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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________________to _______________
Commission File Number 1-15259
PXRE GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda 98-0214719
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Swan Building P.O. Box HM 1282
26 Victoria Street Hamilton HM FX
Hamilton HM 12 Bermuda
Bermuda
(Address, including zip code,
of principal executive offices) (Mailing address)
(441) 296-5858
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes X No
------ -----
As of May 5, 2004 14,104,523 common shares, $1.00 par value per share,
of the Registrant were outstanding.
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PXRE GROUP LTD.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003...................................3
Consolidated Statements of Income and Comprehensive Income for the three months ended March
31, 2004 and 2003...............................................................................4
Consolidated Statements of Shareholders' Equity for the three months ended March 31, 2004
and 2003........................................................................................5
Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003.................6
Notes to Consolidated Financial Statements...............................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..............18
Item 3. Quantitative and Qualitative Disclosures About Market Risk.........................................33
Item 4. Controls and Procedures............................................................................34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................................................34
Item 2. Changes in Securities and Use of Proceeds..........................................................35
Item 3. Defaults Upon Senior Securities....................................................................35
Item 4. Submission of Matters to a Vote of Security Holders................................................35
Item 5. Other Information..................................................................................36
Item 6. Exhibits and Reports on Form 8-K...................................................................36
2
PXRE Consolidated Balance Sheets
Group Ltd. (Dollars in thousands, except par value per share)
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March 31, December 31,
2004 2003
---- ----
(Unaudited)
Assets Investments:
Fixed maturities:
Available-for-sale (amortized cost $689,381 and $613,833, respectively) $ 701,068 $ 617,658
Trading (cost $20,370 and $20,370, respectively) 21,541 21,451
Short-term investments 196,363 175,771
Hedge funds (cost $84,338 and $87,691, respectively) 119,869 121,466
Other invested assets (cost $8,583 and $9,365, respectively) 9,274 10,173
------------- -----------
Total investments 1,048,115 946,519
Cash 17,812 65,808
Accrued investment income 6,560 5,490
Premiums receivable, net 72,409 79,501
Other receivables 30,103 30,695
Reinsurance recoverable on paid losses 15,956 15,494
Reinsurance recoverable on unpaid losses 134,873 146,924
Ceded unearned premiums 14,942 10,454
Deferred acquisition costs 2,529 2,495
Income tax recoverable 14,728 14,133
Other assets 57,543 42,134
------------- -----------
Total assets $ 1,415,570 $ 1,359,647
============= ===========
Liabilities Losses and loss expenses $ 436,680 $ 450,635
Unearned premiums 46,626 21,566
Subordinated debt 167,070 -
Reinsurance balances payable 48,473 53,373
Deposit liabilities 75,808 80,583
Other liabilities 27,931 32,133
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Total liabilities 802,588 638,290
------------- -----------
Minority interest in consolidated subsidiaries:
Company-obligated mandatorily redeemable capital trust
pass-through securities of subsidiary trusts holding solely a
company-guaranteed related subordinated debt - 156,841
------------- -----------
Shareholders' Serial convertible preferred shares, $1.00 par value, $10,000 stated
Equity value -- 10 million shares authorized, 0.02 million shares
issued and outstanding 175,634 172,190
Common shares, $1.00 par value -- 50 million shares
authorized, 14.1 million and 13.3 million shares issued
and outstanding, respectively 14,101 13,277
Additional paid-in capital 209,717 192,078
Accumulated other comprehensive income net of deferred income
tax expense of $2,242 and $1,242, respectively 7,215 1,692
Retained earnings 215,322 188,670
Restricted shares at cost (0.4 million and 0.3 million shares, respectively) (9,007) (3,391)
-------------- -----------
Total shareholders' equity 612,982 564,516
-------------- -----------
Total liabilities and shareholders' equity $ 1,415,570 $ 1,359,647
============== ===========
The accompanying notes are an integral part of these statements.
3
XRE Consolidated Statements of Income and Comprehensive Income
Group Ltd. (Dollars in thousands, except per share amounts)
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Three Months Ended
March 31,
2004 2003
---- ----
(Unaudited)
Revenues Net premiums earned $ 68,952 $ 84,772
Net investment income 6,869 5,475
Net realized investment gains (losses) 89 (1)
Fee income 599 1,276
-------------- ------------
76,509 91,522
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Losses and Losses and loss expenses incurred 18,139 32,599
Expenses Commissions and brokerage 9,172 20,027
Operating expenses 12,620 9,176
Foreign exchange losses 266 241
Interest expense 3,675 2,259
Minority interest in consolidated subsidiaries - 2,106
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43,872 66,408
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Income before income taxes and cumulative effect of
accounting change 32,637 25,114
Income tax provision 653 1,507
-------------- ------------
Income before cumulative effect of accounting change and
convertible preferred share dividends 31,984 23,607
Cumulative effect of accounting change, net of $0.2 million tax expense (1,053) -
-------------- ------------
Net income before convertible preferred share dividends $ 30,931 $ 23,607
-------------- ------------
Convertible preferred share dividends 3,444 3,182
-------------- ------------
Net income available to common shareholders $ 27,487 $ 20,425
============== ============
Comprehensive Net income before convertible preferred share dividends $ 30,931 $ 23,607
Income, Net Net unrealized appreciation on investments 4,550 111
of Tax Cumulative effect of accounting change 973 -
Net unrealized appreciation on cash flow hedge - 945
-------------- ------------
Comprehensive income $ 36,454 $ 24,663
============== ============
Per Share Basic:
Income before cumulative effect of accounting change and
convertible preferred share dividends $ 2.38 $ 1.98
Cumulative effect of accounting change (0.08) -
Convertible preferred share dividends (0.26) (0.27)
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Net income available to common shareholders $ 2.04 $ 1.71
============== ============
Average shares outstanding (000's) 13,417 11,894
============== ============
Diluted:
Income before cumulative effect of accounting change $ 1.22 $ 1.04
Cumulative effect of accounting change (0.04) -
-------------- ------------
Net income $ 1.18 $ 1.04
============== ============
Average shares outstanding (000's) 26,282 22,664
============== ============
The accompanying notes are an integral part of these statements.
4
PXRE Consolidated Statements of Shareholders' Equity
Group Ltd. (Dollars in thousands)
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Three Months Ended
March 31,
2004 2003
---- ----
(Unaudited)
Convertible Balance at beginning of period $ 172,190 $ 159,077
Preferred Shares Dividends to convertible preferred shareholders 3,444 3,182
-------------- ------------
Balance at end of period $ 175,634 $ 162,259
============== ============
Common Shares Balance at beginning of period $ 13,277 $ 12,030
Issuance of shares, net 824 147
-------------- ------------
Balance at end of period $ 14,101 $ 12,177
============== ============
Additional Balance at beginning of period $ 192,078 $ 168,866
Paid-in Capital Issuance of shares 16,883 3,341
Other 756 64
-------------- ------------
Balance at end of period $ 209,717 $ 172,271
============== ============
Accumulated Balance at beginning of period $ 1,692 $ 7,142
Other Change in unrealized gains 5,523 111
Comprehensive Change in cash flow hedge - 945
Income -------------- ------------
Balance at end of period $ 7,215 $ 8,198
============== ============
Retained Balance at beginning of period $ 188,670 $ 108,062
Earnings Net income before convertible preferred share dividends 30,931 23,607
Dividends to convertible preferred shareholders (3,444) (3,182)
Dividends to common shareholders (835) (732)
-------------- ------------
Balance at end of period $ 215,322 $ 127,755
============== ============
Restricted Shares Balance at beginning of period $ (3,391) $ (1,713)
Issuance of restricted shares (6,966) (3,845)
Amortization of restricted shares 1,350 776
-------------- ------------
Balance at end of period $ (9,007) $ (4,782)
============== ============
Total Balance at beginning of period $ 564,516 $ 453,464
Shareholders' Issuance of shares 17,707 3,488
Equity Restricted shares, net (5,616) (3,069)
Unrealized appreciation on investments, net of deferred
income tax 5,523 111
Unrealized appreciation on cash flow hedge, net of deferred
income tax - 945
Net income before convertible preferred share dividends 30,931 23,607
Dividends to common shareholders (835) (732)
Other 756 64
-------------- ------------
Balance at end of period $ 612,982 $ 477,878
============== ============
The accompanying notes are an integral part of these statements.
5
PXRE Consolidated Statements of Cash Flows
Group Ltd. (Dollars in thousands)
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Three Months Ended
March 31,
2004 2003
---- ----
(Unaudited)
Cash Flow Premiums collected, net of reinsurance $ 91,716 $ 96,665
from Operating Loss and loss adjustment expenses paid, net of reinsurance (20,505) (9,620)
Activities Commission and brokerage paid, net of fee income (8,613) (12,476)
Operating expenses paid (13,096) (10,661)
Net investment income received 2,908 3,376
Interest paid (5,796) (4,749)
Income taxes paid (1,252) (3,523)
Trading portfolio purchased - (5,688)
Deposit (paid) received (4,775) 30,937
Other (11,317) (8,342)
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Net cash provided by operating activities 29,270 75,919
------------ -----------
Cash Flow Fixed maturities available for sale purchased (174,949) (3,814)
from Investing Fixed maturities available for sale disposed or matured 102,470 35,162
Activities Hedge funds purchased - (4,000)
Hedge funds disposed 5,028 7,835
Other invested assets purchased - (100)
Other invested assets disposed 891 374
Net change in short-term investments (20,592) (84,475)
Payable for securities (18) 233
------------ -----------
Net cash used by investing activities (87,170) (48,785)
------------ -----------
Cash Flow Proceeds from issuance of common shares 11,382 286
from Financing Cash dividends paid to common shareholders (835) (732)
Activities Repayment of debt - (20,000)
Cost of shares repurchased (643) (642)
------------ -----------
Net cash provided (used) by financing activities 9,904 (21,088)
------------ -----------
Net change in cash (47,996) 6,046
Cash, beginning of period 65,808 46,630
------------ -----------
Cash, end of period $ 17,812 $ 52,676
============ ===========
Reconciliation of net income to net cash provided by
operating activities:
Net income before convertible preferred share dividends $ 30,931 $ 23,607
Adjustments to reconcile net income to net cash
provided by operating activities:
Losses and loss expenses (13,955) (10,217)
Unearned premiums 20,572 8,572
Deferred acquisition costs (34) 7,073
Receivables 7,685 (1,645)
Reinsurance balances payable (4,900) (4,495)
Reinsurance recoverable 11,590 33,451
Income taxes (610) (2,015)
Equity in earnings of limited partnerships (3,424) (2,377)
Trading portfolio purchased - (5,688)
Deposit liability (4,775) 30,937
Other (13,810) (1,284)
------------ -----------
Net cash provided by operating activities $ 29,270 $ 75,919
============ ===========
The accompanying notes are an integral part of these statements.
6
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
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1. Organization
PXRE Group Ltd. (the "Company" or collectively with its subsidiaries,
"PXRE") is an insurance holding company domiciled in Bermuda. The Company
provides reinsurance products and services to a worldwide marketplace through
subsidiary operations in Bermuda, Barbados, Europe and the United States. The
Company's primary focus is providing property catastrophe reinsurance and
retrocessional coverage. PXRE also provides marine, aviation and aerospace
products and services.
The Company was formed in 1999 as part of the reorganization of PXRE
Delaware, a Delaware corporation ("PXRE Delaware"). Prior to the reorganization,
PXRE Delaware was the ultimate parent holding company of the various PXRE
companies and its common shares were publicly traded on the New York Stock
Exchange. As a result of the reorganization, the Company became the ultimate
parent holding company of PXRE Delaware and the holders of PXRE Delaware common
stock automatically became holders of the same number of the Company's common
shares. The reorganization was consummated at the close of business on October
5, 1999 and, on October 6, 1999, the Company's common shares commenced trading
on the New York Stock Exchange under the symbol "PXT." The reorganization also
involved the establishment of a Bermuda based reinsurance subsidiary, PXRE
Reinsurance Ltd. ("PXRE Bermuda"), and a Barbados based reinsurance subsidiary,
PXRE Reinsurance (Barbados) Ltd. ("PXRE Barbados") and the formation of a
reinsurance intermediary, PXRE Solutions, Inc. ("PXRE Solutions").
2. Significant Accounting Policies
Basis of Presentation and Consolidation
The consolidated financial statements have been prepared in U.S.
dollars in conformity with accounting principles generally accepted ("GAAP") in
the United States of America. These statements reflect the consolidated
operations of the Company and its wholly owned subsidiaries, including PXRE
Delaware, PXRE Reinsurance Company ("PXRE Reinsurance"), PXRE Bermuda, PXRE
Barbados, PXRE Solutions, PXRE Solutions, S.A. ("PXRE Europe") and PXRE Limited.
All material inter-company transactions have been eliminated in preparing these
consolidated financial statements.
GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
The interim consolidated financial statements are unaudited; however,
in the opinion of management, such consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair statement of the results for the interim periods. These interim statements
should be read in conjunction with the 2003 audited consolidated financial
statements and related notes. The preparation of interim consolidated financial
statements relies significantly upon estimates. Use of such estimates, and the
seasonal nature of the reinsurance business, necessitate caution in drawing
specific conclusions from interim results.
7
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
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Certain reclassifications have been made for 2003 to conform to the
2004 presentation.
Share-Based Compensation
At March 31, 2004, PXRE has share option plans, which are accounted for
under the recognition and measurement principles of the Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related
Interpretations. No share-based compensation cost is reflected in net income, as
all options granted under those plans had an exercise price equal to the market
value of the underlying common shares on the date of grant. The following table
illustrates the effect on net income and earnings per share if PXRE had applied
the fair value recognition provisions of the Financial Accounting Standards
Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation" to share-based employee compensation.
($000's, except per share data) Three Months Ended March 31,
- ------------------------------- ----------------------------------
2004 2003
-------------- -------------
Net income before convertible preferred share dividends:
As reported $ 30,931 $ 23,607
Deduct:
Total share-based compensation expense determined under fair value
based method for all awards, net of related tax effects (971) (562)
--------------- -------------
Pro-forma $ 29,960 $ 23,045
=============== =============
Basic income per share:
As reported $ 2.04 $ 1.71
Pro-forma $ 1.98 $ 1.67
Diluted income per share:
As reported $ 1.18 $ 1.04
Pro-forma $ 1.14 $ 1.02
Debt and Equity Classification
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within the scope of the statement as a liability or an asset in some
circumstances. PXRE adopted this statement during the quarter ended September
30, 2003, however, due to certain parts of this statement being deferred by the
FASB, the adoption of this statement did not have any impact on the Company's
Consolidated Financial Statements, financial position or results of operations
until the quarter ended March 31, 2004. Accordingly, during the quarter, the
Company's mandatorily redeemable capital trust pass-through securities were
reclassified on its Consolidated Balance Sheet to liabilities and entitled
"Subordinated debt." In the Company's Consolidated Statements of Income and
Comprehensive Income for the quarter ended March 31, 2004, the interest expense
related to these securities was included with "Interest expense." SFAS 150 did
not require that these changes be made retroactively.
8
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
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Consolidation of Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), which requires
consolidation of all "Variable Interest Entities" ("VIEs") by the "primary
beneficiary," as these terms are defined in FIN 46, and on October 9, 2003 the
FASB issued FASB Staff Position FIN 46-6, "Effective Date of FASB Interpretation
No. 46, Consolidation of VIE's", which required PXRE to implement FIN 46 during
the quarter ended March 31, 2004. The adoption of this statement resulted in
PXRE deconsolidating the five special purpose trusts which issued the Company's
trust preferred securities. As a result, the subordinated loans from the trusts
are reflected as liabilities under the caption "Subordinated debt" on the
Company's March 31, 2004 Consolidated Balance Sheet, while PXRE's minority
investments of approximately $5.2 million in such trusts in the form of equity,
which prior to March 31, 2004 were eliminated on consolidation, are reflected as
assets under the caption "Other assets" with a corresponding increase in
liabilities under the caption "Subordinated debt". FIN 46 did not require that
these changes be made retroactively. In addition, gains on the repurchase of
$5.2 million of the Company's trust preferred securities in prior periods of
$1.1 million, net of tax, that were previously accounted for as extinguishments
of debt, were reversed in the quarter and presented as a cumulative effect of an
accounting change in the Company's Consolidated Statement of Income and
Comprehensive Income for the quarter ended March 31, 2004. These repurchased
securities are reflected in the Company's March 31, 2004 Consolidated Balance
Sheet under the caption "Fixed Maturities: Available-for-sale."
Consolidated Statement of Changes in Cash Flow
In the first quarter of 2004, the Company changed the presentation of
its Consolidated Statement of Changes in Cash Flow to the direct cash flow
method, replacing the indirect cash flow method as previously presented. Amounts
presented for the period ended March 31, 2003 were reclassified to be consistent
with the new presentation.
3. Underwriting
Premiums written and earned for the quarters ended March 31, 2004 and
2003 are as follows:
Three Months Ended March 31,
------------------------------- % Increase
($000's) 2004 2003 (Decrease)
------------ ----------- ----------
Premiums written
Gross premiums written $ 107,403 $ 112,470
Ceded premiums written (17,691) (19,126)
------------ -----------
Net premiums written $ 89,712 $ 93,344 (4)
============ ===========
Premiums earned
Gross premiums earned $ 82,156 $ 98,362
Ceded premiums earned (13,204) (13,590)
------------ -----------
Net premiums earned $ 68,952 $ 84,772 (19)
============ ===========
9
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
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PXRE from time to time purchases catastrophe retrocessional coverage
for its own protection, depending on market conditions. PXRE purchases
reinsurance primarily to reduce its exposure to severe losses related to any one
event or catastrophe. PXRE currently has reinsurance treaties in place with
several different coverages, territories, limits and retentions that serve to
reduce a large gross loss emanating from any one event. In addition, primarily
related to the Company's exposure assumed on per-risk treaties, the Company
purchases clash reinsurance protection which allows the Company to recover
losses ceded by more than one reinsured related to any one particular property.
In the event that retrocessionaires are unable to meet their contractual
obligations, PXRE would remain liable for the underlying covered claims.
4. Earnings Per Share
The table below presents the computation of basic and diluted earnings
per share:
Three Months Ended March 31,
-----------------------------
($000's, except per share data) 2004 2003
----------- ----------
Net income available to common shareholders:
Income before cumulative effect of accounting change and
convertible preferred share dividends $ 31,984 $ 23,607
Cumulative effect of accounting change, net of tax (1,053) -
----------- ----------
Net income before convertible preferred share dividends 30,931 23,607
Convertible preferred share dividends (3,444) (3,182)
----------- ----------
Net income available to common shareholders $ 27,487 $ 20,425
=========== ==========
Weighted average common shares outstanding:
Weighted average common share outstanding (basic) 13,417 11,894
Equivalent shares of underlying options 559 320
Equivalent number of restricted shares 83 76
Equivalent number of convertible preferred shares 12,223 10,374
----------- ----------
Weighted average common equivalent shares (diluted) 26,282 22,664
=========== ==========
Per share amounts:
Basic:
Income before cumulative effect of accounting change and
convertible preferred share dividends $ 2.38 $ 1.98
Cumulative effect of accounting change (0.08) -
Convertible preferred share dividends (0.26) (0.27)
----------- ----------
Net income available to common shareholders $ 2.04 $ 1.71
=========== ==========
Diluted:
Net income before cumulative effect of accounting change $ 1.22 $ 1.04
Cumulative effect of accounting change (0.04) -
----------- ----------
Net income $ 1.18 $ 1.04
=========== ==========
5. Income Taxes
The Company is incorporated under the laws of Bermuda and, under
current Bermuda law, is not obligated to pay any taxes in Bermuda based upon
income or capital gains. The Company has received an undertaking from the
Supervisor of Insurance in Bermuda pursuant to the provisions of the Exempted
Undertakings Tax Protection Act, 1966, which exempts the Company from any
Bermuda taxes computed on profits, income or any capital asset, gain or
appreciation, or any tax in the nature of estate duty or inheritance tax, at
least until the year 2016.
10
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- ----------------------------------------------------------------------
The Company does not consider itself to be engaged in a trade or
business in the United States and, accordingly, does not expect to be subject to
direct United States income taxation.
The United States subsidiaries of the Company file a consolidated U.S.
federal income tax return.
6. Shareholders' Equity
On December 16, 2003, the Company completed a public offering of 2.2
million of its common shares at $21.75 per share, pursuant to a Shelf
Registration Statement on Form S-3 that was filed in 2003 for up to $150.0
million of various types of securities. Of the 2.2 million shares sold, 1.1
million were offered by PXRE and 1.1 million were offered by Phoenix Life
Insurance Company ("Phoenix"), one of the Company's common shareholders. The
underwriters were given an option to purchase up to an additional 0.3 million
common shares from the Company, which they exercised on January 22, 2004. As a
result of the offering and the exercise of the option, the Company received
total net proceeds of approximately $26.9 million. The Company did not receive
any of the proceeds from the sale of shares by Phoenix.
On April 4, 2002, the Company issued $150.0 million of additional
capital comprised of 15,000 convertible voting preferred shares in a private
placement not involving a public offering under Section 4(2) of the Securities
Act of 1933, as amended. The convertible preferred share investment occurred
pursuant to a share purchase agreement, dated as of December 10, 2001, between
the Company and certain investors. On February 12, 2002, the shareholders
approved the sale and issuance of three series of convertible preferred shares
pursuant to the share purchase agreement, including 7,500 Series A convertible
preferred shares, 5,000 Series B convertible preferred shares, and 2,500 Series
C convertible preferred shares. Proceeds of the offering of the convertible
preferred shares, net of offering expenses of $9.1 million, amounted to $140.9
million. As of March 31, 2004, 17,563 convertible preferred shares were issued
and outstanding.
The convertible preferred shares accrue cumulative dividends per share
at the rate per annum of 8% of the sum of the stated value of each share plus
any accrued and unpaid dividend thereon payable on a quarterly basis. The
shareholders also voted to approve the division of 20.0 million of PXRE's 50.0
million authorized common shares into three new classes of convertible common
shares including 10.0 million Class A convertible voting common shares, 6.7
million Class B convertible voting common shares, and 3.3 million Class C
convertible voting common shares. No convertible voting common shares of any
class are currently outstanding.
Convertible preferred shares are convertible into convertible common
shares at the option of the holder at any time at a conversion price equal to
the original conversion price, subject to adjustment if PXRE experiences adverse
development in excess of a $7.0 million after-tax threshold. The number of
convertible common shares issued upon the conversion of each convertible
preferred share would be equal to the sum of the original purchase price
($10,000) of such convertible preferred share plus accrued but unpaid dividends
divided by the adjusted conversion price. Certain adverse development, excluding
that related to most of the adverse development on loss reserves within the
exited lines segment and all of the losses arising from the events of September
11, 2001, is subject to a cap of $12.0 million after-tax. Adverse development on
the reserves excluded is not subject to any cap or limit. As of March 31, 2004,
after giving effect to the $12.0 million cap referred to above, PXRE has
incurred $24.9 million of net after-tax adverse development above this $7.0
million threshold, resulting in an adjusted conversion price of $14.01.
Two-thirds of the convertible preferred shares mandatorily convert by April 4,
2005, and the balance by April 4, 2008. Convertible preferred shares vote on a
fully converted basis on all matters brought before the shareholders other than
the election of directors.
11
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- ----------------------------------------------------------------------
7. Segment Information
PXRE operates in three reportable property and casualty segments -
catastrophe and risk excess, finite and exited lines - based on PXRE's approach
to managing the business. Commencing with the 2002 underwriting renewal season,
PXRE returned its focus to its core property catastrophe and risk excess
business. Businesses that were not renewed in 2002 are reported as exited lines.
Commencing with the 2004 underwriting renewal season, PXRE is reporting its
previously existing "other lines" segment, which in the past has consisted of a
single pro rata treaty, with its catastrophe and risk excess segment. PXRE's
segments for 2003 were reclassified to be comparable to the three 2004 segments
discussed above. In addition, PXRE operates in two geographic segments - North
American, representing North American based risks written by North American
based clients, and International (principally the United Kingdom, Continental
Europe, Latin America, the Caribbean, Australia and Asia), representing all
other premiums written.
There are no significant differences among the accounting policies of
the segments as compared to PXRE's consolidated financial statements.
PXRE does not maintain separate balance sheet data for each of its
operating segments nor does it allocate net investment income, net realized
investment gains or losses, operating expenses, foreign exchange gains or losses
and financing costs to these segments. Accordingly, PXRE does not review and
evaluate the financial results of its operating segments based upon balance
sheet data and these other income statement items.
The following tables summarize the net premiums written and net
premiums earned by PXRE's business segments. The amounts shown for the North
American and International geographic segments are presented net of proportional
reinsurance but gross of corporate catastrophe excess of loss reinsurance
cessions, which are separately itemized where applicable.
12
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- ----------------------------------------------------------------------
Net Premiums Written
Three Months Ended March 31,
---------------------------------------------------------
($000's, except percentages) 2004 2003
--------------------------- --------------------------
Amount Percent Amount Percent
-------------- ------- -------------- -------
Catastrophe and Risk Excess
North American $ 20,678 $ 18,420
International 83,184 78,979
Excess of Loss Cessions (15,021) (8,088)
-------------- -------------
88,841 99% 89,311 96%
-------------- -------------
Finite Business
North American 769 2,362
International - -
-------------- -------------
769 1 2,362 2
-------------- -------------
Exited Lines
North American 37 297
International 65 1,374
-------------- -------------
102 - 1,671 2
-------------- ------ ------------- -----
Total $ 89,712 100% $ 93,344 100%
============= ====== ============= =====
Net Premiums Earned
Three Months Ended March 31,
---------------------------------------------------------
($000's, except percentages) 2004 2003
--------------------------- --------------------------
Amount Percent Amount Percent
-------------- ------- -------------- -------
Catastrophe and Risk Excess
North American $ 18,189 $ 15,925
International 57,837 52,158
Excess of Loss Cessions (9,830) (6,384)
-------------- -------------
66,196 96% 61,699 72%
-------------- -------------
Finite Business
North American 2,540 20,850
International - -
-------------- -------------
2,540 4 20,850 25
-------------- -------------
Exited Lines
North American 151 795
International 65 1,428
-------------- -------------
216 - 2,223 3
-------------- ------ ------------- -----
Total $ 68,952 100% $ 84,772 100%
============= ====== ============= =====
13
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- ----------------------------------------------------------------------
The following table summarizes the underwriting income (loss) by
segment. The amounts shown in the North American and International geographic
segments are presented net of proportional reinsurance but gross of corporate
catastrophe excess of loss reinsurance cessions, which are separately itemized
where applicable. Underwriting income (loss) includes premiums earned, losses
incurred and commission and brokerage, net of fee income, but does not include
investment income, net realized investment gains or losses, interest expense,
operating expenses or foreign exchange gains or losses.
Underwriting Income (Loss)
Three Months Ended March 31,
---------------------------------------------------------
($000's, except percentages) 2004 2003
--------------------------- --------------------------
Amount Percent Amount Percent
-------------- ------- -------------- -------
Catastrophe and Risk Excess
North American $ 14,999 $ 11,650
International 36,510 40,829
Excess of Loss Cessions (9,471) (9,978)
------------- ---------------
42,038 100% 42,501 127%
------------- ---------------
Finite Business
North American (5) (2,925)
International - -
------------- ---------------
(5) - (2,925) (9)
------------- ---------------
Exited Lines
North American (2,207) (2,699)
International 2,414 (3,435)
------------- ---------------
207 - (6,134) (18)
------------- ------ --------------- -----
Total $ 42,240 100% $ 33,442 100%
============= ====== ================ =====
14
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- ----------------------------------------------------------------------
The following table reconciles the net underwriting income for the
operating segments to income before income taxes and cumulative effect of
accounting change as reported in the Consolidated Statements of Income and
Comprehensive Income.
($000's) Three Months Ended March 31,
-----------------------------------
2004 2003
--------------- ---------------
Net underwriting income $ 42,240 $ 33,442
Net investment income 6,869 5,475
Net realized investment gains (losses) 89 (1)
Interest expense (3,675) (2,259)
Minority interest in consolidated subsidiaries - (2,106)
Other operating expenses (12,620) (9,176)
Foreign exchange losses (266) (241)
Other - (20)
--------------- ---------------
Income before income taxes and cumulative effect of
accounting change $ 32,637 $ 25,114
=============== ===============
8. Subordinated Debt
Trust preferred securities were previously shown as minority interest
in consolidated subsidiaries. Trust preferred securities are mandatorily
redeemable subordinated debt securities issued to separate special purpose
trusts holding solely those securities. As discussed in Note 2, following the
implementation of FIN 46 during the quarter ended March 31, 2004, these trusts
are no longer consolidated and the securities issued to these trusts by the
Company (rather than the securities issued by the trusts as was done previously)
are now classified as liabilities on the Company's March 31, 2004 Consolidated
Balance Sheet. The subordinated debt securities are as follows:
March 31, December 31,
2004 2003
($000's) ---------------- ---------------
$103.1 million 8.85% fixed rate due February 1, 2027 $ 102,635 $ 94,341
$18.0 million 7.35% fixed/floating rate due May 15, 2033 18,042 17,500
$15.5 million 9.75% fixed rate due May 23, 2033 15,464 15,000
$20.6 million 7.70% fixed/floating rate due October 29, 2033 20,619 20,000
$10.3 million 7.58% fixed/floating rate due September 30, 2033 10,310 10,000
($000's) ---------------- ---------------
$ 167,070 $ 156,841
================ ==============
The 8.85% fixed rate capital trust pass-through securities pay interest
semi-annually and are redeemable by PXRE from February 1, 2007 at 104.180%
declining to 100.418% at February 1, 2016, and at par thereafter. The 7.35%
fixed/floating rate capital trust pass-through securities initially pay interest
quarterly at a fixed rate of 7.35% for 5 years and then at a floating rate of 3
month LIBOR plus 4.1% reset quarterly thereafter, and are redeemable by PXRE at
par on or after May 15, 2008. The 9.75% fixed rate capital trust pass-through
securities pay interest quarterly and are redeemable by PXRE from May 23, 2008
at 104.875% declining to 100.975% at May 23, 2013, and at par thereafter. The
7.70% fixed/floating rate capital trust pass-through securities initially pay
interest quarterly at a rate of 7.70% for 5 years and then at a floating rate of
3 month LIBOR plus 3.85% reset quarterly thereafter, and are redeemable by PXRE
at par on or after October 29, 2008. The 7.58% fixed/floating rate capital trust
pass-through securities initially pay interest quarterly at a rate of 7.58% for
5 years and then at a floating rate of 3 month LIBOR plus 3.90% reset quarterly
thereafter, and are redeemable by PXRE at par on or after September 30, 2008.
15
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- ----------------------------------------------------------------------
PXRE has the option to defer interest payments on the capital trust
pass-through securities and redeem them earlier than the due dates, subject to
limits and penalties as set out in the relevant indentures.
9. Employee Benefits
The qualified and non-qualified defined benefit pension plans were
curtailed effective March 31, 2004.
The components of net pension expense for these company-sponsored plans
are as follows:
($000's) Three Months Ended March 31,
-------- ------------------------------------
2004 2003
------------- -------------
Components of net periodic cost:
Service cost $ 303 $ 245
Interest cost 136 139
Expected return on assets (103) (107)
Amortization of prior service costs 68 50
Recognized net actuarial costs - (11)
Settlement - 149
Curtailment (486) -
------------- -------------
Net periodic benefit costs $ (82) $ 465
============= =============
During the first quarter of 2004, the Company made no contributions to
its pension plans and expects no significant contributions during 2004.
10. Contingencies
In April 2000, PXRE Reinsurance entered into an aggregate excess of
loss retrocessional reinsurance agreement with a U.S. based cedent. In the
agreement, PXRE Reinsurance reinsured a portfolio of treaties underwritten by a
former business unit of the cedent, which had been divested. Pursuant to this
excess of loss retrocessional agreement, PXRE Reinsurance agreed to indemnify
the cedent for losses in excess of a 75% paid loss ratio on this underlying
portfolio of treaties up to a 100% paid loss ratio, subject to an aggregate
limit of liability of $50.0 million. The latest loss reports related to the
agreement provided by the cedent forecast an ultimate net loss ratio in excess
of 100%, which could result in a full limit loss to PXRE.
In June 2003, PXRE Reinsurance performed an audit of this portfolio of
treaties reinsured under the agreement. As a result of this audit, management
identified problems and believes that the cedent breached its contractual
obligations and fiduciary duties under the agreement. PXRE Reinsurance therefore
filed suit against the cedent on July 24, 2003 in a United Stated District Court
seeking rescission of the agreement and/or compensatory and punitive damages.
16
PXRE Group Ltd. Notes to Consolidated Financial Statements (Unaudited)
- ----------------------------------------------------------------------
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to vigorously prosecute its suit. As of March 31, 2004, the Company
has recorded $34.7 million of loss reserves related to the agreement. If the
Company's lawsuit is unsuccessful, the Company could potentially incur
additional losses under the agreement of up to $10.0 million on an after-tax
basis.
17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
Unless the context otherwise requires, references in this Form 10-Q to
the "Company" refer to PXRE Group Ltd. a Bermuda holding company, while "PXRE",
"we", "us" and "our" include PXRE Group Ltd. and its subsidiaries, which
principally include PXRE Corporation ("PXRE Delaware"), PXRE Reinsurance Company
("PXRE Reinsurance"), PXRE Reinsurance Ltd. ("PXRE Bermuda"), PXRE Reinsurance
(Barbados) Ltd. ("PXRE Barbados"), PXRE Solutions Inc. ("PXRE Solutions"), PXRE
Solutions, S.A. ("PXRE Europe") and PXRE Limited. References to GAAP refer to
accounting principles generally accepted in the United States ("GAAP").
References to SAP refer to statutory accounting principles ("SAP") in either the
State of Connecticut where PXRE Reinsurance is domiciled or Bermuda where PXRE
Bermuda is domiciled, as applicable.
The following is a discussion and analysis of PXRE's results of
operations for the three months ended March 31, 2004 compared with the three
months ended March 31, 2003, and also a discussion of our financial condition as
of March 31, 2004. This discussion and analysis should be read in conjunction
with the attached unaudited consolidated financial statements and notes thereto
and PXRE's Annual Report on Form 10-K for the year ended December 31, 2003 (the
"10-K"), including the audited consolidated financial statements and notes
thereto, the discussion of Certain Risks and Uncertainties and the discussion of
Critical Accounting Policy Disclosures contained in the 10-K.
Overview
PXRE Group Ltd. is an insurance holding company domiciled in Bermuda.
We provide reinsurance products and services to a worldwide marketplace through
our wholly owned subsidiary operations located in Bermuda, Barbados, Europe and
the United States. Our primary business is catastrophe and risk excess
reinsurance, which accounted for 99% of net premiums written and substantially
all of our underwriting income for the three months ended March 31, 2004. Our
catastrophe and risk excess business includes property catastrophe excess of
loss, property catastrophe retrocessional, property risk excess, marine excess
and aerospace excess and pro rata reinsurance products. We also provide, to a
lesser extent and on an opportunistic basis, finite reinsurance products to a
small number of clients.
We generated net income of $30.9 million in the quarter ended March 31,
2004, which represented a 31% increase over the $23.6 million net income
generated in the first quarter of 2003. This strong increase in net income was
primarily driven by the continued strength of our core catastrophe and risk
excess segment, the low level of catastrophe losses during the quarter and the
favorable run-off of our exited lines businesses.
Our ability and willingness to generate significant premium growth is
highly dependent upon the premium pricing levels in the reinsurance market.
Pricing in our catastrophe and risk excess business was healthy during the first
quarter of 2004 following the significant rate increases experienced in 2002 and
2003. During the first quarter of 2004, pricing was generally flat to up
slightly in our North America property catastrophe and world-wide retrocessional
businesses. We experienced modest single digit rate decreases in our
international property catastrophe business.
18
Comparison of First quarter Results for 2004 with 2003
For the quarter ended March 31, 2004, net income before convertible
preferred share dividends increased by 31% to $30.9 million compared to net
income before convertible preferred share dividends of $23.6 million for the
comparable period of 2003. Net income per diluted common share was $1.18 for the
first quarter of 2004 compared to $1.04 for the first quarter of 2003, based on
diluted average shares outstanding of approximately 26.3 million in the first
quarter of 2004 and 22.7 million in the first quarter of 2003.
Premiums
Gross and net premiums written for the first quarter of 2004 and 2003
were as follows:
($000's) Three Months Ended March 31,
--------------------------------- % Increase
2004 2003 (Decrease)
------------- -------------- ----------
Gross premiums written $ 107,403 $ 112,470 (5)
Ceded premiums written (17,691) (19,126) (8)
------------- --------------
Net premiums written $ 89,712 $ 93,344 (4)
============= ==============
Gross premiums written for the first quarter of 2004 decreased 5% to
$107.4 million from $112.5 million in the first quarter of 2003. This decrease
in gross premiums written is due, in part, to a planned decrease in our finite
segment of $1.0 million, or 57%, compared to the year earlier period and a
decrease in our exited lines segment of $1.8 million, or 85%, compared to the
year earlier period. Gross premiums written in our core catastrophe and risk
excess segment decreased $2.3 million, or 2%, compared to the corresponding
period of 2003 due primarily to moderate rate decreases in our international
property catastrophe business.
As part of our efforts to return to our core catastrophe and risk
business, we have intentionally de-emphasized our finite business. This business
is currently focused on a limited group of cedents and on policies that do not
contain significant risk transfer. Finite contracts that do not contain
sufficient risk transfer are not recorded as reinsurance arrangements but are
treated as deposits for accounting purposes. As such, the income related to
these transactions is recorded as fee income, and liabilities, if any, are
recorded as deposit liabilities. As a result, finite premiums are expected to be
less than in prior periods.
Ceded premiums written decreased by 8% to $17.7 million for the first
quarter of 2004 compared to $19.1 million for the first quarter of 2003,
primarily as a result of a decrease of $5.7 million from a quota share cession
to Select Reinsurance Company ("Select Re") in 2003 that was not renewed at
January 1, 2004. Offsetting this decrease was an increase in ceded premiums
written related to excess of loss retrocessional catastrophe treaties.
19
Net premiums written for the first quarter of 2004 decreased 4% to
$89.7 million from $93.3 million in the first quarter of 2003. Net premiums
written in the finite segment decreased $1.6 million, or 67%, while the exited
lines segment decreased $1.6 million, or 94%, during the first quarter of 2004
versus the prior-year comparable quarter due to the same factors that caused the
decrease in gross premiums written as explained above. Net premiums written in
our catastrophe and risk excess segment were $88.8 million in the first quarter
of 2004 compared to $89.3 million in the first quarter of 2003.
Gross and net premiums earned for the first quarter of 2004 and 2003
were as follows:
($000's) Three Months Ended March 31,
--------------------------------- % Increase
2004 2003 (Decrease)
------------- -------------- ----------
Gross premiums earned $ 82,156 $ 98,362 (16)
Ceded premiums earned (13,204) (13,590) (3)
------------ --------------
Net premiums earned $ 68,952 $ 84,772 (19)
============= ==============
Gross premiums earned for the first quarter of 2004 decreased 16% to
$82.2 million from $98.4 million in the first quarter of 2003. This decrease is
primarily due to decreases in our finite segment of $17.8 million, or 87%, and
our exited lines segment of $2.2 million, or 84%, both compared to the
corresponding period of 2003. The changes in these segments are due to the same
factors as those discussed above in gross and net premium written. Offsetting
the decrease in finite and exited lines was an increase in the gross premiums
earned in the catastrophe and risk excess segment of $3.8 million, or 5%,
compared to the corresponding period of 2003. This increase was due primarily to
the continued strong pricing environment as well as the increased participations
and new business acquired during 2002 and 2003.
Ceded premiums earned decreased by 3% to $13.2 million for the first
quarter of 2004 compared to $13.6 million for the first quarter of 2003,
primarily as a result of a decrease of $2.3 million from a quota share cession
to Select Re in 2003 that was not renewed at January 1, 2004. Offsetting this
decrease was an increase in ceded premiums earned related to excess of loss
catastrophe retrocession treaties.
Net premiums earned for the first quarter of 2004 decreased 19% to
$69.0 million from $84.8 million for the corresponding period of 2003. Net
premiums earned in the catastrophe and risk excess segment increased $4.5
million, or 7%, for the first quarter of 2004 as compared to the corresponding
prior-year period. The change in this segment is due to the same factors as
those discussed above in gross premiums earned. Net premiums earned in the
finite segment decreased $18.3 million, or 88%, and net premiums earned in the
exited lines segment decreased $2.0 million, or 90%, for the first quarter of
2004 as compared to the first quarter of 2003. The changes in these segments are
due to the same factors as those discussed above in gross and net premiums
written.
A summary of our net premiums written and earned by business segment
for the three months ended March 31, 2004 and 2003 is included in Note 7 to the
Consolidated Financial Statements.
20
Ratios
The underwriting results of a property and casualty insurer are
discussed frequently by reference to its loss ratio, expense ratio (including
the commission and brokerage ratio, net of fee income, if any, and the operating
expense ratio) and combined ratio. The loss ratio is the result of dividing
losses and loss expenses incurred by net premiums earned. The expense ratio is
the result of dividing underwriting expenses (including commission and
brokerage, net of fee income, if any, and the operating expenses) by net
premiums earned. The combined ratio is the sum of the loss ratio and the expense
ratio. A combined ratio less than 100% indicates underwriting profits and a
combined ratio greater than 100% indicates underwriting losses. The combined
ratio does not reflect the effect of investment income on underwriting results.
The ratios discussed below have been calculated on a GAAP basis.
The following table summarizes the loss ratio, expense ratio and
combined ratio for the quarters ended March 31, 2004 and 2003, respectively:
(%) Three Months Ended March 31,
----------------------------
2004 2003
-------- --------
Loss ratio 26.3 38.5
Expense ratio 30.7 32.9
-------- --------
Combined ratio 57.0 71.4
======== ========
Catastrophe and risk excess loss ratio 25.7 14.7
======== ========
Losses and Loss Expenses
Losses and loss expenses incurred amounted to $18.1 million in the
first quarter of 2004 compared to $32.6 million in the first quarter of 2003.
Our loss ratio was 26.3% for the first quarter of 2004 compared to 38.5% for the
comparable prior-year period. There were no significant catastrophes during the
three months ended March 31, 2004 and 2003. As a result of two property per-risk
losses, the loss ratio in the core catastrophe and risk excess segment increased
to 25.7% for the quarter from 14.7% for the comparable prior-year period.
During the first quarter of 2004, we experienced net favorable
development of $2.3 million for prior-year losses and loss expenses, due
primarily to $2.0 million of favorable development on our core catastrophe and
risk excess segment. During the first quarter of 2003, we experienced net
adverse development of $13.2 million for prior-year loss and loss expenses, $7.6
million of which was due to loss development on our exited lines segment
relating primarily to the 2000 and 2001 underwriting years including adverse
development of $3.3 million primarily caused by larger than expected reported
claims under our direct reinsurance contracts. The remaining exited lines
development was attributable to the late reported credit losses. We also
experienced $3.9 million of adverse loss development on our finite segment
during the first quarter of 2003.
Underwriting Expenses
The expense ratio was 30.7% for the first quarter of 2004 compared to
32.9% during the comparable year-earlier period. The commission and brokerage
ratio, net of fee income, was 12.4% for the first quarter of 2004 compared with
22.1% for the first quarter of 2003. The catastrophe and risk excess commission
and brokerage ratio, net of fee income, was 10.8% for the first quarter of 2004
compared with 16.4% for the first quarter of 2003, primarily due to $4.0 million
of structuring fees related to a reinsurance agreement with P-1 Re Ltd. and the
subsequent commutation thereof in the first quarter of 2003. The finite
commission and brokerage ratio, net of fee income, remained fairly level at
42.9% and 42.5% during the first quarter of 2004 and 2003, respectively. During
2003 however, the $20.9 million of finite net earned premium served to increase
the overall commission and brokerage ratio more so than it did during 2004.
21
The operating expense ratio was 18.3% for the three months ended March
31, 2004 compared with 10.8% for the comparable period of 2003. Other operating
expenses increased 38% to $12.6 million for the three months ended March 31,
2004 from $9.2 million in the comparable period of 2003. This increase is
primarily due to severance expenses, net of a pension gain during the quarter
related to a 10% reduction in personnel and curtailment of the Company's
retirement plans which in total amounted to $1.3 million. In addition, in the
first quarter of 2004, the Board of Directors terminated the Restated Employee
Annual Incentive Bonus Plan and approved the Bonus Incentive Compensation Plan.
As a result a contingent bonus liability at December 31, 2003 related to the
Restated Employee Annual Incentive Bonus Plan was approved for payment in three
equal annual installments to officers and in a single lump sum for non-officers,
resulting in a charge in the first quarter of 2004 of $1.1 million. Lastly,
there was an increase in various expenses amounting to $0.8 million in the first
quarter of 2004 compared to the first quarter of 2003 due to the relocation of
underwriters to our Bermuda offices, following the first quarter of 2003.
Interest Expense and Minority Interest in Consolidated Subsidiaries
Interest expense, including minority interest in consolidated
subsidiaries, decreased to $3.7 million for the three months ended March 31,
2004 from $4.4 million in the comparable period of 2003. This decrease was due
to the non-recurrence of $1.5 million of expense reflected in 2003 from an
interest rate swap that during the quarter ended March 31, 2003 became
ineffective as a hedging instrument and as a result began to be accounted for as
a speculative instrument as well as the non-recurrence of interest expense under
the Company's bank loan facility, for which the principal balance was $30.0
million as of December 31, 2002 and $10.0 million as of March 31, 2003, but was
fully repaid during the second quarter of 2003, offset by $1.3 million of
interest expense on an additional $64.4 million of subordinated debt issued in
the last nine months of 2003. As discussed in Note 2 to the Consolidated
Financial Statements, following the implementation of FIN 46 during the quarter
ended March 31, 2004, the interest on trust preferred securities is now shown as
interest expense, whereas it was previously recorded as minority interest in
consolidated subsidiaries.
Net Investment Income
Net investment income for the first quarter of 2004 increased 25% to
$6.9 million from $5.5 million in the first quarter of 2003 primarily as a
result of a $1.2 million increase in income from hedge funds as well as an
increase in the average invested balance due to cash flows from operating and
financing activities, offset by lower yields on fixed maturities. Investment
income related to our hedge fund portfolio increased to $3.4 million in the
first quarter of 2004 from $2.2 million in the first quarter of 2003 as
investments in hedge funds produced a return of 2.9% for the first quarter of
2004 compared with 2.0% in the comparable prior-year period. Offsetting these
increases was a decrease in the book yield of fixed maturity and short-term
investment portfolios to 3.4% during the first quarter of 2004 from 4.0% on an
annualized basis during the comparable prior-year period.
22
Investment income for the quarter was also affected by various finite
and other reinsurance contracts where premiums payable under such contracts were
retained on a funds withheld basis. In order to reduce credit risk or to comply
with regulatory credit for reinsurance requirements, a portion of premiums paid
under such reinsurance contracts is retained by the cedent pending payment of
losses or commutation of the contract. Investment income on such withheld funds
is typically for the benefit of the reinsurer and the cedent may provide a
minimum investment return on such funds. We have both ceded and assumed
reinsurance contracts that involve the withholding of premiums by the cedent. On
assumed reinsurance contracts, cedents held premiums and accrued investment
income due to us of $26.9 million and $24.7 million as of March 31, 2004 and
2003, respectively, for which we have recognized $0.5 million and $0.4 million
of investment income for the first quarter of 2004 and 2003, respectively. On
ceded reinsurance contracts, we held premiums and accrued investment income of
$123.9 million and $129.6 million due to reinsurers as of March 31, 2004 and
2003, respectively, for which we recognized a charge to investment income of
$2.2 million and $2.3 million for the first quarter of 2004 and 2003,
respectively. On a net basis, this reduction to investment income was $0.7
million for both the quarters ended March 31, 2004 and 2003, representing the
difference between the stated investment return under such contracts and the
overall yield achieved on our total investment portfolio for the quarter. The
weighted average contractual investment return on the funds held by PXRE is 7.4%
and 7.2% for the quarters ended March 31, 2004 and 2003, respectively, and we
expect to be obligated for this contractual investment return for the life of
the underlying liabilities, which is expected to be six years as of March 31,
2004 on a weighted average basis.
Income Taxes
PXRE recognized a tax expense of $0.7 million in the first quarter of
2004 compared to a tax expense of $1.5 million in the comparable prior-year
period. The tax expense in the first quarter of 2004 differed from the U.S.
statutory rate primarily due to the reinsurance business written in our Bermuda
reinsurance subsidiary.
Cumulative Adjustment
The Company adopted the provisions of FIN 46 during the first quarter.
The cumulative effect of this accounting pronouncement reduced net income by
$1.1 million but did not materially impact shareholders' equity.
23
FINANCIAL CONDITION
Capital Resources
The Company relies primarily on dividend payments from its
subsidiaries, including PXRE Reinsurance and PXRE Bermuda, to pay its operating
expenses, to meet its debt service obligations and to pay dividends. During the
first quarter of 2004, PXRE Reinsurance and PXRE Bermuda did not pay dividends.
Based on the statutory surplus as of December 31, 2003, the aggregate dividends
that are available to be paid during 2004, without prior regulatory approval, by
PXRE Reinsurance and PXRE Bermuda are $197.6 million. We anticipate that this
available dividend capacity will be sufficient to fund our liquidity needs
during 2004.
Liquidity
The primary sources of liquidity for PXRE Reinsurance and PXRE Bermuda,
our principal operating subsidiaries, are net cash flow from operating
activities (including interest income from investments), the maturity or sale of
investments, borrowings, capital contributions and advances. Funds are applied
primarily to the payment of claims, operating expenses, income taxes and to the
purchase of investments. Premiums are typically received in advance of related
claim payments.
Financings
As of March 31, 2004, PXRE had $167.1 million in subordinated debt
securities outstanding as follows:
($000's) March 31, 2004
----------------
$103.1 million 8.85% fixed rate due February 1, 2027 $ 102,635
$18.0 million 7.35% fixed/floating rate due May 15, 2033 18,042
$15.5 million 9.75% fixed rate due May 23, 2033 15,464
$20.6 million 7.70% fixed/floating rate due October 29, 2033 20,619
$10.3 million 7.58% fixed/floating rate due September 30, 2033 10,310
----------------
$ 167,070
================
Share Dividends and Book Value
Dividends to common shareholders declared in the first quarter of 2004
and 2003 were $0.8 million. The expected annual dividend based on common shares
outstanding at March 31, 2004 is approximately $3.4 million. Book value per
common share was $23.02 at March 31, 2004 after considering convertible
preferred shares.
The convertible preferred shares accrue cumulative dividends per share
at the rate per annum of 8% of the sum of the stated value of each share plus
any accrued and unpaid dividend thereon payable on a quarterly basis. As of
March 31, 2004, 17,563 convertible preferred shares were issued and outstanding.
Dividends to preferred shareholders, paid in kind, during the first quarter of
2004 and 2003 amounted to $3.4 million and $3.2 million, respectively.
24
On December 16, 2003, the Company completed an offering of 2.2 million
of its common shares at $21.75 per share, pursuant to a Shelf Registration on
Form S3, filed in 2003 for $150.0 million. Of the 2.2 million shares sold, 1.1
million were offered by PXRE and 1.1 million were offered by Phoenix Life
Insurance Company ("Phoenix"), one of the Company's common shareholders. The
Company did not receive any of the proceeds from the sale of shares by Phoenix.
On January 22, 2004, the underwriters of the above mentioned share
offering exercised in-full the over-allotment option to purchase 0.3 million
additional common shares at $21.75 per share. As a result of the exercise of the
option, the Company received additional proceeds, net of offering costs, of $6.5
million. We used the net proceeds for general corporate purposes, including
contributions to the capital of PXRE Bermuda. After giving effect to the sale of
the over-allotment shares, a total of 2.5 million shares were sold in the
offering.
Cash Flows
Net cash flows provided by operations were $29.3 million in the first
quarter of 2004 compared to $75.9 million in the first quarter of 2003 due to
the effects of timing of collection of premium receivables and reinsurance
recoverables, the payments of losses and the receipt of funds associated with
deposit contracts in the first quarter of 2003 of $30.9 million associated with
business that was not renewed in 2004. Because of the nature of the coverages we
provide, which typically can produce infrequent losses of high severity, it is
not possible to predict accurately our future cash flows from operating
activities. As a consequence, cash flows from operating activities may
fluctuate, perhaps significantly, between individual quarters and years.
Net cash used by investing activities were $87.2 million in the first
quarter of 2004 compared to $48.8 million in the first quarter of 2003 due
primarily to purchases of securities for investment partially offset by proceeds
received on sale or maturity of investments.
Commitments and Contingencies
As of March 31, 2004, other commitments and pledged assets include (a)
letters of credit of $15.5 million which are secured by cash and securities
amounting to $17.8 million, (b) securities with a par value of $10.6 million on
deposit with various state insurance departments in order to comply with
insurance laws, (c) securities with a fair value of $59.6 million deposited in a
trust for the benefit of a cedent in connection with certain finite reinsurance
transactions, (d) funding commitments to certain limited partnerships of $0.7
million, (e) a commitment to lend a further $0.1 million to finance the
construction of an office building that we intend to use as our headquarters in
Bermuda, (f) a contingent liability amounting to $1.8 million under the Restated
Employee Annual Incentive Bonus Plan plus interest, and (g) commitments under
the capital trust pass-through securities discussed above.
In connection with the capitalization of PXRE Lloyd's Syndicate 1224,
PXRE Reinsurance had placed on deposit a $30.4 million par value U.S. Treasury
security as collateral for Lloyd's of London ("Lloyd's"). Cash and invested
assets held by PXRE Lloyd's Syndicate 1224, amounting to $14.5 million at March
31, 2004, are restricted from being paid as a dividend until the run-off of our
exited Lloyd's business has been completed.
25
We entered into a joint venture agreement, dated June 2001 (the "JV
Agreement"), with BF&M Properties Limited to form a Bermuda corporation, Barr's
Bay Properties Limited ("Barr's Bay"). Barr's Bay was formed to construct an
office building in Hamilton, Bermuda, in which we will have the option to lease
office space for three consecutive five-year terms. We own 40% of the
outstanding shares of Barr's Bay. Pursuant to the JV Agreement, we have agreed
to lend up to $7.0 million to Barr's Bay to finance the construction of the
subject office building of which $6.9 million has been advanced as of March 31,
2004. The loans are secured by a first mortgage on the property.
In April 2000, PXRE Reinsurance entered into an aggregate excess of
loss retrocessional reinsurance agreement with a U.S. based cedent. In the
agreement, PXRE Reinsurance reinsured a portfolio of treaties underwritten by a
former business unit of the cedent, which had been divested. Pursuant to this
excess of loss retrocessional agreement, PXRE Reinsurance agreed to indemnify
the cedent for losses in excess of a 75% paid loss ratio on this underlying
portfolio of treaties up to a 100% paid loss ratio, subject to an aggregate
limit of liability of $50.0 million. The latest loss reports related to the
agreement provided by the cedent forecast an ultimate net loss ratio in excess
of 100%, which could result in a full limit loss to PXRE.
In June 2003, PXRE Reinsurance performed an audit of this portfolio of
treaties reinsured under the agreement. As a result of this audit, management
identified problems and believes that the cedent breached its contractual
obligations and fiduciary duties under the agreement. PXRE Reinsurance therefore
filed suit against the cedent on July 24, 2003 in a United Stated District Court
seeking rescission of the agreement and/or compensatory and punitive damages.
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to vigorously prosecute its suit. As of March 31, 2004, we have
recorded $34.7 million of loss reserves related to the agreement. If our lawsuit
is unsuccessful, we could potentially incur additional losses under the
agreement of up to $10.0 million on an after-tax basis.
Investments
As of March 31, 2004, our investment portfolio, at fair value, was
allocated 69.0% in fixed maturity debt instruments, 18.7% in short-term
investments, 11.4% in hedge funds and 0.9% in other investments.
26
The following table summarizes our investments at March 31, 2004 and
December 31, 2003 at fair value:
Analysis of Investments
------------------------------------------------------
March 31, 2004 December 31, 2003
------------------------- -------------------------
($000's, except percentages) Amount Percent Amount Percent
------------- ------- ------------ -------
Fixed maturities:
United States treasury securities $ 41,407 4.0% $ 40,237 4.2%
Foreign denominated securities 21,541 2.1 21,451 2.3
United States government sponsored agency debentures 84,383 8.1 115,440 12.2
United States government sponsored agency
mortgage-backed securities 131,908 12.6 134,323 14.2
Other mortgage and asset-backed securities 199,608 19.0 146,196 15.4
Municipal securities 17,988 1.7 18,584 2.0
Corporate securities 225,774 21.5 162,878 17.2
------------- ----- ------------ -----
Total fixed maturities 722,609 69.0 639,109 67.5
Short-term investments 196,363 18.7 175,771 18.6
------------- ----- ------------ -----
Total fixed maturities and short-term investments 918,972 87.7 814,880 86.1
Hedge funds 119,869 11.4 121,466 12.8
Other investments 9,274 0.9 10,173 1.1
------------- ----- ------------ -----
Total investment portfolio $ 1,048,115 100.0% $ 946,519 100.0%
============= ===== ============ =====
At March 31, 2004, 97.6% of the fair value of our fixed maturities and
short-term investments portfolio was in obligations rated "A" (strong) or better
by Moody's or S&P. Mortgage and asset-backed securities accounted for 36.1% of
fixed maturities and short-term investments or 31.6% of our total investment
portfolio based on fair value at March 31, 2004. The average yield on our fixed
maturities and short-term investments at March 31, 2004 and 2003 was 3.0% and
2.9%, respectively.
Fixed maturity investments, other than trading securities, are reported
at fair value, with the net unrealized gain or loss, net of tax, reported as a
separate component of shareholders' equity. Fixed maturity investments
classified as trading securities are reported at fair value, with the net
unrealized gain or loss reported as investment income. At March 31, 2004, an
after-tax unrealized gain of $7.2 million (a gain of 27 cents per share, after
considering convertible preferred shares) was included in shareholders' equity.
Short-term investments are carried at amortized cost, which
approximates fair value. Our short-term investments, principally short-term
agencies and United States treasuries, amounted to $196.4 million at March 31,
2004, compared to $175.8 million at December 31, 2003.
A significant component of our investment strategy is investing a
portion of our invested assets in a diversified portfolio of hedge funds. At
March 31, 2004, total hedge fund investments amounted to $119.9 million,
representing 11.4% of the total investment portfolio. At December 31, 2003,
total hedge fund investments amounted to $121.5 million, representing 12.8% of
the total investment portfolio. For the three months ended March 31, 2004, our
hedge funds yielded a return of 2.9% as compared to 2.0% in the three months
ended March 31, 2003. At March 31, 2004, hedge fund investments with fair values
ranging from $1.3 million to $16.8 million were administered by seventeen
managers.
27
As of March 31, 2004, our investment portfolio also included $9.3
million of other invested assets of which 98% is in two mezzanine bond funds.
The remaining aggregate cash call commitments in respect of such investments are
$0.7 million.
Hedge funds and other limited partnership investments are accounted for
under the equity method. Total investment income for the three months ended
March 31, 2004, included $3.4 million attributable to hedge funds and other
investments.
Our hedge fund and other privately held securities program should be
viewed as exposing us to the risk of substantial losses, which we seek to reduce
through our multi-asset and multi-management strategy. There can be no
assurance, however, that this strategy will prove to be successful.
Taxes
PXRE Delaware files U.S. income tax returns for itself and all of its
direct or indirect U.S. subsidiaries that satisfy the stock ownership
requirements for consolidation. PXRE Delaware is party to a tax allocation
agreement concerning filing of consolidated federal income tax returns pursuant
to which each of these U.S. subsidiaries makes tax payments to PXRE Delaware in
an amount equal to the federal income tax payment that would have been payable
by the relevant U.S. subsidiary for the year if it had filed a separate income
tax return for that year. PXRE Delaware is required to provide payment of the
consolidated federal income tax liability for the entire group. If the aggregate
amount of tax payments made in any tax year by one of these U.S. subsidiaries is
less than (or greater than) the annual tax liability for that U.S. subsidiary on
a stand-alone basis for that year, the U.S. subsidiary will be required to make
up the deficiency to PXRE Delaware (or will be entitled to receive a credit if
payments exceed the separate return tax liability of that U.S. subsidiary).
Certain Related Party Transactions
Since 1997, PXRE has been a party to a retrocessional agreement (the
"Obligatory Quota Share Treaty") with Select Re, pursuant to which we have ceded
varying proportional shares of our non-casualty reinsurance business ranging
from a high of 16.5% in 2001 to as low as 2.62% in 1997. These cessions
satisfied an undertaking we entered into with Select Re to use commercially
reasonable efforts to present Select Re with aggregate annual premiums equal to
a minimum of 20% of Select Re's shareholders' equity (as defined in the
undertaking). This undertaking was amended in November 2002 and extended until
2005. In return, Select Re is obligated to pay us a management fee of 15% based
on the gross premiums ceded to them under the Obligatory Quota Share Treaty,
which resulted in fee income of $0.3 million for the three months ended March
31, 2004.
28
Commencing on January 1, 2004, the cession percentage under the
Obligatory Quota Share Treaty was reduced to 0% and the parties agreed that
PXRE's undertaking would be satisfied through cessions under two other
retrocessional contracts. The first contract is a pro rata retrocessional
contract (the "Specific Pro Rata Contract") which is effective for the period
January 1, 2004 to December 31, 2004 and pursuant to which PXRE Bermuda will
cede a 53% proportional share of the risks assumed by PXRE Bermuda under one
large retrocessional contract. Premiums ceded to Select Re under the Specific
Pro Rata Contract are expected to be approximately $2.6 million, subject to a
22% underwriting commission. The second contract is an excess of loss
reinsurance agreement (the "XOL Contract") which is effective for the period
April 1, 2004 to March 31, 2006 and pursuant to which Select Re will indemnify
PXRE Bermuda for up to $30.0 million in the event that losses arising from a
single catastrophe loss event exceed $280.0 million. The reinsurance premium
under the XOL Contract is $20.0 million, $5.5 million of which is payable at the
inception of the contract. The remaining balance of $14.5 million is payable on
a funds withheld basis, provided that if no loss is ceded to Select Re during
the term of the XOL Contract, then PXRE Bermuda will receive a profit commission
of $14.5 million. In connection with these two retrocessional contracts, Select
Re has agreed to deposit collateral equal to $26.0 million into a trust for the
benefit of PXRE Bermuda.
In connection with the decision to move away from the Obligatory Quota
Share in which Select Re assumed a pro rata share of all of PXRE's non-casualty
business and instead enter into an excess of loss agreement and a specific pro
rata agreement, PXRE and Select Re entered into a commutation agreement,
effective March 31, 2004, pursuant to which Select Re commuted all of its
liability for business assumed under certain finite casualty contracts and for
exited lines business assumed under the Obligatory Quota Share Treaty. Pursuant
to this commutation agreement, Select Re paid PXRE $10.2 million, which resulted
in an underwriting gain for the Company of $5.1 million for the quarter ended
March 31, 2004.
Overall, in connection with the foregoing contracts and other in-force
reinsurance contracts, ceded earned reinsurance premiums were $2.9 million to
Select Re during the first quarter of 2004 and net assets of $68.5 million were
due to us in the aggregate from Select Re, all of which were fully secured by
way of reinsurance trusts or remitted to us during April 2004. In addition to
the collateralization requirements, we have various additional protections to
ensure Select Re's performance of its obligations to us. In this regard,
pursuant to the Select Re Quota Share Agreement, among other rights, we have the
right to designate one member of Select Re's board of directors and we have the
right to limit the amount of non-PXRE reinsurance business assumed by Select Re.
In the event we do not designate a member of Select Re's board (which as of May
6, 2004we have not), then we have the right to send an observer to the Select Re
board meetings.
Mr. William Michaelcheck is a member of the Board of Select Re and also
one of its founding shareholders. Mr. Michaelcheck is also the President and a
major shareholder of Mariner Investment Group, Inc. ("Mariner"), which acts as
the investment manager for our hedge fund and alternative investment portfolio.
During both the three months ended March 31, 2004 and 2003, we incurred
investment management fees of $0.2 million relating to services provided by
Mariner.
The Company's Board of Directors reviews the various transactions with
Select Re at each of its meetings. In addition, the Board of Directors requires
the prior approval of the Company's Chief Financial Officer for any transaction
entered into with Select Re.
29
Update on Critical Accounting Policy Disclosures
The Company's Annual Report on Form 10-K for the year ended December
31, 2003 contains a discussion concerning critical accounting policy disclosures
(See Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations -Critical Accounting Policy Disclosures contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 2003). We
disclose our significant accounting policies in the notes to the Consolidated
Financial Statements which should be read in conjunction with the notes to the
interim Consolidated Financial Statements and the 2003 audited Consolidated
Financial Statements and notes. Certain of these policies are critical to the
portrayal of our financial condition and results since they require management
to establish estimates based on complex and subjective judgments. This included
disclosure concerning our estimation of losses and loss expenses.
Estimation of Loss and Loss Expenses
As a property catastrophe reinsurer, our estimations of losses are
inherently less reliable than for reinsurers of risks that have an established
historical pattern of losses. In addition, with respect to insured events that
occur near the end of a reporting period, as well as with respect to our
retrocessional book of business, the significant delay in losses being reported
to insurance carriers, reinsurers and finally retrocessionaires requires us to
make estimates of losses based on limited information from our clients, industry
loss estimates and our own underwriting data. Because of the uncertainty in the
process of estimating our losses from insured events, there is a risk that our
liabilities for losses and loss expenses could prove to be inadequate, with a
consequent adverse impact on our future earnings and shareholders' equity.
In reserving for catastrophe losses, our estimates are influenced by
underwriting information provided by our clients, industry catastrophe models
and our internal analyses of this information. This reserving approach can cause
significant development for an accident year when events occur late in the year,
as happened in 1999. As an event matures, we rely more and more on our own
development patterns by type of event as well as contract information to project
ultimate losses for the event. This process can cause our ultimate estimates to
differ significantly from initial projections. The French Storm Martin that
occurred on December 27, 1999 presents an extreme example of these potential
uncertainties. We based our reserves to a significant degree on industry
estimates, which were approximately $1.0 billion. In 2001, the cost was
estimated to be $2.5 billion by SIGMA a widely used industry publication. Our
gross loss estimate at December 31, 1999 for this event was $31.3 million. Our
gross loss estimate at March 31, 2004 for this event was $67.6 million. Thus,
the original industry loss estimate increased by 150%, and our loss estimate has
increased by 116%.
In reserving for non-catastrophe losses from recent years, we are
required to make assumptions concerning the expected loss ratio usually for
broad lines of business, but sometimes on an individual contract basis. We
consider historical loss ratios for each line of business and utilize
information provided by our clients and estimates provided by underwriters and
actuaries concerning the impact of pricing and coverage changes. As experience
emerges, we will revise our prior estimates concerning pricing adequacy and
non-catastrophe loss potential for our coverages and we will eventually rely
solely on our estimated development pattern in projecting ultimate losses.
30
Excluding the extraordinary development of French storms Martin and
Lothar in 2000, during the last 10 years, reserve development in any single year
from prior year losses, expressed as a percentage of shareholders' equity,
ranged from 15% adverse development in 1993 (primarily arising from Hurricane
Andrew) to 4% favorable development in 1996.
In addition, the risk for recent underwriting years includes the
increased casualty exposures assumed by us through our casualty and finite
businesses. Unlike property losses that tend to be reported more promptly and
usually are settled within a shorter time period, casualty losses are frequently
slower to be reported and may be determined only through the lengthy,
unpredictable process of litigation. Moreover, given our limited experience in
the casualty and finite businesses, we do not have established historical loss
development patterns that can be used to establish these loss liabilities. We
must therefore rely on the inherently less reliable historical loss development
patterns reported by our clients and industry loss development data in
calculating our liabilities.
During the first quarter of 2004, we experienced net favorable
development of $2.3 million for prior-year loss and loss expenses, $2.0 million
of which was due to favorable loss development on our core catastrophe and risk
excess segment. The loss ratio for the comparable period of 2003 was affected by
net adverse development of $13.2 million for prior-year loss and loss expenses
mainly due to our exited lines segment relating primarily to the 2000 and 2001
underwriting years.
PXRE's loss reserve estimation process takes into consideration the
facts and circumstances related to reported losses; however, for immature
accident years, reported casualty losses are relatively insignificant when
compared to ultimate losses. As such, it is difficult to determine how facts and
circumstances related to early-notified claims will impact future reported
losses. When reported losses grow to a magnitude at which they suggest a trend,
PXRE can, and does, re-estimate loss reserves for periods which will appear to
be affected by such trend.
Loss and loss expense liabilities as estimated by PXRE's actuaries and
recorded by management in the statement of financial position as of March 31,
2004 were as follows:
($000's) Gross Net
-------------- -------------
Catastrophe and Risk Excess $ 192,525 $ 99,929
Finite Business 126,685 93,066
Exited Lines 117,470 108,812
-------------- -------------
Total $ 436,680 $ 301,807
============== =============
On an overall basis, the low and high ends of a range of reasonable net
loss reserves are $32.4 million below and $35.8 million above the $301.8 million
best estimate displayed above. Note that the range around the overall estimate
is not the sum of the ranges about the component segments due to the impact of
diversification when the reserve levels are considered in total. The low and
high ends of a range of reasonable net loss reserves around the best estimate
displayed in the table above with respect to each segment are as follows:
31
($000's) Low End Net High End
------------- -------------- -------------
Catastrophe and Risk Excess $ 84,538 $ 99,929 $ 116,978
Finite Business 76,050 93,066 112,497
Exited Lines 96,755 108,812 121,775
Cautionary Statement Regarding Forward-Looking Statements
This report contains various forward-looking statements and includes
assumptions concerning our operations, future results and prospects. Statements
included herein, as well as statements made by or on our behalf in press
releases, written statements or other documents filed with the Securities and
Exchange Commission (the "SEC"), or in our communications and discussions with
investors and analysts in the normal course of business through meetings, phone
calls and conference calls, which are not historical in nature are intended to
be, and are hereby identified as, "forward-looking statements" for purposes of
the safe harbor provided by Section 21E of the Securities Exchange Act of 1934
as amended. These forward-looking statements, identified by words such as
"intend," "believe," "anticipate," or "expects" or variations of such words or
similar expressions are based on current expectations, speak only as of the date
hereof, and are subject to risk and uncertainties. In light of the risks and
uncertainties inherent in all future projections, these forward-looking
statements in this report should not be considered as a representation by us or
any other person that our objectives or plans will be achieved. We caution
investors and analysts that actual results or events could differ materially
from those set forth or implied by the forward-looking statements and related
assumptions, depending on the outcome of certain important factors including,
but not limited to, the following:
(i) because of exposure to catastrophes, our financial results may
vary significantly from period to period;
(ii) we may be overexposed to losses in certain geographic areas
for certain types of catastrophe events;
(iii) we operate in a highly competitive environment;
(iv) reinsurance prices may decline, which could affect our
profitability;
(v) underwriting reinsurance includes the application of judgment,
the assessment of probabilities and outcomes, and assumption
of correlations, which are subject to inherent uncertainties;
(vi) reserving for losses includes significant estimates which are
also subject to inherent uncertainties;
(vii) a decline in the credit rating assigned to our claim-paying
ability may impact our potential to write new or renewal
business;
32
(viii) a decline in our ratings may require us to transfer premiums
retained by us into a beneficiary trust or may allow clients
to terminate their contract with us;
(ix) our investment portfolio is subject to market and credit risks
which could result in a material adverse impact on our
financial position or results;
(x) because we depend on a few reinsurance brokers for a large
portion of revenue, loss of business provided by them could
adversely affect us; and our reliance on reinsurance brokers
exposes us to their credit risk;
(xi) we may be adversely affected by foreign currency fluctuations;
(xii) retrocessional reinsurance subjects us to credit risk and may
become unavailable on acceptable terms;
(xiii) the impairment of our ability to provide collateral to cedents
could affect our ability to offer reinsurance in certain
markets;
(xiv) the reinsurance business is historically cyclical, and we may
experience periods with excess underwriting capacity and
unfavorable premium rates; conversely, we may have a shortage
of underwriting capacity when premium rates are strong;
(xv) regulatory constraints may restrict our ability to operate our
business;
(xvi) contention by the United States Internal Revenue Service that
we or our offshore subsidiaries are subject to U.S. taxation
could result in a material adverse impact on our financial
position or results; and
(xvii) changes in tax laws, tax treaties, tax rules and
interpretations could result in a material adverse impact on
our financial position or results.
In addition to the factors outlined above that are directly related to
our business, we are 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. The factors listed above should not be construed as
exhaustive.
We undertake no obligation to release publicly the results of any
future revisions we may make to forward-looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We have reviewed our exposure to market risks at March 31, 2004 and the
changes in exposure since December 31, 2003. The principal market risks which we
are exposed to, continue to be interest rate and credit risk.
33
The composition of our fixed maturity portfolio did not change
materially during the first quarter of 2004. There were no material changes in
our exposure to market risks or our risk management strategy during the first
quarter of 2004.
Item 4. Controls and Procedures
An evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) of the
Securities Exchange Act of 1934, as amended) was carried out under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer. Based on that evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that the
disclosure controls and procedures were effective as of the end of the period
covered by this report.
No change in our internal control over financial reporting (as defined
in Rule 13a-15(f) of the Securities Exchange Act of 1934, as amended) occurred
during the period covered by this report that materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are subject to litigation and arbitration in the ordinary course of
business. Except as disclosed below, management does not believe that the
eventual outcome of any such pending litigation or arbitration is likely to have
a material effect on our financial condition or business. Pursuant to our
insurance and reinsurance arrangements, disputes are generally required to be
finally settled by binding arbitration.
In April 2000, PXRE Reinsurance entered into an aggregate excess of
loss retrocessional reinsurance agreement with a U.S. based cedent. In the
agreement, PXRE Reinsurance reinsured a portfolio of treaties underwritten by a
former business unit of the cedent, which had been divested. Pursuant to this
excess of loss retrocessional agreement, PXRE Reinsurance agreed to indemnify
the cedent for losses in excess of a 75% paid loss ratio on this underlying
portfolio of treaties up to a 100% paid loss ratio, subject to an aggregate
limit of liability of $50.0 million. The latest loss reports related to the
agreement provided by the cedent forecast an ultimate net loss ratio in excess
of 100%, which could result in a full limit loss to PXRE.
In June 2003, PXRE Reinsurance performed an audit of this portfolio of
treaties reinsured under the agreement. As a result of this audit, management
identified problems and believes that the cedent breached its contractual
obligations and fiduciary duties under the agreement. PXRE Reinsurance therefore
filed suit against the cedent on July 24, 2003 in a United Stated District Court
seeking rescission of the agreement and/or compensatory and punitive damages.
Although the ultimate outcome of the litigation cannot presently be
determined, management believes that PXRE Reinsurance's claims are meritorious
and intends to vigorously prosecute its suit. As of March 31, 2004, we have
recorded $34.7 million of loss reserves related to the agreement. If our lawsuit
is unsuccessful, we could potentially incur additional losses under the
agreement of up to $10.0 million on an after-tax basis.
34
Item 2. Changes in Securities and Use of Proceeds.
During the quarter ended March 31, 2004, the Company issued the
following equity securities in transactions that were not registered under the
Securities Act of 1933, as amended (the "Act"):
(a) Securities sold. On March 31, 2004, the Company issued 344.38
Convertible Voting Preferred Shares to the existing holders of
the Company's Convertible Preferred Shares in payment of its
dividend obligation thereon. The 344.38 Convertible Voting
Preferred Shares issued were allocated among Series as
follows:
i. 172.19 shares of Series A convertible voting
preferred shares, allocated to two sub-series of
shares, 114.79 shares allocated to sub-series Al and
57.40 shares allocated to sub-series A2;
ii. 114.79 shares of Series B convertible voting
preferred shares, allocated to two sub-series of
shares, 76.53 shares allocated to Series B1 and 38.26
shares allocated to Series B2; and
iii. 57.40 shares of Series C convertible voting preferred
shares, allocated to two sub-series of shares, 38.27
shares allocated to Series Cl and 19.13 shares
allocated to Series C2.
(b) Underwriters and other purchasers. No underwriter
participated. The additional Convertible Voting Preferred
Shares were issued to the holders of record on March 12, 2004
of the outstanding convertible voting preferred shares.
(c) Consideration. The convertible voting preferred shares were
issued in satisfaction of the Company's obligation to pay a
quarterly dividend of $3.4 million to the holders of the
outstanding convertible voting preferred shares.
(d) Exemption from registration claimed. Exemption from
registration under the Act was claimed based upon Section 4(2)
of the Act as a sale by an issuer not involving a public
offering.
(e) Terms of conversion and exercise. The description of the terms
of the Preferred Shares contained in Part II, Item 5 of the
Company's Annual Report on Form 10-K for the year ended
December 31, 2003 is incorporated herein by reference.
(f) Use of proceeds. Not applicable.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
35
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
a. Exhibits
A list of exhibits required to be filed as part of this report is set
forth in the Exhibit Index of this Form 10-Q, which immediately precedes such
exhibits, and is incorporated herein by reference.
b. Current Reports on Form 8-K
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
10.1 Retrocessional Agreement, effective January 1, 2004 between
Select Reinsurance Ltd. and PXRE Reinsurance Ltd.
10.2 Commutation Agreement, effective March 31, 2004, between
Select Reinsurance Ltd., PXRE Reinsurance Company and PXRE
Reinsurance Ltd.
10.3 Reinsurance Slip, effective April 1, 2004 between Select
Reinsurance Ltd. and PXRE Reinsurance Ltd.
31.1 Certification by the Chief Executive Officer Relating to a
Periodic Report Containing Financial Statements pursuant to
Section 302 of the Sarbanes-Oxley Act of 2003.
31.2 Certification by the Chief Financial Officer Relating to a
Periodic Report Containing Financial Statements Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2003.
32.1 Certification of Periodic Report Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2003.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report or amendment thereto to be signed on
its behalf by the undersigned thereunto duly authorized.
PXRE GROUP LTD.
May 7, 2004 By: /s/ John M. Modin
---------------------------
John M. Modin
Executive Vice President
and Chief Financial Officer
37