-----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, VeXQ+iiWFPzi4PTJRb4CDmaIDTyg1vkwkWUtJ+L5o8ihAOTEW2Bh5NKvaNfBV5wb oFBYn2ivaOHhjPlQUg0WgA== /in/edgar/work/20000822/0000912047-00-000022/0000912047-00-000022.txt : 20000922 0000912047-00-000022.hdr.sgml : 20000922 ACCESSION NUMBER: 0000912047-00-000022 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000822 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRENWICK GROUP INC CENTRAL INDEX KEY: 0000787952 STANDARD INDUSTRIAL CLASSIFICATION: [6331 ] IRS NUMBER: 061152790 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-15389 FILM NUMBER: 707757 BUSINESS ADDRESS: STREET 1: ONE CANTERBURY GREEN CITY: STAMFORD STATE: CT ZIP: 06901 BUSINESS PHONE: 2033535500 10-K/A 1 0001.txt AMENDMENT NO. 1 ON FORM 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 31, 1999. OR | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period to ---------------------- ---------------------- Commission file number 1-15389 TRENWICK GROUP INC. (Exact name of registrant as specified in its charter) Delaware 06-1152790 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Canterbury Green, Stamford, Connecticut 06901 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (203) 353-5500 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered Common Stock, par value $.10 per share New York Stock Exchange Preferred Stock Purchase Rights 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. |_| The aggregate market value on March 24, 2000 of the voting stock held by non-affiliates of the registrant was $224,696,190. The number of shares outstanding of each of the issuer's classes of common stock as of the close of the period covered by this report: Class Outstanding at March 24, 2000 ----- ----------------------------- Common Stock, $.10 par value 16,295,207 Certain portions of the registrant's definitive proxy statement relating to its annual meeting of stockholders scheduled to be held on May 18, 2000 are incorporated by reference into Part III of this report and certain portions of the registrant's annual report to stockholders are incorporated by reference into Parts II and IV of this report. AMENDMENT NO. 1 ON FORM 10-K/A TO THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 This Amendment No. 1 on Form 10-K/A is being filed to correct a printer transmission error in the tables listing gross premiums written and net premiums written on page 2, to include additional disclosure in the second paragraph on page 12, to revise the classification of certain assets and related cash flows in the 1999 column in Schedule II - Condensed Financial Information of Registrant on pages S-1 and S-3, to amend the presentation of certain information in Schedule V - Valuation and Qualifying Accounts on page S-5, to revise the Report of Independent Accountants on Financial Statement Schedules on page S-6 and to revise certain portions of management's discussion and analysis and footnotes to the financial statements to clarify certain disclosures. The revised portions of the Annual Report on Form 10-K are set forth in Attachment A. SIGNATURES Pursuant to the Requirements of Section 13 or 15(d) of Securities Exchange Act of 1934, the registrant has duly caused this Amendment No. 1 on Form 10-K/A to be signed on its behalf by the undersigned, thereunto duly authorized. TRENWICK GROUP INC. (Registrant) By /s/ James F. Billett, Jr. ------------------------------ James F. Billett, Jr. Chairman, President and Chief Executive Officer Dated: August 22, 2000 Attachment A PART I Item 1. Business General Background and History Trenwick Group Inc. ("Trenwick") is a specialty insurance underwriting organization with multiple distribution platforms in insurance and reinsurance operating through its subsidiaries located in the United States and the United Kingdom. Trenwick's four principal operating units are Trenwick America Reinsurance Corporation ("Trenwick America Re"), which provides treaty reinsurance to insurers of property and casualty risks in the United States; Trenwick International Limited ("Trenwick International"), which underwrites treaty and facultative reinsurance as well as specialty insurance on a worldwide basis; Chartwell Managing Agents Limited ("Chartwell Managing Agents"), Trenwick's managing agency at Lloyd's; and Canterbury Financial Group Inc. ("Canterbury Financial"), which underwrites U.S. property and casualty insurance through specialty program administrators. Trenwick was incorporated in the State of Delaware in 1985. Trenwick America Re, a Connecticut corporation, operated as a subsidiary of Trenwick America Corporation from 1983 through 1985 and was acquired by Trenwick in 1985 as a result of a corporate restructuring. Trenwick acquired Trenwick International in February 1998 and Chartwell Re Corporation ("Chartwell") in October 1999. In connection with the acquisition of Chartwell, Trenwick acquired Chartwell Managing Agents, Chartwell Reinsurance Company ("Chartwell Reinsurance"), whose reinsurance business was assumed by Trenwick America Re, and The Insurance Corporation of New York ("INSCORP") and Dakota Specialty Insurance Company ("Dakota"), both of which are operating companies for Canterbury Financial. In addition, Trenwick owns several inactive Bermuda subsidiaries. On December 19, 1999, Trenwick announced that it had entered into a definitive agreement to combine with LaSalle Re Holdings Limited, with shareholders of each company to receive shares in a new Bermuda holding company to be named Trenwick Group Ltd. This transaction is expected to be completed in the second quarter of 2000. Each of Trenwick's operating insurance company subsidiaries is rated "A" (Excellent) by A.M. Best Company and has been assigned an A+ financial strength rating by Standard & Poor's. All of Chartwell Managing Agents' syndicates enjoy the benefit of the ratings of Lloyd's, which is rated "A" (Excellent) by A.M. Best Company and has an A+ claims paying ability rating from Standard & Poor's. These ratings are based upon factors that may be of concern to policy or contract holders, agents and intermediaries, but may not reflect the considerations applicable to an equity investment in a reinsurance or insurance company. A change in any such rating is at the discretion of the respective rating agencies. Trenwick's gross and net premium writings for its operational units are as follows: 1 1999 1998 1997 --------------- --------------- ------------ Gross Premiums Written Trenwick America Re $ 210,921(1) $ 218,249 $ 248,662 Trenwick International 171,698 105,114(2) - Chartwell Managing Agents 84,834(3) - - Canterbury Financial 38,088(4) - - --------------- --------------- ------------ Total $ 505,541 $ 323,363 $ 248,662 =============== =============== ============ Net Premiums Written Trenwick America Re $ 155,108(1) $ 169,112 $ 195,230 Trenwick International 129,399 81,107(2) - Chartwell Managing Agents 64,462(3) - - Canterbury Financial 5,641(4) - - --------------- --------------- ------------ Total $ 354,610 $ 250,219 $ 195,230 =============== =============== ============ (1) Includes reinsurance business of Chartwell Reinsurance and its subsidiaries since its acquisition on October 27, 1999. (2) Includes Trenwick International business since its acquisition on February 27, 1998. (3) Includes Chartwell Managing Agents business since its acquisition on October 27, 1999. (4) Includes Canterbury Financial business since its acquisition on October 27, 1999. Trenwick America Reinsurance Corporation Trenwick America Re, which comprised 44% of Trenwick's total net premiums written in 1999, underwrites United States treaty reinsurance, which accounts for the majority of its business, as well as a small amount of facultative reinsurance. In this section, Trenwick America Re's 1999 results include the reinsurance business of Chartwell Reinsurance and its subsidiaries since its acquisition on October 27, 1999. Trenwick America Re generally obtains all of its business through brokers and reinsurance intermediaries which seek its participation on reinsurance being placed for their customers. In underwriting reinsurance, Trenwick America Re does not target types of clients, classes of business or types of reinsurance. Rather, it selects transactions based upon the quality of the reinsured, the attractiveness of the reinsured's insurance rates and policy conditions and the adequacy of the proposed reinsurance terms. Trenwick America Re's commitment is currently limited to $2,500,000 per contract on casualty treaty business and $1,500,000 on property business. Larger commitments are subject to Trenwick's Underwriting Committee referral process. 2 Trenwick America Re's net premiums written by line of business are set forth in the following table for the periods indicated. Trenwick America Reinsurance Corporation Net Premiums Written By Lines of Business (in thousands) 1999(1) 1998 1997 ---------------- -------------- ----------- Casualty Automobile Liability $ 17,831 $ 51,299 $ 50,187 Errors and Omissions 45,557 36,655 40,063 General Liability 22,170 17,743 20,795 Accident and Health 17,922 11,014 6,326 Medical Malpractice 3,422 7,700 10,293 Workers' Compensation 8,297 3,025 18,328 Products Liability 1,834 2,312 1,743 Other Casualty 12,431 2,697 9,133 ---------------- -------------- ----------- Total Casualty 129,464 132,445 156,868 ---------------- -------------- ----------- Property 25,644 36,667 38,362 ---------------- -------------- ----------- Total $ 155,108 $ 169,112 $ 195,230 ================ ============== =========== (1)Includes reinsurance business of Chartwell Reinsurance and its subsidiaries since its acquisition on October 27, 1999. The major lines of reinsurance currently written by Trenwick America Re are automobile liability, errors and omissions, general liability and accident and health. Together these lines account for an aggregate of at least 67% of its net premiums written in all years indicated. The overall decline in net premiums written since 1997 is a result of three principal causes. Competition among primary companies has caused cedants to reduce their own premium writings or restructure their reinsurance programs, reducing the amount of reinsurance they purchase. As a result of consolidation within the industry, many ceding companies are now larger and financially stronger, enabling them to retain more risk. In addition, increasingly intense competition in the reinsurance markets has driven reinsurance prices on a number of accounts below pricing levels which Trenwick America Re will accept. The 65% decline in automobile liability net premium writings in 1999 resulted from the non-renewal of two significant accounts, one of which was commuted in the fourth quarter of 1999. Accident and health net premiums written increased by 63% compared to 1998 as a result of Trenwick America Re's strategic alliance with Duncanson and Holt. This account was non-renewed in 2000 following the sale of Duncanson and Holt. In 1999, the amount of property business, including automobile physical damage, underwritten by Trenwick America Re remained constant as a percentage of total net written premiums. Three ceding companies accounted for approximately 25%, 38%, and 32% of Trenwick America Re's gross premiums written in 1999, 1998 and 1997, respectively. During 1999, Duncanson and Holt, American International Group and CNA Insurance Companies accounted for 11%, 7% and 7%, respectively, of Trenwick America Re's gross premiums written. While Trenwick America Re believes that the loss of these accounts will not have a material adverse effect on the business and operations of Trenwick, Trenwick does not believe that such a loss would have a long-term adverse effect because of Trenwick's competitive position within the reinsurance market and the availability of business from other brokers and ceding companies. Further, Trenwick believes that it will continue to underwrite new business to replace the accounts. 3 Trenwick International Limited Trenwick International's business, which accounted for 36% of Trenwick's total net premiums written in 1999, consists principally of insurance and facultative reinsurance of specialty classes. Trenwick International also underwrites property and casualty treaty reinsurance. In the latter part of 1998, Trenwick International opened a branch office in Paris which specializes in facultative reinsurance of large, technically complex property risks. Premiums written by the Paris branch in 1999 were not material. Trenwick International also obtains all of its business through brokers. Trenwick International's business consists of Specialist Risk Underwriting ("SRU") which includes direct insurance, facultative reinsurance and treaty reinsurance. The following table reflects Trenwick International's net premiums written by type of business for 1999 and 1998. International Net Premiums Written By Type of Business (dollars in thousands) 1999 1998 ------------------------------ ---------------------------- SRU 98,926 76 % 83,397 83 % Treaty 30,473 24 % 17,385 17 % -------------- ------------ -------------- ----------- Total $ 129,399 100 % 100,782 100 % ============== ============ ============== =========== Specialist Risk Underwriting SRU underwrites business in both London and Paris. Trenwick's branch office in Paris was opened in September of 1998. The principal lines of business underwritten in 1999 and 1998 include property, engineering, accident and health professional indemnity, financial institutions, liability, extended warranty and yacht hull. In 1999, approximately 53% of Trenwick International's net premiums were written directly as insurance. Trenwick's Paris branch specializes in large, complex property risks that require a high degree of underwriting expertise. Trenwick International generally underwrites this business, which includes large manufacturing facilities, construction projects as well as both onshore and offshore energy risks, as facultative reinsurance, but can also function directly as an insurer. The Paris branch benefits from a pool of underwriters trained as engineers and has emerged as a center for this type of technical underwriting. Treaty Trenwick International's treaty business includes liability business, which accounted for approximately 51% of treaty business in 1999, as well as property and credit business. Treaty is written both on a proportional and non-proportional basis. 4 Chartwell Managing Agents Trenwick participates in the Lloyd's market through Chartwell Managing Agents, which is a managing agent at Lloyd's and through four Lloyd's corporate members. Chartwell Managing Agents receives fees and profit commissions in respect of the underwriting and administrative services it provides to the Lloyd's underwriting syndicates that it manages. For the 2000 year of account, Chartwell Managing Agents manages three syndicates with a total underwriting capacity of approximately $377.1 million. In 1998 and 1999, Chartwell Managing Agents sold to third parties the rights to manage syndicates 866 (motor), 947 (non-marine) and 994 (non-marine) and combined into a single syndicate for the 2000 year of account the remaining non-life syndicates. Trenwick retains the benefits and obligations with respect to its Lloyd's corporate member participation interests in those syndicates for the open years of account at the time of the sale. Trenwick's Lloyd's corporate members participated on three Lloyd's syndicates for the 2000 year of account, providing an aggregate of approximately $350.1 million of capacity to those syndicates. Approximately 93% of Chartwell Managing Agents syndicates' 2000 year of account capacity was supplied by Trenwick. Classes of business covered by Chartwell Managing Agents' syndicates include marine, non-marine property, non-marine liability, motor, aviation and life. The table set forth below shows the gross premiums written for Trenwick's Lloyd's corporate members for the periods indicated. All amounts in the table below are presented in accordance with U.S. generally accepted accounting principles ("GAAP"). Trenwick's Lloyd's Corporate Members Gross Premiums Written by Lloyd's Market Segment (dollars in thousands)(1) Year Ended December 31, ---------------------------------------------- 1999 1998 ----------------------- -------------------- Amount % of Total Amount % of Total ---------- ----------- ---------- --------- Motor........................ $ 37,370 17.7% $ 36,212 49.9% Non-Marine................... 140,337 66.5 31,121 42.9 Aviation..................... 19,802 9.4 3,194 4.4 Marine....................... 12,350 5.9 1,757 2.4 Life......................... 1,092 .5 289 0.4 ---------- ----------- ---------- --------- Total........................ $ 210,951 100.0 % $ 72,573 100.0% ========== =========== ========== ========= (1) Business at Lloyd's is conducted in pounds sterling. The dollar amounts shown here have been converted from pounds sterling at the average exchange rate for each of the years presented. Data shown for 1998 and that portion of 1999 prior to October 27, 1999 is not included in Trenwick's financial statements because Trenwick acquired Chartwell Managing Agents and its related Lloyd's corporate members on October 27, 1999. Canterbury Financial Group Canterbury Financial Group develops insurance programs through specialty production sources with a focus on a specific line or lines of business, with a limited geographic emphasis, and where the program administrator's compensation is adjusted based on the underwriting results of the business. Canterbury Financial Group evaluates each business relationship based upon the underwriting experience and operational expertise of the production source. Canterbury Financial Group periodically performs underwriting, claims and operational audits of each of its production sources. Canterbury Financial Group's gross written premiums grew 32.7%, 4.3% and 81.3% for the years ended December 31, 1999, 1998 and 1997, respectively, over the prior year. The increases in premium reflect the geographic expansion of existing programs as well as the development of new programs during the periods shown. 5 The table set forth below shows the gross premiums written for Canterbury Financial Group for the periods indicated:
Canterbury Financial Group Gross Premiums Written by Line of Business (dollars in thousands)(1) Year Ended December 31, ------------------------------------------------------------------------------- 1999 1998 1997 ------------------------ ------------------------- ------------------------ Amount Total Amount Total Amount Total ----------- ----------- ----------- ----------- ----------- ----------- Commercial Multiple Peril......$ 41,909 28.4% $ 45,737 41.2% $ 48,404 45.4 % General Liability.............. 36,743 25.0 31,575 28.4 30,418 28.6 Automobile..................... 46,471 31.5 23,354 21.0 22,267 20.9 Workers Compensation........... 12,589 8.5 4,224 3.8 4,169 3.9 Homeowners and Other........... 9,786 6.6 6,241 5.6 1,285 1.2 ------------ ----------- ----------- ----------- ----------- ----------- Total..........................$ 147,498 100.0% $ 111,131 100.0% $ 106,543 100.0 % ============ =========== =========== =========== =========== ===========
(1) Data shown for 1998 and that portion of 1999 prior to October 27, 1999 is not included in Trenwick's financial statements because Trenwick acquired Canterbury Financial on October 27, 1999. During the year ended December 31, 1999, Canterbury Financial Group underwrote approximately 64% of its gross premiums through three managing general agents, of which Florida Intracoastal Underwriters accounted for approximately 31%, HDR Insurance Services accounted for approximately 22% and Inter-Reco accounted for approximately 11%. No other managing general agent accounted for more than 10% of Canterbury Financial Group's gross insurance premiums written for such period. In order to reduce the potential adverse effect arising from the termination of any specific business relationship, Canterbury Financial Group continues to seek to establish and develop relationships with a large number of managing general agents. While management believes that its relationships with its managing general agents are satisfactory, the termination of all or a substantial number of these relationships could have a material adverse effect on the business and operations of Canterbury Financial Group. Marketing Trenwick generally obtains its business through insurance and reinsurance brokers which represent the ceding company and clients in negotiations for the purchase of insurance or reinsurance. The process of effecting a brokered placement typically begins when a client or ceding company enlists the aid of a broker in structuring an insurance or reinsurance program. Often the various parties will consult with one or more lead underwriters as to the pricing and contract terms of the protection being sought. Once the terms quoted by the lead underwriter have been approved, the broker will offer participation to qualified insurers or reinsurers until the program is fully subscribed at terms agreed to by all parties. 6 Trenwick pays such intermediaries or brokers commissions representing negotiated percentages of the premium it writes. These commissions constitute part of Trenwick's total acquisition costs and are included in its underwriting expenses. Brokers do not have the authority to bind Trenwick America Re with respect to agreements. Under certain limited circumstances, selected administrators have the authority to bind Trenwick International, Chartwell Managing Agents and Canterbury Financial Group business. These administrators are subject to periodic financial and operational reviews. Trenwick does not commit in advance to accept any portion of the business that brokers submit to it. Business from any company, whether new or renewal, is subject to acceptance by Trenwick. During 1999, three reinsurance brokers, AON Reinsurance Agency, Guy Carpenter and E. W. Blanch generated 37%, 16% and 8%, respectively, of Trenwick America Re's gross written premiums. These brokers are among the ten largest brokers in the insurance and reinsurance industry. Loss of all or a substantial portion of the business provided by Trenwick's brokers could have a material adverse effect on the business and operations of Trenwick. Trenwick does not believe, however, that the loss of such business would have a long-term adverse effect because of Trenwick's competitive position within the broker insurance and reinsurance market and the availability of business from other brokers. Underwriting Trenwick's underwriting philosophy emphasizes a transactional approach to underwriting in which any insurance or reinsurance transaction for any line of property or casualty business is considered on its own merits. The underwriter's primary objective is to assess the potential for an underwriting profit. The risk assessment process undertaken by Trenwick's underwriters involves a comprehensive analysis of historical data, when available, and estimates of future value of loss costs which may not be evident in the historical data. The factors which Trenwick considers include the type of risk, details of the underlying insurance coverage provided, adequacy of pricing using actuarial analysis and the terms and conditions. With respect to its domestic operations which comprises fewer but significantly larger accounts, Trenwick frequently conducts underwriting and claims audits of ceding companies to assist it in evaluating the information submitted by the ceding companies, before agreeing to participate in a reinsurance transaction. Trenwick has established formal underwriting policy standards for both domestic and international operations. This process involves pre-binding reviews of individual material transactions by its senior underwriting staff. Underwriting policies for insurance and reinsurance transactions are supplemented by conducting periodic internal audits of each underwriting department to ensure compliance with underwriting policies and procedures. Competition Trenwick competes with numerous major international and domestic insurance and reinsurance companies. These competitors, many of which have substantially greater financial and staff resources than Trenwick, include independent insurance and reinsurance companies, subsidiaries or affiliates of established insurance companies, reinsurance departments of certain commercial insurance companies and underwriting syndicates. Competition in the types of business which Trenwick underwrites is based on many factors. These factors include the perceived overall financial strength of the insurer or reinsurer, rates charged, other terms and conditions, agency ratings (including A.M. Best Company and Standard & Poor's), service offered, speed of service (including claims payment) and perceived technical ability and experience of staff. The number of jurisdictions in which an insurer or reinsurer is licensed or authorized to do business is also a factor. 7 The financial security of insurers and reinsurers has emerged as a key issue throughout the 1990's. To be accepted by clients, and by ceding companies and their brokers, insurers and reinsurers must demonstrate higher levels of financial security and solvency than were previously required. Transactions tend to have fewer and larger participants, which may negatively affect the availability of underwriting opportunities for Trenwick. Trenwick's management believes that the insurance and reinsurance industry, including the broker market, will continue to undergo further consolidation and that size and financial strength will continue to be significant factors in effective competition. Claims Administration Claims are managed by Trenwick's professional claims staff whose responsibilities include the review of initial loss reports, creation of claim files, determination of whether further investigation is required, establishment and adjustment of case reserves and payment of claims. In addition, the claims staff conducts comprehensive claims audits of both specific claims and overall claims procedures at the offices of selected brokers and ceding companies. In certain instances, a claims audit may be performed prior to assuming reinsurance business as part of a comprehensive risk evaluation process. For insurance business, Trenwick's claim staff uses their own judgement as well as advice from lawyers and loss adjusters where appropriate. In connection with the acquisition of Chartwell, Trenwick acquired an environmental claims unit to evaluate the complex toxic tort and latent injury claims resident in one of Chartwell's subsidiaries, The Insurance Corporation of New York. Unpaid Claims and Claims Expenses General Insurers and reinsurers establish claims and claims expense reserves representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Claims and claims expense reserves have two components: case reserves, which are reserves for reported claims, and incurred but not reported ("IBNR") reserves, which are reserves for claims not yet reported. Significant periods of time may elapse between the occurrence of an insured claim, the reporting of the claims to the insurer and the subsequent reporting of the claims to the reinsurer, the insurer's payment of that claim, and later payments by the reinsurer. Trenwick first establishes its case reserves for reported claims when it receives notice of the claim. It is Trenwick's policy to establish reserves for reported claims in an amount equal to the greater of the reserve recommended by the ceding company or the claim as estimated by Trenwick's claims personnel. Trenwick periodically conducts investigations to determine if the amount reserved by the ceding company is appropriate or should be adjusted. During the claim settlement period, which may be many years, additional facts regarding individual claims may become known. As Trenwick learns additional facts, it may become necessary to refine and adjust upward or downward the estimated reserves on a claim, and even then the ultimate net reserve may be less than or greater than the revised estimates. Trenwick does not discount any of its reserves for reported or unreported claims in any line of its business for anticipated investment income. 8 Actuarial Methods Trenwick utilizes the two most common methods of actuarial evaluation used within the insurance industry, the Bornhuetter-Ferguson method and the loss development method. The Bornhuetter-Ferguson method involves the application of selected loss ratios to Trenwick's earned premiums to determine estimates of ultimate expected loss and loss adjustment expenses for each underwriting year. Multiplying expected losses by underwriting year by a selected loss reporting pattern gives an estimate of reported and unreported IBNR losses. When the IBNR is added to the loss and loss adjustment expense amounts with respect to claims that have been reported to date, an estimated ultimate expected loss results. This method provides a more stable estimate of IBNR that is insulated from wide variations in reported losses. In contrast, the loss development method extrapolates the current value of reported losses to ultimate expected losses by using selected reporting patterns of losses over time. The selected reporting patterns are based on historical information (organized into loss development triangles) and are adjusted to reflect the changing characteristics of the book of business written by Trenwick. Trenwick provides capital to its Lloyd's corporate members, which support the underwriting capacity of the Lloyd's syndicates managed by Chartwell Managing Agents. Loss reserves for this business are established using methods similar to those used by Trenwick for its operating insurance company subsidiaries. Chartwell Managing Agents has engaged Bacon & Woodrow London Market Services Ltd. ("B&W"), an independent actuarial consulting firm, to review the loss reserves and prepare an actuarial opinion for each of its syndicates, including the actuarial opinion required by Lloyd's solvency regulations. The B&W opinions, which are prepared solely for the use of Lloyd's regulators and are only to be relied upon by Chartwell Managing Agents, assist its syndicates in establishing appropriate reserve estimates for both the reinsurance to close and the open years of account. In the reserve setting process, Trenwick includes provisions for inflation and "social inflation" if appropriate, as losses are generally not determined until some time in the future. Trenwick continually monitors legislative activity and evaluates the potential effect of any legislative changes on its reserve liabilities. Trenwick's reserves are carried at the full amount estimated for ultimate expected losses and loss adjustment expense without any discount to reflect the time value of money in accordance with both statutory accounting practices and GAAP. Trenwick's actuarial department regularly performs loss reserve analyses for its operating insurance company subsidiaries. 9 Reserve Analysis The following table presents the development of Trenwick's net unpaid claims and claims expenses for 1989 through 1999. The top line of the table shows the net unpaid claims and claims expenses at the balance sheet date for each of the indicated years. This reflects the net estimated amounts of claims and claims expenses for claims arising in that year and in all prior years that are unpaid at the balance sheet date, including claims that had been incurred but not yet reported to Trenwick. The upper portion of the table shows the net cumulative subsequently paid amounts as of successive years with respect to that liability. The middle portion of the table shows the net re-estimated amount of the previously recorded net unpaid claims and claims expenses based on experience as of the end of each succeeding year. The estimates change as more information becomes known about the frequency and severity of claims for individual years. A redundancy (deficiency) exists when the net re-estimated liability at each December 31 is less (greater) than the prior net liability estimate. The net "Cumulative Redundancy (Deficiency)" depicted in the table for any particular calendar year represents the aggregate change in the initial net estimates over all subsequent calendar years. The lower portion of the table presents a reconciliation of the net unpaid claims and claims expenses as of the end of the year with the related gross unpaid claims and claims expenses as of December 31, 1991 through 1999. Additionally, the table presents a reconciliation of the gross re-estimated unpaid claims and claims expenses as of the end of the latest re-estimation year, with separate disclosure of the related re-estimated reinsurance recoverable on unpaid claims and claims expenses. The "gross cumulative redundancy" depicted in the table for the calendar years 1991 through 1999 represents the aggregate change in the initial gross estimates over all subsequent calendar years. 10 DEVELOPMENT OF UNPAID CLAIMS AND CLAIMS EXPENSES (in thousands)
- ---------------------------------------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 1994 1993 1992 - ---------------------------------------------------------------------------------------------------------------------------------- Net unpaid claims and claims expenses, end of year $1,207,436 $449,264 $ 379,351 $386,887 $327,001 $294,008 $268,091 $266,685 Cumulative amount of net liability paid as of: One year later 172,674 104,718 94,197 46,860 61,804 52,300 52,260 Two years later 194,188 162,565 110,289 81,417 90,382 93,312 Three years later -- 215,803 149,810 121,133 89,445 118,345 Four years later -- -- 178,919 142,485 112,119 111,174 Five years later -- -- -- 156,204 124,096 125,847 Six years later -- -- -- -- 134,535 133,502 Seven years later -- -- -- -- -- 139,779 Eight years later -- -- -- -- -- -- Nine years later -- -- -- -- -- -- Ten years later -- -- -- -- -- -- Net liability re-estimated as of: One year later 463,892 372,176 381,521 322,562 291,943 267,644 255,379 Two years later 383,584 374,336 317,199 279,561 263,473 255,379 Three years later 381,463 308,700 274,283 246,367 252,458 Four years later -- -- 309,282 265,041 241,478 236,009 Five years later -- -- -- 266,583 229,742 230,488 Six years later -- -- -- -- 230,824 222,094 Seven years later -- -- -- -- -- 223,473 Eight years later -- -- -- -- -- -- Nine years later -- -- -- -- -- -- Ten years later -- -- -- -- -- -- Net cumulative redundancy (deficiency) (14,628) (4,233) 5,424 17,719 27,425 37,267 43,212 Percentage (1)% 1% 5% 9% 14% 16% Gross Liability, end of year 682,428 518,387 467,177 411,874 389,298 354,582 351,897 Reinsurance recoverable 233,164 139,036 80,290 84,873 95,290 86,491 85,212 Net liability, end of year 449,264 379,351 386,887 327,001 294,008 268,091 266,685 Gross re-estimated liability-latest 719,143 521,011 462,384 393,765 339,514 293,613 288,355 Re-estimated recoverable-latest 255,251 137,427 80,921 84,483 72,931 62,789 64,882 Net re-estimated liability-latest 463,892 383,584 381,463 309,282 266,583 230,824 223,473 Gross cumulative redundancy (deficiency) (36,715) (2,624) 4,793 18,109 49,784 60,969 63,542 - -------------------------------------------------------------------------- 1991 1990 1989 - -------------------------------------------------------------------------- Net unpaid claims and claims expenses, end of year $258,774 $245,105 $214,391 Cumulative amount of net liability paid as of: One year later 44,930 42,234 29,407 Two years later 80,725 77,183 60,888 Three years later 111,225 102,590 84,283 Four years later 127,431 124,129 101,597 Five years later 116,224 134,657 116,047 Six years later 127,130 122,089 124,465 Seven years later 132,194 129,100 110,656 Eight years later 137,401 132,888 115,017 Nine years later -- 136,959 117,364 Ten years later -- -- 120,895 Net liability re-estimated as of: One year later 253,781 238,324 206,724 Two years later 243,488 233,565 199,864 Three years later 243,586 223,417 196,232 Four years later 241,600 224,171 188,052 Five years later 225,592 223,172 189,148 Six years later 217,852 213,327 188,884 Seven years later 208,701 205,179 180,619 Eight years later 211,487 199,948 176,778 Nine years later -- 202,578 172,846 Ten years later -- -- 175,362 Net cumulative redundancy (deficiency) 47,287 42,527 39,029 Percentage 18% 17% 18% Gross Liability, end of year 332,503 Reinsurance recoverable 73,729 Net liability, end of year 258,774 Gross re-estimated liability-latest 268,217 Re-estimated recoverable-latest 56,730 Net re-estimated liability-latest 211,487 Gross cumulative redundancy (deficiency) 64,286
11 In evaluating the information in the table on the preceding page, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, if a claim determined in 1991 to be $150,000 was first reserved in 1986 at $100,000, the $50,000 deficiency (actual claim minus original estimate) would be included in the gross cumulative redundancy (deficiency) in each of the years 1986-1991 shown on the preceding page. This table does not present accident or policy year development data. Conditions and trends that have affected the development of liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table. The trend depicted in the table indicates that net unpaid claims and claims expense liability at December 31, 1998 have developed unfavorably due to Trenwick America Re's unfavorable development for claims occurring in accident years 1996 through 1998. Net unpaid claims and claims expenses at December 31, 1999 includes reinsurance recoverable of $46,460,000 under the adverse development cover purchased by Chartwell in connection with its acquisition by Trenwick. For further discussion of unpaid claims and claims expenses, see Notes 4 and 5 of Notes to the Consolidated Financial Statements of Trenwick. Management believes that Trenwick's reserves are adequate. However, the process of estimating reserves is inherently imprecise and involves an evaluation of many variables, including potentially unpredictable social and economic conditions. Accordingly, there can be no assurance that Trenwick's ultimate liability will not vary significantly from amounts reserved. The inherent uncertainties of estimating such reserves are greater for reinsurers than for primary insurers, primarily due to the longer-term reporting nature of the reinsurance business, the diversity of development patterns among different types of reinsurance, the necessary reliance on ceding companies for information regarding reported claims and differing reserving practices among ceding companies. Reserves also include provisions for latent injury or toxic tort claims that cannot be estimated with traditional reserving techniques. Due to inconsistent court decisions in federal and state jurisdictions and the wide variation among insureds with respect to underlying facts and coverage, uncertainty exists with respect to these claims as to liabilities of ceding companies and, consequently, reinsurance coverage. Management believes that Trenwick's exposure to such latent losses is lessened because of its relatively recent entry into the reinsurance business (other than INSCORP), its low historical levels of premium volume prior to the application of exclusions for asbestos and environmental liabilities, its retrocessional programs and the protection afforded by Trenwick's Contingent Interest Notes due June 30, 2006 (the "Contingent Interest Notes") the payment of which is subject to reduction in the event of such adverse reserve development related to INSCORP's business. Reserves for Trenwick's participation in Lloyd's syndicates through its Lloyd's corporate members are included in the 1999 year end reserves. Part of the reserve represents reinsurance to close balances brought forward to the open years of account (for example, 1996 reinsured into the 1997 open year). Favorable or unfavorable development of the prior year's reserves can influence the results of the open years of 1997, 1998 and 1999. Consequently, there can be no assurance as to the adequacy of reserves and the risk of future developments, both favorable and unfavorable, exists. 12 Trenwick's reserves include an estimate of Trenwick's ultimate liability for asbestos and environmental claims. The gross and net unpaid claims and claims expenses for asbestos and environmental claims are as follows: 1999 1998 1997 --------- -------- --------- (in thousands) Unpaid claims and claims expenses gross of reinsurance recoverable, end of year $ 100,131 $ 8,476 $ 8,924 Unpaid claims and claims expenses, net of reinsurance recoverable, end of year 72,092 8,428 8,814 Reinsurance recoverable on unpaid claims and claims expenses, end of year 28,039 48 110 The increase of the gross and net unpaid claims and claims expenses reflect the inclusion of the reserves related to the Chartwell acquisition. Under Trenwick's current interpretation of policy language, management does not believe that it has a material exposure to environmental claims that requires additional reserves beyond its current estimates. Contingent Interest Notes Upon consummation of the acquisition of Chartwell, Trenwick assumed all of Chartwell's obligations under the Contingent Interest Notes, which were originally issued by Piedmont Management Company Inc. to its stockholders just prior to its acquisition by Chartwell in 1995. The Contingent Interest Notes, which mature on June 30, 2006, are designed to provide Trenwick with protection against adverse development of INSCORP's reserves for losses and loss adjustment expenses. In the event there is no adverse development, Trenwick will be required to pay the holders of the CI Notes approximately $55 million in contingent interest. This contingent interest payment is in addition to the $1 million principal amount of the Contingent Interest Notes and interest on such principal amount at 8% per annum (collectively, the "Fixed Amount") which Trenwick in any event must pay at maturity or earlier redemption of the Contingent Interest Notes. In general, assuming the Contingent Interest Notes are settled at maturity, the contingent interest will be equal to $55 million (a) less an amount equal to (i) the amount of any adverse development of the loss and loss adjustment expense reserves and related accounts (including certain reinsurance recoverable, commissions and unearned premiums) of INSCORP recorded as of March 31, 1995, minus (ii) $25 million, (b) plus the amount of certain tax benefits received or recorded by Trenwick as a result of the amount determined pursuant to clause (a) above. The amount so calculated may not be greater than $55 million nor less than a minimum amount equal to the lesser of (a) $10 million less the Fixed Amount and (b) the tax benefits referred to above. In the event that the Contingent Interest Notes are settled prior to maturity, the foregoing formula will in general apply, except that the $55 million maximum amount of the Contingent Interest Notes will be reduced to an amount equal to $55 million discounted back from June 30, 2006 at a discount rate of 8% per annum, compounded annually, and the tax benefits will be calculated in a prescribed manner. The carrying value of the Contingent Interest Notes on Trenwick's consolidated financial statements at December 31, 1999 was $34.7 million, representing the sum of the aggregate principal amount of the Contingent Interest Notes and the present value as of such date of the maximum amount of contingent interest payable on the Contingent Interest Notes at their stated maturity in 2006. 13 During the term of the Contingent Interest Notes, the discounted carrying value of the Contingent Interest Notes will be increased to reflect accretion of (i) interest on the principal amount and (ii) the discounted contingent interest. To the extent that adverse development of INSCORP's reserves (including IBNR reserves) occurs prior to the maturity or redemption of the Contingent Interest Notes, the contingent interest payable on the Contingent Interest Notes (and, therefore, the then-current carrying value of such Contingent Interest Notes) will be reduced. Such reductions in the carrying value of the Contingent Interest Notes would offset in part, in the period in which such adverse development occurs, any reduction in Trenwick's GAAP net income and stockholders' equity resulting from such adverse reserve development (that would, however, still be reflected in Trenwick's statutory underwriting results and in the policyholders' surplus of INSCORP and any parent insurer of INSCORP). At its option, Trenwick may settle the Contingent Interest Notes with shares of common stock of Trenwick instead of payment of cash. For purposes of settlement of the Contingent Interest Notes, such common stock would be valued at 85% of its average closing market price over a specified period prior to the settlement date. However, Trenwick may not settle the Contingent Interest Notes in its common stock unless (i) such stock is registered under the Securities Act of 1933 (or is otherwise freely tradeable other than by certain affiliates of Trenwick), (ii) such stock is listed on a national securities exchange or the NASDAQ National Market and (iii) all Contingent Interest Notes are settled in such common stock. Moreover, Trenwick may not settle the Contingent Interest Notes in its common stock if the Contingent Interest Notes are being settled following acceleration thereof due to an event of default under the Contingent Interest Notes. Reinsurance and Retrocessional Agreements Trenwick enters into reinsurance and retrocessional agreements to reduce its net liability on individual risks, protect against catastrophic losses and maintain acceptable ratios. Trenwick America Re has various retrocessional facilities, all of which are on a treaty basis. These retrocessional facilities include one treaty for Trenwick America Re's facultative casualty reinsurance business, which applies on a risk or account basis, and two for its treaty property business, which protect it against multiple claims arising out of a single occurrence or event. As a result of these facilities, Trenwick America Re's maximum retention generally does not exceed $500,000 per occurrence on facultative business and $2,300,000 per occurrence on property catastrophe business. From 1989 to 1999, Trenwick America Re has purchased aggregated excess of loss ratio treaties from several reinsurers. These facilities provided Trenwick with a layer of protection against adverse results from its domestic casualty business in excess of specified loss ratios. Trenwick did not purchase an aggregate excess of loss ratio treaty for 2000. Trenwick International, as customary with companies operating in the London market, buys large amounts of reinsurance. Reinsurance and retrocessional coverage is customized for each class of business. During 1998, following an increase in its share capital, Trenwick International increased its retention of business by reducing the amount of reinsurance it buys, principally proportional reinsurance treaties with its former parent. Chartwell Managing Agency, as part of its business strategy, has historically purchased a significant amount of reinsurance for the Lloyd's syndicates it manages. Reinsurance is generally purchased to protect the syndicates against extraordinary loss or loss involving one or more underwriting classes. The amount purchased is determined with reference to the syndicates' aggregate exposure and potential loss scenarios. Canterbury Financial Group purchases reinsurance specifically tailored to each of the specialty programs underwritten by its insurance subsidiaries. 14 In connection with the acquisition of Chartwell by Trenwick, Chartwell's insurance company subsidiaries purchased an aggregate excess of loss reinsurance agreement providing up to $100 million in coverage against unanticipated increases in Chartwell's reserves for business written on or before October 27, 1999, the date of completion of the acquisition of Chartwell. Within the $100 million maximum, the protection is limited to $100 million for increased reserves attributable to Chartwell's Lloyd's operations, $25 million for increased reserves attributable to catastrophe and year 2000 losses and $50 million for increased reserves attributable to asbestos and environmental coverage losses. The aggregate excess of loss reinsurance agreement is not cancelable by the reinsurers, London Life and Scandanavian Re and their obligations have been secured by a trust account. The premium payable for this aggregate excess of loss reinsurance agreement was approximately $56 million. Trenwick remains liable with respect to insurance and reinsurance ceded in the event that the insurer or retrocessionaire is unable to meet its obligations. All reinsurers and retrocessionaires must be formally approved by the operating company's Security Committee. The Security Committees re-evaluate the financial condition of Trenwick reinsurers and retrocessionaires at least annually. The evaluation process involves financial analysis of current audited financial data and comparative analysis of such data in accordance with guidelines established by Trenwick. Business may not be conducted with retrocessionaires who are not currently approved by the Security Committees. Trenwick America Re's principal retrocessionaires are Zurich Reinsurance, Continental Casualty Company, Unum Life Insurance Company of America and National Union Fire Insurance Company. Chartwell Re's principal retrocessionaires are Centre Reinsurance (Bermuda) Limited, London Life and Casualty Reinsurance Corp. and Scandinavian Reinsurance Company Limited. INSCORP's largest reinsurers in 1999 were American Reinsurance Company, Navigators Insurance Company and European International Reinsurance Company Limited. Trenwick International has two principal retrocessionaires, Lloyds of London and Transatlantic Re. All these retrocessionaires are rated A (Excellent) or better by A.M. Best Company. At December 31, 1999, Trenwick had no material uncollectible amounts due from its retrocessionaires. Investments The Investment Committee of Trenwick's Board of Directors oversees investments and sets procedures and guidelines for investment strategy. Trenwick's internal staff manage these investments and utilize the services of investment advisers. Trenwick's investment strategy focuses on capital preservation and income predictability. This strategy also requires that the risks associated with these objectives are properly managed. Accordingly, Trenwick emphasizes investment grade debt investments. At December 31, 1999, 79% of Trenwick's investments in debt securities were rated Aa or better. In October 1998, certain securities had their ratings withdrawn by various nationally recognized statistical rating organizations. The servicer of these securities, Commercial Financial Services, Inc., filed for protection under Chapter 11 of the Federal Bankruptcy Code in December 1998. During 1999, Trenwick wrote down the value of these securities by $5.2 million. Trenwick's investment strategy permits an allocation for equity securities. At December 31, 1999, 6% of Trenwick's total investments and cash were invested in common and preferred equities, which consist primarily of securities issued by U.S. and United Kingdom corporations. The primary risk associated with these securities is the exposure to daily market fluctuations. 15 The investments of each of Trenwick's insurance company subsidiaries must comply with the respective insurance laws of the jurisdiction of domicile of that insurance company, and of the other jurisdictions in which it is licensed or authorized. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stock, real estate mortgages and real estate. These laws generally penalize high concentrations of riskier types of assets and high exposures to certain types of issuers. Trenwick invests in three types of structured securities, collateralized mortgage obligations ("CMO"), mortgage-backed securities not backed by U.S. government agencies ("non-agency MBS") and asset-backed securities ("ABS"), each accounting for 5%, 5% and 2%, respectively, of Trenwick's portfolio at December 31, 1999. CMOs consist of planned amortization classes ("PACs") which have been constructed with a certain amount of call protection and CMOs that have lost their PAC protection (sometimes called "broken" or "busted" PACs), due to actual prepayments being significantly higher or lower than originally forecast. These agency backed CMOs are not subject to credit risk, as all holdings are backed indirectly or directly by the Federal government or one of its agencies. The material risk inherent to holding these CMOs is prepayment risk, which relates to the timing of cash flows that result from amortization, whether it accelerated, because of lower interest rates and therefore higher than expected prepayments, or decelerated, because of higher interest rates and therefore lower than expected prepayments. Changes in principal repayments could negatively affect investment income due to the timing of the reinvested funds. Non-agency MBSs are constructed primarily from the securitization of mortgages on commercial or residential real estate and, lacking any agency backing, are inherently subject to credit risk. They also have an element of prepayment risk which is contingent on the structure of each security and its underlying collateral. 93% of the non-agency MBS issues Trenwick has purchased have a rating of A or better from various Nationally Recognized Statistical Rating Organizations. The asset-backed securities owned by Trenwick have primarily credit card and home equity receivables as collateral and are subject also to credit risk. These securities have less cash flow uncertainty than non-agency MBS and CMO issues, because the issuer has the ability to add in new collateral should the asset-backed security experience faster prepayments, or in the event of default on the underlying collateral. 94% of the asset-backed securities owned by Trenwick are rated A or better by various Nationally Recognized Statistical Rating Organizations. The remaining 6% include the asset-backed securities serviced by Commercial Financial Services, Inc. for which ratings have been withdrawn. Trenwick also invests in agency pass-through securities which account for 7% of Trenwick's portfolio at December 31, 1999. As with CMOs, these securities are subject to prepayment risk. Trenwick holds debt securities and cash in a number of currencies. At December 31, 1999, approximately 16% of Trenwick's debt securities and cash were held in U.K. sterling, and the remainder in six other currencies. 16 The table below sets forth the distribution of Trenwick's investments available for sale at December 31, 1999 by type, maturity and quality rating.
Investments (dollars in thousands) Average Estimated Maturity Fair Amortized In Years Value Cost Type (debt securities) U.S. Government bonds 4.3 $ 114,537 $ 114,839 Obligations of states and political subdivisions(1) 6.3 454,993 460,176 Mortgage-backed and asset-backed securities 8.1 288,535 290,801 Debt securities issued by British government 3.7 115,023 117,165 Debt securities issued by other foreign governments 4.9 54,996 55,436 Public utilities 14.7 20,891 21,229 Corporate securities 8.3 259,446 262,855 Certificates of deposit .2 2,940 2,937 ----------- ------------ Total debt securities 6.8 $ 1,311,361 $ 1,325,438 =========== ============ Maturity (debt securities) Due in one year or less .5 94,546 93,913 Due in one year through five 2.9 544,077 545,161 Due after five years through ten years 7.3 482,652 490,465 Due after ten years 19.1 190,086 195,899 ----------- ------------ Total debt securities 6.8 $ 1,311,361 $ 1,325,438 =========== ============ Quality (debt securities) Aaa(2)-U.S. government bonds $ 114,537 $ 114,839 Obligations of states and political subdivisions 349,474 352,936 Mortgage-backed and asset-backed securities 211,980 211,775 Debt securities issued by British government 115,023 117,165 Debt securities issued by other foreign governments 31,402 31,783 Corporate securities 14,585 14,959 Certificates of deposit 1,991 1,988 ----------- ------------ 838,992 845,445 ----------- ------------ Aa(2)-Obligations of states and political subdivisions 77,762 78,661 Mortgage-backed and asset-backed securities 44,554 45,923 Corporate securities 58,250 58,558 Debt securities issued by other foreign governments 16,707 16,715 Public utilities 2,438 2,483 ----------- ------------ 199,711 202,340 ----------- ------------ A(2)-Obligations of states and political subdivisions 16,006 16,232 Mortgage-backed and asset-backed securities 24,522 25,465 Debt securities issued by other foreign governments 6,887 6,938 Public utilities 13,065 13,152 Corporate securities 105,932 106,928 Certificates of deposit 809 809 ----------- ------------ 167,221 169,524 ----------- ------------ Baa(2)-Obligations of states and political subdivisions 11,751 12,347 Mortgage-backed and asset-backed securities 5,983 6,142 Public utilities 4,335 4,469 Corporate securities 56,631 57,476 ----------- ------------ 78,700 80,434 ----------- ------------ Ba(2)-Public utilities 1,053 1,125 Corporate securities 12,543 13,032 ----------- ------------ 13,596 14,157 ----------- ------------ B(2)-Corporate securities 11,143 11,495 ----------- ------------ Caa(2)-Corporate securities 138 183 ----------- ------------ P1(2)-Certificates of deposits 140 140 ----------- ------------ Non-rated Corporate security 224 224 ----------- ------------ Withdrawn - Asset-backed securities 1,496 1,496 =========== ============ Total debt securities $ 1,311,361 $ 1,325,438 ----------- ------------
(1) Obligations of states and political subdivisions include $38,240,000 escrowed in U.S. Government Securities, $242,320,000 insured by Municipal Bond Investors Assurance Corporation, Financial Guaranty Insurance Company, AMBAC Indemnity Corporation, or Financial Security Assurance Corporation and $29,940,000 both escrowed and insured. (2) Quality rating as assigned by Moody's Investors Service, Inc. for all except certain mortgage-backed securities not backed by U.S. government agencies and certain asset-backed securities. Quality ratings for these other securities are as assigned by Fitch Investors Service, Standard and Poor's or Duff and Phelps. Ratings are generally assigned upon the issuance of the securities, subject to revision on the basis of ongoing evaluations. 17 Regulation Trenwick and its insurance company subsidiaries are subject to regulatory oversight under the insurance statutes and regulations of the jurisdictions in which they conduct business, including all states of the United States and the United Kingdom. These regulations vary from jurisdiction to jurisdiction and are generally designed to protect ceding insurance companies and policyholders by regulating Trenwick's financial integrity and solvency in its business transactions and operations. Many of the insurance statutes and regulations applicable to Trenwick's subsidiaries relate to reporting and enable regulators to closely monitor Trenwick's performance. Typical required reports include information concerning Trenwick's capital structure, ownership, financial condition, and general business operations. Trenwick International is subject to the regulatory authority of the United Kingdom Financial Services Authority. Both Chartwell Managing Agents and Trenwick's dedicated Lloyd's underwriting entities, as a Lloyd's managing general agent and Lloyd's corporate members, respectively, are subject to regulation and supervision by the Council of Lloyd's. Lloyd's operates under a self-regulatory regime under the Lloyd's Act 1982 and has the power to set, interpret and change the rules which govern the operation of the Lloyd's market, subject to regulation for solvency purposes by the Financial Services Authority. Lloyd's prescribes, in respect of its managing agents and corporate members, certain minimum standards relating to their management and control, solvency and various other requirements. In addition, Lloyd's imposes restrictions against persons becoming controllers and major shareholders of managing agents and corporate members without the consent of Lloyd's first having been obtained. The United Kingdom government has established the Financial Services Authority as a single regulator to supervise securities, banking and insurance business, including Lloyd's. When the Financial Services and Market Bill becomes law, probably in late 2000, the Financial Services Authority will have wide authorization and intervention powers in relation to Lloyd's. A consultation process has commenced in relation to Lloyd's regulatory framework. NAIC The National Association of Insurance Commissioners ("NAIC") is an organization which assists state insurance supervisory officials in achieving insurance regulatory objectives, including the maintenance and improvement of state regulation. From time to time various regulatory and legislative changes have been proposed in the insurance industry, some of which could have an effect on reinsurers. Among the proposals that have in the past been or are at present being considered are the possible introduction of federal regulation in addition to, or in lieu of, the current system of state regulation of insurers, and proposals in various state legislatures (some of which proposals have been enacted) to conform portions of their insurance laws and regulations to various model acts adopted by the NAIC. Trenwick is unable to predict what effect, if any, these developments may have on its operations and financial condition. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. Risk Based Capital The NAIC has adopted Risk-Based Capital ("RBC") requirements for property and casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines minimum capital standards that supplement the system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the enterprise's regulatory total adjusted capital to its authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The ratios of Total Adjusted Capital to Authorized Control Level RBC for each of Trenwick's United States insurance company subsidiaries exceeded all the RBC trigger points at December 31, 1999, 1998 and 1997. 18 State Insurance Regulation The premium rates and policy terms of Trenwick's reinsurance agreements generally are not subject to regulation by any government authority. This contrasts with Trenwick's property and casualty insurance operations where the premium rates and policy terms are generally closely regulated by state insurance departments. As a practical matter, however, the premium rates charged by insurers may place a limit on the rates which can be charged by reinsurers. The regulation and supervision to which Trenwick's insurance subsidiaries are subject relate primarily to the standards of solvency that must be met and maintained, licensing requirements for reinsurers, the nature of and limitations on investments, restrictions on the size of risks which may be insured, deposits of securities for the benefit of insureds or reinsureds, methods of accounting, periodic examinations of the financial condition and affairs of reinsurers, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of the insureds and reinsureds, rather than Trenwick's security holders. Trenwick believes that it is in compliance with all such material regulations. Trenwick is subject to regulation under the insurance statutes and insurance holding company statutes of various states, including Connecticut, New York and North Dakota, the domicile states of its U.S. insurance companies. These laws and regulations vary from state to state, but generally require an insurance holding company, and insurers and reinsurers that are subsidiaries of an insurance holding company, to register with the state regulatory authorities and to file with those authorities certain reports including information concerning their capital structure, ownership, financial condition and general business operations. State laws also require prior notice or regulatory agency approval of direct or indirect changes in control of an insurer, reinsurer or its holding company and of certain significant intercorporate transfers of assets within the holding company structure. An investor who acquires securities representing or convertible into more than 10% of the voting power of the securities of Trenwick would become subject to at least some of such regulations and would be subject to approval by the Connecticut, New York and North Dakota Insurance Commissioners prior to acquiring such shares. Such investor would also be required to file certain notices and reports with the Insurance Commissioners prior to such acquisition. Codification of Statutory Accounting Principles In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles ("Codification"). The Codification, which is intended to standardize regulatory accounting and reporting for the insurance industry, is proposed to be January 1, 2001. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. Effective January 1, 2001, the states of Connecticut (domicile of Trenwick America Re), Minnesota (domicile of Chartwell Reinsurance), New York (domicile of INSCORP and ReCor) and North Dakota (domicile of Dakota) will adopt the Codification. It is uncertain what effect adoption of the Codification for the preparation of statutory financial statements would have on those statutory financial statements. 19 Dividends Because Trenwick's operations are conducted through its operating subsidiaries, Trenwick is dependent upon the ability of its operating subsidiaries, to transfer funds, principally in the form of cash dividends, tax reimbursements and other statutorily permissible payments. In addition to general legal restrictions on payments of dividends and other distributions to shareholders applicable to all corporations, Trenwick's insurance subsidiaries are subject to further regulations that, among other things, restrict the amount of dividends and other distributions that may be paid to their parent corporations. Under the applicable provisions of the insurance holding company laws of the states of domicile of Trenwick America Re, Chartwell Reinsurance and Dakota, such companies may only pay dividends without the approval of the applicable state insurance regulator, if such dividends, together with other dividends paid within the preceding twelve months, are less than the greater of (i) 10% of the insurer's policyholders' surplus as of the end of the prior calendar year or (ii) the insurer's statutory net income, excluding realized capital gains, for the prior calendar year. As a further restriction, the maximum amount of dividends most U.S. insurers may pay is limited to its earned surplus, also known as its unassigned funds. Any dividend in excess of the amount determined pursuant to the foregoing formula would be characterized as an "extraordinary dividend" requiring the prior approval of the state insurance regulator. Under New York law, which is applicable to INSCORP and ReCor Insurance Company Inc. ("ReCor") the maximum ordinary dividend payable in any twelve month period without the approval of the New York Insurance Department is the lesser of (i) 10% of policyholders surplus as shown on the company's last annual statement or any more recent quarterly statement or (ii) the company's adjusted net investment income. Adjusted net investment income is defined as net investment income for the twelve months preceding the declaration of the dividend plus the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months prior to the declaration or distribution of the current dividend and ending twelve months prior thereto. In any case, New York law permits the payment of an ordinary dividend by an insurer or reinsurer only out of earned surplus. In addition to the foregoing limitations, the New York Insurance Department, as is its practice in any change of control situation, required Trenwick to commit to preclude the acquired New York-domiciled insurers, INSCORP and ReCor, from paying any dividends for two years after the merger with Chartwell without prior regulatory approval. The foregoing restriction will expire on October 27, 2001. Neither INSCORP nor ReCor paid any dividends in 1997, 1998 or 1999. Moreover, insurance holding company laws generally provide that, notwithstanding the receipt of any dividend from a subsidiary insurer, an insurer may make dividend payments to its parent only to the extent it is permitted to do so under its applicable dividend restrictions. In other words, the ability of a subsidiary insurer to pay dividends without restriction may be impaired if its parent insurer cannot pay dividends without restriction. The maximum dividend permitted by law may not be indicative of an insurer's actual ability to pay dividends, which may be constrained by business and other regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends. Furthermore, beyond the limits described in the preceding paragraph, insurance regulatory authorities often have the discretion to limit the payment of dividends by insurance companies domiciled in their jurisdictions. 20 In 2000, of Trenwick's U.S. insurance subsidiaries, only Dakota could pay a dividend or other distribution without prior approval of the applicable insurance regulatory authority. In 2000, Dakota Specialty could pay a dividend of $2.8 million without prior approval. During 1999, 1998 and 1997, Trenwick America Re paid dividends of $53.4 million, $30.1 million and $8.3 million, respectively. Chartwell Reinsurance paid dividends of $30.3 million in 1999 and $3.0 million in 1997. Chartwell Reinsurance did not pay any dividends in 1998. None of Trenwick's other U.S. insurance subsidiaries paid any dividends in 1999, 1998 or 1997. Under the applicable laws of the United Kingdom, Trenwick's U.K. subsidiaries may make shareholder distributions only from accumulated realized profits, net of accumulated realized losses. In addition, under the U.K. Insurance Companies Act, Trenwick International is not permitted to make any distribution that would reduce its net assets below the required minimum margin of solvency which, as determined under the U.K. Financial Service Authority's rules, is approximately $16.7 million as of December 31, 1999. Trenwick International must also notify the United Kingdom Financial Services Authority of any proposal to declare or pay a dividend on any of its share capital. Under Lloyd's regulations, Chartwell Managing Agents is not permitted to make any distribution that would cause its assets to fall below any of Chartwell Managing Agents' share capital, minimum net current asset margin or minimum net asset margin. As of December 31, 1999, the highest of the three tests required Chartwell Managing Agents to maintain approximately $1.1 million of capital. Investment Limitations Connecticut, New York and North Dakota laws and regulations govern the types and amounts of investments which are permissible for Trenwick's insurance company subsidiaries. These rules are designated to ensure the safety and liquidity of the insurers' investment portfolio. In general, these rules permit insurers to purchase only investments which are interest bearing, interest accruing, entitled to dividends or otherwise income earning and not then in default in any respect, and insurers must be entitled to receive for its exclusive account and benefit the interest or income accruing thereon. No security or investment is eligible for purchase at a price above its fair value or market value. In addition, these rules require investments by Trenwick to be diversified. The U.K. Financial Services Authority governs the types and amounts of investments which are permissible for insurers in the United Kingdom, including Trenwick International. Likewise, Lloyd's regulations govern the types and amounts of investments that are permissible for Chartwell Managing Agents to make with the assets of the Lloyd's syndicates that it manages. These laws penalize high concentrations of riskier types of assets and high exposures to certain types of issuers. Trenwick believes that it is in compliance with all material applicable investment laws. Employees At December 31, 1999, Trenwick employed a total of 124 and 284 persons in its domestic and international operations, respectively. Trenwick has no employees represented by a labor union and believes that its employee relations are good. 21 TRENWICK GROUP INC. AND SUBSIDIARIES SCHEDULE II-CONDENSED FINANCIAL INFORMATION OF REGISTRANT TRENWICK GROUP INC. BALANCE SHEET (Parent Company Only) December 31, ---------------------------- 1999 1998 ------------ ----------- (in thousands) Assets: Investments in consolidated subsidiaries $ 558,151 $ 532,069 Cash and cash equivalents 2,331 523 Due from consolidated subsidiaries 57,526 4,287 Deferred debt issuance costs 6,388 2,463 Accrued investment income 128 125 Net deferred income taxes 15,000 4,198 Goodwill 153,824 1,605 Other assets 9,421 9 ------------ ----------- Total assets $ 802,769 $ 545,279 ============ =========== Liabilities: 6.70% Senior notes due 2003 $ 75,000 $ 75,000 Junior subordinated debentures 113,403 113,403 Contingent interest notes 34,699 - Due to consolidated subsidiaries 10,965 2,700 Accrued interest expense 5,497 5,424 Chase syndicated senior credit facilities 94,501 - Other liabilities 6,455 723 ------------ ----------- Total liabilities 340,520 197,250 Stockholders' equity 462,249 348,029 ------------ ----------- Total liabilities and stockholders' equity $ 802,769 $ 545,279 ============ =========== S-1 TRENWICK GROUP INC. AND SUBSIDIARIES SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT-(continued) TRENWICK GROUP INC. STATEMENT OF INCOME (Parent Company Only) Year ended December 31, --------------------------------------- 1999 1998 1997 ----------- ------------ ---------- (in thousands) Revenues: Consolidated subsidiary dividends $ 46,100 $ 26,600 $ 8,250 Net investment income 358 1,500 4,974 Net realized investment gains - 778 - Other income 1 12 - ----------- ------------ ---------- Total revenues 46,459 28,890 13,224 Interest and operating expenses 16,938 13,950 10,090 Amortization expense 1,423 33 - Income before income taxes, equity in undistributed income of unconsolidated subsidiaries and extraordinary item 28,098 14,907 3,134 Income tax benefit (5,077) (3,942) (1,239) ----------- ------------ ---------- Income before equity in undistributed income of consolidated subsidiaries 33,175 18,849 4,373 Equity in undistributed income (loss) of consolidated subsidiaries (44,223) 15,943 31,916 ----------- ------------ ---------- Income (loss) before extraordinary loss on debt redemption (11,048) 34,792 36,289 Extraordinary loss on debt redemption, net of $558 income tax benefit - - 1,037 ----------- ------------ ---------- Net income (loss) $ (11,048) $ 34,792 $ 35,252 =========== ============ ========== S-2 TRENWICK GROUP INC. AND SUBSIDIARIES SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT-(continued) TRENWICK GROUP INC. STATEMENT OF CASH FLOWS (Parent Company Only)
Year ended December 31, ----------------------------------------------- 1999 1998 1997 ---------------- ------------ ------------ (in thousands) Cash flows from operating activities: Dividends and net investment income received $ 46,466 $ 28,548 $ 12,642 Interest and operating expenses paid (14,979) (11,786) (4,983) Income taxes received 3,669 5,035 794 ---------------- ------------ ------------ Cash provided by operating activities 35,156 21,797 8,453 ---------------- ------------ ------------ Cash flows for investing activities: Purchases of debt securities - (16,637) (72,932) Sales of debt securities - 88,190 - Maturities of debt securities - 911 16,050 Investment in subsidiaries (8,282) (130,582) (3,403) ---------------- ------------ ------------ Cash used for investing activities (8,282) (58,118) (60,285) ---------------- ------------ ------------ Cash flows from financing activities: Issuance of senior notes - 75,000 - Issuance of junior subordinated debentures - - 113,403 Issuance costs of senior notes and capital securities (4,055) (922) (1,669) Long term debt proceeds 94,473 - - Redemption of convertible debentures - - (46,997) Issuance of common stock - 1,536 956 Repurchase of common stock (44,604) (34,880) (171) Dividends paid (12,787) (11,698) (11,546) Intercompany loans (58,093) 2,700 - ---------------- ----------- ------------ Cash provided by financing activities (25,066) 31,736 53,976 ---------------- ----------- ------------ Change in cash and cash equivalents 1,808 (4,585) 2,144 Cash and cash equivalents, beginning of year 523 5,108 2,964 ---------------- ----------- ------------ Cash and cash equivalents, end of year $ 2,331 $ 523 $ 5,108 ================ =========== ============
S-3 TRENWICK GROUP INC. AND SUBSIDIARIES SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION (in thousands)
1999 1998 1997 ----------- ---------- --------- Deferred policy acquisition costs Trenwick America Re $34,757 $21,023 $22,524 Canterbury Financial Group 3,215 - - Trenwick International 19,982 14,238 - Chartwell Managing Agents 20,942 - - ----------- ---------- --------- 78,896 35,261 22,524 Unpaid claims and claim expenses Trenwick America Re 1,201,954 546,292 518,387 Canterbury Financial Group 142,215 - - Trenwick International 164,264 136,136 - Chartwell Managing Agents 455,706 - - ----------- ---------- --------- 1,964,139 682,428 518,387 Unearned premium income Trenwick America Re 110,909 75,206 87,020 Canterbury Financial Group 63,133 - - Trenwick International 100,336 76,845 - Chartwell Managing Agents 105,306 - - ----------- ---------- --------- 379,684 152,051 87,020 Net premiums earned Trenwick America Re 166,906 174,443 190,156 Canterbury Financial Group 10,343 - - Trenwick International 107,911 71,118 - Chartwell Managing Agents 39,954 - - ----------- ---------- --------- 325,114 245,561 190,156 Net Investment Income Trenwick America Re 49,315 44,490 43,692 Canterbury Financial Group 1,722 - - Trenwick International 11,253 10,614 - Chartwell Managing Agents 3,845 - - Unallocated 259 1,212 4,710 ----------- ---------- --------- 66,394 56,316 48,402 Claims and claims expenses incurred Trenwick America Re 130,603 105,478 109,554 Canterbury Financial Group 5,766 - - Trenwick International 80,866 47,657 - Chartwell Managing Agents 37,303 - - ----------- ---------- --------- 254,538 153,135 109,554 Policy acquisition costs Trenwick America Re 61,633 58,310 58,549 Canterbury Financial Group 916 - - Trenwick International 22,627 15,887 - Chartwell Managing Agents 10,919 - - ----------- ---------- --------- 96,095 74,197 58,549 Underwriting expenses Trenwick America Re 13,790 13,789 15,425 Canterbury Financial Group 2,687 - - Trenwick International 15,364 10,006 - Chartwell Managing Agents 5,548 - - ----------- ---------- --------- 37,389 23,795 15,425 Net premiums written Trenwick America Re 155,108 169,112 195,230 Canterbury Financial Group 5,641 - - Trenwick International 129,399 81,107 - Chartwell Managing Agents 64,462 - - ----------- ---------- --------- 354,610 250,219 195,230
S-4 TRENWICK GROUP INC. AND SUBSIDIARIES SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS PERIOD FROM OCTOBER 28, 1999 TO DECEMBER 31, 1999 (in thousands) Balance at Charged to Balance at Beginning Costs and End of of Period Expenses Period ----------- ----------- ----------- Period Ended December 31, 1999 Reinsurance recoverable: Allowance for Uncollectible Reinsurance (1)....................$ 6,402 $ 167 $ 6,569 Year Ended December 31, 1998 Reinsurance recoverable: Allowance for Uncollectible Reinsurance (1)....................$ 6,394 $ 8 $ 6,402 Year Ended December 31, 1997 Reinsurance recoverable: Allowance for Uncollectible Reinsurance (1)....................$ 5,731 $ 663 $ 6,394 (1) Trenwick has a reinsurance agreement which protects Trenwick from certain uncollectible reinsurance balances. Uncollectible amounts have been ceded to said contract and are reflected as reinsurance recoverable in the balance sheet. Deductions to reserve represent subsequent collections of amounts deemed uncollectible. S-5 Report of Independent Accountants on Financial Statement Schedules To the Board of Directors of Trenwick Group Inc. Our audits of the consolidated financial statements referred to in our report dated February 29, 2000, except as to Note 19, which is as of March 1, 2000, appearing in the 1999 Annual Report to Stockholders of Trenwick Group Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedules listed in this Annual Report on Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP New York, New York February 29, 2000 S-6 EXHIBIT 13.1 AMENDED EXCERPTS FROM TRENWICK'S 1999 ANNUAL REPORT TO STOCKHOLDERS EXPRESSLY INCORPORATED BY REFERENCE IN THIS FORM 10-K MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Industry Overview The trends experienced by the property and casualty insurance and reinsurance industry during the past five years continued in 1999. The industry's underwriting margins continued to experience pressure due to highly competitive conditions. While the number of industry participants declined further, principally because of industry consolidation, the remaining insurance and reinsurance industry participants are larger and better capitalized. Insurers' and reinsurers' investment portfolios, which consist principally of fixed income securities, continued to underperform primarily due to low interest rates experienced in recent years. Operating cash flow declined as a result of lower underwriting margins and continued deterioration in prior years' claim reserves. There have recently been indications of increases in insurance and reinsurance rates primarily associated with international property business; however, at this time the increases reported are isolated and sporadic, and as such, no significant improvement in general market conditions is expected in the near term. Several years ago, in response to ongoing industry conditions, Trenwick embarked on a strategy of increasing its size and the diversity of its insurance and reinsurance businesses in order to compete more effectively in the insurance and reinsurance marketplace. On October 27, 1999, Trenwick, upon its merger with Chartwell Re Corporation, became the second-largest independent reinsurer in the United States on the basis of surplus. The acquisition of Chartwell provided Trenwick with additional cost-effective means of augmenting capital, accelerating premium growth and added structural platforms for further expansion. The addition of Chartwell's U.S. reinsurance business, its admitted and non-admitted U.S. insurance companies and its operations at Lloyd's continued Trenwick's strategy of entering new markets and product lines that began with Trenwick's acquisition of Trenwick International (formerly SOREMA (UK) Limited) in 1998. Trenwick International, a London market company, underwrites specialty insurance and treaty and facultative reinsurance on a worldwide basis. Trenwick expects that the merger with Chartwell will produce between $15 million and $25 million in annual expense synergies in 2000 and 2001, respectively. Trenwick's plan to diversify and broaden its markets continued with the December 19, 1999 announcement by Trenwick and LaSalle Re Holdings Limited of a definitive agreement to combine the two companies, with shareholders of both companies receiving shares in a new Bermuda holding company to be named Trenwick Group Ltd. This transaction will create a new Bermuda-based global insurance and reinsurance underwriting organization with an anticipated total capitalization of approximately $1.1 billion. The new Trenwick is expected to have larger scale and stronger competitive capabilities in a consolidating global insurance/reinsurance market, add higher margin business to Trenwick's existing mix, establish a stronger platform to enhance shareholder returns and expand Trenwick's management depth. Trenwick anticipates that the combined enterprise will have a strong presence in the three most significant insurance markets in the world: the United States, London and Bermuda. 1 On a pro forma basis, Trenwick would have had assets of approximately $4.0 billion and shareholders' equity, including minority interest, of approximately $800 million as of December 31, 1999 and combined 1999 gross written premiums for Trenwick, Chartwell and LaSalle of approximately $1.0 billion. Premium Trenwick's gross and net premium writings for its domestic and international operations were as follows: 1999 1998 1997 ----------- ----------- ---------- Gross Premiums Written Trenwick America Re $210,921(1) $218,249 $248,662 Trenwick International 171,698 105,114(2) - Chartwell Managing Agents 84,834(3) - - Canterbury Financial 38,088(4) - - Total $505,541 $323,363 $248,662 Net Premiums Written Trenwick America Re $155,108(1) $169,112 $195,230 Trenwick International 129,399 81,107(2) - Chartwell Managing Agents 64,462(3) - - Canterbury Financial 5,641(4) - - Total $354,610 $250,219 $195,230 (1) Includes reinsurance business of Chartwell Reinsurance and its subsidiaries since its acquisition on October 27, 1999. (2) Includes Trenwick International business since its acquisition on February 27, 1998. (3) Includes Chartwell Managing Agents business since its acquisition on October 27, 1999. (4) Includes Canterbury Financial business since its acquisition on October 27, 1999. In 1999, Trenwick reported net premiums written of $354.6 million, a 42% increase compared to $250.2 million in 1998. Net premiums written in 1998 increased 28% compared to 1997. Trenwick's domestic net reinsurance premiums written decreased 8% in 1999 over 1998 compared to a 13% decrease in 1998 over 1997. The decline in Trenwick's domestic reinsurance premium volume in 1999 and 1998 is primarily attributable to a decline in net casualty premium writings of 2%. This decline reflects Trenwick America Re's withdrawal from accounts when pricing fell below what it believed to be acceptable rate levels. The decline in net premiums written was magnified by Trenwick's decision to buy increased reinsurance protection in 1999, 1998 and 1997 at more favorable terms than in prior years. Competition among primary companies also caused cedants to reduce their own premium writings or restructure their reinsurance programs, reducing the amount of reinsurance they purchase. As a result of consolidation within the industry, many ceding companies are now larger and financially stronger, enabling them to retain more risk. 2 Trenwick International reported net premiums written of $129.4 million for the year ended December 31, 1999 compared to net premiums written of $81.1 million for the post-acquisition period ended December 31, 1998. Trenwick International's net premium writings for the full year 1998 were $100.8 million. While the international business is also highly competitive, growth in this business has occurred as a result of emerging pockets of opportunity and as a result of Trenwick International's expansion into new geographic markets previously limited by its former parent. During the period from October 28, 1999 to December 31, 1999, Chartwell Managing Agents' syndicates reported net premiums written of $64.5 million. Including the period prior to Chartwell Managing Agents' acquisition by Trenwick, Chartwell Managing Agents' syndicates reported net premiums written of $190.4 million for the year ended December 31, 1999 compared to net premiums written of $64.9 million for the prior year. Prior to its acquisition by Trenwick, Chartwell had increased significantly the amount of capacity it supplied to the syndicates managed by Chartwell Managing Agents, resulting in the aforementioned increase in premium writings. During 1999, Trenwick supplied 45.8% of the overall syndicate capacity for Chartwell Managing Agents. From October 28, 1999 to December 31, 1999, Canterbury Financial reported net premiums written of $5.6 million. For the year ended December 31, 1999, which includes the period before Canterbury Financial was acquired by Trenwick, Canterbury Financial reported net premiums of $43.8 million, a 7% decrease over the year ended December 31, 1998. The decrease in net premium writings resulted principally from changes in certain reinsurance programs, increasing the amount of reinsurance purchased in 1999. Operating Ratios The following table sets forth Trenwick's combined ratios and its components calculated on a GAAP basis for the periods indicated:
Claims and Policy Claims Acquisition Underwriting Total Combined Expense Ratio Expense Ratio Expense Ratio Expense Ratio Ratio -------------- ---------------- ----------------- -------------- ---------- 1999 Trenwick America Re(1) 78.3% 36.9% 8.3% 45.2% 123.5% Trenwick International 74.9% 21.0% 14.2% 35.2% 110.1% Canterbury Financial(2) 55.7% 8.9% 26.0% 34.9% 90.6% Chartwell Managing Agents(3) 93.4% 27.3% 13.9% 41.2% 134.6% Trenwick Group 78.3% 29.6% 11.5% 41.1% 119.4% 1998 Trenwick America Re 60.5% 33.4% 7.9% 41.3% 101.8% Trenwick International 67.0% 22.3% 14.1% 36.4% 103.4% Trenwick Group 62.4% 30.2% 9.7% 39.9% 102.3% 1997 Trenwick America Re 57.6% 30.8% 8.1% 38.9% 96.5% Trenwick Group 57.6% 30.8% 8.1% 38.9% 96.5%
- ---------------------------------------- (1) Includes reinsurance business of Chartwell Reinsurance and its subsidiaries since its acquisition on October 27, 1999 (2) Includes Canterbury Financial business since its acquisition on October 27, 1999 (3) Includes Chartwell Managing Agents business since its acquisition on October 27, 1999 The combined ratio is one means of measuring the profitability of a property and casualty insurance or reinsurance company. The combined ratio reflects underwriting experience, but does not reflect income from investments or provisions for income taxes. A combined ratio below 100% indicates profitable underwriting, and a combined ratio exceeding 100% indicates unprofitable underwriting. Although an insurer or reinsurer may have unprofitable underwriting results, the reinsurer may still be profitable because of investment income earned on its accumulated invested assets. 3 The most significant underwriting cost affecting an insurance or reinsurance company's underwriting result is represented by its claims and claims expense ratio, which is the ratio of incurred claims and claims adjustment expenses to net earned premiums. The claims and claims expense ratio is a function of estimates of claims associated with business written in the current period and changes in estimates of claims on business written in prior periods. Trenwick's claims and claims expense ratio increased from 62.4% in 1998 to 78.3% in 1999. Trenwick's claims and claims expense ratio deteriorated in 1999 due to the effects of property catastrophe claims of approximately $12.9 million and adverse development of prior year reserves for claims and claims expense of approximately $14.6 million. At December 31, 1999, losses ceded to the Company's adverse development cover amounted to $46.5 million. Excluding the benefit of the adverse development cover, the claims and claims expense ratio in 1999 would have been 92.6%. Trenwick America Re's claims and claims expense ratio was 78.3% in 1999 compared to 60.5% in 1998 and 57.6% in 1997. The increase in Trenwick America Re's claims and claims expense ratio in 1999 is primarily due to the reasons described in the paragraph above. Trenwick International's claims and claims expense ratio was 74.9% in 1999 compared to 67.0% in 1998. The increase was due primarily to catastrophe losses associated with the European winter storms that occurred in the fourth quarter of 1999. Trenwick's expense ratio, which is the ratio of policy acquisition costs and underwriting expenses to net earned premiums as determined in accordance with GAAP, increased in 1999 to 41.1% compared to 39.9% in 1998 and 38.9% in 1997. As was the case in 1998, the overall increase in the expense ratio reflected the continued increase in costs associated with Trenwick America Re. During 1999 and 1998, insurance companies continued to increase commissions on business ceded to reinsurers. The increase associated with domestic reinsurance business was partially offset by a reduction in Trenwick International's expense ratio and the inclusion of Canterbury Financial and Chartwell Managing Agents in the fourth quarter of 1999 whose underwriting results, in aggregate, carry a lower expense ratio. Trenwick's domestic reinsurance expense ratio in 1999 was 45.2% compared to 41.3% in 1998 and 38.9% in 1997. Trenwick International's expense ratio was 35.2% in 1999 compared to 36.4% in 1998. 4 Trenwick America Re's statutory combined ratios for 1999, 1998 and 1997 were 165.5%, 102.3% and 95.9% respectively. Trenwick America Re's 1999 statutory combined ratio includes the results of Chartwell Reinsurance Company, both before and after its acquisition by Trenwick. Trenwick America Re's statutory combined ratios were 50.9 percentage points worse, 2.2 percentage points better and 6.8 percentage points better, respectively, than the weighted average statutory combined ratios for all reinsurance companies which reported their results to the Reinsurance Association of America ("RAA") in those periods. The statutory combined ratios for this group of reinsurance companies in 1999, 1998 and 1997 were 114.6%, 104.5% and 102.7%, respectively. The statutory combined ratios as reported to the RAA by those companies, including Trenwick America Re, which primarily accept business from brokers, for 1999, 1998 and 1997 were 112.3%, 106.2% 104.6%, respectively. Consolidated Results of Operations Year Ended December 31, 1999 Compared With Year Ended December 31, 1998 Revenues Total revenues for the year ended December 31, 1999 increased 26.7% to $394.3 million, compared to $311.3 million for the comparable period in 1998. Included in Trenwick's consolidated results of operations for 1999 are Chartwell's operating results since its merger with Trenwick on October 27, 1999. Net Premiums Earned Net premiums earned for the year ended December 31, 1999 were $325.1 million, compared to $245.6 million in 1998, a 32.4% increase compared to the same period in 1998. This increase reflects the inclusion of Chartwell's business since its acquisition on October 27, 1999 and an increase in business underwritten by Trenwick International, offset in part by a decline in business underwritten by Trenwick America Re. Net Investment Income Trenwick's net investment income was $66.4 million in 1999 compared to $56.3 million in 1998. The overall increase in investment income in 1999 is due to the continued growth in Trenwick's invested asset base resulting primarily from the acquisition of Chartwell's business, offset by decreases resulting from funding requirements for the repurchase of Trenwick's common stock, reduced business written by Trenwick America Re and lower interest rates on the reinvestment of securities at maturity. Pre-tax yields on Trenwick's invested assets, excluding equity securities, were 6.2% in 1999 compared to 6.4% in 1998. This decline in 1999 resulted primarily from the reinvestment of approximately $397.2 million of maturing securities at lower yields. In 1999, maturing securities included $24.6 million of principal repayments associated with Trenwick's portfolio of mortgage-backed and asset-backed securities, compared to $32.0 million in 1998. Principal repayments decreased in 1999 due to the increase in interest rates from 1998. Net Realized Investment Gains Trenwick realized net investment gains of $1.9 million or $.16 per basic and diluted share for 1999 compared to $9.0 million or $.77 per basic and diluted share for the same period in 1998. Included in 1999 net realized investment gains were $5.2 million of losses related to the write-down to net realizable value of certain debt securities in Trenwick's portfolio. 5 Other Income and Equity Earnings of Investees For the years ended December 31, 1999 and 1998, other income was $.7 million and $.4 million, respectively, which consisted of foreign transaction gains. Equity earnings of investees was $.2 million in 1999. Claims and Claims Expenses Incurred Trenwick's principal expense, claims and claims expenses incurred, was $254.5 million for the year ended December 31, 1999, a 66.2% increase compared to $153.1 million for the comparable period in 1998. The increase is principally attributable to an increase in premium volume following the inclusion of Chartwell's business since its acquisition on October 27, 1999. Claims and claims expenses associated with Chartwell's business amounted to $42.7 million. In addition, claims and claims expense increased as a result of increases in estimates of prior accident year claims of $14.6 million in 1999 and claims arising from catastrophe losses in 1999 of $12.9 million. Policy Acquisition Costs Policy acquisition costs, which vary directly with premium volume and consist primarily of commissions paid to ceding companies and agents and brokerage fees paid to intermediaries, less commissions received on business ceded to other reinsurers, were $96.1 million for the year ended December 31, 1999, compared to $74.2 million for the same period in 1998. Policy acquisition costs expressed as a percentage of net earned premiums (the acquisition expense ratio) decreased slightly to 29.6% in 1999 from 30.2% in 1998. Underwriting Expenses In 1999, Trenwick recorded underwriting expenses of $37.4 million compared to $23.8 million in 1998. The reason for the increase in underwriting expenses was due to the inclusion of Chartwell's business since its acquisition on October 27, 1999 and certain non-recurring expenses, including severance costs associated with the acquisition of Chartwell. As a result, Trenwick recorded an underwriting loss, which is net earned premiums less claims and claims expenses incurred, policy acquisition costs and underwriting expenses, of $62.9 million in 1999 compared to an underwriting loss of $5.6 million in 1998. Other Expenses Other expenses, which include amortization of goodwill and other intangibles, general and administrative expenses, interest expense and minority interest in subsidiary trust were $27.5 million for the year ended December 31, 1999 compared to $17.2 million for the same period in 1998. The increase reflects the addition of goodwill and increases in general and administrative expenses and interest expense in conjunction with the acquisition of Chartwell. Income Before Income Taxes Trenwick incurred a net loss before income taxes of $21.2 million for the year ended December 31, 1999 compared to net income of $43.0 million for the same period in 1998. The net loss occurred for the reasons described above. Income Taxes The income tax benefit for the year ended December 31, 1999 was $10.2 million compared with a provision for income taxes of $8.2 million for the same period in 1998. The effective tax rate was 48% and 19% for the years ended December 31, 1999 and 1998, respectively. The main reason for the increase in Trenwick's effective tax rate above the statutory rate of 35% in 1999 was the loss experienced by Trenwick in 1999, which limited the benefits recognizable on investments in tax-exempt securities. The principal factor in the decline below the statutory rate of 35% for 1998 results from the benefit recognized on investments in tax-exempt securities. 6 As of December 31, 1999, Trenwick has U.S. net operating loss carryforwards of $53.2 million available to offset future regular taxable income until 2019. Of the total net operating loss carryforward, $15.7 million was generated by The Insurance Corporation of New York (INSCORP) prior to its acquisition by Chartwell in 1995 and is limited by Section 382 of the Internal Revenue Code to an annual amount of $3.5 million to offset future taxable income each year. During 1999, Trenwick recorded a valuation allowance of $24.0 million to reduce its deferred tax asset. The valuation allowance is necessary because sufficient uncertainty exists regarding the realizability of certain foreign tax credits and other deferred tax assets related to the excess tax basis of foreign subsidiaries. Any reduction in the valuation allowance will be offset against goodwill. Net Income Trenwick incurred a net loss of $11.0 million for the year ended December 31, 1999 compared with a net profit of $34.8 million for the comparable 1998 period. The basic loss per share was $.94 for the year ended December 31, 1999 as compared to basic net income of $2.99 per share for the same period in 1998. The diluted loss per share was $.94 per share compared to diluted net income of $2.95 per share for the year ended December 31, 1998. Year Ended December 31, 1998 Compared With Year Ended December 31, 1997 Revenues Total revenues for the year ended December 31, 1998 increased 29.2% to $311.3 million, compared to $240.9 million for the comparable period in 1997. Included in Trenwick's consolidated results of operations for 1998 are Trenwick International's operating results since its acquisition on February 27, 1998. Net Premiums Earned Net premiums earned for the year ended December 31, 1998 were $245.6 million, compared to $190.2 million in 1997, a 29.1% increase compared to the same period in 1997. This increase reflects the inclusion of Trenwick International's business since its acquisition on February 27, 1998. Net Investment Income Trenwick's net investment income was $56.3 million in 1998 compared to $48.4 million in 1997. The overall increase in investment income in 1998 was due to the continued growth in Trenwick's invested asset base resulting primarily from the acquisition of Trenwick International offset in part by the decrease in Trenwick America Re's invested asset base resulting from sales of approximately $88.1 million of securities to fund the acquisition of Trenwick International and the repurchase of Trenwick's common stock. Trenwick's pre-tax yield on invested assets, excluding equity securities, was 6.4% in 1998, unchanged from 1997. Net Realized Investment Gains Trenwick realized net investment gains of $9.0 million or $.77 per basic and diluted share for 1998 compared to $2.3 million or $.20 per basic share and $.19 per diluted share for the same period in 1997. 7 Other Income Other income was $.4 million for the year ended December 31, 1998 compared to $.01 million for the same period in 1997. This increase was due to the inclusion of Trenwick International's foreign transaction gains and losses. Claims and Claims Expenses Incurred Trenwick's principal expense, claims and claims expenses incurred was $153.1 million for the year ended December 31, 1998, a 39.7% increase compared to $109.6 million for the comparable period in 1997. The increase was principally attributable to the increase in premiums written by Trenwick due to the inclusion of Trenwick International's underwriting results since its acquisition on February 27, 1998. Policy Acquisition Costs Policy acquisition costs, which vary directly with premium volume and consist primarily of commissions paid to ceding companies and agents and brokerage fees paid to intermediaries, less commissions received on business ceded to other reinsurers, were $74.2 million for the year ended December 31, 1998, compared to $58.5 million for the same period in 1997. Policy acquisition costs expressed as a percentage of net earned premiums (the acquisition expense ratio) decreased slightly to 30.2% in 1998 from 30.8% in 1997. Underwriting Expenses In 1998, Trenwick recorded underwriting expenses of $23.8 million compared to underwriting expenses of $15.4 million in 1997. The reason for the increase in underwriting expenses was due to the inclusion of higher expenses relating to the business of Trenwick International since its acquisition on February 27, 1998. As a result, Trenwick recorded an underwriting loss, which is net earned premiums less claims and claims expenses incurred, policy acquisition costs and underwriting expenses, of $5.6 million in 1998 compared to an underwriting profit of $6.6 million in 1997. Other Expenses Other expenses include $1.4 million of amortization of goodwill and other intangibles, $7.2 million of general and administrative expenses and $18.9 million of interest expense and minority interest in subsidiary trust for the year ended December 31, 1999 compared to $33,000 of amortization of goodwill and other intangibles, $3.5 million of general and administrative expenses and $13.7 million for interest expense and minority interest in subsidiary trust for the same period in 1998. The increase reflects the addition of goodwill and increases in general and administrative expenses and interest expense in conjunction with the acquisition of Chartwell. Income Before Income Taxes and Extraordinary Item Net income before income taxes decreased to $43.0 million for the year ended December 31, 1998 compared to $47.5 million for the same period in 1997. The decrease resulted primarily from after-tax charges of $5.7 million associated with catastrophe losses, including Hurricanes Mitch and Georges. There were no material catastrophe losses included in the results for 1997. Income Taxes The provision for income taxes for the year ended December 31, 1998 decreased to $8.2 million compared with $11.2 million for the same period in 1997. The effective tax rate was 19% and 24% for the years ended December 31, 1998 and 1997, respectively. The principal factor in the decline below the statutory rate of 35% for both periods resulted from the benefit recognized on investments in tax-exempt securities. 8 Extraordinary Loss Trenwick incurred an extraordinary loss, net of the related tax benefit, of $1.0 million in 1997 in connection with the redemption of outstanding debt. Net Income Trenwick realized a net profit of $34.8 million for the year ended December 31, 1998 compared with a net profit of $35.3 million for the comparable 1997 period. Basic earnings per share decreased 1.3% to $2.99 per share for the year ended December 31, 1998 from $3.03 per share for the same period in 1997. Diluted net income per share decreased 2.0% to $2.95 per share from $3.01 per share for the year ended December 31, 1998. Investments Trenwick's investment objective is to fund policyholder and other liabilities in a manner that enhances shareholder value, subject to appropriate risk constraints. Trenwick seeks to meet this investment objective through a mix of investments that reflect the characteristics of the liabilities they support; diversify the types of investment risks by interest rate, liquidity, credit and equity price risk; and achieve asset diversification by investment type, industry, issuer and geographic location. Trenwick regularly projects duration and cash flow characteristics of its liabilities and makes appropriate adjustments in its investment portfolios. At December 31, 1999, Trenwick had investments, cash and cash equivalents of $1.7 billion, an increase of 74.0% compared to investments, cash and cash equivalents of $1.0 billion at December 31, 1998. This increase resulted principally from the acquisition of Chartwell's invested asset base. All debt and equity investments are classified as available for sale and reported at fair value with the unrealized gain or loss, net of income taxes, reported in other comprehensive income. During 1999, the market value of Trenwick's debt and equity investments decreased by $41.7 million as a result of an overall increase in interest rates, the effect of which was amplified by the increase in 1999 of the size of Trenwick's asset base. During 1999, the proceeds from sales and maturities of taxable and tax-exempt securities of $769.4 million were invested by Trenwick America Re primarily in tax-exempt securities in the amount of $69.6 million and by Trenwick International in debt securities issued by the British Government in the amount of $138.2 million. Trenwick also purchased mortgage-backed and asset-backed securities in the amount of $6.6 million, U.S. government and agency securities of $31.4 million, securities of other governments of $60.6 million, investment grade corporate bonds of $44.7 million and high yield corporate bonds of $29.2 million. In addition, Trenwick purchased and disposed of certificates of deposit in the amount of $261.6 million during 1999. Also in 1999, $29.7 million of equities were purchased. Trenwick's debt securities consisted primarily of investment grade securities, with 79% having a quality rating of Aa or better at December 31, 1999. High yield, or non-investment grade debt securities carry a rating of below BBB-/Baa3. These securities, along with unrated securities, represented less than 2% of the portfolio at December 31, 1999 and .5% of the portfolio at December 31, 1998. 9 The average maturity of Trenwick's debt securities at December 31, 1999 was 6.8 years compared to 5.7 years at December 31, 1998 and 6.2 years at December 31, 1997. The shortening during 1998 reflected the addition of Trenwick International's portfolio which had a much shorter average maturity. The lengthening during 1999 reflects the longer average maturity of the Chartwell portfolio along with the 1999 duration extension of the Trenwick International portfolio. Trenwick has not invested in derivative financial instruments such as futures, forward contracts, swaps, options or other financial instruments with similar characteristics such as interest rate caps or floors and fixed-rate loan commitments. Trenwick's portfolio includes market sensitive instruments, such as mortgage-backed and asset-backed securities, which amounted to approximately $288.5 million at December 31, 1999 or 16.5% of cash and invested assets. These investments are classified as available for sale and are not held for trading purposes. There are various categories of mortgage-backed and asset-backed securities that are subject to different degrees of risk from changes in interest rates and, for those mortgage-backed and asset-backed securities that are not agency-backed, defaults. Approximately 60.6% of Trenwick's mortgage-backed and asset-backed securities holdings were backed by government agencies, such as GNMA, FNMA and FHLMC, at December 31, 1999 and 45.8% at December 31, 1998. The principal risks inherent in holding mortgage-backed and asset-backed securities are prepayment and extension risks related to dramatic decreases and increases in interest rates, resulting in the repayment of principal from the underlying mortgages either earlier or later than originally anticipated. At December 31, 1999, approximately .3% of Trenwick's mortgage-backed and asset-backed securities holdings were invested in mortgage-backed and asset-backed securities that are subject to more prepayment and extension risk (such as interest- or principal-only strips) than traditional mortgage-backed and asset-backed securities. At December 31, 1998, no such securities were held. Liquidity and Capital Resources Cash Flows Trenwick is a holding company whose principal assets are its investments in the common stock of its operating subsidiaries. As a holding company, Trenwick's principal source of funds consists of permissible dividends, tax allocation payments and other statutorily permissible payments from its operating subsidiaries together with income on the holding company's fixed-income portfolio. Trenwick's principal uses of cash are dividends to its stockholders, servicing its debt obligations and repurchases of its own common stock when the pricing is attractive. Trenwick's operating subsidiaries receive cash from premiums, investment income and proceeds from sales and maturities of portfolio investments. They utilize cash to pay claims, purchase their own reinsurance protections, meet operating and capital expenses and purchase fixed-income and equity securities. Cash used in Trenwick's operating activities in 1999 was $52.3 million compared to cash provided by Trenwick's operating activities of $37.9 million in 1998 and $47 million in 1997. The reduction in cash flow from operations in 1999 was due primarily to a cash payment of $56 million in premium payments for the reinsurance policy which provides protection against adverse development of Chartwell's reserves following its acquisition by Trenwick and an overall increase in claims and claims expenses paid. In 1999, cash used for financing activities was $24.4 million compared to cash provided by financing activities of $29.0 million in 1998. Cash used by financing activities in 1999 includes the repayment of long-term debt of $48.4 million and the repurchase of common stock of $44.6 million, offset by $94.5 million of borrowings under a credit facility established in 1999. Cash provided by financing activities in 1998 included proceeds from the issuance of $75 million principal amount of 6.70% Senior Notes partially offset by repurchases of common stock of approximately $34.9 million. Included in cash provided by financing activities in 1997 was $110 million from the issuance of the Subordinated Capital Income Securities, partially offset by the redemption of convertible debt of approximately $47 million. 10 Trenwick's current liquidity objectives are to maximize the use of available cash to fund ongoing operating needs, pay shareholder dividends, strategically invest in core businesses and meet common stock repurchase objectives. During 1999, net cash generated from investing, financing and operating activities was used to pay $44.6 million for common stock repurchases and pay $12.8 million of dividends to shareholders. In 1998, net cash generated by investing, financing and operating activities was used to pay $34.9 million for common stock repurchases and pay $11.7 million of dividends to shareholders. Dividends Trenwick paid a quarterly dividend of $.26 per share of common stock in 1999 and $.25 per share of common stock in 1998. Trenwick's Board of Directors reviews Trenwick's common stock dividend each quarter. Among the factors considered by the Board of Directors in determining the amount of each dividend are Trenwick's results of operations and the capital requirements, growth and other characteristics of its businesses. Financings, Financing Capacity and Capitalization Substantially all of Trenwick's borrowings and financings are conducted through Trenwick Group Inc. Trenwick continually monitors existing and alternative financing sources to support Trenwick's capital and liquidity needs, including, but not limited to, debt issuance, preferred or common stock issuance, intercompany borrowings and pledging or selling of assets. Trenwick's total debt to capital ratio (total debt divided by total debt and shareholders' equity, adjusted for unrealized gains or losses on available-for-sale investment securities) was 43% at the end of 1999, 36% at the end of 1998 and 25% at the end of 1997. The increases in 1999 and 1998 primarily reflect the incurrence of indebtedness in connection with the acquisition of Trenwick International and the assumption of indebtedness in connection with the Chartwell acquisition. On November 24, 1999, Trenwick entered into a $400 million credit agreement with various lending institutions, The Chase Manhattan Bank, as Administrative Agent, First Union National Bank, as Syndication Agent, and Fleet National Bank, as Documentation Agent. This new credit facility provides for a $170 million, 364-day revolving credit facility with an option to pay out outstanding borrowings under such facility over the four years following the expiration of the 364-day period. In addition, the credit facility provides for a $230 million five year, Lloyd's letter of credit facility, with a one year automatic renewal option. The applicable interest rate on borrowings under the credit facility is currently 1.3% above the London interbank offered rate or The Chase Manhattan Bank prime commercial lending rate. The credit facility's representations, warranties and covenants are typical for transactions of this type and include limitations based upon Trenwick's leverage ratio, interest coverage ratio, combined surplus and risk-based capital. Trenwick and the banks party to the credit facility executed an amendment to the credit facility, dated as of December 31, 1999, reducing the required minimum consolidated tangible net worth of Trenwick from $325 million to $290 million until June 30, 2000. 11 In addition to the credit facility, Trenwick has outstanding $75 million aggregate principal amount of 6.70% Senior Notes, which are due April 1, 2003. Interest is payable semi-annually on April 1 and October 1 of each year; interest payments commenced on October 1, 1998. The notes are not subject to redemption prior to maturity. They are unsecured obligations and rank senior in right of payment to all existing and future subordinated indebtedness of Trenwick. Trenwick's long-term debt obligations also include 8.82% Junior Subordinated Deferrable Interest Debentures held by Trenwick Capital Trust I in respect of the $110 million in 8.82% Subordinated Capital Income Securities issued by the Trust. Under the terms of the debentures, Trenwick is not restricted from incurring indebtedness, but is subject to limits on its ability to incur secured indebtedness for borrowed money. Upon consummation of the acquisition of Chartwell in 1999, Trenwick became the successor obligor under Chartwell's Contingent Interest Notes due June 30, 2006. The Contingent Interest Notes were issued in an aggregate principal amount of $1 million, which accrues interest at a rate of 8% per annum, compounded annually. The interest is not payable until the maturity or earlier redemption of the Contingent Interest Notes. In addition, the Contingent Interest Notes entitle their holders to receive at maturity, in proportion to the principal amount of the Contingent Interest Notes held by them, an aggregate of from $10 million up to $55 million in contingent interest. The amount of contingent interest payable under the Contingent Interest Notes is dependent upon the level of loss and loss adjustment expense reserves related to business written by INSCORP prior to 1996. Settlement of the Contingent Interest Notes may be made by payment of cash or, under certain specified conditions, by delivery of shares of Trenwick's common stock. Trenwick also assumed Chartwell's 10.25% Senior Notes due 2004 upon the closing of the acquisition. As of December 31, 1999, $40.1 million in principal amount of the Senior Notes were outstanding. On March 1, 2000, Trenwick redeemed the remaining outstanding Senior Notes at a redemption price of 102.56% of the par value of the notes. Common Stock Transactions In May 1997, Trenwick's Board of Directors authorized the repurchase of one million shares of common stock. In September 1998, August 1999, November 1999 and December 1999, the Board of Directors authorized the repurchase of additional shares, increasing the total number of shares of common stock which Trenwick could purchase under the stock repurchase program to 4.6 million at purchase prices not to exceed Trenwick's book value. Under the stock repurchase plan, Trenwick repurchased 2,176,200 shares of common stock at a cost of approximately $46.6 million in 1999 and an additional 829,300 shares of common stock at a cost of approximately $13.7 million in January of 2000. Since May 1997, Trenwick has purchased an aggregate of 3,276,700 shares of common stock at a cost of approximately $81.9 million under its stock repurchase program. Trenwick issued 65,985 shares of common stock in 1999, 82,889 shares in 1998 and 9,782 shares in 1997 pursuant to employee benefit plans. 12 Restrictions on Certain Payments within Trenwick Because Trenwick's operations are conducted through its operating subsidiaries, Trenwick is dependent upon the ability of its operating subsidiaries to transfer funds, principally in the form of cash dividends, tax reimbursements and other statutorily permissible payments. In addition to general legal restrictions on payments of dividends and other distributions to shareholders applicable to all corporations, Trenwick's insurance subsidiaries are subject to further regulations that, among other things, restrict the amount of dividends and other distributions that may be paid to their parent corporations. Management believes that current levels of cash flow from operations and assets held at the holding company level, together with approval of one or more extraordinary dividends from Trenwick's operating subsidiaries, will provide Trenwick with sufficient liquidity to meet its operating needs in the short-term (over the next twelve months). Since the ability of Trenwick to meet its obligations in the long-term (beyond such twelve month period) is dependent upon such factors as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet its operating needs. Trenwick expects that, in order to repay the principal amount of certain currently outstanding indebtedness at maturity or otherwise, it will be required to seek additional financing or engage in asset sales or similar transactions. There can be no assurance that sufficient funds for any of the foregoing purposes would be available to Trenwick at such time. Under the applicable provisions of the insurance holding company laws of the states of domicile of most of Trenwick's U.S. insurance companies, the insurance companies may only pay dividends without the approval of the applicable state insurance regulator if such dividends, together with other dividends paid within the preceding twelve months, are less than the greater of (i) 10% of the insurer's policyholders' surplus as of the end of the prior calendar year or (ii) the insurer's statutory net income, excluding realized capital gains, for the prior calendar year. As a further restriction, the maximum amount of dividends most U.S. insurers may pay is limited to its earned surplus, also known as its unassigned funds. Any dividend in excess of the amount determined pursuant to the foregoing formula would be characterized as an "extraordinary dividend" requiring the prior approval of the state insurance regulator. Under New York law, which is applicable to two of Trenwick's insurance company subsidiaries, INSCORP and ReCor Insurance Company Inc. (ReCor), the maximum ordinary dividend payable in any twelve month period without the approval of the New York Insurance Department is the lesser of (i) 10% of policyholders' surplus as shown on the company's last annual statement or any more recent quarterly statement or (ii) the company's adjusted net investment income. Adjusted net investment income is defined as net investment income for the twelve months preceding the declaration of the dividend plus the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months prior to the declaration or distribution of the current dividend and ending twelve months prior thereto. In any case, New York law permits the payment of an ordinary dividend by an insurer or reinsurer only out of earned surplus. In addition to the foregoing limitations, the New York Insurance Department, as is its practice in any change of control situation, required Trenwick to commit to preclude the acquired New York-domiciled insurers, INSCORP and ReCor, from paying any dividends for two years after the merger with Chartwell without prior regulatory approval. The foregoing restriction will expire on October 27, 2001. Neither INSCORP nor ReCor paid any dividends in 1997, 1998 or 1999. 13 Moreover, insurance holding company laws generally provide that, notwithstanding the receipt of any dividend from a subsidiary insurer, an insurer may make dividend payments to its parent only to the extent it is permitted to do so under its applicable dividend restrictions. In other words, the ability of a subsidiary insurer to pay dividends without restriction may be impaired if its parent insurer cannot pay dividends without restriction. The maximum dividend permitted by law may not be indicative of an insurer's actual ability to pay dividends, which may be constrained by business and other regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends. Furthermore, beyond the limits described in the preceding paragraph, insurance regulatory authorities often have the discretion to limit the payment of dividends by insurance companies domiciled in their jurisdictions. In 2000, of Trenwick's U.S. insurance subsidiaries, only Dakota Specialty could pay a dividend or other distribution without prior approval of the applicable insurance regulatory authority. In 2000, Dakota Specialty could pay a dividend of $2.8 million without prior approval. During 1999, 1998 and 1997, Trenwick America Re paid dividends of $53.4 million, $30.1 million and $8.3 million, respectively. Chartwell Reinsurance paid dividends of $30.3 million in 1999 and $3.0 million in 1997. Chartwell Reinsurance did not pay any dividends in 1998. None of Trenwick's other U.S. insurance subsidiaries paid any dividends in 1999, 1998 or 1997. Under the applicable laws of the United Kingdom, Trenwick Holdings Limited, Chartwell Holdings Limited and their respective subsidiaries may make shareholder distributions only from accumulated realized profits, net of accumulated realized losses. In addition, under the U.K. Insurance Companies Act, Trenwick International is not permitted to make any distribution that would reduce its net assets below the required minimum margin of solvency which, as determined under the U.K. Financial Service Authority's rules, is approximately $16.7 million as of December 31, 1999. Trenwick International must also notify the U.K. Financial Services Authority of any proposal to declare or pay a dividend on any of its share capital. Under Lloyd's regulations, Chartwell Managing Agents is not permitted to make any distribution that would cause its assets to fall below any of Chartwell Managing Agents' share capital, minimum net current asset margin or minimum net asset margin. As of December 31, 1999, the highest of the three tests required Chartwell Managing Agents to maintain approximately $1.1 million of capital. Reinsurance Trenwick's operating subsidiaries purchase reinsurance to reduce its exposure to catastrophe claims and the frequency and severity of claims in all lines of business. In 1999, 1998 and 1997, Trenwick America Re's reinsurance treaties consisted principally of an excess of loss treaty for its facultative casualty business and property catastrophe reinsurance treaties. In addition, Trenwick America Re purchased an annual aggregate excess of loss ratio treaty for casualty business effective January 1, 1999. Except for property catastrophe reinsurance treaties, these coverages were not renewed effective January 1, 2000. Trenwick International and Chartwell Managing Agents, as is customary with companies operating in the London market and at Lloyd's, buy larger amounts of reinsurance to protect themselves. Reinsurance and retrocessional coverage is customized for each class of business. Canterbury Financial purchased specific reinsurance programs for each of the programs underwritten by its insurance companies. 14 As part of the merger with Trenwick, Chartwell purchased, at the time of the closing of the transaction, a reinsurance policy providing for up to $100 million in coverage in order to indemnify Trenwick against unanticipated increases in Chartwell's reserves for business written on or before the date the merger was completed. The reinsurance policy applies to all of Chartwell's business, including its operations at Lloyd's. In addition, as part of the merger, Chartwell commuted several aggregate stop-loss reinsurance treaties. Reinsurance agreements provide for recovery of a portion of certain claims and claims expenses from reinsurers. Trenwick remains liable in the event that the reinsurer is unable to meet its obligation; however, Trenwick holds partial collateral under these agreements. Regulatory Matters Trenwick and its domestic subsidiaries are subject to regulatory oversight under the insurance statutes and regulations of the jurisdictions in which they conduct business, including all states of the United States and the United Kingdom. These regulations vary from jurisdiction to jurisdiction and are generally designed to protect ceding insurance companies and policyholders by regulating Trenwick's financial integrity and solvency in its business transactions and operations. Many of the insurance statutes and regulations applicable to Trenwick's subsidiaries relate to reporting and enable regulators to closely monitor their performance. Reports typically required the inclusion of information concerning Trenwick's capital structure, ownership, financial condition and general business operations. Trenwick International is subject to the regulatory authority of the United Kingdom Financial Services Authority. Both Chartwell Managing Agents and Trenwick's dedicated Lloyd's underwriting entities, as a Lloyd's managing general agent and Lloyd's corporate members, respectively, are subject to regulation and supervision by the Council of Lloyd's. Lloyd's operates under a self-regulatory regime under the Lloyd's Act 1982 and has the power to set, interpret and change the rules which govern the operation of the Lloyd's market, subject to regulation for solvency purposes by the Financial Services Authority. Lloyd's prescribes, in respect of its managing agents and corporate members, certain minimum standards relating to their management and control, solvency and various other requirements. In addition, Lloyd's imposes restrictions against persons becoming controllers and major shareholders of managing agents and corporate members without the consent of Lloyd's first having been obtained. The United Kingdom government has established the Financial Services Authority as a single regulator to supervise securities, banking and insurance business, including Lloyd's. When the Financial Services and Market Bill becomes law, probably in late 2000, the Financial Services Authority will have wide authorization and intervention powers in relation to Lloyd's. A consultation process has commenced in relation to Lloyd's regulatory framework. The National Association of Insurance Commissioners (NAIC) has adopted Risk-Based Capital (RBC) requirements for property and casualty insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, asset and liability matching, loss reserve adequacy and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. In addition, the formula defines minimum capital standards that supplement the system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the enterprise's regulatory total adjusted capital to its authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. The ratios of Total Adjusted Capital to Authorized Control Level RBC for each of Trenwick's United States insurance company subsidiaries exceeded all of the RBC trigger points at December 31, 1999, 1998 and 1997. 15 In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles (Codification). The Codification, which is intended to standardize regulatory accounting and reporting for the insurance industry, is proposed to be implemented January 1, 2001. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas. However, statutory accounting principles will continue to be established by individual state laws and permitted practices. Effective January 1, 2001, Connecticut, New York, Minnesota and North Dakota, the states of domicile of Trenwick's U.S. insurance subsidiaries, are adopting the Codification. It is uncertain what effect adoption of the Codification for the preparation of the statutory financial statements of Trenwick's U.S. insurance subsidiaries would have on those statutory financial statements. Quantitative and Qualitative Disclosure About Market Risk The following sections address the significant market risks associated with Trenwick's business activities as of the years ended December 31, 1999 and 1998. The 1999 risk analysis differs from that of 1998 because it includes the assets and liabilities of the Chartwell group. The 1998 comparative data only reflects Trenwick information. Trenwick's primary market risk exposures are: foreign currency exchange risk, in particular the U.S. dollar to the British pound sterling; interest rate risk on fixed and variable rate U.S. dollar and British pound sterling denominated short and long-term instruments; and equity price risk. With respect to the Trenwick investment portfolio, the risk management strategy is to place its investments with high credit quality issuers and to limit the amount of credit exposure with respect to particular ratings categories and any one issuer. Trenwick selects investments with characteristics such as duration, yield, currency and liquidity to reflect the underlying characteristics of related estimated claim liabilities. In 1999, Trenwick allocated a portion of its bond portfolio to high yield investments. While these investments are more susceptible to credit risk, their total market value represents less than 2% of total investments, and therefore, management believes that the exposure to credit risk is not material. Trenwick has no derivatives and its investments do not contain terms that may result in potential losses due to leverage. Limited information is available with respect to the investments held by Chartwell Managing Agents' syndicates, and therefore, risk information provided does not include such data. Some or all of the risks described in this section may apply to the investments held by Chartwell Managing Agents' syndicates. The investment portfolio and borrowings of Trenwick are summarized in the Notes to the Financial Statements. 16 Foreign Currency Exchange Rate Risk Foreign currency risk is the risk that Trenwick will incur economic losses due to adverse changes in foreign currency exchange rates. This risk arises from Trenwick's international operations, debt obligations and securities denominated in foreign currencies and foreign equity investments. Trenwick generally conducts its international businesses through foreign operating entities which generally maintain assets and liabilities in local currencies, substantially limiting exchange rate risk to net assets denominated in the foreign currency which is the British pound sterling. At December 31, 1999 and 1998, Trenwick's net investment in foreign subsidiaries was approximately $24.1 million and $133.9 million, respectively. Debt obligations denominated in foreign currencies were $19.4 million and foreign equity investments were $2.9 million at December 31, 1999. Trenwick did not hold any debt obligations denominated in foreign currencies or foreign equity investments at December 31, 1998. Trenwick's reinsurance, international insurance and Lloyd's operations all have exposures to movements in various currencies around the world, (particularly the British pound sterling, the Euro and the Canadian dollar) as such businesses are denominated in those currencies. Therefore, changes in currency exchange rates affect Trenwick's Balance Sheet, Statement of Operations and Statement of Cash Flows. This exposure is somewhat mitigated by the fact that premiums received are invested in the same currency portfolios, to partially offset related unpaid claims and claims expense liabilities denominated in the same currency. Management estimates that a 10% immediate unfavorable change in each of the foreign currency exchange rates to which Trenwick is exposed as of December 31, 1999 would decrease the fair value of Trenwick's foreign denominated net assets by approximately $9.1 million, which is comprised of $7.4 million to the British pound sterling, $1.5 million to the Canadian dollar and an aggregate of $.2 million to all other foreign currencies. At December 31, 1998, the same 10% shift in currency exchange rates primarily the British pound sterling) would result in a potential loss in fair value of $18.2 million. Trenwick has not experienced a 10% shift in currency exposure in either 1998 or 1999. Interest Rate Risk Trenwick's fixed maturity investments and indebtedness are subject to interest rate risk. Increases and decreases in prevailing interest rates generally translate into decreases and increases in the fair value of fixed maturity investments and the interest payable on Trenwick's outstanding variable rate debt. Additionally, the fair value of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, a prepayment option, relative values of alternative investments, liquidity of the investment and other general market conditions. The table below summarizes the estimated effects of hypothetical increases and decreases in interest rates. It is assumed that the changes occur immediately and uniformly to each category of instrument containing interest rate risks. The hypothetical changes in market interest rates reflect what could be deemed best or worst case scenarios. Significant variations in market interest rates could produce changes in the timing of repayments due to prepayment options available. The fair value of such instruments could be affected and therefore actual results might differ from those reflected in the following table:
Estimated Estimated Hypothetical Fair Gain (Loss) Change in Value After After Interest Rate Hypothetical Hypothetical Fair Value at (bp=basis Change in Change in (dollars in thousands) Dec 31, 1999 points) Interest Rate Interest Rate Assets(1) U.S. treasury 1,404,248 100 bp decrease 1,467,926 63,678 100 bp increase 1,343,017 (61,231) 200 bp increase 1,284,971 (119,276) 300 bp increase 1,226,926 (177,322) Liabilities(2) Borrowings 344,775 100 bp decrease 356,579 11,805 100 bp increase 334,419 (10,355) 200 bp increase 325,231 (19,544) 300 bp increase 316,994 (27,781) Aggregate 1,059,473 100 bp decrease 1,111,347 51,874 100 bp increase 1,008,598 (50,876) 200 bp increase 959,741 (99,733) 300 bp increase 909,932 (149,541)
17 (1) Excludes investments held by Chartwell Managing Agents managed syndicates, as information is not available, but includes preferred shares, which are grouped with equities on the face of the Balance Sheet but more closely resemble debt instruments for risk analysis purposes. (2) Liabilities include Trust Preferred for this analysis.
Estimated Estimated Hypothetical Fair Gain (Loss) Change in Value After After Interest Rate Hypothetical Hypothetical Fair Value at (bp=basis Change in Change in (dollars in thousands) Dec 31, 1998 points) Interest Rate Interest Rate Assets(1) U.S. treasury 773,144 100 bp decrease 802,195 29,051 100 bp increase 743,831 (29,313) 200 bp increase 714,351 (58,793) 300 bp increase 687,113 (86,031) Liabilities Borrowings 188,900 100 bp decrease 206,394 17,494 100 bp increase 174,233 (14,667) 200 bp increase 161,766 (27,134) 300 bp increase 151,033 (37,867) Aggregate 584,244 100 bp decrease 595,801 11,557 100 bp increase 569,598 (14,646) 200 bp increase 552,585 (31,659) 300 bp increase 536,080 (48,164)
(1) Does not include Trenwick International assets. Trenwick has not experienced unrealized gains or losses to the extent indicated on the table above. 18 Equity Price Risk The carrying values of investments subject to equity price risks are based on quoted market prices or management's estimates of fair value as of the balance sheet date. Market prices are subject to fluctuation and, consequently, the amount realized in the subsequent sale of an investment may significantly differ from the reported market value. Fluctuation in the market price of a security may result from perceived changes in the underlying economic characteristics of the investee, the relative price of alternative investments and general market conditions. Furthermore, amounts realized in the sale of a particular security may be affected by the relative quantity of the security being sold. Of Trenwick's $110.6 million equity portfolio at December 31, 1999, $56.6 million of common equity investments is subject to equity risk. The total also includes $54.0 million of preferred shares, which are included in the interest rate risk analysis, as their characteristics more closely resemble debt instruments. Additionally, $19.5 million of other investments generally represent partnership interests that more closely resemble equity investments. Trenwick's potential exposure on equity securities of $56.6 million and partnership interests of $19.5 million is estimated in terms of an immediate 10% drop in equity prices across all equity securities holdings from those prevailing at December 31, 1999 which would result in a $7.6 million loss. Trenwick's actual loss in fair value on a quarterly basis never exceeded this amount during 1999. Trenwick's common equity portfolio of $49.2 million at December 31, 1998, was subject to changes in value based on changes in equity prices. Trenwick's potential exposure from those equity securities, estimated in terms of fair value, to an immediate 10% drop in equity prices across all equity securities holdings from those prevailing at December 31, 1998 would have been $4.9 million. Trenwick's actual loss in fair value on a quarterly basis never exceeded this amount during 1998. The fair value estimates shown are based on the composition of the equity security portfolio at year-end and these exposures will change as a result of ongoing portfolio activities in response to management's assessment of changing market conditions and available investment opportunities. The above analyses do not take into account any correlation among foreign currency exchange rates, or any correlation among various markets (i.e., the fixed income markets and foreign exchange and equity markets). Trenwick's actual experience may differ from the results noted above due to the correlation assumptions utilized, or if events occur that were not included in the methodology, such as significant liquidity or market events. The selection of the amount of increases or decreases in currency exchange rates, interest rates and equity values in the above analyses should not be construed as a prediction of future market events, but rather, to illustrate the potential impact of such an event. Goodwill and Other Acquired Intangible Assets Goodwill was $153.8 million at December 31, 1999, or approximately 33.3% of consolidated shareholders' equity. Goodwill represents the unamortized excess of purchase price over the fair value of net assets of acquired entities. Other intangibles represent Trenwick's acquisition of its prospective participation of $9.5 million on syndicate 839 which entitles one of its U.K. subsidiaries to increase its syndicate premium limit for the 2000 year of account to $344.0 million. The amortization of goodwill and other acquired intangible assets was $1.4 million in 1999, or approximately 6.7% of the pre-tax loss. Trenwick amortizes goodwill and other acquired intangibles on a straight-line basis over twenty-five years and five years, respectively. The risk associated with the carrying value of goodwill and other acquired intangible assets is whether future operating income (before amortization of goodwill and other acquired intangible assets) will be sufficient on an undiscounted basis to recover the carrying value. Trenwick regularly evaluates the recoverability of goodwill and other acquired intangible assets and believes such amounts are currently recoverable. However, any significant change in the useful lives of goodwill or other acquired intangible assets, as estimated by management, could have a material adverse effect on Trenwick's results of operations and financial condition. 19 Accounting Standards Accounting for Derivative Instruments and Hedging Activities - SFAS No. 133 In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," which becomes effective for Trenwick on January 1, 2001. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. Trenwick will be required to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The accounting for a change in the fair value of a derivative in earnings or other comprehensive income will depend on the intended use of the derivative and the resulting designation. Derivatives can be designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or a firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in foreign operations, an unrecognized firm commitment, an available-for-sale security, or a foreign currency denominated forecasted transaction. The difference between a derivative's previous carrying amount and its fair value at the date of implementation of SFAS No. 133 shall be reported as a transition adjustment. Such adjustment shall be reported in net income or other comprehensive income as the effect of a change in accounting principle and presented in a manner similar to the cumulative effect of a change in accounting principle in accordance with Accounting Principles Board Opinion No. 20, "Accounting Changes." Trenwick is currently reviewing the impact of the implementation of SFAS No. 133 on its financial statements. The Euro On January 1, 1999, eleven of the fifteen member countries of the European Union established a fixed conversion ratio between their local currencies and a newly-formed currency, the "Euro." The Euro began trading on foreign currency exchanges on January 1, 1999. Beginning in January 2002, coins and paper currency denominated in Euros will be issued and local currencies of the eleven countries will be withdrawn from circulation. As Trenwick conducts a considerable amount of business in countries participating in the Euro, work was undertaken in 1998 to ensure that the introduction of the Euro would have no adverse effect on Trenwick's business. Consequently, Trenwick modified its computer systems to accommodate transactions denominated in the Euro. The total cost for implementing these changes was not material. Trenwick believes the Euro conversion will not have a material impact on its consolidated financial position or results from operations. Safe Harbor Disclosure In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, Trenwick sets forth below cautionary statements identifying important risks and uncertainties that could cause its actual results to differ materially from those that might be projected, forecasted or estimated in its "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, made by or on behalf of Trenwick in this annual report and in press 20 releases, written statements or documents filed with the Securities and Exchange Commission, or in its communications and discussions with investors and analysts in the normal course of business through meetings, phone calls and conference calls. Such statements may include, but are not limited to, projections of premium revenue, investment income, other revenue, losses, expenses, earnings (including earnings per share), cash flows, plans for future operations, common shareholders' equity (including book value per share), investments, financing needs, capital plans, dividends, plans relating to products or services of Trenwick and estimates concerning the effects of litigation or other disputes, as well as assumptions for any of the foregoing and generally expressed with words such as "believes," "estimates," "expects," "anticipates," "plans," "projects," "forecasts," "goals," "could have," "may have," and similar expressions. Trenwick, as a matter of policy, does not make any specific projections as to future earnings nor does it endorse any projections regarding future performance that may be made by others. Forward-looking statements involve known and unknown risks and uncertainties, which may cause Trenwick's results to differ materially from such forward-looking statements. These risks and uncertainties include, but are not limited to, the following: - - Changes in the level of competition in the domestic and international reinsurance or primary insurance markets that affect the volume or profitability of Trenwick's property/casualty business. These changes include, but are not limited to, changes in the intensity of price competition, the entry of new competitors, existing competitors exiting the market and the development of new products by new and existing competitors; - - Changes in the demand for reinsurance, including changes in ceding companies' risk retentions and changes in the demand for excess and surplus lines insurance coverages; - - The ability of Trenwick to execute its strategies in its property/casualty operations; - - Catastrophe losses in Trenwick's domestic and international property/casualty businesses; - - Adverse development on property/casualty claims and claims expense liabilities related to business written in prior years, including, but not limited to, evolving case law and its effect on environmental and other latent injury claims, changing government regulations, newly identified toxins, newly reported claims, new theories of liability, such as possible Year 2000 computer-related losses, or new insurance and reinsurance contract interpretations; - - Changes in inflation that affect the profitability of Trenwick's current property/casualty business or the adequacy of its property/casualty claims and claims expense liabilities and policy benefit liabilities related to prior years' business; - - Changes in Trenwick's property/casualty retrocessional arrangements; - - Lower than estimated retrocessional or reinsurance recoveries on unpaid losses, including, but not limited to, losses due to a decline in the creditworthiness of Trenwick's retrocessionaires or reinsurers; 21 - - Increases in interest rates, which may cause a reduction in the market value of Trenwick's fixed income portfolio, and its common shareholders' equity; - - Decreases in interest rates which may cause a reduction of income earned on new cash flow from operations and the reinvestment of the proceeds from sales or maturities of existing investments; - - Decline in the value of Trenwick's equity investments; - - Changes in the composition of Trenwick's investment portfolio; - - Credit losses on Trenwick's investment portfolio; - - Adverse results in litigation matters, including, but not limited to, litigation related to environmental, asbestos and other potential mass tort claims; - - The impact of mergers and acquisitions; - - Gains or losses related to changes in foreign currency exchange rates; and - - Changes in Trenwick's capital needs. In addition to the factors outlined above that are directly related to Trenwick's businesses, Trenwick is also subject to general business risks, including, but not limited to, adverse state, federal or foreign legislation and regulation, adverse publicity or news coverage, changes in general economic factors and the loss of key employees. The facts set forth above should be considered in connection with any forward-looking statement contained in this Annual Report. The important factors that could affect such forward-looking statements are subject to change, and Trenwick does not intend to update any forward-looking statement or the foregoing list of important factors. By this cautionary note Trenwick intends to avail itself of the safe harbor from liability with respect to forward-looking statements provided by Section 27A and Section 21E referred to above. 22 TRENWICK GROUP INC. CONSOLIDATED BALANCE SHEET
December 31, 1999 1998 (dollars in thousands) Assets Securities available for sale at fair value: Debt securities (amortized cost: $1,325,438 and $867,552) $1,311,361 $ 893,020 Equity securities (cost: $107,946 and $44,342) 110,666 49,188 Other investments 19,446 - Investments held by managed syndicates 137,745 - Total investments 1,579,218 942,208 Cash and cash equivalents 125,954 63,003 Cash and cash equivalents held by managed syndicates 44,687 - Accrued investment income 26,122 15,974 Premiums in process of collection 270,455 138,550 Reinsurance recoverable balances, net 644,578 140,173 Prepaid reinsurance premiums 100,000 22,632 Goodwill 153,824 1,605 Deferred policy acquisition costs 78,896 35,261 Net deferred income taxes 97,442 14,101 Current income taxes receivable 27,292 2,544 Deposits 20,227 - Other assets 71,904 16,210 Total asset $3,240,599 $1,392,261 Liabilities and common stockholders' equity Liabilities Unpaid claims and claims expenses $1,964,139 $ 682,428 Unearned premium income 379,684 152,051 Senior credit facilities 94,501 - 6.70% senior notes due 2003 75,000 75,000 10.25% senior notes due 2004 39,831 - Contingent interest notes 34,699 - Other long term debt 4,874 - Other liabilities 75,541 24,753 Total liabilities 2,668,269 934,232 Company-obligated mandatorily redeemable preferred capital securities of subsidiary trust holding solely junior subordinated debentures of Trenwick Group Inc. 110,000 110,000 Minority interest 81 - Common stockholders' equity Common stock, $.10 par value, 30,000,000 shares authorized, 16,888,981 and 11,051,394 shares outstanding 1,689 1,105 Additional paid-in-capital 291,361 124,180 Deferred compensation under stock award plan (3,553) (2,905) Retained earnings 182,477 206,312 Accumulated other comprehensive income (9,725) 19,337 Total common stockholders' equity 462,249 348,029 Total liabilities and common stockholders' equity $3,240,599 $1,392,261
The accompanying notes are an integral part of these statements. 23 TRENWICK GROUP INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
Year ended December 31, 1999 1998 1997 (in thousands except per share data) Revenues Net premiums earned $325,114 $245,561 $190,156 Net investment income 66,394 56,316 48,402 Equity in net earnings of investees 188 - - Net realized investment gains 1,916 9,016 2,304 Other income 673 421 10 Total revenues 394,285 311,314 240,872 Expenses Claims and claims expenses incurred 254,538 153,135 109,554 Policy acquisition costs 96,095 74,197 58,549 Underwriting expenses 37,389 23,795 15,425 General and administrative expenses 7,182 3,461 - Interest expense 9,176 3,954 894 Amortization expense 1,423 33 - Minority interest in subsidiary trust 9,702 9,702 8,920 Total expenses 415,505 268,277 193,342 Income (loss) before income taxes and extraordinary item (21,220) 43,037 47,530 Income tax (benefit) expense (10,172) 8,245 11,241 Income (loss) before extraordinary item (11,048) 34,792 36,289 Extraordinary loss on debt redemption, net of $558 income tax benefit - - (1,037) Net income (loss) $(11,048) $ 34,792 $ 35,252 Basic earnings per share Income (loss) before extraordinary item $(.94) $2.99 $3.12 Net income (loss) $(.94) $2.99 $3.03 Diluted earnings per share Income (loss) before extraordinary item $(.94) $2.95 $3.01 Net income (loss) $(.94) $2.95 $3.01 Comprehensive income Net income (loss) $(11,048) $ 34,792 $ 35,252 Other comprehensive income (loss) Unrealized investment gains (losses) (39,779) 8,183 15,316 Realized investment gains included in net income (1,916) (9,016) (2,304) Foreign currency translation adjustment (3,302) (553) - Income tax benefit (expense) applicable to other comprehensive income 15,935 478 (4,556) Total other comprehensive income (loss) (29,062) (908) 8,456 Comprehensive income (loss) $(40,110) $ 33,884 $ 43,708
The accompanying notes are an integral part of these statements. 24 TRENWICK GROUP INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Year ended December 31, 1999 1998 1997 (dollars in thousands except per share data) Common stockholders' equity, beginning of year $348,029 $357,649 $265,753 Common stock, $.10 par value, and additional paid-in-capital Common shares issued in exchange for Chartwell shares (7,964,998 shares) 209,400 - - Fair value of stock options issued in exchange for Chartwell options 3,632 - - Exercise of employer stock options (122,195 and 76,750 shares) - 1,536 956 Restricted common stock awarded (65,985, 82,889, and 9,782 shares) 1,914 2,952 327 Restricted common stock awards cancelled (8,827 and 2,133 shares) (284) - (42) Income tax benefit (expense) from Additional compensation deductions Allowable for income tax purposes (28) 1,321 626 Conversion of debentures (1,783,926 shares) - - 57,780 Common stock purchased and retired (2,184,569, 1,104,750 and 5,091 shares) (46,869) (35,433) (171) Deferred compensation under stock award plans Restricted common stock awarded (1,914) (2,952) (327) Restricted common stock awards cancelled 284 - 42 Compensation expense recognized 982 770 543 Retained earnings Net income (loss) (11,048) 34,792 35,252 Cash dividends ($1.04, $1.00 and $.97 per share) (12,787) (11,698) (11,546) Accumulated other comprehensive income Other comprehensive income (loss) (29,062) (908) 8,456 Common stockholders' equity, end of year $462,249 $348,029 $357,649
The accompanying notes are an integral part of these statements. 25 TRENWICK GROUP INC. CONSOLIDATED STATEMENT OF CASH FLOWS
Year ended December 31, 1999 1998 1997 (in thousands) Cash flows for operating activities Premiums collected $386,087 $242,620 $149,351 Ceded premiums paid (138,622) (53,643) (10,026) Claims and claims expenses paid (369,033) (184,386) (117,916) Claims and claims expenses recovered 56,897 25,815 2,841 Underwriting expenses paid (30,579) (27,378) (13,753) Cash provided by (used for) underwriting activities (95,250) 3,028 10,497 Net investment income received 71,858 59,443 50,469 Service and other income received, net of expenses 18 91 - General and administrative expenses paid (7,182) (3,461) - Interest expense and subsidiary trust dividends paid (19,946) (12,276) (5,364) Income taxes paid (1,796) (8,956) (8,592) Cash provided by (used for) operating activities (52,298) 37,869 47,010 Cash flows for investing activities Purchases of debt securities (647,670) (537,787) (203,554) Sales of debt securities 372,225 116,895 33,980 Maturities of debt securities 397,165 445,800 78,770 Purchases of equity securities (29,656) (11,538) (12,967) Sales of equity securities 21,560 15,088 5,009 Acquisition of subsidiary, net of cash acquired 74,229 (39,799) - Additions to premises and equipment (1,783) (4,596) (227) Other, net (55) - - Cash provided by (used for) investing activities 186,015 (15,937) (98,989) Cash flows for financing activities Issuance of other long-term debt 94,473 - - Issuance of senior notes - 75,000 - Issuance of mandatorily redeemable Preferred capital securities - - 110,000 Repayment of other long-term debt (48,417) - - Issuance costs of senior notes and capital securities - (922) (1,669) Issuance costs of long-term debt (4,055) - - Redemption of convertible debentures - - (46,997) Issuance of common stock - 1,536 956 Repurchase of common stock (44,604) (34,880) (171) Dividends paid (12,787) (11,698) (11,546) Other, net (9,056) - - Cash provided by (used for) financing activities (24,446) 29,036 50,573 Effect of exchange rate on cash (1,633) (812) - Change in cash and cash equivalents 107,638 50,156 (1,406) Cash and cash equivalents, beginning of year 63,003 12,847 14,253 Cash and cash equivalents, end of year $170,641 $ 63,003 $12,847
The accompanying notes are an integral part of these statements. 26 TRENWICK GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 Organization and Summary of Significant Accounting Policies Organization Trenwick Group Inc. (Trenwick or the Company) is a holding company whose principal subsidiaries underwrite specialty insurance and reinsurance. Trenwick's principal operating subsidiaries include Trenwick America Reinsurance Corporation (Trenwick America Re), Chartwell Reinsurance Company (Chartwell Reinsurance), The Insurance Corporation of New York (INSCORP), Dakota Specialty Insurance Company (Dakota), Trenwick International Limited (Trenwick International) and Chartwell Managing Agents Limited (CMA), a managing agency in the Lloyd's marketplace. Trenwick America Re, located in Stamford, Connecticut, reinsures property and casualty risks primarily written by U.S. insurance companies. Trenwick America Re underwrites treaty reinsurance. Trenwick America Re is domiciled in Connecticut and is licensed, authorized or approved to write reinsurance in all 50 states and the District of Columbia. Chartwell Reinsurance, located in Stamford, Connecticut, underwrote treaty reinsurance for casualty, property, marine and aviation risks prior to its acquisition by the Company. Chartwell Reinsurance is currently domiciled in Minnesota and is licensed, authorized or approved to write reinsurance in 49 states and the District of Columbia. Chartwell Reinsurance is in the process of re-domesticating to Connecticut and changing its name to Chartwell Insurance Company. It will be used by the Company to underwrite primary insurance in the future. INSCORP, located in Jericho, New York, is a primary insurance company that develops property and casualty insurance programs through specialty production sources focusing on a specific line of business and geographic region. INSCORP is domiciled in New York and is licensed, authorized or approved to transact business in all 50 states, the District of Columbia and Canada. Trenwick International, headquartered in London, England, underwrites specialty insurance and reinsurance of risks primarily located outside the U.S. Trenwick International's business principally consists of insurance and facultative reinsurance of specialty classes. Trenwick International also underwrites property and casualty treaty reinsurance. A branch office in Paris specializes in facultative reinsurance of large, technically complex property risks. Trenwick International is domiciled in England and is authorized to write insurance in over 30 countries and participates in the London market for worldwide reinsurance. Trenwick, through corporate subsidiaries, participates in the underwriting of Lloyd's syndicates managed by Chartwell Managing Agents Limited (CMA) by providing funds at Lloyd's, primarily in the form of letters of credit supporting underwriting capacity. The syndicates in which the Company participates underwrite aviation, marine and non-marine risks. 27 CMA is the eighteenth largest managing agency at Lloyd's, managing three Lloyd's syndicates for the 2000 year of account. CMA is domiciled in England and, as a Lloyd's managing general agent, is subject to regulation and supervision by the Council of Lloyd's. Basis of Presentation The consolidated financial statements include the accounts of the Company and all subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. Certain items in the financial statements have been reclassified to conform with the 1999 presentation. The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) in the U.S. which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following is a summary of significant accounting policies. Investments and Cash Equivalents Trenwick has classified all of its debt and equity securities as "available for sale" and reported them at fair value with net unrealized gains and losses included in other comprehensive income, net of related deferred income taxes. The fair value of debt securities and equity securities is estimated using quoted market prices or broker dealer quotes. Cash equivalents represent investments with maturities at date of purchase of three months or less and are carried at cost which approximates fair value. Investments in companies in which the Company has the ability to exercise significant influence over the operating and financial policies of the investees are accounted for under the equity method. In addition, limited partnerships in which the Company holds greater than 3% interest are accounted for under the equity method. Realized gains or losses on disposition of investments are determined on the basis of the specific identification method. Investment income consisting of dividends and interest, net of investment expenses, is recognized in income when earned. The amortization of premiums and accretion of discount for debt securities is computed utilizing the interest method. The effective yield utilized in the interest method is adjusted when sufficient information exists to estimate the probability and timing of prepayments on mortgage-backed and asset-backed securities. The net investment in the security is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the security and that adjustment is included in net investment income. The Company has included in the consolidated balance sheet its pro-rata share of the investments and cash and cash equivalents held by CMA's managed syndicates. Such pro-rata share is determined based on the Company's percentage of capacity owned through its dedicated corporate capital vehicles. Revenues Insurance and reinsurance premiums are earned (net of reinsurance ceded) on a pro-rata basis over the related contract period. Unearned premium income represents the portion of premiums applicable to the unexpired portion of premium coverage with renewal dates later than year-end. Such reserves are computed by pro-rata methods for direct business and are established based on reports received from ceding companies for reinsurance. Premiums on contracts are accrued on an estimated basis throughout the term of such contracts. These estimates may change in the near term. Retrospectively rated and other experience rated reinsurance contracts are estimated and accrued for based on the difference between total costs before and after the experience under the contract (the with-and-without method). These estimates of experience to date are based on statistical data with subsequent adjustments recorded in the period in which they become known. 28 Deposits Reinsurance contracts that do not meet insurance accounting risk transfer requirements are classified as deposits. These deposits are treated as financing transactions and are credited or charged with interest income or expense according to contract terms. Cash flows from these deposit transactions are included in "cash flows for financing activities" in the consolidated statement of cash flows. Policy Acquisition Costs Policy acquisition costs are stated net of policy acquisition costs ceded and primarily consist of commissions and brokerage expenses incurred at policy or contract issue date. These costs vary with, and are primarily related to, the acquisition of business and are deferred and amortized over the period in which the related premiums are earned. Deferred policy acquisition costs are reviewed periodically to determine that they do not exceed recoverable amounts after allowing for anticipated investment income. Reserve for Unpaid Claims and Claims Expenses Claims are recorded as incurred so as to match such costs with premiums over the contract periods. The amount provided for unpaid claims consists of any unpaid reported claims and estimates for incurred but not reported claims, net of salvage and subrogation. The estimates for claims incurred but not reported were developed based on the Company's historical claims experience and an actuarial evaluation of expected claims experience. Insurance liabilities are based on estimates and the ultimate liability may vary from such estimates. Any adjustments to these estimates are reflected in income when known. Income Taxes Income taxes are provided based on income reported in the financial statements. Deferred income taxes are provided based on an asset and liability approach which requires the recognition of deferred income tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Provision for U. S. income taxes on undistributed earnings of foreign subsidiaries is made only on those amounts in excess of the funds considered to be permanently reinvested. Repatriation of undistributed earnings of non-U.S. subsidiaries is done only when it is tax efficient to do so. 29 Goodwill and Other Acquired Intangible Assets Goodwill represents the unamortized excess of purchase price over the fair value of net assets of acquired entities. Other acquired intangible assets represent Trenwick's acquisition of its prospective participation of $9,485,000 on syndicate 839, which entitled one of its U.K. subsidiaries to increase its syndicate premium limit for the 2000 year of account to $344,000,000. The Company amortizes goodwill and other acquired intangible assets on a straight-line basis over 25 years and 5 years, respectively. On a periodic basis, the Company estimates the future undiscounted cash flows of the business to which it relates in order to ensure that the carrying value of goodwill and other acquired intangible assets has not been impaired. Amortization charged to operations for each of the years ended December 31, 1999 and 1998 was $1,423,000 and $33,000, respectively. Accumulated amortization of goodwill at December 31, 1999 and 1998 was $1,456,000 and $33,000, respectively. Stock-Based Compensation Trenwick grants stock options for a fixed number of common shares to employees and non-employee directors with an exercise price equal to the market value of the shares at the date of grant. The accounting standard, "Accounting for Stock-Based Compensation," supersedes the previous opinion and establishes a fair value-based method of accounting for stock-based compensation plans. However, it permits an entity to continue to apply the accounting provisions of Accounting Principles Board Opinion, "Accounting for Stock Issued to Employees," and make pro forma disclosures of net income and earnings per share, as if the fair market value-based method had been applied. Trenwick continues to account for the stock option grants in accordance with the previous opinion and has included the pro forma disclosures required by the fair value-based method in Note 10. Earnings Per Share Trenwick adopted the accounting standard, "Earnings Per Share," which specifies the computation, presentation and disclosure requirements of earnings per share and supersedes the previous standard. It requires a dual presentation of basic and diluted earnings per share. Basic earnings per share, which excludes the effect of common stock equivalents, replaces primary earnings per share. Diluted earnings per share, which utilizes the average market price per share as opposed to the greater of the average market price per share or ending market price per share when applying the treasury stock method in determining common stock equivalents, replaces fully-diluted earnings per share. Minority Interest Minority interest represents the minority stockholders' proportionate share of the equity of certain subsidiaries of Chartwell UK. Premises and Equipment Premises and equipment, including leasehold improvements are included in other assets in the accompanying Consolidated Balance Sheet and are recorded at cost and are amortized or depreciated using the straight-line method over their useful lives. Accumulated amortization and depreciation was $6,863,000 and $5,703,000 as of December 31, 1999 and 1998, respectively. Issuance Costs of Capital Securities and Other Debt The issuance costs of the capital securities, senior notes and senior credit facilities are being amortized over the term of the related financial instrument using the interest method. Accumulated amortization was $421,000 and $129,000 as of December 31, 1999 and 1998, respectively. 30 Insurance Brokerage Assets and Liabilities The following fiduciary assets and liabilities maintained by the Company's insurance agency subsidiaries on behalf of the insureds are presented net in the consolidated financial statements at December 31, 1999 (in thousands): Cash $ 3,000 Accounts receivable 31,603 Accounts payable (34,603) Comprehensive Income Trenwick adopted the accounting standard, "Reporting Comprehensive Income," which establishes standards for reporting and presentation of comprehensive income and its components. Comprehensive income comprises net income and other comprehensive income. Other comprehensive income consists of the change in the net unrealized appreciation of investments and the change in foreign currency translation adjustments, both net of income taxes. Foreign Exchange The assets and liabilities of foreign operations whose functional currency is other than the U.S. dollar are translated at the rate of exchange in effect at the balance sheet date. Revenues and expenses of foreign operations are translated at the average exchange rates during the year. The effect of the translation adjustments for foreign operations, net of applicable deferred income taxes, is recorded as a cumulative translation adjustment in accumulated other comprehensive income within stockholders' equity. Investments denominated in foreign currencies are translated into the U.S. dollar using the rate of exchange at the balance sheet date and unrealized gains and losses on translation, net of applicable deferred income taxes, are recorded to other comprehensive income. Foreign currency transaction gains and losses are included in other income. Accounting for Derivative Instruments and Hedging Activities Effective January 1, 2001, Trenwick expects to adopt the new accounting standard, "Accounting for Derivative Instruments and Hedging Activities," which requires all derivatives to be recognized on the balance sheet at fair value. The Company is currently reviewing the impact of the implementation of the standard on its financial statements. Note 2 Acquisitions Chartwell Re Corporation On October 27, 1999, Trenwick completed the merger of Chartwell Re Corporation (Chartwell) with and into Trenwick. Under the terms of the merger, stockholders of Chartwell received 0.825 Trenwick shares for each Chartwell share in a tax-free transaction. Described below are the adjustments to record the assets and liabilities at fair value and allocate the purchase price over fair value of net assets acquired. All amounts are in thousands, except per share amounts. Chartwell's outstanding common shares 9,655 Exchange ratio for the conversion of shares 0.825 Trenwick common shares issued in exchange for Chartwell common shares 7,965 Trenwick's average price per common share $ 26.29 Total consideration for Chartwell's common shares $209,400 Total consideration for Chartwell's common stock options 3,632 Acquisition costs 18,294 Total purchase price $231,326 Less Fair value of Chartwell's net assets 78,011 Goodwill $153,315 31 The acquisition has been accounted for using the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets purchased and the liabilities assumed based on the estimated fair values at the date of acquisition. As a condition to the merger, Chartwell purchased, at the time of the closing of the transaction, a reinsurance policy providing for up to $100,000,000 in order to indemnify Trenwick against unanticipated increases in Chartwell's reserves for business written on or before the date the merger was completed. See Note 5 - Reinsurance. In connection with the acquisition of Chartwell, the Company recognized a liability of approximately $4,700,000 for anticipated severance costs of former Chartwell employees. The total amount paid under the severance plan as of December 31, 1999 was approximately $4,300,000. The excess of the purchase price over the estimated fair value of the net assets of approximately $153,315,000 has been recorded as goodwill, which is being amortized on a straight-line basis over 25 years. The purchase price has been allocated based on a preliminary estimate of the fair value of net assets acquired. All assets and liabilities of Chartwell are consolidated in the balance sheet as of December 31, 1999 and its operating results are consolidated in Trenwick's results commencing with the period from October 28, 1999 through December 31, 1999. The following unaudited pro forma consolidated results of operations for the years ended December 31 assume the acquisition had occurred on January 1 of each year: 1999 1998 (in thousands, except per share data) Net premiums earned $ 478,226 $ 475,065 Total revenue 573,660 609,118 Net income (loss) (124,331) 59,697 Basic net income (loss) per share $ (6.76) $ 3.04 Diluted net income (loss) per share $ (6.76) $ 2.99 The above unaudited pro forma financial information is not necessarily indicative either of the results of operations that would have occurred had this transaction been consummated at the beginning of the periods presented or of future results of operations. LaSalle Re Holdings Limited On December 19, 1999, Trenwick and LaSalle Re Holdings Limited (LaSalle Re) signed a definitive agreement for Trenwick and LaSalle Re to combine, with shareholders of both companies receiving shares in a new Bermuda holding company to be named Trenwick Group Ltd. Under the terms of the business combination agreement, shareholders of Trenwick and LaSalle Re will each receive shares in the newly formed Trenwick on a one-for-one basis. The acquisition will be accounted for as a purchase. Trenwick expects to close the transaction in the second quarter of 2000, subject to shareholder and regulatory approvals and other customary conditions. 32 On March 20, 2000, Trenwick and LaSalle Re amended and restated the business combination agreement in order to revise the portion of the business combination agreement related to the restructuring of Trenwick immediately prior to the combination with LaSalle Re. Note 3 Investments The following tables reconcile amortized cost to the estimated fair value of debt and equity securities: (in thousands) December 31, 1999
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 114,839 $ 379 $ (681) $ 114,537 Obligations of states and political subdivisions 460,176 2,221 (7,404) 454,993 Mortgage-backed and asset-backed securities 290,801 1,263 (3,529) 288,535 Debt securities issued by British government 117,165 110 (2,252) 115,023 Debt securities issued by other foreign governments 55,436 44 (484) 54,996 Public utilities 21,229 43 (381) 20,891 Corporate securities 262,855 443 (3,852) 259,446 Certificates of deposit 2,937 3 - 2,940 Total debt securities $1,325,438 $ 4,506 $(18,583) $1,311,361 Equity securities $ 107,946 $ 7,752 $ (5,032) $ 110,666
(in thousands) December 31, 1998
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 64,831 $ 3,851 $ (14) $ 68,668 Obligations of states and political subdivisions 380,593 13,544 (120) 394,017 Mortgage-backed and asset-backed securities 206,790 8,648 (3,322) 212,116 Debt securities issued by British government 45,949 587 - 46,536 Debt securities issued by other foreign governments 8,163 78 - 8,241 Public utilities 2,864 222 - 3,086 Corporate securities 55,364 2,011 (65) 57,310 Redeemable preferred stock 2,000 48 - 2,048 Certificates of deposit 100,998 - - 100,998 Total debt securities $867,552 $28,989 $(3,521) $893,020 Equity securities $ 44,342 $ 6,514 $(1,668) $ 49,188
33 The fair value and amortized cost at December 31, 1999 are shown below by contractual maturity periods for all debt securities except mortgage-backed and asset-backed securities. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty. The maturities for mortgage-backed and asset-backed securities are included in the table based on expected maturity dates. Fair Amortized (in thousands) Value Cost ---------- ---------- Due in one year or less $ 94,546 $ 93,913 Due after one year through five years 544,077 545,161 Due after five years through ten years 482,652 490,465 Due after ten years 190,086 195,899 Total debt securities $1,311,361 $1,325,438 Net Investment Income and Net Realized Investment Gains During the twelve months ended December 31, 1999, all investments were income producing. The sources of net investment income for the years ended December 31 are as follows: (in thousands) 1999 1998 1997 ------- ------- ------- Debt securities $61,964 $53,752 $47,400 Equity securities 2,442 1,744 1,257 Investments held by managed syndicates 1,843 - - Cash and cash equivalents 1,666 2,470 1,228 Cash and cash equivalents held by managed syndicates 644 - - Other investments 177 - - Gross investment income 68,736 57,966 49,885 Investment expenses (2,342) (1,650) (1,483) Net investment income $66,394 $56,316 $48,402 Net realized gains (losses) on sales of investments are as follows: (in thousands) 1999 1998 1997 Debt securities Gross realized gains $ 3,147 $2,250 $ 151 Gross realized losses (6,797) (201) (146) Equity securities Gross realized gains 6,009 7,012 2,299 Gross realized losses (443) (45) - Net realized investment gains $ 1,916 $9,016 $2,304 Trenwick generally limits its investments in debt securities that are rated below investment grade, as these investments are subject to a higher degree of credit risk than investment grade securities. Trenwick closely monitors its below investment grade securities as well as the creditworthiness of the portfolio as a whole. When fair values decline for reasons other than changes in interest rates or other perceived temporary conditions, the security is written down to its net realizable value. In the twelve months ended December 31, 1999, Trenwick wrote down the value of certain securities by $5,179,000. 34 Unrealized Appreciation of Investments Available for Sale The components of the net unrealized appreciation (depreciation) of investments available for sale at December 31 are as follows: (in thousands) 1999 1998 --------- --------- Net unrealized appreciation (depreciation) of debt securities $(14,077) $ 25,468 Net unrealized appreciation of equity securities 2,720 4,846 Net unrealized appreciation (depreciation) of investments (11,357) 30,314 Deferred tax benefit (expense) 3,907 (10,622) Net unrealized appreciation (depreciation) of investments available for sale, net of income taxes $ (7,450) $ 19,692 Investments and Cash Held as Collateral or on Deposit Debt securities and cash with a carrying value of $127,026,000 are being held in trust as collateral for certain reinsurance obligations. In addition, debt securities and cash with a carrying value of $41,104,000 at December 31, 1999 were on deposit with various state or governmental insurance departments in order to comply with insurance laws. Cash in the amount of $4,954,000 has also been pledged as collateral for letters of credit for reinsurance obligations. At December 31, 1999, the Company had cash of $5,040,000 held in a collateral account in conjunction with a loan guarantee. At December 31, 1999, the Company had loaned securities with carrying value of approximately $16,155,000 at fair market value under a security lending agreement administered through U.S. Bank. In connection with these transactions, the Company holds as collateral cash or securities with a fair value equal to 102% of the fair value of the securities lent to others. Such collateral securities are marked to market on a daily basis and borrowers are required to supply additional collateral to prevent any collateral from falling below 102% of the fair value of the loaned securities. 35 Note 4 Unpaid Claims and Claims Expenses The following table presents an analysis of gross and net unpaid claims and claims expenses and a reconciliation of beginning and ending net unpaid claims and claims expense balances. The gross unpaid claims and claims expense balances at December 31, 1999 and 1998 are reflected in Trenwick's consolidated balance sheet. The net unpaid claims and claims expense balances are stated on a net basis after deductions for reinsurance recoverable on unpaid claims and claims expenses from retrocessionaires.
(in thousands) 1999 1998 1997 ---- ---- ---- Gross unpaid claims and claims expenses, beginning of year $682,428 $518,387 $ 467,177 Reinsurance recoverable on unpaid claims and claims expenses, beginning of year 233,164 139,036 80,290 Unpaid claims and claims expenses, net of reinsurance recoverable, beginning of year 449,264 379,351 386,887 ---------- --------- -------- Unpaid claims and claims expenses, net of reinsurance recoverable, of companies acquired 808,466 81,299 - ---------- --------- --------- Provision for claims and claims expenses, net of reinsurance recoverable: For claims incurred in the current year 239,910 165,691 114,920 For claims incurred prior to the current year 14,628 (12,556) (5,366) ---------- --------- ---------- Subtotal 254,538 153,135 109,554 ---------- --------- ---------- Payments for claims and claims expenses, net of reinsurance: For claims incurred in the current year (65,856) (42,883) (22,893) For claims incurred prior to the current year (230,493) (122,145) (94,197) ---------- --------- ---------- Subtotal (296,349) (165,028) (117,090) ---------- --------- ---------- Effect of exchange rate changes on unpaid claims and claims expenses (8,483) 507 - ---------- --------- ---------- Unpaid claims and claims expenses, net of reinsurance recoverable, end of year 1,207,436 449,264 379,351 ---------- --------- ---------- Reinsurance recoverable on unpaid claims and claims expenses, end of year 756,703 233,164 139,036 ---------- --------- ---------- Gross unpaid claims and claims expenses, end of year $1,964,139 $682,428 $518,387 ========== ========= ===========
In 1999, Trenwick recorded a gross increase of $83,175,000 and a net increase of $14,628,000 in estimates for claims occurring in prior accident years, including cessions of $46,460,000 to the Chartwell adverse development cover discussed in Note 5. In 1998 and 1997, Trenwick recorded net decreases of $12,556,000 and $5,366,000, respectively, in estimates for claims occurring in prior accident years. The increase in 1999 is due to unfavorable development of prior year reserves in Trenwick America Re. In 1999, Trenwick America Re's estimates of prior accident year claims increased by approximately $25,402,000 on a gross basis and $16,189,000 on a net basis. In 1998 and 1997, estimates of prior accident year claims were reduced by approximately $7,175,000 and $5,366,000, respectively. Trenwick America Re's increase in 1999 reflects a deterioration in market conditions since 1997. In 1999 estimates of Trenwick International's prior year claims increased by $11,313,000 on a gross basis and decreased by $1,561,000 on a net basis. In 1998, Trenwick International's prior year claims were reduced by approximately $5,381,000 on a net basis. The gross increase in 1999 was offset by the effect of reinsurance and favorable development across certain lines of business. 36 Inflation raises the cost of economic losses and non-economic damages covered by insurance contracts and, therefore, is a factor in determining effective rates of reinsurance. The methods used by Trenwick to estimate individual case reserves and reserves for claims incurred but not yet reported implicitly incorporate the effects of inflation in the projection of ultimate losses. Due to the inherent uncertainties of estimating insurance company claim reserves, actual claims and claims expenses may deviate, perhaps substantially, from estimates of Trenwick's reserves reflected in Trenwick's consolidated financial statements. Trenwick's management believes that its claim reserve methods are reasonable and prudent and that Trenwick's reserve for claims and claims expenses at December 31, 1999 are adequate. However, reserves also include provisions for latent injury or toxic tort claims that cannot be estimated with traditional reserving techniques. Due to inconsistent court decisions' in federal and state jurisdictions and the wide variation among insureds with respect to underlying facts and coverage, uncertainty exists with respect to these claims as to liabilities of ceding companies and, consequently, reinsurance coverage. With the exception of INSCORP, the Company's exposure to such latent losses is not expected to be significant due to its relatively recent entry into the reinsurance business, its low historical levels of premium volume prior to the application of exclusions for asbestos and environmental liabilities and its retrocessional programs. To the extent that there is adverse development in INSCORP's loss reserves, including its reserves for latent losses, the Company's obligation under the Contingent Interest Notes due June 30, 2006 (the CI Notes) will be reduced. To the extent the CI Notes do not provide sufficient protection against adverse development in INSCORP's loss reserves, Trenwick may be entitled to recoveries under the $100,000,000 reinsurance policy purchased by Chartwell immediately prior to its acquisition by Trenwick. See Note 5-Reinsurance. Trenwick's reserves include an estimate of Trenwick's ultimate liability for asbestos and environmental claims. The gross and net unpaid claims and claims expenses for asbestos and environmental claims are as follows: (in thousands) 1999 1998 1997 ---- ---- ---- Unpaid claims and claims expenses gross of reinsurance recoverable, end of year $100,131 $8,476 $8,924 Unpaid claims and claims expenses, net of reinsurance recoverable, end of year 72,092 8,428 8,814 Reinsurance recoverable on unpaid claims and claims expenses, end of year 28,039 48 110 The increase of the gross and net unpaid claims and claims expenses reflects the inclusion of the reserves related to the Chartwell acquisition. 37 Note 5 Reinsurance Trenwick enters into reinsurance and retrocessional agreements to reduce its net liability on individual risks, protect against catastrophic losses and maintain acceptable ratios. Trenwick America Re has various retrocessional facilities, all of which are on a treaty basis. These retrocessional facilities include one treaty for Trenwick America Re's facultative casualty reinsurance business, which applies on a risk or account basis, and two for its treaty property business, which protect it against multiple claims arising out of a single occurrence or event. As a result of these facilities, Trenwick America Re's maximum retention generally does not exceed $500,000 per occurrence on facultative business and $2,300,000 per occurrence on property catastrophe business. From 1989 to 1999, Trenwick America Re has purchased aggregated excess of loss ratio treaties from several reinsurers. These facilities provided Trenwick with a layer of protection against adverse results from its domestic casualty business in excess of specified loss ratios. Trenwick did not purchase an aggregate excess of loss ratio treaty for 2000. Trenwick International, as customary with companies operating in the London market, buys large amounts of reinsurance. Reinsurance and retrocessional coverage is customized for each class of business. During 1998, following an increase in its share capital, Trenwick International increased its retention of business by reducing the amount of reinsurance it buys, principally proportional reinsurance treaties with its former parent. Chartwell Managing Agency, as part of its business strategy, has historically purchased a significant amount of reinsurance for the Lloyd's syndicates it manages. Reinsurance is generally purchased to protect the syndicates against extraordinary loss or loss involving one or more underwriting classes. The amount purchased is determined with reference to the syndicates' aggregate exposure and potential loss scenarios. INSCORP and Dakota, the primary insurance subsidiaries of Canterbury Financial Group, each purchases reinsurance specifically tailored to each of the specialty programs which they underwrite. Effective October 27, 1999, Chartwell purchased, at the time of the closing of the transaction, a reinsurance policy providing for up to $100,000,000 in order to indemnify Trenwick against unanticipated increases in Chartwell's reserves for business written on or before the date the merger was completed. The Company has applied the provisions of the Financial Accounting Standards Board's Emerging Issues Task Force Topic D-54 to account for future adverse development covered by the agreement. Recoverables under the agreement are presented gross in the consolidated balance sheet as "Reinsurance recoverable balances." The related benefit for losses ceded to the agreement is reflected as a reduction to "Claims and claims expenses incurred" as discussed in Note 4. The benefit related to other underwriting balances is reflected as a reduction to "Underwriting expenses." In addition, as part of the merger, Chartwell commuted several aggregate stop-loss contracts. Reinsurance agreements provide for recovery of a portion of certain claims and claims expenses from reinsurers. 38 Trenwick remains liable in the event that the reinsurer is unable to meet its obligation; however, Trenwick holds partial collateral under these agreements. The effects of reinsurance on premiums written and premiums earned for the three years ended December 31, are as follows: (in thousands) 1999 1998 1997 ---- ---- ---- Direct premiums written $ 128,224 $ 60,510 $ - Assumed premiums written 377,317 262,854 248,662 Ceded premiums written (150,931) (73,145) (53,432) --------- ---------- --------- Net premiums written $ 354,610 $ 250,219 $195,230 ======== ========= ========= Direct premiums earned $ 84,542 $ 54,605 $ - Assumed premiums earned 376,927 269,093 233,090 Ceded premiums earned (136,355) (78,137) (42,934) --------- ---------- --------- Net premiums earned $ 325,114 $ 245,561 $ 190,156 ======== ======== ========= The Company recorded ceded claims and claims expenses incurred of $204,399,000, $81,955,000 and $60,789,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The components of reinsurance recoverable balances, net on the balance sheet at December 31 are as follows: (in thousands) 1999 1998 ---------- --------- Paid claims $ 66,698 $ 17,098 Unpaid claims and claims expenses 756,703 233,164 Funds held liability (126,222) (86,614) Reinsurance balances payable (52,601) (23,475) ---------- ---------- Reinsurance recoverable balances, net $ 644,578 $ 140,173 ========== ========== The funds held liability includes approximately $27,277,000 and $16,641,000 of imputed interest as of December 31, 1999 and 1998, respectively. Approximately $10,636,000, $7,009,000 and $4,989,000 of interest expense was incurred during 1999, 1998 and 1997, respectively, and recorded as a reduction to net earned premiums. Letters of credit, trust accounts and funds withheld in the aggregate amount of $269,344,000 (including interest) have been arranged in favor of Trenwick collateralizing reinsurance recoverables with respect to certain retrocessionaires. At December 31, 1999, approximately 36% of Trenwick's reinsurance recoverables on unpaid claims and claims expenses are recoverable from five principal retrocessionaires. These retrocessionaires are Zurich Reinsurance N.A, Continental Casualty Company, Centre Re-Insurance Ltd., London Life and Casualty Reinsurance Corporation and UNUM Life Insurance Company of America which had reinsurance recoverable balances of $148,854,000, $39,209,000, $37,163,000, $24,391,000 and $22,363,000, respectively at December 31, 1999. Such companies are rated A or better by A.M. Best Company. Included in Deposits on the balance sheet at December 31, 1999 are $13,310,000 deposited with European International Reinsurance Limited and $6,917,000 deposited with Centre Reinsurance (Bermuda) Limited, both of which are secured by letters of credit. 39 For the years ended December 31, 1999, 1998 and 1997, Trenwick earned commissions on cessions to retrocessionaires of $25,422,000, $10,495,000 and $4,503,000, respectively. Note 6 Income Taxes Income taxes are established on a consolidated basis for all domestic and international operations of Trenwick. In 1997, the income tax provision includes an income tax benefit of $558,000 applicable to an extraordinary loss on debt redemption. The components of the provision for income taxes for the years ended December 31 are as follows: (in thousands) 1999 1998 1997 -------- ------- -------- Current expense (benefit) Federal $(14,578) $4,392 $ 7,197 Foreign 1,515 2,324 - State (44) 200 262 Total current expense (benefit) $(13,107) $6,916 $ 7,459 Deferred expense (benefit) Federal $ 6,765 $1,110 $ 3,224 Foreign (3,830) 219 - Total deferred expense 2,935 1,329 3,224 Total income tax expense (benefit) $(10,172) $8,245 $10,683 Due to the carryback of current year's losses to previous years taxable income including the Chartwell companies, the Company will recoup the maximum amount refundable for taxes paid in the preceding two tax years. The income tax provision for each of the years presented differs from the amounts determined by applying the applicable U.S. statutory federal income tax rate of 35% to income (loss) before income taxes as a result of the following: (in thousands) 1999 1998 1997 -------- -------- -------- Income (loss) before income taxes $(21,220) $43,037 $45,935 Income taxes at statutory rate ($7,427) $15,063 $16,077 Effect of tax-exempt investment income (6,227) (5,654) (5,757) Foreign operations 903 (256) - Amortization of goodwill 498 - - Valuation allowance 770 - - Other, net 1,311 (908) 363 Income tax provision (benefit) $(10,172) $8,245 $10,683 As of December 31, 1999, the Company and all includible subsidiaries have U.S. net operating loss carryforwards of $53,195,000 which will be available (subject to the annual limitation discussed below) to offset regular taxable income during the carryforward period (expiring 2019). Of the total net operating loss carryforward, $15,717,000 was generated by INSCORP prior to its acquisition in 1995 and is limited by Section 382 of the Internal Revenue Code, to an annual amount of $3,483,000 to offset future taxable income each year. 40 The Company provides income taxes on the undistributed earnings of non-U.S. subsidiaries except to the extent that such earnings are considered permanently reinvested outside the U.S. It is not practicable to determine the amount of income or withholding tax that would be payable upon the remittance of those earnings. However, the Company does not anticipate that the income or withholding tax that would be payable upon remittance of the undistributed earnings of the non-U.S. subsidiaries would aggregate to a material amount. Deferred income tax assets (liabilities) are attributable to the following temporary differences as of December 31: (in thousands) 1999 1998 -------- -------- Deferred income tax asset Discounting and other loss reserve adjustments $ 30,647 $ 27,152 Unearned premium income 8,657 6,862 Net operating losses 18,618 - Lloyd's loss reserve accrual 22,980 - Contingent interest note 11,514 - Tax basis difference on portfolio securities 3,938 - Employee stock option and compensation plans 1,135 651 Foreign tax credit 7,722 - Alternative minimum taxes 3,684 1,390 Currency translation adjustments 1,603 197 Excess tax basis of foreign subsidiaries 18,305 632 Foreign operations 6,207 - Unrealized depreciation of investments available for sale 3,907 - Other 2,206 - Gross deferred income tax assets 141,123 36,884 Less: Valuation allowance (23,982) - Deferred tax assets after valuation allowance 117,141 36,884 Deferred income tax liability Policy acquisition costs deferred (13,289) (10,716) Unrealized appreciation of investments available for sale - (10,622) Earned but not reported premiums net of loss and expense (2,358) - Accretion of market discount on debt securities (1,416) (1,282) Equity investment adjustments (1,102) - Other (1,534) (163) Gross deferred income tax liabilities (19,699) (22,783) Net deferred income tax assets $ 97,442 $ 14,101 41 During 1999, the Company recorded a valuation allowance of $23,982,000 to reduce its deferred tax asset in accordance with the provisions of the accounting standard "Accounting For Income Taxes" (FASB 109). The valuation allowance is necessary because sufficient uncertainty exists regarding the realizability of certain foreign tax credits and other deferred tax assets related to the excess tax basis of foreign subsidiaries. The Company will periodically review the adequacy of the valuation allowance and will recognize benefits only as the reassessment indicates that it is "more likely than not" that these benefits will be realized. In accordance with the provisions of FASB 109, any reduction in the valuation allowance will be offset against goodwill. Realization of the related tax benefits will depend upon the recognition of future earnings from foreign operations or a change in circumstances that cause the recognition of these benefits to meet the "more likely than not" standard of FASB 109. Note 7 Long-Term Debt Senior Notes On March 27, 1998 Trenwick completed a private offering of $75,000,000 aggregate principal amount of its 6.70% Senior Notes due April 1, 2003 (the Senior Notes). Interest is payable semi-annually on April 1 and October 1 of each year, which commenced on October 1, 1998. The Senior Notes are not subject to redemption prior to maturity. They are unsecured obligations and will rank senior in right of payment to all existing and future subordinated indebtedness of Trenwick, including Trenwick's obligations with respect to its 8.82% Junior Subordinated Debentures held by Trenwick Capital Trust I in respect of the $110,000,000 in 8.82% Subordinated Capital Income Securities issued by the Trust. Under the terms of the Senior Notes, Trenwick is not restricted from incurring indebtedness, but is subject to limits on its ability to incur secured indebtedness for borrowed money. On March 17, 1994, Chartwell completed a public offering of 10.25% Senior Notes due 2004, having a total principal amount of $75,000,000. On December 13, 1995, the obligations were assumed by Chartwell Re Holdings Corporation (Chartwell Re Holdings). Of the original balance, Chartwell Re Holdings redeemed $26,250,000 on April 8, 1996 and repurchased $8,675,000 on November 24, 1999. Mandatorily Redeemable Preferred Capital Securities On January 28, 1997, Trenwick completed a private offering of $110,000,000 in 8.82% Subordinated Capital Income Securities through Trenwick Capital Trust I, a Delaware statutory business trust. Trenwick owns all of the common securities of the trust. Concurrently with the issuance of the capital securities, the trust invested the proceeds of their sale, together with the consideration paid to the trust by Trenwick for the common securities, in Trenwick's junior subordinated debentures, whose terms are similar to those of the capital securities. 42 The trust was formed for the sole purpose of issuing the capital securities and the common securities, investing the proceeds thereof in the junior subordinated debentures and making distributions to the holders of the capital securities. The capital securities mature on February 1, 2037; require preferential cumulative cash distributions at an annual rate of 8.82%, payable semi-annually on February 1 and August 1 (beginning August 1, 1997) from the payment of interest on the junior subordinated debentures; and are guaranteed by Trenwick, within certain limits, as to the payment of distributions and liquidation or redemption payments. They are subject to mandatory redemption; (i) in whole but not in part at maturity, upon repayment of the junior subordinated debentures, at a redemption price equal to the greater of the principal amount plus accrued and unpaid interest; (ii) in whole but not in part at any time, contemporaneously with the optional prepayment of the junior subordinated debentures upon the occurrence and continuation of certain events, at a redemption price equal to the greater of the principal amount or the present value of principal and interest payable to February 1, 2007, plus accrued and unpaid interest and possible additional sums; and (iii) in whole or in part, after February 1, 2007, contemporaneously with the optional prepayment of the junior subordinated debentures, at a redemption price equal to the principal amount plus accrued and unpaid interest and possible additional sums. Upon the occurrence and continuation of an event of default with respect to the junior subordinated debentures, the capital securities shall have a preference over the common securities. Upon the occurrence of an event of default with respect to the junior subordinated debentures which is attributable to Trenwick's failure to make required payments or with respect to Trenwick's guarantee, the holders of the capital securities may institute a direct action against Trenwick. In accordance with their terms, the capital securities were subsequently exchanged for fully registered capital securities, which are not subject to restrictions on transfer. Convertible Debentures On February 20, 1997, Trenwick called for redemption all $103,500,000 aggregate principal amount of Trenwick's 6% convertible debentures due December 15, 1999, at a redemption price of 102.57% principal amount plus accrued interest to the redemption date. Of the $103,500,000 principal amount of debentures outstanding on that date, $45,819,000 principal amount were redeemed and $57,681,000 principal amount were converted into an aggregate of 1,783,926 shares of Trenwick's common stock. As a result of the redemption, Trenwick recorded an extraordinary loss of $1,037,000 net of a tax benefit of $558,000 in 1997. Senior Credit Facilities On November 24, 1999, Trenwick entered into a $400,000,000 credit agreement with various lending institutions, The Chase Manhattan Bank, as Administrative Agent, First Union National Bank, as Syndication Agent, and Fleet National Bank, as Documentation Agent. This new credit facility provides for a $170,000,000, 364 day revolving credit facility with an option to pay out outstanding borrowings under such facility over the four years following the expiration of the 364 day period. In addition, the credit facility provides for a $230,000,000 five year, Lloyd's letter of credit facility, with a one year automatic renewal option. The applicable interest rate on borrowings under the credit facility is currently 1.3% above the London Interbank Offered Rate or The Chase Manhattan Bank prime commercial lending rate. A commitment fee is charged on the unutilized portion of the facility and is currently at .25%. At the end of the revolving period, all outstanding revolving loans will, at the option of Trenwick, convert to a four-year term loan facility, subject to scheduled principal amortization over the four-year period. As of December 31, 1999, Trenwick has approximately $94,501,000 of revolving loans outstanding, the proceeds of which were used to retire Chartwell Re Holdings' syndicated debt facility with First Union, repurchase Trenwick common shares, and redeem a portion of the Chartwell Re Holdings senior debt. The Letter of Credit Facility of $230,000,000 is available in U.S. Dollars or Pounds Sterling and shall only be issued for the account of Lloyd's to support Trenwick's syndicate participations. The unsecured letters of credit are in force for five years and will automatically renew for one additional year on the anniversary of the November closing date. The Applicable Margin is charged on an annual basis on the utilized portion of the facility, which is currently $208,000,000. A commitment fee, which is currently .25%, is charged on the unused portion of the Letter of Credit Facility. 43 The Chase Credit Facility contain general covenants and restrictions as well as financial covenants relating to, among other things, minimum interest coverage, debt to capital leverage, minimum earned surplus and tangible net worth. Trenwick and the banks party to the credit facility executed an amendment to the credit facility, dated as of December 31, 1999, reducing the required minimum consolidated tangible net worth of Trenwick from $325,000,000 to $290,000,000 until June 30, 2000. After giving effect to the amendment, as of December 31, 1999, the Company is in compliance with the covenants. Contingent Interest Notes In conjunction with the 1999 acquisition of Chartwell, the Company assumed all of the obligations under the CI Notes, which were originally issued by Piedmont Management Company Inc. (Piedmont), INSCORP's former parent, to its stockholders just prior to its acquisition by Chartwell in 1995. The CI Notes were issued immediately prior to Chartwell's acquisition of Piedmont to protect Chartwell against the possibility of adverse development of INSCORP's reserves for losses and loss adjustment expenses and long-tail casualty exposures. The CI Notes were issued in an aggregate principal amount of $1,000,000, with principal accruing interest at a rate of 8% per annum, compounded annually. Such interest will not be payable until maturity or earlier redemption of the CI Notes. In addition, the CI Notes will entitle the holders thereof to receive at maturity, in proportion to the principal amount of the CI Notes held by them, an aggregate of from $10,000,000 up to $55,000,000 in contingent interest. Settlement of the CI Notes may be made by payment of cash or, at the Company's election, by delivery of shares of the Company's common stock. In order for the CI Notes to be settled in common stock of the Company, the Company's common stock must be registered under the Securities Act of 1933 and listed on a national securities exchange or the NASDAQ National Market. For purposes of any settlement of the CI Notes in the Company's common stock, the value ascribed to each share of common stock shall be 85% of the average of the closing sales prices of the common stock for the 20 trading days immediately preceding the fifth trading day prior to the settlement date. The CI Notes mature on June 30, 2006. At December 31, 1999, the CI Notes are recorded at the present value of the amount which is reasonably determined to be payable at maturity. The Company believes that INSCORP's reserves for loss and loss adjustment expenses are an appropriate estimate of projected ultimate losses and loss adjustment expenses to be paid and therefore, at this time, the maximum amount of contingent interest on the CI Notes is presently expected to be paid at maturity. The CI Notes contain covenants, which relate to the maintenance of certain records and limitations on certain indebtedness. As of December 31, 1999 the Company is in compliance with those covenants. Future minimum payments on long term debt as of December 31, 1999 are as follows (in thousands): 1999 ------- 2000 $94,501 2002 4,874 2003 75,000 2004 40,075 2006 34,699 ------ $249,149 44 Note 8 Commitments and Contingencies Letters of Credit At December 31, 1999, Trenwick has outstanding standby letters of credit totaling $208,000,000 as part of the senior credit facilities supporting CMA syndicate participations. Additionally, INSCORP has a $3,100,000 letter of credit to support the participation in Riverside Underwriters, plc. Both of these standby letters of credit are in force for five years, and provide capital to participate in certain Lloyd's syndicates for the 1996 to 2000 underwriting years of account. Lloyd's syndicate 839 has a letter of credit facility for $21,400,000, which is secured by its Sterling Premium Trust Fund. This letter of credit is deposited in the United States Surplus Lines Trust Fund. Letters of credit are also provided to support domestic and international reinsurance operations, totaling approximately $2,700,000. Lines of Credit Trenwick International has established a line of credit under which it can borrow up to $1,618,000 at a rate of 2.5% above the lending bank's base rate. Chartwell UK also has established a line of credit under which it can borrow up to $1,618,000 at a rate of 1% above the lending bank's base rate. These lines of credit are available in the event that funds are required to supplement short-term working capital. There were no material borrowings under either line of credit during 1999. Lloyd's syndicates 270, 741 and 2741 have separate lines of credit of $7,000,000, $1,780,000 and $485,000 respectively. There were no material borrowings under these lines of credit during 1999. Limited Partnership Investment Chartwell Reinsurance has committed to invest $15,000,000 in a private equity fund, High Ridge Capital Limited Partnership, which makes investments in the insurance industry. The Company contributed a total of $13,300,000 to this fund as of December 31, 1999. Operating Lease Agreements Trenwick leases office space under non-cancelable operating leases which expire at various dates through 2015. Trenwick's future minimum lease commitments as of December 31, 1999 are as follows: 2000 $ 5,659,633 2001 5,250,608 2002 5,139,674 2003 5,303,349 2004 5,453,766 2005 and thereafter 19,870,082 Total office rent expense for the years ended December 31, 1999, 1998 and 1997 is $3,024,000, $2,042,000 and $917,000, respectively. 45 Litigation The Company is party to various legal proceedings generally arising in the normal course of its business. The Company does not believe that the eventual outcome of any such proceeding will have a material effect on its financial condition or results of operations or cash flows. The Company's subsidiaries are regularly engaged in the investigation and the defense of claims arising out of the conduct of their business. Pursuant to the Company's insurance and reinsurance arrangements, disputes are generally required to be finally settled by arbitration. Note 9 Stockholders' Equity Preferred Stock Trenwick has 2,000,000 shares of $.10 par value preferred stock authorized and none outstanding. Common Stock During the year, Trenwick's Board of Directors approved an additional 3,000,000 shares to its stock repurchase program for a total of 4,600,000 shares. The program was originally adopted on May 21, 1997. During 1999, 2,176,200 shares were repurchased at an average price of $21.42 per share. Between January 1, 2000 and March 30, 2000, Trenwick has purchased 829,300 shares under its buyback plan, at an average price of $16.56 per share. Trenwick has an authorization of 494,000 shares remaining under the plan. Stockholder Rights Plan During 1997, Trenwick adopted a new stockholder rights plan, replacing the plan adopted in 1989, and redeemed the rights issued under the 1989 plan. Stockholders of record at the close of business on September 24, 1997 received $0.01 for each redeemed right (equivalent to $0.00667 per share) and received one new right for each share of common stock held. The rights are exercisable only if a person or group acquires beneficial ownership of 15% or more of Trenwick's common stock or commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more of Trenwick's common stock. Each right entitles a stockholder to buy 1/200 of a share of Trenwick's Series B Junior Participating Preferred Stock at an exercise price of $125, subject to adjustment. Trenwick has reserved 200,000 shares of such preferred stock for possible issuance under the plan. In the event that an acquirer accumulates 15% or more of Trenwick's common stock, all rights holders except the acquirer may purchase, for the exercise price, in lieu of the Series B Junior Participating Preferred Stock, shares of common stock of Trenwick having a market value of twice the exercise price of each right. If Trenwick is acquired in a merger or other business combination after the acquisition of 15% of Trenwick's common stock, all rights holders except the acquirer may purchase the acquirer's shares at a similar discount. Trenwick is entitled to redeem the rights at $0.01 per right, subject to certain restrictions. The rights will expire on September 23, 2007. 46 Note 10 Employee Benefits and Compensation Arrangements Retirement Plans Trenwick has a defined contribution plan and a 401(k) savings plan for substantially all U.S. full-time employees. Trenwick contributes 8% of an eligible employee's total compensation to the pension plan; no employee contributions are made to the plan. Trenwick matches 100% of employees' contributions to the savings plan up to 6% of each eligible employee's total compensation. Assets of both plans are administered by life insurance companies. Trenwick's contributions to the pension plan were $429,000, $463,000 and $503,000 for 1999, 1998 and 1997, respectively; its contributions to the savings plan were $365,000, $351,000 and $330,000 for 1999, 1998 and 1997, respectively. A member of management will receive a supplemental employee benefit payable at the earlier of age 65 or employment termination. The supplement will be equal to the aggregate contributions made with respect to the employee to a trust established by the company. Annual contribution to the trust is 13.5% of the employee's base salary as stated in the employment agreement. The amount expensed in 1999 for this employee benefit obligation is not material. Trenwick also maintains a money purchase defined contribution pension plan covering substantially all Trenwick International employees. Contributions under this plan are determined on the basis of salary and age. Trenwick's contribution to this plan in 1999 and 1998 was $1,427,000 and $997,000, respectively. Chartwell U.K. operates contributory defined contribution plans for its U.K. employees. The level of the contribution varies between 5% and 20% dependent upon the age of each participant at the beginning of each calendar year. The amount expensed in 1999 for the obligation under these plans amounted to $435,000. The defined contribution plan for Chartwell's U.S. employees was terminated immediately prior to the consummation of the merger of Chartwell into Trenwick. As a result, certain former Chartwell employees became members of the Company's plan and, in certain instances, the assets held by those employees in Chartwell's plans were transferred to the Company's plans. Stock Options and Common Stock Warrants Trenwick has several plans through which it makes options in common stock available to Trenwick employees at the discretion of the Board of Directors. Non-employee directors receive automatic grants under a separate plan. Exercise prices are generally fixed at the market value at the date of grant. Options vest and are exercisable on various terms, usually either over a five year period or up to a ten year period. All options have an expiration date not exceeding ten years. Total authorized common stock reserved for future issuance under all stock benefit plans at December 31, 1999 is 1,827,527 shares. 47 Transactions under the stock option plans during 1999, 1998 and 1997 are summarized as follows: 1999 1998 1997 -------- ------- -------- Number of options Outstanding, beginning of year 907,210 911,195 981,195 Issued in exchange for Chartwell options 1,160,182 - - Granted 175,960 124,210 8,250 Cancelled (46,029) (6,000) (1,500) Exercised - (122,195) (76,750) Outstanding, end of year 2,197,323 907,210 911,195 Exercisable, end of year 1,387,789 210,112 312,807 Average exercise price Issued in exchange for Chartwell options $30.57 - - Granted 28.34 $36.72 $32.88 Cancelled 29.41 29.70 30.92 Exercised - 12.57 12.46 Outstanding, end of year 29.80 29.07 25.82 Exercisable, end of year 30.30 27.87 21.81 Included in the table above are options granted to certain senior officers under the 1993 Stock Option Plan. The exercise and vesting of these options are accelerated if the price of Trenwick's common stock achieves certain specified levels, subject to certain conditions. At the time of Trenwick's acquisition of Chartwell, all of the options issued under Chartwell's stock option plans became fully vested. At December 31, 1999, there were warrants outstanding which were issued in exchange for Chartwell warrants upon consummation of the acquisition for the purchase of 275,989 shares of common stock at an average price of $25.45 per share. Pro Forma Information Trenwick applies the provisions of Accounting Principles Board Opinion "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock-based compensation plans. Since stock options under Trenwick's plans are issued at fair market value on the date of grant, no compensation expense has been recognized for these stock options or warrants. Had Trenwick applied the fair value based method, net income and net income per share would have been the pro forma amounts indicated below (in thousands, except per share data): 1999 1998 1997 ---- ---- ---- Net income (loss) As reported $(11,048) $34,792 $35,252 Pro forma (11,393) 34,850 35,083 Basic earnings (loss) per share As reported $(.94) $2.99 $3.03 Pro forma (.97) 2.97 $3.01 48 The pro forma adjustments relate to options granted from 1995 to 1999 for which a fair value on the date of grant was determined using the Black-Scholes option pricing model. No effect has been given to options and warrants granted prior to 1995. Valuation and related assumption information are presented below: 1999 1998 1997 ---- ---- ---- Valuation Assumptions: Expected volatility Employees 28% 23% - Non-employee directors 28% 23% 27% Non-employee directors (former Chartwell) 27% - - Risk-free interest rate Employees 6.1% 5.6% - Non-employee directors 6.1% 5.6% 6.1% Non-employee directors (former Chartwell) 6.1% - - Dividend Yield 3.0% 3.1% 2.6% The Black-Scholes option valuation model was developed for use in estimating the fair value of options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because Trenwick's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. Restricted Common Stock Awards Trenwick awards restricted common stock to key employees, under the terms of the 1989 and 1993 Stock Plans. In 1999, 65,985 shares were awarded at an average price of $29.00 per share (approximately $1,914,000), which vest over five years. Shares awarded in 1998 and 1997 vest over five years. Shares were repurchased in 1999, 1998 and 1997 in connection with the satisfaction of employees' withholding taxes payable upon the vesting of previously awarded shares. During 1999, 8,369 shares were repurchased at an average price of $31.54 per share (approximately $264,000). Trenwick has recognized compensation expense of $982,000, $770,000 and $543,000 for 1999, 1998 and 1997, respectively, determined by the award value of the shares amortized over the applicable vesting period. 49 Note 11 Comprehensive Income The components of accumulated other comprehensive income at December 31 are as follows: (in thousands) 1999 1998 ----- ----- Unrealized investment gains (losses) $(9,464) $ 39,330 Realized investment gains included in net income (1,916) (9,016) Foreign currency translation adjustment (3,854) (552) Deferred income tax (benefit) expense 5,509 (10,425) Accumulated other comprehensive income (loss) $(9,725) $ 19,337 The income tax benefit (expense) applicable to each component of other comprehensive income are as follows: (in thousands) 1999 1998 1997 ----- ---- ----- Unrealized investment gains (losses) $13,880 $(2,810) $(3,750) Realized investment gains (losses) included in net income 649 3,091 (806) Foreign currency translation adjustment 1,406 197 - Income tax benefit (expense) applicable to other comprehensive income (loss) $15,935 $ 478 $(4,556) 50 Note 12 Insurance Regulation Trenwick America Re, Chartwell Reinsurance, INSCORP, ReCor Insurance Company (ReCor) and Dakota Specialty Insurance Company (Dakota) are subject to the insurance laws and regulations of their respective domiciliary state insurance departments which were, as of December 31, 1999, Connecticut, Minnesota, New York, New York and North Dakota, respectively. Effective January 1, 2001, the Connecticut, Minnesota, New York and North Dakota Insurance Departments will adopt the Codification of Statutory Accounting Principles (the Codification). The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas. The Company has not finalized the quantification of the effects of Codification on its statutory financial statements. Under the holding company structure, Trenwick is dependent upon the ability of its operating subsidiaries for the transfer of funds principally in the form of cash dividends and tax reimbursements. Under the applicable provisions of the insurance holding company laws of Connecticut, Minnesota and North Dakota, insurance companies may only pay dividends without the approval of the applicable state insurance regulator, if such dividends, together with other dividends paid within the preceding twelve months, are less than the greater of (i) 10% of the insurer's policyholders' surplus as of the end of the prior calendar year or (ii) the insurer's statutory net income, excluding realized capital gains, for the prior calendar year. As a further restriction, the maximum amount of dividends insurers may pay is limited to its earned surplus, also known as its unassigned funds. Any dividend in excess of the amount determined pursuant to the foregoing formula would be characterized as an "extraordinary dividend" requiring the prior approval of the state insurance regulator. 51 Under New York law, which is applicable to INSCORP and ReCor, the maximum ordinary dividend payable in any twelve month period without the approval of the New York Insurance Department is the lesser of (i) 10% of policyholders' surplus as shown on the company's last annual statement or any more recent quarterly statement or (ii) the company's adjusted net investment income. Adjusted net investment income is defined as net investment income for the twelve months preceding the declaration of the dividend plus the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months prior to the declaration or distribution of the current dividend and ending twelve months prior thereto. In any case, New York law permits the payment of an ordinary dividend by an insurer or reinsurer only out of earned surplus. In addition to the foregoing limitations, the New York Insurance Department, as is its practice in any change of control situation, required Trenwick to commit to preclude the acquired New York-domiciled insurers, INSCORP and ReCor, from paying any dividends for two years after the merger with Chartwell without prior regulatory approval. The foregoing restriction will expire on October 27, 2001. Neither INSCORP nor ReCor paid any dividends in 1997, 1998 or 1999. In 2000, of Trenwick's U.S. insurance subsidiaries, only Dakota could pay a dividend or other distribution without prior approval of the applicable insurance regulatory authority. In 2000, Dakota could pay a dividend of $2,800,000 without prior approval. During 1999, 1998 and 1997, Trenwick America Re paid dividends of $53,400,000, $30,100,000 and $8,300,000, respectively. Chartwell Reinsurance paid dividends of $30,300,000 in 1999 and $3,000,000 in 1997. Chartwell Reinsurance did not pay any dividends in 1998. None of Trenwick's other U.S. insurance subsidiaries paid any dividends in 1999, 1998 or 1997. Under the applicable laws of the United Kingdom, Trenwick's U.K. subsidiaries may make distributions only from accumulated realized profits, net of accumulated realized losses. In addition, under the U.K. Insurance Companies Act, Trenwick International is not permitted to make any distribution that would reduce its net assets below the required minimum margin of solvency which, as determined under the U.K. Financial Services Authority's rules, is approximately $16,700,000 as of December 31, 1999. In addition, Trenwick International must also notify the U.K. Financial Services Authority of any proposal to declare or pay a dividend on any of its share capital. Under Lloyd's regulations, Chartwell Managing Agents is not permitted to make any distribution that would cause its assets to fall below any of Chartwell Managing Agents' share capital, minimum net current asset margin or minimum net asset margin. As of December 31, 1999, the highest of the three tests required Chartwell Managing Agents to maintain approximately $1,100,000 of capital. Trenwick Group Inc.'s reinsurance and insurance subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by insurance regulators of their respective state of domicile. Combined net income and statutory surplus of Trenwick Group Inc. were as follows: (in thousands) 1999 1998 1997 --------- -------- ------- Net income (loss) $(53,270) $ 40,930 $42,797 Statutory surplus 458,824 330,496 - 52 The NAIC's model risk-based capital regulation (the RBC Model Act) requires insurance companies to calculate and report information under a risk-based capital formula which measures statutory capital and surplus needs based on the risks in a company's mix of business and investment portfolio. Based on its calculation as of December 31, 1999, Trenwick America Re, Chartwell Reinsurance, INSCORP, ReCor and Dakota each exceeds all of the capital levels prescribed in the RBC Model Act. Note 13 Supplemental Cash Flows Information A reconciliation of cash provided by (used for) operations for the three years ended December 31 is as follows: (in thousands) 1999 1998 1997 -------- -------- -------- Net income (loss) $(11,048) $34,792 $ 35,252 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities Equity in net earnings of investees (188) - - Contingent interest 642 - - Amortization of premiums on investments, net 1,832 4,219 2,557 Deferred income taxes 2,935 1,329 3,224 Net realized investment gains (1,916) (9,016) (2,304) Depreciation expense 1,942 998 371 Amortization of debt issuance costs 292 124 32 Extraordinary loss on debt redemption - - 1,595 Amortization expense 1,423 - - Other 1,013 908 558 Change in assets and liabilities, net of effects from purchase of subsidiary Premiums in process of collection 8,906 2,543 (29,178) Deferred policy acquisition costs (6,655) (679) (719) Current income taxes receivable/payable (24,748) 1,865 (1,759) Other assets 109 (1,270) (5,268) Unpaid claims and claims expenses, net of reinsurance recoverable balances (10,142) (3,638) 32,621 Unearned premium income, net of prepaid reinsurance premiums 27,393 3,552 5,073 Other liabilities (44,088) 2,142 4,955 Net cash provided by (used for) operating activities $(52,298) $37,869 $ 47,010 53 Note 14 Fair Value of Financial Instruments The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties. In the event that quoted market prices were not available, fair values were based on estimates using discounted cash or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates and estimates of the amount and timing of future cash flows. Accrued premiums have estimated payment dates ranging from 1999 to 2003. Premium payment dates are estimated using the anticipated payout pattern of claims which result in the additional premium due from ceding companies. The fair value is estimated using cash flows discounted at an interest rate of 5%. These fair value estimates may vary in the near term. The following table presents in summary form the carrying amounts and estimated fair values of Trenwick's financial instruments at December 31:
(in thousands) 1999 1998 ------ ------ Carrying Fair Carrying Fair Amount Value Amount Value --------- ------- --------- ------ Assets Debt securities $1,311,361 $1,311,361 $893,020 $893,020 Equity securities 110,666 110,666 49,188 49,188 Other investments 19,446 19,446 - - Investments held by managed syndicates 137,745 137,745 - - Cash and cash equivalents 125,954 125,954 63,003 63,003 Cash and cash equivalents held by managed syndicates 44,687 44,687 - - Accrued premiums 279,480 276,474 126,758 124,832 Deposits 20,227 20,227 - - Liabilities 6.70% senior notes due 2003 $ 75,000 $ 74,153 $ 75,000 $ 78,750 10.25% senior notes due 2004 39,831 42,778 - - 7.67% senior credit facility due 2000 80,000 81,801 - - 6.94% senior credit facility due 2000 14,501 14,723 - - Contingent interest notes 34,699 34,699 - - Other long-term debt 4,874 4,638 - - Company-obligated mandatorily redeemable preferred capital securities of subsidiary trust holding solely junior subordinated debentures of Trenwick Group Inc. $ 110,000 $ 91,982 $110,000 $110,150
54 Note 15 Related-Party Transactions The Company holds an equity investment in certain managing general agents (MGAs) through which it writes primary insurance business. Such investments are accounted for under the equity method. At December 31, 1999, the carrying value of the investments in Florida Intracoastal Underwriters (25% owned), HDR Insurance Services (20% owned), Cambridge Alliance (35% owned) and Inter-Reco, Inc. (49% owned) were $1,148,000, $654,000, $211,000 and $204,000, respectively. For the year ended December 31, 1999, the Company incurred $6,238,000 of commission expense payable to these MGAs. At December 31, 1999, the Company's balance sheet includes $28,740,000 of agents' balances receivable from these MGAs including installment premiums deferred and not yet due. The current portion of balances due from these MGAs are settled on a monthly basis. Note 16 Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share: (in thousands except per share data) 1999 1998 1997 -------- -------- -------- Income (loss) available to common stockholders Income (loss) before extraordinary item (basic) $(11,048) $34,792 $36,289 Add interest on convertible debentures, net of income taxes - - 578 Income (loss) before extraordinary item (diluted) $(11,048) $34,792 $36,867 Net income (loss) (basic) $(11,048) $34,792 $35,252 Add interest on convertible debentures and loss on debt redemption, net of income taxes - - 1,615 Net income (loss) (diluted) $(11,048) $34,792 $36,867 Weighted average shares of common stock outstanding Weighted average shares outstanding (basic) 11,762 11,657 11,645 Weighted average shares issuable on exercise of employee stock options and stock warrants net of assumed repurchases - 122 173 Weighted average shares issuable on conversion of debt - - 447 Weighted average shares outstanding (diluted) 11,762 11,779 12,265 Basic earnings (loss) per share Income (loss) before extraordinary item $(.94) $2.99 $3.12 Net income (loss) $(.94) $2.99 $3.03 Diluted earnings (loss) per share Income (loss) before extraordinary item $(.94) $2.95 $3.01 Net income (loss) $(.94) $2.95 $3.01 55 Note 17 Segment Information In 1998, Trenwick adopted the accounting standard "Disclosures about Segments of an Enterprise and Related Information." This statement requires reporting of information utilizing a management approach. This approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. This statement also requires disclosures about products and services, geographic areas and major customers. The adoption of this statement did not affect the results of operations or financial position. Trenwick has determined that its reportable segments are those that are based on the Company's method of internal reporting, which segregates its business by geographic location. Trenwick has four reportable business segments: (1) Trenwick America Re, (2) Canterbury Financial Group Inc. (3) Trenwick International and (4) CMA. Trenwick America Re underwrites treaty reinsurance of property and casualty risks primarily written by U.S. insurance companies. Trenwick America Re includes reinsurance business of Chartwell Reinsurance and its subsidiaries since its acquisition on October 27, 1999. Canterbury Financial Group underwrites specialty insurance in the United States. Trenwick International provides specialty insurance and treaty and facultative reinsurance on a world-wide basis. CMA manages Trenwick's participation in the Lloyd's market. 56 The summary financial results for Trenwick's operating segments for the year ended December 31, are as follows:
(in thousands) 1999 1998 1997 -------- -------- -------- Net premiums earned Trenwick America Re $166,906 $174,443 $190,156 Canterbury Financial Group 10,343 - - Trenwick International 107,911 71,118 - Chartwell Managing Agents 39,954 - - 325,114 245,561 190,156 Net investment Trenwick America Re 49,315 44,490 43,692 income Canterbury Financial Group 1,722 - - Trenwick International 11,253 10,614 - Chartwell Managing Agents 3,845 - - Unallocated 259 1,212 4,710 66,394 56,316 48,402 Net realized Trenwick America Re 962 6,444 2,304 investment gains Canterbury Financial Group 8 - - (losses) Trenwick International 1,098 1,794 - Chartwell Managing Agents (152) - - Unallocated - 778 - 1,916 9,016 2,304 Total revenues Trenwick America Re 217,322 225,351 236,162 Canterbury Financial Group 12,234 - - Trenwick International 120,028 83,961 - Chartwell Managing Agents 44,233 - - Unallocated 468 2,002 4,710 394,285 311,314 240,872 Underwriting Trenwick America Re (39,118) (3,167) 6,628 profit (loss) Canterbury Financial Group 974 - - Trenwick International (10,946) (2,432) - Chartwell Managing Agents (13,817) - - (62,907) (5,599) 6,628 Interest expense Trenwick America Re 112 6 - and minority Canterbury Financial Group 76 - - interest Trenwick International 4,513 3,434 - Chartwell Managing Agents - - - Unallocated 14,177 10,216 9,814 18,878 13,656 9,814 Income (loss) before Trenwick America Re 4,369 44,320 52,644 income taxes and Canterbury Financial Group 2,659 - - extraordinary item Trenwick International 1,171 6,977 - Chartwell Managing Agents (9,537) - - Unallocated (19,882) (8,260) (5,114) (21,220) 43,037 47,530 Income tax (benefit) Trenwick America Re (3,104) 9,644 12,514 expense Canterbury Financial Group 979 - - Trenwick International 204 1,341 - Chartwell Managing Agents (2,519) - - Unallocated (5,732) (2,740) (1,273) (10,172) 8,245 11,241 Income (loss) before Trenwick America Re 7,473 34,676 40,130 extraordinary Canterbury Financial Group 1,680 - - item Trenwick International 967 5,636 - Chartwell Managing Agents (7,018) - - Unallocated (14,150) (5,520) (3,841) (11,048) 34,792 36,289 Total investments Trenwick America Re 1,209,923 792,868 and cash Canterbury Financial Group 104,216 - Trenwick International 215,846 211,599 Chartwell Managing Agents 196,313 - Unallocated 23,561 744 1,749,859 1,005,211 Total assets Trenwick America Re 1,837,261 1,028,569 Canterbury Financial Group 262,233 - Trenwick International 406,430 353,079 Chartwell Managing Agents 533,455 - Unallocated 201,220 10,613 3,240,599 1,392,261
57 Brokers and Ceding Companies During the year ended December 31, 1999, Trenwick America Re received approximately 61% of its gross written premiums from three reinsurance brokers of which AON Reinsurance Agency accounted for approximately 37%, Guy Carpenter accounted for approximately 16% and E.W. Blanch accounted for approximately 8%. In 1998, Trenwick America Re produced approximately 37%, 10% and 10% of its gross written premiums from three reinsurance brokers; AON Reinsurance Agency, Peglar and Associates, Inc. and Willis Faber, respectively. In 1997, Trenwick America Re produced approximately 41%, 14% and 10% of its gross written premiums from three reinsurance brokers; AON Reinsurance Agency, Willis Faber, N.A. and G.J. Sullivan, respectively. Two reinsurance brokers accounted for approximately 13% of Trenwick International's 1999 gross written premiums of which AON Reinsurance Agency accounted for approximately 8% and Alexander Forbes accounted for 5%. In 1998, Nelson Hurst and AON Reinsurance Agency accounted for approximately 15% and 12% of gross written premiums, respectively. Trenwick's concentration of business in the U.S. reinsurance market through a small number of sources is consistent with the concentration of the property and casualty broker reinsurance market, in which a majority of the business is written through the top ten largest brokers in the reinsurance industry. Contrary to Trenwick America Re's concentration, Trenwick International's business is produced from a variety of sources including insurance and reinsurance brokers. During the year ended December 31, 1999, Trenwick America Re received approximately 26% of its gross written premiums from three ceding companies of which Duncanson and Holt accounted for approximately 12%, American International Group accounted for approximately 7% and CNA Insurance Companies accounted for approximately 7%. In 1998, Trenwick America Re produced approximately 16%, 12% and 10% of its gross written premiums from three ceding companies: Duncanson and Holt, American International Group and Fort Washington Holdings, respectively. In 1997, Trenwick America Re produced approximately 11%, 11% and 10% of its gross written premiums from three ceding companies: American International Group, Canal Insurance Company and Travelers Group. No one ceding company accounted for more than 3% of Trenwick International's gross written premium in 1999 and 1998. Loss of all or a substantial portion of the business provided by these brokers and ceding companies could have a material adverse effect on the business and operations of Trenwick. Trenwick does not believe, however, that the loss of such business would have a long-term adverse effect because of Trenwick's competitive position within the reinsurance market and the availability of business from other brokers and ceding companies. Managing General Agencies In 1999, Canterbury Financial Group wrote approximately 66% of its gross written premiums through four managing general agents as follows: HDR Insurance Services (23%), Florida Intracoastal Underwriters, Ltd. (19%), Inter-Reco, Inc. (13%), and Professional Insurance Underwriters, Inc. (11%). Loss of all or a substantial portion of the business provided by these managing general agencies could have a material adverse effect on the business and operations of Trenwick. 58 Note 18 Unaudited Quarterly Financial Data Summarized unaudited quarterly financial data is as follows:
(in thousands except per share data) 1999 1998 1997 ----- ---- ---- Quarter ended Earned premiums December 31 $141,467 $63,612 $45,414 September 30 58,608 65,161 43,723 June 30 66,071 70,964 47,105 March 31 58,968 45,824 53,914 Net investment December 31 26,207 14,639 12,372 income September 30 13,047 14,317 12,178 June 30 13,317 14,976 12,123 March 31 13,823 12,384 11,729 Net realized December 31 (1,075) 7,572 388 investment September 30 (38) 184 - gains (losses) June 30 523 540 1 March 31 2,506 720 1,915 Income (loss) before December 31 (2,392) 11,329 9,122 extraordinary September 30 (22,426) 5,243 8,773 item June 30 5,665 8,975 8,593 March 31 8,105 9,245 9,801 Basic income (loss) December 31 (.16) 1.03 .77 before extra- September 30 (2.15) .45 .74 ordinary item June 30 .54 .75 .72 per share March 31 .75 .78 .90 Diluted income (loss) December 31 (.16) 1.02 .75 before extra- September 30 (2.15) .44 .73 ordinary item June 30 .53 .74 .71 per share March 31 .74 .77 .81
Amounts for 1999 reflect the results of Chartwell, accounted for as a purchase, from October 27, 1999, the date of acquisition. Amounts for 1998 reflect the results of Trenwick International, accounted for as a purchase, from February 27, 1998, the date of acquisition. In the quarter ended March 31, 1997, Trenwick had an extraordinary loss on debt redemption of $1,037,000, or $0.09 per basic share, which was net of a $558,000 income tax benefit. Note 19 Subsequent Event On March 1, 2000, Chartwell Re Holdings fully redeemed its 10.25% Senior Notes due 2004 at a redemption price of 102.56% of par value. The net balance of these notes as of December 31, 1999 was $40,075,000. 59 -----END PRIVACY-ENHANCED MESSAGE-----