-----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, UVZjYmVxVOggqiBGKDLqGwbEohOm+va8NJTFBnuEW/H94S7JYYxxq4taSM8vE0oy kbv/9qZ4m1uL2GcJU86jcQ== 0000950130-99-001428.txt : 19990316 0000950130-99-001428.hdr.sgml : 19990316 ACCESSION NUMBER: 0000950130-99-001428 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990315 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: 99564882 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-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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, 1998 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 7.2% Senior Notes due 2007 New York Stock Exchange 7.0% Senior Notes due 2008 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 15, 1999 was 25,977,642 (includes 606,800 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, 1999 and information from the registrant's annual report to shareholders for the fiscal year ended December 31, 1998. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TERRA NOVA (BERMUDA) HOLDINGS LTD. INDEX TO FORM 10-K
Page ---- PART I Item 1. Business 3 Item 2. Properties 25 Item 3. Legal Proceedings 25 Item 4. Submission of Matters to a Vote of Security Holders 25 PART II Market for the Registrant's Common Shares and Related Item 5. Shareholder Matters 26 Selected Financial Data for the five years ended December 31, Item 6. 1998 26 Management's Discussion and Analysis of Results of Operations Item 7. and Financial Condition 26 Item 7A. Quantitative and Qualitative Disclosure About Market Risk 36 Item 8. Financial Statements 38 Changes in and Disagreements with Accountants on Accounting Item 9. and Financial Disclosure 69 PART III Item 10. Directors and Executive Officers of the Registrant 70 Item 11. Executive Compensation 70 Item 12. Security Ownership of Certain Beneficial Owners and Management 70 Item 13. Certain Relationships and Related Transactions 70 PART IV Exhibits, Financial Statement Schedules and Reports on Form 8- Item 14. K 71 Index to Exhibits 71
2 PART I ITEM 1--BUSINESS Safe Harbor Disclosure The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Any written or oral statements made by or on behalf of the Company may include forward-looking statements which reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to certain uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors (which are described in more detail elsewhere in documents filed by the Company with the Securities and Exchange Commission) include, but are not limited to: (i) uncertainties relating to government and regulatory policies (such as subjecting the Company to insurance regulation or taxation in additional jurisdictions), (ii) the occurrence of catastrophic events with a frequency or severity exceeding the Company's estimates, (iii) the uncertainties of the reserving process, (iv) loss of the services of any of the Company's executive officers, (v) the competitive environment in which the Company operates and related pricing weaknesses in some lines of business, (vi) changing rates of inflation and other economic conditions, (vii) losses due to foreign currency exchange rate fluctuations, (viii) ability to collect reinsurance recoverables, (ix) developments in global financial markets which could affect the Company's investment portfolio, (x) risks associated with the introduction of new products and services, (xi) the impact of Year 2000 related issues, and (xii) the legal environment. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligation to update or revise any forward-looking statements publicly, whether as a result of new information, future events or otherwise. Overview of the Company The Company is the holding company for five wholly owned operating entities. The principal operating entities are: 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. Octavian manages the eight Lloyd's syndicates in which the Company has a participation. Through these subsidiaries, the Company writes a specialty property, casualty, marine and aviation insurance and reinsurance business worldwide and is organized as follows: Terra Nova (Bermuda) Holdings Ltd. ("The Company") | ------------------------------------------ | | | | Terra Nova | Insurance (UK) | Holdings plc | ("UK Holdings") | --------------------------|------------------ | | | | | | | | | Terra Nova Octavian Syndicate Terra Nova Terra Nova Insurance Company Management Capital Limited (Bermuda) Limited Limited ("Terra Nova Insurance Company ("Terra Nova") ("Octavian") Capital") Ltd. | ("Terra Nova Compagnie de (Bermuda)") Reassurance D'Ile de France ("Corifrance") 3 Terra Nova and the Lloyd's syndicates managed by Octavian are based in the London Market. The London Market is comprised of Lloyd's and companies with underwriting offices close to Lloyd's. 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. Terra Nova (Bermuda) operates in the Bermuda Market which consists of both captive and independent companies. In recent years, the Bermuda Market has become one of the world's largest insurance and reinsurance markets for international business. The Company wrote $759.4 million of gross written premiums in 1998 and a combined ratio of 98.8%. The Company's net operating earnings before extraordinary items were $70.9 million, up $8.0 million from 1997, representing $2.72 per share on a diluted basis. Shareholders' equity at December 31, 1998 was $570.9 million and total assets were $2,479.4 million. The Company's Class A ordinary shares are publicly traded on the New York Stock Exchange under the symbol TNA. Gross written premiums and shareholders' equity of the operating subsidiaries for 1998 were as follows:
Gross Written Shareholders' AM Best S&P Premiums Equity Rating Rating ------------- ------------- ------- ------ (dollars in millions) The Company $759.4 $570.9 ------ ------ Terra Nova 302.2 281.9 A A Terra Nova (Bermuda) 80.5 333.9 A A Terra Nova Capital 358.9 (3.4)(/1/) A(/2/) A+(/3/) Corifrance 17.8 48.7 A- A-
- -------- (/1/) Backed by $250.6 million of letters of credit from a subsidiary of Terra Nova (Bermuda). (/2/) Benefits from the Lloyd's global rating of "A". (/3/) Benefits from the Lloyd's global rating of "A+". Business Segments Breakdown of Gross Written Premiums by Operating Entity and Class of Business (dollars in millions)
Year ended December 31, ----------------------------------------------------- 1998 1997 1996 ----------------- ----------------- ----------------- Percent of Percent of Percent of Amount Total Amount Total Amount Total ------ ---------- ------ ---------- ------ ---------- Terra Nova $302.2 39.8% $292.4 53.2% $288.9 80.0% Terra Nova (Bermuda) 80.5 10.6 51.2 9.3 35.3 9.8 Terra Nova Capital 358.9 47.3 204.2 37.1 36.8 10.2 Corifrance 17.8 2.3 2.4 0.4 -- -- ------ ----- ------ ----- ------ ----- Total 759.4 100.0 550.2 100.0 361.0 100.0 Property 329.1 43.3 226.7 41.2 178.9 49.6 Casualty 158.1 20.8 115.1 20.9 69.8 19.3 Marine & Aviation 204.6 27.0 169.3 30.8 112.3 31.1 Orphan syndicate business 67.6 8.9 39.1 7.1 -- -- ------ ----- ------ ----- ------ ----- Total 759.4 100.0 550.2 100.0 361.0 100.0 Direct business 407.8 53.7 269.6 49.0 119.6 33.2 Reinsurance assumed 351.6 46.3 280.6 51.0 241.4 66.8 ------ ----- ------ ----- ------ ----- Total for the Company $759.4 100.0% $550.2 100.0% $361.0 100.0% ====== ===== ====== ===== ====== =====
4 The Company's principal lines 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. In 1997 and 1998, the Company received premiums related to reinsurance to close of orphan Lloyd's syndicates. The Company's mix of business by operating entity and by class of business, is set out in the table above. Terra Nova Since it began in 1970 as a reinsurance company, Terra Nova has expanded into other fields of insurance. Although the largest segment of the business continues to be reinsurance, growth in recent years has been in specialty areas of primary insurance. Terra Nova is authorized in the United Kingdom to transact all classes of insurance business and underwrites a significant volume of property, marine and casualty treaty reinsurance. Terra Nova is approved to underwrite excess and surplus lines insurance in almost every state of the United States, and has also gained accreditation in various states under statutes providing for accreditation of non-US reinsurers. As at March 15, 1999, Terra Nova was accredited as a reinsurer in forty-two jurisdictions of the United States and had an application for approval pending in a further five. Marine insurance is a major part of the business, transacted both on a direct and a reinsurance basis through the International Underwriting Association of London. This segment encompasses cargo, specie and liability. In December 1998, Terra Nova announced its decision to withdraw from the marine hull and marine energy markets. A Terra Nova branch office operates from Brussels, transacting treaty reinsurance in continental European reinsurance markets. Terra Nova is also licensed to transact non-marine reinsurance in Canada through its branch office in Toronto. In 1998, Terra Nova wrote $151.3 million of property business (representing 50.1% of total business), $71.5 million of casualty business (23.6%) and $79.4 million of marine business (26.3%). Terra Nova (Bermuda) Terra Nova (Bermuda) is a specialty property and casualty insurance and reinsurance company operating in the Bermuda Market. The principal lines of business are various classes of property and casualty coverage written on a reinsurance basis. Writings originate worldwide. Terra Nova Capital The Company participates on the eight syndicates managed by Octavian, through Terra Nova Capital. The syndicates' writings include mainly UK liability, UK and overseas auto, marine and aviation lines. Terra Nova Capital's average participation on the Octavian syndicates increased to approximately 60% in 1998, from 44% in 1997 and 11% in 1996. For the 1999 year of account, Octavian has $617.6 million ((Pounds)386.0 million) of aggregate underwriting capacity, net of commission, of which $477.4 million ((Pounds)298.4 million), or 77%, is provided by the Company through Terra Nova Capital. The Octavian syndicates are as follows: 5
The Company's Syndicate 1998 Share of Number Active Underwriter Capacity 1998 Capacity Products - --------- --------------------- --------------------- ------------- ------------------------------- (dollars in millions) % 329 Jonathan L. Jones $ 71.9 72.9% Marine hull, war/political risks, cargo & specie, energy 554 Malcolm H. Waterlow 31.7 72.1 UK auto 702 Reg E. Brown 143.7 35.3 Professional indemnity, crime, legal expenses, property, personal accident, employers' liability/public liability, bloodstock 959 Ray J. Busbridge 84.7 72.1 Airlines, commercial/charter products, satellites, other aviation, personal accident 1009 David E. Hope 104.0 42.1 Energy, liability, hull, war, specie, cargo, excess of loss, onshore property 1227 J. Nick C. Wooldridge 40.0 100.0 Reinsurance of orphan syndicates, property direct & facultative, financial institutions business, contingency, US property/casualty packages 1228 Peter M. Routledge 104.0 66.3 Private auto, commercial auto, UK & overseas contracts auto, household & commercial property 1239 Malcolm E. Warrington 48.2 72.4 Property, financial institutions, casualty, personal accident, contingency
Corifrance Corifrance is a French reinsurance company based in Paris. Corifrance transacts specialty treaty and facultative reinsurance business internationally, although mainly outside the US, on a direct and brokered basis. Marketing The Company's writings originate worldwide and are accepted through insurance brokers, principally Lloyd's brokers. By using broker distribution, the Company maintains low fixed overhead costs. Brokers charge commissions varying with the type and in proportion to the volume of business written. This allows the Company flexibility to vary its volume and mix of business according to perceived opportunities. The following table shows the percentage of gross written premiums by the brokers placing more than five percent of the Company's business for the year ended December 31, 1998: Percentage of Gross Written Premiums (1) by Broker (2) for year ended December 31, 1998
Broker Percentage ------ ---------- J & H Marsh & McLennan, Incorporated 19.9% Aon Corporation 9.9 Willis Corroon 6.7
- -------- (1) Based on premiums reported by each broker for the 1998 underwriting year. (2) Affiliate companies are combined within each broking group. 6 Underwriting Underwriting of new and renewal business is conducted on a risk by risk basis. Consideration is 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 exposure to 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 management's approval. The underwriting process includes an assessment of (i) the geographic profile of the business underwritten, (ii) historical loss information for the cedent or insured, and (iii) historical loss information for the segment of the industry involved. Judgment about the quality and integrity of the cedent, insured and/or agent is fundamental to the underwriting. Close attention is paid to financial ratings of cedents. Complex risks are usually written only after considerable research, often needing significant actuarial analysis, a full underwriting survey by a qualified surveyor and/or a visit to the client. For property catastrophe reinsurance business, the underwriting guidelines limit the aggregate exposure to any one cedent and in defined geographic zones. In addition, the Company uses CATMAP/2(TM), a commercially available software program developed by Applied Insurance Inc., as well as other commercial and its own proprietary models to assess pricing adequacy and manage ongoing loss exposure. The underwriting policy for casualty business emphasizes well-defined exposures, for example, by profession and narrow geographic region. These allow detailed analysis leading to informed pricing decisions. Diversification of exposures is achieved by underwriting individual contracts in varying geographic regions. Also, most 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). Marine hull underwriting involves detailed analysis of the loss record of individual vessels as well as the fleets of which they may form a part. 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 loss adjustment expense ("LAE") liabilities consist of case reserves and IBNR reserves. Case reserves are estimates of future loss payments for 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 paid and is not discounted or otherwise adjusted for the time value of money. IBNR reserves are established actuarially. They reflect: (i) an estimated ultimate loss amount for claims not yet notified; and (ii) an estimate of possible changes in the value of those claims which have already been reported. The method of setting IBNR reserves depends on 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. While management believes 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. 7 The following table shows the development of net reserves for losses and LAE for the calendar years 1988 to 1998 for all lines of business, except the Company's aviation business in run-off. The deterioration between 1988 and 1993 is mainly the result of LMX Spiral losses in the marine account and asbestos- related and environmental pollution losses in both the marine and casualty accounts. The first line of the table presents the net liabilities, including IBNR, as recorded in the Company's balance sheet for the indicated year and all unpaid losses for prior years. The upper portion of the table shows the liability re- estimated at the end of each of the succeeding years. The conditions that have caused 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 later years. For example, an adjustment to 1988 loss reserves in 1990 will show in the re-estimation of reserves for the years 1988 through 1989. A redundancy (or deficiency) arises when the re-estimation of reserves at the end of the year is less (or more) than the estimate at the preceding year-end. The redundancy (or deficiency) would be recorded in the income statement of that year. The cumulative redundancy (or deficiency) is the difference between the re-estimation of reserves as at the end of 1998 and the original estimate as shown on the top line of the table. The lower portion of the table shows the cumulative amounts paid at the end of each successive year for such claims. Analysis of Net Loss and LAE Reserve Development (dollars in millions)
Year Ended December 31, -------------------------------------------------------------------------------------------- 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Reserves for unpaid losses and LAE at December 31 $585.6 $637.1 $693.9 $724.9 $784.5 $775.6 $847.3 $814.2 $824.0 $911.0 $982.9 Reserves re-estimated(1) as of: One year later 607.4 655.0 719.3 761.0 806.9 802.5 850.1 811.6 813.6 886.0 Two years later 622.7 671.1 736.5 773.7 821.5 810.5 850.1 793.0 793.0 Three years later 628.2 691.2 743.8 780.5 829.0 810.7 832.9 777.8 Four years later 640.3 681.2 738.1 792.4 829.8 800.7 812.8 Five years later 626.6 663.6 755.5 793.5 816.5 784.7 Six years later 607.5 674.1 756.5 776.6 800.5 Seven years later 617.5 674.0 741.2 760.2 Eight years later 617.5 667.2 724.7 Nine years later 618.8 655.3 Ten years later 618.9 Cumulative (deficiency) redundancy (33.3) (18.2) (30.8) (35.3) (16.0) (9.1) 34.5 36.4 31.0 25.0 as a percentage of unpaid losses and LAE (5.69)% (2.86)% (4.44)% (4.87)% (2.04)% (1.17)% 4.07% 4.47% 3.76% 2.74% Paid (cumulative) as of: One year later $ 91.4 $ 94.2 $115.3 $119.3 $143.8 $151.8 $168.8 $123.4 $145.7 $187.6 Two years later 158.9 174.6 201.3 228.2 268.3 259.0 253.6 227.6 241.6 Three years later 200.4 190.1 274.3 316.1 350.8 311.8 327.8 293.0 Four years later 222.7 242.2 341.0 379.9 383.8 368.8 380.7 Five years later 276.3 293.0 395.8 402.5 426.8 405.8 Six years later 312.6 330.2 407.8 438.3 457.7 Seven years later 338.3 336.6 435.5 464.0 Eight years later 354.1 353.5 456.8 Nine years later 360.9 370.8 Ten years later 373.4
8 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 (dollars in millions)
Year Ended December 31, ------------------------------------------------------------ 1993 1994 1995 1996 1997 1998 -------- -------- -------- -------- -------- -------- Gross reserves for unpaid losses and LAE $1,238.8 $1,223.8 $1,168.7 $1,078.2 $1,157.7 $1,209.0 Reinsurance recoveries on unpaid losses and LAE 463.2 376.5 354.5 254.1 246.7 226.1 Gross reserves re- estimated (1) as of: One year later 1,332.8 1,310.2 1,174.8 1,067.0 1,142.5 Two years later 1,428.9 1,319.9 1,168.4 1,058.6 Three years later 1,428.0 1,311.2 1,150.6 Four years later 1,431.3 1,291.4 Five years later 1,428.4 Reinsurance recoveries on unpaid losses and LAE re-estimated (2) as of: One year later 530.3 460.1 363.2 253.4 260.9 Two years later 618.4 469.9 370.1 264.1 Three years later 617.3 478.3 372.8 Four years later 630.6 478.7 Five years later 643.6 Gross cumulative (deficiency) redundancy (189.6) (67.6) 18.1 19.6 15.3 as a percentage of unpaid losses and LAE (15.3%) (5.5%) 1.6% 1.8% 1.3% Paid (cumulative) as of: One year later $ 303.9 $ 290.6 $ 229.7 $ 179.6 $ 246.3 Two years later 517.9 479.8 364.4 328.0 Three years later 679.3 576.4 477.2 Four years later 752.5 672.3 Five years later 829.2
- -------- (1) "Reserves re-estimated" includes losses paid in current and prior years. (2) "Reinsurance recoveries on unpaid losses" includes reinsurance recoveries received in current and prior years. 9 The following table represents a reconciliation of reserve balances for the years indicated:
1998 1997 1996 ---------- ---------- ---------- (dollars in thousands) Reserves for unpaid losses and loss adjustment expenses, at beginning of year $1,157,724 $1,078,108 $1,168,652 Less reinsurance recoverables on unpaid losses (246,728) (254,129) (354,417) ---------- ---------- ---------- Net balance at beginning of year 910,996 823,979 814,235 ---------- ---------- ---------- Net incurred losses and loss adjustment expenses related to: Current year 384,531 292,876 180,874 Prior years (24,964) (10,396) (2,600) ---------- ---------- ---------- Total net incurred losses and loss adjustment expenses 359,567 282,480 178,274 ---------- ---------- ---------- Net paid losses and loss adjustment expenses related to: Current year (138,918) (69,685) (50,303) Prior years (187,559) (145,702) (123,438) ---------- ---------- ---------- Total net paid losses and loss adjustment expenses (326,477) (215,387) (173,741) Foreign exchange adjustment (5,169) (10,967) 5,211 ---------- ---------- ---------- Net balance at end of year 938,917 880,105 823,979 Net reserves from reinsurance to close of 1996 year 43,988 -- (/1/) -- Net reserves from Corifrance Acquisition -- 30,891 -- ---------- ---------- ---------- Net reserves at end of year 982,905 910,996 823,979 Plus Reinsurance recoverables: The Company 226,098 236,847 254,129 Reinsurance recoverables related to net reserves from Corifrance acquisition -- 9,881 -- ---------- ---------- ---------- Reinsurance recoverable by the Company 226,098 246,728 254,129 ---------- ---------- ---------- Reserves for unpaid losses and loss adjustment expenses, at end of year $1,209,003 $1,157,724 $1,078,108 ========== ========== ==========
- -------- (/1/)The net reserves from the reinsurance to close of the 1995 year, of $17,910,000, have been included in net incurred losses and loss adjustment expenses for the year ended December 31, 1997. The premiums of $17,910,000 in respect of these losses were included in gross written and net earned premiums in 1997. Incurred claims relating to prior years are offset by decreases to prior year net written and net earned premiums less related acquisition costs of $9,757,000, $4,800,000 and $3,550,000 for 1998, 1997 and 1996, respectively. When these revisions to prior written and earned premiums are considered, the Company experienced net prior year improvement of $15,207,000 in 1998, $5,596,000 in 1997 and deterioration of $950,000 for 1996. The Company believes that its reserves at December 31, 1998, are adequate. Establishment of reserves, however, is a 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 right to extrapolate future deficiencies or redundancies based on the results set out above. By line of Business 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. 10 Non-Marine Casualty Reserves. The non-marine casualty account 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 monitored individually and reserved separately. The reserves established for long-tail asbestos-related and environmental pollution claims are reviewed quarterly based on emerging loss reports. 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 large part of the gross total claim amount for these years is made up of a small number of especially large losses which are heavily reinsured. Each of these losses is analyzed 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 considerably reduced. In other areas of the marine account, and for recent underwriting years, traditional actuarial techniques are used for each class. These techniques include establishing initial loss ratio assumptions for the most recent underwriting years. In addition, exceptional and unusual claims are analyzed separately as part of the Company's reserving procedures. The following table summarizes the Company's reserve balances for continuing operations by line of business. The reserve results include loss reserves and allocated LAE reserves. Breakdown of Reserve Balances Relating to Continuing Operations by Line of Business at December 31, 1998 (dollars in millions)
Reinsurance Gross Reserves Recoverables Net Reserves ----------------- ---------------- ----------------- Case IBNR Case IBNR Case IBNR Total -------- -------- -------- ------- -------- -------- -------- Non-Marine Property $162,339 $ 44,392 $ 17,903 $ 1,303 $144,436 $ 43,089 $187,525 Non-Marine Casualty 277,384 312,899 43,553 8,730 233,831 304,169 538,000 Marine & Aviation 291,517 98,805 151,851 2,759 139,666 96,046 235,712 Unallocated LAE -- 21,667 -- -- -- 21,667 21,667 -------- -------- -------- ------- -------- -------- -------- Total $731,240 $477,763 $213,307 $12,792 $517,933 $464,971 $982,904 ======== ======== ======== ======= ======== ======== ========
Asbestos-Related and Environmental Pollution Reserves. Before 1974, the Company had little exposure to casualty business. Since the mid-1980s, the Company's casualty business has been written increasingly on a claims-made basis with the majority written on such a basis since 1986. From the Company's inception through 1998, payments made by the Company for asbestos-related and environmental pollution claims totaled approximately $29.6 million. Included in the liability for loss reserves at December 31, 1998, are $95.9 million (net of recoverables from reinsurers) of loss reserves concerning asbestos-related and environmental pollution claims. Included in this liability 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 determining that coverage exists and defining an occurrence, may cause the loss development to display more variation than the rest of the Company's book of business. Traditional reserving techniques cannot be used to estimate asbestos- related and environmental pollution claims. 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. However, there is no assurance that such losses will not materially affect the Company's results of operations for any period. 11 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 (Net of Reinsurance)
Year Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- (dollars in millions) Incurred losses $ 13.1 $ 1.6 $ (3.4) Incurred LAE 4.6 1.2 3.5 ------- ------- ------- Incurred losses and LAE $ 17.7 $ 2.8 $ 0.1 ======= ======= ======= Net paid losses and LAE $ 1.1 $ 2.5 $ 1.7 ======= ======= ======= Reclassification of reserves previously identified as non asbestos-related losses -- -- 12.1(1) Losses and LAE case reserves $ 29.0 $ 28.3 $ 26.2 Losses and LAE IBNR reserves 46.3 30.5 32.2 ------- ------- ------- Total reserves $ 75.3 $ 58.8 $ 58.4 ======= ======= ======= - -------- (1) The reclassification of reserves previously identified as non asbestos- related losses relates to risks specific to one cedent. The reserves established for these risks had previously been treated as non asbestos related losses because of a lack of information being available about the type of these losses. Environmental Pollution Losses and LAE Incurred and Reserves Outstanding (Net of Reinsurance) Year Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- (dollars in millions) Incurred losses $ (6.7) $ (2.9) $ (1.4) Incurred LAE (1.8) 0.9 (0.1) ------- ------- ------- Incurred losses and LAE $ (8.5) $ (2.0) $ (1.5) ======= ======= ======= Net paid losses and LAE $ 1.3 $ 1.5 $ 3.0 ======= ======= ======= Losses and LAE case reserves $ 9.5 $ 9.5 $ 9.9 Losses and LAE IBNR reserves 11.1 20.8 24.0 ------- ------- ------- Total reserves $ 20.6 $ 30.3 $ 33.9 ======= ======= ======= Reinsurance recoverables netted against the asbestos-related and environmental pollution loss reserves for each of the years 1998, 1997 and 1996: Year Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- (dollars in millions) Gross reserves $ 129.2 $ 111.8 $ 111.9 Reinsurance recoverables 33.3 22.7 19.6 ------- ------- ------- Net reserves $ 95.9 $ 89.1 $ 92.3 ======= ======= ======= Litigation expenses included in the asbestos-related and environmental pollution loss reserves for each of the years 1998, 1997 and 1996: Year Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- (dollars in millions) Total reserves $ 95.9 $ 89.1 $ 92.3 Litigation expenses included 25.8 24.1 24.8
12 Risk Management and Reinsurance Protection Following 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 the general practice of insurers to regard the reinsured portion of the risks as the liability of the reinsuring company. The Company buys reinsurance primarily to manage exposures in its insurance and reinsurance business. Reinsurance serves to reduce 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. It also allows for large or "shock" losses to be managed over time. Each decision to buy reinsurance coverage and the amounts, types and attachment points of coverage bought is the result of careful evaluation. The Company looks at the costs and benefits involved relative to the size of the Company's aggregate exposures and the business outlook for the applicable line, among other factors. Reinsurance placement standards are maintained by the Company's security committee. Information on historical financial performance, current solvency and business practices likely to influence future solvency is assembled from various sources, with special attention given to new and small companies. The current system is based on recognized rating agency reports. Also, the reinsurance element of the Company's total gross exposure is reviewed regularly for issues about collectability, including solvency and disputes. As needed, the Company sets up a bad debt reserve for reinsurance recoverables that are in doubt. At December 31, 1998, this reserve stood at $38.8 million or 12.4% of total reinsurance recoverables. The Company's recoverables from its reinsurers consist of: (i) amounts recoverable for paid and outstanding claims; and (ii) amounts recoverable related to IBNR. The following table sets out net reinsurance recoverables from continuing operations from December 31, 1996, to December 31, 1998: Aggregate of Net Reinsurance Recoverables
At December 31, At December 31, At December 31, 1998 Movement 1997 Movement 1996 --------------- -------- --------------- -------- --------------- (dollars in millions) Paid claims $ 61.5 $ 12.6 $ 48.9 $ (6.4) $ 55.3 Notified outstanding claims 220.1 (7.0) 227.1 17.2 209.9 IBNR 29.2 (9.8) 39.0 (22.8) 61.8 Bad Debt provision (38.8) (9.9) (28.9) 0.2 (29.1) ------ ------ ------ ------ ------ Total $272.0 $(14.1) $286.1 $(11.8) $297.9 ====== ====== ====== ====== ======
The following table sets out 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 40.1%, to $91.2 million in 1998 from $152.3 million in 1997, and by 7.6%, to $152.3 million in 1997 from $164.9 million in 1996. Analysis of Net Reinsurance Recoverables
At December 31, -------------------- 1998 1997 1996 ------ ------ ------ (dollars in millions) Reinsurance recoverable: Continuing operations $180.8 $133.8 $133.0 Marine LMX business 91.2 152.3 164.9 ------ ------ ------ Total $272.0 $286.1 $297.9 ====== ====== ======
13 At December 31, 1998, syndicates at Lloyd's were the Company's principal reinsurers, with reinsurance recoverables on paid and outstanding claims and IBNR from continuing business of approximately $77.9 million. Five Largest Providers of Reinsurance for the 1998 Underwriting Year
A.M. Best Premium Reinsurer Rating(1) Ceded(2) --------- --------- -------- Lloyd's Syndicates A 13.5% Hannover Ruckversicherungs AG A+ 4.6 CNA Reinsurance Company Ltd. A 4.5 ERC Frankona Ruckversicherungs AG A+ 3.7 Zurich Insurance Co./Centre Reinsurance International Ltd. A+ 2.8
- -------- (1) A rating from A.M. Best reflects the opinion of A.M. Best about an insurer's financial strength, operating performance and ability to meet its obligations to policyholders. (2) Premium ceded for the 1998 underwriting year. 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. At the same time, the Company must maintain sufficient liquidity to enable it to meet its obligations on a timely basis. An in-house team of seven people at Terra Nova Asset Management Limited, headed by the Director of Investments and the Director of Fixed Interest Investment, manages investments for Terra Nova and the Octavian syndicates. Investment management for Terra Nova (Bermuda) is the responsibility of its Vice President--Administration and Finance. 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 carried out in accordance with U.K. regulations which govern the admissibility and valuation of individual investments within its portfolio for solvency calculation purposes. Terra Nova (Bermuda)'s investments are made in accordance with Bermuda regulations which 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 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 for both the "technical funds" and the "capital funds" for its insurance businesses. 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 income securities and cash. The objectives of the investment strategy for technical funds are to: (i) maintain diversified fixed income portfolios to optimize investment income without undue risk, (ii) manage portfolio duration, and (iii) maintain sufficient liquidity to meet its obligations on a timely basis. The Company's investment strategy for 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 also maintains satisfactory levels of current income. 14 The Company does not invest in real estate, mortgages or high yield fixed income securities. Nor does the Company engage 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 on 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 the duration of 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. About 79% of the investment portfolio of the Company is held in U.S. dollars. At December 31, 1998, 64% of the investments of the Company supported the Company's loss reserves and 36% supported the Company's capital. On that date, 44% of the investments of the Company were investments of Terra Nova. For more information about the investment portfolio, including breakdowns of the sector and maturity distributions, see Note 4 to the consolidated financial statements. Competition The property and casualty insurance and reinsurance industry is very 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 are larger and have greater financial resources than the Company. Also, other well-capitalized insurers and reinsurers could start writing or increase their writing of the classes of business in which the Company participates. Competition in the classes of business which the Company writes is based on many factors. These include the overall financial strength of the insurer or reinsurer, claims paying ability rating, premiums charged and other terms and conditions, services provided, reputation and technical ability and experience of staff. Management of the Company believes that its principal competitive strengths are its management and flexibility, its expertise in risk assessment and underwriting skills and its relationships with Lloyd's brokers, other leading brokers and reinsurance intermediaries. Ratings At March 15, 1999, the Company carried A, A and A+ claims paying ability ratings 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 15, 1999, the Company's long term senior debt rating was BBB, Baa1 and BBB+ at S&P, Moody's and Duff & Phelps, respectively. Claims paying ability ratings are based on a review of publicly available information and communications between rating agency analysts and an insurance company's management. Such ratings are the opinion of the rating agency giving the rating and are not directed toward protecting investors. Aviation Business in Run-Off In February 1992, having suffered 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, 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. 15 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 related to other overhead considered necessary to complete the run-off of the aviation business was treated as a one-time charge ($2.1 million in 1992). This was set up as a separate provision in Terra Nova's GAAP financial statements. Since the acquisition of Terra Nova by the Company in 1994, any charges or credits resulting from changes in estimates are recorded 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 underwriting operations support. This separate group of claims personnel has a significant amount of experience with the Company's aviation business. The level of disclosure on aviation business in run-off has been reduced from that provided in prior year financial statements to reflect the stable run-off pattern experienced by this business in recent years. Management expects this stability to continue in future years. The following table represents a reconciliation of reserve balances for the years indicated: Reconciliation of Aviation Reserve Balances (dollars in millions)
Year Ended December 31, --------------------------- 1998 1997 1996 ------- -------- -------- Reserves for unpaid losses and loss adjustment expenses, gross of reinsurance, at the end of the year $ 75.8 $ 139.7 $ 164.9 Less reinsurance recoverables 42.8 91.1 85.5 ------- -------- -------- Net balance at beginning of the year 33.0 48.6 79.4 ------- -------- -------- Incurred related to: Prior years (1.4) -- 0.8 ------- -------- -------- Total incurred (1.4) -- 0.8 ------- -------- -------- Paid related to: Prior years (5.1) (14.5) (32.0) ------- -------- -------- Total paid (5.1) (14.5) (32.0) Foreign exchange adjustment 0.1 (1.1) 0.4 ------- -------- -------- Net reserves at end of year 26.6 33.0 48.6 Reinsurance recoverables by the Company 39.2 42.8 91.1 ------- -------- -------- Reserves for unpaid losses and loss adjustment expenses, gross of reinsurance, at the end of the year $ 65.8 $ 75.8 $ 139.7 ======= ======== ========
Employees At December 31, 1998, Terra Nova, Terra Nova Asset Management Limited and Terra Nova (Bermuda) had 181 employees, none of which was represented by a labor union. The Company believes that its relationship with employees is excellent. At the same date, Corifrance had 33 employees. Octavian has 404 employees, and is reimbursed by the Octavian syndicates for costs relating to most of these employees. Terra Nova Information Services Ltd., a subsidiary of Octavian, had 73 employees. Regulation of the Company United Kingdom Authorization to Transact Business. Subject to certain exceptions (particularly in relation to European Union companies), no person may carry on insurance business in the U.K. unless authorized by the H.M. 16 Treasury ("Treasury") to do so. Previously, supervision of insurance companies was undertaken by the Department of Trade and Industry ("D.T.I. "), whose responsibilities have now been assumed by the Treasury, Insurance Directorate and are currently delegated to the Financial Services Authority ("FSA") pending enactment of the Financial Services and Markets Bill under which the regulation of all financial services business, including insurance, will pass to the FSA. 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% of gross claims). 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, 1998, Terra Nova's estimated minimum solvency margin was $24.5 million and the excess of its solvency margin over its minimum solvency margin was $214.6 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, 1998, Terra Nova's solvency margin was $214.6 million, in excess of its estimated minimum solvency margin, and its distributable profits under U.K. GAAP were $101.0 million. 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; 17 (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) of such shareholder controller). In the case of the appointment of a managing director or a chief executive, the obligation is on the insurance 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. 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. 18 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. This will change in the near future and Lloyd's will be regulated by the new Finance Services Authority. The exact form of such regulation and the degree to which Lloyd's will be left to regulate market participants is not yet settled, though the preferred approach would involve the FSA's exercising some direct supervision and allowing Lloyd's to exercise other supervision under its direction. 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 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 19 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 currently operates under a self-regulatory regime and has the power to change the rules which govern the operation of the Lloyd's market although this may change following enactment of the Financial Services and Markets Bill. Lloyd's wide discretion in the application and interpretation of the rules 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 its consent first having been obtained. The tests are similar to those of the Treasury set out 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 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. 20 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 written premiums (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. 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. 21 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. John J. Dwyer 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, 1998, the trust fund was valued at $21.0 million. The Company's surplus lines trust fund may have to be increased by July 31, 1999, in order to comply with the new trust fund requirement adopted by Louisiana (please refer to the discussion regarding the Model Non-admitted Insurance Act below). Terra Nova also complies with minimum capital and surplus requirements in the United States. As of March 1, 1999, 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 Non-admitted Insurance Act. At its September 1998 meeting, the NAIC agreed rules for calculating surplus lines liabilities for purposes of funding the liabilities-based trust fund provisions for the NAIC Model Non-admitted Insurance Model Act (the "Model Act") adopted by the NAIC at its December 1996 meeting and later adopted by Louisiana. Under this new trust fund standard, Terra Nova may be required to increase its surplus lines trust fund by July 31, 1999, in order to maintain its surplus lines eligibility in Louisiana, to an amount equal to: $18 million plus either (i) 30% of its gross surplus lines liabilities (case reserves plus IBNR) attributable to U.S. surplus lines business written on or after January 1, 1998; or (ii) 30% of its direct non- admitted U.S. liabilities (case reserves plus IBNR), excluding MAT exempt business and direct placements, attributable to U.S. direct non-admitted business written on or after January 1, 1998, subject to a cap of $60 million. Only Louisiana has adopted the Model Act's new trust fund standards. Terra Nova is adopting this standard as well, however, it is not aware that other states are considering legislation. Terra Nova 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. 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. 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, which was valued at $105.75 million as at December 31, 1998. As of March 1, 1999, Terra Nova had received trusteed reinsurer approval from the departments of insurance of 42 states and had applications for trusteed reinsurer status pending in 5 additional states. 22 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 15, 1999, 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 world-wide profits, currently at the rate of 31% but to be reduced to 30% from April 1, 1999. 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 reported and made on an arm's length basis. No U.K. withholding tax will be imposed on dividends paid to the Company by UK Holdings and the Company will have no U.K. tax liability in respect of such dividends. On paying a dividend to the Company before April 6, 1999, UK Holdings will be required to account to the U.K. Inland Revenue for Advance Corporation Tax ("ACT"). However, ACT is to be abolished in respect of dividends paid after that date. 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 23 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, and possibly 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 U.K. 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 U.K. Holdings or Terra Nova has, or will have, a permanent establishment in the United States. While there can be no assurance that U.K. 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 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 U.K. 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). 24 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. However, 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 No matters were submitted to a vote of security holders during the last quarter of the fiscal year covered by this report. 25 PART II ITEM 5--MARKET FOR THE REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDERS MATTERS (a) The Company's Class A common shares, par value $5.80 per share, began trading on April 17, 1996, on the New York Stock Exchange ("NYSE") under the symbol of TNA. The following table presents the high and low sales prices of the Class A common shares in each fiscal quarter of 1998 and 1997, with cash dividends paid:
1998 1997 ----------------------------- ------------------------- Market Price Market Price ------------------- Dividend --------------- Dividend Quarter High Low Per Share High Low Per Share ------- --------- --------- --------- ------- ------- --------- 1 $30 1/2 $23 13/16 $0.05 $21 1/2 $18 3/4 $0.02 2 $33 $29 $0.06 $22 1/8 $18 $0.05 3 $34 1/2 $25 7/8 $0.06 $27 1/4 $20 7/8 $0.05 4 $29 15/16 $23 1/16 $0.06 $29 5/8 $24 1/4 $0.05 --------- --------- ----- ------- ------- ----- Year end closing price: $25 1/4 $26 1/4
(b) The approximate number of holders of common shares, as at December 31, 1998, was 1,500. ITEM 6--SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1998 Information for this item is in the section captioned "Five Year Financial Summary" within the 1998 Annual Report. 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 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"). Certain information enclosed is based on management's estimates, assumptions and projections. Important factors that could cause results to differ materially from those estimated by management include an unexpected increase in competition, unfavorable government regulation, the pricing environment and other industry developments. 26 Mix of Business The Company's mix of business for the years ended December 31, 1998, 1997 and 1996 and the key ratios by major line of business are as set out in the following table:
Year Ended December 31, -------------------------------------------------- 1998 1997 1996 ---------------- ---------------- ---------------- Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- (dollars in thousands) Gross Written Premiums Non-marine property $333,847 44.0% $237,270 43.2% $180,561 50.0% Non-marine casualty 220,905 29.1 128,472 23.3 68,107 18.9 Marine & Aviation 204,636 26.9 184,501 33.5 112,342 31.1 -------- ----- -------- ----- -------- ----- Total $759,388 100.0% $550,243 100.0% $361,010 100.0% ======== ===== ======== ===== ======== ===== Net Written Premiums Non-marine property $305,564 47.3% $212,198 43.9% $157,737 50.7% Non-marine casualty 202,384 31.3 119,194 24.6 62,244 20.0 Marine & Aviation 138,250 21.4 152,153 31.5 91,185 29.3 -------- ----- -------- ----- -------- ----- Total $646,198 100.0% $483,545 100.0% $311,166 100.0% ======== ===== ======== ===== ======== ===== Net Earned Premiums Non-marine property $261,578 47.8% $192,607 46.0% $132,677 47.6% Non-marine casualty 157,798 28.9 96,445 23.0 55,992 20.1 Marine & Aviation 127,532 23.3 130,017 31.0 90,087 32.3 -------- ----- -------- ----- -------- ----- Total $546,908 100.0% $419,069 100.0% $278,756 100.0% ======== ===== ======== ===== ======== ===== Loss and Loss Adjustment Expense Ratios Non-marine property 66.9% 65.8% 61.6% Non-marine casualty 71.8 74.9 82.0 Marine & Aviation 55.8 64.6 55.9 ----- ----- ----- Total 65.8% 67.4% 64.0% ===== ===== ===== Underwriting Expense Ratios Non-marine property 32.2% 31.6% 31.7% Non-marine casualty 24.3 26.1 28.8 Marine & Aviation 45.7 33.2 38.4 ----- ----- ----- Total 33.0% 30.8% 33.2% ===== ===== ===== Combined Ratios Non-marine property 99.1% 97.4% 93.3% Non-marine casualty 96.1 101.0 110.8 Marine & Aviation 101.5 97.8 94.3 ----- ----- ----- Total 98.8% 98.2% 97.2% ===== ===== =====
Results of Operations The Company's principal 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 $1.66 for 1998, $1.64 for 1997 and $1.57 for 1996. Year Ended December 31, 1998 Compared with Year Ended December 31, 1997 Gross Written Premiums; Net Written Premiums; Net Earned Premiums. Gross written premiums increased 38.0% to $759.4 million in 1998 from $550.2 million in 1997. The increase in gross written premiums of $209.2 million was primarily due to: 27 (a) Increased writings by Terra Nova Capital to $331.6 million (excluding orphan syndicate business and reinsurance to close premiums) in 1998 from $162.8 million in 1997 due to the Company's increased participation in the Octavian syndicates from 44% in 1997 to approximately 60% in 1998. The major lines of business written by Terra Nova Capital are marine, aviation, motor and UK liability; (b) $67.6 million of premiums related to reinsurance to close of orphan Lloyd's syndicates, compared to $39.1 million in 1997. In 1998, this business related to non-marine casualty risks compared to a mixture of non- marine casualty and marine risks in 1997; and (c) $17.8 million of premiums from Corifrance, which was acquired in September 1997. Corifrance writes specialty property business. The increases in premium volumes have been partially offset by the effect of a fall in premium rates since 1997 as a result of competition in the markets in which the Company operates, with the exception of motor business which experienced rate increases of approximately 15% in 1998. Reinsurance ceded increased by 69.7% to $113.2 million in 1998 from $66.7 million in 1997. Reinsurance ceded as a percentage of gross written premiums, increased to 14.9% in 1998 from 12.1% in 1997. The increase is primarily due to: (a) The Company's bigger participation on the Octavian syndicates in 1998 compared to 1997. The Octavian syndicates, especially the marine and aviation syndicates, buy more reinsurance than Terra Nova and Terra Nova (Bermuda); and (b) The Company buying more reinsurance, especially at the Octavian syndicates, due to the general perception that reinsurance prices are relatively inexpensive in the very competitive conditions that currently exist in the market place. This applies particularly in the marine and aviation lines of business. Net written premiums increased by 33.7% to $646.2 million in 1998 from $483.5 million in 1997, as a result of the increase in gross written premiums, partially offset by higher reinsurance costs. Net earned premiums increased 30.5%, to $546.9 million in 1998 from $419.1 million in 1997. Net Investment Income. Net investment income increased 9.6%, to $93.3 million in 1998 from $85.1 million in 1997. The increase was due to average invested assets being 10.3% higher in 1998 than 1997. The average investment yield before realized gains and losses was 6.1% in 1998 and 6.2% in 1997. The investment yield was similar to 1997, as the Company had a lower proportion of equities in 1998 compared to 1997 and a larger proportion of single A and BBB bonds in 1998 compared to 1997. The effect of these factors was offset by the lower interest rates in 1998 compared to 1997. The average duration of fixed maturity investments at December 31, 1998 and 1997, was 4.8 years and 4.9 years, respectively. Realized Net Capital Gains on Sales of Investments. Realized net capital gains on sales of investments increased $2.7 million to $18.0 million in 1998 from $15.3 million in 1997. Of the gain in 1998, $8.9 million arose from sales of fixed maturities and $9.1 million from sales of equity securities. Foreign Exchange Losses. Foreign exchange losses of $0.6 million in 1998 and $1.3 million in 1997 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 principal functional currency. Agency Income. This income consists of fees and profit commissions earned by Octavian for managing certain Lloyd's syndicates. Losses and Loss Adjustment Expenses. Losses and LAE increased 27.3%, to $359.6 million in 1998 from $282.5 million in 1997. As a percentage of net earned premiums, losses and LAE decreased 1.6 points, to 65.8% in 1998 from 67.4% in 1997. 28 The loss and LAE ratio for non-marine property business increased to 66.9% in 1998 from 65.8% in 1997, following the catastrophe activity in the third quarter of 1998 and an increase in losses on the Company's motor business due to the competitive market conditions that exist in this class. The loss associated with Hurricane Georges was approximately $15 million, with Hurricane Mitch adding a further $2 million of losses. The loss and LAE ratio for non-marine casualty business decreased to 71.8% in 1998 from 74.9% in 1997. This decrease reflects the prior year reserve redundancies on casualty business written by Terra Nova in the period 1986-1993 and profits on the orphan syndicate business written in 1997 and 1998. The decrease in the marine and aviation loss and LAE ratio to 55.8% in 1998 from 64.6% in 1997 was partly a result of Terra Nova (Bermuda) recognizing reserve redundancies on the business written prior to its acquisition by the Company and Terra Nova recognizing reserve redundancies on marine LMX business written prior to 1992. Terra Nova (Bermuda), formerly Underwriters Capital (Merrett) Ltd. ("UCM"), was organized in Bermuda in 1993 to provide reinsurance to certain Lloyd's syndicates. These decreases were partially offset by an increase in losses on the Company's aviation business due to weaker prices and higher losses in 1998 compared to 1997. Acquisition Costs. Acquisition costs, which consist of commission expenses and other underwriting expenses, increased 39.0% to $160.4 million in 1998 from $115.4 million in 1997. Acquisition costs as a percentage of net earned premiums increased to 29.3% in 1998 from 27.5% in 1997. The increase in the ratio is caused by a change in the Company's mix of business resulting from its greater participation in the Octavian syndicates. Octavian business carries a higher expense ratio due to a higher level of reinsurance ceded. Other Operating Expenses. Other operating expenses increased 48.2% to $20.3 million in 1998 from $13.7 million in 1997. As a percentage of net earned premiums, they increased to 3.7% in 1998 from 3.3% in 1997, reflecting the greater proportion of Lloyd's charges. Combined Ratios. The Company's combined ratios were 98.8% for 1998 and 98.2% for 1997. This is the net result of a reduction in the loss ratio and an increase in the expense ratio. Net Interest Expense. Net interest expense in 1998 consisted of interest on the $100 million 10.75% Senior Notes issued on June 30, 1995 and redeemed on May 18, 1998, interest on the $75 million 7.2% Senior Notes issued on August 26, 1997, and interest on the $100 million 7.0% Senior Notes issued on May 18, 1998. The net interest expense in 1997 related 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. Agency Expenses. These expenses were incurred by Octavian in managing certain Lloyd's syndicates. Other Expenses. Other expenses increased 5.7%, to $5.6 million in 1998 from $5.3 million in 1997. Income before Income Tax and Extraordinary Charge. Income before income tax and extraordinary charge increased 11.3% to $101.3 million in 1998 from $91.0 million in 1997. This was due to higher investment income in 1998 and an increase in the net contribution from the managing agent. Income Tax Expense. Income tax expense decreased $0.4 million, to $17.2 million in 1998 from $17.6 million in 1997. The lower tax charge reflects a reduction in the average UK tax rate from 31.5% in 1997 to 31% in 1998 and an increase in underwriting profits in Terra Nova (Bermuda). As a consequence of these factors, the income tax expense as a percentage of income before income tax and extraordinary charge fell to 17.0% in 1998 from 19.4% in 1997. Net Income before Extraordinary Charge. Net income before extraordinary charge increased 14.5% to $84.0 million in 1998 from $73.4 million in 1997, because of the increase in income before income tax and extraordinary charge and the decrease in the income tax expense, referred to above. 29 Extraordinary Charge. An extraordinary charge of $11.6 million arose during the second quarter as a result of UK Holdings extinguishing all of its $100 million 10.75% Senior Notes due 2005. The charge was net of a $5.2 million income tax benefit. Net Income. Net income decreased $1.0 million, to $72.4 million in 1998 from $73.4 million in 1997, after the $11.6 million extraordinary charge recognized in the second quarter of 1998. Year Ended December 31, 1997 Compared with Year Ended December 31, 1996 Gross Written Premiums; Net Written Premiums; Net Earned Premiums. Gross written premiums increased to $550.2 million in 1997 from $361.0 million in 1996. The increase in gross written premiums arose from: (a) Increased writings by Terra Nova Capital to $162.8 million (excluding orphan 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 44% in 1997; (b) $39.1 million of premiums related to reinsurance to close of orphan Lloyd's syndicates from the 1993 year of account; and (c) $17.9 million of premiums in respect of Terra Nova Capital's 11% share of the closure of the 1995 year of account into the 1996 year of account. 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 written premiums 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 written premiums increased by 55.4% to $483.5 million in 1997 from $311.2 million in 1996, as a consequence of the increase in gross written premiums referred to above and lower reinsurance costs. Net earned premiums 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 earned premiums, losses and LAE increased 3.4 points, to 67.4% in 1997 from 64.0% in 1996. The loss and LAE ratio for non-marine property business increased to 30 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 consisted 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 earned premiums decreased to 27.5% in 1997 from 29.6% in 1996. The decrease was largely a result of the earned premiums from the orphan syndicate and RITC business written during 1997, which have very low acquisition costs; excluding this business, acquisition costs would have been 31.3% of earned premiums. 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 earned premiums decreased to 3.3% in 1997 from 3.7% in 1996. Net Interest Expense. Net interest expense in 1997 related 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 related 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 losses and any adverse development of prior year claims in both 1997 and 1996. Liquidity and Capital Resources The Company's assets consist mainly of the capital stock of UK Holdings and Terra Nova (Bermuda), and UK Holdings' assets consist mainly of the capital stock of Terra Nova, Terra Nova Capital and Octavian. The Company's ability to pay dividends on its capital stock and to pay its obligations depends on dividends or other payments from Terra Nova, Terra Nova (Bermuda), Terra Nova Capital, Octavian and Corifrance. Dividend and other payments by Terra Nova, Terra Nova Capital and Octavian are subject to limits under U.K. law, Terra Nova (Bermuda), Bermuda law and Corifrance, French law. The principal sources of funds for the Company's subsidiaries consist of net premiums, investment income and proceeds from sales and redemption of investments. The funds are used to pay claims and operating expenses and to buy investments, largely fixed income securities. 31 For the years ended December 31, 1998 and 1997, the cashflow provided by operating activities of the Company and available for investment was $75.9 million and $81.9 million, respectively. The decrease in cash flows provided by operating activities in 1998 was due to lower cash-flows at Terra Nova caused by a change in business mix, as it wrote a greater proportion of proportional treaty business in 1998, that produced a greater time lag between writing the business and receiving the premiums. Total investments and cash were $1,575.0 million at December 31, 1998. At December 31, 1998, 91.8%, 5.6% and 2.6% of total investments and cash were held in fixed maturities, common stocks and cash and cash equivalents, respectively. At December 31, 1998, approximately 91% 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 6.1% and 6.2% in 1998 and 1997, respectively. The Company had realized investment gains of $18.0 million and $15.3 million in 1998 and 1997, respectively. On April 29, 1998, Moody's Investor Services raised its debt rating on UK Holdings' Senior Notes to "Baa1" from "Baa3". This rating increase reflects the improved strength of UK Holdings' financial position. On May 5, 1998, AM Best raised its claims-paying ability rating of Terra Nova and Terra Nova (Bermuda) to "A" from "A-". AM Best stated that, "The rating increase reflects the Company's excellent financial performance, liquidity and conservative investment strategy. The rating also reflects its experienced management team, which has expanded the business profitably since Bermuda Holdings was established in 1994". On May 28, 1998, the Company filed a Form 8-K concerning the issue of $100 million 7.0% Senior Notes due 2008, fully and unconditionally guaranteed by Bermuda Holdings. On October 9, 1998, the Company announced that Octavian had established new operating entities in Australia and Hong Kong. On October 12, 1998, the Company announced that Terra Nova Capital's participation in the Lloyd's Capacity Auctions for the 1999 underwriting year resulted in the acquisition of $102.4 million ((Pounds)64.0 million) of new capacity. Foreign Currency The Company's assets, liabilities, revenues and expenses, except for most corporate overheads which are paid in British pounds, are chiefly in U.S. dollars. Therefore, the Company's principal functional currency is the U.S. dollar. Certain other net translation adjustments are shown as a separate item of shareholders' equity. The Euro On January 1, 1999, the Economic and Monetary Union (EMU) and a new currency, the "euro", were adopted by eleven of the fifteen member states of the European Union (EU). Other member states, including the United Kingdom, currently remain outside the EMU but may join in the future. Today, Corifrance and the Brussels branch of Terra Nova are the Company's only operations in EMU countries. The eleven participating EMU countries adopted the euro as their national currency on January 1, 1999. The European Central Bank (ECB) established a fixed conversion rate between each participant's existing currency and the euro as from that date. The euro is now traded on foreign currency exchanges and fluctuates in value against currencies of non-participating countries. It can be used for non-cash transactions throughout the three year transition period which ends on December 31, 2001. On January 1, 2002, the ECB will begin to issue bills and coins denominated in euro for use in cash transactions. The Company identified relevant issues and established a strategy to deal with each phase of the euro's implementation. The Company has the requisite capability to process and account for current transactions in the euro, and, as needs are identified, will modify its information technology and other systems in response to changed or expanded exposures to euro transactions. 32 The competitive impact of the euro is not expected to be significant because less than 10% of the Company's business is conducted within EMU member states. Management believes that the costs of modifying information systems software will not be material to the Company's results, operations, financial condition or liquidity. Accordingly, such costs are expensed as incurred. Year 2000 General The Year 2000 issue arises from the fact that many computers and computer programs use two digits rather than four to represent the year portion of a date. The faulty interpretation or the misinterpretation of these two digits could result in system failure or miscalculation causing disruption to business processes. The Year 2000 date change problem is widely recognized as the biggest single issue to have faced the information technology ("IT") industry. Its impact is likely to extend into all areas of business and commerce. Accordingly, the Company is addressing Year 2000 as both an IT issue and a business issue. The Company has established a Year 2000 Project team composed of representatives from all IT and business areas in order to ensure a co-ordinated approach. The Project team reports directly to senior management who, in turn, report regularly to the Board of Directors on the status of the Company's Year 2000 compliance. The Company's State of Readiness The Company has divided the Year 2000 Project into three major areas of focus: IT, underwriting and third parties. Each section addresses unique risks, but shares a common approach to the Project, which includes five phases: (1) assessing the nature and scope of the Company's exposure to the Year 2000 issue; (2) identifying the business critical areas of exposure; (3) developing solutions for Year 2000-related problems; (4) testing the solutions; and (5) implementing the solutions. Business critical systems were defined as those that are likely to have a material impact on the financial condition and results of operations of the Company should they malfunction or fail. The Company initiated the IT section of the Year 2000 Project in March 1997 with the objective of bringing all business critical systems into Year 2000 compliance by September 30, 1998 and all other systems into compliance by December 31, 1998. These key milestones have been met. Market testing with the main processing bureaus, the London Processing Centre, the Lloyd's Policy Signing Office and the Lloyd's Claims Office, has also been completed successfully. Internal certification on compliance has been received from Lloyd's. The assessment phase for the IT section of the Project consisted of an inventory and high level analysis of all hardware, software and embedded systems. ("Embedded systems" include "non-IT items" such as facsimile machines, elevators and telephones.) As a result of the assessment phase, the Company identified five business critical systems. All five were deemed compliant by December 31, 1998, following completion of testing and implementation work. Other internally-supported software that was not identified as business critical was deemed compliant by December 31, 1998, after testing and implementation work. Externally supported packages and services were assessed. All suppliers and manufacturers were contacted for their compliance status. Where possible, all essential packages are also being tested. The target for completion of this work is April 30, 1999. The remediation of non-business critical software with embedded chips has been challenging. Work has targeted systems within the Company's control. Developers of old software have been reluctant to reply to questions concerning their Year 2000 compliance status, or are no longer trading. After assessing this area of the Project for criticality, the Project team determined that only a few systems were at risk. Approximately half of those systems have been deemed compliant. Remediation work will continue into the first half of 1999. 33 As part of the IT section of the Project, a contingency plan is being developed to ensure that fully workable alternatives, covering all aspects of IT, are available in the event of the failures of any business critical systems. Initially, contingency planning had a target completion date of December 31, 1998. This is now being brought into line with Lloyd's timescales for the Octavian syndicates, who plan to complete their work during the third quarter of 1999. An outline plan for the Company will be produced by March 31, 1999. The Underwriting section of the Project is managed by a committee comprised of senior representatives from the Company's major underwriting units, covering a broad spectrum of business classes. The committee is: (1) co-ordinating and reviewing the evaluation of the Company's current and ongoing underwriting exposure to the Year 2000 and other date-related issues; (2) developing and producing relevant Company underwriting guidelines and monitoring procedures, where practicable; (3) identifying business opportunities; and (4) communicating and raising awareness of date-related underwriting issues within the Company. Among its responsibilities, the committee discusses and disseminates information, research and policy language relating to the Year 2000 issue. A central database for this information has been established and made accessible by all Company employees. When regulators or customers require assessment of the Company's Year 2000 compliance, responses are cleared through the committee. By December 31, 1998, the Company had substantially completed an initial assessment of risks already written. This initial assessment forms the basis for more detailed ongoing reviews. At Terra Nova, the in-force portfolio of insurance and reinsurance contracts was broken down into those risks that currently provide no cover beyond December 31, 1999, those that might provide cover beyond December 31, 1999 (by virtue of run-off provisions or extended reporting clauses) and those risks that run beyond the millennium. A matrix coding system was developed to numerically quantify the class exposure and effect of the underwriting action taken at the insurance or reinsurance level. The matrix is applied on a risk by risk basis. The matrix multiplies a "class exposure" coding by an "underwriting action" coding to give a geometric weighting. This geometric weighting, combined with the potential in-force analysis, and overlaid by "likelihood of loss factors", enables a calculation to be made of Terra Nova's probable maximum loss ("PML"). To support the matrix, a detailed commentary was prepared by each class underwriter of the potential exposure on a class by class basis, together with the current underwriting approach, based on individual judgment and experience. This work was reviewed by the underwriting committee and the senior underwriter of each underwriting unit for commonality of approach. The described underwriting approach will be monitored and re-evaluated with reference to external factors and market position. Equally, the method of calculating the PML, the weightings applied for the individual factors and likelihood of loss factors will be subject to review and revision, as necessary. Terra Nova (Bermuda) has applied the matrix coding system in the same way as Terra Nova. The Octavian syndicates are also represented on the underwriting committee. However, the senior underwriters on the Octavian syndicates have adopted a different approach from that of their colleagues at Terra Nova, reflecting the different regulatory environment in which they operate. The syndicate underwriters have analyzed the Year 2000 exposure on each class of business that they write. They have then drawn up a course of action for dealing with the exposure, using the results of their analysis. The regulatory department at Lloyd's requests detailed Year 2000 returns from each syndicate. This is to assist the Corporation of Lloyd's in determining whether or not each syndicate is taking appropriate action to address the issue. It is difficult to estimate the degree of completeness of the underwriting section of the Project, just as it is difficult to estimate the frequency and severity of Year 2000 related claims, notifications and associated costs. However, management believes that reliance on the combined experience of the Company's underwriters who contribute to the ongoing assessment will enable the Company to make prudent judgments about exposures and to react accordingly. The Third Parties section of the Year 2000 Project includes the process of identifying critical suppliers, customers and trading partners who deal directly with the Company and ascertaining their plans and progress in addressing Year 2000 issues. The Company receives the majority of its underwriting data from bureaus, most notably, the London Processing Centre and Lloyd's. Market testing has been performed to insure continuous and reliable connectivity to, and the ongoing provision of effective services from, these organizations and has been successfully completed. 34 The Company provides IT services to third party customers. The related IT systems have been assessed, remedied, tested and re-implemented. Material trading partners at all business levels have been contacted and asked to respond with an assessment of the Year 2000 compliance status of their own businesses. The target for completion of this work was December 31, 1998. However, approximately sixty-eight percent of the responses were still outstanding at that date. These responses will be pursued during 1999. The replies from trading partners will be taken into account as the contingency plan is developed which covers critical business areas considered to be at risk in the event of the failure of third parties to provide effective ongoing essential services and supplies. Costs The total cost of the Year 2000 project is not expected to be material to the Company's financial position. The estimated total cost of analyzing and implementing required modifications to bring the Company to Year 2000 compliance is $3.0 million, which is being funded from operating cash flows. The Company primarily used internal human resources for work on the Year 2000 Project. The total amount expended on the Project through December 31, 1998, was $2.5 million of which approximately $2.4 million related to the cost to repair or replace software and resolve related hardware problems and approximately $0.1 million related to the cost of identifying and communicating with third parties. The estimated future cost of completing the Year 2000 Project is $0.5 million. Risks From an IT perspective, the Year 2000 risks have been reduced significantly by bringing business critical systems into compliance and should not restrict the ability of the Company to trade through the Year 2000. The Company's reliance on compliance adequacy of outside suppliers and trading partners can only be addressed through questionnaires and compliance statements. Even with apparently thorough third parties' responses, the Company cannot guarantee their Year 2000 readiness. The inability of such parties to complete their Year 2000 resolution process could materially affect the Company. From an underwriting perspective, management anticipates an increase in the frequency of certain kinds of claims as a result of software malfunction causing or otherwise contributing to losses related to normally insured perils, such as fire and theft. The Company is taking steps to make its own reinsurance and retrocession programs as responsive as possible to such circumstances. Given the breadth and ambiguity of the Year 2000 issues for the Company, largely as a result of uncertainty about the Year 2000 readiness of third party suppliers, customers and trading partners, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on its future results of operations, liquidity or financial condition. The Company considers that the work already done on its internal systems and the continuing assessment and remediation in other areas, should significantly reduce the possible effect of the Year 2000. Dividend Policy The Company declared and paid dividends according to the following table:
Dividend Per Share Date Declared Date Paid/ Payable Date of Record --------- ------------- ------------------ -------------- 1998 $0.05 February 6, 1998 March 27, 1998 March 6, 1998 $0.06 May 8, 1998 June 26, 1998 June 5, 1998 $0.06 August 6, 1998 September 25, 1998 September 4, 1998 $0.06 November 2, 1998 December 28, 1998 December 4, 1998 1999 $0.06 February 10, 1999 March 26, 1999 March 5, 1999
35 ITEM 7A--QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Market Sensitive Instruments and Risk Management The following discussion about the Company's risk management activities includes forward-looking statements that involve risk and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. This analysis presents the hypothetical loss in earnings, cash flows, or fair value of the financial instruments held by the Company at December 31, 1998, which are sensitive to changes in interest rates, foreign exchange rates and equity prices. Rather than use derivative instruments to manage the primary market exposures associated with the underlying assets, liabilities and anticipated transactions, the Company closely monitors interest rate movements using sensitivity analysis. The Company manages foreign currency exposures by matching assets to liabilities in individual currencies. These risk management techniques are discussed in more detail below. In the normal course of business, the Company also faces risks that are either non-financial or non-quantifiable. Such risks include political risk and credit risk and are not included in the following analysis. Interest Rate Risk Management The Company's major market risk exposure is changing interest rates, primarily in the United States. A change in interest rates would affect the fair value of the Company's investments and could cause fluctuations in Accumulated Other Comprehensive Income in the balance sheet. Basis Point Movement (dollars in millions, unless stated)
-200 pts -100 pts Zero +100 pts + 200 pts -------- -------- ------ -------- --------- Movement in fair value of Fixed Maturity portfolio 10.1% 4.8% 0.0% (4.5)% (8.6)% Movement after tax $119.1 $ 57.0 $ 0.0 $(52.7) $(101.4) Adjusted Shareholders' Equity 690.0 627.9 570.9 518.2 469.5 Adjusted book value per share $27.20 $24.75 $22.51 $20.43 $ 18.51 Adjusted debt/debt plus equity 20.23% 21.80% 23.46% 25.25 % 27.15 %
The matrix above shows the sensitivity of the Company's shareholders' equity at December 31, 1998, to movements in fixed maturity valuations related to changes in interest rates. The aggregate hypothetical reduction in net assets that would have resulted from a hypothetical increase in yield of 100 basis points is $52.7 million. As a consequence, shareholders' equity at December 31, 1998, would have been $518.2 million and book value per share, $20.43. The ratio of debt to debt plus equity would have increased to 25.25% from 23.46%. The Company manages this risk by limiting the portfolio duration. The Company's long-term debt is all at fixed rates. At December 31, 1998, the Company's total outstanding indebtedness was $175 million, comprised of $75 million 7.2% Senior Notes due 2007 and $100 million 7.0% Senior Notes due 2008. The estimated fair value of the debt at December 31, 1998, was $180.8 million. Foreign Exchange Risk Management The Company has foreign exchange risk on assets and liabilities and manages this risk by matching assets to liabilities in each foreign currency as closely as possible. At December 31, 1998, 79.2% of the Company's investment portfolio was denominated in US Dollars. At that date, the largest foreign currency exposure was UK Sterling. Hypothetically, if Sterling assets and liabilities had been mismatched by 10% and the year end Sterling/US Dollar exchange rate had increased or decreased by 5%, the effect on after tax earnings would have been approximately $1.0 million. 36 The Company does not ordinarily use derivative instruments to manage its exposure to foreign exchange movements. Equity Price Risk Management The Company does not ordinarily hedge its equity portfolio risk by purchasing derivatives. The Company reduced its exposure in 1998 by increasing the ratio of fixed maturities to equity in its portfolio by transferring part of the equity portfolio into fixed interest securities. At December 31, 1998, the cost of the Company's equity security portfolio was $56.9 million and the fair value was $88.0 million, compared to $69.8 million and $104.2 million, respectively, at December 31, 1997. 37 ITEM 8--FINANCIAL STATEMENTS INDEX
Page ---- Report of Management's Responsibilities 39 Report of Independent Accountants 40 Audited Consolidated Financial Statements: Consolidated Balance Sheets as of December 31, 1998 and 1997 41 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 42 Consolidated Statements of Comprehensive Income for the years ended December 31, 1998, 1997 and 1996 43 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997 and 1996 44 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 45 Notes to Consolidated Financial Statements--including summarized consolidated financial information of Terra Nova Insurance (UK) Holdings plc as of December 31, 1998 and 1997 46
38 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 and all other financial information presented here. 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 PricewaterhouseCoopers, 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. J.J. Dwyer W.J. Wedlake Chairman Senior Vice President and Chief Financial Officer 39 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Board of Directors of Terra Nova (Bermuda) Holdings Ltd. In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries at December 31, 1998 and 1997, and the results of their operations, their comprehensive income and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14(a) on page 71 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers Hamilton, Bermuda March 9, 1999 40 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS At December 31, (dollars in thousands)
1998 1997 ---------- ---------- ASSETS ------ Investments available for sale and cash and cash equivalents, at fair value: Fixed maturities: Bonds (amortized cost $1,374,272 and $1,219,799, respectively) $1,446,621 $1,261,458 Common stocks (cost $56,924 and $69,781, respectively) 88,022 104,234 Cash and cash equivalents 40,394 109,864 ---------- ---------- Total investments and cash and cash equivalents 1,575,037 1,475,556 Accrued investment income 30,015 28,076 Insurance balances receivable 81,634 74,774 Reinsurance recoverable on paid losses 45,882 39,402 Reinsurance recoverable on unpaid losses 226,099 246,728 Accrued premium income 283,383 188,055 Prepaid reinsurance premiums 37,472 26,853 Deferred acquisition costs 107,607 76,380 Other assets 92,243 64,310 ---------- ---------- Total assets $2,479,372 $2,220,134 ========== ========== LIABILITIES ----------- Unpaid losses and loss adjustment expenses $1,209,003 $1,157,724 Unearned premiums 401,002 274,934 Insurance balances payable 23,941 33,833 Income taxes payable 4,228 10,274 Deferred income taxes 27,450 15,244 Long-term debt 175,000 175,000 Other liabilities 67,886 71,237 ---------- ---------- Total liabilities 1,908,510 1,738,246 ---------- ---------- SHAREHOLDERS' EQUITY -------------------- Common shares "A" ordinary shares, 75,000,000 authorized, $5.80 par value (24,172,717 issued and outstanding; 1997: 24,090,335) 140,202 139,724 "B" ordinary shares, convertible, 10,000,000 authorized, $5.80 par value (1,796,217 issued and outstanding; 1997: 1,796,217) 10,418 10,418 Stock held in Trust, at cost (12,900) (9,500) Deferred equity compensation 4,623 3,275 Additional capital 111,727 111,568 Retained earnings 236,292 169,861 Accumulated other comprehensive income 80,500 56,542 ---------- ---------- Total shareholders' equity 570,862 481,888 ---------- ---------- Total liabilities and shareholders' equity $2,479,372 $2,220,134 ========== ==========
See accompanying notes to the consolidated financial statements 41 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, (dollars in thousands except per share amounts)
1998 1997 1996 -------- -------- -------- Revenues Net written premiums $646,197 $483,545 $311,166 Increase in unearned premiums (99,289) (64,476) (32,410) -------- -------- -------- Net earned premiums 546,908 419,069 278,756 Net investment income 93,262 85,130 78,130 Realized net capital gains on sales of investments 17,963 15,333 11,750 Foreign exchange (losses) gains (586) (1,268) 425 Agency income 17,057 15,571 8,998 -------- -------- -------- Total revenues 674,604 533,835 378,059 -------- -------- -------- Expenses Losses and loss adjustment expenses, net 359,567 282,480 178,274 Policy acquisition costs 160,380 115,427 82,394 Other operating expenses 20,322 13,706 10,175 Interest expense 13,697 12,710 10,750 Agency expenses 13,760 13,130 8,537 Other expenses 5,617 5,333 5,261 -------- -------- -------- Total expenses 573,343 442,786 295,391 -------- -------- -------- Income from operations before income tax and minority interests 101,261 91,049 82,668 Income tax expense 17,221 17,639 17,777 Minority interests in income of consolidated subsidiaries -- -- 985 -------- -------- -------- Net income before extraordinary charge 84,040 73,410 63,906 Extraordinary charge after income tax 11,641 -- -- -------- -------- -------- Net income $ 72,399 $ 73,410 $ 63,906 ======== ======== ======== Basic earnings per common share Net income before extraordinary charge $ 3.30 $ 2.87 $ 2.81 Extraordinary charge after income tax (0.46) -- -- -------- -------- -------- Net income $ 2.84 $ 2.87 $ 2.81 ======== ======== ======== Diluted earnings per common share Net income before extraordinary charge $ 3.22 $ 2.82 $ 2.69 Extraordinary charge after income tax (0.45) -- -- -------- -------- -------- Net income $ 2.77 $ 2.82 $ 2.69 ======== ======== ========
See accompanying notes to the consolidated financial statements 42 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Year Ended December 31, (dollars in thousands)
1998 1997 1996 -------- -------- -------- Net Income $ 72,399 $ 73,410 $ 63,906 -------- -------- -------- Other comprehensive income (loss): Unrealized appreciation (depreciation) of investments before tax 45,299 39,543 (6,680) Tax (expense) benefit (8,242) (8,872) 698 -------- -------- -------- Unrealized appreciation (depreciation) of investments after tax 37,057 30,671 (5,982) -------- -------- -------- Less: Reclassification adjustment for gains included in net income before tax (17,963) (15,333) (11,750) Tax expense 4,818 4,821 4,031 Reclassification adjustment for gains included in net income after tax (13,145) (10,512) (7,719) -------- -------- -------- Currency translation adjustments 46 (78) 190 -------- -------- -------- Other comprehensive income (loss) 23,958 20,081 (13,511) -------- -------- -------- Comprehensive income $ 96,357 $ 93,491 $ 50,395 ======== ======== ========
See accompanying notes to the consolidated financial statements 43 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Year Ended December 31, (dollars in thousands except share numbers)
Unrealized Common "A" Shares Common "B" Shares Stock held in Trust Deferred Appreciation ------------------- ------------------ -------------------- Equity Additional (Depreciation) Number Value Number Value Number Value Compensation Capital of Investments ---------- -------- --------- ------- ---------- --------- ------------ ---------- -------------- Balance, January 1, 1996 12,583,518 $ 72,984 2,809,956 $16,298 -- $ -- $ -- $ 18,203 $49,972 Shares issued in initial public offering 7,275,000 42,195 -- -- -- -- -- 71,758 -- Shares issued in exchange for minority interests in subsidiaries 2,038,869 11,826 -- -- -- -- -- 8,655 -- Shares issued for conversion of convertible redeemable preferred shares 989,697 5,740 -- -- -- -- -- 12,108 -- Other shares issued during period 153,526 890 -- -- -- -- -- 820 -- Conversion of "B" shares into "A" shares 761,816 4,419 (761,816) (4,419) -- -- -- -- -- Net depreciation -- -- -- -- -- -- -- -- (18,430) Income tax benefit -- -- -- -- -- -- -- -- 4,729 Change during the year -- -- -- -- -- -- -- -- -- Net income -- -- -- -- -- -- -- -- -- Dividends paid-- $0.06 per ordinary share -- -- -- -- -- -- -- -- -- Dividends paid on convertible redeemable preferred shares -- -- -- -- -- -- -- -- -- ---------- -------- --------- ------- --------- --------- ------ -------- ------- Balance, December 31, 1996 23,802,426 138,054 2,048,140 11,879 -- -- -- 111,544 36,271 Shares issued for exercise of share options 35,986 209 -- -- 26,000 520 -- 24 -- Shares repurchased during the year -- -- -- -- (500,000) (10,020) -- -- -- Deferred compensation expense -- -- -- -- -- -- 3,644 -- -- Deferred compensation expense released on exercise of share options -- -- -- -- -- -- (369) -- -- Conversion of "B" shares into "A" shares 251,923 1,461 (251,923) (1,461) -- -- -- -- -- Net appreciation -- -- -- -- -- -- -- -- 24,210 Income tax expense -- -- -- -- -- -- -- -- (4,051) Change during the year -- -- -- -- -- -- -- -- -- Net income -- -- -- -- -- -- -- -- -- Dividends paid-- $0.17 per ordinary share -- -- -- -- -- -- -- -- -- ---------- -------- --------- ------- --------- --------- ------ -------- ------- Balance, December 31, 1997 24,090,335 139,724 1,796,217 10,418 (474,000) (9,500) 3,275 111,568 56,430 Shares issued for exercise of share options 82,382 478 -- -- -- -- -- 159 -- Shares repurchased during the year -- -- -- -- (132,800) (3,400) -- -- -- Deferred compensation expense -- -- -- -- -- -- 1,348 -- -- Net appreciation -- -- -- -- -- -- -- -- 27,336 Income tax expense -- -- -- -- -- -- -- -- (3,424) Change during the year -- -- -- -- -- -- -- -- -- Net income -- -- -- -- -- -- -- -- -- Dividends paid-- $0.23 per ordinary share -- -- -- -- -- -- -- -- -- ---------- -------- --------- ------- --------- --------- ------ -------- ------- Balance, December 31, 1998 24,172,717 $140,202 1,796,217 $10,418 (606,800) $ (12,900) $4,623 $111,727 $80,342 ========== ======== ========= ======= ========= ========= ====== ======== ======= Cumulative Total Translation Retained Shareholders' Adjustments Earnings Equity ----------- --------- ------------- Balance, January 1, 1996 $-- $ 39,551 $197,008 Shares issued in initial public offering -- -- 113,953 Shares issued in exchange for minority interests in subsidiaries -- -- 20,481 Shares issued for conversion of convertible redeemable preferred shares -- -- 17,848 Other shares issued during period -- -- 1,710 Conversion of "B" shares into "A" shares -- -- -- Net depreciation -- -- (18,430) Income tax benefit -- -- 4,729 Change during the year 190 -- 190 Net income -- 63,906 63,906 Dividends paid-- $0.06 per ordinary share -- (1,548) (1,548) Dividends paid on convertible redeemable preferred shares -- (1,088) (1,088) ----------- --------- ------------- Balance, December 31, 1996 190 100,821 398,759 Shares issued for exercise of share options -- -- 753 Shares repurchased during the year -- -- (10,020) Deferred compensation expense -- -- 3,644 Deferred compensation expense released on exercise of share options -- -- (369) Conversion of "B" shares into "A" shares -- -- -- Net appreciation -- -- 24,210 Income tax expense -- -- (4,051) Change during the year (78) -- (78) Net income -- 73,410 73,410 Dividends paid-- $0.17 per ordinary share -- (4,370) (4,370) ----------- --------- ------------- Balance, December 31, 1997 112 169,861 481,888 Shares issued for exercise of share options -- -- 637 Shares repurchased during the year -- -- (3,400) Deferred compensation expense -- -- 1,348 Net appreciation -- -- 27,336 Income tax expense -- -- (3,424) Change during the year 46 -- 46 Net income -- 72,399 72,399 Dividends paid-- $0.23 per ordinary share -- (5,968) (5,968) ----------- --------- ------------- Balance, December 31, 1998 $158 $236,292 $570,862 =========== ========= =============
See accompanying notes to the consolidated financial statements 44 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, (dollars in thousands)
1998 1997 1996 --------- --------- --------- Cash flows from operating activities: Net income $ 72,399 $ 73,410 $ 63,906 Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities: Amortization of goodwill 781 642 1,105 Bad debt expenses (benefits) 9,464 1,238 (1,142) Realized net capital gains (17,963) (15,333) (11,750) Stock option compensation expense 1,348 3,208 -- Change in unpaid losses and loss adjustment expenses 50,389 47,612 (95,658) Change in unearned premiums and prepaid reinsurance 115,448 60,705 28,809 Change in insurance balances payable (9,892) 4,965 (7,097) Change in insurance balances receivable, accrued premium income and reinsurance recoverable on paid and unpaid losses (97,303) (58,960) 68,751 Change in deferred acquisition costs (31,227) (26,475) (8,329) Change in accrued investment income (1,939) (1,510) (606) Change in current and deferred income taxes 896 (7,407) 17,521 Change in other assets and liabilities, net (16,508) (194) (24,742) --------- --------- --------- Total adjustments 3,494 8,491 (33,138) --------- --------- --------- Net cash and cash equivalents provided by operating activities 75,893 81,901 30,768 --------- --------- --------- Cash flows from investing activities: Proceeds of fixed maturities matured 57,616 65,096 65,589 Proceeds of fixed maturities sold 391,757 521,301 291,803 Proceeds of equity securities sold 140,564 215,732 163,173 Purchase of fixed maturities (587,751) (665,228) (491,326) Purchase of equity securities (119,341) (175,307) (183,492) Acquisition of capacity at Octavian (5,657) (639) (180) Payment consideration for Corifrance -- (42,225) -- Acquisition expenses for Corifrance -- (461) -- Payment consideration for Octavian -- -- (9,393) Acquisition expenses for Octavian -- -- (644) --------- --------- --------- Net cash and cash equivalents used in investing activities (122,812) (81,731) (164,470) --------- --------- --------- Cash flows from financing activities: Stock repurchases (3,400) (10,020) -- Proceeds from public debt offerings 99,899 74,866 -- Payment of fees for financing public debt offerings (913) (1,179) -- Redemption of public debt (113,053) -- -- Net proceeds from initial public offering -- -- 113,953 Redemption of preferred shares -- -- (16,035) Proceeds from shares issued 637 384 158 Preference dividends paid to stockholders -- -- (499) Ordinary dividends paid to stockholders (5,968) (4,370) (1,548) --------- --------- --------- Net cash and cash equivalents (used in) provided by financing activities (22,798) 59,681 96,029 --------- --------- --------- Change in cash and cash equivalents (69,717) 59,851 (37,673) Exchange on foreign currency cash balances 247 (531) (508) Cash and cash equivalents at beginning of year 109,864 50,544 88,725 --------- --------- --------- Cash and cash equivalents at end of year $ 40,394 $ 109,864 $ 50,544 ========= ========= ========= Supplemental disclosure of cash flow information Income taxes paid $ 13,642 $ 23,001 $ 303 ========= ========= ========= Interest paid $ 14,638 $ 10,750 $ 10,750 ========= ========= =========
See accompanying notes to the consolidated financial statements 45 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization Terra Nova (Bermuda) Holdings Ltd. ("Bermuda Holdings") is incorporated in Bermuda. All references here to the "Company" are to Bermuda Holdings and all of its direct and indirect subsidiaries. These include 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. It operates in the London market through its London based subsidiary, Terra Nova, in the Continental European Market through its French subsidiary, Corifrance, 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. It writes most insurance and reinsurance business through brokers authorized to place business at Lloyd's. It also writes 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 of the rights to manage eight Lloyd's syndicates (the "Octavian syndicates"). 2. Basis of Preparation The accompanying consolidated financial statements have been prepared on the basis of United States generally accepted accounting principles ("GAAP"). All material intercompany transactions and balances have been eliminated. 3. Significant Accounting Policies (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 recorded in shareholders' equity. Realized gains and losses are included in operations and determined by specific identification. Investment income is recorded as earned. (b) Cash and cash equivalents: Cash and cash equivalents consist of cash and various short-term investments which have maturities when bought of 90 days or less. Cash equivalents are stated at fair value which approximates cost. (c) Premiums: Premiums are earned pro-rata over the term of the related coverage. The balance of unearned premiums represents the portion of gross written premiums relating to the unexpired terms of coverage. (d) Deferred acquisition costs: Acquisition costs, which represent net commission and other expenses incurred in producing business, are deferred and amortized over the period in which the related premiums are earned. Deferred acquisition costs are limited to the amounts estimated as recoverable from the applicable unearned premiums and the related expected investment income, after giving effect to anticipated losses, loss adjustment expenses and expenses necessary to maintain the contracts in force. (e) 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. 46 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (f) Income taxes: Deferred income taxes are recorded on 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 reporting currency and principal functional currency, as most 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 historical 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 item of shareholders' equity. (h) Accrued premium income: Accrued premium income represents the difference between the estimated cumulative ultimate gross written premiums and cumulative billed premiums. (i) Prepaid reinsurance premiums: Prepaid reinsurance premiums represent the portion of premiums ceded to reinsurers applicable to the unexpired terms of reinsurance contracts. (j) 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 estimates for reported losses, including provisions for losses incurred but not reported ("IBNR"). The adequacy of these estimates is assessed by reference to projections of the ultimate losses for each accident year. The methods of determining such estimates and establishing reserves are reviewed continually and updated. Resulting adjustments are reflected in current operations. (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 recognized 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, recorded as a component of shareholders' equity, represents options the Company expects to settle in stock. (l) Risks and uncertainties: Information about risks and uncertainties existing at the balance sheet date related to the following areas are included in Notes 1, 3, 4, 10, 11, 12, 13, 14 and 17: .Nature of operations; .Use of estimates in preparing financial statements; .Certain significant estimates; .Current vulnerability due to certain concentrations. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These 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. 47 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (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 on 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 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. (p) Accounting pronouncements: The Company has adopted the provisions of SFAS No.130 "Reporting Comprehensive Income" and SFAS No.131 "Disclosures about Segments of an Enterprise and Related Information". SFAS No.130 establishes standards for reporting and display of comprehensive income and its components within a set of financial statements. SFAS No.131 requires the Company to report financial and descriptive information about its reportable operating segments. The Company has adopted the provisions of SFAS No.132 "Employers' Disclosures about Pensions and Other Postretirement Benefits". This statement significantly changes current financial statement disclosure requirements from those that were required under SFAS No.87, "Employers' Accounting for Pensions", SFAS No.88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits", and SFAS No.106, "Employers' Accounting for Postretirement Benefits Other Than Pensions". However, SFAS No.132 does not change the existing measurement or recognition provisions of SFAS Nos. 87, 88, or 106. In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.133 "Accounting for Derivative Instruments and Hedging Activities". SFAS No.133 is effective for fiscal years beginning after June 15, 1999, and will require all derivatives to be recognized in the statement of financial position as either assets or liabilities, measured at fair value. In addition, all hedging relationships must be designated, reassessed and documented under the provisions of SFAS No.133. The Company does not expect SFAS No.133 to have a significant impact on its financial reporting. 4. Investments and Cash (a) Deposits: Securities with a carrying value of $103,731,433 and $74,832,873 at December 31, 1998 and 1997, respectively, were held in trust for the benefit of the Company's U.S. cedents and to facilitate the Company's accreditation as an alien reinsurer by certain States. Cash and securities with a carrying value of $21,100,926 and $19,465,928 at December 31, 1998 and 1997, 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 $50,929,708 and $53,350,644 at December 31, 1998 and 1997, respectively, were held in trust for the benefit of the Company's Canadian cedents. The Company has contingent liabilities regarding undrawn letters of credit supporting certain reinsurance business written by the Company in the U.S. of $106,105,003 and $121,020,906 at December 31, 1998 and 48 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 1997, respectively. The Company has deposited cash and investments with a carrying value of $158,018,677 and $175,213,503 at December 31, 1998 and 1997, respectively, as collateral against these amounts. The Company has contingent liabilities regarding irrevocable undrawn letters of credit of $248,212,339 and $199,334,500 supporting the Company's underwriting activities on the Octavian syndicates at December 31, 1998 and, 1997, respectively. The Company has deposited cash and investments with a carrying value of $250,553,300 and $221,670,000 at December 31, 1998 and 1997, respectively, as collateral to support this commitment. Cash and securities with a carrying value of $149,076,000 and $66,246,000 at December 31, 1998 and 1997, respectively, were held in trust for the benefit of the Octavian syndicates' policyholders. (b) Net investment income: An analysis of the net investment income of the Company is as follows:
Year Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- dollars in thousands Fixed maturities $86,899 $77,690 $71,365 Equity securities 463 1,538 1,373 Cash and cash equivalents 8,754 9,470 7,539 ------- ------- ------- Total investment income 96,116 88,698 80,277 Investment expenses (2,854) (3,568) (2,147) ------- ------- ------- Net investment income $93,262 $85,130 $78,130 ======= ======= =======
(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, ------------------------- 1998 1997 1996 ------- ------- -------- dollars in thousands Realized net capital gains on sale of investments: Fixed maturities $ 8,854 $ 5,342 $ 1,509 Equity securities 9,109 9,991 10,241 ------- ------- -------- Realized net capital gains 17,963 15,333 11,750 ------- ------- -------- Changes in net unrealized appreciation (depreciation) of investments: Fixed maturities 30,691 17,291 (34,358) Equity securities (3,355) 6,919 15,928 ------- ------- -------- Changes in net unrealized appreciation (depreciation) of investments 27,336 24,210 (18,430) ------- ------- -------- Realized net capital gains and change in net unrealized appreciation (depreciation) of investments $45,299 $39,543 $ (6,680) ======= ======= ========
Realized net capital gains on sale of fixed maturities for the years ended December 31, 1998, 1997 and 1996, included gross capital gains of $9,420,000, $9,600,000 and $6,802,000, and gross capital losses of $566,000, $4,258,000 and $5,293,000, respectively. Proceeds from sales of investments in equity securities during 1998, 1997 and 1996, respectively, were $140,564,000, $215,732,000 and $163,173,000. Realized net capital gains on sale of equity securities for the years ended December 31, 1998, 1997 and 1996, included gross capital gains of $24,567,000, $29,613,000 and $22,512,000, and gross capital losses of $15,458,000, $19,622,000 and $12,271,000, respectively. 49 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Net unrealized appreciation of equities (before income tax) at December 31, 1998, of the Company included gross unrealized appreciation of $38,551,000 and gross unrealized depreciation of $7,453,000. Net unrealized appreciation of equities at December 31, 1997, of the Company included gross unrealized appreciation of $38,111,000 and gross unrealized depreciation of $3,658,000. (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:
1998 ----------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair Cost appreciation depreciation value ---------- ------------ ------------ ---------- dollars in thousands U.S. government and agencies $ 253,282 $18,920 $ 20 $ 272,182 Foreign governments and agencies 575,699 34,246 220 609,725 Mortgage backed and asset backed 50,945 1,558 29 52,474 Supranationals 121,945 7,142 -- 129,087 Corporate 372,401 11,177 425 383,153 ---------- ------- ------ ---------- Total fixed maturities $1,374,272 $73,043 $ 694 $1,446,621 ========== ======= ====== ========== 1997 ----------------------------------------------- Gross Gross Estimated Amortized unrealized unrealized fair Cost appreciation depreciation value ---------- ------------ ------------ ---------- dollars in thousands U.S. government and agencies $ 298,618 $14,410 $ 308 $ 312,720 Foreign governments and agencies 469,941 19,302 683 488,560 Mortgage backed and asset backed 74,528 1,259 211 75,576 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 ========== ======= ====== ==========
The amortized cost and estimated fair value of the Company's fixed maturities at December 31, 1998, 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 % of Total -------------- ---------- ---------- dollars in thousands Due in one year or less $ 99,798 $ 100,494 7% Due after one year through five years 539,631 558,039 39 Due after five years through ten years 665,953 708,051 49 Due after ten years 68,890 80,037 5 ---------- ---------- --- $1,374,272 $1,446,621 100% ========== ========== ===
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. 50 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (e) At December 31, 1998, the Company's portfolio by rating category, determined by recognized rating agencies, was:
Estimated fair value -------------------- dollars in thousands U.S. government and agency $ 272,182 U.K. government and agency 131,761 AAA 458,877 AA 281,090 A 175,080 BBB 93,757 Not Rated 33,874 ---------- $1,446,621 ==========
Not Rated securities consist mainly of securities issued by municipalities 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, 1998, the estimated fair value of the following investments exceeded 10% of shareholders' equity:
dollars in thousands United States Treasury $272,182 Government of Japan 113,909 Canadian Treasury 111,772 UK Treasury 63,731
(g) Equities available for sale: At December 31, 1998, the cost and estimated fair value of investments in common stocks were as follows:
Estimated Cost Fair Value ---------- ------------- dollars in thousands Public utilities $ 1,558 $ 1,806 Banks, trust and insurance companies 10,604 12,861 Industrial, miscellaneous and all other 44,762 73,355 ---------- ---------- Total equity securities $ 56,924 $ 88,022 ========== ==========
51 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 5. Income Taxes (a) The U.K. corporation tax rate applicable to ordinary income was 33% for 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 and 1998. The difference between the actual tax expense and the "expected" amount calculated by applying the U.K. corporation tax rate is explained as follows:
Year Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- dollars in thousands "Expected" tax expense $31,391 $28,680 $27,280 Adjustments: Non-taxable income (15,042) (10,004) (9,872) Other 872 (1,037) 369 ------- ------- ------- Actual tax expense $17,221 $17,639 $17,777 ======= ======= =======
(b) The components of income tax expense attributable to continuing operations are as follows:
Year Ended December 31, ----------------------- 1998 1997 1996 ------- ------- ------- dollars in thousands Current U.K. corporation tax $ 2,789 $10,743 $17,409 Current French corporation tax 1,310 -- -- Deferred tax 13,122 6,896 368 ------- ------- ------- Income tax expense $17,221 $17,639 $17,777 ======= ======= =======
(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. Measurement of a deferred tax asset, if any, is subject to the expectation of future realization. The components of net deferred tax liabilities of the Company as at December 31, 1998 and 1997, were as follows:
1998 1997 ---------- ---------- dollars in thousands Deferred tax assets: Unrealized depreciation of investments $ 321 $ 433 Other 318 1,039 ---------- ---------- Total deferred tax assets 639 1,472 ---------- ---------- Deferred tax liabilities: Unrealized appreciation of investments (11,718) (7,275) Other (16,371) (9,441) ---------- ---------- Total deferred tax liabilities (28,089) (16,716) ---------- ---------- Net deferred tax liabilities $ (27,450) $ (15,244) ========== ==========
52 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (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 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 so does not expect to be subject to U.S. income taxation. 6. 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, ------------------------ 1998 1997 1996 -------- ------- ------- dollars in thousands Balance at beginning of year $ 76,380 $45,279 $36,950 -------- ------- ------- Acquisition costs deferred Commissions 151,371 119,610 78,051 Other 40,236 26,918 12,672 -------- ------- ------- 191,607 146,528 90,723 -------- ------- ------- Amortization charged to income Commissions 126,239 92,713 71,759 Other 34,141 22,714 10,635 -------- ------- ------- 160,380 115,427 82,394 -------- ------- ------- Balance at end of year $107,607 $76,380 $45,279 ======== ======= =======
7. Employee Benefits Terra Nova operates a defined benefit pension plan ("Terra Nova Plan") covering 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 according to 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. Mandatory employee contributions to the Terra Nova Plan ceased in 1988. There are no present plans to reintroduce such contributions. Employees may elect to make voluntary contributions to supplement their pension benefits when payable. 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 on pension and related benefits and has negotiated for a plan on the same cost basis. 53 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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. 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. The annual contribution rate for managers is 5.66% of pensionable salary and, for employees, is 1.43% of pensionable salary. The total cost of the Company's defined contribution plans for the year was $2,351,000. The following tables set 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, 1998 and 1997:
1998 1997 1996 ------ ------ ------ dollars in thousands Component of net periodic benefit costs: Service cost $2,692 $2,612 $1,664 Interest cost 2,973 3,153 1,975 Expected return on plan assets (4,787) (4,274) (2,442) Amortization of prior service cost (94) (100) (90) Recognized net actuarial gain (192) -- -- ------ ------ ------ Net periodic benefit cost $ 592 $1,391 $1,108 ====== ====== ======
54 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1998 1997 ---------- ---------- dollars in thousands Change in benefit obligation Benefit obligation at beginning of year $ 40,386 $ 35,964 Service cost 2,692 2,709 Interest cost 2,973 3,158 Benefits paid (587) (558) Actuarial loss (gain) 8,600 (887) ---------- ---------- Benefit obligation at end of year 54,064 40,386 ---------- ---------- Change in plan assets Fair value of plan assets at beginning of year 50,161 43,048 Actual return on plan assets 7,490 6,031 Employer contribution 1,993 1,640 Benefits paid (587) (558) ---------- ---------- Fair value of plan assets at end of year 59,057 50,161 ---------- ---------- Funded Status 4,991 9,775 Unrecognized net actuarial gain -- (4,481) Unrecognized prior service cost -- (564) ---------- ---------- Prepaid benefit cost $ 4,991 $ 4,730 ========== ========== Weighted-average assumptions as of December 31 Discount rate 5.5% 7.5% Expected return on plan assets 8.0% 10.0% Rate of compensation increase 4.5% 5.0%
55 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 8. Earnings Per Share The following EPS have been calculated using SFAS No.128 "Earnings per Share":
1998 1997 1996 --------------- --------------- --------------- dollars in thousands except per share amounts Net income $ 72,399 $ 73,410 $ 63,906 Add: Minority interest -- -- 985 Less: Preference share dividends -- -- (1,088) --------------- --------------- --------------- Income available to common shareholders 72,399 73,410 63,803 --------------- --------------- --------------- Weighted average number of shares outstanding: Common shares 25,449,091 25,586,648 22,677,879 Basic EPS $ 2.84 $ 2.87 $ 2.81 =============== =============== =============== Net income $ 72,399 $ 73,410 $ 63,906 Add: Minority interest -- -- 985 Less: Preference share dividends -- -- (499) --------------- --------------- --------------- Income available to common shareholders 72,399 73,410 64,392 --------------- --------------- --------------- Weighted average number of shares outstanding: Common shares 25,449,091 25,586,648 22,677,879 --------------- --------------- --------------- Add: Incremental shares arising from: Preferred shares -- -- 859,040 Options 654,445 406,643 407,607 --------------- --------------- --------------- Adjusted weighted average number of shares outstanding 26,103,536 25,993,291 23,944,526 =============== =============== =============== Diluted EPS $ 2.77 $ 2.82 $ 2.69 =============== =============== ===============
9. Share Capital The "A" ordinary shares and "B" ordinary shares rank pari passu in right to receive dividends. Each "B" ordinary share at the Company is convertible, at the choice of the holder into an "A" ordinary share without payment or adjustment for accrued dividends. During 1998, the Company issued 82,382 ordinary shares to satisfy options exercised under the Company's stock option plan (see Note 10). Also during the year, the Company repurchased 132,200 shares at a total cost of $3,395,670, excluding commissions. As at December 31, 1998, the Company had purchased a total of 632,800 shares at a total cost of $13,395,670, leaving a further $6,604,330 available for future repurchases under the Board of Directors' authorization, dated May 5, 1997. The shares are to be held in trust for the satisfaction of employees' and directors' long-term compensation plans and any other corporate purposes. 10. Share Options and Awards At December 31, 1998, the Company had various stock-based compensation plans which are described below. The Company applies APB Opinion No.25 and related interpretations in accounting for its plans. Compensation expense of $1,348,000 has been charged against income for 1998 (1997: $3,244,000). 56 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The net income and earnings per share would have been reduced to the pro forma amounts indicated below had compensation expense been determined using the fair value methodology of SFAS No.123:
1998 1997 1996 --------------- --------------- --------------- dollars in thousands except per share amounts Net income: As reported $ 72,399 $ 73,410 $ 63,803 =============== =============== =============== Proforma $ 70,417 $ 73,352 $ 63,567 =============== =============== =============== Basic earnings per share: As reported $ 2.84 $ 2.87 $ 2.81 =============== =============== =============== Proforma $ 2.77 $ 2.87 $ 2.80 =============== =============== ===============
The assumptions made in calculating the pro forma amounts above were: risk free rate of return, 5.05%; volatility, 0.37; dividend yield, 0.47%; and expected life, 4 years. On January 9, 1995, the Company adopted an Executive Share Option Plan (the "Stock Option Plan"). Amendments to the Stock Option Plan were adopted by the Company on May 4, 1998. The Stock Option Plan provides for the grant to eligible employees of options to buy 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 15% of the aggregate number of common shares of the Company outstanding. The options are only exercisable on certain specified events occurring 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 decides which employees are granted options. A summary of the Company's Stock Option Plan at December 31, 1998, and changes during the year then ended is presented below:
Weighted- average Fixed options Shares exercise price ------------- --------- -------------- 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 January 1, 1998 1,792,610 17.47 Granted 188,900 25.75 Exercised (82,382) 7.72 Forfeited (22,824) 13.72 --------- ------ Outstanding at December 31, 1998 1,876,304 $18.78 ========= ======
At December 31, 1998, the outstanding Option Shares under the Stock Option Plan had exercise prices between $5.80 and $25.75 and a weighted-average remaining contractual life of 6.8 years. 57 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Options outstanding and options exercisable at December 31, 1998, are summarized as follows:
Options outstanding Options exercisable -------------------------------------------- -------------------------- Range of Weighted Weighted Weighted exercise Number average remaining average Number average prices outstanding contractual life exercise price exercisable exercise price --------- ----------- ----------------- -------------- ----------- -------------- $ 5.01--10.00 493,021 5.97 $6.37 462,394 $6.41 10.01--15.00 108,133 4.93 12.80 65,351 12.80 15.01--20.00 265,950 6.46 18.94 80,770 18.83 20.01--25.00 55,000 7.03 23.19 11,000 23.19 25.01--30.00 954,200 7.50 25.56 290,000 25.52 --------- ------- 1,876,304 909,515 ========= ======= Options exercisable at December 31, 1997 581,986 Options exercisable at December 31, 1996 391,198
The Company established the Octavian Stock Option Plan in 1996. It provides for the grant of options to certain individual members of management of Octavian based on profit commissions receivable 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 related underwriters' and management bonuses 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 share 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 are to be issued on receiving 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 from the January next succeeding the date of grant, beginning January 1, 2000, except that all options issued after January 1, 2002 become immediately exercisable. A summary of the Octavian Stock Option Plan at December 31, 1998, and changes during the two years then ended is shown below:
Weighted- average Performance-based options Shares exercise price ------------------------- ------- -------------- Outstanding at January 1, 1996 -- $ -- Reserved for grant 29,849 0.00 Exercised -- -- Forfeited -- -- ------- ----- Outstanding at January 1, 1997 29,849 0.00 Reserved for grant 66,648 0.00 Exercised -- -- Forfeited -- -- ------- ----- Outstanding at January 1, 1998 96,497 0.00 Reserved for grant 117,661 0.00 Exercised -- -- Forfeited -- -- ------- ----- Outstanding at December 31, 1998 214,158 $0.00 ======= ===== Options exercisable at December 31, 1998, 1997 and 1996 Nil
58 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) At December 31, 1998, the 214,158 options outstanding under the Octavian Stock Option Plan all had exercise prices of $nil and a weighted-average remaining contractual life of 7.54 years. The weighted average fair value per share of options granted in the Company's stock-based compensation plans at December 31, 1998, was $14.25. 11. 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 mainly consist 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 aviation and non-marine business. Availability of reinsurance at reasonable cost and under favorable terms is one of the key determinants in the decision about which categories of business to emphasize at any given time. A credit risk exists with 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; so allowances are established for amounts thought 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. At December 31, 1998, the aggregate exposure in respect of reinsurance ceded to Lloyd's syndicates in respect of continuing operations, including estimated reinsurance recoveries for losses incurred but not reported, was approximately $77,877,000. The majority 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. (a) Net written premiums are comprised of the following:
Year Ended December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- dollars in thousands Direct business $407,841 $269,577 $119,601 Reinsurance assumed 351,547 280,666 241,409 Reinsurance ceded (113,191) (66,698) (49,844) -------- -------- -------- Net written premiums $646,197 $483,545 $311,166 ======== ======== ========
(b) Net earned premiums are comprised of the following:
Year Ended December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- dollars in thousands Direct business $318,213 $209,414 $100,309 Reinsurance assumed 317,499 260,603 227,574 Reinsurance ceded (88,804) (50,948) (49,127) -------- -------- -------- Net earned premiums $546,908 $419,069 $278,756 ======== ======== ========
59 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (c) Losses and loss adjustment expenses, net, are comprised of the following:
Year Ended December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- dollars in thousands Losses and loss adjustment expenses, gross $448,066 $329,463 $213,872 Reinsurance ceded (88,499) (46,983) (35,598) -------- -------- -------- Losses and loss adjustment expenses, net $359,567 $282,480 $178,274 ======== ======== ========
12. 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 notifying certain claims and a large 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. Movement in unpaid losses and loss adjustment expenses for the years ended December 31, 1998, 1997 and 1996, is summarized in the table below. Incurred claims relating to prior years are offset by decreases to prior year net written and net earned premiums less related acquisition costs of $9,757,000, $4,800,000 and $3,550,000 for 1998, 1997 and 1996, respectively. When these revisions to prior written and earned premiums are considered, the Company experienced net prior year improvements of $15,207,000 in 1998, $5,596,000 in 1997 and deterioration of $950,000 in 1996. 60 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1998 1997 1996 ---------- ---------- ---------- dollars in thousands Reserves for unpaid losses and loss adjustment expenses, at beginning of year $1,157,724 $1,078,108 $1,168,652 Less reinsurance recoverables on unpaid losses (246,728) (254,129) (354,417) ---------- ---------- ---------- Net balance at beginning of year 910,996 823,979 814,235 ---------- ---------- ---------- Net incurred losses and loss adjustment expenses related to: Current year 384,531 292,876 180,874 Prior years (24,964) (10,396) (2,600) ---------- ---------- ---------- Total net incurred losses and loss adjustment expenses 359,567 282,480 178,274 ---------- ---------- ---------- Net paid losses and loss adjustment expenses related to: Current year (138,918) (69,685) (50,303) Prior years (187,559) (145,702) (123,438) ---------- ---------- ---------- Total net paid losses and loss adjustment expenses (326,477) (215,387) (173,741) Foreign exchange adjustment (5,169) (10,967) 5,211 ---------- ---------- ---------- Net balance at end of year 938,917 880,105 823,979 Net reserves from reinsurance to close of 1996 year 43,988 -- (/1/) -- Net reserves from Corifrance Acquisition -- 30,891 -- ---------- ---------- ---------- Net reserves at end of year 982,905 910,996 823,979 Plus Reinsurance recoverables: The Company 226,098 236,847 254,129 Reinsurance recoverables related to net reserves from Corifrance acquisition -- 9,881 -- ---------- ---------- ---------- Reinsurance recoverable by the Company 226,098 246,728 254,129 ---------- ---------- ---------- Reserves for unpaid losses and loss adjustment expenses, at end of year $1,209,003 $1,157,724 $1,078,108 ========== ========== ==========
(/1/) The net reserves from the reinsurance to close of the 1995 year, of $17,910,000, have been included in net incurred losses and loss adjustment expenses for the year ended December 31, 1997. The premiums of $17,910,000 in respect of these losses were included in gross written and net earned premiums in 1997. Management has considered environmental and latent injury claims and claims expenses in establishing the Company's reserve 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 affecting policies written in prior years. Coverage and claim settlement issues, such as determining that coverage exists and defining an occurrence, may cause the actual loss development to show more variation than the rest of the Company's book of business. Traditional reserving techniques cannot be used to estimate asbestos-related and environmental pollution claims and so the uncertainty about 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 adverse effect on its financial position. Still, there is no assurance that such losses will not materially affect the Company's results of operations for any period. Management is not able to estimate the additional loss, or range of loss, that is reasonably possible. 61 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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, ---------------------------- 1998 1997 1996 -------- -------- -------- dollars in thousands Reserves for unpaid losses and loss adjustment expenses, at beginning of year $ 58,755 $ 58,400 $ 47,900 Incurred losses and loss adjustment expenses 17,721 2,808 97 Paid losses and loss adjustment expenses (1,138) (2,453) (1,700) -------- -------- -------- Reserves for unpaid losses and loss adjustment expenses, at end of year prior to reclassification 75,338 58,755 46,297 Reclassification of reserves previously identified as non-Asbestos-Related losses -- -- 12,103 -------- -------- -------- Reserves for unpaid losses and loss adjustment expenses, at end of year $ 75,338 $ 58,755 $ 58,400 ======== ======== ======== Environmental Pollution Losses and Loss Adjustment Expenses Incurred and Reserves Outstanding (net of reinsurance) Year Ended December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- dollars in thousands Reserves for unpaid losses and loss adjust- ment expenses, at beginning of year $ 30,342 $ 33,900 $ 38,400 Incurred losses and loss adjustment expenses (8,505) (2,032) (1,500) Paid losses and loss adjustment expenses (1,285) (1,526) (3,000) -------- -------- -------- Reserves for unpaid losses and loss adjust- ment expenses, at end of year $ 20,552 $ 30,342 $ 33,900 ======== ======== ======== The reinsurance recoverables netted against the asbestos-related and environmental pollution loss reserves for each of the years 1998, 1997 and 1996, are as follows: Year Ended December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- dollars in thousands Gross reserves $129,166 $111,805 $111,900 Reinsurance recoverables (33,276) (22,708) (19,600) -------- -------- -------- Net reserves $ 95,890 $ 89,097 $ 92,300 ======== ======== ========
62 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 13. 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 at December 31, 1998 and 1997, of $38,823,000 and $28,904,000, respectively. Doubtful accounts against which provisions of $455,000 had previously been made were written back during 1998. The charge to doubtful accounts was $9,464,000 for the year ended December 31, 1998, and $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. The charge in 1998 included $5,558,000 in respect of a provision which had previously been included in unpaid losses and was transferred to the bad debt provision during 1998 due to additional information received by the Company in the year. 14. Commitments and Contingent Liabilities (a) The Company is involved regularly, directly or indirectly, in litigation in the ordinary course of conducting insurance and reinsurance business. In some 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 management's opinion, 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. However, there is no assurance that such losses will not materially affect 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 for 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 fitting out of the new LUC resulted in a shortfall of annual rental income and the possibility of further shortfalls 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. As well as 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, 1998, under non-cancelable operating leases are as follows:
dollars in thousands 1999 $ 3,926 2000 3,434 2001 1,922 2002 996 2003 845 2004 and later years 2,455 ------- $13,578 =======
Rental expense on property leases of $4,246,000, $4,102,000 and $3,802,000 was incurred for the periods to December 31, 1998, 1997 and 1996, respectively. 63 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 15. Extraordinary Charge Arising on Extinguishment of Debt An extraordinary charge of $11.6 million arose during the second quarter as a result of UK Holdings extinguishing all of its $100 million 10.75% Senior Notes due 2005 (the "Senior Notes"). The charge was net of a $5.2 million income tax benefit. The Senior Notes were extinguished as follows: (a) On April 1, 1998, UK Holdings repurchased $4.5 million of the Senior Notes for consideration of $5.2 million, including accrued interest. (b) On May 18, 1998, UK Holdings completed a cash tender for the remaining $95.5 million of the Senior Notes for consideration of $111.9 million, including accrued interest. The extraordinary charge has been recognized in the period of extinguishment under SFAS No.125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". 16. Long-Term Debt On May 18, 1998, UK Holdings completed an issue of $100 million 7.0% Senior Notes due 2008, guaranteed fully and unconditionally by Bermuda Holdings. The net proceeds were used to finance the tender for $95.5 million 10.75% Senior Notes due 2005, as described in Note 15. The Company's total outstanding consolidated indebtedness at December 31, 1998, was made up of $175 million of the Senior Notes including the $75 million 7.2% Senior Notes due 2007, issued in 1997. The estimated fair value of these Senior Notes at December 31, 1998, was $180.8 million, comprising $102.8 million of 7.0% Senior Notes due 2008 and $78.0 million of 7.2% Senior Notes due 2007. The 7.2% Senior Notes due 2007 and 7.0% Senior Notes due 2008 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. Under certain circumstances, these covenants limit 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 In 1992, Terra Nova's directors decided to cease writing aviation business ("Aviation"). Since the acquisition of Terra Nova by the Company in 1994, any charges or credits resulting from changes in estimates are recorded in continuing operations of the Company. Included within other liabilities in the Company's balance sheet is $23,197,000 (1997:$28,235,000) relating to net liabilities of Aviation business in run-off. 64 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 18. Ownership and Related Party Transactions Fees of $838,750, $487,500 and $3,216,004 were paid to a related party, who is a significant shareholder, in 1998, 1997 and 1996, respectively. The fees related to the issue of the Senior Notes and the capitalization of the Company. 19. Segment Information The Company's operations are conducted through four segments: Marine & Aviation, Non-Marine, Agency and the Corporate operations. The Marine & Aviation and Non-Marine segments earn income from insurance and reinsurance business written worldwide. The Agency segment comprises the operations of Octavian (see Note 1). The Corporate segment holds the assets, principally investments not allocable to the insurance underwriting and agency operations. The Company's reportable segments are strategic business units that offer different products and services, other than the Corporate segment, which runs the Company's non-insurance related activities. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from operations before income taxes and extraordinary items. Inter-segment transactions are eliminated from segmental reporting, such that the segmental accounts are consistent with the Company's consolidated financial statements. 65 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table is a summary of the operations and assets of the four segments for the years ended December 31, 1998, 1997 and 1996:
1998 ------------------------------------------------- Marine & Non- Aviation Marine Agency Corporate Consolidated -------- --------- ------- --------- ------------ (dollars in thousands) Revenues from external customers $127,532 $ 419,376 $17,057 $ -- $ 563,965 Investment income and realized gains 15,681 53,014 -- 41,944 110,639 -------- --------- ------- ------- --------- Total revenues 143,213 472,390 17,057 41,944 674,604 -------- --------- ------- ------- --------- Interest expense -- -- -- 13,697 13,697 -------- --------- ------- ------- --------- Segment profit 13,764 61,570 3,297 22,630 101,261 -------- --------- ------- ------- --------- Segment assets 565,460 1,190,720 17,570 705,622 2,479,372 -------- --------- ------- ------- --------- 1997 ------------------------------------------------- Marine & Non- Aviation Marine Agency Corporate Consolidated -------- --------- ------- --------- ------------ (dollars in thousands) Revenues from external customers $130,017 $ 289,052 $15,571 $ -- $ 434,640 Investment income and realized gains 16,930 42,140 -- 40,125 99,195 -------- --------- ------- ------- --------- Total revenues 146,947 331,192 15,571 40,125 533,835 -------- --------- ------- ------- --------- Interest expense -- -- -- 12,710 12,710 -------- --------- ------- ------- --------- Segment profit 19,827 46,698 2,441 22,083 91,049 -------- --------- ------- ------- --------- Segment assets 523,972 986,780 12,567 696,815 2,220,134 -------- --------- ------- ------- --------- 1996 ------------------------------------------------- Marine & Non- Aviation Marine Agency Corporate Consolidated -------- --------- ------- --------- ------------ (dollars in thousands) Revenues from external customers $ 90,087 $ 188,669 $ 8,998 $ -- $ 287,754 Investment income and realized gains 15,471 36,677 -- 38,157 90,305 -------- --------- ------- ------- --------- Total revenues 105,558 225,346 8,998 38,157 378,059 -------- --------- ------- ------- --------- Interest expense -- -- -- 10,750 10,750 -------- --------- ------- ------- --------- Segment profit 20,582 39,479 461 22,146 82,668 -------- --------- ------- ------- --------- Segment assets 558,475 788,916 6,183 513,773 1,867,347 -------- --------- ------- ------- ---------
Total revenues, segment profit and segment assets agree with total revenues, income before income taxes and extraordinary items and total assets, respectively, in the consolidated financial statements. Substantially all the revenues are drawn from business within the London Market. Additional operations are conducted in Belgium, Bermuda, Canada and France. No further geographic information is provided since it is impracticable to do so. The Company does not rely on any one major customer for ten percent or more of its revenues. 66 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 Financial Services Authority (the "FSA"), as previously with H.M. Treasury (the "Treasury"), in the U.K. The regulations require U.K. insurance companies to comply with prescribed minimum solvency margins. Terra Nova's unaudited required minimum solvency margin and unaudited solvency margin at December 31, 1998, were $24,479,000 and $239,053,000, respectively. Terra Nova's unaudited and estimated Treasury Return policyholders' surplus and unaudited net income for the year ended December 31, 1998, 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, 1997 and 1996, are as follows:
1998 1997 1996 ----------- -------- -------- (Unaudited) Policyholders' surplus $239,053 $233,936 $234,400 Net income before dividends 44,915 49,855 23,615
Terra Nova's ability to pay dividends is limited by a Notice of Requirements issued by a predecessor of the FSA which requires Terra Nova to give 14 days' advance notice to the FSA 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 to it 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, 1998, 1997 and 1996, respectively, were:
1998 1997 1996 ----------- -------- -------- (Unaudited) Statutory capital and surplus $324,580 $260,612 $219,374 Minimum required statutory capital and surplus 100,000 100,000 100,000
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, to acquire 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. Summarized consolidated balance sheet information as at December 31, 1998, and 1997, and summarized consolidated statements of operations information for the years December 31, 1998, 1997 and 1996, about UK Holdings is set out below. 67 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, --------------------- 1998 1997 ---------- ---------- dollars in thousands Investments and cash $ 900,442 $ 960,191 Reinsurance recoverable on unpaid losses 459,497 407,560 Accrued premium income 236,885 170,006 Other assets 364,172 288,077 ---------- ---------- Total assets $1,960,996 $1,825,834 ========== ========== Unpaid losses and loss adjustment expenses $1,093,082 $1,077,327 Unearned premiums 375,574 254,833 Long-term debt 175,000 175,000 Other liabilities 108,250 141,956 ---------- ---------- Total liabilities 1,751,906 1,649,116 ========== ========== Total shareholders' equity 209,090 176,718 ========== ========== Total liabilities, minority interests and shareholders' equity $1,960,996 $1,825,834 ========== ==========
Year Ended December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- dollars in thousands Net earned premiums $453,406 $357,939 $243,812 Net investment income 56,858 55,698 52,102 Realized investment gains 15,544 15,306 12,217 Foreign exchange (losses) gains (483) (1,240) 213 Agency income 17,057 15,571 8,998 -------- -------- -------- Total revenues 542,382 443,274 317,342 -------- -------- -------- Underwriting costs and expenses 489,646 384,530 264,627 -------- -------- -------- Income from operations before income tax, minority interests and extraordinary charge 52,736 58,744 52,715 -------- -------- -------- Net income $ 23,878 $ 41,105 $ 34,430 ======== ======== ========
68 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 22. Unaudited Selected Quarterly Financial Data
1998 --------------------------------------------------- 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 $171,917 $148,986 $158,579 $195,122 ======== ======== ======== ======== Extraordinary charge after income tax -- $ 11,641 -- -- ======== ======== ======== ======== Net income $ 24,423 $ 8,959 $ 19,771 $ 19,246 ======== ======== ======== ======== Basic earnings per share $ 0.96 $ 0.35 $ 0.78 $ 0.75 ======== ======== ======== ======== Diluted earnings per share $ 0.94 $ 0.34 $ 0.75 $ 0.74 ======== ======== ======== ======== 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 ======== ======== ======== ========
The Company's net income per share amounts are based on the weighted average number of shares outstanding during the periods (see Note 8). The quarterly 1997 per share data shown above do not agree to those previously reported on Form 10-Q due to 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 None. 69 PART III ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required by this Item is included in the 1998 Proxy Statement dated March 30, 1999, and such information is incorporated here by reference. ITEM 11--EXECUTIVE COMPENSATION Information required by this Item is included in the 1998 Proxy Statement dated March 30, 1999, and such information is incorporated here by reference. ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required by this Item is included in the 1998 Proxy Statement dated March 30, 1999, and such information is incorporated here by reference. ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by this Item is included in the 1998 Proxy Statement dated March 30, 1999, and such information is incorporated here by reference. 70 PART IV ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS OF FORM 8-K (a) Index to Financial Statements. The financial statements filed as part of this report are listed in the Index to Financial Statements on page 38. INDEX TO FINANCIAL STATEMENT SCHEDULES
Page ---- --Condensed Financial Information of Registrant Schedule II(a) (Parent Company) 72 --Condensed Balance Sheets --Condensed Financial Information of Registrant Schedule II(b) (Parent Company) 73 --Condensed Statements of Operations --Condensed Financial Information of Registrant Schedule II(c) (Parent Company) 74 --Condensed Statements of Cash Flows Schedule III --Supplementary Insurance Information 75 Schedule IV --Reinsurance 76 --Supplementary Information Concerning Schedule VI Property/Casualty Insurance Operations 77 Schedules I and V have been omitted because the required information is included in the consolidated financial statements or notes. (b) Reports on Form 8-K. No reports on Form 8-K have been filed during the last quarter of 1998. (c) Exhibits. 78 The Index to Exhibits and the Exhibits filed as part of this report.
71 SUPPLEMENTAL SCHEDULE II(a) TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION(1) CONDENSED BALANCE SHEETS (dollars in thousands)
December 31, ------------------ 1998 1997 -------- -------- ASSETS ------ Investments in subsidiaries $542,948 $446,838 Fixed interest securities 22,039 28,703 Cash 1,480 2,146 -------- -------- Total investments and cash 566,467 477,687 Other assets 5,812 5,619 -------- -------- Total assets $572,279 $483,306 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Other liabilities $ 1,417 $ 1,418 -------- -------- Total liabilities 1,417 1,418 -------- -------- Shareholders' equity: Common shares 150,620 150,142 Stock held in Trust (12,900) (9,500) Deferred equity compensation 4,623 3,275 Additional capital 111,727 111,568 Unrealized appreciation in investments of subsidiaries, net of income tax 80,342 56,430 Retained earnings 236,450 169,973 -------- -------- Total shareholders' equity 570,862 481,888 -------- -------- Total liabilities and shareholders' equity $572,279 $483,306 ======== ========
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes 72 SUPPLEMENTAL SCHEDULE II(b) TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION(1) CONDENSED STATEMENTS OF OPERATIONS (dollars in thousands)
Year Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- Revenues: Net investment income $ 3,618 $ 1,953 $ 2,205 Realized gains (losses) on sales of investments 246 (25) (39) Foreign exchange (losses) gains (1) 5 -- Dividend income -- 44,400 -- ------- ------- ------- Total revenues 3,863 46,333 2,166 ------- ------- ------- Expenses: Deferred debt expenses 664 664 664 Salaries 1,436 1,864 1,592 Legal and professional expenses 842 639 463 Other expenses 1,007 1,065 1,677 ------- ------- ------- Total expenses 3,949 4,232 4,396 ------- ------- ------- (Loss) income from operations before equity in net income of consolidated subsidiaries (86) 42,101 (2,230) Equity in net income of consolidated subsidiaries 72,485 31,309 66,136 ------- ------- ------- Net income $72,399 $73,410 $63,906 ======= ======= =======
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes 73 SUPPLEMENTAL SCHEDULE II(c) TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION(1) CONDENSED STATEMENTS OF CASH FLOWS (dollars in thousands)
Year Ended December 31, ----------------------------- 1998 1997 1996 -------- -------- --------- Cash flows from operating activities: Net loss $ (86) $ (2,299) $ (2,230) -------- -------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Realized capital (gains) losses (246) 25 39 Stock option compensation expense -- 804 -- Change in accrued investment income 201 (604) -- Change in other assets and liabilities, net 950 (289) (3,478) -------- -------- --------- Net cash provided by (used in) operating activities 819 (2,363) (5,669) -------- -------- --------- Cash flows from investing activities: Proceeds of fixed maturities sold 19,291 46,181 80,196 Purchase of fixed maturities (12,045) (74,808) (80,235) -------- -------- --------- Net cash provided by (used in) investing activities 7,246 (28,627) (39) -------- -------- --------- Cash flows from financing activities: Investment in subsidiary company -- -- (101,001) Net proceeds from initial public offering -- -- 113,953 Redemption of preference shares -- -- (16,035) Proceeds from shares issued 637 384 158 Stock repurchases (3,400) (10,020) -- Ordinary dividends received from subsidiary company -- 44,400 -- Preference dividends paid to stockholders -- -- (499) Ordinary dividends paid to stockholders (5,968) (4,370) (1,548) -------- -------- --------- Net cash (used in) provided by financing activities (8,731) 30,394 (4,972) -------- -------- --------- Change in cash and cash equivalents (666) (596) (10,680) Cash and cash equivalents at beginning of year 2,146 2,742 13,422 -------- -------- --------- Cash and cash equivalents at end of year $ 1,480 $ 2,146 $ 2,742 ======== ======== =========
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes 74 SUPPLEMENTAL SCHEDULE III TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION (dollars in thousands)
Losses Benefits, Amortization Deferred and loss Net claims, losses of deferred Other acquisition adjustment Unearned Premium investment and settlement acquisition operating Premiums Segment costs expenses premiums revenue income expenses costs expenses Written ------- ----------- ---------- -------- -------- ---------- -------------- ------------ --------- -------- Year ended December 31, 1998 Non-marine $75,388 $818,916 $279,991 $419,376 $53,014(a) $288,386 $107,867 $14,567 $507,947 Marine 32,219 390,087 121,011 127,532 15,681(a) 71,181 52,513 5,755 138,250 Year ended December 31, 1997 Non-marine $52,010 $747,551 $184,136 $289,052 $42,140(a) $198,478 $77,497 $8,522 $331,391 Marine 24,370 410,173 90,798 130,017 16,930(a) 84,002 37,930 5,184 152,154 Year ended December 31, 1996 Non-marine $27,347 $643,339 $109,227 $188,669 $36,677(a) $127,883 $52,243 $5,720 $219,981 Marine 17,932 434,769 63,893 90,087 15,471(a) 50,391 30,151 4,455 91,185
- ---- (a) Net investment income excludes investment income and realized gains of $41,944,000, $40,125,000 and $38,157,000 for 1998, 1997 and 1996, respectively, which is attributed to the Parent as disclosed in Note 19 to the Consolidated Financial Statements. 75 SUPPLEMENTAL SCHEDULE IV TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES REINSURANCE As of December 31, 1998 (dollars in thousands)
Percentage Ceded to Assumed of amount Gross other from other Net assumed Written premiums amount companies companies amount to net ---------------- -------- --------- ---------- -------- ---------- Property-Casualty Year Ended December 31, 1998 $407,841 $113,191 $351,547 $646,197 54.40% 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%
76 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 Net (1) (2) of Deferred Loss Acquisition Adjustment Unearned Earned Investment Current Prior Acquisition Adjustment Written Segment Costs Expenses Premiums Premiums Income Year Years Costs Expenses premiums ------- ----------- ---------- -------- -------- ---------- -------- -------- ------------ ---------- -------- Year Ended December 31, 1998 Continuing operations $107,607 $1,209,003 $401,002 $546,908 $60,852 $380,592 $(21,025) $160,380 $326,477 $646,197 Aviation business in run-off -- 65,752 -- 304 -- -- (1,284) -- 5,100 304 Year Ended December 31, 1997 Continuing operations 76,380 1,157,724 274,934 419,069 57,999 292,876 (10,396) 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
77 ITEM 14--EXHIBITS (c) Exhibits
Exhibit Number ------- 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 Statementon 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).
78
Exhibit Number ------- 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). 10.16 Employment Agreement, dated July 1, 1998, between the Company and John J. Dwyer. 10.17 Employment Agreement, dated July 1, 1998, between the Company and Nigel H.J. Rogers. 10.18 Employment Agreement, dated July 1, 1998, between the Company and Jean M. Waggett. 10.19 Letter Agreement, dated November 26, 1998, between the Company and John Riddick. 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).
79 SIGNATURES Under the requirements of the Securities Exchange Act of 1934, the registrant has had this report signed on its behalf by the undersigned who are so authorized. Terra Nova (Bermuda) Holdings Ltd.
Signature Title Date --------- ----- ---- /s/ John J. Dwyer Chairman March 15, 1999 ____________________________________ John J. Dwyer /s/ Nigel H.J. Rogers President and Chief March 15, 1999 ____________________________________ Executive Officer Nigel H.J. Rogers /s/ William J. Wedlake Senior Vice President and March 15, 1999 ____________________________________ Chief Financial Officer William J. Wedlake /s/ Hugh P. Lowenstein Director March 15, 1999 ____________________________________ Hugh P. Lowenstein /s/ Mark J. Byrne Director March 15, 1999 ____________________________________ Mark J. Byrne
80 EX-10.16 2 EMPLOYMENT AGREEMENT BETW. THE CO. AND JOHN DWYER EXHIBIT 10.16 EMPLOYMENT AGREEMENT -------------------- THIS AGREEMENT between TERRA NOVA (BERMUDA) HOLDINGS LTD., a Bermuda corporation (the "Company"), and JOHN J. DWYER ("Executive"), dated as of July 31, 1998. W I T N E S S E T H: -------------------- WHEREAS, the Company has employed Executive in several key executive officer positions, including currently as Chairman. WHEREAS, the Company further believes that, in the event it is confronted with a situation that could result in a change in ownership or control of the Company, continuity of management will be essential to its ability to evaluate and respond to such situation in the best interest of shareholders; WHEREAS, the Company deems it desirable and in its best interests to make provision for the availability to the Company of Executive's services on the terms set forth herein; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is hereby agreed by and between the company and Executive as follows: 1. AGREEMENT TO EMPLOY. Except as otherwise expressly provided herein, the ------------------- Company agrees to employ Executive for an initial period commencing on the date hereof (the "Commencement Date") and ending on the later of the third anniversary thereof, and December 31, 2002 ("Anniversary Date"). Upon that Anniversary Date and each anniversary thereof, the term of this Agreement will be extended for one (1) additional year without any action by the Company or Executive, unless either the Company or Executive delivers written notice (the "Notice") to the other party, at least 90 days prior to such Anniversary Date stating that it or he does not want the term of this Agreement further extended; provided that, except as provided in the next following sentence, if a Change of - -------------- Control (as defined below) occurs during the term of this Agreement, this Agreement shall in all events continue in effect until the third anniversary of the date upon which such Change of Control occurs (the "Change of Control Date"). The period during which Executive is employed pursuant to this Agreement, including any extension thereof in accordance with the preceding sentence, shall be referred to as the "Employment Period." 2. DUTIES AND RESPONSIBILITIES. Executive shall be employed as the Company's --------------------------- Chairman, and shall serve in such other executive capacity or capacities with the Company or its subsidiaries as its Board of Directors (the "Board") may determine from time to time and at any time prior to a Change of Control Date. During the Employment Period, Executive shall have the duties, responsibilities and obligations customarily assigned to individuals serving in the position or positions in which Executive serves hereunder and such other duties, responsibilities and obligations as the Board shall from time to time specify. During the Employment Period, Executive shall be renominated for election as a member of the Board of Directors, and the Company shall use its reasonable commercial best efforts to cause Executive to be elected and re-elected to the Board. During the Employment Period, Executive shall devote his full time to the services required of him hereunder, except for vacation time and reasonable periods of absence due to sickness, personal injury or other disability, and shall use his best efforts, judgement, skill and energy to perform such services in a manner consonant with the duties of his position and to improve and advance the business and interests of the Company and its subsidiaries. Nothing contained herein shall preclude Executive from (i) serving on the board of directors of any business corporation with the consent of the Board, (ii) serving on the board of, or working for, any charitable or community organization or (iii) pursuing his personal financial and legal affairs, so long as such activities, individually or collectively, do not interfere with the performance of Executive's duties hereunder. Executive shall at all times perform his services for the Company at its headquarters in Hamilton, Bermuda, except for reasonable periods of travel as are required in the performance of his duties hereunder and consistent with past practices. 2 3. ANNUAL COMPENSATION ------------------- (a) BASE SALARY. During the Employment Period, the Company shall pay ------------ Executive a base salary at the annual rate in effect on the date hereof. The annual base salary payable under this paragraph shall be reduced, however, to the extent Executive elects to defer such salary under the terms of any deferred compensation or savings plan or arrangement maintained or established by the Company. The Board shall annually review Executive's base salary in light of the base salaries paid to other executive officers of the Company and the performance of Executive and the Company may, in its discretion, increase such base salary by an amount it determines to be appropriate. Once increased, such base salary shall not thereafter be decreased. Any such increase shall not reduce or limit any other obligation of the Company hereunder. Executive's annual base salary payable hereunder, as it may be increased from time to time and without reduction for any amounts deferred as described above is referred to herein as "Base Salary". The Company shall pay Executive the portion of his Base Salary not deferred in accordance with the Company's generally applicable practices in respect of senior officers. (b) INCENTIVE COMPENSATION. During the term of the Employment Period, ----------------------- Executive shall participate in the Company's existing and future annual and long term incentive compensation programs at a level commensurate with his position at the Company and consistent with the Company's then current policies and practices. 4. BENEFITS, PERQUISITES AND EXPENSES ---------------------------------- (a) BENEFITS. During the Employment Period, Executive shall be eligible -------- to participate in (i) each welfare benefit plan sponsored or maintained by the Company, including, without limitation, each group life, hospitalization, medical, dental, health, accident or disability insurance or similar plan or program of the Company, and (ii) each pension, profit sharing, retirement, deferred compensation or savings plan sponsored or maintained by the Company, in each case, whether now existing or established hereafter, to the extent that Executive is eligible to participate in any such plan under the generally applicable provisions thereof. Without limiting the generality of the foregoing, the Company reserves the right to amend or terminate any such pan in its discretion. 3 (b) PERQUISITES. During the Employment Period, Executive shall be ----------- entitled to up to five weeks' paid vacation annually and all of the other current perquisites set forth on Schedule A and shall also be entitled to receive such perquisites as are generally provided to other senior officers of the Company in accordance with the then current policies and practices of the Company. (c) BUSINESS EXPENSES. During the Employment Period, the Company shall ----------------- pay or reimburse Executive for all reasonable expenses incurred or paid by Executive in the performance of Executive's duties hereunder, upon presentation of expense statements or vouchers and such other information as the Company may require and in accordance with the generally applicable policies and procedures of the Company. (d) INDEMNIFICATION. The Company shall indemnify Executive and hold --------------- Executive harmless from and against any claim, loss or cause of action arising from or out of Executive's performance as an officer, director or employee of the Company or any of its subsidiaries or in any other capacity, including any fiduciary capacity, in which Executive serves at the request of the Company to the maximum extent permitted by applicable law. If any claim is asserted hereunder with respect to which Executive reasonably believes in good faith he is entitled to indemnification, the Company shall pay Executive's legal expenses (or cause such expenses to be paid) on a quarterly basis, provided that Executive shall reimburse the Company for such amounts, plus simple interest thereon at the 90-day United States Treasury Bill rate as in effect from time to time, compounded annually, if Executive shall be found by a court of competent jurisdiction not to have been entitled to indemnification. 5. DEFINITIONS ----------- (a) CHANGE OF CONTROL. For the purposes of this Agreement, a "Change of ----------------- Control" shall mean (i) a merger or consolidation to which the Company is a party and for which the approval of any shareholders of the Company is required; (ii) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) becoming the beneficial owner, directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's 4 then outstanding securities or (iii) a sale or transfer of substantially all of the assets of the Company. (b) POTENTIAL CHANGE OF CONTROL. For the purposes of this Agreement, a --------------------------- Potential Change of Control shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) commences a tender offer for securities, which if consummated, would result in such person owing 20% or more of the combined voting power of the company's then outstanding securities; (ii) the Company enters into an agreement the consummation of which would constitute a Change of Control: (iii) proxies for the election of directors of the Company are solicited by anyone other than the Company; or (iv) any other event occurs which is deemed to be a Potential Change of Control by the Board. 6. TERMINATION ----------- (a) DEATH, DISABILITY OR RETIREMENT. This Agreement shall terminate ------------------------------- automatically upon Executive's death, termination due to "Disability" (as defined below) or voluntary retirement under any of the Company's retirement plans as in effect from time to time. For purposes of this Agreement, Disability shall mean Executive's inability to perform the duties of his position, as determined in accordance with the policies and procedures applicable with respect to the Company's long-term disability plan, as in effect from time to time, except that, following a Change of Control disability shall be determined based on the policies and procedures in effect immediately prior to the Change of Control Date. (b) VOLUNTARY TERMINATION. Notwithstanding anything in this Agreement to --------------------- the contrary, following a Change of Control Executive may, upon not less than 60 days' written notice to the Company, voluntarily terminate his employment for any reason (including early retirement under the terms of any of the Company's retirement plans as 5 in effect from time to time), PROVIDED THAT any termination by Executive ------------- pursuant to Section 6(d) on account of Good Reason (as defined therein) shall not be treated as a voluntary termination under this Section 6(b). (c) CAUSE. The Company may terminate Executive's employment for Cause. ----- For purposes of this Agreement, "Cause" means (i) Executive's conviction or plea of nolo contendere to a felony; --------------- (ii) an act or acts of dishonesty or gross misconduct on Executive's part which result or are intended to result in material damage to the Company's business or reputation; or (iii) repeated material violations by Executive of his obligations under Section 2 of this Agreement, PROVIDED THAT, following a ------------- Change of Control Date, Cause shall not exist due to such violations of Executive's obligations unless such violations are demonstrably wilful and deliberate on Executive's part and result in material damage to the Company's business or reputation. (d) GOOD REASON. Executive may terminate his employment for Good Reason. ----------- For purposes of this Agreement, "Good Reason" means the occurrence of any of the following, without the express written consent of Executive, except that subclauses (iv) and (v) below shall only apply after the occurrence of a Change of Control: (i) a) the assignment to Executive of any duties inconsistent in any material adverse respect with Executive's position, authority or responsibilities as contemplated by Section 2 of this Agreement, or b) any other material adverse change in such position, including titles, authority or responsibilities. (ii) any failure by the Company to comply with any of the provisions of Section 3 of this Agreement, other than an insubstantial or inadvertent failure remedied by the Company promptly after receipt of notice thereof given by Executive; 6 (iii) the Company's requiring Executive to be based at any office or location more than 35 miles from that location specified under the provisions of Section 2; (iv) the failure by the Company to permit Executive to participate in all long-term incentive compensation programs for key executives at a level that is commensurate with Executive's participation in such plans immediately prior to the Change of Control Date (or, if more favorable to Executive, at the level made available to Executive or other similarly situated officers at any time thereafter); or (v) the failure by the Company to permit Executive (and, to the extent applicable, his dependents) to participate in or be covered under all pension, retirement, deferred compensation, savings, medical, dental, health, disability, group life, accidental death and travel accident insurance plans and programs of the Company and its affiliated companies at a level that is commensurate with Executive's participation in such plans immediately prior to the Change of Control Date (or, if more favorable to Executive, at the level made available to Executive or other similarly situated officers at any time thereafter); or (vi) any failure by the Company to obtain the assumption and agreement to perform this Agreement by a successor as contemplated by Section 11(b). In no event shall the mere occurrence of a Change of Control, absent any further impact on Executive, be deemed to constitute Good Reason. (e) NOTICE OF TERMINATION. Any termination by the Company for Cause or by --------------------- Executive for Good Reason shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 12(d). For purposes of this Agreement, a "Notice of Termination" means a written notice given, in the case of a termination for Cause, within 10 business days of the Company's having actual knowledge of the events giving rise to such termination, and in the case of a termination 7 for Good Reason, within 180 days of Executive's having actual knowledge of the events giving rise to such termination, and which (i) indicates the specific termination provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated, and (iii) if the termination date is other than the date of receipt of such notice, specifies the termination date of this Agreement (which date shall be not more than 15 days after the giving of such notice). The failure by Executive to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason shall not waive any right of Executive hereunder or preclude Executive from asserting such fact or circumstance in enforcing his rights hereunder. (f) DATE OF TERMINATION. For the purpose of this Agreement, the term ------------------- "Date of Termination" means (i) in the case of a termination for which a Notice of Termination is required, the date of receipt of such Notice of Termination or, if later, the date specified therein, as the case may be, and (ii) in all other cases, the actual date on which Executive's employment terminates during the Employment Period. 7. OBLIGATION OF THE COMPANY UPON TERMINATION ------------------------------------------ (a) DEATH OR DISABILITY. If Executive's employment is terminated during ------------------- the term hereof by reason of Executive's death or Disability, this Agreement shall terminate without further obligations accrued hereunder to the Date of Termination, and the Company shall pay to Executive (or his beneficiary or estate) (i) Executive's full Base Salary through the Date of Termination (the "Earned Salary"), (ii) any vested amounts or benefits owing to Executive under the Company's otherwise applicable employee benefit plans and programs, including any compensation previously deferred by Executive (together with any accrued earnings thereon) and not yet paid by the Company and any accrued vacation pay not yet paid by the company (the "Accrued Obligations"), and (iii) any other benefits payable due to Executive's death or Disability under the Company's plans, policies or programs (the "Additional Benefits"). 8 Any Earned Salary shall be paid in cash in a single lump sum, as soon as practicable but in no event more than 10 business days (or at such earlier date required by law) following the Date of Termination, or as otherwise directed by Executive or his estate. Accrued Obligations and Additional Benefits shall be paid in accordance with the terms of the applicable plan, program or arrangement. (b) CAUSE AND VOLUNTARY TERMINATION. If, during the Employment Period, ------------------------------- Executive's employment shall be terminated for cause or voluntarily terminated by Executive in accordance with Section 6(b) other than during the 90 day period described in Section 7(c)(i) below, the Company shall pay Executive (i) the Earned Salary in cash in a single lump sum, or otherwise directed by Executive, as soon as practicable, but in no event more than 10 days following the Date of Termination, and (ii) the Accrued Obligations in accordance with the terms of the applicable plan, program or arrangement. (c) TERMINATION BY THE COMPANY WITHOUT CAUSE. ---------------------------------------- (i) LUMP SUM PAYMENTS. If (x) the Company terminates Executive's ----------------- employment other than for Cause, (y) Executive terminates his employment at any time for Good Reason or (z) Executive voluntarily terminates his employment without Good Reason during the one year period beginning on the Change of Control Date, then the Company shall pay to Executive the following amounts: a) Executive's Earned Salary; b) a cash amount, without offset for other amounts payable in conjunction with a Change of Control, (the "Severance Amount") equal to three times the sum of 1) Executive's annual Base Salary; and 2) the greater of (x) the highest bonus amount paid to or deferred by Executive in respect of any of the last three fiscal years of the Company ending immediately prior to the Change of Control Date or (y) the amount that would have been payable to 9 Executive as a target bonus for the year in which the Change of Control occurs; and c) the Accrued Obligations. The Earned Salary and Severance Amount shall be paid in cash, or as otherwise reasonably directed by the Executive, based on a calculation of 36 equal installments, the first such installment to be paid as soon as practicable but in no event more than 10 business days following the Date of Termination (or at such earlier date as may be required by law), each of the subsequent 22 installments to be paid on the same date of each calendar month following the first payment and the final 13 installments to be paid as a lump sum on the same date of the calendar month following the 23rd payment; provided that any unpaid installments ------------- shall be immediately paid as a lump sum in the event of the death or disability of the Executive or a second Change of Control of the Company or its successor which occurs following an initial Change of Control. Accrued Obligations shall be paid in accordance with the terms of the applicable plan, program or arrangement. (ii) CONTINUATION OF BENEFITS. If Executive is entitled to receive ------------------------ the Severance Amount, Executive (and, to the extent applicable, his dependents) shall be entitled, after the Date of Termination until the earlier of (1) the third anniversary of the Date of Termination (the "End Date") or (2) the date Executive becomes eligible for comparable benefits under a similar plan, policy or program of a subsequent employer, to continue participation in all of the Company's Executive and executive welfare and fringe benefit plans (the "Benefit Plans") and to receive such perquisites as were generally provided to Executive in accordance with the Company's policies and practices immediately prior to the Change of Control Date. To the extent any such benefits or perquisites cannot be 10 proved under the terms of the applicable plan, policy or program, the Company shall provide a comparable benefit under another plan or from the Company's general assets. Executive's participation in the Benefit plans and eligibility for perquisites will be on the same terms and conditions that would have applied had Executive continued to be employed by the Company through the End Date. (d) DISCHARGE OF THE COMPANY'S OBLIGATIONS. Except as expressly provided -------------------------------------- in the last sentence of this Section 7(d), the amounts payable to Executive pursuant to this Section 7 following termination of his employment shall be in full and complete satisfaction of Executive's rights under this Agreement and any other claims he may have in respect of his employment by the Company or any of its subsidiaries. Such amounts shall constitute liquidated damages with respect to any and all such rights and claims and, upon Executive's receipt of such amounts, the Company shall be released and discharged from any and all liability to Executive in connection with this Agreement or otherwise in connection with Executive's employment with the Company and its subsidiaries. Nothing in this Section 7(d) shall be construed to release the Company from its commitment to indemnify Executive and hold Executive harmless from and against any claim, loss or cause of action arising from or out of Executive's performance as an officer, director or Executive of the Company or any of its subsidiaries or in any other capacity, including any fiduciary capacity, in which Executive served at the request of the Company to the maximum extent permitted by applicable law. (e) CERTAIN FURTHER PAYMENTS BY THE COMPANY. --------------------------------------- (i) In the event that any amount or benefit paid or distributed to Executive pursuant to this Agreement, taken together with any amounts or benefits otherwise paid or distributed to Executive by the Company or any affiliated company (collectively, the "Covered Payments"), are or become subject to the tax (the "Excise Tax") imposed under Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code)), or any similar tax that the Company shall 11 pay to Executive at the time specified in Section 7(e)(v) below an additional amount (the "Tax Reimbursement Payment") such that the net amount retained by Executive with respect to such Covered Payments, after deduction of any Excise Tax on the Covered Payments and any Federal, state and local income or employment tax and Excise Tax on the Tax Reimbursement Payment provided for by this Section 7(e), but before deduction for any Federal, state or local income or employment tax withholding on such Covered Payments, shall be equal to the amount of the Covered Payments. (ii) For purposes of determining whether any of the Covered Payments will be subject to the Excise Tax and the amount of such Excise Tax: a) such Covered Payments will be treated as "parachute payments" within the meaning of Section 280G of the Code, and all "parachute payments" in excess of the "base amount" (as defined under Section 280G(b)(3) of the Code) shall be treated as subject to the Excise Tax, unless, and except to the extent that, in the good faith judgment of the Company's independent certified public accountants appointed prior to the Change of Control Date or tax counsel selected by such accountants (the "Accountants"), the Company has a reasonable basis to conclude that such Covered Payments (in whole or in part) either do not constitute "parachute payments" or represent reasonable compensation for personal services actually rendered (within the meaning of Section 280G(b)(4)(B) of the code) in excess of the "base amount," or such "parachute payments" are otherwise not subject to such Excise Tax, and 12 b) the value of any non-cash benefits or any deferred payment accordance with the principles of Section 280G of the Code. (iii) For purposes of determining the amount of the Tax Reimbursement Payment, Executive shall be deemed to pay: a) Federal income taxed at the highest applicable marginal rate of Federal income taxation for the calendar year in which the Tax Reimbursement Payment is to be made, and b) any applicable state and local income taxes at the highest applicable marginal rate of taxation for the calendar year in which the Tax Reimbursement Payment is to be made, net of the maximum reduction in Federal income taxes which could be obtained from the deduction of such state or local taxes if paid in such year. (iv) In the event that the Excise Tax is subsequently determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to be less than the amount taken into account hereunder in calculating the Tax Reimbursement Payment made, Executive shall repay to the Company, at the time that the amount of such reduction in the Excise Tax is finally determined, the portion of such prior Tax Reimbursement Payment that would not have been paid if such Excise Tax had been applied in initially calculating such Tax Reimbursement Payment, plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code. Notwithstanding the foregoing, in the event any portion of the Tax Reimbursement Payment to be refunded to the Company has been paid to any Federal, state or local tax authority, repayment thereof shall not be required until actual refund or credit of such portion has been made to Executive, and interest payable to the Company shall not exceed interest 13 received or credited to Executive by such tax authority for the period it held such portion. Executive and the Company shall mutually agree upon the course of action to be pursued (and the method of allocating the expenses thereof) if Executive's good faith claim for refund or credit is denied. In the event that the Excise Tax is later determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to exceed the amount taken into account hereunder at the time the Tax Reimbursement Payment is made (including, but not limited to, by reason of any payment the existence or amount of which cannot be determined at the time of the Tax Reimbursement Payment), the Company shall make an additional Tax Reimbursement Payment in respect of such excess (plus any interest or penalty payable with respect to such excess) at the time that the amount of such excess is finally determined. (v) The Tax Reimbursement Payment (or portion thereof) provided for in Section 7(e)(i) above shall be paid to Executive not later than 10 business days following the payment of the Covered Payments' provided, however, that if the amount of such Tax Reimbursement Payment (or portion thereof) cannot be finally determined on or before the date on which payment is due, the Company shall pay to Executive by such date an amount estimated in good faith by the Accountants to be the minimum amount of such Tax Reimbursement Payment and shall pay the remainder of such Tax Reimbursement Payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined, but in no event later than 45 calendar days after payment of the related Covered Payment. In the event that the amount of the estimated Tax Reimbursement payment exceeds the amount subsequently determined to have 14 been due, such excess shall constitute a loan by the Company to Executive, payable on the fifth business day after written demand by the Company for payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code). 8. NON-EXCLUSIVE OF RIGHTS. Except as expressly provided herein, nothing in ----------------------- this Agreement shall prevent or limit Executive's continuing or future participation in any benefit, bonus, incentive or other plan or program provided by the Company or any of its affiliated companies and for which Executive may qualify, nor shall anything herein limit or otherwise prejudice such rights as Executive may have under any other agreement with the Company or any of its affiliated companies, including employment agreements or stock option agreements. Amounts which are vested benefits or which Executive is otherwise entitled to receive under any plan or program of the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan or program. 9. FULL SETTLEMENT. Following a Change of Control, the Company's obligation --------------- to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any circumstances, including without limitation, any set-off, counterclaim, recoupment, defense or other right which the Company may have against Executive or others whether by reason of the subsequent employment of Executive or otherwise. 10. NON-COMPETITION AND CONFIDENTIALITY ----------------------------------- (a) NON-COMPETITION. During the Employment Period and during the two year --------------- period (the "Restriction Period") following any termination of Executive's employment other than a Termination by the Company without Cause, Executive shall not become associated with any entity, whether as a principal, partner, employee, consultant or shareholder (other than as a holder of not in excess of 1% of the outstanding voting shares of any publicly traded company), that is actively engaged in any geographic 15 area in any business which is in competition with the business of the Company without the prior written consent of the Company. (b) CONFIDENTIALITY. Without the prior written consent of the Company, --------------- except to the extent required by an order of a court having competent jurisdiction or under subpoena from an appropriate government agency, Executive shall not disclose any trade secrets, customer lists, drawings, designs, information regarding product development, marketing plans, sales plans, manufacturing plans, management organization information (including data and other information relating to members of the Board of Directors and management), operating policies or manuals, business plans, financial records, packaging design or other financial, commercial, business or technical information relating to the Company or any of its subsidiaries or information designated as confidential or proprietary that the Company or any of its subsidiaries may receive belonging to suppliers, customers or others who do business with the Company or any of its subsidiaries (collectively, "Confidential Information") to any third person unless such Confidential Information has been previously disclosed to the public by the Company or is in the public domain (other than by reason of Executive's breach of this Section 9(b)). (c) COMPANY PROPERTY. Promptly following Executive's termination of ---------------- employment, Executive shall return to the Company all property of the Company, and all copies thereof in Executive's possession or under his control. (d) NON-SOLICITATION OF EMPLOYEES. During the Employment period and the ----------------------------- Restriction Period, Executive shall not directly or indirectly induce any employee of the Company or any of its subsidiaries to terminate employment with such entity, and shall not directly or indirectly, either individually or as owner, agent, employee, consultant or otherwise, employ or offer employment to any person who is or was employed by the Company or a subsidiary thereof unless such person shall have ceased to be employed by such entity for a period of at least 6 months. (e) INJUNCTIVE RELIEF WITH RESPECT TO COVENANTS. Executive acknowledges ------------------------------------------- and agrees that the covenants and obligations of Executive with respect to noncompetition, nonsolicitation, confidentiality and Company property relate to special, unique and extraordinary matters and that a violation of any of the terms of such 16 convenants and obligations will cause the Company irreparable injury for which adequate remedies are not available at law. Therefore, Executive agrees that the Company shall be entitled to an injunction, restraining order or such other equitable relief (without the requirement to post bond) restraining Executive from committing any violation of the convenants and obligations contained in this Section 10. These injunctive remedies are cumulative and are in addition to any other rights and remedies the Company may have at law or in equity. In connection with the foregoing provisions of this Section 10, Executive represents that his economic means and circumstances are such that such provisions will not prevent him from providing for himself and his family on a basis satisfactory to him. 11. LEGAL FEES AND EXPENSES. If Executive asserts any claim in any content ----------------------- (whether initiated by Executive or by the Company) as to the validity, enforceability or interpretation of any provision of this Agreement, the Company shall pay Executive's legal expenses (or cause such expenses to be paid) including, without limitation, his reasonable attorney's fees, on a quarterly basis, upon presentation of proof of such expenses, PROVIDED THAT Executive ------------- shall reimburse the Company for such amounts, plus simple interest thereon at the 90-day United States Treasury Bill rate as in effect form time to time, compounded annually, if Executive shall not prevail in whole or in part, as to any material issue as to the validity, enforceability or interpretation of any provision of this Agreement. 12. SUCCESSORS ---------- (a) This Agreement is personal to Executive and without the prior written consent of the Company, shall not be assignable by Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by Executive's legal representatives. (b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors. The Company shall require any successor to all or substantially all of the business and/or assets of the Company, whether direct or indirect, 17 by purchase, merger, consolidation, acquisition of stock, or otherwise, by an agreement in form and substance satisfactory to Executive, expressly to assume and agree to perform this Agreement in the same manner and to the same extent as the Company would be required to perform if no such succession had taken place. 13. MISCELLANEOUS ------------- (a) APPLICABLE LAW. This Agreement shall be governed by and construed in -------------- accordance with the laws of Bermuda, applied with reference to principles of conflict of laws. (b) EXPENSES. During the term hereof, Executive shall be entitled to -------- receive prompt reimbursement for all reasonable expenses incurred by Executive in accordance with its usual policies and procedures as in effect from time to time. Notwithstanding the foregoing, after the Change of Control Date, such policies and procedures shall be no less favorable to Executive than those in effect immediately prior to the Change of Control Date. (c) ENTIRE AGREEMENT. This Agreement constitutes the entire agreement ---------------- between the parties hereto with respect to the matters referred to herein. No other agreement relating to the terms of Executive's employment by the Company, oral or otherwise, shall be binding between the parties unless it is in writing and signed by the party against whom enforcement is sought. There are no promises, representations, inducements or statements between the parties other than those that are expressly contained herein. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. In the event any provision of this Agreement is invalid or unenforceable, the validity and enforceability of the remaining provisions hereof shall not be affected. Executive acknowledges that he is entering into this Agreement of his own free will and accord, and with no duress, that he has read this Agreement and that he understands it and its legal consequences. 18 (d) NOTICES. All notices and other communications hereunder shall be in ------- writing and shall be given by hand-delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to Executive: Home address of Executive noted on the records of the Company. If to the Company: Terra Nova (Bermuda) Holdings Ltd. Richmond House, 2/nd/ Floor 12 Par-La-Ville Road Hamilton HM 08 Bermuda Attention: Corporate Secretary ------------------------------- Or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. IN WITNESS WHEREOF, Executive has hereunto set his hand and the Company has caused this Agreement to be executed in its name on its behalf, and its corporate seal to be hereunto affixed and attested by its Secretary, all as of the day and year first above written. TERRA NOVA (BERMUDA) HOLDINGS LTD. /s/ David Jaffe ------------------------ By: David Jaffe --------------------- Title: Director WITNESSED: /s/ Ellen E. Hines - ------------------- JOHN J. DWYER /s/ John J. Dwyer ------------------------ WITNESSED: /s/ N. Rogers - ------------------- 19 EX-10.17 3 EMPLOYMENT AGREEMENT BETW. THE CO. AND N. ROGERS EXHIBIT 10.17 EMPLOYMENT AGREEMENT -------------------- THIS AGREEMENT between TERRA NOVA (BERMUDA) HOLDINGS LTD., a Bermuda corporation (the "Company"), and NIGEL H.J. ROGERS ("Executive"), dated as of July 31, 1998. W I T N E S S E T H: -------------------- WHEREAS, the Company has employed Executive in several key executive officer positions, including currently as President and Chief Executive Officer. WHEREAS, the Company further believes that, in the event it is confronted with a situation that could result in a change in ownership or control of the Company, continuity of management will be essential to its ability to evaluate and respond to such situation in the best interest of shareholders; WHEREAS, the Company deems it desirable and in its best interests to make provision for the availability to the Company of Executive's services on the terms set forth herein; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is hereby agreed by and between the company and Executive as follows: 1. AGREEMENT TO EMPLOY. Except as otherwise expressly provided herein, the ------------------- Company agrees to employ Executive for an initial period commencing on the date hereof (the "Commencement Date") and ending on the later of the third anniversary thereof, and December 31, 2002 ("Anniversary Date"). Upon that Anniversary Date and each anniversary thereof, the term of this Agreement will be extended for one (1) additional year without any action by the Company or Executive, unless either the Company or Executive delivers written notice (the "Notice") to the other party, at least 90 days prior to such Anniversary Date stating that it or he does not want the term of this Agreement further extended; provided that, except as provided in the next following sentence, if a Change of - -------------- Control (as defined below) occurs during the term of this Agreement, this Agreement shall in all events continue in effect until the third anniversary of the date upon which such Change of Control occurs (the "Change of Control Date"). The period during which Executive is employed pursuant to this Agreement, including any extension thereof in accordance with the preceding sentence, shall be referred to as the "Employment Period." 2. DUTIES AND RESPONSIBILITIES. Executive shall be employed as the Company's --------------------------- President and Chief Executive Officer, and shall serve in such other executive capacity or capacities with the Company or its subsidiaries as its Board of Directors (the "Board") may determine from time to time and at any time prior to a Change of Control Date. During the Employment Period, Executive shall have the duties, responsibilities and obligations customarily assigned to individuals serving in the position or positions in which Executive serves hereunder and such other duties, responsibilities and obligations as the Board shall from time to time specify. During the Employment Period, Executive shall be renominated for election as a member of the Board of Directors, and the Company shall use its reasonable commercial best efforts to cause Executive to be elected and re- elected to the Board. During the Employment Period, Executive shall devote his full time to the services required of him hereunder, except for vacation time and reasonable periods of absence due to sickness, personal injury or other disability, and shall use his best efforts, judgement, skill and energy to perform such services in a manner consonant with the duties of his position and to improve and advance the business and interests of the Company and its subsidiaries. Nothing contained herein shall preclude Executive from (i) serving on the board of directors of any business corporation with the consent of the Board, (ii) serving on the board of, or working for, any charitable or community organization or (iii) pursuing his personal financial and legal affairs, so long as such activities, individually or collectively, do not interfere with the performance of Executive's duties hereunder. Executive shall at all times perform his services for the Company at its offices in London, except for reasonable periods of travel as are required in the performance of his duties hereunder and consistent with past practices. 2 3. ANNUAL COMPENSATION ------------------- (a) BASE SALARY. During the Employment Period, the Company shall pay ------------ Executive a base salary at the annual rate in effect on the date hereof. The annual base salary payable under this paragraph shall be reduced, however, to the extent Executive elects to defer such salary under the terms of any deferred compensation or savings plan or arrangement maintained or established by the Company. The Board shall annually review Executive's base salary in light of the base salaries paid to other executive officers of the Company and the performance of Executive and the Company may, in its discretion, increase such base salary by an amount it determines to be appropriate. Once increased, such base salary shall not thereafter be decreased. Any such increase shall not reduce or limit any other obligation of the Company hereunder. Executive's annual base salary payable hereunder, as it may be increased from time to time and without reduction for any amounts deferred as described above is referred to herein as "Base Salary". The Company shall pay Executive the portion of his Base Salary not deferred in accordance with the Company's generally applicable practices in respect of senior officers. (b) INCENTIVE COMPENSATION. During the term of the Employment Period, ----------------------- Executive shall participate in the Company's existing and future annual and long term incentive compensation programs at a level commensurate with his position at the Company and consistent with the Company's then current policies and practices. 4. BENEFITS, PERQUISITES AND EXPENSES ---------------------------------- (a) BENEFITS. During the Employment Period, Executive shall be eligible to -------- participate in (i) each welfare benefit plan sponsored or maintained by the Company, including, without limitation, each group life, hospitalization, medical, dental, health, accident or disability insurance or similar plan or program of the Company, and (ii) each pension, profit sharing, retirement, deferred compensation or savings plan sponsored or maintained by the Company, in each case, whether now existing or established hereafter, to the extent that Executive is eligible to participate in any such plan under the generally applicable provisions thereof. Without limiting the generality of the foregoing, the Company reserves the right to amend or terminate any such pan in its discretion. 3 (b) PERQUISITES. During the Employment Period, Executive shall be entitled ----------- to up to five weeks' paid vacation annually and all of the other current perquisites set forth on Schedule A and shall also be entitled to receive such perquisites as are generally provided to other senior officers of the Company in accordance with the then current policies and practices of the Company. (c) BUSINESS EXPENSES. During the Employment Period, the Company shall pay ----------------- or reimburse Executive for all reasonable expenses incurred or paid by Executive in the performance of Executive's duties hereunder, upon presentation of expense statements or vouchers and such other information as the Company may require and in accordance with the generally applicable policies and procedures of the Company. (d) INDEMNIFICATION. The Company shall indemnify Executive and hold --------------- Executive harmless from and against any claim, loss or cause of action arising from or out of Executive's performance as an officer, director or employee of the Company or any of its subsidiaries or in any other capacity, including any fiduciary capacity, in which Executive serves at the request of the Company to the maximum extent permitted by applicable law. If any claim is asserted hereunder with respect to which Executive reasonably believes in good faith he is entitled to indemnification, the Company shall pay Executive's legal expenses (or cause such expenses to be paid) on a quarterly basis, provided that Executive shall reimburse the Company for such amounts, plus simple interest thereon at the 90-day United States Treasury Bill rate as in effect from time to time, compounded annually, if Executive shall be found by a court of competent jurisdiction not to have been entitled to indemnification. 5. DEFINITIONS ----------- (a) CHANGE OF CONTROL. For the purposes of this Agreement, a "Change of ----------------- Control" shall mean (i) a merger or consolidation to which the Company is a party and for which the approval of any shareholders of the Company is required; (ii) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) becoming the beneficial owner, directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's 4 then outstanding securities or (iii) a sale or transfer of substantially all of the assets of the Company. (b) POTENTIAL CHANGE OF CONTROL. For the purposes of this Agreement, a --------------------------- Potential Change of Control shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) commences a tender offer for securities, which if consummated, would result in such person owing 20% or more of the combined voting power of the company's then outstanding securities; (ii) the Company enters into an agreement the consummation of which would constitute a Change of Control: (iii) proxies for the election of directors of the Company are solicited by anyone other than the Company; or (iv) any other event occurs which is deemed to be a Potential Change of Control by the Board. 6. TERMINATION ----------- (a) DEATH, DISABILITY OR RETIREMENT. This Agreement shall terminate ------------------------------- automatically upon Executive's death, termination due to "Disability" (as defined below) or voluntary retirement under any of the Company's retirement plans as in effect from time to time. For purposes of this Agreement, Disability shall mean Executive's inability to perform the duties of his position, as determined in accordance with the policies and procedures applicable with respect to the Company's long-term disability plan, as in effect from time to time, except that, following a Change of Control disability shall be determined based on the policies and procedures in effect immediately prior to the Change of Control Date. (b) VOLUNTARY TERMINATION. Notwithstanding anything in this Agreement to --------------------- the contrary, following a Change of Control Executive may, upon not less than 60 days' written notice to the Company, voluntarily terminate his employment for any reason (including early retirement under the terms of any of the Company's retirement plans as 5 in effect from time to time), PROVIDED THAT any termination by Executive ------------- pursuant to Section 6(d) on account of Good Reason (as defined therein) shall not be treated as a voluntary termination under this Section 6(b). (c) CAUSE. The Company may terminate Executive's employment for Cause. ----- For purposes of this Agreement, "Cause" means (i) Executive's conviction or plea of nolo contendere to a felony; --------------- (ii) an act or acts of dishonesty or gross misconduct on Executive's part which result or are intended to result in material damage to the Company's business or reputation; or (iii) repeated material violations by Executive of his obligations under Section 2 of this Agreement, PROVIDED THAT, following a ------------- Change of Control Date, Cause shall not exist due to such violations of Executive's obligations unless such violations are demonstrably wilful and deliberate on Executive's part and result in material damage to the Company's business or reputation. (d) GOOD REASON. Executive may terminate his employment for Good Reason. ----------- For purposes of this Agreement, "Good Reason" means the occurrence of any of the following, without the express written consent of Executive, except that subclauses (iv) and (v) below shall only apply after the occurrence of a Change of Control: (i) a) the assignment to Executive of any duties inconsistent in any material adverse respect with Executive's position, authority or responsibilities as contemplated by Section 2 of this Agreement, or b) any other material adverse change in such position, including titles, authority or responsibilities. (ii) any failure by the Company to comply with any of the provisions of Section 3 of this Agreement, other than an insubstantial or inadvertent failure remedied by the Company promptly after receipt of notice thereof given by Executive; 6 (iii) the Company's requiring Executive to be based at any office or location more than 35 miles from that location specified under the provisions of Section 2; (iv) the failure by the Company to permit Executive to participate in all long-term incentive compensation programs for key executives at a level that is commensurate with Executive's participation in such plans immediately prior to the Change of Control Date (or, if more favorable to Executive, at the level made available to Executive or other similarly situated officers at any time thereafter); or (v) the failure by the Company to permit Executive (and, to the extent applicable, his dependents) to participate in or be covered under all pension, retirement, deferred compensation, savings, medical, dental, health, disability, group life, accidental death and travel accident insurance plans and programs of the Company and its affiliated companies at a level that is commensurate with Executive's participation in such plans immediately prior to the Change of Control Date (or, if more favorable to Executive, at the level made available to Executive or other similarly situated officers at any time thereafter); or (vi) any failure by the Company to obtain the assumption and agreement to perform this Agreement by a successor as contemplated by Section 11(b). In no event shall the mere occurrence of a Change of Control, absent any further impact on Executive, be deemed to constitute Good Reason. (e) NOTICE OF TERMINATION. Any termination by the Company for Cause or by --------------------- Executive for Good Reason shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 12(d). For purposes of this Agreement, a "Notice of Termination" means a written notice given, in the case of a termination for Cause, within 10 business days of the Company's having actual knowledge of the events giving rise to such termination, and in the case of a termination 7 for Good Reason, within 180 days of Executive's having actual knowledge of the events giving rise to such termination, and which (i) indicates the specific termination provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated, and (iii) if the termination date is other than the date of receipt of such notice, specifies the termination date of this Agreement (which date shall be not more than 15 days after the giving of such notice). The failure by Executive to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason shall not waive any right of Executive hereunder or preclude Executive from asserting such fact or circumstance in enforcing his rights hereunder. (f) DATE OF TERMINATION. For the purpose of this Agreement, the term "Date ------------------- of Termination" means (i) in the case of a termination for which a Notice of Termination is required, the date of receipt of such Notice of Termination or, if later, the date specified therein, as the case may be, and (ii) in all other cases, the actual date on which Executive's employment terminates during the Employment Period. 7. OBLIGATION OF THE COMPANY UPON TERMINATION ------------------------------------------ (a) DEATH OR DISABILITY. If Executive's employment is terminated during ------------------- the term hereof by reason of Executive's death or Disability, this Agreement shall terminate without further obligations accrued hereunder to the Date of Termination, and the Company shall pay to Executive (or his beneficiary or estate) (i) Executive's full Base Salary through the Date of Termination (the "Earned Salary"), (ii) any vested amounts or benefits owing to Executive under the Company's otherwise applicable employee benefit plans and programs, including any compensation previously deferred by Executive (together with any accrued earnings thereon) and not yet paid by the Company and any accrued vacation pay not yet paid by the company (the "Accrued Obligations"), and (iii) any other benefits payable due to Executive's death or Disability under the Company's plans, policies or programs (the "Additional Benefits"). 8 Any Earned Salary shall be paid in cash in a single lump sum, as soon as practicable but in no event more than 10 business days (or at such earlier date required by law) following the Date of Termination, or as otherwise directed by Executive or his estate. Accrued Obligations and Additional Benefits shall be paid in accordance with the terms of the applicable plan, program or arrangement. (b) CAUSE AND VOLUNTARY TERMINATION. If, during the Employment Period, ------------------------------- Executive's employment shall be terminated for cause or voluntarily terminated by Executive in accordance with Section 6(b) other than during the 90 day period described in Section 7(c)(i) below, the Company shall pay Executive (i) the Earned Salary in cash in a single lump sum, or otherwise directed by Executive, as soon as practicable, but in no event more than 10 days following the Date of Termination, and (ii) the Accrued Obligations in accordance with the terms of the applicable plan, program or arrangement. (c) TERMINATION BY THE COMPANY WITHOUT CAUSE. ---------------------------------------- (i) LUMP SUM PAYMENTS. If (x) the Company terminates Executive's ----------------- employment other than for Cause, (y) Executive terminates his employment at any time for Good Reason or (z) Executive voluntarily terminates his employment without Good Reason during the one year period beginning on the Change of Control Date, then the Company shall pay to Executive the following amounts: a) Executive's Earned Salary; b) a cash amount, without offset for other amounts payable in conjunction with a Change of Control, (the "Severance Amount") equal to three times the sum of 1) Executive's annual Base Salary; and 2) the greater of (x) the highest bonus amount paid to or deferred by Executive in respect of any of the last three fiscal years of the Company ending immediately prior to the Change of Control Date or (y) the amount that would have been payable to 9 Executive as a target bonus for the year in which the Change of Control occurs; and c) the Accrued Obligations. The Earned Salary and Severance Amount shall be paid in cash, or as otherwise reasonably directed by the Executive, based on a calculation of 36 equal installments, the first such installment to be paid as soon as practicable but in no event more than 10 business days following the Date of Termination (or at such earlier date as may be required by law), each of the subsequent 22 installments to be paid on the same date of each calendar month following the first payment and the final 13 installments to be paid as a lump sum on the same date of the calendar month following the 23rd payment; provided that any unpaid installments ------------- shall be immediately paid as a lump sum in the event of the death or disability of the Executive or a second Change of Control of the Company or its successor which occurs following an initial Change of Control. Accrued Obligations shall be paid in accordance with the terms of the applicable plan, program or arrangement. (ii) CONTINUATION OF BENEFITS. If Executive is entitled to receive ------------------------ the Severance Amount, Executive (and, to the extent applicable, his dependents) shall be entitled, after the Date of Termination until the earlier of (1) the third anniversary of the Date of Termination (the "End Date") or (2) the date Executive becomes eligible for comparable benefits under a similar plan, policy or program of a subsequent employer, to continue participation in all of the Company's Executive and executive welfare and fringe benefit plans (the "Benefit Plans") and to receive such perquisites as were generally provided to Executive in accordance with the Company's policies and practices immediately prior to the Change of Control Date. To the extent any such benefits or perquisites cannot be 10 proved under the terms of the applicable plan, policy or program, the Company shall provide a comparable benefit under another plan or from the Company's general assets. Executive's participation in the Benefit plans and eligibility for perquisites will be on the same terms and conditions that would have applied had Executive continued to be employed by the Company through the End Date. (d) DISCHARGE OF THE COMPANY'S OBLIGATIONS. Except as expressly provided -------------------------------------- in the last sentence of this Section 7(d), the amounts payable to Executive pursuant to this Section 7 following termination of his employment shall be in full and complete satisfaction of Executive's rights under this Agreement and any other claims he may have in respect of his employment by the Company or any of its subsidiaries. Such amounts shall constitute liquidated damages with respect to any and all such rights and claims and, upon Executive's receipt of such amounts, the Company shall be released and discharged from any and all liability to Executive in connection with this Agreement or otherwise in connection with Executive's employment with the Company and its subsidiaries. Nothing in this Section 7(d) shall be construed to release the Company from its commitment to indemnify Executive and hold Executive harmless from and against any claim, loss or cause of action arising from or out of Executive's performance as an officer, director or Executive of the Company or any of its subsidiaries or in any other capacity, including any fiduciary capacity, in which Executive served at the request of the Company to the maximum extent permitted by applicable law. (e) CERTAIN FURTHER PAYMENTS BY THE COMPANY. --------------------------------------- (i) In the event that any amount or benefit paid or distributed to Executive pursuant to this Agreement, taken together with any amounts or benefits otherwise paid or distributed to Executive by the Company or any affiliated company (collectively, the "Covered Payments"), are or become subject to the tax (the "Excise Tax") imposed under Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code)), or any similar tax that the Company shall 11 pay to Executive at the time specified in Section 7(e)(v) below an additional amount (the "Tax Reimbursement Payment") such that the net amount retained by Executive with respect to such Covered Payments, after deduction of any Excise Tax on the Covered Payments and any Federal, state and local income or employment tax and Excise Tax on the Tax Reimbursement Payment provided for by this Section 7(e), but before deduction for any Federal, state or local income or employment tax withholding on such Covered Payments, shall be equal to the amount of the Covered Payments. (ii) For purposes of determining whether any of the Covered Payments will be subject to the Excise Tax and the amount of such Excise Tax: a) such Covered Payments will be treated as "parachute payments" within the meaning of Section 280G of the Code, and all "parachute payments" in excess of the "base amount" (as defined under Section 280G(b)(3) of the Code) shall be treated as subject to the Excise Tax, unless, and except to the extent that, in the good faith judgment of the Company's independent certified public accountants appointed prior to the Change of Control Date or tax counsel selected by such accountants (the "Accountants"), the Company has a reasonable basis to conclude that such Covered Payments (in whole or in part) either do not constitute "parachute payments" or represent reasonable compensation for personal services actually rendered (within the meaning of Section 280G(b)(4)(B) of the code) in excess of the "base amount," or such "parachute payments" are otherwise not subject to such Excise Tax, and 12 b) the value of any non-cash benefits or any deferred payment accordance with the principles of Section 280G of the Code. (iii) For purposes of determining the amount of the Tax Reimbursement Payment, Executive shall be deemed to pay: a) Federal income taxed at the highest applicable marginal rate of Federal income taxation for the calendar year in which the Tax Reimbursement Payment is to be made, and b) any applicable state and local income taxes at the highest applicable marginal rate of taxation for the calendar year in which the Tax Reimbursement Payment is to be made, net of the maximum reduction in Federal income taxes which could be obtained from the deduction of such state or local taxes if paid in such year. (iv) In the event that the Excise Tax is subsequently determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to be less than the amount taken into account hereunder in calculating the Tax Reimbursement Payment made, Executive shall repay to the Company, at the time that the amount of such reduction in the Excise Tax is finally determined, the portion of such prior Tax Reimbursement Payment that would not have been paid if such Excise Tax had been applied in initially calculating such Tax Reimbursement Payment, plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code. Notwithstanding the foregoing, in the event any portion of the Tax Reimbursement Payment to be refunded to the Company has been paid to any Federal, state or local tax authority, repayment thereof shall not be required until actual refund or credit of such portion has been made to Executive, and interest payable to the Company shall not exceed interest 13 received or credited to Executive by such tax authority for the period it held such portion. Executive and the Company shall mutually agree upon the course of action to be pursued (and the method of allocating the expenses thereof) if Executive's good faith claim for refund or credit is denied. In the event that the Excise Tax is later determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to exceed the amount taken into account hereunder at the time the Tax Reimbursement Payment is made (including, but not limited to, by reason of any payment the existence or amount of which cannot be determined at the time of the Tax Reimbursement Payment), the Company shall make an additional Tax Reimbursement Payment in respect of such excess (plus any interest or penalty payable with respect to such excess) at the time that the amount of such excess is finally determined. (v) The Tax Reimbursement Payment (or portion thereof) provided for in Section 7(e)(i) above shall be paid to Executive not later than 10 business days following the payment of the Covered Payments' provided, however, that if the amount of such Tax Reimbursement Payment (or portion thereof) cannot be finally determined on or before the date on which payment is due, the Company shall pay to Executive by such date an amount estimated in good faith by the Accountants to be the minimum amount of such Tax Reimbursement Payment and shall pay the remainder of such Tax Reimbursement Payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined, but in no event later than 45 calendar days after payment of the related Covered Payment. In the event that the amount of the estimated Tax Reimbursement payment exceeds the amount subsequently determined to have 14 been due, such excess shall constitute a loan by the Company to Executive, payable on the fifth business day after written demand by the Company for payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code). 8. NON-EXCLUSIVE OF RIGHTS. Except as expressly provided herein, nothing in ----------------------- this Agreement shall prevent or limit Executive's continuing or future participation in any benefit, bonus, incentive or other plan or program provided by the Company or any of its affiliated companies and for which Executive may qualify, nor shall anything herein limit or otherwise prejudice such rights as Executive may have under any other agreement with the Company or any of its affiliated companies, including employment agreements or stock option agreements. Amounts which are vested benefits or which Executive is otherwise entitled to receive under any plan or program of the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan or program. 9. FULL SETTLEMENT. Following a Change of Control, the Company's obligation to --------------- make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any circumstances, including without limitation, any set-off, counterclaim, recoupment, defense or other right which the Company may have against Executive or others whether by reason of the subsequent employment of Executive or otherwise. 10. NON-COMPETITION AND CONFIDENTIALITY ----------------------------------- (a) NON-COMPETITION. During the Employment Period and during the two year --------------- period (the "Restriction Period") following any termination of Executive's employment other than a Termination by the Company without Cause, Executive shall not become associated with any entity, whether as a principal, partner, employee, consultant or shareholder (other than as a holder of not in excess of 1% of the outstanding voting shares of any publicly traded company), that is actively engaged in any geographic 15 area in any business which is in competition with the business of the Company without the prior written consent of the Company. (b) CONFIDENTIALITY. Without the prior written consent of the Company, --------------- except to the extent required by an order of a court having competent jurisdiction or under subpoena from an appropriate government agency, Executive shall not disclose any trade secrets, customer lists, drawings, designs, information regarding product development, marketing plans, sales plans, manufacturing plans, management organization information (including data and other information relating to members of the Board of Directors and management), operating policies or manuals, business plans, financial records, packaging design or other financial, commercial, business or technical information relating to the Company or any of its subsidiaries or information designated as confidential or proprietary that the Company or any of its subsidiaries may receive belonging to suppliers, customers or others who do business with the Company or any of its subsidiaries (collectively, "Confidential Information") to any third person unless such Confidential Information has been previously disclosed to the public by the Company or is in the public domain (other than by reason of Executive's breach of this Section 9(b)). (c) COMPANY PROPERTY. Promptly following Executive's termination of ---------------- employment, Executive shall return to the Company all property of the Company, and all copies thereof in Executive's possession or under his control. (d) NON-SOLICITATION OF EMPLOYEES. During the Employment period and the ----------------------------- Restriction Period, Executive shall not directly or indirectly induce any employee of the Company or any of its subsidiaries to terminate employment with such entity, and shall not directly or indirectly, either individually or as owner, agent, employee, consultant or otherwise, employ or offer employment to any person who is or was employed by the Company or a subsidiary thereof unless such person shall have ceased to be employed by such entity for a period of at least 6 months. (e) INJUNCTIVE RELIEF WITH RESPECT TO COVENANTS. Executive acknowledges ------------------------------------------- and agrees that the covenants and obligations of Executive with respect to noncompetition, nonsolicitation, confidentiality and Company property relate to special, unique and extraordinary matters and that a violation of any of the terms of such 16 convenants and obligations will cause the Company irreparable injury for which adequate remedies are not available at law. Therefore, Executive agrees that the Company shall be entitled to an injunction, restraining order or such other equitable relief (without the requirement to post bond) restraining Executive from committing any violation of the convenants and obligations contained in this Section 10. These injunctive remedies are cumulative and are in addition to any other rights and remedies the Company may have at law or in equity. In connection with the foregoing provisions of this Section 10, Executive represents that his economic means and circumstances are such that such provisions will not prevent him from providing for himself and his family on a basis satisfactory to him. 11. LEGAL FEES AND EXPENSES. If Executive asserts any claim in any content ----------------------- (whether initiated by Executive or by the Company) as to the validity, enforceability or interpretation of any provision of this Agreement, the Company shall pay Executive's legal expenses (or cause such expenses to be paid) including, without limitation, his reasonable attorney's fees, on a quarterly basis, upon presentation of proof of such expenses, PROVIDED THAT Executive ------------- shall reimburse the Company for such amounts, plus simple interest thereon at the 90-day United States Treasury Bill rate as in effect form time to time, compounded annually, if Executive shall not prevail in whole or in part, as to any material issue as to the validity, enforceability or interpretation of any provision of this Agreement. 12. SUCCESSORS ---------- (a) This Agreement is personal to Executive and without the prior written consent of the Company, shall not be assignable by Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by Executive's legal representatives. (b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors. The Company shall require any successor to all or substantially all of the business and/or assets of the Company, whether direct or indirect, 17 by purchase, merger, consolidation, acquisition of stock, or otherwise, by an agreement in form and substance satisfactory to Executive, expressly to assume and agree to perform this Agreement in the same manner and to the same extent as the Company would be required to perform if no such succession had taken place. 13. MISCELLANEOUS ------------- (a) APPLICABLE LAW. This Agreement shall be governed by and construed in -------------- accordance with the laws of Bermuda, applied with reference to principles of conflict of laws. (b) EXPENSES. During the term hereof, Executive shall be entitled to -------- receive prompt reimbursement for all reasonable expenses incurred by Executive in accordance with its usual policies and procedures as in effect from time to time. Notwithstanding the foregoing, after the Change of Control Date, such policies and procedures shall be no less favorable to Executive than those in effect immediately prior to the Change of Control Date. (c) ENTIRE AGREEMENT. This Agreement constitutes the entire agreement ---------------- between the parties hereto with respect to the matters referred to herein. No other agreement relating to the terms of Executive's employment by the Company, oral or otherwise, shall be binding between the parties unless it is in writing and signed by the party against whom enforcement is sought. There are no promises, representations, inducements or statements between the parties other than those that are expressly contained herein. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. In the event any provision of this Agreement is invalid or unenforceable, the validity and enforceability of the remaining provisions hereof shall not be affected. Executive acknowledges that he is entering into this Agreement of his own free will and accord, and with no duress, that he has read this Agreement and that he understands it and its legal consequences. 18 (d) NOTICES. All notices and other communications hereunder shall be in ------- writing and shall be given by hand-delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to Executive: Home address of Executive noted on the records of the Company. If to the Company: Terra Nova (Bermuda) Holdings Ltd. Richmond House, 2/nd/ Floor 12 Par-La-Ville Road Hamilton HM 08 Bermuda Attention: Corporate Secretary ------------------------------ Or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. IN WITNESS WHEREOF, Executive has hereunto set his hand and the Company has caused this Agreement to be executed in its name on its behalf, and its corporate seal to be hereunto affixed and attested by its Secretary, all as of the day and year first above written. TERRA NOVA (BERMUDA) HOLDINGS LTD. /s/ David Jaffe ------------------------ By: David Jaffe --------------------- Title: Director WITNESSED: /s/ Ellen E. Hines - --------------------- NIGEL H.J. ROGERS /s/ Nigel H.J. Rogers WITNESSED: ------------------------ /s/ John J. Dwyer - --------------------- 19 EX-10.18 4 EMPLOYMENT AGREEMENT BETW. THE CO. AND J. WAGGETT EXHIBIT 10.18 EMPLOYMENT AGREEMENT -------------------- THIS AGREEMENT between TERRA NOVA (BERMUDA) HOLDINGS LTD., a Bermuda corporation (the "Company"), and JEAN M. WAGGETT ("Executive"), dated as of July 31, 1998. W I T N E S S E T H: -------------------- WHEREAS, the Company has employed Executive in several key executive officer positions, including currently as Senior Vice President, General Counsel and Corporate Secretary. WHEREAS, the Company further believes that, in the event it is confronted with a situation that could result in a change in ownership or control of the Company, continuity of management will be essential to its ability to evaluate and respond to such situation in the best interest of shareholders; WHEREAS, the Company deems it desirable and in its best interests to make provision for the availability to the Company of Executive's services on the terms set forth herein; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is hereby agreed by and between the company and Executive as follows: 1. AGREEMENT TO EMPLOY. Except as otherwise expressly provided herein, the ------------------- Company agrees to employ Executive for an initial period commencing on the date hereof (the "Commencement Date") and ending on the later of the second anniversary thereof, and December 31, 2001 ("Anniversary Date"). Upon that Anniversary Date and each anniversary thereof, the term of this Agreement will be extended for one (1) additional year without any action by the Company or Executive, unless either the Company or Executive delivers written notice (the "Notice") to the other party, at least 90 days prior to such Anniversary Date stating that it or he does not want the term of this Agreement further extended; provided that, except as provided in the next following sentence, if a Change of - --------------- Control (as defined below) occurs during the term of this Agreement, this Agreement shall in all events continue in effect until the second anniversary of the date upon which such Change of Control occurs (the "Change of Control Date"). The period during which Executive is employed pursuant to this Agreement, including any extension thereof in accordance with the preceding sentence, shall be referred to as the "Employment Period." 2. DUTIES AND RESPONSIBILITIES. Executive shall be employed as the Company's --------------------------- Senior Vice President, General Counsel and Corporate Secretary, and shall serve in such other executive capacity or capacities with the Company or its subsidiaries as its Board of Directors (the "Board") may determine from time to time and at any time prior to a Change of Control Date. During the Employment Period, Executive shall have the duties, responsibilities and obligations customarily assigned to individuals serving in the position or positions in which Executive serves hereunder and such other duties, responsibilities and obligations as the Board shall from time to time specify. During the Employment Period, Executive shall devote his full time to the services required of him hereunder, except for vacation time and reasonable periods of absence due to sickness, personal injury or other disability, and shall use his best efforts, judgement, skill and energy to perform such services in a manner consonant with the duties of his position and to improve and advance the business and interests of the Company and its subsidiaries. Nothing contained herein shall preclude Executive from (i) serving on the board of directors of any business corporation with the consent of the Board, (ii) serving on the board of, or working for, any charitable or community organization or (iii) pursuing his personal financial and legal affairs, so long as such activities, individually or collectively, do not interfere with the performance of Executive's duties hereunder. Executive shall at all times perform his services for the Company at its headquarters in Hamilton, Bermuda, except for reasonable periods of travel as are required in the performance of his duties hereunder and consistent with past practices. 2 3. ANNUAL COMPENSATION ------------------- (a) BASE SALARY. During the Employment Period, the Company shall pay ------------ Executive a base salary at the annual rate in effect on the date hereof. The annual base salary payable under this paragraph shall be reduced, however, to the extent Executive elects to defer such salary under the terms of any deferred compensation or savings plan or arrangement maintained or established by the Company. The Board shall annually review Executive's base salary in light of the base salaries paid to other executive officers of the Company and the performance of Executive and the Company may, in its discretion, increase such base salary by an amount it determines to be appropriate. Once increased, such base salary shall not thereafter be decreased. Any such increase shall not reduce or limit any other obligation of the Company hereunder. Executive's annual base salary payable hereunder, as it may be increased from time to time and without reduction for any amounts deferred as described above is referred to herein as "Base Salary". The Company shall pay Executive the portion of his Base Salary not deferred in accordance with the Company's generally applicable practices in respect of senior officers. (b) INCENTIVE COMPENSATION. During the term of the Employment Period, ----------------------- Executive shall participate in the Company's existing and future annual and long term incentive compensation programs at a level commensurate with his position at the Company and consistent with the Company's then current policies and practices. 4. BENEFITS, PERQUISITES AND EXPENSES ---------------------------------- (a) BENEFITS. During the Employment Period, Executive shall be eligible to -------- participate in (i) each welfare benefit plan sponsored or maintained by the Company, including, without limitation, each group life, hospitalization, medical, dental, health, accident or disability insurance or similar plan or program of the Company, and (ii) each pension, profit sharing, retirement, deferred compensation or savings plan sponsored or maintained by the Company, in each case, whether now existing or established hereafter, to the extent that Executive is eligible to participate in any such plan under the generally applicable provisions thereof. Without limiting the generality of the foregoing, the Company reserves the right to amend or terminate any such pan in its discretion. 3 (b) PERQUISITES. During the Employment Period, Executive shall be entitled ----------- to up to five weeks' paid vacation annually and all of the other current perquisites set forth on Schedule A and shall also be entitled to receive such perquisites as are generally provided to other senior officers of the Company in accordance with the then current policies and practices of the Company. (c) BUSINESS EXPENSES. During the Employment Period, the Company shall pay ----------------- or reimburse Executive for all reasonable expenses incurred or paid by Executive in the performance of Executive's duties hereunder, upon presentation of expense statements or vouchers and such other information as the Company may require and in accordance with the generally applicable policies and procedures of the Company. (d) INDEMNIFICATION. The Company shall indemnify Executive and hold --------------- Executive harmless from and against any claim, loss or cause of action arising from or out of Executive's performance as an officer, director or employee of the Company or any of its subsidiaries or in any other capacity, including any fiduciary capacity, in which Executive serves at the request of the Company to the maximum extent permitted by applicable law. If any claim is asserted hereunder with respect to which Executive reasonably believes in good faith he is entitled to indemnification, the Company shall pay Executive's legal expenses (or cause such expenses to be paid) on a quarterly basis, provided that Executive shall reimburse the Company for such amounts, plus simple interest thereon at the 90-day United States Treasury Bill rate as in effect from time to time, compounded annually, if Executive shall be found by a court of competent jurisdiction not to have been entitled to indemnification. 5. DEFINITIONS ----------- (a) CHANGE OF CONTROL. For the purposes of this Agreement, a "Change of ----------------- Control" shall mean (i) a merger or consolidation to which the Company is a party and for which the approval of any shareholders of the Company is required; (ii) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) becoming the beneficial owner, directly or indirectly, of securities of the Company representing 25% or more of the combined voting power of the Company's 4 then outstanding securities or (iii) a sale or transfer of substantially all of the assets of the Company. (b) POTENTIAL CHANGE OF CONTROL. For the purposes of this Agreement, a --------------------------- Potential Change of Control shall be deemed to have occurred if (i) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended) commences a tender offer for securities, which if consummated, would result in such person owing 20% or more of the combined voting power of the company's then outstanding securities; (ii) the Company enters into an agreement the consummation of which would constitute a Change of Control: (iii) proxies for the election of directors of the Company are solicited by anyone other than the Company; or (iv) any other event occurs which is deemed to be a Potential Change of Control by the Board. 6. TERMINATION ----------- (a) DEATH, DISABILITY OR RETIREMENT. This Agreement shall terminate ------------------------------- automatically upon Executive's death, termination due to "Disability" (as defined below) or voluntary retirement under any of the Company's retirement plans as in effect from time to time. For purposes of this Agreement, Disability shall mean Executive's inability to perform the duties of his position, as determined in accordance with the policies and procedures applicable with respect to the Company's long-term disability plan, as in effect from time to time, except that, following a Change of Control disability shall be determined based on the policies and procedures in effect immediately prior to the Change of Control Date. (b) VOLUNTARY TERMINATION. Notwithstanding anything in this Agreement to --------------------- the contrary, following a Change of Control Executive may, upon not less than 60 days' written notice to the Company, voluntarily terminate his employment for any reason (including early retirement under the terms of any of the Company's retirement plans as 5 in effect from time to time), PROVIDED THAT any termination by Executive ------------- pursuant to Section 6(d) on account of Good Reason (as defined therein) shall not be treated as a voluntary termination under this Section 6(b). (c) CAUSE. The Company may terminate Executive's employment for Cause. ----- For purposes of this Agreement, "Cause" means (i) Executive's conviction or plea of nolo contendere to a felony; --------------- (ii) an act or acts of dishonesty or gross misconduct on Executive's part which result or are intended to result in material damage to the Company's business or reputation; or (iii) repeated material violations by Executive of his obligations under Section 2 of this Agreement, PROVIDED THAT, following a ------------- Change of Control Date, Cause shall not exist due to such violations of Executive's obligations unless such violations are demonstrably wilful and deliberate on Executive's part and result in material damage to the Company's business or reputation. (d) GOOD REASON. Executive may terminate his employment for Good Reason. ----------- For purposes of this Agreement, "Good Reason" means the occurrence of any of the following, without the express written consent of Executive, except that subclauses (iv) and (v) below shall only apply after the occurrence of a Change of Control: (i) a) the assignment to Executive of any duties inconsistent in any material adverse respect with Executive's position, authority or responsibilities as contemplated by Section 2 of this Agreement, or b) any other material adverse change in such position, including titles, authority or responsibilities. (ii) any failure by the Company to comply with any of the provisions of Section 3 of this Agreement, other than an insubstantial or inadvertent failure remedied by the Company promptly after receipt of notice thereof given by Executive; 6 (iii) the Company's requiring Executive to be based at any office or location more than 35 miles from that location specified under the provisions of Section 2; (iv) the failure by the Company to permit Executive to participate in all long-term incentive compensation programs for key executives at a level that is commensurate with Executive's participation in such plans immediately prior to the Change of Control Date (or, if more favorable to Executive, at the level made available to Executive or other similarly situated officers at any time thereafter); or (v) the failure by the Company to permit Executive (and, to the extent applicable, his dependents) to participate in or be covered under all pension, retirement, deferred compensation, savings, medical, dental, health, disability, group life, accidental death and travel accident insurance plans and programs of the Company and its affiliated companies at a level that is commensurate with Executive's participation in such plans immediately prior to the Change of Control Date (or, if more favorable to Executive, at the level made available to Executive or other similarly situated officers at any time thereafter); or (vi) any failure by the Company to obtain the assumption and agreement to perform this Agreement by a successor as contemplated by Section 11(b). In no event shall the mere occurrence of a Change of Control, absent any further impact on Executive, be deemed to constitute Good Reason. (e) NOTICE OF TERMINATION. Any termination by the Company for Cause or by --------------------- Executive for Good Reason shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 12(d). For purposes of this Agreement, a "Notice of Termination" means a written notice given, in the case of a termination for Cause, within 10 business days of the Company's having actual knowledge of the events giving rise to such termination, and in the case of a termination 7 for Good Reason, within 180 days of Executive's having actual knowledge of the events giving rise to such termination, and which (i) indicates the specific termination provision in this Agreement relied upon, (ii) sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of Executive's employment under the provision so indicated, and (iii) if the termination date is other than the date of receipt of such notice, specifies the termination date of this Agreement (which date shall be not more than 15 days after the giving of such notice). The failure by Executive to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason shall not waive any right of Executive hereunder or preclude Executive from asserting such fact or circumstance in enforcing his rights hereunder. (f) DATE OF TERMINATION. For the purpose of this Agreement, the term ------------------- "Date of Termination" means (i) in the case of a termination for which a Notice of Termination is required, the date of receipt of such Notice of Termination or, if later, the date specified therein, as the case may be, and (ii) in all other cases, the actual date on which Executive's employment terminates during the Employment Period. 7. OBLIGATION OF THE COMPANY UPON TERMINATION ------------------------------------------ (a) DEATH OR DISABILITY. If Executive's employment is terminated during ------------------- the term hereof by reason of Executive's death or Disability, this Agreement shall terminate without further obligations accrued hereunder to the Date of Termination, and the Company shall pay to Executive (or his beneficiary or estate) (i) Executive's full Base Salary through the Date of Termination (the "Earned Salary"), (ii) any vested amounts or benefits owing to Executive under the Company's otherwise applicable employee benefit plans and programs, including any compensation previously deferred by Executive (together with any accrued earnings thereon) and not yet paid by the Company and any accrued vacation pay not yet paid by the company (the "Accrued Obligations"), and (iii) any other benefits payable due to Executive's death or Disability under the Company's plans, policies or programs (the "Additional Benefits"). 8 Any Earned Salary shall be paid in cash in a single lump sum, as soon as practicable but in no event more than 10 business days (or at such earlier date required by law) following the Date of Termination, or as otherwise directed by Executive or his estate. Accrued Obligations and Additional Benefits shall be paid in accordance with the terms of the applicable plan, program or arrangement. (b) CAUSE AND VOLUNTARY TERMINATION. If, during the Employment Period, ------------------------------- Executive's employment shall be terminated for cause or voluntarily terminated by Executive in accordance with Section 6(b) other than during the 90 day period described in Section 7(c)(i) below, the Company shall pay Executive (i) the Earned Salary in cash in a single lump sum, or otherwise directed by Executive, as soon as practicable, but in no event more than 10 days following the Date of Termination, and (ii) the Accrued Obligations in accordance with the terms of the applicable plan, program or arrangement. (c) TERMINATION BY THE COMPANY WITHOUT CAUSE. ---------------------------------------- (i) LUMP SUM PAYMENTS. If (x) the Company terminates Executive's ----------------- employment other than for Cause, (y) Executive terminates his employment at any time for Good Reason or (z) Executive voluntarily terminates his employment without Good Reason during the one year period beginning on the Change of Control Date, then the Company shall pay to Executive the following amounts: a) Executive's Earned Salary; b) a cash amount, without offset for other amounts payable in conjunction with a Change of Control, (the "Severance Amount") equal to three times the sum of 1) Executive's annual Base Salary; and 2) the greater of (x) the highest bonus amount paid to or deferred by Executive in respect of any of the last three fiscal years of the Company ending immediately prior to the Change of Control Date or (y) the amount that would have been payable to 9 Executive as a target bonus for the year in which the Change of Control occurs; and c) the Accrued Obligations. The Earned Salary and Severance Amount shall be paid in cash, or as otherwise reasonably directed by the Executive, based on a calculation of 24 equal installments, the first such installment to be paid as soon as practicable but in no event more than 10 business days following the Date of Termination (or at such earlier date as may be required by law), each of the subsequent 10 installments to be paid on the same date of each calendar month following the first payment and the final 13 installments to be paid as a lump sum on the same date of the calendar month following the 11th payment; provided that any unpaid installments -------------- shall be immediately paid as a lump sum in the event of the death or disability of the Executive or a second Change of Control of the Company or its successor which occurs following an initial Change of Control. Accrued Obligations shall be paid in accordance with the terms of the applicable plan, program or arrangement. (ii) CONTINUATION OF BENEFITS. If Executive is entitled to receive ------------------------ the Severance Amount, Executive (and, to the extent applicable, his dependents) shall be entitled, after the Date of Termination until the earlier of (1) the third anniversary of the Date of Termination (the "End Date") or (2) the date Executive becomes eligible for comparable benefits under a similar plan, policy or program of a subsequent employer, to continue participation in all of the Company's Executive and executive welfare and fringe benefit plans (the "Benefit Plans") and to receive such perquisites as were generally provided to Executive in accordance with the Company's policies and practices immediately prior to the Change of Control Date. To the extent any such benefits or perquisites cannot be 10 proved under the terms of the applicable plan, policy or program, the Company shall provide a comparable benefit under another plan or from the Company's general assets. Executive's participation in the Benefit plans and eligibility for perquisites will be on the same terms and conditions that would have applied had Executive continued to be employed by the Company through the End Date. (d) DISCHARGE OF THE COMPANY'S OBLIGATIONS. Except as expressly provided -------------------------------------- in the last sentence of this Section 7(d), the amounts payable to Executive pursuant to this Section 7 following termination of his employment shall be in full and complete satisfaction of Executive's rights under this Agreement and any other claims he may have in respect of his employment by the Company or any of its subsidiaries. Such amounts shall constitute liquidated damages with respect to any and all such rights and claims and, upon Executive's receipt of such amounts, the Company shall be released and discharged from any and all liability to Executive in connection with this Agreement or otherwise in connection with Executive's employment with the Company and its subsidiaries. Nothing in this Section 7(d) shall be construed to release the Company from its commitment to indemnify Executive and hold Executive harmless from and against any claim, loss or cause of action arising from or out of Executive's performance as an officer, director or Executive of the Company or any of its subsidiaries or in any other capacity, including any fiduciary capacity, in which Executive served at the request of the Company to the maximum extent permitted by applicable law. (e) CERTAIN FURTHER PAYMENTS BY THE COMPANY. --------------------------------------- (i) In the event that any amount or benefit paid or distributed to Executive pursuant to this Agreement, taken together with any amounts or benefits otherwise paid or distributed to Executive by the Company or any affiliated company (collectively, the "Covered Payments"), are or become subject to the tax (the "Excise Tax") imposed under Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code)), or any similar tax that the Company shall 11 pay to Executive at the time specified in Section 7(e)(v) below an additional amount (the "Tax Reimbursement Payment") such that the net amount retained by Executive with respect to such Covered Payments, after deduction of any Excise Tax on the Covered Payments and any Federal, state and local income or employment tax and Excise Tax on the Tax Reimbursement Payment provided for by this Section 7(e), but before deduction for any Federal, state or local income or employment tax withholding on such Covered Payments, shall be equal to the amount of the Covered Payments. (ii) For purposes of determining whether any of the Covered Payments will be subject to the Excise Tax and the amount of such Excise Tax: a) such Covered Payments will be treated as "parachute payments" within the meaning of Section 280G of the Code, and all "parachute payments" in excess of the "base amount" (as defined under Section 280G(b)(3) of the Code) shall be treated as subject to the Excise Tax, unless, and except to the extent that, in the good faith judgment of the Company's independent certified public accountants appointed prior to the Change of Control Date or tax counsel selected by such accountants (the "Accountants"), the Company has a reasonable basis to conclude that such Covered Payments (in whole or in part) either do not constitute "parachute payments" or represent reasonable compensation for personal services actually rendered (within the meaning of Section 280G(b)(4)(B) of the code) in excess of the "base amount," or such "parachute payments" are otherwise not subject to such Excise Tax, and 12 b) the value of any non-cash benefits or any deferred payment accordance with the principles of Section 280G of the Code. (iii) For purposes of determining the amount of the Tax Reimbursement Payment, Executive shall be deemed to pay: a) Federal income taxed at the highest applicable marginal rate of Federal income taxation for the calendar year in which the Tax Reimbursement Payment is to be made, and b) any applicable state and local income taxes at the highest applicable marginal rate of taxation for the calendar year in which the Tax Reimbursement Payment is to be made, net of the maximum reduction in Federal income taxes which could be obtained from the deduction of such state or local taxes if paid in such year. (iv) In the event that the Excise Tax is subsequently determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to be less than the amount taken into account hereunder in calculating the Tax Reimbursement Payment made, Executive shall repay to the Company, at the time that the amount of such reduction in the Excise Tax is finally determined, the portion of such prior Tax Reimbursement Payment that would not have been paid if such Excise Tax had been applied in initially calculating such Tax Reimbursement Payment, plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code. Notwithstanding the foregoing, in the event any portion of the Tax Reimbursement Payment to be refunded to the Company has been paid to any Federal, state or local tax authority, repayment thereof shall not be required until actual refund or credit of such portion has been made to Executive, and interest payable to the Company shall not exceed interest 13 received or credited to Executive by such tax authority for the period it held such portion. Executive and the Company shall mutually agree upon the course of action to be pursued (and the method of allocating the expenses thereof) if Executive's good faith claim for refund or credit is denied. In the event that the Excise Tax is later determined by the Accountants or pursuant to any proceeding or negotiations with the Internal Revenue Service to exceed the amount taken into account hereunder at the time the Tax Reimbursement Payment is made (including, but not limited to, by reason of any payment the existence or amount of which cannot be determined at the time of the Tax Reimbursement Payment), the Company shall make an additional Tax Reimbursement Payment in respect of such excess (plus any interest or penalty payable with respect to such excess) at the time that the amount of such excess is finally determined. (v) The Tax Reimbursement Payment (or portion thereof) provided for in Section 7(e)(i) above shall be paid to Executive not later than 10 business days following the payment of the Covered Payments' provided, however, that if the amount of such Tax Reimbursement Payment (or portion thereof) cannot be finally determined on or before the date on which payment is due, the Company shall pay to Executive by such date an amount estimated in good faith by the Accountants to be the minimum amount of such Tax Reimbursement Payment and shall pay the remainder of such Tax Reimbursement Payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can be determined, but in no event later than 45 calendar days after payment of the related Covered Payment. In the event that the amount of the estimated Tax Reimbursement payment exceeds the amount subsequently determined to have 14 been due, such excess shall constitute a loan by the Company to Executive, payable on the fifth business day after written demand by the Company for payment (together with interest at the rate provided in Section 1274(b)(2)(B) of the Code). 8. NON-EXCLUSIVE OF RIGHTS. Except as expressly provided herein, nothing in ----------------------- this Agreement shall prevent or limit Executive's continuing or future participation in any benefit, bonus, incentive or other plan or program provided by the Company or any of its affiliated companies and for which Executive may qualify, nor shall anything herein limit or otherwise prejudice such rights as Executive may have under any other agreement with the Company or any of its affiliated companies, including employment agreements or stock option agreements. Amounts which are vested benefits or which Executive is otherwise entitled to receive under any plan or program of the Company or any of its affiliated companies at or subsequent to the Date of Termination shall be payable in accordance with such plan or program. 9. FULL SETTLEMENT. Following a Change of Control, the Company's obligation to --------------- make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any circumstances, including without limitation, any set-off, counterclaim, recoupment, defense or other right which the Company may have against Executive or others whether by reason of the subsequent employment of Executive or otherwise. 10. NON-COMPETITION AND CONFIDENTIALITY ----------------------------------- (a) NON-COMPETITION. During the Employment Period and during the one year --------------- period (the "Restriction Period") following any termination of Executive's employment other than a Termination by the Company without Cause, Executive shall not become associated with any entity, whether as a principal, partner, employee, consultant or shareholder (other than as a holder of not in excess of 1% of the outstanding voting shares of any publicly traded company), that is actively engaged in any geographic 15 area in any business which is in competition with the business of the Company without the prior written consent of the Company. (b) CONFIDENTIALITY. Without the prior written consent of the Company, --------------- except to the extent required by an order of a court having competent jurisdiction or under subpoena from an appropriate government agency, Executive shall not disclose any trade secrets, customer lists, drawings, designs, information regarding product development, marketing plans, sales plans, manufacturing plans, management organization information (including data and other information relating to members of the Board of Directors and management), operating policies or manuals, business plans, financial records, packaging design or other financial, commercial, business or technical information relating to the Company or any of its subsidiaries or information designated as confidential or proprietary that the Company or any of its subsidiaries may receive belonging to suppliers, customers or others who do business with the Company or any of its subsidiaries (collectively, "Confidential Information") to any third person unless such Confidential Information has been previously disclosed to the public by the Company or is in the public domain (other than by reason of Executive's breach of this Section 9(b)). (c) COMPANY PROPERTY. Promptly following Executive's termination of ---------------- employment, Executive shall return to the Company all property of the Company, and all copies thereof in Executive's possession or under his control. (d) NON-SOLICITATION OF EMPLOYEES. During the Employment period and the ----------------------------- Restriction Period, Executive shall not directly or indirectly induce any employee of the Company or any of its subsidiaries to terminate employment with such entity, and shall not directly or indirectly, either individually or as owner, agent, employee, consultant or otherwise, employ or offer employment to any person who is or was employed by the Company or a subsidiary thereof unless such person shall have ceased to be employed by such entity for a period of at least 6 months. (e) INJUNCTIVE RELIEF WITH RESPECT TO COVENANTS. Executive acknowledges ------------------------------------------- and agrees that the covenants and obligations of Executive with respect to noncompetition, nonsolicitation, confidentiality and Company property relate to special, unique and extraordinary matters and that a violation of any of the terms of such 16 convenants and obligations will cause the Company irreparable injury for which adequate remedies are not available at law. Therefore, Executive agrees that the Company shall be entitled to an injunction, restraining order or such other equitable relief (without the requirement to post bond) restraining Executive from committing any violation of the convenants and obligations contained in this Section 10. These injunctive remedies are cumulative and are in addition to any other rights and remedies the Company may have at law or in equity. In connection with the foregoing provisions of this Section 10, Executive represents that his economic means and circumstances are such that such provisions will not prevent him from providing for himself and his family on a basis satisfactory to him. 11. LEGAL FEES AND EXPENSES. If Executive asserts any claim in any content ----------------------- (whether initiated by Executive or by the Company) as to the validity, enforceability or interpretation of any provision of this Agreement, the Company shall pay Executive's legal expenses (or cause such expenses to be paid) including, without limitation, his reasonable attorney's fees, on a quarterly basis, upon presentation of proof of such expenses, PROVIDED THAT Executive ------------- shall reimburse the Company for such amounts, plus simple interest thereon at the 90-day United States Treasury Bill rate as in effect form time to time, compounded annually, if Executive shall not prevail in whole or in part, as to any material issue as to the validity, enforceability or interpretation of any provision of this Agreement. 12. SUCCESSORS ---------- (a) This Agreement is personal to Executive and without the prior written consent of the Company, shall not be assignable by Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by Executive's legal representatives. (b) This Agreement shall inure to the benefit of and be binding upon the Company and its successors. The Company shall require any successor to all or substantially all of the business and/or assets of the Company, whether direct or indirect, 17 by purchase, merger, consolidation, acquisition of stock, or otherwise, by an agreement in form and substance satisfactory to Executive, expressly to assume and agree to perform this Agreement in the same manner and to the same extent as the Company would be required to perform if no such succession had taken place. 13. MISCELLANEOUS ------------- (a) APPLICABLE LAW. This Agreement shall be governed by and construed in -------------- accordance with the laws of Bermuda, applied with reference to principles of conflict of laws. (b) EXPENSES. During the term hereof, Executive shall be entitled to -------- receive prompt reimbursement for all reasonable expenses incurred by Executive in accordance with its usual policies and procedures as in effect from time to time. Notwithstanding the foregoing, after the Change of Control Date, such policies and procedures shall be no less favorable to Executive than those in effect immediately prior to the Change of Control Date. (c) ENTIRE AGREEMENT. This Agreement constitutes the entire agreement ---------------- between the parties hereto with respect to the matters referred to herein. No other agreement relating to the terms of Executive's employment by the Company, oral or otherwise, shall be binding between the parties unless it is in writing and signed by the party against whom enforcement is sought. There are no promises, representations, inducements or statements between the parties other than those that are expressly contained herein. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. In the event any provision of this Agreement is invalid or unenforceable, the validity and enforceability of the remaining provisions hereof shall not be affected. Executive acknowledges that he is entering into this Agreement of his own free will and accord, and with no duress, that he has read this Agreement and that he understands it and its legal consequences. 18 (d) NOTICES. All notices and other communications hereunder shall be in ------- writing and shall be given by hand-delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to Executive: Home address of Executive noted on the records of the Company. If to the Company: Terra Nova (Bermuda) Holdings Ltd. Richmond House, 2/nd/ Floor 12 Par-La-Ville Road Hamilton HM 08 Bermuda Attention: Corporate Secretary ------------------------------- Or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. IN WITNESS WHEREOF, Executive has hereunto set his hand and the Company has caused this Agreement to be executed in its name on its behalf, and its corporate seal to be hereunto affixed and attested by its Secretary, all as of the day and year first above written. TERRA NOVA (BERMUDA) HOLDINGS LTD. /s/ John J. Dwyer ---------------------------- By: John J. Dwyer ------------------------- Title: Chairman WITNESSED: /s/ Pat Thomas - -------------------- JEAN M. WAGGETT /s/ Jean M. Waggett ---------------------------- WITNESSED: /s/ Gloria Gullon - -------------------- 19 EX-10.19 5 LETTER AGREEMENT BETW. THE CO. AND JOHN RIDDICK EXHIBIT 10.19 [LETTERHEAD OF TERRA NOVA (BERMUDA) HOLDINGS LTD. APPEARS HERE] November 26, 1998 Mr J Riddick 22 Stanhopes Limpsfield Surrey RH8 0TY Dear John, In response to our discussions regarding your departure from Terra Nova (Bermuda) Holdings Ltd. and its subsidiary companies (individually or collectively, the "Company"), including Terra Nova Insurance Company Limited ("Terra Nova"), I am writing to set out the terms that have been agreed in respect of that termination of your employment. The following summary sets out the terms of your retirement on which we have agreed: 1. The Company will cause the terms and conditions of your service agreement with Terra Nova, dated October 18, 1993 (the "Service Agreement"), to be fulfilled through March 31, 2000 as provided under the terms of the contract and on to June 1, 2000 as we have mutually agreed. As we also have agreed, your paid leave from Terra Nova will begin on January 1, 1999 and your employment termination date will be May 31, 2000 at which time you will retire from Terra Nova. During the period of your paid leave, you agree to be available to assist the management of the Company, as may reasonably be requested from time to time. The Company will reimburse you for reasonable travel or other expenses in connection with such assistance. 2. Under the terms of your employment contract, the following salary and benefits will continue until May 31, 2000. A. Your monthly salary will continue at the present rate from which the Company will deduct income tax at the applicable basic rate and any employee's National Insurance contributions and will account to the Inland Revenue for these amounts; B. An annual bonus equal to 10% of your current salary will be paid for the performance year 1998 and 7800 (pounds) for the performance year 1999. The customary payment dates would be on February 1, 1999 and February 1, 2000. At your election, the Company will pay the bonus amounts in a single lump sum on February 1, 1999. John Riddick 2 November 26, 1998 C. The following benefits provided by the Company will continue at the current levels: . Life insurance; . Private medical insurance for yourself and your family; . Contribution to the Terra Nova pension scheme; . Membership in the Royal Automobile Club; and . "Vesting" of share options under the Company's Executive Share Option Schemes ("Option Schemes") according to the schedule specifically applicable to each option granted. In lieu of the customary automobile benefit, the Company will transfer ownership of the Company-owned Jaguar Sovereign, registration number MGT 1Y, that is currently in your possession, to you on approximately January 1, 1999 free from all encumbrances, except that you will be liable for any income tax that may be charged or levied in respect of the transfer. The Company makes no warranty as to the fitness and condition of the car. Estimated motor expenses for the period to May 31, 2000 of 5,000 (pounds) will be paid to you at the time of the transfer. 3. The Company has requested the Trustees of the Terra Nova Insurance Company Limited Pension and Life Assurance Scheme and the Trustees have agreed that your Normal Retirement Age be lowered from the age of 62 to 60 years at which time you will be entitled, subject to the rules of the Pension Scheme, to take your pension without discount. We have agreed to extend your pensionable service so that at the date of your leaving on May 31, 2000, your pension will be calculated on the basis of 24 years of pensionable service. If you elect to take your pension at an earlier date than age 60, your new normal retirement age, your discounted pension will be calculated using a discount rate of 4%. The Trustees will write to you separately setting out in full your options under the Pension Scheme rules. 4. At the time of your retirement on June 1, 2000, the exercise period applicable to exercisable Terra Nova Share options held by you on that date, subject to the applicable rules of the Options Schemes, should extend to the earlier of the expiration date of each option or May 31, 2005. 5. The Company will provide up to 10,000 (pounds) of outplacement services for you which will be paid by the Company when invoices are provided which document actual utilization. The Company will also reimburse you for the reasonable costs, including V.A.T., of the review of this letter by your counsel within seven days of your presentation of the applicable invoices. 6. You will resign as a director of the Company, from any other direct or indirect subsidiary of the Company and as a trustee of the Pension Scheme with effect from January 1, 1999 in the form or forms of resignation that will be provided by the Company. 7. The Company will reimburse you, on receipt of appropriate documentation, for all legitimate unclaimed expenses incurred by you up to and including December 31, 1998. John Riddick 3 November 26, 1998 8. The Company will meet the cost of one full medical with BUPA (the Company's medical insurer) at their scale fee during 1999. 9. On the basis of our long association, I anticipate that your efforts will be directed towards assisting Terra Nova's management in assuring a smooth transition related to your departure. The terms of this letter and the Company's arrangements with you are confidential. You may discuss the terms with your family and with your personal legal and financial advisors. No other disclosure is to be made by you or by the Company to any third party without the prior written consent of you or the Company, as the case may be. 10. All announcements concerning your leaving the Company will be drafted with your assistance and agreed with you before they are issued and no comment is to be made by you, by the Company or by any employee or officer of the Company to any third party other than in a manner which is consistent with the agreed announcement made by the Company. Neither party will make any untrue and/or derogatory statements about the other. The Company will respond to all requests for a written reference in the agreed form (attached). All references given orally will be consistent with the terms and spirit of the agreed reference. 11. You have requested information on the restrictions which will apply in respect of your holding of Terra Nova (Bermuda) Holdings Ltd. Ordinary Shares. Generally, you will be free to buy or sell shares at any time after January 1, 1999. Jean Waggett, the Company's General Counsel, will be available to consult with you from time to time if you have questions about transactions in the Company's shares or options. 12. As provided in your Service Agreement, you will not, without the consent in writing of the Company, divulge to any person or use for your own benefit or for the benefit of any person, any information of a private, secret or confidential nature concerning the business, accounts or finances of the Company or any other of the secrets, dealings, transactions or affairs of the Company or any of its or their clients which have come to your knowledge during your employment with the Company. This shall not apply to any secrets or information which come into the public domain (otherwise than through an authorised disclosure by you). 13. During your paid leave and for a period of six months thereafter you undertake with the Company to comply with the restrictions in Clause 11 of your Service Agreement relating to non-solicitation. 14. These terms are to be construed in accordance with and subject to English Law. These terms are in full and final settlement of all claims in all jurisdictions (whether arising under statue, common law or otherwise), that you have on December 31, 1998 against the Company or any of its officers or employees in connection with your position as an officer or director of the Company or your contract of employment with Terra Nova, its termination or in any other respect. You have agreed that you will hold the Company harmless against any and all claims that John Riddick 4 November 26, 1998 may be filed against the Company, now or in the future for any purpose, by you or any member of your family. The Company agrees that these terms are in full and final settlement of all claims it has or may have against you provided that such agreement will not extend to claims arising from breach of fiduciary duties as a director or involving fraud or criminal activities on your part or to claims by third parties. For the avoidance of doubt, no such claims are known to the Company as of December 9, 1998. Please review this agreement with your counsel, and confirm your agreement to these terms by signing and returning to me the duplicate of this letter by December 9, 1998. Very truly yours, /s/ John J Dwyer John J Dwyer, Chairman Signed: /s/ John Riddick ---------------------- Terra Nova (Bermuda) Holdings Ltd. John Riddick Date: 9 December, 1998 ------------------------ -----END PRIVACY-ENHANCED MESSAGE-----