-----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, CJuGpDLpftL/x8LSE/fditP48EDDXXUp7+GO5ZR9LHVHuip80l+VDSg9wpZJ/oK0 xcOxcTqzgytiX7MBXzUq2Q== 0000950130-98-001264.txt : 19980317 0000950130-98-001264.hdr.sgml : 19980317 ACCESSION NUMBER: 0000950130-98-001264 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980316 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: TERRA NOVA BERMUDA HOLDING LTD CENTRAL INDEX KEY: 0000935937 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 000000000 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-13834 FILM NUMBER: 98566313 BUSINESS ADDRESS: STREET 1: RICHMOND HOUSE 2ND FLOOR STREET 2: 12 PAR-LA-VILLE ROAD CITY: HAMILTON HM 11 BERMU STATE: D0 BUSINESS PHONE: 4112927731 MAIL ADDRESS: STREET 1: RICHMOND HOUSE 2ND FLOOR STREET 2: 12 PAR-LA-VILLE ROAD CITY: HAMILTON HM 11 BERMU STATE: D0 10-K405 1 FORM 10-K405 FOR THE PERIOD ENDED 12/31/1997 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES 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, 1997 COMMISSION FILE NUMBER 1-13832 ---------------- TERRA NOVA (BERMUDA) HOLDINGS LTD. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) BERMUDA N/A (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANISATION) IDENTIFICATION NO.)
RICHMOND HOUSE, 12 PAR-LA-VILLE ROAD, HAMILTON, HM08, BERMUDA (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) TELEPHONE: (441) 292-7731 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) ---------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- Common shares, par value $5.80 per share New York Stock Exchange 10.75% Senior Notes due 2005 New York Stock Exchange 7.2% Senior Notes due 2007 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. [X] 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 number of registrant's ordinary shares ($5.80 par value) outstanding as of March 16, 1998 was 25,932,204 (includes 474,000 ordinary shares owned by trusts on behalf of the Company). DOCUMENTS INCORPORATED BY REFERENCE Part III of this Form 10-K incorporates by reference information from the registrant's Proxy Statement dated March 30, 1998. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TERRA NOVA (BERMUDA) HOLDINGS LTD. INDEX TO FORM 10-K
PAGE ---- PART I Item 1. Business 3 Item 2. Properties 34 Item 3. Legal Proceedings 34 Item 4. Submission of Matters to a Vote of Security Holders 34 PART II Market for the Registrant's Common Shares and Related Item 5. Shareholder Matters 35 Selected Financial Data for the five years ended December 31, Item 6. 1997 36 Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition 37 Item 8. Financial Statements 43 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 73 PART III Item 10. Directors and Executive Officers of the Registrant 74 Item 11. Executive Compensation 74 Item 12. Security Ownership of Certain Beneficial Owners and Management 74 Item 13. Certain Relationships and Related Transactions 74 PART IV Exhibits, Financial Statement Schedules and Reports on Form 8- Item 14. K 75 Index to Exhibits 86
2 PART I ITEM 1--BUSINESS Unless the context requires otherwise and except as provided below, all references in this Form 10-K to the "Company" refer to Terra Nova (Bermuda) Holdings Ltd., ("Bermuda Holdings") a Bermuda holding corporation, and all of its direct and indirect subsidiaries, including its principal subsidiaries, Terra Nova Insurance Company Limited ("Terra Nova"), Terra Nova (Bermuda) Insurance Company Ltd. ("Terra Nova (Bermuda)"), Compagnie de Reassurance d'lle de France ("Corifrance"), Octavian Syndicate Management Limited ("Octavian") and Terra Nova Capital Limited ("Terra Nova Capital"), through which it conducts substantially all of its operations. OVERVIEW The Company is the holding company for five wholly owned operating entities--Terra Nova in the U.K., Terra Nova (Bermuda), Corifrance in Paris, Terra Nova Capital, the Company's corporate capital provider at Lloyd's and Octavian, which manages the eight Lloyd's syndicates in which the Company has a participation. Through these subsidiaries, the Company writes a diverse property, casualty, marine and aviation insurance and reinsurance business on a world-wide basis. The Company had gross premiums written of $550.2 million in 1997 and shareholders' equity of $481.9 million at December 31, 1997. Terra Nova and the Lloyd's syndicates managed by Octavian are based in the London Market, which is composed of Lloyd's and companies with underwriting offices in proximity to Lloyd's ("London Market companies"). The London Market is one of the world's largest insurance and reinsurance marketplaces and attracts business from clients throughout the world who seek flexible and innovative protection for a wide variety of risks. The Bermuda Market in which Terra Nova (Bermuda) operates is comprised of both captive and independent companies, and in recent years has become one of the world's largest insurance and reinsurance markets in which international business is written. BUSINESS, PROFITABILITY AND FINANCIAL STRENGTH The Company's principal lines of business consist of various classes of non- marine property business, non-marine casualty business, and marine and aviation business written on both an insurance and reinsurance basis, accounting for approximately 43.2%, 23.3% and 33.5%, respectively, of the Company's 1997 gross premiums written. Additionally, of the Company's gross premiums written in 1997, approximately 51.0% consisted of reinsurance business and approximately 34.5%, 33.5% and 32.0% were attributable to clients from the U.S., Europe and the rest of the world, respectively. The average combined ratio and average operating ratio of the Company was 99.4% and 74.4%, respectively, for the three years ended December 31, 1997. The Company's net operating earnings from continuing operations before minority interests and realised gains on investments after tax was $62.9 million for 1997, up 10% from $57.2 million in 1996. At December 31, 1997, approximately 92.9% of the Company's $1.476 billion investment portfolio consisted of fixed maturity debt securities and cash and cash equivalents, with the balance consisting of equity securities. Of the fixed maturity debt securities, 93.5% were rated "A" or better by Standard & Poor's Corporation ("S&P") and Moody's Investors Service, Inc. ("Moody's"). The Company currently has no investments in high yield fixed income securities, real estate or mortgages. 3 HISTORY On December 21, 1994, the Company, a holding company, acquired substantially all of the capital stock of Terra Nova, its predecessor, and substantially all of the capital stock of Underwriters Capital (Merrett) Ltd. ("UCM"), a Bermuda insurance company, which was renamed "Terra Nova (Bermuda) Insurance Company Ltd." Terra Nova was established in 1969 and is believed by management to be one of the largest London Market companies. UCM was organised in Bermuda in 1993 to provide reinsurance to certain Lloyd's syndicates. These acquisitions provided the Company with both additional capital and a presence in London and the Bermuda Markets from which the Company has begun to grow and diversify its book of business. On January 5, 1996, in continuation of its market diversification strategy, the Company purchased the business and assets of Octavian, a Lloyd's Managing agent. Octavian currently manages eight syndicates, whose writings include primarily U.K. liability, U.K. motor, marine and aviation lines. Octavian has $628.8 million of aggregate underwriting capacity, net of commission, for the 1998 year of account, of which $372.8 million, net of commission, is provided by the Company through Terra Nova Capital. On April 17, 1996, the Company completed an initial public offering ("IPO") of 7,275,000 shares at a price to the public of $17. The proceeds of the IPO were $114 million after expenses. Of these net proceeds $16 million was used to redeem a portion of the Company's non-voting convertible redeemable preference shares, $75 million was contributed to Terra Nova (Bermuda) to support its insurance operations, including increasing the capacity potentially available to the Octavian Syndicates and $15 million was contributed to Terra Nova, with the balance retained for general corporate purposes. On August 26, 1997, Terra Nova Insurance (UK) Holdings plc ("UK Holdings") completed an issue of $75 million 7.2% Senior Notes due 2007, guaranteed fully and unconditionally by Bermuda Holdings. The net proceeds were used to finance the acquisition of Corifrance on September 8, 1997, with the balance being used for general corporate purposes. On September 8, 1997, the Company purchased all of the issued and outstanding shares of Corifrance, a French reinsurance company, for a purchase price of $42.2 million. The acquisition was made by a French subsidiary holding company of Terra Nova. Corifrance transacts business internationally, although mainly outside of the United States. SHAREHOLDERS The current shareholders of the Company include DLJ Merchant Banking Funding, Inc. ("DLJMB Funding") and certain related investors ("the DLJ Entities"). The Company's Class A Ordinary shares are publicly traded on the New York Stock Exchange under the symbol TNA. 4 MIX OF BUSINESS The Company's mix of business is as follows: BREAKDOWN OF GROSS PREMIUMS WRITTEN BY CLASS OF BUSINESS (DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31, -------------------------------------------------------- 1997 1996 1995 ------------------ ------------------ ------------------ PERCENT OF PERCENT OF PERCENT OF CLASS OF BUSINESS AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL ----------------- ------ ---------- ------ ---------- ------ ---------- PROPERTY Catastrophe treaty-- U.S. 22.4 4.1 % 25.1 7.0 % 17.4 5.7 % Catastrophe treaty-- all other 13.5 2.4 16.4 4.5 17.8 5.9 Proportional treaty 60.3 11.0 58.1 16.1 42.7 14.1 Risk excess of loss 22.1 4.0 19.5 5.4 19.4 6.4 Other property 109.0 19.8 57.1 15.8 39.0 12.9 Reinsurance to close 3.5 0.6 -- -- -- -- Orphaned syndicate business 10.6 1.9 -- -- -- -- ----- ----- ----- ----- ----- ----- Total before prior year revisions 241.4 43.8 176.2 48.8 136.3 45.0 Prior year revisions (4.1) (0.7) 2.7 0.7 3.0 1.0 ----- ----- ----- ----- ----- ----- Total 237.3 43.1 178.9 49.5 139.3 46.0 CASUALTY Medical malpractice 9.8 1.8 11.3 3.1 14.5 4.8 Professional indemnity 25.5 4.6 16.0 4.4 7.4 2.5 Casualty clash and working layer 4.0 0.7 10.6 2.9 13.1 4.3 Motor 27.8 5.1 6.0 1.7 -- -- Other casualty 37.1 6.7 20.7 5.8 19.9 6.6 Reinsurance to close 7.4 1.3 -- -- -- -- Orphaned syndicate business 13.3 2.4 -- -- -- -- ----- ----- ----- ----- ----- ----- Total before prior year revisions 124.9 22.7 64.6 17.9 54.9 18.2 Prior year revisions 3.6 0.7 3.5 1.0 (0.2) (0.1) ----- ----- ----- ----- ----- ----- Total 128.5 23.4 68.1 18.9 54.7 18.1 MARINE & AVIATION Marine hull 47.5 8.6 49.4 13.7 50.1 16.6 Energy 29.8 5.4 19.0 5.3 25.7 8.5 Marine cargo 39.6 7.2 31.9 8.7 25.8 8.4 Marine casualty 13.5 2.4 8.9 2.5 9.5 3.1 Marine excess of loss 2.1 0.4 0.8 0.2 2.6 0.9 Aviation hull 35.6 6.5 6.7 1.9 -- -- Reinsurance to close 7.0 1.3 -- -- -- -- Orphaned syndicate business 15.2 2.8 -- -- -- -- ----- ----- ----- ----- ----- ----- Total before prior year revisions 190.3 34.6 116.7 32.3 113.7 37.5 Prior year LMX reinstatement premiums 0.6 0.1 4.2 1.2 9.3 3.1 Revisions of prior year premiums written for non-LMX business (6.5) (1.2) (8.6) (2.4) (18.5) (6.1) ----- ----- ----- ----- ----- ----- Total 184.4 33.5 112.3 31.1 104.5 34.5 Life -- -- 1.7 0.5 4.2 1.4 ----- ----- ----- ----- ----- ----- TOTAL FOR THE COMPANY 550.2 100.0 % 361.0 100.0 % 302.7 100.0 % ===== ===== ===== ===== ===== ===== Direct business 269.6 49.0 % 119.6 33.2 % 86.3 28.5 % Reinsurance assumed 280.6 51.0 241.4 66.8 216.4 71.5 ----- ----- ----- ----- ----- ----- Total for the company 550.2 100.0 % 361.0 100.0 % 302.7 100.0 % ===== ===== ===== ===== ===== =====
5 NON-MARINE PROPERTY Property Catastrophe Treaty Reinsurance Property catastrophe excess of loss reinsurance provides coverage when total losses and loss expenses from a single occurrence of a covered peril under a portfolio of insurance and reinsurance contracts exceed the attachment point specified in the reinsurance contract with the primary insurer. Some of the Company's property catastrophe excess of loss policies limit coverage to one occurrence in a policy year, but most policies provide for coverage of a second occurrence after the payment of a reinstatement premium. In 1997, 66% and 34% of the Company's catastrophe treaty business was written by Terra Nova and Terra Nova (Bermuda), respectively. In 1997, based on gross premiums written, approximately 62%, 14% and 24% of the non-marine property catastrophe reinsurance risks underwritten by the Company were located in the U.S., Europe, and the rest of the world, respectively. Proportional Treaty Reinsurance and Risk Excess of Loss Reinsurance In proportional treaty reinsurance, the Company assumes a proportional part of the original premiums and losses of the reinsured on non-catastrophe reinsurance contracts. In proportional treaty 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 (including commissions, premium taxes, assessments and miscellaneous administrative expenses) and also may include a profit factor. In 1997, 72% of proportional treaty risks underwritten by the Company were located outside the U.S.. The Company's property risk excess of loss contracts cover a cedent's loss on a single "risk" in excess of the cedent's attachment point, rather than covering multiple risks as does property catastrophe reinsurance. A "risk" in this context might mean the insurance coverage on one building or a group of buildings or the insurance coverage under a single policy, which the reinsured treats as a single risk. In 1997, 40% of risk excess risks underwritten by the Company were located in the U.S. Other Property The balance of the non-marine property account consists of a number of minor classes of primary insurance business covering risks such as crop, boiler and machinery insurance and short-term trade credit insurance business. The Company also writes U.S. "excess and surplus lines" property and automobile physical damage risks largely through limited authorities which authorise selected U.S. insurance brokers to bind certain risks on behalf of the Company, subject to premium income, geographic locations, pricing, policy terms and conditions and other contract restrictions. The Company writes motor insurance through Terra Nova Capital's participation on motor syndicates 554 and 1228. In 1997, the property element of this business was $26.4 million which accounts for a large proportion of the increase in other property writings in 1997 compared to 1996 due to Syndicate 1228 being established in 1997 and Terra Nova Capital having a significantly lower participation on Syndicate 554 in 1996 compared to 1997. NON-MARINE CASUALTY Medical Malpractice The Company's medical malpractice book of business consists of medical malpractice reinsurance for U.S. medical malpractice carriers, many of which are mutual or reciprocal companies. Since 1990, there has been a deterioration in both primary pricing and reinsurance terms for medical malpractice business, which has led to a reduction of approximately one-half of the Company's gross premiums written in respect of such business and a move toward more hospital business and large groupings of health care providers. Despite this reduction, the Company continues to write accounts that management believes offer attractive rates and deductibles. 6 Professional Indemnity In 1997, $16.9 million of the Company's professional indemnity business was written by Octavian's Syndicate 702 which specializes in U.K. professional indemnity insurance and directors and officers insurance. The remaining professional indemnity business is written by Terra Nova on an excess of loss basis and includes lawyers' groups, architects and engineers, insurance agents, accountants and some miscellaneous errors and omissions coverages. The majority of the business consists of smaller firms of professionals in these categories. Casualty Clash and Working Layer Casualty clash business, involving exposure at levels well in excess of individual underlying policy limits, is critical to the reinsurance programs of many major U.S. primary companies and is generally placed in markets not heavily involved in those companies' lower levels of exposure. The Company's book of clash business, which includes a roster of leading U.S. insurers, has experienced little turnover in reinsureds. Motor The Company through Terra Nova Capital's participation on Octavian's motor Syndicates 554 and 1228 wrote U.K. motor business, the liability portion of this business has been included in this category of business. In addition, Terra Nova writes U.S. Motor reinsurance business on a proportional treaty and excess of loss basis. Other Casualty Business Other non-marine casualty lines of business include excess of loss reinsurance of fidelity and surety business, workers' compensation, crime, bloodstock and personal accident business. MARINE & AVIATION The Company's Marine & Aviation business is written by Terra Nova and by Terra Nova Capital, through its participation on the two Octavian marine Syndicates of 329 and 1009 and Octavian's aviation Syndicate 959. Marine Hull The risks written within this account are those associated with the world's maritime fleet. Vessels such as oil supertankers, dry cargo ships, cruise liners, tugs and barges are insured. Certain casualty risks such as ship collision incidents are also insured within the portfolio. The Company's marine hull account consists of two distinct components, hull risk and hull treaty business. The hull risk account consists of participations in individual protections for ships of all types in all geographical areas. Examples of the larger type of hull risks would be passenger cruise ships. Hull treaty business, which is not a traditional core business for most London Market marine underwriters, is a speciality of Terra Nova. As a treaty reinsurer, the Company reinsures primary underwriters in local markets, such as Japan, which are closed to foreign primary writers. In this manner, the Company is able to access business which would otherwise not be available to it, local expertise, local market knowledge and local survey and claims skills. Energy The risks in this account relate to rigs and other equipment used in the exploration and development of energy sources such as oil and natural gas. The risks underwritten are located both onshore and offshore. The Company is involved principally with the "upstream" activities of its insureds, such as offshore and onshore drilling rigs, in both property damage and casualty exposures. 7 Marine Cargo The marine cargo account is involved in insuring the transportation of all types of commodities, both dry and liquid, imports and exports world wide, together with associated warehousing risks. The Company also underwrites in this portfolio specie risks comprising, for example, gold, silver and bullion in transit and contained within vaults and fine art. Marine Casualty Within the marine casualty account are such diverse risks as shipowners' liabilities, port authority liabilities, marine terminal operators' liabilities and other casualty risks such as pollution arising from the operations of these activities. Pollution risks are restricted to "sudden and accidental" incidents, generally with specific reporting requirements. Aviation The Company writes aviation business through Terra Nova Capital's participation on Octavian's Syndicate 959. The business consists of airline hull, personal accident and liability business written on a worldwide basis. LIFE The Company ceased writing new life insurance business on March 1, 1996, and the account went into run-off with effect from such date. The life insurance business operation, comprising most of its staff, was transferred to another U.K. insurance company. REINSURANCE TO CLOSE In 1997 Terra Nova Capital wrote $17.9 million of premiums in respect of the closure of the 1995 year of account into the 1996 year of account of which it had an 11% share. These premiums include property, casualty, marine and aviation risks. In 1998 Terra Nova Capital will receive premiums in respect of the closure of the 1996 year of account into the 1997 year of account of which it had a 40% share. ORPHANED SYNDICATE BUSINESS In 1997 the Company wrote $39.1 million of premiums related to reinsurance to close of "orphaned" Lloyd's syndicates from the 1993 year of account. In 1998 the Company is planning to write orphaned syndicate business, however, due to the one off nature of this business the amount of premiums that will be written is difficult to predict. DISTRIBUTION SYSTEM The vast majority of insurance and reinsurance business that is written by participants in the London Market is brought to both Lloyd's and London Market company underwriters by brokers authorized to place business at Lloyd's ("Lloyd's brokers"). London Market companies (but as a general rule not Lloyd's syndicates) may also deal directly with non-Lloyd's brokers and individual ceding companies. Brokers are responsible for providing information necessary to support the underwriting decision, such as details of the risks, claims experience and changes in risks insured. The broker is regarded as the agent of the insured or reinsured in placing the business. 8 The Company's writings originate worldwide and are accepted through non-U.S. insurance brokers, principally Lloyd's brokers. By using the broker distribution system, the Company maintains low fixed overhead costs. Brokers charge commissions varying in accordance with the type and in proportion to the volume of business written, thus allowing the Company flexibility to vary its volume and mix of business according to perceived opportunities. The following table shows the percentage of gross premiums written by the ten brokers writing the largest amount of gross premiums for the Company for the year ended December 31, 1997: PERCENTAGE OF GROSS PREMIUMS WRITTEN, (1) BY BROKER, (2) FOR YEAR ENDED DECEMBER 31, 1997
BROKER PERCENTAGE ------ ---------- J H Marsh & McLennan 19.5% AON 10.3 Willis Corroon 8.3 Sedgwick Group 6.7 Ballantyne McKean & Sullivan 3.5 Jardine Thompson Graham 2.8 C E Heath & Co. 2.1 Steel Burrill Jones 2.0 Benfield Greig 2.0 Nelson Hurst 2.0
- -------- (1) Based on premiums notified by each broker for the 1997 underwriting year. (2) Affiliate companies are combined within each brokering group. UNDERWRITING General Underwriting of new and renewal business is conducted on a risk by risk basis, with consideration given to the general direction of rates and policy terms and conditions of each class of business, the Company's acceptance limits and exposure to accumulation of loss in catastrophe events. The mix of business for a given year is derived from both the historical development of the business and analysis by the Company of current pricing and other relevant trends. Underwriters are encouraged to research and develop new areas of business subject to the approval of management. The underwriting process includes an assessment of (i) the geographic profile of the business underwritten, (ii) historic loss information for the cedent or insured and (iii) historic loss information for the segment of the industry involved. Judgement as to the quality and integrity of the cedent, insured and/or agent is paramount to the underwriting. Close attention is paid to financial ratings of cedents. Complex risks are usually only written after considerable research often requiring significant actuarial analysis, a full underwriting survey by a qualified surveyor and/or a visit to the client. Property For property catastrophe reinsurance business, the underwriting guidelines limit the aggregate exposure to any one cedent and in defined geographic zones. The Company seeks to reinsure such business at attachment points which produce a relatively low frequency of loss and also spreads its involvement over a range of attachment points. In addition, the Company uses CATMAP(TM), a commercially available software program developed by Applied Insurance Inc., and its own proprietary models to assess pricing adequacy and manage loss exposure on an ongoing basis. Where the Company cannot allocate risks specifically to geographic areas, a degree of experience and judgement is applied. Wherever possible, however, aggregate exposure is calculated and recorded on all business judged to have catastrophe exposure. 9 Market share data on all multi-state U.S. cedents is recorded and potential exposure in various loss scenarios is calculated. For U.K. exposures, postal code aggregate exposures are requested and "Storm Path" estimated maximum exposures are calculated. Exposure databases and computer-based analytical tools are also used to monitor and control aggregates along with other available data requested of cedents in order to control exposures. Casualty The underwriting policy for non-marine casualty business places emphasis upon well defined exposures, for example by profession and narrow geographic region, which permit detailed analysis leading to informed pricing decisions. Diversification of exposures is achieved by underwriting individual contracts in varying geographic regions. Additionally, the majority of non-marine casualty business is underwritten on a claims-made basis, under which the Company is liable only for those claims made during the contract period (and generally subject to a limited discovery period). This permits a more timely and accurate assessment of the Company's likely exposure to losses under each contract than is the case under loss occurrence contracts where the insurer is liable for losses occurring during or attributable to the contract period, no matter when reported. Marine Marine hull underwriting involves detailed analysis of the loss record of individual vessels as well as of the fleets of which they may form a part. Ownership and management are taken into account and data relating to the classification of the vessel is recorded and analyzed. Marine hull insurance is not catastrophe-exposed to the same extent as fixed, land-based structures, but accumulation potentials are monitored. Marine energy exposures for fixed platforms and land-based structures are maintained and controlled with the aid of computer-based analytical tools. Cargo and specie exposures are monitored against catastrophe scenarios. The Company's marine liability account is geographically diverse and does not have the catastrophe accumulation potential of some other marine classes. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES General The loss and LAE liabilities consist of two components: case reserves and IBNR reserves. Case reserves are estimates of future loss payments with respect to insured events which have been reported to the insurer. These reports may be made formally by the cedent or informally by other means, such as evaluation of claims by attorneys. The Company determines case reserves on a contract by contract basis. The amount reserved is the amount expected to be ultimately paid and is not discounted or otherwise adjusted for the time value of money. IBNR reserves are actuarially determined and reflect (i) the estimated ultimate loss amount which will be paid by the insurer and (ii) an estimate of possible changes in the value of those claims which have already been reported to the insurer. The particular method of setting IBNR reserves depends upon the class of business involved. The specific techniques involve the use of projections and models based on the Company's or the relevant market's experience and exposure. IBNR reserves reflect a margin for the uncertainty involved as determined by sensitivity tests. While management believes that the Company's reserves for losses and LAE are adequate, there can be no assurances that the Company's ultimate losses and LAE will not deviate, perhaps substantially, from the estimates reflected in its financial statements. If the Company's reserves should prove to be inadequate, the Company will be required to increase reserves, which could have a material adverse effect on the Company's financial condition. In accordance with the procedures provided in the above paragraph, the Company's reserving approach is to maintain an adequate level of undiscounted reserves. The Company does not discount its reserves to account for the time value of money, nor does it explicitly include an inflation adjustment, as the methodologies employed reflect past information. 10 By line of Business The following table breaks down the Company's reserve balances relating to continuing operations by line of business. The reserve results include loss reserves and allocated LAE reserves. BREAKDOWN OF RESERVE BALANCE RELATING TO CONTINUING OPERATIONS BY LINE OF BUSINESS AT DECEMBER 31, 1997
GROSS REINSURANCE RESERVES RECOVERABLE NET RESERVES ------------- ------------ ------------- CASE IBNR CASE IBNR CASE IBNR TOTAL ------ ------ ------ ----- ------ ------ ------ (DOLLARS IN MILLIONS) Non-Marine Property $125.2 $ 57.8 $ 19.3 $ 0.3 $105.9 $ 57.5 $163.4 Non-Marine Casualty 238.5 300.0 43.5 11.6 195.0 288.4 483.4 Marine and Aviation 287.2 130.7 155.2 16.8 132.0 113.9 245.9 Unallocated LAE 2.6 15.7 0.0 0.0 2.6 15.7 18.3 ------ ------ ------ ----- ------ ------ ------ Total $653.5 $504.2 $218.0 $28.7 $435.5 $475.5 $911.0 ====== ====== ====== ===== ====== ====== ======
The following table shows the development of net reserves for losses and LAE for the calendar years 1987 to 1997 for all lines of business, except the Company's aviation business in run-off. The first line of the table presents the net liabilities, including IBNR, as recorded in the Company's balance sheet in respect of the indicated year and all unpaid losses for prior years. The upper portion of the table shows the re-estimation of the liability at the end of each of the succeeding years. The conditions that have given rise to the deficiencies are referred to below and may not be indicative of future developments. The re-estimated liabilities are increased or decreased as more information becomes available about the severity and frequency of claims for individual years. An adjustment to the carrying value of unpaid claims for a prior year will also be reflected in the adjustments for subsequent years. For example, an adjustment in 1990 in respect of 1987 loss reserves will be reflected in the re-estimation of reserves for the years 1987 through 1989. A surplus (or deficiency) arises when the re-estimation of reserves at the end of the year is less (or greater) than its estimation at the preceding year-end, and would be reflected in the income statement of that year. The cumulative deficiency is the difference between the re-estimation of reserves as at the end of 1997 and the original estimation as shown on the top line of the table. The lower portion of the table shows the cumulative amounts paid as of the end of each successive year for such claims. 11 ANALYSIS OF NET LOSS AND LAE RESERVE DEVELOPMENT (DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31, --------------------------------------------------------------------------------------------- 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Reserves for unpaid losses and LAE at December 31 $527.0 $585.6 $637.1 $693.9 $724.9 $784.5 $775.6 $847.3 $814.2 $824.0 $911.0 Reserves re-estimated(1) as of: One year later 530.6 607.4 655.0 719.3 761.0 806.9 802.5 850.1 811.6 813.6 Two years later 537.6 622.7 671.1 736.5 773.7 821.5 810.5 850.1 798.3 Three years later 545.6 628.2 691.2 743.8 780.5 829.0 810.7 832.9 Four years later 551.8 640.3 681.2 738.1 792.4 829.8 800.7 Five years later 555.4 626.6 663.6 755.5 793.5 816.5 Six years later 547.9 607.5 674.1 756.5 776.6 Seven years later 537.9 617.5 674.0 741.2 Eight years later 547.0 617.5 667.2 Nine years later 547.9 618.8 Ten years later 548.3 Cumulative redundancy (deficiency) (21.3) (33.2) (30.1) (47.3) (51.7) (32.0) (25.1) 14.4 15.9 10.4 As a percentage of unpaid losses and LAE (4.03)% (5.67)% (4.73)% (6.82)% (7.13)% (4.08)% (3.23)% 1.70% 1.95% 1.26% Paid (cumulative) as of: One year later $ 83.7 $ 91.4 $ 94.2 $115.3 $119.3 $143.8 $151.8 $168.8 $123.4 $145.7 Two years later 133.5 158.9 174.6 201.3 228.2 268.3 259.0 253.6 227.6 Three years later 155.0 200.4 190.1 274.3 316.1 350.8 311.8 327.8 Four years later 192.8 222.7 242.2 341.0 379.9 383.8 368.8 Five years later 207.5 276.3 293.0 395.8 402.5 426.8 Six years later 233.6 312.6 330.2 407.8 438.3 Seven years later 254.6 338.3 336.6 435.5 Eight years later 278.6 354.1 353.5 Nine years later 296.4 360.9 Ten years later 317.0
- -------- (1) "Reserves re-estimated" includes losses actually paid in current and prior years. The deterioration between 1987 and 1993 is primarily the result of LMX Spiral losses in the marine account. 12 The following table represents an analysis of gross loss and LAE reserve development for the years indicated: ANALYSIS OF GROSS LOSS AND LAE RESERVE DEVELOPMENT
YEAR ENDED DECEMBER 31, -------------------------------------------------- 1993 1994 1995 1996 1997 -------- -------- -------- -------- -------- (DOLLARS IN MILLIONS) Gross reserves for unpaid losses and LAE $1,238.8 $1,223.8 $1,168.7 $1,078.2 $1,157.7 Reinsurance recoveries on unpaid losses and LAE 463.2 376.5 354.5 254.1 246.7 Gross reserves re-estimated (1) as of: One year later 1,332.8 1,310.2 1,174.8 1,067.0 Two years later 1,428.9 1,319.9 1,168.4 Three years later 1,428.0 1,311.2 Four years later 1,431.3 Reinsurance recoveries on unpaid losses and LAE re-estimated (2) as of: One year later 530.3 460.1 363.2 253.4 Two years later 618.4 469.9 370.1 Three years later 617.3 478.3 Four years later 630.6 Gross cumulative redundancy (deficiency) (192.5) (87.4) 0.3 11.2 As expressed as a percentage of unpaid losses and LAE (15.5)% (7.1)% 0.0% 1.0% Paid (cumulative) as of: One year later 303.9 290.6 229.7 179.6 Two years later 517.9 479.8 364.4 Three years later 679.3 576.4 Four years later 752.5
- -------- (1) "Gross reserves re-estimated" includes losses actually paid in current and prior years. (2) "Reinsurance recoveries on unpaid losses and LAE re-estimated" includes reinsurance recoveries actually received in current and prior years. 13 The following table represents a reconciliation of reserve balances for the years indicated. RECONCILIATION OF RESERVE BALANCES
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (DOLLARS IN MILLIONS) Reserves for unpaid losses and loss adjustment expenses, gross of reinsurances, at the beginning of the year $1,078.1 $1,168.7 $1,223.8 Less reinsurance recoverables (254.1) (354.5) (376.5) -------- -------- -------- Net balance at beginning of the year 824.0 814.2 847.3 -------- -------- -------- Incurred related to: Current year 292.9 180.9 175.9 Prior years (10.4) (2.6) 3.2 -------- -------- -------- Total incurred 282.5 178.3 179.1 -------- -------- -------- Paid related to: Current year (69.7) (50.3) (43.8) Prior years (145.7) (123.4) (169.8) -------- -------- -------- Total paid (215.4) (173.7) (213.6) Foreign exchange adjustment (11.0) 5.2 1.4 -------- -------- -------- Net balance at end of year 880.1 824.0 814.2 Net reserves from Corifrance acquisition 30.9 -- -- -------- -------- -------- Net reserves at end of year 911.0 824.0 814.2 Plus reinsurance recoverables: The Company 236.8 254.1 354.5 Reinsurance recoverables related to net reserves from Corifrance acquisition 9.9 -- -- -------- -------- -------- Reinsurance recoverable by the Company 246.7 254.1 354.5 Reserves for unpaid losses and loss adjustment expenses, gross of reinsurance at the end of the year $1,157.7 $1,078.1 $1,168.7 ======== ======== ========
Incurred claims relating to prior years are offset by decreases to prior year net written and earned premiums less related acquisition costs of $4.8 million, $3.6 million and $6.4 million for 1997, 1996 and 1995 respectively. When these revisions to prior year written and earned premiums are taken into account, the Company experienced a net prior year improvement of $5.6 million in 1997 and deteriorations of $1.0 million and $9.6 million for 1996 and 1995, respectively. The Company believes that its reserves at December 31, 1997 are adequate. The establishment of reserves, however, is an inherently subjective process, and there can be no assurance that currently established reserves will prove adequate in light of actual experience. Accordingly, it would not be appropriate to extrapolate future deficiencies or redundancies based on the results set forth above. Non-Marine Property Reserves. Several statistical methods are used to estimate the ultimate loss position and to determine loss reserves for the non-marine property account. The Company also compares results based on separate large loss and attritional claim development. An analysis is completed for each underwriting category and, within the categories, for each major territory. Non-Marine Casualty Reserves. For the non-marine casualty account, which includes a significant amount of "long-tail" exposures, reserves are established using what management believes are prudent initial loss ratio assumptions. Within the overall non-marine casualty reserving methodology, significant risks such as major medical malpractice policies and other large policies which may have unusual or adverse loss emergence patterns are individually monitored and separately reserved. The reserves established for long-tail asbestos-related and environmental pollution claims are reviewed quarterly based on emerging loss reports. 14 Marine Reserves. The impact of LMX Spiral losses dominates the process of establishing reserves on the marine account for underwriting years prior to 1992. A substantial proportion of the gross total claim amount for these years is composed of a small number of especially large losses which are heavily reinsured. Each of these losses is analysed separately within the overall methodology. As loss development has matured in the past few years, and as reinsurers have achieved a better understanding of reserving issues, the inherent uncertainty in estimating the ultimate position has been reduced considerably. In other areas of the marine account, and for recent underwriting years, traditional actuarial techniques are used for each class. These techniques include the establishment of initial loss ratio assumptions in respect of the most recent underwriting years. In addition, exceptional and unusual claims are analysed separately as part of the Company's reserving procedures. Asbestos-Related and Environmental Pollution Reserves. Prior to 1974, the Company had very little exposure to casualty business. Since the mid-1980s, the Company's casualty business has been increasingly written on a claims-made basis with the majority written on such a basis since 1986. From the Company's inception through 1997, payments made by the Company for asbestos-related and environmental pollution claims arising from business written by it totalled approximately $27.2 million. Included in the liability for loss reserves at December 31, 1997 are $89.1 million (net of recoverables from reinsurers) of loss reserves pertaining to asbestos-related and environmental pollution claims. Included in these reserves are reserves for IBNR and reserves for LAE, which include litigation expenses. The Company continues to be advised of claims asserting injuries from hazardous materials and alleged damages to cover various clean-up costs relating to policies written in prior years. Coverage and claim settlement issues, such as the determination that coverage exists and the definition of an occurrence, may cause the actual loss development to exhibit more variation than the remainder of the Company's book of business. Traditional reserving techniques cannot be used to estimate asbestos-related and environmental pollution claims, and accordingly, the uncertainty in respect of the ultimate cost of these types of claims is greater than the uncertainty relating to standard lines of business. The Company believes it has made reasonable provision for claims, although the ultimate liability may be more or less than held reserves. The Company believes that future losses associated with these claims will not have a material adverse effect on its financial position, although there is no assurance that such losses will not materially affect the Company's results of operations for any period. The following table presents selected data on asbestos-related and environmental pollution losses and LAE incurred and reserves outstanding, net of amounts recoverable from reinsurers. ASBESTOS-RELATED LOSSES AND LAE INCURRED AND RESERVES OUTSTANDING
YEAR ENDED DECEMBER 31, -------------------- 1997 1996 1995 ----- ----- ----- (DOLLARS IN MILLIONS) Incurred losses (net of reinsurance) $ 1.6 $(3.4) $ 5.7 Incurred LAE 1.2 3.5 2.3 ----- ----- ----- Incurred losses and LAE (net of reinsurance) $ 2.8 $ 0.1 $ 8.0 ===== ===== ===== Net paid losses and LAE (net of reinsurance) $ 2.5 $ 1.7 $ 0.9 ===== ===== ===== Reclassification of reserves previously identified as non asbestos-related losses -- $12.1(1) -- Losses and LAE case reserves (net of reinsurance) $28.3 $26.2 $20.3 Losses and LAE IBNR reserves (net of reinsurance) 30.5 32.2 27.6 ----- ----- ----- Total reserves (net of reinsurance) $58.8 $58.4 $47.9 ===== ===== =====
- -------- (1) The reclassification of reserves previously identified as non asbestos- related losses relates to risks specific to one cedent. The reserves established in respect of these risks had previously been treated as non asbestos- related losses due to no information regarding the type of these losses being available. 15 ENVIRONMENTAL POLLUTION LOSSES AND LAE INCURRED AND RESERVES OUTSTANDING
YEAR ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (DOLLARS IN MILLIONS) Incurred losses (net of reinsurance) $ (2.9) $ (1.4) $ 1.2 Incurred LAE 0.9 (0.1) 0.5 ------ ------ ------ Incurred losses and LAE (net of reinsurance) $ (2.0) $ (1.5) $ 1.7 ------ ------ ------ Net paid losses and LAE (net of reinsurance) $ 1.5 $ 3.0 $ 0.9 ====== ====== ====== Losses and LAE case reserves (net of reinsurance) $ 9.5 $ 9.9 $ 9.8 Losses and LAE IBNR reserves (net of reinsurance) 20.8 24.0 28.6 ------ ------ ------ Total reserves (net of reinsurance) $ 30.3 $ 33.9 $ 38.4 ------ ------ ------ The reinsurance recoverables netted against the loss reserves for each of the years 1997, 1996 and 1995 are as follows: YEAR ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (DOLLARS IN MILLIONS) Reserves (gross of reinsurance) $111.8 $111.9 $100.0 Reinsurance recoverables 22.7 19.6 13.7 ------ ------ ------ Reserves (net of reinsurance) $ 89.1 $ 92.3 $ 86.3 ====== ====== ====== The litigation expenses included in the loss reserves for each of the years 1997, 1996 and 1995 are as follows: YEAR ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (DOLLARS IN MILLIONS) Total reserves $ 89.1 $ 92.3 $ 86.3 Litigation expenses included 24.1 24.8 23.3
RISK MANAGEMENT AND REINSURANCE PROTECTION In accordance with the general practice of insurance and reinsurance companies and in the ordinary course of its business, the Company reinsures a portion of the risks it underwrites. Although reinsurance does not discharge the insurer from its liability to its policyholder, it is general practice of insurers to regard the reinsured portion of the risks as the liability of the reinsuring company. The Company purchases reinsurance primarily to manage exposures in its insurance and reinsurance business. Reinsurance serves to reduce where necessary the exposure to any one policy or physical risk, or to a catastrophic accumulation of loss in one event, to a level judged to be commensurate with the Company's financial resources, and to allow for large or "shock" losses to be managed over time. Reinsurance is not used as a device to pass on business that is unsatisfactorily rated, or to "arbitrage" an original underwriting judgment. Each decision by the Company to purchase reinsurance coverage, and the amounts, types and attachment points of coverage purchased, is the result of careful evaluation by the Company of the costs and benefits involved in light of the size of the Company's aggregate exposures and the business outlook in the applicable line, among other factors. Reinsurance placement standards are maintained by the Company's security committee, which until 1996 used a rating system developed by the Company's financial staff. Information on historical financial performance, current solvency and business practices likely to impact future solvency is assembled from a variety of sources, with special attention given to new and small companies. The current system is based upon recognized rating agency reports. 16 Additionally, the reinsurance component of the Company's total gross exposure is regularly reviewed for issues relating to collectability, including solvency and credit disputes. As needed, the Company establishes a bad debt reserve for reinsurance recoverables that are in doubt. At December 31, 1997, this reserve stood at $28.9 million or 9.2% of total reinsurance recoverables. The Company's recoverables from its reinsurers are composed of (i) amounts recoverable in respect of paid and outstanding claims and (ii) amounts recoverable related to IBNR. The following table sets forth net reinsurance recoverables from continuing operations from December 31, 1995 to December 31, 1997. AGGREGATE OF NET REINSURANCE RECOVERABLES
AT AT AT DECEMBER 31, DECEMBER 31, DECEMBER 31, 1997 MOVEMENT 1996 MOVEMENT 1995 ------------ -------- ------------ -------- ------------ (DOLLARS IN MILLIONS) Paid claims $ 48.9 $ (6.4) $ 55.3 $ 6.9 $ 48.4 Notified outstanding claims 227.1 17.2 209.9 (31.3) 241.2 IBNR 39.0 (22.8) 61.8 (71.5) 133.3 Bad Debt provision (28.9) 0.2 (29.1) 1.1 (30.2) ------ ------ ------ ------ ------ Total $286.1 $(11.8) $297.9 $(94.8) $392.7 ====== ====== ====== ====== ======
The following table sets forth the Company's net reinsurance recoverables on its continuing operations (excluding marine LMX) and on its marine LMX business, which is no longer written. For marine LMX business, reinsurance recoverables have decreased by 7.6%, to $152.3 million in 1997 from $164.9 million in 1996, and by 24.0%, to $164.9 million in 1996 from $217.1 million in 1995. ANALYSIS OF NET REINSURANCE RECOVERABLES
AT DECEMBER 31, -------------------- 1997 1996 1995 ------ ------ ------ (DOLLARS IN MILLIONS) Reinsurance recoverable: Continuing operations $133.8 $133.0 $175.6 Marine LMX business 152.3 164.9 217.1 ------ ------ ------ Total $286.1 $297.9 $392.7 ====== ====== ======
At December 31, 1997, syndicates at Lloyd's were the Company's principal reinsurers, with reinsurance recoverables on notified outstanding claims and IBNR from continuing business of approximately $87.6 million. 17 TEN LARGEST PROVIDERS OF REINSURANCE FOR THE 1997 UNDERWRITING YEAR
A.M. BEST PREMIUM REINSURER RATING(1) CEDED(2) --------- --------- -------- Lloyd's Syndicates A 15.1% Continental Re A- 8.1 Swiss Re/European General Reinsurance Co. A+ 4.9 ERC Frankona Ruckverscherungs--AG A 4.0 PX Re (ex Pheonix Re) A 3.9 Zurich Insurance/Centre Re International--Dublin (Bermuda) A+ 3.2 Hanover Ruckverscherungs--AG A+ 3.1 Underwriters Reinsurance Co. (Barbados) A+ 2.7 Copenhagen Re (Denmark) A 2.7 London & Edinburgh Gen. Ins. Co. Ltd. (3) 2.7
- -------- (1) A rating from A.M. Best reflects the opinion of A.M. Best as to an insurer's financial strength, operating performance and ability to meet its obligations to policyholders. (2) Premium ceded for the 1997 underwriting year. (3) London & Edinburgh Gen. Ins. Co. Ltd. is rated "A" by S&P. INVESTMENT PORTFOLIO The Company's investment objectives are to optimize current income and total return on its investments consistent with high quality, safety, diversification and tax and regulatory considerations and to maintain sufficient liquidity to enable it to meet its obligations on a timely basis. An in-house team of seven people, headed by the Director of Investments and the Director of Fixed Interest Investment, is responsible for Terra Nova's investment management. The Vice President--Administration of Terra Nova (Bermuda) is responsible for the investment management of Terra Nova (Bermuda). The Company operates in several jurisdictions and must comply with local insurance regulations which prescribe the type and amount of investments permissible. In addition, Terra Nova's investment policy is implemented in accordance with U.K. regulations, which regulations govern the admissibility and valuation of individual investments within its portfolio for solvency calculation purposes, and conformity with Terra Nova's Notice of Requirements. Terra Nova (Bermuda)'s investments are made in accordance with Bermuda regulations, which regulations govern the admissibility of individual assets for solvency margin and liquidity ratio calculation purposes. Certain assets are held in Canada and the U.S. in accordance with applicable local regulations. Such assets are currently required to be denominated in local currency and invested in domestic securities. Terra Nova Capital's investments are made in accordance with Lloyd's regulations. The Company has specific investment policy guidelines with respect to both its "technical funds" and its "capital funds" for its insurance business. The "technical funds" support claims reserves; the "capital funds" represent shareholders' funds, including solvency margins. The Company's "technical funds" are invested in readily marketable high grade fixed interest securities and cash. The objectives of the investment strategy for "technical funds" are to: (i) maintain diversified fixed income portfolios in order to optimize investment income without undue risk; (ii) manage portfolio maturities; and (iii) maintain sufficient liquidity to meet its obligations on a timely basis. The Company's investment strategy with respect to "capital funds" is to optimize total return after all taxes including, where applicable, withholding tax and U.K. corporation tax. The objective is to provide for long-term growth in market value through investment in a diversified portfolio which includes listed common stocks but which is also geared to maintaining satisfactory levels of current income. 18 The Company does not invest in real estate, mortgages or high yield fixed income securities. Nor does the Company participate in the derivatives markets for trading or speculative purposes although such instruments may be used to a limited extent to hedge against fluctuations in interest rates, foreign exchange or equity security risk. The market value of the Company's investments varies depending upon economic and market conditions. Absent other factors, the market values of fixed maturity securities are likely to decline as interest rates rise and are likely to increase as interest rates fall. The Company's policy is to match the duration of its assets with its insurance liabilities and to manage the foreign currency exposure by matching technical liabilities against assets of the same currency as far as is considered practical. Approximately 78% of the investment portfolio of the Company is maintained in U.S. dollars. The following table shows a breakdown of the Company's investment portfolio by type of security: BREAKDOWN BY TYPE OF SECURITY (DOLLARS IN MILLIONS)
AT DECEMBER 31, ---------------------------------------------- 1997 1996 1995 -------------- -------------- -------------- CARRYING % OF CARRYING % OF CARRYING % OF AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL -------- ----- -------- ----- -------- ----- Fixed maturities: U.S. Government and agencies $ 312.7 21.2% $ 421.7 32.6% $ 389.2 33.3% Foreign governments and supranationals 592.1 40.1 508.0 39.4 453.4 38.8 Foreign regional government 41.4 2.8 20.3 1.6 20.5 1.7 Corporate 239.7 16.2 89.9 7.0 69.8 6.0 Asset backed securities (1) 64.4 4.4 65.4 5.1 55.8 4.8 Mortgage backed securities (2) 11.2 0.8 14.2 1.1 10.2 0.9 -------- ----- -------- ----- -------- ----- Total fixed maturities 1,261.5 85.5 1,119.5 86.8 998.9 85.5 -------- ----- -------- ----- -------- ----- Common stocks 104.2 7.1 120.4 9.3 80.4 6.9 Cash and cash equivalents 109.9 7.4 50.6 3.9 88.7 7.6 -------- ----- -------- ----- -------- ----- Total fixed maturities, common stocks and cash $1,475.6 100.0% $1,290.5 100.0% $1,168.0 100.0% ======== ===== ======== ===== ======== =====
- -------- (1) As at December 31, 1997, 100% of the asset backed securities were rated "AAA" by S&P or Moody's. (2) As at December 31, 1997, 100% of the mortgage backed securities are issued or guaranteed by U.S. or Canadian federal agencies or government sponsored enterprises. 19 The following tables breakdown the Company's portfolio of fixed maturity securities by credit quality and maturity: BREAKDOWN OF FIXED MATURITY SECURITIES BY CREDIT QUALITY (DOLLARS IN MILLIONS)
AT DECEMBER 31, ---------------------------------------------- 1997 1996 1995 -------------- -------------- -------------- TYPE OF RATING OF CARRYING % OF CARRYING % OF CARRYING % OF INVESTMENTS (1) AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL ----------------- -------- ----- -------- ----- -------- ----- U.S. Government and agencies $ 312.7 24.8% $ 421.7 37.7% $389.2 39.0% U.K. Government and agencies 90.3 7.2 39.3 3.5 55.8 5.6 AAA 475.9 37.7 417.2 37.3 264.8 26.5 AA 206.7 16.4 166.2 14.8 188.6 18.9 A 93.4 7.4 27.8 2.5 40.3 4.0 -------- ----- -------- ----- ------ ----- Total A or higher 1,179.0 93.5 1,072.2 95.8 938.7 94.0 BBB 45.8 3.6 -- -- -- -- Not rated (2) 36.7 2.9 47.3 4.2 60.2 6.0 -------- ----- -------- ----- ------ ----- Total $1,261.5 100.0% $1,119.5 100.0% $998.9 100.0% ======== ===== ======== ===== ====== =====
- -------- (1) The ratings set forth above are assigned to the securities by S&P, except for securities which have not been assigned a rating by S&P, in which case the ratings assigned by Moody's were used. (2) All of the securities not rated at December 31, 1997 by S&P or Moody's are issued by state or provincial governments located in countries other than the U.S. or the U.K., and are believed by management to be at least the equivalent in quality of "AA" rated investments. BREAKDOWN BY MATURITY (DOLLARS IN MILLIONS)
AT DECEMBER 31, ---------------------------------------------- 1997 1996 1995 -------------- -------------- -------------- CARRYING % OF CARRYING % OF CARRYING % OF MATURITY AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL -------- -------- ----- -------- ----- -------- ----- 1 year or less $ 53.1 4.2% $ 75.4 6.7% $ 84.1 8.4% Over 1 year up to 5 years 493.8 39.2 533.7 47.7 450.7 45.1 Over 5 years up to 10 years 646.4 51.2 457.4 40.9 410.4 41.1 Over 10 years 68.2 5.4 53.0 4.7 53.7 5.4 -------- ----- -------- ----- ------ ----- Total $1,261.5 100.0% $1,119.5 100.0% $998.9 100.0% ======== ===== ======== ===== ====== ===== Weighted average life(1) 6.6 years 5.8 years 5.9 years
- -------- (1) Weighted average life is calculated by reference to contractual maturities. 20 The following table breaks down the Company's portfolio by currency: BREAKDOWN BY CURRENCY (DOLLARS IN MILLIONS)
AT DECEMBER 31, ---------------------------------------------- 1997 1996 1995 -------------- -------------- -------------- CARRYING % OF CARRYING % OF CARRYING % OF AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL -------- ----- -------- ----- -------- ----- U.S. Dollar $1,154.7 78.3% $1,069.0 82.8% $ 951.1 81.4% British Pound 195.4 13.2 113.6 8.8 114.6 9.8 Canadian Dollar 41.8 2.8 47.9 3.7 39.7 3.4 German Mark 8.4 0.6 14.6 1.1 17.3 1.5 Other 75.3 5.1 45.4 3.6 45.3 3.9 -------- ----- -------- ----- -------- ----- Total $1,475.6 100.0% $1,290.5 100.0% $1,168.0 100.0% ======== ===== ======== ===== ======== =====
At December 31, 1997, 70% of the investments of the Company supported the Company's loss reserves and 30% supported the Company's capital. As of such date, 52% of the investments of the Company were investments of Terra Nova. The following table shows in summary form recent investment portfolio results. SUMMARY OF INVESTMENT STATISTICS (DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- Average invested assets (1) $1,383.0 $1,245.6 $1,113.2 Net investment income (2) 85.1 78.1 74.5 Net effective yield (3) 6.2% 6.3% 6.7% Realized investment gains $ 15.3 $ 11.8 $ 9.4 Total effective return (4) 7.3% 7.2% 7.5%
- -------- (1) Average of beginning and ending amounts of cash and investments for the period at carrying value. The average invested assets have been adjusted to exclude the effects of the Offering in 1996. (2) Investment income after investment expenses, excluding realized investment gains. (3) Net investment income for the period divided by average invested assets for the same period, expressed on an annualized basis. (4) Includes realized investment gains. COMPETITION The property and casualty insurance and reinsurance industry is highly competitive. The Company competes for its business in the United States and internationally with other Lloyd's syndicates, other London Market companies, other domestic Bermuda reinsurers, domestic United States insurers and reinsurers and other international insurers and reinsurers, many of whom are larger and have greater financial resources than the Company. Additionally, other well-capitalized insurers and reinsurers could start writing, or increase their writing of, the classes of business in which the Company is primarily engaged. Competition in the classes of business which the Company writes is based on many factors, including the perceived overall financial strength of the insurer or reinsurer, claims paying ability rating, premiums charged and other terms and conditions, services provided, reputation and perceived technical ability and experience of staff. Management of the Company believes that its principal competitive strengths are its management and 21 operational flexibility, its expertise in risk assessment and underwriting skills and its relationships with Lloyd's brokers, other leading brokers and reinsurance intermediaries. RATINGS The Company at March 16, 1998 carried A, A- and A+ claims paying ability rating by S&P, A.M. Best and Duff & Phelps, respectively. S&P and Duff & Phelps ratings range from a high "AAA" to a low "CCC", while A.M. Best ratings range from a high "A++" to a low "C-". At March 16, 1998 the rating of the Company's long term senior debt was BBB-, Baa3 and BBB at S&P, Moody's and Duff & Phelps, respectively. Claims paying ability ratings are based upon a review of publicly available information and communications between rating agency analysts and the insurance company's management. Such ratings are the opinion of the rating agency giving the rating and are not directed toward the protection of investors. AVIATION BUSINESS IN RUN-OFF In February 1992, having sustained major losses in the aviation business in the 1989, 1991 and 1992 underwriting years and believing that premium income was inadequate to cover the likely levels of claims arising for the foreseeable future, Terra Nova withdrew from the aviation primary and reinsurance market. Historically, Terra Nova had recorded strong profitability from writing aviation on predominately an excess of loss reinsurance basis. The cessation of aviation underwriting has been treated as a discontinued operation in the financial statements of Terra Nova, the Company's predecessor. Under this approach, the estimated cost relating to other overhead deemed necessary to complete the run-off of the aviation business was treated as a one-time charge ($2.1 million in 1992) and set up as a separate provision in Terra Nova's GAAP financial statements. 22 As a result of the Terra Nova Acquisition, charges or credits resulting from changes in estimates after December 31, 1994 are reflected in continuing operations of the Company. The run-off of aviation business is managed by a separate claims staff with analytical support from the actuarial and finance departments and management supervision by the technical department. This separate group of claims personnel has a significant amount of experience with the Company's aviation business. The following table shows the development of net reserves for losses and LAE for the calendar years 1987 to 1997 for the aviation business in run-off: ANALYSIS OF AVIATION NET LOSS AND LAE RESERVE DEVELOPMENT (DOLLARS IN MILLIONS)
YEAR ENDED DECEMBER 31, -------------------------------------------------------------------------------------------- 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 ----- ------ ------- ------ ------- ------ ------ ----- ----- ----- ----- Reserves for unpaid losses and LAE $29.9 $ 36.1 $ 31.7 $ 47.5 $ 60.9 $ 97.9 $ 82.3 $90.6 $79.4 $48.6 $32.9 Reserves re-estimated(1) as of: One year later 30.9 33.5 35.0 36.6 108.2 98.1 90.6 95.1 80.2 48.7 Two years later 29.5 34.4 22.8 71.3 108.6 106.4 95.2 95.9 80.2 Three years later 29.1 23.9 69.5 67.7 117.1 111.0 95.9 95.8 Four years later 23.1 28.1 70.4 77.0 122.1 111.7 95.8 Five years later 23.8 26.3 78.8 86.6 122.9 111.6 Six years later 23.3 35.2 71.3 86.6 123.7 Seven years later 22.2 48.5 70.6 86.9 Eight years later 24.4 46.8 70.6 Nine years later 24.5 46.7 Ten years later 24.3 Cumulative redundancy (deficiency) 5.6 (10.6) (38.9) (39.4) (62.8) (13.7) (13.5) (5.2) (0.8) (0.1) As a percentage of unpaid losses and LAE 18.70% (29.36)% (122.40)% (82.95)% (103.12)% (13.99)% (16.40)% (5.74)% (0.88)% (0.21)% Paid (cumulative) as of: One year later $ 2.9 $ 0.8 $ (6.9) $(22.1) $ 18.6 $ 13.0 $ (1.0) $15.0 $32.0 $14.6 Two years later 8.2 1.9 (16.8) (6.8) 20.9 11.9 13.8 47.1 46.4 Three years later 8.4 (2.6) (11.2) 9.6 19.4 26.0 45.6 61.6 Four years later 8.4 (4.8) 4.1 8.2 35.2 57.9 60.0 Five years later 9.2 (9.6) 2.5 24.5 68.2 72.4 Six years later 9.3 (16.3) 17.1 57.4 83.1 Seven years later 9.2 (0.7) 48.1 72.3 Eight years later 11.3 10.5 68.6 Nine years later 12.1 30.5 Ten years later 12.5
- -------- (1) "Reserves re-estimated" includes losses actually paid in current and prior years. 23 The following table represents an analysis of gross loss and LAE reserve development for the years indicated for the aviation business in run-off: ANALYSIS OF GROSS LOSS AND LAE RESERVE DEVELOPMENT
YEAR ENDED DECEMBER 31, --------------------------------------- 1993 1994 1995 1996 1997 ------ ------ ------ ------ ----- (DOLLARS IN MILLIONS) Gross reserves for unpaid losses and LAE $315.1 $318.7 $164.9 $139.7 $75.8 Reinsurance recoveries on unpaid losses and LAE 232.8 228.1 85.5 91.1 42.8 Gross reserves re-estimated (1) as of: One year later 373.6 214.0 170.1 140.6 Two years later 268.9 218.8 170.8 Three years later 273.7 219.5 Four years later 274.3 Reinsurance recoveries on unpaid losses and LAE re-estimated (2) as of: One year later 283.0 118.9 89.9 91.9 Two years later 173.7 122.9 90.6 Three years later 177.8 123.7 Four years later 178.5 Gross cumulative redundancy (deficiency) 40.8 99.2 (5.9) (0.9) As expressed as a percentage of unpaid losses and LAE 12.94% 31.12% (3.58)% (0.64)% Paid (cumulative) as of: One year later 38.5 49.2 33.2 64.1 Two years later 104.0 83.3 96.3 Three years later 119.7 146.4 Four years later 182.2
- -------- (1) "Gross reserves re-estimated" includes losses actually paid in current and prior years. (2) "Reinsurance recoveries on unpaid losses and LAE re-estimated" includes reinsurance recoveries actually received in current and prior years. 24 The following table represents a reconciliation of reserve balances for the years indicated: RECONCILIATION OF AVIATION RESERVE BALANCES
YEAR ENDED DECEMBER 31, ---------------------- 1997 1996 1995 ------ ------ ------ (DOLLARS IN MILLIONS) Reserves for unpaid losses and loss adjustment expenses, gross of reinsurance, at the beginning of the year $139.7 $164.9 $318.7 Less reinsurance recoverables 91.1 85.5 228.1 ------ ------ ------ Net balance at beginning of the year 48.6 79.4 90.6 ------ ------ ------ Incurred related to: Prior years -- 0.8 4.6 ------ ------ ------ Total incurred -- 0.8 4.6 ------ ------ ------ Paid related to: Prior years (14.5) (32.0) (15.0) ------ ------ ------ Total paid (14.5) (32.0) (15.0) Foreign exchange adjustment (1.1) 0.4 (0.8) ------ ------ ------ Net reserves at end of year 33.0 48.6 79.4 Reinsurance recoverables by the Company 42.8 91.1 85.5 ------ ------ ------ Reserves for unpaid losses and loss adjustment expenses, gross of reinsurance at the end of the year $ 75.8 $139.7 $164.9 ====== ====== ======
ANALYSIS OF AVIATION RUN-OFF
AT DECEMBER 31, ------------ 1997 1996 ----- ------ (DOLLARS IN MILLIONS) Gross reserves: Claims outstanding $45.6 $ 57.1 IBNR 30.2 82.6 ----- ------ Total $75.8 $139.7 ===== ====== Reinsurance recoverables as to: Claims outstanding $41.1 $ 59.8 IBNR 1.7 31.3 ----- ------ Total $42.8 $ 91.1 ===== ====== Net Reserves: Claims outstanding $ 4.5 $ (2.7) IBNR 28.5 51.3 ----- ------ Total $33.0 $ 48.6 ===== ======
EMPLOYEES At December 31, 1997, Terra Nova and Terra Nova (Bermuda) had 206 employees, none of which was represented by a labor union. The Company believes that its relationship with its employees is excellent. At the same date, Corifrance had 33 employees. Octavian has 344 employees, and is reimbursed by the Octavian Syndicates for costs relating to most of these employees. 25 REGULATION OF THE COMPANY UNITED KINGDOM Authorization to Transact Business. Subject to certain exceptions, particularly in relation to EC companies, no person may carry on insurance business in the U.K. unless authorized by the H.M. Treasury ("Treasury") to do so. Previously supervision of insurance companies was undertaken by the D.T.I., whose responsibilities have now been assumed by the Treasury, Insurance Directorate. Insurance companies authorized to carry on insurance business by the Treasury in the U.K. are required to file with the Treasury independently audited financial statements (the "Treasury Returns") within six months of the period to which such figures relate. A company which carries on long-term business is also required to arrange an actuarial appraisal of such business and to submit an abstract of the actuarial report to the Treasury within six months of the period to which such figures relate. In addition, companies incorporated in the U.K. must comply with certain provisions of the Companies Act 1985 (the "Companies Act") requiring them to file and provide their shareholders with audited financial statements and related reports by their directors. Under the Companies Act, a company is required to produce an annual financial statement reported on by an independent auditor and signed by at least one director. The Treasury Returns. The contents of the Treasury Returns include: (i) a balance sheet and profit and loss account; (ii) general business revenue accounts and additional information regarding premiums, claims and risk exposure; and (iii) directors' and auditors' certificates. The required contents of such returns depend on the category of the company and the business conducted. The Treasury Returns must also provide additional information relating to the reinsurance of business written, including details regarding: (i) the amount of business reinsured; (ii) the names of the major reinsurers; (iii) the relationship between Terra Nova and any major reinsurer; and (iv) the types of reinsurance cover purchased by Terra Nova. Minimum Solvency Margins. Companies authorized to transact non-life insurance business in the U.K. are required to maintain a minimum solvency margin; that is, their assets must exceed their liabilities by a minimum specified amount, subject in each case to a minimum amount (the "minimum guarantee fund"). Each non-life insurance company must calculate margins under both a premium basis method and a claims basis method. There are regulations in accordance with which assets and liabilities are valued. The higher (i.e., the more conservative) of the two results is the required solvency margin. In calculating the solvency margin under each method, the level of gross claims before reinsurance is used, and a subsequent credit is applied for reinsurance recoverables (subject in each case to a maximum credit of 50%). Additional solvency margins apply to companies also transacting life business. In practice the Treasury like to see a solvency margin of at least twice the statutory solvency margin. At December 31, 1997, Terra Nova's estimated minimum solvency margin was $30.1 million and the excess of its solvency margin over its minimum solvency margin was $171.5 million. Dividends. The ability of Terra Nova to declare and pay dividends is limited by a Notice of Requirements issued by the DTI (now the Treasury) on May 22, 1995 (the "Notice"). The Notice provides that Terra Nova must give 14 days' advance notice to the Treasury of its intention to declare and pay a dividend. The Treasury may direct that no such declaration or payment be made. In reviewing dividend proposals, the Treasury considers the adequacy of Terra Nova's solvency margin, its recent operating performance and other factors deemed appropriate by the Treasury. In addition, Terra Nova must comply with the Companies Act, which provides that dividends may only be paid out of distributable profits (i.e., its accumulated realized profits (so far as not previously used by distribution or capitalization) less its accumulated realized losses (so far as not previously written off in a reduction or reorganization of capital)). At December 31, 1997, Terra Nova's solvency margin was $201.6 million in excess of its estimated minimum solvency margin, and its distributable profits under U.K. GAAP were $100.2 million. 26 Supervision of Management and Control. No U.K. insurance company may appoint any person as managing director or chief executive officer without the Treasury's prior approval and no person may otherwise become a "controller" of an insurance company without such approval. For these purposes, "controller" of an insurance company means (in addition to a managing director or chief executive officer of the insurance company): (i) a managing director of a company of which the insurance company is a subsidiary; (ii) the chief executive officer of an insurance company of which the insurance company is a subsidiary; (iii) a person in accordance with whose directions or instructions the directors of the insurance company or of a body corporate of which the insurance company is a subsidiary are accustomed to act; (iv) a person who either alone or with any associate(s) (as defined by section 96C of the Insurance Companies Act 1982 for these purposes): (a) holds 10% or more of the shares in the insurance company or another company of which the insurance company is a subsidiary; or (b) is able to exercise or control the exercise of 10% or more of the voting power at any general meeting of the insurance company or another company of which the insurance company is a subsidiary; or (c) is able to exercise a significant influence over the management of the insurance company or another company of which the insurance company is a subsidiary by virtue of a holding of shares or an entitlement to control the exercise of voting rights thereof. For the purposes of paragraphs (i) and (iv), "subsidiary" means "subsidiary undertaking" as defined by Section 736 of the Companies Act 1985. Similar approvals are required to be obtained for a shareholder controller to acquire a "notifiable holding" in a U.K. insurance company (i.e., a holding of 10% or more but less than 20%; 20% or more but less than 33%; and 33% or more but less than 50%; 50% exactly; or a shareholding which is such that the insurance company becomes a subsidiary (as defined by U.K. statute for these purposes) or such shareholder controller). In the case of the appointment of a managing director or a chief executive, the obligation is on the Company to notify the Treasury. In each of the other cases, the obligation is on the controller itself to notify the Treasury. The Treasury is deemed to have approved the appointment or change of controller, or the acquisition or increase in the level of a notifiable holding, if it receives the prescribed notice and does not object within three months (or extend such three-month period) to such appointment, change of control or acquisition on the grounds that the person in question is either not a fit and proper person or that if the person were to be appointed or become such a controller or acquire a, or increase its, notifiable holding, the criteria of sound and prudent management would not or might not continue to be fulfilled in respect of the insurance company. An insurance company is also required to notify the Treasury of the identity and business history of its directors and senior managers and any changes with respect to such directors and managers. The business of an insurer is required by statute to be carried out with integrity, due care and the professional skills appropriate to the nature and scale of its activities. It must be directed and managed by a sufficient number of persons who are fit and proper persons to hold their positions and its business must be conducted in a sound and prudent manner. Upon a change of control (as defined by U.K. statute for these purposes), the Treasury has the power to serve a Notice of Requirements on an insurance company. Such a notice was served on Terra Nova as a result of the Terra Nova Acquisition. 27 In addition to the requirement regarding prior notification of intended dividends, the Notice requires Terra Nova to, among other things: (a) notify the Treasury in respect of certain transactions with connected persons; and (b) restrict the range of permitted investment of assets to the extent of the value of the liabilities of Terra Nova. Management does not believe that compliance with the Notice has a material effect on Terra Nova's business. The Treasury has further powers of intervention in the event that the criteria of sound and prudent management are not fulfilled. These powers are in addition to the Treasury's general power under Section 45 of the Insurance Companies Act 1982 to impose individual requirements on companies for the protection of policyholders. Lloyd's. Lloyd's is subject to a degree of overall regulation by the Treasury to which it must supply a return each year demonstrating the solvency of its members, both globally and on an individual basis. Lloyd's is, however, primarily self-governing, through the Council and its Market Board and Regulatory Board, to which the Council has delegated the majority of its functions, although it is proposed that this will change in the near future and that Lloyd's will be regulated by the new Finance Services Authority. For the purposes of the Lloyd's Act the Company is a Lloyd's "managing agent". The Lloyd's Act prohibits any person from acting as a Lloyd's broker if that person is a managing agent or is "associated" with a managing agent and also prohibits any person from acting as a managing agent if that person is a Lloyd's broker or is "associated" with a Lloyd's broker. The scope of these prohibitions is extremely broad. A person (which includes an individual or company) is associated with a Lloyd's broker for these purposes if: (a) it is: (i) a holding company, subsidiary or sister subsidiary of the Lloyd's broker; (ii) an individual or company which controls the Lloyd's broker. This is the case if the individual or company (either alone or with associates) is entitled to exercise or to control the exercise of a third or more of the voting power at any general meeting of the Lloyd's broker; (iii) an individual or company which is controlled by the Lloyd's broker; (iv) an individual or company which is controlled by a holding company, subsidiary or sister subsidiary of the Lloyd's broker; (v) a director of the Lloyd's broker; (vi) a director of any holding company, subsidiary or sister subsidiary of the Lloyd's broker; and (b) that person holds any interest in the Lloyd's broker (or supplies the services of an individual to the Lloyd's broker). The term "interest" includes any beneficial interest in any of the stock, shares or other securities of the Lloyd's broker. Similar rules to those above apply in relation to partnerships and partners therein. In addition, the term "Lloyd's broker" is expressed to include not only the Lloyd's broker itself but also a holding company (a company which is entitled to exercise more than 50% of the voting power) of the Lloyd's broker and any person or company which "controls" the Lloyd's broker (a person or company which is entitled to exercise a third or more of the voting power). These provisions therefore prohibit a Lloyd's broker or any of the persons listed in paragraph (a) above from holding a direct interest in the Company. However, it is permitted for a Lloyd's broker (or any of its 28 associates) to acquire an interest in the Company provided such an interest represents not more than 5% in nominal amount of the Company's stock, shares or other securities, or any class thereof, which are authorized to be traded on a stock exchange or in any over-the-counter market, and in either case are so traded regularly or from time to time. In ascertaining in any case whether any person would fall within this exemption it should be noted that the Lloyd's Act requires not only the shareholding of the particular body corporate, partnership or individual concerned to be taken into account but also those of persons connected therewith (as widely defined in the Lloyd's Act). The Lloyd's Bye-Laws also contain a number of further requirements and restrictions relating to Lloyd's brokers having interests in managing agents compliance with which would have to be ensured prior to any shareholding in the Company being acquired. Subject to certain limited exceptions, the Bye- Laws of the Company permit the directors or their designee to decline to register the transfer of any shares of capital stock of the Company if they have reason to believe that such transfer may expose the Company, any subsidiary thereof or any shareholder to adverse tax, legal or regulatory treatment or would be in breach of any applicable legal or regulatory requirements, in each case in any jurisdiction, including the Lloyd's Act and Bye-Laws and other laws and regulations governing Lloyd's and members of Lloyd's. Any person who is or may fall within the definition "Lloyd's broker" or is unsure whether or not this is the case should take independent legal advice before acquiring any shareholding in the Company. Both Terra Nova Capital and Octavian are subject to regulation and supervision by Lloyd's. Lloyd's prescribes, in respect of each business, certain minimum standards relating to the management and control, solvency and various other requirements. Lloyd's operates under a self-regulatory regime and has the power to change the rules which govern the operation of the Lloyd's market. Lloyd's has wide discretion in the application and interpretation of the rules, which would, for example, permit Lloyd's to rescind the membership of a member (such as Terra Nova Capital or Octavian) if Lloyd's believes the member not to be "fit and proper." In addition Lloyd's imposes similar restrictions against persons becoming controllers and major shareholders of corporate members and managing agents without their consent first having been obtained. The tests are similar to those set out in respect of the Treasury above. BERMUDA The Insurance Act 1978 and Related Regulations. As a holding company, the Company is not subject to Bermuda insurance regulation. However, Terra Nova (Bermuda) is subject to regulation under The Insurance Act 1978, amendments thereto and related regulations of Bermuda (the "Bermuda Act"), which provide that no person may carry on insurance business in or from within Bermuda unless registered as an insurer under the Bermuda Act by the Minister. In deciding whether to grant registration, the Minister has broad discretion to act as he thinks fit in the public interest. The Minister is required by the Bermuda Act to determine whether the applicant is a fit and proper body to be engaged in insurance business and, in particular, whether it has, or has available to it, adequate knowledge and expertise. In connection with registration, the Minister may impose conditions relating to the writing of certain types of insurance business. The Bermuda Act imposes on Bermuda insurance companies solvency and liquidity standards and auditing and reporting requirements and grants to the Minister powers to supervise, investigate and intervene in the affairs of insurance companies. Significant aspects of the Bermuda insurance regulatory framework are set forth below. Cancellation of an Insurer's Registration. An insurer's registration may be cancelled by the Minister on certain grounds specified in the Bermuda Act including failure of the insurer to comply with its obligations under the Bermuda Act or if, in the opinion of the Minister after consultation with the Insurance Advisory Committee, the insurer has not been carrying on business in accordance with sound insurance principles. Independent Approved Auditor; Statutory Financial Statements; Statutory Financial Return. Every registered insurer must appoint an independent auditor approved by the Minister who will annually audit and 29 report on the statutory financial statements and the statutory financial return of the insurer, which are required to be filed annually with the Registrar of Companies of Bermuda (the "Registrar"), who is the chief administrative officer under the Bermuda Act. The approved auditor may be the same person or firm that audits the insurer's financial statements and reports for presentation to its shareholders. An insurer must prepare annual statutory financial statements. The statutory financial statements are not prepared in accordance with GAAP and are distinct from the financial statements prepared for presentation to the insurer's shareholders under The Companies Act 1981. The insurer is required to submit the annual statutory financial statements as part of the annual statutory financial return. An insurer is required to file with the Registrar a statutory financial return that includes, among other matters, a report of the approved independent auditor on the statutory financial statements of the insurer, a declaration of the statutory ratios and a related solvency certificate. Minimum Solvency Margin. The Bermuda Act provides that the statutory assets of an insurer must exceed its statutory liabilities by an amount greater than the prescribed minimum solvency margin. Pursuant to the Bermuda Act, Terra Nova (Bermuda) is registered as a Class 4 insurer and, as such, is: (i) required to maintain a minimum statutory capital and surplus equal to the greatest of (a) $100 million, (b) 50% of its net premiums written (with a maximum credit of 25% for reinsurance ceded) or (c) 15% of its loss and other insurance reserves; (ii) required to file annually, within four months following the end of the relevant financial year, with the Registrar, a statutory financial return together with a copy of its annual statutory financial statements, an opinion of a loss reserve specialist in respect of its loss and loss expense provisions and a schedule of reinsurance ceded; (iii) prohibited from declaring or paying any dividends during any financial year if it is in breach of its minimum solvency margin or minimum liquidity ratio or if the declaration or payment of such dividends would cause it to fail to meet such margin or ratio (if it has failed to meet its minimum solvency margin or minimum liquidity ratio on the last day of any financial year, Terra Nova (Bermuda) will be prohibited, without the approval of the Minister, from declaring or paying any dividends during the next financial year); (iv) prohibited from declaring or paying in any financial year dividends of more than 25% of its total statutory capital and surplus (as shown on its previous statutory balance sheet) unless it files with the Registrar an affidavit stating that it will continue to meet the required margins; (v) prohibited, without the approval of the Minister, from reducing by 15% or more its total statutory capital, as set out in its previous year's financial statements and any application for such approval must include an affidavit stating that it will continue to meet required margins; and (vi) required, at anytime it fails to meet its solvency margin, within 30 days (45 days where total statutory capital and surplus falls to $75 million or less) after becoming aware of that failure or having reason to believe that such failure has occurred, to file with the Minister a written report containing certain information. Minimum Liquidity Ratio. The Bermuda Act provides a minimum liquidity ratio for general business. An insurer engaged in general business is required to maintain the value of its relevant assets at not less than 75% of the amount of its relevant liabilities. Relevant assets include cash and time deposits, quoted investments, unquoted bonds and debentures, first liens on real estate, investment income due and accrued, accounts and premiums receivable and reinsurance balances receivable. There are certain categories of assets which, unless specifically permitted by the Minister, do not automatically qualify as relevant assets, such as unquoted equity securities, investments in and advances to affiliates, real estate and collateral loans. The relevant liabilities are total general business insurance reserves and total other liabilities less deferred income tax and sundry liabilities (by interpretation, those not specifically defined). Supervision, Investigation and Intervention. The Minister may appoint an inspector with extensive powers to investigate the affairs of an insurer if the Minister believes that an investigation is required in the interest of the insurer's policyholders or persons who may become policyholders. In order to verify or supplement information otherwise provided to him, the Minister may direct an insurer to produce documents or information relating to matters connected with the insurer's business. 30 If it appears to the Minister that there is a risk of the insurer becoming insolvent, or that it is in breach of the Bermuda Act or any conditions imposed on its registration the Minister may, among other things, direct the insurer not to take on any new insurance business; not to vary any insurance contract if the effect would be to increase the insurer's liabilities; not to make certain investments; to realize certain investments; to maintain, or transfer to the custody of a specified bank, certain assets; not to declare or pay any dividends or other distributions or to restrict the making of such payments; and/or to limit its premium income. An insurer is required to maintain a principal office in Bermuda and to appoint and maintain a principal representative in Bermuda. For the purpose of the Bermuda Act, the principal office of Terra Nova (Bermuda) is Richmond House, 12 Par-la-Ville Road, Hamilton HM 08, Bermuda, and Mr. William O. Bailey is the principal representative of Terra Nova (Bermuda). Without a reason acceptable to the Minister, an insurer may not terminate the appointment of its principal representative, and the principal representative may not cease to act as such, unless 30 days' notice in writing to the Minister is given of the intention to do so. It is the duty of the principal representative, within 30 days of his reaching the view that there is a likelihood of the insurer for which he acts becoming insolvent or its coming to his knowledge, or his having reason to believe, that an "event" has occurred, to make a report in writing to the Minister setting out all the particulars of the case that are available to him. Examples of such an "event" include failure by the insurer to comply substantially with a condition imposed upon the insurer by the Minister relating to a solvency margin or a liquidity or other ratio. UNITED STATES Excess and Surplus Lines Insurance. Terra Nova is an approved or eligible excess and surplus lines insurer in 47 states, as well as in the District of Columbia and the U.S. Virgin Islands. In order to maintain such approvals and eligibilities, Terra Nova agreed to establish a U.S. trust fund, having a value of at least $18.0 million for the benefit of U.S. surplus lines policyholders. At December 31, 1997, the trust fund was valued at $19.0 million. Terra Nova's U.S. surplus lines trust fund exceeds California's requirement of $5.4 million which, as of March 1, 1998, was the highest minimum trust fund amount in any U.S. jurisdiction. Terra Nova also complies with minimum capital and surplus requirements in the United States. As of March 1, 1998, the highest such requirement was $15.0 million. Terra Nova also files annually with the International Insurers Department (the "IID") of the NAIC and with regulatory authorities in many of the U.S. jurisdictions in which Terra Nova is an approved or eligible surplus lines insurer, its annual financial statements, actuarial certifications as to the adequacy of its loss reserves, descriptions of its outward reinsurance programs (including premiums, recoveries and recoverables thereunder), and directors' and officers' biographical affidavits and related information. Model Nonadmitted Insurance Act. At its December 1996 meeting, the NAIC adopted amendments to the Nonadmitted Insurance Model Act (the "Model Act"). As individual U.S. jurisdictions adopt the Model Act Terra Nova's continued surplus lines eligibility or approval will hinge upon maintenance of a U.S. surplus lines trust fund in an amount equal to the greater of (a) $5.4 million or (b) 30% of U.S. surplus lines gross liabilities (excluding aviation wet marine and transportation insurance), subject to a cap of $60.0 million. The Model Act provides a two-year phase-in for the new trust fund requirement. Only Louisiana has adopted the Model Act's new trust fund standards. The Company is not aware that any other state legislatures are considering Model Act legislation. The Company also believes that the implementation of the Model Act, whether by statute or regulation, will not have a material adverse impact upon Terra Nova's business or financial position. Maintenance of a U.S. surplus lines trust fund that exceeds the current level could provide competitive advantages for Terra Nova vis-a-vis other non-U.S. surplus lines insurers that maintain lower trust funds and U.S. domestic surplus lines insurers that do not maintain such trust funds. The Model Law on Credit for Reinsurance (the "Reinsurance Model Law") adopted in 1984 and subsequently amended on several occasions by the NAIC has now been enacted or promulgated in nearly all U.S. jurisdictions. The Reinsurance Model Law contains a provision that allows overseas-based reinsurers to establish a single U.S. reinsurance trust fund equal in amount to their prospective reinsurance liabilities in respect of U.S. cedents plus $20.0 million for the purpose of securing business written in the United States by U.S. 31 cedents and permitting such cedents to deduct ceded liabilities when preparing statutory financial statements. Terra Nova has established such a U.S. reinsurance trust fund. As of March 1, 1998, Terra Nova had received trusteed reinsurer approval from the departments of insurance of 39 states and had applications for trusteed reinsurer status pending in 6 additional states. Terra Nova provides U.S. cedents that are not domiciled in one of the states in which it is approved as a trusteed reinsurer with letters of credit to secure ceded liabilities. Such cedents are thus permitted to deduct such liabilities when preparing statutory financial statements. CERTAIN U.K., U.S. AND BERMUDA TAX CONSIDERATIONS TAXATION OF THE COMPANY AND ITS SUBSIDIARIES BERMUDA Under current Bermuda law, there is no income or capital gains tax payable by the Company or its Bermuda subsidiaries. The Company and its Bermuda subsidiaries have received from the Minister assurances, under The Exempted Undertakings Tax Protection Act 1966 of Bermuda, to the effect that in the event of there being enacted in Bermuda any legislation imposing tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax shall not be applicable to them or to any of their respective operations or to their shares, debentures or other obligations until March 28, 2016. These assurances are subject to the proviso that they are not to be construed so as to prevent the application of any tax or duty to such persons as are ordinarily resident in Bermuda or to prevent the application of any tax payable in accordance with the provisions of The Land Tax Act 1967 of Bermuda or otherwise payable in relation to any property leased to the Company or its Bermuda subsidiaries. The Company and its Bermuda subsidiaries are required to pay certain annual Bermuda government fees. In addition, Terra Nova (Bermuda) is required to pay certain business fees as an insurer under the Bermuda Act. As of March 16, 1998, there would be no Bermuda withholding tax on dividends paid by Terra Nova (Bermuda) to the Company. UNITED KINGDOM UK Holdings and its U.K. resident subsidiaries are chargeable to U.K. corporation tax on their worldwide profits, currently at the rate of 31%. Provided UK Holdings and its U.K. resident subsidiaries are members of the same group for purposes of the U.K. group relief provisions, losses of one member will be available for surrender to the other members on a current year basis, subject to satisfying the detailed conditions of the relevant legislation. For the purpose of calculating U.K. corporation tax, all transactions between Terra Nova, UK Holdings, the Company and Terra Nova (Bermuda) must be deemed made on an arm's length basis. No U.K. withholding tax will be imposed on dividends paid to the Company by U.K. Holdings and the Company will have no U.K. tax liability in respect of such dividends. On paying a dividend to the Company, however, UK Holdings will be required to account to the U.K. Inland Revenue for Advance Corporation Tax ("ACT"). The rate of ACT is currently set at 25% of the dividend. ACT may in certain circumstances be offset by the paying company (or other members of the U.K. group) against its (or their) U.K. corporation tax liability and may in certain circumstances give rise to a repayment of corporation tax paid in respect of prior years. The Company will not be entitled to any U.K. tax credit corresponding to the ACT in respect of any dividends paid to it by UK Holdings. 32 UNITED STATES In general, a foreign corporation is subject to U.S. federal income tax on its taxable income that is treated as effectively connected with its conduct of a trade or business within the United States and to the 30% U.S. branch profits tax on its effectively connected earnings and profits (with certain adjustments) deemed repatriated out of the United States unless the corporation is entitled to relief under the provisions of a tax treaty into which the United States has entered. The United States has entered into tax treaties with Bermuda (the "Bermuda Treaty") and the U.K. (the "U.K. Treaty"). Pursuant to the U.K. Treaty, business profits earned by residents of the U.K. may be taxed in the United States only if such profits are attributable to the conduct of a trade or business in the United States through a permanent establishment situated therein. The U.K. Treaty also prevents the imposition of the branch profits tax on qualified treaty residents of the U.K.. The Bermuda Treaty provides that business profits derived from carrying on the business of insurance by a Bermuda company that is an "enterprise of insurance" may only be taxed in the United States if such profits are attributable to the conduct of a trade or business in the United States through a permanent establishment situated therein. However, a Bermuda company is entitled to the Bermuda Treaty benefits described above only if (i) more than 50% of its shares are beneficially owned, directly or indirectly, by individuals who are U.S. citizens or residents or Bermuda residents and (ii) the company's income is not used in substantial part, to make disproportionate distributions to, or to meet certain liabilities to, persons who are not U.S. citizens or residents or Bermuda residents. The Bermuda Treaty does not preclude the imposition of the U.S. branch profits tax. The Company believes that the Company and its subsidiaries have been operated and in the future, will continue to be operated, in a manner that will not cause any of them to be treated as being engaged in a U.S. trade or business. However, because the Internal Revenue Code of 1986, as amended (the "Code"), the Treasury Regulations and court decisions do not identify definitively activities that constitute being engaged in a U.S. trade or business, and because of the factual nature of the determination, there can be no assurance that the Internal Revenue Service (the "Service") will not contend that the Company or one of its subsidiaries is engaged in a U.S. trade or business. If the Company or any of its subsidiaries were considered to be engaged in a U.S. trade or business, that entity would be subject to U.S. federal income tax on income effectively connected with that trade or business, and would be subject to the branch profits tax as well, unless it was entitled to relief under the U.K. Treaty or the Bermuda Treaty. There can be no assurance that Terra Nova (Bermuda) is entitled, or in the future will be entitled, to the benefits of the Bermuda Treaty. However, if Terra Nova (Bermuda) were so entitled and were considered to be engaged in a U.S. trade or business, application of U.S. federal income tax, but not the U.S. branch profits tax, would be limited to business profits attributable to a permanent establishment. As stated above, the Company believes that Terra Nova (Bermuda) will not be engaged in a U.S. trade or business. Additionally, the Company believes that UK Holdings and Terra Nova will be entitled to the benefits of the U.K. Treaty. Thus, even if UK Holdings or Terra Nova were considered to be engaged in a U.S. trade or business, that entity would not be subject to U.S. federal income tax, unless it were considered to engage in a U.S. trade or business through a permanent establishment, in which case such entity would be subject to U.S. federal income tax only on taxable income attributable to its permanent establishment, and would not be subject to the branch profits tax. Although there can be no assurances, the Company believes that none of Terra Nova (Bermuda) or UK Holdings or Terra Nova has, or will have, a permanent establishment in the United States. While there can be no assurance that UK Holdings will be entitled to the U.K. Treaty exemption from the branch profits tax, and although the Company will not be entitled to relief under the Bermuda Treaty, as stated above, the Company believes that neither it nor UK Holdings will be engaged in a U.S. trade or business and that therefore they will not be subject to U.S. federal income tax. Foreign corporations not engaged in a trade or business in the United States (as well as foreign corporations engaged in the conduct of a trade or business in the United States, but only with respect to their income that is 33 not effectively connected with such trade or business) are subject to U.S. federal withholding tax on certain "fixed or determinable annual or periodical" income (such as dividends and interest on certain investments) derived from sources within the United States. Such tax is generally imposed at a rate of 30% on the gross income subject to tax. Under the U.K. Treaty, the rate applicable to interest and dividends paid to Terra Nova or UK Holdings generally will be reduced to zero and 15%, respectively. The Bermuda Treaty does not provide for a reduction. The United States also imposes an excise tax on insurance and reinsurance premiums paid to foreign insurers or reinsurers with respect to risks located in the United States. The rates of tax currently applicable are 4% of gross casualty insurance premiums and 1% of gross reinsurance premiums. In general, premiums paid to Terra Nova have been and, the Company believes, will continue to be exempt from this excise tax under the U.K. Treaty. Similar relief will not be available with respect to premiums paid to Terra Nova (Bermuda). ITEM 2--PROPERTIES The principal offices of the Company are leased by the Company in Hamilton, Bermuda. Terra Nova's London executive offices are leased by Terra Nova and its underwriting and claims staff is located in space leased by Terra Nova in the London Underwriting Centre and in the Institute of London Underwriters' building. Octavian leases offices in London, Poole, Leeds and Chelmsford and also leases space in the Lloyd's building. Corifrance leases offices in Paris, France. Additionally, Terra Nova leases offices in Brussels and Toronto. Management believes that its office space is adequate for the Company's current needs. ITEM 3--LEGAL PROCEEDINGS The Company, like the insurance industry in general, is subject to litigation in the normal course of its business. Management does not believe that any pending or threatened litigation or dispute will have a material adverse effect on its financial position, although there can be no assurance that losses resulting from any pending or threatened litigation or dispute will not materially affect the Company's result of operations for any period. ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Matters submitted to a vote of security holders during the year were: (a) those matters ordinarily dealt with at the Annual General Meeting of the Company in accordance with Bermudian law; and (b) changes to the capital structure, Bye-Laws and executive share option plans of the Company in connection with the Offerings. 34 PART II ITEM 5--MARKET FOR THE REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDERS MATTERS (a) The Company's common shares, par value $5.80 per share, commenced trading on April 17, 1996 on the New York Stock Exchange ("NYSE") under the symbol of TNA. The following table sets forth the high and low sales prices of the common shares in each of the fiscal quarters since such trading commenced, together with cash dividends paid:
1997 1996 ------------------------- ------------------------- MARKET PRICE MARKET PRICE --------------- --------------- DIVIDEND DIVIDEND QUARTER HIGH LOW PER SHARE HIGH LOW PER SHARE ------- ------- ------- --------- ------- ------- --------- 1 $21 1/2 $18 3/4 $0.02 N/A N/A N/A 2 $22 1/8 $18 $0.05 $17 5/8 $14 1/8 $0.02 3 $27 1/4 $20 7/8 $0.05 $20 1/2 $15 $0.02 4 $29 5/8 $24 1/4 $0.05 $25 $19 7/8 $0.02 ------- ------- ----- ------- ------- ----- Year end closing price $26 1/4 $20 1/2
(b) The approximate number of holders of common shares, as at December 31, 1997, was 1,700. 35 ITEM 6--SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION The following table sets forth selected consolidated financial information with respect to the Company and Terra Nova, its predecessor, for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements of the Company and Terra Nova and related notes thereto and "Management's Discussion and Analysis of Results of Operations and Financial Condition". In view of the short period between the date of the Terra Nova Acquisition and year-end, December 31, 1994 has been considered the date of the Terra Nova Acquisition for accounting purposes. As a result, the operations of the Company, UK Holdings and Terra Nova (Bermuda) for the period December 21, 1994 to December 31, 1994, which were not material, have been included in the results of operations of Terra Nova. FIVE YEAR FINANCIAL SUMMARY
COMPANY TERRA NOVA -------------------------- ----------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Gross premiums written 550.2 361.0 302.7 359.4 320.2 Net premiums written 483.5 311.2 247.0 282.5 262.0 Net premiums earned 419.1 278.8 251.9 250.4 229.5 Net investment income 85.1 78.1 74.5 51.6 46.9 Income from continuing operations, before taxes and minority interests 91.0 82.7 62.4 50.7 81.9 Net income 73.4 63.9 43.3 27.4 51.6 Net operating earnings (1) 62.9 57.2 39.3 25.0 27.1 BALANCE SHEET DATA (AT END OF PERIOD): Total assets 2,220.1 1,867.3 1,785.0 1,751.8 1,641.6 Shareholders' equity 481.9 398.8 197.0 59.1 163.7 Long-term debt 175.0 100.0 100.0 85.0 -- Convertible redeemable preferred shares -- -- 33.4 33.4 -- PER SHARE DATA: Earnings per share (2) $ 2.82 $ 2.69 $ 2.63 -- -- Net operating earnings per share (2) $ 2.42 $ 2.37 $ 2.24 -- -- Book value per share (3) $ 18.96 $ 15.43 $ 12.80 $ 5.80 -- Dividends paid per common share $ 0.17 $ 0.06 -- -- --
- -------- (1) Net operating earnings represents net income before discontinued operations, minority interests and realized gains on investments after tax. (2) Earnings per share and net operating earnings per share are calculated on a diluted basis by using the weighted average number of common shares outstanding during the period. 1996 and 1995 disclosures have been restated in order to comply with SFAS No. 128--"Earnings per Share". (3) Book value per share is equal to total shareholders' equity divided by the number of common shares outstanding at the end of the period. 36 ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION THE COMPANY The following discussion addresses the principal factors affecting the earnings and financial condition of the Company. All references herein to the "Company" are to Terra Nova (Bermuda) Holdings Ltd. ("Bermuda Holdings") and all of its direct and indirect subsidiaries, including Terra Nova Insurance (UK) Holdings plc ("UK Holdings"), Terra Nova Insurance Company Limited ("Terra Nova"), Terra Nova (Bermuda) Insurance Company Ltd. ("Terra Nova (Bermuda)"), Compagnie de Reassurance d'Ile de France ("Corifrance"), Octavian Syndicate Management Limited ("Octavian") and Terra Nova Capital Limited ("Terra Nova Capital"). Mix of Business The Company's mix of business for the years ended December 31, 1997, 1996 and 1995 and the key ratios by major line of business are as set forth in the following table:
YEAR ENDED DECEMBER 31, -------------------------------------------------- 1997 1996 1995 ---------------- ---------------- ---------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT -------- ------- -------- ------- -------- ------- (DOLLARS IN THOUSANDS) Gross Premiums Written Non-marine property $237,270 43.2% $180,561 50.0% $143,486 47.4% Non-marine casualty 128,472 23.3 68,107 18.9 54,716 18.1 Marine & Aviation 184,501 33.5 112,342 31.1 104,456 34.5 -------- ----- -------- ----- -------- ----- Total $550,243 100.0% $361,010 100.0% $302,658 100.0% ======== ===== ======== ===== ======== ===== Net Premiums Written Non-marine property $212,198 43.9% $157,737 50.7% $113,239 45.9% Non-marine casualty 119,194 24.6 62,244 20.0 48,118 19.5 Marine & Aviation 152,153 31.5 91,185 29.3 85,628 34.6 -------- ----- -------- ----- -------- ----- Total $483,545 100.0% $311,166 100.0% $246,985 100.0% ======== ===== ======== ===== ======== ===== Net Premiums Earned Non-marine property $192,607 46.0% $132,677 47.6% $110,572 43.9% Non-marine casualty 96,445 23.0 55,992 20.1 48,983 19.5 Marine & Aviation 130,017 31.0 90,087 32.3 92,345 36.6 -------- ----- -------- ----- -------- ----- Total $419,069 100.0% $278,756 100.0% $251,900 100.0% ======== ===== ======== ===== ======== ===== Loss and Loss Adjustment Expense Ratios Non-marine property 65.8% 61.6% 62.5% Non-marine casualty 74.9 82.0 101.3 Marine & Aviation 64.6 55.9 63.9 ----- ----- ----- Total 67.4% 64.0% 71.1% ===== ===== ===== Underwriting Expense Ratios Non-marine property 31.6% 31.7% 33.5% Non-marine casualty 26.1 28.8 27.4 Marine & Aviation 33.2 38.4 35.0 ----- ----- ----- Total 30.8% 33.2% 32.7% ===== ===== ===== Combined Ratios Non-marine property 97.4% 93.3% 96.0% Non-marine casualty 101.0 110.8 128.7 Marine & Aviation 97.8 94.3 98.9 ----- ----- ----- Total 98.2% 97.2% 103.8% ===== ===== =====
37 RESULTS OF OPERATIONS The Company's functional currency is the U.S. dollar. The changes in line item amounts from year to year as discussed below are all affected by the movement in exchange rates, principally the dollar/sterling average rate which varied from $1.64 for 1997, $1.57 for 1996 and $1.58 for 1995. Year Ended December 31, 1997 Compared with Year Ended December 31, 1996 Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written increased to $550.2 million in 1997 from $361.0 million in 1996. The increase in gross premiums written arises from: (a) Increased writings by Terra Nova Capital to $162.8 million (excluding orphaned syndicate business and reinsurance to close premiums) in 1997 from $36.8 million in 1996 due to the Company's increased participation in the Octavian Syndicates from 11% in 1996 to approximately 47% in 1997; (b) $39.1 million of premiums related to reinsurance to close of "orphaned" Lloyd's syndicates from the 1993 year of account; and (c) $17.9 million of premiums in respect of Terra Nova Capital's share of the closure of the 1995 year of account into the 1996 year of account of which it had an 11% share. Reinsurance ceded increased by 33.8% to $66.7 million in 1997 from $49.8 million in 1996. However, reinsurance ceded as a proportion of gross premiums written decreased to 12.1% in 1997 from 13.8% in 1996. The decrease was due to lower reinsurance costs at Terra Nova in 1997 due to structural changes on the non- marine property program and rate reductions obtained on the non-marine property, non-marine casualty and marine programs, partially offset by a higher level of reinsurance purchased by Terra Nova Capital in 1997. Net premiums written increased by 55.4% to $483.5 million in 1997 from $311.2 million in 1996, as a consequence of the increase in gross premiums written referred to above and lower reinsurance costs. Net premiums earned increased 50.3%, to $419.1 million in 1997 from $278.8 million in 1996. Net Investment Income. Net investment income increased 9.0%, to $85.1 million in 1997 from $78.1 million in 1996. The increase arose from an increase of 11.0% in average invested assets, primarily attributable to the higher operating cash flows in 1997 compared to 1996, $75 million debt issue in August 1997 and the acquisition of Corifrance in the following month partially offset by lower investment yields. The average investment yield before realized gains and losses was 6.2% and 6.3% in 1997 and 1996, respectively. The average duration of fixed maturity investments at December 31, 1997 and 1996 was 4.9 years and 4.2 years, respectively. Realized Net Capital Gains on Sales of Investments. Realized net capital gains on sales of investments increased $3.5 million to $15.3 million in 1997 from $11.8 million in 1996 mainly due to equity securities sold in the year. Foreign Exchange (Losses) Gains. Foreign exchange losses of $1.3 million in 1997 and gains of $0.4 million in 1996 arose from foreign currency transactions during the year together with the translation of foreign currency assets and liabilities into U.S. dollars, the Company's functional currency. The loss in 1997 was primarily a result of the dollar strengthening against the majority of major currencies in 1997. Agency Income. This income consists of fees received by Octavian in respect of the managing of certain Lloyd's syndicates. Losses and Loss Adjustment Expenses. Losses and LAE increased 58.5%, to $282.5 million in 1997 from $178.3 million in 1996. As a percentage of net premiums earned, losses and LAE increased 3.4 percentage points, to 67.4% in 1997 from 64.0% in 1996. The loss and LAE ratio for non-marine property business increased 38 to 65.8% in 1997 from 61.6% in 1996, due to a movement away from property catastrophe reinsurance towards less volatile, but lower margin, primary business. The loss and LAE ratio for non-marine casualty business decreased to 74.9% in 1997 from 82.0% in 1996 as a result of stable results for prior years in 1997. The increase in the marine loss and LAE ratio to 64.6% in 1997 from 55.9% in 1996 was a consequence of the competitive market conditions that existed in 1997 compared to 1996. Acquisition Costs. Acquisition costs, which are comprised of commission expenses and other underwriting expenses, increased 40.1% to $115.4 million in 1997 from $82.4 million in 1996. Acquisition costs as a percentage of net premiums earned decreased to 27.5% in 1997 from 29.6% in 1996. The decrease was largely a result of the earned premiums from the orphaned syndicate and RITC business written during 1997, which have very low acquisition costs; excluding this business, acquisition costs would have been 31.3% of premiums earned. Other Operating Expenses. Other operating expenses increased 34.7% to $13.7 million in 1997 from $10.2 million in 1996. Other operating expenses as a percentage of net premiums earned decreased to 3.3% in 1997 from 3.7% in 1996. Net Interest Expense. Net interest expense in 1997 relates to interest on the $100 million 10.75% Senior Notes issued on June 30, 1995 and interest on the $75 million 7.2% Senior Notes issued on August 26, 1997. The net interest expense in 1996 relates to interest on the $100 million 10.75% Senior Notes. Agency Expenses. These expenses consist of costs incurred in managing certain Lloyd's syndicates. Other Expenses. Other expenses remained constant at $5.3 million in both 1997 and 1996. Income from Continuing Operations before Income Taxes and Minority Interests. Income from continuing operations before income taxes and minority interests increased 10.1% to $91.0 million in 1997 from $82.7 million in 1996, primarily due to the increase in investment income and realized gains on sales of investments in 1997 compared to 1996. Income Tax Expense. Income tax expense marginally decreased $0.2 million, to $17.6 million in 1997 from $17.8 million in 1996, as a consequence of a reduction in the rate of U.K. Corporation Tax from 33% to 31% from April 1997. Income from Continuing Operations. Income from continuing operations increased $8.5 million, to $73.4 million in 1997 from $64.9 million in 1996, as a result of the factors described above. Combined Ratios. The Company's combined ratios were 98.2% for 1997 and 97.2% for 1996 reflecting the absence of significant large loses and any adverse development of prior year claims in both 1997 and 1996. Year Ended December 31, 1996 Compared with Year Ended December 31, 1995 Gross Premiums Written; Net Premiums Written; Net Premiums Earned. Gross premiums written increased 19.3% to $361.0 million in 1996 from $302.7 million in 1995. The overall increase in gross premiums written of $58.3 million was a consequence of the increase in current year gross premiums written of $50.2 million, together with an increase in prior year premiums of $8.1 million. The increase in gross premiums written on the current underwriting year arises from: (a) increased writings by Terra Nova (Bermuda) to $33.3 million in 1996 from $6.9 million in 1995 as a consequence of a full year of marketing prior to the January renewals. At least 95% of the business written by Terra Nova (Bermuda) is property business comprising catastrophe, proportional treaty and risk excess business on a world-wide basis. The increases in the property writings at Terra Nova (Bermuda) and increases in proportional treaty and direct business written by Terra Nova have resulted in property gross premiums written increasing to $178.9 million in 1996 from $139.3 million in 1995. 39 (b) Terra Nova Capital writing gross premiums of $36.8 million in 1996. Terra Nova Capital was established by the Company to participate in business written by the Octavian Syndicates for the 1996 and subsequent years of account. The majority of the business written by the Octavian Syndicates is U.K. casualty, marine and aviation business. Reinsurance ceded decreased by 10.5% to $49.8 million in 1996 from $55.7 million in 1995. The decrease was due to lower reinsurance costs at Terra Nova in 1996 as a result of an increase in the retention of the non-marine property catastrophe reinsurance program and rate reductions obtained on the non-marine property, non-marine casualty and marine programs, partially offset by reinsurance costs of $8.2 million in Terra Nova Capital in 1996. Net premiums written increased by 26.0% to $311.2 million in 1996 from $247.0 million in 1995, as a consequence of the increase in gross premiums written referred to above and lower reinsurance costs. Net premiums earned increased 10.7%, to $278.8 million in 1996 from $251.9 million in 1995. Net Investment Income. Net Investment income increased 4.9%, to $78.1 million in 1996 from $74.5 million in 1995. The increase arose from an increase of 11.9% in average invested assets, primarily attributable to the IPO in April 1996, partially offset by lower portfolio yields. The average investment yield before realized gains and losses was 6.3% and 6.7% in 1996 and 1995, respectively. The average duration of fixed maturity investments at December 31, 1996 and 1995 was 4.2 years and 4.1 years, respectively. Realized Net Capital Gains on Sales of Investments. Realized net capital gains on sales of investments increased $2.4 million to $11.8 million in 1996 from $9.4 million in 1995 mainly due to equity securities sold in the year. Foreign Exchange Gains. Foreign exchange gains of $0.4 million in 1996 and $1.1 million in 1995 arose from foreign currency transactions during the year together with the translation of foreign currency assets and liabilities into U.S. dollars, the Company's functional currency. Agency Income. This income consists of fees received by Octavian in respect of the managing of certain Lloyd's syndicates. Losses and Loss Adjustment Expenses. Losses and LAE decreased 0.5%, to $178.3 million in 1996 from $179.1 million in 1995. As a percentage of net premiums earned, losses and LAE decreased 7.1 percentage points, to 64.0% in 1996 from 71.1% in 1995. The loss and LAE ratio for non-marine property business marginally decreased to 61.6% in 1996 from 62.5% in 1995, due to slightly more favorable loss experience in 1996 compared to 1995. The loss and LAE ratio for non-marine casualty business decreased to 82.0% in 1996 from 101.3% in 1995 as a result of stable results for prior years in 1996. The decrease in the marine loss and LAE ratio to 55.9% in 1996 from 63.9% in 1995 was a consequence of the lower reinsurance costs experienced in 1996 and a decrease in adverse development of the 1992 and prior years on the marine LMX business in 1996. Acquisition Costs. Acquisition costs, which are comprised of commission expenses and other underwriting expenses, increased 13.9% to $82.4 million in 1996 from $72.3 million in 1995. Acquisition costs as a percentage of net premiums earned increased to 29.6% in 1996 from 28.7% in 1995. The increase was a result of changes made to Terra Nova's mix of business in order to protect earnings from price weakness in certain lines of business, but this has been offset by lower claims costs. Other Operating Expenses. Other operating expenses increased 1.1% to $10.2 million in 1996 from $10.1 million in 1995. Other operating expenses as a percentage of net premiums earned decreased to 3.7% in 1996 from 4.0% in 1995. Net Interest Expense. Net interest expense in 1996 relates to interest on the $100 million 10.75% Senior Notes issued on June 30, 1995. The net interest expense in 1995 relates to interest on an $85 million Credit Agreement which became effective on December 21, 1994 and which was repaid in full out of the proceeds of the Senior Notes issued on June 30, 1995, as well as interest of $5.4 million on the Senior Notes. Agency Expenses. These expenses consist of costs incurred in managing certain Lloyd's syndicates. 40 Other Expenses. Other expenses increased 48.9%, to $5.3 million in 1996 from $3.5 million in 1995, due to an increased level of corporate activity in 1996. Income from Continuing Operations before Income Taxes and Minority Interests. Income from continuing operations before income taxes and minority interests increased 32.4% to $82.7 million in 1996 from $62.4 million in 1995, primarily due to an increase in investment income and an improved underwriting result in 1996. Income Tax Expense. Income tax expense increased $1.2 million, to $17.8 million in 1996 from $16.6 million in 1995, as a consequence of the increase in operating income of the United Kingdom subsidiaries. Income from Continuing Operations. Income from continuing operations increased $19.1 million, to $64.9 million in 1996 from $45.8 million in 1995, as a result of the factors described above. Combined Ratios. The Company's combined ratios were 97.2% for 1996 and 103.8% for 1995. This reduction is primarily due to stable results for prior years in 1996. AVIATION BUSINESS IN RUN-OFF Pursuant to a decision by Terra Nova's directors in February 1992 to cease writing aviation business ("Aviation"), Aviation has been accounted for as a discontinued operation in the financial statements of Terra Nova, the Company's predecessor. Insurance cover provided under Aviation policies issued by Terra Nova ceased upon the expiration of the last policy on December 31, 1992. Accordingly, Terra Nova has not been subject to any new Aviation risks since that date. However, Terra Nova may continue to receive payments from policyholders pursuant to existing contracts and to make payments under ceded reinsurance contracts. In addition, Terra Nova will continue to settle claims and make recoveries from its reinsurers. These future receipts and payments, together with the costs of running off the Aviation business, have been considered as part of estimating the loss from abandonment of Aviation for periods up to December 31, 1994. However, estimates of ultimate liabilities for losses and loss adjustment expenses may vary as a result of subsequent development. Following the Terra Nova Acquisition, charges or credits resulting from changes in estimates after December 31, 1994 are reflected in continuing operations of the Company. In 1997, 1996 and 1995, the aviation business in run-off produced a break-even result. LIQUIDITY AND CAPITAL RESOURCES The Company's assets consist primarily of the capital stock of UK Holdings and Terra Nova (Bermuda), and UK Holdings' assets consist primarily of the capital stock of Terra Nova, Terra Nova Capital and Octavian. The ability of the Company to pay dividends on its capital stock and to pay its obligations depends primarily on dividends or other payments from Terra Nova, Terra Nova (Bermuda), Terra Nova Capital, Octavian and Corifrance. The payment of dividends and other payments by Terra Nova, Terra Nova Capital and Octavian are subject to restrictions under U.K. law, Terra Nova (Bermuda), Bermuda law and Corifrance, French law. The sources of funds for the Company's subsidiaries consist primarily of net premiums, investment income and proceeds from sales and redemption of investments. The funds are used primarily to pay claims and operating expenses and for the purchase of investments, largely fixed income securities. For the years ended December 31, 1997 and 1996, the cashflow provided by operating activities of the Company and available for investment was $81.3 million and $30.6 million, respectively. The increase in cash flows provided by operating activities in 1997 was primarily due to: (a) Cashflows from Terra Nova Capital of $60.9 million in 1997 compared to $5.3 million in 1996 due to the Company's increased participation on syndicates managed by Octavian in 1997; (b) Improved insurance cash flows in Terra Nova and Terra Nova (Bermuda) due to favorable loss activity and increases in written premiums; 41 (c) Corifrance providing $4.0 million of operating cash flow in 1997; partially offset by (d) Higher income tax payments of $23.0 million in 1997 compared to $0.3 million in 1996 due to a tax refund of $12.0 million in 1996. Total investments and cash were $1,475.6 million at December 31, 1997. At December 31, 1997, 85.5%, 7.1% and 7.4% of total investments and cash were held in fixed maturities, common stocks and cash and cash equivalents, respectively. At December 31, 1997, approximately 93.5% of the Company's fixed income investments were rated "A" or better by Moody's or S&P. The Company's investment portfolio earned interest and dividend income, net of investment management fees, of 6.2% and 6.3% in 1997 and 1996, respectively. The Company had realized investment gains of $15.3 million and $11.8 million in 1997 and 1996, respectively. On May 5, 1997, the Company announced its plans to buy back up to $20 million of its common stock on the open market at prevailing market prices or in privately negotiated transactions. On May 7, 1997, S&P raised its claims-paying ability rating of the Terra Nova Group to "A" from "A-" and the senior debt rating of UK Holdings to "BBB" from "BBB-". The rating increases reflect the continued enhancement of the Company's overall profile, including a stronger than expected operating performance in 1996 and success in securing a significant participation in the "new" Lloyd's market, while maintaining a strong degree of capitalization. On August 28, 1997, the Company filed a Form 8-K in respect of the issue of $75 million 7.2% Senior Notes due 2007, fully and unconditionally guaranteed by Bermuda Holdings. On September 8, 1997, the Company announced that it had purchased all of the issued and outstanding shares of Corifrance, a French reinsurance company which transacts business internationally. Certain information contained herein is based on management's estimates, assumptions and projections. Important factors that could cause actual results to differ materially from those estimated by management include, among other things, an unexpected increase in competition, unfavorable government regulation, the pricing environment and other industry developments. FOREIGN CURRENCY The Company's assets, liabilities, revenues and expenses, except for the majority of corporate overheads which are paid in British pounds, are predominantly in U.S. dollars. Accordingly, the Company's functional currency is the U.S. dollar. Certain other net translation adjustments are shown as a separate component of shareholders' equity. DIVIDEND POLICY The Company declared and paid dividends in accordance with the following table:
DIVIDEND PER SHARE DATE DECLARED DATE PAID/PAYABLE DATE OF RECORD ------------------ ------------- ----------------- -------------- 1997 $0.02 February 10, 1997 March 27, 1997 March 6, 1997 $0.05 May 5, 1997 June 27, 1997 June 6, 1997 $0.05 August 4, 1997 September 26, 1997 September 5, 1997 $0.05 November 4, 1997 December 29, 1997 December 5, 1997 1998 $0.05 February 6, 1998 March 27, 1998 March 6, 1998
42 ITEM 8--FINANCIAL STATEMENTS INDEX
PAGE ---- Report of Management's Responsibilities 44 Report of Independent Accountants 45 Audited Consolidated Financial Statements: Consolidated Balance Sheets as of December 31, 1997 and 1996 46 Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995 47 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995 48 Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 49 Notes to Consolidated Financial Statements--including summarized consolidated financial information of Terra Nova Insurance (UK) Holdings plc as of December 31, 1997 and 1996 50
43 REPORT OF MANAGEMENT'S RESPONSIBILITIES The management of Bermuda Holdings is responsible for the integrity and fair presentation of the consolidated financial statements, related notes thereto and all other financial information presented herein. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts based on the best estimates and judgments of management. Bermuda Holdings maintains an internal control structure designed to provide reasonable assurance that assets are safeguarded from loss or unauthorized use, that transactions are recorded in accordance with management's direction and that the financial records are reliable for the purposes of preparing financial statements and maintaining accountability of assets. The management of Bermuda Holdings applied the concept of reasonable assurance by weighing the cost of an internal control structure against the benefits to be derived. The internal control structure is supported by the careful selection, training and development of qualified personnel, an appropriate division of responsibilities and the dissemination of written policies and procedures throughout Bermuda Holdings. The internal control structure is continually reviewed and evaluated by qualified personnel and periodically assessed by Coopers & Lybrand, independent accountants, to the extent required under generally accepted auditing standards in connection with their annual audit of Bermuda Holdings financial statements. The Audit Committee of the Board of Directors is comprised solely of non executive directors and meets regularly with management and the independent accountants to review the scope and results of the audit work performed. The independent accountants have unrestricted access to the Audit Committee, without the presence of management, to discuss the results of their work and views on the adequacy of the internal control structure, the quality of financial reporting and any other matters they believe should be brought to the attention of the Audit Committee. W.O. Bailey W.J. Wedlake Chairman, President and Senior Vice President and Chief Executive Officer Chief Financial Officer
44 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Board of Directors of Terra Nova (Bermuda) Holdings Ltd. We have audited the accompanying consolidated balance sheets of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with accounting principles generally accepted in the United States of America. Coopers & Lybrand Hamilton, Bermuda March 6, 1998 45 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS YEAR ENDED DECEMBER 31, (DOLLARS IN THOUSANDS)
1997 1996 ---------- ---------- ASSETS ------ Investments available for sale and cash, at fair value: Fixed maturities: Bonds (amortized cost $1,219,799 and $1,095,126 respectively) $1,261,458 $1,119,531 Common stocks (cost $69,781 and $92,877 respectively) 104,234 120,411 Cash and cash equivalents 109,864 50,544 ---------- ---------- Total investments and cash 1,475,556 1,290,486 Accrued investment income 28,076 24,351 Insurance balances receivable 74,774 31,943 Reinsurance recoverable on paid losses 39,402 43,745 Reinsurance recoverable on unpaid losses 246,728 254,129 Accrued premium income 188,055 121,900 Prepaid reinsurance premiums 26,853 8,261 Deferred acquisition costs 76,380 45,279 Other assets 64,310 47,253 ---------- ---------- Total assets $2,220,134 $1,867,347 ========== ========== LIABILITIES ----------- Unpaid losses and loss adjustment expenses $1,157,724 $1,078,108 Unearned premiums 274,934 173,120 Insurance balances payable 33,833 18,340 Income taxes payable 10,274 21,311 Deferred income taxes 15,244 8,720 Long-term debt 175,000 100,000 Net liabilities of Aviation business in run-off 28,235 43,286 Other liabilities 43,002 25,703 ---------- ---------- Total liabilities $1,738,246 $1,468,588 ========== ========== SHAREHOLDERS' EQUITY -------------------- Common shares 150,142 149,933 Stock held in Trust (9,500) -- Deferred equity compensation 3,275 -- Additional capital 111,568 111,544 Unrealized appreciation of investments, net of income tax 56,430 36,271 Cumulative translation adjustments 112 190 Retained earnings 169,861 100,821 ---------- ---------- Total shareholders' equity 481,888 398,759 ========== ========== Total liabilities and shareholders' equity $2,220,134 $1,867,347 ========== ==========
See accompanying notes to the consolidated financial statements. 46 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
1997 1996 1995 -------- -------- -------- REVENUES Net premiums written $483,545 $311,166 $246,985 (Increase) decrease in unearned premiums (64,476) (32,410) 4,915 -------- -------- -------- Net premiums earned 419,069 278,756 251,900 Net investment income 85,130 78,130 74,478 Realized net capital gains on sales of investments 15,333 11,750 9,384 Foreign exchange (losses) gains (1,268) 425 1,110 Agency income 15,571 8,998 -- -------- -------- -------- Total revenues 533,835 378,059 336,872 -------- -------- -------- EXPENSES Losses and loss adjustment expenses, net 282,480 178,274 179,111 Acquisition costs 115,427 82,394 72,314 Other operating expenses 13,706 10,175 10,069 Interest expense 12,710 10,750 9,411 Agency expenses 13,130 8,537 -- Other expenses 5,333 5,261 3,534 -------- -------- -------- Total expenses 442,786 295,391 274,439 -------- -------- -------- Income from operations before income taxes and minority interests 91,049 82,668 62,433 Income tax expense 17,639 17,777 16,630 Minority interests in income of consolidated subsidiaries -- 985 2,552 -------- -------- -------- Income from continuing operations 73,410 63,906 43,251 -------- -------- -------- Net income $ 73,410 $ 63,906 $ 43,251 ======== ======== ======== Basic earnings per common share $ 2.87 $ 2.81 $ 3.13 Diluted earnings per common share $ 2.82 $ 2.69 $ 2.63
See accompanying notes to the consolidated financial statements. 47 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEAR ENDED DECEMBER 31, (DOLLARS IN THOUSANDS)
UNREALIZED STOCK DEFERRED APPRECIATION CUMULATIVE TOTAL COMMON HELD IN EQUITY ADDITIONAL (DEPRECIATION) TRANSLATION RETAINED SHAREHOLDERS' SHARES TRUST COMPENSATION CAPITAL OF INVESTMENTS ADJUSTMENTS EARNINGS EQUITY -------- -------- ------------ ---------- -------------- ----------- -------- ------------- Balance, January 1, 1995 $ 59,057 $ -- $ -- $ -- $ -- $ -- $ -- $ 59,057 Shares issued 30,225 -- -- 18,203 -- -- -- 48,428 Net appreciation -- -- -- -- 68,144 -- -- 68,144 Income tax expense -- -- -- -- (18,172) -- -- (18,172) Net income -- -- -- -- -- -- 43,251 43,251 Dividends payable on convertible redeemable preferred shares -- -- -- -- -- -- (3,700) (3,700) -------- -------- ------ -------- -------- ---- -------- -------- Balance, December 31, 1995 89,282 -- -- 18,203 49,972 -- 39,551 197,008 Shares issued in initial public offering 42,195 -- -- 71,758 -- -- -- 113,953 Shares issued in exchange for minority interests in subsidiaries 11,826 -- -- 8,655 -- -- -- 20,481 Shares issued for conversion of convertible redeemable preferred shares 5,740 -- -- 12,108 -- -- -- 17,848 Other shares issued during period 890 -- -- 820 -- -- -- 1,710 Net depreciation -- -- -- -- (18,430) -- -- (18,430) Income tax benefit -- -- -- -- 4,729 -- -- 4,729 Changes during the year -- -- -- -- -- 190 -- 190 Net income -- -- -- -- -- -- 63,906 63,906 Dividends paid on ordinary shares--$0.06 per share -- -- -- -- -- -- (1,548) (1,548) Dividends paid on convertible redeemable preferred shares -- -- -- -- -- -- (1,088) (1,088) -------- -------- ------ -------- -------- ---- -------- -------- Balance, December 31, 1996 149,933 -- -- 111,544 36,271 190 100,821 398,759 Shares issued for exercise of share options 209 520 -- 24 -- -- -- 753 Shares repurchased during the year -- (10,020) -- -- -- -- -- (10,020) Deferred compensation expense -- -- 3,644 -- -- -- -- 3,644 Deferred compensation expense released on exercise of share options -- -- (369) -- -- -- -- (369) Net appreciation -- -- -- -- 24,210 -- -- 24,210 Income tax expense -- -- -- -- (4,051) -- -- (4,051) Change during the year -- -- -- -- -- (78) -- (78) Net income -- -- -- -- -- -- 73,410 73,410 Dividends paid on ordinary shares--$0.17 per share -- -- -- -- -- -- (4,370) (4,370) -------- -------- ------ -------- -------- ---- -------- -------- Balance, December 31, 1997 $150,142 $ (9,500) $3,275 $111,568 $ 56,430 $112 $169,861 $481,888 ======== ======== ====== ======== ======== ==== ======== ========
See accompanying notes to the consolidated financial statements. 48 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31, (DOLLARS IN THOUSANDS)
1997 1996 1995 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 73,410 $ 63,906 $ 43,251 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of goodwill 642 1,105 -- Bad debt (benefits) expenses 1,238 (1,142) 3,000 Realized net capital gains (15,333) (11,750) (9,384) Stock option compensation expense 3,208 -- -- Change in unpaid losses and loss adjustment expenses 47,612 (95,658) (57,366) Change in unearned premiums and prepaid reinsurance 60,705 28,809 (4,848) Change in insurance balances payable 4,965 (7,097) (24,056) Change in insurance balances receivable, accrued premium income and reinsurance recoverable on paid and unpaid losses (58,960) 68,751 78,648 Change in deferred acquisition costs (26,475) (8,329) (5,429) Change in accrued investment income (1,510) (606) (4,803) Change in current and deferred income taxes (7,407) 17,521 (6,612) Change in other assets and liabilities, net 14,218 (4,436) 6,601 Change in net liabilities of discontinued operations (15,051) (20,486) (9,576) --------- --------- --------- Total adjustments 7,852 (33,318) (33,825) --------- --------- --------- Net cash provided by operating activities 81,262 30,588 9,426 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds of fixed maturities matured 65,096 65,589 107,643 Proceeds of fixed maturities sold 521,301 291,803 207,581 Proceeds of equity securities sold 215,732 163,173 118,340 Purchase of fixed maturities (665,228) (491,326) (520,052) Purchase of equity securities (175,307) (183,492) (132,451) Payment consideration for Corifrance (42,225) -- -- Acquisition expenses for Corifrance (461) -- -- Payment consideration for Octavian -- (9,393) -- Acquisition expenses for Octavian -- (644) -- --------- --------- --------- Net cash used in investing activities (81,092) (164,290) (218,939) --------- --------- --------- CASH FLOW FROM FINANCING ACTIVITIES: Stock repurchase (10,020) -- -- Proceeds from public debt offerings 74,866 -- 100,000 Repayment of long term bank debt -- -- (85,000) Payment of fees to financing public debt offering (1,179) -- (5,346) Net proceeds from initial public offering -- 113,953 -- Redemption of preferred shares -- (16,035) -- Proceeds from shares issued 384 158 46,383 Proceeds from minority shareholders -- -- 4,229 Preference dividends paid to stockholders -- (499) -- Ordinary dividends paid to stockholders (4,370) (1,548) (3,700) --------- --------- --------- Net cash provided by financing activities 59,681 96,029 56,566 --------- --------- --------- Changes in cash and cash equivalents 59,851 (37,673) (152,947) Exchange on foreign currency cash balances (531) (508) (534) Cash and cash equivalents at beginning of year 50,544 88,725 242,206 --------- --------- --------- Cash and cash equivalents at end of year $ 109,864 $ 50,544 $ 88,725 ========= ========= ========= Supplemental disclosure of cash flow information Income taxes paid $ 23,001 $ 303 $ 14,512 ========= ========= ========= Interest paid $ 10,750 $ 10,750 $ 4,227 ========= ========= =========
See accompanying notes to the consolidated financial statements. 49 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION Terra Nova (Bermuda) Holdings Ltd. ("Bermuda Holdings") was incorporated in Bermuda. All references herein to the "Company" are to Bermuda Holdings and all of its direct and indirect subsidiaries, including Terra Nova Insurance (UK) Holdings plc ("UK Holdings"), Terra Nova Insurance Company Limited ("Terra Nova"), Terra Nova (Bermuda) Insurance Company Ltd. ("Terra Nova (Bermuda)"), Octavian Syndicate Management Limited ("Octavian"), Terra Nova Capital Limited ("Terra Nova Capital") and Compagnie de Reassurance d'Ile de France ("Corifrance"). The Company is a specialty property, casualty, marine and aviation insurance and reinsurance company operating in the London market through its London based subsidiary, Terra Nova, in the Continental European Market through its French subsidiary, Corifrance, purchased on September 8, 1997, in the Bermuda market through its Bermuda based subsidiary, Terra Nova (Bermuda) and in the Lloyd's market through its London based subsidiary, Terra Nova Capital. Writings originate worldwide. The vast majority of insurance and reinsurance business is written through brokers authorized to place business at Lloyd's. Business is also written through non-Lloyd's brokers and with individual ceding companies. The broker is regarded as the agent of the insured or reinsured in placing the business. The Company also owns the business and assets of Octavian, a Lloyd's managing agent, consisting primarily of the rights to manage eight Lloyd's syndicates (the "Octavian syndicates"), for the 1998 year of account. 2. BASIS OF PREPARATION The accompanying consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America. All material intercompany transactions and balances have been eliminated. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The significant accounting policies of the Company are as follows: (a) Investments and related income: Investments in fixed maturities and equity securities are classified as available for sale and held with the intention of selling such investments from time to time, and are carried at fair value. Unrealized gains and losses, net of related deferred income taxes and minority interests, are reflected directly in shareholders' equity. Realized gains and losses are reflected in operations and determined by specific identification. Investment income is recorded as earned. (b) Cash and cash equivalents: Cash and cash equivalents are comprised of cash and various short-term investments which have maturities when purchased of 90 days or less. Cash equivalents are stated at fair value which approximates cost. (c) Premiums: Premiums are earned on a pro-rata basis over the term of the related coverage. The balance of unearned premiums represents the portion of gross premiums written relating to the unexpired terms of coverage. (d) Deferred acquisition costs: Acquisition costs, which represent commission and other expenses directly related to the production of business, are deferred and amortized over the period in which the related premiums are earned. Deferred acquisition costs are limited to the amounts estimated to be recoverable from the applicable unearned premiums and the related anticipated investment income after giving effect to anticipated losses, loss adjustment expenses and expenses necessary to maintain the contracts in force. 50 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (e) Losses and loss adjustment expenses: Losses and loss adjustment expenses are charged to income as incurred. The reserve for unpaid losses and loss adjustment expenses represents the accumulation of estimates for reported losses and includes provisions for losses incurred but not reported ("IBNR"). The adequacy of these estimates is assessed by reference to projections of the ultimate losses in respect of each accident year. The methods of determining such estimates and establishing reserves are continually reviewed and updated, and resulting adjustments are reflected in current operations. (f) Income taxes: Deferred income taxes are recorded with respect to temporary differences between financial reporting and tax bases of assets and liabilities in accordance with Statement of Financial Accounting Standard ("SFAS") No. 109. (g) Foreign currency translation: The U.S. dollar is the functional and reporting currency as a majority of the policies written are denominated in U.S. dollars. Revenues and expenses in non-U.S. dollar currencies are translated at the average rates of exchange. Monetary assets and liabilities are translated at the rate of exchange in effect at the close of the period. Non-monetary assets and liabilities, primarily deferred revenue and expenses, are translated at historic rates of exchange. Gains or losses resulting from non-U.S. dollar transactions are included in net income. Certain other net translation adjustments are shown as a separate component of shareholders' equity. (h) Insurance balances receivable and reinsurance recoverable on paid and unpaid losses: Receivable balances are stated net of allowances for doubtful accounts. Reinsurance recoverable on unpaid losses represents the estimated portion of such liabilities that will be recovered from reinsurers, determined in a manner consistent with the related liabilities. (i) Accrued premium income: Accrued premium income represents the difference between the estimated cumulative ultimate written premiums and cumulative billed premiums. (j) Prepaid reinsurance premiums: Prepaid reinsurance premiums represent the portion of premiums ceded to reinsurers applicable to the unexpired terms of reinsurance contracts. In respect of Terra Nova Capital reinsurance costs have been charged against income on the basis of the benefits derived in order to match the costs with the corresponding earned income. (k) Stock-based compensation: The Company has adopted SFAS No. 123 "Accounting for Stock-Based Compensation". As allowed under this standard, the Company accounts for stock option grants in accordance with APB Opinion No. 25 "Accounting for Stock Issued to Employees". Compensation expense for stock option grants is recognised to the extent that the fair value of the stock exceeds the exercise price of the option at the measurement date. Any resulting compensation expense is accrued over the shorter of the vesting or service period. Deferred compensation, which is recorded as shareholders' equity, represents the options that the Company expects to settle in stock. 51 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (l) Risks and Uncertainties: Information about risks and uncertainties existing at the balance sheet date related to the following areas: . Nature of operations. . Use of estimates in the preparation of financial statements. . Certain significant estimates. . Current vulnerability due to certain concentrations. These disclosures are included in Notes 1, 3, 5, 12, 13, 14, 15 and 17. 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. (m) Fair value of financial instruments: The following methods and assumptions were used by the Company in estimating the fair value of the financial instruments presented: Investments: Fair values were based upon quoted market prices. For securities for which market prices were not readily available, fair values were estimated using quoted market prices of comparable investments. Long term debt: Fair value is based on quoted market price. Other financial instruments: The carrying amounts approximate fair value. (n) Goodwill: The goodwill in the Company's balance sheet has been calculated using the purchase method of accounting and is being amortized on a straight line basis over periods not exceeding 40 years. (o) Reclassifications: Certain prior year amounts have been reclassified to conform with the current year presentation. In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128 "Earnings per Share" ("EPS") effective for financial statements issued for periods ending after December 15, 1997. SFAS No. 128 requires dual presentation of basic and diluted EPS on the face of the income statements for the current period and all comparative periods regardless of whether basic and diluted EPS are the same; it also requires a reconciliation of the numerator and denominator used in computing basic and diluted EPS. Full disclosure of EPS under SFAS No. 128 is provided in Note 9 to the consolidated financial statements. (p) Accounting pronouncements: In February 1997, the FASB issued SFAS No. 129 "Disclosure of Information about Capital Structure". SFAS No. 129 is effective for financial statements for periods ending after December 15, 1997. SFAS No. 129 consolidates existing guidance in APB Opinion No. 10 "Omnibus Opinion", Opinion No. 15 "Earnings per Share" and SFAS No. 47 "Disclosure of Long-Lived Obligations", relating to a company's capital structure. Owing to its quoted status, the Company is already bound by the requirements of SFAS No. 129 and so no additional disclosures are required. In June 1997, FASB issued SFAS No. 130 "Reporting Comprehensive Income" and SFAS 131 "Disclosures about Segments of an Enterprise and Related Information". These statements are effective for financial statements issued for periods beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components within a set of financial statements. 52 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) SFAS No. 131 requires the Company to report financial and descriptive information about its reportable operating segments. The Company is currently reviewing the impact of SFAS No. 130 and SFAS No. 131 on its financial reporting. In February 1998, FASB issued SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits". SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. This statement significantly changes current financial statement disclosure requirements from those that were required under FAS 87, "Employers' Accounting for Pensions", FAS 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits", and FAS 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". However, SFAS No. 132 does not change the existing measurement or recognition provisions of FASB Statement Nos. 87, 88, or 106. The Company is currently reviewing the impact of SFAS No. 132 on its financial reporting. 4. CORIFRANCE ACQUISITION On September 8, 1997, the Company purchased all of the issued and outstanding shares of Corifrance, a French reinsurance company, for a purchase price of $42.2 million. The acquisition was made by a French subsidiary of Terra Nova, the Group's U.K. operating insurance company. Corifrance, which transacts business internationally, although mainly outside of the United States, had a gross written premium volume of $24.2 million in 1997. The Company's share of Corifrance's gross written premiums was $2.4 million. The goodwill in the Company's balance sheet includes the goodwill arising on the acquisition of Corifrance, which has been calculated using the purchase method of accounting and is being amortized on a straight line basis. The impact on the Company's results from the date of the acquisition included in the 1997 consolidated statements of operations comprise the following:
YEAR ENDED DECEMBER 31, 1997 ------------ (DOLLARS IN THOUSANDS) Net written premiums $ 2,400 Net earned premiums 11,800 Underwriting profit 900 Amortization of goodwill 299 Net income before tax 1,600
5. INVESTMENTS AND CASH (a) Deposits: Securities with a carrying value of $74,832,873 and $48,741,933 at December 31, 1997 and 1996, respectively, were held in trust for the benefit of the Company's U.S. cedents and to facilitate the Company being accredited as an alien reinsurer by certain States. Cash and securities with a carrying value of $19,465,928 and $18,583,564 at December 31, 1997 and 1996 respectively, were held in trust for the benefit of the Company's U.S. surplus lines policyholders. Cash and securities with a carrying value of $53,350,644 and $41,487,658 at December 31, 1997 and 1996 respectively, were held in trust for the benefit of the Company's Canadian cedents. The Company has contingent liabilities in respect of undrawn letters of credit supporting certain reinsurance business written by the Company in the U.S. of $121,020,906 and $166,577,765 at December 31, 1997 and 1996, 53 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) respectively. The Company has deposited cash and investments with a carrying value of $175,213,503 and $261,542,735 at December 31, 1997 and 1996 respectively, as collateral against these amounts. The Company has contingent liabilities in respect of irrevocable undrawn letters of credit of $199,334,500 and $156,327,255 supporting the Company's underwriting activities on the Octavian syndicates for the 1997 and 1996 years of account, respectively. The Company has deposited cash and investments with a carrying value of $221,670,000 and $171,959,981 at December 31, 1997 and 1996, respectively, as collateral to support this commitment. (b) Net investment income: An analysis of the net investment income of the Company is as follows:
YEAR ENDED DECEMBER 31, ------------------------- 1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Fixed maturities $77,690 $71,365 $70,999 Equity securities 1,538 1,373 1,273 Cash and cash equivalents 9,470 7,539 4,066 ------- ------- ------- Total investment income 88,698 80,277 76,338 Investment expenses (3,568) (2,147) (1,860) ------- ------- ------- Net investment income $85,130 $78,130 $74,478 ======= ======= =======
(c) Investment gains and losses: The realized net capital gains and changes in net unrealized appreciation or depreciation of investments are summarized below:
YEAR ENDED DECEMBER 31, ------------------------- 1997 1996 1995 ------- -------- ------- (DOLLARS IN THOUSANDS) Realized net capital gains on sale of investments: Fixed maturities $ 5,342 $ 1,509 $933 Equity securities 9,991 10,241 8,451 ------- -------- ------- Realized net capital gains 15,333 11,750 9,384 ------- -------- ------- Changes in net unrealized (depreciation) appreciation of investments: Fixed maturities 17,291 (34,358) 57,317 Equity securities 6,919 15,928 10,827 ------- -------- ------- Changes in net unrealized (depreciation) appreciation of investments 24,210 (18,430) 68,144 ------- -------- ------- Realized net capital gains and change in net unrealized (depreciation) appreciation of investments $39,543 $ (6,680) $77,528 ======= ======== =======
Proceeds from sales of investments in fixed maturity securities during 1997, 1996 and 1995, respectively, were $521,301,000, $291,803,000 and $207,581,000. Realized net capital gains on sale of fixed maturities for the years ended December 31, 1997, 1996 and 1995 included gross capital gains of $9,600,000, $6,802,000 and $2,947,000 and gross capital losses of $4,258,000, $5,293,000 and $2,014,000, respectively. Proceeds from sales of investments in equity securities during 1997, 1996 and 1995, respectively, were $215,732,000, $163,173,000 and $118,340,000. Realized net capital gains on sale of equity securities for the years ended December 31, 1997, 1996 and 1995, included gross capital gains of $29,613,000, $22,512,000 and $13,209,000 and gross capital losses of $19,622,000, $12,271,000 and $4,758,000, respectively. 54 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company's net unrealized appreciation of fixed maturities (before income tax) at December 31, 1997 included gross unrealized appreciation of $43,203,000 and gross unrealized depreciation of $1,544,000. The Company's net unrealized appreciation of fixed maturities at December 31, 1996 included gross unrealized appreciation of $28,682,000 and gross unrealized depreciation of $4,277,000. The Company's net unrealized appreciation of fixed maturities at December 31, 1995 included gross unrealized appreciation of $65,006,000 and gross unrealized depreciation of $4,251,000. Net unrealized appreciation of equities (before income tax) at December 31, 1997 of the Company included gross unrealized appreciation of $38,111,000 and gross unrealized depreciation of $3,658,000. Net unrealized appreciation of equities at December 31, 1996 of the Company included gross unrealized appreciation of $34,047,000 and gross unrealized depreciation of $6,513,000. Net unrealized appreciation of equities at December 31, 1995 of the Company included gross unrealized appreciation of $15,288,000 and gross unrealized depreciation of $4,078,000, and is stated net of minority interests of $383,000. (d) Fixed maturities available for sale: At December 31, the amortized cost and estimated fair value of investments in fixed maturities of the Company were as follows:
1997 ----------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE ---------- ------------ ------------ ---------- (DOLLARS IN THOUSANDS) U.S. government and agency $ 298,618 $14,410 $ 308 $ 312,720 Foreign governments and agencies 429,811 18,015 650 447,176 Foreign regional government 40,130 1,287 33 41,384 Mortgage backed 10,880 357 16 11,221 Asset backed 63,648 902 195 64,355 Supranationals 140,801 4,208 83 144,926 Corporate 235,911 4,024 259 239,676 ---------- ------- ------ ---------- Total fixed maturities $1,219,799 $43,203 $1,544 $1,261,458 ========== ======= ====== ==========
1996 ----------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST APPRECIATION DEPRECIATION VALUE ---------- ------------ ------------ ---------- (DOLLARS IN THOUSANDS) U.S. government and agency $ 416,383 $ 6,994 $1,717 $ 421,660 Foreign governments and agencies 393,079 15,813 1,459 407,433 Foreign regional government 19,381 940 -- 20,321 Mortgage backed 13,801 533 72 14,262 Asset backed 65,119 594 308 65,405 Supranationals 98,319 2,503 280 100,542 Corporate 89,044 1,305 441 89,908 ---------- ------- ------ ---------- Total fixed maturities $1,095,126 $28,682 $4,277 $1,119,531 ========== ======= ====== ==========
55 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The amortized cost and estimated fair value of the Company's fixed maturities at December 31, 1997, by contractual maturity date, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or repay certain obligations with or without call or prepayment penalties.
AMORTIZED COST FAIR VALUE ---------- ---------- (DOLLARS IN THOUSANDS) Due in one year or less $ 52,753 $ 53,068 Due after one year through five years 483,655 493,822 Due after five years through ten years 621,099 646,379 Due after ten years 62,292 68,189 ---------- ---------- $1,219,799 $1,261,458 ========== ==========
Mortgage and asset backed securities which are not due at a single maturity date, have been allocated according to their expected final payment date as at year-end. (e) At December 31, 1997, the Company's portfolio by rating category, determined by recognized rating agencies, was:
(DOLLARS IN THOUSANDS) U.S. government and agency $ 312,720 U.K. government and agency 90,296 AAA 475,857 AA 206,703 A 93,410 BBB 45,742 Not Rated 36,730 ---------- $1,261,458 ==========
Not Rated securities consist primarily of securities issued by municipalities located in countries other than the U.S. or the U.K. and are generally considered by management to be at least the equivalent in quality of AA rated investments. (f) At December 31, 1997, the fair value of the following investments exceeded 10% of shareholders' equity:
(DOLLARS IN THOUSANDS) United States Treasury $312,720 Government of Japan 74,051 Canadian Treasury 49,974
56 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 6. INCOME TAXES (a) The U.K. corporation tax rate applicable to ordinary income was 33% for 1995 and 1996. The tax rate was reduced to 31% from 33% on April 1, 1997. The corporation tax rate in France was 41.67% for 1997. The difference between the actual tax expense on income from continuing operations and the "expected" amount computed by applying the U.K. corporation tax rate is explained as follows:
YEAR ENDED DECEMBER 31, -------------------------- 1997 1996 1995 -------- ------- ------- (DOLLARS IN THOUSANDS) "Expected" tax expense $ 28,680 $27,280 $20,603 Adjustments: Non-taxable income (10,004) (9,872) (4,863) Other (1,037) 369 890 -------- ------- ------- Actual tax expense $ 17,639 $17,777 $16,630 ======== ======= =======
(b) The components of income tax expense attributable to continuing operations are as follows:
YEAR ENDED DECEMBER 31, ----------------------- 1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Current U.K. corporation tax $10,743 $17,409 $14,172 Deferred tax 6,896 368 2,458 ------- ------- ------- Income tax expense $17,639 $17,777 $16,630 ======= ======= =======
(c) Deferred tax liabilities and assets are provided for expected future tax consequences of events that have been recognized in the consolidated financial statements or tax returns. The measurement of current and deferred tax liabilities and assets is based on the difference between the financial statements and tax bases of assets and liabilities using enacted rates in effect for the years in which the differences are expected to reverse. The measurement of a deferred tax asset, if any, is subject to the expectation of future realization. The components of net deferred tax assets (liabilities) of the Company as at December 31, 1997 and 1996 were as follows:
1997 1996 -------- -------- (DOLLARS IN THOUSANDS) Deferred tax assets: Unrealized depreciation of investments $ 433 $ -- Other 1,039 3,798 -------- -------- Total deferred tax assets $ 1,472 $ 3,798 -------- -------- Deferred tax liabilities: Unrealized appreciation of investments (7,275) (7,564) Temporary difference between U.S. GAAP and U.K. tax (4,823) (3,393) Other (4,618) (1,561) -------- -------- Total deferred tax liabilities (16,716) (12,518) -------- -------- Net deferred tax liabilities $(15,244) $ (8,720) ======== ========
(d) Under current Bermuda law, Terra Nova (Bermuda) and Bermuda Holdings are not required to pay any taxes in Bermuda on either income or capital gains. Terra Nova (Bermuda) and Bermuda Holdings have received 57 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) an undertaking from the Minister of Finance in Bermuda that in the event of any such taxes being imposed, they will be exempted from such taxation until the year 2016. (e) The Company does not consider itself to be engaged in trade or business in the U.S. and accordingly does not expect to be subject to U.S. income taxation. 7. DEFERRED ACQUISITION COSTS The following reflects the acquisition costs deferred for amortization against future income and the amortization charged to income, excluding certain amounts deferred and amortized in the same period:
YEAR ENDED DECEMBER 31, ------------------------ 1997 1996 1995 -------- ------- ------- (DOLLARS IN THOUSANDS) Balance at beginning of year $ 45,279 $36,950 $31,521 -------- ------- ------- Acquisition costs deferred Commissions 119,610 78,051 67,942 Other 26,918 12,672 9,801 -------- ------- ------- 146,528 90,723 77,743 -------- ------- ------- Amortization charged to income Commissions 92,713 71,759 62,278 Other 22,714 10,635 10,036 -------- ------- ------- 115,427 82,394 72,314 -------- ------- ------- Balance at end of year $ 76,380 $45,279 $36,950 ======== ======= =======
8. EMPLOYEE BENEFITS Terra Nova operates defined benefit pension plans ("Terra Nova Plan") which cover all employees (except those in Canada and Belgium) over 20 years old who meet the eligibility conditions set out in the plan document. The cost of providing pensions for employees is charged to earnings over the average working life of employees in accordance with the recommendations of qualified actuaries. Annual funding requirements are determined based on the projected unit credit cost method, which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service. Final benefits are based on the employee's years of credited service and the higher of pensionable compensation received in the calendar year preceding retirement or the best average pensionable compensation received in any three consecutive years in the ten years preceding retirement. Terra Nova provides pension and related benefits for the employees of its branch offices in Belgium and Canada. Benefit plans are in line with local market terms and conditions of employment and are generally costed to be within 10% of basic salaries of the participating employees. Neither of the plans is a defined benefit plan. The Company has adopted, for its Bermuda employees, a similar policy regarding pension and related benefits and has negotiated for a plan on the same cost basis. Terra Nova maintains a supplemental pension plan which provides pension benefits for nominated employees above amounts allowed under tax qualified plans, through a funded money purchase plan. Mandatory employee contributions to the Terra Nova Plan ceased in 1988 and there are no present plans to reintroduce such contributions. Employees may elect to make voluntary contributions to supplement their pension benefits when payable. 58 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Octavian provides certain of its employees with one of two defined benefit pension schemes run in conjunction with the Lloyd's Superannuation Scheme ("Octavian Plan"). The Octavian Plan is similar in operation to the Terra Nova Plan though the benefit structure differs. Octavian provides a defined contribution plan for nominated employees and directors. The annual contribution rate for employees is 15% of annual pensionable salary and, for directors and certain senior underwriters, is 25% of annual pensionable salary. Corifrance provides two defined contribution plans for its managers and all other employees, respectively. The annual contribution rate for managers is 5.66% of pensionable salary and, for employees, is 1.43% of pensionable salary. The discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation of the Terra Nova Plan at December 31, 1997 and 1996 were 7.5% and 5.0% respectively. These are considered appropriate given the U.K. interest rate environment. The expected long-term rate of return on plan assets was 10.0%. The fund assets are invested primarily in equity securities. The following table sets out the funded status of all defined benefit plans and the amounts recognized in the accompanying consolidated balance sheets of the Company at December 31, 1997 and 1996:
1997 1996 ------- ------- (DOLLARS IN THOUSANDS) Plan assets at fair value $50,161 $44,414 Actuarial present value of benefit obligations: Accumulated benefits earned prior to valuation date: Vested 36,806 33,364 Non vested 707 744 Additional benefits based on estimated future salary levels 2,873 2,944 ------- ------- Projected benefit obligation 40,386 37,052 ------- ------- Plan assets in excess of projected benefit obligation 9,775 7,362 Unrecognized net (gain) loss (5,045) (2,738) ------- ------- Prepaid pension amount included in other assets $ 4,730 $ 4,624 ======= =======
Net pension expenses included the following components:
YEAR ENDED DECEMBER 31, ------------------------- 1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Cost of benefits earned during the year $ 2,612 $ 1,864 $ 1,468 Interest costs on the projected benefit obligation 3,153 2,337 1,672 Actual return on all retirement plan assets (4,274) (2,905) (2,109) Amortization of (gain) loss (100) -- -- ------- ------- ------- Net pension expense $ 1,391 $ 1,296 $ 1,031 ======= ======= =======
59 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 9. EARNINGS PER COMMON SHARE AND COMMON SHARE EQUIVALENT In February 1997, the Financial Accounting Standards Board issued SFAS No. 128 "Earnings per Share". SFAS No. 128 prescribes the basis for computing basic earnings per share ("EPS") and diluted EPS. Basic EPS are computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted EPS considers all dilutive potential common shares that were outstanding during the period. In accordance with the SEC Staff Accounting Bulletin Topic 4-D, for the purposes of the earnings per share calculations for 1995, application of the topic resulted in an approximately 1,909,766 share increase in the number of shares outstanding utilized in the calculation of earnings per share as presented in the accompanying statement of operations. The following EPS have been computed using SFAS No. 128:
1997 1996 1995 ---------- ---------- ---------- Net income $ 73,410 $ 63,906 $ 43,251 Add: Minority interest -- 985 2,552 Less: Preference share dividends -- (1,088) (3,700) ---------- ---------- ---------- Income available to common shareholders $ 73,410 $ 63,803 $ 42,103 ---------- ---------- ---------- Weighted average number of shares outstanding: Common shares 25,586,648 22,677,879 13,441,816 ---------- ---------- ---------- Basic EPS $ 2.87 $ 2.81 $ 3.13 ========== ========== ========== Net income $ 73,410 $ 63,906 $ 43,251 Add: Minority interest -- 985 2,552 Less: Preference share dividends -- (499) (1,831) ---------- ---------- ---------- Income available to common shareholders $ 73,410 $ 64,392 $ 43,972 ---------- ---------- ---------- Weighted average number of shares outstanding: Common shares 25,586,648 22,677,879 13,441,816 Add: Incremental shares arising from: Rights offering -- -- 1,826,181 Preferred shares -- 859,040 922,323 Options 406,643 407,607 528,844 ---------- ---------- ---------- Adjusted weighted average number of shares outstanding 25,993,291 23,944,526 16,719,164 ---------- ---------- ---------- Diluted EPS $ 2.82 $ 2.69 $ 2.63 ========== ========== ==========
10. SHARE CAPITAL (a) The following table provides the components of the common shares of the Company at December 31, 1997 and 1996:
1997 1996 -------- -------- (DOLLARS IN THOUSANDS) "A" ordinary shares $5.80 par value 75,000,000 authorized, 24,090,335 issued and outstanding (1996: 23,802,426 issued and outstanding) $139,724 $138,054 "B" ordinary shares $5.80 par value 10,000,000 authorized, 1,796,217 issued and outstanding (1996: 2,048,140 issued and outstanding) 10,418 11,879 -------- -------- $150,142 $149,933 ======== ========
Each "B" ordinary share at the Company is convertible, at the option of the holder into an "A" ordinary share without payment or adjustment for accrued dividends. 60 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) On May 5, 1997, the Company's Board of Directors authorized the repurchase of up to $20 million of the Company's common shares. As at December 31, 1997 the Company had purchased 500,000 shares at a total cost of $10,020,000. The shares are to be held in trust for the satisfaction of employees' and directors' long term compensation plans and any other corporate purposes. During 1997, the Company issued 35,986 ordinary shares to satisfy options exercised under the Company's fixed stock option plan (see Note 11). A further 26,000 options were exercised during the year, all of which were satisfied by issuing shares from the trust as described above. In addition, the Company converted 251,923 "B" shares into "A" shares. 11. SHARE OPTIONS AND AWARDS At December 31, 1997 the Company has three stock-based compensation plans, which are described below. The Company applies APB Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, compensation cost of $3,244,000 has been charged against income for 1997 (1996: $400,701). The compensation expense for 1997 and 1996 determined using the fair value methodology of SFAS No. 123 is not materially different from the expense calculated in accordance with APB No. 25 and therefore pro forma net income and earnings per share, as required by SFAS No. 123, are not shown. On January 9, 1995, the Company adopted two Executive Share Option Plans (the "Stock Option Plan"). The Stock Option Plan provides for the grant to eligible employees of options to purchase Class A ordinary shares of the Company (the "Option Shares"). The aggregate number of Option Shares issued and Option Shares for which an option may be granted is limited to 8% of the aggregate number of common shares of the Company outstanding. The options are only exercisable upon the occurrence of certain specified events and will expire no later than 10 years after the date granted. The Stock Option Plan is administered by the Board of Directors of the Company, which determines which employees are granted options. A summary of the Company's fixed stock option plan as of December 31, 1997 and changes during the year then ended is presented below:
WEIGHTED- AVERAGE FIXED OPTIONS SHARES EXERCISE PRICE ------------- --------- -------------- OUTSTANDING AT JANUARY 1, 1995 -- $ -- Granted 685,047 6.25 Exercised -- -- Forfeited (24,138) 5.80 --------- ------ OUTSTANDING AT JANUARY 1, 1996 660,909 $ 6.26 Granted 182,893 13.64 Exercised (27,258) 5.80 Forfeited -- -- --------- ------ OUTSTANDING AT JANUARY 1, 1997 816,544 $ 7.93 Granted 1,059,150 24.02 Exercised (61,986) 6.19 Forfeited (21,098) 10.31 --------- ------ OUTSTANDING AT DECEMBER 31, 1997 1,792,610 $17.47 ========= ======
61 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) As of December 31, 1997, the fixed options outstanding under the Plan have exercise prices between $5.80 and $25.52 and a weighted-average remaining contractual life of 6.99 years. Options outstanding and options exercisable at December 31, 1997 are summarized as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------------- -------------------------- WEIGHTED- WEIGHTED- WEIGHTED- RANGE OF NUMBER AVERAGE REMAINING AVERAGE NUMBER AVERAGE EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE --------------- ----------- ----------------- -------------- ----------- -------------- $ 5.01 - 10.00 562,629 6.97 $ 6.30 464,745 $ 6.41 10.01 - 15.00 134,581 6.04 12.80 17,241 12.80 15.01 - 20.00 270,400 7.51 18.95 -- -- 20.01 - 25.00 55,000 7.88 23.19 -- -- 25.01 - 30.00 770,000 9.84 25.52 100,000 25.52 --------- ------- 1,792,610 581,986 ========= ======= Options exercisable at December 31, 1996 391,198 Options exercisable at December 31, 1995 --
In connection with the Octavian Acquisition in 1996, the Company established the Octavian Stock Option Plan providing for the grant of options to certain individual members of management of Octavian based on profit commissions received by Octavian for the 1996 to 2000 years of account. Under the Octavian Stock Option Plan, such members of management will receive annual option grants to purchase a number of Shares equal in the aggregate to (i) 90% of the profit commission received by Octavian from the Octavian Syndicates (less underwriters' and management bonuses relating thereto and corporate taxes) for each year of account (the "Profit Commission Component"), divided by (ii) the fully diluted net asset value (as defined in the Octavian Stock Option Plan) per ordinary shares of the Company as at the end of the applicable year of account. The aggregate Profit Commission Component for the 1996 to 2000 years of account is subject to a maximum of (Pounds)10 million ($16 million) and no further options shall be issued once such maximum has been reached. The options will be issued upon receipt of the profit commissions on closure of each year of account under applicable Lloyd's regulations, which currently are 1999 to 2003 for each of the years 1996 to 2000, respectively. The options have a nominal exercise price and become exercisable on or after the January, next succeeding the date of grant, commencing January 1, 2000, provided that all options issued after January 1, 2002 become immediately exercisable. 62 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) A summary of the Company's performance-based stock option plan as of December 31, 1997 and changes during the two years then ended is presented below:
WEIGHTED- AVERAGE PERFORMANCE-BASED OPTIONS SHARES EXERCISE PRICE ------------------------- ------ -------------- OUTSTANDING AT JANUARY 1, 1996 -- $ -- Granted 29,849 0.00 Exercised -- -- Forfeited -- -- ------ ----- OUTSTANDING AT JANUARY 1, 1997 29,849 $0.00 ====== ===== Granted 66,648 $0.00 Exercised -- -- Forfeited -- -- ------ ----- Outstanding at December 31, 1997 96,497 $0.00 ====== ===== Options exercisable at December 31, 1997 and 1996 Nil
As of December 31, 1997, the 96,497 performance options outstanding under the Plan all have exercise prices of $nil and a weighted-average remaining contractual life of 7.25 years. 12. REINSURANCE In the ordinary course of business, the Company cedes reinsurance to other insurance companies. Ceded reinsurance arrangements provide greater diversification of business and limit the net loss potential arising from large risks. Certain of these arrangements consist of excess of loss contracts which protect against losses over stipulated amounts. Reinsurance is effected under reinsurance treaties and by negotiation on individual risks. The current reinsurance protections consists almost entirely of non- proportional excess of loss reinsurance (with the balance being proportional and facultative reinsurance). Specific excess of loss reinsurance is purchased for marine and non-marine business. The availability of reinsurance at reasonable cost and under favorable terms is one of the key determinants in the decision as to which categories of business to emphasize at any given time. A credit risk exists with respect to reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance arrangements. As is customary in the London Market, collateral is not generally obtained from reinsurers. Reinsurance contracts do not relieve the ceding company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses; consequently allowances are established for amounts deemed uncollectible. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from its exposure to individual reinsurers. The Company cedes reinsurance to and assumes reinsurance from Lloyd's syndicates. As of December 31, 1997, the aggregate exposure in respect of reinsurance ceded to Lloyd's syndicates in respect of continuing operations, including estimated reinsurance recoveries in respect of losses incurred but not reported, was approximately $87,583,000, the majority of which was ceded into Equitas with effect from September 4, 1996. No specific bad debt provision has been established for amounts due from Lloyd's syndicates. 63 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (a) Net premiums written are comprised of the following:
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) Direct business $269,577 $119,601 $ 86,296 Reinsurance assumed 280,666 241,409 216,362 Reinsurance ceded (66,698) (49,844) (55,673) -------- -------- -------- Net premiums written $483,545 $311,166 $246,985 ======== ======== ========
(b) Net premiums earned are comprised of the following:
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) Direct business $209,414 $100,309 $ 89,323 Reinsurance assumed 260,603 227,574 221,151 Reinsurance ceded (50,948) (49,127) (58,574) -------- -------- -------- Net premiums earned $419,069 $278,756 $251,900 ======== ======== ========
(c) Losses and loss adjustment expenses, net, are comprised of the following:
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) Losses and loss adjustment expenses, gross $329,463 $213,872 $275,962 Reinsurance ceded (46,983) (35,598) (96,851) -------- -------- -------- Losses and loss adjustment expenses, net $282,480 $178,274 $179,111 ======== ======== ========
13. LIABILITY FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES Management believes that its reserves for losses and loss adjustment expenses are adequate. Significant delays occur in the notification of certain claims and a substantial measure of experience and judgment is involved in assessing outstanding liabilities, the ultimate cost of which cannot be known with certainty at the balance sheet date. The reserve for unpaid losses and loss adjustment expenses is determined on the basis of information currently available; however, it is inherent in the nature of the business written that the ultimate liabilities may vary as a result of subsequent development. 64 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Movement in unpaid losses and loss adjustment expenses for the years ended December 31, 1997, 1996 and 1995 is summarized as follows:
1997 1996 1995 ---------- ---------- ---------- (DOLLARS IN THOUSANDS) Reserves for unpaid losses and loss adjustment expenses, at beginning of year $1,078,108 $1,168,652 $1,223,842 Less reinsurance recoverables (254,129) (354,417) (376,529) ---------- ---------- ---------- Net balance at beginning of year 823,979 814,235 847,313 ---------- ---------- ---------- Incurred related to: Current year 292,876 180,874 175,852 Prior years (10,396) (2,600) 3,259 ---------- ---------- ---------- Total incurred 282,480 178,274 179,111 ---------- ---------- ---------- Paid related to: Current year (69,685) (50,303) (43,820) Prior years (145,702) (123,438) (169,786) ---------- ---------- ---------- Total paid (215,387) (173,741) (213,606) Foreign exchange adjustment (10,967) 5,211 1,417 ---------- ---------- ---------- Net balance at end of year $ 880,105 $ 823,979 $ 814,235 Net reserves from Corifrance Acquisition 30,891 -- -- ---------- ---------- ---------- Net reserves at end of year 910,996 823,979 814,235 Plus Reinsurance recoverables: The Company 236,847 254,129 354,417 Reinsurance recoverables related to net reserves from Corifrance acquisition 9,881 -- -- ---------- ---------- ---------- Reinsurance recoverable by the Company 246,728 254,129 354,417 ---------- ---------- ---------- Reserves for unpaid losses and loss adjustment expenses, at end of year $1,157,724 $1,078,108 $1,168,652 ========== ========== ==========
Incurred claims relating to prior years are offset by decreases to prior year net written and net earned premiums less related acquisition costs of $4,800,000, $3,550,000 and $6,396,000 for 1997, 1996 and 1995 respectively. When these revisions to prior written and earned premiums are taken into account, the Company experienced net prior year improvement of $5,596,000 in 1997, and deteriorations of $950,000 and $9,655,000 for 1996 and 1995, respectively. Management has considered environmental and latent injury claims and claims expenses in establishing the liability for unpaid losses and loss adjustment expenses. The Company continues to be advised of claims asserting injuries from hazardous materials and alleged damages to cover various clean-up costs relating to policies written in prior years. Coverage and claim settlement issues, such as the determination that coverage exists and the definition of an occurrence, may cause the actual loss development to show more variation than the remainder of the Company's book of business. Traditional reserving techniques cannot be used to estimate asbestos-related and environmental pollution claims and, accordingly, the uncertainty in respect of the ultimate cost of these types of claims is greater than the uncertainty relating to standard lines of business. The Company believes it has made reasonable provisions for claims, although the ultimate liability may be more or less than held reserves. The Company believes that future losses associated with these claims will not have a material 65 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) adverse effect on its financial position, although there is no assurance that such losses will not materially affect the Company's results of operations for any period. However, management is not able to estimate the additional loss, or range of loss, that is reasonably possible. The following table presents selected data on asbestos-related and environmental pollution losses and loss adjustment expenses incurred and reserves outstanding, net of amounts recoverable from reinsurers: ASBESTOS-RELATED LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED AND RESERVES OUTSTANDING (NET OF REINSURANCE)
YEAR ENDED DECEMBER 31, ------------------------- 1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Reserves for unpaid losses and loss adjustment expenses, at beginning of year $58,400 $47,900 $40,800 Incurred losses and loss adjustment expenses 2,808 97 8,000 Paid losses and loss adjustment expenses (2,453) (1,700) (900) ------- ------- ------- Reserves for unpaid losses and loss adjustment expenses, at end of year prior to reclassification $58,755 $46,297 $47,900 Reclassification of reserves previously identified as non-Asbestos-Related losses -- 12,103 -- ------- ------- ------- Reserves for unpaid losses and loss adjustment expenses, at end of year $58,755 $58,400 $47,900 ======= ======= =======
ENVIRONMENTAL POLLUTION LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED AND RESERVES OUTSTANDING (NET OF REINSURANCE)
YEAR ENDED DECEMBER 31, ------------------------- 1997 1996 1995 ------- ------- ------- (DOLLARS IN THOUSANDS) Reserves for unpaid losses and loss adjustment expenses, at beginning of year $33,900 $38,400 $37,600 Incurred losses and loss adjustment expenses (2,032) (1,500) 1,700 Paid losses and loss adjustment expenses (1,526) (3,000) (900) ------- ------- ------- Reserves for unpaid losses and loss adjustment expenses, at end of year $30,342 $33,900 $38,400 ======= ======= =======
The reinsurance recoverables netted against the loss reserves for each of the years 1997, 1996 and 1995 are as follows:
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) Reserves (gross of reinsurance) $111,805 $111,900 $100,000 Reinsurance recoverables (22,708) (19,600) (13,700) -------- -------- -------- Reserves (net of reinsurance) $ 89,097 $ 92,300 $ 86,300 ======== ======== ========
66 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 14. ALLOWANCE FOR DOUBTFUL ACCOUNTS Insurance balances receivable and reinsurance recoverable on paid and unpaid losses are stated after deduction of an allowance for doubtful accounts as of December 31, 1997 and 1996 of $28,904,000 and $29,149,000, respectively. Doubtful accounts against which provisions of $841,000 had previously been made were written off during 1997. The charge to doubtful accounts was $1,238,000, for the year ended December 31, 1997, a release for doubtful accounts of $1,142,000 was made for the year ended December 31, 1996 and a charge to doubtful accounts of $3,000,000 was made for the year ended December 31, 1995. 15. COMMITMENTS AND CONTINGENT LIABILITIES (a) The Company is regularly involved, directly or indirectly, in litigation in the ordinary course of conducting their insurance and reinsurance business. In a number of cases, plaintiffs seek to establish coverage for liability under environmental protection laws. While the nature and extent of insurance and reinsurance coverage for environmental liability has widened since 1980, there has been no final judgment which would result in the wholesale transfer of environmental liability from insureds to insurers and reinsurers. In the judgment of management, none of these cases, individually or collectively, is likely to result in judgments for amounts which, net of loss and loss adjustment expense liabilities previously established and reinsurance recoverables which management believes are probable of realization, would have a material effect on the financial position of the Company, although there is no assurance that such losses will not materially effect the Company's results of operations for any period. (b) Guarantees have been given by Terra Nova in favor of The Prudential Insurance Company Limited and the Royal Bank of Scotland (Industrial Leasing) Limited in respect of leases granted to Market Building Limited in connection with the development of the London Underwriting Centre ("LUC"). The fire that occurred in August 1991, during the course of fitting out the new LUC, gave rise to the possibility of some shortfall of rental income in the future. Each year, the Company, charges its share of the expense necessary to maintain the LUC as a trading center. (c) The Company entered into various lease agreements for office space. Certain leases have options permitting renewals for additional periods. In addition to minimum fixed rentals, certain leases contain escalation clauses related to the cost of living in future years. The future minimum aggregate rental commitments for office space at December 31, 1997 under non-cancelable operating leases are as follows:
(DOLLARS YEAR IN ---- THOUSANDS) 1998 $ 4,534 1999 3,464 2000 3,072 2001 1,634 2002 723 2003 and later years 3,188 ------- $16,615 =======
Rental expense on property leases of $4,102,000, $3,802,000 and $2,257,000 was incurred for the periods to December 31, 1997, 1996 and 1995 respectively. 67 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 16. LONG-TERM DEBT On August 26, 1997 UK Holdings completed an issue of $75 million 7.2% Senior Notes due 2007, guaranteed fully and unconditionally by Bermuda Holdings. The net proceeds were used to finance the acquisition of Corifrance on September 8, 1997 and for other corporate purposes. The Company's total outstanding consolidated indebtedness at December 31, 1997 was thus comprised of $175 million of the Senior Notes including the $100 million 10.75% Senior Notes due 2005, issued in 1995. The estimated fair value of these Senior Notes at December 31, 1997 was $188.0 million, comprising $76.5 million of 7.2% Senior Notes due 2007 and $111.5 million of 10.75% Senior Notes due 2005. The 10.75% Senior Notes due 2005 may be redeemed at the option of UK Holdings at any time on or after July 1, 2000, at a redemption price equal to 104.031%, 102.688%, 101.344% and 100.000%, for the years 2000, 2001, 2002 and 2003 and thereafter, respectively, of the aggregate principal amount thereof plus accrued and unpaid interest thereon to the date of redemption. Subject to certain limitations, UK Holdings may also redeem on or before the third anniversary of the issuance of the Senior Notes up to 35% of the aggregate principal amount of the Senior Notes originally issued with the net proceeds of one or more offerings of capital stock (other than redeemable capital stock) of Bermuda Holdings or UK Holdings at a redemption price of 109.75% of the principal amount thereof plus accrued and unpaid interest thereon to the date of redemption. In addition, the Senior Notes are subject to redemption at the option of the holder thereof upon certain events constituting a change of control of Bermuda Holdings or UK Holdings (provided that holders of 25% of Senior Notes outstanding have tendered their Senior Notes for redemption), at a redemption price equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest thereon to the date of redemption, and must be redeemed upon certain tax-related events at a redemption price of 100% of the principal amount thereof plus accrued and unpaid interest thereon to the date of redemption. The 7.2% Senior Notes due 2007 may be redeemed at any time at the option of UK Holdings at a redemption price equal to the sum of: (i) the principal amount of the Senior Notes being redeemed plus accrued interest to the redemption date and (ii) the make-whole amount, if any. The indenture governing the Senior Notes contains various covenants that limit, under certain circumstances, among other things, mergers and asset sales, indebtedness, dividends on and redemption of capital stock, the use of proceeds from asset dispositions, liens, sales of capital stock of Bermuda Holdings' principal insurance subsidiaries, encumbrances on the payment of dividends and other payments by subsidiaries, transactions with affiliates, issuance of preferred stock by subsidiaries, issuance of guarantees, investments and certain business activities. The indenture also contains customary events of default, including payment defaults, covenant defaults, defaults in respect of other indebtedness, certain judgments and bankruptcy. 17. AVIATION BUSINESS IN RUN-OFF Pursuant to a decision by Terra Nova's directors in February 1992 to cease writing aviation business ("Aviation"), Aviation has been accounted for as a discontinued operation in the predecessor financial statements. Insurance cover provided under Aviation policies issued by Terra Nova ceased upon the expiration of the last policy on December 31, 1992. However, Terra Nova may continue to receive payments from policyholders pursuant to existing contracts and to make payments under ceded reinsurance contracts. In addition, Terra Nova will continue to settle claims and make recoveries from its reinsurers. These future receipts and payments, together with the costs of running off the Aviation business, have been considered as part of estimating the loss 68 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) from abandonment of Aviation business for periods up to December 31, 1994. However, as explained in Note 13, estimates of ultimate liabilities for losses and loss adjustment expenses may vary as a result of subsequent development. Following the Acquisition charges or credits resulting from changes in estimates after December 31, 1994 are reflected in continuing operations of the Company. Terra Nova estimates that in excess of 90% of Aviation liabilities will have been settled within three years after December 31, 1997. Details of the net liabilities of Aviation are as follows:
AT DECEMBER 31, ------------------- 1997 1996 -------- --------- (DOLLARS IN THOUSANDS) Reinsurance recoverable on paid losses $ 10,201 $ 11,595 Reinsurance recoverable on unpaid losses 42,781 91,066 Insurance balances receivable 41 -- Taxation recoverable 206 227 -------- --------- Total assets 53,229 102,888 -------- --------- Unpaid losses and loss adjustment expenses (75,846) (139,667) Insurance balances payable (4,955) (5,818) Other liabilities (663) (689) -------- --------- Total liabilities (81,464) (146,174) -------- --------- Net liabilities of Aviation business in run-off $(28,235) $ (43,286) ======== =========
Details of the operating results of Aviation business in run-off are as follows:
YEAR ENDED DECEMBER 31, --------------------- 1997 1996 1995 ------ ------ ------ (DOLLARS IN THOUSANDS) Gross premiums written $1,468 $4,432 $9,009 Net premiums earned 1,577 1,624 4,668 Losses and loss adjustment expenses, net (6) 997 4,407 Other expenses 1,563 627 261 Net loss -- -- --
Reinsurance recoverable on paid and unpaid losses in relation to Aviation are stated after deduction of an allowance for doubtful accounts as of December 31, 1997, 1996 and 1995 of $4,715,000, $5,261,000 and $7,294,990, respectively. As of December 31, 1997, Terra Nova's aggregate exposure in respect of reinsurance ceded to Lloyd's syndicates in relation to Aviation, including estimated reinsurance recoveries in respect of losses incurred but not reported, was approximately $15,530,000, all of which was ceded into Equitas with effect from September 4, 1996. In determining the net liabilities and net loss of Aviation, Terra Nova has identified to Aviation all assets, liabilities, revenues and expenses directly related to the Aviation operations. The net cumulative cash flow from Aviation has been negative since the year ended December 31, 1990, and Terra Nova has provided cash to Aviation out of corporate assets to enable Aviation to meet its obligation on a cash basis. Because Aviation has been operating on a negative cash flow basis and has not generated investment assets in the periods presented in these financial statements, no investment income has been allocated to Aviation. Income tax benefits have been 69 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) allocated to Aviation by applying the relevant U.K. corporation tax rates to the pre-tax loss on Aviation operations. 18. OWNERSHIP AND RELATED PARTY TRANSACTIONS Fees of $487,500, $3,216,004 and $2,500,000 were paid to a related party in 1997, 1996 and 1995 respectively, relating to the Offerings, the issue of the Senior Notes, and the Acquisitions and the capitalization of the Company. 19. SEGMENT INFORMATION The Company's operations are conducted principally through four segments: Marine & Aviation, Non-marine, Agency and the Corporate operations. The Corporate segment holds the assets, principally investments not allocable to the insurance underwriting and agency operations. Substantially all of the revenues are derived from business within the London Market. Additional operations are conducted in Belgium, Bermuda, Canada and France. The following table is a summary of the operations of the four segments for the years ended December 31, 1997, 1996 and 1995:
1997 ------------------------------------------------ MARINE & NON- AVIATION MARINE AGENCY CORPORATE CONSOLIDATED -------- -------- ------- --------- ------------ (DOLLARS IN THOUSANDS) Revenues $146,947 $331,192 $15,571 $ 40,125 $ 533,835 -------- -------- ------- -------- ---------- Income from operations before income taxes 19,827 46,698 2,441 22,083 91,049 -------- -------- ------- -------- ---------- Identifiable assets 523,972 986,780 12,567 696,815 2,220,134 -------- -------- ------- -------- ---------- 1996 ------------------------------------------------ MARINE & NON- AVIATION MARINE AGENCY CORPORATE CONSOLIDATED -------- -------- ------- --------- ------------ (DOLLARS IN THOUSANDS) Revenues $105,558 $225,346 $ 8,998 $ 38,157 $ 378,059 -------- -------- ------- -------- ---------- Income from operations before income taxes 20,582 39,479 461 22,146 82,668 -------- -------- ------- -------- ---------- Identifiable assets 558,475 788,916 6,183 513,773 1,867,347 -------- -------- ------- -------- ----------
1995 ---------------------------------------- MARINE & NON- AVIATION MARINE CORPORATE CONSOLIDATED -------- -------- --------- ------------ (DOLLARS IN THOUSANDS) Revenues $108,003 $197,521 $ 31,348 $ 336,872 -------- -------- -------- ---------- Income from operations before income taxes 16,710 27,320 18,403 62,433 -------- -------- -------- ---------- Identifiable assets 614,340 736,852 433,844 1,785,036 -------- -------- -------- ----------
70 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 20. STATUTORY FINANCIAL DATA (a) Terra Nova files an annual audited return with the H.M. Treasury (the "Treasury") in the U.K. The Treasury has assumed the responsibilities for supervision of insurance companies previously undertaken by the D.T.I.. The Treasury requires U.K. insurance companies to comply with prescribed minimum solvency margins. Terra Nova's unaudited required minimum Treasury solvency margin and unaudited solvency margin at December 31, 1997 were $30,117,000 and $201,557,000, respectively. Terra Nova's unaudited and estimated Treasury Return policyholders' surplus and unaudited net income for the year ended December 31, 1997 and the audited Treasury Return policyholders' surplus and net income as reported in the annual returns to the Treasury for the years ended December 31, 1996 and 1995 are as follows:
1997 1996 1995 ----------- -------- -------- (UNAUDITED) (DOLLARS IN THOUSANDS) Policyholders' surplus $231,674 $234,400 $212,480 Net income before dividends 47,586 23,615 18,778
Terra Nova's ability to pay dividends is limited by a Notice of Requirements issued by the Treasury, which requires Terra Nova to give 14 days' advance notice to the Treasury of its intention to declare and pay a dividend. In addition, Terra Nova must comply with the Companies Act 1985, which provides that dividends may only be paid out of distributable profits. (b) Terra Nova (Bermuda)'s ability to pay dividends is subject to certain regulatory restrictions. Under the Insurance Act of 1978, amendments thereto and related regulations of Bermuda (the "Act"), Terra Nova (Bermuda) is required to file in Bermuda statutory financial statements and a statutory financial return. The Act also requires Terra Nova (Bermuda) to maintain certain measures of solvency and liquidity during the year. Terra Nova (Bermuda)'s statutory capital and surplus and minimum required statutory capital and surplus at December 31, 1997, 1996 and 1995 respectively were:
1997 1996 1995 ----------- -------- -------- (UNAUDITED) (DOLLARS IN THOUSANDS) Statutory capital and surplus $260,612 $219,374 $121,970 Minimum required statutory capital and surplus 100,000 100,000 31,577
Bermuda Holdings' and UK Holdings' ability to meet their expenses and debt services requirements is dependent upon the ability of Terra Nova and Terra Nova (Bermuda) to pay dividends as described above. 21. SUMMARIZED FINANCIAL INFORMATION FOR UK HOLDINGS UK Holdings was incorporated in the United Kingdom on November 7, 1994 for the purposes of acquiring Terra Nova. UK Holdings is the issuer of Senior Notes as described in Note 16. Bermuda Holdings is the guarantor of such notes. The Guarantee is full and unconditional. 71 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Summarized consolidated balance sheet information as at December 31, 1997 and 1996 and summarized consolidated statements of operations information for the years December 31, 1997, 1996 and 1995 relating to UK Holdings is set out below.
DECEMBER 31, --------------------- 1997 1996 ---------- ---------- (DOLLARS IN THOUSANDS) Investments and cash $ 960,191 $ 872,171 Reinsurance recoverable on unpaid losses 407,560 387,733 Accrued premium income 170,006 108,012 Other assets 288,077 193,212 ---------- ---------- Total assets $1,825,834 $1,561,128 ========== ========== Unpaid losses and loss adjustment expenses $1,077,327 $1,011,015 Unearned premiums 254,833 157,515 Net liabilities of Aviation business in run-off 21,985 36,913 Long-term debt 175,000 100,000 Other liabilities 119,971 83,440 ---------- ---------- Total liabilities 1,649,116 1,388,883 ---------- ---------- Total shareholders' equity 176,718 172,245 ---------- ---------- Total liabilities, minority interests and shareholders' equity $1,825,834 $1,561,128 ========== ==========
YEAR ENDED DECEMBER 31, --------------------------- 1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) Net premiums earned $357,939 $243,812 $186,292 Net investment income 55,698 52,102 57,374 Realized investment gains 15,306 12,217 8,735 Foreign exchange (losses) gains (1,240) 213 1,575 Agency income 15,571 8,998 -- -------- -------- -------- Total revenues 443,274 317,342 253,976 -------- -------- -------- Underwriting costs and expenses 384,530 264,627 206,278 -------- -------- -------- Income from operations before income taxes and minority interests 58,744 52,715 47,698 -------- -------- -------- Net income $ 41,105 $ 34,430 $ 29,806 ======== ======== ========
72 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 22. UNAUDITED SELECTED QUARTERLY FINANCIAL DATA
1997 --------------------------------------------------- THREE MONTHS THREE MONTHS THREE MONTHS THREE MONTHS ENDED ENDED ENDED ENDED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------ ------------ ------------ (DOLLARS IN THOUSANDS EXCEPT SHARE AMOUNTS) Revenues $108,335 $122,524 $130,409 $173,108 ======== ======== ======== ======== Net income $ 18,144 $ 16,504 $ 19,009 $ 19,753 ======== ======== ======== ======== Basic earnings per share $ 0.70 $ 0.64 $ 0.75 $ 0.78 ======== ======== ======== ======== Diluted earnings per share $ 0.69 $ 0.63 $ 0.74 $ 0.76 ======== ======== ======== ======== 1996 --------------------------------------------------- THREE MONTHS THREE MONTHS THREE MONTHS THREE MONTHS ENDED ENDED ENDED ENDED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------ ------------ ------------ (DOLLARS IN THOUSANDS EXCEPT SHARE AMOUNTS) Revenues $101,942 $ 94,919 $ 88,876 $ 92,322 ======== ======== ======== ======== Net income $ 15,485 $ 18,644 $ 14,449 $ 15,328 ======== ======== ======== ======== Basic earnings per share $ 1.01 $ 0.77 $ 0.56 $ 0.59 ======== ======== ======== ======== Diluted earnings per share $ 0.85 $ 0.77 $ 0.55 $ 0.58 ======== ======== ======== ========
The Company's net income per share amounts are based on the weighted average number of shares outstanding during the periods (see Note 9). The quarterly 1997 and 1996 per share data shown above, do not agree to those previously reported on form 10Q due to the adoption of SFAS No. 128 "Earnings per Share" in the fourth quarter of 1997. ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in nor any disagreements with accountants on accounting and financial disclosure within the 36 months ended December 31, 1997. 73 PART III ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required by this Item is included in the 1997 Proxy Statement dated March 30, 1998, and such information is incorporated herein by reference. ITEM 11--EXECUTIVE COMPENSATION Information required by this Item is included in the 1997 Proxy Statement dated March 30, 1998, and such information is incorporated herein by reference. ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required by this Item is included in the 1997 Proxy Statement dated March 30, 1998, and such information is incorporated herein by reference. ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by this Item is included in the 1997 Proxy Statement dated March 30, 1998, and such information is incorporated herein by reference. 74 PART IV ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Index to Financial Statements. The financial statements filed as part of this report are listed on the Index to Financial Statements on page 43 hereof. INDEX TO FINANCIAL STATEMENT SCHEDULES
PAGE ---- Report of Independent Accountants on Schedules 76 --Summary of Investments--Other than Investments in Schedule I Related Parties 77 --Condensed Financial Information of Registrant Schedule II(a) (Parent Company)(1) 78 --Condensed Balance Sheet --Condensed Financial Information of Registrant Schedule II(b) (Parent Company)(1) 79 --Condensed Statement of Operations --Condensed Financial Information of Registrant Schedule II(c) (Parent Company)(1) 80 --Condensed Statement of Cash Flows Schedule III --Supplementary Insurance Information 81 Schedule IV --Reinsurance 82 Schedule V --Valuation and Qualifying Accounts 83 Schedule VI --Supplementary Information Concerning Property/Casualty Insurance Operations 84 Other Schedules have been omitted as they are not applicable to the Company. (b) Reports on Form 8-K. The reports on Form 8-K have been filed during the last quarter of the period covered by this report 85 (c) Exhibits. The Index to Exhibits and the Exhibits filed as part of this report 86
75 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Board of Directors of Terra Nova (Bermuda) Holdings Ltd. In connection with our audits of the consolidated balance sheets of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997, 1996 and 1995 which financial statements are included in the Form 10-K, we have also audited the financial statement schedules listed in Item 14 herein. In our opinion, the financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. Coopers & Lybrand Hamilton, Bermuda March 6, 1998 76 SUPPLEMENTAL SCHEDULE I TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
AMOUNT AT WHICH SHOWN IN MARKET THE BALANCE TYPE OF INVESTMENT COST VALUE SHEET ------------------ ---------- ---------- ----------- Fixed maturities: Bonds: United States Government and government agencies and authorities $ 298,618 $ 312,720 $ 312,720 States, municipalities and political subdivisions 40,130 41,384 41,384 Foreign governments 429,811 447,176 447,176 Public utilities -- -- -- Convertibles and other bonds with warrants attached -- -- -- All other corporate bonds 451,240 460,178 460,178 Certificates of deposit -- -- -- Redeemable preferred stocks -- -- -- ---------- ---------- ---------- Total fixed maturities $1,219,799 $1,261,458 $1,261,458 ========== ========== ========== Equity securities: Common stocks: Public utilities $ -- $ -- $ -- Banks, trust and insurance companies 15,483 24,909 24,909 Industrial, miscellaneous and all other 54,298 79,325 79,325 Non redeemable preferred stocks -- -- -- ---------- ---------- ---------- Total equity securities $ 69,781 $ 104,234 $ 104,234 ========== ========== ========== Mortgage loans on real estate $ -- $ -- $ -- Real estate -- -- -- Policy loans -- -- -- Other long-term investment -- -- -- ---------- ---------- ---------- Total investments $1,289,580 $1,365,692 $1,365,692 ========== ========== ==========
77 SUPPLEMENTAL SCHEDULE II(A) TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION(1) CONDENSED BALANCE SHEET (DOLLARS IN THOUSANDS)
DECEMBER 31, ------------------ 1997 1996 -------- -------- ASSETS ------ Investments in subsidiaries, at cost $446,838 $395,549 Fixed Interest Securities 28,703 -- Cash 2,146 2,742 -------- -------- Total investments and cash 477,687 398,291 Other assets 5,619 2,812 -------- -------- Total assets $483,306 $401,103 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Other liabilities $ 1,418 $ 2,344 -------- -------- Total liabilities 1,418 2,344 -------- -------- Shareholders' equity: Common shares 150,142 149,933 Stock held in Trust (9,500) -- Deferred equity compensation 3,275 -- Additional capital 111,568 111,544 Unrealized appreciation in investments of subsidiaries, net of minority interests and income tax 56,430 36,271 Retained earnings 169,973 101,011 -------- -------- Total shareholders' equity 481,888 398,759 -------- -------- Total liabilities and shareholders' equity $483,306 $401,103 ======== ========
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein. 78 SUPPLEMENTAL SCHEDULE II(B) TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION(1) CONDENSED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 31, ---------------- 1997 1996 ------- ------- Revenues: Net investment income $ 1,953 $ 2,205 Realizsed losses on sales of investments (25) (39) Foreign exchange gains 5 -- Dividend income 44,400 -- ------- ------- Total revenues 46,333 2,166 ------- ------- Expenses: Deferred debt expenses 664 664 Salaries 1,864 1,592 Legal and professional expenses 639 463 Other expenses 1,065 1,677 ------- ------- Total expenses 4,232 4,396 ------- ------- Income (loss) from continuing operations before equity in net income of consolidated subsidiaries 42,101 (2,230) Equity in net income of consolidated subsidiaries 31,309 66,136 ------- ------- Net income $73,410 $63,906 ======= =======
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein. 79 SUPPLEMENTAL SCHEDULE II(C) TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION(1) CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
FOR THE YEAR ENDED DECEMBER 31, ------------------- 1997 1996 -------- --------- Cash flows from operating activities: Net loss $ (2,299) $ (2,230) -------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Realized capital losses 25 39 Stock option compensation expense 804 -- Change in accrued investment income (604) -- Change in other assets and liabilities, net (289) (3,479) -------- --------- Net cash used in operating activities (2,363) (5,670) -------- --------- Cash flows from investing activities: Proceeds of fixed maturities sold 46,181 80,196 Purchase of fixed maturities (74,808) (80,235) -------- --------- Net cash used in investing activities (28,627) (39) -------- --------- Cash flows from financing activities: Investment in subsidiary company -- (101,001) Net proceeds from initial public offering -- 113,953 Proceeds from shares issued 384 158 Preference dividends paid to stockholders -- (499) Stock repurchase (10,020) -- Ordinary dividends received from subsidiary company 44,400 -- Ordinary dividends paid to stockholders (4,370) (1,548) Redemption of preference shares -- (16,035) -------- --------- Net cash provided by (used in) financing activities 30,394 (4,972) -------- --------- Change in cash and cash equivalents (596) (10,681) -------- --------- Cash and cash equivalents at beginning of year 2,741 13,422 -------- --------- Cash and cash equivalents at end of year $ 2,145 $ 2,741 ======== =========
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere herein. 80 SUPPLEMENTAL SCHEDULE III TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION (DOLLARS IN THOUSANDS)
BENEFITS, LOSSES CLAIMS, AMORTIZATION DEFERRED AND LOSS NET LOSSES AND OF DEFERRED OTHER ACQUISITION ADJUSTMENT UNEARNED PREMIUM INVESTMENT SETTLEMENT ACQUISITION OPERATING PREMIUMS SEGMENT COSTS EXPENSES PREMIUMS REVENUE INCOME EXPENSES COSTS EXPENSES WRITTEN ------- ----------- ---------- -------- -------- ---------- ---------- ------------ --------- --------- Year ended December 31, 1997 Non-marine $36,705 $687,659 $126,141 $225,315 $41,215(a) $149,352 $63,308 $6,073 $ 233,286 Marine 15,931 387,407 51,235 87,247 16,783(a) 54,600 26,892 3,587 84,479 Octavian 23,744 82,658 97,558 106,507 1,072(a) 78,528 25,227 4,046 165,780 Year ended December 31, 1996 Non-marine $25,031 $638,974 $ 98,360 $182,543 $36,582(a) $123,615 $50,799 $5,464 $ 204,334 Marine 15,929 429,596 53,894 83,921 15,471(a) 46,967 28,139 4,084 78,169 Octavian 4,319 9,538 20,866 12,292 95(a) 7,692 3,456 627 28,663 Year ended December 31, 1995 Non-marine $18,584 $650,052 $ 78,112 $159,555 $37,966(a) $120,105 $43,795 $6,301 $ 161,357 Marine 18,366 518,600 61,881 92,345 15,658(a) 59,006 28,519 3,768 85,628 Octavian -- -- -- -- -- -- -- -- --
- ---- (a) Net investment income excludes investment income and realized gains of $41,393,000, $37,732,000 and $30,238,000 for 1997, 1996 and 1995, respectively, which is attributed to the Parent as disclosed in note 19 to the Consolidated Financial Statements. 81 SUPPLEMENTAL SCHEDULE IV TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES REINSURANCE AS OF DECEMBER 31, 1997 (DOLLARS IN THOUSANDS)
PERCENT CEDED ASSUMED OF AMOUNT GROSS TO OTHER FROM OTHER NET ASSUMED PREMIUMS WRITTEN AMOUNT COMPANIES COMPANIES AMOUNT TO NET ---------------- -------- --------- ---------- -------- --------- PROPERTY-CASUALTY Year Ended December 31, 1997 $269,577 $66,698 $280,666 $483,545 58.04% Year Ended December 31, 1996 119,601 49,844 241,409 311,166 77.60% Year Ended December 31, 1995 86,296 55,673 216,362 246,985 87.60%
82 SUPPLEMENTAL SCHEDULE V TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)
CHARGED TO BALANCE CHARGED OTHER BALANCE AT BEGINNING TO COSTS ACCOUNTS-- DEDUCTIONS-- AT END DESCRIPTION OF PERIOD AND EXPENSES DESCRIBE DESCRIBE OF PERIOD ----------- ------------ ------------ ---------- ------------ --------- Year Ended December 31, 1997 Allowance for Doubtful Accounts $29,149 $ 1,238 $ -- $1,483 (a) $28,904 Year Ended December 31, 1996 Allowance for Doubtful Accounts 30,165 (1,142) -- (126)(a) 29,149 Year Ended December 31, 1995 Allowance for Doubtful Accounts 29,076 3,000 -- 1,911 (a) 30,165
- -------- (a) Amounts previously charged utilized against irrecoverable balances. 83 SUPPLEMENTAL SCHEDULE VI TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS (DOLLARS IN THOUSANDS)
LOSSES AND LOSS ADJUSTMENT EXPENSES INCURRED RESERVE RELATED TO PAID FOR LOSSES ----------------- AMORTIZATION LOSSES AND DEFERRED AND LOSS DISCOUNT, NET (1) (2) OF DEFERRED LOSS ACQUISITION ADJUSTMENT IF ANY, UNEARNED EARNED INVESTMENT CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS SEGMENT COSTS EXPENSES DEDUCTED PREMIUMS PREMIUMS INCOME YEAR YEARS COSTS EXPENSES WRITTEN ------- ----------- ---------- --------- -------- -------- ---------- -------- -------- ------------ ---------- -------- Year Ended December 31, 1997 Continuing operations $76,380 $1,157,724 $ -- $274,934 $419,069 $57,998 $292,875 $(10,395) $115,427 $215,387 $483,545 Aviation business in run-off -- 75,846 -- -- 1,577 -- -- (6) -- 14,500 1,577 Year Ended December 31, 1996 Continuing operations 45,279 1,078,108 -- 173,120 278,756 52,053 180,874 (2,600) 82,394 173,741 311,166 Aviation business in run-off -- 139,667 -- -- 1,624 -- -- 997 -- 32,000 1,624 Year Ended December 31, 1995 Continuing operations 36,950 1,168,652 -- 139,993 251,900 53,624 175,852 3,259 72,314 213,606 246,985 Aviation business in run-off -- 164,898 -- -- 4,668 -- -- 4,574 -- 15,025 4,668
84 ITEM 14--EXHIBITS (b) Reports No reports on Form 8-K have been filed during the last quarter of the period covered by this report. 85 ITEM 14--EXHIBITS (c) Exhibits
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 Certificate of Incorporation and Memorandum of Association of the Company (incorporated by reference to Exhibit 3.2 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 3.2 Amended and Restated Bye-Laws of the Company (incorporated by reference to Exhibit 3.2 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 4.1 Form of Share Certificate (incorporated by reference to Exhibit 4.1 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 4.2 Indenture, dated June 15, 1995, among UK Holdings, the Company and The Chase Manhattan Bank, N.A., as trustee (incorporated by reference to Exhibit 4.2 of the Company's Registration Statement Form S-1; Registration No. 333-1726). 4.3 First Supplemental Indenture, dated October 12, 1995, among UK Holdings, the Company and the Chase Manhattan Bank, N.A., as trustee (incorporated by reference to Exhibit 4.3 of the Company's Registration Statement Form S-1; Registration No. 333-1726). 4.4 Deposit and Custody Agreement, dated June 15, 1995, among UK Holdings, the Company, Chase Manhattan Bank Luxembourg, S.A., as Custodian, and The Chase Manhattan Bank, N.A., as Depository (incorporated by reference to Exhibit 4.4 of the Company's Registration Statement Form S-1; Registration No. 333-1726). 4.5 Indenture, dated August 26, 1997, among UK Holdings, the Company and The Chase Manhattan Bank, as Trustee (incorporated by reference to Exhibit 4.1 of the Company's Registration Statement Form F-4 and S-4, Registration No. 333-38063,-01). 4.6 Deposit and Custody Agreement, dated August 26, 1997, among UK Holdings, the Company, Chase Manhattan Bank Luxembourg S.A., as Custodian, and The Chase Manhattan Bank, as Trustee and as Depository (incorporated by reference to Exhibit 4.2 of the Company's Registration Statement Form F-4 and S-4, Registration No. 333-38063,- 01). 10.1 Exchange Agreement, dated December 20, 1994, among the Company, Aetna, CIGNA, Marsh & McLennan, Bowring and Nimrod Securities (incorporated by reference to Exhibit 10.1 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.2 Share Purchase Agreement, dated December 21, 1994, among UK Holdings, Aetna, CIGNA, Marsh & McLennan, Bowring and Nimrod Securities (incorporated by reference to Exhibit 10.6 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.3 Registration Rights Agreement dated as of March 25, 1996, among the Company and certain shareholders of the Company (incorporated by reference to Exhibit 10.13 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.4 Exclusivity Agreement, between the Company and DLJSC (incorporated by reference to Exhibit 10.14 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.5 Service Agreement, dated October 18, 1993, between Terra Nova and John Riddick (incorporated by reference to Exhibit 10.15 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.6 Service Agreement, dated June 14, 1993, between Terra Nova and Richard J. Edmunds (incorporated by reference to Exhibit 10.17 of the Company's Registration Statement on Form S-1, Registration No. 33- 93358).
86
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.7 Service Agreement, dated May 28, 1993, between Terra Nova and Ian L. Bowden (incorporated by reference to Exhibit 10.18 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.8 Service Agreement, dated January 5, 1996, between Octavian (formerly Saffronplace Limited) and Nigel Harold John Rogers (incorporated by reference to Exhibit 10.19 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.9 Letter Agreement, dated January 5, 1996, between the Company and John J. Dwyer (incorporated by reference to Exhibit 10.19 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.10 Letter Agreement, dated March 20, 1995, between the Company and John J. Dwyer (incorporated by reference to Exhibit 10.20 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.11 Approved Executive Share Option Plan (incorporated by reference to Exhibit 10.22 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.12 Octavian 1996 Stock Option Scheme (incorporated by reference to Exhibit 10.23 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.13 The Octavian Group Pension Scheme (incorporated by reference to Exhibit 10.24 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.14 DTI Notice of Requirements (incorporated by reference to Exhibit 10.23 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.15 Terra Nova Insurance Company Limited Non-Approved Funded Pension Scheme (incorporated by reference to Exhibit 10.28 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 21.1 Subsidiaries of the Company (incorporated by reference to Exhibit 21.1 of the Company's Registration Statement on Form S-1, Registration No. 333-1726).
87 EXHIBIT 11.1 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES STATEMENT RE COMPUTATION OF PER SHARE EARNINGS Common Stock outstanding entire year 25,850,566 Add effect of: Options exercised during 1997 34,027 Stock repurchased during 1997 (297,945) -------- (263,918) ---------- Shares outstanding for Basic Per Share Calculation 25,586,548 =========== Basic Net Income: Reported Net Income Available for Common Shareholders $73,410,123 =========== Basic Net Income Per Share $ 2.87 =========== Shares added for Diluted Calculation to reflect the effect of: Stock Options 406,643 ---------- Shares outstanding for Diluted Per Share Calculation 25,993,291 =========== Diluted Net Income: Reported Net Income Available for Common Shareholders $73,410,123 =========== Diluted Net Income Per Share $ 2.82 ===========
88 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized. TERRA NOVA (BERMUDA) HOLDINGS LTD.
SIGNATURE TITLE DATE --------- ----- ---- /s/ William O. Bailey Chairman, President and March 16, 1998 ____________________________________ Chief Executive Officer William O. Bailey /s/ William J. Wedlake Senior Vice President and March 16, 1998 ____________________________________ Chief Financial Officer William J. Wedlake /s/ John J. Dwyer Deputy Chairman March 16, 1998 ____________________________________ John J. Dwyer /s/ John Riddick Deputy Chairman March 16, 1998 ____________________________________ John Riddick /s/ Nigel H.J. Rogers Deputy Chairman March 16, 1998 ____________________________________ Nigel H.J. Rogers /s/ Robert S. Fleischer Director March 16, 1998 ____________________________________ Robert S. Fleischer /s/ David L. Jaffe Director March 16, 1998 ____________________________________ David L. Jaffe
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