-----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, QLbUEL5wR5hfdHGdD5eKnw4sdzyk5j3PP97Q+inNVOw2/sfjiL/PecjVvHUlJoDQ pqcOwTFjzxkGMzjqzAh3Wg== 0000950130-00-001402.txt : 20000321 0000950130-00-001402.hdr.sgml : 20000321 ACCESSION NUMBER: 0000950130-00-001402 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000320 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: 573684 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, 1999 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 (Registrants 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 Common shares, par value $5.80 per registered 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 20, 2000 was 26,144,409 (includes 728,213 ordinary shares owned by trusts on behalf of the Company). - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TERRA NOVA (BERMUDA) HOLDINGS LTD. INDEX TO FORM 10-K
Page ---- PART I Item 1. Business............................................................................... 3 Item 2. Properties............................................................................. 24 Item 3. Legal Proceedings...................................................................... 24 Item 4. Submission of Matters to a Vote of Security Holders.................................... 24 PART II Item 5. Market for the Registrant's Common Shares and Related Shareholder Matters.............. 25 Item 6. Selected Financial Data for the five years ended December 31, 1999..................... 25 Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.. 26 Item 7A. Quantitative and Qualitative Disclosure About Market Risk.............................. 34 Item 8. Financial Statements................................................................... 36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure... 68 PART III Item 10. Directors and Executive Officers of the Registrant..................................... 68 Item 11. Executive Compensation................................................................. 70 Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 75 Item 13. Certain Relationships and Related Transactions......................................... 76 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................ 78 Index to Exhibits...................................................................... 85
2 PART I ITEM 1--BUSINESS Safe Harbor Disclosure The Private Securities Litigation Reform Act of 1995 provides a statutory "safe harbor" for forward-looking statements. Any written or oral statements made by or on behalf of the Company reflect the Company's current views with respect to future events and financial performance. These forward-looking statements are subject to uncertainties and inherent risks that could cause actual results to differ materially from those contained in any forward-looking statement. The Company has identified certain factors that could cause actual plans or results to differ substantially from those included in any forward-looking statements. These risk factors include, but are not limited to, the following: (i) uncertainties and changes in government policy and law (both statute and case law) with respect to the Company, its brokers or customers (for example, the Company is subjected to taxation in an additional jurisdiction, there is a change in the way insurance contracts are interpreted by a court of law, etc.); (ii) uncertainties and changes in regulatory policy and law (for example, the Company is subjected to insurance regulation in an additional jurisdiction); (iii) the occurrence of man-made or natural catastrophic events with a frequency or severity exceeding the estimates of the Company; (iv) the uncertainties of the reserving process; (v) loss of the services of any of the Company's executive officers; (vi) the competitive environment in which the Company operates and related pricing weaknesses in some lines of business; (vii) changing rates of inflation and other economic conditions; (viii) losses due to foreign currency exchange rate fluctuations; (ix) ability to collect reinsurance recoverables; (x) changes in the availability, cost or quality of reinsurance; (xi) developments in global financial markets that could affect the Company's investment portfolio; (xii) risks associated with the introduction of new products and services; (xiii) increased competition on the basis of pricing, capacity, coverage terms or other factors; (xiv) changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers; (xv) the impact of Year 2000 related issues (for example, the impact on the Company's technology systems and underwriting exposures); (xvi) the effects of mergers, acquisitions and divestitures; (xvii) ineffectiveness or obsolescence of the Company's business strategy due to changes in present or future market conditions; and (xviii) the legal environment. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on any forward-looking statements, which speak only as at their dates. Overview of the Company The Company is the holding company for five wholly owned operating entities: Terra Nova Insurance Company Limited ("Terra Nova") in the U.K., Terra Nova (Bermuda) Insurance Company Ltd. ("Terra Nova (Bermuda)"), Compagnie de Reassurance D'Ile de France ("Corifrance") in Paris, Terra Nova Capital Limited ("Terra Nova Capital"), the Company's corporate capital provider at Lloyd's, and Octavian Syndicate Management Limited ("Octavian"). Octavian manages the 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. 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. 3 The Company entered into an Agreement and Plan of Merger and Scheme of Arrangement, dated as of August 15, 1999, and amended on September 10, 1999, and January 28, 2000, with Markel Corporation ("Markel"). The Agreement provides for the merger of a wholly-owned subsidiary of Markel Holdings into Markel and a scheme of arrangement between the Company and its shareholders. After completion of the merger and the scheme of arrangement, each of the Company and Markel will be a wholly-owned subsidiary of Markel Holdings, which will change its name to "Markel Corporation." At the effective time of the merger and scheme of arrangement each outstanding Class A ordinary share, other than 2,069 shares held by Markel or its transferee, and each outstanding Class B ordinary share of the Company will be cancelled and the holders thereof, other than Markel, the Company or its subsidiaries, will be entitled to receive $13.00 in cash, 0.07027 of a Markel Holdings common share and 0.07027 of a Markel Holdings contingent value right per share. On March 16, 2000, the Company's and Markel's shareholders approved the merger and scheme of arrangement at special shareholder meetings called for the purpose. Subject to approval by the Bermuda Supreme Court and completion or waiver of all closing conditions, the merger and scheme of arrangement are expected to be completed on March 24, 2000. The Company is organized as follows: [Company Organizational Chart appears here] Gross written premiums and shareholders' equity of the operating subsidiaries for 1999 were as follows:
Gross Written Shareholders' AM Best S&P (dollars in millions) Premiums Equity Rating Rating --------------------- ------------- ------------- ------- ------ The Company...................... $864.9 $444.0 Terra Nova....................... 246.2 203.0 A A Terra Nova (Bermuda)............. 46.0 177.0 A A Terra Nova Capital............... 552.7 (67.3)(1)(2) A(3) A+(4) Corifrance....................... 20.0 37.6 A- A-
- -------- (1) Backed by $251.5 million of letters of credit from a subsidiary of Terra Nova (Bermuda). (2) On February 12, 2000, $75.0 million of capital was invested in Terra Nova Capital. (3) Benefits from the Lloyd's global rating of "A". (4) Benefits from the Lloyd's global rating of "A+". 4 Business Segments 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, 1998 and 1999, 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 below.
Year ended December 31, ---------------------------------------- 1999 1998 1997 ------------ ------------ ------------ % of % of % of Gross written premiums Amount total Amount total Amount total ---------------------- ------ ----- ------ ----- ------ ----- Terra Nova............................ $246.2 28.5% $302.2 39.8% $288.7 52.5% Terra Nova (Bermuda).................. 46.0 5.3 80.5 10.6 54.9 10.0 Terra Nova Capital.................... 552.7 63.9 358.9 47.3 204.2 37.1 Corifrance............................ 20.0 2.3 17.8 2.3 2.4 0.4 ------ ----- ------ ----- ------ ----- Total............................... 864.9 100.0 759.4 100.0 550.2 100.0 ------ ----- ------ ----- ------ ----- Property.............................. 405.1 46.8 329.1 43.3 226.7 41.2 Casualty.............................. 202.5 23.4 158.1 20.8 115.1 20.9 Marine & aviation..................... 255.0 29.5 204.6 27.0 169.3 30.8 Orphan syndicate business............. 2.3 0.3 67.6 8.9 39.1 7.1 ------ ----- ------ ----- ------ ----- Total............................... 864.9 100.0 759.4 100.0 550.2 100.0 ------ ----- ------ ----- ------ ----- Direct business....................... 601.4 69.5 407.8 53.7 269.6 49.0 Reinsurance assumed................... 263.5 30.5 351.6 46.3 280.6 51.0 ------ ----- ------ ----- ------ ----- Total for the Company............... $864.9 100.0% $759.4 100.0% $550.2 100.0% ------ ----- ------ ----- ------ -----
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-U.S. reinsurers. As at March 20, 2000, Terra Nova was accredited as a reinsurer in forty four jurisdictions of the United States and had an application for approval pending in a further three. Terra Nova is also licensed to transact non-marine reinsurance in Canada through its branch office in Toronto. In December 1999, Terra Nova announced its decision to close its branch office in Brussels. Marine insurance is transacted both on a direct and a reinsurance basis through the International Underwriting Association of London. This segment encompasses cargo, specie, protection and indemnity ("P&I") and liability. Terra Nova's total marine writings were lower in 1999 than in 1998 due in large part to its exit from marine hull and energy business in December 1998. In 1999, Terra Nova wrote $130.2 million of property business (representing 52.9% of total business), $58.3 million of casualty business (23.7%) and $57.7 million of marine business (23.4%). 5 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. In 1999, Terra Nova (Bermuda) wrote $0.8 million of orphan syndicate business compared to $36.0 million in 1998. Terra Nova Capital Through Terra Nova Capital, the Company participates on the Lloyd's syndicates managed by Octavian. The syndicates' writings include mainly U.K. property and liability, U.K. and overseas auto, marine and aviation lines. Terra Nova Capital's average participation on the Octavian syndicates increased to approximately 77% in 1999, from 60% in 1998 and 44% in 1997. This was the main reason for the Company's overall increase in premium writings in 1999 over prior years. For the 2000 underwriting year, Octavian has $543.2 million ((Pounds)339.5 million) of aggregate underwriting capacity, net of commission, of which $483.7 million ((Pounds)302.3 million), or approximately 90%, is provided by the Company through Terra Nova Capital. Syndicates 554 and 959 both ceased writing new business during 1999. Syndicate 959 has been merged into Syndicate 1009 for the 2000 underwriting year. Syndicate 554 has ceased writing business altogether. The Octavian syndicates for the 1999 underwriting year were as follows:
The Company's Syndicate Active 1999 share of number underwriter Capacity 1999 capacity Products --------- ---------------- --------- ------------- -------- (dollars in millions) % Jonathan L. 329 Jones $64.0 77.8% Marine hull, war/political risks, cargo & specie, P&I, energy Malcolm H. 554 Waterlow 39.2 97.4 U.K. auto 702 Reg E. Brown 128.0 55.9 Professional indemnity, crime, legal expenses, property, personal accident, employers' liability/public liability, bloodstock 959 Ray J. Busbridge 72.4 88.3 Airlines, commercial/charter products, satellite, other aviation, personal accident 1009 David E. Hope 96.0 65.6 Energy, liability, hull, war, specie, cargo, excess of loss, onshore property 1227 J. Nick C. 52.8 100.0 Reinsurance of orphan syndicates, property direct & facultative, Wooldridge financial institutions business, contingency, U.S. property/casualty packages 1228 Peter M. 123.8 84.7 Private auto, commercial auto, U.K. and overseas contracts auto, Routledge household & commercial property 1239 Malcolm E. 54.4 84.6 Property, financial institutions, casualty, personal accident, contingency Warrington
Corifrance Corifrance is a French reinsurance company based in Paris. Corifrance transacts specialty treaty and facultative reinsurance business internationally, mainly outside the U.S., on a direct and brokered basis. 6 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, 1999: Percentage of Gross Written Premiums (/1/) by Broker (/2/) for year ended December 31, 1999
Broker Percentage ------ ---------- J & H Marsh & McLennan, Incorporated.......................... 15.1% Aon Corporation............................................... 10.5 Willis Corroon................................................ 7.3
-------- (1) Based on premiums reported by each broker for the 1999 underwriting year. (2) Affiliate companies are combined within each broking group. Underwriting Underwriting of new and renewal business is conducted generally 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 various commercially available software programs 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 and other rating features 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. 7 Loss and Loss Adjustment Expense Reserves General The loss and loss adjustment expense ("LAE") liabilities consist of case reserves and incurred but not reported ("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 an estimated ultimate loss amount for claims not yet notified and 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. Management believes the Company's reserves for losses and LAE are adequate. However, 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. This could have a material adverse effect on the Company's financial condition. The following table shows the development of net reserves for losses and LAE for the calendar years 1989 to 1999 for all lines of business, except the Company's aviation business in run-off. The favourable development is largely attributable to redundancies experienced on the Company's casualty account on the 1986 to 1993 accident years. These redundancies have been partially offset by deteriorations due to LMX spiral losses in the marine account on the 1989 and 1993 accident years and asbestos related and environmental pollution losses in both the marine and casualty accounts on the 1985 and prior accident years. 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 1989 loss reserves in 1991 will show in the re-estimation of reserves for the years 1989 through 1990. 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) is 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 1999 and the original estimate as shown on the top line of the table. 8 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, ---------------------------------------------------------------------------------------- 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ -------- Reserves for unpaid losses and LAE at December 31............ $637.1 $693.9 $724.9 $784.5 $775.6 $847.3 $814.2 $824.0 $911.0 $982.9 $1,063.5 Reserve re-estimated (1) as of: One year later......... 655.0 719.3 761.0 806.9 802.5 850.1 811.6 813.6 886.0 938.4 Two years later........ 671.1 736.5 773.7 821.5 810.5 850.1 793.0 793.0 800.7 Three years later...... 691.2 743.8 780.5 829.0 810.7 832.9 777.8 716.7 Four years later....... 681.2 738.1 792.4 829.8 800.7 812.8 703.2 Five years later....... 663.6 755.5 793.5 816.5 784.7 739.7 Six years later........ 674.1 756.5 776.6 800.5 719.3 Seven years later...... 674.0 741.2 760.2 738.2 Eight years later...... 667.2 724.7 699.3 Nine years later....... 655.3 669.3 Ten years later........ 613.6 Cumulative redundancy... 23.5 24.6 25.6 46.3 56.3 107.6 111.0 107.3 110.3 44.5 As a percentage of unpaid losses and LAE.. 3.69% 3.55% 3.53% 5.90% 7.26% 12.70% 13.63% 13.02% 12.10% 4.53% Paid (cumulative) as of: One year later......... $ 94.2 $115.3 $119.3 $143.8 $151.8 $168.8 $123.4 $145.7 $187.6 245.3 Two years later........ 174.6 201.3 228.2 268.3 259.0 253.6 227.6 241.6 303.7 Three years later...... 190.1 274.3 316.1 350.8 311.8 327.8 293.0 301.7 Four years later....... 242.2 341.0 379.9 383.8 368.8 380.7 336.8 Five years later....... 293.0 395.8 402.5 426.8 405.8 416.6 Six years later........ 330.2 407.8 438.3 457.7 433.7 Seven years later...... 336.6 435.5 464.0 483.1 Eight years later...... 353.5 456.8 487.9 Nine years later....... 370.8 478.2 Ten years later........ 388.5
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 1999 -------- -------- -------- -------- -------- -------- -------- 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 $1,410.0 Reinsurance recoveries on unpaid losses and LAE.................... 463.2 376.5 354.5 254.1 246.7 226.1 346.5 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 1,207.1 Two years later........ 1,428.9 1,319.9 1,168.4 1,058.6 1,071.3 Three years later...... 1,428.0 1,311.2 1,150.6 989.1 Four years later....... 1,431.3 1,291.4 1.081.4 Five years later....... 1,428.4 1.223.9 Six years later........ 1.368.4 Reinsurance recoveries on unpaid losses and LAE re-estimated (2) as of: One year later......... 530.3 460.1 363.2 253.4 260.9 268.7 Two years later........ 618.4 469.9 370.1 264.1 270.6 Three years later...... 617.3 478.3 372.8 272.4 Four years later....... 630.6 478.7 378.2 Five years later....... 643.6 484.2 Six years later........ 649.1 Gross cumulative (deficiency) redundancy............. (129.6) (0.1) 87.3 89.1 86.4 1.9 as a percentage of unpaid losses and LAE................... (10.46%) (0.01%) 7.47% 8.26% 7.46% 0.16% Paid (cumulative) as of: One year later......... $ 303.9 $ 290.6 $ 229.7 $ 179.6 $ 246.3 $ 251.8 Two years later........ 517.9 479.8 364.4 328.0 403.0 Three years later...... 679.3 576.4 477.2 418.7 Four years later....... 752.5 672.3 550.2 Five years later....... 829.2 730.9 Six years later........ 884.3
- ------- (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:
1999 1998 1997 ---------- ---------- ---------- (dollars in thousands) Reserves for unpaid losses and loss adjustment expenses, at beginning of year.................................... $1,209,003 $1,157,724 $1,078,108 Less: reinsurance recoverables on unpaid losses......................... (226,098) (246,728) (254,129) ---------- ---------- ---------- Net balance at beginning of year......... 982,905 910,996 823,979 ---------- ---------- ---------- Net incurred losses and loss adjustment expenses related to: Current year........................... 535,753 384,531 292,876 Prior year............................. (44,510) (24,964) (10,396) ---------- ---------- ---------- Total net incurred losses and loss adjustment expenses..................... 491,243 359,567 282,480 ---------- ---------- ---------- Net paid losses and loss adjustment expenses related to: Current year........................... (179,844) (138,918) (69,685) Prior year............................. (245,323) (187,559) (145,702) ---------- ---------- ---------- Total net paid losses and loss adjustment expenses................................ (425,167) (326,477) (215,387) Foreign exchange adjustment.............. (18,753) (5,169) (10,967) ---------- ---------- ---------- Net balance at end of year............... 1,030,228 938,917 880,105 Net reserves from reinsurance to close................................. 33,257 43,988 -- (1) Net reserves from Corifrance acquisition........................... -- -- 30,891 ---------- ---------- ---------- Net reserves at end of year.............. 1,063,485 982,905 910,996 Plus Reinsurance recoverables: The Company............................ 346,483 226,098 236,847 Reinsurance recoverables related to net reserves from Corifrance acquisition.. -- -- 9,881 ---------- ---------- ---------- Reinsurance recoverable by the Company... 346,483 226,098 246,728 ---------- ---------- ---------- Reserves for unpaid losses and loss adjustment expenses, at end of year..... $1,409,968 $1,209,003 $1,157,724 ========== ========== ==========
- -------- (1) The net reserves of $17,910,000 from the reinsurance to close of the 1995 year of account 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. The reinsurance to close reserves represent a retrospectively rated reinsurance contract in respect of an outstanding claims portfolio from the closing year of account of a Lloyd's syndicate. (The reinsurance to close occurs at the end of the third year of a Lloyd's underwriting year.) In the 1997 financial year, the reinsurance to close premium for the 1995 year of account of $17,910,000 and losses associated with this premium of $17,910,000 were included in the revenue statement in accordance with the then current recommended accounting practice in the London Market. In the 1999 and 1998 financial years, following further deliberation by management on the appropriate U.S. GAAP accounting treatment, the reinsurance to close premium for the 1997 and 1996 years of account of $33,257,000 and $43,988,000 was included as an asset in the balance sheet. The liabilities of $33,257,000 and $43,988,000 associated with this asset were included in unpaid losses in the balance sheet. There was no impact to net income within 1999 and 1998 as a consequence of this change in the Company's practice. Incurred claims relating to prior years are offset by decreases to prior year net written and net earned premiums less related acquisition costs of $27,300,000, $9,757,000 and $4,800,000 for 1999, 1998 and 1997, respectively. When these revisions to prior written and earned premiums are considered, the Company experienced net prior year improvements of $17,210,000, $15,207,000 and $5,596,000 in 1999, 1998 and 1997, respectively. The majority of the movement in unpaid losses and LAE attributable to prior years was in relation 10 to Terra Nova's casualty business. The casualty movements in the 1999 financial year arose from the favorable settlements during these financial years in respect of various casualty contracts. The favorable casualty movements in the 1999 financial year were partially offset by deficiencies on the Company's property, motor and aviation classes as a result of claims experience being worse than expected on certain contracts. The majority of these contracts were in respect of the 1998 accident year. The Company believes that its reserves at December 31, 1999, 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. 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 1999, payments made by the Company for asbestos-related and environmental pollution claims totaled $35.0 million. Included in the liability for loss reserves at December 31, 1999, are $90.3 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 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 Reserve Outstanding (Net of reinsurance) (dollars in millions)
Year ended December 31, ----------------- 1999 1998 1997 ----- ----- ----- Incurred losses.............................................. $ 1.9 $13.1 $ 1.6 Incurred LAE................................................. 1.7 4.6 1.2 ----- ----- ----- Incurred losses and LAE...................................... $ 3.6 $17.7 $ 2.8 ----- ----- ----- Net paid losses and LAE...................................... $ 4.4 $ 1.1 $ 2.5 ----- ----- ----- Losses and LAE case reserves................................. $29.6 $29.0 $28.3 Losses and LAE IBNR reserves................................. 44.9 46.3 30.5 ----- ----- ----- Total reserves............................................. $74.5 $75.3 $58.8 ===== ===== =====
11 Environmental Pollution Losses and LAE Incurred and Reserve Outstanding (Net of reinsurance)(dollars in millions)
Year ended December 31, ---------------------- 1999 1998 1997 ------ ------ ------ Incurred losses........................................ $ (3.1) $ (6.7) $ (2.9) Incurred LAE........................................... (0.7) (1.8) 0.9 ------ ------ ------ Incurred losses and LAE................................ $ (3.8) $ (8.5) $ (2.0) ------ ------ ------ Net paid losses and LAE................................ $ 1.0 $ 1.3 $ 1.5 ------ ------ ------ Losses and LAE case reserves........................... $ 8.4 $ 9.5 $ 9.5 Losses and LAE IBNR reserves........................... 7.4 11.1 20.8 ------ ------ ------ Total reserves....................................... $ 15.8 $ 20.6 $ 30.3 ====== ====== ====== Reinsurance recoverables netted against the asbestos-related and environmental pollution loss reserves for each of the years 1999, 1998 and 1997: Year ended December 31, ---------------------- 1999 1998 1997 ------ ------ ------ (dollars in millions) Gross reserves......................................... $128.2 $129.2 $111.8 Reinsurance recoverables............................... 37.9 33.3 22.7 ------ ------ ------ Net reserves........................................... $ 90.3 $ 95.9 $ 89.1 ====== ====== ======
Litigation expenses included in the asbestos-related and environmental pollution loss reserves for each of the years 1999, 1998 and 1997:
Year ended December 31, ----------------- 1999 1998 1997 ----- ----- ----- (dollars in millions) Total reserves.......................................... $90.3 $95.9 $89.1 Litigation expenses included............................ 24.4 25.8 24.1
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. 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 12 assembled from various sources, with special attention given to new and small companies. The current system is based on recognized rating agency reports. The reinsurance element of the Company's total gross exposure is reviewed regularly for collectability issues, including solvency and disputes. As needed, the Company sets up a bad debt reserve for reinsurance recoverables in doubt. At December 31, 1999, this reserve stood at $46.5 million or 10.2% of total reinsurance recoverables. The Company's recoverables from its reinsurers consist of amounts recoverable for paid and outstanding claims and amounts recoverable related to IBNR claims. The following table sets out net reinsurance recoverables from continuing operations from December 31, 1997, to December 31, 1999: Aggregate of Net Reinsurance Recoverables (dollars in millions)
At December 31, At December 31, At December 31, ---------------- ---------------- --------------- 1999 Movement 1998 Movement 1997 ------ -------- ------ -------- --------------- Paid claims............... $ 79.7 $ 18.2 $ 61.5 $ 12.6 $ 48.9 Notified outstanding claims................... 293.8 73.7 220.1 (7.0) 227.1 IBNR...................... 81.6 52.4 29.2 (9.8) 39.0 Bad Debt Provision........ (46.5) (7.7) (38.8) (9.9) (28.9) ------ ------ ------ ------ ------ Total................... $408.6 $136.6 $272.0 $(14.1) $286.1 ====== ====== ====== ====== ======
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. Analysis of Net Reinsurance Recoverables (dollars in millions)
Year ended December 31, -------------------- 1999 1998 1997 ------ ------ ------ Reinsurance recoverable: Continuing operations............................... $307.9 $180.8 $133.8 Marine LMX business................................. 100.7 91.2 152.3 ------ ------ ------ Total............................................. $408.6 $272.0 $286.1 ====== ====== ======
At December 31, 1999, syndicates at Lloyd's were the Company's principal reinsurers, with reinsurance recoverables on paid and outstanding and IBNR claims from continuing business of approximately $106.5 million.
AM Best Premium Reinsurer Rating(1) Ceded(2) --------- -------- -------- % Lloyd's Syndicates................................... A 7.9% Swiss Reinsurance Co./European General Reinsurance Co. ................................................ A+ 3.1 CNA Reinsurance Company Ltd.......................... A 3.0 ERC Frankona Ruckversicherungs AG.................... A+ 2.7 Hannover Ruckversicherungs AG........................ A+ 1.5
-------- (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 1999 underwriting year. 13 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. In May 1999, the Company transferred the management of its equity portfolio to Wellington Management International, Boston. Blackrock Financial Management Inc, New York, manages a portfolio of the Company's mortgage and asset backed fixed interest securities. An in-house team at Terra Nova Asset Management Limited, headed by the Chief Investment Officer, 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. The Company does not invest in real estate 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 76% of the investment portfolio of the Company is held in U.S. dollars. For more information about the investment portfolio, including breakdowns of the sector and maturity distributions, see Note 4 to the consolidated financial statements. 14 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 20, 2000, 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 20, 2000, the Company's long term senior debt rating was BBB, Baa2 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. 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 overheads considered necessary to complete the run-off of the aviation business was treated as a one-time charge ($2.1 million in 1992). 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 Terra Nova's aviation business. 15 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, -------------------- 1999 1998 1997 ----- ----- ------ Reserve for unpaid losses and loss adjustment expenses, gross of reinsurance, at beginning of the year......... $65.8 $75.8 $139.7 Less reinsurance recoverables........................... 39.2 42.8 91.1 ----- ----- ------ Net reserves at beginning of the year................... 26.6 33.0 48.6 ----- ----- ------ Incurred related to: Prior years........................................... (1.4) (1.4) -- ----- ----- ------ Total incurred.......................................... (1.4) (1.4) -- ----- ----- ------ Paid related to: Prior years........................................... (2.0) (5.1) (14.5) ----- ----- ------ Total paid.............................................. (2.0) (5.1) (14.5) Foreign exchange adjustment............................. (0.2) 0.1 (1.1) ----- ----- ------ Net reserves at end of year............................. 23.0 26.6 33.0 Reinsurance recoverables by the Company................. 36.2 39.2 42.8 ----- ----- ------ Reserves for unpaid losses and loss adjustment expenses, gross of reinsurance, at end of the year............... $59.2 $65.8 $ 75.8 ----- ----- ------
Employees At December 31, 1999, Terra Nova, Terra Nova Asset Management Limited and Terra Nova (Bermuda) had 173 employees. At the same date, Corifrance had 30 employees. Octavian had 418 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 77 employees. The Company believes that its relationship with employees is excellent. 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. Treasury ("Treasury") under the Insurance Companies Act 1982. Previously, supervision of insurance companies was undertaken by the Department of Trade and Industry ("D.T.I."). The D.T.I.'s 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. 16 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 insurance 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 the insurance company and any major reinsurer; and (iv) the types of reinsurance cover purchased by the insurance company. 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, 1999, Terra Nova's estimated minimum statutory solvency margin was $39.2 million and the excess of its solvency margin over its minimum solvency margin was $88.5 million. Dividends. The ability of Terra Nova to declare and pay dividends is limited by a Notice of Requirements issued by the DTI (now the Treasury) on May 22, 1995 (the "Notice"). The Notice provides that Terra Nova must give 14 days' advance notice to the Treasury of its intention to declare and pay a dividend. The Treasury may direct that no such declaration or payment be made. In reviewing dividend proposals, the Treasury considers the adequacy of Terra Nova's solvency margin, its recent operating performance and other factors deemed appropriate by the Treasury. In addition, Terra Nova must comply with the Companies Act, which provides that dividends may only be paid out of distributable profits (i.e., its accumulated realized profits, so far as not previously used by distribution or capitalization, less its accumulated realized losses, so far as not previously written off in a reduction or reorganization of capital). At December 31, 1999, Terra Nova's solvency margin was $88.5 million in excess of its estimated minimum solvency margin, and its distributable profits under U.K. GAAP were $78.5 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; (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 17 (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%; 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 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. 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 exercising some direct supervision and allowing Lloyd's to exercise other supervision under its direction. 18 For the purposes of the Lloyd's Act 1982, the Company is deemed a Lloyd's "managing agent" by virtue of its being the parent company of the Lloyd's managing agent, Octavian Syndicate Management Limited. 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 it owns any interest in a Lloyd's broker (except interests representing not more than 5% in nominal amount of the Lloyd's brokers' stock, shares or other securities or any class thereof which are authorized to be traded on a stock exchange or in any over-the-counter market, and in either case are so traded regularly or from time to time). In 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). Similar rules to those above apply in relation to partnerships and partners therein. These provisions prohibit a Lloyd's broker or any of the persons referred to 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 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 19 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. 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 20 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. 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, 1999, the trust fund was valued at $21.0 million in order to comply with the new trust fund requirement adopted by Louisiana, effective July 31, 1999 (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 December 31, 1999, the highest such requirement was $15.0 million. Terra Nova also files annually with the International Insurers Department (the "IID") of the National Association of Insurance Commissioners ("NAIC") and with regulatory authorities in many of the U.S. jurisdictions in which Terra Nova is an approved or eligible surplus 21 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 and New York. Under this new liabilities-based trust fund standard, Terra Nova was 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. New York adopted this standard, effective January 1, 2000. Terra Nova is not aware that other states are considering adopting this standard at present. 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 $124.3 million as at December 31, 1999. As of December 31, 1999, Terra Nova had received trusteed reinsurer approval from the departments of insurance of 44 states and had applications for trusteed reinsurer status pending in 3 additional states. Terra Nova provides U.S. cedents that are not domiciled in one of the states in which it is approved as a trusteed reinsurer with letters of credit to secure ceded liabilities. Such cedents are thus permitted to deduct such liabilities when preparing statutory financial statements. Certain U.K., U.S. and Bermuda Tax Considerations Taxation of the Company and its Subsidiaries Bermuda Under current Bermuda law, there is no income or capital gains tax payable by the Company or its Bermuda subsidiaries. The Company and its Bermuda subsidiaries have received from the Minister assurances, under The Exempted Undertakings Tax Protection Act 1966 of Bermuda, to the effect that in the event of there being enacted in Bermuda any legislation imposing tax computed on profits or income, or computed on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of any such tax shall not be applicable to them or to any of their respective operations or to their shares, debentures or other obligations until March 28, 2016. These assurances are subject to the proviso that they are not to be construed so as to prevent the application of any tax or duty to such persons as are ordinarily resident in Bermuda or to prevent the application of any tax payable in accordance with the provisions of The Land Tax Act 1967 of Bermuda or otherwise payable in relation to any property leased to the Company or its Bermuda subsidiaries. The Company and its Bermuda subsidiaries are required to pay certain annual Bermuda government fees. In addition, Terra Nova (Bermuda) is required to pay certain business fees as an insurer under the Bermuda 22 Act. As of March 20, 2000, there would be no Bermuda withholding tax on dividends paid by Terra Nova (Bermuda) to the Company. United Kingdom U.K. Holdings and its U.K. resident subsidiaries are chargeable to U.K. corporation tax on their world-wide profits, currently at the rate of 30%, reduced from 31% on April 1, 1999. Provided U.K. 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, U.K. Holdings, the Company and Terra Nova (Bermuda) must be reported and should be made on an arm's length basis or will be subject to adjustment, for tax purposes, as if they were made on an arm's length basis. No U.K. withholding tax will be imposed on dividends paid to the Company by U.K. Holdings and the Company will have no U.K. tax liability in respect of such dividends. United States In general, a foreign corporation is subject to U.S. federal income tax on its taxable income that is treated as effectively connected with its conduct of a trade or business within the United States and to the 30% U.S. branch profits tax on its effectively connected earnings and profits (with certain adjustments) deemed repatriated out of the United States unless the corporation is entitled to relief under the provisions of a tax treaty into which the United States has entered. The United States has entered into tax treaties with Bermuda (the "Bermuda Treaty") and the U.K. (the "U.K. Treaty"). Pursuant to the U.K. Treaty, business profits earned by residents of the U.K. may be taxed in the United States only if such profits are attributable to the conduct of a trade or business in the United States through a permanent establishment situated therein. The U.K. Treaty also prevents the imposition of the branch profits tax on qualified treaty residents of the U.K. The Bermuda Treaty provides that business profits derived from carrying on the business of insurance by a Bermuda company that is an "enterprise of insurance" may only be taxed in the United States if such profits are attributable to the conduct of a trade or business in the United States through a permanent establishment situated therein. However, a Bermuda company is entitled to the Bermuda Treaty benefits described above only if (i) more than 50% of its shares are beneficially owned, directly or indirectly, by individuals who are U.S. citizens or residents or Bermuda residents and (ii) the company's income is not used in substantial part, to make disproportionate distributions to, or to meet certain liabilities to, persons who are not U.S. citizens or residents or Bermuda residents. The Bermuda Treaty does not preclude the imposition of the U.S. branch profits tax. The Company believes that the Company and its subsidiaries have been operated and in the future, will continue to be operated, in a manner that will not cause any of them to be treated as being engaged in a U.S. trade or business. However, because the Internal Revenue Code of 1986, as amended (the "Code"), the Treasury Regulations and court decisions do not identify definitively activities that constitute being engaged in a U.S. trade or business, and because of the factual nature of the determination, there can be no assurance that the Internal Revenue Service (the "Service") will not contend that the Company or one of its subsidiaries is engaged in a U.S. trade or business. If the Company or any of its subsidiaries were considered to be engaged in a U.S. trade or business, that entity would be subject to U.S. federal income tax on income effectively connected with that trade or business, and would be subject to the branch profits tax as well, unless it was entitled to relief under the U.K. Treaty or the Bermuda Treaty. There can be no assurance that Terra Nova (Bermuda) is entitled, or in the future will be entitled, to the benefits of the Bermuda Treaty. However, if Terra Nova (Bermuda) were so entitled and were considered to be 23 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 U.K. 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 U.K. 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). 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 are 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. 24 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 1999 and 1998, with cash dividends paid: 1999 1998 --------------------------------- ---------------------------------- Market Price Dividend Market Price Dividend Quarter High Low Per Share High Low Per Share - ------- --------- -------- --------- --------- --------- --------- 1 $ 26 3/4 $ 21 3/4 $ 0.06 $ 30 1/2 $23 13/16 $ 0.05 2 $ 27 3/4 $ 21 1/2 $ 0.06 $ 33 $ 29 $ 0.06 3 $ 32 7/16 $ 23 $ 0.06 $ 34 1/2 $ 25 7/8 $ 0.06 4 $31 13/16 $28 9/16 $ 0.06 $29 15/16 $ 23 1/16 $ 0.06 Year end closing price: $30 $25
(b) The approximate number of holders of common shares, as at December 31, 1999, was 1,500. ITEM 6--SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1999 The following table sets forth selected consolidated financial information with respect to the Company for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements of the Company and related notes and "Management's Discussion and Analysis of Results of Operations and Financial Conditions".
Five Year Financial Summary ------------------------------------------------ 1999 1998(1) 1997 1996 1995 -------- -------- -------- -------- -------- (dollars in millions, except per share data) Results of Operations Gross written premiums...... $ 864.9 $ 759.4 $ 550.2 $ 361.0 $ 302.7 Net written premiums........ 618.4 646.2 483.5 311.2 247.0 Net earned premiums......... 585.3 546.9 419.1 278.8 251.9 Net investment income....... 93.8 93.3 85.1 78.1 74.5 Net (loss) income before extraordinary charge....... (35.0) 84.0 73.4 63.9 43.3 Comprehensive (loss) income before extraordinary charge..................... (122.9) 108.0 93.5 50.4 93.2 Net operating (losses) earnings (2)............... (55.6) 70.9 62.9 57.2 39.3 Balance Sheet Total assets................ $2,631.7 $2,479.4 $2,220.1 $1,867.3 $1,785.0 Long-term debt.............. 175.0 175.0 175.0 100.0 100.0 Convertible redeemable preferred shares........... -- -- -- -- 33.4 Shareholders' equity........ 444.0 570.9 481.9 398.8 197.0 Ratio Analysis GAAP combined ratio......... 129.4% 98.8% 98.2% 97.2% 103.8% Investment yield (3)........ 6.1% 6.1% 6.2% 6.3% 6.7% Total return (4)............ 0.6% 9.1% 9.0% 5.7% 13.7% Debt to total capital....... 28.3% 23.5% 26.6% 20.0% 33.7% Per Share Data Book value per share (5).... $ 17.50 $ 22.51 $ 18.96 $ 15.43 $ 12.80 Net income before extraordinary charge per share (6).................. $ (1.38) $ 3.22 $ 2.82 $ 2.68 $ 2.59 Dividends per common share.. $ 0.24 $ 0.23 $ 0.17 $ 0.06 --
25 - -------- (1) 1998 net income, comprehensive income and net operating earnings and related per share figures are stated before the extraordinary charge of $11.6 million or $0.45 per share associated with the debt refinancing in May 1998. (2) Net operating (losses) earnings represents net (loss) income before extraordinary charges, discontinued operations, minority interests, and realized gains on investments after tax. Management believes this measure is relevant and useful to the investor as it shows income from core operations. It excludes non-recurring items and realized gains on investments which reflect management's decision to sell investments from time to time. The measure does not replace operating income or net income, computed in accordance with United States generally accepted accounting principles, as a measure of profitability. (3) Investment yield reflects net investment income as a percentage of average invested assets. (4) Total return includes net investment income, net realized investment gains and change in market value during the period as a percentage of average invested assets. (5) Book value per share is equal to shareholders' equity divided by the number of common shares outstanding at the end of the period. (6) Net (loss) income per share is calculated on a diluted basis by using the weighted average number of common shares outstanding during the period. 1996 and 1995 disclosures have been restated in order to comply with SFAS No.128--"Earnings per Share". 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 (U.K.) Holdings plc ("U.K. 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"). Business Operations The Company writes specialty property, casualty, marine and aviation insurance and reinsurance business through its subsidiaries on a worldwide basis. The Company has changed its basis of segmentation from that used last year. The four reportable segments are Terra Nova, Terra Nova (Bermuda), Terra Nova Capital and Corifrance. The segments are strategic business units that operate in different markets. Terra Nova and the Lloyd's syndicates in which Terra Nova Capital participates are based in the London Market. The London Market is comprised of Lloyd's and companies with underwriting offices close to Lloyd's. Terra Nova (Bermuda) operates in the Bermuda Market which consists of both captive and independent companies. Corifrance is a French reinsurer specializing in property reinsurance in the European Market. 26 The Company's premiums by segment for the years ended December 31, 1999, 1998 and 1997, and the combined ratio are set out in the following table:
Year ended December 31, -------------------------------------------------- 1999 1998 1997 ---------------- ---------------- ---------------- Amount Percent Amount Percent Amount Percent -------- ------- -------- ------- -------- ------- (dollars in thousands) Gross Written Premiums Terra Nova................ $246,219 28.5% $302,240 39.8% $288,684 52.5% Terra Nova (Bermuda)..... 45,978 5.3 80,480 10.6 54,834 10.0 Terra Nova Capital....... 552,692 63.9 358,860 47.3 204,325 37.1 Corifrance............... 20,044 2.3 17,808 2.3 2,400 0.4 -------- ----- -------- ----- -------- ----- Total................... $864,933 100.0% $759,388 100.0% $550,243 100.0% ======== ===== ======== ===== ======== ===== Net Written Premiums Terra Nova................ $179,563 29.0% $282,046 43.6% $264,308 54.6% Terra Nova (Bermuda)..... 34,584 5.6 79,842 12.4 48,657 10.1 Terra Nova Capital....... 388,876 62.9 270,740 41.9 168,180 34.8 Corifrance............... 15,153 2.5 13,569 2.1 2,400 0.5 -------- ----- -------- ----- -------- ----- Total................... $618,446 100.0% $646,197 100.0% $483,545 100.0% ======== ===== ======== ===== ======== ===== Net Earned Premiums Terra Nova............... $227,694 38.9% $252,714 46.2% $256,306 61.2% Terra Nova (Bermuda)..... 39,494 6.8 78,061 14.3 42,985 10.2 Terra Nova Capital....... 303,271 51.8 199,506 36.5 107,978 25.8 Corifrance............... 14,822 2.5 16,627 3.0 11,800 2.8 -------- ----- -------- ----- -------- ----- Total................... $585,281 100.0% $546,908 100.0% $419,069 100.0% ======== ===== ======== ===== ======== ===== Combined Ratio Loss ratio (including LAE).................... 83.9% 65.8% 67.4% Expense ratio............ 45.5 33.0 30.8 ----- ----- ----- Combined Ratio........... 129.4% 98.8% 98.2% ===== ===== =====
Results of Operations The table above shows that gross written premiums increased to $864.9 million in 1999 from $759.4 million in 1998, consistent with the Company's strategy of increasing its share of the business written by the Octavian syndicates. In 1999, the Company's share of capacity increased to 77% from 60% in 1998. For the 2000 underwriting year, the Company has approximately 90% of Octavian's capacity. The Company's underwriting results in 1999 were affected by three main factors. First, 1999 was the worst year for international catastrophe losses in recent history. The Company's share of these catastrophes and large losses for the year was $59 million, including $42 million of catastrophe losses in the fourth quarter. Secondly, the Company was active in closing certain businesses, such as the decisions to exit the London Company Market marine hull and energy business at the beginning of the year and to exit high street motor business in the second quarter, and in re-structuring and combining others, such as the merger of aviation syndicate 959 into marine syndicate 1009. Underwriting losses in 1999 from businesses the Company is not continuing in 2000, together with associated closure costs and additional reinsurance costs incurred in protecting the aviation and satellite business written by Syndicate 959, totaled $122 million in the year. Finally, the Company experienced a significant amount of late reported claims relating to certain property loss events which occurred prior to December 31, 1998. As a result, the underwriting loss in 1999 was $172.2 million compared to a profit of $6.6 million in 1998, reflecting an increase in the combined ratio to 129.4% for the year ended December 31, 1999, from 98.8% for the year ended December 31, 1998. 27 Year Ended December 31, 1999 Compared to Year Ended December 31, 1998 Gross written premiums increased 13.9% to $864.9 million in 1999, up from $759.4 million in 1998. Terra Nova's gross written premiums totalled $246.2 million in 1999 compared to $302.2 million in 1998. The decrease in premium writings reflects Terra Nova's exit from marine hull and energy business in December 1998 and lower premium rates on most classes of business in which it participates. Marine writings were down $21.7 million on last year. Property and casualty writings were down $34.3 million on last year due in part to management's decision to write a portfolio of business through the Company's corporate syndicate at Lloyd's. Terra Nova (Bermuda)'s gross written premiums were $46.0 million in 1999 compared to $80.5 million in 1998. The prior year figure includes $36.0 million of orphan syndicate business compared to $0.8 million written in the current year. Excluding orphan syndicate business, Terra Nova (Bermuda)'s gross written premiums were in line with last year. Terra Nova Capital's gross written premiums increased by 54.0% to $552.7 million from $358.9 million in 1998. The growth is due to an increased participation in the Octavian syndicates from approximately 60% of capacity in 1998 to approximately 77% in 1999. This increase also reflects higher writings at syndicates 702 (benefiting from the newly opened Australian office and other initiatives put in place last year), 1227 (expansion of property writings) and 1228 (more overseas auto business). These increases have been partly offset by the impact of management's decision to close auto Syndicate 554 and cease writing business from October 31, 1999. Management also decided to withdraw from writing general aviation and personal accident business through Syndicate 959 and to concentrate on the airline and satellite accounts. As a result, Syndicate 959 has been merged into Syndicate 1009 for the 2000 underwriting year. The segment wrote $1.6 million of orphan syndicate business in the year compared to $31.6 million last year. Corifrance wrote $20.0 million of premiums in 1999 compared to $17.8 million in 1998. The segment's writings were impacted by lower premium rates in the European property market. As noted above, premiums rates remain low in most of the classes of business the Company writes. It is the Company's policy not to relax underwriting standards in order to maintain premium volume. Management is cautious about predicting any improvement in market conditions. However, there is evidence of premium rates rising in the retrocessional market. While good news, because the reinsurance markets historically are the first to move out of recession, and 31% of the Company's overall book is reinsurance, this will exert pressure on the Company's direct insurance business as margins get squeezed. It is also likely the heavy catastrophe loss experience in the fourth quarter of 1999 will add to the pressure for rate increases. The Company arranges reinsurance protection in order to reduce its exposure to any one policy or physical risk or to a catastrophic accumulation of loss in one event. The Company's net retention of gross premium volume decreased to 71.5% in 1999, down from 85.1% in 1998. The primary reason for this decrease was the Company's bigger participation on the Octavian syndicates in 1999. The Octavian syndicates, particularly the marine and aviation syndicates, buy more reinsurance than the Company's other operating segments. The second reason for the Company buying more reinsurance was due to the perception that reinsurance prices were relatively inexpensive in the very competitive conditions existing in the market, particularly early in the year when most of the protection is bought. The third reason is that the Company bought additional reinsurance to protect its exposure to aviation and satellite business written by Syndicate 959. Net written premiums were $618.4 million in 1999 compared to $646.2 million in 1998. The decrease in 1999 is a result of higher reinsurance costs more than offsetting the increase in gross written premiums. Net earned premiums were $585.3 million in 1999 compared to $546.9 million in 1998. Net investment income increased to $93.8 million in 1999 from $93.3 million in 1998. The improvement in 1999 was the result of positive cash flows which increased the size of the Company's investment portfolio, partially offset by the impact of management's decision to increase the equity component of the investment 28 portfolio, consistent with the longer term focus on growing book value of the Company. Invested assets at fair value declined to $1.4 billion at December 31, 1999, from $1.5 billion at December 31, 1998. The average annualized investment yield was 6.1% in both 1999 and 1998. The average duration of fixed maturity investments at December 31, 1999 and 1998, was 4.2 years and 4.8 years, respectively. Realized net capital gains on sales of investments increased $8.9 million to $26.9 million in 1999 from $18.0 million in 1998. The net gains in 1999 comprise $32.9 million of gains on sales of equity securities and $6.0 million of losses on sales of fixed maturities. The variability in realized gains is largely a result of interest rate volatility which influences the market value of the Company's investments. The Company's investment strategy is to focus on maximizing long-term total investment returns. The net contribution from managing agency income was $0.1 million for 1999 compared to $3.3 million in 1998. The current year movement is due to lower profit commission from the syndicates managed by Octavian and a change in the stock option compensation expense estimate for the Octavian Stock Option Plan. The Plan provides for the grant of options based on profit commissions received by Octavian for the 1996 to 2000 Lloyd's underwriting years. The compensation expense is calculated using APB No.25 and is dependent on both the share price at the grant date for each underwriting year and the projected number of options to be granted. Any change in these variables gives rise to a change in the compensation expense. The current year charge consists of an accrual for part of the estimated cost of options to be granted in respect of the 1997, 1998 and 1999 underwriting years. The Company's combined ratio was 129.4% in 1999 against 98.8% in 1998. The combined ratio measures the relationship of losses and loss adjustment expenses, policy acquisition costs and other operating expenses to net earned premiums. The Company's loss ratio was 83.9% in 1999 against 65.8% in 1998. The increase in the loss ratio is largely the result of a series of significant loss events that occurred during the second half of 1999. In the final week of the year, two intense windstorms caused severe damage to heavily industrialized and populated areas of Western Europe. These storms, Lothar and Martin, have been described as the worst in 400 years and are expected to generate heavy losses for the insurance industry. Current estimates are in the range of $5 billion to $6 billion. The storms produced the most severe damage in France, Switzerland and Germany, countries in which the Company has important client relationships and provides related insurance and reinsurance coverage. At December 31, 1999, the Company had provided for its estimated share of these losses, approximating to $30 million. Earlier in December, another severe but unrelated storm, Anatol, hit Denmark causing substantial property damage. Management expects the Company's total incurred losses from catastrophes in 1999 including these European Storms, Hurricanes Floyd, Jose and Lenny in the United States and the earthquakes in Turkey, to be $59 million. As well as these losses from catastrophic events occurring in 1999, the Company has experienced adverse development on claims relating to certain 1998 loss events. A large part of this adverse development is due to deterioration on proportional treaties and includes late reported losses, notably on Hurricane Georges and Hurricane Mitch. Finally, the Company experienced significant losses on its aviation, satellite, personal accident, motor and marine hull and energy accounts. To address these losses, the Company restructured these accounts during 1999. The Company's expense ratio was 45.5% in 1999 against 33.0% in 1998. The increase in the expense ratio is primarily due to restructuring charges associated with the Company's withdrawal from U.K. private passenger auto, light aircraft and general aviation business during 1999. In addition, the Company bought significantly more reinsurance in 1999 and therefore net written premiums as a percentage of gross written premiums were lower in 1999 compared to 1998, thereby increasing the expense ratio. Finally in 1998, the Company wrote $67.6 million of premiums related to reinsurance to close of orphan Lloyd's syndicates compared to $2.3 million in 1999. This business has very low acquisition costs and therefore reduced the 1998 expense ratio. 29 Interest expense in 1999 related to interest on the $100 million 7.0% Senior Notes issued on May 18, 1998 and interest on the $75 million 7.2% Senior Notes issued on August 26, 1997. The interest expense in 1998 related to the $100 million and $75 million Senior Notes issues and the $100 million 10.75% Senior Notes extinguished in the second quarter of that year. Other expenses increased in 1999 because of a higher level of corporate activity primarily arising from the Markel transaction. Year Ended December 31, 1998 Compared to Year Ended December 31, 1997 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: (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 were partly 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 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 lower retention rate was primarily due to: (a) The Company's increased 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's buying more reinsurance, especially at the Octavian syndicates, due to the general perception that reinsurance prices were relatively inexpensive in the very competitive conditions that currently exist in the market place. This applied particularly in the marine and aviation lines of business. Net written premiums increased 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 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 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 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. 30 The Company's combined ratio was 98.8% in 1998 against 98.2% in 1997. 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. Analyzing the movement on the loss ratio by product: (a) 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. (b) The loss and LAE ratio for non-marine casualty business decreased to 71.8% in 1998 from 74.9% in 1997. This decrease reflected 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. (c) The decrease in the marine 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, 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 was 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 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 Lloyd's charges incurred by the Octavian syndicates. 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 and interest on the $75 million 7.2% Senior Notes. An extraordinary charge of $11.6 million arose during the second quarter of 1998 as a result of U.K. 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 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. Liquidity and Capital Resources The Company seeks to maintain prudent levels of liquidity in the interest of protecting its policyholders, creditors and shareholders. The sources of funds for the Company's insurance subsidiaries consist mostly of net premiums, investment income and proceeds from sales and redemptions of investments. The funds are used to pay claims and operating expenses and to buy both short-term and long-term investments, largely fixed income securities. Short-term investments held by the Company's insurance subsidiaries provide liquidity for projected claims, 31 reinsurance costs and operating expenses. Long-term investments are held to meet longer-tail claims and to support statutory and other capital requirements. The holding companies, U.K. Holdings and Bermuda Holdings, receive cash from their subsidiaries as reimbursement for operating and other administrative expenses they incur according to the terms of various management agreements between the companies. U.K. Holdings has to maintain sufficient liquidity to fund interest payments on its debt. For the year ended December 31, 1999, the cash flow provided by operating activities of the Company was $20.1 million compared to $75.9 million in 1998. The movement reflects the higher level of loss activity in 1999 compared to 1998 and costs incurred in 1999 in restructuring the Company's businesses. The cash flow provided by investing activities of the Company was $21.2 million compared to $122.8 million used in investing activities in 1998. The movement reflects the investment of higher operating cash flows in 1998 compared to 1999 and the Company maintaining a high cash balance at the end of 1999 in anticipation of the Markel transaction. The cash flow used in financing activities of the Company was $6.9 million compared to $22.8 million provided by financing activities in 1998. The movement primarily reflects the debt refinancing in 1998. The Company's ability to pay dividends on its capital stock and to meet 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 restrictions under U.K. law. Similarly, dividend and other payments by Terra Nova (Bermuda) and Corifrance are subject to restrictions under Bermudian law and French law, respectively. On December 23, 1999, Terra Nova (Bermuda) paid a dividend of $180 million to Bermuda Holdings. The dividend was settled by transferring Terra Nova (Bermuda)'s full equity portfolio, with the balance made up of cash and fixed interest securities. Bermuda Holdings also received a dividend of $33 million from U.K. Holdings in December 1999. At December 31, 1999, Terra Nova Capital had net liabilities of $67.3 million. The deficit is the result of underwriting losses incurred during the year. As a further result of these underwriting losses, Terra Nova Capital was carrying a deferred tax asset of $31.1 million, representing estimated taxes recoverable on loss making underwriting years which had not closed at year end 1999. The Company is carrying the balance as tax recoverable on the basis that management anticipates full relief against future taxable profits of the Company's U.K. operating entities. In order to facilitate future profitable underwriting, the Company invested in $75 million of new share capital in Terra Nova Capital by U.K. Holdings. The transfer of capital was effected on February 12, 2000. Total assets were $2.6 billion at December 31, 1999 compared to $2.5 billion at December 31, 1998. Shareholders' equity of the Company was $444.0 million at December 31, 1999, compared to $570.9 million at year end 1998, reflecting an after-tax decline of $63.6 million in the market value of the Company's investment portfolio and $55.6 million of operating losses. Book value per share was $17.50 at December 31, 1999, compared to $22.51 at year end 1998. On August 16, 1999, Markel Corporation ("Markel") and the Company announced that they had signed an agreement providing for Markel's acquisition of the Company for cash and stock valued at $905 million, or $34.00 per share, based on the closing price of Markel's stock on August 13, 1999. In addition, Markel would assume $175 million of the Company's debt. On January 26, 2000, Markel and the Company announced that they had agreed to revised terms for the merger and scheme of arrangement. Under the revised agreement, the Company's shareholders would be entitled to receive for each ordinary share, $13.00 in cash, 0.07027 of a common share in a new holding 32 company and 0.07027 of a contingent value right. The new agreement was reached after preliminary information indicated that the Company would report a loss for the fourth quarter and for the full year of 1999 and after taking into account the decline in the market price of Markel shares since the merger agreement was signed in August 1999. The transaction, which was approved by the shareholders of both companies on March 16, 2000, is expected to be completed on March 24, 2000, subject to approval by the Bermuda Supreme Court and completion or waiver of all closing conditions. Terra Nova Capital's participation in the Lloyd's Capacity Auctions for the 2000 underwriting year resulted in the acquisition of additional capacity in the syndicates managed by Octavian. This will bring the Company's share of aggregate capacity on the Octavian syndicates to about 90% for the 2000 underwriting year, up from about 77% for the 1999 underwriting year. Certain information included here is based on management's estimates, assumptions and projections. Important factors that could cause actual results to differ materially from those estimated by management include, among other things, an unexpected increase in competition, unfavorable government regulation, the pricing environment and other industry developments. Foreign Currency The Company's assets, liabilities, revenues and expenses, except for 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 accumulated other comprehensive income. 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 is the Company's only operation in EMU countries. When the eleven participating EMU countries adopted the euro as their national currency, 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. The euro 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 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 changing or expanding exposures to euro transactions. 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 future costs of modifying information systems software will not be material to the Company's results, operations, financial condition or liquidity. Year 2000 General The Year 2000 issue arises from the fact that historically many computers and computer programs used 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 Company has addressed Year 2000 as both an IT issue and a business issue. 33 Current Status At March 20, 2000, the Company had neither identified nor experienced any Year 2000 related problems from its IT or embedded systems (including facsimile machines, photocopiers and elevators), or from third parties with whom it does business. Such third parties include critical suppliers, customers and trading partners. The Company continues to monitor the performance of its systems and third parties with specific reference to the Year 2000 issue. At March 20, 2000, the Company had received no claims in respect of Year 2000 related losses. The Company takes the position that Year 2000 exposures are not fortuitous losses and thus are not covered under insurance policies even without specific exclusions. However, in certain sectors of the Company where there may be a perceived exposure to Year 2000 claims, the Company has bought reinsurance to protect itself. For these reasons, the Company believes that its exposure to Year 2000 claims will not be material. However, as was the case with the environmental exposures, changing social and legal trends may create unintended coverage for exposures by reinterpreting insurance contracts and exclusions. It is impossible to predict what, if any, exposure insurance companies may ultimately have for Year 2000 claims whether coverage for the issue is specifically excluded or included. Costs The total cost of the Year 2000 project is not material to the Company's financial position and is being funded from operating cash flows. The total amount spent on the project through December 31, 1999, was $3.0 million. Risks While there remains a degree of uncertainty about Year 2000 problems that might be inherited from third party suppliers, customers and trading partners, and a potential exposure to changing legal interpretation of Year 2000 claims, the Company believes it has taken all reasonable steps to ensure the consequences of Year 2000 failure will not have a material impact on its future results of operations, liquidity or financial condition. Dividend Policy The Company declared and paid dividends according to the following table:
Dividend Per Share Date Declared Date paid Date of Record ------------------ ----------------- ------------------ ----------------- 1999 $0.06 February 10, 1999 March 26, 1999 March 5, 1999 $0.06 May 5, 1999 June 25, 1999 June 4, 1999 $0.06 August 5, 1999 September 27, 1999 September 3, 1999 $0.06 November 3, 1999 December 27, 1999 December 3, 1999
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, 1999, 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. 34 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. The Company manages this risk by limiting the portfolio duration.
Basis Point Movement ------------------------------------------- (dollars in millions, unless stated) -200 -100 pts pts Zero +100 pts + 200 pts ------ ------ ------ -------- --------- Movement in fair value of Fixed Maturity portfolio............... 7.6% 3.6% 0.0% (3.4)% (6.5)% Movement after tax................ $ 89.0 $ 42.8 $ 0.0 $(39.7) $(76.7) Adjusted Shareholders' Equity..... 533.0 486.8 444.0 404.3 367.3 Adjusted book value per share..... $21.01 $19.19 $17.50 $15.94 $14.48 Adjusted debt/debt plus equity.... 24.7% 26.4% 28.3% 30.2% 32.3%
The matrix above shows the sensitivity of the Company's shareholders' equity at December 31, 1999, 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 $39.7 million. As a consequence, shareholders' equity at December 31, 1999, would have been $404.3 million and book value per share, $15.94. The ratio of debt to debt plus equity would have increased to 30.2% from 28.3%. The Company's long-term debt is all at fixed rates. At December 31, 1999, 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, 1999, was $162.8 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. The Company does not ordinarily use derivative instruments to manage its exposure to foreign exchange movements. At December 31, 1999, 76% of the Company's investment portfolio was denominated in U.S. Dollars. At that date, the largest foreign currency exposure was U.K. Sterling. Hypothetically, if Sterling assets and liabilities had been mismatched by 10% and the year end Sterling/U.S. Dollar exchange rate had increased or decreased by 5%, the effect on after tax earnings would have been approximately $0.9 million. Equity Price Risk Management The Company does not ordinarily hedge its equity portfolio risk by purchasing derivatives. An external fund manager has responsibility for monitoring the equity portfolio. This responsibility involves considering the asset allocation of the portfolio in order to minimize the risk associated with particular markets or industry sectors, while continuing to follow the Company's long-term objective of growing its book value. At December 31, 1999, the cost of the Company's equity security portfolio was $98.3 million and the fair value was $109.9 million, compared to $56.9 million and $88.0 million, respectively, at December 31, 1998. 35 ITEM 8--FINANCIAL STATEMENTS Index Page - ----- ---- . Report of Management's Responsibilities................................ 37 . Report of Independent Accountants...................................... 38
Audited Consolidated Financial Statements: . Consolidated Balance Sheets as of December 31, 1999 and 1998.......... 39 . Consolidated Statements of Operations for the years ended December 31, 1999, 1998 and 1997......................................................... 40 . Consolidated Statements of Comprehensive Income for the years ended December 31, 1999, 1998 and 1997................................................... 41 . Consolidated Statements of Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997......................................................... 42 . Consolidated Statements of Cash Flows for the years ended December 31, 1999, 1998 and 1997......................................................... 43 . Notes to Consolidated Financial Statements--including summarized consolidated financial information of Terra Nova Insurance (U.K.) Holdings plc as of December 31, 1999 and 1998......................... 44
36 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 37 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 on page 36 present fairly, in all material respects, the financial position of Terra Nova (Bermuda) Holdings Ltd. and subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14(a) on page 78 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers Chartered Accountants Hamilton, Bermuda March 10, 2000, except as to note 23 which is as of March 17, 2000 38 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED BALANCE SHEETS At December 31, (dollars in thousands)
1999 1998 ---------- ---------- ASSETS Investments available for sale, at fair value: Fixed maturities Bonds (amortized cost $1,321,888 and $1,374,272, respectively)....................................... $1,306,110 $1,446,621 Common stocks (cost $98,335 and $56,924, respectively)......................................... 109,900 88,022 ---------- ---------- Total investments.................................. 1,416,010 1,534,643 Cash and cash equivalents.............................. 74,798 40,394 Accrued investment income.............................. 27,607 30,015 Insurance balances receivable.......................... 121,094 81,634 Reinsurance recoverable on paid losses................. 62,162 45,882 Reinsurance recoverable on unpaid losses............... 346,483 226,099 Accrued premium income................................. 238,230 283,383 Prepaid reinsurance premiums........................... 97,771 37,472 Deferred acquisition costs............................. 99,683 107,607 Income tax recoverable................................. 4,422 -- Deferred income taxes.................................. 31,820 -- Other assets........................................... 111,620 92,243 ---------- ---------- Total assets....................................... $2,631,700 $2,479,372 ========== ========== LIABILITIES Unpaid losses and loss adjustment expenses............. $1,409,968 $1,209,003 Unearned premiums...................................... 468,178 401,002 Insurance balances payable............................. 53,853 23,941 Income tax payable..................................... -- 4,228 Deferred income taxes.................................. -- 27,450 Long term debt......................................... 175,000 175,000 Other liabilities...................................... 80,691 67,886 ---------- ---------- Total liabilities.................................. 2,187,690 1,908,510 ---------- ---------- SHAREHOLDERS' EQUITY Common shares "A" ordinary shares, 75,000,000 authorized, $5.80 par value (24,348,192 issued and outstanding; 1998: 24,172,717).......................................... 141,219 140,202 "B" ordinary shares, convertible, 10,000,000 authorized, $5.80 par value (1,796,217 issued and outstanding; 1998: 1,796,217).. 10,418 10,418 Stock held in Trust, at cost........................... (16,787) (12,900) Deferred equity compensation........................... 7,564 4,623 Additional capital..................................... 113,855 111,727 Retained earnings...................................... 195,163 236,292 Accumulated other comprehensive (loss) income.......... (7,422) 80,500 ---------- ---------- Total shareholders' equity......................... 444,010 570,862 ---------- ---------- Total liabilities and shareholders' equity......... $2,631,700 $2,479,372 ========== ==========
See accompanying notes to the consolidated financial statements 39 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, (dollars in thousands except per share amounts)
1999 1998 1997 -------- -------- -------- Revenues Net written premiums............................ $618,446 $646,197 $483,545 Increase in unearned premiums................... (33,165) (99,289) (64,476) -------- -------- -------- Net earned premiums............................. 585,281 546,908 419,069 Net investment income........................... 93,829 93,262 85,130 Realized net capital gains on sales of investments.................................... 26,879 17,963 15,333 Foreign exchange gains (losses)................. 3,016 (586) (1,268) Agency income................................... 14,245 17,057 15,571 -------- -------- -------- Total revenues................................ 723,250 674,604 533,835 ======== ======== ======== Expenses Losses and loss adjustment expenses, net........ 491,243 359,567 282,480 Policy acquisition costs........................ 240,836 160,380 115,427 Other operating expenses........................ 25,397 20,322 13,706 Interest expense................................ 12,400 13,697 12,710 Agency expenses................................. 14,138 13,760 13,130 Other expenses.................................. 11,838 5,617 5,333 -------- -------- -------- Total expenses................................ 795,852 573,343 442,786 -------- -------- -------- (Loss) income before income tax................. (72,602) 101,261 91,049 Income tax (benefit) expense.................... (37,628) 17,221 17,639 -------- -------- -------- Net (loss) income before extraordinary charge... (34,974) 84,040 73,410 Extraordinary charge after income tax........... -- 11,641 -- -------- -------- -------- Net (loss) income............................... $(34,974) $ 72,399 $ 73,410 ======== ======== ======== Basic earnings per common share Net (loss) income before extraordinary charge....................................... $ (1.38) $ 3.30 $ 2.87 Extraordinary charge after income tax......... -- (0.46) -- -------- -------- -------- Net (loss) income............................. $ (1.38) $ 2.84 $ 2.87 ======== ======== ======== Diluted earnings per common share Net (loss) income before extraordinary charge....................................... $ (1.38) $ 3.22 $ 2.82 Extraordinary charge after income tax......... -- (0.45) -- -------- -------- -------- Net (loss) income............................. $ (1.38) $ 2.77 $ 2.82 ======== ======== ========
See accompanying notes to the consolidated financial statements 40 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES Consolidated Statements of Comprehensive Income Year Ended December 31, (dollars in thousands)
1999 1998 1997 --------- ------- ------- Net (loss) income................................. $ (34,974) $72,399 $73,410 --------- ------- ------- Other comprehensive (loss) income: Unrealized (depreciation) appreciation of investments before tax......................... (80,781) 45,299 39,543 Tax benefit (expense)........................... 17,150 (8,242) (8,872) --------- ------- ------- Unrealized (depreciation) appreciation of investments after tax.......................... (63,631) 37,057 30,671 --------- ------- ------- Less: Reclassification adjustment for gains included in net income before tax....................................... (26,879) (17,963) (15,333) Tax (benefit) expense........................... 6,219 4,818 4,821 --------- ------- ------- Reclassification adjustment for gains included in net income after tax...................................... (20,660) (13,145) (10,512) --------- ------- ------- Currency translation adjustment................... (3,631) 46 (78) --------- ------- ------- Other comprehensive (loss) income................. (87,922) 23,958 20,081 --------- ------- ------- Comprehensive (loss) income....................... $(122,896) $96,357 $93,491 ========= ======= =======
See accompanying notes to the consolidated financial statements 41 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES Consolidated Statements of Shareholders' Equity Year Ended December 31,
Stock held Unrealized Common "A" Shares Common "B" Shares in Trust Deferred (Depreciation) ------------------- ------------------ ------------------ Equity Additional Appreciation Number Value Number Value Number Value Compensation Capital of Investments ---------- -------- --------- ------- -------- -------- ------------ ---------- -------------- (dollars in thousands except share numbers) Balance, January 1, 1997.......... 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 Shares issued for exercise of share options... 175,475 1,017 -- -- -- -- -- 2,128 -- Shares repurchased during the year............ -- -- -- -- (169,800) (3,887) -- -- -- Deferred compensation expense......... -- -- -- -- -- -- 2,941 -- -- Net depreciation.... -- -- -- -- -- -- -- -- (107,660) Income tax benefit......... -- -- -- -- -- -- -- -- 23,369 Change during the year........ -- -- -- -- -- -- -- -- -- Net income...... -- -- -- -- -- -- -- -- -- Dividends paid-- $0.24 per ordinary share.. -- -- -- -- -- -- -- -- -- ---------- -------- --------- ------- -------- -------- ------ -------- -------- Balance, December 31, 1999......... 24,348,192 $141,219 1,796,217 $10,418 (776,600) $(16,787) $7,564 $113,855 $ (3,949) ========== ======== ========= ======= ======== ======== ====== ======== ======== Cumulative Total Translation Retained Shareholders' Adjustment Earnings Equity ----------- --------- ------------- Balance, January 1, 1997.......... $ 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......... 1 12 169,861 481,888 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 Shares issued for exercise of share options... -- -- 3,145 Shares repurchased during the year............ -- -- (3,887) Deferred compensation expense......... -- -- 2,941 Net depreciation.... -- -- (107,660) Income tax benefit......... -- -- 23,369 Change during the year........ (3,631) -- (3,631) Net income...... -- (34,974) (34,974) Dividends paid-- $0.24 per ordinary share.. -- (6,155) (6,155) ----------- --------- ------------- Balance, December 31, 1999......... $(3,473) $195,163 $444,010 =========== ========= =============
See accompanying notes to the consolidated financial statements 42 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES Consolidated Statements of Cash Flows Year Ended December 31, (dollars in thousands)
1999 1998 1997 --------- --------- --------- Cash flows from operating activities: Net (loss) income.......................... $ (34,974) $ 72,399 $ 73,410 Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities: Amortization of goodwill................... 4,089 781 642 Bad debt expenses.......................... 7,974 9,464 1,238 Realized net capital gains................. (26,879) (17,963) (15,333) Stock option compensation expense.......... 2,941 1,348 3,208 Change in unpaid losses and loss adjustment expenses.................................. 217,433 50,389 47,612 Change in unearned premiums and prepaid reinsurance............................... 6,878 115,448 60,705 Change in insurance balances payable....... 29,912 (9,892) 4,965 Change in insurance balances receivable, accrued premium income and reinsurance recoverable on paid and unpaid losses..... (138,292) (97,303) (58,960) Change in deferred acquisition costs....... 7,922 (31,227) (26,475) Change in accrued investment income........ 2,407 (1,939) (1,510) Change in current and deferred income taxes..................................... (46,201) 896 (7,407) Change in other assets and liabilities, net....................................... (13,067) (16,508) (194) --------- --------- --------- Total adjustments........................ 55,117 3,494 8,491 --------- --------- --------- Net cash and cash equivalents provided by operating activities.................... 20,143 75,893 81,901 --------- --------- --------- Cash flows from investing activities: Proceeds of fixed maturities matured....... 9,240 57,616 65,096 Proceeds of fixed maturities sold.......... 368,146 391,757 521,301 Proceeds of equity securities sold......... 174,530 140,564 215,732 Purchase of fixed maturities............... (347,337) (587,751) (665,228) Purchase of equity securities.............. (177,057) (119,341) (175,307) Acquisition of capacity at Octavian........ (6,314) (5,657) (639) Payment consideration for Corifrance....... -- -- (42,225) Acquisition expenses for Corifrance........ -- -- (461) --------- --------- --------- Net cash and cash equivalents provided by (used in) investing activities.......... 21,208 (122,812) (81,731) --------- --------- --------- Cash flows from financing activities: Stock repurchases.......................... (3,887) (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) -- Proceeds from shares issued................ 3,145 637 384 Ordinary dividends paid to stockholders.... (6,155) (5,968) (4,370) --------- --------- --------- Net cash and cash equivalents (provided by) used in financing activities........ (6,897) (22,798) 59,681 --------- --------- --------- Change in cash and cash equivalents.......... 34,454 (69,717) 59,851 Exchange on foreign currency cash balances... (50) 247 (531) Cash and cash equivalents at beginning of year........................................ 40,394 109,864 50,544 --------- --------- --------- Cash and cash equivalents at end of year..... $ 74,798 $ 40,394 $ 109,864 ========= ========= ========= Supplemental disclosure of cash flow information Income taxes paid.......................... $ 3,506 $ 13,642 $ 23,001 --------- --------- --------- Interest paid.............................. $ 12,400 $ 14,638 $ 10,750 ========= ========= =========
See accompanying notes to the consolidated financial statements 43 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 (U.K.) Holdings plc ("U.K. 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 certain Lloyd's syndicates (the "Octavian syndicates"). A managing agent is permitted by the Council of Lloyd's to perform, on behalf of an underwriting member of any one of the syndicates which it manages, one or more of the following functions: (a) underwriting contracts of insurance at Lloyd's; (b) obtaining reinsurance for such contracts in whole or in part; (c) paying claims on such contracts. Members of Lloyd's underwrite insurance risk at Lloyd's by being a member of one or more Lloyd's syndicates. A syndicate has no separate legal identity and is "managed" by a managing agent. The standard Lloyd's contract between a managing agent and the members of a syndicate managed by that agent, identifies the following services to be provided by the managing agent on behalf of the members: (a) determine underwriting policy and determine policy and effect reinsurance; (b) appoint and supervise the underwriter and associate underwriting, claims, administrative and accounting staff; (c) accept underwriting risks and settle and pay claims on behalf of the syndicate; (d) manage the investment of the monies and other assets held in each syndicate; (e) prepare and distribute annual reports, personal accounts and other reports and documents as required by the Council of Lloyd's. A managing agent charges an annual fee which will be complimented, in profitable years, by a profit commission. The managing agent employs management and underwriting staff, recharging the costs of employment and resourcing the syndicate's activities to the syndicate and retaining costs incurred in respect of the management functions. The managing agent does not participate directly in the profit or loss on underwriting of its syndicates. It is incentivized by earning a commission on syndicate profits. 44 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The managing agency manages but does not participate in its own syndicate and has no liability under contracts of insurance. However, Terra Nova Capital, a subsidiary of U.K. Holdings, is a corporate member of Lloyd's and a member of each of the syndicates managed by Octavian. Terra Nova Capital therefore participates in the underwriting results of 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) Octavian income and expenses: The Company recognizes its share of the premiums, losses and expenses associated with its participation in Lloyd's syndicates consistent with the bases used in its insurance company operations and in accordance with GAAP. Agency income is earned and agency expenses charged as incurred from Octavian's role as managing agent. (e) 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. (f) 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. (g) 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. (h) 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. 45 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (i) Accrued premium income: Accrued premium income represents the difference between the estimated cumulative ultimate gross written premiums and cumulative billed premiums. (j) Prepaid reinsurance premiums: Prepaid reinsurance premiums represent the portion of premiums ceded to reinsurers applicable to the unexpired terms of reinsurance contracts. (k) 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. (l) 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. (m) 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, 7, 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. (n) 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. (o) 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. (p) Reclassifications: Certain prior year amounts have been reclassified to conform with the current year presentation. 46 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 4. Investments and Cash (a) Deposits: Securities with a carrying value of $122,105,666 and $103,731,433 at December 31, 1999 and 1998, 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 $20,994,932 and $21,100,926 at December 31, 1999 and 1998, 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 $49,607,415 and $50,929,708 at December 31, 1999 and 1998, 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 $97,420,004 and $106,105,003 at December 31, 1999 and 1998, respectively. The Company has deposited cash and investments with a carrying value of $105,812,403 (including $812,403 of restricted cash) and $158,018,677 (including $1,018,677 of restricted cash) at December 31, 1999 and 1998, respectively, as collateral against these amounts. The Company has contingent liabilities regarding irrevocable undrawn letters of credit of $246,886,653 and $248,212,339 supporting the Company's underwriting activities on the Octavian syndicates at December 31, 1999 and 1998, respectively. The Company has deposited cash and investments with a carrying value of $251,527,716 at December 31, 1999 and $250,553,300 at December 31, 1998, respectively, as collateral to support this commitment. Cash and securities with a carrying value of $202,931,000 and $149,076,000 at December 31, 1999 and 1998, 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, ------------------------- 1999 1998 1997 ------- ------- ------- (dollars in thousands) Fixed maturities..................................... $88,055 $86,899 $77,690 Equity securities.................................... 608 463 1,538 Cash and cash equivalents............................ 8,258 8,754 9,470 ------- ------- ------- Total investment income.............................. 96,921 96,116 88,698 Investment expenses.................................. (3,092) (2,854) (3,568) ------- ------- ------- Net investment income.............................. $93,829 $93,262 $85,130 ======= ======= =======
(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, --------------------------- 1999 1998 1997 --------- ------- ------- (dollars in thousands) Realized net capital gains on sale of investments: Fixed maturities................................. $ (6,066) $ 8,854 $ 5,342 Equity securities................................ 32,945 9,109 9,991 --------- ------- ------- Realized net capital gains......................... 26,879 17,963 15,333 --------- ------- ------- Changes in net unrealized (depreciation) appreciation: Fixed maturities................................. (88,127) 30,691 17,291 Equity securities................................ (19,533) (3,355) 6,919 --------- ------- ------- Changes in net unrealized (depreciation) appreciation...................................... (107,660) 27,336 24,210 --------- ------- ------- Realized net capital gains and change in net unrealized (depreciation) appreciation of investments....................................... $ (80,781) $45,299 $39,543 ========= ======= =======
47 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Realized net capital gains on sale of fixed maturities for the years ended December 31, 1999, 1998 and 1997, included gross capital gains of $5,754,000, $9,420,000 and $9,600,000, and gross capital losses of $11,820,000, $566,000 and $4,258,000, respectively. Proceeds from sales of investments in equity securities during 1999, 1998 and 1997, were $174,530,000, $140,564,000 and $215,732,000, respectively. Realized net capital gains on sale of equity securities for the years ended December 31, 1999, 1998 and 1997, included gross capital gains of $42,403,000, $24,567,000 and $29,613,000 and gross capital losses of $9,458,000, $15,458,000 and $19,622,000, respectively. Net unrealized appreciation of equities (before income tax) of the Company at December 31, 1999, included gross unrealized appreciation of $12,894,000 and gross unrealized depreciation of $1,329,000. Net unrealized appreciation of equities of the Company at December 31, 1998, included gross unrealized appreciation of $38,551,000 and gross unrealized depreciation of $7,453,000. (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:
Gross Gross Estimated Amortized unrealized unrealized fair cost appreciation depreciation value ---------- ------------ ------------ ---------- (dollars in thousands) 1999 U.S. government and agencies... $ 203,610 $ 2,501 $ (4,157) $ 201,954 Foreign governments and agencies...................... 496,936 10,187 (9,703) 497,420 Mortgage backed and asset backed........................ 108,093 1,053 (723) 108,423 Supranationals................. 106,521 933 (3,371) 104,083 Corporate...................... 406,728 3,045 (15,543) 394,230 ---------- ------- -------- ---------- Total fixed maturities....... $1,321,888 $17,719 $(33,497) $1,306,110 ========== ======= ======== ========== Gross Gross Estimated Amortized unrealized unrealized fair cost appreciation depreciation value ---------- ------------ ------------ ---------- (dollars in thousands) 1998 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 ========== ======= ======== ==========
48 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The amortized cost and estimated fair value of the Company's fixed maturities at December 31, 1999, 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....................... $ 116,121 115,592 9% Due after one year through five years......... 611,434 607,165 46 Due after five years through ten years........ 531,570 519,457 40 Due after ten years........................... 62,763 63,896 5 ---------- ---------- --- $1,321,888 $1,306,110 100% ========== ========== ===
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. (e) At December 31, 1999, the Company's portfolio by rating category, determined by recognized rating agencies, was:
Estimated fair value ---------------------- (dollars in thousands) U.S. government and agencies.... $201,954 U.K. government and agency...... 115,665 AAA............................. 472,009 AA.............................. 295,545 A............................... 135,775 BBB............................. 85,162 ---------- $1,306,110 ==========
(f) At December 31, 1999, the estimated fair value of the following investments exceeded 10% of shareholders' equity:
Estimated fair value ---------------------- (dollars in thousands) United States Treasury.......... $201,954 Government of Japan............. 84,089 Canadian Treasury............... 96,574 U.K. Treasury................... 115,665
(g) Equities available for sale: At December 31, 1999, the cost and estimated fair value of investments in common stocks were as follows:
Estimated fair Cost value ------- --------- (dollars in thousands) Public utilities........................................ $ 374 $ 408 Banks, trust and insurance companies.................... 13,198 14,694 Industrial, miscellaneous and all other................. 84,763 94,798 ------- -------- Total equity securities............................... $98,335 $109,900 ======= ========
49 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 reduced to 31% from 33% on April 1, 1997, and to 30% from 31% on April 1, 1999. The corporation tax rate in France was 41.67% for 1997 and 1998, and 40% for 1999. 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, -------------------------- 1999 1998 1997 -------- ------- ------- (dollars in thousands) "Expected" tax (benefit) expense............... $(21,962) $31,391 $28,680 Adjustments: Non-taxable income........................... (16,878) (15,042) (10,004) Other........................................ 1,212 872 (1,037) -------- ------- ------- Actual tax (benefit) expense................... $(37,628) $17,221 $17,639 ======== ======= ======= (b) The components of income tax (benefit) expense attributable to continuing operations are as follows: Year ended December 31, -------------------------- (dollars in thousands) 1999 1998 1997 -------- ------- ------- Current U.K. corporation tax................... $ (7,644) $ 2,789 $10,743 Current French corporation tax................. (160) 1,310 -- Deferred tax................................... (29,824) 13,122 6,896 -------- ------- ------- Income tax................................... $(37,628) $17,221 $17,639 ======== ======= =======
(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 asset (liability) of the Company as at December 31, 1999 and 1998, were as follows:
1999 1998 ------- -------- (dollars in thousands) Deferred tax assets: Unrealized depreciation of investments............... $ 4,402 $ 321 Operating losses and other........................... 30,977 318 ------- -------- Total deferred tax assets.......................... 35,379 639 ------- -------- Deferred tax liabilities: Unrealized appreciation of investments............... (80) (11,718) Other................................................ (3,479) (16,371) ------- -------- Total deferred tax liabilities..................... (3,559) (28,089) ------- -------- Net deferred tax asset (liability)..................... $31,820 $(27,450) ======= ========
(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. 50 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) (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, including amounts deferred and amortized in the same period:
Year ended December 31, -------------------------- 1999 1998 1997 -------- -------- -------- (dollars in thousands) Balance at beginning of year.................. $107,607 $ 76,380 $ 45,279 -------- -------- -------- Acquisition costs deferred Commissions................................. 161,737 151,371 119,610 Other....................................... 71,175 40,236 26,918 -------- -------- -------- 232,912 191,607 146,528 -------- -------- -------- Amortization charged to income Commissions................................. 171,536 126,239 92,713 Other....................................... 69,300 34,141 22,714 -------- -------- -------- 240,836 160,380 115,427 -------- -------- -------- Balance at end of year........................ $ 99,683 $107,607 $ 76,380 ======== ======== ========
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 office in Canada and its former branch office in Belgium. 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. 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. 51 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 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 $3,121,304 (1998: $2,351,000). The following tables set out the funded status of all defined benefit plans for the years ended December 31, 1999, 1998 and 1997, and the amounts recognized in the accompanying consolidated balance sheets of the Company at December 31, 1999 and 1998:
Year ended December 31, ----------------------- 1999 1998 1997 ------ ------ ------- (dollars in thousands) Component of net periodic benefit costs: Service cost.................................... $3,209 $2,692 $ 2,612 Interest cost................................... 2,429 2,973 3,153 Expected return on plan assets.................. (4,234) (4,787) (4,274) Amortization of transition obligation........... (92) (94) (100) Recognized net actuarial gain................... -- (192) -- ------ ------ ------- Net periodic benefit cost..................... $1,312 $ 592 $ 1,391 ====== ====== =======
1999 1998 ------- ------- (dollars in thousands) Change in benefit obligation Benefit obligation at beginning of year................ $54,064 $40,386 Service cost........................................... 3,209 2,692 Interest cost.......................................... 2,429 2,973 Benefits paid.......................................... (727) (587) Actuarial (gain) loss.................................. (10,720) 8,602 ------- ------- Benefit obligation at end of year.................... 48,255 54,066 ------- ------- Change in plan assets Fair value of plan assets at beginning of year......... 59,057 50,161 Actual return on plan assets........................... 8,365 7,490 Employer contribution.................................. 1,412 1,993 Benefits paid.......................................... (727) (587) ------- ------- Fair value of plan assets at end of year............. 68,107 59,057 ------- ------- Funded status............................................ 19,852 4,991 Unrecognized net actuarial gain........................ (14,491) -- Unrecognized transition obligation..................... (369) -- ------- ------- Prepaid benefit cost................................. $ 4,992 $ 4,991 ======= ======= Weighted-average assumptions as of December 31 Discount rate.......................................... 6.25% 5.50% Expected return on plan assets......................... 8.00% 8.00% Rate of compensation increase.......................... 5.00% 4.50%
52 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":
1999 1998 1997 ---------- ---------- ---------- (dollars in thousands except per share amounts) (Loss) income available to common shareholders............................... $ (34,974) $ 72,399 $ 73,410 ---------- ---------- ---------- Weighted average number of shares outstanding Common shares............................. 25,306,576 25,449,091 25,586,648 ---------- ---------- ---------- Basic EPS................................. $ (1.38) $ 2.84 $ 2.87 ========== ========== ========== (Loss) income available to common shareholders............................... $ (34,974) $ 72,399 $ 73,410 ---------- ---------- ---------- Weighted average number of shares outstanding Common shares............................. 25,306,576 25,449,091 25,586,648 Add: Dilutive effect of shares arising from options............................. -- 654,445 406,643 ---------- ---------- ---------- Adjusted weighted average number of shares outstanding................................ 25,306,576 26,103,536 25,993,291 ---------- ---------- ---------- Diluted EPS............................... $ (1.38) $ 2.77 $ 2.82 ========== ========== ==========
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 1999, the Company issued 175,475 ordinary shares to satisfy options exercised under the Company's stock option plan (see Note 10). Also during the year, the Company repurchased 169,800 shares at a total cost of $3,880,226, excluding commissions. As at December 31, 1999, the Company had purchased a total of 802,600 shares at a total cost of $17,275,896, leaving a further $2,724,104 available for future repurchases under the Board of Directors' authorization, dated May 5, 1997. On May 5, 1999, the Board of Directors authorized the repurchase of an additional $25,000,000 of the Company's common stock. The shares are 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, 1999, 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 $2,941,000 has been charged against income for 1999 (1998: $1,348,000). 53 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:
1999 1998 1997 -------- ------- ------- (dollars in thousands except per share amounts) Net (loss) income: As reported................................... $(34,974) $72,399 $73,410 -------- ------- ------- Pro forma..................................... $(35,039) $70,417 $73,352 -------- ------- ------- Basic (losses) earnings per share: As reported................................... $ (1.38) $ 2.84 $ 2.87 -------- ------- ------- Pro forma..................................... $ (1.38) $ 2.77 $ 2.87 ======== ======= =======
The assumptions made in calculating the pro forma amounts for the three years 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. At December 31, 1999, there were 45,000 options outstanding under the Executive Share Option Plan, all of which were only exercisable on the achievement of certain performance objectives and therefore have been accounted for as variable options under APB No. 25. The performance objectives were not met and subsequently all 45,000 options lapsed. No compensation expense was incurred in respect of the 45,000 options in 1999. The remaining 1,906,686 options have been accounted for as fixed options in accordance with paragraph 10(b) of APB No. 25 as the number of options and option price were known at the date of grant. A summary of the Company's Stock Option Plan at December 31, 1999, and changes during the three years then ended is presented below:
Weighted- average Shares exercise price --------- -------------- Fixed options 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 January 1, 1999................. 1,876,304 18.78 Granted...................................... 339,000 23.65 Exercised.................................... (175,475) 17.93 Forfeited.................................... (88,143) 20.30 --------- ------ Outstanding at December 31, 1999............... 1,951,686 $20.01 ========= ======
54 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) At December 31, 1999, the outstanding Option Shares under the Stock Option Plan had exercise prices between $5.80 and $27.05 and a weighted-average remaining contractual life of 6.00 years. Options outstanding and options exercisable at December 31, 1999, 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- 10.00 424,579 4.97 $ 6.45 421,579 $ 6.45 10.01-15.00 88,166 4.19 12.80 70,990 12.80 15.01-20.00 241,749 5.53 18.91 99,409 18.73 20.01-25.00 369,400 7.14 23.59 22,000 23.19 25.01-30.00 827,792 6.35 26.45 342,962 26.40 ----------- ----------- 1,951,686 956,940 =========== =========== Options exercisable at December 31, 1998 909,515 Options exercisable at December 31, 1997 581,986
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. The Octavian Plan is a variable plan for accounting purposes. The accounting follows paragraphs 27 and 28 of APB Opinion No.25. Estimates of compensation cost are recorded before the measurement date based on the quoted market price of Terra Nova stock at intervening dates and Terra Nova's estimate as of such dates of shares which will be issued under the plan. The compensation expense is recognized over the three year service period which represents the period over which the profit commission for each year of account is earned. 55 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) A summary of the Octavian Stock Option Plan at December 31, 1999, and changes during the three years then ended is shown below:
Weighted- average Performance-based options Shares exercise price ------------------------- ------- -------------- 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 January 1, 1999.................... 214,158 0.00 Reserved for grant.............................. 50,123 0.00 Exercised....................................... -- -- Forfeited....................................... (1,215) 0.00 ------- ---- Outstanding at December 31, 1999.................. 263,066 0.00 ======= ==== Options exercisable at December 31, 1999........ Nil. Options exercisable at December 31, 1998 and 1997........................................... Nil.
At December 31, 1999, the 263,066 options outstanding under the Octavian Stock Option Plan all had exercise prices of $nil and a weighted-average remaining contractual life of 6.82 years. The weighted average fair value per share of options granted in the Company's stock-based compensation plans during 1999 was $10.20 (1998: $13.32; 1997: $8.15). 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. 56 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Company cedes reinsurance to and assumes reinsurance from Lloyd's syndicates. At December 31, 1999, 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 $106,542,000. The majority was ceded into Equitas with effect from September 4, 1996. Equitas is a company with limited liability established by the Lloyd's syndicates. Therefore, ultimate recoveries under the reinsurance contracts ceded into Equitas will be dependent on Equitas being able to fulfil its commitment to the syndicates. 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, ------------------------------ 1999 1998 1997 --------- --------- -------- (dollars in thousands) Direct business............................ $ 601,419 $ 407,841 $269,577 Reinsurance assumed........................ 263,514 351,547 280,666 Reinsurance ceded.......................... (246,487) (113,191) (66,698) --------- --------- -------- Net written premiums..................... $ 618,446 $ 646,197 $483,545 ========= ========= ========
(b) Net earned premiums are comprised of the following:
Year ended December 31, ----------------------------- 1999 1998 1997 --------- -------- -------- (dollars in thousands) Direct business............................. $ 495,339 $318,213 $209,414 Reinsurance assumed......................... 310,384 317,499 260,603 Reinsurance ceded........................... (220,442) (88,804) (50,948) --------- -------- -------- Net earned premiums....................... $ 585,281 $546,908 $419,069 ========= ======== ========
(c) Losses and loss adjustment expenses, net, are comprised of the following:
Year ended December 31, ----------------------------- 1999 1998 1997 --------- -------- -------- (dollars in thousands) Losses and loss adjustment expenses, gross.................................... $ 752,497 $448,066 $329,463 Reinsurance ceded......................... (261,256) (88,499) (46,983) --------- -------- -------- Losses and loss adjustment expenses, net.................................... $ 491,243 $359,567 $282,480 ========= ======== ========
12. 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. 57 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Movement in unpaid losses and loss adjustment expenses for the years ended December 31, 1999, 1998 and 1997, 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 $27,300,000, $9,757,000 and $4,800,000 for 1999, 1998 and 1997, respectively. When these revisions to prior written and earned premiums are considered, the Company experienced net prior year improvements of $17,210,000, $15,207,000 and $5,596,000 in 1999, 1998 and 1997, respectively. The majority of the movement in unpaid losses and loss adjustment expenses attributable to prior years was in relation to Terra Nova's casualty business. The casualty movements arose from the favorable settlements during these financial years in respect of various casualty contracts. The favorable casualty movements in the 1999 financial year were partially offset by deficiencies on the Company's property, motor and aviation classes as a result of claims experience being worse than expected on certain contracts. The majority of these contracts were in respect of the 1998 accident year.
1999 1998 1997 ---------- ---------- ---------- (dollars in thousands) Reserves for unpaid losses and loss adjustment expenses, at beginning of year........... $1,209,003 $1,157,724 $1,078,108 Less: reinsurance recoverables on unpaid losses................................. (226,098) (246,728) (254,129) ---------- ---------- ---------- Net balance at beginning of year.......... 982,905 910,996 823,979 ---------- ---------- ---------- Net incurred losses and loss adjustment expenses related to: Current year............................ 535,753 384,531 292,876 Prior years............................. (44,510) (24,964) (10,396) ---------- ---------- ---------- Total net incurred losses and loss adjustment expenses...................... 491,243 359,567 282,480 ---------- ---------- ---------- Net paid losses and loss adjustment expenses related to: Current year............................ (179,844) (138,918) (69,685) Prior years............................. (245,323) (187,559) (145,702) ---------- ---------- ---------- Total net paid losses and loss adjustment expenses................................. (425,167) (326,477) (215,387) Foreign exchange adjustment............... (18,753) (5,169) (10,967) ---------- ---------- ---------- Net balance at end of year................ 1,030,228 938,917 880,105 Net reserves from reinsurance to close.. 33,257 43,988 -- (1) Net reserves from Corifrance acquisition............................ -- -- 30,891 ---------- ---------- ---------- Net reserves at end of year............... 1,063,485 982,905 910,996 Plus reinsurance recoverables: The Company............................. 346,483 226,098 236,847 Reinsurance recoverables related to net reserves from Corifrance acquisition................. -- -- 9,881 ---------- ---------- ---------- Reinsurance recoverable by the Company.... 346,483 226,098 246,728 ---------- ---------- ---------- Reserves for unpaid losses and loss adjustment expenses, at end of year................. $1,409,968 $1,209,003 $1,157,724 ========== ========== ==========
- -------- (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. The reinsurance to close reserves represent a retrospectively rated reinsurance contract in respect of an outstanding claims portfolio from the closing year of account of a Lloyd's syndicate. (The reinsurance to close occurs at the end of the third year of a Lloyd's underwriting year.) 58 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) In the 1997 financial year, the reinsurance to close premium for the 1995 year of account of $17,910,000 and losses associated with this premium of $17,910,000 were included in the revenue statement in accordance with the current recommended accounting practice in the London Market. In the 1999 and 1998 financial years, following further deliberation by management on the appropriate U.S. GAAP accounting treatment, the reinsurance to close premium for the 1997 and 1996 years of account of $33,257,000 and $43,988,000 were included as an asset in the balance sheet and the liabilities of $33,257,000 and $43,988,000 associated with this asset were included in unpaid losses in the balance sheet. There was no impact to net income within 1999 and 1998 as a consequence of this change in the Company's practice. 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. 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, ------------------------- 1999 1998 1997 ------- ------- ------- (dollars in thousands) Reserves for unpaid losses and loss adjustment expenses, at beginning of year... $75,338 $58,755 $58,400 Incurred losses and loss adjustment expenses.................................... 3,622 17,721 2,808 Paid losses and loss adjustment expenses..... (4,469) (1,138) (2,453) ------- ------- ------- Reserves for unpaid losses and loss adjustment expenses, at end of year.................... $74,491 $75,338 $58,755 ======= ======= =======
Environmental Losses and Loss Adjustment Expenses Incurred and Reserves Outstanding (net of reinsurance)
Year ended December 31, ------------------------- 1999 1998 1997 ------- ------- ------- (dollars in thousands) Reserves for unpaid losses and loss adjustment expenses, at beginning of year... $20,552 $30,342 $33,900 Incurred losses and loss adjustment expenses.................................... (3,759) (8,505) (2,032) Paid losses and loss adjustment expenses..... (1,007) (1,285) (1,526) ------- ------- ------- Reserves for unpaid losses and loss adjustment expenses, at end of year.................... $15,786 $20,552 $30,342 ======= ======= =======
59 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The reinsurance recoverables netted against the asbestos-related and environmental pollution loss reserves for each of the years 1999, 1998 and 1997, are as follows:
1999 1998 1997 -------- -------- -------- (dollars in thousands) Gross reserves.............................. $128,192 $129,166 $111,805 Reinsurance recoverables.................... (37,915) (33,276) (22,708) -------- -------- -------- Net reserves.............................. $ 90,277 $ 95,890 $ 89,097 ======== ======== ========
The incurred asbestos and pollution losses in 1999 reflect better than expected loss development patterns during the year. In 1998, Terra Nova had reallocated general IBNR specifically to cover asbestos-related claims. 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, 1999 and 1998, of $46,440,000 and $38,823,000, respectively. Doubtful accounts against which provisions of $880,000 had previously been made were written off during 1999. The charge to doubtful accounts was $8,497,000, $9,464,000 and $1,238,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The charge in 1999 was primarily in connection with the Company establishing a bad debt provision in respect of New Cap Reinsurance Corporation and Reinsurance Australia Corporation which got into financial difficulties during 1999. The charge in 1998 included $5,558,000 in respect of the 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. The transfer of $5,558,000 concerned an insolvent reinsurer. Prior to December 31, 1998, the liability of $5,558,000 was included in unpaid losses while the reinsurance recovery of $5,558,000 was included in reinsurance recoveries on unpaid losses as an asset. At December 31,1998, the liability previously in unpaid losses was reclassified as a bad debt and deducted from reinsurance recoveries on unpaid losses. This balance sheet reclassification had no effect on net income. 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) Terra Nova is a shareholder of LUC Holdings Limited ("LUCH") (formerly Market Building Limited). LUCH is a joint venture/consortium company formed to establish and operate, through a subsidiary company, the London Underwriting Centre ("LUC") as a trading center for companies operating in the London Insurance Market. LUC provides a range of facilities to its tenants appropriate to a trading center. All shareholders, including Terra Nova, have given guarantees 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 LUC. The guarantee is unlimited. The fire that occurred in August 1991, during fitting out the new LUC resulted in a shortfall of annual rental income and the possibility 60 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) of further shortfalls in the future. Each year, Terra Nova 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, 1999, under non-cancelable operating leases are as follows:
(dollars in thousands) ---------------------- 2000............................ $ 3,784 2001............................ 2,100 2002............................ 1,164 2003............................ 1,001 2004............................ 751 2005 and later years............ 1,934 ------- $10,734 =======
Rental expense on property leases of $4,467,000, $4,246,000 and $4,102,000 was incurred for the periods to December 31, 1999, 1998 and 1997, respectively. 15. Extraordinary Charge Arising on Extinguishment of Debt An extraordinary charge of $11.6 million arose during the second quarter of 1998 as a result of U.K. 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, U.K. Holdings repurchased $4.5 million of the Senior Notes for consideration of $5.2 million, including accrued interest. (b) On May 18, 1998, U.K. 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 The Company's total outstanding consolidated indebtedness at December 31, 1999, was made up of $100 million of 7.0% Senior Notes due 2008, issued in 1998, and $75 million 7.2% Senior Notes due 2007, issued in 1997. The estimated fair value of these Senior Notes at December 31, 1999, was $162.8 million, comprising $92.0 million of 7.0% Senior Notes due 2008 and $70.8 million of 7.2% Senior Notes due 2007. The Senior Notes were issued by U.K. Holdings and are guaranteed fully and unconditionally by Bermuda Holdings. The Senior Notes may be redeemed at any time at the option of U.K. 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 purpose of the make-whole amount payment is to compensate the holder for the lost interest payments that it would otherwise receive had the Senior Notes not been redeemed. Thus, the make-whole amount is the 61 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) difference between "x', the sum of the present values of the principal amount of such Senior Notes together with scheduled interest payments, in each case discounted at an adjusted treasury rate to the redemption date, and "y', the principal amount of such Senior Notes to be redeemed. 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. Since the acquisition of Terra Nova by the Company in 1994, any charges or credits arising from changes in estimates are recorded in continuing operations of the Company. Included within other liabilities in the Company's balance sheet is $20,497,000 (1998: $23,197,000) relating to net liabilities of aviation business in run-off. 18. Ownership and Related Party Transactions Fees of $750,000, $838,750 and $487,500 were paid to Donaldson, Lufkin and Jenrette, a related party, who is a significant shareholder, in 1999, 1998 and 1997, respectively. The fees related to the merger between the Company and Markel Corporation in 1999 and the issue of the Senior Notes in 1998 and 1997. 19. Segment Information The Company's core operations are conducted through four reportable segments: Terra Nova, Terra Nova (Bermuda), Terra Nova Capital and Corifrance. The segments are strategic business units that operate in different markets. 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 revenues are eliminated from segmental reporting, such that the segmental revenues are consistent with the Company's consolidated financial statements. 62 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following tables summarize the operations and assets of the four segments for the years ended December 31, 1999, 1998 and 1997:
1999 ------------------------------------------------------- Terra Nova Terra Nova Terra Nova (Bermuda) Capital Corifrance Total ---------- ---------- ---------- ---------- ---------- (dollars in thousands) Net earned premiums..... $ 227,694 $ 39,494 $303,271 $ 14,822 $ 585,281 ---------- -------- -------- -------- ---------- Segment (loss) profit... (479) 68,869 (107,856) 733 (37,733) ---------- -------- -------- -------- ---------- Segment assets.......... 1,188,042 563,974 715,584 93,221 2,560,821 ---------- -------- -------- -------- ---------- 1998 ------------------------------------------------------- Terra Nova Terra Nova Terra Nova (Bermuda) Capital Corifrance Total ---------- ---------- ---------- ---------- ---------- (dollars in thousands) Net earned premiums..... $ 252,714 $ 78,061 $199,506 $ 16,627 $ 546,908 ---------- -------- -------- -------- ---------- Segment profit (loss)... 61,304 49,304 (6,810) 6,625 110,423 ---------- -------- -------- -------- ---------- Segment assets.......... 1,387,178 753,947 432,281 98,272 2,671,678 ---------- -------- -------- -------- ---------- 1997 ------------------------------------------------------- Terra Nova Terra Nova Terra Nova (Bermuda) Capital Corifrance Total ---------- ---------- ---------- ---------- ---------- (dollars in thousands) Net earned premiums..... $ 256,306 $ 42,985 $107,978 $ 11,800 $ 419,069 ---------- -------- -------- -------- ---------- Segment profit (loss)... 64,722 34,566 (1,017) 2,706 100,977 ---------- -------- -------- -------- ---------- Segment assets.......... 1,438,198 559,526 218,468 110,913 2,327,105 ---------- -------- -------- -------- ----------
The Company has changed its basis of segmentation from that used in the 1998 Annual Report on Form 10-K. Management believes the new basis of segmentation most accurately reflects the Company's operating segments under the definition provided by SFAS No.131. The four segments reported in the 1998 Form 10-K were: (a) Marine & Aviation; (b) Non-Marine; (c) Agency; and (d) Corporate. A reconciliation of the total reportable segments' profit to the Company's consolidated income from operations before tax and extraordinary charge is provided below. The main components of the reconciling item are investment income, foreign exchange losses and other expenses in the non-operating companies, agency income in Octavian and debt interest paid on the Senior Notes.
Year ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- (dollars in thousands) Segment (loss) profit....................... $(37,733) $110,423 $100,977 Reconciling item............................ (34,869) (9,162) (9,928) -------- -------- -------- (Loss) income from operations before income tax and extraordinary charge................... $(72,602) $101,261 $ 91,049 ======== ======== ========
63 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) A reconciliation of the total reportable segments' assets to the Company's consolidated total assets is provided below. The main components of the reconciling item are investments in the non-operating companies and inter- segment insurance balances eliminated on consolidation.
Year ended December 31, --------------------------------- 1999 1998 1997 ---------- ---------- ---------- (dollars in thousands) Segment assets.......................... $2,560,821 $2,671,678 $2,327,105 Reconciling item........................ 70,879 (192,306) (106,971) ---------- ---------- ---------- Total assets............................ $2,631,700 $2,479,372 $2,220,134 ========== ========== ==========
The Company's principal products 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, 1998 and 1999, the Company received premiums related to reinsurance to close of orphan Lloyd's syndicates. Net earned premiums for the years ended December 31, 1999, 1998 and 1997, were as follows:
Year ended December 31, -------------------------- 1999 1998 1997 -------- -------- -------- (dollars in thousands) Property....................................... $331,198 $256,844 $182,032 Casualty....................................... 132,169 94,949 83,143 Marine & aviation.............................. 119,567 127,532 114,751 Orphan syndicate business...................... 2,347 67,583 39,143 -------- -------- -------- Total net earned premiums...................... $585,281 $546,908 $419,069 ======== ======== ========
Because the Company conducts its business through worldwide market places (including Lloyd's and the London market), it is not practicable to provide geographic segment information. 20. Statutory Financial Data (a) Terra Nova files an annual audited return with the Financial Services Authority (the "FSA"), in the U.K. The regulations require U.K. insurance companies to comply with prescribed minimum solvency margins. Assets and liabilities reported within the annual FSA Return are prepared subject to specified rules concerning valuation and admissibility. Consequently, net assets reported within the Return may vary from net assets as they appear in Terra Nova's published financial statements. Technical provisions shown in Terra Nova's annual FSA Return reflect the statutory requirement in the U.K. for insurance companies to maintain equalization provisions. Equalization provisions are established in accordance with specified rules and are in addition to the provisions required to meet the anticipated ultimate cost of settlement of outstanding claims at the balance sheet date. Such provisions are not required under U.S. GAAP. 64 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) A reconciliation of total technical provisions (excluding provision for unearned premiums) reported in Terra Nova's annual FSA Return, to Terra Nova's reserve for unpaid losses and loss adjustment expenses under U.S. GAAP for the years ended December 31, 1999, 1998 and 1997, is provided below:
Year ended December 31, -------------------------------- 1999 1998 1997 ----------- -------- ---------- (Unaudited) (dollars in thousands) Technical provisions (excluding provision for unearned premiums)..... $896,181 $950,173 $1,041,460 Equalization provision................ -- (20,180) (14,250) Aviation business in run-off.......... (59,229) (65,752) (75,846) -------- -------- ---------- Unpaid losses and loss adjustment expenses............................. $836,952 $864,241 $ 951,364 ======== ======== ==========
Terra Nova's unaudited required minimum statutory solvency margin and unaudited statutory solvency margin at December 31, 1999, were $39,248,000 and $127,738,000, respectively. Terra Nova's unaudited and estimated FSA Return policyholders' surplus and unaudited net income for the year ended December 31, 1999, and the audited FSA Return policyholders' surplus and net income as reported in the annual returns to the FSA for the years ended December 31, 1998 and 1997, are as follows:
1999 1998 1997 ----------- -------- -------- (Unaudited) dollars in thousands Policyholders' surplus...................... $166,986 $270,732 $233,936 Net (loss) income before dividends.......... (27,774) 39,327 49,855
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 and net income for the years ended December 31, 1999, 1998 and 1997, respectively, were:
1999 1998 1997 ----------- -------- -------- (Unaudited) dollars in thousands Statutory capital and surplus.............. $168,261 $324,580 $260,612 Minimum required statutory capital and surplus................................... 100,000 100,862 100,000 Net income before dividends................ 69,681 49,570 29,025
Bermuda Holdings' and U.K. 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. 65 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 21. Summarized Financial Information for U.K. Holdings U.K. Holdings was incorporated in the United Kingdom on November 7, 1994, to acquire Terra Nova. U.K. 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, 1999, and 1998, and summarized consolidated statements of operations information for the years December 31, 1999, 1998 and 1997, about U.K. Holdings is set out below:
December 31, --------------------- 1999 1998 ---------- ---------- (dollars in thousands) Investments and cash..................................... $ 803,070 $ 900,442 Reinsurance recoverable on unpaid losses................. 530,102 459,497 Accrued premium income................................... 215,225 236,885 Other assets............................................. 485,555 364,172 ---------- ---------- Total assets........................................... $2,033,952 $1,960,996 ========== ========== Unpaid losses and loss adjustment expenses............... $1,291,312 $1,093,082 Unearned premiums........................................ 446,224 375,574 Long-term debt........................................... 175,000 175,000 Other liabilities........................................ 88,071 108,250 ---------- ---------- Total liabilities...................................... 2,000,607 1,751,906 ---------- ---------- Total shareholders' equity............................. 33,345 209,090 ---------- ---------- Total liabilities and shareholders equity.............. $2,033,952 $1,960,996 ---------- ----------
Year ended December 31, ---------------------------- 1999 1998 1997 -------- -------- -------- (dollars in thousands) Net earned premiums............................. $529,651 $453,406 $357,939 Net investment income........................... 56,034 56,858 55,698 Realized investment gains....................... 20,332 15,544 15,306 Foreign exchange gains (losses)................. 2,945 (483) (1,240) Agency income................................... 12,369 17,057 15,571 -------- -------- -------- Total revenues................................ 621,331 542,382 443,274 -------- -------- -------- Underwriting costs and expenses................. 749,730 489,646 384,530 -------- -------- -------- (Loss) income from operations before income tax and extraordinary charge....................... (128,399) 52,736 58,744 -------- -------- -------- Net (loss) income............................. $(90,771) $ 23,878 $ 41,105 ======== ======== ========
66 TERRA NOVA (BERMUDA) HOLDINGS LTD. AND ITS SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 22. Unaudited Selected Quarterly Financial Data
Three months Three months Three months Three months ended ended ended ended March 31 June 30 September 30 December 31 ------------ ------------ ------------ ------------ (dollars in thousands except per share amounts) 1999 Revenues................. $172,823 $210,213 $187,692 $152,522 -------- -------- -------- -------- Net income............... 21,061 13,239 11,968 (81,242) -------- -------- -------- -------- Basic earnings per share................... $ 0.83 $ 0.53 $ 0.47 $ (3.20) -------- -------- -------- -------- Diluted earnings per share................... $ 0.81 $ 0.51 $ 0.45 $ (3.20) -------- -------- -------- -------- 1998 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 -------- -------- -------- --------
The Company's net income per share amounts are based on the weighted average number of shares outstanding during the periods (see Note 8). 23. Subsequent Event The Company entered into an Agreement and Plan of Merger and Scheme of Arrangement, dated as of August 15, 1999, and amended on September 10, 1999, and January 28, 2000, with Markel Corporation ("Markel"). The Agreement provides for the merger of a wholly-owned subsidiary of Markel Holdings into Markel and a scheme of arrangement between the Company and its shareholders. After completion of the merger and the scheme of arrangement, each of the Company and Markel will be a wholly-owned subsidiary of Markel Holdings, which will change its name to "Markel Corporation." At the effective time of the merger and scheme of arrangement each outstanding Class A ordinary share, other than 2,069 shares held by Markel or its transferee, and each outstanding Class B ordinary share of the Company will be cancelled and the holders thereof, other than Markel, the Company or its subsidiaries, will be entitled to receive $13.00 in cash, 0.07027 of a Markel Holdings common share and 0.07027 of Markel Holdings contingent value right per share. On March 16, 2000, the Company's and Markel's shareholders approved the merger and scheme of arrangement at special shareholder meetings called for the purpose. Subject to approval by the Bermuda Supreme Court and completion or waiver of all closing conditions, the merger and scheme of arrangement are expected to be completed on March 24, 2000. 67 ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table provides biographical information regarding the directors and executive officers of the Company.
Name Age Title ---- --- ------------------------------------------------------------ John J. Dwyer........... 63 Chairman of the Board Chairman and Chief Executive Officer of Terra Nova (Bermuda) Director of U.K. Holdings Director of Corifrance Nigel H.J. Rogers....... 50 President and Chief Executive Officer Chairman of U.K. Holdings Director of Terra Nova Managing Director of Octavian Chairman of TN Capital Director of Corifrance William J. Wedlake...... 43 Senior Vice-President and Chief Financial Officer Director of U.K. Holdings Director of Terra Nova Director of TN Capital Director of Corifrance Jean M. Waggett......... 58 Senior Vice-President, General Counsel and Secretary Director of Terra Nova (Bermuda) Director of Corifrance Ian L. Bowden........... 56 Chief Investment Officer Director of Terra Nova Director of Terra Nova Asset Management Limited ("TNAM") John E. O'Neill......... 50 Group Chief Actuary Director of Terra Nova John J. Byrne........... 67 Director of the Company Mark J. Byrne........... 38 Director of the Company Robert S. Fleischer..... 57 Director of the Company Steven J. Gilbert....... 52 Director of the Company David L. Jaffe.......... 41 Director of the Company Hugh P. Lowenstein...... 69 Director of the Company Philip F. Petronis...... 51 Director of the Company Jerry S. Rosenbloom..... 60 Director of the Company
68 John J. Dwyer has been Chairman of the Board of the Company since May 1998, having been Deputy Chairman since May 1995, and has been a director of Terra Nova (Bermuda) since March 1995. He is a director of U.K. Holdings, TN SAS and Corifrance, and was a director of Octavian and TN Capital from 1995 through December 1997 and January 1998, respectively. Nigel H.J. Rogers has been President and Chief Executive Officer of the Company since May 1998, having been Deputy Chairman since January 1996. Mr. Rogers has served as Managing Director of Octavian since January 1996. He has been a member of Lloyd's since the 1982 year of account. Mr. Rogers also serves as a director of U.K. Holdings, Terra Nova, TN Capital, Corifrance and TNAM. William J. Wedlake has been the Senior Vice President and Chief Financial Officer of the Company and a director and Chief Financial Officer of U.K. Holdings and Terra Nova since September 1996. Mr. Wedlake has been a director of Corifrance since September 1997 and of TN Capital since February 1998. From 1993 to 1996, Mr. Wedlake was Finance Director (U.K. & Ireland) of GRE. Jean M. Waggett has been the Senior Vice President, Secretary and General Counsel of the Company since March 1996. Ms. Waggett has been a director of Terra Nova (Bermuda) since November 1996, and Corifrance since September 1997. From 1980 until February 1996, Ms. Waggett was employed in various positions with Aetna, Inc. and Aetna International, Inc. Ian L. Bowden, Chief Investment Officer, transferred to TNAM in 1996, having been Director of Fixed Interest Investment of Terra Nova since 1986. Mr. Bowden serves as a director of Terra Nova and Managing Director of TNAM. John E. O'Neill is the Group Chief Actuary of the Company and previously was the Chief Actuary of Terra Nova since 1994. Mr. O'Neill has been a director of Terra Nova since September 1999. John J. Byrne has been a Director of the Company since May 1999. Mr. Byrne served as a Director Emeritus of the Company from November, 1996 to May 1999, and as a Director from December 1994 until November 1996. Since 1985, Mr. Byrne has been Chairman of the Board of Fund American Enterprise Holdings, Inc., a financial services holding company, and was its Chief Executive Officer and President until October 1997. Mr. Byrne is also a director of Financial Security Assurance Holdings Ltd. and White Mountains Holdings. Mr. Byrne is the father of Mark J. Byrne, an incumbent Director of the Company. Mark J. Byrne has been a Director of the Company since November 1996. Mr. Byrne is Chairman and President of West End Capital Management (Bermuda) Limited. Mr. Byrne previously was the Managing Director, Global Fixed Income Arbitrage, Credit Suisse First Boston. Mr. Byrne is the son of John J. Byrne, an incumbent Director of the Company. Robert S. Fleischer has been a Director of the Company since December 1994. Mr. Fleischer is currently a Managing Director of Donaldson, Lufkin & Jenrette Securities Corporation Inc. ("DLJSC") and has been employed in various positions by DLJSC since 1978. Steven J. Gilbert has been a Director of the Company since December 1994. Mr. Gilbert is the Chairman of Gilbert Global Equity Partners (Bermuda) Ltd., and was the Managing General Partner of Soros Capital LP, the principal venture capital and leveraged transaction entity of Quantum Group of Funds, from 1992 to 1996. He is the Managing Director of Commonwealth Capital Partners LP, a private equity investment fund. He is also a director of NFO Worldwide Inc., Vertias Inc., Star City Casino Holdings, Ltd., LCC International Inc., and One.Tel Ltd. David L. Jaffe has been a Director of the Company since December 1994. Mr. Jaffe has been a Managing Director of DLJ Merchant Banking, Inc. ("DLJMB") since January 1995 and has been employed in various positions by DLJMB or DLJSC since 1984. He is also a director of OSF Holdings Inc. (Toronto Stock Exchange), Brand Scaffold Services, Inc., Target Media Partners and Duane Reade Inc. 69 Hugh P. Lowenstein has been a Director of the Company since December 1994. Mr. Lowenstein is the founder and owner of Shore Capital Limited, a Bermuda- based consulting and investment firm ("Shore Capital"). Shore Capital currently provides consulting services to DLJSC. He is also a director of Century Business Services Inc. Philip F. Petronis has been a Director of the Company since December 1994. Mr. Petronis has been an Executive Vice President with Guy Carpenter & Company Inc. since April 1998. Formerly, Mr. Petronis was a Principal of Marsh & McLennan Risk Capital Corporation and a Managing Director of Marsh & McLennan Inc., having served in those positions since 1992 and 1984, respectively. He is past Chairman of the National Association of Insurance Brokers. Jerry S. Rosenbloom has been a Director of the Company since May 1998. Dr. Rosenbloom is Frederick H. Ecker Professor of Insurance and Risk Management at The Wharton School of the University of Pennsylvania where he had been a member of the faculty since 1974. He served as Chairman of the Department of Insurance and Risk Management at the Wharton School from 1989 to 1994. Dr. Rosenbloom is also a director of Annuity and Life Re (Holdings) Ltd., Harleysville Insurance Group, and Mutual Risk Management. ITEM 11--EXECUTIVE COMPENSATION The following table summarizes the compensation earned by John J. Dwyer, the Company's Chairman and each of the Company's other four most highly compensated executive officers (collectively, the "Named Executive Officers") for its 1997, 1998 and 1999 fiscal years. Summary Compensation Table
Long-term Annual Compensation (1) Compensation ----------------------------------- Awards-- Other Annual Securities Compensation Underlying Salary Bonus (2) Options Name and Principal Position Year $ $ $ # --------------------------- ---- --------- ------- ------------ ------------ John J. Dwyer................. 1999 3,247,500 900,000 145,500 60,000 Chairman (3) 1998 383,333 475,000 138,000 -- 1997 320,000 240,000 129,000 255,700 Nigel H.J. Rogers............. 1999 440,000 543,177 32,827 80,965 President and Chief Executive Officer (4) 1998 383,333 475,000 31,182 -- 1997 320,000 240,000 29,656 256,400 William J. Wedlake............ 1999 310,040 100,000 23,947 17,500 Senior Vice President and Chief Financial 1998 295,040 200,000 24,014 -- Officer 1997 280,000 150,000 24,244 67,100 Jean M. Waggett............... 1999 1,130,000 300,000 75,000 17,500 Senior Vice President, Secretary and 1998 250,000 150,000 75,000 -- General Counsel (5) 1997 230,000 115,000 75,000 65,500 Ian L. Bowden................. 1999 248,800 80,000 21,581 6,000 Chief Investment Officer 1998 236,800 90,000 22,168 -- 1997 236,800 96,000 24,907 --
- -------- (1) All salary and bonus amounts for the Named Executive Officers were calculated and granted in U.S. dollars and are shown in the table as granted. Compensation was paid to Mr. Dwyer and Ms. Waggett in U.S. dollars. Salary and bonus amounts for Messrs. Rogers, Wedlake and Bowden were translated into, and paid in, British pounds at the exchange rate of $1.60. Because the British pound and U.S. dollar relationship varies from day to day, the U.S. dollar equivalent of the compensation paid to Messrs. Rogers, 70 Wedlake and Bowden in British pounds will fluctuate. For each of 1999, 1998 and 1997, the payments to Messrs. Rogers, Wedlake and Bowden for "Other Annual Compensation" were made in British pounds and have been translated into U.S. dollars at the year-end exchange rate for each of 1999, 1998 and 1997 of $1.6117, $1.6638 and $1.6418. (2) This column includes the cost to the Company of personal health insurance and the value attributable for personal taxation purposes of car, fuel and private telephone expenses paid by the Company for the Named Executive Officer where appropriate. In the case of Mr. Dwyer and Ms. Waggett, the amounts include housing allowances as residents in Bermuda. (3) Mr. Dwyer's salary amount includes $2,807,500 paid in lieu of severance in December 1999. (4) Mr. Rogers also participates in the Octavian Stock Option Plan which provides for a grant of options in the years 1999 to 2003, based on profit commissions received by Octavian following the closing of each of the underwriting years of account 1996 to 2000. In December 1999, Mr. Rogers was granted 20,965 options on Terra Nova Class A shares under the Plan based on profit commissions received by Octavian on the closing of the 1996 underwriting year of account. Included in Mr. Roger's bonus was an Octavian Syndicate Management bonus paid in 1999 for the 1996 underwriting year of account. (5) Ms. Waggett's salary amount includes $865,000 paid in lieu of severance in December 1999. Option Grants in 1999 The following table sets forth information on grants of stock options, exercisable for Class A Ordinary Shares awarded to the Company's Named Executive Officers. No options were granted in 1999 to Directors who were not executive officers.
Number of % of Total Potential Realized Securities Options Value of Assumed Underlying Granted to Annual Rates of Options Employees Exercise Stock Price Granted in Fiscal Price Expiration Appreciation for Name (#) Year ($/Sh) Date Option Term (1) ---- ---------- ---------- -------- ---------- ------------------- 5% 10% -------- ---------- John J. Dwyer........... 15,000(2) 3.0% $23.65 02/04/09 $223,100 $ 565,380 45,000(3) 8.9% 23.65 02/04/09 669,301 1,696,140 Nigel H.J. Rogers....... 15,000(2) 3.0% 23.65 02/04/06 144,419 336,557 45,000(3) 8.9% 23.65 02/04/06 433,257 1,009,672 20,965(4) 4.1% Nominal 12/20/06 256,046 596,696 William J. Wedlake...... 7,500(2) 1.5% 23.65 02/04/06 72,209 168,279 10,000(3) 2.0% 23.65 02/04/06 96,279 224,372 Jean M. Waggett......... 7,500(2) 1.5% 23.65 02/04/09 111,550 282,690 10,000(3) 2.0% 23.65 02/04/09 148,734 376,920 Ian L. Bowden........... 6,000(3) 1.2% 23.65 02/04/06 57,768 134,623
(1) Assumes market value of stock on date of grant equal to exercise price. (2) Options lapsed in 2000 without becoming exercisable. (3) Each option becomes exercisable with respect to 20% of the underlying shares on each of the first through fifth anniversaries of the date of grant. (4) Options granted in terms of the Octavian Stock Option Plan with an exercise price of less than $l per share. The share price on date of issue is assumed as $30. No further grants of options have been made to Messrs. Dwyer, Rogers, Wedlake, Waggett or Bowden since December 31, 1999. 71 Option Exercises in 1999 and Year End 1999 Option Values The following table presents information about the exercise of options to purchase Class A Ordinary Shares during 1999 and the value realized on exercise by each Named Executive Officer. The table also provides the number of exercisable and unexercisable options and the value of the in-the-money options as of December 31, 1999, for each Named Executive Officer. The Company has never granted SAR's. The value of unexercised options has been calculated by subtracting the exercise price from the market price of the Class A Ordinary Shares on December 31, 1999 ($30 per Share).
Number of Securities Value of Unexercised Underlying Options In-the-Money Options Number of at December 31, 1999 at December 31, 1999 Shares ------------------------- ------------------------- Acquired Value Unexercisable Unexercisable on Exercise Realized Exercisable (1) Exercisable (1) Name ----------- -------- ----------- ------------- ----------- ------------- John J. Dwyer........... -- -- 164,507 204,820 $1,621,379 $ 906,488 Nigel H. J. Rogers...... -- -- 114,560 222,805 472,789 1,481,455 William J. Wedlake...... -- -- 50,840 63,780 386,576 403,290 Jean M. Waggett......... -- -- 39,096 61,145 261,273 412,902 Ian L. Bowden........... -- -- 51,194 15,449 1,106,702 115,099
- -------- (1) The unexercisable options would become exercisable in the event of a change of control. The Terra Nova/Markel merger and scheme of arrangement, if consummated, would constitute such a change of control. Pension Plans The following table presents the estimated maximum annual retirement benefits payable to employees of Terra Nova and TNAM under the Terra Nova Pension and Life Assurance Plan (1986) (the "Pension Plan") at the specified average compensation and years of service classifications. Pension Plan Table
Years of Service -------------------------------------------- Average Compensation 15 20 25 30 35 -------------------- -------- -------- -------- -------- -------- $125,000 $ 36,058 $ 48,077 $ 60,096 $ 72,115 $ 83,333 $150,000 43,269 57,692 72,115 86,538 100,000 $175,000 50,481 67,308 84,135 100,962 116,667 $200,000 57,692 76,923 96,154 115,385 133,333 $225,000 64,904 86,538 108,173 129,808 150,000 $250,000 72,115 96,154 120,192 144,231 166,667 $300,000 86,538 115,385 144,231 173,077 200,000 $400,000 115,385 153,846 192,308 230,769 266,667 $450,000 129,808 173,077 216,346 259,615 300,000 $500,000 144,231 192,308 240,385 288,462 333,333
The Pension Plan qualifies Terra Nova and TNAM for an exemption from compulsory participation in the State Earnings Related Pension Scheme ("SERPS"), a state-run pension plan to which non-exempted UK companies are required to make annual contributions. Only permanent employees between the ages of 20 and 61 are eligible to participate in the Pension Plan. Retirement benefits are calculated by multiplying the number of years of covered service by 1/52nd , multiplied by pensionable salary received in the calendar year prior to normal retirement age (age 62) or the date of leaving service, if earlier. The Pension Plan has a supplementary section which provides that certain employees of Terra Nova and TNAM shall receive retirement benefits based on the same formula as that for the ordinary plan member, except the multiple is a maximum of 1/30th for each year of service. 72 The maximum fraction for the purposes of computing retirement benefits is 2/3rds and, for employees joining the scheme after March 1987, the pensionable salary is limited. The limit as of December 31, 1999, was $144,960 using a British pound-to-U.S. dollar exchange rate of $1.60. Pensionable salary excludes bonuses, commissions, overtime or any other discretionary or fluctuating payments, except where a member is specifically advised to the contrary. A member is fully vested in the Pension Plan after two years of participation. The Pension Plan provides for the payment of reduced benefits on early retirement between the ages of 50 and 62. On the death of a member before retirement, the Pension Plan provides for a cash lump sum payment of four times basic salary and a survivor annuity benefit to the member's spouse of 50% of the member's prospective benefit. This benefit is payable from the date of the death of the member. The same benefits are payable to minor children up to the age of 18, or for such longer period as their education continues on a full- time basis if there is no surviving spouse. Pension Plan participants may make additional voluntary contributions up to 15% of annual salary to supplement their Pension Plan benefits. Such voluntary contributions are not matched by Terra Nova and TNAM. Terra Nova provides Mr. Wedlake and one other employee with a "Non-Approved" Pension Plan which provides a money purchase fund and additional term life assurance coverage targeted to raise total retirement and death benefits to a level broadly equivalent to that enjoyed by employees who joined the Company prior to June 1, 1989, the date on which the United Kingdom imposed limits on pensionable earnings. The credit years of pensionable services for Messrs. Wedlake and Bowden at December 31, 1999, were 6.4 years and 22.7 years, respectively. Mr. Dwyer, Ms. Waggett and employees of the Company who were based in Bermuda, Canada and Belgium participate in money purchase pension plans which are in line with local market terms and conditions of employment and generally cost the Company 10% of the basic salary of each participating employee. Mr. Rogers participates in The Octavian Group Pension Scheme (the "OMP Plan"), a defined contribution plan. Participation in the OMP Plan is at the discretion of the Compensation Committee. For employees of Octavian, the current annual contribution rate is 15% of annual pensionable salary, and for underwriters and directors of Octavian, the current annual contribution rate is 25% of annual pensionable salary. Normal retirement age is 60. Octavian provides certain of its employees with one of two defined benefit pension schemes, both run in conjunction with the Lloyd's Superannuation Scheme (the "Abbey Plan" and the "Lloyd's Plan", respectively). The Abbey Plan provides benefits which are similar to those in the Pension Plan, the principal difference being that the multiple is 1/60th and retirement age is 60. The Lloyd's Plan provides benefits which are in addition to those under SERPS as a retirement age of 60. The formula for computing pensions is similar to that in the Pension Plan, the principal difference being that the multiple is 1/100th. Service Agreements The Company entered into employment agreements with Messrs. Dwyer and Rogers and Ms. Waggett, that require them to maintain the confidentiality of information concerning the Company's business and not to work for a competitor of the Company for two years (one year for Ms. Waggett) after termination of employment. The employment agreements provided for a period of employment of three years (two for Ms. Waggett) which is automatically extended for subsequent one-year periods. Under these agreements, if the employment of Messrs. Dwyer or Rogers, or Ms. Waggett is involuntarily terminated other than for cause (including termination for gross misconduct or dishonesty), or if the executive terminates employment for a defined good reason or in the event of a change of control of the Company, the following benefits will be paid: three years of salary continuation (two years for Ms. Waggett), which includes annual base pay in the year of termination and a bonus amount equal to the greater of target bonus in the year of termination or the highest of the last three years, and all Company benefits during the salary continuation period or until the executive becomes eligible for comparable benefits under a similar plan with a subsequent employer. 73 The agreements with Mr. Dwyer and Ms. Waggett were terminated in December 1999, preserving the requirement to maintain confidentiality of information. Terra Nova entered into settlement agreements with each of Mr. Dwyer and Ms. Waggett for payments of $3,707,500 and $1,165,000, respectively, in settlement of their rights under the employment agreements and bonuses in respect of 1999. Mr. Dwyer will remain with the Company until the closing date of the Terra Nova/Markel merger and scheme of arrangements and Ms. Waggett will remain until the later of the closing date and April 30, 2000. The Company had previously entered into a service agreement with Nigel H.J. Rogers that was superseded by the new employment agreement with respect to all terms and conditions, except an annual bonus plan related to the performance of the Lloyd's syndicates managed by Octavian Syndicate Management. In connection with the proposed Terra Nova/Markel merger and scheme of arrangement, Markel Holdings anticipates a new employment arrangement with Mr. Rogers which would provide for him to continue employment at annual compensation levels comparable to those under his current agreement and to receive a $5 million bonus payment in a combination of cash and Markel Holdings common shares, one half of which would be paid immediately with the remainder vesting in six-month increments over 30 months. The new employment arrangement would supersede Mr. Rogers current Terra Nova employment arrangements at the time of closing. The Company has entered into an employment arrangement with William J Wedlake, which provides for a base salary subject to annual review, an annual bonus, a cash allowance in lieu of the use of a company automobile, the right to participate in the Company's health insurance plan and the right to participate in Terra Nova's approved and funded non-approved pension plans and to receive an additional year of pensionable past service credit for each complete year of actual service with the Company up to an agreed maximum less years of service vested in a previous employer's pension plans. The employment arrangement provides that Mr. Wedlake's employment may be terminated by either party's giving 12 month's notice to the other. The Company can also terminate Mr. Wedlake's employment at any time for cause. Approved Executive Share Option Plans On January 9, 1995, the Board of Directors of the Company adopted The Terra Nova Executive Share Option Schemes (the "Stock Option Plans") as amended on March 13, 1996, August 4, 1996, May 5, 1998 and October 14, 1999. The Stock Option Plans provide for the grant of options to eligible employees to purchase Shares (the "Option Shares"). The maximum number of Option Shares for which Options may be granted is limited: the total number of Option Shares for which options have not yet been granted, the number of options outstanding, the Option Shares issued within the previous ten years under the Stock Option Plans may not exceed 15% of the aggregate number of Ordinary Shares of the Company outstanding on the date preceding any option grant. Unexercised options will expire either seven or ten years after the date granted, as provided in the respective Stock Option Plans, subject to certain limited exceptions. The Stock Option Plans are administered by the Compensation Committee, which determines those employees who will be granted any future options. Octavian Stock Option Plan In connection with the Octavian acquisition, the Company, on January 5, 1996, established the Octavian Stock Option Plan providing for the grant of options to certain individual members of the management of Octavian, including Mr. Rogers, based on profit commissions received by Octavian for the 1996 to 2000 years of account. Under the Octavian Stock Option Plan, such members of management will receive annual option grants to purchase a number of Shares equal to 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, 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 such year. The aggregate Profit 74 Commission Component for the 1996 to 2000 underwriting years of account is subject to a maximum of (Pounds)10.0 million and no further options shall be issued once such maximum has been reached. The options will be granted on receipt of the profit commissions by Octavian on closure of each year of account under applicable Lloyd's regulations, which currently are the years 1999 to 2003 with regard to each of the years 1996 to 2000, respectively. The options have a nominal exercise price and become exercisable on or after the January 1 next succeeding the date of grant, commencing January 1, 2000, provided that all options granted after January 1, 2002, become immediately exercisable. Options expire seven years after the date of grant. The Octavian Stock Option Plan will be administered by the Compensation Committee with respect to persons subject to the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended. In December 1999, 157,012 options were granted following receipt by Octavian of the profit commissions on the 1996 year of account. ITEM 12--BENEFICIAL OWNERSHIP OF ORDINARY SHARES The following table presents the beneficial ownership of Class A Ordinary Shares ("Shares") by the Company's five most highly compensated executive officers, the Company's Directors and all of the Directors and executive officers of the Company as a group as of March 1, 2000. Unless otherwise indicated, the named individual has sole voting and investment power over the Ordinary Shares presented below.
Number of Class A Shareholder Ordinary Shares Percentage ----------- ----------------- ---------- John J. Dwyer................................................. 30,862 * Nigel H.J. Rogers............................................. 10,000 * Ian Bowden.................................................... 40,791 * William J. Wedlake............................................ 4,500 * Jean M. Waggett............................................... 2,000 * John J. Byrne (1)............................................. 484,787 1.99 Mark J. Byrne................................................. 1,000 * Robert S. Fleischer (2)....................................... 5,140 * Steven J. Gilbert (2) (3)..................................... 14,900 * David L. Jaffe (2)............................................ 6,140 * Hugh P. Lowenstein (2)........................................ 40,140 * Philip F. Petronis (2) (4).................................... 3,940 * Jerry S. Rosenbloom (2)....................................... 2,985 * All directors and executive officers as a group (14 persons).. 645,685 2.48
- -------- (1) The above table includes some shares in a private foundation and a family partnership over which Mrs. Byrne has voting control. The above table does not include an additional 892,691 shares held by partnership and corporation in which Mr. Byrne has an indirect economic interest but does not have investment control or voting power. Mr. Byrne disclaims direct beneficial ownership to these 892,691 shares. (2) 1,162 of the Shares owned by Mr. J. Byrne, 3,140 of the Shares owned by each of Messrs. Fleischer, Jaffe, Lowenstein and Petronis, 2,921 of the Shares owned by Mr. Gilbert, and 1,985 of the Shares owned by Mr. Rosenbloom, represent shares as to which the Director has voting but not dispositive power. (3) Mr. Gilbert is the indirect beneficial owner of 1,530 Shares held by various interests of which he is a trustee or director and has both voting and investment power with respect to such Shares. (4) Includes 300 Shares owned by custodial accounts for Mr. Petronis' daughters of which he disclaims beneficial ownership. 75 Other Beneficial Owners The following table presents information with respect to beneficial ownership of the Shares, as of March 1, 2000, by each person known to the Company (including corporate groups) who beneficially owns more than five percent of the Company's outstanding Ordinary Shares ("Shares"):
Shareholder Number of Shares Percentage ----------- ---------------- ---------- Markel Corporation (1)...................... 8,241,090 31.52% DLJ Entities (2)............................ 4,924,799 18.84% Fidelity Mgt. & Res. (3).................... 1,797,000 7.38% Robert E. Torray & Co., Inc./The Torray Fund(4).................................... 1,261,000 5.18%
- -------- (1) Consists of 1,082,470 Class A Shares over which Markel Corporation has sole voting and dispositive power and 7,158,620 Class A and B Shares, which are the subject of a Shareholder Agreement, dated as of August 15, 1999 and confirmed on January 28, 2000 between Markel Corporation and the following shareholders of the Company: DLJ entities, John J. Byrne and related entities, and Marsh & McLennan Risk Capital Holdings, Ltd. and related entities. The Shareholder Voting Agreement gives Markel Corporation the right to vote the 7,158,620 Terra Nova Shares in favor of the proposed Terra Nova/Markel merger and scheme of arrangement. (2) Consists of 3,128,582 Class A (voting) Shares and 1,796,217 Class B (non- voting) Shares, which are convertible into Class A Shares, held directly by the following related investors: DLJMB Funding, 929,990 Shares (567,905 Class A and 362,085 Class B); DLJSC, 134,352 Shares (82,048 Class A and 52,304 Class B); DLJMB Overseas Partners C.V. ("DLJMB Overseas"), 2,183,345 Shares (1,121,517 Class A and 1,061,828 Class B); DLJ International Partners C.V. ("DLJIP"), 1,039,181 Shares (967,499 Class A and 71,682 Class B); DLJ Offshore Partners C.V. ("DLJOP"), 60,253 Shares (36,797 Class A and 23,456 Class B); and DLJ First ESC, L.L.C. ("DLJ First"), 577,678 Shares (352,816 Class A and 224,862 Class B). As the parent of both DLJMB Funding and DLJSC, Donaldson, Lufkin & Jenrette, Inc. ("DLJ") may be deemed to beneficially own all of the shares held by such entities. As DLJMB is the general partner of each of DLJMB Overseas, DLJIP, DLJOP and DLJ First, DLJ may be deemed to beneficially own indirectly all of the shares held by such entities. DLJ is an indirect subsidiary of The Equitable Companies Incorporated. The address of DLJ is 277 Park Avenue, New York, New York 10172. (3) Consists of 1,797,000 Class A Shares owned by a number of mutual funds and other investment accounts managed by affiliates of FMR Corp. The percentage of Shares owned is calculated without giving effect to possible conversion of the Class B Shares owned by the DLJ Entities. (4) Consists of 852,500 Class A Shares owned by Robert E. Torray & Co., Inc. and 408,500 Class A Shares owned by The Torray Fund over which the two entities hold shared voting and dispositive power. The percentage of Shares owned is calculated without giving effect to possible conversion of the Class B Shares owned by the DLJ Entities. ITEM 13--CERTAIN BUSINESS RELATIONSHIPS Registration Rights Agreement The Company and the existing shareholders of the Company as of April 1, 1996 (the "Shareholders"), entered into a Registration Rights Agreement, which grants the Shareholders certain incidental and demand registration rights with respect to Ordinary Shares held by them. Under this agreement, Shareholders other than the DLJ Entities (individually or as a group) owning or having the rights to acquire 30% or more of the Ordinary Shares outstanding and issuable prior to the initial public offering of shares on April 17, 1996 ("Offering"), or any subsequent offering have the right to require the Company on one occasion, and one or more of the DLJ Entities have the right to require the Company on two occasions, to register Shares under the Securities Act for sale in the public market, provided that the total fair value of the Shares requested to be registered in the exercise of any such right must be at least $15 million. Any other Shareholder not making the request will have the right to participate in such registration on a first-priority basis (pro rata according to the respective Ordinary Shares requested for registration) subject to a customary underwriter's reduction. 76 In addition, if the Company proposes to file a registration statement covering Ordinary Shares held by it or any other shareholder of the Company at any time, each Shareholder will have the right to include Ordinary Shares held by it in the registration, in each case on a first-priority basis with other Shareholders and any other holders of Shares requesting registration, pro-rata according to the respective Shares requested for registration, and on a second- priority basis with the Company, in each case subject to a customary underwriter's reduction. The Company has agreed to indemnify each Shareholder in respect of certain liabilities, including civil liabilities under the Securities Act and to pay certain expenses relating to such registration. Under the terms of the proposed Terra Nova/Markel merger and scheme of arrangement, DLJ entities who are shareholders of the Company; John J. Byrne and related entities who own shares of the Company over which he has voting or dispositive control; and Marsh & McLennan Risk Capital Holdings, Ltd. and related entities who own shares of the Company, each of whom would receive new shares of Markel Holdings, will have the benefit of a new registration rights agreement. The current Registration Rights Agreement will terminate on the closing of the Terra Nova/Markel merger and scheme of arrangement. Mr. Byrne is a director of the Company and Mr. Philip F. Petronis, a director of the Company, is an executive officer of an affiliate of Marsh & McLennan. Transactions with Five Percent Shareholders From time to time, in the ordinary course of its insurance business, the Company may insure risks of 5% shareholders and, in addition, may cede risks to insurance companies who are affiliates of 5% shareholders. The business may be conducted through intermediaries, which may from time to time include affiliates of 5% shareholders. As an investor, the Company may transact business with counterparties and intermediaries which may be affiliated with certain 5% shareholders. All transactions would be conducted on an arm's length basis. DLJSC acted as the financial advisor to the Company during the negotiation and approval of the proposed Terra Nova/Markel merger and scheme of arrangement by the Board of Directors. DLJSC received $750,000 from the Company for the fairness opinion issued by DLJSC to the Board in relation to the proposed transaction and $26,588 for reasonable expenses incurred. Upon completion of the proposed Terra Nova/Markel merger and scheme of arrangement, the Company will pay to DLJSC an additional fee equal to 0.60% of the aggregate value of the Company's ordinary shares, treating any shares issuable upon exercise of options, warrants or other rights of conversion as outstanding, plus the amount of any debt assumed, acquired, remaining outstanding, retired or defeased or preferred shares redeemed or remaining outstanding in connection with the proposed Terra Nova/Markel merger and scheme of arrangement, minus the sum of $750,000, which has already been paid, and $250,000. The Company retained DLJSC as its investment banker and financial advisor on an exclusive basis until December 21, 1999. The Company agreed to indemnify DLJSC in connection with this. Messrs. Fleischer and Jaffe, both Directors of the Company, are managing directors of DLJSC and DLJMB (an affiliate of DLJSC), respectively. Mr. Lowenstein, who is also a Director of the Company, provides consulting services to DLJSC through Shore Capital. Mr. Jaffe is Chairman of the Board's Compensation Committee. Section 16 Reporting Directors and certain executives of the Company are subject to the reporting requirements of Section 16 of the Securities Exchange Act of 1934 as amended. The Company is not aware of any Director or executive who failed to make a required filing on a timely basis. 77 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 36. Index to Financial Statement Schedules
Page ---- Schedule II(a) -- Condensed Financial Information of Registrant (Parent Company) -- Condensed Balance Sheets..................................................... 79 Schedule II(b) -- Condensed Financial Information of Registrant (Parent Company) -- Condensed Statements of Operations........................................... 80 Schedule II(c) -- Condensed Financial Information of Registrant (Parent Company) -- Condensed Statements of Cash Flows........................................... 81 Schedule III -- Supplementary Insurance Information.......................................... 82 Schedule IV -- Reinsurance.................................................................. 83 Schedule VI -- Supplementary Information Concerning Property/Casualty Insurance Operations.. 84
Schedules I and V have been omitted because the required information is included in theconsolidated financial statements or notes. (b) Reports on Form 8-K. Reports on Form 8-K filed since the third quarter 1999 Form 10-Q filing:
-- February 4, 2000 -- February 22, 2000 -- March 3, 2000 (Form 8-KA)
(c) Exhibits. The Index to Exhibits and the Exhibits filed as part 85 of this report.......................................................... 78 Supplemental Schedule II(a) TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES PARENT COMPANY FINANCIAL INFORMATION (1) CONDENSED BALANCE SHEETS (dollars in thousands)
December 31, ------------------ 1999 1998 -------- -------- ASSETS Investment in subsidiaries................................. $210,389 $542,948 Fixed maturities........................................... 119,627 22,039 Common stocks.............................................. 108,025 -- -------- -------- Total investments........................................ 438,041 564,987 Other assets............................................... 13,281 7,292 -------- -------- Total assets............................................. $451,322 $572,279 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Other liabilities.......................................... $ 7,312 $ 1,417 -------- -------- Total liabilities.......................................... 7,312 1,417 -------- -------- Shareholders' equity: Common shares............................................ 151,637 150,620 Stock held in Trust...................................... (16,787) (12,900) Deferred equity compensation............................. 7,564 4,623 Additional capital....................................... 113,855 111,727 Unrealized (depreciation) appreciation in investment of subsidiaries net of income tax.......................... (3,949) 80,342 Cumulative translation adjustments....................... (3,473) 158 Retained earnings........................................ 195,163 236,292 -------- -------- Total shareholders' equity............................. 444,010 570,862 -------- -------- Total liabilities and shareholders' equity............. $451,322 $572,279 ======== ========
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes 79 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, -------------------------- 1999 1998 1997 -------- ------- ------- Revenues: Net investment income........................... $ 3,497 $ 3,618 $ 1,953 Realized gains (losses) on sales of investments.................................... (29) 246 (25) Foreign exchange gains (losses)................. -- (1) 5 -------- ------- ------- Total revenues................................ 3,468 3,863 1,933 -------- ------- ------- Expenses: Deferred debt expenses.......................... 665 664 664 Salaries........................................ 6,722 1,436 1,864 Legal and professional expenses................. 1,824 842 639 Other expenses.................................. 1,111 1,007 1,065 -------- ------- ------- Total expenses................................ 10,322 3,949 4,232 -------- ------- ------- Loss from operations before equity in net income of consolidated subsidiaries..................... (6,854) (86) (2,299) Equity in net (loss) income of consolidated subsidiaries..................................... (28,120) 72,485 75,709 -------- ------- ------- Net (loss) income............................... $(34,974) $72,399 $73,410 ======== ======= =======
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes 80 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, ---------------------------- 1999 1998 1997 -------- -------- -------- Cash flows from operating activities: Net (loss) income.............................. $(34,974) $ 72,399 $ 73,410 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in net loss (income) of consolidated subsidiaries.................................. 28,120 (72,485) (75,709) Realized capital losses (gains)................ 29 (246) 25 Stock option compensation expense.............. (660) -- 804 Change in accrued investment income............ (976) 201 (604) Change in other assets and liabilities, net.... 4,235 950 (289) -------- -------- -------- Net cash provided by (used in) operating activities.................................. (4,226) 819 (2,363) -------- -------- -------- Cash flows from investing activities: Proceeds of fixed maturities sold.............. 11,774 19,291 46,181 Purchase of fixed maturities................... (34,211) (12,045) (74,808) -------- -------- -------- Net cash (used in) provided by investing activities.................................. (22,437) 7,246 (28,627) -------- -------- -------- Cash flows from financing activities: Proceeds from shares issued.................... 3,145 637 384 Stock repurchases.............................. (3,887) (3,400) (10,020) Ordinary dividends received from subsidiary company(2).................................... 37,889 -- 44,400 Ordinary dividends paid to stockholders........ (6,155) (5,968) (4,370) -------- -------- -------- Net cash provided by (used in) financing activities.................................. 30,992 (8,731) 30,394 -------- -------- -------- Change in cash and cash equivalents.............. 4,329 (666) (596) Cash and cash equivalents at beginning of year... 1,480 2,146 2,742 -------- -------- -------- Cash and cash equivalents at end of year......... $ 5,809 $ 1,480 $ 2,146 -------- -------- --------
- -------- (1) The parent company condensed financial information should be read in conjunction with the consolidated financial statements and notes (2) Total dividends received from subsidiaries were $213,000 in 1999 and $44,400 in 1997. 81 Supplemental Schedule III TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION (dollars in thousands)
Benefits, Amortization Deferred Losses and Net claims, losses of deferred Other acquisition loss adjustment Unearned Earned investment and settlement acquisition operating Written Segment costs expenses premiums premiums income expenses costs expenses premiums - ---------------- ----------- --------------- -------- -------- ---------- -------------- ------------ --------- -------- Year ended December 31, 1999 Terra Nova...... $38,887 $836,952 $123,901 $227,694 $64,618 (a) $187,118 $85,446 $10,315 $179,563 Terra Nova (Bermuda)...... 6,419 118,656 21,954 39,494 43,219 (a) 26,525 13,756 288 34,584 Terra Nova Capital........ 53,213 418,399 313,937 303,271 11,686 (a) 263,936 138,362 12,436 388,876 Corifrance...... 1,164 35,961 8,386 14,822 5,207 (a) 13,664 3,272 2,358 15,153 Year ended December 31, 1998 Terra Nova...... $50,755 $864,241 $170,918 $252,714 $49,420 (a) $141,971 $79,720 $ 9,228 $266,571 Terra Nova (Bermuda)...... 8,044 115,920 25,428 78,061 37,375 (a) 68,017 13,807 1,115 95,317 Terra Nova Capital........ 46,639 195,794 195,693 199,506 7,954 (a) 141,968 62,465 8,471 270,740 Corifrance...... 2,169 33,048 8,963 16,627 3,525 (a) 7,611 4,388 1,508 13,569 Year ended December 31, 1997 Terra Nova...... $41,741 $951,364 $147,228 $256,306 $63,690 (a) $151,911 $77,268 $ 9,421 $249,927 Terra Nova (Bermuda)...... 8,378 80,397 20,101 42,985 28,434 (a) 45,141 9,232 1,025 65,438 Terra Nova Capital........ 23,744 82,658 97,558 107,978 277 (a) 78,528 25,227 2,860 165,780 Corifrance...... 2,517 43,305 10,047 11,800 1,900 (a) 6,900 3,700 400 2,400
- ------- (a) Net investment income excludes investment income and realized gains of $(1,007,000), $12,364,000 and $4,892,000 for 1999, 1998 and 1997, respectively, which is attributed to the Parent and its other subsidiaries. 82 Supplemental Schedule IV TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES REINSURANCE AS OF DECEMBER 31, 1999 (dollars in thousands)
Percentage Ceded to Assumed of amount Gross other from other Net assumed to Written premiums amount companies companies amount net - ---------------- -------- --------- ---------- -------- ---------- Property--Casualty Year ended December 31, 1999....................... $601,419 $246,487 $263,514 $618,446 42.61% 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%
83 Supplemental Schedule VI TERRA NOVA (BERMUDA) HOLDINGS LTD. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS (dollars in thousands)
Losses and loss adjustment expenses incurred related to Paid Losses and ----------------- Amortization losses and Deferred loss Net (1) (2) of deferred loss acquisition adjustment Unearned Earned investment Current Prior acquisition adjustment Written Segment costs expenses premiums premiums income year Year costs expenses premiums - ---------------- ----------- ---------- -------- -------- ---------- -------- -------- ------------ ---------- -------- Year ended December 31, 1999 Continuing operations..... $ 99,683 $1,409,968 $468,178 $585,281 $66,919 $546,253 $(55,010) $240,836 $425,167 $618,446 Aviation business in run-off........ -- 59,229 -- 12 -- -- (1,388) -- 2,026 12 Year ended December 31, 1998 Continuing operations..... 107,607 1,209,003 401,002 546,908 60,852 384,531 (24,964) 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
84 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 U.K. 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 U.K. 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 U.K. 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 U.K. 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 U.K. 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 U.K. Holdings, Aetna, CIGNA, Marsh & McLennan, Bowring and Nimrod Securities (incorporated by reference to Exhibit 10.6 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.3 Registration Rights Agreement dated as of March 25, 1996, among the Company and certain shareholders of the Company (incorporated by reference to Exhibit 10.13 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.4 Exclusivity Agreement, between the Company and DLJSC (incorporated by reference to Exhibit 10.14 of the Company's Registration Statement on Form S-1, Registration No. 333-1726). 10.5 Service Agreement, dated October 18, 1993, between Terra Nova and John Riddick (incorporated by reference to Exhibit 10.15 of the Company's Registration Statement on Form S-1, Registration No. 33-93358). 10.6 Service Agreement, dated June 14, 1993, between Terra Nova and Richard J. Edmunds (incorporated by reference to Exhibit 10.17 of the Company's Registration Statement on Form S-1, Registration No. 33- 93358).
85
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 (incorporated by reference to 1998 Form 10-K filed on March 15, 1999). 10.17 Employment Agreement, dated July 1, 1998, between the Company and Nigel H.J.Rogers (incorporated by reference to 1998 Form 10-K filed on March 15, 1999). 10.18 Employment Agreement, dated July 1, 1998, between the Company and Jean M. Waggett (incorporated by reference to 1998 Form 10-K filed on March 15, 1999). 10.19 Letter Agreement, dated November 26, 1998, between the Company and John Riddick (incorporated by reference to 1998 Form 10-K filed on March 15, 1999). 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).
86 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 and Title Date ------------------- ---- /s/ John J. Dwyer March 20, 2000 By ________________________________________ John J. Dwyer Chairman /s/ Nigel H.J. Rogers March 20, 2000 By ________________________________________ Nigel H.J. Rogers President and Chief Executive Officer /s/ William J. Wedlake March 20, 2000 By ________________________________________ William J. Wedlake Senior Vice President and Chief Financial Officer /s/ Robert S. Fleischer March 20, 2000 By ________________________________________ Robert S. Fleischer Director /s/ David L. Jaffe March 20, 2000 By ________________________________________ David L. Jaffe Director
87 EX-27 2 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM TERRA NOVA(BERMUDA) HOLDINGS LTD AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS 12-MOS DEC-31-1999 DEC-31-1999 OCT-01-1999 JAN-01-1999 DEC-31-1999 DEC-31-1999 1,306,110 1,306,110 0 0 0 0 109,900 109,000 0 0 0 0 1,416,010 1,416,010 74,798 74,798 62,162 62,162 99,638 99,638 2,631,700 2,631,700 1,409,968 1,409,968 468,178 468,178 0 0 0 0 175,000 175,000 0 0 0 0 151,637 151,637 292,373 292,373 2,631,700 2,631,700 125,910 585,281 24,084 93,829 (2,747) 26,879 5,275 17,261 177,309 491,243 70,171 240,836 8,431 25,397 (116,515) (72,602) (35,274) (37,628) (81,241) (34,974) 0 0 0 0 0 0 (81,241) (34,974) (3.20) (1.38) (3.20) (1.38) 967,911 982,904 239,699 569,010 (29,134) (44,510) 136,609 179,844 (21,618) 264,075 1,063,485 1,063,485 0 0 (1) Foreign exchange movement during the year has been allocated to prior year paid claims. (2) Net reserves from reinsurance to close has been included as prior year provision.
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