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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period to .
-------------- -----------------
Commission file number 0-13891.
NAC Re Corp.
(Exact name of registrant as specified in its charter)
Delaware 13-3297840
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
One Greenwich Plaza, Greenwich,
CT 06836-2568
(Address of principal executive
offices)
(203) 622-5200
(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year, if changed since last
report)
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Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
There were 18,330,800 shares outstanding of the Registrant's Common Stock,
$.10 par value, as of September 30, 1998.
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NAC RE CORP. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE NO.
Independent Accountants' Review Report 3
Consolidated Balance Sheet -
September 30, 1998 and December 31, 1997 4
Consolidated Statement of Income -
Three Months and Nine Months Ended September 30, 1998 and 1997 5
Consolidated Statement of Stockholders' Equity -
Nine Months Ended September 30, 1998 and 1997 6
Consolidated Statement of Cash Flows -
Nine Months Ended September 30, 1998 and 1997 7
Notes to Consolidated Financial Statements 8-9
Management's Discussion and Analysis
of Financial Condition and Results of Operations 10-16
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
Exhibit 15 19
Exhibit 27 20-21
INDEPENDENT ACCOUNTANT'S REVIEW REPORT
Board of Directors and Shareholders
NAC Re Corporation
We have reviewed the accompanying consolidated balance sheet of NAC Re
Corporation and subsidiaries as of September 30, 1998, and the related
consolidated statements of income for the three-month and nine-month periods
ended September 30, 1998 and 1997 and the consolidated statements of
stockholders' equity and cash flows for the nine-month periods ended
September 30, 1998 and 1997. These financial statements are the
responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquires of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, which will be performed
for the full year with the objective of expressing an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of NAC Re Corporation as of December
31, 1997, and the related consolidated statements of income, stockholders'
equity and cash flows for the year then ended (not presented herein) and in our
report dated February 3, 1998, we expressed an unqualified opinion on those
consolidated financial statements.
New York, New York ERNST & YOUNG LLP
October 21, 1998
3
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In thousands)
(Unaudited)
September 30, December 31,
1998 1997
------------------ ----------------
------------------ ----------------
ASSETS
Investments:
Available for sale:
Fixed maturities (amortized cost: 1998, $2,056,829; 1997, $2,021,501) $2,158,026 $2,088,588
Equity securities (cost: 1998, $137,227; 1997, $124,999) 138,901 142,527
Short-term investments 141,076 108,489
---------- ----------
TOTAL INVESTMENTS 2,438,003 2,339,604
Cash 24,234 8,430
Accrued investment income 34,384 36,347
Premiums receivable 222,062 227,569
Reinsurance recoverable balances, net 238,175 172,277
Reinsurance recoverable on unearned premiums 45,465 31,297
Deferred policy acquisition costs 97,299 92,709
Excess of cost over net assets acquired 8,222 3,276
Deferred tax asset, net 33,317 42,646
Other assets 48,844 30,710
---------- ----------
TOTAL ASSETS $3,190,005 $2,984,865
========== ==========
LIABILITIES
Claims and claims expenses $1,698,265 $1,603,972
Unearned premiums 330,976 301,711
8% Notes due 1999 100,000 100,000
7.15% Notes due 2005 99,947 99,942
5.25% Convertible Subordinated Debentures due 2002 100,000 100,000
Investment accounts payable 7,612 26,108
Revolving credit agreement 12,924 12,924
Other liabilities 107,420 83,147
---------- ----------
TOTAL LIABILITIES 2,457,144 2,327,804
---------- ----------
STOCKHOLDERS' EQUITY Preferred stock, $1.00 par value:
1,000 shares authorized, none issued
(Includes 277.5 shares of Series A Junior Preferred Stock) - -
Common stock, $.10 par value:
25,000 shares authorized (1998, 21,946; 1997, 21,707 shares issued) 2,195 2,171
Additional paid-in capital 266,509 255,424
Accumulated other comprehensive income 72,445 60,989
Retained earnings 490,371 426,309
Treasury stock, at cost (1998, 3,615; 1997, 3,398 shares) (98,659) (87,832)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY 732,861 657,061
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $3,190,005 $2,984,865
========== ==========
See Notes to Consolidated Financial Statements
4
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
----------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
-------------------------------- ---------------------------------
1998 1997 1998 1997
-------------- ------------- ------------- ---------------
PREMIUMS AND OTHER REVENUES
Net premiums written $135,472 $153,657 $412,931 $438,482
Increase in unearned premiums (6,502) (5,773) (14,516) (16,410)
------- ------- ------- -------
Premiums earned 128,970 147,884 398,415 422,072
Net investment income 33,403 31,917 98,066 90,797
Net investment gains 10,226 5,641 23,298 28,458
------- ------- ------- -------
Total revenues 172,599 185,442 519,779 541,327
OPERATING COSTS AND EXPENSES
Claims and claims expenses 85,857 97,304 264,945 278,388
Commissions and brokerage 35,372 40,200 103,166 111,362
Acquisition and operating expenses 17,444 16,971 51,482 47,472
Interest expense 5,425 5,426 16,278 16,308
------- ------- ------- -------
Total operating costs and expenses 144,098 159,901 435,871 453,530
INCOME
Operating income before income taxes 28,501 25,541 83,908 87,797
------- ------- ------- -------
Federal and foreign income taxes:
Current 685 7,628 11,966 30,939
Deferred 4,093 (2,757) 3,209 (12,248)
------- ------- ------- -------
Income tax expense (benefit) 4,778 4,871 15,175 18,691
------- ------- ------- -------
Operating income/net income $23,723 $20,670 $68,733 $69,106
======= ======= ======= =======
PER SHARE DATA*
Basic:
Average shares outstanding 18,263 18,372 18,264 18,393
Operating income/net income $1.30 $1.13 $3.76 $3.76
Diluted:
Average shares outstanding 20,807 20,914 20,843 20,808
Operating income/net income $1.18 $1.03 $3.42 $3.45
Cash dividends declared per share $0.09 $0.075 $0.255 $0.21
* Prior year data restated per SFAS 128.
See Notes to Consolidated Financial Statements
5
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In thousands)
(Unaudited)
-------------------------------------------------------------------------------------------
Accumulated
Other Total
Common Paid-in Comprehensive Retained Treasury Comprehensive Stockholders'
Stock Capital Income Earnings Stock Income Equity
----- ------- ------ -------- ----- ------ ------
Balance, At December 31, 1997 $2,171 $255,424 $426,309 $(87,832) $60,989 $657,061
Comprehensive income:
Net income $68,733 68,733 68,733
Other comprehensive income,
net of tax:
Unrealized appreciation of
investments 11,866 11,866
Currency translation adjustments (410) (410)
------
Other comprehensive income 11,456 11,456
------ ------
Total comprehensive income $80,189
=======
Issuance of shares 24 11,085 11,109
Dividends declared on common stock (4,671) (4,671)
Purchase of treasury shares, net of
reissuance (10,827) (10,827)
------ -------- -------- -------- ------- -------
Balance at September 30, 1998 $2,195 $266,509 $490,371 $(98,659) $72,445 $732,861
====== ======== ======= ======== ======= ========
(Unaudited)
---------------------------------------------------------------------------------------------
Accumulated
Other Total
Common Paid-in Comprehensive Retained Treasury Comprehensive Stockholders'
Stock Capital Income Earnings Stock Income Equity
----- ------- ------ -------- ----- ------ ------
Balance, At December 31, 1996 $2,146 $248,662 $335,868 $(73,484) $40,077 $553,269
Comprehensive income:
Net income $69,106 69,106 69,106
Other comprehensive income,
net of tax:
Unrealized appreciation of
investments 17,736 17,736
Currency translation adjustments (4,818) (4,818)
-------
Other comprehensive income 12,918 12,918
-------
Total comprehensive income $82,024
=======
Issuance of shares 22 6,509 6,531
Dividends declared on common stock (3,864) (3,864)
Purchase of treasury shares, net of
reissuance (10,434) (10,434)
------ -------- -------- -------- ------- --------
Balance at September 30, 1997 $2,168 $255,171 $401,110 $(83,918) $52,995 $627,526
====== ======== ======== ======== ======= ========
See Notes to Consolidated Financial Statements
6
NAC RE CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Nine months ended September 30,
-------------------------------
1998 1997
OPERATING ACTIVITIES ---------- ----------
Net income $68,733 $69,106
Adjustments to reconcile net income to net cash
provided by operating activities:
Reserve for claims and claims expenses, net 26,563 286,492
Unearned premiums, net 14,808 16,411
Premiums receivable 5,827 (30,619)
Accrued investment income 2,025 (6,483)
Reinsurance balances, net 16,210 (26,895)
Deferred policy acquisition costs (4,515) (6,324)
Net investment gains (23,300) (28,452)
Deferred tax asset, net (5,549) (13,273)
Other liabilities 15,140 17,841
Other items, net (8,686) 10,785
------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 107,256 288,589
------- -------
INVESTING ACTIVITIES
Sales of fixed maturity investments 972,759 1,120,587
Maturities of fixed maturity investments 20,027 20,148
Purchases of fixed maturity investments (1,035,369) (1,428,210)
Net purchases of short-term investments (31,825) (48,935)
Sales of equity securities 60,755 125,146
Purchases of equity securities (63,314) (70,368)
Purchases of furniture and equipment (3,442) (3,476)
------- -------
NET CASH USED BY INVESTING ACTIVITIES (80,409) (285,108)
------- -------
FINANCING ACTIVITIES
Issuance of shares 5,145 5,232
Purchase of treasury shares, net of reissuance (10,827) (10,434)
Cash dividends paid to stockholders (4,389) (3,590)
------- -------
NET CASH USED BY FINANCING ACTIVITIES (10,071) (8,792)
------- -------
Effects of exchange rate changes on cash (972) (172)
------- -------
Increase (decrease) in cash 15,804 (5,483)
Cash - beginning of year 8,430 18,853
------- -------
Cash - end of period $24,234 $13,370
======= =======
See Notes to Consolidated Financial Statements
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
The accompanying consolidated financial statements have been prepared
on the basis of generally accepted accounting principles and in the
opinion of management, reflect all adjustments necessary (consisting of
normal recurring accruals) for a fair presentation of results for such
periods. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and related
notes contained in the Company's Annual Report to Shareholders.
2. Per Share Data
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. The following table is a reconciliation of the numerators
and denominators used in the basic and diluted earnings per share
calculations.
(In Thousands)
----------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- -----------------------
1998 1997 1998 1997
------------ ----------- ---------- ----------
Basic Earnings Per Share:
Net income $23,723 $20,670 $68,733 $69,106
Weighted average shares 18,263 18,372 18,264 18,393
Basic earnings per share $1.30 $1.13 $3.76 $3.76
Diluted Earnings Per Share:
Net income $23,723 $20,670 $68,733 $69,106
Add back after-tax interest on convertible 876 876 2,628 2,628
debentures
------- ------- ------- -------
Adjusted net income $24,599 $21,546 $71,361 $71,734
Weighted average shares 18,263 18,372 18,264 18,393
Assumed exercise of dilutive stock options (1) 524 522 559 395
Assumed conversion of convertible debentures (2) 2,020 2,020 2,020 2,020
------- ------- ------- -------
Weighted average shares and dilutive securities 20,807 20,914 20,843 20,808
Diluted earnings per share $1.18 $1.03 $3.42 $3.45
(1) Computed utilizing the average market price of Common Stock for
the period.
(2) Reflects the assumed conversion of the Company's 5.25%
Convertible Subordinated Debentures due 2002.
8
3. Retrocession
The Company's balance sheets as of September 30, 1998 and December 31,
1997 reflect reinsurance recoverable balances as assets, the components
of which are stated in the table below.
(In Thousands)
Reinsurance Recoverable Balances, Net
--------------------------------------------------
September 30, 1998 December 31, 1997
--------------------- ------------------
Paid Claims $10,737 $10,646
Unpaid Claims and Claims Expenses 263,152 196,836
Ceded Balances Payable (34,857) (34,305)
Funds Held Liability (857) (900)
--------------------- ------------------
Net $238,175 $172,277
===================== ==================
The effect of retrocessional activity on premiums written, premiums earned and
claims expenses is as follows:
(In Thousands)
------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------------- -------------------------
1998 1997 1998 1997
---------- ---------- ----------- ----------
Ceded premiums written $46,372 $34,345 $109,256 $98,580
Ceded premiums earned $40,343 $32,007 $95,497 $90,700
Ceded claims and claims expenses $49,647 $21,695 $88,181 $57,961
4. Comprehensive Income
In the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," which 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.
For the quarter ended September 30, 1998, total comprehensive income
totaled $33.2 million compared to $36.2 million for the 1997 third
quarter. Total comprehensive income for the nine months ended September
30, 1998 totaled $80.2 million compared to $82.0 million for the 1997
nine month period. Comprehensive income includes all changes in equity
during a period resulting from transactions and other events from
nonowner sources. Changes in unrealized appreciation of investments and
currency translation adjustments, after-tax, are the principal items
that are added to net income to derive comprehensive income.
Accumulated other comprehensive income, net of tax, for the Company
includes unrealized appreciation of investments of $66.8 million and
foreign currency translation adjustments of $5.6 million at September
30, 1998.
5. Accounting Pronouncement
In September 1998, The Financial Accounting Standards Board issued
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which is required to be adopted in years beginning after
June 15, 1999. The Company does not anticipate that the adoption of
this Statement will have a material effect on the Company's financial
position.
6. Supplemental Cash Flow Information
In August 1998, NAC Re acquired Denham Syndicate Management Limited for
100,610 shares of NAC Re Common Stock. The acquisition was accounted
for by the purchase method of accounting. The excess purchase price
over the estimated fair market value of $5.2 million has been allocated
to goodwill and is being amortized over a 20 year period.
9
Management's Discussion and Analysis of
Financial Condition and Results of Operations
NAC Re Corporation ("NAC Re") is the holding company for NAC Reinsurance
Corporation ("NAC") and its wholly owned insurance and reinsurance domestic and
foreign subsidiaries. NAC Re and its subsidiaries are collectively referred to
as the Company.
Results of Operations
- ---------------------
For the quarter ended September 30, 1998, operating earnings, excluding
investment gains, were $17.1 million or $.94 per basic share ($.86 cents per
diluted share). This represents an increase of 1.1% over the $.93 per basic
share ($.85 per diluted share) that was reported in the comparable quarter of
1997. For the nine months of 1998, operating earnings, excluding investment
gains were $53.6 million or $2.93 per basic share ($2.70 per diluted share), an
increase of 6.9% over the $2.74 per basic share ($2.55 per diluted share) that
was reported in the comparable 1997 period. Operating earnings for the 1998
third quarter and nine month period were reduced by $7.2 million ($4.7 million
after-tax) or $.26 per basic share ($.22 per diluted share) for property
catastrophe claims resulting predominately from Hurricane Georges, inclusive of
an expected charge for reinstating the Company's catastrophe protection. Net
income, including investment gains for the third quarter of 1998, was $23.7
million or $1.30 per basic share ($1.18 per diluted share), representing an
increase of 15.0% over the $1.13 per basic share ($1.03 per diluted share) that
was reported for the 1997 third quarter. Net income for the nine months of 1998
was $68.7 million or $3.76 per basic share ($3.42 per diluted share), compared
to $69.1 million or $3.76 per basic share ($3.45 per diluted share), for the
comparable 1997 period. Included in net income per share were realized
investment gains, net of tax of $.36 and $.83 per basic share ($.32 and $.72 per
diluted share) for the 1998 third quarter and nine month period, respectively,
compared to $.20 and $1.02 per basic share ($.18 and $.90 per diluted share) for
the same prior year periods.
Premium Revenues
The Company's premium revenue from its domestic and international operations are
as follows:
(In millions)
Net Premiums Written
--------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- ----------------------------------
1998 1997 % Chg 1998 1997 % Chg
---------- --------- -------- --------- --------- --------
Domestic:
Casualty $70.1 $78.6 (10.9) % $200.5 $235.1 (14.7)%
Property 28.4 30.8 (7.7) 98.6 88.7 11.2
Specialty/Other 23.9 33.1 (27.9) 71.1 75.9 (6.4)
---- ---- ----- ---- ---- ----
Subtotal 122.4 142.5 (14.1) 370.2 399.7 (7.4)
----- ----- ----- ----- ----- ----
International:
Casualty 5.6 6.4 (11.5) 19.3 20.5 (5.6)
Property 4.5 4.8 (7.1) 15.6 18.3 (15.0)
Other 3.0 - N/A 7.8 - N/A
----- ----- ----- ----- ----- ----
Subtotal 13.1 11.2 17.7 42.7 38.8 10.3
---- ---- ---- ---- ---- ----
Total $135.5 $153.7 (11.8) % $412.9 $438.5 (5.8)%
====== ====== ===== ====== ====== =====
As shown in the table above, the Company's worldwide net premiums written for
the 1998 third quarter and nine month period were $135.5 million and $412.9
million, respectively, compared to $153.7 million and $438.5 million for the
1997 third quarter and nine month period, respectively. This represents a
decline of 11.8% and 5.8% from the 1997 third quarter and nine month period,
respectively.
10
Domestic net premiums written for the 1998 third quarter and nine month period
were $122.4 million and $370.2 million, respectively, compared to $142.5 million
and $399.7 million for the 1997 third quarter and nine month period,
respectively.
Domestic casualty net premiums written for the 1998 third quarter and nine month
period were $70.1 million and $200.5 million, respectively, representing a
decline of 10.9% and 14.7% from the comparable 1997 periods. These declines
continue to reflect the competitive pressures in the casualty insurance market
and NAC Re's decision to nonrenew accounts which do not meet the Company's
profitability standards.
Domestic property net premiums written for the 1998 third quarter and nine month
period totaled $28.4 million and $98.6 million, respectively, a decrease of 7.7%
from the comparable 1997 third quarter and an increase of 11.2% over the
comparable 1997 nine month period. The decline in the third quarter is primarily
due to the reinstatement charge resulting from the property catastrophes. The
overall increase for the nine months is primarily attributable to growth in both
our treaty and facultative business. Net premiums written from the specialty
lines which consist of fidelity/surety, ocean marine, aviation business and
certain primary program business totaled $23.9 million and $71.1 million for the
1998 third quarter and nine month period, respectively, a decrease of 27.9% and
6.4% over the 1997 comparable periods. The decline in the specialty lines was
attributable to the decrease in fidelity/surety business partially offset by
growth in the Company's primary programs.
The Company's international operation, NAC Reinsurance International Holdings
Limited, reported consolidated net premiums written of $13.1 million and $42.7
million for the 1998 third quarter and nine month period, respectively,
representing an increase of 17.7% and 10.3% over the 1997 comparable periods.
International reinsurance premiums written were $10.1 million and $34.9 million
for the 1998 third quarter and nine month period, respectively, representing a
decline of 9.6% and 10.0% from the 1997 comparable periods, reflecting the
difficult market conditions. International primary net premium growth for the
third quarter and nine month period were principally attributable to the
Company's subsidiary, Stonebridge Underwriting Ltd., which is participating at
Lloyd's as a corporate capital vehicle on the Denham Syndicate for the 1998
underwriting year. During the third quarter, the Company increased its capacity
in Denham for the 1999 underwriting year from 13% to 43%, which is estimated to
provide total gross premiums of $40 million for 1999.
In August 1998, the Company announced the completion of the purchase of Denham
Syndicate Management Limited, the Lloyd's managing agency that manages
non-marine syndicate 990 (Denham). Denham underwrites a specialized book of
international business, concentrating on long-tail casualty lines and non-marine
physical damage. In 1997, NAC Re formed Stonebridge Underwriting Ltd., a
corporate capital vehicle which is participating on the Denham Syndicate. The
transaction is not expected to have a material impact on the financial condition
or results of operations of the Company in 1998.
Operating Costs and Expenses
Generally, claims and claims expenses represent the Company's most significant
and uncertain costs. These expenses are only estimates at a given point in time
of what the insurer or reinsurer expects the ultimate settlement and
administration of claims to cost based on facts and circumstances then known.
The Company would generally expect to refine such estimates in subsequent
accounting periods with adjustments possible in either direction as additional
information becomes known.
One traditional means of measuring the underwriting performance of a
property/casualty insurer is the statutory composite ratio. The composite ratio,
based upon statutory accounting practices which differ from generally accepted
accounting principles in several respects, reflects underwriting experience, but
does not reflect income from investments. A composite ratio under 100% indicates
underwriting profitability while a composite ratio exceeding 100% indicates an
underwriting loss.
11
The following chart sets forth statutory composite ratios and the relevant
components for the periods indicated for the Company's domestic reinsurance
subsidiary. The consolidated statutory composite ratio combines the results of
the Company's international subsidiary on a U.S. statutory basis:
Three months ended Nine months ended Year ended
September 30, September 30, December 31,
------------------------- ---------------------- ----------------
1998 1997 1998 1997 1997
---------- ----------- --------- --------- ----------------
Claims and Claims Expenses 66.2 % 65.6 % 66.1 % 65.8 % 65.9 %
Commissions and Brokerage 28.8 27.9 26.8 27.3 27.3
Other Underwriting Expenses 10.9 9.5 10.9 9.7 9.9
---------- ----------- --------- --------- ----------------
Domestic Statutory Composite Ratio 105.9 % 103.0 % 103.8 % 102.8 % 103.1 %
========== =========== ========== ========== =================
International Statutory Composite Ratio 120.6 % 111.2 % 112.6 % 110.1 % 108.9 %
========== =========== ========== ========== =================
Consolidated Statutory Composite Ratio 107.2 % 103.6 % 104.6 % 103.4 % 103.6 %
========== =========== ========== ========== =================
The Company's domestic statutory composite ratios for the 1998 third quarter and
nine month period were 105.9% and 103.8%, respectively, compared to 103.0% and
102.8% for the comparable 1997 periods. The 1998 third quarter and nine month
domestic statutory composite ratios reflect approximately 5.1 percentage points
and 1.7 percentage points, respectively, related to property catastrophes. The
statutory composite ratio for NAC Reinsurance International Limited was 120.6
percent and 112.6 percent for the third quarter and nine month period,
respectively, compared to 111.2 percent and 110.1 percent for the same prior
year periods. The 1998 third quarter and nine month statutory composite ratio
for NAC Reinsurance International reflects approximately 10.3 percentage points
and 3.3 percentage points, respectively, attributable to Hurricane Georges.
The Company experienced net favorable claim development for business written
since 1986. 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. The favorable development in more recent underwriting
years has offset certain unfavorable development on business written prior to
1986, including asbestos and environmental claims.
The pricing of the Company's reinsurance contracts contemplates many factors,
including exposure to claims and the expenses of both the client company and
broker. 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. The 1998 third
quarter commission and brokerage ratio reflected a slight increase from prior
year, principally due to the effect of the reinstatement premium charge on the
Company's retrocessional programs resulting from third quarter property
catastrophe claims. The Company's domestic commission and brokerage ratio for
the 1998 nine month period reflects a decrease compared to the 1997 comparable
period, principally due to the effects of certain contractual provisions which
adjust commission expense based on claim experience.
The statutory underwriting expense ratio was 10.9% for both the 1998 third
quarter and nine month period, compared to 1997 ratios of 9.5% and 9.7%. The
increase in the underwriting expense ratios is reflective of the continuing
business expansion and investments in technology coupled with lower premium
volume. The Company continues to seek measures to contain operating expenses
that are not central to its underwriting activities and to better utilize its
resources.
12
Investments
Cash and invested assets at September 30, 1998 and December 31, 1997 were $2.5
billion and $2.3 billion, respectively, excluding net investment payables of
$7.6 million and $25.8 million for 1998 and 1997, respectively.
Net investment income for the 1998 third quarter and nine month period was $33.4
million and $98.1 million, respectively, increases of 4.7% and 8.0%,
respectively, over the 1997 comparable periods. On an after-tax basis, net
investment income for the 1998 third quarter and nine month period was $26.6
million and $78.5 million, or $1.46 and $4.30 per basic share ($1.28 and $3.77
per diluted share), increases of 5.0% and 9.1 % over the comparable 1997
periods. The increase is primarily attributable to the higher invested asset
base. The Company's pretax investment yield was 5.8% for the 1998 nine month
period, compared to 5.9% for the 1997 nine month period. The after-tax
investment yield was 4.6% for the 1998 nine month period, compared to 4.7% for
the 1997 nine month period.
Net investment gains, net of tax for the 1998 third quarter and nine month
period were $6.6 million and $15.1 million, compared to net investment gains of
$3.7 million and $18.8 million for the comparable 1997 periods. 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 September 30, 1998, our
fixed maturity investments amounted to $2.2 billion, which is 87.6% of cash and
invested assets, and 94.4% of such investments are rated investment grade by
Moody's Investor Services, Inc. or Standard & Poor's.
The balance of the Company's investment portfolio at September 30, 1998,
consisting of cash, short-term investments and equity securities, amounted to
$304.2 million. As of September 30, 1998, the Company held $138.9 million or
5.6% of cash and invested assets in equity securities which represented 19.8% of
statutory surplus.
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 claim payments and the
Company's future cash flow projections in evaluating its investment
opportunities.
Liquidity and Capital Resources
- -------------------------------
NAC Re is a holding company and has no revenue producing operations of its own.
Cash flow within NAC Re consists of investment income, operating and interest
expenses, dividends to stockholders, rental income, and dividends and tax
reimbursements from NAC. These dividends from NAC are subject to statutory
restrictions.
The statutory surplus of the reinsurance subsidiary, NAC Reinsurance
Corporation, was $701.2 million at September 30, 1998, which ranks among the
largest domestic reinsurers measured on this basis.
Total assets exceeded $3.0 billion at September 30, 1998. Stockholders' equity
reached $732.9 million or $39.98 per share at September 30, 1998 compared to
$657.1 million or $35.89 per share at December 31, 1997. The unrealized
appreciation of investments, net of tax, which is the principal component of
accumulated other comprehensive income, increased to $66.8 million at September
30, 1998 from $55.0 million at December 31, 1997, principally resulting from
changes in market interest rates.
Cash flow from operations for the 1998 nine month period was $107.3 million,
compared to $288.6 million for the comparable 1997 period. The decline is
primarily attributable to approximately $180 million from
the termination of two retrocessional programs in 1997.
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NAC Re maintains a revolving credit facility under which it can borrow up to
$32.1 million as of September 30, 1998. Outstanding borrowings as of September
30, 1998 were $12.9 million and were principally used to finance the Company's
periodic repurchases of Common Stock. The facility is being reduced by $2.9
million on a quarterly basis as of July 1998. The Company periodically reviews
its credit arrangements for renewal based on its working capital requirements
and other financing needs. As a result, on September 30, 1998, the Company
canceled its $15 million line of credit facility for its reinsurance subsidiary.
During the first nine months of 1998, the Company repurchased over 220,000
shares of common stock at an average cost of $49.54 per share. From the
inception of the program, approximately 3.6 million shares have been repurchased
at an average cost of $27.25 per share. Approximately 436,000 shares remain
authorized for repurchase under the program.
The Company declared a quarterly cash dividend of $.09 per share for the 1998
third quarter. The regular cash dividend was increased to $.09 from $.075 in
June 1998.
Accounting Pronouncement
- ------------------------
In September 1998, The Financial Accounting Standards Board issued Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities", which is
required to be adopted in years beginning after June 15, 1999. The Company does
not anticipate that the adoption of this Statement will have a material effect
on the Company's financial position.
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 Re's
international subsidiary is subject to the regulatory authority of the UK
Insurance Directorate HM Treasury. The international subsidiary's Australian
branch office is also subject to the Australian Insurance and Supervisory
Commission's 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 strength 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, NAC's 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 regulatory and legislative initiatives have been proposed from
time to time that could impact reinsurers. Generally, the thrust of regulatory
efforts has been to improve the solvency of reinsurers and create incentives for
insurers to do business with well capitalized, prompt paying reinsurers
operating under U.S. jurisdiction. While we cannot quantify the impact of these
regulatory efforts on the Company's operations, we believe the Company is
adequately positioned to compete in an environment of more stringent regulation.
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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 or upgrade with Year 2000-compliant versions before year-end 1999
due to normal business requirements. All other critical systems are being
assessed for Year 2000-related problems, which will be remediated to reduce the
likelihood that they will have a material adverse effect on the Company's
operations or financial condition. As of this disclosure date, the Company has
completed its inventory of all systems (including embedded technology); remedied
the computer code of its legacy reinsurance system; and is currently testing all
critical systems to determine whether they will be affected by the Year 2000
problem and whether any further remediation is necessary. Management has not
identified any hardware or software computer system with a significant Year 2000
compliance problem that is expected to have a materially adverse effect on the
Company's financial condition or results of operations. The remediation,
testing, and implementation process is expected to continue through the end of
the 1999 third quarter.
The Company has contacted its critical customers, retrocessionaires, reinsurance
intermediaries, managing general agents, suppliers, and other constituents to
determine the nature and extent of their Year 2000 compliance efforts and
whether their failure to resolve their own Year 2000 problems would have a
material adverse affect on the Company's financial condition or results of
operations. Because many of the third parties with whom the Company has material
relationships believe that they will be Year 2000 compliant by year-end 1998 or
sometime in 1999, the Company is not yet able to determine with any degree of
confidence whether and when those third parties will actually attain their Year
2000 compliance objectives. The Company intends to resurvey these third parties
in early 1999 in an attempt to confirm their Year 2000 compliance status and
factor this updated information into its contingency plans.
Management is currently revising its existing business recovery plans to address
any material internal or external Year 2000-related failures that may arise. The
Company expects to complete the contingency planning phase of its Year 2000
compliance effort prior to the end of the 1999 third quarter. The Company's
estimated aggregate Year 2000 compliance costs are not expected to exceed $2
million, with a majority of those costs attributable to consulting fees.
Although the Company is attempting, whenever possible, to avoid or otherwise
limit its overall exposure to Year 2000-related risks in the context of both its
assumed business and retrocessional protection, it may still have material
exposure in its property and casualty operations to Year 2000-related claims. It
is not yet possible to determine whether such claims might be made against
insurance or reinsurance contracts in which the Company participates or if such
claims will be held to have merit.
Significant failures of certain essential services including, but not limited
to, the telecommunications, utility, banking, securities, and transportation
industries, due to their own Year 2000 problems are generally beyond the
Company's control and could have a material adverse impact on the Company's
financial condition or results of operations.
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.
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
15
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 Year 2000 compliance 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.
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:
- 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;
- 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;
- The ability of the Company to execute its business strategies;
- 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;
- 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;
- Changes in the Company's retrocessional arrangements;
- 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;
- 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;
- Declines in the value of the Company's common equity investments and
credit losses on the Company's investment portfolio;
- Gains or losses related to foreign currency exchange rate
fluctuations; and
- 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.
16
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index:
Exhibit Description Page
15 Letter Re Unaudited Interim Financial Information 19
27 Financial Data Schedule 20
(b) There were no reports filed on Form 8-K for the quarter ended September 30,
1998.
Omitted from this Part II are items which are inapplicable or to which the
answer is negative for the period covered.
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NAC Re CORP.
------------
(Registrant)
Date: November 11, 1998 NICHOLAS M. BROWN, JR.
----------------------------------------- --------------------------------------
Nicholas M. Brown, Jr.
President and Chief Operating Officer
Date: November 11, 1998 RICHARD H. MILLER
----------------------------------------- --------------------------------------
Richard H. Miller
Vice President, Chief Financial Officer
and Treasurer
18