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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001 Commission file number 1-13816
EVEREST REINSURANCE HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware 22-3263609
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
477 Martinsville Road
Post Office Box 830
Liberty Corner, New Jersey 07938-0830
(908) 640-3000
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive office)
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Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
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8.5% Senior Notes Due 2005 NYSE
8.75% Senior Notes Due 2010 NYSE
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Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
At March 28, 2002, the number of common shares of the registrant
outstanding was 1,000, all of which are owned by Everest Re Group, Ltd.
The Registrant meets the conditions set forth in General Instruction
I(1)(a) and (b) of Form 10-K and is therefore filing this form with the reduced
disclosure format permitted by General Instruction I of Form 10-K.
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TABLE OF CONTENTS
Item Page
- ---- ----
PART I
1. Business
2. Properties
3. Legal Proceedings
4. Submission of Matters to a Vote of Security Holders
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters
6. Selected Financial Data
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
7A. Quantitative and Qualitative Disclosures About Market Risk
8. Financial Statements and Supplementary Data
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
PART III
10. Directors and Executive Officers of the Registrant
11. Executive Compensation
12. Security Ownership of Certain Beneficial Owners and Management
13. Certain Relationships and Related Transactions
PART IV
14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K
3
PART I
UNLESS OTHERWISE INDICATED, ALL FINANCIAL DATA IN THIS DOCUMENT HAVE BEEN
PREPARED USING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP"). AS USED IN
THIS DOCUMENT, "HOLDINGS" MEANS EVEREST REINSURANCE HOLDINGS, INC.; "GROUP"
MEANS EVEREST RE GROUP, LTD. (FORMERLY EVEREST REINSURANCE GROUP, LTD.);
"EVEREST RE" MEANS EVEREST REINSURANCE COMPANY AND ITS SUBSIDIARIES (UNLESS THE
CONTEXT OTHERWISE REQUIRES); "BERMUDA RE" MEANS EVEREST REINSURANCE (BERMUDA),
LTD. AND THE "COMPANY" MEANS HOLDINGS AND ITS SUBSIDIARIES (UNLESS THE CONTEXT
OTHERWISE REQUIRES).
ITEM 1. BUSINESS
THE COMPANY
Holdings, a Delaware corporation, is a wholly-owned subsidiary of Group, which
is a Bermuda holding company whose common shares are publicly traded in the
United States on the New York Stock Exchange under the symbol "RE". Group files
an annual report on Form 10-K with the Securities and Exchange Commission with
respect to its consolidated operations, including Holdings. Holdings became a
wholly-owned subsidiary of Group on February 24, 2000 in a corporate
restructuring pursuant to which holders of shares of common stock of Holdings
automatically became holders of the same number of common shares of Group.
On March 14, 2000, Holdings completed public offerings of $200 million principal
amount of 8.75% senior notes due March 15, 2010 and $250 million principal
amount of 8.50% senior notes due March 15, 2005. This abbreviated filing is
required as a result of this outstanding debt. During 2000, the net proceeds of
these offerings and additional funds were distributed by Holdings to Group.
The Company's principal business, conducted through its operating subsidiaries,
is the underwriting of reinsurance and insurance in the United States and
international markets. The Company underwrites reinsurance both through brokers
and directly with ceding companies, giving it the flexibility to pursue business
regardless of the ceding company's preferred reinsurance purchasing method. The
Company underwrites insurance principally through general agency relationships.
The Company's operating subsidiaries, excluding Mt. McKinley Insurance Company,
are each rated A+ ("Superior") by A.M. Best Company ("A.M. Best"), an
independent insurance industry rating organization that rates insurance
companies on factors of concern to policyholders.
Following is a summary of the Company's operating subsidiaries:
o Everest Re, a Delaware insurance company and a direct subsidiary of
Holdings, is a licensed property and casualty insurer and/or reinsurer
in all states (except Nevada and Wyoming), the District of Columbia,
Puerto Rico and Canada, and is authorized to conduct reinsurance
business in the United Kingdom and Singapore. Everest Re underwrites
property and casualty reinsurance on a treaty and facultative basis for
insurance and reinsurance companies in the United States and
international markets. Everest Re had statutory surplus at December 31,
2001 of $1,293.8 million.
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o Everest National Insurance Company ("Everest National"), an Arizona
insurance company and a direct subsidiary of Everest Re, is licensed in
42 states and the District of Columbia and is authorized to write
property and casualty insurance in the states in which it is licensed.
This is often called writing insurance on an admitted basis.
o Everest Insurance Company of Canada ("Everest Canada"), a Canadian
insurance company and a direct subsidiary of Everest Re, is licensed in
all Canadian provinces and territories and is federally licensed to
write property and casualty insurance under the Insurance Companies Act
of Canada.
o Everest Indemnity Insurance Company ("Everest Indemnity"), a Delaware
insurance company and a direct subsidiary of Everest Re, engages in the
excess and surplus lines insurance business in the United States.
Excess and surplus lines insurance is specialty property and liability
coverage that an insurer not licensed to write insurance in a
particular state is permitted to provide when the specific specialty
coverage is unavailable from admitted insurers. This is often called
writing insurance on a non-admitted basis. Everest Indemnity is
licensed in Delaware and is eligible to write business on a
non-admitted basis in 41 states, the District of Columbia and Puerto
Rico.
o Everest Security Insurance Company ("Everest Security"), formerly
Southeastern Security Insurance Company, a Georgia insurance company
and a direct subsidiary of Everest Re, was acquired in January 2000 and
writes property and casualty insurance on an admitted basis in Georgia.
o Mt. McKinley Managers, L.L.C. ("Managers"), a New Jersey limited
liability company and a direct subsidiary of Holdings, is licensed in
New Jersey as an insurance producer. An insurance producer is any
intermediary, such as an agent or broker, which acts as the conduit
between an insurance company and an insured. Managers, which is
licensed to act in New Jersey as an insurance producer in connection
with policies written on both an admitted and a surplus lines basis, is
the underwriting manager for Everest Indemnity. As a result of a 1998
acquisition of the assets of insurance agency operations in Alabama
and Georgia, the continuing insurance agency operations are now carried
on by subsidiaries of Managers. These subsidiaries are WorkCare
Southeast, Inc., an Alabama insurance agency, and WorkCare Southeast
of Georgia, Inc., a Georgia insurance agency.
o Mt. McKinley Insurance Company (f/k/a Gibraltar Casualty Company,
"Gibraltar") ("Mt. McKinley"), a Delaware insurance company and a
direct subsidiary of Holdings, was acquired by Holdings in September
2000 from The Prudential. Mt. McKinley was formed by Everest Re in
1978 to engage in the excess and surplus lines insurance business
in the United States. In 1985, Mt. McKinley ceased writing new and
renewal insurance and now its ongoing operations relate to servicing
claims arising from its previously written business. Mt. McKinley
was a subsidiary of Everest Re until 1991 when Everest Re distributed
the stock of Mt. McKinley to a wholly-owned subsidiary of The
Prudential.
o Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda company and a
direct subsidiary of Everest Re, was formed in 1998 and owns Everest Re
Ltd., a United Kingdom company that is in the process of being
dissolved because its reinsurance operations have been converted into
branch operations of Everest Re. Everest Ltd. also holds $104.3 million
of investments, the management of which constitutes its principal
operations.
2
REINSURANCE INDUSTRY OVERVIEW
Reinsurance is an arrangement in which an insurance company, the reinsurer,
agrees to indemnify another insurance company, the ceding company, against all
or a portion of the insurance risks underwritten by the ceding company under one
or more insurance contracts. Reinsurance can provide a ceding company with
several benefits, including a reduction in net liability on individual or
classes of risks, catastrophe protection from large or multiple losses and
assistance in maintaining acceptable financial ratios. Reinsurance also provides
a ceding company with additional underwriting capacity by permitting it to
accept larger risks and write more business than would be possible without a
concomitant increase in capital and surplus. Reinsurance, however, does not
discharge the ceding company from its liability to policyholders.
There are two basic types of reinsurance arrangements: treaty and facultative
reinsurance. In treaty reinsurance, the ceding company is obligated to cede and
the reinsurer is obligated to assume a specified portion of a type or category
of risks insured by the ceding company. Treaty reinsurers do not separately
evaluate each of the individual risks assumed under their treaties and,
consequently, after a review of the ceding company's underwriting practices, are
largely dependent on the original risk underwriting decisions made by the ceding
company. In facultative reinsurance, the ceding company cedes and the reinsurer
assumes all or part of the risk under a single insurance contract. Facultative
reinsurance is negotiated separately for each insurance contract that is
reinsured. Facultative reinsurance normally is purchased by ceding companies for
individual risks not covered by their reinsurance treaties, for amounts in
excess of the dollar limits of their reinsurance treaties and for unusual risks.
Both treaty and facultative reinsurance can be written on either a pro rata
basis or an excess of loss basis. Under pro rata reinsurance, the ceding company
and the reinsurer share the premiums as well as the losses and expenses in an
agreed proportion. Under excess of loss reinsurance, the reinsurer indemnifies
the ceding company against all or a specified portion of losses and expenses in
excess of a specified dollar amount, known as the ceding company's retention or
reinsurer's attachment point, generally subject to a negotiated reinsurance
contract limit.
Premiums paid by the ceding company to a reinsurer for excess of loss
reinsurance are not directly proportional to the premiums that the ceding
company receives because the reinsurer does not assume a proportionate risk. In
pro rata reinsurance, the reinsurer generally pays the ceding company a ceding
commission. The ceding commission generally is based on the ceding company's
cost of acquiring the business being reinsured (commissions, premium taxes,
assessments and miscellaneous administrative expense). There is usually no
ceding commission on excess of loss reinsurance.
Reinsurers may purchase reinsurance to cover their own risk exposure.
Reinsurance of a reinsurer's business is called a retrocession. Reinsurance
companies cede risks under retrocessional agreements to other reinsurers, known
as retrocessionaires, for reasons similar to those that cause insurers to
purchase reinsurance: to reduce net liability on individual or classes of risks,
protect against catastrophic losses, stabilize financial ratios and obtain
additional underwriting capacity.
Reinsurance can be written through professional reinsurance brokers or directly
with ceding companies. From a ceding company's perspective, both the broker
market and the direct market have advantages and disadvantages. A ceding
company's decision to select one market over the other will be influenced by its
perception of such advantages and disadvantages relative to the reinsurance
coverage being placed.
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BUSINESS STRATEGY
The Company's underwriting strategies seek to capitalize on its financial
capacity, its employee expertise and its flexibility to offer multiple products
through multiple distribution channels. The Company's strategies include
effective management of the property and casualty underwriting cycle, which
refers to the tendency of insurance premiums, profits and the demand for and
availability of coverage to rise and fall over time. The Company also seeks to
manage its catastrophe exposures and retrocessional costs. Efforts to control
expenses and to operate in a cost-efficient manner are also a continuing focus
for the Company.
The Company's products include the full range of property and casualty
reinsurance and insurance coverages, including marine, aviation, surety, errors
and omissions liability ("E&O"), directors' and officers' liability ("D&O"),
medical malpractice, other specialty lines, accident and health ("A&H"), workers
compensation, and other standard lines. The Company's distribution channels
include both the direct and broker reinsurance markets, U.S. and international
markets, reinsurance, both treaty and facultative, and insurance, both admitted
and non-admitted.
The Company's underwriting strategy emphasizes underwriting profitability rather
than premium volume, writing specialized property and casualty risks and
integration of underwriting expertise across all underwriting units. Key
elements of this strategy are prudent risk selection, appropriate pricing
through strict underwriting discipline and continuous adjustment of the
Company's business mix to respond to changing market conditions. The Company
focuses on reinsuring companies that effectively manage the underwriting cycle
through proper analysis and pricing of underlying risks and whose underwriting
guidelines and performance are compatible with its objectives.
The Company's underwriting strategy also emphasizes flexibility and
responsiveness to changing market conditions, such as increased demand or
favorable pricing trends. The Company believes that its existing strengths,
including its broad underwriting expertise, U.S. and international presence and
substantial capital, facilitate adjustments to its mix of business
geographically, by line of business and by type of coverage, allowing it to
capitalize on those market opportunities that provide the greatest potential for
underwriting profitability. The Company's insurance infrastructure further
facilitates this strategy by allowing the Company to develop business that
requires the Company to issue insurance policies. The Company also carefully
monitors its mix of business to avoid inappropriate concentrations of geographic
or other risk.
RATINGS
The following table shows the financial strength ratings of the Company's
operating subsidiaries as reported by A.M. Best, Standard & Poor's Ratings
Services ("Standard & Poor's) and Moody's Investors Service ("Moody's"). These
ratings are based upon factors of concern to policyholders and should not be
considered an indication of the degree or lack of risk involved in an equity
investment in an insurance company.
4
Operating Subsidiary A.M. Best Standard & Poor's Moody's
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Everest Re A+ (Superior) AA- (Very Strong) Aa3 (Excellent)
Everest National A+ (Superior) AA- (Very Strong) Not Rated
Everest Indemnity A+ (Superior) Not Rated Not Rated
Everest Security A+ (Superior) BB pi Not Rated
Everest Canada A+ (Superior) Not Rated Not Rated
Mt. McKinley Not Rated B pi Not Rated
A.M. Best states that the "A+" ("Superior") rating is assigned to those
companies which, in its opinion, have, on balance, achieved superior financial
strength, operating performance and market profile when compared to the
standards established by A.M. Best and have demonstrated a very strong ability
to meet their ongoing obligations to policyholders. The "A+" ("Superior") rating
is the second highest of fifteen ratings assigned by A.M. Best, which range from
"A++" ("Superior") to "F" ("In Liquidation"). Additionally, A.M. Best has eleven
classifications within the "Not Assigned" category. Standard & Poor's states
that the "AA-" rating is assigned to those insurance companies which, in its
opinion, offer excellent financial security and whose capacity to meet
policyholder obligations is strong under a variety of economic and underwriting
conditions. The "AA-" rating is the fourth highest of nineteen ratings assigned
by Standard & Poor's, which range from "AAA" (Superior) to "R" (Regulatory
Action). Ratings from AA to B may be modified by the use of a plus or minus sign
to show relative standing of the insurer within those rating categories.
Ratings, denoted with a "pi" subscript, are ratings based on Standard & Poor's
analysis of published financial information and do not reflect in-depth meetings
with the Company's management. The "BB pi" and "B pi" ratings are the twelfth
and fifteenth highest of the nineteen Standard & Poor's ratings. Moody's states
that insurance companies rated "Aa" offer excellent financial security. Together
with the Aaa rated companies, Aa rated companies constitute what are generally
known as high grade companies, with Aa rated companies generally having somewhat
larger long-term risks. Moody's rating gradations are shown through the use of
nine distinct symbols, each symbol representing a group of ratings in which the
financial security is broadly the same. The "Aa3" (Excellent) rating is the
fourth highest of ratings assigned by Moody's, which range from "Aaa"
(Exceptional) to "C" (Lowest). Moody's further distinguishes the ranking of an
insurer within its generic rating classification from Aa to B with 1, 2 and 3
("1" being the highest).
The following table shows the investment grade ratings of the Holdings' senior
notes due March 15, 2005 and March 15, 2010 by A.M. Best, Standard & Poor's and
Moody's. Debt ratings are a current assessment of the credit-worthiness of an
obligor with respect to a specific obligation.
A.M. Best Standard & Poor's Moody's
- --------------------------------------------------------------------------------
Senior Notes a A- A3
A company with a debt rating of "a" is considered by A.M. Best to have a strong
capacity and willingness to meet the terms of the obligation and possesses a low
level of credit risk. The "a" rating is the sixth highest of 19 ratings assigned
by A.M. Best, which range from "aaa" to "ccc". A company with a debt rating of
"A-" is considered by Standard & Poor's to have a strong capacity to pay
interest and repay principal, although it is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher rated categories. The "A-" rating from Standard & Poor's is the seventh
highest of 24 ratings assigned by Standard & Poor's, which range from "AAA" to
"D". A company with a debt rating of "A3" is considered to be an
upper-medium-grade obligation by Moody's. This rating represents adequate
5
capacity with respect to repayment of principal and interest, but elements may
be present which suggest a susceptibility to impairment sometime in the future.
The "A3" rating is the seventh highest of 21 ratings assigned by Moody's which
range from "AAA" to "C".
All of the above-mentioned ratings are continually monitored and revised, if
necessary, by each of the rating agencies.
COMPETITION
The worldwide reinsurance and insurance businesses are highly competitive. The
September 11 terrorist attacks resulted in losses which reduced industry
capacity and were of sufficient magnitude to cause most individual companies to
reassess their capital position, tolerance for risk, exposure control mechanisms
and the pricing terms and conditions at which they are willing to take on risk.
The gradual and variable improving trend, which has been apparent through 2000
and earlier in 2001 firmed significantly. This firming generally took the form
of immediate and significant upward pressure on prices, including more
restrictive terms and conditions and a reduction of coverage limits and capacity
availability. Such pressures were widespread with some variability depending on
the product and markets involved, but mainly depending on the characteristics of
the underlying risk exposures. The magnitude of the changes was sufficient to
create temporary disequilibrium in some markets as individual buyers and sellers
adapted to changes in both their internal and market dynamics.
These changes reflect a reversal of the general trend from 1987 through 1999
toward increasingly competitive global market conditions across most lines of
business as reflected by decreasing prices and broadening contract terms. The
earlier trend resulted from a number of factors including the emergence of
significant reinsurance capacity in Bermuda, changes in the Lloyds market,
consolidation and increased capital levels in the insurance and reinsurance
industries, as well as the emergence of new reinsurance and financial products
addressing traditional exposures in alternative fashions. Many of these factors
continue to exist. As a result, although the Company is encouraged by the recent
improvements, and more generally, current market conditions, the Company cannot
predict with any reasonable certainty whether and to what extent these
improvements will persist.
Competition with respect to the types of reinsurance and insurance business in
which the Company is engaged is based on many factors, including the perceived
overall financial strength of the reinsurer or insurer, the A.M. Best and/or
Standard & Poor's rating of the reinsurer or insurer, underwriting expertise,
the jurisdictions where the reinsurer or insurer is licensed or otherwise
authorized, capacity and coverages offered, premiums charged, other terms and
conditions of the reinsurance and insurance business offered, services offered,
speed of claims payment and reputation and experience in lines written. The
Company competes in the United States and international reinsurance and
insurance markets with numerous international and domestic reinsurance and
insurance companies. The Company's competitors include independent reinsurance
and insurance companies, subsidiaries or affiliates of established worldwide
insurance companies, reinsurance departments of certain insurance companies and
domestic and international underwriting operations, including underwriting
syndicates at Lloyd's. Some of these competitors have greater financial
resources than the Company and have established long-term and continuing
business relationships throughout the industry, which can be a significant
competitive advantage. In addition, the potential for securitization of
reinsurance and insurance risks through capital markets provides an additional
source of potential reinsurance and insurance capacity and competition.
6
EMPLOYEES
As of March 1, 2002, the Company employed 345 persons. Management believes that
its employee relations are good. None of the Company's employees are subject to
collective bargaining agreements, and the Company is not aware of any current
efforts to implement such agreements.
ITEM 2. PROPERTIES
Everest Re's corporate offices are located in approximately 112,000 square feet
of leased office space in Liberty Corner, New Jersey. The Company's other
thirteen locations occupy a total of approximately 67,000 square feet, all of
which are leased. Management believes that the above-described office space is
adequate for its current and anticipated needs.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in ordinary routine litigation and
arbitration proceedings incidental to its business. The Company does not believe
that there are any other material pending legal proceedings to which it or any
of its subsidiaries or their properties are subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Information for this Item 4 is not required pursuant to General Instruction I(2)
of Form 10-K.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION AND HOLDER OF COMMON STOCK
As of December 31, 2001, all of the Company's common stock was owned by Group
and was not publicly traded.
During 2000 and 1999, the Company declared dividends on its common stock
totaling $495.0 million and $11.6 million, respectively. The Company did not pay
any dividends during 2001.
The declaration and payment of future dividends, if any, by the Company will be
at the discretion of the Board of Directors and will depend upon many factors,
including the Company's earnings, financial condition, business needs and growth
objectives, capital and surplus requirements of operating subsidiaries,
regulatory restrictions, rating agency considerations and other factors. As an
insurance holding company, the Company is dependent on dividends and other
permitted payments from its subsidiaries to pay cash dividends to its
stockholders. The payment of dividends to Holdings by Everest Re is subject to
limitations imposed by Delaware law. Generally, Everest Re may only pay
dividends out of its statutory earned surplus, which was $915.2 million at
December 31, 2001, and only after it has given 10 days prior notice to the
Delaware Insurance Commissioner. During this 10-day period, the Commissioner
may, by order, limit or disallow the payment of ordinary dividends if the
Commissioner finds the insurer to be presently or potentially in financial
distress. Further the maximum amount of dividends that may be paid without the
prior approval of the Delaware Insurance Commissioner in any twelve month period
is the greater of (1) 10% of an insurer's statutory surplus as of the end of the
prior calendar year or (2) the insurer's statutory net income, not including
realized capital gains, for the prior calendar year. Under this definition, the
maximum amount that will be available for the payment of dividends by Everest Re
in 2002 without triggering the requirement for prior approval of regulatory
authorities in connection with a dividend is $129.4 million. See Note 11A of
Notes to Consolidated Financial Statements.
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RECENT SALES OF UNREGISTERED SECURITIES
None.
ITEM 6. SELECTED FINANCIAL DATA
Information for this Item 6 is not required pursuant to General Instruction I(2)
of Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is a discussion of the results of operations and financial
condition of Everest Reinsurance Holdings, Inc. and its subsidiaries (the
"Company"). This discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto presented under ITEM 8.
RESTRUCTURING
On February 24, 2000, a corporate restructuring was completed and Everest Re
Group, Ltd. ("Group") became the new parent holding company of the Company,
which remains the holding company for Group's U.S. based operations. Holders of
the Company's common stock automatically became holders of the same number of
Group common shares. The Company is filing this report as a result of its public
issuance of senior notes on March 14, 2000. See ITEM 1 - "Business - The
Company" for a further discussion.
ACQUISITIONS
On September 19, 2000, the Company completed the acquisition of all of the
issued and outstanding capital stock of Gibraltar Casualty Company ("Gibraltar")
from The Prudential Insurance Company of America ("The Prudential") for $51.8
million, which approximated book value. As a result of the acquisition,
Gibraltar became a wholly owned subsidiary of the Company and, immediately
following the acquisition, its name was changed to Mt. McKinley Insurance
Company ("Mt. McKinley"). In connection with the acquisition of Mt. McKinley,
which has significant exposure to asbestos and environmental claims, Prudential
Property and Casualty Insurance Company ("Prupac"), a subsidiary of The
Prudential, provided reinsurance to Mt. McKinley covering 80% ($160.0 million)
of the first $200.0 million of any adverse development of Mt. McKinley's
reserves as of September 19, 2000 and The Prudential guaranteed Prupac's
obligation to Mt. McKinley. There were $22.2 million of cessions under this
reinsurance at December 31, 2001, reducing the limit available under this
contract to $137.8 million.
In connection with the Mt. McKinley acquisition, Prupac also provided excess of
loss reinsurance for 100% of the first $8.5 million of loss with respect to
certain of Mt. McKinley's retrocessions and potentially uncollectible
reinsurance coverage. There were $2.5 million and $3.6 million of cessions under
this reinsurance during the periods ending December 31, 2000 and 2001,
respectively, reducing the limit available under the contract to $2.4 million.
Mt. McKinley, a run-off property and casualty insurer in the United States, has
had a long relationship with the Company and its principal operating company,
Everest Reinsurance Company ("Everest Re"). Mt. McKinley was formed in 1978 by
Everest Re and wrote insurance until 1985, when it was placed in run-off. In
1991, Mt. McKinley became a subsidiary of The Prudential. Mt. McKinley is also a
reinsurer of Everest Re. Under a series of transactions dating to 1986, Mt.
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McKinley reinsured several components of Everest Re's business. In particular,
Mt. McKinley provided stop-loss reinsurance protection, in connection with the
Company's October 5, 1995 IPO, for any adverse loss development on Everest Re's
June 30, 1995 (December 31, 1994 for catastrophe losses) reserves, with $375.0
million in limits, of which $89.4 million remains available (the "Stop Loss
Agreement"). The Stop Loss Agreement and other reinsurance contracts between Mt.
McKinley and Everest Re remain in effect following the acquisition. However,
these contracts have become transactions with affiliates with the financial
impact eliminated in consolidation.
Effective September 19, 2000, Mt. McKinley and Everest Reinsurance (Bermuda),
Ltd. ("Bermuda Re") entered into a loss portfolio transfer reinsurance
agreement, whereby Mt. McKinley transferred, for arm's-length consideration, all
of its net insurance exposures and reserves, including allocated and unallocated
loss adjustment expenses, to Bermuda Re.
During 2000, the Company completed an additional acquisition, Everest Security
Insurance Company ("Everest Security"), formerly known as Southeastern Security
Insurance Company, a United States property and casualty company whose primary
business is non-standard automobile insurance.
RESULTS OF OPERATIONS
Unusual Loss Events. As a result of the terrorist attacks at the World Trade
Center, the Pentagon and on various airlines on September 11, 2001 (collectively
the "September 11 attacks"), the Company incurred pre-tax losses, based on an
estimate of ultimate exposure developed through a review of its coverages, which
totaled $213.2 million gross of reinsurance and $55.0 million net of
reinsurance. Associated with this reinsurance were $60.0 million of pre-tax
charges, predominantly from adjustment premiums, resulting in a total pre-tax
loss from the September 11 attacks of $115.0 million. After tax recoveries
relating specifically to this unusual loss event, the net loss from the
September 11 attacks totaled $75.0 million. Over 90% of the losses ceded were to
treaties where the reinsurers' obligations are secured, which in the Company's
opinion eliminates material reinsurance collection risk.
As a result of the Enron bankruptcy, the Company has incurred losses, after-tax
and reinsurance, amounting to $18.6 million. This unusual loss reflects all of
the Company's exposures, including underwriting, credit and investment.
INDUSTRY CONDITIONS. The worldwide reinsurance and insurance businesses are
highly competitive. The September 11 attacks resulted in losses which reduced
industry capacity and were of sufficient magnitude to cause most individual
companies to reassess their capital position, tolerance for risk, exposure
control mechanisms and the pricing terms and conditions at which they are
willing to take on risk. The gradual and variable improving trend, which has
been apparent through 2000 and earlier in 2001 firmed significantly. This
firming generally took the form of immediate and significant upward pressure on
prices, including more restrictive terms and conditions and a reduction of
coverage limits and capacity availability. Such pressures were widespread with
variability depending on the product and markets involved, but mainly depending
on the characteristics of the underlying risk exposures. The magnitude of the
changes was sufficient to create temporary disequilibrium in some markets as
individual buyers and sellers adapted to changes in both their internal and
market dynamics.
These changes reflect a reversal of the general trend from 1987 through 1999
toward increasingly competitive global market conditions across most lines of
business as reflected by decreasing prices and broadening contract terms. The
earlier trend resulted from a number of factors including the emergence of
significant reinsurance capacity in Bermuda, changes in the Lloyds market,
9
consolidation and increased capital levels in the insurance and reinsurance
industries, as well as the emergence of new reinsurance and financial products
addressing traditional exposures in alternative fashions. Many of these factors
continue to exist. As a result, although the Company is encouraged by the recent
improvements, and more generally, current market conditions, the Company cannot
predict with any reasonable certainty whether and to what extent these
improvements will persist.
SEGMENT INFORMATION
The Company, through its subsidiaries, operates in four segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting, and International. The U.S.
Reinsurance operation writes property and casualty reinsurance on both a treaty
and facultative basis through reinsurance brokers as well as directly with
ceding companies within the United States. The U.S. Insurance operation writes
property and casualty insurance primarily through general agent relationships
and surplus lines brokers within the United States. The Specialty Underwriting
operation writes accident and health ("A&H"), marine, aviation and surety
business within the United States and worldwide through brokers and directly
with ceding companies. The International operation writes property and casualty
reinsurance through the Company's branches in Belgium, London, Canada, and
Singapore, in addition to foreign "home-office" business.
These segments are managed in a carefully coordinated fashion with strong
elements of central control, including with respect to capital, investments and
support operations. As a result, management monitors and evaluates the financial
performance of these operating segments principally based upon their
underwriting results.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
PREMIUMS. Gross premiums written increased 34.6% to $1,849.8 million in 2001
from $1,374.0 million in 2000, as the Company took advantage of selected growth
opportunities, while continuing to maintain a disciplined underwriting approach.
Premium growth areas included a 100.6% ($251.9 million) increase in the U.S.
Insurance operation, principally attributable to growth in worker's compensation
insurance, a 30.1% ($95.7 million) increase in the Specialty Underwriting
operation, mainly attributable to growth in A&H medical stop loss writings and a
26.7% ($128.8 million) increase in the U.S. Reinsurance operation, primarily
reflecting improved market conditions. These increases were partially offset by
a 0.2% ($0.8 million) decrease in the International operation. The Company
continued to decline business that did not meet its objectives regarding
underwriting profitability.
Ceded premiums increased to $432.9 million in 2001 from $166.7 million in 2000.
This increase was principally attributable to $123.2 million of ceded premiums
in 2001 relating to an arm's-length loss portfolio reinsurance transaction,
whereby the Company transferred the net exposures and reserves of its Belgium
branch to Bermuda Re. In addition, ceded premiums in 2001 also reflect $81.3
million of adjustment premiums incurred under the 2001 accident year aggregate
excess of loss element of the Company's corporate retrocessional program
relating to losses incurred as a result of the September 11 attacks and the
Enron bankruptcy. In addition, ceded premiums for 2001 and 2000 also include
adjustment premiums of $58.1 million and $35.2 million, respectively, relating
to claims made under the 1999 accident year aggregate excess of loss element of
the Company's corporate retrocessional program. The increase in ceded premiums
in 2001 also reflects the impact on the U.S. Insurance operation's specific
reinsurance protections resulting from this unit's volume increase.
Net premiums written increased by 17.4% to $1,416.9 million in 2001 from
$1,207.3 million in 2000. This increase was consistent with the increase in
gross premiums written and the increase in ceded premiums.
10
PREMIUM REVENUES. Net premiums earned increased by 14.7% to $1,333.5 million in
2001 from $1,162.6 million in 2000. Contributing to this increase were a 189.7%
($192.6 million) increase in the U.S. Insurance operation, a 22.9% ($69.2
million) increase in the Specialty Underwriting operation and a 5.5% ($26.0
million) increase in the U.S. Reinsurance operation. These increases were
partially offset by a 40.8% ($116.9 million) decrease in the International
operation principally attributable to $122.3 million relating to the reinsurance
transaction between the Company and Bermuda Re noted earlier. All of these
changes reflect period to period variability in gross written and ceded
premiums, and business mix, together with normal variability in earnings
patterns. Business mix changes occur not only as the Company shifts emphasis
between products, lines of business, distribution channels and markets but also
as individual contracts renew or non-renew, almost always with changes in
coverage, structure, prices and/or terms, and as new contracts are accepted with
coverages, structures, prices and/or terms different from those of expiring
contracts. As premium reporting and earnings and loss and commission
characteristics derive from the provisions of individual contracts, the
continuous turnover of individual contracts, arising from both strategic shifts
and day to day underwriting, can and does introduce appreciable background
variability in various underwriting line items.
EXPENSES. Incurred loss and loss adjustment expenses ("LAE") increased by 22.9%
to $1,079.2 million in 2001 from $878.2 million in 2000. The increase in
incurred losses and LAE was principally attributable to an increase in business
volume as reflected by the increase in net premiums earned, the impact of
incurred losses relating to the September 11 attacks and the Enron bankruptcy
and modest reserve strengthening in select areas, together with the impact of
changes in the Company's mix of business. The Enron bankruptcy contributed $34.0
million of unusual losses in 2001, before cessions under the corporate
retrocessional program. Incurred losses and LAE include catastrophe losses,
which reflect the impact of both current period events and favorable and
unfavorable development on prior period events and are net of reinsurance. A
catastrophe is an event that causes a pre-tax loss on property exposures of at
least $5.0 million and has an event date of January 1, 1988 or later.
Catastrophe losses, net of contract specific cessions but before cessions under
the corporate retrocessional program in 2001, were $222.6 million, relating
principally to the September 11 attacks, tropical storm Alison, the Petrobras
Oil Rig loss and the El Salvador earthquake loss, compared to $13.9 million in
2000. Incurred losses and LAE in 2001 reflected ceded losses and LAE of $619.4
million compared to ceded losses and LAE in 2000 of $176.4 million, with the
increase principally attributable to cessions relating to the September 11
attack losses and the Enron bankruptcy, together with increased cessions under
specific reinsurance arrangements in the U.S. Insurance operation. The ceded
losses and LAE for 2001 reflect $164.0 million of losses ceded under the 2001
accident year aggregate excess of loss component of the Company's corporate
retrocessional program. The ceded losses and LAE for 2001 and 2000 reflect
$105.0 million and $70.0 million, respectively, of losses ceded under the 1999
accident year aggregate excess of loss component of the Company's corporate
retrocessional program, with the amounts in both periods reflecting reserve
strengthening in select lines. In addition, ceded losses and LAE in 2001 also
reflects $119.4 million relating to the reinsurance transaction between the
Company and Bermuda Re noted earlier.
Contributing to the increase in incurred losses and LAE in 2001 from 2000 were a
200.7% ($141.0 million) increase in the U.S. Insurance operation principally
reflecting increased premium volume, a 41.5% ($131.9 million) increase in the
U.S. Reinsurance operation, principally reflecting losses in connection with the
September 11 attacks and tropical storm Alison and a 30.1% ($76.5 million)
increase in the Specialty Underwriting operation principally attributable to
increased premium volume in A&H medical stop loss business together with marine,
11
aviation and surety losses relating to the September 11 attacks, the Enron
bankruptcy and the Petrobras Oil Rig loss event. These increases were partially
offset by a 62.9% ($148.5 million) decrease in the International operation
principally attributable to $119.4 million relating to the reinsurance
transaction between the Company and Bermuda Re noted earlier, and to more
favorable loss experience. Incurred losses and LAE for each operation were also
impacted by variability relating to changes in the level of premium volume and
mix of business by class and type.
The Company's loss and LAE ratio ("loss ratio"), which is calculated by dividing
incurred losses and LAE by premiums earned, increased by 5.4 percentage points
to 80.9% in 2001 from 75.5% in 2000 reflecting the incurred losses and LAE
discussed above. The following table shows the loss ratios for each of the
Company's operating segments for 2001 and 2000. The loss ratios for all
operations were impacted by the expense factors noted above, the impact on ceded
premiums of adjustment premiums under the Company's corporate retrocessional
program.
OPERATING SEGMENT LOSS RATIOS
- --------------------------------------------------------------------------------
Segment 2001 2000
- --------------------------------------------------------------------------------
U.S. Reinsurance 90.4% 67.4%
U.S. Insurance 71.8% 69.2%
Specialty Underwriting 89.0% 84.0%
International 51.5% 82.3%
Underwriting expenses increased by 41.3% to $448.9 million in 2001 from $317.7
million in 2000. Commission, brokerage, taxes and fees increased by $126.2
million, principally reflecting increases in premium volume and changes in the
mix of business. In addition, in 2000, the Company's reassessment of the
expected losses on a multi-year reinsurance treaty led to a $33.8 million
decrease in contingent commissions with a corresponding increase to losses.
Other underwriting expenses increased by $5.0 million as the Company has
expanded its business volume and operations. Contributing to the underwriting
expense increase were a 122.7% ($45.6 million) increase in the U.S. Insurance
operation, mainly relating to the increased premium volume, a 70.8% ($68.0
million) increase in the U.S. Reinsurance operation, which included the impact
of the contingent commission adjustment noted above and a 22.5% ($19.8 million)
increase in the Specialty operation. These increases were partially offset by a
0.2% ($1.9 million) decrease in the International operation. Except as noted,
the changes for each operation's expenses principally resulted from changes in
commission expenses related to changes in premium volume and business mix by
class and type and, in some cases, the underwriting performance of the
underlying business. The Company's expense ratio, which is calculated by
dividing underwriting expenses by premiums earned, increased by 6.4 percentage
points to 33.7% in 2001 compared to 27.3% in 2000.
The Company's combined ratio, which is the sum of the loss and expense ratios,
increased by 11.8 percentage points to 114.6% in 2001 compared to 102.8% in
2000. The following table shows the combined ratios for each of the Company's
operating segments for 2001 and 2000. The combined ratios for all operations
were impacted by the loss and expense ratio variability noted above as well as
by the impact on ceded premiums of adjustment premiums under the Company's
corporate retrocessional program and, for the International operation, the
effect on the expense ratio related to the ceded premium associated with the
reinsurance transaction between the Company and Bermuda Re noted earlier.
12
OPERATING SEGMENT COMBINED RATIOS
- --------------------------------------------------------------------------------
Segment 2001 2000
- --------------------------------------------------------------------------------
U.S. Reinsurance 123.3% 88.0%
U.S. Insurance 99.9% 105.8%
Specialty Underwriting 118.0% 113.1%
International 106.2% 115.4%
INVESTMENTS. Net investment income decreased by 0.2% to $265.9 million in 2001
from $271.4 million in 2000, principally reflecting the effect of investing the
$303.8 million of cash flow from operations in 2001, offset by the lower
interest rate environment and increased interest expense on funds held relating
to the utilization of the 1999 and 2001 accident year aggregate excess of loss
elements of the corporate retrocessional program. The following table shows a
comparison of various investment yields as of December 31, 2001 and 2000,
respectively, and for the periods then ended.
2001 2000
-------------------------
Imbedded pre-tax yield of cash and
invested assets at end of period 6.0% 6.7%
Imbedded after-tax yield of cash and
invested assets at end of period 4.6% 5.0%
Annualized pre-tax yield on average
cash and invested assets 6.2% 6.5%
Annualized after-tax yield on average
cash and invested assets 4.7% 5.0%
Net realized capital losses were $15.7 million in 2001, reflecting realized
capital losses on the Company's investments of $45.5 million, which includes
$3.1 million relating to write-downs in the value of securities deemed to be
other than temporary, partially offset by $29.8 million of realized capital
gains, compared to realized capital gains of $0.3 million in 2000. The net
realized capital gains in 2000 reflected realized capital gains of $30.3
million, which were partially offset by $30.0 million of realized capital
losses. The net realized capital losses for 2001 allowed the Company to
recapture taxes paid on net realized capital gains in prior periods. The
realized capital gains in 2001 and 2000 arose mainly from activity in the
Company's equity portfolio. The realized capital losses in 2001 and 2000 arose
mainly from activity in the Company's fixed maturity portfolios.
Interest expense was $46.0 million for 2001 compared to $39.4 million in 2000.
Interest expense for 2001 reflects $38.9 million relating to the Company's
senior notes issued on March 14, 2000 and $7.1 million relating to the company's
borrowing under its revolving credit facility. Interest expense for 2000
reflects $30.9 million relating to the Company's issuance of senior notes and
$8.5 million relating to the Company's borrowing under its revolving credit
facility.
Other income was $26.6 million in 2001 compared to $3.3 million in 2000. Other
income for 2001 includes $25.9 million arising from a non-recurring receipt of
shares in connection with the demutualization of a former insurance company
client, which issued annuities, owned by the Company, in connection with certain
claim settlement transactions. In addition, other income for 2001 includes
foreign exchange gains as well as financing fees from Everest Security, offset
by the amortization of deferred expenses relating to the Company's issuance of
13
senior notes. Significant contributors to other income for 2000 were foreign
exchange gains as well as financing fees from Everest Security, partially offset
by net derivative expense and the amortization of deferred expenses relating to
Holdings' issuance of senior notes. The foreign exchange gains and losses are
attributable to fluctuations in foreign currency exchange rates.
During 2000, the Company added to its product portfolio a credit default swap,
which it no longer offers, that has characteristics which allow this transaction
to be analyzed using approaches consistent with those used in the Company's
other operations. This product meets the definition of a derivative under
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"). Net derivative expense from this
transaction in 2001 was $7.0 million, principally attributable to credit default
losses relating to the Enron bankruptcy.
INCOME TAXES. The Company generated income tax benefits of $9.2 million in 2001
compared to income tax expense of $43.8 million in 2000. This tax benefit
primarily resulted from the impact of losses relating to the September 11
attacks, the Enron bankruptcy and realized capital losses recognized in 2001,
which reduced taxable income, partially offset by the impact of income tax
expense relating to the non-recurring receipt of shares in connection with a
former client's demutualization.
NET INCOME. Net income was $38.3 million in 2001 compared to $158.5 million in
2000. This decrease generally reflects the losses attributable to the September
11 attacks and the Enron bankruptcy, partially offset by improved investment
results and the non-recurring receipt of shares in connection with a former
client's demutualization.
SAFE HARBOR DISCLOSURE
This report contains forward-looking statements within the meaning of the U.S.
federal securities laws. The Company intends these forward-looking statements to
be covered by the safe harbor provisions for forward-looking statements in the
federal securities laws. In some cases, these statements can be identified by
the use of forward-looking words such as "may", "will", "should", "could",
"anticipate", "estimate", "expect", "plan", "believe", "predict", "potential"
and "intend". Forward-looking statements contained in this report include
information regarding the Company's reserves for losses and LAE and estimates of
the Company's catastrophe exposure. Forward-looking statements only reflect the
Company's expectations and are not guarantees of performance. These statements
involve risks, uncertainties and assumptions. Actual events or results may
differ materially from the Company's expectations. Important factors that could
cause actual events or results to be materially different from the Company's
expectations include those discussed below under the caption "Risk Factors". The
Company undertakes no obligation to update or revise publicly any
forward-looking statements, whether as a result of new information, future
events or otherwise.
RISK FACTORS
The following risk factors, in addition to the other information provided in
this report, should be considered when evaluating the Company. The risks and
uncertainties described below are not the only ones the Company faces. There may
be additional risks and uncertainties. If any of the following risks actually
occur, the Company's business, financial condition or results of operations
could be materially and adversely affected and the trading price of the
Company's common shares could decline significantly.
THE COMPANY'S RESULTS MAY FLUCTUATE AS A RESULT OF FACTORS GENERALLY AFFECTING
THE INSURANCE AND REINSURANCE INDUSTRY.
The results of companies in the insurance and reinsurance industry historically
have been subject to significant fluctuations and uncertainties. Factors that
14
affect the industry in general could also cause the Company's results to
fluctuate. The industry's profitability can be affected significantly by:
o fluctuations in interest rates, inflationary pressures and other changes
in the investment environment, which affect returns on invested capital
and may impact the ultimate payout of loss amounts;
o rising levels of actual costs that are not known by companies at the
time they price their products;
o volatile and unpredictable developments, including weather-related and
other natural catastrophes;
o events like the September 11, 2001 attacks, which affect the insurance
and reinsurance markets generally;
o changes in reserves resulting from different types of claims that may
arise and the development of judicial interpretations relating to the
scope of insurers' liability; and
o the overall level of economic activity and the competitive environment
in the industry.
IF THE COMPANY'S LOSS RESERVES ARE INADEQUATE TO MEET ITS ACTUAL LOSSES, THE
COMPANY'S NET INCOME WOULD BE REDUCED OR IT COULD INCUR A LOSS.
The Company is required to maintain reserves to cover its estimated ultimate
liability of losses and loss adjustment expenses for both reported and
unreported claims incurred. These reserves are only estimates of what the
Company thinks the settlement and administration of claims will cost based on
facts and circumstances known to the Company. Because of the uncertainties that
surround estimating loss reserves and loss adjustment expenses, the Company
cannot be certain that ultimate losses will not exceed these estimates of losses
and loss adjustment reserves. If the Company's reserves are insufficient to
cover its actual losses and loss adjustment expenses, the Company would have to
augment its reserves and incur a charge to its earnings. These charges could be
material. The difficulty in estimating the Company's reserves is increased
because the Company's loss reserves include reserves for potential asbestos and
environmental liabilities. Asbestos and environmental liabilities are especially
hard to estimate for many reasons, including the long waiting periods between
exposure and manifestation of any bodily injury or property damage, difficulty
in identifying the source of the asbestos or environmental contamination, long
reporting delays and difficulty in properly allocating liability for the
asbestos or environmental damage.
THE COMPANY'S INABILITY TO ASSESS UNDERWRITING RISK ACCURATELY COULD REDUCE ITS
NET INCOME.
The Company's success is dependent on its ability to assess accurately the risks
associated with the businesses on which the risk is retained. If the Company
fails to assess accurately the risks it retains, the Company may fail to
establish appropriate premium rates and the Company's reserves may be inadequate
to cover its losses, requiring augmentation of the Company's reserves, which in
turn, could reduce the Company's net income.
DECREASES IN RATES FOR PROPERTY AND CASUALTY REINSURANCE AND INSURANCE COULD
REDUCE THE COMPANY'S NET INCOME.
15
The Company primarily writes property and casualty reinsurance and insurance.
The property and casualty industry historically has been highly cyclical. Rates
for property and casualty reinsurance and insurance are influenced primarily by
factors that are outside of the Company's control. Any significant decrease in
the rates for property and casualty insurance or reinsurance could reduce the
Company's net income.
IF RATING AGENCIES DOWNGRADE THEIR RATINGS OF THE COMPANY'S INSURANCE COMPANY
SUBSIDIARIES, THE COMPANY'S FUTURE PROSPECTS FOR GROWTH AND PROFITABILITY COULD
BE SIGNIFICANTLY AND ADVERSELY AFFECTED.
The Company's insurance company subsidiaries, other than Mt. McKinley, currently
hold an A+ ("Superior") financial strength rating from A.M. Best Company, an AA-
("Very Strong") financial strength rating from Standard & Poor's Ratings
Services and an Aa3 ("Excellent") financial strength rating from Moody's
Investors Service, Inc. Financial strength ratings are used by insurers and
reinsurance and insurance intermediaries as an important means of assessing the
financial strength and quality of reinsurers. In addition, the rating of a
company purchasing reinsurance may be adversely affected by an unfavorable
rating or the lack of a rating of its reinsurer. A downgrade or withdrawal of
any of these ratings might adversely affect the Company's ability to market its
insurance products and would have a significant and adverse effect on its future
prospects for growth and profitability.
THE COMPANY'S REINSURERS MAY NOT SATISFY THEIR OBLIGATIONS.
The Company is subject to credit risk with respect to its reinsurers because the
transfer of risk to a reinsurer does not relieve the Company of its liability to
the insured. In addition, reinsurers may be unwilling to pay the Company even
though they are able to do so. The failure of one or more of the Company's
reinsurers to honor their obligations in a timely fashion would impact the
Company's cash flow and reduce its net income and could cause the Company to
incur a significant loss.
IF THE COMPANY IS UNABLE TO PURCHASE REINSURANCE AND TRANSFER RISK TO
REINSURERS, ITS NET INCOME COULD BE REDUCED OR THE COMPANY COULD INCUR A LOSS.
The Company attempts to limit its risk of loss by purchasing reinsurance to
transfer a portion of the risks it assumes. The availability and cost of
reinsurance is subject to market conditions, which are outside of the Company's
control. As a result, the Company may not be able to successfully purchase
reinsurance and transfer risk through reinsurance arrangements. A lack of
available reinsurance might adversely affect the marketing of the Company's
programs and/or force the Company to retain all or a part of the risk that
cannot be reinsured. If the Company were required to retain these risks and
ultimately pay claims with respect to these risks, the Company's net income
could be reduced or the Company could incur a loss.
THE COMPANY'S INDUSTRY IS HIGHLY COMPETITIVE AND THE COMPANY MAY NOT BE ABLE TO
COMPETE SUCCESSFULLY IN THE FUTURE.
The Company's industry is highly competitive and has experienced severe price
competition over the last several years. The Company competes in the United
States and international markets with domestic and international insurance
companies. Some of these competitors have greater financial resources than the
Company, have been operating for longer than the Company and have established
long-term and continuing business relationships throughout the industry, which
can be a significant competitive advantage. In addition, the Company expects to
face further competition in the future. The Company may not be able to compete
successfully in the future.
16
THE COMPANY IS DEPENDENT ON ITS KEY PERSONNEL.
The Company's success has been, and will continue to be, dependent on its
ability to retain the services of its existing key executive officers and to
attract and retain additional qualified personnel in the future. The loss of the
services of any of its key executive officers or the inability to hire and
retain other highly qualified personnel in the future could adversely affect the
Company's ability to conduct its business.
THE VALUE OF THE COMPANY'S INVESTMENT PORTFOLIO AND THE INVESTMENT INCOME IT
RECEIVES FROM THAT PORTFOLIO COULD DECLINE AS A RESULT OF MARKET FLUCTUATIONS
AND ECONOMIC CONDITIONS.
A significant portion of the Company's investment portfolio consists of fixed
income securities and a smaller portion consists of equity securities. Both the
fair market value of these assets and the investment income from these assets
fluctuate depending on general economic and market conditions. For example, the
fair market value of the Company's fixed income securities generally increases
or decreases in an inverse relationship with fluctuations in interest rates. The
fair market value of the Company's fixed income securities can also decrease as
a result of any downturn in the business cycle that causes the credit quality of
those securities to deteriorate. The net investment income that the Company
realizes from future investments in fixed income securities will generally
increase or decrease with interest rates. Interest rate fluctuations can also
cause net investment income from investments that carry prepayment risk, such as
mortgage-backed and other asset-backed securities, to differ from the income
anticipated from those securities at the time the Company bought them. Because
all of the Company's securities are classified as available for sale, changes in
the market value of the Company's securities are reflected in its financial
statements. Similar treatment is not available for liabilities. As a result, a
decline in the value of the securities in the Company's portfolio could reduce
its net income or cause the Company to incur a loss.
INSURANCE LAWS AND REGULATIONS RESTRICT THE COMPANY'S ABILITY TO OPERATE.
The Company is subject to extensive regulation under U.S., state and foreign
insurance laws. These laws limit the amount of dividends that can be paid to the
Company by its operating subsidiaries, impose restrictions on the amount and
type of investments that they can hold, prescribe solvency standards that must
be met and maintained by them and require them to maintain reserves. These laws
also require disclosure of material intercompany transactions and require prior
approval of certain "extraordinary" transactions. These "extraordinary"
transactions include declaring dividends from operating subsidiaries that exceed
statutory thresholds. These laws also generally require approval of changes of
control. The Company's failure to comply with these laws could subject it to
fines and penalties and restrict it from conducting business. The application of
these laws could affect the Company's liquidity and ability to pay dividends on
its common shares and could restrict the Company's ability to expand its
business operations through acquisitions involving the Company's insurance
subsidiaries.
FAILURE TO COMPLY WITH INSURANCE LAWS AND REGULATIONS COULD HAVE A MATERIAL
ADVERSE EFFECT ON THE COMPANY'S BUSINESS.
The Company cannot assure that it has or can maintain all required licenses and
approvals or that its business fully complies with the wide variety of
applicable laws and regulations or the relevant authority's interpretation of
the laws and regulations. In addition, some regulatory authorities have
relatively broad discretion to grant, renew or revoke licenses and approvals. If
the Company does not have the requisite licenses and approvals or do not comply
17
with applicable regulatory requirements, the insurance regulatory authorities
could preclude or temporarily suspend the Company from carrying on some or all
of its activities or monetarily penalize the Company. These types of actions
could have a material adverse effect on the Company's business.
THE COMPANY MAY EXPERIENCE EXCHANGE LOSSES IF IT DOES NOT MANAGE ITS FOREIGN
CURRENCY EXPOSURE PROPERLY.
The Company's functional currency is the United States dollar. However, the
Company writes a portion of its business and receives a portion of its premiums
in currencies other than United States dollars. The Company also maintains a
portion of its investment portfolio in investments denominated in currencies
other than United States dollars. Consequently, the Company may experience
exchange losses if its foreign currency exposure is not properly managed or
otherwise hedged. If the Company seeks to hedge its foreign currency exposure by
using forward foreign currency exchange contracts or currency swaps, the Company
will be subject to the risk that the counter parties to those arrangements will
fail to perform, or that those arrangements will not precisely offset the
Company's exposure.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET SENSITIVE INSTRUMENTS
The Securities and Exchange Commission Financial Reporting Release #48 requires
registrants to clarify and expand upon the existing financial statement
disclosure requirements for derivative financial instruments, derivative
commodity instruments, and other financial instruments (collectively, "market
sensitive instruments").
The Company's current investment strategy seeks to maximize after-tax income
through a high quality, diversified, taxable and tax-preferenced fixed maturity
portfolio, while maintaining an adequate level of liquidity. The Company's mix
of taxable and tax-preferenced investments is adjusted continuously, consistent
with its current and projected operating results, market conditions, and tax
position. The fixed maturities in the investment portfolio are comprised of
non-trading available for sale securities. Additionally, the Company invests in
equity securities, which it believes will enhance the risk-adjusted total return
of the investment portfolio. The Company has also engaged in a credit default
swap, the market sensitivity of which is believed to be immaterial.
The overall investment strategy considers the scope of present and anticipated
Company operations. In particular, estimates of the financial impact resulting
from non-investment asset and liability transactions, together with the
Company's capital structure and other factors, are used to develop a net
liability analysis. This analysis includes estimated payout characteristics for
which the investments of the Company provide liquidity. This analysis is
considered in the development of specific investment strategies for asset
allocation, duration, and credit quality. The change in overall market sensitive
risk exposure principally reflects the asset changes that took place during the
year together with minor changes in the underlying risk characteristics.
The $4.5 billion investment portfolio is comprised of fixed maturity securities
that are subject to interest rate risk and foreign currency rate risk, and
equity securities that are subject to equity price risk. The impact of these
risks in the investment portfolio is generally mitigated by changes in the value
of operating assets and liabilities and their associated income statement
impact.
18
Interest rate risk is the potential change in value of the fixed maturity
portfolio due to change in market interest rates. Further, it includes
prepayment risk in a declining interest rate environment on the $450.8 million
of the $4.3 billion fixed maturity portfolio, which consists of mortgage-backed
securities. Prepayment risk results from potential accelerated principal
payments that shorten the average life and thus, the expected yield of the
security.
The tables below display the potential impact of market value fluctuations and
after-tax unrealized appreciation on the fixed maturity portfolio as of December
31, 2001 and 2000 based on parallel 200 basis point shifts in interest rates up
and down in 100 basis point increments. For legal entities with a U.S. dollar
functional currency, this modeling was performed on each security individually.
To generate appropriate price estimates on mortgage-backed securities, changes
in prepayment expectations under different interest rate environments are taken
into account. For legal entities with a non-U.S. dollar functional currency, the
effective duration of the involved portfolio of securities was used as a proxy
for the market value change under the various interest rate change scenarios.
All amounts are in U.S. dollars and are presented in millions.
2001
INTEREST RATE SHIFT IN BASIS POINTS
- ------------------------------------------------------------------------------------------
-200 -100 0 100 200
- ------------------------------------------------------------------------------------------
Total Market Value $ 4,875.7 $ 4,578.3 $ 4,302.8 $ 4,043.8 $ 3,807.1
Market Value Change
from Base (%) 13.3% 6.4% 0.0% (6.0%) (11.5%)
Change in Unrealized
Appreciation After-tax
from Base ($) $ 372.4 $ 179.1 $ - $ (168.3) $ (322.2)
2000
INTEREST RATE SHIFT IN BASIS POINTS
- ------------------------------------------------------------------------------------------
-200 -100 0 100 200
- ------------------------------------------------------------------------------------------
Total Market Value $ 4,637.3 $ 4,384.1 $ 4,150.6 $ 3,923.7 $ 3,710.2
Market Value Change
from Base (%) 11.8% 5.6% 0.0% (5.5%) (10.6%)
Change in Unrealized
Appreciation After-tax
from Base ($) $ 316.4 $ 151.8 $ - $ (147.5) $ (286.3)
Foreign currency rate risk is the potential change in value, income, and cash
flow arising from adverse changes in foreign currency exchange rates. The
Company's foreign operations each maintain capital in the currency of the
country of its geographic location consistent with local regulatory guidelines.
Generally, the Company prefers to maintain the capital of its foreign operations
in U.S. dollar assets although this varies by regulatory jurisdiction in
accordance with market needs. Each foreign operation may conduct business in its
19
local currency as well as the currency of other countries in which it operates.
The primary foreign currency exposures are the Canadian Dollar, the British
Pound Sterling and the Euro for these foreign operations. The Company mitigates
foreign exchange exposure by a general matching of the currency and duration of
its assets to its corresponding operating liabilities. In accordance with
Financial Accounting Standards Board Statement No. 52, the Company translates
the assets, liabilities and income of non-U.S. dollar functional currency legal
entities to the U.S. dollar. This translation amount is reported as a component
of other comprehensive income. The primary functional foreign currency exposures
are the Canadian Dollar, the Belgian Franc and the British Pound Sterling for
these foreign operations.
The tables below display the potential impact of a parallel 20% increase and
decrease in foreign exchange rates on the valuation of invested assets subject
to foreign currency exposure in 10% increments as of December 31, 2001 and 2000.
This analysis includes the after-tax impact of translation from transactional
currency to functional currency as well as the after-tax impact of translation
from functional currency to the U.S. dollar reporting currency. All amounts are
in U.S. dollars and are presented in millions.
2001
CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT
- ---------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ---------------------------------------------------------------------------------
Total After-tax Foreign
Exchange Exposure ($ 40.7) ($ 21.6) $ - $ 23.3 $ 47.9
2000
CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT
- ---------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ---------------------------------------------------------------------------------
Total After-tax Foreign
Exchange Exposure ($ 42.9) ($ 22.5) $ - $ 24.2 $ 49.5
Equity risk is the potential change in market value of the common stock and
preferred stock portfolios arising from changing equity prices. The Company
invests in index mutual funds and high quality common and preferred stocks that
are traded on the major exchanges in the United States. The primary objective in
managing the $67.5 million equity portfolio is to provide long-term capital
growth through market appreciation and income.
The tables below display the impact on market value and after-tax unrealized
appreciation of a 20% change in equity prices up and down in 10% increments as
of December 31, 2001 and 2000. All amounts are in U.S. dollars and are presented
in millions.
2001
CHANGE IN EQUITY VALUES IN PERCENT
- ----------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ----------------------------------------------------------------------------------
Market Value of the
Equity Portfolio $ 54.0 $ 60.7 $ 67.5 $ 74.2 $ 80.9
After-tax Change in
Unrealized Appreciation (8.8) (4.4) - 4.4 8.8
20
2000
CHANGE IN EQUITY VALUES IN PERCENT
- ----------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ----------------------------------------------------------------------------------
Market Value of the
Equity Portfolio $ 29.3 $ 33.0 $ 36.6 $ 40.3 $ 44.0
After-tax Change in
Unrealized Appreciation (4.8) (2.4) - 2.4 4.8
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information for this Item 10 is not required pursuant to General Instruction
I(2) of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Information for this Item 11 is not required pursuant to General Instruction
I(2) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information for this Item 12 is not required pursuant to General Instruction
I(2) of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information for this Item 13 is not required pursuant to General Instruction
I(2) of Form 10-K.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS AND SCHEDULES
The financial statements and schedules listed in the accompanying Index to
Financial Statements and Schedules on page F-1 are filed as part of this report.
EXHIBITS
The exhibits listed on the accompanying Index to Exhibits on page E-1 are filed
as part of this report.
REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the last quarter of 2001.
21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on March 28, 2002.
EVEREST REINSURANCE HOLDINGS, INC.
By: /s/ JOSEPH V. TARANTO
-----------------------------------------
Joseph V. Taranto
(Chairman and Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ JOSEPH V. TARANTO Chairman and Chief March 28, 2002
- ------------------------ Executive Officer and
Joseph V. Taranto Director (Principal
Executive Officer)
/s/ STEPHEN L. LIMAURO Executive Vice President, March 28, 2002
- ------------------------ Chief Financial Officer and
Stephen L. Limauro Director (Principal Financial
and Accounting Officer)
/s/ THOMAS J. GALLAGHER Director March 28, 2002
- ------------------------
Thomas J. Gallagher
22
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Pages
-----
Everest Reinsurance Holdings, Inc.
Report of Independent Accountants on Financial
Statements and Schedules F-2
---
Consolidated Balance Sheets at December 31, 2001 and 2000 F-3
---
Consolidated Statements of Operations and Comprehensive Income
for the years ended December 31, 2001, 2000 and 1999 F-4
---
Consolidated Statements of Changes in Stockholder's Equity
for the years ended December 31, 2001, 2000 and 1999 F-5
---
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999 F-6
---
Notes to Consolidated Financial Statements F-7
---
Schedules
I Summary of Investments Other Than Investments in Related
Parties at December 31, 2001 S-1
---
II Condensed Financial Information of Registrant:
Balance Sheets as of December 31, 2001 and 2000 S-2
---
Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999 S-3
---
Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999 S-4
---
III Supplementary Insurance Information as of
December 31, 2001 and 2000 and for the years
ended December 31, 2001, 2000 and 1999 S-5
---
IV Reinsurance for the years ended December 31, 2001,
2000 and 1999 S-6
---
Schedules other than those listed above are omitted for the reason that they are
not applicable or the information is otherwise contained in the Financial
Statements.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder
of Everest Reinsurance Holdings, Inc.
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Everest Reinsurance Holdings, Inc. and its subsidiaries at December 31, 2001 and
2000, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001 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 accompanying index
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 our opinion.
PricewaterhouseCoopers LLP
New York, New York
February 14, 2002
F-2
Part I - Item 1
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except par value per share)
December 31, December 31,
------------ ------------
2001 2000
------------ ------------
ASSETS:
Fixed maturities - available for sale,
at market value (amortized cost:
2001, $4,051,833; 2000, $3,793,279) $ 4,186,923 $ 3,879,335
Equity securities, at market value
(cost: 2001, $66,412; 2000, $22,395) 67,453 36,634
Short-term investments 115,850 271,216
Other invested assets 32,039 29,211
Cash 67,509 68,397
------------ ------------
Total investments and cash 4,469,774 4,284,793
Accrued investment income 64,972 64,508
Premiums receivable 454,548 393,229
Reinsurance receivables 1,471,357 996,689
Funds held by reinsureds 149,710 161,350
Deferred acquisition costs 114,948 92,478
Prepaid reinsurance premiums 48,100 58,196
Deferred tax asset 178,476 174,451
Other assets 60,496 37,622
------------ ------------
TOTAL ASSETS $ 7,012,381 $ 6,263,316
============ ============
LIABILITIES:
Reserve for losses and loss
adjustment expenses $ 4,274,335 $ 3,785,747
Unearned premium reserve 473,308 401,148
Funds held under reinsurance
treaties 308,811 110,464
Losses in the course of payment 83,360 101,995
Contingent commissions 3,345 9,380
Other net payable to reinsurers 132,252 60,332
Current federal income taxes (30,365) (8,210)
8.5% Senior notes due 3/15/2005 249,694 249,615
8.75% Senior notes due 3/15/2010 199,077 199,004
Revolving credit agreement
borrowings 105,000 235,000
Accrued interest on debt and
borrowings 11,944 12,212
Other liabilities 90,211 56,142
------------ ------------
Total liabilities 5,900,972 5,212,829
------------ ------------
Commitments and contingencies (Note 12)
STOCKHOLDER'S EQUITY:
Common stock, par value: $0.01; 200
million shares authorized; 1,000
shares issued in 2001 and 2000 - -
Additional paid-in capital 258,775 255,359
Accumulated other comprehensive
income, net of deferred income
taxes of $40.8 million in 2001
and deferred income taxes of
$30.4 million in 2000 76,003 56,747
Retained earnings 776,631 738,381
------------ ------------
Total stockholder's equity 1,111,409 1,050,487
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDER'S EQUITY $ 7,012,381 $ 6,263,316
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Dollars in thousands, except per share amounts)
Years Ended December 31,
-------------------------------------------
2001 2000 1999
----------- ----------- -----------
REVENUES:
Premiums earned $ 1,333,501 $ 1,162,597 $ 1,071,451
Net investment income 265,924 271,389 252,999
Net realized capital
(loss) gain (15,745) 291 (16,760)
Net derivative (expense) (7,020) - -
Other income (expense) 26,565 3,341 (1,030)
----------- ----------- -----------
1,603,225 1,437,618 1,306,660
----------- ----------- -----------
CLAIMS AND EXPENSES:
Incurred losses and loss
adjustment expenses 1,079,219 878,241 771,570
Commission, brokerage,
taxes and fees 393,645 267,410 285,957
Other underwriting expenses 55,292 50,264 48,263
Non-recurring restructure
expenses - - 2,798
Interest expense on senior
notes 38,903 30,896 -
Interest expense on credit
facility 7,101 8,490 1,490
----------- ----------- -----------
1,574,160 1,235,301 1,110,078
----------- ----------- -----------
INCOME BEFORE TAXES 29,065 202,317 196,582
Income tax (benefit) expense (9,185) 43,822 38,521
----------- ----------- -----------
NET INCOME $ 38,250 $ 158,495 $ 158,061
=========== =========== ===========
Other comprehensive income
(loss), net of tax 19,256 73,448 (202,219)
----------- ----------- -----------
COMPREHENSIVE INCOME (LOSS) $ 57,506 $ 231,943 $ (44,158)
=========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDER'S EQUITY
(Dollars in thousands, except per share amounts)
Years Ended December 31,
-------------------------------------------
2001 2000 1999
----------- ----------- -----------
COMMON STOCK (shares outstanding):
Balance, beginning of period 1,000 46,457,817 49,989,204
Issued during the period - 8,500 17,400
Treasury stock acquired during
the period - (650,400) (3,554,047)
Treasury stock reissued during
the period - 1,780 5,260
Common stock retired during the
period - (45,817,697) -
Issued during the period - 1,000 -
----------- ----------- -----------
Balance, end of period 1,000 1,000 46,457,817
=========== =========== ===========
COMMON STOCK (par value):
Balance, beginning of period $ - $ 509 $ 509
Common stock retired during
the period - (509) -
----------- ----------- -----------
Balance, end of period - - 509
----------- ----------- -----------
ADDITIONAL PAID IN CAPITAL:
Balance, beginning of period 255,359 390,912 390,559
Retirement of treasury stock
during the period - (138,546) -
Common stock issued during
the period 3,416 2,339 317
Treasury stock reissued
during period - (2) 36
Contribution from subsidiary - 198 -
Common stock retired during
the period - 458 -
----------- ----------- -----------
Balance, end of period 258,775 255,359 390,912
----------- ----------- -----------
UNEARNED COMPENSATION:
Balance, beginning of period - (109) (240)
Net increase during the period - 109 131
----------- ----------- -----------
Balance, end of period - - (109)
----------- ----------- -----------
ACCUMULATED OTHER COMPREHENSIVE
INCOME, NET OF DEFERRED INCOME
TAXES:
Balance, beginning of period 56,747 (16,701) 185,518
Net increase (decrease) during
the period 19,256 73,448 (202,219)
----------- ----------- -----------
Balance, end of period 76,003 56,747 (16,701)
----------- ----------- -----------
RETAINED EARNINGS:
Balance, beginning of period 738,381 1,074,941 928,500
Net income 38,250 158,495 158,061
Restructure adjustments - (55) -
Dividends paid to parent - (495,000) (11,620)
----------- ----------- -----------
Balance, end of period 776,631 738,381 1,074,941
----------- ----------- -----------
TREASURY STOCK AT COST:
Balance, beginning of period - (122,070) (25,642)
Treasury stock retired
during the period - 138,454 -
Treasury stock acquired
during period - (16,426) (96,551)
Treasury stock reissued
during period - 42 123
----------- ----------- -----------
Balance, end of period - - (122,070)
----------- ----------- -----------
TOTAL STOCKHOLDER'S EQUITY,
END OF PERIOD $ 1,111,409 $ 1,050,486 $ 1,327,482
=========== =========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
EVEREST REINSURANCE HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Years Ended December 31,
-------------------------------------------
2001 2000 * 1999
----------- ----------- -----------
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income $ 38,250 $ 158,495 $ 158,061
Adjustments to reconcile net
income to net cash provided
by operating activities net
of effects from the purchase
of Mt. McKinley Insurance
Company
(Increase) in premiums
receivable (62,901) (101,894) (36,179)
Decrease in funds held by
reinsureds, net 209,558 29,135 23,007
(Increase) decrease in
reinsurance receivables (476,736) (173,954) 239,763
(Increase) in deferred tax asset (15,968) (16,247) (17,169)
Increase (decrease) in reserve
for losses and loss adjustment
expenses 506,128 827 (133,706)
Increase in unearned premiums 73,201 95,076 25,077
Decrease (increase) in other
assets and liabilities 22,179 (16,887) (67,106)
Non cash compensation expense - 109 131
Accrual of bond discount/
amortization of bond premium (5,836) (7,553) (5,203)
Amortization of underwriting
discount on senior notes 152 112 -
Restructure adjustment - (55) -
Realized capital losses (gains) 15,745 (291) 16,760
----------- ----------- -----------
Net cash provided by (used in)
operating activities 303,772 (33,127) 203,436
----------- ----------- -----------
CASH FLOWS FROM INVESTING
ACTIVITIES:
Proceeds from fixed maturities
matured/called - available
for sale 265,316 181,381 205,669
Proceeds from fixed maturities
sold - available for sale 470,561 730,589 665,873
Proceeds from equity
securities sold 33,373 49,556 69,397
Proceeds from other invested
assets sold 47 - 181
Cost of fixed maturities
acquired - available for sale (1,036,759) (1,174,662) (990,369)
Cost of equity securities
acquired (64,267) (2,732) (16,643)
Cost of other invested assets
acquired (1,497) (1,698) (23,109)
Net sales (purchases) of
short-term securities 156,735 (205,524) (38,200)
Net increase (decrease) in
unsettled securities
transactions 1,595 (955) (47)
Payment for purchase of Mt.
McKinley Insurance Company,
net of cash acquired - 349,743 -
----------- ----------- -----------
Net cash (used in) investing
activities (174,896) (74,302) (127,248)
----------- ----------- -----------
CASH FLOWS FROM FINANCING
ACTIVITIES:
Acquisition of treasury stock
net of reissuances - (16,478) (96,392)
Common stock issued during
the period 3,416 2,288 317
Dividends paid to stockholders - (495,000) (11,620)
Proceeds from issuance of
senior notes - 448,507 -
Borrowings on revolving credit
agreement 22,000 176,000 59,000
Repayments on revolving credit
agreement (152,000) - -
Contribution from subsidiary - 198 -
----------- ----------- -----------
Net cash (used in) provided
by financing activities (126,584) 115,515 (48,695)
----------- ----------- -----------
EFFECT OF EXCHANGE RATE
CHANGES ON CASH (3,180) (1,916) (4,592)
----------- ----------- -----------
Net (decrease) increase in cash (888) 6,170 22,901
Cash, beginning of period 68,397 62,227 39,326
----------- ----------- -----------
Cash, end of period $ 67,509 $ 68,397 $ 62,227
=========== =========== ===========
Supplemental cash flow
information
Cash transactions:
Income taxes paid, net $ 24,370 $ 62,141 $ 59,586
Interest paid $ 46,120 $ 27,169 $ 1,384
Non-cash operating/investing
transaction:
Shares received from
demutualization $ 25,921 $ - $ -
Non-cash financing
transaction:
Issuance of common stock $ - $ 109 $ 131
* In the quarter ended September 30, 2000, the Company purchased all of the
capital stock of Mt. McKinley Insurance Company for $51,800. In conjunction
with the acquisition, the fair value of assets acquired was $679,672 and
liabilities was $627,872.
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
EVEREST REINSURANCE HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2001, 2000 and 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. BUSINESS AND BASIS OF PRESENTATION
Everest Re Group, Ltd. ("Group"), a Bermuda company with its principal executive
office in Barbados, was established in 1999 as a wholly-owned subsidiary of
Everest Reinsurance Holdings, Inc. ("Holdings"). On February 24, 2000, a
corporate restructuring was completed and Group became the new parent holding
company of Holdings. Holders of shares of common stock of Holdings automatically
became holders of the same number of common shares of Group. The "Company" means
Holdings and its subsidiaries, unless the context otherwise requires. The
Company, through its subsidiaries, principally provides property and casualty
reinsurance and insurance in the United States and internationally. The Company
is filing this report as a result of its public issuance of senior notes on
March 14, 2000. See also Note 5.
The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles in the United States of
America. The statements include the following domestic and foreign direct and
indirect subsidiaries of the Company: Everest Reinsurance Company ("Everest
Re"), Everest National Insurance Company ("Everest National"), Everest Indemnity
Insurance Company ("Everest Indemnity"), Everest Re Holdings, Ltd. ("Everest
Ltd."), a Bermuda domiciled successor company of Everest Re Ltd. (the assets of
which funded Everest Ltd. and which was formerly known as Everest Reinsurance
Ltd.), Everest Security Insurance Company ("Everest Security"), formerly
Southeastern Security Insurance Company, Everest Insurance Company of Canada
("Everest Canada"), Mt. McKinley Managers, L.L.C. ("Managers"), Workcare
Southeast, Inc. ("Workcare Southeast"), Workcare Southeast of Georgia, Inc.
("Workcare Georgia"), Workcare, Inc and Mt. McKinley Insurance Company ("Mt.
McKinley"). All amounts are reported in U.S. dollars.
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities (and disclosure of contingent assets and liabilities) at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
B. INVESTMENTS
Fixed maturity investments are all classified as available for sale. Unrealized
appreciation and depreciation, as a result of temporary changes in market value
during the period, are reflected in shareholders' equity, net of income taxes in
"accumulated other comprehensive income". Equity securities are carried at
market value with unrealized appreciation or depreciation, as a result of
temporary changes in market value during the period, are reflected in
shareholders' equity, net of income taxes in "accumulated other comprehensive
income". Unrealized losses on fixed maturities and equity securities, which are
deemed other than temporary, are charged to net income as realized capital
losses. Short-term investments are stated at cost, which approximates market
value. Realized gains or losses on sale of investments are determined on the
basis of identified cost. For non-publicly traded securities, market prices are
determined through the use of pricing models that evaluate securities relative
to the U.S. Treasury yield curve, taking into account the issue type, credit
quality and cash flow characteristics of each security. For publicly traded
securities, market value is based on quoted market prices. Retrospective
adjustments are employed to recalculate the values of loan-backed and
asset-backed securities. Each acquisition lot is reviewed to recalculate the
effective yield. The recalculated effective yield is used to derive a book value
as if the new yield were applied at the time of acquisition. Outstanding
principal factors from the time of acquisition to the adjustment date are used
F-7
to calculate the prepayment history for all applicable securities. Conditional
prepayment rates, computed with life to date factor histories and weighted
average maturities, are used to affect the calculation of projected and
prepayments for pass through security types. Other invested assets include
limited partnerships and rabbi trusts. Limited partnerships are valued pursuant
to the equity method of accounting, which management believes approximates
market value. The Supplemental Retirement Plan rabbi trust is carried at market
value, while the Deferred Compensation Plan rabbi trust and Supplemental Savings
Plan rabbi trust are carried at cost, which approximates market value. Cash
includes cash and bank time deposits with original maturities of ninety days or
less.
C. UNCOLLECTIBLE REINSURANCE BALANCES
The Company provides reserves for uncollectible reinsurance balances based on
management's assessment of the collectibility of the outstanding balances. Such
reserves were $34.1 million at December 31, 2001 and $27.9 million at December
31, 2000. See also Note 8.
D. DEFERRED ACQUISITION COSTS
Acquisition costs, consisting principally of commissions and brokerage expenses
and certain premium taxes and fees associated with the Company's reinsurance and
insurance business incurred at the time a contract or policy is issued, are
deferred and amortized over the period in which the related premiums are earned,
generally one year. Deferred acquisition costs are limited to their estimated
realizable value based on the related unearned premiums, anticipated claims and
claim expenses and anticipated investment income. Deferred acquisition costs
amortized to income (expense) were $22.7 million, $10.1 million and $12.4
million in 2001, 2000 and 1999, respectively.
E. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The reserve for unpaid losses and loss adjustment expenses ("LAE") is based on
individual case estimates and reports received from ceding companies. A
provision is included for losses and LAE incurred but not reported ("IBNR")
based on past experience. A provision is also included for certain potential
liabilities relating to asbestos and environmental exposures, which liabilities
cannot be estimated with traditional reserving techniques. See also Note 12. The
reserves are reviewed continually and any changes in estimates are reflected in
earnings in the period the adjustment is made. Management believes that adequate
provision has been made for the Company's losses and LAE. Loss and LAE reserves
are presented gross of reinsurance receivables and incurred losses and LAE are
presented net of ceded reinsurance.
Accruals for contingent commission liabilities are established for reinsurance
contracts that provide for the stated commission percentage to increase or
decrease based on the loss experience of the contract. Changes in the estimated
liability for such arrangements are recorded as contingent commissions. Accruals
for contingent commission liabilities are determined through the review of the
contracts that have these adjustable features and are estimated based on
expected loss and loss adjustment expenses.
F. PREMIUM REVENUES
Premiums written are earned ratably over the periods of the related insurance
and reinsurance contracts or policies. Unearned premium reserves are established
to cover the remainder of the unexpired contract period. Such reserves are
established based upon reports received from ceding companies or computed using
F-8
pro rata methods based on statistical data. Written and earned premiums, and the
related costs, which have not yet been reported to the Company are estimated and
accrued. Premiums are net of ceded reinsurance.
G. INCOME TAXES
The Company and its wholly-owned subsidiaries file a consolidated U.S. federal
income tax return. Group and its other subsidiaries, not included in Holdings'
consolidated tax return, file separate company U.S. federal income tax returns,
where required. Deferred income taxes have been recorded to recognize the tax
effect of temporary differences between the financial reporting and income tax
bases of assets and liabilities.
H. FOREIGN CURRENCY TRANSLATION
Assets and liabilities relating to foreign operations are translated into U.S.
dollars at the exchange rates in effect at the balance sheet date; revenues and
expenses are translated into U.S. dollars using average exchange rates. Gains
and losses resulting from translating foreign currency financial statements, net
of deferred income taxes, are excluded from net income and accumulated in
stockholder's equity.
I. UNUSUAL LOSS EVENTS
As a result of the terrorist attacks at the World Trade Center, the Pentagon and
on various airlines on September 11, 2001 (collectively the "Se