-----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, S2271ME+GKsXX3JKB8rZsHKPXjB48L9tbhd5Nwgbi7tofyyJrMHSwF6yZYxfib15 Hpodyh32cqsh8PQLPg4CVQ== 0000914748-99-000002.txt : 19990325 0000914748-99-000002.hdr.sgml : 19990325 ACCESSION NUMBER: 0000914748-99-000002 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EVEREST REINSURANCE HOLDINGS INC CENTRAL INDEX KEY: 0000914748 STANDARD INDUSTRIAL CLASSIFICATION: ACCIDENT & HEALTH INSURANCE [6321] IRS NUMBER: 223263609 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-14527 FILM NUMBER: 99571787 BUSINESS ADDRESS: STREET 1: 477 MARTINSVILLE RD STREET 2: PO BOX 830 CITY: LIBERTY CORNER STATE: NJ ZIP: 07938 BUSINESS PHONE: 9086043000 MAIL ADDRESS: STREET 1: 477 MARTINSVILLE RD STREET 2: PO BOX 830 CITY: LIBERTY CORNER STATE: NJ ZIP: 07938 FORMER COMPANY: FORMER CONFORMED NAME: PRUDENTIAL REINSURANCE HOLDINGS INC DATE OF NAME CHANGE: 19931115 10-K405 1 EVEREST REINSURANCE HOLDINGS, INC. 1998 10-K ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- FORM 10-K -------------- ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 Commission file number 1-13816 EVEREST REINSURANCE HOLDINGS, INC. (Exact name of registrant as specified in its charter) DELAWARE 22-3263609 (State or other jurisdiction) (I.R.S. Employer of incorporation or organization) Identification No.) 477 MARTINSVILLE ROAD POST OFFICE BOX 830 LIBERTY CORNER, NEW JERSEY 07938-0830 (908) 604-3000 (Address, including zip code, and telephone number, including area code, of registrant's principal executive office) -------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: Name of Each Exchange Title of Each Class on Which Registered ------------------- --------------------- Common Stock, $.01 par value per share New York Stock Exchange -------------- Securities registered pursuant to Section 12(g) of the Act: None -------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] The aggregate market value on March 9, 1999 of the voting stock held by non-affiliates of the registrant was $1,685 million. At March 9, 1999, the number of shares outstanding of the registrant's common stock was 49,656,940. DOCUMENTS INCORPORATED BY REFERENCE Certain information required by Items 10, 11, 12, and 13 of Form 10-K is incorporated by reference into Part III hereof from the registrant's proxy statement for the 1999 Annual Meeting, which will be filed with the Securities and Exchange Commission within 120 days of the close of the registrant's fiscal year ended December 31, 1998. ================================================================================ TABLE OF CONTENTS ITEM PAGE - ---- ---- PART I 1. Business ........................................................... 1 2. Properties ......................................................... 23 3. Legal Proceedings .................................................. 23 4. Submission of Matters to a Vote of Security Holders ................ 23 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters ............................................... 23 6. Selected Financial Data ............................................ 24 7. Management's Discussion and Analysis of Financial Condition and Results of Operation ................................ 26 7A. Quantitative and Qualitative Disclosures About Market Risk ....................................................... 38 8. Financial Statements and Supplementary Data ........................ 38 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ............................... 38 PART III 10. Directors and Executive Officers of the Registrant ................. 39 11. Executive Compensation ............................................. 39 12. Security Ownership of Certain Beneficial Owners and Management .................................................... 39 13. Certain Relationships and Related Transactions ..................... 39 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ............................................... 39 PART I UNLESS OTHERWISE INDICATED, (I) ALL FINANCIAL DATA IN THIS DOCUMENT HAVE BEEN PREPARED USING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP"), AND (II) ALL STATUTORY FINANCIAL DATA REFERRED TO IN THIS DOCUMENT REFER TO STATUTORY FINANCIAL DATA OF EVEREST RE. AS USED IN THIS DOCUMENT, "EVEREST RE" MEANS EVEREST REINSURANCE COMPANY (FORMERLY PRUDENTIAL REINSURANCE COMPANY) AND ITS SUBSIDIARIES (UNLESS THE CONTEXT OTHERWISE REQUIRES); "HOLDINGS" MEANS EVEREST REINSURANCE HOLDINGS, INC. (FORMERLY PRUDENTIAL REINSURANCE HOLDINGS, INC.); AND THE "COMPANY" MEANS HOLDINGS AND ITS SUBSIDIARIES. ITEM 1. BUSINESS THE COMPANY Everest Reinsurance Holdings, Inc., a Delaware corporation, was established in 1993 to serve as the parent holding company of Everest Reinsurance Company (formed in 1973), a property and casualty reinsurer. Until October 6, 1995, the Company was an indirect wholly-owned subsidiary of The Prudential Insurance Company of America ("The Prudential"). On October 6, 1995, The Prudential sold its entire interest in Holdings' shares of common stock in an initial public offering (the "IPO"). Holdings, through its wholly-owned subsidiary, Everest Re, underwrites property and casualty reinsurance on a treaty and facultative basis for insurance and reinsurance companies in the United States and selected international markets. Everest Re writes reinsurance both through brokers and directly with ceding insurance companies, giving it the flexibility to pursue business regardless of the ceding company's preferred reinsurance purchasing method. Everest Re and its subsidiaries also write primary insurance. The Company had gross premiums written in 1998 of $1,045.9 million and stockholders' equity at December 31, 1998 of $1,479.2 million and Everest Re had statutory surplus at December 31, 1998 of $1,059.4 million. Based on industry data at December 31, 1998 published by the Reinsurance Association of America ("RAA"), Everest Re is the sixth largest reinsurance company in the United States, ranked by statutory surplus and is rated "A+" ("Superior") by A.M. Best, an independent insurance industry rating organization which rates insurance companies on factors of concern to policyholders. Everest Re has four direct subsidiaries: Everest Re Holdings, Ltd. ("Everest Ltd.") Everest National Insurance Company ("Everest National", formerly Prudential National Insurance Company), Everest Insurance Company of Canada ("Everest Canada") and Everest Indemnity Insurance Company ("Everest Indemnity"). Everest Ltd., a Bermuda company, was formed by Everest Re in 1998. Following its formation, Everest Re contributed to Everest Ltd. its ownership of Everest Re Ltd., a United Kingdom company which was previously authorized to engage in the reinsurance business in the United Kingdom and, prior to January 1, 1997, which reinsured risks worldwide. In 1996, Everest Re obtained authorization to engage in the reinsurance business in the United Kingdom, and the operations of Everest Re Ltd. were converted to branch operations of Everest Re, effective January 1, 1997. The assets of Everest Re Ltd. have been transferred to Everest Ltd. and Everest Re Ltd. is in the process of being dissolved. Everest National, an Arizona insurance company, is licensed in 42 states and the District of Columbia and writes primary insurance on an admitted basis. On December 31, 1996, Everest Re acquired Everest Canada (formerly OTIP/RAEO Insurance Company Inc.) from a subsidiary of The Prudential. All liabilities incurred before the acquisition date, including insurance obligations under expired and in-force business, were assumed by Prudential of America General Insurance Company (Canada), a subsidiary of The Prudential which was subsequently sold to Liberty Mutual Insurance Company, whereupon it was renamed Liberty Insurance Company of Canada. Everest Canada is federally licensed to write primary insurance under the Insurance Companies Act of Canada and licensed in all Canadian provinces and territories. In 1997, Everest Re formed Everest Indemnity, a Delaware insurance company, to engage in the excess and surplus lines insurance business in the United States. Everest Indemnity is licensed in Delaware and is eligible to write business in 37 states and the District of Columbia on a non-admitted basis. In 1997, Holdings formed Mt. McKinley Managers, L.L.C. ("Mt. McKinley"), a New Jersey limited liability company, which is licensed as an insurance producer, including surplus lines authority, in New Jersey. In 1998, the Company acquired the assets of certain insurance agency operations in Alabama, Georgia and Texas, which previously produced business for Everest Re and Everest National. The continuing insurance agency operations are now carried on by subsidiaries of Mt. McKinley, WorkCare Southeast, Inc., an Alabama insurance agency and WorkCare Southeast of Georgia, Inc., a Georgia insurance agency. Pursuant to an agreement with Everest National, the WorkCare companies produce business for Everest National. REINSURANCE INDUSTRY OVERVIEW Reinsurance is an arrangement in which an insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, against all or a portion of the insurance risks underwritten by the ceding company under one or more insurance contracts. Reinsurance can provide a ceding company with several benefits, including a reduction in net liability on individual risks, catastrophe protection from large or multiple losses and assistance in maintaining acceptable financial ratios. Reinsurance also provides a ceding company with additional underwriting capacity by permitting it to accept larger risks and write more business than would be possible without a concomitant increase in capital and surplus. Reinsurance, however, does not discharge the ceding company from its liability to policyholders. There are two basic types of reinsurance arrangements: treaty and facultative reinsurance. In treaty reinsurance, the ceding company is obligated to cede and the reinsurer is obligated to assume a specified portion of a type or category of risks insured by the ceding company. Treaty reinsurers, including Everest Re, do not separately evaluate each of the individual risks assumed under their treaties and, consequently, after a review of the ceding company's underwriting practices, are largely dependent on the original risk underwriting decisions made by the ceding company. Such dependence subjects reinsurers in general, including Everest Re, to the possibility that the ceding companies have not adequately evaluated the risks to be reinsured and, therefore, that the premiums ceded in connection therewith may not adequately compensate the reinsurer for the risk assumed. The reinsurer's evaluation of the ceding company's risk management and underwriting practices, therefore, will usually impact the pricing of the treaty. In facultative reinsurance, the ceding company cedes and the reinsurer assumes all or part of the risk under a single insurance contract. Facultative reinsurance is negotiated separately for each insurance contract that is reinsured. Facultative reinsurance normally is purchased by ceding companies for individual risks not covered by their reinsurance treaties, for amounts in excess of the dollar limits of their reinsurance treaties and for unusual risks. Underwriting expenses and, in particular, personnel costs, are higher on facultative business because each risk is individually underwritten and administered. The ability to separately evaluate each risk reinsured, however, increases the probability that the reinsurer can price the contract to more accurately reflect the risks involved. Both treaty and facultative reinsurance can be written on either a pro rata basis or an excess of loss basis. With respect to pro rata reinsurance, the ceding company and the reinsurer share the premiums as well as the losses and expenses in an agreed proportion. In the case of reinsurance written on an excess of loss basis, the reinsurer indemnifies the ceding company against all or a specified portion of losses and expenses in excess of a specified dollar amount, known as the ceding company's retention or reinsurer's attachment point, generally subject to a negotiated reinsurance contract limit. Premiums payable by the ceding company to a reinsurer for excess of loss reinsurance are not directly proportional to the premiums that the ceding company receives because the reinsurer does not assume a proportionate risk. In contrast, premiums that the ceding company pays to the reinsurer for pro rata reinsurance are proportional to the premiums that the ceding company receives, consistent with the proportional sharing of risk. In addition, in pro rata reinsurance the reinsurer generally pays the ceding company a ceding commission. The ceding commission generally is based on the ceding company's cost of acquiring the business being reinsured (commissions, premium taxes, assessments and miscellaneous administrative expense) and also may include a profit factor for producing the business. Reinsurers typically purchase reinsurance to cover their own risk exposure. Reinsurance of a reinsurer's business is called a retrocession. Reinsurance companies cede risks under retrocessional agreements to other reinsurers, known as retrocessionaires, for reasons similar to those that cause primary insurers to purchase reinsurance: to reduce net liability on individual risks, protect against catastrophic losses, stabilize financial ratios and obtain additional underwriting capacity. Reinsurance can be written through professional reinsurance brokers or directly for ceding companies. From a ceding company's perspective, both the broker market and the direct market have advantages and disadvantages. A ceding company's decision to select one market over the other will be influenced by its perception of such advantages and disadvantages relative to the reinsurance coverage being placed. BUSINESS STRATEGY The Company's business strategies include effective management of the underwriting cycle, management of catastrophe exposures and retrocessional costs and expense control. The underwriting strategies seek to capitalize on the Company's staff expertise and its flexibility to offer multiple products through multiple production sources in a cost efficient manner. Efforts to control expenses and to operate in a more cost efficient manner are a continuing focus of the Company. The Company's products include the full range of property and casualty coverages, including marine, aviation, surety, errors & omissions liability ("E&O"), directors' & officers' liability ("D&O"), medical malpractice, other specialty lines, accident and health, workers compensation, non-standard auto and loss portfolios. The Company's distribution channels include both the direct and broker reinsurance markets, international and domestic markets, reinsurance, both treaty and facultative, and insurance, both admitted and non-admitted. The Company's underwriting strategy emphasizes underwriting profitability rather than premium volume, writing specialized risks and integration of underwriting expertise across all underwriting units. Key elements of this strategy are prudent risk selection, appropriate pricing through strict underwriting discipline and adjusting the Company's business mix to respond to changing market conditions. Management intends to focus on reinsuring companies that effectively manage the underwriting cycle through proper analysis and pricing of underlying risks and whose underwriting guidelines and performance are compatible with the Company's profitability objectives. 2 The Company's underwriting strategy also emphasizes flexibility and responsiveness to changing market conditions, such as increased demand or favorable pricing trends. Management believes that Everest Re's existing strengths, including its broad underwriting expertise, international presence and substantial capital, facilitate adjustments to its mix of business geographically, by line of business and by type of coverage, allowing it to capitalize on those market opportunities that provide the greatest potential for underwriting profitability. The Company's primary insurance infrastructure further facilitates this strategy by allowing the Company to develop business that requires the Company to issue primary insurance policies. The Company will also continue to carefully monitor its mix of business to avoid inappropriate concentrations of geographic or other risk. The Company's underwriting guidelines seek to limit the accumulation of known risks in exposed areas, to require that business which is exposed to catastrophe losses be written with greater geographic spread and to maintain a cost-effective retrocession program. The Company's underwriting guidelines also seek to better reflect the relationship between premiums and risk assumed while maintaining the Company's probable maximum loss at appropriate levels. SEGMENT INFORMATION The Company, through its subsidiaries, operates as a single segment focusing on the coverage of property and casualty risks using an approach which emphasizes central control and coordination of critical business elements. The Company's product is distributed globally through multiple markets and distribution channels including insurance and reinsurance, originated on a broker, direct and program manager basis, accepting primary, proportional and excess layers, treaty and facultative arrangements, covering virtually all lines of business. The management approach of the Company is to focus on the enterprise's overall profitability as opposed to an analysis of the stand alone profitability results of any unit. MARKETING The Company writes its business on a worldwide basis for many different customers and for many lines of property and casualty business. Its products provide a broad array of coverages. The Company is not materially dependent on any single customer, small group of customers, line of business or geographical area. For the 1998 calendar year, no single customer generated more than 4.6% of the Company's gross premiums written. The Company does not believe that the reduction of business assumed from any one customer will have a materially adverse effect on its future financial condition or results of operations due to the Company's competitive position in the market place and the continuing availability of other sources of business. Approximately 68.5% and 31.5% of Everest Re's 1998 gross premiums written were written in the broker and direct markets, respectively. Everest Re's ability to write reinsurance both through brokers and directly with ceding companies gives it the flexibility to pursue business regardless of the ceding company's preferred reinsurance purchasing method. The reinsurance broker market consists of several substantial national and international brokers and a number of smaller specialized brokers. Brokers do not have the authority to bind Everest Re with respect to reinsurance agreements, nor does Everest Re commit in advance to accept any portion of the business that brokers submit to it. Reinsurance business from any ceding company, whether new or renewal, is subject to acceptance by Everest Re. Brokerage fees generally are paid by reinsurers. The Company's largest ten brokers accounted for an aggregate of approximately 51.8% of gross premiums written in 1998 with the two largest brokers accounting for approximately 17.0% and 8.3%, respectively, of gross premiums written. The Company does not believe that the reduction of business assumed from any one broker will have a materially adverse effect on the Company due to its competitive position in the market place, relationships with ceding companies and the continuing availability of other sources of business. The direct market remains an important distribution system for reinsurance business written by Everest Re and primary insurance written through Everest National and Everest Indemnity in the United States and Everest Canada in Canada. Direct placement of reinsurance enables Everest Re to access clients who prefer to place their reinsurance directly with their reinsurers based upon the reinsurer's in-depth understanding of the ceding company's needs. The Company's primary insurance business is written principally through general agency relationships. The Company evaluates each business relationship, including the underwriting expertise and experience of each distribution channel selected, performs an analysis to evaluate financial security and monitors performance. UNDERWRITING OPERATIONS The following table presents the distribution of Everest Re's gross premiums written by its U.S. broker treaty, U.S. direct treaty reinsurance and insurance, marine, aviation and surety, U.S. facultative and international operations for the years ended December 31, 1998, 1997, 1996, 1995 and 1994, classified according to whether such premium is derived from property or casualty business and whether it represents pro rata or excess of loss business: 3
GROSS PREMIUMS WRITTEN BY UNDERWRITING UNIT YEARS ENDED DECEMBER 31, --------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 --------------------------------------------------------------------------------------- (Dollars In Millions) $ % $ % $ % $ % $ % --------------------------------------------------------------------------------------- U.S. Broker Treaty Property Pro Rata(1) $ 59.0 5.6% $ 62.8 5.8% $ 45.4 4.4% $ 51.7 5.4% $ 59.7 6.3% Excess 41.3 3.9 53.3 5.0 60.4 5.8 59.0 6.2 53.9 5.7 Casualty Pro Rata(1) 110.9 10.6 84.6 7.9 63.4 6.1 18.5 1.9 29.6 3.1 Excess 149.0 14.2 124.3 11.6 137.5 13.2 122.6 12.9 113.5 11.9 --------------------------------------------------------------------------------------- Total(2) 360.2 34.4 325.0 30.2 306.8 29.4 251.8 26.5 256.6 26.9 --------------------------------------------------------------------------------------- U.S. Direct Treaty Reinsurance and Insurance Property Pro Rata(1) 4.6 0.4 11.7 1.1 12.6 1.2 3.3 0.3 5.4 0.6 Excess 1.4 0.1 4.4 0.4 8.9 0.9 9.1 1.0 12.5 1.3 Casualty Pro Rata(1) 148.6 14.2 128.0 11.9 114.5 11.0 99.8 10.5 83.2 8.7 Excess 14.6 1.4 14.3 1.3 12.5 1.2 10.0 1.1 38.6 4.0 --------------------------------------------------------------------------------------- Total(2) 169.2 16.2 158.4 14.7 148.6 14.2 122.2 12.9 139.7 14.7 --------------------------------------------------------------------------------------- Marine, Aviation and Surety Property Pro Rata(1) 62.5 6.0 92.9 8.6 94.6 9.1 89.2 9.4 74.1 7.8 Excess 15.6 1.5 16.9 1.6 17.8 1.7 18.7 2.0 16.8 1.8 Casualty Pro Rata(1) 39.3 3.8 45.4 4.2 43.1 4.1 53.0 5.6 66.0 6.9 Excess 3.0 0.3 6.4 0.6 5.6 0.5 6.0 0.6 4.8 0.5 --------------------------------------------------------------------------------------- Total(2) 120.4 11.5 161.6 15.0 161.1 15.4 166.9 17.6 161.7 17.0 --------------------------------------------------------------------------------------- U.S. Facultative Property Pro Rata(1) - - - - - - - - - - Excess 22.5 2.2 29.0 2.7 26.9 2.6 22.3 2.3 27.4 2.9 Casualty Pro Rata(1) - - - - - - - - - - Excess 49.0 4.7 53.4 5.0 61.8 5.9 46.6 4.9 39.3 4.1 --------------------------------------------------------------------------------------- Total(2) 71.5 6.8 82.4 7.7 88.7 8.5 68.8 7.2 66.7 7.0 --------------------------------------------------------------------------------------- Total U.S. Property Pro Rata(1) 126.1 12.1 167.4 15.6 152.6 14.6 144.2 15.2 139.2 14.6 Excess 80.8 7.7 103.6 9.6 114.0 10.9 109.1 11.5 110.6 11.6 Casualty Pro Rata(1) 298.8 28.6 258.0 24.0 221.1 21.2 171.3 18.0 178.8 18.8 Excess 215.6 20.6 198.4 18.5 217.6 20.8 185.2 19.5 196.1 20.6 --------------------------------------------------------------------------------------- Total(2) 721.3 69.0 727.4 67.7 705.2 67.5 609.7 64.2 624.7 65.5 --------------------------------------------------------------------------------------- International Property Pro Rata(1) 141.9 13.6 144.2 13.4 124.2 11.9 136.2 14.3 147.0 15.4 Excess 45.7 4.4 62.9 5.9 79.8 7.6 84.9 8.9 89.2 9.4 Casualty Pro Rata(1) 93.4 8.9 99.2 9.2 90.5 8.7 66.4 7.0 49.6 5.2 Excess 43.6 4.2 41.3 3.8 44.4 4.3 52.3 5.5 42.7 4.5 --------------------------------------------------------------------------------------- Total(2) 324.6 31.1 347.6 32.4 338.8 32.5 339.8 35.8 328.5 34.5 --------------------------------------------------------------------------------------- Total Company Property Pro Rata(1) 268.0 25.6 311.6 29.0 276.7 26.5 280.4 29.5 286.2 30.0 Excess 126.5 12.1 166.5 15.5 193.8 18.6 194.0 20.4 199.8 21.0 Casualty Pro Rata(1) 392.2 37.5 357.2 33.2 311.6 29.8 237.6 25.0 228.4 24.0 Excess 259.2 24.8 239.7 22.3 261.9 25.1 237.5 25.0 238.8 25.1 --------------------------------------------------------------------------------------- Total(2) $ 1,045.9 100.0% $ 1,075.0 100.0% $ 1,044.0 100.0% $ 949.5 100.0% $ 953.2 100.0% =======================================================================================
- ------------- (1) For purposes of the presentation above, pro rata reinsurance means reinsurance attaching to the first dollar of loss incurred by the ceding company. (2) Certain totals and subtotals may not reconcile due to rounding. 4 U.S. BROKER TREATY OPERATIONS. Everest Re's U.S. broker treaty operations write property, accident and health and casualty reinsurance through reinsurance brokers. The Company targets certain brokers and, through the broker market, specialty companies and small to medium sized standard lines companies. The U.S. broker treaty operations also write portions of reinsurance programs for larger, national insurance companies. In 1998, $100.3 million of gross premiums written were attributable to domestic property business (which in 1998 and 1997 included accident and health business), of which 41.2% was written on an excess of loss basis and 58.8% was written on a pro rata basis. This unit utilizes sophisticated underwriting methods which management believes are necessary to analyze and price property business, particularly that segment of the property market which has catastrophe exposure. Accident and health underwriting utilizes both third party and proprietary actuarial pricing techniques. Domestic casualty business accounted for $259.9 million of gross premiums written in 1998, of which 57.3% was written on an excess of loss basis and 42.7% was written on a pro rata basis. The treaty casualty portfolio consists principally of professional liability, directors' & officers' liability, workers' compensation, excess and surplus lines, and other liability coverages. As a result of the complex technical nature of most of these risks, the Company's casualty underwriters tend to specialize by line of business and work closely with the Company's pricing actuaries. DIRECT TREATY REINSURANCE AND INSURANCE OPERATIONS. The Company's direct treaty reinsurance operation writes a full line of property and casualty business. In 1998, direct treaty business accounted for $90.6 million of gross premiums written, of which 17.7% was written on an excess of loss basis and 82.3% was written on a pro rata basis. The U.S. direct treaty underwriters target companies which place their business predominantly in the direct market, including small to medium sized regional ceding companies, and seek to develop long-term relationships with such companies. A broad array of coverages are offered. In 1998, the Company's domestic insurance operation consisted of $78.6 million of gross premiums written primarily through Everest National, which is licensed in 42 states and the District of Columbia to write primary insurance. Everest National targets commercial property and casualty business written through agency relationships with program administrators. With respect to primary insurance written through such agents, the Company supplements the initial underwriting process with periodic claims and underwriting reviews. MARINE, AVIATION AND SURETY OPERATIONS. The Company's marine and aviation unit focuses on ceding companies with a particular expertise in marine and aviation business. The marine and aviation business is written primarily through brokers and contains a significant international component written primarily in the London market. Surety business underwritten by the Company consists mainly of reinsurance of contract surety bonds. Gross premiums written by the marine and aviation unit in 1998 totaled $68.6 million, substantially all of which was written on a treaty basis and 66.7% of which was sourced through reinsurance brokers. Marine treaties represented 38.3% of marine and aviation gross premiums written in 1998 and consisted of hull and liability coverage. Approximately 82.5% of the marine unit premiums in 1998 were written on a pro rata basis and 17.5% as excess of loss. Aviation premiums accounted for 61.7% of marine and aviation gross premiums written in 1998 and included reinsurance for airlines, general aviation and satellites. Approximately 92.9% of the aviation unit's premiums in 1998 were written on a pro rata basis and 7.1% as excess of loss. In 1998, gross premiums written by the surety unit totaled $51.8 million. Approximately 78.9% of the surety unit premiums in 1998 were written on a pro rata basis and 21.1% on an excess of loss basis. Most of the portfolio is reinsurance of contract surety bonds written directly with ceding companies, with the remainder being credit reinsurance, mostly in international markets. The unit's strategy is to maintain long-term relationships with major surety and fidelity writers and to continue to expand its international business. FACULTATIVE OPERATIONS. The Company's U.S. facultative unit conducts business both through brokers and directly with ceding companies. The U.S. facultative operations consist of three underwriting units representing property, casualty and specialty lines of business. Business is written from a facultative headquarters office in New York and satellite offices in Chicago and San Francisco. In 1998, $22.0 million, $25.2 million, and $24.3 million of gross premiums written were attributable to property, general casualty and specialty lines of business, respectively. 5 INTERNATIONAL. Everest Re's international operations are designed to enable it to capitalize on the growth opportunities in the international reinsurance market. The Company targets several international markets, including: Europe and the London market, which are serviced by branch operations in London and Brussels and a representative office in Moscow; Canada, with branch operations in Toronto; Asia and Australia, with branch operations in Hong Kong and Singapore; and Latin America, Africa and the Middle East, which business is serviced from Everest Re's New Jersey headquarters and Miami office. The Company also writes "home-foreign" business, which provides reinsurance on the international portfolios of U.S. insurers, from its headquarters in New Jersey. Approximately 57.8% of the gross premiums written by the Company's international underwriters in 1998 represented property business, while the balance represented casualty business. As with its U.S. operations, Everest Re's international operations focus on financially sound companies that have strong management and underwriting discipline and expertise. Approximately 67.0% of the Company's international business was written through brokers, with the remainder written directly with ceding companies. In 1998, Everest Re's gross premiums written by its London and Brussels operations totaled $148.5 million and consisted of pro rata property (31.0%), excess property (21.1%), pro rata casualty (35.9%) and excess casualty (12.0%). Substantially all of the London and Brussels premiums consisted of treaty reinsurance. The Brussels office focuses on the continental European reinsurance markets, while the London office covers international business written through the London market. Gross premiums written in 1998 from the Brussels and London offices totaled $69.3 million and $79.2 million, respectively. Gross premiums written by Everest Re's Canadian operation totaled $53.9 million in 1998 and consisted of pro rata property (5.0%), excess property (2.7%), pro rata multi-line (47.1%), excess casualty (35.7%) and primary insurance written by Everest Canada (9.5%). Approximately 67.6% of the Canadian premiums consisted of treaty reinsurance while 22.9% was facultative reinsurance and 9.5% was primary insurance. Everest Re's Hong Kong and Singapore offices cover the Asian and Australian markets and accounted for $33.0 million of gross written premiums in 1998. This business consisted of pro rata property (86.1%), excess property (8.7%) and pro rata and excess casualty (5.2%). International business written out of Everest Re's New Jersey and Miami offices accounted for $89.2 million of Everest Re's 1998 gross premiums written and consisted of pro rata treaty property (68.2%), pro rata treaty casualty (13.3%), excess treaty property (10.4%), excess treaty casualty (2.0%) and excess facultative property and casualty (6.1%). Of this international business 52.9% was sourced from Latin America, 23.7% was sourced from the Middle East, 2.3% was sourced from Europe, 5.6% was sourced from Africa, 1.0% was sourced from Asia and 14.5% was "home-foreign" business. GEOGRAPHIC AREAS The Company conducts its business both in the United States, its country of domicile, and in a number of foreign countries. For select financial information about geographic areas, see Note 13 of Notes to the Consolidated Financial Statements. Risks attendant to the foreign operations of the Company parallel those attendant to the United States operations of the Company, with the primary exception of foreign exchange risks. See ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Safe Harbor Disclosure". UNDERWRITING PROCESS Everest Re offers ceding companies full service capability, including actuarial, claims, accounting and systems support, either directly or through the broker community. Everest Re's capacity for both casualty and property risks allows it to underwrite entire contracts or major portions thereof that might otherwise need to be syndicated among several reinsurers. Everest Re's strategy is to act as "lead" reinsurer in many of the reinsurance treaties it underwrites. The lead reinsurer on a treaty generally accepts one of the largest percentage shares of the treaty and is in a stronger position to negotiate price, terms and conditions than is a reinsurer which takes a smaller position. Management believes this strategy enables it to influence more effectively the terms and conditions of the treaties on which it participates. When Everest Re does not lead the treaty, it may still suggest changes to any aspect of the treaty. Everest Re may decline to participate in a treaty based upon its assessment of all relevant factors. Everest Re's treaty underwriting process emphasizes a team approach among Everest Re's underwriters, actuaries and claims staff. Treaties are reviewed for compliance with Everest Re's general underwriting standards and certain larger treaties are evaluated in part based upon actuarial analyses conducted by Everest Re. The actuarial models used in such analyses are tailored in each case to the exposures and experience underlying the specific treaty and the loss experience for the risks covered by such treaties. Everest Re does not separately evaluate each of the individual risks assumed under 6 its treaties. Everest Re does, however, generally evaluate the underwriting guidelines of its ceding companies to determine their adequacy prior to entering into a treaty. Everest Re, when appropriate, also conducts underwriting audits at the offices of ceding companies to ensure that the ceding companies operate within such guidelines. Underwriting audits focus on the quality of the underwriting staff, the selection and pricing of risks and the capability of monitoring price levels over time. Claim audits, when appropriate, are performed in order to evaluate the client's claims handling abilities and practices. Everest Re's domestic facultative underwriters operate within guidelines specifying acceptable types of risks, limits and maximum risk exposures. Specified classes of risks and large premium risks are referred to the Company's New York facultative headquarters for specific review before premium quotations are given to clients. In addition, Everest Re's guidelines require certain types of risks to be submitted for review because of their aggregate limits, complexity or volatility regardless of premium amount or size of the insured on the underlying contract. Everest National and Everest Canada write property, casualty and professional liability coverages for homogeneous risks through select program managers. These commercial programs are evaluated based upon actuarial analysis and the program manager's capabilities. The Company's rates, forms and underwriting guidelines are tailored to specific risk types. RISK MANAGEMENT AND RETROCESSION ARRANGEMENTS Everest Re manages its risk of loss through a combination of aggregate exposure limits, underwriting guidelines that take into account risks, prices and coverage, and retrocessional arrangements. Everest Re is exposed to multiple insured losses arising out of a single occurrence, whether a natural event such as a hurricane or an earthquake, or other catastrophe, such as a riot or an explosion at a major factory. Any such catastrophic event could generate insured losses in one or many of Everest Re's treaties or lines of business. Everest Re employs various techniques, including licensed software modeling, to assess its accumulated exposure to property catastrophe losses and summarizes that exposure in terms of the probable maximum loss ("PML"). The Company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years. Management estimates that the Company's greatest catastrophe exposure worldwide from any single event is to hurricanes and earthquakes in the coastal regions of the United States, where Everest Re estimates it has a PML exposure, before reinsurance, of approximately $170 million in each such region based on its current book of business. Similarly, management estimates that the largest current PML exposure, before reinsurance, outside the United States is approximately $86 million. There can be no assurance that Everest Re will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML. Underwriting guidelines have been established for each business unit. These guidelines place dollar limits on the amount of business that can be written based on a variety of factors, including ceding company, line of business, geographical location and risk hazards. In each case, those guidelines permit limited exceptions, which must be authorized by the Company's senior management. Everest Re does not typically retrocede individual risks, but does, from time to time, purchase retrocessional protections where the underwriter deems it to be prudent to reinsure a portion of the specific risk being assumed. Everest Re also participates in "common account" retrocessional arrangements for certain reinsurance treaties. Common account reinsurance arrangements are arrangements whereby the ceding company purchases a cover for the benefit of the ceding company and its reinsurers on a reinsurance treaty. Common account retrocessional arrangements reduce the effect of individual or aggregate losses to all participating companies with respect to a reinsurance treaty, including the ceding company. During 1998, Everest Re had purchased a three-layer property facultative retrocession program which provided $18 million of coverage in excess of $2 million of retained losses per facultative certificate. For 1999, this program was modified and renewed and provides $16.6 million part of $18 million of coverage in excess of $2 million of retained losses per facultative certificate. During 1998, Everest Re purchased three retrocessional workers' compensation excess of loss treaties which collectively provide $115 million of coverage in excess of $5 million of retained losses on accidental death and dismemberment claims resulting from a catastrophe loss. These retrocessional workers compensation treaties were renewed for 1999. During 1998, the Company also purchased a workers' compensation reinsurance program which 7 provided for statutory limits coverage in excess of $250,000 per occurrence on the Company's primary workers' compensation insurance business. For 1999, this program was renewed and provides for statutory limits coverage in excess of $75,000 per occurrence. For 1999, the Company also purchases reinsurance covering certain primary insurance programs written by the Company, including an 85.0% quota share of primary California non-standard automobile business written by the Company. For the period October 1, 1998 through October 1, 1999, the Company purchased a 50% quota share of $1 million net retained liability and $4 million excess $1 million of automatic property facultative protection covering Texas property and casualty program business. The Company also purchases catastrophe retrocessions covering the potential accumulation of all property exposures that may be involved in the same catastrophe, such as an earthquake or hurricane. During 1998, the Company's worldwide catastrophe retrocession program provided coverage of 75.0% of $112.5 million of losses in excess of a $25 million attachment point, net of inuring retrocessions, incurred on a per catastrophe and aggregate basis. The worldwide catastrophe retrocession program was cancelled by the retrocessionaire effective December 31, 1998. For the period from May 15, 1998 through May 15, 1999, the Company's catastrophe retrocession program also provides coverage of 70.0% of $20.0 million per occurrence in excess of $10.0 million in losses incurred by the Company outside of the United States. And for the period from May 23, 1998 through May 23, 1999, the Company's catastrophe retrocession program provides coverage of 87.5% of $20.0 million per occurrence in excess of $30.0 million in losses incurred by the Company outside of the United States. The Company also purchases a corporate level retrocession covering the potential accumulation of all exposures. During 1998, the Company purchased an accident year aggregate excess of loss retrocession agreement which provided up to $100.0 million of limit if Everest Re's statutory basis loss ratio exceeded 79.0% for the 1998 accident year. For 1999, the Company purchased an accident year aggregate excess of loss protection which provides up to $175.0 million of coverage if Everest Re's statutory basis accident year loss ratio exceeds a certain threshold and responds on an aggregate basis with respect to both property and casualty losses, including those arising from catastrophies. The attachment point is net of inuring retrocessions and includes adjustable premium provisions which effectively cause the Company to offset, on a pre-tax income basis, up to 52.5% of such ceded losses, depending upon the character of the underlying losses, through additional premiums. The maximum recovery is $175.0 million before giving effect to a maximum adjustable premium of $86.3 million. Although the catastrophe and aggregate excess of loss retrocessions have terms which provide for additional premiums to be paid to the retrocessionaire in the event that losses are ceded, all aspects of the Company's retrocessional program have been structured to permit these agreements to be accounted for as reinsurance under Statement of Financial Accounting Standards ("SFAS") No. 113. If a single catastrophe were to occur in the United States that resulted in $170.0 million of gross losses and allocated loss adjustment expenses ("ALAE") in 1999, an amount equivalent to Everest Re's PML, management estimates that the effect, including additional premiums and retained losses and ALAE, on the Company's income before taxes would be $93 million. This pre-tax net loss estimate assumes that Everest Re's aggregate losses and ALAE for 1999 would exceed the threshold loss ratio requirement in the aggregate excess of loss cover by $170.0 million. In addition, Everest Re continues to have coverage under an aggregate stop loss retrocession agreement (the "Stop Loss Agreement") purchased from Gibraltar Casualty Company ("Gibraltar"), an affiliate of The Prudential, in 1995. See "Stop Loss Agreement". As of December 31, 1998, Everest Re had retrocessional arrangements with 432 retrocessionaires, and it carried as an asset $982.0 million in reinsurance receivables with respect to losses ceded to retrocessionaires, which, except for $142.0 million which is due from Gibraltar in the first quarter of 1999 under the terms of the Stop Loss Agreement, will not be due to Everest Re until Everest Re makes payment on the underlying claims. Of this amount, $563.3 million, or 57.4%, was receivable from Gibraltar, including the $142.0 million due under the Stop Loss Agreement ($266.5 million, net of collateral held and liability balances for which Everest Re has a contractual right of offset). An additional $150.0 million, or 15.3%, was receivable from Continental Insurance Company ("Continental"). No other retrocessionaire accounted for more than $25.0 million of Everest Re's receivables. None of the reinsurance receivables from Gibraltar was in dispute or more than 90 days in arrears, with the exception of $63.0 million and $39.7 million items, which Gibraltar has disputed. The $63.0 million disputed amount, which is part of the $142.0 million due from Gibraltar in the first quarter, has been disputed pursuant to the Stop Loss Agreement 8 and, in accordance with the terms of the Stop Loss Agreement, Gibraltar has secured the disputed amount. Gibraltar paid the $79.0 million remaining balance of the $142.0 million amount to Everest Re in the first quarter of 1999. Gibraltar has also disputed Everest Re's level of reserves previously ceded to and paid by Gibraltar under the Stop Loss Agreement and claims a refund of $91.7 million. Should Everest Re and Gibraltar not resolve these disputes, pursuant to the terms of the Stop Loss Agreement, each will appoint an independent examiner to review the disputed amounts and to determine the appropriate amount of cessions to Gibraltar, and Everest Re will secure the $91.7 million amount. If the examination process does not resolve the disputes, the Stop Loss Agreement provides for resolution through arbitration. In the event the cessions to Gibraltar were determined to be excessive, Everest Re would reduce the cession to Gibraltar by such excess, refund previous payments made by Gibraltar, if applicable, and the unused portion of the limits of the Stop Loss Agreement would be restored. Also, Everest Re would consider the independent examiners' findings in its ongoing determination of appropriate reserve levels, which may lead to a corresponding reduction in Everest Re's gross reserves, and net reserves to the extent of the coinsurance under the Stop Loss Agreement. In the event the cessions are not determined to be excessive, Gibraltar would be obligated to pay the disputed amount. Accordingly, if the disputes are resolved in Gibraltar's favor, any adverse effect on the Company's financial condition and results of operations would likely be limited to a reduction in cash flows from operations with a corresponding impact on investment income. The $39.7 million has been disputed pursuant to the Direct Excess Retrocession (defined below - see "Relationships with Gibraltar") primarily reflecting reserve increases for asbestos losses ceded by the Company in 1998. Gibraltar is disputing the level of reserves established by the Company for such losses, but Gibraltar is not disputing its responsibility to pay the ultimate losses in accordance with the terms of the Direct Excess Retrocession. Management does not expect that this dispute will have a material adverse effect on the Company's future financial condition, results of operations or cash flows. Everest Re's arrangement with Continental is managed on a funds held basis, which means that Everest Re has not released premium payments to the retrocessionaire but rather retains such payments to secure obligations of the retrocessionaire, records them as a liability and reduces the liability account as payments become due. As of December 31, 1998, such funds had reduced Everest Re's net exposure to Continental to $90.4 million. No assurance can be given that the Company will be able to obtain retrocessional coverage similar to that currently in place in the future. Although management carefully selects its retrocessionaires, the Company is subject to credit risk with respect to its retrocessions because the ceding of risk to retrocessionaires does not relieve the reinsurer of its liability to ceding companies. RELATIONSHIPS WITH GIBRALTAR During its early years, Everest Re also wrote some direct insurance. In 1978, Everest Re expanded its direct insurance operation by forming Gibraltar as a subsidiary. In 1985, Gibraltar and Everest Re ceased writing new and renewal direct insurance, and Gibraltar was put into run-off. While Gibraltar actively wrote direct insurance, it was able to reinsure certain business through Everest Re's management underwriting facility ("MUF"). Begun in 1977, MUF was a reinsurance arrangement pursuant to which Everest Re ceded certain business to a number of insurance and reinsurance companies (the "MUF Participants"), many of them domiciled outside the United States. Gibraltar ceded its MUF-qualifying business first to Everest Re, which then immediately and entirely retroceded it to the MUF Participants. As a result of these cessions to Everest Re, Everest Re became, and remains, a reinsurer of Gibraltar with respect to the Gibraltar MUF cessions. As of December 31, 1998, Gibraltar's reinsurance receivables from Everest Re totaled $169.6 million. MUF became inactive with respect to new business in 1991. Following the 1985 decision to put Gibraltar in runoff, Everest Re and Gibraltar entered into the following agreements pursuant to which Gibraltar became, and remains, a reinsurer of Everest Re (the "Gibraltar Contracts"): o In 1986, Gibraltar reinsured all insurance obligations of Everest Re pursuant to certain insurance contracts written by Everest Re's former direct excess insurance operations, which ceased writing business in 1985 (the "Ceded Direct Insurance") (the "Direct Excess Retrocession"). o In 1989, Gibraltar reinsured Everest Re's medical malpractice and other professional liability reinsurance written in 1988 and prior years (the "Professional Liability Retrocession"). o During 1985 through 1990, Gibraltar and Everest Re commuted the obligations of a number of MUF Participants. In exchange for a cash payment from each commuted MUF Participant, Gibraltar assumed the obligations of such MUF Participant. The commuted business included assumed reinsurance originally retroceded to MUF Participants by Everest Re and direct insurance ceded by Everest Re and Gibraltar. 9 In 1991, Everest Re distributed the stock of Gibraltar to PRUCO, Inc., a direct, wholly-owned subsidiary of The Prudential ("PRUCO"). Simultaneously, PRUCO and Gibraltar entered into a surplus maintenance agreement pursuant to which PRUCO agreed to purchase such amount of surplus notes as may be necessary to maintain Gibraltar's statutory surplus at no less than $15 million at all times. PRUCO shortly thereafter distributed the stock of Gibraltar to The Prudential. The Direct Excess Retrocession can be terminated by either Gibraltar or Everest Re upon 90 days' notice, whereas the Professional Liability Retrocession can only be terminated by Everest Re. A total of $165.2 million of the Gibraltar receivables is attributable to the Direct Excess Retrocession. If the Direct Excess Retrocession is terminated, all outstanding claims, including incurred but not reported losses ("IBNR"), will be commuted with the value of such claims, which may not exceed Everest Re's then outstanding loss reserves with respect thereto, to be mutually agreed upon or, if no agreement can be reached, determined by an actuary or appraiser mutually appointed. At the time of the IPO, the parties agreed that if Gibraltar terminates the Direct Excess Retrocession and the parties cannot agree on the value of the claims to be commuted, Everest Re's chief actuary will determine such value. Gibraltar could arbitrate the actuary's determination. If the Direct Excess Retrocession were to be so terminated and Everest Re's ultimate losses on the Ceded Direct Insurance were to exceed the commutation amount, the resulting reserve increases would constitute adverse development eligible for coverage under the Stop Loss Agreement (described below), subject to the applicable limits thereof. STOP LOSS AGREEMENT On October 5, 1995, Everest Re and Gibraltar entered into an aggregate stop loss retrocession agreement (the "Stop Loss Agreement"). The Stop Loss Agreement is intended to mitigate the impact on the Company's future earnings that could result from the adverse development, if any, of Everest Re's consolidated reserves for losses, allocated LAE and uncollectible reinsurance as of June 30, 1995, including IBNR; provided, that adverse development, if any, of such reserves relating to catastrophes (as defined in the Stop Loss Agreement) will only be covered to the extent that the catastrophe event to which such reserves relate occurred prior to January 1, 1995. Such adverse development is referred to herein as "Adverse Development". For a description of the Stop Loss Agreement, see Note 7 of Notes to Consolidated Financial Statements. STANDBY CAPITAL CONTRIBUTION AGREEMENT AND PRUCO INDEMNITY On October 6, 1995, Holdings agreed, pursuant to a Standby Capital Contribution Agreement (the "Capital Contribution Agreement"), to make certain capital contributions ("Capital Contributions") to Everest Re in respect of all or a portion of the $375.0 million of Adverse Development experienced by Everest Re that is not ceded in accordance with the terms of the Stop Loss Agreement to Gibraltar. And, on October 6, 1995, PRUCO agreed to make payments ("Indemnity Payments") to Holdings, pursuant to an Indemnity Agreement (the "PRUCO Indemnity"), in an amount equal to the Capital Contributions. PRUDENTIAL GUARANTEES On October 6, 1995, The Prudential guaranteed (i) up to $775.0 million of Gibraltar's obligations to Everest Re, and (ii) PRUCO's obligation to make the Indemnity Payments (the "Prudential Guarantees"). The Prudential agreed, subject to the terms and conditions thereof, to guarantee Gibraltar's (i) payment obligations with respect to the Stop Loss Agreement, subject to maximum aggregate payments of $375.0 million, and (ii) payment obligations under the Gibraltar Contracts, subject to maximum aggregate payments of $400.0 million. The maximum aggregate payments under the Prudential Guarantee of Gibraltar's obligations will be reduced in certain circumstances to take account of payments made and collateral provided in respect of the guaranteed obligations. As of December 31, 1998, based on publicly available information, The Prudential had GAAP basis total assets of $279.4 billion and GAAP based equity of $20.4 billion. CLAIMS Claims are managed by the Company's professional claims staff whose responsibilities include reviewing initial loss reports and coverage issues, monitoring claims handling activities of ceding companies, establishing and adjusting proper case reserves and approving payment of claims. In addition to claims assessment, processing and payment, the claims staff selectively conducts comprehensive claims audits of both specific claims and overall claims procedures at the offices of selected ceding companies. In most instances, primary insurance claims are handled by third party claims services providers who have limited authorities and are subject to oversight by the Company's professional claims staff. 10 RESERVES FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss to the ceding company and the reinsurer and the ceding company's payment of that loss and subsequent payments to the ceding company by the reinsurer. To recognize liabilities for unpaid losses and loss adjustment expenses ("LAE"), insurers and reinsurers establish reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay reported and unreported claims and related expenses on losses that have already occurred. Actual losses and LAE paid may deviate, perhaps substantially, from such reserves. To the extent reserves prove to be insufficient to cover actual losses and LAE after taking into account available retrocessional coverage, including the reinsurance provided through the Stop Loss Agreement, Everest Re would have to augment such reserves and incur a charge to earnings which could be material in the period such augmentation takes place. See ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Loss and LAE Reserves". While the reserving process is difficult and subjective for the ceding companies, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to the longer time between the date of an occurrence and the reporting of any attendant claims to the reinsurer, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development to the same degree in the future. Thus, actual losses and LAE may deviate, perhaps substantially, from estimates of reserves reflected in the Company's consolidated financial statements. Like many other property and casualty insurance and reinsurance companies, Everest Re has experienced adverse loss development for prior accident years, which has led to adjustments in losses and LAE reserves. The increase in net reserves for prior accident years reduced net income for the periods in which the adjustments were made. There can be no assurance that adverse development from prior years will not continue in the future or that such adverse development will not have a material adverse effect on net income. Adverse Development will be reinsured under the Stop Loss Agreement, up to the maximum limits thereunder and subject to the other terms and conditions thereof. See "Relationships with Gibraltar" and "Stop Loss Agreement". CHANGES IN HISTORICAL RESERVES The following table shows changes in historical loss reserves for Everest Re for 1988 and subsequent years. The top line of each table shows the estimated reserves for unpaid losses and LAE recorded at each year end date. Each amount in the top line represents the estimated amount of future payments for losses and LAE on claims occurring in that year and in all prior years. The upper (paid) portion of the table presents the cumulative amounts paid through each subsequent year on those claims for which reserves were carried as of each specific year end. The lower (liability re-estimated) portion shows the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the actual claims for which the initial reserves were carried. The cumulative redundancy/deficiency line represents the cumulative change in estimates since the initial reserve was established. It is equal to the latest liability re-estimated amount less the initial reserve. Each amount other than the original reserves in the top half of the table below includes the effects of all changes in amounts for prior periods. For example, if a loss settled in 1995 for $100,000 was first reserved in 1991 at $60,000 and remained unchanged until settlement, the $40,000 deficiency (actual loss minus original estimate) would be included in the cumulative redundancy (deficiency) in each of the years in the period 1991 through 1994 shown below. Conditions and trends that have affected 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. 11
TEN YEAR STATUTORY LOSS DEVELOPMENT TABLE PRESENTED NET OF REINSURANCE WITH SUPPLEMENTAL GROSS DATA (1) YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------------------------------------ (Dollars in millions) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ------------------------------------------------------------------------------------------------------------ Reserves for unpaid loss and LAE $1,775.8 $1,766.7 $1,891.9 $1,752.9 $1,854.7 $1,934.2 $2,104.2 $2,316.0 $2,551.6 $2,810.0 $2,953.5 Paid (cumulative) as of: One year later 299.1 321.9 597.1 333.3 461.5 403.5 359.5 270.4 331.2 450.8 Two years later 522.3 829.5 785.9 550.4 740.1 627.7 638.0 502.8 619.2 Three years later 984.3 966.3 933.1 758.3 897.0 820.5 828.0 682.0 Four years later 1,096.1 1,078.2 1,096.9 868.1 1,036.0 953.0 983.6 Five years later 1,189.5 1,209.0 1,176.9 970.0 1,141.0 1,071.5 Six years later 1,308.9 1,276.3 1,257.3 1,052.9 1,232.7 Seven years later 1,367.9 1,346.6 1,329.8 1,130.3 Eight years later 1,430.7 1,407.9 1,395.6 Nine years later 1,489.0 1,462.1 Ten years later 1,539.1 Liability re- estimated as of: One year later 1,794.6 1,835.4 1,866.3 1,737.8 1,929.2 2,008.5 2,120.8 2,286.5 2,548.4 2,836.1 Two years later 1,813.2 1,834.3 1,872.8 1,775.7 1,988.9 2,015.4 2,233.7 2,264.5 2,575.9 Three years later 1,805.6 1,849.5 1,907.5 1,843.3 2,010.0 2,119.0 2,271.2 2,285.1 Four years later 1,867.6 1,913.6 1,976.5 1,855.7 2,111.9 2,164.5 2,452.3 Five years later 1,934.5 1,982.3 1,984.3 1,955.1 2,155.3 2,344.9 Six years later 2,007.6 1,984.1 2,080.0 1,995.8 2,332.3 Seven years later 2,008.0 2,089.4 2,123.2 2,178.0 Eight years later 2,122.6 2,135.9 2,307.8 Nine years later 2,167.6 2,310.8 Ten years later 2,339.3 Cumulative redundancy/ (deficiency) $ (563.5) $ (544.1) $ (415.9) $ (425.1) $ (477.6) $ (410.7) $ (348.1) $ 30.9 $ (24.3) $ (26.1) ================================================================================================== Gross liability- end of year $2,752.7 $3,016.9 $3,298.2 $3,498.7 $3,869.2 Reinsurance receivable 648.5 700.9 746.6 688.7 915.7 ------------------------------------------------ Net liability- end of year 2,104.2 2,316.0 2,551.6 2,810.0 2,953.5 -------------------------------------- ======== Gross re-estimated liability at December 31, 1998 3,412.5 3,553.0 3,702.8 3,811.2 Re-estimated receivable at December 31, 1998 960.2 1,267.9 1,126.9 975.1 -------------------------------------- Net re-estimated liability at December 31, 1998 2,452.3 2,285.1 2,575.9 2,836.1 -------------------------------------- Gross cumulative redundancy/ (deficiency) $ (659.8) $ (536.1) $ (404.6) $ (312.5) ======================================
- ---------- (1) Includes Gibraltar data through September 30, 1991 12 For years prior to 1988, management believes that two factors had the most significant impact on loss development. First, through the mid-1980's, a number of industry and external factors, such as the propensity of courts to award large damage awards in liability cases, combined to increase loss frequency and severity to unexpectedly high levels. Second, contracts written prior to 1986 contained coverage terms which, for Everest Re and the industry in general, have been interpreted by courts to provide coverage for asbestos and environmental exposures not contemplated by either the pricing or the initial reserving of the contracts. Legal developments during the mid-1980's necessitated additional reserving for such exposures on both a case and IBNR basis. Incurred losses with respect to asbestos and environmental claims, net of reinsurance, were $15.4 million, $3.5 million, $0, $0 and $40.5 million in 1998, 1997, 1996, 1995 and 1994, respectively. Substantially all of these losses related to pre-1986 exposures. The absence of net incurred losses in 1996 and 1995 is attributable to coverage under the Company's Stop Loss Agreement. The net incurred losses in 1998 and 1997 reflect coinsurance under the Stop Loss Agreement. To the extent loss reserves on assumed reinsurance need to be increased, Everest Re would be entitled to certain payments under the Stop Loss Agreement. See "Stop Loss Agreement" and Note 7 of Notes to Consolidated Financial Statements. Additionally, Holdings may be required to make payments under the Capital Contribution Agreement for which it would be entitled to indemnification under the PRUCO Indemnity. See "Standby Capital Contribution Agreement and PRUCO Indemnity". To the extent loss reserves on the Ceded Direct Insurance need to be increased and subject to the terms of the Gibraltar Contracts, Everest Re will be entitled to 100% protection from Gibraltar under the Gibraltar Contracts, which reinsurance obligations are guaranteed by The Prudential subject to the terms and conditions of the applicable Prudential Guarantee. See "Relationships with Gibraltar" and "Prudential Guarantees". Management believes that adequate provision has been made for Everest Re's loss and LAE reserves regardless of the availability of any such payments under the Stop Loss Agreement, the PRUCO Indemnity, and the Prudential Guarantees. Additionally, while there can be no assurance that reserves for and losses from these claims will not increase in the future, management believes that Everest Re's existing reserves and retrocessional arrangements and payments available under the Stop Loss Agreement, the PRUCO Indemnity and the Prudential Guarantees lessen the probability that such increases would have a material adverse effect on the Company's financial condition, results of operations or cash flows. The Ten Year Statutory Loss Development Table includes Gibraltar data until September 30, 1991, at which time Everest Re distributed the stock of Gibraltar to PRUCO. Thus the 1988-1990 "Reserves for unpaid loss and LAE" includes the Gibraltar liability. Similarly, the "Paid (cumulative) as of" and "Liability re-estimated as of" data include Gibraltar experience until September 30, 1991. At the time of the distribution of Gibraltar, Gibraltar still had $288.5 million of reserves outstanding. To more accurately reflect reserve development, the Gibraltar reserves were removed from the reserves for unpaid losses and LAE line for periods after 1991 and the $288.5 million was treated as a paid loss. The amount so treated as paid in 1991 was $288.5 for each of the years 1988 through 1990. The following table identifies the cumulative reserve redundancy/(deficiency) relating to Gibraltar only, Everest Re excluding Gibraltar and the consolidated group.
CUMULATIVE RESERVE REDUNDANCY/(DEFICIENCY) ATTRIBUTABLE TO GIBRALTAR YEARS ENDED DECEMBER 31, -------------------------------------------------------------------------------------------------- (Dollars in millions) 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 -------------------------------------------------------------------------------------------------- Everest Re excluding Gibraltar $ (433.6) $ (446.0) $ (385.9) $ (425.1) $ (477.6) $ (410.7) $ (348.1) $ 30.9 $ (24.3) $ (26.1) Gibraltar (129.9) (98.1) (30.0) - - - - - - - -------------------------------------------------------------------------------------------------- Consolidated $ (563.5) $ (544.1) $ (415.9) $ (425.1) $ (477.6) $ (410.7) $ (348.1) $ 30.9 $ (24.3) $ (26.1) ==================================================================================================
The following table is derived from the Ten Year Statutory Loss Development Table above and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations for the same ten year period ended December 31, 1998. Each column represents the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column on the far right represent the cumulative reserve re-estimates for the indicated accident years. 13
EFFECT OF RESERVE REESTIMATES ON CALENDAR YEAR OPERATIONS CUMULATIVE CALENDAR YEAR ENDED DECEMBER 31, RE-ESTIMATES FOR (Dollars in ------------------------------------------------------------------------------------------------- EACH ACCIDENT millions) 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 YEAR ------------------------------------------------------------------------------------------------------------------ Accident Years 1988 & prior $ (18.7) $ (18.6) $ 7.6 $ (62.0) $ (66.9) $ (73.0) $ (0.4) $ (114.5) $ (45.1) $ (171.7) $ (563.3) 1989 (50.1) (6.5) 46.8 2.8 4.4 (1.4) 9.2 (1.5) (3.2) 0.5 1990 24.5 8.7 29.4 (0.4) (6.0) 9.7 3.3 (9.7) 59.5 1991 21.6 (3.2) 1.4 (4.6) (3.8) 2.5 2.4 16.3 1992 (36.6) 7.9 (8.7) (2.5) (2.7) 5.2 (37.4) 1993 (14.6) 14.2 (1.7) (2.1) (3.4) (7.6) 1994 (9.8) (9.2) 8.0 (0.7) (11.7) 1995 142.4 59.6 160.4 362.4 1996 (18.8) (6.8) (25.6) 1997 1.4 1.4 Total calendar year effect $ (18.7) $ (68.7) $ 25.6 $ 15.1 $ (74.5) $ (74.3) $ (16.7) $ 29.6 $ 3.2 $ (26.1) $ (205.5)
As illustrated by this table, the factors which caused the deficiencies shown in the Ten Year Statutory Loss Development Table relate almost entirely to accident years prior to 1989 principally reflecting the impact of asbestos and environmental exposures discussed above. The significant favorable development experienced for the 1995 accident year is due to recoveries under the Stop Loss Agreement. This contract, because of the 1995 inception date, is attributed to the 1995 accident year. Aggregate historical development excluding the impact of these two unusual items is not material. The following table presents a reconciliation of beginning and ending reserve balances for the years indicated on a GAAP basis:
RECONCILIATION OF RESERVES FOR LOSSES AND LAE YEARS ENDED DECEMBER 31, --------------------------------------- (Dollars in millions) 1998 1997 1996 --------------------------------------- Reserves at beginning of period $ 3,437.8 $ 3,246.9 $ 2,969.3 --------------------------------------- Incurred related to: Current year 752.3 768.6 745.6 Prior years 26.1 (3.2) (29.6) --------------------------------------- Total incurred losses 778.4 765.4 716.0 --------------------------------------- Paid related to: Current year 192.4 185.3 213.9 Prior years 450.8 331.2 270.4 --------------------------------------- Total paid losses 643.2 516.5 484.3 --------------------------------------- Change in reinsurance receivables on unpaid losses and LAE 227.0 (58.0) 45.9 --------------------------------------- Reserves at end of period $ 3,800.0 $ 3,437.8 $ 3,246.9 =======================================
14 The reconciliation of reserves on a GAAP basis to reserves reported on a statutory basis for each of the three years in the period ended December 31, 1998 is shown below: RECONCILIATION OF RESERVES FOR LOSSES AND LAE FROM STATUTORY BASIS TO GAAP BASIS
YEARS ENDED DECEMBER 31, -------------------------------------------- (Dollars In Millions) 1998 1997 1996 -------------------------------------------- Statutory reserves-net (1) $ 2,922.9 $ 2,778.5 $ 2,313.0 Statutory retroactive reinsurance reserves 29.8 31.4 15.4 Financing arrangement - - (10.3) -------------------------------------------- Subtotal 2,952.7 2,809.9 2,318.1 Foreign subsidiary reserves (1) 0.8 0.1 233.5 -------------------------------------------- Subtotal-net reserves as shown in loss development schedule 2,953.5 2,810.0 2,551.6 Reinsurance receivable on unpaid losses 915.7 688.7 746.6 -------------------------------------------- Subtotal-gross reserves as shown in loss development schedule 3,869.2 3,498.7 3,298.2 Foreign translation effect of Canadian reserves (2) (69.2) (60.9) (51.3) -------------------------------------------- Reserves on a GAAP basis $ 3,800.0 $ 3,437.8 $ 3,246.9 ============================================
- -------------------- (1) On January 1, 1997 the insurance operations of Everest Re Ltd. were converted to branches of Everest Re. For 1998 and 1997, the net reserves for the branches are included in statutory net reserves, and for 1996 the Everest Re Ltd. reserves are shown as foreign subsidiary reserves. For 1998 and 1997, the foreign subsidiary reserve amounts represent the reserves for Everest Canada. (2) Pursuant to statutory accounting conventions, reserves with respect to the Canadian Branch are reflected in Canadian dollars. RESERVES FOR ASBESTOS AND ENVIRONMENTAL LOSSES AND LOSS ADJUSTMENT EXPENSES Everest Re's reserves include an estimate of Everest Re's ultimate liability for asbestos and environmental claims for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of Everest Re's potential losses from asbestos and environmental claims. See ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Asbestos and Environmental Exposures" and Note 11 of Notes to Consolidated Financial Statements. The following table summarizes the composition of Everest Re's total reserves for asbestos and environmental losses, gross and net of reinsurance for the years ended December 31, 1998, 1997 and 1996.
YEARS ENDED DECEMBER 31, -------------------------------------------- (Dollars In Millions) 1998 1997 1996 -------------------------------------------- Case reserves reported by ceding companies $ 137.5 $ 125.9 $ 101.2 Additional reserves established by Everest Re (assumed reinsurance) 67.9 52.0 50.1 Case reserves established by Everest Re (Ceded Direct Insurance) 40.9 45.8 52.8 IBNR reserves 414.5 222.4 219.2 -------------------------------------------- Gross reserves 660.8 446.1 423.3 Reinsurance receivable (397.3) (233.7) (223.7) -------------------------------------------- Net reserves $ 263.5 $ 212.4 $ 199.6 ============================================
Everest Re's asbestos and environmental claims are managed by an experienced staff consisting of eight people. This claims unit works closely with members of Everest Re's in-house legal staff on legal developments. The claims unit also meets with the management of primary insurance companies to understand their asbestos and environmental exposures and reserving practices. 15 Additional losses, the type or magnitude of which cannot be foreseen by the Company, or the reinsurance and insurance industry generally, may emerge in the future. Such future emergence, to the extent not covered by existing retrocessional contracts, including the Stop Loss Agreement, could have material adverse effects on the Company's future financial condition, results of operations and cash flows. INVESTMENTS Everest Re's overall financial strength and results of operations are, in part, dependent on the quality and performance of its investment portfolio. Net investment income and net realized capital gains (losses) on Everest Re's invested assets constituted 18.6%, 18.8% and 16.9% of the Company's revenues for the years ending December 31, 1998, 1997 and 1996, respectively. The Company's cash and invested assets totalled $4,325.8 million at December 31, 1998 of which 93.7% were cash or investment grade fixed maturities. Everest Re's current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable bond and tax-exempt fixed maturity portfolio, while maintaining an adequate level of liquidity. Everest Re's mix of taxable and tax-preferenced investments is adjusted continuously, consistent with Everest Re's current and projected operating results, market conditions and tax position. Additionally, Everest Re invests in marketable equity securities which it believes will enhance the risk-adjusted total return of the investment portfolio. The Investment Committee of Everest Re's Board of Directors is responsible for establishing investment policy and guidelines and, together with senior management, for overseeing their execution. Everest Re's investment portfolio is in compliance with the insurance laws of the state of Delaware, its domiciliary state, and of other jurisdictions in which it is regulated. 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 government obligations, corporate bonds, preferred and common stocks, real estate mortgages and real estate. An independent investment advisor is utilized to manage the Company's investment portfolio within the established guidelines and is required to report activities on a current basis and to meet with the Company periodically to review and discuss the portfolio structure, securities selection and performance results. Everest Re's investment guidelines include a current duration guideline of five to six years. The duration of an investment is based on the maturity of the security but also reflects the payment of interest and the possibility of early prepayment of such security. This investment duration guideline is established and periodically revised by management considering economic and business factors including Everest Re's average duration of potential liabilities which, at December 31, 1998, was approximately five years based on the estimated payouts of underwriting liabilities using standard duration calculations. Approximately 7.7% of the Company's consolidated reserves for losses and LAE and unearned premiums represents estimated amounts payable in foreign currencies. For each currency in which the Company has established substantial reserves, the Company seeks to maintain invested assets denominated in such currency in an amount comparable to the estimated liabilities which are denominated in such currency. As of December 31, 1998, 96.5% of Everest Re's total investments and cash were comprised of fixed maturity investments or cash and 97.0% of Everest Re's fixed maturities consisted of investment grade securities. The average maturity of fixed maturities was 8.7 years at December 31, 1998, and their overall duration was 5.7 years. As of December 31, 1998, Everest Re did not have any material holdings of issuers who management believes are experiencing cash flow difficulty to an extent that the ability of the obligor to meet debt service payments is threatened or any investments in commercial real estate or direct commercial mortgages. Also, investments in derivative products (i.e., products which include features such as futures, forwards, swaps, options and other investments with similar characteristics) are generally prohibited, without the prior approval of Everest Re's Investment Committee. At December 31, 1998, the Company had no investments in derivative products. As of December 31, 1998, the common stock portfolio was $146.3 million at market value, comprising 3.4% of total investments and cash and is managed with a growth and income orientation consisting primarily of investments in dividend paying mid and large capitalization companies. 16 The following table reflects investment results for Everest Re for each of the five years in the period ended December 31, 1998:
PRE-TAX PRE-TAX REALIZED NET AVERAGE INVESTMENT EFFECTIVE CAPITAL GAINS Years Ended December 31, INVESTMENTS(1) INCOME(2) YIELD (LOSSES) (Dollars in millions) ---------------------------------------------------------- 1998 $ 4,243.3 $ 244.9 5.77% $ (0.8) 1997 3,888.9 228.5 5.88 15.9 1996 3,416.4 191.9 5.62 5.7 1995 2,894.9 166.0 5.73 33.8 1994 2,620.9 143.6 5.48 (10.5)
- ----------------- (1) Average of the beginning and ending carrying values of investments and cash, less net funds held and non-interest bearing cash. Bonds, common stock and redeemable and non-redeemable preferred stocks are carried at market value. (2) After investment expenses, excluding realized net capital gains (losses). The following table summarizes fixed maturities as of December 31, 1998 and 1997:
AMORTIZED UNREALIZED UNREALIZED MARKET (Dollars In Millions) COST APPRECIATION DEPRECIATION VALUE ------------------------------------------------------- December 31, 1998: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 152.0 $ 7.6 $ - $ 159.6 Obligations of states and political subdivisions 1,982.5 134.4 0.5 2,116.4 Corporate Securities 839.9 46.5 5.7 880.7 Mortgage-backed securities 388.8 20.2 0.1 408.9 Foreign government securities 241.3 29.8 - 271.1 Foreign corporate securities 246.6 17.5 0.2 263.9 ------------------------------------------------------- Total $ 3,851.1 $ 256.0 $ 6.5 $ 4,100.6 ======================================================= December 31, 1997: U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 144.1 $ 3.1 $ 0.1 $ 147.1 Obligations of states and political subdivisions 1,610.2 112.2 0.3 1,722.1 Corporate Securities 893.9 39.2 - 933.1 Mortgage-backed securities 521.0 20.5 - 541.5 Foreign government securities 232.8 20.6 0.1 253.3 Foreign corporate securities 256.4 13.4 - 269.8 ------------------------------------------------------- Total $ 3,658.4 $ 209.0 $ 0.5 $ 3,866.9 =======================================================
17 The following table presents the credit quality distribution by the National Association of Insurance Commissioners ("NAIC") rating of Everest Re's fixed maturities as of December 31, 1998:
NAIC PERCENT OF RATING(1) STANDARD AND POOR'S EQUIVALENT DESCRIPTION AMOUNT TOTAL --------------------------------------------------------------------------------------------- 1 AAA/AA/A $ 3,562.8 86.9% 2 BBB 415.6 10.1 3 BB 122.2 3.0 4 B - - 5 CCC/CC/C - - 6 CI/D - - ------------------------ Total $ 4,100.6 100.0% ========================
- ------------ (1) The Securities Valuation Office of the NAIC maintains a security valuation system that assigns a numerical rating to securities. The numerical ratings generally correspond to S & P's classifications, as indicated, although S & P has not necessarily rated the securities indicated. Rating categories 1 and 2 are considered investment grade and categories 3 through 6 are considered non-investment grade. The following table summarizes fixed maturities by contractual maturity as of December 31, 1998:
PERCENT OF AMOUNT TOTAL ----------------------------- Maturity category: Less than one year $ 75.6 1.8% Due after 1-5 years 477.7 11.7 Due after 5-10 years 1,534.3 37.4 Due after 10 years 1,604.0 39.1 ----------------------------- Subtotal 3,691.6 90.0 Mortgage-backed securities (1) 409.0 10.0 ----------------------------- Total (2) $ 4,100.6 100.0% =============================
- ------------ (1) Mortgage-backed securities generally are more likely to be prepaid than other fixed maturities. Therefore, contractual maturities are excluded from this table since they may not be indicative of actual maturities. (2) Certain totals may not reconcile due to rounding. YEAR 2000 ISSUES Like many other companies, the Company faces potential business disruption and costs and possible claims under reinsurance contracts and insurance policies associated with the possible inability of many computer systems to accurately process data containing information about the year 2000 or later. For a discussion of these issues, see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Year 2000 Readiness Disclosures. RATINGS Everest Re currently has a rating of "A+" ("Superior") from A.M. Best, an independent insurance industry rating organization which rates companies on factors of concern to policyholders. A.M. Best states that the "A+" ("Superior") rating is assigned to those companies which, in its opinion, have, on balance, achieved superior financial strength, operating performance and market profile when compared to the standards established by A.M. Best and have demonstrated a very strong ability to meet their ongoing obligations to policyholders. The "A+" ("Superior") rating is the second highest of fifteen ratings assigned by A.M. Best, which range from "A++" (Superior) to "F" (In liquidation). Additionally, A.M. Best has eleven classifications within the "Not Assigned" category. 18 Everest Re currently has a claims-paying ability rating of "AA-" (Very Strong) from Standard & Poor's, an independent rating organization which rates an insurance company's financial capacity to meet the obligations of its insurance policies in accordance with their terms. Standard & Poor's states that the "AA-" rating is assigned to those companies which, in its opinion, offer excellent financial security and whose capacity to meet policyholder obligations is strong under a variety of economic and underwriting conditions. The "AA-" rating is the fourth highest of nineteen ratings assigned by Standard & Poor's, which range from "AAA" (Superior) to "R" (Regulatory Action). Ratings from AA to B may be modified by the use of a plus or minus sign to show relative standing of the insurer within those rating categories. Everest Re currently has an insurance financial strength rating of "A2" (Good) from Moody's which rating as of February 18, 1999 is under review for possible upgrade. Moody's states that insurance companies rated "A" offer good financial security. However, elements may be present which suggest a susceptibility to impairment sometime in the future. Moody's rating gradations are shown through the use of nine distinct symbols, each symbol representing a group of ratings in which the financial security is broadly the same. The "A2" (Good) rating is the sixth highest of ratings assigned by Moody's, which range from "Aaa" (Exceptional) to "C" (Lowest). Moody's further distinguishes the ranking of an insurer within its generic rating classification from Aa to B with 1, 2 and 3 ("1" being the highest). A.M. Best's, Standard & Poor's and Moody's ratings are based upon factors of concern to policyholders and should not be considered an indication of the degree or lack of risk involved in an equity investment in an insurance company. Each of these rating agencies reviews its ratings periodically, and there can be no assurance that Everest Re's ratings will be maintained in the future. COMPETITION The worldwide property and casualty reinsurance business is highly competitive, characterized by severe price competition and expanding terms and conditions over the last several years. Similar conditions also exist in the primary insurance market. Competition with respect to the types of reinsurance in which Everest Re is engaged is based on many factors, including the perceived overall financial strength of the reinsurer, A.M. Best's and/or Standard & Poor's rating of the reinsurer, underwriting expertise, the jurisdictions where the reinsurer is licensed or otherwise authorized, premiums charged, other terms and conditions of the reinsurance offered, services offered, speed of claims payment and reputation and experience in lines written. Everest Re competes for its business in the United States and international reinsurance markets with numerous international and domestic reinsurance companies, some of which have greater financial resources than Everest Re. Everest Re's competitors include independent reinsurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance departments of certain primary insurance companies and domestic and international underwriting operations, including underwriting syndicates in Lloyd's of London. Some of these competitors have greater financial resources than Everest Re, have been operating for longer than Everest Re, and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. Although most U.S. reinsurance companies operate in the broker market, most of Everest Re's largest competitors work directly with ceding companies, competing with brokers. Management believes that Everest Re's major competitors are large U.S. and foreign reinsurance companies. Since 1987, the industry has experienced increased global competition. During this period, the demand for reinsurance by primary insurers has been adversely affected by several factors, including consolidation of primary insurers, increased primary insurer capital levels and continued access to capital markets and increases in primary insurer's net retention levels. These factors have precluded reinsurance rate improvement and resulted in generally low rates of reinsurance premium growth, if any. Other factors affecting the capacity of reinsurance companies to offer reinsurance and which factors contributed to the increased global competition since 1987, include consolidation of reinsurance companies, new reinsurance companies, including several well-capitalized Bermuda-based companies which operate within a tax-advantaged jurisdiction and generally greater capital levels maintained by reinsurance companies resulting from earnings growth, investment gains, mergers and other factors (including a relatively low level of catastrophic events). In addition, Lloyd's of London relaxed its requirement that syndicate members have unlimited liability for losses and allows limited liability investors to join syndicates, thereby increasing the reinsurance capacity at Lloyd's. In 1996, Lloyd's implemented its reconstruction and renewal plan in an attempt to separate 1992 and prior years losses from the current market participants and to provide a more secure market going forward, thereby enhancing its competitive position. And, the potential for securitization of insurance and reinsurance risks through the capital markets provide an additional source of insurance and reinsurance capacity. 19 Management believes that the factors noted above which affect the demand for and supply of reinsurance have resulted in increasingly competitive market conditions and have influenced the continuing pressure on insurance and reinsurance rates and the expansion of contract terms in the current market place. The Company may, in the future, face additional competition from other well-capitalized companies or from market participants that may devote more of their capital to the reinsurance business or from the capital markets entry into insurance and reinsurance investment products. The Company also believes that the insurance and reinsurance industries, including reinsurance brokers, will continue to undergo further consolidation and that reinsurers will need significant size, financial strength and service capabilities to compete effectively. EMPLOYEES As of March 2, 1999, Everest Re employed 386 persons, including 24 persons in the WorkCare agency operations, which were acquired in 1998. Management believes that its employee relations are good. None of Everest Re's employees are subject to collective bargaining agreements, and the Company is not aware of any current efforts to implement such agreements at Everest Re. INFORMATION RELATING TO DOMESTIC AND FOREIGN OPERATIONS Financial information relating to geographic areas of operation set forth in Note 13 of Notes to Consolidated Financial Statements of the Company is incorporated herein by reference. REGULATORY MATTERS The Company is subject to regulation under the insurance statutes of various jurisdictions, including Delaware, the domiciliary state of Everest Re and Everest Indemnity, Arizona, the domiciliary state of Everest National, and Canada, the domiciliary jurisdiction of Everest Canada. INSURANCE HOLDING COMPANY REGULATION. Insurance holding company laws and regulations generally require the holding company to register with the relevant state regulatory authorities and file certain reports which include current information concerning the capital structure, ownership, management, financial condition and general business operations of the insurance holding company and its subsidiaries licensed in the state. State regulators also require prior notice or regulatory approval of changes in control of an insurer or its holding company and of certain material inter-affiliate transactions within the holding company structure. See "-Dividends by Everest Re". Under the Delaware and Arizona Codes and regulations thereunder, no person, corporation or other entity may acquire a controlling interest in the Company, unless such person, corporation or entity has obtained the prior approval of the Delaware and Arizona Insurance Commissioners for such acquisition. For the purposes of the Delaware and Arizona Codes, any person acquiring, directly or indirectly, 10% or more of the voting securities of an insurance company is presumed to have acquired "control" of such company. To obtain the approval of any such change in control, the proposed acquirer must file an application with the Delaware and Arizona Insurance Commissioners. This application requires the acquirer to disclose its background, financial condition, the financial condition of its affiliates, the source and amount of funds by which it will effect the acquisition, the criteria used in determining the nature and amount of consideration to be paid for the acquisition, proposed changes in the management and operations of the insurance company and any other related matters. The Insurance Companies Act of Canada also requires prior approval by the Minister of Finance of anyone acquiring a significant interest in an authorized Canadian insurance company. In addition, the Company is subject to regulation by the insurance regulators of other states and foreign jurisdictions in which it does business. Certain of these states and foreign jurisdictions impose regulations regulating the ability of any person to acquire control of an insurance company without appropriate regulatory approval similar to those described above. DIVIDENDS BY EVEREST RE. Because the operations of the Company are conducted through Everest Re and its subsidiaries, the Company is dependent upon dividends and other permissible payments from Everest Re to meet its obligations and to pay dividends in the future should Holdings' Board of Directors decide to do so. The payment of dividends to Holdings by Everest Re is subject to limitations imposed by Delaware law. 20 Under the Delaware Code, before a Delaware domiciled insurer may pay any dividend it must give 10 days prior notice to the Delaware Insurance Commissioner. During this 10-day period, the Commissioner may, by order, limit or disallow the payment of ordinary dividends if the Commissioner finds the insurer to be presently or potentially in financial distress. A Delaware domiciled insurer may only pay cash dividends from the portion of its available and accumulated surplus funds derived from realized net operating profits and realized capital gains. Additionally, a Delaware domiciled insurer may not pay any "extraordinary" dividend or distribution until (i) 30 days after the Delaware Insurance Commissioner has received notice of a declaration thereof and has not within such period disapproved such a payment or (ii) the Delaware Insurance Commissioner has approved such payment within the 30-day period. Under the Delaware Code, an "extraordinary" dividend of a property and casualty insurer is a dividend the amount of which, together with all other dividends and distributions made in the preceding 12 months, exceeds the greater of (i) 10% of an insurer's statutory surplus as of the end of the prior calendar year or (ii) the insurer's statutory net income, not including realized capital gains, for the prior calendar year. Under this definition, the maximum amount that will be available for the payment of dividends by Everest Re in 1999 without triggering the requirement for prior approval of regulatory authorities in connection with an extraordinary dividend is $179.2 million. As of December 31, 1998, Everest Re's accumulated statutory surplus from realized net operating profits and realized gains was $686.5 million. INSURANCE REGULATION. U.S. domestic property and casualty insurers, including reinsurers, are subject to regulation by their state of domicile and by those states in which they are licensed. The rates and policy terms of reinsurance agreements generally are not subject to regulation by any governmental authority. This contrasts with primary insurance policies and agreements, the rates and policy terms of which are generally regulated closely by state insurance departments. Everest Re is subject primarily to regulation and supervision that relate to licensing requirements, solvency requirements, investment requirements, restrictions on the size of risks which may be insured, deposit of securities for the benefit of ceding companies and/or policyholders, accounting requirements, periodic examinations of financial condition and affairs, the form and content of financial statements that must be filed with regulators and the level of minimum reserves necessary to cover unearned premiums, losses and other purposes. In general, such regulation is designed to protect ceding insurers and, ultimately, their policyholders, rather than stockholders. The operations of Everest Re's foreign branch offices in Canada, Hong Kong, Singapore and the United Kingdom are subject to regulation by the insurance regulatory officials of those jurisdictions. Management believes that the Company is in material compliance with applicable laws and regulations pertaining to its business and operations. Everest Canada, Everest Indemnity and Everest National are subject to similar regulation and, in addition, Everest National must comply with substantial regulatory requirements in each state where it does business. These additional requirements include, but are not limited to, rate and policy form requirements, requirements with regard to licensing, agent appointments, participation in residual markets and claims handling procedures. These regulations are primarily designed for the protection of policyholders. LICENSES. Ordinarily, in the United States, a primary insurer will only enter into reinsurance agreements if it can obtain credit for the reinsurance on its statutory financial statements. Credit is usually granted when the reinsurer is licensed or accredited in a state where the primary insurer is domiciled. In addition, many states permit credit for reinsurance ceded to a reinsurer that is domiciled and licensed in another state. Such a reinsurer must meet certain financial requirements and, in some instances, the domiciliary state of such a reinsurer must have substantially similar reinsurance credit law requirements as the domiciliary state of the primary insurer or if credit for reinsurance is not available, the primary insurer may reduce its liabilities on its statutory financial statements if it is provided with collateral to secure the reinsurer's obligations. Everest Re is a licensed property/casualty insurer and/or reinsurer in all states and the District of Columbia with the exception of Nevada and Wyoming. In New Hampshire and Puerto Rico, Everest Re is licensed for reinsurance only. 21 Everest Re is licensed as a property/casualty reinsurer in Canada. It is also authorized to conduct reinsurance business in the United Kingdom, Hong Kong and Singapore and to maintain a representative office in Moscow. Everest Re can also write reinsurance in other foreign countries. Because some jurisdictions require a reinsurer to register in order to be an acceptable market for local insurers, Everest Re is registered as a foreign insurer and/or reinsurer in the following countries: Argentina, Bolivia, Chile, Colombia, Ecuador, El Salvador, Guatemala, Mexico, Peru, Venezuela and the Philippines. Everest National is licensed in 42 states and the District of Columbia. Everest Indemnity is licensed in Delaware and is eligible to write insurance on a surplus lines basis in 37 states and the District of Columbia. Everest Canada is federally licensed under the Insurance Companies Act of Canada and licensed in all Canadian provinces and territories. PERIODIC EXAMINATIONS. Everest Re, Everest National and Everest Indemnity are subject to examination of their affairs by the insurance departments of the states in which they are licensed, authorized or accredited. Delaware and Arizona, the domiciliary states of Everest Re and Everest Indemnity, and Everest National, respectively, usually conduct examinations of domestic companies every 3 years and may do so at such other times as are deemed advisable by the respective insurance commissioner. Everest Re's and Everest National's last examination reports were as of December 31, 1994. Neither report contained any material recommendations. Everest Indemnity's last examination report was conducted upon its organization in 1997. This report did not contain any material recommendations. Delaware and Arizona are currently conducting routine examinations of Everest Re and Everest Indemnity and Everest National, respectively. NAIC RISK-BASED CAPITAL REQUIREMENTS. The NAIC has instituted a formula to measure the amount of capital appropriate for a property and casualty insurance company to support its overall business operations in light of its size and risk profile. The major categories of a company's risk profile are its asset risk, credit risk, and underwriting risk. The new standards are an effort by the NAIC to prevent insolvencies, to ward off other financial difficulties of insurance companies, and to establish uniform regulatory standards among state insurance departments. Under the approved formula, a company's statutory surplus is compared to its risk based capital (RBC). If this ratio is above a minimum threshold, no action is necessary. Below this threshold are four distinct action levels at which a regulator can intervene with increasing degrees of authority over a domestic insurer as the ratio of surplus to RBC decreases. The mildest intervention requires the company to submit a plan of appropriate corrective actions. The most severe action requires the company to be rehabilitated or liquidated. Based upon Everest Re's, Everest National's and Everest Indemnity's financial positions at December 31, 1998, Everest Re, Everest National and Everest Indemnity exceed the minimum thresholds. Various proposals to change the RBC formula arise from time to time. The Company is unable to predict whether any such proposal will be adopted, the form in which any such proposals would be adopted or the effect, if any, the adoption of any such proposal or change in the RBC calculations would have on the Company. LEGISLATIVE AND REGULATORY PROPOSALS. Various regulatory and legislative changes have from time to time been proposed that could affect reinsurers and insurers. 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, Superfund re-authorization, modernization of financial services regulation, product liability and tort reform, state and federal involvement in insuring catastrophes, limitations on the ability of primary insurance carriers to effect premium rate increases or to cancel or not renew existing policies, modifications to investment limitations, creation of interstate compacts for multi-state insurer receivership proceedings or multi-state insurance regulation and the codification of Statutory Accounting Principles. The Company is unable to predict whether any of these proposals will be adopted, the form in which any such proposals would be adopted, or the impact, if any, such adoption would have on the Company. 22 ITEM 2. PROPERTIES Everest Re's corporate offices are located in Liberty Corner, New Jersey, and occupy approximately 112,000 square feet of office space under a sublease with The Prudential that expires on November 29, 2003. In January, 1999, Everest Re entered into an agreement to sub-sublease, for the remaining term of Everest Re's sub-lease, approximately 27,000 square feet of space in Everest Re's corporate headquarters. Everest Re's other ten office locations occupy a total of approximately 56,600 square feet, all of which are leased. Management believes that the above described office space is adequate for its current and anticipated needs. ITEM 3. LEGAL PROCEEDINGS The Company is involved in litigation and arbitration in the normal course of its business. Management does not believe that any such pending litigation or arbitration will have a material adverse effect on the Company's results of operations, financial condition and cash flows. However, no assurance can be given as to the decisions that may be rendered by the courts or arbitration panels in any of such litigation and arbitration matters. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II ITEM 5. (A) MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION Since October 3, 1995, the common stock of Holdings has been traded on the New York Stock Exchange under the symbol "RE". Quarterly high and low market prices of Holdings' common stock in 1998 and 1997 were as follows: High Low ------------------------ First Quarter 1998: 41.6250 35.2500 Second Quarter 1998: 45.2500 36.1250 Third Quarter 1998: 43.5000 34.1875 Fourth Quarter 1998: 38.9375 28.7500 First Quarter 1997: 32.7500 26.0000 Second Quarter 1997: 40.2500 26.7500 Third Quarter 1997: 41.1250 34.5000 Fourth Quarter 1997: 43.0000 33.0000
NUMBER OF HOLDERS OF COMMON STOCK The number of record holders of common stock as of March 1, 1999 was 110. That number excludes the beneficial owners of shares held in "street" names or held through participants in depositories, such as The Depository Trust Company. DIVIDEND HISTORY AND RESTRICTIONS In 1995, the Board of Directors of the Company established a policy of declaring regular quarterly cash dividends. The first such dividend was $0.03 per share, declared and paid in the fourth quarter of 1995. The Company declared and paid its regular quarterly cash dividend of $0.03 per share for each quarter of 1996, $0.04 per share for each quarter of 1997 and $0.05 per share for each quarter of 1998. On February 23, 1999, the Board of Directors raised the quarterly dividend to $0.06 per share and declared a dividend, payable on or before March 26, 1999 to shareholders of record on March 8, 1999. 23 The declaration and payment of future dividends, if any, by the Company will be at the discretion of the Board of Directors and will depend upon many factors, including the Company's earnings, financial condition and business needs, capital and surplus requirements of the Company's operating subsidiaries, regulatory considerations and other factors, and the ability of Everest Re to pay dividends to the Company. As an insurance holding company, the Company depends on payments from Everest Re to pay cash dividends to stockholders. The payment of dividends by Everest Re is subject to certain limitations imposed by the Delaware Code. See "Regulatory Matters -- Dividends by Everest Re" and Note 10A of Notes to Consolidated Financial Statements. RECENT SALES OF UNREGISTERED SECURITIES Information required by Item 701 of Regulation S-K: (a) On October 1, 1998, 1,080 common shares of the Company and on January 1, 1999, 1,056 common shares of the Company (previously held as treasury shares) were distributed. (b) The securities were distributed to the Company's four non-employee Directors. (c) The securities were issued as compensation to the non-employee Directors for services rendered to the Company during the third and fourth quarters of 1998. (d) Exemption from registration was claimed pursuant to Section 4(2) of the Securities Act of 1933. There was no public offering and the participants in the transactions were the Company and its non-employee Directors. (e) Not applicable. ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated GAAP financial data of the Company as of and for the years ended December 31, 1998, 1997, 1996, 1995 and 1994 were derived from the consolidated financial statements of the Company, which were audited by PricewaterhouseCoopers LLP (1998, 1997 and 1996) and by other independent auditors (1995 - 1994). The statutory data have been derived from statutory financial statements of Everest Re filed with the Delaware Insurance Department. Such statutory financial statements are prepared in accordance with Statutory Accounting Principals ("SAP"), which differ from GAAP. The statutory financial statements are unconsolidated and reflect the net assets of Everest Re's subsidiaries, Everest Ltd., Everest National, Everest Canada and Everest Indemnity on the equity method. The following financial data should be read in conjunction with the Consolidated Financial Statements and accompanying notes. The supplemental information for 1995 excludes the effects of an IPO-related premium charge of $140.0 million ($91.0 million after taxes) for the Stop Loss Agreement and an IPO-related compensation expense charge of $13.3 million ($8.7 million after taxes) principally for stock awards to the Company's Chief Executive Officer. Such supplemental information is presented to facilitate an understanding of the impact on the Company's results of operations of these non-recurring charges, but should not, however, be considered as an alternative to the respective amounts determined in accordance with GAAP as an indicator of the Company's operating performance. 24
YEARS ENDED DECEMBER 31, --------------------------------------------------------- (Dollars in millions, except 1998 1997 1996 1995 1994 per share amounts) --------------------------------------------------------- OPERATING DATA: Gross premiums written $ 1,045.9 $ 1,075.0 $ 1,044.0 $ 949.5 $ 953.2 Net premiums written 1,016.6 1,031.1 1,030.5 783.2 863.2 Net premiums earned 1,068.0 1,049.8 973.6 753.3 853.3 Net investment income 244.9 228.5 191.9 166.0 143.6 Net realized capital gains (losses)(1) (0.8) 15.9 5.7 33.8 (10.5) Total revenue 1,315.2 1,299.2 1,169.3 948.9 982.8 Losses and LAE incurred (including catastrophes) 778.4 765.4 716.0 674.7 720.8 Total catastrophe losses(2) 30.6 8.6 7.1 31.4 81.9 Commission, brokerage, taxes and fees 274.6 274.8 254.6 227.4 197.9 Other underwriting expenses 49.6 51.7 54.9 60.0 68.3 Compensation related to public offering - - - 13.3 - Restructuring and early retirement costs - - - - 7.8 Total expenses(3) 1,102.5 1,091.9 1,025.5 975.4 994.8 Income (loss) before taxes(3) 212.7 207.3 143.8 (26.6) (12.0) Income tax (benefit) 47.5 52.3 31.8 (27.3) (22.6) Net income (3) $ 165.2 $ 155.0 $ 112.0 $ 0.7 $ 10.7 ========================================================= Net income per basic share (4) $ 3.28 $ 3.07 $ 2.22 $ 0.01 $ 0.21 ========================================================= Net income per diluted share (5) $ 3.26 $ 3.05 $ 2.21 $ 0.01 $ 0.21 ========================================================= Dividends paid per share $ 0.20 $ 0.16 $ 0.12 $ 0.14 $ 0.15 ========================================================= CERTAIN GAAP FINANCIAL RATIOS: Loss and LAE ratio(6) 72.9% 72.9% 73.5% 89.6% 84.5% Underwriting expense ratio(7) 30.3 31.1 31.8 39.9 31.2 --------------------------------------------------------- Combined ratio 103.2% 104.0% 105.3% 129.5% 115.7% ========================================================= CERTAIN SAP DATA(8): Ratio of net premiums written to surplus(9) 1.0x 1.4x 1.2x 1.0x 1.2x Statutory surplus $ 1,059.4 $ 908.8 $ 772.7 $ 686.9 $ 600.7 Loss and LAE ratio(10) 72.2% 75.7% 71.2% 92.2% 85.8% Underwriting expense ratio(11) 31.1 25.6 31.7 38.9 32.6 --------------------------------------------------------- Combined ratio 103.3% 101.3% 102.9% 131.1% 118.4% ========================================================= BALANCE SHEET DATA (AT END OF PERIOD): Total investments and cash $ 4,325.8 $ 4,163.3 $ 3,624.6 $ 3,238.3 $ 2,573.2 Total assets 5,996.7 5,538.0 5,047.8 4,647.8 4,040.6 Loss and LAE reserves 3,800.0 3,437.8 3,246.9 2,969.3 2,706.4 Total liabilities 4,517.5 4,230.5 3,961.7 3,664.2 3,299.6 Stockholders' equity(12) 1,479.2 1,307.5 1,086.0 983.6 741.0 Book value per share(13) 29.59 25.90 21.51 19.36 14.82 SUPPLEMENTAL INFORMATION, EXCLUDING IPO-RELATED CHARGES: Net premiums written $ 923.2 Net premiums earned 893.3 Income before taxes 126.8 Net income $ 100.4 ========= Net income per basic and diluted share $ 2.00 ========= Supplemental GAAP financial ratios: Loss and LAE ratio 75.5% Underwriting expense ratio 32.2 --------- Combined ratio 107.7% ========= Supplemental SAP data: Ratio of net premiums written to surplus 1.2x Loss and LAE ratio 75.5% Underwriting expense ratio 32.0 --------- Combined ratio 107.5% =========
25 - ------------ (1) After-tax operating income (loss), before after-tax net realized capital gains or losses, was $165.7 million (or $3.29 per basic share and $3.27 per diluted share), $144.6 million (or $2.86 per basic and $2.85 per diluted share), $108.3 million (or $2.14 per basic and diluted share), ($21.2) million (or ($0.42) per basic and diluted share) and $17.5 million (or $0.35 per basic and diluted share) for the years ended December 31, 1998, 1997, 1996, 1995 and 1994, respectively. Supplemental after-tax operating income, before net realized gains and excluding IPO-related charges was, $78.4 million (or $1.56 per basic and diluted share) for the year ended December 31, 1995. (2) Catastrophe losses are net of reinsurance. A catastrophe is defined, for purposes of the Selected Consolidated Financial Data, as an event that causes a pre-tax loss before reinsurance of at least $5.0 million and has an event date of January 1, 1988 or later. (3) Some amounts may not reconcile due to rounding. (4) Based on weighted average basic shares outstanding of 50.4 million, 50.5 million, 50.6 million, 50.2 million and 50.0 million for 1998, 1997, 1996, 1995 and 1994, respectively. (5) Based on weighted average diluted shares outstanding of 50.7 million, 50.8 million, 50.7 million, 50.2 million and 50.0 million for 1998, 1997, 1996, 1995 and 1994, respectively. (6) GAAP losses and LAE incurred as a percentage of GAAP net premiums earned. (7) GAAP underwriting expenses as a percentage of GAAP net premiums earned. Including restructuring and early retirement costs, incurred in the fourth quarter of 1994, the Company's GAAP underwriting expense ratio in 1994 was 32.1%. (8) Statutory results are on a Everest Re legal entity basis; consequently, investments in subsidiary operations are accounted for on an equity basis. Effective January 1, 1997, the reinsurance operations of Everest Re Ltd. were transferred to Everest Re on a portfolio basis. Excluding the impact of the portfolio transaction, the 1997 ratio of net written premiums to surplus, the 1997 loss and LAE ratio, the 1997 underwriting expense ratio and the 1997 combined ratio were 1.1 x, 70.5%, 32.2% and 102.7%, respectively. (9) Statutory net premiums written as a percentage of period-end surplus. (10) Statutory losses and LAE incurred as a percentage of SAP net premiums earned. (11) Statutory underwriting expenses as a percentage of SAP net premiums written. (12) Excluding net unrealized appreciation (depreciation) of investments, stockholders' equity was $1,281.6 million, $1,147.1 million, $1,008.3 million, $899.9 million and $799.1 million as of December 31, 1998, 1997, 1996, 1995 and 1994, respectively. (13) Based on 50.0 million shares outstanding for December 31, 1998, 50.5 million shares outstanding for December 31, 1997 and 1996, 50.8 million shares outstanding for December 31, 1995, and 50.0 million shares outstanding for December 31, 1994. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS INDUSTRY CONDITIONS. Since 1987, a number of factors, including the emergence of significant reinsurance capacity from the Bermuda and rejuvenated Lloyds' markets, higher retentions by primary insurance companies and consolidation and increased capital levels in the insurance industry, have caused increasingly competitive global market conditions across most lines of business and have influenced the softening of prices and contract terms in the current market place. The Company cannot predict with any reasonable certainty, if, when or to what extent market conditions as a whole will change. See "Business-Competition" for a further discussion. SEGMENT INFORMATION The Company, through its subsidiaries, operates as a single segment focusing on the coverage of property and casualty risks using an approach which emphasizes central control and coordination of critical business elements. YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 The following discussion and analysis is focused on a comparison of 1998 results of operations to 1997 results of operations. PREMIUMS. Gross premiums written decreased 2.7% to $1,045.9 million in 1998 from $1,075.0 million in 1997 as the Company maintained a disciplined underwriting approach in the face of increasingly competitive market conditions. Premium growth areas included a 10.8% ($35.2 million) increase in U.S. broker treaty premiums, largely attributable to growth in non-standard auto, accident and health and workers compensation lines where the Company's relatively recent entry to these lines has provided growth opportunities and a 6.8% ($10.8 million) increase in U.S. direct treaty reinsurance and insurance due mainly to portfolio reinsurance transactions. These increases were offset by a 25.5% ($41.2 million) decrease in marine, aviation, and surety premiums, a 13.2% ($10.9 million) decrease in facultative premiums and a 6.6% ($23.0 million) decrease in international premiums reflecting highly competitive current market conditions. The Company continued to decline business that did not meet the Company's objectives regarding underwriting profitability. Ceded premiums decreased by 33.2% to $29.3 million in 1998 from $43.8 million in 1997, principally as a result of a $32.3 million return premium in 1998 relating to a restructuring of the Company's catastrophe retrocessional protection. The impact of this transaction was partially offset by increases in ceded premiums in 1998 over 1997 attributable to increased utilization of contract specific retrocessions, including common account protections, and reinstatement premiums on corporate catastrophe reinsurance protections. 26 Net premiums written decreased by 1.4% to $1,016.6 million in 1998 from $1,031.1 million in 1997, reflecting the decreases in international, marine, aviation and surety and facultative gross written premiums, partially offset by growth in U.S. broker and U.S. direct treaty reinsurance and insurance premiums and the decrease in ceded premiums. REVENUES. Net premiums earned increased by 1.7% to $1,068.0 million in 1998 from $1,049.8 million in 1997, with the increase attributable to premium earnings patterns coupled with the decrease in premiums written. Pre-tax investment income increased 7.2% to $244.9 million in 1998 from $228.5 million in 1997, principally reflecting the effect of investing the $183.3 million of cash flow from operating activities in 1998. The Company's pre-tax yield on average cash and invested assets decreased to 5.8% in 1998 from 5.9% in 1997 reflecting an increase in tax preferenced investments and a lower interest rate environment. After-tax investment income increased 9.9% to $190.8 million in 1998 from $173.5 million in 1997 reflecting growth in the Company's tax preferenced investment holdings. The Company's after-tax yield on average cash and invested assets was 4.5% in 1998, the same yield as in 1997. Net realized capital losses were $0.8 million in 1998 reflecting normal portfolio management activity compared to a net realized capital gain of $15.9 million in 1997, mainly arising from a $14.0 million gain on the sale of the Company's remaining investment in the common stock of Corporacion MAPFRE, a publicly traded Spanish insurer. EXPENSES. Incurred losses and loss adjustment expenses ("LAE") increased by 1.7% to $778.4 million in 1998 from $765.4 million in 1997. The Company's loss and LAE ratio was 72.9% for 1998 and 1997. Excluding the impact of catastrophes and the one-time return premium of $32.3 million, the Company's loss and LAE ratio increased by 0.1 percentage points to 72.2% in 1998 as compared to 72.1% in 1997. Net catastrophe losses for 1998 were $30.6 million mainly arising from Hurricanes Georges and Mitch, Canadian Ice Storm losses and a major fire impacting a facultative coverage partially offset by favorable development on prior period catastrophes compared to net catastrophe losses of $8.6 million for 1997. Catastrophe losses include the impact of both current period events and favorable and unfavorable development on prior period events and are net of reinsurance. The underlying loss ratio increase was attributable to changes to the Company's business mix consistent with its underwriting strategy together with the impact of $17.1 million in incurred losses relating to the coinsurance provisions of the Aggregate Excess of Loss Reinsurance coverage ("Stop Loss Agreement") acquired from Gibraltar Casualty Company ("Gibraltar"), an affiliate of the Prudential Insurance Company of America ("The Prudential"), the Company's former parent, at the time of the Company's initial public offering in 1995. This coverage protects the Company's consolidated earnings against up to $375.0 million of the first $400.0 million of adverse development, if any, on the Company's consolidated reserves for losses, allocated LAE and uncollectible reinsurance at June 30, 1995 (December 31, 1994 for catastrophe losses). Incurred losses and LAE for 1998 reflected ceded losses and LAE of $357.4 million. Ceded losses and LAE included $153.9 million net ceded under the Stop Loss Agreement, $33.5 million net ceded to Gibraltar pursuant to a 1986 quota share reinsurance ("Direct Excess Retrocession") through which Gibraltar assumed 100% of the liabilities related to Everest Re's former direct excess insurance operations which ceased writing business in 1985, and $102.4 million ceded under the Company's management underwriting facility ("MUF"), a reinsurance arrangement begun in 1977 pursuant to which Everest Re ceded certain business written prior to 1992 to a number of insurance and reinsurance companies which, as the result of commutations, also includes Gibraltar. Gibraltar has disputed $63.0 million ceded under the Stop Loss Agreement in 1998 and pursuant to the terms of the Stop Loss Agreement, Gibraltar has secured the disputed amount. Gibraltar has also disputed Everest Re's level of reserves previously ceded to and paid by Gibraltar under the Stop Loss Agreement and claims a refund of $91.7 million. Should Everest Re and Gibraltar not resolve these disputes, pursuant to the terms of the Stop Loss Agreement, each will appoint an independent examiner to review the disputed amounts and to determine the appropriate amount of cessions to Gibraltar, and Everest Re will secure the $91.7 million amount. If the examination process does not resolve the disputes, the Stop Loss Agreement provides for resolution through arbitration. In the event the cessions to Gibraltar were determined to be excessive, Everest Re would reduce the cession to Gibraltar by such excess, refund previous payments made by Gibraltar, if applicable, and the unused portion of the limits of the Stop Loss Agreement would be restored. Also, Everest Re would consider the independent examiners' findings in its ongoing determination of appropriate reserve levels, which may lead to a corresponding reduction in Everest Re's gross reserves, and net reserves to the extent of the coinsurance under the Stop Loss Agreement. In the event the cessions are not determined to be excessive, Gibraltar would be obligated to pay the disputed amount. Accordingly, if the disputes are resolved in Gibraltar's favor, any adverse effect on the Company's financial condition and results of operations would likely be limited to a reduction in cash flows from operations with a corresponding impact on investment income. 27 Gibraltar has disputed $39.7 million ceded under the Direct Excess Retrocession primarily reflecting reserve increases for asbestos losses ceded by the Company in 1998. Gibraltar is disputing the level of reserves established by the Company for such losses, but Gibraltar is not disputing its responsibility to pay the ultimate losses in accordance with the terms of the Direct Excess Retrocession. Management does not expect that this dispute will have a material adverse effect on the Company's future financial condition, results of operations or cash flows. The ceded losses and LAE for 1998 principally reflect a $214.9 million increase in gross reserves with respect to asbestos exposures which the Company judged to be necessary based on continuing reported and paid loss emergence, particularly with respect to secondary defendants, internal and third party statistical analysis, and its assessment of potential ultimate liabilities, $25.7 million of non-asbestos related losses ceded under the Stop Loss Agreement and $23.1 million ceded under various catastrophe retrocessions. The 1998 ceded losses and LAE compares to ceded losses and LAE of $109.6 million in 1997, including $45.0 million ceded under the Stop Loss Agreement. See "Financial Condition" below for a further discussion. Underwriting expenses decreased by 0.7% to $324.1 million in 1998 from $326.5 million in 1997. Commission, brokerage, taxes and fees decreased by $0.2 million attributable to decreases in written premium and changes in the Company's business mix. Other underwriting expenses decreased by $2.1 million, as the Company's cost reduction initiatives continued to provide benefits over the course of 1998 and 1997. The benefits more than offset the impact of salary and other expense increases that were generally in line with inflation. The Company's expense ratio decreased by 0.8 percentage points to 30.3% in 1998 from 31.1% in 1997 as a result of the increase in premiums earned and the decrease in underwriting expenses. The Company's combined ratio decreased by 0.8 percentage points to 103.2% in 1998 from 104.0% in 1997 reflecting the lower expense ratio, increased earned premium and loss ratio factors described above. INCOME TAXES. The Company had income tax expense of $47.5 million in 1998 compared to $52.3 million in 1997, with the decrease resulting from the relationship of tax exempt income to pre-tax income as the Company increased the tax preferenced element of investment income at a rate greater than the increase in pre-tax income as a result of growth in the Company's tax preferenced investment holdings. NET INCOME. Net income was $165.2 million in 1998 compared to $155.0 million in 1997. This improvement mainly reflects higher earned premium, higher investment income, and lower income taxes partially offset by a decrease in net capital gains and an increase in net incurred losses. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 The following discussion and analysis is focused on a comparison of 1997 results of operations to 1996 results of operations. PREMIUMS. Gross premiums written increased 3.0% to $1,075.0 million in 1997 from $1,044.0 million in 1996, as the Company maintained a cautious approach to the increasingly competitive market conditions. Factors contributing to this increase included a 5.9% ($18.2 million) increase in U.S. broker treaty premiums, largely attributable to product line expansion, a 6.6% ($9.8 million) increase in U.S. direct treaty reinsurance and insurance due to the growth in primary insurance written through Everest National, a 2.6% ($8.8 million) increase in international premiums, and a 0.3% ($0.5 million) increase in marine, aviation, and surety premiums. These increases were partially offset by a 7.2% ($6.4 million) decrease in facultative premiums. Ceded premiums increased by 224.7% to $43.8 million in 1997 from $13.5 million in 1996, principally as a result of a return premium in 1996 under the Company's catastrophe retrocessional protection, coupled with increased retrocessional protections for international catastrophe exposures and increases in the Company's contract specific retrocessions in 1997. Net premiums written increased by 0.1% to $1,031.1 million in 1997 from $1,030.5 million in 1996, reflecting the growth in U.S. broker, U.S. direct treaty reinsurance and insurance, international and marine, aviation and surety gross written premiums offset by the decrease in facultative gross premiums written and the increase in ceded premiums. REVENUES. Net premiums earned increased by 7.8% to $1,049.8 million in 1997 from $973.6 million in 1996, with the increase attributable to premium earnings patterns coupled with a decrease in the rate of written premium growth. Net investment income increased 19.1% to $228.5 million in 1997 from $191.9 million in 1996, reflecting the effect of investing the $376.4 million of cash flow from operating activities in 1997 and the increase in the Company's pre-tax yield on average cash and invested assets to 5.9% in 1997 from 5.6% in 1996. 28 Net realized capital gains increased 179.5% to $15.9 million in 1997 from $5.7 million in 1996, with the gains in both periods mainly arising from activity in the Company's portfolio of equity securities, including, in 1997, a $14.0 million gain on the sale of the Company's remaining investment in the common stock of Corporacion MAPFRE, a publicly traded Spanish insurer. EXPENSES. Incurred losses and loss adjustment expenses ("LAE") increased by 6.9% to $765.4 million in 1997 from $716.0 million in 1996. The Company's loss and LAE ratio decreased by 0.6 percentage points to 72.9% in 1997 from 73.5% in 1996. This improvement was attributable principally to changes in the Company's business mix consistent with the Company's underwriting strategy together with modest and comparable catastrophe losses in both years. Net incurred losses and LAE for 1997 reflected ceded losses and LAE of $109.6 million, including $45.0 million ceded under the Stop Loss Agreement, compared to ceded losses and LAE of $206.0 million in 1996, including $116.5 million ceded under the Stop Loss Agreement. Underwriting expenses increased by 5.5% to $326.5 million in 1997 from $309.5 million in 1996. Commission, brokerage, taxes and fees increased by $20.2 million attributable primarily to increases in written premium and changes in the Company's business mix. Other underwriting expenses decreased by $3.2 million, as the impact of the continued reductions in the number of employees over the course of 1996 and 1997 together with other cost reduction initiatives more than offset the impact of salary and other expense increases that were generally in line with inflation. The Company's expense ratio decreased by 0.7 points to 31.1% in 1997 from 31.8% in 1996 as the increase of premiums earned more than offset the increases in underwriting expenses. The Company's combined ratio decreased by 1.3 points to 104.0% in 1997 from 105.3% in 1996, reflecting the lower loss ratio and increased premiums. INCOME TAXES. The Company had income tax expense of $52.3 million in 1997 compared to $31.8 million in 1996, with the difference substantially attributable to the improvement in pre-tax income to $207.3 million in 1997 from $143.8 million in 1996. NET INCOME. Net income was $155.0 million in 1997 compared to $112.0 million in 1996. This improvement mainly reflects higher premiums earned, higher investment income, higher capital gains and a lower combined ratio, offset by higher income taxes. FINANCIAL CONDITION CASH AND INVESTED ASSETS. Aggregate invested assets, including cash and short-term investments, were $4,325.8 million at December 31, 1998, $4,163.3 million at December 31, 1997 and $3,624.6 million at December 31, 1996. The change in invested assets resulted primarily from cash flows from operations generated during the period together with net realized and unrealized gains and losses on investments. LOSS AND LAE RESERVES GENERAL. Gross loss and LAE reserves totaled $3,800.0 million at December 31, 1998, $3,437.8 million at December 31, 1997 and $3,246.9 million at December 31, 1996. The increases were mainly due to reserve increases on pre-1986 accident years for asbestos and environmental exposures, most of which were ceded under various retrocessional arrangements resulting in offsetting increases to reinsurance receivables, together with continued growth in the Company's book of business. Reinsurance receivables totaled $982.0 million at December 31, 1998, $692.5 million at December 31, 1997 and $749.1 million at December 31, 1996. At December 31, 1998, $563.3 million or 57.4% of the total was receivable from Gibraltar including $142.0 million which is contractually due in the first quarter of 1999, subject to resolution of the dispute noted above (See - "Year Ended December 31, 1998 Compared to Year Ended December 31, 1997" above), $154.8 million which is collateralized by funds held by the Company or offsetting liabilities and $266.5 million which is subject to the terms and conditions of The Prudential's guarantee of Gibraltar's payment obligations to the Company. Additionally, $150.0 million or $15.3% is receivable from Continental Insurance Company which is secured by a funds held arrangement wherein the Company has retained the premium payments due the retrocessionaire, recognized a liability for such amounts and reduces such liability as payments are due from the retrocessionaire. No other retrocessionaire accounted for more than $25.0 million of the Company's receivable. Everest Re maintains reserves to cover its estimated ultimate liability for losses and LAE with respect to reported and unreported claims. Because reserves are estimates of ultimate losses and LAE, management monitors reserve adequacy over time, evaluating new information as it becomes known and adjusting reserves, as necessary. Management considers many factors when setting reserves, including: (i) current legal interpretations of coverage and liability; (ii) economic conditions; (iii) internal actuarial methodologies which analyze Everest Re's experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments, pending levels of unpaid claims 29 and product mix; and (iv) the uncertainties discussed below regarding reserve requirements for asbestos and environmental claims. Based on these considerations, management believes that adequate provision has been made for Everest Re's loss and LAE reserves. Actual losses and LAE ultimately paid may deviate, perhaps substantially, from such reserves. ASBESTOS AND ENVIRONMENTAL EXPOSURES. Everest Re's asbestos claims typically involve liability or potential liability for bodily injury from exposure to asbestos or liability for property damage resulting from asbestos or asbestos containing materials. Everest Re's environmental claims typically involve potential liability for the mitigation or remediation of environmental contamination or bodily injury or property damages caused by the release of hazardous substances into the land, air or water. In addition to the previously described general uncertainties inherent in estimating reserves, there are significant additional uncertainties in estimating the amount of Everest Re's potential losses from asbestos and environmental claims. Among the complications impacting the estimation of such losses are: (i) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (ii) difficulty in identifying sources of asbestos or environmental contamination; (iii) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (iv) changes in underlying laws and judicial interpretation of those laws; (v) potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (vi) long reporting delays, both from insureds to insurance companies and ceding companies to reinsurers; (vii) historical data concerning asbestos and environmental losses, which is more limited than historical information on other types of casualty claims; (viii) questions concerning interpretation and application of insurance and reinsurance coverage; and (ix) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure. Although these complications have become less severe in recent years, management believes that these factors continue to render reserves for asbestos and environmental losses significantly less subject to traditional actuarial methods than are reserves on other types of losses. Given these uncertainties, management believes that no meaningful range for such ultimate losses can be established. Everest Re establishes reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for Everest Re or its ceding company. Due to the uncertainties discussed above, the ultimate losses may vary materially from current loss reserves and, if coverage under the Stop Loss Agreement were exhausted, could have a material adverse effect on the Company's future financial condition, results of operations and cash flows. The table below summarizes reserves and claim activity for asbestos and environmental claims, on both a gross and net of ceded reinsurance basis, for the periods indicated: ASBESTOS AND ENVIRONMENTAL RESERVES YEARS ENDED DECEMBER 31, --------------------------------- (Dollars in millions) 1998 1997 1996 --------------------------------- Gross Basis: Beginning of period reserves $ 446.1 $ 423.3 $ 428.5 --------------------------------- Incurred losses and LAE: Reported losses 57.6 80.5 36.7 Change in IBNR 192.0 3.2 (6.7) --------------------------------- Total 249.6 83.7 30.0 Paid losses (34.9) (60.9) (35.2) --------------------------------- End of period reserves $ 660.8 $ 446.1 $ 423.3 ================================= Net Basis: Beginning of period reserves $ 212.4 $ 199.6 $ 186.0 --------------------------------- Incurred losses and LAE: Reported losses (1) (105.9) (18.3) (4.4) Change in IBNR 121.3 21.8 4.4 --------------------------------- Total 15.4 3.5 0.0 Paid losses (2) 35.7 9.3 13.6 --------------------------------- End of period reserves $ 263.5 $ 212.4 $ 199.6 =================================
- ---------- (1) Net of $138.5 million in 1998, $41.2 million in 1997 and $24.2 million in 1996 ceded under the incurred loss reimbursement feature of the Stop Loss Agreement. (2) Net of $39.7 million in 1998, $22.6 million in 1997 and $34.5 million in 1996 ceded as paid losses under the Stop Loss Agreement. 30 The $397.3 million of reinsurance receivables with respect to asbestos and environmental reserves as of December 31, 1998 was attributable principally to three retrocessional arrangements: (i) $168.6 million was ceded to various insurance and reinsurance companies, including Gibraltar, in connection with their participation in MUF; (ii) $118.8 million was ceded to Gibraltar under the Company's Stop Loss Agreement which is contractually due to the Company in the first quarter of 1999, subject to resolution of the dispute noted above; and (iii) $96.5 million resulting from the Company's former direct excess insurance operations, which ceased writing business in 1985 and which has been 100% ceded to Gibraltar since 1986, a portion of which is subject to resolution of the dispute noted above. See - "Year Ended December 31, 1998 Compared to Year Ended December 31, 1997" above. STOP LOSS AGREEMENT AND PRUDENTIAL GUARANTEES. To the extent reserves as of June 30, 1995 (December 31, 1994 for catastrophe losses) for losses, allocated LAE and uncollectible reinsurance experience adverse development ("Adverse Development"), Everest Re is entitled, at the time reserves are increased, to payments under the Stop Loss Agreement, subject to the limit and other terms thereof. Gibraltar's obligations to make payments to Everest Re under the Stop Loss Agreement are guaranteed by The Prudential. Management expects that the general effect of the Stop Loss Agreement will be to protect the Company's consolidated earnings against up to $375.0 million of the first $400.0 million of Adverse Development. There can be no assurance, however, that the Company's net liability for such Adverse Development will be limited to $25.0 million. With respect to liquidity, the incurred loss reimbursement features of these agreements provide the Company with cash on or prior to the time it is required to make payment on account of such Adverse Development. Through December 31, 1998, Adverse Development ceded under the Stop Loss Agreement have aggregated $339.2 million with remaining limits available of $35.8 million (net of coinsurance) as respects the next $39.8 million of Adverse Development. See - "Year Ended December 31, 1998 Compared to Year Ended December 31, 1997" - above. The Prudential has guaranteed all of Gibraltar's payment obligations under the Stop Loss Agreement and up to $400.0 million of Gibraltar's net obligations under all other reinsurance agreements between Gibraltar and Everest Re, $128.3 million of which has been discharged by loss payments made to the Company subsequent to June 30, 1995. At December 31, 1998, Gibraltar's net obligations under such other reinsurance agreements consisted of the following balances: Reinsurance receivables from Gibraltar $ 421.3 Reserve for losses and loss adjustment expenses assumed from Gibraltar (164.2) Losses in the course of payment assumed from Gibraltar (5.4) Funds held by Everest Re under reinsurance treaties with Gibraltar (127.2) -------- Net obligations of Gibraltar $ 124.5 ========
STOCKHOLDERS' EQUITY. Holdings' stockholders' equity increased to $1,479.2 million as of December 31, 1998 from $1,307.5 million as of December 31, 1997 principally reflecting a $155.1 million increase in retained earnings for the year and an increase of $37.2 million in unrealized appreciation of investments. Stockholders' equity as of December 31, 1997 increased to $1,307.5 million from $1,086.0 million as of December 31, 1996 principally reflecting an increase of $146.9 million in retained earnings and an increase of $82.6 million in unrealized appreciation of investments. Dividends of $10.1 million, $8.1 million and $6.1 million were declared and paid by Holdings in 1998, 1997 and 1996, respectively. Holdings' stockholders' equity of $1,479.2 million exceeded Everest Re's statutory-basis surplus of $1,059.4 million by $419.8 million at December 31, 1998. The primary differences between GAAP and SAP as they relate to the Company are: (i) the deferral of acquisition costs under GAAP, which are immediately expensed under SAP; (ii) the provision for deferred taxes on temporary tax differences under GAAP, which are excluded under SAP; and (iii) the carrying at market value of fixed maturities available for sale under GAAP, as compared to at amortized cost under SAP. LIQUIDITY AND CAPITAL RESOURCES EVEREST RE. Everest Re's liquidity requirements are met on both a short-term and long-term basis by funds provided by premiums collected, investment income and collected reinsurance receivables balances, and from the sale and maturity of investments. Everest Re's net cash flows from operating activities were $183.3 million, $376.4 million and $414.0 million, in 1998, 1997 and 1996, respectively. The decreases from 1997 and 1996 in cash provided by operating activities were principally a result of increases in net paid losses, reflecting maturation of the Company's loss reserves, combined with the changes in the Company's mix of business and modest, if any, growth in gross written premium, all of which may affect growth in cash flow from operations in subsequent periods, offset by improved profitability. Recoveries under the Company's Stop Loss Agreement with Gibraltar contributed $31.9 million, $99.8 million and $53.4 million of such net cash flows in 1998, 1997 and 1996 respectively. 31 Proceeds and applications from sales and acquisitions of investment assets were $634.2 million and $755.3 million, respectively, in 1998 principally reflecting reduced portfolio turnover as the result of the tax implications of capital gain realization, compared to $1,077.0 million and $1,482.8 million, respectively, in 1997 and $1,632.9 million and $2,014.9 million, respectively, in 1996. Everest Re's current investment strategy seeks to maximize after-tax income through a high quality, diversified, duration sensitive, taxable bond and tax-exempt municipal bond portfolio, while maintaining an adequate level of liquidity. EXPOSURE TO CATASTROPHES. As with other reinsurers, Everest Re's operating results and financial condition can be adversely affected by volatile and unpredictable natural and other disasters, such as hurricanes, windstorms, earthquakes, floods, fires and explosions. Although Everest Re attempts to limit its exposure to acceptable levels, it is possible that an actual catastrophic event or multiple catastrophic events could have a material adverse effect on the financial condition, results of operations and cash flows of the Company. Everest Re employs various techniques, including licensed software modeling, to assess its accumulated exposure to property catastrophe losses and summarizes that exposure in terms of the probable maximum loss ("PML"). The company defines PML as its anticipated maximum loss, taking into account contract limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake of such a magnitude that it is expected to occur once in every 100 years. Management estimates that the Company's greatest catastrophe exposure worldwide from any single event is to hurricanes and earthquakes in the coastal regions of the United States, where Everest Re estimates it has a PML exposure, before reinsurance, of approximately $170.0 million in each such region based on its current book of business. Similarly, management estimates that the largest current PML exposure, before reinsurance, outside the United States is approximately $86.0 million. There can be no assurance that Everest Re will not experience losses from one or more catastrophic events that exceed, perhaps by a substantial amount, its estimated PML. The Company maintains a corporate-level retrocessional protection program, above and beyond retrocessions purchased with respect to specific assumed coverage, to mitigate the potential impact of catastrophe losses. Prior to the December 31, 1998 cancellation of significant elements of this program, the attachment point of this program was $25.0 million per catastrophe in the United States and $10.0 million per catastrophe outside the United States. During 1998, $23.1 million was ceded under the corporate level retrocession program as a result of catastrophes occurring outside the United States. Effective January 1, 1999 the Company has purchased an accident year aggregate excess of loss protection which provides up to $175.0 million of coverage if Everest Re's statutory basis accident year loss ratio exceeds a certain threshold and responds on an aggregate basis with respect to both property and casualty losses, including those arising from catastrophes. The attachment point is net of inuring retrocessions and includes adjustable premium provisions which effectively cause the Company to offset, on a pre-tax income basis, up to 52.5% of such ceded losses, depending upon the character of the underlying losses, through additional premiums. The maximum recovery is $175.0 million before giving effect to a maximum adjustable premium of $86.3 million. Retrocessions inuring to the benefit of this program, for the period from May 15, 1998 through May 15, 1999, include a catastrophe retrocession which provides coverage of 70.0% of $20.0 million per occurrence in excess of $10.0 million in losses incurred by the Company outside of the United States, and for the period from May 23, 1998 through May 23, 1999, include a catastrophe retrocession which provides coverage of 87.5% of $20.0 million per occurrence in excess of $30.0 million in losses incurred by the Company outside of the United States. All aspects of the retrocession program have been structured to permit the program to be accounted for as reinsurance under SFAS No. 113. If a single catastrophe were to occur in the United States that resulted in $170.0 million of gross losses and allocated loss adjustment expenses ("ALAE") in 1999 (an amount equivalent to Everest Re's PML), management estimates that the effect (including additional premiums and retained losses and ALAE) on the Company's income before taxes would be $93.0 million. This pre-tax net loss estimate assumes that Everest Re's aggregate losses and ALAE for 1999 would exceed the threshold loss ratio requirement in the aggregate excess of loss cover by $170.0 million. HOLDINGS. Holdings is a holding company whose only material asset is the capital stock of Everest Re. Holdings' cash flow will consist primarily of dividends and other permissible payments from Everest Re. Holdings depends upon such payments for funds for general corporate purposes and for the payment of any dividends on its common stock. In May 1998, the Company renewed its 364 day revolving line of credit with First Union National Bank originally entered into in June 1997. This credit facility, which will be used for liquidity and general corporate purposes, provides for the borrowing of up to $50 million. There have been no borrowings under this facility in 1998 or 1997. The credit facility agreement continues to require that Everest Re maintains statutory surplus of not less than $575 million and that the Company not allow its ratio of certain debt to capital to be greater than a specified amount. The Company may 32 choose an interest rate on borrowings equal to either (i) the Base Rate (as defined below), (ii) an adjusted London InterBank Offered Rate ("LIBOR") plus a margin (the "Margin") or (iii) a Money Market Rate, which is a daily uncommitted advised rate. The Base Rate is the higher of the rate of interest established by the bank from time to time as its reference rate in making loans or the Federal Funds rate plus 0.5% per annum. The amount of the Margin and the commitment fee payable to the bank for the credit facility depend upon the insurance strength or claims paying ability ratings of Everest Re. The payment of dividends to Holdings by Everest Re is subject to limitations imposed by the Delaware Insurance Code. Based upon these restrictions, the maximum amount that will be available for payment of dividends to Holdings by Everest Re in 1999 without the prior approval of regulatory authorities is $179.2 million. Everest Re's future cash flow available to Holdings may be influenced by a variety of factors, including changes in the property and casualty reinsurance market, Everest Re's financial results, insurance regulatory changes and changes in general economic conditions. The availability of such cash flow to Holdings could also be influenced by, among other things, changes in the limitations imposed by the Delaware Insurance Code on the payment of dividends by Everest Re. Holdings expects that, absent significant catastrophe losses, such restrictions should not affect Everest Re's ability to declare and pay dividends sufficient to support Holdings' current dividend policy. During 1998, 1997 and 1996 Holdings declared and paid dividends of $10.1 million, $8.1 million and $6.1 million, respectively. On March 21, 1996 the Holdings' Board of Directors approved a stock repurchase plan authorizing the repurchase of an aggregate amount of 2.5 million shares of common stock from time to time in open market transactions. During 1998, the first year in which purchases were made under this authorization, 516,900 shares were repurchased at an average price of $33.68 per share. In September 1998, Holdings adopted a shareholder rights plan ("Plan"). To implement the Plan, the Company declared a dividend of one preferred share purchase right ("Right") for each outstanding share of common stock. Pursuant to the Plan, the Rights can only be exercised in certain situations involving a potential change in control of the Company. For more information see Exhibit 4.1. INCOME TAXES On April 21, 1998, the Supreme Court issued its decision in Atlantic Mutual Insurance Company v. Commissioner, upholding the Internal Revenue Service's position regarding the computation of the fresh start benefit relating to 1986 reserve strengthening. Pursuant to a separation agreement entered into with The Prudential, its former parent at the time of the Company's initial public offering in 1995, the Company paid The Prudential $10.4 million representing tax and interest in resolution of the matter. The Company had adequate provisions for this tax contingency and, as a result, this item has not materially impacted the Company's financial position. MARKET SENSITIVE INSTRUMENTS The Securities and Exchange Commission Financial Reporting Release #48 requires registrants to clarify and expand upon the existing financial statement disclosure requirements for derivative financial instruments, derivative commodity instruments, and other financial instruments (collectively, "market sensitive instruments"). Everest Re's current investment strategy does not provide for investments in derivative financial instruments or derivative commodity instruments. The Company's current investment strategy seeks to maximize after-tax income through a high quality, diversified, taxable and tax-exempt fixed maturity portfolio, while maintaining an adequate level of liquidity. Everest Re's mix of taxable and tax-preferenced investments are adjusted continuously, consistent with Everest Re's current and projected operating results, market conditions, and tax position. The fixed maturities in the investment portfolio are comprised of non-trading available for sale securities. Additionally, Everest Re invests in marketable equity securities, which it believes will enhance the risk-adjusted total return of the investment portfolio. The overall strategy considers the scope of present and anticipated Company operations. In particular, estimates of the financial impact resulting from non-investment asset and liability transactions, together with the Company's capital structure and other factors, are used to develop a net liability analysis. This analysis includes estimated payout characteristics for which the investments of the Company provide liquidity. This analysis is considered in the development of specific investment strategies for asset allocation, duration, and credit quality. 33 The $4.3 billion investment portfolio is comprised of fixed maturity securities that are subject to interest rate risk and foreign currency rate risk, and equity securities that are subject to equity price risk. The impact of these risks in the investment portfolio is generally mitigated by changes in the value of operating assets and liabilities and their associated income statement impact. Interest rate risk is the potential change in value of the fixed maturity portfolio due to change in market interest rates. Further, it includes prepayment risk in a declining interest rate environment on the $408.9 million of the $4.1 billion fixed maturity portfolio, which consists of mortgage-backed securities. Prepayment risk results from accelerated principal payments that shorten the average life and thus, the expected yield of the security. The table below displays the potential impact of market value fluctuations and after-tax unrealized appreciation on the fixed maturity portfolio as of December 31, 1998 based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. For legal entities with a US dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments are taken into account. For legal entities with a non-US dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios. All amounts are in millions of US$.
Interest Rate Shift in Basis Points -200 -100 0 100 200 ------------------------------------------------------------------- Total Market Value $ 4,638.4 $ 4,381.9 $ 4,135.4 $ 3,892.0 $ 3,653.8 Market Value Change from Base (%) 12.2% 6.0% 0.0% (5.9%) (11.7%) Change in Unrealized Appreciation After-tax from Base ($) $ 326.9 $ 160.2 $ 0 $ (158.2) $ (313.0)
Foreign currency rate risk is the potential change in value, income, and cash flow arising from adverse changes in foreign currency exchange rates. The Company's foreign operations each maintain capital in the currency of the country of its geographic location consistent with local regulatory guidance. Generally, the Company prefers to maintain the capital of its foreign operations in US dollar assets although this varies by regulatory jurisdiction in accordance with market needs. Each foreign operation may conduct business in its local currency as well as the currency of other countries in which it operates. The primary foreign currency exposures are the Canadian Dollar, the Belgian Franc, the British Pound Sterling, the German Deutschmark, and the French Franc for these foreign operations. The Company mitigates foreign exchange exposure by a general matching of the currency and duration of its assets to its corresponding operating liabilities. In accordance with FAS 52, the Company translates the assets, liabilities, and income of non-US dollar functional currency legal entities to the US dollar. This translation amount is reported as a component of other comprehensive income. The primary functional foreign currency exposures are the Canadian Dollar, the British Pound Sterling and the Belgian Franc for these foreign operations. The table below displays the potential impact of a parallel 20% increase and decrease in foreign exchange rates on the valuation of invested assets subject to foreign currency exposure in 10% increments as of December 31, 1998. This analysis includes the after-tax impact of translation from transactional currency to functional currency as well as the after-tax impact of translation from functional currency to the US dollar reporting currency. All amounts are in millions of US$.
Change in Foreign Exchange Rates in Percent -20% -10% 0% 10% 20% ----------------------------------------------------- Total After-tax Foreign Exchange Exposure ($ 31.0) ($ 17.5) $ 0 $ 20.4 $ 42.8
Equity risk is the potential change in market value of the common stock and preferred stock portfolios arising from changing equity prices. The Company invests in predominately high quality preferred and common stocks that are traded on the major exchanges in the United States. The primary objective in managing the $146.3 million equity portfolio is to provide long-term capital growth through market appreciation and income. 34 The table below displays the impact on market value and after-tax unrealized appreciation of a 20% change in equity prices up and down in 10% increments as of December 31, 1998. All amounts are in millions of US$.
Change in Equity Values in Percent -20% -10% 0% 10% 20% ----------------------------------------------------------------- Market Value of the Equity Portfolio $ 117.0 $ 131.6 $ 146.3 $ 160.9 $ 175.5 After-tax Change in Unrealized Appreciation (19.0) (9.5) 0 9.5 19.0
YEAR 2000 READINESS DISCLOSURES Many computers, software programs and microprocessors embedded in certain equipment (collectively, "systems") were designed to accommodate only two-digit date fields to represent a given year (e.g., "98" represents 1998). It is possible that such systems will not be able to accurately process data containing information relating to dates before, during or after the year 2000. It is also possible that such systems could fail entirely, although in many instances the consequences of a system not being "year 2000 compliant" are unknown. The "year 2000 issue" has the potential to affect the Company through (i) the disruption of the processing of business and general corporate transactions, both at the Company and between the Company and other business entities with which it interacts, and (ii) claims which may be brought asserting that costs associated with the issue may be covered under insurance or reinsurance contracts in which the Company participates. READINESS. The Company has been actively engaged in a project to mitigate the potential effects of the year 2000 issue. For each segment of its internal computer processing environment (mainframe, midrange and personal computer equipment), the Company has a multi-phase plan that involves (a) the identification and assessment of year 2000 compliance, (b) the design and development of remedies (including the replacement of non-compliant systems if needed), (c) testing of year 2000 readiness and (d) the implementation of fully integrated year 2000-compliant processing. The assessment phase is complete, and many of the Company's systems are already year 2000-compliant. For those that are not yet compliant, steps are being taken to upgrade or replace them. With the exception of one non-critical application, which will be replaced in the third quarter of 1999, all processing/reporting systems are currently planned to be compliant by June 30, 1999. Testing has indicated that virtually all mission-critical mainframe hardware and software is compliant, and that the few software applications that are non-compliant can be made compliant by June 30, 1999; additional testing of remaining systems will continue as those remaining systems are brought into compliance. Although the Company has devoted significant efforts to assessing and upgrading its systems, most of the Company's computerized systems have been developed and maintained by third-party vendors, and the Company is thus dependent in large part on the efforts of those vendors. In many cases the involved systems have already been made compliant. In other cases the Company continues to communicate with the vendors regarding their plans for making the involved systems compliant. On the basis of those communications, the Company believes that those vendors have a critical business need to make their products compliant and are exercising their best efforts to make their products fully compliant. In addition to addressing hardware/software information technology ("IT"), the Company has also been assessing year 2000 issues with respect to non-IT systems such as telephones and various building services which may rely on embedded microprocessors. Although failure of non-IT systems such as telephone service could disrupt the Company's business, the Company's inquiries of the relevant vendors have not identified any material year 2000 problems. The Company's plan also addresses potential year 2000 issues related to the processing of transactions with its external business contacts, including business partners (e.g., ceding companies) and service providers (e.g., banks). The Company has actively surveyed its significant business partners and service providers concerning their compliance status. The information received to date has not identified any significant barriers to year 2000 compliance, and the Company believes that these entities will be sufficiently compliant that the year 2000 issue will not cause material disruption to the Company's business. 35 COSTS. The Company's historical and expected future costs to make its systems year 2000 compliant are not material. The total expected out-of-pocket costs of the year 2000 effort are approximately $0.6 million, of which approximately $ 0.3 million had been incurred as of December 31, 1998. These figures include only expenses specifically related to Year 2000 compliance and do not include the cost of hardware or software acquisitions made in the normal course of business. RISKS. The Company does not rely on computer-dependent transactions to the same extent as many other businesses. However, in the event that the Company's internal processing environment could not be made year 2000-compliant, or in the event that significant business partners or service providers or other business entities experienced serious year 2000 problems, the Company could experience disruption in its business. Such disruption could conceivably take several forms: (a) having to compile information and process transactions manually, (b) if compliance problems persisted, impairing the Company's ability to receive premiums from and make claim payments to its ceding companies, (c) impairing the Company's ability to obtain information about its investments or (d) impairing the value of the Company's bond and equity investments, if the entities underlying those investments themselves have substantial year 2000 costs, liabilities or disruptions. Any or all of the types of possible disruptions in such a "worst case scenario" could materially increase the cost of doing business, could impair the Company's ability to make required regulatory filings and could materially affect the Company's results of operations, liquidity or financial condition. However, based upon current information, the Company does not expect such scenarios to occur and does not expect material disruption to its business. CONTINGENCY PLANS. Although it has considered various scenarios concerning the possible effects of the year 2000 issue, the Company does not yet have formal contingency plans relating to either its internal processing environment or its external business contacts. As it completes the upgrading and testing of non-compliant systems and continues to monitor the status of its important external contacts throughout 1999, the Company will develop contingency plans as necessary for mission-critical systems and relationships. POTENTIAL CLAIMS EXPOSURE. It appears probable that individuals or entities which experience business disruption, increased costs or other problems associated with the year 2000 issue may assert claims against their own insurance carrier to recover such costs or against other entities for damages, which entities may in turn assert that such potential damages are covered by insurance. While it appears probable that some such claims will be made against insurers, it is not yet possible to determine whether such claims will be held to have merit or whether any such claims may be made against insurance or reinsurance contracts in which the Company participates. With respect to prospective business, the Company works with brokers and ceding companies to attempt to determine whether prospective or existing business written carries potential year 2000 exposures. If the ceding company, in the Company's opinion, is adequately underwriting the exposures, the Company may not exclude such exposures from its contracts. If the ceding company is not adequately addressing the issue, the Company will attempt to exclude those exposures from its contracts or non-renew those contracts. There can be no assurance, however, that such business will be completely free of potential exposure to claims related to the year 2000 issue. EURO CONVERSION. On January 1, 1999 eleven of the fifteen member countries of the European Union (the "participating countries") established fixed conversion rates between their existing sovereign currencies (the "legacy currencies") and the Euro. The participating countries have agreed to adopt the Euro as their common legal currency, to issue sovereign debt exclusively in the Euro and to redenominate outstanding sovereign debt. Between January 1, 1999 and January 1, 2002 (the "transition period") the legacy currencies are scheduled to remain legal tender in the participating countries. During the transition period, public and private parties may pay for goods and services using either the Euro or the participating country's legacy currency. European Union regulations, among other matters, specify how legacy currencies convert to Euros. Beginning January 1, 2002, new Euro-denominated bills and coins will be issued and by July 1, 2002, the participating countries' legacy currencies will no longer be legal tender for any transactions. The Company has operations in Belgium and the United Kingdom, both members of the European Union; Belgium became a participating country on January 1, 1999. The nature of the Company's reinsurance business and its investments is such that the Company does not expect the impact of the Euro conversion to be material to the Company's business, operations or financial condition. Although systems which support the Company's United Kingdom and Belgian operations require modifications to enable conversion of legacy currency historical data and accommodate conversions in accordance with European Union requirements, which modifications the system vendor is investigating, a failure of the vendor to modify the system is not expected to be material to the Company's business, operations or financial condition. The Company has not yet determined when it will convert the functional currency for its Belgian operation to the Euro. 36 SAFE HARBOR DISCLOSURE In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 (the "Act"), the Company sets forth below cautionary statements identifying important factors, among others, that in some cases have affected and that could cause its actual results to differ materially from those which might be projected, forecasted, or estimated in its forward-looking statements, as defined in the Act, made by or on behalf of the Company in press releases, written statements or documents filed with the Securities and Exchange Commission, or in its communications and discussions with investors and analysts in the normal course of business through meetings, phone calls and conference calls. These cautionary statements supplement other factors contained in this report which could cause the Company's actual results to differ materially from those which might be projected, forecasted or estimated in its forward-looking statements. Such forward-looking 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 stockholders' equity (including book value per share), investments, financing needs, capital plans, dividends, plans relating to products or services of the Company, and estimates concerning the effects of litigation or other disputes, as well as assumptions for any of the foregoing and are generally expressed with words such as "believes," "estimates," "expects," "anticipates," "plans," "projects," "forecasts," "goals," "could have," "may have" and similar expressions. Undue reliance on any forward-looking statements should be avoided. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the Company's results to differ materially from such forward-looking statements. Such risks, uncertainties and other factors include, but are not limited to, the following: 1) Changes in the level of competition in the domestic and international reinsurance or primary insurance markets that adversely affect the volume or profitability of the Company's reinsurance or insurance business. These changes include, but are not limited to, the intensification of price and contract terms competition, the entry of new competitors, consolidation in the reinsurance and insurance industry and the development of new products by new and existing competitors; 2) Changes in the demand for reinsurance and insurance products of the type offered by the Company and its ceding insurer customers; 3) The ability of the Company to execute its strategies; 4) Catastrophe losses in the Company's domestic or international reinsurance or insurance business; 5) Adverse development on claim and claim 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, or new insurance and reinsurance contract interpretations, to the extent that such adverse development exceeds the limits available under or is not covered by the Stop Loss Agreement; 6) Greater than expected loss ratios on reinsurance or insurance written by the Company; 7) Changes in inflation that affect the profitability of the Company's current reinsurance and insurance businesses or the adequacy of its claim and claim expense liabilities; 8) Changes in the Company's retrocessional arrangements; 9) Lower than estimated retrocessional or reinsurance recoveries on losses, including, but not limited to, losses due to a decline in the creditworthiness of the Company's retrocessionaires or reinsurers; 10) Changes in the reinsurance/retrocessional market impacting the Company's ability to cede risks above its desired level of retention. 11) Changes in interest rates, increases in which cause a reduction in the market value of the Company's fixed income investment portfolio, and its common stockholders' equity, and decreases in which cause a reduction of income earned on new cash flow from operations as well as on the reinvestment of the proceeds from sales, calls or maturities of existing investments; 12) Decline in the value of the Company's common equity investments; 37 13) Changes in the composition of the Company's investment portfolio; 14) Gains or losses related to changes in foreign currency exchange rates; 15) Changes in the role of reinsurance brokers and the relationship of the Company with such brokers; 16) Impact of Year 2000 computer hardware, software and microprocessors embedded in certain equipment issues on the Company's operations and potential for Year 2000 claims under reinsurance and insurance contracts written by the Company; 17) Impact of the Euro on the Company's operations or financial condition; 18) Adverse results in litigation matters, including, but not limited to, litigation related to environmental, asbestos and other potential mass tort claims; 19) Changes in the Company's capital needs; 20) Changes in the Company's ratings; 21) The impact of current and future regulatory environments, generally, and on the ability of the Company's subsidiaries to enter and exit reinsurance or insurance markets; and 22) Changes in the commission or brokerage levels that competitors are willing to offer to ceding companies, brokers or agents. In addition to the factors outlined above that are directly related to the Company's businesses, the Company is also subject to general business risks, including, but not limited to, adverse state, federal or foreign legislation and regulation, adverse publicity or news coverage, changes in general economic factors, and the loss of key employees. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Market Sensitive Instruments" in Item 7. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and schedules listed in the accompanying Index to Financial Statements and Schedules on page F-1 are filed as part of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 38 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Reference is made to "Election of Directors", "Information Concerning Nominees" and "Information Concerning Continuing Directors and Executive Officers" in the Company's proxy statement for the 1999 Annual Meeting of Stockholders, which will be filed with the Commission within 120 days of the close of the Company's fiscal year ended December 31, 1998 (the "Proxy Statement"), and which are incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Reference is made to "Directors' Compensation" and "Compensation of Executive Officers" in the Proxy Statement, which is incorporated herein by reference, except that the Compensation Committee Report and the Performance Graph are not so incorporated. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Reference is made to "Common Stock Ownership by Directors and Executive Officers" and "Principal Holders of Common Stock" in the Proxy Statement, which are incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to "Certain Transactions with Directors" in the Proxy Statement, which is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K FINANCIAL STATEMENTS AND SCHEDULES The financial statements and schedules listed in the accompanying Index to Financial Statements and Schedules on page F-1 are filed as part of this report. EXHIBITS The exhibits listed on the accompanying Index to Exhibits on page E-1 are filed as part of this report. REPORTS ON FORM 8-K No reports on Form 8-K were filed during the last quarter of 1998. 39 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED ON MARCH 22, 1999. EVEREST REINSURANCE HOLDINGS, INC. By: /s/ JOSEPH V. TARANTO ---------------------------- JOSEPH V. TARANTO (CHAIRMAN AND CHIEF EXECUTIVE OFFICER) PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED. /s/ JOSEPH V. TARANTO Chairman and Chief March 22, 1999 - ---------------------------- Executive Officer JOSEPH V. TARANTO and Director /s/ STEPHEN L. LIMAURO Vice President and March 22, 1999 - ---------------------------- Comptroller (also STEPHEN L. LIMAURO principal financial officer) /s/ MARTIN ABRAHAMS Director March 22, 1999 - ---------------------------- MARTIN ABRAHAMS /s/ KENNETH J. DUFFY Director March 22, 1999 - ---------------------------- KENNETH J. DUFFY /s/ JOHN R. DUNNE Director March 22, 1999 - ---------------------------- JOHN R. DUNNE /s/ THOMAS J. GALLAGHER Director March 22, 1999 - ---------------------------- THOMAS J. GALLAGHER /s/ WILLIAM F. GALTNEY, JR. Director March 22, 1999 - ---------------------------- WILLIAM F. GALTNEY, JR. 40 INDEX TO FINANCIAL STATEMENTS AND SCHEDULES PAGES ----- EVEREST REINSURANCE HOLDINGS, INC. Report of Independent Accountants on Financial Statements and Schedules...................................... F-2 Consolidated Balance Sheets at December 31, 1998 and 1997...... F-3 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996........................ F-4 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996.......... F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996.............................. F-6 Notes to Consolidated Financial Statements..................... F-7 SCHEDULES I Summary of Investments Other Than Investments in Related Parties at December 31, 1998.................................. S-1 II Condensed Financial Information of Registrant: Balance Sheets as of December 31, 1998 and 1997............. S-2 Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996........................... S-3 Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996........................... S-4 III Supplementary Insurance Information as of December 31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and 1996................................................. S-5 IV Reinsurance for the years ended December 31, 1998, 1997 and 1996...................................................... S-6 Schedules other than those listed above are omitted for the reason that they are not applicable or the information is otherwise contained in the Financial Statements. F-1 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Everest Reinsurance Holdings, Inc. In our opinion, the consolidated financial statements listed in the index on page F-1 of this Form 10-K present fairly, in all material respects, the financial position of Everest Reinsurance Holdings, Inc. and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules listed in the index on page F-1 of this Form 10-K present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP New York, New York February 17, 1999 Except for Note 14, as to which the date is March 11, 1999 F-2
EVEREST REINSURANCE HOLDINGS, INC. CONSOLIDATED BALANCE SHEETS December 31, ----------------------------------- (Dollars in thousands, except par value per share) 1998 1997 ----------------------------------- ASSETS: Fixed maturities - available for sale, at market value (amortized cost: 1998, $3,851,051; 1997, $3,658,370) $ 4,100,575 $ 3,866,860 Equity securities, at market value (cost: 1998, $91,787; 1997, $120,510) 146,274 158,784 Short-term investments 34,846 75,244 Other invested assets 4,736 10,848 Cash 39,326 51,578 ----------------------------------- Total investments and cash 4,325,757 4,163,314 Accrued investment income 64,220 60,424 Premiums receivable 261,488 256,191 Reinsurance receivables 981,959 692,473 Funds held by reinsureds 200,302 186,454 Deferred acquisition costs 70,753 82,332 Prepaid reinsurance premiums 8,592 8,980 Deferred tax asset 62,237 74,434 Other assets 21,420 13,418 ----------------------------------- TOTAL ASSETS $ 5,996,728 $ 5,538,020 =================================== LIABILITIES: Reserve for losses and adjustment expenses $ 3,800,041 $ 3,437,818 Unearned premium reserve 284,640 337,383 Funds held under reinsurance treaties 195,169 190,639 Losses in the course of payment 64,630 55,969 Contingent commissions 111,344 100,027 Other net payable to reinsurers 18,731 13,231 Current federal income taxes (581) 13,567 Other liabilities 43,550 81,903 ----------------------------------- Total liabilities 4,517,524 4,230,537 ----------------------------------- Commitments and contingencies (Note 11) STOCKHOLDERS' EQUITY: Preferred stock, par value: $0.01; 50 million shares authorized; no shares issued and outstanding (Includes 0.2 million shares of Series A Junior Preferred Stock) - - Common stock, par value: $0.01; 200 million shares authorized; 50.9 million shares issued in 1998 and 50.8 million shares issued in 1997 509 508 Additional paid-in capital 390,559 389,876 Unearned compensation (240) (514) Accumulated other comprehensive income, net of deferred income taxes ($99.8 million in 1998 and $81.9 million in 1997) 185,518 152,319 Retained earnings 928,500 773,380 Treasury stock, at cost; 0.9 million shares in 1998 and 0.3 million shares in 1997 (25,642) (8,086) ----------------------------------- Total stockholders' equity 1,479,204 1,307,483 ----------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 5,996,728 $ 5,538,020 ===================================
The accompanying notes are an integral part of the consolidated financial statements. F-3
EVEREST REINSURANCE HOLDINGS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, ------------------------------------------- (Dollars in thousands, except per share amounts) 1998 1997 1996 ------------------------------------------- REVENUES: Premiums earned $ 1,068,010 $ 1,049,847 $ 973,611 Net investment income 244,909 228,546 191,901 Net realized capital gain/(loss) (765) 15,916 5,695 Other income/(loss) 3,046 4,880 (1,867) ------------------------------------------- 1,315,200 1,299,189 1,169,340 ------------------------------------------- CLAIMS AND EXPENSES: Incurred losses and loss adjustment expenses 778,404 765,421 716,033 Commission, brokerage, taxes and fees 274,559 274,796 254,598 Other underwriting expenses 49,561 51,672 54,870 ------------------------------------------- 1,102,524 1,091,889 1,025,501 ------------------------------------------- INCOME BEFORE TAXES 212,676 207,300 143,839 Income tax 47,479 52,345 31,812 ------------------------------------------- NET INCOME $ 165,197 $ 154,955 $ 112,027 =========================================== Other comprehensive income, net of tax 33,199 74,907 1,524 ------------------------------------------- COMPREHENSIVE INCOME $ 198,396 $ 229,862 $ 113,551 =========================================== PER SHARE DATA: Average shares outstanding (000's) 50,374 50,476 50,567 Net income per common share - basic $ 3.28 $ 3.07 $ 2.22 =========================================== Average diluted shares outstanding (000's) 50,665 50,765 50,711 Net income per common share - diluted $ 3.26 $ 3.05 $ 2.21 ===========================================
The accompanying notes are an integral part of the consolidated financial statements. F-4
EVEREST REINSURANCE HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, --------------------------------------------------- (Dollars in thousands, except per share amounts) 1998 1997 1996 --------------------------------------------------- COMMON STOCK (SHARES OUTSTANDING): Balance, beginning of period 50,479,271 50,490,273 50,792,869 Issued during the period 34,436 22,600 3,800 Treasury stock acquired during period (529,040) (37,287) (306,396) Treasury stock reissued during period 4,537 3,685 - --------------------------------------------------- Balance, end of period 49,989,204 50,479,271 50,490,273 =================================================== COMMON STOCK (PAR VALUE): Balance, beginning of period $ 508 $ 508 $ 508 Issued during the period 1 - - --------------------------------------------------- Balance, end of period 509 508 508 --------------------------------------------------- ADDITIONAL PAID IN CAPITAL: Balance, beginning of period 389,876 389,196 387,349 Contributions during the period - - 1,783 Common stock issued during the period 610 636 64 Treasury stock reissued during period 73 44 - --------------------------------------------------- Balance, end of period 390,559 389,876 389,196 --------------------------------------------------- UNEARNED COMPENSATION: Balance, beginning of period (514) (374) (692) Net increase (decrease) during the period 274 (140) 318 --------------------------------------------------- Balance, end of period (240) (514) (374) --------------------------------------------------- ACCUMULATED OTHER COMPREHENSIVE INCOME, NET OF DEFERRED INCOME TAXES: Balance, beginning of period 152,319 77,412 75,888 Net increase during the period 33,199 74,907 1,524 --------------------------------------------------- Balance, end of period 185,518 152,319 77,412 --------------------------------------------------- RETAINED EARNINGS: Balance, beginning of period 773,380 626,501 520,541 Net income 165,197 154,955 112,027 Dividends declared ( $0.20 per share in 1998, $0.16 per share in 1997 and $0.12 per share in 1996) (10,077) (8,076) (6,067) --------------------------------------------------- Balance, end of period 928,500 773,380 626,501 --------------------------------------------------- TREASURY STOCK AT COST: Balance, beginning of period (8,086) (7,220) - Treasury stock acquired during period (17,663) (953) (7,220) Treasury stock reissued during period 107 87 - --------------------------------------------------- Balance, end of period (25,642) (8,086) (7,220) --------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY, END OF PERIOD $ 1,479,204 $ 1,307,483 $ 1,086,023 ===================================================
The accompanying notes are an integral part of the consolidated financial statements. F-5
EVEREST REINSURANCE HOLDINGS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, ------------------------------------------------ (Dollars in thousands) 1998 1997 1996 ------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 165,197 $ 154,955 $ 112,027 Adjustments to reconcile net income to net cash provided by operating activities: (Increase) decrease in premiums receivable (4,466) (30,867) 38,285 (Increase) in funds held by reinsureds, net (7,766) (1,065) (21,606) (Increase) decrease in reinsurance receivables (289,908) 56,544 (37,084) (Increase) decrease in deferred tax asset (2,532) 10,451 (13,065) Increase in reserve for losses and loss adjustment expenses 359,178 202,191 281,590 Increase (decrease) in unearned premiums (52,757) (16,970) 60,293 (Increase) decrease in other assets and liabilities 16,949 17,706 (1,064) Non cash compensation expense 274 (140) 318 Accrual of bond discount/ amortization of bond premium (1,617) (500) (46) Realized capital (gains) losses 765 (15,916) (5,695) ------------------------------------------------ Net cash provided by operating activities 183,317 376,389 413,953 ------------------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES : Proceeds from fixed maturities matured/called - held to maturity - 2,155 20,582 Proceeds from fixed maturities matured/called - available for sale 162,514 132,231 143,114 Proceeds from fixed maturities sold - available for sale 373,327 880,189 1,281,882 Proceeds from equity securities sold 50,508 59,494 160,429 Proceeds from other invested assets sold 7,605 1,368 - Cost of fixed maturities acquired - held to maturity - - (17,378) Cost of fixed maturities acquired - available for sale (731,500) (1,413,516) (1,836,274) Cost of equity securities acquired (22,350) (45,825) (150,861) Cost of other invested assets acquired (935) - (7,184) Net (purchases) sales of short-term securities 40,273 (23,422) 26,890 Net increase (decrease) in unsettled securities transactions (499) 1,533 (3,166) ------------------------------------------------ Net cash (used in) investing activities (121,057) (405,793) (381,966) ------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Acquisition of treasury stock net of reissuances (17,498) (822) (7,220) Contributions during the period - - 1,783 Common stock issued during the period 625 636 64 Dividends paid to stockholders (10,077) (8,076) (6,067) Net increase (decrease) in collateral for loaned securities (47,119) 47,119 (19,897) ------------------------------------------------ Net cash provided by (used in) financing activities (74,069) 38,857 (31,337) ------------------------------------------------ EFFECT OF EXCHANGE RATE CHANGES ON CASH (443) (10,470) 1,033 ------------------------------------------------ Net increase (decrease) in cash (12,252) (1,017) 1,683 Cash, beginning of period 51,578 52,595 50,912 ------------------------------------------------ Cash, end of period $ 39,326 $ 51,578 $ 52,595 ================================================ SUPPLEMENTAL CASH FLOW INFORMATION CASH TRANSACTIONS: Income taxes paid, net $ 65,659 $ 53,645 $ 38,055 NON-CASH FINANCING TRANSACTION: Issuance of common stock $ 274 $ (140) $ 318
The accompanying notes are an integral part of the consolidated financial statements. F-6 EVEREST REINSURANCE HOLDINGS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996 For purposes of footnote presentation, all dollar values, except per share amounts, are presented in thousands. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. BUSINESS AND BASIS OF PRESENTATION Everest Reinsurance Holdings, Inc. ("Holdings") (formerly known as Prudential Reinsurance Holdings, Inc.), is a holding company incorporated in the state of Delaware. Prior to an initial public offering ("IPO") of all 50 million shares outstanding on October 6, 1995, Holdings was a direct wholly owned subsidiary of PRUCO, Inc. ("PRUCO"), which is wholly owned by The Prudential Insurance Company of America ("The Prudential"). The stock of Everest Reinsurance Company ("Everest Re") (formerly known as Prudential Reinsurance Company) was contributed by PRUCO to Holdings effective December 31, 1993. The contribution has been accounted for at historical cost in a manner similar to the pooling of interests method of accounting as the entities were under common control. Everest Re's principal business is reinsuring property and casualty risks of domestic and foreign insurance companies under excess and pro rata reinsurance contracts. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities (and disclosure of contingent assets and liabilities) at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The consolidated financial statements include the domestic and foreign subsidiaries of Everest Re: Everest National Insurance Company ("Everest National") (formerly known as Prudential National Insurance Company), Everest Indemnity Insurance Company ("Everest Indemnity"), Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda domiciled successor company of Everest Re Ltd. (the assets of which funded Everest Ltd. and which was formerly known as Everest Reinsurance Ltd. and Le Rocher Reinsurance Ltd.) and Everest Insurance Company of Canada ("Everest Canada") (formerly known as OTIP/RAEO Insurance Company, Inc.), which was acquired from The Prudential for $3,700 on December 31, 1996. They also include Mt. McKinley Managers, L.L.C. ("Mt. McKinley") which was formed by Holdings and Everest National in 1997 as an insurance producer and which acquired in 1998 the assets of certain agency operations in Alabama and Georgia which now operate as Workcare Southeast, Inc. ("Workcare Southeast") and Workcare Southeast of Georgia, Inc. ("Workcare Georgia"). Everest National also acquired an agency operation in Texas, Workcare, Inc. The acquisition price of these three agency operations was $2,900 and the transaction occurred on July 1, 1998. These acquisitions have been accounted for by the purchase method. Had these acquisitions occurred at the beginning of 1996, they would have had no material effect on the Company's results of operations. All material intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the 1996 financial statements to conform to the 1997 and 1998 presentation. B. INVESTMENTS SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" requires that a company segment its fixed maturity investment portfolio between held to maturity (carried at amortized cost), available for sale (carried at market value, with unrealized appreciation or depreciation, net of applicable deferred income taxes, reflected as a separate component of stockholders' equity) and trading (carried at market value with unrealized appreciation or depreciation reflected in income). Investments that are available for sale are expected to be held for an indefinite period but may be sold depending on tax position, interest rates and other considerations. Short-term investments are stated at cost, which approximates market value. Equity securities are carried at market value with unrealized appreciation or depreciation of equity securities, net of applicable deferred income tax, credited or charged directly to stockholders' equity. Realized gains or losses on sale of investments are determined on the basis of identified cost. With respect to securities which are not publicly traded, market value has been determined based on pricing models. For publicly traded securities, market value is based on quoted market prices. Cash includes cash and bank time deposits with original maturities of ninety days or under. F-7 C. UNCOLLECTIBLE REINSURANCE BALANCES The Company provides reserves for uncollectible reinsurance balances based on management's assessment of the collectibility of the outstanding balances. Such reserves were $25,102 and $14,399 at December 31, 1998 and December 31, 1997, respectively (see also Note 7). D. DEFERRED ACQUISITION COSTS Acquisition costs, consisting principally of commissions and brokerage expenses and certain premium taxes and fees associated with the Company's primary insurance business incurred at the time a contract or policy is issued, are deferred and amortized over the period in which the related premiums are earned, generally one year. Deferred policy acquisition costs are limited to their estimated realizable value based on the related unearned premiums, anticipated claims and claim expenses and anticipated investment income. Deferred acquisition costs amortized to income were $269,160, $270,605 and $252,928 in 1998, 1997 and 1996, respectively. E. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE The reserve for unpaid losses and loss adjustment expenses is based on individual case estimates and reports received from ceding companies. A provision is included for losses and loss adjustment expenses incurred but not reported ("IBNR") based on past experience. A provision is also included for certain potential liabilities relating to asbestos and environmental exposures, which liabilities cannot be estimated with traditional reserving techniques (see also Note 11). The reserves are reviewed continually and any changes in estimates are reflected in earnings in the period the adjustment is made. Management believes that adequate provision has been made for the Company's loss and loss adjustment expenses. Loss and loss adjustment expense reserves are presented gross of reinsurance receivables and incurred losses and loss adjustment expenses are presented net of ceded reinsurance. Accruals for contingent commission liabilities are estimated based on carried loss and loss adjustment expense reserves. F. PREMIUM REVENUES Premiums written are earned ratably over the periods of the related insurance and reinsurance contracts or policies. Unearned premium reserves are established to cover the remainder of the unexpired contract period. Such reserves are established based upon reports received from ceding companies or computed using pro rata methods based on statistical data. Written and earned premiums, and the related costs, which have not yet been reported to the Company are estimated and accrued. Premiums are net of retrocessions (ceded reinsurance). G. INCOME TAXES The Company and its subsidiaries file their own federal tax returns and calculate their current tax provisions accordingly. Deferred income taxes have been recorded to recognize the tax effect of temporary differences between the financial reporting and income tax bases of assets and liabilities. Prior to the IPO, the Company was a member of a group of affiliated companies which joined in filing a consolidated federal tax return. Current tax liabilities were determined for individual companies based upon their separate return basis taxable income. Members with taxable income incurred an amount in lieu of the separate return basis federal tax. Members with a loss for tax purposes recognized a current benefit in proportion to the amount of their losses utilized in computing consolidated taxable income. H. FOREIGN CURRENCY TRANSLATION Assets and liabilities relating to foreign operations are translated into U.S. dollars at the exchange rates in effect at the balance sheet date; revenues and expenses are translated into U.S. dollars using average exchange rates. Gains and losses resulting from translating foreign currency financial statements, net of deferred income taxes, are excluded from income and accumulated in stockholders' equity. I. EARNINGS PER SHARE SFAS No. 128 requires an enterprise to present basic and diluted earnings per share on the income statement. Basic earnings per share is calculated by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. F-8 Net income per common share has been computed below in accordance with SFAS No. 128, based upon weighted average common and dilutive shares outstanding. 1998 1997 1996 ------------------------------------------ Net income (numerator) $ 165,197 $ 154,955 $ 112,027 ========================================== Weighted average common and effect of dilutive shares used in the computation of net income per share: Average shares outstanding - basic (denominator) 50,374 50,476 50,567 Effect of dilutive shares 291 289 144 ------------------------------------------ Average shares outstanding - diluted (denominator) 50,665 50,765 50,711 ========================================== Net income per common share: Basic $ 3.28 $ 3.07 $ 2.22 Diluted 3.26 3.05 2.21
Options to purchase 738,600, 337,750 and 20,000 shares of common stock at prices ranging from $37.41 to $39.16, $39.16 and $26.63, per share were outstanding at the end of 1998, 1997 and 1996, respectively, but were not included in the computation of earnings per diluted share for the respective years, because the options' exercise price was greater than the average market price of the common shares at the end of such years. The options, which expire between September 26, 2007 and September 25, 2008, September 26, 2007 and November 18, 2006, respectively, were still outstanding at the end of 1998 with the exception of 26,400 shares which were not included in the computation at the end of 1997. J. SEGMENTATION In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information". This statement establishes standards for the way a public enterprise reports information about its operating segments in its financial statements. The Company, through its subsidiaries, operates as a single segment focusing on the coverage of property and casualty risks which emphasizes central control and coordination of critical business elements. The Company's product is distributed globally through multiple markets and distribution channels including insurance and reinsurance, originated on a broker, direct and program manager basis, accepting primary, proportional and excess layers, treaty and facultative arrangements, covering virtually all lines of business. The management approach of the Company is to focus on the enterprise's overall profitability as opposed to an analysis of the stand alone profitability results of any unit. K. FUTURE APPLICATION OF ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities". This statement requires all derivatives to be recognized as either assets or liabilities in the statement of financial position and to be measured at fair value. This statement is effective for all fiscal quarters and fiscal years beginning after June 15, 1999. Management believes that the statement will not have a material impact on the financial position of the Company. F-9 2. INVESTMENTS The amortized cost, market value, and gross unrealized appreciation and depreciation of fixed maturity investments are presented in the tables below: Amortized Unrealized Unrealized Market Cost Appreciation Depreciation Value ---------------------------------------------------------- As of December 31, 1998 Fixed maturities - available for sale U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 151,976 $ 7,644 $ 4 $ 159,616 Obligations of states and political subdivisions 1,982,490 134,411 470 2,116,431 Corporate securities 839,892 46,444 5,682 880,654 Mortgage-backed securities 388,843 20,171 68 408,946 Foreign government securities 241,310 29,744 - 271,054 Foreign corporate securities 246,540 17,547 213 263,874 ---------------------------------------------------------- TOTAL $ 3,851,051 $ 255,961 $ 6,437 $ 4,100,575 ========================================================== As of December 31, 1997 Fixed maturities - available for sale U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 144,079 $ 3,076 $ 86 $ 147,069 Obligations of states and political subdivisions 1,610,190 112,211 293 1,722,108 Corporate securities 893,885 39,189 16 933,058 Mortgage-backed securities 521,048 20,504 2 541,550 Foreign government securities 232,815 20,540 57 253,298 Foreign corporate securities 256,353 13,426 2 269,777 ---------------------------------------------------------- TOTAL $ 3,658,370 $ 208,946 $ 456 $ 3,866,860 ==========================================================
During 1997, the Company transferred all of the fixed maturity securities in its held-to-maturity classification (with an amortized cost of $78,974 and market value of $85,508) to the available-for-sale classification to enhance management's flexibility with respect to future portfolio management. The net financial statement impact at the time of the transfer was a $4,247 increase in net after-tax unrealized appreciation of investments. The amortized cost and market value of fixed maturities are shown in the following table by contractual maturity. Actual maturities may differ from contractual maturities because securities may be called or prepaid with or without call or prepayment penalties. Mortgage-backed securities generally are more likely to be prepaid than other fixed maturites. As the stated maturity of such securities may not be indicative of actual maturities, the total for mortgage-backed securities is shown separately. December 31, 1998 ---------------------------- Amortized Market Cost Value ---------------------------- Fixed maturities - available for sale Due in one year or less $ 75,137 $ 75,594 Due after one year through five years 452,953 477,709 Due after five years through ten years 1,423,395 1,534,307 Due after ten years 1,510,724 1,604,019 Mortgage-backed securities 388,842 408,946 ---------------------------- TOTAL $ 3,851,051 $ 4,100,575 ============================
F-10 Proceeds from sales of fixed maturity investments during 1998, 1997 and 1996 were $373,327, $880,189 and $1,281,882, respectively. Gross gains of $6,328, $6,766 and $9,146, and gross losses of $6,615, $9,439 and $20,952 were realized on those sales during 1998, 1997 and 1996, respectively. The cost, market value and gross unrealized appreciation and depreciation of investments in equity securities is presented in the table below: December 31, --------------------------- 1998 1997 --------------------------- Cost $ 91,787 $ 120,510 Unrealized appreciation 54,748 39,162 Unrealized depreciation (261) (888) --------------------------- Market value $ 146,274 $ 158,784 ===========================
The changes in net unrealized gains (losses) of investments of the Company (including unrealized gains and losses on fixed maturities not reflected in stockholders' equity) are derived from the following sources: Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------------------------------- Increase (decrease) during the period between the market value and cost of investments carried at market value, and deferred tax thereon: Equity securities $ 16,212 $ 6,361 $ 5,897 Fixed maturities 41,034 120,764 (14,440) Other invested assets - - - Deferred taxes (20,036) (44,494) 2,583 ---------------------------------- Increase (decrease) in unrealized appreciation, net of deferred taxes, included in stockholders' equity 37,210 82,631 (5,960) Increase (decrease) during the period between the market value and cost of fixed maturities carried at amortized cost - (7,852) (4,288) ---------------------------------- TOTAL $ 37,210 $ 74,779 $(10,248) ==================================
The components of net investment income are presented in the table below: Years Ended December 31, ------------------------------------- 1998 1997 1996 ------------------------------------- Fixed maturities $ 249,382 $ 232,779 $ 198,947 Equity securities 4,601 4,473 2,835 Short-term securities 2,849 3,435 5,357 Other interest income 3,273 2,582 1,450 ------------------------------------- Total gross investment income 260,105 243,269 208,589 ------------------------------------- Interest on funds held 11,983 11,173 12,294 Other investment expenses 3,213 3,550 4,394 ------------------------------------- Total investment expenses 15,196 14,723 16,688 ------------------------------------- Total net investment income $ 244,909 $ 228,546 $ 191,901 =====================================
F-11 The components of realized capital gains (losses) are presented in the table below: Years Ended December 31, ------------------------------------- 1998 1997 1996 ------------------------------------- Fixed maturities $ (287) $ (2,673) $ (11,805) Equity securities (455) 18,572 17,443 Short-term investments (23) 17 57 ------------------------------------- TOTAL $ (765) $ 15,916 $ 5,695 =====================================
Securities with a carrying value amount of $280,245 at December 31, 1998 were on deposit with various state or governmental insurance departments in compliance with insurance laws. The Company had no investments in derivative financial instruments for the years ended December 31, 1998, 1997 and 1996. 3. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the reserve for losses and loss adjustment expenses is summarized as follows: Years Ended December 31, ------------------------------------------- 1998 1997 1996 ------------------------------------------- Reserves at January 1 $ 3,437,818 $ 3,246,858 $ 2,969,341 Less reinsurance recoverables 688,694 746,640 700,877 ------------------------------------------- Net balance at January 1 2,749,124 2,500,218 2,268,464 ------------------------------------------- Incurred related to: Current year 752,349 768,597 745,594 Prior years 26,055 (3,176) (29,561) ------------------------------------------- Total incurred losses and loss adjustment expenses 778,404 765,421 716,033 ------------------------------------------- Paid related to: Current year 192,404 185,310 213,832 Prior years 450,824 331,205 270,447 ------------------------------------------- Total paid losses and loss adjustment expenses 643,228 516,515 484,279 ------------------------------------------- Net balance at December 31 2,884,300 2,749,124 2,500,218 Plus reinsurance recoverables 915,741 688,694 746,640 ------------------------------------------- Balance at December 31 $ 3,800,041 $ 3,437,818 $ 3,246,858 ===========================================
4. CREDIT LINE In May 1998, the Company renewed its 364 day revolving line of credit with First Union National Bank originally entered into in June 1997. This credit facility, which will be used for liquidity and general corporate purposes, provides for the borrowing of up to $50 million. There have been no borrowings under this facility in 1998 or 1997. The credit facility agreement continues to require that Everest Re maintains statutory surplus of not less than $575 million and that the Company not allow its ratio of certain debt to capital to be greater than a specified amount. The Company may choose an interest rate on borrowings equal to either (i) the Base Rate (as defined below), (ii) an adjusted London Interbank Offered Rate ("LIBOR") plus a margin (the "Margin") or (iii) a Money Market Rate, which is a daily uncommitted advised rate. The Base Rate is the higher of the rate of interest established by the bank from time to time as its reference rate in making loans or the Federal Funds rate plus 0.5% per annum. The amount of the Margin and the commitment fee payable to the bank for the credit facility depend upon the insurance strength or claims paying ability ratings of Everest Re. F-12 5. OPERATING LEASE AGREEMENTS The future minimum rental commitments, exclusive of cost escalation clauses, for all of the Company's operating leases with remaining non-cancelable terms in excess of one year are as follows: (in thousands) 1999 $ 3,892 2000 4,093 2001 4,076 2002 3,664 2003 3,046 Thereafter 731 -------------- Total payments 19,502 Sublease rental income 3,025 -------------- Net Commitments $ 16,477 ==============
All of these leases, the expiration terms of which range from 1999 to 2008, are for the rental of office space. Rental expense, net of sublease rental income, was $5,313, $4,903 and $5,334 for 1998, 1997 and 1996, respectively. 6. INCOME TAXES The components of income taxes for the periods presented are as follows: Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------------------------------- Current tax: U.S. $ 44,341 $ 18,892 $ 24,363 Foreign 8,854 23,000 20,735 ---------------------------------- Total current tax 53,195 41,892 45,098 Total deferred U.S. tax (benefit) (5,716) 10,453 (13,286) ---------------------------------- Total income tax $ 47,479 $ 52,345 $ 31,812 ==================================
A reconciliation of the U.S. Federal income tax rate to the Company's effective tax rate is as follows: Years Ended December 31, ------------------------------------- 1998 1997 1996 ------------------------------------- Federal income tax rate 35.0% 35.0% 35.0% Increase (reduction) in taxes resulting from: Tax exempt income (14.8) (12.1) (15.1) Other, net 2.1 2.4 2.2 ------------------------------------- Effective tax rate 22.3% 25.3% 22.1% =====================================
F-13 Deferred income taxes reflect the tax effect of the temporary differences between the value of assets and liabilities for financial statement purposes and such values as measured by the tax laws and regulations. The principal items making up the net deferred income tax asset are as follows: December 31, -------------------------- 1998 1997 -------------------------- Deferred tax assets: Reserve for losses and loss adjustment expenses $ 164,894 $ 155,666 Unearned premium reserve 19,323 22,988 Foreign currency translation 6,637 4,480 Net operating loss carryforward 1,401 1,222 Other assets 6,505 8,866 -------------------------- Total deferred tax assets 198,760 193,222 Deferred tax liabilities: Deferred acquisition costs 24,764 28,816 Net unrealized appreciation of investments 106,404 86,368 Other liabilities 5,355 3,604 -------------------------- Total deferred tax liabilities 136,523 118,788 -------------------------- Net deferred tax assets $ 62,237 $ 74,434 ==========================
Holdings has total net operating loss carryforwards of $4,002 which expire during years 2001-2014. Management believes that it is more likely than not that the Company will realize the benefits of its net deferred tax assets and, accordingly, no valuation allowance has been recorded for the periods presented. Everest Re has not provided for U.S. Federal income or foreign withholding taxes on $9,393 of pre-1987 undistributed earnings of non-U.S. subsidiaries, because such earnings are intended to be retained by the foreign subsidiaries indefinitely. If these earnings were distributed, foreign tax credits are available under current law to reduce or eliminate any resulting income tax liability. On April 21, 1998, the Supreme Court issued its decision in ATLANTIC MUTUAL INSURANCE COMPANY V. COMMISSIONER, upholding the Internal Revenue Service's position regarding the computation of the fresh start benefit relating to 1986 reserve strengthening. Pursuant to a separation agreement entered into with The Prudential, its former parent at the time of the Company's initial public offering in 1995, the Company paid The Prudential $10,445 representing tax and interest in resolution of the matter. The Company had adequate provisions for this tax contingency and, as a result, this item has not materially impacted the Company's financial position. 7. RETROCESSIONS The Company utilizes retrocessional (reinsurance) agreements to reduce its exposure to large claims and catastrophic loss occurrences. These agreements provide for recovery from retrocessionaires of a portion of losses and loss expenses under certain circumstances without relieving the insurer of its obligation to the policyholder. Losses and loss adjustment expenses incurred and earned premiums are after deduction for retrocessions. In the event retrocessionaires were unable to meet their obligations under retrocession agreements, the Company would not be able to realize the full value of the reinsurance recoverable balances. The Company may hold partial collateral, including letters of credit, under these agreements and has never suffered a significant loss because of a retrocessionaire's default. (see Note 1(C) and the following paragraph). Effective October 5, 1995, Everest Re entered into a stop loss agreement (the "Stop Loss Agreement") with Gibraltar Casualty Company ("Gibraltar"). This agreement, for a premium of $140,000, provides protection against 100% of the first $150,000 of adverse development, if any, and 90% of the next $250,000 of adverse development, if any, of Everest Re's consolidated reserves for losses and uncollectible reinsurance as of June 30, 1995, including allocated loss adjustment expense and incurred but not reported losses, provided that adverse development, if any, relating to catastrophes will be covered only to the extent that the catastrophe event occurred prior to January 1, 1995. All such adverse development is referred to herein as "Adverse Development". Payments will be made to Everest Re under the Stop Loss Agreement as Adverse Development is incurred by Everest Re. Coverage under the Stop Loss Agreement terminates on F-14 December 31, 2007, or earlier if coverage is exhausted. Through December 31, 1998 and 1997, cessions under the Stop Loss Agreement have aggregated $339,179 and $185,231, respectively, yielding remaining limits, net of coinsurance, of $35,821 and $189,769 at December 31, 1998 and 1997, respectively. The Prudential has, subject to the terms and conditions of the guarantee, guaranteed all of Gibraltar's payment obligations under the Stop Loss Agreement and up to $400,000 of Gibraltar's net payment obligations under all other reinsurance agreements between Gibraltar and Everest Re, $128,275 of which has been discharged by loss payments made to the Company subsequent to June 30, 1995. At December 31, 1998, Gibraltar's net obligations under such other reinsurance agreements consisted of the following balances: Reinsurance receivables from Gibraltar $ 421,278 Reserve for losses and loss adjustment expenses assumed from Gibraltar (164,204) Losses in the course of payment assumed from Gibraltar (5,382) Funds held by Everest Re under reinsurance treaties with Gibraltar (127,183) --------- Net obligations of Gibraltar $ 124,509 =========
Gibraltar has disputed $63,000 ceded under the Stop Loss Agreement and, in accordance with the terms of the Stop Loss Agreement, Gibraltar has secured the disputed amount. Gibraltar has also disputed Everest Re's level of reserves previously ceded to and paid by Gibraltar under the Stop Loss Agreement and claims a refund of $91,700. Should Everest Re and Gibraltar not resolve these disputes, pursuant to the terms of the Stop Loss Agreement, each will appoint an independent examiner to review the disputed amounts and to determine the appropriate amount of cessions to Gibraltar, and Everest Re will secure the $91,700 amount. If the examination process does not resolve the disputes, the Stop Loss Agreement provides for resolution through arbitration. In the event the cessions to Gibraltar were determined to be excessive, Everest Re would reduce the cession to Gibraltar by such excess, refund previous payments made by Gibraltar, if applicable, and the unused portion of the limits of the Stop Loss Agreement would be restored. Also, Everest Re would consider the independent examiners' findings in its ongoing determination of appropriate reserve levels, which may lead to a corresponding reduction in Everest Re's gross reserves, and net reserves to the extent of the coinsurance under the Stop Loss Agreement. In the event the cessions are not determined to be excessive, Gibraltar would be obligated to pay the disputed amount. Accordingly, if the disputes are resolved in Gibraltar's favor, any adverse effect on the Company's financial condition and results of operations would likely be limited to a reduction in cash flows from operations with a corresponding impact on investment income. Gibraltar has disputed $39,714 ceded under a 1986 quota share reinsurance ("Direct Excess Retrocession") through which Gibraltar assumed 100% of the liabilities related to Everest Re's former direct excess insurance operations which ceased writing business in 1985. Gibraltar is disputing the level of reserves established by the Company primarily reflecting reserves for asbestos losses, but Gibraltar is not disputing its responsibility to pay the ultimate losses in accordance with the terms of the Direct Excess Retrocession. Management does not expect that this dispute will have a material adverse effect on the Company's future financial condition, results of operations or cash flows. Written and earned premiums are comprised of the following: Years Ended December 31, --------------------------------------------- 1998 1997 1996 --------------------------------------------- Written premium: Direct $ 78,976 $ 75,653 $ 59,691 Assumed 966,914 999,316 984,340 Retroceded (29,291) (43,827) (13,497) --------------------------------------------- Net written premium $ 1,016,599 $ 1,031,142 $ 1,030,534 ============================================= Earned premium Direct $ 75,017 $ 77,784 $ 37,963 Assumed 1,022,611 1,012,168 945,698 Retroceded (29,618) (40,105) (10,050) --------------------------------------------- Net earned premium $ 1,068,010 $ 1,049,847 $ 973,611 =============================================
The amounts deducted from losses and loss adjustment expenses incurred for retrocessional recoveries were $357,366, $109,574 and $206,032 for the years ended December 31, 1998, 1997 and 1996, respectively. F-15 8. COMPREHENSIVE INCOME The Company adopted SFAS No. 130, "Reporting Comprehensive Income", in 1998 which requires an enterprise to present items of other comprehensive income in a financial statement and to display accumulated balances of other comprehensive income in the equity section of a financial statement. The components of comprehensive income for the periods ending December 31, 1998, 1997 and 1996 are shown in the following table: 1998 1997 1996 ----------------------------------------- Net Income $ 165,197 $ 154,955 $ 112,027 ----------------------------------------- Other comprehensive income, before tax: Foreign currency translation adjustments (6,304) (11,891) 11,287 Unrealized gains on securites: Unrealized gains arising during period 58,012 111,209 (14,238) Less: reclassification adjustment for realized (gains) losses included in net income 765 (15,916) (5,695) ----------------------------------------- Other comprehensive income, before tax 50,943 115,234 2,744 ----------------------------------------- Income tax expense (benefit) related to items of other comprehensive income: Tax expense (benefit) from foreign currency translation (2,292) (4,167) 3,803 Tax expense (benefit) from holding gains arising during period 20,304 38,923 (4,576) Tax expense (benefit) from gains included in net income (268) 5,571 1,993 ----------------------------------------- Income tax expense (benefit) related to items of other comprehensive income: 17,744 40,327 1,220 Other comprehensive income, net of tax 33,199 74,907 1,524 ----------------------------------------- Comprehensive Income $ 198,396 $ 229,862 $ 113,551 =========================================
The following table shows the components of the change in accumulated other comprehensive income for the years ending December 31, 1998 and 1997. 1998 1997 ---------------------------------------------------- Beginning balance of accumulated other comprehensive income $ 152,319 $ 77,412 --------- --------- Beginning balance of foreign currency translation adjustments $ (8,078) $ (354) Current period change in foreign currency translation adjustmens (4,012) (4,012) (7,724) (7,724) ---------------------------------------------------- Ending balance of foreign currency translation adjustments (12,090) (8,078) -------- -------- Beginning balance of unrealized gains on securities 160,397 77,766 Current period change in unrealized gains on securities 37,211 37,211 82,631 82,631 ---------------------------------------------------- Ending balance of unrealized gains on securities 197,608 160,397 -------- -------- Current period change in accumulated other comprehensive income 33,199 74,907 --------- --------- Ending balance of accumulated other comprehensive income $ 185,518 $ 152,319 ========= =========
F-16 9. EMPLOYEE BENEFIT PLANS The Company adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," in 1998 which revises employers' disclosures with respect to pension and other postretirement benefit plans. The Company maintains both a qualified and non-qualified defined benefit pension plan for its U.S. employees. Generally, the Company computes the benefits based on average earnings over a period prescribed by the plans and credited length of service. The Company has not been required to fund contributions to its qualified defined benefit pension plan for the years ended December 31, 1998 and 1997 because the Company's qualified plan was subject to the full funding limitation under the Internal Revenue Service guidelines. The Company's non-qualified defined benefit pension plan, established in 1998, provides compensating pension benefits for participants whose benefits have been curtailed under the qualified plan due to Internal Revenue Code limitations. Pension expense for the Company's plans for the years ended December 31, 1998, 1997 and 1996 were $1,565, $770 and $901, respectively. The following table summarizes the status of these plans: Years Ended December 31, ------------------------ 1998 1997 ------------------------ Change in projected benefit obligation: Benefit obligation at beginning of year $ 17,115 $ 15,131 Service cost 1,089 1,063 Interest cost 1,178 1,030 Change in accumulated benefit obligation 954 - Affect of future salary increases 1,286 - Actuarial gain (228) (900) Change in discount rate 869 834 Benefits paid (168) (43) ----------------------- Benefit obligation at end of year 22,095 17,115 ----------------------- Change in plan assets: Fair value of plan assets at beginning of year 17,389 14,610 Actual return on plan assets 911 2,822 Benefits paid (168) (43) ----------------------- Fair value of plan assets at end of year 18,132 17,389 ----------------------- Funded status (3,963) 274 Unrecognized prior service cost 1,328 - Unrecognized net loss or (gain) (913) (2,257) ----------------------- (Accrued) pension cost $ (3,548) $(1,983) =======================
Plan assets are comprised of shares in investment trusts with approximately 64% and 36% of the underlying assets consisting of equity securities and fixed maturities, respectively. Net periodic pension cost included the following components: Years Ended December 31, -------------------------------------- 1998 1997 1996 -------------------------------------- Service cost $ 2,001 $ 1,063 $ 1,102 Interest cost 1,178 1,031 948 Actual return on assets (1,560) (2,824) (1,841) Amortization of net gain from earlier periods (54) (10) - Net asset gain during period deferred for later recognition - 1,510 692 -------------------------------------- Net periodic pension cost $ 1,565 $ 770 $ 901 ======================================
The weighted average discount rates used to determine the actuarial present value of the projected benefit obligation for 1998, 1997 and 1996 are 6.75%, 7.00% and 7.25%, respectively. The rate of compensation increase used to determine the actuarial present value of the projected benefit obligation for 1998, 1997 and 1996 is 4.50%. The expected long-term rate of return on plan assets for 1998, 1997 and 1996 is 9.0%. F-17 The Company also maintains both qualified and non-qualified defined contribution plans ("Savings Plan" and "Non-Qualified Savings Plan", respectively) covering U.S. employees. Under the plans, the Company contributes up to a maximum 3% of the participants compensation based on the contribution percentage of the employee. The Non-Qualified Savings Plan provides compensating savings plan benefits for participants whose benefits have been curtailed under the Savings Plan due to Internal Revenue Code limitations. The Company's incurred expenses related to these plans are $488, $489 and $466 for 1998, 1997 and 1996, respectively. In addition, the Company maintains several defined contribution pension plans covering non-U.S. employees. Each branch office (Canada, London, Belgium, Hong Kong and Singapore) maintains a separate plan for the non-U.S. employees working in that location. The Company contributes various amounts based on salary, age, and/or years of service. The contributions as a percentage of salary for the branch offices range from 2% to 12%. The contributions are generally used to purchase pension benefits from local insurance providers. The Company's incurred expenses related to these plans are $348, $650 and $414 for 1998, 1997 and 1996, respectively. During 1998, the Company adopted a Senior Executive Change of Control Plan and entered into a change of control agreement with the Chief Executive Officer, which will provide benefits to certain officers in the event of a change in control of the Company. 10. DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION A. DIVIDEND RESTRICTIONS Delaware law provides that an insurance company which is either an insurance holding company or a member of an insurance holding system and is domiciled in the state shall not pay dividends without giving prior notice to the Insurance Commissioner of Delaware and may not pay dividends without the approval of the Insurance Commissioner if the value of the proposed dividend, together with all other dividends and distributions made in the preceding twelve months, exceeds the greater of (1) 10% of statutory surplus or (2) net income, not including realized capital gains, each as reported in the prior year's statutory annual statement. In addition, no dividend may be paid in excess of unassigned earned surplus. At December 31, 1998, Everest Re had $179,176 available for payment of dividends in 1999 without prior regulatory approval. B. STATUTORY FINANCIAL INFORMATION Everest Re prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by the National Association of Insurance Commissioners ("NAIC") and the Delaware Insurance Department. Prescribed statutory accounting practices are set forth in a variety of publications of the NAIC, as well as state laws, regulations, and general administrative rules. The capital and statutory surplus of Everest Re was $1,059,429 and $908,766 at December 31, 1998 and 1997, respectively. The statutory net income of Everest Re was $176,672, $193,057 and $88,517 for the years ended December 31, 1998, 1997 and 1996, respectively. 11. CONTINGENCIES Everest Re continues to receive claims under expired contracts which assert alleged injuries and/or damages relating to or resulting from toxic torts, toxic waste and other hazardous substances, such as asbestos. Everest Re's asbestos claims typically involve liability or potential liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. Everest Re's environmental claims typically involve potential liability for (i) the mitigation or remediation of environmental contamination or (ii) bodily injury or property damages caused by the release of hazardous substances into the land, air or water. Everest Re's reserves include an estimate of Everest Re's ultimate liability for asbestos and environmental claims for which ultimate value cannot be estimated using traditional reserving techniques. There are significant uncertainties in estimating the amount of Everest Re's potential losses from asbestos and environmental claims. Among the complications are: (i) potentially long waiting periods between exposure and manifestation of any bodily injury or property damage; (ii) difficulty in identifying sources of asbestos or environmental contamination; (iii) difficulty in properly allocating responsibility and/or liability for asbestos or environmental damage; (iv) changes in underlying laws and judicial interpretation of those laws; (v) potential for an asbestos or environmental claim to involve many insurance providers over many policy periods; (vi) long reporting delays, both from insureds to insurance companies and ceding companies to reinsurers; (vii) historical data concerning asbestos and environmental losses, which is more limited than historical F-18 information on other types of casualty claims; (viii) questions concerning interpretation and application of insurance and reinsurance coverage; and (ix) uncertainty regarding the number and identity of insureds with potential asbestos or environmental exposure. Although these complications have become less severe in recent years, management believes that these factors continue to render reserves for asbestos and environmental losses significantly less subject to traditional actuarial methods than are reserves on other types of losses. Given these uncertainties, management believes that no meaningful range for such ultimate losses can be established. Everest Re establishes reserves to the extent that, in the judgment of management, the facts and prevailing law reflect an exposure for Everest Re or its ceding company. Due to the uncertainties discussed above, the ultimate losses may vary materially from current loss reserves and, if coverage under the Stop Loss Agreement is exhausted, could have a material adverse effect on the Company's future financial condition, results of operations and cash flows (see Note 7). The following table shows the development of prior year asbestos and environmental reserves on both a gross and net of retrocessional basis for the years ended: 1998 1997 1996 ----------------------------------------- Gross basis Beginning of reserves $ 446,132 $ 423,336 $ 428,495 Incurred losses 249,597 83,724 30,028 Paid losses (34,936) (60,928) (35,187) ----------------------------------------- End of period reserves $ 660,793 $ 446,132 $ 423,336 ========================================= Net basis Beginning of reserves $ 212,376 $ 199,557 $ 185,981 Incurred losses (1) 15,385 3,490 - Paid losses (2) 35,781 9,329 13,576 ----------------------------------------- End of period reserves $ 263,542 $ 212,376 $ 199,557 =========================================
- --------------------- (1) Net of $138,467, $41,178 and $24,196 ceded in 1998, 1997 and 1996, respectively, under the incurred loss reimbursement feature of the Stop Loss Agreement. (2) Net of $39,667, $22,610 and $34,451 ceded paid losses in 1998, 1997 and 1996, respectively, under the Stop Loss Agreement. At December 31, 1998, the gross reserves for asbestos and environmental losses were comprised of $137,560 representing case reserves reported by ceding companies, $67,863 representing additional case reserves established by Everest Re on assumed reinsurance claims, $40,905 representing case reserves established by Everest Re on direct excess insurance claims and $414,465 representing IBNR reserves. To the extent loss reserves for claims incurred on June 30, 1995 (December 31, 1994 for catastrophe losses) or prior on assumed reinsurance needed to be increased, and were not ceded to unaffiliated reinsurers under existing reinsurance agreements, Everest Re would be entitled to certain reimbursements under the Stop Loss Agreement (see Note 7). To the extent loss reserves on direct excess insurance policies needed to be increased and were not ceded to unaffiliated reinsurers under existing reinsurance agreements, Everest Re would be entitled to 100% protection under a 100% quota share retrocession entered into with Gibraltar in 1986. While there can be no assurance that reserves for and losses from these claims would not increase in the future, management believes that Everest Re's existing reserves and ceded reinsurance arrangements and reimbursements available under the Stop Loss Agreement lessen the probability that such increases, if any, would have a material effect on Everest Re's financial condition, results of operations or cash flows. Everest Re is also named in various legal proceedings incidental to its normal business activities. In the opinion of Everest Re, none of these proceedings would have a material adverse effect upon the financial condition, results of operations or cash flows of Everest Re. The Prudential sells annuities which are purchased by property and casualty insurance companies to settle certain types of claim liabilities. In 1993 and prior, Everest Re, for a fee, accepted the claim payment obligation of the property and casualty insurer, and, concurrently, became the owner of the annuity or assignee of the annuity proceeds. In these circumstances, Everest Re would be liable if The Prudential were unable to make the annuity payments. The estimated cost to replace all such annuities for which Everest Re was contingently liable at December 31, 1998 and 1997 was $143,204 and $140,478, respectively. F-19 Everest Re has purchased annuities from an unaffiliated life insurance company to settle certain claim liabilities of Everest Re. Should the life insurance company become unable to make the annuity payments, Everest Re would be liable. The estimated cost to replace such annuities at December 31, 1998 and 1997 was $10,790 and $9,968, respectively. 12. STOCK BASED COMPENSATION PLANS The Company has in place its 1995 Stock Incentive Plan for key employees (the `1995 Employee Plan") and its 1995 Stock Option Plan for Non-Employee Directors (the "1995 Director Plan") and applies APB Opinion 25 and related interpretations in accounting for these plans. Accordingly, no compensation expense has been recognized in the accompanying financial statements in respect of stock options granted under these plans. Under the 1995 Employee Plan, a total of 3,949,000 shares of common stock have been authorized to be granted as stock options, stock awards or restricted stock awards to officers and key employees of the Company. At December 31, 1998, there were 1,800,051 remaining shares available to be granted. Under the 1995 Director Plan, a total of 50,000 shares of common stock have been authorized to be granted as stock options to non-employee directors of the Company. At December 31, 1998, there were 38,145 remaining shares available to be granted. Options granted under the 1995 Employee Plan vest at 20% per year over five years and options granted under the 1995 Director Plan vest at 50% per year over two years. All options are exercisable at fair market value of the stock at the date of grant and expire ten years after the date of grant. Restricted stock granted under the 1995 Employee Plan vests, beginning one year after the date of grant, in equal annual installments over five years. A summary of the status of the Company's stock options as of December 31, 1998, 1997 and 1996 and changes during the years then ended is presented below: 1998 1997 1996 ---------------------------------------------------------------------------------------- Weighted- Weighted- Weighted- Average Average Average Shares Exercise Price Shares Exercise Price Shares Exercise Price ---------------------------------------------------------------------------------------- Outstanding, beginning of year 999,020 $ 26.39 732,570 $ 19.72 459,700 $ 16.93 Granted 429,750 37.57 339,250 39.13 286,270 24.10 Exercised 34,436 17.74 11,100 16.75 3,800 16.75 Forfeited 87,235 25.58 61,700 19.00 9,600 18.25 --------- --------- --------- Outstanding, end of year 1,307,099 $ 30.35 999,020 $ 26.39 $ 19.72 ========= ========= Options exercisable at year-end 365,189 215,313 91,496 ========= ========= ========= Weighted-average fair value of options granted during the year $ 17.21 $ 18.37 $ 11.55 ============== ============== ==============
The following table summarizes information about stock options outstanding at December 31, 1998: Options Options Outstanding Exercisable -------------------------------------------------------------------------------------- Weighted- Number Average Weighted- Number Weighted- Range of Outstanding Remaining Average Exercisable Average Exercise Prices at 12/31/98 Contractual Life Exercise Price at 12/31/98 Exercise Price - --------------------------------------------------------------------------------------------------------------- $16.75 to $20.94 324,600 6.5 $ 17.01 196,400 $ 17.01 $22.56 to $26.63 242,399 7.6 24.13 104,939 24.07 $33.00 to $39.16 740,100 9.3 38.23 63,850 39.13 ----------- ------------------------------------------------- 1,307,099 8.3 $ 30.35 365,189 $ 22.90 =========== =================================================
Since its 1995 initial public offering, the Company has issued to certain key employees of the Company 58,100 restricted shares of stock. Upon issuance of restricted shares, unearned compensation is charged to stockholders' equity for the cost of the restricted stock and is amortized over the vesting period. The amount of earned compensation recognized as expense with respect to restricted stock awards was $99, $203 and $318 for 1998, 1997 and 1996, respectively. In 1998, 10,460 restricted shares were forfeited, while 6,400 restricted shares were forfeited in 1997. The F-20 Company acquired 1,680 shares and 30,887 shares of its common stock at a cost of $58 and $846 in 1998 and 1997 respectively, and, pursuant to the 1995 Employee Plan, 306,396 shares of the common stock at a cost of $7,220 in 1996, primarily from the Chief Executive Officer, to fund required withholding taxes arising from a prior period stock award. Also, the Company recorded contributions to paid in capital representing the tax benefits attributable to the difference between the amount of compensation expense deductible for tax purposes with respect to the stock awards and the amount of such compensation expense reflected in the Company's financial statements. Had the compensation cost for the Company's stock based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 1998 1997 1996 ------------------------------------- Net Income As reported $ 165,197 $ 154,955 $ 112,027 Pro forma $ 162,768 $ 153,492 $ 110,850 Earnings per share - basic As reported $ 3.28 $ 3.07 $ 2.22 Pro forma $ 3.23 $ 3.04 $ 2.19 Earnings per share - diluted As reported $ 3.26 $ 3.05 $ 2.21 Pro forma $ 3.21 $ 3.02 $ 2.19
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yields ranging from 0.5% to 0.7%, (ii) expected volatility ranging from 32.86% to 34.79%, (iii) risk-free interest rates ranging from a low of 4.71% to a high of 7.01%, and (iv) expected life of 7.5 years. In addition to the 1995 Employee Plan and 1995 Director Plan, the Company transferred 4,537 and 3,685 shares of treasury stock having an aggregate value of $179 and $131 to its non-employee directors as compensation for their service as directors in 1998 and 1997, respectively. 13. GEOGRAPHIC INFORMATION Everest Re's principal business is reinsuring property and casualty risks of domestic and foreign insurance companies. The following table provides summary financial information by geographic region for the periods disclosed. Years Ended December 31, --------------------------------------------- 1998 1997 1996 --------------------------------------------- Premiums earned: Domestic $ 737,384 $ 696,645 $ 655,097 International 330,626 353,202 318,514 --------------------------------------------- Total premiums earned $ 1,068,010 $ 1,049,847 $ 973,611 ============================================= Net income (loss): Domestic $ 170,434 $ 115,728 $ 70,978 International (5,237) 39,227 41,049 --------------------------------------------- Total net income $ 165,197 $ 154,955 $ 112,027 ============================================= December 31, ---------------------------- 1998 1997 ---------------------------- Total identifiable assets: Domestic $ 5,173,103 $ 4,714,134 International 823,625 823,886 ---------------------------- Total identifiable assets $ 5,996,728 $ 5,538,020 ============================
The basis for "International" is the geographic area of the Company's internal marketing units. Approximately 17.0%, 19.3% and 15.9% of the Company's gross premiums written in 1998, 1997 and 1996, respectively, were sourced through one intermediary. F-21 14. SUBSEQUENT EVENTS On February 9, 1999 and March 11, 1999, Gibraltar disputed $39,714 and $154,700 with respect to cessions under the Direct Excess Retrocession and the Stop Loss Agreement, respectively. Management is pursuing contractual dispute resolution mechanisms with respect to these disputes. (See Note 7) 15. UNAUDITED QUARTERLY FINANCIAL DATA Summarized quarterly financial data were as follows: 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter --------------------------------------------------- 1998 OPERATING DATA: Gross written premium $ 253,011 $ 267,452 $ 272,408 $ 253,019 Net written premium 242,694 255,599 257,985 260,321 Earned premium 241,336 264,726 265,242 296,707 Net investment income 60,013 62,525 60,667 61,704 Net realized capital gain (loss) (17) 2,523 989 (4,260) Incurred losses and LAE 178,592 195,552 189,905 214,355 Underwriting expenses 72,261 77,861 83,830 90,168 Underwriting loss (9,517) (8,687) (8,493) (7,816) Net income (loss) $ 39,801 $ 43,544 $ 42,125 $ 39,728 =================================================== Weighted average basic shares outstanding (000's) 50,481 50,480 50,465 50,075 Net income per common share - basic $ 0.79 $ 0.86 $ 0.83 $ 0.79 Weighted average diluted shares outstanding (000's) 50,800 50,799 50,748 50,317 Net income per common share - diluted $ 0.78 $ 0.86 $ 0.83 $ 0.79 1997 OPERATING DATA: Gross written premium $ 246,011 $ 253,233 $ 285,796 $ 289,928 Net written premium 233,811 246,072 275,915 275,344 Earned premium 230,443 247,515 271,520 300,368 Net investment income 54,042 57,368 57,917 59,219 Net realized capital gain (loss) (199) 13,410 2,722 (17) Incurred losses and LAE 166,841 180,191 204,234 214,155 Underwriting expenses 74,754 78,237 76,677 96,799 Underwriting loss (11,152) (10,913) (9,391) (10,586) Net income (loss) $ 34,464 $ 44,338 $ 38,432 $ 37,721 =================================================== Weighted average basic shares outstanding (000's) 50,490 50,469 50,466 50,479 Net income per common share - basic $ 0.68 $ 0.88 $ 0.76 $ 0.75 Weighted average diluted shares outstanding (000's) 50,725 50,738 50,791 50,807 Net income per common share - diluted $ 0.68 $ 0.87 $ 0.76 $ 0.74
F-22
EVEREST REINSURANCE HOLDINGS, INC. SCHEDULE I - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1998 COLUMN A COLUMN B COLUMN C COLUMN D - -------------------------------------------------------------------------------- Amount Shown in Market Balance (Dollars in thousands) Cost Value Sheet -------------------------------------------- Fixed maturities-available for sale Bonds: U.S. Government and government agencies $ 151,976 $ 159,616 $ 159,616 State, municipalities and political subdivisions 1,982,490 2,116,431 2,116,431 Foreign government securities 241,310 271,054 271,054 Foreign corporate securities 246,540 263,874 263,874 Public Utilities 63,120 67,490 67,490 All other corporate bonds 766,800 802,739 802,739 Mortgage pass-through securities 388,843 408,946 408,946 Redeemable preferred stock 9,972 10,425 10,425 -------------------------------------------- Total fixed maturities-available for sale 3,851,051 4,100,575 4,100,575 Equity securities 91,787 146,274 146,274 Short-term investments 34,846 34,846 34,846 Other invested assets 4,736 4,736 4,736 Cash 39,326 39,326 39,326 -------------------------------------------- Total investments and cash $ 4,021,746 $ 4,325,757 $ 4,325,757 ============================================
S-1
EVEREST REINSURANCE HOLDINGS, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT CONDENSED BALANCE SHEET December 31, -------------------------------------- (Dollars in thousands, except par value per share) 1998 1997 -------------------------------------- ASSETS Cash - - Investment in subsidiaries, at equity in the underlying net assets $ 1,460,084 $ 1,301,913 Receivable from affliate 18,884 5,731 Current tax receivable - - Deferred tax asset 1,904 1,688 -------------------------------------- Total assets $ 1,480,872 $ 1,309,332 ====================================== LIABILITIES Other liabilities $ 1,668 $ 1,849 -------------------------------------- STOCKHOLDERS' EQUITY Preferred stock, par value: $0.01; 50 million shares authorized; no shares issued and outstanding (Includes 0.2 million shares of Series A Junior Preferred Stock) - - Common stock, par value: $0.01; 200 million shares authorized; 50.9 million shares issued in 1998 and 50.8 million shares issued in 1997 509 508 Paid-in capital 390,559 389,876 Unearned compensation (240) (514) Accumulated other comprehensive income, net of deferred taxes ($99.8 million in 1998 and $81.9 million in 1997) 185,518 152,319 Treasury stock, at cost; 0.9 million shares in 1998 and 0.3 million shares in 1997 (25,642) (8,086) Retained earnings 928,500 773,380 -------------------------------------- Total stockholders' equity 1,479,204 1,307,483 -------------------------------------- Total liabilities and stockholders' equity $ 1,480,872 $ 1,309,332 ======================================
See notes to consolidated financial statements. S-2
EVEREST REINSURANCE HOLDINGS, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT CONDENSED STATEMENT OF OPERATIONS For Years Ended December 31, ------------------------------------------------- (Dollars in thousands) 1998 1997 1996 ------------------------------------------------- REVENUES Dividends received from subsidiary $ 43,125 $ 9,270 $ 17,924 Net Investment Income 521 241 55 Equity in undistributed net income of subsidiary 122,197 146,970 95,242 ------------------------------------------------- Total revenues 165,843 156,481 113,221 ------------------------------------------------- EXPENSES Other expenses 862 1,184 1,807 ------------------------------------------------- Income before taxes 164,981 155,297 111,414 Income tax (benefit) (216) 342 (613) ------------------------------------------------- Net income $ 165,197 $ 154,955 $ 112,027 =================================================
See notes to consolidated financial statements. S-3
EVEREST REINSURANCE HOLDINGS, INC. SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT CONDENSED STATEMENT OF CASH FLOWS For Years Ended December 31, --------------------------------------------- (Dollars in thousands) 1998 1997 1996 --------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 165,197 $ 154,955 $ 112,027 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed (earnings) loss of subsidiaries (122,197) (146,970) (95,242) (Decrease) in other liabilities (181) (296) (364) Decrease (increase) in current tax receivable - 2,918 (972) Decrease (increase) in deferred tax asset (216) - - (Increase) in receivable from affliates (13,154) (2,300) (3,431) Non-cash compensation 273 203 407 --------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 29,722 8,510 12,425 CASH FLOWS FROM INVESTING ACTIVITIES Additional investment in subsidiaries (2,772) (248) - CASH FLOWS FROM FINANCING ACTIVITIES Acquisition of treasury stock net of reissuances (17,498) (822) (7,220) Common stock issued during the period 625 636 420 Dividends paid to stockholders (10,077) (8,076) (6,067) --------------------------------------------- Net cash (used in) financing activities (26,950) (8,262) (12,867) Net (decrease) in cash - - (442) Cash, begining of period - - 442 --------------------------------------------- Cash, end of period $ - $ - $ - ============================================= SUPPLEMENTAL CASH FLOW INFORMATION NON-CASH OPERATING TRANSACTION: Dividends received from subsidiary in the form of forgiveness of liabilities $ 967 $ 1,536 $ 1,767
See notes to consolidated financial statements. S-4
EVEREST REINSURANCE HOLDINGS, INC. SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION COLUMN A COLUMN B COLUMN C COLUMN D COLUMN F COLUMN G COLUMN H COLUMN I COLUMN J COLUMN K - ------------------------------------------------------------------------------------------------------------------------------------ RESERVE FOR INCURRED AMORTIZATION DEFERRED LOSSES AND UNEARNED NET LOSS AND LOSS OF DEFERRED OTHER GEOGRAPHIC ACQUISITION LOSS ADJUSTMENT PREMIUM EARNED INVESTMENT ADJUSTMENT ACQUISITION OPERATING WRITTEN AREA COSTS EXPENSES RESERVES PREMIUM INCOME EXPENSES COSTS EXPENSES PREMIUM - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 1998 Domestic $ 50,476 $3,242,579 $ 217,982 $ 737,384 $ 194,607 $ 497,113 $ 182,918 $ 38,287 $ 713,022 International 20,277 557,462 66,658 330,626 50,302 281,291 86,242 16,673 303,577 ------------------------------------------------------------------------------------------------------------------ Total $ 70,753 $3,800,041 $ 284,640 $1,068,010 $ 244,909 $ 778,404 $ 269,160 $ 54,960 $1,016,599 ================================================================================================================== December 31, 1997 Domestic $ 56,747 $2,914,616 $ 244,335 $ 696,645 $ 175,053 $ 514,021 $ 185,885 $ 38,267 $ 695,211 International 25,585 523,202 93,048 353,202 53,493 251,400 84,720 17,596 335,931 ------------------------------------------------------------------------------------------------------------------ Total $ 82,332 $3,437,818 $ 337,383 $1,049,847 $ 228,546 $ 765,421 $ 270,605 $ 55,863 $1,031,142 ================================================================================================================== December 31, 1996 Domestic $ 655,097 $ 143,301 $ 508,247 $ 175,241 $ 43,738 $ 694,053 International 318,514 48,600 207,786 77,687 12,802 336,481 ------------------------------------------------------------------------ Total $ 973,611 $ 191,901 $ 716,033 $ 252,928 $ 56,540 $1,030,534 ========================================================================
S-5
EVEREST REINSURANCE HOLDINGS, INC. SCHEDULE IV - REINSURANCE Column A Column B Column C Column D Column E Column F - -------------------------------------------------------------------------------------------------------- GROSS CEDED TO ASSUMED FROM NET ASSUMED TO (Dollars in thousands) AMOUNT OTHER COMPANIES OTHER COMPANIES AMOUNT NET -------------------------------------------------------------------------------- DECEMBER 31, 1998 Total property and liability insurance earned premium $ 75,017 $ 29,618 $ 1,022,611 $ 1,068,010 95.7% DECEMBER 31, 1997 Total property and liability insurance earned premium $ 77,784 $ 40,105 $ 1,012,168 $ 1,049,847 96.4% DECEMBER 31, 1996 Total property and liability insurance earned premium $ 37,963 $ 10,050 $ 945,698 $ 973,611 97.1%
S-6 INDEX TO EXHIBITS EXHIBIT NO. - ----------- 3.1 Certificate of Incorporation of Everest Reinsurance Holdings, Inc., incorporated herein by reference to Exhibit 4.1 to the Registration Statement on Form S-8 (No. 333-05771) 3.2 By-Laws (as amended and restated) of Everest Reinsurance Holdings, Inc., incorporated herein by reference to Exhibit 3.2 to the Annual Report on Form 10-K for the year ended December 31, 1997 (the "1997 10-K") 4.1 Rights Agreement, dated as of September 24, 1998, between Everest Reinsurance Holdings, Inc. and First Chicago Trust Company of New York, as Rights Agent. The Rights Agreement includes as exhibits thereto the form of Certificate of Designation specifying the terms of the Preferred Shares and the form of Right Certificate. Pursuant to the Rights Agreement, printed Right Certificates will not be mailed until as soon as practicable after the earlier of (i) the tenth day after public announcement that a person or group has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of Common Stock or (ii) the tenth business day after the commencement of, or the announcement of an intention to commence, a tender or exchange offer the consummation of which would result in the beneficial ownership by a person or group of 15% or more of the outstanding shares of Common Stock. The Rights Agreement is incorporated herein by reference to Exhibit 4.1 to the Form 8-K filed on September 28, 1998 *10.1 Everest Reinsurance Holdings, Inc. Annual Incentive Plan effective January 1, 1999, filed herewith 10.2 Stop Loss Agreement entered into between Everest Reinsurance Company and Gibraltar Casualty Company, incorporated herein by reference to Exhibit 10.6 to the Registration Statement on Form S-1 (No. 33-71652) 10.3 Everest Reinsurance Holdings, Inc. Amended 1995 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.3 to the Annual Report on Form 10-K for the year ended December 31, 1995 (the "1995 10-K") *10.4 Everest Reinsurance Holdings, Inc. Amended Annual Incentive Plan, incorporated herein by reference to Exhibit 10.4 to the 1995 10-K 10.5 Sublease, effective as of February 1, 1997 between The Prudential Insurance Company of America and Everest Reinsurance Company, incorporated herein by reference to Exhibit 10.5 to the 1996 10-K *10.6 Everest Reinsurance Holdings, Inc. 1995 Stock Option Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 4.3 to the Registration Statement on Form S-8 (No. 333-05771) *10.7 Amended and Restated Employment Agreement between Everest Reinsurance Company and Joseph V. Taranto, incorporated herein by reference to Exhibit 10.50 to the Registration Statement on Form S-1 (No. 33-71652) *10.8 Resolution adopted by the Compensation Committee of Everest Reinsurance Holdings, Inc. on February 24, 1997 establishing a Chief Executive Officer's Bonus Plan incorporated herein by reference to Exhibit 10.8 to the 1997 10-K 10.9 Standby Capital Contribution Agreement between Everest Reinsurance Holdings, Inc. and Everest Reinsurance Company, incorporated herein by reference to Exhibit 10.69 to the Registration Statement on Form S-1 (No. 33-71652) 10.10 Indemnification Agreement between PRUCO, Inc. and Everest Reinsurance Holdings, Inc., incorporated herein by reference to Exhibit 10.70 to the Registration Statement on Form S-1 (No. 33-71652) 10.11 Guarantee made by The Prudential Insurance Company of America in favor of Everest Reinsurance Company, incorporated herein by reference to Exhibit 10.71 to the Registration Statement on Form S-1 (No. 33-71652) 10.12 Guarantee made by The Prudential Insurance Company of America in favor of Everest Reinsurance Holdings, Inc., incorporated herein by reference to Exhibit 10.72 to the Registration Statement on Form S-1 (No. 33-71652) 10.13 1995 Service Contract between Everest Reinsurance Company and Gibraltar Casualty Company, incorporated herein by reference to Exhibit 10.73 to the Registration Statement on Form S-1 (No. 33-71652) E-1 10.14 Separation Agreement among The Prudential Insurance Company of America, Gibraltar Casualty Company, Everest Reinsurance Company, PRUCO, Inc., and Everest Reinsurance Holdings, Inc., incorporated herein by reference to Exhibit 10.2 to the Registration Statement on Form S-1 (No. 33-71652) *10.15 Form of Non-Qualified Stock Option Award Agreement to be entered into between Everest Reinsurance Holdings, Inc. and participants in the 1995 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.15 to the 1995 10-K *10.16 Form of Restricted Stock Agreement to be entered into between Everest Reinsurance Holdings, Inc. and participants in the 1995 Stock Incentive Plan, incorporated herein by reference to Exhibit 10.16 to the 1995 10-K *10.17 Form of Stock Option Agreement (Version 1) to be entered into between Everest Reinsurance Holdings, Inc. and participants in the 1995 Stock Option Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 10.17 to the 1995 10-K *10.18 Form of Stock Option Agreement (Version 2) to be entered into between Everest Reinsurance Holdings, Inc. and participants in the 1995 Stock Option Plan for Non-Employee Directors, incorporated herein by reference to Exhibit 10.18 to the 1995 10-K 10.19 Credit agreement between Everest Reinsurance Holdings, Inc. and First Union National Bank dated June 16, 1997 providing for a $50 million revolving credit facility, incorporated herein by reference to Exhibit 10.19 to the Form 8-K filed on June 24, 1997 *10.20 Deferred Compensation Plan, as amended, for certain United States employees of Everest Reinsurance Holdings, Inc. and its participating subsidiaries filed herewith. *10.21 Employment Agreement with Joseph V. Taranto executed on July 15, 1998, incorporated herein by reference to Exhibit 10.21 to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (the "second quarter 1998 10-Q") *10.22 Change of Control Agreement with Joseph V. Taranto effective July 15, 1998, incorporated herein by reference to Exhibit 10.22 to the second quarter 1998 10-Q 10.23 Credit Line Extension dated May 20, 1998 between Everest Reinsurance Holdings, Inc. and First Union National Bank, incorporated herein by reference to Exhibit 10.23 to the second quarter 1998 10-Q *10.24 Senior Executive Change of Control Plan, incorporated herein by reference to Exhibit 10.24 to the Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 11.1 Statement regarding computation of per share earnings filed herewith 21.1 Subsidiaries of the registrant filed herewith 23.1 Consent of PricewaterhouseCoopers LLP filed herewith 27.1 Financial Data Schedule filed herewith - -------------------------- * Management contract or compensatory plan or arrangement. E-2 EX-10.1 2 ANNUAL INCENTIVE PLAN EXHIBIT 10.1 ADOPTED BY BOARD OF DIRECTORS DECEMBER 10, 1998 (EFFECTIVE JANUARY 1, 1999) EVEREST REINSURANCE HOLDINGS, INC. ANNUAL INCENTIVE PLAN 1. PURPOSE ------- The purpose of the Everest Reinsurance Holdings, Inc. Annual Incentive Plan (the "Plan") is to provide incentive for employees who are in a position to contribute materially to the success of the Company and its Subsidiaries; to reward their accomplishments; to motivate future accomplishments; and to aid in attracting and retaining employees of the caliber necessary for the continued success of the Company and its Subsidiaries. 2. DEFINITIONS ----------- The following terms as used herein shall have the meaning specified: (a) Amount Available" means the maximum aggregate amount that may be awarded for any year as determined in accordance with paragraph 3. (b) "Award" means an incentive bonus paid pursuant to the Plan. (c) "Board" means the Board of Directors of the Company. (d) "Cause" means (i) a felony conviction of a Participant; (ii) the commission by a Participant of an act of fraud or embezzlement against the Company and/or a Subsidiary; (iii) willful misconduct or gross negligence materially detrimental to the Company and/or a Subsidiary; (iv) the Participant's continued failure to implement reasonable requests or directions arising from actions of the Board after thirty (30) days written notice to the Participant; (v) the Participant's wrongful dissemination or use of confidential or proprietary information; (vi) the intentional and habitual neglect by the Participant of his or her duties to the Company and/or a Subsidiary; (vii) any other reasons consistent with the Company's and/or a Subsidiary's policies and procedures regarding dismissals as they are adopted and implemented from time to time. (e) "Committee" means the Compensation Committee of the Board. (f) "Company" means Everest Reinsurance Holdings, Inc. or any successor corporation. (g) "Employee" means employees of the Company and its Subsidiaries. (h) "Participant" means an Employee selected by the Committee to participate in the Plan. If an Employee is governed by an individual employment agreement, such an Employee may be a Participant in the Plan to the extent the terms of such agreement do not supersede this Plan. (i) "Performance Goals" means any financial, statistical or other measures selected by the Committee to measure Company and/or Subsidiary performance. (j) "Subsidiary" means any corporation in which the Company, directly or indirectly, controls 50% or more of the total combined voting power of all classes of such corporation's stock. 3. AWARDS ------ (a) Persons eligible for Awards shall consist of Employees who hold positions of significant responsibility and/or whose performance or potential contribution, in the judgment of the Committee, will contribute materially to the success of the Company and/or its Subsidiaries. (b) The Committee shall have absolute discretion to determine the Employees who are eligible to receive Awards under the Plan for any year and to determine the amount of such Awards based on such criteria and factors as the Committee in its sole discretion may determine. Recommendations as to the Employees who are to receive Awards under the Plan for any year and the amount of such Awards shall be made to the Committee by the Chief Executive Officer of the Company. The fact that an Employee is eligible for an Award shall not mean, however, that such Employee will necessarily receive or be entitled to receive an Award. The fact that an Employee received an Award in any given year does not mean that the Employee will receive or be entitled to receive an Award in any subsequent year. (c) As to any year, no Awards may be paid except out of the Amount Available for such year. The Amount Available will be determined annually by the Committee based upon Performance Goals established by the Committee within ninety (90) days of the beginning of each year for which the Performance Goals are being established. The Committee shall have the authority at any time to make adjustments to the Performance Goals which the Committee deems necessary or desirable. Nothing contained herein shall require the Committee to establish any Amount Available for any year in which the Committee in its sole discretion determines that no Awards will be made pursuant to this Plan. (d) As soon as practicable following each year while the Plan is in effect, the Committee shall determine the extent to which the Performance Goals for the year were achieved, the Amount Available and the Awards payable to each Participant. Awards will be paid to each Participant in cash following such determination by the Committee and no later than ninety (90) days following the close of the year with respect to which the Awards are made, unless a Participant has elected to defer all or a portion of such payment pursuant to the Company's or a Subsidiary's Deferred Compensation Plan, in which event, payment of the amount deferred will be made in accordance with the terms of the Deferred Compensation Plan. 2 (e) No Award will be paid to any Participant who is not an employee of the Company on the last day of the year, except that if during the last eight (8) months of the year, the Participant retires, dies, or is involuntarily terminated other than for Cause, the Participant or his estate may be awarded a prorated Award as and to the extent determined by the Committee in its sole discretion. If a Participant is on disability for more than four (4) months of the year, the Participant will be entitled to a prorated Award. Participants who resign voluntarily after the end of the year, but before Award payments are actually made, will be eligible for an Award as and to the extent determined by the Committee in its sole discretion. The provisions of this subparagraph are subject to the terms of any written agreement between a Participant and the Company. 4. ADMINISTRATION -------------- (a) The Plan shall be administered by the Committee. The Committee shall have all discretion and authority necessary or appropriate to administer the Plan and to interpret the provisions of the Plan. Any determination, decision or action of the Committee in connection with the construction, interpretation, administration or application of the Plan shall be final, conclusive and binding upon all persons. (b) With the exception of actions and determinations relating to the Chief Executive Officer and the four most highly compensated officers, the Committee may delegate to the officers or employees of the Company and/or a Subsidiary the authority to execute and deliver such instruments and documents, to do all such acts and things, and to take all such other steps deemed necessary, advisable or convenient for the effective administration of the Plan in accordance with its terms and purpose; provided, however, all Awards will be subject to the final approval of the Committee. (c) Neither the Company, its Subsidiaries, nor any member of the Board or of the Committee, nor any other person participating in any determination of any question under the Plan, or in the interpretation, administration or application of the Plan, shall have any liability to any party for any good faith action taken or not taken under the Plan. 5. MISCELLANEOUS ------------- (a) NONASSIGNABILITY. No Award shall be assignable or transferable (including pursuant to a pledge or security interest) other than by will or by laws of descent and distribution. (b) WITHHOLDING TAXES. Whenever payments under the Plan are to be made, the Company and/or the Subsidiary shall withhold therefrom an amount sufficient to satisfy any applicable governmental withholding tax requirements related thereto. (c) AMENDMENT OR TERMINATION OF THE PLAN. The Committee may at any time and without notice to any Employee suspend, discontinue, revise, amend or terminate the Plan. 3 (d) NON-UNIFORM DETERMINATIONS. The Committee's determinations under the Plan need not be uniform and may be made by it selectively among persons who receive, or are eligible to receive, Awards under the Plan, whether or not such persons are similarly situated. Without limiting the generality of the foregoing, the Committee shall be entitled, among other things, to make non-uniform and selective determinations and to establish non-uniform and selective Performance Goals. (e) OTHER PAYMENTS OR AWARDS. Nothing contained in the Plan shall be deemed in any way to limit or restrict the Company, its Subsidiaries, or the Committee from making any award or payment to any person under any other plan, arrangement or understanding, whether now existing or hereafter in effect. (f) PAYMENTS TO OTHER PERSONS. If payments are legally required to be made to any person other than the person to whom any amount is available under the Plan, payments shall be made accordingly. Any such payment shall be a complete discharge of the liability of the Company, its Subsidiaries, and the Committee. (g) UNFUNDED PLAN. A Participant shall have no interest in any fund or specified asset of the Company or a Subsidiary. Nothing contained in the Plan, and no action taken pursuant to its provisions, shall create or be construed to create a trust of any kind, or a fiduciary relationship between the Company or its Subsidiaries and any Participant, beneficiary, legal representative or any other person. To the extent that any person acquires a right to receive payments from the Company and its Subsidiaries under the Plan, such right shall be no greater than the right of an unsecured general creditor of the Company and its Subsidiaries. All payments to be made hereunder shall be paid from the general funds of the Company and its Subsidiaries and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of such amounts. The Plan is not intended to be an employee benefit plan subject to the Employee Retirement Income Security Act of 1974, as amended. (h) NO RIGHT TO EMPLOYMENT. Nothing contained in this Plan shall confer upon any Participant any right to continue in the employ or other service of the Company or a Subsidiary, or constitute any contract or limit in any way the right of the Company or a Subsidiary to change such person's compensation or other benefits or to terminate the employment or other service of such person with or without cause. (i) INVALIDITY. If any term or provision contained herein shall to any extent be invalid or unenforceable, such term or provision shall be reformed so that it is valid, and such invalidity or unenforceability shall not affect any other provision or part hereof. (k) APPLICABLE LAW. The Plan shall be governed by the laws of the State of Delaware as determined without regard to the conflict of law principles thereof. (l) SUCCESSORS. The obligations of the Company and its Subsidiaries under this Plan shall be binding upon any organization that shall succeed to all or substantially all of the Company's or a Subsidiary's assets. 4 EX-10.20 3 DEFERRED COMPENSATION PLAN EXHIBIT 10.20 Adopted: December 10, 1997 Amended: December 10, 1998 - -------------------------------------------------------------------------------- DEFERRED COMPENSATION PLAN FOR UNITED STATES EMPLOYEES - -------------------------------------------------------------------------------- For Certain United States Employees of Everest Reinsurance Holdings, Inc. and its participating subsidiaries - -------------------------------------------------------------------------------- PURPOSE The Deferred Compensation Plan ("Plan") permits deferral of all or part of the cash bonuses awarded under any bonus plan or incentive compensation plan to a specified date or occurrence. ELIGIBLE U.S. Employees of Everest Reinsurance Holdings, PARTICIPANTS Inc. and its participating subsidiaries at Vice President through Chief Executive Officer rank who have a minimum annual salary of $150,000 in 1997 and each year thereafter increasing the minimum salary by 3% of the previous year's threshold amount. ELIGIBLE All cash bonuses awarded to Eligible COMPENSATION Participants of the Plan under any bonus plan or incentive compensation plan may be deferred in whole or in part in accordance with the terms of this Deferred Compensation Plan. PERIOD OF Compensation as described above may be deferred DEFERRAL until a specified date, retirement, January 1 of the year following retirement, or such dates as may apply if death, permanent disability, extreme hardship or termination of employment occurs. ALL PAYMENTS MUST BEGIN NO LATER THAN THE PARTICIPANT'S ATTAINMENT OF AGE 70 1/2. AMOUNT OF The entire incentive payment, or any 10% DEFERRAL multiple thereof, may be deferred. 1 ELECTION 1. The election shall be made by completing a Deferred Compensation Election Form. For bonuses which may be awarded in 1998, this form must be completed and returned by December 31, 1997. For bonuses which may be awarded in 1999 and subsequent years, this form must be completed and returned by December 31st of the year preceding the year in which the services will be performed. If an Election Form is not returned by the deadline for any given year, it will be assumed that there is no desire to participate in the Deferred Compensation Plan for that particular year and no follow-up will be made. 2. When such elections are made, the participant must elect: a. A payment date. Participants may elect a different payment date for each year that they participate in the Plan. The payment date options are: o Retirement, o January 1 of the year following retirement, or o any future specified date. b. A distribution option for payments made at the elected date: o a single sum, o 12 quarterly installments, or o 20 quarterly installments. c. A distribution option in case of termination of employment: o a single sum payable at termination, or o 12 quarterly installments beginning January 1 of the year following termination. 3. The election to defer compensation shall be irrevocable, subject to the hardship provisions as outlined in Payment Section 2 below. 2 DEFERRED 1. A record shall be established for each COMPENSATION eligible individual who elects to defer ACCOUNTS compensation. 2. The amount elected for deferral will be credited on the date the funds would otherwise have been paid. 3. The amounts deferred will accrue interest, beginning with the date of deferral until such time as payment is made. 4. Interest on amounts deferred will be credited at a rate each year equal to the rates established for the fixed rate fund under the Everest Reinsurance Employee Savings Plan (ERESP). PAYMENT 1. Payment will begin on the specified date or the occurrence the participant selected for each year's deferred funds but not later than attainment of age 70 1/2. The form of payment(s) will be made according to the option(s) selected for each year's deferred funds. Regardless of the option elected, payment will be made in a single sum if death occurs. a. Payments are subject to such deductions as may be required in accordance with federal and state tax regulations. b. Should permanent disability occur, payment(s) in the elected form will begin immediately. If monthly installments have already started, payments will continue for the remainder of the elected installment period. Note: The participant shall be deemed to be permanently disabled if he or she would qualify for benefits under the Company's applicable Long-Term Disability Benefits Plan. 3 PAYMENT CONT'D. c. Should death occur when monthly installments have already started, the balance of the participant's deferred compensation account shall immediately become due and payable in one single sum. d. Should termination occur when monthly installments have already started, payments will continue for the remainder of the elected installment period. 2. Only in case of extreme hardship may contributions to the Plan be discontinued and/or payment of the amounts already deferred be advanced. a. If contributions are to be discontinued or payment advanced, the amount involved cannot exceed the funds required to satisfy the financial consequences of the hardship. b. FOR PURPOSES OF THIS PLAN, EXTREME HARDSHIP SHALL MEAN ANY UNFORESEEABLE AND EXTRAORDINARY OCCURRENCE OR EVENT, SUCH AS ILLNESS, ACCIDENT OR FAMILY PROBLEMS RESULTING IN A PARTICIPANT'S FINANCIAL NEED THAT CANNOT BE MET FROM OTHER ASSETS OR NORMAL SOURCES OF INCOME. ASSIGNMENT No rights under the Plan shall be transferable. EMPLOYEE The following items apply to deferred amounts BENEFITS that normally generate benefits: Retirement benefits attributable to compensation that has been deferred shall be provided on a non-qualified basis. 4 BENEFICIARY A participant may designate an individual, a DESIGNATIONS trustee or his or her estate as beneficiary. A participant may change his or her beneficiary at any time. The request must be in writing and in a form approved by the Company. It will take effect only when it is received in the compensation administration area of the corporate Human Resources Department. Any previous beneficiary's interest will end as of the date the request is received even if the participant is not living when the request is received. If a participant fails to designate a beneficiary or if the designated beneficiary does not survive the participant, payment will be made to the participant's estate. ADMINISTRATION The Plan shall be administered by the members of Everest Reinsurance Company's Employee Benefits Committee. This committee will have responsibility for its interpretation and, subject to its provisions, authority to make all determinations necessary or desirable for its operation. TERMINATION The Board of Directors may terminate the Plan at AND AMENDMENT any time so that no further amounts shall be credited to Deferred Compensation Accounts or may, from time to time, amend the Plan, provided, however, no such amendment or termination shall impair any rights which have accrued under the Plan. 5 EX-11.1 4 COMPUTATION OF EARNINGS PER SHARE Exhibit 11.1
EVEREST REINSURANCE HOLDINGS, INC. COMPUTATION OF EARNINGS PER SHARE For The Years Ended December 31, 1998, 1997 and 1996 (Dollars in thousands) Years Ended December 31, ------------------------------------------------ 1998 1997 1996 ------------------------------------------------ Net Income (Numerator) $ 165,197 $ 154,955 $ 112,027 ================================================ Weighted average common and effect of dilutive shares used in the computation of net income per share: Average shares outstanding - basic (denominator) 50,374,329 50,476,330 50,566,566 Effect of dilutive shares: Options outstanding 287,298 285,685 143,855 Options exercised 739 676 167 Options cancelled 2,632 2,476 247 ------------------------------------------------ Average share outstanding - diluted (denominator) 50,664,998 50,765,167 50,710,835 Net Income per common share: Basic $ 3.28 $ 3.07 $ 2.22 Diluted 3.26 3.05 2.21
EX-21.1 5 SUBSIDIARIES OF HOLDINGS EXHIBIT 21.1 SUBSIDIARIES OF HOLDINGS ------------------------ The following is a list of Everest Reinsurance Holdings, Inc. subsidiaries: Everest Reinsurance Company, a Delaware corporation Everest Indemnity Insurance Company, a Delaware corporation Everest Insurance Company of Canada, a Canada corporation Everest National Insurance Company, an Arizona corporation Everest Re Holdings, Ltd., a Bermuda corporation Everest Re Ltd., a United Kingdom corporation Mt. McKinley Managers, L.L.C., a New Jersey limited liability company WorkCare, Inc., a Texas corporation WorkCare Southeast, Inc., an Alabama corporation WorkCare Southeast of Georgia, Inc., a Georgia corporation EX-23.1 6 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Everest Reinsurance Holdings, Inc. on Forms S-8 (File No. 333-1972 and File No. 333-05771) of our report dated February 17, 1999 except for Note 14, as to which the date is March 11, 1999, on our audit of the consolidated financial statements and financial statement schedules of Everest Reinsurance Holdings, Inc. as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998, which report is included in this Annual Report on Form 10-K. PricewaterhouseCoopers LLP New York, New York March 23, 1999 EX-27.1 7 FDS FOR EVEREST REINSURANCE HOLDINGS, INC. 10-K
7 EVEREST REINSURANCE HOLDINGS, INC. FINANCIAL DATA SCHEDULE THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM EVEREST REINSURANCE HOLDINGS, INC.'S FORM 10-K FOR THE PERIOD ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 4,100,575 0 0 146,274 0 0 4,286,431 39,326 981,959 70,753 5,996,728 3,800,041 284,640 0 0 0 0 0 509 1,478,695 5,996,728 1,068,010 244,909 (765) 3,046 778,404 11,410 312,710 212,676 47,479 165,197 0 0 0 165,197 3.28 3.26 2,749,124 752,349 26,055 192,404 450,824 2,884,300 (26,055)
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