-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VV+IhJZa19LHwephmhrcq1mjblkkDBdgZgB8hji8rxiwqlgzq4QfCMuKJ7JuJHHQ FdzwXNgJdEV6Tpp/NC8rWA== 0000898080-07-000324.txt : 20071109 0000898080-07-000324.hdr.sgml : 20071109 20071109172605 ACCESSION NUMBER: 0000898080-07-000324 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20070930 FILED AS OF DATE: 20071109 DATE AS OF CHANGE: 20071109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCOTTISH RE GROUP LTD CENTRAL INDEX KEY: 0001064122 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 000000000 STATE OF INCORPORATION: E9 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-16855 FILM NUMBER: 071233048 BUSINESS ADDRESS: STREET 1: GRAND PAVILION COMMERCIAL CENTRE STREET 2: 802 WEST BAY RD GEORGE TOWN GRAND CAYMAN CITY: GRAND CAYMAN CAYMAN STATE: E9 ZIP: 00000 BUSINESS PHONE: 3459492800 MAIL ADDRESS: STREET 1: P O BOX HM 2939 CITY: HAMILTON STATE: D0 ZIP: HM MX FORMER COMPANY: FORMER CONFORMED NAME: SCOTTISH LIFE HOLDINGS LTD DATE OF NAME CHANGE: 19980615 10-Q 1 form10q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------- FORM 1O-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2007 [ ] 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: 001-16855 SCOTTISH RE GROUP LIMITED (Exact Name of Registrant as Specified in Its Charter) Cayman Islands 98-0362785 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) P.O. Box HM 2939 Crown House, Second Floor 4 Par-la-Ville Road Hamilton HM08 Bermuda (Address of Principal Executive Offices) Not Applicable (Zip Code) (441) 295-4451 (Registrant's telephone number, including area code) (Former name, former address and former fiscal year, if changed since last report) 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 checkmark whether the registrant is a large accelerated filer, or a non-accelerated filer. See definition of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer /X/ Accelerated filer / / Non-accelerated filer / / Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes / / No /X/ As of November 5, 2007, the Registrant had 68,383,370 ordinary shares outstanding. ================================================================================ Table of Contents PART I. FINANCIAL INFORMATION.................................................2 Item 1 Financial Statements..................................................2 Consolidated Balance Sheets - September 30, 2007 (Unaudited) and December 31, 2006 (Audited)........................................2 Consolidated Statements Of Loss - Three and nine months ended September 30, 2007 and 2006 (Unaudited)......................3 Consolidated Statements Of Comprehensive Income (Loss) - Three and nine months ended September 30, 2007 and 2006 (Unaudited)..........4 Consolidated Statements Of Shareholders' Equity - Nine months ended September 30, 2007 and 2006 (Unaudited)......................5 Consolidated Statements Of Cash Flows - Nine months ended September 30, 2007 and 2006 (Unaudited)............................7 Notes to Consolidated Financial Statements (Unaudited)................8 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations.........................................23 Item 3 Quantitative and Qualitative Disclosures about Market Risk...........58 Item 4 Controls and Procedures..............................................58 PART II. OTHER INFORMATION....................................................59 Item 1 Legal Proceedings....................................................59 Item 1A. Risk Factors.........................................................59 Item 2 Unregistered Sales of Equity Securities and Use of Proceeds..........60 Item 3 Defaults upon Senior Securities......................................60 Item 4 Submission of Matters to a Vote of Security Holders..................60 Item 7 Other Information....................................................61 Item 8 Exhibits.............................................................61 1 PART I. FINANCIAL INFORMATION Item 1. Financial Statements SCOTTISH RE GROUP LIMITED CONSOLIDATED BALANCE SHEETS (Expressed in Thousands of United States dollars, except share data)
September 30, December 31, 2007 2006 (Unaudited) (Audited) -------------- ------------ ASSETS Fixed maturity investments, available for sale, at fair value (Amortized cost $8,053,906; 2006 - $8,103,743) ............................. $ 7,635,704 $ 8,065,524 Preferred stock, available for sale, at fair value (Cost $103,091; 2006 - $119,721) ........................................... 99,340 116,933 Cash and cash equivalents .................................................... 1,253,071 622,756 Other investments ............................................................ 66,250 65,448 Funds withheld at interest ................................................... 1,636,229 1,942,079 ------------ ------------ Total investments .......................................................... 10,690,594 10,812,740 Accrued interest receivable .................................................. 57,579 57,538 Reinsurance balances and risk fees receivable ................................ 421,772 372,512 Deferred acquisition costs ................................................... 630,732 618,737 Amount recoverable from reinsurers ........................................... 574,517 663,985 Present value of in-force business ........................................... 46,310 48,779 Other assets ................................................................. 125,642 178,311 Current income tax receivable ................................................ 7,787 - Deferred tax asset ........................................................... 101,087 - Segregated assets ............................................................ 715,923 683,470 ------------ ------------ Total assets ............................................................... $ 13,371,943 $ 13,436,072 ============ ============ LIABILITIES Reserves for future policy benefits .......................................... $ 4,036,410 $ 3,919,901 Interest sensitive contract liabilities ...................................... 2,744,340 3,399,410 Collateral finance facilities ................................................ 4,000,422 3,757,435 Accounts payable and other liabilities ....................................... 158,418 69,949 Reinsurance balances payable ................................................. 154,416 97,615 Current income tax payable ................................................... - 48 Deferred tax liability ....................................................... - 169,977 Long term debt ............................................................... 129,500 129,500 Segregated liabilities ....................................................... 715,923 683,470 ------------ ------------ Total liabilities .......................................................... 11,939,429 12,227,305 ------------ ------------ MINORITY INTEREST ............................................................ 7,367 7,910 MEZZANINE EQUITY Convertible cumulative participating preferred shares, (liquidation preference, $617.6 million) ................................................ 555,857 - Hybrid capital units ......................................................... - 143,665 ------------ ------------ Total mezzanine equity ..................................................... 555,857 143,665 ------------ ------------ SHAREHOLDERS' EQUITY Ordinary shares, par value $0.01: Issued 68,383,370 shares (2006 - 60,554,104) .............................. 684 606 Non-cumulative perpetual preferred shares, par value $0.01: Issued: 5,000,000 shares (2006 - 5,000,000) ............................... 125,000 125,000 Additional paid-in capital ................................................... 1,213,688 1,050,860 Accumulated other comprehensive income (loss) ................................ (273,394) 340 Retained deficit ............................................................. (196,688) (119,614) ------------ ------------ Total shareholders' equity ................................................. 869,290 1,057,192 ------------ ------------ Total liabilities, minority interest, mezzanine equity and shareholders' equity .................................................................... $ 13,371,943 $ 13,436,072 ============ ============
See Accompanying Notes to Consolidated Financial Statements (unaudited) 2 SCOTTISH RE GROUP LIMITED CONSOLIDATED STATEMENTS OF LOSS (UNAUDITED) (Expressed in Thousands of United States dollars, except share data)
Three months ended Nine months ended ------------------------------ ------------------------------ September 30, September 30, September 30, September 30, 2007 2006 2007 2006 ------------- ------------- ------------- ------------- Revenues Premiums earned, net ............................... $ 456,340 $ 453,521 $ 1,360,850 $ 1,347,484 Investment income, net ............................. 154,450 162,408 456,926 439,407 Fee and other income ............................... 6,017 2,380 14,881 10,752 Net realized losses ................................ (101,986) (1,072) (108,330) (25,971) Change in value of embedded derivatives, net ....... (14,777) (5,891) (5,886) 11,621 ------------- ------------- ------------- ------------- Total revenues ................................... 500,044 611,346 1,718,441 1,783,293 ------------- ------------- ------------- ------------- Benefits and expenses Claims and other policy benefits ................... 368,731 377,713 1,140,562 1,124,277 Interest credited to interest sensitive contract liabilities ............................. 34,793 42,423 106,515 140,523 Acquisition costs and other insurance expenses, net .................................... 97,755 86,241 289,363 278,644 Operating expenses ................................. 36,982 39,447 131,364 109,904 Collateral finance facilities expense .............. 73,667 67,323 222,647 145,646 Interest expense ................................... 3,304 5,005 14,914 16,964 ------------- ------------- ------------- ------------- Total benefits and expenses ...................... 615,232 618,152 1,905,365 1,815,958 ------------- ------------- ------------- ------------- Loss before income taxes and minority interest ..... (115,188) (6,806) (186,924) (32,665) Income tax benefit (expense) ....................... 7,777 (20,841) 148,717 (102,427) ------------- ------------- ------------- ------------- Loss before minority interest ...................... (107,411) (27,647) (38,207) (135,092) Minority interest .................................. 227 232 501 (64) ------------- ------------- ------------- ------------- Net loss ........................................... (107,184) (27,415) (37,706) (135,156) Dividend declared on non-cumulative perpetual preferred shares ................................. (2,266) (2,266) (6,797) (6,797) Deemed dividend on beneficial conversion feature .......................................... - - (120,750) - Imputed dividend on prepaid variable share forward contract ................................. - (809) - (881) ------------- ------------- ------------- ------------- Net loss attributable to ordinary shareholders ..... $ (109,450) $ (30,490) $ (165,253) $ (142,834) ============= ============= ============= ============= Loss per ordinary share - Basic ................... $ (1.60) $ (0.54) $ (2.47) $ (2.61) ============= ============= ============= ============= Loss per ordinary share - Diluted ................. $ (1.60) $ (0.54) $ (2.47) $ (2.61) ============= ============= ============= ============= Dividends declared per ordinary share .............. $ - $ - $ - $ 0.10 ============= ============= ============= ============= Weighted average number of ordinary shares outstanding Basic ............................................ 68,383,370 56,933,566 66,939,007 54,708,914 ============= ============= ============= ============= Diluted .......................................... 68,383,370 56,933,566 66,939,007 54,708,914 ============= ============= ============= =============
See Accompanying Notes to Consolidated Financial Statements (unaudited) 3 SCOTTISH RE GROUP LIMITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED) (Expressed in Thousands of United States dollars)
Three months ended Nine months ended ----------------------------- ----------------------------- September 30, September 30, September 30, September 30, 2007 2006 2007 2006 ------------- ------------- ------------- ------------- Net loss ............................................... $(107,184) $ (27,415) $ (37,706) $(135,156) ---------- ---------- ---------- ---------- Other comprehensive loss, net of tax: Unrealized appreciation (depreciation) on investments... (273,808) 86,716 (361,492) (18,998) Reclassification adjustment for net realized losses included in net loss ......................... 76,250 3,805 81,932 14,807 ---------- ---------- ---------- ---------- Net unrealized appreciation (depreciation) on investments net of income tax benefit (expense) and deferred acquisition costs of $82,715, $(53,916), $102,768 and $5,779 ....................... (197,558) 90,521 (279,560) (4,191) Cumulative translation adjustment ...................... 2,436 (790) 5,826 8,114 ---------- ---------- ---------- ---------- Other comprehensive income (loss) ...................... (195,122) 89,731 (273,734) 3,923 ---------- ---------- ---------- ---------- Comprehensive income (loss) ............................ $(302,306) $ 62,316 $(311,440) $(131,233) ========== ========== ========== ==========
See Accompanying Notes to Consolidated Financial Statements (unaudited) 4 SCOTTISH RE GROUP LIMITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED) (Expressed in Thousands of United States dollars, except share data)
Nine months ended --------------------------------- September 30, September 30, 2007 2006 ------------- ------------- Ordinary shares: Beginning of period .......................................................... 60,554,104 53,391,939 Issuance to holders of HyCUs on conversion of purchase contracts ............ 7,440,478 - Issuance to holders of restricted stock awards ............................... 388,313 - Issuance to employees on exercise of options and awards ...................... 475 583,217 Ordinary shares issued ....................................................... - 6,578,948 ------------ ------------ End of period ................................................................ 68,383,370 60,554,104 ============ ============ Non-cumulative perpetual preferred shares: Beginning and end of period .................................................. 5,000,000 5,000,000 ------------ ------------ Share capital: Ordinary shares: Beginning of period .......................................................... $ 606 $ 534 Issuance to holders of HyCUs on conversion of purchase contracts ............ 74 - Issuance to holders of restricted stock awards ............................... 4 - Issuance to employees on exercise of options ................................. - 6 Ordinary shares issued ....................................................... - 66 ------------- ------------- End of period ................................................................ 684 606 ------------- -------------- Non cumulative perpetual preferred shares: Beginning and end of period .................................................. 125,000 125,000 ------------- ------------- Additional paid-in capital: Beginning of period .......................................................... 1,050,860 893,767 Issuance to holders of HyCUs on conversion of purchase contracts ............ 143,675 - Beneficial conversion feature related to convertible cumulative participating preferred shares .............................................. 120,750 - Accretion of beneficial conversion feature related to convertible cumulative participating preferred shares ................................... (120,750) - Option and restricted stock unit expense ..................................... 19,122 1,483 Ordinary shares issued ....................................................... - 147,318 Issuance to employees on exercise of options ................................. - 6,795 Other ........................................................................ 31 427 ------------- ------------- End of period ................................................................ 1,213,688 1,049,790 ------------- ------------- Accumulated other comprehensive loss: Unrealized depreciation on investments Beginning of period .......................................................... (19,624) (17,879) Change in period (net of tax and deferred acquisition costs) ................. (279,560) (4,191) ------------- ------------- End of period ................................................................ (299,184) (22,070) ------------- ------------- Cumulative translation adjustment Beginning of period .......................................................... 22,826 7,888 Change in period (net of tax) ................................................ 5,826 8,114 ------------- ------------- End of period ................................................................ 28,652 16,002 ------------- ------------- Benefit plans Beginning and end of period ................................................. (2,862) - ------------- -------------- Total accumulated other comprehensive loss ..................................... $ (273,394) $ (6,068) ------------- -------------
5 SCOTTISH RE GROUP LIMITED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED) (UNAUDITED) (Expressed in Thousands of United States dollars, except share data)
Nine months ended --------------------------------- September 30, September 30, 2007 2006 ------------- ------------- Retained earnings (deficit): Beginning of period .......................................................... $ (119,614) $ 262,402 Adoption of FIN 48 on January 1, 2007 ........................................ (32,571) - Net loss .................................................................... (37,706) (135,156) Dividends declared on ordinary shares ........................................ - (5,359) Dividends declared on non-cumulative perpetual preferred shares .............. (6,797) (6,797) Imputed dividend on prepaid variable share forward contract .................. - (881) ------------ ------------ End of period ................................................................ (196,688) 114,209 ------------ ------------ Total shareholders' equity ..................................................... $ 869,290 $ 1,283,537 ============ ============
See Accompanying Notes to Consolidated Financial Statements (unaudited) 6 SCOTTISH RE GROUP LIMITED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Expressed in Thousands of United States dollars)
Nine months ended --------------------------------- September 30, September 30, 2007 2006 ------------- ------------- Operating activities Net loss ....................................................................... $ (37,706) $ (135,156) Adjustments to reconcile net loss to net cash provided by operating activities: Net realized losses .......................................................... 108,330 25,971 Change in value of embedded derivatives, net ................................. 5,886 (11,621) Amortization of discount on investments ...................................... 9,146 12,270 Amortization of deferred acquisition costs ................................... 69,929 71,798 Amortization of present value of in-force business ........................... 2,469 3,278 Changes in assets and liabilities: Accrued interest receivable ................................................. 35 (14,539) Reinsurance balances and risk fees receivable ............................... 4,464 106,684 Deferred acquisition costs .................................................. (72,490) (94,147) Deferred tax asset and liability ............................................ (174,824) 106,934 Other assets ................................................................ 41,949 (65,490) Current income tax receivable and payable ................................... (7,717) (5,044) Reserves for future policy benefits, net of amounts recoverable from reinsurers ................................................................ 198,588 70,983 Interest sensitive contract liabilities, net of funds withheld at interest .. 47,326 452,891 Accounts payable and other liabilities ...................................... 55,729 2,235 Other ....................................................................... 20,833 5,845 ------------ ------------ Net cash provided by operating activities .................................... 271,947 532,892 ------------ ------------ Investing activities Purchase of fixed maturity investments ......................................... (703,682) (3,927,956) Proceeds from sales of fixed maturity investments .............................. 164,187 1,311,070 Proceeds from maturity of fixed maturity investments ........................... 476,523 377,652 Purchase of preferred stock investments ........................................ (1,899) (10,299) Proceeds from sales and maturity of preferred stock investments ................ 15,052 12,901 Purchase of and proceeds from other investments ................................ 963 (9,608) Other .......................................................................... 5,475 (7,244) ------------ ------------ Net cash used in investing activities ........................................ (43,381) (2,253,484) ------------ ------------ Financing activities Deposits to interest sensitive contract liabilities ............................ 7,541 122,194 Withdrawals from interest sensitive contract liabilities ....................... (122,621) (632,527) Net proceeds from issuance of convertible cumulative participating preferred shares ....................................................................... 555,857 - Proceeds from issuance to holders of HyCUs on conversion of purchase contracts . 7,338 - Redemption of convertible preferred shares ..................................... (7,338) - Dividends paid on redemption of convertible preferred shares ................... (222) - Proceeds from collateral finance facility liabilities .......................... 431,514 1,760,237 Repayment of funds drawdown on collateral finance facility liabilities ......... (188,527) - Net proceeds from drawdown of Stingray facility ................................ - 265,000 Repayment of funds drawn down on Stingray ...................................... (275,000) - Proceeds from issuance of ordinary shares ...................................... 4 153,731 Dividends paid on non-cumulative perpetual preferred shares .................... (6,797) (6,797) Dividends paid on ordinary shares .............................................. - (5,359) ------------ ------------ Net cash provided by financing activities .................................... 401,749 1,656,479 ------------ ------------ Net change in cash and cash equivalents ........................................ 630,315 (64,113) Cash and cash equivalents, beginning of period ................................. 622,756 1,420,205 ------------ ------------ Cash and cash equivalents, end of period ....................................... $ 1,253,071 $ 1,356,092 ============ ============
See Accompanying Notes to Consolidated Financial Statements (unaudited) 7 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2007 (UNAUDITED) 1. Organization On May 7, 2007, we completed the $600.0 million equity investment transaction by MassMutual Capital Partners LLC ("MassMutual Capital"), a member of the MassMutual Financial Group, and SRGL Acquisition, LDC ("SRGL LDC"), an affiliate of Cerberus Capital Management, L.P. ("Cerberus"), announced by us on November 27, 2006 (the "Transaction"). We incurred $44.1 million in closing costs, which resulted in aggregate net proceeds of $555.9 million. Pursuant to the Transaction, MassMutual Capital and Cerberus each invested $300.0 million in us in exchange for 500,000 (1,000,000 in the aggregate) newly issued Convertible Cumulative Participating Preferred Shares (see Note 8), which are convertible into 150,000,000 ordinary shares in the aggregate at any time. On the ninth anniversary of issue, the Convertible Cumulative Participating Preferred Shares will automatically convert into an aggregate of 150,000,000 ordinary shares if not previously converted. Pursuant to Assignment and Assumption Agreements dated as of June 5, 2007 between MassMutual Capital and each of Benton Street Partners I, L.P., Benton Street Partners II, L.P. and Benton Street Partners III, L.P (collectively, the "Funds"), MassMutual Capital assigned its Convertible Cumulative Participating Preferred Shares to the Funds. The sole general partner of each of the Funds is Benton Street Advisors, Inc., an indirect wholly-owned subsidiary of Massachusetts Mutual Life Insurance Company. Also on June 5, 2007, MassMutual Capital, SRGL LDC and Benton Street Advisors, Inc. entered into an Amended and Restated Investors Agreement (the "Amended and Restated Investors Agreement"), in order to reallocate voting and governance rights and obligations of MassMutual Capital to and among the Funds. Pursuant to the Amended and Restated Investors Agreement, MassMutual Capital, SRGL LDC and the Funds agreed, among other things, to: (i) certain restrictions on the transfer of the Convertible Cumulative Participating Preferred Shares, (ii) certain voting provisions with respect to the Company's ordinary shares, (iii) the election of a certain number of directors to the Company's Board and (iv) a third-party sale process. Because of the Amended and Restated Investors Agreement, for the purposes of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, Massachusetts Mutual Life Insurance Company and the Funds are deemed to be members of a group with SRGL LDC and, therefore, the beneficial owners of the securities of the Company beneficially owned by SRGL LDC. On June 5, 2007, SRGL LDC subscribed for and purchased limited partnership interests in Benton Street Partners III, L.P., pursuant to a Subscription Agreement dated as of June 5, 2007 by and between Benton Street Partners III, L.P. and SRGL LDC. Benton Street Partners III, L.P. holds 134,667 Convertible Cumulative Participating Preferred Shares. Pursuant to an Amended and Restated Limited Partnership Agreement dated as of June 5, 2007 by and among Benton Street Advisors, Inc., MassMutual Capital and SRGL LDC, SRGL LDC shares certain rights over the voting and disposition of securities of the Company held by Benton Street Partners III, L.P. Because SRGL LDC directly holds 500,000 Convertible Cumulative Participating Preferred Shares and exercises certain rights over the voting and disposition of the 134,667 Convertible Cumulative Participating Preferred Shares held by Benton Street Partners III, L.P., which Convertible Cumulative Participating Preferred Shares, in the aggregate, may be converted into 95,200,050 ordinary shares, Cerberus is deemed to beneficially own 95,200,050 ordinary shares, or 43.6% of the ordinary shares deemed issued and outstanding as of June 30, 2007. In addition, because of the Amended and Restated Investors Agreement, Cerberus is deemed to beneficially own the 365,333 Convertible Cumulative Participating Preferred Shares, which may be converted into 54,799,950 ordinary shares, beneficially owned by Massachusetts Mutual Life Insurance Company. As of September 30, 2007, MassMutual Capital and Cerberus hold in the aggregate approximately 68.7% of our equity voting power, along with the right to designate two-thirds of the members of the Board of Directors. 2. Basis of presentation Accounting Principles -- The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and the instructions to Form 10-Q and 8 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 2. Basis of presentation (continued) Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results for the interim period are not necessarily indicative of the results to be expected for the full year ending December 31, 2007. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our 2006 Annual Report on Form 10-K for the year ended December 31, 2006 ("2006 Annual Report"). Consolidation -- We consolidate the results of all of our subsidiaries and all variable interest entities for which we are the primary beneficiary. All significant intercompany transactions and balances have been eliminated on consolidation. Estimates, Risks and Uncertainties -- The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported on the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates and assumptions used by management. Our most significant assumptions are for assumed reinsurance liabilities, premiums receivable, deferred acquisition costs, realization of deferred tax assets and valuation of investment impairments. We review and revise these estimates as appropriate. Any adjustments made to these estimates are reflected in the period the estimates are revised. All tabular amounts are reported in thousands of United States dollars, except share and per share data, or as otherwise noted. Certain prior period amounts have been reclassified to conform to the current period presentation. 3. New accounting pronouncements FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes". FIN 48 prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes". Tax positions must meet a "more likely than not" recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. On January 1, 2007, we adopted FIN 48. See Note 7. FASB Statement No. 157, Fair Value Measurements In September 2006, the FASB issued Statement No. 157 ("SFAS No. 157"), "Fair Value Measurements", which defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. We are required to adopt SFAS No. 157 on January 1, 2008 and are currently evaluating the implications of SFAS No. 157 on our results of operations and financial position. 9 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 3. New accounting pronouncements (continued) FASB Statement No. 159, Fair Value Option for Financial Assets and Financial Liabilities In February 2007, the FASB issued Statement No. 159 ("SFAS No. 159"), "Fair Value Option for Financial Assets and Financial Liabilities", which permits entities to choose to measure many financial instruments and certain other items at fair value. A company must report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied on an instrument by instrument basis, with a few exceptions. The fair value option is irrevocable (unless a new election date occurs) and the fair value option may be applied only to entire instruments and not to portions of instruments. SFAS 159 will be effective for interim and annual financial statements issued after January 1, 2008. We are currently evaluating the implications of SFAS No. 159 on our results of operations and financial position. 4. Business segments Our reportable segments are strategic business units that are primarily segregated by geographic region. We report segments in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". Our segments are Life Reinsurance North America, Life Reinsurance International and Corporate and Other. The segment reporting is as follows:
Three months ended September 30, 2007 ------------------------------------------------------------ Life Reinsurance ----------------------------- Corporate North America International & Other Total ------------- ------------- ---------- ---------- Premiums earned, net ................................... $ 428,806 $ 27,534 $ - $ 456,340 Investment income, net ................................. 147,754 3,440 3,256 154,450 Fee and other income ................................... 5,661 (353) 709 6,017 Net realized gains (losses) ............................ (103,182) 245 951 (101,986) Change in value of embedded derivatives, net ........... (14,777) - - (14,777) ---------- ---------- ---------- ---------- Total revenues ....................................... 464,262 30,866 4,916 500,044 ---------- ---------- ---------- ---------- Claims and other policy benefits ....................... 349,811 18,920 - 368,731 Interest credited to interest sensitive contract liabilities ................................. 34,793 - - 34,793 Acquisition costs and other insurance expenses, net ........................................ 89,613 6,167 1,975 97,755 Operating expenses ..................................... 12,841 7,923 16,218 36,982 Collateral finance facilities expense .................. 72,525 - 1,142 73,667 Interest expense ....................................... 3,180 11 113 3,304 ---------- ---------- ---------- ---------- Total benefits and expenses .......................... 562,763 33,021 19,448 615,232 ---------- ---------- ---------- ---------- Loss before income taxes and minority interest ......... $ (98,501) $ (2,155) $ (14,532) $(115,188) ========== ========== ========== ==========
10 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 4. Business segments (continued)
Three months ended September 30, 2006 ----------------------------------------------------------- Life Reinsurance ----------------------------- Corporate North America International & Other Total ------------- ------------- ---------- ---------- Premiums earned, net ................................... $ 421,707 $ 31,814 $ - $ 453,521 Investment income, net ................................. 151,872 8,528 2,008 162,408 Fee and other income ................................... 1,620 - 760 2,380 Net realized gains (losses) ............................ 173 (2,832) 1,587 (1,072) Change in value of embedded derivatives, net ........... (5,891) - - (5,891) ---------- ---------- ---------- ---------- Total revenues ....................................... 569,481 37,510 4,355 611,346 ---------- ---------- ---------- ---------- Claims and other policy benefits ....................... 360,968 16,745 - 377,713 Interest credited to interest sensitive contract liabilities ................................. 42,423 - - 42,423 Acquisition costs and other insurance expenses, net ........................................ 74,082 9,396 2,763 86,241 Operating expenses ..................................... 14,569 7,678 17,200 39,447 Collateral finance facilities expense .................. 63,866 - 3,457 67,323 Interest expense ....................................... 2,986 - 2,019 5,005 ---------- ---------- ---------- ---------- Total benefits and expenses .......................... 558,894 33,819 25,439 618,152 ---------- ---------- ---------- ---------- Income (loss) before income taxes and minority interest .................................... $ 10,587 $ 3,691 $ (21,084) $ (6,806) ========== ========== ========== ==========
Nine months ended September 30, 2007 ----------------------------------------------------------------- Life Reinsurance ------------------------------ Corporate North America International & Other Total ------------- ------------- ------------ ------------ Premiums earned, net ................................... $ 1,282,459 $ 78,391 $ - $ 1,360,850 Investment income, net ................................. 439,122 9,520 8,284 456,926 Fee and other income ................................... 12,288 400 2,193 14,881 Net realized gains (losses) ............................ (108,180) (390) 240 (108,330) Change in value of embedded derivatives, net ........... (5,886) - - (5,886) ------------ ------------ ------------ ------------ Total revenues ....................................... 1,619,803 87,921 10,717 1,718,441 ------------ ------------ ------------ ------------ Claims and other policy benefits ....................... 1,083,379 57,183 - 1,140,562 Interest credited to interest sensitive contract liabilities ................................. 106,515 - - 106,515 Acquisition costs and other insurance expenses, net ........................................ 266,493 17,325 5,545 289,363 Operating expenses ..................................... 38,260 29,190 63,914 131,364 Collateral finance facilities expense .................. 210,466 - 12,181 222,647 Interest expense ....................................... 9,468 11 5,435 14,914 ------------ ------------ ------------ ------------ Total benefits and expenses .......................... 1,714,581 103,709 87,075 1,905,365 ------------ ------------ ------------ ------------ Loss before income taxes and minority interest ......... $ (94,778) $ (15,788) $ (76,358) $ (186,924) ============ ============ ============ ============
11 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 4. Business segments (continued)
Nine months ended September 30, 2006 --------------------------------------------------------------- Life Reinsurance ----------------------------- Corporate North America International & Other Total ------------- ------------- ----------- ----------- Premiums earned, net ................................... $ 1,258,174 $ 89,310 $ - $ 1,347,484 Investment income, net ................................. 412,576 20,488 6,343 439,407 Fee and other income ................................... 8,516 - 2,236 10,752 Net realized gains (losses) ............................ (19,225) (10,878) 4,132 (25,971) Change in value of embedded derivatives, net ........... 11,621 - - 11,621 ------------ ------------ ---------- ------------ Total revenues ....................................... 1,671,662 98,920 12,711 1,783,293 ------------ ------------ ---------- ------------ Claims and other policy benefits ....................... 1,046,874 77,403 - 1,124,277 Interest credited to interest sensitive contract liabilities ................................. 140,523 - - 140,523 Acquisition costs and other insurance expenses, net ........................................ 255,770 18,398 4,476 278,644 Operating expenses ..................................... 43,699 21,329 44,876 109,904 Collateral finance facilities expense .................. 140,300 - 5,346 145,646 Interest expense ....................................... 8,586 - 8,378 16,964 ------------ ------------ ---------- ------------ Total benefits and expenses .......................... 1,635,752 117,130 63,076 1,815,958 ------------ ------------ ---------- ------------ Income (loss) before income taxes and minority interest .................................... $ 35,910 $ (18,210) $ (50,365) $ (32,665) ============ ============ ========== ============
September 30, December 31, 2007 2006 ------------- ------------ Assets Life Reinsurance North America............................................................ $12,019,394 $12,194,291 International............................................................ 456,142 431,222 ----------- ----------- Total Life Reinsurance..................................................... 12,475,536 12,625,513 Corporate & Other.......................................................... 896,407 810,559 ----------- ----------- Total...................................................................... $13,371,943 $13,436,072 =========== ===========
12 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 5. Earnings per ordinary share The following table sets forth the computation of basic and diluted earnings per ordinary share under the two-class method and the if converted method, respectively, as required under SFAS Statement No. 128 ("SFAS No. 128"), "Earnings Per Share" and EITF No. 03-06, "Participating Securities and the Two-Class Method under FASB Statement No. 128". Basic earnings per share is computed based on the weighted average number of ordinary shares outstanding and assumes an allocation of net income to Convertible Cumulative Participating Preferred Shares for the period or portion of the period that this security is outstanding. We determined that in accordance with EITF 98-5, the non-cash beneficial conversion feature recorded on issue of the Convertible Cumulative Participating Preferred Shares amounting to $120.8 million is to be treated as a deemed dividend and deducted from the net loss attributable to ordinary shareholders for the purposes of calculating earnings per share. Under the provisions of SFAS No. 128, basic earnings per share are computed by dividing the net loss attributable to ordinary shareholders by the weighted average number of shares of our ordinary shares outstanding for the period. Diluted earnings per share is calculated based on the weighted average number of shares of ordinary shares outstanding plus the diluted effect of potential ordinary shares in accordance with the if converted method. Basic earnings per share is computed based on the weighted average number of ordinary shares outstanding and assumes an allocation of net income to Convertible Cumulative Participating Preferred Shares for the period or portion of the period that this security is outstanding. Losses are not allocated to Convertible Cumulative Participating Preferred Shares. Under the provisions of SFAS No. 128, basic earnings per share are computed by dividing the net loss attributable to ordinary shareholders by the weighted average number of shares of our ordinary shares outstanding for the period. Diluted earnings per share is calculated based on the weighted average number of shares of ordinary shares outstanding plus the diluted effect of potential ordinary shares in accordance with the if converted method. In accordance with SFAS No. 128, the exercise of options and warrants or conversion of convertible securities is not assumed unless it would reduce earnings per share or increase loss per share.
Three months ended Nine months ended -------------------------------- ------------------------------ September 30, September 30, September 30, September 30, 2007 2006 2007 2006 --------------- ------------- ------------- ------------- Numerator: Net loss ........................................... $ (107,184) $ (27,415) $ (37,706) $ (135,156) Dividend declared on non-cumulative perpetual preferred shares ....................... (2,266) (2,266) (6,797) (6,797) Deemed dividend on beneficial conversion feature .......................................... - - (120,750) - Imputed dividend on prepaid variable share forward contract ................................. - (809) - (881) ------------- ------------- ------------- ------------- Net loss attributable to ordinary shareholders ..................................... $ (109,450) $ (30,490) $ (165,253) $ (142,834) ============= ============= ============= ============= Denominator: Denominator for basic and diluted loss per ordinary share - weighted average number of ordinary shares .................................. 68,383,370 56,933,566 66,939,007 54,708,914 ------------- ------------- ------------- ------------- Basic loss per ordinary share ...................... $ (1.60) $ (0.54) $ (2.47) $ (2.61) ============= ============= ============= ============= Diluted loss per ordinary share .................... $ (1.60) $ (0.54) $ (2.47) $ (2.61) ============= ============= ============= =============
13 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 6. Collateral finance facility Clearwater Re On June 25, 2007, Clearwater Re Limited ("Clearwater") was incorporated under the laws of Bermuda and issued in a private offering $365.9 million of Floating Rate Variable Funding Notes due August 11, 2037 to external investors (the "Clearwater Notes"). Proceeds from this offering were used to fund the Regulation XXX reserve requirements for a defined block of level premium term life insurance policies issued between January 1, 2004 and December 31, 2006 reinsured by Scottish Re (U.S.), Inc. Clearwater replaces the 2004 collateral finance facility with HSBC ("HSBC I"), which has been terminated. Prior to its termination, the HSBC I facility had provided $188.5 million of Regulation XXX reserve funding. Upon termination, this amount was repaid to HSBC in accordance with the termination provisions of the agreement. In addition, HSBC was paid an early termination fee of $2.2 million. Proceeds from the Clearwater Notes have been deposited into a reinsurance credit trust to collateralize the statutory reserve obligations of the defined block of policies noted above. External investors have committed to funding up to $555.0 million in order to fund the ongoing Regulation XXX collateral requirements on this block. Payment of interest and principal under the Clearwater Notes on the maturity date and following an event of default by Clearwater and related acceleration of the Clearwater Notes are guaranteed by Scottish Annuity & Life Insurance Company (Cayman) Ltd. ("SALIC") and by Scottish Re Group Limited ("SRGL). Interest on the principal amount of the Clearwater Notes is payable quarterly at a rate equivalent to three month LIBOR plus a spread determined by SALIC's insurance financial strength rating and SRGL's senior unsecured credit rating. The Clearwater Notes also contain customary events of default provisions, which if breached, could result in the accelerated maturity of the Clearwater Notes. In accordance with FIN 46R, Clearwater Re is considered to be a variable interest entity and we are considered to hold the primary beneficial interest. As a result, Clearwater Re is consolidated in our financial statements beginning in the third quarter of 2007. The assets of Clearwater Re are recorded as fixed maturity investments and cash and cash equivalents. Our consolidated statements of income (loss) include the investment return of Clearwater Re as investment income and the cost of the facility is reflected in collateral finance facilities expense. 7. Income taxes Income tax benefit for the three months ended September 30, 2007 was $7.8 million compared to income tax expense of $20.8 million in the same period in 2006. Income tax benefit for the nine months ended September 30, 2007 was $148.7 million compared to income tax expense of $102.4 million in the same period in 2006. The change in our effective tax rate in the third quarter ended September 30, 2007 compared to the same period in 2006 is primarily related to a release of our valuation allowance which was established in previous periods on deferred tax assets for certain operating entities, as well as an increase in the valuation allowance related to other operating entities for which no current period benefit is being recognized. As discussed in Note 12 to the consolidated financial statements in the 2006 Annual Report, at December 31, 2006 we had a valuation allowance of $304.9 million established against our deferred tax assets. We currently provide a valuation allowance against deferred tax assets when it is more likely than not that some portion, or all, of our deferred tax assets, will not be realized. Our valuation allowance decreased by approximately $27.3 million during the three months ended March 31, 2007 to $277.6 million, including the impact of first quarter activity, the impact from applying FIN 48 and other adjustments. 14 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 7. Income taxes (continued) In the second quarter, our valuation allowance decreased by approximately $203.6 million to $74.0 million. A majority of the valuation release is attributable to the expected utilization of net operating loss carryforwards at the U.S. consolidated tax life group to offset significant current year taxable income generated from the redomestication of Orkney Re, Inc. from South Carolina to Delaware, which occurred in May 2007. We redomesticated Orkney Re, Inc. to Delaware to, among other considerations, take advantage of the synergies created by having both Orkney Re, Inc. and our principle U.S. operating subsidiary, Scottish Re (U.S.), Inc., subject to a single regulator with a more comprehensive understanding of the overall combined business and statutory considerations. The net operating loss carryforwards which were previously written off via a valuation allowance, can now be used as an offsetting valuation allowance release. Other significant activity which offset the valuation allowance release included; the write down of a portion of the U.S. non-life tax group's deferred tax asset in conjunction with the provision of Section 382, as discussed below; and a valuation allowance recorded on the U.K. and Singapore deferred taxes. As of the end of the second quarter of 2007, the majority of our deferred tax assets of the U.S. consolidated tax life group are no longer net operating losses, which in previous periods were subject to a restricted carryforward period. In the third quarter, our valuation allowance increased by approximately $25.3 million to $99.3 million. The movement in the valuation allowance primarily relates to an increase in the valuation allowance recorded on Irish deferred taxes of $25.0 million related to additional losses accrued during the period; a decrease in the valuation allowance attributable to the U.S. non-life group's deferred tax asset; an increase in the valuation allowance attributable to the U.S. life group's deferred tax asset; and finally a reduction to the valuation allowance recorded during previous quarters to date on U.K. deferred taxes. With the exception of unrealized losses, the Company's gross deferred tax asset is principally supported by the reversal of deferred tax liabilities. Additionally, the Company has recognized a deferred tax asset on its unrealized losses. This asset is supported by a tax planning strategy for which management believes that it is more likely than not that the deferred tax asset will be utilized in subsequent periods, although there is a risk that we will need to establish additional valuation allowances in future quarters. Finally, we have maintained a full valuation allowance against any remaining deferred tax asset in the U.S., U.K., Ireland and Singapore, given our inability to rely on future taxable income tax projections. Section 382 event The investments made by MassMutual Capital and Cerberus on May 7, 2007 qualify as a change in ownership under Section 382 of the Internal Revenue Code. Section 382 operates to limit the future deduction of net operating losses that were in existence as of the change in ownership. As a result of this limitation, the Company has written off $134.7 million of net operating losses that it will be unable to utilize prior to expiration with respect to its U.S. entities. Because the Company had previously established a valuation allowance against these net operating losses, there is not a significant tax expense associated with Section 382 limitations. FIN 48 adoption On January 1, 2007, we adopted FIN 48. As a result of the implementation of FIN 48, we recorded a net decrease to our beginning retained earnings of $32.6 million representing a total FIN 48 liability of $78.0 million (excluding previously recognized liabilities of $6.5 million and including interest and penalties of $11.1 million) reduced by a $45.4 million reduction of our existing valuation allowance. We had total unrecognized tax benefits (excluding interest and penalties) of $73.4 million at January 1, 2007, the recognition of which would result in a $28.0 million benefit to the effective tax rate. At September 30, 2007 we had total unrecognized tax benefits (excluding interest and penalties) of $171.9 million, the recognition of which would result in a $63.4 million benefit to the effective tax rate. Our policy for recording interest and penalties associated with uncertain tax positions is to record such items as a component of income tax expense (on a going forward basis excluding the initial amount noted above). We do not reasonably estimate that the unrecognized tax benefit will change significantly within the next twelve months. 15 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 7. Income taxes (continued) We file our tax returns as prescribed by the tax laws of the jurisdictions in which we operate. As of September 30, 2007, we remained subject to examination in the following major tax jurisdictions for the years indicated below: Major Tax Jurisdictions Open Years ----------------------- ---------- U.S. Life Group.............................. 2001 through 2006 Non-Life Group.......................... 2005 through 2006 Ireland................................... 2002 through 2006 U.K....................................... 2001 through 2006 8. Mezzanine equity Convertible cumulative participating preferred shares On May 7, 2007, in connection with the Transaction with MassMutual Capital and Cerberus, we issued in a private offering 1,000,000 Convertible Cumulative Participating Preferred Shares. The gross proceeds were $600.0 million less $44.1 million in closing costs, which resulted in aggregate net proceeds of $555.9 million. Each Convertible Cumulative Participating Preferred Share has a par value of $0.01 per share with a liquidation preference of $600 per share, as adjusted for dividends or distributions as described further below. The Convertible Cumulative Participating Preferred Shares are convertible at the option of the holder, at any time, into an aggregate of 150,000,000 ordinary shares of SRGL. On the ninth anniversary of issue, the Convertible Cumulative Participating Preferred Shares will automatically convert into an aggregate of 150,000,000 ordinary shares if not previously converted. We are not required at any time to redeem the Convertible Cumulative Participating Preferred Shares for cash, except in the event of a liquidation or a change-in-control event. We have accounted for the Convertible Cumulative Participating Preferred Shares in accordance with EITF D-98: "Classification and Measurement of Redeemable Securities". Dividends on the Convertible Cumulative Participating Preferred Shares are cumulative and accrete daily on a non-compounding basis at a rate of 7.25% per annum on the stated value of $600.0 million, and shall be accrued but not paid at such time. Dividends will only be paid in a liquidation preference scenario upon liquidation or change-in-control of the Company prior to the ninth anniversary. There have been no dividends accrued in the period as this scenario is not deemed probable at this time. As of September 30, 2007, the amount of dividends not accrued pursuant to the terms of the Convertible Cumulative Participating Preferred Shares is $17.6 million. To the extent that the Convertible Cumulative Participating Preferred Shares participate on an as-converted basis in dividends paid on ordinary shares, a corresponding reduction will be made to the liquidation preference for the Convertible Cumulative Participating Preferred Shares. The Convertible Cumulative Participating Preferred Shares have a liquidation preference equal to their stated value, as adjusted for (x) the accretion of dividends and (y) any cash payment or payment in property of dividends or distributions. The holders of Convertible Cumulative Participating Preferred Shares may, among other things, require us to redeem the Convertible Cumulative Participating Preferred Shares upon a change-in-control. Upon a change-in-control, the redemption price is an amount equal to the greater of (i) the stated value of the outstanding Convertible Cumulative Participating Preferred Shares, plus an amount equal to the sum of all accrued dividends through the earlier of (A) the date of payment of the consideration payable upon a change-in-control, or (B) the fifth anniversary of the issue date of the Convertible Cumulative Participating Preferred Shares, or (ii) the amount that the holder of the Convertible Cumulative 16 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 8. Mezzanine equity (continued) Participating Preferred Shares would have been entitled to receive with respect to such change-in-control if it had exercised its right to convert all or such portion of its Convertible Cumulative Participating Preferred Shares for ordinary shares immediately prior to the date of such change-in-control. The liquidation preference of the Convertible Cumulative Participating Preferred Shares is not applicable once the Convertible Cumulative Participating Preferred Shares have been converted into ordinary shares, as described above. The Convertible Cumulative Participating Preferred Shares conversion price ($4.00 per ordinary share) was lower than the trading value of $4.66 of our ordinary shares on the date of issue. This discount has been accounted for as an embedded beneficial conversion feature in accordance with EITF 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios", and EITF 00-27, "Application of Issue No. 98-5 to Certain Convertible Instruments". Accordingly the Company recognized a $120.8 million embedded beneficial conversion feature, which reduced the Convertible Cumulative Participating Preferred Share issue amount shown in Mezzanine Equity and increased the amount of additional paid in capital. Under the accounting guidance above, we had the choice to accrete the full intrinsic value of the embedded beneficial conversion feature out of retained earnings over the nine year term of the shares or immediately due to the ability of the holders to convert at their option at any time. Given the ability of the holders to convert at any time, we have elected to accrete the full intrinsic value of the embedded beneficial conversion feature on the date of issue. As we did not have any retained earnings on the date of issue, this has resulted in the $120.8 million beneficial conversion feature being accreted out of additional paid in capital into Mezzanine Equity. Hybrid capital units On December 17, 2003 and December 22, 2003, we issued in a public offering a total of 5,750,000 Hybrid Capital Units ("HyCUs"). The aggregate net proceeds were $141.9 million. Each HyCU consisted of (i) a purchase contract ("purchase contract") to which the holder was obligated to purchase from us, on February 15, 2007, an agreed upon number of ordinary shares for a price of $25.00 and (b) a convertible preferred share with a liquidation preference of $25.00 ("Convertible Preferred Share"). Holders of the HyCUs had the option to allow the Convertible Preferred Shares to be included in the remarketing process and use the proceeds of the remarketing to settle the purchase contract or elect not to participate in the remarketing by either delivering the requisite amount of cash to settle the purchase contract or surrendering the Convertible Preferred Shares. On January 25, 2007, we gave notice to holders of the HyCUs that we were unable to satisfy certain conditions precedent to the remarketing that were contained in the Remarketing Agreement and, therefore, the remarketing of the Convertible Preferred Shares had failed. Accordingly, holders of the HyCUs only had the option to settle the purchase contracts in cash or surrender the Convertible Preferred Shares. On February 15, 2007, we received cash proceeds of $7.3 million to settle purchase contracts, in exchange for 293,500 of our ordinary shares. We also released to the settling holder 293,500 Convertible Preferred Shares which were previously held as collateral against the holder's obligation under the purchase contracts. Also on February 15, 2007, we issued 7,146,978 of our ordinary shares to the holders of our HyCUs who did not settle in cash, and who had elected to surrender their Convertible Preferred Shares. On February 22, 2007, we exercised our right to foreclose on the 5,456,500 Convertible Preferred Shares held as collateral for the 5,456,500 purchase contracts that were not settled in cash. 17 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 8. Mezzanine equity (continued) In aggregate, we issued 7,440,478 of our ordinary shares on February 15, 2007. We redeemed the 293,500 Convertible Preferred Shares for an aggregate of $7.3 million plus accrued dividends on May 21, 2007. Following their redemption on May 21, 2007, there were no Convertible Preferred Shares outstanding. 9. Contingencies Mediation On June 16, 2005, we requested mediation from Employers Reinsurance Corporation ("ERC") pursuant to the stock purchase agreement transferring a 95% interest in Scottish Re Life Corporation (formerly ERC Life Corporation) to Scottish Holdings, Inc. We assert that ERC breached certain representations and warranties under the agreement. Any negative outcome from this mediation will not have a material adverse impact on our financial position because the asserted breaches have already been fully reflected in our financial position at September 30, 2007. The parties have held two mediation sessions, but have been unable to resolve the dispute. No date has been scheduled for a future mediation session. Class action lawsuit On August 2, 2006, a putative class action lawsuit was filed against us and certain of our current and former officers and directors in the U.S. District Court for the Southern District of New York on behalf of a putative class consisting of investors who purchased our publicly traded securities between December 16, 2005 and July 28, 2006. Between August 7, 2006 and October 3, 2006, seven additional related class action lawsuits were filed against us, certain of our current and former officers and directors, and certain third parties. Two of the complaints were filed on August 7, 2006, and the remaining five complaints were filed on August 14, 2006, August 22, 2006, August 23, 2006, September 15, 2006, and October 3, 2006, respectively. Each of the class actions filed seeks an unspecified amount of damages, as well as other forms of relief. On October 12, 2006, all of the class actions were consolidated. On December 4, 2006, a consolidated class action complaint was filed. The complaint names us; Dean E. Miller, our former Chief Financial Officer; Scott E. Willkomm, our former Chief Executive Officer; Elizabeth Murphy, our former Chief Financial Officer; our former Board members Michael Austin, Bill Caulfeild-Browne, Robert Chmely, Michael French, Lord Norman Lamont, Hazel O'Leary, and Glenn Schafer; and certain third parties, including Goldman Sachs and Bear Stearns in their capacities as underwriters in various securities offerings by us and Ernst & Young LLP in their capacity as independent registered public accounting firm. The complaint is brought on behalf of a putative class consisting of investors who purchased our securities between February 17, 2005 and July 31, 2006. The complaint alleges violations of Sections 10(b) and 20(a) of the Exchange Act, Rule 10b-5, and Sections 11, 12(a)(2), and 15 of the Securities Act. The complaint seeks an unspecified amount of damages, as well as other forms of relief. On March 7, 2007 we filed a motion to dismiss the putative class action lawsuit. On November 2, 2007, the Court dismissed the Section 10(b) and Rule 10b-5 claims against Ernst & Young LLP, but gave the plaintiffs leave to amend. The Court denied the motions to dismiss brought by the other named defendants. The Company believes the plaintiffs' claims to be without merit and intends to defend itself against them. 18 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 9. Contingencies (continued) Shareholder derivative lawsuit In addition, on October 20, 2006, a shareholder derivative lawsuit was filed against certain of our current and former directors in the U.S. District Court for the Southern District of New York. The derivative lawsuit alleges, among other things, that defendants improperly permitted us to make false and misleading statements to investors concerning our business and operations, thereby exposing us to liability from class action suits alleging violations of the U.S. securities laws. The derivative lawsuit asserts claims against defendants for breach of fiduciary duty, abuse of control, gross mismanagement, constructive fraud, and unjust enrichment. On January 8, 2007 we filed a motion to dismiss the derivative lawsuit. On May 7, 2007, our motion was granted and the lawsuit was dismissed without prejudice. The plaintiff declined to submit an amended complaint and, on May 30, 2007, the court dismissed the case with prejudice. Ballantyne Re The terms of the Class C-1 and Class C-2 Notes issued in connection with the Ballantyne Re securitization require Ballantyne Re to write-off all or a portion of the accrued interest and principal of the notes if the equity balance of Ballantyne Re (determined in accordance with International Financial Reporting Standards) falls below a specified amount as of September 30 of any year. As of September 30, 2007, such equity balance fell below this specified amount primarily due to mark to market declines affecting a large portion of Ballantyne Re's investment portfolio. We are currently attempting to amend the Notes to postpone the determination date for any write-off of the Class C-1 Notes for a 12-month period, although such an amendment requires the consent of certain third parties. Absent this amendment, we expect that a portion of the $42.0 million principal amount of Class C-1 Notes held by third parties would be written off, in addition to any accrued and unpaid interest. Indemnification In connection with an examination of the statutory accounting books of certain of our operating insurance subsidiaries, and specifically, the purchase accounting entries made in connection with the 2004 acquisition of the ING business, we determined that certain intercompany receivables and intercompany claims were not reflected in the statutory financial statements of Scottish Re (U.S.), Inc. and Scottish Re (Dublin) Limited in accordance with applicable statutory accounting practices. Management has determined that as a result of these errors the statutory surplus for Scottish Re (Dublin) Limited was overstated on a cumulative basis at year end 2004, 2005 and 2006, resulting in a restated statutory surplus at year end 2006 of approximately $285.0 million after giving effect to these corrections. In addition, management has determined that the statutory surplus for Scottish Re (U.S.), Inc. was understated on a cumulative basis at year end 2005 and 2006, resulting in a restated statutory surplus at year end 2006 of approximately $344.0 million after giving effect to these corrections. The restated statutory surplus of each of Scottish Re (U.S.), Inc. and Scottish Re (Dublin) Limited met the applicable minimum statutory surplus requirements at December 31, 2006. None of these corrections impact our historical consolidated financial statements under U.S. GAAP. Pursuant to our Securities Purchase Agreement, dated November 26, 2006 (the "Agreement") with Mass Mutual Capital and Cerberus, we made certain representations and warranties regarding the statutory financial statements of each of our insurance subsidiaries, including Scottish Re (Dublin) Limited and Scottish Re (U.S.), Inc., for the years ended 2003, 2004 and 2005 and, with respect to Scottish Re (U.S.), Inc. but not Scottish Re (Dublin) Limited, the first three quarters of 2006, including that these statements were prepared in conformity with applicable statutory accounting practices and fairly present in accordance with such practices in all 19 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 9. Contingencies (continued) material respects the statutory financial condition of the relevant insurance subsidiary at the respective dates. In light of our recent discovery of the corrections described above, we have notified the Investors, as required by the terms of the Agreement, of the overstatement of statutory surplus in Scottish Re (Dublin) Limited at year end 2004 and the understatement of such statutory surplus at year end 2005 resulting in a cumulative overstatement for the two year period at year end 2005 of approximately $70.6 million on an after-tax basis, and the understatement of statutory surplus in Scottish Re (U.S.), Inc. for the year ended 2005 of approximately $14.5 million on an after-tax basis. It is possible that the Investors may assert a claim against us for indemnification of losses (including diminution in value), if any, they may have incurred as a result of these inaccuracies. Under the Agreement, in the event of a claim for losses resulting from a diminution in value, such losses would be determined by an independent investment banking firm of national reputation, agreed upon by us and the Investors, based on changes in the valuation of Scottish Re Group Limited using the assumptions and models used by the Investors at the time of their decision to invest in us. Furthermore, should any claim for indemnification be made by the Investors, the Agreement provides that any decision regarding defending or settling such claim will be taken by a committee of independent directors of our Board of Directors. At this time, we do not know if any actual claim for indemnification will be asserted, if asserted what the amount of any indemnifiable losses would be, if any, or what potential defenses or other limitations on indemnification may be available to the Company under those circumstances. The Agreement provides that any indemnification claim would be satisfied by adjusting the conversion amount at which the Convertible Cumulative Preferred Shares issued to the Investors are convertible into our Ordinary Shares. We have been informed of the Investors' intention to file an indemnification claim on this matter although no such claim has been received by the Company at this time. 10. Stock based compensation 2007 Stock Option Plan On July 18, 2007, the shareholders of the Company approved and adopted the Scottish Re Group Limited 2007 Stock Option Plan ("2007 Plan"). The 2007 Plan provides for the granting of stock options to eligible employees, directors and consultants of the Company. The total number of our shares reserved and available for issuance under the 2007 Plan is 18,000,000. The exercise price of stock options granted under the 2007 Plan shall be the fair market value of our ordinary shares on the date of grant and such options shall expire ten years after the date of grant, or such shorter period as determined by the Compensation Committee (unless earlier exercised or terminated pursuant to the terms of the 2007 Plan). On July 18, 2007, we issued 2,250,000 options to directors and 8,370,000 options to eligible employees. Options issued under the 2007 Plan vest as follows: o 50% of an option grant to an employee or consultant vests based on the recipient's continued employment with the Company ("Time-Based Options"). 20% of the Time-Based Options vest on the grant date and an additional 20% vest in four equal installments on each of the first, second, third and fourth anniversary of the grant date, based on continued employment. The Time-Based Options are exercisable upon vesting. o 50% of an option grant to an employee or consultant vests based on the achievement of certain performance targets as established by the Board with respect to each relevant fiscal year ("Performance-Based Options"). 10% of the Performance-Based Options vest following the close of each of the five fiscal years following the grant date, subject to the Company's attainment of the performance targets established by the Board with respect to the relevant fiscal year. In addition, 10% of the Performance-Based Options vest following the close of each of the five fiscal years following the grant date, subject to the recipient's respective division's or segment's attainment of the performance targets established by the Board with respect to the relevant fiscal year. Although the Performance-Based Options may vest, they shall not become exercisable until the end of the fifth fiscal year following May 7, 2007; provided, however, that if the Company achieves an A- rating or better from Standard & Poor's or AM Best within eighteen (18) months following the closing of the Transaction, all Performance-Based Options with regard to fiscal years 2007 and 2008 will fully vest and become exercisable. 20 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 10. Stock based compensation (continued) o 100% of options granted to directors vest on the grant date and are exercisable. Upon a change of control (as defined in the 2007 Plan), to the extent not previously cancelled or forfeited, all Time-Based Options and Performance-Based Options shall become 100% vested and exercisable. Option activity Option activity under the 2007 Plan for the three months ended September 30, 2007 is as follows:
Outstanding, beginning of period...... - Granted............................... 6,535,000 Cancelled............................. (80,500) ---------- Outstanding, end of period............ 6,454,500 ========== Options exercisable, end of period.... 3,044,500 ==========
Of the 10,620,000 options issued on July 18, 2007, 6,535,000 are Time-Based Options and 4,085,000 are Performance Based options. As at September 30, 2007, only the Time-Based Options are considered granted and fair valued as we have not yet finalized the performance criteria of the Performance-Based Options to eligible employees. The terms and conditions for the Performance-Based Options are to be finalized and communicated to eligible employees in the fourth quarter of 2007 and at that time, in accordance with SFAS No. 123(R) "Share Based Payment", we can determine a grant date, calculate the fair value and recognize the expense of the Performance-Based Options. During the three months ended September 30, 2007, the following activity occurred under the 2007 Plan:
Weighted average grant date fair value of options................................. $ 2.8902 Total fair value of options vested........ $ 8,799,214
Valuation of options Stock options are accounted for in accordance with SFAS 123(R) "Share Based Payment". The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model, which uses the assumptions noted in the following table. o Expected dividend yield - The Company does not have a dividend policy at this time. We have assumed no dividends and under the Forbearance Agreement with HSBC, we are prohibited from declaring any cash dividend, exclusive of the Non-Cumulative Perpetual Preferred Shares, during the forbearance period from November 26, 2006 until December 31, 2008 and, therefore, we have used 0% for the expected dividend yield. 21 SCOTTISH RE GROUP LIMITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) SEPTEMBER 30, 2007 (UNAUDITED) 10. Stock based compensation (continued) o Expected volatility - The expected volatility is a measure of the amount by which a price has fluctuated and is expected to fluctuate during a period of time. The expected volatility of the Company's stock is based on historical volatility. o Expected term - The expected term represents the anticipated amount of time between the grant date of the option and the exercise date or cancellation date based on historical data. o Risk free interest rate - The risk-free interest rate at the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. September 30, 2007 -------------------- Expected dividend yield.......................... 0.00% Expected volatility.............................. 63.4% Expected term of Time-Based Options.............. 5.6 years Risk free interest rate for Time-Based Options... 4.97% Compensation expense Compensation expense for stock options for the three months ended September 30, 2007 was $9.0 million. We recognize compensation costs for stock options with pro-rata vesting evenly over the requisite service period. As of September 30, 2007, there was $9.8 million of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a period of four years. Compensation expense for stock-based compensation for the nine months ended September 30, 2007 was $19.1 million, which includes $10.1 million of compensation expense associated with the pre-Transaction stock-based compensation plans. Upon closing the Transaction on May 7, 2007, all previously unrecognized compensation expense associated with the pre-Transaction stock-based compensation plans was recognized immediately. Under the pre-Transaction stock-based compensation plans, compensation expense for the three and nine months ended September 30, 2006 was $(3.0) million and $1.6 million, respectively. As of September 30, 2006, there was $7.8 million of unrecognized compensation expense related to stock-based compensation plans, which was expected to be recognized over a period of up to three years. 11. Form 10-K Disclosure - Consolidated statements of comprehensive income On December 31, 2006, we adopted Financial Accounting Standards SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and other Postretirement Plans". Upon adoption we recorded a $2.9 million reduction in comprehensive income (loss) for the year ended December 31, 2006. However, the cumulative effect of the change in accounting, net of tax should have been recorded as a separate component of accumulated other comprehensive income (loss). As of December 31, 2006, we reported comprehensive loss of $356.4 million for the year. With this revised presentation, comprehensive loss for the year ended December 31, 2006 would have been $353.5 million. This revised presentation will be reflected in our Form 10-K for the year ending December 31, 2007, since we consider the adjustment to be not material in the context of comprehensive income (loss) for the year ended December 31, 2006. 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General Forward-Looking Statements Some of the statements contained in this report are not historical facts and are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results to differ materially from the forward-looking statements. Words such as "anticipates", "expects", "intends", "plans", "believes", "seeks", "estimates", "may", "will", "continue", "project", and similar expressions, as well as statements in the future tense, identify forward-looking statements. These forward-looking statements are not guarantees of our future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements. These risks and uncertainties include: o uncertainties relating to the ratings accorded to us and our insurance subsidiaries; o uncertainties in our ability to raise equity capital or other sources of funding to support ongoing capital and liquidity needs; o uncertainties relating to future actions that may be taken by creditors, regulators and ceding insurers relating to our ratings and financial condition; o the risk that our risk analysis and underwriting may be inadequate; o changes in expectations regarding future realization of gross deferred tax assets; o exposure to mortality experience which differs from our assumptions; o risks related to recent negative developments in the residential mortgage market, especially in the sub-prime sector, and our exposure to such market; o risks arising from our investment strategy, including risks related to the market value of our investments, fluctuations in interest rates and our need for liquidity; o uncertainties arising from control of our invested assets by third parties; o developments in global financial markets that could affect our investment portfolio and fee and other income; o changes in the rate of policyholder withdrawals or recapture of reinsurance treaties, whether caused by ratings pressures or general market conditions; o the impact of adjustments to previous financial estimates arising from our process improvement program under which we, among other things, enhance the automation of our reporting, valuation and administrative tools (such as cedant and retrocession accounting); o the risk that our retrocessionaires may not honor their obligations to us; o terrorist attacks on the United States and the impact of such attacks on the economy in general and on our business in particular; o political and economic risks in developing countries; o the impact of acquisitions, including our ability to successfully integrate acquired businesses, the competing demands for our capital and the risk of undisclosed liabilities; o the risk that an ownership change will result in a limitation on our ability to fully utilize tax net operating losses; o loss of the services of any of our key employees; 23 o losses due to foreign currency exchange rate fluctuations; o uncertainties relating to government and regulatory policies (such as subjecting us to insurance regulation or taxation in additional jurisdictions); o risks relating to recent class action litigations; o the competitive environment in which we operate and associated pricing pressures; and o changes in accounting principles. The effects of these factors are difficult to predict. New factors emerge from time to time and we cannot assess the financial impact of any such factor on our business or the extent to which any factor, or combination of factors, may cause results to differ materially from those contained in any forward-looking statement. Any forward-looking statement speaks only as of the date of this report and we do not undertake any obligation, other than as may be required under the Federal securities laws, to update any forward looking statements to reflect events or circumstances after the date of such statement or to reflect the occurrence of unanticipated events. This discussion and analysis should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited Consolidated Financial Statements and Notes thereto, presented under Item 7 and Item 8, respectively, of our 2006 Annual Report. Overview See the introduction to "Management's Discussion & Analysis of Financial Condition and Results of Operations" contained in our 2006 Annual Report. Status of Financial Strength and Credit Ratings As of November 9, 2007, our insurer financial strength and credit ratings are as follows:
Moody's A.M. Best Fitch Investors Standard Company (1) Ratings (2) Service (2) & Poor's (3) ----------- ----------- ----------- ------------ Insurer Financial Strength - -------------------------- Ratings: - ------- Scottish Annuity & Life Insurance Company (Cayman) Ltd B+ BBB- Baa3 BB+ Scottish Re (U.S.), Inc......... B+ BBB- Baa3 BB+ Scottish Re Limited............. B+ BBB- - BB+ Scottish Re Life Corporation.... B+ - - BB+ Scottish Re Group Limited Credit - -------------------------------- Ratings: ------- Senior unsecured................ bb- BB- Ba3 B+ Preferred stock................. b B B2 CCC+
- ---------------------------- 1 Negative outlook 2 Stable outlook 3 Developing outlook The ability to write reinsurance partially depends on an insurer's financial condition and its financial strength ratings. These ratings are based on an insurance company's ability to pay policyholder obligations and are not directed toward the protection of investors. Our ability to raise capital for our business and the cost of this capital is influenced by our credit ratings. A security rating is not a recommendation to buy, sell or hold securities. It is subject to revision or withdrawal at any time by the assigning rating organization, and each rating should be evaluated independently of any other rating. 24 Critical Accounting Policies SFAS No. 123(R) "Share Based Payment" Effective January 1, 2006, we adopted SFAS No. 123(R) "Share Based Payment". In accordance with SFAS No. 123(R), compensation cost is determined on the option grant date using the Black-Scholes model to estimate the fair value of the option. Under SFAS No. 123(R), the grant date for all Time-Based Options is the date the options are issued, while the grant date for all Performance-Based Options is the date the performance criteria are communicated to the option holders, which may occur substantially after the issuance date. Compensation cost, net of estimated pre-vesting forfeitures, is then recognized on a straight-line basis over the requisite service period (vesting period). However, per SFAS No. 123(R), compensation cost for the Performance-Based Options is only recognized when it is probable that the performance criteria will be met. Compensation cost is recognized as a component of operating expenses with a corresponding increase in additional paid in capital. The Black-Scholes model incorporates six key factors: (i) the price of the Company's stock on the grant date, (ii) the exercise price of the option, (iii) the expected term of the option, (iv) the expected volatility of the Company's stock, (v) the expected dividend rate and (vi) the risk-free interest rate as of the grant date. Several of these factors (the expected term of the option, the expected volatility of the Company's stock, and the expected dividend rate) incorporate management's judgment, which could materially impact the fair value of the option. Management has used historical Company data to estimate the expected term or amount of time between the option grant date and the exercise/cancellation date. The expected term of the option is also used to select the risk-free interest rate as of the grant date. The expected volatility of the Company's stock is based on historical volatility. As the Company is currently prohibited from declaring any cash dividends, management has used an expected dividend rate of zero in calculating the fair value of the option. See the discussion of our additional Critical Accounting Policies in Item 7 of our 2006 Annual Report. 25 Results of Operations - Three and Nine Months Ended September 30, 2007 and 2006 All amounts are reported in thousands of United States dollars, except share amounts. Consolidated results of operations
Three months ended Nine months ended ----------------------------- ----------------------------- September 30, September 30, September 30, September 30, 2007 2006 2007 2006 ------------- ------------- ------------- ------------- Premiums earned, net ................................... $ 456,340 $ 453,521 $ 1,360,850 $ 1,347,484 Investment income, net ................................. 154,450 162,408 456,926 439,407 Fee and other income ................................... 6,017 2,380 14,881 10,752 Net realized losses .................................... (101,986) (1,072) (108,330) (25,971) Change in value of embedded derivatives, net ........... (14,777) (5,891) (5,886) 11,621 ------------ ------------ ------------ ------------ Total revenues ....................................... 500,044 611,346 1,718,441 1,783,293 ------------ ------------ ------------ ------------ Claims and other policy benefits ....................... 368,731 377,713 1,140,562 1,124,277 Interest credited to interest sensitive contract liabilities ................................. 34,793 42,423 106,515 140,523 Acquisition costs and other insurance expenses, net ........................................ 97,755 86,241 289,363 278,644 Operating expenses ..................................... 36,982 39,447 131,364 109,904 Collateral finance facilities expense .................. 73,667 67,323 222,647 145,646 Interest expense ....................................... 3,304 5,005 14,914 16,964 ------------ ------------ ------------ ------------ Total benefits and expenses .......................... 615,232 618,152 1,905,365 1,815,958 ------------ ------------ ------------ ------------ Loss before income taxes and minority interest ......... (115,188) (6,806) (186,924) (32,665) Income tax benefit (expense) ........................... 7,777 (20,841) 148,717 (102,427) ------------ ------------ ------------ ------------ Loss before minority interest .......................... (107,411) (27,647) (38,207) (135,092) Minority interest ...................................... 227 232 501 (64) ------------ ------------ ------------ ------------ Net loss ............................................... (107,184) (27,415) (37,706) (135,156) Dividend declared on non-cumulative perpetual preferred shares ..................................... (2,266) (2,266) (6,797) (6,797) Deemed dividend on beneficial conversion feature .............................................. - - (120,750) Imputed dividend on prepaid variable share forward contract ..................................... - (809) - (881) ------------ ------------ ------------ ------------ Net loss attributable to ordinary shareholders ......... $ (109,450) $ (30,490) $ (165,253) $ (142,834) ============ ============ ============ ============
Net loss attributable to ordinary shareholders increased by 259% to $109.5 million for the three months ended September 30, 2007 compared to $30.5 million in the same period in 2006 and increased by 16% to $165.3 million for the nine months ended September 30, 2007 compared to $142.8 million in the same period in 2006. The increase in net loss attributable to ordinary shareholders for the three and nine months ended September 30, 2007 is primarily the result of the impact of write-downs taken on our sub-prime and Alt-A bonds held within our consolidated investment portfolio. Revenues Total revenues decreased by 18% to $500.0 million for the three months ended September 30, 2007 compared to $611.3 million in the same period in 2006, primarily due to the write-downs taken on our sub-prime and Alt-A bonds and changes in the value of embedded derivatives relating to our funds withheld at interest. Premiums earned increased 1% to $456.3 million for the three months ended September 30, 2007 compared to $453.5 million in the same period in 2006. During the prior year quarter, there was a $16.5 million negative change in estimate related to experience refunds in our Life Reinsurance North America Segment. Excluding the effects of this adjustment, premiums earned has decreased by $13.7 million compared to the prior year quarter due primarily to lower new business production and lapsation effects. Investment income decreased by 5% to $154.5 million for the three months ended September 30, 2007 compared to $162.4 million in the same period in 2006. This decrease is primarily the result of reduced investment income on annuity business relating to declining account values resulting from higher lapses. The decrease was partially offset by an increase in interest rates. 26 Realized losses for the quarter increased to $102.0 million for the three months ended September 30, 2007 compared to $1.1 million in the same period in 2006. The increase is primarily due to write-downs taken on our sub-prime and Alt-A bonds during the quarter. The net embedded derivative movement increased to a $14.8 million loss for the three months ended September 30, 2007 compared to a $5.9 million loss in the same period in 2006. These embedded derivatives relate to our funds withheld at interest on modified coinsurance treaties under DIG B36 "Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures that Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor Under Those Instruments". The increase during the quarter is primarily due to a change in the yield curve used to value the derivatives. Total revenues decreased by 4% to $1,718.4 million for the nine months ended September 30, 2007 compared to $1,783.3 million in the same period in 2006 due to the impact of write-downs taken on our sub-prime and Alt-A bonds. Premiums earned increased by 1% to $1,360.9 million for the nine months ended September 30, 2007 compared to $1,347.5 million in the same period in 2006. The increase is primarily the result of a $13.4 million increase in premium earned in the Life Reinsurance North America Segment partially offset by a $10.9 million decrease in the Life Reinsurance International Segment. In the Life Reinsurance North America Segment, the increase is primarily due to the aforementioned $16.5 million negative experience refund change in estimate in the third quarter of 2006 along with a negative premium accrual adjustment of $8.0 million in the second quarter of 2006. In the Life Reinsurance International Segment, the decrease primarily relates to the retrocession of our Middle Eastern business and adjustments to premium accruals on treaties in runoff. Investment income increased by 4% to $456.9 million for the nine months ended September 30, 2007 compared to $439.4 million in the same period in 2006. The increase is primarily the result of higher interest rates and the level of our average invested assets, which include the $556.0 million received in connection with the closing of the Transaction with MassMutual Capital and Cerberus. In the prior year, our invested assets increased due to the closing of the Ballantyne Re securitization in May 2006 which contributed $1.7 billion to our invested asset base and the closing of a $560.0 million annuity contract, which was subsequently recaptured in the third quarter of 2006. These positive variances are partially offset by the effect of the termination of four funding agreements in 2006 and by a continued decline in account values on certain Life Reinsurance North America Segment annuity treaties due to higher lapse rates. Realized losses for the nine months ended September 30, 2007 increased to $108.3 million compared to $26.0 million in the same period in 2006. The increase is primarily due to write-downs taken on our sub-prime and Alt-A investments during the quarter. The net embedded derivative movement for the nine months ended September 30, 2007 decreased to a $5.9 million compared to an $11.6 million gain in the same period in 2006. The movement is partially due to a change in the yield curve used to value the derivatives in the current quarter and partially related to a prior year realization of losses on certain securities held under a modified coinsurance arrangement that were sold in the first quarter of 2006 in order to provide collateral for the Ballantyne Re securitization. Benefits and expenses Claims and other policy benefits decreased by 2% to $368.7 million for the three months ended September 30, 2007 compared to $377.7 million in the same period in 2006. The decrease is primarily the result of favorable mortality due to lower claims volume and fewer large claims in the Life Reinsurance North America Segment. Interest credited to interest sensitive contract liabilities decreased by 18% to $34.8 million for the three months ended September 30, 2007 compared to $42.4 million in the same period in 2006. The decrease is primarily the result of $4.9 million interest credited in the third quarter of 2006 on the aforementioned terminated funding agreements. Also contributing to the decrease was lower interest credited on annuity business relating to declining account values resulting from higher lapses in the Life Reinsurance North America Segment. Acquisition costs and other insurance expenses increased by 13% to $97.8 million for the three months ended September 30, 2007 compared to $86.2 million in the same period in 2006. The increase is primarily the result of a $15.5 million increase in the Life Reinsurance North America Segment due to the unfavorable impact of unlocking deferred acquisition costs on certain interest sensitive 27 contracts. This was as a result of higher than expected policy surrenders in the current period along with the effect of a third quarter of 2006 change in estimate for expense allowances on certain interest sensitive contracts that reduced expenses for that quarter. This is offset by a decrease in the Life Reinsurance International Segment of $3.2 million which relates to the high level of costs incurred in the third quarter of 2006 to honor secondary collateral obligations in respect of a recaptured annuity agreement. Operating expenses decreased by 6% to $37.0 million for the three months ended September 30, 2007 compared to $39.4 million in the same period in 2006. The decrease is primarily the result of lower professional fees along with the prior year effect of executive severance paid in the third quarter of 2006 in both the Life Reinsurance North America Segment and Corporate and Other Segment. Collateral finance facilities expense increased by 9% to $73.7 million for the three months ended September 30, 2007 compared to $67.3 million in the same period in 2006. The increase is primarily the result of higher guarantor costs relating to ratings downgrades and the timing of implementation of our Clearwater Re securitization which coincides with the termination of the HSBC I securitization in the Life Reinsurance North America Segment. This is offset by the reduced borrowing cost on the Stingray financing facility in the Corporate and Other Segment, which was fully drawn down during the third quarter of 2006 and repaid in June 2007. Claims and other policy benefits increased by 1% to $1,140.6 million for the nine months ended September 30, 2007 compared to $1,124.3 million in the same period in 2006. The increase is primarily the result of an $11.1 million increase in the Life Reinsurance North America Segment, which is consistent with expectations for a growing block of early duration mortality risk business for which the increase in year over year mortality rates exceeds the underlying rate of lapsation. This was partially offset by a net $2.2 million decrease in the Life Reinsurance International Segment due to the retrocession of our Middle Eastern business in January 1, 2007. Interest credited to interest sensitive contract liabilities decreased by 24% to $106.5 million for the nine months ended September 30, 2007 compared to $140.5 million in the same period in 2006. The decrease is primarily the result of the termination of four funding agreements in the third quarter of 2006 along with a continued decline in account values on some Life Reinsurance North America Segment annuity treaties due to higher surrender levels. Acquisition costs and other insurance expenses increased by 4% to $289.4 million for the nine months ended September 30, 2007 compared to $278.6 million in the same period in 2006. In the Life Reinsurance North America Segment, acquisition costs and other insurance expenses are consistent at 21% of premium earned compared to 2006. In the Life Reinsurance International Segment acquisition costs and other insurance expenses have decreased due to the absence of secondary collateral costs incurred in 2006 related to an annuity contract which was subsequently recaptured. Operating expenses increased by 20% to $131.4 million for the nine months ended September 30, 2007 compared to $109.9 million in the same period in 2006. The increase is primarily the result of payments triggered by the change-in-control in May 2007, including employee bonuses relating to the completion of the Transaction, change-in-control costs related to certain executive officers, severance payments and the recognition of all previously unrecognized compensation expense for our stock options and restricted share awards. Collateral finance facilities expense increased by 53% to $222.6 million for the nine months ended September 30, 2007 compared to $145.6 million in the same period in 2006. The increase is primarily the result of the impact of the Ballantyne Re securitization which closed in May 2006, along with higher financial guarantor costs resulting from our credit rating downgrades and an additional forbearance fee relating to the HSBC facilities incurred on the change-in-control in May 2007. This is partially offset by the borrowing cost on the Stingray financing facility in the Corporate and Other Segment, which was fully drawn down during the third quarter of 2006 and repaid in June 2007. 28 Segment Operating Results - Three and Nine Months Ended September 30, 2007 and 2006 Life Reinsurance North America
Three months ended Nine months ended ----------------------------- ------------------------------- September 30, September 30, September 30, September 30, 2007 2006 2007 2006 ------------- ------------- ------------- ------------- Premiums earned, net ............................... $ 428,806 $ 421,707 $ 1,282,459 $ 1,258,174 Investment income, net ............................. 147,754 151,872 439,122 412,576 Fee and other income ............................... 5,661 1,620 12,288 8,516 Net realized gains (losses) ........................ (103,182) 173 (108,180) (19,225) Change in value of embedded derivatives, net ....... (14,777) (5,891) (5,886) 11,621 ------------ ------------ ------------ ------------ Total revenues ................................... 464,262 569,481 1,619,803 1,671,662 ------------ ------------ ------------ ------------ Claims and other policy benefits ................... 349,811 360,968 1,083,379 1,046,874 Interest credited to interest sensitive contract liabilities ............................. 34,793 42,423 106,515 140,523 Acquisition costs and other insurance expenses, net .................................... 89,613 74,082 266,493 255,770 Operating expenses ................................. 12,841 14,569 38,260 43,699 Collateral finance facilities expense .............. 72,525 63,866 210,466 140,300 Interest expense ................................... 3,180 2,986 9,468 8,586 ------------ ------------ ------------ ------------ Total benefits and expenses ...................... 562,763 558,894 1,714,581 1,635,752 ------------ ------------ ------------ ------------ Income (loss) before income taxes and minority interest ................................ $ (98,501) $ 10,587 $ (94,778) $ 35,910 ============ ============ ============ ============
Loss before income taxes and minority interest increased to $98.5 million and to $94.8 million for the three and nine months ended September 30, 2007, compared to the same periods in 2006. The increase for both the three and nine months ended September 30, 2007 is primarily the result of write-downs taken on our sub-prime and Alt-A bonds. Revenues Total revenues decreased by 18% to $464.3 million for the three months ended September 30, 2007 compared to $569.5 million in the same period in 2006 primarily relating to write-downs taken on our sub-prime and Alt-A bonds. Net premiums earned increased by 2% to $ 428.8 million for the three months ended September 30, 2007 compared to $421.7 million in the same period in 2006. The increase is primarily the result of a $16.5 million experience refund adjustment that reduced premiums in the third quarter of 2006 partially offset by lower new business production and lapsation effects. Net investment income decreased by 3% to $147.8 million for the three months ended September 30, 2007 from $151.9 million in the same period in 2006. This decrease is primarily the result of reduced investment income on annuity business driven by declining account values resulting from higher lapses. This decrease was partially offset by an increase in interest rates. Realized losses of $103.2 million in the third quarter 2007 compared to $0.2 million realized gains in the same period in 2006 is due to the impact of impairment charges and mark to market adjustments taken on our subprime and Alt-A investments during the quarter. The net embedded derivative movement increased to a $14.8 million loss for the three months ended September 30, 2007 compared to a $5.9 million loss in the same period in 2006. The decrease during the quarter is primarily due to a change in the yield curve used to value the derivatives. Fee income increased by 249% for the three months ended September 30, 2007 to $5.7 million compared to $1.6 million for the same period in 2006. The increase is driven primarily by a gain on the re-pricing of one of our significant excess retrocession treaties. Total revenues decreased by 3% to $1,619.8 million for the nine months ended September 30, 2007 compared to $1,671.7 million in the same period in 2006 primarily relating to write-downs taken on our sub-prime and Alt-A bonds. Net premiums earned increased by 2% to $1,282.5 million for the nine months ended September 30, 2007 from $1,258.2 million in the same period in 2006. The increase in net premiums earned is primarily the result of the aforementioned $16.5 million experience 29 refund adjustment that reduced premiums in the third quarter of 2006, and revised estimates of $8.0 million in the second quarter of 2006 related to prior period premium accruals that resulted in lower premiums for the second quarter of 2006. The prior year period adjustment of $8.0 million was comprised of two adjustments of $4.0 million each and related primarily to the newly acquired ING block in December 2004. In respect of the first $4.0 million adjustment, we conducted a review of the policy administration data provided to us by ING in the first year post acquisition of the block, which exhibited unusual premium levels as a result of two policy years of data being received together. This data had been used for trend purposes for the accrual estimate as of December 31, 2005. Based on actual cash received and the analysis of the data, we determined a different trend on which to base our premium accrual and, consequently, reduced our premium accrual estimate by $4.0 million. In respect of the second $4.0 million adjustment, we made a revision to our previous estimation process for a certain group of new issuances from late 2004, for which our administrative system did not have sufficient historical information to provide a best estimate at December 31, 2005. During 2006, we determined the premium estimates for these new issuances based on actual cash received. We then revised the premium accrual because our updated data from the administrative system showed clearer historical trends of actual cash received for our automatic premium estimation process. Net investment income increased by 6% to $439.1 million for the nine months ended September 30, 2007 compared to $412.6 million in the same period in 2006. The increase is primarily the result of growth in our average invested assets. Our total invested assets have increased significantly due to the proceeds of the Ballantyne Re securitization that closed in May 2006, which contributed approximately $1.7 billion to our invested asset base. Partially offsetting the favorable variance was a $23.0 million reduction due to the termination of four funding agreements in the third quarter of 2006 as a result of ratings downgrades and $13.6 million of reduced investment income on annuity business driven by declining account values resulting from higher lapses. Realized losses of $108.2 million for the nine months ended September 30, 2007 increased from $19.2 million in the prior year period due to the impact of impairment charges and mark to market adjustments taken on our subprime and Alt-A investments in the current year which was partially offset by prior year losses driven predominantly by the Ballantyne Re securitization. The net embedded derivative movement for the nine months ended September 30, 2007 decreased to a $5.9 million loss compared to an $11.6 million gain in the same period in 2006. The movement is partially due to a change in the yield curve used to value the derivatives in the current quarter and partially related to a prior year realization of losses on certain securities held under a modified coinsurance arrangement that were sold in the first quarter of 2006 in order to provide collateral for the Ballantyne Re securitization. Fee income increased by 44% to $12.3 million for the nine months ended September 30, 2007 from $8.5 million for the same period in 2006. The increase primarily relates to the aforementioned gain on the re-pricing of one of our significant excess retrocession treaties. Benefits and expenses Claims and other policy benefits decreased by 3% to $349.8 million for the three months ended September 30, 2007 compared to $361.0 million in the same period in 2006. The decrease is primarily the result of favorable mortality in the third quarter of 2007 due to lower claims volumes and fewer large claims. Interest credited to interest sensitive contract liabilities decreased by 18% to $34.8 million for the three months ended September 30, 2007 compared to $42.4 million in the same period in 2006. The decrease is primarily the result of $4.9 million interest credited in the third quarter of 2006 on the aforementioned terminated funding agreements. Also contributing to the decrease was lower interest credited on annuity business driven by declining account values resulting from higher lapses. Acquisition costs and other insurance expenses increased by 21% to $89.6 million for the three months ended September 30, 2007 compared to $74.1 million in the same quarter in 2006. This increase is primarily the result of an $8.9 million change in estimate in the third quarter of 2006 for expense allowances on certain interest sensitive contracts that reduced expenses for that quarter. Additionally contributing to the increase is an unfavorable impact of unlocking the deferred acquisition costs on interest sensitive contracts due to higher than expected policy surrenders in the current period. Partially offsetting these was a $5.7 million reduction in expenses, relating to one of our significant traditional life treaties. This adjustment was driven by revised premium accruals estimates, reserve and claims liabilities, and deferred acquisition costs. 30 Operating expenses decreased by 12% to $12.8 million for the three months ended September 30, 2007 compared to $14.6 million in the same period in 2006. Operating expenses as a percentage of operating revenues (total revenues excluding realized gains and losses and changes in the value of embedded derivatives) were 2% and 3% for the 2007 and 2006 periods, respectively. The decrease is primarily the result of $2.0 million executive severance costs recognized in the third quarter of 2006. Collateral finance facilities expense increased by 14% to $72.5 million for the three months ended September 30, 2007 compared to $63.9 million in the same period of 2006. The increase is primarily the result of higher guarantor costs driven by ratings downgrades and the timing of implementation of our Clearwater Re securitization which coincides with the unwinding of the HSBC securitization. Claims and other policy benefits increased by 3% to $1,083.4 million for the nine months ended September 30, 2007 compared to $1,046.9 million in the same period in 2006. The increase is primarily the result of an increase in claims consistent with expectations for a growing block of early duration mortality risk business for which the increase in year over year mortality rates exceeds the underlying rate of lapsation. Total net mortality for the nine months ended September 30, 2007 is moderately favorable to our internal expectations. Interest credited to interest sensitive contract liabilities decreased by 24% to $106.5 million for the nine months ended September 30, 2007 compared to $140.5 million in the same period in 2006. The decrease is primarily the result of the termination of four funding agreements in the third quarter of 2006 for which the nine month period of that year contained $19.9 million of interest credited. Also impacting the decline was lower annuity business due to higher lapses which drove a reduction of $13.9 million for the nine months ended September 30, 2007. Acquisition costs and other insurance expenses increased by 4% to $266.5 million for the nine months ended September 30, 2007 compared to $255.8 million in the same period in 2006. As a percentage of net premiums earned, acquisition and other insurance expenses was 21% for both the nine months ended September 30, 2007 and 2006. This ratio remained flat as the aforementioned $5.7 million reduction in expenses in the third quarter of 2007, was predominantly offset by a greater adverse impact from the unlocking of deferred acquisition costs in the prior year. Operating expenses decreased by 12% to $38.3 million for the nine months ended September 30, 2007 compared to $43.7 million in the same period in 2006. Operating expenses as a percentage of operating revenues (total revenues excluding realized gains and losses and changes in the value of embedded derivatives) were 2% and 3% for the 2007 and 2006 periods, respectively. The decrease is primarily the result of the first quarter 2007 receipt of a $2.6 million indemnification settlement related to the acquisition of the ERC business. This settlement was based on a provision in the purchase agreement regarding the level of statutory unauthorized reinsurance liabilities required for certain reinsurers. This indemnification settlement is not related to the ERC mediation described in Note 9 to the Consolidated Financial Statements. Also contributing to the expense reduction is $3.1 million executive severance paid out in the second and third quarters of 2006. Collateral finance facilities expense increased by 50% to $210.5 million for the nine months ended September 30, 2007 compared to $140.3 million in the same period of 2006. The increase is primarily the result of the impact of the Ballantyne Re securitization which closed in May 2006 along with higher financial guarantor costs resulting from our credit rating downgrades. 31 Life Reinsurance International
Three months ended Nine months ended ------------------------------ ------------------------------ September 30, September 30, September 30, September 30, 2007 2006 2007 2006 ------------- ------------- ------------- ------------- Premiums earned, net ............................... $ 27,534 $ 31,814 $ 78,391 $ 89,310 Investment income, net ............................. 3,440 8,528 9,520 20,488 Fee and other income ............................... (353) - 400 - Net realized gains (losses) ........................ 245 (2,832) (390) (10,878) ---------- ---------- ---------- ---------- Total revenues ................................... 30,866 37,510 87,921 98,920 ---------- ---------- ---------- ---------- Claims and other policy benefits ................... 18,920 16,745 57,183 77,403 Acquisition costs and other insurance expenses, net .................................... 6,167 9,396 17,325 18,398 Operating expenses ................................. 7,923 7,678 29,190 21,329 Interest expense ................................... 11 - 11 - ---------- ---------- ---------- ---------- Total benefits and expenses ...................... 33,021 33,819 103,709 117,130 ---------- ---------- ---------- ---------- Income (loss) before income taxes and minority interest ................................ $ (2,155) $ 3,691 $ (15,788) $ (18,210) ========== ========== ========== ==========
Loss before income taxes and minority interest increased by 158% to $2.2 million for the three months ended September 30, 2007 compared to an income of $3.7 million for the same period in 2006. The decrease is primarily due to the positive gain in the prior year quarter resulting from the recapture of an annuity contract, in addition to negative incurred but not reported claims adjustments in the third quarter of 2007. Loss before income taxes and minority interest decreased by 13% to $15.8 million for the nine months ended September 30, 2007 compared to $18.2 million for the same period in 2006. The decrease is primarily the result of the absence of realized losses on recapture from the aforementioned annuity contract and contribution from new business on U.K. protection treaties in 2007. Increased claims in relation to our Loss of License business and expenses were offset by the absence of updates to cedant data in 2006. Revenues Total revenues decreased by 18% to $30.9 million for the three months ended September 30, 2007 compared to $37.5 million in the same period in 2006. Net premiums earned decreased 13% to $27.5 million for the three months ended September 30, 2007 compared to $31.8 million in the same period in 2006. The decrease is expected, and is primarily the result of the retrocession of our Middle East block of business along with premium accrual adjustments reflected in the prior year quarter, partially offset by new U.K. and Ireland protection business. Investment income decreased by 60% to $3.4 million for the three months ended September 30, 2007 compared to $8.5 million in the same period in 2006. The decrease is primarily the result of an annuity contract which provided $5.1 million of investment income during the prior year quarter. Realized gains increased to $0.2 million for the three months ended September 30, 2007 compared to a $2.8 million loss for the same period in 2006. The prior year quarter realized loss was due to the realization of previously unrealized losses on an annuity contract which was recaptured during the quarter. Total revenues decreased by 11% to $87.9 million for the nine months ended September 30, 2007 compared to $98.9 million in the same period in 2006. Net premiums earned decreased by 12% to $78.4 million for the nine months ended September 30, 2007 compared to $89.3 million in the same period in 2006. The decrease is primarily due to the effect of the retrocession of the Middle East block of business along with the net negative impact of certain premium accrual adjustments, partially offset by new U.K. and Ireland protection business. Investment income decreased by 54% to $9.5 million for the nine months ended September 30, 2007 compared to $20.5 million in the same period in 2006. The decrease is primarily the result of an annuity contract which provided $11.0 million of investment income before it was recaptured in the third quarter of 2006. Realized losses for the nine months ended September 30, 2007 were $0.4 million compared to $10.9 million in the prior year period. The decrease in the current year period is due to the aforementioned recaptured annuity contract. Realized loss 32 for the prior year period was initially driven by a $7.2 million loss incurred upon the restructuring of the annuity investment portfolio prior to recapture, and then another $3.3 million loss upon recapture where previously unrealized positions were then realized. Benefits and expenses Claims and other policy benefits increased by 13% to $18.9 million for the three months ended September 30, 2007 compared to $16.7 million in the same period in 2006. The increase is primarily due to reserve releases upon recapture of an annuity treaty in 2006, which decreased the overall expense for the period and a strengthening in the basis of our reserve for incurred but not reported claims in 2007. Reduced claims due to the retrocession of our Middle East business along with the release of reserves related to premiums accrual estimates offset these increases. Acquisition costs and other insurance expenses decreased by 34% to $6.2 million for the three months ended September 30, 2007 compared to $9.4 million in the same period in 2006. The decrease is primarily the result of the $3.5 million expense to honor secondary collateral obligations to the cedant related to the annuity contract in 2006. Operating expenses increased by 3% to $7.9 million for the three months ended September 30, 2007 compared to $7.7 million in the same period in 2006. The increase is primarily attributable to an increase in personnel costs in response to the anticipated future growth in the Life Reinsurance International Segment. Claims and other policy benefits decreased by 26% to $57.2 million for the nine months ended September 30, 2007 compared to $77.4 million in the same period in 2006. The prior year period included $15.2 million of unfavorable claims and reserve mainly from updated cedant data. In the current year period, a number of one time adjustments affect the claims cost. Reduced claims following the retrocession of our Middle East business and accrual adjustments are partially offset by adverse claims experience on our loss of license business and reserve increases on our new U.K. and Ireland protection treaties. Acquisition costs and other insurance expenses decreased by 6% to $17.3 million for the nine months ended September 30, 2007 compared to $18.4 million in the same period in 2006. The decrease is primarily the result of the $3.5 million expense to honor secondary collateral obligations to the cedant related to the recapture of an annuity contract in 2006 offset by higher commission rates due to a shift in business mix towards long term protection business. Operating expenses increased by 37% to $29.2 million for the nine months ended September 30, 2007 compared to $21.3 million in the same period in 2006. The increase is primarily the result of additional provisions taken on the Windsor leasehold property along with change in control related employee bonuses, stock option expense and equity based compensation costs incurred during the current year period. In addition, there is an increase in personnel costs in support of the anticipated growth in the Life Reinsurance International Segment. Corporate & Other
Three months ended Nine months ended ------------------------------ ------------------------------ September 30, September 30, September 30, September 30, 2007 2006 2007 2006 ------------- ------------- ------------- ------------- Investment income, net ............................. $ 3,256 $ 2,008 $ 8,284 $ 6,343 Fee and other income ............................... 709 760 2,193 2,236 Net realized gains ................................. 951 1,587 240 4,132 --------- --------- --------- --------- Total revenues ................................... 4,916 4,355 10,717 12,711 --------- --------- --------- --------- Acquisition costs and other insurance expenses, net .................................... 1,975 2,763 5,545 4,476 Operating expenses ................................. 16,218 17,200 63,914 44,876 Collateral finance facilities expense .............. 1,142 3,457 12,181 5,346 Interest expense ................................... 113 2,019 5,435 8,378 --------- --------- --------- --------- Total benefits and expenses ...................... 19,448 25,439 87,075 63,076 --------- --------- --------- --------- Loss before income taxes ........................... $(14,532) $(21,084) $(76,358) $(50,365) ========= ========= ========= =========
33 The Corporate and Other Segment is comprised of revenues and expenses that are not included in the Life Reinsurance Segments and includes corporate related overhead along with the results of our Wealth Management business. Revenues Total revenues increased by 13% to $4.9 million for the three months ended September 30, 2007 compared to $4.4 million in the same period in 2006. Investment income increased by 62% to $3.3 million for the three months ended September 30, 2007 from $2.0 million in the same period in 2006. The increase is primarily the result of the remaining proceeds from the Transaction generating additional investment income. Total revenues in the same period in 2006 primarily related to the drawdown of the Stingray facility and to the proceeds received on the forward share sale agreement. Investment income increased by 31% to $8.3 million for the nine months ended September 30, 2007 compared to $6.3 million in the same period in 2006. The increase is primarily the result of the remaining proceeds received in connection with the closing of the Transaction on May 7, 2007. Investment income in the same period in 2006 primarily related to the drawdown of the Stingray facility and receipt of proceeds from the forward share purchase agreement executed in December 2005. Benefits and expenses Acquisition costs and other insurance expenses decreased by 29% to $2.0 million for the three months ended September 30, 2007 compared to $2.8 million in the same period in 2006. The decrease is primarily the result of $1.0 million of federal excise tax incurred in 2006, which relates to payments made to offshore companies. Operating expenses decreased by 6% to $16.2 million for the three months ended September 30, 2007 compared to $17.2 million in the same period in 2006. The decrease is primarily due to lower executive severance and lower professional and directors' fees, which were high in the prior year due to certain strategic evaluation costs incurred during the quarter, offset by the $7.6 million of new stock option plan expense incurred in the current quarter. Collateral finance facilities expense decreased by 67% to $1.1 million for the three months ended September 30, 2007 compared to $3.5 million in the same period in 2006. The decrease is primarily due to the borrowing cost on the Stingray financing facility, which was fully drawn down during the third quarter of 2006 and repaid in June 2007. Interest expense decreased by 94% to $0.1 million for the three months ended September 30, 2007 compared to $2.0 million in the same period in 2006. The decrease results from repayments during 2006 and 2007 of facilities no longer available, including the unsecured credit facility, the 4.5% Senior Convertible Notes, the reverse repurchase security agreement, and the 1% dividend payable on the Convertible Preferred Shares of our Hybrid Capital Units. Acquisition costs and other insurance expenses increased by 24% to $5.5 million for the nine months ended September 30, 2007 from $4.5 million in the same period in 2006. The increase is primarily due to incurring nine months of costs related to the Tartan Capital Limited catastrophe bond, which was issued in May 2006. Operating expenses increased by 42% to $63.9 million for the nine months ended September 30, 2007 compared to $44.9 million in the same period in 2006. The increase primarily relates to expenses triggered by the change-in-control, which include a $5.8 million charge to restricted stock and stock option expense, $11.9 million in severance payments, $5.9 million in change-in-control costs related to employees and $2.0 million in employee retention bonuses relating to the completion of the Transaction and a $7.6 million charge related to the issuance of stock options in the third quarter. In addition to these items, recruitment, audit fees and D&O insurance costs have increased in the current year period. In comparison to the prior year period, a number of costs affected the 2006 expense base including executive severance, restricted stock awards reversals, and increased professional fees and directors' expenses related to the strategic evaluation process. Collateral finance facilities expense increased by 128% to $12.2 million for the nine months ended September 30, 2007 compared to $5.3 million in the same period in 2006. The collateral finance facilities expense consists of the interest charges and put premium on the Stingray financing facility along with other collateral facility costs not associated with the operating segments. The increase is primarily the result of the draw down of the full Stingray financing facility in the third quarter of 2006, which remained outstanding until June 2007, along with a one-time $2.0 million fee incurred as part of the change-in-control. 34 Interest expense decreased by 35% to $5.4 million for the nine months ended September 30, 2007 compared to $8.4 million in the same period in 2006. The decrease is primarily the result of the repayments of facilities, including the unsecured credit facility, a reverse repurchase security agreement, the 4.5% Senior Convertible Notes and the 1.0% dividend payable on the Convertible Preferred Shares of our Hybrid Capital Units. This decrease in expenses is offset in the current year by $4.7 million of expenses incurred relating to an interim term loan facility put in place by MassMutual Capital and an affiliate of Cerberus between shareholder approval of the Transaction and closing of the Transaction. Of the incremental expenses, $2.6 million of the expenses incurred were paid to an affiliate of Cerberus in connection with the interim term loan facility. The loan facility was terminated in connection with closing the Transaction. The remaining balance of the 2007 expense is due to final settlement amounts incurred on the Hybrid Capital Units. Realized gains (losses) During the three months ended September 30, 2007, consolidated net realized losses amounted to $102.0 million compared to $1.1 million in the same period in 2006. During the three months ended September 30, 2007 and 2006, there were losses of $99.5 million and $0.3 million, respectively, in respect of other than temporary impairments and adjustments required under Statement No. 115 ("SFAS No. 115"), "Accounting for Certain Investments in Debt and Equity Securities". The increase in net realized losses for the three months ended September 30, 2007 compared to the respective prior year periods was primarily due to the deterioration of the sub-prime and Alt-A mortgage markets and liquidity disruptions. For further discussion, see the "Securities Backed by Sub-Prime and Alt-A Residential Mortgage Loans" section of the MD&A. During the nine months ended September 30, 2007, consolidated net realized losses amounted to $108.3 million compared to $26.0 million in the same period in 2006. During the nine months ended September 30, 2007 and 2006, there were losses of $107.4 million and $1.3 million, respectively, in respect of other than temporary impairments and SFAS No. 115 adjustments. Income Taxes Income taxes are recorded in accordance with SFAS No. 109, "Accounting for Income Taxes" ("SFAS No. 109"). In accordance with SFAS No. 109, for all years presented we use the asset and liability method to record deferred income taxes. Accordingly, deferred income tax assets and liabilities recognized reflect the net tax effect of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, using enacted tax rates. Such temporary differences are primarily due to tax basis of reserves for future policy benefits, deferred acquisition costs, and net operating loss carry forwards. A valuation allowance is applied to deferred tax assets if it is more likely than not that all, or some portion, of the benefits related to the deferred tax assets will not be realized. Our effective tax rate in each reporting period is determined by dividing the net tax benefit (expense) by our pre-tax income or loss. The change in our effective tax rate is due primarily to the amount in any reporting period of pre-tax earnings attributable to different subsidiaries (which changes from time to time), each of which is subject to different statutory tax rates, as well as any adjustment to the deferred tax asset valuation allowance. Pre-tax earnings of certain subsidiaries in any period may be impacted by the amount of various inter-company charges, including but not limited to net worth maintenance fees and other management fees paid to Scottish Annuity & Life Insurance Company (Cayman) Ltd. and to the parent holding company. These fees are charged in accordance with our inter-company charging policy and may be adjusted periodically within limits prescribed by applicable transfer pricing regulations. We generate deferred tax assets principally due to net operating losses, reserves and unrealized losses on investment securities. In accordance with GAAP, we must conclude whether the future realization of our deferred tax asset is "more likely than not" to occur. The evaluation regarding realizability of deferred tax assets is made on a gross as opposed to a net basis. Sources of support for the gross deferred tax asset are the reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Pursuant to the guidance under SFAS No. 109, we are currently unable to rely on projections of future taxable income. Future quarterly tax amounts will continue to be dependent upon the relationship between pre-tax GAAP profits and statutory profits and will also be impacted by the size and timing of certain statutory related deferred tax liabilities. Moreover, management will continue to assess and determine the need for the amount of the valuation allowance in subsequent periods in accordance with the requirements of SFAS No. 109 or in accordance with FIN 48. Income tax benefit in the three months ended September 30, 2007 was $7.8 million compared to income tax expense of $20.8 million in the same period in 2006. The change in our effective tax rate in the third quarter ended September 30, 2007 compared to the same period in 2006 is primarily related to a release of our valuation allowance which was established in 35 previous periods on deferred tax assets for certain operating entities, as well as an increase in the valuation allowance related to other operating entities for which no current period benefit is being recognized. Income tax benefit in the nine months ended September 30, 2007 was $148.7 million compared to income tax expense of $102.4 million in the same period in 2006. The change in our effective tax rate in the nine months ended September 30, 2007 compared to the same period in 2006 is primarily related to the net release of a $159.7 million valuation allowance, the impact from applying FIN 48 and other adjustments. Financial Condition Investments At September 30, 2007, the investment portfolio controlled by us consisted of fixed income securities, preferred stock and cash amounting to $8.87 billion expressed at estimated fair value. The portfolio controlled by us excludes the assets held by ceding insurers under modified coinsurance and funds withheld coinsurance arrangements. The majority of these assets are publicly traded securities; however, at September 30, 2007, $458.4 million of this amount represents investments in private securities. Of the total portfolio controlled by us, $7.74 billion expressed at estimated fair value represented the fixed income and preferred stock portfolios managed by external investment managers and $1.1 billion represented other cash balances. At December 31, 2006, the portfolio controlled by us consisted of fixed income securities, preferred stock and cash was $8.7 billion. The majority of these assets were publicly traded; however, at December 31, 2006, $532.9 million was invested in private securities. Of the total portfolio controlled by us, $8.2 billion represented the fixed income and preferred stock portfolios managed by external investment managers and $0.5 billion represented other cash balances. At September 30, 2007, the average Standard & Poor's rating of our portfolio was "AA", the average effective duration was 3.4 years and the average book yield was 5.5%, as compared with an average rating of "AA", an average effective duration of 2.9 years and an average book yield of 5.5% at December 31, 2006. At September 30, 2007, the unrealized depreciation on investments, was $422.0 million as compared with unrealized depreciation on investments, of $41.0 million at December 31, 2006. The unrealized depreciation on investments is included in our consolidated balance sheet as part of shareholders' equity. The following table presents the fixed income investment portfolio credit exposure by Standard & Poor's ratings, where available, and otherwise by ratings provided by other agencies.
$ in millions September 30, 2007 December 31, 2006 ----------------------- ------------------------ Estimated Estimated Ratings fair value % fair value % ------- ------------- ------ ------------- ------ AAA............................... $ 3,895.2 43.9% $ 3,350.5 38.5% AA................................ 2,273.6 25.6 2,353.1 27.0 A 1,867.9 21.1 2,050.9 23.6 BBB............................... 806.8 9.1 918.5 10.6 BB or below....................... 23.6 0.3 24.9 0.3 ------------- ------ ------------- ------ Total............................. $ 8,867.1 100.0% $ 8,697.9 100.0% ============= ====== ============= ======
36 The following table illustrates the fixed income investment portfolio sector exposure.
$ in millions September 30, 2007 December 31, 2006 ----------------------- ------------------------ Estimated Estimated Sector fair value % fair value % ------- ------------- ------ ------------- ------ U.S. Treasury securities and U.S. government agency obligations... $ 64.0 0.7% $ 68.0 0.8% Corporate securities.............. 2,747.2 31.0 2,700.5 31.1 Municipal bonds................... 51.0 0.6 52.2 0.6 Mortgage and asset backed securities 4,773.5 53.8 5,244.8 60.3 Preferred stock................... 99.3 1.1 116.9 1.3 ------------- ------ ------------- ------ 7,735.0 87.2 8,182.4 94.1 Cash.............................. 1,132.1 12.8 515.5 5.9 ------------- ------ ------------- ------ Total............................. $ 8,867.1 100.0% $ 8,697.9 100.0% ============= ====== ============= ======
The Company reviews securities with material unrealized losses and tests for other than temporary impairments on a quarterly basis. Factors involved in the determination of potential impairment include fair value as compared to cost, length of time the value has been below cost, credit worthiness of the issuer, forecasted financial performance of the issuer, position of the security in the issuer's capital structure, the presence and estimated value of collateral or other credit enhancement, length of time to maturity, interest rates and our intent and ability to hold the security until the estimated fair value recovers. When a decline is considered to be other than temporary, the cost basis of the impaired asset is adjusted to its fair value and a corresponding realized investment loss is recognized in the consolidated statements of income (loss). The actual value at which such financial instruments could actually be sold or settled with a willing buyer may differ from such estimated fair values. The following tables present the estimated fair values and gross unrealized losses for the fixed maturity investments and preferred stock that have estimated fair values below amortized cost or cost as of September 30, 2007 and December 31, 2006. These investments are presented by class and grade of security, as well as the length of time the related estimated fair value has remained below amortized cost or cost.
September 30, 2007 ($ in thousands) ------------------------------------------------------------------------------------------- Less than or equal to Greater than 12 months 12 months Total ------------------------- --------------------------- ----------------------------- Estimated Unrealized Estimated Unrealized Estimated Unrealized fair value loss fair value loss fair value loss ------------ ------------ ----------- ------------ ------------ ------------- Investment grade securities: - --------------------------- CMO............................... $ 874,455 $ (39,019) $ 309,034 $ (14,606) $ 1,183,489 $ (53,625) Corporates........................ 992,735 (35,982) 881,615 (36,871) 1,874,350 (72,853) Governments....................... 19,558 (314) 28,543 (720) 48,101 (1,034) MBS............................... 22,008 (367) 129,909 (4,322) 151,917 (4,689) Municipals........................ 9,425 (76) 24,699 (644) 34,124 (720) Other structured securities 2,130,246 (268,496) 569,091 (27,104) 2,699,337 (295,600) Preferred stocks.................. 16,368 (1,204) 78,034 (2,521) 94,402 (3,725) ----------- ------------ ----------- ------------ ----------- ------------ Total Investment grade securities....................... 4,064,795 (345,458) 2,020,925 (86,788) 6,085,720 (432,246) ----------- ------------ ----------- ------------ ----------- ------------ Below investment grade - ---------------------- securities: ---------- Corporates........................ 5,403 (142) 7,453 (531) 12,856 (673) Other structured securities 6,037 (4,868) 859 (1,506) 6,896 (6,374) Preferred stock................... 423 (2) 943 (78) 1,366 (80) ----------- ------------ ----------- ------------ ----------- ------------ Total below investment grade securities....................... 11,863 (5,012) 9,255 (2,115) 21,118 (7,127) ----------- ------------ ----------- ------------ ----------- ------------ Total............................. $ 4,076,658 $ (350,470) $ 2,030,180 $ (88,903) $ 6,106,838 $ (439,373) =========== ============ =========== ============ =========== ============
37
December 31, 2006 ($ in thousands) ----------------------------------------------------------------------------------------- Less than or equal to Greater than 12 months 12 months Total ------------------------- --------------------------- ---------------------------- Estimated Unrealized Estimated Unrealized Estimated Unrealized fair value loss fair value loss fair value loss ----------- ------------ ---------- ------------ ----------- ------------ Investment grade securities: - --------------------------- CMO................................ $ 369,457 $ (2,365) $ 252,252 $ (6,327) $ 621,709 $ (8,692) Corporates......................... 750,806 (15,690) 864,053 (29,078) 1,614,859 (44,768) Governments........................ 35,805 (615) 21,072 (752) 56,877 (1,367) MBS................................ 12,116 (136) 138,992 (4,674) 151,108 (4,810) Municipal.......................... 19,865 (187) 18,013 (640) 37,878 (827) Other structured securities 415,596 (2,511) 613,974 (11,735) 1,029,570 (14,246) Preferred stock.................... 12,246 (295) 95,646 (3,181) 107,892 (3,476) ----------- ------------ ----------- ------------ ----------- ------------ Total investment grade securities....................... $ 1,615,891 $ (21,799) $ 2,004,002 $ (56,387) $ 3,619,893 $ (78,186) ----------- ------------ ----------- ------------ ----------- ------------ Below investment grade - ---------------------- securities: ---------- Corporates......................... $ 3,416 $ (58) $ 14,975 $ (570) $ 18,391 $ (628) Other structured securities 1,405 (421) 1,256 (662) 2,661 (1,083) Preferred stock.................... - - 664 (33) 664 (33) ----------- ------------ ----------- ------------ ----------- ------------ Total below investment grade securities....................... 4,821 (479) 16,895 (1,265) 21,716 (1,744) ----------- ------------ ----------- ------------ ----------- ------------ Total.............................. $ 1,620,712 $ (22,278) $ 2,020,897 $ (57,652) $ 3,641,609 $ (79,930) =========== ============ =========== ============ =========== ============
At September 30, 2007, our fixed income portfolio contained 3,053 securities, with total gross unrealized losses of $439.4 million and total gross unrealized gains of $17.4 million. No single security had an unrealized loss greater than $6.9 million. Included in the fixed income portfolio were 159 private securities with gross unrealized losses of $14.7 million. At December 31, 2006, our fixed income portfolio contained 2,967 securities, with total gross unrealized losses of $79.9 million and total gross unrealized gains of $38.9 million. No single security had an unrealized loss greater than $1.3 million. Included in the fixed income portfolio were 128 private securities with gross unrealized losses of $5.1 million. After giving considerations to the write-downs taken on our sub-prime and Alt-A bonds as disclosed under "Impairment methodology and realized losses", we believe that the financial strength, liquidity, leverage, future outlook, and our ability and intent to hold each security, whose price has been below market for greater than twelve months, until recovery supports the view that the security was not other than temporarily impaired as of September 30, 2007. The unrealized losses on fixed maturity securities are primarily a result of rising interest rates, changes in credit spreads and the long-dated maturities of the securities. Additionally, as of September 30, 2007, approximately 98.4% of the gross unrealized losses are associated with investment grade securities. Again after giving consideration to the write-downs taken on our sub-prime and Alt-A bonds as disclosed under "Impairment methodology and realized losses", unrealized losses on securities that have been in an unrealized loss position for periods greater than two years amounted to $59.7 million at September 30, 2007 and $7.8 million at December 31, 2006. Unrealized losses on below-investment grade securities amounted to $7.1 million and $1.7 million at September 30, 2007 and December 31, 2006, respectively. Of these amounts, below-investment grade securities with unrealized losses of $2.1 million at September 30, 2007 and $1.3 million at December 31, 2006 had been in an unrealized loss position for a period greater than one year. 38 The following tables illustrate analysis of those securities that have an unrealized loss at September 30, 2007 and December 31, 2006 by industry:
September 30, 2007 ($ in thousands) ----------------------------------------------------------------------------------------- Amortized Estimated Fair Unrealized Cost % Value % Loss % ------------- -------- -------------- -------- ------------ ---------- Industry - -------- Mortgage and asset backed securities...................... $ 4,391,928 67.1% $ 4,032,440 66.0% $ (359,488) 81.8% Banking........................... 377,003 5.8 363,853 6.0 (13,150) 3.0 Communications.................... 196,087 3.0 188,227 3.1 (7,860) 1.8 Consumer non-cyclical............. 153,049 2.3 145,676 2.4 (7,373) 1.7 Brokerage......................... 160,765 2.5 155,589 2.5 (5,176) 1.2 Insurance......................... 173,667 2.6 166,607 2.7 (7,060) 1.6 Consumer cyclical................. 145,761 2.2 138,544 2.3 (7,217) 1.6 Finance companies................. 164,727 2.5 157,683 2.6 (7,044) 1.6 Electric.......................... 135,332 2.1 130,362 2.1 (4,970) 1.1 Other*............................ 647,892 9.9 627,857 10.3 (20,035) 4.6 ----------- ------ ----------- ------ ------------ ------ Total............................. $ 6,546,211 100.0% $ 6,106,838 100.0% $ (439,373) 100.0% =========== ====== =========== ====== ============ ======
* Other industries represent less than 2% of the estimated fair value.
December 31, 2006 ($ in thousands) ---------------------------------------------------------------------------------------- Amortized Estimated Fair Unrealized Cost % Value % Loss % ------------- -------- -------------- -------- ------------ ---------- Industry - -------- Mortgage and asset backed securities...................... $ 1,833,878 49.3% $ 1,805,047 49.6% $ (28,831) 36.1% Banking........................... 302,782 8.1 296,225 8.1 (6,557) 8.2 Communications.................... 204,320 5.5 196,181 5.4 (8,139) 10.2 Consumer non-cyclical............. 153,941 4.1 148,277 4.1 (5,664) 7.1 Insurance......................... 137,378 3.7 134,516 3.7 (2,862) 3.6 Finance companies................. 126,646 3.4 124,233 3.4 (2,413) 3.0 Consumer cyclical................. 127,643 3.5 123,455 3.4 (4,188) 5.2 Other*............................ 834,951 22.4 813,675 22.3 (21,276) 26.6 ----------- ------ ----------- ------ ------------ ------ Total............................. $ 3,721,539 100.0% $ 3,641,609 100.0% $ (79,930) 100.0% =========== ====== =========== ====== ============ ======
* Other industries represent less than 3% of the estimated fair value. 39 The expected maturity dates of our fixed maturity investments that have an unrealized loss at September 30, 2007 and December 31, 2006 are presented in the tables below.
September 30, 2007 ($ in thousands) ------------------------------------------------------------------------------------------ Amortized Estimated Fair Unrealized Cost % Value % Loss % ------------- -------- -------------- -------- -------------- ---------- Maturity - -------- Due in one year or less........... $ 572,769 8.7% $ 550,494 9.0% $ (22,275) 5.1% Due in one through five years..... 3,656,439 55.9 3,338,230 54.6 (318,209) 72.4 Due in five through ten years..... 1,311,552 20.0 1,267,880 20.8 (43,672) 9.9 Due after ten years............... 1,005,451 15.4 950,234 15.6 (55,217) 12.6 ----------- ------ ----------- ------ ------------ ------- Total............................. $ 6,546,211 100.0% $ 6,106,838 100.0% $ (439,373) 100.0% =========== ====== =========== ====== ============ =======
December 31, 2006 ($ in thousands) ----------------------------------------------------------------------------------------- Amortized Estimated Fair Unrealized Cost % Value % Loss % ------------- -------- -------------- --------- ------------- -------- Maturity - -------- Due in one year or less........... $ 337,455 9.1% $ 334,582 9.2% $ (2,873) 3.6% Due in one through five years..... 1,401,180 37.6 1,377,519 37.8 (23,661) 29.6 Due in five through ten years..... 1,206,367 32.4 1,179,292 32.4 (27,075) 33.9 Due after ten years............... 776,537 20.9 750,216 20.6 (26,321) 32.9 ----------- ------ ----------- ------ ------------ ------- Total............................. $ 3,721,539 100.0% $ 3,641,609 100.0% $ (79,930) 100.0% =========== ====== =========== ====== ============ =======
At September 30, 2007, there were 2,376 securities with unrealized loss positions, with 94 securities having an unrealized loss greater than $1 million. At December 31, 2006, there were 1,796 securities with unrealized loss, with two securities having an unrealized loss greater than $1.0 million. At September 30, 2007, there were 6 securities with a fair value that traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months. The total unrealized loss on these securities amounted to $1.7 million. At December 31, 2006, there were three securities with a fair value that traded continuously at less than 80% of amortized cost for at least six months or 90% of amortized cost for at least 12 months. The total unrealized loss on these securities amounted to $0.8 million. The following tables provide details of the sales proceeds, realized loss, length of time the security had been in an unrealized loss position and reason for sale for securities sold with a realized loss during the periods September 30, 2007 and 2006.
Three months ended September 30, 2007 ($ in thousands) --------------------------------------------------------------------------------------------------------- Credit Concern Relative Value Tactical Total ------------------------ ------------------------ ------------------------ ------------------------ Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Days - ---- 0-90................ $ 586 $ (116) $ 5,256 $ (111) $ 2,085 $ (11) $ 7,927 $ (238) 91-180.............. 1,681 (340) - - 1,671 (1) 3,352 (341) 181-270............. 685 (454) - - - - 685 (454) Greater than 270.... 13,390 (1,946) - - 6,194 (346) 19,584 (2,292) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total............... $ 16,342 $ (2,856) $ 5,256 $ (111) $ 9,950 $ (358) $ 31,548 $ (3,325) ========== ========== ========== ========== ========== ========== ========== ==========
40
Three months ended September 30, 2006 ($ in thousands) --------------------------------------------------------------------------------------------------------- Credit Concern Relative Value Tactical Total ------------------------ ------------------------ ------------------------ ------------------------ Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Days - ---- 0-90................ $ 11,555 $ - $ 81 $ (2) $ 190,764 $ (467) $ 202,400 $ (469) 91-180.............. - - 906 (14) 37,405 (203) 38,311 (217) 181-270............. - - - - 3,223 (13) 3,223 (13) Greater than 270.... - - 1,851 (121) 17,069 (160) 18,920 (281) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total............... $ 11,555 $ - $ 2,838 $ (137) $ 248,461 $ (843) $ 262,854 $ (980) ========== ========== ========== ========== ========== ========== ========== ==========
Nine months ended September 30, 2007 ($ in thousands) --------------------------------------------------------------------------------------------------------- Credit Concern Relative Value Tactical Total ------------------------ ------------------------ ------------------------ ------------------------ Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Days - ---- 0-90................ $ 4,252 $ (180) $ 6,465 $ (161) $ 169,350 $ (158) $ 180,067 $ (499) 91-180.............. 1,681 (340) 1,639 (72) 2,971 (21) 6,291 (433) 181-270............. 3,059 (487) - - 1,314 (7) 4,373 (494) Greater than 270.... 23,511 (2,320) 3,278 (34) 16,556 (594) 43,345 (2,948) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total............... $ 32,503 $ (3,327) $ 11,382 $ (267) $ 190,191 $ (780) $ 234,076 $ (4,374) ========== ========== ========== ========== ========== ========== ========== ==========
Nine months ended September 30, 2006 ($ in thousands) --------------------------------------------------------------------------------------------------------- Credit Concern Relative Value Tactical Total ------------------------ ------------------------ ------------------------ ------------------------ Proceeds Loss Proceeds Loss Proceeds Loss Proceeds Loss ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Days - ---- 0-90................ $ 19,452 $ (822) $ 193,855 $ (3,909) $ 260,546 $ (845) $ 473,853 $ (5,576) 91-180.............. 4,105 (81) 11,597 (331) 61,052 (822) 76,754 (1,234) 181-270............. 8,072 (798) 2,099 (34) 7,978 (186) 18,149 (1,018) Greater than 270.... 3,540 (351) 16,864 (480) 30,655 (551) 51,059 (1,382) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total............... $ 35,169 $ (2,052) $ 224,415 $ (4,754) $ 360,231 $ (2,404) $ 619,815 $ (9,210) ========== ========== ========== ========== ========== ========== ========== ==========
Funds withheld at interest Funds withheld at interest arise on contracts written under modified coinsurance agreements and funds withheld coinsurance agreements. In substance, these agreements are identical to coinsurance treaties except that the ceding company retains control of and title to the assets. The deposits paid to the ceding company by the underlying policyholders are held in a segregated portfolio and managed by the ceding company or by investment managers appointed by the ceding company. These treaties transfer a quota share of the risks. The funds withheld at interest represent our share of the ceding companies' statutory reserves. The cash flows exchanged with each monthly settlement are netted and include, among other items, our quota share of investment income on our proportionate share of the portfolio, realized losses, realized gains (amortized to reflect the statutory rules relating to interest maintenance reserve), interest credited and expense allowances. At September 30, 2007, funds withheld at interest totaled $1.7 billion with an average rating of "A+", an average effective duration of 4.91 years and an average book yield of 5.92%, as compared to $1.9 billion with an average rating of "A", an average effective duration of 5.0 years and an average book yield of 5.9% at December 31, 2006. These are fixed income investments and include marketable securities, commercial mortgages, private placements and cash. The estimated fair value of the funds withheld amounted to $1.7 billion at September 30, 2007 and $1.9 billion at December 31, 2006. 41 At September 30, 2007 and December 31, 2006, funds withheld at interest were in respect of seven contracts with five ceding companies, respectively. At September 30, 2007, we had three contracts with Lincoln National Life Insurance Company that accounted for $629.1 million or 38% of the funds withheld balances. Additionally, we had one contract with Security Life of Denver International Limited that accounted for $371.8 million or 22% of the funds withheld balances and one contract with Fidelity & Guaranty Life that accounted for $626.9 million or 38% of the funds withheld balances. The remaining contracts were with Illinois Mutual Insurance Company and American Founders Life Insurance Company. Lincoln National Life Insurance Company has financial strength ratings of "A+" from AM. Best, "AA" from Standard & Poor's, "Aa3" from Moody's and "AA" from Fitch. In the event of insolvency of the ceding companies on these arrangements, we would need to exert a claim on the assets supporting the contract liabilities. However, the risk of loss is mitigated by our ability to offset amounts owed to the ceding company with the amounts owed to us by the ceding company. Reserves for future policy benefits and interest sensitive contract liabilities relating to these contracts amounted to $1.6 billion and $1.9 billion at September 30, 2007 and December 31, 2006, respectively. The investment objectives for these arrangements are included in the modified coinsurance and funds withheld coinsurance agreements. The primary objective is to maximize current income, consistent with the long-term preservation of capital. The overall investment strategy is executed within the context of prudent asset/liability management. The investment guidelines permit investments in fixed maturity securities, and include marketable securities, commercial mortgages, private placements and cash. The maximum percentage of below investment grade securities is 10%, and other guidelines limit risk, ensure issuer and industry diversification, and maintain liquidity and overall portfolio credit quality. According to data provided by our ceding companies, the following table reflects the estimated fair value of assets including cash backing the funds withheld at interest portfolio using the lowest rating assigned by the three major rating agencies.
$ in millions September 30, 2007 December 31, 2006 ------------------------ ------------------------- Estimated Estimated Ratings fair value % fair value % ------- ------------- ------- ------------- ------- AAA............................... $ 449.5 27.0% $ 427.5 22.1% AA................................ 163.2 9.8 166.6 8.6 A................................. 451.3 27.1 561.1 29.0 BBB............................... 462.7 27.7 605.6 31.3 BB or below....................... 51.7 3.1 75.1 3.9 ------------- ------ ------------- ------ Sub-total: 1,578.4 94.7 1,835.9 94.9 Commercial mortgage loans......... 88.7 5.3 98.8 5.1 ------------- ------ ------------- ------ Total............................. $ 1,667.1 100.0% $ 1,934.7 100.0% ============= ====== ============= ======
According to data provided by our ceding companies, the following table reflects the estimated fair value of assets backing the funds withheld at interest portfolio by sector.
$ in millions September 30, 2007 December 31, 2006 ------------------------ ------------------------ Estimated Estimated Sector fair value % fair value % ------- ------------- ------- ------------- ------ U.S. Treasury securities and U.S. government agency obligations... $ 35.7 2.1% $ 58.8 3.0% Corporate securities.............. 1,075.2 64.5 1,321.1 68.3 Municipal bonds................... 29.4 1.8 29.9 1.6 Mortgage and asset backed securities 470.7 28.2 463.4 24.0 Commercial mortgage loans......... 88.7 5.3 98.9 5.1 Preferred stock................... 2.5 0.2 2.6 0.1 -------------- ------- ------------- ------ Sub-total 1,702.2 102.1 1,974.7 102.1 Cash.............................. (35.1) (2.1) (40.0) (2.1) -------------- ------- ------------- ------ Total............................. $ 1,667.1 100.0% $ 1,934.7 100.0% ============== ======= ============= ======
42 Securities Backed by Sub-Prime and Alt-A Residential Mortgage Loans Exposure to Sub-prime ABS and Alt-A RMBS At September 30, 2007, our total investment portfolio including controlled assets and funds withheld at interest, had an amortized cost of $11.0 billion, and an estimated fair value of $10.6 billion. Of the amortized cost, $1.9 billion, or 17.4%, were asset-backed securities ("ABS") backed by sub-prime residential mortgage loans and $1.1 billion, or 9.8%, were residential mortgage-backed securities ("RMBS") backed by Alt-A mortgage loans. These include bonds held in portfolios in our securitizations, in portfolios of our subsidiaries and by ceding companies in funds withheld at interest. Our exposure to collateralized debt obligations backed by similar ABS and RMBS was approximately $12,500. The slowing U.S. housing market, greater use of affordable mortgage products, and relaxed underwriting standards for some originators of sub-prime loans has recently led to higher delinquency and loss rates, especially for those issued during 2006 and 2007. These factors have caused a decrease in market liquidity and repricing of risk, which has led to estimated fair value declines from December 31, 2006 to September 30, 2007. We expect delinquency and loss rates in the sub-prime mortgage sector to continue to increase in the future. Tranches of securities will experience losses according to the seniority of the claim on the collateral, with the least senior (or most junior), typically the unrated residual tranche, taking the initial loss. The credit ratings of the securities reflect the seniority of the securities that we own. As sub-prime and Alt-A loan performance has deteriorated, the market has become increasingly illiquid and unbalanced, with an absence of buyers, causing market prices to decrease and a decline in the estimated fair value of our bonds below their amortized cost. To date, all of our sub-prime and Alt-A holdings are still paying full interest and principal and no securities have experienced any defaults. Currently, it is our intention to hold these securities to recover our amortized cost and we expect to recover principal and interest substantially greater than what the current market prices indicate. We have written down any bonds where we estimate we will not recover the full amortized cost or where we lack the ability to hold the bonds through recovery of amortized cost. Impairment Methodology and Realized Losses As part of our quarterly tests for other than temporary impairments of investments, we have reviewed our sub-prime and Alt-A holdings in accordance with Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS No. 115") and related accounting guidance including Emerging Issues Task Force 03-01 "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("EITF 03-01") and Emerging Issues Task Force 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Interests in Securitized Financial Assets ("EITF 99-20"). Among other matters, these GAAP accounting rules require that we evaluate, for each security where the estimated fair value is less than its amortized cost, whether we have the intent and ability to hold the security for a reasonable time for a forecasted recovery of the fair value up to the amortized cost of the investment. This requires us to consider our capital and liquidity requirements and any contractual or regulatory obligations that might indicate that securities may need to be sold before the forecasted recovery of fair value occurs. Notwithstanding our intent and ability to hold our sub-prime and Alt-A bonds through a forecasted recovery period, we have conducted an assessment of each bond to evaluate the likely realization of amortized cost. Through our third-party investment managers, we have performed detailed cash flow analyses on our sub-prime and Alt-A holdings stressing multiple variables, and our best estimate scenario considered deal specific assumptions and some general assumptions for all bonds. The deal assumptions included a deal specific default curve, taking into account the underlying collateral, loan, originator, vintage, and tranche seniority. The general assumptions included loss severity and prepayment speed. For all the bonds, we assumed prepayments on the securities underlying collateral will be slower than originally modeled or 75% of pricing speed. When home prices were rising and underwriting standards were becoming more aggressive, borrowers were able to refinance or sell their homes and repay the loans at the time mortgage rates reset. We assumed that this type of prepayment will be less available going forward. For sub-prime bonds, we assumed the existing delinquency pipeline experienced a severity of 50% over 18 months and then we assumed a 40% severity after the initial 18 months. For Alt-A bonds, we assumed the existing delinquency pipeline experienced a severity of 25% over 18 months and then we assumed a 20% severity after the initial 18 months. Second lien mortgages have very high severity, usually 100%. We have no such pure second lien bonds and our existing bonds have limited exposure to second liens, typically 5% to 10%. Based on these multiple simulation analyses, our current best estimate of projected principal losses over the next four years for our sub-prime and Alt-A holdings is approximately $60.1 million and $26.2 million, respectively. We have written down the amortized costs of any bonds for which we expect to experience principal losses. The amortized cost of this subset of bonds were reduced to estimated fair value as of September 30, 2007 resulting in the recognition of realized losses of $54.2 million for the quarter ended September 30, 2007. The simulation analysis results are a function of assumptions made. To the extent that these assumptions are not correct, our conclusions will change. 43 Currently, we do not intend to sell any of our sub-prime and Alt-A bonds and our available capital and liquidity resources as noted in the "Liquidity and Capital Resources" section are adequate to preclude the need to liquidate any of our sub-prime and Alt-A investments. However, a subset of bonds that are held within our securitizations were recently downgraded by one or more of Fitch, Moody's and Standard & Poor's. The investment guidelines for certain trust accounts within our securitizations govern our ability to continue to hold individual securities that are no longer rated A3/A- or better or where the weighted average rating factor for the portfolio exceeds a predetermined limit. The recent ratings downgrades have resulted in individual securities with a total amortized cost at September 30, 2007 of $127.8 million being out of compliance with the investment guidelines of our securitizations. Although we do not presently intend to sell these bonds, we can no longer demonstrate the unfettered ability to hold them to realization of amortized cost. Accordingly, we have written-down the amortized cost of these bonds to estimated fair value as of September 30, 2007 in order to record a realized loss representing an other-than-temporary impairment of $41.1 million for the quarter ended September 30, 2007. Further ratings downgrades of any of our sub-rime and Alt-A holdings below the A3/A- credit rating requirements of our investment management agreements which govern securitizations may result in additional other-than-temporary impairments charges in future periods. The other-than-temporary impairments of $41.1 million related to individual bonds did not show any projected principal losses in our simulation analyses mentioned below and we currently expect each of these bonds to continue to pay full interest and principal. The table below summarizes the amortized cost, projected principal losses and realized losses on our sub-prime and Alt-A bonds at September 30, 2007: - ------------------- ----------------- ----------------- ---------------- Projected Principal Amortized Cost Losses at Realized Loss at September September 30, at September Impairment 30, 2007 2007 30, 2007 Methodology ($ in millions) ($ in millions) ($ in millions) - ------------------- ----------------- ----------------- ---------------- SFAS No. 115 bonds without projected principal losses..... $84.4 $ - $41.1 Bonds with projected principal losses..... 89.9 86.3 54.2 ----------------- ----------------- ---------------- Total................ $174.3 $86.3 $95.3 ================= ================= ================ 44 The credit rating, amortized cost, estimated fair value and related unrealized and realized losses related to our sub-prime and Alt-A securities are set out below:
September 30, 2007 ($ in millions) -------------------------------------------------------------------------- Non-securitizations Securitizations Total -------------------------------------------------------------------------- Sub-prime Alt-A Sub-prime Alt-A Sub-prime Alt-A --------- ------- --------- ------- ---------- --------- Book Value by Rating - -------------------- AAA....................... $ 152.2 $ 172.2 $ 294.8 $ 66.2 $ 447.0 $ 238.4 AA........................ 157.9 58.6 844.2 650.4 1,002.1 709.0 A+........................ 5.9 2.5 175.4 43.3 181.3 45.8 A......................... 41.5 23.4 149.2 43.4 190.7 66.8 A-........................ 26.4 2.1 15.5 - 41.9 2.1 BBB+ or lower............. 42.1 15.8 7.9 - 50.0 15.8 ------- ------- --------- ------ --------- --------- Total..................... $ 426.0 $ 274.6 $ 1,487.0 $803.3 $ 1,913.0 $ 1,077.9 ------- ------- --------- ------ --------- --------- Estimated fair value by Rating - ------------------------------ AAA....................... $ 146.7 $ 168.0 $ 279.2 $ 65.0 $ 425.9 $ 233.0 AA........................ 142.5 56.2 696.8 614.4 839.3 670.6 A+........................ 5.2 2.1 142.7 37.7 147.9 39.8 A......................... 36.1 21.2 130.3 33.1 166.4 54.3 A-........................ 22.9 1.6 13.5 - 36.4 1.6 BBB+ or lower............. 29.4 11.7 7.9 - 37.3 11.7 ------- ------- --------- ------ --------- --------- Total..................... $ 382.8 $ 260.8 $ 1,270.4 $750.2 $ 1,653.2 $ 1,011.0 ------- ------- --------- ------ --------- --------- Unrealized Loss by Rating - ------------------------- AAA....................... $ (5.5) $ (4.2) $ (15.6) $ (1.2) $ (21.1) $ (5.4) AA........................ (15.4) (2.4) (147.4) (36.0) (162.8) (38.4) A+........................ (0.7) (0.4) (32.7) (5.6) (33.4) (6.0) A......................... (5.4) (2.2) (18.9) (10.3) (24.3) (12.5) A-........................ (3.5) (0.5) (2.0) - (5.5) (0.5) BBB+ or lower............. (12.7) (4.1) - - (12.7) (4.1) ------- ------- --------- ------ --------- ---------- Total..................... $ (43.2) $ (13.8) $ (216.6) $(53.1) $ (259.8) $ (66.9) ------- ------- --------- ------ --------- ---------- Realized Loss by Impairment - --------------------------- Methodology ----------- SFAS No. 115 bonds without projected principal losses $ - $ - $ (41.1) $ - $ (41.1) $ - Bonds with projected principal losses......... (1.4) (0.2) (45.1) (7.5) (46.5) (7.7) ------- ------- --------- ------ --------- --------- Total..................... $ (1.4) $ (0.2) $ (86.2) $ (7.5) $ (87.6) $ (7.7) ------- ------- --------- ------ --------- ---------
Consolidated Sub-prime and Alt-A Portfolios The consolidated sub-prime portfolio includes securities that are collateralized by mortgage loans issued in the United States to borrowers that cannot qualify for prime financing terms due in part to an impaired or limited credit history. The sub-prime portfolio also includes securities that are collateralized by certain second lien mortgages regardless of the borrower's credit profile. Of our $1,913.0 million in sub-prime residential ABS holdings, o $447.0 million (23.4%) were rated AAA/Aaa; o $1,449.1 million (75.8%) were rated AA-/Aa3 or above; o $1,863.0 million (97.4%) were rated A-/A3 or above; 45 o $1,487.2 million (77.7%) reside in our securitizations. As part of our third quarter impairment process, we marked down sub-prime bonds with a amortized cost of $137.1 million, realizing losses of $87.6 million. The unrealized loss of our sub-prime holdings was $259.8 million, or 13.6% of the amortized cost of our sub-prime holdings at September 30, 2007. As a result of estimated fair value reductions from September 30, 2007 to October 31, 2007, we estimate that unrealized losses increased by approximately $150.8 million, or 7.9% of amortized cost of our sub-prime holdings and is 1.4% of our investment portfolio. The following table shows the amortized costs of our consolidated sub-prime portfolio by rating and vintage:
Consolidated Sub-Prime Portfolio as at September 30, 2007 ($ in millions) ------------------------------------------------------------------------------------------------ Vintage ------------------------------------------------------------------------------------------------ Years ended December Six Six Nine 31, 1997 Year months months months to ended ended ended ended % of December December June December September Investment Rating 31, 2004 31, 2005 30, 2006 30, 2007 30,2007 Total Portfolio - ------ ------------- --------- --------- --------- --------- --------- ----------- AAA............. $ 70.7 $ 78.3 $ 133.0 $ 146.2 $ 18.8 $ 447.0 4.1% AA.............. 126.6 208.1 423.5 214.0 29.9 1,002.1 9.1% A+.............. 3.5 122.0 19.4 20.6 15.8 181.3 1.7% A............... 33.1 11.4 57.5 78.8 9.9 190.7 1.7% A-.............. 21.0 6.0 12.3 2.6 - 41.9 0.3% BBB+ and lower.. 28.9 6.7 10.4 4.0 - 50.0 0.5% -------- -------- --------- --------- -------- --------- ------ Total........... $ 283.8 $ 432.5 $ 656.1 $ 466.2 $ 74.4 $1,913.0 17.4% ======== ======== ========= ========= ======== ========= ====== % of investment 2.6% 3.9% 6.0% 4.2% 0.7% 17.4% portfolio.... -------- -------- --------- --------- -------- ---------
Our consolidated Alt-A portfolio includes securities that are collateralized by residential mortgage loans issued to borrowers with stronger credit profiles than sub-prime borrowers, but who cannot qualify for prime financing terms due to high loan-to-value ratios and/or limited supporting documentation. Of our $1,077.9 million of Alt-A holdings, o $238.4 million (22.1%) were rated AAA/Aaa; o $947.4 million (87.9%) were rated AA-/Aa3 or above; o $1,062.1 million (98.5%) were rated A-/A3 or above; o $803.3 million (74.5%) reside in our securitizations. As part of our third quarter impairment process, we marked down Alt-A bonds with an amortized cost of $37.1 million, realizing losses of $7.7 million. The unrealized loss of our Alt-A holdings was $66.9 million, or 6.2% of amortized cost of our Alt-A holdings at September 30, 2007. As a result of estimated fair value reductions from September 30, 2007 to October 31, 2007, we estimate that unrealized losses increased by approximately $26.3 million, or 2.4% of amortized cost of our Alt-A holdings and is 0.2% of our investment portfolio. 46 The following table shows the amortized costs of our Alt-A RMBS exposure by rating and vintage:
Consolidated Alt-A Portfolio as at September 30, 2007 ($ in millions) ---------------------------------------------------------------------------------------------- Vintage ---------------------------------------------------------------------------------------------- Years ended December Six Six Nine 31, 1997 Year months months months to ended ended ended ended % of December December June December September Investment Rating 31, 2004 31, 2005 30, 2006 30, 2007 30,2007 Total Portfolio - ------ ------------- --------- --------- --------- --------- ---------- ----------- AAA............. $ 64.2 $ 74.3 $ 64.2 $ 35.7 $ - $ 238.4 2.2% AA.............. 58.7 70.3 305.9 272.7 1.4 709.0 6.5% A+.............. 1.6 0.9 1.1 42.2 - 45.8 0.4% A............... 16.8 5.6 22.2 22.2 - 66.8 0.6% A-.............. - 2.1 - - - 2.1 0.0% BBB+ and lower.. 4.1 11.7 - - - 15.8 0.1% ---------- -------- -------- -------- --------- --------- -------- Total........... $ 145.4 $ 164.9 $ 393.4 $ 372.8 $ 1.4 $ 1,077.9 9.8% ========== ======== ======== ======== ========= ========= ======== % of investment portfolio.... 1.3% 1.5% 3.6% 3.4% 0.0% 9.8% ----------- -------- -------- -------- --------- ---------
Consolidated Sub-Prime and Alt-A Portfolios Excluding Those Held in Securitizations The following table details the amount of amortized costs of the Company's sub-prime ABS and Alt-A holdings by rating and vintage for its consolidated portfolios excluding invested assets held in the Company's four securitizations: Orkney Re, Inc., Orkney Re II plc, Ballantyne Re plc and Clearwater Re.
Sub-Prime Portfolio Excluding Securitizations as at September 30, 2007 ($ in millions) ------------------------------------------------------------------------------------------------ Vintage ------------------------------------------------------------------------------------------------ Years ended December Six Six Nine 31, 1997 Year months months months to ended ended ended ended % of December December June December September Investment Rating 31, 2004 31, 2005 30, 2006 30, 2007 30,2007 Total Portfolio - ------ ------------- --------- --------- --------- --------- --------- ----------- AAA............. $ 59.6 $ 43.4 $ 44.1 $ 1.6 $ 3.4 $ 152.1 1.4% AA.............. 76.8 43.6 37.5 - - 157.9 1.4% A+.............. 3.5 2.4 - - - 5.9 0.1% A............... 30.1 11.4 - - - 41.5 0.4% A-.............. 21.0 5.2 0.2 - - 26.4 0.2% BBB+ and lower.. 28.9 6.7 6.4 - - 42.0 0.4% --------- -------- -------- ------- -------- -------- ------- Total........... $ 219.9 $ 112.7 $ 88.2 $ 1.6 $ 3.4 $ 425.8 3.9% ========= ======== ======== ======= ======= ======== ======= % of investment portfolio.... 2.1% 1.0% 0.8% 0.0% 0.0% 3.9% --------- -------- -------- ------- -------- --------
47
Alt-A Portfolio Excluding Securitizations As at September 30, 2007 ($ in millions) -------------------------------------------------------------------------------------------------- Vintage -------------------------------------------------------------------------------------------------- Years ended December Six Six Nine 31, 1997 Year months months months to ended ended ended ended % of December December June December September Investment Rating 31, 2004 31, 2005 30, 2006 30, 2007 30,2007 Total Portfolio - ------ ------------- --------- --------- --------- --------- --------- ----------- AAA............. $ 64.2 $ 37.8 $ 57.8 $ 12.5 $ - $ 172.3 1.6% AA.............. 30.2 9.7 17.2 - 1.4 58.5 0.6% A+.............. 1.6 0.9 - - - 2.5 0.0% A............... 16.8 5.6 1.0 - - 23.4 0.2% A-.............. - 2.1 - - - 2.1 0.0% BBB+ and lower.. 4.1 11.7 - - - 15.8 0.1% --------- -------- -------- -------- --------- ------- ------- Total........... $ 116.9 $ 67.8 $ 76.0 $ 12.5 $ 1.4 $ 274.6 2.5% ========= ======== ======== ======== ========= ======= ======= % of investment portfolio.... 1.1% 0.6% 0.7% 0.1% 0.0% 2.5% --------- -------- -------- -------- --------- --------
Sub-Prime and Alt-A Portfolios in Securitization Structures The following table details the amount of amortized costs of the Company's sub-prime and Alt-A holdings by rating and vintage held in the Company's four securitization structures:
Sub-Prime Portfolio in Securitizations as at September 30, 2007 ($ in millions) -------------------------------------------------------------------------------------------------- Vintage -------------------------------------------------------------------------------------------------- Years ended December Six Six Nine 31, 1997 Year months months months to ended ended ended ended % of December December June December September Investment Rating 31, 2004 31, 2005 30, 2006 30, 2007 30,2007 Total Portfolio - ------ ------------- --------- --------- --------- --------- --------- ----------- AAA............. $ 11.1 $ 34.9 $ 88.9 $144.6 $15.4 $ 294.9 2.7% AA.............. 49.8 164.5 386.0 214.0 29.9 844.2 7.7% A+.............. - 119.6 19.4 20.6 15.8 175.4 1.6% A............... 3.0 - 57.5 78.8 9.9 149.2 1.3% A-.............. - 0.8 12.1 2.6 - 15.5 0.1% BBB+ and lower.. - - 4.0 4.0 - 8.0 0.1% ------ ------- ------- ------- ------ --------- ------ Total........... $63.9 $319.8 $567.9 $464.6 $71.0 $1,487.2 13.5% ====== ======= ======= ======= ====== ========= ====== % of investment portfolio.... 0.6% 2.9% 5.2% 4.2% 0.6% 13.5% ------ ------- ------- ------- ------ ---------
48
Alt-A Portfolio in Securitizations as at September 30, 2007 ($ in millions) -------------------------------------------------------------------------------------------------- Vintage -------------------------------------------------------------------------------------------------- Years ended December Six Six Nine 31, 1997 Year months months months to ended ended ended ended % of December December June December September Investment Rating 31, 2004 31, 2005 30, 2006 30, 2007 30,2007 Total Portfolio - ------ ------------- --------- --------- --------- --------- --------- ----------- AAA............. $ - $ 36.5 $ 6.4 $ 23.2 $ - $ 66.1 0.6% AA.............. 28.5 60.6 288.7 272.7 - 650.5 5.9% A+.............. - - 1.1 42.2 - 43.3 0.4% A............... - - 21.2 22.2 - 43.4 0.4% A-.............. - - - - - - 0.0% BBB+ and lower.. - - - - - - 0.0% --------- -------- --------- -------- ----- -------- ------- Total........... $ 28.5 $ 97.1 $ 317.4 $ 360.3 $ - $ 803.3 7.3% ========= ======== ========= ======== ===== ======== ======= % of investment portfolio.... 0.2% 0.9% 2.9% 3.3% 0.0% 7.3% --------- -------- --------- -------- ----- --------
Excess Assets and Liquidity Available for Securitizations As of September 30, 2007, the Company estimates that it had in excess of $468.0 million of available liquidity among itself and its subsidiary, Scottish Annuity & Life Insurance Company (Cayman) Ltd. This amount represents liquidity in excess of liquidity held by the Company's insurance operating subsidiaries and includes cash and marketable securities as well as $275.0 million available under the Stingray facility. Our securitization structures provide reserve credit to the Company's operating subsidiaries for business reinsured. Therefore, an important metric is whether the value of the assets in the securitization portfolios is greater than the statutory reserves of the underlying blocks of business. All of the securitization structures are currently providing full reserve credit. If any deficiency were to develop, then the Company's operating subsidiaries may be required to pledge additional assets to secure reserve credit outside of the securitization structure. As such, the amount of invested assets that exceeds statutory reserves within the securitization portfolios potentially represents additional protection from unexpected estimated fair value declines in invested assets. As of September 30, 2007, the total invested assets within the Company's three securitization structures, Orkney I, Orkney II and Ballantyne Re, exceeded the statutory reserves covered by the structures by approximately $831.7 million, as summarized in the following table. Clearwater Re was excluded from this table as it contains no sub-prime or Alt-A assets.
As of As of June 30, September 30, 2007 2007 ($ in millions) ($ in millions) --------------- --------------- Invested assets within securitization portfolios................................ $ 4,548.0 $ 4,216.5 Statutory reserves........................ ( 3,161.0) (3,384.8) Amount of invested assets that exceed statutory reserves within securitization --------------- --------------- portfolios................................ $ 1,387.0 $ 831.7 =============== ===============
Management believes the Company's current financial position provides it with sufficient capital and liquidity to withstand temporary market dislocations or potential losses arising from underperformance of its sub-prime ABS and Alt-A holdings in the current market environment. 49 Over time, the Company expects to receive distributions from the securitization structures through its debt and equity investments in the securitization structures. Temporary and permanent changes in the estimated fair value of assets in these structures could impact the size and timing of these distributions. Liquidity and Capital Resources Liquidity Cash flow Net cash provided by operating activities amounted to $271.9 million in the nine months ended September 30, 2007 compared to net cash provided by operating activities of $532.9 million in the same period in 2006. Operating cash flow includes cash inflows from premiums, fees and investment income, and cash outflows for benefits and expenses paid. In periods of growth of new business, our operating cash flow may decrease due to first year commissions paid on new business generated. For income recognition purposes these commissions are deferred and amortized over the life of the business. The decrease in net cash provided by operating activities principally relates to activity in the prior year period where $442.3 million of funds withheld were released as a result of the Ballantyne Re securitization. The remaining cash provided by operating activities in the prior year was mainly due to the increase in reserves for future policy benefits related to a new annuity contract written by the Life Reinsurance International Segment, which was subsequently recaptured. We believe cash flows from operations will be positive over time. However, they may be positive or negative in any one period depending on the amount of new life reinsurance business written, the level of ceding commissions paid in connection with writing that business, the level of renewal premiums earned in the period and the timing of receipt of reinsurance receivables and settlement of reinsurance payables. Net cash used in investing activities was $43.4 million in the nine months ended September 30, 2007 compared to net cash used in investing activities of $2,253.5 million in the same period in 2006. The decrease in net cash used in investing activities principally relates to the purchases of fixed maturity securities in the first quarter of 2006. Net cash provided by financing activities was $401.7 million in the nine months ended September 30, 2007 compared to $1,656.5 million in the same period in 2006. The decrease in net cash provided by financing activities principally relates to prior year financings of $1,760.2 million mainly raised in the Ballantyne Re securitization, $265.0 million related to drawdown of funds on the Stingray facility, and $153.7 million from proceeds from a prepaid variable share forward contract. The current year financings include $365.9 million raised in the Clearwater Re securitization, $556.0 million in net proceeds from the issuance of Convertible Cumulative Participating Preferred Shares offset by $275.0 million repayment of funds drawn down on the Stingray financing facility. The Holding Company We are a holding company whose primary uses of liquidity include, but are not limited to, operating expenses, the immediate capital and collateral needs of our operating companies, dividends paid to our shareholders and interest payments on our indebtedness. The primary sources of our liquidity include proceeds from our capital raising efforts and interest income on corporate investments. The holding company also receives funding from its subsidiaries through transfer pricing reflecting services performed by the holding company on behalf of its subsidiaries. We will continue to be dependent upon these sources of liquidity. Our liquidity position was greatly improved by the closing of the Transaction, which provided net proceeds of $555.9 million (see Note 8 to the Consolidated Financial Statements). The capital provided in the Transaction allowed us to repay the $275.0 million previously drawn on the Stingray financing facility and pay the closing costs of the Transaction. The remaining proceeds from the Transaction remain in our holding company and Scottish Annuity & Life Insurance Company (Cayman) Ltd., which will be used to fund the uses of liquidity as described above. The amounts that we repaid under the Stingray financing facility remain available as an additional source of liquidity to us should we determine that it is needed. As of September 30, 2007, the Company estimates that it had in excess of $468.0 million of available liquidity among itself and its subsidiary, Scottish Annuity & Life Insurance Company (Cayman) Ltd. This amount represents liquidity in excess of liquidity held by the Company's insurance operating subsidiaries and includes cash and marketable securities as well as $275.0 million available under the Stingray facility. 50 Capital and Long-Term Debt Since the Company has significant operations and capital outside of the United States, the Company does not believe that limiting an analysis of its financial position to U.S. statutory surplus calculated in accordance with the NAIC Accounting Practices and Procedures Manual is an appropriate way to evaluate the financial condition of its consolidated worldwide operations. Management believes that a more appropriate measure is shareholders' equity. The Company had total shareholders' equity, as calculated in accordance with GAAP, of approximately $869.3 million as of September 30, 2007. Total capitalization at September 30, 2007 and December 31, 2006 is as follows:
September 30, December 31, 2007 2006 ($ in thousands) ($ in thousands) ---------------- ---------------- Shareholders' equity............................. $ 869,290 $ 1,057,192 Mezzanine equity................................. 555,857 143,665 Long-term debt................................... 129,500 129,500 ------------ ----------- Total............................................ $ 1,554,647 $ 1,330,357 ============ ===========
The decrease in shareholders' equity at September 30, 2007 as compared to December 31, 2006 was primarily due to the issuance of the convertible cumulative participating preferred shares resulting in aggregate net proceeds of $555.9 million and the issuance of ordinary shares to holders of HyCUs on the conversion of purchase contracts of $143.7 million. This is offset by the net loss attributable to ordinary shareholders of $37.7 million for the nine months ended September 30, 2007, the effect of the adoption of FIN 48 which reduced beginning retained earnings by $32.6 million (see Note 7 to the Consolidated Financial Statements) and the increase in unrealized depreciation net of tax and deferred acquisition costs of $279.6 million. Our securitization structures provide reserve credit to the Company's operating subsidiaries for business reinsured. Therefore, an important metric is whether the value of the assets in the securitization portfolios is greater than the statutory reserves of the underlying blocks of business. All of the securitization structures are currently providing full reserve credit. If any deficiency were to develop, then the Company's operating subsidiaries may be required to pledge additional assets to secure reserve credit outside of the securitization structure. As such, the amount of invested assets that exceeds statutory reserves within the securitization portfolios potentially represents additional protection from unexpected estimated fair value declines in invested assets. As of September 30, 2007, the total invested assets within the Company's three securitization structures, Orkney I, Orkney II and Ballantyne Re, exceeded the statutory reserves covered by the structures by approximately $831.7 million, as summarized in the following table. Clearwater Re was excluded from this table as it contains no sub-prime or Alt-A assets.
As of As of June 30, September 30, 2007 2007 ($ in millions) ($ in millions) --------------- --------------- Invested assets within securitization portfolios................................ $ 4,548.0 $ 4,216.5 Statutory reserves........................ (3,161.0) (3,384.8) Amount of invested assets that exceed --------------- -------------- statutory reserves within securitization portfolios................................ $ 1,387.0 $ 831.7 =============== ==============
Management believes the Company's current financial position provides it with sufficient capital and liquidity to withstand temporary market dislocations or potential losses arising from underperformance of its sub-prime ABS and Alt-A holdings in the current market environment. Over time, the Company expects to receive distributions from the securitization structures through their debt and equity investments in the securitization structures. Temporary and permanent changes in the estimated fair value of assets in these structures could impact the size and timing of these distributions. 51 Shareholder dividends On July 28, 2006, the Board of Directors suspended the dividend on our ordinary shares. All future payments of dividends are at the discretion of our Board of Directors and will depend on our income, capital requirements, insurance regulatory conditions, operating conditions and such other factors as the Board of Directors may deem relevant. In accordance with the Forbearance Agreement with HSBC (see Collateral section below), we are prohibited from declaring any cash dividend, exclusive of the Non-Cumulative Perpetual Preferred Shares, during the forbearance period from November 26, 2006 until December 31, 2008, unless at the time of declaration and payment of such cash dividend, Scottish Annuity & Life Insurance Company (Cayman) Ltd. has an insurer financial strength rating of at least A- for Standard & Poor's and A3 for Moody's Investors Service. Collateral We must have sufficient assets available for use as collateral to support our borrowings, letters of credit and certain reinsurance transactions. With reinsurance transactions, the need for collateral or letters of credit arises in the following ways: o When Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re (Dublin) Limited or Scottish Re Limited enter into a reinsurance treaty with a U.S. customer, they must contribute assets into a qualifying reserve credit trust and/or provide a letter of credit to enable the U.S. ceding company to obtain a reserve credit for the reinsurance transaction since these companies are not licensed or accredited U.S. reinsurers. o When Scottish Re (U.S.), Inc. enters into a reinsurance transaction, it typically incurs a need for additional statutory capital to cover strain from acquisition costs and increases in required risk-based capital. To the degree its own surplus is not sufficient to meet this need, we can make an additional capital contribution into Scottish Re (U.S.), Inc. or Scottish Re (U.S.), Inc. can cede a portion of the transaction to another company within the group or to an unrelated reinsurance company. If that reinsurer is not a licensed or accredited U.S. reinsurer, it must contribute assets to a qualifying reserve credit trust and/or provide a letter of credit in order for Scottish Re (U.S.), Inc. to obtain reserve credit. Scottish Re (U.S.), Inc. has ceded significant amounts of business to Scottish Re (Dublin) Limited, relieving Scottish Annuity & Life Insurance Company (Cayman) Ltd. of the need to contribute substantial amounts of capital to Scottish Re (U.S.), Inc. in connection with such cessions by Scottish Re (U.S.), Inc. to Scottish Re (Dublin) Limited. Scottish Re (Dublin) Limited must contribute eligible assets to qualifying reserve credit trusts and/or provide letters of credit to provide Scottish Re (U.S.), Inc. with reserve credit. o Scottish Re (U.S.), Inc. and Scottish Re Life Corporation are licensed, accredited, approved or authorized to write reinsurance in 50 states and the District of Columbia. As a result, they generally are not required to provide collateral in order for each of the Company's U.S. customers to receive reserve credit; however, Scottish Re (U.S.), Inc. may agree to provide a reserve credit trust, security trust, or letter of credit to mitigate the counter-party risk from the customer's perspective, thereby enabling transactions that otherwise would be unavailable or would be available only on significantly less attractive terms. ING Collateral Arrangement Pursuant to the terms of our acquisition of the individual life reinsurance business of ING, ING is obligated to maintain collateral for the Regulation XXX and AXXX statutory reserve requirements of the acquired business for the duration of such requirements. We pay ING a fee based on the face amount of the collateral provided until satisfactory alternative collateral arrangements are made. In 2005 and 2006, we completed three transactions that collectively provided approximately $3.7 billion in collateral arrangements to fund peak Regulation XXX statutory reserve requirements that were assumed in connection with the acquisition of ING's individual life reinsurance business. As of September 30, 2007, ING is primarily providing collateral support for our AXXX business. HSBC I In 2004, we entered into a collateral finance facility with HSBC ("HSBC I"). This facility originally provided $200.0 million, and as of July 1, 2007, provided $188.5 million of amounts utilized for the purpose of collateralizing reinsurance obligations under inter-company reinsurance agreements. Simultaneously, we entered into a total return swap with HSBC under which we are entitled to the total return of the investment portfolio of the trust established for this facility. In 52 accordance with Financial Accounting Standards Board ("FASB") Interpretation No. 46R "Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51" ("FIN 46R"), the trust is considered to be a variable interest entity and we are deemed to hold the primary beneficial interest in the trust. As a result, the trust has been consolidated in our financial statements. The assets of the trust have been recorded as fixed maturity investments. Our consolidated statements of income (loss) show the investment return of the trust as investment income and the cost of the facility is reflected in collateral finance facilities expense. The creditors of the trust have no recourse against our general assets. On September 7, 2007, we terminated this facility in connection with the establishment of the Clearwater Re transaction. In addition to repaying the $188.5 million notional amount due to HSBC under a total return swap, we paid $2.2 million in fees associated with the early termination of this facility. Due to the rating agency downgrades after our announcement of earnings for the second quarter of 2006, HSBC requested additional collateral under the total return swap agreements related to HSBC I. $65.0 million of additional collateral was provided to HSBC in 2006. On November 26, 2006, we entered into an amended and restated forbearance agreement with HSBC, pursuant to which HSBC has agreed not to make demands for additional collateral under our collateral finance facilities with HSBC so long as certain conditions are met during the forbearance period which ends on December 31, 2008. Following the closing of the Transaction on May 10, 2007, $40.0 million of the additional collateral noted above was returned to us. The remaining amount will be returned upon the attainment of an A- credit rating. No additional collateral was released in connection with the termination of HSBC I. Orkney Re, Inc. On February 11, 2005, Orkney Holdings, LLC, a Delaware limited liability company ("Orkney I"), issued and sold in a private offering an aggregate of $850.0 million Series A Floating Rate Insured Notes due February 11, 2035 (the "Orkney Notes"). Orkney I was organized for the limited purpose of holding the stock of Orkney Re, Inc., a special purpose captive insurance company, and issuing the Orkney Notes. During May 2007, we redomesticated Orkney Re, Inc. to Delaware to, among other considerations, take advantage of the synergies created by having both Orkney Re, Inc. and our principle U.S. operating subsidiary, Scottish Re (U.S.), Inc., subject to a single regulator with a more comprehensive understanding of the overall combined business and statutory considerations. Scottish Re (U.S.), Inc. holds all of the limited liability company interest in Orkney I, and has contributed capital to Orkney I in the amount of $268.5 million. Proceeds from this offering were used to fund the Regulation XXX reserve requirements for a defined block of level premium term life insurance policies issued between January 1, 2000 and December 31, 2003 reinsured by Scottish Re (U.S.), Inc. to Orkney Re, Inc. Proceeds from the Orkney Notes have been deposited into a series of trusts that collateralize the notes. The holders of the Orkney Notes cannot require repayment from us or any of our subsidiaries, other than Orkney I. The timely payment of interest and ultimate payment of principal for the Orkney Notes are guaranteed by MBIA Insurance Corporation. Interest on the principal amount of the Orkney Notes is payable quarterly at a rate equivalent to three month LIBOR plus 0.53%. At September 30, 2007, the interest rate was 6.03%. Any payment of principal, including by redemption, or interest on the Orkney Notes is sourced from dividends from Orkney Re, Inc. and the balances available in a series of trust accounts. Dividends may only be made with the prior approval of the Director of Insurance in accordance with the terms of its licensing orders and in accordance with applicable law. The Orkney Notes also contain a customary limitation on lien provisions and customary events of default provisions, which, if breached, could result in the accelerated maturity of the Orkney Notes. Orkney I has the option to redeem all or a portion of the Orkney Notes on or after February 11, 2010, subject to certain call premiums. In accordance with FIN 46R, Orkney I is considered to be a variable interest entity and we are considered to hold the primary beneficial interest. As a result, Orkney I has been consolidated in our financial statements. The assets of Orkney I have been recorded as fixed maturity investments and cash and cash equivalents. Our consolidated statements of income (loss) show the investment return of Orkney I as investment income and the cost of the facility is reflected in collateral finance facilities expense. Orkney Re II plc On December 21, 2005, Orkney Re II plc, an orphan special purpose vehicle incorporated under the laws of Ireland ("Orkney II"), whose issued ordinary shares are held by a share trustee and its nominees in trust for charitable purposes, issued 53 in a private offering $450.0 million of debt to external investors. The debt consisted of $382.5 million Series A-1 Floating Rate Guaranteed Notes (the "Series A-1 Notes"), $42.5 million in aggregate principal amount of Series A-2 Floating Rate Notes (the "Series A-2 Notes"), and $25.0 million Series B Floating Rate Notes (the "Series B Notes"), all due December 31, 2035 (collectively, the "Orkney II Notes"). The Orkney II Notes are listed on the Irish Stock Exchange. Proceeds from this offering were used to fund the Regulation XXX reserve requirements for a defined block of level premium term life insurance policies issued between January 1, 2004 and December 31, 2004 reinsured by Scottish Re (U.S.), Inc. to Orkney II. Proceeds from the Orkney II Notes have been deposited into a series of trusts that collateralize the notes. The holders of the Orkney II Notes cannot require repayment from us or any of our subsidiaries, other than Orkney II. Assured Guaranty (UK) Ltd. has guaranteed the timely payment of the scheduled interest payments and the principal on the maturity date, December 21, 2035, of the Series A-1 Notes. The debt issued to Scottish Annuity & Life Insurance Company (Cayman) Ltd. consisted of $30.0 million of Series C Floating Rate Notes due December 21, 2036. These notes accrue interest, but actual payment of interest does not occur until the Orkney II Notes are fully repaid. The Company owns $0.5 million Series D Convertible Notes due December 21, 2036 and 76,190,000 Preference Shares of $1.00 each in capital. Interest on the principal amount of the Orkney II Notes is payable quarterly at a rate equivalent to three-month LIBOR plus 0.425% for the Series A-1 Notes, three-month LIBOR plus 0.73% for the Series A-2 Notes, and three-month LIBOR plus 3.0 % for the Series B Notes. At September 30, 2007, the interest rate on the Series A-1 Notes was 5.93%, Series A-2 Notes was 6.23%, and Series B Notes was 8.5%. The Orkney II Notes also contain a customary limitation on lien provisions and customary events of default provisions, which, if breached, could result in the accelerated maturity of the Orkney II Notes. Orkney II has the option to redeem all or a portion of the Orkney II Notes after February 11, 2007, subject to certain call premiums. In accordance with FIN 46R, Orkney II is considered to be a variable interest entity and we are considered to hold the primary beneficial interest. As a result, Orkney II has been consolidated in our financial statements. The assets of Orkney II have been recorded as fixed maturity investments and cash and cash equivalents. Our consolidated statements of income (loss) show the investment return of Orkney II as investment income and the cost of the facility is reflected in collateral finance facilities expense. HSBC II On December 22, 2005, we entered into a second collateral finance facility with HSBC ("HSBC II"). This facility is a 20 year collateral finance facility that provides up to $1.0 billion of Regulation XXX collateral support for the business acquired from ING and can be used to collateralize reinsurance obligations under inter-company reinsurance agreements. Simultaneously, we entered into a total return swap with HSBC under which we are entitled to the total return of the investment portfolio of the trust established for this facility. In accordance with FIN 46R, the trust is considered to be a variable interest entity and we are deemed to hold the primary beneficial interest in the trust. As a result, the trust has been consolidated in our financial statements. The assets of the trust have been recorded as fixed maturity investments, cash and cash equivalents. Our consolidated statements of income (loss) show the investment return of the trust as investment income and the cost of the facility is reflected in collateral finance facilities expense. The creditors of the trust have no recourse against our general assets. As at September 30, 2007, $595.0 million of this facility was being utilized. On November 26, 2006, we entered into an amended and restated forbearance agreement with HSBC, pursuant to which HSBC has agreed not to make demands for additional collateral under our collateral finance facilities with HSBC so long as certain conditions are met during the forbearance period which ends on December 31, 2008. Reinsurance Facility On December 22, 2005, we entered into a long term reinsurance facility ("Reinsurance Facility"), with a third-party Bermuda-domiciled reinsurer that provides up to $1.0 billion of Regulation XXX collateral support for the business acquired from ING. The Bermuda reinsurer provides security in the form of letters of credit in trust equal to the statutory reserves. All risks and returns arising out of the underlying book of business are retained by us. 54 Ballantyne Re plc On May 2, 2006, Ballantyne Re plc, an orphan special purpose vehicle incorporated under the laws of Ireland issued in a private offering $1.74 billion of debt to external investors and $178.0 million of debt to Scottish Annuity & Life Insurance Company (Cayman) Ltd. The total debt issued to external investors (collectively, the "Notes") consisted of: o $250.0 million of Class A-1 Floating Rate Notes, o $500.0 million of Class A-2 Floating Rate Guaranteed Notes Series A, o $500.0 million of Class A-2 Floating Rate Guaranteed Notes Series B, o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series A, o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series B, o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series C, o $100.0 million of Class A-3 Floating Rate Guaranteed Notes Series D, o $10.0 million of Class B-1 7.51244% Subordinated Notes, o $40.0 million of Class B-2 Subordinated Floating Rate Notes, and o $42.0 million of Class C-1 Subordinated Variable Interest Rate Notes. The debt issued to Scottish Annuity & Life Insurance Company (Cayman) Ltd. consisted of $8.0 million of Class C-1 Subordinated Variable Interest Rate Notes and $170.0 million Class C-2 Subordinated Variable Interest Rate Notes, which Scottish Annuity & Life Insurance Company (Cayman) Ltd. intends to hold (collectively, the "SALIC Notes", and together with the Notes, the "Ballantyne Notes"). Concurrently with its offering of the Ballantyne Notes, Ballantyne Re issued (i) $500,000 of Class D Convertible Notes, which were purchased by the Company, (ii) 163.0 million Redeemable Preference Shares of U.S. $1.00 par value per share which were purchased by Scottish Annuity & Life Insurance Company (Cayman) Ltd., and (iii) 18.2 million Non-Redeemable Preference Shares of U.S. $1.00 par value per share which were also purchased by Scottish Annuity & Life Insurance Company (Cayman) Ltd. Interest on the principal amount of the Ballantyne Notes is payable in intervals ranging from every 28 days to monthly to annually, depending on the note, initially at a rate equivalent to one-month LIBOR plus 0.61% for the Class A-1 Floating Rate Notes (and after May 2, 2022, one-month LIBOR plus 1.22%), one-month LIBOR plus 0.31% for the Class A-2 Floating Rate Guaranteed Notes Series A (and after May 2, 2027, one-month LIBOR plus 0.62%), one-month LIBOR plus 0.36% for the Class A-2 Floating Rate Guaranteed Notes Series B (and after May 2, 2027, one-month LIBOR plus 0.72%), 4.99%, 4.99%, 5.00% and 5.01% for Series A, Series B, Series C, and Series D of the Class A-3 Notes, respectively (with the rate on the Class A-3 Notes to reset every 28 days), 7.51% for the Class B-1 Subordinated Notes, one-month LIBOR plus 2.00% for the Class B-2 Subordinated Floating Rate Notes, and a variable rate based on performance of the underlying block of business for the Class C-1 Subordinated Variable Interest Rate Notes and the Class C-2 Subordinated Variable Interest Rate Notes. Proceeds from this offering were used to fund the Regulation XXX reserve requirements for the business acquired from ING. $1.65 billion of the proceeds from the Ballantyne Notes have been deposited into a series of accounts that collateralize the reserve obligations of Scottish Re (U.S.), Inc. The holders of the Ballantyne Notes cannot require repayment from us or any of our subsidiaries other than Ballantyne Re. The timely payment of the scheduled interest payments and the principal on the maturity date of Series A of the Class A-2 Notes and Series A, Series B, Series C, Series D and, if issued, Series E of the Class A-3 Notes has been guaranteed by Ambac Assurance UK Limited. The timely payment of the scheduled interest payments and the principal on the maturity date of Series B of the Class A-2 Notes and, if issued, Series F of the Class A-3 Notes has been guaranteed by Assured Guaranty (UK) Ltd. 55 On and after September 4, 2007, interest payment on the Class B-1 Notes and the Class B-2 Notes were suspended pursuant to the Indenture. Interest will continue to accrue until it becomes eligible for payment under the terms of the Indenture, which is primarily driven by the market value of the assets in Ballantyne Re's accounts. In accordance with FIN 46R, Ballantyne Re is considered to be a variable interest entity and we are considered to hold the primary beneficial interest. As a result, Ballantyne Re is consolidated in our financial statements beginning in the second quarter of 2006. The assets of Ballantyne Re are recorded as fixed maturity investments and cash and cash equivalents. Our consolidated statements of income (loss) include the investment return of Ballantyne Re as investment income and the cost of the facility is reflected in collateral finance facilities expense. The terms of the Class C-1 and Class C-2 Notes issued in connection with the Ballantyne Re securitization require Ballantyne Re to write-off all or a portion of the accrued interest and principal of the notes if the equity balance of Ballantyne Re (determined in accordance with International Financial Reporting Standards) falls below a specified amount as of September 30 of any year. As of September 30, 2007, such equity balance fell below this specified amount primarily due to mark to market declines affecting a large portion of Ballantyne Re's investment portfolio. We are currently attempting to amend the Notes to postpone the determination date for any write-off of the Class C-1 Notes for a 12-month period, although such an amendment requires the consent of certain third parties. Absent this amendment, we expect that a portion of the $42.0 million principal amount of Class C-1 Notes held by third parties would be written off in addition to any accrued and unpaid interest. Stingray On January 12, 2005, we entered into a put agreement with Stingray Investor Trust ("Stingray") for an aggregate value of $325.0 million. Under the terms of the put agreement, we acquired an irrevocable put option to issue funding agreements to Stingray in return for the assets in a portfolio of 30 day commercial paper. This put option may be exercised at any time. In addition, we may be required to issue funding agreements to Stingray under certain circumstances, including, but not limited to, the non-payment of the put option premium and a non-payment of interest under any outstanding funding agreements under the put agreement. The facility matures on January 12, 2015. This transaction may also provide collateral for Scottish Re (U.S.), Inc. for reinsurance obligations under inter-company reinsurance agreements. At September 30, 2007, $50.0 million was in use for this purpose. We drew down most of the funds available under the facility, in the amount of $265.0 million, during 2006 and $10.0 million in the first quarter of 2007 and repaid the funds drawn down of $275.0 million on June 10, 2007. The put premium and interest costs incurred during the three months ended September, 2007 and 2006 amounted to $1.2 million and $3.0 million, respectively, and is included in collateral finance facilities expense in the consolidated statements of income (loss). The put premium and interest costs incurred during the nine months ended September 30, 2007 and 2006 amounted to $9.9 million and $5.4 million, respectively. In accordance with FIN 46R, we are not considered to be the primary beneficiary of Stingray and, as a result, we are not required to consolidate Stingray. We are not responsible for any losses incurred by the Stingray Pass Through Trust. Clearwater Re On June 25, 2007, Clearwater Re Limited ("Clearwater") was incorporated under the laws of Bermuda and issued in a private offering $365.9 million of Floating Rate Variable Funding Notes due August 11, 2037 to external investors (the "Clearwater Notes"). Proceeds from this offering were used to fund the Regulation XXX reserve requirements for a defined block of level premium term life insurance policies issued between January 1, 2004 and December 31, 2006 reinsured by Scottish Re (U.S.), Inc. Clearwater replaces the 2004 collateral finance facility with HSBC ("HSBC I"), which has been terminated. Prior to its termination, the HSBC I facility had provided $188.5 million of Regulation XXX reserve funding. Upon termination, this amount was repaid to HSBC in accordance with the termination provisions of the agreement. In addition, HSBC was paid an early termination fee of $2.2 million. Proceeds from the Clearwater Notes have been deposited into a reinsurance credit trust to collateralize the statutory reserve obligations of the defined block of policies noted above. External investors have committed to funding up to $555.0 million in order to fund the ongoing Regulation XXX collateral requirements on this block. Payment of interest and principal under the Clearwater Notes on the maturity date and following an event of default by Clearwater and related acceleration of the Clearwater Notes are guaranteed by Scottish Annuity and Life Insurance Company (Cayman) Ltd. ("SALIC") and by Scottish Re Group Limited ("SRGL). 56 Interest on the principal amount of the Clearwater Notes is payable quarterly at a rate equivalent to three month LIBOR plus a spread determined by SALIC's insurance financial strength rating and SRGL's senior unsecured credit rating. The Clearwater Notes also contain customary events of default provisions, which if breached, could result in the accelerated maturity of the Clearwater Notes. In accordance with FIN 46R, Clearwater Re is considered to be a variable interest entity and we are considered to hold the primary beneficial interest. As a result, Clearwater Re is consolidated in our financial statements beginning in the third quarter of 2007. The assets of Clearwater Re are recorded as fixed maturity investments and cash and cash equivalents. Our consolidated statements of income (loss) include the investment return of Clearwater Re as investment income and the cost of the facility is reflected in collateral finance facilities expense. Collateral Summary At September 30, 2007, we had $4.2 billion of collateral finance facility obligations relating to the HSBC II, Orkney I, Orkney II, Ballantyne Re and Clearwater Re transactions. In connection with these transactions, we have assets in trust of approximately $5.6 billion that represent assets supporting the economic reserves, excess reserves, additional funding amounts and surplus in the transactions. The assets in trust are managed in accordance with predefined investment guidelines as to permitted investments, portfolio quality, diversification and duration. During the first quarter of 2007, we entered into a $100 million term loan facility with MassMutual Capital and Cerberus to provide a source of liquidity between the shareholder vote of the Transaction and the closing of the Transaction, if needed. No amounts were drawn on this facility and it was terminated upon the closing of the Transaction on May 7, 2007. Regulatory & Other Capital Requirements Scottish Annuity & Life Insurance Company (Cayman) Ltd. has agreed with Scottish Re (U.S.), Inc. that it will (1) cause Scottish Re (U.S.), Inc. to maintain capital and surplus equal to the greater of $20.0 million or such amount necessary to prevent the occurrence of a Company Action Level Event under the risk-based capital laws of the State of Delaware and (2) provide Scottish Re (U.S.), Inc. with enough liquidity to meet its obligations in a timely manner. Scottish Annuity & Life Insurance Company (Cayman) Ltd. has agreed with Scottish Re Life Corporation that it will (1) cause Scottish Re Life Corporation to maintain capital and surplus equal to at least 175% of Company Action Level RBC, as defined under the laws of the State of Delaware and (2) provide Scottish Re Life Corporation with enough liquidity to meet its obligations in a timely manner. Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Scottish Re Group Limited have agreed with Scottish Re Limited that in the event Scottish Re Limited is unable to meet its obligations under its insurance or reinsurance agreements, Scottish Annuity & Life Insurance Company (Cayman) Ltd. or if Scottish Annuity & Life Insurance Company (Cayman) Ltd. cannot fulfill such obligations, then Scottish Re Group Limited will assume all of Scottish Re Limited's obligations under such agreements. Scottish Re Group Limited and Scottish Annuity & Life Insurance Company (Cayman) Ltd. have executed similar agreements for Scottish Re (Dublin) Limited and Scottish Re Life (Bermuda) Limited and may, from time to time, execute additional agreements guaranteeing the performance and/or obligations of their subsidiaries. All of our regulated insurance entities are in excess of their minimum regulatory capital requirements as of September 30, 2007 and we expect them to remain as such. Off Balance Sheet Arrangements We have no obligations, assets or liabilities other than those disclosed in the financial statements; no trading activities involving non-exchange traded contracts accounted for at fair value; and no relationships and transactions with persons or entities that derive benefits from their non-independent relationship with us or our related parties. 57 New Accounting Standards FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes". FIN 48 prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise's financial statements in accordance with SFAS No. 109. Tax positions must meet a "more likely than not" recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. (See Note 7 to the Consolidated Financial Statements.) FASB Statement No. 157, Fair Value Measurements In September 2006, the FASB issued Statement No. 157 ("SFAS No. 157"), "Fair Value Measurements", which defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. We are required to adopt SFAS No. 157 on January 1, 2008 and are evaluating the implications of SFAS No. 157 on our results of operations and financial position. FASB Statement No. 159, Fair Value Option for Financial Assets and Financial Liabilities In February 2007, the FASB issued Statement No. 159 ("SFAS No. 159"), "Fair Value Option for Financial Assets and Financial Liabilities", which permits entities to choose to measure many financial instruments and certain other items at fair value. A company must report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied on an instrument by instrument basis, with a few exceptions. The fair value option is irrevocable (unless a new election date occurs) and the fair value option may be applied only to entire instruments and not to portions of instruments. SFAS 159 will be effective for interim and annual financial statements issued after January 1, 2008. We are evaluating the implications of SFAS No. 159 on our results of operations and financial position. Item 3. Quantitative and Qualitative Disclosures about Market Risk Please refer to Part II "Item 1A: Risk Factors" and "Item 7A: Quantitative and Qualitative Disclosures about Market Risk" in our 2006 Annual Report. Item 4. Controls and Procedures Evaluation of disclosure controls and procedures Our Chief Executive Officer and Chief Accounting Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on such evaluation, such officers have concluded that our disclosure controls and procedures were effective as of September 30, 2007 to ensure that information required to be disclosed by us in the reports filed and submitted by us under the Exchange Act were recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Changes in internal controls In connection with the restatement of our Form 10-Q for the quarter ended June 30, 2007, our Chief Executive Officer and Chief Accounting Officer, in consultation with our management, have determined that, as of June 30, 2007, we had a material weakness in our internal control over financial reporting, as defined in the standards established by the Public Company Accounting Oversight Board. Specifically, as of June 30, 2007, we had a material weakness relating to our controls over the calculation of earnings per share in that our procedures did not operate effectively to detect errors in the calculation of net loss attributable to ordinary shareholders. To remedy the material weakness, we enhanced our procedures to provide additional management oversight of our accounting activities and at the date of this report, we consider our material weakness to be remediated. Other than the remediation activity referred to above, there have not been any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) promulgated by the SEC under the Securities Exchange Act of 1934) during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 58 PART II. OTHER INFORMATION Item 1. Legal Proceedings On August 2, 2006, a putative class action lawsuit was filed against us and certain of our current and former officers and directors in the U.S. District Court for the Southern District of New York on behalf of a putative class consisting of investors who purchased our publicly traded securities between December 16, 2005 and July 28, 2006. Between August 7, 2006 and October 3, 2006, seven additional related class action lawsuits were filed against us, certain of our current and former officers and directors, and certain third parties. Two of the complaints were filed on August 7, 2006, and the remaining five complaints were filed on August 14, 2006, August 22, 2006, August 23, 2006, September 15, 2006, and October 3, 2006, respectively. Each of the class actions filed seeks an unspecified amount of damages, as well as other forms of relief. On October 12, 2006, all of the class actions were consolidated. On December 4, 2006, a consolidated class action complaint was filed. The complaint names us; Dean E. Miller, our former Chief Financial Officer; Scott E. Willkomm, our former Chief Executive Officer; Elizabeth Murphy, our former Chief Financial Officer; our former Board members Michael Austin, Bill Caulfeild-Browne, Robert Chmely, Michael French, Lord Norman Lamont, Hazel O'Leary, and Glenn Schafer; and certain third parties, including Goldman Sachs and Bear Stearns in their capacities as underwriters in various securities offerings by us and Ernst & Young LLP in their capacity as independent registered public accounting firm. The complaint is brought on behalf of a putative class consisting of investors who purchased our securities between February 17, 2005 and July 31, 2006. The complaint alleges violations of Sections 10(b) and 20(a) of the Exchange Act, Rule 10b-5, and Sections 11, 12(a)(2), and 15 of the Securities Act. The complaint seeks an unspecified amount of damages, as well as other forms of relief. On March 7, 2007 we filed a motion to dismiss the putative class action lawsuit. On November 2, 2007, the court dismissed the Section 10(b) and Rule 10b-5 claims against Ernst & Young LLP, but gave the plaintiffs leave to amend. The court denied the motions to dismiss brought by the other named defendants. The Company believes the plaintiffs' claims to be without merit and intends to defend itself against them. In addition, on or about October 20, 2006, a shareholder derivative lawsuit was filed against certain of our current and former directors in the U.S. District Court for the Southern District of New York. The derivative lawsuit alleges, among other things, that defendants improperly permitted us to make false and misleading statements to investors concerning our business and operations, thereby exposing us to liability from class action suits alleging violations of the U.S. securities laws. The derivative lawsuit asserts claims against defendants for breach of fiduciary duty, abuse of control, gross mismanagement, constructive fraud, and unjust enrichment. On January 8, 2007 we filed a motion to dismiss the derivative lawsuit. On May 7, 2007, our motion was granted and the lawsuit was dismissed without prejudice. The Plaintiff declined to submit an amended complaint and, on May 30, 2007, the court dismissed the case with prejudice. Item 1A. Risk Factors As a result of the closing of the Transaction, certain risks set forth in our 2006 Annual Report relating to whether the Transaction would be completed are no longer applicable. However, the other risks identified in our 2006 Annual Report and those set forth below could materially affect our business, results of operations or financial condition. Recent developments in the residential mortgage market, especially in the nonprime sector, may adversely affect our financial condition. Recently, the residential mortgage market in the United States has experienced a variety of difficulties and changed economic conditions. We have exposure to the sub-prime market as a result of securities held in our investment portfolio, as described in more detail under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Exposure to Sub-prime ABS and Alt-A RMBS". Due to these recent developments, especially in the nonprime sector, there is a risk that these investment values may further decline which may adversely affect our financial condition. Process Improvement Risk We are implementing a process improvement program under which, among other things, we intend to enhance the automation of our reporting, valuation and administrative tools including the conversion of treaty level data onto our SAGE platform. The results of such program may give rise to unforeseen adjustments to our previous financial estimates, which could adversely affect our results of operations. 59 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Not applicable. Item 3. Defaults upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders The Company held its 2007 Annual Meeting of Shareholders on July 18, 2007. The items of business set forth below were presented to our shareholders (the "Shareholders"). The number of shares set forth below includes the ordinary shares into which the Convertible Cumulative Participating Preferred Shares are convertible. Election of Directors The results of the vote of the Shareholders with respect to the eleven directors who were elected as proposed in the Proxy Statement dated June 22, 2007, under the caption titled "Proposal for Election of Directors" were as follows:
- ----------------------------------- ---------------------- -------------------------- Item 6. Total Vote Item 5. Total Vote Withheld From Each Name For Each Director Director - ----------------------------------- ---------------------- -------------------------- Jonathan Bloomer 168,186,128 12,959,523 - ----------------------------------- ---------------------- -------------------------- Christopher Brody 168,115,225 13,030,426 - ----------------------------------- ---------------------- -------------------------- James Butler 178,204,800 2,940,851 - ----------------------------------- ---------------------- -------------------------- James Chapman 178,204,550 2,941,101 - ----------------------------------- ---------------------- -------------------------- Thomas Finke 168,186,028 12,959,623 - ----------------------------------- ---------------------- -------------------------- Paul Goldean 168,152,724 12,992,411 - ----------------------------------- ---------------------- -------------------------- Jeffrey Hughes 178,208,306 2,937,345 - ----------------------------------- ---------------------- -------------------------- Robert Joyal 178,196,306 2,949,345 - ----------------------------------- ---------------------- -------------------------- Larry Port 168,112,005 13,033,646 - ----------------------------------- ---------------------- -------------------------- Michael Rollings 168,179,975 12,965,676 - ----------------------------------- ---------------------- -------------------------- Lenard Tessler 168,188,402 12,957,249 - ----------------------------------- ---------------------- --------------------------
Approval of the 2007 Stock Option Plan The Compensation Committee of the Board of Directors recommended and the Board of Directors approved, subject to shareholder approval, the 2007 Plan. The results of the vote of the Shareholders with respect to this recommendation were as follows: - ---------------------- ---------------- For: 167,754,033 - ---------------------- ---------------- Against: 13,350,228 - ---------------------- ---------------- Abstain: 41,390 - ---------------------- ---------------- Ratification of Independent Auditors The Board of Directors has selected, based upon the recommendation of the Audit Committee, Ernst & Young LLP, as the independent auditors for the Company for the fiscal year ending December 31, 2007. The results of the vote of the Shareholders with respect to this selection were as follows: - ---------------------- ---------------- For: 178,291,151 - ---------------------- ---------------- Against: 2,817,117 - ---------------------- ---------------- Abstain: 37,373 - ---------------------- ---------------- 60 Item 7. Other Information Not applicable. Item 8. Exhibits Except as otherwise indicated, the following Exhibits are filed herewith and made a part hereof: 3.1 Memorandum of Association of Scottish Re Group Limited. 3.2 Articles of Association of Scottish Re Group Limited. 4.1 Specimen Ordinary Share Certificate (incorporated herein by reference to Exhibit 4.1 to Scottish Re Group Limited's Registration Statement on Form S-1). (1) 4.2 Form of Amended and Restated Class A Warrant (incorporated herein by reference to Exhibit 4.2 to Scottish Re Group Limited's Registration Statement on Form S-1). (1) 4.3 Form of Securities Purchase Agreement for the Class A Warrants (incorporated herein by reference to Exhibit 4.4 to Scottish Re Group Limited's Registration Statement on Form S-1). (1) 4.4 Form of Securities Purchase Agreement between Scottish Re Group Limited and the Shareholder Investors (incorporated herein by reference to Exhibit 4.10 to Scottish Re Group Limited's Registration Statement on Form S-1). (1) 4.5 Form of Securities Purchase Agreement between Scottish Re Group Limited and the Non-Shareholder Investors (incorporated herein by reference to Exhibit 4.12 to Scottish Re Group Limited's Registration Statement on Form S-1). (1) 4.6 Certificate of Designations of Convertible Preferred Shares of Scottish Re Group Limited (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (10) 4.7 Certificate of Designations of Scottish Re Group Limited's Non-Cumulative Perpetual Preferred Shares, dated June 28, 2005 (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (16) 4.8 Specimen Stock Certificate for the Company's Non-Cumulative Perpetual Preferred Shares (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (16) 10.1 Second Amended and Restated 1998 Stock Option Plan effective October 22, 1998 (incorporated herein by reference to Exhibit 10.3 to Scottish Re Group Limited's Registration Statement on Form S-1). (1)(25) 10.2 Form of Stock Option Agreement in connection with 1998 Stock Option Plan (incorporated herein by reference to Exhibit 10.4 to Scottish Re Group Limited's Registration Statement on Form S-1). (1)(25) 10.3 Investment Management Agreement dated October 22, 1998 between Scottish Re Group Limited and General Re-New England Asset Management, Inc. (incorporated herein by reference to Exhibit 10.14 to Scottish Re Group Limited's Registration Statement on Form S-1). (1) 10.4 Form of Omnibus Registration Rights Agreement (incorporated herein by reference to Exhibit 10.17 to Scottish Re Group Limited's Registration Statement on Form S-1). (1) 10.5 1999 Stock Option Plan (incorporated herein by reference to Exhibit 10.14 to Scottish Re Group Limited's 1999 Annual Report on Form 10-K). (2)(25) 10.6 Form of Stock Options Agreement in connection with 1999 Stock Option Plan (incorporated herein by reference to Exhibit 10.15 to Scottish Re Group Limited's 1999 Annual Report on Form 10-K). (2)(25) 61 10.7 2001 Stock Option Plan (incorporated herein by reference to Exhibit 10.17 to Scottish Re Group Limited's 2001 Annual Report on Form 10-K). (4)(25) 10.8 Form of Nonqualified Stock Option Agreement in connection with 2001 Stock Option Plan (incorporated herein by reference to Exhibit 10.17 to Scottish Re Group Limited's 2001 Annual Report on Form 10-K). (4)(25) 10.9 Form of Indemnification Agreement between Scottish Re Group Limited and each of its directors and officers (incorporated by reference to Scottish Re Group Limited's Amended Quarterly Report on Form 10-Q/A for the period ended September 30, 2002). (8)(25) 10.10 Employment Agreement dated July 1, 2002 between Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Thomas A. McAvity, Jr. (incorporated by reference to Scottish Re Group Limited's Amended Quarterly Report on Form 10-Q/A for the period ended September 30, 2002). (8)(25) 10.11 Employment Agreement dated June 1, 2002 between Scottish Re Group Limited and Paul Goldean (incorporated herein by reference to Scottish Re Group Limited's Quarterly Report on Form 10-Q for the period ended March 31, 2004). (14)(25) 10.12 Employment Agreement dated June 1, 2002 between Scottish Re Group Limited and Clifford J. Wagner (incorporated by reference to Scottish Re Group Limited's Amended Quarterly Report on Form 10-Q/A for the period ended September 30, 2002). (8)(25) 10.13 Amended Employment Agreement dated February 10, 2003 between Scottish Re Group Limited and Thomas A. McAvity, Jr. (incorporated herein by reference to Scottish Re Group Limited's 2002 Annual Report on Form 10-K). (12)(25) 10.14 Indenture, dated November 22, 2002, between Scottish Re Group Limited and The Bank of New York (incorporated herein by reference to Scottish Re Group Limited's Registration Statement on Form S-3). (9) 10.15 Registration Rights Agreement, dated November 22, 2002, by and among Scottish Re Group Limited and Bear Stearns & Co. and Putnam Lovell Securities Inc. (incorporated herein by reference to Scottish Re Group Limited's Registration Statement on Form S-3). (9) 10.16 Stock Purchase Agreement, dated as of October 24, 2003, by and among Scottish Re Group Limited, Scottish Holdings, Inc. and Employers Reinsurance Corporation (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (11) 10.17 Tax Matters Agreement, dated as of January 22, 2003, by and among Scottish Re Group Limited, Scottish Holdings, Inc. and Employers Reinsurance Corporation (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (11) 10.18 Transition Services Agreement, dated as of January 22, 2003, by and among Scottish Holdings, Inc. and Employers Reinsurance Corporation (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (11) 10.19 Asset Purchase Agreement, dated as of October 17, 2004, by and among Security Life of Denver Insurance Company, Security Life of Denver International Limited, ING America Insurance Holdings, Inc. (for purposes of Section 11.11), Scottish Re Group Limited, Scottish Re (U.S.), Inc., Scottish Annuity & Life Insurance Company (Cayman) Ltd. (for purposes of Section 5.26) and Scottish Re Life Corporation (for purposes of Section 5.24) (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (15) 10.20 Securities Purchase Agreement, dated as of October 17, 2004, by and among Scottish Re Group Limited and Cypress Merchant B Partners II (Cayman) L.P., Cypress Merchant Banking II-A C.V., 55th Street Partners II (Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P. (including form of Subordinated Note, Class C Warrant, Shareholders' Agreement and Amendments to Articles of Association) (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (15) 62 10.21 Form of Voting Agreement, by and among Cypress Merchant B Partners II (Cayman) L.P., Cypress Merchant Banking II-A C.V., 55th Street Partners II (Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P., Scottish Re Group Limited and, respectively, each director and each officer of Scottish Re Group Limited (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (15) 10.22 Voting Agreement, dated as of October 15, 2004, by and among Scottish Re Group Limited, Cypress Merchant B Partners II (Cayman) L.P., Cypress Merchant Banking II-A C.V., 55th Street Partners II (Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P. and Pacific Life Insurance Company (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (15) 10.23 Letter Agreement, dated as of October 17, 2004, by and among Scottish Re Group Limited and Cypress Merchant B Partners II (Cayman) L.P., Cypress Merchant Banking II-A C.V., 55th Street Partners II (Cayman) L.P. and Cypress Side-by-Side (Cayman) L.P. (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (15) 10.24 First Supplemental Indenture, dated as of October 26, 2004, between Scottish Re Group Limited and The Bank of New York (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K, filed with the SEC on October 29, 2004). 10.25 Administrative Services Agreement, dated as of December 31, 2004, between Security Life of Denver Insurance Company and Security Life of Denver International Limited and Scottish Re (U.S.), Inc. (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.26 Coinsurance Agreement dated December 31, 2004 between Security Life of Denver Insurance Company and Scottish Re (U.S.), Inc. (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.27 Coinsurance/Modified Coinsurance Agreement, dated December 31, 2004, between Security Life of Denver Insurance Company and Scottish Re (U.S.), Inc. (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.28 Retrocession Agreement, dated December 31, 2004, between Scottish Re (U.S.), Inc. and Security Life of Denver Insurance Company (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.29 Retrocession Agreement, dated December 31, 2004, between Scottish Re Life (Bermuda) Limited and Security Life of Denver Insurance Company (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.30 Reserve Trust Agreement, dated as of December 31, 2004, between Scottish Re (U.S.) Inc., as Grantor, and Security Life of Denver Insurance Company, as Beneficiary, and The Bank of New York, as Trustee, and The Bank of New York, as Securities Intermediary (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.31 Security Trust Agreement, dated as of December 31, 2004, by and among Scottish Re (U.S.), Inc., as Grantor, Security Life of Denver Insurance Company, as Beneficiary, The Bank of New York, as Trustee, and The Bank of New York, as Securities Intermediary (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.32 Coinsurance Agreement, dated December 31, 2004, between Security Life of Denver International Limited and Scottish Re Life (Bermuda) Limited (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.33 Coinsurance/Modified Coinsurance Agreement, dated December 31, 2004, between Security Life of Denver International Limited and Scottish Re Life (Bermuda) Limited (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 63 10.34 Coinsurance Funds Withheld Agreement, dated December 31, 2004, between Security Life of Denver International Limited and Scottish Re Life (Bermuda) Limited (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.35 Reserve Trust Agreement, dated December 31, 2004, between Scottish Re Life (Bermuda) Limited, as Grantor, and Security Life of Denver International Limited, as Beneficiary. The Bank of New York, as Trustee, and The Bank of New York, as Securities Intermediary (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.36 Security Trust Agreement, dated as of December 31, 2004, by and among Scottish Re Life (Bermuda) Limited, as Grantor, Security Life of Denver International Limited, as Beneficiary, The Bank of New York, as Trustee, and the Bank of New York, as Securities Intermediary (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.37 Technology Transfer and License Agreement, dated as of December 31, 2004, between Security Life of Denver Insurance Company, ING North America Insurance Corporation and Scottish Re (U.S.), Inc. (incorporated herein by reference to Scottish Re Group Limited's 2004 Annual Report on Form 10-K). (20) 10.38 Transition and Integration Services Agreement, dated December 31, 2004, between Security Life of Denver Insurance Company and Scottish Re (U.S.), Inc. (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (19) 10.39 Form of Remarketing Agreement, between the Company and Lehman Brothers, Inc., as Remarketing Agent (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (16) 10.40 Scottish Re Group Limited 2004 Equity Incentive Compensation Plan (incorporated herein by reference to Scottish Re Group Limited's Proxy Statement filed with the SEC on April 1, 2004). 10.41 Amendment No. 1 to Scottish Re Group Limited 2004 Equity Incentive Compensation Plan (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (18) (25) 10.42 Amendment No. 2 to Scottish Re Group Limited 2004 Equity Incentive Compensation Plan (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (18) (25) 10.43 Form of Management Stock Option Agreement under the Scottish Re Group Limited 2004 Equity Incentive Compensation Plan (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (18) (25) 10.44 Form of Management Performance Share Unit Agreement under the Scottish Re Group Limited 2004 Equity Incentive Compensation Plan (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (18) (25) 10.45 Form of Management Restricted Share Unit Agreement under the Scottish Re Group Limited 2004 Equity Incentive Compensation Plan (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (18) (25) 10.46 Letter of Credit Agreement, dated as of August 18, 2005, among Scottish Re (Dublin) Limited, as Borrower, Scottish Annuity & Life Insurance Company (Cayman) Ltd., as Guarantor, Bank of America, N.A., as Administrative Agent and L/C Issuer, and the Other Lenders Party Hereto, and Bank of America Securities LLC, as Sole Lead Arranger and Sole Book Manager (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (21) 10.47 Amendment to Employment Agreement, dated as of October 29, 2006, between Scottish Re Group Limited and Paul Goldean (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K which was filed with the SEC on November 2, 2006). (25) 64 10.48 Securities Purchase Agreement, dated as of November 26, 2006, by and among Scottish Re Group Limited, MassMutual Capital Partners LLC and SRGL Acquisition, LLC (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (22) 10.49 Form of Registration Rights and Shareholders Agreement (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (22) 10.50 Voting Agreement, dated as of November 26, 2006, by and among Scottish Re Group Limited, MassMutual Capital Partners LLC, SRGL Acquisition, LLC, Cypress Merchant B Partners II (Cayman) L.P., Cypress Merchant B II-A C.V., Cypress Side-By-Side (Cayman) L.P. and 55th Street Partners II (Cayman) L.P. (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (22) 10.51 First Amendment to Asset Purchase Agreement, dated as of November 26, 2006, by and among Scottish Re (U.S.), Inc., Scottish Re Life (Bermuda) Limited, Security Life of Denver Insurance Company and Security Life of Denver International Limited (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (22) 10.52 Letter Agreement, dated as of November 30, 2006, by and among Scottish Annuity & Life Insurance Company (Cayman) Ltd., Scottish Re Limited and Comerica Bank (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (23) 10.53 Standby Letter of Credit Application and Agreement, dated as of November 30, 2006, by and between Scottish Annuity & Life Insurance Company (Cayman) Ltd. and Comerica Bank (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (23) 10.54 Standby Letter of Credit Application and Agreement, dated as of November 30, 2006, by and between Scottish Re Limited and Comerica Bank (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K). (23) 10.55 Amendment No. 2 to Securities Purchase Agreement, dated as of February 20, 2007, by and among Scottish Re Group Limited, MassMutual Capital Partners LLC and SRGL Acquisition, LDC (incorporated herein by reference to Scottish Re Group Limited's Current Report on Form 8-K which was filed with the SEC on February 21, 2007). 10.56 Amendment Three to the 2004 Equity Incentive Compensation Plan. (25) 10.57 Scottish Re Group Limited 2007 Stock Option Plan (incorporated herein by reference to Scottish Re Group Limited's Proxy Statement filed with the SEC on June 22, 2007). (25) 10.58 Employment Agreement dated May 30, 2006 between Scottish Re Holdings Limited and Duncan Hayward. (24)(25) 10.59 Employment Agreement dated June 28, 2007 between Scottish Holdings, Inc. and Jeffrey M. Delle Fave. (24)(25) 10.60 Employment Agreement dated July 18, 2007 between Scottish Re Group Limited and George R. Zippel. (24)(25) 10.61 Employment Agreement dated July 25, 2007 between Scottish Holdings, Inc. and Michael Baumstein. (24)(25) 10.62 Employment Agreement dated July 26, 2007 between Scottish Re (U.S.), Inc. and Meredith Ratajczak. (24)(25) 10.63 Employment Agreement dated September 24, 2007 between Scottish Re Group Limited and Terry Eleftheriou. (25) 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 65 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (1) Scottish Re Group Limited's Registration Statement on Form S-1 was filed with the SEC on June 19, 1998, as amended. (2) Scottish Re Group Limited's 1999 Annual Report on Form 10-K was filed with the SEC on April 3, 2000. (3) Scottish Re Group Limited's 2000 Annual Report on Form 10-K was filed with the SEC on March 30, 2001. (4) Scottish Re Group Limited's 2001 Annual Report on Form 10-K was filed with the SEC on March 5, 2002. (5) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on December 31, 2001. (6) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on June 2, 2005. (7) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on August 9, 2001. (8) Scottish Re Group Limited's Amended Quarterly Report on Form 10-Q/A was filed with the SEC on August 8, 2002. (9) Scottish Re Group Limited's Registration Statement on Form S-3 was filed with the SEC on January 31, 2003, as amended. (10) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on December 17, 2003. (11) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on January 6, 2004. (12) Scottish Re Group Limited's 2002 Annual Report on Form 10-K was filed with the SEC on March 31, 2003. (13) Scottish Re Group Limited's Quarterly Report on Form 10-Q was filed with the SEC on August 12, 2003. (14) Scottish Re Group Limited's Quarterly Report on Form 10-Q was filed with the SEC on May 10, 2004. (15) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on October 21, 2004. (16) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on July 1, 2005. (17) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on July 18, 2005. (18) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on August 8, 2005. (19) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on August 4, 2005. (20) Scottish Re Group Limited's 2004 Annual Report on Form 10-K was filed with the SEC on March 18, 2005. (21) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on August 22, 2005. (22) Scottish Re Group Limited's Current Report on Form 8-K as filed with the SEC on November 29, 2006. (23) Scottish Re Group Limited's Current Report on Form 8-K was filed with the SEC on December 1, 2006. (24) Scottish Re Group Limited's Quarterly Report on Form 10-Q for the period ended June 30, 2007 was filed with the SEC on August 11, 2007. (25) This exhibit is a management contract or compensatory plan or arrangement. 66 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SCOTTISH RE GROUP LIMITED Date: November 9, 2007 By: /s/ George Zippel ------------------------------------- George Zippel President and Chief Executive Officer Date: November 9, 2007 By: /s/ Duncan Hayward ------------------------------------- Duncan Hayward Chief Accounting Officer 67 EX-31 2 ex31_1.txt EXHIBIT 31.1 Exhibit 31.1 CERTIFICATION I, George Zippel, President and Chief Executive Officer of Scottish Re Group Limited, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Scottish Re Group Limited (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. designed such internal control over financial reporting, or caused such control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 9, 2007 /s/ George Zippel ------------------------------------- George Zippel President and Chief Executive Officer EX-31 3 ex31_2.txt EXHIBIT 31.2 Exhibit 31.2 CERTIFICATION I, Duncan Hayward, Chief Accounting Officer of Scottish Re Group Limited, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Scottish Re Group Limited (the "registrant"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. designed such internal control over financial reporting, or caused such control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 9, 2007 /s/ Duncan Hayward ------------------------------- Duncan Hayward Chief Accounting Officer EX-32 4 ex32_1.txt EXHIBIT 32.1 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Scottish Re Group Limited (the "Company") on Form 10-Q for the quarterly period ended September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, George Zippel, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ George Zippel - ----------------- George Zippel President and Chief Executive Officer November 9, 2007 A signed original of this written statement required by Section 906 has been provided to Scottish Re Group Limited and will be retained by Scottish Re Group Limited and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 5 ex32_2.txt EXHIBIT 32.2 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Scottish Re Group Limited (the "Company") on Form 10-Q for the quarterly period ended September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Duncan Hayward, Chief Accounting Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Duncan Hayward - ------------------ Duncan Hayward Chief Accounting Officer November 9, 2007 A signed original of this written statement required by Section 906 has been provided to Scottish Re Group Limited and will be retained by Scottish Re Group Limited and furnished to the Securities and Exchange Commission or its staff upon request. EX-10 6 ex10_63.txt EXHIBIT 10.63 - EMPLOYMENT AGREEMENT EXHIBIT 10.63 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT ("Agreement") dated as of September 24, 2007 between Scottish Re Group Limited (the "Company") and Terry Eleftheriou (the "Employee") (together, the "Parties"). WHEREAS, the Parties wish to establish the terms of the Employee's employment with the Company upon the terms and conditions set forth herein, and all other agreements with respect to the subject matter hereof; Accordingly, the Parties agree as follows: 1. Employment and Acceptance. The Company shall employ the Employee, and the Employee shall accept employment, subject to the terms of this Agreement, on October 1, 2007 (the "Effective Date"). 2. Term. Subject to earlier termination pursuant to Section 5 of this Agreement, this Agreement and the employment relationship hereunder shall continue from the Effective Date until the second (2nd) anniversary of the Effective Date and shall automatically renew for successive one (1) year intervals thereafter unless either party shall have given at least sixty (60) days advance written notice to the other that it does not wish to extend the Term. As used in this Agreement, the "Term" shall refer to the period beginning on the Effective Date and ending on the date the Employee's employment terminates in accordance with this Section 2 or Section 5. In the event of the Employee's termination of employment during the Term, the Company's obligation to continue to pay all base salary, as adjusted, bonus and other benefits then due and payable shall terminate except as may be provided for in Section 5 of this Agreement, or as otherwise required by law. 3. Duties and Positions. 3.1 Positions. During the Term, the Employee shall serve as Chief Financial Officer of the Company and shall report solely and directly to the President and Chief Executive Officer of the Company (the "CEO"). The Employee shall also serve during the Term in executive positions for one or more of the Company's subsidiaries and affiliates for no additional consideration. 3.2 Duties. The Employee will have such authority and responsibilities and will perform such executive duties as are customarily performed by a Chief Financial Officer of a public company of similar size in similar lines of business as the Company and its subsidiaries as may be assigned to the Employee by the CEO. The Employee will devote all his full working-time and attention to the performance of such duties and to the promotion of the business and interests of the Company and its subsidiaries. Nothing in this Agreement shall prevent the Employee from (i) devoting reasonable time to charitable, community, industry or professional activities, or (ii) participating in, or serving on, the governing body of any civic, community or charitable organization with which the Employee may currently be or hereafter become involved; provided that such activities (A) do not materially interfere with and are not inconsistent with Employee's performance of his duties and obligations under this Agreement, (B) cannot reasonably be expected to cause injury or harm to the business or reputation of the Company or any of its subsidiaries and affiliates and (C) do not violate any provision of this Agreement. 3.3 Location. The Employee shall perform his full-time services to the Company and its subsidiaries in the Company's Bermuda office; provided that the Employee shall be required to travel as reasonably necessary to perform his duties hereunder. The Employee shall establish residence in Bermuda as soon as practicable following the Effective Date. 4. Compensation and Benefits by the Company. As compensation for all services rendered pursuant to this Agreement, the Company shall provide the Employee the following during the Term and thereafter as applicable: 4.1 Base Salary. During the Term, the Company will pay to the Employee an annual base salary of $500,000, payable in accordance with the customary payroll practices of the Company ("Base Salary"). The Employee's Base Salary shall be subject to review and may be increased (but not decreased) to an amount determined at the discretion of the Board of Directors of the Company (the "Board") or the compensation committee thereof (which, thereafter, shall be his "Base Salary") after taking into consideration the Employee's performance, the Company's performance, increases in the cost of living and such other factors as the Board or the compensation committee thereof in good faith deems relevant. Such review shall be conducted no less frequently than once during each calendar year at the same time the Company conducts its review of the compensation of the Company's other senior executive officers. 4.2 Bonuses. During the Term, the Employee shall be eligible to receive an annual cash bonus ("Bonus") under a plan established by the Company in the amount determined by the Board or the compensation committee thereof based upon achievement of performance measures established by the Company, after reasonable consultation with the Employee, and approved by the Board in its sole discretion. The Employee's target bonus shall be seventy five percent (75%) of Base Salary (the "Target Bonus"). For the calendar year 2007, the Employee shall receive a Bonus in an amount equal to $150,000 (the "2007 Bonus"). The Employee's Bonus (including the 2007 Bonus) shall be payable at such times and in the manner consistent with the Company's policies regarding compensation of executive employees. The Employee must not have given notice of his intention to terminate without Good Reason prior to or at the time the Employee's Bonus payment is to be made in order to be eligible to receive the Bonus. The Bonus with respect to any calendar year shall be paid no earlier than January 1 and no later than March 15 of the following calendar year. 4.3 Participation in Employee Benefit Plans. The Employee shall be entitled during the Term, if and to the extent eligible, to participate in all of the applicable pension and welfare benefit plans and fringe benefits of the Company, which may be available to other senior executives of the Company. These plans shall include, without limitation, medical, prescription drug, dental, vision, disability, life and accidental death insurance plans and programs and a 401(k) plan to the extent, and on terms at least as favorable as, such plans and programs are available to other senior executives of the Company. The Company may at any time or from time to time amend, modify, suspend or terminate any employee benefit plan, program or arrangement for any reason without the Employee's consent if such amendment, modification, suspension or termination is consistent with the amendment, modification, suspension or termination for other executives of the Company. In each calendar year prior to the date the Employee's employment terminates due to Disability (as defined below), the Employee shall be entitled to receive up to ninety (90) days of full salary continuation in the 2 event he is unable to perform his duties hereunder without reasonable accommodation due to a physical or mental illness or injury. 4.4 Equity Compensation. During the Term, the Employee shall be eligible to participate in the 2007 Scottish Re Group Limited Stock Option Plan, an equity incentive compensation plan established by the Company (the "Equity Incentive Plan"), pursuant to the terms of the Equity Incentive Plan and any applicable agreements thereunder as determined from time to time by the Board. The Employee shall receive an initial grant of the option to purchase 800,000 ordinary shares of the Company (the "Initial Grant") pursuant to the terms of the Equity Incentive Plan and any applicable agreements thereunder. Notwithstanding the foregoing or the terms of the equity Incentive Plan, the Employee's award agreement with respect to the Initial Grant shall provide that if the Employee's employment is terminated by the Company without "Cause" (as defined below), the Employee terminates his employment with "Good Reason" (as defined below) or the Employee's employment with the Company terminates in connection with the Company's determination not to extend or renew the Term pursuant to Section 2, to the extent not previously forfeited, the unvested portion of the Initial Grant, if any, shall become vested and exercisable, and shall remain exercisable for a period of ninety (90) days following the date of such termination of employment. 4.5 Relocation. The Company shall provide the Employee (on a fully grossed up tax neutral basis), directly or through reimbursement (as determined in the Company's reasonable discretion) the following relocation, housing and transportation benefits: (a) a suitable apartment or comparable residence in Bermuda, which the Company shall directly lease for the Employee's use, and shall pay or reimburse other reasonable costs associated with such residence during the Term (at a cost not to exceed $12,000 per month plus utilities), (b) a car and a scooter to be used in Bermuda by the Employee for local ground transportation, (c) through the end of the 2008 calendar year, a suitable apartment or comparable residence for the Employee in the Charlotte, NC area when the Employee is required to perform services for the Company in its Charlotte, NC location (at a cost not to exceed $2,000 per month plus utilities); (d) until the earlier of (i) September 1, 2008 and (ii) the date of the relocation of the Employee's family to a Company location, pursuant to the Company's normal travel expense policy, weekly air travel between the Employee's home in Houston, TX and the Company locations (such payment or reimbursement to include ground transportation between the Employee's home and the applicable Houston metropolitan area airport), and (e) all reasonable costs associated with relocating the Employee and his family and transporting the Employee's household goods to Bermuda or to Charlotte, NC (such amounts paid by the Company pursuant to subsection (e), the "Relocation Expenses"). Notwithstanding anything to the contrary in the Scottish Re Executive Homeowner Corporate Relocation Policy (the "Relocation Policy"), the Employee's Relocation Allowance (as defined in the Relocation Policy) shall equal one (1) month of the Employee's salary. For the avoidance of doubt, the Relocation Allowance shall not be provided to the Employee on a fully grossed up tax neutral basis. Any such reimbursements and any applicable tax gross-up payments for any reimbursement or in-kind benefit shall be made no later than thirty (30) business days following presentation to the Company of the bill or invoice for any such benefit. In no event will any reimbursement or in-kind benefit in any calendar year affect any reimbursement or in-kind benefit made in any subsequent calendar year. In no event will any tax gross-up payment be made later than the Employee's taxable year next following the taxable year in which the Employee remits the related taxes. In the event that the Employee should terminate his employment with the Company without Good Reason, the Employee shall 3 reimburse to the Company a pro rata share of the Relocation Expenses in accordance with the Relocation Policy in effect as of the Effective Date. 4.6 Retention Bonus. Subject to the Employee's continued employment with the Company through the date such payment is made, in the event of a Change in Control (as defined below), the Company shall pay the Employee a lump-sum payment equal to the sum of (x) the Employee's then current Base Salary plus (y) the highest annual Bonus earned by the Employee (or, if higher, the Target Bonus) during the prior two (2) fiscal years (collectively, the "Retention Bonus"), payable within ten (10) days following the first anniversary of the Change in Control. "Change of Control" shall mean (1) any person, other than Cerberus Capital Management, L.P. ("Cerberus") or Mass Mutual Capital Partners LLC ("Mass Mutual") or their respective affiliates, becomes the beneficial owner, directly or indirectly, of fifty percent (50%) or more of the combined voting power of the then issued and outstanding equity securities of the Company, or (2) the sale, transfer or other disposition of all or substantially all of the business and assets of the Company, whether by sale of assets, merger or otherwise (determined on a consolidated basis) to another person other than a transaction in which the survivor or transferee is a person controlled, directly or indirectly, by Cerberus or Mass Mutual Capital or their affiliates. 4.7 Expense Reimbursement. During the Term, the Employee shall be entitled to receive reimbursement for all appropriate business expenses incurred by him in connection with his duties under this Agreement in accordance with the policies of the Company applicable to other executive employees as in effect from time to time. 4.8 Professional Fees. The Company shall pay or reimburse the Employee (on a fully grossed up tax neutral basis) for the Employee's reasonable attorneys' fees and costs (not to exceed $10,000) incurred during 2007 in connection with advice pertaining to and negotiation of this Agreement upon presentation to the Company of bills or invoices for such services and such other supporting information as the Company may reasonably require. Such payment or reimbursement and the corresponding gross-up payment shall be made no later than fifteen (15) business days following presentation to the Company of the bill or invoice for such services. In no event will the payment or reimbursement affect any other reimbursement or in-kind benefit made in any subsequent calendar year or be made later than December 31, 2007. In no event will the tax gross-up payment be made later than March 31, 2008. 4.9 Club Membership. The Company shall pay or reimburse the Employee for (a) the initiation fee for a Bermuda country club membership and (b) the dues for such membership (not to exceed $5,000 per calendar year) following presentation to the Company of the bill or invoice for such membership dues, in accordance with the Company's expense reimbursement policy. 4.10 Signing Bonus. The company shall pay the Employee a $100,000 signing bonus upon execution of this Agreement (the "Signing Bonus"). If the Employee's employment with the Company is terminated either (x) by the Company for Cause or (y) by the Employee without Good Reason within one (1) year of the Effective Date, the Employee agrees to return the entire amount of the Signing Bonus to the Company. 4 4.11 Vacation. The Employee shall be entitled to four (4) weeks of paid vacation per annum, in accordance with the Company's vacation policy. 5. Termination of Employment. 5.1 By the Company for Cause or by the Employee Without Good Reason. If: (i) the Company terminates the Employee's employment with the Company for Cause (as defined below); or (ii) the Employee terminates his employment without Good Reason (as defined below) (provided that the Employee shall be required to give the Company at least forty-five (45) days prior written notice of such termination), the Employee or the Employee's legal representatives (as appropriate), shall be entitled to receive the following (the "Accrued Benefits"): (i) the Employee's accrued but unpaid Base Salary and benefits set forth in Sections 4.1 and 4.3, if any, to the date of termination; (ii) the unpaid portion of the Bonus, if any, relating to the calendar year prior to the calendar year of the Employee's termination, payable in accordance with Section 4.2; provided, however, that if the Employee is terminated by the Company for Cause, or gives notice of his intention to terminate his employment without Good Reason, prior to the date on the Employee's Bonus payment is to be made, the Employee shall not be eligible for and shall not be paid such Bonus amount; (iii) in accordance with the Company's policies, any accrued but unused vacation time or paid time off; and (iv) expenses reimbursable under Section 4.7 incurred but not yet reimbursed to the Employee to the date of termination. For the purposes of this Agreement, "Cause" means, as determined by a majority of the Board, in the Board's reasonable business judgment acting in good faith and engaging in fair dealing with the Employee, with respect to conduct during the Employee's employment with the Company, whether or not committed during the Term, (i) commission of a felony by the Employee; (ii) intentional acts of dishonesty by the Employee resulting or intending to result in personal gain or enrichment at the expense of the Company or its subsidiaries; (iii) the Employee's breach of his material obligations under this Agreement; (iv) conduct by the Employee in connection with his duties hereunder that is fraudulent or grossly negligent or that the Employee knew or reasonably should have known to be unlawful; provided that any action taken by the Employee on the advice of the Company's Chief Administrative Officer (or his designee) shall not be treated as unlawful for purposes of this clause (iv); (v) engaging in personal conduct by the Employee (including, but not limited to, employee harassment or discrimination, the use or possession at work of any illegal controlled substance) which discredits or damages the Company or its subsidiaries; (vi) contravention of specific lawful direction of the Board or continuing inattention to or continuing failure to attempt, in good faith, to perform the duties to be performed by the Employee under the terms of Section 3.2 of this Agreement or (vii) breach of the Employee's covenants set forth in Section 6 below before termination of employment. The Employee shall have fifteen (15) days after notice from the Company, which notice shall set forth in reasonable detail a description of the deficiency determined by the Board to constitute Cause, to cure the deficiency leading to the Cause 5 determination (except with respect to (i) above), if curable. A termination for "Cause" shall be effective immediately (or on such other date set forth by the Company), following the Employee's failure to timely cure such conduct, if curable. For the purposes of this Agreement, "Good Reason" means, without the Employee's consent, (i) a material adverse reduction in the Employee's authority, responsibilities or duties; (ii) a reduction in the Employee's Base Salary or bonus opportunity; provided that the Company may at any time or from time to time amend, modify, suspend or terminate any bonus, incentive compensation or other benefit plan or program provided to the Employee for any reason and without the Employee's consent if such modification, suspension or termination (x) is a result of the underperformance of the Employee or the Company under its business plan, and (y) is consistent with an "across the board" reduction for all similar employees of the Company, and, in each case, is undertaken in the Board's reasonable business judgment acting in good faith and engaging in fair dealing with the Employee; or (iii) the Company's material breach of the Agreement; provided that a suspension of the Employee and the requirement that the Employee not report to work shall not constitute "Good Reason" if the Employee continues to receive the compensation and benefits required by this Agreement. The Company shall have thirty (30) days after receipt of notice from the Employee in writing specifying the deficiency to cure the deficiency that would result in Good Reason. 5.2 By the Company Without Cause; by the Employee with Good Reason; or Following the Company's Decision Not to Renew the Term. If, (1) during the Term: (i) the Company terminates the Employee's employment without Cause (which may be done at any time without prior notice) or (ii) the Employee terminates his employment for Good Reason (within ninety (90) days following the initial condition giving rise to such Good Reason), upon at least forty-five (45) days prior written notice, or (2) the Employee's employment with the Company terminates in connection with the Company's determination not to extend or renew the Term pursuant to Section 2, upon execution without revocation of a valid release agreement in a form reasonably acceptable to the Parties, drafted diligently and in good faith, consistent with the terms and conditions of this Agreement, and not in violation of any applicable laws (the "Release"), the Employee shall be entitled to receive: (i) the Accrued Benefits; (ii) an amount equal to (x) the Employee's annual Base Salary as of the date of termination plus (y) the highest annual Bonus earned by the Employee (or, if higher, the Target Bonus) during the prior two (2) fiscal years (collectively, the "Severance Amount"), payable in a lump sum, less standard income and payroll tax withholding and other authorized deductions within fifteen (15) days following the effective date of the Release or such later time as required by Section 409A of the Internal Revenue Code of 1986, as amended ("Section 409A"); (iii) continued payment of the Employee's Base Salary for the remainder of the Term, payable in accordance with the customary payroll practices of the Company; provided that each payroll payment shall be treated as a separate payment for purposes of Section 409A, and the regulations promulgated thereunder (the "Code"); 6 (iv) if the Employee elects continuing group coverage pursuant to the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended ("COBRA"), reimbursement of the cost of such continuation coverage (on a fully grossed up tax neutral basis) for the earlier of (x) twelve (12) months or (y) such earlier date that the Employee is covered (or eligible to be covered) under another group health plan, subject to the terms of the plans and applicable law; (v) if such termination of employment occurs prior to the date that is ten (10) days subsequent to the first (1st) anniversary of a Change in Control, an amount equal to the Retention Bonus, payable pursuant to Section 4.6 above; and (vi) the Company shall pay or reimburse the Employee (in either case, on a fully grossed up tax neutral basis in accordance with the terms of Section 4.5) for the Employee's reasonable costs (not to exceed $50,000) associated with relocating the Employee and his family and transporting the Employee's household goods from Bermuda to the Employee's future principal residence. The Company shall have no obligation to provide the benefits set forth above in the event that the Employee breaches the provisions of Section 6. 5.3 Due to Death or Disability. If: (i) the Employee's employment terminates due to his death; or (ii) the Company terminates the Employee's employment with the Company due to the Employee's Disability (as defined below), in addition to Accrued Benefits, the Employee or the Employee's spouse, dependents or legal representatives (as appropriate), shall be entitled to receive (A) a lump-sum equal to the prorated portion of the Employee's Target Bonus for the year of the Employee's death or termination of employment due to Disability, less standard income and payroll tax withholding and other authorized deductions, payable within thirty (30) days following the date the Employee's employment terminates, and (B) if the Employee, or his spouse or dependants (as appropriate) elects continuing group coverage pursuant to COBRA, reimbursement of the cost of such continuation coverage (on a fully grossed up tax neutral basis) for the earlier of (x) twelve (12) months or (y) such earlier date that the Employee, his spouse or dependents, as the case may be, is covered under another group health plan, subject in all cases to the terms of the plans and applicable law. For the purposes of this Agreement, "Disability" means a determination by the Company in accordance with applicable law that as a result of a physical or mental injury or illness, the Employee is unable to perform the essential functions of his job with or without reasonable accommodation for a period of (i) ninety (90) consecutive days; or (ii) one hundred eighty (180) days in any one (1) year period. 5.4 No Mitigation; No Offset. The Employee shall be under no obligation to seek other employment after his termination of employment with the Company and the obligations of the Company to the Employee which arise upon the termination of his employment pursuant to this Section 5 shall not be subject to mitigation or offset. 5.5 Removal from any Boards and Position. If the Employee's employment is terminated for any reason under this Agreement, he shall be deemed to have resigned, effective as of the date of the Employee's termination, (i) if a member, from the Board or board of directors of any subsidiary of the Company or any other board to which he has been 7 appointed or nominated by or on behalf of the Company and (ii) from any position with the Company or any subsidiary of the Company, including, but not limited to, as an officer of the Company and any of its subsidiaries. 5.6 Nondisparagement. The Employee and the Company agree that each will not at any time (whether during or after the Term) publish or communicate to any person or entity any Disparaging (as defined below) remarks, comments or statements concerning the other (including, when regarding the Company, its parents, subsidiaries and affiliates, and their respective present and former members, partners, directors, officers, shareholders, employees, agents, attorneys, successors and assigns). "Disparaging" remarks, comments or statements are those that impugn the character, honesty, integrity or morality or business acumen or abilities in connection with any aspect of the operation of business of the individual or entity being disparaged. 5.7 Certain Additional Payments by the Company. (i) Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be determined that any payment or distribution by the Company to, or for the benefit of the Employee (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 5.7) (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Code, or any interest or penalties are incurred by the Employee with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Employee shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Employee of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Employee retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. (ii) Notwithstanding the foregoing provisions of Section 5.7(a), if the Parachute Value (as defined below) of all Payments does not exceed 110% of the Employee's Safe Harbor Amount (as defined below), then the Company shall not pay the Employee a Gross-Up Payment, and the Payments due under this Agreement shall be reduced so that the Parachute Value of all Payments, in the aggregate, equals the Safe Harbor Amount; provided, that if even after all Payments due under this Agreement are reduced to zero, the Parachute Value of all Payments would still exceed the Safe Harbor Amount, then no reduction of any Payments shall be made and the Gross -Up Payment shall be made. The reduction of the Payments due hereunder, if applicable, shall be made as designated by the Employee, and in any event shall be made in such a manner as to maximize the economic present value of all Payments actually made to the Employee, determined by the Accounting Firm (as defined in Section 5.7(c) below) as of the date of the change of control for purposes of Section 280G of the Code using the discount rate required by Section 280G(d)(4) of the Code. For purposes of this Section 5.7, the "Parachute Value" of a Payment means the present value as of the date of the change of control for purposes of Section 8 280G of the Code of the portion of such Payment that constitutes a "parachute payment" under Section 280G(b)(2) of the Code, as determined by the Accounting Firm for purposes of determining whether and to what extent the Excise Tax will apply to such Payment. For purposes of this Section 5.7, Employee's "Safe Harbor Amount" means one dollar less than three times the Employee's "base amount" within the meaning of Section 280G(b)(3) of the Code. 5.8 All determinations required to be made under this Section 5.7, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be used in arriving at such determination, shall be made by the Company's independent auditing firm or such other certified public accounting firm as may be designated by the Employee (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Employee within fifteen (15) business days after the receipt of notice from the Employee that there has been a Payment, or such earlier time as is requested by the Company. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, the Employee may appoint another nationally recognized accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 5.7, shall-be paid by the Company to the Employee or to the Internal Revenue Service on the Employee's behalf within five (5) business days after the receipt of the Accounting Firm's determination, but in no event later than December 31 of the year after the year in which the Employee remits the Excise Tax to the relevant taxing authorities. Any determination by the Accounting Firm shall be binding upon the Company and the Employee. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Employee thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Employee, but no later than December 31 of the year after the year in which the Employee remits the Excise Tax to the relevant taxing authorities. 6. Restrictions and Obligations of the Employee. 6.1 Confidentiality. (a) During the course of the Employee's employment by the Company, the Employee has had and will have access to certain trade secrets and confidential information relating to the Company and its subsidiaries (the "Protected Parties") which is not readily available from sources outside the Company. The confidential and proprietary information and, in any material respect, trade secrets of the Protected Parties are among their most valuable assets, including but not limited to, their customer, supplier and vendor lists, databases, competitive strategies, computer programs, frameworks, or models, their marketing programs, their sales, financial, marketing, training and technical information, their product development (and proprietary product data) and any other information, whether communicated orally, electronically, in writing or in other tangible forms concerning how the Protected Parties create, develop, acquire or maintain their products and marketing plans, target their potential customers and operate their retail and other businesses. The Protected Parties invested, and continue to invest, considerable amounts of time and money in their process, 9 technology, know-how, obtaining and developing the goodwill of their customers, their other external relationships, their data systems and data bases, and all the information described above (hereinafter collectively referred to as "Confidential Information"), and any misappropriation or unauthorized disclosure of Confidential Information in any form would irreparably harm the Protected Parties. The Employee acknowledges that such Confidential Information constitutes valuable, highly confidential, special and unique property of the Protected Parties. The Employee shall hold in a fiduciary capacity for the benefit of the Protected Parties all Confidential Information relating to the Protected Parties and their businesses, which shall have been obtained by the Employee during the Employee's employment by the Company or its subsidiaries and which shall not be or become public knowledge (other than by acts by the Employee or representatives of the Employee in violation of this Agreement). Except as required by law (including, but not limited to, pursuant to a lawful subpoena) or an order of a court or governmental agency with jurisdiction, the Employee shall not, during the period the Employee is employed by the Company or its subsidiaries or at any time thereafter, disclose any Confidential Information, directly or indirectly, to any person or entity for any reason or purpose whatsoever, nor shall the Employee use it in any way, except in the course of the Employee's employment with, and for the benefit of, the Protected Parties or to enforce any rights or defend any claims hereunder or under any other agreement to which the Employee is a party; provided that such disclosure is relevant to the enforcement of such rights or defense of such claims and is only disclosed in the formal proceedings related thereto. The Employee shall take reasonable steps to safeguard the Confidential Information and to protect it against disclosure, misuse, espionage, loss and theft. The Employee understands and agrees that the Employee shall acquire no rights to any such Confidential Information. (b) All Company files, records, documents, drawings, specifications, data, computer programs, evaluation mechanisms and analytics and similar items relating thereto or to the Business (for the purposes of this Agreement, "Business" shall be as defined in Section 6.3 hereof), as well as all customer lists, specific customer information, compilations of product research and marketing techniques of the Company and its subsidiaries, whether prepared by the Employee or otherwise coming into the Employee's possession, shall remain the exclusive property of the Company and its subsidiaries, and the Employee shall not remove any such items from the premises of the Company and its subsidiaries, except in furtherance of the Employee's duties under this Agreement. (c) It is understood that while employed by the Company or its subsidiaries, the Employee will promptly disclose to it, and assign to it the Employee's interest in any invention, improvement or discovery made or conceived by the Employee, either alone or jointly with others, which arises out of the Employee's employment. At the Company's request and expense, the Employee will assist the Company and its subsidiaries during the period of the Employee's employment by the Company or its subsidiaries and thereafter in connection with any controversy or legal proceeding relating to such invention, improvement or discovery and in obtaining domestic and foreign patent or other protection covering the same. (d) As requested by the Company and at the Company's expense, from time to time and upon the termination of the Employee's employment with the Company for any reason, the Employee will promptly deliver to the Company and its subsidiaries all copies and embodiments, in whatever form, of all Confidential Information in the Employee's possession or within his control (including, but not limited to, memoranda, records, notes, plans, photographs, manuals, notebooks, documentation, program listings, flow charts, magnetic media, disks, 10 diskettes, tapes and all other materials containing any Confidential Information) irrespective of the location or form of such material. If requested by the Company, the Employee will provide the Company with written confirmation that all such materials have been delivered to the Company as provided herein. 6.2 Non-Solicitation or Hire. During the Term and for a period of eighteen months (18) months following the termination of the Employee's employment for any reason, the Employee shall not directly or indirectly solicit or attempt to solicit or induce, directly or indirectly, (a) any party who is a customer of the Company or its subsidiaries, or who was a customer of the Company or its subsidiaries at any time during the twelve (12) month period immediately prior to the date the Employee's employment terminates, for the purpose of marketing, selling or providing to any such party any services or products offered by or available from the Company or its subsidiaries (provided that if the Employee intends to solicit any such party for any other purpose, he shall notify the Company of such intention and receive prior written approval from the Company, which approval shall not unreasonably be withheld), (b) any supplier to or customer or client of the Company or any subsidiary to terminate, reduce or alter negatively its relationship with the Company or any subsidiary or in any manner interfere with any agreement or contract between the Company or any subsidiary and such supplier, customer or client or (c) any employee of the Company or any of its subsidiaries or any person who was an employee of the Company or any of its subsidiaries during the twelve (12) month period immediately prior to the date the Employee's employment terminates to terminate such employee's employment relationship with the Protected Parties in order, in either case, to enter into a similar relationship with the Employee, or any other person or any entity in competition with the Business of the Company or any of its subsidiaries. 6.3 Non-Competition. During the Term and for a period of twelve (12) months following the termination of the Employee's employment for any reason, without the prior written consent of the Company, the Employee shall not, directly or indirectly, for his own account or on behalf of any other person or entity (such activities described in Sections 6.3(i) - (iii) below, the "Business"): (i) sell or market the reinsurance of life insurance, annuities and/or annuity-type products which the Employee had responsibility for promoting while employed by the Company (either directly or through another Company employee under his management); or (ii) provide financial advice in connection with the business of offering reinsurance of life insurance, annuities and/or annuity-type products which are similar to those offered by the Company; or (iii) solicit, induce, or attempt to induce any client or customer of the Company that the Employee became aware of by virtue of his employment by the Company to cease doing business in whole or in part with the Company or to do business with any other person or entity engage in the business of offering reinsurance of life insurance, annuities and/or annuity-type products provided, however, that the restrictions set forth in Sections 6.3(i) and (ii) above shall only prohibit the activities described therein in the following geographical jurisdictions: 11 (a) Charlotte, North Carolina; (b) St. Louis, Missouri; (c) the New York City metropolitan area; and (d) Bermuda. provided, further, however, that the Employee shall not be prohibited from serving as an employee, consultant or advisor (or in such other similar capacity) to an entity engaged in the Business if such employment, etc. is with a unit, division, affiliate or department of such entity that does not engage in the Business in any material respect so long as the Employee is not directly or indirectly involved in the Business performed by such entity. The phrase "client or customer" means an entity to whom that the Company was providing reinsurance of life insurance, annuities and/or annuity-type products at the time of the Employee's separation from employment. The Employee acknowledges that the Company's business success and competitive position in the industry are dependent on its exclusive possession of secret or confidential information, knowledge or data, and its relationships with customers. The Employee agrees that each restriction in this Agreement is reasonable as to the time, territory, and line of business and is reasonably necessary to protect the Company's legitimate business interests. The Employee acknowledges and agrees that, during the term and for the twelve (12) months following termination of the Employee's employment with the Company, he shall notify anyone employing the Employee after his separation from the Company's employ or evidencing an intent to employ the Employee as to the existence of the provisions of this Section 6.3; provided, however, that the Employee shall not be required under this Agreement to notify an employer or potential employer of the provisions of this Section 6.3 if such employer does not engage in the Business in any material respect. The invalidity or unenforceability of any provision of this Agreement as applied to a particular occurrence or circumstance or otherwise shall not affect the validity, enforceability, and applicability of any other provision of this Agreement. The Employee asks any reviewing court to reform any restriction determined to be unenforceable due to its duration, geographic scope, or type of activity. The Employee agrees that his education, skills, and abilities are such that, after he leaves the Company's employ, he will be able to obtain employment that does not violate the terms of this paragraph 6.3. Notwithstanding the foregoing, nothing in this Agreement shall prevent the Employee from owning for passive investment purposes not intended to circumvent this Agreement, less than five percent (5%) of the publicly traded common equity securities of any company engaged in the Business (so long as the Employee has no power to manage, operate, advise, consult with or control the competing enterprise and no power, alone or in conjunction with other affiliated parties, to select a director, manager, general partner, or similar governing official of the 12 competing enterprise other than in connection with the normal and customary voting powers afforded the Employee in connection with any permissible equity ownership). 6.4 Property. The Employee acknowledges that all originals and copies of materials, records and documents generated by him or coming into his possession during his employment by the Company or its subsidiaries are the sole property of the Company and its subsidiaries ("Company Property"). During the Term, and at all times thereafter, the Employee shall not remove, or cause to be removed, from the premises of the Company or its subsidiaries, copies of any record, file, memorandum, document, computer related information or equipment, or any other item relating to the business of the Company or its subsidiaries, except in furtherance of his duties under the Agreement. When the Employee's employment with the Company terminates, or upon request of the Company at any time, the Employee shall promptly deliver to the Company all copies of Company Property in his possession or control. 7. Remedies; Specific Performance. The Parties acknowledge and agree that the Employee's breach or overtly threatened breach of any of the restrictions set forth in Section 6 will result in irreparable and continuing damage to the Protected Parties for which there may be no adequate remedy at law and that the Protected Parties shall be entitled to equitable relief, including specific performance and injunctive relief as remedies for any such breach or threatened or attempted breach. The Employee hereby consents to the grant of an injunction (temporary or otherwise) against the Employee or the entry of any other court order against the Employee prohibiting and enjoining him from violating, or directing him to comply with any provision of Section 6. The Employee also agrees that such remedies shall be in addition to any and all remedies, including damages, available to the Protected Parties against him for such breaches or threatened or attempted breaches. In addition, without limiting the Protected Parties' remedies for any breach of any restriction on the Employee set forth in Section 6, except as required by law, the Employee shall not be entitled to any payments set forth in Section 5.2 hereof if the Employee has breached the covenants applicable to the Employee contained in Section 6, the Employee will immediately return to the Protected Parties any such payments previously received under Section 5.2 upon such a breach, and, in the event of such breach, the Protected Parties will have no obligation to pay any of the amounts that remain payable by the Company under Section 5.2. 8. Indemnification. The Company shall indemnify the Employee from and against any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by, or in the right of the Company) brought to impose a liability or penalty on the Employee in his capacity of director, officer, employee or agent of the Company or of any other corporation or entity which he serves as such at the request of the Company, against judgments, fines, amounts paid in settlement and expenses, including attorneys' fees actually and reasonably incurred as a result of such action (such attorneys' fees to be directly paid by the Company), suit or proceeding, or any appeal thereof, and provide for the coverage of the Employee under any applicable directors and officers liability insurance policy maintained by the Company, to the same extent and on the same terms that the Company provides such indemnification to officers and directors of the Company with respect to occurrences while Employee is or was an officer or director of the Company, to the maximum extent permitted by applicable law. 9. Other Provisions. 13 9.1 Notices. Any notice or other communication required or which may be given hereunder shall be in writing and shall be delivered personally, telegraphed, telexed, sent by facsimile transmission or sent by certified, registered or express mail, postage prepaid or overnight mail and shall be deemed given when so delivered personally, telegraphed, telexed, or sent by facsimile transmission or, if mailed, four (4) days after the date of mailing or one (1) day after overnight mail, as follows: (i) If the Company, to: 13840 Ballantyne Corporate Place, Suite 500 Charlotte, NC 28277 Attention: Chief Administrative Officer Telephone: (704) 542-9192 Fax: (704) 542-5744 (ii) If the Employee, to the Employee's home address reflected in the Company's records. 9.2 Entire Agreement. This Agreement contains the entire agreement between the Parties with respect to the subject matter hereof and supersedes all prior agreements, written or oral, with respect thereto. 9.3 Representations and Warranties. (i) The Employee represents and warrants that he is not a party to or subject to any restrictive covenants, legal restrictions or other agreements in favor of any entity or person which would in any way preclude, inhibit, impair or limit the Employee's ability to perform his obligations under this Agreement, including, but not limited to, non-competition agreements, non-solicitation agreements or confidentiality agreements. (ii) The Company represents and warrants that this Agreement has been authorized by all necessary corporate action and is a valid and binding agreement of the Company enforceable against it in accordance with its terms. 9.4 Waiver and Amendments. This Agreement may be amended, modified, superseded, canceled, renewed or extended, and the terms and conditions hereof may be waived, only by a written instrument signed by the Parties or, in the case of a waiver, by the party waiving compliance. No delay on the part of any party in exercising any right, power or privilege hereunder shall operate as a waiver thereof, nor shall any waiver on the part of any right, power or privilege hereunder, nor any single or partial exercise of any right, power or privilege hereunder, preclude any other or further exercise thereof or the exercise of any other right, power or privilege hereunder. 9.5 Governing Law, Dispute Resolution and Venue. (i) This Agreement shall be governed and construed in accordance with the laws of the State of New York applicable to agreements made and not to be performed entirely within such state, without regard to conflicts of laws principles. 14 (ii) The parties agree irrevocably to submit to the exclusive jurisdiction of the federal courts or, if no federal jurisdiction exists, the state courts, located in the City of New York, Borough of Manhattan, for the purposes of any suit, action or other proceeding brought by any party arising out of any breach of any of the provisions of this Agreement and hereby waive, and agree not to assert by way of motion, as a defense or otherwise, in any such suit, action, or proceeding, any claim that it is not personally subject to the jurisdiction of the above-named courts, that the suit, action or proceeding is brought in an inconvenient forum, that the venue of the suit, action or proceeding is improper, or that the provisions of this Agreement may not be enforced in or by such courts. In addition, the parties agree to waive trial by jury. 9.6 Assignability by the Company and the Employee. This Agreement, and the rights and obligations hereunder, may not be assigned by the Company or the Employee without written consent signed by the other party; provided that this Agreement shall be binding upon any successor that continues the business of the Company, and that the Company shall require any such successor shall assume this agreement, whether expressly or by operation of law. 9.7 Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original but all of which shall constitute one and the same instrument. 9.8 Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect the meaning of terms contained herein. 9.9 Severability. If any term, provision, covenant or restriction of this Agreement, or any part thereof, is held by a court of competent jurisdiction of any foreign, federal, state, county or local government or any other governmental, regulatory or administrative agency or authority to be invalid, void, unenforceable or against public policy for any reason, the remainder of the terms, provisions, covenants and restrictions of this Agreement shall remain in full force and effect and shall in no way be affected or impaired or invalidated. The Employee acknowledges that the restrictive covenants contained in Section 6 are a condition of this Agreement and are reasonable and valid in temporal scope and in all other respects. 9.10 Judicial Modification. If any court determines that any of the covenants in Section 6, or any part of any of them, is invalid or unenforceable, the remainder of such covenants and parts thereof shall not thereby be affected and shall be given full effect, without regard to the invalid portion. If any court determines that any of such covenants, or any part thereof, is invalid or unenforceable because of the geographic or temporal scope of such provision, such court shall reduce such scope to the minimum extent necessary to make such covenants valid and enforceable. 9.11 Tax Withholding. The Company or other payor is authorized to withhold from any benefit provided or payment due hereunder, the amount of withholding taxes due any federal, state or local authority in respect of such benefit or payment and to take such other action as may be necessary in the opinion of the Board to satisfy all obligations for the payment of such withholding taxes. 9.12 Compliance with Law. 15 (i) This Agreement is intended to comply with the requirements of Section 409A. To the extent that any provision in this Agreement is ambiguous as to its compliance with Section 409A, the provision shall be read in such a manner so that all payments under Section 5 shall comply with Section 409A. The Company shall make reasonable best efforts to make all payments hereunder in compliance with this Agreement and Section 409A and to minimize any adverse consequences of any such payments to the Employee as a result of Section 409A. (ii) Notwithstanding anything in this Agreement to the contrary, if any amount or benefit that would constitute non-exempt "deferred compensation" for purposes of Section 409A would otherwise be payable or distributable under this Agreement by reason of the Employee's separation from service during a period in which he is a Specified Employee (as defined below), then, subject to any permissible acceleration of payment by the Company under Treas. Reg. Section 1.409A-3(j)(4)(ii) (domestic relations order), (j)(4)(iii) (conflicts of interest), or (j)(4)(vi) (payment of employment taxes): (i) if the payment or distribution is payable in a lump sum, the maximum amount that can be paid to the Employee without becoming subject to or violating Section 409A shall be paid to the Employee and the Employee's right to receive payment or distribution of any additional non-exempt deferred compensation will be delayed until the earlier of the Employee's death or the first day of the seventh month following the Employee's separation from service; and (ii) if the payment or distribution is payable over time, the amount of such non-exempt deferred compensation that would otherwise be payable during the six-month period immediately following the Employee's separation from service will be accumulated and the Employee's right to receive payment or distribution of such accumulated amount will be delayed until the earlier of the Employee's death or the first day of the seventh month following the Employee's separation from service, whereupon the accumulated amount will be paid or distributed to the Employee and the normal payment or distribution schedule for any remaining payments or distributions will resume. (iii) in the case of any such delayed payment, the Company shall pay interest on the deferred amount at 100% of the short-term applicable federal rate as in effect for the month in which the termination of employment occurred. For purposes of this Agreement, the term "Specified Employee" has the meaning given such term in Section 409A, provided, however, that, the Company's Specified Employees and its application of the six-month delay rule shall be determined in accordance with rules adopted by the Board of Directors, which shall be applied consistently with respect to all nonqualified deferred compensation arrangements of the Company, including this Agreement. 16 IN WITNESS WHEREOF, the Parties hereto, intending to be legally bound hereby, have executed this Agreement as of the day and year first above mentioned. EMPLOYEE /s/ Terry Eleftheriou ------------------------------------ Terry Eleftheriou SCOTTISH RE GROUP LIMITED By: /s/ George R. Zippel -------------------------------- Name: George R. Zippel Title: President & CEO 17 -----END PRIVACY-ENHANCED MESSAGE-----