-----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, D+2xvCXPt6E9KaoXjOAUMAutwZHFf7EpJ+oIVMzy4XGI8EA7xFmSuBilGzqKpXB4 8bKeSAJNnsmh6XhMH3fXcg== 0001095073-03-000009.txt : 20030317 0001095073-03-000009.hdr.sgml : 20030317 20030317133129 ACCESSION NUMBER: 0001095073-03-000009 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030317 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EVEREST RE GROUP LTD CENTRAL INDEX KEY: 0001095073 STANDARD INDUSTRIAL CLASSIFICATION: ACCIDENT & HEALTH INSURANCE [6321] IRS NUMBER: 000000000 STATE OF INCORPORATION: C8 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-15731 FILM NUMBER: 03605508 BUSINESS ADDRESS: STREET 1: C/O ABG FINANCIAL & MANAGEMENT SERVICES STREET 2: PARKER HOUSE WILDEY ROAD CITY: ST MICHAEL BARBADOS BUSINESS PHONE: 2464366287 MAIL ADDRESS: STREET 1: C/O REINSURANCE HOLDINGS INC STREET 2: 477 MARTINSVILLE RD PO BOX 830 CITY: LIBERTY CORNER STATE: NJ ZIP: 07938 FORMER COMPANY: FORMER CONFORMED NAME: EVEREST REINSURANCE GROUP LTD DATE OF NAME CHANGE: 19990915 10-K 1 text.txt EVEREST RE GROUP, LTD. 10-K ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- FORM 10-K -------------- ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 Commission file number 1-15731 EVEREST RE GROUP, LTD. (Exact name of registrant as specified in its charter) BERMUDA 98-0365432 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) C/O ABG FINANCIAL & MANAGEMENT SERVICES, INC. PARKER HOUSE WILDEY BUSINESS PARK, WILDEY ROAD ST. MICHAEL, BARBADOS (246) 228-7398 (Address, including zip code, and telephone number, including area code, of registrant's principal executive office) -------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Name of Each Exchange Title of Each Class on Which Registered ------------------- --------------------- Common Shares, $.01 par value per share New York Stock Exchange -------------- Securities registered pursuant to Section 12(g) of the Act: None -------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes _X_ No___ The aggregate market value on June 28, 2002, the last business day of the registrant's most recently completed second quarter, of the voting stock held by non-affiliates of the registrant was $2,871.2 million. At March 14, 2003, the number of shares outstanding of the registrant's common shares was 50,901,893. DOCUMENTS INCORPORATED BY REFERENCE Certain information required by Items 10, 11, 12, and 13 of Form 10-K is incorporated by reference into Part III hereof from the registrant's proxy statement for the 2003 Annual General Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days of the close of the registrant's fiscal year ended December 31, 2002. ================================================================================ 2 TABLE OF CONTENTS ITEM PAGE ---- ---- PART I 1. Business 2. Properties 3. Legal Proceedings 4. Submission of Matters to a Vote of Security Holders PART II 5. Market for Registrant's Common Equity and Related Shareholder Matters 6. Selected Financial Data 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 7A. Quantitative and Qualitative Disclosures About Market Risk 8. Financial Statements and Supplementary Data 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PART III 10. Directors and Executive Officers of the Registrant 11. Executive Compensation 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters 13. Certain Relationships and Related Transactions 14. Controls and Procedures PART IV 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 3 PART I UNLESS OTHERWISE INDICATED, ALL FINANCIAL DATA IN THIS DOCUMENT HAVE BEEN PREPARED USING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP") IN THE UNITED STATES OF AMERICA. AS USED IN THIS DOCUMENT, "EVEREST RE" MEANS EVEREST REINSURANCE COMPANY AND ITS SUBSIDIARIES (UNLESS THE CONTEXT OTHERWISE REQUIRES); "HOLDINGS" MEANS EVEREST REINSURANCE HOLDINGS, INC.; "GROUP" MEANS EVEREST RE GROUP, LTD. (FORMERLY EVEREST REINSURANCE GROUP, LTD.); "CAPITAL TRUST" MEANS EVEREST RE CAPITAL TRUST; AND THE "COMPANY" MEANS GROUP AND ITS SUBSIDIARIES, EXCEPT WHEN REFERRING TO PERIODS PRIOR TO FEBRUARY 24, 2000, WHEN IT MEANS HOLDINGS AND ITS SUBSIDIARIES. ITEM 1. BUSINESS THE COMPANY Group, a Bermuda company, with its principal executive office in Barbados, was established in 1999 as a wholly-owned subsidiary of Holdings. On February 24, 2000, a corporate restructuring was completed and Group became the new parent holding company of Holdings, which remains the holding company for the Company's U.S. based operations. Holders of shares of common stock of Holdings automatically became holders of the same number of common shares of Group. Prior to the restructuring, Group had no significant assets or capitalization and had not engaged in any business or prior activities other than in connection with the restructuring. The Company had gross premiums written in 2002 of $2,846.5 million and shareholders' equity at December 31, 2002 of $2,368.6 million. In connection with the restructuring, Group established a Bermuda-based reinsurance subsidiary, Everest Reinsurance (Bermuda), Ltd. ("Bermuda Re"), which commenced business in the second half of 2000. Group also formed Everest Global Services, Inc., a Delaware subsidiary, to perform administrative and back-office functions for Group and its U.S.-based and non-U.S. based subsidiaries. Holdings, a Delaware corporation, was established in 1993 to serve as the parent holding company of Everest Re, a Delaware property and casualty reinsurer formed in 1973. Until October 6, 1995, Holdings was an indirect wholly-owned subsidiary of The Prudential Insurance Company of America ("The Prudential"). On October 6, 1995, The Prudential sold its entire interest in the shares of common stock of Holdings in an initial public offering (the "IPO"). The Company's principal business, conducted through its operating subsidiaries, is the underwriting of reinsurance and insurance in the United States, Bermuda and international markets. The Company underwrites reinsurance both through brokers and directly with ceding companies, giving it the flexibility to pursue business regardless of the ceding company's preferred reinsurance purchasing method. The Company underwrites insurance principally through general agent relationships and surplus lines brokers. Group's operating subsidiaries, excluding Mt. McKinley Insurance Company ("Mt. McKinley") and Everest International Reinsurance, Ltd. ("Everest International"), are each rated A+ ("Superior") by A.M. Best Company ("A.M. Best"), an independent insurance industry rating organization that rates insurance companies on factors of concern to policyholders. 1 Following is a summary of the Company's operating subsidiaries: o Everest Re, a Delaware insurance company and a direct subsidiary of Holdings, is a licensed property and casualty insurer and/or reinsurer in all states (except Nevada and Wyoming), the District of Columbia, Puerto Rico and is authorized to conduct reinsurance business in the United Kingdom, Canada and Singapore. Everest Re underwrites property and casualty reinsurance for insurance and reinsurance companies in the United States and international markets. Everest Re had statutory surplus at December 31, 2002 of $1,494.0 million. o Bermuda Re, a Bermuda insurance company and a direct subsidiary of Group, is registered in Bermuda as a Class 4 insurer and long-term insurer and is authorized to write property and casualty business and life and annuity business. Bermuda Re commenced business in the second half of 2000. In December 2000, Bermuda Re acquired all of the issued and outstanding shares of AFC Re Ltd. ("AFC Re"), a Bermuda long-term insurance company. AFC Re wrote annuity reinsurance business, which business has been assumed by Bermuda Re. In September 2001, AFC Re was sold to Group and renamed Everest International and is currently inactive. Bermuda Re had capital at December 31, 2002 of $931.9 million based on U.S. generally accepted accounting principles. o Everest National Insurance Company ("Everest National"), an Arizona insurance company and a direct subsidiary of Everest Re, is licensed in 45 states and the District of Columbia and is authorized to write property and casualty insurance in the jurisdictions in which it is licensed. This is often called writing insurance on an admitted basis. o Everest Indemnity Insurance Company ("Everest Indemnity"), a Delaware insurance company and a direct subsidiary of Everest Re, engages in the excess and surplus lines insurance business in the United States. Excess and surplus lines insurance is specialty property and liability coverage that an insurer not licensed to write insurance in a particular jurisdiction is permitted to provide to insureds when the specific specialty coverage is unavailable from admitted insurers. This is often called writing insurance on a non-admitted basis. Everest Indemnity is licensed in Delaware and is eligible to write business on a non-admitted basis in 48 states, the District of Columbia and Puerto Rico. o Everest Security Insurance Company ("Everest Security"), formerly Southeastern Security Insurance Company, a Georgia insurance company and a direct subsidiary of Everest Re, was acquired in January 2000 and writes property and casualty insurance on an admitted basis in Georgia and Alabama. o Mt. McKinley Managers, L.L.C. ("Managers"), a New Jersey limited liability company and a direct subsidiary of Holdings, is licensed in New Jersey as an insurance producer. An insurance producer is any intermediary, such as an agent or broker, which acts as the conduit between an insurance company and an insured. Managers, which is licensed to act in New Jersey as an insurance producer in connection with policies written on both an admitted and a non-admitted basis, is the underwriting manager for Everest Indemnity. Managers is also the parent company for WorkCare Southeast, Inc., an Alabama insurance agency, and WorkCare Southeast of Georgia, Inc., a Georgia insurance agency. 2 o Mt. McKinley (f/k/a Gibraltar Casualty Company, "Gibraltar") ("Mt. McKinley"), a Delaware insurance company and a direct subsidiary of Holdings, was acquired by Holdings in September 2000 from The Prudential. Mt. McKinley was formed by Everest Re in 1978 to engage in the excess and surplus lines insurance business in the United States. In 1985, Mt. McKinley ceased writing new and renewal insurance and now its ongoing operations relate to servicing claims arising from its previously written business. Mt. McKinley was a subsidiary of Everest Re until 1991 when Everest Re distributed the stock of Mt. McKinley to a wholly-owned subsidiary of The Prudential. o Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda company and a direct subsidiary of Everest Re, was formed in 1998 and owned Everest Re Ltd., a United Kingdom company that was dissolved after its reinsurance operations were converted into branch operations of Everest Re. Everest Ltd. holds $79.4 million of investments, the management of which constitutes its principal operations. REINSURANCE INDUSTRY OVERVIEW Reinsurance is an arrangement in which an insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, against all or a portion of the insurance risks underwritten by the ceding company under one or more insurance contracts. Reinsurance can provide a ceding company with several benefits, including a reduction in net liability on individual or classes of risks, catastrophe protection from large or multiple losses and assistance in maintaining acceptable financial ratios. Reinsurance also provides a ceding company with additional underwriting capacity by permitting it to accept larger risks and write more business than would be possible without a concomitant increase in capital and surplus. Reinsurance, however, does not discharge the ceding company from its liability to policyholders. There are two basic types of reinsurance arrangements: treaty and facultative reinsurance. In treaty reinsurance, the ceding company is obligated to cede and the reinsurer is obligated to assume a specified portion of a type or category of risks insured by the ceding company. Treaty reinsurers do not separately evaluate each of the individual risks assumed under their treaties and, consequently, after a review of the ceding company's underwriting practices, are largely dependent on the original risk underwriting decisions made by the ceding company. In facultative reinsurance, the ceding company cedes and the reinsurer assumes all or part of the risk under a single insurance contract. Facultative reinsurance is negotiated separately for each insurance contract that is reinsured. Facultative reinsurance normally is purchased by ceding companies for individual risks not covered by their reinsurance treaties, for amounts in excess of the dollar limits of their reinsurance treaties and for unusual risks. Both treaty and facultative reinsurance can be written on either a pro rata basis or an excess of loss basis. Under pro rata reinsurance, the ceding company and the reinsurer share the premiums as well as the losses and expenses in an agreed proportion. Under excess of loss reinsurance, the reinsurer indemnifies the ceding company against all or a specified portion of losses and expenses in excess of a specified dollar amount, known as the ceding company's retention or reinsurer's attachment point, generally subject to a negotiated reinsurance contract limit. Premiums paid by the ceding company to a reinsurer for excess of loss reinsurance are not directly proportional to the premiums that the ceding company receives because the reinsurer does not assume a proportionate risk. In pro rata reinsurance, the reinsurer generally pays the ceding company a ceding commission. The ceding commission generally is based on the ceding company's cost of acquiring the business being reinsured (commissions, premium taxes, assessments and miscellaneous administrative expense). There is usually no ceding commission on excess of loss reinsurance. 3 Reinsurers may purchase reinsurance to cover their own risk exposure. Reinsurance of a reinsurer's business is called a retrocession. Reinsurance companies cede risks under retrocessional agreements to other reinsurers, known as retrocessionaires, for reasons similar to those that cause insurers to purchase reinsurance: to reduce net liability on individual or classes of risks, protect against catastrophic losses, stabilize financial ratios and obtain additional underwriting capacity. Reinsurance can be written through professional reinsurance brokers or directly with ceding companies. From a ceding company's perspective, both the broker market and the direct market have advantages and disadvantages. A ceding company's decision to select one market over the other will be influenced by its perception of such advantages and disadvantages relative to the reinsurance coverage being placed. BUSINESS STRATEGY The Company's underwriting strategies seek to capitalize on its financial capacity, its employee expertise and its flexibility to offer multiple products through multiple distribution channels. The Company's strategies include effective management of the property and casualty underwriting cycle, which refers to the tendency of insurance premiums, profits and the demand for and availability of coverage to rise and fall over time. The Company also seeks to manage its catastrophe exposures and retrocessional costs. Efforts to control expenses and to operate in a cost-efficient manner are also a continuing focus for the Company. The Company's products include: (1) the full range of property and casualty reinsurance and insurance coverages, including marine, aviation, surety, errors and omissions liability ("E&O"), directors' and officers' liability ("D&O"), medical malpractice, other specialty lines, accident and health ("A&H"), workers' compensation and other standard lines; and (2) reinsurance of life and annuity business. The Company's distribution channels include both the direct and broker reinsurance markets, U.S., Bermuda and international markets, reinsurance, both treaty and facultative, and insurance, both admitted and non-admitted. The Company's underwriting strategy emphasizes underwriting profitability rather than premium volume, writing specialized property and casualty risks and integration of underwriting expertise across all underwriting units. Key elements of this strategy are prudent risk selection, appropriate pricing through strict underwriting discipline and continuous adjustment of the Company's business mix to respond to changing market conditions. The Company focuses on reinsuring companies that effectively manage the underwriting cycle through proper analysis and pricing of underlying risks and whose underwriting guidelines and performance are compatible with its objectives. The Company's underwriting strategy also emphasizes flexibility and responsiveness to changing market conditions, such as increased demand or favorable pricing trends. The Company believes that its existing strengths, including its broad underwriting expertise, U.S., Bermuda and international presence, high ratings and substantial capital, facilitate adjustments to its mix of business geographically, by line of business and by type of coverage, allowing it to capitalize on those market opportunities that provide the greatest potential for underwriting profitability. The Company's insurance operations complement these strategies by allowing the Company access to business that would not likely be available to it on a reinsurance basis. The Company carefully monitors its mix of business across all operations to avoid inappropriate concentrations of geographic or other risk. 4 MARKETING The Company writes business on a worldwide basis for many different customers and for many lines of business, providing a broad array of coverages. The Company is not materially dependent on any single customer, small group of customers, line of business or geographical area. For the 2002 calendar year, no single customer (ceding company or insured) generated more than 7.4% of the Company's gross premiums written. The Company does not believe that a reduction of business from any one customer would have a material adverse effect on its future financial condition or results of operations due to the Company's competitive position in the market place and the continuing availability of other sources of business. Approximately 48.6%, 22.5% and 28.9% of the Company's 2002 gross premiums written were written in the broker reinsurance, direct reinsurance and insurance markets, respectively. The Company's ability to write reinsurance both through brokers and directly with ceding companies gives it the flexibility to pursue business regardless of the ceding company's preferred reinsurance purchasing method. The reinsurance broker market consists of several substantial national and international brokers and a number of smaller specialized brokers. Brokers do not have the authority to bind the Company with respect to reinsurance agreements, nor does the Company commit in advance to accept any portion of the business that brokers submit to it. Reinsurance business from any ceding company, whether new or renewal, is subject to acceptance by the Company. Brokerage fees are generally paid by reinsurers. The Company's ten largest brokers accounted for an aggregate of approximately 39.0% of gross premiums written in 2002, with each of the two largest brokers accounting for approximately 12.9% and 12.4% of gross premiums written, respectively. The Company does not believe that a reduction of business assumed from any one broker would have a materially adverse effect on the Company due to its competitive position in the market place, relationships with ceding companies and the continuing availability of other sources of business. The direct market remains an important distribution system for reinsurance business written by the Company. Direct placement of reinsurance enables the Company to access clients who prefer to place their reinsurance directly with reinsurers based upon the reinsurer's in-depth understanding of the ceding company's needs. The Company's insurance business is written principally through general agent relationships and surplus lines brokers. The Company's largest agency relationship accounted for approximately 15.9% of gross premiums written, which consists of approximately 27,800 individual workers' compensation policies. The Company evaluates each business relationship, including the underwriting expertise and experience of each distribution channel selected, performs analyses to evaluate financial security and monitors performance. SEGMENT INFORMATION The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance on both a treaty and facultative basis through reinsurance brokers as well as directly with ceding companies within the United States. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the United States. The Specialty Underwriting operation writes A&H, marine, aviation and surety business within the United States and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance 5 through the Company's branches in London, Canada and Singapore, in addition to foreign business written through the Company's New Jersey headquarters and Miami office. The Bermuda operation writes property, casualty, life and annuity business through brokers and directly with ceding companies. These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management monitors and evaluates the financial performance of these operating segments principally based upon their underwriting results. The Company utilizes inter-affiliate reinsurance but such reinsurance does not impact segment results, since business is generally reported within the segment in which the business was first produced. For selected financial information regarding these segments, see Note 17 of Notes to Consolidated Financial Statements. UNDERWRITING OPERATIONS The following table presents the distribution of the Company's gross premiums written by its U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda operations for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, classified according to whether the premium is derived from property or casualty business and, for reinsurance business, whether it represents pro rata or excess of loss business: 6 GROSS PREMIUMS WRITTEN BY OPERATION
YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------------------------ 2002 2001 2000 1999 1998 ----------------- ----------------- --------------- ---------------- --------------- $ % $ % $ % $ % $ % -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- (DOLLARS IN MILLIONS) U.S. REINSURANCE Property Pro Rata(1) $ 148.7 5.2% $ 62.9 3.4% $ 60.2 4.3% $ 48.6 4.3% $ 30.1 2.9% Excess 177.8 6.2 104.0 5.5 75.6 5.5 67.0 5.9 65.1 6.2 Casualty Pro Rata(1) 219.2 7.7 191.2 10.2 151.1 10.9 152.9 13.4 183.9 17.6 Excess 348.9 12.3 252.3 13.5 194.7 14.1 222.1 19.5 212.5 20.3 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total(2) 894.6 31.4 610.4 32.6 481.6 34.8 490.6 43.0 491.6 47.0 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- U.S. INSURANCE Property Pro Rata(1) 6.5 0.2 6.2 0.3 9.3 0.7 3.8 0.3 3.1 0.3 Excess - 0.0 - 0.0 - 0.0 - 0.0 - 0.0 Casualty Pro Rata(1) 815.0 28.6 496.1 26.5 241.2 17.4 66.6 5.8 75.5 7.2 Excess - 0.0 - 0.0 - 0.0 - 0.0 - 0.0 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total(2) 821.5 28.9 502.4 26.8 250.5 18.1 70.4 6.2 78.6 7.5 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- SPECIALTY UNDERWRITING Property Pro Rata(1) 397.5 14.0 356.3 19.0 274.0 19.8 213.6 18.7 92.9 8.9 Excess 43.8 1.5 35.0 1.9 19.3 1.4 19.7 1.7 15.8 1.5 Casualty Pro Rata(1) 41.9 1.5 18.4 1.0 21.4 1.5 32.3 2.8 39.3 3.8 Excess 5.3 0.2 4.3 0.2 3.6 0.3 2.9 0.3 3.0 0.3 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total(2) 488.5 17.2 414.0 22.1 318.3 23.0 268.5 23.5 151.0 14.4 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- TOTAL U.S. Property Pro Rata(1) 552.7 19.4 425.5 22.7 343.4 24.8 266.0 23.3 126.1 12.1 Excess 221.6 7.8 139.0 7.4 94.9 6.9 86.7 7.6 80.9 7.7 Casualty Pro Rata(1) 1,076.1 37.8 705.8 37.6 413.8 29.9 251.8 22.1 298.7 28.6 Excess 354.2 12.4 256.7 13.7 198.3 14.3 225.1 19.7 215.6 20.6 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total(2) 2,204.6 77.4 1,526.8 81.4 1,050.4 75.9 829.5 72.7 721.2 69.1 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- INTERNATIONAL Property Pro Rata(1) 328.4 11.5 171.0 9.1 143.4 10.3 124.6 10.9 141.9 13.6 Excess 122.9 4.3 60.0 3.2 55.6 4.0 54.8 4.8 45.8 4.4 Casualty Pro Rata(1) 35.3 1.2 54.3 2.9 78.4 5.7 84.4 7.4 93.4 8.9 Excess 54.3 1.9 37.5 2.0 46.2 3.3 48.5 4.3 43.6 4.2 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total(2) 540.9 19.0 322.8 17.2 323.6 23.4 312.3 27.4 324.7 31.0 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- BERMUDA OPERATIONS Property Pro Rata(1) 37.1 1.3 6.2 0.3 - 0.0 - 0.0 - 0.0 Excess 36.0 1.3 0.6 0.0 - 0.0 - 0.0 - 0.0 Casualty Pro Rata(1) 15.1 0.5 18.1 1.0 11.6 0.8 - 0.0 - 0.0 Excess 12.8 0.4 0.1 0.0 - 0.0 - 0.0 - 0.0 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total(2) (3) 101.0 3.5 25.0 1.3 11.6 0.8 - 0.0 - 0.0 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- TOTAL COMPANY Property Pro Rata(1) 918.2 32.3 602.6 32.1 486.8 35.1 390.6 34.2 268.0 25.6 Excess 380.5 13.4 199.6 10.6 150.5 10.9 141.4 12.4 126.6 12.1 Casualty Pro Rata(1) 1,126.5 39.6 778.1 41.5 503.8 36.4 336.2 29.4 392.1 37.5 Excess 421.3 14.8 294.3 15.7 244.5 17.6 273.6 24.0 259.2 24.8 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total(2) $2,846.5 100.0% $1,874.6 100.0% $1,385.6 100.0% $1,141.8 100.0% $1,045.9 100.0% ======== ===== ======== ===== ======== ===== ======== ===== ======== =====
- ------------- (1) For purposes of the presentation above, pro rata includes reinsurance attaching to the first dollar of loss incurred by the ceding company and insurance. (2) Certain totals and subtotals may not reconcile due to rounding. (3) Includes immaterial amounts of life and annuity premium. 7 U.S. REINSURANCE OPERATION. The Company's U.S. Reinsurance operation writes property and casualty reinsurance, both treaty and facultative, through reinsurance brokers as well as directly with ceding companies within the United States. The Company targets certain brokers and, through the broker market, specialty companies and small to medium sized standard lines companies. On a direct basis, the Company targets companies that place their business predominantly in the direct market, including small to medium sized regional ceding companies, and seeks to develop long-term relationships with those companies. In addition, the U.S. Reinsurance operation writes portions of reinsurance programs for larger, national insurance companies. In 2002, $230.9 million of gross premiums written were attributable to U.S. treaty property business, of which 35.6% was written on an excess of loss basis and 64.4% was written on a pro rata basis. The Company's property underwriters utilize sophisticated underwriting methods which management believes are necessary to analyze and price property business, particularly that segment of the property market which has catastrophe exposure. U.S. treaty casualty business accounted for $418.1 million of gross premiums written in 2002, of which 47.6% was written on an excess of loss basis and 52.4% was written on a pro rata basis. The treaty casualty portfolio consists of professional liability, D&O liability, workers' compensation, excess and surplus lines, and other liability coverages. As a result of the complex technical nature of most of these risks, the Company's casualty underwriters tend to specialize by line of business and work closely with the Company's pricing actuaries. The Company's facultative unit conducts business both through brokers and directly with ceding companies, and consists of four underwriting units representing property, casualty, specialty and national brokerage lines of business. Business is written from a facultative headquarters office in New York and satellite offices in Chicago and Oakland. In 2002, $71.4 million, $133.5 million, $17.3 million and $23.4 million of gross premiums written were attributable to the property, casualty, specialty and national brokerage lines of business, respectively. In 2002, 79.9% and 20.1% of the U.S. Reinsurance operation's gross premiums written were written in the broker and direct reinsurance markets, respectively. U.S. INSURANCE OPERATION. In 2002, the Company's U.S. Insurance operation wrote $821.5 million of gross premiums, of which 99.2% was casualty and 0.8% was property. Of the casualty business, the predominant class was workers' compensation insurance. Everest National wrote $706.1 million and Everest Re wrote $14.1 million, with both principally targeting commercial property and casualty business written through general agency relationships with program administrators. Everest Indemnity wrote $78.1 million, principally targeting excess and surplus lines insurance business written through surplus lines brokers. Everest Security wrote $23.2 million, principally targeting non-standard auto business written through retail agency relationships. With respect to insurance written through general agents and surplus lines brokers, the Company supplements the initial underwriting process with periodic claims, underwriting and operational reviews and ongoing monitoring. 8 SPECIALTY UNDERWRITING OPERATION. The Company's Specialty Underwriting operation writes A&H, marine, aviation and surety reinsurance. The A&H unit primarily focuses on health reinsurance of traditional indemnity plans, self-insured health plans and specialty medical plans. The marine and aviation unit focuses on ceding companies with a particular expertise in marine and aviation business. The marine and aviation business is written primarily through brokers and contains a significant international component written primarily in the London market. Surety business underwritten by the Company consists mainly of reinsurance of contract surety bonds. Gross premiums written by the A&H unit in 2002 totaled $314.4 million, of which $78.1 million was written through the broker market and $236.3 million was written through the direct market. Gross premiums written by the marine and aviation unit in 2002 totaled $94.1 million, substantially all of which was written on a treaty basis and 86.6% of which was sourced through reinsurance brokers. Marine treaties represented 49.9% of marine and aviation gross premiums written in 2002 and consisted mainly of hull and liability coverage. Approximately 69.4% of the marine unit premiums in 2002 were written on a pro rata basis and 30.6% as excess of loss. Aviation premiums accounted for 50.1% of marine and aviation gross premiums written in 2002 and included reinsurance for airlines, general aviation and satellites. Approximately 88.8% of the aviation unit's premiums in 2002 were written on a pro rata basis and 11.2% as excess of loss. In 2002, gross premiums written by the surety unit totaled $80.1 million. Approximately 69.4% of the surety unit premiums in 2002 were written on a pro rata basis and 30.6% on an excess of loss basis. Most of the portfolio is reinsurance of contract surety bonds written directly with ceding companies, with the remainder being credit reinsurance, mostly in international markets. INTERNATIONAL OPERATION. The Company's International operation is designed to enable it to capitalize on the growth opportunities in the international reinsurance market. The Company targets several international markets, including: Europe and the London markets, which are serviced by a branch in London; Canada, with a branch in Toronto; Asia and Australia, with a branch in Singapore; and Latin America, Africa and the Middle East, which business is serviced from Everest Re's New Jersey headquarters and Miami office. The Company also writes "home-foreign" business, which provides reinsurance on the international portfolios of U.S. insurers, from New Jersey. Approximately 83.4% of the gross premiums written by the Company's international underwriters in 2002 represented property business, while the balance represented casualty business. As with its U.S. operations, the Company's International operation focuses on financially sound companies that have strong management and underwriting discipline and expertise. Approximately 73.4% of the Company's international business was written through brokers, with the remainder written directly with ceding companies. In 2002, the Company's gross premiums written by its London branch totaled $186.5 million and consisted of pro rata property (56.8%), excess property (24.1%), pro rata casualty (3.9%) and excess casualty (15.2%). Substantially all of the London premiums consisted of treaty reinsurance. 9 Gross premiums written by the Company's Canadian office totaled $74.0 million in 2002 and consisted of pro rata property (51.3%), excess property (21.5%), pro rata multi-line (2.7%) and excess casualty (24.4%). Approximately 76.4% of the Canadian premiums consisted of treaty reinsurance, while 23.4% was facultative reinsurance. The Company's Singapore branch covers the Asian and Australian markets and accounted for $25.5 million of gross written premiums in 2002. This business consisted of pro rata property (56.4%), excess property (33.4%), pro rata casualty (9.0%) and excess casualty (1.2%). International business written out of Everest Re's New Jersey and Miami offices accounted for $254.9 million of gross premiums written in 2002 and consisted of pro rata treaty property (66.8%), pro rata treaty casualty (9.3%), excess treaty property (15.5%), excess treaty casualty (2.6%) and excess facultative property and casualty (5.8%). Of this international business, 67.6% was sourced from Latin America, 27.3% was sourced from the Middle East, 3.2% was sourced from Europe, Africa and Asia, and 1.9% was "home-foreign" business. BERMUDA OPERATION. The Company's Bermuda operation writes property, casualty, life and annuity business through Bermuda Re. In 2002, the Bermuda operation continued to scale up and had gross property and casualty premiums written of $101.0 million. GEOGRAPHIC AREAS The Company conducts its business in Bermuda, in the United States and in a number of foreign countries. For select financial information about geographic areas, see Note 17 of Notes to the Consolidated Financial Statements. Risks attendant to the foreign operations of the Company parallel those attendant to the United States operations of the Company, with the primary exception of foreign exchange risks. See ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Safe Harbor Disclosure". UNDERWRITING PROCESS The Company offers ceding companies full service capability, including actuarial, claims, accounting and systems support, either directly or through the broker community. The Company's capacity for both property and casualty risks allows it to underwrite entire contracts or major portions thereof that might otherwise need to be syndicated among several reinsurers. The Company's strategy is to act as "lead" reinsurer in many of the reinsurance treaties it underwrites. The lead reinsurer on a treaty generally accepts one of the largest percentage shares of the treaty and is in a stronger position to negotiate price, terms and conditions than is a reinsurer that takes a smaller position. Management believes this strategy enables it to more effectively influence the terms and conditions of the treaties on which it participates. When the Company does not lead the treaty, it may still suggest changes to any aspect of the treaty. The Company may decline to participate in a treaty based upon its assessment of all relevant factors. 10 The Company's treaty underwriting process emphasizes a team approach among the Company's underwriters, actuaries and claim staff. Treaties are reviewed for compliance with the Company's general underwriting standards and certain larger treaties are evaluated in part based upon actuarial analyses by the Company. The actuarial models used in such analyses are tailored in each case to the exposures and experience underlying the specific treaty and the loss experience for the risks covered by such treaties. The Company does not separately evaluate each of the individual risks assumed under its treaties. The Company does, however, generally evaluate the underwriting guidelines of its ceding companies to determine their adequacy prior to entering into a treaty. The Company, when appropriate, also conducts underwriting, operational and claim audits at the offices of ceding companies to ensure that the ceding companies operate within such guidelines. Underwriting audits focus on the quality of the underwriting staff, the selection and pricing of risks and the capability of monitoring price levels over time. Claim audits, when appropriate, are performed in order to evaluate the client's claims handling abilities and practices. The Company's U.S. facultative underwriters operate within guidelines specifying acceptable types of risks, limits and maximum risk exposures. Specified classes of risks and large premium risks are referred to Everest Re's New York facultative headquarters for specific review before premium quotations are given to clients. In addition, the Company's guidelines require certain types of risks to be submitted for review because of their aggregate limits, complexity or volatility, regardless of premium amount or size of the insured on the underlying contract. The Company's insurance operations principally write property and casualty coverages for homogeneous risks through select program managers. These programs are evaluated based upon actuarial analysis and the program manager's capabilities. The Company's rates, forms and underwriting guidelines are tailored to specific risk types. The Company's underwriting, actuarial, claim and financial functions work closely with its program managers to establish appropriate underwriting and processing guidelines as well as appropriate monitoring mechanisms. RISK MANAGEMENT AND RETROCESSION ARRANGEMENTS The Company manages its risk of loss through a combination of aggregate exposure limits, underwriting guidelines that take into account risks, prices and coverage, and retrocessional arrangements. The Company is exposed to multiple insured losses arising out of a single occurrence, whether a natural event, such as a hurricane or an earthquake, or other catastrophe, such as an explosion at a major factory. Any such catastrophic event could generate insured losses in one or many of the Company's treaties or lines of business, including property and/or casualty exposures. The Company employs various techniques, including licensed software modeling, to assess its accumulated exposure. Such techniques are inherently more difficult to apply to non-property exposures. Accumulated exposures with respect to catastrophe losses are generally summarized in terms of the probable maximum loss ("PML"). The Company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years. Management believes that the Company's greatest catastrophe exposure world wide from any single event is to an earthquake affecting the west coast of the United States where the Company estimates it has a PML exposure of $338 million, including workers' compensation exposures. The Company further estimates that its PML exposure with respect to its greatest windstorm exposure, which relates to a hurricane affecting the east coast of the United States, is $264 million and that its single event International PML exposure is $197 million. There can 11 be no assurance that the Company will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML. The U.S. Terrorism Risk Insurance Act of 2002 was signed into law in November 2002. This legislation provides Federal reimbursement of 90% of insured losses, in excess of statutory retention levels, due to acts of terrorism carried out by foreign powers on U.S. soil or against U.S. air carriers, vessels or foreign missions. This coverage does not apply to reinsurance. Reinsurance contracts generally exclude losses arising from terrorist events, except where such coverage has been specifically included in the underwriting and pricing of the involved reinsurance. The Company does not believe that this legislation will have a significant impact on its operations. Underwriting guidelines have been established for each business unit. These guidelines place dollar limits on the amount of business that can be written based on a variety of factors, including ceding company, line of business, geographical location and risk hazards. In each case, those guidelines permit limited exceptions, which must be authorized by the Company's senior management. The Company employs a retrocessional approach under which the Company may purchase reinsurance to cover specific business written or exposure accumulations or as a corporate level retrocessional program covering the potential accumulation or aggregation of exposures across some or all of the Company's operations. All reinsurance purchasing decisions consider both the potential coverage and market conditions with respect to the pricing, terms, conditions and availability of such coverage, with the aim of securing cost-effective protection. The level of reinsurance coverage varies over time, reflecting the underwriter's and/or Company's view of the changing dynamics of both the underlying exposure and the reinsurance markets. The Company does not typically purchase reinsurance to cover specific reinsurance business written, but it does from time to time purchase retrocessional protections where underwriting management deems it to be prudent and/or cost-effective to reinsure a portion of the specific risks being assumed. In 2001 and 2000, the Company purchased an excess property facultative retrocessional program and an excess workers' compensation retrocessional program. In addition, the Company purchased an excess property catastrophe retrocessional program for losses incurred outside of the U.S. for 2002, 2001 and 2000. The Company also participates in "common account" retrocessional arrangements for certain reinsurance treaties. Common account reinsurance arrangements are arrangements whereby the ceding company purchases reinsurance for the benefit of itself and its reinsurers on one or more of its reinsurance treaties. Common account retrocessional arrangements reduce the effect of individual or aggregate losses to all participating companies, including the ceding company, with respect to the involved treaties. The Company typically considers the purchase of reinsurance to cover insurance programs written by the U.S. Insurance operation. Such consideration includes balancing the underlying exposures against the availability of cost-effective reinsurance protection. For policies incepting on or after November 1998, the Company purchased a workers' compensation reinsurance program that provided for statutory limits coverage in excess of $75,000 of losses per occurrence on the Company's workers' compensation insurance business written prior to November 1, 2000. Since November 1, 2000, this primary workers' compensation reinsurance 12 program provides statutory limits coverage in excess of $250,000 of losses per occurrence for business written prior to December 31, 2001. The Company has not purchased such coverage for the period subsequent to December 31, 2001. In addition, for the twelve-month period commencing July 31, 2000, the Company purchased reinsurance for a specific program of business. The reinsurance, subject to certain aggregate limits, covered U.S. Longshore and Harbor Workers' Compensation Act and state act workers' compensation business for 100% of loss occurrences up to $100 million. Consistent with the $1 million limits of the underlying policies in the program, reinsurance for 100% of Maritime Employers Liability and Employers Liability was also provided. Neither the program nor the reinsurance were purchased in 2002 or 2001. The Company also considers purchasing corporate level retrocessional protection covering the potential accumulation of exposures. Such consideration includes balancing the underlying exposures against the availability of cost-effective retrocessional protection. For 2001, the Company purchased an accident year aggregate excess of loss retrocession agreement which provides up to $175.0 million of coverage if Everest Re's consolidated statutory basis accident year loss ratio exceeds a loss ratio attachment point provided in the contract for the 2001 accident year. The attachment point is net of inuring reinsurance and retrocessions and includes adjustable premium provisions that effectively cause the Company to offset, on a pre-tax income basis, up to 52.9% of such ceded losses, depending upon the character of the underlying losses, through additional premiums. The maximum recovery is $175.0 million before giving effect to a maximum adjustable premium of $82.5 million. Cessions under this cover have reduced the limit available to $0.0 million at December 31, 2002. Similar coverage was purchased and remains in effect for the 2000 accident year. Cessions under this cover have reduced the limit available to $85.0 million as of December 31, 2002. The Company has not purchased similar coverage for the period subsequent to December 31, 2001. Although certain of the Company's catastrophe and aggregate excess of loss retrocessions have terms which provide for additional premiums to be paid to the retrocessionaire in the event that losses are ceded, all aspects of the Company's retrocessional program have been structured to permit these agreements to be accounted for as reinsurance under Financial Accounting Standard ("FAS") No. 113. If a single catastrophe were to occur in the United States that resulted in $338 million of gross losses and allocated loss adjustment expenses ("ALAE") in 2003 (an amount equivalent to the Company's PML, including its property and workers' compensation exposures), management estimates that the effect on the Company's income would be approximately $338 million and $264 million before and after taxes, respectively. In addition, the Company has coverage under an aggregate excess of loss reinsurance agreement provided by Prudential Property and Casualty Insurance Company of Indiana ("Prupac"), a wholly-owned subsidiary of The Prudential, in connection with the Company's acquisition of Mt. McKinley in September 2000. This agreement covers 80% or $160 million of the first $200 million of any adverse loss reserve development on the carried reserves of Mt. McKinley at the date of acquisition and reimburses the Company as such losses are paid by the Company. There were $78.9 million of cessions under this reinsurance at December 31, 2002, reducing the limit available under the contract to $81.1 million. In connection with the Mt. McKinley acquisition, Prupac also provided excess of loss reinsurance for 100% of the first $8.5 million of loss with respect to certain of Mt. McKinley's retrocessions and potentially uncollectible reinsurance coverage. There were $0.0 million and $3.6 million of cessions under this reinsurance during the periods ending December 31, 2002 and 2001, respectively, reducing the limit available under the contract to $2.4 million. 13 As of December 31, 2002, the Company carried as an asset $1,116.4 million in reinsurance receivables with respect to losses ceded. Of this amount, $440.0 million, or 39.4%, was receivable from subsidiaries of London Reinsurance Group ("London Life"), $145.0 million, or 13.0%, was receivable from Continental Insurance Company ("Continental") and $78.9 million, or 7.1% was receivable from Prupac. No other retrocessionaire accounted for more than 5% of the Company's receivables. See ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition". The Company's arrangements with London Life and Continental are managed on a funds held basis, which means that the Company has not released premium payments to the retrocessionaire but rather retains such payments to secure obligations of the retrocessionaire, records them as a liability, credits interest on the balances and reduces the liability account as payments become due. As of December 31, 2002, such funds had reduced the Company's net exposure to London Life to $190.2 million, effectively 100% of which has been secured by letters of credit, and its exposure to Continental to $60.9 million. Prupac's obligations are guaranteed by The Prudential. No assurance can be given that the Company will seek or be able to obtain retrocessional coverage in the future similar to that in place currently or in the past. The Company continuously evaluates its exposures and risk capacities in the context of reinsurance market conditions, at both the specific and corporate level. Although management carefully selects its reinsurers, the Company is subject to credit risk with respect to its reinsurance because the ceding of risk to reinsurers does not relieve the Company of its liability to insureds or ceding companies. MT. MCKINLEY INSURANCE COMPANY-ACQUISITION The Company completed its acquisition of Gibraltar, subsequently renamed Mt. McKinley, in September 2000. In connection with the acquisition, the seller provided the reinsurance described above and the Company terminated certain relationships between Mt. McKinley and its former parent, The Prudential, and its affiliates. Mt. McKinley's ongoing operations relate to servicing claims arising from (1) insurance written by Mt. McKinley or Everest Re prior to 1985, (2) reinsurance of insurance business and certain Everest Re reinsurance business written prior to 1991 which had previously been reinsured with third parties and commuted with those third parties into Mt. McKinley and (3) exposure to adverse loss reserve development on Everest Re's reserves as of June 30, 1995, which exposure was assumed by Mt. McKinley at the time of the Company's initial public offering. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for what management believes to be arm's-length consideration, all of its net insurance exposures and reserves to Bermuda Re. CLAIMS Reinsurance claims are managed by the Company's professional claims staff whose responsibilities include reviewing initial loss reports and coverage issues, monitoring claims handling activities of ceding companies, establishing and adjusting proper case reserves and approving payment of claims. In addition to claims assessment, processing and payment, the claims staff selectively conducts comprehensive claim audits of both specific claims and overall claim procedures at the offices of selected ceding companies. Insurance claims, except those relating to Mt. McKinley's business, are generally handled by third party claims services providers who have limited authority and are subject to oversight by the Company's professional claims staff. 14 The Company intensively manages its asbestos and environmental ("A&E") exposures through dedicated, centrally managed claim staffs for Mt. McKinley and Everest Re. Both are staffed with experienced claim and legal professionals that specialize in the handling of such exposures. These units actively manage each individual insured and reinsured account, responding to claim developments with evaluations of the involved exposures and adjustment of reserves as appropriate. Specific or general claim developments that may have material implications for the Company are regularly communicated to senior management, and as appropriate, to actuarial, legal and financial areas. Meetings among these areas, claim management and senior management are held at least quarterly to review the Company's overall reserve positions and make changes, if appropriate. The Company continually reviews its internal processing, communications and analytics to determine whether it can enhance the management of it's A&E exposures, in particular in the context of changes in the landscape of asbestos claims and litigation. RESERVES FOR UNPAID PROPERTY AND CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the reinsurer and the payment of that loss by the insurer and subsequent payments to the insurer by the reinsurer. To recognize liabilities for unpaid losses and loss adjustment expenses ("LAE"), insurers and reinsurers establish reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay reported and unreported claims and related expenses on losses that have already occurred. Actual losses and LAE paid may deviate, perhaps substantially, from such reserves. To the extent reserves prove to be insufficient to cover actual losses and LAE after taking into account available reinsurance coverage, the Company would have to augment such reserves and incur a charge to earnings, which could be material in the period such augmentation takes place. See ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Loss and LAE Reserves". While the reserving process is difficult and subjective for insurance companies, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to the longer time between the date of an occurrence and the reporting of any attendant claims to the reinsurer, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future. As a result, actual losses and LAE may deviate, perhaps substantially, from estimates of reserves reflected in the Company's consolidated financial statements. Like many other property and casualty insurance and reinsurance companies, the Company has experienced adverse loss development for prior accident years, which has led to adjustments in losses and LAE reserves. The increase in net reserves for prior accident years reduced net income for the periods in which the adjustments were made. There can be no assurance that adverse development from prior years will not continue in the future or that such adverse development will not have a material adverse effect on net income. CHANGES IN HISTORICAL RESERVES The following table shows changes in historical loss reserves for the Company for 1992 and subsequent years. The table is presented on a GAAP basis except 15 that the Company's loss reserves for its Canadian branch operations are presented in Canadian dollars, the impact of which is not material. The top line of each table shows the estimated reserves for unpaid losses and LAE recorded at each year-end date. Each amount in the top line represents the estimated amount of future payments for losses and LAE on claims occurring in that year and in all prior years. The upper (paid) portion of the table presents the cumulative amounts paid through each subsequent year on those claims for which reserves were carried as of each specific year end. The lower (liability re-estimated) portion shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The reserve estimate changes as more information becomes known about the actual claims for which the initial reserves were carried. The cumulative redundancy/deficiency line represents the cumulative change in estimates since the initial reserve was established. It is equal to the latest liability re-estimated amount less the initial reserve. Each amount other than the original reserves in the top half of the table below includes the effects of all changes in amounts for prior periods. For example, if a loss settled in 1995 for $100,000 was first reserved in 1992 at $60,000 and remained unchanged until settlement, the $40,000 deficiency (actual loss minus original estimate) would be included in the cumulative redundancy (deficiency) in each of the years in the period 1992 through 1994 shown below. Conditions and trends that have affected development of liability in the past are not indicative of future developments. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on this table. 16 TEN YEAR GAAP LOSS DEVELOPMENT TABLE PRESENTED NET OF REINSURANCE WITH SUPPLEMENTAL GROSS DATA (1) (2) (3)
Years Ended December 31, ------------------------------------------------------------------------------------------------------------ 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- (Dollars in millions) Reserves for unpaid loss and LAE $1,854.7 $1,934.2 $2,104.2 $2,316.1 $2,551.6 $2,810.0 $2,953.5 $2,977.4 $3,364.9 $3,472.5 $3,895.8 Paid (cumulative) as of: One year later 461.5 403.5 359.5 270.4 331.2 450.8 484.3 673.4 718.1 892.7 Two years later 740.1 627.7 638.0 502.8 619.2 747.9 955.3 1,159.1 1,264.2 Three years later 897.0 820.5 828.0 682.0 813.7 1,101.5 1,295.5 1,548.3 Four years later 1,036.0 953.0 983.6 806.3 1,055.9 1,363.1 1,575.9 Five years later 1,141.0 1,071.5 1,143.4 990.9 1,253.0 1,592.5 Six years later 1,232.7 1,202.2 1,294.8 1,131.5 1,450.2 Seven years later 1,334.8 1,324.0 1,412.2 1,300.0 Eight years later 1,433.3 1,421.1 1,538.6 Nine years later 1,512.3 1,528.2 Ten years later 1,603.7 Liability re-estimated as of: One year later 1,929.2 2,008.5 2,120.8 2,286.5 2,548.4 2,836.2 2,918.1 2,985.2 3,364.9 3,612.6 Two years later 1,988.9 2,015.4 2,233.7 2,264.5 2,575.9 2,802.2 2,921.6 2,977.2 3,484.6 Three years later 2,010.0 2,119.0 2,271.2 2,285.1 2,546.0 2,794.7 2,910.3 3,070.5 Four years later 2,111.9 2,164.5 2,452.3 2,260.7 2,528.0 2,773.5 2,924.5 Five years later 2,155.3 2,344.9 2,381.7 2,254.5 2,515.7 2,765.2 Six years later 2,332.3 2,278.3 2,382.0 2,247.3 2,507.9 Seven years later 2,269.9 2,279.1 2,380.8 2,243.9 Eight years later 2,273.0 2,277.3 2,367.3 Nine years later 2,268.3 2,265.6 Ten years later 2,252.8 Cumulative (deficiency)/ redundancy $ (398.1) $ (331.4) $ (263.1) $ 72.2 $ 43.7 $ 44.8 $ 29.0 $ (93.1) $ (119.7) $ (140.1) ======== ======== ======== ======== ======== ======== ======== ======== ======== ======== Gross liability-end of year $2,476.7 $2,576.0 $2,752.7 $3,017.0 $ 3,298.2 $3,498.7 $3,869.2 $3,705.2 $3,853.7 $4,356.0 $4,985.8 Reinsurance receivable 622.0 641.8 648.5 700.9 746.6 688.7 915.7 727.8 488.8 883.5 1,090.0 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Net liability-end of year 1,854.7 1,934.2 2,104.2 2,316.1 2,551.6 2,810.0 2,953.5 2,977.4 3,364.9 3,472.5 $3,895.8 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ======== Gross re-estimated liability at December 31, 2002 3,434.2 3,371.9 3,396.4 3,492.4 3,618.6 3,744.1 3,870.8 4,045.3 4,334.2 4,727.7 Re-estimated receivable at December 31, 2002 1,181.4 1,106.3 1,029.1 1,248.5 1,110.7 978.9 946.4 974.9 849.6 1,115.1 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Net re-estimated liability at December 31, 2002 2,252.8 2,265.6 2,367.3 2,243.9 2,507.9 2,765.2 2,924.5 3,070.5 3,484.6 3,612.6 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- Gross cumulative (deficiency)/ redundancy $ (957.5) $ (795.9) $ (643.7) $(475.4) $ (320.4) $ (245.4) $ (1.6) $ (340.1) $ (480.5) $ (371.7) ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
- ---------- (1) Includes $480.9 million relating to Mt. McKinley at December 31, 2000, principally reflecting $491.1 million of Mt. McKinley reserves at the acquisition date. (2) The Canadian Branch reserves are reflected in Canadian dollars. (3) Some totals may not reconcile due to rounding. 17 For years prior to 1992, management believes that two factors had the most significant impact on loss development. First, through the mid-1980s, a number of industry and external factors, such as the propensity of courts to award large damage awards in liability cases, combined to increase loss frequency and severity to unexpectedly high levels. Second, contracts written prior to 1986 contained coverage terms which, for the Company and the industry in general, have been interpreted by courts to provide coverage for asbestos and environmental exposures not contemplated by either the pricing or the initial reserving of the contracts. Legal developments during the mid-1980s necessitated additional reserving for such exposures on both a case basis and an incurred but not reported ("IBNR") basis. More recently, particularly as reflected for periods subsequent to 1998, the Company has experienced unforeseen adverse shifts in loss emergence patterns, particularly in classes of business where the underlying exposures have been impacted by unfavorable trends in litigation and economic variability. The change between 1994 and 1995 reflects the impact of a stop loss reinsurance agreement with Mt. McKinley, which was then a subsidiary of The Prudential. This stop loss agreement commenced in 1995 when The Prudential sold the Company in an initial public offering. This coverage became an inter-affiliate reinsurance transaction with the acquisition of Mt. McKinley in 2000. See Footnote 1L to Notes to Consolidated Financial Statements. Management believes that adequate provision has been made for the Company's loss and LAE reserves. While there can be no assurance that reserves for and losses from these claims will not increase in the future, management believes that the Company's existing reserves, reserving methodologies and retrocessional arrangements lessen the probability that any such increases would have a material adverse effect on the Company's financial condition, results of operations or cash flows. These statements regarding the Company's loss reserves are forward looking statements within the meaning of the U.S. federal securities laws and are intended to be covered by the safe harbor provisions contained therein. See ITEM 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations - Safe Harbor Disclosure." The following table is derived from the Ten Year GAAP Loss Development Table above and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations for the same ten-year period ended December 31, 2002. Each column represents the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column on the far right represent the cumulative reserve re-estimates for the indicated accident years. EFFECT OF RESERVE REESTIMATES ON CALENDAR YEAR OPERATIONS (1)
Cumulative Re- Calendar Year Ended December 31, estimates for --------------------------------------------------------------------------------------------- each Accident 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Year ------- ------ ------ ------- ------ ------- ------ ------ ------ ------- ------------- (Dollars in millions) Accident Years 1992 & prior $ (74.5) $(59.7) $(21.1) $(101.9) $(43.4) $(176.9) $ 62.4 $ (3.1) $ 4.7 $ 15.6 $(398.1) 1993 (14.5) 14.2 (1.7) (2.1) (3.5) 4.2 2.3 (2.8) (4.0) (7.9) 1994 (9.8) (9.3) 8.0 (0.7) 4.1 0.4 (0.6) 1.9 (6.0) 1995 142.4 59.6 160.4 (46.2) 6.5 6.1 (10.2) 318.7 1996 (18.9) (6.8) 5.5 11.8 5.0 4.5 1.1 1997 1.3 4.1 (10.4) 8.9 0.4 4.3 1998 1.4 (11.0) (9.8) (22.5) (41.9) 1999 (4.3) (3.3) (79.1) (86.7) 2000 (7.9) (26.4) (34.4) 2001 (20.4) (20.4) Total calendar year effect $ (74.5) $(74.3) $(16.7) $ 29.6 $ 3.2 $ (26.2) $ 35.4 $ (7.8) $ 0.0 $(140.1) $(271.4)
(1) Some totals may not reconcile due to rounding. 18 As illustrated by this table, the factors that caused the deficiencies shown in the Ten Year GAAP Loss Development Table relate mainly to accident years prior to 1992 principally reflecting the impact of asbestos and environmental exposures discussed above. The significant favorable development experienced for the 1995 accident year is due to aggregate excess of loss reinsurance provided to the Company at the time of its initial public offering. This contract, because of its 1995 inception date, is attributed to the 1995 accident year. The adverse development experienced in the 1998 through 2001 accident years relates principally to a limited number of business classes, mainly casualty classes, including D&O, surety and certain international business where adverse loss experience has emerged as the result of unforeseen loss trend shifts affecting the underlying exposures. The Company's loss reserving methodologies continuously monitor the emergence of such loss trend shifts, seeking both to adjust reserves for their impact and to factor such developments into its underwriting and pricing on a prospective basis. The following table presents a reconciliation of beginning and ending reserve balances for the years indicated on a GAAP basis: RECONCILIATION OF RESERVES FOR LOSSES AND LAE
Years Ended December 31, ------------------------------------- 2002 2001 2000 --------- --------- --------- (Dollars in millions) Reserves at beginning of period $ 4,278.3 $ 3,786.2 $ 3,647.0 --------- --------- --------- Incurred related to: Current year 1,489.3 1,209.5 876.8 Prior years 140.1 - 7.8 --------- --------- --------- Total incurred losses 1,629.4 1,209.5 884.6 --------- --------- --------- Paid related to: Current year (1) 314.5 393.9 (166.9) Prior years 892.7 718.1 673.4 --------- --------- --------- Total paid losses 1,207.2 1,112.0 506.5 --------- --------- --------- Change in reinsurance receivables on unpaid losses and LAE 205.1 394.6 (238.9) --------- --------- --------- Reserves at end of period $ 4,905.6 $ 4,278.3 $ 3,786.2 ========= ========= =========
(1) Current year paid losses for 2000 are net of ($483.8) million resulting from the acquisition of Mt. McKinley. Prior year incurred losses increased by $140.1 million in 2002 and were stable in 2001. These changes were the result of the reserve development noted above, as well as inherent uncertainty in establishing loss and LAE reserves. See also Note 1L of Notes to Consolidated Financial Statements. 19 RESERVES FOR ASBESTOS AND ENVIRONMENTAL LOSSES AND LOSS ADJUSTMENT EXPENSES The Company's reserves include an estimate of the Company's ultimate liability for A&E claims for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of the Company's potential losses from A&E claims. See ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asbestos and Environmental Exposures" and Note 3 of Notes to Consolidated Financial Statements. Mt. McKinley's book of direct A&E exposed insurance is relatively small and homogenous. The book of business is based principally on excess liability policies; thus the claim/legal staff does not have to analyze exposure under many different policy forms, but rather can focus on a limited number of policies and policy forms. As a result of this focused structure, the Company believes that it is able to comprehensively analyze its exposures, allowing it to identify and analyze those claims on which it has unusual exposure, such as policies in which it may be exposed to pay expenses in addition to policy limits or non-products asbestos claims, for concentrated ongoing attention. The Company aims to be actively engaged with every insured account posing significant potential asbestos exposure to Mt. McKinley. Such engagement can take the form of a final settlement, negotiation, litigation, or the monitoring of claim activity under Coverage in Place ("CIP") agreements. CIP agreements generally condition an insurer's payment upon the actual claim experience of the insured and may have annual payment caps or other measures to control the insurer's payments. The Company's Mt. McKinley operations are currently managing five CIP agreements, all of which were executed prior to the acquisition of Mt. McKinley in 2000. Its preference with respect to coverage settlements is to execute settlements that call for a fixed schedule of payments, because such settlements eliminate future uncertainty. During 2002, the Company significantly enhanced its classification of insureds by exposure characteristics, as well as its analysis by insured for those it considers to be more exposed or active. Those insureds identified as relatively less exposed or active are subject to less rigorous, but still active management, with an emphasis on monitoring those characteristics which may indicate an increasing exposure or levels of activity. The Company continually focuses on further enhancement of the detailed estimation processes used to evaluate potential exposure of policyholders, including those that may not have reported significant A&E losses. Everest Re's book of assumed reinsurance is relatively concentrated within a modest number of A&E exposed relationships. Because the book of business is relatively concentrated and the Company has been managing the A&E exposures for many years, its claim staff is familiar with the ceding companies that have generated most of these liabilities in the past and which are therefore most likely to generate future liabilities. The Company's claim staff has developed familiarity both with the nature of the business written by its ceding companies and the claims handling and reserving practices of those companies. This level of familiarity enhances the quality of the Company's analysis of its exposure through those companies. As a result, the Company believes that it can identify those claims on which it has unusual exposure, such as non-products asbestos claims, for concentrated attention. 20 The following table summarizes the composition of the Company's total reserves for A&E losses, gross and net of reinsurance, for the years ended December 31, 2002, 2001 and 2000.
YEARS ENDED DECEMBER 31, ----------------------------------- 2002 2001 2000 (1) ------- ------- ------- (Dollars in millions) Case reserves reported by ceding companies $ 112.5 $ 107.1 $ 106.8 Additional reserves established by the Company (assumed reinsurance) 55.5 59.5 74.0 Case reserves established by the Company 262.1 154.1 118.3 IBNR reserves 237.8 323.7 394.6 ------- ------- ------- Gross reserves 667.9 644.4 693.7 Reinsurance receivable (140.4) (75.8) (65.2) ------- ------- ------- Net reserves $ 527.5 $ 568.6 $ 628.5 ======= ======= =======
- ------------------ (1) In 2000, Holdings acquired Mt. McKinley, resulting in an increase to the Company's gross and net asbestos and environmental exposure. Additional losses, including those relating to currently unrecognized latent injuries, the type or magnitude of which cannot be foreseen by the Company, or the reinsurance and insurance industry generally, may emerge in the future. Such future emergence, to the extent not covered by existing retrocessional contracts, could have material adverse effects on the Company's future financial condition, results of operations and cash flows. FUTURE POLICY BENEFIT RESERVES Future policy benefit liabilities for annuities are reported at the accumulated fund balance of these contracts. Reserves for those liabilities include both mortality and morbidity provisions with respect to life and annuity claims, both reported and unreported. Actual experience in a particular period may be worse than assumed experience and, consequently, may adversely affect the Company's operating results for the period. See Note 1F of Notes to Consolidated Financial Statements. INVESTMENTS The Company's overall financial strength and results of operations are, in part, dependent on the quality and performance of its investment portfolio. Net 21 investment income and net realized capital gains (losses) on the Company's invested assets constituted 11.8%, 17.7%, and 20.4% of the Company's revenues for the years ending December 31, 2002, 2001 and 2000, respectively. The Company's cash and invested assets totaled $7,259.1 million at December 31, 2002, of which 94.5% were cash or investment-grade fixed maturities. The Company's current investment strategy seeks to maximize after-tax income, through a high quality, diversified, taxable bond and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. The Company's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with the Company's current and projected operating results, market conditions and tax position. Additionally, the Company invests in equity securities, which it believes will enhance the risk-adjusted total return of the investment portfolio. The board of directors of each company is responsible for establishing investment policy and guidelines and, together with senior management, for overseeing their execution. The Company's investment portfolio is in compliance with the insurance laws of the jurisdictions in which its subsidiaries are regulated. An independent investment advisor is utilized to manage the Company's investment portfolio within the established guidelines and is required to report activities on a current basis and to meet with the Company periodically to review and discuss the portfolio structure, securities selection and performance results. The Company's investment guidelines include a current duration guideline of five to six years. The duration of an investment is based on the maturity of the security but also reflects the payment of interest and the possibility of early prepayment of such security. This investment duration guideline is established and periodically revised by management, which considers economic and business factors. An important factor considered by management is the Company's average duration of potential liabilities, which, at December 31, 2002, is estimated at approximately five years based on the estimated payouts of underwriting liabilities using standard duration calculations. Approximately 7.6% of the Company's consolidated reserves for losses and LAE and unearned premiums represent estimated amounts payable in foreign currencies. For each currency in which the Company has established substantial reserves, the Company seeks to maintain invested assets denominated in such currency in an amount approximately comparable to the estimated liabilities. As of December 31, 2002, 98.6% of the Company's total investments and cash were comprised of fixed maturity investments or cash and 94.5% of the Company's fixed maturities consisted of investment grade securities. The average maturity of fixed maturities was 8.1 years at December 31, 2002, and their overall duration was 5.4 years. As of December 31, 2002, the Company did not have any investments in commercial real estate or direct commercial mortgages or any material holdings of derivative investments or securities of issuers that are experiencing cash flow difficulty to an extent that the Company's management believes could threaten the issuer's ability to meet debt service payments, except where other than temporary impairments have been recognized. As of December 31, 2002, the Company's common stock portfolio had a market value of $47.5 million, comprising 0.7% of total investments and cash. The common stock portfolio is managed with a growth orientation. 22 The following table reflects investment results for the Company for each of the five years in the period ended December 31, 2002:
Pre-Tax Pre-Tax Realized Net Average Investment Effective Capital (Losses) Years Ended December 31, Investments(1) Income(2) Yield Gains - ------------------------ -------------- ------------ --------- --------------- (Dollars in millions) 2002 $ 6,064.8 $ 350.6 5.78% $ (50.0) 2001 5,374.9 340.4 6.33 (22.3) 2000 4,824.0 301.5 6.25 0.8 1999 4,219.4 253.0 6.00 (16.8) 1998 4,243.3 244.9 5.77 (0.8)
- ----------------- (1) Average of the beginning and ending carrying values of investments and cash, less net funds held and non-interest bearing cash. Bonds, common stock and redeemable and non-redeemable preferred stocks are carried at market value. (2) After investment expenses, excluding realized net capital gains (losses). The following table summarizes fixed maturities as of December 31, 2002 and 2001:
Amortized Unrealized Unrealized Market Cost Appreciation Depreciation Value --------- ------------ ------------ --------- (Dollars in millions) December 31, 2002: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 506.6 $ 10.1 $ 0.5 $ 516.2 Obligations of states and political subdivisions 2,520.6 144.6 2.6 2,662.6 Corporate securities 2,066.0 119.2 31.7 2,153.5 Mortgage-backed securities 839.5 43.0 1.1 881.4 Foreign government securities 312.7 25.2 - 337.9 Foreign corporate securities 215.4 14.3 1.4 228.3 --------- ------------ ------------ --------- Total $ 6,460.8 $ 356.4 $ 37.3 $ 6,779.9 ========= ============ ============ ========= December 31, 2001: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 114.8 $ 5.2 $ 0.1 $ 119.9 Obligations of states and political subdivisions 1,762.9 78.4 2.8 1,838.5 Corporate securities 2,254.7 77.6 39.5 2,292.8 Mortgage-backed securities 701.2 28.3 0.8 728.7 Foreign government securities 194.9 18.1 0.1 212.9 Foreign corporate securities 260.4 10.2 1.8 268.8 --------- ------------ ------------ --------- Total $ 5,288.9 $ 217.8 $ 45.1 $ 5,461.6 ========= ============ ============ =========
23 The following table presents the credit quality distribution of the Company's fixed maturities as of December 31, 2002:
Percent of Rating Agency Credit Quality Distribution Amount Total - ----------------------------------------- --------- ---------- (Dollars in millions) AAA/AA/A $ 5,612.5 82.8% BBB 797.0 11.8 BB 306.2 4.5 B 56.9 0.8 CCC/CC/C 2.4 0.0 CI/D 4.9 0.1 --------- ---------- Total $ 6,779.9 100.0% ========= ==========
The following table summarizes fixed maturities by contractual maturity as of December 31, 2002:
Percent of Amount Total --------- ---------- (Dollars in millions) Maturity category: Less than one year $ 75.8 1.1% 1-5 years 1,628.6 24.0 5-10 years 1,519.7 22.4 After 10 years 2,674.4 39.4 --------- ---------- Subtotal (2) 5,898.5 87.0 Mortgage-backed securities (1) 881.4 13.0 --------- ---------- Total (2) $ 6,779.9 100.0% ========= ==========
- ----------- (1) Mortgage-backed securities generally are more likely to be prepaid than other fixed maturities. Therefore, contractual maturities are excluded from this table since they may not be indicative of actual maturities. (2) Certain totals may not reconcile due to rounding. 24 RATINGS The following table shows the financial strength ratings of the Company's operating subsidiaries as reported by A.M. Best, Standard & Poor's Rating Services ("Standard & Poor's") and Moody's Investor Service, Inc. ("Moody's"). These ratings are based upon factors of concern to policyholders and should not be considered an indication of the degree or lack of risk involved in an equity investment in an insurance company.
Operating Subsidiary A.M. Best Standard & Poor's Moody's - -------------------------------------------------------------------------------------- Everest Re A+ (Superior) AA- (Positive) Aa3 (Excellent) Bermuda Re A+ (Superior) AA- (Positive) Aa3 (Excellent) Everest National A+ (Superior) AA- (Positive) Not Rated Everest Indemnity A+ (Superior) Not Rated Not Rated Everest Security A+ (Superior) Not Rated Not Rated Mt. McKinley Not Rated Not Rated Not Rated Everest International Not Rated Not Rated Not Rated
A.M. Best states that the "A+" ("Superior") rating is assigned to those companies which, in its opinion, have, on balance, achieved superior financial strength, operating performance and market profile when compared to the standards established by A.M. Best and have demonstrated a very strong ability to meet their ongoing obligations to policyholders. The "A+" ("Superior") rating is the second highest of fifteen ratings assigned by A.M. Best, which range from "A++" ("Superior") to "F" ("In Liquidation"). Additionally, A.M. Best has eleven classifications within the "Not Assigned" category. Standard & Poor's states that the "AA-" rating is assigned to those insurance companies which, in its opinion, offer excellent financial security and whose capacity to meet policyholder obligations is strong under a variety of economic and underwriting conditions. The "AA-" rating is the fourth highest of nineteen ratings assigned by Standard & Poor's, which range from "AAA" to "R". Ratings from AA to B may be modified by the use of a plus or minus sign to show relative standing of the insurer within those rating categories. Moody's states that insurance companies rated "Aa" offer excellent financial security. Together with the Aaa rated companies, Aa rated companies constitute what are generally known as high grade companies, with Aa rated companies generally having somewhat larger long-term risks. Moody's rating gradations are shown through the use of nine distinct symbols, each symbol representing a group of ratings in which the financial security is broadly the same. The "Aa3" (Excellent) rating is the fourth highest of ratings assigned by Moody's, which range from "Aaa" (Exceptional) to "C" (Lowest). Moody's further distinguishes the ranking of an insurer within its generic rating classification from Aa to B with 1, 2 and 3 ("1" being the highest). 25 The following table shows the investment grade ratings of the Holdings' senior notes due March 15, 2005, Holdings' senior notes due March 15, 2010 and Capital Trust's trust preferred securities by A.M. Best, Standard & Poor's and Moody's. Debt ratings are a current assessment of the credit-worthiness of an obligor with respect to a specific obligation.
A.M. Best Standard & Poor's Moody's - ----------------------------------------------------------------------------------- Senior Notes a A- A3 Trust Preferred Securities a- BBB Baa1
A company with a debt rating of "a" or "a-" is considered by A.M. Best to have a strong capacity and willingness to meet the terms of the obligation and possesses a low level of credit risk. The "a" and "a-" ratings are the sixth and seventh highest of 19 ratings assigned by A.M. Best, which range from "aaa" to "ccc". A company with a debt rating of "A-" is considered by Standard & Poor's to have a strong capacity to pay interest and repay principal, although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. A company with a debt rating of "BBB" is considered by Standard & Poor's to have adequate capacity to pay interest and repay principal, but is susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. The "A-" and "BBB" ratings from Standard & Poor's are the seventh and ninth highest of 24 ratings assigned by Standard & Poor's, which range from "AAA" to "D". A company with a debt rating of "A3" is considered to be an upper-medium-grade obligation by Moody's. This rating represents adequate capacity with respect to repayment of principal and interest, but elements may be present which suggest a susceptibility to impairment sometime in the future. A company with a debt rating of "Baa1" is considered to be a medium-grade obligation by Moody's. This rating represents adequate capacity with respect to repayment of principal and interest, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. The "A3" and "Baa1" ratings are the seventh and eighth highest of 21 ratings assigned by Moody's, which range from "AAA" to "C". All of the above-mentioned ratings are continually monitored and revised, if necessary, by each of the rating agencies. COMPETITION The worldwide reinsurance and insurance businesses are highly competitive, yet cyclical by product and market. The terrorist attacks on September 11, 2001 (the "September 11 attacks") resulted in losses which reduced industry capacity and were of sufficient magnitude to cause most companies to reassess their capital position, tolerance for risk, exposure control mechanisms and the pricing terms and conditions at which they are willing to take on risk. The gradual and variable improving trend that had been apparent through 2000 and earlier in 2001 firmed significantly after the September 11 attacks. This firming generally took the form of immediate and significant upward pressure on prices, more restrictive terms and conditions and a reduction of coverage limits and capacity availability. Such pressures were widespread, with variability depending on the product and markets involved, but mainly depending on the characteristics of the underlying risk exposures. The magnitude of the changes was sufficient to create temporary disequilibrium in some markets as individual buyers and sellers adapted to changes in both their internal and market dynamics. 26 During 2002, the reinsurance and insurance markets continued to firm. This firming reflects the losses arising from the September 11 attacks as well as reactions to broad and growing recognition that competition in the late 1990s reached extremes in many classes and markets, which ultimately led to inadequate pricing and overly broad terms, conditions and coverages. The effect of these extremes, which is becoming apparent through excessive loss emergence, varies widely by company depending on product offerings, markets accessed, underwriting and operating practices, competitive strategies and business volumes. Across all market participants; however, the aggregate effect has been impaired financial results and erosion of the industry capital base. Coupled with deteriorating investment market conditions and results, and renewed concerns regarding longer-term industry specific issues, including asbestos exposure and sub-par capital returns, these financial impacts have introduced substantial, and in some cases extreme, pressure for the initiation and/or strengthening of corrective action by individual market participants. These pressures have resulted in firming prices, more restrictive terms and conditions and tightened coverage availability across most classes and markets. These changes reflect a clear reversal of the general trend from 1987 through 1999 toward increasingly competitive global market conditions across most lines of business as reflected by decreasing prices and broadening contract terms. The earlier trend resulted from a number of factors, including the emergence of significant reinsurance capacity in Bermuda, changes in the Lloyd's market, consolidation and increased capital levels in the insurance and reinsurance industries, as well as the emergence of new reinsurance and financial products addressing traditional exposures in alternative fashions. Many of these factors continue to exist and have taken on additional importance as the result of the firming conditions which have emerged. As a result, although the Company is encouraged by the recent improvements, and more generally, by current market conditions, the Company cannot predict with any reasonable certainty whether and to what extent these improvements will persist. Competition with respect to the types of reinsurance and insurance business in which the Company is engaged is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, A.M. Best's and/or Standard & Poor's rating of the reinsurer or insurer, underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written. The Company competes in the United States, Bermuda and international reinsurance and insurance markets with numerous international and domestic reinsurance and insurance companies. The Company's competitors include independent reinsurance and insurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain insurance companies and domestic and international underwriting operations, including underwriting syndicates at Lloyd's. Some of these competitors have greater financial resources than the Company and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. In addition, the potential for securitization of reinsurance and insurance risks through capital markets provides an additional source of potential reinsurance and insurance capacity and competition. EMPLOYEES As of March 1, 2003, the Company employed 536 persons. Management believes that its employee relations are good. None of the Company's employees are subject to collective bargaining agreements, and the Company is not aware of any current efforts to implement such agreements. 27 REGULATORY MATTERS The Company and its insurance subsidiaries are subject to regulation under the insurance statutes of the various jurisdictions in which they conduct business, including essentially all states of the United States, Canada, Singapore, the United Kingdom and Bermuda. These regulations vary from jurisdiction to jurisdiction and are generally designed to protect ceding insurance companies and policyholders by regulating the Company's conduct of business, financial integrity and ability to meet its obligations relating to its business transactions and operations. Many of these regulations require reporting of information designed to allow insurance regulators to closely monitor the Company's performance. INSURANCE HOLDING COMPANY REGULATION. Under applicable United States laws and regulations, no person, corporation or other entity may acquire a controlling interest in the Company, unless such person, corporation or entity has obtained the prior approval for such acquisition from the Insurance Commissioners of Delaware and the other states in which the Company's insurance subsidiaries are domiciled or deemed domiciled, currently Arizona, California and Georgia. Under these laws, "control" is presumed when any person acquires, directly or indirectly, 10% or more of the voting securities of an insurance company. To obtain the approval of any change in control, the proposed acquirer must file an application with the relevant insurance commissioner disclosing, among other things, the background of the acquirer and that of its directors and officers, the acquirer's financial condition and its proposed changes in the management and operations of the insurance company. U.S. state regulators also require prior notice or regulatory approval of material inter-affiliate transactions within the holding company structure. See "Dividends". The Insurance Companies Act of Canada also requires prior approval by the Minister of Finance of anyone acquiring a significant interest in an authorized Canadian insurance company. In addition, the Company is subject to regulation by the insurance regulators of other states and foreign jurisdictions in which it does business. Certain of these states and foreign jurisdictions impose regulations regulating the ability of any person to acquire control of an insurance company authorized to do business in that jurisdiction without appropriate regulatory approval similar to those described above. DIVIDENDS. Under Bermuda law, Group is prohibited from declaring or paying a dividend if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities and its issued share capital and share premium (additional paid-in capital) accounts. Group's ability to pay dividends and its operating expenses is partially dependent upon dividends from its subsidiaries. The payment of dividends by insurance subsidiaries is limited under Bermuda law as well as the laws of the various U.S. states in which Group's insurance and reinsurance subsidiaries are licensed to transact business. The limitations are generally based upon net income and compliance with applicable policyholders' surplus or minimum solvency margin and liquidity ratio requirements as determined in accordance with the relevant statutory accounting practices. As Holdings has outstanding debt obligations, it is dependent upon dividends and other permissible payments from its operating subsidiaries to enable it to meet its debt and operating expense obligations and to pay dividends to Group. The payment of dividends to Holdings by Everest Re is subject to limitations imposed by Delaware law. Generally, Everest Re may only pay dividends out of its statutory earned surplus, which was $921.0 million at December 31, 2002, and only after it has given 10 days prior notice to the Delaware Insurance 28 Commissioner. During this 10-day period, the Commissioner may, by order, limit or disallow the payment of ordinary dividends if the Commissioner finds the insurer to be presently or potentially in financial distress. Further, the maximum amount of dividends that may be paid without the prior approval of the Delaware Insurance Commissioner in any twelve month period is the greater of (1) 10% of an insurer's statutory surplus as of the end of the prior calendar year or (2) the insurer's statutory net income, not including realized capital gains, for the prior calendar year. Under this definition, the maximum amount that will be available for the payment of dividends by Everest Re in 2003 without triggering the requirement for prior approval of regulatory authorities in connection with a dividend is $149.4 million. Under Bermuda law, Bermuda Re is unable to declare or make payment of a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio. As a long-term insurer, Bermuda Re is also unable to declare or pay a dividend to anyone who is not a policyholder unless, after payment of the dividend, the value of the assets in its long-term business fund, as certified by its approved actuary, exceeds its liabilities for long-term business by at least the $250,000 minimum solvency margin. Prior approval of the Bermuda Monetary Authority is required if Bermuda Re's dividend payments would reduce its prior year-end total statutory capital by 15.0% or more. At December 31, 2002, Bermuda Re met its solvency and liquidity requirements by a significant margin. INSURANCE REGULATION. U.S. domestic property and casualty insurers, including reinsurers, are subject to regulation by their state of domicile and by those states in which they are licensed. The regulation of reinsurers is typically related to the reinsurer's financial condition, investments, management and operation. The rates and policy terms of reinsurance agreements are generally not subject to direct regulation by any governmental authority. The operations of Everest Re's foreign branch offices in Canada, Singapore and the United Kingdom are subject to regulation by the insurance regulatory officials of those jurisdictions. Management believes that the Company is in material compliance with applicable laws and regulations pertaining to its business and operations. Bermuda Re is not admitted to do business as an insurer in any jurisdiction in the U.S. Bermuda Re conducts its insurance business from its offices in Bermuda. In Bermuda, Bermuda Re is regulated by the Insurance Act 1978 (as amended) and related regulations (the "Act"). The Act establishes solvency and liquidity standards, auditing and reporting requirements and subjects Bermuda Re to the supervision, investigation and intervention powers of the Bermuda Monetary Authority. Under the Act, Bermuda Re, as a Class 4 insurer, is required to maintain $100 million in statutory capital and surplus, to have an independent auditor approved by the Bermuda Monetary Authority conduct an annual audit and report on its statutory financial statements and filings and to have an appointed loss reserve specialist (also approved by the Bermuda Monetary Authority) review and report on its loss reserves annually. Bermuda Re is also registered under the Act as a long-term insurer and is thereby authorized to write life and annuity business. As a long-term insurer, Bermuda Re is required to maintain a long-term business fund, to separately account for this business and to have an approved actuary prepare a certificate concerning its long-term business assets and liabilities to be filed annually. Everest Indemnity, Everest National, Everest Security and Mt. McKinley are subject to regulations similar to the U.S. regulations applicable to Everest Re. In addition, Everest National and Everest Security must comply with substantial regulatory requirements in each state where they conduct business. These additional requirements include, but are not limited to, rate and policy form requirements, requirements with regard to licensing, agent appointments, participation in residual markets and claim handling procedures. These regulations are primarily designed for the protection of policyholders. 29 LICENSES. Everest Re is a licensed property and casualty insurer and/or reinsurer in all states (except Nevada and Wyoming), the District of Columbia and Puerto Rico. In New Hampshire and Puerto Rico, Everest Re is licensed for reinsurance only. Such licensing enables U.S. domestic ceding company clients to take credit for reinsurance ceded to Everest Re. Everest Re is licensed as a property and casualty reinsurer in Canada. It is also authorized to conduct reinsurance business in the United Kingdom and Singapore. Everest Re can also write reinsurance in other foreign countries. Because some jurisdictions require a reinsurer to register in order to be an acceptable market for local insurers, Everest Re is registered as a foreign insurer and/or reinsurer in the following countries: Argentina, Bolivia, Chile, Colombia, Ecuador, El Salvador, Guatemala, Mexico, Peru, Venezuela and the Philippines. Everest National is licensed in 45 states and the District of Columbia. Everest Indemnity is licensed in Delaware and is eligible to write insurance on a surplus lines basis in 48 states, the District of Columbia and Puerto Rico. Everest Security is licensed in Georgia and Alabama. Mt. McKinley is licensed in Delaware and California. Bermuda Re is registered as a Class 4 insurer and a long-term insurer in Bermuda. PERIODIC EXAMINATIONS. Everest Re, Everest National, Everest Indemnity, Everest Security and Mt. McKinley are subject to periodic financial examination (usually every 3 years) of their affairs by the insurance departments of the states in which they are licensed, authorized or accredited. Everest Re's, Everest Security's, Everest Indemnity's and Mt. McKinley's last examination reports were as of December 31, 2000, while Everest National's last examination was as of December 31, 2001. None of these reports contained any material findings or recommendations. In addition, U.S. insurance companies are subject to examinations by the various state insurance departments where they are licensed concerning compliance with applicable conduct of business regulations. NAIC RISK-BASED CAPITAL REQUIREMENTS. The U.S. National Association of Insurance Commissioners ("NAIC") employs a formula to measure the amount of capital appropriate for a property and casualty insurance company to support its overall business operations in light of its size and risk profile. The major categories of a company's risk profile are its asset risk, credit risk, and underwriting risk. The standards are an effort by the NAIC to prevent insolvencies, to ward off other financial difficulties of insurance companies and to establish uniform regulatory standards among state insurance departments. Under the approved formula, a company's statutory surplus is compared to its risk based capital ("RBC"). If this ratio is above a minimum threshold, no action is necessary. Below this threshold are four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer as the ratio of surplus to RBC decreases. The mildest intervention requires the company to submit a plan of appropriate corrective actions. The most severe action requires the company to be rehabilitated or liquidated. Based on their financial positions at December 31, 2002, Everest Re, Everest National, Everest Indemnity and Everest Security exceed the minimum thresholds. Since Mt. McKinley ceased writing new and renewal insurance in 1985, its domiciliary regulator, Delaware, has exempted Mt. McKinley from complying with RBC requirements. Various proposals to change the RBC formula arise from time to time. The Company is unable to predict whether any such proposal will be adopted, the form in which any such proposals would be adopted or the effect, if any, the adoption of any such proposal or change in the RBC calculations would have on the Company. 30 CODIFICATION OF STATUTORY ACCOUNTING PRINCIPLES. The NAIC has published a codification of statutory accounting principles, which has been adopted by the states of domicile of the Company's U.S. operating subsidiaries with an effective date of January 1, 2001. On January 1, 2001, significant changes to the statutory-basis of accounting became effective. The cumulative effect of these changes in 2001 was a $57.1 million increase to Everest Re's statutory surplus. TAX MATTERS. The following summary of the taxation of the Company is based on current law. There can be no assurances that legislative, judicial, or administrative changes will not be enacted that materially affect this summary. BERMUDA. Under current Bermuda law, no income, withholding or capital gains taxes are imposed upon Group and its Bermuda subsidiaries. Group and its Bermuda subsidiaries have received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, Group and its Bermuda subsidiaries will be exempt from taxation in Bermuda until March 2016. Non-Bermuda branches of Bermuda subsidiaries are subject to local taxes in the jurisdictions in which they operate. BARBADOS. Group, a Bermuda company with its principal office in Barbados, is registered as an external company under the Companies Act, Cap. 308 of Barbados and is licensed as an international business company under the Barbados International Business Companies Act, 1991-24. As a result, Group is subject to a preferred rate of corporation tax on profits and gains in Barbados and is exempt from withholding tax on dividends, interest, royalties, management fees, fees or other income paid or deemed paid to a person who is not resident in Barbados or who, if so resident, carries on an international business. No tax is imposed on capital gains. UNITED STATES. Group's U.S. subsidiaries conduct business in and are subject to taxation in the United States. Non-U.S. branches of U.S. subsidiaries are subject to local taxation in the jurisdictions in which they operate. Should the U.S. subsidiaries distribute current or accumulated earnings and profits in the form of dividends or otherwise to Group, the Company would be subject to withholding taxes. Group and its Bermuda subsidiaries believe that they have operated and will continue to operate their business in a manner that will not cause them to generate income treated as effectively connected with the conduct of a trade or business within the United States. On this basis, Group does not expect that it and its Bermuda subsidiaries will be required to pay U.S. corporate income taxes other than withholding taxes on certain investment income and premium excise taxes. If Group or Bermuda Re were subject to U.S. income tax, there could be a material adverse effect on the Company's financial condition, results of operations or cash flows. AVAILABLE INFORMATION The Company's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those reports are available free of charge through the Company's internet website at HTTP://WWW.EVERESTRE.COM as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission. ITEM 2. PROPERTIES Everest Re's corporate offices are located in approximately 115,000 square feet of leased office space in Liberty Corner, New Jersey. Bermuda Re's corporate offices are located in approximately 3,600 total square feet of leased office 31 space in Hamilton, Bermuda. The Company's other twelve locations occupy a total of approximately 64,000 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs. ITEM 3. LEGAL PROCEEDINGS In the ordinary course of business, the Company is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine the Company's rights and obligations under insurance and reinsurance agreements and other more general contracts. In some disputes, the Company seeks to enforce its rights under an agreement or to collect funds owing to it. In other matters, the Company is resisting attempts by others to collect funds or enforce alleged rights. Such disputes are resolved through formal and informal means, including litigation and arbitration. In all such matters, the Company believes that its positions are legally and commercially reasonable. The Company also regularly evaluates those positions, and where appropriate, establishes or adjusts insurance reserves to reflect its evaluation. The Company's aggregate reserves take into account the possibility that the Company may not ultimately prevail in each and every disputed matter. The Company believes its aggregate reserves reduce the potential that an adverse resolution of one or more of these matters, at any point in time, would have a material impact on the Company's financial condition or results of operations. However, there can be no assurances that adverse resolutions of such matters in any one period or in the aggregate will not result in a material adverse effect on the Company's results of operations. The Company does not believe that there are any other material pending legal proceedings to which it or any of its subsidiaries or their properties are subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS MARKET INFORMATION The common shares of Group trade on the New York Stock Exchange under the symbol, "RE". Quarterly high and low market prices of the Company's common shares in 2002 and 2001 were as follows:
High Low First Quarter 2002: 75.0000 66.0000 Second Quarter 2002: 71.7000 55.9400 Third Quarter 2002: 57.9700 43.2500 Fourth Quarter 2002: 62.4900 52.1800 First Quarter 2001: 68.8750 55.3750 Second Quarter 2001: 74.8000 62.0000 Third Quarter 2001: 72.9700 48.7500 Fourth Quarter 2001: 78.5000 63.8000
32 NUMBER OF HOLDERS OF COMMON SHARES The number of record holders of common shares as of March 1, 2003 was 68. That number excludes the beneficial owners of shares held in "street" name or held through participants in depositories, such as The Depository Trust Company. DIVIDEND HISTORY AND RESTRICTIONS In 1995, the Board of Directors of Holdings established a policy of declaring regular quarterly cash dividends and has paid a regular quarterly dividend in each quarter since the fourth quarter of 1995. The Company declared and paid its regular quarterly cash dividend of $0.07 per share for each quarter of 2001 and $0.08 per share for each quarter of 2002. A committee of the Company's Board of Directors declared a dividend of $0.09 per share, payable on or before March 21, 2003 to shareholders of record on March 3, 2003. The declaration and payment of future dividends, if any, by the Company will be at the discretion of the Board of Directors and will depend upon many factors, including the Company's earnings, financial condition, business needs and growth objectives, capital and surplus requirements of its operating subsidiaries, regulatory restrictions, rating agency considerations and other factors. As an insurance holding company, the Company is partially dependent on dividends and other permitted payments from its subsidiaries to pay cash dividends to its stockholders. The payment of dividends to Group by Holdings and to Holdings by Everest Re is subject to Delaware regulatory restrictions and the payment of dividends to Group by Bermuda Re will be subject to Bermuda insurance regulatory restrictions. See "Regulatory Matters - Dividends" and Note 13A of Notes to Consolidated Financial Statements. RECENT SALES OF UNREGISTERED SECURITIES The following securities were issued by the Company during 2002 and were not registered under the U.S. Securities Act of 1933: - - On April 1, 2002, 724 common shares of the Company and on July 1, 2002, 892 common shares of the Company were distributed. - - The securities were distributed to the Company's four non-employee Directors. - - The securities were issued as compensation to the non-employee Directors for services rendered to the Company in their capacities as Directors. - - Exemption from registration was claimed pursuant to Section 4(2) of the Securities Act of 1933. There was no public offering and the participants in the transactions were the Company and its non-employee Directors. - - Not applicable. - - Not applicable. 33 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated GAAP financial data of the Company as of and for the years ended December 31, 2002, 2001, 2000, 1999 and 1998 were derived from the consolidated financial statements of the Company, which were audited by PricewaterhouseCoopers LLP. The following financial data should be read in conjunction with the Consolidated Financial Statements and accompanying notes.
Years Ended December 31, --------------------------------------------------------------- 2002 2001 2000 1999 1998 --------- --------- ---------- --------- ---------- (Dollars in millions, except per share amounts) OPERATING DATA: Gross premiums written $ 2,846.5 $ 1,874.6 $ 1,385.6 $ 1,141.8 $ 1,045.9 Net premiums written 2,637.6 1,560.1 1,218.9 1,095.6 1,016.6 Net premiums earned 2,273.7 1,467.5 1,174.2 1,071.5 1,068.0 Net investment income 350.6 340.4 301.5 253.0 244.9 Net realized capital (losses) gains (50.0) (22.3) 0.8 (16.8) (0.8) Losses and LAE incurred (including catastrophes) 1,629.4 1,209.5 884.6 771.6 778.4 Total catastrophe losses (1) 30.2 222.6 13.9 45.9 30.6 Commission, brokerage, taxes and fees 551.8 396.8 272.4 286.0 274.6 Other underwriting expenses 69.9 58.9 51.6 48.3 49.6 Interest expense 42.4 46.0 39.4 1.5 - Income before taxes 262.0 90.3 231.7 196.6 212.7 Income tax expense (benefit) 30.7 (8.7) 45.4 38.5 47.5 Net income (2) $ 231.3 $ 99.0 $ 186.4 $ 158.1 $ 165.2 ========= ========= ========== ========= ========== Net income per basic share (3) $ 4.60 $ 2.14 $ 4.06 $ 3.26 $ 3.28 ========= ========= ========== ========= ========== Net income per diluted share (4) $ 4.52 $ 2.10 $ 4.02 $ 3.25 $ 3.26 ========= ========= ========== ========= ========== Dividends paid per share $ 0.32 $ 0.28 $ 0.24 $ 0.24 $ 0.20 ========= ========= ========== ========= ========== CERTAIN GAAP FINANCIAL RATIOS: (5) Loss and LAE ratio 71.7% 82.4% 75.3% 72.0% 72.9% Underwriting expense ratio 27.4 31.1 27.6 31.5 30.3 --------- --------- ---------- --------- ---------- Combined ratio (2) 99.0% 113.5% 102.9% 103.5% 103.2% ========= ========= ========== ========= ========== Balance sheet data (at end of period): Total investments and cash $ 7,259.1 $ 5,783.5 $ 5,493.0 $ 4,139.2 $ 4,325.8 Total assets 9,864.6 7,796.2 7,013.1 5,704.3 5,996.7 Loss and LAE reserves 4,905.6 4,278.3 3,786.2 3,647.0 3,800.0 Total debt 518.9 553.8 683.6 59.0 - Total liabilities 7,286.0 6,075.6 5,429.7 4,376.8 4,517.5 Trust preferred securities 210.0 - - - - Shareholders' equity 2,368.6 1,720.5 1,583.4 1,327.5 1,479.2 Book value per share (6) 46.55 37.19 34.40 28.57 29.59
- ------------ (1) Catastrophe losses are net of reinsurance. A catastrophe is defined, for purposes of the Selected Consolidated Financial Data, as an event that causes a pre-tax loss on property exposures before reinsurance of at least $5.0 million and has an event date of January 1, 1988 or later. (2) Some amounts may not reconcile due to rounding. (3) Based on weighted average basic shares outstanding of 50.3 million, 46.2 million, 45.9 million, 48.5 million and 50.4 million for 2002, 2001, 2000, 1999 and 1998, respectively. (4) Based on weighted average diluted shares outstanding of 51.1 million, 47.1 million, 46.4 million, 48.7 million and 50.7 million for 2002, 2001, 2000, 1999 and 1998, respectively. (5) Loss ratio is the GAAP losses and LAE incurred as a percentage of GAAP net premiums earned. Underwriting expense ratio is the GAAP commissions, brokerage, taxes, fees and general expenses as a percentage of GAAP net premiums earned. Combined ratio is the sum of the loss ratio and underwriting expense ratio. (6) Based on 50.9 million, 46.3 million, 46.0 million, 46.5 million and 50.0 million shares outstanding for December 31, 2002, 2001, 2000, 1999 and 1998, respectively. 34 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion of the results of operations and financial condition of Everest Re Group, Ltd. and its subsidiaries. This discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto presented under ITEM 8. RESTRUCTURING On February 24, 2000, a corporate restructuring was completed and Everest Re Group, Ltd. ("Group") became the new parent holding company of Everest Reinsurance Holdings, Inc. ("Holdings"), which remains the holding company for Group's U.S. based operations. The "Company" means Group and its subsidiaries, except when referring to periods prior to February 24, 2000, when it means Holdings and its subsidiaries. ACQUISITIONS On September 19, 2000, Holdings completed the acquisition of all of the issued and outstanding capital stock of Gibraltar Casualty Company ("Gibraltar") from The Prudential Insurance Company of America ("The Prudential") for $51.8 million, which approximated book value. As a result of the acquisition, Gibraltar became a wholly owned subsidiary of Holdings and, immediately following the acquisition, its name was changed to Mt. McKinley Insurance Company ("Mt. McKinley"). In connection with the acquisition of Mt. McKinley, which has significant exposure to asbestos and environmental claims, Prudential Property and Casualty Insurance Company ("Prupac"), a subsidiary of The Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinley's reserves as of September 19, 2000. In addition, The Prudential guaranteed Prupac's obligation to Mt. McKinley. There were $78.9 million of cessions under this reinsurance at December 31, 2002, reducing the limit available under this contract to $81.1 million. In connection with the Mt. McKinley acquisition, Prupac also provided excess of loss reinsurance for 100% of the first $8.5 million of loss with respect to certain of Mt. McKinley's retrocessions and potentially uncollectible reinsurance coverage. There were $0.0 million and $3.6 million of cessions under this reinsurance during the periods ending December 31, 2002 and 2001, respectively, reducing the limit available under the contract to $2.4 million. Mt. McKinley, a run-off property and casualty insurer in the United States, has had a long relationship with Holdings and its principal operating company, Everest Reinsurance Company ("Everest Re"). Mt. McKinley was formed in 1978 by Everest Re and wrote insurance until 1985, when it was placed in run-off. In 1991, Mt. McKinley became a subsidiary of The Prudential. Mt. McKinley is also a reinsurer of Everest Re. Under a series of transactions dating to 1986, Mt. McKinley reinsured several components of Everest Re's business. In particular, Mt. McKinley provided stop-loss reinsurance protection, in connection with the Company's October 5, 1995 initial public offering, for any adverse loss development on Everest Re's June 30, 1995 (December 31, 1994 for catastrophe losses) reserves, with $375.0 million in limits, of which $103.9 million remains available (the "Stop Loss Agreement"). The Stop Loss Agreement and other reinsurance contracts between Mt. McKinley and Everest Re remain in effect following the acquisition. However, these contracts became transactions with affiliates effective on the date of the Mt. McKinley acquisition, and their financial impact is thereafter eliminated in consolidation. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for what management believes to be arm's-length consideration, all of its net insurance exposures and reserves to Bermuda Re. 35 During 2000, the Company completed two additional acquisitions, Everest Security Insurance Company ("Everest Security"), formerly known as Southeastern Security Insurance Company, a United States property and casualty company whose primary business is non-standard automobile insurance, and Everest International Reinsurance, Ltd. ("Everest International"), formerly known as AFC Re, Ltd., a Bermuda based life and annuity reinsurer. INDUSTRY CONDITIONS The worldwide reinsurance and insurance businesses are highly competitive, yet cyclical by product and market. The terrorist attacks on September 11, 2001 (the "September 11 attacks") resulted in losses which reduced industry capacity and were of sufficient magnitude to cause most companies to reassess their capital position, tolerance for risk, exposure control mechanisms and the pricing terms and conditions at which they are willing to take on risk. The gradual and variable improving trend that had been apparent through 2000 and earlier in 2001 firmed significantly after the September 11 attacks. This firming generally took the form of immediate and significant upward pressure on prices, more restrictive terms and conditions and a reduction of coverage limits and capacity availability. Such pressures were widespread, with variability depending on the product and markets involved, but mainly depending on the characteristics of the underlying risk exposures. The magnitude of the changes was sufficient to create temporary disequilibrium in some markets as individual buyers and sellers adapted to changes in both their internal and market dynamics. During 2002, the reinsurance and insurance markets continued to firm. This firming reflects the losses arising from the September 11 attacks as well as reactions to broad and growing recognition that competition in the late 1990s reached extremes in many classes and markets, which ultimately led to inadequate pricing and overly broad terms, conditions and coverages. The effect of these extremes, which is becoming apparent through excessive loss emergence, varies widely by company depending on product offerings, markets accessed, underwriting and operating practices, competitive strategies and business volumes. Across all market participants however, the aggregate effect has been impaired financial results and erosion of the industry capital base. Coupled with deteriorating investment market conditions and results, and renewed concerns regarding longer-term industry specific issues, including asbestos exposure and sub-par capital returns, these financial impacts have introduced substantial, and in some cases extreme, pressure for the initiation and/or strengthening of corrective action by individual market participants. These pressures have resulted in firming prices, more restrictive terms and conditions and tightened coverage availability across most classes and markets. These changes reflect a clear reversal of the general trend from 1987 through 1999 toward increasingly competitive global market conditions across most lines of business as reflected by decreasing prices and broadening contract terms. The earlier trend resulted from a number of factors, including the emergence of significant reinsurance capacity in Bermuda, changes in the Lloyd's market, consolidation and increased capital levels in the insurance and reinsurance industries, as well as the emergence of new reinsurance and financial products addressing traditional exposures in alternative fashions. Many of these factors continue to exist and have taken on additional importance as the result of the firming conditions which have emerged. As a result, although the Company is encouraged by the recent improvements and, more generally, by current market conditions, the Company cannot predict with any reasonable certainty whether and to what extent these improvements will persist. 36 SEGMENT INFORMATION The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance on both a treaty and facultative basis through reinsurance brokers as well as directly with ceding companies within the United States. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the United States. The Specialty Underwriting operation writes accident and health ("A&H"), marine, aviation and surety business within the United States and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance through the Company's branches in London, Canada, and Singapore, in addition to foreign business written through the Company's New Jersey headquarters and Miami office. The Bermuda operation writes property, casualty, life and annuity business through brokers and directly with ceding companies. These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management monitors and evaluates the financial performance of these operating segments principally based upon their underwriting results. The Company utilizes inter-affiliate reinsurance but such reinsurance does not impact segment results, since business is generally reported within the segment in which the business was first produced. RESULTS OF OPERATIONS Unusual Loss Events in 2001. As a result of the September 11 attacks, the Company incurred pre-tax losses, based on an estimate of ultimate exposure developed through a review of its coverages, which totaled $213.2 million gross of reinsurance and $55.0 million net of reinsurance. Associated with this reinsurance were $60.0 million of pre-tax charges, predominantly from adjustment premiums, resulting in a total pre-tax loss from the September 11 attacks of $115.0 million. After tax recoveries relating specifically to this unusual loss event, the net loss from the September 11 attacks totaled $75.0 million. Over 90% of the losses ceded by the Company were pursuant to treaties, where the reinsurers' obligations are secured, which the Company believes eliminates material reinsurance collection risk. As a result of the Enron bankruptcy in 2001, the Company incurred losses, after-tax and net of reinsurance, amounting to $25.0 million. This unusual loss reflects all of the Company's exposures to this event, including underwriting, credit and investment. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Premiums. Gross premiums written increased 51.8% to $2,846.5 million in 2002 from $1,874.6 million in 2001, as the Company took advantage of selected growth opportunities and improving pricing in many classes of business, while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 303.8% ($76.0 million) increase in the Bermuda operation, which continues to expand its product line offerings, a 67.6% ($218.1 million) increase in the International operation, mainly attributable to growth in the London, Canadian and Latin American markets, a 63.5% ($319.1 million) increase in the U.S. Insurance operation, principally attributable to growth in worker's compensation insurance, a 46.5% ($284.1 million) increase in the U.S. Reinsurance operation, primarily reflecting growth across property and casualty lines, and an 18.0% ($74.6 million) increase in the Specialty Underwriting operation, mainly attributable to growth in marine, aviation and surety business. The Company continued to decline business that did not meet its objectives regarding underwriting profitability. 37 Ceded premiums decreased to $208.9 million in 2002 from $314.5 million in 2001. This decrease was principally attributable to a reduction in cessions made under the Company's corporate retrocessional program and to a decrease in ceded premiums in the U.S. Insurance operation as a result of changes in this segment's specific reinsurance programs. Ceded premiums in 2002 included $5.1 million and $49.4 million in adjustment premiums relating to claims made under the 2001 and 2000 accident year aggregate excess of loss elements of the Company's corporate retrocessional programs, respectively. Ceded premiums in 2001 included $81.3 million and $58.1 million in adjustment premiums relating to claims made under the 2001 and 1999 accident year aggregate excess of loss elements of the Company's corporate retrocessional programs, respectively, with the 2001 accident year cessions principally relating to losses incurred as a result of the September 11 attacks and Enron bankruptcy. Net premiums written increased by 69.1% to $2,637.6 million in 2002 from $1,560.1 million in 2001. This increase was a result of the increase in gross premiums written and the decrease in ceded premiums. PREMIUM REVENUES. Net premiums earned increased by 54.9% to $2,273.7 million in 2002 from $1,467.5 million in 2001. Contributing to this increase were a 154.4% ($25.3 million) increase in the Bermuda operation, a 94.8% ($278.8 million) increase in the U.S. Insurance operation, a 64.4% ($185.1 million) increase in the International operation, a 46.0% ($228.8 million) increase in the U.S. Reinsurance operation and a 23.7% ($88.2 million) increase in the Specialty Underwriting operation. All of these changes reflect period to period variability in gross written and ceded premiums and business mix, together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. As premium reporting and earnings and loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, can and does introduce appreciable background variability in various underwriting line items. EXPENSES. Incurred loss and loss adjustment expenses ("LAE") increased by 34.7% to $1,629.4 million in 2002 from $1,209.5 million in 2001. The increase in incurred losses and LAE was principally attributable to the increase in net premiums earned and modest reserve strengthening in select areas, most notably in directors and officers liability, surety and workers' compensation lines, and with respect to asbestos exposures, partially offset by lower catastrophe losses and improvements in rates, terms and conditions in many classes of business, as well as the impact of changes in the Company's mix of business. Incurred losses and LAE include catastrophe losses, which reflect the impact both of current period events and favorable and unfavorable development on prior period events and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss on property exposures of at least $5.0 million and has an event date of January 1, 1988 or later. Catastrophe losses, net of contract specific cessions but before cessions under the corporate retrocessional program, were $30.2 million in 2002, principally relating to European flood losses and Hurricanes Isidore and Kenna, compared to net catastrophe losses of $222.6 million in 2001, which was principally related to the September 11 attacks. Incurred losses and LAE in 2002 reflected ceded losses and LAE of $287.7 million compared to ceded losses and LAE in 2001 of $486.3 million. The ceded losses and LAE in 2002 included $11.0 million and $90.0 million of losses ceded under the 2001 and 2000 accident year aggregate excess of loss components of the Company's corporate retrocessional program, respectively. The ceded losses and LAE in 2001 included $164.0 million and $105.0 million of losses ceded under the 2001 and 1999 accident year aggregate excess of loss components of the Company's corporate 38 retrocessional program, respectively, with the 2001 accident year cessions relating principally to losses incurred as the result of the September 11 attacks. Contributing to the increase in incurred losses and LAE in 2002 from 2001 were a 242.3% ($36.7 million) increase in the Bermuda operation, principally reflecting reserve strengthening with respect to Mt. McKinley asbestos exposures and increased premium volume, a 104.9% ($221.6 million) increase in the U.S. Insurance operation, principally reflecting increased premium volume coupled with changes in this segment's specific reinsurance programs, a 45.8% ($92.8 million) increase in the International operation, principally reflecting increased premium volume and a 19.2% ($86.3 million) increase in the U.S. Reinsurance operation, principally due to increased premium volume, partially offset by decreased catastrophe losses. These increases were partially offset by a 5.3% ($17.5 million) decrease in the Specialty Underwriting operation, principally attributable to decreased catastrophe losses. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type. The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing incurred losses and LAE by premiums earned, decreased by 10.7 percentage points to 71.7% in 2002 from 82.4% in 2001, reflecting the earned premium and incurred losses and LAE discussed above. The following table shows the loss ratios for each of the Company's operating segments for 2002 and 2001. The loss ratios for all operations were impacted by the expense factors noted above as well as by the impact on ceded premiums of the adjustment premiums under the Company's corporate retrocessional program.
OPERATING SEGMENT LOSS RATIOS - -------------------------------------------------------------------------------- Segment 2002 2001 - -------------------------------------------------------------------------------- U.S. Reinsurance 73.8% 90.4% U.S. Insurance 75.5% 71.8% Specialty Underwriting 68.1% 89.0% International 62.5% 70.5% Bermuda 124.2% 92.3%
Underwriting expenses increased by 36.4% to $621.7 million in 2002 from $455.7 million in 2001. Commission, brokerage, taxes and fees increased by $155.0 million, principally reflecting increases in premium volume and changes in the mix of business. Other underwriting expenses increased by $11.0 million as the Company expanded its operations to support its increased business volume. Contributing to the underwriting expense increase were a 95.6% ($4.0 million) increase in the Bermuda operation, a 79.7% ($65.9 million) increase in the U.S. Insurance operation, a 31.9% ($29.8 million) increase in the International operation, a 27.0% ($29.1 million) increase in the Specialty operation and a 22.8% ($37.4 million) increase in the U.S. Reinsurance operation. The changes for each operation's expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, the underwriting performance of the underlying business. The Company's expense ratio, which is calculated by dividing underwriting expenses by premiums earned, decreased by 3.8 percentage points to 27.3% in 2002 compared to 31.1% in 2001. The Company's combined ratio, which is the sum of the loss and expense ratios, decreased by 14.5 percentage points to 99.0% in 2002 compared to 113.5% in 2001. 39 The following table shows the combined ratios for each of the Company's operating segments for 2002 and 2001. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above as well as by the impact on ceded premiums of the adjustment premiums under the Company's corporate retrocessional program.
OPERATING SEGMENT COMBINED RATIOS - -------------------------------------------------------------------------------- Segment 2002 2001 - -------------------------------------------------------------------------------- U.S. Reinsurance 101.5% 123.3% U.S. Insurance 101.5% 99.9% Specialty Underwriting 97.9% 118.0% International 88.6% 103.0% Bermuda 143.8% 117.9%
INVESTMENTS. Net investment income increased by 3.0% to $350.6 million in 2002 from $340.4 million in 2001, principally reflecting the effect of investing the $736.1 million of cash flow from operations in 2002, $346.3 million of net proceeds from the offering of common shares in February 2002 and $203.4 million of net proceeds from Everest Re Capital Trust's ("Capital Trust") issuance of trust preferred securities in November 2002, partially offset by the lower interest rate environment. The following table shows a comparison of various investment yields as of December 31, 2002 and 2001, respectively, and for the periods then ended.
2002 2001 ------------------ Imbedded pre-tax yield of cash and invested assets at end of period 5.3% 6.0% Imbedded after-tax yield of cash and invested assets at end of period 4.6% 5.0% Annualized pre-tax yield on average cash and invested assets 5.6% 6.2% Annualized after-tax yield on average cash and invested assets 4.6% 5.0%
Net realized capital losses were $50.0 million in 2002, reflecting realized capital losses on the Company's investments of $142.8 million, which includes $101.3 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, of which $33.0 million were for WorldCom, partially offset by $92.8 million of realized capital gains, compared to net realized capital losses of $22.3 million in 2001. The net realized capital losses in 2001 reflected realized capital losses of $55.1 million, which included $22.6 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, which were partially offset by $32.8 million of realized capital gains. Interest expense was $42.4 million for 2002 compared to $46.0 million for 2001. Interest expense for 2002 reflects $38.9 million relating to Holdings' senior notes and $3.5 million relating to Holdings' borrowing under its revolving credit facility. Interest expense for 2001 reflects $38.9 million relating to Holdings' senior notes and $7.1 million relating to Holdings' borrowing under its revolving credit facility. In addition, 2002 includes incurred expense of $2.1 million for distributions on Capital Trust's trust preferred securities. Other expense was $2.1 million in 2002 compared to other income of $28.2 million in 2001. Significant contributors to other expense in 2002 were foreign exchange losses, normal provision for uncollectible audit premium in the U.S. Insurance 40 operation and the amortization of deferred expenses relating to Holdings' issuance of senior notes and Capital Trust's issuance of trust preferred securities, partially offset by fee income. Other income for 2001 includes $25.9 million arising from a non-recurring receipt of shares in connection with the demutualization of a former insurance company client that had issued annuities to the Company in connection with certain claim settlement transactions. In addition, other income for 2001 includes foreign exchange gains as well as fee income, offset by the amortization of deferred expenses relating to Holdings' issuance of senior notes. The Company has a small number of credit default swaps, which it no longer writes, and specialized equity put options in its product portfolio. These products meet the definition of a derivative under Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). Net derivative expense from these derivative transactions in 2002, essentially reflecting changes in fair value, was $14.5 million, principally relating to the specialized equity put options, compared to $12.2 million in 2001, principally relating to the credit default swaps. Net after tax exposure remaining on the credit default agreements is $3.1 million. See also Footnote 2 to Notes to the Consolidated Financial Statements. INCOME TAXES. The Company generated income tax expense of $30.7 million in 2002 compared to income tax benefits of $8.7 million in 2001. The tax expense in 2002 was mainly attributable to improved underwriting and investment results. The tax benefit in 2001 primarily resulted from the impact of losses relating to the September 11 attacks, the Enron bankruptcy and realized capital losses recognized in 2001, which reduced taxable income, partially offset by taxable income relating to the non-recurring receipt of shares in connection with a former client's demutualization. NET INCOME. Net income was $231.3 million in 2002 compared to $99.0 million in 2001. This increase generally reflects the improved underwriting and investment results, partially offset by increased tax expense, realized capital losses, derivative expense and a reduction in other income. YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 Premiums. Gross premiums written increased 35.3% to $1,874.6 million in 2001 from $1,385.6 million in 2000, as the Company took advantage of selected growth opportunities, while continuing to maintain a disciplined underwriting approach. Premium growth areas included a 115.9% ($13.4 million) increase in the Bermuda operation, a 100.6% ($251.9 million) increase in the U.S. Insurance operation, principally attributable to growth in worker's compensation insurance, a 30.1% ($95.7 million) increase in the Specialty Underwriting operation, mainly attributable to growth in A&H medical stop loss writings, and a 26.7% ($128.8 million) increase in the U.S. Reinsurance operation, primarily reflecting improved market conditions. These increases were partially offset by a 0.2% ($0.8 million) decrease in the International operation. The Company continued to decline business that did not meet its objectives regarding underwriting profitability. Ceded premiums increased to $314.5 million in 2001 from $166.7 million in 2000. This increase was principally attributable to $81.3 million of adjustment premiums incurred under the 2001 accident year aggregate excess of loss element of the Company's corporate retrocessional program relating to losses incurred as a result of the September 11 attacks and the Enron bankruptcy. In addition, ceded premiums for 2001 and 2000 also include adjustment premiums of $58.1 million and $35.2 million, respectively, relating to claims made under the 1999 accident year aggregate excess of loss element of the Company's corporate retrocessional program. The increase in ceded premiums in 2001 also reflects the impact on the U.S. Insurance operation's specific reinsurance protections resulting from this segment's volume increase. 41 Net premiums written increased by 28.0% to $1,560.1 million in 2001 from $1,218.9 million in 2000. This increase was a result of the increase in gross premiums written and the increase in ceded premiums. PREMIUM REVENUES. Net premiums earned increased by 25.0% to $1,467.5 million in 2001 from $1,174.2 million in 2000. Contributing to this increase were a 189.7% ($192.6 million) increase in the U.S. Insurance operation, a 41.6% ($4.8 million) increase in the Bermuda operation, a 22.9% ($69.2 million) increase in the Specialty Underwriting operation, a 5.5% ($26.0 million) increase in the U.S. Reinsurance operation and a 0.2% ($0.7 million) increase in the International operation. All of these changes reflect period to period variability in gross written and ceded premiums, and business mix, together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. As premium reporting and earnings and loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, can and does introduce appreciable background variability in various underwriting line items. EXPENSES. Incurred loss and LAE increased by 36.7% to $1,209.5 million in 2001 from $884.6 million in 2000. The increase in incurred losses and LAE was principally attributable to an increase in business volume as reflected by the increase in net premiums earned, the impact of incurred losses relating to the September 11 attacks and the Enron bankruptcy and modest reserve strengthening in select areas, together with the impact of changes in the Company's mix of business. The Enron bankruptcy contributed $34.0 million of unusual losses in 2001 before cessions under the corporate retrocessional program. Incurred losses and LAE include catastrophe losses, which reflect the impact of both current period events and favorable and unfavorable development on prior period events and are net of reinsurance. A catastrophe is an event that causes a pre-tax loss on property exposures of at least $5.0 million and has an event date of January 1, 1988 or later. Catastrophe losses, net of contract specific cessions but before cessions under the corporate retrocessional program in 2001, were $222.6 million, relating principally to the September 11 attacks, tropical storm Alison, the Petrobras Oil Rig loss and the El Salvador earthquake, compared to $13.9 million in 2000. Incurred losses and LAE in 2001 reflected ceded losses and LAE of $486.3 million compared to ceded losses and LAE in 2000 of $161.6 million, with the increase principally attributable to cessions relating to the September 11 attack losses and the Enron bankruptcy, together with the increased cessions under specific reinsurance arrangements in the U.S. Insurance operation. The ceded losses and LAE for 2001 reflect $164.0 million of losses ceded under the 2001 accident year aggregate excess of loss component of the Company's corporate retrocessional program. The ceded losses and LAE for 2001 and 2000 reflect $105.0 million and $70.0 million, respectively, of losses ceded under the 1999 accident year aggregate excess of loss component of the Company's corporate retrocessional program, with the amounts in both periods reflecting reserve strengthening in select lines, including with respect to 1999 accident year catastrophes. Contributing to the increase in incurred losses and LAE in 2001 from 2000 were a 200.7% ($141.0 million) increase in the U.S. Insurance operation, principally reflecting increased premium volume, a 137.5% ($8.8 million) increase in the Bermuda operation, principally reflecting increased premium volume, a 41.5% ($131.9 million) increase in the U.S. Reinsurance operation, principally 42 reflecting losses in connection with the September 11 attacks and tropical storm Alison and a 30.1% ($76.5 million) increase in the Specialty Underwriting operation, principally attributable to increased premium volume in A&H medical stop loss business together with marine, aviation and surety losses relating to the September 11 attacks, the Enron bankruptcy and the Petrobras Oil Rig loss. These increases were partially offset by a 14.1% ($33.3 million) decrease in the International operation, principally due to more favorable loss experience. Incurred losses and LAE for each operation were also impacted by variability relating to changes in the level of premium volume and mix of business by class and type. The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing incurred losses and LAE by premiums earned, increased by 7.1 percentage points to 82.4% in 2001 from 75.3% in 2000, reflecting the incurred losses and LAE discussed above. The following table shows the loss ratios for each of the Company's operating segments for 2001 and 2000. The loss ratios for all operations were impacted by the expense factors noted above as well as by the impact on ceded premiums of the adjustment premiums under the Company's corporate retrocessional program.
OPERATING SEGMENT LOSS RATIOS - -------------------------------------------------------------------------------- Segment 2001 2000 - -------------------------------------------------------------------------------- U.S. Reinsurance 90.4% 67.4% U.S. Insurance 71.8% 69.2% Specialty Underwriting 89.0% 84.0% International 70.5% 82.3% Bermuda 92.3% 55.0%
Underwriting expenses increased by 40.6% to $455.7 million in 2001 from $324.1 million in 2000. Commission, brokerage, taxes and fees increased by $124.4 million, principally reflecting increases in premium volume and changes in the mix of business. In addition, in 2000, the Company's reassessment of the expected losses on a multi-year reinsurance treaty led to a $33.8 million decrease in contingent commissions with a corresponding increase to losses. Other underwriting expenses increased by $7.3 million as the Company expanded its business volume and operations. Contributing to the underwriting expense increase were a 122.7% ($45.6 million) increase in the U.S. Insurance operation, mainly relating to the increased premium volume, a 70.8% ($68.0 million) increase in the U.S. Reinsurance operation, which included the impact of the contingent commission adjustment noted above, and a 22.5% ($19.8 million) increase in the Specialty operation. These increases were partially offset by a 29.0% ($1.7 million) decrease in the Bermuda operation and a 1.5% ($1.4 million) decrease in the International operation. Except as noted, the changes for each operation's expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, the underwriting performance of the underlying business. The Company's expense ratio, which is calculated by dividing underwriting expenses by premiums earned, increased by 3.5 percentage points to 31.1% in 2001 compared to 27.6% in 2000. The Company's combined ratio, which is the sum of the loss and expense ratios, increased by 10.6 percentage points to 113.5% in 2001 compared to 102.9% in 2000. The following table shows the combined ratios for each of the Company's operating segments for 2001 and 2000. The combined ratios for all operations were impacted by the loss and expense ratio variability noted above as well as by the impact on ceded premiums of the adjustment premiums under the Company's corporate retrocessional program. 43
OPERATING SEGMENT COMBINED RATIOS - -------------------------------------------------------------------------------- Segment 2001 2000 - -------------------------------------------------------------------------------- U.S. Reinsurance 123.3% 87.8% U.S. Insurance 99.9% 105.8% Specialty Underwriting 118.0% 113.1% International 103.0% 115.4% Bermuda 117.9% 106.0%
INVESTMENTS. Net investment income increased by 12.9% to $340.4 million in 2001 from $301.5 million in 2000, principally reflecting the effect of investing the $406.0 million of cash flow from operations in 2001, partially offset by the lower interest rate environment and increased interest expense on funds held relating to the utilization of the 1999 and 2001 accident year aggregate excess of loss elements of the corporate retrocessional program. The following table shows a comparison of various investment yields as of December 31, 2001 and 2000, respectively, and for the periods then ended.
2001 2000 ------------------- Imbedded pre-tax yield of cash and invested assets at end of period 6.0% 6.7% Imbedded after-tax yield of cash and invested assets at end of period 5.0% 5.4% Annualized pre-tax yield on average cash and invested assets 6.2% 6.3% Annualized after-tax yield on average cash and invested assets 5.0% 5.0%
Net realized capital losses were $22.3 million in 2001, reflecting realized capital losses on the Company's investments of $55.1 million, which includes $22.6 million relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis, partially offset by $32.8 million of realized capital gains, compared to realized capital gains of $0.8 million in 2000. The net realized capital gains in 2000 reflected realized capital gains of $30.9 million, which were partially offset by $30.1 million of realized capital losses. The net realized capital losses for 2001 allowed the Company to recapture taxes paid on net realized capital gains in prior periods. The realized capital gains in 2001 and 2000 arose mainly from activity in the Company's equity portfolio. The realized capital losses in 2001 and 2000 arose mainly from activity in the Company's fixed maturity portfolios. Interest expense was $46.0 million for 2001 compared to $39.4 million in 2000. Interest expense for 2001 reflects $38.9 million relating to Holdings' senior notes and $7.1 million relating to Holdings' borrowing under its revolving credit facility. Interest expense for 2000 reflects $30.9 million relating to Holdings' senior notes and $8.5 million relating to Holdings' borrowing under its revolving credit facility. Other income was $28.2 million in 2001 compared to $3.3 million in 2000. Other income for 2001 includes $25.9 million arising from a non-recurring receipt of shares in connection with the demutualization of a former insurance company client that had issued annuities to the Company in connection with certain claim settlement transactions. In addition, other income for 2001 includes foreign exchange gains as well as financing fees from Everest Security, offset by the amortization of deferred expenses relating to Holdings' issuance of senior notes. Significant contributors to other income for 2000 were foreign exchange 44 gains as well as financing fees from Everest Security, partially offset by net derivative expense and the amortization of deferred expenses relating to Holdings' issuance of senior notes. The foreign exchange gains and losses are attributable to fluctuations in foreign currency exchange rates. During 2000 and 2001, the Company added to its product portfolio a small number of credit default swaps, which it no longer writes, and specialized equity put options. These products meet the definition of a derivative under FAS 133. Net derivative expense from these transactions in 2001 was $12.2 million. INCOME TAXES. The Company generated income tax benefits of $8.7 million in 2001 compared to income tax expense of $45.4 million in 2000. This tax benefit primarily resulted from the impact of losses relating to the September 11 attacks, the Enron bankruptcy and realized capital losses recognized in 2001, which reduced taxable income, partially offset by taxable income relating to the non-recurring receipt of shares in connection with a former client's demutualization. NET INCOME. Net income was $99.0 million in 2001 compared to $186.4 million in 2000. This decrease generally reflects the losses attributable to the September 11 attacks and the Enron bankruptcy, partially offset by improved investment results and the non-recurring receipt of shares in connection with a former client's demutualization. CRITICAL ACCOUNTING POLICIES LOSS AND LAE RESERVES. The Company's most critical accounting policy is the determination of its loss and LAE reserves. The Company maintains reserves to cover its estimated ultimate liability for losses and LAE with respect to reported and unreported claims. Because reserves are estimates of ultimate losses and LAE, management monitors reserve adequacy over time, evaluating new information as it becomes known and adjusting reserves as necessary. Management considers many factors when setting reserves, including: (1) its exposure base, generally its earned premiums; (2) its expected loss ratios on current year writings as determined through extensive interaction between its underwriters and actuaries by product and class categories (3) internal actuarial methodologies which analyze the Company's experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments, pending levels of unpaid claims and product mix; (4) current legal interpretations of coverage and liability; (5) economic conditions; and (6) the uncertainties discussed below regarding reserve requirements for asbestos and environmental claims. Based on these considerations, management believes that adequate provision has been made for the Company's loss and LAE reserves. Actual losses and LAE ultimately paid may deviate, perhaps substantially, from such reserves, impacting income in the period in which the change is made. See also Footnote 1 to Notes to the Consolidated Financial Statements. ASBESTOS AND ENVIRONMENTAL EXPOSURES. The Company continues to receive claims under expired contracts which assert alleged injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. The Company's asbestos claims typically involve potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. The Company's environmental claims typically involve potential liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damage caused by the release of hazardous substances into the land, air or water. The Company's reserves include an estimate of the Company's ultimate liability for asbestos and environmental ("A&E") claims for which ultimate value cannot be estimated using traditional reserving techniques. There are significant 45 uncertainties in estimating the amount of the Company's potential losses from A&E claims. Among the complications are: (a) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (b) difficulty in identifying sources of A&E contamination; (c) difficulty in properly allocating responsibility and/or liability for A&E damage; (d) changes in underlying laws and judicial interpretation of those laws; (e) potential for an A&E claim to involve many insurance providers over many policy periods; (f) long reporting delays, both from insureds to insurance companies and ceding companies to reinsurers; (g) historical data on A&E losses, which is more limited and variable than historical information on other types of casualty claims; (h) questions concerning interpretation and application of insurance and reinsurance coverage; and (i) uncertainty regarding the number and identity of insureds with potential A&E exposure. With respect to asbestos claims in particular, several additional factors have emerged recently that further compound the difficulty in estimating the Company's liability. These developments include: (a) continued growth in the number of claims filed, in part reflecting a much more aggressive plaintiff bar; (b) a disproportionate percentage of claims filed by individuals with no functional injury from asbestos, claims with little to no financial value but that have increasingly been considered in jury verdicts and settlements; (c) the growth in the number and significance of bankruptcy filings by companies as a result of asbestos claims; (d) the growth in claim filings against defendants formerly regarded as "peripheral"; (e) the concentration of claims in a small number of states that favor plaintiffs; (f) the growth in the number of claims that might impact the general liability portion of insurance policies rather than the product liability portion; (g) responses in which specific courts have adopted measures to ameliorate the worst procedural abuses; and (h) the potential that the U. S. Congress or state legislatures may consider legislation to address the asbestos litigation issue. These uncertainties and factors continue to render reserves for A&E losses significantly less subject to traditional actuarial analysis than are reserves for other types of losses. As a result, management believes that no meaningful range for such ultimate losses can be established. The Company establishes reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for the Company or its ceding companies. In connection with the acquisition of Mt. McKinley, which has significant exposure to A&E claims, Prupac, a subsidiary of The Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinley's reserves as of September 19, 2000. In addition, The Prudential guaranteed Prupac's obligations to Mt. McKinley. Through December 31, 2002, cessions under this reinsurance agreement have reduced the available remaining limits to $81.1 million net of coinsurance. Due to the uncertainties discussed above, the ultimate losses may vary materially from current loss reserves and, depending on coverage under the Company's various reinsurance arrangements, could have a material adverse effect on the Company's future financial condition, results of operations and cash flows. See also Footnote 1 and 3 to Notes to the Consolidated Financial Statements. REINSURANCE RECEIVABLE. The Company utilizes reinsurance agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from reinsurers of a portion of losses and loss expenses under certain circumstances without relieving the insurer of its obligation to the policyholder. In the event reinsurers were unable to meet their obligations under these reinsurance agreements, the Company would not be able to realize the full value of the reinsurance recoverable balance. In some cases, the Company may hold partial collateral, including letters of credit and funds held arrangements, for these agreements. The Company establishes reserves for uncollectible balances based on management's assessment of the collectibility of the outstanding balances. To minimize exposure from uncollectible reinsurance 46 receivables, the Company has a reinsurance credit security committee that generally evaluates the financial strength of a reinsurer prior to entering into a reinsurance arrangement. Additionally, creditworthy foreign reinsurers of business written in the United States are generally required to secure their obligations. Management believes that adequate provision has been made for the Company's uncollectible balances. Actual uncollectible amounts may vary, perhaps substantially, from such reserves, impacting income in the period in which the change is made. See also Footnote 1 to Notes to the Consolidated Financial Statements. PREMIUMS WRITTEN AND EARNED. Premiums written by the Company are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the remainder of the unexpired contract period. Such reserves are established based upon reports received from ceding companies or computed using pro rata methods based on statistical data. Written and earned premiums, and the related costs, which have not yet been reported to the Company are estimated and accrued. As earned premium generally correlates with the Company's estimate of its exposure base, variations in premium earnings are to a large degree offset by related variability in incurred losses and commission expense. See also Footnote 1 to Notes to the Consolidated Financial Statements. INVESTMENT VALUATION. The Company's investment portfolio consists of investments available for sale and accordingly these securities are marked to market on a quarterly basis. Most securities are traded on national exchanges where market values are readily available. The Company holds some privately placed securities that are either valued by an investment advisor or by the Company using cash flow projections. Unrealized gains and losses from market fluctuations are reflected as comprehensive income, while market value declines that are considered other than temporary are reflected in the income statement as realized capital losses. The Company considerers many factors when determining whether a market value decline is other than temporary, including: (1) the length of time the market value has been below book value, (2) the credit strength of the issuer, (3) the issuer's market sector and (4) the length of time to maturity. Due to the uncertainty of these factors, investment losses may arise and could have a material adverse effect on the Company's future financial condition, results of operations and cash flows. See also Footnote 1 to Notes to the Consolidated Financial Statements. FINANCIAL CONDITION CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and short-term investments, were $7,259.1 million at December 31, 2002, $5,783.5 million at December 31, 2001 and $5,493.0 million at December 31, 2000. The increase in cash and invested assets from 2001 to 2002 resulted primarily from $736.1 million in cash flows from operations generated in 2002, $346.3 million of net proceeds from the offering of common shares in February 2002, $203.4 million of net proceeds from Capital Trust's issuance of trust preferred securities in November 2002 and $135.9 million in net unrealized appreciation of the Company's investments. These increases were partially offset by $35.0 million in net payments on Holdings' credit facility and $22.9 million in share repurchases. The increase in cash and invested assets from 2000 to 2001 resulted primarily from $406.0 million in cash flows from operations generated in 2001 and $57.3 million in net unrealized appreciation of the Company's investments. These increases were partially offset by $130.0 million in net payments on Holdings' credit facility. LOSS AND LAE RESERVES. Gross loss and LAE reserves totaled $4,905.6 million at December 31, 2002, $4,278.3 million at December 31, 2001 and $3,786.2 million at December 31, 2000. The increase in 2002 was primarily attributable to increased premiums earned, modest reserve strengthening in select areas and normal 47 variability in claim settlements. The increase in 2001 was primarily attributable to increased catastrophe losses resulting from the September 11 attacks, together with increased earned premiums and normal variability in claim settlements. Reinsurance receivables totaled $1,116.4 million at December 31, 2002, $895.1 million at December 31, 2001 and $509.0 million at December 31, 2000, with the changes in 2002 principally reflecting losses ceded under the accident year aggregate excess of loss element of the Company's corporate retrocessional program and losses ceded as part of a reinsurance agreement between Mt. McKinley and Prupac. At December 31, 2002, $440.0 million, or 39.4%, was receivable from subsidiaries of London Reinsurance Group ("London Life"). These receivables are effectively secured by a combination of letters of credit and funds held arrangements under which the Company has retained the premium payments due the retrocessionaires, recognized liabilities for such amounts and reduced such liabilities as payments are due from the retrocessionaire. In addition, $145.0 million, or 13.0%, was receivable from Continental Insurance Company ("Continental), which is partially secured by funds held arrangements, and $78.9 million or 7.1%, was receivable from Prupac, whose obligations are guaranteed by The Prudential. No other retrocessionaire accounted for more than 5% of the Company's receivables. The Company generally has exposure to A&E losses through its Mt. McKinley operation with respect to insurance policies and through Everest Re with respect to reinsurance contracts. In each case, the Company's management and analysis of its exposures takes into account a number of features of its business that differentiate the Company's exposures from many other insurers and reinsurers that have significant A&E exposures. Mt. McKinley began writing small amounts of A&E exposed insurance in 1975 and increased the volume of its writings in 1977. These writings ceased in 1984, giving Mt. McKinley an approximate 10-year window of potential A&E exposure, which is appreciably shorter than is the case for many companies with significant A&E exposure. Additionally, due to changes in and standardization of policy forms, it is rare for policies in the 1970s and 1980s to have been issued without aggregate limits on at least the product liability coverage offered; policies issued in earlier decades are generally more at risk of not having aggregate limits. The vast majority of Mt. McKinley's A&E exposed insurance policies are excess casualty policies, with aggregate coverage limits, which by definition also have protection afforded by underlying coverage. Mt. McKinley's attachment points vary but usually are protected by millions, often tens of millions, of dollars of underlying coverage. The excess nature of most of Mt. McKinley's policies also offers protection against non-product claims (for example, claims arising under general liability coverage). Although under some circumstances an excess policy could be exposed to non-product claims, such claims generally pose more of a risk to primary policies because non-product claims are generally less likely to aggregate. In addition, environmental claims arise under general liability coverage, and generally do not aggregate. Thus, these claims tend to create exposure for primary policies to a greater extent than excess policies. Virtually all of the Mt. McKinley policies that are still potentially exposed to claims have policy language providing that expenses were paid within limits rather than in addition to limits. This is a substantial difference from primary coverage, which would most often cover expenses in addition to limits. Everest Re was formed in 1973 but was not fully engaged in underwriting casualty business under which A&E exposures generally arise until 1974, and it effectively eliminated A&E exposures through contract exclusions effected in 1984. Therefore, Everest Re has an approximate 11-year window of A&E exposure, 48 much shorter than that of many reinsurance companies that have significant A&E exposures. In the earlier years of its existence, Everest Re was not as heavily involved in casualty business as in property business, which generally is not exposed to asbestos claims. Everest Re generally took smaller lines of exposure per contract than many other reinsurers operating in the casualty reinsurance market and those lines were generally also smaller than the excess limits provided by Mt. McKinley policies. This means that the potential adverse development on Everest Re's reinsurance business would not be subject to the same level of volatility as would be the case for companies having greater exposures per risk. Everest Re reinsured both primary and excess policies. However, its claim experience to date indicates that the majority of its reinsurance supported excess policies. As a result, most of Everest Re's exposure derives from excess policies similar to those written by Mt. McKinley. With respect to both the Mt. McKinley and Everest Re operations, the Company was not a member of the Asbestos Claims Facility ("Wellington") or the Center for Claims Resolution ("CCR") claim settlement facilities. Insurers supporting those facilities made broad commitments concerning the application of insurance coverage to asbestos claims. With respect to its direct insurance exposures, the fact that the Company has not made those commitments may allow it to resolve insurance exposure to Wellington/CCR insureds more economically than if it had joined these facilities. With respect to its reinsurance exposures, although the Company was not a signatory to the Wellington or CCR facilities, it has, within the bounds of its reinsurance contracts, generally supported ceding companies that were signatories. Because the insurers supporting these facilities have generally paid their exposures more quickly than non-signatory insurers, the Company believes that this has generally meant that it has paid its reinsurance exposure more quickly than it likely would have if it had not been subject to Wellington/CCR payments. The Company believes that its A&E exposures are unique and differentiated from those insurers and reinsurers with appreciable A&E exposure by the points noted above, but there can be no assurance that such factors will protect the Company from adverse development, perhaps material, or allow it to secure advantages in the settlement of its claims obligations. Additional losses, including those relating to currently unrecognized latent injuries, the type or magnitude of which cannot be foreseen by the Company, or the reinsurance and insurance industry generally, may emerge in the future. Such future emergence, to the extent not covered by existing retrocessional contracts, could have material adverse effects on the Company's future financial condition, results of operations and cash flows. 49 The table below summarizes the Company's overall reserves and claim activity for asbestos and environmental claims, on both a gross and net of ceded reinsurance basis, for the periods indicated:
ASBESTOS AND ENVIRONMENTAL RESERVES YEARS ENDED DECEMBER 31, ----------------------------------------- 2002 2001 2000 ------- ------- ------- (DOLLARS IN MILLIONS) Gross Basis: Beginning of period reserves $ 644.4 $ 693.7 $ 614.2 ------- ------- ------- Incurred losses and LAE: Reported losses 180.9 100.5 (51.1) Change in IBNR (85.9) (70.8) 45.3 ------- ------- ------- Total incurred losses and LAE 95.0 29.7 (5.8) Paid losses (71.5) (79.0) 85.3 ------- ------- ------- End of period reserves $ 667.9 $ 644.4 $ 693.7 ======= ======= ======= Net Basis: Beginning of period reserves $ 568.6 $ 628.5 $ 365.1 ------- ------- ------- Incurred losses and LAE: Reported losses (1) 102.7 67.7 (173.0) Change in IBNR (79.2) (62.5) 167.2 ------- ------- ------- Total incurred losses and LAE 23.5 5.2 (5.8) Paid losses (1) (64.6) (65.1) 269.2 ------- ------- ------- End of period reserves $ 527.5 $ 568.6 $ 628.5 ======= ======= =======
- -------------------------------------------------------------------------------- 1) Reported losses and paid losses for 2000 are net of ($311.3) million and $311.3 million, respectively, reflecting the establishment of Mt. McKinley's reserves at the acquisition date. Net paid losses, excluding the impact of the Mt. McKinley acquisition transaction, were ($42.3) million. The gross reserves for asbestos and environmental exposures increased in 2002, principally due to an increase in management's estimate of the ultimate asbestos and environmental exposures, the effect of which was partially offset by paid losses. The net reserves for asbestos and environmental exposures decreased in 2002, principally due to an increase in losses ceded as part of a reinsurance agreement between Mt. McKinley and Prupac, the effect of which was partially offset by paid losses. The gross and net reserves for asbestos and environmental exposures in 2000 include Holdings' acquisition of Mt. McKinley. Industry analysts have developed a measurement, known as the survival ratio, to compare the asbestos and environmental reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company's current reserves by the three-year average of paid losses, and therefore measures the number of years that it would take to exhaust the current reserves based on historical payment patterns. Using this measurement, the Company's net three-year asbestos and environmental survival ratio was 9.2 years at December 31, 2002. Adjusting these ratios to include the effect of the remaining limits of reinsurance available under the reinsurance agreement with Prupac, the measures rise to the equivalent of 10.6 years at December 31, 2002. Because the survival ratio was developed as a comparative measure of reserve strength and 50 not of absolute reserve adequacy, the Company considers, but does not rely on, the survival ratio when evaluating its reserves. As noted earlier, there were developments in 2002 affecting asbestos exposures in general and the Company's asbestos exposures in particular. These developments together with enhancements in the Company's claim management and analytical processes resulted in the reserve strengthening noted earlier. These developments and actions have increased the emphasis on asbestos exposures as a separate component of the Company's A&E exposures. Despite the Company's approach of handling A&E exposures on a combined basis, management believes additional disclosure of the asbestos element of its A&E exposures is appropriate. The following tables summarize reserves and claim activity for asbestos claims, on both a gross and net of ceded reinsurance basis, for the periods indicated with particular emphasis on the differentiation of insured categories within the Mt. McKinley operation, which the Company believes reflects the most volatile element of its asbestos exposures. 51
GROSS ASBESTOS EXPOSURES (1) (DOLLARS IN MILLIONS) -------------------------------- 2002 2001 2000 ------ ------ ------ Beginning of period reserves: Direct Operations (Mt. McKinley) Coverage in place ("CIP") settlements (2) $ 43.5 $ 32.1 $ 12.0 Actively managed (3) 32.2 5.6 - Remaining high profile insureds 41.2 34.6 10.8 Other direct exposures 2.5 11.4 10.6 Incurred by not reported ("IBNR") 100.6 133.0 90.0 ------ ------ ------ 220.0 216.6 123.4 Reinsurance Operations (Everest Re) Case reserves 120.5 117.7 140.0 IBNR 117.3 154.1 176.5 ------ ------ ------ 237.7 271.8 316.5 Total beginning of period reserves 457.7 488.4 439.8 ------ ------ ------ Incurred losses and LAE: Direct Operations (Mt. McKinley) CIP settlements 32.8 16.1 26.6 Actively managed (0.3) 36.1 10.5 Remaining high profile insureds 108.2 7.2 24.0 Other direct exposures 3.2 2.7 (104.3) IBNR (8.9) (32.3) 43.0 ------ ------ ------ 135.0 29.7 (0.2) Reinsurance Operations (Everest Re) Reported Losses 29.0 36.9 20.5 IBNR (29.0) (36.9) (22.3) ------ ------ ------ - - (1.9) Total incurred losses and LAE 135.0 29.7 (2.1) ------ ------ ------ Paid losses: Direct Operations (Mt. McKinley) CIP settlements 4.2 4.7 6.6 Actively managed 25.3 9.5 4.9 Remaining high profile insureds 1.7 0.5 0.2 Other direct exposures (4) 4.0 11.6 (105.1) ------ ------ ------ 35.2 26.3 (93.5) Reinsurance Operations (Everest Re) 16.1 34.1 42.8 Total paid losses 51.3 60.4 (50.7) ------ ------ ------ End of period reserves: Direct Operations (Mt. McKinley) CIP settlements 72.1 43.5 32.1 Actively managed 6.6 32.2 5.6 Remaining high profile insureds 147.7 41.2 34.6 Other direct exposures 1.7 2.5 11.4 IBNR 91.7 100.6 133.0 ------ ------ ------ 319.8 220.0 216.6 Reinsurance Operations (Everest Re) Case reserves 133.3 120.5 117.7 IBNR 88.2 117.3 154.1 ------ ------ ------ 221.6 237.7 271.8 Total end of period reserves $541.4 $457.7 $488.4 ====== ====== ======
(1) Some totals may not reconcile due to rounding. (2) Under CIP agreements, payments depend upon the insured's actual claims experience and may be subject to annual caps or other controls on the rate of payment. (3) Actively Managed means that Mt. McKinley is managing the defense of claims against the insured. (4) Includes ($114.8) million of paid loss impact arising from the Mt. McKinley acquisition in 2000. 52
NET ASBESTOS EXPOSURES (1) (DOLLARS IN MILLIONS) ------------------------------------ 2002 2001 2000 ------- ------- ------- Beginning of period reserves: Direct Operations (Mt. McKinley) CIP settlements (2) $ 39.4 $ 28.2 $ - Actively managed (3) 28.5 4.9 - Remaining high profile insureds 36.8 30.5 - Losses Ceded to Prupac (19.6) - - Other direct exposures 1.8 10.3 - IBNR 94.5 120.4 7.1 ------- ------- ------- 181.5 194.3 7.1 Reinsurance Operations (Everest Re) Case reserves 110.7 106.9 109.8 IBNR 97.3 131.5 133.2 ------- ------- ------- 207.9 238.5 243.1 Total beginning of period reserves 389.4 432.8 250.2 ------- ------- ------- Incurred losses and LAE: Direct Operations (Mt. McKinley) CIP settlements 29.8 15.4 29.7 Actively managed 1.1 30.9 5.9 Remaining high profile insureds 97.5 6.8 30.6 Losses Ceded to Prupac (61.1) (19.6) - Other direct exposures 2.8 (2.6) (185.6) IBNR (9.7) (25.9) 113.3 ------- ------- ------- 60.4 5.0 (6.2) Reinsurance Operations (Everest Re) Reported Losses 27.0 34.3 5.8 IBNR (27.1) (34.3) (1.7) ------- ------- ------- (0.1) - 4.1 Total incurred losses and LAE 60.3 5.0 (2.0) ------- ------- ------- Paid losses: Direct Operations (Mt. McKinley) CIP settlements 3.8 4.2 1.4 Actively managed 23.7 7.2 1.0 Remaining high profile insureds 1.5 0.5 0.2 Other direct exposures (4) 3.1 5.9 (196.0) ------- ------- ------- 32.1 17.9 (193.3) Reinsurance Operations (Everest Re) 14.2 30.5 8.7 Total paid losses 46.3 48.4 (184.6) ------- ------- ------- End of period reserves: Direct Operations (Mt. McKinley) CIP settlements 65.4 39.4 28.2 Actively managed 5.9 28.5 4.9 Remaining high profile insureds 132.8 36.8 30.5 Losses Ceded to Prupac (80.7) (19.6) - Other direct exposures 1.5 1.8 10.3 IBNR 84.8 94.5 120.4 ------- ------- ------- 209.7 181.5 194.3 Reinsurance Operations (Everest Re) Case reserves 123.5 110.7 106.9 IBNR 70.2 97.3 131.5 ------- ------- ------- 193.7 207.9 238.5 Total end of period reserves (5) (6) $ 403.4 $ 389.4 $ 432.8 ======= ======= =======
(1) Some totals may not reconcile due to rounding. (2) Under CIP agreements, payments depend upon the insured's actual claims experience and may be subject to annual caps or other controls on the rate of payment. (3) Actively Managed means that Mt. McKinley is managing the defense of claims against the insured. (4) Includes ($215.1) million of paid loss impact arising from the Mt. McKinley acquisition in 2000. (5) Net liabilities represent Everest Re's inception-to-date losses and Mt. McKinley's losses since its acquisition in 2000. (6) Includes $203.8 million ceded to and collected from The Prudential as part of the Company's Stop Loss protection resulting from the initial public offering in 1995. 53 The Company's net three year survival ratio on its asbestos exposures was 9.7 years for the period ended December 31, 2002. This three year survival ratio when adjusted to exclude the CIP and actively managed reserves was 11.9 years, and when adjusted to exclude the CIP and actively managed reserves and to include stop loss protection from The Prudential was 14.8 years. SHAREHOLDERS' EQUITY. The Company's shareholders' equity increased to $2,368.6 million as of December 31, 2002 from $1,720.5 million as of December 31, 2001, principally reflecting $346.3 million in net proceeds from the Company's offering of 5.0 million common shares in February 2002, $231.3 million of net income in 2002 and an increase of $104.2 million in net unrealized appreciation of investments, partially offset by $22.9 million in share repurchases and $16.3 million in shareholder dividends. Shareholders' equity increased to $1,720.5 million as of December 31, 2001 from $1,583.4 million as of December 31, 2000, principally reflecting an increase of $86.1 million in retained earnings, an increase of $44.8 million in net unrealized appreciation of investments and $10.0 million in common shares issued during the year in connection with the exercise of stock options. Dividends of $16.3 million, $12.9 million and $11.0 million were declared and paid by the Company in 2002, 2001 and 2000, respectively. During the year ended December 31, 2002, the Company repurchased 0.450 million of its common shares at an average price of $50.86 per share with all such repurchases occurring in the three months ended September 30, 2002. At December 31, 2002, 1.730 million shares remained under the existing repurchase authorization. As part of the Company's restructuring, the treasury shares held by the Company prior to February 24, 2000 were retired, resulting in a reduction to treasury shares with a corresponding reduction of paid-in capital and common shares. LIQUIDITY AND CAPITAL RESOURCES CAPITAL. The Company's business operations are in part dependent on the Company's financial strength, and the market's perception thereof, as measured by shareholders' equity, which was $2,368.6 million and $1,720.5 million at December 31, 2002 and 2001, respectively. The Company has flexibility with 54 respect to capitalization as the result of its perceived financial strength, including its financial strength ratings as assigned by independent rating agencies, and its access to the debt and equity markets. The Company continuously monitors its capital and financial position, as well as investment and security market conditions, both in general and with respect to the Company's securities, and responds accordingly. On July 30, 2002, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission, providing for the issuance of up to $475.0 million of securities. Generally, under this shelf registration statement, Group may issue common shares, preferred shares, debt, warrants and hybrid securities, Holdings may issue debt securities and warrants and Capital Trust may issue trust preferred securities. In November 2002, pursuant to a trust agreement between Holdings and JPMorgan Chase Bank, the property trustee, and Chase Manhattan Bank USA, the Delaware trustee, Capital Trust completed a public offering of $210.0 million of 7.85% trust preferred securities, resulting in net proceeds of $203.4 million. The proceeds of the issuance were used to purchase $210 million of 7.85% junior subordinated debt securities of Holdings that will be held in trust by the property trustee for the benefit of the holders of the preferred securities. Holdings used the proceeds from the sale of the junior subordinated debt for general corporate purposes and made capital contributions to its operating subsidiaries. Capital Trust will redeem all of the outstanding trust preferred securities when the junior subordinated debt securities are paid at maturity on November 15, 2032. Holdings may elect to redeem the junior subordinated debt securities, in whole or in part, at any time after November 14, 2007. If such an early redemption occurs, the outstanding trust preferred securities will also be proportionately redeemed. Distributions on the trust preferred securities are cumulative and are paid quarterly in arrears. Disbributions relating to the trust preferred securities for the year ended December 31, 2002 were $2.1 million. On November 7, 2001, the Company filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission, providing for the issuance of up to $575.0 million of common equity. On February 27, 2002, the Company completed an offering of 5,000,000 of its common shares at a price of $69.25 per share, which resulted in $346.3 million of proceeds before expenses of approximately $0.5 million related to the offering. The Company has used the net proceeds for working capital and general corporate purposes. On October 2, 2002, the Company filed a Post- Effective Amendment to this registration statement that removed the remaining securities from registration. On March 14, 2000, Holdings completed public offerings of $200.0 million principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million principal amount of 8.5% senior notes due March 15, 2005. During 2000, the net proceeds of these offerings and additional funds were distributed by Holdings to Group. Interest expense incurred in connection with these senior notes was $38.9 million, $38.9 million and $30.9 million for the years ended December 31, 2002, 2001 and 2000, respectively. LIQUIDITY. The Company's liquidity requirements are met on a short-term and long-term basis by funds provided by premiums collected, investment income and collected reinsurance receivables balances, and by the sale and maturity of investments, together with the availability of funds under the Company's revolving credit facility. The Company's net cash flows from operating 55 activities were $736.1 million, $406.0 million and $90.0 million for the years ended December 31, 2002, 2001 and 2000, respectively. The following table shows cash flows from operating activities, as well as the impact of select transactions on those cash flows, for the years ended December 31, 2002, 2001 and 2000.
- -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Cash flow from operations $736.1 $406.0 $ 90.0 Catastrophe loss payments 62.0 32.5 44.1 Stop Loss Agreement recoveries (1) - - (9.5) Derivative settlement payments 39.5 1.5 - Net tax payments (2) 10.0 24.9 63.7 Non-recurring receipt of shares (3) - (25.9) - ------ ------ ------ Cash flow from operations, net of adjustments $847.6 $439.0 $188.3 ====== ====== ======
(1) Recoveries under the Stop Loss Agreement with Mt. McKinley prior to the acquisition of Mt. McKinley. (2) Net tax payments for 2001 include a $35.0 million payment to the Internal Revenue Service in connection with the Company's 1997 tax year liabilities. This one-time payment effectively settled a deferred tax liability relating to the tax basis losses incurred in the 1997 tax year. This payment, which related to a timing item, had no impact on the Company's results of operations for the period. (3) Non-recurring receipt of shares in a demutualized insurer. The growth in net cash flows from operating activities reflects improvements in product pricing, together with growth in the Company's invested asset base, and is generally consistent with expectations, given the Company's investment strategies and mix of business and the normal variability of premium collections and the payout of loss reserves. The Company's current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable bond and tax-preferenced fixed maturity portfolio, while maintaining an adequate level of liquidity. The Company's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with the Company's current and projected operating results, market conditions and the Company's tax position. Proceeds from sales, calls and maturities and investment asset acquisitions were $2,822.1 million and $3,929.7 million, respectively, in 2002 compared to $1,492.2 million and $1,767.4 million, respectively, in 2001 and $1,006.5 million and $2,024.6 million, respectively, in 2000. On December 21, 1999, Holdings entered into a three-year senior revolving credit facility with a syndicate of lenders (the "Credit Facility"). On November 21, 2002, the maturity date of the Credit Facility was extended to December 19, 2003. Wachovia Bank, National Association (formerly First Union National Bank) is the administrative agent for the Credit Facility. The Credit Facility is used for liquidity and general corporate purposes. The Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either (1) the Base Rate (as defined below) or (2) an adjusted London InterBank Offered Rate ("LIBOR") plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate plus 0.5% per annum. On December 18, 2000, the Credit Facility was amended to extend the borrowing limit to $235.0 million for a period of 120 days. This 120-day period expired during the three months ended March 31, 2001 and the limit reverted to $150.0 million. The amount of margin and the fees payable for the Credit Facility depend upon Holding's senior unsecured debt rating. Group has guaranteed Holdings' obligations under the Credit Facility. 56 The Credit Facility requires the Company to maintain a debt to capital ratio of not greater than 0.35 to 1, Holdings to maintain a minimum interest coverage ratio of 2.5 to 1 and Everest Re to maintain its statutory surplus at $850.0 million plus 25% of future aggregate net income and 25% of future aggregate capital contributions. As of December 31, 2002, the Company was in compliance with these requirements. During the years ended December 31, 2002, 2001 and 2000, Holdings made payments on the Credit Facility of $80.0 million, $152.0 million and $0.0 million, respectively. During the years ended December 31, 2002, 2001 and 2000, Holdings had new Credit Facility borrowings of $45.0 million, $22.0 million and $176.0 million, respectively. As of December 31, 2002 and 2001, Holdings had outstanding Credit Facility borrowings of $70.0 million and $105.0 million, respectively. Interest expense incurred in connection with these borrowings was $3.5 million, $7.1 million and $8.5 million for the years ended December 31, 2002, 2001 and 2000, respectively. The cash flow activity in 2002 included $346.3 million of new cash resulting from the offering of common shares in February and $210.0 million of new cash from the issuance of trust preferred securities in November. The cash flow activity in 2000 included $340.1 million of new cash resulting from the acquisitions of Mt. McKinley and Everest International and $448.5 million in proceeds from Holdings' offering of senior notes. The Company has arrangements available for the issue of letters of credit, which letters are generally collateralized by the Company's cash or investments. At December 31, 2002, $156.5 million of letters of credit were issued and outstanding under these arrangements. EXPOSURE TO CATASTROPHES. As with other reinsurers, the Company's operating results and financial condition can be adversely affected by volatile and unpredictable natural and other disasters, such as hurricanes, windstorms, earthquakes, floods, fires and explosions. Any such catastrophic event could generate insured losses in one or many of the Company's treaties or lines of business, including property and/or casualty exposures. Although the Company attempts to limit its exposure to acceptable levels, including through the purchase of reinsurance when considered to be cost effective, it is possible that an actual catastrophic event or multiple catastrophic events could have a material adverse effect on the financial condition, results of operations and cash flows of the Company. The Company employs various techniques, including licensed software modeling, to assess its accumulated exposure. Such techniques are inherently more difficult to apply to non-property exposures. Accumulated exposures with respect to catastrophe losses are generally summarized in terms of the probable maximum loss ("PML"). The Company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years. Management believes that the Company's greatest catastrophe exposure worldwide from any single event is to an earthquake affecting the west coast of the United States where the Company estimates it has a PML exposure of $338 million, including workers' compensation exposures. The Company further estimates that its PML exposure with respect to its greatest windstorm exposure, which relates to a hurricane affecting the east coast of the United States, is $264 million and that its single event International PML exposure is $197 million. There can be no assurance that the Company will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML. 57 The Company employs a retrocessional approach under which the Company may purchase reinsurance to cover specific business written or exposure accumulations or as a corporate level retrocessional program covering the potential accumulation or aggregation of exposures across some or all of the Company's operations. All reinsurance purchasing decisions consider both the potential coverage and market conditions with respect to the pricing, terms, conditions and availability of such coverage, with the aim of securing cost- effective protection. The level of reinsurance coverage varies over time, reflecting the underwriter's and/or Company's view of the changing dynamics of both the underlying exposure and the reinsurance markets. If a single catastrophe were to occur in the United States that resulted in $338 million of gross losses and allocated loss adjustment expenses ("ALAE") in 2003 (an amount equivalent to the Company's PML including its property and workers' compensation exposures), management estimates that the effect on the Company's income before and after taxes would be approximately $338 million and $264 million, respectively. Such impact represents approximately 11.1% of the Company's beginning of year capital. For 2002 and initially in 2003, the Company has chosen not to purchase corporate retrocessional protection and to generally de-emphasize the purchase of specific reinsurance by its underwriters reflecting the Company's view that its exposures in the context of its capital and financial position do not warrant reinsurance purchases at current price levels. For both 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage, which provides up to $175.0 million of recoveries if Everest Re's consolidated statutory basis accident year loss ratio exceeds a loss ratio attachment point provided in the contract for the respective accident years. Each arrangement provides for an adjustment premium, which reduces the net benefit by approximately 50%, in the event that the coverage is used. The remaining limit available under these coverages is $85.0 million and $0.0 million, respectively. See ITEM 1 - "Risk Management and Retrocession Arrangements" for further details. DIVIDENDS During 2002, 2001 and 2000, the Company declared and paid shareholder dividends of $16.3 million, $12.9 million and $11.0 million, respectively. As an insurance holding company, the Company is partially dependent on dividends and other permitted payments from its subsidiaries to pay cash dividends to its shareholders. The payment of dividends to Group by Holdings and to Holdings by Everest Re is subject to Delaware regulatory restrictions and the payment of dividends to Group by Bermuda Re is subject to Bermuda insurance regulatory restrictions. Management expects that, absent significant catastrophe losses, such restrictions should not affect Everest Re's ability to declare and pay dividends sufficient to support Holdings' general corporate needs and Holdings' and Bermuda Re's ability to declare and pay dividends sufficient to support Group's general corporate needs. See ITEM 1, "Business - Regulatory Matters - Dividends" and Note 13A of Notes to Consolidated Financial Statements. MARKET SENSITIVE INSTRUMENTS The Securities and Exchange Commission Financial Reporting Release #48 requires registrants to clarify and expand upon the existing financial statement disclosure requirements for derivative financial instruments, derivative commodity instruments, and other financial instruments (collectively, "market sensitive instruments"). The Company does not enter into market sensitive instruments for trading purposes. The Company's current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable and tax-preferenced fixed maturity 58 portfolio, while maintaining an adequate level of liquidity. The Company's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with its current and projected operating results, market conditions, and the Company's tax position. The fixed maturities in the investment portfolio are comprised of non-trading available for sale securities. Additionally, the Company invests in equity securities, which it believes will enhance the risk-adjusted total return of the investment portfolio. The Company has also engaged in a small number of credit default swaps and specialized equity options, the market sensitivity of which is believed not to be material. The overall investment strategy considers the scope of the Company's present and anticipated operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with the Company's capital structure and other factors, are used to develop a net liability analysis. This analysis includes estimated payout characteristics for which the investments of the Company provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration and credit quality. The change in overall market sensitive risk exposure principally reflects the asset changes that took place during the year, with no material change in the underlying risk characteristics. The Company's $7.3 billion investment portfolio is principally comprised of fixed maturity securities that are subject to interest rate risk and foreign currency rate risk, and equity securities that are subject to equity price risk. The impact of these risks on the investment portfolio is generally mitigated by changes in the value of operating assets and liabilities and their associated income statement impact. Interest rate risk is the potential change in value of the fixed maturity portfolio, including short-term investments, due to change in market interest rates. In a declining interest rate environment, it includes prepayment risk on the $881.4 million of mortgage-backed securities in the $6.9 billion fixed maturity portfolio. Prepayment risk results from potential accelerated principal payments that shorten the average life and thus the expected yield of the security. The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on the fixed maturity portfolio as of December 31, 2002 and 2001 based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments are taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios. All amounts are in U.S. dollars and are presented in millions. 59
2002 INTEREST RATE SHIFT IN BASIS POINTS - -------------------------------------------------------------------------------------------------- -200 -100 0 100 200 - -------------------------------------------------------------------------------------------------- Total Market Value $7,985.3 $7,480.3 $6,949.0 $6,514.4 $6,116.2 Market Value Change from Base (%) 14.9% 7.7% 0.0% (6.3)% (12.0)% Change in Unrealized Appreciation After-tax from Base ($) $ 764.8 $ 401.8 $ - $ (313.5) $ (604.0)
2001 INTEREST RATE SHIFT IN BASIS POINTS - -------------------------------------------------------------------------------------------------- -200 -100 0 100 200 - -------------------------------------------------------------------------------------------------- Total Market Value $6,332.1 $5,957.7 $5,610.4 $5,283.2 $4,982.7 Market Value Change from Base (%) 12.9% 6.2% 0.0% (5.8)% (11.2)% Change in Unrealized Appreciation After-tax from Base ($) $ 521.1 $ 250.8 $ - $ (236.6) $ (454.2)
Foreign currency rate risk is the potential change in value, income and cash flow arising from adverse changes in foreign currency exchange rates. Each of the Company's foreign operations maintains capital in the currency of the country of its geographic location consistent with local regulatory guidelines. Generally, the Company prefers to maintain the capital of its foreign operations in U.S. dollar assets, although this varies by regulatory jurisdiction in accordance with market needs. Each foreign operation may conduct business in its local currency as well as the currency of other countries in which it operates. The primary foreign currency exposures for these foreign operations are the Canadian Dollar, the British Pound Sterling and the Euro. The Company mitigates foreign exchange exposure by a general matching of the currency and duration of its assets to its corresponding operating liabilities. In accordance with Financial Accounting Standards Board Statement No. 52, the Company translates the assets, liabilities and income of non-U.S. dollar functional currency legal entities to the U.S. dollar. This translation amount is reported as a component of other comprehensive income. The primary functional foreign currency exposures for these foreign operations are the Canadian Dollar, the Euro and the British Pound Sterling. The tables below display the potential impact of a parallel 20% increase and decrease in foreign exchange rates on the valuation of invested assets subject to foreign currency exposure in 10% increments as of December 31, 2002 and 2001. This analysis includes the after-tax impact of translation from transactional currency to functional currency as well as the after-tax impact of translation from functional currency to the U.S. dollar reporting currency. All amounts are in U.S. dollars and are presented in millions. 60
2002 CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT - -------------------------------------------------------------------------------------------------- -20% -10% 0% 10% 20% - -------------------------------------------------------------------------------------------------- Total After-tax Foreign Exchange Exposure $ (44.5) $(24.3) $ - $26.7 $56.8
2001 CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT - -------------------------------------------------------------------------------------------------- -20% -10% 0% 10% 20% - -------------------------------------------------------------------------------------------------- Total After-tax Foreign Exchange Exposure $(40.7) $(21.6) $ - $23.3 $47.9
Equity risk is the potential change in market value of the common stock and preferred stock portfolios arising from changing equity prices. The Company invests in high quality common and preferred stocks that are traded on the major exchanges in the United States and funds investing in such securities. The primary objective in managing the $47.5 million equity portfolio is to provide long-term capital growth through market appreciation and income. The tables below display the impact on market value and after-tax unrealized appreciation of a 20% change in equity prices up and down in 10% increments as of December 31, 2002 and 2001. All amounts are in U.S. dollars and are presented in millions.
2002 CHANGE IN EQUITY VALUES IN PERCENT - -------------------------------------------------------------------------------------------------- -20% -10% 0% 10% 20% - -------------------------------------------------------------------------------------------------- Market Value of the Equity Portfolio $ 38.0 $ 42.7 $ 47.5 $ 52.2 $ 57.0 After-tax Change in Unrealized Appreciation $ (6.2) $ (3.1) $ - $ 3.1 $ 6.2
2001 CHANGE IN EQUITY VALUES IN PERCENT - -------------------------------------------------------------------------------------------------- -20% -10% 0% 10% 20% - -------------------------------------------------------------------------------------------------- Market Value of the Equity Portfolio $ 53.8 $ 60.6 $ 67.3 $ 74.0 $ 80.8 After-tax Change in Unrealized Appreciation $ (8.8) $ (4.4) $ - $ 4.4 $ 8.8
Although not considered material in the context of the Company's aggregate exposure to market sensitive instruments, the Company has issued five specialized equity put options based on the Standard & Poor's 500 ("S&P 500") index that are market sensitive and sufficiently unique to warrant supplemental disclosure. The duration and nature of these specialized instruments are such that no active trading market exists. This was recognized at the time the transactions were entered into and was the principal rationale for the Company's use of a 61 probability weighted cash flow model for its analysis of the economics of these transactions, an approach quite similar to analytical models used throughout the Company's reinsurance business. As these specialized equity put options are derivatives within the framework of FAS No.133, the Company is required to report the fair value of these instruments in its balance sheet and record any changes to fair value in its statement of operations. The Company has recorded fair values for its obligations on these specialized equity put options at December 31, 2002 and December 31, 2001 of $22.4 million and $13.0 million, respectively; however, the Company does not believe that the ultimate settlement of these transactions is likely to require a payment that would exceed the initial consideration received or any payment at all. As there is no active market for these instruments, the determination of their fair value is based on an industry accepted option pricing model which requires estimates and assumptions, including those regarding volatility and expected rates of return. The table below estimates the impact of potential movements in interest rates and the S&P 500 index, which are the principal factors affecting fair value of these instruments, looking forward from the fair value at December 31, 2002. These are estimates and there can be no assurances regarding future market performance. AS OF DECEMBER 31, 2002 S & P 500 INDEX PUT OPTIONS OBLIGATION - SENSITIVITY ANALYSIS (Dollar amounts in millions)
Interest Rate Shift in Basis Points: -100 -50 0 50 100 ------------------------------------------------------------ Total Market Value $ 35.6 $ 28.3 $ 22.4 $ 17.6 $ 13.7 Market Value Change from Base (%) (59.0)% (26.5)% 0.0% 21.4% 38.6%
S & P Index Shift in Points: -200 -100 0 100 200 ------------------------------------------------------------ Total Market Value $ 32.6 $ 26.9 $ 22.4 $ 18.8 $ 15.9 Market Value Change from Base (%) (45.3)% (20.0)% 0.0% 16.1% 29.1%
Combined Interest Rate/S & P Index Shift: -100/-200 -50/-100 0/0 50/100 100/200 ------------------------------------------------------------ Total Market Value $ 49.5 $ 33.7 $ 22.4 $ 14.6 $ 9.4 Market Value Change from Base (%) (121.1)% (50.2)% 0.0% 34.7% 58.2%
62 AS OF DECEMBER 31, 2001 S & P 500 INDEX PUT OPTIONS OBLIGATION - SENSITIVITY ANALYSIS (Dollar amounts in millions)
Interest Rate Shift in Basis Points: -100 -50 0 50 100 ------------------------------------------------------------ Total Market Value $ 21.2 $ 16.4 $ 13.0 $ 9.7 $ 7.4 Market Value Change from Base (%) (62.5)% (26.2)% 0.0% 25.2% 43.0%
S & P Index Shift in Points: -200 -100 0 100 200 ------------------------------------------------------------ Total Market Value $ 17.2 $ 14.7 $ 13.0 $11.0 $ 9.6 Market Value Change from Base (%) (31.7)% (12.9)% 0.0% 15.4% 26.1%
Combined Interest Rate/S & P Index Shift: -100/-200 -50/-100 0/0 50/100 100/200 ------------------------------------------------------------ Total Market Value $ 27.7 $ 18.9 $ 13.0 $ 8.4 $ 5.7 Market Value Change from Base (%) (112.5)% (44.8)% 0.0% 35.7% 55.9%
SAFE HARBOR DISCLOSURE This report contains forward-looking statements within the meaning of the U.S. federal securities laws. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as "may", "will", "should", "could", "anticipate", "estimate", "expect", "plan", "believe", "predict", "potential" and "intend". Forward-looking statements contained in this report include information regarding the Company's reserves for losses and LAE, the adequacy of the Company's provision for uncollectible balances, estimates of the Company's catastrophe exposure, the effects of catastrophic events on the Company's financial statements, the ability of Everest Re, Holdings and Bermuda Re to pay dividends and the settlement costs of the Company's specialized equity put options. Forward-looking statements only reflect the Company's expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from the Company's expectations. Important factors that could cause actual events or results to be materially different from the Company's expectations include those discussed below under the caption "Risk Factors". The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. RISK FACTORS The following risk factors, in addition to the other information provided in this report, should be considered when evaluating the Company. If any of the following risks actually occur, the Company's business, financial condition or results of operations could be materially and adversely affected and the trading price of the Company's common shares could decline significantly. THE COMPANY'S RESULTS MAY FLUCTUATE AS A RESULT OF FACTORS GENERALLY AFFECTING THE INSURANCE AND REINSURANCE INDUSTRY. The results of companies in the insurance and reinsurance industry historically have been subject to significant fluctuations and uncertainties. Factors that 63 affect the industry in general could also cause the Company's results to fluctuate. The industry's profitability can be affected significantly by: o fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested capital and may impact the ultimate payout of loss amounts; o rising levels of actual costs that are not known by companies at the time they price their products; o volatile and unpredictable developments, including weather-related and other natural catastrophes; o events like the September 11, 2001 attacks, which affect the insurance and reinsurance markets generally; o changes in reserves resulting from different types of claims that may arise and the development of judicial interpretations relating to the scope of insurers' liability; and o the overall level of economic activity and the competitive environment in the industry. IF THE COMPANY'S LOSS RESERVES ARE INADEQUATE TO MEET ITS ACTUAL LOSSES, THE COMPANY'S NET INCOME WOULD BE REDUCED OR IT COULD INCUR A LOSS. The Company is required to maintain reserves to cover its estimated ultimate liability of losses and loss adjustment expenses for both reported and unreported claims incurred. These reserves are only estimates of what the Company thinks the settlement and administration of claims will cost based on facts and circumstances known to the Company. Because of the uncertainties that surround estimating loss reserves and loss adjustment expenses, the Company cannot be certain that ultimate losses will not exceed these estimates of losses and loss adjustment reserves. If the Company's reserves are insufficient to cover its actual losses and loss adjustment expenses, the Company would have to augment its reserves and incur a charge to its earnings. These charges could be material. The difficulty in estimating the Company's reserves is increased because the Company's loss reserves include reserves for potential asbestos and environmental liabilities. Asbestos and environmental liabilities are especially hard to estimate for many reasons, including the long waiting periods between exposure and manifestation of any bodily injury or property damage, difficulty in identifying the source of the asbestos or environmental contamination, long reporting delays and difficulty in properly allocating liability for the asbestos or environmental damage. THE COMPANY'S INABILITY TO ASSESS UNDERWRITING RISK ACCURATELY COULD REDUCE ITS NET INCOME. The Company's success is dependent on its ability to assess accurately the risks associated with the businesses on which the risk is retained. If the Company fails to assess accurately the risks it retains, the Company may fail to establish appropriate premium rates and the Company's reserves may be inadequate to cover its losses, requiring augmentation of the Company's reserves, which in turn, could reduce the Company's net income. 64 DECREASES IN RATES FOR PROPERTY AND CASUALTY REINSURANCE AND INSURANCE COULD REDUCE THE COMPANY'S NET INCOME. The Company primarily writes property and casualty reinsurance and insurance. The property and casualty industry historically has been highly cyclical. Rates for property and casualty reinsurance and insurance are influenced primarily by factors that are outside of the Company's control. Any significant decrease in the rates for property and casualty insurance or reinsurance could reduce the Company's net income. IF RATING AGENCIES DOWNGRADE THEIR RATINGS OF THE COMPANY'S INSURANCE COMPANY SUBSIDIARIES, THE COMPANY'S FUTURE PROSPECTS FOR GROWTH AND PROFITABILITY COULD BE SIGNIFICANTLY AND ADVERSELY AFFECTED. The Company's insurance company subsidiaries, other than Mt. McKinley and Everest International, currently hold an A+ ("Superior") financial strength rating from A.M. Best Company. Everest Re, Bermuda Re and Everest National hold an AA- ("Positve") financial strength rating from Standard & Poor's Ratings Services. Everest Re and Bermuda Re hold an Aa3 ("Excellent") financial strength rating from Moody's Investors Service, Inc. Financial strength ratings are used by insurers and reinsurance and insurance intermediaries as an important means of assessing the financial strength and quality of reinsurers. In addition, the rating of a company purchasing reinsurance may be adversely affected by an unfavorable rating or the lack of a rating of its reinsurer. A downgrade or withdrawal of any of these ratings might adversely affect the Company's ability to market its insurance products and would have a significant and adverse effect on its future prospects for growth and profitability. THE COMPANY'S REINSURERS MAY NOT SATISFY THEIR OBLIGATIONS. The Company is subject to credit risk with respect to its reinsurers because the transfer of risk to a reinsurer does not relieve the Company of its liability to the insured. In addition, reinsurers may be unwilling to pay the Company even though they are able to do so. The failure of one or more of the Company's reinsurers to honor their obligations in a timely fashion would impact the Company's cash flow and reduce its net income and could cause the Company to incur a significant loss. IF THE COMPANY IS UNABLE TO PURCHASE REINSURANCE AND TRANSFER RISK TO REINSURERS, ITS NET INCOME COULD BE REDUCED OR THE COMPANY COULD INCUR A LOSS. The Company attempts to limit its risk of loss by purchasing reinsurance to transfer a portion of the risks it assumes. The availability and cost of reinsurance is subject to market conditions, which are outside of the Company's control. As a result, the Company may not be able to successfully purchase reinsurance and transfer risk through reinsurance arrangements. A lack of available reinsurance might adversely affect the marketing of the Company's business and/or force the Company to retain all or a part of the risk that cannot be reinsured. If the Company were required to retain these risks and ultimately pay claims with respect to these risks, the Company's net income could be reduced or the Company could incur a loss. THE COMPANY'S INDUSTRY IS HIGHLY COMPETITIVE AND THE COMPANY MAY NOT BE ABLE TO COMPETE SUCCESSFULLY IN THE FUTURE. The Company's industry is highly competitive and has experienced significant price competition. The Company competes in the Bermuda, United States and international markets with domestic and international insurance companies. Some of these competitors have greater financial resources than the Company, have been operating for longer than the Company and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. In addition, the Company expects to face further competition in the future. The Company may not be able to compete successfully in the future. 65 THE COMPANY IS DEPENDENT ON ITS KEY PERSONNEL. The Company's success has been, and will continue to be, dependent on its ability to retain the services of its existing key executive officers and to attract and retain additional qualified personnel in the future. The loss of the services of any of its key executive officers or the inability to hire and retain other highly qualified personnel in the future could adversely affect the Company's ability to conduct its business. This dependency is particularly important for the Company's Bermuda operations where, under Bermuda law, non-Bermudians, other than spouses of Bermudians, are not permitted to engage in any gainful occupation in Bermuda without a work permit issued by the Bermuda government. A work permit is only granted or extended if the employer can show that, after proper public advertisement, no Bermudian or spouse of a Bermudian, is available who meets the minimum standards for the position. The Bermuda government has announced a policy that places a six-year term limit on individuals with work permits, subject to specified exemptions for persons deemed to be key employees. These restrictions make it difficult to hire and retain highly qualified personnel in Bermuda. If work permits are not obtained or renewed for the Company's key employees in Bermuda, the Company could lose their services, which could adversely affect the Company's ability to conduct its business. THE VALUE OF THE COMPANY'S INVESTMENT PORTFOLIO AND THE INVESTMENT INCOME IT RECEIVES FROM THAT PORTFOLIO COULD DECLINE AS A RESULT OF MARKET FLUCTUATIONS AND ECONOMIC CONDITIONS. A significant portion of the Company's investment portfolio consists of fixed income securities and a smaller portion consists of equity securities. Both the fair market value of these assets and the investment income from these assets fluctuate depending on general economic and market conditions. For example, the fair market value of the Company's fixed income securities generally increases or decreases in an inverse relationship with fluctuations in interest rates. The fair market value of the Company's fixed income securities can also decrease as a result of any downturn in the business cycle that causes the credit quality of those securities to deteriorate. The net investment income that the Company realizes from future investments in fixed income securities will generally increase or decrease with interest rates. Interest rate fluctuations can also cause net investment income from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, to differ from the income anticipated from those securities at the time the Company bought them. In addition, if issuers of individual investments are unable to meet their obligations, investment income will be reduced and realized capital losses may arise. Because all of the Company's securities are classified as available for sale, changes in the market value of the Company's securities are reflected in its financial statements. Similar treatment is not available for liabilities. As a result, a decline in the value of the securities in the Company's portfolio could reduce its net income or cause the Company to incur a loss. INSURANCE LAWS AND REGULATIONS RESTRICT THE COMPANY'S ABILITY TO OPERATE. The Company is subject to extensive regulation under U.S., state and foreign insurance laws. These laws limit the amount of dividends that can be paid to the Company by its operating subsidiaries, impose restrictions on the amount and type of investments that they can hold, prescribe solvency standards that must be met and maintained by them and require them to maintain reserves. These laws also require disclosure of material intercompany transactions and require prior approval of certain "extraordinary" transactions. These "extraordinary" transactions include declaring dividends from operating subsidiaries that exceed statutory thresholds. These laws also generally require approval of changes of control. The Company's failure to comply with these laws could subject it to 66 fines and penalties and restrict it from conducting business. The application of these laws could affect the Company's liquidity and ability to pay dividends on its common shares and could restrict the Company's ability to expand its business operations through acquisitions involving the Company's insurance subsidiaries. FAILURE TO COMPLY WITH INSURANCE LAWS AND REGULATIONS COULD HAVE A MATERIAL ADVERSE EFFECT ON THE COMPANY'S BUSINESS. The Company may not have all required licenses and approvals or may not comply with the wide variety of applicable laws and regulations or the relevant authorities' interpretation of the laws and regulations. If the Company does not have the requisite licenses and approvals or does not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend the Company from carrying on some or all of its activities or monetarily penalize the Company. These types of actions could have a material adverse effect on the Company's business. THE COMPANY'S HOLDING COMPANY STRUCTURE COULD PREVENT IT FROM PAYING DIVIDENDS ON ITS COMMON SHARES. Group is a holding company whose most significant assets consist of the stock of its operating subsidiaries. Thus, Group's ability to pay dividends on its common shares in the future may be dependent on the earnings and cash flows of its subsidiaries and the ability of the subsidiaries to pay dividends or to advance or repay funds to Group. This ability is subject to general economic, financial, competitive, regulatory and other factors beyond the Company's control. Payment of dividends and advances and repayments from some of Group's operating subsidiaries are regulated by U.S., state and foreign insurance laws and regulatory restrictions, including minimum solvency and liquidity thresholds. Accordingly, Group's operating subsidiaries may not be able to pay dividends or advance or repay funds to Group in the future, which could prevent the Company from paying dividends or making other payments or distributions on its securities. THE COMPANY MAY EXPERIENCE EXCHANGE LOSSES IF IT DOES NOT MANAGE ITS FOREIGN CURRENCY EXPOSURE PROPERLY. The Company's functional currency is the United States dollar. However, the Company writes a portion of its business and receives a portion of its premiums in currencies other than United States dollars. The Company also maintains a portion of its investment portfolio in investments denominated in currencies other than United States dollars. Consequently, the Company may experience exchange losses if its foreign currency exposure is not properly managed or otherwise hedged. If the Company seeks to hedge its foreign currency exposure by using forward foreign currency exchange contracts or currency swaps, the Company will be subject to the risk that the counter parties to those arrangements will fail to perform, or that those arrangements will not precisely offset the Company's exposure. IF U.S. TAX LAW CHANGES, THE COMPANY'S NET INCOME MAY BE REDUCED. In the last few years, some members of Congress have expressed concern about U.S. corporations that move their place of incorporation to low-tax jurisdictions. Also, some members of Congress have expressed concern over a competitive advantage that foreign-controlled insurers and reinsurers may have over U.S. controlled insurers and reinsurers due to the purchase of reinsurance by U.S. insurers from affiliates operating in some foreign jurisdictions, including Bermuda. Legislation has recently been proposed in Congress that would increase the U.S. tax burden on so-called "inverting" companies and increase the 67 U.S. tax burden on related-party reinsurance transactions. The Company does not know whether this legislation or any similar legislation will ever be enacted into law. If it were enacted, the U.S. tax burden on the Company's Bermuda operations, or on some business ceded from its licensed U.S. subsidiaries to some offshore reinsurers, could be increased. This could reduce the Company's net income. GROUP AND/OR BERMUDA RE MAY BE SUBJECT TO U.S. CORPORATE INCOME TAX, WHICH WOULD REDUCE THE COMPANY'S NET INCOME. The income of Bermuda Re is a significant portion of the Company's worldwide income from operations. The Company has established guidelines for the conduct of its Bermuda operations that are designed to ensure that Bermuda Re is not engaged in the conduct of a trade or business in the United States. Based on its compliance with those guidelines, the Company believes that Bermuda Re should not be required to pay U.S. corporate income tax, other than withholding tax on U.S. source dividend income. However, if the IRS successfully contended that Bermuda Re was engaged in a trade or business in the United States, Bermuda Re would be required to pay U.S. corporate income tax on any income that is subject to the taxing jurisdiction of the United States, and possibly the U.S. branch profits tax. Even if the IRS successfully contended that Bermuda Re was engaged in a U.S. trade or business, the U.S.-Bermuda tax treaty would preclude the IRS from taxing Bermuda Re's income except to the extent that its income were attributable to a permanent establishment maintained by that subsidiary. The Company does not believe that Bermuda Re has a permanent establishment in the United States. If the IRS successfully contended that Bermuda Re did have income attributable to a permanent establishment in the United States, it would be subject to U.S. tax on that income. The Company believes it qualifies for benefits under the U.S.-Barbados tax treaty. Based on the Company's compliance with guidelines designed to ensure that it generates only immaterial amounts, if any, of income that is subject to the taxing jurisdiction of the United States, the Company believes that it should be required to pay only immaterial amounts, if any, of U.S. corporate income tax, other than withholding tax on U.S. source dividend income. However, if the IRS successfully contended that the Company had material amounts of income that is subject to the taxing jurisdiction of the United States, the Company would be required to pay U.S. corporate income tax on that income, and possibly the U.S. branch profits tax. Even if the IRS successfully contended that the Company had material amounts of income that is subject to the taxing jurisdiction of the United States, the U.S.-Barbados tax treaty would preclude the IRS from taxing the Company's income, except to the extent that its income were attributable to a permanent establishment maintained in the United States. The Company does not believe that it has material amounts of income attributable to a permanent establishment in the United States. If the IRS successfully contended, however, that the Company did have income attributable to a permanent establishment in the United States, the Company would be subject to U.S. tax on that income. If Bermuda Re became subject to U.S. income tax on its income or if the Company became subject to U.S. income tax on more than immaterial amounts of income, the Company's income could also be subject to the U.S. branch profits tax. In that event, Group and Bermuda Re would be subject to taxation at a higher combined effective rate than if they were organized as U.S. corporations. The combined effect of the 35% U.S. corporate income tax rate and the 30% branch profits tax rate is a net tax rate of 54.5%. The imposition of these taxes would reduce the Company's net income. 68 HOLDERS OF THE COMPANY'S COMMON SHARES COULD BE SUBJECT TO U.S. TAXES ON UNDISTRIBUTED INCOME OF GROUP AND/OR BERMUDA RE. U.S. holders of common shares generally will not be subject to any U.S. tax until they receive a distribution from Group or dispose of their common shares. However, special provisions of the U.S. Internal Revenue Code of 1986, which the Company refers to in this document as the Code, may apply to U.S. taxpayers who directly, indirectly or by attribution own 10% or more of the total combined voting power of all classes of share capital of Group and/or Bermuda Re. Under these provisions, those taxpayers generally will be required to include in their income their pro rata share of the income of Group and/or Bermuda Re as earned, even if not distributed. The Company has attempted to avoid having its shareholders become subject to these provisions by including in Group's by-laws provisions that limit the ownership of the common shares to levels that will not subject U.S. shareholders to U.S. tax on undistributed income under these provisions. Based on these bye-laws, the Company believes that its shareholders should not be subject to U.S. tax on undistributed income. In addition, special provisions of the Code apply to U.S. persons who are shareholders of a foreign insurance company and have related person insurance income allocated to them. Related person insurance income, often called RPII, is investment income and premium income derived from the direct or indirect insurance or reinsurance of the risk of: o any U.S. tax payer who directly or indirectly through foreign entities owns shares of a foreign insurance company; or o any person related to a U.S. taxpayer meeting the above definition. The RPII provisions of the Code could apply to U.S. taxpayers who directly, indirectly or by attribution own any shares of Bermuda Re if: o 25% or more of the value or voting power of the share capital of Bermuda Re is owned directly, indirectly or by attribution by U.S. taxpayers; o 20% or more of the value or voting power of the share capital of Bermuda Re is owned directly, indirectly or by attribution by U.S. taxpayers, or persons related to U.S. taxpayers, who are insured or reinsured by Bermuda Re; and o Bermuda Re has gross RPII equal to 20% or more of its gross insurance income. The Company currently believes that less than 20% of the value or voting power of the share capital of Bermuda Re is owned directly, indirectly or by attribution by U.S. taxpayers insured or reinsured by it or persons related to those taxpayers, and/or that less than 20% of the gross insurance income of Bermuda Re for any taxable year will constitute RPII. However, if neither of these conditions is satisfied, since the Company's U.S. shareholders are treated by the Code as indirectly owning shares of Bermuda Re, they will be required to include in their income their pro rata share of Bermuda Re's RPII as earned, even if not distributed. GAINS RESULTING FROM THE SALE OF THE COMPANY'S COMMON SHARES BY U.S. SHAREHOLDERS COULD BE TAXED IN THE U.S. AS DIVIDENDS. Generally, a U.S. shareholder will realize capital gain or loss on the sale or exchange of the common shares. However, the IRS could contend that special provisions of the Code apply and that the amount of any gain equal to the 69 Company's allocable untaxed earnings and profits should be taxed as a dividend. If the IRS successfully contended that those provisions apply to the Company, shareholders would be taxed on that amount of gain at the rates applicable to ordinary income rather than the lower rates applicable to long-term capital gains. Assuming that none of the Company's non- U.S. subsidiaries have any RPII, the Company believes that these provisions of the Code should not apply to the disposition of any common shares by a U.S. shareholder who holds less than 10% of the outstanding common shares. THE ORGANIZATION FOR ECONOMIC COOPERATION AND DEVELOPMENT AND THE EUROPEAN UNION ARE CONSIDERING MEASURES THAT MIGHT INCREASE THE COMPANY'S TAXES AND REDUCE ITS NET INCOME. A number of multinational organizations, including the Organization for Economic Cooperation and Development ("OECD"), the European Union, the Financial Action Task Force and the Financial Stability Forum have all recently identified some countries as not participating in adequate information exchange, engaging in harmful tax practices or maintaining adequate controls to prevent corruption, such as money laundering activities. The OECD has threatened non-member jurisdictions that do not agree to cooperate with the OECD with punitive sanctions by OECD member countries, though specific sanctions have yet to be adopted by OECD member countries. It is as yet unclear as to what these sanctions will be, who will adopt them and when or if they will be imposed. On April 18, 2002, the OECD published a list of "uncooperative tax havens," which are those jurisdictions from whom the OECD has not received commitments to the OECD's principles of regulatory and tax transparency and effective exchange information. The governments of both Bermuda and Barbados have made these commitments. As a result, neither Bermuda nor Barbados was listed as an uncooperative tax haven. GROUP AND/OR BERMUDA RE MAY BECOME SUBJECT TO BERMUDA TAX, WHICH WOULD REDUCE THE COMPANY'S NET INCOME. Group and Bermuda Re currently are not subject to income or capital gains taxes in Bermuda. Both companies have received an assurance from the Bermuda Minister of Finance under The Exempted Undertakings Tax Protection Act 1966 of Bermuda to the effect that if any legislation is enacted in Bermuda that imposes any tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then that tax will not apply to them or to any of their operations or their shares, debentures or other obligations until March 28, 2016. This assurance does not prevent the application of any of those taxes to persons ordinarily resident in Bermuda and does not prevent the imposition of any tax payable in accordance with the provisions of The Land Tax Act of 1967 of Bermuda or otherwise payable in relation to any property leased to the Company. There are currently no procedures for extending these assurances. As a result, Group and Bermuda Re could be subject to taxes in Bermuda after March 28, 2016, which could reduce the Company's net income. GROUP MAY BECOME SUBJECT TO BARBADOS TAX, WHICH WOULD REDUCE THE COMPANY'S NET INCOME. Group has obtained an international business company license under the Barbados International Business Companies Act, 1991-24. Based on this license, Group is entitled to special tax benefits, including a preferred rate of tax on profits and gains and an exemption from withholding tax in respect of any dividends, interest, royalties, fees or management fees deemed to be paid to another international business company or to a person not resident in Barbados. Group has also obtained from the Ministry of Economic Development a fifteen year 70 guarantee in accordance with Section 27 of the International Business Companies Act with respect to its continued eligibility for this preferred status. This guarantee is applicable until 2014 and is subject to negative resolution, which means that this guarantee can be revoked at any time. In addition, there are currently no procedures for extending this guarantee. As a result, Group could be ineligible for these benefits after that period, which could reduce the Company's net income. THE COMPANY'S NET INCOME WILL BE REDUCED IF U.S. EXCISE AND WITHHOLDING TAXES ARE INCREASED. Bermuda Re is subject to an excise tax on reinsurance and insurance premiums it collects with respect to risks located in the United States. In addition, Bermuda Re may be subject to withholding tax on dividend income from United States sources. These taxes could increase and other taxes could be imposed in the future on Bermuda Re's business, which could reduce the Company's net income. REGULATORY CHALLENGES IN THE UNITED STATES COULD ADVERSELY AFFECT THE ABILITY OF BERMUDA RE TO CONDUCT BUSINESS. Bermuda Re does not intend to be licensed or admitted as an insurer or reinsurer in any U.S. jurisdiction. Under current law, Bermuda Re generally is permitted to reinsure U.S. risks from its office in Bermuda without obtaining those licenses. However, the insurance and reinsurance regulatory framework has become subject to increased scrutiny. In the past, there have been congressional and other initiatives in the United States regarding increased supervision and regulation of the insurance industry, including proposals to supervise and regulate reinsurers domiciled outside the United States. If Bermuda Re were to become subject to any insurance laws of the United States or any U.S. state at any time in the future, it might be required to post deposits or maintain minimum surplus levels and might be prohibited from engaging in lines of business or from writing types of policies. Complying with those laws could have a material adverse effect on the Company's ability to conduct business in the Bermuda market. BERMUDA RE MAY NEED TO BE LICENSED OR ADMITTED IN ADDITIONAL JURISDICTIONS TO DEVELOP ITS BUSINESS. As Bermuda Re's business develops, it will monitor the need to obtain licenses in jurisdictions other than Bermuda in order to comply with applicable law or to be able to engage in additional insurance-related activities. In addition, Bermuda Re may be at a competitive disadvantage in jurisdictions where it is not licensed or does not enjoy an exemption from licensing relative to competitors that are so licensed or exempted from licensing. Bermuda Re may not be able to obtain any additional licenses that it determines are necessary or desirable. Furthermore, the process of obtaining those licenses is often costly and may take a long time. BERMUDA RE'S ABILITY TO WRITE REINSURANCE MAY BE SEVERELY LIMITED IF IT IS UNABLE TO ARRANGE FOR SECURITY TO BACK ITS REINSURANCE. Many jurisdictions do not permit insurance companies to take credit for reinsurance obtained from unlicensed or non-admitted insurers on their statutory financial statements without appropriate security. Bermuda Re's reinsurance clients generally require it to post a letter of credit or enter into other security arrangements. If Bermuda Re is unable to obtain or maintain a letter of credit facility on commercially acceptable terms or unable to arrange for other types of security, its ability to operate its business may be severely limited. If Bermuda Re defaults on any letter of credit that it obtains, it may be required to prematurely liquidate a substantial portion of its investment portfolio and other assets pledged as collateral. 71 SECURITY HOLDERS MAY NOT BE ABLE TO RECOVER DAMAGES FROM THE COMPANY AND SOME OF ITS DIRECTORS, OFFICERS AND EXPERTS NAMED IN THIS REPORT. The Company is organized under the laws of Bermuda. Some of its directors and officers, as well as some of the experts named in this report, may reside outside the United States. A substantial portion of the Company's and their assets are or may be located in jurisdictions outside the United States. Security holders may not be able to effect service of process within the United States on directors and officers of the Company and those experts who reside outside the United States. Security holders also may not be able to recover against them or the Company on judgments of U.S. courts or to obtain original judgments against them or the Company in Bermuda courts, including judgments predicated upon civil liability provisions of the U.S. federal securities laws. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Market Sensitive Instruments" in ITEM 7. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and schedules listed in the accompanying Index to Financial Statements and Schedules on page F-1 are filed as part of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Reference is made to the sections captioned "Election of Directors", "Information Concerning Nominees", "Information Concerning Continuing Directors and Executive Officers" and "Compliance with Section 16(a) of the Exchange Act" in the Company's proxy statement for the 2003 Annual General Meeting of Shareholders, which will be filed with the Commission within 120 days of the close of the Company's fiscal year ended December 31, 2002 (the "Proxy Statement"), which sections are incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Reference is made to the sections captioned "Directors' Compensation" and "Compensation of Executive Officers" in the Proxy Statement, which are incorporated herein by reference, except that the Compensation Committee Report and the Performance Graph are not so incorporated. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS Reference is made to the sections captioned "Common Share Ownership by Directors and Executive Officers", "Principal Holders of Common Shares" and "Equity Compensation Plans" in the Proxy Statement, which are incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the section captioned "Certain Transactions with Directors" in the Proxy Statement, which is incorporated herein by reference. 72 ITEM 14. CONTROLS AND PROCEDURES Within the 90-day period prior to the filing of this report, an evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the disclosure controls and procedures (as defined in Rule 13a-14I under the Securities Exchange Act of 1934). Based on their evaluation, the Chief Executive Officer and Chief Financial Officer believe that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of their evaluation, there were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls, including any corrective actions with regard to significant deficiencies and material weaknesses. PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS AND SCHEDULES The financial statements and schedules listed in the accompanying Index to Financial Statements and Schedules on page F-1 are filed as part of this report. EXHIBITS The exhibits listed on the accompanying Index to Exhibits on page E-1 are filed as part of this report. REPORTS ON FORM 8-K A report on Form 8-K dated February 20, 2003 was filed on February 20, 2003 reporting an increase in the Company's quarterly dividend and declared a dividend. 73 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 on March 14, 2003. EVEREST RE GROUP, LTD. By: /s/ JOSEPH V. TARANTO ------------------------------------- Joseph V. Taranto (Chairman and Chief Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ JOSEPH V. TARANTO Chairman and Chief Executive March 14, 2003 - --------------------- Officer and Director (Principal Joseph V. Taranto Executive Officer) /s/ STEPHEN L. LIMAURO Executive Vice President and March 14, 2003 - ---------------------- Chief Financial Officer (Principal Stephen L. Limauro Financial Officer) /s/ KEITH T. SHOEMAKER Comptroller (Principal Accounting March 14, 2003 - ---------------------- Officer) Keith T. Shoemaker /s/ MARTIN ABRAHAMS Director March 14, 2003 - ------------------- Martin Abrahams /s/ KENNETH J. DUFFY Director March 14, 2003 - -------------------- Kenneth J. Duffy /s/ JOHN R. DUNNE Director March 14, 2003 - ----------------- John R. Dunne /s/ THOMAS J. GALLAGHER Director March 14, 2003 - ----------------------- Thomas J. Gallagher /s/ WILLIAM F. GALTNEY, JR. Director March 14, 2003 - --------------------------- William F. Galtney, Jr. 74 I, Joseph V. Taranto, certify that: 1. I have reviewed this annual report on Form 10-K of Everest Re Group, Ltd; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual 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-14 and 15d-14) for the registrant and we have; a. designed such disclosure controls and procedures 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 annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. March 17, 2003 /s/ JOSEPH V. TARANTO - -------------- ----------------------- Joseph V. Taranto Chairman and Chief Executive Officer I, Stephen L. Limauro, certify that: 1. I have reviewed this annual report on Form 10-K of Everest Re Group, Ltd; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual 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 annual 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-14 and 15d-14) for the registrant and we have; a. designed such disclosure controls and procedures 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 annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. March 17, 2003 /s/ STEPHEN L. LIMAURO - -------------- --------------------------- Stephen L. Limauro Executive Vice President and Chief Financial Officer INDEX TO EXHIBITS EXHIBIT NO. PAGE - ----------- ---- 2.1 Agreement and Plan of Merger among Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd. and Everest Re Merger Corporation, incorporated herein by reference to Exhibit 2.1 to the Registration Statement on Form S-4 (No. 333-87361) 3.1 Memorandum of Association of Everest Re Group, Ltd., incorporated herein by reference to Exhibit 3.1 to the Registration Statement on Form S-4 (No. 333-87361) 3.2 By-Laws of Everest Re Group, Ltd., incorporated herein by reference to Exhibit 3.2 to the Everest Re Group, Ltd. Annual Report on Form 10-K for the year ended December 31, 1999 (the "1999 10-K") 4.1 Specimen Everest Re Group, Ltd. Common share certificate, incorporated herein by reference to Exhibit 4.1 of the Registration Statement on Form S-4 (No. 333-87361) 4.2 Indenture, dated March 14, 2000, between Everest Reinsurance Holdings, Inc. and The Chase Manhattan Bank, as Trustee, incorporated herein by reference to Exhibit 4.1 to Everest Reinsurance Holdings, Inc. Form 8-K filed on March 15, 2000 4.3 First Supplemental Indenture relating to the 8.5% Senior Notes due March 15, 2005, dated March 14, 2000, between Everest Reinsurance Holdings, Inc. and The Chase Manhattan Bank, as Trustee, incorporated herein by reference to Exhibit 4.2 to Everest Reinsurance Holdings, Inc. Form 8-K filed on March 15, 2000 4.4 Second Supplemental Indenture relating to the 8.75% Senior Notes due March 15, 2010, dated March 14, 2000, between Everest Reinsurance Holdings, Inc. and The Chase Manhattan Bank, as Trustee, incorporated herein by reference to Exhibit 4.3 to the Everest Reinsurance Holdings, Inc. Form 8-K filed on March 15, 2000 *10.1 Everest Re Group, Ltd. Annual Incentive Plan effective January 1, 1999, incorporated herein by reference to Exhibit 10.1 to Everest Reinsurance Holdings, Inc. Annual Report on Form 10-K for the year ended December 31, 1998 (the "1998 10-K") E-1 *10.2 Everest Re Group, Ltd. Amended 1995 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.3 to Everest Reinsurance Holdings, Inc. Annual Report on Form 10-K for the year ended December 31, 1995 (the "1995 10-K") *10.3 Everest Re Group, Ltd. 1995 Stock Option Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 4.3 to the Registration Statement on Form S-8 (No. 333-05771) *10.4 Resolution adopted by Board of Directors of Everest Reinsurance Holdings, Inc. on April 1, 1999 awarding stock options to outside Directors, incorporated herein by reference to Exhibit 10.25 to Everest Reinsurance Holdings, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 1999 (the "second quarter 1999 10-Q") *10.5 Resolution adopted by the Board of Directors of Everest Reinsurance Holdings, Inc. on February 23, 2000 awarding stock options to outside Directors, incorporated herein by reference to Exhibit 10.8 to the 1999 10-K *10.6 Form of Non-Qualified Stock Option Award Agreement to be entered into between Everest Re Group, Ltd. and participants in the 1995 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.15 to the 1995 10-K *10.7 Form of Restricted Stock Agreement to be entered into between Everest Re Group, Ltd. and participants in the 1995 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.16 to the 1995 10-K *10.8 Form of Stock Option Agreement (Version 1) to be entered into between Everest Re Group, Ltd. and participants in the 1995 Stock Option Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 10.17 to the 1995 10-K *10.9 Form of Stock Option Agreement (Version 2) to be entered into between Everest Re Group, Ltd. and participants in the 1995 Stock Option Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 10.18 to the 1995 10-K *10.10 Form of Stock Option Agreement for Non-Employee Directors, incorporated herein by reference to Exhibit 10.34 to the 1999 10-K *10.11 Deferred Compensation Plan, as amended, for certain United States employees of Everest Re Group, Ltd. and its participating subsidiaries incorporated herein by reference to Exhibit 10.20 to the 1998 10-K E-2 *10.12 Senior Executive Change of Control Plan, incorporated herein by reference to Exhibit 10.24 to Everest Reinsurance Holdings, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 *10.13 Executive Performance Annual Incentive Plan adopted by stockholders on May 20, 1999, incorporated herein by reference to Exhibit 10.26 to the second quarter 1999 10-Q *10.14 Employment Agreement with Joseph V. Taranto executed on July 15, 1998, incorporated herein by reference to Exhibit 10.21 to Everest Reinsurance Holdings, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (the "second quarter 1998 10-Q") *10.15 Amendment of Employment Agreement by and among Everest Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd. and Joseph V. Taranto dated February 15, 2000, incorporated herein by reference to Exhibit 10.29 to the 1999 10-K *10.16 Change of Control Agreement with Joseph V. Taranto effective July 15, 1998, incorporated herein by reference to Exhibit 10.22 to the second quarter 1998 10-Q *10.17 Amendment of Change of Control Agreement by and among Everest Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd. and Joseph V. Taranto dated February 15, 2000, incorporated herein by reference to Exhibit 10.30 to the 1999 10-K 10.18 Credit Agreement Between Everest Reinsurance Holdings, Inc., the Lenders Named Therein and First Union National Bank dated December 21, 1999 providing for a $150 million Senior Revolving Credit Facility, incorporated herein by reference to Exhibit 10.30 to Everest Reinsurance Holdings, Inc. Form 8-K, filed on December 28, 1999 10.19 First Amendment to Credit Agreement dated as of December 21, 1999 between Everest Reinsurance Holdings, Inc., the Lenders named therein and First Union National Bank, incorporated herein by reference to Exhibit 10.19 to the Everest Re Group, Ltd. Annual Report on Form 10-K for the year ended December 31, 2000 (the "2000 10-K") 10.20 Parent Guaranty dated February 24, 2000 made by Everest Re Group, Ltd. in favor of the Lenders under Everest Reinsurance Holdings, Inc.'s Credit Facility, incorporated herein by reference to Exhibit 10.33 to the 1999 10-K E-3 10.21 Guarantor Consent dated December 18, 2000 made by Everest Re Group, Ltd. in favor of the Lenders under Everest Reinsurance Holdings, Inc.'s Credit Facility, incorporated herein by reference to Exhibit 10.21 to the 2000 10-K 10.22 Stock Purchase Agreement between The Prudential Insurance Company of America and Everest Reinsurance Holdings, Inc. for the sale of common stock of Gibraltar Casualty Company dated February 24, 2000, incorporated herein by reference to Exhibit 10.32 to the 1999 10-K 10.23 Amendment No. 1 to Stock Purchase Agreement between The Prudential Insurance Company of America and Everest Reinsurance Holdings, Inc. for the sale of common stock of Gibraltar Casualty Company dated August 8, 2000, incorporated herein by reference to Exhibit 10.1 to the Everest Re Group, Ltd. Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 10.24 Proportional Excess of Loss Reinsurance Agreement entered into between Gibraltar Casualty Company and Prudential Property and Casualty Insurance Company, incorporated herein by reference to Exhibit 10.24 to the 2000 10-K 10.25 Guarantee Agreement made by The Prudential Insurance Company of America in favor of Gibraltar Casualty Company, incorporated herein by reference to Exhibit 10.25 to the 2000 10-K 10.26 Lease, effective December 26, 2000 between OTR, an Ohio general partnership, and Everest Reinsurance Company, incorporated herein by reference to Exhibit 10.26 to the 2000 10-K *10.27 Amendment of Employment Agreement by and among Everest Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd., Everest Global Services, Inc. and Joseph V. Taranto, dated March 30, 2001, incorporated herein by reference to Exhibit 10.1 to Everest Re Group, Ltd. Report on Form 10-Q for the quarter ended March 31, 2001 (the "first quarter 2001 10-Q") *10.28 Amendment of Employment Agreement by and among Everest Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd., Everest Global Services, Inc. and Joseph V. Taranto, dated April 20, 2001, incorporated herein by reference to Exhibit 10.2 to the first quarter 2001 10-Q. E-4 *10.29 Amendment of Change of Control Agreement by and among Everest Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd., Everest Global Services, Inc. and Joseph V. Taranto, dated March 30, 2001, incorporated herein by reference to Exhibit 10.3 to the first quarter 2001 10-Q *10.30 Resolution adopted by the Board of Directors of Everest Re Group, Ltd. on September 20, 2001 awarding stock options to outside Directors, incorporated herein by reference to Exhibit 10.30 to Everest Re Group, Ltd. Report on Form 10-K for the year ended December 31, 2001 (the "2001 10-K") 10.31 Second Amendment to Credit Agreement dated as of November 21, 2002 between Everest Reinsurance Holdings, Inc., the Lenders named therein and Wachovia Bank, National Association (formerly known as First Union National Bank), filed herewith *10.32 Employment Agreement executed on April 15, 2002, between Peter J. Bennett and Everest Reinsurance (Bermuda), Ltd., filed herewith *10.33 Special Employment Agreement executed on March 22, 2002, between Janet J. Burak and Everest Global Services, Inc., filed herewith *10.34 Everest Re Group, Ltd. 2002 Stock Incentive Plan, incorporated herein by reference to Appendix A to Everest Re Group, Ltd. Proxy Statement in connection with the Annual General Meeting of Shareholders on May 22, 2002 11.1 Statement regarding computation of per share earnings, filed herewith 21.1 Subsidiaries of the registrant, filed herewith 23.1 Consent of PricewaterhouseCoopers LLP, filed herewith 99.1 Certification of Chief Executive Officer and Chief Financial Officer, filed herewith - -------------------------- * Management contract or compensatory plan or arrangement. E-5 INDEX TO FINANCIAL STATEMENTS AND SCHEDULES Pages Everest Re Group, Ltd. Report of Independent Accountants on Financial Statements and Schedules F-2 --- Consolidated Balance Sheets at December 31, 2002 and 2001 F-3 --- Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2002, 2001 and 2000 F-4 --- Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2002, 2001 and 2000 F-5 --- Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 F-6 --- Notes to Consolidated Financial Statements F-7 --- Schedules I Summary of Investments Other Than Investments in Related Parties at December 31, 2002 S-1 --- II Condensed Financial Information of Registrant: Balance Sheets as of December 31, 2002 and 2001 S-2 --- Statements of Operations for the Years Ended December 31, 2002, 2001 and 2000 S-3 --- Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000 S-4 --- III Supplementary Insurance Information as of December 31, 2002 and 2001 and for the years ended December 31, 2002, 2001 and 2000 S-5 --- IV Reinsurance for the years ended December 31, 2002, 2001 and 2000 S-6 --- Schedules other than those listed above are omitted for the reason that they are not applicable or the information is otherwise contained in the Financial Statements. F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Everest Re Group, Ltd. In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Everest Re Group, Ltd. and its subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP New York, New York February 6, 2003 F-2 EVEREST RE GROUP, LTD. CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except par value per share)
December 31, December 31, ------------ ------------ 2002 2001 ------------ ------------ ASSETS: Fixed maturities - available for sale, at market value (amortized cost: 2002, $6,460,839; 2001, $5,288,860) $ 6,779,858 $ 5,461,584 Equity securities, at market value (cost: 2002, $56,841; 2001, $66,357) 47,473 67,311 Short-term investments 169,116 148,851 Other invested assets 53,856 33,899 Cash 208,830 71,878 ------------ ------------ Total investments and cash 7,259,133 5,783,523 Accrued investment income 85,959 83,088 Premiums receivable 673,377 468,897 Reinsurance receivables 1,116,362 895,061 Funds held by reinsureds 121,308 149,969 Deferred acquisition costs 207,416 130,709 Prepaid reinsurance premiums 63,437 47,185 Deferred tax asset 139,176 178,507 Other assets 198,435 59,221 ------------ ------------ TOTAL ASSETS $ 9,864,603 $ 7,796,160 ============ ============ LIABILITIES: Reserve for losses and adjustment expenses $ 4,905,582 $ 4,278,267 Future policy benefit reserve 227,925 238,753 Unearned premium reserve 872,340 489,171 Funds held under reinsurance treaties 347,360 267,105 Losses in the course of payment 45,511 89,492 Contingent commissions 1,932 2,119 Other net payable to reinsurers 61,244 66,462 Current federal income taxes (16,696) (30,459) 8.5% Senior notes due 3/15/2005 249,780 249,694 8.75% Senior notes due 3/15/2010 199,158 199,077 Revolving credit agreement borrowings 70,000 105,000 Accrued interest on debt and borrowings 13,481 11,944 Other liabilities 308,340 109,013 ------------ ------------ Total liabilities 7,285,957 6,075,638 ------------ ------------ Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely subordinated debentures ("trust preferred securities") 210,000 - ------------ ------------ SHAREHOLDERS' EQUITY: Preferred shares, par value: $0.01; 50 million shares authorized; no shares issued and outstanding - - Common shares, par value: $0.01; 200 million shares authorized; 50.9 million shares issued in 2002 and 46.3 million shares issued in 2001 513 463 Additional paid-in capital 618,521 269,945 Unearned compensation (340) (115) Accumulated other comprehensive income, net of deferred income taxes of $74.4 million in 2002 and $40.8 million in 2001 221,542 113,880 Retained earnings 1,551,360 1,336,404 Treasury shares, at cost; 0.5 million shares in 2002 and 0.0 million shares in 2001 (22,950) (55) ------------ ------------ Total shareholders' equity 2,368,646 1,720,522 ------------ ------------ TOTAL LIABILITIES, TRUST PREFERRED SECURTIES AND SHAREHOLDERS' EQUITY $ 9,864,603 $ 7,796,160 ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-3 EVEREST RE GROUP, LTD. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (Dollars in thousands, except per share amounts)
Years Ended December 31, -------------------------------------------------------- 2002 2001 2000 ------------ ------------- ------------ REVENUES: Premiums earned $ 2,273,677 $ 1,467,477 $ 1,174,183 Net investment income 350,603 340,441 301,493 Net realized capital (loss) gain (50,043) (22,313) 807 Net derivative (expense) (14,509) (12,218) - Other (expense) income (2,091) 28,158 3,341 ------------ ------------- ------------ 2,557,637 1,801,545 1,479,824 ------------ ------------- ------------ CLAIMS AND EXPENSES: Incurred losses and loss adjustment expenses 1,629,382 1,209,517 884,616 Commission, brokerage, taxes and fees 551,787 396,797 272,447 Other underwriting expenses 69,916 58,884 51,633 Distribuitions related to trust preferred securities 2,091 - - Interest expense on senior notes 38,916 38,903 30,896 Interest expense on credit facility 3,501 7,101 8,490 ------------- ------------- ------------ 2,295,593 1,711,202 1,248,082 ------------- ------------- ------------ INCOME BEFORE TAXES 262,044 90,343 231,742 Income tax expense (benefit) 30,741 (8,675) 45,362 ------------- ------------- ------------ NET INCOME $ 231,303 $ 99,018 $ 186,380 ============= ============= ============ Other comprehensive income, net of tax 107,662 41,034 89,547 ------------- ------------- ------------ COMPREHENSIVE INCOME $ 338,965 $ 140,052 $ 275,927 ============= ============= ============ PER SHARE DATA: Average shares outstanding (000's) 50,325 46,174 45,873 Net income per common share - basic $ 4.60 $ 2.14 $ 4.06 ============= ============= ============ Average diluted shares outstanding (000's) 51,139 47,114 46,358 Net income per common share - diluted $ 4.52 $ 2.10 $ 4.02 ============= ============= ============
The accompanying notes are an integral part of the consolidated financial statements. F-4 EVEREST RE GROUP, LTD. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Dollars in thousands, except per share amounts)
Years Ended December 31, ---------------------------------------------------- 2002 2001 2000 ------------ ------------ ------------ COMMON SHARES (shares outstanding): Balance, beginning of period 46,269,015 46,029,354 46,457,817 Issued during the period 5,062,678 239,661 220,157 Treasury shares acquired during the period (450,000) - (650,400) Treasury shares reissued during the period - - 1,780 ------------ ------------ ------------ Balance, end of period 50,881,693 46,269,015 46,029,354 ============ ============ ============ COMMON SHARES (par value): Balance, beginning of period $ 463 $ 460 $ 509 Retirement of common shares during the period - - (51) Issued during the period 50 3 2 ------------ ------------ ------------ Balance, end of period 513 463 460 ------------ ------------ ------------ ADDITIONAL PAID IN CAPITAL: Balance, beginning of period 269,945 259,958 390,912 Retirement of treasury shares during the period - - (138,546) Common shares issued during the period 348,576 9,987 7,594 Treasury shares reissued during period - - (2) ------------ ------------ ------------ Balance, end of period 618,521 269,945 259,958 ------------ ------------ ------------ UNEARNED COMPENSATION: Balance, beginning of period (115) (170) (109) Net (decrease) increase during the period (225) 55 (61) ------------ ------------ ------------ Balance, end of period (340) (115) (170) ------------ ------------ ------------ ACCUMULATED OTHER COMPREHENSIVE INCOME, NET OF DEFERRED INCOME TAXES: Balance, beginning of period 113,880 72,846 (16,701) Net increase during the period 107,662 41,034 89,547 ------------ ------------ ------------ Balance, end of period 221,542 113,880 72,846 ------------ ------------ ------------ RETAINED EARNINGS: Balance, beginning of period 1,336,404 1,250,313 1,074,941 Net income 231,303 99,018 186,380 Dividends declared ( $0.32 per share in 2002, $0.28 per share in 2001 and $0.24 per share in 2000) (16,347) (12,927) (11,008) ------------ ------------ ------------ Balance, end of period 1,551,360 1,336,404 1,250,313 ------------ ------------ ------------ TREASURY SHARES AT COST: Balance, beginning of period (55) (55) (122,070) Retirement of treasury shares during the period - - 138,399 Treasury shares acquired during the period (22,895) - (16,426) Treasury shares reissued during the period - - 42 ------------ ------------ ------------ Balance, end of period (22,950) (55) (55) ------------ ------------ ------------ TOTAL SHAREHOLDERS' EQUITY, END OF PERIOD $ 2,368,646 $ 1,720,522 $ 1,583,352 ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. F-4 EVEREST RE GROUP, LTD. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands)
Twelve Months Ended December 31, ------------------------------------------- 2002 2001 2000 ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 231,303 $ 99,018 $ 186,380 Adjustments to reconcile net income to net cash provided by operating activities net of effects from the purchase of subsidiaries: (Increase) in premiums receivable (196,940) (76,342) (102,802) Decrease in funds held by reinsureds, net 112,906 167,593 29,135 (Increase) in reinsurance receivables (201,644) (388,131) (69,160) Decrease (increase) in deferred tax asset 5,713 (27,226) (16,248) Increase in reserve for losses and loss adjustment expenses 564,029 509,629 1,257 (Decrease) increase in future policy benefit reserve (10,828) 32,164 - Increase in unearned premiums 380,150 89,064 95,076 (Increase) in other assets and liabilities (191,043) (13,760) (22,780) Non cash compensation (benefit) expense (225) 55 (61) Accrual of bond discount/amortization of bond premium (7,503) (8,494) (10,138) Amortization of underwriting discount on senior notes 167 152 112 Realized capital losses (gains) 50,043 22,312 (807) ---------- ---------- ---------- Net cash provided by operating activities 736,128 406,034 89,964 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from fixed maturities matured/called - available for sale 663,088 454,389 191,850 Proceeds from fixed maturities sold - available for sale 2,029,129 757,825 764,432 Proceeds from equity securities sold 19,940 33,373 50,259 Proceeds from other invested assets sold 4,017 305 - Cost of fixed maturities acquired - available for sale (3,877,205) (1,699,010) (1,762,183) Cost of equity securities acquired (9,788) (64,267) (3,380) Cost of other invested assets acquired (24,614) (4,121) (1,698) Net (purchases) sales of short-term securities (18,100) 244,509 (256,421) Net increase (decrease) in unsettled securities transactions 105,958 1,832 (955) Payment for purchase of subsidiaries, net of cash acquired - - 340,130 ---------- ---------- ---------- Net cash (used in) investing activities (1,107,575) (275,165) (677,966) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Acquisition of treasury shares net of reissuances (22,895) - (16,533) Common shares issued during the period 348,626 9,990 7,545 Dividends paid to shareholders (16,347) (12,927) (11,008) Proceeds from issuance of senior notes - - 448,507 Proceeds from trust preferred securities 210,000 - - Borrowing on revolving credit agreement 45,000 22,000 176,000 Repayments on revolving credit agreement (80,000) (152,000) - ---------- ---------- ---------- Net cash provided by (used in) financing activities 484,384 (132,937) 604,511 ---------- ---------- ---------- EFFECT OF EXCHANGE RATE CHANGES ON CASH 24,015 (2,877) (1,913) ---------- --------- ---------- Net increase (decrease) in cash 136,952 (4,945) 14,596 Cash, beginning of period 71,878 76,823 62,227 ---------- ---------- ---------- Cash, end of period $ 208,830 $ 71,878 $ 76,823 ========== ========== ========== SUPPLEMENTAL CASH FLOW INFORMATION CASH TRANSACTIONS: Income taxes paid, net $ 9,993 $ 24,923 $ 63,682 Interest paid $ 42,805 $ 46,120 $ 27,169 NON-CASH OPERATING/INVESTING TRANSACTION: Shares received from demutualization $ - $ 25,921 $ - NON-CASH FINANCING TRANSACTION: Issuance of common shares $ (225) $ 55 $ (61)
In the quarter ended December 31, 2000, the Company purchased all of the capital stock of AFC Re, Ltd. for $16,573. In conjunction with the acquisition, the fair value of assets acquired was $231,874 and liabilities assumed was $215,301. In the quarter ended September 30, 2000, the Company purchased all of the capital stock of Mt. McKinley Insurance Company for $51,800. In conjunction with the acquisition, the fair value of assets acquired was $679,672 and liabilities assumed was $627,872. The accompanying notes are an integral part of the consolidated financial statements. F-6 EVEREST RE GROUP, LTD. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. BUSINESS AND BASIS OF PRESENTATION Everest Re Group, Ltd. ("Group"), a Bermuda company with its principal executive office in Barbados, was established as a wholly-owned subsidiary of Everest Reinsurance Holdings, Inc. ("Holdings"). On February 24, 2000, a corporate restructuring was completed and Group became the new parent holding company of Holdings. Holders of shares of common stock of Holdings automatically became holders of the same number of common shares of Group. Prior to the restructuring, Group had no significant assets or capitalization and had not engaged in any business or prior activities other than in connection with the restructuring. Group, through its subsidiaries, principally provides reinsurance and insurance in the United States, Bermuda and international markets. As used in this document, the "Company" means Group and its subsidiaries, except when referring to periods prior to February 24, 2000, when it means Holdings and its subsidiaries. The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America. The statements include the following domestic and foreign direct and indirect subsidiaries of Group: Holdings, Everest Reinsurance (Bermuda), Ltd. ("Bermuda Re"), Everest Re Capital Trust ("Capital Trust"), Everest International Reinsurance, Ltd. ("Everest International"), formerly AFC Re Ltd., Mt. McKinley Insurance Company ("Mt. McKinley"), formerly Gibraltar Casualty Company, Everest Global Services, Inc. ("Global Services"), Everest Advisors (Ireland) Limited, Everest Re Advisors, Ltd., Everest Reinsurance Company ("Everest Re"), Everest National Insurance Company ("Everest National"), Everest Indemnity Insurance Company ("Everest Indemnity"), Everest Re Holdings, Ltd. ("Everest Ltd."), Everest Security Insurance Company ("Everest Security"), formerly Southeastern Security Insurance Company, Everest Insurance Company of Canada ("Everest Canada"), Mt. McKinley Managers, L.L.C. ("Managers"), Workcare Southeast, Inc. ("Workcare Southeast"), Workcare Southeast of Georgia, Inc. ("Workcare Georgia") and Workcare, Inc. All amounts are reported in U.S. dollars. The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities (and disclosure of contingent assets and liabilities) at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. B. INVESTMENTS Fixed maturity investments are all classified as available for sale. Unrealized appreciation and depreciation, as a result of temporary changes in market value during the period, are reflected in shareholders' equity, net of income taxes in "accumulated other comprehensive income". Equity securities are carried at market value with unrealized appreciation or depreciation, as a result of temporary changes in market value during the period, are reflected in shareholders' equity, net of income taxes in "accumulated other comprehensive income". Unrealized losses on fixed maturities and equity securities, which are deemed other than temporary, are charged to net income as realized capital losses. Short-term investments are stated at cost, which approximates market value. Realized gains or losses on sale of investments are determined on the basis of identified cost. For non-publicly traded securities, market prices are determined through the use of pricing models that evaluate securities relative to the U.S. Treasury yield curve, taking into account the issue type, credit quality and cash flow characteristics of each security. For publicly traded securities, market value is based on quoted market prices. Retrospective F-7 adjustments are employed to recalculate the values of loan-backed and asset-backed securities. Each acquisition lot is reviewed to recalculate the effective yield. The recalculated effective yield is used to derive a book value as if the new yield were applied at the time of acquisition. Outstanding principal factors from the time of acquisition to the adjustment date are used to calculate the prepayment history for all applicable securities. Conditional prepayment rates, computed with life to date factor histories and weighted average maturities, are used to affect the calculation of projected and prepayments for pass through security types. Other invested assets include limited partnerships and rabbi trusts. Limited partnerships are valued pursuant to the equity method of accounting, which management believes approximates market value. The Supplemental Retirement Plan rabbi trust is carried at market value, while the Deferred Compensation Plan rabbi trust and Supplemental Savings Plan rabbi trust are carried at cost, which approximates market value. Cash includes cash and bank time deposits with original maturities of ninety days or less. C. UNCOLLECTIBLE REINSURANCE BALANCES The Company provides reserves for uncollectible reinsurance balances based on management's assessment of the collectibility of the outstanding balances. Such reserves were $31.6 million at December 31, 2002 and $34.4 million at December 31, 2001. See also Note 10. D. DEFERRED ACQUISITION COSTS Acquisition costs, consisting principally of commissions and brokerage expenses and certain premium taxes and fees associated with the Company's reinsurance and insurance business incurred at the time a contract or policy is issued, are deferred and amortized over the period in which the related premiums are earned, generally one year. Deferred acquisition costs are limited to their estimated realizable value based on the related unearned premiums, anticipated claims and claim expenses and anticipated investment income. Deferred acquisition costs amortized to income were $551.8 million, $396.8 million and $272.4 million in 2002, 2001 and 2000, respectively. The present value of in force annuity business is included in deferred acquisition costs. This value is amortized over the expected life of the business at the time of acquisition. The amortization each year will be a function of the gross profits each year in relation to the total gross profits expected over the life of the business, discounted at an assumed net credit rate. E. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES The reserve for losses and loss adjustment expenses ("LAE") is based on individual case estimates and reports received from ceding companies. A provision is included for losses and LAE incurred but not reported ("IBNR") based on past experience. A provision is also included for certain potential liabilities relating to asbestos and environmental exposures, which liabilities cannot be estimated with traditional reserving techniques. See also Note 3. The reserves are reviewed continually and any changes in estimates are reflected in earnings in the period the adjustment is made. Management believes that adequate provision has been made for the Company's losses and LAE. Loss and LAE reserves are presented gross of reinsurance receivables and incurred losses and LAE are presented net of ceded reinsurance. Accruals for contingent commission liabilities are established for reinsurance contracts that provide for the stated commission percentage to increase or decrease based on the loss experience of the contract. Changes in the estimated liability for such arrangements are recorded as contingent commissions. Accruals F-8 for contingent commission liabilities are determined through the review of the contracts that have these adjustable features and are estimated based on expected loss and loss adjustment expenses. F. FUTURE POLICY BENEFIT RESERVE Liabilities for future policy benefits on annuity policies are carried at their accumulated values. Reserves for policy benefits include both mortality and morbidity claims in the process of settlement and claims that have been incurred but not yet reported. Interest rate assumptions used to estimate liabilities for policy benefits range from 4.5% to 6.4%. Actual experience in a particular period may vary. G. PREMIUM REVENUES Premiums written are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the remainder of the unexpired contract period. Such reserves are established based upon reports received from ceding companies or computed using pro rata methods based on statistical data. Written and earned premiums, and the related costs, which have not yet been reported to the Company are estimated and accrued. Premiums are net of ceded reinsurance. Annuity premiums are recognized as revenue over the premium-paying period of the policies. H. INCOME TAXES Holdings and its wholly-owned subsidiaries file a consolidated U.S. federal income tax return. Group and its other subsidiaries, not included in Holdings' consolidated tax return, file separate company U.S. federal income tax returns, where required. Deferred income taxes have been recorded to recognize the tax effect of temporary differences between the financial reporting and income tax bases of assets and liabilities. I. FOREIGN CURRENCY TRANSLATION Assets and liabilities relating to foreign operations are translated into U.S. dollars at the exchange rates in effect at the balance sheet date; revenues and expenses are translated into U.S. dollars using average exchange rates. Gains and losses resulting from translating foreign currency financial statements, net of deferred income taxes, are excluded from net income and accumulated in shareholders' equity. J. EARNINGS PER SHARE Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if options granted under various stock-based compensation plans were exercised resulting in the issuance of common shares that then shared in the earnings of the entity. See also Note 15. Net income per common share has been computed below, based upon weighted average common and dilutive shares outstanding. F-9
(dollar values in thousands, except per share amounts) 2002 2001 2000 -------- -------- -------- Net income (numerator) $231,303 $ 99,018 $186,380 ======== ======== ======== Weighted average common and effect of dilutive shares used in the computation of net income per share: Weighted average shares outstanding - basic (denominator) 50,325 46,174 45,873 Effect of dilutive shares 814 940 485 -------- -------- -------- Weighted average shares outstanding - diluted (denominator) 51,139 47,114 46,358 ======== ======== ======== Net income per common share: Basic $ 4.60 $ 2.14 $ 4.06 Diluted $ 4.52 $ 2.10 $ 4.02
Options to purchase 212,000 common shares at prices ranging from $63.31 to $70.18 per share and 15,000 common shares at prices ranging from $46.09 to $64.97 per share were outstanding at the end of 2002 and 2000, respectively, but were not included in the computation of earnings per diluted share for the respective years because the options' exercise price was greater than the average market price of the common shares at the end of such years. All options to purchase common shares at the end of 2001 were included in the computation of earnings per diluted share because the average market price of the common shares was greater than the options' exercise price at the end of 2001. The options expire on or between October 6, 2005 and September 26, 2012. K. UNUSUAL LOSS EVENTS IN 2001 As a result of the terrorist attacks at the World Trade Center, the Pentagon and on various airlines on September 11, 2001 (collectively the "September 11 attacks"), the Company incurred pre-tax losses, based on an estimate of ultimate exposure developed through a review of its coverages, which totaled $213.2 million gross of reinsurance and $55.0 million net of reinsurance. Associated with this reinsurance were $60.0 million of pre-tax charges, predominantly from adjustment premiums, resulting in a total pre-tax loss from the September 11 attacks of $115.0 million. After tax recoveries relating specifically to this unusual loss event, the net loss from the September 11 attacks totaled $75.0 million. Over 90% of the losses ceded were to treaties, where the reinsurers' obligations are secured, which the Company believes eliminates material reinsurance collection risk. As a result of the Enron bankruptcy in 2001, the Company incurred losses, after-tax and net of reinsurance, amounting to $25.0 million. This unusual loss reflects all of the Company's exposures to this event, including underwriting, credit and investment. L. ACQUISITIONS On September 19, 2000, Holdings acquired Mt. McKinley, f/k/a Gibraltar Casualty Company, for $51.8 million. Mt. McKinley is a run-off property and casualty insurer in the United States. No goodwill was generated in the transaction. The acquisition was recorded using the purchase method of accounting. Accordingly, the December 31, 2000 consolidated financial statements of the Company include the results of Mt. McKinley from September 19, 2000. F-10 In connection with the acquisition of Mt. McKinley, Prudential Property and Casualty Insurance Company ("Prupac"), a subsidiary of The Prudential Insurance Company of America ("The Prudential"), provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinley's reserves as of September 19, 2000 and The Prudential guaranteed Prupac's obligation to Mt. McKinley. The stop loss reinsurance protection that was provided by Mt. McKinley at the time of the Company's initial public offering and other reinsurance contracts between Mt. McKinley and Everest Re remain in effect following the acquisition. However, these contracts became transactions with affiliates effective on the date of the Mt. McKinley acquisition, and their financial impact is thereafter eliminated in consolidation. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for what management believes to be arm's-length consideration, all of its net insurance exposures and reserves to Bermuda Re. The following unaudited pro forma information assumes the acquisition of Mt. McKinley occurred at the beginning of the year presented. The unaudited pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisition been consummated at the beginning of the year presented, nor is it necessarily indicative of future operating results.
Years ended December 31, ------------------------ 2000 (dollars in thousands, except per share amounts) (Unaudited) ------------------------ Revenues $ 1,499,490 Net income $ 188,964 Basic earnings per share $ 4.12 Diluted earnings per share $ 4.08
The Company also completed two additional acquisitions during 2000, Everest Security, a United States property and casualty company, whose primary business is non-standard auto and Everest International, a Bermuda based life and annuity company. The combined purchase price of the acquisitions was approximately $27.0 million. Goodwill of $3.0 million and $0.0 million for Everest Security and Everest International, respectively, was generated as a result of these acquisitions and both were recorded using the purchase method of accounting. M. SEGMENTATION The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. See also Note 17. N. CODIFICATION The NAIC published a codification of statutory accounting principles, which was adopted by the states of domicile of the Company's U.S. operating subsidiaries with an effective date of January 1, 2001. On January 1, 2001, significant changes to the statutory-basis of accounting became effective. The cumulative effect of these changes was recorded as a direct adjustment to statutory surplus. See also Note 13C. F-11 O. DERIVATIVES The Company has in its product portfolio three credit default swaps, which it no longer offers, and five specialized equity put options. These products meet the definition of a derivative under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). The Company's position in these contracts is unhedged and is accounted for as a derivative in accordance with FAS 133. Accordingly, these contracts are carried at fair value and are recorded in "Other liabilities" in the statement of financial position and changes in fair value are recorded in the statement of operations. P. DEPOSIT ASSETS AND LIABILITIES In the normal course of its operations, the Company enters into contracts that do not meet the risk transfer provisions of FAS No. 113, "Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts". These contracts are accounted for using the deposit accounting method. For these contracts, the Company originally records deposit liabilities for an amount equivalent to the assets received. Actuarial studies are used to estimate the final liabilities under these contracts with any change reflected in the Statement of Operations. Q. STOCK-BASED EMPLOYEE COMPENSATION Prior to 2002, the Company accounted for its stock-based employee compensation plans (See Note 15) under the recognition and measurement provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Effective January 1, 2002, the Company adopted the fair value recognition provisions of FAS No. 123, "Accounting for Stock-Based Compensation, prospectively to all employee awards granted, modified or settled after January 1, 2002. Had the compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards prior to January 1, 2002 under those plans consistent with the method of FAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
(dollar values in thousands, except per share amounts) 2002 2001 2000 -------- ------- -------- Net income As reported $231,303 $99,018 $186,380 Pro forma $227,562 $95,011 $181,558 Earnings per share - basic As reported $4.60 $2.14 $4.06 Pro forma $4.52 $2.06 $3.96 Earnings per share - diluted As reported $4.52 $2.10 $4.02 Pro forma $4.45 $2.02 $3.92
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yields ranging from 0.5% to 0.9%, (ii) expected volatility ranging from 29.3% to 45.8%, (iii) risk-free interest rates ranging from a low of 3.4% to a high of 7.0% and (iv) expected life of 7.3-7.5 years. F-12 R. POLICYHOLDER DIVIDENDS The Company issues certain insurance policies with dividend payment features. These policyholders share in the operating results of their respective policies in the form of dividends declared. Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on the terms of the individual policies. S. APPLICATION OF NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board issued FAS 142, "Goodwill and Other Intangible Assets". FAS 142 established new accounting and reporting standards for acquired goodwill and other intangible assets. It requires that an entity determine if other intangible assets have an indefinite useful life or a finite useful life. Goodwill and those intangible assets with indefinite useful lives are not subject to amortization and must be tested at least annually for impairment. Those with finite useful lives are subject to amortization and must be tested annually for impairment. This statement is effective for all fiscal quarters of all fiscal years beginning after December 15, 2001. The Company adopted FAS 142 on January 1, 2002. The implementation of this statement has not had a material impact on the financial position, results of operations or cash flows of the Company. F-13 2. INVESTMENTS The amortized cost, market value, and gross unrealized appreciation and depreciation of fixed maturity investments and equity securities are presented in the tables below:
(dollar values in thousands) Amortized Unrealized Unrealized Market Cost Appreciation Depreciation Value ---------- ------------ ------------ ---------- As of December 31, 2002 Fixed maturities - available for sale U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 506,583 $ 10,143 $ 475 $ 516,251 Obligations of U.S. states and political subdivisions 2,520,597 144,574 2,593 2,662,578 Corporate securities 2,066,060 119,234 31,770 2,153,524 Mortgage-backed securities 839,477 43,038 1,086 881,429 Foreign government securities 312,723 25,152 - 337,875 Foreign corporate securities 215,399 14,273 1,471 228,201 ---------- ------------ ------------ ---------- Total fixed maturities $6,460,839 $ 356,414 $ 37,395 $6,779,858 ========== ============ ============ ========== Equity securities $ 56,841 $ 66 $ 9,435 $ 47,473 ========== ============ ============ ========== As of December 31, 2001 Fixed maturities - available for sale U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 114,814 $ 5,243 $ 127 $ 119,930 Obligations of U.S. states and political subdivisions 1,762,867 78,427 2,768 1,838,526 Corporate securities 2,254,674 77,643 39,516 2,292,801 Mortgage-backed securities 701,175 28,260 790 728,645 Foreign government securities 194,920 18,145 123 212,942 Foreign corporate securities 260,410 10,191 1,861 268,740 ---------- ------------ ------------ ---------- Total fixed maturities $5,288,860 $ 217,909 $ 45,185 $5,461,584 ========== ============ ============ ========== Equity securities $ 66,357 $ 1,393 $ 439 $ 67,311 ========== ============ ============ ==========
F-14 The amortized cost and market value of fixed maturities are shown in the following table by contractual maturity. Mortgage-backed securities generally are more likely to be prepaid than other fixed maturities. As the stated maturity of such securities may not be indicative of actual maturities, the total for mortgage-backed securities is shown separately.
December 31, 2002 -------------------------- Amortized Market (dollar values in thousands) Cost Value ---------- ---------- Fixed maturities - available for sale Due in one year or less $ 74,008 $ 75,821 Due after one year through five years 1,554,004 1,628,579 Due after five years through ten years 1,442,819 1,519,724 Due after ten years 2,550,531 2,674,305 Mortgage-backed securities 839,477 881,429 ---------- ---------- Total $6,460,839 $6,779,858 ========== ==========
Proceeds from sales of fixed maturity investments during 2002, 2001 and 2000 were $2,029.1 million, $757.8 million and $764.4 million, respectively. Gross gains of $91.9 million, $19.3 million and $9.3 million and gross losses of $106.0 million, $46.0 million and $27.8 million were realized on those fixed maturity sales during 2002, 2001 and 2000, respectively. Proceeds from sales of equity security investments during 2002, 2001 and 2000 were $19.9 million, $33.3 million and $50.3 million, respectively. Gross gains of $0.9 million, $13.4 million and $21.0 million and gross losses of $0.3 million, $0.1 million and $1.7 million were realized on those equity sales during 2002, 2001 and 2000, respectively. The changes in net unrealized gains (losses) of investments of the Company are derived from the following sources:
Years Ended December 31, -------------------------------------- (dollar values in thousands) 2002 2001 2000 -------------------------------------- Increase (decrease) during the period between the market value and cost of investments carried at market value, and deferred tax thereon: Equity securities $(10,323) $(13,197) $(26,318) Fixed maturities 146,295 70,511 157,560 Other invested assets (32) 20 24 Deferred taxes (31,741) (12,550) (40,288) -------- -------- -------- Increase in unrealized appreciation, net of deferred taxes, included in shareholders' equity $104,199 $ 44,784 $ 90,978 ======== ======== ========
F-15 The components of net investment income are presented in the table below:
Years Ended December 31, -------------------------------------- (dollar values in thousands) 2002 2001 2000 -------------------------------------- Fixed maturities $379,062 $ 358,980 $302,094 Equity securities 861 895 1,198 Short-term investments 5,087 7,562 9,968 Other interest income 1,708 4,132 3,145 -------------------------------------- Total gross investment income 386,718 371,569 316,405 -------------------------------------- Interest on funds held 19,205 11,463 11,316 Interest credited to future policy benefit reserves 14,036 14,557 - Other investment expenses 2,874 5,108 3,596 -------------------------------------- Total investment expenses 36,115 31,128 14,912 -------------------------------------- Total net investment income $350,603 $ 340,441 $301,493 ======================================
The components of realized capital (losses) gains are presented in the table below:
Years Ended December 31, -------------------------------------- (dollar values in thousands) 2002 2001 2000 -------------------------------------- Fixed maturities $(50,689) $(35,645) $(18,402) Equity securities 620 13,326 19,261 Short-term investments 26 6 (52) -------------------------------------- Total $(50,043) $(22,313) $ 807 ======================================
The net realized capital losses for 2002 and 2001 include $101.3 million and $22.6 million respectively, relating to write-downs in the value of securities deemed to be impaired on an other than temporary basis. Securities with a carrying value amount of $424.2 million at December 31, 2002 were on deposit with various state or governmental insurance departments in compliance with insurance laws. During 2001, the Company sold five European put options based on the Standard & Poor's 500 ("S & P 500") index for total consideration, net of commission, of $16.9 million. These contracts each have a single exercise date with maturities ranging from 18 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. No amounts would be payable under these contracts if the S & P 500 index is at or above the strike price on the exercise dates. If the S & P 500 index is lower than the strike price on the applicable exercise date, the amount due would vary proportionately with the percentage the index was below the strike price. Based on historical index values and trends, the Company estimates the probability for each contract of the S & P index being below the strike price on the exercise date ranges from .78% to 10.64%. The theoretical maximum payouts under the contracts would occur if on each of the exercise dates the S&P 500 index value were zero. The present value of these theoretical maximum payouts using a 6% discount factor is $144.1 million. Since there are no published market values available for these long term index put options, a Black-Scholes model is used to estimate market value. The factors used in determining market value are; the S & P 500 index value at the financial statement date, current interest rates matching the duration of the puts, and estimated volatility with current market option volatility extrapolated to the put maturities using historical data. Movements in the mark to model are reflected through the income statement. F-16 During 2000, the Company entered into three credit swap derivative contracts which provide credit default protection on a portfolio of referenced securities. Due to changing credit market conditions and defaults, the Company recorded net after-tax losses from these contracts of $3.9 million and $13.7 million in 2002 and 2001, respectively, to reflect them at fair value, with the 2001 losses principally attributable to the Company's exposure to the Enron bankruptcy. As of December 31, 2002 and 2001, the remaining maximum after-tax net loss exposure under these contracts is $3.1 million and $6.6 million, respectively. The Company's position in these contracts is unhedged and is accounted for as derivatives in accordance with FAS 133. Accordingly, these contracts are carried at fair value with changes in fair value recorded in the statement of operations. 3. RESERVE FOR LOSSES AND LAE Activity in the reserve for losses and LAE is summarized as follows:
Years Ended December 31, ------------------------------------------ (dollar values in thousands) 2002 2001 2000 ---------- ---------- ---------- Reserves at January 1 $4,278,267 $3,786,178 $3,646,992 Less reinsurance recoverables 883,460 488,824 727,780 ---------- ---------- ---------- Net balance at January 1 3,394,807 3,297,354 2,919,212 ---------- ---------- ---------- Incurred related to: Current year 1,489,271 1,209,470 876,829 Prior years 140,111 47 7,787 ---------- ---------- ---------- Total incurred losses and LAE 1,629,382 1,209,517 884,616 ---------- ---------- ---------- Paid related to: Current year (1) 314,506 393,958 (166,955) Prior years 892,690 718,106 673,429 ---------- ---------- ---------- Total paid losses and LAE 1,207,196 1,112,064 506,474 ---------- ---------- ---------- Net balance at December 31 3,816,993 3,394,807 3,297,354 Plus reinsurance recoverables 1,088,589 883,460 488,824 ---------- ---------- ---------- Balance at December 31 $4,905,582 $4,278,267 $3,786,178 ========== ========== ==========
- ----------- (1) Current year paid losses for 2000 are net of ($483,789) resulting from the acquisition of Mt. McKinley. Prior year incurred losses increased by $140.1 million in 2002 and $7.8 million in 2000. The increase in 2002 was the result of modest reserve strengthening in select areas, most notably in directors and officers, surety and workers' compensation lines, and with respect to asbestos exposures, while the increase in 2000 was the result of normal reserve development inherent in the uncertainty in establishing loss and LAE reserves, as well as the impact of foreign exchange rate fluctuations on loss reserves for both periods. See also Note 1L. F-17 Activity in the reserve for future policy benefits is summarized as follows:
Years Ended December 31, -------------------------------------- (dollar values in thousands) 2002 2001 2000 -------- -------- -------- Balance at beginning of year $238,753 $206,589 $ - Liabilities assumed 6,563 42,439 206,589 Adjustments to reserves 8,519 10,802 - Benefits paid in the current year (25,910) (21,077) - -------- -------- -------- Balance at end of year $227,925 $238,753 $206,589 ======== ======== ========
The Company continues to receive claims under expired contracts which assert alleged injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. The Company's asbestos claims typically involve potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. The Company's environmental claims typically involve potential liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damages caused by the release of hazardous substances into the land, air or water. The Company's reserves include an estimate of the Company's ultimate liability for asbestos and environmental ("A&E") claims for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of the Company's potential losses from asbestos and environmental claims. Among the complications are: (a) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (b) difficulty in identifying sources of asbestos or environmental contamination; (c) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (d) changes in underlying laws and judicial interpretation of those laws; (e) potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (f) long reporting delays, both from insureds to insurance companies and ceding companies to reinsurers; (g) historical data on asbestos and environmental losses, which is more limited and variable than historical information on other types of casualty claims; (h) questions concerning interpretation and application of insurance and reinsurance coverage; and (i) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure. With respect to asbestos claims in particular, several additional factors have emerged recently that further compound the difficulty in estimating the Company's liability. These developments include: (a) continued growth in the number of claims filed, in part reflecting a much more aggressive plaintiff bar; (b) a disproportionate percentage of claims filed by individuals with no functional injury from asbestos, claims with little to no financial value but that have increasingly been considered in jury verdicts and settlements; (c) the growth in the number and significance of bankruptcy filings by companies as a result of asbestos claims; (d) the growth in claim filings against defendants formerly regarded as "peripheral"; (e) the concentration of claims in a small number of states that favor plaintiffs; (f) the growth in the number of claims that might impact the general liability portion of insurance policies rather than the product liability portion; (g) responses in which specific courts have adopted measures to ameliorate the worst procedural abuses; and (h) the potential that the U. S. Congress or state legislatures may consider legislation to address the asbestos litigation issue. Management believes that these uncertainties and factors continue to render reserves for A&E losses significantly less subject to traditional actuarial analysis than are reserves for other types of losses. Given these uncertainties, F-18 management believes that no meaningful range for such ultimate losses can be established. The Company establishes reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for the Company or its ceding companies. In connection with the acquisition of Mt. McKinley, which has significant exposure to asbestos and environmental claims, Prupac, a subsidiary of The Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million) of the first $200.0 million of any adverse development of Mt. McKinley's reserves as of September 19, 2000 and The Prudential guaranteed Prupac's obligations to Mt. McKinley. Through December 31, 2002, cessions under this reinsurance agreement have reduced the available remaining limits to $81.1 million net of coinsurance. Due to the uncertainties discussed above, the ultimate losses may vary materially from current loss reserves and, depending on coverage under the Company's various reinsurance arrangements, could have a material adverse effect on the Company's future financial condition, results of operations and cash flows. The following table shows the development of prior year A&E reserves on both a gross and net of retrocessional basis for the years ended December 31, 2002, 2001 and 2000:
(dollar values in thousands) 2002 2001 2000 --------------------------------------- Gross basis Beginning of reserves $644,390 $693,704 $614,236 Incurred losses 95,004 29,673 (5,852) Paid losses (71,472) (78,987) 85,320 -------- -------- -------- End of period reserves $667,922 $644,390 $693,704 ======== ======== ======== Net basis Beginning of reserves $568,592 $628,535 $365,069 Incurred losses 23,491 5,155 (5,800) Paid losses (1) (64,621) (65,098) 269,266 -------- -------- -------- End of period reserves $527,462 $568,592 $628,535 ======== ======== ========
(1) Reported losses and paid losses for 2000 are net of ($311.3) million and $311.3 million, respectively, reflecting the establishment of Mt. McKinley's reserves at the acquisition date. Net paid losses, excluding the impact of the Mt. McKinley acquisition transaction, were ($42.3) million. At December 31, 2002, the gross reserves for asbestos and environmental losses were comprised of $112.5 million representing case reserves reported by ceding companies, $55.5 million representing additional case reserves established by the Company on assumed reinsurance claims, $110.5 million representing case reserves established by the Company on direct excess insurance claims, including Mt. McKinley, $151.6 million representing case reserves resulting from the acquisition of Mt. McKinley and $237.8 million representing IBNR reserves. 4. CREDIT LINE On December 21, 1999, Holdings entered into a three-year senior revolving credit facility with a syndicate of lenders (the "Credit Facility"). On November 21, 2002, the maturity date of the Credit Facility was extended to December 19, 2003. Wachovia Bank, National Association (formerly First Union National Bank) is the administrative agent for the Credit Facility. The Credit Facility is used F-19 for liquidity and general corporate purposes. The Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either (1) the Base Rate (as defined below) or (2) an adjusted London InterBank Offered Rate ("LIBOR") plus a margin. The Base Rate is the higher of the rate of interest established by Wachovia Bank from time to time as its prime rate or the Federal Funds rate plus 0.5% per annum. On December 18, 2000, the Credit Facility was amended to extend the borrowing limit to $235.0 million for a period of 120 days. This 120-day period expired during the three months ended March 31, 2001 and the limit reverted to $150.0 million. The amount of margin and the fees payable for the Credit Facility depend upon Holding's senior unsecured debt rating. Group has guaranteed Holdings' obligations under the Credit Facility. The Credit Facility agreement requires the Company to maintain a debt to capital ratio of not greater than 0.35 to 1, Holdings to maintain a minimum interest coverage ratio of 2.5 to 1 and Everest Re to maintain statutory surplus at $850.0 million plus 25% of future aggregate net income and 25% of future aggregate capital contributions. As of December 31, 2002, the Company was in compliance with these requirements. During the years ended December 31, 2002, 2001 and 2000, Holdings made payments on the Credit Facility of $80.0 million, $152.0 million and $0.0 million, respectively. During the years ended December 31, 2002, 2001 and 2000, Holdings had new Credit Facility borrowings of $45.0 million, $22.0 million and $176.0 million, respectively. As of December 31, 2002 and 2001, Holdings had outstanding Credit Facility borrowings of $70.0 million and $105.0 million, respectively. Interest expense incurred in connection with these borrowings was $3.5 million, $7.1 million and $8.5 million for the years ended December 31, 2002, 2001 and 2000, respectively. 5. SENIOR NOTES On March 14, 2000, Holdings completed public offerings of $200.0 million principal amount of 8.75% senior notes due March 15, 2010 and $250.0 million principal amount of 8.5% senior notes due March 15, 2005. During 2000, the net proceeds of these offerings and additional funds were distributed by Holdings to Group. Interest expense incurred in connection with these senior notes was $38.9 million, $38.9 million and $30.9 million for the years ending December 31, 2002, 2001, and 2000, respectively. 6. TRUST PREFERRED SECURITIES In November 2002, pursuant to a trust agreement between Holdings and JPMorgan Chase Bank, the property trustee, and Chase Manhattan Bank USA, the Delaware trustee, Capital Trust completed a public offering of $210.0 million of 7.85% trust preferred securities, resulting in net proceeds of $203.4 million. The proceeds of the issuance were used to purchase $210 million of 7.85% junior subordinated debt securities of Holdings that will be held in trust by the property trustee for the benefit of the holders of the trust preferred securities. Holdings used the proceeds from the sale of the junior subordinated debt for general corporate purposes and made capital contributions to its operating subsidiaries. Capital Trust will redeem all of the outstanding trust preferred securities when the junior subordinated debt securities are paid at maturity on November 15, 2032. Holdings may elect to redeem the junior subordinated debt securities, in whole or in part, at any time after November 14, 2007. If such an early redemption occurs, the outstanding trust preferred securities will also be proportionately redeemed. Distributions on the trust preferred securities will be cumulative and pay quarterly in arrears. Distributions relating to the trust preferred securities for the year ended December 31, 2002 were $2.1 million. F-20 7. LETTERS OF CREDIT The Company has arrangements available for the issue of letters of credit, which letters are generally collateralized by the Company's cash and investments. At December 31, 2002, $156.5 million of letters of credit were issued and outstanding under these arrangements, generally supporting reinsurance provided by the Company's non-U.S. operations. The following table summarizes the Company's letters of credit as of December 31, 2002. All dollar amounts are in the thousands.
Year of Bank Commitment In Use Expiry - ------------------------------------------------------------------------------------------ Citibank $100,000 $ 25,411 12/31/2003 $ 64,000 12/31/2006 Wachovia $100,000 $ - N/A Citibank (London) Individual $ 3,208 1/28/2005 $ 1,272 12/31/2005 $ 62,641 12/31/2006
8. OPERATING LEASE AGREEMENTS The future minimum rental commitments, exclusive of cost escalation clauses, at December 31, 2002 for all of the Company's operating leases with remaining non-cancelable terms in excess of one year are as follows:
-------------------------- (dollar values in thousands) -------------------------- 2003 $ 5,518 2004 5,445 2005 4,954 2006 4,849 2007 4,680 Thereafter 15,068 -------------------------- Net commitments $40,514 ==========================
All of these leases, the expiration terms of which range from 2004 to 2013, are for the rental of office space. Rental expense, net of sublease rental income, was $6.7 million, $5.8 million and $4.5 million for 2002, 2001 and 2000, respectively. 9. INCOME TAXES Under current Bermuda law, no income or capital gains taxes are imposed on Group and its Bermuda subsidiaries. The Minister of Finance of Bermuda has also assured Group and its Bermuda subsidiaries that, pursuant to The Exempted Undertakings Tax Protection Act of 1966, they will be exempt until 2016 from any such taxes imposed in the future. In Barbados, Group is registered as an external company and licensed as an international business company. This provides Group with certain tax benefits, including a preferred rate of F-21 corporation tax on profits and gains in Barbados and exemption from withholding tax on dividend payments. No tax is imposed on capital gains. All the income of the U.S. subsidiaries is subject to the applicable federal, foreign, state and local taxes on corporations. The provision for income taxes in the consolidated statement of income has been determined by reference to the individual income of each entity and the respective applicable tax laws. It reflects the permanent differences between financial and taxable income relevant to each entity. The significant components of the provision are as follows:
Years Ended December 31, ------------------------------------ (dollar values in thousands) 2002 2001 2000 ------- ------- ------- Current tax: U.S. $12,717 $ (46) $62,941 Foreign 12,317 5,938 (289) ------- ------- ------- Total current tax 25,034 5,892 62,652 Total deferred U.S. tax expense (benefit) 5,707 (14,567) (17,290) ------- ------- ------- Total income tax expense (benefit) $30,741 $(8,675) $45,362 ======= ======= =======
The weighted average expected tax provision has been calculated using the pre-tax income (loss) in each jurisdiction multiplied by that jurisdiction's applicable statutory tax rate. Reconciliation of the difference between the provision for income taxes and the expected tax provision at the weighted average tax rate for the years ended December 31, 2002 and 2001 is provided below:
Years Ended December 31, ------------------------ (dollar values in thousands) 2002 2001 ------- -------- Expected tax provision at weighted average rate $49,354 $ 10,676 Increase (reduction) in taxes resulting from: Tax exempt income (36,949) (33,039) Disallowed expenses 5,671 5,310 State taxes, net of federal benefit 750 1,000 Other 11,915 7,378 ------- -------- Total income tax (benefit) provision $30,741 $ (8,675) ======= ========
Deferred income taxes reflect the tax effect of the temporary differences between the value of assets and liabilities for financial statement purposes and such values as measured by the U.S. tax laws and regulations. The principal items making up the net deferred income tax asset are as follows: F-22
December 31, ------------------------- (dollar values in thousands) 2002 2001 -------- -------- Deferred tax assets: Reserve for losses and LAE $184,963 $226,532 Unearned premium reserve 46,224 29,765 Foreign currency translation 4,965 6,848 Impairments 7,799 - Deferred compensation 7,599 - Capital loss carryforward 371 - Net operating loss and foreign tax credit carryforwards 17,956 21,159 Other assets 17,632 - -------- -------- Total deferred tax assets 287,509 284,304 -------- -------- Deferred tax liabilities: Deferred acquisition costs 58,638 40,232 Investments 8,019 - Net unrealized appreciation of investments 79,357 47,616 Other liabilities 2,319 17,949 -------- -------- Total deferred tax liabilities 148,333 105,797 -------- -------- Net deferred tax assets $139,176 $178,507 ======== ========
Management believes that it is more likely than not that the Company will realize the benefits of its net deferred tax assets and, accordingly, no valuation allowance has been recorded for the periods presented. Tax benefits of $0.7 million and $3.4 million related to compensation expense deductions for stock options exercised in 2002 and 2001, respectively, are reflected in the change in shareholders' equity in "additional paid in capital". 10. REINSURANCE The Company utilizes reinsurance agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from reinsurers of a portion of losses and loss expenses under certain circumstances without relieving the insurer of its obligation to the policyholder. Losses and LAE incurred and earned premiums are after deduction for reinsurance. In the event reinsurers were unable to meet their obligations under reinsurance agreements, the Company would not be able to realize the full value of the reinsurance recoverable balances. The Company may hold partial collateral, including letters of credit and funds held, under these agreements. See also Note 1C. The Company considers the purchase of corporate level retrocessions covering the potential accumulation of all exposures. For 1999, the Company purchased an accident year aggregate excess of loss retrocession agreement which provided up to $175.0 million of coverage if Everest Re's consolidated statutory basis accident year loss ratio exceeded a loss ratio attachment point provided in the contract for the 1999 accident year. During 2000 and 2001, the Company ceded $70.0 million and $105.0 million of losses, respectively, to this cover, reducing the limit available under the contract to $0.0 million. For 2000, the Company purchased an accident year aggregate excess of loss retrocession agreement which provided up to $175.0 million of coverage if Everest Re's consolidated statutory basis accident year loss ratio exceeded a loss ratio attachment point provided in the contract for the 2000 accident year. During 2002, the Company ceded $90.0 million of losses to this cover, reducing the F-23 limit available under the contract to $85.0 million. For 2001, the Company purchased an accident year aggregate excess of loss retrocession agreement which provided up to $175.0 million of coverage if Everest Re's consolidated statutory basis accident year loss ratio exceeded a loss ratio attachment point provided in the contract for the 2001 accident year. During 2001 and 2002, the Company ceded $164.0 million and $11.0 million of losses, respectively, to this cover, reducing the limit available under the contract to $0.0 million. In addition, the Company has coverage under an aggregate excess of loss reinsurance agreement provided by Prupac, a wholly-owned subsidiary of The Prudential, in connection with the Company's acquisition of Mt. McKinley in September 2000. This agreement covers 80% or $160 million of the first $200 million of any adverse loss reserve development on the carried reserves of Mt. McKinley at the date of acquisition and reimburses the Company as such losses are paid by the Company. There were $78.9 million of cessions under this reinsurance at December 31, 2002, reducing the limit available under the contract to $81.1 million. In connection with the Mt. McKinley acquisition, Prupac also provided excess of loss reinsurance for 100% of the first $8.5 million of loss with respect to certain of Mt. McKinley's retrocessions and potentially uncollectible reinsurance coverage. There were $0.0 million and $3.6 million of cessions under this reinsurance during the periods ending December 31, 2002 and 2001, respectively, reducing the limit available under the contract to $2.4 million. Written and earned premiums are comprised of the following:
Years Ended December 31, --------------------------------------------- (dollar values in thousands) 2002 2001 2000 ---------- ---------- ---------- Written premium: Direct $ 864,335 $ 438,837 $ 224,606 Assumed 1,982,166 1,435,804 1,161,004 Ceded (208,881) (314,499) (166,704) ---------- ---------- ---------- Net written premium $2,637,620 $1,560,142 $1,218,906 ========== ========== ========== Earned premium: Direct $ 672,823 $ 380,178 $ 139,413 Assumed 1,793,461 1,412,734 1,156,297 Ceded (192,607) (325,435) (121,527) ---------- ---------- ---------- Net earned premium $2,273,677 $1,467,477 $1,174,183 ========== ========== ==========
The amounts deducted from losses and LAE incurred for net reinsurance recoveries were $287.7 million, $486.3 million and $161.6 million for the years ended December 31, 2002, 2001 and 2000, respectively. As of December 31, 2002, the Company carried as an asset $1,116.4 million in reinsurance receivables with respect to losses ceded. Of this amount, $440.0 million, or 39.4%, was receivable from subsidiaries of London Reinsurance Group ("London Life"), $145.0 million, or 13.0%, was receivable from Continental Insurance Company ("Continental") and $78.9 million, or 7.1%, was receivable from Prupac. As of December 31, 2001, the Company carried as an asset $895.1 million in reinsurance receivables with respect to losses ceded. Of this amount, $339.0 million, or 37.9%, was receivable from subsidiaries of London Life and $145.0 million, or 16.2%, was receivable from Continental. No other retrocessionaire accounted for more than 5% of the Company's receivables. F-24 The Company's arrangements with London Life and Continental are managed on a funds held basis, which means that the Company has not released premium payments to the retrocessionaire but rather retains such payments to secure obligations of the retrocessionaire, records them as a liability, credits interest on the balances and reduces the liability account as payments become due. As of December 31, 2002, such funds had reduced the Company's net exposure to London Life to $190.2 million, effectively 100% of which has been secured by letters of credit, and its exposure to Continental to $60.9 million. As of December 31, 2001, such funds reduced the Company's net exposure to London Life to $158.9 million, 100% of which was secured by letters of credit, and its exposure to Continental to $67.9 million. Prupac's obligations are guaranteed by The Prudential. 11. COMPREHENSIVE INCOME The components of comprehensive income for the periods ending December 31, 2002, 2001 and 2000 are shown in the following table:
(dollar values in thousands) 2002 2001 2000 -------- -------- -------- Net income $231,303 $ 99,018 $186,380 -------- -------- -------- Other comprehensive income, before tax: Foreign currency translation adjustments 5,346 (5,931) (2,202) Unrealized gains on securities arising during the period 85,897 35,021 131,822 Less: reclassification adjustment for realized losses (gains) included in net income 50,043 22,313 (807) -------- -------- -------- Other comprehensive income, before tax 141,286 51,403 128,813 -------- -------- -------- Income tax expense related to items of other comprehensive income: Tax expense (benefit) from foreign currency translation 1,883 (2,181) (771) Tax expense from unrealized gains arising during the period 13,146 7,039 40,319 Tax (benefit) expense from realized (losses) gains included in net income (18,595) (5,511) 282 -------- -------- -------- Income tax expense related to items of other comprehensive income: 33,624 10,369 39,266 Other comprehensive income, net of tax 107,662 41,034 89,547 -------- -------- -------- Comprehensive income $338,965 $140,052 $275,927 ======== ======== ========
F-25 The following table shows the components of the change in accumulated other comprehensive income for the years ending December 31, 2002 and 2001.
(dollar values in thousands) 2002 2001 ----------------------------------------------------------- Beginning balance of accumulated other comprehensive income $113,880 $ 72,846 -------- -------- Beginning balance of foreign currency translation adjustments $ (12,184) $ (8,434) Current period change in foreign currency translation adjustments 3,463 3,463 (3,750) (3,750) --------- -------- -------- -------- Ending balance of foreign currency translation adjustments (8,721) (12,184) --------- -------- Beginning balance of unrealized gains on securities 126,064 81,280 Current period change in unrealized gains on securities 104,199 104,199 44,784 44,784 --------- -------- -------- -------- Ending balance of unrealized gains on securities 230,263 126,064 --------- -------- Current period change in accumulated other comprehensive income 107,662 41,034 -------- -------- Ending balance of accumulated other comprehensive income $221,542 $113,880 ======== ========
12. EMPLOYEE BENEFIT PLANS A. DEFINED BENEFIT PENSION PLANS The Company maintains both qualified and non-qualified defined benefit pension plans for its U.S. employees. Generally, the Company computes the benefits based on average earnings over a period prescribed by the plans and credited length of service. The Company was not required to fund contributions to its qualified defined benefit pension plan for the years ended December 31, 2001 and 2000 because the Company's qualified plan was subject to the full funding limitation under the Internal Revenue Service guidelines. The Company's non-qualified defined benefit pension plan, effected in October 1995, provides compensating pension benefits for participants whose benefits have been curtailed under the qualified plan due to Internal Revenue Code limitations. Although not required under Internal Revenue Service guidelines, the Company contributed $3.2 million and $2.0 million to the qualified, and non-qualified plans respectively in 2002. The change in the accumulated pension benefit obligation reflects the net effect of amendments made to the plans during 2002 and 2001. Pension expense for the Company's plans for the years ended December 31, 2002, 2001 and 2000 were $3.6 million, $1.6 million and $1.0 million, respectively. F-26 The following table summarizes the status of these plans:
Years Ended December 31, ----------------------- (dollar values in thousands) 2002 2001 ------- ------- Change in projected benefit obligation: Benefit obligation at beginning of year $31,402 $24,572 Service cost 1,877 1,398 Interest cost 2,376 1,921 Change in accumulated benefit obligation 784 36 Actuarial gain 3,666 3,786 Benefits paid (309) (311) ------- ------- Benefit obligation at end of year 39,796 31,402 ------- ------- Change in plan assets: Fair value of plan assets at beginning of year 20,868 20,200 Actual return on plan assets (2,387) (250) Actual contributions during the year 5,172 1,229 Benefits paid (309) (311) ------- ------- Fair value of plan assets at end of year 23,344 20,868 ------- ------- Funded status (16,453) (10,534) Unrecognized prior service cost 811 924 Unrecognized net loss 11,738 4,099 ------- ------- (Accrued) pension cost $(3,904) $(5,511) ======= =======
Plan assets are comprised of shares in investment trusts with approximately 77% and 23% of the underlying assets consisting of equity securities and fixed maturities, respectively. Net periodic pension cost included the following components:
Years Ended December 31, -------------------------------------- (dollar values in thousands) 2002 2001 2000 ------- ------- ------- Service cost $ 1,877 $ 1,397 $ 1,351 Interest cost 2,376 1,921 1,628 Expected return on assets (1,861) (1,905) (1,915) Amortization of net loss (gain) from earlier periods 275 21 (225) Amortization of unrecognized prior service cost 898 148 147 ------- ------- ------- Net periodic pension cost $ 3,565 $ 1,582 $ 986 ======= ======= =======
The weighted average discount rates used to determine the actuarial present value of the projected benefit obligation for 2002, 2001 and 2000 are 6.75%, 7.0% and 7.5%, respectively. The rate of compensation increase used to determine the actuarial present value of the projected benefit obligation for 2002, 2001 and 2000 is 4.50%. The expected long-term rate of return on plan assets for 2002, 2001 and 2000 is 9.0%. The Company also maintains both qualified and non-qualified defined contribution plans ("Savings Plan" and "Non-Qualified Savings Plan", respectively) covering U.S. employees. Under the plans, the Company contributes up to a maximum 3% of F-27 the participants' compensation based on the contribution percentage of the employee. The Non-Qualified Savings Plan provides compensating savings plan benefits for participants whose benefits have been curtailed under the Savings Plan due to Internal Revenue Code limitations. The Company's incurred expenses related to these plans were $0.7 million, $0.6 million and $0.6 million for 2002, 2001 and 2000, respectively. In addition, the Company maintains several defined contribution pension plans covering non-U.S. employees. Each non-U.S. office (Canada, London, Belgium, Hong Kong, Singapore and Bermuda) maintains a separate plan for the non-U.S. employees working in that location. The Company contributes various amounts based on salary, age, and/or years of service. The contributions as a percentage of salary for the branch offices range from 2% to 12%. The contributions are generally used to purchase pension benefits from local insurance providers. The Company's incurred expenses related to these plans were $0.4 million, $0.4 million and $0.3 million for 2002, 2001 and 2000, respectively. B. POST-RETIREMENT PLAN Beginning January 1, 2002, the Company established the Retiree Health Plan. This plan provides health care benefits for eligible retired employees (and their eligible dependants), who have elected coverage to traditional formula. The Company currently anticipates that most covered employees will become eligible for these benefits if they retire while working for the Company. The cost of these benefits is shared with the retiree. The Company accrues the postretirement benefit expense during the period of the employee's service. A health care inflation rate of 9.0% in 2002, was assumed to change to 8.0% in 2003; and then decrease one percentage point annually to 5.0% in 2006; and then remain at that level. Changes in the assumed health care cost trend can have a significant effect on the amounts reported for the health care plans. A one percent change in the rate would have the following effects on:
Percentage Percentage (Dollars in thousands) Point Increase Point Decrease ---------------------------------------- a. Effect on total service and $148 ($114) interest cost components b. Effect on accumulated postretirement $952 ($745)
Benefit expense for this plan for the year ended December 31, 2002 was $0.6 million. F-28 The following table summarizes the status of these plans:
Years Ended December 31, ------------------------ (dollar values in thousands) 2002 2001 ------- ---- Change in projected benefit obligation: Benefit obligation at beginning of year $ - $ - Accrual for Retiree Health Plan 3,888 - Service cost 327 Interest cost 294 - Actuarial gain (208) - Benefits paid (29) - ------- ---- Benefit obligation at end of year 4,272 - ------- ---- Funded status (4,271) - Unrecognized net loss (208) - ------- ---- (Accrued) cost $(4,479) $ - ======= ====
Net periodic cost included the following components:
Years Ended December 31, ----------------------------- (dollar values in thousands) 2002 2001 2000 ----- ---- ---- Service cost $ 327 $ - $ - Interest cost 294 - - ----- ---- ---- Net periodic cost $ 621 $ - $ - ===== ==== ====
13. DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION A. DIVIDEND RESTRICTIONS Under Bermuda law, Group is prohibited from declaring or paying a dividend if such payment would reduce the realizable value of its assets to an amount less than the aggregate value of its liabilities and its issued share capital and share premium (additional paid-in capital) accounts. Group's ability to pay dividends and its operating expenses is dependent upon dividends from its subsidiaries. The payment of such dividends by insurer subsidiaries is limited under Bermuda law and the laws of the various U.S. states in which Group's insurance and reinsurance subsidiaries are licensed to transact business. The limitations are generally based upon net income and compliance with applicable policyholders' surplus or minimum solvency margin and liquidity ratio requirements as determined in accordance with the relevant statutory accounting practices. Under Bermuda law, Bermuda Re is prohibited from declaring or making payment of a dividend if it fails to meet its minimum solvency margin or minimum liquidity ratio. As a long-term insurer, Bermuda Re is also unable to declare or pay a dividend to anyone who is not a policyholder unless, after payment of the dividend, the value of the assets in its long-term business fund, as certified by its approved actuary, exceeds its liabilities for long-term business by at least the $250,000 minimum solvency margin. Prior approval of the Bermuda Monetary Authority is required if Bermuda Re's dividend payments would reduce its prior year-end total statutory capital by 15.0% or more. F-29 Delaware law provides that an insurance company which is either an insurance holding company or a member of an insurance holding system and is domiciled in the state shall not pay dividends without giving prior notice to the Insurance Commissioner of Delaware and may not pay dividends without the approval of the Insurance Commissioner if the value of the proposed dividend, together with all other dividends and distributions made in the preceding twelve months, exceeds the greater of (1) 10% of statutory surplus or (2) net income, not including realized capital gains, each as reported in the prior year's statutory annual statement. In addition, no dividend may be paid in excess of unassigned earned surplus. At December 31, 2002, Everest Re had $149.4 million available for payment of dividends in 2003 without prior regulatory approval. B. STATUTORY FINANCIAL INFORMATION Everest Re prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by the National Association of Insurance Commissioners ("NAIC") and the Delaware Insurance Department. Prescribed statutory accounting practices are set forth in the NAIC Accounting Practices and Procedures Manual. The capital and statutory surplus of Everest Re was $1,494.0 million (unaudited) and $1,293.8 million at December 31, 2002 and 2001, respectively. The statutory net income of Everest Re was $77.6 million (unaudited), $78.9 million and $165.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. Bermuda Re prepares its statutory financial statements in conformity with the accounting principles set forth in Bermuda in The Insurance Act 1978, amendments thereto and Related Regulations. The statutory capital and surplus of Bermuda Re was $931.9 million (unaudited) and $451.9 million at December 31, 2002 and 2001, respectively. The statutory net income of Bermuda Re was $88.1 million (unaudited), $46.2 million and $21.2 million for the years ended December 31, 2002, 2001, and 2000 respectively. C. CODIFICATION The Company's U.S. insurance subsidiaries file statutory-basis financial statements with the state departments of insurance in the states in which the subsidiary is licensed. On January 1, 2001, significant changes to the statutory-basis of accounting became effective. The cumulative effect of these changes has been recorded as a direct adjustment to statutory surplus. The cumulative effect of these changes in 2001 increased Everest Re's statutory surplus by $57.1 million. 14. CONTINGENCIES In the ordinary course of business, the Company is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine the Company's rights and obligations under insurance and reinsurance agreements and other more general contracts. In some disputes, the Company seeks to enforce its rights under an agreement or to collect funds owing to it. In other matters, the Company is resisting attempts by others to collect funds or enforce alleged rights. Such disputes are resolved through formal and informal means, including litigation and arbitration. In all such matters, the Company believes that its positions are legally and commercially reasonable. The Company also regularly evaluates those positions, and where appropriate, establishes or adjusts insurance reserves to reflects its F-30 evaluation. The Company's aggregate reserves take into account the possibility that the Company may not ultimately prevail in each and every disputed matter. The Company believes its aggregate reserves reduce the potential that an adverse resolution of one or more of these matters, at any point in time, would have a material impact on the Company's financial condition or results of operations. However, there can be no assurances that adverse resolutions of such matters in any one period or in the aggregate will not result in a material adverse effect on the Company's results of operations. The Company does not believe that there are any other material pending legal proceedings to which it or any of its subsidiaries or their properties are subject. The Prudential sells annuities which are purchased by property and casualty insurance companies to settle certain types of claim liabilities. In 1993 and prior years, the Company, for a fee, accepted the claim payment obligation of these property and casualty insurers, and, concurrently, became the owner of the annuity or assignee of the annuity proceeds. In these circumstances, the Company would be liable if The Prudential were unable to make the annuity payments. The estimated cost to replace all such annuities for which the Company was contingently liable at December 31, 2002 and 2001 was $150.5 million and $147.1 million, respectively. The Company has purchased annuities from an unaffiliated life insurance company with an A+ (Superior) rating from A.M. Best to settle certain claim liabilities of the Company. Should the life insurance company become unable to make the annuity payments, the Company would be liable for those claim liabilities. The estimated cost to replace such annuities at December 31, 2002 and 2001 was $14.8 million and $13.7 million respectively. 15. STOCK BASED COMPENSATION PLANS The Company has a 2002 Stock Incentive Plan ("2002 Employee Plan"), its 1995 Stock Incentive Plan ("1995 Employee Plan"), its 1995 Stock Option Plan for Non-Employee Directors ("1995 Director Plan") and Board actions in 2001, 2000 and 1999 which award options to non-employee directors. The Company implemented FAS No. 123 in 2002, and related interpretations in accounting for these plans and Board actions. Accordingly, option compensation expense of $0.6 million has been recognized in the accompanying consolidated financial statements in respect of stock options granted under the 2002 Employee Plan. F-31 A summary of the status of the Company's shareholder approved and non-approved plans as of December 31, 2002, 2001 and 2000 and changes during the years then ended is presented in the following table: Compensation Plans Approved by Shareholders:
2002 2001 2000 --------------------------------------------------------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------- -------- --------- -------- --------- -------- Outstanding, beginning of year 2,038,474 $ 37.52 1,805,749 $ 30.39 1,628,099 $ 30.50 Granted 477,000 55.66 572,800 54.77 439,300 26.68 Exercised 58,850 29.58 236,425 26.08 218,250 23.32 Forfeited 49,100 38.26 103,650 34.63 43,400 32.61 --------- --------- --------- Outstanding, end of year 2,407,524 $41.23 2,038,474 $37.52 1,805,749 $30.39 --------- --------- --------- Options exercisable at year-end 1,092,879 784,984 697,099 ========= ========= ========= Weighted-average fair value of options exercisable at year-end $ 35.72 $ 27.05 $ 13.95 ======== ======== ========
The 2002 Employee Plan replaced the 1995 Employee Plan, therefore no further awards will be granted under the 1995 Employee Plan. Under the 2002 Employee Plan 4,000,000 common shares have been authorized to be granted as stock options, stock awards or restricted stock awards to officers and key employees of the Company. At December 31, 2002, there were 3,528,500 remaining shares available to be granted under the 2002 Employee Plan. Under the 1995 Director Plan, a total of 50,000 common shares have been authorized to be granted as stock options to non-employee directors of the Company. At December 31, 2002, there were 38,145 remaining shares available to be granted. F-32 Compensation Plans Not Approved by Shareholders:
2002 2001 2000 -------------------------------------------------------------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ -------- ------ -------- ------ -------- Outstanding, beginning of year 96,000 $ 36.22 56,000 $ 27.80 26,000 $ 30.63 Granted - - 40,000 48.01 30,000 25.34 Exercised - - - - - - Forfeited - - - - - - ------ ------ ------ Outstanding, end of year 96,000 $ 36.22 96,000 $ 36.22 56,000 $27.80 ------ ------ ------ Options exercisable at year-end 59,333 27,360 8,684 ====== ====== ====== Weighted-average fair value of options exercisable at year-end $ 32.76 $ 28.69 $ 30.63 ======== ======== =========
Compensation plans not approved by shareholders refer to Board actions in 2001, 2000 and 1999 which awarded options to non-employee directors. The Board actions were designed to award non-employee directors with the options to purchase common stock to increase the ownership interest in the Company of non-employee directors whose services are considered essential to the Company's continued progress, to align such interests with those of the shareholders of the Company and to provide them with a further incentive to serve as directors to the Company. Under Board actions in 2001, 2000 and 1999 a total of 40,000, 30,000 and 26,000 common shares have been granted as stock options to non-employee directors of the Company. There were no common shares granted as stock options to non-employee directors in 2002. Options granted under the 2002 Employee Plan and the 1995 Employee Plan vest at 20% per year over five years, options granted under the 1995 Director Plan vest at 50% per year over two years and options granted under the 2001, 2000 and 1999 Board actions vest at 33% per year over three years. All options are exercisable at fair market value of the stock at the date of grant and expire ten years after the date of grant. Restricted stock granted under the 2002 Employee Plan and the 1995 Employee Plan vests, beginning one year after the date of grant, in equal annual installments over five years. F-33 The following table summarizes information about stock options outstanding at December 31, 2002:
Options Options Outstanding Exercisable --------------------------------------------------------------------------------- Weighted- Number Average Weighted- Number Weighted- Range of Outstanding Remaining Average Exercisable Average Exercise Prices at 12/31/02 Contractual Life Exercise Price at 12/31/02 Exercise Price - --------------------------- ----------- ---------------- -------------- ----------- -------------- $14.04 - $21.05 86,100 2.8 $17.14 86,100 $17.14 $21.05 - $28.07 493,174 6.1 $24.96 281,702 $24.67 $28.07 - $35.09 320,650 6.2 $30.86 193,250 $30.79 $35.09 - $42.11 534,050 5.2 $38.23 464,150 $38.32 $42.11 - $49.13 386,050 8.6 $47.97 84,010 $47.96 $49.13 - $56.14 468,500 9.7 $55.60 - - $56.14 - $63.16 3,000 6.7 $56.60 - - $63.16 - $70.18 212,000 8.3 $66.17 43,000 $66.10 ----------- -------------- ----------- -------------- 2,503,524 7.1 $41.09 1,152,212 $33.88 =========== ============== =========== ==============
In addition to the 2002 Employee Plan, the 1995 Employee Plan and 1995 Director Plan, Group issued 2,248 common shares in 2002. Group issued 2,604 and 3,732 common shares in 2001 and 2000 respectively, and Holdings issued 1,780 shares of treasury stock in 2000. These issuances had aggregate values of $145,000, $179,500 and $179,500 to the Company's non-employee directors as compensation for their service as directors in 2002, 2001 and 2000, respectively. Since its 1995 initial public offering, the Company has issued to certain key employees of the Company 66,100 restricted shares of stock. Upon issuance of restricted shares, unearned compensation is charged to shareholders' equity for the cost of the restricted stock and is amortized over the vesting period. The amount of earned compensation recognized as expense with respect to restricted stock awards was $339,994, $114,708 and $69,684 for 2002, 2001 and 2000, respectively. The Company acquired 488 common shares at a cost of $26,882 in 2002 from employees who chose to pay required withholding taxes with shares exercised under the stock option grants. There were no such transactions in 2001. Also in 2002 and 2001, the Company recorded contributions of paid in capital in the amount of $0.7 million and $3.4 million, respectively, representing the tax benefits attributable to the difference between the amount of compensation expense deductible for tax purposes with respect to the stock awards and the amount of such compensation expense reflected in the Company's financial statements. 16. RELATED-PARTY TRANSACTIONS During the normal course of business, the Company, through its affiliates, engages in reinsurance and brokerage and commission business transactions, which management believes to be at arm's-length, with companies controlled by or affiliated with its outside directors. Such transactions, individually and in the aggregate, are not material to the Company's financial condition, results of operations and cash flows. F-34 17. SEGMENT REPORTING The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance on both a treaty and facultative basis through reinsurance brokers as well as directly with ceding companies within the United States. The U.S. Insurance operation writes property and casualty insurance primarily through general agent relationships and surplus lines brokers within the United States. The Specialty Underwriting operation writes accident and health ("A&H"), marine, aviation and surety business within the United States and worldwide through brokers and directly with ceding companies. The International operation writes property and casualty reinsurance through the Company's branches in London, Canada, and Singapore, in addition to foreign business written through the Company's New Jersey headquarters and Miami office. The Bermuda operation writes property, casualty, life and annuity business through brokers and directly with ceding companies. These segments are managed in a carefully coordinated fashion with strong elements of central control, including with respect to capital, investments and support operations. As a result, management monitors and evaluates the financial performance of these operating segments based upon their underwriting gain or loss ("underwriting results"). The Company utilizes inter-affiliate reinsurance and such reinsurance does not impact segment results, since business is generally reported within the segment in which the business was first produced. Underwriting results include earned premium less losses and LAE incurred, commission and brokerage expenses and other underwriting expenses. The accounting policies of the operating segments are generally the same as those described in Note 1M, Summary of Significant Accounting Policies. The Company does not maintain separate balance sheet data for its operating segments. Accordingly, the Company does not review and evaluate the financial results of its operating segments based upon balance sheet data. The following tables present the relevant underwriting results for the operating segments for the three years ended December 31, 2002, 2001 and 2000.
U.S. REINSURANCE - -------------------------------------------------------------------------------------- (dollar values in thousands) 2002 2001 2000 --------- --------- --------- Earned premiums $ 726,352 $ 497,600 $ 471,631 Incurred losses and loss adjustment expenses 535,950 449,635 317,735 Commission and brokerage 182,558 148,807 78,978 Other underwriting expenses 18,876 15,211 17,039 --------- --------- --------- Underwriting (loss) gain $ (11,032) $(116,053) $ 57,879 ========= ========= =========
F-35
U.S. INSURANCE - -------------------------------------------------------------------------------------- (dollar values in thousands) 2002 2001 2000 --------- --------- --------- Earned premiums $ 573,081 $ 294,225 $ 101,576 Incurred losses and loss adjustment expenses 432,917 211,311 70,277 Commission and brokerage 122,806 63,512 25,487 Other underwriting expenses 25,802 19,185 11,646 --------- --------- --------- Underwriting (loss) gain $ (8,444) $ 217 $ (5,834) ========= ========= =========
SPECIALTY UNDERWRITING - -------------------------------------------------------------------------------------- (dollar values in thousands) 2002 2001 2000 --------- --------- --------- Earned premiums $ 459,973 $ 371,805 $ 302,637 Incurred losses and loss adjustment expenses 313,352 330,841 254,302 Commission and brokerage 130,552 102,144 81,794 Other underwriting expenses 6,363 5,688 6,253 --------- --------- --------- Underwriting gain (loss) $ 9,706 $ (66,868) $ (39,712) ========= ========= =========
INTERNATIONAL - -------------------------------------------------------------------------------------- (dollar values in thousands) 2002 2001 2000 --------- --------- --------- Earned premiums $ 472,542 $ 287,446 $ 286,753 Incurred losses and loss adjustment expenses 295,349 202,591 235,927 Commission and brokerage 110,160 79,678 81,151 Other underwriting expenses 13,196 13,829 13,798 --------- --------- --------- Underwriting gain (loss) $ 53,837 $ (8,652) $ (44,123) ========= ========= =========
BERMUDA OPERATIONS - -------------------------------------------------------------------------------------- (dollar values in thousands) 2002 2001 2000 --------- --------- --------- Earned premiums $ 41,729 $ 16,401 $ 11,586 Incurred losses and loss adjustment expenses 51,814 15,139 6,375 Commission and brokerage 5,711 2,656 5,037 Other underwriting expenses 2,493 1,539 868 --------- --------- --------- Underwriting (loss) $ (18,289) $ (2,933) $ (694) ========= ========= =========
F-36 The following table reconciles the underwriting results for the operating segments to income before tax as reported in the consolidated statements of operations and comprehensive income:
(dollar values in thousands) 2002 2001 2000 --------- ---------- --------- Underwriting gain (loss) $ 25,778 $ (194,289) $ (32,484) Net investment income 350,603 340,441 301,493 Realized (loss) gain (50,043) (22,313) 807 Net derivative (expense) (14,509) (12,218) - Corporate expenses (3,186) (3,432) (2,029) Distributions on trust preferred securities (2,091) - - Interest expense (42,417) (46,004) (39,386) Other (expense) income (2,091) 28,158 3,341 --------- ---------- --------- Income before taxes $ 262,044 $ 90,343 $ 231,742 ========= ========== =========
The Company produces business in its United States, Bermuda and international operations. The net income and assets of the individual foreign countries in which the Company writes business are not identifiable in the Company's financial records. The largest country, other than the United States, in which the Company writes business is the United Kingdom, with $224.5 million of written premium for the year ended December 31, 2002. No other country represented more than 5% of the Company's revenues. Approximately 15.9%, 13.4% and 12.8% of the Company's gross premiums written in 2002, 2001 and 2000, respectively, were sourced through the Company's largest intermediary. F-37 18. UNAUDITED QUARTERLY FINANCIAL DATa Summarized quarterly financial data were as follows:
(dollar values in thousands, except per share amounts) 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter --------- --------- --------- --------- 2002 Operating data: Gross written premium $ 596,310 $ 630,055 $ 707,977 $ 912,159 Net written premium 565,016 600,673 660,640 811,291 Earned premium 491,208 502,330 555,600 724,539 Net investment income 85,540 90,830 86,412 87,821 Net realized capital (loss) (3,855) (31,008) (7,680) (7,500) Total claims and underwriting expenses 487,640 490,221 537,337 735,887 Net income $ 61,061 $ 53,407 $ 61,270 $ 55,565 ========= ========= ========= ========= Net income per common share - basic $ 1.27 $ 1.04 $ 1.20 $ 1.09 Net income per common share - diluted $ 1.24 $ 1.02 $ 1.19 $ 1.08 2001 Operating data: Gross written premium $ 419,429 $ 484,289 $ 501,930 $ 468,993 Net written premium 387,326 418,443 378,825 375,545 Earned premium 328,493 392,797 347,229 398,958 Net investment income 86,155 87,095 83,993 83,198 Net realized capital (loss) gain (5,057) 3,936 (6,525) (14,667) Total claims and underwriting expenses 338,179 403,568 490,005 433,446 Net income (loss) $ 50,130 $ 57,291 ($ 43,765) $ 35,362 ========= ========= ========= ========= Net income (loss) per common share - basic $ 1.09 $ 1.24 ($ 0.95) $ 0.76 Net income (loss) per common share - diluted $ 1.07 $ 1.22 ($ 0.95) $ 0.75
F-38 EVEREST RE GROUP, LTD. SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2002 (Dollars in thousands)
Column A Column B Column C Column D - ----------------------------------------------------- ----------- ----------- ----------- Amount Shown in Market Balance Cost Value Sheet ----------- ----------- ----------- Fixed maturities-available for sale Bonds: U.S. government and government agencies $ 506,583 $ 516,251 $ 516,251 State, municipalities and political subdivisions 2,520,597 2,662,578 2,662,578 Foreign government securities 312,723 337,875 337,875 Foreign corporate securities 215,399 228,201 228,201 Public utilities 161,304 168,286 168,286 All other corporate bonds 1,858,374 1,935,795 1,935,795 Mortgage pass-through securities 839,477 881,429 881,429 Redeemable preferred stock 46,382 49,443 49,443 ----------- ----------- ----------- Total fixed maturities-available for sale 6,460,839 6,779,858 6,779,858 Equity securities 56,841 47,473 47,473 Short-term investments 169,116 169,116 169,116 Other invested assets 53,887 53,856 53,856 Cash 208,830 208,830 208,830 ----------- ----------- ----------- Total investments and cash $ 6,949,513 $ 7,259,133 $ 7,259,133 =========== =========== ===========
S-1 EVEREST RE GROUP, LTD. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT CONDENSED BALANCE SHEET (Dollars in thousands, except par value per share)
December 31, December 31, ----------- ----------- 2002 2001 ----------- ----------- ASSETS Fixed maturities - available for sale, at market value (amortized cost: 2002, $127,048; 2001, $133,198) $ 133,203 $ 136,438 Short-term investments 3,678 3,071 Cash 343 541 Investment in subsidiaries, at equity in the underlying net assets 2,229,241 1,578,675 Accrued investment income 1,452 1,873 Receivable from affliate 760 104 Other assets 752 462 ----------- ----------- Total assets $ 2,369,429 $ 1,721,164 =========== =========== LIABILITIES Due to affiliates $ 541 $ 256 Other liabilities 242 386 ----------- ----------- Total liabilities 783 642 ----------- ----------- SHAREHOLDERS' EQUITY Preferred shares, par value: $0.01; 50 million shares authorized; no shares issued and outstanding - - Common shares, par value: $0.01; 200 million shares authorized; 50.9 million shares issued in 2002 and 46.3 million shares issued in 2001 513 463 Paid-in capital 618,521 269,945 Unearned compensation (340) (115) Accumulated other comprehensive income, net of deferred taxes of $74.4 million in 2002 and $40.5 million in 2001 221,542 113,880 Treasury shares, at cost; 0.5 million shares in 2002 and 2001 (22,950) (55) Retained earnings 1,551,360 1,336,404 ----------- ----------- Total shareholders' equity 2,368,646 1,720,522 ----------- ----------- Total liabilities and shareholders' equity $ 2,369,429 $ 1,721,164 =========== ===========
See notes to consolidated financial statements. S-2 EVEREST RE GROUP, LTD. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT CONDENSED STATEMENT OF OPERATIONS (Dollars in thousands)
For Years Ended December 31, --------------------------------------------- 2002 2001 2000 --------- -------- --------- REVENUES Dividends received from subsidiaries $ - $ - $ 495,000 Net investment income 13,570 17,305 8,680 Net realized capital gain/(loss) 1,363 2,453 (17) Other (expense) (628) (20) - Equity in undistributed change in retained earnings of subsidiaries 217,909 80,343 (315,283) --------- -------- --------- Total revenues 232,214 100,081 188,380 --------- -------- --------- EXPENSES Other expenses 904 1,077 500 --------- -------- --------- Income before taxes 231,310 99,004 187,880 Income tax expense (benefit) 7 (14) 1,500 --------- -------- --------- Net income $ 231,303 $ 99,018 $ 186,380 ========= ======== =========
See notes to consolidated financial statements. S-3 EVEREST RE GROUP, LTD. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT CONDENSED STATEMENT OF CASH FLOWS (Dollars in thousands)
For Years Ended December 31, ---------------------------------------------- 2002 2001 2000 ---------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 231,303 $ 99,018 $ 186,380 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed change in retained earnings of subsidiaries (217,909) (80,343) 315,283 Increase (decrease) in other liabilities 141 (19) 603 Decrease (increase) in other assets 132 894 (3,229) (Increase) in receivable from affliates (656) (75) (29) Accrual of bond discount/amortization of bond premium (252) (665) (1,088) Realized capital (gains) losses (1,363) (2,453) 17 Non-cash compensation (225) 55 (61) --------- -------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 11,171 16,412 497,876 --------- -------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Additional investment in subsidiaries (350,000) (119,369) (250,001) Proceeds from fixed maturities matured/called - available for sale 388,115 189,532 2,701 Cost of fixed maturities acquired - available for sale (380,779) (115,985) (206,229) Net sales (purchases) of short-term securities (179) 35,180 (37,280) --------- -------- --------- NET CASH (USED IN) INVESTING ACTIVITIES (342,843) (10,642) (490,809) --------- -------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Effect of restructuring - - 14,003 Treasury shares, at cost - - (16,533) Common shares issued during the period 347,893 6,574 7,545 Dividends paid to shareholders (16,419) (12,927) (11,008) --------- -------- --------- Net cash provided by (used in) financing activities 331,474 (6,353) (5,993) Net (decrease) increase in cash (198) (583) 1,074 Cash, beginning of period 541 1,124 50 --------- -------- --------- Cash, end of period $ 343 $ 541 $ 1,124 ========= ======== =========
See notes to consolidated financial statements. S-4 EVEREST RE GROUP, LTD. SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION (DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I COLUMN J - ----------------- --------- ---------- --------- ---------- --------- ---------- --------- -------- ---------- RESERVE FOR INCURRED AMORTIZATION DEFERRED LOSSES & Loss UNEARNED NET LOSS AND LOSS OF DEFERRED OTHER NET ACQUISITION ADJUSTMENT PREMIUM EARNED INVESTMENT ADJUSTMENT ACQUISITION OPERATING WRITTEN GEOGRAPHIC AREA COSTS EXPENSES RESERVES PREMIUM INCOME EXPENSES COSTS EXPENSES PREMIUM - ----------------- --------- ---------- --------- ---------- --------- ---------- --------- -------- ---------- DECEMBER 31, 2002 Domestic $ 133,824 $3,481,424 $ 702,970 $1,759,406 $ 229,990 $1,282,219 $ 435,916 $ 52,860 $2,026,526 International 27,626 749,836 106,843 472,542 27,932 295,349 110,160 13,196 533,972 Bermuda 45,966 674,322 62,527 41,729 92,681 51,814 5,711 3,860 77,122 --------- ---------- --------- ---------- --------- ---------- --------- -------- ---------- Total $ 207,416 $4,905,582 $ 872,340 $2,273,677 $ 350,603 $1,629,382 $ 551,787 $ 69,916 $2,637,620 ========= ========== ========= ========== ========= ========== ========= ======== ========== DECEMBER 31, 2001 Domestic $ 98,491 $3,072,439 $ 411,224 $1,163,630 $ 231,863 $ 991,787 $ 314,463 $ 42,369 $1,224,117 International 16,457 632,962 61,169 287,446 34,357 202,591 79,678 13,829 311,239 Bermuda 15,761 572,866 16,778 16,401 74,221 15,139 2,656 2,686 24,786 --------- ---------- --------- ---------- --------- ---------- --------- -------- ---------- Total $ 130,709 $4,278,267 $ 489,171 $1,467,477 $ 340,441 $1,209,517 $ 396,797 $ 58,884 $1,560,142 ========= ========== ========= ========== ========= ========== ========= ======== ========== DECEMBER 31, 2000 Domestic $ 875,844 $ 236,079 $ 642,314 $ 186,259 $ 36,467 $ 902,945 International 286,753 35,310 235,927 81,151 13,798 304,375 Bermuda 11,586 30,104 6,375 5,037 1,368 11,586 ---------- --------- ---------- --------- -------- ---------- Total $1,174,183 $ 301,493 $ 884,616 $ 272,447 $ 51,633 $1,218,906 ========== ========= ========== ========= ======== ==========
S-5 EVEREST RE GROUP, LTD. SCHEDULE IV - REINSURANCE (DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F - ---------------------------- --------- --------- ----------- ----------- -------- GROSS CEDED TO ASSUMED FROM NET ASSUMED TO AMOUNT OTHER COMPANIES OTHER COMPANIES AMOUNT NET --------- --------- ----------- ----------- -------- DECEMBER 31, 2002 Total property and liability insurance earned premium $ 672,823 $ 192,607 $ 1,793,461 $ 2,273,677 78.9% DECEMBER 31, 2001 Total property and liability insurance earned premium $ 380,178 $ 325,435 $ 1,412,734 $ 1,467,477 96.3% DECEMBER 31, 2000 Total property and liability insurance earned premium $ 139,413 $ 121,527 $ 1,156,297 $ 1,174,183 98.5%
S-6 EX-10 3 ex1031.txt EX 10.31 SECOND AMENDMENT TO CREDIT AGREEMENT Exhibit 10.31 Execution Copy ================================================================================ SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER among EVEREST REINSURANCE HOLDINGS, INC., THE LENDERS NAMED HEREIN, and WACHOVIA BANK, NATIONAL ASSOCIATION (formerly known as First Union National Bank), as Administrative Agent, Lead Arranger: WACHOVIA SECURITIES, INC. (formerly known as First Union Securities, Inc.) Dated as of November 21, 2002 ================================================================================ Exhibits - -------- Exhibit A Form of Second Guarantor Consent i SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER THIS SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER, dated as of November 21, 2002 (this "SECOND AMENDMENT"), is made in respect of the Credit Agreement, dated as of December 21, 1999 (as amended by a First Amendment thereto dated December 18, 2000 and as amended, modified or supplemented from time to time, the "CREDIT AGREEMENT"), among EVEREST REINSURANCE HOLDINGS, INC., a Delaware corporation (the "BORROWER"), the financial institutions listed on the signature pages thereof or that become parties thereto after the date thereof (collectively, the "LENDERS"), and WACHOVIA BANK, NATIONAL ASSOCIATION (formerly known as First Union National Bank) ("Wachovia"), as administrative agent for the Lenders (in such capacity, the "ADMINISTRATIVE AGENT"). Capitalized terms used but not defined herein shall have the meanings given to such terms in the Credit Agreement, as amended by this Second Amendment. Unless otherwise specified, section references herein refer to sections set forth in the Credit Agreement, as amended by this Second Amendment. BACKGROUND STATEMENT A. Borrower has requested that the Lenders agree to extend the current Maturity Date of the Credit Agreement of December 21, 2002 pursuant to Section 2.18 of the Credit Agreement. Section 2.18 of the Credit Agreement provides that Borrower may, by written notice to the Administrative Agent, request up to two (2) one-year extensions of the Maturity Date, PROVIDED that each such request is to be given not less than 90 nor more than 120 days prior to the Maturity Date. Borrower has requested that the Lenders waive the 90-day notice period set forth in Section 2.18. The Lenders have agreed to extend the Maturity Date and waive the 90-day notice period upon the terms and subject to the conditions set forth herein. B. Borrower has further requested that the Lenders agree to amend the pricing matrix set forth in the "Applicable Margin Percentage" definition of the Credit Agreement. The Lenders have agreed to effect such amendment upon the terms and subject to the conditions set forth herein. STATEMENT OF AGREEMENT NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, for themselves and their successors and assigns, agree as follows: ARTICLE I AMENDMENTs TO CREDIT AGREEMENT 1.1 AMENDMENTS TO SECTION 1.1. Section 1.1 of the Credit Agreement is hereby amended as follows: (a) Section 1.1 is hereby amended by adding the following definitions thereto in appropriate alphabetical order: "SECOND AMENDMENT" shall mean the Second Amendment to Credit Agreement, Consent and Waiver, dated as of November 21, 2002, among the Borrower, the Lenders, and the Administrative Agent. "SECOND AMENDMENT EFFECTIVE DATE" shall have the meaning given to such term in the Second Amendment. "SECOND AMENDMENT FEE LETTER" shall mean the letter from Wachovia to the Borrower, dated November 5, 2002, relating to certain fees payable by the Borrower in respect of the Second Amendment. "SECOND GUARANTOR CONSENT" shall mean the Second Guarantor Consent, in the form of Exhibit A to the Second Amendment, executed and delivered by Everest Re Group, Ltd. on or prior to the Second Amendment Effective Date. (b) The definition of "Agreement" is amended by deleting and replacing it in its entirety with the following: "AGREEMENT" shall mean this Credit Agreement, as amended by the First Amendment and by the Second Amendment, and as further amended, modified or supplemented from time to time. (c) The matrix set forth in the definition of "Applicable Margin Percentage" is amended by deleting and replacing it in its entirety with the following:
Standard & Poor's / Applicable Margin Moody's Percentage for Utilization Fee Level Rating Commitment Fee LIBOR Loans Usage > 50% - ----- ------------------- -------------- ----------------- --------------- I A+/A1 or above 0.070% 0.350% 0.100% II A/A2 0.080% 0.450% 0.100% III A-/A3 0.100% 0.525% 0.125% IV BBB+/Baa1 0.135% 0.675% 0.175% V BBB/Baa2 0.175% 0.850% 0.250% VI Less than BBB/Baa2 0.250% 1.250% 0.250%
(d) The definition of "Parent Guaranty" in Section 1.1 is amended by deleting and replacing it in its entirety with the following: 2 "PARENT GUARANTY" shall mean the Guaranty Agreement, dated as of February 24, 2000, made by the Guarantor in favor of the Administrative gent and the Lenders, as amended by the Guarantor Consent and Second Guarantor Consent, and as further amended, modified or supplemented from time to time. ARTICLE II CONSENT AND WAIVER 2.1 CONSENT TO EXTENSION OF MATURITY DATE. Pursuant to Section 2.18 of the Credit Agreement, the Borrower hereby requests that the Lenders extend the Maturity Date of the Credit Agreement to December 19, 2003. The Lenders, subject to the terms and conditions of this Second Amendment, hereby agree to extend the Maturity Date to December 19, 2003. 2.2 WAIVER. In consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Lenders hereby agree that the 90-day notice period set forth in Section 2.18 of the Credit Agreement solely with respect of the extension set forth in SECTION 2.1 of this Second Amendment shall be, and hereby is, waived. The waiver of the Lenders set forth herein is limited as specified, and shall not constitute or be deemed to constitute an amendment, modification or waiver of any provision of the Credit Agreement or a waiver of any Default or Event of Default except as expressly set forth herein. ARTICLE III EFFECTIVENESS This Second Amendment shall become effective on the date (the "SECOND AMENDMENT EFFECTIVE DATE") when the last of the following conditions shall have been satisfied: (a) The Administrative Agent shall have received counterparts of this Second Amendment, duly executed by the Borrower and the Lenders listed on the signature pages attached hereto and in sufficient copies for each Lender. (b) The Administrative Agent shall have received the following, each dated as of the Second Amendment Effective Date (unless otherwise specified) and in sufficient copies for each Lender: (i) the Second Guarantor Consent, duly completed and executed by Everest Re Group, Ltd., in substantially the form of EXHIBIT A; (ii) a favorable opinion of (i) Mayer, Brown, Rowe & Maw, special New York counsel to the Borrower, (ii) Joseph A. Gervasi, General Counsel of Everest Re Group, Ltd., and (iii) Conyers Dill & Pearman, Bermuda counsel of the Guarantor, in each case in form reasonably satisfactory to the Administrative Agent and substantially covering such opinion matters as the Administrative Agent may reasonably request. 3 (c) The Administrative Agent shall have received a certificate, signed by the president, the chief financial officer, treasurer or comptroller of the Borrower, in form and substance satisfactory to the Administrative Agent, certifying that (i) all representations and warranties of the Borrower contained in the Credit Agreement and the other Credit Documents are true and correct in all material respects on and as of the Second Amendment Effective Date, both immediately before and after giving effect to this Second Amendment (except to the extent any such representation or warranty is expressly stated to have been made as of a specific date, in which case such representation or warranty shall be true and correct in all material respects as of such date), (ii) no Default or Event of Default has occurred and is continuing, both immediately before and after giving effect to this Second Amendment, (iii) there is no pending litigation, bankruptcy or insolvency, insurance regulatory proceeding, injunction, order or claim pending or, to such individual's knowledge, threatened against the Borrower or any of its Subsidiaries which (A) is reasonably likely to result in a Material Adverse Change or (B) purports to affect this Second Amendment or the transactions contemplated hereby, and (iv) both immediately before and after giving effect to this Second Amendment, no Material Adverse Change has occurred since December 31, 2001, and there exists no event, condition or state of facts that could reasonably be expected to result in a Material Adverse Change. (d) Since December 31, 2001, both immediately before and after giving effect to the consummation of the transactions contemplated by this Second Amendment, there shall not have occurred any Material Adverse Change or any event, condition or state of facts that could reasonably be expected to result in a Material Adverse Change. (e) The Borrower shall have paid (i) to Wachovia, for the ratable benefit of the Lenders, an amendment fee in the amount of 3 basis points (0.03%) on the aggregate principal amount of the Lenders' Commitments; and (ii) all other fees and expenses of the Administrative Agent and the Lenders required hereunder, under the Second Amendment Fee Letter or under any other Credit Document to be paid on or prior to the Second Amendment Effective Date. (f) The Administrative Agent and each Lender shall have received such other documents, certificates, and instruments in connection with this Second Amendment and the other transactions contemplated hereby as it shall have reasonably requested. On the Second Amendment Effective Date, the Credit Agreement will be automatically amended as set forth herein. On and after the Second Amendment Effective Date, the rights and obligations of the parties hereto shall be governed by the Credit Agreement as amended by this Second Amendment; PROVIDED, that the rights and obligations of the parties hereto with respect to the period prior to the Second Amendment Effective Date shall continue to be governed by the terms of the Credit Agreement. ARTICLE IV GENERAL 4.1 FULL FORCE AND EFFECT. Except as expressly amended hereby, the Credit Agreement shall continue in full force and effect in accordance with the provisions thereof on the date hereof. As used in the Credit Agreement, "hereinafter," "hereto," "hereof," and words of similar import shall, unless the context otherwise requires, mean the Credit Agreement after amendment by this Second Amendment. Any reference to the Credit Agreement or any of the other 4 Credit Documents herein or in any such documents shall refer to the Credit Agreement and Credit Documents as amended hereby. 4.2 APPLICABLE LAW. THIS SECOND AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK, WITHOUT REGARD TO PRINCIPLES OF CONFLICT OF LAWS (EXCLUDING NEW YORK GENERAL OBLIGATIONS LAW ss.5-1401). THE PARTIES HERETO HEREBY DECLARE THAT IT IS THEIR INTENTION THAT THIS SECOND AMENDMENT SHALL BE REGARDED AS MADE UNDER THE LAWS OF THE STATE OF NEW YORK AND THAT THE LAWS OF SAID STATE SHALL BE APPLIED IN INTERPRETING ITS PROVISIONS IN ALL CASES WHERE LEGAL INTERPRETATION SHALL BE REQUIRED. EACH OF THE PARTIES HERETO AGREES (A) THAT THIS SECOND AMENDMENT INVOLVES AT LEAST $250,000; AND (B) THAT THIS SECOND AMENDMENT HAS BEEN ENTERED INTO BY THE PARTIES HERETO IN EXPRESS RELIANCE UPON NEW YORK GENERAL OBLIGATIONS LAW ss. 5-1401. 4.3 COUNTERPARTS. This Second Amendment may be executed in two or more counterparts, each of which shall constitute an original, but all of which when taken together shall constitute but one instrument. 4.4 HEADINGS. The headings of this Second Amendment are for the purposes of reference only and shall not affect the construction of this Second Amendment. [signatures appear on the following pages] 5 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their duly authorized officers as of the date first above written. EVEREST REINSURANCE HOLDINGS, INC. By: /s/ STEPHEN L. LIMAURO ---------------------------- Name: Stephen L. Limauro Title: Executive Vice President and Chief Financial Officer (signatures continued) SIGNATURE PAGE TO SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER WACHOVIA BANK, NATIONAL ASSOCIATION (formerly known as First Union National Bank), as Administrative Agent and as a Lender By: /s/ KIMBERLY SHAFFER --------------------- Name: Kimberly Shaffer Title: Director (signatures continued) SIGNATURE PAGE TO SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER BANK ONE, NA, as a Lender By: /s/ MARK L. GOLDSTEIN --------------------- Name: Mark L. Goldstein Title: Managing Director (signatures continued) SIGNATURE PAGE TO SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER DEUTSCHE BANK AG, New York and/or Cayman Island Branches, as a Lender By: /s/ RUTH LEUNG ----------------------------- Name: Ruth Leung Title: Director By: /s/ CLINTON JOHNSON ----------------------------- Name: Clinton Johnson Title: Managing Director (signatures continued) SIGNATURE PAGE TO SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER RBC FINANCE B.V., as a Lender By: /s/ L.P. VOWELL ----------------------- Name: L.P. Vowell Title: Managing Director (signatures continued) SIGNATURE PAGE TO SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER JPMORGAN CHASE BANK, as a Lender By: /s/ HELEN L. NEWCOMB -------------------------- Name: Helen L. Newcomb Title: Vice President SIGNATURE PAGE TO SECOND AMENDMENT TO CREDIT AGREEMENT, CONSENT AND WAIVER EX-10 4 ex1032.txt EX 10.32 EMPLOYMENT CONTRACT Exhibit 10.32 April 24, 2002 Mr. Peter J. Bennett c/o Everest Reinsurance (Bermuda) Ltd. Wessex House 45 Reid Street PO Box HM845 Hamilton, HM DX Bermuda Dear Mr. Bennett: This letter is to confirm that Everest Reinsurance (Bermuda) Ltd. ("Company") wishes to renew your employment subject to the following terms and conditions. The term "Group" as used in this letter shall refer to Everest Re Group, Ltd. and all its subsidiaries and affiliates as now or hereafter constituted. 1. (a) This Employment Agreement will commence on May 1, 2002 and unless sooner terminated according to its terms or extended in writing, shall terminate on May 1, 2003. You will be employed as the Managing Director and Chief Executive Officer, Everest Reinsurance (Bermuda) Ltd. This offer is conditional upon your maintaining an appropriate, valid work permit issued by the Bermuda immigration authorities. (b) You will be entitled to receive 25 days of annual vacation with pay, which may be taken in the calendar year for which it is earned. This annual vacation entitlement is in addition to those public holidays mandated by Bermuda law. (c) During the term of your employment, you shall not engage in any activities competitive with the business of the Group or detrimental to the best interests of the Group or the business of the Group. (d) Your responsibilities as Managing Director and Chief Executive Officer of the Company will consist of those duties customarily associated with that position and any duties that the Company (acting through the Board, the Chairman or the Deputy Chairman of the Company) may from time to time direct you to undertake and to perform, that are consistent with and appropriate to the position. As Managing Director and Chief Executive Officer, you will be responsible for the day-to-day management and operations of the Company and its subsidiaries and any affiliates as may be directed by the Company. You will not have authority to act on behalf of any U.S. operation except with a specific delegation of authority from the Board of such U.S. operation. 2. As compensation for your services to the Company during the term of your employment, the Company shall pay you a salary at the rate of U.S. $270,400 per annum. The Company has secured an appropriate Work Permit for you in connection with this Agreement. This Work Permit is valid beyond May 1, 2003 but has no bearing on the termination date of this agreement and cannot be construed as the Company extending the terms of this Agreement. Medical Insurance, dental insurance, group life insurance and a pension scheme will be available to you. 3. In addition to your salary, you will be eligible to participate in Everest Re Group, Ltd.'s Annual Incentive Plan as implemented by the Company. It is understood that this bonus plan is entirely discretionary in nature and may Page 2 be amended or terminated by that company at any time with or without prior notice to you. 4. You will receive a housing allowance of U.S. $5,000 per month. 5. (a) If the Company terminates your employment prior to the terminated date of this Agreement for reasons other than misconduct or a breach of Company policies, a separation payment equivalent to one (1) year's salary will be made to you and a reasonable allowance will be provided to move your personal possessions from Bermuda to the UK. "Misconduct" shall be defined as any activity as set forth in Paragraph 5(b)(i) and 6(b)(iv), below. (b) The Company may terminate your employment for cause at any time during the term of this Agreement without prior notice to you. In that event, your employment with the Company shall forthwith be terminated, and except as may be required under Paragraph 5(a) above, the Company shall have no further obligations to you. Termination for cause shall mean a termination of your employment on account of: (i) failure to maintain an appropriate work permit as required under Paragraph 1(a); (ii) willful misfeasance or gross negligence by you in a matter of material importance to the conduct of the Group's affairs; (iii) your negligence having an adverse effect, financial or otherwise, on the Group or on the conduct of the Group's affairs; (iv) a material breach by you of your obligations under this Agreement or your refusal satisfactorily to perform any duties reasonably required hereunder, after notification by the Company of such breach or refusal and your refusal or failure to remedy such breach within 10 days of such notification; or (v) your conviction for a criminal offense. 6. You recognize that, by reason of your employment hereunder, you may acquire confidential information and trade secrets concerning the operation of the Group and of the clients of the Group, the use or disclosure of which could cause the Group substantial loss and damages that could not be readily calculated and for which no remedy under applicable law would be adequate. Accordingly, you covenant and agree with the Company that you will not, either during the term of your employment hereunder or at any time thereafter, disclose, furnish or make accessible to any person, firm or corporation (except in the ordinary course of business in performance of your obligations to the Group hereunder or with the prior written consent of the Company pursuant to authority granted by a resolution of the Company) any confidential information that you have learned or may learn by reason of your association with the Group. As used in this Paragraph 6, the term "confidential information" shall include, without limitation, information not previously disclosed to the public or to the trade by the Group with respect to the business or affairs of the Group including, without limitation, information relating to business opportunities, trade secrets, systems, techniques, procedures, methods, inventions, facilities, financial information, business plans or prospects. 7. Without intending to limit the remedies available to the Company, you acknowledge that a breach of the covenants and agreements contained in Paragraph 6 of this Agreement may result in material irreparable injury to the Group for which there is no adequate remedy at law and that it will not be possible to precisely measure damages for such injuries. Therefore, in the event of such a breach or threat thereof, the Company shall be entitled to obtain a temporary restraining order and/or a preliminary or permanent injunction restraining you from engaging in activities prohibited by Paragraph 6 or such other relief as may be required specifically to enforce any of the covenants in such Paragraph. Page 3 8. This Agreement will be binding upon and inure to the benefit of you and the Company and any successors and assigns of the business of the Company. 9. This Agreement contains all the terms and conditions agreed upon by the parties hereto, and no other agreements, oral or otherwise, regarding your employment and/or this Agreement shall be deemed to exist or to bind any of the parties hereto. 10. The terms of this Agreement may not be modified or amended except by written instrument signed by the Company and you. 11. The validity, interpretation, and performance of this Agreement shall be governed by and construed in accordance with the laws of the Islands of Bermuda. 12. Any notice required or permitted to be given under this Agreement shall be in writing and shall be deemed sufficiently given if delivered in person, or mailed by certified first class, postage prepaid, or sent by a reputable overnight courier service. Notices shall be deemed given as of the date delivered or the date entrusted to the Bermuda postal service or an appropriate courier service. 13. If any one or more of the provisions contained in this Agreement shall be held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provisions hereof. If you wish to accept this offer on the terms and conditions set out above, please sign a copy of this letter and return it to Mr. Michael Ashford, Secretary, Everest Reinsurance (Bermuda) Ltd., c/o Codan Services Limited, Clarendon House, 2 Church Street, Hamilton HM DX, Bermuda, by April 30, 2002. Sincerely, /s/ JOSEPH V. TARANTO - ---------------------- Joseph V. Taranto CONFIRMED AND ACCEPTED: /s/ PETER J. BENNETT - --------------------- Mr. Peter J. Bennett April 25, 2002 - -------------- Date EX-10 5 ex1033.txt EX 10.33 SPECIAL EMPLOYMENT AGREEMENT Exhibit 10.33 SPECIAL EMPLOYMENT AGREEMENT AGREEMENT made this 22nd day of March, 2002, by and between EVEREST GLOBAL SERVICES, INC., a corporation having an address at 477 Martinsville Road, Liberty Corner, New Jersey 07938 (the "COMPANY"), and JANET J. BURAK, an individual (the "EXECUTIVE"), residing at 136 Eileen Drive, Cedar Grove, New Jersey 07009. W I T N E S S E T H: WHEREAS, the Company wishes to ensure the employment of the Executive with the Company and the Executive wishes to accept such employment upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the premises and other good and valuable consideration, receipt of which is hereby acknowledged, the parties hereto agree as follows: 1. EMPLOYMENT The Company agrees to employ the Executive, and the Executive agrees to accept such employment, upon the terms and conditions hereinafter set forth. 2. TERM (a) The Agreement shall commence as of February 1, 2002. The Agreement shall continue until November 30, 2005, unless earlier terminated in accordance with the terms and conditions set forth in this Agreement. The period during which this Agreement is operational shall be referred to in this Agreement as the "TERM" or the "TERM OF AGREEMENT". The final day that the Agreement is operative will be referred to in this Agreement as the "EXPIRATION DATE". The effective date of the termination of the Executive's employment with the Company, regardless of the reason, is referred to in this Agreement as the "DATE OF TERMINATION." (b) Upon termination of the employment of the Executive with the Company on or before the Expiration Date, the Company shall pay the Executive her compensation through the Date of Termination. In the event the Executive's employment terminates as a result of her death, the Company shall pay the compensation specified in sections 4(a) & (b) from the date of death through November 30, 2005 in a lump sum to the Executive or the Executive's estate. Any benefits to which the Executive or her beneficiaries may be entitled to under the plans and programs described in section 5 below, as of the Date of Termination shall be determined in accordance with the terms of such plans and programs, and in accordance with federal and applicable state laws. Any compensation and benefits which serve as consideration for this Agreement shall inure to the benefit of the Executive and her heirs, beneficiaries, administrators, representatives and executors. Except as provided in this section 2(b) in connection with the Executive's termination of employment, the Company shall have no further liability to the Executive or the Executive's heirs, beneficiaries or estate for damages, compensation, benefits, severance, indemnities or other amount of whatever nature. 3. DUTIES AND RESPONSIBILITIES (a) During the Term of this Agreement, the Executive shall serve without specific job title. The Executive shall perform such duties and responsibilities as may be assigned to her from time to time consistent with her former position of regular employment with the Company as Senior Vice President, General Counsel and Secretary. The Executive will hold herself to be reasonably available to assist the Company in prosecuting or defending against legal claims or suits as to which she has knowledge by virtue of her prior regular employment. (b) The Executive's employment by the Company shall not preclude Executive from accepting other assignments, or employment with other entities, provided that such activities are not inconsistent with, and do not require Executive to breach her obligations under the Company's Ethics Guidelines and Index to Compliance Policies ("Ethics Guidelines"), as attached hereto and incorporated herein. Provided, however, that it shall not be deemed a breach of Executive's obligations under the Ethics Guidelines and the Company and all parent and subsidiary corporations, partnerships and other entities and affiliates controlled by, controlling or under common control with the Company, specifically including Everest Re Group, Ltd., together with any predecessor and successor entities (hereinafter being collectively referred to as "EVEREST") hereby grant approval for her to (1) serve as an expert witness or consultant in a matter in which EVEREST is not a party and has no direct interest; or (2) represent a party other than EVEREST in a proceeding to which EVEREST is not a party and in which it has no direct interest; or (3) serve on an arbitration panel or as a mediator in any matter in which EVEREST is not a party and in which it has no direct interest; or (4) engage in activities in furtherance of her expert witness, consultant, counsel, arbitrator, umpire and/or mediator career provided, however, that no such activities during the term of this Agreement may be rendered in any matter in which EVEREST has a direct interest. The Executive agrees that notwithstanding any commitments to other employment or undertakings, she will make herself reasonably available from time to time, at reasonable times and places, for such consultations as deemed necessary by the Company during the Term of this Agreement. 2 (c) On and after the execution of this Agreement, the Executive shall not be provided an office by the Company. 4. COMPENSATION As compensation for her services hereunder, the Executive shall receive the following base salary and bonus payments, subject to applicable tax withholding requirements, during the term of this agreement: (a) The Company shall pay the Executive, in accordance with its customary payroll practices, salary compensation at an annual rate of $120,000, payable on a bi-weekly basis according to the Company's regular payroll cycle, from February 1, 2002 until January 31, 2005. Any payments due to the Executive for the period prior to the execution of this Agreement and the Release, Covenant Not To Sue, Non-Disclosure, and Special Employment Agreement (the "Release") shall be paid retroactively in the next regular Company payroll following execution of those two documents and the expiration of the revocation period described in section 6 of the Release. (b) The Company shall pay the Executive a total of $50,000, payable on a bi-weekly basis according to the Company's regular payroll cycle, for the period from February 1, 2005 until November 30, 2005. (c) On or shortly before the Expiration Date, the Company will tender to the Executive a General Release and Waiver in the form attached hereto referred to as Exhibit A. In exchange for the Executive's executing this General Release and Waiver on or following the Expiration Date, the Company will pay the Executive a special bonus payment of $50,000, in the next regular Company payroll following the expiration of seven calendar days after the date the Executive executes the General Release and Waiver, provided that the Executive has not rescinded such release in the seven days following its execution. 5. EXPENSES; FRINGE BENEFITS (a) The Company shall pay or reimburse the Executive during the Term for any reasonable and necessary business expenses incurred in the performance of services requested by and rendered to the Company hereunder. (b) During the Term, the Executive shall be entitled to participate in and receive benefits under the Company's medical and dental plans, as applicable generally to the employees of the Company, subject, however, to the terms and conditions of the various plans and programs in effect from time to time. During the Term, the Executive shall accrue benefits under the Company's retirement 3 plans, which are the qualified and non-qualified retirement plans maintained by Everest Reinsurance Company, as applicable generally to the employees of the Company, subject, however, to the terms and conditions of the various plans and programs in effect from time to time. (c) The Executive will not receive any Company stock options after February 1, 2002. As to such stock options as may have vested with the Executive prior to February 1, 2002, the Executive must exercise such options on or before May 27, 2002 (three months following the expiration of the most recent "blackout period"). The Executive further acknowledges and agrees that she will be subject to any further "blackout periods" for the purchase and sale of Everest Re Group, Ltd. Stock as may apply to any other Company employee. In addition, all stock options previously awarded to the Executive under the Everest Re Group, Ltd. 1995 Stock Incentive Plan which were not vested as of February 1, 2002 are forfeited and cancelled effective February 1, 2002. And, all shares of restricted stock of Everest Re Group, Ltd. previously issued to the Executive shall be forfeited effective February 1, 2002. (d) The Executive will not, after February 1, 2002, participate in the Company's Annual Incentive Plan, Incentive Compensation Plan or in the Everest Re Group, Ltd. 1995 Stock Incentive Plan. (e) The Executive waives any right to make contributions to or receive Company-matching contributions in the Everest Reinsurance Employee Savings Plan (also known as ERESP) for salary received after February 1, 2002. She understands that she may continue to manage her existing account in ERESP, and may access such funds, under the same terms and conditions as generally applicable to employees of the Company. (f) While the Executive will be covered by the Company Short Term Disability Plan as required by New Jersey law, she agrees that in the event that she is eligible for and receives payments under that plan, the Company may offset any such amounts received against the salary and/or bonus payments specified in paragraph 4 above, such that over the Term, the Executive's compensation from the Short Term Disability Plan, combined with salary (and bonus, if applicable), does not exceed $460,000. (g) The Executive waives any participation in the Company's Long Term Disability Plan and agrees to execute any documents required to effectuate an opt-out from that Plan. (h) The Executive shall not be entitled to accrue any paid vacation during the Term. 4 (i) The Executive will not be entitled to participate further in the Everest Re Group, Ltd. Senior Executive Change of Control Plan and will no longer be entitled to any benefits under such plan. (j) The Executive will not be eligible for benefits under any new benefit plan adopted by the Company during the Term, other than new medical, dental or pension plans. (k) Notwithstanding anything contained herein to the contrary, the Company reserves the right to modify, amend or terminate any employee benefit plan or policy as it deems appropriate in its discretion; provided that unless required by law, the Company shall not amend, modify or terminate any such plan or policy in a manner that treats the Executive differently from other employees. 6. TERMINATION (a) The Company shall be entitled to terminate this Agreement and discharge the Executive for "cause" effective upon the giving of written notice. The term "cause" shall be limited to the following grounds: (i) The misappropriation of the funds or property of the Company or any act of fraud or dishonesty with respect to the Company, its business, or its property; (ii) Conviction of a felony or of any crime involving moral turpitude, dishonesty or theft; or (iii) The commission by the Executive of any act, or the Executive's failure to act, which could reasonably be expected to injure the reputation, business or business relationships of the Company. (b) Upon termination of the Executive's employment with the Company, pursuant to section 6(a), the Company shall pay the Executive her salary compensation only through the date of Termination. Any benefits to which the Executive or her beneficiaries may be entitled to under the plans and programs described in section 5 above, or any other applicable plans and programs, as of her Date of Termination shall be determined in accordance with the terms of such plans and programs. The Company shall have no further liability to the Executive or the Executive's heirs, beneficiaries or estate for damages, compensation, benefits, severance, indemnities or other amount of whatever nature. 5 7. DEATH (a) In the event the Executive's employment terminates as a result of the Executive's death, the Executive, or the Executive's estate, shall be entitled to receive all compensation specified in section 4(a) & (b) through November 30, 2005 unless previously paid as provided in section 2(b). Any benefits to which the Executive or her beneficiaries may be entitled under the plans and programs described in section 5 as of her Date of Termination shall be determined in accordance with the terms of such plans and programs. In the event of the Executive's termination due to death, the Company shall have no further liability to the Executive or the Executive's heirs, beneficiaries or estate for damages, compensation, benefits, severance, indemnities or other amounts of whatever nature. 8. CONFIDENTIAL INFORMATION In consideration of the covenants of the Company herein, the Executive agrees as follows: (a) The Executive hereby agrees and acknowledges that she has and has had access to or is aware of Confidential Information. The Executive hereby agrees that she shall keep strictly confidential and will not prior to or after Date of Termination, without the Company's express written consent, divulge, furnish or make accessible to any person or entity, or make use of for the benefit of herself or others, any Confidential Information obtained, possessed, or known by her except as required in the regular course of performing the duties and responsibilities of her employment by the Company while in the employ of the Company, and that she will, prior to or upon her Date of Termination deliver or return to the Company all such Confidential Information that is in written or other physical or recorded form or which has been reduced to written or other physical or recorded form, and all copies thereof, in her possession, custody or control. The foregoing covenant shall not apply to (i) any information that becomes generally known or available to the public other than as a result of a breach of the agreements of the Executive contained herein, (ii) any disclosure of Confidential Information by the Executive that is expressly required by judicial or administrative order; provided however that the Executive shall have notified the Company as promptly as possible of the existence, terms and circumstances of any notice, subpoena or other process or order issued by a court or administrative authority that may require her to disclose any Confidential Information, and cooperate with the Company, at the Company's request and at the Company's expense, in taking legally available steps to resist or narrow such process or order and to obtain an order or other reliable assurance that confidential treatment will be given to such Confidential Information as is required to be disclosed. 6 (b) For purposes of this Agreement, "CONFIDENTIAL INFORMATION" means all non-public or proprietary information, data, trade secrets, "know-how", or technology with respect to any products, designs, improvements, research, styles, techniques, suppliers, clients, markets, methods of distribution, accounting, advertising and promotion, pricing, sales, finances, costs, profits, financial condition, organization, personnel, business systems (including without limitation computer systems, software and programs), business activities, operations, budgets, plans, prospects, objectives or strategies of the Company. 9. ENFORCEABILITY The failure of any party at any time to require performance by another party of any provision hereunder shall in no way affect the right of that party thereafter to enforce the same, nor shall it affect any other party's right to enforce the same, or to enforce any of the other provisions in this Agreement; nor shall the waiver by any party of the breach of any provision hereof be taken or held to be a waiver of any subsequent breach of such provision or as a waiver of the provision itself. 10. ASSIGNMENT This Agreement is a personal contract and the Executive's rights and obligations hereunder may not be sold, transferred, assigned, pledged or hypothecated by the Executive. The rights and obligation of the Company hereunder shall be binding upon and run in favor of the successors and assigns of the Company; provided, however, the Company may not assign or transfer its rights or obligations under this Agreement unless such assignee or transferee assumes the liabilities, obligations and duties of the Company, as contained in this Agreement, either contractually or as a matter of law. 11. ARBITRATION The Company and the Executive expressly agree that any and all disputes, controversies or claims arising out of Executive's Special Employment relationship, including alleged violation of a statute regulating employment such as, but not limited to the New Jersey Law Against Discrimination, the Age Discrimination in Employment Act, Title VII of the Civil Rights Act of 1964, and the Americans With Disabilities Act, as well as claims arising out of this Agreement or concerning its meaning or application, shall be determined exclusively by final and binding arbitration before a single arbitrator in Somerset County, New Jersey, under the Model Employment Arbitration Procedures of the American Arbitration Association, and that judgment upon the award rendered by the Arbitrator may be entered in any court of competent jurisdiction. Each party shall share equally the fees and costs of the Arbitrator. Each party shall pay for its or her attorneys' fees and costs including, without limitation, costs of any experts. However, if any party 7 prevails on a statutory claim which entitles the prevailing party to a reasonable attorneys' fee (with or without expert fees) as part of the costs, the Arbitrator may award reasonable fees (with or with or without expert fees) to the prevailing party in accordance with such statute. Any controversy over whether a dispute is an arbitrable dispute or as to the interpretation or enforceability of this paragraph with respect to such arbitration shall be determined by the Arbitrator. 12. MODIFICATION This Agreement may not be orally canceled, changed, modified or amended, and no cancellation, change, modification or amendment shall be effective or binding, unless in writing and signed by the parties to this Agreement. 13. SEVERABILITY; SURVIVAL In the event any provision or portion of this Agreement is determined to be invalid or unenforceable for any reason, in whole or in part, the remaining provisions of this Agreement shall nevertheless be binding upon the parties with the same effect as though the invalid or unenforceable part had been severed and deleted. The respective rights and obligations of the parties hereunder shall survive the termination of the Executive's employment to the extent necessary to the intended preservation of such rights and obligations. 14. NOTICE Any notice, request, instruction or other document to be given hereunder by any party hereto to another party shall be in writing and shall be deemed effective (a) upon person delivery, if delivered by hand, or (b) three days after the date of deposit in the mails, postage prepaid if mailed by certified or registered mail, or (c) on the next business day, if sent by facsimile transmission or prepaid overnight courier service, and in each case, addressed as follows: If to the Executive: ------------------- Janet J. Burak *** ****** Drive ***** *****, NJ 07009 ***-***-3145 (tele) ***-***-5133 (fax) 8 If to the Company: Barry Smith, Senior Vice President Everest Global Services, Inc. 477 Martinsville Road Liberty Corner, New Jersey 07938 908-604-3535 (tele) 908-604-3571 (fax) with a copy sent to: Christopher H. Mills, Esq. Collier, Jacob & Mills 580 Howard Avenue Somerset, NJ 08873 732-560-7100 (tele) 732-560-0788 (fax) Any party may change the address to which notices are to be sent by giving notice of such change of address to the other party in the manner herein provided for giving notice. 15. APPLICABLE LAW This Agreement shall be governed by and construed in accordance with the laws of the State of New Jersey, without application of conflict or law provisions applicable herein. 16. NO CONFLICT The Executive represents and warrants that she is not subject to any agreement, instrument, order, judgment or decree of any kind, or any other restrictive agreement of any character, which would prevent her from entering into this Agreement or which would be breached by the Executive upon her performance of her duties pursuant to this Agreement. 17. ENTIRE AGREEMENT This Agreement represents the entire agreement between the Company and the Executive with respect to the Executive's employment by the Company during the Term and all prior agreements, plans and arrangements relating to the employment of the Executive by the Company are nullified and superseded hereby. 9 18. HEADINGS The headings contained in this Agreement are for reference purposes only, and shall not affect the meaning or interpretation of this Agreement. IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written. EVEREST GLOBAL SERVICES, INC. By: /s/ THOMAS J. GALLAGHER ----------------------- Name: Thomas J. Gallagher Title: President and COO /s/ JANET J. BURAK ------------------- EXECUTIVE'S SIGNATURE Janet J. Burak -------------- Executive's Name Everest Reinsurance Company, its successors and assigns, acknowledges the existence of and agrees to the terms of this Special Employment Agreement and hereby guarantees its terms. EVEREST REINSURANCE COMPANY By: /s/ THOMAS J. GALLAGHER ----------------------- Dated: ----------------------- 10 RELEASE, COVENANT NOT TO SUE, NON-DISCLOSURE AND SPECIAL EMPLOYMENT AGREEMENT This RELEASE, COVENANT NOT TO SUE, NON-DISCLOSURE AND SPECIAL EMPLOYMENT AGREEMENT (the "AGREEMENT") dated as of February 1, 2002, between (1) JANET J. BURAK ("Executive"), and (2) Everest Global Services, Inc., and all parent and subsidiary corporations, partnerships and other entities and affiliates controlled by, controlling or under common control with Everest Global Services, Inc., specifically including Everest Re Group, LTD., together with any predecessor and successor entities (hereinafter being collectively referred to as "EVEREST"), sets forth the agreements of the parties hereto with regard to the matters set forth herein: 1. BACKGROUND. Executive has been continuously employed by an EVEREST company as a regular employee since March 17, 1980. She has most recently served (among other positions) as Senior Vice President General Counsel and Secretary of Everest Re Group, Ltd. At EVEREST's initiative, Executive's regular employment with EVEREST terminated on February 1, 2002, which shall be referred to as Executive's Regular Termination Date. EVEREST wishes to respond to Executive's expressions of concern over the effect that leaving EVEREST's payroll prior to attaining age 55 with the requisite years of service to retire would have on Executive's benefits under the Everest Reinsurance Retirement Plans and possible retiree medical benefits. Therefore, EVEREST has agreed to continue Executive's employment with EVEREST on a special basis, described more fully in the attached Special Employment Agreement, which is incorporated herein and made a part hereof. Such Special Employment will be retroactive to February 1, 2002 and will continue until November 30, 2005, at which time Executive will be 55 years of age. As of November 30, 2005, Executive's Special Employment will terminate and she will be eligible for retirement under the then- current Everest Reinsurance Retirement Plans and any successor plans. 2. CONSIDERATION TO BE EXTENDED TO EXECUTIVE BY EVEREST. In exchange for Executive's execution of this AGREEMENT within 21 days of her receiving it, and provided that Executive does not rescind the AGREEMENT as provided in section 6, below, EVEREST agrees to enter into the Special Employment Agreement with Executive. Executive acknowledges that absent the Special Employment Agreement, her benefits under the Everest Reinsurance Retirement Plans would be substantially less than they will be if she terminates service pursuant to the Special Employment Agreement on November 30, 2005. 1 This is so because as of that date, Executive will have 25 years and 8 months of service and be 55 years old. Executive acknowledges that when the Special Employment Agreement ends, she will be eligible for whatever pension and retiree medical benefits are then generally available to other EVEREST employees of similar age and with similar length of service and compensation amounts. Executive's actual pension benefit will be calculated at the time she retires. Executive understands and acknowledges that EVEREST retains its normal rights to amend or terminate employee pension or other benefit plans, at any time, so long as it acts generally as to plan participants and not in a way that is specifically designed to disadvantage only Executive and consistent with all applicable laws. 3. REPRESENTATIONS BY EXECUTIVE. In consideration of the promises by EVEREST to Executive as specified in paragraph 2 above, Executive agrees as follows: a. NON-DISCLOSURE OF PROPRIETARY INFORMATION. Executive acknowledges that during the course of Executive's employment with EVEREST Executive received, obtained or became aware of or had access to proprietary information, lists and records of customers and trade secrets which are the property of EVEREST and which are not known by competitors or generally by the public ("Proprietary Information") and recognizes such Proprietary Information to be valuable and unique assets of EVEREST. For purposes of this subparagraph: (i) Proprietary Information is deemed to include, without limitation, (A) marketing materials, marketing manuals, policy manuals, procedure manuals, policy and procedure manuals, operating manuals and procedures and product documentation, (B) all information about pricing, products, procedures, practices, business methods, systems, plans, strategies or personnel of EVEREST, (C) circumstances surrounding the relationships with, knowledge of, or information about the customers, clients, and accounts of EVEREST, including but not limited to the identity of current active customers or prospects who have been contacted by EVEREST, and (D) all other information about EVEREST which has not been otherwise publicly disseminated by EVEREST, whether or not that information is recorded and notwithstanding the method of recordation, if any; and (ii) Proprietary Information is deemed to exclude all information legally in the public domain. Executive agrees to hold the Proprietary Information in the strictest confidence and agrees not to use or disclose any Proprietary Information, directly or indirectly, at any time for any purpose, without the prior 2 written consent of EVEREST or to use for Executive's benefit or the benefit of any person, firm, corporation or other entity (other than EVEREST), any Proprietary Information. The foregoing covenant shall not apply to (i) any information that becomes generally known or available to the public other than as a result of a breach of the agreements of the Executive contained herein, (ii) any disclosure of Proprietary Information by the Executive that is expressly required by judicial or administrative order; provided however that the Executive shall have notified the Company as promptly as possible of the existence, terms and circumstances of any notice, subpoena or other process or order issued by a court or administrative authority that may require her to disclose any Proprietary Information and reasonably cooperate with the Company at the Company's request and at the Company's expense in taking legally available steps to resist or narrow such process or order and to obtain an order or other reliable assurance that confidential treatment will be given to such Proprietary Information as required to be disclosed. Executive has returned all Proprietary Information in Executive's possession or control to EVEREST. b. COOPERATION, NO DETRIMENTAL ACTIONS. Executive will reasonably cooperate with EVEREST in enforcing or defending against legal claims, including appearing as a witness for EVEREST in court or administrative proceedings, subject to reasonable reimbursement for Executive's expenses, it being understood that doing so is one of the obligations undertaken by Executive in connection with the Special Employment Agreement. Executive will not take actions or make disparaging statements which are detrimental to EVEREST or the RELEASEES, as defined in paragraph 5 below. 4. STOCK OPTIONS. Executive acknowledges that Executive will no longer vest in any unvested EVEREST stock options after February 1, 2002. Executive further agrees that she forfeited all remaining restricted shares as of February 1, 2002. Executive acknowledges that all stock options which are vested as of February 1, 2002 must be exercised no later than May 27, 2002. Failure by Executive to exercise vested options before 5:00 p.m. that date will result in such unexercised vested options being forfeited and cancelled. 5. RELEASE. In consideration of EVEREST's undertakings to Executive as specified in paragraph 2 above, Executive grants EVEREST a RELEASE of all claims, both known and unknown, that Executive may have which relate to 3 Executive's employment or the termination of Executive's Regular employment up to the date this RELEASE is executed by Executive (hereafter an "EMPLOYMENT CLAIM"). The Executive and EVEREST agree that an EMPLOYMENT CLAIM, specifically and without limitation, does not include claims: a. for indemnification and defense as an employee, officer, director or corporate agent of EVEREST against claims by third parties; b. for vested benefits including, but not limited to, vested benefits under the Everest Reinsurance Retirement Plans, including but not limited to rights under any workers compensation program; Section 502(a) of the Employee Retirement Income Security Act, as amended, 29 U.S.C.ss.1001 et seq., and under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA"); c. For workers compensation benefits, provided however that any monies that Executive receives under a workers compensation award will serve as an offset to the total compensation to be paid under the Special Employment Agreement. d. arising out of enforcement of this Agreement by Executive; or e. constituting cross-claims against EVEREST as a result of claims brought by unaffiliated third parties against Executive based on Executive's service as a regular employee of EVEREST. The statutes which could form the basis for an EMPLOYMENT CLAIM include, but are not limited to, Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C.ss. 1971 et seq.; the Age Discrimination in Employment Act of 1967, as amended, 29 U.S.C.ss. 621 et seq.; Section 510 of the Employee Retirement Income Security Act of 1974, as amended, 29 U.S.C.ss. 1001 et seq.; the Americans With Disabilities Act, as amended, 42 U.S.C.ss. 12101 et seq.; the Older Workers Benefit Protection Act, as amended, 29 U.S.C. ss. 621 et seq.; the Civil Rights Act of 1866, as amended, 42 U.S.C.ss. 1981 et seq.; the New Jersey Law Against Discrimination, as amended, N.J.S.A. 10:5-1 et seq.; the New Jersey Conscientious Employee Protection Act, as amended, N.J.S.A. 34:19-1 et seq.; and the New Jersey Family Leave Act, N.J.S.A. 34:11B-1 et seq.. The common law (non-statutory) theories under which an EMPLOYMENT CLAIM could be made include, but are not limited to, breach of an express employment contract, breach of a contract implied from a personnel handbook or manual, or commission of a civil wrong (known as a "tort") resulting in Executive's termination, or for alleged 4 violation of the public policy of the United States or any state. Granting a RELEASE of any EMPLOYMENT CLAIM pursuant to this AGREEMENT means that on behalf of Executive and all who succeed to Executive's rights and responsibilities, Executive releases and gives up any and all EMPLOYMENT CLAIMS that Executive may have against EVEREST, and any of its subsidiaries, benefit plans, affiliates or divisions, and all of their directors, officers, representatives, shareholders, agents, employees, and all who succeed to their rights and responsibilities (collectively referred to as "RELEASEES"). With respect to any charges filed concerning events or actions relating to an EMPLOYMENT CLAIM that occurred on or before the date of this AGREEMENT or Executive's regular Termination Date (whichever is later), Executive waives and releases any right that Executive may have to recover in any lawsuit or proceeding brought by Executive or by an administrative agency on Executive's behalf against the RELEASEES. 6. REVIEW PERIOD. Executive acknowledges that she has up to 21 days to review this AGREEMENT, and she is hereby advised to review it with an attorney of her choice. Executive also acknowledges that she was further advised that she has seven days after she signs this AGREEMENT to revoke it by notifying EVEREST in writing, of such revocation as set forth under Notices below. Executive agrees that if she signs this AGREEMENT before twenty-one days have expired, it was a voluntary decision to do so, on the basis that she did not need any additional time to decide whether to sign this AGREEMENT. This AGREEMENT shall become effective on the eighth (8th) day following its execution by Executive (the "EFFECTIVE DATE"), unless revoked in accordance with this paragraph. Executive agrees that by entering this AGREEMENT, she will be knowingly and voluntarily relinquishing certain rights and benefits that are otherwise available to other employees of the Company who have not entered into employment agreements with EVEREST. 7. REVOCATION OF AUTHORITY TO BIND EVEREST. Executive agrees and acknowledges that as of the Regular Termination Date, Executive no longer is empowered to bind EVEREST in any agreement, whether verbal or written, and that Executive shall have no authority to execute any documents, deeds, leases, or other contracts on behalf of EVEREST, notwithstanding Executive's status under the Special Employment Agreement. To the extent not effected by the termination of Executive's regular employment, Executive resigns from all officer and director positions with any Everest Re Group company. 8. SUCCESSORS AND ASSIGNS. All rights and duties of EVEREST under this 5 Agreement shall be binding on and inure to the benefit of EVEREST, its successors and assigns. All rights of Executive hereunder shall be binding upon and inure to the benefit of Executive and her heirs, beneficiaries, representatives, administrators and executors. 9. NOTICES. All notices, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered personally with receipt acknowledged or sent by registered or certified mail, postage prepaid or by reputable national overnight delivery service, to the addresses shown below, unless changed by notices given as herein provided, except that notice of change of address only shall be effective upon actual receipt: If to Everest, to: Everest Global Services, Inc. 477 Martinsville Road P.O. Box 830 Liberty Corner, New Jersey 07938 908-604-3535 (tele) 908-604-3571 (fax) Attention: Barry Smith, Senior Vice President With a copy to: Collier, Jacob & Mills, P.C. 580 Howard Avenue Somerset, New Jersey 08873 Attention: Christopher H. Mills, Esq. 732-560-7100 (tele) 732-560-0788 (fax) If to the Executive, to: Janet J. Burak *** ****** Drive ***** *****, New Jersey 07009 ***-***-3145 (tele) ***-***-5133 (fax) 10. CONFIDENTIALITY. Executive agrees to keep the terms of this AGREEMENT confidential. Executive will not, at any time, talk about, write about or otherwise publicize this AGREEMENT, or its negotiation, execution or implementation, except with (1) the attorney who is advising her in connection with it; (2) financial or tax consultants or advisors; and (3) her immediate family, provided that all such persons with whom she discusses this AGREEMENT promise in advance to keep the information that may be revealed to them confidential and not to disclose it to others. 6 Provided, however, that if disclosure of the existence or terms of this AGREEMENT is specifically required by law, Executive shall notify EVEREST's general counsel, in writing, of any such required disclosure not less than 10 days (or such shorter period if the time set for disclosure is less than 10 days) prior to the time set for disclosure, in order to allow EVEREST sufficient time to move to quash. Notwithstanding anything contained hereunto the contrary, Executive is permitted to disclose the existence and terms of this Agreement as reasonably necessary or appropriate in connection with her expert witness, consultant, counsel, arbitrator, umpire and/or mediator career. 11. ARBITRATION. EVEREST and Executive expressly agree that any and all disputes, controversies or claims arising out of this AGREEMENT, or concerning its meaning, application or enforceability, shall be determined exclusively by final and binding arbitration before a single arbitrator in Somerset County, New Jersey, under the Model Employment Arbitration Procedures of the American Arbitration Association, and that judgment upon the award rendered by the Arbitrator may be entered in any court of competent jurisdiction. Each party shall share equally the fees and costs of the Arbitrator. Each party shall pay for its or her attorneys' fees and costs including, without limitation, costs of any experts. However, if any party prevails on a statutory claim which entitles the prevailing party to a reasonable attorneys' fee (with or without expert fees) as part of the costs, the Arbitrator may award reasonable fees (with or without expert fees) to the prevailing party in accordance with such statute. Any controversy over whether a dispute is an arbitrable dispute, or as to the interpretation or enforceability of this paragraph with respect to such arbitration, shall be determined by the Arbitrator. 12. RETURN OF PROPERTY. Executive represents she is not in possession of any of the Company's property or business records. 13. APPLICABLE LAW. This AGREEMENT shall be deemed to have been made within the State of New Jersey, and it shall be interpreted, construed, and enforced in accordance with the law of the State of New Jersey, and before the Courts of the State of New Jersey. 14. ENTIRE AGREEMENT; AMENDMENTS, MODIFICATIONS, WAIVERS. This AGREEMENT and the incorporated Special Employment Agreement contain the sole and the entire agreement between Executive and EVEREST, and completely and fully supersede and replace any and all prior contracts, agreements, discussions, representations, negotiations, understandings and any other communications between the parties pertaining to the subject matter hereof. Executive 7 represents and acknowledges that, in executing this AGREEMENT, she has not relied upon any representation or statement made by EVEREST, or its counsel or representatives, with regard to the subject matter of this AGREEMENT, that is not set forth in this AGREEMENT. No other promises or agreements shall be binding unless in writing, signed by the parties hereto, and expressly stated to represent an amendment to this AGREEMENT. This AGREEMENT cannot be amended or modified except by a written document signed by both EVEREST and Executive, and no provision can be waived except by a written document signed by the waiving party. 15. By signing this AGREEMENT, Executive acknowledges: 1. EXECUTIVE HAS READ THIS AGREEMENT COMPLETELY. 2. EXECUTIVE HAS HAD AN OPPORTUNITY TO CONSIDER THE TERMS OF THIS AGREEMENT. 3. EXECUTIVE HAS BEEN ADVISED TO CONSULT WITH AN ATTORNEY OF EXECUTIVE'S CHOOSING PRIOR TO EXECUTING THIS AGREEMENT. 4. EXECUTIVE KNOWS THAT EXECUTIVE MAY BE GIVING UP IMPORTANT LEGAL RIGHTS BY SIGNING THIS AGREEMENT. 5. EXECUTIVE UNDERSTANDS AND MEANS EVERYTHING THAT EXECUTIVE HAS SAID IN THIS AGREEMENT, AND EXECUTIVE AGREES TO ALL ITS TERMS. 6. EXECUTIVE IS NOT RELYING ON EVEREST OR ANY REPRESENTATIVE OF EVEREST TO EXPLAIN THIS AGREEMENT AND RELEASE TO EXECUTIVE. EXECUTIVE HAS HAD AN OPPORTUNITY TO CONSULT AN ATTORNEY OR OTHER ADVISOR TO EXPLAIN THIS AGREEMENT AND ITS CONSEQUENCES TO EXECUTIVE BEFORE EXECUTIVE SIGNED IT, AND EXECUTIVE HAS AVAILED HERSELF OF THIS OPPORTUNITY TO WHATEVER EXTENT EXECUTIVE DESIRED. 7. EXECUTIVE HAS SIGNED THIS AGREEMENT VOLUNTARILY AND ENTIRELY OF EXECUTIVE'S OWN FREE WILL, WITHOUT ANY PRESSURE FROM EVEREST OR ANY REPRESENTATIVE OF EVEREST, OR ANYONE ELSE. 8 IN WITNESS WHEREOF, and intending to be legally bound hereby, this Agreement has been executed as of the 22nd day of March, 2002. EVEREST GLOBAL SERVICES, INC. ON BEHALF OF ITSELF AND ALL AFFILIATED EVEREST COMPANIES By: /s/ THOMAS J. GALLAGHER ------------------------- /s/ JANET J. BURAK - ------------------- Janet J. Burak ***-**-**** - ----------- (Social Security Number) 9 Exhibit A --------- GENERAL RELEASE AND WAIVER I understand that my active employment with Everest Global Services, Inc ("Everest Global Services") will terminate on November 30, 2005. I understand that in consideration for my agreement to the following terms of this General Release and Waiver, I will receive the special bonus payment described in Section 4(c) of the Special Employment Agreement dated as of March ___, 2002. 1. I understand and agree that I will not receive the special bonus payment specified in the Special Employment Agreement unless I execute this General Release and Waiver. 2. I knowingly and voluntarily release and forever discharge Everest Global Services and all of its affiliates, subsidiaries and employees and their officers and directors (hereinafter "Everest") from any and all claims known and unknown, which I, my heirs, executors, administrators and assigns may have including, but not limited to, any claim that arises out of my employment with or the termination of my employment with Everest; or any allegation, claim or violation arising under Title VII of the Civil Rights Act of 1964, as amended; The Civil Rights Act of 1991; the Age Discrimination in Employment Act of 1967; as amended; the Older Workers Benefits Protection Act; The Equal Pay Act of 1963, as amended; the Americans with Disabilities Act of 1990; the Family and Medical Leave Act of 1993; the Civil Rights Act of 1866, as amended; the Worker Adjustment Retraining and Notification Act; the Employee Retirement Income Security Act of 1974; any applicable Executive Order Programs; the Fair Labor Standards Act, or their state or local counterparts; the New Jersey Law Against Discrimination; the Conscientious Employee Protection Act; and any other federal, state or local civil or human rights law or any other local, state or federal law, regulation or ordinance; or under any public policy, contract or tort, or under common law; for wrongful discharge; breach of contract, infliction of emotional distress; defamation; or arising under any policies, practices or procedures of Everest; or any claim for costs, fees or other expenses, including attorneys fees, incurred in these matters. 3. I agree that this General Release and Waiver does not waive or release any rights or claims that I may have under the Age Discrimination in Employment Act of 1967 which arise after the date I execute this General Release and Waiver. 4. I agree not to file any charge or complaint on my own behalf, based upon claims arising from, or attributable in any way to, my employment with or separation from Everest, before any federal, state or local court, or administrative agency, or to participate in any such charge or complaint which may be made by any other person or organization on my behalf. I also agree to withdraw and/or dismiss any such pending charges or complaints. 5. I acknowledge that I have been advised I have fourteen (14) days to consider this General Release and Waiver, and I acknowledge that Everest has advised me in writing to consult with an attorney regarding the legal consequences of the General Release and Waiver. I have had an opportunity to discuss the terms of this General Release and Waiver with an attorney and I understand the legal consequences of the General Release and Waiver. 6. I agree that neither this General Release and Waiver, nor the furnishing of the consideration for this General Release and Waiver, shall be deemed or construed at any time to be an admission by either Everest or myself of any improper or unlawful conduct. 7. I agree that if I violate this General Release and Waiver by suing Everest or those associated with Everest, I will pay all costs and expenses of defending against the suit incurred by Everest or those associated with Everest, including reasonable attorneys' fees. 8. I agree that this General Release and Waiver is confidential and agree not to disclose any information regarding the terms of this General Release and Waiver, except to an attorney with whom I choose to consult regarding this General Release and Waiver or as required by law. BY SIGNING THIS GENERAL RELEASE AND WAIVER, I STATE THAT: A. I HAVE READ IT. B. I UNDERSTAND IT AND KNOW THAT I AM GIVING UP IMPORTANT RIGHTS, INCLUDING BUT NOT LIMITED TO, RIGHTS UNDER THE AGE DISCRIMINATION IN EMPLOYMENT ACT OF 1967, AS AMENDED, TITLE VII OF THE CIVIL RIGHTS ACT OF 1964, AS AMENDED, THE EQUAL PAY ACT OF 1963, AND THE AMERICANS WITH DISABILITIES ACT OF 1990. C. I AGREE WITH EVERYTHING IN IT. D. I HAVE BEEN ADVISED TO CONSULT WITH AN ATTORNEY BEFORE EXECUTING IT. E. I HAVE BEEN GIVEN WHAT I CONSIDER A SUFFICIENT PERIOD OF TIME TO REVIEW AND CONSIDER THIS GENERAL RELEASE AND WAIVER BEFORE SIGNING IT. F. I HAVE SIGNED THIS GENERAL RELEASE AND WAIVER KNOWINGLY AND VOLUNTARILY. G. I AGREE THAT THE PROVISIONS OF THIS GENERAL RELEASE AND WAIVER MAY NOT BE AMENDED, WAIVED, CHANGED, OR MODIFIED EXCEPT BY AN INSTRUMENT IN WRITING SIGNED BY AN AUTHORIZED REPRESENTATIVE OF EVEREST. DATE -------------------- ---------------------------------- SIGNATURE ---------------------------------- PRINT NAME EX-11 6 ex111.txt EX 11.1 COMPUTATION OF PER SHARE EARNINGS Exhibit 11.1 EVEREST RE GROUP, LTD. COMPUTATION OF EARNINGS PER SHARE FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (DOLLARS IN THOUSANDS)
Years Ended December 31, ----------------------------------------------------- 2002 2001 2000 ----------------------------------------------------- Net Income $ 231,303 $ 99,018 $ 186,379 ============ ============ ============ Weighted average common and effect of dilutive shares used in the computation of net income per share: Average shares outstanding - basic 50,325,465 46,173,895 45,873,232 Effect of dilutive shares: Options outstanding 807,230 914,630 471,951 Options exercised 4,916 7,251 12,780 Options cancelled 1,247 17,963 540 ------------ ------------ ------------ Average share outstanding - diluted 51,138,858 47,113,739 46,358,503 Net Income per common share: Basic $ 4.60 $ 2.14 $ 4.06 Diluted $ 4.52 $ 2.10 $ 4.02
EX-21 7 ex211.txt EX 21.1 LIST OF SUBSIDIARIES EXHIBIT 21.1 SUBSIDIARIES OF EVEREST RE GROUP, LTD. -------------------------------------- The following is a list of Everest Re Group, Ltd. subsidiaries: Name of Subsidiary Jurisdiction of Incorporation - ------------------ ----------------------------- Everest Reinsurance Holdings, Inc. Delaware Everest Reinsurance Company Delaware Everest Indemnity Insurance Company Delaware Everest Insurance Company of Canada Canada Everest National Insurance Company Arizona Everest Re Holdings, Ltd. Bermuda Everest Security Insurance Company Georgia Mt. McKinley Managers, L.L.C. New Jersey WorkCare Southeast, Inc. Alabama WorkCare Southeast of Georgia, Inc. Georgia Mt. McKinley Insurance Company Delaware Everest Reinsurance (Bermuda), Ltd. Bermuda Everest Global Services, Inc. Delaware Everest Re Capital Trust Delaware Everest International Reinsurance, Ltd. Bermuda Everest Re Advisors, Ltd. - Bermuda Bermuda Everest Advisors (Ireland) Limited Ireland EX-23 8 ex231.txt EX 23.1 CONSENT OF INDEPENDANT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Forms S-8 (File No. 333-1972 and File No. 333-05771) and Form S-3 (File No. 333-97367) of Everest Re Group, Ltd. of our report dated February 6, 2003, relating to the financial statements and financial statement schedules, which appears in this Form 10-K. We also consent to the reference to us under the heading "Selected Financial Data" in this Form 10-K. New York, New York March 14, 2003 EX-99.1 9 ex991.txt EX 99.1 CERTIFICATION Exhibit 99.1 EVEREST RE GROUP, LTD. c/o ABG Financial & Management Services, Inc. Parker House Wildey Business Park, Wildey Road St. Michael, Barbados Telephone: (246) 228-7398 March 17, 2003 Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Re: Certification pursuant to 18 U.S.C.ss.1350, as enacted by Section 906 of the Sarbanes-Oxley Act of 2002 ----------------------------------------------------------- Ladies and Gentlemen: In connection with the Annual Report on Form 10-K for the year ended December 31, 2002 of Everest Re Group, Ltd., a company organized under the laws of Bermuda (the "Company"), filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned hereby certify, pursuant to 18 U.S.C. ss. 1350, as enacted by section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934, and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ JOSEPH V. TARANTO ------------------------------------ Joseph V. Taranto Chairman and Chief Executive Officer /s/ STEPHEN L. LIMAURO ------------------------------------ Stephen L. Limauro Executive Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----