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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2002 Commission File Number 1-15259
PXRE GROUP LTD.
(Exact name of registrant as specified in its charter)
Bermuda 98-0214719
(State of other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
Swan Building P.O. Box HM 1282
26 Victoria Street Hamilton HM FX
Hamilton HM 12 Bermuda
Bermuda
(Address, including zip code, of (Mailing address)
principal executive offices)
(441) 296-5858
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: COMMON SHARES, par
value $1.00 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, 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. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
--- ---
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of March 14, 2003 computed by reference to
the closing price of such common equity as of the close of business on March 14,
2003 was $243,087,319. As of March 14, 2003, 12,184,828 of the registrant's
common shares were issued and outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Part III Portions of PXRE Group Ltd.'s definitive Proxy Statement for the
Annual General Meeting of Shareholders to be held on May 28, 2003.
2
PART I
Unless the context otherwise requires, references in this Form 10-K to
"PXRE", "we", the "Company", "us" and "our" include PXRE Group Ltd., a Bermuda
company (the "Company") and its subsidiaries, which principally include PXRE
Reinsurance Company ("PXRE Reinsurance"), PXRE Corporation ("PXRE Delaware"),
PXRE Reinsurance Ltd. ("PXRE Bermuda"), PXRE Reinsurance (Barbados) Ltd. ("PXRE
Barbados"), PXRE Solutions Inc. ("PXRE Solutions") and PXRE Solutions, S.A.
("PXRE Europe"). References to GAAP refer to accounting principles generally
accepted in the United States ("GAAP"). References to SAP refer to statutory
accounting principles ("SAP") in either the State of Connecticut where PXRE
Reinsurance is domiciled or Bermuda where PXRE Bermuda is domiciled.
Cautionary Statement Regarding Forward-Looking Statements
This report contains various forward-looking statements and includes
assumptions concerning our operations, future results and prospects. Statements
included herein, as well as statements made by or on our behalf in press
releases, written statements or other documents filed with the Securities and
Exchange Commission (the "SEC"), or in our communications and discussions with
investors and analysts in the normal course of business through meetings, phone
calls and conference calls, which are not historical in nature are intended to
be, and are hereby identified as, "forward-looking statements" for purposes of
the safe harbor provided by Section 21E of the Securities Exchange Act of 1934
as amended. These forward-looking statements, identified by words such as
"intend," "believe," "anticipate," or "expects" or variations of such words or
similar expressions are based on current expectations and are subject to risk
and uncertainties. In light of the risks and uncertainties inherent in all
future projections, the inclusion of forward-looking statements in this report
should not be considered as a representation by us or any other person that our
objectives or plans will be achieved. We caution investors and analysts that
actual results or events could differ materially from those set forth or implied
by the forward-looking statements and related assumptions, depending on the
outcome of certain important factors including, but not limited to, the
following:
(i) significant catastrophe losses or losses under other
coverages, the timing and extent of which are difficult to
predict;
(ii) changes in the level of competition in the reinsurance or
primary insurance markets that impact the volume or
profitability of business (these changes include, but are not
limited to, the intensification of price competition, the
entry of new competitors, existing competitors exiting the
market and competitors' development of new products);
(iii) the lowering or loss of one of the financial or claims paying
ratings of ours or one or more of our subsidiaries;
(iv) changes in the demand for reinsurance, including changes in
the amount of risk that our clients elect to maintain for
their own account;
(v) risks associated with the termination and run-off of our
diversification initiatives;
(vi) adverse development on loss reserves related to business
written in current and prior years;
3
(vii) lower than estimated retrocessional recoveries on unpaid
losses, including the effects of losses due to a decline in
the creditworthiness of our retrocessionaires;
(viii) increases in interest rates, which cause a reduction in the
market value of our interest rate sensitive investments,
including our fixed income investment portfolio, and potential
underperformance in our finite coverages;
(ix) decreases in interest rates causing a reduction of income
earned on net cash flow from operations and the reinvestment
of the proceeds from sales, calls or maturities of existing
investments and shortfalls in cash flows necessary to pay
fixed rate amounts due to finite contract counterparties;
(x) market fluctuations in equity securities and with respect to
our portfolio of hedge funds and other privately held
securities: leverage, concentration of investments, lack of
liquidity, market fluctuations and direction (including as a
result of interest rate fluctuations and direction, with
respect to price levels and volatility thereof), currency
fluctuations, credit risk, yield curve risk, spread risk
between two or more similar securities, political risk,
counterparty risk and risks relating to settlements on foreign
exchanges;
(xi) foreign currency fluctuations resulting in exchange gains or
losses;
(xii) a contention by the United States Internal Revenue Service
that the Company or our offshore subsidiaries are subject to
U.S. taxation; and
(xiii) changes in tax laws, tax treaties, tax rules and
interpretations.
In addition to the factors outlined above that are directly related to
our business, we are also subject to general business risks, including, but not
limited to, adverse state, federal or foreign legislation and regulation,
adverse publicity or news coverage, changes in general economic factors and the
loss of key employees. The factors listed above should not be construed as
exhaustive. See "Certain Risks and Uncertainties" on page 43 of this report.
We undertake no obligation to release publicly the results of any
future revisions we may make to forward looking statements to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Item 1. Business
Overview of the Business
We provide reinsurance products and services to a worldwide marketplace
through subsidiary operations in the United States, Europe, Bermuda and
Barbados. Our primary focus is providing property catastrophe reinsurance and
retrocessional coverage to a worldwide group of clients, where we have been
among the leading franchises for two decades. Property catastrophe reinsurance
generally covers claims arising from large catastrophes such as hurricanes,
windstorms, hailstorms, earthquakes, volcanic eruptions, fires, industrial
explosions, freezes, riots, floods and other man-made or natural disasters.
Substantially all of our non-finite reinsurance products have been, and will
continue to be, offered on an excess-of-loss basis with aggregate limits on our
exposure to losses. This means that we do not begin to pay our clients' claims
until their claims exceed a certain specified amount and our obligation to pay
those claims is limited to a specified aggregate amount.
4
We also offer our clients property-per-risk, marine and aviation
reinsurance and retrocessional products. Unlike property catastrophe
reinsurance, which protects against the accumulation of a large number of
related losses arising out of one catastrophe, per-risk excess of loss
reinsurance protects our clients against a large loss arising from a single risk
or location. Substantially all of our property-per-risk and marine and aviation
business is also written on an excess-of-loss basis with aggregate limits on our
exposure to losses.
We also provide our clients with finite reinsurance products. Finite
reinsurance contracts are highly customized for each transaction. If the loss
experience with respect to the risks assumed by us is as expected or better than
expected, our finite clients may share in the profitability of the underlying
business through premium adjustments or profit commissions. If the loss
experience is worse than expected, our finite clients may participate in this
negative outcome to a certain extent. In addition, we offer finite reinsurance
products where investment returns on the funds transferred to us affect the
profitability of the contract and the magnitude of any premium or commission
adjustments.
As of December 31, 2002, we had approximately 300 clients, including
many of the leading insurance and reinsurance companies in the world. Our
clients include both primary insurance companies and other reinsurance
companies. Approximately 70% of our clients in 2002 were based outside of the
United States.
The global reinsurance market has historically been highly cyclical. In
the wake of the events of September 11, 2001, which have resulted in industry
losses estimated as high as $45 to $75 billion, reinsurance markets across the
world have hardened significantly. These developments follow on significant
pricing increases in 2000 and 2001 across sectors and geographic regions. These
market changes have dramatically impacted the specialized short tail,
high-severity sectors of the market, which represent our focus areas and in
which we are a significant and established provider.
Following a diversification effort into Lloyd's and the casualty
sectors during the soft reinsurance market of the late 1990's, we decided during
2000 and 2001 to exit these businesses, and are today focused on our traditional
core property reinsurance operations. While our core businesses are volatile due
to significant potential loss severity, we have been a successful underwriting
organization over the long term. This proven expertise in some of the most
dynamic areas of the reinsurance sector represents an opportunity to achieve
particularly strong financial results in the current favorable phase of the
underwriting cycle.
We conduct our business primarily through our principal operating
subsidiaries, PXRE Reinsurance, PXRE Bermuda, PXRE Solutions, PXRE Europe and
PXRE Barbados. PXRE Reinsurance is a broker-market reinsurer with approximately
$457.2 million of statutory capital and surplus as of December 31, 2002, which
principally underwrites treaty reinsurance for property (including marine and
aerospace) risks. PXRE Reinsurance is licensed, accredited or permitted to do
business in all states and the District of Columbia, Puerto Rico, Bermuda,
Colombia and Mexico and until December 31, 2002 operated a branch in Belgium
("PXRE's Brussels Branch").
5
PXRE Bermuda is a broker-market reinsurer with approximately $74.5
million of statutory capital and surplus as of December 31, 2002, which
principally underwrites treaty reinsurance for property (including marine and
aerospace) risks. PXRE Bermuda's reinsurance business is also supported by a
parental guarantee from the Company and an aggregate excess of loss reinsurance
treaty from PXRE Reinsurance that provides $80 million of reinsurance
protection. PXRE Bermuda is neither licensed nor admitted as an insurer in any
jurisdiction other than Bermuda.
PXRE Barbados was licensed as an insurance company in March 2001 under
Barbados' Insurance Act, 1996 and changed its name from PXRE (Barbados) Ltd. to
PXRE Reinsurance (Barbados) Ltd. It is neither licensed nor admitted as an
insurer in any jurisdiction other than Barbados. PXRE Barbados commenced
underwriting business in 2001. PXRE Barbados provides finite reinsurance
coverages to clients and provides reinsurance coverage to other PXRE entities.
PXRE Europe, a Belgian reinsurance intermediary, and PXRE Solutions, a
U.S. reinsurance intermediary, perform reinsurance intermediary activities on
behalf of PXRE Bermuda, PXRE Reinsurance and PXRE Barbados.
History
Introduction
The Company was formed in 1999 as part of the reorganization of PXRE
Delaware, a Delaware corporation. Prior to the reorganization, PXRE Delaware was
the ultimate parent holding company of the various PXRE companies and its common
shares were publicly-traded on the New York Stock Exchange. As a result of the
reorganization, the Company became the ultimate parent holding company of PXRE
Delaware and the holders of PXRE Delaware common stock automatically became
holders of the same number of the Company's common shares. The reorganization
was consummated at the close of business on October 5, 1999 and, on October 6,
1999 the Company's common shares commenced trading on the New York Stock
Exchange under the symbol "PXT". The reorganization also involved the
establishment of a Bermuda-based reinsurance subsidiary, PXRE Bermuda, and a
Barbados based reinsurance subsidiary, PXRE Barbados, and the formation of a
reinsurance intermediary, PXRE Solutions.
The Company's predecessor, PXRE Delaware, was organized in July 1986 by
Phoenix Home Life Mutual Insurance Company ("Phoenix Home Life") to succeed,
through PXRE Reinsurance, to the property and casualty reinsurance business
carried on since 1982 by Phoenix General Insurance Company, formerly a
wholly-owned subsidiary of Phoenix Home Life. As of February 28, 2003, Phoenix
Home Life owned 1.1 million of the Company's common shares.
In November 1993, PXRE Delaware sponsored the initial public offering
of Transnational Re Corporation ("TREX") to raise capital and take advantage of
favorable conditions in the worldwide retrocessional reinsurance market. PXRE
Delaware, through PXRE Reinsurance, retained a 21% ownership position in TREX
and was responsible for the day-to-day operations of TREX, including all the
reinsurance operations of TREX's subsidiary, Transnational Reinsurance Company
("Transnational Reinsurance").
On December 11, 1996, TREX merged into PXRE Delaware (the "Merger").
Following the Merger, Transnational Reinsurance became a wholly-owned subsidiary
of PXRE Reinsurance and was re-named Transnational Insurance Company
("Transnational Insurance"). The Merger was accounted for using the purchase
method of accounting; and as a result, net income of TREX (including
Transnational Reinsurance/Transnational Insurance) was included in PXRE
Delaware's consolidated results of operations from the date of the Merger.
6
In mid-1999, PXRE Reinsurance formed a finite reinsurance unit to
provide structured/finite coverages combining elements of insurance risk
transfer and finance to manage certain risks on a client's financial statements
and cash flow.
In the third quarter of 2001, we announced that we were returning our
focus to our core property catastrophe, property per-risk, marine and aerospace
reinsurance and retrocessional products. Prior to 1998, these were our only
significant lines of coverage. Beginning in 1997, the pricing and terms in our
core property reinsurance markets began to deteriorate, resulting in a soft
reinsurance market that only began to recover in late 2000. We decided to pursue
a variety of diversification efforts to enhance our competitiveness and growth
opportunities in that soft reinsurance market environment that included:
o the establishment of a Lloyd's of London ("Lloyd's")
underwriting syndicate and managing agent;
o the establishment of an excess and surplus lines operation;
o the addition of a reinsurance platform offering primarily
casualty products directly to insurance companies (rather than
through reinsurance brokers);
o the enhancement of our international broker market reinsurance
platform to include additional lines of business, including
casualty and credit risks;
o an acceleration of business offerings to one of our managed
business participants;
o the formation of a finite reinsurance unit; and
o the establishment of a direct presence in the Bermuda market.
As the reinsurance market conditions began to improve, we undertook a
significant strategic realignment in 2000 and 2001, exiting our excess and
surplus lines, Lloyd's and direct operations.
During the third quarter of 2000, we stopped underwriting new or
renewal business through our Lloyd's vehicle, PXRE Limited, the sole member of
Lloyd's Syndicate 1224 ("PXRE Lloyd's Syndicate"), which had been active in the
accident and health, property catastrophe, aerospace, facultative and casualty
reinsurance areas. This decision followed our redomestication to Bermuda and the
resulting direct access to the risks written in this market, which reduced the
benefit of a Lloyd's presence. Our Lloyd's Managing Agency, PXRE Managing Agency
Limited, ceased managing third party syndicates at Lloyd's as of January 1, 2001
and was sold in April 2001 at approximately book value. We are continuing to
run-off the business underwritten through PXRE Lloyd's Syndicate.
During the fourth quarter of 2000, Transnational Insurance, an excess
and surplus lines carrier, which prior to our withdrawal, had specialized in
non-standard and excess property insurance risks distributed substantially all
of its assets and liabilities to PXRE Reinsurance and the remaining corporate
shell was sold on December 21, 2000.
7
In September 2001, completing the return to our core business, we
exited the casualty reinsurance business that was principally underwritten by
our direct reinsurance unit. Our direct reinsurance portfolio consists primarily
of North American general liability, automobile, workers' compensation and
per-risk excess business. We had expanded into this area in an effort to
diversify during the soft period in the property catastrophe pricing cycle, and
hired a direct underwriting team to establish the operation de novo, with a
focus on small to medium-sized insurance company clients. This unit ceased
writing both new and renewal treaties in September 2001 and the unit was closed
at the end of February, 2002. We also ceased underwriting our more limited
portfolio of international pro-rata casualty reinsurance as part of the return
to our core property reinsurance focus. We remain liable for losses incurred in
these lines of business and expect that the majority of this business will be
run-off during the next five to seven years.
As a result of this strategic realignment, we have returned our focus
to our core property catastrophe, property per-risk, marine and aerospace
reinsurance and retrocessional products and have reduced the number of our
employees from a high of 103 in December 1999 to 61 at December 31, 2002.
Underwriting Operations
Through our subsidiaries, we are principally engaged in providing
treaty reinsurance to primary insurers and retrocessional coverage to other
reinsurers of commercial and personal property risks. We also provide marine and
aerospace reinsurance and retrocessional products and services. We specialize in
property reinsurance, with a strong focus on catastrophe-type products.
Operating Segments
We operate in four reportable property and casualty segments -
catastrophe and risk excess, finite business, other lines and exited lines -
based on our approach to managing the business. Commencing with the 2002
underwriting renewal season, we returned our focus to our core catastrophe and
risk excess and finite business. Businesses that were not renewed in 2002 are
reported as exited lines. The Company's segments for 2000 and 2001 were
reclassified to be comparable to the 2002 segments used for our method of
managing the business. In addition, we operate in two geographic segments -
North American representing North American based risks written by North American
based clients and International (principally the United Kingdom, Continental
Europe, Latin America, the Caribbean, Australia and Asia), representing all
other premiums written.
8
The following tables present the distribution of our net premiums
written, net premiums earned and our underwriting income (loss) for the years
ended December 31, 2002, 2001 and 2000:
Net Premiums Written (1)
Year Ended December 31,
-----------------------------------------------------------------------
2002 2001 2000
-------------------- ------------------- --------------------
($000's, except percentages) Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Catastrophe and Risk Excess
North American $ 51,608 $ 27,981 $ 16,532
International 153,038 90,714 68,754
Excess of Loss Cessions (28,652) (60,485) (15,489)
--------- --------- ---------
175,994 60% 58,210 38% 69,797 40%
--------- --------- ---------
Finite Business
North American 102,754 33,651 20,245
International - - -
--------- --------- ---------
102,754 35 33,651 22 20,245 12
--------- --------- ---------
Other Lines
North American 7,822 4,086 2,720
International 83 404 1,855
--------- --------- ---------
7,905 3 4,490 3 4,575 3
--------- --------- ---------
Exited Lines
North American 8,550 33,679 29,898
International (720) 24,448 48,186
--------- --------- ---------
7,830 2 58,127 37 78,084 45
--------- --- --------- --- ---------
Total $ 294,483 100% $ 154,478 100% $ 172,701 100%
========= === ========= === ========= ===
9
Net Premiums Earned (1)
Year Ended December 31,
-----------------------------------------------------------------------
2002 2001 2000
-------------------- ------------------- --------------------
($000's, except percentages) Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Catastrophe and Risk Excess
North American $ 50,436 $ 26,916 $ 16,727
International 148,650 92,407 68,038
Excess of Loss Cessions (23,052) (58,839) (19,115)
--------- --------- ---------
176,034 65% 60,484 37% 65,650 41%
--------- --------- ---------
Finite Business
North American 57,107 32,365 17,791
International - - -
--------- --------- ---------
57,107 21 32,365 20 17,791 11
--------- --------- ---------
Other Lines
North American 8,002 3,434 1,498
International 143 479 2,009
--------- --------- ---------
8,145 3 3,913 3 3,507 2
--------- --------- ---------
Exited Lines
North American 18,895 33,109 23,332
International 9,179 32,254 49,926
--------- --------- ---------
28,074 11 65,363 40 73,258 46
--------- --- --------- --- --------- ---
Total $ 269,360 100% $ 162,125 100% $ 160,206 100%
========= === ========= === ========= ===
10
Underwriting Income (Loss) (2)
Year Ended December 31,
-----------------------------------------------------------------------
2002 2001 2000
-------------------- ------------------- --------------------
($000's, except percentages) Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Catastrophe and Risk Excess
North American $ 43,591 $ (31,740) $ 10,888
International 80,874 (17,639) (1,075)
Excess of Loss Cessions (16,383) 38,117 (11,265)
--------- --------- ---------
108,082 117% (11,262) 77% (1,452) 19%
--------- --------- ---------
Finite Business
North American 2,544 2,944 1,661
International - - -
--------- --------- ---------
2,544 3 2,944 (20) 1,661 (22)
--------- --------- ---------
Other Lines
North American 4,378 (385) (543)
International (58) (934) (39)
--------- --------- ---------
4,320 4 (1,319) 9 (582) 8
--------- --------- ---------
Exited Lines
North American (20,234) 2,023 (446)
International (2,075) (6,996) (6,610)
--------- --------- ---------
(22,309) (24) (4,973) 34 (7,056) 95
--------- --- --------- --- --------- ---
Total $ 92,637 100% $ (14,610) 100% $ (7,429) 100%
========= === ========= === ========= ===
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(1) Premiums written and earned are expressed on a net basis (after
deduction for ceded reinsurance premiums) in order to more accurately
reflect business written for our own account.
(2) Underwriting income (loss) includes premiums earned, losses incurred
and commission and brokerage net of management fees, but do not include
investment income, realized gains or losses, interest expense,
operating expenses, unrealized foreign exchange gains or losses on
losses incurred, or management fees for syndicate agency management.
See Note 10 of Notes to Consolidated Financial Statements.
11
Catastrophe and Risk Excess
Our catastrophe and risk excess portfolio consists principally of
property catastrophe excess of loss, property retrocessional, property risk
excess, property London Market Excess ("LMX") and marine and aerospace excess
reinsurance coverages. This portfolio can be characterized on a longer-term
basis as being comprised of coverages involving higher expected margins and
greater volatility than the other coverages that we underwrite. In 2002, $204.6
million of premiums written after reduction for quota share cessions were
attributable to the catastrophe and risk excess portfolio, or $176.0 million net
of specific excess of loss retrocessional reinsurance ceded to other reinsurers.
In 2002, this segment produced an underwriting profit of $108.1 million. In 2001
and 2000, this segment produced underwriting losses of $11.3 million and $1.5
million, respectively, largely as a result of the September 11, 2001 terrorist
attacks in 2001 and, in 2000, as a consequence of adverse development of losses
arising from severe French winter storms that occurred in the last week of 1999.
The increase in premium volume for catastrophe and risk excess coverages in 2002
was largely attributable to increases in the volume of business written and
price increases in the aftermath of the events of September 11, 2001. The
increase in premium volume for catastrophe and risk excess coverages in 2001 was
largely attributable to increases in the volume of business written in the
aftermath of the 1999 French losses.
The exposures underlying the North American portion of this segment
emanate principally from East Coast and Gulf hurricanes and Midwest and West
Coast earthquakes. The exposures underlying the International portion of this
segment emanate principally from European, Japanese and Caribbean windstorm,
flood and earthquake risks, major oil rig explosions, cruise ship disasters,
satellite failures, commercial airplane crashes and similar risks.
Finite Business
We entered the finite business in mid-1999 with products combining
elements of insurance risk transfer and finance to manage certain risks of our
clients. Due to our small size, we pursued a niche focus on smaller to
medium-sized clients. At the same time, we believe we have maintained a more
conservative underwriting approach than many competitors, eschewing riskier
transactions and opportunistically ceding business to other reinsurers to reduce
timing and investment risks where appropriate. In returning to our core property
reinsurance focus, we elected to continue our finite business, which we believe
provides significant diversification and reduces the volatility of our overall
portfolio.
Our finite business involves a relatively small number of large
reinsurance transactions. As a result, premiums in this segment are expected to
vary widely from period to period. The risks reinsured are primarily casualty
risks and are subject to some of the similar risks as our casualty coverages
included in our exited lines segment. Net premiums written of $102.8 million
were attributable to our finite business in 2002. In 2002, the finite segment
produced an underwriting profit of $2.5 million. Included in the finite segment
were net premiums written of $83.8 million and underwriting profit of $3.0
million in 2002, assumed pursuant to various finite reinsurance contracts with
one insurance company, Tower Insurance Company of New York.
Finite contracts that do not meet certain accounting requirements of
the Financial Accounting Standard Board's Statement of Financial Accounting
Standard ("SFAS") No. 113 and other accounting literature, that generally define
a reinsurance transaction, are not booked as premiums, but rather are treated as
deposits. We have entered into contracts in 2001 and 2002 that have $38.1
million of deposit liabilities to ceding companies at December 31, 2002 on this
deposit accounting basis. We also have two finite retrocessional agreements in
place with Select Reinsurance, Ltd. ("Select Re") that are accounted for as
deposit assets pursuant to SFAS No. 113 and other accounting literature,
totaling $21.4 million including investment income earned to December 31, 2002.
We believe these retrocessional agreements will enhance the long-term
profitability of the finite contracts to which they relate.
12
Other Lines
In 2002, our Other Lines segment consisted of a single property
pro-rata reinsurance treaty that generated $7.9 million in net premiums written.
Our Other Lines segment produced an underwriting profit of $4.3 million in 2002
compared to an underwriting loss of $1.3 million in 2001. With the return to our
core lines of business, we do not expect to write a significant volume of
premium in our Other Lines segment in the near future.
Exited Lines
Our Exited Lines segment consists principally of North American general
liability, commercial and personal auto liability, risk excess and other
liability coverages and International pro-rata casualty coverages. We decided to
stop underwriting new or renewal casualty business in September 2001 as part of
our strategic realignment. Other coverages include accident and health
coverages, binding and line slip authorities written through PXRE Lloyd's
Syndicate and credit coverages. During the third quarter of 2000, we ceased
accepting new and renewal risks at PXRE Lloyd's Syndicate. The Exited Lines
segment accounted for $7.8 million of net premiums written in 2002. Net premiums
written in 2002 for this segment decreased 87% from 2001. These premiums relate
to reinsurance contracts that were entered into prior to September 2001, but had
not expired before 2002. Virtually all of these contracts had expired by
December 31, 2002 and we do not expect to report a material amount of premiums
in this segment in 2003. In 2002, the Exited Lines segment produced an
underwriting loss of $22.3 million.
See Note 10 of Notes to Consolidated Financial Statements for
additional information regarding our reportable segments and geographic areas.
Underwriting
Since inception, we have pursued a core strategy of leveraging the
specialized analytical and underwriting expertise of our reinsurance
professionals in high-severity, low-frequency lines of business.
Our underwriting process emphasizes a team approach among our
underwriters, actuaries and claims staff and is strictly geared toward
profitability rather than market share, with a resulting willingness to reduce
underwriting commitments in a soft market.
Reinsurance treaties are reviewed for compliance with our general
underwriting standards and certain treaties are evaluated in part based upon our
internal actuarial analysis. We manage our risk of loss through a combination of
aggregate exposure limits, underwriting guidelines that take into account risks,
prices and coverage and retrocessional agreements. As we underwrite risks from a
large number of clients based on information generally supplied by reinsurance
brokers, there is a risk of developing a concentration of exposure to loss in
certain geographic areas prone to specific types of catastrophes. We have
developed systems and software tools to monitor and manage the accumulation of
our exposure to such losses. We have established guidelines for maximum
tolerable losses from a single or multiple catastrophic events based on
historical data. However, no assurance can be given that these maximums will not
be exceeded in some future catastrophe.
13
We utilize a two-tier approach to risk management, including both a
portfolio optimization system and overall risk limits. Our portfolio
optimization system incorporates third-party catastrophe modeling software and
internally developed models. This system is used to price each reinsurance
contract based on marginal capital requirements, and enables our underwriters to
dynamically evaluate potential new business and exposures against the background
of our existing business to optimize the overall portfolio. Any new business
bound is incorporated in this analytical approach to enable a dynamic assessment
of the portfolio. Our portfolio is also subject to management-specified
probabilistic risk limits for the business as a whole, by territory and by type
of event. Our management believes that the portfolio model is a valuable tool to
supplement the experience and judgment of our underwriters.
We have traditionally maintained strict limits to departmental
underwriting authority, with approval by two, three or more members of a
seven-member underwriting committee required for all business deemed outside the
predominant risk distribution of the overall portfolio.
Marketing
We provide reinsurance for international insurance and reinsurance
companies headquartered, principally, in the United Kingdom, Continental Europe,
Latin America, the Caribbean, Australia and Asia. In the United States, we
currently reinsure both national and regional insurance and reinsurance
companies and specialty insurance companies.
Historically, we have obtained substantially all of our reinsurance
business through reinsurance intermediaries, which represent our clients in
negotiations for the purchase of reinsurance. None of the reinsurance
intermediaries through whom we obtain this business are authorized to arrange
any business in our name without our approval. We pay commissions to these
intermediaries or brokers that vary in size based on the amount of premiums and
type of business ceded. These commission payments constitute part of our total
acquisition costs and are included in our underwriting expenses. We generally
pay reinsurance brokerage commissions believed to be comparable to industry
norms.
Approximately 84% of gross premiums written in fiscal year 2002 were
arranged through brokers individually representing 10% or more of gross premiums
written including Pegasus Advisors-Towers Perrin Reinsurance (31%), the
worldwide branch offices of Guy Carpenter & Company, Inc. (a subsidiary of Marsh
& McLennan Companies, Inc.) (16%), Benfield Greig Ltd. (13%), Aon Group Ltd.
(13%), and Willis Re. Inc. (11%). The commissions we paid to these
intermediaries are generally at the same rates as those paid to other
intermediaries.
In mid-1998, we established a U.S.-based direct writing reinsurance
unit to complement our existing brokerage-based reinsurance operations. As part
of our strategic realignment, we decided in September 2001 to abandon this
initiative and to focus exclusively on the broker reinsurance market.
Approximately 97% and 3% of PXRE's 2002 gross premiums written and 88% and 12%
of PXRE's 2001 gross premiums written were written in the broker and direct
markets, respectively.
14
Competition
Competitive forces in the property and casualty reinsurance and
insurance industry are substantial. We operate in an industry that is highly
competitive and is undergoing a variety of challenging developments. The
industry has in recent years placed increased importance on size and financial
strength in the selection of reinsurers. This trend became more pronounced in
the wake of September 11, 2001, with the formation of a number of large well
capitalized reinsurance companies in Bermuda and the significant level of
additional capital raised by existing competitors. Additionally, reinsurers are
tapping new markets and complementing their range of traditional reinsurance
products with innovative new products that bring together capital markets and
reinsurance experience. We compete with numerous major reinsurance and insurance
companies. These competitors, many of which have substantially greater
financial, marketing and management resources than us, include independent
reinsurance companies, subsidiaries or affiliates of established worldwide
insurance companies, reinsurance departments of certain commercial insurance
companies and underwriting syndicates. We also may face competition from new
market entrants or from market participants that decide to devote greater
amounts of capital to the types of business written by us.
Competition in the types of reinsurance business that we underwrite is
based on many factors, including the perceived overall financial strength of a
reinsurer, premiums charged, other terms and conditions, ratings of A.M. Best
Company ("A.M. Best"), an independent insurance industry rating organization,
Standard & Poor Ratings Services ("S&P"), a division of the McGraw-Hill
Companies, Inc. and Moody's Investors Service, Inc. ("Moody's"), service
offered, speed of service (including claims payment), and perceived technical
ability and experience of staff. The number of jurisdictions in which a
reinsurer is licensed or authorized to do business is also a factor. PXRE
Reinsurance is licensed, accredited, or otherwise authorized or permitted to
conduct reinsurance business in all states and the District of Columbia, Puerto
Rico, Bermuda, Colombia and Mexico, and through to December 31, 2002, PXRE's
Brussels Branch operated from Belgium. PXRE Bermuda is licensed to do business
only in Bermuda. PXRE Barbados is licensed only in Barbados.
The property and casualty reinsurance industry experienced an extended
period of soft market conditions characterized by inadequate pricing. These
conditions began to improve as a result of loss activity in Europe and the
Caribbean region in late 1999. In the wake of the September 11, 2001 attacks on
the World Trade Center and the Pentagon, which have resulted in industry losses
estimated as high as $45 to $75 billion, representing the largest insured event
in history, reinsurance markets across the world have hardened significantly.
Even before the September 11, 2001 attacks, property catastrophe rates were
improving at a significant pace. In the wake of this loss, we experienced
significant rate increases of 20% to 100% in our core property catastrophe, risk
excess and marine and aerospace lines in 2002. The global property-catastrophe
reinsurance market has historically been very cyclical, and as a result, it is
impossible to predict how long the current favorable pricing environment will
continue.
Retrocessional Agreements
The following table sets forth certain information regarding the volume
of premiums we ceded to other reinsurers pursuant to retrocessional agreements
for the periods indicated:
15
Year Ended December 31,
------------------------------------------------
($000's) 2002 2001 2000
------------- ------------- -------------
Gross premiums written $ 366,768 $ 290,213 $ 268,990
Reinsurance premiums ceded:
Managed business participants 31,699 50,271 36,239
Finite 7,466 13,573 26,814
Catastrophe coverage, surplus reinsurance and other 33,120 71,891 33,236
------------- ------------- -------------
Total reinsurance premiums ceded 72,285 135,735 96,289
------------- ------------- -------------
Net premiums written $ 294,483 $ 154,478 $ 172,701
============= ============= =============
In 2001, we incurred significant reinstatement and additional premium
obligations to retrocessionaires as a result of the cession of losses arising
from the events of September 11, 2001.
At December 31, 2002, estimated losses recoverable (including incurred
but not reported losses ("IBNR")), from retrocessionaires were $237.1 million,
including $29.7 million of paid loss recoverables. $161.6 million, or 68%, of
our reinsurance recoverables are attributable to the terrorist attacks of
September 11, 2001. Approximately 91% of our September 11, 2001 related
reinsurance recoverables as of March 1, 2003 are either fully collateralized or
reside with entities rated "A-" or higher.
We have a committee consisting of our chief executive officer, chief
financial officer and senior underwriting executives responsible for the
selection of reinsurers as managed business participants or as participating
reinsurers in the catastrophe coverage protecting us. Proposed reinsurers are
evaluated at least annually based on consideration of a number of factors
including the management, financial statements and the historical experience of
the reinsurer. This procedure is followed whether or not a rating has been
assigned to a proposed reinsurer by any rating organization. All reinsurers,
whether obtained through direct contact or the use of reinsurance
intermediaries, are subject to our approval.
Although management carefully selects our retrocessionaires, we are
subject to credit risk with respect to our retrocessionaires because the ceding
of risk to retrocessionaires does not relieve us of our liability to clients.
In the past, we have been able to increase our underwriting commitments
and to generate management fee income by retroceding some of our underwritten
risks to other reinsurers through various retrocessional arrangements whereby we
managed business for such participants. In 2002, we were a party to a
retrocessional agreement with Select Re (as amended from time to time, the
"Select Re Quota Share Agreement"), pursuant to which we offer to cede a
proportional share of our non-casualty reinsurance business. The proportional
share of our non-casualty business ceded to Select Re under that agreement was
8.0% in 2002 and 16.5% in 2001. As a complement to the Select Re Quota Share
Agreement, we cede an additional proportional share to Select Re on certain
agreed risks under a variable quota share agreement. In connection with the
Select Re Quota Share Agreement, we have entered into an undertaking to use
commercially reasonable efforts to present Select Re with aggregate annual
premiums equal to a minimum of 20% of Select Re's shareholders' equity (as
defined in the undertaking). This undertaking was amended in November 2002 and
extended until 2005. In return, Select Re is obligated to pay us a management
fee based on the gross premiums ceded to them under these quota share
agreements.
16
In addition to the Select Re Quota Share Agreement, we have entered
into several other reinsurance transactions with Select Re during 2002 and 2001
whereby: (i) Select Re provided retrocessional support on several finite and
other lines reinsurance transactions underwritten by PXRE; (ii) Select Re
provided us with aggregate excess of loss retrocessional coverage in 2001 that
protects us against large losses arising from a single catastrophe event and
against the accumulation of aggregate losses arising from a number of events;
and (iii) we provided Select Re with catastrophe excess of loss retrocessional
coverage that protects them in the event they incur significant losses arising
from a single catastrophe event which involved premiums of $1.7 million in 2002
and $0.7 million in 2001. In 2002, we ceded reinsurance premiums of $30.5
million to Select Re and earned management fees and ceding commissions of $7.6
million.
As of December 31, 2002, net assets of $85.3 million were due in the
aggregate from Select Re, all of which are secured by way of a reinsurance
trust, or funds withheld by us. In addition to the collateralization
requirements, we have various additional protections to ensure Select Re's
performance of its obligations to us. In this regard, pursuant to the Select Re
Quota Share Agreement, among other rights, we have the right to designate one
member of Select Re's board of directors and we have the right to limit the
amount of non-PXRE reinsurance business assumed by Select Re.
Select Re is a Class 3 Bermuda reinsurance company that was formed in
1997. As of December 31, 2002, it had shareholders' equity of approximately $137
million and is privately owned by approximately 120 shareholders. In accordance
with our contractual rights under the Select Re Quota Share Agreement, we have
designated Jeffrey L. Radke, our President and Chief Operating Officer, to serve
on Select Re's board of directors. Prior to joining us in 1999, Jeffrey Radke
had served as the President of Select Re. Jeffrey Radke receives no remuneration
for serving on Select Re's board.
As of December 31, 2001, Select Re held 1.1 million of the Company's
Common Shares, but subsequently liquidated its entire position in the open
market during February 2002. Gerald Radke, Jeffrey Radke and Halbert Lindquist,
one of our directors, each individually hold Select Re shares, but each such
person holds less than 1% of Select Re's outstanding shares. Pursuant to an
agreement with shareholders of Select Re, Gerald Radke and Jeffrey Radke have
each given notice of redemption to Select Re to sell all of their Select Re
shares. The redemption of shares was effective December 31, 2002 and will be
settled by October 2003 in accordance with the terms of the agreement.
Mr. William Michaelcheck is the Chairman of the Board of Select Re and
also one of its founding shareholders. Mr. Michaelcheck is also the President
and sole shareholder of Mariner Investment Group, Inc. ("Mariner"). Mariner acts
as the investment manager for our hedge fund and alternative investment
portfolio. In 2002 and 2001, we incurred investment management fees of $0.7
million and $0.8 million, respectively, relating to services provided by
Mariner.
The Company's Board of Directors reviews the various transactions with
Select Re at each of its meetings. In addition, the Board requires the prior
approval of the Company's Chief Financial Officer for any transaction with
Select Re.
In December 2002, we entered into a catastrophe quota share reinsurance
agreement with P-1 Re Ltd., a newly formed Bermuda Class 3 reinsurer ("P-1 Re").
P-1 Re was initially capitalized with $194 million by a group of unaffiliated
private institutional investors. Under this reinsurance agreement, P-1 Re will
assume a quota share of our property catastrophe, marine, aviation, satellite
and per-risk portfolios in 2003 and 2004. This arrangement has allowed us to
increase the capacity and capital we can offer to clients. It also provides us
with additional management fee income. P-1 Re is not permitted to conduct any
reinsurance transactions other than the reinsurance agreement with PXRE.
17
The quota share ceded to P-1 Re in either calendar year is dependent on
how much exposure we underwrite in excess of specified thresholds set by PXRE.
The cession is split into two sub-portfolios, a Specialty Subportfolio and
Property Catastrophe Subportfolio. The Specialty Subportfolio includes our
aviation, satellite, marine and risk excess business. The Property Catastrophe
Subportfolio includes our North American, International and London Market
property catastrophe business. Based on the reinsurance business written during
the January 1st renewal season, the quota share cession percentages determined
for 2003 are 59% and 2.74%, for the Specialty and Property Catastrophe
Subportfolios, respectively.
The reinsurance limits available under the reinsurance agreement vary
depending upon the reinsurance exposures in force during various periods. Based
upon business written during the January 1st renewal season, P-1 Re's aggregate
limit of liability for losses attaching from January 1 to July 30, 2003 is
$119.4 million. This aggregate limit is expected to increase to $123.8 million
for losses attaching from July 1 to December 31, 2003. P-1 Re's obligations are
fully secured through a securities account pledged for the benefit of PXRE.
The following table sets forth our earned commissions from
retrocessionaires pursuant to our managed business arrangements for the periods
indicated:
Year Ended December 31,
------------------------------------------------
($000's) 2002 2001 2000
------------- ------------- -------------
Commission $ 3,540 $ 5,130 $ 4,159
Contingent profit commission (1) (108) 624 (271)
------------- ------------- -------------
Total $ 3,432 $ 5,754 $ 3,888
============= ============= =============
- -------------------------------------------------------------------------------------------------------------------
(1) Contingent profit commission is paid after a three-year period and is
subject to adjustment based on cumulative experience under the various
quota share arrangements and, prior to 1998, also under the arrangement
with Select Re.
Loss Liabilities and Claims
We establish loss and loss expense liabilities (to cover expenses
related to settling claims, including legal and other fees) to provide for the
ultimate cost of settlement and administration of claims for losses, including
claims that have been reported to us by our reinsureds and claims for losses
that have occurred but have not yet been reported to us. Under GAAP, we are not
permitted to establish loss reserves until an event that may give rise to a
claim occurs.
For reported losses, we establish liabilities when we receive notice of
the claim. It is our general policy to establish liabilities for reported losses
in an amount equal to the liability set by the reinsured. In certain instances,
we will conduct an investigation to determine if the amount established by the
reinsured is appropriate or if it should be adjusted.
For incurred but not reported losses, a variety of methods have been
developed in the insurance industry for use in determining our provision for
such liabilities. In general, these methods involve the extrapolation of
reported loss data to estimate ultimate losses. Our loss calculation methods
generally rely upon a projection of ultimate losses based upon the historical
patterns of reported loss development. Additionally, we make provision through
our liabilities for incurred but not reported losses for any identified
deficiencies in the liabilities for reported losses set by our reinsureds.
18
Management believes that our overall liability for losses and loss
expenses maintained as of December 31, 2002 is adequate. There is a risk that
our liability for losses and loss expenses could prove to be greater than
expected in any year, because of the inherent uncertainty in the reserving
process with a consequent adverse impact on future earnings and stockholders'
equity. Estimating the ultimate liability for losses and loss expenses is an
imprecise science subject to variables that are influenced by both internal and
external factors. Historically, we have focused on property related coverages.
In contrast to casualty losses, which frequently are slow to be reported and may
be determined only through the lengthy, unpredictable process of litigation,
property losses tend to be reported more promptly and usually are settled within
a shorter time period. However, the estimation of losses for catastrophe
reinsurers is inherently less reliable than for reinsurers of risks that have an
established historical pattern of losses. In addition, we are required to make
estimates of losses based on limited information from ceding companies as well
as our own underwriting data due to the significant reporting delays that
normally occur under our retrocessional book of business and with respect to
insured losses that occur near the end of a reporting period.
Historically, we have underwritten a small amount of casualty
reinsurance. In 1998, we began underwriting new casualty lines of business and,
in 1999 and 2000, we substantially expanded our casualty and finite businesses.
In September 2001, we ceased underwriting non-finite casualty business. With
respect to casualty business, significant delays, ranging up to several years or
more, can be expected between the reporting of a loss to us and settlement of
our liability for that loss. As a result, such future claim settlements could be
influenced by changing rates of inflation and other economic conditions,
changing legislative, judicial and social environments and changes in our claims
handling procedures. In addition, most of the risks reinsured in our finite
business are also casualty risks and are subject to some of the same risks as
our casualty business. While the reserving process is difficult and subjective
for ceding companies, the inherent uncertainties of estimating such reserves are
even greater for a reinsurer, due primarily to the longer time between the date
of the occurrence and the reporting of any attendant claims to the reinsurer,
the diversity of development patterns among different types of reinsurance
treaties, the necessary reliance on the ceding companies for information
regarding reported claims and differing reserving practices among ceding
companies.
Our difficulty in accurately predicting casualty losses may also be
exacerbated by the limited amount of statistically significant historical data
regarding losses on our casualty lines of business. We must therefore rely on
the inherently less reliable historical loss patterns reported by ceding
companies and industry loss standards in calculating our casualty reserves.
Thus, the actual casualty losses and loss expenses may deviate, perhaps
substantially, from estimates of liabilities reflected in our consolidated
financial statements.
The following table provides a reconciliation of beginning and ending
loss and loss expense liabilities under GAAP for the fiscal years ended December
31, 2002, 2001 and 2000. Except with respect to certain workers' compensation
liabilities, discounted by $0.8 million and $0.4 million at December 31, 2002
and 2001, respectively and the reserve maintained by PXRE Bermuda at December
31, 2001 and 2000, we do not discount our loss and loss expense liabilities;
that is, we do not calculate them on a present value basis.
19
Year Ended December 31,
------------------------------------------------
($000's) 2002 2001 2000
------------- ------------- -------------
Gross GAAP liability for losses and loss expenses at
beginning of year................................... $ 453,705 $ 251,620 $ 261,551
Add - Gross provision for losses and loss expenses:
Occurring in current year......................... 118,345 318,373 137,123
Occurring in prior years.......................... 41,352 34,339 77,330
------------- ------------- -------------
Total gross provision (1)......................... 159,697 352,712 214,453
------------- ------------- -------------
Less - Gross payments for losses and loss expenses:
Occurring in current year......................... 19,026 63,960 20,920
Occurring in prior years.......................... 149,365 85,904 210,520
------------- ------------- -------------
Total gross payments.............................. 168,391 149,864 231,440
------------- ------------- -------------
Add - Asset related to retroactive reinsurance assumed. 2,818 (763) 7,056
Gross GAAP liability for losses and loss expenses at
end of year......................................... $ 447,829 $ 453,705 $ 251,620
============= ============= =============
Ceded GAAP liability for losses and loss expenses at
end of year......................................... (207,444) (245,906) (96,117)
------------- ------------- -------------
Net GAAP liability for losses and loss expenses at end
of year............................................. $ 240,385 $ 207,799 $ 155,503
============= ============= =============
- -------------------------------------------------------------------------------------------------------------------
(1) The GAAP provision for losses and loss expenses includes net foreign
currency exchange gains (losses) of $(7,000), $981,000 and $(1,196,000)
for 2002, 2001, and 2000, respectively.
The following table presents the development of our GAAP balance sheet
liability for losses and loss expenses for the period 1992 through 2002. The top
line of the table shows the liabilities at the balance sheet date for each of
the indicated years. This reflects the estimated amount of losses and loss
expenses for claims arising in that year and all prior years that are unpaid at
the balance sheet date, including losses incurred but not yet reported to us.
The upper portion of the table shows the cumulative amounts subsequently paid as
of successive years with respect to such liabilities. The lower portion of the
table shows the re-estimated amount of previously recorded liabilities based on
experience as of the end of each succeeding year. These estimates change as more
information becomes known about the frequency and severity of claims for
individual years. A redundancy (deficiency) exists when the re-estimated
liability at each December 31 is less (greater) than the prior liability
estimate. The "cumulative redundancy (deficiency)" depicted in the table, for
any particular calendar year, represents the aggregate change in the initial
estimates over all subsequent calendar years.
Each amount in the table below includes the effects of all changes in
amounts for prior periods. For example, if a loss determined in 1995 to be
$150,000 was first reserved in 1992 at $100,000, the $50,000 deficiency (actual
loss minus original estimate) would be included in the cumulative redundancy
(deficiency) in each of the years 1993-1994 shown below. This table does not
present accident or policy year development data.
20
Year Ended December 31,
-----------------------------------------------------------------------------------------------------
($000's, except percentages) 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- ------- ------- ------- ------- ------- --------
Gross liabilities for losses
and loss expenses $447,829 $453,705 $251,620 $261,551 $102,592 $57,189 $61,389 $72,719 $81,836 $71,442 $88,668
Cumulative amount of liability
paid through:
One year later 149,365 85,904 210,519 75,814 29,108 23,708 42,698 41,601 37,820 59,773
Two years later 138,567 265,904 102,526 39,853 40,673 55,620 58,968 54,400 79,926
Three years later 293,313 112,966 47,373 46,545 67,296 67,630 60,850 89,519
Four years later 118,317 50,085 52,220 70,676 76,762 64,566 94,261
Five years later 52,117 54,144 74,533 79,433 69,414 96,895
Six years later 55,815 75,741 82,930 70,392 99,864
Seven years later 76,337 84,049 71,091 100,724
Eight years later 84,651 71,773 101,357
Nine years later 71,890 101,935
Ten years later 102,040
Liabilities reestimated as of:
One year later 497,874 285,959 338,881 135,227 57,280 66,257 83,228 87,818 78,188 101,423
Two years later 305,558 344,773 141,087 52,271 63,292 85,162 87,750 76,902 103,632
Three years later 350,451 139,220 63,151 61,178 83,178 90,409 74,683 105,165
Four years later 140,054 62,664 66,137 82,129 89,284 75,392 103,801
Five years later 63,909 65,819 85,820 88,326 74,880 104,330
Six years later 66,676 85,842 91,663 74,173 104,222
Seven years later 86,229 93,116 73,934 103,854
Eight years later 93,505 75,126 103,663
Nine years later 75,042 105,082
Ten years later 105,056
Gross reserves of TREX at date
of merger 9,589 5,242 2,067 26
Gross reserve for elimination
of one quarter lag for UK
subsidiary (1,191)
Gross retroactive accounting 2,817 2,055
Gross cumulative redundancy
(deficiency) through
December 31, 2002:
Amount (41,352) (51,883) (88,900) (38,653) (6,720) 4,302 (8,268) (9,602) (3,574) (16,388)
Percentage (9%) (21%) (34%) (38%) (12%) 6% (11%) (11%) (5%) (18%)
Retrocessional recoveries 15,945 15,768 23,646 10,287 6,056 86 8,268 4,115 1,573 3,564
Net cumulative redundancy
(deficiency) through
December 31, 2002:
Amount (25,406) (36,116) (65,253) (28,366) (665) 4,389 1 (5,487) (2,001) (12,824)
Percentage (12%) (23%) (41%) (41%) (1%) 8% 0% (11%) (5%) (36%)
21
During 2002, we incurred adverse development from prior-year losses
amounting to $25.4 million net of reinsurance, $16.9 million of which was due to
loss development in our Exited Lines segment relating primarily to the 2000 and
2001 underwriting years. Adverse development of $16.7 million was primarily
caused by larger than expected reported claims under our direct reinsurance
contracts, corroborated by revised industry data.
Conditions and trends that have affected reserve development in the
past may not necessarily occur in the future. Accordingly, it would not be
appropriate to extrapolate the future adequacy or inadequacy of our reserves
based on the foregoing.
Investments
We have established general procedures and guidelines for our
investment portfolio and oversee investment management carried out by our
investment managers. General Re-New England Asset Management, Inc ("NEAM") and
Mariner, a specialist in alternative investments, are our principal investment
managers. Our investment policies stress conservation of principal,
diversification of risk and liquidity. Our invested assets consist primarily of
bonds with fixed maturities, hedge funds, and short-term investments, but also
include limited amounts of equity securities and other non-hedge fund limited
partnership investments. Our investments are subject to market-wide risks and
fluctuations, as well as to risks inherent in particular securities.
As of December 31, 2002, we had, at fair value, $500.7 million in fixed
maturities, $133.3 million in short-term investments, $113.1 million in hedge
fund limited partnerships, and $11.5 million in other invested assets that are
comprised primarily of other limited partnerships. As at December 31, 2002,
hedge fund investments were allocated among sixteen managers, with fair values
ranging from $1.8 million to $18.1 million. Hedge funds and other limited
partnership investments are accounted for under the equity method whereby both
the investment income and any change in the fair value are recorded through the
investment income line of the income statement. Foreign denominated fixed
maturities, and in 2001, certain hedge funds are accounted for as part of a
trading portfolio, whereby both the investment income and any change in the fair
value are recorded through the investment income line of the income statement.
Included in investments in limited partnerships and the trading portfolio are
investments actively managed by Mariner. See Note 3 of Notes to Consolidated
Financial Statements. See also, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Certain Risks and Uncertainties;
Relating to Critical Accounting Policies - Investments" for further information
regarding our investment portfolio, including our hedge fund portfolio.
22
The following table summarizes our investments at December 31, 2002 and
2001 at fair value:
Analysis of Investments
December 31, 2002 December 31, 2001
----------------------- ----------------------
($000's, except percentages) Amount Percent Amount Percent
----------- ------- ----------- -------
Fixed maturities:
United States treasury securities $ 46,165 6.1% $ 48,413 9.5%
Foreign denominated securities 21,871 2.9 - -
Foreign government securities 315 - 5,355 1.1
United States government sponsored agency debentures 38,062 5.0 45,923 9.0
United States government sponsored agency
mortgage-backed securities 42,467 5.6 8,612 1.7
Other mortgage and asset-backed securities 143,736 19.0 20,620 4.1
Municipal securities 76,522 10.1 35,070 6.9
Corporate securities 131,611 17.3 55,489 10.9
----------- ------ ----------- ------
Total fixed maturities 500,749 66.0 219,482 43.2
Short-term investments 133,318 17.6 153,503 30.2
----------- ------ ----------- ------
Total 634,067 83.6 372,985 73.4
Hedge funds 113,105 14.9 115,569 22.7
Other investments 11,529 1.5 19,791 3.9
----------- ------ ----------- ------
Total investment portfolio $ 758,701 100.0% $ 508,345 100.0%
=========== ====== =========== ======
At December 31, 2002, the fair value of our investment portfolio
exceeded its cost by $44.5 million, of which $31.6 million related to limited
partnerships and trading portfolios and $12.9 million related to unrealized
appreciation on fixed maturities. At December 31, 2001, the fair value of our
investment portfolio exceeded its cost by $39.7 million, of which $38.9 million
related to limited partnerships and trading portfolios and $0.8 million related
to unrealized appreciation on fixed maturities.
We regularly monitor the difference between the estimated fair value of
our investments and their cost or book values to identify underperforming
investments and whether declines in value are temporary in nature, or "other
than temporary". If we believe a decline in the value of a particular investment
is temporary, we record the decline as an unrealized loss, net of tax, in our
stockholders' equity. If we believe the decline is "other than temporary", we
write down the carrying value of the investment and record a realized loss on
our statement of income and comprehensive income. We formally review each
quarter the largest unrealized losses by value, and all investments that have
been in an unrealized loss position for more than six months. In assessing
whether an investment is suffering a decline in value that is other than
temporary we pay particular attention to those trading at 80% or less of face
value, and those investments that have been downgraded by any of the major
ratings agencies in the period, general market conditions, and the status of
principal and interest payments. If we conclude that a decline is other than
temporary we recognize a realized investment loss for the impairment. In 2002,
we recognized $0.7 million of impairment losses.
23
The following table indicates the composition of our fixed maturity
investments, including short-term investments, at fair value, by time to
maturity at December 31, 2002 and 2001:
Composition of Investments By Maturity
December 31, 2002 December 31, 2001
----------------------- ----------------------
($000's, except percentages) Amount Percent Amount Percent
----------- ------- ----------- -------
Maturity (1)
One year or less $ 189,805 29.9% $ 157,467 42.2%
Over 1 year through 5 years 117,241 18.5 77,335 20.7
Over 5 years through 10 years 123,334 19.5 93,969 25.2
Over 10 years through 20 years 17,484 2.7 - -
Over 20 years - - 14,982 4.0
----------- ------ ----------- ------
447,864 70.6 343,753 92.1
United States government sponsored agency mortgage-backed and
other mortgage and asset-backed securities 186,203 29.4 29,232 7.9
----------- ------ ----------- ------
Total fixed maturities $ 634,067 100.0% $ 372,985 100.0%
=========== ====== =========== ======
- -------------------------------------------------------------------------------------------------------------------
(1) Based on stated maturity dates with no prepayment assumptions.
The average yield to maturity of our long-term fixed maturities
portfolio at December 31, 2002 and 2001, was 3.3% and 4.5%, respectively.
24
The following table indicates the composition of our fixed maturities
portfolio, at fair value, excluding short-term investments, by rating at
December 31, 2002 and 2001:
Composition of
Fixed Maturities Portfolio By Rating
--------------------------------------------
December 31, 2002 December 31, 2001
------------------- --------------------
($000's, except percentages) Amount Percent Amount Percent
-------- -------- -------- --------
Ratings (1)
United States treasury securities $ 46,165 9.2% $ 48,413 22.1%
Foreign denominated securities
Aaa and/or AAA 21,871 4.4 -- --
Foreign government securities
Aa2 and/or AA 315 0.1 -- --
Ba2 and/or BB -- -- 5,355 2.4
United States government sponsored agency debentures 38,062 7.6 45,923 20.9
United States government sponsored agency mortgage-
backed securities 42,467 8.5 8,612 4.0
Other mortgage and asset-backed securities
Aaa and/or AAA 111,788 22.3 20,229 9.2
Aa2 and/or AA 7,510 1.5 -- --
A2 and/or A 23,920 4.8 -- --
Baa2 and/or BBB 343 0.1 391 0.2
Not rated or below BB 175 -- -- --
Municipal securities
Aaa and/or AAA 53,659 10.7 24,658 11.2
Aa2 and/or AA 22,863 4.6 10,412 4.7
Corporate securities
Aaa and/or AAA 7,846 1.6 687 0.3
Aa2 and/or AA 14,104 2.8 1,023 0.5
A2 and/or A 87,358 17.4 37,482 17.1
Baa2 and/or BBB 21,680 4.3 11,395 5.2
Ba2 and/or BB 623 0.1 1,192 0.5
Not rated or below BB -- -- 3,710 1.7
-------- -------- -------- --------
Total fixed maturities $500,749 100.0% $219,482 100.0%
======== ======== ======== ========
- -------------------------------------------------------------------------------------------------
(1) Ratings as assigned by Moody's and S&P, respectively. Such ratings are
generally assigned upon the issuance of the securities, subject to
revision on the basis of ongoing evaluations.
The investment committee of our Board of Directors and management
periodically evaluate the composition of the investment portfolio and reposition
the portfolio in response to market conditions in order to improve total
risk-adjusted returns while maintaining liquidity and superior credit quality.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources - Market Risk."
25
Ratings
PXRE Reinsurance and PXRE Bermuda are rated "A" (Excellent) by A.M.
Best. PXRE has been assigned an "A" financial strength rating by S&P.
The property catastrophe reinsurance market is highly sensitive to the
ratings assigned by the rating agencies. If either of S&P or A.M. Best were to
downgrade us, such downgrade would likely have a material negative impact on our
ability to expand our reinsurance portfolio and renew our existing reinsurance
portfolio, especially if we were to be downgraded more than one level from the
"A" rating category to the "B" rating category.
These ratings are based upon factors that may be of concern to
policyholders, agents and intermediaries, but may not reflect the considerations
applicable to an investment in a reinsurance or insurance company. A change in
any such rating is at the discretion of the respective rating agencies.
In addition, if we were downgraded below "A-" by either rating agency,
an event of default would occur under PXRE Delaware's credit agreement with
Wachovia Bank, National Association (formerly known as First Union National
Bank, "Wachovia") as agent, and the lenders thereunder (the "Wachovia Loan"). As
of December 31, 2002, the principal amount of $30 million was outstanding under
the Wachovia Loan. See "Item 7 - Management's Discussion and Analysis of
Financial Condition and Results of Operation - Financial Condition - Liquidity
and Capital Resources" for a full description of the terms and provisions of the
Wachovia Loan.
It is increasingly common for our assumed reinsurance contracts to
contain terms that would allow our clients to cancel the contract if we are
downgraded below various rating levels by one or more rating agencies. Whether a
client would exercise such rights would depend, among other things, on the
reasons for such a downgrade, the extent of the downgrade, the prevailing market
conditions, and the pricing and availability of replacement reinsurance
coverage. We cannot predict in advance whether and how many of our clients would
actually exercise such rights or what effect such cancellations would have on
our financial condition or future prospects, but such an effect could
potentially be materially adverse.
In addition, certain of our excess of loss reinsurance contracts
require us to transfer premiums currently retained by us on a funds withheld
basis into a trust for the benefit of the reinsurers if A.M. Best were to
downgrade us below "A-." If A.M. Best were to downgrade us to "B++" or below,
certain other ceded excess of loss reinsurance contracts contain provisions that
give the reinsurer the right to cancel the contract and require us to pay a
termination fee. The amount of the termination fee would be dependent upon
various factors, including level of loss activity.
Regulation
United States
The Company and PXRE Reinsurance are subject to regulation under the
insurance statutes of various U.S. states, including Connecticut, the
domiciliary state of PXRE Reinsurance. The regulation and supervision to which
PXRE Reinsurance is subject relates primarily to the standards of solvency that
must be met and maintained, licensing requirements for reinsurers, the nature of
and limitations on investments, deposits of securities for the benefit of a
reinsured, methods of accounting, periodic examinations of the financial
condition and affairs of reinsurers, the form and content of reports of
financial condition required to be filed, reserves for losses and other matters.
In general, such regulation is for the protection of the reinsureds and
policyholders, rather than investors.
26
In addition, the Company and PXRE Delaware are subject to regulation
under the insurance holding company statutes of various U.S. states, including
Connecticut. These laws and regulations vary from state to state, but generally
require an insurance holding company and reinsurers that are subsidiaries of an
insurance holding company to register with the state regulatory authorities and
to file with those authorities certain reports including information concerning
their capital structure, ownership, financial condition, and general business
operations. Moreover, PXRE Reinsurance may not enter into certain transactions,
including certain reinsurance agreements, management agreements, and service
contracts, with members of its insurance holding company system, unless it has
first notified the Connecticut Insurance Commissioner of its intention to enter
into any such transaction and the Connecticut Insurance Commissioner had not
disapproved of such transaction within the period specified by the Connecticut
insurance statute. Among other things, such related company transactions are
subject to the requirements that their terms be fair and reasonable, charges or
fees for services performed be reasonable and the interests of policyholders not
be adversely affected.
State laws also require prior notice or regulatory agency approval of
direct or indirect changes in control of an insurer, reinsurer, or its holding
company, and of certain significant inter-corporate transfers of assets within
the holding company structure. An investor who acquires or attempts to acquire
shares representing or convertible into more than 10% of the voting power of the
securities of the Company would become subject to at least some of such
regulations, would require approval by the Connecticut Insurance Commissioner
prior to acquiring such shares and would be required to file certain notices and
reports with the Connecticut Insurance Commissioner prior to such acquisition.
See "Market for Registrant's Common Equity and Related Stockholder Matters" for
a discussion of other limitations on voting and ownership of the Company's
securities contained in the Company's Bye-Laws.
The principal sources of cash for the payment of operating expenses and
income taxes, debt service obligations, and dividends by the Company are the
receipt of dividends and net tax allocation payments from PXRE Reinsurance, PXRE
Bermuda and PXRE Barbados. Under the Connecticut insurance laws, the maximum
amount of dividends or other distributions that PXRE Reinsurance may declare or
pay within any twelve-month period, without regulatory approval, is limited to
the lesser of (a) earned surplus or (b) the greater of 10% of policyholders
surplus at December 31 of the preceding year or 100% of net income for the
twelve-month period ended December 31 of the preceding year, all determined in
accordance with SAP. Accordingly, the Connecticut insurance laws could limit the
amount of dividends available for distribution by PXRE Reinsurance without prior
regulatory approval, depending upon a variety of factors outside our control,
including the frequency and severity of catastrophe and other loss events and
changes in the reinsurance market, in the insurance regulatory environment and
in general economic conditions. The maximum amount of dividends or distributions
that PXRE Reinsurance may declare and pay without regulatory approval during
2003 is limited to approximately $45.7 million. During 2002, $29.4 million in
dividends were paid by PXRE Reinsurance. See below for a discussion of dividend
restrictions applicable to PXRE Bermuda and PXRE Barbados. See also
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
27
Additionally, Connecticut has adopted regulations respecting certain
minimum capital requirements for property and casualty companies, based upon a
model adopted by the National Association of Insurance Commissioners (the
"NAIC"). The NAIC assists state insurance supervisory officials in achieving
insurance regulatory objectives, including the maintenance and improvement of
state regulation. The risk-based capital regulations adopted provide for the use
of a formula to measure statutory capital and surplus needs based on the risk
characteristics of a company's products and investment portfolio to identify
weakly capitalized companies. As of December 31, 2002, PXRE Reinsurance's
surplus was $457.2 million and substantially exceeded its calculated risk-based
capital authorized control level which was $37.3 million.
Effective January 1, 2001, Connecticut required that insurance
companies domiciled in Connecticut prepare their statutory basis financial
statements in accordance with the NAIC Accounting Practices and Procedures
Manual - Version Effective as of January 1, 2001 ("Codification") subject to any
deviations prescribed or permitted by the Insurance Commissioner of the State of
Connecticut. Accounting changes adopted to conform to the provisions of
Codification are reported as an adjustment to unassigned surplus in the period
of the change in accounting principle. The cumulative effect is the difference
between the amount of capital and surplus at the beginning of the year and the
amount of capital and surplus that would have been reported at that date if the
new accounting had been applied retroactively for all prior periods. The effect
of the adoption was a decrease in statutory surplus of $2.5 million.
The NAIC's Insurance Regulatory Information System ("IRIS") was
developed by a committee of state insurance regulators and is primarily intended
to assist state insurance departments in executing their statutory mandates to
oversee the financial condition of insurance companies operating in their
respective states. IRIS identifies twelve industry ratios and specifies "usual
values" for each ratio. Departure from the usual values on four or more of the
ratios can lead to inquiries from individual state insurance commissioners as to
certain aspects of an insurer's business. For the years ended December 31, 2002,
2001 and 2000, PXRE Reinsurance's results were within the usual values for each
of the twelve ratios, except for three ratios in 2002, one ratio in 2001 and
three ratios in 2000. The three ratios that fell outside of the range in 2002
were due to (a) increases in net writings in 2002 due to the hardening market
following September 11, 2001 and the decreased net writings in 2001 due to
premiums ceded as a result of September 11, 2001, (b) decreased investment yield
associated with general market interest rate levels in 2002 and interest on
funds held, and (c) reserve deficiencies relative to surplus due to deficiencies
in PXRE's Exited Lines segment which included its direct writing unit. The one
ratio that fell outside the usual range in 2001 was due to (a) an increase in
excess of loss ceded premiums written, and (b) the statutory accounting effect
of one retroactive contract. PXRE Reinsurance's three ratios outside the usual
range in 2000 were due to (a) an increase in PXRE Reinsurance's net written
premium in 2000 as compared in 1999 due to the non-renewal in 2000 of the
intercompany pooling agreement between Transnational Insurance and PXRE
Reinsurance caused by the sale of Transnational Insurance, (b) a decrease in
investment income from certain alternative limited partnership investments in
2000 compared to 1999, and (c) the statutory accounting effect of one
retroactive reinsurance contract.
28
From time to time, various regulatory and legislative changes have been
proposed in the U.S. insurance industry, some of which could have an effect on
reinsurers and insurers. Among the proposals that have in the past been or are
at present being considered are the possible introduction of federal regulation
in addition to, or in lieu of, the current system of state regulation of
insurers, an initiative to create a federally guaranteed disaster reinsurance
pool pre-funded by insurers and proposals in various state legislatures (some of
which have been enacted) to conform portions of their insurance laws and
regulations to various model acts adopted by the NAIC. We are unable to predict
what effect, if any, the foregoing developments may have on our operations and
financial condition in the future.
Bermuda
The Insurance Act 1978 of Bermuda and related regulations
(collectively, the "Act") imposes on Bermuda insurance companies, including PXRE
Bermuda, solvency and liquidity standards and auditing and reporting
requirements, and grants to the Supervisor of Insurance powers to supervise,
investigate and intervene in the affairs of insurance companies.
The Act provides that the value of the general business assets of a
Class 3 insurer must exceed the amount of its general business liabilities by a
prescribed minimum solvency margin. PXRE Bermuda, as a Class 3 insurer, is
required to maintain a minimum solvency margin equal to the greatest of: (a) $1
million, (b) 20% of net premiums written up to $6 million, or where net premiums
are projected to exceed $6 million, $1.2 million plus 15% of net premiums
written over $6 million or (c) 15% of loss reserves. In addition, PXRE Bermuda
is prohibited from declaring or paying any dividends during any financial year
it is in breach of its minimum solvency margin or minimum liquidity ratio or if
the declaration or payment of such dividends would cause it to fail to meet such
margin or ratio. If it fails to meet its minimum solvency margin or minimum
liquidity ratio on the last day of any financial year, the insurer will be
prohibited, without the approval of the Supervisor of Insurance, from declaring
or paying any dividends during the next financial year.
As a Class 3 insurer, PXRE Bermuda also is prohibited, without the
approval of the Supervisor of Insurance, from reducing by 15% or more its total
statutory capital, as set out in its previous year's financial statements, and
if it appears to the Supervisor of Insurance that there is a risk of the insurer
becoming insolvent or that it is in breach of the Act or any conditions imposed
upon its registration, the Supervisor may, in addition to the restrictions
specified above, direct the insurer not to declare or pay any dividends or any
other distributions or may restrict it from making such payments to such extent
as the Supervisor of Insurance may think fit.
The Act provides a minimum liquidity ratio for general business. An
insurer engaged in general business is required to maintain the value of its
relevant assets at not less than 75% of the amount of its relevant liabilities.
Relevant assets include cash and time deposits, quoted investments, unquoted
bonds and debentures, first liens on real estate, investment income due and
accrued, accounts and premiums receivable and reinsurance balances receivable.
There are certain categories of assets that, unless specifically permitted by
the Supervisor of Insurance, do not automatically qualify as relevant assets
such as unquoted equity securities, investments in and advances to affiliates,
real estate and collateral loans. The relevant liabilities are total general
business insurance reserves and total other liabilities less deferred income tax
and sundry liabilities (by interpretation, those not specifically defined).
29
Under Bermuda law, PXRE Bermuda may not lawfully declare or pay a
dividend unless there are reasonable grounds for believing that it is, or will
after payment of the dividend be, able to pay its liabilities as they become
due, and that the realizable value of its assets will, after payment of the
dividend, be greater than the aggregate value of its liabilities, issued share
capital and share premium accounts.
At December 31, 2002, PXRE Bermuda's solvency and liquidity margins and
statutory capital and surplus were in excess of the minimum levels required by
the Act.
Barbados
PXRE Barbados is subject to regulation under Barbados' Insurance Act,
1996, (the "Barbados Act"). Under the Barbados Act, PXRE Barbados may only pay a
dividend out of the realized profits of the company and may not pay a dividend
unless (a) after payment of the dividend it is able to pay its liabilities as
they become due, and (b) the realizable value of its assets is greater than the
aggregate value of its liabilities and (c) the stated capital accounts are
maintained in respect of all classes of shares.
PXRE Barbados is also required to maintain assets in an amount that
permits it to meet the prescribed minimum solvency margin for the net premium
income level of its business. In respect of its general insurance business, PXRE
Barbados is required to maintain the following margin of solvency:
(i) to the extent that premium income of the preceding financial
year did not exceed US$750,000, assets must exceed liabilities
by US$125,000;
(ii) to the extent that premium income of the preceding financial
year exceeds US$750,000 but is equal to or less than US$5
million, the assets must exceed liabilities by 20% of the
premium income of the preceding financial year; and
(iii) to the extent that premium income of the preceding financial
year exceeds US$5 million, the assets must exceed liabilities
by the aggregate of US$1 million and 10% of the premium income
of the preceding financial year.
PXRE Barbados is not required at the present time to maintain any
additional statutory deposits or reserves relative to its business.
United Kingdom
PXRE Limited and PXRE Lloyd's Syndicate are subject to regulation by
Lloyd's. The form of that regulation is prescribed by the Lloyd's Act of 1982
and Lloyd's internal regulatory bye-laws and directions. The regulation and
supervision to which PXRE Limited is subject relates primarily to the
maintenance of a risk based capital requirement (by way of a deposit of
securities and a letter of credit with Lloyd's to support its underwriting) and
prescribed methods of accounting. PXRE Lloyd's Syndicate has to comply with
accounting regulation, internal reporting, and is subject to periodic
examinations of compliance. The Lloyd's market is regulated externally by the
Financial Services Authority, although the day-to-day regulation of the market
remains the responsibility of the Council of Lloyd's. All cash and invested
assets of PXRE Lloyd's Syndicate, amounting to approximately $13.6 million at
December 31, 2002, are restricted from being paid as a dividend until the run
off is completed.
30
Taxation of PXRE and its Subsidiaries
The following summary of the taxation of the Company, PXRE Bermuda,
PXRE Barbados and our U.S. subsidiaries, including PXRE Reinsurance
(collectively, the "PXRE U.S. Companies") is based upon current law.
Legislative, judicial or administrative changes may be forthcoming that could
affect this summary. See, for example, "Legislation" below. Certain subsidiaries
and branch offices of PXRE are subject to taxation related to our operations in
the United Kingdom and Belgium.
Bermuda
Under current Bermuda law, no income, withholding or capital gains
taxes are imposed on the Company or PXRE Bermuda. The Company and PXRE Bermuda
have each received an assurance from the Minister of Finance under The Exempted
Undertakings Tax Protection Act, 1966 of Bermuda, to the effect that in the
event of there being enacted in Bermuda any legislation imposing tax computed on
profits or income, or computed on any capital asset, gain or appreciation, or
any tax in the nature of estate duty or inheritance tax, then the imposition of
any such tax shall not be applicable to the Company or PXRE Bermuda or to any of
their operations or their shares, debentures or other obligations until March
28, 2016. These assurances are subject to the proviso that they are not to be
construed so as to prevent the application of any tax or duty to such persons as
are ordinarily resident in Bermuda (the Company and PXRE Bermuda are not
currently so designated) or to prevent the application of any tax payable in
accordance with the provisions of The Land Tax Act of 1967 of Bermuda or
otherwise payable in relation to the land leased to the Company or PXRE Bermuda.
The Company and PXRE Bermuda each pay annual Bermuda government fees and PXRE
Bermuda pays annual insurance license fees. In addition, all entities employing
individuals in Bermuda are required to pay a payroll tax and other sundry fees
and levies, directly or indirectly, to the Bermuda government.
Barbados
Under Barbados law, PXRE Barbados is subject to tax on its worldwide
income at the normal corporation tax rate of 40%. PXRE Barbados is allowed a tax
credit in respect of premiums from insurance business and investment income that
does not originate in Barbados ("foreign business"). To the extent that the
foreign business constitutes more than 81% of the aggregate total insurance
business and investment returns of PXRE Barbados, PXRE Barbados will be allowed
a tax credit of 93%, thereby reducing the effective tax rate in Barbados to
2.8%.
31
United States
The PXRE U.S. Companies carry on business in, and are subject to
taxation in, the United States. The Company believes that it and its
subsidiaries, other than the PXRE U.S. Companies, have operated and will
continue to operate their business in a manner that will not cause them to be
treated as engaged in a trade or business within the United States. Tax
conventions between the United States and Bermuda or Barbados may provide relief
to PXRE Bermuda and PXRE Barbados, respectively, if either such company is
deemed to be engaged in the conduct of a U.S. trade or business. Under the tax
convention between Bermuda and the United States (the "Bermuda Treaty"), a
Bermuda company predominantly engaged in the insurance business, such as PXRE
Bermuda, is subject to U.S. income tax on its insurance income found to be
effectively connected with a U.S. trade or business only if that trade or
business is conducted through a permanent establishment in the United States. As
a holding company that is not predominantly engaged directly in an insurance
business, the Company is not entitled to the benefits of the Bermuda Treaty.
Similarly, under the tax convention between Barbados and the United States (the
"Barbados Treaty"), a corporation that is a Barbados resident will not be
subject to U.S. income tax on income that is effectively connected with a U.S.
business, unless such business is conducted through a permanent establishment in
the United States. Each of the Company, PXRE Bermuda and PXRE Barbados operate
under guidelines that are intended to minimize the risk that they will be
treated as engaged in a U.S. trade or business; and each of PXRE Bermuda and
PXRE Barbados operate under guidelines that are intended to minimize the risk
that they will be found to have a U.S. permanent establishment.
On this basis, we do not expect that the Company and our subsidiaries,
other than the PXRE U.S. Companies, will be required to pay U.S. federal
corporate income taxes (other than withholding taxes on certain U.S. source
investment income and excise taxes on reinsurance premiums as described below).
However, irrespective of such guidelines, there can be no assurance that PXRE
Bermuda and PXRE Barbados will qualify for the Bermuda Treaty and the Barbados
Treaty, respectively, now or in the future, or that the Bermuda Treaty or the
Barbados Treaty will not be terminated or revised in a manner that could
adversely affect any protection from U.S. corporate tax that they currently
provide. In addition, because there is uncertainty as to the activities that
constitute being engaged in a trade or business in the United States, there can
be no assurances that the U.S. Internal Revenue Service will not contend
successfully that the Company or a non-U.S. subsidiary is engaged in a trade or
business in the United States. The maximum federal tax rates currently are 35%
for a corporation's income that is effectively connected with a trade or
business in the United States. In addition, the U.S. branch profits tax of 30%
is imposed each year on a foreign (or non-U.S.) corporation's earnings and
profits (with certain adjustments) effectively connected with its U.S. trade or
business that are deemed repatriated out of the United States, for a potential
maximum effective tax rate of approximately 55% on the net business connected
with a U.S. trade or business.
The Company and its non-U.S. subsidiaries are subject to U.S.
withholding tax at the 30% rate on certain "U.S. source investment income,"
which is not considered effectively connected with the conduct of a U.S. trade
or business. This rate is reduced under the Barbados Treaty, to 5% for dividends
paid to PXRE Barbados by our U.S. subsidiaries.
32
The United States also imposes an excise tax on insurance and
reinsurance premiums paid to foreign insurers or reinsurers with respect to
risks located in the United States. The rate of tax applicable to reinsurance
premiums paid to PXRE Bermuda and PXRE Barbados is 1% of gross premiums.
Legislation
In March, 2002 two bills were proposed in the U.S. House of
Representatives that seek to prevent so-called "corporate inversion"
transactions. Under these bills, a foreign corporation would be taxed as a U.S.
domestic corporation under the Internal Revenue Code if it became a foreign
corporation as a result of an "inversion transaction" under the bill proposed by
Representative McInnis or "corporate expatriation transaction" under the bill
proposed by Representative Neal. As originally drafted, the McInnis bill would
only apply to transactions completed after December 31, 2001. Commencing with
the 2004 tax year, the Neal bill would apply to "corporate expatriation
transactions" that occurred prior to September 11, 2001. It is unclear whether
our 1999 reorganization would be treated as a "corporate expatriation
transaction" under the Neal bill as originally drafted. Neither bill was acted
on in 2002.
In January 2003, two bills were introduced into Senate (S.9, by Sen.
Daschle and S.135, by Sen. Dayton), which would treat certain foreign
corporations created through inversion transactions as domestic corporations. In
February 2003, Senators Reid and Levin introduced a bill into the Senate that
closely mirrors Representative Neal's 2002 bill.
We are unable to predict whether the effort to enact either of the
current legislative proposals to amend the Internal Revenue Code will be
successful, what form any legislation may ultimately take and what impact any
such legislation would have on us.
Employees
We employed 61 full-time employees at December 31, 2002. No employees
are represented by a labor union, and management considers its relationship with
our employees to be excellent.
A significant number of PXRE Bermuda employees, including senior
management of the Company and PXRE Bermuda, are employed pursuant to work
permits granted by Bermuda authorities. These permits expire at various times
over the next few years. We have no reason to believe that these permits would
not be extended at expiration upon request, although no assurance can be given
in this regard.
Available Information
We file annual, quarterly and current reports, proxy statements and
other information with the SEC. You may read and copy any documents we file at
the SEC's public reference room at room 1024, 450 Fifth Street, NW, Washington,
D.C. 20549. Please call the SEC at 1-800-SEC-0330 for information on the public
reference room. The SEC maintains a website that contains annual, quarterly and
current reports, proxy statements and other information that we file
electronically with the SEC. The SEC's website is http://www.sec.gov.
33
We maintain an Internet website at http://www.pxregroup.com. We make
available free of charge on our website our annual report on Form 10-K, our
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) of the Securities
Exchange Act of 1934 as soon as practicable after we electronically file such
material with, or furnish it to, the SEC. The information on our website is not
incorporated by reference into this report.
Item 2. Properties
The Company leases office space in Bermuda where the Company's
principal executive offices are located, and in Edison, New Jersey, where PXRE
Reinsurance's principal offices are located. We also lease office space in
Brussels, Belgium. Our properties are leased on terms and for durations that are
reflective of commercial standards in the communities where these properties are
located. The Company believes the facilities it occupies are adequate for the
purposes for which they are currently used and are well maintained.
Item 3. Pending Legal Proceedings
We are subject to litigation and arbitration in the ordinary course of
business. Except as disclosed below, management does not believe that the
eventual outcome of any such pending litigation or arbitration is likely to have
a material effect on our financial condition or business. Pursuant to our
insurance and reinsurance arrangements, disputes are generally required to be
finally settl