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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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COMMISSION FILE NUMBER 000-23427
STIRLING COOKE BROWN HOLDINGS LIMITED
(Exact name of registrant as specified in its charter)
BERMUDA NOT APPLICABLE
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
VICTORIA HALL, 3RD FLOOR, 11 VICTORIA STREET, HAMILTON HM 11, BERMUDA
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
TELEPHONE NUMBER: (441) 295-7556
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS
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Ordinary Shares, Par Value $0.25 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. NOT APPLICABLE.
The aggregate market value of the shares of all classes of voting stock of
the registrant held by non-affiliates of the registrant on March 15, 1999 was
approximately $59.8 million computed upon the basis of the closing sales price
of the Ordinary Shares on the Nasdaq National Market on that date. For purposes
of this computation, shares held by directors and officers of the registrant
have been excluded. Such exclusion is not intended, nor shall it be deemed to be
an admission that such persons are affiliates of the registrant.
As of March 15, 1999 there were 9,776,372 outstanding Ordinary Shares, the
only class of the registrant's common stock outstanding, of $0.25 par value.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's Proxy Statement relating to its Annual
General Meeting of Shareholders scheduled to be held on May 27, 1999 are
incorporated by reference into Part III of this Form 10-K.
Although Stirling Cooke Brown Holdings Limited is a "foreign private
issuer" within the meaning of Rule 3b-4 under the Securities Exchange Act of
1934, as amended, it is voluntarily electing to file its Annual Report for the
year ended December 31, 1998 on a Form 10-K.
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INDEX
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PART I Page
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Item 1 Business........................................................................................................ 1
Item 2 Properties...................................................................................................... 10
Item 3 Legal Proceedings............................................................................................... 10
Item 4 Submission of Matters to a Vote of Security Holders............................................................. 11
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder Matters........................................... 13
Item 6 Selected Financial Data......................................................................................... 14
Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 14
Item 8 Financial Statements and Supplementary Data..................................................................... 21
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................ 47
PART III
Item 10 Directors and Executive Officers of the Registrant.............................................................. 47
Item 11 Executive Compensation.......................................................................................... 47
Item 12 Security Ownership of Certain Beneficial Owners and Management.................................................. 47
Item 13 Certain Relationships and Related Transactions.................................................................. 47
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K................................................. 48
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Note: All dollar amounts are in U.S. dollars, unless otherwise specifically
noted.
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PART 1
ITEM 1--BUSINESS
THE COMPANY
Stirling Cooke Brown Holdings Limited (the "Company") is a Bermuda holding
company incorporated on December 12, 1995 which, through its subsidiaries,
provides risk management services and products. The Company provides its range
of services to independent insurance carriers and reinsurance companies as well
as directly to the insureds. The Company arranges reinsurance for its products
as well as for those offered by independent U.S.-based insurance carriers active
in the workers compensation, occupational accident and health and casualty
insurance markets.
The Company, through its original operating subsidiary, Stirling Cooke
Brown Insurance Brokers Limited, began operations in 1989 as an insurance broker
in London specializing in the placement of alternatives to traditional workers'
compensation insurance and the arrangement of associated reinsurance programs.
The Company soon began to develop and market its own innovative services and
products designed for employers seeking cost effective methods of alleviating
onerous insurance costs.
Beginning in 1992, the Company identified a number of opportunities and
undertook certain strategic initiatives to enhance its growth prospects. To
further these plans, the Company acquired Realm Investments Ltd. in January
1996. Realm Investments Ltd., a Bermuda company, acted as a holding company for
a number of Bermuda and United States subsidiaries involved in the insurance
industry. The Company has expanded to include a number of business segments
including brokerage, program business, underwriting management, insurance and
reinsurance located in Bermuda, the United Kingdom and the United States.
Through these segments, the Company is able to diversify its revenues and
increase its overall control of the risk transfer process. Refer to Note 15 to
the consolidated financial statements for further segmental and geographical
information.
Immediately after the acquisition of Realm Investments Ltd. in January
1996, certain investment funds affiliated with The Goldman Sachs Group, L.P.
made an equity investment in the Company. The Company used the proceeds from
this investment to acquire, and provide additional capital for, Realm National
Insurance Company Limited ("Realm National") in September 1996. The Company is
integrating Realm National's insurance underwriting capabilities with the
Company's risk management services and will seek to earn additional income
through a combination of policy issuance fees and net premiums earned associated
with the underwriting function while retaining a minimum amount of risk.
In December 1997, the Company and certain selling shareholders consummated
an Initial Public Offering of 3,421,250 Ordinary Shares. Of these shares,
1,375,000 were sold by the Company and 2,046,250 were sold by the selling
shareholders. Net proceeds of $26.8 million were received by the Company upon
consummation of the Initial Public Offering.
THE COMPANY'S OPERATIONS
The Company's five main business segments are Brokerage, Program Business,
Underwriting Management, Insurance and Reinsurance. As each segment comprises
separate companies, the results of each segment reflect all fees and income for
the companies in that segment. For example, revenues for the insurance segment
which is comprised of Realm National include all of Realm National's income
including premiums, policy issuance fees and interest income.
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BROKERAGE
The Company's brokerage segment comprises insurance and reinsurance
brokering subsidiaries based in London, Bermuda and New York that for a fee or
commission, place contracts which transfer risk and associated premium from one
company to another. These subsidiaries specialize in placing insurance and
reinsurance business in alternative and traditional workers' compensation,
accident, health and specialty casualty lines. The Company generates fees and
commission-based revenues from this business. The brokerage segment generated
revenues of $27.1 million in 1998, $23.4 million in 1997 and $19.2 million in
1996.
The Company, through its original operating subsidiary, Stirling Cooke
Brown Insurance Brokers Limited, began operating in 1989 as an insurance broker
in London specialising in the placement of alternatives to traditional workers'
compensation insurance and the arrangement of assorted reinsurance programs. The
Company now owns insurance and reinsurance brokering subsidiaries based in
London, Bermuda and New York.
PROGRAM BUSINESS
The Company's program business segment comprises subsidiaries that market
and manage insurance products and programs developed by the Company. Through
these programs, the segment is able to transfer risk from an insured to insurers
and ultimately to reinsurers in the workers' compensation market as well as for
other specialty casualty lines. The segment's subsidiaries are integrated in
such a manner so that the Company can offer complete business production and
administration to reinsurers. The program business segment services are provided
through various independent and group owned primary insurance carriers. This
segment primarily includes managing general agents, program management, claims
administration and loss control and premium audit companies. The program
business segment generated revenues of $27.1 million in 1998, $19.8 million in
1997 and $11.9 million in 1996.
The program managers are responsible for design, management and placement
of a program. The program manager oversees the program and coordinates with
reinsurers on all aspects of the program. The Company's Managing General Agency
("MGA") subsidiaries are responsible for marketing the program through their
agency network. The MGA's are also responsible for underwriting the business,
policy issuance, and administration of the business bound. The Company has in
recent years expanded its MGA network to include offices in: Dallas, Texas;
Sarasota, Ft. Lauderdale and Orlando in Florida; New York City, New York and
Montgomery, Alabama. The programs also use the services of a claims
administration, loss control and premium audit company to provide these
services.
UNDERWRITING MANAGEMENT
The Company's underwriting management segment comprises two Managing
General Underwriters ("MGUs") based in Bermuda who are authorized to underwrite
and administer reinsurance business on behalf of various independent insurance
and reinsurance companies. The MGUs earn fees for providing these underwriting
and associated administration services relating to the business underwritten.
The underwriting management segment generated revenues of $3.6 million in 1998,
$4.2 million in 1997, and $4.3 million in 1996.
INSURANCE
The Company's insurance segment comprises Realm National. The Company
currently uses independent primary insurance carriers, primarily Clarendon
National Insurance Company ("Clarendon") and Legion Insurance Company
("Legion"), in connection with most of its existing workers' compensation
business, and expects these arrangements to continue for much of this existing
business. However, following the acquisition of Realm National in September
1996, the Company started to act as an issuing carrier for a portion of its new
business opportunities and receives a combination of policy issuance fees and/or
net premiums earned in respect of this business. Realm National provides the
Company with the opportunity to generate business and receive premiums and fees
from sources outside the Company's MGA network, as non-affiliated MGAs place
business with Realm National. The Company expects that the revenues generated
through the continuing integration of Realm National into the
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Company's existing businesses will be an important component of future earnings
growth. The insurance segment generated revenues of $11.1 million in 1998, $5.4
million in 1997 and $1.4 million in 1996.
Realm National had shareholder's equity of approximately $22.5 million at
December 31, 1998 (1997--$21.5 million), net premiums earned of approximately
$7.7 million for the year ended December 31, 1998 (1997--$2.9 million) and a B+
(Very Good) rating from A.M. Best Company. Prior to its acquisition by the
Company, Realm National primarily wrote property and casualty insurance in a
limited number of states. For the year ended December 31, 1998, Realm National's
gross premiums written were $48.6 million (1997--$21.7 million); net premiums
written were $9.7 million (1997--$4.0 million), of which $8.2 million (1997--
$2.3 million) were related to workers' compensation insurance and $1.5 million
(1997--$1.7 million) were related to property insurance.
REINSURANCE
The Company's reinsurance segment comprises Comp Indemnity Reinsurance
Company Limited (CIRCL). CIRCL reinsures a portion of the underwriting risk on
business provided to or by the Company and receives a reinsurance premium to
cover that risk. CIRCL accepts a portion of the reinsurance risk from insurance
carriers on programs managed by the Company, and then purchases reinsurance
protection to reduce its risk. CIRCL primarily reinsures workers' compensation,
and associated property and general liability risks. The reinsurance segment
generated revenues of $10.9 million in 1998, $9.4 million in 1997 and $8.2
million in 1996.
For the year ended December 31, 1998, CIRCL's gross premiums assumed were
$11.8 million (1997--$14.1 million), of which $6.9 million (1997--$13.1 million)
were related to workers' compensation insurance and $4.9 million (1997--$1.0
million) were related to property and general liability insurance. Net premiums
assumed were $7.7 million (1997--$9.2 million). During the course of the year,
the Company's management evaluated CIRCL's underwriting results, and as a result
of unfavorable results, reduced CIRCL's underwriting. Management decided in
early 1999 to cease underwriting any new programs in CIRCL and a number of
existing contracts were not renewed for the 1999 year. Those renewed will be
allowed to run until they expire at December 31, 1999. Because some contracts
were not renewed by CIRCL during 1999, revenues should decrease accordingly.
MARKETING
The Company's marketing strategies vary by business segment. Marketing by
the Brokering and Underwriting Management segments is focused on insurance and
reinsurance companies while marketing by the Program Business and Insurance
segments is focused on independent and wholesale insurance agents. The Company
advertises in U.S. and international trade journals, and has also contributed
articles to a quarterly trade magazine circulated to agents and policyholders.
Additionally, the Company participates as an exhibitor in the annual Risk and
Insurance Management Society conventions.
The Insurance and Underwriting Management segments market to a number of
specialty insurance markets and focus their marketing efforts on a number of
insurance and reinsurance companies.
The Company's Insurance segment which comprises Realm National markets its
insurance products to independent agents and other procurers of insurance
through unaffiliated networks and to a lesser extent through the Company's
program business segment. The Company expects Realm National's marketing
efforts to increase as it becomes licensed in additional states.
The Company's Program Business segment markets its workers' compensation
programs and other specialty lines to retail agents in the U.S. through its
MGAs. Individual MGA offices market their services and products through sales
representatives, targeted direct mail, local and regional advertising, seminars,
and trade and industry conventions. Given its general reliance on retail agents
as an important source of business production, special emphasis is placed on
building and maintaining relationships with individual retail agents, and on
expanding its network of retail producers. To encourage loyalty from the retail
agents, the Company seeks to provide a high level of service, offer insurance
products that satisfy the needs of clients and reward increased levels of
production
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through incentive compensation schedules. The Company believes that it has
successfully developed a reputation for providing quality service, cost-
effective products and strong marketing support which has enabled it to develop
strong relationships with its retail agents, commercial customers, insurers and
reinsurers.
COMPETITION
The business of providing risk management services and products to the
workers' compensation and property and casualty insurance markets is highly
competitive. The Company competes with providers of traditional insurance
coverage and with other providers of alternative market services (including
domestic and foreign insurance companies, reinsurers, insurance brokers, captive
insurance companies, rent-a-captives, self-insurance plans, risk retention
groups, state funds, assigned risk pools and other risk-financing mechanisms).
The Company believes the key factors to effectively compete in the risk
management market are price, the ability to tailor programs to the needs of the
insured and the ability to rapidly develop new solutions to address changing
market needs. The Company believes that its services and products are
competitively priced, and that its combination of services and products enables
it to rapidly develop tailored programs and act as a competitive single source
provider of risk management services and products.
Realm National is rated B+ (Very Good) by A.M. Best Company and in certain
circumstances may be at a competitive disadvantage to insurance carriers with
higher ratings. The Company's MGAs also represent carriers with higher ratings
from A.M. Best Company, ensuring that the Company's MGAs are not negatively
impacted in circumstances where Realm National is not selected as the insurance
carrier due to its rating.
EMPLOYEES
As of December 31, 1998, the Company had 356 employees. The service nature
of the Company's business makes its employees an important corporate asset.
While the market for qualified personnel is extremely competitive, the Company
believes that its relationship with its employees is good. None of the Company's
employees is represented by a union.
REGULATION
The Company's subsidiaries that are engaged in the insurance and
reinsurance segments (Realm National and CIRCL) are subject to regulation by
government agencies in the states and foreign jurisdictions in which they do
business. The nature and extent of such regulation vary from jurisdiction to
jurisdiction, but typically involve prior approval of the acquisition of control
of an insurance company or of any company controlling an insurance company;
regulation of certain transactions entered into by an insurance company with any
of its affiliates; approval of premium rates, forms and policies used for many
lines of insurance; standards of solvency and minimum amounts of capital and
surplus which must be maintained; establishment of reserves required to be
maintained for unearned premium, losses and loss expense or for other purposes;
limitations on types and amounts of investments; restrictions on the size of
risks which may be insured by a single company; licensing of insurers and
agents; deposits of securities for the benefit of policyholders; and the filing
of periodic reports with respect to financial condition and other matters.
Most states require property and casualty insurers licensed to transact
insurance in the state to become members of insolvency funds or associations
which generally protect policyholders against the insolvency of such insurers.
Members of the fund or association must contribute to the payment of certain
claims made against insolvent insurers. Maximum contributions required by law in
any one year vary between 1% and 2% of annual premiums written by a member in
that state. Assessments from insolvency funds paid by Realm National were
immaterial in 1996, 1997 and 1998. The cost of most of these assessments is
recoverable through future policy surcharges and premium tax deductions.
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Realm National is also required to participate in various mandatory
insurance facilities or in funding mandatory pools, which are generally designed
to provide insurance coverage for consumers who are unable to obtain insurance
in the voluntary insurance market. One such pool is the multi-state workers'
compensation pool operated by the National Council on Compensation Insurance.
These pools typically require all companies writing applicable lines of
insurance in the state for which the pool has been established to fund
deficiencies experienced by the pool based upon each company's relative premium
writings in that state, with any excess funding typically distributed to the
participating companies on the same basis. Total assessments incurred by Realm
National from all such facilities for 1996, 1997, and 1998 were immaterial.
Realm National is subject to various state statutory and regulatory
restrictions, generally applicable to each insurance company in its state of
incorporation, which limit the amount of dividends or distributions payable by
an insurance company to its shareholders. The restrictions are generally based
on certain levels of surplus, investment income, and operating income, as
determined under statutory accounting practices.
The insurance code of New York regulates the distribution of dividends and
other payments to the Company by Realm National. Under the applicable New York
statute, unless prior regulatory approval is obtained, an insurer may not
declare or distribute any dividend to shareholders which, together with all
dividends declared or distributed by it during the preceding twelve months,
exceeds the lesser of (i) 10% of its surplus to policyholders as shown by its
last statement on file with the New York Department of Insurance, or (ii) 100%
of adjusted net investment income during such period. Such restrictions or any
additional subsequently imposed restrictions may in the future affect the
Company's ability to pay principal and interest on its debt, expenses, and any
cash dividends to its shareholders. Future dividends from the Company's
subsidiaries may also be limited by business considerations.
The National Association of Insurance Commissioners has adopted a
methodology for assessing the adequacy of statutory surplus of property and
casualty insurers which includes a risk-based capital requirement. Insurance
companies are required to calculate and report information under a risk-based
formula which attempts to measure statutory capital and surplus needs based on
the risks in a company's mix of products and investment portfolio. The formula
is designed to allow state insurance regulators to identify potential weakly
capitalized companies. Under the formula, a company determines its "risk-based
capital" ("RBC") by taking into account certain risks related to the insurer's
assets (including risks related to its investment portfolio and ceded
reinsurance) and the insurer's liabilities (including underwriting risks related
to the nature and experience of its insurance business). The RBC rules provide
for different levels of regulatory attention depending on the ratio of a
company's total adjusted capital to its "authorized control level" of RBC. Under
the formula, a higher ratio reflects a greater adequacy of capital. Based on
calculations made by the Company, the RBC level for the Company's insurance
subsidiaries exceeds levels that would trigger regulatory attention. At December
31, 1998, Realm National's RBC ratio was approximately 703% (1997--1,624%), and
the threshold requiring minimum regulatory involvement was 200%. Therefore, the
Company's capital exceeds all requirements of the Risk-Based Capital Model Act.
The NAIC has also developed an Insurance Regulatory Information System ("IRIS")
to assist state insurance departments in their oversight of the financial
condition of insurance companies operating in their respective states. IRIS
identifies 11 industry ratios and specifies "usual values" for each ratio.
Departure from the usual values in four or more ratios generally leads to
inquiries from individual state insurance commissioners. Management believes
Realm National's IRIS ratios are such as to not attract such regulatory
attention.
In addition to the oversight of the Company's insurance subsidiaries, the
Company, as the ultimate parent of a New York domiciled insurer (Realm
National), is also subject to regulation under the New York Insurance Holding
Company System Regulatory Act (the "Holding Company Act"). The Holding Company
Act contains certain reporting requirements including those requiring the
Company, as the ultimate parent company, to file information relating to its
capital structure, ownership, and financial condition and general business
operations of its insurance subsidiaries. The Holding Company Act contains
special reporting and prior approval requirements with respect to transactions
among affiliates.
Realm National is organized under the insurance laws of the State of New
York (the "Insurance Code of New York"). The Insurance Code of New York provides
that the acquisition or change of "control" of a domestic insurer, or any person
who controls a domestic insurer, cannot be consummated without the prior
approval of the relevant insurance regulatory authority. A person seeking to
acquire control, directly or indirectly, of a domestic insurance
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company, or any person controlling a domestic insurance company, must generally
file with the relevant insurance regulatory authority an application for change
of control (commonly known as a "Form A") containing certain information
required by statute and published regulations and provide a copy of such Form A
to the domestic insurer. Under the Insurance Code of New York, control is
presumed to exist if any person, directly or indirectly, owns, controls, holds
with power to vote or holds proxies representing ten percent or more of the
voting securities of any other person.
In addition, many state insurance regulatory laws contain provisions that
require pre-notification to state agencies of a change in control of a non-
domestic admitted insurance company in that state. While such pre-notification
statutes do not authorize the state agency to disapprove the change of control,
such statutes do authorize issuance of a cease and desist order with respect to
the non-domestic admitted insurer if certain conditions exist such as undue
market concentration.
The Company is in the process of expanding Realm National's business to
include workers' compensation and other specialty casualty insurance lines in
each of the 20 states in which Realm National is currently licensed to provide
property and casualty insurance. The Company intends to eventually license Realm
National in substantially all of the remaining states and the District of
Columbia. In order to obtain a license in a given state, Realm National must
complete an application and demonstrate compliance with state licensing
requirements. The applicable insurance regulatory authority reviews the
application, which review may take from three months to two or more years. If
all the requirements are met, a license is issued.
In determining whether to issue a license to do business in a state, the
state's insurance regulatory agency is required by statute or regulation to
consider a number of factors, largely for the purpose of protecting
policyholders within the state. Typically, the application process will involve
a review of the applicant's recent audited and statutory financial statements,
and in many states one or more years of operating projections, to assess the
financial strength of the applicant; biographical information concerning the
experience and fitness of directors, officers and major shareholders; reports of
recent examinations as to the applicant's compliance record, finances and market
practices in its state of domicile; proposed policy forms and rate schedules;
and the applicant's experience in underwriting the line or lines of business to
be offered.
As a holding company, the Company is not subject to Bermuda insurance
regulations. However, the Bermuda Insurance Act 1978, as amended (the
"Insurance Act"), which regulates the insurance business of CIRCL, a
reinsurance subsidiary of the Company, provides that no person shall carry on
insurance business in or from within Bermuda unless registered as an insurer
under the Insurance Act by the Minister of Finance (the "Minister"). The
registration of an applicant as an insurer is subject to its compliance with the
terms of its registration and such other conditions as the Minister may impose
from time to time.
In general, the regulation of insurers in Bermuda relies heavily upon
auditors, loss reserve specialists, directors, and managers, who must certify
that an insurer meets minimum capital and solvency requirements. Every
registered insurer must appoint a government approved auditor who will annually
audit and report on the Statutory Financial Statements and the Statutory
Financial Return of the insurer.
CIRCL is registered as a Class 3 insurer and, as such: (i) is required to
maintain a minimum statutory capital and surplus equal to the greatest of: (a)
$1 million; (b) 20% of the first $6 million of its net premiums written plus 15%
of its net premiums written over $6 million; and (c) 15% of its net outstanding
losses and loss expenses; (ii) is limited in declaring or paying any dividends
during any financial year with respect to a specified minimum solvency margin or
minimum liquidity ratio or if the declaration or payment of such dividends would
cause it to fail to meet such margin or ratio; (iii) is prohibited, without the
approval of the Minister, from reducing by 15% or more its total statutory
capital, as set out in its previous year's financial statements; and (iv) is
required to report its failure to meet its minimum solvency margin to the
Minister within 30 days after becoming aware of such failure or having reason to
believe that such failure has occurred. CIRCL is also required to obtain an
annual loss reserve opinion issued by a government approved loss reserve
specialist.
The Insurance Act provides a minimum liquidity ratio for general business.
An insurer engaged in general business is required to maintain the value of its
relevant assets at not less than 75% of the amount of its relevant
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liabilities. Relevant assets include cash and time deposits, quoted investments,
unquoted bonds and debentures, first liens on real estate, investment income due
and accrued, accounts and premiums receivable, reinsurance balances receivable
and funds held by ceding reinsurers. There are certain categories of assets
which, unless specifically permitted by the Minister, do not automatically
qualify as relevant assets such as unquoted equity securities, investments in
and advances to affiliates, real estate and collateral loans. The relevant
liabilities are total general business insurance reserves and total other
liabilities less deferred income tax and sundry liabilities (by interpretation,
those not specifically defined), letters of credit and guarantees.
An insurer is required to maintain a principal office in Bermuda and to
appoint and maintain a principal representative in Bermuda to oversee the
business of the insurer and to report to the Minister and the Bermuda Registrar
of Companies in respect of certain events. Unless the approval of the Minister
is obtained, an insurer may not terminate the appointment of its principal
representative, and the principal representative may not cease to act as such,
unless 30 days' notice in writing to the Minister is given of the intention to
do so. Within 30 days of the principal representative's knowing or having reason
to believe that the insurer the representative represents is likely to become
insolvent or that an "event" has occurred, the principal representative must
provide a written report to the Minister setting out all the particulars of the
case that are available to the representative. Examples of such an "event"
include failure by the insurer to comply substantially with a condition imposed
upon the insurer by the Minister relating to a solvency margin or a liquidity or
other ratio.
The Minister may appoint an inspector with extensive powers to investigate
the affairs of an insurer if the Minister believes that an investigation is
required in the interest of the insurer's policyholders or persons who may
become policyholders. In order to verify or supplement information otherwise
provided to him, the Minister may direct an insurer to produce documents or
information relating to matters connected with the insurer's business.
If it appears to the Minister that there is a risk of the insurer becoming
insolvent, the Minister may direct the insurer not to take on any new insurance
business; not to vary any insurance contract if the effect would be to increase
the insurer's liabilities; not to make certain investments; to realize certain
investments; to maintain in Bermuda, or transfer to the custody of a Bermuda
bank, certain assets; and to limit its premium income.
The Bermuda Government actively encourages foreign investment in
"exempted" entities like CIRCL that are based in Bermuda but do not operate in
competition with local businesses. As well as having no restrictions on the
degree of foreign ownership, CIRCL is exempted from taxes on its income until
March 28, 2016 and is not subject to tax on its dividends or to any foreign
exchange controls in Bermuda. In addition, there currently is no capital gains
tax in Bermuda, and profits can be accumulated by CIRCL, as required, without
limitation.
Certain of the Company's subsidiaries are also subject to regulation as
insurance intermediaries. Under the applicable regulations, the intermediary is
responsible as a fiduciary for funds received for the account of the parties to
the insurance or reinsurance transaction and is required to hold such funds in
appropriate bank accounts subject to restriction on withdrawals and prohibitions
on commingling.
The Company's insurance intermediaries include several MGAs. MGAs produce,
underwrite, and manage claims or negotiate reinsurance for a specific portion of
an insurance company's business in certain states, and they are subject to
regulation under state laws regarding licensure, fiduciary obligations with
respect to premium and concerning the general management of the insurer's
business.
The activities of Stirling Cooke Brown Insurance Brokers Limited as an
insurance broker in the UK require it to be authorized under the Insurance
Brokers (Registration) Act of 1977 by the Insurance Brokers Registration Council
(the "Council"). Authorization by this body involves continuing compliance
with rules made by the Council, which require, among other things, that the
Company maintain a minimum level of working capital, that it allocate not more
than a specified level of its business to any particular insurance company or
group of insurance companies, that it supply reports to the Council, and that it
conduct its business in accordance with the conduct of business rules published
by the Council. It is a condition to the authorization from the Council that a
majority of the directors of Stirling Cooke Brown Insurance Brokers Limited are
and remain registered as insurance brokers in the UK.
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OUTSTANDING LOSSES AND LOSS EXPENSES
Both Realm National and CIRCL maintain loss reserves to reflect anticipated
future claims and claims expense payments. CIRCL was acquired in January 1996
and Realm National was acquired in September 1996. The Company establishes
reserves for losses and loss adjustment expenses related to claims which have
been reported on the basis of the evaluations of independent claims adjusters
and the Company's own claims staff. In addition, reserves are established for
losses which have occurred but have not yet been reported and for adverse
development of reserves on reported losses. The estimate of claims and claims
expenses arising for accidents which have occurred but not yet been reported is
based upon the Company's and the insurance industry's experience together with
statistical information with respect to the probable number and nature of such
claims. The Company engages independent actuaries to assist in this process.
The following table sets forth a reconciliation of beginning and ending
reserves for losses and loss adjustment expenses:
RECONCILIATION OF OUTSTANDING LOSSES AND LOSS EXPENSES
<TABLE>
<CAPTION>
For the Years Ended December 31,
1996 1997 1998
--------- ----------- ------------
(dollars in thousands)
<S> <C> <C> <C>
Balance beginning of year........................... $ -- $ 24,301 $ 36,276
Less outstanding losses recoverable................. -- (16,588) (23,072)
Net balance for CIRCL, at acquisition............... 1,270 -- --
Net balance for Realm National, at acquisition...... 1,687 -- --
------- -------- --------
Net balance......................................... 2,957 7,713 13,204
------- -------- --------
Incurred related to:
Current year.................................. 6,515 10,174 12,578
Prior years................................... 250 777 4,693
------- -------- --------
Total incurred................................ 6,765 10,951 17,271
------- -------- --------
Paid related to:
Current year.................................. 1,334 2,011 3,066
Prior years................................... 675 3,449 9,438
------- -------- --------
Total paid................................. 2,009 5,460 12,504
------- -------- --------
Net balance......................................... 7,713 13,204 17,971
Plus outstanding losses recoverable................. 16,588 23,072 48,146
------- -------- --------
Balance at end of year........................ $24,301 $ 36,276 $ 66,117
======= ======== ========
</TABLE>
The adverse development during 1998 on prior years reflects primarily an
increase in claims frequency on one particular program that covers bodily injury
and property risks in the construction industry, and the provision for doubtful
recoveries of $2.5 million. This provision is included in the balance sheet as a
component of paid and outstanding losses recoverable from reinsurers. The
provision is necessarily an estimate and amounts not collectible from reinsurers
may ultimately be significantly greater or lesser than the provision
established. It is reasonably possible that management will revise this
estimate significantly in the near term. Any subsequent differences arising
will be recorded in the period in which they occur.
The adverse development during 1997 on prior years primarily represents an
increase in claims frequency on one particular program that covers bodily injury
and property risks in the construction industry.
The Company's underwriting loss ratio (i.e. the ratio of net losses and net
loss expenses to net assumed premium earned) for 1998 was 97.2% (1997--92.9%).
The Company believes that the provision for outstanding losses and loss
expenses is adequate to cover the ultimate net cost of losses and loss expenses
incurred; however, such a provision is necessarily an estimate and may
ultimately be settled for a significantly greater or lesser amount. The Company
has limited historical loss experience available to serve as a reliable basis
for the estimation of ultimate losses. It is at least reasonably possible that
management will revise the estimate of outstanding losses and loss expenses
significantly in the near term. Any subsequent differences arising are recorded
in the period in which they are determined.
8
<PAGE>
The previous table represents a reconciliation of reserves in accordance
with generally accepted accounting principals ("GAAP"). The following table
reconciles the difference between the Company's portion of these reserves and
those contained in regulatory filings made by the Company's subsidiaries in
accordance with statutory accounting practices ("SAP").
RECONCILIATION OF SAP AND GAAP RESERVES
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------------------
1996 1997 1998
------------ ------------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Reserves for losses and loss adjustment expenses, end of year
SAP.................................................................. $ 7,843 $ 13,355 $18,024
Gross-up for ceded reinsurance reserves.................................. 16,588 23,072 48,146
Provision for salvage receivable not included on a SAP basis............. (29) (128) (30)
Provision for loss portfolio transfer not included in SAP
reserves............................................................. (101) (23) (23)
------- -------- -------
Reserves for losses and loss adjustment expenses, end of year
GAAP................................................................. $24,301 $ 36,276 $66,117
======== ======= =======
</TABLE>
The following table presents the development of the Company's ongoing net
reserves for 1996 through 1998. The top line of the table shows the estimated
reserve for unpaid losses and loss adjustment expenses recorded at the balance
sheet date for each of the indicated years. This amount represents the estimated
amount of losses and loss adjustment expenses for claims that are unpaid at the
balance sheet date, including losses that have been incurred but not yet
reported to the Company. The table also shows the re-estimated amount of the
previously recorded reserve based on experience as of the end of each succeeding
year. The estimate changes as more information becomes known about the frequency
and severity of claims for individual years. The "Cumulative Deficiency"
represents the aggregate change in the estimates over all prior years. The
Company's insurance entities were both purchased in 1996 so, accordingly, there
has only been two years' movement in the Company's reserves. It should be noted
that the following table presents a "run-off" of balance sheet reserves rather
than accident or policy year loss development. Therefore, each amount in the
table includes the effects of changes in reserves for all prior years.
ANALYSIS OF LOSS AND LOSS EXPENSE DEVELOPMENT
(NET OF REINSURANCE RECOVERABLE)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------------------------
1996 1997 1998
--------------- --------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Gross reserve for losses and loss adjustment expenses......... $ 24,301 $ 36,276 $ 66,117
Less outstanding losses recoverable........................... (16,588) (23,072) (48,146)
-------- -------- --------
Net reserve for losses and loss adjustment expenses........... 7,713 13,204 17,971
Reserve re-estimated as of:
One year later............................................. 8,490 17,897
Two years later............................................ 11,830
-------- --------
Cumulative deficiency......................................... (4,117) (4,693)
-------- --------
Percentage.................................................... (53.4%) (35.5%)
-------- --------
Cumulative amount of reserve paid through:
One year later............................................. 3,449 9,438
Two years later............................................ 7,669
</TABLE>
The increase in reserves one year later and two years later on 1996 and
1997 reserves reflects primarily an increase in claims frequency on one
particular program that covers bodily injury and property risks in the
9
<PAGE>
construction industry, and the provision for doubtful recoveries of $2.5 million
discussed in Note 8 to the consolidated financial statements.
NOTE ON FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward looking statements. The Company's Form 10-K for the year
ended December 31, 1998, the Company's 1998 Annual Report, any Form 10-Q or Form
8-K of the Company, or any oral or written statements made by or on behalf of
the Company, may include forward-looking statements which reflect the Company's
current views with respect to future events and financial performance. These
forward-looking statements are identified by their use of such terms and phrases
as "intends," "intend," "intended," "goal," "estimate," "estimates," "expects,"
"expect," "expected," "project," "projects," "projected," "projections,"
"plans," "anticipates," "anticipated," "should," "designed to," "foreseeable
future," "believe," "believes" and "scheduled" and similar expressions. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date the statement was made. The Company undertakes
no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
Reference is made to the cautionary statements contained in Exhibit 99 to
this Form 10-K for a discussion of the factors that may cause actual results to
differ from the results discussed in these forward-looking statements.
ITEM 2--PROPERTIES
The Company's principal executive offices are located in Hamilton, Bermuda.
This facility currently serves as the headquarters for senior management, the
financial and administrative departments and the Company's Bermuda subsidiaries.
The following table sets forth additional information concerning the Company's
facilities:
<TABLE>
<CAPTION>
APPROXIMATE
PROPERTY SQUARE FEET LEASE EXPIRATION
--------------------- ----------- ----------------
<S> <C> <C>
Hamilton, Bermuda................ 10,307 June 20, 2006
London, England.................. 12,500 August 10, 2009
Dallas, Texas.................... 27,200 August 31, 2003
New York, New York............... 7,900 October 3, 2003
Sarasota, Florida................ 12,350 June 28, 2008
Orlando, Florida................. 6,700 June 30, 2002
Fort Lauderdale, Florida......... 11,100 January 1, 2000
Montgomery, Alabama.............. 5,000 June 30, 1999
Southington, Connecticut......... 2,500 January 1, 2003
Dallas, Texas.................... 10,500 May 31, 2001
</TABLE>
All of the Company's facilities are leased. Aggregate lease payments for
1998 were $2.2 million (1997 - $1.9 million). The Company anticipates that it
will be able to extend these leases as they expire or, if necessary or
desirable, locate substitute facilities on acceptable terms.
ITEM 3--LEGAL PROCEEDINGS
(a) There currently are pending several arbitration proceedings in England
between reinsurers and their ceding insurers relating to reinsurance
transactions involving the personal accident excess of loss market ("LMX") for
the years 1993, 1994, 1995 and 1996. Although, with one exception, neither the
Company nor its subsidiaries are a party to any of these arbitrations, certain
of the Company's subsidiaries acted as a reinsurance broker for ceding companies
that are parties to certain of the arbitrations. The exception entails a
subsidiary that is directly involved in an arbitration because it assumed the
position of one of the reinsureds by way of portfolio transfer.
The reinsurers have alleged that they sustained losses due to a spiral in
the LMX market which was not disclosed to them by the ceding insurers or their
reinsurance brokers. As a consequence, these reinsurers have
10
<PAGE>
asserted that they are no longer obliged to honor their reinsurance agreements
and have ceased paying claims. If one or more reinsurers prevail in the pending
arbitration, it is possible that one or more ceding insurers that are
reinsurance brokerage clients of the Company's subsidiaries or for whom a
subsidiary performs the role of underwriting manager, may assert a claim against
a subsidiary and in the case of the one exception the subsidiary would be unable
to recover under certain contracts of reinsurance.
During 1998 certain of the reinsurers and reinsureds filed a total of 7
writs in the English courts (which are the equivalent of a complaint in U.S.
jurisdictions) against the Company or certain of its subsidiaries to toll the
statute of limitations. Some of these writs were issued pending the outcome of
related arbitrations. None of these writs specified an amount of damages sought.
In most cases, the Company or the relevent subsidiaries have negotiated
standstill agreements with the reinsurer or reinsured to toll the statute of
limitations.
The primary factual allegation by the reinsurers is that, although they
believed they reinsured the subject risks only at high excess levels, the LMX
spiral caused their high excess positions to not equate with their expectation
of remoteness from the incidence of risk. As to the Company or its subsidiaries,
the reinsurers and reinsureds have alleged in their writs that the Company or
its subsidiary was negligent, misrepresented, or failed to disclose the
potential effect of the spiral on the reinsurers' exposure to risk.
The Company does not yet have sufficient information to determine whether
any claims ultimately will be prosecuted against the Company or its subsidiaries
or whether any such claims ultimately will result in payment of any liability or
settlement by the Company or its subsidiaries.
The Company understands that the parties to the arbitration and court
proceedings and other participants in these markets currently are attempting to
achieve a business solution that could involve a financial contribution by
participants in the market. Although no assurances can be given as to the
outcome of the pending proceedings and their effect on the Company, the Company
believes, based on the information presently available to it, that any such
effect should not materially adversely affect the Company's financial condition.
(b) The Company is subject to other litigation and arbitration in the
ordinary course of its business. While any of these proceedings contains an
element of uncertainty, management presently believes the outcome of these
currently pending proceedings will not have a material adverse effect on the
Company.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth
quarter of the fiscal year 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth certain information regarding the Executive
Officers of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------- ----- --------------------------------------------------------
<S> <C> <C>
Nicholas Mark Cooke............ 41 Chairman, President, Chief Executive Officer and
Director (1)
Nicholas Brown................. 40 Managing Director of Stirling Cooke Brown Insurance
Brokers Limited and Stirling Cooke Brown Reinsurance
Brokers Limited; Director (2)
George W. Jones................ 44 Chief Financial Officer and Director (3)
</TABLE>
(1) Term expires at annual shareholders meeting in 2000.
(2) Term expires at annual shareholders meeting in 1999.
(3) Term expires at annual shareholders meeting in 2001.
11
<PAGE>
NICHOLAS MARK COOKE has been Chief Executive Officer of the Company or its
predecessors since 1990 and Chairman, President and Director of the Company
since it began operations in January 1996. Prior to 1990, Mr. Cooke was a
director of two Lloyds brokers and has had continuous employment in the
insurance and reinsurance industry in the London market since 1976.
NICHOLAS BROWN has been a Director of the Company since it began operations
in January 1996. Mr. Brown has been a Director and the Managing Director of
Stirling Cooke Brown Insurance Brokers Limited and of Stirling Cooke Brown
Reinsurance Brokers Limited, U.K. subsidiaries of the Company since 1992. Prior
to 1992, Mr. Brown was a director of a Lloyds broker and has had continuous
employment in the insurance and reinsurance industry in the London market since
1977.
GEORGE W. JONES has been Chief Financial Officer and a Director of the
Company since it began operations in January 1996, and was Chief Financial
Officer and a Director of Stirling Cooke Brown Holdings (U.K.) Limited since
1992 and its subsidiaries since 1988.
12
<PAGE>
PART II
ITEM 5--MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Ordinary Shares, $0.25 par value, have been quoted on the
Nasdaq National Market under the symbol "SCBHF" since November 26, 1997. The
Ordinary Shares were listed in connection with the Company's Initial Public
Offering completed in December 1997. As of March 15, 1999, the approximate
number of holders of the Company's Ordinary Shares was 800.
The following table sets forth the high and low closing sale prices per
share of the Company's Ordinary Shares for the period from November 26, 1997
through the year ended December 31, 1998:
<TABLE>
<CAPTION>
HIGH LOW
-------- --------
<S> <C> <C>
November 26, 1997 -- December 31, 1997................ $25 1/2 $23 3/8
Year ended December 31, 1998
First Quarter.................................... $27 3/4 $23 5/16
Second Quarter................................... $30 $25 1/4
Third Quarter.................................... $27 7/8 $11 5/8
Fourth Quarter................................... $20 $11 1/8
</TABLE>
The closing market price of the Ordinary Shares on March 15, 1999 was
$11 3/4.
During 1998, the Company paid dividends of $0.12 per Ordinary Share.
Dividends are paid quarterly. During 1997, the Company did not pay any
dividends. A dividend of $0.03 per Ordinary Share was declared on March 8, 1999
and will be paid on March 30, 1999 to record holders at March 19, 1999. The
declaration and payment of future dividends is at the discretion of the
Company's Board of Directors and will depend upon, among other things, future
earnings, capital requirements, the general financial condition of the Company,
general business conditions and other factors. The Company's ability to pay
dividends is restricted due to certain insurance regulations. See "Management
Discussion and Analysis of Financial Condition and Results of Operations" and
Note 17 to the Consolidated Financial Statements.
In October 1998, the Company purchased a further 47,000 Ordinary Shares on
the open market for a total cost of $567,000. These shares were recorded as
treasury stock at cost.
Subsequent to the year end, the Company has purchased a further 346,400
Ordinary Shares on the open market at a total cost of $4,306,000.
Under current Bermuda law, there is no income tax, withholding tax, capital
gains or capital transfer tax on the Company or its Shareholders.
13
<PAGE>
ITEM 6--SELECTED FINANCIAL DATA
The selected consolidated financial data below should be read in
conjunction with the Consolidated Financial Statements and the notes thereto
presented under Item 8.
<TABLE>
<CAPTION>
AS OF OR FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------
1994 1995 1996(1) 1997 1998
------------ ------------- ---------------- ------------ -------------
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Revenues........................................ $ 12,373 $ 19,048 $ 47,061 $ 65,310 $ 85,093
Income Before Taxation.......................... 4,131 7,154 12,199 15,918 19,808
Taxation........................................ 1,298 2,560 2,281 2,925 3,790
Net income...................................... $ 2,833 $ 4,594 $ 9,918 $ 12,993 $ 16,018
BASIC EARNINGS PER SHARE
Net Income per share(2)......................... $ 0.66 $ 1.07 $ 1.22 $ 1.55 $ 1.63
Weighted average number of ordinary
shares outstanding............................. 4,288,908 4,288,908 8,100,782 8,383,482 9,814,101
DILUTED EARNINGS PER SHARE
Net Income per share assuming dilution(2)....... $ 0.66 $ 1.07 $ 1.19 $ 1.53 $ 1.63
Weighted average number of ordinary
shares outstanding assuming dilution........... 4,288,908 4,304,098 8,306,610 8,515,473 9,840,159
Dividends per Ordinary Share.................... $ 0.19 $ 0.53 $ 0.00 $ 0.00 $ 0.12
BALANCE SHEET DATA:
Total assets(3)................................. $ 61,914 $ 103,273 $ 235,084 $ 406,330 $ 649,641
Long term debt.................................. 0 0 0 0 0
Ordinary Shares subject to redemption(4)........ 0 0 14,457 0 0
Total shareholders' equity...................... $ 4,596 $ 7,055 $ 29,001 $ 83,103 $ 97,632
</TABLE>
(1) Includes the operations of Realm Investments Limited from its January 1996
acquisition by the Company. Realm National from its September 1996
acquisition by the Company and the operations of North American Risk, Inc.
from its July 1996 acquisition by the Company. All of such acquisitions
were accounted for as purchases. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
(2) See Note 2(k) of Notes to the Consolidated Financial Statements for an
explanation of the methods used to determine Net Income per share.
(3) Total assets comprise corporate assets together with cash held and
insurance balances receivable in a fiduciary capacity. See Note 4 to the
Consolidated Financial Statements.
(4) The Ordinary Shares subject to redemption were reclassified to
shareholders' equity upon consummation of the Initial Public Offering since
those shares were no longer redeemable.
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Stirling Cooke Brown Holdings Limited (the "Company") was incorporated in
Bermuda on December 12, 1995. The Company is a holding company engaged, through
its subsidiaries, in providing insurance services primarily in the United
States, Bermuda and the U.K. The Company's activities include brokerage, program
business, underwriting management, insurance and reinsurance. In January 1996,
the Company acquired all the outstanding common shares of Realm Investments Ltd.
in exchange for 1,999,980 of its newly issued ordinary shares. The Company also
acquired in September 1996 its own United States domiciled insurance company
(Realm National) which, together with the Company's Bermuda based reinsurance
company (CIRCL), writes insurance and reinsurance business. Realm National also
earns policy issuance fees. The Company specializes in the North American
occupational accident and workers' compensation alternative risk transfer
markets.
The Company did not conduct any business from the date of its incorporation
until January 1996. In January 1996, under the terms of a share purchase
agreement, the Company exchanged 4,000,020 of its newly issued ordinary shares
for 100% of the outstanding share capital of Stirling Cooke Brown Holdings (UK)
Limited. Stirling Cooke Brown Holdings (UK) Limited was incorporated in England
on February 5, 1990 and formerly acted as the
14
<PAGE>
ultimate holding company for a number of United Kingdom subsidiaries involved in
the insurance brokering industry.
Stirling Cooke Brown Holdings (UK) Limited was the predecessor entity of
the Company. Accordingly, the consolidated financial statements of the Company
for the year ended December 31, 1996 are those of Stirling Cooke Brown Holdings
(UK) Limited.
The following is a discussion of the Company's results of operations and
financial condition. This discussion and analysis should be read in conjunction
with the consolidated financial statements and the notes thereto presented under
Item 8.
Results of Operations For the Years Ended December 31, 1996, 1997 and 1998.
REVENUES AND NET INCOME
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1996 1997 1998
-------- -------- --------
(dollars in thousands)
<S> <C> <C> <C>
Revenues $47,061 $65,310 $85,093
Expenses 34,862 49,392 65,285
------- ------- -------
Income before Taxation 12,199 15,918 19,808
Taxation 2,281 2,925 3,790
------- ------- -------
Net Income $ 9,918 $12,993 $16,018
======= ======= =======
Net Income per Share - Basic $ 1.22 $ 1.55 $ 1.63
Net Income per Share assuming dilution $ 1.19 $ 1.53 $ 1.63
</TABLE>
Revenues of $85.1 million in 1998 represents a $19.8 million or 30.3%
increase over 1997 revenues of $65.3 million which was in turn a $18.2 million
or 38.8% increase over the 1996 revenues of $47.1 million. Net income of $16.0
million in 1998 represents a $3.0 million or 23.3% increase over 1997 net income
of $13.0 million which was in turn a $3.1 million or 31.0% increase over the
1996 net income of $9.9 million.
Basic net income per share increased to $1.63 in 1998 from $1.55 in 1997
(excluding the profit on disposal of subsidiaries during 1997, basic net income
per share was $1.49 during the year) and $1.22 in 1996. Diluted net income per
share increased to $1.63 in 1998 from $1.53 in 1997 (excluding the profit on
disposal of subsidiaries during 1997, diluted net income per share was $1.47
during the year) and $1.19 in 1996.
REVENUES AND NET INCOME BY SEGMENT
<TABLE>
<CAPTION>
Segment Revenues Segment Net Income (loss)
For the Years Ended December 31, For the Years Ended December 31,
--------------------------------------- --------------------------------------------
1996 1997 1998 1996 1997 1998
------------ ----------- ------------ ------------- --------------- ------------
(dollars in thousands) (dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Brokerage $19,219 $23,385 $27,144 $ 5,980 $ 8,591 $11,501
Program Business 11,912 19,770 27,119 3,091 3,938 5,187
Underwriting Management 4,276 4,174 3,554 2,790 2,491 1,689
Insurance 1,426 5,399 11,073 51 471 1,169
Reinsurance 8,187 9,382 10,905 201 57 (3,357)
Other 2,041 3,200 5,798 86 370 3,619
Adjustments & Eliminations -- -- (500) -- -- --
------- ------- ------- ------- ------- -----------
Total $47,061 $65,310 $85,093 $12,199 $15,918 $19,808
======= ======= ======= ======= ======= ===========
</TABLE>
15
<PAGE>
Brokerage
- ---------
Revenues of $27.1 million in 1998 represented an increase of $3.8 million
or 16.1% from revenues of $23.4 million in 1997 which was in turn a $4.2 million
or 21.7% increase from revenues of $19.2 million in 1996. Despite competitive
pressures in the marketplace, the brokerage operations, primarily based in the
United Kingdom, provided growth throughout the year.
The brokerage segment's profit of $11.5 million in 1998 represented an
increase of $2.9 million or 33.9% from segment profit of $8.6 million in 1997
which was in turn a $2.6 million or 43.7% increase from segment profit of $6.0
million in 1996. The segment benefited from increased margins due to volume
efficiencies.
Program Business
- ----------------
The Company's program business segment also grew in terms of both revenues
and profits. Revenues of $27.1 million in 1998 represented an increase of $7.3
million or 36.9% from revenues of $19.8 million in 1997 which was in turn a $7.9
million or 66.0% increase from revenues of $11.9 million in 1996. Despite
increasingly competitive market conditions particularly in the latter part of
the year, the Company was able to increase the volume of premiums written
through its program business segment during the year. The increasingly
competitive workers compensation market in which the majority of the Company's
programs compete has resulted in a change in the Company's fee arrangements with
reinsurers which is expected to negatively impact earnings in 1999. The Company
is trying to minimize the effect of these changes in fee structure but it is
expected that while the workers compensation market remains so competitive, the
Company's fees will continue to be under pressure.
Segment profit of $5.2 million in 1998 represented an increase of $1.2
million or 31.7% from segment profit of $3.9 million in 1997 which was in turn a
$0.8 million or 27.4% increase from segment profit of $3.1 million in 1996.
Underwriting Management
- -----------------------
The Company's underwriting management segment continued to experience
significant competitive pressures during 1998 following the already competitive
market in 1997. Revenues of $3.6 million in 1998 represented a decrease of $0.6
million or 14.9% from revenues of $4.2 million in 1997 which was in turn a $0.1
million or 2.4% decrease from revenues of $4.3 million in 1996. The Company has
not seen any change in market conditions in the early part of 1999 and
consequently expects revenues for this segment to continue to decline until
market conditions improve.
Segment profit of $1.7 million in 1998 represented a decrease of $0.8
million or 32.2% from segment profit of $2.5 million in 1997 which was in turn a
$0.3 million or 10.7% decrease from segment profit of $2.8 million in 1996.
Insurance
- ---------
The Company's insurance segment comprising Realm National experienced
significant growth in 1998 following 1997 which also saw significant growth.
During 1998 Realm National continued its relicensing process to facilitate the
growth of its business during the year and promote the opportunity for growth in
the years ahead. By the end of the year, Realm National was fully licensed in 20
states and partially licensed in 8 states. During 1998, Realm National wrote
business in 15 states compared to 12 states in 1997 and 18 states in 1996.
Revenues of $11.1 million in 1998 represented an increase of $5.7 million or
105.1% from revenues of $5.4 million in 1997 which was in turn a $4.0 million or
278.6% increase from revenues of $1.4 million in 1996 (1996 figures for Realm
National reflect amounts from the Company's acquisition in September of 1996).
A useful indicator of Realm National's growth is the increase in gross written
premiums which were $48.6 million in 1998 which represents a $26.9 million or
123.6% increase from $21.7 million in 1997 which represented a $17.7 million or
442.4% increase from $4.0 million in 1996. Net premiums earned increased to $7.7
million in 1998 which represents a $4.8 million
16
<PAGE>
or 164.2% increase from $2.9 million in 1997 which represented a $2.1 million or
248.8% increase from $0.8 million in 1996. The remainder of the growth in
revenues is due to policy issuance fees and interest income. Policy issuance
fees increased to $2.1 million in 1998 which represents a $1.3 million or 167.8%
increase from $0.8 million in 1997 which represented a $0.6 million or 257.8%
increase from $0.2 million in 1996.
Market conditions in the workers compensation insurance market in which
Realm National writes the majority of its business grew increasingly competetive
during 1998 and this trend has continued into 1999. While these competitive
market conditions continue they are likely to restrict Realm National's ability
to continue its rate of expansion in its workers compensation book of business
during 1999. Realm National is continuing to seek to expand its volume of
business in other lines of insurance, where market conditions are less
competetive.
Segment profit of $1.2 million in 1998 represented an increase of $0.7
million or 148.2% from segment profit of $0.5 million in 1997 which was in turn
a $0.4 million or 823.5% increase from segment profit of $0.1 million in 1996.
Reinsurance
- -----------
The Company's reinsurance segment comprising CIRCL experienced limited
growth in revenues in 1998 and 1997. Revenues of $10.9 million in 1998
represented an increase of $1.5 million or 16.2% from revenues of $9.4 million
in 1997 which was in turn a $1.2 million or 14.6% increase from revenues of $8.2
million in 1996. Net premiums earned are the largest component of revenues in
CIRCL. Net premiums earned of $10.1 million in 1998 represented an increase of
$1.2 million or 13.4% from net premiums earned of $8.9 million in 1997 which was
in turn a $1.0 million or 12.0% decrease from net premiums earned of $7.9
million in 1996.
Segment loss of $3.4 million in 1998 represented a decrease of $3.5 million
from segment profit of $0.1 million in 1997 which was in turn a $0.1 million
decrease from segment profit of $0.2 million in 1996. There were two main
factors leading to the segment loss in 1998, adverse development on one program
and a provision of $2.5 million against reinsurance recoveries. The adverse
development during 1998 reflects primarily an increase in claims frequency on
one particular program that covers bodily injury and property risks in the
construction industry. This program was not renewed by CIRCL in 1999. At
December 31, 1998, the Company was in dispute with certain of its reinsurers in
respect of amounts due under retrocession coverages. The Company has provided
$2.5 million against reinsurance contracts with total recoveries of $13.4
million of which $10.2 million has been reported to date. The provision
represents management's best estimates at this time of a possible shortfall in
recoveries. This provision is included in the balance sheet as a component of
paid losses recoverable from reinsurers. The provision is necessarily an
estimate and amounts not collectible from reinsurers may ultimately be
significantly greater or lesser than the provision established. It is reasonably
possible that management will revise this estimate significantly in the near
term. Any subsequent differences arising will be recorded in the period in which
they occur.
During the course of the year, the Company's management evaluated CIRCL's
underwriting results and, as a result of unfavorable results, reduced CIRCL's
underwriting. Management decided in early 1999 to cease underwriting any new
programs in CIRCL and a number of existing contracts were not renewed for the
1999 year. Those renewed will be allowed to run until they expire at December
31, 1999. Because some contracts were not renewed by CIRCL during 1999, revenues
should decrease accordingly.
Other
- -----
Other includes primarily the Company's holding companies and other
operating subsidiaries, and income earned in investments in affiliates.
Revenues, consisting primarily of interest earnings, of $5.8 million in 1998
represented an increase of $2.6 million or 81.3% from revenues of $3.2 million
in 1997 which was in turn a $1.2 million or 60.0% increase from revenues of $2.0
million in 1996. The increase in revenues in 1998 as compared to 1997 is
primarily due to interest earnings on proceeds received from the Company's
initial public offering in December, 1997, as well as income earned in
investments in affiliates.
17
<PAGE>
Segment profit of $3.6 million in 1998 represented an increase of $3.2
million from $0.4 million in 1997 which was in turn a $0.3 million increase from
of $0.1 million in 1996. As with revenues, the increase in net income in 1998 as
compared to 1997 is primarily due to interest earnings on proceeds received from
the Company's initial public offering in December, 1997, as well as income
earned on equity investments.
Liquidity and Capital Resources
At December 31, 1998, the Company held cash and marketable securities of
$97.4 million compared to $71.7 million at December 31, 1997 and $38.2 million
at December 31, 1996. In addition, the Company held cash in fiduciary accounts
relating to insurance client premiums amounting to $63.9 million at December 31,
1998 compared to $60.2 million at December 31, 1997 and $50.2 million at
December 31, 1996. These increased cash balances reflect the growth in the
Company's business activities for 1998 together with the cash held following
completion of the initial public offering. Of the $97.4 million of cash and
marketable securities held by the Company at December 31, 1998 (1997--$71.7
million, 1996--$38.2 million), $58.9 million (1997--$40.9 million, 1996--$35.9
million) were held by subsidiaries whose payment of dividends to the Company was
subject to regulatory restrictions or possible tax liabilities. At December 31,
1998, the Company's investment portfolio (at fair market value) totalled $29.2
million (1997--$21.0 million, 1996--$22.6 million). The portfolio consisted
primarily of U.S. Treasury, short-term cash and A-rated corporate debt
securities.
During 1998, the Company's operating activities generated $28.7 million of
net cash, compared to generating $8.1 million of net cash during 1997 and $14.8
million in 1996. The cash generated from operating activities varies according
to the timing of collections and payments of insurance and reinsurance balances.
The Company expects its operations will continue to generate positive cash flow
for 1999.
Shareholders' equity increased by $14.5 million, to $97.6 million, at
December 31, 1998 from $83.1 million at December 31, 1997 due primarily to net
income earned during the year. Shareholders' equity increased by $54.1 million,
to $83.1 million, at December 31, 1997 from $29.0 million at December 31, 1996.
This increase was primarily attributable to the following:
(i) $26.8 million of net proceeds from the Initial Public Offering
during the year;
(ii) a reclassification of Ordinary Shares subject to redemption of
$14.5 million since these shares are no longer redeemable after
consummation of the Initial Public Offering; and
(iii) net income of $13.0 million earned during 1997.
Total assets increased to $649.6 million at December 31, 1998 from $406.3
million at December 31, 1997 and $235.1 million at December 31, 1996,
principally as a result of increased business activity and a significant
increase in client insurance balances outstanding. The Company had no
outstanding debt at December 31, 1996, 1997 and 1998.
Accounting Pronouncements
In December 1997, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 97-3. Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments. The accounting guidance of this SOP focuses
on the timing of recognition and measurement of liabilities for insurance-
related assessments. Guidance is also provided on recording assets representing
future recoveries of assessments through premium tax offsets or policy
surcharges. The SOP is effective for fiscal years beginning after December 15,
1998. The Company does not anticipate the statement to have a significant impact
on the Company's financial position or results of operations.
During 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-5. Reporting on the costs of start-up activities.
The accounting guidance of this SOP requires that the costs of start-up
activities be expensed as incurred and any costs that are carried as an asset
prior to adoption of SOP 98-5 would be written off by reporting a cumulative
effect of a change in accounting principle in the statement of income as of
January 1, 1999. The cumulative effect of a change in accounting principle to be
recorded in the statement of income for the quarter ended March 31, 1999 will be
approximately $495.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities". This statement
is effective for all quarters of fiscal years beginning after June
18
<PAGE>
15, 1999. Given the limited number of transactions currently entered into by the
Company that are covered by the Statement, the Company does not anticipate any
significant changes to its current financial reporting.
In November 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-7, "Deposit accounting: Accounting for Insurance
and Reinsurance Contracts that do not transfer risk". This SOP provides
accounting guidance for insurance and reinsurance contracts that do not transfer
risk, as determined by the provisions of SFAS 113. The Company is currently
reviewing the impact of this standard on its financial reporting.
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income". This statement establishes rules for the reporting of comprehensive
income and its components. Comprehensive income consists of net income and
unrealized gains and losses on available for sale investments, and is presented
in the Consolidated Statement of Income and Comprehensive Income. The adoption
of SFAS 130 had no impact on total shareholders' equity. Prior year financial
statements have been reclassified to conform to the SFAS 130 requirements.
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". SFAS 131 establishes standards for
reporting information about operating segments and related disclosures about
products and services, geographic areas and major customers. This disclosure is
located within Note 15 to the Company's consolidated financial statements.
Year 2000
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four digits to define the applicable year. Any of the
Company's programs or non-information systems that have date-sensitive software
may recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in a major system failure or in miscalculations.
In 1997, the Company appointed individuals in each of the Company's
geographic regions to review and assess the Company's state of readiness and its
ability to process transactions in the Year 2000. These individuals and the
overall committee that they are a part of are providing guidance to the
operating and support departments, and have and will continue to monitor the
progress of efforts made to address the Year 2000 issue. The Company is
currently implementing its plan and preparing its various computer systems and
selected applications for the Year 2000. This process involves taking inventory,
testing, evaluating and adjusting all known date-sensitive systems and equipment
for Year 2000 compliance. In addition, the Company is reviewing its essential
non-information technology systems for Year 2000 compliance. The Company has
also consulted with various third parties, including, but not limited to,
outside consultants, outside service providers and infrastructure providers to
develop approaches to the Year 2000 issue, to gain insight to problems and to
provide additional perspective on solutions. The Company expects that compliance
work with respect to the internal systems will be substantially completed by the
end of the first quarter of 1999. In 1999, all systems critical to the Company's
core businesses will be retested.
The individuals in each geographic region report at least quarterly to the
overall committee that they are a part of and update that committee on their
respective region's progress. The latest update is that each geographic region
is proceeding on schedule as planned. In the US and Bermuda, the Company's
internal computer system and software is relatively modern and few costs have
been or are expected to be incurred to bring those systems into compliance. In
the U.K., the Company's internal systems and software were not as modern and the
majority of the Company's Year 2000 costs in upgrading the Company's systems and
software have been incurred in that region. Because of the Year 2000 issue, one
large system in the U.K. was replaced in late 1998.
The Company continues to assess its external relationships with third
parties. The Company is in the process of communicating with its significant
vendors and large customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
issues. Where deemed necessary by the Company, this process involves onsite
review of the third party's procedures and plans for Year 2000 compliance.
However, there can be no assurance that the systems of third parties, such as
utility companies, regulatory bodies, government entities, insurance related
companies or insurance carriers on which the Company's operations rely, will be
timely converted, or that a failure to convert by another company would not have
a material adverse effect on the
19
<PAGE>
Company's operating results. However, management believes that ongoing
communication with and assessment of third parties will minimize these risks.
The Company's insurance and reinsurance subsidiaries may also have an
underwriting exposure to the Year 2000 phenomenon. Although the subsidiaries
have not received any claims of coverage from insureds based on losses resulting
from Year 2000 issues, there can be no assurance that insureds will be free from
losses of this type or that these subsidiaries will be free from claims made
under their policies.
The total estimated cost of compliance is $0.8 million. Approximately $0.5
million of the cost is related to reprogramming or replacement of software, and
approximately $0.3 million is related to acquisition of hardware. Costs related
to non-information technology are expected to be immaterial. Approximately $0.5
million of the $0.8 million cost of compliance has been incurred as of the end
of December 31, 1998. All of these costs are being funded through operating cash
flows. Total costs have not had and are not expected to have a material impact
on the Company's financial results.
Based on the review of the state of readiness of the Company and its risks,
the Company currently anticipates minimal business disruption will occur as a
result of Year 2000 issues. Nonetheless, the Year 2000 issue represents a risk
that cannot be assessed with precision nor controlled with certainty. Possible
consequences of disruptions that could occur given non-compliance include, but
are not limited to, loss of communication links with subsidiaries and insurance
carriers, loss of electric power, inability to process transactions or inability
to engage in similar normal business activities. Furthermore, failure of
significant third parties with which the Company conducts business, including
insurance carriers, to meet Year 2000 compliance could have a materially
detrimental effect on the Company. To date, the Company has not established a
contingency plan for possible Year 2000 issues. Where needed, the Company will
establish contingency plans based on actual testing experience with its systems
and assessment of outside risks.
Inflation
The Company does not believe its operations have been materially affected by
inflation. The potential adverse impacts of inflation include: (a) a decline in
the market value of the Company's fixed maturity investment portfolio; (b) an
increase in the ultimate cost of settling claims which remain unresolved for a
significant period of time; and (c) an increase in the Company's operating
expenses. However, the Company generally holds its fixed maturity investments to
maturity and currently believes that an acceptable amount is included in the
yield to compensate the Company for the risk of inflation. Any increase in the
cost of settling claims will be offset by increases in investment income earned
and, generally, an increase in operating expenses resulting from inflation
should be matched by similar increases in investment income earned on the
Company's general surplus funds.
ITEM 7A--MARKET RISK
The Company's investment portfolio is comprised of fixed maturity investments,
equity securities, and short term investments. The Company's exposure to market
risk is primarily limited to changing interest rates, primarily in the United
States, as all fixed maturity investments are denominated in U.S. dollars. The
fair value of the fixed maturity investments as at December 31, 1998 was $17.1
million. A change in interest rates will affect the fair value of the Company's
investments and will lead to fluctuations in "Accumulated Other Comprehensive
Income" on the balance sheet. The Company does not use derivative financial
instruments to manage market risk in its portfolio.
The table below (expressed in millions of U.S. dollars) presents the par value
amounts and related weighted average interest rates by year of maturity for the
Company's U.S. dollar denominated investment portfolio.
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1999 2000 2001 2002 2003 2004 2005 2006 2012 2019 2020 Total
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- -----
Investments Fixed Maturity ($) 1.0 2.4 1.0 0.7 2.5 1.5 4.9 0.3 0.5 0.4 1.3 16.5
Weighted average interest rate 7.7% 6.9% 6.7% 7.5% 5.9% 5.5% 5.5% 6.0% 5.6% 6.3% 6.5% 6.2%
</TABLE>
20
<PAGE>
Given the limited value of balances and transactions in foreign currencies, the
Company's exposure to foreign currency movements is considered to be
insignificant
Item 8--Financial Statements and Supplementary Data
Index to Consolidated Financial Statements and Related Notes:
<TABLE>
<CAPTION>
Page #
<S> <C>
Independent Auditor's Report............................................ 22
Consolidated Balance Sheets............................................. 23
Consolidated Statements of Income and Comprehensive Income.............. 24
Consolidated Statements of Changes in Shareholders' Equity.............. 25
Consolidated Statements of Cash Flows................................... 26
Notes to Consolidated Financial Statements.............................. 27-47
</TABLE>
21
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of
Stirling Cooke Brown Holdings Limited
We have audited the consolidated financial statements of Stirling Cooke Brown
Holdings Limited and subsidiaries as listed in the accompanying index. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with United States generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Stirling
Cooke Brown Holdings Limited and subsidiaries as at December 31, 1997 and 1998
and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 1998, in conformity with United
States generally accepted accounting principles.
/s/ KPMG Peat Marwick
KPMG Peat Marwick
Hamilton, Bermuda
March 5, 1999
22
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 and 1998
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE
DATA)
<TABLE>
<CAPTION>
ASSETS 1997 1998
------ ------------ ------------
<S> <C> <C>
Marketable securities, at fair value (Note 5)
Debt securities (amortized cost, 1997--$14,882, 1998--$16,722)....................... $ 14,971 $ 17,057
Equity securities (cost, 1997--$454, 1998--$2,384)................................... 486 2,536
Short term investments (amortized cost, 1997--$5,579, 1998--$9,643).................. 5,579 9,643
-------- --------
Total marketable securities............................................................ 21,036 29,236
Cash and cash equivalents (Note 3)..................................................... 50,631 68,165
Fiduciary funds-restricted (Notes 3 and 4)............................................. 60,224 63,895
Insurance and reinsurance balances receivable (affiliates, 1997--$8,118, 1998--$9,994)
(Notes 3, 4 and 18)................................................................... 211,339 382,417
Paid losses recoverable from reinsurers (Note 8)....................................... 3,542 8,916
Outstanding losses recoverable from reinsurers (Notes 8 and 9)......................... 23,072 48,146
Deferred acquisition costs............................................................. 579 2,286
Deferred reinsurance premiums ceded (Note 8)........................................... 12,503 18,711
Deferred tax asset (Note 12)........................................................... 1,109 1,755
Goodwill (Note 2(i))................................................................... 8,613 8,775
Other assets (Note 6).................................................................. 10,926 14,026
Assets related to deposit liabilities (Note 7)......................................... 2,756 3,313
-------- --------
Total assets........................................................................ $406,330 $649,641
======== ========
LIABILITIES
-----------
Outstanding losses and loss expenses (Note 9).......................................... $ 36,276 $ 66,117
Unearned premiums...................................................................... 19,187 25,037
Deferred income........................................................................ 2,853 3,992
Insurance and reinsurance balances payable (affiliates, 1997--$16,187, 1998--$957)
(Notes 3, 4 and 18)................................................................... 251,713 438,456
Funds withheld......................................................................... 1,314 1,359
Accounts payable and accrued liabilities............................................... 6,170 10,719
Income taxes payable (Note 12)......................................................... 2,958 3,016
Deposit liabilities (Note 7)........................................................... 2,756 3,313
-------- --------
Total liabilities................................................................... 323,227 552,009
-------- --------
Contingencies (Note 19)
SHAREHOLDERS' EQUITY
--------------------
Share capital
Authorized 20,000,000 ordinary shares of par value $0.25 each. Issued and fully paid
9,863,372 ordinary shares (Note 10)................................................... 2,466 2,466
Additional paid in capital............................................................. 54,167 54,167
Accumulated other comprehensive income................................................. 63 319
Retained earnings...................................................................... 27,074 41,914
-------- --------
83,770 98,866
Less: Ordinary shares in treasury (1997--40,000, 1998--87,000) at cost (Note 10)....... (667) (1,234)
-------- --------
Total shareholders' equity.......................................................... 83,103 97,632
-------- --------
Total liabilities and shareholders' equity.......................................... $406,330 $649,641
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
23
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1996 1997 1998
--------- ---------- ----------
REVENUES
<S> <C> <C> <C>
Risk management fees (Note 2 (f)).............................. $34,061 $45,664 $55,580
Net premiums earned (Note 8)................................... 8,754 11,790 17,774
Net investment income (Note 5)................................. 3,405 5,782 8,771
Other income................................................... 841 2,074 2,968
------- ------- -------
Total revenues.............................................. 47,061 65,310 85,093
------- ------- -------
EXPENSES
Net losses and loss expenses incurred (Notes 2(e) and 9)....... 6,765 10,951 17,271
Acquisition costs.............................................. 1,837 1,344 3,618
Depreciation and amortization of capital assets................ 1,018 1,199 1,562
Amortization of goodwill....................................... 423 707 740
Salaries and benefits.......................................... 13,106 18,503 22,805
Other operating expenses....................................... 11,713 16,688 19,289
------- ------- -------
Total expenses.............................................. 34,862 49,392 65,285
------- ------- -------
Income before taxation........................................... 12,199 15,918 19,808
Taxation (Note 12)............................................... 2,281 2,925 3,790
------- ------- -------
Net income....................................................... $ 9,918 $12,993 $16,018
------- ------- -------
Other comprehensive income (loss), net of tax:
Unrealized holding gains arising during
the year (net of tax of $75, $130 and $130).................... 147 188 314
Less: reclassification adjustments for realized gains
included in net income (net of tax of $0, $166 and $1)......... -- (272) (58)
------- ------- ------
Other comprehensive income (loss), net of tax.................. 147 (84) 256
Comprehensive income........................................... $10,065 $12,909 $16,274
======= ======= =======
Net income per share (Note 13)................................... $1.22 $1.55 $1.63
======= ======= =======
Net income per share assuming dilution (Note 13)................. $1.19 $1.53 $1.63
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
24
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Ordinary shares of par value $0.25 each
Balance at beginning of year.................................. $ 1,000 $ 1,500 $ 2,466
Issuance of shares............................................ 500 344 --
Options exercised............................................. -- 150 --
Cancellation of ordinary shares in treasury................... -- (100) --
Reclassification of ordinary shares subject to redemption..... -- 572 --
------- ------- -------
Balance at end of year........................................ $ 1,500 $ 2,466 $ 2,466
------- ------- -------
Additional paid in capital
Balance at beginning of year.................................. $ -- $12,319 $54,167
Issuance of shares............................................ 12,319 26,488 --
Proceeds from exercise of options in excess of par............ -- 1,475 --
Issuance of shares (conversion of Class A).................... -- (72) --
Reclassification of ordinary shares subject to redemption..... -- 13,957 --
------- ------- -------
Balance at end of year........................................ $12,319 $54,167 $54,167
------- ------- -------
Notes receivable
Balance at beginning of year.................................. $ -- $ -- $ --
Receivable on exercise of options............................. -- (1,625) --
Repayment of notes............................................ -- 1,625 --
------- ------- -------
Balance at end of year........................................ $ -- $ -- $ --
------- ------- -------
Accumulated other comprehensive income
Balance at beginning of year.................................. $ -- $ 147 $ 63
Change in unrealized gain..................................... 147 (84) 256
------- ------- -------
Balance at end of year........................................ $ 147 $ 63 $ 319
------- ------- -------
Retained earnings
Balance at beginning of year.................................. $ 6,055 $15,973 $27,074
Net income.................................................... 9,918 12,993 16,018
Dividends..................................................... -- -- (1,178)
Cancellation of ordinary shares in treasury................... -- (1,892) --
------- ------- -------
Balance at end of year........................................ $15,973 $27,074 $41,914
------- ------- -------
Treasury stock
Balance at beginning of year.................................. $ -- $ (938) $ (667)
Purchase of ordinary shares in treasury....................... (938) (1,807) (567)
Sale of ordinary shares from treasury......................... -- 86 --
Cancellation of ordinary shares in treasury................... -- 1,992 --
------- ------- -------
Balance at end of year........................................ $ (938) $ (667) $(1,234)
------- ------- -------
Total shareholders' equity.................................... $29,001 $83,103 $97,632
======= ======= =======
</TABLE>
Dividends per share were $0, $0 and $0.12 for the years ended December 31,
1996, 1997 and 1998, respectively.
See accompanying notes to consolidated financial statements.
25
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
1996 1997 1998
-------- --------- ---------
<S> <C> <C> <C>
Operating activities
Net income.......................................................................... $ 9,918 $ 12,993 $ 16,018
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of capital assets................................... 1,018 1,199 1,562
Net gain on sale of subsidiaries.................................................. -- (478) --
Amortization of goodwill.......................................................... 423 707 740
Amortization of marketable securities............................................. (10) 197 68
Net realized gains on sale of marketable securities............................... -- (438) (59)
Equity in income of affiliates.................................................... (282) (1,266) (2,631)
Gain on sale of capital assets.................................................... -- -- (67)
Changes in non cash operating assets and liabilities:
Fiduciary funds................................................................... (18,349) (13,245) (3,671)
Insurance and reinsurance balances receivable..................................... (30,292) (115,935) (170,926)
Paid losses recoverable from reinsurers........................................... (731) (2,811) (5,374)
Outstanding losses recoverable from reinsurers.................................... (5,159) (6,484) (25,074)
Deferred acquisition costs........................................................ 1,436 (408) (1,707)
Deferred reinsurance premiums ceded............................................... (762) (5,281) (6,208)
Other assets...................................................................... (942) (3,620) (1,405)
Deferred tax asset................................................................ 141 (801) (710)
Assets related to deposit liabilities............................................. (579) 1,292 (557)
Outstanding losses and loss expenses.............................................. 9,916 11,975 29,841
Unearned premiums................................................................. 938 6,672 5,850
Insurance and reinsurance balances payable........................................ 47,065 120,887 186,743
Funds withheld.................................................................... (355) (69) 45
Accounts payable and accrued liabilities.......................................... 893 2,431 4,467
Income taxes payable.............................................................. (559) 782 58
Deferred income................................................................... 522 1,060 1,139
Deposit liabilities............................................................... 579 (1,292) 557
-------- --------- ---------
Net cash provided by operating activities....................................... 14,829 8,067 28,699
-------- --------- ---------
Investing activities
Purchase of capital assets........................................................ (1,446) (1,619) (2,899)
Sale of capital assets............................................................ 58 88 229
Purchase of debt securities....................................................... (13,751) (318) (12,584)
Purchase of equity securities..................................................... (39) (3,977) (2,530)
Purchase of short-term investments, net........................................... (120) (5,459) (4,064)
Proceeds on sale of debt securities............................................... 2,273 4,190 10,680
Proceeds on sale of equity securities............................................. 15 7,262 658
Purchase of subsidiaries, net of cash acquired.................................... (290) (1,197) (1,055)
Cash received upon sale of subsidiaries........................................... -- 861 --
Investments in affiliates......................................................... (134) (198) --
Dividends received from affiliates................................................ -- 593 2,145
-------- --------- ---------
Cash (used) provided by investing activities.................................... (13,434) 226 (9,420)
-------- --------- ---------
Financing activities
Dividends......................................................................... -- -- (1,178)
Net proceeds of subscription to share capital subject to redemption............... 14,457 -- --
Net proceeds from subscriptions to share capital.................................. -- 26,832 --
Proceeds from exercise of options................................................. -- 1,625 --
Purchase of ordinary shares in treasury........................................... (938) (1,807) (567)
Sales of ordinary shares in treasury.............................................. -- 86 --
-------- --------- ---------
Cash provided (used) by financing activities.................................... 13,519 26,736 (1,745)
-------- --------- ---------
Increase in cash and cash equivalents............................................... 14,914 35,029 17,534
Cash and cash equivalents at beginning of year...................................... $ 688 $ 15,602 $ 50,631
-------- --------- ---------
Cash and cash equivalents at end of year............................................ $ 15,602 $ 50,631 $ 68,165
======== ========= =========
Supplemental disclosure of cash flow information
Cash paid during the year for income taxes...................................... $ 1,928 $ 3,755 $ 3,275
======== ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
26
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997 AND 1998
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE
DATA)
1. GENERAL
Stirling Cooke Brown Holdings Limited (the "Company") was incorporated in
Bermuda on December 12, 1995. The Company is a holding company which, through
its subsidiaries, provides risk management services and products. The Company
provides its range of services to independent insurance carriers and reinsurance
companies as well as directly to the insureds. The Company arranges reinsurance
for its products as well as for those offered by independent U.S.-based
insurance carriers active in the workers compensation, occupational accident and
health and casualty insurance markets. In January 1996, the Company acquired all
the outstanding common shares of Realm Investments Ltd. in exchange for
1,999,980 of its newly issued ordinary shares. The Company also acquired, in
September 1996, its own United States domiciled insurance company Realm National
Insurance Company ("Realm National") which, together with the Company's Bermuda
based reinsurance company, writes insurance and reinsurance business. The
Company specializes in the North American occupational accident and workers'
compensation alternative risk transfer markets.
The Company did not conduct any business from the date of its incorporation
until January 1996. In January 1996, under the terms of a share purchase
agreement, the Company exchanged 4,000,020 of its newly issued ordinary shares
for 100% of the outstanding share capital of Stirling Cooke Brown Holdings (UK)
Limited. Stirling Cooke Brown Holdings (UK) Limited was incorporated in England
on February 5, 1990 and formerly acted as the ultimate holding company for a
number of United Kingdom subsidiaries involved in the insurance brokering
industry.
On December 2, 1997, the Company and certain Selling Shareholders consummated
an initial public offering of 3,421,250 ordinary shares. Of these shares,
1,375,000 were sold by the Company and 2,046,250 were sold by Selling
Shareholders. Net proceeds of $26,832 were received by the Company upon
consummation of the initial public offering.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements are prepared in accordance
with United States generally accepted accounting principles which require
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The following are the significant accounting policies
adopted by the Company:
a) Basis of presentation
These consolidated financial statements include the financial statements of
the Company and all of its majority owned subsidiaries (collectively referred to
as the "Company"). All significant intercompany balances and transactions have
been eliminated on consolidation. The results of a number of subsidiaries have
been included from the dates of their acquisition.
b) Marketable securities
Marketable securities comprise investments in debt and equity securities and
short term investments. All investments are classified as available for sale and
are carried at fair value. The difference between fair value and amortized
cost/cost is recorded as accumulated other comprehensive income as a separate
component of shareholders' equity, net of applicable deferred income taxes. Bond
discounts and premiums are amortized over the remaining term of the securities.
Such amortization is included as a component of net investment income in the
consolidated statements of income. Realized gains and losses are determined
27
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
on the basis of specific identification. Investment income is recorded as earned
and accrued to the balance sheet date.
c) Premiums written, assumed and ceded
Premiums written and assumed are recorded on the accruals basis and included
in income on a pro-rata basis over the life of the policies or reinsurance
agreements to which they relate, with the unearned portion deferred in the
consolidated balance sheets. Adjustment premiums arising from premium audits are
recorded in the period in which they are determined. Reinsurance premiums ceded
are similarly pro-rated over the terms of the reinsurance contract with the
unearned portion being deferred in the consolidated balance sheets as deferred
reinsurance premiums ceded.
d) Acquisition costs
Acquisition costs associated with the acquisition of new or renewal business,
including commissions and brokerage, are deferred and amortized to income over
the periods in which the premiums are earned. The method followed in determining
the deferred acquisition expenses limits the amount of the deferral to its
realizable value by giving consideration to losses and expenses expected to be
incurred as premiums are earned. Future investment income is anticipated in
determining whether a premium deficiency exists.
e) Losses and loss expenses
Losses and related loss adjustment expenses are charged to income as they are
incurred and are net of losses recovered and recoverable of $6,775, $16,866 and
$44,312 for the years ended December 31, 1996, 1997 and 1998 respectively.
Amounts recoverable from reinsurers are estimated in a manner consistent with
the underlying liability associated with the reinsured policy. Outstanding
losses recoverable are shown separately on the consolidated balance sheets.
Reserves are established for losses and loss expenses relating to claims which
have been reported. In addition, reserves are established, in consultation with
the Company's independent actuaries, for losses which have occurred but have not
yet been reported to the Company and for adverse development of reserves on
reported losses. Management believes that the resulting provision for
outstanding losses and loss expenses is adequate to cover the ultimate net cost
of losses and loss expenses incurred; however, such a provision is necessarily
an estimate and may ultimately be settled for a significantly greater or lesser
amount. The Company has limited historical loss experience available to serve as
a reliable basis for the estimation of ultimate losses. It is at least
reasonably possible that management will revise the estimate of outstanding
losses and loss expenses significantly in the near term. Any subsequent
differences arising are recorded in the period in which they are determined.
f) Risk management fees
<TABLE>
<CAPTION>
For the Years Ended
-------------------------------
December 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Brokerage fees and commissions................. $20,117 $23,965 $26,968
Managing general agency fees................... 6,016 11,391 14,743
Underwriting management fees................... 4,045 4,022 3,357
Program and captive management fees............ 1,625 2,876 3,908
Loss control and audit fees.................... 2,039 2,627 4,508
Policy issuance fees........................... 219 783 2,096
------- ------- -------
Total risk management fees............... $34,061 $45,664 $55,580
======= ======= =======
</TABLE>
28
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(i) Brokerage fees and commissions are recorded and earned as premiums are
billed since substantially all placement services have been provided at that
time. Any subsequent adjustments, including adjustments due to policy
cancellations, premium rate adjustments and profit commissions are recognized
in risk management fees when advised by the client.
(ii) Managing general agency fees are included within Program Business
revenue, and are reported net of commission expense to agents and are
initially recorded as of the effective date of the related insurance policy.
Fee income on installment premiums is recognized periodically when the
installment is billed. Such fees are recognized in income over the period that
services are performed in accordance with the Company's contractual
obligations, typically ranging up to five years, based on the Company's
estimation of expected claims handling requirements in each accounting period.
Such estimation is based upon the Company's claims handling experience over
recent years. Any subsequent adjustments, including adjustments due to policy
cancellation and premium adjustments, are recorded when advised by the client
or agent. The portion that will be earned in the future is deferred and
reported as deferred income in the consolidated balance sheets.
(iii) Underwriting management fees are initially recorded when premium is
billed in accordance with terms of trade. Fee income on installment premiums
is recognized periodically when the installment is billed. Fees are recognized
in income over the period that services are performed in accordance with the
Company's contractual obligations. Such fees are recognized in income over the
period that contractual services are performed, typically up to five years,
based on the Company's estimation of expected claims handling requirements in
each accounting period. Such estimation is based upon the Company's claims
handling experience over recent years. Any subsequent adjustments, including
adjustments due to policy cancellations, and premium adjustments are recorded
when advised by the client or agent. The portion of recorded management fees
that will be earned in the future is deferred and reported as deferred income
in the consolidated balance sheets.
(iv) Program and captive management fees are included within Program
Business revenue, and are initially recorded as of the effective date of the
insurance policy or, in the case of installment premiums, when the installment
is billed and are recognized in income over the period of the underlying
policy (which is typically one year) in proportion to the level of services
provided in accordance with the Company's contractual obligations. Any
subsequent adjustments are recognized in income when advised by the client or
agent. The portion of recorded management fees that will be earned in the
future is deferred and reported as deferred income in the consolidated balance
sheets.
(v) Loss control and audit fees are included within Program Business
revenue, and comprise claims administration handling, loss and safety control
fees and premium audit fees. Such fees are recorded as the fees are billed and
are recognized in income over the period that services are performed in
accordance with the Company's contractual obligations, typically ranging up to
five years depending on the type of service provided, based on the Company's
estimation of expected claims handling requirements in each accounting period.
Such estimation is based upon the Company's claims handling experience over
recent years. The proportion that will be earned in the future is deferred and
reported as deferred income in the consolidated balance sheets.
(vi) Policy issuance fees are recorded as the premium is written and earned
over the applicable policy period. The unearned portion is included in
deferred income in the consolidated balance sheet.
g) Cash and cash equivalents
The Company considers time deposits with original maturity dates of three
months or less to be equivalent to cash. Fiduciary funds are restricted from use
and are not considered cash equivalents.
29
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
h) Investments in affiliates
The Company's investments in affiliated companies which are not majority owned
or controlled are accounted for using the equity method if the Company is able
to exert significant influence upon such companies. Other investments in
affiliates are carried at cost. Investments in affiliates of $1,350 and $1,982
for the years ended December 31, 1997 and 1998, respectively, are recorded in
other assets. The Company's equity share in the net income of affiliates, for
the years ended December 31, 1996, 1997 and 1998 of $282, $1,266 and $2,631
respectively, is included in other income. Dividends received from affiliated
companies of $0, $593 and $2,145 during 1996, 1997 and 1998, respectively, are
recorded as a reduction in the carrying value of the investment.
i) Goodwill
Goodwill in the amount of $8,613 and $8,775 at December 31, 1997, and 1998,
respectively, represents the excess of purchase price over fair value of net
assets acquired. Goodwill is amortized on a straight-line basis over the
expected periods to be benefited, generally 5 to 20 years. Accumulated
amortization at December 31, 1997 and 1998 is $1,130 and $1,870, respectively.
The Company assesses the recoverability of this intangible asset by determining
whether the amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operation. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of the
recoverability of goodwill will be impacted if estimated future operating cash
flows are not achieved.
j) Capital assets and depreciation
Capital assets are stated at cost less accumulated depreciation. Depreciation
is calculated using the straight-line method over four to five years, which is
the estimated useful lives of the related assets.
k) Earnings per share
Earnings per share have been calculated in accordance with Statement of
Financial Accounting Standards No. 128. Net income per share is calculated by
dividing income available to ordinary shareholders by the weighted average
number of ordinary shares outstanding. The ordinary shares which were subject to
redemption are included in the computation of the weighted average number of
outstanding ordinary shares since they have identical rights. Shares held in
treasury are not considered outstanding for purposes of the computation. Net
income per share assuming dilution is computed by dividing income available to
ordinary shareholders by the weighted average number of ordinary shares and
potentially dilutive securities such as stock options. The dilutive effect of
options are reflected in the computation by application of the treasury stock
method.
In accordance with SEC Staff Accounting Bulletin 98, ordinary shares which were
issued in connection with the conversion of 25 class "A" non-voting shares are
considered outstanding for all periods presented for purposes of both basic and
diluted presentations.
l) Income taxes
Under the asset and liability method used by the Company, deferred tax assets
and liabilities are recognized for the future tax consequences attributable to
temporary differences between the consolidated financial statements carrying
amounts of existing assets and liabilities and their respective tax bases. A
valuation allowance is provided for a portion or all of the deferred tax assets
when it is more likely than not that such portion or all such deferred assets
will not be realized.
30
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
m) Foreign exchange
The United States Dollar is the Company's functional currency. Foreign
currency monetary assets and liabilities are translated at exchange rates in
effect at the balance sheet date. Fixed assets and deferred income are
translated at their historical exchange rates. Foreign currency revenues and
expenses are translated at exchange rates in effect at the date of the
transaction. Net exchange gains of $559, $311 and $223 are included in other
income for the years ended December 31, 1996, 1997 and 1998, respectively.
n) Derivative financial instruments
The Company is party to certain derivative financial instruments, being
forward foreign exchange contracts which are used to manage foreign currency
exposures on non-U.S. dollar denominated assets and liabilities. The Company
does not engage in derivatives for any other purpose. Forward foreign exchange
contracts are recorded at their fair value. The fair values of open contracts at
the balance sheet dates are based on the quoted market prices of forward
contracts with similar maturities. Changes in fair values are recognized in
other income as appropriate in the period in which the changes occur. Amounts
receivable or payable on open positions are recorded in other assets or accounts
payable and accrued liabilities as appropriate. See Note 14(c).
o) Stock compensation plans
As permitted by FASB Statement No. 123, "Accounting for Stock-Based
Compensation", the Company has elected to continue to account for stock option
grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and, accordingly, recognizes compensation expense for stock option
grants to the extent that the fair value of the stock exceeds the exercise price
of the option at the measurement date. Any resulting compensation expense is
recorded over the shorter of the vesting or service period.
p) Accounting pronouncements
In December 1997, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 97-3. "Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments." The accounting guidance of this SOP focuses
on the timing of recognition and measurement of liabilities for insurance-
related assessments. Guidance is also provided on recording assets representing
future recoveries of assessments through premium tax offsets or policy
surcharges. The SOP is effective for fiscal years beginning after December 15,
1998. The Company does not anticipate the statement to have a significant
impact on the Company's financial position or results of operations.
During 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-5. "Reporting on the costs of start-up
activities." The accounting guidance of this SOP requires that the costs of
start-up activities be expensed as incurred and any costs that are carried as an
asset prior to adoption of SOP 98-5 would be written off by reporting a
cumulative effect of a change in accounting principle in the statement of income
as of January 1, 1999. The cumulative effect of a change in accounting principle
to be recorded in the statement of income for the quarter ended March 31, 1999
will be approximately $495.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities". This statement
is effective for all quarters of fiscal years beginning after June 15, 1999.
Given the limited number of transactions currently entered into by the
31
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Company that are covered by the Statement, the Company does not anticipate any
significant changes to its current financial reporting.
In November 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-7. "Deposit accounting: Accounting for Insurance
and Reinsurance Contracts that do not transfer risk." This SOP provides
accounting guidance for insurance and reinsurance contracts that do not transfer
risk, as determined by the provisions of SFAS 113. The Company is currently
reviewing the impact of this standard on its financial reporting.
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income".
This statement establishes rules for the reporting of comprehensive income and
its components. Comprehensive income consists of net income and unrealized gains
and losses on available for sale investments, and is presented in the
Consolidated Statement of Income and Comprehensive Income. The adoption of SFAS
130 had no impact on total shareholders' equity. Prior year financial statements
have been reclassified to conform to the SFAS 130 requirements.
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". SFAS 131 establishes standards for
reporting information about operating segments and related disclosures about
products and services, geographic areas and major customers. This disclosure is
located within Note 15.
3. LETTERS OF CREDIT AND ASSETS HELD IN TRUST
In the normal course of reinsurance operations the Company's bankers have
issued letters of credit totalling $12,226 and $13,141 at December 31, 1997 and
1998, respectively in favor of ceding insurance companies. At December 31, 1997
and 1998, $12,226 and $13,141, respectively, of cash and cash equivalents were
pledged as collateral for these letters of credit.
One of the Company's subsidiaries is registered with the Society of Lloyd's as
a registered Lloyd's Broker. As required by Lloyd's Brokers Byelaw (No. 5 of
1988), the subsidiary has entered into a trust deed under which all insurance
broking account assets are subject to a floating lien held in trust for the
Society of Lloyd's for the benefit of the insurance creditors. Insurance and
reinsurance balances payable covered by the floating lien at December 31, 1997
and 1998, amounted to $95,279 and $139,216, respectively, including relevant
creditors of other subsidiaries. The purpose of the trust deed is to provide
security to the Lloyds Broker's insurance creditors in the event of the Brokers
insolvency by creating a charge over the Broker's insurance transaction assets.
The lien becomes enforceable only in the event the Lloyds Broker becomes
insolvent or breaches Lloyds solvency rules or regulations. The assets which
were subject to this floating lien at December 31, 1997 and 1998 were:
<TABLE>
<CAPTION>
1997 1998
-------- ---------
<S> <C> <C>
Fiduciary funds................................. $13,872 $ 22,797
Insurance and reinsurance balances
receivable..................................... 83,937 117,753
------- --------
$97,809 $140,550
======= ========
</TABLE>
4. FIDUCIARY ASSETS AND LIABILITIES
In its various capacities as an insurance intermediary, the Company acts as a
conduit for insurance and reinsurance premiums from insureds and other
intermediaries, and after deducting its risk management fee and, where
appropriate, surplus lines taxes and stamping fees, remits the premium to the
respective insurance company or underwriter. Additionally, the Company acts as a
conduit for loss payments. Pending the remittance of such funds to the insurance
company or underwriter in accordance with the applicable insurance contract, the
Company holds collected funds in its own segregated bank accounts and is
entitled to any accrued interest on such funds. The obligation to remit these
funds is recorded as insurance and
32
<PAGE>
STERLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
reinsurance balances payable on the Company's balance sheet. The period for
which the Company holds such funds is dependent upon the date the insured remits
the payment of the premium to the Company and the date the Company is required
to forward such payment to the insurer.
5. Marketable securities
a) The cost/amortized cost and estimated fair value of marketable securities
held as available for sale are as follows:
<TABLE>
<CAPTION>
1997
-----------------------------------
COST/ GROSS GROSS ESTIMATED
--------- ---------- ----------- ---------
AMORTIZED UNREALIZED UNREALIZED FAIR
--------- ---------- ----------- ---------
COST GAINS LOSSES VALUE
--------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of U.S. Government
agencies...................................................... $ 5,082 $107 $ -- $ 5,189
Foreign government............................................. 1,032 1 20 1,013
Obligations of states and political subdivisions............... 75 -- -- 75
Corporate securities........................................... 8,693 2 1 8,694
------- ---- ----------- -------
Debt securities................................................ 14,882 110 21 14,971
Equity securities.............................................. 454 32 -- 486
Short term investments......................................... 5,579 -- -- 5,579
------- ---- ----------- -------
Total..................................................... $20,915 $142 $ 21 $21,036
======= ==== =========== =======
1998
----------------------------------
COST/ GROSS GROSS ESTIMATED
--------- ---------- ----------- ---------
AMORTIZED UNREALIZED UNREALIZED FAIR
--------- ---------- ----------- ---------
COST GAINS LOSSES VALUE
--------- ---------- ----------- ---------
U.S. Treasury securities and obligations Of U.S. Government
agencies...................................................... $ 5,694 $152 $ -- $ 5,846
Foreign government............................................. 29 1 -- 30
Obligations of states and political subdivisions............... 6,897 90 -- 6,987
Corporate securities........................................... 4,102 92 -- 4,194
------- ---- ----------- -------
Debt securities................................................ 16,722 335 -- 17,057
Equity securities.............................................. 2,384 152 -- 2,536
Short term investments......................................... 9,643 -- -- 9,643
------- ---- ----------- -------
Total..................................................... $28,749 $487 $ -- $29,236
======= ==== =========== =======
</TABLE>
A deferred tax liability of $39 and $168 at December 31, 1997 and 1998,
respectively, has been provided against unrealized gains on marketable
securities held as "available for sale" which has been presented net as
accumulated other comprehensive income within shareholders' equity.
b) The amortized cost and estimated fair value of debt securities by
contractual maturity are shown in the following table. Actual maturities may
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
1998
--------------------
AMORTIZED ESTIMATED
--------- ---------
COST FAIR VALUE
--------- ----------
<S> <C> <C>
Due in one year or less....................... $ 1,105 $ 1,117
Due after one year through five years......... 6,713 6,880
Due after five years through ten years........ 6,675 6,816
Due after ten years through twenty years...... 540 548
Due after twenty years........................ 1,689 1,696
------- -------
$16,722 $17,057
======= =======
</TABLE>
33
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
c) Proceeds from sales of investments in debt securities during 1997 and 1998
were $4,190 and $10,680, respectively. Proceeds from sales of investments in
equity securities during 1997 and 1998 were $7,262 and $658, respectively. There
was $5 of realized losses and $443 of realized gains during 1997. There was $0
of realized losses and $59 of realized gains during 1998.
d) At December 31, 1997 and 1998, debt securities having an amortized cost of
$2,925 and $2,878 respectively, were on deposit with government authorities as
required by law.
e) At December 31, 1997 and 1998, there were no individual investments, other
than investments in U.S. Government securities, which exceeded 10% of
shareholders' equity.
f) Net investment income by source is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
Debt securities........................................... $ 134 $1,029 $ 731
Equity securities......................................... 67 70 52
Cash, cash equivalents and short-term investments......... 3,216 4,754 8,068
Other..................................................... 1 2 16
------ ------ ------
Total investment income................................... 3,418 5,855 8,867
Less applicable expenses.................................. 13 73 96
------ ------ ------
Net investment income.................................. $3,405 $5,782 $8,771
====== ====== ======
</TABLE>
6. OTHER ASSETS
a) Capital assets
Included within other assets are capital assets as follows:
<TABLE>
<CAPTION>
1997 1998
------------------------------ --------------------------------
ACCUMULATED NET BOOK ACCUMULATED NET BOOK
------------ -------- ------------ --------
COST DEPRECIATION VALUE COST DEPRECIATION VALUE
------ ------------ -------- ------ ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Furniture and fixtures... $1,266 $ 580 $ 686 $1,732 $ 875 $ 857
Computer equipment....... 3,305 1,664 1,641 4,598 2,409 2,189
Office equipment......... 700 341 359 973 483 490
Motor vehicles........... 950 491 459 1,321 482 839
------ ------ ------ ------ ------ ------
Total............... $6,221 $3,076 $3,145 $8,624 $4,249 $4,375
====== ====== ====== ====== ====== ======
</TABLE>
b) Investment in affiliates
Included within other assets are investments in affiliates. Summarized
condensed financial information of a Bermuda based underwriting management
company, a 39% owned affiliate, which is accounted for by the equity method, is
as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
INCOME STATEMENT DATA
Underwriting management fees............... $1,191 $3,959 $8,057
Interest income............................ 63 88 195
Net income................................. 633 3,294 7,250
Company's share of net income.............. $ 247 $1,285 $2,828
====== ====== ======
</TABLE>
34
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1998
------- -------
<S> <C> <C>
BALANCE SHEET DATA
Cash and cash equivalents..................... $ 1,224 $ 1,785
Fiduciary cash................................ 2,267 5,782
Insurance balances receivable................. 12,821 4,925
Other assets.................................. 60 85
------- -------
Total assets............................. $16,372 $12,577
------- -------
Insurance balances payable.................... $13,179 $ 6,835
Deferred income............................... 496 1,543
Other liabilities............................. 56 105
Shareholders' equity.......................... 2,641 4,094
------- -------
Total liabilities and shareholders' equity $16,372 $12,577
======= =======
Company's share of shareholders' equity.. $ 1,030 $ 1,597
======= =======
</TABLE>
The Company received dividends from this affiliate of $0, $593 and $2,145
during 1996, 1997 and 1998, respectively.
7. DEPOSIT LIABILITIES AND RELATED ASSETS
Certain of the Company's reinsurance contracts, referred to as rent-a-captive
programs, do not satisfy the conditions for reinsurance accounting as the
maximum exposure to loss is fully funded by premium, cash and other collateral
and indemnity agreements. Accordingly, these contracts are accounted for as
deposit liabilities. The assets related to these programs represent funds under
management as the insured retains the risks and rewards of ownership. Such
assets are recorded as assets related to deposit liabilities in the consolidated
balance sheets. These assets comprised cash and short-term deposits at December
31, 1997 and 1998. The Company receives a fee based on a percentage of premiums
written and investment income earned for structuring and providing ongoing
management of the programs.
In addition, deposit liabilities and related assets include $2,459 and $2,687
of deposits received from customers as security for the timely payment of
premiums for workers' compensation insurance at December 31, 1997 and 1998,
respectively. The deposit is restricted from use by the Company, and is the
property of the customer. The deposit is refunded to the customer after the
policy expires or is canceled and all claims related to the insurance policy
have been settled. The interest income earned by these restricted deposit
accounts is the property of the customer, and is therefore excluded from the
Company's operating results.
8. REINSURANCE ASSUMED AND CEDED
The Company accounts for reinsurance assumed and ceded in accordance with
SFAS 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-
Duration Contracts". Net premiums earned are the result of the following:
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------ -----------
<S> <C> <C> <C>
Premiums written........................................ $ 4,009 $21,743 $48,625
Premiums assumed........................................ 12,467 14,115 11,806
Change in unearned premiums............................. (938) (6,672) (5,850)
------- ------- -------
Premiums earned......................................... 15,538 29,186 54,581
------- ------- -------
Premiums ceded.......................................... 7,546 22,677 43,015
Change in deferred reinsurance premiums ceded........... (762) (5,281) (6,208)
------- ------- -------
Net premiums ceded...................................... 6,784 17,396 36,807
------- ------- -------
Net premiums earned..................................... $ 8,754 $11,790 $17,774
======= ======= =======
</TABLE>
35
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The Company, in the ordinary course of business, reinsures certain risks
with other companies. Such arrangements serve to enhance the Company's capacity
to write business and limit the Company's maximum loss on large or unusually
hazardous risks.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Failure of reinsurers to honor their obligations could result in
losses to the Company; consequently, allowances are established for amounts
deemed uncollectible. The Company evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk arising from similar
geographic regions, activities, or economic characteristics of the reinsurers to
minimize its exposure to significant losses from reinsurer insolvencies. At
December 31, 1998, the Company is in dispute with certain of its reinsurers in
respect of amounts due under retrocessional coverages. Management believes that
approximately $2.5 million (1997 - $0) of paid and outstanding losses
recoverable from reinsurers is uncollectible and has established a provision for
doubtful recoveries accordingly. This provision of $2.5 million against
reinsurance recoveries of $13.4 million represents management's best estimate at
this time of a shortfall in recoveries. This provision is included in the
balance sheet as a component of paid and outstanding losses recoverable from
reinsurers. The provision is necessarily an estimate and amounts not collectible
from reinsurers may ultimately be significantly greater or lesser than the
provision established. It is reasonably possible that management will revise
this estimate significantly in the near term. Any subsequent differences arising
will be recorded in the period in which they occur.
At December 31, 1998 there was an amount due from one reinsurer that
totaled $17,276. This reinsurer is rated `Superior' by A.M. Best. At December
31, 1997 there were no amounts due from any individual reinsurer in excess of
10% of the Company's shareholders' equity.
The Company recognizes reinsurance recoveries when the associated loss is
booked.
Realm National Insurance Company ("Realm National"), a subsidiary of the
Company, has written property and workers compensation business since its
acquisition. Realm National's workers' compensation business is subject to quota
share reinsurance whereby it retains 25% of the first $1,000. Realm National's
retention under the quota share treaty is further protected by common account
excess coverage in excess of $3. Realm National purchases excess loss coverage
on an occurrence basis up to $200,000.
Realm National has also purchased a standard property reinsurance program
whereby Realm National retains 25% of the first $1,000 on any one risk and
purchased facultative per risk reinsurance for limits above $1,000 to $200,000.
In addition, Realm National's net retained line is further protected by a per
risk excess of loss cover which reduces the maximum loss on any one risk to
$125.
Comp Indemnity Reinsurance Company Limited ("CIRCL"), a subsidiary of the
Company, assumes various quota shares of workers' compensation, employers'
liability on both a primary and excess basis, bodily injury, difference in
conditions, general liability risks, and property written on a treaty basis.
CIRCL's exposure under the reinsurance contracts assumed is limited in most
instances to $25 and $1,000 per occurrence for workers' compensation and
employers liability, respectively and is subject to an annual aggregate limit
based on various percentages of original gross written premium income. CIRCL
further limits its exposure through the purchase of reinsurance protection for
certain risks covering losses in excess of $1 and $50 per occurrence for
workers' compensation and employers' liability.
9. OUTSTANDING LOSSES AND LOSS EXPENSES
Outstanding losses and loss expenses relate to the insurance activities of
CIRCL and Realm National.
The changes in outstanding losses and loss expenses are summarized as follows:
<TABLE>
<CAPTION>
1996 1997 1998
--------- ----------- ------------
<S> <C> <C> <C>
Balance beginning of year........................... $ -- $ 24,301 $ 36,276
</TABLE>
36
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
<TABLE>
<S> <C> <C> <C>
Less outstanding losses recoverable.............. -- (16,588) (23,072)
Net balance for CIRCL, at acquisition............ 1,270 -- --
Net balance for Realm National, at acquisition... 1,687 -- --
------- -------- --------
Net balance...................................... 2,957 7,713 13,204
------- -------- --------
Incurred related to:
Current year............................... 6,515 10,174 12,578
Prior years................................ 250 777 4,693
------- -------- --------
Total incurred............................. 6,765 10,951 17,271
------- -------- --------
Paid related to:
Current year............................... 1,334 2,011 3,066
Prior years................................ 675 3,449 9,438
------- -------- --------
Total paid.............................. 2,009 5,460 12,504
------- -------- --------
Net balance...................................... 7,713 13,204 17,971
Plus outstanding losses recoverable.............. 16,588 23,072 48,146
------- -------- --------
Balance at end of year..................... $24,301 $ 36,276 $ 66,117
======= ======== ========
</TABLE>
The adverse development during 1998 on prior years reflects primarily an
increase in claims frequency on one particular program that covers bodily injury
and property risks in the construction industry, and the provision for doubtful
recoveries of $2,500 discussed in Note 8. The adverse development during 1997 on
prior years primarily represents an increase in claims frequency on one
particular program that covers bodily injury and property risks in the
construction industry.
10. SHARE CAPITAL AND ADDITIONAL PAID IN CAPITAL
The Company's authorized share capital at December 31, 1997 and 1998
comprised 20,000,000 ordinary shares of par value $0.25 each of which 9,863,372
ordinary shares were issued and fully-paid at that date. The Company's
authorized share capital at December 31, 1996 comprised 8,048,000 ordinary
shares of par value $0.25 each and 25 Class "A" non-voting shares with a par
value of $1 each, of which 8,000,000 ordinary shares and 25 Class "A" non-voting
shares were issued and fully-paid at that date.
As discussed in Note 1 to the consolidated financial statements, during
1996, the Company issued 1,999,980 shares in exchange for 100% of the share
capital of Realm Investments Ltd. The fair value assigned to the shares issued
was $12,819. The excess of the fair value of the shares issued over par value
was recorded in additional paid in capital. This represents a non-cash financing
and investing activity for the purpose of the statements of cash flows. The
Company also issued 2,000,000 ordinary shares and 25 Class "A" non-voting shares
to a private investor group. Contemporaneously, the private investor group also
acquired additional ordinary shares from existing shareholders on a pro-rata
basis, such that the private investor group's total ownership represented 32.5%
of the total number of issued ordinary share capital at that time.
The 2,000,000 ordinary shares and related 25 Class "A" shares issued to the
private investor group were subject to a put option whereby, after 2004, the
holders of such shares could request that the Company repurchase the shares for
fair market value at that date. As such shares were subject to redemption at the
option of the holder, the aggregate subscription price was classified outside of
shareholders' equity as at December 31, 1996. The put option expired upon the
consummation by the Company of an Initial Public Offering ("IPO") in December
1997 and accordingly the shares were reclassified into shareholders' equity at
that date.
Treasury stock is recorded at cost as a deduction from shareholders'
equity. During 1996 the Company repurchased 202,784 of its ordinary shares from
one of its founding shareholders at a price negotiated between the Company and
the shareholder. The shares were held as treasury stock at December 31, 1996.
In April 1997, the Company purchased a further 213,732 of its ordinary
shares from a founding shareholder for a total cost of $1,141. Such shares were
recorded as treasury stock at cost.
37
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In June 1997, the Company reissued 16,000 ordinary shares of its treasury
stock for a total subscription price of $86.
On June 30, 1997, the remaining 400,516 ordinary shares held in treasury at
that date were cancelled. The excess cost of treasury shares over their par
value was recorded as a deduction from retained earnings.
On June 30, 1997, the Company increased its authorized share capital to
20,000,000 ordinary shares of par value $0.25 each and effected a four for one
stock split whereby each of the Company's ordinary shares of par value $1.00
each was divided into four ordinary shares of par value $0.25 each.
On June 30, 1997, the shareholders exercised their options to purchase
600,000 ordinary shares in the Company (see Note 11 to the consolidated
financial statements) at an exercise price of $2.71 per share.
Contemporaneously, 288,888 ordinary shares of par value of $0.25 each were
issued to the holders of the Class "A" shares pursuant to certain anti-
dilution rights, and the Class "A" shares were repurchased by the Company for
nominal consideration. The $72 excess of the par value of the ordinary shares
issued over the original par value of the Class "A" shares was recorded as a
deduction from additional paid in capital. On the same date the Company loaned
the shareholders $1,625, an amount equal to the aggregate exercise price of the
options. Such loans were evidenced by promissory notes, bearing interest at 7%
per annum until maturity in June 1998 or earlier in the event of early
repayment. Included within notes receivable was $325, $866 and $109 due from
Messrs. Cooke, Brown and Jones, respectively. The loans were repaid in full in
December 1997 following the successful completion of the IPO of the Company's
ordinary shares.
On December 2, 1997, the Company and certain Selling Shareholders
consummated the IPO of 3,421,250 ordinary shares at $22 per share. Of these
shares 1,375,000 were sold by the Company and 2,046,250 were sold by Selling
Shareholders. The Company received net proceeds of $26,832 after deducting
underwriting commissions of $2,117 and expenses of $1,301 relating to the issue.
In December 1997, under a put and call option originally granted in April
1997, the Company purchased 40,000 ordinary shares for a total cost of $667.
These shares were held as treasury stock at December 31, 1997 and 1998.
In October 1998, the Company purchased a further 47,000 of its ordinary
shares on the open market for a total cost of $567. These shares were held as
treasury stock at cost at December 31, 1998.
11. STOCK OPTIONS
Employees have been granted options to purchase Ordinary Shares in the
Company. These options have been issued in two series:
i) Options issued to Employees--Shareholders
On June 29, 1995, the Company granted 600,000 options to certain
employee shareholders. The terms of the options were subsequently
amended in 1996 to reflect the share exchange factor in the Share
Purchase Agreement between the Company and Stirling Cooke Brown
Holdings (UK) Limited discussed in Note 1.
The options had an exercise price of $2.71 per share, which
reflected the estimated fair value of the shares at the original grant
date as updated for the exchange factor. The options were fully vested
at the grant date and were able to be exercised at any time prior to
January 23, 2003.
On June 30, 1997, the shareholders exercised these options and
purchased 600,000 ordinary shares in the Company at an exercise price
of $2.71.
38
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(ii) Options issued under Equity Incentive Plan
On November 25, 1997 the Company granted 300,000 options to
certain employees.
The options have an exercise price of $22 per share, which
reflected the estimated fair value of the shares at the grant date. The
options vest ratably over a three year period and may be exercised at any
time prior to November 25, 2007. All of these options were outstanding at
December 31, 1997 and 1998.
In accordance with the provisions of FASB Statement No. 123, the Company
applies APB Opinion 25 and related interpretations in accounting for its stock
option plans and accordingly, recognizes compensation cost based on the
intrinsic value of the options at the grant date. If the Company had elected to
recognize compensation cost based on the fair value of the options granted at
the grant date as prescribed by SFAS 123, net income and earnings per share
would have been reduced to the pro forma amounts indicated in the table below:
<TABLE>
<CAPTION>
1996 1997 1998
------ ------- -------
<S> <C> <C> <C>
Net income--as reported................................. $9,918 $12,993 $16,018
Net income--pro forma................................... $9,918 $12,926 $14,820
Net income per share--as reported....................... $ 1.22 $ 1.55 $ 1.63
Net income per share--pro forma......................... $ 1.22 $ 1.54 $ 1.51
Net income per share assuming dilution--as reported..... $ 1.19 $ 1.53 $ 1.63
Net income per share assuming dilution--pro forma....... $ 1.19 $ 1.52 $ 1.51
</TABLE>
These pro forma compensation costs may not be representative of those to be
expected in future years. As the options were granted on November 25, 1997, only
approximately one month's compensation cost was expensed within the pro-forma
net income for the year ended December 31, 1997.
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following assumptions
used:
<TABLE>
<S> <C>
Expected dividend yield................ 0.55%
Expected stock price volatility........ 30.00%
Risk-free interest rate................ 5.00%
Expected life of options............... 4 years
</TABLE>
There were no options granted during 1996 or 1998. The fair value of
options granted during 1997 was $6.59 per share.
12. TAXATION
Under current Bermuda law, the Company is not required to pay any taxes in
Bermuda on either income or capital gains. The Company has received an
undertaking from the Minister of Finance in Bermuda that in the event of any
such taxes being imposed the Company will be exempted from taxation until the
year 2016.
Total income tax expense for the years ended December 31, 1996, 1997 and
1998 was allocated as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
Income from continuing operations............... $2,281 $2,925 $3,790
Shareholders' equity (for unrealized gains on
marketable securities)........................ 75 (36) 129
------ ------ ------
$2,356 $2,889 $3,919
====== ====== ======
</TABLE>
39
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Income tax expense attributable to income from continuing operations consists
of:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
------- -------- ------
<S> <C> <C> <C>
Year ended December 31, 1996
U.S. Federal and State......... $ 627 $ (339) $ 288
Foreign (U.K.)................. $1,993 -- 1,993
------ ------ ------
$2,620 $ (339) $2,281
====== ====== ======
Year ended December 31, 1997
U.S. Federal and State......... $ 934 $ (809) $ 125
Foreign (U.K.)................. 2,800 -- 2,800
------ ------ ------
$3,734 $ (809) $2,925
====== ====== ======
Year ended December 31, 1998
U.S. Federal and State......... $1,324 $ (753) $ 571
Foreign (U.K.)................. 3,219 -- 3,219
------ ------ ------
$4,543 $ (753) $3,790
====== ====== ======
</TABLE>
Income tax expense attributable to income from continuing operations was
$2,281, $2,925 and $3,790 for the years ended December 31, 1996, 1997 and 1998
respectively, and differed from the amounts computed by applying the U.S.
federal income tax rate of 34% to income before taxation as a result of the
following:
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Computed expected tax expense.................... $ 4,148 $ 5,412 $ 6,888
Foreign income not subject to US taxes........... (1,813) (2,305) (2,988)
Income subject to tax at foreign rates........... (55) (200) (99)
Change in valuation allowance.................... 190 (86) (104)
Miscellaneous permanent differences.............. 56 98 94
Acquired temporary difference.................... (320) -- --
State taxes...................................... 75 80 79
Utilization of acquired net operating losses..... -- (74) (80)
------- ------- -------
Actual tax expense............................... $ 2,281 $ 2,925 $ 3,790
======= ======= =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1997 and 1998, are presented below:
<TABLE>
<CAPTION>
1997 1998
------ ------
<S> <C> <C>
Deferred tax assets:
Deferred revenue............................................... $ 687 $1,220
Discount on unearned premiums and outstanding loss reserves.... 104 459
Deferred interest deductions................................... 316 280
Other.......................................................... 145 --
Valuation allowance............................................ (104) --
------ ------
1,148 1,959
Deferred tax liabilities:
Unrealized investment gains.................................... (39) (168)
Other.......................................................... -- (36)
------ ------
Net deferred tax asset......................................... $1,109 $1,755
====== ======
</TABLE>
Valuation allowances of $104 and $0 have been established against the
deferred tax asset as of December 31, 1997 and 1998, respectively. There was no
valuation allowance for deferred tax assets as of December 31, 1998, since it is
management's belief that it is more likely than not that the deferred tax assets
will be realized. However, the amount of deferred tax assets could be reduced in
the near term if estimates of taxable income are reduced.
The Company has not recognized a deferred tax liability for the
undistributed earnings of its United States subsidiaries. (A 30% tax is
generally imposed in the United States on dividends paid by United States
corporations to non-United States shareholders). The Company does not expect
those unremitted
40
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
earnings to become taxable in the foreseeable future. A deferred tax liability
will be recognized when the Company expects that it will recover those
undistributed earnings in a taxable manner, such as the receipt of dividends.
The deferred tax liability relating to these unremitted earnings which is not
recognized by the Company is approximately $200, $542 and $986 at December 31,
1996, 1997, 1998, respectively.
13. EARNINGS PER SHARE
Earnings per share have been calculated in accordance with SFAS 128:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Net Income....................................................... $ 9,918 $ 12,993 $ 16,018
---------- ---------- ----------
Weighted average number of ordinary shares outstanding........... 8,100,782 8,383,482 9,814,101
---------- ---------- ----------
Net income per share............................................. $ 1.22 $ 1.55 $ 1.63
========== ========== ==========
Income available to ordinary shareholders........................ $ 9,918 $ 12,993 $ 16,018
---------- ---------- ----------
Weighted average number of ordinary shares outstanding........... 8,100,782 8,383,482 9,814,101
Plus: incremental shares from assumed exercise of options........ 205,828 131,991 26,058
---------- ---------- ----------
Adjusted weighted average number of ordinary shares outstanding.. 8,306,610 8,515,473 9,840,159
---------- ---------- ----------
Net income per share assuming dilution........................... $ 1.19 $ 1.53 $ 1.63
========== ========== ==========
</TABLE>
See Notes 10 and 11 to the consolidated financial statements for further
discussion of share capital and share option transactions.
14. FINANCIAL INSTRUMENTS
a) Fair value
The carrying values of all financial instruments, as defined by SFAS 107
and as recorded in the consolidated balance sheets approximate their fair value.
The Company does not have any significant off-balance sheet financial
instruments. The following methods and assumptions were used by the Company in
estimating fair values:
Cash and cash equivalents and fiduciary funds: The fair values for these
instruments approximate their carrying amounts because of the short maturity of
such instruments.
Marketable securities: The fair values of debt and equity securities are
based on quoted market prices and dealer quotes at the consolidated balance
sheet dates.
Deposit liabilities and related assets: Underlying assets comprise mainly
cash and deposits. The fair values of these assets and related liabilities
approximate their carrying value due to the short maturity of these instruments.
Forward foreign exchange contracts: The fair values of such contracts are
based on quoted forward rates available for the remaining duration of the
contracts at the balance sheet dates.
Other assets and liabilities: The fair values of all other financial
instruments, as defined by SFAS 107, approximate their carrying values due to
their short-term nature.
The estimates of fair values presented herein are subjective in nature and
are not necessarily indicative of the amounts that the Company would actually
realize in a current market exchange. Any differences
41
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
would not be expected to be material. Certain instruments such as prepaid
expenses, other assets, goodwill and deferred expenses, deferred fee income,
outstanding losses recoverable from reinsurers, and outstanding losses and loss
expenses are excluded from fair value disclosure. Thus the total fair value
amounts cannot be aggregated to determine the underlying economic value of the
Company.
b) Concentrations of credit risk and provision for doubtful accounts
The Company's financial instruments exposed to possible concentrations of
credit risk consist primarily of its cash and cash equivalents, paid and
outstanding losses recoverable from reinsurers and insurance and reinsurance
balances receivable.
The Company maintains a substantial portion of its cash and cash
equivalents in two financial institutions which the Company considers of high
credit quality.
Concentrations of credit risk with respect to other financial instruments
are to some extent limited due to the number of reinsurers, agents and customers
comprising the Company's receivable base. At December 31, 1998 there was an
amount due from one reinsurer that totals $17,276 as discussed in Note 8. As at
December 31, 1998, management believes that approximately $2,500 (1997 - $Nil)
of paid and outstanding losses recoverable from reinsurers is uncollectible and
has established a provision for doubtful accounts accordingly, as discussed in
Note 8.
c) Forward foreign exchange contracts
The Company's functional currency is the U.S. dollar; however, as the
Company operates internationally, it has exposure to changes in foreign currency
exchange rates. These exposures include net cash inflows on non-U.S. dollar
denominated transactions.
To manage the Company's exposure to these risks, the Company enters into
forward foreign exchange contracts in the currencies to which the Company is
exposed. These contracts generally involve the exchange of one currency for
another at some future date. The Company had a notional principal amount
outstanding of (Pounds)1,000 and (Pounds)Nil at December 31, 1997 and 1998,
respectively, relating to contracts to buy British Pounds Sterling in the
future. Net unrealized gains on the forward exchange contracts for the year
ended December 31, 1997 and 1998 amounted to $83 and $Nil, respectively and have
been accrued in other income and included in other assets in the consolidated
balance sheets. A net realized gain (loss) of $465, $(22) and $182 is included
in other income in the consolidated statements of income in respect of such
contracts during the years ended December 31, 1996, 1997 and 1998, respectively.
15. SEGMENTAL INFORMATION
(a) The Company has five main business segments; Brokerage, Program Business,
Underwriting Management, Insurance, and Reinsurance. Brokerage companies design
and arrange, for a fee or commission, insurance and reinsurance contracts which
transfer risk and associated premium from one company to another. Program
Business companies market and manage insurance products and programs developed
by the Company on behalf of reinsurers. Underwriting Management companies
underwrite and administer reinsurance business on behalf of a number of
independent reinsurance companies. The insurance and reinsurance segments
represent companies that retain risks and their revenues include premiums earned
on insurance polices, investment income and policy issuance fees. Other includes
the Company's holding companies, group services companies, and income earned
from investments in affiliated companies (1996 - $282, 1997 - $1,266, 1998-
$2,631). Intercompany transactions are recorded under normal terms of trade.
Adjustments and eliminations to revenue are in respect of intersegment revenues
that are eliminated at the consolidated level. Adjustments and eliminations to
assets are primarily in respect of intersegment insurance balances receivable
that are eliminated at the consolidated level.
42
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
<TABLE>
<CAPTION>
Adj. and
Program Underwriting ----------
Brokerage Business Management Insurance Reinsurance Other eliminations Total
--------- -------- ------------ --------- ----------- ----- ------------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1996
Revenues 19,219 11,912 4,276 1,426 8,187 2,041 -- 47,061
Income before tax 5,980 3,091 2,790 51 201 86 -- 12,199
Assets 138,297 15,282 32,736 45,423 22,798 9,676 (29,128) 235,084
DECEMBER 31, 1997
Revenues 23,385 19,770 4,174 5,399 9,382 3,200 -- 65,310
Income (loss) before tax 8,591 3,938 2,491 471 57 370 -- 15,918
Assets 249,334 22,465 32,038 58,306 40,452 35,029 (31,294) 406,330
DECEMBER 31, 1998
Revenues 27,144 27,119 3,554 11,073 10,905 5,798 (500) 85,093
Income (loss) before tax 11,501 5,187 1,689 1,169 (3,357) 3,619 -- 19,808
Assets 462,420 35,015 38,179 94,843 58,761 47,123 (86,700) 649,641
</TABLE>
(b) Summarized financial information by geographic location of subsidiary
for the years ended December 31, 1996, 1997 and 1998 is as follows:
<TABLE>
<CAPTION>
Adjustments &
Bermuda U.K. U.S.A. eliminations Consolidated
------- ------ ------ ------------- ------------
<S> <C> <C> <C> <C> <C>
REVENUES FOR THE YEAR ENDED
December 31, 1996 16,436 19,284 11,534 (193) 47,061
December 31, 1997 21,326 22,459 22,262 (737) 65,310
December 31, 1998 27,485 23,632 34,713 (737) 85,093
IDENTIFIABLE ASSETS AT THE YEAR ENDED
December 31, 1996 68,306 139,494 60,825 (33,541) 235,084
December 31, 1997 119,066 250,668 85,006 (48,410) 406,330
December 31, 1998 178,489 477,639 127,851 (134,338) 649,641
</TABLE>
(c) The Company's Program Business companies market and manage insurance
products and programs developed by the Company on behalf of independent
insurance carriers. In addition, the Company, through its brokerage operations
and managing general underwriters provide additional business and services to
certain of these independent insurance carriers in respect of these products and
other insurance and reinsurance policies. For the year ended December 31, 1996,
1997 and 1998 revenues received from one independent insurance carrier
approximately accounted for the following percentage of total revenues.
<TABLE>
<CAPTION>
Program Underwriting
--------- ------------
Brokerage Business Management Insurance Reinsurance Other Total
--------- --------- ---------- --------- ----------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C>
December 31, 1996 28% 71% 82% 0% 93% 26% 55%
December 31, 1997 22% 79% 89% 0% 83% 30% 51%
December 31, 1998 19% 71% 94% 0% 74% 11% 43%
</TABLE>
The loss of this carrier could have a material adverse effect on the
Company. However, the Company believes that the availability of alternative
underwriting capacity at Realm National and other independent insurance carriers
would reduce the impact of such a loss.
16. COMMITMENTS
Future minimum lease payments under non-cancelable operating leases as at
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
<S> <C>
1999.................... $2,452
2000.................... 2,142
2001.................... 2,050
2002.................... 1,737
</TABLE>
43
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
<TABLE>
<CAPTION>
<S> <C>
2003...................... 1,467
2004 and thereafter....... 4,673
------
14,521
------
</TABLE>
Total rental expense for the years ended December 31, 1996, 1997 and 1998,
was $1,319, $1,894, and $2,191, respectively.
Certain lease commitments are subject to annual adjustment under escalation
clauses, for real estate taxes and the landlord's operating expenses. Such
adjustments will not be material to the Company.
17. STATUTORY SURPLUS AND DIVIDEND RESTRICTIONS
The Company's ability to pay dividends is subject to certain restrictions
including the following:
a) The Company is subject to a 30% withholding tax on certain
dividends and interest received from its United States subsidiaries.
b) Under New York law, Realm National may pay cash dividends only
from earned surplus determined on a statutory basis. Further, Realm
National is restricted (on the basis of the lower of 10% of statutory
surplus at the end of the preceding twelve month period or 100% of the
adjusted net investment income for the preceding twelve month period) as to
the amount of dividends it may declare or pay in any twelve month period
without the approval of the Insurance Department of the State of New York.
Realm National did not have any earned surplus available for the
payment of dividends in 1997 and 1998 due to its statutory-basis
accumulated deficit. Additionally, $21 and $21 of statutory surplus has
been segregated as special funds as of December 31, 1997 and 1998 and will
not become available for dividend payments until earned.
Realm National's total capital and surplus and net income determined
on a New York statutory basis are as follows:
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Total capital and surplus at December 31.... $18,991 $18,889
Net income for year ended December 31....... $ 370 $ 663
</TABLE>
By agreement with the Insurance Department of the State of New York,
Realm National was restricted from declaring dividends for a two year
period from September 5, 1996 the date upon which its acquisition by the
Company was completed.
c) The NAIC has a model law which establishes certain minimum risk-
based capital ("RBC") requirements for property-casualty insurance
companies. The RBC calculation serves as a benchmark for the regulation of
insurance companies by state insurance regulators. The calculation
specifies various formulas and weighting factors that are applied to
financial balances or various levels of activity based on the perceived
degree of risk and are set forth in the RBC requirements. The capital of
Realm National as of December 31, 1997 and 1998 exceeded the amount
calculated using the RBC requirements.
d) The Company's Bermuda reinsurance subsidiary, CIRCL, is required
by its license to maintain capital and surplus greater than a minimum
statutory amount determined as the greater of a percentage of outstanding
losses and loss expenses (net of reinsurance recoverable) or a given
fraction of net written premiums. At December 31, 1997 and 1998,
respectively, CIRCL was required to maintain a
44
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
minimum statutory capital and surplus of $1,680 and $2,135. Accordingly,
approximately $1,664 of contributed surplus and retained earnings is
restricted from distribution.
CIRCL's total surplus and net loss determined on a Bermuda statutory basis
is as follows:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Total surplus at December 31........................... $2,261 $ 2,304
Net loss for year ended December 31.................... $ (85) $(3,558)
</TABLE>
CIRCL is also required to maintain a minimum liquidity ratio whereby the
value of its relevant assets are not less than 75% of the amount of its
relevant liabilities. Certain categories of assets do not qualify as relevant
assets under the statute. At December 31, 1997 and 1998, respectively, CIRCL
was required to maintain relevant assets of at least $17,900 and $25,000. At
that date relevant assets were approximately $23,900 and $35,600 and the
minimum liquidity ratio was therefore met.
18. RELATED PARTY TRANSACTIONS
a) Amounts due from/to affiliates are interest free and unsecured with no
fixed terms of repayment.
b) Goldman, Sachs & Co. acted as a co-managing underwriter for the
Company's IPO completed in December 1997, from which the underwriters received
aggregate underwriting discounts of $5.3 million from the Company and selling
shareholders.
Goldman, Sachs & Co. or certain of their affiliates maintain certain
contractual relationships with the Company and have provided investment banking
services to the Company. Goldman, Sachs & Co. also provide investment management
services to Realm National pursuant to a Corporate Account Agreement dated
December 24, 1996 and received customary fees and expenses of approximately $20
during 1998 (1997 - $52) for such services.
19. CONTINGENCIES
(a) There currently are pending several arbitration proceedings in England
between reinsurers and their ceding insurers relating to reinsurance
transactions involving the personal accident excess of loss market ("LMX") for
the years 1993, 1994, 1995 and 1996. Although, with one exception, neither the
Company nor its subsidiaries are a party to any of these arbitrations, certain
of the Company's subsidiaries acted as a reinsurance broker for ceding companies
that are parties to certain of the arbitrations. The exception entails a
subsidiary that is directly involved in an arbitration because it assumed the
position of one of the reinsureds by way of portfolio transfer.
The reinsurers have alleged that they sustained losses due to a spiral in
the LMX market which was not disclosed to them by the ceding insurers or their
reinsurance brokers. As a consequence, these reinsurers have asserted that they
are no longer obliged to honor their reinsurance agreements and have ceased
paying claims. If one or more reinsurers prevail in the pending arbitration, it
is possible that one or more ceding insurers that are reinsurance brokerage
clients of the Company's subsidiaries or for whom a subsidiary performs the role
of underwriting manager, may assert a claim against a subsidiary and in the case
of the one exception the subsidiary would be unable to recover under certain
contracts of reinsurance.
During 1998 certain of the reinsurers and reinsureds filed a total of 7
writs in the English courts (which are the equivalent of a complaint in U.S.
jurisdictions) against the Company or certain of subsidiaries to toll the
statute of limitations. Some of these writs were issued pending the outcome of
related arbitrations. None of these writs specified an amount of damages sought.
In most cases, the Company or the relevent subsidiaries have negotiated
standstill agreements with the reinsurer or reinsured to toll the statute of
limitations.
45
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The primary factual allegation by the reinsurers is that, although they
believed they reinsured the subject risks only at high excess levels, the LMX
spiral caused their high excess positions to not equate with their expectation
of remoteness from the incidence of risk. As to the Company or its subsidiaries,
the reinsurers and reinsureds have alleged in their writs that the Company or
its subsidiary was negligent, misrepresented, or failed to disclose the
potential effect of the spiral on the reinsurers' exposure to risk.
The Company does not yet have sufficient information to determine whether
any claims ultimately will be prosecuted against the Company or its subsidiaries
or whether any such claims ultimately will result in payment of any liability or
settlement by the Company or its subsidiaries.
The Company understands that the parties to the arbitration and court
proceedings and other participants in these markets currently are attempting to
achieve a business solution that could involve a financial contribution by
participants in the market. Although no assurances can be given as to the
outcome of the pending proceedings and their effect on the Company, the Company
believes, based on the information presently available to it, that any such
effect should not materially adversely affect the Company's financial condition.
(b) The Company is subject to other litigation and arbitration in the
ordinary course of its business. While any of these proceedings contains an
element of uncertainty, management presently believes the outcome of these
currently pending proceedings will not have a material adverse effect on the
Company.
20. QUARTERLY FINANCIAL DATA--UNAUDITED
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
------- ------- ------- -------
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
YEAR ENDED DECEMBER 31, 1997 (i)
---
<S> <C> <C> <C> <C>
Total revenues............................... $14,345 $16,645 $17,019 $17,301
Net income................................... 2,820 3,172 3,590 3,411
Net income per share......................... 0.35 0.40 0.42 0.38
Net income per share assuming dilution....... $ 0.34 $ 0.39 $ 0.42 $ 0.38
YEAR ENDED DECEMBER 31, 1998 (ii)
----
Total revenues (iii)......................... $19,989 $22,245 $20,925 $21,934
Net income................................... 3,987 4,025 4,129 3,877
Net income per share......................... 0.41 0.41 0.42 0.40
Net income per share assuming dilution....... $ 0.40 $ 0.41 $ 0.42 $ 0.40
</TABLE>
(i) Total revenues and net income includes $478 net gain on the sale of
subsidiaries during the fourth quarter of 1997.
(ii) As discussed in Note 8, the Company recorded a provision of $2,500
against paid and outstanding losses recoverable from reinsurers during the
fourth quarter of 1998.
(iii) Quarterly revenues have been reclassified to conform to the year end
presentation.
46
<PAGE>
ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in, nor any disagreements with, accountants on
accounting and financial disclosure within the three years ending December 31,
1998.
PART III
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Certain of the information required by this item is included in Part 1 of
this Form 10-K.
The remainder of this item is omitted because the information will be
contained in a definitive proxy statement, which involves the election of
directors, to be filed with the Securities and Exchange Commission not later
than 120 days after December 31, 1998. Such information is hereby incorporated
by reference.
ITEM 11--EXECUTIVE COMPENSATION
This item is omitted because the information will be contained in a
definitive proxy statement, which involves the election of directors, to be
filed with the Securities and Exchange Commission not later than 120 days after
December 31, 1998. Such information is hereby incorporated by reference.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This item is omitted because the information will be contained in a
definitive proxy statement, which involves the election of directors, to be
filed with the Securities and Exchange Commission not later than 120 days after
December 31, 1998. Such information is hereby incorporated by reference.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This item is omitted because the information will be contained in a
definitive proxy statement, which involves the election of directors, to be
filed with the Securities and Exchange Commission not later than 120 days after
December 31, 1998. Such information is hereby incorporated by reference.
47
<PAGE>
PART IV
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) EXHIBITS
<TABLE>
<CAPTION>
Exhibit No. Description
- -------------- --------------------------------------------------------------
<S> <C>
3.l Memorandum of Association of the Company (1)
3.2 Bye-Laws of the Company (1)
4.1 Shareholders' Agreement, dated as of January 24, 1996, among
the Management Shareholders (as defined therein), Bridge
Street Fund 1995, L.P., Goldman Sachs & Co. Verwaltungs GmbH
(for GS Capital Partners II German Civil Law Partnership), GS
Capital Partners II, L.P., GS Capital Partners Offshore, L.P.,
Stone Street Fund 1995, L.P. and the Company (1)
4.2 Registration Rights Agreement, dated January 24, 1996, between
the Company, the Management Shareholders (as defined therein)
and the Investors (as defined therein) (1)
10.1 Stirling Cooke Brown Holdings Limited 1997 Equity Incentive
Plan (1)*
10.2 Employment Agreement dated September 1, 1997 between Realm
Investments Ltd. and Nicholas Mark Cooke (1)*
10.3 Employment Agreement dated September 1, 1997 between Stirling
Cooke Brown Holdings Limited and Nicholas Brown (1)*
10.4 Employment Agreement dated September 1, 1997 between Stirling
Cooke Brown Holdings Limited and George W. Jones (l)*
10.5 Agency Agreement dated as of June 1, 1995 between Clarendon
National Insurance Company and Stirling Cooke Insurance
Services, Inc. (1)
10.6 Amendment Number One to Agency Agreement dated as of June 1,
1995 between Clarendon National Insurance Company and Stirling
Cooke Insurance Services, Inc. (1)
10.7 Amendment Number Two to Agency Agreement dated as of June 1,
1995 between Clarendon National Insurance Company and Stirling
Cooke Insurance Services, Inc. (1)
10.8 Addendum dated April 1, 1997 to Agency Agreement dated as of
June 1, 1995 between Clarendon National Insurance Company and
Stirling Cooke Insurance Services, Inc. (1)
10.9 Agency Agreement dated as of October 1, 1995 between Clarendon
National Insurance Company and Stirling Cooke Texas, Inc. (1)
10.10 Management Agreement dated as of August 1, 1995 between Legion
Insurance Company and Stirling Cooke Insurance Services, Inc.
(1)
11. Statement Re Computation of Per Share Earnings
21. Subsidiaries of the Company (1)
99. Forward-Looking Information
</TABLE>
(1) Incorporated by reference from Registration Statement on Form S-1 (No. 333-
32995) of Stirling Cooke Brown Holdings Limited.
*Management Compensation
48
<PAGE>
(B) REPORTS ON FORM 8-K.
The Company filed a Form 8-K on October 7, 1998 to report a press
release announcing that the Company had authorized a subsidiary of the
Company to repurchase up to 250,000 of the Company's Ordinary Shares.
The Company filed a Form 8-K on November 9, 1998 to report a press
release announcing the Company's results for the 3rd quarter ended
September 30, 1998.
(C) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
1. Financial Statements
Included in Part II--Item 8 of this report.
2. Index to Financial Statement Schedules
Included in Part IV of this report:
<TABLE>
<CAPTION>
SCHEDULE
--------
NUMBER PAGE
------ -----
<S> <C> <C>
Report of Independent Accountants on financial statement schedules included
in Form 10-K. 50
Schedule of Investments excluding Investments in Related Parties as of
December 31, 1998 I 51
Condensed Financial Information of Registrant as of and for the years ended
December 31, 1996, 1997 and 1998 II 52-54
Supplementary Insurance Information as of and for the years ended December
31, 1996, 1997 and 1998 III 55
Reinsurance for the years ended December 31, 1996, 1997 and 1998 IV 56
Valuation and Qualifying Accounts for the years ended December 31, 1996, 1997
and 1998 V 57
Supplemental Information concerning Property-Casualty Insurance Operations for
the years ended December 31, 1996, 1997 and 1998 VI 58
</TABLE>
49
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders of
Stirling Cooke Brown Holdings Limited
Under date of March 5, 1999, we reported on the consolidated balance sheets
of Stirling Cooke Brown Holdings Limited and subsidiaries as of December 31,
1997 and 1998, and the related consolidated statements of income and
comprehensive income, retained earnings, and cash flows for each of the years in
the three-year period ended December 31, 1998, which are included in item 8 of
this Annual Report on Form 10-K for the year ended December 31, 1998. In
connection with our audits of the aforementioned consolidated financial
statements, we also audited the related financial statement schedules listed in
the accompanying index. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statement schedules based on our audits.
In our opinion, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
/s/ KPMG Peat Marwick
KPMG Peat Marwick
Hamilton, Bermuda
March 5, 1999
50
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
SCHEDULE OF INVESTMENTS EXCLUDING INVESTMENTS IN RELATED PARTIES
SCHEDULE I
<TABLE>
<CAPTION>
AMOUNT AT WHICH
-----------------
SHOWN IN THE
-----------------
FAIR BALANCE SHEET
--------- -----------------
COST VALUE DECEMBER 31, 1998
--------- --------- -----------------
<S> <C> <C> <C>
Fixed maturities
Bonds:
United States Government and government agencies and
authorities................................................. $ 5,694 $ 5,846 $ 5,846
States, municipalities and political subdivisions............. 29 30 30
Foreign governments........................................... 6,897 6,987 6,987
All other corporate bonds..................................... 4,102 4,194 4,194
------- ------- -------
Total fixed maturities..................................... 16,722 17,057 17,057
Equity securities
Common stocks:
Industrial, miscellaneous and all other....................... 2,056 2,168 2,168
Nonredeemable preferred stocks.................................. 328 368 368
------- ------- -------
Total equity securities.................................... 2,384 2,536 2,536
Short-term investments.......................................... 9,643 9,643 9,643
------- ------- -------
Total investments.......................................... $28,749 $29,236 $29,236
</TABLE>
51
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY BALANCE SHEETS--SCHEDULE II
DECEMBER 31, 1997 AND 1998
(Expressed in thousands of United States Dollars, except share and per share
data)
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Assets
Cash and cash equivalents............................................................ $27,803 $28,007
Due from subsidiaries................................................................ 11,238 15,569
Investments in subsidiaries.......................................................... 44,908 49,786
Other assets......................................................................... 295 427
Marketable securities................................................................ -- 4,092
------- -------
Total Assets...................................................................... $84,244 $97,881
Liabilities
Accounts payable and accrued liabilities............................................. $ 1,141 $ 249
------- -------
Total Liabilities................................................................. 1,141 249
------- -------
Shareholders' equity
Share capital
Authorized 20,000,000 ordinary shares of par value $0.25 each issued and fully
paid 9,863,372 ordinary shares.................................................... 2,466 2,466
Additional paid in capital........................................................... 54,167 54,167
Accumulated other comprehensive income............................................... 63 319
Retained earnings.................................................................... 27,074 41,914
------- -------
83,770 98,866
Less: ordinary shares in treasury (1997--40,000, 1998--87,000) at cost............... (667) (1,234)
------- -------
Total shareholders' equity........................................................ 83,103 97,632
------- -------
Total Liabilities and Shareholders' equity............................................. $84,244 $97,881
======= =======
</TABLE>
52
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY STATEMENTS OF INCOME AND COMPREHENSIVE INCOME--SCHEDULE II
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARE AND PER SHARE
DATA)
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
REVENUES
Net investment income..................................... $ 489 $ 139 $ 1,920
Other income.............................................. 465 -- --
------- ------- -------
Total Revenues.............................................. 954 139 1,920
EXPENSES
Salaries and benefits..................................... -- 395 184
Other operating expenses.................................. 432 683 1,015
------- ------- -------
Total Expenses.............................................. 432 1,078 1,199
NET INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES... 522 (939) 721
Equity in income of subsidiaries............................ 9,396 13,932 15,297
------- ------- -------
NET INCOME.................................................. $ 9,918 $12,993 $16,018
------- ------- -------
Other comprehensive income (loss), net of tax:
Unrealized holding gains arising during
the year (net of tax of $75, $130 and $130) 147 188 314
Less: reclassification adjustments for realized gains
included in net income (net of tax of $0, $166 and $1) -- (272) (58)
------- ------- -------
Other comprehensive income (loss), net of tax 147 (84) 256
Comprehensive income $10,065 $12,909 $16,274
======= ======= =======
</TABLE>
53
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY STATEMENTS OF CASH FLOWS--SCHEDULE II
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(Expressed in thousands of United States Dollars, except share and per share
data)
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.............................................................. $ 9,918 $ 12,993 $ 16,018
Items not effecting cash
Amortization of goodwill................................................ 373 373 373
Amortization of marketable securities................................... 0 0 (8)
Depreciation and amortization of capital assets......................... 0 0 2
Equity in income of subsidiaries........................................ (9,396) (13,932) (15,297)
Gain on sale of marketable securities................................... 0 0 (55)
Changes in non cash operating assets and liabilities
Other assets.......................................................... 0 (258) (134)
Accounts payable and accrued liabilities.............................. 16 1,125 (892)
Due to subsidiaries................................................... 193 (193) 0
-------- -------- --------
Net cash provided by operating activities............................ 1,104 108 7
-------- -------- --------
INVESTING ACTIVITIES
Purchase of capital assets.............................................. 0 (37) 0
Investments in subsidiaries............................................. (8,965) (274) 960
Due from subsidiaries................................................... (5,638) (5,600) (4,331)
Dividends received from subsidiaries.................................... 0 6,850 9,250
Purchase of debt securities............................................. 0 0 (3,992)
Purchase of equity securities........................................... 0 0 (503)
Proceeds on sale of equity securities................................... 0 0 558
-------- -------- --------
Cash (used) provided by investing activities......................... (14,603) 939 1,942
-------- -------- --------
FINANCING ACTIVITIES
Dividends............................................................... 0 0 (1,178)
Net proceeds of subscription to share capital subject to redemption..... 14,457 0 0
Net proceeds from subscription to share capital......................... 0 26,832 0
Proceeds from exercise of options....................................... 0 1,625 0
Purchase of ordinary shares in treasury................................. (938) (1,807) (567)
Sales of ordinary shares in treasury.................................... 0 86 0
-------- -------- --------
Cash provided (used) by financing activities......................... 13,519 26,736 (1,745)
-------- -------- --------
INCREASE IN CASH AND CASH EQUIVALENTS..................................... 20 27,783 204
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR............................ 0 20 27,803
-------- -------- --------
CASH AND CASH EQUIVALENTS FROM END OF YEAR................................ $ 20 $ 27,803 $ 28,007
======== ======== ========
</TABLE>
All dividends received were from consolidated subsidiaries.
54
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
SUPPLEMENTARY INSURANCE INFORMATION--SCHEDULE III
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
FUTURE
------
POLICY
------
BENEFITS, OTHER BENEFITS, AMORTIZATION
-------- ----- --------- ------------
DEFERRED LOSSES, POLICY CLAIMS, OF DEFERRED
-------- ------- ------ ------- -----------
POLICY CLAIMS CLAIMS NET LOSSES AND POLICY OTHER
------ ------ ------ --- ---------- ------ -----
ACQUISITION AND LOSS UNEARNED AND PREMIUM INVESTMENT SETTLEMENT ACQUISITION OPERATING PREMIUMS
----------- -------- -------- --- ------- ---------- ---------- ----------- --------- --------
COSTS EXPENSES PREMIUMS BENEFITS REVENUE INCOME EXPENSES COSTS EXPENSES WRITTEN
----- -------- -------- -------- ------- ------ -------- ----- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Insurance.................. $ 77 $14,371 $ 7,003 $0 $ 838 $ 370 $ 630 $ 237 $ 508 $ 799
Reinsurance................ 94 9,930 5,512 0 7,916 271 6,135 1,600 251 8,131
Brokerage.................. 0 0 0 0 0 1,773 0 0 13,239 0
Program Business........... 0 0 0 0 0 255 0 0 8,821 0
Underwriting Management.... 0 0 0 0 0 232 0 0 1,486 0
Other...................... 0 0 0 0 0 504 0 0 1,955 0
------ ------- ------- -- ------- ------ ------- ------ ------- -------
$ 171 $24,301 $12,515 $0 $ 8,754 $3,405 $ 6,765 $1,837 $26,260 $ 8,930
Year ended December 31, 1997
Insurance.................. $ 343 $14,969 $13,338 $0 $ 2,921 $1,696 $ 2,426 $ 840 $ 1,662 $ 3,988
Reinsurance................ 236 21,307 5,849 0 8,869 517 8,525 504 296 9,193
Brokerage.................. 0 0 0 0 0 2,531 0 0 14,794 0
Program Business........... 0 0 0 0 0 740 0 0 15,832 0
Underwriting Management.... 0 0 0 0 0 152 0 0 1,684 0
Other...................... 0 0 0 0 0 146 0 0 2,829 0
------ ------- ------- -- ------- ------ ------- ------ ------- -------
$ 579 $36,276 $19,187 $0 $11,790 $5,782 $10,951 $1,344 $37,097 $13,181
Year ended December 31, 1998
Insurance.................. $1,848 $30,788 $22,477 $0 $ 7,716 $1,261 $ 4,790 $2,052 $ 3,062 $ 9,676
Reinsurance................ 438 35,329 2,560 0 10,058 847 12,481 1,566 215 7,740
Brokerage.................. 0 0 0 0 0 3,336 0 0 15,643 0
Program Business........... 0 0 0 0 0 777 0 0 21,932 0
Underwriting Management.... 0 0 0 0 0 197 0 0 1,865 0
Other...................... 0 0 0 0 0 2,353 0 0 1,679 0
------ ------- ------- -- ------- ------ ------- ------ ------- -------
$2,286 $66,117 $25,037 $0 $17,774 $8,771 $17,271 $3,618 $44,396 $17,416
</TABLE>
55
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
REINSURANCE--SCHEDULE IV
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
------- --------- --------- ------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996..... $ 4,493 $ 6,784 $11,045 $ 8,754 126%
Year ended December 31, 1997..... $15,408 $17,396 $13,778 $11,790 117%
Year ended December 31, 1998..... $39,526 $36,807 $15,055 $17,774 85%
</TABLE>
56
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
VALUATION AND QUALIFYING ACCOUNTS--SCHEDULE V
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
CHARGED TO
----------
BALANCE AT CHARGED TO OTHER
---------- ---------- -----
BEGINNING COSTS AND ACCOUNTS- DEDUCTIONS- BALANCE AT
--------- --------- --------- ----------- ----------
OF PERIOD EXPENSES DESCRIBE DESCRIBE END OF PERIOD
--------- -------- -------- -------- -------------
DESCRIPTION
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Allowance for Doubtful Accounts $ -- $ -- $ -- $ -- $ --
Year ended December 31, 1997
Allowance for Doubtful Accounts $ -- $ -- $ -- $ -- $ --
Year ended December 31, 1998
Allowance for Doubtful Accounts $ -- $ $2,500 $ -- $ -- $ 2,500
</TABLE>
57
<PAGE>
STIRLING COOKE BROWN HOLDINGS LIMITED
SUPPLEMENTARY INSURANCE INFORMATION
CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS--SCHEDULE VI
(EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)
<TABLE>
<CAPTION>
RESERVE FOR LOSSES AND LOSS AMORTIZATION
----------- ADJUSTMENT EXPENSES ------------
LOSSES AND INCURRED RELATED TO OF DEFERRED PAID LOSSES
---------- ----------- -----------
DEFERRED LOSS DISCOUNT, NET (1) POLICY AND LOSS
-------- ---- --------- --- --- ------ --------
ACQUISITION ADJUSTMENT IF ANY, UNEARNED EARNED INVESTMENT CURRENT (2) ACQUISITION ADJUSTMENT PREMIUMS
----------- ---------- ------- -------- ------ ---------- ------- --- ----------- ---------- --------
COSTS EXPENSES DEDUCTED PREMIUMS PREMIUMS INCOME YEAR PRIOR YEAR COSTS EXPENSES WRITTEN
----- -------- -------- -------- -------- ------ ---- ---------- ----- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Year ended
December 31, 1996
Property/Casualty
entities............ $ 171 $24,301 $ -- $12,515 $ 8,754 $ 641 $ 6,515 $ 250 $1,837 $ 2,009 $ 8,930
Year ended
December 31, 1997
Property/Casualty
entities............ $ 579 $36,276 $ -- $19,187 $11,790 $2,213 $10,174 $ 777 $1,344 $ 5,460 $13,181
Year ended
December 31, 1998
Property/Casualty
entities............ $2,286 $66,117 $ -- $25,037 $17,774 $2,108 $12,578 $4,693 $3,618 $12,504 $17,416
</TABLE>
58
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED IN HAMILTON, BERMUDA,
ON THE 26TH DAY OF MARCH, 1999.
STIRLING COOKE BROWN HOLDINGS LIMITED
/s/ George W. Jones
By
George W. Jones
Chief Financial Officer and Director
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW AS OF THIS 26TH DAY OF MARCH, 1999, BY THE
FOLLOWING PERSONS IN THE CAPACITIES INDICATED:
<TABLE>
<CAPTION>
Signature Title
- -------------------------------- ------------------------------------------------
<S> <C>
/s/ NICHOLAS MARK COOKE Chairman, President, Chief Executive Officer and
Director (Principal Executive Officer)
Nicholas Mark Cooke
/s/ GEORGE W. JONES Chief Financial Officer and Director (Principal
Financial and Accounting Officer)
George W. Jones
/s/ NICHOLAS BROWN Director
Nicholas Brown
/s/ REUBEN JEFFERY III Director
Reuben Jeffery III
</TABLE>
59
<PAGE>
EXHIBIT 11
STIRLING COOKE BROWN HOLDINGS LIMITED
STATEMENT OF COMPUTATION OF NET INCOME PER ORDINARY SHARE
(Expressed in thousands of United States dollars, except share and per share
data)
<TABLE>
<CAPTION>
AS OF OR FOR THE YEAR ENDED
DECEMBER 31,
------------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Net income............................................. $ 9,918 $ 12,993 $ 16,018
========== ========== ==========
BASIC
Number of shares:
Weighted average number of Ordinary Shares out-
standing.............................................. 7,879,121 8,382,434 9,863,372
Weighted average treasury shares held.................. (67,227) (143,396) (49,271)
Shares issued in June 1997............................. 288,888 144,444 --
---------- ---------- ----------
8,100,782 8,383,482 9,814,101
========== ========== ==========
Net income per share................................... $ 1.22 $ 1.55 1.63
========== ========== ==========
DILUTED
Number of shares:
Weighted average number of Ordinary Shares out-
standing.............................................. 7,879,121 8,237,990 9,863,372
Weighted average treasury shares held.................. (67,227) (143,396) (49,271)
Shares issued in June 1997............................. 288,888 288,888
Incremental shares from assumed exercise of options.... 205,828 131,991 26,058
---------- ---------- ----------
8,306,610 8,515,473 9,840,159
========== ========== ==========
Net income per share assuming dilution................. $ 1.19 $ 1.53 1.63
========== ========== ==========
</TABLE>
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EXHIBIT 99--FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. The Company's Form l0-K for the year
ended December 31, 1998, the Company's 1998 Annual Report to Shareholders, any
Form 10-Q or Form 8-K of the Company, or any other oral or written statements
made by or on behalf of the Company, may include forward-looking statements
which reflect the Company's current views with respect to future events and
financial performance. These forward-looking statements are identified by their
use of such terms and phrases as "intends," "intend," "intended," "goal,"
"estimate," "estimates," "expects," "expect," "expected," "project," "projects,"
"projected," "projections," "plans," "anticipates," "anticipated," "should,"
"designed to," "foreseeable future," "believe," "believes," and "scheduled" and
similar expressions. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date the statement was
made. The Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
The actual results of the Company may differ significantly from the results
discussed in forward-looking statements. Factors that might cause such a
difference include but are not limited to, (a) the general political, economic
and competitive conditions in the United States, Bermuda and the United Kingdom,
and other markets where the Company operates; (b) changes in capital
availability or costs, such as changes in interest rates; (c) market perceptions
of the industry in which the Company operates, or security or insurance ratings;
(d) government regulation; (e) authoritative generally accepted accounting
principles or policy changes from such standard-setting bodies as the Financial
Accounting Standards Board and the Securities and Exchange Commission, (f)
possible disruptions from the Year 2000 problem, and the factors set forth
below.
COMPETITION; CYCLICALITY OF INSURANCE AND REINSURANCE BUSINESSES
The business of providing risk management services and products to the
workers' compensation and property and casualty insurance markets is highly
competitive. The Company competes with other providers of alternative market
services (including domestic and foreign insurance companies, reinsurers,
insurance brokers, captive insurance companies, rent-a-captives, self-insurance
plans, risk retention groups, state funds, assigned risk pools and other risk-
financing mechanisms) and with providers of traditional insurance coverage. Many
of the Company's competitors have significantly greater financial resources,
longer operating histories, and better financial or insurance ratings and offer
a broader line of insurance products than the Company.
Factors affecting the traditional insurance and reinsurance industry
influence the environment for alternative risk management services and products.
Insurance market conditions historically have been subject to cyclicality and
volatility due to premium rate competition, judicial trends, changes in the
investment and interest rate environment, regulation and general economic
conditions, causing many insurance buyers to search for more stable
alternatives. The traditional insurance and reinsurance industry is in a
protracted period of significant price competition, due in part to excess
capacity in most lines of business. While some form of workers' compensation
insurance is a statutory requirement in most states, the choices exercised by
employers in response to the underwriting cycle in traditional insurance and
reinsurance markets have had and will continue to have a material effect on the
Company's results of operations. Although most of the Company's revenues are
derived from fees and commissions rather than underwriting activities, a
substantial portion of the Company's fees are calculated as a percentage of
premium volume, and therefore the Company's fee revenues are directly and
adversely affected by highly competitive market conditions. Additionally,
changes in risk retention patterns by purchasers of insurance and reinsurance
products could have an adverse effect upon the Company.
DEPENDENCE ON RELATIONSHIPS WITH INDEPENDENT PRIMARY INSURANCE CARRIERS
The Company's Managing General Agencies market insurance products and
programs developed by the Company on behalf of insurers and reinsurers. The
primary insurers are Clarendon National Insurance Company and its affiliates
("Clarendon") and Legion Insurance Company and its affiliates ("Legion"). In
addition, the Company's insurance brokering and reinsurance brokering
operations, Managing General Underwriters, and claims
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and loss control servicing operations provide additional business and services
to Clarendon and Legion in respect of these products and other insurance and
reinsurance policies. In 1998, fees received from Clarendon accounted for
approximately 43% (1997 -- 51%) of the Company's total revenues, while fees
received from Legion accounted for less than 10% (1997 -- same) of the Company's
total revenues. Historically, the Company has had a good relationship with both
Clarendon and Legion. There can be no assurance, however, that Clarendon or
Legion will not institute changes which affect their relationships with the
Company. The loss of business from Clarendon or Legion could have a material
adverse effect on the Company's results of operations and financial conditions.
Additionally, any decline in or disruption of Clarendon's or Legion's business
could disrupt the Company's business and could have a material adverse effect on
the Company's results of operations and financial condition.
REINSURANCE CONSIDERATIONS; AVAILABILITY AND COSTS; CREDIT RISKS
The Company relies upon the use of reinsurance agreements in its various
programs to limit and manage the amount of risk retained by the Company or its
customers, including insurance companies. The availability and cost of
reinsurance may vary over time and is subject to prevailing market conditions. A
lack of available reinsurance coverage could limit the Company's ability to
continue certain of its insurance programs. In respect of the Company's own
insurance operations, the lack of available reinsurance or increases in the cost
of reinsurance could also increase the amount of risk retained by the Company.
In addition, while the Company seeks to obtain reinsurance with coverage limits
intended to be appropriate for the risk exposures assumed, there can be no
assurance that losses experienced by the Company will be within the coverage
limits of the Company's reinsurance agreements.
The Company is also subject to credit risk as a result of its reinsurance
arrangements, as the Company is not relieved of its liability to policyholders
by ceding risk to its reinsurers. The Company is selective in regard to its
reinsurers, placing reinsurance with only those reinsurers that it believes have
strong balance sheets. The Company monitors the financial strength of its
reinsurers on an ongoing basis. The insolvency, inability, or unwillingness of
any of the reinsurers used by the Company to meet its obligations could have a
material adverse effect on the results of operations and financial position of
the Company. No assurance can be given regarding the future ability of any of
the Company's reinsurers to meet their obligations. The establishment of
provisions against reinsurance balances receivable is an inherently uncertain
process and there can be no assurance that the ultimate provision will not
materially increase or decrease. Although the Company has no reason to believe
that its provision against reinsurance balances receivable are inadequate, it is
possible that the Company will need to revise the provision significantly in the
near term. In the event of such an increase or decrease, the amount would be
reflected in the Company's income statement in the period in which the provision
was adjusted.
DEPENDENCE ON KEY PERSONNEL
The Company's success depends to a substantial extent on the ability and
experience of its executive officers. The loss of the services of one or more
such persons could have a material adverse effect on the business of the Company
and its future operations.
POSSIBLE REVISIONS TO LOSS RESERVES
To the extent its activities involve any retention of risk of loss, the
Company maintains loss reserves to cover its estimated ultimate liability for
losses and loss adjustment expenses with respect to reported and unreported
claims incurred. Reserves are estimates involving actuarial and statistical
projections at a given time of what the Company expects to be the cost of the
ultimate settlement and administration of claims based on facts and
circumstances then known, estimates of future trends in claims severity and
other variable factors such as inflation. To the extent that reserves prove to
be inadequate in the future, the Company would have to increase such reserves
and incur a charge to earnings in the period such reserves are increased, which
could have a material adverse effect on the Company's results of operations and
financial condition. The establishment of appropriate reserves is an
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inherently uncertain process and there can be no assurance that ultimate losses
will not materially exceed the Company's loss reserves. The Company has limited
historical claim loss experience to serve as a reliable basis for the estimation
of ultimate claim losses. Although the Company has no reason to believe that its
loss reserves are inadequate, it is possible that the Company will need to
revise the estimate of claim losses significantly in the near term. In the event
of such an increase, the amount, net of associated reinsurance recoveries, would
be reflected in the Company's income statement in the period in which the
reserves were increased.
ADVERSE EFFECT OF LEGISLATION AND REGULATORY ACTIONS
The Company conducts business in a number of states and foreign countries.
Certain of the Company's subsidiaries are subject to comprehensive regulation
and supervision by government agencies in the states and foreign jurisdictions
in which they do business. The primary purpose of such regulation and
supervision is to provide safeguards for policyholders rather than to protect
the interests of shareholders. The laws of the various state jurisdictions
establish supervisory agendas with broad administrative powers with respect to,
among other things, licensing to transact business, licensing of agents,
admittance of assets, regulating premium rates, approving policy forms,
regulating unfair trade and claims practices, establishing reserve requirements
and solvency standards, requiring participation in guarantee funds and shared
market mechanisms, and restricting payment of dividends. Also, in response to
perceived excessive cost or inadequacy of available insurance, states have from
time-to-time created state insurance funds and assigned risk pools which compete
directly, on a subsidized basis, with private providers such as the Company. Any
such event, in a state in which the Company has substantial operations, could
substantially affect the profitability of the Company's operations in such
state, or cause the Company to change its marketing focus.
State insurance regulators and the National Association of Insurance
Commissioners continually re-examine existing laws and regulations. It is
impossible to predict the future impact of potential state, federal and foreign
country regulations on the Company's operations, and there can be no assurance
that future insurance-related laws and regulations, or the interpretation
thereof, will not have an adverse effect on the operations of the Company's
business.
POSSIBLE ADVERSE IMPACT OF LICENSING PROCESS ON REALM NATIONAL
The Company is in the process of seeking the regulatory approvals necessary
to expand Realm National Insurance Company Limited's ("Realm National") business
to include workers' compensation and other specialty casualty insurance lines in
each of the states in which Realm National is currently licensed to offer other
insurance products, and intends to license Realm National in substantially all
of the remaining 50 states and the District of Columbia. The Company expects
that as Realm National receives such approvals and licenses, the revenues to be
generated by Realm National and its integration into the Company's existing
businesses will become an important component of the Company's future earnings
growth. However, no assurance can be given that Realm National will receive such
approvals and licenses, or when such approvals and licenses will be granted if
Realm National does receive them. A state may require as part of its licensing
process that the insurer or its management have a certain period of experience
(typically one to three years) in the lines of business for which a license is
being sought. Although the Company's management has been involved in offering
workers' compensation products and services for many years, Realm National's own
experience in this line of business began for all material purposes after Realm
National's acquisition by the Company in September 1996. Therefore, some states
may determine that Realm National does not have the requisite experience to meet
this requirement. In the absence of such experience, the insurance regulatory
authority may delay issuing a license until such time as the experience is
obtained. The failure to receive, or a delay in receiving, one or more of such
approvals and licenses could have a material adverse impact on Realm National's
ability to generate future earnings growth for the Company.
TAXATION OF THE COMPANY AND CERTAIN OF ITS SUBSIDIARIES
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The Company and certain of its subsidiaries are incorporated outside the
United States and, as foreign corporations, do not file United States tax
returns. These entities believe that they operate in such a manner that they
will not be subject to U.S. tax (other than U.S. excise tax on reinsurance
premiums and withholding tax on certain investment income from U.S. sources)
because they do not engage in business in the United States. There can be no
assurance, however, that these entities will not become subject to U.S. tax
because U.S. law does not provide definitive guidance as to the circumstances in
which they would be considered to be doing business in the United States. If
such entities are deemed to be engaged in business in the United States (and, if
the Company were to qualify for benefits under the income tax treaty between the
United States and Bermuda or the United States and the United Kingdom, such
business would be attributable to a "permanent" establishment in the United
States), the Company would be subject to U.S. tax at regular corporate rates on
its income that is effectively connected with its U.S. business plus an
additional 30% "branch profits" tax on income remaining after the regular tax.
INTEREST RATE FLUCTUATIONS
The Company maintains most of its cash in the form of short-term, fixed-
income securities, the value of which is subject to fluctuation depending on
changes in prevailing interest rates. The Company generally does not hedge its
cash investments against interest rate risk. Accordingly, changes in interest
rates may result in fluctuations in the income derived from the Company's cash
investments.
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