Back to GetFilings.com
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM 10-K
--------------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002 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)
--------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class on Which Registered
- -------------------------------- ---------------------
8.5% Senior Notes Due 2005 NYSE
8.75% Senior Notes Due 2010 NYSE
7.85% Trust Preferred Securities NYSE
--------------
Securities registered pursuant to Section 12(g) of the Act: None
--------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes ___ No _X_
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes ___ No __X__
The aggregate market value on June 28, 2002 (the last business day of the
registrant's most recently completed second quarter) of the voting stock held by
non-affiliates was zero.
At March 20, 2003, 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.
================================================================================
2
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 and Related Stockholder Matters
13. Certain Relationships and Related Transactions
14. Controls and Procedures
PART IV
15. 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.);
"CAPITAL TRUST" MEANS EVEREST RE CAPITAL TRUST; "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.
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 agent relationships
and surplus lines brokers. The Company's operating subsidiaries, excluding Mt.
McKinley Insurance Company ("Mt. McKinley"), 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:
- - 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, 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, 2002 of $1,494.0 million.
- - Everest National Insurance Company ("Everest National"), an Arizona
insurance company and a direct subsidiary of Everest Re, is licensed in 45
states and the District of Columbia and is authorized to write property and
casualty insurance in the jurisdictions in which it is licensed. This is
often called writing insurance on an admitted basis.
1
- - 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
jurisdiction is permitted to provide to insureds 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 48 states, the District of Columbia and Puerto Rico.
- - 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 and
Alabama.
- - 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 non-admitted basis, is the underwriting manager for Everest
Indemnity. Managers is also the parent company for WorkCare Southeast,
Inc., an Alabama insurance agency, and WorkCare Southeast of Georgia, Inc.,
a Georgia insurance agency.
- - Mt. McKinley (f/k/a Gibraltar Casualty Company, "Gibraltar"), a Delaware
insurance company and a direct subsidiary of Holdings, was acquired by
Holdings in September 2000 from The Prudential Insurance Company of America
("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.
- - Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda company and a direct
subsidiary of Everest Re, was formed in 1998 and owned Everest Re Ltd., a
United Kingdom company that was dissolved after its reinsurance operations
were converted into branch operations of Everest Re. Everest Ltd. holds
$79.4 million of investments, the management of which constitutes its
principal operations.
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.
2
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.
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.
3
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,
high ratings 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.
CAPITAL TRANSACTIONS
The Company has flexibility with respect to capitalization as the result of its
perceived financial strength, including its financial strength ratings as
assigned by independent rating agencies, and its access to the capital markets.
The Company continuously monitors its capital and financial position, as well as
investment and security market conditions, in general and with respect to the
Company's securities, and responds accordingly.
In November 2002, Capital Trust completed public offerings of $210 million
principal amount of 7.85% trust preferred securities. The net proceeds of this
offering were used for working capital and general corporate purposes. Capital
Trust, a Delaware statutory trust owned by the Company, was established in 1999
and exists to issue and sell preferred securities to the public.
On March 14, 2000, Holdings completed a public offering 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. During 2000, the net
proceeds of these offerings and additional funds were distributed by Holdings to
Group.
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, Inc. ("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
- -----------------------------------------------------------------------------------------------------
Everest Re A+ (Superior) AA- (Positive) Aa3 (Excellent)
Everest National A+ (Superior) AA- (Positive) Not Rated
Everest Indemnity A+ (Superior) Not Rated Not Rated
Everest Security A+ (Superior) Not Rated Not Rated
Mt. McKinley Not Rated Not Rated 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" to "R". 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. 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
Trust Preferred Securities a- BBB Baa1
A company with a debt rating of "a" or "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" and "a-" ratings are the sixth and
seventh 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. A company with a debt
rating of "BBB" is considered by Standard & Poor's to have adequate capacity to
pay interest and repay principal, but is susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories. The "A-" and "BBB" ratings from Standard & Poor's are the seventh
and ninth highest of 24 ratings assigned by Standard & Poor's, which range from
5
"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
capacity with respect to repayment of principal and interest, but elements may
be present which suggest a susceptibility to impairment sometime in the future.
A company with a debt rating of "Baa1" is considered to be a medium-grade
obligation by Moody's. This rating represents adequate capacity with respect to
repayment of principal and interest, but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
The "A3" and "Baa1" ratings are the seventh and eighth 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, yet
cyclical by product and market. The terrorist attacks on September 11, 2001 (the
"September 11 attacks") resulted in losses which reduced industry capacity and
were of sufficient magnitude to cause most 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 that had been apparent through 2000 and earlier in 2001
firmed significantly after the September 11 attacks. This firming generally took
the form of immediate and significant upward pressure on prices, 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.
During 2002, the reinsurance and insurance markets continued to firm. This
firming reflects the losses arising from the September 11 attacks as well as
reactions to broad and growing recognition that competition in the late 1990s
reached extremes in many classes and markets, which ultimately led to inadequate
pricing and overly broad terms, conditions and coverages. The effect of these
extremes, which is becoming apparent through excessive loss emergence, varies
widely by company depending on product offerings, markets accessed, underwriting
and operating practices, competitive strategies and business volumes. Across all
market participants, however, the aggregate effect has been impaired financial
results and erosion of the industry capital base. Coupled with deteriorating
investment market conditions and results, and renewed concerns regarding
longer-term industry specific issues, including asbestos exposure and sub-par
capital returns, these financial impacts have introduced substantial, and in
some cases extreme, pressure for the initiation and/or strengthening of
corrective action by individual market participants. These pressures have
resulted in firming prices, more restrictive terms and conditions and tightened
coverage availability across most classes and markets.
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 Lloyd's 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, by current market conditions, the Company
cannot predict with any reasonable certainty whether and to what extent these
improvements will persist.
6
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.
EMPLOYEES
As of March 1, 2003, the Company employed 367 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.
AVAILABLE INFORMATION
The Company's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and
Current Reports on Form 8-K and amendments to those reports are available free
of charge through the Company's internet website at HTTP://WWW.EVERESTRE.COM as
soon as reasonably practicable after such reports are electronically filed with
the Securities and Exchange Commission.
ITEM 2. PROPERTIES
Everest Re's corporate offices are located in approximately 115,000 square feet
of leased office space in Liberty Corner, New Jersey. The Company's other eleven
locations occupy a total of approximately 56,000 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
In the ordinary course of business, the Company is involved in lawsuits,
arbitrations and other formal and informal dispute resolution procedures, the
outcomes of which will determine the Company's rights and obligations under
insurance and reinsurance agreements and other more general contracts. In some
disputes, the Company seeks to enforce its rights under an agreement or to
collect funds owing to it. In other matters, the Company is resisting attempts
by others to collect funds or enforce alleged rights. Such disputes are resolved
through formal and informal means, including litigation and arbitration.
In all such matters, the Company believes that its positions are legally and
commercially reasonable. The Company also regularly evaluates those positions,
and where appropriate, establishes or adjusts insurance reserves to reflect the
results of its evaluation. The Company's aggregate reserves take into account
the possibility that the Company may not ultimately prevail in each and every
disputed matter. The Company believes its aggregate reserves reduce the
7
potential that an adverse resolution of one or more of these matters, at any
point in time, would have a material impact on the Company's financial condition
or results of operations. However, there can be no assurances that adverse
resolutions of such matters in any one period or in the aggregate will not
result in a material adverse effect on the Company's results of operations.
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, 2002, all of the Company's common stock was owned by Group
and was not publicly traded.
During 2000, the Company declared dividends on its common stock totaling $495.0
million. The Company did not pay any dividends during 2002 and 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
stockholder. 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 $921.0 million at
December 31, 2002, 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 2003 without triggering the requirement for prior approval of regulatory
authorities in connection with a dividend is $149.4 million. See Note 13A of
Notes to Consolidated Financial Statements.
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.
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is a discussion of the results of operations 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. 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. In addition, The Prudential guaranteed
Prupac's obligation to Mt. McKinley. There were $78.9 million of cessions under
this reinsurance at December 31, 2002, reducing the limit available under this
contract to $81.1 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 $0.0 million and $3.6 million of cessions under
this reinsurance during the periods ending December 31, 2002 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 Holdings 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.
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 initial public offering, 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 $103.9 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 became transactions with
affiliates effective on the date of the Mt. McKinley acquisition, and their
financial impact is thereafter eliminated in consolidation. Effective September
19, 2000, Mt. McKinley and Everest Reinsurance (Bermuda), Ltd. ("Bermuda Re")
9
entered into a loss portfolio transfer reinsurance agreement, whereby Mt.
McKinley transferred, for what management believes to be arm's-length
consideration, all of its net insurance exposures and reserves 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.
INDUSTRY CONDITIONS
The worldwide reinsurance and insurance businesses are highly competitive, yet
cyclical by product and market. The terrorist attacks on September 11, 2001 (the
"September 11 attacks") resulted in losses which reduced industry capacity and
were of sufficient magnitude to cause most 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 that had been apparent through 2000 and earlier in 2001
firmed significantly after the September 11 attacks. This firming generally took
the form of immediate and significant upward pressure on prices, 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.
During 2002, the reinsurance and insurance markets continued to firm. This
firming reflects the losses arising from the September 11 attacks as well as
reactions to broad and growing recognition that competition in the late 1990's
reached extremes in many classes and markets, which ultimately led to inadequate
pricing and overly broad terms, conditions and coverages. The effect of these
extremes, which is becoming apparent through excessive loss emergence, varies
widely by company depending on product offerings, markets accessed, underwriting
and operating practices, competitive strategies and business volumes. Across all
market participants, however, the aggregate effect has been impaired financial
results and erosion of the industry capital base. Coupled with deteriorating
investment market conditions and results, and renewed concerns regarding
longer-term industry specific issues, including asbestos exposure and sub-par
capital returns, these financial impacts have introduced substantial, and in
some cases extreme, pressure for the initiation and/or strengthening of
corrective action by individual market participants. These pressures have
resulted in firming prices, more restrictive terms and conditions and tightened
coverage availability across most classes and markets.
These changes reflect a clear 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 Lloyd's 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 and have taken on additional importance as the result of the
firming conditions which have emerged. As a result, although the Company is
encouraged by the recent improvements, and more generally, by current market
conditions, the Company cannot predict with any reasonable certainty whether and
to what extent these improvements will persist.
10
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 London, Canada, and Singapore, in
addition to foreign business written through the Company's New Jersey
headquarters and Miami office.
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.
RESULTS OF OPERATIONS
Unusual Loss Events in 2001. As a result of 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 by the Company were pursuant to treaties, where the
reinsurers' obligations are secured, which the Company believes eliminates
material reinsurance collection risk.
As a result of the Enron bankruptcy in 2001, the Company incurred losses,
after-tax and net of reinsurance, amounting to $18.6 million. This unusual loss
reflects all of the Company's exposures to this event, including underwriting,
credit and investment.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
PREMIUMS. Gross premiums written increased 49.0% to $2,755.4 million in 2002
from $1,849.8 million in 2001, as the Company took advantage of selected growth
opportunities and improving pricing in many classes of business, while
continuing to maintain a disciplined underwriting approach. Premium growth areas
included a 70.5% ($227.9 million) increase in the International operation,
mainly attributable to growth in the London, Canadian and Latin American
markets, a 63.5% ($319.1 million) increase in the U.S. Insurance operation,
principally attributable to growth in worker's compensation insurance, a 46.5%
($284.1 million) increase in the U.S. Reinsurance operation, primarily
reflecting growth across property and casualty lines, and an 18.0% ($74.6
million) increase in the Specialty Underwriting operation, mainly attributable
to growth in marine, aviation and surety business. The Company continued to
decline business that did not meet its objectives regarding underwriting
profitability.
Ceded premiums increased to $565.9 million in 2002 from $432.9 million in 2001.
This increase was principally attributable to $372.9 million of ceded premiums
relating to a Quota Share Reinsurance Agreement between Everest Re and Bermuda
Re, whereby Everest Re cedes 20% of its net retained liability on all new and
renewal policies written during the term of this agreement, and an Excess of
Loss Agreement between Everest Re, Everest National Insurance Company, Everest
11
Security and Bermuda Re, whereby Bermuda Re assumes liability for primary
insurance workers' compensation losses exceeding $100,000 per occurrence, with
its liability not to exceed $150,000 per occurrence. Ceded premiums in 2002
included $5.1 million and $49.4 million in adjustment premiums relating to
claims made under the 2001 and 2000 accident year aggregate excess of loss
elements of the Company's corporate retrocessional program, respectively. Ceded
premiums in 2001 included $81.3 million and $58.1 million in adjustment premiums
relating to claims made under the 2001 and 1999 accident year aggregate excess
of loss elements of the Company's corporate retrocessional program,
respectively, with the 2001 accident year cessions principally relating to
losses incurred as a result of the September 11 attacks and the Enron
bankruptcy.
Net premiums written increased by 54.5% to $2,189.5 million in 2002 from
$1,416.9 million in 2001. This increase was a result of the increase in gross
premiums written and ceded premiums.
PREMIUM REVENUES. Net premiums earned increased by 46.8% to $1,957.3 million in
2002 from $1,333.5 million in 2001. Contributing to this increase were a 140.7%
($239.0 million) increase in the International operation, a 58.3% ($171.5
million) increase in the U.S. Insurance operation, a 32.3% ($160.5 million)
increase in the U.S. Reinsurance operation and a 14.2% ($52.9 million) increase
in the Specialty Underwriting operation. 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 29.6%
to $1,399.0 million in 2002 from $1,079.2 million in 2001. The increase in
incurred losses and LAE was principally attributable to the increase in net
premiums earned and modest reserve strengthening in select areas, most notably
in directors and officers liability, surety and workers' compensation lines and
with respect to asbestos exposures, partially offset by lower catastrophe losses
and improvements in rates, terms and conditions in many classes of business, as
well as the impact of changes in the Company's mix of business. Incurred losses
and LAE include catastrophe losses, which reflect the impact both of 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, were $30.2 million
in 2002, principally relating to European flood losses and Hurricanes Isidore
and Kenna, compared to net catastrophe losses of $222.6 million in 2001, which
was principally related to the September 11 attacks. Incurred losses and LAE in
2002 reflected ceded losses and LAE of $486.1 million compared to ceded losses
and LAE in 2001 of $619.4 million. Ceded losses and LAE in 2002 include $178.6
million of ceded losses relating to the reinsurance transactions noted earlier
between the Company and Bermuda Re. The ceded losses and LAE in 2002 included
$11.0 million and $90.0 million of losses ceded under the 2001 and 2000 accident
year aggregate excess of loss components of the Company's corporate
retrocessional program, respectively. The ceded losses and LAE in 2001 included
$164.0 million and $105.0 million of losses ceded under the 2001 and 1999
12
accident year aggregate excess of loss components of the Company's corporate
retrocessional program, respectively, with the 2001 accident year cessions
relating principally to losses incurred as the result of the September 11
attacks.
Contributing to the increase in incurred losses and LAE in 2002 from 2001 were a
198.4% ($173.4 million) increase in the International operation, a 63.4% ($134.0
million) increase in the U.S. Insurance operation, principally reflecting
increased premium volume coupled with changes in this segment's specific
reinsurance programs and an 11.4% ($51.4 million) increase in the U.S.
Reinsurance operation, principally due to increased premium volume, partially
offset by decreased catastrophe losses. These increases were partially offset by
an 11.8% ($39.1 million) decrease in the Specialty Underwriting operation,
principally attributable to decreased catastrophe losses. 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, decreased by 9.4 percentage points
to 71.5% in 2002 from 80.9% in 2001, reflecting the earned premiums and incurred
losses and LAE discussed above. The following table shows the loss ratios for
each of the Company's operating segments for 2002 and 2001. The loss ratios for
all operations were impacted by the expense factors noted above as well as by
the impact on ceded premiums of the adjustment premiums under the Company's
corporate retrocessional program.
OPERATING SEGMENT LOSS RATIOS
- ---------------------------------------------------------------------------
Segment 2002 2001
- ---------------------------------------------------------------------------
U.S. Reinsurance 76.1% 90.4%
U.S. Insurance 74.1% 71.8%
Specialty Underwriting 68.7% 89.0%
International 63.8% 51.5%
Underwriting expenses increased by 23.3% to $553.5 million in 2002 from $448.9
million in 2001. Commission, brokerage, taxes and fees increased by $94.8
million, principally reflecting increases in premium volume and changes in the
mix of business. Other underwriting expenses increased by $9.8 million as the
Company expanded its operations to support its increased business volume.
Contributing to the underwriting expense increase were a 66.1% ($54.7 million)
increase in the U.S. Insurance operation, a 17.6% ($19.0 million) increase in
the Specialty operation, a 13.8% ($12.8 million) increase in the International
operation and an 11.4% ($18.7 million) increase in the U.S. Reinsurance
operation. 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, decreased by 5.4 percentage
points to 28.3% in 2002 compared to 33.7% in 2001.
The Company's combined ratio, which is the sum of the loss and expense ratios,
decreased by 14.9 percentage points to 99.7% in 2002 compared to 114.6% in 2001.
The following table shows the combined ratios for each of the Company's
operating segments for 2002 and 2001. 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 the adjustment premiums under the Company's
corporate retrocessional program.
13
OPERATING SEGMENT COMBINED RATIOS
- --------------------------------------------------------------------------------
Segment 2002 2001
- --------------------------------------------------------------------------------
U.S. Reinsurance 103.8% 123.3%
U.S. Insurance 103.6% 99.9%
Specialty Underwriting 98.6% 118.0%
International 89.7% 106.2%
INVESTMENTS. Net investment income decreased by 3.0% to $257.9 million in 2002
from $265.9 million in 2001, principally reflecting the lower interest rate
enviroment, partially offset by the effect of investing the $425.2 million of
cash flow from operations in 2002 and $203.4 million of net proceeds from
Everest Re Capital Trust's ("Capital Trust") issuance of trust preferred
securities in November 2002. The following table shows a comparison of various
investment yields as of December 31, 2002 and 2001, respectively, and for the
periods then ended.
2002 2001
-----------------------
Imbedded pre-tax yield of cash and invested
assets at end of period 5.1% 6.0%
Imbedded after-tax yield of cash and invested
assets at end of period 4.2% 4.6%
Annualized pre-tax yield on average cash and
invested assets 5.6% 6.2%
Annualized after-tax yield on average cash and
invested assets 4.3% 4.7%
Net realized capital losses were $53.1 million in 2002, reflecting realized
capital losses on the Company's investments of $108.9 million, which includes
$79.7 million relating to write-downs in the value of securities deemed to be
impaired on an other than temporary basis, of which $25.7 million were for
WorldCom, partially offset by $55.8 million of realized capital gains, compared
to net realized capital losses of $15.7 million in 2001. The net realized
capital losses in 2001 reflected realized capital losses of $45.5 million, which
included $16.7 million relating to write-downs in the value of securities deemed
to be impaired on an other than temporary basis, which were partially offset by
$29.8 million of realized capital gains.
Interest expense was $42.4 million for 2002 compared to $46.0 million for 2001.
Interest expense for 2002 reflects $38.9 million relating to the Company's
senior notes and $3.5 million relating to the Company's borrowing under its
revolving credit facility. Interest expense for 2001 reflects $38.9 million
relating to the Company's senior notes and $7.1 million relating to the
Company's borrowing under its revolving credit facility. In addition, 2002
includes incurred expense of $2.1 million for distributions on Capital Trust's
trust preferred securities.
Other expense was $21.8 million in 2002 compared to other income of $26.6
million in 2001. Significant contributors to other expense in 2002 were deferred
gains principally on the Mt. McKinley reinsurance transaction with Bermuda Re,
which is retroactive in nature, foreign exchange losses, normal provision for
uncollectible audit premium in the U.S. Insurance operation and the amortization
of deferred expenses relating to the Company's issuance of senior notes and
Capital Trust's issuance of trust preferred securities in November 2002,
partially offset by fee income. 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 that had issued annuities
to the Company in connection with certain claim settlement transactions. In
14
addition, other income for 2001 includes foreign exchange gains as well as fee
income, offset by the amortization of deferred expenses relating to the
Company's issuance of senior notes.
The Company has in its product portfolio a credit default swap, which it no
longer writes. This product meets the definition of a derivative under Financial
Accounting Standard No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"). Net derivative expense, essentially reflecting changes
in fair value from this credit default transaction in 2002, was $3.5 million,
compared to $7.0 million in 2001. See also Footnote 2 to Notes to the
Consolidated Financial Statements.
INCOME TAXES. The Company generated income tax expense of $24.8 million in 2002
compared to an income tax benefit of $9.2 million in 2001. The tax expense in
2002 was mainly attributable to improved underwriting results. The tax benefit
in 2001 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 taxable income relating to the
non-recurring receipt of shares in connection with a former client's
demutualization.
NET INCOME. Net income was $115.1 million in 2002 compared to $38.3 million in
2001. This increase generally reflects the improved underwriting results,
partially offset by increased tax expense, realized capital losses and a
decrease in other income.
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 elements 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 as a result of the increase in gross
premiums written and the increase in ceded premiums.
15
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 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,
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 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,
aviation and surety losses relating to the September 11 attacks, the Enron
bankruptcy and the Petrobras Oil Rig loss. These increases were partially offset
by a 62.9% ($148.5 million) decrease in the International operation, principally
16
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 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.
17
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
$16.7 million relating to write-downs in the value of securities deemed to be
impaired on an other than temporary basis, 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.
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 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 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 that had issued annuities to 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 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 the
Company's issuance of senior notes. The foreign exchange gains and losses are
attributable to fluctuations in foreign currency exchange rates.
18
During 2000, the Company added to its product portfolio a credit default swap,
which it no longer writes, 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 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 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. If any of the
following risks actually occur, the Company's business, financial condition or
results of operations could be materially and adversely affected.
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
affect the industry in general could also cause the Company's results to
fluctuate. The industry's profitability can be affected significantly by:
- - 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;
19
- - rising levels of actual costs that are not known by companies at the time
they price their products;
- - volatile and unpredictable developments, including weather-related and
other natural catastrophes;
- - events like the September 11, 2001 attacks, which affect the insurance and
reinsurance markets generally;
- - 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
- - 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.
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.
20
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. Everest Re and
Everest National hold an AA- ("Positive") financial strength rating from
Standard & Poor's. Everest Re holds an Aa3 ("Excellent") financial strength
rating from Moody's. 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
business 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 signifiacant
price competition. 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.
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
21
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. In
addition, if issuers of individual investments are unable to meet their
obligations, investment income will be reduced and realized capital losses may
arise. 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 may not have all required licenses and approvals or may not comply
with the wide variety of applicable laws and regulations or the relevant
authorities' interpretation of the laws and regulations. If the Company does not
have the requisite licenses and approvals or does not comply 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.
22
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 does not enter into market sensitive
instruments for trading purposes.
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 the
Company's 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
not to be material.
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, with minor changes in the underlying risk characteristics.
The $5.2 billion investment portfolio is comprised principally of fixed maturity
securities that are subject to interest rate risk and foreign currency rate
risk, and equity securities that are subject to equity price risk. The impact of
these risks in the investment portfolio is generally mitigated by changes in the
value of operating assets and liabilities and their associated income statement
impact.
Interest rate risk is the potential change in value of the fixed maturity
portfolio, including short-term investments, due to change in market interest
rates. In a declining interest rate environment, it includes prepayment risk on
the $401.4 million of mortgage-backed securities in the $4.9 billion fixed
23
maturity portfolio. 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, 2002 and 2001 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.
2002
INTEREST RATE SHIFT IN BASIS POINTS
- ---------------------------------------------------------------------------------------------------------
-200 -100 0 100 200
- ---------------------------------------------------------------------------------------------------------
Total Market Value $5,711.7 $5,306.2 $4,936.1 $4,590.3 $4,282.3
Market Value Change from Base
(%) 15.7% 7.5% 0.0% (7.0)% (13.2)%
Change in Unrealized
Appreciation After-tax from
Base ($) $ 504.2 $ 240.6 $ - $ (224.7) $ (425.0)
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)
Foreign currency rate risk is the potential change in value, income, and cash
flow arising from adverse changes in foreign currency exchange rates. Each of
the Company's foreign operations maintains 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
local currency as well as the currency of other countries in which it operates.
The primary foreign currency exposures for these foreign operations are the
Canadian Dollar, the British Pound Sterling and the Euro. The Company mitigates
24
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
for these foreign operations are the Canadian Dollar, the Euro and the British
Pound Sterling.
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, 2002 and 2001.
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.
2002
CHANGE IN FOREIGN EXCHANGE RATES IN PERCENT
- ------------------------------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ------------------------------------------------------------------------------------------------------
Total After-tax Foreign
Exchange Exposure $(29.9) $(16.8) $ - $ 19.0 $ 41.3
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
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 high quality common and preferred stocks that are traded on the major
exchanges in the United States and funds investing in such securities. The
primary objective in managing the $72.5 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, 2002 and 2001. All amounts are in U.S. dollars and are presented
in millions.
2002
CHANGE IN EQUITY VALUES IN PERCENT
- ----------------------------------------------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ----------------------------------------------------------------------------------------------------------
Market Value of the Equity Portfolio $58.0 $65.2 $72.5 $79.7 $87.0
After-tax Change in Unrealized Appreciation $(9.4) $(4.7) $ - $ 4.7 $ 9.4
25
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
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 AND
RELATED STOCKHOLDER MATTERS
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.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation was
carried out under the supervision and with the participation of the Company's
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the disclosure controls and procedures (as defined in
Rule 13a-14(c) under the Securities Exchange Act of 1934). Based on their
evaluation, the Chief Executive Officer and Chief Financial Officer believe that
the Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. Subsequent to the date of their evaluation, there were no significant
changes in the Company's internal controls or in other factors that could
significantly affect these controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
26
PART IV
ITEM 15. 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 2002.
27
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 Executive Officer March 20, 2003
- ---------------------- and Director (Principal Executive
Joseph V. Taranto Officer)
/s/ STEPHEN L. LIMAURO Executive Vice President, Chief March 20, 2003
- ----------------------- Financial Officer and Director
Stephen L. Limauro (Principal Financial Officer)
/s/ KEITH T. SHOEMAKER Comptroller (Principal Accounting March 20, 2003
- ----------------------- Officer)
Keith T. Shoemaker
/s/ THOMAS J. GALLAGHER Director March 20, 2003
- ------------------------
Thomas J. Gallagher
28
I, Joseph V. Taranto, certify that:
1. I have reviewed this annual report on Form 10-K of Everest Reinsurance
Holdings, Inc;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
March 20, 2003 /s/ JOSEPH V. TARANTO
- -------------- -----------------------
Joseph V. Taranto
Chairman and Chief
Executive Officer
I, Stephen L. Limauro, certify that:
1. I have reviewed this annual report on Form 10-K of Everest Reinsurance
Holdings, Inc;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
March 20, 2003 /s/ STEPHEN L. LIMAURO
- -------------- ---------------------------
Stephen L. Limauro
Executive Vice President
and Chief Financial Officer
INDEX TO EXHIBITS
EXHIBIT NO. PAGE
- ----------- ----
2.1 Agreement and Plan of Merger among Everest Reinsurance Holdings,
Inc.,Everest Re Group, Ltd. and Everest Re Merger Corporation,
incorporated herein by reference to Exhibit 2.1 to the Registration
Statement on Form S-4 (No. 333-87361)
3.1 Certificate of Incorporation of Everest Reinsurance Holdings, Inc.,
incorporated herein by reference to Exhibit 4.1 to the Registration
Statement on Form S-8 (No. 333-05771)
3.2 By-Laws of Everest Reinsurance Holdings, Inc., incorporated herein by
reference to Exhibit 3.2 to the Everest Reinsurance Holdings, Inc.
Quarterly Report on Form 10-Q for the quarter ended March 31, 2000
4.1 Indenture, dated March 14, 2000, between Everest Reinsurance Holdings,
Inc. and The Chase Manhattan Bank, as Trustee, incorporated herein by
reference to Exhibit 4.1 to Everest Reinsurance Holdings, Inc. Form
8-K filed on March 15, 2000
4.2 First Supplemental Indenture relating to the 8.5% Senior Notes due
March 15, 2005, dated March 14, 2000, between Everest Reinsurance
Holdings, Inc. and The Chase Manhattan Bank, as Trustee, incorporated
herein by reference to Exhibit 4.2 to Everest Reinsurance Holdings,
Inc. Form 8-K filed on March 15, 2000
4.3 Second Supplemental Indenture relating to the 8.75% Senior Notes due
March 15, 2010, dated March 14, 2000, between Everest Reinsurance
Holdings, Inc. and The Chase Manhattan Bank, as Trustee, incorporated
herein by reference to Exhibit 4.3 to the Everest Reinsurance
Holdings, Inc. Form 8-K filed on March 15, 2000
*10.1 Employment Agreement with Joseph V. Taranto executed on July 15,
1998, incorporated herein by reference to Exhibit 10.21 to Everest
Reinsurance Holdings, Inc. Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 (the "second quarter 1998 10-Q")
*10.2 Amendment of Employment Agreement by and among Everest Reinsurance
Company, Everest Reinsurance Holdings, Inc., Everest Re Group, Ltd.
And Joseph V. Taranto dated February 15, 2000, incorporated herein by
reference to Exhibit 10.29 to Everest Re Group, Ltd. Annual Report on
Form 10-K for the year ended December 31, 1999 (the "1999 10-K")
*10.3 Change of Control Agreement with Joseph V. Taranto effective July
15, 1998, incorporated herein by reference to Exhibit 10.22 to the
second quarter 1998 10-Q
*10.4 Amendment of Change of Control Agreement by and among Everest
Reinsurance Company, Everest Reinsurance Holdings, Inc., Everest Re
Group, Ltd. And Joseph V. Taranto dated February 15, 2000,
incorporated herein by reference to Exhibit 10.30 to the 1999 10-K
10.5 Credit Agreement Between Everest Reinsurance Holdings, Inc., the
Lenders Named Therein and First Union National Bank dated December 21,
1999 providing for a $150 million Senior Revolving Credit Facility,
incorporated herein by reference to Exhibit 10.30 to Everest
Reinsurance Holdings, Inc. Form 8-K filed on December 28, 1999
10.6 First Amendment to Credit Agreement dated as of December 21, 1999
between Ever