Exhibit 13
Management's Discussion and Analysis of
Financial Condition and Results of Operations
GENERAL
NAC Re Corp. ("NAC Re") is the holding company for NAC Reinsurance
Corporation ("NAC"), which is engaged in the reinsurance and insurance business.
NAC Re, NAC and its subsidiaries are collectively referred to as the Company.
(This discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto of NAC Re included elsewhere
herein.)
INDUSTRY OVERVIEW
The domestic and international property and casualty reinsurance industry
has been characterized by severe price competition over the last few years.
Generally, these competitive conditions have prevailed across both treaty and
facultative reinsurance products and within most business lines, including
casualty, property, and specialty lines. While reinsurance product terms,
underwriting expertise, and service quality offered by particular reinsurance
companies are important factors that may influence the reinsurance purchasing
decisions of primary companies, overall market conditions affecting supply and
demand for reinsurance products have led to substantial pressure on reinsurance
pricing. In particular, the substantial level of capital maintained by
reinsurance companies, resulting from, among other things, earnings growth,
investment portfolio gains, and the access to additional capital from capital
markets have contributed to growing capacity in the reinsurance industry.
Notwithstanding the decrease in the number of active reinsurance companies due
to acquisitions and the decision by certain companies to exit the industry,
there continues to be a substantial number of industry participants. In
addition, as a result of earnings growth, investment portfolio gains, mergers
and other factors (including a relatively low level of catastrophic events),
remaining industry competitors, despite increased share repurchase and dividend
activity, are in many cases characterized by greater capital levels.
The demand for reinsurance by primary property and casualty insurance
companies is influenced by prevailing economic and market conditions,
anticipated underwriting and investment results, capital levels and risk
tolerance. While certain primary property and casualty insurance companies may
be inclined to purchase more reinsurance protection as a result of the
prevailing pricing environment, overall reinsurance demand has been adversely
affected by several factors. Consolidation among primary insurance companies,
increased primary company capital levels, and continued access to capital
markets have contributed to competitive pricing pressure by primary companies.
In a number of instances, primary insurance companies have chosen to increase
their net retention levels, thereby purchasing less reinsurance protection
(albeit with a greater level of risk). In addition, a number of primary
companies have commenced reducing the number of reinsurers with whom they
conduct business, thereby fostering increased competition for such
opportunities.
Other factors that have contributed to the prevailing competitive conditions
in the reinsurance industry include new entrants to the reinsurance market
(including certain specialized reinsurance operations) and the presence of
certain reinsurance companies which operate within tax-advantaged jurisdictions
(e.g., Bermuda, Cayman Islands) that benefit from higher after-tax investment
returns. In addition, concerns with respect to the financial security of Lloyds
of London that had adversely impacted the competitive position of that
marketplace have apparently been overcome by actions taken at Lloyds over the
last few years, thereby enhancing its competitive position.
To the extent that primary insurance companies increasingly emphasize
underwriting expertise, financial security and service levels in their selection
of reinsurers, management believes that the Company is well positioned to
compete as compared to those competitors which do not have the personnel,
systems, controls, capital position and service capabilities enjoyed by the
Company.
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The primary insurance industry in which the Company conducts its program
business is also characterized by substantial competitive pricing. Many
primary property and casualty insurance companies have created operations or
marketing initiatives to develop program business to utilize the underwriting
operational capabilities already in existence. The program business,
including large groups of insureds with substantially consistent
underwriting, administration, and claims handling requirements, presents such
primary insurance companies with the opportunity to leverage their
underwriting, marketing, and claims handling capabilities. The Company writes
primary program business through its wholly-owned subsidiaries, Greenwich
Insurance Company (licensed in 50 states) and Indian Harbor Insurance Company
(excess and surplus lines). Such business is written through both managing
and general agents and includes certain specialty classes such as auto
warranty business.
RESULTS OF OPERATIONS
The Company's net operating income, excluding realized investment gains, was
$67.7 million for 1997, $57.8 million for 1996, and $45.9 million for 1995. On a
basic per share basis, operating income, excluding realized investment gains,
was $3.68, $3.07, and $2.59 for 1997, 1996, and 1995, respectively. On a diluted
per share basis, operating income, excluding realized investment gains, was
$3.42, $2.90, and $2.45 for 1997, 1996, and 1995, respectively.
Net income was $95.7 million for 1997, $70.5 million for 1996, and $62.8
million for 1995. On a basic per share basis, net income was $5.21, $3.74, and
$3.55 for 1997, 1996, and 1995, respectively. On a diluted per share basis, net
income was $4.77, $3.51 and $3.30 for 1997, 1996, and 1995, respectively. Net
income for 1997 includes after-tax realized investment gains of $28.0 million or
$1.35 per diluted share compared to $12.7 million or $.61 per diluted share in
1996 and $17.0 million or $.84 per diluted share in 1995.
PREMIUM REVENUES
The Company's premium revenue for its domestic and international operations
is as follows:
GROSS PREMIUMS WRITTEN PERCENT CHANGE
------------------------------- --------------------------
(DOLLARS IN MILLIONS) 1997 1996 1995 97 VS. 96 96 VS. 95
- ---------------------------------------------------------------- --------- --------- --------- ----------- -------------
Domestic:
Casualty........................................................ $ 340.1 $ 364.1 $ 354.8 (6.6)% 2.6%
Property........................................................ 178.5 189.2 179.8 (5.7) 5.2
Specialty/other................................................. 148.6 102.1 92.3 45.5 10.7
--------- --------- --------- ----------- -------------
Subtotal...................................................... 667.2 655.4 626.9 1.8 4.6
--------- --------- --------- ----------- -------------
International:
Casualty........................................................ 30.3 22.8 19.2 32.9 18.1
Property........................................................ 32.2 38.9 33.9 (17.0) 14.7
--------- --------- --------- ----------- -------------
Subtotal...................................................... 62.5 61.7 53.1 1.4 15.9
--------- --------- --------- ----------- -------------
Intercompany transactions....................................... (5.8) (3.0) (2.1) -- --
--------- --------- --------- ----------- -------------
Total........................................................... $ 723.9 $ 714.1 $ 677.9 1.4% 5.3%
--------- --------- --------- ----------- -------------
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MANAGEMENT'S DISCUSSION AND ANALYSIS
NET PREMIUMS WRITTEN PERCENT CHANGE
------------------------------- ------------------------
(DOLLARS IN MILLIONS) 1997 1996 1995 97 VS. 96 96 VS. 95
- ---------------------------------------------------------------- --------- --------- --------- ----------- -----------
Domestic:
Casualty........................................................ $ 313.3 $ 328.9 $ 311.7 (4.8)% 5.5%
Property........................................................ 122.6 121.1 111.1 1.3 9.0
Specialty/Other................................................. 105.5 71.9 53.3 46.7 35.0
--------- --------- --------- ----------- -------------
Subtotal...................................................... 541.4 521.9 476.1 3.7 9.6
--------- --------- --------- ----------- -------------
International:
Casualty........................................................ 27.5 22.1 18.7 24.0 18.4
Property........................................................ 24.8 30.0 26.7 (17.2) 12.1
--------- --------- --------- ----------- -------------
Subtotal...................................................... 52.3 52.1 45.4 .3 14.7
--------- --------- --------- ----------- -------------
Total........................................................... $ 593.7 $ 574.0 $ 521.5 3.4% 10.1%
--------- --------- --------- ----------- -------------
Worldwide gross premiums written were $723.9 million in 1997 compared to
$714.1 million in 1996 and $677.9 million in 1995. The 1.4% increase in 1997 was
primarily attributable to the increase in domestic gross premiums written,
specifically the specialty/other segment. The 5.3% increase in 1996 was
attributed to increases in all business lines: casualty, property, specialty,
and international. Worldwide net premiums written were $593.7 million in 1997
compared to $574.0 million in 1996 and $521.5 million in 1995. The increases in
1997 and 1996 were principally due to the reductions in ceded premium as
discussed below.
Worldwide casualty gross premiums written in 1997 totaled $368.0 million, a
decrease of 4.7% compared to increases of 3.4% in 1996 and 21.5% in 1995.
Domestic casualty gross premiums written decreased 6.6% in 1997 compared to
increases of 2.6% in 1996 and 20.9% in 1995. Casualty business declined in 1997
due principally to NACs continued strong underwriting discipline amid prolonged
soft market conditions defined by a further decline in market rates. The decline
in the 1997 casualty treaty gross premiums offset the 28% increase in casualty
facultative premiums, principally attributable to the increase in facultative
automatic business. The rate of growth in 1996 casualty gross premiums was
diminished as a result of increased retentions by certain ceding companies,
particularly from one large account. Casualty growth in 1996 was attributed to
increased opportunities from existing facultative and treaty clients, which more
than offset the overall impact of increased retention levels of the Company's
clients. Casualty growth in 1995 was generated by increased participations with
existing treaty clients.
Worldwide property gross premiums written were $207.3 million in 1997,
compared to $225.8 million in 1996 and $212.2 million in 1995. Domestic property
gross premiums written decreased 5.7% in 1997 compared to increases of 5.2% in
1996 and 18.5% in 1995. The 1997 decrease resulted from increased competitive
market conditions. Property facultative growth of 4.8% in 1997 was more than
offset by the decline in property treaty that contributed to the overall
decrease in property gross premiums written. The increase in property gross
premiums written in 1996 and 1995 was the result of growth in facultative
business.
Worldwide specialty and other gross premiums written in 1997 totaled $148.6
million which included fidelity/surety, ocean marine, aviation business, and
certain primary program business. Fidelity/surety bond gross premiums were $37.8
million in 1997, $45.9 million in 1996, and $33.3 million in 1995. The lower
premium amount in 1997 was primarily due to the Company's strong underwriting
and pricing
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standards in a heightened competitive environment. The growth in 1996
fidelity/surety bond premiums was primarily attributable to one significant
new account. The 1997, 1996, and 1995 fidelity/surety bond premiums were
affected by the weak market conditions and increased retentions by primary
companies. Specialty lines include a significant portion of the Company's
primary program business. The balance of the program business is included in
casualty and property business. The majority of the growth reported by the
Company's primary companies in 1997 emanated from increased opportunities with
an auto warranty program. Primary insurance business represented
approximately 18% of total gross premiums written for the Company in 1997.
Specialty lines were expanded to include ocean marine business in 1994.
Ocean marine gross premiums written totaled $18.8 million in 1997 compared to
$12.7 million in 1996. The 1997 increase reflects the benefits derived from
several new contracts. The Company's participation in aviation began in 1992 and
expanded in 1994 with participation in an industry aviation underwriting pool.
Net premiums written from aviation business totaled $14.9 million, $8.3 million,
and $10.9 million in 1997, 1996, and 1995, respectively. The increase in 1997
was principally due to the Company's participation in the aviation pool combined
with additional premiums in connection with providing reinsurance to the
aviation pool.
International gross premiums written were $62.5 million, $61.7 million, and
$53.1 million for the years 1997, 1996, and 1995, respectively. The 1.4%
increase in 1997 was largely due to an increase in casualty business offset by a
decline in property business. The 15.9% increase in 1996 was due to the growth
of casualty and property treaty business.
In 1998 the Company announced an agreement in principle to acquire the
managing agency assets of Morgan, Fentiman & Barber, a Lloyds managing agency,
which manages Denham Syndicate 990. In conjunction with this proposed
acquisition, the Company established a corporate capital vehicle, Stonebridge
Underwriting, Ltd., to participate on the Denham Syndicate commencing in 1998.
The acquisition is subject to the completion of due diligence and regulatory
approval. (See "Subsequent Event" for further explanation.)
Worldwide ceded premiums recorded for retrocession agreements were $130.2
million, $140.1 million, and $156.4 million in 1997, 1996, and 1995,
respectively. The Company continually evaluates its retrocessional programs
based on market conditions, pricing, and its own risk tolerance. The 1997 and
1996 decreases in ceded premium were primarily due to improved pricing for the
Company's catastrophe and per risk retrocessional programs, partially offset in
1997 by growth in certain primary programs with specific reinsurance protection.
The Company's underwriting philosophy of long-term partnerships with quality
core clients as well as further expansion of its client base continues to
underscore the Company's success. Insurers, rated A- or better by A.M. Best,
comprised the top 30 clients of the Company in 1997. However, no single client
generated more than 6% of premium volume in 1997, and the top 10 clients
represented 37% of premiums compared to 56% three years prior. Given this client
depth, the Company does not believe that any future reduction of business
assumed from any one client will have a materially adverse effect on its future
financial condition or results of operations due to the Company's competitive
position in the marketplace and the continuing availability of other sources of
business.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OPERATING COSTS AND EXPENSES
CLAIMS AND CLAIMS ADJUSTMENT
Generally, claims and claims expenses represent the Company's most
significant and uncertain costs. Claims and claims expense reserves are
estimates involving actuarial and statistical projections, at a given point in
time, of what the Company expects the ultimate settlement and administration of
claims to cost based on facts and circumstances then known. The reserves are
based on estimates of claims and claims expenses incurred and, therefore, the
amount ultimately paid may be more or less than such estimates. These expenses
are principally based on NACs analysis of reports and individual case estimates
received from ceding companies. A provision, on the basis of past experience,
claims audits, and other factors, is included for losses and loss adjustment
expenses incurred but not reported ("IBNR"). The Company expects to refine such
estimates in subsequent accounting periods based upon facts and circumstances
then known.
The fact that the Company's exposure to claims generally begins excess of
its clients exposure contributes to the uncertainty of its claims estimates.
With this excess coverage, claims occur less frequently than coverages which
attach within the primary insurance coverages, thereby providing less
credible historical claims experience from which to estimate ultimate claims
costs. Further, the Company writes coverage in certain volatile casualty
lines of business, such as general liability, directors and officers
liability and medical malpractice. Claims activity for these lines is
characterized by lengthy litigation, the ultimate cost of which can be
influenced significantly by future court rulings.
Estimates of claims and claims expenses are based in part on a prediction
of future events, estimates of future trends in claims severity and frequency
and other variable factors. The Company's ability to predict future trends
based solely upon its own historical claims experience is inherently
difficult because of its substantial growth in premiums since 1985.
Therefore, for purposes of evaluating future trends and providing an estimate
of ultimate claims costs, the Company has supplemented its historical claims
experience to a certain extent with claims experience derived from external
sources, such as reinsurance industry data. As the Company's book of business
continues to mature, its own historical claims experience achieves greater
credibility and enhances its ability to evaluate future trends. Accordingly,
the Company believes its reserving process improves as additional claims
experience emerges.
Claims and claims expenses incurred were $379.5 million in 1997 compared to
$339.0 million in 1996 and $326.1 million in 1995. The increase in 1997 was
principally attributable to growth in earned premium and a higher loss ratio.
The increase in 1996 was primarily due to growth in earned premium partially
offset by a lower loss ratio. Net claims and claims expenses expressed as a
percentage of net earned premiums (the claims and claims expense ratio)
increased to 65.9% in 1997 from 63.7% in 1996 on a domestic statutory basis. The
change in the 1997 ratio was primarily due to competitive market conditions. The
improvement in the 1996 ratio of 63.7% from the 1995 ratio of 65.1% was due to a
somewhat more favorable prior years claims and claims expense development in
1996.
The Company's total net claims and claims expenses for each year reflect
favorable claims development from prior years of $38.6 million in 1997, $33.3
million in 1996, and $19.6 million in 1995.
Claims payments were $78.9 million in 1997 compared to $190.4 million in
1996 and $180.4 million in 1995. The decrease in 1997 was due to the net impact
of the retrocessional termination discussed below, partially offset by several
commutations of assumed business during 1997.
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The Company's net favorable claims development for business written since
1986 continued to emerge during 1997, 1996, and 1995. This favorable development
is driven by several factors, some of which are interdependent. A principal
factor is the strength of the actuarial assumptions underlying the business
written, particularly with respect to social and economic inflation. These
actuarial assumptions are utilized to establish the initial expected target loss
ratio employed in the actuarial methodologies from which the reserves for claims
and claims expenses are derived. Such loss ratios are periodically adjusted to
reflect comparisons of actuarially-computed expected claims to actual claims and
claims expense development, inflation and other considerations. This favorable
development has offset certain unfavorable development on business written prior
to 1986, principally related to asbestos and environmental claims.
An important area of focus in the reinsurance and insurance industries is
exposure to asbestos and environmental claims. The Company's reserving process
includes a supplemental evaluation of the potential impact on claims liabilities
from exposure to asbestos and environmental claims, including related loss
adjustment expenses. The Company recorded claims and claims expenses incurred
relating to asbestos and environmental claims of $8.1 million in 1997, $10.7
million in 1996, and $7.0 million in 1995, inclusive of paid claims of $3.8
million, $4.2 million, and $4.8 million, respectively. The Company's claims and
claims expense reserves for such exposures, net of reinsurance, as of December
31, 1997, 1996, and 1995 were $32.8 million, $28.5 million, and $22.0 million,
respectively. A reconciliation of the Company's gross and net liabilities for
such exposures for the three years ending December 31, 1997 is set forth in Note
4 of the Notes to Consolidated Financial Statements.
The Company believes it has made a reasonable provision for its asbestos and
environmental exposures and is unaware of any specific issues which would
materially affect its claims and claims expense estimate. The estimation of
claims and claims expense liabilities for asbestos and environmental exposures
is subject to a much greater uncertainty than is normally associated with the
establishment of liabilities for certain other exposures due to several factors,
including: i) uncertain legal interpretation and application of insurance and
reinsurance coverage and liability; ii) the lack of reliability of available
historical claims data as an indicator of future claims development; iii) an
uncertain political climate which may impact, among other areas, the nature and
amount of costs for remediating waste sites; and iv) the potential of insurers
and policyholders to reach agreements in order to avoid further significant
legal costs. Due to the potential significance of these uncertainties, the
Company believes that no meaningful range of claims and claims expense
liabilities beyond recorded reserves can be established. The Company believes
that these issues are not likely to be resolved in the near future. However, as
they are resolved, additional reserve provisions, which could be material in
amount, may be necessary.
The Company is aware of certain evolving potential exposures, generally
referred to as other mass tort liabilities, and to the extent appropriate, the
Company has considered these exposures in its claims and claims expense
reserves.
The Company is unaware of any specific, unusual and significant
circumstances affecting claims reserve estimates, except to the extent
disclosed.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
REINSURANCE/CATASTROPHE MANAGEMENT
The Company purchases reinsurance to increase premium capacity and to reduce
the risk of loss on reinsurance underwritten. Historically, the Company has
obtained reinsurance for itself primarily through excess of loss reinsurance
agreements. The Company has also obtained reinsurance protection against
liability on a single event arising from different treaty obligations or from
related losses involving more than one reinsured or contract. The Company
evaluates the financial condition of its retrocessionnaires periodically. Based
on this analysis, a reserve for potential and actual non-recovery from
retrocessionnaires unable to meet their obligation under the retrocession
agreement is included in claims and claims expenses. Charges to earnings for
potential and actual non-recovery amounted to $3.7 million, $1.2 million, and
$1.4 million for 1997, 1996, and 1995, respectively, and reflect a provision for
paid and unpaid claims, inclusive of IBNR claims. This 1997 charge and
substantially all such charges relate to reinsurance purchased prior to 1986.
During 1997, the Company maintained catastrophe reinsurance protection of
$115 million in excess of the Company's initial retention of $5 million on a
first and second event. For 1998, the Company has obtained catastrophe
reinsurance protection of $97 million in excess of a $5 million initial net
retention, subject to a graduated increase of $3 million in net retention in the
event gross losses exceed $60 million. The Company evaluates its potential
catastrophe exposure, including both gross loss estimates and the impact of
available reinsurance protection. While the Company believes its management of
catastrophe exposures and underwriting guidelines are adequate, an extremely
large catastrophic event or multiple catastrophic events could have a material
adverse effect on the financial condition and results of operation of the
Company.
In recognition of the Company's surplus position, financial capacity and
continued positive results from business written since 1986, the Company
terminated two retrocessional programs effective January 1, 1997. As a result,
the Company received total consideration of approximately $225 million,
representing reinsurance recoverable balances for unpaid claims and claims
expenses, with total cash and invested assets increasing by approximately $180
million. The termination of these programs resulted in an increase in the
Company's retention levels for the years 1996 and prior. As the casualty book of
business matures, the increase in net retentions for those years may result in
increased volatility in future years to the extent the actual frequency and
severity of claims differs from the Company's current estimates. The Company
believes its exposure to such volatility is within acceptable levels. See Note 6
of the Notes to Consolidated Financial Statements for the impact of this action
on 1997 and 1996 retention levels.
UNDERWRITING RESULTS
One traditional means of measuring the underwriting performance of a
property/casualty insurer is the statutory composite ratio. This ratio, which is
based upon statutory accounting practices (which differ from generally accepted
accounting principles), reflects underwriting experience, but does not reflect
income from investments. A composite ratio of under 100% generally indicates
underwriting profitability while a composite ratio exceeding 100% generally
indicates an underwriting loss.
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The following chart sets forth statutory composite ratios for the Company's
domestic reinsurance subsidiary:
1997 1996 1995
--------- --------- ---------
Domestic Composite Ratio:
Claims and claims expenses............................................................... 65.9% 63.7% 65.1%
Commissions and brokerage................................................................ 27.3 28.3 29.7
Other operating expenses................................................................. 9.9 9.1 8.3
--------- --------- ---------
Total.................................................................................... 103.1% 101.1% 103.1%
--------- --------- ---------
The increase in the Company's domestic composite ratio for 1997 primarily
reflected the increase in the claims and claims expenses and other operating
expenses. The 1996 ratio indicated an improvement in underwriting results
compared to 1995. The claims and claims expense ratio increased in 1997 due to
the impact of competitive market conditions on pricing adequacy. Operating
expenses increased in 1997, 1996, and 1995 reflecting continued business
expansion, investment in technology and a continued investment in facultative
business. The Company continues to seek measures to contain operating expenses
that are not central to its underwriting activities and to better utilize its
resources.
The 1997 statutory composite ratio for the Company's international
reinsurance subsidiary was 108.9% compared to 105.6% in 1996 and 111.7% in 1995.
A principal cause of these relatively high composite ratios was the contribution
of the operating expense ratios of 18.7%, 13.7%, and 13.0% for the years ended
December 31, 1997, 1996, and 1995, respectively. The Australian branch of the
international reinsurance subsidiary, although established in 1996, did not
commence writing premium until 1997 contributing to the increase in the
operating expense ratio in 1997 from 1996. The Company generally expects a
higher expense ratio in the start-up years of an operation. The expense ratio of
the international subsidiary is expected to decline over time to the extent that
it leverages its investment in infrastructure and marketing, broadens client
relationships, and generates increases in premium revenues.
The pricing of the Company's reinsurance contracts incorporates many
factors, including exposure to claims and the expenses of the client and the
broker. Commissions and brokerage expenses, as a percentage of premium
revenues, declined moderately in 1997 compared to 1996 and 1995. This
decrease was principally due to the relative increase in 1997 of primary
program business, where commission costs were significantly lower, partially
offset by increases in pro rata contracts written in the Company's specialty
lines of business, contracts which generally carry a higher commission rate.
The Company's actuaries and underwriters evaluate the adequacy of premium
revenue net of these expenses, thereby mitigating the effect of variations in
these expenses to overall underwriting results.
INVESTMENTS
Cash and invested assets were $2.3 billion at December 31, 1997 compared to
$2.0 billion at December 31, 1996, excluding net investment payables of $25.8
million and $24.9 million for 1997 and 1996, respectively.
Net investment income increased 17.9% in 1997 compared to 16.8% in 1996 and
10.9% in 1995. The 1997 increase was principally attributable to the benefit
derived from investment of the proceeds of approximately $180 million resulting
from two retrocessional program terminations in early 1997. (See
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Note 6 to the Notes to Consolidated Financial Statements.) Further, the 1997
investment portfolio was repositioned during the year to maximize after-tax
earnings. This portfolio shift consisted of increasing the Company's
investment in tax-exempt securities to take advantage of the higher after-tax
yields of these securities as well as extending the Company's fixed maturity
duration to approximately 5.6 years to capture the yield benefit of a higher
interest rate environment in early 1997. As such, the Company's after-tax
investment yield was 4.7% in 1997 compared to 4.4% in 1996 and 4.6% in 1995.
The Company anticipates continued growth in investment income during 1998 due
to a higher invested asset base. However, this growth will be tempered by the
decreasing yields available in the current interest rate environment.
Realized investment gains, net of tax, were $1.35 per diluted share for
1997, $.61 per diluted share for 1996, and $.84 per diluted share for 1995.
Gains and losses on the sale of investments are recognized as a component of
operating income, but the timing and recognition of such gains and losses are
unpredictable and are not indicative of future operating results.
The Company's investment strategy is focused principally on income
predictability and asset value stability. The Company's emphasis on high
quality, fixed maturity investments reflects this strategy. Tactical shifts
between taxable and tax-exempt bonds may occur in order to maximize after-tax
investment returns without compromising balance sheet integrity. At the end
of 1997, the Company's fixed maturity investments amounted to $2.1 billion,
which approximates 89% of cash and invested assets. Approximately 94% of such
investments are rated investment grade with an average rating of Aa2/AA by
Moodys Investor Services, Inc. or Standard & Poors.
The balance of the Company's investment portfolio at December 31, 1997,
consisting of cash, short-term investments and equity securities, amounted to
$259.4 million. As of December 31, 1997, the Company held $142.5 million or 6.1%
of cash and invested assets in equity securities, representing 20.3% of
statutory surplus. This was compared to $179.6 million or 9.1% of invested
assets in equity securities at December 31, 1996, representing 27% of statutory
surplus.
Changes in market interest rates in late 1997 resulted in an increase in the
market value of the Company's investment securities compared to 1996. Net
unrealized appreciation of investments, net of tax, was $55.0 million or $3.00
per share at December 31, 1997 compared to $31.7 million or $1.72 per share at
December 31, 1996. The unrealized appreciation was primarily attributable to the
market value fluctuations in the Company's fixed income securities, which are
recorded at their fair market values.
Uncertainties exist regarding interest rates and inflation and their
potential impact on the market values of the Company's fixed income securities.
The Company actively considers the risks and financial rewards associated with
the maturity distribution of its fixed income portfolio. In this regard, the
Company takes into consideration the pattern of expected claims payments and the
Company's future cash flow projections in evaluating its investment
opportunities.
Since the initial capitalization of the Company's international reinsurance
operation in London, England (NAC Re International) with $75 million in 1993 and
subsequent contributions in 1994 and 1995, the stockholders equity of NAC Re
International has grown to $148.5 million as of December 31, 1997. This capital,
a component of the invested assets described above, is being invested in
accordance with the
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Company's overall investment strategy. At December 31, 1997, NAC Re
Internationals investment portfolio, which was primarily invested in U.K.
Government securities, had an average duration of 4.4 years and an after-tax
investment yield of 4.4%.
INCOME TAXES
The Company's effective tax rate increased to 22.1% in 1997 compared to
20.8% in 1996 and 20.3% in 1995. Excluding investment gains, the Company's
1997 effective tax rate was 15.6% compared to 16.8% in 1996. This decrease
reflects the shift to tax-exempt fixed maturities in 1997. The Company's
effective tax rate increased in 1996 over 1995 principally due to improved
underwriting results and a slightly higher effective tax rate on investment
income. Note that the Company's future tax position is subject to changes in
the tax laws.
LIQUIDITY AND CAPITAL RESOURCES
As a holding company, NAC Res assets consist primarily of its common
stock investment in NAC. Cash flow within NAC Re consists of investment
income, operating and interest expenses, dividends to stockholders, and
dividends and tax reimbursements from NAC. These dividends are subject to
statutory restrictions as described in Note 11 of the Notes to Consolidated
Financial Statements.
The Company's debt-to-capital ratio improved to 32.3% in 1997 from 36.1% in
1996. In late 1995, the Company issued $100 million of 7.15% Notes due November
15, 2005 and raised approximately $49 million on the issuance of 1,530,000
shares of Common Stock. Previously, the Company had raised $200 million in 1992
through the issuance of $100 million of 5.25% Convertible Subordinated
Debentures due December 2002 and $100 million of 8% Notes due June 1999. As a
result of the transactions and borrowings described below, pretax interest
expense including amortization expense was $21.7 million in 1997, $22.3 million
in 1996, and $15.6 million in 1995.
NAC Re maintains a revolving credit facility, under which it can borrow up
to $35 million. Outstanding borrowings as of December 31, 1997 and 1996 were
$12.9 million and were principally used to finance the Company's repurchase of
its Common Stock. The facility is scheduled to be reduced on a quarterly basis
beginning in July 1998. NAC has a $15 million line of credit which is available
for catastrophe claims payments or working capital purposes. There were no
outstanding borrowings on this facility at December 31, 1997. Interest costs on
borrowing facilities were approximately $1.0 million, $1.6 million, and $1.4
million in 1997, 1996, and 1995, respectively.
During 1997, the Company repurchased approximately 345,400 shares of NAC Re
Common Stock under the stock repurchase program for an aggregate purchase price
of approximately $14.5 million. As of December 31, 1997, approximately 656,000
shares remain authorized for repurchase.
The Company's quarterly dividend on its common stock was increased in June
1997 to $.075 per share from $.06 per share. It is anticipated that the cash
dividend level will leave sufficient retained earnings to meet the Company's
future financial needs.
29
Management's Discussion and Analysis
Consolidated stockholders equity totaled $657.1 million or $35.89 per share
at December 31, 1997 compared to $553.3 million or $30.06 per share at December
31, 1996.
Statutory surplus of the reinsurance subsidiary was approximately $702
million and $664 million at the end of 1997 and 1996, respectively. Indicative
of its strengthened capital position is NACs growth in surplus and its rank as
one of the 10 largest domestic reinsurers as measured on this basis. The Company
believes its surplus level enhances its ability to attract new business and
retain its existing client base.
The Company's insurance operations create liquidity in that premiums are
received substantially in advance of the time claims are paid. Over the most
recent three years, cash flow provided by operating activities totaled over $654
million, including 1997 cash flow of $314 million. The cash flow for 1997
increased from 1996 principally due to the proceeds received from the
terminations of certain retrocessional agreements described above.
Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income,"
which is effective for years beginning after December 15, 1997. The Company
will apply the provisions of this Statement beginning in the first quarter of
1998.
Also in June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures About Segments of an
Enterprise and Related Information," which is effective for years beginning
after December 15, 1997. The Company plans to adopt the Statement in the 1998
annual financial statements.
For explanation of the requirements of each of these pronouncements, See
Note 2 of the Notes to the Consolidated Financial Statements.
Subsequent Event On January 22, 1998, the Company announced an agreement
in principle to acquire the managing agency assets of Morgan, Fentiman &
Barber (MFB), a Lloyds managing agency. MFB currently manages Denham
Syndicate 990 which underwrites a specialized book of business, concentrating
on long-tail casualty lines and non-marine physical damage, including both
direct and reinsurance business. In late 1997, the Company formed a
subsidiary, Stonebridge Underwriting Ltd., which is participating as a
corporate capital vehicle on the Denham Syndicate commencing with the 1998
underwriting year. These transactions are intended to provide the Company
access to Lloyds worldwide insurance capabilities.
The acquisition is subject to the completion of due diligence and regulatory
approval and is expected to close during the second quarter of 1998, however,
there are no assurances that the acquisition discussed above will be
consummated. The transaction is not expected to have a material impact on the
financial condition or results of operations of the Company in 1998.
IMPACT OF THE YEAR 2000 ISSUE
The Company began assessing the impact of the Year 2000 issue on its
computer hardware and software systems in 1995. Certain systems have been
identified for replacement before year-end 1999 due to normal business
requirements. The replacement systems will be reviewed or designed to ensure
they are
30
Year 2000 compliant prior to implementation. Systems not identified
for replacement are expected to be assessed and made Year 2000 compliant
prior to year-end 1999 at a cost that is not expected to be material to the
Company. Currently, management is conducting a review of all such systems. As
of December 31, 1997, management had not identified any hardware or software
computer system with a significant Year 2000 compliance problem that would be
expected to have a materially adverse effect on its financial condition or
results of operations.
The Company has initiated a Year 2000 assessment of the Company's business
operations and products that could potentially be affected by the Year 2000
problem. The purpose of this review is to determine what impact, if any, the
Year 2000 issue may have on the Company and its significant customers,
suppliers, and other constituents, and whether that impact will be material to
the Company's financial condition or results of operations. The Company expects
to contact certain customers, retrocessionnaires, reinsurance intermediaries,
managing general agents, suppliers, and other constituents to determine the
nature and extent of their Year 2000 compliance efforts and to assess whether
their noncompliance would have a material adverse affect on the Company's
financial condition or results of operations. Based on this assessment,
management will establish a strategy responsive to any issues identified.
The ability of the Company's customers, suppliers, and other constituents
to achieve Year 2000 compliance, notwithstanding the Company's due diligence
inquiries, presents inherent and unpredictable risks and uncertainties. The
extent to which the Company's financial condition or results of operations
may be materially affected by the Year 2000 problems of third parties depends
on a variety of factors including, but not limited to, whether these third
parties can achieve their own timely Year 2000 compliance objectives; whether
their compliant systems remain compatible with the Company's systems; and the
nature and extent to which the Company's systems may be affected by the third
partys noncompliant systems. Unpredictable long-term failures of certain
essential services including, but not limited to, the banking, securities,
utility, telecommunications, and transportation industries, due to their own
Year 2000 problems are generally beyond the Company's control and could have
an adverse material impact on the Company's financial condition or results of
operations.
There is presently uncertainty as to whether Year 2000-related claims will
have a material affect on the industrys financial condition or results of
operations. Due to these uncertainties, the Company believes that no meaningful
range of claims and claims expense liabilities beyond recorded reserves can be
established. As these uncertainties are resolved, additional reserve provisions,
which could be material in amount, may be necessary.
All predictions regarding the impact of the Year 2000 issue on the Company
and third parties and the attendant costs are inherently subject to risks and
uncertainties. The Company cautions that the factors and assumptions described
above, as well as unknown factors, may cause the Company's actual Year 2000
compliance costs, and the resultant impact on its business, operations, or
financial condition to differ materially from those discussed above.
REGULATORY INITIATIVES
NAC Re and its domestic subsidiaries are subject to regulatory oversight
under the insurance statutes and regulations of the jurisdictions in which they
conduct business, including all states of the United States and Canada. NAC Res
international subsidiary is subject to the regulatory authority of the United
Kingdom
31
Management's Discussion and Analysis
Department of Trade and Industry. The international subsidiarys
Australian branch office is also subject to the Australian Insurance and
Supervisory Commissions solvency and regulatory authority. These regulations
vary from jurisdiction to jurisdiction and are generally designed to protect
ceding insurance companies and policyholders by regulating the Company's
financial integrity and solvency in its business transactions and operations.
Many of the insurance statutes and regulations applicable to the Company relate
to reporting and disclosure standards which allow insurance regulators to
closely monitor the Company's performance. Typical required reports include
information concerning the Company's capital structure, ownership, financial
condition, and general business operations.
In 1993, the National Association of Insurance Commissioners (the
"NAIC"), by adopting a model risk-based capital act, intended to provide an
additional tool for regulators to evaluate the capital of property and
casualty insurers and reinsurers with respect to the risks assumed by them
and determine whether there is a perceived need for corrective action. The
nature of the corrective action depends upon the extent of the calculated
risk-based capital deficiency and ranges from requiring the Company to submit
a comprehensive plan to placing the insurer under regulatory control. While
the model risk-based capital act has not yet been adopted in New York, NACs
domicile, New York has issued a circular letter requiring the filing of
risk-based capital reports by property and casualty insurers and reinsurers.
The NAIC also adopted a proposal that requires property and casualty insurers
and reinsurers to report the results of their risk-based capital calculations
as part of the statutory annual statements filed with state regulatory
authorities. Surplus (as calculated for statutory annual statement purposes)
for each of the Company's domestic subsidiaries is well above the risk-based
capital thresholds that would require either company or regulatory action.
Various other legislative and regulatory initiatives have been proposed from
time-to-time that could impact the property/casualty insurance industry.
Congress is expected to consider bills targeting financial services
modernization, tax reform, Superfund and product liability reform, and natural
disaster protection. The NAIC continues to refine the risk-based capital formula
for property/casualty insurers as well as adopt model legislation and
regulations regarding insurer investments, accounting standards, and other
regulatory matters. While the Company cannot quantify the impact of any of these
legislative or regulatory measures on its operations, we believe the Company is
adequately positioned to compete in an environment of more stringent regulation.
To the extent that federal legislation, if passed, reduces litigation costs, it
would be a favorable development for the Company.
SAFE HARBOR DISCLOSURE FOR FORWARD-LOOKING STATEMENTS
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995 (the "Act"), the Company sets forth below
cautionary statements identifying important factors that could cause the
Company's actual results to differ materially from those which might be
projected, forecasted, or estimated or otherwise implied in the Company's
forward-looking statements, as defined in the Act, made by or on behalf of the
Company in press releases, written statements or documents filed with the
Securities and Exchange Commission, or in its communications and discussions
with investors and analysts in the normal course of business through meetings,
telephone calls and conference calls. Such statements may include, but are not
limited to, projections of premium revenue, investment income, other revenue,
losses, expenses, earnings (including earnings per share), cash flows, plans for
future operations, common shareholders equity, financing needs, capital plans,
dividends, plans relating to products or services of the Company, and estimates
concerning the effects of litigation or other disputes, as well as assumptions
for any of the foregoing and are generally expressed with words such as
"believes," "estimates," "expects," "anticipates," "could have," "may have," and
similar expressions.
32
Forward-looking statements are inherently subject to risks and
uncertainties. The Company cautions that factors which may cause the Company's
results to differ materially from such forward-looking statements include, but
are not limited to, the following:
(1) Changes in the level of competition in the reinsurance or primary
insurance markets that adversely affect the volume or profitability
of the Company's business. These changes include, but are not limited
to, the intensification of price competition, the entry of new
competitors, existing competitors exiting the market, and the
development of new products by new and existing competitors;
(2) Changes in the demand for reinsurance, including changes in ceding
companies retentions, and changes in the demand for primary and
excess and surplus lines insurance coverages;
(3) The ability of the Company to execute its business strategies;
(4) Changes in the frequency and severity of catastrophes which could
significantly impact the Company's business in terms of net income,
reinsurance costs, and cash flow;
(5) Adverse development on claims and claims expense liabilities related
to business written in prior years, including, but not limited to,
evolving case law and its effect on environmental and other latent
injury claims, changing government regulations, newly identified
toxins, newly reported claims, inflation, new theories of liability,
or new insurance and reinsurance contract interpretations;
(6) Changes in the Company's retrocessional arrangements;
(7) Lower than estimated retrocessional or reinsurance recoveries on
unpaid losses, including, but not limited to, losses due to a
decline in the creditworthiness of the Company's retrocessionnaires
or reinsurers;
(8) Increases in interest rates, which cause a reduction in the market
value of the Company's interest rate sensitive investments,
including, but not limited to, its fixed income investment
portfolio, and its common shareholders equity and decreases in
interest rates causing a reduction of income earned on new cash flow
from operations and the reinvestment of the proceeds from sales,
calls or maturities of existing investments;
(9) Declines in the value of the Company's common equity investments and
credit losses on the Company's investment portfolio;
(10) Gains or losses related to foreign currency exchange rate fluctuations;
and
(11) Adverse results in litigation matters including, but not
limited to, litigation related to environmental, asbestos, other
potential mass tort claims, and claims related to the Year 2000.
In addition to the factors outlined above that are directly related to the
Company's business, the Company is also subject to general business risks,
including, but not limited to, adverse state, federal or foreign legislation and
regulation, adverse publicity or news coverage, changes in general economic
factors, and the loss of key employees.
33
- -------------------------------------------------------------------------------
ELEVEN YEAR FINANCIAL SUMMARY
- -----------------------------------------------------------------------------------------------------------------------------------
In Thousands, except per share amounts 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA
Gross premiums written .............................................. $ 723,868 $ 714,080 $ 677,938 $ 575,037
Net premiums written ................................................ 593,656 574,004 521,489 438,201
Premiums earned ..................................................... 574,647 526,342 491,785 395,731
Net investment income ............................................... 123,050 104,330 89,308 80,504
Net investment gains (losses) ....................................... 42,675 19,569 25,391 2,155
Total revenues ...................................................... 740,372 650,241 606,484 478,390
Operating costs and expenses ........................................ 617,542 561,205 527,663 436,100
Operating income .................................................... 95,677 70,520 62,824 35,612
Net income .......................................................... 95,677 70,520 62,824 35,612
Return on stockholders' equity (3)(4) ............................... 17.3% 13.8% 19.7% 9.5%
- -----------------------------------------------------------------------------------------------------------------------------------
PER SHARE DATA (5)
Basic: (6)
Average shares outstanding ........................................ 18,378 18,855 17,709 17,603
Operating income .................................................. $ 5.21 $ 3.74 $ 3.55 $ 2.02
Net income ........................................................ 5.21 3.74 3.55 2.02
Diluted (assuming conversion of dilutive convertible
securities): (6)
Average shares outstanding ........................................ 20,809 21,115 20,115 19,915
Net income ........................................................ $ 4.77 $ 3.51 $ 3.30 $ 1.96
Cash dividends declared per share ................................... .285 .23 .19 .16
Stock prices:
High ............................................................ 52.88 40.63 39.00 34.00
Low ............................................................. 33.25 28.50 28.25 24.00
Close ........................................................... 48.81 33.88 36.00 33.50
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Total assets (4)(7) ................................................. $2,984,865 $2,745,631 $2,462,131 $1,916,768
Cash and invested assets (4) ........................................ 2,348,034 1,983,902 1,863,526 1,414,527
Claims and claims expense reserves, gross (7) ....................... 1,603,972 1,513,345 1,292,415 1,086,170
Net of reinsurance recoverable .................................... 1,407,136 1,107,217 953,669 808,433
Long-term debt ...................................................... 299,942 299,934 299,927 200,000
Unrealized appreciation (depreciation) of investments,
net of tax: (4)
Fixed maturities ................................................ 43,607 14,526 27,102 (44,204)
Equity securities ............................................... 11,393 17,174 8,085 (1,826)
Total reported ................................................ 55,000 31,700 35,187 (46,030)
Stockholders' equity (4) ............................................ 657,061 553,269 511,756 319,085
Stockholders' equity per share (4)(5) ............................... 35.89 30.06 26.65 18.23
- -----------------------------------------------------------------------------------------------------------------------------------
DOMESTIC STATUTORY DATA
Statutory composite ratio ........................................... 103.1% 101.1% 103.1% 105.7%
Statutory surplus ................................................... $ 702,222 $ 663,867 $ 615,433 $ 407,024
- -----------------------------------------------------------------------------------------------------------------------------------
(1) In 1992, the Company adopted SFAS No. 109, "Accounting for Income Taxes."
The cumulative effect from prior years increased net income by $12.1
million or $.68 per share.
(2) In 1988, the Company adopted the practice of discounting workers'
compensation tabular case reserves. The cumulative effect from prior
years increased net income by $1.9 million or $.12 per share. In
addition, 1988 income tax expense included a charge for the utilization
of an operating loss carry forward. The tax benefit of $1.2 million, or
$.08 per share, resulting from such utilization was recorded as an
extraordinary item.
(3) Based on net income divided by stockholders' equity as reported at the
beginning of each year.
34
- -------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
1993 1992(1) 1991 1990 1989 1988(2) 1987 CAGR*
- -----------------------------------------------------------------------------------------------------------------------------------
$ 431,582 $ 366,292 $ 291,775 $ 261,099 $ 234,960 $ 206,761 $ 183,818 14.7%
336,941 268,023 233,044 217,106 193,323 171,430 154,510 14.4
306,379 250,533 229,358 215,085 190,657 161,978 137,376 15.4
76,632 65,590 58,743 51,930 45,475 35,640 25,341 17.1
19,095 9,081 5,533 (1,121) 3,236 142 878 47.5
402,106 325,204 293,634 265,894 239,368 197,760 163,595 16.3
352,609 321,598 251,916 236,464 209,883 177,830 151,945 15.1
42,351 10,386 34,816 24,961 25,626 17,732 11,113 24.0
42,351 22,443 34,816 24,961 25,626 20,827 11,113 24.0
13.7% 9.3% 17.2% 13.4% 15.8% 14.0% 8.1% --
- -----------------------------------------------------------------------------------------------------------------------------------
17,895 17,789 15,403 15,630 15,623 15,762 16,304 --
$ 2.37 $ .58 $ 2.26 $ 1.60 $ 1.64 $ 1.12 $ .68 22.6
2.37 1.26 2.26 1.60 1.64 1.32 .68 22.6
20,440 18,330 18,232 18,318 18,285 18,215 16,304 --
$ 2.24 $ 1.23 $ 2.05 $ 1.51 $ 1.55 $ 1.29 $ .68 21.5
.16 .16 .14 .13 .10 -- -- --
44.75 42.00 31.50 25.83 27.33 14.11 14.33 --
28.00 21.75 19.33 17.00 13.78 8.22 7.78 --
29.75 40.50 31.50 22.00 23.83 14.11 7.89 --
- -----------------------------------------------------------------------------------------------------------------------------------
$1,778,868 $1,596,209 $1,106,573 $ 988,809 $ 869,810 $ 705,832 $ 591,474 17.6
1,412,624 1,258,016 892,581 781,591 689,481 544,304 423,286 18.7
909,061 808,489 681,110 596,236 520,723 389,279 303,623 18.1
697,221 626,090 528,521 468,637 387,767 291,531 201,051 21.5
200,000 200,000 51,750 51,750 51,750 51,750 51,750 19.2
30,865 2,402 2,374 (2,588) -- -- -- --
6,521 3,786 3,452 (2,958) (323) (158) -- --
37,386 6,188 5,826 (5,546) (323) (158) -- --
375,540 309,221 241,387 202,525 186,104 162,501 148,278 16.1
21.13 17.35 15.70 12.98 11.92 10.38 9.10 14.7
- -----------------------------------------------------------------------------------------------------------------------------------
110.9% 126.9% 108.2% 108.2% 108.5% 106.8% 107.8% --
$ 406,163 $ 384,032 $ 230,041 $ 197,391 $ 189,018 $ 174,217 $ 163,233 15.7
- -----------------------------------------------------------------------------------------------------------------------------------
(4) The Company adopted SFAS No. 115 at December 31, 1993. As such, all of
the Company's fixed maturities and equity securities were classified as
"available for sale" and recorded at their fair values. The effect of
adopting SFAS No. 115 was to record in stockholders' equity unrealized
appreciation, net of deferred income taxes of $28.4 million, related to
fixed maturities that were previously recorded at amortized cost.
Retroactive application to prior periods is prohibited.
(5) Stock price and per share figures have been restated to reflect the
three-for-two stock splits effective in 1989 and 1991.
(6) Prior year data restated per SFAS No. 128. See Note 1 of the Notes of
Consolidated Financial Statements.
(7) Reclassified to reflect the adoption of SFAS No. 113 in 1993, which
requires reinsurance recoverables on claims and claims expenses
(including IBNR) and unearned premiums to be reported as assets.
* Compound annual growth rate.
35
- -------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET
In Thousands
- -------------------------------------------------------------------------------
December 31,
-----------------------
1997 1996
- -------------------------------------------------------------------------------
ASSETS
Investments:
Available for sale:
Fixed maturities (amortized cost: 1997,
$2,021,501; 1996, $1,681,190..................... $2,088,588 $1,703,537
Equity securities (cost: 1997, $124,999;
1996, $153,197).................................. 142,527 179,619
Short-term investments................................ 108,489 81,893
- -------------------------------------------------------------------------------
Total investments................................ 2,339,604 1,965,049
Cash.................................................. 8,430 18,853
Accrued investment income............................. 36,347 28,472
Premiums receivable................................... 227,569 200,036
Reinsurance recoverable balances, net................. 172,277 336,324
Reinsurance recoverable on unearned premiums.......... 31,297 20,320
Deferred policy acquisition costs..................... 92,709 85,211
Excess of cost over net assets acquired............... 3,276 3,644
Deferred tax asset, net............................... 42,646 30,390
Other assets.......................................... 30,710 57,332
- -------------------------------------------------------------------------------
Total assets..................................... $2,984,865 $2,745,631
- -------------------------------------------------------------------------------
LIABILITIES
Claims and claims expenses............................ $1,603,972 $1,513,345
Unearned premiums..................................... 301,711 271,898
8% Notes due 1999..................................... 100,000 100,000
7.15% Notes due 2005.................................. 99,942 99,934
5.25% Convertible Subordinated Debentures due 2002.... 100,000 100,000
Investment accounts payable........................... 26,108 25,326
Revolving credit agreement............................ 12,924 12,924
Other liabilities..................................... 83,147 68,935
- -------------------------------------------------------------------------------
Total liabilities................................ 2,327,804 2,192,362
- -------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value:
1,000 shares authorized, none issued
(includes 90 shares of Series A
Junior Participating Preferred Stock).............. -- --
Common stock, $.10 par value: 25,000 shares
authorized (1997, 21,707; 1996, 21,464
shares issued)...................................... 2,171 2,146
Additional paid-in capital............................. 255,424 248,662
Unrealized appreciation of investments, net of tax..... 55,000 31,700
Currency translation adjustments, net of tax........... 5,989 8,377
Retained earnings...................................... 426,309 335,868
Treasury stock, at cost (1997, 3,398; 1996,
3,061 shares)........................................ (87,832) (73,484)
- -------------------------------------------------------------------------------
Total stockholders' equity........................ 657,061 553,269
- -------------------------------------------------------------------------------
Total liabilities and stockholders' equity........$2,984,865 $2,745,631
- -------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
36
- ------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF INCOME
In Thousands, except per share amounts
- --------------------------------------------------------------------------------
Year ended December 31,
-----------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Premiums and Other Revenues
Net premiums written...................... $593,656 $574,004 $521,489
Increase in unearned premiums............. (19,009) (47,662) (29,704)
- --------------------------------------------------------------------------------
Premiums earned........................... 574,647 526,342 491,785
Net investment income..................... 123,050 104,330 89,308
Net investment gains...................... 42,675 19,569 25,391
- --------------------------------------------------------------------------------
Total revenues....................... 740,372 650,241 606,484
- --------------------------------------------------------------------------------
Operating Costs and Expenses
Claims and claims expenses................ 379,495 338,953 326,148
Commissions and brokerage................. 151,152 143,324 139,063
Other operating expenses.................. 65,160 56,606 46,804
Interest expense.......................... 21,735 22,322 15,648
- --------------------------------------------------------------------------------
Total operating cost and expenses.... 617,542 561,205 527,663
- --------------------------------------------------------------------------------
Income
Operating income before income taxes...... 122,830 89,036 78,821
Federal and foreign income taxes:
Current................................. 50,556 23,310 18,779
Deferred................................ (23,403) (4,794) (2,782)
- --------------------------------------------------------------------------------
Income tax expense (benefit).............. 27,153 18,516 15,997
- --------------------------------------------------------------------------------
Operating income/net income............... $95,677 $70,520 $62,824
- --------------------------------------------------------------------------------
Per Share Data
Basic:*
Average shares outstanding.............. 18,378 18,855 17,709
Operating income/net income............. $5.21 $3.74 $3.55
- --------------------------------------------------------------------------------
Diluted (assuming conversion
of dilutive convertible securities):*
Average shares outstanding.............. 20,809 21,115 20,115
Operating income/net income............. $4.77 $3.51 $3.30
- --------------------------------------------------------------------------------
Cash dividends declared per share......... $.285 $.23 $.19
- --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
* Prior year data restated per SFAS No. 128.
37
- -------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
In Thousands
- -------------------------------------------------------------------------------------------
Year ended December 31,
---------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------------
Common Stock
Balance at beginning of year $ 2,146 $ 2,134 $ 1,964
Issuance of shares 25 12 170
- -------------------------------------------------------------------------------------------
Balance at end of year 2,171 2,146 2,134
- -------------------------------------------------------------------------------------------
Additional Paid-Capital
Balance at beginning of year 248,662 246,356 194,231
Issuance of shares 6,762 2,306 52,125
- -------------------------------------------------------------------------------------------
Balance at end of year 255,424 248,662 246,356
- -------------------------------------------------------------------------------------------
Unrealized Appreciation (Depreciation) of
Investments, Net of Tax
Balance at beginning of year 31,700 35,187 (46,030)
Unrealized appreciation (depreciation) 23,300 (3,487) 81,217
- -------------------------------------------------------------------------------------------
Balance at end of year 55,000 31,700 35,187
- -------------------------------------------------------------------------------------------
Currency Translation Adjustments, Net of Tax
Balance at beginning of year 8,377 1,017 1,059
Translation adjustments (2,388) 7,360 (42)
- -------------------------------------------------------------------------------------------
Balance at end of year 5,989 8,377 1,017
- -------------------------------------------------------------------------------------------
Retained Earnings
Balance at beginning of year 335,868 269,660 210,255
Net income 95,677 70,520 62,824
Dividends (5,236) (4,312) (3,419)
- -------------------------------------------------------------------------------------------
Balance at end of year 426,309 335,868 269,660
- -------------------------------------------------------------------------------------------
Treasury Stock
Balance at beginning of year (73,484) (42,598) (42,394)
Purchase of treasury shares, net of reissuance (14,348) (30,886) (204)
- -------------------------------------------------------------------------------------------
Balance at end of year (87,832) (73,484) (42,598)
- -------------------------------------------------------------------------------------------
Total Stockholders' Equity
Balance at beginning of year 553,269 511,756 319,085
Issuance of shares 6,787 2,318 52,295
Unrealized appreciation (depreciation) 23,300 (3,487) 81,217
Translation adjustments (2,388) 7,360 (42)
Net income 95,677 70,520 62,824
Dividends (5,236) (4,312) (3,419)
Purchase of treasury shares, net of reissuance (14,348) (30,886) (204)
- --------------------------------------------------------------------------------------------
Balance at end of year $657,061 $553,269 $511,756
- --------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
38
- -------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
In Thousands
- ------------------------------------------------------------------------------------------------------------------
Year ended December 31,
---------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Operating Activities
Net income................................................................... $ 95,677 $ 70,520 $ 62,824
Adjustments to reconcile net income to net cash provided by operating
activities:
Reserve for claims and claims expenses, net.............................. 300,609 147,927 145,404
Unearned premiums, net................................................... 19,025 47,703 29,584
Premiums receivable...................................................... (27,692) (43,512) (34,415)
Accrued investment income................................................ (7,903) (1,266) (6,916)
Reinsurance balances, net................................................ (33,637) (18,063) 6,976
Deferred policy acquisition costs........................................ (7,522) (14,518) (10,523)
Net investment gains..................................................... (42,678) (19,577) (25,386)
Deferred tax asset, net.................................................. (24,499) (4,980) (2,781)
Other liabilities........................................................ 12,937 6,447 950
Other items, net......................................................... 30,055 (4,564) 8,194
- ------------------------------------------------------------------------------------------------------------------
Net Cash Provided By Operating Activities...................................... 314,372 166,117 173,911
- ------------------------------------------------------------------------------------------------------------------
Investing Activities
Sales of fixed maturity investments........................................ 1,469,950 1,336,125 1,479,415
Maturities of fixed maturity investments................................... 31,680 31,094 31,099
Purchases of fixed maturity investments.................................... (1,839,020) (1,508,258) (1,849,492)
Net (purchases) sales of short-term investments............................ (27,212) 53,646 3,072
Sales of equity securities................................................. 154,196 79,569 101,918
Purchases of equity securities............................................. (94,681) (104,917) (84,910)
Purchases of furniture and equipment....................................... (5,634) (6,775) (2,365)
- ------------------------------------------------------------------------------------------------------------------
Net Cash Used By Investing Activities.......................................... (310,721) (119,516) (321,263)
- ------------------------------------------------------------------------------------------------------------------
Financing Activities
Issuance of shares......................................................... 5,864 1,951 52,056
Net proceeds from issuance of 7.15% Notes.................................. -- -- 99,214
Purchase of treasury shares, net of reissuance............................. (14,348) (30,886) (204)
Cash dividends paid to stockholders........................................ (4,968) (4,163) (3,260)
Borrowings under revolving credit agreement................................ -- 8,162 --
Repayments under revolving credit agreement............................... -- (13,000) --
- ------------------------------------------------------------------------------------------------------------------
Net Cash (Used) Provided By Financing Activities............................... (13,452) (37,936) 147,806
- ------------------------------------------------------------------------------------------------------------------
Effects of exchange rate changes on cash....................................... (622) (132) 242
- ------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash.................................................... (10,423) 8,533 696
Cash -- beginning of year...................................................... 18,853 10,320 9,624
- ------------------------------------------------------------------------------------------------------------------
Cash -- end of year............................................................ $ 8,430 $ 18,853 $ 10,320
- ------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements have been prepared on the basis of
generally accepted accounting principles ("GAAP") and include the accounts of
NAC Re Corp. ("NAC Re") and its insurance and reinsurance subsidiaries NAC
Reinsurance Corporation ("NAC"), Greenwich Insurance Company, Indian Harbor
Insurance Company and NAC Re International Holdings Limited and its
subsidiaries. NAC Re and its subsidiaries are collectively referred to herein as
the Company. All intercompany transactions and balances have been eliminated in
consolidation.
The preparation of the financial statements in conformity with GAAP requires
the use of estimates and assumptions that affect amounts reported in the
financial statements and the accompanying notes. Actual results could differ
from such estimates.
PREMIUM REVENUES AND RELATED EXPENSES
Property/casualty premiums are recognized as income over the terms of the
related reinsurance contracts and policies. Unearned premium reserves represent
the portion of premiums written that relate to the unexpired terms of contracts
and policies in force. Such reserves are computed by pro rata methods based on
statistical data or reports received from ceding companies. Certain of the
Company's assumed and retrocession agreements include provisions that adjust
premium payments based upon the experience under the contracts. Premiums are
recorded based upon the expected ultimate experience under the agreements.
Acquisition costs, consisting principally of commissions and brokerage
expenses incurred at the time a contract or policy is issued, are deferred and
amortized over the period in which the related premiums are earned. Deferred
policy acquisition costs are limited to their estimated realizable value based
on the related unearned premiums and take into account anticipated claims and
claims expenses, based on historical and current experience, and anticipated
investment income.
INVESTMENTS
Fixed maturities, which include bonds, notes and redeemable preferred stocks
and equity securities, including common and non-redeemable preferred stocks have
been categorized as "available for sale" and recorded at their fair value. The
fair value of fixed maturities and equity securities is estimated using quoted
market prices or dealer quotes. Short-term investments, which have an original
maturity of one year or less, are carried at cost, which approximates fair
value.
The Company categorizes all of its fixed maturities and equity securities as
available for sale in order to provide the Company the flexibility to respond to
various factors, including changes in market conditions and tax planning
considerations. Unrealized appreciation or depreciation of the securities
available for sale, net of applicable deferred income taxes, is excluded from
income, and recorded as a separate component of stockholders equity.
Realized investment gains or losses on the sale or maturity of investments
are determined by the specific identification method. Net investment income,
consisting of dividends and interest, net of investment expenses, is recognized
when earned. The amortization of premium and accretion of discount for fixed
maturities is computed utilizing the interest method. The effective yield
utilized in the interest method is adjusted when sufficient information exists
to estimate the probability and timing of prepayments.
40
CLAIMS AND CLAIMS EXPENSES
The reserves for claims and claims expenses are based on the Company's
analysis of reports and individual case estimates received from ceding
companies. An amount is included for claims and claims expenses incurred but not
reported on the basis of past experience of the Company and the reinsurance
industry. These estimates are reviewed regularly and, as claims develop and new
information becomes known, the reserves are adjusted as necessary. Such
adjustments, if any, are reflected in results of operations in the period in
which they become known and are accounted for as changes in estimates. Reserves
are generally recorded without consideration of potential salvage or subrogation
recoveries which are estimated to be immaterial; such recoveries, when realized,
are reflected as a reduction of claims incurred. Certain workers compensation
case reserves are considered fixed and determinable and are subject to tabular
reserving. Such tabular reserves are discounted using an interest rate of 7%.
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes.
Under the liability method, deferred income taxes reflect the net tax effect of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. A
valuation allowance is established for any portion of a deferred tax asset that
management believes will not be realized.
STOCK PLANS
The Company accounts for stock compensation plans in accordance with
Accounting Principals Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees." Accordingly, compensation expense for stock option grants and
stock appreciation rights ("SARs") is recognized to the extent that the fair
value of the stock exceeds the exercise price of the option at the measurement
date.
PER SHARE DATA
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." This
Statement replaced the historical presentation of primary and fully diluted
earnings per share with basic and diluted earnings per share. Basic earnings per
share is based on weighted average common shares and excludes any dilutive
effects of options and convertible securities. Diluted earnings per share
assumes the conversion of dilutive convertible securities and the exercise of
all dilutive stock options. All earnings per share amounts for all periods have
been presented, and where appropriate, restated to conform to the Statement No.
128 requirements. See Note 12 for information with respect to the computation of
earnings per share.
FURNITURE, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
The costs of furniture and equipment are charged against income over their
estimated service lives. Leasehold improvements are amortized over the remaining
terms of the office leases. Depreciation and amortization are computed using the
straight-line method. Maintenance and repairs are charged to expense as
incurred. Depreciation and amortization expense was approximately $3.5 million,
$3.0 million and $2.2 million for the years ended December 31, 1997, 1996 and
1995, respectively.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOREIGN EXCHANGE
The assets and liabilities of foreign operations are translated at the
rate of exchange in effect at the balance sheet date. Revenues and expenses
of foreign operations are translated at the average exchange rates during the
year. The effect of the translation adjustments for foreign operations is
recorded as a cumulative translation adjustment in a separate component of
stockholders equity, net of applicable deferred income taxes. Foreign
currency transaction gains and losses are included in net income and are not
material.
COST IN EXCESS OF NET ASSETS ACQUIRED
The excess of cost over net assets acquired is amortized on a straight-line
basis over a period of twenty years. Amortization charged to operating expenses
was approximately $368,000 for each of the years ended December 31, 1997, 1996
and 1995.
2. ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which is effective for years beginning after December 15, 1997.
Statement No. 130 requires that a company classify items that meet the
definition of components of other comprehensive income in a financial statement
and display the accumulated balance of other comprehensive income in the equity
section of the statement of financial position. Comprehensive income includes
all changes in equity during a period resulting from transactions and other
events from nonowner sources. Reclassification of prior period financial
statements is required for comparative purposes. The Company will apply the
provisions of this Statement beginning in the first quarter of 1998.
If the Company adopted Statement No. 130 for the year ended December 31,
1997, comprehensive income would be as follows:
IN THOUSANDS
------------------------
YEAR ENDED DECEMBER 31,
------------------------
1997 1996
----------- -----------
Net income........................................................................ $ 95,677 $ 70,520
Change in unrealized appreciation (depreciation), net of tax...................... 23,300 (3,487)
Change in foreign currency translation adjustments, net of tax.................... (2,388) 7,360
----------- -----------
Comprehensive income.............................................................. $ 116,589 $ 74,393
----------- -----------
----------- -----------
Accumulated other comprehensive income for the Company would include
unrealized appreciation or depreciation of investments, net of tax, and foreign
currency translation adjustments, net of tax, and would total $61 million at
December 31, 1997.
Also in June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information," which is effective for years
beginning after December 15, 1997. Statement No. 131 establishes standards for
the way that companies report information about operating segments in annual
financial statements and requires that those companies report selected
information about operating segments in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The Company plans to adopt the Statement
in the
42
1998 annual financial statements. The Company has not completed its
analysis of all matters associated with the implementation, but the effect of
adopting this Statement will not be material to the Company's financial
position.
3. INVESTMENT INFORMATION
INVESTMENT INCOME
The components of net investment income were as follows:
IN THOUSANDS
---------------------------------
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ---------
Fixed maturities............................................................... $ 112,738 $ 97,048 $ 81,485
Equity securities.............................................................. 6,373 5,228 4,371
Cash and short-term investments................................................ 7,110 7,271 8,341
---------- ---------- ---------
Gross investment income........................................................ 126,221 109,547 94,197
Interest (benefit) expense..................................................... (1,646) 472 685
Investment expenses............................................................ 4,817 4,745 4,204
---------- ---------- ---------
Net investment income.......................................................... $ 123,050 $ 104,330 $ 89,308
---------- ---------- ---------
---------- ---------- ---------
Investment Gains (Losses)
Realized and unrealized investment gains (losses) were as follows:
IN THOUSANDS
-------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------
Net realized investment gains: 1997 1996 1995
- --------------------------------------------------------------------------------- --------- --------- ---------
Fixed maturities............................................................... $ 10,345 $ 7,243 $ 17,868
Equity securities.............................................................. 32,330 12,326 7,523
--------- --------- ---------
Subtotal....................................................................... 42,675 19,569 25,391
Tax expense.................................................................... 14,682 6,861 8,422
--------- --------- ---------
Net realized investment gains, net of tax...................................... $ 27,993 $ 12,708 $ 16,969
--------- --------- ---------
--------- --------- ---------
Change in unrealized appreciation (depreciation) of investments:
Fixed maturities............................................................... $ 44,742 $(19,348) $ 85,899
Equity securities.............................................................. (8,894) 13,983 14,265
--------- --------- ---------
Subtotal....................................................................... 35,848 (5,365) 100,164
Increase (decrease) in deferred income tax liability........................... 12,548 (1,878) 18,947
--------- --------- ---------
Net change reflected in stockholders equity.................................... $ 23,300 $(3,487) $ 81,217
--------- --------- ---------
--------- --------- ---------
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables reconcile amortized cost to the estimated fair value
(which equals carrying value) of fixed maturity securities and equity
securities.
IN THOUSANDS
---------------------------------------------------
DECEMBER 31, 1997
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ----------- ------------ ----------
Available for Sale:
U.S. Treasury.............................................. $ 13,957 $ 550 -- $ 14,507
Tax-exempt................................................. 1,200,314 51,892 $(1,233) 1,250,973
Foreign Government......................................... 166,899 5,624 (202) 172,321
Corporate.................................................. 419,715 8,826 (2,684) 425,857
Mortgage-backed............................................ 212,434 4,686 (275) 216,845
Subordinated convertibles.................................. 8,182 434 (531) 8,085
------------ ----------- ------------ ----------
Total fixed maturities..................................... 2,021,501 72,012 (4,925) 2,088,588
Equity securities.......................................... 124,999 19,122 (1,594) 142,527
------------ ----------- ------------ ----------
Total...................................................... $ 2,146,500 $ 91,134 $(6,519) $2,231,115
------------ ----------- ------------ ----------
------------ ----------- ------------ ----------
IN THOUSANDS
---------------------------------------------------
DECEMBER 31, 1996
---------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------------ ----------- ------------ ----------
Available for Sale:
U.S. Treasury.............................................. $ 71,354 $431 $(1,177) $70,608
Tax-exempt................................................. 828,501 21,853 (1,964) 848,390
Foreign Government......................................... 160,490 2,452 (954) 161,988
Corporate.................................................. 377,294 4,456 (4,924) 376,826
Mortgage-backed............................................ 191,467 734 (2,453) 189,748
Subordinated convertibles.................................. 52,084 5,030 (1,137) 55,977
------------ ----------- ------------ ----------
Total fixed maturities..................................... 1,681,190 34,956 (12,609) 1,703,537
Equity securities.......................................... 153,197 29,918 (3,496) 179,619
------------ ----------- ------------ ----------
Total...................................................... $ 1,834,387 $ 64,874 $(16,105) $1,883,156
------------ ----------- ------------ ----------
------------ ----------- ------------ ----------
44
Contractual maturities of fixed maturity securities are shown below.
Expected maturities, which are best estimates, will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.
IN THOUSANDS
--------------------------
DECEMBER 31, 1997
--------------------------
AMORTIZED FAIR
COST VALUE
------------ ------------
Available for Sale:
Due in one year or less............................................................. $ 6,136 $ 6,239
Due after one year through five years............................................... 274,723 281,087
Due after five years through ten years.............................................. 799,247 826,608
Due after ten years................................................................. 728,961 757,809
------------ ------------
Subtotal............................................................................ 1,809,067 1,871,743
Mortage-backed securities........................................................... 212,434 216,845
------------ ------------
Total............................................................................... $ 2,021,501 $ 2,088,588
------------ ------------
The weighted average contractual and expected maturities, based on fair
value, of the fixed maturity investments excluding convertible securities, as of
December 31, 1997 were 11.4 years and 7.9 years, respectively.
Proceeds from the sales of fixed maturity securities during 1997, 1996 and
1995 were $1,470.0 million, $1,336.1 million and $1,479.4 million, respectively.
Gross gains of $20.7 million, $16.3 million and $25.3 million were realized on
those sales during 1997, 1996 and 1995, respectively. Gross losses of $10.3
million, $9.1 million and $7.4 million were realized during 1997, 1996 and 1995,
respectively.
Approximately 94% of all fixed maturity investments held at December 31,
1997, were considered investment grade by Standard and Poors or Moodys Investor
Services, Inc.
Securities on Deposit
Securities with a face amount of $68.6 million at December 31, 1997, were on
deposit with various state or governmental insurance departments in order to
comply with insurance laws.
Assets Held in Escrow
Included in NAC Res cash and invested assets at December 31, 1997 is
approximately $23.8 million of assets held in a "holding company" escrow
account arising from a tax allocation agreement between NAC Re and its
domestic subsidiaries. The agreement provides that each subsidiary must remit
to NAC Re its tax liability based upon its separate return. The excess of the
taxes paid by the subsidiaries to NAC Re over the consolidated groups tax
liability are restricted for current operating use, but may become available
for unrestricted use two years following the filing of the consolidated tax
return that generated the asset. Approximately $9 million of the escrow
balance will become available for use in 1998.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. CLAIMS AND CLAIMS EXPENSES
The following table represents an analysis of paid and unpaid claims and
claims expenses and a reconciliation of beginning and ending reserve balances
for the years indicated.
IN THOUSANDS
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Reserves for claims and claims expenses, at beginning of year........... $ 1,513,345 $ 1,292,415 $ 1,086,170
Reinsurance recoverables, at beginning of year.......................... 406,128 338,746 277,737
Reserves for claims and claims expenses, net of reinsurance
recoverables, at beginning of year.................................... 1,107,217 953,669 808,433
------------ ------------ ------------
------------ ------------ ------------
Provision for claims and claims expenses, net of reinsurance, occurring
in the current year................................................... 418,091 372,294 345,783
Decrease in estimated claims and claims expenses, net of reinsurance,
occurring in prior years.............................................. (38,596) (33,341) (19,635)
------------ ------------ ------------
Total incurred claims and claims expenses, net of reinsurance........... 379,495 338,953 326,148
------------ ------------ ------------
------------ ------------ ------------
Less payments for claims and claims expenses, net of reinsurance,
occurring during:
The current year...................................................... 52,370 44,025 40,123
Prior years........................................................... 26,548 146,399 140,263
------------ ------------ ------------
Total............................................................... 78,918 190,424 180,386
------------ ------------ ------------
------------ ------------ ------------
Effects of exchange rate changes on reserves............................ (658) 5,019 (526)
------------ ------------ ------------
Reserves for claims and claims expenses, net of reinsurance
recoverables, at end of year.......................................... 1,407,136 1,107,217 953,669
Reinsurance recoverables, at end of year................................ 196,836 406,128 338,746
------------ ------------ ------------
Reserves for claims and claims expenses, at end of year................. $ 1,603,972 $ 1,513,345 $ 1,292,415
------------ ------------ ------------
------------ ------------ ------------
Estimates of claims and claims expenses are based in part on a prediction
of future events, estimates of future trends in claims severity and frequency
and other variable factors. The Company's ability to predict future trends
based upon its own historical claims experience is inherently difficult
because of its substantial growth in premiums since 1985. Therefore, the
Company has supplemented its historical claims experience to a certain extent
with claims experience derived from external sources, such as reinsurance
industry data, for purposes of evaluating future trends and providing an
estimate of ultimate claims costs. As the Company's book of business
continues to mature, its own historical claims experience achieves greater
credibility and enhances its ability to evaluate future trends. Accordingly,
the Company believes its reserving process improves as additional claims
experience emerges.
46
Claims and claims expenses reflect favorable claims development from prior
years. Net favorable claims development for business written since 1986
continued to emerge during 1997, 1996 and 1995. This favorable development is
affected by several factors, some of which are interdependent. A principal
factor is the strength of the actuarial assumptions underlying the business
written, particularly with respect to the consideration given to social and
economic inflation. These actuarial assumptions are utilized to establish the
expected loss ratio employed in the actuarial methodologies used to establish
the reserves for claims and claims expenses. Such loss ratios are periodically
adjusted to reflect comparisons of actuarially computed expected to actual
claims and claims expense development, inflation and other considerations. This
favorable development has offset certain unfavorable development for business
written prior to 1986, principally related to asbestos and environmental
claims.
The Company's incurred claims and claims expenses include a provision of
$3.7 million, $1.2 million and $1.4 million in 1997, 1996 and 1995,
respectively, for estimates of actual and potential non-recoveries from
retrocessionnaires. Included in claims and claims expense reserves at
December 31, 1997, 1996 and 1995 is a reserve for potential non-recoveries
from retrocessionnaires of $13.8 million, $12.7 million and $10.7 million,
respectively. Such charges for non-recoveries relate principally to
retrocessional contracts for business written prior to 1986. See Note
6--Retrocession Agreements.
Except for certain workers compensation case reserves, the Company does
not discount its claims and claims expense reserves. The Company utilizes
tabular reserving for workers compensation case reserves that are considered
fixed and determinable and discounts such reserves using an interest rate of
7% for financial statements prepared in accordance with GAAP and a 5%
interest rate for statutory accounting purposes. The tabular reserving
methology results in applying a uniform and consistent criteria for
establishing expected future indemnity and medical payments (including an
explicit factor for inflation) and the use of mortality tables to determine
expected payment periods.
Tabular reserves, net of reinsurance, reflected in the GAAP financial
statements for the years ending December 31, 1997, 1996 and 1995 were $42.4
million, $35.8 million and $29 million, respectively. The related discounted
case reserves, net of reinsurance, were $16.1 million, $15 million and $10.6
million as of December 31, 1997, 1996 and 1995, respectively.
Asbestos and Environmental Related Claims
The Company's reserving process includes a continuing evaluation of the
potential impact on claims liabilities from exposure to asbestos and
environmental claims, including related loss adjustment expenses. Liabilities
are established to cover both known and incurred but not reported claims.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the beginning and ending reserves related to asbestos
and environmental exposure claims for the years indicated is as follows:
IN THOUSANDS
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Reserves for claims and claims expenses, net of reinsurance recoverables, at
beginning of year.............................................................. $ 28,500 $ 22,029 $ 19,849
Provisions for claims and claims expenses, net of reinsurance.................... 8,067 10,683 6,989
Less payments for claims and claims expenses, net of reinsurance................. 3,800 4,212 4,809
--------- --------- ---------
Reserves for claims and claims expenses, net of reinsurance recoverables, at end
of year........................................................................ 32,767 28,500 22,029
Reinsurance recoverables, at end of year......................................... 37,905 32,584 35,135
--------- --------- ---------
Reserves for claims and claims expenses, gross of reinsurance recoverables, at
year end....................................................................... $ 70,672 $ 61,084 $ 57,164
--------- --------- ---------
--------- --------- ---------
Incurred but not reported claims and claims expense reserves (IBNR), net of
reinsurance, included in the above table totaled $16.6 million in 1997, $13.4
million in 1996 and $10.3 million in 1995. Ceded liabilities reflect amounts
expected to be recoverable from retrocessionnaires, after reduction for
potential uncollectible amounts.
As of December 31, 1997 and 1996, the Company had approximately 380 and 300
open claim files, respectively, for potential asbestos exposures and 840 and 800
open claim files, respectively, for potential environmental exposures.
Approximately 49% and 53% of the total open claim files for 1997 and 1996,
respectively, are due to precautionary claim notices. Precautionary claim
notices are submitted by the ceding company in order to preserve their right to
receive coverage under the reinsurance contract. Such notices do not contain an
incurred loss amount to the Company. The Company actively evaluates potential
exposure to asbestos and environmental claims and records claims and claims
expense reserves as appropriate.
The Company believes it has made a reasonable provision for its asbestos and
environmental exposures and is unaware of any specific issues which would
materially affect its claims and claims expense estimate. The estimation of
claims and claims expense liabilities for asbestos and environmental exposures
is subject to a much greater uncertainty than is normally associated with the
establishment of liabilities for certain other exposures due to several factors,
including: i) uncertain legal interpretation and application of insurance and
reinsurance coverage and liability; ii) the lack of reliability of available
historical claims data as an indicator of future claims development; iii) an
uncertain political climate which may impact, among other areas, the nature and
amount of costs for remediating waste sites; and iv) the potential of insurers
and policyholders to reach agreements in order to avoid further significant
legal costs. Due to the potential significance of these uncertainties, the
Company believes that no meaningful range of claims and claims expense
liabilities beyond recorded reserves can be established. As these uncertainties
are resolved, additional reserve provisions, which could be material in amount,
may be necessary.
48
5. INCOME TAXES
The provision for federal income taxes has been determined on the basis of a
consolidated tax return consisting of NAC Re and its subsidiaries.
The income tax provision in the consolidated statement of income gives
effect to permanent differences between financial and taxable income. Due to the
contribution of tax-exempt income and other factors as noted below, the
Company's
effective income tax rate is less than the statutory rate on operating income.
An analysis of the Company's effective tax rate is as follows:
IN THOUSANDS
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1997 1996 1995
--------------- --------------- ---------------
% OF % OF % OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
------- ------ ------- ------ ------- ------
Income taxes computed on pretax operating income................. $42,991 35% $31,163 35% $27,587 35%
(Reduction) increase in taxes resulting from:
Tax-exempt investment income................................. (16,680) (14) (12,272) (14) (10,150) (13)
Dividend received deduction.................................. (1,219) (1) (895) (1) (822) (1)
Other, net................................................... 2,061 2 520 1 (618) (1)
------- ------ ------- ------ ------- ------
Tax expense on operating income.................................. $27,153 22% $18,516 21% $15,997 20%
------- ------ ------- ------ ------- ------
Significant components of the provision for income taxes attributable to
operations were as follows:
IN THOUSANDS
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Current expense:
Federal...................................................................... $ 43,754 $ 19,879 $ 17,809
Foreign...................................................................... 6,802 3,431 970
--------- --------- ---------
Total current expense............................................................ 50,556 23,310 18,779
--------- --------- ---------
--------- --------- ---------
Deferred (benefit) expense:
Federal...................................................................... (23,205) (4,845) (3,245)
Foreign...................................................................... (198) 51 463
--------- --------- ---------
Total deferred benefit........................................................... (23,403) (4,794) (2,782)
--------- --------- ---------
--------- --------- ---------
Total tax expense................................................................ $ 27,153 $ 18,516 $ 15,997
--------- --------- ---------
The Company's current federal tax expense for the years 1997, 1996 and 1995
was based on regular taxable income. Federal and foreign taxes paid in the years
1997, 1996 and 1995 were $35 million, $22 million and $19 million, respectively.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Significant components of the Company's deferred tax assets and liabilities
as of December 31, 1997 and 1996 were as follows:
IN THOUSANDS
--------------------
DECEMBER 31,
--------------------
1997 1996
--------- ---------
Deferred tax asset:
Net claims reserve discount............................................. $ 87,704 $ 62,629
Net unearned premiums................................................... 18,854 17,524
Compensation liabilities................................................ 6,195 4,756
Other................................................................... 2,631 2,129
--------- ---------
Deferred tax asset........................................................ 115,384 87,038
--------- ---------
Deferred tax liability:
Deferred policy acquisition costs....................................... 32,375 29,766
Unrealized appreciation of investments.................................. 29,616 17,068
Currency translation adjustments........................................ 3,225 4,511
Other................................................................... 7,522 5,303
--------- ---------
Deferred tax liability.................................................... 72,738 56,648
--------- ---------
Net deferred tax asset.................................................... $ 42,646 $ 30,390
--------- ---------
Stockholders equity at December 31, 1997 and 1996 reflects tax benefits of
$4.5 million and $3.1 million, respectively, related to compensation expense
deductions for stock options exercised.
As a result of the merger of its previously existing parent into NAC Re in
January 1987, $12 million of tax loss carryforwards are currently available for
use to offset future taxable income of NAC Re under the separate return
limitation year rules, with the following expiration dates: $1.8 million
expiring in 1998, $6.2 million expiring in 1999, $3.9 million expiring in 2000
and $.1 million expiring in 2001. A deferred tax asset was not recorded for
these loss carryforwards, as the Company does not expect to utilize these
carryforwards in future years.
6. RETROCESSION AGREEMENTS
The Company utilizes retrocession agreements principally to increase
aggregate premium capacity and to reduce the risk of loss on reinsurance
underwritten. In addition, the Company maintains catastrophe reinsurance
programs for the purpose of limiting its exposure with respect to multiple
claims arising from a single occurrence or event. The Company's retrocession
agreements provide for recovery of a portion of claims and claims expenses from
retrocessionnaires. Reinsurance recoverables are recorded as assets, predicated
on the retrocessionnaires ability to meet their obligations under the
retrocession agreements. If the retrocessionnaires are unable to satisfy their
obligation under the agreements, the Company would be liable for such defaulted
amounts.
50
The effect of retrocessional activity on premiums written and earned is set
forth below:
IN THOUSANDS
--------------------------------------------------------------------------------
PREMIUMS WRITTEN PREMIUMS EARNED
-------------------------------------- ----------------------------------------
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
-------------------------------------- ----------------------------------------
1997 1996 1995 1997 1996 1995
----------- ------------ ------------ ------------ ------------ ------------
Direct.............................. $ 120,483 $ 72,810 $ 70,183 $ 88,622 $ 65,667 $ 58,475
Assumed............................. 603,385 641,270 607,755 604,512 608,542 583,764
Ceded............................... (130,212) (140,076) (156,449) (118,487) (147,867) (150,454)
----------- ------------ ------------ ------------ ------------ ------------
Net................................. $ 593,656 $ 574,004 $ 521,489 $ 574,647 $ 526,342 $ 491,785
The Company recorded ceded claims and claims expenses incurred of $51
million, $123.2 million and $120.4 million for the years ended December 31,
1997, 1996 and 1995, respectively. The decrease from 1996 is due to the
terminations of two retrocessional programs discussed later in this Note.
The Company's balance sheet as of December 31, 1997 and 1996 reflects
reinsurance recoverables as assets, net of available offsets, as follows:
IN THOUSANDS
------------------------
DECEMBER 31,
------------------------
1997 1996
---------- ----------
Reinsurance recoverable balances:
Paid claims............................................................................. $ 10,646 $ 15,457
Unpaid claims and claims expenses....................................................... 196,836 406,128
Ceded balances payable.................................................................. (34,305) (38,205)
Funds held liability.................................................................... (900) (47,056)
----------- -----------
Reinsurance recoverable balances, net..................................................... $ 172,277 $ 336,324
----------- -----------
Reinsurance recoverable on unearned premiums.............................................. $ 31,297 $ 20,320
----------- -----------
The Company is the beneficiary of letters of credit, trust accounts and
funds withheld in the aggregate amount of $68 million at December 31, 1997,
collateralizing reinsurance recoverables with respect to certain
retrocessionnaires.
In recognition of the Company's strong surplus position and financial
capacity, and the continued positive contribution of business written since
1986, the Company terminated two retrocessional programs effective January 1,
1997. The Company received total consideration of approximately $225 million,
representing reinsurance recoverable balances for unpaid claims and claims
expenses of approximately the same amount. As a result, at December 31, 1997,
the Company's reinsurance recoverables, exclusive of available offsets in the
form of letters of credit, trust accounts and funds withheld, were $238.8
million, with approximately 165 domestic and 147 foreign retrocessionnaires. The
Company had no amounts recoverable from a single entity or group of entities
that exceeded 5% of stockholders equity as of December 31, 1997.
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's maximum retention on any one claim for non-catastrophe
property/casualty losses for 1998 and 1997 is generally $5 million ($10
million in certain limited circumstances), compared to $7.5 million for 1996.
The Company's maximum retention for surety losses for 1998 and 1997 is $4
million per principal, compared to $12.5 million per principal for 1996.
Further, the Company's retention level for property catastrophe claims in 1998
remains the same as 1997 at $5 million per event compared to $15 million for
1996. For 1998, the Company has obtained $97 million of catastrophe protection
($65 million with respect to claims outside the U.S. and Canada). If claims
within the U.S. and Canada exceed $60 million, the agreements provide an
increase to the Company's net retention of up to an additional $3 million.
7. LEASE AGREEMENTS
The Company leases office space under noncancellable, and in most instances
renewable, operating leases. As a result of a recent extension, these leases
expire at various dates through 2016. The following is a schedule of future
minimum rental payments, exclusive of escalation clauses and rental income,
as of December 31, 1997:
YEAR IN THOUSANDS
-------------------------------------------------------------------------------- -------------
1998............................................................................ $ 4,152
1999............................................................................ 4,067
2000............................................................................ 3,894
2001............................................................................ 3,059
2002 and thereafter............................................................. 25,730
--------------
Total........................................................................... $ 40,902
--------------
Rental expense, net of sublease rental income, was approximately $4.4
million for 1997, $3.9 million for 1996 and $3.5 million for 1995.
8. LONG-TERM DEBT AND FINANCING ARRANGEMENTS
The Company's $100 million of 7.15% Senior Notes due November 15, 2005, were
issued in November 1995 through a public offering at a price of $99.9 million.
The expenses incurred in the offering of approximately $.8 million were deferred
and are being amortized over the life of the Notes. Interest and amortization
costs were $7.2 million for 1997 and 1996 and $.8 million for 1995. The fair
value of the Notes, estimated based on quoted market prices, was approximately
$102.3 million as of December 31, 1997. The Company contributed the net proceeds
of $99.1 million to NAC in 1995.
The Company's $100 million of 5.25% Convertible Subordinated Debentures due
December 15, 2002, were issued in December 1992 through a private offering. The
Debentures are callable as of January 15, 1996 and are convertible into
approximately 2 million shares of the Company's Common Stock at a conversion
price of $49.50 per share. The expenses incurred in the offering of
approximately $1.4 million were deferred and are being amortized over the life
of the Debentures. Interest and amortization costs were $5.4 million annually
for 1997, 1996 and 1995. The fair value of the Debentures, estimated based on
quoted market prices, was approximately $106.5 million as of December 31, 1997.
The Company contributed $85 million of the net proceeds of the offering to NAC
in 1992.
52
The Company's $100 million of 8% Senior Notes due June 15, 1999 were issued
in June 1992 through a public offering. The expenses incurred in the offering of
approximately $.8 million were deferred and are being amortized over the life of
the Notes. Interest and amortization costs were $8.1 million annually for 1997,
1996 and 1995. The fair value of the Notes, estimated based on quoted market
prices, was approximately $102.3 million as of December 31, 1997. The Company
contributed $80 million of the net proceeds of the offering to NAC in 1992.
NAC Re has a revolving credit agreement and term loan bank facility under
which it can borrow up to $35 million. A commitment fee of 3/8 of 1% per year is
paid on the unused credit line. Borrowings of $12.9 million were outstanding at
December 31, 1997 and were principally used in connection with repurchases of
the Company's Common Stock. The facility is scheduled to be reduced on a
quarterly basis beginning in July 1998. NAC has a $15 million line of credit
which is available for catastrophe claim payments or working capital purposes. A
commitment fee of 1/4 of 1% per year is paid on the unused credit line. There
were no outstanding borrowings on this facility at December 31, 1997. Interest
costs on borrowing facilities were approximately $1.0 million, $1.6 million and
$1.4 million in 1997, 1996 and 1995, respectively.
Total interest expense paid in connection with the Company's long-term debt
and financing arrangements was $21.3 million, $22 million and $14.6 million for
the years ended December 31, 1997, 1996 and 1995, respectively.
9. EMPLOYEE BENEFITS AND COMPENSATION ARRANGEMENTS
STOCK PLANS
The Company accounts for stock compensation plans in accordance with APB
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly,
compensation expense for stock option grants and SARs is recognized to the
extent that the fair value of the stock exceeds the exercise price of the option
at the measurement date.
The Company maintains stock option plans which provide for the granting of
options and SARs to purchase shares of Common Stock to certain officers of the
Company. Under such plans, the Company had the authority to grant up to
3,569,000 options at December 31, 1997, of which 1,194,000 options related to a
plan implemented during 1997. Options and SARs have generally been granted with
a five or six-year vesting schedule. The majority of the options expire 10 years
from the date of grant; the remainder of the options have no expiration.
Outstanding SARs are generally converted by the Company to options prior to
vesting.
The Company also maintains a stock option plan for non-employee directors
that provides for automatic annual grants of options to eligible directors.
Under such plan, the Company had the authority to grant up to 375,000 options at
December 31, 1997. Options expire 10 years from the date of grant and are fully
exercisable six months after their grant date.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information concerning stock options (including SARs) for all of the
Company's stock option plans is as follows:
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------
1997 1996 1995
------------------------ ------------------------ ----------------------------
NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE
OPTIONS EXERCISE OPTIONS EXERCISE OPTIONS EXERCISE
(000S) PRICE (000S) PRICE (000S) PRICE
----------- ----------- ----------- ----------- ----------- ----------
Outstanding, beginning of year............... 2,380 $ 30.51 1,772 $ 28.27 1,548 $ 25.11
Granted...................................... 307 43.12 713 35.93 412 38.02
Exercised.................................... (163) 22.33 (33) 19.79 (102) 17.97
Cancelled.................................... (62) 37.56 (72) 33.73 (86) 30.24
----------- ----------- ----------- ----------- ----------- ----------
Outstanding, end of year..................... 2,462 $ 32.45 2,380 $ 30.51 1,772 $ 28.27
----------- ----------- ----------- ----------- ----------- ----------
Exercisable, end of year..................... 1,119 $ 26.93 931 $ 23.59 738 $ 21.66
----------- ----------- ----------- ----------- ----------- ----------
Available for grant, end of year............. 1,077 -- 139 -- 784 --
----------- ----------- ----------- ----------- ----------- ----------
The following table summarizes information about the Company's stock options
(including SARs) for options outstanding as of December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- ------------------------
AVERAGE
NUMBER OF AVERAGE REMAINING NUMBER OF AVERAGE
RANGE OF OPTIONS EXERCISE CONTRACTUAL OPTIONS EXERCISE
EXERCISE PRICES (000S) PRICE LIFE (YEARS) (000S) PRICE
- -------------------------------------------------------- ----------- ----------- --------------- ----------- -----------
$13.61--$18.83.......................................... 270 $ 15.29 4.8 270 $ 15.29
$21.83--$29.63.......................................... 471 $ 24.97 6.1 344 $ 24.38
$30.13--$39.75.......................................... 1,427 $ 35.96 8.4 504 $ 34.88
$40.38--$47.44.......................................... 294 $ 43.13 9.4 1 $ 40.38
$13.61--$47.44.......................................... 2,462 $ 32.45 7.7 1,119 $ 26.93
The Company has an Employee Stock Purchase Plan through which all employees
have the option, subject to certain limitations, to purchase NAC Res Common
Stock, at the end of each offering period at a discounted price. The discounted
price is based on 85% of the lesser of the stocks market price at the beginning
of the period and the market price at the end of the period. During the 1997,
1996 and 1995 plan years, employees purchased approximately 46,400, 28,400 and
21,200 shares of Common Stock, respectively. The Company's stock purchase plan
qualifies as a non-compensatory plan under APB 25.
The Company has restricted stock plans, pursuant to which employees have
been granted approximately 71,100, 57,600 and 44,500 shares of Common Stock
during 1997, 1996 and 1995, respectively. Vesting for such shares generally
occurs over a five or six-year period. In 1996, the Company also granted 20,000
shares of restricted stock to an executive in connection with his employment
contract, the majority of which have vested due to the attainment of the stock
appreciation performance measures; the remainder
54
of the shares vest over a five year period. The Company incurred compensation
expense, under APB 25, for the years ended December 31, 1997, 1996 and 1995 of
approximately $1,983,000, $974,000 and $613,000, respectively, in connection
with restricted stock grants.
Supplemental and Pro Forma Disclosures
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." This Statement, if adopted, requires companies to recognize
compensation expense for grants of stock, stock options and other equity
instruments to employees based on their respective fair values on the date
of grant. Companies that choose not to adopt the new rules will continue to
apply the existing accounting rules contained in APB No. 25, but are required
to disclose the pro forma effects of net income and earnings per share, as if
the fair value based method of accounting had been applied.
The following pro forma information regarding net income and earnings per
share required by Statement No. 123 has been determined as if the Company had
accounted for its employee stock plans under the fair value method described in
that Statement. The fair value of options and other awards granted under the
Company's stock-based compensation plans was estimated on the date of grant
using a Black-Scholes option valuation model. The Black-Scholes option model
was developed for use in estimating the fair value of traded options which
have no vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions including
the expected dividend yield, the expected life of the options, the expected
stock price volatility and the risk-free interest rate.
The weighted average assumptions for the stock option grants were as
follows:
1997 1996 1995
--------- --------- ---------
Expected life........................................................... 7.5 yrs 7.5 yrs 7.5 yrs
Volatility.............................................................. 30% 28% 28%
Dividend yield .70% .67% .63%
Risk-free interest rate................................................. 6.6% 6.3% 6.3%
Grant date fair value................................................... $19.20 $15.32 $16.24
The assumptions for the stock purchase plan were as follows:
1997 1996 1995
--------- --------- ---------
Expected life.......................................................... 1 yr 1 yr 1 yr
Volatility............................................................. 30% 28% 28%
Dividend yield .87% .72% .72%
Risk-free interest rate................................................ 5.3% 5.3% 5.3%
Grant date fair value.................................................. $ 9.14 $ 8.75 $ 8.69
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For purposes of pro forma disclosures, the estimated fair value of each
option is amortized to expense over the options vesting period and does not
include grants prior to January 1, 1995. As such, the pro forma net income and
earnings per share are not indicative of future years. The Company's pro forma
information is as follows:
THOUSANDS, EXCEPT PER SHARE AMOUNTS
----------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
1997 1996 1995
---------------------- ---------------------- ----------------------
REPORTED PRO FORMA REPORTED PRO FORMA REPORTED PRO FORMA
--------- ----------- --------- ----------- --------- -----------
Net income..................................... $ 95,677 $ 93,047 $ 70,520 $ 69,111 $ 62,824 $ 62,322
Earnings per share*
Basic........................................ $ 5.21 $ 5.06 $ 3.74 $ 3.67 $ 3.55 $ 3.52
Diluted...................................... $ 4.77 $ 4.66 $ 3.51 $ 3.44 $ 3.30 $ 3.27
- ------------------------
* Prior year data restated per SFAS No. 128.
INCENTIVE COMPENSATION PLANS
The Company maintains two incentive compensation plans. The Long-term
Incentive Plan provides for cash awards to eligible officers based on
achievement of certain corporate goals over a three-year performance cycle. The
Annual Incentive Plan for all employees (which was amended in 1996 to
incorporate a previously separate plan for non-officers) provides for annual
cash awards based on individual and corporate performance. Based on estimated
performance levels, the Company expensed $10.4 million, $8.5 million and $6.4
million for the years ended December 31, 1997, 1996 and 1995, respectively,
related to these plans.
SEVERANCE PROGRAM
The Company has severance agreements with officers and a severance program
for non-officers to provide for severance payments and continuation of benefits
in the event of employment termination resulting from a change in control. The
extent of the severance payments and when they are triggered vary depending upon
the position of the employee and, in the case of non-officers, the length of
tenure of the employee.
EMPLOYMENT CONTRACTS
The Company has employment contracts with certain officers, the terms of
which expire at various times through December 31, 2001. Such agreements provide
for minimum salary levels, incentive bonuses payable in accordance with bonus
plans and, in two contracts, supplemental retirement benefits.
RETIREMENT PLANS
The Company maintains a qualified non-contributory defined benefit pension
plan covering substantially all U.S. employees. Pension benefits generally vest
after five years of service. Benefits are based on years of service and
compensation, as defined in the plan, during the highest consecutive three years
of the employees last ten years of employment.
56
The Company's policy is to make annual contributions to the plan that are
deductible for federal income tax purposes and that meet the minimum funding
standards required by law. This contribution level is determined by utilizing
the entry age cost method and different actuarial assumptions than those used
for pension expense purposes.
The Company also maintains a non-qualified unfunded supplemental defined
benefit plan designed to compensate individuals to the extent their benefits
under the Company's qualified plan are curtailed due to Internal Revenue Code
limitations.
The following tables set forth the amounts recognized in the Company's
financial statements with respect to the qualified and non-qualified pension
plans.
IN THOUSANDS
-------------------------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------------------------- ------------------------------------
NON- NON-
QUALIFIED QUALIFIED QUALIFIED QUALIFIED
PLAN PLAN TOTAL PLAN PLAN TOTAL
----------- ----------- --------- ----------- ----------- ----------
Actuarial present value of benefit obligations:
Accumulated benefit obligation:
Vested...............................................$ 5,176 $ 2,013 $ 7,189 $ 3,676 $ 1,422 $ 5,098
Nonvested............................................ 864 126 990 769 141 910
----------- ----------- --------- ----------- ----------- ---------
Accumulated benefit obligation......................... 6,040 2,139 8,179 4,445 1,563 6,008
Effect of projected salary increases................... 3,947 1,988 5,935 3,174 1,330 4,504
----------- ----------- --------- ----------- ----------- ---------
Projected benefit obligation........................... 9,987 4,127 14,114 7,619 2,893 10,512
Plan assets at market value...................... 8,442 -- 8,442 6,461 -- 6,461
----------- ----------- --------- ----------- ----------- ---------
Projected benefit obligation in excess of plan assets.. 1,545 4,127 5,672 1,158 2,893 4,051
Unrecognized net gain (loss)........................... 1,944 (49) 1,895 1,866 608 2,474
Unrecognized net transition obligation................. (85) -- (85) (96) -- (96)
Unrecognized net prior service costs................... (70) (243) (313) (72) (255) (327)
----------- ----------- --------- ----------- ----------- ---------
Pension liability, end of year........................... 3,334 3,835 7,169 2,856 3,246 6,102
Pension liability, beginning of year................... (2,856) (3,246) (6,102) (2,338) (2,716) (5,054)
Company contributions.................................. 679 -- 679 557 -- 557
----------- ----------- --------- ----------- ----------- ---------
Net pension cost.........................................$ 1,157 $ 589 $ 1,746 $ 1,075 $ 530 $ 1,605
----------- ----------- --------- ----------- ----------- ---------
IN THOUSANDS
----------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
--------- --------- ---------
Net pension cost included the following components:
Service costs--benefits earned during the year.............................$ 1,333 $ 1,247 $ 1,111
Interest cost on projected benefit obligations............................. 898 741 660
Net amortization and deferral.............................................. (1,376) (807) 751
Actual return on plan assets............................................... 891 424 (1,076)
--------- --------- ---------
Net pension cost...........................................................$ 1,746 $ 1,605 $ 1,446
--------- --------- ---------
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The discount rates used in determining the actuarial present value of
benefit obligations were 6.75% and 7.25% for 1997 and 1996, respectively. The
rate of increase for future compensation levels was 5.5% and 6% for 1997 and
1996, respectively. The assumed rate of return on plan assets was 8.5% for 1997,
1996 and 1995. Assets of the qualified plan are invested principally in equity
securities and fixed maturities. Plan assets include approximately $700,000 and
$486,000 of NAC Re Common Stock as of December 31, 1997 and 1996, respectively.
The Company maintains a qualified contributory defined contribution plan for
substantially all U.S. employees. Under this plan, the Company makes a matching
contribution equal to 50% of each participants eligible elective contributions,
which may be up to 6% of the participants compensation. The Company may make an
additional annual discretionary matching contribution. The Company also
maintains a non-qualified unfunded supplemental defined contribution plan
designed to compensate individuals to the extent the Company's contributions
under the qualified plan are curtailed due to Internal Revenue Code limitations.
The Company expensed $2.2 million for 1997, $2.0 million for 1996 and $1.6
million for 1995, related to these plans. Contributions to the qualified plan
are invested, at the election of the participant, in several funds, including a
NAC Re Common Stock fund. The fund held approximately 111,000 and 137,000 shares
of NAC Re Common Stock as of December 31, 1997 and 1996, respectively.
The Company maintains a qualified non-contributory defined contribution plan
covering substantially all U.K. employees. Contributions under this plan are
determined on the basis of salary, age and position within the organization. The
Company also maintains an unfunded supplemental defined contribution plan
designed to compensate individuals to the extent their benefits under the
qualified plan are curtailed due to U.K. Inland Revenue limitations. The Company
incurred expenses of $563,000, $436,000 and $375,000 for the years ended
December 31, 1997, 1996 and 1995, respectively, related to these plans.
10. Domestic and International Financial Information
The Company's principal business segment, for both its domestic and
international operations, is the reinsurance of property and casualty lines
of business, including general liability, automobile liability, aviation,
fidelity/surety and commercial and personal property. The Company's domestic
operation includes business written in the United States and Canada.
International property and casualty reinsurance is conducted through a
wholly-owned subsidiary, NAC Re International Holdings Limited, which
established a fully licensed property and casualty reinsurance subsidiary,
NAC Reinsurance International Limited, located in London, England in December
1993. The subsidiary was initially capitalized with L50 million, or
approximately $75 million, and, subsequent to contributions by the Company in
1994 and 1995, its statutory surplus level was approximately L83.3 million or
$139.4 million at December 31, 1997. During 1997, NAC Re International
Holdings Limited formed a subsidiary, Stonebridge Underwriting, Ltd, which is
participating as a corporate capital vehicle on a Lloyds syndicate commencing
with underwriting year 1998. See Subsequent Event Note 15 for further details.
58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following is a summary of financial information related to the Company's
domestic and international operations:
IN THOUSANDS
------------------------------------------
YEAR ENDED DECEMBER 31, 1997
------------------------------------------
DOMESTIC INTERNATIONAL TOTAL
------------ ------------- -------------
Net premiums written................................................. $ 541,362(1) $ 52,294 $ 593,656
------------ ------------ --------------
Premiums earned...................................................... 523,631 51,016 574,647
Net investment income................................................ 109,087 13,963 123,050
Net investment gains................................................. 37,556 5,119 42,675
------------ ------------ --------------
Total revenues.................................................... 670,274 70,098 740,372
------------ ------------ --------------
------------ ------------ --------------
Claims and claims expense............................................ 344,308 35,187 379,495
Commissions and brokerage............................................ 140,862 10,290 151,152
Other operating expenses............................................. 55,871 9,289 65,160
Interest expense..................................................... 21,735 -- 21,735
------------ ------------ --------------
Total expenses.................................................... 562,776 54,766 617,542
------------ ------------ --------------
------------ ------------ --------------
Pretax operating income.............................................. 107,498 15,332 122,830
------------ ------------ --------------
Net income........................................................... $ 85,626 $ 10,051 $ 95,677
------------ ------------ --------------
------------ ------------ --------------
Identifiable assets.................................................. $ 2,870,280 $ 277,219 $ 2,984,865(2)
------------ ------------ --------------
------------ ------------ --------------
Statutory composite ratio............................................ 103.1% 108.9% 103.6%
------------ ------------ --------------
------------ ------------ --------------
- ------------------------
(1) Includes approximately $5.8 million of business assumed from our
international subsidiary.
(2) The total is net of intercompany transactions of $162.6 million.
IN THOUSANDS
------------------------------------------
YEAR ENDED DECEMBER 31, 1996
------------------------------------------
DOMESTIC INTERNATIONAL TOTAL
------------ ------------- --------------
Net premiums written................................................. $ 521,876(1) $ 52,128 $ 574,004
------------ ------------ --------------
Premiums earned...................................................... 476,012 50,330 526,342
Net investment income................................................ 93,206 11,124 104,330
Net investment gains (losses)........................................ 19,603 (34) 19,569
------------ ------------ --------------
Total revenues....................................................... 588,821 61,420 650,241
------------ ------------ --------------
------------ ------------ --------------
Claims and claims expense............................................ 302,535 36,418 338,953
Commissions and brokerage............................................ 133,423 9,901 143,324
Other operating expenses............................................. 49,019 7,587 56,606
Interest expense..................................................... 22,322 -- 22,322
------------ ------------ --------------
Total expenses..................................................... 507,299 53,906 561,205
------------ ------------ --------------
------------ ------------ --------------
Pretax operating income.............................................. 81,522 7,514 89,036
------------ ------------ --------------
Net income........................................................... $ 65,566 $ 4,954 $ 70,520
------------ ------------ --------------
------------ ------------ --------------
Identifiable assets.................................................. $ 2,640,727 $ 252,043 $ 2,745,631(2)
------------ ------------ --------------
------------ ------------ --------------
Statutory composite ratio............................................ 101.1% 105.6% 101.6%
------------ ------------ --------------
------------ ------------ --------------
- ------------------------
(1) Includes approximately $3.0 million of business assumed from our
international subsidiary.
(2) The total is net of intercompany transactions of $147.1 million.
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
IN THOUSANDS
---------------------------------------------
YEAR ENDED DECEMBER 31, 1995
---------------------------------------------
DOMESTIC INTERNATIONAL TOTAL
------------ ------------- --------------
Net premiums written................................................. $ 476,048(1) $ 45,441 $ 521,489
------------ ----------- --------------
Premiums earned...................................................... 452,994 38,791 491,785
Net investment income................................................ 81,583 7,725 89,308
Net investment gains................................................. 24,063 1,328 25,391
------------ ----------- --------------
Total revenues..................................................... 558,640 47,844 606,484
------------ ----------- --------------
------------ ----------- --------------
Claims and claims expense............................................ 295,038 31,110 326,148
Commissions and brokerage............................................ 132,049 7,014 139,063
Other operating expenses............................................. 40,760 6,044 46,804
Interest expense..................................................... 15,648 -- 15,648
------------ ----------- --------------
Total expenses..................................................... 483,495 44,168 527,663
------------ ----------- --------------
------------ ----------- --------------
Pretax operating income.............................................. 75,145 3,676 78,821
------------ ----------- --------------
Net income........................................................... $ 60,449 $ 2,375 $ 62,824
------------ ----------- --------------
------------ ----------- --------------
Identifiable assets.................................................. $ 2,405,051 $ 180,060 $ 2,462,131(2)
------------ ----------- --------------
------------ ----------- --------------
Statutory composite ratio............................................ 103.1% 111.7% 103.7%
------------ ----------- --------------
------------ ----------- --------------
- ------------------------
(1) Includes approximately $2.1 million of business assumed from our
international subsidiary.
(2) The total is net of intercompany transactions of $123 million.
During 1997, three reinsurance brokers, AON Reinsurance Agency, Guy
Carpenter and Company, Inc., and E.W. Blanch, Inc., generated 24%, 17% and
11%, respectively, of the Company's premiums assumed from client companies.
These same reinsurance brokers generated 23%, 13% and 8%, respectively,
during 1996, and 16%, 16% and 9%, respectively, during 1995, of the Company's
assumed premiums. The Company does not believe that the reduction of business
assumed from any one client or broker will have a materially adverse effect
on the Company due to its competitive position in the marketplace and the
continuing availability of other sources of business.
11. Statutory Financial Information
Consolidated statutory net income and surplus of NAC, as reported to the
insurance regulatory authorities, differs in certain respects from the
amounts as prepared in accordance with generally accepted accounting
principles (GAAP). The following schedules identify the significant
reconciling differences:
IN THOUSANDS
-------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Net Income:
Domestic statutory net income.................................................... $ 70,292 $ 59,827 $ 57,670
Domestic GAAP adjustments:
Deferred acquisition costs..................................................... 6,703 14,211 9,128
Deferred income taxes.......................................................... 23,257 4,421 3,204
Other, net..................................................................... (560) 401 (1,074)
--------- --------- ---------
Domestic GAAP net income....................................................... 99,692 78,860 68,928
International operation.......................................................... 10,051 4,954 2,375
Parent company operations........................................................ (14,066) (13,294) (8,479)
--------- --------- ---------
Consolidated GAAP net income..................................................... $ 95,677 $ 70,520 $ 62,824
--------- --------- ---------
60
IN THOUSANDS
----------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
Stockholders Equity:
Consolidated statutory surplus............................................... $ 702,222 $ 663,867 $ 615,433
Consolidated GAAP adjustments:
Deferred acquisition costs................................................. 92,709 85,211 70,466
Deferred income tax asset, net............................................. 41,795 29,599 27,492
Excess of cost over net assets acquired.................................... 3,276 3,644 4,011
Unrealized appreciation of investments..................................... 71,846 25,537 46,783
Unauthorized/authorized reinsurance charges................................ 15,452 12,730 6,814
Other, net................................................................. 6,824 4,695 4,101
---------- ---------- ----------
Investment in insurance subsidiaries, GAAP................................... 934,124 825,283 775,100
Parent company:
Other net assets........................................................... 22,879 27,920 36,583
Long-term debt............................................................. (299,942) (299,934) (299,927)
---------- ---------- ----------
Consolidated stockholders equity, GAAP....................................... $ 657,061 $ 553,269 $ 511,756
---------- ---------- ----------
---------- ---------- ----------
Under the holding company structure, NAC Re is dependent upon the ability of
its principal operating subsidiary, NAC, for the transfer of funds principally
in the form of cash dividends and tax reimbursements. Such transactions,
including the payment of cash dividends, are subject to restrictions imposed by
New York insurance law. Generally, NAC may pay cash dividends only out of its
statutory earned surplus which was $190.8 million at December 31, 1997. However,
the maximum amount of dividends that may be paid in any twelve-month period
without the prior approval of the New York Insurance Department is the lesser of
net investment income or 10% of statutory surplus as such terms are defined in
the New York insurance law. The maximum amount of cash dividends that NAC could
pay without such regulatory approval, based on 10% of statutory surplus as of
December 31, 1997, is approximately $70.2 million. During 1997, 1996 and 1995,
NAC declared dividends of $22.5 million, $38 million and $7.5 million,
respectively, to NAC Re.
In 1993, the National Association of Insurance Commissioners (the
"NAIC"), by adopting a model risk-based capital act, intended to provide an
additional tool for regulators to evaluate the capital of property and
casualty insurers and reinsurers with respect to the risks assumed by them
and to determine whether there is a perceived need for corrective action. The
nature of the corrective action depends upon the extent of the calculated
risk-based capital deficiency and ranges from requiring the company to submit
a comprehensive plan to placing the insurer under regulatory control. While
the model risk-based capital act has not yet been adopted in New York, NACs
domicile, New York has issued a circular letter requiring the filing of
risk-based capital reports by property and casualty insurers and reinsurers.
The NAIC also adopted a proposal that requires property and casualty insurers
and reinsurers to report the results of their risk-based capital calculations
as part of the statutory annual statements filed with state regulatory
authorities. Surplus (as calculated for statutory annual statement purposes)
for each of the Company's domestic subsidiaries is well above the risk-based
capital thresholds that would require either company or regulatory action.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share:
IN THOUSANDS
-------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------
IN THOUSANDS
1997 1996 1995
--------- --------- ---------
Basic Earnings Per Share:
Net income..................................................................... $ 95,677 $ 70,520 $ 62,824
Weighted average shares........................................................ 18,378 18,855 17,709
Basic earnings per share....................................................... $ 5.21 $ 3.74 $ 3.55
--------- --------- ---------
Diluted Earnings Per Share:
Net income..................................................................... $ 95,677 $ 70,520 $ 62,824
Add back after tax interest on convertible debentures.......................... 3,504 3,504 3,504
--------- --------- ---------
Adjusted net income............................................................ $ 99,181 $ 74,024 $ 66,328
Weighted average shares........................................................ 18,378 18,855 17,709
Assumed exercise of dilutive stock options (1)................................. 411 240 386
Assumed conversion of convertible debentures (2)............................... 2,020 2,020 2,020
--------- --------- ---------
Weighted average shares and dilutive securities................................ 20,809 21,115 20,115
Diluted earnings per share..................................................... $ 4.77 $ 3.51 $ 3.30
--------- --------- ---------
--------- --------- ---------
- ------------------------
(1) Computed utilizing the average market price of the Common Stock for the
period.
(2) Reflects the assumed conversion of the Company's 5.25% Convertible
Subordinated Debentures due 2002.
13. CAPITAL STOCK
Changes in Common Stock outstanding were as follows:
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
Common Stock:
Balance, beginning of year............................................ 21,463,982 21,341,053 19,638,865
Shares issued......................................................... 243,241 122,929 1,702,188
------------ ------------ ------------
Balance, end of year.................................................... 21,707,223 21,463,982 21,341,053
------------ ------------ ------------
------------ ------------ ------------
Treasury Stock:
Balance, beginning of year............................................ 3,060,543 2,137,501 2,131,633
Purchases............................................................. 345,375 943,042 5,868
Shares reissued....................................................... (7,432) (20,000) --
------------ ------------ ------------
Balance, end of year.................................................. 3,398,486 3,060,543 2,137,501
------------ ------------ ------------
------------ ------------ ------------
Total Common Stock outstanding.......................................... 18,308,737 18,403,439 19,203,552
------------ ------------ ------------
------------ ------------ ------------
62
13. CAPITAL STOCK (CONTINUED)
EQUITY OFFERING
The Company issued 1,530,000 shares of Common Stock through a secondary
public offering in November 1995. Approximately $47.5 million of the net
proceeds was contributed to the statutory surplus of NAC.
STOCK REPURCHASE
The Company maintains a stock repurchase program pursuant to which the Board
of Directors has authorized the repurchase of approximately 4,082,000 shares of
Common Stock. Since January 1, 1997, the Company repurchased approximately
345,000 shares of Common Stock, at an average cost of $42.05 per share. From its
inception in 1988 through December 31, 1997, approximately 3,426,000 shares were
repurchased at a cost of approximately $88.5 million or an average price of
$25.82 per share. As of December 31, 1997, approximately 656,000 shares remain
authorized for repurchase under the program.
RIGHTS PLAN
In June 1988, the Company declared a dividend of one Preferred Stock
Purchase Right (a "Right") for each outstanding share of NAC Re Common Stock.
Pursuant to the related Rights Plan, as amended in 1990, the Rights will become
exercisable only in the event, with certain exceptions, a person or group
becomes the beneficial owner of 15% or more of NAC Re voting stock. The Rights
Plan provides, however, that the Rights will not become exercisable due to the
beneficial ownership by The Equitable Life Assurance Society of the United
States and its affiliates of up to 28.5% of such stock. Each Right currently
entitles the holder to purchase from the Company, for a price of $37.78 (the
"Exercise Price"), 1/225 of a share of Series A Junior Participating Preferred
Stock (the "Series A Stock") or that number of shares of Series A Stock having a
market value equal to two times the Exercise Price.
In addition, upon the occurrence of certain events, holders of the Rights
will be entitled to purchase the shares of Series A Stock or shares in an
acquiring entity, whichever is applicable, having a market value of two times
the Exercise Price.
NAC Re will generally be entitled to redeem the Rights at $.0222 per Right
following a public announcement that a person or group has become the beneficial
owner of 15% of the NAC Re voting stock. The Rights will expire on June 21,
1998.
At December 31, 1997, there were 18,308,737 Rights outstanding which, if
exercised, would result in the issuance of approximately 81,400 shares of Series
A Stock.
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. Quarterly Financial Information (Unaudited)
The following is a summary of quarterly financial data, in thousands, except
per share data and stock prices:
THREE MONTHS ENDED
----------------------------------------------------------------------------------------------
DECEMBER 31, SEPTEMBER 30, JUNE 30, MARCH 31,
---------------------- ---------------------- ---------------------- ----------------------
1997 1996 1997 1996 1997 1996 1997 1996
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income Statement Data:
Gross premiums written..... $ 186,806 $ 197,964 $ 188,002 $ 183,052 $ 180,518 $ 172,718 $ 168,542 $ 160,346
Net premiums written....... 155,174 159,332 153,657 150,681 148,654 140,852 136,171 123,139
Premiums earned............ 152,575 140,060 147,884 139,115 142,078 130,346 132,110 116,821
Net investment income...... 32,253 26,831 31,917 26,140 30,308 25,616 28,572 25,743
Net investment gains....... 14,217 4,915 5,641 2,122 17,684 2,715 5,133 9,817
Operating costs and
expenses................. 164,012 149,668 159,901 147,432 152,561 138,676 141,068 125,429
Operating income/net
income................... 26,571 17,296 20,670 16,038 28,582 16,414 19,854 20,772
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Per Share Data:
Basic:*
Operating/net income..... $ 1.45 $ .93 $ 1.13 $ .86 $ 1.56 $ .87 $ 1.08 $ 1.08
Diluted:*
Operating/net income..... 1.32 .87 1.03 .80 1.42 .81 1.00 1.00
Stockholders equity per
share.................... 35.89 30.06 34.15 28.18 32.30 26.96 29.96 26.54
Cash dividends declared per
share .075 .06 .075 .06 .075 .06 .06 .05
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Stock Prices:
High....................... $ 52.88 $ 37.63 $ 51.56 $ 40.63 $ 49.00 $ 33.88 $ 39.88 $ 36.25
Low........................ 43.50 32.63 45.50 30.25 35.50 28.50 33.25 31.75
Close...................... 48.81 33.88 51.38 36.00 48.38 33.50 35.63 32.63
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
- ------------------------
* The 1996 and first three quarters of 1997 earnings per share amounts have
been restated to comply with SFAS No. 128.
15. Subsequent Event
On January 22, 1998, the Company announced an agreement in principle to
acquire the managing agency assets of a Lloyds agency currently managing
non-marine Syndicate 990 (Denham). Denham underwrites a specialized book of
business on both a direct and reinsurance basis, concentrating on long-tail
casualty lines and non-marine physical damage. In late 1997, the Company
formed a subsidiary, Stonebridge Underwriting Ltd., which is participating as
a corporate capital vehicle on the Denham Syndicate commencing with
underwriting year 1998.
The acquisition is subject to the completion of due diligence and regulatory
approval and is expected to close during the second quarter of 1998; however,
there are no assurances that the acquisition will be consummated. The
transaction is not expected to have a material impact on the financial condition
or results of operations of the Company in 1998.
64