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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002 Commission file number 1-15731
EVEREST RE GROUP, LTD.
(Exact name of registrant as specified in its charter)
BERMUDA 98-0365432
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
C/O ABG FINANCIAL & MANAGEMENT SERVICES, INC.
PARKER HOUSE
WILDEY BUSINESS PARK, WILDEY ROAD
ST. MICHAEL, BARBADOS
(246) 228-7398
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive office)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class on Which Registered
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Common Shares, $.01 par value per share New York Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes _X_ No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes _X_ No___
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 of the registrant was $2,871.2 million.
At March 14, 2003, the number of shares outstanding of the registrant's
common shares was 50,901,893.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12, and 13 of Form 10-K is
incorporated by reference into Part III hereof from the registrant's proxy
statement for the 2003 Annual General Meeting of Shareholders, which will be
filed with the Securities and Exchange Commission within 120 days of the close
of the registrant's fiscal year ended December 31, 2002.
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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
Shareholder 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 Shareholder 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") IN THE UNITED
STATES OF AMERICA. AS USED IN THIS DOCUMENT, "EVEREST RE" MEANS EVEREST
REINSURANCE COMPANY AND ITS SUBSIDIARIES (UNLESS THE CONTEXT OTHERWISE
REQUIRES); "HOLDINGS" MEANS EVEREST REINSURANCE HOLDINGS, INC.; "GROUP" MEANS
EVEREST RE GROUP, LTD. (FORMERLY EVEREST REINSURANCE GROUP, LTD.); "CAPITAL
TRUST" MEANS EVEREST RE CAPITAL TRUST; AND THE "COMPANY" MEANS GROUP AND ITS
SUBSIDIARIES, EXCEPT WHEN REFERRING TO PERIODS PRIOR TO FEBRUARY 24, 2000, WHEN
IT MEANS HOLDINGS AND ITS SUBSIDIARIES.
ITEM 1. BUSINESS
THE COMPANY
Group, a Bermuda company, with its principal executive office in Barbados, was
established in 1999 as a wholly-owned subsidiary of Holdings. On February 24,
2000, a corporate restructuring was completed and Group became the new parent
holding company of Holdings, which remains the holding company for the Company's
U.S. based operations. Holders of shares of common stock of Holdings
automatically became holders of the same number of common shares of Group. Prior
to the restructuring, Group had no significant assets or capitalization and had
not engaged in any business or prior activities other than in connection with
the restructuring. The Company had gross premiums written in 2002 of $2,846.5
million and shareholders' equity at December 31, 2002 of $2,368.6 million.
In connection with the restructuring, Group established a Bermuda-based
reinsurance subsidiary, Everest Reinsurance (Bermuda), Ltd. ("Bermuda Re"),
which commenced business in the second half of 2000. Group also formed Everest
Global Services, Inc., a Delaware subsidiary, to perform administrative and
back-office functions for Group and its U.S.-based and non-U.S. based
subsidiaries.
Holdings, a Delaware corporation, was established in 1993 to serve as the parent
holding company of Everest Re, a Delaware property and casualty reinsurer formed
in 1973. Until October 6, 1995, Holdings was an indirect wholly-owned subsidiary
of The Prudential Insurance Company of America ("The Prudential"). On October 6,
1995, The Prudential sold its entire interest in the shares of common stock of
Holdings in an initial public offering (the "IPO").
The Company's principal business, conducted through its operating subsidiaries,
is the underwriting of reinsurance and insurance in the United States, Bermuda
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. Group's operating subsidiaries,
excluding Mt. McKinley Insurance Company ("Mt. McKinley") and Everest
International Reinsurance, Ltd. ("Everest International"), 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.
1
Following is a summary of the Company's operating subsidiaries:
o Everest Re, a Delaware insurance company and a direct subsidiary of
Holdings, is a licensed property and casualty insurer and/or reinsurer
in all states (except Nevada and Wyoming), the District of Columbia,
Puerto Rico and is authorized to conduct reinsurance business in the
United Kingdom, Canada and Singapore. Everest Re underwrites property
and casualty reinsurance 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.
o Bermuda Re, a Bermuda insurance company and a direct subsidiary of
Group, is registered in Bermuda as a Class 4 insurer and long-term
insurer and is authorized to write property and casualty business and
life and annuity business. Bermuda Re commenced business in the second
half of 2000. In December 2000, Bermuda Re acquired all of the issued
and outstanding shares of AFC Re Ltd. ("AFC Re"), a Bermuda long-term
insurance company. AFC Re wrote annuity reinsurance business, which
business has been assumed by Bermuda Re. In September 2001, AFC Re was
sold to Group and renamed Everest International and is currently
inactive. Bermuda Re had capital at December 31, 2002 of $931.9 million
based on U.S. generally accepted accounting principles.
o 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.
o Everest Indemnity Insurance Company ("Everest Indemnity"), a Delaware
insurance company and a direct subsidiary of Everest Re, engages in the
excess and surplus lines insurance business in the United States.
Excess and surplus lines insurance is specialty property and liability
coverage that an insurer not licensed to write insurance in a
particular 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.
o Everest Security Insurance Company ("Everest Security"), formerly
Southeastern Security Insurance Company, a Georgia insurance company
and a direct subsidiary of Everest Re, was acquired in January 2000 and
writes property and casualty insurance on an admitted basis in Georgia
and Alabama.
o Mt. McKinley Managers, L.L.C. ("Managers"), a New Jersey limited
liability company and a direct subsidiary of Holdings, is licensed in
New Jersey as an insurance producer. An insurance producer is any
intermediary, such as an agent or broker, which acts as the conduit
between an insurance company and an insured. Managers, which is
licensed to act in New Jersey as an insurance producer in connection
with policies written on both an admitted and a 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.
2
o Mt. McKinley (f/k/a Gibraltar Casualty Company, "Gibraltar") ("Mt.
McKinley"), a Delaware insurance company and a direct subsidiary of
Holdings, was acquired by Holdings in September 2000 from The
Prudential. Mt. McKinley was formed by Everest Re in 1978 to engage in
the excess and surplus lines insurance business in the United States.
In 1985, Mt. McKinley ceased writing new and renewal insurance and now
its ongoing operations relate to servicing claims arising from its
previously written business. Mt. McKinley was a subsidiary of Everest
Re until 1991 when Everest Re distributed the stock of Mt. McKinley to
a wholly-owned subsidiary of The Prudential.
o Everest Re Holdings, Ltd. ("Everest Ltd."), a Bermuda company and a
direct subsidiary of Everest Re, was formed in 1998 and 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.
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.
3
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.
The Company's products include: (1) 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; and (2) reinsurance of life and
annuity business. The Company's distribution channels include both the direct
and broker reinsurance markets, U.S., Bermuda 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., Bermuda 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
operations complement these strategies by allowing the Company access to
business that would not likely be available to it on a reinsurance basis. The
Company carefully monitors its mix of business across all operations to avoid
inappropriate concentrations of geographic or other risk.
4
MARKETING
The Company writes business on a worldwide basis for many different customers
and for many lines of business, providing a broad array of coverages. The
Company is not materially dependent on any single customer, small group of
customers, line of business or geographical area. For the 2002 calendar year, no
single customer (ceding company or insured) generated more than 7.4% of the
Company's gross premiums written. The Company does not believe that a reduction
of business from any one customer would have a material adverse effect on its
future financial condition or results of operations due to the Company's
competitive position in the market place and the continuing availability of
other sources of business.
Approximately 48.6%, 22.5% and 28.9% of the Company's 2002 gross premiums
written were written in the broker reinsurance, direct reinsurance and insurance
markets, respectively. The Company's ability to write reinsurance both through
brokers and directly with ceding companies gives it the flexibility to pursue
business regardless of the ceding company's preferred reinsurance purchasing
method.
The reinsurance broker market consists of several substantial national and
international brokers and a number of smaller specialized brokers. Brokers do
not have the authority to bind the Company with respect to reinsurance
agreements, nor does the Company commit in advance to accept any portion of the
business that brokers submit to it. Reinsurance business from any ceding
company, whether new or renewal, is subject to acceptance by the Company.
Brokerage fees are generally paid by reinsurers. The Company's ten largest
brokers accounted for an aggregate of approximately 39.0% of gross premiums
written in 2002, with each of the two largest brokers accounting for
approximately 12.9% and 12.4% of gross premiums written, respectively. The
Company does not believe that a reduction of business assumed from any one
broker would have a materially adverse effect on the Company due to its
competitive position in the market place, relationships with ceding companies
and the continuing availability of other sources of business.
The direct market remains an important distribution system for reinsurance
business written by the Company. Direct placement of reinsurance enables the
Company to access clients who prefer to place their reinsurance directly with
reinsurers based upon the reinsurer's in-depth understanding of the ceding
company's needs. The Company's insurance business is written principally through
general agent relationships and surplus lines brokers. The Company's largest
agency relationship accounted for approximately 15.9% of gross premiums written,
which consists of approximately 27,800 individual workers' compensation
policies.
The Company evaluates each business relationship, including the underwriting
expertise and experience of each distribution channel selected, performs
analyses to evaluate financial security and monitors performance.
SEGMENT INFORMATION
The Company, through its subsidiaries, operates in five segments: U.S.
Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda.
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 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
5
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. The Bermuda operation writes property, casualty, life and annuity
business through brokers and directly with ceding companies.
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. The Company utilizes inter-affiliate reinsurance but such
reinsurance does not impact segment results, since business is generally
reported within the segment in which the business was first produced. For
selected financial information regarding these segments, see Note 17 of Notes to
Consolidated Financial Statements.
UNDERWRITING OPERATIONS
The following table presents the distribution of the Company's gross premiums
written by its U.S. Reinsurance, U.S. Insurance, Specialty Underwriting,
International and Bermuda operations for the years ended December 31, 2002,
2001, 2000, 1999 and 1998, classified according to whether the premium is
derived from property or casualty business and, for reinsurance business,
whether it represents pro rata or excess of loss business:
6
GROSS PREMIUMS WRITTEN BY OPERATION
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
----------------- ----------------- --------------- ---------------- ---------------
$ % $ % $ % $ % $ %
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
(DOLLARS IN MILLIONS)
U.S. REINSURANCE
Property
Pro Rata(1) $ 148.7 5.2% $ 62.9 3.4% $ 60.2 4.3% $ 48.6 4.3% $ 30.1 2.9%
Excess 177.8 6.2 104.0 5.5 75.6 5.5 67.0 5.9 65.1 6.2
Casualty
Pro Rata(1) 219.2 7.7 191.2 10.2 151.1 10.9 152.9 13.4 183.9 17.6
Excess 348.9 12.3 252.3 13.5 194.7 14.1 222.1 19.5 212.5 20.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 894.6 31.4 610.4 32.6 481.6 34.8 490.6 43.0 491.6 47.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
U.S. INSURANCE
Property
Pro Rata(1) 6.5 0.2 6.2 0.3 9.3 0.7 3.8 0.3 3.1 0.3
Excess - 0.0 - 0.0 - 0.0 - 0.0 - 0.0
Casualty
Pro Rata(1) 815.0 28.6 496.1 26.5 241.2 17.4 66.6 5.8 75.5 7.2
Excess - 0.0 - 0.0 - 0.0 - 0.0 - 0.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 821.5 28.9 502.4 26.8 250.5 18.1 70.4 6.2 78.6 7.5
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
SPECIALTY UNDERWRITING
Property
Pro Rata(1) 397.5 14.0 356.3 19.0 274.0 19.8 213.6 18.7 92.9 8.9
Excess 43.8 1.5 35.0 1.9 19.3 1.4 19.7 1.7 15.8 1.5
Casualty
Pro Rata(1) 41.9 1.5 18.4 1.0 21.4 1.5 32.3 2.8 39.3 3.8
Excess 5.3 0.2 4.3 0.2 3.6 0.3 2.9 0.3 3.0 0.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 488.5 17.2 414.0 22.1 318.3 23.0 268.5 23.5 151.0 14.4
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
TOTAL U.S.
Property
Pro Rata(1) 552.7 19.4 425.5 22.7 343.4 24.8 266.0 23.3 126.1 12.1
Excess 221.6 7.8 139.0 7.4 94.9 6.9 86.7 7.6 80.9 7.7
Casualty
Pro Rata(1) 1,076.1 37.8 705.8 37.6 413.8 29.9 251.8 22.1 298.7 28.6
Excess 354.2 12.4 256.7 13.7 198.3 14.3 225.1 19.7 215.6 20.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 2,204.6 77.4 1,526.8 81.4 1,050.4 75.9 829.5 72.7 721.2 69.1
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
INTERNATIONAL
Property
Pro Rata(1) 328.4 11.5 171.0 9.1 143.4 10.3 124.6 10.9 141.9 13.6
Excess 122.9 4.3 60.0 3.2 55.6 4.0 54.8 4.8 45.8 4.4
Casualty
Pro Rata(1) 35.3 1.2 54.3 2.9 78.4 5.7 84.4 7.4 93.4 8.9
Excess 54.3 1.9 37.5 2.0 46.2 3.3 48.5 4.3 43.6 4.2
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) 540.9 19.0 322.8 17.2 323.6 23.4 312.3 27.4 324.7 31.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
BERMUDA OPERATIONS
Property
Pro Rata(1) 37.1 1.3 6.2 0.3 - 0.0 - 0.0 - 0.0
Excess 36.0 1.3 0.6 0.0 - 0.0 - 0.0 - 0.0
Casualty
Pro Rata(1) 15.1 0.5 18.1 1.0 11.6 0.8 - 0.0 - 0.0
Excess 12.8 0.4 0.1 0.0 - 0.0 - 0.0 - 0.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) (3) 101.0 3.5 25.0 1.3 11.6 0.8 - 0.0 - 0.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
TOTAL COMPANY
Property
Pro Rata(1) 918.2 32.3 602.6 32.1 486.8 35.1 390.6 34.2 268.0 25.6
Excess 380.5 13.4 199.6 10.6 150.5 10.9 141.4 12.4 126.6 12.1
Casualty
Pro Rata(1) 1,126.5 39.6 778.1 41.5 503.8 36.4 336.2 29.4 392.1 37.5
Excess 421.3 14.8 294.3 15.7 244.5 17.6 273.6 24.0 259.2 24.8
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total(2) $2,846.5 100.0% $1,874.6 100.0% $1,385.6 100.0% $1,141.8 100.0% $1,045.9 100.0%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
- -------------
(1) For purposes of the presentation above, pro rata includes reinsurance
attaching to the first dollar of loss incurred by the ceding company and
insurance.
(2) Certain totals and subtotals may not reconcile due to rounding.
(3) Includes immaterial amounts of life and annuity premium.
7
U.S. REINSURANCE OPERATION. The Company's U.S. Reinsurance operation writes
property and casualty reinsurance, both treaty and facultative, through
reinsurance brokers as well as directly with ceding companies within the United
States. The Company targets certain brokers and, through the broker market,
specialty companies and small to medium sized standard lines companies. On a
direct basis, the Company targets companies that place their business
predominantly in the direct market, including small to medium sized regional
ceding companies, and seeks to develop long-term relationships with those
companies. In addition, the U.S. Reinsurance operation writes portions of
reinsurance programs for larger, national insurance companies.
In 2002, $230.9 million of gross premiums written were attributable to U.S.
treaty property business, of which 35.6% was written on an excess of loss basis
and 64.4% was written on a pro rata basis. The Company's property underwriters
utilize sophisticated underwriting methods which management believes are
necessary to analyze and price property business, particularly that segment of
the property market which has catastrophe exposure.
U.S. treaty casualty business accounted for $418.1 million of gross premiums
written in 2002, of which 47.6% was written on an excess of loss basis and 52.4%
was written on a pro rata basis. The treaty casualty portfolio consists of
professional liability, D&O liability, workers' compensation, excess and surplus
lines, and other liability coverages. As a result of the complex technical
nature of most of these risks, the Company's casualty underwriters tend to
specialize by line of business and work closely with the Company's pricing
actuaries.
The Company's facultative unit conducts business both through brokers and
directly with ceding companies, and consists of four underwriting units
representing property, casualty, specialty and national brokerage lines of
business. Business is written from a facultative headquarters office in New York
and satellite offices in Chicago and Oakland. In 2002, $71.4 million, $133.5
million, $17.3 million and $23.4 million of gross premiums written were
attributable to the property, casualty, specialty and national brokerage lines
of business, respectively.
In 2002, 79.9% and 20.1% of the U.S. Reinsurance operation's gross premiums
written were written in the broker and direct reinsurance markets, respectively.
U.S. INSURANCE OPERATION. In 2002, the Company's U.S. Insurance operation wrote
$821.5 million of gross premiums, of which 99.2% was casualty and 0.8% was
property. Of the casualty business, the predominant class was workers'
compensation insurance. Everest National wrote $706.1 million and Everest Re
wrote $14.1 million, with both principally targeting commercial property and
casualty business written through general agency relationships with program
administrators. Everest Indemnity wrote $78.1 million, principally targeting
excess and surplus lines insurance business written through surplus lines
brokers. Everest Security wrote $23.2 million, principally targeting
non-standard auto business written through retail agency relationships. With
respect to insurance written through general agents and surplus lines brokers,
the Company supplements the initial underwriting process with periodic claims,
underwriting and operational reviews and ongoing monitoring.
8
SPECIALTY UNDERWRITING OPERATION. The Company's Specialty Underwriting operation
writes A&H, marine, aviation and surety reinsurance. The A&H unit primarily
focuses on health reinsurance of traditional indemnity plans, self-insured
health plans and specialty medical plans. The marine and aviation unit focuses
on ceding companies with a particular expertise in marine and aviation business.
The marine and aviation business is written primarily through brokers and
contains a significant international component written primarily in the London
market. Surety business underwritten by the Company consists mainly of
reinsurance of contract surety bonds.
Gross premiums written by the A&H unit in 2002 totaled $314.4 million, of which
$78.1 million was written through the broker market and $236.3 million was
written through the direct market.
Gross premiums written by the marine and aviation unit in 2002 totaled $94.1
million, substantially all of which was written on a treaty basis and 86.6% of
which was sourced through reinsurance brokers. Marine treaties represented 49.9%
of marine and aviation gross premiums written in 2002 and consisted mainly of
hull and liability coverage. Approximately 69.4% of the marine unit premiums in
2002 were written on a pro rata basis and 30.6% as excess of loss. Aviation
premiums accounted for 50.1% of marine and aviation gross premiums written in
2002 and included reinsurance for airlines, general aviation and satellites.
Approximately 88.8% of the aviation unit's premiums in 2002 were written on a
pro rata basis and 11.2% as excess of loss.
In 2002, gross premiums written by the surety unit totaled $80.1 million.
Approximately 69.4% of the surety unit premiums in 2002 were written on a pro
rata basis and 30.6% on an excess of loss basis. Most of the portfolio is
reinsurance of contract surety bonds written directly with ceding companies,
with the remainder being credit reinsurance, mostly in international markets.
INTERNATIONAL OPERATION. The Company's International operation is designed to
enable it to capitalize on the growth opportunities in the international
reinsurance market. The Company targets several international markets,
including: Europe and the London markets, which are serviced by a branch in
London; Canada, with a branch in Toronto; Asia and Australia, with a branch in
Singapore; and Latin America, Africa and the Middle East, which business is
serviced from Everest Re's New Jersey headquarters and Miami office. The Company
also writes "home-foreign" business, which provides reinsurance on the
international portfolios of U.S. insurers, from New Jersey. Approximately 83.4%
of the gross premiums written by the Company's international underwriters in
2002 represented property business, while the balance represented casualty
business. As with its U.S. operations, the Company's International operation
focuses on financially sound companies that have strong management and
underwriting discipline and expertise. Approximately 73.4% of the Company's
international business was written through brokers, with the remainder written
directly with ceding companies.
In 2002, the Company's gross premiums written by its London branch totaled
$186.5 million and consisted of pro rata property (56.8%), excess property
(24.1%), pro rata casualty (3.9%) and excess casualty (15.2%). Substantially all
of the London premiums consisted of treaty reinsurance.
9
Gross premiums written by the Company's Canadian office totaled $74.0 million in
2002 and consisted of pro rata property (51.3%), excess property (21.5%), pro
rata multi-line (2.7%) and excess casualty (24.4%). Approximately 76.4% of the
Canadian premiums consisted of treaty reinsurance, while 23.4% was facultative
reinsurance.
The Company's Singapore branch covers the Asian and Australian markets and
accounted for $25.5 million of gross written premiums in 2002. This business
consisted of pro rata property (56.4%), excess property (33.4%), pro rata
casualty (9.0%) and excess casualty (1.2%).
International business written out of Everest Re's New Jersey and Miami offices
accounted for $254.9 million of gross premiums written in 2002 and consisted of
pro rata treaty property (66.8%), pro rata treaty casualty (9.3%), excess treaty
property (15.5%), excess treaty casualty (2.6%) and excess facultative property
and casualty (5.8%). Of this international business, 67.6% was sourced from
Latin America, 27.3% was sourced from the Middle East, 3.2% was sourced from
Europe, Africa and Asia, and 1.9% was "home-foreign" business.
BERMUDA OPERATION. The Company's Bermuda operation writes property, casualty,
life and annuity business through Bermuda Re. In 2002, the Bermuda operation
continued to scale up and had gross property and casualty premiums written of
$101.0 million.
GEOGRAPHIC AREAS
The Company conducts its business in Bermuda, in the United States and in a
number of foreign countries. For select financial information about geographic
areas, see Note 17 of Notes to the Consolidated Financial Statements. Risks
attendant to the foreign operations of the Company parallel those attendant to
the United States operations of the Company, with the primary exception of
foreign exchange risks. See ITEM 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Safe Harbor Disclosure".
UNDERWRITING PROCESS
The Company offers ceding companies full service capability, including
actuarial, claims, accounting and systems support, either directly or through
the broker community. The Company's capacity for both property and casualty
risks allows it to underwrite entire contracts or major portions thereof that
might otherwise need to be syndicated among several reinsurers. The Company's
strategy is to act as "lead" reinsurer in many of the reinsurance treaties it
underwrites. The lead reinsurer on a treaty generally accepts one of the largest
percentage shares of the treaty and is in a stronger position to negotiate
price, terms and conditions than is a reinsurer that takes a smaller position.
Management believes this strategy enables it to more effectively influence the
terms and conditions of the treaties on which it participates. When the Company
does not lead the treaty, it may still suggest changes to any aspect of the
treaty. The Company may decline to participate in a treaty based upon its
assessment of all relevant factors.
10
The Company's treaty underwriting process emphasizes a team approach among the
Company's underwriters, actuaries and claim staff. Treaties are reviewed for
compliance with the Company's general underwriting standards and certain larger
treaties are evaluated in part based upon actuarial analyses by the Company. The
actuarial models used in such analyses are tailored in each case to the
exposures and experience underlying the specific treaty and the loss experience
for the risks covered by such treaties. The Company does not separately evaluate
each of the individual risks assumed under its treaties. The Company does,
however, generally evaluate the underwriting guidelines of its ceding companies
to determine their adequacy prior to entering into a treaty. The Company, when
appropriate, also conducts underwriting, operational and claim audits at the
offices of ceding companies to ensure that the ceding companies operate within
such guidelines. Underwriting audits focus on the quality of the underwriting
staff, the selection and pricing of risks and the capability of monitoring price
levels over time. Claim audits, when appropriate, are performed in order to
evaluate the client's claims handling abilities and practices.
The Company's U.S. facultative underwriters operate within guidelines specifying
acceptable types of risks, limits and maximum risk exposures. Specified classes
of risks and large premium risks are referred to Everest Re's New York
facultative headquarters for specific review before premium quotations are given
to clients. In addition, the Company's guidelines require certain types of risks
to be submitted for review because of their aggregate limits, complexity or
volatility, regardless of premium amount or size of the insured on the
underlying contract.
The Company's insurance operations principally write property and casualty
coverages for homogeneous risks through select program managers. These programs
are evaluated based upon actuarial analysis and the program manager's
capabilities. The Company's rates, forms and underwriting guidelines are
tailored to specific risk types. The Company's underwriting, actuarial, claim
and financial functions work closely with its program managers to establish
appropriate underwriting and processing guidelines as well as appropriate
monitoring mechanisms.
RISK MANAGEMENT AND RETROCESSION ARRANGEMENTS
The Company manages its risk of loss through a combination of aggregate exposure
limits, underwriting guidelines that take into account risks, prices and
coverage, and retrocessional arrangements.
The Company is exposed to multiple insured losses arising out of a single
occurrence, whether a natural event, such as a hurricane or an earthquake, or
other catastrophe, such as an explosion at a major factory. Any such
catastrophic event could generate insured losses in one or many of the Company's
treaties or lines of business, including property and/or casualty exposures. The
Company employs various techniques, including licensed software modeling, to
assess its accumulated exposure. Such techniques are inherently more difficult
to apply to non-property exposures. Accumulated exposures with respect to
catastrophe losses are generally summarized in terms of the probable maximum
loss ("PML"). The Company defines PML as its anticipated maximum loss, taking
into account contract limits, caused by a single catastrophe affecting a broad
contiguous geographic area, such as that caused by a hurricane or earthquake of
such a magnitude that it is expected to occur once in every 100 years.
Management believes that the Company's greatest catastrophe exposure world wide
from any single event is to an earthquake affecting the west coast of the United
States where the Company estimates it has a PML exposure of $338 million,
including workers' compensation exposures. The Company further estimates that
its PML exposure with respect to its greatest windstorm exposure, which relates
to a hurricane affecting the east coast of the United States, is $264 million
and that its single event International PML exposure is $197 million. There can
11
be no assurance that the Company will not experience losses from one or more
catastrophic events that exceed, perhaps by a substantial amount, its estimated
PML.
The U.S. Terrorism Risk Insurance Act of 2002 was signed into law in November
2002. This legislation provides Federal reimbursement of 90% of insured losses,
in excess of statutory retention levels, due to acts of terrorism carried out by
foreign powers on U.S. soil or against U.S. air carriers, vessels or foreign
missions. This coverage does not apply to reinsurance. Reinsurance contracts
generally exclude losses arising from terrorist events, except where such
coverage has been specifically included in the underwriting and pricing of the
involved reinsurance. The Company does not believe that this legislation will
have a significant impact on its operations.
Underwriting guidelines have been established for each business unit. These
guidelines place dollar limits on the amount of business that can be written
based on a variety of factors, including ceding company, line of business,
geographical location and risk hazards. In each case, those guidelines permit
limited exceptions, which must be authorized by the Company's senior management.
The Company employs a retrocessional approach under which the Company may
purchase reinsurance to cover specific business written or exposure
accumulations or as a corporate level retrocessional program covering the
potential accumulation or aggregation of exposures across some or all of the
Company's operations. All reinsurance purchasing decisions consider both the
potential coverage and market conditions with respect to the pricing, terms,
conditions and availability of such coverage, with the aim of securing
cost-effective protection. The level of reinsurance coverage varies over time,
reflecting the underwriter's and/or Company's view of the changing dynamics of
both the underlying exposure and the reinsurance markets.
The Company does not typically purchase reinsurance to cover specific
reinsurance business written, but it does from time to time purchase
retrocessional protections where underwriting management deems it to be prudent
and/or cost-effective to reinsure a portion of the specific risks being assumed.
In 2001 and 2000, the Company purchased an excess property facultative
retrocessional program and an excess workers' compensation retrocessional
program. In addition, the Company purchased an excess property catastrophe
retrocessional program for losses incurred outside of the U.S. for 2002, 2001
and 2000. The Company also participates in "common account" retrocessional
arrangements for certain reinsurance treaties. Common account reinsurance
arrangements are arrangements whereby the ceding company purchases reinsurance
for the benefit of itself and its reinsurers on one or more of its reinsurance
treaties. Common account retrocessional arrangements reduce the effect of
individual or aggregate losses to all participating companies, including the
ceding company, with respect to the involved treaties.
The Company typically considers the purchase of reinsurance to cover insurance
programs written by the U.S. Insurance operation. Such consideration includes
balancing the underlying exposures against the availability of cost-effective
reinsurance protection. For policies incepting on or after November 1998, the
Company purchased a workers' compensation reinsurance program that provided for
statutory limits coverage in excess of $75,000 of losses per occurrence on the
Company's workers' compensation insurance business written prior to November 1,
2000. Since November 1, 2000, this primary workers' compensation reinsurance
12
program provides statutory limits coverage in excess of $250,000 of losses per
occurrence for business written prior to December 31, 2001. The Company has not
purchased such coverage for the period subsequent to December 31, 2001. In
addition, for the twelve-month period commencing July 31, 2000, the Company
purchased reinsurance for a specific program of business. The reinsurance,
subject to certain aggregate limits, covered U.S. Longshore and Harbor Workers'
Compensation Act and state act workers' compensation business for 100% of loss
occurrences up to $100 million. Consistent with the $1 million limits of the
underlying policies in the program, reinsurance for 100% of Maritime Employers
Liability and Employers Liability was also provided. Neither the program nor the
reinsurance were purchased in 2002 or 2001.
The Company also considers purchasing corporate level retrocessional protection
covering the potential accumulation of exposures. Such consideration includes
balancing the underlying exposures against the availability of cost-effective
retrocessional protection. For 2001, the Company purchased an accident year
aggregate excess of loss retrocession agreement which provides up to $175.0
million of coverage if Everest Re's consolidated statutory basis accident year
loss ratio exceeds a loss ratio attachment point provided in the contract for
the 2001 accident year. The attachment point is net of inuring reinsurance and
retrocessions and includes adjustable premium provisions that effectively cause
the Company to offset, on a pre-tax income basis, up to 52.9% of such ceded
losses, depending upon the character of the underlying losses, through
additional premiums. The maximum recovery is $175.0 million before giving effect
to a maximum adjustable premium of $82.5 million. Cessions under this cover have
reduced the limit available to $0.0 million at December 31, 2002. Similar
coverage was purchased and remains in effect for the 2000 accident year.
Cessions under this cover have reduced the limit available to $85.0 million as
of December 31, 2002. The Company has not purchased similar coverage for the
period subsequent to December 31, 2001.
Although certain of the Company's catastrophe and aggregate excess of loss
retrocessions have terms which provide for additional premiums to be paid to the
retrocessionaire in the event that losses are ceded, all aspects of the
Company's retrocessional program have been structured to permit these agreements
to be accounted for as reinsurance under Financial Accounting Standard ("FAS")
No. 113.
If a single catastrophe were to occur in the United States that resulted in $338
million of gross losses and allocated loss adjustment expenses ("ALAE") in 2003
(an amount equivalent to the Company's PML, including its property and workers'
compensation exposures), management estimates that the effect on the Company's
income would be approximately $338 million and $264 million before and after
taxes, respectively.
In addition, the Company has coverage under an aggregate excess of loss
reinsurance agreement provided by Prudential Property and Casualty Insurance
Company of Indiana ("Prupac"), a wholly-owned subsidiary of The Prudential, in
connection with the Company's acquisition of Mt. McKinley in September 2000.
This agreement covers 80% or $160 million of the first $200 million of any
adverse loss reserve development on the carried reserves of Mt. McKinley at the
date of acquisition and reimburses the Company as such losses are paid by the
Company. There were $78.9 million of cessions under this reinsurance at December
31, 2002, reducing the limit available under the 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.
13
As of December 31, 2002, the Company carried as an asset $1,116.4 million in
reinsurance receivables with respect to losses ceded. Of this amount, $440.0
million, or 39.4%, was receivable from subsidiaries of London Reinsurance Group
("London Life"), $145.0 million, or 13.0%, was receivable from Continental
Insurance Company ("Continental") and $78.9 million, or 7.1% was receivable from
Prupac. No other retrocessionaire accounted for more than 5% of the Company's
receivables. See ITEM 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition".
The Company's arrangements with London Life and Continental are managed on a
funds held basis, which means that the Company has not released premium payments
to the retrocessionaire but rather retains such payments to secure obligations
of the retrocessionaire, records them as a liability, credits interest on the
balances and reduces the liability account as payments become due. As of
December 31, 2002, such funds had reduced the Company's net exposure to London
Life to $190.2 million, effectively 100% of which has been secured by letters of
credit, and its exposure to Continental to $60.9 million. Prupac's obligations
are guaranteed by The Prudential.
No assurance can be given that the Company will seek or be able to obtain
retrocessional coverage in the future similar to that in place currently or in
the past. The Company continuously evaluates its exposures and risk capacities
in the context of reinsurance market conditions, at both the specific and
corporate level. Although management carefully selects its reinsurers, the
Company is subject to credit risk with respect to its reinsurance because the
ceding of risk to reinsurers does not relieve the Company of its liability to
insureds or ceding companies.
MT. MCKINLEY INSURANCE COMPANY-ACQUISITION
The Company completed its acquisition of Gibraltar, subsequently renamed Mt.
McKinley, in September 2000. In connection with the acquisition, the seller
provided the reinsurance described above and the Company terminated certain
relationships between Mt. McKinley and its former parent, The Prudential, and
its affiliates. Mt. McKinley's ongoing operations relate to servicing claims
arising from (1) insurance written by Mt. McKinley or Everest Re prior to 1985,
(2) reinsurance of insurance business and certain Everest Re reinsurance
business written prior to 1991 which had previously been reinsured with third
parties and commuted with those third parties into Mt. McKinley and (3) exposure
to adverse loss reserve development on Everest Re's reserves as of June 30,
1995, which exposure was assumed by Mt. McKinley at the time of the Company's
initial public offering. Effective September 19, 2000, Mt. McKinley and Bermuda
Re 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.
CLAIMS
Reinsurance claims are managed by the Company's professional claims staff whose
responsibilities include reviewing initial loss reports and coverage issues,
monitoring claims handling activities of ceding companies, establishing and
adjusting proper case reserves and approving payment of claims. In addition to
claims assessment, processing and payment, the claims staff selectively conducts
comprehensive claim audits of both specific claims and overall claim procedures
at the offices of selected ceding companies. Insurance claims, except those
relating to Mt. McKinley's business, are generally handled by third party claims
services providers who have limited authority and are subject to oversight by
the Company's professional claims staff.
14
The Company intensively manages its asbestos and environmental ("A&E") exposures
through dedicated, centrally managed claim staffs for Mt. McKinley and Everest
Re. Both are staffed with experienced claim and legal professionals that
specialize in the handling of such exposures. These units actively manage each
individual insured and reinsured account, responding to claim developments with
evaluations of the involved exposures and adjustment of reserves as appropriate.
Specific or general claim developments that may have material implications for
the Company are regularly communicated to senior management, and as appropriate,
to actuarial, legal and financial areas. Meetings among these areas, claim
management and senior management are held at least quarterly to review the
Company's overall reserve positions and make changes, if appropriate. The
Company continually reviews its internal processing, communications and
analytics to determine whether it can enhance the management of it's A&E
exposures, in particular in the context of changes in the landscape of asbestos
claims and litigation.
RESERVES FOR UNPAID PROPERTY AND CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES
Significant periods of time may elapse between the occurrence of an insured
loss, the reporting of the loss to the insurer and the reinsurer and the payment
of that loss by the insurer and subsequent payments to the insurer by the
reinsurer. To recognize liabilities for unpaid losses and loss adjustment
expenses ("LAE"), insurers and reinsurers establish reserves, which are balance
sheet liabilities representing estimates of future amounts needed to pay
reported and unreported claims and related expenses on losses that have already
occurred. Actual losses and LAE paid may deviate, perhaps substantially, from
such reserves. To the extent reserves prove to be insufficient to cover actual
losses and LAE after taking into account available reinsurance coverage, the
Company would have to augment such reserves and incur a charge to earnings,
which could be material in the period such augmentation takes place. See ITEM 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Loss and LAE Reserves".
While the reserving process is difficult and subjective for insurance companies,
the inherent uncertainties of estimating such reserves are even greater for the
reinsurer, due primarily to the longer time between the date of an occurrence
and the reporting of any attendant claims to the reinsurer, the diversity of
development patterns among different types of reinsurance treaties or
facultative contracts, the necessary reliance on the ceding companies for
information regarding reported claims and differing reserving practices among
ceding companies. In addition, trends that have affected development of
liabilities in the past may not necessarily occur or affect liability
development to the same degree in the future. As a result, actual losses and LAE
may deviate, perhaps substantially, from estimates of reserves reflected in the
Company's consolidated financial statements.
Like many other property and casualty insurance and reinsurance companies, the
Company has experienced adverse loss development for prior accident years, which
has led to adjustments in losses and LAE reserves. The increase in net reserves
for prior accident years reduced net income for the periods in which the
adjustments were made. There can be no assurance that adverse development from
prior years will not continue in the future or that such adverse development
will not have a material adverse effect on net income.
CHANGES IN HISTORICAL RESERVES
The following table shows changes in historical loss reserves for the Company
for 1992 and subsequent years. The table is presented on a GAAP basis except
15
that the Company's loss reserves for its Canadian branch operations are
presented in Canadian dollars, the impact of which is not material. The top line
of each table shows the estimated reserves for unpaid losses and LAE recorded at
each year-end date. Each amount in the top line represents the estimated amount
of future payments for losses and LAE on claims occurring in that year and in
all prior years. The upper (paid) portion of the table presents the cumulative
amounts paid through each subsequent year on those claims for which reserves
were carried as of each specific year end. The lower (liability re-estimated)
portion shows the re-estimated amount of the previously recorded reserves based
on experience as of the end of each succeeding year. The reserve estimate
changes as more information becomes known about the actual claims for which the
initial reserves were carried. The cumulative redundancy/deficiency line
represents the cumulative change in estimates since the initial reserve was
established. It is equal to the latest liability re-estimated amount less the
initial reserve.
Each amount other than the original reserves in the top half of the table below
includes the effects of all changes in amounts for prior periods. For example,
if a loss settled in 1995 for $100,000 was first reserved in 1992 at $60,000 and
remained unchanged until settlement, the $40,000 deficiency (actual loss minus
original estimate) would be included in the cumulative redundancy (deficiency)
in each of the years in the period 1992 through 1994 shown below. Conditions and
trends that have affected development of liability in the past are not
indicative of future developments. Accordingly, it is not appropriate to
extrapolate future redundancies or deficiencies based on this table.
16
TEN YEAR GAAP LOSS DEVELOPMENT TABLE PRESENTED NET OF REINSURANCE
WITH SUPPLEMENTAL GROSS DATA (1) (2) (3)
Years Ended December 31,
------------------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in millions)
Reserves for unpaid
loss and LAE $1,854.7 $1,934.2 $2,104.2 $2,316.1 $2,551.6 $2,810.0 $2,953.5 $2,977.4 $3,364.9 $3,472.5 $3,895.8
Paid (cumulative)
as of:
One year later 461.5 403.5 359.5 270.4 331.2 450.8 484.3 673.4 718.1 892.7
Two years later 740.1 627.7 638.0 502.8 619.2 747.9 955.3 1,159.1 1,264.2
Three years later 897.0 820.5 828.0 682.0 813.7 1,101.5 1,295.5 1,548.3
Four years later 1,036.0 953.0 983.6 806.3 1,055.9 1,363.1 1,575.9
Five years later 1,141.0 1,071.5 1,143.4 990.9 1,253.0 1,592.5
Six years later 1,232.7 1,202.2 1,294.8 1,131.5 1,450.2
Seven years later 1,334.8 1,324.0 1,412.2 1,300.0
Eight years later 1,433.3 1,421.1 1,538.6
Nine years later 1,512.3 1,528.2
Ten years later 1,603.7
Liability
re-estimated as of:
One year later 1,929.2 2,008.5 2,120.8 2,286.5 2,548.4 2,836.2 2,918.1 2,985.2 3,364.9 3,612.6
Two years later 1,988.9 2,015.4 2,233.7 2,264.5 2,575.9 2,802.2 2,921.6 2,977.2 3,484.6
Three years later 2,010.0 2,119.0 2,271.2 2,285.1 2,546.0 2,794.7 2,910.3 3,070.5
Four years later 2,111.9 2,164.5 2,452.3 2,260.7 2,528.0 2,773.5 2,924.5
Five years later 2,155.3 2,344.9 2,381.7 2,254.5 2,515.7 2,765.2
Six years later 2,332.3 2,278.3 2,382.0 2,247.3 2,507.9
Seven years later 2,269.9 2,279.1 2,380.8 2,243.9
Eight years later 2,273.0 2,277.3 2,367.3
Nine years later 2,268.3 2,265.6
Ten years later 2,252.8
Cumulative
(deficiency)/
redundancy $ (398.1) $ (331.4) $ (263.1) $ 72.2 $ 43.7 $ 44.8 $ 29.0 $ (93.1) $ (119.7) $ (140.1)
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Gross
liability-end
of year $2,476.7 $2,576.0 $2,752.7 $3,017.0 $ 3,298.2 $3,498.7 $3,869.2 $3,705.2 $3,853.7 $4,356.0 $4,985.8
Reinsurance
receivable 622.0 641.8 648.5 700.9 746.6 688.7 915.7 727.8 488.8 883.5 1,090.0
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net liability-end
of year 1,854.7 1,934.2 2,104.2 2,316.1 2,551.6 2,810.0 2,953.5 2,977.4 3,364.9 3,472.5 $3,895.8
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- ========
Gross re-estimated
liability at
December 31, 2002 3,434.2 3,371.9 3,396.4 3,492.4 3,618.6 3,744.1 3,870.8 4,045.3 4,334.2 4,727.7
Re-estimated
receivable at
December 31, 2002 1,181.4 1,106.3 1,029.1 1,248.5 1,110.7 978.9 946.4 974.9 849.6 1,115.1
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net re-estimated
liability at
December 31, 2002 2,252.8 2,265.6 2,367.3 2,243.9 2,507.9 2,765.2 2,924.5 3,070.5 3,484.6 3,612.6
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Gross cumulative
(deficiency)/
redundancy $ (957.5) $ (795.9) $ (643.7) $(475.4) $ (320.4) $ (245.4) $ (1.6) $ (340.1) $ (480.5) $ (371.7)
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
- ----------
(1) Includes $480.9 million relating to Mt. McKinley at December 31, 2000,
principally reflecting $491.1 million of Mt. McKinley reserves at the
acquisition date.
(2) The Canadian Branch reserves are reflected in Canadian dollars.
(3) Some totals may not reconcile due to rounding.
17
For years prior to 1992, management believes that two factors had the most
significant impact on loss development. First, through the mid-1980s, a number
of industry and external factors, such as the propensity of courts to award
large damage awards in liability cases, combined to increase loss frequency and
severity to unexpectedly high levels. Second, contracts written prior to 1986
contained coverage terms which, for the Company and the industry in general,
have been interpreted by courts to provide coverage for asbestos and
environmental exposures not contemplated by either the pricing or the initial
reserving of the contracts. Legal developments during the mid-1980s necessitated
additional reserving for such exposures on both a case basis and an incurred but
not reported ("IBNR") basis. More recently, particularly as reflected for
periods subsequent to 1998, the Company has experienced unforeseen adverse
shifts in loss emergence patterns, particularly in classes of business where the
underlying exposures have been impacted by unfavorable trends in litigation and
economic variability. The change between 1994 and 1995 reflects the impact of a
stop loss reinsurance agreement with Mt. McKinley, which was then a subsidiary
of The Prudential. This stop loss agreement commenced in 1995 when The
Prudential sold the Company in an initial public offering. This coverage became
an inter-affiliate reinsurance transaction with the acquisition of Mt. McKinley
in 2000. See Footnote 1L to Notes to Consolidated Financial Statements.
Management believes that adequate provision has been made for the Company's loss
and LAE reserves. While there can be no assurance that reserves for and losses
from these claims will not increase in the future, management believes that the
Company's existing reserves, reserving methodologies and retrocessional
arrangements lessen the probability that any such increases would have a
material adverse effect on the Company's financial condition, results of
operations or cash flows. These statements regarding the Company's loss reserves
are forward looking statements within the meaning of the U.S. federal securities
laws and are intended to be covered by the safe harbor provisions contained
therein. See ITEM 7 "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Safe Harbor Disclosure."
The following table is derived from the Ten Year GAAP Loss Development Table
above and summarizes the effect of reserve re-estimates, net of reinsurance, on
calendar year operations for the same ten-year period ended December 31, 2002.
Each column represents the amount of reserve re-estimates made in the indicated
calendar year and shows the accident years to which the re-estimates are
applicable. The amounts in the total accident year column on the far right
represent the cumulative reserve re-estimates for the indicated accident years.
EFFECT OF RESERVE REESTIMATES ON CALENDAR YEAR OPERATIONS (1)
Cumulative Re-
Calendar Year Ended December 31, estimates for
--------------------------------------------------------------------------------------------- each Accident
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Year
------- ------ ------ ------- ------ ------- ------ ------ ------ ------- -------------
(Dollars in millions)
Accident
Years
1992 & prior $ (74.5) $(59.7) $(21.1) $(101.9) $(43.4) $(176.9) $ 62.4 $ (3.1) $ 4.7 $ 15.6 $(398.1)
1993 (14.5) 14.2 (1.7) (2.1) (3.5) 4.2 2.3 (2.8) (4.0) (7.9)
1994 (9.8) (9.3) 8.0 (0.7) 4.1 0.4 (0.6) 1.9 (6.0)
1995 142.4 59.6 160.4 (46.2) 6.5 6.1 (10.2) 318.7
1996 (18.9) (6.8) 5.5 11.8 5.0 4.5 1.1
1997 1.3 4.1 (10.4) 8.9 0.4 4.3
1998 1.4 (11.0) (9.8) (22.5) (41.9)
1999 (4.3) (3.3) (79.1) (86.7)
2000 (7.9) (26.4) (34.4)
2001 (20.4) (20.4)
Total calendar
year effect $ (74.5) $(74.3) $(16.7) $ 29.6 $ 3.2 $ (26.2) $ 35.4 $ (7.8) $ 0.0 $(140.1) $(271.4)
(1) Some totals may not reconcile due to rounding.
18
As illustrated by this table, the factors that caused the deficiencies shown in
the Ten Year GAAP Loss Development Table relate mainly to accident years prior
to 1992 principally reflecting the impact of asbestos and environmental
exposures discussed above. The significant favorable development experienced for
the 1995 accident year is due to aggregate excess of loss reinsurance provided
to the Company at the time of its initial public offering. This contract,
because of its 1995 inception date, is attributed to the 1995 accident year. The
adverse development experienced in the 1998 through 2001 accident years relates
principally to a limited number of business classes, mainly casualty classes,
including D&O, surety and certain international business where adverse loss
experience has emerged as the result of unforeseen loss trend shifts affecting
the underlying exposures. The Company's loss reserving methodologies
continuously monitor the emergence of such loss trend shifts, seeking both to
adjust reserves for their impact and to factor such developments into its
underwriting and pricing on a prospective basis.
The following table presents a reconciliation of beginning and ending reserve
balances for the years indicated on a GAAP basis:
RECONCILIATION OF RESERVES FOR LOSSES AND LAE
Years Ended December 31,
-------------------------------------
2002 2001 2000
--------- --------- ---------
(Dollars in millions)
Reserves at beginning of period $ 4,278.3 $ 3,786.2 $ 3,647.0
--------- --------- ---------
Incurred related to:
Current year 1,489.3 1,209.5 876.8
Prior years 140.1 - 7.8
--------- --------- ---------
Total incurred losses 1,629.4 1,209.5 884.6
--------- --------- ---------
Paid related to:
Current year (1) 314.5 393.9 (166.9)
Prior years 892.7 718.1 673.4
--------- --------- ---------
Total paid losses 1,207.2 1,112.0 506.5
--------- --------- ---------
Change in reinsurance receivables on
unpaid losses and LAE 205.1 394.6 (238.9)
--------- --------- ---------
Reserves at end of period $ 4,905.6 $ 4,278.3 $ 3,786.2
========= ========= =========
(1) Current year paid losses for 2000 are net of ($483.8) million resulting
from the acquisition of Mt. McKinley.
Prior year incurred losses increased by $140.1 million in 2002 and were stable
in 2001. These changes were the result of the reserve development noted above,
as well as inherent uncertainty in establishing loss and LAE reserves. See also
Note 1L of Notes to Consolidated Financial Statements.
19
RESERVES FOR ASBESTOS AND ENVIRONMENTAL LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company's reserves include an estimate of the Company's ultimate liability
for A&E claims for which ultimate value cannot be estimated using traditional
reserving techniques. There are significant uncertainties in estimating the
amount of the Company's potential losses from A&E claims. See ITEM 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Asbestos and Environmental Exposures" and Note 3 of Notes to
Consolidated Financial Statements.
Mt. McKinley's book of direct A&E exposed insurance is relatively small and
homogenous. The book of business is based principally on excess liability
policies; thus the claim/legal staff does not have to analyze exposure under
many different policy forms, but rather can focus on a limited number of
policies and policy forms. As a result of this focused structure, the Company
believes that it is able to comprehensively analyze its exposures, allowing it
to identify and analyze those claims on which it has unusual exposure, such as
policies in which it may be exposed to pay expenses in addition to policy limits
or non-products asbestos claims, for concentrated ongoing attention.
The Company aims to be actively engaged with every insured account posing
significant potential asbestos exposure to Mt. McKinley. Such engagement can
take the form of a final settlement, negotiation, litigation, or the monitoring
of claim activity under Coverage in Place ("CIP") agreements. CIP agreements
generally condition an insurer's payment upon the actual claim experience of the
insured and may have annual payment caps or other measures to control the
insurer's payments. The Company's Mt. McKinley operations are currently managing
five CIP agreements, all of which were executed prior to the acquisition of Mt.
McKinley in 2000. Its preference with respect to coverage settlements is to
execute settlements that call for a fixed schedule of payments, because such
settlements eliminate future uncertainty.
During 2002, the Company significantly enhanced its classification of insureds
by exposure characteristics, as well as its analysis by insured for those it
considers to be more exposed or active. Those insureds identified as relatively
less exposed or active are subject to less rigorous, but still active
management, with an emphasis on monitoring those characteristics which may
indicate an increasing exposure or levels of activity. The Company continually
focuses on further enhancement of the detailed estimation processes used to
evaluate potential exposure of policyholders, including those that may not have
reported significant A&E losses.
Everest Re's book of assumed reinsurance is relatively concentrated within a
modest number of A&E exposed relationships. Because the book of business is
relatively concentrated and the Company has been managing the A&E exposures for
many years, its claim staff is familiar with the ceding companies that have
generated most of these liabilities in the past and which are therefore most
likely to generate future liabilities. The Company's claim staff has developed
familiarity both with the nature of the business written by its ceding companies
and the claims handling and reserving practices of those companies. This level
of familiarity enhances the quality of the Company's analysis of its exposure
through those companies. As a result, the Company believes that it can identify
those claims on which it has unusual exposure, such as non-products asbestos
claims, for concentrated attention.
20
The following table summarizes the composition of the Company's total reserves
for A&E losses, gross and net of reinsurance, for the years ended December 31,
2002, 2001 and 2000.
YEARS ENDED DECEMBER 31,
-----------------------------------
2002 2001 2000 (1)
------- ------- -------
(Dollars in millions)
Case reserves reported by ceding companies $ 112.5 $ 107.1 $ 106.8
Additional reserves established by the Company
(assumed reinsurance) 55.5 59.5 74.0
Case reserves established by the Company 262.1 154.1 118.3
IBNR reserves 237.8 323.7 394.6
------- ------- -------
Gross reserves 667.9 644.4 693.7
Reinsurance receivable (140.4) (75.8) (65.2)
------- ------- -------
Net reserves $ 527.5 $ 568.6 $ 628.5
======= ======= =======
- ------------------
(1) In 2000, Holdings acquired Mt. McKinley, resulting in an increase to the
Company's gross and net asbestos and environmental exposure.
Additional losses, including those relating to currently unrecognized latent
injuries, the type or magnitude of which cannot be foreseen by the Company, or
the reinsurance and insurance industry generally, may emerge in the future. Such
future emergence, to the extent not covered by existing retrocessional
contracts, could have material adverse effects on the Company's future financial
condition, results of operations and cash flows.
FUTURE POLICY BENEFIT RESERVES
Future policy benefit liabilities for annuities are reported at the accumulated
fund balance of these contracts. Reserves for those liabilities include both
mortality and morbidity provisions with respect to life and annuity claims, both
reported and unreported. Actual experience in a particular period may be worse
than assumed experience and, consequently, may adversely affect the Company's
operating results for the period. See Note 1F of Notes to Consolidated Financial
Statements.
INVESTMENTS
The Company's overall financial strength and results of operations are, in part,
dependent on the quality and performance of its investment portfolio. Net
21
investment income and net realized capital gains (losses) on the Company's
invested assets constituted 11.8%, 17.7%, and 20.4% of the Company's revenues
for the years ending December 31, 2002, 2001 and 2000, respectively. The
Company's cash and invested assets totaled $7,259.1 million at December 31,
2002, of which 94.5% were cash or investment-grade fixed maturities.
The Company's current investment strategy seeks to maximize after-tax income,
through a high quality, diversified, taxable bond 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 the Company's current and projected operating
results, market conditions and tax position. Additionally, the Company invests
in equity securities, which it believes will enhance the risk-adjusted total
return of the investment portfolio.
The board of directors of each company is responsible for establishing
investment policy and guidelines and, together with senior management, for
overseeing their execution. The Company's investment portfolio is in compliance
with the insurance laws of the jurisdictions in which its subsidiaries are
regulated. An independent investment advisor is utilized to manage the Company's
investment portfolio within the established guidelines and is required to report
activities on a current basis and to meet with the Company periodically to
review and discuss the portfolio structure, securities selection and performance
results.
The Company's investment guidelines include a current duration guideline of five
to six years. The duration of an investment is based on the maturity of the
security but also reflects the payment of interest and the possibility of early
prepayment of such security. This investment duration guideline is established
and periodically revised by management, which considers economic and business
factors. An important factor considered by management is the Company's average
duration of potential liabilities, which, at December 31, 2002, is estimated at
approximately five years based on the estimated payouts of underwriting
liabilities using standard duration calculations.
Approximately 7.6% of the Company's consolidated reserves for losses and LAE and
unearned premiums represent estimated amounts payable in foreign currencies. For
each currency in which the Company has established substantial reserves, the
Company seeks to maintain invested assets denominated in such currency in an
amount approximately comparable to the estimated liabilities.
As of December 31, 2002, 98.6% of the Company's total investments and cash were
comprised of fixed maturity investments or cash and 94.5% of the Company's fixed
maturities consisted of investment grade securities. The average maturity of
fixed maturities was 8.1 years at December 31, 2002, and their overall duration
was 5.4 years. As of December 31, 2002, the Company did not have any investments
in commercial real estate or direct commercial mortgages or any material
holdings of derivative investments or securities of issuers that are
experiencing cash flow difficulty to an extent that the Company's management
believes could threaten the issuer's ability to meet debt service payments,
except where other than temporary impairments have been recognized.
As of December 31, 2002, the Company's common stock portfolio had a market value
of $47.5 million, comprising 0.7% of total investments and cash. The common
stock portfolio is managed with a growth orientation.
22
The following table reflects investment results for the Company for each of the
five years in the period ended December 31, 2002:
Pre-Tax
Pre-Tax Realized Net
Average Investment Effective Capital (Losses)
Years Ended December 31, Investments(1) Income(2) Yield Gains
- ------------------------ -------------- ------------ --------- ---------------
(Dollars in millions)
2002 $ 6,064.8 $ 350.6 5.78% $ (50.0)
2001 5,374.9 340.4 6.33 (22.3)
2000 4,824.0 301.5 6.25 0.8
1999 4,219.4 253.0 6.00 (16.8)
1998 4,243.3 244.9 5.77 (0.8)
- -----------------
(1) Average of the beginning and ending carrying values of investments and
cash, less net funds held and non-interest bearing cash. Bonds, common
stock and redeemable and non-redeemable preferred stocks are carried at
market value.
(2) After investment expenses, excluding realized net capital gains (losses).
The following table summarizes fixed maturities as of December 31, 2002 and
2001:
Amortized Unrealized Unrealized Market
Cost Appreciation Depreciation Value
--------- ------------ ------------ ---------
(Dollars in millions)
December 31, 2002:
U.S. Treasury securities and obligations of U.S.
government agencies and corporations $ 506.6 $ 10.1 $ 0.5 $ 516.2
Obligations of states and political subdivisions 2,520.6 144.6 2.6 2,662.6
Corporate securities 2,066.0 119.2 31.7 2,153.5
Mortgage-backed securities 839.5 43.0 1.1 881.4
Foreign government securities 312.7 25.2 - 337.9
Foreign corporate securities 215.4 14.3 1.4 228.3
--------- ------------ ------------ ---------
Total $ 6,460.8 $ 356.4 $ 37.3 $ 6,779.9
========= ============ ============ =========
December 31, 2001:
U.S. Treasury securities and obligations of U.S.
government agencies and corporations $ 114.8 $ 5.2 $ 0.1 $ 119.9
Obligations of states and political subdivisions 1,762.9 78.4 2.8 1,838.5
Corporate securities 2,254.7 77.6 39.5 2,292.8
Mortgage-backed securities 701.2 28.3 0.8 728.7
Foreign government securities 194.9 18.1 0.1 212.9
Foreign corporate securities 260.4 10.2 1.8 268.8
--------- ------------ ------------ ---------
Total $ 5,288.9 $ 217.8 $ 45.1 $ 5,461.6
========= ============ ============ =========
23
The following table presents the credit quality distribution of the Company's
fixed maturities as of December 31, 2002:
Percent of
Rating Agency Credit Quality Distribution Amount Total
- ----------------------------------------- --------- ----------
(Dollars in millions)
AAA/AA/A $ 5,612.5 82.8%
BBB 797.0 11.8
BB 306.2 4.5
B 56.9 0.8
CCC/CC/C 2.4 0.0
CI/D 4.9 0.1
--------- ----------
Total $ 6,779.9 100.0%
========= ==========
The following table summarizes fixed maturities by contractual maturity as of
December 31, 2002:
Percent of
Amount Total
--------- ----------
(Dollars in millions)
Maturity category:
Less than one year $ 75.8 1.1%
1-5 years 1,628.6 24.0
5-10 years 1,519.7 22.4
After 10 years 2,674.4 39.4
--------- ----------
Subtotal (2) 5,898.5 87.0
Mortgage-backed securities (1) 881.4 13.0
--------- ----------
Total (2) $ 6,779.9 100.0%
========= ==========
- -----------
(1) Mortgage-backed securities generally are more likely to be prepaid than
other fixed maturities. Therefore, contractual maturities are excluded from
this table since they may not be indicative of actual maturities.
(2) Certain totals may not reconcile due to rounding.
24
RATINGS
The following table shows the financial strength ratings of the Company's
operating subsidiaries as reported by A.M. Best, Standard & Poor's Rating
Services ("Standard & Poor's") and Moody's Investor 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.
Operating Subsidiary A.M. Best Standard & Poor's Moody's
- --------------------------------------------------------------------------------------
Everest Re A+ (Superior) AA- (Positive) Aa3 (Excellent)
Bermuda 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
Everest International 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).
25
The following table shows the investment grade ratings of the Holdings' senior
notes due March 15, 2005, Holdings' senior notes due March 15, 2010 and Capital
Trust's trust preferred securities 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
"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.
26
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 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.
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, A.M. Best's 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, Bermuda 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 536 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.
27
REGULATORY MATTERS
The Company and its insurance subsidiaries are subject to regulation under the
insurance statutes of the various jurisdictions in which they conduct business,
including essentially all states of the United States, Canada, Singapore, the
United Kingdom and Bermuda. These regulations vary from jurisdiction to
jurisdiction and are generally designed to protect ceding insurance companies
and policyholders by regulating the Company's conduct of business, financial
integrity and ability to meet its obligations relating to its business
transactions and operations. Many of these regulations require reporting of
information designed to allow insurance regulators to closely monitor the
Company's performance.
INSURANCE HOLDING COMPANY REGULATION. Under applicable United States laws and
regulations, no person, corporation or other entity may acquire a controlling
interest in the Company, unless such person, corporation or entity has obtained
the prior approval for such acquisition from the Insurance Commissioners of
Delaware and the other states in which the Company's insurance subsidiaries are
domiciled or deemed domiciled, currently Arizona, California and Georgia. Under
these laws, "control" is presumed when any person acquires, directly or
indirectly, 10% or more of the voting securities of an insurance company. To
obtain the approval of any change in control, the proposed acquirer must file an
application with the relevant insurance commissioner disclosing, among other
things, the background of the acquirer and that of its directors and officers,
the acquirer's financial condition and its proposed changes in the management
and operations of the insurance company. U.S. state regulators also require
prior notice or regulatory approval of material inter-affiliate transactions
within the holding company structure. See "Dividends".
The Insurance Companies Act of Canada also requires prior approval by the
Minister of Finance of anyone acquiring a significant interest in an authorized
Canadian insurance company. In addition, the Company is subject to regulation by
the insurance regulators of other states and foreign jurisdictions in which it
does business. Certain of these states and foreign jurisdictions impose
regulations regulating the ability of any person to acquire control of an
insurance company authorized to do business in that jurisdiction without
appropriate regulatory approval similar to those described above.
DIVIDENDS. Under Bermuda law, Group is prohibited from declaring or paying a
dividend if such payment would reduce the realizable value of its assets to an
amount less than the aggregate value of its liabilities and its issued share
capital and share premium (additional paid-in capital) accounts. Group's ability
to pay dividends and its operating expenses is partially dependent upon
dividends from its subsidiaries. The payment of dividends by insurance
subsidiaries is limited under Bermuda law as well as the laws of the various
U.S. states in which Group's insurance and reinsurance subsidiaries are licensed
to transact business. The limitations are generally based upon net income and
compliance with applicable policyholders' surplus or minimum solvency margin and
liquidity ratio requirements as determined in accordance with the relevant
statutory accounting practices. As Holdings has outstanding debt obligations, it
is dependent upon dividends and other permissible payments from its operating
subsidiaries to enable it to meet its debt and operating expense obligations and
to pay dividends to Group.
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
28
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.
Under Bermuda law, Bermuda Re is unable to declare or make payment of a dividend
if it fails to meet its minimum solvency margin or minimum liquidity ratio. As a
long-term insurer, Bermuda Re is also unable to declare or pay a dividend to
anyone who is not a policyholder unless, after payment of the dividend, the
value of the assets in its long-term business fund, as certified by its approved
actuary, exceeds its liabilities for long-term business by at least the $250,000
minimum solvency margin. Prior approval of the Bermuda Monetary Authority is
required if Bermuda Re's dividend payments would reduce its prior year-end total
statutory capital by 15.0% or more. At December 31, 2002, Bermuda Re met its
solvency and liquidity requirements by a significant margin.
INSURANCE REGULATION. U.S. domestic property and casualty insurers, including
reinsurers, are subject to regulation by their state of domicile and by those
states in which they are licensed. The regulation of reinsurers is typically
related to the reinsurer's financial condition, investments, management and
operation. The rates and policy terms of reinsurance agreements are generally
not subject to direct regulation by any governmental authority.
The operations of Everest Re's foreign branch offices in Canada, Singapore and
the United Kingdom are subject to regulation by the insurance regulatory
officials of those jurisdictions. Management believes that the Company is in
material compliance with applicable laws and regulations pertaining to its
business and operations.
Bermuda Re is not admitted to do business as an insurer in any jurisdiction in
the U.S. Bermuda Re conducts its insurance business from its offices in Bermuda.
In Bermuda, Bermuda Re is regulated by the Insurance Act 1978 (as amended) and
related regulations (the "Act"). The Act establishes solvency and liquidity
standards, auditing and reporting requirements and subjects Bermuda Re to the
supervision, investigation and intervention powers of the Bermuda Monetary
Authority. Under the Act, Bermuda Re, as a Class 4 insurer, is required to
maintain $100 million in statutory capital and surplus, to have an independent
auditor approved by the Bermuda Monetary Authority conduct an annual audit and
report on its statutory financial statements and filings and to have an
appointed loss reserve specialist (also approved by the Bermuda Monetary
Authority) review and report on its loss reserves annually.
Bermuda Re is also registered under the Act as a long-term insurer and is
thereby authorized to write life and annuity business. As a long-term insurer,
Bermuda Re is required to maintain a long-term business fund, to separately
account for this business and to have an approved actuary prepare a certificate
concerning its long-term business assets and liabilities to be filed annually.
Everest Indemnity, Everest National, Everest Security and Mt. McKinley are
subject to regulations similar to the U.S. regulations applicable to Everest Re.
In addition, Everest National and Everest Security must comply with substantial
regulatory requirements in each state where they conduct business. These
additional requirements include, but are not limited to, rate and policy form
requirements, requirements with regard to licensing, agent appointments,
participation in residual markets and claim handling procedures. These
regulations are primarily designed for the protection of policyholders.
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LICENSES. Everest Re is a licensed property and casualty insurer and/or
reinsurer in all states (except Nevada and Wyoming), the District of Columbia
and Puerto Rico. In New Hampshire and Puerto Rico, Everest Re is licensed for
reinsurance only. Such licensing enables U.S. domestic ceding company clients to
take credit for reinsurance ceded to Everest Re.
Everest Re is licensed as a property and casualty reinsurer in Canada. It is
also authorized to conduct reinsurance business in the United Kingdom and
Singapore. Everest Re can also write reinsurance in other foreign countries.
Because some jurisdictions require a reinsurer to register in order to be an
acceptable market for local insurers, Everest Re is registered as a foreign
insurer and/or reinsurer in the following countries: Argentina, Bolivia, Chile,
Colombia, Ecuador, El Salvador, Guatemala, Mexico, Peru, Venezuela and the
Philippines. Everest National is licensed in 45 states and the District of
Columbia. Everest Indemnity is licensed in Delaware and is eligible to write
insurance on a surplus lines basis in 48 states, the District of Columbia and
Puerto Rico. Everest Security is licensed in Georgia and Alabama. Mt. McKinley
is licensed in Delaware and California. Bermuda Re is registered as a Class 4
insurer and a long-term insurer in Bermuda.
PERIODIC EXAMINATIONS. Everest Re, Everest National, Everest Indemnity, Everest
Security and Mt. McKinley are subject to periodic financial examination (usually
every 3 years) of their affairs by the insurance departments of the states in
which they are licensed, authorized or accredited. Everest Re's, Everest
Security's, Everest Indemnity's and Mt. McKinley's last examination reports were
as of December 31, 2000, while Everest National's last examination was as of
December 31, 2001. None of these reports contained any material findings or