Total expenses .............................................. 220,818 249,976 218,425
--------- --------- ---------
Income before taxes - underwriting operations .......................... 55,892 37,949 35,179
--------- --------- ---------
SERVICE OPERATIONS:
Service and other revenue .............................................. 14,289 28,322 3,367
Equity in net earnings of investees .................................... 5,327 4,794 3,559
Net investment income .................................................. 1,092 1,104 9
--------- --------- ---------
Total revenues .............................................. 20,708 34,220 6,935
--------- --------- ---------
Other expenses ......................................................... 12,888 18,084 2,233
Amortization of goodwill ............................................... 2,298 2,297
--------- --------- ---------
Total expenses .............................................. 15,186 20,381 2,233
--------- --------- ---------
Income before taxes - service operations ............................... 5,522 13,839 4,702
--------- --------- ---------
CORPORATE:
Net investment income .................................................. 187 125 594
Net realized capital gains ............................................. 368 51
General and administrative expenses .................................... 2,668 1,776 1,043
Interest expense ....................................................... 9,858 9,057 7,367
Amortization expense ................................................... 859 579 410
--------- --------- ---------
Loss before taxes - corporate .......................................... (12,830) (11,287) (8,175)
--------- --------- ---------
Consolidated income before taxes, minority interest and ................ 48,584 40,501 31,706
extraordinary item
Income tax expense ..................................................... 15,351 12,202 9,337
--------- --------- ---------
Net income before minority interest and extraordinary item ............. 28,299 22,369
33,233
Minority interest ...................................................... 1,924 (525)
Extraordinary item, net of tax ......................................... (1,874)
--------- --------- ---------
Net income ............................................................. $ 35,157 $ 27,774 $ 20,495
========= ========= =========
See notes to consolidated financial statements.
F-4
CHARTWELL RE HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(dollars in thousands)
Accumulated Other
Comprehenisive Income
----------------------------
Net Unrealized Foreign
Common Stock Appreciation/ Currency
--------------------------- Additional (Depreciation) Translation
Shares Amount Paid-in-Capital of Investments Adjustment
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1995 ..................... $ $ 169,320 $ 5,219 $ 9
Comprehensive income:
Net income for the period ....................
Unrealized appreciation/(depreciation)
during the period (net of tax of ($4,176) .. (7,755)
Reclassification adjustment for gains
included in net income (net of tax of ($623) 1,157
Foreign currency translation adjustment ...... 1,282
------------ ------------ ------------ ------------ ------------
Total comprehensive income ..................... (6,598) 1,282
Issuance of common stock ....................... 100 48,546
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1996 ..................... 100 $ $ 217,866 $ (1,379) $ 1,291
============ ============ ============ ============ ============
Balance, December 31, 1996 ..................... 100 $ $ 217,866 $ (1,379) $ 1,291
Comprehensive income:
Net income for the period ....................
Unrealized appreciation/(depreciation)
during the period (net of tax of $5,451) ... 10,123
Reclassification adjustment for gains
included in net income (net of tax of $(2) . (3)
Foreign currency translation adjustment ...... (995)
------------ ------------ ------------ ------------ ------------
Total comprehensive income ..................... 10,120 (995)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1997 ..................... 100 $ $ 217,866 $ 8,741 $ 296
============ ============ ============ ============ ============
Balance, December 31, 1997 ..................... 100 $ $ 217,866 $ 8,741 $ 296
Comprehensive income:
Net income for the period ....................
Unrealized appreciation/(depreciation)
during the period (net of tax of $2,037) ... 3,783
Reclassification adjustment for gains
included in net income (net of tax of ($5) . 10
Foreign currency translation adjustment ...... (79)
------------ ------------ ------------ ------------ ------------
Total comprehensive income ..................... 3,793 (79)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 1998 ..................... 100 $ $ 217,866 $ 12,534 $ 217
============ ============ ============ ============ ============
Total
Retained Stockholder's
Earnings Equity
------------ ------------
Balance, December 31, 1995 ..................... $ (6,120) $ 168,428
Comprehensive income:
Net income for the period .................... 20,495 20,495
Unrealized appreciation/(depreciation)
during the period (net of tax of ($4,176) .. (7,755)
Reclassification adjustment for gains
included in net income (net of tax of ($623) 1,157
Foreign currency translation adjustment ...... 1,282
------------ ------------
Total comprehensive income ..................... 20,495 15,179
Issuance of common stock ....................... 48,546
------------ ------------
Balance, December 31, 1996 ..................... $ 14,375 $ 232,153
============ ============
Balance, December 31, 1996 ..................... $ 14,375 $ 232,153
Comprehensive income:
Net income for the period .................... 27,774 27,774
Unrealized appreciation/(depreciation)
during the period (net of tax of $5,451) ... 10,123
Reclassification adjustment for gains
included in net income (net of tax of $(2) . (3)
Foreign currency translation adjustment ...... (995)
------------ ------------
Total comprehensive income ..................... 27,774 36,899
------------ ------------
Balance, December 31, 1997 ..................... $ 42,149 $ 269,052
============ ============
Balance, December 31, 1997 ..................... $ 42,149 $ 269,052
Comprehensive income:
Net income for the period .................... 35,157 35,157
Unrealized appreciation/(depreciation)
during the period (net of tax of $2,037) ... 3,783
Reclassification adjustment for gains
included in net income (net of tax of ($5) . 10
Foreign currency translation adjustment ...... (79)
------------ ------------
Total comprehensive income ..................... 35,157 38,871
------------ ------------
Balance, December 31, 1998 ..................... $ 77,306 $ 307,923
============ ============
See notes to consolidated financial statements.
F-5
CHARTWELL RE HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(dollars in thousands)
1998 1997 1996
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net premiums collected .................................................... $ 203,434 $ 174,864 $ 126,456
Net losses and loss adjustment expenses ................................... (172,771) (150,682) (136,753)
Overhead expenses ......................................................... (27,813) (21,052) (17,166)
Service and other revenue ................................................. 1,868 (4,479) 3,190
Net income taxes paid ..................................................... (11,190) (7,173) (5,168)
Interest received on investments .......................................... 51,671 44,763 43,158
Interest paid ............................................................. (9,963) (9,071) (7,415)
Other, net ................................................................ (1,421) (1,643) 8,443
--------- --------- ---------
Net cash provided by operating activities ............................ 33,815 25,527 14,745
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of held to maturity securities .................................. (596) (8,105)
Purchases of available for sale securities ................................ (164,082) (275,794) (640,182)
Maturities of held to maturity securities ................................. 7,280 1,850 430
Maturities of available for sale securities ............................... 8,639 31,415 20,729
Sales of available for sale securities .................................... 158,416 200,792 500,706
Investment in Oak Dedicated Two Limited, net of cash acquired ............. (23,048)
Investment in Archer Dedicated plc, net of cash acquired .................. (4,600)
Net cash from sale of Syndicate 866 ....................................... 10,041
Investment in Chartwell UK plc, net of cash acquired ...................... (39,156)
--------- --------- ---------
Net cash used in investing activities ................................ (7,354) (42,333) (165,578)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contribution from Parent .......................................... 48,546
Issuance of long term debt ................................................ 5,624 693 48,057
Redemption of long term debt .............................................. (1,710) (3,476) (48,280)
--------- --------- ---------
Net cash provided by (used in) financing activities .................. 3,914 (2,783) 48,323
--------- --------- ---------
Effect of exchange rate on cash ...................................... 410 (1,220) 346
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ............................ 30,785 (20,809) (102,164)
Cash and cash equivalents at beginning of year .................................. 29,534 50,343 152,507
--------- --------- ---------
Cash and cash equivalents at end of year ........................................ $ 60,319 $ 29,534 $ 50,343
========= ========= =========
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net income ................................................................ $ 35,157 $ 27,774 $ 20,495
Adjustments to reconcile net income to net cash provided by
operating activities:
Extraordinary item ................................................... 1,874
Equity in net earnings of investees .................................. (3,445) (4,794) (3,559)
Net realized capital (gains) losses .................................. (29) 3 (1,158)
Minority interest .................................................... (1,924) 525
Deferred policy acquisition costs .................................... 2,016 (8,197) 906
Unpaid loss and loss adjustment expenses ............................. (1,045) 40,382 6,391
Unearned premiums .................................................... (2,654) 29,550 (8,974)
Other reinsurance balances ........................................... 8,596 10,438 6,475
Reinsurance recoverable .............................................. (21,710) (34,951) (6,710)
Amortization of goodwill ............................................. 2,198 2,294 (12)
Deferred income taxes ................................................ 6,688 12,313 (2,643)
Net change in receivables and payables ............................... 8,792 (44,815) 500
Other net ............................................................ 1,175 (4,995) 1,160
--------- --------- ---------
Net cash provided by operating activities ............................ $ 33,815 $ 25,527 $ 14,745
========= ========= =========
See notes to consolidated financial statements.
F-6
CHARTWELL RE HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation--Chartwell Re Holdings Corporation ("Chartwell"
or the "Company") is a wholly-owned subsidiary of Chartwell Re Corporation
("Chartwell Re") and, as such, acts as an intermediate level insurance holding
company for Chartwell Re, conducting its business through its principal
operating subsidiaries, Chartwell Reinsurance Company ("Chartwell Reinsurance"),
The Insurance Corporation of New York ("INSCORP") (formerly The Reinsurance
Corporation of New York) and Chartwell Managing Agents Limited ("CMA"), a
managing agency in the Lloyd's marketplace which is a wholly-owned subsidiary of
Chartwell UK plc ("Chartwell UK").
The consolidated financial statements include the accounts of the Company
and all subsidiaries. All significant inter-company transactions and accounts
have been eliminated in consolidation.
Due to custom and practice in the Lloyd's market, the fiscal year end for
Chartwell UK is September 30. Therefore, the Company consolidates the results of
Chartwell UK and subsidiaries on a one quarter lag. There were no events
affecting Chartwell UK during the period from October 1, 1998 through December
31, 1998 which would have a material impact on the financial position of the
Company.
Investments in companies in which the Company owns 20 to 50 percent of the
voting common stock or has the ability to exercise significant influence over
the operating and financial policies of the investees are accounted for under
the equity method.
(b) Investments--Fixed maturity securities are categorized as either assets
held to maturity or as available for sale. Securities on deposit with state
regulatory authorities are designated as held to maturity and are recorded at
amortized cost. The Company has both the ability and intent to hold these
securities until their maturity. All investments designated as available for
sale are stated at aggregate market value with unrealized appreciation and
depreciation reported as a separate component of stockholders' equity, net of
applicable deferred income taxes.
Realized gains and losses on sales of securities are determined on the
specific identification method. Investment income is recognized when earned.
(c) Investments and Cash and Cash Equivalents Held By Managed Syndicates -
The Company has included in the consolidated balance sheet its pro-rata share of
the investments and cash and cash equivalents held by CMA managed syndicates.
Such pro-rata share is determined based on the Company's percentage of capacity
owned through its dedicated corporate capital vehicles.
(d) Cash and Cash Equivalents--The Company considers all highly liquid
investments with a maturity of three months or less when purchased to be cash
equivalents.
(e) Premiums Earned and Unearned Premiums-- Premiums, net of reinsurance
ceded, are recognized as income ratably during the terms of the related
insurance and reinsurance contracts. Unearned and prepaid reinsurance premium
reserves are established to cover the unexpired portion of premiums written.
Such reserves are computed by pro rata methods for direct business and are
established based on reports received from ceding companies for reinsurance.
The Company estimates and accrues for unreported premiums and losses, as
well as premium and commission adjustments on retrospectively rated or other
experience rated reinsurance contracts, based on the difference between total
costs before and after the experience under the contract (the with-and-without
method). These estimates of experience to date are based on statistical data
with subsequent adjustments recorded in the period in which they become known.
(f) Profit Commissions--Profit commissions earned on business emanating
from Lloyd's syndicates are estimated, earned and recorded using studies of the
profitability of the business underwritten. Profit commission estimates are
continually monitored and reviewed. As new information is received, changes are
reflected in current operations with final settlement three years after the
underwriting year to which it relates.
(g) Deferred Policy Acquisition Costs--Acquisition costs, comprised
primarily of commissions, are deferred and amortized over the period in which
the related premiums are earned. Deferred policy acquisition costs are reviewed
to determine that they do not exceed recoverable amounts, after considering
investment income.
(h) Deposits--Deposits are those premiums paid in relation to reinsurance
contracts which do not qualify as a transfer of risk under the Company's
accounting policies. The deposits earn interest at the contractual amounts set
forth in the reinsurance contracts.
F-7
(i) Loss and Loss Adjustment Expenses--The liability for loss and loss
adjustment expenses ("LAE") is based on reports and individual case estimates
and additional estimates provided by the Company's claims department. This
liability also includes an amount for loss and LAE incurred but not reported
based on past experience of the Company and the reinsurance and insurance
industries. These estimates are regularly reviewed and, as new information
becomes known, the liability is adjusted as necessary. Such adjustments, if any,
are reflected in results of operations in the period in which they become known.
(j) Income Taxes--Income taxes are accounted for using the asset and
liability method pursuant to Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes." Deferred taxes are recognized
for the tax consequences of "temporary differences" by applying enacted
statutory tax rates applicable to future years to differences arising between
the financial statement carrying amounts and the tax bases of existing assets
and liabilities. SFAS No. 109 requires the recognition of future tax benefits to
the extent that realization of such benefits is "more likely than not."
Provision for U.S. income taxes on undistributed earnings of foreign
subsidiaries is made only on those amounts in excess of the funds considered to
be permanently reinvested. Repatriation of undistributed earnings of non-U.S.
subsidiaries is done only when it is tax efficient to do so.
(k) Goodwill--Goodwill represents the unamortized excess of purchase price
over the fair value of net assets of acquired entities. Goodwill is amortized
generally on a straight-line basis over periods not to exceed forty years. On a
periodic basis, the Company estimates the future undiscounted cash flows of the
business to which it relates in order to ensure that the carrying value of
goodwill has not been impaired. If impairment exists, the carrying amount of the
goodwill is reduced by the estimated shortfall of cash flows. Amortization
charged to operations for each of the years ended December 31, 1998, 1997 and
1996 was $2,198,000, $2,294,000 and ($12,000), respectively. Accumulated
amortization of goodwill at December 31, 1998 and 1997 was $5,910,000 and
$4,179,000 respectively. Approximately $1,575,000 and $2,042,000, respectively,
of accumulated amortization at December 31, 1998 and 1997 reflects the effect of
foreign currency fluctuations on goodwill related to Chartwell UK.
(l) Insurance Brokerage Assets and Liabilities - The following fiduciary
assets and liabilities maintained by the Company's insurance agency subsidiaries
on behalf of the insureds are presented net in the consolidated financial
statements at December 31, 1998 and 1997 (in thousands):
1998 1997
---- ----
Cash .................................. $ 6,132 $ 6,397
Accounts receivable ................... $ 20,566 $ 19,559
Accounts payable ...................... $(26,698) $(25,956)
(m) Comprehensive Income--In June 1997, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income," which
became effective for the Company beginning January 1, 1998. SFAS No. 130
established standards for reporting and display of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. Comprehensive income consists of net
income, foreign currency translation adjustment and net unrealized appreciation
(depreciation) of investments and is presented in the Consolidated Statement of
Stockholder's Equity. The adoption of SFAS No. 130 had no impact on the
Company's financial position or results of operations. Prior year financial
statements have been reclassified to conform to the SFAS No. 130 requirements.
(n) Minority Interest--Minority interest primarily represents Chartwell
Re's 35% share of the equity of Chartwell Holdings Limited ("Holdings Limited").
(o) Foreign Currency Translation--Adjustments resulting from the
translation of the financial statements of non-U.S. subsidiaries to U.S. dollars
are reported as a separate component of stockholder's equity. Assets and
liabilities denominated in foreign currency are translated at the exchange rates
in effect at the balance sheet date. Results of operations are translated at
average exchange rates during each period.
(p) Disclosure about Fair Value of Financial Instruments - SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments," requires disclosures of
the estimated fair market value of certain financial instruments. In cases where
quoted market prices are not readily available, fair values are based on
estimates that use present value or other valuation techniques.
(q) Management Estimates--The consolidated financial statements have been
prepared in accordance with generally accepted accounting principles. In
preparing the consolidated financial statements, management is required 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 consolidated statements of the financial condition and the reported amounts
of revenue and expenses during the reporting period. Actual results could differ
from those estimates. The Company's most significant estimates concern the
liability for loss and LAE, described above.
F-8
(r) New Accounting Standards--In June 1998, the FASB issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which becomes
effective for the Company January 1, 2000. SFAS No. 133 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 as either assets or liabilities in
the statement of financial position and measure those instruments at fair value.
The accounting for a change in the 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
forecasted transaction, or (c) a hedge of the 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 difference between a derivative's previous carrying amount and its fair
value at the date of implementation of SFAS No. 133 shall be reported as a
transition adjustment. Such adjustment shall be reported in net income or other
comprehensive income as the effect of a change in accounting principle and be
presented in a manner similar to the cumulative effect of a change in accounting
principle in accordance with APB Opinion No. 20, "Accounting Changes."
The Company is currently reviewing the impact of the implementation of SFAS
No. 133 on its financial statements.
(s) Reclassification--Certain account balances from prior years'
presentations have been reclassified to conform with the current year
presentation.
2. ACQUISITIONS AND DISPOSITIONS
Chartwell UK Acquisition
On November 19, 1996, Holdings Limited, a newly-formed, indirect
wholly-owned subsidiary of Chartwell Re acquired 100% of the outstanding stock
(the "Acquisition") of Chartwell UK (formerly Archer Group Holdings plc) in
exchange for cash and loan notes ("Loan Notes"). The Loan Notes, guaranteed by
First Union National Bank N.A., pay interest semi-annually at one percent below
the Sterling London Interbank Offered Rate ("Sterling LIBOR") and, unless
previously redeemed or purchased, mature in June 2002. The Loan Notes are
transferable, subject to certain restrictions, but are not listed on any
exchange. Prior to the Acquisition, Chartwell UK was publicly traded on the
London Stock Exchange.
The Acquisition has been accounted for under the purchase method of
accounting. Accordingly, the purchase price was allocated to the net assets
acquired based on the preliminary determination of the respective fair values at
the date of acquisition, which were estimated based upon information available
at December 31, 1996. During 1997, the Company decreased the fair value of
tangible net assets acquired by approximately $6,642,000, as more information
became available. Goodwill of approximately $58,936,000, representing the final
determination of the fair value of net assets acquired over the purchase price,
is being amortized on a straight-line basis over twenty-five years.
The purchase price presented at the U.S. Dollar equivalent at the date of
acquisition, was determined to be $60,289,000 and was allocated to the
respective net assets and liabilities received as follows (in thousands):
Historical book value of Chartwell UK ........ $ 6,044
--------
Acquisition adjustments:
Deferred taxes ......................... (1,666)
Accrued expenses ....................... (8,072)
Other assets ........................... 5,047
--------
(4,691)
Fair value adjustment - Goodwill ............. 58,936
--------
Total purchase price ......................... $ 60,289
========
Results of Chartwell UK's operations from the date of acquisition to
December 31, 1996 were not material to the consolidated financial statements of
the Company and, accordingly, have not been included in such financial
statements.
Chartwell Re directly owns 35% of Holdings Limited. Such minority interest
is presented in the consolidated balance sheet. The Company recognized
$1,924,000 and ($525,000) of minority interest during the years ended December
31, 1998 and 1997, respectively, representing Chartwell Re's ownership interest
in the net income of Holdings Limited.
F-9
Other Transactions
On September 30, 1998, Chartwell Reinsurance acquired 100% of the
outstanding stock of Oak Dedicated Two Limited (formerly LIMIT (No. 8) Limited)
in exchange for cash of (pound)3.3 million ($5.4 million). Oak Dedicated Two
Limited is a corporate member of Lloyd's which underwrote a total capacity of
(pound)41.7 million ($69.2 million) for the 1998 year of account on syndicates
managed by CMA.
On October 28, 1998, Holdings Limited commenced the acquisition of the
remaining 70.8% of the Ordinary Shares and the remaining 69.3% of the Preference
Shares of Archer Dedicated plc ("Archer") in exchange for cash of (pound)5.7
million ($9.5 million). Archer is a holding company for ADIT One Limited, a
Lloyd's dedicated corporate capital vehicle formed in 1994 to provide a means
for investors to participate exclusively in underwriting on syndicates managed
by CMA. ADIT One Limited underwrote a total capacity of (pound)45.4 million
($75.4 million) for the 1998 year of account on syndicates managed by CMA.
On September 10, 1998, Chartwell UK sold the business of Shead Motor
Policies at Lloyd's ("Syndicate 866") and Archer Personal Lines in exchange for
cash of (pound)6.1 million ($10.0 million).
Pro Forma Information
The following pro forma unaudited consolidated income statement information
for the Company for the year ended December 31, 1996 is presented as though the
acquisition of Chartwell UK and the redemption of 35% of the outstanding 10.25%
Senior Notes due 2004 ("Senior Notes") (See Note 13) had occurred on January 1,
1996 (in thousands):
1996
----
Total revenues................................................ $ 289,336
Net income.................................................... 24,990
This pro forma financial information has been prepared for informational
purposes only and includes certain adjustments such as amortization expense as a
result of goodwill and certain other adjustments, together with related income
tax effects. The pro forma financial information is not necessarily indicative
of the results of operations as they would have been had the transactions been
consummated on the assumed dates.
3. BUSINESS SEGMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information Footnotes," which became effective for the
Company beginning January 1, 1998. SFAS No. 131 establishes standards for the
way public business enterprises report information about operating segments,
products and services, geographic areas and major customers in annual financial
statements and related footnote disclosures. The adoption of SFAS No. 131 had no
impact on the Company's financial position or results of operations. Prior year
segment information has been reclassified to conform to the SFAS No. 131
requirements.
The Company's operations have been classified into four segments. The
Reinsurance, Controlled Source Insurance and CMA Dedicated Facilities segments
include the pre-tax results of the insurance and reinsurance entities over which
management of the Company is responsible for making all underwriting decisions,
including Chartwell Reinsurance, INSCORP, Oak Dedicated Limited, Oak Dedicated
Two Limited and ADIT One Ltd. The insurance and reinsurance operations of these
entities have been separated among the three segments based upon the nature of
the clientele and their business or products.
The Reinsurance products include treaty reinsurance written through
reinsurance brokers for casualty and, to a lesser extent, property risks as well
as for marine and aviation risks. The Controlled Source Insurance products
include property and casualty insurance written through specialty program
administrators. The CMA Dedicated Facilities products include marine, non-marine
property, non-marine liability, aviation, motor and life business underwritten
by Lloyd's syndicates.
The Service Operations segment includes the pre-tax results from services
or capital provided to or investments in insurance entities over which
management of the Company does not influence the underwriting decisions and the
pre-tax results of Chartwell Advisers Limited and CMA, net of related goodwill
amortization. Corporate items relate primarily to capital costs associated with
the Company's debt as well as unallocated employee expenses incurred in
connection with the investigation of possible acquisition targets.
The accounting policies of the operating segments are the same as those
described in Note 1 of Notes to Consolidated Financial Statements. The measure
of profitability of the insurance segments is composite underwriting result,
which represents gross profit margin on insurance products before insurance
administrative expenses and consists of premiums, less loss and LAE, acquisition
costs and commissions. The measure of profitability of the service operations
segment is net income (loss) before taxes, excluding non-recurring investment
and foreign exchange gains and losses.
F-10
Assets for each segment are reported based on a specific identification
basis. The insurance segments' assets primarily consist of cash and investments,
premiums in process of collection, reinsurance recoverable and deferred
acquisition costs. The service operations segment's assets primarily consist of
cash and investments, goodwill and service receivables.
F-11
Summarized financial information concerning the Company's operating
segments is shown in the following table (in thousands):
Controlled CMA
Source Dedicated Service
Reinsurance Insurance Facilities Operations Corporate Total
----------- --------- ---------- ---------- --------- -----
1998
Segment profit or loss:
Total revenues $ 156,234 $ 48,681 $ 71,795 $ 20,708 $ 555 $ 297,973
Net investment income 34,541 6,125 6,879 1,092 187 48,824
Composite underwriting result 20,859 5,988 5,828 32,675
Income (loss) before taxes 44,582 6,016 5,294 5,522 (12,830) 48,584
Segment assets:
Deferred acquisition costs 17,592 6,492 24,084
Goodwill 8,122 43,780 51,902
Total assets 671,991 591,341 195,169 45,887 24,166 1,528,554
1997
Segment profit or loss:
Total revenues $ 227,814 $ 39,787 $ 20,324 $ 34,220 $ 125 $ 322,270
Net investment income 36,053 5,851 324 1,104 125 43,457
Composite underwriting result 9,467 2,013 717 12,197
Income (loss) before taxes 35,097 3,047 (195) 13,839 (11,287) 40,501
Segment assets:
Deferred acquisition costs 18,201 7,899 26,100
Goodwill 54,259 54,259
Total assets 676,263 575,534 14,950 59,511 38,802 1,365,060
1996
Segment profit or loss:
Total revenues $ 233,264 $ 20,340 $ 6,935 $ 645 $ 261,184
Net investment income 37,093 5,902 9 594 43,598
Composite underwriting result 5,323 1,529 6,852
Income (loss) before taxes 34,160 1,019 4,702 (8,175) 31,706
Segment assets:
Deferred acquisition costs 11,928 5,975 17,903
Goodwill 52,609 52,609
Total assets 696,042 444,094 87,800 17,288 1,245,224
Because of the nature of the insurance and reinsurance industries, the
Company has no individual or group which would be considered a major customer.
The Company's principle areas of operation include the United States, the United
Kingdom and, to a limited extent, Canada and continental Europe. Geographic
information is presented below (in thousands):
United United Other
States Kingdom Foreign Consolidated
------ ------- ------- ------------
1998
Total revenue........................................ $ 210,289 $ 85,390 $ 2,294 $ 297,973
Income before taxes.................................. 45,957 380 2,247 48,584
Net income (loss).................................... 34,411 (616) 1,362 35,157
Identifiable net assets.............................. 1,289,303 211,175 28,076 1,528,554
1997
Total revenue........................................ $ 270,682 $ 48,130 $ 3,458 $ 322,270
Income before taxes.................................. 31,480 5,057 3,964 40,501
Net income........................................... 22,774 2,310 2,690 27,774
Identifiable net assets.............................. 1,240,053 97,281 27,726 1,365,060
1996
Total revenue........................................ $ 256,136 $ 2,124 $ 2,924 $ 261,184
Income before taxes.................................. 27,142 992 3,572 31,706
Net income........................................... 17,217 699 2,579 20,495
Identifiable net assets.............................. 1,156,747 60,755 27,722 1,245,224
F-12
4. INVESTMENTS
The amortized cost and estimated market values of investments in securities
with fixed maturities were as follows (in thousands):
Gross Unrealized Estimated
Amortized --------------------- Market Carrying
Cost Gains Losses Value Amount
--------- -------- -------- --------- ---------
December 31, 1998
Held to maturity:
U.S. Treasury securities and obligations of U.S.
government and government agencies............. $ 19,248 $ 379 $ $ 19,627 $ 19,248
Obligations of states and political subdivisions... 1,862 16 1,878 1,862
Debt securities issued by foreign governments...... 8,376 807 9,183 8,376
Corporate securities............................... 1,053 45 1,098 1,053
--------- -------- -------- --------- ---------
Subtotal............................................. 30,539 1,247 31,786 30,539
--------- -------- -------- --------- ---------
Available for sale:
U.S. Treasury securities and obligations of U.S.
government and government agencies............. 56,841 2,618 6 59,453 59,453
Obligations of states and political subdivisions... 163,369 6,652 170,021 170,021
Debt securities issued by foreign governments...... 19,144 940 4 20,080 20,080
Corporate securities............................... 227,775 8,224 704 235,295 235,295
Redeemable preferred stock......................... 35,773 1,732 83 37,422 37,422
Mortgage backed securities......................... 134,845 2,728 92 137,481 137,481
--------- -------- -------- --------- ---------
Subtotal............................................. 637,747 22,894 889 659,752 659,752
--------- -------- -------- --------- ---------
Total ............................................... $ 668,286 $ 24,141 $ 889 $ 691,538 $ 690,291
========= ======== ======== ========= =========
December 31, 1997
Held to maturity:
U.S. Treasury securities and obligations of U.S.
government and government agencies............. $ 20,594 $ 95 $ 107 $ 20,582 $ 20,594
Obligations of states and political subdivisions... 1,868 11 1,879 1,868
Debt securities issued by foreign governments...... 13,013 773 26 13,760 13,013
Corporate securities............................... 1,155 45 1,200 1,155
--------- -------- -------- --------- ---------
Subtotal............................................. 36,630 924 133 37,421 36,630
--------- -------- -------- --------- ---------
Available for sale:
U.S. Treasury securities and obligations of U.S.
government and government agencies............. 58,922 604 77 59,449 59,449
Obligations of states and political subdivisions... 155,109 4,578 11 159,676 159,676
Debt securities issued by foreign governments...... 15,342 513 1 15,854 15,854
Corporate securities 212,143 4,415 461 216,097 216,097
Redeemable preferred stock......................... 36,780 1,602 3 38,379 38,379
Mortgage backed securities......................... 166,812 2,064 358 168,518 168,518
--------- -------- -------- --------- ---------
Subtotal............................................. 645,108 13,776 911 657,973 657,973
--------- -------- -------- --------- ---------
Total ............................................... $ 681,738 $ 14,700 $ 1,044 $ 695,394 $ 694,603
========= ======== ======== ========= =========
F-13
The amortized cost and estimated market value of securities with fixed
maturities at December 31, 1998 and 1997, by contractual maturity, are shown
below (in thousands). Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Held to Maturity Available for Sale
---------------------- ----------------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
-------- -------- --------- ---------
December 31, 1998
Due in one year or less....................................... $ 11,287 $ 11,334 $ 22,516 $ 22,631
Due after one year through five years......................... 13,538 14,350 176,799 181,020
Due after five years through ten years........................ 1,172 1,436 189,474 196,966
Due after ten years........................................... 4,542 4,666 114,113 121,654
Mortgage backed securities.................................... 134,845 137,481
-------- -------- --------- ---------
$ 30,539 $ 31,786 $ 637,747 $ 659,752
======== ======== ========= =========
December 31, 1997
Due in one year or less....................................... $ 8,763 $ 8,856 $ 13,106 $ 13,187
Due after one year through five years......................... 17,332 17,566 170,525 172,485
Due after five years through ten years........................ 6,007 6,514 175,901 180,650
Due after ten years........................................... 4,528 4,485 118,764 123,133
Mortgage backed securities.................................... 166,812 168,518
-------- -------- --------- ---------
$ 36,630 $ 37,421 $ 645,108 $ 657,973
======== ======== ========= =========
Proceeds from sales of available for sale securities (excluding fixed
income security paydowns and calls) during 1998, 1997, and 1996 were
$90,588,000, $77,339,000 and $281,712,000, respectively. Gross gains of
$788,000, $523,000 and $3,421,000 and gross losses of $759,000, $526,000, and
$2,264,000 were realized on those sales during the years ended December 31,
1998, 1997 and 1996, respectively.
Sources of net investment income for the years ended December 31, 1998,
1997 and 1996 were as follows (in thousands):
1998 1997 1996
-------- -------- --------
Investment income:
Fixed maturities ...................... $ 40,684 $ 39,752 $ 43,344
Equity securities ..................... 2,618 2,841 1,150
Other ................................. 6,501 1,867 96
-------- -------- --------
Total investment income ................. 49,803 44,460 44,590
Investment expenses ..................... (979) (1,003) (992)
-------- -------- --------
Net investment income ................... $ 48,824 $ 43,457 $ 43,598
======== ======== ========
Realized gains (losses) on investments:
Fixed maturities ...................... $ 232 $ (4) $ 373
Equity securities ..................... (203) 1 784
-------- -------- --------
Net realized capital gains (losses) ..... $ 29 $ (3) $ 1,157
======== ======== ========
The net unrealized appreciation (depreciation) of investments included as a
separate component of stockholder's equity 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 ...................................... $ 22,005 $ 12,865
Equity securities ..................................... (2,721) 583
-------- --------
19,284 13,448
Deferred tax benefit (expense) .......................... (6,750) (4,707)
-------- --------
Net unrealized appreciation (depreciation)
of investments ........................................ $ 12,534 $ 8,741
======== ========
F-14
Unrealized appreciation (depreciation) of investments in equity securities
at December 31, 1998 and 1997 includes gross unrealized gains of $1,026,000 and
$1,513,000, respectively, and gross unrealized losses of $3,747,000 and
$930,000, respectively.
At December 31, 1998 and 1997, bonds with a carrying value of approximately
$35,895,000 and $36,630,000, respectively, were on deposit with state regulatory
authorities, as required by law. The Company also had cash, cash equivalents and
bonds totaling $16,449,000 and $18,681,000, in trusts held for the benefit of
ceding companies at December 31, 1998 and 1997, respectively.
At December 31, 1998 and 1997, the Company had $17,105,000 and $15,914,000,
respectively, of investments held in collateral accounts subject to certain
restrictions in conjunction with a loan guarantee and a letter of credit
arrangement (Note 14).
At December 31, 1998 and 1997, the Company had loaned securities of
approximately $12,819,000 and $14,443,000, respectively, at fair market value
under a security lending agreement administered through U.S. Bank, the Company's
primary custodian. In connection with these transactions, the Company holds as
collateral securities with a fair value equal to 102% of the fair value of the
securities lent to others. Such collateral securities are marked to market on a
daily basis and borrowers are required to supply additional collateral to
prevent any collateral from falling below 102% of the fair value of the loaned
securities.
5. FAIR VALUE AND FINANCIAL INSTRUMENTS
The following methods were used in estimating fair value disclosures for
significant financial instruments. Cash equivalents approximate their carrying
amount due to the short duration of those investments. Fixed maturity securities
are based upon quoted market information. The fair value of long term debt at
December 31, 1998 and 1997 which bears interest at a fixed rate is based upon
current rates offered to the company for debt of similar remaining maturity. The
fair value of debt at December 31, 1998 and 1997 which bears interest at a
variable rate is assumed to equal the carrying value of the debt. The carrying
amounts and fair values of the Company's significant financial instruments are
as follows (in thousands):
1998 1997
-------------------- --------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
Assets:
Cash and cash equivalents .... $ 60,319 $ 60,319 $ 29,534 $ 29,534
Fixed maturity securities .... 690,291 691,538 694,603 695,394
Liabilities:
Long-term debt ............... $108,477 112,162 $104,126 $109,722
Interest Rate Swap ........... 539
On June 30, 1998, the Company entered into an interest rate swap agreement
(the "Swap") for other than trading purposes with First Union to convert a
specific portion of the floating rate loans outstanding under the Credit
Facility to a fixed rate. The Swap requires the company to pay First Union
interest on a notional amount equivalent to the principal outstanding
((pound)10,280,000 at December 31, 1998) at a fixed annual rate throughout the
term of the related debt obligation of 6.85% and for First Union to pay the
Company interest equal to the three month LIBOR interest rate determined at the
commencement of each calendar quarter. The Swap terminates on December 31, 2002.
The weighted average LIBOR rate payable by First Union in 1998 under the Swap
was 7.62%. The Swap is valued based on a mathematical approximation of market
values derived from proprietary models as of a given date and calculated on a
mid-market basis excluding any bid/offered spread that would be reflected in an
actual price quotation.
The notional amount set forth in the Swap does not represent an amount
exchanged by the Company and First Union, and thus is not a measure of exposure
of the Company. Since First Union is not required to collateralize its
obligations under the Swap, the Company is exposed to loss if First Union were
to default on its obligations under the Swap. The Company does not believe that
any reasonably likely change in interest rates would, as a result of the Swap,
have a material adverse effect on the financial position, the results of
operations or cash flows of the Company. The Swap was reviewed and approved by
the Company's Board of Directors.
F-15
6. FEDERAL INCOME TAXES
The Company files a consolidated Federal income tax return with its parent
and all includable subsidiaries. The 1998, 1997 and 1996 current income taxes
are based upon regular taxable income.
Consolidated income before taxes, minority interest and extraordinary item,
for the years ended December 31, 1998, 1997 and 1996 consisted of the following
(in thousands):
1998 1997 1996
-------- -------- --------
United States .............................. $ 45,957 $ 31,480 $ 27,142
Foreign .................................... 2,627 9,021 4,564
-------- -------- --------
Total .................................... $ 48,584 $ 40,501 $ 31,706
======== ======== ========
The components of income tax expense (benefit) for the years ended December
31, 1998, 1997 and 1996 are as follows (in thousands):
1998 1997 1996
-------- -------- --------
U.S. Taxes:
Current .................................... $ 5,703 $ 3,743 $ 8,537
Deferred ................................... 4,616 4,942 (213)
-------- -------- --------
10,319 8,685 8,324
-------- -------- --------
Foreign Taxes:
Current .................................... 5,032 2,183 1,013
Deferred ................................... 1,334
-------- -------- --------
5,032 3,517 1,013
-------- -------- --------
Total U.S. and foreign income tax expense .. $ 15,351 $ 12,202 $ 9,337
======== ======== ========
The difference between actual income tax expense and the amount computed by
applying the statutory Federal income tax rate of 35% for the years ended
December 31, 1998, 1997 and 1996, is as follows (in thousands):
1998 1997 1996
-------- -------- --------
Income tax expense at statutory rate ....... $ 17,004 $ 14,176 $ 11,097
Non-taxable investment income .............. (2,773) (2,598) (1,400)
Foreign operations ......................... 219 (682)
Amortization of goodwill ................... 769 769 (35)
Other, net ................................. 132 537 (325)
-------- -------- --------
$ 15,351 $ 12,202 $ 9,337
======== ======== ========
As of December 31, 1998, the Company and all includable subsidiaries have
U.S. net operating loss carryforwards of $15,717,000 which will be available
(subject to the annual limitation discussed below) to offset regular taxable
income during the carryforward period (expiring 2007). The net operating losses
were generated by INSCORP prior to its acquisition by the Company. Due to this
change in ownership, as defined by Section 382 of the Internal Revenue Code, the
amount of net operating loss available to offset future taxable income each year
is limited to a maximum of $3,483,000.
The Company provides income taxes on the undistributed earnings of non-U.S.
subsidiaries except to the extent that such earnings are considered permanently
reinvested outside the United States. It is not practicable to determine the
amount of income or withholding tax that would be payable upon the remittance of
those earnings. However, the Company does not anticipate that the income or
withholding tax that would be payable upon remittance of the undistributed
earnings of the non-U.S. subsidiaries would aggregate to a material amount.
F-16
The tax effects of the temporary differences comprising the Company's net
deferred tax asset at December 31, 1998 and 1997 are as follows (in thousands):
1998 1997
------- -------
Deferred tax assets:
Discounting of loss reserves ............................. $32,846 $37,429
Unearned premiums ........................................ 4,729 5,686
Deposit accounting ....................................... 715 980
Allowance for uncollectible reinsurance .................. 1,225 1,225
Net operating losses ..................................... 5,375 6,802
Others, net .............................................. 5,085 4,820
------- -------
Gross deferred tax assets .................................. 49,975 56,942
------- -------
Deferred tax liabilities:
Deferred acquisition costs ............................... 8,429 9,135
Earned but not reported premiums net of loss and expense . 3,223 3,141
Unrealized appreciation of investments ................... 6,750 4,707
Accrued market discount .................................. 52 609
Profit commission ........................................ 696 3,149
Others, net .............................................. 1,214 1,534
------- -------
Gross deferred tax liabilities ............................. 20,364 22,275
------- -------
Net deferred asset ......................................... $23,159 $29,847
======= =======
Realization of the deferred tax asset is dependent on the Company
generating sufficient taxable income to realize the benefits of the net deferred
tax assets. Although realization is not assured, management believes it is more
likely than not that the entire net deferred tax asset will be realized and as
such no valuation allowance has been recorded at December 31, 1998 or 1997.
7. EMPLOYEE BENEFIT PLANS
Eligible employees of the Company may participate in a defined contribution
plan (the "Plan") established by Chartwell Re. Under the Plan, the Company makes
a matching contribution equal to 50% of each employee's pretax contribution, not
to exceed 6% of the employee's compensation. Amounts expensed under the Plan for
the years ended December 31, 1998, 1997 and 1996 were $209,000, $188,000 and
$168,000, respectively.
Certain members of management will receive a supplement to the Plan payable
at the earlier of age 65 or employment termination. The supplement will be equal
to the aggregate contributions made with respect to the employee to a trust
established by the Company. Annual contributions to the trust are 13.5% to 20.0%
of the employee's base salary as stated in their employment agreements. The
amounts expensed in 1998, 1997 and 1996 for the obligation under this plan
amounted to $206,500 each year.
Chartwell UK operates contributory defined contribution plans for its U.K.
employees. The level of the contribution varies between 5% and 20% dependent
upon the age of each participant at the beginning of each calendar year. The
amount expensed in 1998 and 1997 for the obligation under these plans amounted
to $2,305,000 and $2,523,000, respectively.
F-17
8. RELATED-PARTY TRANSACTIONS
The Company holds an equity investment in certain managing general agents
("MGAs") through which it writes Controlled Source Insurance business. Such
investments are accounted for under the equity method. At December 31, 1998, the
carrying values of the investments in Florida Intracoastal Underwriters (25%
owned), HDR Insurance Services (20% owned) and Inter-Reco (49% owned) were
$1,281,000, $894,000 and $181,000, respectively. For the years ended December
31, 1998, 1997 and 1996, the Company incurred $21,554,000, $19,536,000 and
$10,038,000, respectively, of commission expense payable to these MGAs. At
December 31, 1998 and 1997, the Company's consolidated balance sheet includes
$19,332,000 and $10,811,000, respectively, of agents' balances receivable from
these MGAs including installment premiums deferred and not yet due. The current
portion of balances due from these MGAs are settled on a monthly basis.
During 1992, Chartwell Reinsurance entered into a reinsurance contract with
Old American Insurance Company, then a related party. For the years ended
December 31, 1997 and 1996, Chartwell Reinsurance earned $3,819,000 and
$1,716,000 of premium on this contract and incurred, prior to the effect of
reinsurance ceded $2,750,000 and $1,506,000 in loss and LAE, respectively. At
December 31, 1997, the loss and LAE liability for this contract was $1,141,000
and unearned premiums were $569,000, respectively. Old American Insurance
Company is no longer a related party.
9. RESTRICTION ON PAYMENT OF DIVIDENDS
The ability of the Company to pay cash dividends to Chartwell Re is
dependent upon the amount of dividends received from Chartwell Reinsurance.
Chartwell Reinsurance's ability to pay cash dividends to the Company is, in
turn, restricted by law or subject to approval of the insurance regulatory
authorities of Minnesota, Chartwell Reinsurance's state of domicile. Insurance
regulatory authorities recognize statutory accounting practices for the ability
of an insurer to pay dividends to its shareholders.
Under the insurance laws of the State of Minnesota, payment of dividends by
Chartwell Reinsurance in any year is limited to the greater of: (i) 10% of
capital and surplus as of the prior year end as determined in accordance with
statutory accounting practices; or (ii) statutory net income from operations of
the next preceding year excluding realized capital gains. Notwithstanding the
foregoing, Chartwell Reinsurance may pay dividends only from its earned surplus,
also known as unassigned funds. The maximum dividend that can be paid without
prior approval of the Minnesota Department of Commerce in 1999 is $30.3 million.
On November 25, 1997, Chartwell Reinsurance paid a $3.0 million dividend to
the Company. On February 24, 1999, Chartwell Reinsurance paid a $5.5 million
dividend to the Company. No dividends were paid in 1996 or 1998.
In addition, under the insurance laws of the State of New York, INSCORP may
pay dividends to Chartwell Reinsurance only out of its statutory earned surplus.
The maximum amount of cash dividends INSCORP may pay out of its statutory earned
surplus, without prior regulatory approval, is subject to statutory restrictions
imposed by New York State Insurance Law. Generally, the maximum amount that may
be paid in any twelve month period without prior approval is the lesser of net
investment income as defined or 10% of statutory surplus to policyholders.
In addition to the foregoing limitation, the New York State Insurance
Department, as is its practice in any change of control situation, required the
Company to commit to preclude INSCORP from paying any dividends for two years
from the date of its merger with Chartwell Re without prior regulatory approval.
The two year period ended on December 13, 1997. INSCORP paid no dividends in
1997 or 1998.
The capital and surplus of Chartwell Reinsurance on the basis of statutory
accounting practices was $302,871,000 and $262,606,000 at December 31, 1998 and
1997, respectively. Net income of Chartwell Reinsurance based on statutory
accounting principles was $23,791,000, $10,239,000 and $6,156,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
The capital and surplus of INSCORP on the basis of statutory accounting
practices was $131,747,000 and $113,677,000 at December 31, 1998 and 1997,
respectively. Net income of INSCORP based on statutory accounting principles was
$22,627,000, $14,234,000 and $22,270,000 for the years ended December 31, 1998,
1997 and 1996, respectively.
10. REINSURANCE ASSUMED AND CEDED
The Company cedes a portion of its risks by utilizing various
retrocessional contracts. These contracts do not relieve the Company from its
obligations to policyholders. The Company regularly evaluates the financial
F-18
condition of its reinsurers and monitors concentration of credit risk with
respect to amounts recoverable under these contracts.
The effect of reinsurance on premiums written and earned at December 31,
1998, 1997 and 1996 is as follows (in thousands):
1998 1997 1996
-------------------------- -------------------------- --------------------------
Written Earned Written Earned Written Earned
--------- --------- --------- --------- --------- ---------
Primary insurance ............ $ 116,853 $ 116,109 $ 105,635 $ 86,343 $ 68,308 $ 66,709
Reinsurance assumed .......... 226,098 228,288 257,135 245,662 195,530 210,871
Reinsurance ceded ............ (125,897) (114,893) (94,510) (86,305) (71,587) (68,077)
--------- --------- --------- --------- --------- ---------
Net premiums ................. $ 217,054 $ 229,504 $ 268,260 $ 245,700 $ 192,251 $ 209,503
========= ========= ========= ========= ========= =========
Certain of the Company's large assumed reinsurance programs were not
renewed for 1998. During 1997, the Company's earned premiums related to these
programs were $48.2 million.
The effect of reinsurance on loss and LAE for the years ended December 31,
1998, 1997 and 1996 is a decrease of $74,498,000, $70,135,000 and $45,908,000,
respectively.
In 1997 and 1998, the Company entered into aggregate excess of loss
treaties. These treaties provide the Company with a layer of protection against
adverse results in all lines of business in excess of specified loss ratios.
Liabilities held by the Company under such treaties were $37.0 million and $10.5
million at December 31, 1998 and 1997, respectively.
The reinsurance recoverable balance on paid and unpaid losses and LAE from
any single entity or company in excess of 5% of the total at December 31, 1998
were as follows: London Life and Casualty Company, $51,009,000 (19.7%), Centre
Reinsurance (Bermuda) Limited, $16,608,000 (6.4%), and Western General Insurance
Ltd., $15,017,000 (5.8%).
In the normal course of business, the Company enters into trust agreements
effecting funds held arrangements or obtains letters of credit issued by banks
on behalf of the retrocessionaires which are not registered as "authorized
reinsurers" with the Minnesota Department of Commerce or the New York State
Insurance Department. The letters of credit or trust agreements serve as
collateral to the extent of their limit for the contingent liability which
exists in the event that the retrocessionaire is unable to meet its obligations
assumed under a retrocession agreement. Reinsurance recoverables with
"unauthorized reinsurers" totaled $153,709,000 and $119,768,000 as of December
31, 1998 and 1997, respectively. The respective portions collateralized were
$145,815,000 and $111,319,000.
Included in deposits on the balance sheet at December 31, 1998 and 1997 are
$12,306,000 and $11,548,000, respectively, deposited with European International
Reinsurance Limited and $7,669,000 and $7,492,000, respectively, deposited with
Centre Reinsurance (Bermuda) Limited, both of which are secured by letters of
credit as described in the preceding paragraph.
11. PERMITTED STATUTORY ACCOUNTING PRACTICES
Chartwell Reinsurance, INSCORP and Dakota prepare statutory financial
statements in accordance with accounting principles and practices prescribed or
permitted by their respective domiciliary state insurance departments.
Prescribed practices include state laws, regulations, and general administrative
rules, as well as a variety of publications of the National Association of
Insurance Commissioners ("NAIC"). Permitted statutory accounting practices
encompass all accounting practices that are not prescribed; such practices
differ from state to state, may differ from company to company within a state,
and may change in the future. In March 1998, the NAIC adopted the Codification
of Statutory Accounting Principles ("Codification"). The Codification, which is
intended to standardize regulatory accounting and reporting for the insurance
industry, 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 states of
Minnesota, New York and North Dakota will require adoption of 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.
F-19
12. LOSS AND LAE
The following table presents the activity in the liability for loss and LAE
for the years indicated (in thousands):
1998 1997 1996
--------- --------- ---------
Loss and LAE at beginning of year ................................. $ 788,240 $ 747,858 $ 741,467
Less reinsurance recoverables ..................................... 202,593 172,377 179,854
--------- --------- ---------
Net balance at beginning of year ................................ 585,647 575,481 561,613
--------- --------- ---------
Add provision for loss and LAE for claims occurring during:
Current year .................................................... 142,665 163,003 152,338
Prior years ..................................................... (7,400) (2,155) (1,717)
--------- --------- ---------
Total incurred loss and LAE ..................................... 135,265 160,848 150,621
--------- --------- ---------
Less losses and LAE payments for claims occurring during:
Current year .................................................... 42,102 45,286 29,554
Prior Years ..................................................... 130,669 105,396 107,199
--------- --------- ---------
Total paid loss and LAE ......................................... 172,771 150,682 136,753
--------- --------- ---------
Loss and LAE acquired as of acquisition date of:
Oak Dedicated Two Limited ....................................... 50,293
Archer Dedicated PLC ............................................ 41,124
--------- --------- ---------
Total loss and LAE acquired ..................................... 91,417
--------- --------- ---------
Net balance at end of year ........................................ 639,558 585,647 575,481
Plus reinsurance recoverables ..................................... 239,059 202,593 172,377
--------- --------- ---------
Loss and LAE at end of year ....................................... $ 878,617 $ 788,240 $ 747,858
========= ========= =========
As a result of changes in estimates of insured events in prior years, the
net provision for loss and LAE decreased by $7,400,000, $2,155,000, and
$1,717,000 in 1998, 1997 and 1996, respectively. These amounts, which represent
a decrease of 1.3%, 0.4% and 0.3% of the net loss and LAE at the beginning of
1998, 1997 and 1996, respectively, are the result of normal reserve development
inherent in the uncertainty of establishing loss and LAE liabilities. The
slightly larger redundancy in 1998 is attributable to favorable development in
asbestos and environmental reserves, which are in runoff.
The liabilities include provisions for latent injury or toxic tort claims
that cannot be estimated with traditional reserving techniques. Case reserves,
including LAE, have been established upon notification of loss from ceding
companies. In addition, the Company establishes additional liabilities in excess
of its share of the reserve established by the ceding company to cover exposures
on both known and unasserted claims. These liabilities are periodically reviewed
by the Company's claims department. In the reserve setting process, the Company
also includes provisions for social inflation (i.e. awards by judges and juries
that have progressively increased in recent years) and evaluates the potential
effect of any legislative changes on its reserve liabilities. However, because
of inconsistent court decisions in federal and state jurisdictions and the wide
variation among insureds with respect to underlying facts and coverage,
uncertainty exists with respect to these claims as to liabilities of ceding
companies and, consequently, reinsurance coverage.
At December 31, 1998, the Company carried case reserves and allocated LAE
attributable to asbestos claims and environmental pollution claims in the amount
of $78,974,000 ($54,926,000 after reduction for reinsurance recoverable) of
which $10,752,000 ($6,645,000 after reduction for reinsurance recoverable)
related to Chartwell Reinsurance and $68,222,000 ($48,281,000 after reduction
for reinsurance recoverable) related to INSCORP. The net deficiency attributable
to asbestos claims and environmental pollution claims for the years ended
December 31, 1998, 1997 and 1996 was $13.2 million, $8.7 million and $6.5
million, respectively. All of the net deficiency for the 1996 and 1997 years and
$11.3 million of the net deficiency for the 1998 year results from development
on business underwritten by INSCORP prior to its merger with Chartwell Re (the
"Merger") and, therefore, is subject to the protection provided by the
Contingent Interest Notes ("CI Notes") issued immediately prior to the Merger.
The CI Notes were issued to protect Chartwell Re against the possibility of
adverse development of INSCORP's reserves for losses and LAE, particularly with
respect to INSCORP's potential exposures for environmental impairment,
asbestos-related and latent injury claims and other long-tail casualty exposure.
Management believes that Chartwell Reinsurance's exposure to asbestos and
environmental losses is lessened because of its relatively recent entry into the
reinsurance business in 1979, its low historical levels of premium volume prior
to 1985, and its retrocessional programs
F-20
Environmental claims are particularly challenging to a reinsurance company.
Such claims involve underlying coverage disputes between the insured party and
its insurer; substantial legal defense costs; questions as to occurrences and
aggregation of claims and "late notice" issues. Environmental liability suits
often contain multiple party and multiple site actions that result in varied
adjudications among insureds and their insurers. Such a complex setting forces
the parties to find a reasonable basis for settling the claims. These widely
varying settlements involving primary insurers force challenges upon the
reinsurer with respect to the extent to which they should follow the settlements
of their ceding companies. Accordingly, there can be no assurance that the
Company's ultimate liability for losses and LAE will not vary significantly from
amounts reserved.
13. DEBT
(a) Long-term debt--The components of long-term debt at December 31, 1998
and 1997 are as follows (in thousands):
1998 1997
-------- --------
Senior notes ......................... $ 48,750 $ 48,750
Bank loan ............................ 56,303 51,198
Other ................................ 3,424 4,178
-------- --------
Total ................................ $108,477 $104,126
======== ========
On March 17, 1994, Chartwell Re completed a public offering (the
"Offering") of 10.25% Senior Notes due 2004, having a total principal amount of
$75,000,000. The net proceeds to Chartwell Re from the Offering were
approximately $71,934,000 after deducting expenses related to the Offering. Of
the net proceeds, $30,000,000 was contributed to the statutory surplus of
Chartwell Reinsurance and $23,400,000 was used to retire Chartwell Re's then
outstanding senior term loan. The remaining funds were retained by Chartwell Re
for general corporate purposes, which included the payment of interest on the
Senior Notes.
On April 8, 1996, the Company redeemed 35% of the Senior Notes for
$28,300,000, including the redemption premium. Due to this early extinguishment
of debt, the Company recognized an extraordinary loss of $1,874,000, net of
applicable income taxes of $1,000,000. This extraordinary charge represents the
redemption premium and 35% of the remaining original debt issuance costs
relating to the Senior Notes.
On December 13, 1995, Chartwell Re entered into a $20,000,000 loan
agreement with Fleet Bank (the "Fleet Loan"), with a variable interest rate
based upon the Eurodollar rate plus a margin based upon the S&P rating of the
Notes, scheduled to expire on December 13, 2002. The Fleet Loan was repaid
during 1996.
On November 14, 1996, the Company entered into a new credit facility with
First Union National Bank, N.A., ("First Union") as agent. The credit facility
provides for a term loan in two tranches, A & B, (the "First Union Loans"), with
outstanding balances of $30,000,000 and $15,858,000 (denominated in Pounds
Sterling), respectively at December 31, 1998 and outstanding balances of
$30,000,000 and $13,983,000 at December 31, 1997. In addition, at December 31,
1998, $5,467,000 of the Term B Loan was used to guarantee the Loan Notes. Both
loans are subject to a quarterly repayment schedule, commencing on March 31,
1999 and ending on December 31, 2002. The Company used $20,000,000 of the First
Union Loans to repay all outstanding borrowings under the $20,000,000 loan
agreement with Fleet Bank. Portions of the remainder of the First Union Loans
were drawn down in cash by the Company and contributed to Holdings Limited for
the purchase of Chartwell UK, and portions were utilized to guarantee the
obligations of Holdings Limited under the Loan Notes (the "First Union
Guarantee"). The holders of Loan Notes may require the Company to redeem all or
part of their holdings in June or December of each year. As the Loan Notes are
redeemed ("Loan Note Redemptions"), the First Union Guarantee is reduced and
replaced with loan proceeds to fund the Loan Note Redemptions. During 1998,
$1,800,000 of Loan Note Redemptions occurred, resulting in an outstanding
balance of Loan Notes of $5,467,000 at December 31, 1998.
The Company currently has a $60,000,000 Revolving Credit Commitment from
First Union (the "First Union Revolver"), which was increased from $35,000,000
in October of 1997. The First Union Revolver replaced the Company's $10,000,000
revolving credit facility from Fleet Bank (under which no borrowings were
outstanding). The First Union Revolver may be used to provide additional Loan
Note guarantees, to support underwriting at Lloyd's by the Company's
subsidiaries or for other general corporate purposes. At December 31, 1998, $1.4
million of the First Union credit facility was unused, $53.6 million was used to
finance unsecured letters of credit, and $5.0 million was used to secure a line
of credit. All obligations of the Company under the First Union credit facility
are guaranteed by Chartwell Re.
The other portion of long-term debt primarily represents capital lease
obligations.
F-21
The Company's long-term debt agreement contains general covenants and
restrictions as well as financial covenants relating to, among other things,
minimum earned surplus, minimum statutory surplus, minimum net worth, certain
financial ratios, and maintenance of minimum cash and cash equivalent balances
on the books of the borrower.
Annual maturities of long-term debt outstanding at December 31, 1998 are as
follows (in thousands):
1999 ........................................ $ 10,799
2000 ........................................ 14,271
2001 ........................................ 13,845
2002 ........................................ 20,812
2003 ........................................ 0
Future Years ................................ 48,750
--------
$108,477
========
(b) Capital Leases - During 1996, the Company began leasing certain
facilities and equipment under agreements which are classified as capital
leases. The leases have original terms of 3 to 5 years and have purchase options
at the end of the original lease term. At the end of the term, the Company may
purchase the equipment for a mutually agreeable price, renew the lease or return
the equipment to the lessor and enter into a new lease. Leased capital assets
include the buildout costs of the Company's leased office space for its
principal executive offices, furniture and equipment, and electronic data
processing hardware and software and are included in Other Assets in the
consolidated balance sheet at December 31, 1998 and 1997 as follows (in
thousands):
1998 1997
------ ------
Office space build-out costs ................... $ 884 $1,179
Furniture and equipment ........................ 2,302 2,648
EDP hardware and software ...................... 569 1,137
------ ------
$3,755 $4,964
====== ======
Leased capital assets are amortized to interest expense on a straight-line
basis over the original lease term. For the years ended December 31, 1998 and
1997, the Company recorded $312,000 and $230,000, respectively, of interest
expense related to such leased assets. Future minimum payments, including
principal and interest, by year and in the aggregate, under non-cancelable
capital leases are as follows (in thousands):
1999 .................................. $1,771
2000 .................................. 1,440
2001 .................................. 1,014
2002 .................................. 435
------
$4,660
======
14. COMMITMENTS AND CONTINGENCIES
Operating leases--The Company leases office space for its principal
executive offices in the U.S. and U.K. under non-cancelable, renewable operating
leases expiring on July 31, 2006 and December 24, 2008, respectively. The rent
expense has been accounted for on a straight-line basis after amortization of a
rent abatement allowance (on the U.S. lease). Rental expense for 1998, 1997 and
1996 was $2,521,000, $2,828,000 and $1,386,000, respectively. The future minimum
rental payments, exclusive of escalation clauses, under the existing leases as
of December 31, 1998 are as follows (in thousands):
1999 .................................. $2,489
2000 .................................. 1,450
2001 .................................. 1,560
2002 .................................. 1,628
2003 .................................. 1,725
Future Years .......................... 5,903
F-22
Line of credit--The Company has a $60 million revolving credit facility
with First Union, of which $1.4 million was unused, $53.6 million was used to
finance unsecured letters of credit, and $5.0 million was used to secure a line
of credit as of December 31, 1998.
Loan guarantees and letters of credit--At December 31, 1998, the Company
has outstanding loan guarantees and standby letters of credit totaling
$4,353,000 and $68,905,000, respectively. The loan guarantees and standby
letters of credit are in force for five years, for which the Company pays annual
fees of $562,000. The loan guarantees and letters of credit provide capital to
NLC Name No. 6 Limited, Riverside Underwriters Plc and Oak Dedicated, corporate
members of Lloyd's, to participate in certain Lloyd's syndicates for the 1995
Underwriting Year and thereafter. The investments in NLC Name No. 6 and
Riverside Underwriters Plc, which amount to $16,429,000 at December 31, 1998,
are included in other assets with corresponding amounts included in other
liabilities for the loan guarantees and letters of credit.
Limited Partnership Investment--In 1996, the Company made a commitment to
invest $15 million in a private equity fund, High Ridge Capital Limited
Partnership, which makes investments in the insurance industry. The Company
contributed a total of $9.8 million and $3.8 million to this fund as of December
31, 1998 and 1997, respectively.
American Eagle--In 1996 and early 1997, the Company entered into certain
assumption of liability endorsement ("ALE") agreements with American Eagle
Insurance Company ("American Eagle"). On December 3, 1997, American Eagle was
placed in receivership by the Texas Department of Insurance. The Company's
contingent liability under these agreements was originally secured by $3,600,000
of funds held in trust. As of December 31, 1998, $1,200,000 of such funds have
been paid to the Company as reimbursement for losses incurred under the ALE's.
Since a significant portion of the Company's liabilities in connection with
American Eagle are colateralized by this trust fund, management of the Company
does not presently believe that any residual exposure resulting from the
receivership of American Eagle is likely to have a material adverse effect on
its financial position or results of operations.
Lloyd's Names exposure--The Company's balance sheet at December 31, 1998
includes a provision for potential exposure to certain of the Names who had
participated on syndicates managed by CMA. The provision was established by the
Company based on actuarial projections of the expected deterioration for the
applicable years of account. Management believes at the present time that the
provisions related to such potential exposure is sufficient.
Other--The Company, Chartwell Reinsurance, INSCORP and CMA are subject to
the litigation of disputes in the normal course of their business. Management
does not believe that any pending litigation or arbitration to which it is a
party, or of which any of its properties or assets are subject, is likely to
have a materially adverse effect on its current financial position or results of
operations.
15. PUBLIC STOCK OFFERING
Chartwell Re completed a public offering of 2,725,000 shares of common
stock at $23.00 per share during the first half of 1996. The net proceeds to
Chartwell Re were $58,503,000 after deduction of underwriting discount and
expenses. Of the net proceeds, $48,500,000 was contributed to the Company, of
which $20,000,000 was contributed to the statutory surplus of Chartwell
Reinsurance and $28,500,000 was used to retire 35% of the Company's outstanding
Senior Notes plus accrued interest (Note 13). The remaining funds were retained
for general corporate purposes.
16. STOCK OPTION PLANS AND COMMON STOCK WARRANTS
During 1997, Chartwell Re adopted the 1997 Omnibus Stock Incentive Plan
(the "1997 Plan") as the successor to the 1993 Stock Option Plan (the "1993
Plan") which was adopted on October 15, 1993. Under the 1993 Plan, options to
acquire 1,000,000 shares of Common Stock of Chartwell Re were authorized to be
granted to officers, key employees and directors of Chartwell Re and its
designated subsidiaries. Upon adoption of the 1997 Plan, no further awards shall
be made under the 1993 Plan and 107,000 of previously authorized non-granted
shares under the 1993 Plan became available under the 1997 Plan. Chartwell Re
also authorized an additional 800,000 shares to be granted under the 1997 Plan.
Under both plans, the options become exercisable at various dates.
F-23
A total of 50,000 shares are available for grants of options to
non-employee directors of Chartwell Re until December 31, 2006 under the 1996
Non-Employee Directors Stock Option Plan. An option to purchase 1,000 shares of
Chartwell Re's Common Stock was granted to all non-employee directors of
Chartwell Re in office at January 1, 1996 and will be granted to all
non-employee directors of Chartwell Re on the date of each annual meeting of
stockholders. The options are exercisable after six months from the grant date
at a price equal to the fair value of Chartwell Re's stock on the date of grant.
The options expire ten years after the grant date.
The total number of options available to purchase shares of Chartwell Re's
Common Stock under the Company's stock option plans at December 31, 1998, 1997
and 1996 are as follows:
1998 1997 1996
---------------------- ------------------------ ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- --------- ------- --------
Outstanding, beginning of year...... 1,275,300 $ 24.55 876,400 $ 21.92 672,900 $ 21.00
Granted............................. 316,500 29.36 431,000 29.65 203,500 24.95
Exercised........................... (15,000) 21.43 (22,400) 21.04
Cancelled........................... (61,750) 29.42 (9,700) 22.01
--------- --------- -------
Outstanding, end of year............ 1,515,050 25.39 1,275,300 24.55 876,400 21.92
========= ========= =======
Options exercisable at end of year.. 820,725 665,040 554,060
========= ========= =======
At December 31, 1998, there were warrants outstanding for the purchase of
335,002 shares of Common Stock of Chartwell Re at prices of $21 and $22 per
share.
17. EMPLOYEE STOCK PURCHASE PLANS
Chartwell Re established an Employee Stock Purchase Plan which became
effective January 1, 1996. Participating employees are permitted to purchase,
annually, shares of Chartwell Re's Common Stock through payroll deductions in an
amount ranging from 2% to 10% of the employee's base pay (as elected by the
employee). The purchase price for shares purchased in a particular plan year is
equal to the lesser of (i) 85 percent of the fair market value of the Common
Stock on the beginning of such plan year or (ii) 85 percent of the fair market
value of the Common Stock at the end of such plan year. Chartwell Re has
authorized 100,000 shares of common stock for purchase under the plan of which
13,692, 11,587 and 12,381 were purchased in January 1999, February 1998 and
January 1997, respectively.
Chartwell UK established an Employee Stock Purchase Plan which became
effective May 1, 1997. Participating employees contribute savings to the Plan
ranging from (pound)5 to (pound)250 per month (as elected by the employee). At
the end of three years, the employees may use their savings to buy shares in
Chartwell Re at a price equal to 85% of the fair value of Chartwell Re's Common
Stock as of the inception of the three year period.
F-24
18. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data is as follows (in thousands):
First Second Third Fourth
Quarter Quarter Quarter Quarter
--------- --------- --------- ---------
For the year ended December 31, 1998
Premiums earned ............................... $ 52,743 $ 56,430 $ 59,333 $ 60,998
Net investment income ......................... 11,872 12,157 12,177 12,618
Net realized capital gains (losses) ........... 99 (39) 199 (230)
Income tax expense ............................ 3,318 3,573 3,725 4,735
Net income .................................... 8,233 8,405 8,383 10,136
Stockholder's equity .......................... 278,474 289,429 302,705 307,923
For the year ended December 31, 1997
Premiums earned ............................... $ 61,785 $ 73,890 $ 59,002 $ 51,023
Net investment income ......................... 10,173 11,189 10,910 11,185
Net realized capital gains (losses) ........... (20) (29) 112 (66)
Income tax expense ............................ 2,799 3,078 3,097 3,228
Net income .................................... 6,678 6,945 7,225 6,926
Stockholder's equity .......................... 229,374 244,135 256,825 269,052
F-25
CHARTWELL RE HOLDINGS CORPORATION
SCHEDULE I-SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
At December 31, 1998
(in thousands)
Column A Column B Column C Column D
- ----------------------------------------------------------------------------- -------- -------- --------
Amount at
which shown
in the
Fair balance
Cost Value sheet
-------- -------- --------
Fixed Maturities:
Bonds:
United States Government and government agencies and
authorities (1) ....................................................... $206,820 $212,467 $212,088
States, municipalities and political subdivisions (1) .................... 165,231 171,899 171,883
Foreign governments ...................................................... 27,520 29,263 28,456
All other corporate bonds ................................................ 232,942 240,487 240,442
Redeemable preferred stock ................................................... 35,773 37,422 37,422
-------- -------- --------
Total fixed maturities ................................................ 668,286 691,538 690,291
-------- -------- --------
Equity Securities-Common stocks of insurance
companies/partnership interests .......................................... 33,637 36,358 36,358
-------- -------- --------
Total investments (2) ................................................. $701,923 $727,896 $726,649
======== ======== ========
- ----------
(1) Balance sheet value differs from column B and C because category includes a
combination of securities "Held to Maturity" and "Available for Sale." See
Notes 1b and 4 of the audited consolidated financial statements.
(2) Excludes investments held by CMA managed syndicates.
S-1
CHARTWELL RE HOLDINGS CORPORATION
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(in thousands)
December 31,
---------------------
1998 1997
-------- --------
ASSETS:
Investment in and receivable/payable from/to subsidiaries ................ $400,642 $353,726
Cash and cash equivalents ................................................ 1,820 3,070
Other assets ............................................................. 11,775 18,924
-------- --------
$414,237 $375,720
======== ========
LIABILITIES:
Long term debt ........................................................... $101,603 $ 95,940
Other liabilities ........................................................ 4,711 10,728
-------- --------
Total liabilities .................................................. 106,314 106,668
-------- --------
STOCKHOLDER'S EQUITY:
Common stock, par value $1.00 per share; authorized 1,000 shares;
shares issued and outstanding 100 ......................................
Additional paid-in capital .............................................. 217,866 217,866
Net unrealized appreciation of investments ............................... 12,534 8,741
Foreign currency translation adjustment .................................. 217 296
Retained earnings ........................................................ 77,306 42,149
-------- --------
Total stockholder's equity ......................................... 307,923 269,052
-------- --------
$414,237 $375,720
======== ========
The condensed financial statements should be read in conjunction with the
consolidated financial statements and the accompanying notes thereto.
S-2
CHARTWELL RE HOLDINGS CORPORATION
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF OPERATIONS
(in thousands)
1998 1997 1996
-------- -------- --------
REVENUES:
Net investment income .................................................. $ 589 $ 3,879 $ 651
Other income ........................................................... 2,545 2,021 1,203
Realized gains ......................................................... 368 51
-------- -------- --------
Total revenues ................................................... 3,502 5,900 1,905
-------- -------- --------
EXPENSES:
Interest and amortization .............................................. 7,382 7,347 7,835
General expenses ....................................................... 2,668 2,276 2,144
-------- -------- --------
Total expenses ................................................... 10,050 9,623 9,979
-------- -------- --------
Loss before federal income taxes, equity in undistributed
income of subsidiaries and extraordinary item ........................ (6,548) (3,723) (8,074)
-------- -------- --------
Federal income taxes:
Current .............................................................. (1,920) (2,436) (2,783)
Deferred ............................................................. (307) (74)
-------- -------- --------
Total income tax benefit ......................................... (2,227) (2,510) (2,783)
-------- -------- --------
Loss before equity in undistributed income of subsidiaries and
extraordinary item ................................................... (4,321) (1,213) (5,291)
Equity in undistributed income of subsidiaries ......................... 39,478 28,987 27,660
-------- -------- --------
Income before extraordinary item ....................................... 35,157 27,774 22,369
Extraordinary item, net of tax ......................................... 1,874
-------- -------- --------
Net income ............................................................. $ 35,157 $ 27,774 $ 20,495
======== ======== ========
The condensed financial statements should be read in conjunction with the
consolidated financial statements and the accompanying notes thereto.
S-3
CHARTWELL RE HOLDINGS CORPORATION
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STATEMENTS OF CASH FLOWS
(in thousands)
1998 1997 1996
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income taxes recovered ................................................. $ 5,265 $ 2,698 $ 1,941
Interest received on investments ........................................... 104 3,879 485
Overhead expenses .......................................................... (416) (4,682)
Service and other revenue .................................................. 300 300
Interest paid .............................................................. (9,963) (9,071) (7,415)
Other, net ................................................................. 217 2,365 (5,766)
-------- -------- --------
Net cash used in operating activities .................................. (4,493) (4,511) (10,755)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital contributions and advances to subsidiaries ......................... (3,871) (18,058)
Proceeds of investments sold expenses paid ................................. 343 4,723
-------- -------- --------
Net cash used in investing activities .................................. (3,528) (13,335)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock ................................. 48,546
Issuance of long term debt ................................................. 6,771 2,689 48,057
Redemption of long term debt ............................................... (3,425) (73,109)
-------- -------- --------
Net cash provided by (used in) financing activities .................... 6,771 (736) 23,494
-------- -------- --------
Effect of exchange rate on cash ........................................ 206
-------- -------- --------
Net decrease in cash and cash equivalents .................................... (1,250) (5,247) (390)
Cash and cash equivalents at beginning of year ............................... 3,070 8,317 8,707
-------- -------- --------
Cash and cash equivalents at end of year ..................................... $ 1,820 $ 3,070 $ 8,317
======== ======== ========
RECONCILIATION OF NET INCOME TO NET CASH
USED IN OPERATING ACTIVITIES:
Net income ................................................................. $ 35,157 $ 27,774 $ 20,495
Adjustments to reconcile net income to net cash used in
operating activities .......................................................
Equity in undistributed earnings of subsidiaries ....................... (39,478) (28,987) (27,660)
Net realized capital gains ............................................. (51)
Deferred income taxes .................................................. (140) (89) (1,008)
Net change in other assets and liabilities ............................. (32) (3,209) (2,531)
-------- -------- --------
Net cash used in operating activities .................................. $ (4,493) $ (4,511) $ 10,755
======== ======== ========
The condensed financial statements should be read in conjunction with the
consolidated financial statements and accompanying notes thereto.
S-4
CHARTWELL RE HOLDINGS CORPORATION
SCHEDLE IV - REINSURANCE
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(in thousands)
Column A Column B Column C Column D Column E Column F
- ----------------------------------------------------- -------- -------- -------- -------- --------
Percentage
Ceded to Assumed from of amount
Gross other other assumed to
amount companies companies Net amount net
-------- --------- --------- ---------- -----
1998
Premiums earned:
Property and casualty insurance ................... $116,109 $114,893 $228,288 $229,504 99.5%
-------- -------- -------- -------- -----
Total premiums ................................ $116,109 $114,893 $228,288 $229,504 99.5%
======== ======== ======== ======== =====
1997
Premiums earned:
Property and casualty insurance ................... $ 86,343 $ 86,305 $245,662 $245,700 100.0%
-------- -------- -------- -------- -----
Total premiums ................................ $ 86,343 $ 86,305 $245,662 $245,700 100.0%
======== ======== ======== ======== =====
1996
Premiums earned:
Property and casualty insurance ................... $ 66,709 $ 68,077 $210,871 $209,503 100.7%
-------- -------- -------- -------- -----
Total premiums ................................ $ 66,709 $ 68,077 $210,871 $209,503 100.7%
======== ======== ======== ======== =====
S-5
CHARTWELL RE HOLDINGS CORPORATION
SCHEDLE V - VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(in thousands)
Column A Column B Column C Column D Column E
Additions
Balance at Charged to Charged to Balance at
Beginning of Costs and Other Deductions End of
Period Expenses Accounts Describe Period
Year Ended December 31, 1998
Reinsurance recoverable:
Allowance for Uncollectible
Reinsurance (1) ......................... $6,394 $ 8 $6,402
Year Ended December 31, 1997
Reinsurance recoverable:
Allowance for Uncollectible
Reinsurance (1) ......................... $5,731 $ 663 $6,394
Year Ended December 31, 1996
Reinsurance recoverable:
Allowance for Uncollectible
Reinsurance (1) ......................... $5,717 $ 14 $5,731
(1) The Company has a reinsurance agreement which protects the Company from
certain uncollectible reinsurance balances. Uncollectible amounts have been
ceded to said contract and are reflected as reinsurance recoverable in the
balance sheet. Deductions to reserve represent subsequent collections of
amounts deemed uncollectible.
S-6
CHARTWELL RE HOLDINGS CORPORATION
SCHEDULE VI - SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY
INSURANCE OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Reserves Claims and Claim
for Unpaid Adjustment Expenses
Deferred Claim and Discount Incurred Related to
Policy Claim if any, Net ---------------------
Affiliation with Acquisition Adjustment deducted Unearned Earned Investment Current Prior
Registrant Costs Expenses(1) in Column C Premiums Premiums Income Year Year
---------- ----- ----------- ----------- -------- -------- ------ ---- ----
Years Ended:
December 31, 1998..... $ 24,084 $ 878,617 $ 108,495 $ 229,504 $ 48,824 $ 142,665 $ (7,400)
December 31, 1997..... 26,100 788,240 111,149 245,700 43,457 163,003 (2,155)
December 31, 1996..... 17,903 747,858 81,599 209,503 43,598 152,338 (1,717)
Amortization
of Deferred Paid Claims
Policy and Claim Other Net
Affiliation with Acquisition Adjustment Operating Premiums
Registrant Costs Expenses Expenses Written
---------- ----- -------- -------- -------
Years Ended:
December 31, 1998..... $ 61,564 $ 172,771 $ 39,545 $ 217,054
December 31, 1997.....
72,655 150,682 36,333 268,260
December 31, 1996..... 52,030 136,753 19,050 192,251
(1) The Company adopted SFAS No. 113 which, among other things, requires the
Company to record its reserves for unpaid losses and LAE without reduction
for amounts that would be recovered from retrocessionaires. The amount
recoverable from retrocessionaires is recorded as an asset on the Company's
balance sheet. The net of such asset and the reserves for loss and LAE is
$639.6, $585.6 and $575.5 million at December 1998, 1997 and 1996,
respectively.
S-7
INDEX TO EXHIBITS
Exhibits
- --------
3.1 Certificate of Incorporation of Chartwell Re Holdings
Corporation. Incorporated by reference to Exhibit 3.1 to Chartwell Re
Holdings Corporation's Annual Report on Form 10-K for the year ended
December 31, 1995 (File No. 0-28188).
3.2 By-laws of Chartwell Re Holdings Corporation. Incorporated by
reference to Exhibit 3.2 to Chartwell Re Holdings Corporation's Annual
Report on Form 10-K for the year ended December 31, 1995 (File No.
0-28188).
4.1 Indenture, dated as of March 17, 1994, between Chartwell Re
Corporation and Bankers Trust Company, as Trustee, for the 10 1/4%
Senior Notes due 2004 (the "Senior Notes"). Incorporated by reference
to Exhibit 4.1 to Chartwell Re Corporation's Registration Statement on
Form S-1 (File No. 33-75386).
4.2 First Supplemental Indenture, dated as of December 12, 1995,
among Chartwell Re Corporation, Chartwell Re Holdings Corporation and
Bankers Trust Company, as Trustee, for the Senior Notes. Incorporated
by reference to Exhibit 4.3 to Chartwell Re Corporation's Registration
Statement on Form S-1 (File No. 333-678).
4.3 Second Supplemental Indenture, dated as of December 12, 1995,
between Chartwell Re Holdings Corporation and Bankers Trust Company,
as Trustee, for the Senior Notes. Incorporated by reference to Exhibit
4.4 to Chartwell Re Corporation's Registration Statement on Form S-1
(File No. 333-678).
10.1 First Amended and Restated Credit Agreement, dated as of
November 14, 1996 among Chartwell Re Holdings Corporation, the Lenders
named therein, First Union National Bank of North Carolina, as Agent
and as an Issuing Bank, First Union National Bank, (London Branch), as
an Issuing Bank as amended by the First Amendment to First Amended and
Restated Credit Agreement, dated as of January 24, 1997 by and between
Chartwell Re Holdings Corporation, the Lenders named therein, First
Union National Bank of North Carolina, as Agent and as Issuing Bank,
and First Union National Bank (London Branch), as an Issuing Bank.
Incorporated by reference to Exhibit 10.1 to Chartwell Re
Corporation's Annual Report on Form 10-K for the year ended December
31, 1996 (File No. 1-12502).
10.2 Second Amendment to First Amended and Restated Credit
Agreement, dated as of October 30, 1997, among Chartwell Re Holdings
Corporation, the Lenders named therein, First Union National Bank, as
Agent and as Issuing Bank, and First Union National Bank (London
Branch) as an Issuing Bank. Incorporated by reference to Exhibit 10.3
to Chartwell Re Holdings Corporation's Annual Report on Form 10-K for
the year ended December 31, 1997 (File No. 0-28188).
10.3 Third Amendment to First Amended and Restated Credit
Agreement and Acknowledgement, dated as of December 1, 1998, among
Chartwell Re Holdings Corporation. Chartwell Reinsurance Company,
Chartwell Re Corporation, Chartwell Holdings Limited, the Lenders
named therein, First Union National Bank, as Agent and as an Issuing
Bank and First Union National Bank (London Branch), as an Issuing
Bank.
10.4 Form of Change of Control Agreement between Chartwell Re
Holdings Corporation and senior officers of Chartwell Re Holdings
Corporation. Incorporated by Reference to Exhibit 10.32 to Chartwell
Re Corporation's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 1-12502).*
10.5 Workers Compensation Retrocessional Stop Loss Agreement,
dated September 30, 1997, by and between both Chartwell Reinsurance
Company and The Insurance Corporation of New York and Western General
Insurance Ltd. Incorporated by Reference to Exhibit 10.4 to Chartwell
Re Holdings Corporation's Annual Report on Form 10-K for the year
ended December 31, 1997 (File No. 0-28188).
10.6 Aggregate Excess of Loss Reinsurance Treaty among Chartwell
Reinsurance Company, Dakota Specialty Insurance Company, The Insurance
Corporation of New York and London Life and Casualty Reinsurance
Corporation, dated as of July 1, 1997. Incorporated by Reference to
Exhibit 10.5 to Chartwell Re Holdings Corporation's Annual Report on
Form 10-K for the year ended December 31, 1997 (File No. 0-28188).
10.7 Aggregate Excess of Loss Reinsurance Treaty among Chartwell
Reinsurance Company, Dakota Specialty Insurance Company, The Insurance
Corporation of New York, Drayton Company Limited, Chartwell Re
Holdings Corporation, London Life and Casualty Reinsurance Corporation
of Western General Insurance Ltd, dated October 1, 1998.
10.8 Tax Allocation Agreement, dated December 13, 1995, by and
among Chartwell Re Corporation, Chartwell Re Holdings Corporation,
Drayton Company Limited, Chartwell Reinsurance Company, The
Reinsurance Corporation of New York and The ReCor Insurance Company
Inc. Incorporated by Reference to Exhibit 10.2 to Chartwell Re
Holdings Corporation 's Annual Report on Form 10-K for the year ended
December 31, 1997 (File No. 0-28188).
12.1 Computation of ratio of earnings to fixed charges.
21. Subsidiaries of Chartwell Re Corporation.
27.1 Financial Data Schedule
- -------------------------
*Management contract, compensatory plan or arrangement