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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, 2003 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 June 30, 2003 computed by reference to
the closing price of such common equity as of the close of business on June 30,
2003 was $240,950,615. As of March 11, 2004, 14,063,868 of the registrant's
common shares were issued and outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of PXRE Group Ltd.'s definitive Proxy Statement for the Annual General
Meeting of Shareholders to be held on May 5, 2004 are incorporated by reference
into Part III of this Form 10-K to the extent stated herein. Additionally,
certain documents are incorporated by reference into Part IV of this Form 10-K
as stated therein.
2
PART I
Unless the context otherwise requires, references in this Form 10-K to
"PXRE", "we", "us" and "our" include PXRE Group Ltd., a Bermuda company (the
"Company") and its subsidiaries, which principally include PXRE Corporation
("PXRE Delaware"), PXRE Reinsurance Company ("PXRE Reinsurance"), PXRE
Reinsurance Ltd. ("PXRE Bermuda"), PXRE Reinsurance (Barbados) Ltd. ("PXRE
Barbados"), PXRE Solutions Inc. ("PXRE Solutions"), PXRE Solutions, S.A. ("PXRE
Europe"), PXRE Capital Trust I, PXRE Capital Statutory Trust II, PXRE Capital
Trust III, PXRE Capital Statutory Trust V, PXRE Capital Trust VI and PXRE
Limited. 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, as applicable.
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, speak only as of the date
hereof, and are subject to risk and uncertainties. In light of the risks and
uncertainties inherent in all future projections, these 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) because of exposure to catastrophes, our financial results may
vary significantly from period to period;
(ii) we may be overexposed to losses in certain geographic areas
for certain types of catastrophe events;
(iii) we operate in a highly competitive environment;
(iv) reinsurance prices may decline, which could affect our
profitability;
(v) underwriting reinsurance includes the application of judgment,
the assessment of probabilities and outcomes, and assumption
of correlations, which are subject to inherent uncertainties;
3
(vi) reserving for losses includes significant estimates which are
also subject to inherent uncertainties;
(vii) a decline in the credit rating assigned to our claim-paying
ability may impact our potential to write new or renewal
business;
(viii) a decline in our ratings may require us to transfer premiums
retained by us into a beneficiary trust or may allow clients
to terminate their contract with us;
(ix) our investment portfolio is subject to market and credit risks
which could result in a material adverse impact on our
financial position or results;
(x) because we depend on a few reinsurance brokers for a large
portion of revenue, loss of business provided by them could
adversely affect us; and our reliance on reinsurance brokers
exposes us to their credit risk;
(xi) we may be adversely affected by foreign currency fluctuations;
(xii) retrocessional reinsurance subjects us to credit risk and may
become unavailable on acceptable terms;
(xiii) the impairment of our ability to provide collateral to cedents
could affect our ability to offer reinsurance in certain
markets;
(xiv) the reinsurance business is historically cyclical, and we may
experience periods with excess underwriting capacity and
unfavorable premium rates; conversely, we may have a shortage
of underwriting capacity when premium rates are strong;
(xv) regulatory constraints may restrict our ability to operate our
business;
(xvi) contention by the United States Internal Revenue Service that
we or our offshore subsidiaries are subject to U.S. taxation
could result in a material adverse impact on our financial
position or results; and
(xvii) changes in tax laws, tax treaties, tax rules and
interpretations could result in a material adverse impact on
our financial position or results.
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 Management's Discussion and Analysis of Financial Condition and
Results of Operations - Certain Risks and Uncertainties.
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.
4
Item 1. Business
Business: Overview
PXRE Group Ltd. is an insurance holding company domiciled in Bermuda.
We provide reinsurance products and services to a worldwide marketplace through
our wholly owned subsidiary operations located in Bermuda, Barbados, Europe and
the United States. Our primary business is catastrophe and risk excess
reinsurance, which accounted for 93% of net premiums written and substantially
all of our underwriting income for the year ended December 31, 2003.
Our property catastrophe and risk excess business includes property
catastrophe excess of loss, property catastrophe retrocessional, property risk
excess, marine excess and aerospace excess and pro rata reinsurance products.
Catastrophe and risk excess business has been our primary focus since our
predecessor company was formed in 1986. This focus on short-tail, high-severity,
and low frequency lines of business exposes us to short term volatility. We have
been able to successfully underwrite these products over the long term, as
evidenced by our cumulative average catastrophe and risk excess loss ratio of
47.0% for the period from 1987 to December 31, 2003. Our strong growth in net
premiums written in our catastrophe and risk excess segment of 46% for the year
ended December 31, 2003 as compared with the year earlier period has served as a
catalyst for our recent increase in net income of 50% for the year ended
December 31, 2003 as compared with 2002. Our growth in 2003 builds on the prior
growth of net premiums written in the catastrophe and risk excess segment during
the year ended December 31, 2002 of 202%, as compared with 2001.
Property catastrophe reinsurance generally covers claims arising from
large catastrophes around the world such as hurricanes, windstorms, hailstorms,
earthquakes, volcanic eruptions, fires, industrial explosions, freezes, riots,
floods and other man-made or natural disasters. In underwriting our property
catastrophe portfolio, we seek to diversify our exposures geographically and by
peril in order to manage the risk assumed and maximize the return on our
portfolio. Substantially all of our property catastrophe reinsurance products
are offered on an excess-of-loss basis with aggregate limits on our exposure to
losses. This means that we do not begin to pay a client's claims until its
claims exceed a certain contractually specified amount and our obligation to pay
those claims is limited to a contractually specified aggregate amount. For the
year ended December 31, 2003, approximately 77% of our property catastrophe and
risk excess net premiums written emanated from clients located outside of North
America, including clients located in the United Kingdom, Continental Europe,
Latin America, the Caribbean, Australia and Asia.
We provide property catastrophe products to both insurers and
reinsurers. The reinsurance of a reinsurer or retrocedent is referred to as
retrocessional reinsurance. As of December 31, 2003, insurance and reinsurance
companies comprise approximately 78% and 22%, respectively, of our total number
of clients, based on client count. Retrocessional business generally carries
substantially higher risk premiums than property catastrophe reinsurance
business. We believe this risk premium is required because retrocessional
coverage is characterized by higher volatility, principally due to the fact that
retrocessional contracts expose a reinsurer to an aggregation of losses from a
single catastrophic event. In addition, the information available to
retrocessional underwriters concerning the original primary risk is often less
precise than the information received from primary insurers directly. Moreover,
exposures from retrocessional business can change within a contract term as a
retrocedent alters its book of business after retrocessional coverage has been
bound. Relative to catastrophe reinsurance, there are substantially fewer
competitors offering this type of coverage due to the risks entailed in
underwriting retrocessional business.
5
We have been able to achieve a significant position in the property
catastrophe retrocessional market and have considerable experience in
successfully underwriting property catastrophe retrocessional business. We have
developed proprietary risk models that take into account the lack of
transparency in the underwriting information and allow us to view this business
within the context of our entire portfolio. Our tenure in this business has
allowed us to develop the relationships and market knowledge necessary to manage
the risk associated with a retrocedent's alteration of its book of business
after we have bound coverage.
We also offer our clients property-per-risk, marine and aerospace
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 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 aerospace business is
also written on an excess-of-loss basis with contractual aggregate limits on our
exposure to losses. Our aerospace reinsurance business includes both excess of
loss aviation business and excess of loss and pro rata satellite reinsurance
business.
We also provide, to a lesser extent and on an opportunistic basis,
finite reinsurance products to a small number of clients. 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
through, for example, increased premiums or reductions in profit commissions. In
addition, we offer finite reinsurance products where investment returns on the
funds transferred to us affect the profitability of the contract and the amount
of any premium or commission adjustments.
Recent events in the insurance marketplace, including large losses
resulting from catastrophic events, recognized industry-wide reserve
deficiencies, poor investment performance and the continued exit of insurance
industry players, have resulted in considerable increases in pricing in
conjunction with improved terms and conditions for the insurance industry.
Importantly, this has impacted our markets considerably. As a direct result, we
experienced significant rate increases and strong profitability in our core
property catastrophe and risk excess segment for the years ended December 31,
2003 and 2002.
Following a diversification effort into Lloyd's of London ("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. We have exited or have
significantly de-emphasized all of our other lines of business in order to
concentrate our management and financial resources on our core operations. We
believe that this strategic and financial realignment positions us to capitalize
on opportunities in our most profitable business segments, based on our
underwriting strength and industry experience. While our core businesses are
volatile due to significant potential loss severity, we have been a successful
underwriting organization over the long term.
6
As of December 31, 2003, we had 413 clients, including many of the
leading insurance and reinsurance companies in the world. Our clients include
both primary insurance companies and other reinsurance companies. In 2003,
approximately 67% of our clients were based outside of the United States.
We conduct our business primarily through our principal operating
subsidiaries, PXRE Reinsurance, PXRE Bermuda, PXRE Barbados, PXRE Solutions and
PXRE Europe. PXRE Reinsurance is a broker-market reinsurer with approximately
$425.2 million of statutory capital and surplus as of December 31, 2003, which
principally underwrites treaty reinsurance for property (including marine and
aerospace) risks. PXRE Reinsurance is licensed, accredited or permitted to do
business in each of the 50 states and the District of Columbia, Puerto Rico,
Bermuda, Colombia, Mexico and until January 31, 2003 operated a branch in
Belgium, which we refer to as PXRE's Brussels Branch.
PXRE Bermuda is a broker-market reinsurer with approximately $425.8
million of statutory capital and surplus as of December 31, 2003, 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 $80.0 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 at that time 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.
Business: History
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.
7
The Company's predecessor, PXRE Delaware, was organized in July 1986 to
succeed, through PXRE Reinsurance, to the property and casualty reinsurance
business carried on since 1982 by Phoenix General Insurance Company.
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: the
establishment of a Lloyd's underwriting syndicate and managing agent; the
establishment of an excess and surplus lines operation; the addition of a
reinsurance platform offering primarily casualty products directly to insurance
companies (rather than through reinsurance brokers); the enhancement of our
international broker market reinsurance platform to include additional lines of
business, including casualty and credit risks; an acceleration of business
offerings to one of our managed business participants; and the formation of a
finite reinsurance unit.
As a result of this strategic realignment in the third quarter of 2001,
we discontinued or deemphasized each of those initiatives and since 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 72 at December
31, 2003.
Business: 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 property
catastrophe and risk excess business. Businesses that were not continued in 2002
are reported as exited lines. PXRE's segments for 2001 were reclassified to be
comparable to the 2003 and 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.
There are no differences among the accounting policies of the segments
as compared to PXRE's consolidated financial statements.
PXRE does not maintain separate balance sheet data for each of its
operating segments nor does it allocate net investment income, net realized
investment gains or losses, operating expenses and financing costs to these
segments. Accordingly, PXRE does not review and evaluate the financial results
of its operating segments based upon balance sheet data and these other income
statement items.
8
Operating Segments-Catastrophe and Risk Excess
Our key business is our catastrophe and risk excess business. Our
catastrophe and risk excess portfolio consists principally of property
catastrophe excess of loss, property catastrophe retrocessional, property risk
excess, marine excess and aerospace excess reinsurance coverages, which together
account for approximately 79% and 65%, respectively, of net premiums earned for
the year ended December 31, 2003 and 2002 and virtually all of the net
underwriting income for each of those periods. This portfolio can be
characterized as being comprised of coverages involving higher expected margins
and greater volatility than the other coverages that we underwrite.
Net premiums written in this key segment were $257.6 million and $176.0
million for the year ended December 31, 2003 and 2002, respectively. In 2003 and
2002, this segment produced an underwriting profit of $156.3 million and $108.1
million, respectively. In 2001, this segment produced underwriting losses of
$10.3 million, largely as a result of the September 11, 2001 terrorist attacks
in 2001. The increase in premium volume for catastrophe and risk excess
coverages in 2003 and 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 winter wind storms in France.
Our property catastrophe and risk excess business is diversified
geographically. For 2003 and 2002, approximately 77% and 75%, respectively, of
our catastrophe and risk excess net premiums written were derived from clients
located outside of North America, including clients located in the United
Kingdom, Continental Europe, Latin America, the Caribbean, Australia and Asia.
9
The following table presents net premiums written, net premiums earned,
losses incurred, commission and brokerage, net of fee income and our
underwriting income (loss) for the periods indicated under our catastrophe and
risk excess segment.
Catastrophe and risk excess segment: Year Ended December 31,
-------------------------------------------------
2003 2002 2001
------------ ------------ --------------
($000's)
Net Premiums Written (1)
North American $ 64,560 $ 51,657 $ 27,981
International 220,380 153,038 90,714
Excess of Loss Cessions (27,320) (28,652) (60,485)
------------ ------------ --------------
$ 257,620 $ 176,043 $ 58,210
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Net Premiums Earned (1)
North American $ 64,212 $ 50,487 $ 26,916
International 217,310 148,650 92,407
Excess of Loss Cessions (27,325) (23,052) (58,839)
------------ ------------ --------------
$ 254,197 $ 176,085 $ 60,484
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Losses Incurred
North American $ 20,090 $ 2,586 $ 57,537
International 49,606 53,086 102,640
Excess of Loss Cessions (625) (2,901) (86,758)
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$ 69,071 $ 52,771 $ 73,419
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Commissions and Brokerage,
Net of Fee Income
North American $ 5,952 $ 4,262 $ 1,119
International 19,794 14,697 6,425
Excess of Loss Cessions 3,062 (3,768) (10,198)
------------ ------------ --------------
$ 28,808 $ 15,191 $ (2,654)
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Underwriting Income (Loss) (2)
North American $ 38,170 $ 43,639 $ (31,740)
International 147,910 80,867 (16,658)
Excess of Loss Cessions (29,762) (16,383) 38,117
------------ ------------ --------------
$ 156,318 $ 108,123 $ (10,281)
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(1) Premiums written and earned are expressed on a net basis in order
to more accurately reflect business written for our own account.
The amounts shown in the North American and International
geographic segments are presented net of proportional reinsurance
and allocated excess of loss reinsurance cessions, but gross of
corporate catastrophe excess of loss reinsurance cessions, which
are separately itemized where applicable.
(2) Underwriting income (loss) includes premiums earned, losses
incurred and commission and brokerage net of fee income, but does
not include investment income, net realized investment gains or
losses, interest expense, or operating expenses. See Note 12 of
our consolidated financial statements for additional information
regarding our reportable segments and geographic areas.
10
Property Catastrophe Excess of Loss Reinsurance. Our property
catastrophe excess of loss reinsurance business reinsures catastrophic perils
for insurance companies on a treaty basis and provides protection for most
catastrophic losses that are covered in the underlying insurance policies
written by our clients. The perils in our portfolio underlying the North
American portion of this segment emanate principally from East Coast and Gulf
hurricanes and Midwest and West Coast earthquakes. The perils underlying the
International portion of this segment emanate principally from European,
Japanese and Caribbean windstorm, flood and earthquake risks, and similar risks.
Although we generally seek to exclude coverage for terrorist events, we are
potentially exposed to losses arising from terrorist attacks. This business is
generally comprised of reinsurance contracts that incur losses only when events
occur that impact more than one risk or insured. Coverage for other perils may
be negotiated on a case-by-case basis. Protection under property catastrophe
treaties is generally provided on an occurrence basis, allowing our ceding
company clients to combine losses that have been incurred in any single event
from multiple underlying policies. The multiple claimant nature of property
catastrophe reinsurance requires careful monitoring and control of cumulative
aggregate exposure.
The property catastrophe excess of loss reinsurance business operates
on a subscription basis, with the reinsurance intermediaries seeking
participation for specific treaties among a number of reinsurers. All
subscribing reinsurers participate at substantially the same pricing and terms
and conditions.
Property Catastrophe Retrocessional Reinsurance. We enter into
retrocessional contracts that provide property catastrophe coverage to other
reinsurers or retrocedents. In providing retrocessional coverage, we focus on
reinsurance that covers the retrocedent on an excess of loss basis when
aggregate claims and claim expenses from a single occurrence of a covered peril
and from a multiple number of reinsureds exceed a contractually specified
attachment point. The coverage provided under excess of loss retrocessional
contracts may be on a worldwide basis or limited in scope to selected geographic
areas. Coverage can also vary from "all property" perils to limited coverage on
selected perils, such as "earthquake only" coverage.
Retrocessional coverage is characterized by high volatility,
principally because retrocessional contracts expose a reinsurer to an
aggregation of losses from a single catastrophic event. In addition, the
information available to retrocessional underwriters concerning the original
primary risk can be less precise than the information received from primary
companies directly. Moreover, exposures from retrocessional business can change
more quickly than on catastrophe business within a contract term if a
retrocedent alters its book of business after retrocessional coverage has been
bound.
We have been able to achieve a significant position in the property
catastrophe retrocessional market and have considerable experience in
successfully underwriting property catastrophe retrocessional business. We have
developed proprietary risk models that take into account the lack of
transparency in the underwriting information and allow us to view this business
within the context of our entire portfolio. Our tenure in this business has
allowed us to develop the relationships and market knowledge necessary to manage
the risk associated with a retrocedent's alteration of its book of business
after we have bound coverage.
11
Property Risk Excess Reinsurance. Our property risk excess business
reinsures individual property risks of ceding companies on a treaty basis. This
business is comprised of a highly diversified portfolio of property risk excess
reinsurance contracts covering claims from individual insurance policies issued
by our ceding company clients. Loss exposures in this business include the
perils of fire, explosion, collapse, riot, vandalism, wind, tornado, flood and
earthquake. For the year ended December 31, 2003, approximately 22% of the
clients reinsured by us in this business were located in North America and
approximately 78% were located internationally, based on net premiums written.
Because the reinsurance contracts written in this business are exposed
to losses on an individual policy basis, we underwrite and price the agreements
based on anticipated claims frequency. We use actuarial techniques to examine
our ceding companies' underwriting results as well as the underwriting results
from ceding companies with comparable books of business and pertinent industry
results. These experience analyses are compared against actuarial exposure
analyses to refine our pricing assumptions. Our pricing also takes into account
our variable and fixed expenses and our assessment of an appropriate return on
the capital required to support each individual contract relative to our
portfolio of risks.
Reinsurance contracts that provide coverage of individual underlying
insurance policies may contain significant risk of accumulation of exposures to
natural or other perils. Our underwriting process explicitly recognizes these
exposures. Natural perils, such as windstorm, earthquake and flood, are analyzed
through our catastrophe modeling system. Other perils, such as fire and
terrorism events, are considered on a contract-by-contract basis and monitored
for cumulative aggregate exposure.
This property per risk business operates as a subscription market.
Those reinsurers that ultimately subscribe to any given treaty participate at
substantially the same pricing and terms and conditions.
Aerospace Reinsurance. Our aerospace business includes hull, aircraft
liability, aircraft products and space coverages. We write all of these
exposures as reinsurance and retrocessional coverages. In all cases, we track
our exposures by original insured in order to monitor our maximum exposures by
major airline and by major manufacturer. The space business includes satellite
launch and limited in-orbit coverage. We write space business on an excess of
loss and on a proportional reinsurance basis where we seek to provide
retrocessional support to underwriters that have demonstrated a positive track
record in this business.
Marine Reinsurance. The marine portfolio is currently very limited and
provides retrocessional coverage primarily against large insured market losses
in the offshore energy, protection and indemnity, and pollution business
segments.
Operating Segments-Finite Business
We entered the finite business in mid-1999 with products combining
elements of insurance risk transfer and financing to manage certain risks of our
clients. Due to our small size, we pursued a niche focus on smaller to
medium-sized clients. We believe we have maintained a disciplined underwriting
approach, eschewing riskier transactions and opportunistically ceding business
to other reinsurers to reduce timing and investment risks where appropriate.
12
Our finite business involves a relatively small number of large
reinsurance transactions. The risks reinsured are primarily casualty risks and
are subject to some of the same risks as our casualty coverages included in our
exited lines segment. Net premiums written of $8.1 million and $102.8 million
were attributable to our finite business in 2003 and 2002, respectively. In
2003, the finite segment produced an underwriting loss of $10.0 million compared
to underwriting profits of $2.5 million and $2.9 million in 2002 and 2001,
respectively. Included in the finite segment in 2002 were net premiums written
of $83.8 million and underwriting income of $3.0 million, assumed pursuant to
various finite reinsurance contracts with one insurance company, Tower Insurance
Company of New York ("Tower"). In 2003, there were no net premiums written and
an underwriting loss of $0.1 million pursuant to various finite reinsurance
contracts with Tower.
The significant decrease in net premiums written in the finite segment
during 2003 is a result of our decision to emphasize our core property
reinsurance business and to de-emphasize our finite segment. This business is
currently focused on a limited group of cedents as well as on policies that do
not contain significant risk transfer. As a result, finite premiums are expected
to be less than in prior periods. Finite contracts that do not contain
sufficient risk transfer are not recorded as reinsurance arrangements but are
treated as deposits for accounting purposes. As such, the income related to
these transactions is recorded as fee income, and liabilities, if any, are
recorded as deposit liabilities. As of December 31, 2003, we have $7.6 million
of unearned fee income and $80.6 million of deposit liabilities to ceding
companies on this deposit accounting basis compared to $3.0 million of unearned
fee income and $35.1 million of deposit liabilities as of December 31, 2002.
13
The following table presents net premiums written, net premiums earned,
losses incurred, commissions and brokerage, net of fee income and our
underwriting income (loss) for the periods indicated under our finite segment.
Finite segment: Year Ended December 31,
-------------------------------------------------
2003 2002 2001
------------ ------------ --------------
($000's)
Net Premiums Written (1)
North American $ 8,064 $ 102,754 $ 33,651
International - - -
------------ ------------ --------------
$ 8,064 $ 102,754 $ 33,651
============ ============ ==============
Net Premiums Earned (1)
North American $ 53,689 $ 57,107 $ 32,365
International - - -
------------ ------------ --------------
$ 53,689 $ 57,107 $ 32,365
============ ============ ==============
Losses Incurred
North American $ 52,253 $ 31,346 $ 20,261
International - - -
------------ ------------ --------------
$ 52,253 $ 31,346 $ 20,261
============ ============ ==============
Commissions and Brokerage,
Net of Fee Income
North American $ 11,475 $ 23,217 $ 9,160
International - - -
------------ ------------ --------------
$ 11,475 $ 23,217 $ 9,160
============ ============ ==============
Underwriting Income (Loss) (2)
North American $ (10,039) $ 2,544 $ 2,944
International - - -
------------ ------------ --------------
$ (10,039) $ 2,544 $ 2,944
============ ============ ==============
================================================================================
(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 fee income, but does not include
investment income, net realized investment gains or losses, interest
expense, or operating expenses. See Note 12 of our consolidated
financial statements for additional information regarding our
reportable segments and geographic areas.
Operating Segments-Other Lines
In 2003 and 2002, our other lines segment primarily consisted of a
single property pro rata reinsurance treaty between us and the FM Global group
of companies that generated $8.6 million and $7.9 million, respectively, in net
premiums written. Our other lines segment produced underwriting income of $3.1
million and $4.3 million, in 2003 and 2002, respectively compared to an
underwriting loss of $1.3 million for 2001. With the return to our core lines of
business, we do not currently expect to write a significant volume of premium in
our other lines segment in the future.
14
The following table presents net premiums written, net premiums earned,
losses incurred, commissions and brokerage, net of fee income and our
underwriting income (loss) for the periods indicated under our other lines
segment.
Other lines segment: Year Ended December 31,
-------------------------------------------------
2003 2002 2001
------------ ------------ --------------
($000's)
Net Premiums Written (1)
North American $ 7,361 $ 7,822 $ 4,086
International 1,242 83 404
------------ ------------ --------------
$ 8,603 $ 7,905 $ 4,490
============ ============ ==============
Net Premiums Earned (1)
North American $ 6,911 $ 8,002 $ 3,434
International 955 143 479
------------ ------------ --------------
$ 7,866 $ 8,145 $ 3,913
============ ============ ==============
Losses Incurred
North American $ 2,789 $ 900 $ 2,760
International 192 111 1,404
------------ ------------ --------------
$ 2,981 $ 1,011 $ 4,164
============ ============ ==============
Commissions and Brokerage,
Net of Fee Income
North American $ 1,679 $ 2,724 $ 1,059
International 128 90 9
------------ ------------ --------------
$ 1,807 $ 2,814 $ 1,068
============ ============ ==============
Underwriting Income (Loss) (2)
North American $ 2,443 $ 4,378 $ (385)
International 635 (58) (934)
------------ ------------ --------------
$ 3,078 $ 4,320 $ (1,319)
============ ============ ==============
================================================================================
(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 fee income, but does not include
investment income, net realized investment gains or losses, interest
expense, or operating expenses. See Note 12 of our consolidated
financial statements for additional information regarding our
reportable segments and geographic areas.
Operating Segments-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, all business
written through PXRE Lloyd's Syndicate 1224, and credit coverages. During the
third quarter of 2000, we ceased accepting new and renewal risks at PXRE Lloyd's
Syndicate 1224. We ceased underwriting virtually all of the other business
within the exited lines segment in 2001 and all premiums written and earned
relate to reinsurance contracts that were entered into prior to September 2001,
but for which coverage had not expired. The exited lines segment accounted for
$4.1 million and $7.8 million of net premiums written in 2003 and 2002,
respectively. Net premiums written for the year ended December 31, 2002 for this
segment decreased 87% from net premiums written for 2001. The premiums for
virtually all of these contracts have now been earned and we do not expect to
report a material amount of premiums in this segment in 2004. In 2003, 2002 and
2001, the exited lines segment produced underwriting losses of $29.2 million,
$22.4 million and $5.0 million, respectively.
15
The following table presents net premiums written, net premiums earned,
losses incurred, commissions and brokerage, net of fee income and our
underwriting income (loss) for the periods indicated under our exited lines
segment.
Exited lines segment: Year Ended December 31,
-------------------------------------------------
2003 2002 2001
------------ ------------ --------------
($000's)
Net Premiums Written (1)
North American $ 997 $ 8,501 $ 33,679
International 3,127 (720) 24,448
------------ ------------ --------------
$ 4,124 $ 7,781 $ 58,127
============ ============ ==============
Net Premiums Earned (1)
North American $ 1,982 $ 18,844 $ 33,109
International 3,199 9,179 32,254
------------ ------------ --------------
$ 5,181 $ 28,023 $ 65,363
============ ============ ==============
Losses Incurred
North American $ 23,905 $ 33,831 $ 24,346
International 10,278 7,903 29,512
------------ ------------ --------------
$ 34,183 $ 41,734 $ 53,858
============ ============ ==============
Commissions and Brokerage,
Net of Fee Income
North American $ (121) $ 5,295 $ 6,740
International 357 3,351 9,738
------------ ------------ --------------
$ 236 $ 8,646 $ 16,478
============ ============ ==============
Underwriting Income (Loss) (2)
North American $ (21,802) $ (20,282) $ 2,023
International (7,436) (2,075) (6,996)
------------ ------------ --------------
$ (29,238) $ (22,357) $ (4,973)
============ ============ ==============
================================================================================
(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 fee income, but does not include
investment income, net realized investment gains or losses, interest
expense, or operating expenses. See Note 12 of our consolidated
financial statements for additional information regarding our
reportable segments and geographic areas.
16
Business: Underwriting
We pursue a core strategy of leveraging the specialized analytical and
underwriting expertise of our reinsurance professionals in short-tail,
high-severity, and low frequency lines of business. Our underwriting process
emphasizes a team approach among our underwriters 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.
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. Our software tools use exposure data provided by
our ceding company clients to simulate catastrophic losses. We have high
standards for the quality and level of detail of the exposure data that we
require and have an expressed preference for data at the zip code or postal code
level or finer.
Data output from the commercial modeling software is incorporated in
our proprietary model for multiple purposes. First, the data is used to estimate
the amount of reinsurance premium that is required to pay the long-term expected
losses under the proposed contracts. Second, the data is used to estimate
correlation among the contracts we have written. The degree of correlation is
used to estimate the incremental capital required to support our participation
on each proposed contract. Finally, the data is used to monitor and control our
cumulative exposure to individual perils across all of our businesses. 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 real-time assessment of the portfolio.
Our pricing of property catastrophe reinsurance contracts is based on a
combination of modeled loss estimates, actual ceding company loss history,
surcharges for potential unmodeled exposures, fixed and variable expense
estimates and profit requirements. The profit requirements are based on
incremental capital usage estimates described above and our required return on
consumed capital.
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.
17
Business: 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 is 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.
In 2003 and 2002, approximately 96% and 97%, respectively, of gross
premiums written were written in the broker market. Approximately 78% of gross
premiums written for the year ended December 31, 2003 were arranged through
brokers individually representing 10% or more of gross premiums written
including Benfield Greig Ltd. (approximately 27%), the worldwide branch offices
of Guy Carpenter & Company, Inc., a subsidiary of Marsh & McLennan Companies,
Inc. (approximately 21%), Willis Re Inc. (approximately 16%), and Aon Group Ltd.
(approximately 15%). The commissions we paid to these intermediaries are
generally at the same rates as those paid to other intermediaries.
Business: 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.
18
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.
In particular, we compete with reinsurers that provide property-based
lines of reinsurance, such as ACE Tempest Reinsurance Ltd., Arch Reinsurance
Ltd., Aspen Insurance Holdings Limited, AXIS Reinsurance Company, Converium
Reinsurance (North America), Inc., Endurance Specialty Insurance Ltd., Everest
Reinsurance Company, IPC Re Limited, Lloyd's of London syndicates, Montpelier
Reinsurance Ltd., Munich Reinsurance Company, Partner Reinsurance Company Ltd.,
Platinum Underwriters Reinsurance, Inc., Renaissance Reinsurance Ltd., Swiss
Reinsurance Company and XL Re Ltd. Competition varies depending on the type of
business being insured or reinsured and whether we are in a leading position or
acting on a following basis.
It is difficult to accurately measure the annual industry premium
related to catastrophe and risk excess reinsurance; and therefore, difficult to
measure PXRE's share of this market. Several factors contribute to this lack of
market information, including the fact that catastrophe reinsurance is often
written by non-public reinsurance companies and public multi-line reinsurance
companies often do not disclose the amount that they write. While we have access
to the transactions presented to us, we do not have access to all of the
transactions in the market. Furthermore, we may not know the final outcomes of
all business submitted to PXRE due to (i) not receiving allocations on all
business authorized and (ii) not authorizing all business submitted. We do know
however our share of business that we have bound. For the recent January 1, 2004
renewals, our dollar weighted average is approximately 4% of the total. We
believe our market share is significantly less than 4% due to the reasons listed
above, especially related to PXRE not having access to all business transacted.
Business: Ceded Reinsurance Agreements
We selectively increase our underwriting commitments and generate fee
income by retroceding some of our underwritten risks to other reinsurers through
various retrocessional arrangements. Our underwriting committee is responsible
for the selection of reinsurers as quota share reinsurers 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.
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:
19
Year Ended December 31,
-----------------------------------------------
($000's) 2003 2002 2001
------------ ------------ ------------
Gross premiums written $ 339,140 $ 366,768 $ 290,213
Reinsurance premiums ceded:
Quota share reinsurers (27,919) (31,699) (50,271)
Finite segment 584 (7,466) (13,573)
Catastrophe coverage, surplus reinsurance and other (33,394) (33,120) (71,891)
------------ ------------ ------------
Total reinsurance premiums ceded (60,729) (72,285) (135,735)
------------ ------------ ------------
Net premiums written $ 278,411 $ 294,483 $ 154,478
============ ============ ============
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, 2003, estimated losses recoverable (including incurred
but not reported losses ("IBNR")), from retrocessionaires were $162.4 million,
including $15.5 million of paid loss recoverables. As of December 31, 2003,
approximately 91% of our reinsurance recoverables are either fully
collateralized or reside with entities rated "A-" or its equivalent or higher by
A.M. Best or S&P.
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 2003, 2002 and 2001, 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% in 2003 and 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, subject to PXRE's business needs, 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 of 15% based on the gross premiums ceded to
them under these quota share agreements, which resulted in fee income of $3.8
million, $3.0 million and $4.0 million for the years ended December 31, 2003,
2002 and 2001 respectively.
In addition to the Select Re Quota Share Agreement, we have entered
into several other reinsurance transactions with Select Re whereby: (i) Select
Re provided retrocessional support on several reinsurance transactions, (ii)
Select Re provided us with aggregate excess of loss retrocessional coverage in
2001 that protected 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 $1.5
million in 2003, $1.7 million in 2002 and $0.7 million in 2001.
20
In 2003, 2002 and 2001, we ceded reinsurance premiums of $26.1 million,
$30.5 million and $58.0 million to Select Re and as of December 31, 2003 net
assets of $64.6 million were due in the aggregate to us from Select Re, all of
which are secured by way of reinsurance trusts. 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, 2003, it had shareholders' equity of approximately
$113.0 million and is privately owned by approximately 70 shareholders. In
accordance with our contractual rights under the Select Re Quota Share
Agreement, we had designated Jeffrey L. Radke, our President and Chief Executive
Officer, to serve on Select Re's board of directors. Jeffrey Radke received no
remuneration for serving on Select Re's board. Prior to joining us in 1999,
Jeffrey Radke had served as the President of Select Re. On January 6, 2004,
Jeffrey Radke resigned from Select Re's board of directors; however, we have
retained our right to designate a person to serve on Select Re's board of
directors.
Mr. William Michaelcheck is a member of the Board of Select Re and also
one of its founding shareholders. Mr. Michaelcheck is also the President and a
major shareholder of Mariner Investment Group, Inc. ("Mariner"). Mariner acts as
the investment manager for our hedge fund and alternative investment portfolio.
In 2003 and 2002, we incurred investment management fees of $0.8 million and
$0.7 million, respectively, relating to services provided by Mariner.
PXRE'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 our Chief Financial Officer for any transaction entered into with Select Re.
The following table sets forth our earned commissions from our quota
share reinsurers for the periods indicated:
Year Ended December 31,
------------------------------------------------
($000's) 2003 2002 2001
------------- ------------- -------------
Commission $ 5,209 $ 3,540 $ 5,130
Contingent profit commission (1) (195) (108) 624
------------- ------------- -------------
Total $ 5,014 $ 3,432 $ 5,754
============= ============= =============
================================================================================
(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.
Business: 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.
21
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.
In reserving for catastrophe losses, our estimates are influenced by
underwriting information provided by our clients, industry catastrophe models
and our internal analyses of this information. This reserving approach can cause
significant development for an accident year when events occur late in the year,
as happened in 1999. As an event matures, we rely more and more on our own
development patterns by type of event as well as contract information to project
ultimate losses for the event.
In reserving for non-catastrophe losses from recent years, we are
required to make assumptions concerning the expected loss ratio usually for
broad lines of business, but sometimes on an individual contract basis. We
consider historical loss ratios for each line of business and utilize
information provided by our clients and estimates provided by underwriters and
actuaries concerning the impact of pricing and coverage changes. As experience
emerges, we revise our prior estimates concerning pricing adequacy and
non-catastrophe loss potential for our coverages and we will eventually rely
solely on our estimated development pattern in projecting ultimate losses.
Management believes that our overall liability for losses and loss
expenses recorded as of December 31, 2003 is adequate. There is a risk that our
liability for losses and loss expenses could prove to be greater or less than
expected in any year, because of the inherent uncertainty in the reserving
process with a consequent adverse impact on future earnings and shareholders'
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.
22
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, 2003, 2002 and 2001. Except with respect to certain workers' compensation
liabilities, discounted by $0.6 million and $0.8 million at December 31, 2003
and 2002, respectively, we do not discount our loss and loss expense
liabilities; that is, we do not calculate them on a present value basis.
23
Years Ended December 31,
------------------------------------------------
($000's) 2003 2002 2001
------------- ------------- -------------
Gross GAAP liability for losses and loss expenses, beginning of
year....................................................... $ 447,829 $ 453,705 $ 251,620
Gross provision for losses and loss expenses:
Occurring in current year................................ 119,889 118,345 318,373
Occurring in prior years................................. 58,121 41,352 34,339
------------- ------------- -------------
Total gross provision (1)................................ 178,010 159,697 352,712
------------- ------------- -------------
Gross payments for losses and loss expenses:
Occurring in current year................................ (27,304) (19,753) (63,960)
Occurring in prior years................................. (142,803) (151,264) (85,904)
------------- ------------- -------------
Total gross payments..................................... (170,107) (171,017) (149,864)
------------- ------------- -------------
Retroactive reinsurance adjustment............................ (8,074) 2,818 (763)
Foreign exchange and other adjustments........................ 2,977 2,626 -
------------- ------------- -------------
Gross GAAP liability for losses and loss expenses, end of year $ 450,635 $ 447,829 $ 453,705
============= ============= =============
Ceded GAAP liability for losses and loss expenses, end of year (146,924) (207,444) (245,906)
------------- ------------- -------------
Net GAAP liability for losses and loss expenses, end of year.. $ 303,711 $ 240,385 $ 207,799
============= ============= =============
================================================================================
(1) The GAAP provision for losses and loss expenses includes net foreign
currency exchange (losses) gains of $(3,272), $(7) and $981 for 2003,
2002, and 2001, respectively.
The following table presents the development of our GAAP balance sheet
liability for losses and loss expenses for the period 1993 through 2003. 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 1996 to be
$150,000 was first reserved in 1993 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 1993-1995 shown below. This table does not
present accident or policy year development data.
24
Year Ended December 31,
---------------------------------------------------------------------------------------------
($000's, except percentages) 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993
-------- -------- -------- -------- -------- -------- ------- ------- ------- ------- -------
Gross liabilities for losses
and loss expenses $450,635 $447,829 $453,705 $251,620 $261,551 $102,592 $57,189 $61,389 $72,719 $81,836 $71,442
Cumulative amount of liability
paid through:
One year later 142,803 151,264 85,904 210,519 75,814 29,108 23,708 42,698 41,601 37,820
Two years later 262,860 140,051 265,904 102,526 39,853 40,673 55,620 58,968 54,400
Three years later 172,147 294,211 112,966 47,373 46,545 67,296 67,630 60,850
Four years later 308,432 118,441 50,085 52,220 70,676 76,762 64,566
Five years later 124,796 52,181 54,144 74,533 79,433 69,414
Six years later 54,615 55,863 75,741 82,930 70,392
Seven years later 57,324 76,376 84,049 71,091
Eight years later 77,104 84,672 71,773
Nine years later 85,339 71,901
Ten years later 72,522
Liabilities reestimated as of:
One year later 500,643 499,773 285,959 338,881 135,227 57,280 66,257 83,228 87,818 78,188
Two years later 552,169 307,042 344,773 141,087 52,271 63,292 85,162 87,750 76,902
Three years later 330,963 351,349 139,220 63,151 61,178 83,178 90,409 74,683
Four years later 359,604 140,178 62,664 66,137 82,129 89,284 75,392
Five years later 143,745 63,973 65,819 85,820 88,326 74,880
Six years later 63,706 66,724 85,842 91,663 74,173
Seven years later 65,717 86,268 93,116 73,934
Eight years later 84,592 93,526 75,126
Nine years later 91,848 75,053
Ten years later 75,222
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 (8,074) 2,817 2,055
Foreign exchange and other
adjustments 2,767 1,805 1,196 734 73 176 171 132 58 21
Gross cumulative redundancy
(deficiency) through December 31,
2003:
Amount (58,121) (93,842) (76,092) (97,319) (42,271) (6,341) 5,432 (6,499) (7,887) (3,733)
Percentage (13%) (21%) (30%) (37%) (41%) (11%) 9% (9%) (10%) (5%)
Retrocessional recoveries 12,325 23,471 21,609 25,504 10,381 5,353 (732) 7,386 3,240 2,480
Net cumulative redundancy
(deficiency) through December 31,
2003:
Amount (45,796) (70,371) (54,483) (71,815) (31,890) (988) 4,700 887 (4,647) (1,253)
Percentage (19%) (34%) (35%) (45%) (46%) (2%) 8% 2% (9%) (3%)
25
In calendar years 2003, 2002, 2001, 2000 and 1999 we experienced
adverse development of $45.8 million, $25.4 million, $17.9 million, $58.2
million and $19.8 million, respectively.
During 2003, we experienced net adverse development of $45.8 million
for prior-year loss and loss expenses, $21.8 million of which was due to loss
development on our exited direct casualty reinsurance operations, $8.8 million
adverse development from aerospace claims arising to a significant degree from
our first receipt of notice that the increase in industry losses related to a
1998 air crash had resulted in the exhaustion of deductibles under three
aerospace contracts between PXRE and Reliance Insurance Company and $8.2 million
of development from finite contracts, $7.3 million of which related to the
aggregate excess of loss reinsurance agreement referred to in Item 3. Pending
Legal Proceedings.
During 2002, we experienced net adverse development of $25.4 million
for prior-year loss and loss expenses, with $16.9 million from our exited lines
segment, $16.2 million of which was due to loss development on our exited direct
casualty reinsurance operations.
During 2001, we experienced net adverse development of $17.9 million
for prior-year loss and loss expenses. The adverse development was due primarily
to international casualty ($4.5 million), marine excess ($2.7 million), winter
storm Anatol ($2.7 million) and exited direct casualty reinsurance ($2.4
million).
In each of the calendar years 2001 to 2003, our direct casualty
business has sustained losses beyond what was originally estimated. We
underwrote this business primarily from 1999 to 2001. Initially, as described in
"Management's Discussion and Analysis - Critical Accounting Policy Disclosures -
Loss and Loss Expenses," we utilized several loss reserving techniques,
including those which were dependent on industry loss reporting patterns as
provided by various industry sources, estimates of pricing adequacy as measured
by the expected loss ratio, and earned premiums. As the data and the business
have matured, we have placed more weight on loss development techniques that
rely on the loss reporting pattern and reported losses. As a result of shifting
to actuarial methodologies more appropriate to a seasoned portfolio as well as
new information from both the industry and clients, we have re-estimated our
incurred losses recorded related to our direct casualty business for several
years.
During 2000, we experienced net adverse development of $58.2 million
for prior-year loss and loss expenses, $43.4 million of which was due to loss
development from catastrophic events that occurred late in 1999; during 1999, we
experienced net adverse development of $19.8 million for prior-year loss and
loss expenses, $8.1 million of which was due to loss development from
catastrophic events that occurred late in 1998.
In the last week of December 1999, French storms Lothar and Martin
resulted in significant losses to several of our reinsureds. Because of the
lateness in the year of the storms' occurrences and the unprecedented nature of
the catastrophes, only limited relevant data could be obtained from both our
clients and the industry by the time the loss reserving estimates were required
to be determined. As a result, our reserves (which utilize industry data as a
check on client-supplied data) were increased in subsequent years due to the
events that occurred at year-end 1999. There was a similar result in the
estimation of losses due to Hurricane George, which occurred in 1998, in that
industry wide losses were significantly underestimated.
26
A large portion of our adverse development during the previous five
years is due to significant industry-wide underpricing of underwriting years
1998 to 2001. The complete effect of the soft market during that period was not
initially reflected in the historical industry loss ratios. We estimate that the
underpricing of these three underwriting years amounted to $21.2 million of the
$45.8 million of 2003 adverse development, $17.0 million of the $25.4 million of
2002 adverse development, $9.0 million of the $17.9 million of adverse
development in 2001, $10.5 million of the $58.2 million of adverse development
in 2000 and $4.3 million of the $19.8 million of adverse development in 1999.
The balance of the adverse development in each of the years discussed
above is due to a variety of factors outlined in the section "Loss Liabilities
and Claims" and in "Management Discussion and Analysis - Critical Accounting
Policy Disclosures - Loss and Loss Expenses", including late reporting by
clients (particularly retrocedents) and the imprecise nature of the actuarial
science accentuated when the risk is catastrophe coverage rather than large
numbers of homogeneous small dollar risks. Our reserving assumptions are updated
on an ongoing basis as new information becomes available to minimize this
residual adverse development, which arises from many causes.
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.
Business: Investments
Our investment strategy focuses on maintaining the majority of our
investment portfolio in high quality fixed income investments while allocating a
percentage of the portfolio to a well diversified portfolio of hedge fund
investments. As of December 31, 2003, approximately 86% of the carrying value of
our investment portfolio was comprised of fixed maturity and short-term
securities with a weighted average credit rating of AA+ and approximately 14% of
the carrying value of our portfolio was comprised of investments in 24 different
hedge funds and other limited partnerships. Our current diversified managed
hedge fund strategy has generated only one quarter of negative returns over the
past seven years. Our goal is to achieve a low correlation between risks in our
underwriting operation and risks in our investment portfolio. Management of all
our investments is outsourced to third parties, with strict oversight by
management and our Board.
We have established general procedures and guidelines for our
investment portfolio. 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 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.
27
As of December 31, 2003, we had, at fair value, $639.1 million in fixed
maturities, $175.8 million in short-term investments (which we define as being
investments which have an original maturity of one year or less), $121.5 million
in hedge fund limited partnerships, and $10.2 million in other invested assets
that are comprised primarily of other limited partnerships. As at December 31,
2003, hedge fund investments were allocated among eighteen managers, with fair
values ranging from $1.4 million to $16.6 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. The fair value of hedge funds,
which approximate their redemption values, are established by the individual
hedge fund managers based on the underlying contractual agreements for such
hedge funds. Foreign denominated fixed maturities are accounted for as part of a
trading portfolio, whereby both the investment income and a portion of the
change in the fair value are recorded through the investment income line of the
income statement. Included in investments in limited partnerships are
investments actively managed by Mariner. See Note 4 of Notes to Consolidated
Financial Statements. See also, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations -Critical Accounting Policy
Disclosures - Valuation of Investments" for further information regarding our
investment portfolio, including our hedge fund portfolio.
The following table summarizes our investments at December 31, 2003 and
2002 at carrying value:
Analysis of Investments
December 31, 2003 December 31, 2002
----------------------- ----------------------
($000's, except percentages) Amount Percent Amount Percent
----------- ------- ----------- -------
Fixed maturities:
United States treasury securities $ 40,237 4.2% $ 46,165 6.1%
Foreign denominated securities 21,451 2.3 21,871 2.9
Foreign government securities - - 315 -
United States government sponsored agency debentures 115,440 12.2 38,062 5.0
United States government sponsored agency
mortgage-backed securities 134,323 14.2 42,467 5.6
Other mortgage and asset-backed securities 146,196 15.4 143,736 19.0
Municipal securities 18,584 2.0 76,522 10.1
Corporate securities 162,878 17.2 131,611 17.3
----------- ------- ----------- -------
Total fixed maturities 639,109 67.5 500,749 66.0
Short-term investments 175,771 18.6 133,318 17.6
----------- ------- ----------- -------
Total 814,880 86.1 634,067 83.6
Hedge funds 121,466 12.8 113,105 14.9
Other invested assets 10,173 1.1 11,529 1.5
----------- ------- ----------- -------
Total investment portfolio $ 946,519 100.0% $ 758,701 100.0%
=========== ======= =========== =======
At December 31, 2003, the fair value of our investment portfolio
exceeded its cost by $39.5 million, of which $35.7 million related to limited
partnerships and the trading portfolio and $3.8 million related to unrealized
appreciation on fixed maturities. 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 the trading portfolio and $12.9 million
related to unrealized appreciation on fixed maturities.
28
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
shareholders' 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 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 original cost, and those
investments that have been downgraded by any of the major ratings agencies,
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 2003, we recognized $0.2 million of
impairment losses on an asset-backed security whose value had fallen below 80%
of face value for more than six months.
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, 2003 and 2002:
Composition of Investments By Maturity
December 31, 2003 December 31, 2002
----------------------- ----------------------
($000's, except percentages) Amount Percent Amount Percent
----------- ------- ----------- -------
Maturity (1)
One year or less $ 197,757 24.3% $ 195,487 30.8%
Over 1 year through 5 years 435,373 53.4 227,583 35.9
Over 5 years through 10 years 172,737 21.2 195,287 30.8
Over 10 years through 20 years 392 - 7,089 1.1
Over 20 years 8,621 1.1 8,621 1.4
----------- ------- ----------- -------
Total fixed maturities and short-term investments $ 814,880 100.0% $ 634,067 100.0%
=========== ======= =========== =======
===============================================================================
(1) Based on expected maturity dates, which consider call options and prepayment
assumptions.
The average yield to maturity of our fixed maturities portfolio,
including short-term investments at December 31, 2003 and 2002 was 3.2% and
3.3%, respectively.
The following table summarizes investments with unrealized losses at
fair value by length of continuous unrealized loss position:
29
One Year or Less Over One Year
------------------------- --------------------------
Unrealized Unrealized
($000's) Fair Value Loss Fair Value Loss
----------- ----------- ----------- -----------
United States treasury securities $ 30,614 $ (61) $ - $ -
United States government sponsored agency debentures 34,384 (1,439) - -
United States government sponsored agency mortgage-backed
securities 52,337 (222) - -
Other mortgage and asset-backed securities 71,545 (985) - -
Corporate securities 54,656 (1,501) - -
----------- ----------- ----------- -----------
Total temporarily impaired securities $ 243,536 $ (4,208) $ - $ -
=========== =========== =========== ===========
30
The following table indicates the composition of our fixed maturities
portfolio, at fair value, excluding short-term investments, by rating at
December 31, 2003 and 2002:
Composition of
Fixed Maturities Portfolio By Rating (1)
December 31, 2003 December 31, 2002
--------------------------- --------------------------
($000's, except percentages) Amount Percent Amount Percent
--------------- ------- ------------- -------
United States treasury securities $ 40,237 6.3% $ 46,165 9.2%
Foreign denominated securities
Aaa and/or AAA 15,808 2.5 21,871 4.4
Aa2 and/or AA 5,643 0.9 - -
Foreign government securities
Aa2 and/or AA - - 315 0.1
United States government sponsored agency debentures
Aaa and/or AAA 114,926 18.0 38,062 7.6
Aa2 and/or AA 514 0.1 - -
United States government sponsored agency mortgage-
backed securities 134,323 21.0 42,467 8.5
Other mortgage and asset-backed securities
Aaa and/or AAA 130,256 20.4 111,788 22.3
Aa2 and/or AA 12,271 1.9 7,510 1.5
A2 and/or A 3,447 0.5 23,920 4.8
Baa2 and/or BBB - - 343 0.1
Not rated or below BB 222 0.1 175 -
Municipal securities
Aaa and/or AAA 11,540 1.8 53,659 10.7
Aa2 and/or AA 7,044 1.1 22,863 4.6
Corporate securities
Aaa and/or AAA 5,332 0.8 7,846 1.6
Aa2 and/or AA 16,918 2.6 14,104 2.8
A2 and/or A 123,588 19.3 87,358 17.4
Baa2 and/or BBB 16,811 2.6 21,680 4.3
Ba2 and/or BB 229 0.1 623 0.1
--------------- ------- ------------- -------
Total fixed maturities $ 639,109 100.0% $ 500,749 100.0%
=============== ======= ============= =======
Aaa and/or AAA $ 452,422 70.8% $ 321,858 64.3%
Aa2 and/or AA 42,390 6.6 44,792 8.9
A2 and/or A 127,035 19.9 111,278 22.2
Baa2 and/or BBB 16,811 2.6 22,023 4.4
Ba2 and/or BB and/or below 451 0.1 798 0.2
--------------- ------- ------------- -------
Total fixed maturities $ 639,109 100.0% $ 500,749 100.0%
=============== ======= ============= =======
================================================================================
(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. Where Moody's and S&P
have different ratings for a security, the lower rating is used for
classification.
Set out below are the actual total returns of the different elements of
our investment portfolio, together with the indices against which we benchmark
the portfolio's performance. We use a composite of U.S. Lehman Bond indices for
fixed maturities, 1-month LIBOR for short-term investments and the CISDM Fund of
Funds Index for hedge funds and other investments. The composite used for fixed
maturities is derived from the Lehman Aggregate Index, the Lehman Government 1-3
Year Index, and the Lehman AA Credit Index. Since we do not have an equity
portfolio, the Standard & Poors 500 Index is not used as a comparative measure
of performance.
31
Actual vs. Benchmark Total Return Year Ended December 31,
-----------------------------------------------------
2003 2002
----------------------- -----------------------
Actual Benchmark Actual Benchmark
------ --------- ------ ---------
Fixed maturities 3.3% 3.2% 11.1% 10.9%
Short-term investments 1.1% 1.2% 1.4% 1.8%
Total fixed maturities and short-term investments 2.8% 2.7% 8.6% 8.7%
Hedge funds 11.8% 9.9% 7.1% 1.0%
Other invested assets 0.0% 9.9% 13.0% 1.0%
Total investment portfolio 4.0% 3.8% 8.5% 7.2%
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 - Investments - Market Risk."
Business: Ratings
A.M. Best maintains a letter scale rating system ranging from "A++"
(superior) to "F" (in liquidation). S&P maintains a letter scale rating system
ranging from "AAA" (extremely strong) to "R" (under regulatory supervision).
PXRE Group Ltd., including its main operating subsidiaries, PXRE Reinsurance and
PXRE Bermuda, is rated "A" (excellent) by A.M. Best, which is the third highest
of fifteen rating levels, and "A" (strong) by S&P, which is the sixth highest of
twenty-one rating levels.
The property catastrophe reinsurance market is highly sensitive to the
ratings assigned by the rating agencies. If A.M. Best or S&P 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. 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.
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. Typically
such cancellation clauses are triggered if A.M. Best or S&P were to downgrade us
below "A-." 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, the degree of unexpired coverage, 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.
For new or renewed contracts at January 1, 2004, 57% (by premium volume) contain
provisions allowing clients additional rights upon a decline in PXRE's ratings.
32
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-." In addition, 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.
Business: Regulation
United States
PXRE Reinsurance is 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
relate 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.
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 does not
disapprove 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.
33
The principal sources of cash for the payment of operating expenses,
debt service obligations, and dividends by the Company are the receipt of
dividends 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. Th